Table of Contents
Index to Financial Statements

 

 

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, 2008

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)

Registrant’s telephone number, including area code: (301) 984-9400

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

 

Title of Each Class

 

Name of exchange on which registered

Shares of Beneficial Interest

  New York Stock Exchange

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

Indicate by check mark 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 12 months (or such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 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 registrant’s 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.  x

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

Large accelerated filer  x            Accelerated filer  ¨            Non-accelerated filer  ¨            Smaller reporting company  ¨

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 June 30, 2008, the aggregate market value of such shares held by non-affiliates of the registrant was approximately $1,470,494,526 (based on the closing price of the stock on June 30, 2008).

As of February 26, 2009, 52,996,595 common shares were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of our definitive Proxy Statement relating to the 2009 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.

 

 

 


Table of Contents
Index to Financial Statements

WASHINGTON REAL ESTATE INVESTMENT TRUST

2008 FORM 10-K ANNUAL REPORT

INDEX

 

               Page

PART I

        
   Item 1.    Business    3
   Item 1A.    Risk Factors    6
   Item 1B.    Unresolved Staff Comments    12
   Item 2.    Properties    13
   Item 3.    Legal Proceedings    15
   Item 4.    Submission of Matters to a Vote of Security Holders    15

PART II

        
   Item 5.   

Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   16
   Item 6.    Selected Financial Data    17
   Item 7.   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   18
   Item 7A.    Qualitative and Quantitative Disclosures about Market Risk    52
   Item 8.    Financial Statements and Supplementary Data    53
   Item 9.   

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   53
   Item 9A.    Controls and Procedures    53
   Item 9B.    Other Information    53

PART III

        
   Item 10.    Directors and Executive Officers and Corporate Governance    54
   Item 11.    Executive Compensation    54
   Item 12.   

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters, and Director Independence

   54
   Item 13.    Certain Relationships and Related Transactions    54
   Item 14.    Principal Accountant Fees and Services    54

PART IV

        
   Item 15.    Exhibits and Financial Statements Schedules    55

Signatures

      58

 

2


Table of Contents
Index to Financial Statements

PART I

 

ITEM 1: BUSINESS

WRIT Overview

Washington Real Estate Investment Trust (“we” or “WRIT”) 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 operation 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 (a) reinvesting the sale price of properties sold, allowing for a deferral of income taxes on the sale, (b) paying out capital gains to the shareholders with no tax to us or (c) treating the capital gains as having been distributed to our shareholders, paying the tax on the gain deemed distributed and allocating the tax paid as a credit to our shareholders.

Over the last five years, dividends paid per share have been $1.72 for 2008, $1.68 for 2007, $1.64 for 2006, $1.60 for 2005 and $1.55 for 2004.

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 nation’s 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 Washington within two hours by car. While we have historically focused most of our investments in the greater Washington metro region, in order to maximize acquisition opportunities we will consider investments within the two-hour radius described above. We also may 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 a majority of 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 50.

The Greater Washington Metro Area Economy

In 2008, the Washington metro region experienced positive job growth, an increase in gross regional product (“GRP”), and the lowest unemployment rate among the major markets in the nation. However, the national economic recession has still negatively affected our region. Current projections indicate that the Washington metro region added 26,000 new jobs in 2008 as one of the few national markets with positive job growth in 2008. The professional and business services, leisure and hospitality, health care and federal/state government sectors led job growth in the region. According to the Center for Regional Analysis (“CRA”) at George Mason University, the Washington area’s GRP in 2008 is estimated to have increased 2.5%, which is similar to the experience of the 2001-2002 economic slowdown. Approximately one-third of the area’s GRP was generated by the federal government. The region’s unemployment rate was 4.1% at October 2008, up a full 1.0% as compared to 2007, but still remains the lowest rate among all of the nation’s largest metro areas. In addition, the region’s unemployment rate is well below the national average of 6.5% in October 2008.

Growth in the Washington metro region is expected to be modest compared to past years. According to CRA, The Washington Leading Index, which forecasts area economic performance over the next 18 months, was 107.0, as of September 2008, below the 108.9 achieved in September 2007, but above the 20-year average of 102.1. GRP for the Washington metro region is forecasted to increase by only 1.5% in 2009 and gradually improve going forward into 2010. Job growth in the region is forecasted to soften in 2009 and increase in 2010, adding 24,000 and 37,000 new jobs, respectively, compared to the long-term 15-year average of 53,000.

 

3


Table of Contents
Index to Financial Statements

Greater Washington Metro Region Real Estate Markets

Despite softening economic conditions, we believe the greater Washington metro region remains one of the top performing real estate markets in the nation. The region experienced a decrease in investment sales in excess of 70% from 2007 levels. However, the Association of Foreign Investors in Real Estate (AFIRE) has publicized that it now considers Washington, DC as the top global city for real estate investment. The area’s economy has translated into stronger relative real estate market performance in each of our segments, 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. Nevertheless, we believe the potential exists in the current economic environment for downward pressure on rents in 2009. Market statistics and information from Delta are set forth below:

Office and Medical Office Sectors

 

   

Rents increased 0.1% in 2008 in the region compared to 2.2% in 2007.

 

   

Vacancy was 10.5% at year-end 2008, up from 9.1% one year ago and up from 8.5% at year-end 2006.

 

   

The region has the fifth lowest vacancy rate of large metro areas in the United States.

 

   

Net absorption totaled 3.6 million square feet, down from 5.4 million square feet in 2007.

 

   

Of the 15.4 million square feet of office space under construction at year-end 2008, 26% is pre-leased compared to 28% one year ago.

 

   

The overall vacancy rate is projected to increase to 11.8% by 2010.

Retail Sector

 

   

Rental rates at grocery-anchored centers increased 1.7% in the region in 2008, a decrease from the 3.9% increase in 2007.

 

   

Vacancy rates increased to 3.7 % at year-end 2008 – from 2.3% in 2007.

 

   

Sales volume for food retailers in the greater Washington metro area increased 4.0% in 2008.

Multifamily Sector

 

   

Rents for all investment grade apartments increased 1.3% in the greater Washington metro region during 2008. Class A rents grew only by 0.1% compared to 1.3% in 2007.

 

   

Rents are expected to remain relatively flat in the region depending on submarket, less than the long-term average of 4.4% per annum.

 

   

Vacancy rates for all apartments increased to 4.3% in 2008 from 3.7% in 2007. Class A vacancy increased to 4.5% from 3.6% in 2007.

Industrial/Flex Sector

 

   

Rental rates for the industrial sector increased 0.3% in the greater Washington region in 2008 compared to 2.8% in 2007.

 

   

Overall vacancy was 10.1% at year-end 2008, up from 9.5% one year ago.

 

   

Net absorption was 4.4 million square feet, compared to 6.6 million square feet in 2007.

 

   

Of the 3.5. million square feet of industrial space under construction at year-end, 30% is pre-leased, compared to 24% of space under construction that was pre-leased one year ago.

 

4


Table of Contents
Index to Financial Statements

Our Portfolio

As of December 31, 2008, we owned a diversified portfolio of 93 properties consisting of 28 office properties, 17 medical office properties, 14 retail centers, 12 multifamily properties, 22 industrial/flex properties and land under 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 2008, 2007 and 2006, and the percent leased, calculated as the percentage of physical net rentable area leased, as of December 31, 2008, were as follows:

 

Percent Leased*

December 31, 2008

         Real Estate Rental
Revenue*
 
       2008     2007     2006  
94 %   Office    42 %   41 %   39 %
97 %   Medical office    15     15     12  
98 %   Retail    15     16     18  
91 %   Multifamily    13     12     14  
91 %   Industrial    15     16     17  
                    
     100 %   100 %   100 %
                    

 

* Data excludes discontinued operations.

On a combined basis, our commercial portfolio was 94% leased at December 31, 2008, 97% leased at December 31, 2007 and 95% leased at December 31, 2006.

The commercial lease expirations for the next five years are as follows:

 

     # of
Leases
   Square Feet    Gross Annual
Rent
   Percentage of
Total Gross
Annual Rent
 

2009

   277    1,158,000    $ 22,963,000    9 %

2010

   298    1,637,000      41,307,000    17  

2011

   282    1,523,000      34,834,000    14  

2012

   183    1,038,000      23,812,000    10  

2013

   129    1,446,000      31,444,000    13  

2014 and thereafter

   314    3,269,000      91,876,000    37  
                       

Total

   1,483    10,071,000    $ 246,236,000    100 %
                       

Total real estate rental revenue from continuing operations was $282.3 million for 2008, $252.7 million for 2007 and $205.9 million for 2006. During the three year period ended December 31, 2008, we acquired eight office buildings, ten medical office buildings, two retail centers, one multifamily building and five industrial/flex properties. We also placed into service from development one office building and two multifamily buildings. During that same time frame, we sold two office buildings and two industrial properties. These acquisitions and dispositions were the primary reason for the shifting of each group’s percentage of total real estate rental revenue reflected above.

No single tenant accounted for more than 3.5% of real estate rental revenue in 2008, 3.6% of revenue in 2007, and 3.7% of revenue in 2006. All federal government tenants in the aggregate accounted for approximately 2.1% of our 2008 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. Our larger non-federal government tenants include the World Bank, Sunrise Senior Living, Inc., INOVA Health Systems, URS Corporation, Lafarge North America, Inc., George Washington University, Westat, Inc., IQ Solutions and Sun Microsystems.

We expect to continue investing in additional income producing properties. We invest in properties which we believe will increase in income and value. Our properties typically compete for tenants with other properties throughout the respective areas in which they are located on the basis of location, quality and rental rates.

 

5


Table of Contents
Index to Financial Statements

In prior years, we have been engaged in significant ground-up development in order to further strengthen our portfolio with long-term growth prospects. In 2007 and 2008, we completed construction on three ground-up development projects. The first was Bennett Park, a 224-unit multifamily property located in Arlington, VA, with the majority of units delivered by the end of 2007. The second development project was The Clayborne Apartments, a 74-unit multifamily property located in Alexandria, VA. All of the units at Clayborne were delivered during the first quarter of 2008. Bennett Park and Clayborne were 78% and 64% leased, respectively, at December 31, 2008. The third development project was 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 was 86% leased at December 31, 2008. Construction of the 360,000 square foot second building remains in the planning phase.

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 2008, 2007, and 2006 are discussed under the heading “Capital Improvements and Development Costs.”

Further description of the property groups is contained in Item 2, Properties and in Schedule III. Reference is also made to Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

On February 18, 2009, we had 307 employees including 229 persons engaged in property management functions and 78 persons engaged in corporate, financial, leasing, asset management and other functions.

Tax Treatment of Recent Disposition Activity

In June 2008, Sullyfield Center and The Earhart Building were sold for a gain of $15.3 million. The capital gain from the sales was paid out to shareholders. In September 2007, Maryland Trade Centers I and II were sold for a gain of $25.0 million. The proceeds from the sales were reinvested in replacement properties. We did not dispose of any of our properties in 2006. We distributed all of our 2008, 2007 and 2006 ordinary taxable income to our shareholders. No provision for income taxes was necessary in 2008, 2007 or 2006.

Availability of Reports

Copies 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 WRIT as our “common 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 50.

Recent disruptions in the financial markets could affect our ability to obtain financing or have other adverse effects on us or the market price of our common shares.

The United States and global equity and credit markets have recently experienced significant price volatility and liquidity disruptions which have caused the market prices of stocks to fluctuate substantially and the spreads on prospective debt financings to widen considerably. These circumstances have significantly negatively impacted liquidity in the financial markets, making terms for certain financings less attractive or unavailable. Continued uncertainty in the equity and credit markets will negatively impact our ability to access additional financing at reasonable terms or at all. In the event of a debt financing, our cost of borrowing in the future will likely be significantly higher than historical levels. In the case of a common equity financing, the disruptions in the financial markets could continue to have a material adverse effect on the market value of our common shares, potentially requiring us to issue more shares than we would otherwise have issued with a higher market value for our common shares. These financial market circumstances also will negatively affect our ability to make acquisitions, undertake new development projects and refinance our debt. These circumstances have also made it more difficult for us to sell properties and may adversely affect the price we receive for properties that we do sell, as prospective buyers are experiencing increased costs of financing and difficulties in obtaining financing.

 

6


Table of Contents
Index to Financial Statements

The current market conditions are also adversely affecting many of our tenants and their businesses, including their ability to pay rents when due and renew their leases at rates at least as favorable as their current rates. As well, our ability to attract prospective new tenants in the future could be adversely affected. There is a risk that government responses to the disruptions in the financial markets will not restore consumer confidence, stabilize the markets or increase liquidity and the availability of equity or credit financing.

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, retail, multifamily and industrial properties do not generate revenues sufficient to meet our operating expenses, 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;

 

   

the economic health of our tenants and the ability to collect rents;

 

   

consumer confidence, unemployment rates, and consumer tastes and preferences;

 

   

competition from similar asset type properties;

 

   

local real estate market conditions, such as oversupply or reduction in demand for office, medical office, retail, multifamily and industrial properties;

 

   

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;

 

   

civil disturbances, earthquakes and other natural disasters, terrorist acts or acts of war; and

 

   

significant expenditures associated with each investment, such as debt service payments, real estate taxes, insurance and maintenance costs, which are generally not reduced when circumstances cause a reduction in revenues from a property.

We are dependent upon the economic climate of the Washington metropolitan region.

All of our properties are located in the Washington metropolitan region, which may expose us to a greater amount of market dependent 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 results may be exposed to the following risks:

 

   

we may be unable to finance acquisitions on favorable terms;

 

   

acquired properties may fail to perform as we expected in analyzing our investments;

 

   

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; and

 

   

our estimates of the costs of repositioning or redeveloping acquired properties may be inaccurate.

 

7


Table of Contents
Index to Financial Statements

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;

 

   

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 potential difficulties or delays renewing leases or re-leasing space.

From 2009 through 2013, leases on our commercial properties will expire on a total of approximately 67% of our leased square footage as of December 31, 2008, with leases on approximately 12% of our leased square footage expiring in 2009, 16% in 2010, 15% in 2011, 10% in 2012 and 14% in 2013. 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 2008, 2007 and 2006, the residential tenant retention rate was 67%, 67% and 68%, respectively.

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. During the fourth quarter of 2008, the bankruptcy of a large retail tenant caused a loss of approximately $1.0 million. In light of the current economic recession, it is possible that additional major tenants 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. Provision for losses on accounts receivable for the entire portfolio increased to $4.3 million in 2008, from $2.0 million in 2007 and $1.2 million in 2006. This unfavorable trend could continue or worsen in 2009 and forward.

We face risks associated with property development.

Developing properties present a number of 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 management’s time and attention.

 

8


Table of Contents
Index to Financial Statements

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.

Our properties face significant competition.

We face significant competition from developers, owners and operators of office, medical office, retail, multifamily, industrial 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.

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, 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 that other parties to the agreements may not perform or that the agreements may be unenforceable.

