UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For fiscal year ended December 31, 2007
OR
¨ | 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) |
6110 EXECUTIVE BOULEVARD, SUITE 800, ROCKVILLE, MARYLAND |
20852 | |
(Address of principal executive office) | (Zip code) |
Registrants telephone number, including area code (301) 984-9400
Securities registered pursuant to Section 12(b) of the Act: None
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 if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES x NO ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES ¨ NO x
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 twelve (12) months (or such shorter period that the Registrant was required to file such report) and (2) has been subject to such filing requirements for the past ninety (90) days. YES x NO ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrants knowledge in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. (See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act).
Large Accelerated Filer x Accelerated Filer ¨ Non-Accelerated Filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). YES ¨ NO x
As of February 26, 2008 46,684,238 Shares of Beneficial Interest were outstanding. As of June 29, 2007, the aggregate market value of such shares held by non-affiliates of the registrant was approximately $1,587,264,092 (based on the closing price of the stock on June 29, 2007).
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Trusts definitive Proxy Statement relating to the 2008 Annual Meeting of Shareholders, to be filed with the Securities and Exchange Commission, are incorporated by reference in Part III, Items 10-14 of this Annual Report on Form 10-K as indicated herein.
WASHINGTON REAL ESTATE INVESTMENT TRUST
2007 FORM 10-K ANNUAL REPORT
INDEX
Page | ||||
PART I | ||||
Item 1. |
3 | |||
Item 1A. |
6 | |||
Item 1B. |
13 | |||
Item 2. |
13 | |||
Item 3. |
16 | |||
Item 4. |
16 | |||
PART II |
||||
Item 5. |
17 | |||
Item 6. |
17 | |||
Item 7. |
Managements Discussion and Analysis of Financial Condition and Results of Operations |
18 | ||
Item 7A. |
50 | |||
Item 8. |
51 | |||
Item 9. |
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
51 | ||
Item 9A. |
51 | |||
Item 9B. |
51 | |||
PART III |
||||
Item 10. |
52 | |||
Item 11. |
52 | |||
Item 12. |
52 | |||
Item 13. |
52 | |||
Item 14. |
52 | |||
PART IV |
||||
Item 15. |
53 | |||
57 |
PART I
ITEM 1. | BUSINESS |
The Trust
Washington Real Estate Investment Trust (WRIT, the Trust, or the company) is a self-administered, self-managed, equity real estate investment trust (REIT) successor to a trust organized in 1960. Our business consists of the ownership and development of income-producing real properties in the greater Washington metro region. We own a diversified portfolio of office buildings, medical office buildings, industrial/flex properties, multifamily buildings and retail centers.
We believe that we qualify as a REIT under Sections 856-860 of the Internal Revenue Code and intend to continue to qualify as such. To maintain our status as a REIT, we are required to distribute 90% of our ordinary taxable income to our shareholders. When selling properties, we have the option of (i) reinvesting the sale price of properties sold, allowing for a deferral of income taxes on the sale, (ii) paying out capital gains to the shareholders with no tax to the company or (iii) treating the capital gains as having been distributed to the shareholders, paying the tax on the gain deemed distributed and allocating the tax paid as a credit to the shareholders. In September 2007, Maryland Trade Centers I and II were sold for a gain of $25.0 million. The proceeds from the sale were reinvested in replacement properties. We did not dispose of any of our properties in 2006. In 2005, $33.5 million of the gains from property disposals were reinvested in replacement properties and approximately $3.5 million of the gains were distributed to shareholders. We distributed all of our 2007, 2006, and 2005 ordinary taxable income to our shareholders. No provision for income taxes was necessary in 2007, 2006, or 2005. Over the last five years, dividends paid per share have been $1.68 for 2007, $1.64 for 2006, $1.60 for 2005, $1.55 for 2004, and $1.47 for 2003.
We generally incur short-term floating rate debt in connection with the acquisition and development of real estate. As market conditions permit, we replace the floating rate debt with fixed-rate secured loans or unsecured senior notes, or repay the debt with the proceeds of sales of equity securities. We may acquire one or more properties in exchange for our equity securities or operating partnership units which are convertible into WRIT shares.
Our geographic focus is based on two principles:
1. | Real estate is a local business and is more effectively selected and managed by owners located, and with expertise, in the region. |
2. | Geographic markets deserving of focus must be among the nations best markets with a strong primary industry foundation and diversified enough to withstand downturns in their primary industry. |
We consider markets to be local if they can be reached from the Washington centered market within two hours by car. Our Washington centered market reaches north to Philadelphia, Pennsylvania and south to Richmond, Virginia. While we have historically focused most of our investments in the greater Washington metro region, in order to maximize acquisition opportunities we will and have considered investments within the two-hour radius described above. We will also consider opportunities to duplicate our Washington focused approach in other geographic markets which meet the criteria described above.
All of our Trustees, officers and employees live and work in the greater Washington metro region and our officers average over 20 years of experience in this region.
This section includes or refers to certain forward-looking statements. You should refer to the explanation of the qualifications and limitations on such forward-looking statements beginning on page 49.
3
The Greater Washington Metro Area Economy
Economic conditions in the greater Washington metro region were strong in 2007. The region experienced positive job growth, an increase in gross regional product, higher retail sales, and had the lowest unemployment rate in the nation. The metro Washington region added 44,500 new jobs in 2007, in line with the long-term average of 45,000. The professional and business services, retail trade, and leisure and hospitality sectors led job growth in the region. In 2006, professional and business services, education and health services, and retail trade were the sectors that led growth. According to the Center for Regional Analysis (CRA) at George Mason University, the Washington areas gross regional product (GRP) in 2007 is estimated to have increased 3.3% compared to 2006. Approximately one-third of the areas GRP was generated by the Federal government. In 2007, retail sales in the Washington metro area increased 3.8%. The regions unemployment rate was 3.1% at October 2007, slightly up compared to 2006 but remains the lowest rate among all of the nations largest metro areas and well below the national average of 4.7%. The Washington metro region is currently the 8th largest metropolitan statistical area in the United States.
The outlook for 2008 is positive, but growth will be modest compared to past years. The Washington Leading Index, which forecasts area economic performance over the next 12 months, was 108.6, as of September 2007, which is 180 bps below the long term average. Gross regional product for the Washington metro region is forecasted to increase by 2.9% in 2008 and 3.3% in 2009. Job growth in the region is forecasted to rise in 2008 and 2009, adding 47,400 and 49,000 new jobs, respectively, compared to the long-term 15-year average of 45,000.
Greater Washington Metro Region Real Estate Markets
Despite softening conditions, the greater Washington metro region remains one of the top performing markets in the nation. According to the Association of Foreign Investors in Real Estate (AFIRE), Washington, DC is tied with London for second place in the Top 5 Global Cities for Real Estate Investment 2007. The areas robust economy has translated into stronger relative real estate market performance in each of our sectors, compared to other national metropolitan regions as reported by Delta Associates / Transwestern Commercial Services (Delta), a national full service real estate firm that provides market research and evaluation services for commercial property types including office, industrial, retail and apartments:
Office and Medical Office Sectors
| Rents increased 2.2% in 2007 in the region, and rents are expected to stabilize in 2008. |
| Vacancy was 9.1% at year-end 2007, up from 8.5% one year ago and up from 7.9% at year-end 2005. |
| The region has the fifth lowest vacancy rate of large metro areas in the United States. |
| The overall vacancy rate is projected to increase to 11.3% over the next year. |
| Net absorption totaled 5.4 million square feet, down from 6.8 million square feet in 2006. |
| Of the 20.6 million square feet of office space under construction at year-end 2007, 28% is pre-leased. |
Multifamily Sector
| Rents for investment grade apartments increased 1.8% in the greater Washington metro region during 2007. |
| Rents are expected to increase in the region, but by less than the long-term average of 4.4% per annum. |
Grocery-Anchored Retail Centers Sector
| Sales volume for food retailers in the greater Washington metro area increased 1.8% in 2007. |
4
| Vacancy rates were 2.3% at year-end 2007 no change from 2.3% in 2006. |
| Rental rates at grocery-anchored centers increased 3.9% in the region in 2007. |
Industrial/Flex Sector
| Rental rates for the industrial sector increased 2.8% in the greater Washington region in 2007. |
| Overall vacancy was 9.5% at year-end 2007, down from 9.8% one year ago. |
| Net absorption was 6.6 million square feet, compared to 4.3 million square feet in 2006 and above the long-term average of 5.4 million square feet. |
| Of the 6.4 million square feet of industrial space under construction at year-end, 24% is pre-leased, compared to 21% of space under construction that was pre-leased one year ago. |
WRIT PORTFOLIO
As of December 31, 2007, we owned a diversified portfolio of 89 properties consisting of 25 office properties, 17 medical office properties, 14 retail centers, 10 multifamily properties, 23 industrial/flex properties and land held for development. Our principal objective is to invest in high quality properties in prime locations, then proactively manage, lease, and direct ongoing capital improvement programs to improve their economic performance. The percentage of total real estate rental revenue by property group for 2007, 2006 and 2005 and the percent leased, calculated as the percentage of physical net rentable area leased, as of December 31, 2007 were as follows:
Percent Leased* | Real Estate Rental Revenue* |
||||||||||
December 31, 2007 |
2007 |
2006 |
2005 |
||||||||
97% |
Office buildings | 40 | % | 38 | % | 39 | % | ||||
98% |
Medical office buildings | 15 | 12 | 10 | |||||||
98% |
Retail centers | 16 | 18 | 18 | |||||||
87% |
Multifamily | 13 | 15 | 17 | |||||||
96% |
Industrial | 16 | 17 | 16 | |||||||
100 | % | 100 | % | 100 | % | ||||||
* | Data excludes discontinued operations. |
On a combined basis, our portfolio was 97% leased at December 31, 2007, 95% leased at December 31, 2006 and 94% leased at December 31, 2005.
Total rental revenue from continuing operations was $255.7 million for 2007, $208.7 million for 2006 and $180.3 million for 2005. During the three year period ended December 31, 2007, we acquired seven office buildings, ten medical office buildings, three retail centers and six industrial properties. During that same time frame, we sold five office buildings and one industrial center. These acquisitions and dispositions were the primary reason for the shifting of each groups percentage of total revenue reflected above.
No single tenant accounted for more than 3.6% of revenue in 2007, 3.7% of revenue in 2006, and 3.5% of revenue in 2005. All Federal government tenants in the aggregate accounted for approximately 2.2% of our 2007 total revenue. Federal government tenants include the Department of Defense, U.S. Patent and Trademark Office, Federal Bureau of Investigation, Office of Personnel Management, Secret Service, Federal Aviation Administration, NASA and the National Institutes of Health. WRITs larger non-federal government tenants include the World Bank, Sunrise Senior Living, Inc., Sun Microsystems, INOVA Health Systems, URS Corporation, George Washington University, United Communications Group, Westat and Lafarge North America, Inc.
5
We expect to continue investing in additional income producing properties. We only invest in properties which we believe will increase in income and value. Our properties compete for tenants with other properties throughout the respective areas in which they are located on the basis of location, quality and rental rates.
We are engaged in ground-up development in order to further strengthen our portfolio with long-term growth prospects. This year we continued construction on three ground-up development projects. The first is Bennett Park, a 224-unit multifamily property located in Arlington, VA. The majority of units at Bennett Park were delivered at the end of 2007. The second is The Clayborne Apartments, a 74-unit multifamily property located in Alexandria, VA. WRIT began delivering units at The Clayborne Apartments in February 2008. The third is Dulles Station, a Class A office property located in Herndon, VA. Dulles Station is entitled for two office buildings totaling 540,000 square feet. The first 180,000 square foot office building was completed in the third quarter 2007 and construction of the 360,000 square foot second building is being evaluated and is dependent on market conditions.
We make capital improvements on an ongoing basis to our properties for the purpose of maintaining and increasing their value and income. Major improvements and/or renovations to the properties in 2007, 2006, and 2005 are discussed under the heading Capital Improvements.
Further description of the property groups is contained in Item 2, Properties and in Schedule III. Reference is also made to Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations.
On February 21, 2008, we had 305 employees including 214 persons engaged in property management functions and 91 persons engaged in corporate, financial, leasing, asset management and other functions.
AVAILABILITY OF REPORTS
A copy of this Annual Report on Form 10-K, as well as our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to such reports are available, free of charge, on the Internet on our website www.writ.com. All required reports are made available on the website as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission. The reference to our website address does not constitute incorporation by reference of the information contained in the website and such information should not be considered part of this document.
ITEM 1A. | RISK FACTORS |
Set forth below are the risks that we believe are material to our shareholders. We refer to the shares of beneficial interest in Washington Real Estate Investment Trust as our shares, and the investors who own shares as our shareholders. This section includes or refers to certain forward-looking statements. You should refer to the explanation of the qualifications and limitations on such forward-looking statements beginning on page 49.
Our performance and value are subject to risks associated with our real estate assets and with the real estate industry.
Our economic performance and the value of our real estate assets are subject to the risk that if our office, medical office, industrial, multifamily and retail properties do not generate revenues sufficient to meet our operating expenses, including debt service and capital expenditures, our cash flow and ability to pay distributions to our shareholders will be adversely affected. The following factors, among others, may adversely affect the revenues generated by our commercial and multifamily properties:
| downturns in the national, regional and local economic climate; |
| competition from similar asset type properties; |
| local real estate market conditions, such as oversupply or reduction in demand for office, medical office, industrial, multi-family or retail properties; |
6
| changes in interest rates and availability of financing; |
| vacancies, changes in market rental rates and the need to periodically repair, renovate and re-let space; |
| increased operating costs, including insurance premiums, utilities and real estate taxes; |
| inflation; |
| weather conditions; |
| consumer confidence, unemployment rates, and consumer tastes and preferences; |
| civil disturbances, earthquakes and other natural disasters, terrorist acts or acts of war may result in uninsured or underinsured losses; |
| significant expenditures associated with each investment, such as debt service payments, real estate taxes, insurance and maintenance costs, are generally not reduced when circumstances cause a reduction in revenues from a property; and |
| the economic health of our tenants and the ability to collect rents. |
We are dependent upon the economic climate of the Washington metropolitan region.
All of our properties are located in the Washington metropolitan region, which exposes us to a greater amount of risk than if we were geographically diverse. General economic conditions and local real estate conditions in our geographic region may be dependent upon one or more industries, thus a downturn in one of the industries may have a particularly strong effect. In particular, economic conditions in our market are directly affected by Federal government spending in the region. In the event of reduced Federal spending or negative economic changes in our region, we may experience a negative impact to our profitability and may be limited in our ability to make distributions to our shareholders.
We face risks associated with property acquisitions.
We intend to continue to acquire properties which would continue to increase our size and could alter our capital structure. Our acquisition activities and success may be exposed to the following risks:
| we may be unable to acquire a desired property because of competition from other real estate investors, including publicly traded real estate investment trusts, institutional investment funds and private investors; |
| even if we enter into an acquisition agreement for a property, it is subject to customary conditions to closing, including completion of due diligence investigations which may have findings that are unacceptable; |
| competition from other real estate investors may significantly increase the purchase price; |
| we may be unable to finance acquisitions on favorable terms; |
| acquired properties may fail to perform as we expected in analyzing our investments; and |
| our estimates of the costs of repositioning or redeveloping acquired properties may be inaccurate. |
We may acquire properties subject to liabilities and without recourse, or with limited recourse, with respect to unknown liabilities. As a result, if liability were asserted against us based upon the acquisition of a property, we may have to pay substantial sums to settle it, which could adversely affect our cash flow. Unknown liabilities with respect to properties acquired might include:
| liabilities for clean-up of undisclosed environmental contamination; |
| claims by tenants, vendors or other persons dealing with the former owners of the properties; |
7
| liabilities incurred in the ordinary course of business; and |
| claims for indemnification by general partners, directors, officers and others indemnified by the former owners of the properties. |
We face new and different risks associated with property development.
The ground-up development of Bennett Park, The Clayborne Apartments, and Dulles Station, as opposed to renovation and redevelopment of an existing property, is a relatively new activity for WRIT. Developing properties, in addition to the risks historically associated with our business, presents a number of new and additional risks for us, including risks that:
| the development opportunity may be abandoned after expending significant resources resulting in the loss of deposits or failure to recover expenses already incurred, if we are unable to obtain all necessary zoning and other required governmental permits and authorizations or abandon the project for any other reason; |
| the development and construction costs of the project may exceed original estimates due to increased interest rates and increased materials, labor, leasing or other costs, which could make the completion of the project less profitable because market rents may not increase sufficiently to compensate for the increase in construction costs; |
| construction and/or permanent financing may not be available on favorable terms or may not be available at all, which may cause the cost of the project to increase and lower the expected return; |
| the project may not be completed on schedule as a result of a variety of factors, many of which are beyond our control, such as weather, labor conditions and material shortages, which would result in increases in construction costs and debt service expenses; and |
| occupancy rates and rents at the newly completed property may not meet the expected levels and could be insufficient to make the property profitable. |
Properties developed or acquired for development may generate little or no cash flow from the date of acquisition through the date of completion of development. In addition, new development activities, regardless of whether or not they are ultimately successful, may require a substantial portion of managements time and attention.
These risks could result in substantial unanticipated delays or expenses and, under certain circumstances, could prevent completion of development activities once undertaken, any of which could have an adverse effect on our financial condition, results of operations, cash flow, the trading price of our common shares, and ability to satisfy our debt service obligations and to pay dividends to shareholders.
We face potential difficulties or delays renewing leases or re-leasing space.
From 2008 through 2012, leases on our commercial properties will expire on a total of approximately 68% of our leased square footage as of December 31, 2007, with leases on approximately 13% of our leased square footage expiring in 2008, 14% in 2009, 17% in 2010, 13% in 2011 and 11% in 2012. We derive substantially all of our income from rent received from tenants. Also, if our tenants decide not to renew their leases, we may not be able to re-let the space. If tenants decide to renew their leases, the terms of renewals, including the cost of required improvements or concessions, may be less favorable than current lease terms. As a result, our cash flow could decrease and our ability to make distributions to our shareholders could be adversely affected. Residential properties are leased under operating leases with terms of generally one year or less. For the years ended 2007, 2006 and 2005, the residential tenant retention rate was 67%, 68% and 57%, respectively.
8
We face potential adverse effects from major tenants bankruptcies or insolvencies.
The bankruptcy or insolvency of a major tenant may adversely affect the income produced by a property. Although we have not experienced material losses from tenant bankruptcies or insolvencies in the past, a major tenant could file for bankruptcy protection or become insolvent in the future. We cannot evict a tenant solely because of its bankruptcy. On the other hand, a court might authorize the tenant to reject and terminate its lease. In such case, our claim against the bankrupt tenant for unpaid, future rent would be subject to a statutory cap that might be substantially less than the remaining rent actually owed under the lease, and, our claim for unpaid rent would likely not be paid in full. This shortfall could adversely affect our cash flow and results from operations. If a tenant experiences a downturn in its business or other types of financial distress, it may be unable to make timely rental payments.
Our properties face significant competition.
We face significant competition from developers, owners and operators of office, medical office, industrial, multifamily, retail and other commercial real estate. Substantially all of our properties face competition from similar properties in the same market. Such competition may affect our ability to attract and retain tenants and may reduce the rents we are able to charge. These competing properties may have vacancy rates higher than our properties, which may result in their owners being willing to make space available at lower prices than the space in our properties.
Compliance or failure to comply with the Americans with Disabilities Act and other laws could result in substantial costs.
The Americans with Disabilities Act generally requires that public buildings, including commercial and multifamily properties, be made accessible to disabled persons. Noncompliance could result in imposition of fines by the Federal government or the award of damages to private litigants. If, pursuant to the Americans with Disabilities Act, we are required to make substantial alterations and capital expenditures in one or more of our properties, including the removal of access barriers, it could adversely affect our financial condition and results of operations, as well as the amount of cash available for distribution to our shareholders. We may also incur significant costs complying with other regulations. Our properties are subject to various federal, state and local regulatory requirements, such as state and local fire and life safety requirements. If we fail to comply with these requirements, we may incur fines or private damage awards. We believe that our properties are currently in material compliance with all of these regulatory requirements. However, we do not know whether existing requirements will change or whether compliance with future requirements will require significant unanticipated expenditures that will adversely affect our cash flow and results from operations.
Some potential losses are not covered by insurance.
