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

Show all filings for PARKWAY PROPERTIES INC

Form 10-K for PARKWAY PROPERTIES INC


3-Mar-2014

Annual Report


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

Overview

We are a fully integrated, self-administered and self-managed real estate investment trust ("REIT") specializing in the acquisition, ownership and management of quality office properties in high-growth submarkets in the Sunbelt region of the United States. At January 1, 2014, we owned or had an interest in a portfolio of 50 office properties located in eight states with an aggregate of approximately 17.6 million square feet of leasable space. We offer fee-based real estate services through our wholly owned subsidiaries, which in total managed and/or leased approximately 12.2 million square feet for third-party property owners at January 1, 2014. Unless otherwise indicated, all references to square feet represent net rentable area.

Business Objective and Operating Strategies

Our business objective is to maximize long-term stockholder value by generating sustainable cash flow growth and increasing the long-term value of our real estate assets through operations, acquisitions and capital recycling, while maintaining a conservative and flexible balance sheet. We intend to achieve this objective by executing on the following business and growth strategies:
Create Value as the Leading Owner of Quality Assets in Core Submarkets. Our investment strategy is to pursue attractive returns by focusing primarily on owning high-quality office buildings and portfolios that are well-located and competitively positioned within central business district and urban infill locations within our core submarkets in the Sunbelt region of the United States. In these submarkets, we seek to maintain a portfolio that consists of core, core-plus, and value-add investment opportunities. Further, we intend to pursue an efficient capital allocation strategy that maximizes the returns on our invested capital. This may include selectively disposing of properties when we believe returns have been maximized and redeploying capital into acquisitions or other opportunities.

Maximize Cash Flow by Continuing to Enhance the Operating Performance of Each Property. We provide property management and leasing services to our portfolio, actively managing our properties and leveraging our customer relationships to improve operating performance, maximize long-term cash flow and enhance stockholder value. We seek to attain a favorable customer retention rate by providing outstanding property management and customer service programs responsive to the varying needs of our diverse customer base. We also employ a judicious prioritization of capital projects to focus on projects that enhance the value of our property through increased rental rates, occupancy, service delivery, or enhanced reversion value.

Realize Leasing and Operational Efficiencies and Gain Local Advantage. We concentrate our real estate portfolio in submarkets where we believe that we can maximize market penetration by accumulating a critical mass of properties and thereby enhance operating efficiencies. We believe that strengthening our local presence and leveraging our extensive market relationships will yield superior market information and service delivery and facilitate additional investment opportunities to create long-term stockholder value.

Occupancy. Our revenues are dependent on the occupancy of our office buildings.
At January 1, 2014, occupancy of our office portfolio was 88.9% compared to 89.2% at October 1, 2013 and 88.0% at January 1, 2013. Not included in the January 1, 2014 occupancy rate is the impact of signed leases totaling 225,000 square feet expected to take occupancy between now and the first quarter of 2015, of which the majority will commence during the first two quarters of 2014.
Including these signed leases, our portfolio was 90.2% leased at January 1, 2014. Our average occupancy for the three months and year ended December 31, 2013 was 89.0% and 88.8%, respectively.

During the fourth quarter of 2013, 23 leases were renewed totaling 394,000 rentable square feet at an average annual rental rate per square foot of $23.10, representing a 6.6% rate increase as compared to expiring rental rates, and at an average cost of $1.99 per square foot per year of the lease term. During the year ended December 31, 2013, 131 leases were renewed totaling 1.5 million rentable square feet at an average annual rental rate per square foot of $26.03, representing a 2.8% increase as compared to expiring rental rates, and at an average cost of $3.22 per square foot per year of the lease term.

During the fourth quarter of 2013, 12 expansion leases were signed totaling 57,000 rentable square feet at an average annual rental rate per square foot of $19.53 and at an average cost of $4.50 per square foot per year of the lease term. During the year ended December 31, 2013, 64 expansion leases were signed totaling 446,000 rentable square feet at an average annual rental rate per square foot of $24.61 and at an average cost of $5.15 per square foot per year of the lease term.


During the fourth quarter of 2013, 18 new leases were signed totaling 121,000 rentable square feet at an average annual rental rate per square foot of $26.31 and at an average cost of $4.91 per square foot per year of the term. During the year ended December 31, 2013, 71 new leases were signed totaling 431,000 rentable square feet at an average annual rental rate per square foot of $25.40 and at an average cost of $6.08 per square foot per year of the lease term.