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 a minimum tangible net worth and certain ratios, including a maximum of total liabilities to total gross asset value, a maximum of secured indebtedness to gross asset value, a minimum of annual EBITDA to fixed charges, a minimum of unencumbered asset value to unsecured indebtedness, a minimum of net operating income from unencumbered properties to unsecured interest expense and a maximum of permitted investments to gross asset value. Our ability to borrow under our credit facilities is subject to compliance with our financial and other covenants. The recent economic downturn and disruptions in the financial markets may adversely affect our ability to comply with these 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.

 

9


Table of Contents
Index to Financial Statements

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 fair housing, rent control and 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.

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, the U.S. Occupational Safety and Health Administration and other state and local governmental authorities are increasingly involved in indoor air quality standards, especially with respect to asbestos, mold, medical waste and lead-based paint. 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.

 

10


Table of Contents
Index to Financial Statements

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 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.

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.

 

11


Table of Contents
Index to Financial Statements

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.

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 us, 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;

 

   

the market’s 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;

 

   

relatively low trading volume of shares of REITs in general, which tends to exacerbate a market trend with respect to our shares; and

 

   

any negative change in the level of our dividend or the partial payment thereof in common shares.

Provisions of the Maryland General Corporation Law, or the MGCL, may limit a change in control.

There are several provisions of the Maryland General Corporation Law, or the MGCL, that may limit the ability of a third party to undertake a change in control, including:

 

   

a provision where a corporation is not permitted 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 corporation’s stock, for a period of five years after that holder becomes an “interested stockholder;” and

 

   

a provision where the voting rights of “control shares” acquired in a “control share acquisition,” as defined in the MGCL, may be restricted, such that the “control shares” have no voting rights, except to the extent approved by a vote of holders of two-thirds of the common shares entitled to vote on the matter.

These provisions may delay, defer, or prevent a transaction or a change in control that may involve a premium price for holders of our shares or otherwise be in their best interests.

 

ITEM 1B: UNRESOLVED STAFF COMMENTS

None.

 

12


Table of Contents
Index to Financial Statements
ITEM 2: PROPERTIES

The schedule on the following pages lists our real estate investment portfolio as of December 31, 2008, which consisted of 93 properties and land under development.

As of December 31, 2008, 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.

Schedule of Properties

 

Properties

  

Location

  

Year
Acquired

  

Year
Constructed

   Net Rentable
Square Feet
   Percent
Leased
12/31/08
 

Office Buildings

              

1901 Pennsylvania Avenue

   Washington, D.C.    1977    1960    97,000    99 %

51 Monroe Street

   Rockville, MD    1979    1975    210,000    93 %

515 King Street

   Alexandria, VA    1992    1966    76,000    88 %

The Lexington Building

   Rockville, MD    1993    1970    46,000    59 %

The Saratoga Building

   Rockville, MD    1993    1977    58,000    79 %

Brandywine Center

   Rockville, MD    1993    1969    35,000    79 %

6110 Executive Boulevard

   Rockville, MD    1995    1971    198,000    98 %

1220 19th Street

   Washington, D.C.    1995    1976    102,000    88 %

1600 Wilson Boulevard

   Arlington, VA    1997    1973    166,000    100 %

7900 Westpark Drive

   McLean, VA    1997    1972/1986/1999    523,000    96 %

600 Jefferson Plaza

   Rockville, MD    1999    1985    112,000    98 %

1700 Research Boulevard

   Rockville, MD    1999    1982    101,000    97 %

Parklawn Plaza

   Rockville, MD    1999    1986    40,000    96 %

Wayne Plaza

   Silver Spring, MD    2000    1970    91,000    97 %

Courthouse Square

   Alexandria, VA    2000    1979    113,000    98 %

One Central Plaza

   Rockville, MD    2001    1974    267,000    74 %

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    98 %

West Gude Drive

   Rockville, MD    2006    1984/1986/1988    276,000    99 %

The Ridges

   Gaithersburg, MD    2006    1990    104,000    100 %

The Crescent

   Gaithersburg, MD    2006    1989    49,000    100 %

Monument II

   Herndon, VA    2007    2000    205,000    100 %

Woodholme Center

   Pikesville, MD    2007    1989    73,000    91 %

2000 M Street

   Washington, D.C.    2007    1971    227,000    91 %

Dulles Station

   Herndon, VA    2005    2007    180,000    86 %

2445 M Street

   Washington, D.C.    2008    1986    290,000    100 %
                    

Subtotal

            4,211,000    94 %
                    

Medical Office Buildings

              

Woodburn Medical Park I

   Annandale, VA    1998    1984    71,000    98 %

Woodburn Medical Park II

   Annandale, VA    1998    1988    96,000    97 %

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    75 %

Alexandria Professional Center

   Alexandria, VA    2006    1968    113,000    98 %

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 %

 

13


Table of Contents
Index to Financial Statements

SCHEDULE OF PROPERTIES (continued)

 

Properties

  

Location

  

Year
Acquired

  

Year
Constructed

        Net Rentable*
Square Feet
   Percent
Leased
12/31/08
 

15005 Shady Grove Road

   Rockville, MD    2006    2002       52,000    100 %

2440 M Street

   Washington, D.C.    2007    1986/2006       110,000    97 %

Woodholme Medical Office Bldg

   Pikesville, MD    2007    1996       125,000    100 %

Ashburn Farm Office Park

   Ashburn, VA    2007    1998/2000/2002       75,000    98 %

CentreMed I & II

   Centreville, VA    2007    1998       52,000    100 %

Sterling Medical Office Building1

   Sterling, VA    2008    1986/2000       36,000    100 %
                       

Subtotal

               1,222,000    97 %
                       

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    96 %

Bradlee

   Alexandria, VA    1984    1955       168,000    99 %

Chevy Chase Metro Plaza

   Washington, D.C.    1985    1975       49,000    100 %

Montgomery Village Center

   Gaithersburg, MD    1992    1969       198,000    90 %

Shoppes of Foxchase2

   Alexandria, VA    1994    1960/2006       134,000    95 %

Frederick County Square

   Frederick, MD    1995    1973       227,000    97 %

800 S. Washington Street

   Alexandria, VA    1998/2003    1955/1959       44,000    96 %

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    98 %

Montrose Shopping Center

   Rockville, MD    2006    1970       143,000    97 %
                       

Subtotal

               2,022,000    98 %
                       

Multifamily Buildings

           

# of units

     

3801 Connecticut Avenue

   Washington, D.C.    1963    1951    307    179,000    96 %

Roosevelt Towers

   Falls Church, VA    1965    1964    191    170,000    97 %

Country Club Towers

   Arlington, VA    1969    1965    227    163,000    92 %

Park Adams

   Arlington, VA    1969    1959    200    173,000    94 %

Munson Hill Towers

   Falls Church, VA    1970    1963    279    259,000    93 %

The Ashby at McLean

   McLean, VA    1996    1982    253    252,000    93 %

Walker House Apartments

   Gaithersburg, MD    1996    1971/20033    212    159,000    92 %

Bethesda Hill Apartments

   Bethesda, MD    1997    1986    195    226,000    93 %

Avondale

   Laurel, MD    1999    1987    237    170,000    92 %

Bennett Park

   Arlington, VA    2007    2007    224    268,000    78 %

Clayborne

   Alexandria, VA    2008    2008    74    87,000    64 %

Kenmore

   Washington, D.C.    2008    1948    374    269,000    91 %
                         

Subtotal

            2,773    2,375,000    91 %
                         

Industrial/Flex Properties

                 

Fullerton Business Center

   Springfield, VA    1985    1980       104,000    91 %

Charleston Business Center

   Rockville, MD    1993    1973       85,000    95 %

Tech 100 Industrial Park

   Elkridge, MD    1995    1990       166,000    73 %

Crossroads Distribution Center

   Elkridge, MD    1995    1987       85,000    100 %

The Alban Business Center

   Springfield, VA    1996    1981/1982       87,000    100 %

Ammendale Technology Park I

   Beltsville, MD    1997    1985       167,000    78 %

Ammendale Technology Park II

   Beltsville, MD    1997    1986       107,000    80 %

Pickett Industrial Park

   Alexandria, VA    1997    1973       246,000    97 %

Northern Virginia Industrial Park

   Lorton, VA    1998    1968/1991       787,000    89 %

8900 Telegraph Road

   Lorton, VA    1998    1985       32,000    43 %

Dulles South IV

   Chantilly, VA    1999    1988       83,000    100 %

Sully Square

   Chantilly, VA    1999    1986       95,000    74 %

 

14


Table of Contents
Index to Financial Statements

SCHEDULE OF PROPERTIES (continued)

 

Properties

  

Location

  

Year
Acquired

  

Year
Constructed

   Net Rentable
Square Feet
   Percent
Leased
12/31/08
 

Amvax

   Beltsville, MD    1999    1986    31,000    100 %

Fullerton Industrial Center

   Springfield, VA    2003    1980    137,000    91 %

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    93 %

Hampton South

   Capital Heights, MD    2006    1989/2005    168,000    96 %

9950 Business Parkway

   Lanham, MD    2006    2005    102,000    100 %

270 Technology Park

   Frederick, MD    2007    1986-1987    157,000    87 %

6100 Columbia Park road

   Landover, MD    2008    1969    150,000    100 %
                    

Subtotal

            3,595,000    91 %
                    

TOTAL

            13,425,000   
                

 

1

The sellers of Sterling Medical Office Building agreed to lease 37% of the building’s space for a period of 12—18 months following the date of sale.

 

2

Development on approximately 60,000 square feet of the center was completed in December 2006.

 

3

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.

 

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 2008.

 

15


Table of Contents
Index to Financial Statements

PART II

 

ITEM 5: MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our shares trade on the New York Stock Exchange. Currently, there are approximately 6,789 shareholders of record.

The high and low sales price for our shares for 2008 and 2007, by quarter, and the amount of dividends we paid per share are as follows:

 

          Quarterly Share
Price Range

Quarter

   Dividends
Per Share
   High    Low

2008

        

Fourth

   $ .4325    $ 36.39    $ 20.33

Third

   $ .4325    $ 37.61    $ 28.98

Second

   $ .4325    $ 36.07    $ 30.05

First

   $ .4225    $ 34.38    $ 26.91

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

We have historically paid dividends on a quarterly basis. Dividends are primarily paid from 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 year covered by this report.

 

16


Table of Contents
Index to Financial Statements
ITEM 6: SELECTED FINANCIAL DATA

The following table sets forth our selected financial data on a historical basis, which has been revised for properties disposed of or classified as held for sale in accordance with SFAS No. 144. Refer to Note 3 of the consolidated financial statements. The following data should be read in conjunction with our financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this Form 10-K.

 

     2008    2007    2006    2005    2004
     (in thousands, except per share data)

Real estate rental revenue

   $ 282,312    $ 252,732    $ 205,940    $ 177,592    $ 160,020

Income from continuing operations

   $ 15,214    $ 31,355    $ 34,826    $ 36,994    $ 37,810

Discontinued operations:

              

Income from operations of properties sold or held for sale

   $ 2,352    $ 5,504    $ 3,835    $ 3,633    $ 6,725

Gain on property disposed

   $ 15,275    $ 25,022      —      $ 37,011    $ 1,029

Net income

   $ 32,841    $ 61,881    $ 38,661    $ 77,638    $ 45,564

Income per share from continuing operations – diluted

   $ 0.31    $ 0.68    $ 0.79    $ 0.88    $ 0.90

Earnings per share – diluted

   $ 0.67    $ 1.34    $ 0.88    $ 1.84    $ 1.09

Total assets

   $ 2,111,391    $ 1,898,326    $ 1,531,265    $ 1,139,159    $ 1,012,393

Lines of credit payable

   $ 67,000    $ 192,500    $ 61,000    $ 24,000    $ 117,000

Mortgage notes payable

   $ 421,286    $ 252,484    $ 229,240    $ 161,631    $ 164,942

Notes payable

   $ 902,900    $ 879,123    $ 728,255    $ 518,600    $ 319,597

Shareholders’ equity

   $ 626,393    $ 486,544    $ 441,931    $ 380,305    $ 366,009

Cash dividends paid

   $ 85,564    $ 78,050    $ 72,681    $ 67,322    $ 64,836

Cash dividends declared and paid per share

   $ 1.72    $ 1.68    $ 1.64    $ 1.60    $ 1.55

 

17


Table of Contents
Index to Financial Statements
ITEM 7: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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, 2008, we owned a diversified portfolio of 93 properties, consisting of 28 office properties, 22 industrial/flex properties, 17 medical office properties, 14 retail centers, and 12 multifamily properties, encompassing in the aggregate 13.0 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, we focus on the following financial and non-financial indicators, discussed in further detail herein:

 

   

Net operating income (“NOI”) by segment, calculated as real estate rental revenue less real estate operating expenses excluding general and administrative and depreciation. NOI is a non-GAAP supplemental measure to net income.

 

   

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

 

   

Economic occupancy (“occupancy”), calculated as actual real estate rental revenue recognized for the period indicated as a percentage of gross potential real estate rental revenue for that period. Percentage rents and expense reimbursements are not considered in computing economic occupancy percentages.

 

   

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

 

   

Rental rates.

 

   

Leasing activity, including new leases, renewals and expirations.

During 2008, we continued our fundamental strategy of investing in diversified property types in the greater Washington metro region. The area’s economy softened as the national economy moved into recession. The unemployment rate for the Washington metro area is 4.1%, compared to 6.5% nationally, as of October 2008. Job growth increased 1.2%, compared to a 1.4% decline nationally. Government, professional and business services, and education and health sectors, led job growth in the metro area in 2008. The Washington metro area’s economic growth is forecasted to moderate in 2009, adding 24,000 new payroll jobs, according to Delta Associates and economist Dr. Steven Fuller of George Mason University.

Our results of operations in 2008 were primarily impacted by acquisitions and dispositions and the performance of our core portfolio. We completed total acquisitions and dispositions totaling $576.7 million and $99.1 million, respectively, during the prior two years. The performance of our core portfolio, consisting of properties owned for the entirety of 2008 and the same time period in 2007, declined compared to 2007, primarily due to lower occupancy and higher bad debt expense.

 

18


Table of Contents
Index to Financial Statements

The performance of our five operating segments generally reflected market conditions in our region:

 

   

The regional office market contracted during 2008, with vacancy increasing to 10.5% from 9.1% in 2007. The Washington metro region has the fifth lowest overall vacancy rate in the United States at 10.5%. Vacancy in the submarkets was 12.4% for Northern Virginia, 11.5% for Suburban Maryland, and 7.3% in the District of Columbia. Net absorption (defined as the change in occupied, standing inventory from one year to the next) was well below average in all submarkets, and the pipeline of new office properties in the region decreased to 15.4 million square feet from 20.6 million square feet in the prior year. Our office portfolio was 93.9% leased at year-end 2008, a decrease from 96.7% leased in the prior year. By submarket, our office portfolio was 95.5% leased in Northern Virginia, 91.0% leased in Suburban Maryland, and 96.5% leased in the District of Columbia.

