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2: EX-10.1 Material Contract HTML 663K
3: EX-31.1 Certification -- §302 - SOA'02 HTML 32K
4: EX-31.2 Certification -- §302 - SOA'02 HTML 32K
5: EX-31.3 Certification -- §302 - SOA'02 HTML 32K
6: EX-31.4 Certification -- §302 - SOA'02 HTML 32K
7: EX-32.1 Certification -- §906 - SOA'02 HTML 31K
14: R1 Cover Page HTML 83K
15: R2 Consolidated Balance Sheets (Unaudited) HTML 115K
16: R3 Consolidated Statements of Income (Unaudited) HTML 96K
17: R4 Consolidated Statements of Comprehensive Income HTML 68K
(Unaudited)
18: R5 Consolidated Statement of Changes in Stockholders' HTML 159K
Equity and Noncontrolling Interests (Unaudited)
19: R6 Consolidated Statements of Cash Flows (Unaudited) HTML 168K
20: R7 Organization and basis of presentation HTML 30K
21: R8 Summary of significant accounting policies HTML 164K
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23: R10 Consolidated and unconsolidated real estate joint HTML 160K
ventures
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31: R18 Accounts payable, accrued expenses, and tenant HTML 45K
security deposits
32: R19 Earnings per share HTML 72K
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34: R21 Noncontrolling interests HTML 30K
35: R22 Assets classified as held for sale HTML 36K
36: R23 Subsequent Event (Notes) HTML 30K
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38: R25 Summary of significant accounting policies HTML 218K
(Policies)
39: R26 Summary of significant accounting policies HTML 54K
(Tables)
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ventures (Tables)
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(Tables)
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51: R38 Stockholders' equity (Tables) HTML 69K
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54: R41 Summary of significant accounting policies HTML 95K
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55: R42 Schedule of investment in real estates (Details) HTML 49K
56: R43 Acquisition (Details) HTML 98K
57: R44 Real estate asset sales (Details) HTML 41K
58: R45 Consolidated and unconsolidated real estate joint HTML 55K
ventures (Details)
59: R46 Consolidated VIE's balance sheet information HTML 64K
(Details)
60: R47 Unconsolidated real estate joint ventures HTML 87K
(Details)
61: R48 Lessor (Details) HTML 120K
62: R49 Lessee (Details) HTML 82K
63: R50 Cash, cash equivalents, and restricted cash HTML 45K
(Details)
64: R51 Summary of Investments (Details) HTML 71K
65: R52 Investment Income (Details) HTML 54K
66: R53 Other assets (Detail) HTML 59K
67: R54 Assets and Liabilities on Recurring Basis HTML 55K
(Details)
68: R55 Book and Fair Values (Details) HTML 58K
69: R56 Summary of secured and unsecured debt (Details) HTML 56K
70: R57 Detail of secured and unsecured debt (Details) HTML 197K
71: R58 Unsecured senior notes payable (Details) HTML 101K
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secured notes payable (Details)
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Income (Details)
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(Exact
name of registrant as specified in its charter)
iMaryland
i95-4502084
(State
or other jurisdiction of
incorporation or organization)
(I.R.S. Employer Identification Number)
i385 East Colorado Boulevard, Suite 299, iPasadena,
iCaliforniai91101
(Address of principal executive offices) (Zip code)
(i626)
i578-0777
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Exchange Act:
Title
of each class
Trading Symbol(s)
Name of each exchange on which registered
iCommon Stock, $0.01 par value per share
iARE
iNew
York Stock Exchange
i7.00% Series D Cumulative Convertible Preferred Stock
iARE/PD
iNew
York Stock Exchange
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 for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. iYes☒
No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
iYes☒ No
☐
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 the definitions of “large accelerated filer,”“accelerated filer,”“smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
iLarge
accelerated filer
☒
Accelerated filer
☐
Non-accelerated filer
☐
Smaller reporting company
i☐
Emerging
growth company
i☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes i☐ No ☒
As of July 15, 2019, i113,417,511
shares of common stock, par value $0.01 per share, were outstanding.
Reclassification
of cumulative net unrealized gains on non-real estate investments upon adoption of new financial instruments standard on January 1, 2018
—
—
—
—
i140,521
(i49,771
)
—
i90,750
—
Redemption
of noncontrolling interests
—
—
—
—
—
—
—
—
(i1,397
)
Distributions
to noncontrolling interests
—
—
—
—
—
—
(i18,018
)
(i18,018
)
(i426
)
Contributions
from noncontrolling interests
—
—
—
i257
—
—
i13,557
i13,814
i750
Issuance
of common stock
—
i3,299,637
i33
i400,174
—
—
—
i400,207
—
Issuance
pursuant to stock plan
—
i262,794
i2
i24,132
—
—
—
i24,134
—
Dividends
declared on common stock ($1.83 per share)
—
—
—
—
(i189,571
)
—
—
(i189,571
)
—
Dividends
declared on preferred stock ($0.875 per share)
—
—
—
—
(i2,604
)
—
—
(i2,604
)
—
Reclassification
of distributions in excess of earnings
Repayments
of borrowings from secured notes payable
(i302,878
)
(i3,162
)
Proceeds
from issuance of unsecured senior notes payable
i854,209
i899,321
Borrowings
from unsecured senior line of credit
i2,114,000
i2,469,000
Repayments
of borrowings from unsecured senior line of credit
(i1,808,000
)
(i2,519,000
)
Payment
of loan fees
(i15,796
)
(i8,003
)
Taxes
paid related to net settlement of equity awards
(i4,086
)
i—
Repurchase
of 7.00% Series D cumulative convertible preferred stock
(i9,240
)
i—
Proceeds
from issuance of common stock
i85,394
i400,207
Dividends
on common stock
(i218,914
)
(i183,040
)
Dividends
on preferred stock
(i2,132
)
(i2,604
)
Contributions
from and sales of noncontrolling interests
i441,251
i14,564
Distributions
to and purchases of noncontrolling interests
(i24,590
)
(i19,841
)
Net
cash provided by financing activities
i1,109,218
i1,056,486
Effect
of foreign exchange rate changes on cash and cash equivalents
i774
(i1,173
)
Net
(decrease) increase in cash, cash equivalents, and restricted cash
(i33,905
)
i44,655
Cash,
cash equivalents, and restricted cash as of the beginning of period
i272,130
i277,186
Cash,
cash equivalents, and restricted cash as of the end of period
$
i238,225
$
i321,841
Supplemental
Disclosures and Non-Cash Investing and Financing Activities:
Cash paid during the period for interest, net of interest capitalized
$
i71,338
$
i68,885
Change
in accrued construction
$
i5,558
$
i48,074
Accrued
construction for current-period additions to real estate
$
i181,922
$
i183,573
Assumption
of secured notes payable in connection with purchase of properties
$
(i28,200
)
$
i—
Right-of-use
asset
$
i239,653
$
i—
Lease
liability
$
(i245,638
)
$
i—
The
accompanying notes are an integral part of these consolidated financial statements.
9
Alexandria Real Estate Equities, Inc.
Notes to Consolidated Financial Statements
(Unaudited)
1.
i
Organization
and basis of presentation
Alexandria Real Estate Equities, Inc. (NYSE:ARE), an S&P 500® urban office REIT, is the first and longest-tenured owner, operator, and developer uniquely focused on collaborative life science, technology, and agtech campuses in AAA innovation cluster locations. As used in this quarterly report on Form 10‑Q, references to the “Company,”“Alexandria,”“ARE,”“we,”“us,” and “our” refer to Alexandria Real Estate Equities, Inc. and its consolidated subsidiaries. The accompanying unaudited consolidated financial statements include the accounts of Alexandria Real Estate Equities,
Inc. and its consolidated subsidiaries. All significant intercompany balances and transactions have been eliminated.
We have prepared the accompanying interim consolidated financial statements in accordance with GAAP and in conformity with the rules and regulations of the SEC. In our opinion, the interim consolidated financial statements presented herein reflect all adjustments, of a normal recurring nature, that are necessary to fairly present the interim consolidated financial statements. The results of operations for the interim period are not necessarily indicative of the results that may be expected for the year ending December 31, 2019. These unaudited consolidated financial statements
should be read in conjunction with the audited consolidated financial statements and the notes thereto included in our annual report on Form 10‑K for the year ended December 31, 2018. Any references to our market capitalization, number or quality of buildings or tenants, quality of location, square footage, number of leases, or occupancy percentage, and any amounts derived from these values in these notes to consolidated financial statements, are outside the scope of our independent registered public accounting firm’s review.
2.
i
Summary
of significant accounting policies
i
Reclassifications
Certain prior-period amounts have been reclassified to conform to current-period presentation. Refer to the “Lease Accounting” section within this Note 2 – “Summary of Significant Accounting Policies.”
i
Consolidation
On
an ongoing basis, as circumstances indicate the need for reconsideration, we evaluate each legal entity that is not wholly owned by us in accordance with the consolidation guidance. Our evaluation considers all of our variable interests, including equity ownership, as well as fees paid to us for our involvement in the management of each partially owned entity. To fall within the scope of the consolidation guidance, an entity must meet both of the following criteria:
•
The entity has a legal structure that has been established to conduct business activities and to hold assets; such entity can be in the form of a partnership, limited liability company, or corporation, among others; and
•
We
have a variable interest in the legal entity – i.e., variable interests that are contractual, such as equity ownership, or other financial interests that change with changes in the fair value of the entity’s net assets.
If an entity does not meet both criteria above, we apply other accounting literature, such as the cost or equity method of accounting. If an entity does meet both criteria above, we evaluate such entity for consolidation under either the variable interest model if the legal entity meets any of the following characteristics to qualify as a VIE, or under the voting model for all other legal entities that are not VIEs.
A legal entity is determined to be a VIE if it has any of the following three characteristics:
1)
The
entity does not have sufficient equity to finance its activities without additional subordinated financial support;
2)
The entity is established with non-substantive voting rights (i.e., where the entity deprives the majority economic interest holder(s) of voting rights); or
3)
The equity holders, as a group, lack the characteristics of a controlling financial interest. Equity holders meet this criterion if they lack any of the following:
•
The
power, through voting rights or similar rights, to direct the activities of the entity that most significantly influence the entity’s economic performance, as evidenced by:
•
Substantive participating rights in day-to-day management of the entity’s activities; or
•
Substantive kick-out rights over the party responsible for significant decisions;
•
The
obligation to absorb the entity’s expected losses; or
•
The right to receive the entity’s expected residual returns.
10
2.
Summary of significant accounting policies (continued)
Once
we consider the sufficiency of equity and voting rights of each legal entity, we then evaluate the characteristics of the equity holders’ interests, as a group, to see if they qualify as controlling financial interests. Our real estate joint ventures consist of limited partnerships or limited liability companies. For an entity structured as a limited partnership or a limited liability company, our evaluation of whether the equity holders (equity partners other than us in each of our joint ventures) lack the characteristics of a controlling financial interest includes the evaluation of whether the limited partners or non-managing members (the noncontrolling equity holders) lack both substantive participating rights and substantive kick-out rights, defined as follows:
•
Participating
rights provide the noncontrolling equity holders the ability to direct significant financial and operating decisions made in the ordinary course of business that most significantly influence the entity’s economic performance.
•
Kick-out rights allow the noncontrolling equity holders to remove the general partner or managing member without cause.
If we conclude that any of the three characteristics of a VIE are met, including that the equity holders lack the characteristics of a controlling financial interest because they lack both substantive participating rights and substantive kick-out rights, we conclude that the entity is a VIE and
evaluate it for consolidation under the variable interest model.
Variable interest model
If an entity is determined to be a VIE, we evaluate whether we are the primary beneficiary. The primary beneficiary analysis is a qualitative analysis based on power and benefits. We consolidate a VIE if we have both power and benefits – that is, (i) we have the power to direct the activities of a VIE that most significantly influence the VIE’s economic performance (power), and (ii) we have the obligation to absorb losses of or the right to receive benefits from the VIE that could potentially be significant to the VIE (benefits). We consolidate VIEs whenever we determine that we are the primary beneficiary. Refer to Note 4 – “Consolidated and Unconsolidated Real Estate Joint Ventures” to these
unaudited consolidated financial statements for information on specific joint ventures that qualify as VIEs. If we have a variable interest in a VIE but are not the primary beneficiary, we account for our investment using the equity method of accounting.
Voting model
If a legal entity fails to meet any of the three characteristics of a VIE (due to insufficiency of equity, existence of non-substantive voting rights, or lack of a controlling financial interest), we then evaluate such entity under the voting model. Under the voting model, we consolidate the entity if we determine that we, directly or indirectly, have greater than 50% of the voting shares and that other equity holders do not have substantive participating rights. Refer to Note 4 – “Consolidated and Unconsolidated Real
Estate Joint Ventures” to these unaudited consolidated financial statements for further information on our unconsolidated real estate joint ventures that qualify for evaluation under the voting model.
i
Use of estimates
The preparation of consolidated financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, and equity; the
disclosure of contingent assets and liabilities as of the date of the consolidated financial statements; and the amounts of revenues and expenses during the reporting period. Actual results could materially differ from those estimates.
i
Investments
in real estate
Evaluation of business combination or asset acquisition
We evaluate each acquisition of real estate or in-substance real estate (including equity interests in entities that predominantly hold real estate assets) to determine whether the integrated set of assets and activities acquired meets the definition of a business and needs to be accounted for as a business combination. An acquisition of an integrated set of assets and activities that does not meet the definition of a business is accounted for as an asset acquisition. If either of the following criteria is met, the integrated set of assets and activities acquired would not qualify as a business:
•
Substantially
all of the fair value of the gross assets acquired is concentrated in either a single identifiable asset or a group of similar identifiable assets; or
•
The integrated set of assets and activities is lacking, at a minimum, an input and a substantive process that together significantly contribute to the ability to create outputs (i.e., revenue generated before and after the transaction).
An acquired process is considered substantive if:
•
The
process includes an organized workforce (or includes an acquired contract that provides access to an organized workforce) that is skilled, knowledgeable, and experienced in performing the process;
•
The process cannot be replaced without significant cost, effort, or delay; or
•
The process is considered unique or scarce.
11
2.
Summary
of significant accounting policies (continued)
Generally, we expect that acquisitions of real estate or in-substance real estate will not meet the definition of a business because substantially all of the fair value is concentrated in a single identifiable asset or group of similar identifiable assets (i.e., land, buildings, and related intangible assets) or because the acquisition does not include a substantive process in the form of an acquired workforce or an acquired contract that cannot be replaced without significant cost, effort, or delay. When evaluating acquired service or management contracts, we consider
the nature of the services performed, the terms of the contract relative to similar arm’s-length contracts, and the availability of comparable vendors in evaluating whether the acquired contract constitutes a substantive process.
Recognition of real estate acquired
We evaluate each acquisition of real estate or in-substance real estate (including equity interests in entities that predominantly hold real estate assets) to determine whether the integrated set of assets and activities acquired
meets the definition of a business and needs to be accounted for as a business combination. An acquisition of an integrated set of assets and activities that does not meet the definition of a business is accounted for as an asset acquisition.
For acquisitions of real estate or in-substance real estate that are accounted for as business combinations, we allocate the acquisition consideration (excluding acquisition costs) to the assets acquired, liabilities assumed, noncontrolling interests, and previously existing ownership interests at fair value as of the acquisition date. Assets include intangible assets such as tenant relationships, acquired in-place leases, and favorable intangibles associated with in-place leases in which we are the lessor. Liabilities include unfavorable intangibles associated with in-place leases in which we are the lessor. In addition, for acquired in-place
operating leases in which we are the lessee, acquisition consideration is allocated to lease liabilities and related right-of-use assets, adjusted to reflect favorable or unfavorable terms of the lease when compared with market terms. Any excess (deficit) of the consideration transferred relative to the fair value of the net assets acquired is accounted for as goodwill (bargain purchase gain). Acquisition costs related to business combinations are expensed as incurred.
Generally, we expect that acquisitions of real estate or in-substance real estate will not meet the definition of a business because substantially all of the fair value is concentrated in a single identifiable asset or group of similar identifiable assets (i.e., land, buildings, and related intangible assets). The accounting model for asset acquisitions is similar to the accounting model for business combinations,
except that the acquisition consideration (including acquisition costs) is allocated to the individual assets acquired and liabilities assumed on a relative fair value basis. Any excess (deficit) of the consideration transferred relative to the sum of the fair value of the assets acquired and liabilities assumed is allocated to the individual assets and liabilities based on their relative fair values. As a result, asset acquisitions do not result in the recognition of goodwill or a bargain purchase gain. Incremental and external direct acquisition costs (such as legal and third-party services) are capitalized.
We exercise judgment to determine the key assumptions used to allocate the purchase price of real estate acquired among its components. The allocation of the consideration to the various components of properties acquired during the year can have an effect on our net income
due to the differing depreciable and amortizable lives of each component and the recognition of the related depreciation and amortization expense in our consolidated statements of income. We apply judgment in utilizing available comparable market information to assess relative fair value. We assess the relative fair values of tangible and intangible assets based on numerous factors, including estimated cash flow projections that utilize appropriate discount and capitalization rates and available comparable market information. Estimates of future cash flows are based on a number of factors, including the historical operating results, known and anticipated trends, and market/economic conditions that may affect the property.
The value of tangible assets acquired is based upon our estimation of fair value on an “as if vacant” basis. The value of acquired in-place leases includes
the estimated costs during the hypothetical lease-up period and other costs that would have been incurred in the execution of similar leases under the market conditions at the acquisition date of the acquired in-place lease. If there is a bargain fixed-rate renewal option for the period beyond the non-cancelable lease term of an in-place lease, we evaluate intangible factors such as the business conditions in the industry in which the lessee operates, the economic conditions in the area in which the property is located, and the ability of the lessee to sublease the property during the renewal term, in order to determine the likelihood that the lessee will renew. When we determine there is reasonable assurance that such bargain purchase option will be exercised, we consider the option in determining the intangible value of such lease and its related amortization period. We also recognize the relative fair values of assets acquired, the liabilities assumed, and any noncontrolling
interest in acquisitions of less than a 100% interest when the acquisition constitutes a change in control of the acquired entity.
The values allocated to buildings and building improvements, land improvements, tenant improvements, and equipment are depreciated on a straight-line basis using the shorter of the respective ground lease term, estimated useful life, or up to i40 years, for
buildings and building improvements, estimated life, or up to i20 years, for land improvements, the respective lease term or estimated useful life for tenant improvements, and the shorter of the lease term or estimated useful life for equipment. The values of acquired in-place leases are classified in other assets in the accompanying consolidated balance sheets and amortized over the remaining terms of the related leases.
12
2.
Summary
of significant accounting policies (continued)
Capitalized project costs
We capitalize project costs, including pre-construction costs, interest, property taxes, insurance, and other costs directly related and essential to the development, redevelopment, pre-construction, or construction of a project. Capitalization of development, redevelopment, pre-construction, and construction costs is required while activities are ongoing to prepare an asset for its intended use. Fluctuations in our development, redevelopment, pre-construction, and construction activities could result in significant changes to total expenses and net income. Costs incurred after a project is substantially complete and ready for its intended use are expensed as incurred. Should
development, redevelopment, pre-construction, or construction activity cease, interest, property taxes, insurance, and certain other costs would no longer be eligible for capitalization and would be expensed as incurred. Expenditures for repairs and maintenance are expensed as incurred.
Real estate sales
A property is classified as held for sale when all of the following criteria for a plan of sale have been met: (i) management, having the authority to approve the action, commits to a plan to sell the property; (ii) the property is available for immediate sale in its present condition, subject only to terms that are usual and customary; (iii) an active program to locate a buyer and other actions required to complete the plan to sell have been initiated; (iv) the sale of the property
is probable and is expected to be completed within ione year; (v) the property is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and (vi) actions necessary to complete the plan of sale indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. Depreciation of assets ceases upon designation of a property as held for sale.
If the disposal of a property represents a strategic shift that has (or
will have) a major effect on our operations or financial results, such as (i) a major line of business, (ii) a major geographic area, (iii) a major equity method investment, or (iv) other major parts of an entity, then the operations of the property, including any interest expense directly attributable to it, are classified as discontinued operations in our consolidated statements of income, and amounts for all prior periods presented are reclassified from continuing operations to discontinued operations. The disposal of an individual property generally will not represent a strategic shift and therefore will typically not meet the criteria for classification as a discontinued operation.
We recognize gains/losses on real estate sales in accordance with the accounting standard on the derecognition of nonfinancial assets arising from contracts
with noncustomers. Our ordinary output activities consist of the leasing of space to our tenants in our operating properties, not the sales of real estate. Therefore, sales of real estate (in which we are the seller) qualify as contracts with noncustomers. In our transactions with noncustomers, we apply certain recognition and measurement principles consistent with our method of recognizing revenue arising from contracts with customers. Derecognition of the asset is based on the transfer of control. If a real estate sales contract includes our ongoing involvement with the property, then we evaluate each promised good or service under the contract
to determine whether it represents a separate performance obligation, constitutes a guarantee, or prevents the transfer of control. If a good or service is considered a separate performance obligation, an allocated portion of the transaction price is recognized as revenue as we transfer the related good or service to the buyer.
The recognition of gain or loss on the sale of a partial interest also depends on whether we retain a controlling or noncontrolling interest. If we retain a controlling interest upon completion of the sale, we continue to reflect the asset at its book value, record a noncontrolling interest for the book value of the partial interest sold, and recognize additional paid-in capital for the difference between the consideration received and the partial interest at book value. Conversely, if we retain a noncontrolling interest upon completion
of the partial sale of real estate, we would recognize a gain or loss as if 100% of the real estate were sold.
i
Impairment of long-lived assets
Prior to and subsequent to the end of each quarter, we review current activities and changes in the business conditions
of all of our long-lived assets to determine the existence of any triggering events or impairment indicators requiring an impairment analysis. If triggering events or impairment indicators are identified, we review an estimate of the future undiscounted cash flows, including, if necessary, a probability-weighted approach if multiple outcomes are under consideration.
Long-lived assets to be held and used, including our rental properties, CIP, land held for development, right-of-use assets related to operating leases in which we are the lessee, and intangibles, are individually evaluated for impairment when conditions exist that may indicate that the carrying amount of a long-lived asset may not be recoverable. The carrying amount of a long-lived asset to be held and used is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and
eventual disposition of the asset. Triggering events or impairment indicators for long-lived assets to be held and used are assessed by project and include significant fluctuations in estimated net operating income, occupancy changes, significant near-term lease expirations, current and historical operating and/or cash flow losses, construction costs, estimated completion dates, rental rates, and other market factors. We assess the expected undiscounted cash flows based upon numerous factors, including, but not limited to, construction costs, available market information, current and historical operating results, known trends, current market/economic conditions that may affect the asset, and our assumptions about the use of the asset, including, if necessary, a probability-weighted approach if multiple outcomes are under consideration.
13
2.
Summary
of significant accounting policies (continued)
Upon determination that an impairment has occurred, a write-down is recognized to reduce the carrying amount to its estimated fair value. If an impairment loss is not required to be recognized, the recognition of depreciation or amortization is adjusted prospectively, as necessary, to reduce the carrying amount of the real estate to its estimated disposition value over the remaining period that the asset is expected to be held and used. We may adjust depreciation of properties that are expected to be disposed of or redeveloped prior to the end of their useful lives.
We use the held for sale impairment model for our properties classified as held for sale. The held for sale impairment model is different
from the held and used impairment model. Under the held for sale impairment model, an impairment loss is recognized if the carrying amount of the long-lived asset classified as held for sale exceeds its fair value less cost to sell. Because of these two different models, it is possible for a long-lived asset previously classified as held and used to require the recognition of an impairment charge upon classification as held for sale.
i
International
operations
In addition to operating properties in the U.S., we have ithree operating properties in Canada and ione
operating property in China. The functional currency for our subsidiaries operating in the U.S. is the U.S. dollar. The functional currencies for our foreign subsidiaries are the local currencies in each respective country. The assets and liabilities of our foreign subsidiaries are translated into U.S. dollars at the exchange rate in effect as of the financial statement date. Income statement accounts of our foreign subsidiaries are translated using the weighted-average exchange rate for the periods presented. Gains or losses resulting from the translation are classified in accumulated other comprehensive
income as a separate component of total equity and are excluded from net income.
Whenever a foreign investment meets the criteria for classification as held for sale, we evaluate the recoverability of the investment under the held for sale impairment model. We may recognize an impairment charge if the carrying amount of the investment exceeds its fair value less cost to sell. In determining an investment’s carrying amount, we consider its net book value and any cumulative unrealized foreign currency translation adjustment related to the investment.
The appropriate amounts of foreign exchange rate gains or losses classified in accumulated other comprehensive income are reclassified to net income when realized upon the sale of our investment or upon the complete or substantially complete
liquidation of our investment.
/
i
Investments
We hold investments in publicly traded companies and privately held entities primarily involved in the life science
and technology industries. As a REIT, we generally limit our ownership percentage in the voting stock of each individual entity to less than i10%.
Our equity investments (except those accounted for under the equity method and those that result in consolidation of the investee) are measured as follows:
•
Investments
in publicly traded companies are classified as investments with readily determinable fair values. These investments are carried at fair value, with changes in fair value recognized in net income. The fair values for our investments in publicly traded companies are determined based on sales prices/quotes available on securities exchanges.
•
Investments in privately held entities without readily determinable fair values fall into two categories:
•
Investments in privately held entities that report NAV per share, such as our
privately held investments in limited partnerships, are carried at fair value using NAV as a practical expedient with changes in fair value recognized in net income. We use NAV per share reported by limited partnerships without adjustment, unless we are aware of information indicating that the NAV per share reported by a limited partnership does not accurately reflect the fair value of the investment at our reporting date. We disclose the timing of liquidation of an investee’s assets and the date when redemption restrictions will lapse (or indicate if this timing is unknown) if the investee has communicated this information to us or has announced it publicly.
•
Investments in privately held entities that do not report NAV per share are accounted
for using a measurement alternative that measures these investments at cost, adjusted for observable price changes and impairments, with changes recognized in net income.
For investments in privately held entities that do not report NAV per share, an observable price is a price observed in an orderly transaction for an identical or similar investment of the same issuer. Observable price changes result from, among other things, equity transactions for the same issuer executed during the reporting period, including subsequent equity offerings or other reported equity transactions related to the same issuer. For these transactions to be considered observable price changes of the same issuer, we evaluate whether these transactions have similar rights and obligations, including voting rights, distribution preferences, conversion rights, and other factors, to the
investments we hold.
/
14
2.
Summary of significant accounting policies (continued)
We monitor investments in privately held entities that do not report NAV per share throughout the year for new developments, including operating results, prospects and results
of clinical trials, new product initiatives, new collaborative agreements, capital-raising events, and merger and acquisition activities. These investments are evaluated on the basis of a qualitative assessment for indicators of impairment by monitoring the presence of the following triggering events or impairment indicators: (i) a significant deterioration in the earnings performance, asset quality, or business prospects of the investee; (ii) a significant adverse change in the regulatory, economic, or technological environment of the investee, (iii) a significant adverse change in the general market condition, including the research and development of technology and products that the investee is bringing or attempting to bring to the market, or (iv) significant concerns about the investee’s ability to continue as a going concern. If such indicators are present, we are required to estimate the investment’s fair value and immediately recognize an impairment loss in an
amount equal to the investment’s carrying value in excess of its estimated fair value.
Investments in privately held entities are accounted for under the equity method, unless our interest in the entity is deemed to be so minor that we have virtually no influence over the entity’s operating and financial policies. Under the equity method of accounting, we initially recognize our investment at cost and adjust the carrying amount of the investment to recognize our share of the earnings or losses of the investee subsequent to the date of our investment. We had no investments accounted for under the equity method as of June 30, 2019.
We recognize both realized and unrealized gains and losses in
our consolidated statements of income, classified within investment income. Unrealized gains and losses represent changes in fair value for investments in publicly traded companies, changes in NAV, as a practical expedient to estimate fair value, for investments in privately held entities that report NAV per share, and observable price changes on our investments in privately held entities that do not report NAV per share. Impairments are realized losses, which result in an adjusted cost, and represent charges to reduce the carrying values of investments in privately held entities that do not report NAV per share to their estimated fair value. Realized gains and losses represent the difference between proceeds received upon disposition of investments and their historical or adjusted cost.
i
Revenues
i
The
table below provides detail of our consolidated total revenues for the three and six months ended June 30, 2019 (in thousands):
Revenues subject to the new lease accounting standard:
Operating
leases
$
i358,461
$
i701,802
Direct
financing lease
i604
i1,205
Revenues
subject to the new lease accounting standard
i359,065
i703,007
Revenues
subject to the revenue recognition accounting standard
i12,553
i23,360
Income
from rentals
i371,618
i726,367
Other
income
i2,238
i6,331
Total
revenues
$
i373,856
$
i732,698
/
During
the three and six months ended June 30, 2019, revenues that were subject to the new lease accounting standard aggregated $i359.1 million and $i703.0
million, respectively, and represented i96.0% and i95.9%, respectively, of our total revenues.
During
the three and six months ended June 30, 2019, our total revenues also included $i14.8 million, or i4.0%,
and $i29.7 million, or i4.1%,
respectively, subject to other accounting guidance. For a detailed discussion related to our revenue streams, refer to the “Lease Accounting” and “Recognition of Revenue Arising From Contracts With Customers” sections within this Note 2 – “Summary of Significant Accounting Policies.”
/
15
2.
Summary
of significant accounting policies (continued)
i
Lease accounting
Transition
On January 1, 2019, we adopted a new lease accounting standard that sets out the principles for the recognition, measurement, presentation, and disclosure of leases for both parties to a lease agreement (i.e., lessees and lessors).
The new lease accounting standard requires the use of the modified retrospective transition method. Upon adoption of the new lease accounting standard, we elected the following practical expedients and accounting policies provided by this lease standard:
•
Package of practical expedients – requires us not to reevaluate our existing or expired leases as of January 1, 2019, under the new lease accounting standard.
•
Optional transition method practical expedient – requires us to apply the new
lease accounting standard prospectively from the adoption date of January 1, 2019.
•
Single component accounting policy – requires us to account for lease and nonlease components within a lease under the new lease accounting standard if certain criteria are met.
•
Land easements practical expedient – requires us to continue to account for land easements existing as of January 1, 2019, under the accounting standards applied
to them prior to January 1, 2019.
•
Short-term lease accounting policy – requires us not to record the related lease liabilities and right-of-use assets for operating leases in which we are the lessee with a term of 12 months or less.
Upon adoption of the new lease accounting standard, we elected the package of practical expedients and the optional transition method, which permitted January 1, 2019 to be our initial application date. Our election of the package of practical expedients and the optional transition method allowed us not to
reassess:
•
Whether any contracts effective prior to January 1, 2019, are leases or contain leases. This practical expedient is primarily applicable to entities that have contracts containing embedded leases. As of December 31, 2018, we had no such contracts; therefore, this practical expedient had no effect on us.
•
The
lease classification for any leases that commenced prior to January 1, 2019. Our election of the package of practical expedients requires us not to revisit the classification of our leases that commenced prior to January 1, 2019. For example, all of our leases that were classified as operating leases in accordance with the lease accounting standards in effect prior to January 1, 2019, continue to be classified as operating leases after adoption of the new lease accounting standard.
•
Previously capitalized initial direct costs for any leases that commenced prior to January 1,
2019. Our election of the package of practical expedients and the optional transition method requires us not to reassess whether initial direct leasing costs capitalized prior to the adoption of the new lease accounting standard in connection with the leases that commenced prior to January 1, 2019, qualify for capitalization under the new lease accounting standard.
We applied the package of practical expedients consistently to all leases (i.e., in which we are the lessee or the lessor) that commenced before January 1, 2019. The election of this package permits us to “run off” our leases that commenced before January 1, 2019, for the remainder of their lease terms and to apply
the new lease accounting standard to leases commencing or modified after January 1, 2019.
For our leases that had commenced prior to January 1, 2019, under the package of practical expedients and optional transition method we are not required to reassess whether initial direct leasing costs capitalized prior to the adoption of the new lease accounting standard in connection with such leases qualified for capitalization under the new lease accounting standard. Therefore, we continue to amortize these initial direct leasing costs over their respective lease terms.
On January 1, 2019, as required by the new lease accounting standard, we recognized
a cumulative adjustment to retained earnings aggregating $i3.5 million to write off initial direct leasing costs that were capitalized in connection with leases that were executed but had not commenced before January 1, 2019. These costs were capitalized in accordance with the lease accounting standards existing prior to January 1, 2019, and would not qualify for capitalization under the
new lease accounting standard.
/
16
2.
Summary of significant accounting policies (continued)
Under the package of practical expedients that we elected upon adoption of the new lease accounting standard, all of
our operating leases existing as of January 1, 2019, for which we are the lessee, continue to be classified as operating leases subsequent to the adoption of the new lease accounting standard. In accordance with the new lease accounting standard, we were required to classify in our consolidated balance sheets the present value of remaining future rental payments aggregating $i590.3 million related to ground and office leases in which we are the lessee existing as of January
1, 2019. Consequently, on January 1, 2019, we recognized a lease liability aggregating $i218.7 million classified within accounts payable, accrued expenses, and tenant security deposits in our consolidated balance sheets, which included approximately $i27.0 million
reclassified out of the deferred rent liabilities balance in accordance with the new lease standard. We have also recognized a corresponding right-of-use asset, which was classified within other assets in our consolidated balance sheets. The present value of the remaining lease payments was calculated for each operating lease existing as of January 1, 2019, in which we were the lessee by using each respective remaining lease term and a corresponding estimated incremental borrowing rate. The incremental borrowing rate is the interest rate that we estimated we would have to pay to borrow on a collateralized basis over a similar term for an amount equal to the lease payments.
Subsequent application of the new lease accounting guidance
Definition
of a lease
Effective January 1, 2019, when we enter into a contract or amend an existing contract, we evaluate whether the contract meets the definition of a lease. To meet the definition of a lease, the contract must meet all three criteria:
(i)
One
party (lessor) must hold an identified asset,
(ii)
The counterparty (lessee) must have the right to obtain substantially all of the economic benefits from the use of the asset throughout the period of the contract, and
(iii)
The counterparty (lessee) must have the right to direct the use of the identified asset throughout the period of the contract.
Lease classification
The new lease accounting standard also sets new criteria for determining the classification of finance leases for lessees and sales-type leases for lessors. The criteria to determine whether a lease should be accounted for as a finance/sales-type lease include any of the following:
(i)
Ownership is transferred from lessor to lessee by the end of the lease term,
(ii)
An
option to purchase is reasonably certain to be exercised,
(iii)
The lease term is for the major part of the underlying asset’s remaining economic life,
(iv)
The present value of lease payments equals or exceeds substantially all of the fair value of the underlying asset, or
(v)
The underlying
asset is specialized and is expected to have no alternative use at the end of the lease term.