Rental Rates. An increase in vacancy rates in a market or at a specific property has the effect of reducing market rental rates. Inversely, a decrease in vacancy rates in a market or at a specific property has the effect of increasing market rental rates. Our leases typically have three to seven year terms, though we do enter into leases with terms that are either shorter or longer than that typical range from time to time. As leases expire, we seek to replace existing leases with new leases at the current market rental rate. For our properties owned as of January 1, 2014, management estimates that we have approximately $2.30 per square foot in annual rental rate embedded growth in our office property leases. Embedded growth is defined as the difference between the weighted average in-place cash rents including operating expense reimbursements and the weighted average estimated market rental rate.

Customer Retention. Keeping existing customers is important as high customer retention leads to increased occupancy, less downtime between leases, and reduced leasing costs. We estimate that it costs five to six times more to replace an existing customer with a new one than to retain the existing customer. In making this estimate, we take into account the sum of revenue lost during downtime on the space plus leasing costs, which typically rise as market vacancies increase. Therefore, we focus a great amount of energy on customer retention. We seek to retain our customers by continually focusing on operations at our office properties. We believe in providing superior customer service; hiring, training, retaining and empowering each employee; and creating an environment of open communication both internally and externally with customers and stockholders. Over the past ten years, we maintained an average 67% customer retention rate. Our customer retention rate was 76.7% for the quarter ended December 31, 2013, as compared to 59.4% for the quarter ended September 30, 2013, and 68.9% for the quarter ended December 31, 2012. Customer retention for the years ended December 31, 2013 and 2012 was 73.3% and 64.2%, respectively.

Recent Significant Activity

On December 19, 2013, we completed the merger transactions contemplated by the Merger Agreement pursuant to which TPGI merged with and into Parkway Properties, Inc., with Parkway Properties, Inc. continuing as the surviving corporation in the Parent Merger, and TPG LP merged with and into Merger Sub, with TPG LP continuing as the surviving entity and an indirect wholly owned subsidiary of Parkway LP in the Partnership Merger. Pursuant to the terms and subject to the conditions set forth in the Merger Agreement, at the effective time of the Parent Merger, each outstanding share of TPGI Common Stock was converted into the right to receive 0.3822 (the "Exchange Ratio") shares of our common stock, with cash paid in lieu of fractional shares, and each share of TPGI Limited Voting Stock was converted into the right to receive a number of shares of newly created limited voting stock, equal to the Exchange Ratio. At the effective time of the Partnership Merger, which occurred immediately prior to the Parent Merger, each outstanding TPG LP Unit, including long term incentive units, was converted into the right to receive a number of Parkway LP Units equal to the Exchange Ratio. We issued 17,820,972 shares of our common stock and 4,451,461 shares of our limited voting stock as consideration in the Parent Merger and Parkway LP issued 4,451,461 Parkway LP Units in the Partnership Merger. On December 19, 2013, the last reported sales price per share of our common stock on the New York Stock Exchange was $18.05.

In connection with the Mergers, we acquired TPGI's ownership interest in two wholly owned office properties in Houston, Texas and five office properties in Austin, Texas through an indirect interest in the Austin joint venture, a joint venture with CalSTRS. See "Note 4 - Investments in Unconsolidated Joint Ventures" and mortgage notes payable discussed in "Note 8 - Capital and Financing Transactions" of our consolidated financial statements. In addition, in connection with the Mergers, we acquired a parcel of land in Houston, Texas and a 73% interest in a 302-unit residential condominium tower in Philadelphia, Pennsylvania.

Joint Ventures and Partnerships

Management views investing in wholly owned properties as the highest priority of our capital allocation. However, we may selectively pursue joint ventures if we determine that such a structure will allow us to reduce anticipated risks related to a property or portfolio, limit concentration of rental revenue from a particular market or building or address unusual operational risks. To the extent we enter into joint ventures and partnerships, we will seek to manage all phases of the investment cycle including acquisition, financing, operations, leasing and dispositions, and we will seek to receive fees for providing these services.


Parkway Properties Office Fund II, L.P.

At December 31, 2013, we had one partnership structured as a discretionary fund.
Fund II, a $750.0 million discretionary fund, was formed on May 14, 2008 and was fully invested at February 10, 2012. Fund II was structured with TRST as a 70% investor and our operating partnership as a 30% investor, with an original target capital structure of approximately $375.0 million of equity capital and $375.0 million of non-recourse, fixed-rate first mortgage debt. Fund II currently owns seven properties totaling 2.5 million square feet in Atlanta, Georgia; Phoenix, Arizona; Jacksonville, Florida; and Philadelphia, Pennsylvania. In August 2012, Fund II increased its investment capacity by $20.0 million to purchase Hayden Ferry Lakeside III, IV and V, a 2,500 space parking garage, a 21,000 square foot office property and a vacant parcel of land available for development, all adjacent to our Hayden Ferry Lakeside I and Hayden Ferry Lakeside II office properties in Phoenix. In August 2013, Fund II expanded its investment guidelines solely for the purpose of authorizing the purchase of a parcel of land available for development in Tempe, Arizona.