 

   

The medical office market in the region remains healthy. Our medical office portfolio was 97.0% leased as of year-end 2008, a small decrease from 97.5% in 2007.

 

   

The region’s retail market declined in 2008. Vacancy in the region for grocery-anchored shopping centers was 3.7%, compared to 2.3% in 2007. Overall retail rental rates in the region increased 1.7% in 2008, after rising by 3.9% in 2007. Our retail portfolio was 97.8% leased at year-end 2008, a slight increase from 97.6% in 2007.

 

   

The region’s multifamily sector also slowed in 2008. The region’s vacancy rate for investment grade apartments increased to 4.3% from 3.7% a year ago. The Washington metro area’s vacancy rate remains well below the national rate of 6.1%. The region’s rents increased by 1.3% in 2008, below the long-term average of 4.4%. Our multifamily portfolio was 91% leased at year-end 2008, up from 87% in 2007.

 

   

The industrial market softened in 2008. Rents have increased only 0.3% and vacancy increased to 10.1%, compared to 9.5% one year ago. Net absorption decreased to 4.4 million square feet, compared to 6.6 million square feet in 2007. Our industrial portfolio was 91.3% leased at year-end 2008, a decrease from 95.1% in 2007.

During 2008, we completed the development of Dulles Station Phase I, Bennett Park and 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.

We summarize below our significant transactions during the two years ended December 31, 2008:

2008

 

   

The acquisition of one office property for $181.4 million, adding approximately 290,000 square feet, which was 100.0% leased at the end of 2008.

 

   

The acquisition of one 374 unit apartment building for $58.3 million, adding approximately 269,000 square feet, which was 90.9% leased at the end of 2008.

 

   

The acquisition of one medical office property for $6.5 million, adding approximately 36,000 square feet, which was 100.0% leased at the end of 2008.

 

   

The acquisition of one industrial/flex property for $11.2 million, adding approximately 150,000 square feet, which was 100.0% leased at the end of 2008.

 

   

The disposition of two industrial/flex properties for a sales price of $41.1 million and a gain on sale of $15.3 million.

 

   

The agreement to acquire one medical office property, currently under construction, for $19.5 million. The purchase is expected to occur by the end of the second quarter of 2009 and will add 85,300 square feet of medical office space.

 

   

The completion of a public offering of 2,600,000 common shares priced at $34.80 per share, raising $86.7 million in net proceeds during the second quarter of 2008.

 

19


Table of Contents
Index to Financial Statements
   

The completion of a public offering of 1,725,000 common shares priced at $35.00 per share, raising $57.6 million in net proceeds during the fourth quarter of 2008.

 

   

The issuance of 1.1 million common shares at a weighted average price of $36.15 under our sales agency financing agreement, raising $40.7 million in net proceeds.

 

   

The execution of three mortgage notes totaling approximately $81.0 million at a fixed rate of 5.71%, secured by three multifamily properties.

 

   

The repayment of the $60 million outstanding principal balance under our 6.74% 10-year Mandatory Par Put Remarketed Securities (“MOPPRS”) notes. The total aggregate consideration paid to repurchase the notes was $70.8 million, which amount included the $8.7 million remarketing option value paid to the remarketing dealer and accrued interest paid to the holders. The loss on extinguishment of debt was $8.4 million, net of unamortized loan premium costs, upon settlement of these securities. We refinanced the repurchase of these notes, and refinanced a portion of line outstandings, by issuing a $100 million two-year term loan. We also entered into an interest rate swap on a notional amount of $100 million, which had the effect of fixing the interest rate on the term loan at 4.45%.

 

   

The repurchase of $16.0 million of our 3.875% convertible notes at a 25% discount to par value, resulting in a gain on extinguishment of debt of $3.5 million.

 

   

The increase in the capacity of our unsecured revolving credit facility with a syndicate of banks led by Wells Fargo Bank, National Association from $200 million to $262 million.

 

   

The execution of two leases totaling 154,000 square feet at the previously unleased Dulles Station, Phase I office building. In addition to those leases, we executed new leases for 1,508,000 square feet of commercial space elsewhere in our portfolio, with an average rental rate increase of 19.4%.

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.

 

   

The acquisition of four medical office properties for $119.1 million, adding approximately 362,000 square feet, which were 97.5% leased at the end of 2007.

 

   

The acquisition of one industrial/flex property for $26.5 million, adding approximately 157,000 square feet, which was 87.3% leased at the end of 2007.

 

   

The acquisition of land under development, which land acquisition was funded by issuing operating partnership units in a consolidated subsidiary of WRIT.

 

   

The disposition of two office buildings for a 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 in net proceeds during the first quarter of 2007.

 

   

The completion of a public offering of 1,600,000 common shares priced at $37.00 per share, raising $57.8 million in net proceeds during the second quarter of 2007.

 

   

The opening of a new unsecured revolving credit facility with Suntrust Bank having a committed capacity of $75.0 million and a maturity date of June 2011.

 

   

The completion of a modification to our indenture covenants governing our senior notes from a restrictive total assets definition to a market based asset definition.

 

   

The investment of $66.5 million in our development projects.

 

20


Table of Contents
Index to Financial Statements
   

The execution of new leases for 1,765,000 square feet of commercial space, with an average rental rate increase of 17.3%.

Critical Accounting Policies and Estimates

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.

We believe the following critical accounting policies reflect the significant judgments and estimates used in the preparation of our consolidated financial statements. Our significant accounting policies are also described in Note 2 to the consolidated financial statements in Item 8 of this Form 10-K.

Revenue Recognition

Our multifamily properties are leased under operating leases with terms of generally one year or less, and our 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 real estate rental revenue 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 real estate rental revenue 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 our receivables. Percentage rents, which represent additional rents based on gross tenant sales, are recognized when tenant 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.

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable primarily represents amounts accrued and unpaid from tenants in accordance with the terms of the respective leases, subject to our revenue recognition policy. Receivables are reviewed monthly and reserves are established when, in the opinion of management, collection of the receivable is doubtful. Reserves are established for tenants whose rent payment history or financial condition casts doubt upon the tenant’s ability to perform under its lease obligation. When the collection of a receivable is deemed doubtful in the same quarter that the receivable was established, then the allowance for that receivable is recognized as an offset to real estate revenues. When a receivable that was initially established in a prior quarter is deemed doubtful, then the allowance is recognized as an operating expense. In addition to rents due currently, accounts receivable include amounts representing minimal rental income accrued on a straight-line basis to be paid by tenants over the remaining term of their respective leases.

Included in our accounts receivable balance are notes receivable totaling $7.4 million and $0.4 million as of December 31, 2008 and 2007, respectively. $7.3 million of the 2008 balance represents the fair value of a note receivable acquired with 2445 M Street during the fourth quarter of 2008. The note receivable is from a prior tenant at that property.

Real Estate and Depreciation

We depreciate buildings on a straight-line basis over estimated useful lives ranging from 28 to 50 years. We capitalize all capital improvement expenditures associated with replacements, improvements or major repairs to real property that extend its useful life and depreciate them using the straight-line method over their estimated useful lives ranging from

 

21


Table of Contents
Index to Financial Statements

three to 30 years. We also capitalize costs incurred in connection with our development projects, including capitalizing interest and other internal costs during periods in which qualifying expenditures have been made and activities necessary to get the development projects ready for their intended use are in progress. In addition, we capitalize tenant leasehold improvements when certain criteria are met, including when we supervise construction and will own the improvements. We depreciate all tenant improvements over the shorter of the useful life of the improvements or the term of the related tenant lease. Real estate depreciation expense from continuing operations for the years ended December 31, 2008, 2007 and 2006 was $69.2 million, $55.7 million and $44.1 million, respectively. Maintenance and repair costs that do not extend an asset’s life are charged to expense as incurred.

We capitalize interest costs incurred on borrowing obligations while qualifying assets are being readied for their intended use in accordance with SFAS No. 34, Capitalization of Interest Cost. Total interest expense capitalized to real estate assets related to development and major renovation activities was $2.1 million, $6.1 million and $3.8 million, for the years ended December 31, 2008, 2007 and 2006, respectively. Interest capitalized is amortized over the useful life of the related underlying assets upon those assets being placed into service.

We recognize impairment losses on long-lived assets used in operations and held for sale, development assets or land under development, if 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. During 2008, we expensed $0.6 million, included in general and administrative expenses, related to development projects no longer considered probable. There were no property impairments recognized during the periods ended December 31, 2007 and 2006.

We allocate the purchase price of acquired properties to the related physical assets and in-place leases based on their fair values, in accordance with SFAS No. 141, Business Combinations. The total acquisition cost comprises the acquisition-date fair value of all assets transferred, equity issued, and liabilities assumed. 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. No goodwill was recorded on our acquisitions for the years ended December 31, 2008, 2007 and 2006.

The fair value of in-place leases consists of the following components – (a) 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”), (b) the estimated cost of tenant improvements, and other direct costs associated with obtaining a new tenant (referred to as “tenant origination cost”); (c) estimated leasing commissions associated with obtaining a new tenant (referred to as “leasing commissions”); (d) 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 (e) the value, if any, of customer relationships, determined based on our evaluation of the specific characteristics of each tenant’s lease and our overall relationship with the tenant (referred to as “customer relationship value”). We have attributed no value to customer relationship value as of December 31, 2008 or 2007.

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 income producing property 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.

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 taxable income to our shareholders. When selling properties, we have the option of (a) reinvesting the sale price of properties sold,

 

22


Table of Contents
Index to Financial Statements

allowing for a deferral of income taxes on the sale, (b) paying out capital gains to the shareholders with no tax to us or (c) treating the capital gains as having been distributed to our shareholders, paying the tax on the gain deemed distributed and allocating the tax paid as a credit to our shareholders. In June 2008, two industrial properties, Sullyfield Center and The Earhart Building, were sold for a gain of $15.3 million. The proceeds from the sales were treated as a distribution to 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, and we distributed all of our 2008, 2007 and 2006 ordinary taxable income to our shareholders. No provision for income taxes was necessary in 2008, 2007 or 2006.

Results of Operations

The discussion that follows is based on our consolidated results of operations for the years ended December 31, 2008, 2007 and 2006. 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 or placed into service 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 four properties were acquired during 2008, eight properties and land for development were acquired during 2007 and fourteen properties were acquired during 2006. Two development properties were placed into service in 2008, and one development property was placed into service during 2007. Two properties were sold and one property was classified as held for sale in 2008, and two properties were sold in 2007. These held for sale and sold properties are classified as discontinued operations for the 2008, 2007 and 2006 periods. There were no properties sold or classified as held for sale in 2006.

To provide more insight into our operating results, our discussion is divided into two main sections: (a) the consolidated results of operations section, in which we provide an overview analysis of results on a consolidated basis, and (b) the net operating income (“NOI”) section, in which we provide a detailed analysis of core versus non-core NOI results by segment. NOI is a non-GAAP measure 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):

 

     2008     2007     2006     2008 vs
2007
    %
Change
    2007 vs
2006
    %
Change
 

Minimum base rent

   $ 245,262     $ 220,749     $ 182,373     $ 24,513     11.1 %   $ 38,376     21.0 %

Recoveries from tenants

     31,631       25,765       18,079       5,866     22.8 %     7,686     42.5 %

Provisions for doubtful accounts

     (4,592 )     (1,981 )     (1,149 )     (2,611 )   131.8 %     (832 )   72.4 %

Lease termination fees

     1,270       506       268       764     151.0 %     238     88.8 %

Parking and other tenant charges

     8,741       7,693       6,369       1,048     13.6 %     1,324     20.8 %
                                                    
   $ 282,312     $ 252,732     $ 205,940     $ 29,580     11.7 %   $ 46,792     22.7 %
                                                    

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

Minimum Base Rent: Minimum base rent increased by $24.5 million in 2008 as compared to 2007 due primarily to properties acquired or placed into service in 2008 and 2007 ($22.5 million), combined with a $2.0 million increase in minimum base rent from core properties due to higher rental rates in all segments, partially offset by higher vacancy in the commercial segments.

 

23


Table of Contents
Index to Financial Statements

Minimum base rent increased by $38.4 million in 2007 as compared to 2006 due primarily to properties acquired or placed into service 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 segments and rental rate increases in all segments.

Recoveries from Tenants: Recoveries from tenants increased by $5.9 million in 2008 as compared to 2007 due primarily to properties acquired or placed into service in 2008 and 2007 ($4.0 million), combined with a $1.9 million increase in recoveries from tenants from core properties primarily due to higher real estate tax reimbursements ($1.6 million) and common area maintenance reimbursements ($0.2 million).

Recoveries from tenants increased by $7.7 million in 2007 as compared to 2006 due primarily to properties acquired or placed into service in 2007 and 2006 ($4.0 million), combined with a $3.7 million increase in recovery income from core properties due to higher operating expenses and utilities ($0.9 million), common area maintenance ($0.9 million) and real estate taxes ($1.8 million).

Provisions for Doubtful Accounts: Provisions for doubtful accounts increased by $2.6 million in 2008 as compared to 2007 due to higher provisions in the retail ($1.0 million), industrial ($1.0 million) and office ($0.6 million) segments. Provisions for bad debt in the multifamily and medical office segments were flat. The higher overall provision is reflective of the economic recession that began in 2008. In addition to the provision for doubtful accounts included in real estate rental revenue, net recoveries of previously written-off receivables of $0.3 million were recorded in property operating expenses.

Provisions for doubtful accounts increased by $0.8 million in 2007 as compared to 2006.

Lease Termination Fees: Lease termination fees increased by $0.8 million in 2008 as compared to 2007 due primarily to higher fees in the office ($0.8 million) and industrial ($0.2 million) segments, partially offset by lower fees in the retail segment ($0.2 million).

Lease termination fees increased slightly by $0.2 million in 2007 as compared to 2006.

Parking and Other Tenant Charges: Parking and other tenant charges increased by $1.1 million in 2008 as compared to 2007 due primarily to higher parking revenue ($0.8 million) and miscellaneous fees ($0.3 million).

Parking and other tenant charges increased by $1.3 million in 2007 as compared to 2006 due to higher parking revenue and antenna rent.

A summary of economic occupancy for properties classified as continuing operations by segment follows:

Consolidated Economic Occupancy

Segment

   2008     2007     2006     2008 vs
2007
    2007 vs
2006
 

Office

   93.2 %   94.6 %   92.1 %   (1.4 %)   2.5 %

Medical Office

   96.5 %   98.3 %   99.0 %   (1.8 %)   (0.7 %)

Retail

   94.9 %   95.2 %   96.0 %   (0.3 %)   (0.8 %)

Multifamily

   83.0 %   89.2 %   92.3 %   (6.2 %)   (3.1 %)

Industrial

   93.3 %   95.3 %   93.7 %   (2.0 %)   1.6 %
                              

Total

   92.3 %   94.5 %   93.8 %   (2.2 %)   0.7 %
                              

Economic occupancy represents actual real estate rental revenue recognized for the period indicated as a percentage of gross potential real estate rental revenue for that period. Percentage rents and expense reimbursements are not considered in computing economic occupancy percentages.