If any of these criteria is met, a lease is classified as a finance lease by the lessee and as a sales-type lease by the lessor. If none of the criteria are met, a lease is classified as an operating lease by the lessee but may still qualify as a direct financing lease or an operating lease for the lessor. The existence of a residual value guarantee from an unrelated third party other than the lessee may qualify the lease as a direct financing lease by the lessor. Otherwise, the lease is classified as an operating lease by the lessor. Therefore, under the new lease accounting standard, lessees apply a dual approach by classifying leases as either finance or operating leases based on the principle of whether the lease is effectively a financed purchase of the leased
asset by the lessee. This classification will determine whether the lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease, which corresponds to a similar evaluation performed by lessors.
i
Lessor accounting
Costs to execute leases
The new lease accounting standard requires
that lessors (and, if applicable, lessees) capitalize, as initial direct costs, only incremental costs of a lease that would not have been incurred if the lease had not been obtained. Costs that we incur to negotiate or arrange a lease, regardless of its outcome, such as for fixed employee compensation, tax, or legal advice to negotiate lease terms, and other costs are expensed as incurred.
Operating leases
We account for the revenue from our lease contracts utilizing the single component accounting policy. This policy requires us to account for, by class of underlying asset, the lease component and nonlease component(s) associated with each lease as a single component if two criteria are met:
(i)
The timing and pattern of transfer of the lease component and the nonlease component(s) associated with it are the same,
(ii)
The lease component would be classified as an operating lease if it were accounted for separately.
17
2.
Summary
of significant accounting policies (continued)
Lease components consist primarily of fixed rental payments, which represent scheduled rental amounts due under our leases, and contingent rental payments. Nonlease components consist primarily of tenant recoveries representing reimbursements of rental operating expenses under our triple net lease structure, including recoveries for utilities, repairs and maintenance, and common area expenses.
If the lease component is the predominant component, we account for all revenues under such lease as a single component in accordance with the new lease accounting standard. Conversely, if the nonlease component is the predominant component, all revenues under such lease are accounted for in accordance with
the revenue recognition accounting standard. Our operating leases qualify for the single component accounting, and the lease component in each of our leases is predominant. Therefore, we account for all revenues from our operating leases under the new lease accounting standard and classify these revenues as income from rentals in our consolidated statements of income.
We commence recognition of income from rentals related to the operating leases at the date the property is ready for its intended use by the tenant and the tenant takes possession, or controls the physical use, of the leased asset. Income from rentals related to fixed rental payments under operating leases is recognized on a straight-line basis over the respective operating lease terms. We classify amounts expected to be received in later periods as deferred rent in our consolidated balance sheets. Amounts received
currently but recognized as revenue in future periods are classified in accounts payable, accrued expenses, and tenant security deposits in our consolidated balance sheets.
Income from rentals related to variable payments includes tenant recoveries and contingent rental payments. Tenant recoveries, including reimbursements of utilities, repairs and maintenance, common area expenses, real estate taxes and insurance, and other operating expenses, are recognized as revenue in the period during which the applicable expenses are incurred and the tenant’s obligation to reimburse us arises. Income from rentals related to other variable payments is recognized when associated contingencies are removed.
Subsequent to lease commencement, we assess collectibility from our tenants of future lease
payments for each of our operating leases. If we determine that collectibility is probable, we recognize income from rentals based on the methodology described above. If we determine that collectibility is not probable, we recognize an adjustment to lower our income from rentals. As of June 30, 2019, we assessed the collectibility of future lease payments under operating leases in which we are the lessor and determined that collectibility was probable.
Reclassification of the prior-year presentation of rental revenues and tenant recoveries
As described above, rental revenues and tenant recoveries related to our operating leases in which we are the lessor qualified for the single component
practical expedient and were classified as income from rentals in our consolidated statements of income. Prior to the adoption of the new lease accounting standard, we classified rental revenues and tenant recoveries separately in our consolidated statements of income, in accordance with the guidance in effect prior to January 1, 2019. Upon adoption of the new lease accounting standard, our comparative income statements of prior years have been reclassified to conform to the new single component presentation of rental revenues and tenant recoveries.
i
The
table below provides a reconciliation of the prior-period presentation of the income statement line items that were reclassified in our consolidated statements of income to conform to the current-period presentation, pursuant to the adoption of the new lease accounting standard and election of the single component practical expedient (in thousands):
Income
from rentals (presentation effective January 1, 2019)
$
i322,794
$
i640,449
/
Direct
financing and sales-type leases
As of June 30, 2019, we had one direct financing lease and no sales-type leases. Income from rentals related to our direct financing lease is recognized over the lease term using the effective interest rate method. At lease commencement, we record an asset within other assets in our consolidated balance sheets, which represents our net investment in the direct financing lease. This initial net investment is determined by aggregating the total future lease payments attributable to the direct financing lease and the estimated residual value of the property less unearned income. Over the lease term, the investment in the direct financing lease is reduced and rental income is recognized as income from rentals in our consolidated statements of income, producing
a constant periodic rate of return on the net investment in the direct financing lease.
18
2.
Summary of significant accounting policies (continued)
Subsequent to lease commencement, we assess collectibility from our tenants of future lease payments. If we determine that collectibility is probable, we recognize income from rentals based on the methodology described above. If we determine
that collectibility is not probable, we evaluate our net investment in the direct financing lease for impairment. Upon determination that an impairment has occurred, an impairment charge is recognized to reduce the carrying balance in the net investment in the direct financing lease to its estimated fair value. As of June 30, 2019, we assessed the collectibility of future lease payments under our direct financing lease, and determined that collectibility was probable.
i
Lessee accounting
We
have operating lease agreements in which we are the lessee consisting of ground and office leases. At the lease commencement date (or at the acquisition date if the lease is acquired as part of a real estate acquisition), we are required to recognize a liability to account for our future obligations under these operating leases, and a corresponding right-of-use asset.
The lease liability is measured based on the present value of the future lease payments, including payments during the term under our extension options that we are reasonably certain to exercise. The present value of the future lease payments is calculated for each operating lease using each respective remaining lease term and a corresponding estimated incremental borrowing rate, which is the interest rate that we estimate we would have to pay to borrow on a collateralized basis over a similar term for an amount
equal to the lease payments. Subsequently, the lease liability is accreted by applying a discount rate established at the lease commencement date to the lease liability balance as of the beginning of the period, and is reduced by the payments made during the period. We classify the operating lease liability in accounts payable, accrued expenses, and tenant security deposits in our consolidated balance sheets.
The right-of-use asset is measured based on the corresponding lease liability, adjusted for initial direct leasing costs and any other consideration exchanged with the landlord prior to the commencement of the lease, as well as adjustments to reflect favorable or unfavorable terms of an acquired lease when compared with market terms at the time of acquisition. Subsequently, the right-of-use asset is amortized on a straight-line basis during the lease term. We classify the
right-of-use asset in other assets in our consolidated balance sheets.
i
Recognition of revenue arising from contracts with customers
We recognize revenues associated with transactions arising from contracts
with customers, excluding revenues subject to the new lease accounting standard discussed in the “Lease Accounting” section above, in accordance with the revenue recognition accounting standard. A customer is distinguished from a noncustomer by the nature of the goods or services that are transferred. Customers are provided with goods or services that are generated by a company’s ordinary output activities, whereas noncustomers are provided with nonfinancial assets that are outside of a company’s ordinary output activities.
We generally recognize revenue representing the transfer of goods and services to customers in an amount that reflects the consideration to which we expect to be entitled in the exchange. In order to determine the recognition of revenue from customer contracts,
we use a five-step model to (i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, including variable consideration to the extent that it is probable that a significant future reversal will not occur, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) we satisfy the performance obligation.
We identify contractual performance obligations and determine whether revenue should be recognized at a point in time or over time, based on when control of goods
and services transfers to a customer. We consider whether we control the goods or services prior to the transfer to the customer in order to determine whether we should account for the arrangement as a principal or agent. If we determine that we control the goods or services provided to the customer, then we are the principal to the transaction, and we recognize the gross amount of consideration expected in the exchange. If we simply arrange but do not control the goods or services being transferred to the customer, then we are considered to be an agent to the transaction, and we recognize the net amount of consideration we are entitled to retain in the exchange.
Total revenues subject to the revenue recognition accounting standard for the three and six months ended June 30, 2019,
included $i12.6 million and $i23.4
million, respectively, primarily related to short-term parking revenues associated with long-term lease agreements. These revenues are classified within income from rentals in our consolidated income statements. Short-term parking revenues do not qualify for the single lease component practical expedient, discussed in the “Lessor Accounting” subsection of the “Lease Accounting” section within this Note 2, due to the difference in the timing and pattern of transfer of our parking service obligations and associated lease components within the same lease agreement. We recognize short-term parking revenues in accordance with the revenue recognition accounting standard when the services are provided and the performance obligations are satisfied, which normally occurs at a point in time.
/
19
2.
Summary
of significant accounting policies (continued)
i
Monitoring of tenant credit quality
During the term of each lease, we monitor the credit quality and any related material changes of our tenants by (i) monitoring the credit rating of tenants that are rated by a nationally recognized credit rating agency, (ii) reviewing financial statements of the tenants that are publicly available or that are required to be delivered to us pursuant to the applicable lease,
(iii) monitoring news reports regarding our tenants and their respective businesses, and (iv) monitoring the timeliness of lease payments.
i
Income taxes
We are organized and operate as a REIT pursuant to the Internal Revenue Code (the “Code”). Under the Code, a REIT that distributes at least i90%
of its REIT taxable income to its stockholders annually (excluding net capital gains) and meets certain other conditions is not subject to federal income tax on its distributed taxable income, but could be subject to certain federal, foreign, state, and local taxes. We distribute i100% of our taxable income annually; therefore, a provision for federal income taxes is not required. In addition to our REIT returns, we file federal, foreign, state, and local tax returns for our subsidiaries.
We file with jurisdictions located in the U.S., Canada, India, China, and other international locations. Our tax returns are subject to routine examination in various jurisdictions for the 2013 through 2018 calendar years.
/
i
Employee and non-employee share-based payments
We
have implemented an entity-wide accounting policy to account for forfeitures of share-based awards granted to employees and non-employees when they occur. As a result of this policy, we recognize expense on share-based awards with time-based vesting conditions without reductions for an estimate of forfeitures. This accounting policy only applies to service condition awards. For performance condition awards, we continue to assess the probability that such conditions will be achieved. Expenses related to forfeited awards are reversed as forfeitures occur. In addition, all nonforfeitable dividends paid on share-based payment awards are initially classified in retained earnings and reclassified to compensation cost only if forfeitures of the underlying awards occur. Our employee and non-employee share-based awards are measured on the grant date and recognized over the required service period of the recipient.
i
Forward
equity sales agreements
To account for the forward equity sales agreements, we consider the accounting guidance governing financial instruments and derivatives. As of June 30, 2019, none of our forward equity sales agreements were deemed to be liabilities as they did not embody obligations to repurchase our shares, nor did they embody obligations to issue a variable number of shares for which the monetary value was predominantly fixed, varied with something other than the fair value of our shares, or varied inversely in relation to our shares. We then evaluated whether the agreements met the derivatives and hedging guidance scope exception to be accounted for as equity instruments and concluded that the agreements can be classified as equity contracts
based on the following assessment: (i) none of the agreements’ exercise contingencies were based on observable markets or indices besides those related to the market for our own stock price and operations; and (ii) none of the settlement provisions precluded the agreements from being indexed to our own stock.
i
Hedge accounting
We
utilize interest rate hedge agreements to manage a portion of our exposure to variable interest rates primarily associated with borrowings based on LIBOR. As a result, all of our interest rate hedge agreements are designated as cash flow hedges. At inception of a hedge agreement, we are required to perform an initial quantitative assessment to determine whether a hedge is highly effective in offsetting changes in cash flows associated with the hedged item. Subsequently, we may perform only a qualitative assessment, unless facts and circumstances change.
We determined that each our cash flow hedges were highly effective at inception and continue to be highly effective. Therefore, we record all changes (effective and ineffective components) in fair value of our hedges in accumulated other comprehensive income within total equity and reclassify them into earnings when the hedged
item affects earnings.
In October 2018, the FASB issued an accounting standard that expands the list of U.S. benchmark interest rates permitted in the application of hedge accounting to include the overnight index swap rate based on the Secured Overnight Financing Rate (“SOFR”). The accounting standard became effective for us and was adopted on January 1, 2019. We have no hedges based on SOFR; therefore, the adoption of this accounting standard had no effect on our consolidated financial statements.
20
2.
Summary
of significant accounting policies (continued)
i
Joint venture distributions
We use the “nature of the distribution” approach to determine the classification within our statement of cash flows of cash distributions received from equity method investments, including unconsolidated joint ventures. Under this approach, distributions are classified based on the nature of the underlying activity that generated the cash distributions. If we lack the information necessary to apply this approach
in the future, we will be required to apply the “cumulative earnings” approach as an accounting change on a retrospective basis. Under the cumulative earnings approach, distributions up to the amount of cumulative equity in earnings recognized are classified as cash inflows from operating activities, and those in excess of that amount are classified as cash inflows from investing activities.
i
Restricted
cash
We present cash and cash equivalents separately from restricted cash within our consolidated balance sheets. We include restricted cash with cash and cash equivalents when reconciling the beginning of period and end of period total amounts shown in the consolidated statements of cash flows. We provide a reconciliation between the balance sheet and statement of cash flows, as required when the balance includes more than one line item for cash, cash equivalents and restricted cash. We also provide a disclosure of the nature of the restrictions related to material restricted cash balances.
i
Recent
accounting pronouncements
Allowance for credit losses
In June 2016, the FASB issued an accounting standard (further clarified with subsequently issued updates) that will require companies to estimate and recognize lifetime expected losses, rather than incurred losses, which will result in the earlier recognition of credit losses. The accounting standard will apply to most financial assets measured at amortized cost and certain other instruments, including trade and other receivables, loans, held-to-maturity debt securities, net investments in leases arising from sales-type and direct financing leases, and off-balance-sheet credit exposures (i.e., loan commitments).
The accounting standard is effective for reporting periods beginning after December 15, 2019, with early adoption permitted, and will be applied as a cumulative adjustment to retained earnings as of the effective date. As a lessor, this standard will apply to our net investments in direct financing and sales-type leases and will not apply to the receivables arising from our operating leases. An assessment of the collectibility of operating lease payments and the recognition of an adjustment to lease income based on this assessment will continue to be governed by the lease accounting standard discussed in the “Lease Accounting” section earlier within this Note 2.
In addition to direct financing and sales-type leases, the accounting standard on credit losses will also apply to our receivables that result from revenue transactions
within the scope of the revenue recognition standard discussed in the “Recognition of Revenue Arising From Contracts With Customers” section earlier within this Note 2. As of June 30, 2019, we had one lease classified as a direct financing lease with a net investment balance aggregating $i39.5 million,
and no leases classified as sales-type leases, which will be subject to this new guidance. As of June 30, 2019, our receivables resulting from revenue transactions within the scope of revenue recognition standard aggregated $i10.3 million. We have had no collectibility issues
related to our direct financing lease and have determined that the collectibility of future payments for this lease is probable. Our receivables resulting from revenue transactions within the scope of the revenue recognition standard are short term in nature and are expected to be collected in full. Based on the aforementioned facts, we do not expect the adoption of this ASU to have a material effect on our consolidated financial statements.
Recognition and measurement of financial instruments
In January 2016, the FASB issued an accounting standard (further clarified with subsequently issued updates) that updated the framework for companies to account for financial instruments.
We adopted this accounting standard on January 1, 2018. Subsequently in April 2019, the FASB issued an accounting standard that amends the financial instruments standard by clarifying that all adjustments made under the measurement alternative elected for equity securities without readily determinable fair values represent nonrecurring fair value measurement adjustments and therefore require applicable fair value disclosures, including disclosures about the level of the fair value hierarchy within which the fair value measurements are categorized. The standard is effective for reporting periods beginning after December 15, 2019, with early adoption permitted. Except for the expanded fair value disclosures related to our investments in privately held entities that do not report NAV, we do not expect the adoption of this standard to impact our consolidated financial statements.
21
3.
i
Investments in real estate
i
Our
consolidated investments in real estate, including real estate assets held for sale as described in Note 16, consisted of the following as of June 30, 2019, and December 31, 2018 (in thousands):
Excludes
$i65.0 million paid in January 2019 for two properties at 10260 Campus Point Drive and 4161 Campus Point Court that we acquired in December 2018. Total purchase price was $i80.0
million, of which $i15.0 million was paid in December 2018.
We evaluated each acquisition to determine whether the integrated set of assets and activities acquired met the definition of a business. Acquisitions that do
not meet the definition of a business are accounted for as asset acquisitions. An integrated set of assets and activities does not qualify as a business if substantially all of the fair value of the gross assets is concentrated in either a single identifiable asset or a group of similar identifiable assets, or if the acquired assets do not include a substantive process.
Based upon our evaluation of each acquisition, we determined that substantially all of the fair value related to each acquisition is concentrated in a single identifiable asset or a group of similar identifiable assets, or is associated with a land parcel with no operations. Accordingly, each transaction did not meet the definition of a business and consequently was accounted for as an asset acquisition. In each of these transactions, we allocated the total consideration for each acquisition to the individual
assets and liabilities acquired on a relative fair value basis.
22
3.
Investments in real estate (continued)
Sale of real estate asset
In February 2019, we completed a partial sale of a i60%
interest in 75/125 Binney Street, a Class A property in our Cambridge submarket aggregating i388,270 RSF, for a sales price of $i438
million, or $i1,880 per RSF. We retained control over, and continue to consolidate, the new joint venture. We accounted for the $i202.2
million difference between the consideration received and the book value of the 60% interest sold as an equity transaction with no gain recognized in earnings. Refer to Note 4 – “Consolidated and Unconsolidated Real Estate Joint Ventures” to these unaudited consolidated financial statements for additional information.
23
4.
i
Consolidated
and unconsolidated real estate joint ventures
i
From time to time, we enter into joint venture agreements through which we own a partial interest in real estate entities that own, develop, and operate real estate properties. As of June 30, 2019, our real estate joint ventures held the following properties:
Property
Market
Submarket
Our
Ownership Interest
RSF
Consolidated joint ventures(1):
75/125
Binney Street
Greater Boston
Cambridge
i40.0
%
i388,270
225
Binney Street
Greater Boston
Cambridge
i30.0
%
i305,212
409
and 499 Illinois Street
San Francisco
Mission Bay/SoMa
i60.0
%
i455,069
1500
Owens Street
San Francisco
Mission Bay/SoMa
i50.1
%
i158,267
Campus
Pointe by Alexandria(2)
San Diego
University Town Center
i55.0
%
i798,799
9625
Towne Centre Drive
San Diego
University Town Center
i50.1
%
i163,648
Unconsolidated
joint ventures(1):
Menlo
Gateway
San Francisco
Greater Stanford
i48.3
%
(3)
i772,983
1401/1413
Research Boulevard
Maryland
Rockville
i65.0
%
(4)
(5
)
704
Quince Orchard Road
Maryland
Gaithersburg
i56.8
%
(4)
i79,931
1655
and 1725 Third Street
San Francisco
Mission Bay/SoMa
i10.0
%
i593,765
(1)
In
addition to the consolidated real estate joint ventures listed, various partners hold insignificant noncontrolling interests in four other joint ventures in North America, and we hold an insignificant noncontrolling interest in one unconsolidated real estate joint venture in North America.
(2)
Includes only 10290 and 10300 Campus Point Drive and 4110 Campus Point Court in our University Town Center submarket.
(3)
As of
June 30, 2019, we had a i48.3% ownership interest in Menlo Gateway and expect our ownership to increase to i49%
through future funding of construction costs in 2019.
(4)
Represents our ownership interest; our voting interest is limited to 50%.
/
(5)
Joint venture with a distinguished retail real estate developer for the development of an approximate i90,000
RSF retail shopping center.
Our consolidation policy is fully described under the “Consolidation” section of Note 2 – “Summary of Significant Accounting Policies” to these unaudited consolidated financial statements. Consolidation accounting is highly technical, but its framework is primarily based on the controlling financial interests and benefits of the joint ventures. We generally consolidate a joint venture that is a legal entity that we control (i.e., we have the power to direct the activities of the joint venture that most significantly affect its economic performance) through contractual rights, regardless of our ownership interest, and where we determine that we have benefits through the allocation of earnings or losses and fees paid to us that could be significant to the joint venture (the “VIE model”).
We also generally consolidate joint ventures when we have a controlling financial interest through voting rights and where our voting interest is greater than 50% (the “voting model”). Voting interest differs from ownership interest for some joint ventures. We account for joint ventures that do not meet the consolidation criteria under the equity method of accounting by recognizing our share of income and losses. The table below shows the categorization of our existing significant joint ventures under the consolidation framework:
Property
Consolidation
Model
Voting Interest
Consolidation Analysis
Conclusion
75/125
Binney Street
VIE model
Not applicable under VIE model
We have control and benefits that can be significant to the joint venture; therefore, we are the primary beneficiary of each VIE
Consolidated
225 Binney Street
409
and 499 Illinois Street
1500 Owens Street
Campus Pointe by Alexandria
9625 Towne Centre Drive
Menlo Gateway
We do not control the joint venture and are therefore not the primary beneficiary
Equity
method of accounting
1401/1413 Research Boulevard
704 Quince Orchard Road
Voting model
Does not exceed 50%
Our voting interest is 50% or less
1655 and 1725 Third Street
24
4. Consolidated
and unconsolidated real estate joint ventures (continued)
Consolidated VIEs’ balance sheet information
i
The table below aggregates the balance sheet information of our consolidated VIEs as of June 30, 2019, and December 31, 2018 (in thousands):
Alexandria
Real Estate Equities, Inc.’s share of equity
i775,323
i624,349
Noncontrolling
interests’ share of equity
i770,152
i540,905
Total
liabilities and equity
$
i1,598,270
$
i1,225,464
/
In
determining whether to aggregate the balance sheet information of our consolidated VIEs, we considered the similarity of each VIE, including the primary purpose of these entities to own, manage, operate, and lease real estate properties owned by the VIEs, and the similar nature of our involvement in each VIE as a managing member. Due to the similarity of the characteristics, we present the balance sheet information of these entities on an aggregated basis. For each of our consolidated VIEs, none of its assets have restrictions that limit their use to settle specific obligations of the VIE. There are no creditors or other partners of our consolidated VIEs that have recourse to our general credit. Our maximum exposure to our consolidated VIEs is limited to our variable interests in each VIE.
Unconsolidated real estate joint ventures
iOur
investments in unconsolidated real estate joint ventures, accounted for under the equity method of accounting presented in our consolidated balance sheets as of June 30, 2019, and December 31, 2018, consist of the following (in thousands):
Our
maximum exposure to our unconsolidated VIEs is limited to our investment in each VIE.
25
4. Consolidated and unconsolidated real estate joint ventures (continued)
i
Our unconsolidated real estate joint ventures have the following non-recourse secured loans that include the following key terms as
of June 30, 2019, (dollars in thousands):
Maturity
Date
Stated Rate
Interest Rate(1)
100% at Joint Venture Level
Unconsolidated Joint Venture
Our Share
Debt
Balance(2)
Remaining Commitments
1401/1413 Research Boulevard
i65.0%
i5/17/20
L+i2.50%
i5.91%
$
i22,696
$
i5,997
1655
and 1725 Third Street
i10.0%
i6/29/21
L+i3.70%
i6.14%
i253,366
i121,634
704
Quince Orchard Road
i56.8%
i3/16/23
L+i1.95%
i4.59%
i6,997
i7,865
Menlo
Gateway, Phase II
i48.3%
i5/1/35
i4.53%
i4.59%
i8,019
i147,784
Menlo
Gateway, Phase I
i48.3%
i8/10/35
i4.15%
i4.18%
i143,334
i—
$
i434,412
$
i283,280
(1)
Includes
interest expense and amortization of loan fees.
(2)
Represents outstanding principal, net of unamortized deferred financing costs.
/
5.
iii
Leases
//
On
January 1, 2019, we adopted a new lease accounting standard that sets out the principles for the recognition, measurement, presentation, and disclosure of leases for both parties to a lease agreement (i.e., lessees and lessors).
As a lessor, we are required to disclose, among other things, the following:
•
A description of the nature of leases, including terms for any variable payments, options to extend or terminate, and options to purchase the underlying asset;
•
Tabular
presentation of undiscounted cash flows to be received over the next five years and thereafter separately for operating leases and direct financing leases;
•
The amount of lease income and its location on the statements of income;
•
Income classified separately for operating leases and direct financing leases; and
•
Our
risk management strategy to mitigate declines in residual value of the leased assets.
As a lessee, we are required to disclose, among other things, the following:
•
A description of the nature of leases, including terms for any variable payments, options to extend or terminate, and options to purchase the underlying asset;
•
The amounts of lease liabilities and corresponding right-of-use assets and their respective locations in
the balance sheet;
•
The weighted-average remaining lease term and weighted-average discount rate of leases;
•
Tabular presentation of undiscounted cash flows of our remaining lease payment obligations over the next five years and thereafter; and
•
Total lease costs, including cash paid, amounts
expensed, and amounts capitalized.
Refer to the “Lease Accounting” section of Note 2 – “Summary of Significant Accounting Policies” for additional information.
Leases in which we are the lessor
As of June 30, 2019, we had i257
properties aggregating i23.6 million operating RSF located in key locations, including Greater Boston, San Francisco, New York City, San Diego, Seattle, Maryland, and Research Triangle. We focus on developing Class A properties in AAA innovation cluster locations, which we consider to be highly desirable for tenancy by life science and technology entities. Such locations are generally characterized by high barriers to entry for new landlords, high barriers to exit for tenants,
and a limited supply of available space. As of June 30, 2019, all our leases in which we are the lessor were classified as operating leases with one exception of a direct financing lease. Our operating leases and direct financing lease are described below.
26
5. Leases (continued)
Operating leases
i
As
of June 30, 2019, our i257properties were subject to operating lease agreements. Two of these properties, representing itwo
land parcels, are subject to lease agreements that each contain an option for the lessee to purchase the underlying asset from us at fair market value during each of the 30-day periods commencing on the dates that are i15 years, i30
years, and i74.5 years after the rent commencement date of iOctober 1, 2017. The remaining lease term
related to each of the itwo land parcels is i73.4
years. Our leases generally contain options to extend lease terms at prevailing market rates at the time of expiration. Certain operating leases contain early termination options that require advance notification and payment of a penalty, which in most cases is substantial enough to be deemed economically disadvantageous by a tenant to exercise. Future lease payments to be received under the terms of our operating lease agreements, excluding expense reimbursements, in effect as of June 30, 2019, are outlined in the table below (in thousands):
Year
Amount
2019
$
i472,242
2020
i985,377
2021
i977,440
2022
i943,926
2023
i882,912
Thereafter
i6,228,900
Total
$
i10,490,797
/
Refer
to Note 3 – “Investments in Real Estate” to these unaudited consolidated financial statements for additional information on our owned real estate assets, which are the underlying assets under our operating leases.
Direct financing lease
i
As of June 30, 2019, we had one direct financing lease agreement for a parking
structure with a remaining lease term of i73.4 years. The lessee has an option to purchase the underlying asset at fair market value during each of the 30-day periods commencing on the dates that are i15
years, i30 years, and i74.5 years after the rent commencement date of iOctober
1, 2017. The components of our net investment in our direct financing lease as of June 30, 2019, and December 31, 2018, are summarized in the table below (in thousands):
Future
lease payments to be received under the terms of our direct financing lease as of June 30, 2019, are outlined in the table below (in thousands):
Year
Total
2019
$
i831
2020
i1,705
2021
i1,756
2022
i1,809
2023
i1,863
Thereafter
i253,323
Total
$
i261,287
/
27
5. Leases
(continued)
Income from rentals
i
Our total income from rentals includes revenue related to agreements for rental of our investments in real estate, which primarily includes revenues subject to the guidance of the new lease accounting standard, as well as revenues subject to the revenue recognition accounting standard as summarized below (in thousands):
Revenues subject to the new lease accounting standard:
Operating
leases
$
i358,461
$
i701,802
Direct
financing lease
i604
i1,205
Revenues
subject to the new lease accounting standard
i359,065
i703,007
Revenues
subject to the revenue recognition accounting standard
i12,553
i23,360
Income
from rentals
$
i371,618
$
i726,367
/
Our
revenues that are subject to the revenue recognition accounting standard relate primarily to parking revenues, which consist of short-term rental revenues that are not considered lease revenue under the new lease accounting standard. Refer to the “Revenues” and “Recognition of revenue arising from contracts with customers” sections of Note 2 – “Summary of Significant Accounting Policies” to these unaudited consolidated financial statements for additional information.
Residual value risk management strategy
Our leases do not have guarantees of residual value on the underlying assets. We manage risk associated with the residual value of our leased assets by (i) evaluating each
potential acquisition of real estate to determine whether it meets our business objective to primarily invest in high-demand markets with limited supply of available space, (ii) directly managing our leased properties, conducting frequent property inspections, proactively addressing potential maintenance issues before they arise, and timely resolving any occurring issues, (iii) carefully selecting our tenants and monitoring their credit quality throughout their respective lease terms, and (iv) focusing on making continuous improvements to our sustainability efforts and achievement of our sustainability goals for ground-up development of new buildings, which are targeting Gold of Platinum LEED certification. Our environmentally focused design decisions, careful selection of construction materials, and continuous monitoring of our properties throughout their lives are expected to promote the durability of building infrastructure and enhance residual value of our properties.
Leases in which we are the lessee
We have operating lease agreements in which we are the lessee consisting of ground and office leases. Certain of these leases have options to extend or terminate the contract terms upon meeting certain criteria. There are no notable restrictions or covenants imposed by the leases, nor guarantees of residual value.
Under the new lease accounting standard, we are required to recognize a right-of-use asset and a related liability to account for our future obligations under our ground and office lease arrangements in which we are the lessee. Refer to the “Lessee Accounting”
section of Note 2 – “Summary of Significant Accounting Policies” to these unaudited consolidated financial statements.
As of June 30, 2019, the present value of the remaining contractual payments, aggregating $i653.0 million, under our operating lease agreements, including our extension options that we are reasonably certain to exercise, was
$i243.6 million. Our corresponding operating lease right-of-use assets, adjusted for initial direct leasing costs and other consideration exchanged with the landlord prior to the commencement of the lease, aggregated $i237.0
million. As of June 30, 2019, the weighted-average remaining lease term of operating leases in which we are the lessee was approximately i45 years, and the weighted-average discount rate was i5.37%.
28
5. Leases
(continued)
Ground lease obligations as of June 30, 2019, included leases for i30 of our properties, which accounted for approximately 12% of our total number of properties. Excluding one ground lease that expires in 2036
related to one operating property with a net book value of $i8.1 million as of June 30, 2019, our ground lease obligations have remaining lease terms ranging from approximately i34
years to i95 years, including extension options which we are reasonably certain to exercise.
i
The reconciliation
of future lease payments, under non-cancelable operating ground and office leases in which we are the lessee, to the operating lease liability reflected in our consolidated balance sheet as of June 30, 2019, is presented in the table below (in thousands):
Year
Total
2019
$
i7,882
2020
i14,207
2021
i14,257
2022
i14,390
2023
i14,509
Thereafter
i587,788
Total
future payments under our operating leases for which we are the lessee
i653,033
Effect of discounting
(i409,448
)
Operating
lease liability
$
i243,585
/
Lessee
operating costs
i
Operating lease costs represent amounts recognized related to ground and office leases in which we are the lessee. For the three and six months ended June 30, 2019 and 2018, our costs for operating leases in which we are the lessee were as follows (in thousands):
Expenses
for operating leases in which we are the lessee
$
i4,482
$
i3,916
$
i8,974
$
i7,748
/
For
the six months ended June 30, 2019 and 2018, amounts paid and classified as operating activities in our consolidated statements of cash flows for leases in which we are the lessee, were $i8.9 million and $i7.4
million, respectively.
6.
i
Cash, cash equivalents, and restricted cash
i
Cash,
cash equivalents, and restricted cash consisted of the following as of June 30, 2019, and December 31, 2018 (in thousands):
Funds held in trust under the terms of certain secured notes payable
i23,138
i22,681
Funds
held in escrow related to construction projects and investing activities
i12,074
i10,558
Other
i4,104
i4,710
i39,316
i37,949
Total
$
i238,225
$
i272,130
/
29
7.
i
Investments
We
hold investments in publicly traded companies and privately held entities primarily involved in the life science and technology industries. Investments in publicly traded companies are classified as investments with readily determinable fair values, and are carried at fair value, with changes in fair value classified in net income. Our investments in privately held entities consist of (i) investments that report NAV, such as our privately held investments in limited partnerships, which are carried at fair value using NAV as a practical expedient with changes in fair value classified in net income, and (ii) investments in privately held entities that do not report NAV, which are measured at cost, adjusted for observable price changes and impairments, with changes recognized in net income.
Investments
in publicly traded companies are presented at fair value in our consolidated balance sheet, with changes in fair value recognized in net income.
•
Investments in privately held entities without readily determinable fair values previously accounted for under the cost method are accounted for as follows:
•
Investments in privately held entities that report NAV are presented at fair value using NAV as a practical expedient, with changes in fair value recognized in net income. We use NAV reported by limited partnerships without
adjustment, unless we are aware of information indicating that the NAV reported by a limited partnership does not accurately reflect the fair value of the investment at our reporting date.
•
Investments in privately held entities that do not report NAV are carried at cost, adjusted for observable price changes and impairments, with changes recognized in net income. These investments continue to be evaluated on the basis of a qualitative assessment for indicators of impairment by utilizing the same monitoring criteria described above and monitoring the presence of the following impairment indicators: (i) a significant deterioration in the earnings performance, credit rating, asset quality, or business prospects of the investee; (ii) a significant
adverse change in the regulatory, economic, or technological environment of the investee, (iii) a significant adverse change in the general market condition of either the geographical area or the industry in which the investee operates, (iv) significant concerns about the investee’s ability to continue as a going concern. If such indicators are present, we are required to estimate the investment’s fair value and immediately recognize an impairment loss, without consideration as to whether the impairment is other-than-temporary, in an amount equal to the investment’s carrying value in excess of its estimated fair value.
•
Investments in privately held entities continue to require accounting under the equity method, unless our interest in the entity
is deemed to be so minor that we have virtually no influence over the entity’s operating and financial policies. Under the equity method of accounting, we initially recognize our investment at cost and adjust the carrying amount of the investment to recognize our share of the earnings or losses of the investee subsequent to the date of our investment. We had no investments accounted for under the equity method as of June 30, 2019.
