Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

___________________________________________________

FORM 10-Q

___________________________________________________



x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For quarterly period ended September 30, 2018



o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

COMMISSION FILE NO. 1-6622

WASHINGTON REAL ESTATE

INVESTMENT TRUST

(Exact name of registrant as specified in its charter)



MARYLAND		53-0261100
(State of incorporation)		(IRS Employer Identification Number)

1775 EYE STREET, NW, SUITE 1000, WASHINGTON, DC 20006

(Address of principal executive office) (Zip code)

Registrant’s telephone number, including area code: (202) 774-3200

___________________________________________________

Securities registered pursuant to Section 12(b) of the Act:



Title of Each Class		Name of exchange on which registered
Shares of Beneficial Interest		New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

___________________________________________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. YES x NO o

Indicate by checkmark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). YES x NO o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer	x	Accelerated filer	o
Non-accelerated filer	o	Smaller reporting company	o
		Emerging growth company	o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). YES o NO x

As of October 25, 2018, 79,846,002 common shares were outstanding.

WASHINGTON REAL ESTATE INVESTMENT TRUST

INDEX



		Page
Part I: Financial Information

Item 1.	Consolidated Financial Statements (Unaudited)
	Consolidated Balance Sheets	5
	Condensed Consolidated Statements of Income	6
	Condensed Consolidated Statements of Comprehensive Income	7
	Consolidated Statement of Equity	8
	Consolidated Statements of Cash Flows	9
	Notes to Consolidated Financial Statements	11

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	37

Item 4.	Controls and Procedures	38

Part II: Other Information

Item 1.	Legal Proceedings	39

Item 1A.	Risk Factors	39

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	39

Item 3.	Defaults upon Senior Securities	39

Item 4.	Mine Safety Disclosures	39

Item 5.	Other Information	39

Item 6.	Exhibits	40

	Signatures	41

PART I

FINANCIAL INFORMATION

ITEM 1: FINANCIAL STATEMENTS

The information furnished in the accompanying unaudited Consolidated Balance Sheets, Condensed Consolidated Statements of Income, Condensed Consolidated Statements of Comprehensive Income, Consolidated Statement of Equity and Consolidated Statements of Cash Flows reflects all adjustments, consisting of normal recurring items, which are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods. The accompanying financial statements and notes thereto should be read in conjunction with the financial statements and notes for the three years ended December 31, 2017 included in Washington Real Estate Investment Trust’s 2017 Annual Report on Form 10-K.

WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS, EXCEPT PER SHARE DATA)



	September 30, 2018			December 31, 2017
	(Unaudited)			December 31, 2017
Assets
Land	$	614,659		$	588,025
Income producing property	2,239,917			2,113,977
	2,854,576			2,702,002
Accumulated depreciation and amortization	(745,829		)	(683,692		)
Net income producing property	2,108,747			2,018,310
Properties under development or held for future development	81,765			54,422
Total real estate held for investment, net	2,190,512			2,072,732
Investment in real estate held for sale, net	—			68,534
Cash and cash equivalents	4,810			9,847
Restricted cash	1,352			2,776
Rents and other receivables, net of allowance for doubtful accounts of $2,927 and $2,426, respectively	74,395			69,766
Prepaid expenses and other assets	145,448			125,087
Other assets related to properties held for sale	—			10,684
Total assets	$	2,416,517		$	2,359,426
Liabilities
Notes payable, net	$	995,130		$	894,358
Mortgage notes payable, net	60,541			95,141
Line of credit	183,000			166,000
Accounts payable and other liabilities	63,683			61,565
Dividend payable	—			23,581
Advance rents	10,597			12,487
Tenant security deposits	9,857			9,149
Other liabilities related to properties held for sale	—			1,809
Total liabilities	1,322,808			1,264,090
Equity
Shareholders’ equity
Preferred shares; $0.01 par value; 10,000 shares authorized; no shares issued or outstanding	—			—
Shares of beneficial interest, $0.01 par value; 100,000 shares authorized; 79,844 and 78,510 shares issued and outstanding, respectively	798			785
Additional paid in capital	1,526,125			1,483,980
Distributions in excess of net income	(450,749		)	(399,213		)
Accumulated other comprehensive income	17,181			9,419
Total shareholders’ equity	1,093,355			1,094,971
Noncontrolling interests in subsidiaries	354			365
Total equity	1,093,709			1,095,336
Total liabilities and equity	$	2,416,517		$	2,359,426

See accompanying notes to the consolidated financial statements.

WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)



	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Revenue
Real estate rental revenue	$	82,502		$	82,819		$	253,989		$	243,776
Expenses
Real estate expenses	28,571			29,646			87,975			86,200
Depreciation and amortization	30,272			27,941			90,119			83,271
General and administrative	5,267			5,327			16,737			16,712
Real estate impairment	—			5,000			1,886			5,000
	64,110			67,914			196,717			191,183
Other operating income
Gain on sale of real estate	—			—			2,495			—
Real estate operating income	18,392			14,905			59,767			52,593
Other (expense) income
Interest expense	(12,499		)	(12,176		)	(38,647		)	(35,634		)
Loss on extinguishment of debt	—			—			(1,178		)	—
Other income	—			84			—			209
Income tax benefit	—			—			—			107
	(12,499		)	(12,092		)	(39,825		)	(35,318		)
Net income	5,893			2,813			19,942			17,275
Less: Net loss attributable to noncontrolling interests in subsidiaries	—			20			—			56
Net income attributable to the controlling interests	$	5,893		$	2,833		$	19,942		$	17,331

Basic net income attributable to the controlling interests per common share	$	0.07		$	0.04		$	0.25		$	0.22

Diluted net income attributable to the controlling interests per common share	$	0.07		$	0.04		$	0.25		$	0.22
Weighted average shares outstanding – basic	79,076			77,291			78,695			76,292
Weighted average shares outstanding – diluted	79,238			77,423			78,802			76,415
Dividends declared per share	$	0.30		$	0.30		$	0.90		$	0.90

See accompanying notes to the consolidated financial statements.

WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(IN THOUSANDS)

(UNAUDITED)



	Three Months Ended September 30,					Nine Months Ended September 30,
	2018		2017			2018		2017
Net income	$	5,893	$	2,813		$	19,942	$	17,275
Other comprehensive income:
Unrealized gain (loss) on interest rate hedges	1,474		(9		)	7,762		(763		)
Comprehensive income	7,367		2,804			27,704		16,512
Less: Comprehensive loss attributable to noncontrolling interests	—		20			—		56
Comprehensive income attributable to the controlling interests	$	7,367	$	2,824		$	27,704	$	16,568

See accompanying notes to the consolidated financial statements.

WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF EQUITY

(IN THOUSANDS)

(UNAUDITED)



	Shares Issued and Out-standing	Shares of Beneficial Interest at Par Value		Additional Paid in Capital		Distributions in Excess of Net Income			Accumulated Other Comprehensive Income		Total Shareholders’ Equity			Noncontrolling Interests in Subsidiaries			Total Equity
Balance at December 31, 2017	78,510	$	785	$	1,483,980	$	(399,213	)	$	9,419	$	1,094,971		$	365		$	1,095,336
Net income attributable to the controlling interests	—	—		—		19,942			—		19,942			—			19,942
Unrealized gain on interest rate hedges	—	—		—		—			7,762		7,762			—			7,762
Distributions to noncontrolling interests	—	—		—		—			—		—			(11		)	(11		)
Dividends	—	—		—		(71,478		)	—		(71,478		)	—			(71,478		)
Equity issuances, net of issuance costs	1,165	11		35,461		—			—		35,472			—			35,472
Shares issued under dividend reinvestment program	74	1		1,810		—			—		1,811			—			1,811
Share grants, net of forfeitures and tax withholdings	95	1		4,874		—			—		4,875			—			4,875
Balance at September 30, 2018	79,844	$	798	$	1,526,125	$	(450,749	)	$	17,181	$	1,093,355		$	354		$	1,093,709

See accompanying notes to the consolidated financial statements.



WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

	Nine Months Ended September 30,
	2018			2017
Cash flows from operating activities
Net income	$	19,942		$	17,275
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	90,119			83,271
Provision for losses on accounts receivable	1,077			768
Real estate impairment	1,886			5,000
Gain on sale of real estate	(2,495		)	—
Share-based compensation expense	5,064			3,561
Deferred tax benefit	—			(107		)
Amortization of debt premiums, discounts and related financing costs	1,565			1,422
Loss on extinguishment of debt	1,178			—
Changes in operating other assets	(9,233		)	(21,603		)
Changes in operating other liabilities	(8,229		)	4,381
Net cash provided by operating activities	100,874			93,968
Cash flows from investing activities
Real estate acquisitions, net	(106,400		)	(138,371		)
Net cash received for sale of real estate	174,297			—
Capital improvements to real estate	(33,437		)	(35,186		)
Development in progress	(25,036		)	(12,988		)
Real estate deposits, net	—			775
Non-real estate capital improvements	(626		)	(3,306		)
Net cash provided by (used in) investing activities	8,798			(189,076		)
Cash flows from financing activities
Line of credit borrowings, net	17,000			69,000
Dividends paid	(95,059		)	(91,666		)
Principal payments – mortgage notes payable	(169,480		)	(51,815		)
Repayments of unsecured term loan debt	(150,000		)	—
Proceeds from term loan	250,000			50,000
Payment of financing costs	(5,565		)	(234		)
Distributions to noncontrolling interests	(11		)	(67		)
Proceeds from dividend reinvestment program	1,811			2,482
Net proceeds from equity issuances	35,472			113,225
Payment of tax withholdings for restricted share awards	(301		)	(671		)
Net cash (used in) provided by financing activities	(116,133		)	90,254
Net decrease in cash, cash equivalents and restricted cash	(6,461		)	(4,854		)
Cash, cash equivalents and restricted cash at beginning of period	12,623			17,622
Cash, cash equivalents and restricted cash at end of period	$	6,162		$	12,768



WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

	Nine Months Ended September 30,
	2018		2017
Supplemental disclosure of cash flow information:
Cash paid for interest, net of amounts capitalized	$	32,021	$	29,188
Change in accrued capital improvements and development costs	6,352		3,959
Operating partnership units issued with acquisition	—		376

Reconciliation of cash, cash equivalents and restricted cash:
Cash and cash equivalents	$	4,810	$	11,326
Restricted cash	1,352		1,442
Cash, cash equivalents and restricted cash	$	6,162	$	12,768

See accompanying notes to the consolidated financial statements.

WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2018

(UNAUDITED)

NOTE 1: NATURE OF BUSINESS

Washington Real Estate Investment Trust (“Washington REIT”), a Maryland real estate investment trust, is a self-administered equity real estate investment trust, successor to a trust organized in 1960. Our business consists of the ownership and operation of income producing real estate properties in the greater Washington metro region. We own a diversified portfolio of office buildings, multifamily buildings and retail centers.

Federal Income Taxes

We believe that we qualify as a real estate investment trust (“REIT”) under Sections 856-860 of the Internal Revenue Code of 1986, as amended (the "Code"), and intend to continue to qualify as such. We have considered the provisions of the Tax Cuts and Jobs Act (the "TCJA"), which was signed into law on December 22, 2017 and which generally takes effect for taxable years beginning on or after January 1, 2018, and do not expect the TCJA to have a material impact on our ability to continue to qualify as a REIT. To maintain our status as a REIT, we are, among other things, required to distribute 90% of our REIT taxable income (which is, generally, our ordinary taxable income, with certain modifications), excluding any net capital gains and any deductions for dividends paid to our shareholders on an annual basis. When selling a property, we generally have the option of (a) reinvesting the sales proceeds of property sold, in a way that allows us to defer recognition of some or all taxable gain realized on the sale, (b) distributing gains to the shareholders with no tax to us or (c) treating net long-term capital gains as having been distributed to our shareholders, paying the tax on the gain deemed distributed and allocating the tax paid as a credit to our shareholders. During 2018, we sold our interests in Braddock Metro Center, a 356,000 square foot office property in Alexandria, Virginia, and 2445 M Street, a 292,000 square foot office property in Washington, DC (see note 3).

Generally, and subject to our ongoing qualification as a REIT, no provisions for income taxes are necessary except for taxes on undistributed taxable income and taxes on the income generated by our taxable REIT subsidiaries (“TRSs”). Our TRSs are subject to corporate federal and state income tax on their taxable income at regular statutory rates, or as calculated under the alternative minimum tax, as appropriate. As of both September 30, 2018 and December 31, 2017, our TRSs had a deferred tax asset of $1.4 million that was fully reserved. As of both September 30, 2018 and December 31, 2017, we had a deferred state and local tax liability of $0.6 million. This deferred tax liability is primarily related to temporary differences in the timing of the recognition of revenue, depreciation and amortization.

NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND BASIS OF PRESENTATIONS

Significant Accounting Policies

We have prepared our consolidated financial statements using the accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2017.

Pronouncements Adopted

In August 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2017-12, Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities. The purpose of this updated guidance is to better align a company’s financial reporting for hedging activities with the economic objectives of those activities. The transition guidance provides companies with the option of early adopting the new standard using a modified retrospective transition method in any interim period after issuance of the update, or alternatively requires adoption for fiscal years beginning after December 15, 2018. We adopted the new standard as of January 1, 2018 and the adoption did not have a material impact on our consolidated financial statements.

In May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718) - Scope of Modification Accounting, which provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. The new standard is effective for all entities for fiscal years beginning after December 15, 2017 and for interim periods therein, with early adoption permitted. We adopted the new standard as of January 1, 2018 and the adoption did not have a material impact on our consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments, which provides specific guidance on how cash receipts and payments should be presented and classified in the statement of cash flows for eight specific issues. The new standard is effective for public entities for fiscal years beginning after December 15, 2017 and for interim periods therein, with early adoption permitted. We adopted the new standard as of January 1, 2018 and the adoption did not have a material impact on our consolidated financial statements.

In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Liabilities, which eliminates the requirement for public entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. The new standard is effective for public entities for fiscal years beginning after December 15, 2017 and for interim periods therein. We adopted the new standard as of January 1, 2018 and the adoption did not have a material impact on our consolidated financial statements.

In June 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”), which creates a single source of revenue guidance. The new standard provides accounting guidance for all revenue arising from contracts with customers and affects all entities that enter into contracts to provide goods or services to their customers (unless the contracts are in the scope of other U.S. generally accepted accounting principles (“GAAP”) requirements, such as the leasing literature). The guidance also provides a model for the measurement and recognition of gains and losses on the sale of certain nonfinancial assets, such as property and equipment, including real estate. The new standard is effective for public entities for fiscal years beginning after December 15, 2017 and for interim periods therein. We adopted the new standard for the fiscal year beginning on January 1, 2018. We evaluated the requirements for recognition of revenue from contracts with customers and measuring gains and losses on the sale of properties in accordance with ASU 2014-09 and concluded the adoption of the new standard did not impact in any material respect the amount or timing of our revenue recognition.

Pronouncements Not Yet Adopted

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”), which amends existing lease accounting standards for both lessees and lessors. The standard is effective for fiscal years beginning after December 15, 2018 and for interim periods therein with early adoption permitted. Washington REIT will adopt the standard for the fiscal year beginning on January 1, 2019.

Lessees

For lessees, ASU 2016-02 requires lessees to classify most leases as either finance or operating leases. For lease contracts, or contracts with an embedded lease, with a duration of more than one year in which we are the lessee, the present value of future lease payments will be recognized on our balance sheet as a right-of-use asset and a corresponding lease liability. We are evaluating lease contracts where we are the lessee to determine the impact they may have on Washington REIT’s consolidated financial statements.