Our overall economic occupancy decreased to 92.3% in 2008 from 94.5% in 2007, driven primarily by the lease-up during 2008 of our development properties in the office and multifamily segments. Our development properties Bennett Park, Clayborne Apartments and Dulles Station, Phase I were placed into service at the end of 2007 and during 2008, and were 78%, 64% and 86% leased at year-end, respectively.

Overall economic occupancy increased to 94.5% in 2007 from 93.8% in 2006 due primarily to occupancy gains in the office and industrial segments.

 

24


Table of Contents
Index to Financial Statements

A detailed discussion of occupancy by sector can be found in the Net Operating Income section.

Real Estate Expenses

Real estate expenses are summarized as follows (all data in thousands except percentage amounts):

 

     2008    2007    2006    2008 vs
2007
   %
Change
    2007 vs
2006
   %
Change
 

Property operating expenses

   $ 66,335    $ 56,444    $ 44,616    $ 9,891    17.5 %   $ 11,828    26.5 %

Real estate taxes

     28,238      21,970      17,177      6,268    28.5 %     4,793    27.9 %
                                               
   $ 94,573    $ 78,414    $ 61,793    $ 16,159    20.6 %   $ 16,621    26.9 %
                                               

Real estate expenses as a percentage of revenue were 33.5% for 2008, 31.0% for 2007 and 30.0% for 2006.

Property Operating Expenses: Property operating expenses include utilities, repairs and maintenance, property administration and management, operating services, common area maintenance and other operating expenses.

Property operating expenses increased $9.9 million in 2008 as compared to 2007 due primarily to properties acquired and placed into service in 2008 and 2007, which accounted for $9.0 million of the increase. Property operating expenses from core properties increased by $0.9 million, driven by higher repairs and maintenance costs ($0.5 million) and administrative costs ($0.5 million).

Property operating expenses increased by $11.8 million in 2007 as compared to 2006 due primarily to the properties acquired and placed into service in 2007 and 2006, which accounted for $9.0 million of the increase. Property operating expenses from core properties increased by $2.8 million, driven by higher utilities rates and an increase in core economic occupancy to 95.1% from 94.3%.

Real Estate Taxes: Real estate taxes increased $6.3 million in 2008 as compared to 2007 due primarily to the properties acquired or placed into service in 2008 and 2007, which accounted for $4.1 million of the increase. Real estate taxes on core properties increased by $2.1 million due primarily to higher rates and assessments across the portfolio.

Real estate taxes increased by $4.8 million in 2007 as compared to 2006 due primarily to the properties acquired in 2007 and 2006, which accounted for $2.9 million of the increase. Real estate taxes on core properties increased by $1.9 million due primarily to higher value assessments.

Other Operating Expenses

Other operating expenses are summarized as follows (all data in thousands except percentage amounts):

 

     2008    2007    2006    2008 vs
2007
    %
Change
    2007 vs
2006
   %
Change
 

Depreciation and amortization

   $ 86,429    $ 69,136    $ 50,340    $ 17,293     25.0 %   $ 18,796    37.3 %

Interest expense

     69,909      61,906      47,265      8,003     12.9 %     14,641    31.0 %

General and administrative

     12,321      15,099      12,622      (2,778 )   (18.4 %)     2,477    19.6 %
                                                
   $ 168,659    $ 146,141    $ 110,227    $ 22,518     15.4 %   $ 35,914    32.6 %
                                                

Depreciation and Amortization: Depreciation and amortization expense increased by $17.3 million in 2008 as compared to 2007 due primarily to properties acquired and placed into service of $340.3 million and $411.4 million in 2008 and 2007, respectively.

Depreciation and amortization expense increased by $18.8 million in 2007 as compared to 2006 due primarily to properties acquired and placed into service of $411.4 million and $303.0 million in 2007 and 2006, respectively.

Interest Expense: Interest expense increased $8.0 million in 2008 compared to 2007, reflecting a $4.0 million decrease in capitalized interest due to placing development projects into service at the end of 2007 and during 2008. Also, mortgage interest increased by $3.9 million due to entering into three new mortgage notes during the second quarter of 2008, as well as assuming a mortgage as part of the 2445 M Street acquisition in the fourth quarter of 2008. The proceeds of the new mortgage notes were used to pay down floating rate credit facility debt.

 

25


Table of Contents
Index to Financial Statements

Interest expense increased $14.6 million in 2007 compared to 2006 due to increased acquisition and development activity offset by the refinancing of higher interest rate unsecured notes and mortgages. The acquisition and development activity in 2007 and 2006 was funded primarily by debt, including: (a) in January 2007 the issuance of $150.0 million of 3.875% convertible notes due August 31, 2026, in June 2006 the issuance of $150.0 million of 5.95% unsecured notes due June 15, 2011, and in September 2006 the issuance of $110.0 million of 3.875% convertible notes due September 15, 2026, (b) the increase in short-term borrowing on our lines of credit and (c) 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.

A summary of interest expense for the years ended December 31, 2008, 2007 and 2006 appears below (in millions, except percentage amounts):

 

Debt Type

   2008     2007     2006     2008 vs.
2007
    %
Change
    2007 vs.
2006
    %
Change
 

Notes payable

   $ 47.9     $ 47.2     $ 36.2     $ 0.7     1.5 %   $ 11.0     30.4 %

Mortgages

     18.4       14.5       11.3       3.9     26.9 %     3.2     28.3 %

Lines of credit/short-term note payable

     5.7       6.3       3.6       (0.6 )   (9.5 %)     2.7     75.0 %

Capitalized interest

     (2.1 )     (6.1 )     (3.8 )     4.0     65.6 %     (2.3 )   (60.5 %)
                                                    

Total

   $ 69.9     $ 61.9     $ 47.3     $ 8.0     12.9 %   $ 14.6     30.9 %
                                                    

General and Administrative Expense

General and administrative expense decreased by $2.8 million in 2008 as compared to 2007 due primarily to lower incentive compensation expense. Further, we incurred bondholder consent fees in 2007 that did not recur in 2008.

General and administrative expense increased by $2.5 million in 2007 as compared to 2006 due primarily to bondholder consent fees associated with the modifications to our bond covenants, higher incentive compensation, equity compensation issued to the retiring Chief Executive Officer, 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.

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, used to otherwise support corporate needs or are distributed to our shareholders.

We sold two industrial properties in 2008 and two office properties in 2007. Sullyfied Center and the Earhart Building were classified as held for sale in November 2007 and sold in June 2008. They were sold for a contract sales price of $41.1 million, and we recognized a gain on sale of $15.3 million in accordance with SFAS No. 66, Accounting for Sales of Real Estate. Maryland Trade Centers I and II were classified as held for sale in March 2007 and sold as September 2007. They were sold for a contract sales price of $58.0 million, and we recognized a gain on disposal of $25.0 million. $15.3 million of the proceeds from the disposition were used to fund the purchase of CentreMed I & II in August 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 in December 2007.

In September 2008, we concluded that Avondale, a multifamily property, met the criteria specified in SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, necessary to classify this property as held for sale. Senior management has committed to, and actively embarked upon, a plan to sell the asset, 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 this property 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 five properties classified as held for sale or sold in 2008 and 2007.

 

26


Table of Contents
Index to Financial Statements

Operating results of the properties classified as discontinued operations are summarized as follows (in thousands, except for percentages):

 

     2008     2007     2006     2008 vs.
2007
    %
Change
    2007 vs.
2006
    %
Change
 

Revenues

   $ 4,875     $ 12,278     $ 13,722     $ (7,403 )   (60.3 %)   $ (1,444 )   (10.5 %)

Property expenses

     (2,054 )     (4,885 )     (5,477 )     2,831     58.0 %     592     10.8 %

Depreciation and amortization

     (469 )     (1,889 )     (3,830 )     1,420     75.2 %     1,941     50.7 %

Interest expense

     —         —         (580 )     —       —         580     100.0 %
                                                    

Total

   $ 2,352     $ 5,504     $ 3,835     $ (3,152 )   (57.3 %)   $ 1,669     43.5 %
                                                    

Income from operations of properties sold or held for sale decreased to $2.4 million in 2008 from $5.5 million 2007 due to the sale of Maryland Trade Center I & II in September 2007 and the sale of Sullyfield Center and the Earhart Building in June 2008.

Income from operations of properties sold or held for sale increased to $5.5 million in 2007 from $3.8 million in 2006. The increase from is primarily due to the discontinuation of depreciation expense for Maryland Trade Center I & II in March 2007.

Net Operating Income

NOI, defined as real estate rental revenue less real estate 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.

 

27


Table of Contents
Index to Financial Statements

2008 Compared to 2007

The following tables of selected operating data provide the basis for our discussion of NOI in 2008 compared to 2007. All amounts are in thousands except percentage amounts.

 

     Years Ended December 31,  
     2008     2007     $ Change     % Change  

Real Estate Rental Revenue

        

Core

   $ 235,273     $ 233,398     $ 1,875     0.8 %

Non-core (1)

     47,039       19,334       27,705     143.3 %
                              

Total real estate rental revenue

   $ 282,312     $ 252,732     $ 29,580     11.7 %

Real Estate Expenses

        

Core

   $ 74,674     $ 71,601     $ 3,073     4.3 %

Non-core (1)

     19,899       6,813       13,086     192.1 %
                              

Total real estate expenses

   $ 94,573     $ 78,414     $ 16,159     20.6 %

NOI

        

Core

   $ 160,599     $ 161,797     $ (1,198 )   (0.7 %)

Non-core (1)

     27,140       12,521       14,619     116.8 %
                              

Total NOI

   $ 187,739     $ 174,318     $ 13,421     7.7 %
                              

Reconciliation to Net Income

        

NOI

   $ 187,739     $ 174,318      

Other income

     1,073       1,875      

Income from non-disposal activities

     17       1,303      

Interest expense

     (69,909 )     (61,906 )    

Depreciation and amortization

     (86,429 )     (69,136 )    

General and administrative expenses

     (12,321 )     (15,099 )    

Loss on extinguishment of debt

     (4,956 )     —        

Discontinued operations(2)

     2,352       5,504      

Gain on sale of real estate

     15,275       25,022      
                    

Net income

   $ 32,841     $ 61,881      
                    

 

Economic Occupancy

   2008     2007  

Core

   94.4 %   94.7 %

Non-core (1)

   82.2 %   92.6 %
            

Total

   92.3 %   94.5 %
            

 

(1)

Non-core properties include:

2008 in development – Clayborne Apartments and Dulles Station, Phase I

2007 in development – Bennett Park

2008 acquisitions – 6100 Columbia Park Road, Sterling Medical Office Building, Kenmore Apartments and 2445 M Street

2007 acquisitions – 270 Technology Park, Monument II, 2440 M Street, Woodholme Medical Office Building, Woodholme Center, Ashburn Farm Office Park, CentreMed I & II and 2000 M Street

 

(2)

Discontinued operations include gain on disposals and income from operations for:

2008 disposals – Sullyfield Center and The Earhart Building

2008 held for sale – Avondale

2007 disposals – Maryland Trade Center I and II

 

28


Table of Contents
Index to Financial Statements

Real estate rental revenue in 2008 increased by $29.6 million in 2008 as compared to 2007 due primarily to the acquisition or placing into service of five office properties, five medical office properties, three multifamily properties and two industrial properties in 2007 and 2008, which added approximately 2.3 million square feet of net rentable space. These acquisition and development properties contributed $27.7 million of the increase. Real estate rental revenue from the core properties increased by $1.9 million primarily due to higher cash rental rates in all segments ($6.0 million), partially offset by higher bad debt expense ($2.6 million) and lower core occupancy ($1.6 million) in the commercial segments.

Real estate expenses increased by $16.2 million in 2008 as compared to 2007 due primarily to acquisition and development properties, which contributed $13.1 million of the increase. Real estate expenses from core properties increased by $3.1 million due primarily to higher real estate taxes ($2.2 million), administrative expenses ($0.5 million) and repairs and maintenance ($0.4 million).

Core economic occupancy decreased to 94.4% in 2008 from 94.7% in 2007 due to lower core economic occupancy in the commercial property segments, partially offset by higher core economic occupancy in the multifamily segment. Non-core economic occupancy decreased to 82.2% in 2008 from 92.6% in 2007, driven by the lease-up of our development properties in the office and multifamily segments. During 2008, 60.8% of the commercial square footage expiring was renewed as compared to 79.9% in 2007. During 2008, 1.5 million commercial square feet were leased at an average rental rate of $24.68 per square foot, an increase of 19.4%, with average tenant improvements and leasing costs of $13.36 per square foot. These leasing statistics do not include leases executed during 2008 for Dulles Station, Phase I, a development property.

An analysis of NOI by segment follows.

 

29


Table of Contents
Index to Financial Statements

Office Segment:

 

     Years Ended December 31,  
     2008    2007    $ Change     % Change  

Real Estate Rental Revenue

          

Core

   $ 95,393    $ 94,446    $ 947     1.0 %

Non-core (1)

     23,491      8,177      15,314     187.3 %
                            

Total real estate rental revenue

   $ 118,884    $ 102,623    $ 16,261     15.8 %

Real Estate Expenses

          

Core

   $ 33,243    $ 32,217    $ 1,026     3.2 %

Non-core (1)

     9,452      2,641      6,811     257.9 %
                            

Total real estate expenses

   $ 42,695    $ 34,858    $ 7,837     22.5 %

NOI

          

Core

   $ 62,150    $ 62,229    $ (79 )   (0.1 %)

Non-core (1)

     14,039      5,536      8,503     153.6 %
                            

Total NOI

   $ 76,189    $ 67,765    $ 8,424     12.4 %
                            

 

Economic Occupancy

   2008     2007  

Core

   93.8 %   94.3 %

Non-core (1)

   90.4 %   97.9 %
            

Total

   93.2 %   94.6 %
            

 

(1)

Non-core properties include:

2008 in development – Dulles Station

2008 acquisition – 2445 M Street

2007 acquisitions – Monument II, Woodholme Center and 2000 M Street

Real estate rental revenue in the office segment increased by $16.3 million in 2008 as compared to 2007 due primarily to acquisition and development properties, which contributed $15.3 million of the increase. Real estate rental revenue from core properties increased by $1.0 million primarily due to higher rental rates ($1.4 million) and lease termination fees ($0.6 million), offset by lower core occupancy ($0.5 million) and higher bad debt ($0.5 million).

Real estate expenses in the office segment increased by $7.8 million in 2008 as compared to 2007 due primarily to acquisition and development properties, which contributed $6.8 million of the increase. Real estate expenses from core properties increased by $1.0 million primarily due to higher real estate taxes ($0.7 million) caused by higher rates and assessments, as well as higher repairs and maintenance expense ($0.4 million).