We carry insurance coverage on our properties of types and in amounts that we believe are in line with coverage customarily obtained by owners of similar properties. We believe all of our properties are adequately insured. The property insurance that we maintain for our properties has historically been on an all risk basis, which is in full force and effect until renewal in September 2009. There are other types of losses, such as from wars or catastrophic acts of nature, for which we cannot obtain insurance at all or at a reasonable cost. In the event of an uninsured loss or a loss in excess of our insurance limits, we could lose both the revenues generated from the affected property and the capital we have invested in the affected property. Depending on the specific circumstances of the affected property it is possible that we could be liable for any mortgage indebtedness or other obligations related to the property. Any such loss could adversely affect our business and financial condition and results of operations.
Also, we have to renew our policies in most cases on an annual basis and negotiate acceptable terms for coverage, exposing us to the volatility of the insurance markets, including the possibility of rate increases. Any material increase in insurance rates or decrease in available coverage in the future could adversely affect our results of operations and financial condition.
9
Potential liability for environmental contamination could result in substantial costs.
Under Federal, state and local environmental laws, ordinances and regulations, we may be required to investigate and clean up the effects of releases of hazardous or toxic substances or petroleum products at our properties, regardless of our knowledge or responsibility, simply because of our current or past ownership or operation of the real estate. In addition, the U.S. Environmental Protection Agency and the U.S. Occupational Safety and Health Administration are increasingly involved in indoor air quality standards, especially with respect to asbestos, mold and medical waste. The clean up of any environmental contamination, including asbestos and mold, can be costly. If unidentified environmental problems arise, we may have to make substantial payments which could adversely affect our cash flow, because:
| as owner or operator we may have to pay for property damage and for investigation and clean-up costs incurred in connection with the contamination; |
| the law typically imposes clean-up responsibility and liability regardless of whether the owner or operator knew of or caused the contamination; |
| even if more than one person may be responsible for the contamination, each person who shares legal liability under the environmental laws may be held responsible for all of the clean-up costs; and |
| governmental entities and third parties may sue the owner or operator of a contaminated site for damages and costs. |
These costs could be substantial and in extreme cases could exceed the value of the contaminated property. The presence of hazardous or toxic substances or petroleum products or the failure to properly remediate contamination may adversely affect our ability to borrow against, sell or rent an affected property. In addition, applicable environmental laws create liens on contaminated sites in favor of the government for damages and costs it incurs in connection with a contamination.
We have a storage tank third party liability, corrective action and cleanup policy in place to cover potential hazardous releases from underground storage tanks on our properties. This insurance is in place to mitigate any potential remediation costs from the effect of releases of hazardous or toxic substances from these storage tanks. Additional coverage is in place under a pollution legal liability real estate policy. This would, dependent on circumstance and type of pollutants discovered, provide further coverage above and beyond the storage tank policy.
Environmental laws also govern the presence, maintenance and removal of asbestos. Such laws require that owners or operators of buildings containing asbestos:
| properly manage and maintain the asbestos; |
| notify and train those who may come into contact with asbestos; and |
| undertake special precautions, including removal or other abatement, if asbestos would be disturbed during renovation or demolition of a building. |
Such laws may impose fines and penalties on building owners or operators who fail to comply with these requirements and may allow third parties to seek recovery from owners or operators for personal injury associated with exposure to asbestos fibers.
It is our policy to retain independent environmental consultants to conduct Phase I environmental site assessments and asbestos surveys with respect to our acquisition of properties. These assessments generally include a visual inspection of the properties and the surrounding areas, an examination of current and historical uses of the properties and the surrounding areas and a review of relevant state, Federal and historical documents, but do not always involve invasive techniques such as soil and ground water sampling. Where appropriate, on a property-by-property basis, our practice is to have these consultants conduct additional testing, including
10
sampling for asbestos, for mold, for lead in drinking water, for soil contamination where underground storage tanks are or were located or where other past site usages create a potential environmental problem, and for contamination in groundwater. Even though these environmental assessments are conducted, there is still the risk that:
| the environmental assessments and updates did not identify all potential environmental liabilities; |
| a prior owner created a material environmental condition that is not known to us or the independent consultants preparing the assessments; |
| new environmental liabilities have developed since the environmental assessments were conducted; and |
| future uses or conditions such as changes in applicable environmental laws and regulations could result in environmental liability to us. |
Recently enacted changes in securities laws are likely to increase our costs.
The Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the Securities and Exchange Commission, has required changes in some of our corporate governance and accounting practices. In addition, the New York Stock Exchange has promulgated a number of regulations. We expect these laws, rules and regulations to increase our legal and financial compliance costs and to continue to make some activities more difficult, time consuming and costly. We also expect these rules and regulations to continue to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we incur significantly higher costs to obtain coverage. These laws, rules and regulations could also make it more difficult for us to attract and retain qualified members of our board of trustees, particularly to serve on our audit committee, and qualified executive officers.
We face risks associated with the use of debt to fund acquisitions and developments, including refinancing risk.
We rely on borrowings under our credit facilities and offerings of debt securities to finance acquisitions and development activities and for working capital. The commercial real estate debt markets are currently experiencing volatility due to a number of factors, including the tightening of underwriting standards by lenders and credit rating agencies and the reported significant inventory of unsold mortgage backed securities in the market. The volatility has resulted in investors decreasing the availability of debt financing as well as increasing the cost of debt financing. As a result, we may not be able to obtain debt financing in the future on favorable terms, or at all. If we were unable to borrow under our credit facilities or to refinance existing debt financing, our financial condition and results of operations would likely be adversely affected.
We are subject to the risks normally associated with debt financing, including the risk that our cash flow may be insufficient to meet required payments of principal and interest. We anticipate that only a small portion of the principal of our debt will be repaid prior to maturity. Therefore, we are likely to need to refinance at least a portion of our outstanding debt as it matures. There is a risk that we may not be able to refinance existing debt or that the terms of any refinancing will not be as favorable as the terms of the existing debt. If principal payments due at maturity cannot be refinanced, extended or repaid with proceeds from other sources, such as new equity capital, our cash flow may not be sufficient to repay all maturing debt in years when significant balloon payments come due.
Rising interest rates would increase our interest costs.
We may incur indebtedness that bears interest at variable rates. Accordingly, if interest rates increase, so will our interest costs, which could adversely affect our cash flow and our ability to service debt. As a protection against rising interest rates, we may enter into agreements such as interest rate swaps, caps, floors and other interest rate exchange contracts. These agreements, however, increase our risks including other parties to the agreements not performing or that the agreements may be unenforceable.
11
Covenants in our debt agreements could adversely affect our financial condition.
Our credit facilities contain customary restrictions, requirements and other limitations on our ability to incur indebtedness. We must maintain certain ratios, including total debt to assets, secured debt to total assets, debt service coverage and minimum ratios of unencumbered assets to unsecured debt. Our ability to borrow under our credit facilities is subject to compliance with our financial and other covenants.
Failure to comply with any of the covenants under our unsecured credit facilities or other debt instruments could result in a default under one or more of our debt instruments. This could cause our lenders to accelerate the timing of payments and would therefore have a material adverse effect on our business, operations, financial condition and liquidity.
Further issuances of equity securities may be dilutive to current shareholders.
The interests of our existing shareholders could be diluted if additional equity securities are issued to finance future developments and acquisitions instead of incurring additional debt. Our ability to execute our business strategy depends on our access to an appropriate blend of debt financing, including unsecured lines of credit and other forms of secured and unsecured debt, and equity financing.
Failure to qualify as a REIT would cause us to be taxed as a corporation, which would substantially reduce funds available for payment of dividends.
If we fail to qualify as a REIT for federal income tax purposes, we would be taxed as a corporation. We believe that we are organized and qualified as a REIT and intend to operate in a manner that will allow us to continue to qualify as a REIT.
If we fail to qualify as a REIT we could face serious tax consequences that could substantially reduce the funds available for payment of dividends for each of the years involved because:
| we would not be allowed a deduction for dividends paid to shareholders in computing our taxable income and could be subject to federal income tax at regular corporate rates; |
| we also could be subject to the Federal alternative minimum tax and possibly increased state and local taxes; |
| unless we are entitled to relief under statutory provisions, we could not elect to be subject to tax as a REIT for four taxable years following the year during which we are disqualified; and |
| all dividends would be subject to tax as ordinary income to the extent of our current and accumulated earnings and profits potentially eligible as qualified dividends subject to the 15% income tax rate. |
In addition, if we fail to qualify as a REIT, we would no longer be required to pay dividends. As a result of these factors, our failure to qualify as a REIT could impair our ability to expand our business and raise capital, and could adversely affect the value of our shares.
The market value of our securities can be adversely affected by many factors.
As with any public company, a number of factors may adversely influence the public market price of our common shares, most of which are beyond our control. These factors include:
| level of institutional interest in us; |
| perceived attractiveness of investment in WRIT, in comparison to other REITs; |
| attractiveness of securities of REITs in comparison to other asset classes taking into account, among other things, that a substantial portion of REITs dividends are taxed as ordinary income; |
| our financial condition and performance; |
12
| the markets perception of our growth potential and potential future cash dividends; |
| government action or regulation, including changes in tax law; |
| increases in market interest rates, which may lead investors to expect a higher annual yield from our distributions in relation to the price of our shares; and |
| relatively low trading volume of shares of REITs in general, which tends to exacerbate a market trend with respect to our stock. |
Provisions of the Maryland General Corporation Law, or the MGCL, may limit a change in control of our company.
There are several provisions of the Maryland General Corporation Law, or the MGCL, that may limit the ability of a third party to acquire a change in control of our company, including:
| a provision where a corporation is not required to engage in any business combination with any interested stockholder, defined as any holder or affiliate of any holder of 10% or more of the corporations stock, for a period of five years pursuant to that holder becoming an interested stockholder; |
| a provision where the voting rights of control shares acquired in a control share acquisition, as defined in the law, may be restricted, such that the control shares have no voting rights, except to the extent approved by a vote of two-thirds of the votes entitled to be cast on the matter. |
These provisions may delay, defer, or prevent a transaction or a change in control of our company that may involve a premium price for holders of our common stock or otherwise be in their best interests.
ITEM 1B. | UNRESOLVED STAFF COMMENTS |
None.
ITEM 2. | PROPERTIES |
The schedule on the following pages lists our real estate investment portfolio as of December 31, 2007, which consisted of 89 properties.
As of December 31, 2007, the percent leased is the percentage of net rentable area for which fully executed leases exist and may include signed leases for space not yet occupied by the tenant.
Cost information is included in Schedule III to our financial statements included in this Annual Report on Form 10-K.
13
SCHEDULE OF PROPERTIES | |||||||||||
Properties |
Location |
Year Acquired |
Year Constructed |
Net Rentable Square Feet |
Percent Leased 12/31/07 |
||||||
Office Buildings |
|||||||||||
1901 Pennsylvania Avenue |
Washington, D.C. | 1977 | 1960 | 97,000 | 100 | % | |||||
51 Monroe Street |
Rockville, MD | 1979 | 1975 | 210,000 | 97 | % | |||||
515 King Street |
Alexandria, VA | 1992 | 1966 | 76,000 | 95 | % | |||||
The Lexington Building |
Rockville, MD | 1993 | 1970 | 46,000 | 100 | % | |||||
The Saratoga Building |
Rockville, MD | 1993 | 1977 | 58,000 | 100 | % | |||||
Brandywine Center |
Rockville, MD | 1993 | 1969 | 35,000 | 94 | % | |||||
6110 Executive Boulevard |
Rockville, MD | 1995 | 1971 | 198,000 | 96 | % | |||||
1220 19th Street |
Washington, D.C. | 1995 | 1976 | 102,000 | 100 | % | |||||
1600 Wilson Boulevard |
Arlington, VA | 1997 | 1973 | 166,000 | 100 | % | |||||
7900 Westpark Drive |
McLean, VA | 1997 | 1972/1986/1999 | 523,000 | 94 | % | |||||
600 Jefferson Plaza |
Rockville, MD | 1999 | 1985 | 112,000 | 96 | % | |||||
1700 Research Boulevard |
Rockville, MD | 1999 | 1982 | 101,000 | 100 | % | |||||
Parklawn Plaza |
Rockville, MD | 1999 | 1986 | 40,000 | 100 | % | |||||
Wayne Plaza |
Silver Spring, MD | 2000 | 1970 | 91,000 | 99 | % | |||||
Courthouse Square |
Alexandria, VA | 2000 | 1979 | 113,000 | 100 | % | |||||
One Central Plaza |
Rockville, MD | 2001 | 1974 | 267,000 | 93 | % | |||||
The Atrium Building |
Rockville, MD | 2002 | 1980 | 80,000 | 98 | % | |||||
1776 G Street |
Washington, D.C. | 2003 | 1979 | 263,000 | 100 | % | |||||
Albemarle Point |
Chantilly, VA | 2005 | 2001 | 89,000 | 95 | % | |||||
6565 Arlington Blvd |
Falls Church, VA | 2006 | 1967/1998 | 140,000 | 93 | % | |||||
West Gude Drive |
Rockville, MD | 2006 | 1984/1986/1988 | 289,000 | 95 | % | |||||
The Ridges |
Gaithersburg, MD | 2006 | 1990 | 104,000 | 100 | % | |||||
Monument II |
Herndon, VA | 2007 | 2000 | 205,000 | 97 | % | |||||
Woodholme Center |
Pikesville, MD | 2007 | 1989 | 73,000 | 95 | % | |||||
2000 M Street |
Washington, D.C. | 2007 | 1971 | 227,000 | 100 | % | |||||
Subtotal |
3,705,000 | 97 | % | ||||||||
Medical Office Buildings |
|||||||||||
Woodburn Medical Park I |
Annandale, VA | 1998 | 1984 | 71,000 | 98 | % | |||||
Woodburn Medical Park II |
Annandale, VA | 1998 | 1988 | 96,000 | 100 | % | |||||
Prosperity Medical Center I |
Merrifield, VA | 2003 | 2000 | 92,000 | 100 | % | |||||
Prosperity Medical Center II |
Merrifield, VA | 2003 | 2001 | 88,000 | 100 | % | |||||
Prosperity Medical Center III |
Merrifield, VA | 2003 | 2002 | 75,000 | 100 | % | |||||
Shady Grove Medical Village II |
Rockville, MD | 2004 | 1999 | 66,000 | 100 | % | |||||
8301 Arlington Boulevard |
Fairfax, VA | 2004 | 1965 | 49,000 | 97 | % | |||||
Alexandria Professional Center |
Alexandria, VA | 2006 | 1968 | 113,000 | 99 | % | |||||
9707 Medical Center Drive |
Rockville, MD | 2006 | 1994 | 38,000 | 100 | % | |||||
15001 Shady Grove Road |
Rockville, MD | 2006 | 1999 | 51,000 | 100 | % | |||||
Plumtree Medical Center |
Bel Air, MD | 2006 | 1991 | 33,000 | 100 | % | |||||
15005 Shady Grove Road |
Rockville, MD | 2006 | 2002 | 52,000 | 100 | % | |||||
The Crescent |
Gaithersburg, MD | 2006 | 1989 | 49,000 | 66 | % | |||||
2440 M Street |
Washington, D.C. | 2007 | 1986/2006 | 110,000 | 95 | % | |||||
Woodholme Medical Office Bldg |
Pikesville, MD | 2007 | 1996 | 125,000 | 97 | % | |||||
Ashburn Farm Office Park |
Ashburn, VA | 2007 | 1998/2000/2002 | 75,000 | 100 | % | |||||
CentreMed I & II |
Centreville, VA | 2007 | 1998 | 52,000 | 100 | % | |||||
Subtotal |
1,235,000 | 98 | % | ||||||||
Retail Centers |
|||||||||||
Takoma Park |
Takoma Park, MD | 1963 | 1962 | 51,000 | 100 | % | |||||
Westminster |
Westminster, MD | 1972 | 1969 | 151,000 | 100 | % | |||||
Concord Centre |
Springfield, VA | 1973 | 1960 | 76,000 | 100 | % | |||||
Wheaton Park |
Wheaton, MD | 1977 | 1967 | 72,000 | 100 | % | |||||
Bradlee |
Alexandria, VA | 1984 | 1955 | 168,000 | 97 | % | |||||
Chevy Chase Metro Plaza |
Washington, D.C. | 1985 | 1975 | 49,000 | 100 | % | |||||
Montgomery Village Center |
Gaithersburg, MD | 1992 | 1969 | 198,000 | 98 | % | |||||
Shoppes of Foxchase1 |
Alexandria, VA | 1994 | 1960 | 134,000 | 89 | % | |||||
Frederick County Square |
Frederick, MD | 1995 | 1973 | 227,000 | 98 | % |
14
SCHEDULE OF PROPERTIES (continued) | |||||||||||
Properties |
Location |
Year Acquired |
Year Constructed |
Net Rentable Square Feet |
Percent Leased 12/31/07 |
||||||
Retail Centers (continued) |
|||||||||||
800 S. Washington Street |
Alexandria, VA | 1998/2003 | 1955/1959 | 44,000 | 95 | % | |||||
Centre at Hagerstown |
Hagerstown, MD | 2002 | 2000 | 332,000 | 100 | % | |||||
Frederick Crossing |
Frederick, MD | 2005 | 1999/2003 | 295,000 | 99 | % | |||||
Randolph Shopping Center |
Rockville, MD | 2006 | 1972 | 82,000 | 95 | % | |||||
Montrose Shopping Center |
Rockville, MD | 2006 | 1970 | 143,000 | 96 | % | |||||
Subtotal |
2,022,000 | 98 | % | ||||||||
Multifamily Buildings / # units |
|||||||||||
3801 Connecticut Avenue / 307 |
Washington, D.C. | 1963 | 1951 | 179,000 | 96 | % | |||||
Roosevelt Towers / 191 |
Falls Church, VA | 1965 | 1964 | 170,000 | 87 | % | |||||
Country Club Towers / 227 |
Arlington, VA | 1969 | 1965 | 163,000 | 94 | % | |||||
Park Adams / 200 |
Arlington, VA | 1969 | 1959 | 173,000 | 94 | % | |||||
Munson Hill Towers / 279 |
Falls Church, VA | 1970 | 1963 | 259,000 | 94 | % | |||||
The Ashby at McLean / 253 |
McLean, VA | 1996 | 1982 | 252,000 | 93 | % | |||||
Walker House Apartments / 212 |
Gaithersburg, MD | 1996 | 1971/20032 | 159,000 | 97 | % | |||||
Bethesda Hill Apartments / 195 |
Bethesda, MD | 1997 | 1986 | 226,000 | 89 | % | |||||
Avondale / 237 |
Laurel, MD | 1999 | 1987 | 170,000 | 90 | % | |||||
Bennett Park / 211 |
Arlington, VA | 2007 | 2007 | 268,000 | 24 | % | |||||
Subtotal (2,312 units) |
2,019,000 | 87 | % | ||||||||
Industrial/Flex Properties |
|||||||||||
Fullerton Business Center |
Springfield, VA | 1985 | 1980 | 104,000 | 100 | % | |||||
Charleston Business Center |
Rockville, MD | 1993 | 1973 | 85,000 | 95 | % | |||||
Tech 100 Industrial Park |
Elkridge, MD | 1995 | 1990 | 166,000 | 97 | % | |||||
Crossroads Distribution Center |
Elkridge, MD | 1995 | 1987 | 85,000 | 100 | % | |||||
The Alban Business Center |
Springfield, VA | 1996 | 1981/1982 | 87,000 | 100 | % | |||||
The Earhart Building |
Chantilly, VA | 1996 | 1987 | 92,000 | 86 | % | |||||
Ammendale Technology Park I |
Beltsville, MD | 1997 | 1985 | 167,000 | 91 | % | |||||
Ammendale Technology Park II |
Beltsville, MD | 1997 | 1986 | 107,000 | 91 | % | |||||
Pickett Industrial Park |
Alexandria, VA | 1997 | 1973 | 246,000 | 94 | % | |||||
Northern Virginia Industrial Park |
Lorton, VA | 1998 | 1968/1991 | 787,000 | 97 | % | |||||
8900 Telegraph Road |
Lorton, VA | 1998 | 1985 | 32,000 | 100 | % | |||||
Dulles South IV |
Chantilly, VA | 1999 | 1988 | 83,000 | 100 | % | |||||
Sully Square |
Chantilly, VA | 1999 | 1986 | 95,000 | 74 | % | |||||
Amvax |
Beltsville, MD | 1999 | 1986 | 31,000 | 100 | % | |||||
Sullyfield Center |
Chantilly, VA | 2001 | 1985 | 244,000 | 84 | % | |||||
Fullerton Industrial Center |
Springfield, VA | 2003 | 1980 | 137,000 | 97 | % | |||||
8880 Gorman Road |
Laurel, MD | 2004 | 2000 | 141,000 | 100 | % | |||||
Dulles Business Park Portfolio |
Chantilly, VA | 2004/2005 | 1999-2005 | 324,000 | 96 | % | |||||
Albemarle Point |
Chantilly, VA | 2005 | 2001/2003/2005 | 207,000 | 100 | % | |||||
Hampton Overlook |
Capital Heights, MD | 2006 | 1989 | 134,000 | 96 | % | |||||
Hampton South |
Capital Heights, MD | 2006 | 1989/2005 | 168,000 | 100 | % | |||||
9950 Business Parkway |
Lanham, MD | 2006 | 2005 | 102,000 | 100 | % | |||||
270 Technology Park |
Frederick, MD | 2007 | 1986-1987 | 157,000 | 87 | % | |||||
Subtotal |
3,781,000 | 95 | % | ||||||||
TOTAL |
12,762,000 | ||||||||||
1 |
Development on approximately 60,000 square feet of the center was completed in December 2006. |
2 |
A 16 unit addition referred to as The Gardens at Walker House was completed in October 2003. |
* | Multifamily buildings are presented in gross square feet. |
15
ITEM 3. | LEGAL PROCEEDINGS |
None.
ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
No matters were submitted to a vote of security holders during the fourth quarter of 2007.
16
PART II
ITEM 5. | MARKET FOR THE REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
Our shares trade on the New York Stock Exchange. Currently, there are approximately 48,500 shareholders.
The high and low sales price for our shares for 2007 and 2006, by quarter, and the amount of dividends we paid per share are as follows:
Quarter |
Dividends Per Share |
Quarterly Share Price Range | |||||||
High |
Low | ||||||||
2007 |
|||||||||
Fourth |
$ | .4225 | $ | 35.81 | $ | 29.57 | |||
Third |
$ | .4225 | $ | 35.12 | $ | 28.97 | |||
Second |
$ | .4225 | $ | 39.43 | $ | 33.17 | |||
First |
$ | .4125 | $ | 43.33 | $ | 36.50 | |||
2006 |
|||||||||
Fourth |
$ | .4125 | $ | 43.40 | $ | 38.36 | |||
Third |
$ | .4125 | $ | 41.89 | $ | 35.90 | |||
Second |
$ | .4125 | $ | 39.17 | $ | 33.70 | |||
First |
$ | .4025 | $ | 36.61 | $ | 30.06 |
We have historically paid dividends on a quarterly basis. Dividends are normally paid based on our cash flow from operating activities.
During the period covered by this report, we did not sell equity securities without registration under the Securities Act.
Neither we nor any affiliated purchaser (as that term is defined in Securities Exchange Act Rule 10b-18(a) (3)) made any repurchases of our shares during the fourth quarter of the fiscal years covered by this report.
ITEM 6. | SELECTED FINANCIAL DATA |
2007 |
2006 |
2005 |
2004 |
2003 | |||||||||||
(in thousands, except per share data) | |||||||||||||||
Real estate rental revenue |
$ | 255,655 | $ | 208,741 | $ | 180,255 | $ | 162,631 | $ | 143,085 | |||||
Income from continuing operations |
$ | 32,139 | $ | 35,620 | $ | 37,390 | $ | 38,061 | $ | 36,317 | |||||
Discontinued Operations: |
|||||||||||||||
Income from operations of properties sold or held for sale |
$ | 4,720 | $ | 3,041 | $ | 3,237 | $ | 6,474 | $ | 8,570 | |||||
Gain on property disposed |
$ | 25,022 | | $ | 37,011 | $ | 1,029 | | |||||||
Net income |
$ | 61,881 | $ | 38,661 | $ | 77,638 | $ | 45,564 | $ | 44,887 | |||||
Income per share from continuing operationsdiluted |
$ | 0.70 | $ | 0.81 | $ | 0.89 | $ | 0.91 | $ | 0.92 | |||||
Earnings per sharediluted |
$ | 1.34 | $ | 0.88 | $ | 1.84 | $ | 1.09 | $ | 1.13 | |||||
Total assets |
$ | 1,898,326 | $ | 1,531,265 | $ | 1,139,159 | $ | 1,012,393 | $ | 928,089 | |||||
Lines of credit payable |
$ | 192,500 | $ | 61,000 | $ | 24,000 | $ | 117,000 | | ||||||
Mortgage notes payable |
$ | 252,484 | $ | 229,240 | $ | 161,631 | $ | 164,942 | $ | 133,406 | |||||
Notes payable |
$ | 879,123 | $ | 728,255 | $ | 518,600 | $ | 319,597 | $ | 374,493 | |||||
Shareholders equity |
$ | 486,544 | $ | 441,931 | $ | 380,305 | $ | 366,009 | $ | 378,748 | |||||
Cash dividends paid |
$ | 78,050 | $ | 72,681 | $ | 67,322 | $ | 64,836 | $ | 58,605 | |||||
Cash dividends declared and paid per share |
$ | 1.68 | $ | 1.64 | $ | 1.60 | $ | 1.55 | $ | 1.47 |
* | See footnote 3 which indicates the Companys acquisitions and dispositions as such activity impacts the comparability of the information year to year. |
17
ITEM 7. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, we evaluate these estimates, including those related to estimated useful lives of real estate assets, estimated fair value of acquired leases, cost reimbursement income, bad debts, contingencies and litigation. We base the estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. There can be no assurance that actual results will not differ from those estimates.
Overview
Our revenues are derived primarily from the ownership and operation of income-producing properties in the greater Washington metro region. As of December 31, 2007, we owned a diversified portfolio of 89 properties, consisting of 14 retail centers, 25 office properties, 17 medical office properties, 23 industrial/flex properties, 10 multifamily properties encompassing in the aggregate 12.8 million net rentable square feet, and land for development. We have a fundamental strategy of regional focus, diversification by property type and conservative capital management.
When evaluating our financial condition and operating performance, management focuses on the following financial and non-financial indicators, discussed in further detail herein:
| Net Operating Income (NOI) by segment. NOI is calculated as real estate rental revenue less real estate operating expenses excluding depreciation and general and administrative. It is a supplemental measure to Net Income. |
| Economic occupancy (or occupancydefined as actual rental revenues recognized for the period indicated as a percentage of gross potential rental revenues for that period), leased percentage (the percentage of available physical net rentable area leased for our commercial segments and percentage of apartment units leased for our residential segment) and rental rates. |
| Leasing activitynew leases, renewals and expirations. |
| Funds From Operations (FFO), a supplemental measure to Net Income. |
During 2007, we continued our fundamental strategy of investing in diversified property types in the greater Washington metro region. The areas economy continues to expand and overall economic conditions in the region remain healthy. The unemployment rate for the Washington metro area is 3.1%, compared to 4.7% nationally, as of October 2007. Job growth increased 1.4%, compared to 1.2% nationally. Professional and business services, retail trade, and leisure and hospitality sectors led job growth in the metro area in 2007. The Washington metro area economy is forecasted to expand at a modest pace in 2008, adding 47,400 new payroll jobs, according to Delta Associates and economist Dr. Steven Fuller of George Mason University.
Overall occupancies, as well as our results in 2007, were primarily impacted by acquisitions and dispositions and the performance of our core portfolio. In 2007 and 2006, we completed acquisitions and dispositions totaling, $622.3 million and $58.0 million, respectively. The performance of our core portfolio, consisting of properties owned for the entirety of 2007 and the same time period in 2006, improved compared to 2006.
The performance of our five operating segments generally reflected market conditions in our region:
| The regional office market expanded at a modest pace during 2007. The Washington metro region has the fifth lowest overall vacancy rate in the United States at 9.1%. Vacancy in the submarkets was 10.3% for Northern Virginia, 10.6% for Suburban Maryland, and 6.4% in the District of Columbia. Net |
18
absorption was below average in all submarkets; however, the pipeline increased to 20.6 million SF from 16.8 million SF in the prior year. Our office portfolio was 96.7% leased at year-end 2007, an increase from 93.3% leased in the prior year. By submarket, our office portfolio was 96.0% leased in Northern Virginia, 95.8% leased in Suburban Maryland, and 100% leased in the District of Columbia. |
| The medical office market in the region is very healthy. Demand for medical services continues to increase, especially with the aging baby boomer population. Our medical office portfolio was 97.5% leased as of year-end 2007. |
| The regions retail market continued its strong performance in 2007. Vacancy in the region for grocery-anchored shopping centers was 2.3%, compared to the long-term average of 3.3%. Arlington County, District of Columbia, and Montgomery County submarkets performed the strongest with vacancy below 2.0%; 9 of WRITs 14 retail properties are located in these top performing submarkets. Rental rates in the region increased 3.9% in 2007. Our retail portfolio was 97.6% leased at year-end 2007. |
| The multifamily sector grew at a modest pace in 2007. Demand for apartments remains high with the areas low unemployment rate, new payroll jobs, and a transient workforce. Vacancy in the Washington metro region for investment grade apartments was 3.7% at year-end. Our multifamily portfolio was 87% leased at year-end 2007. |
| The industrial market has improved since last year and is on solid footing. Rents have increased 2.8% and vacancy decreased to 9.5%, compared to 9.8% one year ago. Net absorption increased to 6.6 million SF, compared to 4.3 million SF in 2006. Our industrial portfolio experienced positive rental rate growth and was 95.1% leased at year-end 2007. |
During 2007, we completed the development of Dulles Station Phase One and delivered the majority of units at Bennett Park. Subsequent to the year-end, we began delivering units at The Clayborne Apartments. Dulles Station Phase One is a Class A office property located in Herndon, VA. Bennett Park is a Class A high-rise and mid-rise apartment community with retail space located in Arlington, VA. The Clayborne Apartments is a Class A apartment building with retail space located in Alexandria, VA.
Significant transactions during the two years ended December 31, 2007 are summarized below:
2007
| The acquisition of three office properties for $169.9 million adding approximately 505,000 square feet which were 98.0% leased at the end of 2007, four medical office properties for $119.1 million adding approximately 362,000 square feet which were 97.5% leased at the end of 2007, one industrial/flex property for $26.5 million adding approximately 157,000 square feet which was 87.3% leased at the end of 2007, and land held for development funded by issuing operating partnership units in a consolidated subsidiary of WRIT. |
| The disposition of two office buildings for a contract sales price of $58.0 million and a gain on sale of $25.0 million. |
| The issuance of $150.0 million of 3.875% convertible senior unsecured notes due 2026, raising $146.0 million, net. |
| The completion of a public offering of 1,600,000 shares of beneficial interest priced at $37.00 per share raising $57.8 million, net. |
| The opening of a new unsecured revolving credit facility with a committed capacity of $75.0 million and a maturity date of June 29, 2011. |
| The completion of modification to our bond covenants from a restrictive total assets definition to a market based asset definition. |
19
| The investment of $66.5 million in our development projects. |
| The execution of new leases for 1,765,000 square feet of commercial space. |
2006
| The acquisition of six medical office properties for $105.9 million, adding approximately 336,000 square feet of rentable space, 98.3% leased at the end of 2006; three office properties for $112.0 million adding approximately 533,000 square feet of rentable space, 92.6% leased at the end of 2006; three industrial/flex properties for $34.8 million, adding approximately 404,000 square feet of rentable space, 82.3% leased at the end of 2006; and two retail centers, for $50.3 million, adding approximately 225,000 square feet of rentable space, 70.8% leased as of the end of 2006. |
| The completion of a public offering of 2,745,000 shares of beneficial interest priced at $34.40 per share raising $90.9 million, net. |
| The issuance of $100.0 million of 5.95% senior unsecured notes due June 15, 2011 at an effective yield of 5.961% raising $99.4 million, net. |
| The issuance of $50.0 million of 5.95% senior unsecured notes due June 15, 2011 at an effective yield of 5.917% raising $50.2 million, net. |
| The issuance of $100 million in convertible senior notes with a coupon of 3.875%, raising $97.0 million, net and the issuance of an additional $10.0 million of the convertible senior notes upon the exercise of the underwriters over-allotment option, raising an additional $9.7 million, net. |
| The opening of a new, unsecured revolving credit facility of $200.0 million. This facility replaces Credit Facility No. 3. The new Credit Facility matures on November 2, 2010. |
| The investment of $68.6 million in the major development and redevelopment of several properties. |
| The execution of new leases for 1,611,000 square feet of commercial space. |
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We believe the following critical accounting policies reflect the more significant judgments and estimates used in the preparation of our consolidated financial statements. Our significant accounting policies are described in Note 2 in the Notes to the Consolidated Financial Statements in Item 8 of this Form 10-K.
New Accounting Pronouncements
In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of SFAS 109, Accounting for Income Taxes (FIN 48). FIN 48 prescribes how we should recognize, measure and present in our financial statements uncertain tax positions that have been taken or are expected to be taken in a tax return. Pursuant to FIN 48, we can recognize a tax benefit only if it is more likely than not that a particular tax position will be sustained upon examination or audit. To the extent the more likely than not standard has been satisfied, the benefit associated with a tax position is measured as the largest amount that is greater than 50% likely of being realized upon settlement.
We are subject to U.S. federal income tax as well as income tax of the states of Maryland and Virginia and the District of Columbia but, as a REIT, we generally are not subject to income tax on our net income distributed as dividends to our shareholders. As required, we adopted FIN 48 effective January 1, 2007 and have concluded that the effect is not material to our consolidated financial statements. Accordingly, we did not record a cumulative effect adjustment related to the adoption of FIN 48.
Tax returns filed for the 2004 through 2007 tax years are subject to examination by taxing authorities. We classify interest and penalties related to uncertain tax positions, if any, in our financial statements as a component of general and administrative expense.
20
In September 2006, the FASB issued FASB Statement No. 157, Fair Value Measurements (SAFS No. 157). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. On February 12, 2007, the FASB issued FASB Staff Position No. FAS 157-2, Effective Date of FASB Statement No. 157 (the FSP). The FSP amends SFAS No. 157 to delay the effective date for all non-financial assets and non-financial liabilities, except for those that are recognized or disclosed at fair value in the financial statements on a recurring basis (i.e. at least annually). The FSP defers the effective date of SFAS No. 157 to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years for items within the scope of the proposed FSP. The effective date of the statement related to those items not covered by the deferral (all financial assets and liabilities or non-financial assets and liabilities recorded at fair value on a recurring basis) is for fiscal years beginning after November 15, 2007. We do not have significant assets or liabilities recorded at fair value on a recurring basis, and therefore do not expect adoption of this statement to have a material impact on our financial statements upon adoption. However, this statement will require us to provide expanded disclosures of our valuation techniques.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial LiabilitiesIncluding an Amendment of FASB Statement No. 115. SFAS No. 159 permits entities to choose to measure eligible items at fair value at specified election dates and report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We have not elected the fair value option for any assets or liabilities, and therefore do not expect adoption of the statement to have a material impact on our financial statements upon adoption.
The FASB has released an exposure draft of FASB Staff Position APB 14-a (the proposed FSP) for comment. This proposed guidance clarifies the accounting for convertible debt instruments that may be settled in cash (including partial cash settlement) upon conversion. If issued in final form, the guidance will significantly impact the accounting of the Companys convertible debt. The proposed FSP would require bifurcation of a component of the debt, classification of that component in stockholders equity, and then accretion of the resulting discount on the debt to result in interest expense equal to the issuers nonconvertible debt borrowing rate. The calculation of earnings-per-share would not be affected, other than the impact on net income from the debt discount amortization. In a November 26, 2007 update to its website, the FASB announced it is expected to begin its redeliberations of the guidance in that proposed FSP in January 2008. Final guidance will not be issued until at least the first quarter of 2008, and we are therefore unsure of the final effective date. We believe that adoption of the proposed FSP could have a significant impact on our financial statements if adopted in its current form due to our convertible debt outstanding, but have not quantified the impact because it is uncertain what the final FSP will require.
In December 2007, the FASB issued SFAS No. 141(R), Business Combinations, a revision of SFAS No. 141. This statement changes the accounting for acquisitions specifically eliminating the step acquisition model, changing the recognition of contingent consideration from being recognized when it is probable to being recognized at the time of acquisition, disallowing the capitalization of transaction costs, and delays when restructuring related to acquisitions can be recognized. The standard is effective for fiscal years beginning after December 15, 2008, and will only impact the accounting for acquisitions we make after our adoption. Accordingly, upon our adoption of this standard on January 1, 2009, there will not be any impact on our historical financial statements.
Also in December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, which clarifies the classification of noncontrolling interests in consolidated statements of financial position and the accounting for and reporting of transactions between the reporting entity and holders of such noncontrolling interests. Under the new standard noncontrolling interests are considered equity and should be reported as an element of consolidated equity. Net income will encompass the total income of all consolidated subsidiaries and there will be a separate disclosure on the face of the income statement of the attribution of that
21
income between the controlling and noncontrolling interests. Increases and decreases in the noncontrolling ownership interest amount will be accounted for as equity transactions. The standard is effective for fiscal years beginning after December 15, 2008. The Company is in the process of assessing the impact of the revised SFAS on its financial statements.
Revenue Recognition
Residential properties (our multifamily segment) are leased under operating leases with terms of generally one year or less, and commercial properties (our office, medical office, retail and industrial segments) are leased under operating leases with average terms of three to seven years. We recognize rental income and rental abatements from our residential and commercial leases when earned on a straight-line basis in accordance with SFAS No. 13 Accounting for Leases. Recognition of rental income commences when control of the facility has been given to the tenant. We record a provision for losses on accounts receivable equal to the estimated uncollectible amounts. This estimate is based on our historical experience and a review of the current status of the Companys receivables. Percentage rents, which represent additional rents based on gross tenant sales, are recognized when tenants sales exceed specified thresholds.
In accordance with SFAS No. 66, Accounting for Sales of Real Estate, sales are recognized at closing only when sufficient down payments have been obtained, possession and other attributes of ownership have been transferred to the buyer and we have no significant continuing involvement.
We recognize cost reimbursement income from pass-through expenses on an accrual basis over the periods in which the expenses were incurred. Pass-through expenses are comprised of real estate taxes, operating expenses and common area maintenance costs which are reimbursed by tenants in accordance with specific allowable costs per tenant lease agreements.
Capital Expenditures
We capitalize those expenditures related to acquiring new assets, significantly increasing the value of an existing asset, or substantially extending the useful life of an existing asset. We also capitalize costs incurred in connection with our development projects, including capitalizing interest during periods in which development projects are in progress. Expenditures necessary to maintain an existing property in ordinary operating condition are expensed as incurred. In addition, we capitalize tenant leasehold improvements when certain conditions are met, including when we supervise construction and will own the improvements.
Real Estate Assets
Real estate assets are depreciated on a straight-line basis over estimated useful lives ranging from 28 to 50 years. All capital improvement expenditures associated with replacements, improvements, or major repairs to real property are depreciated using the straight-line method over their estimated useful lives ranging from 3 to 30 years. All tenant improvements are amortized over the shorter of the useful life or the term of the lease.
We allocate the purchase price of acquired properties to the related physical assets and in-place leases based on their relative fair values, in accordance with SFAS No. 141, Business Combinations. The fair values of acquired buildings are determined on an as-if-vacant basis considering a variety of factors, including the physical condition and quality of the buildings, estimated rental and absorption rates, estimated future cash flows and valuation assumptions consistent with current market conditions. The as-if-vacant fair value is allocated to land, building and tenant improvements based on property tax assessments and other relevant information obtained in connection with the acquisition of the property.
The fair value of in-place leases consists of the following components(1) the estimated cost to us to replace the leases, including foregone rents during the period of finding a new tenant and foregone recovery of tenant pass-throughs (referred to as Absorption Cost), (2) the estimated cost of tenant improvements, and other direct costs associated with obtaining a new tenant (referred to as Tenant Origination Cost); (3) estimated leasing
22
commissions associated with obtaining a new tenant (referred to as Leasing Commissions); (4) the above/at/below market cash flow of the leases, determined by comparing the projected cash flows of the leases in place to projected cash flows of comparable market-rate leases (referred to as Net Lease Intangible); and (5) the value, if any, of customer relationships, determined based on our evaluation of the specific characteristics of each tenants lease and our overall relationship with the tenant (referred to as Customer Relationship Value).