We classify unrealized and realized gains and losses on our equity investments within investment income in our consolidated statements of income.
Unrealized gains and losses represent (i) changes in fair value for investments in publicly traded companies,
(ii) changes in NAV, as a practical expedient to estimate fair value, for investments in privately held entities that report NAV, and (iii) observable price changes on our investments in privately held entities that do not report NAV. An observable price is a price observed in an orderly transaction for an identical or similar investment of the same issuer. Observable price changes result from, among other things, equity transactions for the same issuer executed during the reporting period, including subsequent equity offerings or other reported equity transactions related to the same issuer. For these transactions to be considered observable price changes, we evaluate whether these transactions have similar rights and obligations, including voting rights, distribution preferences, conversion rights, and other factors, to the investments we hold.
Realized gains and losses represent
the difference between proceeds received upon disposition of investments and their historical or adjusted cost. Impairments are realized losses, which result in an adjusted cost, and represent charges to reduce the carrying values of investments in privately held entities that do not report NAV to their estimated fair value.
Cumulative
adjustments recognized on investments in privately held entities that do not report NAV held as of June 30, 2019, aggregated $i73.6 million, which consisted of upward adjustments representing unrealized
gains of $i74.3 million and downward adjustments representing unrealized losses of $i730 thousand.
During the six months ended June 30, 2019, adjustments recognized on investments in privately held entities that do not report NAV aggregated $i9.5 million, which consisted
of upward adjustments representing unrealized gains of $i10.0 million, and downward adjustments representing unrealized losses of $i530 thousand.
i
Our
investment income for the three and six months ended June 30, 2019, consisted of the following (in thousands):
Investment
dispositions during the six months ended June 30, 2018:
Recognized in the current period
i—
i16,006
i16,006
Previously
recognized gains
(i4,789
)
i4,789
i—
Total
investment dispositions during the six months ended June 30, 2018
(i4,789
)
i20,795
i16,006
Investment
income
$
i77,296
$
i20,795
$
i98,091
32
7.
Investments
(continued)
Investments in privately held entities that report NAV
Investments in privately held entities that report NAV consist primarily of investments in limited partnerships. We are committed to funding approximately $i238.6 million for all
investments, primarily consisting of $i238.0 million related to investments in limited partnerships. Our funding commitments expire at various dates over the next i11
years, with a weighted-average expiration of i8.7 yearsas of June 30, 2019.
These investments are not redeemable by us, but we normally receive distributions from these investments
through their term. Our investments in privately held entities that report NAV generally have expected initial terms in excess of i10 years. The weighted-average remaining term during which these investments are expected to be liquidated was i5.6
yearsas of June 30, 2019.
8.
i
Other assets
i
The
following table summarizes the components of other assets as of June 30, 2019, and December 31, 2018 (in thousands):
Deferred
financing costs – $2.2 billion unsecured senior line of credit
i14,481
i16,060
Deposits
i22,054
i12,974
Furniture,
fixtures, and equipment
i16,725
i14,787
Interest
rate hedge assets
i38
i2,606
Net
investment in direct financing lease
i39,530
i39,149
Notes
receivable
i482
i528
Operating
lease right-of-use asset(2)
i237,025
i—
Other
assets
i15,437
i19,861
Prepaid
expenses
i15,008
i13,690
Property,
plant, and equipment
i155,100
i81,024
Total
$
i694,627
$
i370,257
(1)
Upon
the adoption of new lease accounting standards on January 1, 2019, this amount has been included in the calculation of our operating lease right-of-use asset.
/
(2)
Refer to Note 2 – “Summary of Significant Accounting Policies” and Note 5 – “Leases” to these unaudited consolidated financial statements for additional information.
33
9.
i
Fair
value measurements
We provide fair value information about all financial instruments for which it is practicable to estimate fair value. We measure and disclose the estimated fair value of financial assets and liabilities by utilizing a fair value hierarchy that distinguishes between data obtained from sources independent of the reporting entity and the reporting entity’s own assumptions about market participant assumptions. This hierarchy consists of three broad levels, as follows: (i) quoted prices in active markets for identical assets or liabilities (Level 1), (ii) significant other observable inputs (Level 2), and (iii) significant unobservable inputs (Level 3). Significant other observable inputs can include quoted prices for similar assets or liabilities in active markets, as well as inputs that are observable for the asset or liability, such as
interest rates, foreign exchange rates, and yield curves. Significant unobservable inputs are typically based on an entity’s own assumptions, since there is little, if any, related market activity. In instances in which the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level of input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability. There were ino
transfers between the levels in the fair value hierarchy during the six months ended June 30, 2019.
i
The following tables set forth the assets and liabilities that we measure at fair value on a recurring basis by level within the fair value hierarchy as of June 30, 2019, and December 31,
2018 (in thousands):
Quoted Prices in Active Markets for Identical Assets (Level 1)
Significant Other Observable Inputs (Level 2)
Significant Unobservable Inputs (Level 3)
Assets:
Investments
in publicly traded companies
$
i184,005
$
i184,005
$
i—
$
i—
Interest
rate hedge agreements
$
i2,606
$
i—
$
i2,606
$
i—
Liabilities:
Interest
rate hedge agreements
$
i768
$
i—
$
i768
$
i—
/
Our
investments in publicly traded companies have been recognized at fair value. Investments in privately held entities are excluded from the fair value hierarchy above as required by the fair value standards. Refer to Note 7 – “Investments” to these unaudited consolidated financial statements for further details.
Our interest rate hedge agreements have been recognized at fair value. Refer to Note 11 – “Interest Rate Hedge Agreements” to these unaudited consolidated financial statements for further details. The carrying values of cash and cash equivalents, restricted cash, tenant receivables, other assets, accounts payable, accrued expenses, and tenant security deposits approximate fair value.
The fair values of our secured notes payable, unsecured senior notes payable, $2.2
billion unsecured senior line of credit, and unsecured senior bank term loan were estimated using widely accepted valuation techniques, including discounted cash flow analyses using significant other observable inputs such as available market information on discount and borrowing rates with similar terms, maturities, and credit ratings. Because the valuations of our financial instruments are based on these types of estimates, the actual fair value of our financial instruments may differ materially if our estimates do not prove to be accurate. Additionally, the use of different market assumptions or estimation methods may have a material effect on the estimated fair value amounts.
34
9.
Fair
value measurements (continued)
i
As of June 30, 2019, and December 31, 2018, the book and estimated fair values of our investments in privately held entities that report NAV, secured notes payable, unsecured senior notes payable, $2.2 billion unsecured senior line of credit, and unsecured senior bank term loan were as follows (in thousands):
Investments
in privately held entities that report NAV
$
i382,625
$
i382,625
$
i317,805
$
i317,805
Liabilities:
Secured
notes payable
$
i354,186
$
i367,193
$
i630,547
$
i638,860
Unsecured
senior notes payable
$
i5,140,914
$
i5,499,248
$
i4,292,293
$
i4,288,335
$2.2
billion unsecured senior line of credit
$
i514,000
$
i513,922
$
i208,000
$
i208,106
Unsecured
senior bank term loan
$
i347,105
$
i349,250
$
i347,415
$
i350,240
/
Nonrecurring
fair value measurements
Refer to Note 7 – “Investments” and Note 16 – “Assets Classified as Held for Sale” to these unaudited consolidated financial statements for further discussion.
10.
i
Secured
and unsecured senior debt
i
The following table summarizes our secured and unsecured senior debt as of June 30, 2019 (dollars in thousands):
Fixed-Rate/Hedged
Variable-Rate
Debt
Unhedged
Variable-Rate Debt
Weighted-Average
Interest
Remaining
Term
(in years)
Total
Percentage
Rate (1)
Secured notes payable
$
i354,186
$
i—
$
i354,186
i5.6
%
i3.58
%
i4.5
Unsecured
senior notes payable
i5,140,914
i—
i5,140,914
i80.8
i4.16
i7.3
$2.2
billion unsecured senior line of credit
i—
i514,000
i514,000
i8.1
i3.53
i4.6
Unsecured
senior bank term loan
i347,105
i—
i347,105
i5.5
i3.62
i5.5
Total/weighted-average
$
i5,842,205
$
i514,000
$
i6,356,205
i100.0
%
i4.05
%
i6.8
Percentage
of total debt
i92
%
i8
%
i100
%
/
(1)
Represents
the weighted-average interest rate as of the end of the applicable period, including expense/income related to our interest rate hedge agreements, amortization of loan fees, amortization of debt premiums (discounts), and other bank fees.
35
10.
Secured and unsecured senior debt (continued)
i
The
following table summarizes our outstanding indebtedness and respective principal payments as of June 30, 2019 (dollars in thousands):
Stated
Rate
Interest
Rate (1)
Maturity Date (2)
Principal Payments Remaining for the Periods Ending December 31,
Represents
the weighted-average interest rate as of the end of the applicable period, including expense/income related to our interest rate hedge agreements, amortization of loan fees, amortization of debt premiums (discounts), and other bank fees.
(2)
Reflects any extension options that we control.
/
(3)
Refer to the “3.375% and 4.00% Unsecured Senior Notes Payable”
and “Extension of Unsecured Senior Bank Term Loan” sections on the next page for additional information.
36
10.
Secured and unsecured senior debt (continued)
4.85%, 3.80%, and 4.00% Unsecured senior notes payable
In March 2019, we completed an
offering of $i850.0 million of unsecured senior notes for net proceeds of $i846.1
million. The unsecured senior notes consisted of $i300.0 million of i4.85%
unsecured senior notes payable on iApril 15, 2049 (“i4.85%
Unsecured Senior Notes”); $i350.0 million of i3.80%
unsecured senior notes payable on iApril 15, 2026 (“i3.80%
Unsecured Senior Notes”), which will be allocated to fund certain eligible green development and redevelopment projects and the repayment of a secured note payable related to 50/60 Binney Street, a recently completed Class A property, which was awarded LEED® Gold certification; and $i200.0 million added to our outstanding i4.00%
unsecured senior notes payable due on iJanuary 15, 2024, issued at a yield to maturity of i3.453%,
which are part of the same series that was originally issued in 2018 and will also be used to fund recently completed and future eligible green projects. As of June 30, 2019, these notes had a weighted-average interest rate of i4.18% and a weighted-average maturity of i14.4
years.
3.375% and 4.00% Unsecured senior notes payable
In July 2019, we issued $i1.25 billion of unsecured senior notes payable with a weighted-average interest rate of i3.72%
and a weighted-average maturity of i19.5 years. The unsecured senior notes consisted of $i750.0
million of i3.375% unsecured senior notes payable on iAugust
15, 2031 (“i3.375% Unsecured Senior Notes”) and $i500.0
million of i4.00% unsecured senior notes payable on iFebruary
1, 2050 (“i4.00% Unsecured Senior Notes Due 2050”).
The proceeds were primarily used to refinance an aggregate $i950.0
million of unsecured senior notes payable comprising $i400.0 million of i2.75%
unsecured senior notes payable due 2020 and $i550.0 million of i4.60%
unsecured senior notes payable due 2022, pursuant to a cash tender offer completed on iJuly 17, 2019, and a subsequent call for redemption. The redemption is expected to settle on iAugust
16, 2019. Additionally, we partially repaid $i175.0 million on our unsecured senior bank term loan with the remaining proceeds used to reduce the outstanding balance of our unsecured senior line of credit. The weighted-average interest rate and maturity of the refinanced unsecured senior notes payable and partially repaid unsecured bank term loan were i3.94%
and i2.4 years, respectively. As a result of our refinancing and partial repayment, we expect to recognize a loss, primarily related to the early extinguishment of debt, of $i43
million during the three months ending September 30, 2019.
Extension of unsecured senior bank term loan
In June 2019, we extended the maturity date of our unsecured senior bank term loan, with a principal balance of $i350.0
million, to iJanuary 2, 2025 from iJanuary
28, 2024. We made a partial repayment of $i175.0 million on this outstanding balance in July 2019.
Repayment of secured notes payable
In January 2019, we repaid early one secured note payable aggregating
$i106.7 million, which was originally due in 2020 and bore interest at i7.75%,
and recognized a loss on early extinguishment of debt of $i7.1 million, including the write-off of unamortized loan fees.
In March 2019, we repaid early the remaining $i193.1
million balance of our secured construction loan related to 50/60 Binney Street, which was due in 2020 and bore interest at LIBOR+i1.5%, and recognized a loss on early extinguishment of debt of $i269
thousand.
Interest expense
i
The following table summarizes interest expense for the three and six months ended June 30, 2019 and 2018 (in thousands):
We use interest rate derivatives to hedge the variable cash flows associated with certain of our existing LIBOR-based variable-rate debt, including our $2.2 billion unsecured senior line of credit and unsecured senior bank term loan, and to manage our exposure to interest rate volatility.
The fair value of each interest rate hedge agreement is determined using widely accepted valuation techniques, including discounted cash flow analyses on the expected cash flows of each derivative. These analyses reflect the contractual terms of the derivatives, including the period to maturity, and use observable market-based inputs, including interest rate curves and implied volatilities. The fair values of our interest rate hedge agreements are determined
using the market-standard methodology of netting the discounted future fixed-cash payments and the discounted expected variable-cash receipts. The variable-cash receipts are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. The fair value calculation also includes an amount for risk of non-performance of our counterparties using “significant unobservable inputs,” such as estimates of current credit spreads to evaluate the likelihood of default, which we have determined to be insignificant to the overall fair value of our interest rate hedge agreements.
Changes in fair value, including accrued interest and adjustments for non-performance risk, of our interest rate hedge agreements that are designated and that qualify as cash flow hedges are classified in accumulated other comprehensive income. Amounts
classified in accumulated other comprehensive income are subsequently reclassified into earnings in the period during which the hedged transactions affect earnings. During the next 12 months, we expect to reclassify approximately $i1.7 million from accumulated other comprehensive income to earnings as an increase of interest expense. As of June 30, 2019, and December 31,
2018, the fair values of our interest rate hedge agreements aggregating an asset balance were classified in other assets, and the fair values of our interest rate hedge agreements aggregating a liability balance were classified in accounts payable, accrued expenses, and tenant security deposits, based upon their respective fair values, without any offsetting pursuant to master netting agreements. Refer to Note 9 – “Fair Value Measurements” to these unaudited consolidated financial statements for further details. Under our interest rate hedge agreements, we have ino
collateral posting requirements.
We have agreements with certain of our derivative counterparties that contain a provision wherein we could be declared in default on our derivative obligations if (i) repayment of the underlying indebtedness is accelerated by the lender due to our default on the indebtedness or (ii) we default on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender. If we had breached any of these provisions as of June 30, 2019, we could have been required to settle our obligations under the agreements at their termination value of $i1.7
million.
i
We had the following outstanding interest rate hedge agreements that were designated as cash flow hedges of interest rate risk as of June 30, 2019 (dollars in thousands):
In
addition to the interest pay rate for each hedge agreement, interest is payable at an applicable margin over LIBOR for borrowings outstanding as of June 30, 2019, as listed under the column heading “Stated Rate” in our summary table of outstanding indebtedness and respective principal payments under Note 10 – “Secured and Unsecured Senior Debt” to these unaudited consolidated financial statements.
/
(2)
Excludes notional amounts aggregating $i175.0
million related to the interest rate hedge agreements terminated in July 2019. Refer to the discussion below.
In July 2019, in conjunction with the $i175.0 million partial repayment of our unsecured senior bank term loan, we also terminated two interest rate hedge agreements aggregating $i175.0
million with a weighted-average interest pay rate of i2.83% and recognized a loss of $i1.1
million related to the early termination of interest rate hedge agreements. This loss was classified within interest expense in our consolidated statements of income.
38
12.
i
Accounts
payable, accrued expenses, and tenant security deposits
i
The following table summarizes the components of accounts payable, accrued expenses, and tenant security deposits as of June 30, 2019, and December 31, 2018 (in thousands):
Refer
to Note 2 – “Summary of Significant Accounting Policies” and Note 5 – “Leases” to these unaudited consolidated financial statements for additional information.
/
Some of our properties may contain asbestos, which, under certain conditions, requires remediation. Although we believe that the asbestos is appropriately contained in accordance with environmental regulations, our practice is to remediate the asbestos upon the development or redevelopment of the affected property. We recognize a liability for the fair value of a conditional asset retirement obligation (including asbestos) when the fair value of the liability can be reasonably estimated. For certain properties we do not recognize
an asset retirement obligation when there is an indeterminate settlement date for the obligation because the period in which we may remediate the obligation may not be estimated with any level of precision to provide for a meaningful estimate of the retirement obligation.
13.
i
Earnings
per share
From time to time we enter into forward equity sales agreements, which are discussed in Note 14 – “Stockholders’ Equity” to these unaudited consolidated financial statements for additional information. We considered the potential dilution resulting from the forward equity sales agreements on the EPS calculations. At inception, the agreements do not have an effect on the computation of basic EPS as no shares are delivered until settlement. The common shares issued upon the settlement of the forward equity sales agreements, weighted for the period these common shares were outstanding, are included in the denominator of basic EPS. To determine the dilution resulting from the forward equity sales agreements during the period of time prior to settlement, we calculate the number of weighted-average shares outstanding – diluted using the treasury
stock method. For the three and six months ended June 30, 2019, the effect on our weighted-average shares – diluted from the forward equity sales agreements entered into during the three months ended June 30, 2019, was i68 thousand and i34
thousand weighted-average incremental shares, respectively. For the three and six months ended June 30, 2018, the effect on our weighted-average shares – diluted from the forward equity sales agreements entered into in January 2018 was i355 thousand and i313
thousand weighted-average incremental shares, respectively.
For purposes of calculating diluted EPS, we did not assume conversion of our i7.00% Series D cumulative convertible preferred stock (“Series D Convertible Preferred Stock”) for the three and six months ended June 30,
2019 and 2018, since the result was antidilutive to EPS attributable to Alexandria Real Estate Equities, Inc.’s common stockholders from continuing operations during each period. Refer to Note 14 – “Stockholders’ Equity” to these unaudited consolidated financial statements for additional information about our Series D Convertible Preferred Stock.
We account for unvested restricted stock awards that contain nonforfeitable rights to dividends as participating securities and include these securities in the computation of EPS using the two-class method. Our Series D Convertible Preferred Stock and forward equity sales agreements are not participating securities and are therefore not included in the computation of EPS using the two-class method. Under
the two-class method, we allocate net income (after amounts attributable to noncontrolling interests, dividends on preferred stock, and preferred stock redemption charge) to common stockholders and unvested restricted stock awards by using the weighted-average shares of each class outstanding for quarter-to-date and year-to-date periods independently, based on their respective participation rights to dividends declared (or accumulated) and undistributed earnings.
39
13.
Earnings per share (continued)
i
The
table below is a reconciliation of the numerators and denominators of the basic and diluted EPS computations for the three and six months ended June 30, 2019 and 2018 (in thousands, except per share amounts):
Net
income attributable to noncontrolling interests
(i8,412
)
(i5,817
)
(i16,071
)
(i11,705
)
Dividends
on preferred stock
(i1,005
)
(i1,302
)
(i2,031
)
(i2,604
)
Preferred
stock redemption charge
i—
i—
(i2,580
)
i—
Net
income attributable to unvested restricted stock awards
(i1,432
)
(i1,412
)
(i3,134
)
(i2,765
)
Numerator
for basic and diluted EPS – net income attributable to Alexandria Real Estate Equities, Inc.’s common stockholders
$
i76,330
$
i52,016
$
i200,181
$
i184,991
Denominator
for basic EPS – weighted-average shares of common stock outstanding
i111,433
i101,881
i111,245
i100,878
Dilutive
effect of forward equity sales agreements
i68
i355
i34
i313
Denominator
for diluted EPS – weighted-average shares of common stock outstanding
i111,501
i102,236
i111,279
i101,191
Net
income per share attributable to Alexandria Real Estate Equities, Inc.’s common stockholders:
Basic
$
i0.68
$
i0.51
$
i1.80
$
i1.83
Diluted
$
i0.68
$
i0.51
$
i1.80
$
i1.83
/
40
14.
i
Stockholders’
equity
Common equity transactions
During the three and six months ended June 30, 2019, we completed issuances and entered into forward equity sales agreement for an aggregate of i8.7
million shares of common stock at a weighted-average price of $i144.50 per share, for aggregate net proceeds of approximately $i1.2
billion as follows:
•
Issued i602,484 shares of common stock, at a weighted-average price of $i145.58
per share, for net proceeds of $i86.1 million.
•
Entered into forward equity sales agreements to sell an aggregate of i8.1
million shares of common stock, at a weighted-average price of $i144.42 per share, for aggregate proceeds (net of underwriters’ discounts) of approximately $i1.1
billion, to be further adjusted as provided in the forward equity sales agreements, including:
(i) agreements to issue i4.4 million shares at a price of $i145.00
per share expiring in June 2020.
(ii) agreements to issue i3.7 million shares at a weighted-average price of $i143.73
per share expiring in July 2020.
•
In connection with these forward equity sales agreements, we incurred initial issuance costs aggregating $i700 thousand.
i
The
following table presents a detail of shares of common stock issued and the remaining aggregate amount available for future sales of common stock under our ATM program as of June 30, 2019 (dollars in thousands, except per share amounts):
Total
August 2018 ATM common stock offering program
$
i750,000
/
7.00%
Series D cumulative convertible preferred stock
As of June 30, 2019 and December 31, 2018, i2.3 million and i2.6
million shares of our Series D Convertible Preferred Stock were outstanding, respectively. During the six months ended June 30, 2019, we repurchased, in privately negotiated transactions, i275,000 outstanding shares of our Series D Convertible Preferred Stock at an aggregate price of $i9.2
million, or $i33.60 per share. We recognized a preferred stock redemption charge of $i2.6
million during the six months ended June 30, 2019, including the write-off of original issuance costs of approximately $i215 thousand.
The dividends on our Series D Convertible Preferred Stock are cumulative and accrue from the date of original issuance. We pay dividends
quarterly in arrears at an annual rate of $i1.75 per share. Our Series D Convertible Preferred Stock has no stated maturity and is not subject to any sinking fund or mandatory redemption provisions. We are not allowed to redeem our Series D Convertible Preferred Stock, except to preserve our status as a REIT. Investors in our Series D Convertible Preferred Stock generally have no voting rights.
We may, at our option, be able to cause some or all of our Series D Convertible Preferred Stock to be automatically converted if the closing sale price per share of our common stock equals or exceeds i150% of the then-applicable conversion price of the Series D Convertible Preferred Stock for at least i20 trading
days in a period of i30 consecutive trading days ending on the trading day immediately prior to our issuance of a press release announcing the exercise of our conversion option. Holders of our Series D Convertible Preferred Stock, at their option, may, at any time and from time to time, convert some or all of their outstanding shares initially at a conversion rate of i0.2477 shares
of common stock per $i25.00 liquidation preference, which was equivalent to an initial conversion price of approximately $i100.93 per
share of common stock. The conversion rate for the Series D Convertible Preferred Stock is subject to adjustments for certain events, including, but not limited to, certain dividends on our common stock in excess of $i0.78 per share per quarter and dividends on our common stock payable in shares of our common stock. As of June 30,
2019, the Series D Convertible Preferred Stock had a conversion rate of approximately i0.2509 shares of common stock per $i25.00 liquidation
preference, which is equivalent to a conversion price of approximately $i99.64 per share of common stock.
Dividends
During the three months ended June 30, 2019, we declared cash
dividends on our common stock aggregating $i113.5 million, or $i1.00 per share, and cash dividends
on our Series D Convertible Preferred Stock aggregating $i1.0 million, or $i0.4375
per share. In July 2019, we paid the cash dividends on our common stock and Series D Convertible Preferred Stock declared for the three months ended June 30, 2019.
41
14.
Stockholders’ equity (continued)
During the six months ended June 30,
2019, we declared cash dividends on our common stock aggregating $i223.1 million, or $i1.97
per share, and cash dividends on our Series D Convertible Preferred Stock aggregating $i2.0 million, or $i0.8750
per share.
Accumulated other comprehensive income (loss)
i
The following table presents the changes in each component of accumulated other comprehensive income (loss) attributable to Alexandria Real Estate Equities, Inc.’s stockholders during the six months ended June 30, 2019 (in thousands):
Common
stock, preferred stock, and excess stock authorizations
Our charter authorizes the issuance of i200.0 million shares of common stock, of which i112.0
million shares were issued and outstanding as of June 30, 2019. Our charter also authorizes the issuance of up to i100.0 million shares of preferred stock, of which i2.3 million
shares were issued and outstanding as of June 30, 2019. In addition, i200.0 million shares of “excess stock” (as defined in our charter) are authorized, inone
of which were issued and outstanding as of June 30, 2019.
15.
i
Noncontrolling interests
Noncontrolling
interests represent the third-party interests in certain entities in which we have a controlling interest. These entities owned i12 properties as of June 30, 2019, and are included in our consolidated financial statements. Noncontrolling interests are adjusted for additional contributions
and distributions, the proportionate share of the net earnings or losses, and other comprehensive income or loss. Distributions, profits, and losses related to these entities are allocated in accordance with the respective operating agreements. During the six months ended June 30, 2019 and 2018, we distributed $i24.6
million and $i18.4 million, respectively, to our consolidated real estate joint venture partners.
Certain of our noncontrolling interests have the right to require us to redeem their ownership interests in the respective entities. We classify these ownership interests in the entities as redeemable noncontrolling interests outside
of total equity in our consolidated balance sheets. Redeemable noncontrolling interests are adjusted for additional contributions and distributions, the proportionate share of the net earnings or losses, and other comprehensive income or loss. If the amount of a redeemable noncontrolling interest is less than the maximum redemption value at the balance sheet date, such amount is adjusted to the maximum redemption value. Subsequent declines in the redemption value are recognized only to the extent that previous increases have been recognized.
16.
i
Assets
classified as held for sale
As of June 30, 2019, three properties aggregating i458,842 RSF were classified as held for sale and did not meet the criteria
for classification as discontinued operations in our consolidated financial statements.
i
The following is a summary of net assets as of June 30, 2019, and December 31, 2018, for our real estate investments that were
classified as held for sale as of each respective date (in thousands):
In July 2019, we issued $i1.25 billion of unsecured senior notes. The net proceeds were primarily used to refinance an aggregate $i950.0
million of unsecured senior notes payable comprising $i400.0 million of i2.75%
unsecured senior notes payable due 2020 and $i550.0 million of i4.60%
unsecured senior notes payable due 2022, pursuant to a cash tender offer and subsequent call for redemption. The remaining net proceeds were used to make a partial repayment of $i175.0 million on our unsecured senior bank term loan balance and to reduce the outstanding balance of our unsecured senior line of credit. Refer to Note 10 – “Secured and Unsecured Senior Debt” to these unaudited consolidated financial statements for further
discussion.
Acquisitions
In July 2019, we acquired a i55% interest in 4224 and 4242 Campus Point Court and 10210
Campus Point Drive, located adjacent to our Campus Pointe by Alexandria campus in our University Town Center submarket of San Diego, for $i140.3 million. The joint venture will include three operating properties aggregating i314,092
RSF, which are currently i83% occupied by multiple tenants. The properties, which have future value-creation opportunities, will be integrated into the current campus to create a i1.9
million RSF mega campus.
18.
i
Condensed consolidating financial information
Alexandria
Real Estate Equities, Inc. (the “Issuer”) has sold certain debt securities registered under the Securities Act of 1933, as amended, that are fully and unconditionally guaranteed by Alexandria Real Estate Equities, L.P. (the “LP” or the “Guarantor Subsidiary”), an indirectly 100% owned subsidiary of the Issuer. The Issuer’s other subsidiaries, including, but not limited to, the subsidiaries that own substantially all of its real estate (collectively, the “Combined Non-Guarantor Subsidiaries”), will not provide a guarantee of such securities, including the subsidiaries that are partially
or 100% owned by the LP. The following condensed consolidating financial information presents the condensed consolidating balance sheets as of June 30, 2019, and December 31, 2018, the condensed consolidating statements of income and comprehensive income for the three and six months ended June 30, 2019 and 2018, and the condensed consolidating statements of cash flows for the six months ended June 30, 2019 and 2018,
for the Issuer, the Guarantor Subsidiary, and the Combined Non-Guarantor Subsidiaries, as well as the eliminations necessary to arrive at the information on a consolidated basis. In presenting the condensed consolidating financial statements, the equity method of accounting has been applied to (i) the Issuer’s interests in the Guarantor Subsidiary and the Combined Non-Guarantor Subsidiaries, (ii) the Guarantor Subsidiary’s interests in the Combined Non-Guarantor Subsidiaries, and (iii) the Combined Non-Guarantor Subsidiaries’ interests in the Guarantor Subsidiary, where applicable, even though all such subsidiaries
meet the requirements to be consolidated under GAAP. All intercompany balances and transactions between the Issuer, the Guarantor Subsidiary, and the Combined Non-Guarantor Subsidiaries have been eliminated, as shown in the column “Eliminations.” All assets and liabilities have been allocated to the Issuer, the Guarantor Subsidiary, and the Combined Non-Guarantor Subsidiaries generally based on legal entity ownership.
43
18.
Condensed
consolidating financial information (continued)
Repayments
of borrowings from secured notes payable
i—
i—
(i3,162
)
i—
(i3,162
)
Proceeds
from issuance of unsecured senior notes payable
i899,321
i—
i—
i—
i899,321
Borrowings
from unsecured senior line of credit
i2,469,000
i—
i—
i—
i2,469,000
Repayments
of borrowings from unsecured senior line of credit
(i2,519,000
)
i—
i—
i—
(i2,519,000
)
Transfers
to/from parent company
i96,432
i837,717
i931,815
(i1,865,964
)
i—
Payment
of loan fees
(i8,003
)
i—
i—
i—
(i8,003
)
Proceeds
from issuance of common stock
i400,207
i—
i—
i—
i400,207
Dividends
on common stock
(i183,040
)
i—
i—
i—
(i183,040
)
Dividends
on preferred stock
(i2,604
)
i—
i—
i—
(i2,604
)
Contributions
from noncontrolling interests
i—
i—
i14,564
i—
i14,564
Distributions
to noncontrolling interests
i—
i—
(i19,841
)
i—
(i19,841
)
Net
cash provided by financing activities
i1,152,313
i837,717
i932,420
(i1,865,964
)
i1,056,486
Effect
of foreign exchange rate changes on cash and cash equivalents
i—
i—
(i1,173
)
i—
(i1,173
)
Net
increase (decrease) in cash, cash equivalents, and restricted cash
i50,981
(i9
)
(i6,317
)
i—
i44,655
Cash,
cash equivalents, and restricted cash as of the beginning of period
i130,516
i9
i146,661
i—
i277,186
Cash,
cash equivalents, and restricted cash as of the end of period
$
i181,497
$
i—
$
i140,344
$
i—
$
i321,841
Supplemental
Disclosures and Non-Cash Investing and Financing Activities:
Cash paid during the period for interest, net of interest capitalized
$
i56,392
$
i—
$
i12,493
$
i—
$
i68,885
Change
in accrued construction
$
i—
$
i—
$
i48,074
$
i—
$
i48,074
Accrued
construction for current-period additions to real estate
$
i—
$
i—
$
i183,573
$
i—
$
i183,573
57
ITEM
2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain information and statements included in this quarterly report on Form 10‑Q, including, without limitation, statements containing the words “forecast,”“guidance,”“projects,”“estimates,”“anticipates,”“goals,”“believes,”“expects,”“intends,”“may,”“plans,”“seeks,”“should,” or “will,” or the negative of those words or similar words, constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements involve inherent risks and uncertainties regarding events, conditions, and financial trends that may affect our future plans of
operations, business strategy, results of operations, and financial position. A number of important factors could cause actual results to differ materially from those included within or contemplated by the forward-looking statements, including, but not limited to, the following:
•
Operating factors such as a failure to operate our business successfully in comparison to market expectations or in comparison to our competitors, our inability to obtain capital when desired or refinance debt maturities when desired, and/or a failure to maintain our status as a REIT for federal tax purposes.
•
Market
and industry factors such as adverse developments concerning the life science and technology industries and/or our tenants.
•
Government factors such as any unfavorable effects resulting from federal, state, local, and/or foreign government policies, laws, and/or funding levels.
•
Global factors such as negative economic, political, financial, credit market, and/or banking conditions.
•
Other
factors such as climate change, cyber intrusions, and/or changes in laws, regulations, and financial accounting standards.
This list of risks and uncertainties is not exhaustive. Additional information regarding risk factors that may affect us is included under “Item 1A. Risk Factors” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our annual report on Form 10‑K for the year ended December 31, 2018. Readers of this quarterly report on Form 10‑Q should also read our other documents filed publicly with the SEC for further discussion regarding such factors.
58
Overview
We
are a Maryland corporation formed in October 1994 that has elected to be taxed as a REIT for federal income tax purposes. We are anS&P 500® urban office REIT and the first and longest-tenured owner, operator, and developer uniquely focused on collaborative life science, technology, and agtech campuses in AAA innovation cluster locations, with a total market capitalization of $22.2 billion and an asset base in North America of 34.3 million SF as of June 30, 2019. The asset base in North America includes 23.6 million RSF of operating properties and 1.5 million
RSF of Class A properties undergoing construction, with projected initial occupancy in 2019, 1.9 million RSF of Class A properties undergoing construction or pre-construction, with projected initial occupancy in 2020, 4.4 million RSF of Class A properties undergoing or nearing pre-construction, with projected initial occupancy in 2021 or 2022, and 2.9 million of future development projects. Founded in 1994, we pioneered this niche and have since established a significant market presence in key locations, including Greater Boston, San Francisco, New York City, San Diego, Seattle, Maryland, and Research Triangle. We have a longstanding and proven track record of developing Class A properties clustered in urban life science, technology, and agtech campuses that provide our innovative tenants with highly dynamic and collaborative environments
that enhance their ability to successfully recruit and retain world-class talent and inspire productivity, efficiency, creativity, and success. Alexandria also provides strategic capital to transformative life science, technology, and agtech companies through our venture capital arm. We believe these advantages result in higher occupancy levels, longer lease terms, higher rental income, higher returns, and greater long-term asset value.
Investment-grade or publicly traded large cap tenants represented 53%
of our total annual rental revenue;
•
Approximately 97%of our leases (on an RSF basis) were triple net leases, which require tenants to pay substantially all real estate taxes, insurance, utilities, repairs and maintenance, common area expenses, and other operating expenses (including increases thereto) in addition to base rent;
•
Approximately 95%of our leases (on an RSF basis) contained
effective annual rent escalations that were either fixed (generally ranging from approximately 3% to 3.5%) or indexed based on a consumer price index or other index; and
•
Approximately 96% of our leases (on an RSF basis) provided for the recapture of capital expenditures (such as HVAC systems maintenance and/or replacement, roof replacement, and parking lot resurfacing) that we believe would typically be borne by the landlord in traditional office leases.
