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PSB > SEC Filings for PSB > Form 10-Q on 2-May-2014All Recent SEC Filings

Show all filings for PS BUSINESS PARKS INC/CA



Quarterly Report


Forward-Looking Statements: Forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, are made throughout this Quarterly Report on Form 10-Q. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words "may," "believes," "anticipates," "plans," "expects," "seeks," "estimates," "intends," and similar expressions are intended to identify forward-looking statements. There are a number of important factors that could cause the results of the Company to differ materially from those indicated by such forward-looking statements, including but not limited to: (a) changes in general economic and business conditions; (b) decreases in rental rates or increases in vacancy rates/failure to renew or replace expiring leases; (c) tenant defaults; (d) the effect of the recent credit and financial market conditions; (e) our failure to maintain our status as a real estate investment trust ("REIT"); (f) the economic health of our tenants; (g) increases in operating costs; (h) casualties to our properties not covered by insurance; (i) the availability and cost of capital;
(j) increases in interest rates and its effect on our stock price; (k) other factors discussed under the heading "Part I, Item 1A. Risk Factors" in our annual report on Form 10-K for the year ended December 31, 2013. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved. Moreover, we assume no obligation to update these forward-looking statements to reflect actual results, changes in assumptions or changes in other factors affecting such forward-looking statements, except as required by law.


As of March 31, 2014, the Company owned and operated 29.7 million rentable square feet of multi-tenant flex, industrial and office properties located in eight states.

The Company focuses on increasing profitability and cash flow aimed at maximizing shareholder value. The Company strives to maintain high occupancy levels while increasing rental rates when market conditions allow, although the Company may decrease rental rates in markets where conditions require. The Company also acquires properties it believes will create long-term value, and from time to time disposes of properties which no longer fit within the Company's strategic objectives. Operating results are driven primarily by income from rental operations and are therefore substantially influenced by rental demand for space within our properties and our markets, which impacts occupancy and rental rates.

During the first three months of 2014, the Company executed leases comprising 2.3 million square feet of space including 1.5 million square feet of renewals of existing leases and 788,000 square feet of new leases. Overall, the rate of decline in rental rates for the Company continued to slow. The Company experienced a decrease in rental rates when comparing new rental rates to outgoing rental rates of 0.7% for the three months ended March 31, 2014 compared to a decrease of 3.4% for the three months ended March 31, 2013. See further discussion of operating results below.

Critical Accounting Policies and Estimates:

Our accounting policies are described in Note 2 to the consolidated financial statements included in this Form 10-Q. We believe our most critical accounting policies relate to revenue recognition, property acquisitions, allowance for doubtful accounts, impairment of long-lived assets, depreciation, accruals of operating expenses and accruals for contingencies, each of which we discuss below.

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Revenue Recognition: The Company must meet four basic criteria before revenue can be recognized: persuasive evidence of an arrangement exists; the delivery has occurred or services have been rendered; the fee is fixed or determinable; and collectability is reasonably assured. All leases are classified as operating leases. Rental income is recognized on a straight-line basis over the terms of the leases. Straight-line rent is recognized for all tenants with contractual fixed increases in rent that are not included on the Company's credit watch list. Deferred rent receivable represents rental revenue recognized on a straight-line basis in excess of billed rents. Reimbursements from tenants for real estate taxes and other recoverable operating expenses are recognized as rental income in the period the applicable costs are incurred. Property management fees are recognized in the period earned.

Property Acquisitions: The Company records the purchase price of acquired properties to land, buildings and improvements and intangible assets and liabilities associated with in-place leases (including tenant improvements, unamortized lease commissions, value of above-market and below-market leases, acquired in-place lease values, and tenant relationships, if any) based on their respective estimated fair values. Acquisition related costs are expensed as incurred.

In determining the fair value of the tangible assets of the acquired properties, management considers the value of the properties as if vacant as of the acquisition date. Management must make significant assumptions in determining the value of assets acquired and liabilities assumed. Using different assumptions in the recording of the purchase cost of the acquired properties would affect the timing of recognition of the related revenue and expenses. Amounts recorded to land are derived from comparable sales of land within the same region. Amounts recorded to buildings and improvements, tenant improvements and unamortized lease commissions are based on current market replacement costs and other market rate information.

The value recorded to the above-market or below-market in-place lease values of acquired properties is determined based upon the present value (using a discount rate which reflects the risks associated with the acquired leases) of the difference between (i) the contractual rents to be paid pursuant to the in-place leases, and (ii) management's estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining non-cancelable term of the lease. The amounts recorded to above-market or below-market leases are included in other assets or other liabilities in the accompanying consolidated balance sheets and are amortized on a straight-line basis as an increase or reduction of rental income over the remaining non-cancelable term of the respective leases.