The amounts used to calculate Net Lease Intangible are discounted using an interest rate which reflects the risks associated with the leases acquired. Tenant Origination Costs are included in Real Estate Assets on our balance sheet and are amortized as depreciation expense on a straight-line basis over the remaining life of the underlying leases. Leasing Commissions and Absorption Costs are classified as Other Assets and are amortized as amortization expense on a straight-line basis over the remaining life of the underlying leases. Net Lease Intangible Assets are classified as Other Assets and are amortized on a straight-line basis as a decrease to Real Estate Rental Revenue over the remaining term of the underlying leases. Net Lease Intangible Liabilities are classified as Other Liabilities and are amortized on a straight-line basis as an increase to Real Estate Rental Revenue over the remaining term of the underlying leases. Should a tenant terminate its lease, the unamortized portion of the Tenant Origination Cost, Leasing Commissions, Absorption Costs and Net Lease Intangible associated with that lease are written off to depreciation expense, amortization expense, and rental revenue, respectively. We have attributed no value to Customer Relationship Value as of December 31, 2007 or December 31, 2006.
Assets Held for Sale/Discontinued Operations
We dispose of assets (sometimes using tax-deferred exchanges) that are inconsistent with our long-term strategic or return objectives and when market conditions for sale are favorable. The proceeds from the sales are reinvested into other properties, used to fund development operations or to support other corporate needs, or are distributed to our shareholders.
We classify properties as held for sale when they meet the necessary criteria specified by SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. These include: senior management commits to and actively embarks upon a plan to sell the assets, the sale is expected to be completed within one year under terms usual and customary for such sales and actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. Depreciation on these properties is discontinued, but operating revenues, operating expenses and interest expense continue to be recognized until the date of sale.
Under SFAS No. 144, revenues and expenses of properties that are either sold or classified as held for sale are treated as discontinued operations for all periods presented in the Statements of Income.
Impairment Losses on Long-Lived Assets
We recognize impairment losses on long-lived assets used in operations, development or land held for future development, when indicators of impairment are present and the net undiscounted cash flows estimated to be generated by those assets are less than the assets carrying amount and estimated undiscounted cash flows associated with future development expenditures. If such carrying amount is in excess of the estimated cash flows from the operation and disposal of the property, we would recognize an impairment loss equivalent to an amount required to adjust the carrying amount to the estimated fair value. There were no property impairments recognized during the three-year period ended December 31, 2007.
Federal Income Taxes
We believe that we qualify as a REIT under Sections 856-860 of the Internal Revenue Code and intend to continue to qualify as such. To maintain our status as a REIT, we are required to distribute 90% of our ordinary
23
taxable income to our shareholders. We have the option of (i) reinvesting the sale price of properties sold, allowing for a deferral of income taxes on the sale, (ii) paying out capital gains to the shareholders with no tax to the company or (iii) treating the capital gains as having been distributed to the shareholders, paying the tax on the gain deemed distributed and allocating the tax paid as a credit to the shareholders. In September 2007 Maryland Trade Centers I and II were sold for a gain of $25.0 million. The proceeds from the sale were reinvested in replacement properties. We distributed 100% of our 2007 and 2006 ordinary taxable income to shareholders. $33.5 million of the gain from property disposed in 2005 was reinvested in replacement properties. Approximately $3.5 million of the gain from disposed property in 2005 was distributed to shareholders. No provision for income taxes was necessary during the three year period ended December 31, 2007.
RESULTS OF OPERATIONS
The discussion that follows is based on our consolidated results of operations for the years ended December 31, 2007, 2006 and 2005. The ability to compare one period to another may be significantly affected by acquisitions completed and dispositions made during those years.
For purposes of evaluating comparative operating performance, we categorize our properties as core, non-core or discontinued operations. A core property is one that was owned for the entirety of the periods being evaluated and is included in continuing operations. A non-core property is one that was acquired during either of the periods being evaluated and is included in continuing operations. Results for properties sold or held for sale during any of the periods evaluated are classified as discontinued operations. A total of nine properties and land for development were acquired during 2007, fourteen properties were acquired during 2006 and four properties were acquired in 2005. Two properties were sold and two properties classified as held for sale in 2007 and are classified as discontinued operations for the 2007, 2006 and 2005 Periods. There were no properties sold or classified as held for sale in 2006. Four properties were sold in 2005 and are classified as discontinued operations for the 2005 Period.
To provide more insight into our operating results, our discussion is divided into two main sections: (1) Consolidated Results of Operations where we provide an overview analysis of results on a consolidated basis and (2) Net Operating Income (NOI) where we provide a detailed analysis of core versus non-core property-level NOI results by segment. NOI is calculated as real estate rental revenue less real estate operating expenses.
Consolidated Results of Operations
Real Estate Rental Revenue
Real Estate Rental Revenue for properties classified as continuing operations is summarized as follows (all data in thousands except percentage amounts):
2007 |
2006 |
2005 |
2007 vs 2006 |
% Change |
2006 vs 2005 |
% Change |
||||||||||||||||
Minimum base rent |
$ | 225,736 | $ | 186,710 | $ | 161,232 | $ | 39,026 | 20.9 | % | $ | 25,478 | 15.8 | % | ||||||||
Recoveries from tenants |
25,782 | 18,088 | 14,638 | 7,694 | 42.5 | % | 3,450 | 23.6 | % | |||||||||||||
Parking and other tenant charges |
4,137 | 3,943 | 4,385 | 194 | 4.9 | % | (442 | ) | (10.1 | %) | ||||||||||||
$ | 255,655 | $ | 208,741 | $ | 180,255 | $ | 46,914 | 22.5 | % | $ | 28,486 | 15.8 | % | |||||||||
Real estate rental revenue is comprised of (1) minimum base rent, which includes rental revenues recognized on a straight-line basis, (2) revenue from the recovery of operating expenses from our tenants and (3) other revenue such as parking and termination fees and percentage rents.
Minimum base rent increased $39.0 million (20.9%) in 2007 as compared to 2006 and $25.5 million (15.8%) in 2006 as compared to 2005. The increase in minimum base rent in 2007 was due primarily to additional rent from
24
properties acquired in 2007 and 2006 ($31.6 million), combined with a $7.4 million increase in minimum base rent from core properties due to increased occupancy in the office and industrial sectors and rental rate increases in all sectors. The increase in minimum base rent in 2006 was due primarily to additional rent from properties acquired in 2005 and 2006 ($18.1 million), combined with a $7.4 million increase in minimum base rent from core properties due to rental rate increases in the office, multifamily, industrial and retail sectors and lower vacancies in the office sector.
A summary of economic occupancy for properties classified as continuing operations by sector follows:
Consolidated Economic Occupancy
Sector |
2007 |
2006 |
2005 |
2007 vs 2006 |
2006 vs 2005 |
||||||||||
Office |
94.7 | % | 92.1 | % | 89.4 | % | 2.6 | % | 2.7 | % | |||||
Medical Office |
98.0 | % | 98.9 | % | 98.4 | % | (0.9 | %) | 0.5 | % | |||||
Retail |
95.2 | % | 96.0 | % | 97.6 | % | (0.8 | %) | (1.6 | %) | |||||
Multifamily |
89.3 | % | 92.4 | % | 93.2 | % | (3.1 | %) | (0.8 | %) | |||||
Industrial |
95.3 | % | 93.7 | % | 94.4 | % | 1.6 | % | (0.7 | %) | |||||
Total |
94.5 | % | 93.8 | % | 93.0 | % | 0.7 | % | 0.8 | % | |||||
Economic occupancy represents actual rental revenues recognized for the period indicated as a percentage of gross potential rental revenues for that period. Percentage rents and expense reimbursements are not considered in computing economic occupancy percentages.
Our overall economic occupancy increased 70 basis points in 2007 as compared to 2006 and increased 80 basis points in 2006 as compared to 2005. Decreased vacancy in the office and industrial sectors, partially offset by higher vacancies in the medical office, retail and multifamily sectors, accounted for the increase in overall economic occupancy in 2007. Property acquisitions and decreased vacancy in the office and medical office sectors, partially offset by higher vacancies in the retail, industrial and multifamily sectors, accounted for the increase in overall economic occupancy in 2006. A detailed discussion of occupancy by sector can be found in the Net Operating Income section.
Recoveries from tenants increased $7.7 million (42.5%) in 2007 as compared to 2006 and $3.5 million (23.6%) in 2006 as compared to 2005. The increase in recoveries from tenants in 2007 was due primarily to properties acquired in 2007 and 2006 ($4.0 million) and increased recovery income from core properties ($3.7 million) due to higher operating expense, utilities, common area maintenance and real estate taxes. The increase in recoveries from tenants in 2006 was due primarily to properties acquired in 2006 and 2005 ($3.1 million) and increased recovery income from core properties ($0.4 million) due to higher operating expense, utilities, common area maintenance and real estate taxes.
Parking and other tenant charges increased $0.2 million in 2007 as compared to 2006 and decreased $0.4 million in 2006 as compared to 2005. The increase in parking and other charges in 2007 was driven by properties acquired in 2007 and 2006 due primarily to higher parking income and antenna rent. The decrease in parking and other charges for 2006 compared to 2005 was driven by core properties due primarily to higher bad debt expense and rent abatements.
25
Real estate operating expenses
Real estate operating expenses are summarized as follows (all data in thousands except percentage amounts):
2007 |
2006 |
2005 |
2007 vs 2006 |
% Change |
2006 vs 2005 |
% Change |
|||||||||||||||
Property operating expenses |
$ | 57,707 | $ | 45,826 | $ | 39,448 | $ | 11,881 | 25.9 | % | $ | 6,378 | 16.2 | % | |||||||
Real estate taxes |
22,207 | 17,399 | 15,080 | 4,808 | 27.6 | % | 2,319 | 15.4 | % | ||||||||||||
$ | 79,914 | $ | 63,225 | $ | 54,528 | $ | 16,689 | 26.4 | % | $ | 8,697 | 15.9 | % | ||||||||
Property operating expenses include utilities, repairs and maintenance, property administration and management, operating services, common area maintenance and other operating expenses. Real estate operating expenses as a percentage of revenue were 31.3% for 2007, 30.3% for 2006 and 30.3% for 2005.
Properties acquired in 2006 and 2007 accounted for $8.1 million (68.1%) of the $11.9 million increase in 2007 property operating expenses. Core property operating expenses increased $3.8 million as a result of higher utility costs due largely to rate increases, higher repairs and maintenance costs and increased administrative expenditures. Real estate taxes increased $4.8 million due primarily to the properties acquired in 2006 and 2007, which accounted for $2.9 million (60.4%) of the increase. The remainder of the increase in real estate taxes was due primarily to higher value assessments among our core properties.
Properties acquired in 2005 and 2006 accounted for $4.8 million (75.0%) of the $6.4 million increase in 2006 property operating expenses. Core property operating expenses increased $1.6 million as a result of higher utility costs due largely to rate increases and higher repairs and maintenance costs. Real estate taxes increased $2.3 million due primarily to the properties acquired in 2005 and 2006, which accounted for $1.8 million (78.3%) of the increase. The remainder of the increase in real estate taxes was due primarily to higher value assessments among our core properties.
Other Operating Expenses
Other operating expenses are summarized as follows (all data in thousands except percentage amounts):
2007 |
2006 |
2005 |
2007 vs 2006 |
% Change |
2006 vs 2005 |
% Change |
|||||||||||||||
Depreciation and amortization |
$ | 69,775 | $ | 50,915 | $ | 44,561 | $ | 18,860 | 37.0 | % | $ | 6,354 | 14.3 | % | |||||||
Interest expense |
61,906 | 47,265 | 37,193 | 14,641 | 31.0 | % | 10,072 | 27.1 | % | ||||||||||||
General and administrative |
15,099 | 12,622 | 8,005 | 2,477 | 19.6 | % | 4,617 | 57.7 | % | ||||||||||||
$ | 146,780 | $ | 110,802 | $ | 89,759 | $ | 35,978 | 32.5 | % | $ | 21,043 | 23.4 | % | ||||||||
Depreciation and amortization
The $18.9 million increase in depreciation and amortization expense in 2007 relative to 2006 was due substantially to acquisitions of $319.3 million and $303.0 million in 2007 and 2006, respectively.
The $6.4 million increase in depreciation and amortization expense in 2006 relative to 2005 was due substantially to acquisitions of $303.0 million and $145.1 million in 2006 and 2005, respectively.
Interest expense
Interest expense increased $14.6 million in 2007 compared to 2006 due to increased acquisition and development activity, partially offset by the refinancing of higher interest rate unsecured notes and mortgages. This activity
26
was funded primarily by debt, including: (1) the issuance in January 2007 of $150.0 million of 3.875% senior convertible notes due August 31, 2026, in June 2006 the issuance of $100.0 million of 5.95% unsecured notes due June 15, 2011 and $50.0 million of 5.95% unsecured notes due June 15, 2011, and in September 2006 the issuance of $110.0 million of 3.875% senior convertible notes due September 15, 2026, (2) the increase in short-term borrowing on our lines of credit, and (3) the assumption of mortgages totaling $26.8 million for the acquisitions of the Woodholme Portfolio ($21.2 million) and Ashburn Farm Office Park ($5.6 million), offset somewhat by an increase in capitalized interest of $2.3 million.
Interest expense increased $10.1 million in 2006 compared to 2005 due to increased acquisition and development activity and increases in short term interest rates, partially offset by the refinancing of higher interest rate unsecured notes and mortgages. This activity was funded primarily by debt, including: (1) the issuance in June 2006 of $100.0 million of 5.95% unsecured notes due June 15, 2011 and $50.0 million of 5.95% unsecured notes due June 15, 2011, in September 2006 the issuance of $110.0 million of 3.875% senior convertible notes due September 15, 2026 as well as the issuance in April 2005 of $50.0 million of 5.05% senior unsecured notes due May 1, 2012 and $50.0 million of 5.35% senior unsecured notes due May 1, 2015 and in October 2005, the issuance of an additional $100.0 million of notes of the series of 5.35% senior unsecured notes due May 1, 2015, (2) the increase in short-term borrowing on our lines of credit, and (3) the assumption of five mortgages totaling $76.1 million for the acquisitions of 9707 Medical Center Drive ($5.7 million), Plumtree Medical Center ($4.9 million), 15005 Shady Grove Road ($8.8 million), West Gude Drive ($33.9 million) and The Ridges and Crescent ($23.0 million), offset somewhat by an increase in capitalized interest of $2.7 million.
A summary of interest expense for the years ended December 31, 2007, 2006 and 2005 appears below (in millions):
Debt Type |
2007 |
2006 |
2005 |
2007 vs. 2006 |
2006 vs. 2005 |
|||||||||||||||
Notes payable |
$ | 47.2 | $ | 36.2 | $ | 25.5 | $ | 11.0 | $ | 10.7 | ||||||||||
Mortgages |
14.5 | 11.3 | 10.7 | 3.2 | 0.6 | |||||||||||||||
Lines of credit/short-term note payable |
6.3 | 3.6 | 2.1 | 2.7 | 1.5 | |||||||||||||||
Capitalized interest |
(6.1 | ) | (3.8 | ) | (1.1 | ) | (2.3 | ) | (2.7 | ) | ||||||||||
Total |
$ | 61.9 | $ | 47.3 | $ | 37.2 | $ | 14.6 | $ | 10.1 | ||||||||||
General and administrative expense
The $2.5 million increase in general and administrative expense in 2007 was due to bondholder consent fees associated with the modifications to our bond covenants, higher incentive compensation, equity compensation issued to the retiring CEO, higher trustee fees due to an increase in the value of annual equity awards and increased staff salaries primarily due to the growth in our portfolio.
The $4.6 million increase in general and administrative expense in 2006 was due to increased salary costs for the addition of the Chief Investment Officer in 2005 and subsequent severance costs associated with his departure in June, 2006 of $1.6 million, recognition of compensation expense for accelerated vesting of CEO share grants (upon the adoption of SFAS No. 123R) of $1.2 million, higher incentive compensation and staff salary increases related to the growth of our portfolio. Benefits expense also increased as a result of these staffing increases.
Discontinued Operations
We dispose of assets (sometimes using tax-deferred exchanges) that are inconsistent with our long-term strategic or return objectives and where market conditions for sale are favorable. The proceeds from the sales are reinvested into other properties, used to fund development operations, support corporate needs, or distributed to our shareholders.
27
WRIT sold two properties and classified two properties as held for sale in 2007. The two sold properties, Maryland Trade Centers I and II, were classified as held for sale as of March 31, 2007 and sold as of September 26, 2007. They were sold for a contract sales price of $58.0 million, and WRIT recognized a gain on disposal of $25.0 million, in accordance with SFAS No. 66, Accounting for Sales of Real Estate. $15.3 million of the proceeds from the disposition was used to fund the purchase of CentreMed I & II on August 16, 2007 in a reverse tax free property exchange, and $40.1 million of the proceeds from the disposition were escrowed in a tax free property exchange account and subsequently used to fund a portion of the purchase price of 2000 M Street on December 4, 2007.
In November 2007 we concluded that Sullyfield Center and The Earhart Building met the criteria specified in SFAS No. 144, accounting for the Impairment or Disposal of Long-Lived Assets, necessary to classify these properties as held for sale. Senior management has committed to, and actively embarked upon, a plan to sell the assets, and the sale is expected to be completed within one year under terms usual and customary for such sales, with no indication that the plan will be significantly altered or abandoned. Depreciation on these properties was discontinued at that time, but operating revenues and other operating expenses continue to be recognized until the date of sale. Under SFAS No. 144, revenues and expenses of properties that are classified as held for sale or sold are treated as discontinued operations for all periods presented in the Statements of Income.
For 2006, discontinued operations consist of the four properties classified as held for sale or sold in 2007. Discontinued operations for 2005 consist of those same properties and the four properties sold in February and September 2005.
On September 8, 2005 the Pepsi Distribution Center, an industrial property, was sold for $6.0 million resulting in a gain of $3.0 million. Proceeds of $5.8 million were escrowed in a tax-free exchange account and subsequently used to fund a portion of the purchase price of Dulles Station I and II.
On February 1, 2005 we sold three office buildings, 7700 Leesburg, Tycon Plaza II, Tycon Plaza III and certain development rights and approvals related to Tycon Plaza II for $67.5 million with a gain on the sale of $32.1 million. Proceeds of $31.3 million were escrowed in a tax-free property exchange account and subsequently used to fund a portion of the purchase price of Frederick Crossing Shopping Center on March 23, 2005 and the Coleman Building on April 8, 2005. The remaining $31.0 million of the proceeds were used to pay down $31.0 million outstanding under Credit Facility No. 2.
On November 15, 2004, we sold 8230 Boone Boulevard for a sale price of $10.0 million. A portion of the proceeds was in the form of a subordinated $1.8 million 10% note receivable from the seller, which matured in November 2005. We recognized a gain on disposal of $1.0 million gain at the time of sale, and offset the $1.8 million note from the buyer with a deferred gain liability in the same amount, in accordance with Statement of Financial Accounting Standards (SFAS) No. 66, Accounting for Sales of Real Estate. SFAS 66 limits gain recognition when the sellers note is subject to future subordination to the amount by which the buyers cash payments at settlement exceed the sellers cost of the property sold. The deferred gain was recognized in April, 2005.
Operating results of the properties classified as discontinued operations are summarized as follows (in thousands):
2007 |
2006 |
2005 |
||||||||||
Revenues |
$ | 9,355 | $ | 10,921 | $ | 10,447 | ||||||
Property expenses |
(3,385 | ) | (4,045 | ) | (3,989 | ) | ||||||
Depreciation and amortization |
(1,250 | ) | (3,255 | ) | (2,671 | ) | ||||||
Interest expense |
| (580 | ) | (550 | ) | |||||||
$ | 4,720 | $ | 3,041 | $ | 3,237 | |||||||
28
Net operations of properties sold or held for sale increased $1.7 million for 2007 compared to 2006 and decreased $0.2 million for 2006 compared to 2005. The increase from 2007 to 2006 is primarily due to the discontinuation of depreciation expense for Maryland Trade Center I & II in March 2007.