Our
primary business objective is to maximize stockholder value by providing our stockholders with the greatest possible total return and long-term asset value based on a multifaceted platform of internal and external growth. A key element of our strategy is our unique focus on Class A properties clustered in urban campuses. These key urban campus locations are characterized by high barriers to entry for new landlords, high barriers to exit for tenants, and a limited supply of available space. They generally represent highly desirable locations for tenancy by life science, technology, and agtech entities because of their close proximity to concentrations of specialized skills, knowledge, institutions, and related businesses. Our strategy also includes drawing upon our deep and broad real estate, life science, and technology relationships in order to identify and attract new and leading tenants and to source additional value-creation real estate.
Net
income attributable to Alexandria’s common stockholders – diluted:
In millions
$
76.3
$
52.0
$
200.2
$
185.0
Per
share
$
0.68
$
0.51
$
1.80
$
1.83
Funds
from operations attributable to Alexandria’s common stockholders – diluted, as adjusted:
In millions
$
192.7
$
167.9
$
382.5
$
330.4
Per
share
$
1.73
$
1.64
$
3.44
$
3.27
The
operating results shown above include certain items related to corporate-level investing and financing decisions. Refer to the tabular presentation of these items at the beginning of the “Results of Operations” section within this Item 2 for additional information.
88 Bluxome Street is the first and only project to win full approval in Central SoMa
In July 2019, we, along with TMG Partners, won full project approval to develop a 1.07 million RSF mixed-use campus at 88 Bluxome Street in Central SoMa. Anchored by a 490,000 RSF lease with Pinterest, Inc., the future development, which is the first and only project in Central SoMa to receive full approval and 100% of its Prop M allocation from the San Francisco Planning Commission, is nearly
60% pre-leased. Construction is expected to commence in 2020, and initial delivery is expected in 2022.
59
Strong internal growth
•
Total revenues:
•
$373.9 million, up 15.0%, for the three
months ended June 30, 2019, compared to $325.0 million for the three months ended June 30, 2018.
•
$732.7 million, up 13.6%, for the six months ended June 30, 2019, compared to $645.2 million for the six months ended June 30, 2018.
•
Net
operating income (cash basis) of $938.5 million for the three months ended June 30, 2019, annualized, up $119.9 million, or 14.6%, compared to the three months ended June 30, 2018, annualized.
•
Same property net operating income growth:
•
4.3%
and 9.5% (cash basis) for the three months ended June 30, 2019, compared to the three months ended June 30, 2018.
•
3.5% and 9.7% (cash basis) for the six months ended June 30, 2019, compared to the six months ended June 30, 2018.
•
Continued
strong leasing activity and rental rate growth in light of modest contractual lease expirations at the beginning of 2019 and a highly leased value-creation pipeline:
Strong external growth; disciplined allocation of capital to visible, highly leased value-creation pipeline
•
Since
the beginning of the fourth quarter of 2018, we have placed into service 1.2 million RSF of development and redevelopment projects, including 218,061 RSF during the three months ended June 30, 2019.
•
Significant near-term growth in net operating income (cash basis) of $58 million annually upon the burn-off of initial free rent on recently delivered projects.
•
Commencements
of development projects aggregating 841,178 RSF during the three months ended June 30, 2019, include:
•
526,178 RSF at Alexandria District for Science and Technology in our Greater Stanford submarket; and
•
315,000 RSF at 201 Haskins Way in our South San Francisco submarket.
•
Projects
with initial occupancy in 2020 have grown to 2.2 million RSF.
•
During 2019, we leased 948,986 RSF of development and redevelopment space, including 196,020 RSF executed in July 2019.
A REIT industry-leading, high-quality tenant roster
•
53%
of annual rental revenue from investment-grade or publicly traded large cap tenants.
•
Weighted-average remaining lease terms of 8.4 years.
New issuance of $1.25 billion unsecured senior notes to elongate debt maturities
In July 2019, we opportunistically issued $1.25 billion of unsecured senior notes payable, with a weighted-average interest rate of 3.72% and a weighted-average maturity of 19.5
years. The proceeds were used to refinance $1.125 billion of unsecured senior notes payable and unsecured senior bank term loan, with a weighted-average interest rate of 3.94% and a weighted-average maturity of 2.4 years, with remaining proceeds used to reduce the outstanding balance of our unsecured senior line of credit. Upon completion of the refinancing, the pro forma weighted-average remaining term on our outstanding debt is 10.1 years, with no debt maturing until 2023.
Increased common stock dividend
Common stock dividend declared for the three months
ended June 30, 2019, of $1.00 per common share, up seven cents, or 7.5%, over the three months ended June 30, 2018; continuation of our strategy to share growth in cash flows from operating activities with our stockholders while also retaining a significant portion for reinvestment.
2019 Nareit Investor CARE Gold Award winner
2019 recipient of the Nareit Investor CARE (Communications and Reporting Excellence) Gold Award in the Large Cap Equity REIT category as the best-in-class REIT
that delivers transparency, quality, and efficient communications and reporting to the investment community; our fourth Nareit Investor CARE Gold Award over the last five years.
60
Completed acquisitions
Refer to the “Acquisitions” subsection of the “Investments in Real Estate” section within Item 2 of this report for information on our opportunistic acquisitions.
Core operating metrics as of or for the quarter ended June 30, 2019
Percentage
of annual rental revenue in effect from:
Investment-grade or publicly traded large cap tenants
53
%
Class A properties in AAA locations
77
%
Occupancy
of operating properties in North America
97.4
%
Operating margin
72
%
Adjusted EBITDA margin
69
%
Weighted-average
remaining lease term:
All tenants
8.4
years
Top 20 tenants
12.0
years
Refer
to the “Strong Internal Growth” subsection on the previous page for information on our total revenues, net operating income, same property net operating income growth, rental rate growth, and leasing activity.
Value-creation pipeline as a percentage of gross investments in real estate:
New
Class A development and redevelopment projects:
Undergoing construction with initial occupancy targeted for 2019 and 2020 and our pre-leased pre-construction project at 88 Bluxome Street
74%
5%
Less
than 15%
Undergoing pre-construction, marketing, and future value-creation projects
N/A
6%
61
Key capital events
•
During
the three months ended June 30, 2019, we completed sales and entered into forward equity sales agreements for an aggregate of 8.7 million shares of common stock, including issuances under our ATM program, at a weighted-average price of $144.50 per share, for aggregate net proceeds of approximately $1.2 billion as follows:
•
Issued 602,484 shares of common stock, at a weighted-average price of $145.58 per share, for net proceeds
of $86.1 million.
•
Entered into forward equity sales agreements to sell an aggregate 8.1 million shares of common stock, at a weighted-average price of $144.42 per share, for expected net proceeds (net of underwriters’ discounts) aggregating $1.1 billion including:
•
4.4 million shares expiring in June 2020 at a price
of $145.00 per share.
•
3.7 million shares expiring in July 2020 at a weighted-average price of $143.73 per share.
•
We expect to settle these forward equity sales in 2019 and the aggregate net proceeds that will be received upon settlement will be further adjusted as provided in the sales agreements.
•
As
of the date of this report, the remaining aggregate amount available under our ATM program for future sales of common stock is $22.5 million. We expect to establish a new ATM program during the three months ending September 30, 2019.
Investments
We carry our investments in publicly traded companies and certain privately held entities at fair value. As of June 30, 2019, cumulative unrealized gains related to changes in fair value aggregated $323.4 million and investments adjusted cost basis aggregated $734.4 million.
Investment income included the following:
•
Unrealized gains of $11.1 million and $83.3 million recognized during the three and six months ended June 30, 2019, respectively.
•
Realized gains of $10.4 million and $21.8 million recognized during the three
and six months ended June 30, 2019, respectively.
Corporate responsibility, industry leadership, and strategic initiatives
•
In April 2019, we announced the launch of a new strategic agricultural technology (agtech) business initiative and the opening of Phase I of the Alexandria Center® for AgTech – Research Triangle, the first and only fully integrated, amenity-rich, multi-tenant agtech R&D and greenhouse campus, in the heart of Research Triangle, the most important,
dense, and diverse agtech cluster in the U.S. The campus opened with a 97% leased, 175,000 RSF first phase redevelopment at 5 Laboratory Drive.
•
In June 2019, we announced our partnership with Columbia University to open our second Alexandria LaunchLabs® in New York City in the spring of 2020. The full-service platform will offer member companies 13,298 RSF of highly flexible, turnkey office/laboratory space and feature a high-tech event center to host workshops, networking events, and educational opportunities for the entrepreneurial life science community.
•
In
June 2019, we celebrated the opening of the first facilities within a tech-focused opioid rehabilitation campus in Dayton, Ohio. In partnership with Verily Life Sciences, LLC, we are leading the design and development of this 59,000 RSF state-of-the-art campus to provide a comprehensive model of care dedicated to the recovery of people suffering from opioid addiction.
62
Subsequent events
•
In July 2019, we opportunistically issued
$1.25 billion of unsecured senior notes payable, with a weighted-average interest rate of 3.72% and a weighted-average maturity of 19.5 years, including $750.0 million of 3.375% unsecured senior notes due 2031 and $500.0 million of 4.00% unsecured senior notes due 2050. The proceeds were used to refinance $1.125 billion of unsecured senior notes payable and unsecured senior bank term loan, with a weighted-average interest rate of 3.94% and a weighted-average maturity of
2.4 years, consisting of the following:
(i)
Refinancing of an aggregate $950.0 million of unsecured senior notes payable comprising $400.0 million of 2.75% unsecured senior notes payable due 2020 and $550.0 million of 4.60% unsecured senior notes payable due 2022, pursuant to a cash tender offer completed on July 17, 2019, and subsequent call for redemption. The redemption is expected to settle on August 16, 2019.
(ii)
Partial
repayment of $175.0 million on our unsecured senior bank term loan. The remaining outstanding balance of the term loan will mature on January 2, 2025, if not repaid before maturity.
•
As a result of our refinancing and partial repayment, we expect to recognize a loss, primarily related to the early extinguishment of debt, of $43 million during the three months ended June 30, 2019.
•
The
remaining proceeds were used to reduce the outstanding balance of our unsecured senior line of credit.
•
Upon completion of the refinancing, the pro forma weighted-average remaining term on our outstanding debt is 10.1 years, with no debt maturing until 2023.
•
In July 2019, we acquired a 55% interest in 4224 and 4242 Campus Point Court and 10210 Campus Point Drive, located adjacent to our Campus Pointe by Alexandria campus in
our University Town Center submarket of San Diego, for $140.3 million. The joint venture will include three operating properties aggregating 314,092 RSF, which are currently 83% occupied by multiple tenants. The properties, which have future value-creation opportunities, will be integrated into the current campus to create a 1.9 million RSF mega campus.
63
Operating summary
Same
Property Net Operating
Income Growth
Favorable Lease Structure(1)
Strategic Lease Structure by Owner and Operator of Collaborative Life Science, Technology, and AgTech Campuses
Stable
cash flows
Percentage of triple
net leases
97%
Increasing cash flows
Percentage of leases containing annual rent escalations
95%
Lower
capex burden
Percentage of leases providing for the recapture of capital expenditures
96%
Rental
Rate Growth: Renewed/Re-Leased Space
Margins(2)
Operating
Adjusted
EBITDA
72%
69%
(1)
Percentages
calculated based on RSF as of June 30, 2019.
(2)
Represents percentages for the three months ended June 30, 2019.
64
Long-Duration
Cash Flows From High-Quality, Diverse, and
Innovative Tenants
Investment-Grade or
Publicly Traded Large Cap Tenants
Long-Duration Lease Terms
53%
8.4
Years
of ARE’s
Weighted-Average
Annual Rental Revenue(1)
Remaining Term
Tenant Mix
Percentage
of ARE’s Annual Rental Revenue(1)
(1)
Represents annual rental revenue in effect as of June 30, 2019. Refer to the “Non-GAAP Measures and Definitions” section within this Item 2 for additional information.
(2)
73% of our annual rental
revenue for technology tenants is from investment-grade or publicly traded large cap tenants.
65
High-Quality Cash Flows From Class A Properties in AAA Locations
Class A Properties in
AAA Locations
AAA
Locations
77%
of ARE’s Annual Rental Revenue(1)
Percentage of ARE’s Annual Rental Revenue(1)
Solid
Demand for Class A Properties
in AAA Locations Drives Solid Occupancy
Solid Historical Occupancy(2)
Occupancy Across Key Locations
96%
Over 10 Years
(1)
Represents
annual rental revenue in effect as of June 30, 2019. Refer to the “Non-GAAP Measures and Definitions” section within this Item 2 for additional information.
(2)
Average occupancy of operating properties in North America as of each December 31 for the last 10 years and as of June 30, 2019.
66
Leasing
The
following table summarizes our leasing activity at our properties:
Leasing
activity includes 100% of results for properties in which we have an investment in North America.
(1)
Excludes month-to-month leases aggregating 35,476 RSF and 50,548 RSF as of June 30, 2019, and December 31, 2018, respectively.
(2)
During
the six months ended June 30, 2019, we granted tenant concessions/free rent averaging 2.0 months with respect to the 2,068,921 RSF leased. Approximately 66% of the leases executed during the six months ended June 30, 2019, did not include concessions for free rent.
67
Summary of contractual
lease expirations
The following table summarizes information with respect to the contractual lease expirations at our properties as of June 30, 2019:
Excludes month-to-month leases for 35,476 RSF as of June 30, 2019.
The following tables present information by market with respect to our lease expirations in North America as of June 30, 2019, for the remainder of 2019
and all of 2020:
2019 Contractual Lease Expirations (in RSF)
Annual
Rental Revenue (per RSF)(3)
Market
Leased
Negotiating/ Anticipating
Targeted for Redevelopment
Remaining Expiring Leases(1)
Total(2)
Greater
Boston
39,968
1,329
—
25,931
67,228
$
53.50
San
Francisco
1,287
—
—
65,195
66,482
41.98
New
York City
—
—
—
1,787
1,787
N/A
San
Diego
54,042
79,450
(4)
—
103,549
(4)
237,041
37.52
Seattle
—
18,374
—
23,443
41,817
50.03
Maryland
—
—
—
—
—
—
Research
Triangle
—
—
—
28,381
28,381
23.49
Canada
—
—
—
—
—
—
Non-cluster
markets
3,111
1,217
—
33,747
38,075
22.26
Total
98,408
100,370
—
282,033
480,811
$
39.43
Percentage
of expiring leases
20
%
21
%
—
%
59
%
100
%
2020
Contractual Lease Expirations (in RSF)
Annual Rental Revenue (per RSF)(3)
Market
Leased
Negotiating/ Anticipating
Targeted for Redevelopment
Remaining Expiring
Leases(5)
Total
Greater Boston
83,680
77,817
—
334,821
496,318
$
46.17
San
Francisco
21,699
—
—
265,276
286,975
44.16
New
York City
—
—
—
38,076
38,076
N/A
San
Diego
679
—
—
293,190
293,869
27.84
Seattle
—
12,727
—
32,047
44,774
38.65
Maryland
26,370
14,446
—
149,288
190,104
19.30
Research
Triangle
—
29,053
—
60,385
89,438
16.50
Canada
59,088
—
—
35,505
94,593
28.10
Non-cluster
markets
—
—
—
31,160
31,160
34.53
Total
191,516
134,043
—
1,239,748
1,565,307
$
35.65
Percentage
of expiring leases
12
%
9
%
—
%
79
%
100
%
(1)
After
the lease expiration noted in footnote 4 below, the largest remaining contractual lease expiration in 2019 is 50,400 RSF at a Class A office/laboratory building in our South San Francisco submarket.
(2)
Excludes month-to-month leases aggregating 35,476 RSF as of June 30, 2019.
Includes 116,556 RSF at 3545 Cray Court in our Torrey Pines submarket, of which 49,506 RSF are under negotiation, and the remaining 67,050 RSF are undergoing marketing. The property will be renovated as a Class A office/laboratory building and will not be classified as a redevelopment. As such, we expect the property will remain in our same property performance pool.
(5)
The
largest remaining contractual lease expiration in 2020 is 72,742 RSF in our South San Francisco submarket.
68
Top 20 tenants
84% of Top 20 Annual Rental Revenue From Investment-Grade
or Publicly Traded Large Cap Tenants(1)
Our
properties are leased to a high-quality and diverse group of tenants, with no individual tenant accounting for more than 3.4% of our annual rental revenue in effect as of June 30, 2019. The following table sets forth information regarding leases with our 20 largest tenants in North America based upon annual rental revenue in effect as of June 30, 2019 (dollars in thousands, except average market cap amounts):
Remaining
Lease Term in Years (1)
Aggregate
RSF
Annual
Rental
Revenue(1)
Percentage of Aggregate Annual Rental Revenue (1)
Investment-Grade
Credit Ratings
Average Market Cap(2)
(in billions)
Tenant
Moody’s
S&P
1
Takeda
Pharmaceutical Company Ltd.
10.1
606,249
$
39,251
3.4
%
Baa2
BBB+
$
44.9
2
Illumina,
Inc.
11.1
891,495
35,907
3.2
—
BBB
$
44.6
3
Sanofi
9.0
494,693
34,219
3.0
A1
AA
$
107.7
4
Eli
Lilly and Company
9.9
554,089
34,096
3.0
A2
A+
$
117.7
5
Celgene
Corporation
6.9
614,082
28,759
2.5
(3)
Baa2
BBB+
$
60.5
6
Novartis
AG
8.4
320,606
25,391
2.2
A1
AA-
$
219.2
7
Merck
& Co., Inc.
11.9
421,623
24,304
2.1
A1
AA
$
195.5
8
Uber
Technologies, Inc.
73.4
(4)
422,980
22,216
2.0
—
—
$
71.7
9
bluebird
bio, Inc.
7.7
290,617
21,709
1.9
—
—
$
7.4
10
Moderna,
Inc.
9.3
373,163
21,186
1.9
—
—
$
6.4
11
Bristol-Myers
Squibb Company
13.3
224,182
20,221
1.8
(3)
A2
A+
$
85.5
12
Roche
4.3
372,943
19,769
1.7
Aa3
AA
$
220.4
13
New
York University
12.2
201,284
19,002
1.7
Aa2
AA-
N/A
14
Facebook,
Inc.
11.2
382,798
18,343
1.6
—
—
$
478.4
15
Pfizer
Inc.
5.7
416,979
17,754
1.6
A1
AA
$
241.3
16
Stripe,
Inc.
8.3
295,333
17,736
1.6
—
—
N/A
17
Massachusetts
Institute of Technology
6.0
256,126
16,843
1.5
Aaa
AAA
N/A
18
Amgen
Inc.
4.8
407,369
16,838
1.5
Baa1
A
$
120.7
19
United
States Government
8.7
264,358
15,472
1.4
Aaa
AA+
N/A
20
FibroGen,
Inc.
4.4
234,249
14,198
1.2
—
—
$
4.3
Total/weighted
average
12.0
(4)
8,045,218
$
463,214
40.8
%
Annual
rental revenue and RSF include 100% of each property managed by us in North America.
(1)
Based on aggregate annual rental revenue in effect as of June 30, 2019. Refer to “Annual Rental Revenue” in the “Non-GAAP Measures and Definitions” section within this Item 2 for our methodologies on annual rental revenue from unconsolidated real estate joint ventures.
(2)
Average daily
market capitalization for the twelve months ended June 30, 2019. Refer to “Total Market Capitalization” in the “Non-GAAP Measures and Definitions” section within this Item 2 for additional information.
(3)
In April 2019, Bristol-Myers Squibb Company’s stockholders approved the acquisition of Celgene Corporation, with the transaction close expected by Bristol-Myers Squibb Company at the end of 2019 or the beginning of 2020. Proforma for the anticipated acquisition, our annual rental revenue from Bristol-Myers Squibb Company is approximately 4.3% based on leases in effect as of June
30, 2019.
(4)
Represents a ground lease with Uber Technologies, Inc. at 1455 and 1515 Third Street in our Mission Bay/SoMa submarket. Excluding the ground lease, the weighted-average remaining lease term for our top 20 tenants was 8.9 years as of June 30, 2019.
69
Locations
of properties
The locations of our properties are diversified among a number of life science and technology cluster markets. The following table sets forth the total RSF, number of properties, and annual rental revenue in effect as of June 30, 2019, in North America of our properties by market (dollars in thousands, except per RSF amounts):
RSF
Number
of Properties
Annual Rental Revenue
Market
Operating
Development
Redevelopment
Total
%
of Total
Total
% of Total
Per RSF
Greater Boston
6,459,424
40,597
19,036
6,519,057
25
%
56
$
408,990
36
%
$
65.05
San
Francisco
5,421,729
2,003,130
—
7,424,859
28
51
287,184
25
54.98
New
York City
1,127,580
—
140,098
1,267,678
5
5
79,599
7
72.31
San
Diego
4,809,604
98,000
—
4,907,604
18
61
175,034
16
38.23
Seattle
1,374,279
80,221
—
1,454,500
6
14
70,490
6
52.69
Maryland
2,524,323
258,904
41,627
2,824,854
11
39
68,601
6
28.30
Research
Triangle
1,173,672
—
45,054
1,218,726
5
16
30,947
3
26.94
Canada
188,967
—
—
188,967
1
2
4,704
—
26.57
Non-cluster
markets
390,179
—
—
390,179
1
11
11,017
1
33.28
Properties
held for sale
124,698
—
—
124,698
—
2
2,380
—
N/A
North
America
23,594,455
2,480,852
245,815
26,321,122
100
%
257
$
1,138,946
100
%
$
50.27
2,726,667
Summary
of occupancy percentages in North America
The following table sets forth the occupancy percentages for our operating properties and our operating and redevelopment properties in each of our North America markets, excluding properties held for sale, as of the following dates:
Operating
Properties
Operating and Redevelopment Properties
Market
6/30/19
3/31/19
6/30/18
6/30/19
3/31/19
6/30/18
Greater
Boston
98.7
%
98.2
%
97.2
%
98.4
%
97.7
%
96.7
%
San
Francisco
98.7
99.8
99.8
98.7
98.4
98.8
New
York City
98.8
98.7
100.0
87.8
87.7
100.0
San
Diego
95.2
94.2
95.8
95.2
94.2
92.3
Seattle
97.3
97.7
97.2
97.3
97.7
97.2
Maryland
96.7
97.0
95.7
95.1
95.3
91.9
Research
Triangle
97.9
97.3
96.5
94.2
87.8
85.3
Subtotal
97.6
97.6
97.4
96.6
95.8
95.2
Canada
93.7
93.5
98.6
93.7
93.5
98.6
Non-cluster
markets
84.9
81.1
77.9
84.9
81.1
77.9
North
America
97.4
%
97.2
%
97.1
%
96.4
%
95.5
%
95.0
%
Refer
to the “Non-GAAP Measures and Definitions” section within this Item 2 for additional information.
70
Investments in real estate
A key component of our business model is our disciplined allocation of capital to the development and redevelopment of new Class A properties located in collaborative life science and technology campuses in AAA urban innovation clusters. These projects are focused on providing high-quality, generic, and reusable spaces that meet the real estate requirements of, and are reusable by, a wide range of tenants. Upon completion, each value-creation project is expected
to generate a significant increase in rental income, net operating income, and cash flows. Our development and redevelopment projects are generally in locations that are highly desirable to high-quality entities, which we believe results in higher occupancy levels, longer lease terms, higher rental income, higher returns, and greater long-term asset values. Our pre-construction activities are undertaken in order to get the property ready for its intended use and include entitlements, permitting, design, site work, and other activities preceding commencement of construction of aboveground building improvements.
Our investments in real estate consisted of the following as of June 30, 2019 (dollars in thousands):
Value-creation
square feet currently included in rental properties(4)
—
—
—
(351,185
)
(688,601
)
(1,039,786
)
(1,039,786
)
24,499,227
1,528,585
2,208,270
4,366,537
4,517,941
12,621,333
37,120,560
Subsequent
acquisitions – pending and completed square feet included in the amounts above(3)
(904,772
)
—
(342,000
)
—
(1,535,938
)
(1,877,938
)
(2,782,710
)
23,594,455
1,528,585
1,866,270
4,366,537
2,982,003
10,743,395
34,337,850
(1)
Excludes construction spending incurred and acquisitions completed and pending subsequent to June 30, 2019. In addition, balances exclude our share of the cost basis associated with square footage of our unconsolidated properties, which is classified in investments in unconsolidated real estate joint ventures in our consolidated balance sheets.
(2)
Represents square footage of development and redevelopment projects by period of
projected initial occupancy. Multi-tenant projects may have occupancy by tenants over a period of time.
(3)
Includes completed and pending acquisitions during the third quarter of 2019. Refer to the “Acquisitions” section within this Item 2 for additional information.
(4)
Refer to the “Non-GAAP Measures and Definitions”section within this Item 2 for additional detail on value-creation square feet currently included in rental properties.
71
Acquisitions
Our
real estate asset acquisitions during the six months ended June 30, 2019, consisted of the following (dollars in thousands):
Property
Submarket/Market
Date
of Purchase
Number of Properties
Operating
Occupancy
Square Footage
Unlevered Yields
Purchase Price
Future
Development
Active Redevelopment
Operating With Future Development/ Redevelopment
Operating
Initial Stabilized
Initial Stabilized (Cash)
Value-creation
10
Necco Street
Seaport Innovation District/Greater Boston
3/26/19
—
N/A
175,000
—
—
—
(1
)
(1
)
81,100
Other
7/10/19
—
N/A
135,938
—
—
—
(1
)
(1
)
25,000
—
310,938
—
—
—
106,100
Operating
with value-creation
5
Necco Street
Seaport Innovation District/Greater Boston
5/9/19(2)
1
87
%
—
—
—
87,163
5.2
%
5.1
%
252,000
15
Necco Street
—
N/A
293,000
—
—
—
(1
)
(1
)
601
Dexter Avenue North
Lake Union/Seattle
6/18/19
1
100
%
188,400
—
18,680
—
(1
)
(1
)
28,500
3911
and 3931 Sorrento Valley Boulevard
Sorrento Valley/
San Diego
1/9/19
2
100
%
—
—
53,220
—
7.2
%
6.6
%
23,250
4075
Sorrento Valley Boulevard
Sorrento Valley/
San Diego
5/13/19
1
100
%
149,000
—
40,000
—
(1
)
(1
)
16,000
Other
2/6/19
4
—
—
75,864
—
39,150
9
630,400
—
187,764
87,163
358,900
Operating
4224/4242
Campus Point Court and 10210 Campus Point Drive (55% interest in consolidated JV)
University Town Center/ San Diego
7/9/19
3
83
%
(3)
—
—
—
314,092
6.9
%
6.0
%
140,250
3170
Porter Drive
Greater Stanford/ San Francisco
1/10/19
1
100
%
—
—
—
98,626
7.5
%
5.1
%
100,250
Shoreway
Science Center
Greater Stanford/ San Francisco
1/10/19
2
100
%
—
—
—
82,462
7.2
%
5.5
%
73,200
260
Townsend Street
Mission Bay/SoMa/ San Francisco
3/14/19
1
100
%
—
—
—
66,682
7.4
%
5.8
%
66,000
Other
7/12/19
1
100
%
—
—
—
30,680
13,200
8
—
—
—
592,542
392,900
Total
acquisitions
17
941,338
—
187,764
679,705
857,900
10260
Campus Point Drive and
4161 Campus Point Court
University Town Center/San Diego
1/2/19
2
100
%
N/A
N/A
N/A
N/A
(4
)
(4
)
65,000
Pending
Various
627,100
Total
$
1,550,000
(1)
We
expect to provide total estimated costs and related yields in the future subsequent to the commencement of development or redevelopment.
(2)
The seller accepted our offer on April 30, 2019, and we completed the acquisition of 5 and 15 Necco Street on May 9, 2019. The 5 Necco building is 87% leased for 12 years and expected to be occupied later in 2019. The remaining 13% of RSF is targeted for retail space.
(3)
The
property is currently 83% occupied and a lease for 10% of the property will commence during the fourth quarter of 2019 upon completion of renovations, increasing occupancy to 93%.
(4)
Refer to the “New Class A Development and Redevelopment Properties: Summary of Pipeline” section within this Item 2 for additional information.
72
Real
estate asset sales
Our completed and pending real estate asset sales during the six months ended June 30, 2019, consisted of the following (dollars in thousands, except for sales price per RSF):
Capitalization
Rate
(Cash Basis)(1)
Sales Price per RSF
Consideration in Excess of Book Value(2)
Property
Submarket/Market
Date
of Sale
Square Footage
Capitalization Rate
Sales Price
Sales of noncontrolling partial interests in core Class A properties:
75/125
Binney Street (sale of 60% noncontrolling interest)
Cambridge/Greater Boston
2/13/19
388,270
4.2%
4.3%
$
438,000
$
1,880
$
202,246
Pending(3)
San
Francisco Bay Area
Pending
TBD
TBD
TBD
140,000
TBD
TBD
Pending(3)
San
Diego
Pending
TBD
TBD
TBD
287,500
TBD
TBD
$
865,500
2019
guidance range
$
820,000
-
$
920,000
(1)
Capitalization
rates are calculated based upon net operating income (cash basis), annualized for the quarter preceding the date on which the property is sold.
(2)
We retained or expect to retain control over and consolidate these joint ventures. For consolidated joint ventures, we account for the difference between the consideration received and the book value of the interest to be sold as an equity transaction, with no gain or loss recognized in earnings.
(3)
We expect to complete this partial interest sale during the third quarter
of 2019.
73
Disciplined management of ground-up developments
(1)
Represents developments commenced since January 1, 2008, comprising 33
projects aggregating 8.3 million RSF.
(2)
Represents developments commenced and delivered since January 1, 2008, comprising 23 projects aggregating 5.5 million RSF.
74
Sustainability
(1)
Upon
completion of 20 projects in process targeting LEED certification.
(2)
Carbon pollution reduction is for directly managed buildings and reflects sum of annual like-for-like progress since 2015.
(3)
Upon completion of three projects in process targeting WELL certification.
(4)
Upon
completion of 10 projects in process targeting Fitwel certification.
75
New Class A development and redevelopment properties: recent deliveries
399
Binney Street
266 and 275 Second Avenue
279 East Grand Avenue
681 Gateway Boulevard
Greater Boston/Cambridge
Greater Boston/Route 128
San Francisco/South San Francisco
San
Francisco/South San Francisco
164,000 RSF
203,757 RSF
211,405 RSF
142,400 RSF
In Service:
In Service:
In Service:
In
Service:
123,403
RSF
|
100% Occupied
40,137
RSF
|
100% Occupied
164,206
RSF
|
100%
Occupied
142,400
RSF
|
89.2% Occupied
Alexandria
PARC
188 East Blaine Street
Alexandria Center® for AgTech, Phase I
San Francisco/Greater Stanford
Seattle/Lake Union
Research Triangle/Research Triangle
197,498 RSF
198,000
RSF
175,000 RSF
In Service:
In Service:
In Service:
48,547
RSF
|
96.8% Occupied
117,779
RSF
|
100%
Occupied
129,946
RSF
|
100% Occupied
RSF
presented represents RSF for the total project, unless otherwise indicated. Refer to “New Class A Development and Redevelopment Properties: Projected 2019-2020 Deliveries and Pre-Construction Projects” sections of this Item 2 for information on the RSF in service and under construction, if applicable.
76
New Class A development and redevelopment properties: recent deliveries (continued)
The following table presents value-creation development and redevelopment of new Class A properties placed into service (dollars in thousands):
Property/Market/Submarket
Our
Ownership Interest
Date Delivered
RSF Placed Into Service
Occupancy Percentage(1)
Total Project
Unlevered Yields
Initial
Stabilized
Initial Stabilized (Cash)
Prior to 10/1/18
4Q18
1Q19
2Q19
Total
RSF
Investment
Consolidated development projects
213
East Grand Avenue/San Francisco/
South San Francisco
100%
12/31/18
—
300,930
—
—
300,930
100%
300,930
$
256,600
7.4
%
6.5
%
399
Binney Street/Greater Boston/Cambridge
100%
1/25/19
—
—
123,403
—
123,403
100%
164,000
$
182,000
7.7
%
7.2
%
279
East Grand Avenue/San Francisco/
South San Francisco
100%
Various
—
—
139,810
24,396
164,206
100%
211,405
$
151,000
7.8
%
8.1
%
188
East Blaine Street/Seattle/Lake Union
100%
Various
—
—
90,615
27,164
117,779
100%
198,000
$
190,000
6.7
%
6.7
%
Consolidated
redevelopment projects
266
and 275 Second Avenue/Greater Boston/ Route 128
Relates
to total operating RSF in service as of June 30, 2019.
77
New Class A development and redevelopment properties: projected 2019 deliveries
399
Binney Street
266 and 275 Second Avenue
1655 and 1725 Third Street
279 East Grand Avenue
Greater Boston/Cambridge
Greater Boston/Route 128
San Francisco/Mission Bay/SoMa
San
Francisco/South San Francisco
164,000 RSF
203,757 RSF
593,765 RSF
211,405 RSF
Menlo
Gateway
Alexandria Center® –
Long Island City
188 East Blaine Street
704 Quince Orchard Road
Alexandria Center® for AgTech, Phase I
San Francisco/Greater Stanford
New
York City/New York City
Seattle/Lake Union
Maryland/Gaithersburg
Research Triangle/Research Triangle
772,983 RSF
176,759 RSF
198,000 RSF
79,931
RSF
175,000 RSF
Square
footage represents development and redevelopment projects by period of projected initial occupancy. Multi-tenant projects may have occupancy by tenants over a period of time.
Refer to “New Class A Development and Redevelopment Properties: Recent Deliveries” and “New Class A Development and Redevelopment Properties: Projected 2019-2020 Deliveries and Pre-Construction Projects” sections within this Item 2 for information on the RSF in service and under construction.
78
New Class A development and redevelopment properties: projected 2020 deliveries and pre-construction
projects
88 Bluxome Street
201 Haskins Way
Alexandria District for Science and Technology(1)
3115 Merryfield Row
9880
Campus Point Drive and
4150 Campus Point Court
San Francisco/Mission Bay/SoMa
San Francisco/South San Francisco
San Francisco/Greater Stanford
San Diego/Torrey Pines
San Diego/University Town Center
1,070,925 RSF
315,000
RSF
526,178 RSF
87,000 RSF
269,102 RSF
1165
Eastlake Avenue East
9800 Medical Center Drive
9950 Medical Center Drive
8 Davis Drive
Alexandria Center® for AgTech, Phase II
Seattle/Lake Union
Maryland/Rockville
Maryland/Rockville
Research
Triangle/Research Triangle
Research Triangle/Research Triangle
100,086 RSF
174,640 RSF
84,264 RSF
150,000 RSF
160,000 RSF
Square
footage represents development and redevelopment projects by period of projected initial occupancy. Multi-tenant projects may have occupancy by tenants over a period of time.