Core economic occupancy decreased to 93.8% in 2008 from 94.3% in 2007, driven by higher vacancy at One Central Plaza, 600 Jefferson Plaza and the Lexington. These were partially offset by higher economic occupancy at West Gude Drive, Wayne Plaza and 7900 Westpark. Non-core economic occupancy decreased to 90.4% from 97.9% due to the lease-up of Dulles Station, Phase I, a development property, as well as lower occupancy at 2000 M Street. During 2008, 41.8% of the square footage that expired was renewed compared to 82.7% in 2007, excluding properties sold or classified as held for sale. During 2008, we executed new leases for 567,700 square feet of office space at an average rental rate of $32.46 per square foot, an increase of 16.5%, with average tenant improvements and leasing costs of $20.90 per square foot. These leasing statistics do not include leases executed during 2008 for Dulles Station, Phase I, a development property.

 

30


Table of Contents
Index to Financial Statements

Medical Office Segment:

 

     Years Ended December 31,  
     2008    2007    $ Change     % Change  

Real Estate Rental Revenue

          

Core

   $ 29,510    $ 29,314    $ 196     0.7 %

Non-core (1)

     14,084      8,533      5,551     65.1 %
                            

Total real estate rental revenue

   $ 43,594    $ 37,847    $ 5,747     15.2 %

Real Estate Expenses

          

Core

   $ 8,897    $ 8,654    $ 243     2.8 %

Non-core (1)

     5,280      2,997      2,283     76.2 %
                            

Total real estate expenses

   $ 14,177    $ 11,651    $ 2,526     21.7 %

NOI

          

Core

   $ 20,613    $ 20,660    $ (47 )   (0.2 %)

Non-core (1)

     8,804      5,536      3,268     59.0 %
                            

Total NOI

   $ 29,417    $ 26,196    $ 3,221     12.3 %
                            

 

Economic Occupancy

   2008     2007  

Core

   97.7 %   98.9 %

Non-core (1)

   93.9 %   96.1 %
            

Total

   96.5 %   98.3 %
            

 

(1)

Non-core properties include:

2008 acquisition – Sterling Medical Office Building

2007 acquisitions – 2440 M Street, Woodholme Medical Office Building, Ashburn Farm Office Park, and CentreMed I & II

Real estate rental revenue in the medical office segment increased by $5.8 million in 2008 as compared to 2007 due primarily to acquisition properties, which contributed $5.6 million of the increase. Real estate rental revenue from core properties increased by $0.2 million primarily due to higher rental rates ($0.5 million) partially offset by lower core occupancy ($0.3 million).

Real estate expenses in the medical office segment increased by $2.5 million in 2008 as compared to 2007 due primarily to acquisition properties, which contributed $2.3 million of the increase. Real estate expenses from core properties increased by $0.2 million due to higher real estate taxes ($0.4 million) caused by higher rates and assessments, partially offset by lower operating services and supplies expense ($0.2 million).

Core economic occupancy decreased to 97.7% in 2008 from 98.9% in 2007, driven by higher vacancy at 8301 Arlington Boulevard and Alexandria Professional Center. Non-core economic occupancy decreased to 93.9% from 96.1% due to higher vacancy at Sterling Medical Office Building, Woodholme Medical Center and 2440 M Street. The sellers of Sterling Medical Office Building are reimbursing us for its vacant space for a period of 12 – 18 months from the acquisition date. During 2008, 63.6% of the square footage that expired was renewed compared to 50.0% in 2007. During 2008, we executed new leases for 183,300 square feet of medical office space at an average rental rate of $37.82, an increase of 23.4%, with average tenant improvements and leasing costs of $26.19 per square foot.

 

31


Table of Contents
Index to Financial Statements

Retail Segment:

 

     Years Ended December 31,  
     2008    2007    $ Change     % Change  

Real Estate Rental Revenue

          

Total

   $ 40,987    $ 41,512    $ (525 )   (1.3 %)

Real Estate Expenses

          

Total

   $ 9,646    $ 8,921    $ 725     8.1 %

NOI

          

Total

   $ 31,341    $ 32,591    $ (1,250 )   (3.8 %)

 

Economic Occupancy

   2008     2007  

Total

   94.9 %   95.2 %

Real estate rental revenue in the retail segment decreased by $0.5 million in 2008 as compared to 2007 due to higher bad debt ($1.0 million), amortization of intangible lease assets ($0.7 million) and lower occupancy ($0.1 million), partially offset by higher rental rates ($1.3 million). The bad debt and amortization of intangible lease assets includes write-offs of $0.4 million and $0.4 million, respectively, caused by the bankruptcy of a major retail tenant.

Real estate expenses in the retail segment increased by $0.7 million in 2008 as compared to 2007 due to higher real estate taxes ($0.4 million) caused by higher rates and assessments, as well as the write-off of a straight-line receivable ($0.3 million) caused by the bankruptcy of a major retail tenant.

Economic occupancy decreased to 94.9% in 2008 from 95.2% in 2007, driven by higher vacancy at Westminster Shopping Center and Montgomery Village Center. This was partially offset by lower vacancy at Montrose Shopping Center and South Washington Street. During 2008, 91.5% of the square footage that expired was renewed compared to 82.1% in 2007. During 2008, we executed new leases for 186,200 square feet of retail space at an average rental rate of $26.27, an increase of 26.9%, with average tenant improvements and leasing costs of $7.91 per square foot.

 

32


Table of Contents
Index to Financial Statements

Multifamily Segment:

 

     Years Ended December 31,  
     2008    2007     $ Change    % Change  

Real Estate Rental Revenue

          

Core

   $ 32,199    $ 31,089     $ 1,110    3.6 %

Non-core (1)

     5,659      275       5,384    —    
                            

Total real estate rental revenue

   $ 37,858    $ 31,364     $ 6,494    20.7 %

Real Estate Expenses

          

Core

   $ 13,315    $ 12,823     $ 492    3.8 %

Non-core (1)

     4,121      639       3,482    —    
                            

Total real estate expenses

   $ 17,436    $ 13,462     $ 3,974    29.5 %

NOI

          

Core

   $ 18,884    $ 18,266     $ 618    3.4 %

Non-core (1)

     1,538      (364 )     1,902    —    
                            

Total NOI

   $ 20,422    $ 17,902     $ 2,520    14.1 %
                            

 

Economic Occupancy

   2008     2007  

Core

   93.5 %   91.3 %

Non-core (1)

   49.6 %   24.0 %
            

Total

   83.0 %   89.2 %
            

 

(1)

Non-core properties include:

2008 in development – Clayborne Apartments

2007 in development – Bennett Park

2008 acquisition – Kenmore Apartments

Real estate rental revenue in the multifamily segment increased by $6.5 million in 2008 as compared to 2007 due primarily to acquisition and development properties, which contributed $5.4 million of the increase. Real estate rental revenue from core properties increased by $1.1 million due to higher rental rates ($0.3 million) and higher core occupancy ($0.7 million).

Real estate expenses in the multifamily segment increased by $4.0 million in 2008 as compared to 2007 due primarily to acquisition and development properties, which contributed $3.5 million of the increase. Real estate expenses from core properties increased by $0.5 million primarily due to higher administrative expenses ($0.3 million) driven by increased personnel and marketing costs, as well as higher real estate taxes ($0.1 million) caused by higher rates and assessments.

Core economic occupancy increased to 93.5% in 2008 from 91.3% in 2007, driven by higher occupancy at Roosevelt Towers and Bethesda Hill Apartments. Non-core economic occupancy increased to 49.6% from 24.0%, reflecting the continuing lease-up of Bennett Park and Clayborne Apartments.

 

33


Table of Contents
Index to Financial Statements

Industrial Segment:

 

     Years Ended December 31,  
     2008    2007    $ Change     % Change  

Real Estate Rental Revenue

          

Core

   $ 37,184    $ 37,037    $ 147     0.4 %

Non-core (1)

     3,805      2,349      1,456     62.0 %
                            

Total real estate rental revenue

   $ 40,989    $ 39,386    $ 1,603     4.1 %

Real Estate Expenses

          

Core

   $ 9,573    $ 8,986    $ 587     6.5 %

Non-core (1)

     1,046      536      510     95.1 %
                            

Total real estate expenses

   $ 10,619    $ 9,522    $ 1,097     11.5 %

NOI

          

Core

   $ 27,611    $ 28,051    $ (440 )   (1.6 %)

Non-core (1)

     2,759      1,813      946     52.2 %
                            

Total NOI

   $ 30,370    $ 29,864    $ 506     1.7 %
                            

 

Economic Occupancy

   2008     2007  

Core

   93.5 %   95.3 %

Non-core (1)

   90.9 %   96.2 %
            

Total

   93.3 %   95.3 %
            

 

(1)

Non-core properties include:

2008 acquisition – 6100 Columbia Park Road

2007 acquisition – 270 Technology Park

Real estate rental revenue in the industrial segment increased by $1.6 million in 2008 as compared to 2007 due primarily to acquisition properties, which contributed $1.5 million of the increase. Real estate rental revenue from core properties increased by $0.1 million primarily due to higher rental rates ($1.0 million), higher recoveries of operating expenses ($0.5 million) and higher lease termination fees ($0.2 million), partially offset by higher bad debt ($1.0 million) and lower core occupancy ($0.6 million).

Real estate expenses in the industrial segment increased by $1.1 million in 2008 as compared to 2007 due primarily to acquisition and development properties, which contributed $0.5 million of the increase. Real estate expenses from core properties increased by $0.6 million due to higher real estate taxes caused by higher rates and assessments.

Core economic occupancy decreased to 93.5% in 2008 from 95.3% in 2007, driven by higher vacancy at Tech 100, Ammendale Technology Park and NVIP I & II. These were partially offset by higher economic occupancy at Sully Square and 9950 Business Parkway. Non-core economic occupancy decreased to 90.9% from 96.2% due to vacancy expense at 270 Tech Park and 6100 Columbia Park Drive. During 2008, 59.8% of the square footage that expired was renewed compared to 83.8% in 2007, excluding properties sold or classified as held for sale. During 2008, we executed new leases for 570,900 square feet of industrial space at an average rental rate of $12.19, an increase of 18.5%, with average tenant improvements and leasing costs of $3.53 per square foot.

 

34


Table of Contents
Index to Financial Statements

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

   $ 200,802     $ 190,524     $ 10,278    5.4 %

Non-core (1)

     51,930       15,416       36,514    236.9 %
                             

Total real estate rental revenue

   $ 252,732     $ 205,940     $ 46,792    22.7 %

Real Estate Expenses

         

Core

   $ 61,385     $ 56,708     $ 4,677    8.2 %

Non-core (1)

     17,029       5,085       11,944    234.9 %
                             

Total real estate expenses

   $ 78,414     $ 61,793     $ 16,621    26.9 %

NOI

         

Core

   $ 139,417     $ 133,816     $ 5,601    4.2 %

Non-core (1)

     34,901       10,331       24,570    237.8 %
                             

Total NOI

   $ 174,318     $ 144,147     $ 30,171    20.9 %
                             

Reconciliation to Net Income

         

NOI

   $ 174,318     $ 144,147       

Other income

     1,875       906       

Gain from non-disposal activities

     1,303       —         

Interest expense

     (61,906 )     (47,265 )     

Depreciation and amortization

     (69,136 )     (50,340 )     

General and administrative expenses

     (15,099 )     (12,622 )     

Discontinued operations(2)

     5,504       3,835       

Gain on sale of real estate

     25,022       —         
                     

Net income

   $ 61,881     $ 38,661       
                     

 

Economic Occupancy

   2007     2006  

Core

   95.1 %   94.3 %

Non-core (1)

   92.5 %   87.9 %
            

Total

   94.5 %   93.8 %
            

 

(1)

Non-core properties include:

2007 in development – Bennett Park

2007 acquisitions – 270 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 acquisitions – Hampton 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

 

(2)

Discontinued operations include gain on disposals and income from operations for:

2008 disposals – Sullyfield Center and The Earhart Building

2008 held for sale – Avondale

2007 disposals – Maryland Trade Center I and II

Real estate rental revenue increased by $46.8 million in 2007 as compared to 2006 due primarily 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. Acquisition and development properties contributed $36.5 million of the increase. Real estate rental revenue from core properties increased by $10.3 million due to rental rate growth of 3.4% across the portfolio and higher core economic occupancy in the office and retail segments.

 

35


Table of Contents
Index to Financial Statements

Real estate expenses increased by $16.6 million in 2007 as compared to 2006 due primarily to acquisition and development properties, which contributed $11.9 million of the increase. Real estate expenses from core properties increased by $4.7 million, due primarily to higher real estate taxes, utilities, repairs and maintenance, and operating services in all segments.

Overall economic occupancy increased to 94.5% in 2007 from 93.8% in 2006 due to higher core occupancy in the office and industrial segments and higher non-core occupancy in our office, retail and industrial properties. During 2007, 79.9% of the commercial square footage expiring from continuing operations was renewed as compared to 77.1% in 2006. During 2007, 1.8 million commercial square feet were leased at an average rental rate of $18.99 per square foot, an increase of 17.3%, with average tenant improvements and leasing costs of $11.05 per square foot.

An analysis of NOI by segment follows.

 

36


Table of Contents
Index to Financial Statements

Office Segment:

 

     Years Ended December 31,  
     2007    2006    $ Change    % Change  

Real Estate Rental Revenue

           

Core

   $ 80,747    $ 75,236    $ 5,511    7.3 %

Non-core (1)

     21,876      4,784      17,092    357.3 %
                           

Total real estate rental revenue

   $ 102,623    $ 80,020    $ 22,603    28.2 %

Real Estate Expenses

           

Core

   $ 27,373    $ 25,136    $ 2,237    8.9 %

Non-core (1)

     7,485      1,668      5,817    348.7 %
                           

Total real estate expenses

   $ 34,858    $ 26,804    $ 8,054    30.0 %

NOI

           

Core

   $ 53,374    $ 50,100    $ 3,274    6.5 %

Non-core (1)

     14,391      3,116      11,275    361.8 %
                           

Total NOI

   $ 67,765    $ 53,216    $ 14,549    27.3 %
                           

 

Economic Occupancy

   2007     2006  

Core

   95.2 %   92.1 %

Non-core (1)

   92.5 %   92.0 %
            

Total

   94.6 %   92.1 %
            

 

(1)

Non-core properties include:

2007 acquisitions – Monument II, Woodholme Center and 2000 M Street

2006 acquisitions – 6565 Arlington Blvd, West Gude Drive, the Ridges and the Crescent

Real estate rental revenue in the office segment increased by $22.6 million in 2007 as compared to 2006 due primarily to acquisition properties, which contributed $17.1 million of the increase. Real estate rental revenue from core properties increased by $5.5 million due to a 3.1% 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, increases in recoveries ($1.7 million), and rental rate increases ($1.6 million).