Net Operating Income
Real estate Net Operating Income (NOI), defined as real estate rental revenue less real estate operating expenses, is the primary performance measure we use to assess the results of our operations at the property level. We provide NOI as a supplement to net income calculated in accordance with accounting principles generally accepted in the United States of America (GAAP). NOI does not represent net income calculated in accordance with GAAP. As such, it should not be considered an alternative to net income as an indication of our operating performance. NOI is calculated as net income, less non-real estate (other) revenue and the results of discontinued operations (including the gain on sale, if any), plus interest expense, depreciation and amortization and general and administrative expenses. A reconciliation of NOI to net income follows.
2007 Compared to 2006
The following tables of selected operating data provide the basis for our discussion of NOI in 2007 compared to 2006. All amounts are in thousands except percentage amounts.
Years Ended December 31, |
||||||||||||||
2007 |
2006 |
$ Change |
% Change |
|||||||||||
Real Estate Rental Revenue |
||||||||||||||
Core |
$ | 203,725 | $ | 193,325 | $ | 10,400 | 5.4 | % | ||||||
Non-core (1) |
51,930 | 15,416 | 36,514 | 236.9 | % | |||||||||
Total Real Estate Rental Revenue |
$ | 255,655 | $ | 208,741 | $ | 46,914 | 22.5 | % | ||||||
Real Estate Expenses |
||||||||||||||
Core |
$ | 62,885 | $ | 58,140 | $ | 4,745 | 8.2 | % | ||||||
Non-core (1) |
17,029 | 5,085 | 11,944 | 234.9 | % | |||||||||
Total Real Estate Expenses |
$ | 79,914 | $ | 63,225 | $ | 16,689 | 26.4 | % | ||||||
Net Operating Income |
||||||||||||||
Core |
$ | 140,840 | $ | 135,185 | $ | 5,655 | 4.2 | % | ||||||
Non-core (1) |
34,901 | 10,331 | 24,570 | 237.8 | % | |||||||||
Total Net Operating Income |
$ | 175,741 | $ | 145,516 | $ | 30,225 | 20.8 | % | ||||||
Reconciliation to Net Income |
||||||||||||||
NOI |
$ | 175,741 | $ | 145,516 | ||||||||||
Other revenue |
3,178 | 906 | ||||||||||||
Interest expense |
(61,906 | ) | (47,265 | ) | ||||||||||
Depreciation and amortization |
(69,775 | ) | (50,915 | ) | ||||||||||
General and administrative expenses |
(15,099 | ) | (12,622 | ) | ||||||||||
Discontinued operations (2) |
4,720 | 3,041 | ||||||||||||
Gain on Disposal |
25,022 | | ||||||||||||
Net Income |
$ | 61,881 | $ | 38,661 | ||||||||||
Economic Occupancy |
2007 |
2006 |
||||||||
Core |
95.0 | % | 94.3 | % | ||||||
Non-core (1) |
92.5 | % | 87.9 | % | ||||||
Total |
94.5 | % | 93.8 | % | ||||||
(1) |
Non-core properties include: |
2007 in developmentBennett Park, Clayborne Apartments and Dulles Station
29
2007 acquisitions270 Technology Park, Monument II, 2440 M Street, Woodholme Medical Office Building, Woodholme Center, Ashburn Farm Office Park, CentreMed I & II and 2000 M Street
2006 acquisitionsHampton Overlook, Hampton South, Alexandria Professional Center, 9707 Medical Center Drive, 15001 Shady Grove Road, Montrose Shopping Center, Randolph Shopping Center, 9950 Business Parkway, Plumtree Medical Center, 15005 Shady Grove Road, 6565 Arlington Blvd, West Gude Drive, The Ridges, The Crescent
(2) |
Discontinued operations include gain on disposals and income from operations for: |
2007 held for saleSullyfield Center and The Earhart Building
2007 disposalsMaryland Trade Center I and II
We recognized NOI of $175.7 million in 2007, which was $30.2 million (20.8%) greater than in 2006 due largely to our acquisitions of six office properties, ten medical office properties, two retail centers and four industrial properties in 2006 and 2007, which added approximately 2.5 million square feet of net rentable space. Non core properties contributed $34.9 million in NOI in 2007 (19.9% of total NOI), a $24.6 million increase over 2006.
Core properties experienced a $5.7 million (4.2%) increase in NOI due to a $10.4 million increase in revenues offset by a $4.7 million increase in real estate expenses. Revenue was positively impacted by improvements in all lines of business due to rental rate growth across the portfolio (3.4%) and higher core occupancy in the office and industrial sectors. The increase in core expenses was driven by the office, multifamily, retail and industrial sectors, which contributed $2.2, $1.1, $0.6 and $0.6 million, respectively, in additional expense as a result of higher real estate taxes, utilities, repairs and maintenance and administrative costs.
Overall economic occupancy increased from 93.8% in 2006 to 94.5% in 2007 due to higher core occupancy in the office and industrial sectors and higher occupancy in our acquired retail and industrial properties. Core economic occupancy increased 70 basis points due to a 310 basis point increase in the office sector and a 90 basis point increase in the industrial sector offset somewhat by a 110 basis point decrease in the multifamily sector. During 2007, 79.9% of the commercial square footage expiring was renewed as compared to 77.1% in 2006 and 1,765,000 commercial square feet were leased at an average rental rate increase of 17.3%.
An analysis of NOI by sector follows.
Office Sector
Years Ended December 31, |
||||||||||||
2007 |
2006 |
$ Change |
% Change |
|||||||||
Real Estate Rental Revenue |
||||||||||||
Core |
$ | 80,747 | $ | 75,236 | $ | 5,511 | 7.3 | % | ||||
Non-core (1) |
20,831 | 4,455 | 16,376 | 367.6 | % | |||||||
Total Real Estate Rental Revenue |
$ | 101,578 | $ | 79,691 | $ | 21,887 | 27.5 | % | ||||
Real Estate Expenses |
||||||||||||
Core |
$ | 27,373 | $ | 25,136 | $ | 2,237 | 8.9 | % | ||||
Non-core (1) |
7,114 | 1,546 | 5,568 | 360.2 | % | |||||||
Total Real Estate Expenses |
$ | 34,487 | $ | 26,682 | $ | 7,805 | 29.3 | % | ||||
Net Operating Income |
||||||||||||
Core |
$ | 53,374 | $ | 50,100 | $ | 3,274 | 6.5 | % | ||||
Non-core (1) |
13,717 | 2,909 | 10,808 | 371.5 | % | |||||||
Total Net Operating Income |
$ | 67,091 | $ | 53,009 | $ | 14,082 | 26.6 | % | ||||
30
Economic Occupancy |
2007 |
2006 |
||||||||
Core |
95.2 | % | 92.1 | % | ||||||
Non-core (1) |
92.7 | % | 92.2 | % | ||||||
Total |
94.7 | % | 92.1 | % | ||||||
(1) |
Non-core properties include: |
2007 acquisitionsMonument II, Woodholme Center and 2000 M Street
2006 acquisitions6565 Arlington Blvd, West Gude Drive, The Ridges
The office sector recognized NOI of $67.1 million which was $14.1 million (26.6%) higher than in 2006 due primarily to the $3.3 million increase in Core NOI and the NOI from acquired properties in 2006 and 2007, which contributed $13.7 million (20.4% of total) to NOI.
Core office properties achieved a $3.3 million (6.5%) increase in NOI due to a $5.5 million increase in revenues offset somewhat by a $2.2 million increase in core real estate expenses. Core revenue was higher due to the 310 basis point increase in occupancy ($2.2 million) led by occupancy gains at 7900 Westpark, 6110 Executive Boulevard, 515 King Street, the Lexington and 1901 Pennsylvania Avenue, rental rate increases ($1.6 million) and increases in recoveries ($1.7 million). The increase in real estate expenses was due to real estate tax expense that increased due to higher value assessments for properties across several tax jurisdictions, higher utility costs driven by escalating fuel rates, consumption and energy taxes, and increased custodial costs associated with the increase in occupancy.
During 2007, 82.7% of the square footage that expired was renewed compared to 67.7% in 2006, excluding properties sold or classified as held for sale. During 2007, we executed new leases for 525,600 square feet of office space at an average rent increase of 12.1%.
Medical Office Sector
Years Ended December 31, |
||||||||||||
2007 |
2006 |
$ Change |
% Change |
|||||||||
Real Estate Rental Revenue |
||||||||||||
Core |
$ | 18,478 | $ | 18,094 | $ | 384 | 2.1 | % | ||||
Non-core (1) |
20,414 | 6,566 | 13,848 | 210.9 | % | |||||||
Total Real Estate Rental Revenue |
$ | 38,892 | $ | 24,660 | $ | 14,232 | 57.7 | % | ||||
Real Estate Expenses |
||||||||||||
Core |
$ | 5,018 | $ | 4,759 | $ | 259 | 5.4 | % | ||||
Non-core (1) |
7,004 | 2,427 | 4,577 | 188.6 | % | |||||||
Total Real Estate Expenses |
$ | 12,022 | $ | 7,186 | $ | 4,836 | 67.3 | % | ||||
Net Operating Income |
||||||||||||
Core |
$ | 13,460 | $ | 13,335 | $ | 125 | 0.9 | % | ||||
Non-core (1) |
13,410 | 4,139 | 9,271 | 224.0 | % | |||||||
Total Net Operating Income |
$ | 26,870 | $ | 17,474 | $ | 9,396 | 53.8 | % | ||||
Economic Occupancy |
2007 |
2006 |
||||||||
Core |
98.8 | % | 98.8 | % | ||||||
Non-core (1) |
97.3 | % | 99.2 | % | ||||||
Total |
98.0 | % | 98.9 | % | ||||||
31
(1) |
Non-core properties include: |
2007 acquisitions2440 M Street, Woodholme Medical Office Building, Ashburn Farm Office Park, and CentreMed I & II
2006 acquisitionsAlexandria Professional Center, 9707 Medical Center Drive, 15001 Shady Grove Road, Plumtree Medical Center, 15005 Shady Grove Road and The Crescent
The medical office sector NOI increased from $17.5 million in 2006 to $26.9 million in 2007, an increase of $9.4 million or 53.8%. This was substantially due to the acquisitions made in 2006 and 2007 which contributed $13.4 million (49.9% of total) to NOI and added approximately 698,000 net rentable square feet to the portfolio.
Core medical office property NOI increased $0.1 million from 2006. Revenues for core properties were positively impacted by a 2.3% increase in rental rates. Expenses increased due to higher repair and maintenance costs.
During 2007, 50.0% of the square footage that expired was renewed compared to 87.7% in 2006. During 2007, we executed new leases for 103,200 square feet of medical office space at an average rent increase of 19.8%.
32
Retail Sector
Years Ended December 31, |
||||||||||||
2007 |
2006 |
$ Change |
% Change |
|||||||||
Real Estate Rental Revenue |
||||||||||||
Core |
$ | 37,066 | $ | 35,194 | $ | 1,872 | 5.3 | % | ||||
Non-core (1) |
4,446 | 2,069 | 2,377 | 114.9 | % | |||||||
Total Real Estate Rental Revenue |
$ | 41,512 | $ | 37,263 | $ | 4,249 | 11.4 | % | ||||
Real Estate Expenses |
||||||||||||
Core |
$ | 8,090 | $ | 7,512 | $ | 578 | 7.7 | % | ||||
Non-core (1) |
831 | 471 | 360 | 76.4 | % | |||||||
Total Real Estate Expenses |
$ | 8,921 | $ | 7,983 | $ | 938 | 11.8 | % | ||||
Net Operating Income |
||||||||||||
Core |
$ | 28,976 | $ | 27,682 | $ | 1,294 | 4.7 | % | ||||
Non-core (1) |
3,615 | 1,598 | 2,017 | 126.2 | % | |||||||
Total Net Operating Income |
$ | 32,591 | $ | 29,280 | $ | 3,311 | 11.3 | % | ||||
Economic Occupancy |
2007 |
2006 |
||||||||
Core |
96.3 | % | 99.2 | % | ||||||
Non-core (1) |
85.7 | % | 59.6 | % | ||||||
Total |
95.2 | % | 96.0 | % | ||||||
(1) |
Non-core properties include: |
2006 acquisitionsRandolph and Montrose Shopping Centers
Retail sector NOI increased $3.3 million (11.3%) in 2007 due to the 2006 acquisitions which contributed $3.6 million to NOI (11.1% of the total) and a $1.3 million increase in NOI from core properties. The core revenue increase was due to rental rate growth of 5.7% driven by the completion of redevelopment at the Shoppes at Foxchase and escalating market rates at Bradlee Shopping Center.
Overall economic occupancy for the retail sector decreased 80 basis points primarily as a result of decreased occupancy at South Washington Street, the Shoppes at Foxchase and Bradlee Shopping Center. Non core occupancy increased by 2,610 basis points due to the successful leasing efforts at Montrose and Randolph shopping centers. During 2007, our retention rate was 82.1% compared to 90.8% in 2006 and we executed new leases for approximately 223,900 square feet of retail space at an average rent increase of 32.7%.
33
Multifamily Sector
Years Ended December 31, |
||||||||||||||
2007 |
2006 |
$ Change |
% Change |
|||||||||||
Real Estate Rental Revenue |
||||||||||||||
Core |
$ | 34,012 | $ | 32,478 | $ | 1,534 | 4.7 | % | ||||||
Non-core (1) |
275 | | 275 | | ||||||||||
Total Real Estate Rental Revenue |
$ | 34,287 | $ | 32,478 | $ | 1,809 | 5.6 | % | ||||||
Real Estate Expenses |
||||||||||||||
Core |
$ | 14,323 | $ | 13,220 | $ | 1,103 | 8.3 | % | ||||||
Non-core (1) |
639 | | 639 | | ||||||||||
Total Real Estate Expenses |
$ | 14,962 | $ | 13,220 | $ | 1,742 | 13.2 | % | ||||||
Net Operating Income |
||||||||||||||
Core |
$ | 19,689 | $ | 19,258 | $ | 431 | 2.2 | % | ||||||
Non-core (1) |
(364 | ) | | (364 | ) | | ||||||||
Total Net Operating Income |
$ | 19,325 | $ | 19,258 | $ | 67 | 0.3 | % | ||||||
Economic Occupancy |
2007 |
2006 |
||||||||
Core |
91.3 | % | 92.4 | % | ||||||
Non-core (1) |
24.0 | % | | |||||||
Total |
89.3 | % | 92.4 | % | ||||||
(1) |
Non-core properties include: |
2007 developmentBennett Park and The Clayborne Apartments
Multifamily NOI was flat in 2007 as compared to 2006. The revenue increase of $1.5 million was driven by higher minimum base rent throughout the portfolio ($1.8 million) and an increase in utilities reimbursement ($0.2 million), offset somewhat by the 110 basis point decrease in occupancy ($0.5 million) compared to 2006. Real estate expenses increased $1.1 million due primarily to higher repairs and maintenance costs, higher real estate taxes, and increased operating services and supplies costs.
The non-core net operating loss of $0.4 million is due to the substantial completion of Bennett Park in the fourth quarter of 2007. The property is in its lease-up phase and had an occupancy of 24.0% at year end.
Overall economic occupancy decreased from 92.4% in 2006 to 89.3% in 2007 primarily due to the substantial completion of Bennett Park in the fourth quarter of 2007 as described in the preceding paragraph.
34
Industrial Sector
Years Ended December 31, |
||||||||||||
2007 |
2006 |
$ Change |
% Change |
|||||||||
Real Estate Rental Revenue |
||||||||||||
Core |
$ | 33,422 | $ | 32,323 | $ | 1,099 | 3.4 | % | ||||
Non-core (1) |
5,964 | 2,326 | 3,638 | 156.4 | % | |||||||
Total Real Estate Rental Revenue |
$ | 39,386 | $ | 34,649 | $ | 4,737 | 13.7 | % | ||||
Real Estate Expenses |
||||||||||||
Core |
$ | 8,081 | $ | 7,513 | $ | 568 | 7.6 | % | ||||
Non-core (1) |
1,441 | 641 | 800 | 124.8 | % | |||||||
Total Real Estate Expenses |
$ | 9,522 | $ | 8,154 | $ | 1,368 | 16.8 | % | ||||
Net Operating Income |
||||||||||||
Core |
$ | 25,341 | $ | 24,810 | $ | 531 | 2.1 | % | ||||
Non-core (1) |
4,523 | 1,685 | 2,838 | 168.4 | % | |||||||
Total Net Operating Income |
$ | 29,864 | $ | 26,495 | $ | 3,369 | 12.7 | % | ||||
Economic Occupancy |
2007 |
2006 |
||||||||
Core |
95.4 | % | 94.5 | % | ||||||
Non-core (1) |
95.1 | % | 84.4 | % | ||||||
Total |
95.3 | % | 93.7 | % | ||||||
(1) |
Non-core properties include: |
2007 acquisition270 Technology Park
2006 acquisitions Hampton Overlook, Hampton South and 9950 Business Parkway
Industrial sector NOI increased $3.4 million (12.7%) over 2006 due to acquisitions in 2006 and 2007. These acquisitions contributed $4.5 million in NOI, 15.1% of the total NOI.
Core properties achieved a $0.5 million (2.1%) increase in NOI due to a $1.1 million increase in real estate revenues, while real estate expenses increased $0.6 million. The revenue increase was driven by a 2.8% increase in rental rates and a 90 basis point increase in occupancy.
During 2007 our retention rate from continuing operations was 83.8% compared to 79.3% in 2006 and we executed new leases for approximately 912,100 square feet of industrial space at an average rent increase of 17.0%.
35
2006 Compared to 2005
The following tables of selected operating data provide the basis for our discussion of NOI in 2006 compared to 2005. All amounts are in thousands except percentage amounts.
Years Ended December 31, |
||||||||||||||
2006 |
2005 |
$ Change |
% Change |
|||||||||||
Real Estate Rental Revenue |
||||||||||||||
Core |
$ | 180,543 | $ | 173,278 | $ | 7,265 | 4.2 | % | ||||||
Non-core (1) |
28,198 | 6,977 | 21,221 | 304.2 | % | |||||||||
Total Real Estate Rental Revenue |
$ | 208,741 | $ | 180,255 | $ | 28,486 | 15.8 | % | ||||||
Real Estate Expenses |
||||||||||||||
Core |
$ | 55,144 | $ | 53,094 | $ | 2,050 | 3.9 | % | ||||||
Non-core (1) |
8,081 | 1,434 | 6,647 | 463.5 | % | |||||||||
Total Real Estate Expenses |
$ | 63,225 | $ | 54,528 | $ | 8,697 | 15.9 | % | ||||||
Net Operating Income |
||||||||||||||
Core |
$ | 125,399 | $ | 120,184 | $ | 5,215 | 4.3 | % | ||||||
Non-core (1) |
20,117 | 5,543 | 14,574 | 262.9 | % | |||||||||
Total Net Operating Income |
$ | 145,516 | $ | 125,727 | $ | 19,789 | 15.7 | % | ||||||
Reconciliation to Net Income |
||||||||||||||
NOI |
$ | 145,516 | $ | 125,727 | ||||||||||
Other revenue |
906 | 918 | ||||||||||||
Other income from property settlement |
| 504 | ||||||||||||
Interest expense |
(47,265 | ) | (37,193 | ) | ||||||||||
Depreciation and amortization |
(50,915 | ) | (44,561 | ) | ||||||||||
General and administrative expenses |
(12,622 | ) | (8,005 | ) | ||||||||||
Discontinued operations (2) |
3,041 | 3,237 | ||||||||||||
Gain on Disposal |
| 37,011 | ||||||||||||
Net Income |
$ | 38,661 | $ | 77,638 | ||||||||||
Economic Occupancy |
2006 |
2005 |
||||||||
Core |
94.1 | % | 92.9 | % | ||||||
Non-core (1) |
92.3 | % | 97.9 | % | ||||||
Total |
93.8 | % | 93.0 | % | ||||||
(1) |
Non-core properties include: |
2006 acquisitionsHampton Overlook, Hampton South, Alexandria Medical Center, 9707 Medical Center Drive, 15001 Shady Grove Road, Montrose Shopping Center, Randolph Shopping Center, 9950 Business Parkway, Plumtree Medical Center, 15005 Shady Grove Road, 6565 Arlington Blvd, West Gude Drive, The Ridges, The Crescent
2005 acquisitionsFrederick Crossing, Coleman Building and Albemarle Point
(2) |
Discontinued operations include gain on disposals and income from operations for: |
2007 held for saleSullyfield Center and The Earhart Building
2007 disposalsMaryland Trade Center I and II
2005 disposalsTycon Plaza II, Tycon Plaza III, 7700 Leesburg Pike and the Pepsi Distribution Center
36
We recognized NOI of $145.5 million in 2006, which was $19.8 million (15.7%) greater than in 2005 due largely to our acquisitions of four office properties, six medical office properties, three retail centers and five industrial properties in 2005 and 2006, which added approximately 2,151,000 square feet of net rentable space. Acquired properties contributed $20.1 million in NOI in 2006 (13.8% of total NOI), a $14.6 million increase over 2005. Core properties experienced a $5.2 million (4.3%) increase in NOI due to a $7.3 million increase in revenues offset by a $2.1 million increase in real estate expenses. Revenue was positively impacted by improvements in all lines of business due to rental rate growth across the portfolio (3.5%) and higher core occupancy in the office, retail and medical office sectors. The increase in core expenses was driven by the office, retail and multifamily sectors, which contributed $1.3, $0.4 and $0.4 million, respectively, in additional expense as a result of higher utilities, repairs and maintenance, operating services, and real estate taxes.