(1)
Campus includes 825 and 835 Industrial Road.
79
New Class A development and redevelopment properties: projected 2019–2020 deliveries and pre-construction
projects
The following table sets forth a summary of our new Class A development and redevelopment properties projected to be delivered in 2019 and 2020, as of June 30, 2019, and pre-construction projects (dollars in thousands):
Square
Footage
Project Start/Projected Start
Property/Market/Submarket
Dev/Redev
CIP
Total
Project
Percentage
Occupancy(1)
In Service
Construction
Pre-Construction
Total
Leased
Leased/Negotiating
Initial
Stabilized
2019
deliveries: consolidated projects
266
and 275 Second Avenue/Greater Boston/Route 128
Redev
184,721
19,036
—
19,036
203,757
100
%
100
%
3Q17
1Q18
2019
Alexandria
Center® for AgTech, Phase I/Research Triangle/
Research Triangle
Redev
129,946
45,054
—
45,054
175,000
97
100
2Q17
2Q18
2019
399
Binney Street/Greater Boston/Cambridge
Dev
123,403
40,597
—
40,597
164,000
98
98
4Q17
1Q19
2019
279
East Grand Avenue/San Francisco/South San Francisco
Dev
164,206
47,199
—
47,199
211,405
100
100
4Q17
1Q19
2020
188
East Blaine Street/Seattle/Lake Union
Dev
117,779
80,221
—
80,221
198,000
67
79
2Q18
1Q19
2020
Alexandria
Center® – Long Island City/New York City/
1655
and 1725 Third Street/San Francisco/Mission Bay/SoMa
Dev
—
593,765
—
593,765
593,765
100
100
1Q18
3Q19
3Q19
Menlo
Gateway/San Francisco/Greater Stanford
Dev
251,995
520,988
—
520,988
772,983
100
100
4Q17
4Q19
4Q19
2019
deliveries
1,047,015
1,528,585
—
1,528,585
2,575,600
90
%
92
%
2020
projected deliveries: consolidated projects
9880
Campus Point Drive and 4150 Campus Point Court/
San Diego/University Town Center(2)
Dev
—
98,000
171,102
269,102
269,102
66
%
69
%
1Q19
2020
2022
9800
Medical Center Drive/Maryland/Rockville
Dev
—
174,640
—
174,640
174,640
82
82
1Q19
2020
2020
9950
Medical Center Drive/Maryland/Rockville
Dev
—
84,264
—
84,264
84,264
100
100
1Q19
2020
2020
201
Haskins Way/San Francisco/South San Francisco
Dev
—
315,000
—
315,000
315,000
—
29
2Q19
2020
2021
Alexandria
District for Science and Technology/San Francisco/
Greater Stanford
Dev
—
526,178
—
526,178
526,178
37
46
2Q19
2020
2021
74
%
79
%
2020
projected deliveries: marketing and pre-construction projects
Third
quarter of 2019 acquisitions:
Pending
acquisition/San Francisco Bay Area(3)
Redev
—
—
250,000
250,000
250,000
3Q19
2020
2021/22
Pending
acquisition/San Francisco Bay Area(3)
Redev
—
—
92,000
92,000
92,000
3Q19
2020
2021
1165
Eastlake Avenue East/Seattle/Lake Union
Dev
—
—
100,086
100,086
100,086
4Q19
2020
2020
8
Davis Drive/Research Triangle/Research Triangle
Dev
—
—
150,000
150,000
150,000
4Q19
2020
2021
Alexandria
Center® for AgTech, Phase II/Research Triangle/
Research Triangle
Dev
—
—
160,000
160,000
160,000
4Q19
2020
2021
3115
Merryfield Row/San Diego/Torrey Pines
Dev
—
—
87,000
87,000
87,000
4Q19
2020
2021
2020
projected deliveries
—
1,198,082
1,010,188
2,208,270
2,208,270
Pre-leased
pre-construction project:
88
Bluxome Street/San Francisco/Mission Bay/SoMa
Dev
—
—
1,070,925
1,070,925
1,070,925
58
%
58
%
2020
2022
TBD
Total
1,047,015
2,726,667
2,081,113
4,807,780
5,854,795
(1)
Initial
occupancy dates are subject to leasing and/or market conditions. Multi-tenant projects may have occupancy by tenants over a period of time. Stabilized occupancy may vary depending on single tenancy versus multi-tenancy.
(2)
Refer to footnote 3 on the next page.
(3)
Pending acquisitions anticipated to be undergoing construction during the third quarter of 2019. Refer to the “Acquisitions” section within this Item 2 for additional information.
80
New
Class A development and redevelopment properties: projected 2019–2020 deliveries and pre-construction projects (continued)
Our
Ownership Interest
Cost to Complete
Unlevered Yields
Property/Market/Submarket
In
Service
CIP
Construction Loan
ARE
Funding
Total at
Completion
Initial Stabilized
Initial
Stabilized (Cash)
2019 deliveries: consolidated projects
266
and 275 Second Avenue/Greater Boston/Route 128
100
%
$
79,231
$
6,712
$
—
$
3,057
$
89,000
8.4
%
7.1
%
Alexandria
Center® for AgTech, Phase I/Research Triangle/Research Triangle(1)
100
%
51,984
18,383
—
6,733
77,100
7.6
7.5
399
Binney Street/Greater Boston/Cambridge
100
%
135,088
42,258
—
4,654
182,000
7.7
7.2
279
East Grand Avenue/San Francisco/South San Francisco
100
%
85,655
42,369
—
22,976
151,000
7.8
8.1
188
East Blaine Street/Seattle/Lake Union
100
%
91,075
51,957
—
46,968
190,000
6.7
6.7
Alexandria
Center® – Long Island City/New York City/New York City
1655
and 1725 Third Street/San Francisco/Mission Bay/SoMa
10.0
%
—
65,482
11,537
981
78,000
7.8
6.0
Menlo
Gateway/San Francisco/Greater Stanford
48.3
%
125,779
222,228
74,940
7,053
430,000
6.9
6.3
2019
deliveries
589,220
521,496
90,429
193,555
1,394,700
7.1
6.7
2020
projected deliveries: consolidated projects
9880
Campus Point Drive and 4150 Campus Point Court/San Diego/
University Town Center(3)
100
%
—
98,463
—
156,537
255,000
6.3
(3)
6.4
(3)
9800
Medical Center Drive/Maryland/Rockville
100
%
—
19,997
—
75,403
95,400
7.7
7.2
9950
Medical Center Drive/Maryland/Rockville
100
%
—
9,753
—
44,547
54,300
7.3
6.8
201
Haskins Way/San Francisco/South San Francisco
100
%
—
91,459
204,541
296,000
6.6
6.6
Alexandria
District for Science and Technology/San Francisco/Greater Stanford
100
%
—
188,255
—
388,745
577,000
6.5
6.2
—
407,927
—
869,773
1,277,700
6.6
6.4
$
90,429
$
1,063,328
$
2,672,400
6.9
%
6.6
%
2020
projected deliveries: marketing and pre-construction projects
1165
Eastlake Avenue East/Seattle/Lake Union
100
%
—
31,115
8
Davis Drive/Research Triangle/Research Triangle
100
%
—
2,880
Alexandria
Center® for AgTech, Phase II/Research Triangle/Research Triangle(1)
100
%
—
2,774
3115
Merryfield Row/San Diego/Torrey Pines
100
%
—
31,196
2020
projected deliveries
—
475,892
Total
$
589,220
$
997,388
(1)
New
strategic collaborative campus, Alexandria Center® for AgTech – Research Triangle consists of Phase I at 5 Laboratory Drive, including campus amenities, and Phase II at 9 Laboratory Drive. 5 Laboratory Drive includes the high-quality LaunchLabs and amenities that create a dynamic ecosystem to accelerate discovery and commercialization.
(2)
Refer to the “Consolidated and Unconsolidated Real Estate Joint Ventures” section within this Item 2 for additional information.
(3)
Represents
a two-phase development project as follows:
•
Initial phase represents 9880 Campus Point Drive, a 98,000 RSF project to development GradLabs™, a highly flexible, first-of-its-kind life science platform designed to provide post-seed-stage life science companies with turnkey, fully furnished office/laboratory suites and an accelerated, scalable path for growth. As of the date of this report, the project is 7% leased and we expect initial occupancy in 2020. The previous R&D building located at 9880 Campus Point Drive was previously demolished and as of June 30, 2019, continues to be included in
our same property performance results. Refer to the “Same Properties” subsection of the “Results of Operations” section within this Item 2 for additional information.
•
Subsequent phase represents 4150 Campus Point Court, a 171,102 RSF, 100% leased pre-construction project with occupancy expected in 2022.
•
Project costs represent development costs for 9880 Campus Point Drive and 4150 Campus Point Court. Yields
represent expected returns for Campus Pointe by Alexandria including 9880, 10290 and 10300 Campus Point Drive and 4150 Campus Point Court.
81
New Class A development and redevelopment properties: summary of pipeline
The following table summarizes the key information for all our development and redevelopment projects in North America as of June 30, 2019
(dollars in thousands):
Property/Submarket
Our
Ownership Interest
Book Value
Square Footage
Projected Deliveries(1)
Future
Total
2019
2020
2021–2022
Construction
Construction
Pre-Construction
Pre-Construction
Intermediate-Term
Greater
Boston
399
Binney (Alexandria Center® at One Kendall Square)/Cambridge
100
%
$
42,258
40,597
—
—
—
—
—
40,597
266
and 275 Second Avenue/Route 128
100
%
6,712
19,036
—
—
—
—
—
19,036
325
Binney Street/Cambridge
100
%
104,421
—
—
—
—
208,965
(2)
—
208,965
15
Necco Street/Seaport Innovation District
100
%
159,242
—
—
—
—
293,000
—
293,000
99
A Street/Seaport Innovation District
96.9
%
38,681
—
—
—
—
235,000
(3)
—
235,000
Alexandria
Technology Square®/Cambridge
100
%
7,787
—
—
—
—
—
100,000
100,000
100
Tech Drive/Route 128
100
%
—
—
—
—
—
—
300,000
300,000
215
Presidential Way/Route 128
100
%
5,481
—
—
—
—
—
130,000
130,000
231
Second Avenue/Route 128
100
%
1,251
—
—
—
—
—
32,000
32,000
10
Necco Street/Seaport Innovation District
100
%
83,425
—
—
—
—
—
175,000
175,000
Other
value-creation projects
100
%
8,592
—
—
—
—
—
41,955
41,955
457,850
59,633
—
—
—
736,965
778,955
1,575,553
San
Francisco
1655
and 1725 Third Street/Mission Bay/SoMa
10.0
%
(4)
593,765
—
—
—
—
—
593,765
279
East Grand Avenue/South San Francisco
100
%
42,369
47,199
—
—
—
—
—
47,199
Menlo
Gateway/Greater Stanford
48.3
%
(4)
520,988
—
—
—
—
—
520,988
201
Haskins Way/South San Francisco
100
%
91,459
—
315,000
—
—
—
—
315,000
Alexandria
District for Science and Technology/
Greater Stanford
100
%
188,255
—
526,178
—
—
—
—
526,178
Pending
acquisition/San Francisco Bay Area
(5
)
(5)
—
—
250,000
—
—
—
250,000
Pending
acquisition/San Francisco Bay Area
(5
)
(5)
—
—
92,000
—
—
—
92,000
88
Bluxome Street/Mission Bay/SoMa
100
%
182,805
—
—
—
1,070,925
(3)
—
—
1,070,925
505
Brannan Street, Phase II/Mission Bay/SoMa
99.7
%
17,038
—
—
—
—
165,000
—
165,000
960
Industrial Road/Greater Stanford
100
%
86,402
—
—
—
—
533,000
(3)
—
533,000
East
Grand Avenue/South San Francisco
100
%
6,008
—
—
—
—
—
90,000
90,000
Pending
acquisition/San Francisco Bay Area
(5
)
(5)
—
—
—
—
—
700,000
700,000
Other
value-creation projects
100
%
45,237
—
—
—
—
418,000
25,000
443,000
$
659,573
1,161,952
841,178
342,000
1,070,925
1,116,000
815,000
5,347,055
(1) Represents
square footage of development and redevelopment projects by period of projected initial occupancy. Multi-tenant projects may have occupancy by tenants over a period of time.
(2) We are seeking additional entitlements to increase the density of the site from its current 208,965 RSF.
(3) Represents total square footage upon completion of development of a new Class A property. RSF presented includes rentable square footage of buildings currently in operation at properties that were recently acquired for their inherent future development opportunities, with the intent to demolish the existing property upon expiration of the existing in-place leases and commencement of future construction. Refer to the definition of “Investments in Real Estate – Value-Creation Square Feet Currently in Rental Properties” in the “Non-GAAP Measures and Definitions” section within this
Item 2 for additional information.
(4) This property is held by an unconsolidated real estate joint venture. Refer to the “Consolidated and Unconsolidated Real Estate Joint Ventures” section within this Item 2 for additional information on our ownership interest.
(5) Refer to the “Acquisitions” section within this Item 2 for additional information.
82
New Class A development and redevelopment properties: summary of pipeline (continued)
Property/Submarket
Our
Ownership Interest
Book Value
Square Footage
Projected Deliveries(1)
Future
Total
2019
2020
2021–2022
Construction
Construction
Pre-Construction
Pre-Construction
Intermediate-Term
New
York City
Alexandria
Center® – Long Island City/New York City
100
%
$
67,832
140,098
—
—
—
—
—
140,098
Alexandria
Center® for Life Science – New York City/New York City
100
%
19,159
—
—
—
—
550,000
—
550,000
219
East 42nd Street/New York City
100
%
—
—
—
—
—
—
579,947
(2)
579,947
Other
value-creation projects
(3
)
(3)
—
—
—
—
—
135,938
135,938
86,991
140,098
—
—
—
550,000
715,885
1,405,983
San
Diego
Campus
Pointe by Alexandria/University Town Center
(4
)
140,263
—
98,000
171,102
—
120,000
410,345
(4)
799,447
3115
Merryfield Row/Torrey Pines
100
%
31,196
—
—
87,000
—
—
—
87,000
5200
Illumina Way/University Town Center
100
%
11,734
—
—
—
—
451,832
—
451,832
Townsgate
by Alexandria/Del Mar Heights
100
%
18,749
—
—
—
—
125,000
—
125,000
4075
Sorrento Valley Boulevard/Sorrento Valley
100
%
7,545
—
—
—
—
—
149,000
(5)
149,000
Vista
Wateridge/Sorrento Mesa
100
%
4,022
—
—
—
—
—
163,000
163,000
Pending
acquisition/San Diego
(3
)
(3)
—
—
—
—
—
700,000
700,000
Other
value-creation projects
100
%
5,931
—
—
—
—
—
222,895
222,895
219,440
—
98,000
258,102
—
696,832
1,645,240
2,698,174
Seattle
188
East Blaine Street/Lake Union
100
%
51,957
80,221
—
—
—
—
—
80,221
1165
Eastlake Avenue East/Lake Union
100
%
31,115
—
—
100,086
—
—
—
100,086
1150
Eastlake Avenue East/Lake Union
100
%
27,810
—
—
—
—
260,000
—
260,000
701
Dexter Avenue North/Lake Union
100
%
39,577
—
—
—
—
217,000
—
217,000
601
Dexter Avenue/Lake Union
100
%
29,837
—
—
—
—
—
188,400
(5)
188,400
$
180,296
80,221
—
100,086
—
477,000
188,400
845,707
(1) Represents
square footage of development and redevelopment projects by period of projected initial occupancy. Multi-tenant projects may have occupancy by tenants over a period of time.
(2) Includes 349,947 RSF in operation with an opportunity to either convert the existing office space into office/laboratory space through future redevelopment or to expand the building by an additional 230,000 RSF through ground-up development. The building is currently occupied by Pfizer Inc. with a remaining lease term of six years.
(3) Refer to the “Acquisitions” section within this Item 2 for additional information.
(4) RSF consists of our acquisition of 4161 Campus Point Court during the first quarter of 2019 aggregating 159,884 RSF and 10260 Campus Point Drive aggregating 109,164 RSF. Both of these buildings are currently operating under short-term
leases. Upon lease expirations, we expect to demolish 4161 Campus Point Court and combine its RSF with other existing entitlements at this campus to complete a new ground-up development aggregating 301,181 RSF. We also expect to convert 10260 Campus Point Drive to office/laboratory space through redevelopment. Refer to “Consolidated and Unconsolidated Real Estate Joint Ventures” within this Item 2 for additional information on our ownership interest.
(5) Represents total square footage upon completion of development of a new Class A property. RSF presented includes rentable square footage of buildings currently in operation at properties that were recently acquired for their inherent future development opportunities, with the intent to demolish the existing property upon expiration of the existing in-place leases and commencement of future construction. Refer to the definition of “Investments in Real Estate –
Value-Creation Square Feet Currently in Rental Properties” in the “Non-GAAP Measures and Definitions” section within this Item 2 for additional information.
83
New Class A development and redevelopment properties: summary of pipeline (continued)
Property/Submarket
Our
Ownership Interest
Book Value
Square Footage
Projected Deliveries(1)
Future
Total
2019
2020
2021–2022
Construction
Construction
Pre-Construction
Pre-Construction
Intermediate-Term
Maryland
704
Quince Orchard Road/Gaithersburg
56.8
%
(2)
41,627
—
—
—
—
—
41,627
9800
Medical Center Drive/Rockville
100
%
$
21,212
—
174,640
—
—
—
64,000
238,640
9950
Medical Center Drive/Rockville
100
%
9,753
—
84,264
—
—
—
—
84,264
30,965
41,627
258,904
—
—
—
64,000
364,531
Research
Triangle
Alexandria
Center® for AgTech, Phase I/ Research Triangle
100
%
18,383
45,054
—
—
—
—
—
45,054
Alexandria
Center® for AgTech, Phase II/ Research Triangle
100
%
2,774
—
—
160,000
—
—
—
160,000
8
Davis Drive/Research Triangle
100
%
3,594
—
—
150,000
—
70,000
—
220,000
6
Davis Drive/Research Triangle
100
%
15,499
—
—
—
—
—
800,000
800,000
Other
value-creation projects
100
%
4,149
—
—
—
—
—
76,262
76,262
44,399
45,054
—
310,000
—
70,000
876,262
1,301,316
Other
value-creation projects
100
%
3,840
—
—
—
—
—
122,800
122,800
$
1,683,354
1,528,585
1,198,082
1,010,188
1,070,925
3,646,797
5,206,542
13,661,119
(3)
2,726,667
2,081,113
8,853,339
(1)
Represents
square footage of development and redevelopment projects by period of projected initial occupancy. Multi-tenant projects may have occupancy by tenants over a period of time.
(2)
This property is held by an unconsolidated real estate joint venture. Refer to the “Consolidated and Unconsolidated Real Estate Joint Ventures” section within this Item 2 for additional information on our ownership interest.
(3)
Total rentable square footage includes 1.0 million RSF
of buildings currently in operation that will be redeveloped or replaced with new development RSF upon commencement of future construction. Refer to the “Non-GAAP Measures and Definitions”section within this Item 2 for additional detail on value-creation square feet currently included in rental properties.
84
Summary of capital expenditures
Our construction spending for the six months ended June 30, 2019,
consisted of the following (in thousands):
Investments in unconsolidated real estate joint ventures
95,950
Contributions from noncontrolling interests
(5,523
)
Construction
spending (cash basis)(1)
667,749
Change in accrued construction
5,558
Construction spending for the six months ended June 30, 2019
673,307
Projected
construction spending for the six months ending December 31, 2019
626,693
Guidance midpoint
$
1,300,000
(1)
Includes
revenue-enhancing projects and non-revenue-enhancing capital expenditures.
The following table summarizes the total projected construction spending for the year ending December 31, 2019, which includes interest, property taxes, insurance, payroll, and other indirect project costs (in thousands):
Non-revenue-enhancing
capital expenditures and tenant improvements
29,000
Guidance midpoint
$
1,300,000
Non-revenue-enhancing
capital expenditures, tenant improvements, and leasing costs
The table below presents the average per RSF of property-related non-revenue-enhancing capital expenditures, tenant improvements, and leasing costs, excluding capital expenditures and tenant improvements that are recoverable from tenants, revenue enhancing, or related to properties that have undergone redevelopment (dollars in thousands, except per RSF amounts):
Total tenant improvements and leasing costs/weighted average
$
22,610
$
20.60
$
17.15
(1)
Excludes amounts that are recoverable from tenants, related to revenue-enhancing capital expenditures, or related to properties that have undergone redevelopment.
(2)
Represents the average of 2015 to 2018 and the six months ended June 30, 2019, annualized.
85
Results
of operations
We present a tabular comparison of items, whether gain or loss, that may facilitate a high-level understanding of our results and provide context for the disclosures included in our most recent annual report on Form 10-K for the year ended December 31, 2018, and our subsequent quarterly reports on Form 10-Q. We believe such tabular presentation promotes a better understanding for investors of the corporate-level decisions made and activities performed that significantly affect comparison of our operating results from period to period. We also believe this tabular presentation will supplement for investors an understanding of our disclosures and real estate operating results. Gains or losses on sales of real estate and impairments of held for sale assets are related to
corporate-level decisions to dispose of real estate. Gains or losses on early extinguishment of debt and preferred stock redemption charges are related to corporate-level financing decisions focused on our capital structure strategy. Significant realized and unrealized gains or losses on non-real estate investments and impairments of real estate and non-real estate investments are not related to the operating performance of our real estate assets as they result from strategic, corporate-level non-real estate investment decisions and external market conditions. Impairments of non-real estate investments are not related to the operating performance of our real estate as they represent the write-down of a non-real estate investment when its fair value declines below its carrying value due to changes in general market or other conditions outside of our control. Significant items, whether a gain or loss, included in the tabular disclosure for current periods are described
in further detail within this Item 2. Key items included in net income attributable to Alexandria’s common stockholders for the three and six months ended June 30, 2019 and 2018 are as follows:
Amount
Per
Share – Diluted
Amount
Per Share – Diluted
Three Months Ended June 30,
Six Months Ended June 30,
(In millions, except per share amounts)
2019
2018
2019
2018
2019
2018
2019
2018
Unrealized
gains on non-real estate investments(1)
$
11.1
$
5.1
$
0.10
$
0.05
$
83.3
$
77.3
$
0.75
$
0.76
Realized
gain on non-real estate investment
—
—
—
—
—
8.3
—
0.08
Impairment
of real estate
—
(6.3
)
—
(0.06
)
—
(6.3
)
—
(0.06
)
Loss
on early extinguishment of debt(2)
—
—
—
—
(7.4
)
—
(0.07
)
—
Preferred
stock redemption charge(3)
—
—
—
—
(2.6
)
—
(0.02
)
—
Total
$
11.1
$
(1.2
)
$
0.10
$
(0.01
)
$
73.3
$
79.3
$
0.66
$
0.78
Weighted-average
shares of common stock outstanding for calculation of EPS – diluted
111.5
102.2
111.3
101.2
(1)
Refer
to Note 7 – “Investments” to our unaudited consolidated financial statements under Item 1 of this report for more information.
(2)
Refer to Note 10 – “Secured and Unsecured Senior Debt” to our unaudited consolidated financial statements under Item 1 of this report for more information.
(3)
Refer to Note 14 – “Stockholders’ Equity” to our unaudited consolidated financial statements under Item 1 of this report for more information.
86
Same
Properties
We supplement an evaluation of our results of operations with an evaluation of operating performance of certain of our properties, referred to as Same Properties. For more information on the determination of our Same Properties portfolio, refer to the definition of “Same Property Comparisons” in the “Non-GAAP Measures and Definitions” section within this Item 2. The following table presents information regarding our Same Properties for the three and six months ended June 30, 2019:
10260
Campus Point Drive and 4161 Campus Point Court
2
99 A Street
1
3170 Porter Drive
1
Shoreway
Science Center
2
3911, 3931, and 4075 Sorrento Valley Boulevard
3
260 Townsend Street
1
5
Necco Street
1
601 Dexter Avenue North
1
Other
6
33
Unconsolidated
real estate JVs
6
Properties held for sale
2
Total properties excluded from Same Properties
62
Same
Properties
195
(1)
Total properties in North America as of June 30, 2019
257
(1)
Includes 9880 Campus Point Drive, a building we acquired in 2001. The building was occupied through January 2018 and subsequently demolished. The 98,000 RSF project is currently in active development.
The
following table presents a comparison of the components of net operating income for our Same Properties and Non-Same Properties for the three months ended June 30, 2019, compared to the three months ended June 30, 2018. Refer to the “Non-GAAP Measures and Definitions” section within this Item 2 for definitions of “Tenant Recoveries” and “Net Operating Income” and their reconciliations from the most directly comparable financial measures presented in accordance with GAAP, income from rentals and net income, respectively.
Three
Months Ended June 30,
(Dollars in thousands)
2019
2018
$ Change
% Change
Income from rentals:
Same
Properties
$
245,715
$
235,576
$
10,139
4.3
%
Non-Same
Properties
43,910
15,059
28,851
191.6
Rental
revenues
289,625
250,635
38,990
15.6
Same
Properties
75,783
69,693
6,090
8.7
Non-Same
Properties
6,210
2,466
3,744
151.8
Tenant
recoveries
81,993
72,159
9,834
13.6
Income
from rentals
371,618
322,794
48,824
15.1
Same
Properties
93
72
21
29.2
Non-Same
Properties
2,145
2,168
(23
)
(1.1
)
Other
income
2,238
2,240
(2
)
(0.1
)
Same
Properties
321,591
305,341
16,250
5.3
Non-Same
Properties
52,265
19,693
32,572
165.4
Total
revenues
373,856
325,034
48,822
15.0
Same
Properties
88,958
82,277
6,681
8.1
Non-Same
Properties
16,731
9,631
7,100
73.7
Rental
operations
105,689
91,908
13,781
15.0
Same
Properties
232,633
223,064
9,569
4.3
Non-Same
Properties
35,534
10,062
25,472
253.2
Net
operating income
$
268,167
$
233,126
$
35,041
15.0
%
Net
operating income – Same Properties
$
232,633
$
223,064
$
9,569
4.3
%
Straight-line
rent revenue
(14,664
)
(23,294
)
8,630
(37.0
)
Amortization
of acquired below-market leases
(2,927
)
(3,403
)
476
(14.0
)
Net
operating income – Same Properties (cash basis)
$
215,042
$
196,367
$
18,675
9.5
%
Income
from rentals
Total income from rentals for the three months ended June 30, 2019, increased by $48.8 million, or 15.1%, to $371.6 million, compared to $322.8 million for the three months ended June 30, 2018, as a result of increases in rental revenues and tenant recoveries, as discussed below.
Income from rentals – rental revenues
Total
rental revenues for the three months ended June 30, 2019, increased by $39.0 million, or 15.6%, to $289.6 million, compared to $250.6 million for the three months ended June 30, 2018. The increase was primarily due to an increase in rental revenues from our Non-Same Properties aggregating $28.9 million primarily related to 1.2 million RSF of development and redevelopment projects placed into service subsequent to April 1, 2018,
and 29 operating properties aggregating 2.0 million RSF acquired subsequent to April 1, 2018.
Rental revenues from our Same Properties for the three months ended June 30, 2019, increased by $10.1 million, or 4.3%, to $245.7 million, compared to $235.6 million for the three months ended June 30, 2018. The increase was primarily
due to significant rental rate increases on lease renewals and re-leasing of space since April 1, 2018.
88
Income from rentals – tenant recoveries
Tenant recoveries for the three months ended June 30, 2019, increased by $9.8 million, or 13.6%, to $82.0 million,
compared to $72.2 million for the three months ended June 30, 2018. This increase is primarily due to an increase from our Non-Same Properties described above. Same Properties’ tenant recoveries for the three months ended June 30, 2019, increased by $6.1 million, or 8.7%, primarily due to the increase in recoverable operating expenses for the three months ended June 30, 2019, as discussed under “Rental Operations” below. As of June 30, 2019,97%of our leases (on an RSF basis) were triple net leases, which require tenants to pay substantially all real estate taxes, insurance, utilities, repairs and maintenance, common area expenses, and other operating expenses (including increases thereto) in addition to base rent.
Other income
Other income for the three months ended June 30, 2019 and 2018, was $2.2 million and $2.2 million, respectively, primarily consisting of construction
management fees and interest income earned during each respective period.
Rental operations
Total rental operating expenses for the three months ended June 30, 2019, increased by $13.8 million, or 15.0%, to $105.7 million, compared to $91.9 million for the three months ended June 30, 2018. Approximately $7.1 million of the increase was due to an increase in rental operating
expenses from our Non-Same Properties primarily related to development and redevelopment projects and acquired properties as discussed above under “Income from Rentals.”
Same Properties’ rental operating expenses increased by$6.7 million, or 8.1%, to $89.0 million during the three months ended June 30, 2019, compared to $82.3 million for the three months ended June 30, 2018. Approximately $2.5 million of the
increase was due to the higher tax expense stemming from a new 3.5% gross receipts tax on rental revenues in the city of San Francisco that went into effect on January 1, 2019, and an increase in property tax expense resulting from the higher assessed values of some of our properties in Greater Boston. The remaining $4.2 million increase was mainly a result of the higher repairs and maintenance expenses, contract services, and payroll incurred during the three months ended June 30, 2018.
General and administrative expenses
General
and administrative expenses for the three months ended June 30, 2019, increased by $3.5 million, or 15.2%, to $26.4 million, compared to $22.9 million for the three months ended June 30, 2018. Approximately $1 million of the increase reflects incremental leasing costs recognized in expense in the current period, resulting from our adoption of a new accounting standard on leases on January 1, 2019. For a detailed discussion related to this new standard, refer to the “Lease Accounting” section of Note
2 – “Summary of Significant Accounting Policies” to our unaudited consolidated financial statements under Item 1 of this report.
The remaining increase of approximately $2.5 million of general and administrative expenses was due to a 23.2% increase in our employee headcount since April 1, 2018, to accommodate the continued growth in the depth and breadth of our operations in multiple markets, including development and redevelopment projects placed into service and properties acquired subsequent to April 1, 2018, as discussed under “Income from Rentals” above. As a percentage of net
operating income, our general and administrative expenses for the three months ended June 30, 2019 and 2018, were 9.5% and 9.4%, respectively.
Interest expense
Interest expense for the three months ended June 30, 2019 and 2018, consisted of the following (dollars in thousands):
Three
Months Ended June 30,
Component
2019
2018
Change
Interest incurred
$
64,553
$
53,624
$
10,929
Capitalized
interest
(21,674
)
(15,527
)
(6,147
)
Interest expense
$
42,879
$
38,097
$
4,782
Average
debt balance outstanding (1)
$
6,129,748
$
5,406,946
$
722,802
Weighted-average
annual interest rate (2)
4.2
%
4.0
%
0.2
%
(1)
Represents
the average debt balance outstanding during the respective periods.
(2)
Represents annualized total interest incurred divided by the average debt balance outstanding in the respective periods.
89
The net change in interest expense during the three months ended June 30, 2019, compared to the three months ended June 30,
2018, resulted from the following (dollars in thousands):
Component
Interest Rate(1)
Effective Date
Change
Increases
in interest incurred due to:
Issuances of debt:
$650
million unsecured senior notes payable – green bonds
4.03
%
June 2018/ March 2019
$
5,798
$450 million unsecured senior notes payable
4.81
%
June
2018
4,707
$300 million unsecured senior notes payable
4.93
%
March 2019
3,640
$350
million unsecured senior notes payable – green bonds
3.96
%
March 2019
3,338
Fluctuations in interest rate and average balance:
Higher
rates for interest rate hedge agreements in effect
1,245
Total increases
18,728
Decreases
in interest incurred due to:
Repayments of debt:
Secured
construction loan
3.29
%
March 2019
(2,885
)
Secured notes payable
8.15
%
January
2019
(2,089
)
2019 unsecured senior bank term loan
2.75
%
September 2018
(1,585
)
Fluctuations
in interest rate and average balance:
$2.2 billion unsecured senior line of credit and senior bank term loan
(1,228
)
Other
decrease in interest
(12
)
Total decreases
(7,799
)
Change
in interest incurred
10,929
Increase in capitalized interest
(6,147
)
Total
change in interest expense
$
4,782
(1)
Represents
the weighted-average interest rate as of the end of the applicable period, including expense/income related to our interest rate hedge agreements, amortization of loan fees, amortization of debt premiums (discounts), and other bank fees.
Depreciation and amortization
Depreciation and amortization expense for the three months ended June 30, 2019, increased by $15.6 million, or 13.1%, to $134.4 million, compared to $118.9 million for the three months ended June 30,
2018. The increase is primarily due to additional depreciation from 1.2 million RSF of development and redevelopment projects placed into service subsequent to April 1, 2018, and 29 operating properties aggregating 2.0 million RSF acquired subsequent to April 1, 2018.
Investment income
During the three months ended June 30, 2019, we recognized
$21.5 million of investment income, which consisted of $10.4 million of realized gains and $11.1 million of unrealized gains. Realized gains of $10.4 million for the three months ended June 30, 2019, primarily consisted of proceeds received from our investments in privately held entities that report NAV. Unrealized gains of $11.1 million recognized during the three months ended June 30, 2019, primarily consisted of increases in the fair values of our investments in publicly traded companies.
During
the three months ended June 30, 2018, we recognized $12.5 million of investment income, which consisted of $7.5 million of realized gains and $5.1 million of unrealized gains. Refer to Note 7 – “Investments” to these unaudited consolidated financial statements for further details.
Sales of real estate assets
During the three months ended June 30, 2018, we recognized an impairment of real estate of $6.3 million
related to one land parcel located in Northern Virginia that was classified as held for sale as of June 30, 2018, and was sold in July 2018 for a sales price of $6.0 million with no gain or loss.
The following table presents a comparison of the components of net operating income for our Same Properties and Non-Same Properties for the six months ended June 30, 2019, compared to the six months ended June 30, 2018. Refer to the “Non-GAAP Measures and Definitions” section within this Item 2 for definitions of “Tenant Recoveries” and “Net Operating Income” and their reconciliations from the most directly comparable financial measures presented in accordance with GAAP, income from rentals and net income, respectively.