Lessors

For lessors, lease contracts currently classified as operating leases will be accounted for similarly to existing guidance. However, under ASU 2016-02, lessors are required to account for each lease and non-lease component, such as common area maintenance or tenant service revenues, of a contract separately. In July 2018, the FASB issued 2018-11, Leases (Topic 842) - Targeted Improvements (“ASU 2018-11”), which provides lessors optional transition relief from implementing this aspect of ASU 2016-02 if the following criteria are met: (1) both components have the same timing and pattern of revenue and (2) if accounted for separately, both components would be classified as an operating lease. We currently believe that the leases where we are lessor meet both criteria and we will elect not to bifurcate lease contracts into lease and non-lease components. Accordingly, both lease and non-lease components will be presented in “Real estate rental revenue” in our consolidated financial statements subsequent to adoption.

Also under ASU 2016-02, the FASB determined that only incremental costs or initial direct costs of executing a lease contract qualify for capitalization, while current accounting standards allow for the capitalization of indirect leasing costs.

Transition

Under ASU 2018-11, the FASB offered optional transition relief, if elected as a package, and applied consistently by an entity to all of its leases. Accordingly, upon adoption, we will elect, as a package, the practical expedients for all leases as follows: (1) we will not reassess whether any expired or existing contracts are or contain leases, (2) we will not reassess the lease classification

for any expired or existing leases and (3) we will not reassess initial direct costs for any existing leases. We are currently evaluating the impact ASU 2016-02 may have on our consolidated financial statements.

Under ASU 2016-02, entities are required to implement the standard as of the beginning of the earliest comparative period presented or January 1, 2017 for calendar-year public business entities. Under ASU 2018-11, the FASB offered optional transition relief that permits entities to continue to apply ASC 840, including its disclosure requirements, in the comparative periods presented in the year of adoption. Accordingly, we will make a policy election to apply ASC 840 to comparative periods on January 1, 2019.

In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments, which requires financial assets measured at an amortized cost basis, including trade receivables, to be presented at the net amount expected to be collected. The new standard is effective for public entities for fiscal years beginning after December 15, 2019 and for interim periods therein with adoption one year earlier permitted. We are currently evaluating the impact the new standard may have on Washington REIT’s consolidated financial statements.

In September 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software, which requires a customer in a cloud computing arrangement that is a service contract to follow the internal-use software guidance to determine which implementation costs to capitalize as assets. The standard is effective for public entities for fiscal years beginning after December 31, 2019 and for interim periods threrein, with early adoption permitted. We are currently evaluating the impact the new standard may have on Washington REIT’s consolidated financial statements.

Principles of Consolidation and Basis of Presentation

The accompanying unaudited consolidated financial statements include the consolidated accounts of Washington REIT, our majority-owned subsidiaries and entities in which Washington REIT has a controlling interest. All intercompany balances and transactions have been eliminated in consolidation.

We have prepared the accompanying unaudited financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and note disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to those rules and regulations, although we believe that the disclosures made are adequate to make the information presented not misleading. In addition, in the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the results for the periods presented have been included. These unaudited financial statements should be read in conjunction with the financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2017.

Within these notes to the financial statements, we refer to the three months ended September 30, 2018 and September 30, 2017 as the “2018 Quarter” and the “2017 Quarter,” respectively, and the nine months ended September 30, 2018 and September 30, 2017 as the “2018 Period” and the “2017 Period,” respectively.

Restricted Cash

Restricted cash includes funds escrowed for tenant security deposits, real estate tax, insurance and mortgage escrows and escrow deposits required by lenders on certain of our properties to be used for future building renovations or tenant improvements.

Use of Estimates in the Financial Statements

The preparation of financial statements in conformity with GAAP requires management to make certain 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 reporting period. Actual results could differ from those estimates.

NOTE 3: REAL ESTATE

Acquisition

Our current strategy includes recycling legacy assets that lack the income growth potential we seek and to invest in high-quality assets with compelling value-add returns through redevelopment opportunities in our existing portfolio and acquisitions that meet our stringent investment criteria. We focus on properties inside the Washington metro region’s Beltway, near major transportation nodes and in areas with strong employment drivers and superior growth demographics. We acquired the following property during the 2018 Period (the “2018 acquisition”):



Acquisition Date	Property	Type	Net Rentable Square Feet	Contract Purchase Price (In thousands)
January 18, 2018	Arlington Tower	Office	391,000	$	250,000

The results of operations from the 2018 acquisition are included in the condensed consolidated statements of income from the acquisition date and are as follows (in thousands):



	Three Months Ended September 30, 2018		Nine Months Ended September 30, 2018
Real estate rental revenue	$	5,947	$	16,485
Net income	843		2,457

We accounted for the 2018 acquisition as an asset acquisition. Accordingly, we capitalized $0.6 million of costs directly associated with the acquisition. We measured the value of the acquired physical assets (land and building), in-place leases (tenant origination costs, leasing commissions, absorption costs and lease intangible assets/liabilities), and any other liabilities by allocating the total cost of the acquisition on a relative fair value basis.

We have recorded the total cost of the 2018 acquisition as follows (in thousands):



Land	$	63,970
Building	142,900
Tenant origination costs	13,625
Leasing commissions/absorption costs	27,465
Lease intangible assets	3,142
Lease intangible liabilities	(545		)
Total	$	250,557

The weighted remaining average life for the 2018 acquisition components above, other than land and building, are 74 months for tenant origination costs, 64 months for leasing commissions/absorption costs, 66 months for lease intangible assets and 81 months for lease intangible liabilities.

The difference in the total contract purchase price of $250.0 million for the 2018 acquisition and cash paid for the acquisition per the consolidated statements of cash flows of $106.4 million is primarily due to a mortgage note assumed and repaid at settlement ($135.5 million), an acquisition deposit made during 2017 ($6.3 million) and a net credit to the buyer for certain expenditures ($1.8 million).

Development/Redevelopment

We have properties under development/redevelopment and held for current or future development as of September 30, 2018.

In the multifamily segment, we have The Trove, a multifamily development adjacent to The Wellington, and own land held for future multifamily development adjacent to Riverside Apartments. As of September 30, 2018, we had invested $52.7 million and $22.4 million, including the costs of acquiring the land, in The Trove and the development adjacent to Riverside Apartments, respectively.

In the retail segment, we currently have a redevelopment project to add rentable space at Spring Valley Village. As of September 30, 2018, we had invested $6.4 million in the redevelopment.

Properties Sold and Held for Sale

We intend to hold our properties for investment with a view to long-term appreciation, to engage in the business of acquiring, developing and owning our properties, and to make occasional sales of the properties that no longer meet our long-term strategy or return objectives and where market conditions for sale are favorable. The proceeds from the sales may be reinvested into other properties, used to fund development operations or to support other corporate needs, or distributed to our shareholders. Depreciation on these properties is discontinued when classified as held for sale, but operating revenues, other operating expenses and interest continue to be recognized until the date of sale.

We sold our interests in the following properties in 2018 and 2017:



Disposition Date	Property Name	Segment	Rentable Square Feet/ Number of Units	Contract Sales Price (in thousands)		Gain on Sale (in thousands)
January 19, 2018	Braddock Metro Center	Office	356,000	$	93,000	$	—
June 28, 2018	2445 M Street	Office	292,000	101,600		2,495
		Total 2018	648,000	$	194,600	$	2,495

October 23, 2017	Walker House Apartments	Multifamily	212	$	32,200	$	23,838

We have fully transferred control of the assets associated with these disposed properties.

During the first quarter of 2018, we sold Braddock Metro Center, a 356,000 square foot office property in Alexandria, Virginia, for a contract sales price of $93.0 million. Due to then-ongoing negotiations to sell the property, we evaluated Braddock Metro Center for impairment and recognized a $9.1 million impairment charge during 2017 in order to reduce the carrying value of the property to its estimated fair value, less selling costs. We based this fair value on the expected sale price from a potential sale. There are few observable market transactions for similar properties. This fair valuation falls into Level 2 of the fair value hierarchy due to its reliance on a quoted price in a market that is not active.