Overall economic occupancy increased from 93.0% in 2005 to 93.8% in 2006 due to higher core occupancy in the office, medical office and retail sectors and higher occupancy in our acquired office and medical office properties. Core economic occupancy increased 120 basis points due to a 270 basis point increase in the office sector and a 180 basis point increase in the retail sector offset somewhat by a 70 basis point decrease in the industrial sector and an 80 basis point decrease in the multifamily sector. During 2006, 77.1% of the commercial square footage expiring from continuing operations was renewed as compared to 67.9% in 2005 and 1,611,000 commercial square feet were leased at an average rental rate increase of 12.8%.
An analysis of NOI by sector follows.
Office Sector
Years Ended December 31, |
||||||||||||
2006 |
2005 |
$ Change |
% Change |
|||||||||
Real Estate Rental Revenue |
||||||||||||
Core |
$ | 72,991 | $ | 70,271 | $ | 2,720 | 3.9 | % | ||||
Non-core (1) |
6,700 | 921 | 5,779 | 627.5 | % | |||||||
Total Real Estate Rental Revenue |
$ | 79,691 | $ | 71,192 | $ | 8,499 | 11.9 | % | ||||
Real Estate Expenses |
||||||||||||
Core |
$ | 24,522 | $ | 23,261 | $ | 1,261 | 5.4 | % | ||||
Non-core (1) |
2,160 | 262 | 1,898 | 724.4 | % | |||||||
Total Real Estate Expenses |
$ | 26,682 | $ | 23,523 | $ | 3,159 | 13.4 | % | ||||
Net Operating Income |
||||||||||||
Core |
$ | 48,469 | $ | 47,010 | $ | 1,459 | 3.1 | % | ||||
Non-core (1) |
4,540 | 659 | 3,881 | 588.9 | % | |||||||
Total Net Operating Income |
$ | 53,009 | $ | 47,669 | $ | 5,340 | 11.2 | % | ||||
Economic Occupancy |
2006 |
2005 |
||||||||
Core |
92.1 | % | 89.4 | % | ||||||
Non-core (1) |
92.1 | % | 89.8 | % | ||||||
Total |
92.1 | % | 89.4 | % | ||||||
(1) |
Non-core properties include: |
2006 acquisitions6565 Arlington Blvd, West Gude Drive, The Ridges
2005 acquisitionsAlbemarle Point Office Building
The office sector recognized NOI of $53.0 million which was $5.3 million (11.2%) higher than in 2005 due primarily to the $3.9 million increase in NOI from acquired properties and the $1.5 million increase in Core NOI in 2006.
37
Core office properties achieved a $1.5 million (3.1%) increase in NOI due to a $2.7 million increase in revenues offset somewhat by a $1.3 million increase in core real estate expenses. Core revenue was higher due to the 270 basis point increase in occupancy ($1.8 million) led by occupancy gains at 1600 Wilson Boulevard, 1700 Research Boulevard, 600 Jefferson Plaza and 7900 Westpark, and rental rate increases ($1.2 million). This increase was offset somewhat by an increase in bad debt reserves ($0.4 million) and rent abatements ($0.3 million). The increase in real estate expenses was due to higher utility costs driven by escalating fuel rates, consumption and energy taxes, real estate tax expense that increased due to higher value assessments for properties across several tax jurisdictions and increased payroll costs.
During 2006, 67.7% of the square footage that expired was renewed compared to 61.9% in 2005, excluding properties sold or classified as held for sale. During 2006, we executed new leases for 597,000 square feet of office space at an average rent increase of 9.1%.
Medical Office Sector
Years Ended December 31, |
|||||||||||||
2006 |
2005 |
$ Change |
% Change |
||||||||||
Real Estate Rental Revenue |
|||||||||||||
Core |
$ | 18,094 | $ | 18,024 | $ | 70 | 0.4 | % | |||||
Non-core (1) |
6,566 | | 6,566 | | |||||||||
Total Real Estate Rental Revenue |
$ | 24,660 | $ | 18,024 | $ | 6,636 | 36.8 | % | |||||
Real Estate Expenses |
|||||||||||||
Core |
$ | 4,759 | $ | 4,649 | $ | 110 | 2.4 | % | |||||
Non-core (1) |
2,427 | | 2,427 | | |||||||||
Total Real Estate Expenses |
$ | 7,186 | $ | 4,649 | $ | 2,537 | 54.6 | % | |||||
Net Operating Income |
|||||||||||||
Core |
$ | 13,335 | $ | 13,375 | ($ | 40 | ) | (0.3 | %) | ||||
Non-core (1) |
4,139 | | 4,139 | | |||||||||
Total Net Operating Income |
$ | 17,474 | $ | 13,375 | $ | 4,099 | 30.6 | % | |||||
Economic Occupancy |
2006 |
2005 |
||||||||
Core |
98.8 | % | 98.4 | % | ||||||
Non-core (1) |
99.2 | % | | |||||||
Total |
98.9 | % | 98.4 | % | ||||||
(1) |
Non-core properties include: |
2006 acquisitionsAlexandria Professional Center, 9707 Medical Center Drive, 15001 Shady Grove Road, Plumtree Medical Center, 15005 Shady Grove Road and The Crescent
The medical office sector NOI increased from $13.4 million in 2005 to $17.5 million in 2006, an increase of $4.1 million or 30.6%. This was substantially due to the acquisitions made in 2006 which contributed $4.1 million to the NOI and added approximately 336,000 net rentable square feet to the portfolio.
Core medical office property NOI was flat. Revenues for core properties were positively impacted by a 40 basis point increase in occupancy and a 0.6% increase in rental rates. Expenses increased due to higher repair and maintenance costs.
During 2006, 87.7% of the square footage that expired was renewed compared to 74.7% in 2005. During 2006, we executed new leases for 119,900 square feet of medical office space at an average rent increase of 19.9%.
38
Retail Sector
Years Ended December 31, |
||||||||||||
2006 |
2005 |
$ Change |
% Change |
|||||||||
Real Estate Rental Revenue |
||||||||||||
Core |
$ | 30,545 | $ | 28,425 | $ | 2,120 | 7.5 | % | ||||
Non-core (1) |
6,718 | 3,482 | 3,236 | 92.9 | % | |||||||
Total Real Estate Rental Revenue |
$ | 37,263 | $ | 31,907 | $ | 5,356 | 16.8 | % | ||||
Real Estate Expenses |
||||||||||||
Core |
$ | 6,718 | $ | 6,296 | $ | 422 | 6.7 | % | ||||
Non-core (1) |
1,265 | 583 | 682 | 117.0 | % | |||||||
Total Real Estate Expenses |
$ | 7,983 | $ | 6,879 | $ | 1,104 | 16.1 | % | ||||
Net Operating Income |
||||||||||||
Core |
$ | 23,827 | $ | 22,129 | $ | 1,698 | 7.7 | % | ||||
Non-core (1) |
5,453 | 2,899 | 2,554 | 88.1 | % | |||||||
Total Net Operating Income |
$ | 29,280 | $ | 25,028 | $ | 4,252 | 17.0 | % | ||||
Economic Occupancy |
2006 |
2005 |
||||||||
Core |
99.1 | % | 97.3 | % | ||||||
Non-core (1) |
84.2 | % | 100.0 | % | ||||||
Total |
96.0 | % | 97.6 | % | ||||||
(1) |
Non-core properties include: |
2006 acquisitionsRandolph and Montrose Shopping Centers
2005 acquisitionFrederick Crossing
Retail sector NOI increased $4.3 million (17.0%) in 2006 due to the 2006 and 2005 acquisitions which contributed $5.4 million to NOI (18.6% of the total) and a $1.7 million increase in NOI from core properties. The core revenue increase was due to rental rate growth of 8.5% driven by the Harris Teeter lease at Shoppes at Foxchase and escalating market rates at other centers and a 180 basis point increase in occupancy across most of the remaining portfolio.
Overall economic occupancy for the retail sector decreased approximately 160 basis points primarily as a result of the acquisitions of the Montrose and Randolph shopping centers which were 58% and 91% leased, respectively, at the time of their acquisition. During 2006, our retention rate was 90.8% compared to 95.3% in 2005 and we executed new leases for approximately 123,000 square feet of retail space at an average rent increase of 20.8%.
39
Multifamily Sector
Years Ended December 31, |
||||||||||||
2006 |
2005 |
$ Change |
% Change |
|||||||||
Real Estate Rental Revenue |
||||||||||||
Core/Total |
$ | 32,478 | $ | 30,529 | $ | 1,949 | 6.4 | % | ||||
Real Estate Expenses |
||||||||||||
Core/Total |
13,220 | 12,815 | 405 | 3.2 | % | |||||||
Net Operating Income |
||||||||||||
Core/Total |
$ | 19,258 | $ | 17,714 | $ | 1,544 | 8.7 | % | ||||
Economic Occupancy |
2006 |
2005 |
||||||||
Core/Total |
92.4 | % | 93.2 | % | ||||||
Multifamily NOI increased $1.5 million (8.7%) in 2006 as compared to 2005 as a result of a $1.9 million increase in revenue offset somewhat by a $0.4 million increase in expenses. The revenue increase was driven by an increase in minimum base rent throughout the portfolio ($2.0 million), offset somewhat by the 80 basis point decrease in occupancy ($0.4 million) compared to 2005 due to units at two properties that were taken off-line for renovation and the move out of a block of 28 units leased by one individual. Real estate expenses increased $0.4 million due primarily to higher repairs and maintenance costs, higher administrative costs related to property-level leasing and maintenance positions and increased marketing costs, and increased utility expense related to higher fuel costs.
40
Industrial Sector
Years Ended December 31, |
|||||||||||||
2006 |
2005 |
$ Change |
% Change |
||||||||||
Real Estate Rental Revenue |
|||||||||||||
Core |
$ | 26,435 | $ | 26,029 | $ | 406 | 1.6 | % | |||||
Non-core (1) |
8,214 | 2,574 | 5,640 | 219.1 | % | ||||||||
Total Real Estate Rental Revenue |
$ | 34,649 | $ | 28,603 | $ | 6,046 | 21.1 | % | |||||
Real Estate Expenses |
|||||||||||||
Core |
$ | 5,925 | $ | 6,073 | ($ | 148 | ) | (2.4 | %) | ||||
Non-core (1) |
2,229 | 589 | 1,640 | 278.4 | % | ||||||||
Total Real Estate Expenses |
$ | 8,154 | $ | 6,662 | $ | 1,492 | 22.4 | % | |||||
Net Operating Income |
|||||||||||||
Core |
$ | 20,510 | $ | 19,956 | $ | 554 | 2.8 | % | |||||
Non-core (1) |
5,985 | 1,985 | 4,000 | 201.5 | % | ||||||||
Total Net Operating Income |
$ | 26,495 | $ | 21,941 | $ | 4,554 | 20.8 | % | |||||
Economic Occupancy |
2006 |
2005 |
||||||||
Core |
93.3 | % | 94.0 | % | ||||||
Non-core (1) |
95.2 | % | 98.6 | % | ||||||
Total |
93.7 | % | 94.4 | % | ||||||
(1) |
Non-core properties include: |
2006 acquisitionsHampton Overlook, Hampton South and 9950 Business Parkway
2005 acquisitionsColeman Building and Albemarle Point Industrial Buildings
Industrial sector NOI increased $4.6 million (20.8%) over 2005 due to acquisitions in 2005 and 2006. These acquisitions contributed $6.0 million in NOI, 22.6% of the total NOI.
Core properties achieved a $0.5 million (2.8%) increase in NOI due to a $0.4 million increase in real estate revenues, while real estate expenses decreased $0.1 million. The revenue increase was driven by a 2.0% increase in rental rates offset somewhat by a 70 basis point decrease in occupancy primarily due to vacancies at Sully Square.
During 2006 our retention rate was 79.3% compared to 60.7% in 2005, excluding properties sold or classified as held for sale. During 2006, we executed new leases for approximately 770,000 square feet of industrial space at an average rent increase of 14.3%.
LIQUIDITY AND CAPITAL RESOURCES
Capital Structure
We manage our capital structure to reflect a long-term investment approach, generally seeking to match the cash flow of our assets with a mix of equity and various debt instruments. We expect that our capital structure will allow us to obtain additional capital from diverse sources that could include additional equity offerings of common shares, public and private secured and unsecured debt financings, and possible asset dispositions. Our ability to raise funds through the sale of debt and equity securities is dependent on, among other things, general economic conditions, general market conditions for REITs, our operating performance, our debt rating and the current trading price of our shares. We will always analyze which source of capital is most advantageous to us at
41
any particular point in time; however the capital markets may not consistently be available on terms that we consider attractive.
We currently expect that our principal sources of liquidity for acquisitions, development, expansion and renovation of properties, plus operating and administrative will include:
| Cash flow from operations; |
| Borrowings under our unsecured credit facilities or other short-term facilities; |
| Issuances of our equity securities and/or common units of partnership in WRIT or its subsidiaries; |
| Proceeds from long-term secured or unsecured debt financings; |
| Investment from joint venture partners; and |
| Net proceeds from the sale of assets. |
During 2008, we expect that we will have significant capital requirements, including the following items. There can be no assurance that our capital requirements will not be materially higher or lower than these expectations.
| Funding dividends on our common shares and minority interest distributions to third party unit holders; |
| Approximately $35.1 million to invest in our existing portfolio of operating assets, including approximately $28.2 million to fund tenant-related capital requirements and leasing commissions; |
| Approximately $12.4 million to invest in our development projects; |
| Approximately $100.0-$120.0 million to fund our expected property acquisitions; |
| In the first quarter of 2008, $8.7 million was used to fund a non-recurring charge, resulting from an extinguishment of debt on $60 million of 10-year Mandatory Par Put Remarketed Securities (MOPPRS); |
We believe that we will generate sufficient cash flow from operations and have access to the capital resources necessary to fund our requirements. However, as a result of general market conditions in the greater Washington metro region, economic downturns affecting the ability to attract and retain tenants, unfavorable fluctuations in interest rates or our share price, unfavorable changes in the supply of competing properties, or our properties not performing as expected, we may not generate sufficient cash flow from operations or otherwise have access to capital on favorable terms, or at all. If we are unable to obtain capital from other sources, we may not be able to pay the dividend required to maintain our status as a REIT, make required principal and interest payments, make strategic acquisitions or make necessary routine capital improvements or undertake re-development opportunities with respect to our existing portfolio of operating assets. In addition, if a property is mortgaged to secure payment of indebtedness and we are unable to meet mortgage payments, the holder of the mortgage could foreclose on the property, resulting in loss of income and asset value.
Debt Financing
We generally use secured or unsecured, corporate-level debt, including mortgages, unsecured notes and our unsecured credit facilities, to meet our borrowing needs. Long-term, we generally use fixed rate debt instruments in order to match the returns from our real estate assets. We also utilize variable rate debt for short-term financing purposes. At times, our mix of variable and fixed rate debt may not suit our needs. At those times, we may use derivative financial instruments including interest rate swaps and caps, forward interest rate options or interest rate options in order to assist us in managing our debt mix. We may either hedge our variable rate debt to give it a fixed interest rate or hedge fixed rate debt to give it a variable interest rate.
42
Typically we have obtained the ratings of two credit rating agencies in the underwriting of our unsecured debt. As of December 31, 2007, Standard & Poors had assigned its BBB+ rating with a stable outlook, and Moodys Investor Service has assigned its Baa1 rating with a stable outlook, to our unsecured debt offerings. A downgrade in rating by either of these rating agencies could result from, among other things, a change in our financial position. Any such downgrade could adversely affect our ability to obtain future financing or could increase the interest rates on our existing debt. However, we have no debt instruments under which the principal maturity would be accelerated upon a downward change in our debt rating. Each rating is subject to revision or withdrawal at any time by the assigning rating organization.
Our total debt at December 31, 2007 is summarized as follows (in thousands):
Total Debt | |||
Fixed rate mortgages |
$ | 252,484 | |
Unsecured credit facilities |
192,500 | ||
Senior unsecured notes |
880,000 | ||
$ | 1,324,984 | ||
Mortgage Debt
At December 31, 2007, our $252.5 million in fixed rate mortgages, which includes $2.5 million in unamortized premiums due to fair value adjustments, bore an effective weighted average interest rate of 5.8% and had a weighted average maturity of 5.0 years. We may either initiate secured mortgage debt or assume mortgage debt from time-to-time in conjunction with property acquisitions.
Unsecured Credit Facilities
Our primary source of liquidity is our two revolving credit facilities. We can borrow up to $337.0 million under these lines, which bear interest at an adjustable spread over LIBOR based on our public debt rating. Credit Facility No. 1 is a four-year, $75.0 million unsecured credit facility expiring in June 2011. We had $70.0 million outstanding and $1.4 million in letters of credit issued as of December 31, 2007, related to Credit Facility No. 1.
Credit Facility No. 2 is a four-year $200.0 million unsecured credit facility expiring in November 2010, with a one year extension option. Subsequent to the year-end, we exercised a portion of the accordion feature to increase our total borrowing capacity on the line from $200.0 million to $262.0 million. We had $122.5 million outstanding and $0.9 million in letters of credit issued as of December 31, 2007, related to Credit Facility No. 2.
Our unsecured credit facilities contain financial and other covenants with which we must comply. Some of these covenants include:
| A minimum tangible net worth; |
| A maximum ratio of total liabilities to gross asset value, calculated using a fair market value of our assets; |
| A maximum ratio of secured indebtedness to gross asset value, calculated using a fair market value of our assets; |
| A minimum ratio of annual EBITDA (earnings before interest, taxes, depreciation and amortization) to fixed charges, including interest expense; |
| A minimum ratio of net operating income from our unencumbered properties to unsecured interest expense; and |
| A maximum ratio of development in progress to gross asset value, calculated using a fair market value of our assets. |
43
Failure to comply with any of the covenants under our unsecured credit facilities or other debt instruments could result in a default under one or more of our debt instruments. This could cause our lenders to accelerate the timing of payments and would therefore have a material adverse effect on our business, operations, financial condition and liquidity.
As of December 31, 2007, we were in compliance with our loan covenants; however, our ability to draw on our unsecured credit facility or incur other unsecured debt in the future could be restricted by the loan covenants.
If principal amounts due at maturity cannot be refinanced, extended or paid with proceeds of other capital transactions, such as new equity capital, our cash flow may be insufficient to repay all maturing debt. Prevailing interest rates or other factors at the time of a refinancing (such as possible reluctance of lenders to make commercial real estate loans) may result in higher interest rates and increased interest expense.
Senior Unsecured Notes
We generally issue senior unsecured notes to fund our real estate assets long-term. We intend to ladder the maturities of our debt to mitigate exposure to interest rate risk in future years.
It is possible that over the near term, interest rate fluctuations could have a material adverse effect on earnings. Our unsecured fixed-rate notes payable have maturities ranging from February 2008 through February 2028 (see Note 6), as follows (in thousands):
December 31, 2007 Note Principal | |||
2008 |
$ | 60,000 | |
2009 |
| ||
2010 |
| ||
2011 |
150,000 | ||
2012 |
50,000 | ||
Thereafter |
620,000 | ||
$ | 880,000 | ||
Our unsecured notes contain covenants with which we must comply. These include:
| Limits on our total indebtedness; |
| Limits on our secured indebtedness; |
| Limits on our required debt service payments; and |
| Maintenance of a minimum level of unencumbered assets. |
We are in compliance with our unsecured notes covenants as of December 31, 2007.