Six
Months Ended June 30,
(Dollars in thousands)
2019
2018
$ Change
% Change
Income from rentals:
Same
Properties
$
464,450
$
447,953
$
16,497
3.7
%
Non-Same
Properties
99,738
47,167
52,571
111.5
Rental
revenues
564,188
495,120
69,068
13.9
Same
Properties
145,512
137,079
8,433
6.2
Non-Same
Properties
16,667
8,250
8,417
102.0
Tenant
recoveries
162,179
145,329
16,850
11.6
Income
from rentals
726,367
640,449
85,918
13.4
Same
Properties
234
134
100
74.6
Non-Same
Properties
6,097
4,590
1,507
32.8
Other
income
6,331
4,724
1,607
34.0
Same
Properties
610,196
585,166
25,030
4.3
Non-Same
Properties
122,502
60,007
62,495
104.1
Total
revenues
732,698
645,173
87,525
13.6
Same
Properties
172,145
162,043
10,102
6.2
Non-Same
Properties
35,045
21,636
13,409
62.0
Rental
operations
207,190
183,679
23,511
12.8
Same
Properties
438,051
423,123
14,928
3.5
Non-Same
Properties
87,457
38,371
49,086
127.9
Net
operating income
$
525,508
$
461,494
$
64,014
13.9
%
Net
operating income – Same Properties
$
438,051
$
423,123
$
14,928
3.5
%
Straight-line
rent revenue
(28,935
)
(48,429
)
19,494
(40.3
)
Amortization
of acquired below-market leases
(5,972
)
(7,162
)
1,190
(16.6
)
Net
operating income – Same Properties (cash basis)
$
403,144
$
367,532
$
35,612
9.7
%
Income
from rentals
Total income from rentals for the six months ended June 30, 2019, increased by $85.9 million, or 13.4%, to $726.4 million, compared to $640.4 million for the six months ended June 30, 2018, as a result of increases in rental revenues and tenant recoveries, as discussed below.
Income from rentals – rental revenues
Total
rental revenues for the six months ended June 30, 2019, increased by $69.1 million, or 13.9%, to $564.2 million, compared to $495.1 million for the six months ended June 30, 2018. The increase was primarily due to an increase in rental revenues from our Non-Same Properties aggregating $52.6 million primarily related to 1.4 million RSF of development and redevelopment projects placed into service subsequent to January 1, 2018,
and 33 operating properties aggregating 2.3 million RSF acquired subsequent to January 1, 2018.
91
Rental revenues from our Same Properties for the six months ended June 30, 2019, increased by $16.5 million, or 3.7%, to $464.5 million, compared to $448.0 million
for the six months ended June 30, 2018. The increase was primarily due to significant rental rate increases on lease renewals and re-leasing of space since January 1, 2018. Refer to the “Leasing” subsection of the “Operating Summary” section within this Item 2 for additional information on our leasing activity.
Income from rentals – tenant recoveries
Tenant recoveries for the six months ended June 30, 2019, increased by $16.9 million, or 11.6%,
to $162.2 million, compared to $145.3 million for the six months ended June 30, 2018. This increase is consistent with the increase in our rental operating expenses of $23.5 million, or 12.8%, as discussed under “Rental Operations” below. Same Properties’ tenant recoveries for the six months ended June 30, 2019, increased by $8.4 million, or 6.2%, primarily due to the increase in recoverable operating expenses for the six months ended June 30,
2019, as discussed below. As of June 30, 2019, 97%of our leases (on an RSF basis) were triple net leases, which require tenants to pay substantially all real estate taxes, insurance, utilities, common area expenses, and other operating expenses (including increases thereto) in addition to base rent.
Other income
Other income for the six months ended June 30, 2019 and 2018 was, $6.3 million
and $4.7 million, respectively, primarily consisting of construction management fees and interest income earned during each respective year.
Rental operations
Total rental operating expenses for the six months ended June 30, 2019, increased by $23.5 million, or 12.8%, to $207.2 million, compared to $183.7 million for the six months ended June 30, 2018. Approximately $13.4 million
of the increase was due to an increase in rental operating expenses from our Non-Same Properties primarily related to 1.4 million RSF of development and redevelopment projects placed into service subsequent to January 1, 2018, and 33 operating properties aggregating 2.3 million RSF acquired subsequent to January 1, 2018.
Same Properties’ rental operating expenses increased by $10.1 million, or 6.2%, to $172.1 million
during the six months ended June 30, 2019, compared to the $162.0 million for the six months ended June 30, 2018. Approximately $3.8 million of the increase was due to the higher tax expense stemming from a new 3.5% gross receipts tax on rental revenues in the city of San Francisco that went into effect on January 1, 2019, and an increase in property tax expense resulting from the higher assessed values of some of our properties in Greater Boston. The remaining $6.3 million increase was mainly a result of the higher repairs and maintenance expenses and payroll incurred during the six
months ended June 30, 2018.
General and administrative expenses
General and administrative expenses for the six months ended June 30, 2019, increased by $5.8 million, or 12.7%, to $51.1 million, compared to $45.4 million for the six months ended June 30, 2018. Approximately $2 million of the increase
reflects incremental leasing costs recognized in expense in the current period, resulting from our adoption of a new accounting standard on leases on January 1, 2019. For a detailed discussion related to this new standard, refer to the “Lease Accounting” section of Note 2 – “Summary of Significant Accounting Policies” to our unaudited consolidated financial statements under Item 1 of this report.
The remaining increase of approximately $3.8 million of general and administrative expenses was due to a 28.2% increase in our employee headcount since January 1, 2018, to accommodate the continued growth in the depth and breadth of our
operations in multiple markets, including development and redevelopment projects placed into service and properties acquired subsequent to January 1, 2018, as discussed under “Income from Rentals” above. As a percentage of net operating income, our general and administrative expenses for the trailing 12 months ended June 30, 2019 and 2018, were 9.5% and 9.4%, respectively.
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Interest
expense
Interest expense for the six months ended June 30, 2019 and 2018, consisted of the following (dollars in thousands):
Six
Months Ended June 30,
Component
2019
2018
Change
Interest incurred
$
122,162
$
103,899
$
18,263
Capitalized
interest
(40,183
)
(28,887
)
(11,296
)
Interest expense
$
81,979
$
75,012
$
6,967
Average
debt balance outstanding (1)
$
5,958,590
$
5,251,827
$
706,763
Weighted-average
annual interest rate (2)
4.1
%
4.0
%
0.1
%
(1)
Represents
the average debt balance outstanding during the respective periods.
(2)
Represents annualized total interest incurred divided by the average debt balance outstanding in the respective periods.
The net change in interest expense during the six months ended June 30, 2019, compared to the six months ended June 30, 2018, resulted from the following (dollars in thousands):
Component
Interest
Rate(1)
Effective Date
Change
Increases in interest incurred due to:
Issuances
of debt:
$650 million unsecured senior notes payable – green bonds
4.03
%
June
2018/ March 2019
$
10,292
$450 million unsecured senior notes payable
4.81
%
June 2018
10,002
$300
million unsecured senior notes payable
4.93
%
March 2019
4,044
$350 million unsecured senior notes payable – green bonds
3.96
%
March
2019
3,709
Fluctuations in interest rate and average balance:
$2.2
billion unsecured senior line of credit and senior bank term loan
1,338
Total increases
29,385
Decreases
in interest incurred due to:
Repayments of debt:
Secured
construction loan
3.29
%
March 2019
(3,591
)
Secured notes payable
8.15
%
January
2019
(4,188
)
2019 Unsecured senior bank term loan
2.75
%
September 2018
(2,991
)
Other
decrease in interest
(352
)
Total decreases
(11,122
)
Change
in interest incurred
18,263
Increase in capitalized interest
(11,296
)
Total
change in interest expense
$
6,967
(1)
Represents
the weighted-average interest rate as of the end of the applicable period, including expense/income related to our interest rate hedge agreements, amortization of loan fees, amortization of debt premiums (discounts), and other bank fees.
In anticipation of LIBOR cessation at the end of 2021, we have been actively reducing borrowings outstanding on our LIBOR-based loans. As of June 30, 2019, our outstanding debt included only two LIBOR-based loans: our $2.2 billion unsecured senior line of credit with an outstanding balance of $514.0 million and our unsecured senior bank term loan with an outstanding balance of $350.0 million. The aggregate outstanding balance of the aforementioned
LIBOR-based loans represented less than 15% of our total debt balance outstanding as of June 30, 2019. Refer to “Item 3. Quantitative and Qualitative Disclosures About Market Risk” within this quarterly report on Form 10-Q for our sensitivity analysis of interest rate risk related to LIBOR fluctuations.
Depreciation and amortization
Depreciation and amortization expense for the six months ended June 30, 2019, increased by $35.5 million, or 15.2%, to $268.5 million,
compared to $233.1 million for the six months ended June 30, 2018. The increase is primarily due to additional depreciation from 1.4 million RSF of development and redevelopment projects placed into service subsequent to January 1, 2018, and 33 operating properties aggregating 2.3 million RSF acquired subsequent to January 1, 2018.
93
Investment
income
During six months ended June 30, 2019, we recognized $105.1 million of investment income, which included $21.8 million of realized gains and $83.3 million of unrealized gains. Realized gains of $21.8 million for the six months ended June 30, 2019, primarily related to the sales of our investments in publicly traded companies. Unrealized gains of $83.3 million during the six months ended June 30,
2019, primarily consisted of increases in fair values of our investments in publicly traded companies aggregating $44.5 million and increases in fair values of our investments in privately held entities that report NAV aggregating $29.3 million.
During the six months ended June 30, 2018, we recognized $98.1 million of investment income, which included $20.8 million of realized gains and $77.3 million of unrealized gains. Refer to Note 7 – “Investments” to these unaudited consolidated financial statements for further details.
Sales
of real estate assets
During the six months ended June 30, 2018, we recognized an impairment of real estate of $6.3 million related to one land parcel located in Northern Virginia that was classified as held for sale as of June 30, 2018, and was sold in July 2018 for a sales price of $6.0 million with no gain or loss.
Loss on early extinguishment of debt
During the six months ended June 30,
2019, we repaid early one secured note payable aggregating $106.7 million, which was originally due in 2020 and bore interest at 7.75%, and recognized a loss on early extinguishment of debt of $7.1 million, including the write-off of unamortized loan fees. Additionally, during the six months ended June 30, 2019, we repaid early the remaining $193.1 million balance of our secured construction loan related to 50/60 Binney Street and recognized a loss on early extinguishment of debt of $269 thousand.
Preferred stock redemption charge
During the six months ended June 30, 2019, we repurchased, in privately negotiated transactions, 275,000 outstanding shares of our Series D Convertible Preferred Stock and recognized a preferred stock redemption charge of $2.6 million.
94
Projected results
On
June 20, 2019, we filed a Current Report on Form 8-K with updated guidance for the year ending December 31, 2019. We present further updated guidance for EPS attributable to Alexandria’s common stockholders – diluted, and funds from operations per share attributable to Alexandria’s common stockholders – diluted, as adjusted, based on our current view of existing market conditions and other assumptions for the year ending December 31, 2019, as set forth, and as adjusted, in the tables below. The tables below also provide a reconciliation of EPS attributable to Alexandria’s common stockholders – diluted, the most directly comparable GAAP measure, to funds from operations per share and funds from operations per share, as adjusted,
non-GAAP measures, and other key assumptions included in our updated guidance for the year ending December 31, 2019. There can be no assurance that actual amounts will not be materially higher or lower than these expectations. Refer to our discussion of “Forward-Looking Statements” in this Item 2.
Guidance
Summary of Key Changes in Guidance
As
of 7/29/19
As of 6/20/19
EPS, FFO per share, and FFO per share, as adjusted
See updates below
Rental rate increases
27.0% to 30.0%
26.0% to 29.0%
Rental rate increases (cash basis)
14.0%
to 17.0%
13.0% to 16.0%
Projected Earnings per Share and Funds From Operations per Share Attributable
to Alexandria’s Common Stockholders – Diluted, as Adjusted
As of 7/29/19
As
of 6/20/19
Earnings per share(1)
$2.39 to $2.47
$2.65 to $2.75
Depreciation and amortization
4.85
4.85
Allocation
of unvested restricted stock awards
(0.05)
(0.05)
Funds from operations per share(2)
$7.19 to $7.27
$7.45
to $7.55
Unrealized gains on non-real estate investment(1)
(0.75)
(0.65)
Loss on early extinguishment of debt(3)
0.45
0.07
Preferred
stock redemption charge
0.02
0.02
Allocation to unvested restricted stock awards
0.01
0.01
Funds
from operations per share, as adjusted
$6.92 to $7.00
$6.90 to $7.00
Midpoint
$6.96
$6.95
(1)
Excludes
future unrealized gains or losses from changes in fair value of equity investments after June 30, 2019, that are required to be recognized in earnings and are excluded from funds from operations per share, as adjusted.
(2)
Calculated in accordance with standards established by the Advisory Board of Governors of Nareit (the “Nareit Board of Governors”). Refer to the definition of “Funds From Operations and Funds From Operations, As Adjusted, Attributable to Alexandria’s Common Stockholders” in the “Non-GAAP Measures and Definitions” section within this Item 2 for additional information.
(3)
In
July 2019, we issued $1.25 billion of unsecured senior notes payable and made a partial repayment of $175.0 million on our unsecured senior bank term loan. Also in July 2019, we refinanced an aggregate $950.0 million of unsecured senior notes payable comprising $400.0 million of 2.75% unsecured senior notes payable due 2020 and $550.0 million of 4.60% unsecured senior notes payable due 2022, pursuant to a cash tender offer completed on July 17, 2019, and a subsequent call for redemption. The redemption is expected to settle on August 16, 2019.
As a result of our refinancing and partial repayment, we expect to recognize a loss, primarily related to the early extinguishment of debt, of $43 million, or $0.38 per share, during the three months ending September 30, 2019.
95
Key Assumptions(1)
(Dollars
in millions)
2019 Guidance
Low
High
Occupancy percentage for operating properties in North America as of December 31, 2019(2)
97.2%
97.8%
Lease
renewals and re-leasing of space:
Rental rate increases
27.0%
30.0%
Rental
rate increases (cash basis)
14.0%
17.0%
Same
property performance:
Net operating income increase
1.0%
3.0%
Net
operating income increase (cash basis)
6.0%
8.0%
Straight-line
rent revenue
$
95
$
105
(3)
General and administrative expenses
$
108
$
113
Capitalization
of interest
$
79
$
89
Interest expense
$
167
$
177
(1)
The completion of our development and redevelopment projects will result in an increase in interest expense and other project costs because these project costs will no longer qualify for capitalization and will therefore be expensed as incurred. Our assumptions for occupancy, rental rate increases, same property net operating income increase, straight-line rent revenue, general and administrative expenses, capitalization of interest, and interest expense presented in the table above are subject to a number of variables and uncertainties, including those discussed as “Forward-Looking Statements” under Part I; “Item 1A. Risk Factors”; and “Item 7. Management’s Discussion and Analysis of Financial
Condition and Results of Operations” of our annual report on Form 10‑K for the year ended December 31, 2018. To the extent our full-year earnings guidance is updated during the year, we will provide disclosure supporting reasons for any significant changes to such guidance.
(2)
On June 20, 2019, we updated guidance for occupancy percentage for operating properties in North America as of December 31, 2019, to reflect the pending acquisition of a campus located in our San Diego market that includes multiple operating buildings aggregating
560,000 RSF which is 76% leased. Additionally, as expected, we will commence renovations on 116,556 RSF at 3545 Cray Court in our Torrey Pines submarket upon expiration of the existing lease in the third quarter of 2019. In aggregate for these items, we expect a temporary decline in occupancy percentage in North America of approximately 1% from the second quarter to the third quarter of 2019.
(3)
Approximately 45% of straight-line rent revenue represents initial free rent on recently delivered and expected 2019 deliveries of new Class A properties from our development and redevelopment pipeline.
Key
Credit Metrics
2019 Guidance
Net debt to Adjusted EBITDA – fourth quarter of 2019, annualized
Less than or equal to 5.3x
Net debt and preferred stock to Adjusted EBITDA – fourth quarter of 2019, annualized
Less than or equal to 5.4x
Fixed-charge
coverage ratio – fourth quarter of 2019, annualized
Greater than 4.0x
Value-creation pipeline as a percentage of gross investments in real estate as of December 31, 2019
Less than 15%
96
Consolidated
and unconsolidated real estate joint ventures
We present components of balance sheet and operating results information for the noncontrolling interest share of our consolidated real estate joint ventures and for our share of investments in unconsolidated real estate joint ventures to help investors estimate balance sheet and operating results information related to our partially owned entities. These amounts are estimated by computing, for each joint venture that we consolidate in our financial statements, the noncontrolling interest percentage of each financial item to arrive at the cumulative noncontrolling interest share of each component presented. In addition, for our real estate joint ventures that we do not control and do not consolidate, we apply our economic ownership percentage to the unconsolidated real estate joint ventures to arrive at our proportionate share of
each component presented. Refer to Note 4 – “Consolidated and Unconsolidated Real Estate Joint Ventures” to our unaudited consolidated financial statements under Item 1 of this report for further discussion.
Consolidated Real Estate Joint Ventures
(controlled by us through contractual rights or majority voting rights)
Property/Market/Submarket
Noncontrolling(1)
Interest
Share
75/125 Binney Street/Greater Boston/Cambridge
60.0
%
225 Binney Street/Greater Boston/Cambridge
70.0
%
409
and 499 Illinois Street/San Francisco/Mission Bay/SoMa
40.0
%
1500 Owens Street/San Francisco/Mission Bay/SoMa
49.9
%
Campus
Pointe by Alexandria/San Diego/University Town Center(2)
45.0
%
9625 Towne Centre Drive/San Diego/University Town Center
49.9
%
Unconsolidated
Real Estate Joint Ventures
(controlled jointly or by our JV partners through contractual rights or majority voting rights)
Property/Market/Submarket
Our Ownership Share(3)
1655 and 1725 Third Street/San Francisco/Mission Bay/SoMa
10.0
%
Menlo
Gateway/San Francisco/Greater Stanford
48.3
%
(4)
1401/1413 Research Boulevard/Maryland/Rockville
65.0
%
(5)
704
Quince Orchard Road/Maryland/Gaithersburg
56.8
%
(5)
(1)
In addition to the consolidated real estate joint ventures listed, various partners hold insignificant noncontrolling interests in four other joint ventures in North America.
(2)
Includes
10290 and 10300 Campus Point Drive and 4110 Campus Point Court in our University Town Center submarket.
(3)
In addition to the unconsolidated real estate joint ventures listed, we hold one other insignificant unconsolidated real estate joint venture in North America.
(4)
As of June 30, 2019, we had a 48.3% ownership interest
in Menlo Gateway and expect our ownership to increase to 49% through future funding of construction costs in 2019.
(5)
Represents our ownership interest; our voting interest is limited to 50%.
Our unconsolidated real estate joint ventures have the following non-recourse secured loans that include the following key terms as of June 30, 2019, (dollars in thousands):
Maturity
Date
Stated Rate
Interest Rate(1)
100% at Joint Venture Level
Unconsolidated Joint Venture
Our Share
Debt
Balance(2)
Remaining Commitments
1401/1413 Research Boulevard
65.0%
5/17/20
L+2.50%
5.91%
$
22,696
$
5,997
1655
and 1725 Third Street
10.0%
6/29/21
L+3.70%
6.14%
253,366
121,634
704
Quince Orchard Road
56.8%
3/16/23
L+1.95%
4.59%
6,997
7,865
Menlo
Gateway, Phase II
48.3%
5/1/35
4.53%
4.59%
8,019
147,784
Menlo
Gateway, Phase I
48.3%
8/10/35
4.15%
4.18%
143,334
—
$
434,412
$
283,280
(1)
Includes
interest expense and amortization of loan fees.
(2)
Represents outstanding principal, net of unamortized deferred financing costs.
97
The following tables present information related to the operating results and financial positions of our consolidated and unconsolidated real estate joint ventures (in thousands):
Noncontrolling
Interest Share of Consolidated Real Estate Joint Ventures
Our Share of Unconsolidated Real Estate Joint Ventures
Fixed returns allocated to redeemable noncontrolling interests(1)
218
435
—
—
$
8,412
$
16,071
$
1,262
$
2,408
Straight-line
rent and below-market lease revenue
$
779
$
1,801
$
563
$
1,016
Funds
from operations
$
15,156
$
28,234
$
2,235
$
4,227
(1)
Represents
an allocation of joint venture earnings to redeemable noncontrolling interests primarily in one property in our South San Francisco submarket. These redeemable noncontrolling interests earn a fixed return on their investment rather than participate in the operating results of the property.
Our Share of Unconsolidated Real Estate Joint Ventures
Investments in real estate
$
713,892
$
444,845
Cash and cash equivalents
21,439
7,350
Restricted
cash
—
99
Other assets
70,029
28,881
Secured notes payable
—
(117,103
)
Other
liabilities
(22,911
)
(29,910
)
Redeemable noncontrolling interests
(10,994
)
—
$
771,455
$
334,162
During
the six months ended June 30, 2019 and 2018, our consolidated real estate joint ventures distributed an aggregate of $24.6 million and $18.4 million, respectively, to our joint venture partners. Refer to our consolidated statements of cash flows and Note 4 – “Consolidated and Unconsolidated Real Estate Joint Ventures” to our unaudited consolidated financial statements under Item 1 of this report for additional information.
98
Investments
We
present our equity investments at fair value whenever fair value or NAV is readily available. Adjustments for our limited partnership investments represent changes in reported NAV as a practical expedient to estimate fair value. For investments without readily available fair values, we adjust the carrying amount whenever such investments have an observable price change and further adjustments are not made until another price change, if any, is observed. Refer to Note 7 – “Investments” to our unaudited consolidated financial statements under Item 1 of this report for additional information.
Includes
realized gains of $14.7 million related to two publicly traded non-real estate investments and impairment of $5.5 million primarily related to one privately held non-real estate investment. Excluding these gains and impairment, our realized gains on non-real estate investments were $27.9 million for the year ended December 31, 2018.
Public/Private Mix (Cost)
Tenant/Non-Tenant Mix
(Cost)
$734.4M
Cost
$1.1B
Carrying
Amount
99
Liquidity
Net Debt to Adjusted EBITDA(1)
Net Debt and Preferred Stock to Adjusted EBITDA(1)
Unsecured
Senior Line of Credit Balance
(In millions)
Fixed-Charge
Coverage Ratio(1)
Liquidity(2)
$3.4B
(In
millions)
Availability under our $2.2 billion unsecured senior line of credit
We expect to meet certain long-term liquidity requirements, such as requirements for development, redevelopment, other construction projects, capital improvements, tenant improvements, property acquisitions, leasing costs, non-revenue-enhancing capital expenditures, scheduled debt maturities, distributions to noncontrolling interests, repurchases/redemptions of preferred stock, and
payment of dividends through net cash provided by operating activities, periodic asset sales, strategic real estate joint venture capital, and long-term secured and unsecured indebtedness, including borrowings under our $2.2 billion unsecured senior line of credit, unsecured senior bank term loan, and issuance of additional debt and/or equity securities.
We expect to continue meeting our short-term liquidity and capital requirements, as further detailed in this section, generally through our working capital and net cash provided by operating activities. We believe that the net cash provided by operating activities will continue to be sufficient to enable us to make the distributions necessary to continue qualifying as a REIT.
100
Over
the next several years, our balance sheet, capital structure, and liquidity objectives are as follows:
•
Retain positive cash flows from operating activities after payment of dividends and distributions to noncontrolling interests for investment in development and redevelopment projects and/or acquisitions;
•
Improve credit profile and relative long-term cost of capital;
•
Maintain
diverse sources of capital, including sources from net cash provided by operating activities, unsecured debt, secured debt, selective real estate asset sales, partial interest sales, non-real estate investment sales, preferred stock, and common stock;
•
Maintain commitment to long-term capital to fund growth;
•
Maintain prudent laddering of debt maturities;
•
Maintain
solid credit metrics;
•
Maintain significant balance sheet liquidity;
•
Mitigate unhedged variable-rate debt exposure through the reduction of short-term and medium-term variable-rate bank debt;
•
Maintain a large unencumbered asset pool to provide financial flexibility;
•
Fund
preferred stock and common stock dividends and distributions to noncontrolling interests from net cash provided by operating activities;
•
Manage a disciplined level of value-creation projects as a percentage of our gross investments in real estate; and
•
Maintain high levels of pre-leasing and percentage leased in value-creation projects.
The
following table presents the availability under our $2.2 billion unsecured senior line of credit; forward equity sales agreements; cash, cash equivalents, and restricted cash; and investments in publicly traded companies as of June 30, 2019 (dollars in thousands):
Description
Stated
Rate
Aggregate
Commitments
Outstanding
Balance
Remaining Commitments/Liquidity
$2.2 billion unsecured senior line of credit
L+0.825
%
$
2,200,000
$
514,000
$
1,686,000
Outstanding
forward equity sales agreements
1,132,209
Cash, cash equivalents, and restricted cash
238,225
Investments
in publicly traded companies
294,084
Total liquidity
$
3,350,518
Cash,
cash equivalents, and restricted cash
As of June 30, 2019, and December 31, 2018, we had $238.2 million and $272.1 million, respectively, of cash, cash equivalents, and restricted cash. We expect existing cash, cash equivalents, and restricted cash, cash flows from operating activities, proceeds from real estate asset sales, non-real estate investment sales, borrowings under our $2.2 billion unsecured senior line of credit, issuances of unsecured notes payable, and issuances of common stock to continue to be sufficient to fund our operating activities and cash commitments for investing and financing
activities, such as regular quarterly dividends, distributions to noncontrolling interests, scheduled debt repayments, acquisitions, and certain capital expenditures, including expenditures related to construction activities.
Cash flows
We report and analyze our cash flows based on operating activities, investing activities, and financing activities. The following table summarizes changes in our cash flows for the six months ended June 30, 2019 and 2018
(in thousands):
Cash flows provided by operating activities are primarily dependent upon the occupancy level of our asset base, the rental rates of our leases, the collectibility of rent and recovery of operating expenses from our tenants, the timing of completion of development and redevelopment projects, and the timing of acquisitions and dispositions of operating properties. Net cash provided by operating activities for the six months ended June 30, 2019, increased to $308.3 million, compared to $258.2 million for the six months ended June 30,
2018. This increase was primarily attributable to (i) cash flows generated from our highly leased development and redevelopment projects recently placed into service, (ii) income-producing acquisitions since January 1, 2018, and (iii) increases in rental rates on lease renewals and re-leasing of space since January 1, 2018.
Investing activities
Cash used in investing activities for the
six months ended June 30, 2019 and 2018, consisted of the following (in thousands):
Six Months Ended June 30,
Increase (Decrease)
2019
2018
Sources
of cash from investing activities:
Sales of investments
$
49,967
$
44,707
$
5,260
Returns
of deposits for investing activities
—
5,500
(5,500
)
49,967
50,207
(240
)
Uses
of cash for investing activities:
Purchases of real estate
715,030
688,698
26,332
Additions
to real estate
577,322
431,225
146,097
Deposits paid for investing activities
9,000
—
9,000
Investments
in unconsolidated real estate joint ventures
95,950
44,486
51,464
Additions to investments
104,902
118,775
(13,873
)
Acquisitions
of interests in unconsolidated real estate joint ventures
—
35,922
(35,922
)
1,502,204
1,319,106
183,098
Net
cash used in investing activities
$
1,452,237
$
1,268,899
$
183,338
The change in net cash used in investing activities for the six
months ended June 30, 2019, is primarily due to an increased use of cash for property acquisitions, additions to real estate, and for investments in unconsolidated real estate joint ventures, partially offset by lower acquisitions of interests in unconsolidated real estate joint ventures. Refer to Note 3 – “Investments in Real Estate” to our unaudited consolidated financial statements under Item 1 of this report for further information.
102
Financing activities
Cash
flows provided by financing activities for the six months ended June 30, 2019 and 2018, consisted of the following (in thousands):
Repayments of borrowings from secured notes payable
(302,878
)
(3,162
)
(299,716
)
Proceeds
from issuance of unsecured senior notes payable
854,209
899,321
(45,112
)
Borrowings from unsecured senior line of credit
2,114,000
2,469,000
(355,000
)
Repayments
of borrowings from unsecured senior line of credit
(1,808,000
)
(2,519,000
)
711,000
Payments of loan fees
(15,796
)
(8,003
)
(7,793
)
Changes
related to debt
841,535
847,200
(5,665
)
Taxes
paid related to net settlement of equity awards
(4,086
)
—
(4,086
)
Repurchase of 7.00% Series D cumulative convertible preferred stock
(9,240
)
—
(9,240
)
Proceeds
from issuance of common stock
85,394
400,207
(314,813
)
Dividend payments
(221,046
)
(185,644
)
(35,402
)
Contributions
from and sales of noncontrolling interests
441,251
14,564
426,687
Distributions to and purchases of noncontrolling interests
(24,590
)
(19,841
)
(4,749
)
Net
cash provided by financing activities
$
1,109,218
$
1,056,486
$
52,732
103
Capital
resources
We expect that our principal liquidity needs for the year ending December 31, 2019, will be satisfied by the following multiple sources of capital, as shown in the table below. There can be no assurance that our sources and uses of capital will not be materially higher or lower than these expectations.
Summary of Key Changes in Key Sources and Uses of Capital Guidance
(In
millions)
Guidance Midpoint
As of 7/29/19
As of 6/20/19
Issuance of unsecured senior notes payable
$
2,100
$
850
Repayments
of unsecured senior notes payable
$
(950
)
$
—
Repayments of unsecured senior bank term loan
$
(175
)
$
—
Key
Sources and Uses of Capital
(In millions)
2019 Guidance
Certain Completed Items
Range
Midpoint
Sources of capital:
Net
cash provided by operating activities after dividends
$
170
$
210
$
190
Incremental
debt
610
570
590
Real estate dispositions and partial interest
sales
820
920
870
$
438
(1)
Common
equity
1,150
1,250
1,200
$
1,218
(2)
Total
sources of capital
$
2,750
$
2,950
$
2,850
Uses
of capital:
Construction
$
1,250
$
1,350
$
1,300
Acquisitions
1,500
1,600
1,550
(1)
Total
uses of capital
$
2,750
$
2,950
$
2,850
Incremental
debt (included above):
Issuance of unsecured senior notes payable
$
2,100
$
2,100
$
2,100
$
2,100
(3)
Assumption
of secured note payable
28
28
28
$
28
Repayments
of unsecured senior notes payable
(950
)
(950
)
(950
)
$
(950
)
(3)
Repayments
of secured notes payable
(310
)
(320
)
(315
)
$
(300
)
Repayments
of unsecured senior bank term loan
(175
)
(175
)
(175
)
$
(175
)
(3)
$2.2
billion unsecured senior line of credit/other
(83
)
(113
)
(98
)
Incremental debt
$
610
$
570
$
590
(1)
Refer
to the “Acquisitions” and “Real Estate Asset Sales” subsections of the “Investments in Real Estate” section within this Item 2 for additional information.
(2)
Includes 602,484 shares of common stock for net proceeds of $86.1 million issued under our ATM program during the second quarter of 2019 and unsettled forward equity sales agreements to sell an aggregate of 8.1 million shares of our common stock.
(3)
In
July 2019, we issued $1.25 billion of unsecured senior notes payable and made a partial repayment of $175.0 million on our unsecured senior bank term loan. Also in July 2019, we refinanced an aggregate $950.0 million of unsecured senior notes payable comprising $400.0 million of 2.75% unsecured senior notes payable due 2020 and $550.0 million of 4.60% unsecured senior notes payable due 2022, pursuant to a cash tender offer completed on July 17, 2019, and a subsequent call for redemption. The redemption is expected to settle on August 16, 2019.
As a result of our refinancing and partial repayment, we expect to recognize a loss, primarily related to the early extinguishment of debt, of $43 million, or $0.38 per share, during the three months ending September 30, 2019.
The key assumptions behind the sources and uses of capital in the table above include a favorable capital market environment, performance of our core operating properties, lease-up and delivery of current and future development and redevelopment projects, and leasing activity. Our expected sources and uses of capital are subject to a number of variables and uncertainties, including those discussed as “Forward-Looking Statements” under Part I; “Item 1A. Risk Factors”; and “Item
7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our annual report on Form 10‑K for the year ended December 31, 2018. We expect to update our forecast of sources and uses of capital on a quarterly basis.
104
Sources of capital
Net cash provided by operating activities after dividends
We
expect to retain $170.0 million to $210.0 million of net cash flows from operating activities after payment of common stock and preferred stock dividends, and distributions to noncontrolling interests for the year ending December 31, 2019. For purposes of this calculation, changes in operating assets and liabilities are excluded as they represent timing differences. For the year ending December 31, 2019, we expect our recently delivered projects, our highly pre-leased value-creation projects expected to be completed, along with contributions from Same Properties and recently acquired properties, to contribute significant increases in income from rentals, net operating income, and cash flows.
We anticipate significant contractual near-term growth in annual cash rents of $58 million related to the commencement of contractual rents on the projects recently placed into service that are near the end of their initial free rent period. Refer to the “Cash Flows” subsection of the “Liquidity” section within this Item 2 of this report for a discussion of cash flows provided by operating activities for the six months ended June 30, 2019.
Debt
In February 2019, S&P Global Ratings raised our corporate issuer credit rating to BBB+/Stable from BBB/Positive. The rating upgrade reflects our consistently strong operating performance
and continued successful delivery of our value-creation pipeline.
The table below reflects the total commitments, outstanding balances, applicable margins, maturity dates, and facility fees for each of the following facilities as of June 30, 2019:
Commitment
Balance(1)
Applicable
Rate
Maturity Date
Facility Fee
Unsecured senior line of credit
$2.2 billion
$514 million
L+0.825%
January 2024(2)
0.15%
Unsecured
senior bank term loan
$350 million
$350 million
L+0.90%
January 2025
N/A
(1)
Excludes
loan fees and premiums (discounts) as of June 30, 2019.
(2)
Includes two six-month extension options that we control.
As of June 30, 2019, we had $514.0 million outstanding balance on our $2.2 billion unsecured senior line of credit and a $350 million outstanding principal balance on our unsecured senior bank term loan. Borrowings under the $2.2 billion
unsecured senior line of credit and our unsecured senior bank term loan bear interest at LIBOR or the base rate specified in the agreement plus, in either case, a specified margin (the “Applicable Margin”) based on our existing credit ratings as set by certain rating agencies.