Allowance for Doubtful Accounts: Rental revenue from our tenants is our principal source of revenue. Tenant receivables consist primarily of amounts due for contractual lease payments, reimbursements of common area maintenance expenses, property taxes and other expenses recoverable from tenants. Deferred rent receivable represents the amount that the cumulative straight-line rental income recorded to date exceeds cash rents billed to date under the lease agreement. We monitor the collectability of our receivable balances including the deferred rent receivable on an ongoing basis. Based on these reviews, we maintain an allowance for doubtful accounts for estimated losses resulting from the possible inability of our tenants to make required rent payments to us. Tenant receivables and deferred rent receivable are carried net of the allowances for uncollectible tenant receivables and deferred rent. Determination of the adequacy of these allowances requires significant judgments and estimates, and our evaluation of the adequacy of the allowance for uncollectible current tenant receivables and deferred rent receivable are performed using a methodology that incorporates specific identification, aging analysis, an overall evaluation of the historical loss trends and the current economic and business environment.

Impairment of Long-Lived Assets: The Company evaluates a property for potential impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. On a quarterly basis, we evaluate our entire portfolio for impairment based on current operating information. In the event that these periodic assessments reflect that the carrying amount of a property exceeds the sum of the undiscounted cash flows (excluding interest) that are expected to result from the use and eventual disposition of the property, the Company would recognize an impairment loss to the extent the carrying amount exceeded the estimated fair value of the property. The estimation of expected future net cash flows is inherently uncertain and relies on subjective assumptions dependent upon future and current market conditions and events that affect the ultimate value of the property. Management must make assumptions related to the property such as future rental rates, tenant allowances, operating expenditures, property taxes, capital improvements, occupancy levels and the estimated proceeds generated from the future sale of the property. These assumptions could differ materially from actual results in future periods. Our intent to hold properties over the long-term directly decreases the likelihood of recording an impairment loss. If our strategy changes or if market conditions otherwise dictate an earlier sale date, an impairment loss could be recognized, and such loss could be material.

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Depreciation: We compute depreciation on our buildings and improvements using the straight-line method based on estimated useful lives generally ranging from five to 30 years. A significant portion of the acquisition cost of each property is recorded to building and building components. The recording of the acquisition cost to building and building components, as well as the determination of their useful lives, are based on estimates. If we do not appropriately record to these components or we incorrectly estimate the useful lives of these components, our computation of depreciation expense may not appropriately reflect the actual impact of these costs over future periods, which will affect net income. In addition, the net book value of real estate assets could be overstated or understated. The statement of cash flows, however, would not be affected.

Accruals of Operating Expenses: The Company accrues for property tax expenses, performance bonuses and other operating expenses each quarter based on historical trends and anticipated disbursements. If these estimates are incorrect, the timing and amount of expense recognized will be affected.

Accruals for Contingencies: The Company is exposed to business and legal liability risks with respect to events that may have occurred, but in accordance with U.S. generally accepted accounting principles ("GAAP") has not accrued for such potential liabilities because the loss is either not probable or not estimable. Future events could result in such potential losses becoming probable and estimable, which could have a material adverse impact on our financial condition or results of operations.

Effect of Economic Conditions on the Company's Operations: During the first three months of 2014, while most markets reflected signs of improving occupancy and rental rates, overall new rental rates for the Company experienced a modest decline over expiring rental rates on executed leases as economic conditions continue to improve at a slow pace. Current and future economic conditions and competition may continue to have a significant impact on the Company, potentially resulting in further reductions in occupancy and rental rates.

The Company historically has experienced a low level of write-offs of uncollectable rents, but there is inherent uncertainty in a tenant's ability to continue paying rent and meet its full lease obligation. The table below summarizes the impact to the Company from tenants' inability to pay rent or continue to meet their lease obligations (in thousands):

                                                                For The Three Months
                                                                   Ended March 31,
                                                              2014                2013
Write-offs of uncollectible rent                            $     161           $     228
Write-offs as a percentage of rental income                       0.2 %               0.3 %
Square footage of leases terminated prior to their
scheduled expiration due to business
failures/bankruptcies                                              87                  84
Accelerated depreciation and amortization related to
unamortized tenant improvements and lease commissions
associated with early terminations                          $     191           $     637

As of April 28, 2014, the Company had 20,000 square feet of leased space occupied by tenants that are protected by Chapter 11 of the U.S. Bankruptcy Code. From time to time, tenants contact us, requesting early termination of their lease, a reduction in space under lease, or rent deferment or abatement. At this time, the Company cannot anticipate what impact, if any, the ultimate outcome of these discussions will have on our future operating results.