Real estate expenses in the office segment increased by $8.1 million in 2007 as compared to 2006 due primarily to acquisition properties, which contributed $5.8 million of the increase. Real estate expenses from core properties increased by $2.2 million due primarily to higher real estate tax expense ($0.9 million) due to higher value assessments for properties across several jurisdictions, higher utility costs ($0.6 million) driven by escalating fuel rates, consumption and energy taxes, and increased administrative, custodial and maintenance costs ($0.7 million) associated with the higher occupancy.

Core economic occupancy increased by 3.1% due to the occupancy gains described in the paragraph above. Non-core economic occupancy had a small increase. 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 rental rate of $28.10 per square foot, an increase of 12.1%, with average tenant improvements and leasing costs of $21.67 per square foot.

 

37


Table of Contents
Index to Financial Statements

Medical Office Segment:

 

     Years Ended December 31,  
     2007    2006    $ Change    % Change  

Real Estate Rental Revenue

           

Core

   $ 18,478    $ 18,094    $ 384    2.1 %

Non-core (1)

     19,369      6,237      13,132    210.5 %
                           

Total real estate rental revenue

   $ 37,847    $ 24,331    $ 13,516    55.6 %

Real Estate Expenses

           

Core

   $ 5,018    $ 4,759    $ 259    5.4 %

Non-core (1)

     6,633      2,305      4,328    187.8 %
                           

Total real estate expenses

   $ 11,651    $ 7,064    $ 4,587    64.9 %

NOI

           

Core

   $ 13,460    $ 13,335    $ 125    0.9 %

Non-core (1)

     12,736      3,932      8,804    223.9 %
                           

Total NOI

   $ 26,196    $ 17,267    $ 8,929    51.7 %
                           

 

Economic Occupancy

   2007     2006  

Core

   98.8 %   98.8 %

Non-core (1)

   97.8 %   99.9 %
            

Total

   98.3 %   99.0 %
            

 

(1)

Non-core properties include:

2006 acquisitions – Alexandria Professional Center, 9707 Medical Center Drive, 15001 Shady Grove Road, Plumtree Medical Center and 15005 Shady Grove Road

Real estate rental revenue in the medical office segment increased by $13.5 million in 2007 as compared to 2006 due primarily to acquisition properties, which contributed $13.1 million of the increase. Real estate rental revenue from core properties increased by $0.4 million primarily due to a 2.3% increase in rental rates.

Real estate expenses in the medical office segment increased by $4.6 million in 2007 as compared to 2006 due primarily to acquisition properties, which contributed $4.3 million of the increase. Real estate expenses from core properties increased by $0.3 million due to higher utilities ($0.1 million) and real estate taxes ($0.2 million).

Core economic occupancy was unchanged from 2006 to 2007. Non-core economic occupancy decreased by 2.1% due primarily to vacancies at 2440 M Street and Woodholme Medical Center. During 2007, 50.0% of the square footage that expired was renewed compared to 87.7% in 2006, excluding properties sold or classified as held for sale. During 2007, we executed new leases for 103,200 square feet of medical office space at an average rental rate of $33.82 per square foot, an increase of 19.8%, with average tenant improvements and leasing costs of $18.28 per square foot.

 

38


Table of Contents
Index to Financial Statements

Retail Segment:

 

     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 %

NOI

           

Core

   $ 28,976    $ 27,682    $ 1,294    4.7 %

Non-core (1)

     3,615      1,598      2,017    126.2 %
                           

Total NOI

   $ 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 acquisitions – Randolph and Montrose Shopping Centers

Real estate rental revenue in the retail segment increased by $4.3 million in 2007 as compared to 2006 due primarily to acquisition properties, which contributed $2.4 million of the increase. Real estate rental revenue from core properties increased by $1.9 million primarily 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.

Real estate expenses in the retail segment increased by $0.9 million in 2007 as compared to 2006 due in part to acquisition properties, which contributed $0.3 million of the increase. Real estate expenses from core properties increased by $0.6 million due to higher common area maintenance costs ($0.3 million) and increased real estate taxes ($0.3 million).

Core economic occupancy for the retail segment decreased by 2.9% due to lower occupancy at South Washington Street, the Shoppes at Foxchase and Bradlee Shopping Center. Non-core economic occupancy increased by 26.1% due to the successful leasing efforts at Montrose and Randolph shopping centers. During 2007, 82.1% of the square footage that expired was renewed compared to 90.8% in 2006, excluding properties sold or classified as held for sale. During 2007, we executed new leases for 223,900 square feet of retail space at an average rental rate of $24.78 per square foot, an increase of 32.7%, with average tenant improvements and leasing costs of $9.26 per square foot.

 

39


Table of Contents
Index to Financial Statements

Multifamily Segment:

 

     Years Ended December 31,  
     2007     2006    $ Change     % Change  

Real Estate Rental Revenue

         

Core

   $ 31,089     $ 29,677    $ 1,412     4.8 %

Non-core (1)

     275       —        275     —    
                             

Total real estate rental revenue

   $ 31,364     $ 29,677    $ 1,687     5.7 %

Real Estate Expenses

         

Core

   $ 12,823     $ 11,788    $ 1,035     8.8 %

Non-core (1)

     639       —        639     —    
                             

Total real estate expenses

   $ 13,462     $ 11,788    $ 1,674     14.2 %

NOI

         

Core

   $ 18,266     $ 17,889    $ 377     2.1 %

Non-core (1)

     (364 )     —        (364 )   —    
                             

Total NOI

   $ 17,902     $ 17,889    $ 13     0.1 %
                             

 

Economic Occupancy

   2007     2006  

Core

   91.3 %   92.3 %

Non-core (1)

   24.0 %   —    
            

Total

   89.2 %   92.3 %
            

 

(1)

Non-core properties include:

2007 in development – Bennett Park

Real estate rental revenue in the multifamily segment increased by $1.7 million in 2007 as compared to 2006 due primarily to higher minimum base rent throughout the portfolio and an increase in utilities reimbursement in the core properties, offset by a 1.0% decrease in core economic occupancy. The real estate rental revenue from non-core properties of $0.3 million was due to the substantial completion of Bennett Park in the fourth quarter of 2007.

Real estate expenses in the multifamily segment increased by $1.7 million in 2007 as compared to 2006 due primarily to higher repairs and maintenance costs, higher real estate taxes, and increased operating services and supplies costs in the core portfolio. Real estate expenses from non-core properties of $0.6 million were due to the substantial completion of Bennett Park.

Overall economic occupancy decreased to 89.2% in 2007 from 92.3% in 2006 due to the substantial completion of Bennett Park in the fourth quarter of 2007. The property was in its lease-up phase and its occupancy was 24.0% at year end.

 

40


Table of Contents
Index to Financial Statements

Industrial Segment:

 

     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 NOI

   $ 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 acquisition – 270 Technology Park

2006 acquisitions – Hampton Overlook, Hampton South and 9950 Business Parkway

Real estate rental revenue in the industrial segment increased by $4.7 million in 2007 as compared to 2006 due primarily to acquisition properties, which contributed $3.6 million of the increase. Real estate rental revenue from core properties increased by $1.1 million due to rental rate growth ($0.9 million) and an increase in economic occupancy ($0.2 million).

Real estate expenses in the industrial segment increased by $1.4 million in 2007 as compared to 2006 due primarily to acquisition properties, which contributed $0.8 million of the increase. Real estate expenses from core properties increased by $0.6 million due to higher common area maintenance costs ($0.3 million), real estate taxes ($0.2 million) and utilities ($0.1 million).

Core economic occupancy increased by 0.9% due primarily to lower vacancy at Sully Square and NVIP I & II. Non-core economic occupancy increased by 10.7% due primarily to lower vacancy at Hampton South. During 2007, 83.8% of the square footage that expired was renewed compared to 79.3% in 2006, excluding properties sold or classified as held for sale. During 2007, we executed new leases for 912,100 square feet of industrial space at an average rental rate of $10.64 per square foot, an increase of 17.0%, with average tenant improvements and leasing costs of $4.56 per square foot.

 

41


Table of Contents
Index to Financial Statements

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 common shares. We analyze which source of capital we believe to be most advantageous to us at any particular point in time. However, the capital markets may not consistently be available on terms that we consider attractive. In particular, as a result of the current economic downturn and turmoil in the capital markets, unsecured notes financings for REITs have currently become virtually unavailable and long-term credit has become significantly more costly. We cannot predict how long these conditions will continue.

We currently expect that our potential 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 in our operating partnership;

 

   

Proceeds from long-term secured or unsecured debt financings;

 

   

Investment from joint venture partners; and

 

   

Net proceeds from the sale of assets.

As noted above, our current access to long-term secured and unsecured debt financings has been adversely affected by the current economic downturn and turmoil in the credit markets. We cannot predict how long these conditions will continue.

During 2009, we expect that we will have modest 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 $35.0 - $40.0 million to invest in our existing portfolio of operating assets, including approximately $15.0 - $20.0 million to fund tenant-related capital requirements and leasing commissions;

 

   

Approximately $15.0 million to fund first generation tenant-related capital requirements and leasing commissions;

 

   

Approximately $2.5 million to invest in our development projects; and

 

   

Approximately $19.5 - $50.0 million to fund our expected property acquisitions.

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.

 

42


Table of Contents
Index to Financial Statements

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 an effective fixed interest rate or hedge fixed rate debt to give it an effective variable interest rate.

Typically we have obtained the ratings of two credit rating agencies in the underwriting of our unsecured debt. As of December 31, 2008, Standard & Poor’s had assigned its BBB+ rating with a stable outlook, and Moody’s 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. A rating is not a recommendation to buy, sell or hold securities, and each rating is subject to revision or withdrawal at any time by the assigning rating organization.

Our total debt at December 31, 2008 is summarized as follows (in thousands):

 

     Total Debt

Fixed rate mortgages

   $ 421,286

Unsecured credit facilities

     67,000

Unsecured notes payable

     902,900
      
   $ 1,391,186
      

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.

Mortgage Debt

At December 31, 2008, our $421.3 million in fixed rate mortgages, which includes a net $8.1 million in unamortized discounts due to fair value adjustments, bore an effective weighted average fair value interest rate of 6.1% and had a weighted average maturity of 5.6 years. We may either initiate secured mortgage debt or assume mortgage debt from time-to-time in conjunction with property acquisitions.

On May 29, 2008 we executed three mortgage notes payable totaling $81.0 million secured by 3801 Connecticut Avenue, Walker House and Bethesda Hill. The mortgages bear interest at 5.71% per annum and interest only is payable monthly until May 31, 2016, at which time all unpaid principal and interest are payable in full.

On February 17, 2009, we executed a mortgage note of $37.5 million at a fixed rate of 5.37% for a term of ten years, secured by Kenmore Apartments. The proceeds from the note were used to pay down borrowings under our lines of credit and to repurchase a portion of our convertible notes.

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 $5.4 million in letters of credit issued as of December 31, 2008, related to Credit Facility No. 1. Borrowings under the facility bear interest at our option of LIBOR plus a spread based on the credit rating on our publicly issued debt or the higher of SunTrust Bank’s prime rate and the Federal Funds Rate in effect plus 0.5%. All outstanding advances are due and payable upon maturity in June 2011. Interest only payments are due and payable generally on a monthly basis. In addition, we pay a facility fee based on the credit rating of our publicly issued debt which currently equals 0.15% per annum of the $75.0 million committed capacity, without regard to usage. Rates and fees may be adjusted up or down based on changes in our senior unsecured credit ratings.

 

43


Table of Contents
Index to Financial Statements

Credit Facility No. 2 is a four-year $262.0 million unsecured credit facility expiring in November 2010, with a one year extension option. We had $67.0 million outstanding and $0.9 million in letters of credit issued as of December 31, 2008, related to Credit Facility No. 2. Advances under this agreement bear interest at our option of LIBOR plus a spread based on the credit rating of our publicly issued debt or the higher of Wells Fargo Bank’s prime rate and the Federal Funds Rate in effect on that day plus 0.5%. All outstanding advances are due and payable upon maturity in November 2010. Interest only payments are due and payable generally on a monthly basis. Credit Facility No. 2 requires us to pay the lender a facility fee on the total commitment of 0.15% per annum. These fees are payable quarterly.

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 an estimate of fair market value of our assets;

 

   

A maximum ratio of secured indebtedness to gross asset value, calculated using an estimate of 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 unencumbered asset value, calculated using a fair value of our assets, to unsecured indebtedness;

 

   

A minimum ratio of net operating income from our unencumbered properties to unsecured interest expense; and

 

   

A maximum ratio of permitted investments to gross asset value, calculated using an estimate of fair market value of our assets.

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, 2008, we were in compliance with our loan covenants. However, our ability to draw on our unsecured credit facilities or incur other unsecured debt in the future could be restricted by the loan covenants.

We anticipate that in the near term we may rely to a greater extent upon our unsecured credit facilities and potentially maintain balances on our unsecured credit facilities for longer periods than has been our historical practice. To the extent that we maintain larger balances on our unsecured credit facilities or maintain balances on our unsecured credit facilities for longer periods, adverse fluctuations in interest rates could have a material adverse effect on earnings.

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.

Depending upon market conditions, opportunities to issue unsecured notes on attractive terms may not be available. In particular, as noted above, current access to unsecured notes financings for REITs has become virtually unavailable as a result of the current economic downturn and turmoil in the credit markets. Accordingly, as noted above we anticipate that in the near term we may rely to a greater extent upon our unsecured credit facilities and potentially maintain balances on our unsecured credit facilities for longer periods than has been our historical practice. To the extent that we maintain larger balances on our unsecured credit facilities or maintain balances on our unsecured credit facilities for longer periods, adverse fluctuations in interest rates could have a material adverse effect on earnings.

 

44


Table of Contents
Index to Financial Statements

Our unsecured fixed-rate notes payable have maturities ranging from February 2010 through February 2028, as follows (in thousands):

 

     December 31,
2008

Note Principal

4.45% notes due 2010

   $ 100,000

5.95% notes due 2011

     150,000

5.05% notes due 2012

     50,000

5.125% notes due 2013

     60,000

5.25% notes due 2014

     100,000

5.35% notes due 2015

     150,000

3.875% notes due 2026 (1)

     244,000

7.25% notes due 2028

     50,000
      
   $ 904,000
      

 

(1)

On or after September 20, 2011, we may redeem the convertible notes at a redemption price equal to the principal amount of the notes plus any accrued and unpaid interest, if any, up to, but excluding, the purchase date. In addition, on September 15, 2011, September 15, 2016 and September 15, 2021 or following the occurrence of certain change in control transactions prior to September 15, 2011, holders of these notes may require us to repurchase the notes for an amount equal to the principal amount of the notes plus any accrued and unpaid interest thereon.

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.

Failure to comply with any of the covenants under our unsecured notes could result in a default under one or more of our debt instruments. This could cause our debt holders 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, 2008, we were in compliance with our unsecured notes 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.