During the first quarter of 2018, we executed a purchase and sale agreement to sell 2445 M Street, a 292,000 square foot office property in Washington, DC, for a contract sales price of $100.0 million, with settlement originally scheduled for the third quarter of 2018. During 2017, we evaluated 2445 M Street for impairment and recognized a $24.1 million impairment charge in order to reduce the carrying value of the property to its estimated fair value. Upon execution of the purchase and sale agreement, the property met the criteria for classification as held for sale. Due to the property’s classification as held for sale, we recorded an additional impairment charge of $1.9 million in the first quarter of 2018 in order to reduce the carrying value of the property to its estimated fair value, less estimated selling costs. We based this fair value on the expected sales price from a potential sale. There are few observable market transactions for similar properties. This fair valuation falls into Level 2 of the fair value hierarchy due to its reliance on a quoted price in a market that is not active. During the second quarter of 2018, we executed an amendment to the purchase and sale agreement which increased the contract sales price to $101.6 million and advanced the settlement date. On June 28, 2018, we sold 2445 M Street, recognizing a gain on sale of real estate of $2.5 million.

NOTE 4: MORTGAGE NOTES PAYABLE

In August 2018, we prepaid without penalty the remaining $31.7 million of the mortgage note secured by Kenmore Apartments.

NOTE 5: UNSECURED LINE OF CREDIT PAYABLE

During the first quarter of 2018, we entered into an amended and restated credit agreement (“Credit Agreement”) which provides for a $700.0 million unsecured revolving credit facility (“Revolving Credit Facility”), the continuation of an existing $150.0 million unsecured term loan (“2015 Term Loan”) and an additional $250.0 million unsecured term loan (“2018 Term Loan”). The Revolving Credit Facility has a four-year term ending in March 2022, with two six-month extension options, and expands our prior $600.0 million unsecured revolving credit facility that was set to expire in June 2019. The Credit Agreement has an accordion feature that allows us to increase the aggregate facility to $1.5 billion, subject to the extent lenders agree to provide additional revolving loan commitments or term loans.

The Revolving Credit Facility bears interest at a rate of either one month LIBOR plus a margin ranging from 0.775% to 1.55% or the base rate plus a margin ranging from 0.0% to 0.55% (in each case depending upon Washington REIT’s credit rating). The base rate is the highest of the administrative agent’s prime rate, the federal funds rate plus 0.50% and the LIBOR market index rate plus 1.0%. In addition, the Revolving Credit Facility requires the payment of a facility fee ranging from 0.10% to 0.30% (depending on Washington REIT’s credit rating) on the $700.0 million committed revolving loan capacity, without regard to usage. As of September 30, 2018, the interest rate on the Revolving Credit Facility is one month LIBOR plus 1.00%, the one month LIBOR is 2.26% and the facility fee is 0.20%.

The 2018 Term Loan increases and replaces the $150.0 million unsecured term loan, initially entered into on July 22, 2016 (“2016 Term Loan”), that was set to mature in July 2023. The 2018 Term Loan matures in July 2023 and bears interest at a rate of either one month LIBOR plus a margin ranging from 0.85% to 1.75% or the base rate plus a margin ranging from 0.0% to 0.75% (in each case depending upon Washington REIT’s credit rating). We used the $100.0 million of additional proceeds from the 2018 Term Loan primarily to repay outstanding borrowings on the Revolving Credit Facility.

We had previously used interest rate derivatives to effectively fix the interest rate of the 2016 Term Loan. These interest rate derivatives now effectively fix the interest rate on a $150.0 million portion of the 2018 Term Loan at 2.31%. In March 2018, we entered into interest rate derivatives that commenced on June 29, 2018 to effectively fix the interest rate on the remaining $100.0 million of the 2018 Term Loan at 3.71%.

The amount of the Revolving Credit Facility’s unsecured line of credit unused and available at September 30, 2018 is as follows (in thousands):



Committed capacity	$	700,000
Borrowings outstanding	(183,000		)
Unused and available	$	517,000

We executed borrowings and repayments on the Revolving Credit Facility during the 2018 Period as follows (in thousands):



Balance at December 31, 2017	$	166,000
Borrowings	397,000
Repayments	(380,000		)
Balance at September 30, 2018	$	183,000

NOTE 6: DERIVATIVE INSTRUMENTS

On September 15, 2015, we entered into two interest rate swap arrangements with a total notional amount of $150.0 million to swap the floating interest rate under the 2015 Term Loan (see note 5) to an all-in fixed interest rate of 2.72% starting on October 15, 2015 and extending until the maturity of the 2015 Term Loan on March 15, 2021.

On July 22, 2016, we entered into two forward interest rate swap arrangements with a total notional amount of $150.0 million to swap the floating interest rate under the 2016 Term Loan to an all-in fixed interest rate of 2.86% starting on March 31, 2017 and extending until the maturity of the 2016 Term Loan on July 21, 2023. On March 29, 2018, we entered into the 2018 Term Loan, a $250.0 million floating interest rate term loan maturing on July 21, 2023, which increased and replaced the 2016 Term Loan. The interest rate swap arrangements that had effectively fixed the 2016 Term Loan now effectively fix the interest rate on a $150.0 million portion of the 2018 Term Loan at 2.31%. On March 29, 2018, we entered into four interest rate swap arrangements with a total notional amount of $100.0 million to effectively fix the interest rate on the remaining $100.0 million of the 2018 Term Loan at 3.71%, that commenced on June 29, 2018 and extending until the maturity of the 2018 Term Loan on July 21, 2023.

The interest rate swaps qualify as cash flow hedges and are recorded at fair value in accordance with GAAP, based on discounted cash flow methodologies and observable inputs. We record the total change in fair value of the interest rate swap arrangements associated with our cash flow hedges in other comprehensive income. The resulting unrealized gain (loss) of the cash flow hedges was the only activity in other comprehensive income during the periods presented in our consolidated financial statements. We assess the effectiveness of our cash flow hedges both at inception and on an ongoing basis. The cash flow hedges were effective for all periods presented.

The fair values of the interest rate swaps as of September 30, 2018 and December 31, 2017, are as follows (in thousands):



					Fair Value
					Derivative Assets
Derivative Instrument	Aggregate Notional Amount		Effective Date	Maturity Date	September 30, 2018		December 31, 2017
Interest rate swaps	$	150,000	October 15, 2015	March 15, 2021	$	4,392	$	1,987
Interest rate swaps	150,000		March 31, 2017	July 21, 2023	11,484		7,432
Interest rate swaps	100,000		June 29, 2018	July 21, 2023	1,305		—
	$	400,000			$	17,181	$	9,419

We record interest rate swaps on our consolidated balance sheets within prepaid expenses and other assets when in a net asset position and within accounts payable and other liabilities when in a net liability position. The interest rate swaps have been effective since inception. The net gains or losses on the effective swaps are recognized in other comprehensive income, as follows (in thousands):



	Three Months Ended September 30,					Nine Months Ended September 30,
	2018		2017			2018		2017
Unrealized gain (loss) on interest rate hedges	$	1,474	$	(9	)	$	7,762	$	(763	)

Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on our variable-rate debt. During the next twelve months, we estimate that an additional $3.6 million will be reclassified as a decrease to interest expense.

We have agreements with each of our derivative counterparties that contain a provision whereby we could be declared in default on our derivative obligations if repayment of the underlying indebtedness is accelerated by the lender due to our default on the indebtedness. As of September 30, 2018, the fair value of derivatives is in a net asset position of $17.2 million, which includes accrued interest but excludes any adjustment for nonperformance risk. As of September 30, 2018, we have not posted any collateral related to these agreements.

Derivative instruments expose us to credit risk in the event of non-performance by the counterparty under the terms of the interest rate hedge agreement. We believe that we minimize our credit risk on these transactions by dealing with major, creditworthy financial institutions. We monitor the credit ratings of counterparties and our exposure to any single entity, thus minimizing our credit risk concentration.