We serve as the general partner of Fund II and provide asset management, property management, leasing and construction management services to the fund, for which we are paid market-based fees. Cash is distributed by Fund II pro rata to each partner until a 9% annual cumulative preferred return is received and invested capital is returned. Thereafter, 56% will be distributed to TRST and 44% to us. The term of Fund II is seven years from the date the fund was fully invested, or until February 2019, with provisions to extend the term for two additional one-year periods at our discretion.

On March 25, 2013, we purchased TRST's 70% interest in three office properties totaling 788,000 square feet located in the Westshore submarket of Tampa, Florida (the "Tampa Fund II Assets"), giving us 100% ownership of the property. The purchase price for TRST's 70% interest in the Tampa Fund II Assets was $97.5 million based on an agreed-upon gross valuation of $139.3 million. Simultaneously with closing, we assumed $40.7 million of existing mortgage indebtedness that is secured by the Tampa Fund II assets, which represents TRST's 70% share of the approximately $58.1 million of existing mortgage indebtedness. The three office properties include Corporate Center IV at International Plaza, Cypress Center I, II, III and Cypress Center garage, and The Pointe.

On December 23, 2013, we acquired TRST's 70% interest in the Bank of America Center, an approximately 421,000 square foot office building located in the central business district of Orlando, Florida, giving us 100% ownership of the property. Our purchase price for TRST's 70% interest in the Bank of America Center was $52.5 million, based on an agreed-upon gross valuation of $75.0 million, including the assumption of approximately $23.7 million of existing mortgage indebtedness. The existing mortgage loan secured by the Bank of America Center has a current outstanding balance of approximately $33.9 million, a fixed interest rate of 4.74% and a maturity date of May 2018.

Joint Ventures

In addition to the 43 office properties included in our consolidated financial
statements, we were also invested in three unconsolidated joint ventures with
unrelated investors as of December 31, 2013. These investments are accounted for
using the equity method of accounting. Accordingly, the assets and liabilities
of the joint ventures are not included on our consolidated balance sheet at
December 31, 2013. Information relating to these unconsolidated joint ventures
is detailed below:

                               Property                     Parkway's                            Percentage
  Joint Venture Entity           Name         Location      Ownership%       Square Feet          Occupied
                                                                            (in thousands)
PKY/CalSTRS Austin, LLC        Various       Austin, TX       33.33%   (1)          2,422           85.5 %
US Airways Building           US Airways
Tenancy in Common              Building      Phoenix, AZ      74.58%                  225          100.0 %
7000 Central Park JV LLC     7000 Central
("7000 Central Park")            Park        Atlanta, GA      40.00%                  414           74.8 %
                                                                                    3,061           85.1 %

(1) As of February 10, 2014, we owned a 40% interest in the Austin joint venture and the Austin properties.

On June 3, 2013, we purchased an approximate 75% interest in the US Airways Building, a 225,000 square foot office property located in the Tempe submarket of Phoenix, Arizona, for a purchase price of $41.8 million. At closing, a subsidiary of ours issued a $3.5 million mortgage loan to an affiliate of US Airways, which is secured by the building. The mortgage loan carries a fixed interest rate of 3.0% and matures in December 2016. This nine-story Class A office building is adjacent to our Hayden Ferry Lakeside and Tempe Gateway assets and shares a parking garage with Tempe Gateway. US Airways is the owner of the remaining approximate 25% interest in the building and has leased 100% of the building through April 2024. US Airways


has a termination option on December 31, 2016 or December 31, 2021 with 12 months prior notice. The balance of the investment in the joint venture entity was $42.5 million as of December 31, 2013.