During the fourth quarter of 2008, we repurchased $16.0 million of our 3.875% convertible notes at a 25% discount to par value, resulting in a gain on extinguishment of debt of $3.5 million. Subsequent to year end, we repurchased an additional $19.5 million of our 3.875% convertible notes at discounts ranging from 16% to 20%. We may from time to time seek to repurchase and cancel our outstanding notes through open market purchases, privately negotiated transactions or otherwise. Such repurchases, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.

Term Loan

On February 21, 2008 we entered into a $100 million unsecured term loan (the “2010 Term Loan”) with Wells Fargo Bank, National Association. The 2010 Term Loan has a maturity date of February 19, 2010 and bears interest at our option of LIBOR plus 1.50% or Wells Fargo’s prime rate. To hedge our exposure to interest rate fluctuations on the $100 million note, we entered into an interest rate swap on a notional amount of $100 million, which had the effect of fixing the LIBOR portion of the interest rate on the term loan at 2.95% through February 2010. The current interest rate, taking into account the swap, is 4.45% (2.95% plus 150 basis points). The interest rate swap agreement will settle contemporaneously with the maturity of the loan.

Common Equity

We have authorized for issuance 100.0 million common shares, of which 52.4 million shares were outstanding at December 31, 2008.

 

45


Table of Contents
Index to Financial Statements

During the second quarter of 2008, we completed a public offering of 2.6 million common shares priced at $34.80 per share, raising $86.7 million in net proceeds. We used the net proceeds from the offering to repay borrowings under our lines of credit. During the fourth quarter of 2008, we completed a public offering of 1.725 million common shares priced at $35.00 per share, raising $57.6 million in net proceeds. We used the net proceeds from the offering to repay borrowings under our lines of credit and for general corporate purposes.

During the third quarter of 2008, we entered into a sales agency financing agreement with BNY Mellon Capital Markets, LLC relating to the issuance and sale of up to $150.0 million of our common shares from time to time over a period of no more than 36 months. Sales of our common shares are made at market prices prevailing at the time of sale. Net proceeds for the sale of common shares under this program are used for the repayment of borrowings under our lines of credit, acquisitions and general corporate purposes. As of the end of 2008, we had issued 1.1 million common shares at a weighted average price of $36.15 under this program, raising $40.7 million in net proceeds.

We have a dividend reinvestment program whereby shareholders may use their dividends and optional cash payments to purchase common shares. The common shares sold under this program may either be common shares issued by us or common shares purchased in the open market. Net proceeds under this program are used for general corporate purposes. As of the end of 2008, 125,348 common shares were issued at a weighted average price of $32.75 per share, raising $4.1 million in net proceeds.

During the second quarter of 2007, we completed a public offering of 1.6 million common shares priced at $37.00 per share, raising $57.8 million in net proceeds. The net proceeds were used for the repayment of debt.

Dividends

We pay dividends quarterly. The maintenance of these dividends is subject to various factors, including the discretion of our 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 2008, 2007 and 2006 (in thousands).

 

     2008    2007    2006

Common dividends

   $ 85,564    $ 78,050    $ 72,681

Minority interest distributions

     192      156      134
                    
   $ 85,756    $ 78,206    $ 72,815
                    

Dividends paid for 2008 as compared to 2007 increased as a direct result of a dividend rate increase from $1.68 per share in 2007 to $1.72 per share in 2008. The dividends paid also increased due to our issuance of 4.325 million shares pursuant to public offerings and our issuance of 1.1 million under our sales agency financing agreement during 2008.

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 our issuance of 1.6 million shares in our public offering in June 2007.

Cash flows from operations are an important factor in our ability to sustain our dividend at its current rate. Cash flows from operations decreased to $97.0 million in 2008 from $115.5 million in 2007, primarily due to higher interest payments, lower prepaid rents and payout of contactors’ retainage related to our development projects. 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 our dividend.

Capital Commitments

We will require capital for development and redevelopment projects currently underway and in the future. As of December 31, 2008, we had under development Dulles Station Phase II and 4661 Kenmore, in which we had invested $25.8 million and $4.8 million, respectively. We are pursuing a number of potential redevelopment projects at properties such as Montrose and 7900 Westpark. Projects placed into service in 2008 included Bennett Park, Clayborne Apartments and Dulles Station Phase I, in which we had invested $86.3 million, $36.6 million and $44.6 million as of December 31, 2008, respectively, including land and carrying costs. We expect our total project costs for Bennett Park, Clayborne Apartments and Dulles Station Phase I, to be $86.9 million, $36.7 million and $60.5 million, respectively. As of December 31, 2008, we were committed to approximately $13.4 million of development spending during 2009, including $12.8 million of Dulles Station Phase I tenant-related capital.

 

46


Table of Contents
Index to Financial Statements

We anticipate funding several major renovation projects in our portfolios during 2009, as follows (in thousands):

 

Segment

   Project
Spending

Office

   $ 2,741

Medical office

     1,501

Retail

     1,635

Multifamily

     1,453

Industrial

     100
      

Total

   $ 7,430
      

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 and medical properties. Not all of the anticipated spending had been committed through executed construction contracts at December 31, 2008. We expect to meet our requirements using cash generated by our real estate operations, through borrowings on our unsecured credit facilities, secured financings of our properties 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)

   $ 1,902,064    $ 124,027    $ 596,716    $ 343,696    $ 837,625

Purchase obligations (2)

     15,745      8,101      7,644      —        —  

Estimated development commitments (3)

     13,430      13,430         —        —  

Tenant-related capital (4)

     6,572      6,572      —        —        —  

Building capital (5)

     7,757      7,757      —        —        —  

Operating leases

     56      40      16      —        —  

 

(1)

See Notes 4, 5 and 6 of our consolidated financial statements. Amounts include principal, interest, unused commitment fees and facility fees.

 

(2)

Represents elevator maintenance contracts with terms through 2009, electricity sales agreements with terms through 2011, and natural gas purchase agreements with terms through 2011.

 

(3)

Committed development obligations based on contracts in place as of December 31, 2008.

 

(4)

Committed tenant-related capital based on executed leases as of December 31, 2008.

 

(5)

Committed building capital additions based on contracts in place as of December 31, 2008.

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, electricity sales 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. 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 $21.0 million in 2009. Due to the competitive office leasing market we expect that tenant-related capital costs will continue at this level into 2009.

 

47


Table of Contents
Index to Financial Statements

Historical Cash Flows

Consolidated cash flow information is summarized as follows (in millions):

 

     For the year ended
December 31,
    Variance  
     2008     2007     2006     2008 vs.
2007
    2007 vs.
2006
 

Cash provided by operating activities

   $ 97.0     $ 115.5     $ 86.5     $ (18.5 )   $ 29.0  

Cash used in investing activities

   $ (181.2 )   $ (348.6 )   $ (334.7 )   $ 167.4     $ (13.9 )

Cash provided by financing activities

   $ 74.6     $ 245.9     $ 251.9     $ (171.3 )   $ (6.0 )

Operations generated $97.0 million of net cash in 2008 compared to $115.5 million in 2007. The decrease in cash provided by operating activities in 2008 as compared to 2007 was due primarily to higher interest payments, lower prepaid rents and the payout of contractors’ retainage related to our development projects.

Operations generated $115.5 million of net cash in 2007 compared to $86.5 million in 2006. The increase in cash provided by operating activities in 2007 compared to 2006 was due primarily to properties acquired in 2006 and 2007. The level of net cash provided by operating activities was also affected by the timing of receipt of revenues and payment of expenses.

Our investing activities used net cash of $181.2 million in 2008 and $348.6 million in 2007. The decrease in cash used by investing activities in 2008 was primarily due to the $168.2 million of cash invested in acquisitions, net of assumed debt, throughout 2008, which was $125.9 million lower than 2007. In addition, cash spent on our development projects decreased to $15.3 million from $66.5 million in 2007, as our three major development projects (Bennett Park, Clayborne Apartments and Dulles Station, Phase I) were completed and placed into service during 2007 and 2008.

Our investing activities used net cash of $348.6 million in 2007 and $334.7 million in 2006. The change in cash used by investing activities in 2007 was primarily due to the $294.2 million of cash invested in acquisitions, net of assumed debt, throughout 2007, which was $67.7 million higher than 2006. 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 $74.6 million in 2008 and $245.9 million in 2007. The decrease in net cash provided by financing activities in 2008 was the primarily result of using much of the borrowings and proceeds from equity issuances to pay down the lines of credit and to pay off the $60 million MOPPRS debt and the related $8.4 million loss on extinguishment. Also, on December 17, 2008 we repurchased $16.0 million of the convertible notes for $12.5 million. The 2007 borrowings and proceeds from equity issuance were primarily used for the acquisition of new properties.

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 was the primarily result of 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 $52.6 million were incurred in 2008, including tenant improvements. These improvements to our properties in 2007 and 2006 were $107.6 million and $106.5 million, respectively.

 

48


Table of Contents
Index to Financial Statements

Our capital improvement and development costs for the three years ending December 31, 2008 were as follows (in thousands):

 

     Year Ended December 31,
     2008    2007    2006

Accretive capital improvements

        

Acquisition related

   $ 6,012    $ 1,954    $ 1,430

Expansions and major renovations

     9,591      10,684      18,258

Development/redevelopment

     15,304      66,489      68,621

Tenant improvements

     11,359      16,587      9,473
                    

Total accretive capital improvements

     42,266      95,714      97,782

Other capital improvements

     10,310      11,897      8,685
                    

Total

   $ 52,576    $ 107,611    $ 106,467
                    

Accretive Capital Improvements

Acquisition related improvements are capital improvements to properties acquired during the preceding three years which were anticipated at the time we acquired the properties. These types of improvements were made in 2008 to 2000 M Street, 2440 M Street, 6100 Columbia Park Drive, Randolph Shopping Center and Alexandria Professional Center.

Expansion projects increase the rentable area of a property, while major renovation projects are improvements sufficient to increase the income otherwise achievable at a property. 2008 expansions and major renovations included garage and deck renovations at 7900 Westpark; roof replacements at Bradlee Shopping Center and NVIP; common area and unit renovations for Bethesda Hill, Country Club Towers and the Ashby at McLean; and elevator modernization at One Central Plaza.

Development costs represent expenditures for ground up development of new operating properties. Redevelopment costs represent expenditures for improvements intended to re-position 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, Clayborne and Dulles Station. Completion of Bennett Park, our residential project under development in Arlington, VA, occurred during 2007. Completion of Clayborne Apartments, our residential project under construction in Alexandria, VA, occurred 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 and the property was substantially leased in the third quarter of 2008. Additionally in 2007, we acquired land for future development of medical office space at 4661 Kenmore in Alexandria, VA. Development spending in 2008 includes pre-development activities related to this project. In 2007 and 2006, re-development costs were incurred for the Shoppes of Foxchase, which was substantially completed in 2006.

 

49


Table of Contents
Index to Financial Statements

Tenant 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:

 

     Year Ended December 31,
     2008    2007    2006

Office*

   $ 12.95    $ 13.68    $ 12.95

Medical Office

   $ 19.12    $ 13.95    $ 17.78

Retail

   $ 3.67    $ 1.85    $ 0.05

Industrial/flex*

   $ 1.56    $ 2.64    $ 1.91

 

* Excludes properties sold or classified as held for sale.

The $0.73 decrease in tenant improvement costs per square foot of space leased for office buildings in 2008 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 in 2007, including $1.1 million and $0.4 million, respectively, for a single tenant. The $5.17 increase in tenant improvement costs per square foot of space leased for medical office buildings in 2008 was primarily due to leases executed at Woodburn II, requiring $1.6 million in tenant improvements, including $1.2 million for a single tenant; and at 8503 Arlington Boulevard, for leases requiring $0.5 million in improvements 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. The $1.77 increase in tenant improvement costs per square foot of retail space leased in 2008 was primarily due to a lease executed at Montrose Center, requiring $0.5 million in tenant improvements. 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 $1.08 decrease in tenant improvement costs per square foot of industrial space leased in 2008 was primarily due to leases executed in 2007 at Dulles Business Park and Gorman Road requiring $0.8 million and $0.4 million, respectively, in tenant improvements, entirely for single tenants. These transactions also were the primary cause of the $0.73 increase in tenant improvement costs per square foot over 2006.

The retail and 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 office. Excluding properties sold or classified as held for sale, approximately 61% of our office tenants renewed their leases with us in 2008, compared to 83% in 2007 and 68% in 2006. Renewing tenants generally require minimal tenant improvements. In addition, lower tenant improvement costs are a benefit 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.

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 property’s 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 $0.8 million in 2008, and averaged $814 per apartment for the 33% 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 2008, we incurred repair and maintenance expenses of $11.1 million that were not capitalized, to maintain the quality of our buildings.

Forward-Looking Statements

This Form 10-K contains forward-looking statements which involve risks and uncertainties. Such forward looking statements include each of the statements in “Item 1: Business” and “Item 7: Management’s Discussion and Analysis of Financial Conditions and Results of Operations” concerning the Washington metro region’s economy, gross regional product, unemployment and job growth and real estate market performance. 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 common shares or notes; and (c) our belief that we have

 

50


Table of Contents
Index to Financial Statements

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 Form 10-K, could affect our future results and could cause those results to differ materially from those expressed in the forward-looking statements: (a) the effect of the current credit and financial market conditions; (b) the availability and cost of capital; (c) fluctuations in interest rates; (d) the economic health of our tenants; (e) the timing and pricing of lease transactions; (f) the economic health of the greater Washington Metro region, or other markets we may enter; (g) the effects of changes in Federal government spending; (h) the supply of competing properties; (i) consumer confidence; (j) unemployment rates; (k) consumer tastes and preferences; (l) our future capital requirements; (m) inflation; (n) compliance with applicable laws, including those concerning the environment and access by persons with disabilities; (o) governmental or regulatory actions and initiatives; (p) changes in general economic and business conditions; (q) terrorist attacks or actions; (r) acts of war; (s) weather conditions; (t) the effects of changes in capital available to the technology and biotechnology sectors of the economy, and (u) 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,
     2008    2007    2006

Earnings to fixed charges

   1.18x    1.37x    1.61x

Debt service coverage

   2.35x    2.56x    2.76x

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.

Both the earnings to fixed charges ratio and the debt service coverage ratio for the year ended December 31, 2008 include the impact of the net loss on extinguishment of debt of $5.0 million (see “Item 2: Consolidated Results of 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 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.

 

51


Table of Contents
Index to Financial Statements

The following table provides the calculation of our FFO and a reconciliation of FFO to net income for the years presented (in thousands):

 

     2008     2007     2006

Net income

   $ 32,841     $ 61,881     $ 38,661

Adjustments

      

Depreciation and amortization

     86,429       69,136       50,340

Gain on property disposed

     (15,275 )     (25,022 )     —  

Other gain

     (17 )     (1,303 )     —  

Discontinued operations depreciation and amortization

     469       1,889       3,830
                      

FFO as defined by NAREIT

   $ 104,447     $ 106,581     $ 92,831
                      

 

ITEM 7A: QUANTITATIVE AND QUALITATIVE 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, 2008.