NOTE 7: FAIR VALUE DISCLOSURES

Assets and Liabilities Measured at Fair Value

For assets and liabilities measured at fair value on a recurring basis, quantitative disclosures about the fair value measurements are required to be disclosed separately for each major category of assets and liabilities, as follows:

Level 1: Quoted prices in active markets for identical assets

Level 2: Significant other observable inputs

Level 3: Significant unobservable inputs

The only assets or liabilities we had at September 30, 2018 and December 31, 2017 that are recorded at fair value on a recurring basis are the assets held in the Supplemental Executive Retirement Plan (“SERP”), which primarily consist of investments in mutual funds, and the interest rate swaps (see note 6).

We base the valuations related to the SERP on assumptions derived from significant other observable inputs and accordingly these valuations fall into Level 2 in the fair value hierarchy.

The valuation of the interest rate swaps is determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each interest rate swap. This analysis reflects the contractual terms of the interest rate swaps, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed

cash payments (or receipts) and the discounted expected variable cash receipts (or payments). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. To comply with the provisions of ASC 820, Fair Value Measurement, we incorporate credit valuation adjustments in the fair value measurements to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk. These credit valuation adjustments were concluded to not be significant inputs for the fair value calculations for the periods presented. In adjusting the fair value of our derivative contracts for the effect of nonperformance risk, we have considered the impact of netting and any applicable credit enhancements, such as the posting of collateral, thresholds, mutual puts and guarantees. The valuation of interest rate swaps fall into Level 2 in the fair value hierarchy.

The fair values of these assets and liabilities at September 30, 2018 and December 31, 2017 were as follows (in thousands):



	September 30, 2018								December 31, 2017
	Fair Value		Level 1		Level 2		Level 3		Fair Value		Level 1		Level 2		Level 3
Assets:
SERP	$	1,364	$	—	$	1,364	$	—	$	1,858	$	—	$	1,858	$	—
Interest rate swaps	17,181		—		17,181		—		9,419		—		9,419		—

Financial Assets and Liabilities Not Measured at Fair Value

The following disclosures of estimated fair value were determined by management using available market information and established valuation methodologies, including discounted cash flow models. Many of these estimates involve significant judgment. The estimated fair value disclosed may not necessarily be indicative of the amounts we could realize on disposition of the financial instruments. The use of different market assumptions or estimation methodologies could have an effect on the estimated fair value amounts. In addition, fair value estimates are made at a point in time and thus, estimates of fair value subsequent to September 30, 2018 may differ significantly from the amounts presented. The valuations of cash and cash equivalents and restricted cash fall into Level 1 in the fair value hierarchy and the valuations of debt instruments fall into Level 3 in the fair value hierarchy.

As of September 30, 2018 and December 31, 2017, the carrying values and estimated fair values of our financial instruments were as follows (in thousands):



	September 30, 2018				December 31, 2017
	Carrying Value		Fair Value		Carrying Value		Fair Value
Cash and cash equivalents	$	4,810	$	4,810	$	9,847	$	9,847
Restricted cash	1,352		1,352		2,776		2,776
Mortgage notes payable, net	60,541		60,482		95,141		97,181
Line of credit	183,000		183,000		166,000		166,000
Notes payable, net	995,130		1,014,067		894,358		931,377

NOTE 8: STOCK BASED COMPENSATION

Washington REIT maintains short-term (“STIP”) and long-term (“LTIP”) incentive plans that allow for stock based awards to officers and non-officer employees. Stock based awards are provided to officers and non-officer employees, as well as trustees, under the Washington Real Estate Investment Trust 2016 Omnibus Incentive Plan which allows for awards in the form of restricted shares, restricted share units, options and other awards up to an aggregate of 2,400,000 shares over the ten-year period in which the plan will be in effect. Restricted share units are converted into shares of our stock upon full vesting through the issuance of new shares.

During the first quarter of 2018, we amended the LTIP for executive officers to eliminate the absolute total shareholder return (“TSR”) component and only utilize relative TSR in the measurement of market condition performance. Under the amended LTIP, relative TSR will be evaluated 50% relative to a defined population of peer companies and 50% relative to the FTSE NAREIT Diversified Index. Prior to this amendment, the LTIP utilized both absolute TSR and relative TSR, with each component having a 50% weighting, and relative TSR was evaluated relative only to a defined population of peer companies. The amendment is effective for three-year performance periods commencing on or after January 1, 2018.

Total Compensation Expense

Total compensation expense recognized in the consolidated financial statements for all outstanding share based awards was $1.7 million and $1.2 million for the 2018 Quarter and 2017 Quarter, respectively, and $5.1 million and $3.6 million for the 2018 Period and 2017 Period, respectively.

Restricted Share Awards

The total fair values of restricted share awards vested was $1.1 million and $2.0 million for the 2018 Period and 2017 Period, respectively.

The total unvested restricted share awards at September 30, 2018 was 479,262 shares, which had a weighted average grant date fair value of $28.58 per share. As of September 30, 2018, the total compensation cost related to unvested restricted share awards was $9.1 million, which we expect to recognize over a weighted average period of 28 months.

NOTE 9: EARNINGS PER COMMON SHARE

We determine “Basic earnings per share” using the two-class method as our unvested restricted share awards and units have non-forfeitable rights to dividends, and are therefore considered participating securities. We compute basic earnings per share by dividing net income attributable to the controlling interest less the allocation of undistributed earnings to unvested restricted share awards and units by the weighted-average number of common shares outstanding for the period.

We also determine “Diluted earnings per share” as the more dilutive of the two-class method or the treasury stock method with respect to the unvested restricted share awards. We further evaluate any other potentially dilutive securities at the end of the period and adjust the basic earnings per share calculation for the impact of those securities that are dilutive. Our dilutive earnings per share calculation includes the dilutive impact of operating partnership units under the if-converted method and our share based awards with performance conditions prior to the grant date and all market condition awards under the contingently issuable method.

The computations of basic and diluted earnings per share for the three and nine months ended September 30, 2018 and 2017 were as follows (in thousands, except per share data):



	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Numerator:
Net income	$	5,893		$	2,813		$	19,942		$	17,275
Net loss attributable to noncontrolling interests in subsidiaries	—			20			—			56
Allocation of earnings to unvested restricted share awards	(144		)	(107		)	(432		)	(291		)
Adjusted net income attributable to the controlling interests	$	5,749		$	2,726		$	19,510		$	17,040
Denominator:
Weighted average shares outstanding – basic	79,076			77,291			78,695			76,292
Effect of dilutive securities:
Operating partnership units	12			12			12			8
Employee restricted share awards	150			120			95			115
Weighted average shares outstanding – diluted	79,238			77,423			78,802			76,415

Basic net income attributable to the controlling interests per common share	$	0.07		$	0.04		$	0.25		$	0.22
Diluted net income attributable to the controlling interests per common share	$	0.07		$	0.04		$	0.25		$	0.22

NOTE 10: SEGMENT INFORMATION

We have three reportable segments: office, multifamily and retail. Office properties provide office space for various types of businesses and professions. Multifamily properties provide rental housing for individuals and families throughout the greater Washington metro region. Retail properties are typically grocery store-anchored neighborhood centers that include other small shop tenants or regional power centers with several junior box tenants.

We evaluate performance based upon net operating income from the combined properties in each segment. Our reportable operating segments are consolidations of similar properties. GAAP requires that segment disclosures present the measure(s) used by the chief operating decision maker for purposes of assessing each segment’s performance. Net operating income is a key measurement of our segment profit and loss. Net operating income is defined as real estate rental revenue less real estate expenses.