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Company Performance and Effect of Economic Conditions on Primary Markets: The Company's operations are substantially concentrated in 10 regions. During the three months ended March 31, 2014, initial rental rates on new and renewed leases within the Company's total portfolio decreased 0.7% over expiring rents, reflecting a continued improvement in the rate of decline in new rental rates. The Company's Same Park (defined below) occupancy rate at March 31, 2014 was 92.2%, compared to 91.0% at March 31, 2013. The Company's total portfolio occupancy rate at March 31, 2014 was 90.7%, compared to 89.6% at March 31, 2013. Each of the 10 regions in which the Company owns assets is subject to its own unique market influences. See "Supplemental Property Data and Trends" below for more information on regional operating data.

Effect of Acquisitions and Dispositions of Properties on the Company's Operations: The Company is focused on growing its operations by looking for opportunities to expand its presence in existing and new markets through strategic acquisitions that meet the Company's focus on multi-tenant flex, industrial and office parks in markets where it has or may obtain a substantial market presence. The Company may from time to time dispose of non-strategic assets that do not meet is long-term strategic objectives.

The Company recently announced its decision to pursue the sale of its portfolio in the Portland market and to further assess its presence in the Phoenix and Sacramento markets. The assets owned in these markets comprise an aggregate 2.4 million square feet and generated 7.3% of the Company's net operating income (see page 23 for definition) in 2013. The ultimate timing and probability of any sale is uncertain at this time.

On December 20, 2013, the Company acquired Bayshore Commons, an eight-building, 340,000 square foot, office park in San Mateo, California, for $60.5 million. On November 8, 2013, the Company acquired nine multi-tenant flex buildings in the Valwood submarket of Dallas, Texas, aggregating 245,000 square feet for $12.4 million. On October 15, 2013, the Company acquired four multi-tenant flex parks along with a four-acre parcel of land aggregating 559,000 square feet of single-story flex buildings located in Dallas, Texas, for a purchase price of $27.9 million. On July 26, 2013, the Company acquired a 389,000 square foot multi-tenant flex park consisting of 18 single-story buildings located in Dallas, Texas, for a purchase price of $14.8 million.

As of March 31, 2014, the blended occupancy rate of the six assets acquired from 2012 to 2013 was 76.4% compared to a blended occupancy rate of 67.7% at the time of acquisition. As of March 31, 2014, the Company had 641,000 square feet of vacancy spread over these six acquisitions which we believe provides the Company with considerable opportunity to generate additional rental income given that the Company's Same Park assets in these same submarkets have a weighted occupancy of 93.0% at March 31, 2014. The table below contains the assets acquired from 2012 to 2013 (in thousands):

                                                                                                 Square        Occupancy at          Occupancy at
Property                      Date Acquired            Location             Purchase Price        Feet         Acquisition          March 31, 2014
Bayshore Commons              December, 2013    San Mateo, California      $         60,500          340                81.8 %                 78.3 %
Valwood Business Park         November, 2013    Dallas, Texas                        12,425          245                83.5 %                 86.9 %
Dallas Flex Portfolio         October, 2013     Dallas, Texas                        27,900          559                72.1 %                 68.7 %
Arapaho Business Park         July, 2013        Dallas, Texas                        14,800          389                66.5 %                 69.0 %
Austin Flex Buildings         December, 2012    Austin, Texas                        14,900          226                86.1 %                100.0 %
212th Business Park           July, 2012        Kent Valley, Washington              37,550          958                52.3 %                 74.9 %

Total                                                                      $        168,075        2,717                67.7 %                 76.4 %

At the beginning of 2013, the Company reclassified a 125,000 square foot building located in Northern Virginia to land and building held for development as the Company intends to redevelop the property. In conjunction with the reclassification, the Company ceased depreciation of the asset. In July, 2013, the Company entered into a joint venture agreement with a real estate development company to pursue a multifamily development of this property. During the entitlement phase, all costs related to the pre-development will be split evenly between the Company and its joint venture partner. The Company will contribute the property to the joint venture upon completion of the entitlement phase. The asset and capitalized development costs were $16.8 million and $16.2 million at March 31, 2014 and December 31, 2013, respectively. For the three months ended March 31, 2014, the Company capitalized costs of $628,000 related to this development, of which $224,000 related to capitalized interest costs.

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Scheduled Lease Expirations: In addition to the 2.8 million square feet, or 9.3%, of space available in our total portfolio as of March 31, 2014, 1,645 leases representing 19.5% of the leased square footage of our total portfolio or 18.3% of annualized rental income are scheduled to expire during the remainder of 2014. Our ability to re-lease available space will depend upon market conditions in the specific submarkets in which our properties are located. As a result, we cannot predict with certainty the rate at which expiring leases will be re-leased.