Common Equity
We have authorized for issuance 100.0 million common shares, of which 46.7 million shares were outstanding at December 31, 2007.
In June 2007, we completed a public offering of 1.6 million common shares of beneficial interest which provided net cash of $57.8 million. We used the proceeds to repay borrowings on our lines of credit.
44
Dividends
We pay dividends quarterly. The maintenance of these dividends is subject to various factors, including the discretion of the Board of Trustees, the ability to pay dividends under Maryland law, the availability of cash to make the necessary dividend payments and the effect of REIT distribution requirements, which require at least 90% of our taxable income to be distributed to shareholders. The table below details our dividend and distribution payments for 2007, 2006 and 2005 (in thousands).
2007 |
2006 |
2005 | |||||||
Common dividends |
$ | 78,050 | $ | 72,681 | $ | 67,322 | |||
Minority interest distributions |
156 | 134 | 131 | ||||||
$ | 78,206 | $ | 72,815 | $ | 67,453 | ||||
Dividends paid for 2007 as compared to 2006 increased as a direct result of a dividend rate increase from $1.64 per share in 2006 to $1.68 per share in 2007 as well as the issuance of 1,600,000 shares in an equity offering in June 2007. Dividends paid for 2006 as compared to 2005 increased as a direct result of a dividend rate increase from $1.60 per share in 2005 to $1.64 per share in 2006 as well as the issuance of 2,745,000 shares in an equity offering in June 2006.
Cash flows from operations are an important factor in our ability to sustain our dividend at its current rate. Cash flows from operations increased from $86.5 million in 2006 to $115.5 million in 2007, primarily due to increases in operating income from properties acquired in 2006 and 2007 and improvement in performance at our core properties. If our cash flows from operations were to decline significantly, we may have to borrow on our lines of credit to sustain the dividend rate or reduce the dividend payout rate.
Capital Commitments
We will require capital for development and redevelopment projects currently underway and in the future. As of December 31, 2007, we had under development Bennett Park, Clayborne Apartments, Dulles Station and 4661 Kenmore. We are evaluating a number of potential redevelopment projects at properties such as 6565 Arlington Boulevard, Montrose and NVIP. Our total investment in Bennett Park is expected to be $83.2 million and we expect to fund $8.3 million during 2008; a construction contract worth approximately $64.1 million has been executed for this project. As of December 31, 2007, we had invested $74.9 million in Bennett Park including land and carrying costs. Our total investment in Clayborne Apartments is expected to be $36.3 million. As of December 31, 2007, we had invested $33.0 million in this project, and we expect to fund approximately $3.3 million of the total project costs during 2008. There is a $16.7 million construction contract in place for the projects completion. Our investment in Dulles Station phase one is expected to be approximately $60.0 million. As of December 31, 2007 we had invested $43.0 million and $24.5 million on phases one and two of this project, respectively, including $26.2 million to acquire the land for both phases. We expect to fund approximately $9.0 million of the total project costs during 2008.
As of December 31, 2006, the redevelopment of the Shoppes at Foxchase was substantially complete after an investment of $11.2 million. We funded the remaining project cost of approximately $0.5 million in 2007. We anticipate funding several major renovation projects in our portfolios during 2008, as follows (in thousands):
Sector |
Project Spending | ||
Office buildings |
$ | 2,301 | |
Medical office buildings |
| ||
Retail centers |
500 | ||
Multifamily |
10,841 | ||
Industrial |
1,932 | ||
Total |
$ | 15,574 | |
45
These projects include common area and unit renovations at several of our multifamily properties, roof replacement projects at some of our industrial and retail properties, and restroom, garage and common area renovations at some of our office properties. Not all of the anticipated spending had been committed via executed construction contracts at December 31, 2007. We expect to meet our requirements using cash generated by our real estate operations, through borrowings on our unsecured credit facilities, or raising additional debt or equity capital in the public market.
Contractual Obligations
Below is a summary of certain contractual obligations that will require significant capital (in thousands):
Payments due by Period | |||||||||||||||
Total |
Less than 1 year |
1-3 years |
4-5 years |
After 5 years | |||||||||||
Long-term debt (1) |
$ | 1,835,633 | $ | 131,431 | $ | 589,832 | $ | 308,133 | $ | 806,237 | |||||
Purchase obligations (2) |
4,219 | 4,219 | | | | ||||||||||
Estimated development commitments (3) |
7,974 | 7,974 | | | |||||||||||
Tenant-related capital (4) |
1,394 | 1,113 | 236 | 45 | | ||||||||||
Building capital (5) |
10,592 | 10,592 | | | | ||||||||||
Operating leases |
104 | 47 | 57 | | |
(1) |
See Notes 4, 5 and 6 of Notes to Consolidated Financial Statements. Amounts include principal, interest, put option on the $60 million MOPPRs, unused commitment fees and facility fees. |
(2) |
Represents elevator maintenance contracts with terms through 2008, electricity sales agreements with terms through 2008, and natural gas purchase agreements with terms through 2008. |
(3) |
Committed development obligations based on contracts in place as of December 31, 2007. |
(4) |
Committed tenant-related capital based on executed leases as of December 31, 2007. |
(5) |
Committed building capital additions based on contracts in place as of December 31, 2007. |
We have various standing or renewable contracts with vendors. The majority of these contracts are cancelable with immaterial or no cancellation penalties, with the exception of our elevator maintenance and natural gas purchase agreements, which are included above on the purchase obligations line. Contract terms on cancelable leases are generally one year or less. Development commitments include executed construction and professional services contracts associated with our Bennett Park and Clayborne Apartments projects. We are currently committed to fund tenant-related capital improvements as described in the table above for executed leases. However, expected leasing levels could require additional tenant-related capital improvements which are not currently committed. We expect that total tenant-related capital improvements, including those already committed, will be approximately $24.0 million in 2008. Due to the competitive office leasing market we expect that tenant-related capital costs will continue at this level into 2008.
Historical Cash Flows
Consolidated cash flow information is summarized as follows (in millions):
For the year ended December 31, |
Variance |
|||||||||||||||||||
2007 |
2006 |
2005 |
2007 vs. 2006 |
2006 vs. 2005 |
||||||||||||||||
Cash provided by operating activities |
$ | 115.5 | $ | 86.5 | $ | 87.7 | $ | 29.0 | $ | (1.2 | ) | |||||||||
Cash used in investing activities |
$ | (348.6 | ) | $ | (334.7 | ) | $ | (98.5 | ) | $ | (13.9 | ) | $ | (236.2 | ) | |||||
Cash provided by financing activities |
$ | 245.9 | $ | 251.9 | $ | 10.7 | $ | (6.0 | ) | $ | 241.2 |
46
Operations generated $115.5 million of net cash in 2007 compared to $86.5 million in 2006. The increase in cash flow in 2007 compared to 2006 was due primarily to properties acquired in 2006 and 2007. The level of net cash provided by operating activities is also affected by the timing of receipt of revenues and payment of expenses.
Our investing activities used net cash of $348.6 million in 2007 and $334.7 million in 2006. The change in cash flows from investing activities in 2007 was primarily due to the $294.2 million of cash invested in acquisitions, net of assumed debt, throughout the year, which was $67.7 million higher than the prior year. This was offset by net cash received of $56.3 million from the sale of Maryland Trade Center I & II.
Our financing activities provided net cash of $245.9 million in 2007 and $251.9 million in 2006. The decrease in net cash provided by financing activities in 2007 is the primarily result of the higher debt and equity offerings in 2006 and an increase in dividends paid in 2007, offset by larger borrowings on lines of credit in 2007. Net borrowings/repayments on the lines of credit provided $131.5 million in 2007, offset somewhat by payment of dividends of $78.1 million and mortgage principal payments of $11.4 million. Dividends increased in 2007 due to the issuance of 1,600,000 shares in June and an increase in the dividend rate.
CAPITAL IMPROVEMENTS AND DEVELOPMENT COSTS
Capital improvements and development costs of $107.6 million were completed in 2007, including tenant improvements. These improvements to our properties in 2006 and 2005 were $106.4 million and $48.6 million, respectively. We consider capital improvements to be accretive to revenue but not necessarily accretive to net income.
Our capital improvement and development costs for the three years ending December 31, 2007 were as follows (in thousands):
Year Ended December 31, | |||||||||
2007 | 2006 | 2005 | |||||||
Accretive capital improvements: |
|||||||||
Acquisition related |
$ | 1,954 | $ | 1,430 | $ | 918 | |||
Expansions and major renovations |
10,684 | 18,258 | 11,762 | ||||||
Development/redevelopment |
66,489 | 68,621 | 17,866 | ||||||
Tenant improvements |
16,587 | 9,473 | 8,932 | ||||||
Total accretive capital improvements |
95,714 | 97,782 | 39,478 | ||||||
Other: |
11,897 | 8,685 | 9,125 | ||||||
Total |
$ | 107,611 | $ | 106,467 | $ | 48,603 | |||
Accretive Capital Improvements
Acquisition RelatedThese are capital improvements to properties acquired during the current and preceding two years which were anticipated at the time we acquired the properties. These types of improvements were made in 2007 to 6565 Arlington Boulevard, Montrose, West Gude, Ridges and Alexandria Professional Center.
Expansions and Major RenovationsExpansion projects increase the rentable area of a property, while major renovation projects are improvements sufficient to increase the income otherwise achievable at a property. 2007 expansions and major renovations included common area and unit renovations for Bethesda Hill; common area renovations at Avondale; restroom renovations at 515 King Street and 6110 Executive Boulevard; balcony renovations at Roosevelt Towers; and elevator modernization projects at 3801 Connecticut Avenue and Country Club Towers.
Development/Re-developmentDevelopment costs represent expenditures for ground up development of new operating properties. Re-development costs represent expenditures for improvements intended to re-position
47
properties in their markets and increase income that would be otherwise achievable. Development costs in each of the years presented include costs associated with the ground up development of Bennett Park and Clayborne. In 2006 and 2007 these costs also include expenditures associated with Dulles Station. Completion of Bennett Park, our residential project under development in Arlington, VA, occurred in the third quarter 2007 for the mid-rise building and fourth quarter 2007 for the high-rise building. Completion of Clayborne Apartments, our residential project under construction in Alexandria, VA, is expected in the first quarter 2008. Completion of Phase I of Dulles Station, our 540,000 square foot office project in Herndon, VA, of which Phase I represents 180,000 square feet, occurred in the third quarter of 2007, however completion of tenant improvements is pending lease up of the space. Additionally in 2007, we acquired land for future development of medical office space at 4661 Kenmore in Alexandria, VA. Development spending in 2007 includes pre-development activities related to this project. Re-development costs in each of the years presented were incurred for the Shoppes of Foxchase, which was substantially completed in 2006. In 2005, re-development costs included expenditures for the completion of the Food Lion grocery store at Westminster.
Tenant ImprovementsTenant Improvements are costs, such as space build-out, associated with commercial lease transactions. Our average Tenant Improvement Costs per square foot of space leased were as follows during the three years ended December 31, 2007:
Year Ended December 31, | |||||||||
2007 |
2006 |
2005 | |||||||
Office Buildings* |
$ | 13.68 | $ | 12.95 | $ | 9.32 | |||
Medical Office Buildings |
$ | 13.95 | $ | 17.78 | $ | 7.65 | |||
Retail Centers |
$ | 1.84 | $ | 0.05 | $ | 0.85 | |||
Industrial/Flex Properties* |
$ | 2.64 | $ | 1.91 | $ | 1.66 |
* | Excludes properties sold or classified as held for sale. |
The $0.73 increase in tenant improvement costs per square foot of space leased for office buildings in 2007 was primarily due to leases executed at 6110 Executive Boulevard and 30 West Gude requiring $1.3 million and $0.7 million, respectively, in tenant improvements, including $1.1 million and $0.4 million, respectively, for a single tenant. The $3.63 increase in tenant improvement costs per square foot of space leased for office buildings in 2006 as compared to 2005 was primarily due to leases executed at 7900 Westpark requiring $2.7 million in tenant improvements, including $1.5 million for a single tenant.
The $3.83 decrease in tenant improvement costs per square foot of space leased for medical office buildings in 2007 was primarily due to leases executed in 2006 at 15001 Shady Grove and Woodburn I requiring $1.8 million in tenant improvements, primarily to a single tenant. These leases drove the $10.13 increase in tenant improvement costs per square foot of space leased for medical office buildings in 2006 over 2005.
The $1.79 increase in tenant improvement costs per square foot of retail space leased in 2007 was primarily due to leases executed at Montrose Center, The Shoppes of Foxchase and South Washington Street requiring $0.3 million in combined tenant improvements for single tenants. The $0.73 increase in tenant improvement costs per square foot of industrial space leased in 2007 was primarily due to leases executed at Dulles Business Park and Gorman Road requiring $0.8 million and $0.4 million, respectively, in tenant improvements, entirely for single tenants.
The industrial tenant improvement costs are substantially lower than office and medical office improvement costs due to the tenant improvements required in these property types being substantially less extensive than in office and medical. The retail tenant improvement costs are substantially lower than office and medical office improvement costs because our retail tenants tend to pay for their own improvements. Excluding properties sold or classified as held for sale, approximately 83% of our office tenants renewed their leases with us in 2007, compared to 68% in 2006 and 62% in 2005. Renewing tenants generally require minimal tenant improvements. In addition, lower tenant improvement costs are one of the many benefits of our focus on leasing to smaller office tenants. Smaller office suites have limited configuration alternatives. Therefore, we are often able to lease an existing suite with limited tenant improvements.
48
Other Capital Improvements
Other Capital Improvements are those not included in the above categories. These are also referred to as recurring capital improvements. Over time these costs will be recurring in nature to maintain a propertys income and value. In our residential properties, these include new appliances, flooring, cabinets and bathroom fixtures. These improvements, which are made as needed upon vacancy of an apartment, totaled $1.0 million in 2007, and averaged $1,273 per apartment for the 38% of apartments turned over relative to our total portfolio of apartment units. In our commercial properties and residential properties aside from apartment turnover discussed above, these include installation of new heating and air conditioning equipment, asphalt replacement, new signage, permanent landscaping, window replacements, new lighting and new finishes. In addition, during 2007, we incurred repair and maintenance expenses of $9.5 million that were not capitalized, to maintain the quality of our buildings.
FORWARD-LOOKING STATEMENTS
This Annual Report contains forward-looking statements which involve risks and uncertainties. Such forward looking statements include the following statements with respect to the metropolitan Washington real estate markets: (a) continued spending by the Federal Government, government contracting firms and professional services firms is expected to continue to drive regional economic growth; (b) industrial rental rates are projected to increase; (c) the Washington metro area is expected to be a strong multifamily market; and (d) office vacancy is expected to increase due to increased supply in the market. Such forward looking statements also include the following statements with respect to WRIT: (a) our intention to invest in properties that we believe will increase in income and value; (b) our belief that external sources of capital will continue to be available and that additional sources of capital will be available from the sale of shares or notes; and (c) our belief that we have the liquidity and capital resources necessary to meet our known obligations and to make additional property acquisitions and capital improvements when appropriate to enhance long-term growth. Forward looking statements also include other 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 the foregoing statements. The following important factors, in addition to those discussed elsewhere in this Annual Report, could affect our future results and could cause those results to differ materially from those expressed in the forward-looking statements: (a) the economic health of our tenants; (b) the economic health of the greater Washington Metro region, or other markets we may enter, including the effects of changes in Federal government spending; (c) the supply of competing properties; (d) inflation; (e) consumer confidence; (f) unemployment rates; (g) consumer tastes and preferences; (h) stock price and interest rate fluctuations; (i) our future capital requirements; (j) compliance with applicable laws, including those concerning the environment and access by persons with disabilities; (k) governmental or regulatory actions and initiatives; (l) changes in general economic and business conditions; (m) terrorist attacks or actions; (n) acts of war; (o) weather conditions; (p) the effects of changes in capital available to the technology and biotechnology sectors of the economy, and (q) other factors discussed under the caption Risk Factors. We undertake no obligation to update our forward-looking statements or risk factors to reflect new information, future events, or otherwise.
RATIOS OF EARNINGS TO FIXED CHARGES AND DEBT SERVICE COVERAGE
The following table sets forth our ratios of earnings to fixed charges and debt service coverage for the periods shown:
Year Ended December 31, | ||||||
2007 |
2006 |
2005 | ||||
Earnings to fixed charges |
1.38x | 1.62x | 1.95x | |||
Debt service coverage |
2.56x | 2.76x | 3.05x |
49
We computed the ratio of earnings to fixed charges by dividing earnings by fixed charges. For this purpose, earnings consist of income from continuing operations plus fixed charges, less capitalized interest. Fixed charges consist of interest expense, including amortized costs of debt issuance, and interest costs capitalized.
We computed the debt service coverage ratio by dividing EBITDA (which is earnings before interest income and expense, taxes, depreciation, amortization and gain on sale of real estate) by interest expense and principal amortization.
Funds From Operations
Funds from Operations (FFO) is a widely used measure of operating performance for real estate companies. We provide FFO as a supplemental measure to net income calculated in accordance with accounting principles generally accepted in the United States of America (GAAP). Although FFO is a widely used measure of operating performance for REITs, FFO does not represent net income calculated in accordance with GAAP. As such, it should not be considered an alternative to net income as an indication of our operating performance. In addition, FFO does not represent cash generated from operating activities in accordance with GAAP, nor does it represent cash available to pay distributions and should not be considered as an alternative to cash flow from operating activities, determined in accordance with GAAP as a measure of our liquidity. The National Association of Real Estate Investment Trusts, Inc. (NAREIT) defines FFO (April, 2002 White Paper) as net income (computed in accordance with GAAP) excluding gains (or losses) from sales of property plus real estate depreciation and amortization. We consider FFO to be a standard supplemental measure for REITs because it facilitates an understanding of the operating performance of our properties without giving effect to real estate depreciation and amortization, which historically assumes that the value of real estate assets diminishes predictably over time. Since real estate values have instead historically risen or fallen with market conditions, we believe that FFO more accurately provides investors an indication of our ability to incur and service debt, make capital expenditures and fund other needs. Our FFO may not be comparable to FFO reported by other REITs. These other REITs may not define the term in accordance with the current NAREIT definition or may interpret the current NAREIT definition differently.
The following table provides the calculation of our FFO and a reconciliation of FFO to net income for the years presented (in thousands):
2007 |
2006 |
2005 |
|||||||||
Net income |
$ | 61,881 | $ | 38,661 | $ | 77,638 | |||||
Adjustments |
|||||||||||
Depreciation and amortization |
69,775 | 50,915 | 44,561 | ||||||||
Gain on property disposed |
(25,022 | ) | | (37,011 | ) | ||||||
Other gain |
(1,303 | ) | | (504 | ) | ||||||
Discontinued operations depreciation and amortization |
1,250 | 3,255 | 2,671 | ||||||||
FFO as defined by NAREIT |
$ | 106,581 | $ | 92,831 | $ | 87,355 | |||||
ITEM 7A. | QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK |
The principal material financial market risk to which we are exposed is interest rate risk. Our exposure to interest rate risk relates primarily to refinancing long-term fixed rate obligations, the opportunity cost of fixed rate obligations in a falling interest rate environment and our variable rate lines of credit. We primarily enter into debt obligations to support general corporate purposes including acquisition of real estate properties, capital improvements and working capital needs. In the past we have used interest rate hedge agreements to hedge against rising interest rates in anticipation of imminent refinancing or new debt issuance.
The table below presents principal, interest and related weighted average fair value interest rates by year of maturity, with respect to debt outstanding on December 31, 2007.