On September 11, 2013, we, through a joint venture, acquired a 40% common equity interest in a mortgage note in the original principal amount of $65 million secured by 7000 Central Park, a 415,000 square foot office property located in the Central Perimeter submarket of Atlanta, Georgia. The total purchase price for the note, which was previously under special servicer oversight, was $56.6 million plus an additional $318,000 in transaction costs. Our share of such amount was approximately $45.0 million, comprised of an investment of approximately $37.0 million for a preferred equity interest in the joint venture that acquired the note and an investment of approximately $8.0 million for a 40% common equity interest. The joint venture foreclosed on the property on November 5, 2013. On December 13, 2013, we and our joint venture partner placed secured financing on the asset in the amount of $30.0 million, the net proceeds of which were used to repay a portion of our initial preferred equity investment, reducing our preferred equity interest to approximately $7.6 million. The balance of our investment in the joint venture was $15.5 million as of December 31, 2013.

On December 19, 2013, we acquired TPGI's interest in the Austin joint venture as part of the Mergers. As of December 31, 2013, we and Madison owned a 50% interest in the joint venture with CalSTRS. The Austin joint venture owns the following properties: San Jacinto Center; Frost Bank Tower; One Congress Plaza; One American Center; and 300 West 6th Street. On January 24, 2014, pursuant to a put right held by Madison, we purchased Madison's approximately 17% interest in the Austin joint venture for a purchase price of approximately $41.5 million. On February 10, 2014, pursuant to an agreement entered into with CalSTRS, CalSTRS exercised an option to purchase 60% of Madison's former interest on the same terms that we acquired the interest from Madison for approximately $24.9 million. After giving effect to these transactions, we have a 40% interest in the Austin joint venture and the Austin properties, with CalSTRS owning the remaining 60%. The balance of the investment in the joint venture entity was $93.2 million as of December 31, 2013.

Financial Condition

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

Assets. In 2013, we continued the execution of our strategy of operating and acquiring office properties as well as disposing of non-core assets that no longer meet our investment criteria or for which a disposition would maximize value. During the year ended December 31, 2013, total assets increased $1.0 billion or 53.4% as compared to the year ended December 31, 2012. The primary reason for the increase relates to the Mergers, which closed on December 19, 2013, and the purchase of three additional wholly owned office properties, two parcels of land available for development, and investments in three unconsolidated joint ventures, partially offset by the disposition of six office properties during 2013. In addition, in connection with the Mergers, we also acquired a parcel of land in Houston, Texas and a 73% interest in a 302-unit residential condominium tower in Philadelphia, Pennsylvania.

Acquisitions and Improvements. Our investment in office properties increased $754.1 million net of depreciation to a carrying amount of $2.3 billion at December 31, 2013 and consisted of 43 office properties. The primary reason for the increase in office properties relates to the Mergers, which closed on December 19, 2013, and the purchase of three additional wholly owned office properties and two parcels of land available for development, partially offset by the sale of six office properties during 2013.


During the year ended December 31, 2013, we acquired TPGI's ownership interest in two wholly owned office properties in Houston, Texas and five office properties in Austin, Texas through an indirect interest in the Austin joint venture, and purchased three additional wholly owned office properties, TRST's interest in four office properties, two parcels of land available for development, and invested in three unconsolidated joint ventures as follows (in thousands):

                                                                                                               Gross
                                              Type of         Ownership        Square          Date          Purchase
Office Property          Location            Ownership          Share           Feet        Purchased          Price
Tower Place 200      Atlanta, GA           Wholly owned         100.00 %         258        01/17/2013      $  56,250
Deerwood
Portfolio (1)        Jacksonville, FL      Wholly owned         100.00 %       1,019        03/07/2013        130,000
Tampa Fund II
Assets (2)           Tampa, FL             Wholly owned         100.00 %         788        03/25/2013        139,300
US Airways           Tempe, AZ             Joint venture         74.58 %         225        06/03/2013         41,750
7000 Central
Park (3)             Atlanta, GA           Joint venture         40.00 %         415        09/11/2013         56,600
Lincoln Place        Miami, FL             Wholly owned         100.00 %         140        12/06/2013         65,382
Bank of America
Center (4)           Orlando, FL           Wholly owned         100.00 %         417        12/23/2013         75,000


Cypress Center
IV (5)               Tampa, FL             Wholly owned         100.00 %           -        08/01/2013          2,900
Tempe Town Lake
(5)                  Tempe, AZ                Fund II            30.00 %           -        08/27/2013          1,200

CityWestPlace
(6)                  Houston, TX           Wholly owned         100.00 %       1,473        12/19/2013            N/A
San Felipe
Plaza (6)            Houston, TX           Wholly owned         100.00 %         980        12/19/2013            N/A
300 West 6th
(7)                  Austin, TX            Joint venture         33.33 %         454        12/19/2013            N/A
One American
Center (7)           Austin, TX            Joint venture         33.33 %         504        12/19/2013            N/A
Frost Bank
Tower (7)            Austin, TX            Joint venture         33.33 %         535        12/19/2013            N/A
One Congress
Plaza (7)            Austin, TX            Joint venture         33.33 %         519        12/19/2013            N/A
San Jacinto
Center (7)           Austin, TX            Joint venture         33.33 %         410        12/19/2013            N/A
                                                                               8,137                        $ 568,382

(1) We purchased two office complexes (collectively, the "Deerwood Portfolio") totaling 1.0 million square feet located in the Deerwood submarket of Jacksonville, Florida.