The following tables present revenues, net operating income, capital expenditures and total assets for the three and nine months ended September 30, 2018 and 2017 from these segments, and reconcile net operating income of reportable segments to net income attributable to the controlling interests as reported (in thousands):



	Three Months Ended September 30, 2018
	Office		Retail		Multifamily		Corporate and Other		Consolidated
Real estate rental revenue	$	42,438	$	16,111	$	23,953	$	—	$	82,502
Real estate expenses	15,368		3,906		9,297		—		28,571
Net operating income	$	27,070	$	12,205	$	14,656	$	—	$	53,931
Depreciation and amortization									(30,272		)
General and administrative									(5,267		)
Interest expense									(12,499		)
Net income									5,893
Less: Net loss attributable to noncontrolling interests in subsidiaries									—
Net income attributable to the controlling interests									$	5,893
Capital expenditures	$	8,537	$	1,098	$	5,708	$	161	$	15,504
Total assets	$	1,246,026	$	344,358	$	785,397	$	40,736	$	2,416,517



	Three Months Ended September 30, 2017
	Office		Retail		Multifamily		Corporate and Other		Consolidated
Real estate rental revenue	$	42,982	$	15,604	$	24,233	$	—	$	82,819
Real estate expenses	16,246		3,687		9,713		—		29,646
Net operating income	$	26,736	$	11,917	$	14,520	$	—	$	53,173
Depreciation and amortization									(27,941		)
General and administrative									(5,327		)
Interest expense									(12,176		)
Other income									84
Real estate impairment									(5,000		)
Net income									2,813
Less: Net loss attributable to noncontrolling interests in subsidiaries									20
Net income attributable to the controlling interests									$	2,833
Capital expenditures	$	5,934	$	305	$	5,024	$	1,356	$	12,619
Total assets	$	1,231,576	$	346,374	$	769,873	$	36,471	$	2,384,294



	Nine Months Ended September 30, 2018
	Office		Retail		Multifamily		Corporate and Other		Consolidated
Real estate rental revenue	$	135,258	$	47,563	$	71,168	$	—	$	253,989
Real estate expenses	48,031		11,932		28,012		—		87,975
Net operating income	$	87,227	$	35,631	$	43,156	$	—	$	166,014
Depreciation and amortization									(90,119		)
General and administrative									(16,737		)
Interest expense									(38,647		)
Real estate impairment									(1,886		)
Gain on sale of real estate									2,495
Loss on extinguishment of debt									(1,178		)
Net income									19,942
Less: Net loss attributable to noncontrolling interests in subsidiaries									—
Net income attributable to the controlling interests									$	19,942
Capital expenditures	$	17,926	$	2,443	$	13,068	$	626	$	34,063



	Nine Months Ended September 30, 2017
	Office		Retail		Multifamily		Corporate and Other		Consolidated
Real estate rental revenue	$	125,118	46,821		$	71,837	$	—	$	243,776
Real estate expenses	46,513		11,147		28,540		—		86,200
Net operating income	$	78,605	$	35,674	$	43,297	$	—	$	157,576
Depreciation and amortization									(83,271		)
General and administrative									(16,712		)
Interest expense									(35,634		)
Other income									209
Real estate impairment									(5,000		)
Income tax benefit									107
Net income									17,275
Less: Net loss attributable to noncontrolling interests in subsidiaries									56
Net income attributable to the controlling interests									$	17,331
Capital expenditures	$	16,753	$	551	$	17,882	$	3,306	$	38,492

NOTE 11: SHAREHOLDERS' EQUITY

On May 4, 2018, we entered into eight separate equity distribution agreements (collectively, the “Equity Distribution Agreements”) with each of Wells Fargo Securities, LLC, BNY Mellon Capital Markets, LLC, Capital One Securities, Inc., Citigroup Global Markets Inc., Goldman Sachs & Co. LLC, J.P. Morgan Securities LLC, KeyBanc Capital Markets Inc. and SunTrust Robinson Humphrey, Inc. relating to the issuance of up to $250.0 million of our common shares from time to time. Issuances of our common shares are made at market prices prevailing at the time of issuance. We may use net proceeds from the issuance of common shares under this program for general corporate purposes, including, without limitation, working capital, the acquisition, renovation, expansion, improvement, development or redevelopment of income producing properties or the repayment of debt. During the 2018 Quarter and 2018 Period, we issued 1.2 million common shares under the Equity Distribution Agreements at an average price of $31.18 per share, raising $35.5 million in net proceeds.

The Equity Distribution Agreements replaced our previous equity distribution agreements with Wells Fargo Securities, LLC, BNY Mellon Capital Markets, LLC, Citigroup Global Markets Inc. and RBC Capital Markets LLC, dated June 23, 2015. During the 2018 Period, we did not issue common shares under the previous equity distribution agreements.

We have a dividend reinvestment program, whereby shareholders may use their dividends and optional cash payments to purchase common shares. The common shares sold under this program may either be common shares issued by us or common shares purchased in the open market. During the 2018 Quarter, we issued approximately 18,000 common shares under this program at a weighted average price of $30.68 per share, raising $0.6 million in net proceeds. During the 2018 Period, we issued approximately 74,000 common shares under the dividend reinvestment program at a weighted average price of $29.29 per share, raising $1.8 million in net proceeds.

ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto appearing in Item 1 of this report and the more detailed information contained in our Annual Report on Form 10-K for the year ended December 31, 2017 filed with the Securities and Exchange Commission (“SEC”) on February 20, 2018.

We refer to the three months ended September 30, 2018 and September 30, 2017 as the “2018 Quarter” and the “2017 Quarter,” respectively, and the nine months ended September 30, 2018 and September 30, 2017 as the “2018 Period” and the “2017 Period” respectively.

Forward-Looking Statements

This Form 10-Q contains forward-looking statements which involve risks and uncertainties. Forward-looking statements include statements in this report preceded by, followed by or that include the words “believe,” “expect,” “intend,” “anticipate,” “potential,” “project,” “will” and other similar expressions. We claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 for these statements. The following important factors, in addition to those discussed elsewhere in this Form 10-Q, could affect our future results and could cause those results to differ materially from those expressed in the forward-looking statements: (a) the effect of credit and financial market conditions; (b) the availability and cost of capital; (c) fluctuations in interest rates; (d) the economic health of our tenants; (e) the timing and pricing of lease transactions; (f) the economic health of the greater Washington metro region, or other markets we may enter; (g) the risks associated with ownership of real estate in general and our real estate assets in particular; (h) the effects of changes in federal government spending; (i) the supply of competing properties; (j) compliance with applicable laws, including those concerning the environment and access by persons with disabilities; (k) governmental or regulatory actions and initiatives; (l) terrorist attacks or actions; (m) weather conditions and natural disasters; (n) failure to qualify as a REIT; (o) the availability of and our ability to attract and retain qualified personnel; (p) uncertainty in our ability to continue to pay dividends at the current rates; and (q) other factors discussed under the caption “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2017 filed with the SEC on February 20, 2018. We undertake no obligation to update our forward-looking statements or risk factors to reflect new information, future events, or otherwise.

General

Introductory Matters

We provide our Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) in addition to the accompanying consolidated financial statements and notes to assist readers in understanding our results of operations and financial condition. We organize the MD&A as follows:


•	Overview. Discussion of our business outlook, operating results, investment activity, financing activity and capital requirements to provide context for the remainder of MD&A.


•	Results of Operations. Discussion of our financial results comparing the 2018 Quarter to the 2017 Quarter and the 2018 Period to the 2017 Period.


•	Liquidity and Capital Resources. Discussion of our financial condition and analysis of changes in our capital structure and cash flows.


•	Funds From Operations. Calculation of NAREIT Funds From Operations (“NAREIT FFO”), a non-GAAP supplemental measure to net income.


•	Critical Accounting Policies and Estimates. Descriptions of accounting policies that reflect significant judgments and estimates used in the preparation of our consolidated financial statements.

When evaluating our financial condition and operating performance, we focus on the following financial and non-financial indicators:


•	Net operating income (“NOI”), calculated as set forth below under the caption "Results of Operations - Net Operating Income." NOI is a non-GAAP supplemental measure to net income.


•	Funds From Operations (“NAREIT FFO”), calculated as set forth below under the caption “Funds from Operations.” NAREIT FFO is a non-GAAP supplemental measure to net income.


•	Ending occupancy, calculated as occupied square footage as a percentage of total square footage as of the last day of that period.