 

     2009     2010     2011     2012     2013     Thereafter     Total     Fair Value
(In thousands)                       

Unsecured fixed rate debt

                

Principal

     —       $ 100,000 (a)   $ 150,000     $ 50,000     $ 60,000     $ 544,000     $ 904,000     $ 712,763

Interest payments

   $ 45,330     $ 43,105     $ 36,418     $ 30,693     $ 27,892     $ 185,412     $ 368,850    

Interest rate

on debt maturities

     —         4.45 %     5.95 %     5.06 %     5.23 %     4.88 %     5.04 %  

Unsecured variable rate debt

                

Principal

     —       $ 67,000       —         —         —         —       $ 67,000     $ 67,000

Variable interest rate

on debt maturities (b)

     —         1.48 %     —         —         —         —         1.48 %  

Mortgages

                

Principal amortization
(30 year schedule)

   $ 53,725     $ 25,424     $ 12,812     $ 20,800     $ 106,032     $ 210,598     $ 429,391     $ 408,089

Interest payments

   $ 24,467     $ 21,140     $ 20,020     $ 18,841     $ 13,335     $ 34,051     $ 131,854    

Weighted average interest rate on principal amortization

     7.03 %     5.77 %     5.32 %     4.90 %     5.58 %     6.41 %     6.14 %  

 

(a) The $100.0 million term loan which matures in 2010 bears interest at a variable rate, which has been effectively fixed at 4.45% through an interest rate swap. See Note 6 to the consolidated financial statements for further discussion.
(b) Variable interest rates based on LIBOR in effect on our borrowings outstanding at December 31, 2008.

 

52


Table of Contents
Index to Financial Statements
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements and supplementary data appearing on pages 62 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 SEC’s 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, 2008. Based on the foregoing, our Chief Executive Officer, Chief Financial Officer and Executive Vice President of Accounting concluded that our disclosure controls and procedures were effective at a reasonable assurance level.

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, 2008, there was no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

ITEM 9B: OTHER INFORMATION

None.

 

53


Table of Contents
Index to Financial Statements

PART III

Certain information required by Part III is omitted from this Form 10-K in that we will file a definitive proxy statement pursuant to Regulation 14A with respect to our 2009 Annual Meeting (the “Proxy Statement”) no later than 120 days after the end of the fiscal year covered by this Form 10-K, 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

   283,039    25.02    1,838,525

Equity compensation plans not approved by security holders

   34,000    27.70    —  
              

Total

   317,039    25.31    1,838,525

 

* 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. See Note 7 to the consolidated financial statements for further discussion.

 

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 herein by reference to the Proxy Statement.

 

54


Table of Contents
Index to Financial Statements

PART IV

 

ITEM 15: EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(A). The following documents are filed as part of this Form 10-K:

 

     Page

1.      Financial Statements

  

Management’s Report on Internal Control Over Financial Reporting

   59

Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting

   60

Report of Independent Registered Public Accounting Firm

   61

Consolidated Balance Sheets as of December 31, 2008 and 2007

   62

Consolidated Statements of Income for the Years Ended December 31, 2008, 2007 and 2006

   63

Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December  31, 2008, 2007 and 2006

   64

Consolidated Statements of Cash Flows for the Years Ended December 31, 2008, 2007 and 2006

   65

Notes to Consolidated Financial Statements

   66

2.      Financial Statement Schedules

  

Schedule III – Consolidated 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 WRIT’s registration statement on Form 8-B dated July 10, 1996.

 

  (b) Bylaws. Incorporated herein by reference to Exhibit 4 to WRIT’s 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 WRIT’s 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 WRIT’s 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 WRIT’s 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 WRIT’s Form S-3 registration statement filed with the Securities and Exchange Commission as of August 28, 2006.

 

  4. Instruments Defining Rights of Security Holders

 

 

(c)

Indenture dated as of August 1, 1996 between WRIT and The First National Bank of Chicago.(2)

 

 

(h)

Form of 2028 Notes (3)

 

 

(n)

Officer’s Certificate Establishing Terms of the 2013 Notes, dated March 12, 2003.(8)

 

 

(o)

Form of 2013 Notes.(8)

 

 

(p)

Officers’ Certificate Establishing Terms of the 2014 Notes, dated December 8, 2003.(9)

 

 

(q)

Form of 2014 Notes.(9)

 

 

(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 2012 and 2015 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 2015 Notes, dated October 3, 2005(13)

 

 

(z)

Form of 5.95% Senior Notes due June 15, 2011(16)

 

55


Table of Contents
Index to Financial Statements
 

(aa)

Officers’ Certificate establishing the terms of the 2011 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 Convertible 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 2011 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 WRIT 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 WRIT, as borrower, the financial institutions party thereto as lenders, and SunTrust Bank as agent (28) 

 

 

(nn)

Term Loan Agreement dated as of February 21, 2008, by and between WRIT and Wells Fargo Bank, National Association (31)

 

 

(oo)

Multifamily Note Agreement (Walker House Apartments) dated as of May 29, 2008, by and between WRIT and Wells Fargo Bank, National Association (33)

 

 

(pp)

Multifamily Note Agreement (3801 Connecticut Avenue) dated as of May 29, 2008, by and between WRIT and Wells Fargo Bank, National Association (33)

 

 

(qq)

Multifamily Note Agreement (Bethesda Hill Apartments) dated as of May 29, 2008, by and between WRIT and Wells Fargo Bank, National Association (33)

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.

(a)      Purchase and Sale Agreement dated as of June 16, 2008, for 2445 M Street, NW, Washington, DC (34)

Management Contracts, Plans and Arrangements.

 

 

(b)

1991 Incentive Stock Option Plan, as amended. (5)

 

  (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 WRIT 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 WRIT 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)

 

 

(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)

 

 

(aa)

Long Term Incentive Plan, effective January 1, 2006(36)

 

 

(bb)

Short Term Incentive Plan, effective January 1, 2006(36)

 

 

(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 (30)

 

 

(gg)

Deferred Compensation for Officers dated January 1, 2007 (30)

 

 

(hh)

Supplemental Executive Retirement Plan II dated May 23, 2007 (30)

 

56


Table of Contents
Index to Financial Statements
 

(ii)

Amended Long Term Incentive Plan, effective January 1, 2008 (32)

 

 

(kk)

Transition Agreement and General Release dated August 5, 2008 with Sara L. Grootwassink (35)

 

  (ll) Change in control Agreement dated October 7, 2008 with Thomas C. Morey

 

  (mm) Change in control Agreement dated November 11, 2008 with William T. Camp

 

  12. Computation of Ratio of Earnings to Fixed Charges

 

  21. Subsidiaries of Registrant

 

  23. Consents

 

  (a) Consent of Independent Registered Public Accounting Firm

 

  24. Power of attorney

 

  31. Rule 13a-14(a)/15(d)-14(a) Certifications

 

  (a) Certification – Chief Executive Officer

 

  (b) Certification – Executive 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 WRIT’s Form 8-K filed August 13, 1996.

 

(3)

Incorporated herein by reference to the Exhibit of the same designation to WRIT’s Form 8-K filed February 25, 1998.

(4)

Incorporated herein by reference to Exhibit 4 to WRIT’s Form 10-Q filed November 14, 2000.

 

(5)

Incorporated herein by reference to the Exhibit of the same designation to Amendment No. 2 to WRIT’s Registration Statement on Form S-3 filed July 17, 1995.

 

(6)

Incorporated herein by reference to Exhibits 4(a) and 4(b), respectively, to WRIT’s Registration Statement on Form S-8 filed on March 17, 1998.

 

(7)

Incorporated herein by reference to Exhibits of the same designation to WRIT’s Form 10-Q filed November 14, 2002.

 

(8)

Incorporated herein by reference to Exhibits 4(a) and 4(b), respectively, to WRIT’s Form 8-K filed March 17, 2003.

 

(9)

Incorporated herein by reference to Exhibits 4(a) and 4(b), respectively, to WRIT’s Form 8-K filed December 11, 2003.

 

(11)

Incorporated herein by reference to Exhibits 4.1, 4.2 and 4.3 to WRIT’s Form 8-K filed April 26, 2005

 

(13)

Incorporated herein by reference to Exhibit 4.1 and 4.2 to WRIT’s Form 8-K filed October 6, 2005

 

(16)

Incorporated herein by reference to Exhibits 4.1 and 4.2, respectively to WRIT’s Form 8-K filed June 6, 2006

 

(17)

Incorporated herein by reference to WRIT’s Form 424B5 filed September 11, 2006

 

(18)

Incorporated herein by reference to Exhibit 4.1 to WRIT’s Form 8-K filed September 26, 2006

 

(19)

Incorporated herein by reference to WRIT’s Form 424B5 filed July 21, 2006

 

(20)

Incorporated herein by reference to Exhibit 4.1 to WRIT’s Form 8-K filed November 8, 2006

 

(21)

Incorporated herein by reference to Exhibit 10 to WRIT’s Form 10-K filed March 16, 2006

 

(22)

Incorporated herein by reference to Exhibit 10 to WRIT’s Form 10-Q filed May 5, 2006

 

(23)

Incorporated herein by reference to Exhibit 10 to WRIT’s Form 10-Q filed August 8, 2006

 

(24)

Incorporated herein by reference to Exhibit 4.1 to WRIT’s Form 8-K filed January 23, 2007

 

(25)

Incorporated herein by reference to Exhibit 4.1 to WRIT’s Form 8-K filed February 2, 2007

 

(26)

Incorporated herein by reference to Appendix B to WRIT’s Form DEF 14A filed April 9, 2007

 

(27)

Incorporated herein by reference to Exhibit 4.1 to WRIT’s Form 8-K filed July 5, 2007

 

(28)

Incorporated herein by reference to Exhibit 4.1 to WRIT’s Form 8-K filed July 6, 2007

 

(29)

Incorporated herein by reference to Exhibit 10 to WRIT’s Form 10-Q filed August 9, 2007

 

(30)

Incorporated herein by reference to Exhibit 10 to WRIT’s Form 10-K filed February 29, 2008

 

(31)

Incorporated herein by reference to Exhibit 4.1 to WRIT’s Form 8-K filed February 27, 2008

 

(32)

Incorporated herein by reference to Exhibit 10 to WRIT’s Form 10-Q filed May 9, 2008

 

(33)

Incorporated herein by reference to Exhibit 4 to WRIT’s Form 10-Q filed August 8, 2008

 

(34)

Incorporated herein by reference to Exhibit 10 to WRIT’s Form 10-Q filed August 8, 2008

 

(35)

Incorporated herein by reference to Exhibit 10 to WRIT’s Form 10-Q filed November 10, 2008

 

(36)

Incorporated herein by reference to Exhibit 10 to WRIT’s Form 10-K filed March 1, 2007

 

57


Table of Contents
Index to Financial Statements

SIGNATURES

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: March 2, 2009     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   March 2, 2009

/s/ George F. McKenzie

George F. McKenzie

   President, Chief Executive Officer and Trustee   March 2, 2009

/s/ John M. Derrick, Jr.*

John M. Derrick, Jr.

   Trustee   March 2, 2009

/s/ John P. McDaniel*

John P. McDaniel

   Trustee   March 2, 2009

/s/ Charles T. Nason*

Charles T. Nason

   Trustee   March 2, 2009

/s/ Edward S. Civera*

Edward S. Civera

   Trustee   March 2, 2009

/s/ Thomas Edgie Russell, III*

Thomas Edgie Russell, III

   Trustee   March 2, 2009

/s/ Terence C. Golden*

Terence C. Golden

   Trustee   March 2, 2009

/s/ Wendelin A. White*

Wendelin A. White

   Trustee   March 2, 2009

/s/ Laura M. Franklin

Laura M. Franklin

   Executive Vice President Accounting, Administration and Corporate Secretary   March 2, 2009

/s/ Sara L. Grootwassink

Sara L. Grootwassink

   Executive Vice President and Chief Financial Officer   March 2, 2009

 

* By:   /s/ Laura M Franklin   through power of attorney
  Laura M Franklin  

 

58


Table of Contents
Index to Financial Statements

MANAGEMENT’S 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 Trust’s internal control system over financial reporting is a process designed under the supervision of the Trust’s 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 Trust’s annual consolidated financial statements, management has undertaken an assessment of the effectiveness of the Trust’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO Framework). Management’s assessment included an evaluation of the design of the Trust’s 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, 2008, the Trust’s internal control over financial reporting was effective at a reasonable assurance level 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 Trust’s consolidated financial statements included in this report, have issued an unqualified opinion on the effectiveness of the Trust’s internal control over financial reporting, a copy of which appears on the next page of this annual report.

 

59


Table of Contents
Index to Financial Statements

Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting

The Board of Trustees and Shareholders of

Washington Real Estate Investment Trust

We have audited Washington Real Estate Investment Trust and Subsidiaries’ internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Washington Real Estate Investment Trust’s 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 Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s 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 company’s 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 company’s 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 company’s 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, Washington Real Estate Investment Trust and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, 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, 2008 and 2007 and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008 of Washington Real Estate Investment Trust and Subsidiaries and our report dated February 27, 2009 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

McLean, Virginia

February 27, 2009

 

60


Table of Contents
Index to Financial Statements

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, 2008 and 2007, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008. Our audits also included the financial statement schedule listed in the Index at Item 15(A). These financial statements are the responsibility of the Company’s 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, 2008 and 2007, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles.

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, 2008, 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, 2009 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

McLean, Virginia

February 27, 2009

 

61


Table of Contents
Index to Financial Statements

WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

AS OF DECEMBER 31, 2008 AND 2007

(IN THOUSANDS, EXCEPT PER SHARE DATA)

 

     2008     2007  

Assets

    

Land

   $ 416,576     $ 325,490  

Income producing property

     1,868,500       1,621,679  
                
     2,285,076       1,947,169  

Accumulated depreciation and amortization

     (401,539 )     (327,759 )
                

Net income producing property

     1,883,537       1,619,410  

Development in progress

     23,630       98,321  
                

Total real estate held for investment, net

     1,907,167       1,717,731  

Investment in real estate sold or held for sale, net

     12,526       36,562  

Cash and cash equivalents

     11,874       21,485  

Restricted cash

     18,823       6,030  

Rents and other receivables, net of allowance for doubtful accounts of $6,308 and $4,196, respectively

     45,439       36,548  

Prepaid expenses and other assets

     115,401       78,394  

Other assets related to properties sold or held for sale

     161       1,576  
                

Total assets

   $ 2,111,391     $ 1,898,326  
                

Liabilities

    

Notes payable

   $ 902,900     $ 879,123  

Mortgage notes payable

     421,286       252,484  

Lines of credit

     67,000       192,500  

Accounts payable and other liabilities

     70,575       63,327  

Advance rents

     9,016       9,537  

Tenant security deposits

     10,298       10,419  

Other liabilities related to properties sold or held for sale

     128       616  
                

Total liabilities

     1,481,203