Impact of Inflation: Although inflation has not been significant in recent years, it remains a potential factor in our economy, and the Company continues to seek ways to mitigate its potential impact. A substantial portion of the Company's leases require tenants to pay operating expenses, including real estate taxes, utilities, and insurance, as well as increases in common area expenses, partially reducing the Company's exposure to inflation.

In order to provide a meaningful period-to-period comparison, the tables below exclude amortization of the Long-Term Equity Incentive Plan ("LTEIP") in cost of operations (for field leadership) and general and administrative expenses (for executive management).

Rental income, cost of operations and rental income less cost of operations, excluding depreciation and amortization, or net operating income (defined as "NOI" for purposes of the following tables), are summarized for the three months ended March 31, 2014 and 2013. NOI is a non-GAAP financial measure. The Company uses NOI and its components as a measurement of the performance of its commercial real estate. Management believes that these financial measures provide them, as well as the investor, the most consistent measurement on a comparative basis of the performance of the commercial real estate and its contribution to the value of the Company. Depreciation and amortization have been excluded from NOI as they are generally not used in determining the value of commercial real estate by management or the investment community. Depreciation and amortization are generally not used in determining value as they consider the historical costs of an asset compared to its current value; therefore, to understand the effect of the assets' historical cost on the Company's results, investors should look at GAAP financial measures, such as total operating costs including depreciation and amortization. The Company's calculation of NOI may not be comparable to those of other companies and should not be used as an alternative to measures of performance calculated in accordance with GAAP. As part of the tables below, we have reconciled total NOI to income from continuing operations, which we consider the most directly comparable financial measure calculated in accordance with GAAP.

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Concentration of Portfolio by Region: The table below reflects the Company's square footage from continuing operations based on regional concentration as of March 31, 2014 (in thousands):

                                                                           Percent of                NOI
                                                              Square         Square          For The Three Months       Percent
Region                                                       Footage        Footage          Ended March 31, 2014        of NOI
Northern California                                             7,493             25.2 %    $               13,404          21.6 %
Southern California                                             3,988             13.4 %                     9,400          15.1 %
Northern Texas                                                  2,961              9.9 %                     4,174           6.7 %
Southern Texas                                                  1,717              5.8 %                     3,098           5.0 %
Virginia                                                        4,040             13.6 %                    13,254          21.3 %
Florida                                                         3,717             12.5 %                     5,874           9.4 %
Maryland                                                        2,352              7.9 %                     7,313          11.8 %
Washington                                                      1,479              5.0 %                     2,190           3.5 %
Oregon                                                          1,314              4.4 %                     2,631           4.2 %
Arizona                                                           679              2.3 %                       868           1.4 %

Total                                                          29,740            100.0 %    $               62,206         100.0 %

Reconciliation of NOI to income from continuing operations
Total NOI                                                                                   $               62,206
Other income and (expenses):
LTEIP amortization:
Cost of operations                                                                                            (329 )
General and administrative                                                                                    (529 )
Facility management fees                                                                                       166
Interest and other income                                                                                       62
Interest and other expenses                                                                                 (3,376 )
Depreciation and amortization                                                                              (28,441 )
General and administrative                                                                                  (1,958 )

Income from continuing operations                                                           $               27,801

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Concentration of Credit Risk by Industry: The information below depicts the industry concentration of our tenant base as of March 31, 2014. The Company analyzes this concentration to minimize significant industry exposure risk.

                                                               Percent of
     Industry                                                 Rental Income
     Business services                                                  16.7 %
     Government                                                         10.6 %
     Health services                                                    10.2 %
     Computer hardware, software and related services                    9.9 %
     Warehouse, distribution, transportation and logistics               9.3 %
     Retail, food, and automotive                                        6.2 %
     Engineering and construction                                        6.0 %
     Insurance and financial services                                    5.3 %
     Communications                                                      4.1 %
     Home furnishings                                                    3.0 %
     Electronics                                                         3.0 %
     Aerospace/defense products and services                             2.8 %
     Educational services                                                1.6 %
     Other                                                              11.3 %

     Total                                                             100.0 %

The information below depicts the Company's top 10 customers by annualized rental income as of March 31, 2014 (in thousands):

                                                                                              Percent of
                                                                   Annualized                 Annualized
Tenants                                Square Footage           Rental Income (1)           Rental Income
US Government                                      874         $            22,405                      5.9 %
Kaiser Permanente                                  199                       4,339                      1.1 %
Lockheed Martin Corporation                        171                       4,020                      1.1 %
. . .
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