50
(In thousands) |
2008 |
2009 |
2010 |
2011 |
2012 |
Thereafter |
Total |
Fair Value | |||||||||||||||||||||||
Unsecured fixed rate debt |
|||||||||||||||||||||||||||||||
Principal |
$ | 60,000 | (a) | | | $ | 150,000 | $ | 50,000 | $ | 620,000 | $ | 880,000 | $ | 853,275 | ||||||||||||||||
Interest payments |
$ | 43,569 | $ | 41,500 | $ | 41,500 | $ | 37,038 | $ | 31,313 | $ | 241,825 | $ | 436,745 | |||||||||||||||||
Interest rate on debt maturities |
6.74 | % | | | 5.95 | % | 5.06 | % | 4.89 | % | 5.20 | % | |||||||||||||||||||
Unsecured variable rate debt |
|||||||||||||||||||||||||||||||
Principal |
| | $ | 122,500 | $ | 70,000 | | | $ | $192,500 | $ | 192,500 | |||||||||||||||||||
Variable interest rate on debt maturities (b) |
| | 5.55 | % | 5.17 | % | | | 5.41 | % | |||||||||||||||||||||
Mortgages |
|||||||||||||||||||||||||||||||
Principal amortization (30 year schedule) |
$ | 4,057 | $ | 54,285 | $ | 25,973 | $ | 13,339 | $ | 21,088 | $ | 133,742 | $ | 252,484 | $ | 249,911 | |||||||||||||||
Interest payments |
$ | 14,677 | $ | 13,557 | $ | 10,240 | $ | 9,142 | $ | 8,203 | $ | 8,199 | $ | 64,018 | |||||||||||||||||
Weighted average interest rate on principal amortization |
5.43 | % | 7.01 | % | 5.75 | % | 5.30 | % | 4.90 | % | 5.44 | % | 5.80 | % |
(a) |
In the first quarter of 2008, WRIT repaid the $60 million outstanding principal balance under its 6.898% 10-year Mandatory Par Put Remarketed Securities (MOPPRS) notes. |
(b) |
Variable interest rates based on LIBOR in effect on our borrowings outstanding at December 31, 2007. |
ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
The financial statements and supplementary data appearing on pages 61 to 96 are incorporated herein by reference.
ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
None.
ITEM 9A. | CONTROLS AND PROCEDURES |
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Securities Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer, Chief Financial Officer and Executive Vice President of Accounting, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer, Chief Financial Officer and Executive Vice President of Accounting, of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2007. Based on the foregoing, our Chief Executive Officer, Chief Financial Officer and Executive Vice President of Accounting concluded that the Trusts disclosure controls and procedures were effective.
Internal Control over Financial Reporting
See the Report of Management in Item 8 of this Form 10-K.
See the Reports of Independent Registered Public Accounting Firm in Item 8 of this Form 10-K. During the three months ended December 31, 2007, there was no change in the Companys internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Companys internal control for financial reporting.
ITEM 9B. | OTHER INFORMATION |
None.
51
PART III
Certain information required by Part III is omitted from this report in that we will file a definitive proxy statement pursuant to Regulation 14A with respect to our 2008 Annual Meeting (the Proxy Statement) no later than 120 days after the end of the fiscal year covered by this report, and certain information included therein is incorporated herein by reference. Only those sections of the Proxy Statement which specifically address the items set forth herein are incorporated by reference. In addition, we have adopted a Code of Ethics which can be reviewed and printed from our website www.writ.com.
ITEM 10. | DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE |
The information required by this Item is hereby incorporated herein by reference to the Proxy Statement.
ITEM 11. | EXECUTIVE COMPENSATION |
The information required by this Item is hereby incorporated herein by reference to the Proxy Statement.
ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |
The information required under this Item by Item 403 of Regulation S-K is hereby incorporated herein by reference to the Proxy Statement.
Equity Compensation Plan Information*
Plan Category |
Number of securities to be issued upon exercise of outstanding options, warrants and rights |
Weighted-average exercise price of outstanding options, warrants and rights |
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) | ||||
(a) | (b) | (c) | |||||
Equity compensation plans approved by security holders |
398,523 | $ | 24.17 | 1,932,000 | |||
Equity compensation plans not approved by security holders |
40,000 | 26.78 | | ||||
Total |
438,523 | $ | 24.40 | 1,932,000 |
* | We previously maintained a Share Grant Plan for officers, trustees and non-officer employees, which expired on December 15, 2007. 322,325 shares and 27,675 restricted share units had been granted under this plan. We previously maintained a stock option plan for trustees which provided for the annual granting of 2,000 non-qualified stock options to trustees the last of which were granted in 2004. The plan expired on December 15, 2007, and 84,000 options had been granted. |
ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE |
The information required by this Item is hereby incorporated herein by reference to the Proxy Statement.
ITEM 14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES |
The information required by this Item is hereby incorporated by reference to the material in the Proxy Statement under the caption Independent Registered Public Accounting Firm.
52
PART IV
ITEM 15. | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES |
(A). | The following documents are filed as part of this Report: |
1. | Financial Statements | Page | ||
Managements Report on Internal Control Over Financial Reporting |
58 | |||
Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting |
59 | |||
Report of Independent Registered Public Accounting Firm |
60 | |||
Consolidated Balance Sheets as of December 31, 2007 and 2006 |
61 | |||
Consolidated Statements of Income for the Years Ended December 31, 2007, 2006 and 2005 |
62 | |||
Consolidated Statements of Changes in Shareholders Equity for the Years Ended December 31, 2007, 2006 and 2005 |
63 | |||
Consolidated Statements of Cash Flows for the Years Ended December 31, 2007, 2006 and 2005 |
64 | |||
Notes to Consolidated Financial Statements |
65 | |||
2. | Financial Statement Schedules |
|||
Schedule IIIConsolidated Real Estate and Accumulated Depreciation |
93 | |||
3. | Exhibits: |
3. | Declaration of Trust and Bylaws | |||||
(a) |
Declaration of Trust. Incorporated herein by reference to Exhibit 3 to the Trusts registration statement on Form 8-B dated July 10, 1996. | |||||
(b) |
Bylaws. Incorporated herein by reference to Exhibit 4 to the Trusts registration statement on Form 8-B dated July 10, 1996. | |||||
(c) |
Amendment to Declaration of Trust dated September 21, 1998. Incorporated herein by reference to Exhibit 3 to the Trusts Form 10-Q dated November 13, 1998. | |||||
(d) |
Articles of Amendment to Declaration of Trust dated June 24, 1999. Incorporated herein by reference to Exhibit 4c to Amendment No. 1 to the Trusts Form S-3 registration statement filed with the Securities and Exchange Commission as of July 14, 1999. | |||||
(e) |
Amendment to Bylaws dated February 21, 2002. Incorporated herein by reference to Exhibit 3(e) to the Trusts Form 10-K dated April 1, 2002. | |||||
(f) |
Articles of Amendment to Declaration of Trust dated June 1, 2006. Incorporated herein by reference to Exhibit 4d to the Trusts Form S-3 registration statement filed with the Securities and Exchange Commission as of August 28, 2006. | |||||
4. | Instruments Defining Rights of Security Holders | |||||
(a) |
[Intentionally omitted] | |||||
(c) |
Indenture dated as of August 1, 1996 between Washington Real Estate Investment Trust and The First National Bank of Chicago.(2) | |||||
(d) |
Officers Certificate Establishing Terms of the Notes, dated August 8, 1996(2) | |||||
(e) |
[Intentionally omitted] | |||||
(f) |
Form of 2006 Notes(2) | |||||
(g) |
Form of MOPPRS Notes(3) | |||||
(h) |
Form of 30 year Notes(3) | |||||
(i) |
Remarketing Agreement(3) | |||||
(j) |
Form of 2004 fixed-rate notes(4) | |||||
(k) |
[Intentionally omitted] | |||||
(n) |
Officers Certificate Establishing Terms of the Notes, dated March 12, 2003.(8) | |||||
(o) |
Form of 2013 Notes.(8) | |||||
(p) | Officers Certificate Establishing Terms of the Notes, dated December 8, 2003.(9) |
53
(q) |
Form of 2014 Notes.(9) | |||||
(r) |
[Intentionally omitted] | |||||
(t) |
Form of 5.05% Senior Notes due May 1, 2012(11) | |||||
(u) |
Form of 5.35% Senior Notes due May 1, 2015 dated April 26, 2005(11) | |||||
(v) |
Officers Certificate establishing the terms of the Notes, dated April 20, 2005(11) | |||||
(x) |
Form of 5.35% Senior Notes due May 1, 2015 dated October 6, 2005(13) | |||||
(y) |
Officers Certificate establishing the terms of the Notes, dated October 3, 2005(13) | |||||
(z) |
Form of 5.95% Senior Notes due June 15, 2011(16) | |||||
(aa) |
Officers Certificate establishing the terms of the Notes, dated June 6, 2006(16) | |||||
(cc) |
Form of 3.875% Senior Convertible Notes due September 15, 2026(17) | |||||
(dd) |
Officers Certification establishing the terms of the Notes, dated September 11, 2006(17) | |||||
(ee) |
Form of additional 3.875% Senior convertible Notes due September 15, 2026(18) | |||||
(ff) |
Form of 5.95% senior notes due June 15, 2011, dated July 21, 2006(19) | |||||
(gg) |
Officers Certification establishing the terms of the Notes, dated July 21, 2006(19) | |||||
(hh) |
Credit agreement dated November 2, 2006 between Washington Real Estate Investment Trust as borrower and a syndicate of banks as lender with The Bank of New York as documentation agent, The Royal Bank of Scotland, plc as syndication agent and Wells Fargo Bank, NA, as agent(20) | |||||
(ii) |
Form of 3.875% Convertible Senior Notes due September 15, 2026(24) | |||||
(jj) |
Officers Certificate establishing the terms of the 3.85% Convertible Senior Notes due September 15, 2026(24) | |||||
(kk) |
Form of additional 3.85% Convertible Senior Notes due September 15, 2026(25) | |||||
(ll) |
Supplemental Indenture by and between the Trust and the Bank of New York Trust Company, N.A. dated as of July 3, 2007(27) | |||||
(mm) |
Credit agreement dated June 29, 2007 by and among Washington Real Estate Investment Trust, as borrower, the financial institutions party thereto as lenders, and SunTrust Bank as agent(28) | |||||
We are a party to a number of other instruments defining the rights of holders of long-term debt. No such instrument authorizes an amount of securities in excess of 10 percent of the total assets of the Trust and its Subsidiaries on a consolidated basis. On request, we agree to furnish a copy of each such instrument to the Commission. | ||||||
10. | Management Contracts, Plans and Arrangements | |||||
(b) |
1991 Incentive Stock Option Plan, as amended.(5) | |||||
(e) |
Share Grant Plan(6) | |||||
(f) |
Share Option Plan for Trustees(6) | |||||
(g) |
Deferred Compensation Plan for Executives dated January 1, 2000, incorporated herein by reference to Exhibit 10(g) to the 2000 Form 10-K filed March 19, 2001. | |||||
(h) |
Split-Dollar Agreement dated April 1, 2000, incorporated herein by reference to Exhibit 10(h) to the 2000 Form 10-K filed March 19, 2001. | |||||
(i) |
2001 Stock Option Plan incorporated herein by reference to Exhibit A to 2001 Proxy Statement dated March 29, 2001. | |||||
(j) |
Share Purchase Plan.(7) | |||||
(k) |
Supplemental Executive Retirement Plan.(7) | |||||
(l) |
Description of Washington Real Estate Investment Trust Short-term and Long-term Incentive Plan incorporated herein by reference to Exhibit 10(l) to the 2005 Form 10-K filed March 16, 2005. | |||||
(m) |
Description of Washington Real Estate Investment Trust Revised Trustee Compensation Plan incorporated herein by reference to Exhibit 10(m) to the 2005 Form 10-K filed March 16, 2005. | |||||
(p) |
Supplemental Executive Retirement Plan(21) | |||||
(q) |
Change in control Agreement dated May 22, 2003 with Thomas L. Regnell(21) | |||||
(r) |
Change in control Agreement dated June 13, 2005 with David A. DiNardo(21) | |||||
(s) |
Change in control Agreement dated May 22, 2003 with George F. McKenzie(21) |
54
(t) |
Change in control Agreement dated May 22, 2003 with Laura M. Franklin(21) | |||||
(u) |
Change in control Agreement dated May 22, 2003 with Kenneth C. Reed(21) | |||||
(v) |
Change in control Agreement dated May 22, 2003 with Sara L. Grootwassink(21) | |||||
(w) |
Change in control Agreement dated January 1, 2006 with James B. Cederdahl(21) | |||||
(x) |
Change in Control Agreement dated December 17, 1999 with Edmund B. Cronin, Jr.(22) | |||||
(y) |
Separation Agreement dated July 10, 2006 with Christopher P. Mundy(23) | |||||
(z) |
Amendment No. 2 to the Share Grant Plan | |||||
(aa) |
Long Term Incentive Plan, effective January 1, 2006 | |||||
(bb) |
Short Term Incentive Plan, effective January 1, 2006 | |||||
(cc) |
2007 Omnibus Long Term Incentive Plan.(26) | |||||
(dd) |
Change in control Agreement dated June 1, 2007 with George F. McKenzie.(29) | |||||
(ee) |
Change in control Agreement dated May 14, 2007 with Michael S. Paukstitus.(29) | |||||
(ff) |
Deferred Compensation Plan for Directors dated December 1, 2000 | |||||
(gg) |
Deferred Compensation for Officers dated January 1, 2007 | |||||
(hh) |
Supplemental Executive Retirement Plan II dated May 23, 2007 | |||||
12. | Computation of Ratio of Earnings to Fixed Charges | |||||
21. | Subsidiaries of Registrant | |||||
23. | Consents | |||||
(a) |
Consent of Independent Registered Public Accounting Firm | |||||
31. | Rule 13a-14(a)/15(d)-14(a) Certifications | |||||
(a) |
Certification Chief Executive Officer | |||||
(b) |
Certification Senior Vice President Accounting and Administration | |||||
(c) |
Certification Chief Financial Officer | |||||
32. | Section 1350 Certifications | |||||
(a) |
Written Statement of Chief Executive Officer and Financial Officers |
(2) |
Incorporated herein by reference to the Exhibit of the same designation to the Trusts Form 8-K filed August 13, 1996. |
(3) |
Incorporated herein by reference to the Exhibit of the same designation to the Trusts Form 8-K filed February 25, 1998. |
(4) |
Incorporated herein by reference to Exhibit 4 to the Trusts Form 10-Q filed November 14, 2000. |
(5) |
Incorporated herein by reference to the Exhibit of the same designation to Amendment No. 2 to the Trusts Registration Statement on Form S-3 filed July 17, 1995. |
(6) |
Incorporated herein by reference to Exhibits 4(a) and 4(b), respectively, to the Trusts Registration Statement on Form S-8 filed on March 17, 1998. |
(7) |
Incorporated herein by reference to the Exhibits of the same designation to the Trusts Form 10-Q filed November 14, 2002. |
(8) |
Incorporated herein by reference to Exhibits 4(a) and 4(b), respectively, to the Trusts Form 8-K filed March 17, 2003. |
(9) |
Incorporated herein by reference to Exhibits 4(a) and 4(b), respectively, to the Trusts Form 8-K filed December 11, 2003. |
(11) |
Incorporated herein by reference to Exhibits 4.1, 4.2 and 4.3 to the Trusts Form 8-K filed April 26, 2005 |
(13) |
Incorporated herein by reference to Exhibit 4.1 and 4.2 to the Trusts Form 8-K filed October 6, 2005 |
(16) |
Incorporated herein by reference to Exhibits 4.1 and 4.2, respectively to the Trusts Form 8-K filed June 6, 2006 |
55
(17) |
Incorporated herein by reference to the Trusts Form 424B5 filed September 11, 2006 |
(18) |
Incorporated herein by reference to Exhibit 4.1 to the Trusts Form 8-K filed September 26, 2006 |
(19) |
Incorporated herein by reference to the Trusts Form 424B5 filed July 21, 2006 |
(20) |
Incorporated herein by reference to Exhibit 4.1 to the Trusts Form 8-K filed November 8, 2006 |
(21) |
Incorporated herein by reference to Exhibit 10 to the Trusts Form 10-K filed March 16, 2006 |
(22) |
Incorporated herein by reference to Exhibit 10 to the Trusts Form 10-Q filed May 5, 2006 |
(23) |
Incorporated herein by reference to Exhibit 10 to the Trusts Form 10-Q filed August 8, 2006 |
(24) |
Incorporated herein by reference to Exhibit 4.1 to the Trusts Form 8-K filed January 23, 2007 |
(25) |
Incorporated herein by reference to Exhibit 4.1 to the Trusts Form 8-K filed February 2, 2007 |
(26) |
Incorporated herein by reference to Appendix B to the Trusts Form DEF 14A filed April 9, 2007 |
(27) |
Incorporated herein by reference to Exhibit 4.1 to the Trusts Form 8-K filed July 5, 2007 |
(28) |
Incorporated herein by reference to Exhibit 4.1 to the Trusts Form 8-K filed July 6, 2007 |
(29) |
Incorporated herein by reference to Exhibit 10 to the Trusts Form 10-Q filed August 9, 2007 |
56
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
WASHINGTON REAL ESTATE INVESTMENT TRUST | ||||||||
Date: February 29, 2008 | ||||||||
By: | /s/ GEORGE F. MCKENZIE | |||||||
George F. McKenzie President and Chief Executive Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature |
Title |
Date | ||
/s/ EDMUND B. CRONIN, JR. Edmund B. Cronin, Jr. |
Chairman, Trustee |
February 29, 2008 | ||
/s/ GEORGE F. MCKENZIE George F. McKenzie |
President, CEO and Trustee |
February 29, 2008 | ||
/s/ JOHN M. DERRICK, JR. John M. Derrick, Jr. |
Trustee |
February 29, 2008 | ||
/s/ JOHN P. MCDANIEL John P. McDaniel |
Trustee |
February 29, 2008 | ||
/s/ CHARLES T. NASON Charles T. Nason |
Trustee |
February 29, 2008 | ||
/s/ SUSAN J. WILLIAMS Susan J. Williams |
Trustee |
February 29, 2008 | ||
/s/ EDWARD S. CIVERA Edward S. Civera |
Trustee |
February 29, 2008 | ||
/s/ THOMAS EDGIE RUSSELL, III Thomas Edgie Russell, III |
Trustee |
February 29, 2008 | ||
/s/ LAURA M. FRANKLIN Laura M. Franklin |
Executive Vice President Accounting, Administration and Corporate Secretary |
February 29, 2008 | ||
/s/ SARA L. GROOTWASSINK Sara L. Grootwassink |
Executive Vice President and Chief Financial Officer |
February 29, 2008 |
57
MANAGEMENTS REPORT ON
INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of Washington Real Estate Investment Trust (the Trust) is responsible for establishing and maintaining adequate internal control over financial reporting and for the assessment of the effectiveness of internal controls over financial reporting. The Trusts internal control system over financial reporting is a process designed under the supervision of the Trusts principal executive and principal financial officers to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements in accordance with U.S. generally accepted accounting principles.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions.
In connection with the preparation of the Trusts annual consolidated financial statements, management has undertaken an assessment of the effectiveness of the Trusts internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO Framework). Managements assessment included an evaluation of the design of the Trusts internal control over financial reporting and testing of the operational effectiveness of those controls.
Based on this assessment, management has concluded that as of December 31, 2007, the Trusts internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.
Ernst & Young LLP, the independent registered public accounting firm that audited the Trusts consolidated financial statements included in this report, have issued an unqualified opinion on the effectiveness of the Trusts internal control over financial reporting, a copy of which appears on the next page of this annual report.
58
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Trustees and Shareholders of
Washington Real Estate Investment Trust
We have audited Washington Real Estate Investment Trust and Subsidiaries (the Company) internal control over financial reporting as of December 31, 2007, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Companys management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Managements Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Washington Real Estate Investment Trust and Subsidiaries as of December 31, 2007 and 2006 and the related consolidated statements of income, shareholders equity, and cash flows for each of the three years in the period ended December 31, 2007 of Washington Real Estate Investment Trust and Subsidiaries and our report dated February 27, 2008 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
McLean, Virginia
February 27, 2008
59
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Trustees and Shareholders of
Washington Real Estate Investment Trust
We have audited the accompanying consolidated balance sheets of Washington Real Estate Investment Trust and Subsidiaries as of December 31, 2007 and 2006, and the related consolidated statements of income, shareholders equity, and cash flows for each of the three years in the period ended December 31, 2007. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Washington Real Estate Investment Trust and Subsidiaries at December 31, 2007 and 2006, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Washington Real Estate Investment Trust and Subsidiaries internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 27, 2008 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
McLean, Virginia
February 27, 2008
60
WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2007 AND 2006
(IN THOUSANDS, EXCEPT PER SHARE DATA)
2007 |
2006 |
|||||||
Assets |
||||||||
Land |
$ | 328,951 | $ | 285,103 | ||||
Income producing property |
1,635,169 | 1,238,548 |