(2) We purchased TRST's interest in Corporate Center IV at International Plaza, Cypress Center I, II, III and Cypress Center garage, and The Pointe for $97.5 million, which represents TRST's 70% interest in these office properties.

(3) We and our joint venture partner purchased the mortgage loan secured by 7000 Central Park. The joint venture foreclosed on the property on November 5, 2013. On December 13, 2013, we and our joint venture partner placed secured financing on the asset in the amount of $30.0 million, the net proceeds of which were used to repay a portion of our initial preferred equity investment, reducing the preferred equity interest to approximately $7.6 million.

(4) We purchased TRST's interest in the Bank of America Center for $28.1 million plus the assumption of debt of approximately $23.7 million, representing TRST's 70% share.

(5) We purchased approximately six acres of land available for development in Tampa, Florida and approximately one acre of land available for development in Tempe, Arizona. The land purchased in Tampa, Florida is adjacent to our Cypress Center I, II, and III assets and the land purchased in Tempe, Arizona is adjacent to our Hayden Ferry Lakeside and Tempe Gateway assets.

(6) In connection with the Mergers, we acquired TPGI's ownership interest in two wholly owned office properties in Houston, Texas.

(7) In connection with the Mergers, we acquired TPGI's ownership interest in five office properties in Austin, Texas through an indirect interest in the Austin joint venture. After giving effect to the transactions subsequent to December 31, 2013, as described in "Note 18 - Subsequent Events", we have a 40% interest in the CalSTRS joint venture and the Austin properties, with CalSTRS owning the remaining 60%.

During the year ended December 31, 2013, we capitalized building improvements of $35.4 million and recorded depreciation expense of $72.3 million related to our office properties.


Dispositions. During the year ended December 31, 2013, we sold the following six office properties (in thousands):

   Office          Type of                                                                Gross Sales
  Property        Ownership        Location          Square Feet       Date of Sale          Price            Gain on Sale
Atrium at          Wholly
Stoneridge          Owned        Columbia, SC               108         03/20/2013       $     3,050        $          542
                   Wholly
Waterstone          Owned        Atlanta, GA                 93         07/10/2013             3,400                    40
                   Wholly
Meridian            Owned        Atlanta, GA                 97         07/10/2013             6,800                    55
Bank of            Wholly
America Plaza       Owned        Nashville, TN              436         07/17/2013            42,750                11,450
Lakewood II        Fund II       Atlanta, GA                123         10/31/2013            10,600                 5,837
Carmel
Crossing           Fund II       Charlotte, NC              326         11/08/2013            37,500                14,569
Total 2013                                                1,183                          $   104,100        $       32,493

For a discussion of dispositions subsequent to December 31, 2013, please reference "Item 7. Management's Discussion and Analysis - Results of Operations
- Discontinued Operations."

Condominium units. In connection with the Mergers with TPGI, we acquired and consolidated our Murano residential condominium project, which we control. Our unaffiliated partner's interest is reflected on our consolidated balance sheets under the "Noncontrolling Interests" caption. Our partner owns 27% of the condominium project. Net proceeds from the project will be distributed, to the extent available, based on an order of preferences described in the partnership agreement. We may receive distributions, if any, in excess of our 73% ownership interest if certain return thresholds are met. The carrying value of our condominium units was $19.9 million as of December 31, 2013.

Mortgage Loans. On June 3, 2013, we issued a first mortgage loan to an affiliate of US Airways, which is secured by the US Airways Building, a 225,000 square foot office building in Phoenix, Arizona. The $3.5 million mortgage loan has a fixed interest rate of 3.0% and matures on December 31, 2016.

Investment in unconsolidated joint ventures. In addition to the 43 office and parking properties included in our consolidated financial statements, we also invested in three unconsolidated joint ventures with unrelated investors as of December 31, 2013. These investments are accounted for using the equity method of accounting. Accordingly, the assets and liabilities of the joint ventures are . . .

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