•	Leased percentage, calculated as the percentage of available physical net rentable area leased for our office and retail segments and percentage of apartments leased for our multifamily segment.


•	Leasing activity, including new leases, renewals and expirations.

For purposes of evaluating comparative operating performance, we categorize our properties as “same-store”, “non-same-store” or discontinued operations. Same-store properties include properties that were owned for the entirety of the years being compared, and exclude properties under redevelopment or development and properties acquired, sold or classified as held for sale during the years being compared. We define development properties as those for which we have planned or ongoing major construction activities on existing or acquired land pursuant to an authorized development plan. We consider a property's development activities to be complete when the property is ready for its intended use. The property is categorized as same-store when it has been ready for its intended use for the entirety of the years being compared. We define redevelopment properties as those for which we have planned or ongoing significant development and construction activities on existing or acquired buildings pursuant to an authorized plan, which has an impact on current operating results, occupancy and the ability to lease space with the intended result of a higher economic return on the property. We categorize a redevelopment property as same-store when redevelopment activities have been complete for the majority of each year being compared.

Overview

Our revenues are derived primarily from the ownership and operation of income producing properties in the greater Washington metro region. As of September 30, 2018, we owned a diversified portfolio of 48 properties, totaling approximately 6.1 million square feet of commercial space and 4,268 multifamily units, and land held for development. These 48 properties consisted of 19 office properties, 16 retail centers and 13 multifamily properties.

Operating Results

Net income attributable to the controlling interests, NOI and NAREIT FFO for the three months ended September 30, 2018 and 2017 were as follows (in thousands):



	Three Months Ended September 30,
	2018		2017		$ Change		% Change
Net income attributable to the controlling interests	$	5,893	$	2,833	$	3,060	108.0	%
NOI ⁽¹⁾	$	53,931	$	53,173	$	758	1.4	%
NAREIT FFO ⁽²⁾	$	36,165	$	35,754	$	411	1.1	%

⁽¹⁾ See page 26 of the MD&A for a reconciliation of NOI to net income.
⁽²⁾ See page 36 of the MD&A for a reconciliation of NAREIT FFO to net income.

The higher net income attributable to the controlling interests is primarily due to real estate impairment ($5.0 million) during 2017 Quarter and higher NOI ($0.8 million) during 2018 Quarter, partially offset by higher depreciation and amortization ($2.3 million), higher interest expense ($0.3 million) and lower other income ($0.1 million) during the 2018 Quarter.

The higher NOI is primarily due to income generated from Arlington Tower ($4.5 million), which was acquired after the 2017 Quarter, and higher NOI from same-store properties ($1.5 million), partially offset by property sales during 2018 and 2017 ($5.2 million). The higher same-store NOI is explained in further detail beginning on page 26 (Results of Operations - 2018 Quarter Compared to 2017 Quarter). Same-store ending occupancy increased to 94.0% as of September 30, 2018, from 93.3% as of September 30, 2017, due to higher occupancy across the portfolio.

The higher NAREIT FFO is primarily attributable to the higher NOI ($0.8 million), partially offset by higher interest expense ($0.3 million).

Investment Activity

Significant investment transactions during the 2018 Period included the following:


•	The disposition of 2445 M Street, a 292,000 square foot office property in Washington, DC, for a contract sales price of $101.6 million. We recognized a gain on sale of $2.5 million related to the transaction.


•	The acquisition of Arlington Tower, a 391,000 net rentable square foot office building in Arlington, Virginia, for a contract purchase price of $250.0 million. We incurred $0.6 million of acquisition costs related to this transaction.


•	The disposition of Braddock Metro Center, a 356,000 net rentable square foot office building in Alexandria, Virginia, for a contract sales price of $93.0 million.

Financing Activity

Significant financing transactions during the 2018 Period included the following:

•

The execution of an amended, extended and expanded $700 million unsecured revolving credit facility (the “Revolving Credit Facility”) and refinancing of an existing $150.0 million seven-year unsecured term loan with a $250.0 million five-year unsecured term loan. We recognized a $1.2 million non-cash loss on extinguishment of debt related to the write-off of unamortized loan origination costs.

•

The execution of eight separate equity distribution agreements on May 4, 2018 relating to the issuance of up to $250.0 million of our common shares from time to time. Issuances of our common shares are made at market prices prevailing at the time of issuance. The equity distribution agreements executed on May 4, 2018 replaced our previous equity distribution agreements, dated June 23, 2015. During the 2018 Quarter, we issued approximately 1.2 million common shares under our at-the-market program at an average price of $31.18 per share, raising approximately $35.5 million in net proceeds.

As of September 30, 2018, the interest rate on the Revolving Credit Facility was one month LIBOR plus 1.00% and the facility fee was 0.20%. As of October 25, 2018, our Revolving Credit Facility has a borrowing capacity of $507.0 million.

Capital Requirements

We prepaid without penalty the $31.7 million mortgage note secured by Kenmore Apartments during the third quarter of 2018 and have no additional debt maturities remaining in 2018. We expect to have additional capital requirements as set forth on page 33 (Liquidity and Capital Resources - Capital Requirements).

Results of Operations

The discussion that follows is based on our consolidated results of operations for the 2018 Quarter and Period and 2017 Quarter and Period. The ability to compare one period to another is significantly affected by acquisitions completed and dispositions made during 2018 and 2017 (see note 3 to the consolidated financial statements).

Net Operating Income

NOI, defined as real estate rental revenue less real estate expenses, is a non-GAAP measure. NOI is calculated as net income, less non-real estate revenue and the results of discontinued operations (including the gain or loss on sale, if any), plus interest expense, depreciation and amortization, general and administrative expenses, acquisition costs, real estate impairment and gain or loss on extinguishment of debt. We believe that NOI is useful as a performance measure because, when compared across periods, NOI reflects the impact on operations of trends in occupancy rates, rental rates and operating costs on an unleveraged basis, providing perspective not immediately apparent from net income. NOI excludes certain components from net income in order to provide results more closely related to a property’s results of operations. For example, interest expense is not necessarily linked to the operating performance of a real estate asset. In addition, depreciation and amortization, because of historical cost accounting and useful life estimates, may distort operating performance at the property level. As a result of the foregoing, we provide NOI as a supplement to net income, calculated in accordance with GAAP. NOI does not represent net income or income from continuing operations, in either case calculated in accordance with GAAP. As such, it should not be considered an alternative to these measures as an indication of our operating performance. A reconciliation of NOI to net income follows.

2018 Quarter Compared to 2017 Quarter

The following table reconciles NOI to net income attributable to the controlling interests and provides the basis for our discussion of our consolidated results of operations and NOI in the 2018 Quarter compared to the 2017 Quarter. All amounts are in thousands, except percentage amounts.



									Non-Same-Store
	Same-Store								Acquisitions ⁽¹⁾				Development/ Re-development ⁽²⁾					Held for Sale or Sold ⁽³⁾				All Properties
	2018		2017		$ Change		% Change		2018		2017		2018			2017		2018		2017		2018			2017			$ Change			% Change
Real estate rental revenue	$	71,716	$	69,664	$	2,052	2.9	%	$	10,786	$	4,831	$	—		$	—	$	—	$	8,324	$	82,502		$	82,819		$	(317	)	(0.4	)%
Real estate expenses	25,496		24,979		517		2.1	%	3,139		1,560		(64		)	—		—		3,107		28,571			29,646			(1,075		)	(3.6	)%
NOI	$	46,220	$	44,685	$	1,535	3.4	%	$	7,647	$	3,271	$	64		$	—	$	—	$	5,217	$	53,931		$	53,173		$	758		1.4	%
Reconciliation to net income attributable to the controlling interests:
Depreciation and amortization																						(30,272		)	(27,941		)	(2,331		)	8.3	%
General and administrative expenses																						(5,267		)	(5,327		)	60			(1.1	)%
Real estate impairment																						—			(5,000		)	5,000			(100.0	)%
Interest expense																						(12,499		)	(12,176		)	(323		)	2.7	%
Other income																						—			84			(84		)	(100.0	)%
Net income																						5,893			2,813			3,080			109.5	%
Less: Net loss attributable to noncontrolling interests																						—			20			(20		)	(100.0	)%
Net income attributable to the controlling interests																						$	5,893		$	2,833		$	3,060		108.0	%


⁽¹⁾	Acquisitions:

2018 Office – Arlington Tower

2017 Office – Watergate 600


⁽²⁾	Development/redevelopment:

Multifamily development property – land adjacent to Riverside Apartments


⁽³⁾	Sold:

2018 Office – Braddock Metro Center and 2445 M Street

2017 Multifamily – Walker House Apartments

Real Estate Rental Revenue

Real estate rental revenue is comprised of (a) minimum base rent, which includes rental revenues recognized on a straight-line basis, (b) revenue from the recovery of operating expenses from our tenants, (c) provisions for doubtful accounts in the same quarter that we established the receivable, which include provisions for straight-line receivables, (d) revenue from the collection of lease termination fees and (e) parking and other tenant charges such as percentage rents.