We use our $2.2 billion unsecured senior line of credit to fund working capital, construction activities, and, from time to time, acquisition of properties. Borrowings under the $2.2 billion unsecured senior line of credit will bear interest at a “Eurocurrency Rate,” a “LIBOR Floating Rate,” or a “Base Rate” specified in the $2.2 billion unsecured senior line of credit agreement plus, in any case, the Applicable Margin. The Eurocurrency Rate specified in the $2.2 billion unsecured senior line of credit agreement is, as applicable, the rate per annum equal
to either (i) the LIBOR or a successor rate thereto as agreed to by the administrative agent and the Company for loans denominated in a LIBOR quoted currency (i.e., U.S. dollars, euro, sterling, or yen), (ii) the average annual yield rates applicable to Canadian dollar bankers’ acceptances for loans denominated in Canadian dollars, (iii) the Bank Bill Swap Reference Bid rate for loans denominated in Australian dollars, or (iv) the rate designated with respect to the applicable alternative currency for loans denominated in a non-LIBOR quoted currency (other than Canadian or Australian dollars). The LIBOR Floating Rate means, for any day, one month LIBOR, or a successor rate thereto as agreed to by the administrative agent and the Company for loans denominated in U.S. dollars. The Base Rate means,
for any day, a fluctuating rate per annum equal to the highest of (i) the federal funds rate plus 1/2 of 1.00%, (ii) the rate of interest in effect for such day as publicly announced from time to time by Bank of America as its “prime rate,” and (iii) the Eurocurrency Rate plus 1.00%. Our $2.2 billion unsecured senior line of credit contains a feature that allows lenders to competitively bid on the interest rate for borrowings under the facility. This may result in an interest rate that is below the stated rate. In addition to the cost of borrowing, the $2.2 billion unsecured senior line of credit is subject to an annual facility fee of 0.15% based on the aggregate commitments outstanding.
We expect to fund a portion of our capital needs in 2019 from the issuance of unsecured senior
notes payable, and from borrowings under our $2.2 billion unsecured senior line of credit.
In March 2019, we completed an offering of $850.0 million of unsecured senior notes for net proceeds of $846.1 million. The unsecured senior notes consisted of $300.0 million of 4.85% Unsecured Senior Notes; $350.0 million of 3.80% Unsecured Senior Notes, the proceeds from which were allocated to fund recently completed and future eligible green projects and the repayment of a secured note payable related to 50/60 Binney Street, a recently completed Class A property, which was awarded LEED®
Gold certification; and $200.0 million added to our outstanding 4.00% unsecured senior notes due on January 15, 2024, issued at a yield to maturity of 3.453%, which are part of the same series that was originally issued in 2018 and will also be used to fund recently completed and future eligible green projects. As of June 30, 2019, these notes had a weighted-average interest rate of 4.18% and a weighted-average maturity of 14.4 years.
105
In
June 2019, we extended the maturity date of our unsecured senior bank term loan to January 2, 2025 from January 28, 2024, and in July 2019 we made a partial repayment of $175.0 million on its $350.0 million principal balance outstanding as of June 30, 2019.
In July 2019, we issued $1.25 billion of unsecured senior notes payable with a weighted-average interest rate of 3.72% and a weighted-average maturity of 19.5
years. The unsecured senior notes consisted of $750.0 million of 3.375% Unsecured Senior Notes and $500.0 million of 4.00% Unsecured Senior Notes. The proceeds were primarily used to refinance an aggregate $950.0 million of unsecured senior notes payable comprising $400.0 million of 2.75% unsecured senior notes payable due 2020 and $550.0 million of 4.60% unsecured senior notes payable due 2022, pursuant to a cash tender offer and a subsequent call for redemption. In July 2019, we tendered $318.6 million,
or 79.64% of our outstanding 2.75% unsecured senior notes payable and $384.9 million, including $135,000 tendered via guaranteed deliveries, or 69.98%, of our outstanding 4.60% unsecured senior notes payable. The call for redemption of the remaining 2.75% and 4.60% unsecured senior notes payable is expected to settle on August 16, 2019. Additionally, we made a partial repayment of $175.0 million on the outstanding balance of our unsecured senior bank term loan, and used
the remaining proceeds to reduce the outstanding balance of our unsecured senior line of credit. The weighted-average interest rate and maturity of the refinanced unsecured senior notes payable and partially repaid unsecured bank term loan were 3.94% and 2.4 years, respectively. As a result of our refinancing and partial repayment, we expect to recognize a loss, primarily related to the early extinguishment of debt, of $43 million during the three months ending September 30, 2019.
During the three months ended March 31, 2019, we repaid early one secured note payable aggregating $106.7 million, which
was originally due in 2020 and bore interest at 7.75%, and recognized a loss on early extinguishment of debt of $7.1 million, including the write-off of unamortized loan fees. Additionally, we repaid early the remaining $193.1 million balance of our secured construction loan related to 50/60 Binney Street and recognized a loss on early extinguishment of debt of $269 thousand.
Management of LIBOR transition
On July 27, 2017, the Financial Conduct Authority (“FCA”) announced that it would phase out LIBOR as a benchmark by the
end of 2021. In June 2017, the ARRC selected the Secured Overnight Financing Rate (“SOFR”), a new index calculated by reference to short-term repurchase agreements backed by Treasury securities, as its preferred replacement for U.S. dollar LIBOR. Since 2012, we have been closely monitoring developments in the LIBOR transition and, subsequently, in the SOFR markets, and have implemented numerous proactive measures to minimize the potential impact to the Company, specifically:
•
We have been actively reducing borrowings outstanding on our LIBOR-based unsecured senior line of credit, unsecured senior bank term loans, and construction
loans through repayments: from January 2017 to July 2019, we retired approximately $1.2 billion of such debt.
•
As of June 30, 2019, our outstanding debt included only two LIBOR-based loans: our $2.2 billion unsecured senior line of credit with an outstanding balance of $514.0 million and our unsecured senior bank term loan with an outstanding balance of $350.0 million. The aggregate outstanding balance of the aforementioned LIBOR-based loans represented less than 15% of our total debt balance outstanding as of June
30, 2019.
•
In July 2019, we completed a partial repayment of $175.0 million of our unsecured senior bank term loan balance and repaid all outstanding borrowings under our unsecured senior line of credit, further reducing our exposure to LIBOR. In addition, we will seek opportunities to further retire the remaining balance of the unsecured senior bank term loan prior to the end of 2021.
•
All of our interest rate swap agreements mature prior to LIBOR cessation at the end
of 2021.
•
Our unsecured senior line of credit and unsecured senior bank term loan contain fallback language generally consistent with the ARRC’s Amendment Approach, which provides a streamlined amendment approach for negotiating a benchmark replacement and introduces clarity with respect to the fallback trigger events and an adjustment to be applied to the successor rate.
•
We continue to monitor developments by the ARRC and other governing bodies involved in LIBOR transition.
Refer
to “Item 1A. Risk Factors” within this quarterly report on Form 10-Q for additional information about LIBOR replacement.
Real estate dispositions and common equity
We expect to continue the disciplined execution of select sales of operating assets. Future sales will provide an important source of capital to fund a portion of our highly leased value-creation development and redevelopment projects. We may also consider additional sales of partial interests in core Class A properties and/or development projects. For 2019, we expect real estate dispositions and issuances of common equity ranging from $2.0 billion to $2.2 billion, which includes the
sale of a 60% interest in 75/125 Binney Street, a Class A property located in our Cambridge submarket for a sales price of $438.0 million. We completed this partial interest sale during the three months ended March 31, 2019. The amount of asset sales necessary to meet our forecasted sources of capital will vary depending upon the amount of EBITDA associated with the assets sold. In addition, the amount of common equity issued will be subject to market conditions.
For additional information, refer to “Real Estate Asset Sales” subsection of the “Investments in Real Estate” section within this Item 2.
106
Common
equity transactions
During the three and six months ended June 30, 2019, we completed issuances and entered into forward equity sales agreement for an aggregate of 8.7 million shares of common stock at a weighted-average price of $144.50 per share, for aggregate net proceeds of approximately $1.2 billion as follows:
•
Issued 602,484 shares of common
stock, at a weighted-average price of $145.58 per share, for net proceeds of $86.1 million.
•
Entered into forward equity sales agreements to sell an aggregate of 8.1 million shares of common stock, at a weighted-average price of $144.42 per share, for aggregate proceeds (net of underwriters’ discounts) of approximately $1.1 billion, to be further adjusted as provided in the forward equity sales agreements, including:
(i) agreements to issue 4.4 million
shares at a price of $145.00 per share expiring in June 2020.
(ii) agreements to issue 3.7 million shares at a weighted-average price of $143.73 per share expiring in July 2020.
•
We expect to settle our forward equity sales agreements in 2019.
•
We expect to establish a new ATM program during the third quarter of 2019.
Other
sources
Under our current shelf registration statement filed with the SEC, we may offer common stock, preferred stock, debt, and other securities. These securities may be issued, from time to time, at our discretion based on our needs and market conditions, including, as necessary, to balance our use of incremental debt capital.
Additionally, we hold interests, together with joint venture partners, in joint ventures that we consolidate in our financial statements. These joint venture partners may contribute equity into these entities primarily related to their share of funds for construction and financing-related activities. During the six months ended June 30, 2019, we received $441.3
million of contributions from and sales of noncontrolling interests.
107
Uses of capital
Summary of capital expenditures
One of our primary uses of capital relates to the development, redevelopment, pre-construction, and construction of properties. We currently
have projects in our growth pipeline aggregating 3.4 million RSF of Class A office/laboratory and tech office space undergoing construction and pre-construction, and intermediate-term and future value-creation projects supporting an aggregate of 7.3 million SF of ground-up development in North America. We incur capitalized construction costs related to development, redevelopment, pre-construction, and other construction activities. We also incur additional capitalized project costs, including interest, property taxes, insurance, and other costs directly related and essential to the development, redevelopment, pre-construction, or construction of a project, during periods when activities necessary to prepare an asset for its intended use are in progress. Refer to the “New Class A Development and Redevelopment Properties: Projected 2019-2020 Deliveries and Pre-Construction Projects”
and “Summary of Capital Expenditures” subsections of the “Investments in Real Estate” section within this Item 2 for more information on our capital expenditures.
We capitalize interest cost as a cost of the project only during the period for which activities necessary to prepare an asset for its intended use are ongoing, provided that expenditures for the asset have been made and interest cost has been incurred. Capitalized interest for the six months ended June 30, 2019 and 2018, of $40.2 million and $28.9 million, respectively, is classified in investments in real estate. Indirect
project costs, including construction administration, legal fees, and office costs that clearly relate to projects under development or construction, are capitalized as incurred during the period an asset is undergoing activities to prepare it for its intended use. We capitalized payroll and other indirect project costs related to development, redevelopment, pre-construction, and construction projects, which aggregated $20.7 million and $13.5 million for the six months ended June 30, 2019 and 2018, respectively.The increase in capitalized payroll and other indirect project costs for the six months ended June 30,
2019, compared to the same period in 2018 was primarily due to an increase in our value-creation pipeline projects undergoing construction and pre-construction activities aggregating eight projects with 1.2 million RSF in 2019 over 2018. Pre-construction activities include entitlements, permitting, design, site work, and other activities preceding commencement of construction of aboveground building improvements. The advancement of pre-construction efforts is focused on reducing the time required to deliver projects to prospective tenants. These critical activities add significant value for future ground-up development and are required for the vertical construction of buildings. Should we cease activities necessary
to prepare an asset for its intended use, the interest, taxes, insurance, and certain other direct project costs related to this asset would be expensed as incurred. Expenditures for repairs and maintenance are expensed as incurred.
Fluctuations in our development, redevelopment, and construction activities could result in significant changes to total expenses and net income. For example, had we experienced a 10% reduction in development, redevelopment, and construction activities without a corresponding decrease in indirect project costs, including interest and payroll, total expenses would have increased by approximately $6.1 million for the six months ended June 30, 2019.
We
use third-party brokers to assist in our leasing activity, who are paid on a contingent basis upon successful leasing. We are required to capitalize initial direct costs related to successful leasing transactions, which result directly from and are essential to the lease transaction, and would not have been incurred had that lease transaction not been successfully executed. During the six months ended June 30, 2019, we capitalized total initial direct leasing costs of $29.9 million. Effective January 1, 2019, costs that we incur to negotiate or arrange a lease regardless of its outcome, such as fixed employee compensation, tax, or legal advice to negotiate lease terms, and other costs are expensed as incurred.
Acquisitions
Refer
to the “Acquisitions” section of Note 3 – “Investments in Real Estate” to our unaudited consolidated financial statements under Item 1, and the “Acquisitions” subsection of the “Investments in Real Estate” section under Item 2 of this report for information on our acquisitions.
108
7.00% Series D cumulative convertible preferred stock repurchases
As of June 30, 2019, we had 2.3 million
shares of our Series D Convertible Preferred Stock outstanding. During the six months ended June 30, 2019, we repurchased, in privately negotiated transactions, 275,000 shares of our Series D Convertible Preferred Stock at an aggregate price of $9.2 million, or $33.60 per share, and recognized a preferred stock redemption charge of $2.6 million.
We may seek to repurchase additional shares of our Series D Convertible Preferred Stock in the future, subject to market conditions. To the extent that we repurchase shares of our Series D Convertible Preferred Stock, we expect to fund such amounts with the proceeds
from issuances, if any, of our common stock, subject to market conditions.
Dividends
During the six months ended June 30, 2019 and 2018, we paid the following dividends (in thousands):
The
increase in dividends paid on our common stock during the six months ended June 30, 2019, compared to the six months ended June 30, 2018, was primarily due to an increase in number of common shares outstanding subsequent to January 1, 2018, as a result of issuances of common stock under our ATM program and settlement of forward equity sales agreements, and partially due to the increase in the related dividends to $1.94 per common share paid during the six months ended June 30, 2019, from $1.80 per common
share paid during the six months ended June 30, 2018.
Dividends paid on our Series D Convertible Preferred Stock during the six months ended June 30, 2019, decreased from the dividends paid during the six months ended June 30, 2018, due to a decrease in number of shares outstanding as a result of the repurchase of 402,000 outstanding shares of our Series D Convertible Preferred Stock during 2018 and the repurchase of 275,000 outstanding shares of our Series D Convertible Preferred Stock during the six
months ended June 30, 2019.
Contractual obligations and commitments
Contractual obligations as of June 30, 2019, consisted of the following (in thousands):
Payments by Period
Total
2019
2020-2021
2022-2023
Thereafter
Secured
and unsecured debt (1)(2)
$
6,379,761
$
3,179
$
413,461
$
1,161,775
$
4,801,346
Estimated
interest payments on fixed-rate and hedged variable-rate debt(3)
1,800,551
117,691
452,263
394,042
836,555
Ground
lease obligations
644,656
7,029
27,329
27,223
583,075
Other
obligations
8,377
853
1,135
1,676
4,713
Total
$
8,833,345
$
128,752
$
894,188
$
1,584,716
$
6,225,689
(1)
Amounts
represent principal amounts due and exclude unamortized premiums (discounts) and deferred financing costs reflected in the consolidated balance sheets under Item 1 of this report.
(2)
Payment dates reflect any extension options that we control.
(3)
Amounts are based upon contractual interest rates, including expenses related to our interest rate hedge agreements, interest payment dates, and scheduled maturity dates.
Secured
notes payable
Secured notes payable as of June 30, 2019, consisted of six notes secured by 11 properties. Our secured notes payable typically require monthly payments of principal and interest and had a weighted-average interest rate of approximately 3.58%. As of June 30, 2019, the total book value of our investments in real estate securing debt was approximately $1.1 billion. As of June 30, 2019, our entire secured
notes payable balance of $354.2 million, including unamortized discounts and deferred financing costs, was fixed-rate debt.
109
Unsecured senior notes payable, $2.2 billion unsecured senior line of credit, and unsecured senior bank term loan
The requirements of, and our actual performance with respect to, the key financial covenants under our unsecured senior notes payable as of June
30, 2019, were as follows:
All covenant ratio titles utilize terms as defined in the respective debt agreements.
(2)
The calculation of consolidated EBITDA
is based on the definitions contained in our loan agreements and is not directly comparable to the computation of EBITDA as described in Exchange Act Release No. 47226.
In addition, the terms of the indentures, among other things, limit the ability of the Company, Alexandria Real Estate Equities, L.P., and the Company’s subsidiaries to (i) consummate a merger, or consolidate or sell all or substantially all of the Company’s
assets, and (ii) incur certain secured or unsecured indebtedness.
The requirements of, and our actual performance with respect to, the key financial covenants under our $2.2 billion unsecured senior line of credit and unsecured senior bank term loan as of June 30, 2019, were as follows:
All
covenant ratio titles utilize terms as defined in the respective debt agreements.
Estimated interest payments
Estimated interest payments on our fixed-rate and hedged variable-rate debt were calculated based upon contractual interest rates, including estimated interest expense related to interest rate hedge agreements, interest payment dates, and scheduled maturity dates. As of June 30, 2019, 92% of our debt was fixed-rate debt or variable-rate debt subject to interest rate hedge agreements. Refer to the “Interest
Rate Hedge Agreements” subsection below for additional information. The remaining 8% of our debt as of June 30, 2019, was unhedged variable-rate debt based on LIBOR. For additional information regarding our debt, refer to Note 10 – “Secured and Unsecured Senior Debt” to our unaudited consolidated financial statements under Item 1 of this report.
Interest rate hedge agreements
Our derivative instruments consist of interest rate hedge agreements. We utilize interest rate derivatives to hedge a portion of our exposure to
volatility in variable interest rates primarily associated with our $2.2 billion unsecured senior line of credit and unsecured senior bank term loan.
Our interest rate hedge agreements involve the receipt of variable-rate amounts from a counterparty in exchange for our payment of fixed-rate amounts to the counterparty over the life of the agreement without the exchange of the underlying notional amount. Interest received under all of our interest rate hedge agreements is based on one-month LIBOR. The net difference between the interest paid and the interest received is reflected as an adjustment to interest expense in our consolidated statements of income.
We have entered into master derivative agreements with our counterparties. These master derivative agreements (all of which are adapted
from the standard International Swaps and Derivatives Association, Inc. form) define certain terms between us and each of our respective counterparties to address and minimize certain risks associated with our interest rate hedge agreements. In order to limit our risk of non-performance by an individual counterparty under our interest rate hedge agreements, these agreements are spread among various counterparties. The largest aggregate notional amount in effect at any single point in time with an individual counterparty in our interest rate hedge agreements existing as of June 30, 2019, was $100.0 million. If one or more of our counterparties fail to perform under our interest rate hedge agreements, we may incur higher costs associated with our variable-rate LIBOR-based debt than the interest costs we originally anticipated. We
have not posted any collateral related to our interest rate hedge agreements.
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Ground lease obligations
Ground lease obligations as of June 30, 2019, included leases for 30 of our properties, which accounted for approximately 12% of our total number of properties. Excluding one ground lease that expires in 2036
related to one operating property with a net book value of $8.1 million as of June 30, 2019, our ground lease obligations have remaining lease terms ranging from approximately 34 to 95 years, including available extension options which we are reasonably certain to exercise.
As of June 30, 2019, the remaining contractual payments under ground and office lease agreements in which we are the lessee aggregated $644.7 million and $8.4 million,
respectively. As of June 30, 2019, all of our ground and office leases, in which we are the lessee, were classified as operating leases. Under the new lease accounting standard effective on January 1, 2019, described in detail under the “Lease Accounting” section of Note 2 – “Summary of Significant Accounting Policies” to our unaudited consolidated financial statements under Item 1 of this report, we are required to recognize a right-of-use asset and a related liability to account for our future obligations under operating lease arrangements in which we are the lessee. The operating lease liability is measured based on the present value of the remaining lease payments, including payments during the term under our extension options that we are reasonably certain to exercise. The right-of-use asset is equal to the
corresponding operating lease liability, adjusted for the initial direct leasing cost and any other consideration exchanged with the landlord prior to the commencement of the lease, as well as adjustments to reflect favorable or unfavorable terms of an acquired lease when compared with market terms at the time of acquisition. As of June 30, 2019, the present value of the remaining contractual payments, aggregating $653.0 million, under our operating lease agreements, including our extension options that we are reasonably certain to exercise, was $243.6 million, which is classified in accounts payable, accrued expenses, and tenant security deposits in our consolidated balance sheet. As of June 30, 2019,
the weighted-average remaining lease term of operating leases in which we are the lessee was approximately 45 years, and the weighted-average discount rate was 5.37%. Our corresponding operating lease right-of-use assets, adjusted for initial direct leasing costs and other consideration exchanged with the landlord prior to the commencement of the lease, aggregated $237.0 million. We classify the right-of-use asset in other assets in our consolidated balance sheets.
Commitments
As of June
30, 2019, remaining aggregate costs under contract for the construction of properties undergoing development, redevelopment, and improvements under the terms of leases approximated $985.9 million. We expect payments for these obligations to occur over one to three years, subject to capital planning adjustments from time to time. We may have the ability to cease the construction of certain properties, which would result in the reduction of our commitments. In addition, we have letters of credit and performance obligations aggregating $9.2 million primarily related to construction projects.
In
November 2017, we entered into an agreement with a real estate developer in the San Francisco Bay Area to own a 49% interest in a real estate joint venture at Menlo Gateway in our Greater Stanford submarket of San Francisco. Our total equity contribution commitment is $269.0 million, of which we have contributed $267.5 million through June 30, 2019.
We are committed to funding approximately $238.6 million for non-real estate investments, which primarily consists of $238.0 million related to investments in limited partnerships. Our funding commitments expire
at various dates over the next 11 years, with a weighted-average expiration of 8.7 yearsas of June 30, 2019.
Exposure to environmental liabilities
In connection with the acquisition of all of our properties, we have obtained Phase I environmental assessments to ascertain the existence of any environmental liabilities or other issues. The Phase I environmental assessments of our properties have not revealed any environmental liabilities that we believe would have a material adverse effect on our financial condition or results of operations taken as a whole, nor are we aware of any material environmental
liabilities that have occurred since the Phase I environmental assessments were completed. In addition, we carry a policy of pollution legal liability insurance covering exposure to certain environmental losses at substantially all of our properties.
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Accumulated other comprehensive income (loss)
The following table presents the changes in each component of accumulated other comprehensive income (loss) attributable to Alexandria Real Estate Equities, Inc.’s common stockholders during the
six months ended June 30, 2019 (in thousands):
Changes in our accumulated other comprehensive income (loss) balance include the change in fair value of our interest rate hedge agreements. We reclassify amounts from accumulated other comprehensive income (loss) as we recognize interest expense related to the hedged variable-rate debt instrument.
Foreign currency translation
Changes in our accumulated other comprehensive income (loss) balance include the changes in the foreign exchange rates for our real estate investments in Canada and Asia. Additionally, we reclassify unrealized foreign currency translation gains and losses into net income as we dispose of these holdings.
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Critical
accounting policies
Refer to our annual report on Form 10‑K for the year ended December 31, 2018, for a discussion of our critical accounting policies related to investments in real estate, impairment of long-lived assets, equity investments, and interest rate hedge agreements. On January 1, 2019, we adopted a new lease accounting guidance that resulted in changes to the accounting policies related to the recognition of rental revenues and tenant recoveries, and to the monitoring of tenant credit quality, during the six months ended June 30, 2019. Refer to the “Lease Accounting” section of Note 2 – “Summary of Significant
Accounting Policies” to our unaudited consolidated financial statements under Item 1 of this report for a discussion of our critical accounting policies related to rental revenues, tenant recoveries, and monitoring of tenant credit quality.
Non-GAAP measures and definitions
This section contains additional information of certain non-GAAP financial measures and the reasons why we use these supplemental measures of performance and believe they provide useful information to investors, as well as the definitions of other terms used in this report.
Funds from operations and funds
from operations, as adjusted, attributable to Alexandria Real Estate Equities, Inc.’s common stockholders
GAAP-basis accounting for real estate assets utilizes historical cost accounting and assumes that real estate values diminish over time. In an effort to overcome the difference between real estate values and historical cost accounting for real estate assets, the Nareit Board of Governors established funds from operations as an improved measurement tool. Since its introduction, funds from operations has become a widely used non-GAAP financial measure among equity REITs. We believe that funds from operations is helpful to investors as an additional measure of the performance of an equity REIT. Moreover, we believe that funds from operations, as adjusted, allows investors to compare our performance to the performance of other real estate companies on a consistent basis, without
having to account for differences recognized because of real estate investment and disposition decisions, financing decisions, capital structure, capital market transactions, and variances resulting from the volatility of market conditions outside of our control. On January 1, 2019, we adopted standards established by the Nareit Board of Governors in its November 2018 White Paper (the “Nareit White Paper”) on a prospective basis. The Nareit White Paper defines funds from operations as net income (computed in accordance with GAAP), excluding gains or losses on sales of real estate, and impairments of real estate, plus real estate-related depreciation and amortization, and after adjustments for our share of consolidated and unconsolidated partnerships and real estate joint ventures. Impairments represent the write-down of assets when fair value over the recoverability period is less than the carrying value due to
changes in general market conditions and do not necessarily reflect the operating performance of the properties during the corresponding period.
We compute funds from operations, as adjusted, as funds from operations calculated in accordance with the Nareit White Paper, excluding significant gains, losses, and impairments realized on non-real estate investments, unrealized gains or losses on non-real estate investments, gains or losses on early extinguishment of debt, preferred stock redemption charges, deal costs, and the amount of such items that is allocable to our unvested restricted stock awards. Neither funds from operations nor funds from operations, as adjusted, should be considered as alternatives to net income (determined in accordance with GAAP) as indications of financial performance, or to cash flows from operating activities (determined in accordance with GAAP)
as measures of liquidity, nor are they indicative of the availability of funds for our cash needs, including our ability to make distributions.
The following table reconciles net income to funds from operations for the share of consolidated real estate joint ventures attributable to noncontrolling interests and our share of unconsolidated real estate joint ventures for the three and six months ended June 30, 2019 (in thousands):
Noncontrolling
Interest Share of Consolidated Real Estate Joint Ventures
Our Share of Unconsolidated Real Estate Joint Ventures
The
following tables present a reconciliation of net income attributable to Alexandria Real Estate Equities, Inc.’s common stockholders, the most directly comparable financial measure presented in accordance with GAAP, including our share of amounts from consolidated and unconsolidated real estate joint ventures, to funds from operations attributable to Alexandria Real Estate Equities, Inc.’s common stockholders – diluted, and funds from operations attributable to Alexandria Real Estate Equities, Inc.’s common stockholders – diluted, as adjusted, and the related per share amounts for the three and six months ended June 30, 2019 and 2018. Per share amounts may not add due to rounding.
Three
Months Ended June 30,
Six Months Ended June 30,
(In thousands)
2019
2018
2019
2018
Net income attributable to Alexandria Real Estate Equities,
Inc.’s common stockholders – basic and diluted
$
76,330
$
52,016
$
200,181
$
184,991
Depreciation
and amortization
134,437
118,852
268,524
233,071
Noncontrolling
share of depreciation and amortization from consolidated real estate JVs
(6,744
)
(3,914
)
(12,163
)
(7,781
)
Our
share of depreciation and amortization from unconsolidated real estate JVs
973
807
1,819
1,451
Assumed
conversion of 7.00% Series D cumulative convertible preferred stock(1)
1,005
—
2,031
2,604
Allocation
to unvested restricted stock awards
(1,445
)
(1,042
)
(3,740
)
(3,212
)
Funds from operations
attributable to Alexandria Real Estate Equities, Inc.’s common stockholders – diluted(2)
204,556
166,719
456,652
411,124
Unrealized
gains on non-real estate investments
(11,058
)
(5,067
)
(83,264
)
(77,296
)
Realized gain on
non-real estate investment
—
—
—
(8,252
)
Impairment real estate –
land parcel
—
6,311
—
6,311
Loss on early extinguishment of debt
—
—
7,361
—
Preferred
stock redemption charge
—
—
2,580
—
Removal of assumed conversion
of 7.00% Series D cumulative convertible preferred stock(1)
(1,005
)
—
(2,031
)
(2,604
)
Allocation
to unvested restricted stock awards
179
(18
)
1,157
1,140
Funds from operations
attributable to Alexandria Real Estate Equities, Inc.’s common stockholders – diluted, as adjusted
$
192,672
$
167,945
$
382,455
$
330,423
(1)
The
assumed conversion requires the add back of preferred dividends paid on our 7.00% Series D cumulative convertible preferred stock, as shown here. Refer to “Weighted-Average Shares of Common Stock Outstanding – Diluted” within this section of this Item 2 for additional information.
(2)
Calculated in accordance with standards established by the Nareit Board of Governors.
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Three
Months Ended June 30,
Six Months Ended June 30,
(Per share)
2019
2018
2019
2018
Net income per share attributable to Alexandria Real Estate
Equities, Inc.’s common stockholders – diluted
$
0.68
$
0.51
$
1.80
$
1.83
Depreciation
and amortization
1.15
1.13
2.32
2.23
Allocation
to unvested restricted stock awards
—
(0.01
)
(0.04
)
(0.03
)
Funds from operations
per share attributable to Alexandria Real Estate Equities, Inc.’s common stockholders – diluted(1)
1.83
1.63
4.08
4.03
Unrealized
gains on non-real estate investments
(0.10
)
(0.05
)
(0.75
)
(0.76
)
Realized gain on non-real
estate investment
—
—
—
(0.08
)
Impairment of land parcels and non-real
estate investments
—
0.06
—
0.06
Loss on early extinguishment
of debt
—
—
0.07
—
Preferred stock redemption charge
—
—
0.02
—
Allocation
to unvested restricted stock awards
—
—
0.02
0.02
Funds from operations
per share attributable to Alexandria Real Estate Equities, Inc.’s common stockholders – diluted, as adjusted
$
1.73
$
1.64
$
3.44
$
3.27
Weighted-average
shares of common stock outstanding(2) for calculationsof:
EPS – diluted
111,501
102,236
111,279
101,191
Funds
from operations – diluted, per share
112,077
102,236
111,857
101,933
Funds
from operations – diluted, as adjusted, per share
111,501
102,236
111,279
101,191
(1)
Calculated
in accordance with standards established by the Nareit Board of Governors.
(2)
Refer to “Weighted-Average Shares of Common Stock Outstanding – Diluted” within this section of this Item 2 for additional information.
Adjusted EBITDA and Adjusted EBITDA margin
We use Adjusted EBITDA as a supplemental performance measure of our operations, for financial and operational decision-making, and as a supplemental means of evaluating period-to-period comparisons on a consistent basis. Adjusted EBITDA is calculated as earnings before interest,
taxes, depreciation, and amortization (“EBITDA”), excluding stock compensation expense, gains or losses on early extinguishment of debt, gains or losses on sales of real estate, and impairments of real estate. Adjusted EBITDA also excludes unrealized gains or losses and significant realized gains and impairments that result from our non-real estate investments. These non-real estate investment amounts are classified in our consolidated statements of income outside of revenues.
We believe Adjusted EBITDA provides investors with relevant and useful information as it allows investors to evaluate the operating performance of our business activities without having to account for differences recognized because of real estate and non-real estate investment and disposition decisions, financing decisions, capital structure, capital market transactions, and variances resulting
from the volatility of market conditions outside of our control. For example, we exclude gains or losses on the early extinguishment of debt to allow investors to measure our performance independent of our indebtedness and capital structure. We believe that adjusting for the effects of impairments and gains or losses on sales of real estate, and significant impairments and significant gains on the sale of non-real estate investments allows investors to evaluate performance from period to period on a consistent basis without having to account for differences recognized because of real estate and non-real estate investment and disposition decisions. We believe that excluding charges related to stock compensation and unrealized gains or losses facilitates for investors a comparison of our business activities across periods without the volatility resulting from market forces outside of our control. Adjusted EBITDA has limitations as a measure of our performance. Adjusted
EBITDA does not reflect our historical expenditures or future requirements for capital expenditures or contractual commitments. While Adjusted EBITDA is a relevant measure of performance, it does not represent net income or cash flows from operations calculated and presented in accordance with GAAP, and it should not be considered as an alternative to those indicators in evaluating performance or liquidity.
Our calculation of Adjusted EBITDA margin divides Adjusted EBITDA by our revenues, as adjusted. We believe that revenues, as adjusted, provides a denominator for Adjusted EBITDA margin that is calculated on a basis more consistent with that of the Adjusted EBITDA numerator. Specifically, revenues, as adjusted, includes the same realized gains on, and impairments of, non-real estate investments that are included in the reconciliation of Adjusted EBITDA. We believe that the
consistent application of results from our non-real estate investments to both the numerator and denominator of Adjusted EBITDA margin provides a more useful calculation for the comparison across periods.
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The following table reconciles net income and revenues, the most directly comparable financial measures calculated and presented in accordance with GAAP, to Adjusted EBITDA and revenues, as adjusted, respectively, for the three and six months ended June 30, 2019 and 2018 (dollars in thousands):
Non-real
estate investments – total realized gains
10,442
7,463
21,792
20,795
Revenues, as adjusted
$
384,298
$
332,497
$
754,490
$
665,968
Adjusted
EBITDA margin
69%
69%
69%
69%
Annual rental revenue
Annual
rental revenue represents the annualized fixed base rental amount, in effect as of the end of the period, related to our operating RSF. Annual rental revenue is presented using 100% of the annual rental revenue of our consolidated properties and our share of annual rental revenue for our unconsolidated real estate joint ventures. Annual rental revenue per RSF is computed by dividing annual rental revenue by the sum of 100% of the RSF of our consolidated properties and our share of the RSF of properties held in unconsolidated real estate joint ventures. As of June 30, 2019, approximately 97% of our leases (on an RSF basis) were triple net leases, which require tenants to pay substantially all real estate taxes, insurance, utilities, repairs and maintenance, common area expenses, and other operating expenses (including increases
thereto) in addition to base rent. Annual rental revenue excludes these operating expenses recovered from our tenants. Amounts recovered from our tenants related to these operating expenses, along with base rent, are classified in income from rentals in our consolidated statements of income.
Cash interest
Cash interest is equal to interest expense calculated in accordance with GAAP plus capitalized interest, less amortization of loan fees and debt premiums (discounts). Refer to the definition of “Fixed-Charge Coverage Ratio” below in this section of this Item 2 for a reconciliation of interest expense, the most directly comparable financial measure calculated and presented in accordance with GAAP, to cash interest.
Class
A properties and AAA locations
Class A properties are properties clustered in AAA locations that provide innovative tenants with highly dynamic and collaborative environments that enhance their ability to successfully recruit and retain world-class talent and inspire productivity, efficiency, creativity, and success. Class A properties generally command higher annual rental rates than other classes of similar properties.
AAA locations are in close proximity to concentrations of specialized skills, knowledge, institutions, and related businesses. Such locations are generally characterized by high barriers to entry for new landlords, high barriers to exit for tenants, and a limited supply of available space.
116
Development,
redevelopment, and pre-construction
A key component of our business model is our disciplined allocation of capital to the development and redevelopment of new Class A properties, and property enhancements identified during the underwriting of certain acquired properties, located in collaborative life science, technology, and agtech campuses in AAA urban innovation clusters. These projects are generally focused on providing high-quality, generic, and reusable spaces that meet the real estate requirements of, and are reusable by, a wide range of tenants. Upon completion, each value-creation project is expected to generate a significant increase in rental income, net operating income, and cash flows. Our development and redevelopment projects are generally in locations that are highly desirable to high-quality entities, which we believe results in higher occupancy levels, longer
lease terms, higher rental income, higher returns, and greater long-term asset value.