Real estate rental revenue for same-store properties for the three months ended September 30, 2018 and 2017 was as follows (in thousands):



	Three Months Ended September 30,
	2018			2017			$ Change			% Change
Minimum base rent	$	61,745		$	60,275		$	1,470		2.4	%
Recoveries from tenants	7,043			6,442			601			9.3	%
Provisions for doubtful accounts	(428		)	(292		)	(136		)	46.6	%
Lease termination fees	369			471			(102		)	(21.7	)%
Parking and other tenant charges	2,987			2,768			219			7.9	%
Total same-store real estate rental revenue	$	71,716		$	69,664		$	2,052		2.9	%


•	Minimum base rent: Increase primarily due to higher rental income ($1.4 million) due to new leases at Army Navy Building, 1901 Pennsylvania Avenue, Monument II and Silverline Center and higher rental rates in multifamily segment, partially offset by lease expirations at Quantico Corporate Center.


•	Recoveries from tenants: Increase primarily due to higher reimbursements for operating expenses ($0.3 million) and real estate taxes ($0.2 million).


•	Provisions for doubtful accounts: Increase primarily due to higher provisions in the office segment ($0.2 million), partially offset by lower provisions in the retail segment ($0.1 million).


•	Lease termination fees: Decrease primarily due to lower fees in the retail segment ($0.2 million), partially offset by higher fees in the office segment ($0.1 million).


•	Parking and other tenant charges: Increase primarily due to higher tenant charges ($0.2 million).

Real estate rental revenue from same-store properties by segment was as follows (in thousands):



	Three Months Ended September 30,
	2018		2017		$ Change		% Change
Office	$	31,652	$	30,672	$	980	3.2	%
Multifamily	23,953		23,388		565		2.4	%
Retail	16,111		15,604		507		3.2	%
Total same-store real estate rental revenue	$	71,716	$	69,664	$	2,052	2.9	%

•

Office: Increase primarily due to higher rental income ($0.7 million), higher reimbursements for operating expenses ($0.2 million), higher lease termination fees ($0.1 million) and higher tenant charges ($0.1 million), partially offset by higher provisions for doubtful accounts ($0.2 million). The higher rental income is primarily due to new leases at Army Navy Building, 1901 Pennsylvania Avenue, Monument II and Silverline Center.


•	Multifamily: Increase primarily due to higher rental rates ($0.5 million).


•	Retail: Increase primarily due to higher reimbursements for operating expenses ($0.4 million), higher rental income ($0.2 million) and lower provisions for doubtful accounts ($0.1 million), partially offset by lower termination fees ($0.2 million).

Real estate rental revenue from acquisitions increased due to the acquisition of Arlington Tower ($5.9 million) in the first quarter of 2018.

Real estate rental revenue from held for sale and sold properties decreased due to the sale of 2445 M Street ($4.5 million) during the second quarter of 2018, Braddock Metro Center ($3.0 million) during the first quarter of 2018 and Walker House Apartments ($0.8 million) during the fourth quarter of 2017.

Ending occupancy represents occupied square footage indicated as a percentage of total square footage as of the last day of that period. Ending occupancy by segment for the 2018 Quarter and 2017 Quarter was as follows:



	September 30, 2018						September 30, 2017						Increase (decrease)
Segment	Same-Store		Non-Same-Store		Total		Same-Store		Non-Same-Store		Total		Same-Store		Non-Same-Store		Total
Office	92.1	%	95.4	%	92.7	%	91.7	%	98.3	%	93.2	%	0.4	%	(2.9	)%	(0.5	)%
Multifamily	95.4	%	N/A		95.4	%	94.5	%	93.2	%	94.5	%	0.9	%	N/A		0.9	%
Retail	94.3	%	N/A		94.3	%	93.5	%	N/A		93.5	%	0.8	%	N/A		0.8	%
Total	94.0	%	95.4	%	94.1	%	93.3	%	97.6	%	93.8	%	0.7	%	(2.2	)%	0.3	%


•	Office: The increase in same-store ending occupancy was primarily due to higher ending occupancy at Army Navy Building and 1901 Pennsylvania Avenue, partially offset by lower ending occupancy at Fairgate at Ballston.


•	Multifamily: The increase in same-store ending occupancy was primarily due to higher ending occupancy at The Ashby at McLean, Bennett Park, Roosevelt Towers and 3801 Connecticut Avenue, partially offset by lower ending occupancy at Clayborne Apartments.


•	Retail: The increase in same-store ending occupancy was primarily due to higher ending occupancy at Concord Centre and Frederick Crossing, partially offset by lower ending occupancy at Randolph Shopping Center, Gateway Overlook and Westminster Shopping Center.

During the 2018 Quarter, we executed new and renewal leases in our office and retail segments as follows:



	Square Feet (in thousands)	Average Rental Rate (per square foot)		% Rental Rate Increase (Decrease)		Leasing Costs ⁽¹⁾ (per square foot)		Free Rent (weighted average months)	Retention Rate
Office	73	$	48.94	13.5	%	$	61.80	5.0	47.1	%
Retail	29	36.64		8.4	%	19.97		0.6	54.3	%
Total	102	45.43		12.3	%	49.89		4.0	49.3	%

⁽¹⁾ Consists of tenant improvements and leasing commissions.

Real Estate Expenses

Real estate expenses as a percentage of revenue for the 2018 Quarter and 2017 Quarter were 34.6% and 35.8%, respectively.

Real estate expenses from same-store properties by segment were as follows (in thousands):



	Three Months Ended September 30,
	2018		2017		$ Change		% Change
Office	$	12,229	$	12,010	$	219	1.8	%
Multifamily	9,361		9,282		79		0.9	%
Retail	3,906		3,687		219		5.9	%
Total same-store real estate expenses	$	25,496	$	24,979	$	517	2.1	%


•	Office: Increase primarily due to higher utilities ($0.1 million) and administrative ($0.1 million) expenses.


•	Multifamily: Increase primarily due to higher administrative ($0.2 million) and contract maintenance ($0.1 million) expenses, partially offset by lower real estate tax ($0.2 million) expenses.


•	Retail: Increase primarily due to higher repairs and maintenance ($0.1 million) and real estate tax ($0.1 million) expenses.

Other Income and Expenses

Depreciation and Amortization: Increase primarily due to the acquisition of Arlington Tower ($3.6 million) in the first quarter of 2018 and Watergate 600 ($0.4 million) in 2017 and due to higher depreciation and amortization at same store properties ($0.7 million), partially offset by the dispositions of 2445 M Street ($1.3 million) and Braddock Metro Center ($1.1 million).

General and administrative expenses: Decrease primarily due to lower estimated cash incentive compensation ($0.4 million) due to higher forecasted operating results in 2017 and lower expenses related to an information systems upgrade ($0.2 million), partially offset by higher share-based compensation ($0.5 million).

Real estate impairment: Impairment charge during the 2017 Quarter reduced the carrying value of Braddock Metro Center to its estimated fair value.

Interest Expense: Interest expense by debt type for the three months ended Septe