Development projects generally consist of the ground-up development of generic and reusable facilities. Redevelopment projects consist of the permanent change in use of office, warehouse, and shell space into office/laboratory, tech office, or agtech space. We generally will not commence new development projects for aboveground construction of new Class A office/laboratory, tech office, and agtech space without first securing significant pre-leasing for such space, except when there is solid market demand for high-quality Class A properties.
Pre-construction activities include entitlements, permitting, design, site work, and other activities preceding commencement of construction of aboveground building
improvements. The advancement of pre-construction efforts is focused on reducing the time required to deliver projects to prospective tenants. These critical activities add significant value for future ground-up development and are required for the vertical construction of buildings. Ultimately, these projects will provide high-quality facilities and are expected to generate significant revenue and cash flows.
Fixed-charge coverage ratio
Fixed-charge coverage ratio is a non-GAAP financial measure representing the ratio of Adjusted EBITDA to fixed charges. We believe this ratio is useful to investors as a supplemental measure of our ability to satisfy fixed financing obligations and preferred stock dividends. Cash interest is equal to interest expense calculated in accordance with GAAP
plus capitalized interest, less amortization of loan fees and debt premiums (discounts).
The following table reconciles interest expense, the most directly comparable financial measure calculated and presented in accordance with GAAP, to cash interest and fixed charges for the three and six months ended June 30, 2019 and 2018 (dollars in thousands):
Initial stabilized yield is calculated as the quotient of the estimated amounts of net operating income at stabilization and our investment in the property. Our initial stabilized yield excludes the benefit of leverage. Our cash rents related to our value-creation projects are generally expected to increase over time due to contractual annual rent escalations. Our estimates for initial stabilized yields, initial stabilized yields (cash basis), and total costs at completion represent our initial estimates at the commencement of the project. We expect to update this information upon completion of the project, or sooner if there are significant changes to the expected project yields or costs.
•
Initial
stabilized yield reflects rental income, including contractual rent escalations and any rent concessions over the term(s) of the lease(s), calculated on a straight-line basis.
•
Initial stabilized yield (cash basis) reflects cash rents at the stabilization date after initial rental concessions, if any, have elapsed and our total cash investment in the property.
Investment-grade or publicly traded large cap tenants
Investment-grade or publicly traded large cap tenants represent tenants that are investment-grade rated or publicly traded companies
with an average daily market capitalization greater than $10 billion for the twelve months ended June 30, 2019, as reported by Bloomberg Professional Services. In addition, we monitor the credit quality and related material changes of our tenants. Material changes that cause a tenant’s market capitalization to decline below $10 billion, which are not immediately reflected in the twelve‑month average, may result in their exclusion from this measure.
Investments in real estate – value-creation square feet currently in rental properties
The following table represents RSF of buildings in operation as of June 30, 2019,
that will be redeveloped or replaced with new development RSF upon commencement of future construction:
Property/Submarket
RSF
2021-2022 Pre-construction and future:
Pre-construction:
88
Bluxome Street/Mission Bay/SoMa
232,470
Future:
960 Industrial Road/Greater Stanford
110,000
99 A Street/Seaport Innovation District
8,715
118,715
351,185
Future:
219
East 42nd Street/New York City
349,947
4161 Campus Point Court/University Town Center
159,884
10260 Campus Point Drive/University Town Center
109,164
4045 Sorrento
Valley Boulevard/Sorrento Valley
10,926
4075 Sorrento Valley Boulevard/Sorrento Valley
40,000
601 Dexter Avenue North/Lake Union
18,680
688,601
Total
value-creation RSF currently included in rental properties
1,039,786
Joint venture financial information
We present components of balance sheet and operating results information related to our joint ventures, which are not presented in accordance with, or intended to be presented in accordance with, GAAP. We present the proportionate share of certain financial line items as follows: (i) for each real estate joint venture that we consolidate in our financial statements, but of which we own less than 100%, we apply the noncontrolling interest economic ownership percentage to each
financial item to arrive at the amount of such cumulative noncontrolling interest share of each component presented; and (ii) for each real estate joint venture that we do not control, and do not consolidate, we apply our economic ownership percentage to each financial item to arrive at our proportionate share of each component presented.
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The components of balance sheet and operating results information related to joint ventures do not represent our legal claim to those items. For each entity that we do not wholly own, the joint venture agreement generally determines what equity holders can receive upon capital events, such as sales or refinancing, or in the event of a liquidation. Equity holders
are normally entitled to their respective legal ownership of any residual cash from a joint venture only after all liabilities, priority distributions, and claims have been repaid or satisfied.
We believe this information can help investors estimate the balance sheet and operating results information related to our partially owned entities. Presenting this information provides a perspective not immediately available from consolidated financial statements and one that can supplement an understanding of the joint venture assets, liabilities, revenues, and expenses included in our consolidated results.
The components of balance sheet and operating results information related to joint ventures are limited as an analytical tool as the overall economic ownership interest does not represent our legal claim to each of our joint ventures’ assets,
liabilities, or results of operations. In addition, joint venture financial information may include financial information related to the unconsolidated real estate joint ventures that we do not control. Refer to Note 4 – “Consolidated and Unconsolidated Real Estate Joint Ventures” to our unaudited consolidated financial statements under Item 1 of this report for more information on our unconsolidated real estate joint ventures. We believe that in order to facilitate for investors a clear understanding of our operating results and our total assets and liabilities, joint venture financial information should be examined in conjunction with our consolidated statements of income and balance sheets. Joint venture financial information should not be considered an alternative to our consolidated financial statements, which are prepared in accordance with GAAP.
Net cash provided
by operating activities after dividends
Net cash provided by operating activities after dividends includes the deduction for distributions to noncontrolling interests. For purposes of this calculation, changes in operating assets and liabilities are excluded as they represent timing differences.
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Net debt to Adjusted EBITDA and net debt and preferred stock to Adjusted EBITDA
Net debt to Adjusted EBITDA and net debt and preferred stock to Adjusted EBITDA are non-GAAP financial measures that we believe are useful to investors
as supplemental measures in evaluating our balance sheet leverage. Net debt is equal to the sum of total consolidated debt less cash, cash equivalents, and restricted cash. Net debt and preferred stock is equal to the sum of net debt, as discussed above, plus preferred stock outstanding as of the end of the period. Refer to “Adjusted EBITDA and Adjusted EBITDA margin” within this section of this Item 2 for further information on the calculation of Adjusted EBITDA.
The following table reconciles debt to net debt, and to net debt and preferred stock, and computes the ratio of each to Adjusted EBITDA as of June 30, 2019, and December 31, 2018 (dollars in thousands):
7.00% Series D cumulative convertible preferred stock
57,461
64,336
Net
debt and preferred stock
$
6,212,346
$
5,301,874
Adjusted EBITDA:
–
quarter annualized
$
1,063,056
$
968,888
– trailing 12 months
$
1,004,724
$
937,906
Net
debt to Adjusted EBITDA:
– quarter annualized
5.8
x
5.4
x
– trailing 12 months
6.1
x
5.6
x
Net
debt and preferred stock to Adjusted EBITDA:
– quarter annualized
5.8
x
5.5
x
– trailing 12 months
6.2
x
5.7
x
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Net
operating income, net operating income (cash basis), and operating margin
The following table reconciles net income to net operating income, and to net operating income (cash basis) for the three and six months ended June 30, 2019 and 2018 (dollars in thousands):
Equity
in earnings of unconsolidated real estate joint ventures
(1,262
)
(1,090
)
(2,408
)
(2,234
)
General
and administrative expenses
26,434
22,939
51,111
45,360
Interest
expense
42,879
38,097
81,979
75,012
Depreciation and amortization
134,437
118,852
268,524
233,071
Impairment
of real estate
—
6,311
—
6,311
Loss on early extinguishment of
debt
—
—
7,361
—
Investment income
(21,500
)
(12,530
)
(105,056
)
(98,091
)
Net
operating income
268,167
233,126
525,508
461,494
Straight-line rent
revenue
(25,476
)
(23,259
)
(52,441
)
(55,890
)
Amortization of acquired below-market leases
(8,054
)
(5,198
)
(15,202
)
(11,368
)
Net
operating income (cash basis)
$
234,637
$
204,669
$
457,865
$
394,236
Net
operating income (cash basis) – annualized
$
938,548
$
818,676
$
915,730
$
788,472
Net
operating income (from above)
$
268,167
$
233,126
$
525,508
$
461,494
Total
revenues
$
373,856
$
325,034
$
732,698
$
645,173
Operating
margin
72%
72%
72%
72%
Net operating income is a non-GAAP financial measure calculated as net income, the most directly comparable financial measure calculated and presented in accordance with GAAP, excluding equity in the earnings of our unconsolidated real estate joint ventures, general and
administrative expenses, interest expense, depreciation and amortization, impairment of real estate, gains or losses on early extinguishment of debt, gains or losses on sales of real estate, and investment income or loss. We believe net operating income provides useful information to investors regarding our financial condition and results of operations because it primarily reflects those income and expense items that are incurred at the property level. Therefore, we believe net operating income is a useful measure for investors to evaluate the operating performance of our consolidated real estate assets. Net operating income on a cash basis is net operating income adjusted to exclude the effect of straight-line rent and amortization of acquired above- and below-market lease revenue adjustments required by GAAP. We believe that net operating income on a cash basis is helpful to investors as an additional measure of operating performance because it eliminates straight-line
rent revenue and the amortization of acquired above- and below-market leases.
Furthermore, we believe net operating income is useful to investors as a performance measure for our consolidated properties because, when compared across periods, net operating income reflects trends in occupancy rates, rental rates, and operating costs, which provide a perspective not immediately apparent from net income or loss. Net operating income can be used to measure the initial stabilized yields of our properties by calculating the quotient of net operating income generated by a property and our investment in the property. Net operating income excludes certain components from net income in order to provide results that are more closely related to the results of operations of our properties. For example, interest expense is not necessarily linked to the operating performance of a real estate
asset and is often incurred at the corporate level rather than at the property level. In addition, depreciation and amortization, because of historical cost accounting and useful life estimates, may distort comparability of operating performance at the property level. Impairments of real estate have been excluded in deriving net operating income because we do not consider impairments of real estate to be property-level operating expenses. Impairments of real estate relate to changes in the values of our assets and do not reflect the current operating performance with respect to related revenues or expenses. Our impairments of real estate represent the write-down in the value of the assets to the estimated fair value less cost to sell. These impairments result from investing decisions or a deterioration in market conditions. We also exclude realized and unrealized investment income or loss calculated under a new ASU effective January
1, 2018, which results from investment decisions that occur at the corporate level related to non-real estate investments in publicly traded companies and certain privately held entities. Therefore, we do not consider these activities to be an indication of operating performance of our real estate assets at the property level. Our calculation of net operating income also excludes charges incurred from changes in certain financing decisions, such as losses on early extinguishment of debt, as these charges often relate to corporate strategy. Property operating expenses included in determining net operating income primarily consist of costs that are related to our
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operating properties, such as utilities, repairs, and maintenance; rental expense
related to ground leases; contracted services, such as janitorial, engineering, and landscaping; property taxes and insurance; and property-level salaries. General and administrative expenses consist primarily of accounting and corporate compensation, corporate insurance, professional fees, office rent, and office supplies that are incurred as part of corporate office management. We calculate operating margin as net operating income divided by total revenues.
We believe that in order to facilitate for investors a clear understanding of our operating results, net operating income should be examined in conjunction with net income or loss as presented in our consolidated statements of income. Net operating income should not be considered as an alternative to net income or loss as an indication of our performance, nor as an alternative to cash flows as a measure of our liquidity
or our ability to make distributions.
Operating statistics
We present certain operating statistics related to our properties, including number of properties, RSF, occupancy percentage, leasing activity, and contractual lease expirations as of the end of the period. We believe these measures are useful to investors because they facilitate an understanding of certain trends for our properties. We compute the number of properties, RSF, occupancy percentage, leasing activity, and contractual lease expirations at 100% for all properties in which we have an investment, including properties owned by our consolidated and unconsolidated real estate joint ventures. For operating metrics based on annual rental revenue, refer to “Annual Rental Revenue” within this section of this Item 2.
Same
property comparisons
As a result of changes within our total property portfolio during the comparative periods presented, including changes from assets acquired or sold, properties placed into development or redevelopment, and development or redevelopment properties recently placed into service, the consolidated total income from rentals, and rental operating expenses in our operating results can show significant changes from period to period. In order to supplement an evaluation of our results of operations over a given quarterly or annual period, we analyze the operating performance for all consolidated properties that were fully operating for the entirety of the comparative periods presented, referred to as same properties. We separately present quarterly and year-to-date same property results to align with the interim financial information required by the SEC in our management’s
discussion and analysis of our financial condition and results of operations. These same properties are analyzed separately from properties acquired subsequent to the first day in the earliest comparable quarterly or year-to-date period presented, properties that underwent development or redevelopment at any time during the comparative periods, unconsolidated real estate joint ventures, properties classified as held for sale, and corporate entities (legal entities performing general and administrative functions), which are excluded from same property results. Additionally, lease termination fees, if any, are excluded from the results of same properties.
Stabilized occupancy date
The stabilized occupancy date represents the estimated date on which the project is expected to reach occupancy
of 95% or greater.
Tenant recoveries
Tenant recoveries represent revenues comprised of reimbursement of real estate taxes, insurance, utilities, repairs and maintenance, common area expenses, and other operating expenses and earned in the period during which the applicable expenses are incurred and the tenant’s obligation to reimburse us arises.
On January 1, 2019, we adopted a new lease accounting standard and, among other practical expedients and policies, we elected the single component accounting policy. As a result of our election of the single component accounting policy, we account for rental revenues and tenant recoveries generated through
the leasing of real estate assets that qualify for this policy as a single component, and classify associated revenue in income from rentals in our consolidated statements of income. Prior to the adoption of the new lease accounting standard, we presented rental revenues and tenant recoveries separately in our consolidated statements of income. Refer to the “Lease Accounting” section of Note 2 - “Summary of Significant Accounting Policies” for additional information. We continue to provide investors with a separate presentation of rental revenues and tenant recoveries in “Comparison of Results for the Three Months Ended June 30, 2019, to the Three Months Ended June 30, 2018” and “Comparison of Results for the Six Months Ended June 30,
2019, to the Six Months Ended June 30, 2018” sections within “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this report because we believe it promotes investors’ understanding of the changes in our operating results. We believe that presentation of tenant recoveries is useful to investors as a supplemental measure of our ability to recover operating expenses under our triple net leases, including recoveries of utilities, repairs and maintenance, insurance, property taxes, common area expenses, and other operating expenses, and of our ability to mitigate the effect to net income for any significant variability to components of our operating expenses.
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The
following table reconciles income from rentals to tenant recoveries for the three and six months ended June 30, 2019 and 2018 (in thousands):
Total equity market capitalization is equal to the sum of outstanding shares of Series D Convertible Preferred Stock and common stock multiplied by the related closing price of each class of security at the end of each period presented.
Total market capitalization
Total market capitalization is equal to the sum of total equity market capitalization and total debt.
Unencumbered net operating income as a percentage of total net operating income
Unencumbered net operating income as a percentage
of total net operating income is a non-GAAP financial measure that we believe is useful to investors as a performance measure of the results of operations of our unencumbered real estate assets as it reflects those income and expense items that are incurred at the unencumbered property level. Unencumbered net operating income is derived from assets classified in continuing operations, which are not subject to any mortgage, deed of trust, lien, or other security interest, as of the period for which income is presented.
The following table summarizes unencumbered net operating income as a percentage of total net operating income for the three and six months ended June 30, 2019 and 2018 (dollars
in thousands):
Unencumbered
net operating income as a percentage of total net operating income
94%
88%
94%
87%
Weighted-average
shares of common stock outstanding – diluted
From time to time, we enter into capital market transactions, including forward equity sales agreements, to fund acquisitions, fund construction of our highly leased development and redevelopment projects, and for general working capital purposes. We are required to consider the potential dilutive effect of our forward equity sales agreements under the treasury stock method while the forward equity sales agreements are outstanding. As of June 30, 2019, we had forward equity sales agreements outstanding to sell an aggregate 8.1 million shares of common stock, including 4.4 million shares expiring in June 2020 and 3.7 million
shares expiring in July 2020. We also consider the effect of assumed conversion of our outstanding Series D Convertible Preferred Stock when determining potentially dilutive incremental shares to our common stock. When calculating the assumed conversion, we add back to net income or loss the dividends paid on our Series D Convertible Preferred Stock to the numerator and then include additional common shares assumed to have been issued (as displayed in the table below) to the denominator of the per share calculation. The effect of the assumed conversion is considered separately for our per share calculations of net income or loss; funds from operations, computed in accordance with the definition in the Nareit White Paper; and funds from operations, as adjusted. Our Series D Convertible Preferred Stock is dilutive and assumed to be converted when quarterly and annual basic EPS, funds from operations, or funds from operations, as adjusted, exceed approximately $1.75
and $7.00 per share, respectively, subject to conversion ratio adjustments and the impact of repurchases of our Series D Preferred Stock. The effect of the assumed conversion is included when it is dilutive on a per share basis. The dilutive effect to both numerator and denominator may result in a per share effect of less than a half cent, which would appear as zero in our per share calculation, even when the dilutive effect to the numerator alone appears in our reconciliation. Refer to Note 13 – “Earnings per Share” and Note 14 – “Stockholders’ Equity” to our unaudited consolidated financial statements under Item 1 of this report for more information related to our forward equity sales agreements and our Series D Convertible Preferred Stock.
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The
weighted-average shares of common stock outstanding used in calculating EPS – diluted, funds from operations per share – diluted, and funds from operations per share – diluted, as adjusted, for the three and six months ended June 30, 2019 and 2018 are calculated as follows (in thousands):
Weighted-average shares of common stock outstanding:
Basic
shares for EPS
111,433
101,881
111,245
100,878
Outstanding forward equity sales agreements
68
355
34
313
Series D
Convertible Preferred Stock
—
—
—
—
Diluted shares for EPS
111,501
102,236
111,279
101,191
Basic
shares for EPS
111,433
101,881
111,245
100,878
Outstanding forward equity sales agreements
68
355
34
313
Series D
Convertible Preferred Stock
576
—
578
742
Diluted shares for FFO
112,077
102,236
111,857
101,933
Basic
shares for EPS
111,433
101,881
111,245
100,878
Outstanding forward equity sales agreements
68
355
34
313
Series D
Convertible Preferred Stock
—
—
—
—
Diluted shares for FFO, as adjusted
111,501
102,236
111,279
101,191
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ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest rate risk
The primary market risk to which we believe we are exposed is interest rate risk, which may result from many factors, including government monetary and tax policies, domestic and international economic and political considerations, and other factors that are beyond our control.
In order to modify and manage the interest rate characteristics of our outstanding debt and to limit the effects of interest rate risks on our operations, we may utilize a variety of financial instruments, including interest rate hedge agreements, caps, floors, and other interest rate exchange contracts.
The use of these types of instruments to hedge a portion of our exposure to changes in interest rates carries additional risks, such as counterparty credit risk and the legal enforceability of hedging contracts.
Our future earnings and fair values relating to our outstanding debt are primarily dependent upon prevalent market rates of interest. We have interest rate hedge agreements that are intended to reduce the effects of interest rate fluctuations. The following table illustrates the effect of a 1% change in interest rates on our fixed- and variable-rate debt after considering the effect of our interest rate hedge agreements as of June 30, 2019 (in thousands):
Annualized
effect on future earnings due to variable-rate debt:
Rate increase of 1%
$
(3,509
)
Rate decrease of 1%
$
3,509
Effect on fair value of total consolidated
debt and interest rate hedge agreements:
Rate increase of 1%
$
(323,769
)
Rate decrease of 1%
$
356,560
These amounts are determined by considering the effect of the hypothetical interest rates on our borrowing cost and our interest rate hedge agreements
in existence on June 30, 2019. These analyses do not consider the effects of the reduced level of overall economic activity that could exist in such an environment. Furthermore, in the event of a change of such magnitude, we would consider taking actions to further mitigate our exposure to the change. Because of the uncertainty of the specific actions that would be taken and their possible effects, the sensitivity analyses assume no changes in our capital structure.
Equity price risk
We have exposure to equity price market risk because of our equity investments in publicly traded companies and privately held entities. All of our investments in actively traded public companies are reflected in
the consolidated balance sheets at fair value. Our investments in privately held entities that report NAV per share are measured at fair value using NAV as a practical expedient to fair value. Our equity investments in privately held entities that do not report NAV per share are measured at cost less impairments, adjusted for observable price changes during the period. Changes in fair value of public investments, changes in NAV per share reported by privately held entities, and observable price changes of privately held entities that do not report NAV per share are classified as investment income in our consolidated statements of income. There is no assurance that future declines in value will not have a material adverse effect on our future results of operations. The following table illustrates the effect that a 10% change in the value of our equity investments would have on earnings as of June 30,
2019 (in thousands):
Equity price risk:
Fair value increase of 10%
$
105,785
Fair value decrease of 10%
$
(105,785
)
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Foreign
currency exchange rate risk
We have exposure to foreign currency exchange rate risk related to our subsidiaries operating in Canada and Asia. The functional currencies of our foreign subsidiaries are the local currencies in each respective country. Gains or losses resulting from the translation of our foreign subsidiaries’ balance sheets and statements of income are classified in accumulated other comprehensive income (loss) as a separate component of total equity and are excluded from net income (loss). Gains or losses will be reflected in our consolidated statements of income when there is a sale or partial
sale of our investment in these operations or upon a complete or substantially complete liquidation of the investment. The following table illustrates the effect that a 10% change in foreign currency rates relative to the U.S. dollar would have on our potential future earnings and on the fair value of our net investment in foreign subsidiaries based on our current operating assets outside the U.S. as of June 30, 2019 (in thousands):
Effect on potential future earnings due to foreign
currency exchange rate:
Rate increase of 10%
$
10
Rate decrease of 10%
$
(10
)
Effect on the fair value of net investment in foreign subsidiaries
due to foreign currency exchange rate:
Rate increase of 10%
$
10,063
Rate decrease of 10%
$
(10,063
)
This sensitivity analysis assumes a parallel shift of all foreign currency exchange rates with respect to the U.S. dollar; however, foreign currency
exchange rates do not typically move in such a manner, and actual results may differ materially.
Our exposure to market risk elements for the six months ended June 30, 2019, was consistent with the risk elements presented above, including the effects of changes in interest rates, equity prices, and foreign currency exchange rates.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures
As
of June 30, 2019, we had performed an evaluation, under the supervision of our principal executive officers and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. These controls and procedures have been designed to ensure that information required for disclosure is recorded, processed, summarized, and reported within the requisite time periods. Based on our evaluation, the principal executive officers and principal financial officer concluded that our disclosure controls and procedures were effective as of June 30, 2019.
Changes in internal control over financial reporting
There
has not been any change in our internal control over financial reporting during the three months ended June 30, 2019, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II – OTHER INFORMATION
ITEM 1A. RISK FACTORS
In
addition to the information set forth in this quarterly report on Form 10‑Q, one should also carefully review and consider the information contained in our other reports and periodic filings that we make with the SEC, including, without limitation, the information contained under the caption “Item 1A. Risk Factors” in our annual report on Form 10‑K for the year ended December 31, 2018. Those risk factors could materially affect our business, financial condition, and results of operations. The risks that we describe in our public filings are not the only risks that we face. Additional risks and uncertainties not currently known to us, or that we presently deem to be immaterial, also may materially adversely affect our business, financial condition, and results of operations.
There
have been no material changes in our risk factors from those disclosed under the caption “Item 1A. Risk Factors” to our annual report on Form 10-K for the year ended December 31, 2018, except for the following updates:
Changes to trade policy, including tariff and import/export regulations, could adversely affect our business operations or those of our tenants.
Changes within and outside of the U.S. leading to political instability, geopolitical tensions, currency controls, changes in import and export regulations, changes in tariff and freight rates, and changes to laws and policies governing trade, manufacturing, development, and investment in the countries
where we currently have and own properties, purchase equipment or materials, or have lease agreements with tenants may adversely affect our business or that of our tenants. Our business operations include the development and redevelopment of value creation projects, which may require us to purchase equipment or supplies from vendors who are affected by such changes in laws or policies. As a result, we may experience delays, increases in costs, or difficulty in obtaining needed supplies, which may result in our failure to complete our value creation projects as intended. Additionally, our tenants who conduct business in countries subject to such changes may be adversely affected and unable to operate their businesses, which may impact their financial condition, ability to make rental payments, and ability to renew lease agreements, which in turn could adversely affect our financial condition, results of operations, cash flows, and our ability to make distributions to
our stockholders.
The U.S. President has proposed or implemented changes in trade policies that include the negotiation or termination of trade agreements, the imposition of higher tariffs on certain U.S. imports, economic sanctions on individuals, corporations or countries, and other government regulations affecting trade between the U.S. and other countries where we or our tenants may conduct business. New tariffs and other changes in U.S. trade policy could trigger retaliatory actions by affected countries, resulting in further impact to the U.S. economy and our or our tenants’ businesses. An example of such changes includes the U.S. President’s negotiation and signing of a replacement trade deal for the North American Free Trade Agreement with Mexico and Canada, known as the United States-Mexico-Canada Agreement ("USMCA"), which has not yet been ratified. We cannot
be certain what the final provisions of the USMCA will include and how those provisions will impact our business or that of our tenants. However, there may be greater restrictions in international trade, and it may become difficult or expensive for us or our tenants to comply with the new regulations, which may result in a material adverse effect on our business, financial condition, or results of operations.
In addition, the U.S. government has recently imposed tariffs on certain foreign goods, including tariffs on steel and aluminum product imports announced by the U.S. Department of Commerce and on certain products that originate in China announced by the United States Trade Representative. Certain foreign governments, including China, have instituted retaliatory tariffs on certain U.S. goods and have indicated a willingness to impose additional tariffs on U.S. products.
Global trade disruption, significant introductions of trade barriers, and bilateral trade frictions, together with any future downturns in the global economy resulting therefrom, may adversely affect our business operations and those of our tenants.
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The risk factor set forth below amends and restates in its entirety the risk factor captioned “Changes in the method of determining LIBOR, or the replacement of LIBOR with an alternative reference rate, may adversely affect interest expense related to outstanding debt” disclosed in our annual report on Form 10-K for the year ended December 31, 2018:
Changes
in the method of determining LIBOR, or the replacement of LIBOR with an alternative reference rate, may adversely affect interest expense related to outstanding debt.
We have outstanding loans and credit facilities with interest based upon LIBOR, depending on our selection of borrowing options. Beginning in 2008, concerns have been raised that some of the member banks surveyed by the BBA in connection with the calculation of daily LIBOR across a range of maturities and currencies may have underreported, overreported, or otherwise manipulated the interbank lending rate applicable to them in order to profit on their derivatives positions or to avoid an appearance of capital insufficiency or adverse reputational or other consequences that might have resulted from reporting interbank lending rates higher than those they actually submitted. A number of BBA member banks have entered
into settlements with their regulators and law enforcement agencies with respect to alleged manipulation of LIBOR, and investigations have been instigated by regulators and government authorities in various jurisdictions. Other member banks may also enter into such settlements with, or have proceedings brought by, their regulators or law enforcement agencies in the future. If manipulation of LIBOR occurred, it may have resulted in LIBOR having been artificially lower (or higher) than it would otherwise have been. Any such manipulation could have occurred over a substantial period of time.
On September 28, 2012, British regulators published a report on the review of LIBOR. The report concluded that LIBOR should be retained as a benchmark but recommended a comprehensive reform of LIBOR, including replacing the BBA with a new independent
administrator of LIBOR. Based on this report, final rules for the regulation and supervision of LIBOR by the Financial Conduct Authority (“FCA”) were published and came into effect on April 2, 2013 (the “FCA Rules”). In particular, the FCA Rules include requirements that (i) an independent LIBOR administrator monitor and survey LIBOR submissions to identify breaches of practice standards and/or potentially manipulative behavior and (ii) firms submitting data to LIBOR establish and maintain a clear conflict-of-interest policy and appropriate systems and controls. In response, ICE Benchmark Administration Limited (“IBA”) was appointed as the independent LIBOR administrator, effective in early 2014. On July 27, 2017, the FCA announced that it would phase out LIBOR as a benchmark by the end of 2021.
In
addition, in November 2014, the U.S. Federal Reserve established a working group composed of large U.S. financial institutions, the Alternative Reference Rates Committee (“ARRC”), to identify a set of alternative interest reference rates to LIBOR. In a May 2016 interim report, the ARRC narrowed its choice to two LIBOR alternatives. The first choice was the Overnight Bank Funding Rate (“OBFR”), which consists of domestic and foreign unsecured borrowing in U.S. dollars. The U.S. Federal Reserve has been calculating and publishing the OBFR since March 2016. The second alternative rate to LIBOR was the Treasury General Collateral Rate, which is composed of repo transactions secured by treasuries or other assets accepted as collateral by the majority of intermediaries in the repo market.
In June 2017, the ARRC selected the Secured Overnight Financing Rate (“SOFR”),
a new index calculated by reference to short-term repurchase agreements backed by Treasury securities, as its preferred replacement for U.S. dollar LIBOR. SOFR is observed and backward looking, which stands in contrast to LIBOR under the current methodology, which is an estimated forward-looking rate and relies, to some degree, on the expert judgment of submitting panel members. Given that SOFR is a secured rate backed by government securities, it does not take into account bank credit risk (as is the case with LIBOR). SOFR is therefore likely to be lower than LIBOR and is less likely to correlate with the funding costs of financial institutions. The first publication of SOFR was released by the Federal Reserve Bank of New York in April 2018.
In April 2019, the ARRC published its recommendations on fallback language for syndicated loans, which ARRC encourages companies to use
in new contracts that reference LIBOR in order to minimize market disruptions when LIBOR ceases to exist. ARRC suggested two alternative fallback language approaches for syndicated loan contracts:
•
“Hardwired Approach”, which clearly specifies SOFR-based successor rate and spread adjustment to be used when LIBOR ceases to exist.
•
“Amendment
Approach”, which, unlike the Hardwired Approach, does not reference specific rates or spread adjustments but provides a streamlined amendment approach for negotiating a benchmark replacement and introduces clarity with respect to the fallback trigger events and an adjustment to be applied to the successor rate.
Since 2012 we have been closely monitoring developments in the LIBOR transition and subsequently in the SOFR markets, and have implemented numerous proactive measures to minimize the potential impact to our company, specifically:
•
We
have been actively reducing borrowings outstanding on our LIBOR-based unsecured senior line of credit, unsecured senior bank term loans, and construction loans through repayments: from January 2017 to July 2019, we retired approximately $1.2 billion of such debt.
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•
As of June 30, 2019, our outstanding debt included only two LIBOR-based loans: our $2.2 billion unsecured senior line of credit with an outstanding balance of $514.0 million
and our unsecured senior bank term loan with an outstanding balance of $350.0 million. The aggregate outstanding balance of the aforementioned LIBOR-based loans represented less than 15% of our total debt balance outstanding as of June 30, 2019.
•
In July 2019, we completed a partial repayment of $175.0 million of our unsecured senior bank term loan balance and repaid all outstanding borrowings under our unsecured senior line of credit, further reducing our exposure to LIBOR. In addition, we will seek opportunities to further retire the outstanding balance of
our variable-rate unsecured senior bank term loan prior to the end of 2021, in order to further reduce our exposure to LIBOR.
•
All of our interest rate swap agreements mature prior to LIBOR cessation at the end of 2021.
•
Our unsecured senior line of credit and unsecured senior bank term loan contain fallback language generally consistent with the ARRC’s Amendment Approach.
•
We
continue to monitor developments by the ARRC and other governing bodies involved in LIBOR transition.
We continue to be proactive in managing the risk of disruption associated with the cessation of LIBOR, however, it is not possible to predict the effect of the FCA Rules, any changes in the methods pursuant to which LIBOR is determined, the administration of LIBOR by IBA, and any other reforms to LIBOR that will be enacted in the United Kingdom and elsewhere. In addition, any changes announced by the FCA, the BBA, IBA, ARRC, or any other successor governance or oversight body, or future changes adopted by such body, in the method pursuant to which LIBOR is determined, as well as manipulative practices or the cessation thereof, may result in a sudden or prolonged increase or decrease in reported LIBOR, which could have an adverse impact on the level of the index.
Fluctuation or discontinuation of LIBOR would affect our interest expense and earnings and the fair value of certain of our financial instruments. We also have certain joint ventures that may require variable rate construction loans with interest based upon LIBOR plus a spread. We rely on interest rate hedge agreements to mitigate our exposure to such interest rate risk on a portion of our debt obligations. However, there is no assurance these arrangements will be effective in reducing our exposure to changes in interest rates.
It is unclear whether new methods of calculating LIBOR will be established such that it continues to exist after 2021. When LIBOR ceases to exist, we may need to amend the credit and loan agreements with our lenders that utilize LIBOR as a factor in determining the interest rate based on a new standard that is established, if any. The transition to an
alternative rate will require careful and deliberate consideration and implementation so as to not disrupt the stability of financial markets. There is no guarantee that a transition from LIBOR to an alternative will not result in financial market disruptions, significant increases in benchmark rates, or borrowing costs to borrowers, any of which could have an adverse effect on our business, results of operations, financial condition, and stock price.
The transition to SOFR may present challenges, including, but not limited to, illiquidity of SOFR derivatives markets that could make it difficult for financial institutions to offer SOFR-based debt products, determination of the spread adjustment required to convert LIBOR to SOFR (and the related determination of a term structure with different maturities), and the greater volatility of SOFR, compared to that of LIBOR. Although
daily pricing resets for SOFR have been noted to be more volatile than that of LIBOR, especially at month end, there is no sufficient evidence to establish how SOFR volatility compares to that of LIBOR. Whether or not SOFR attains market acceptance as a LIBOR replacement tool remains in question. As such, the future of LIBOR and potential alternatives at this time remains uncertain.
Except as set forth above and in our annual report on Form 10-K for the year ended December 31, 2018, additional risks and uncertainties not currently known to us, or that we presently deem to be immaterial, also may materially adversely affect our business, financial condition, and results of operations.
The following materials from the Company’s quarterly report on Form 10-Q for the quarterly period ended June 30, 2019, formatted in iXBRL (Inline eXtensible Business Reporting Language): (i) Consolidated Balance Sheets as of June 30, 2019 and December 31, 2018 (unaudited), (ii) Consolidated Statements of Income for the three and six months ended June 30, 2019 and 2018 (unaudited), (iii) Consolidated Statements of Comprehensive
Income for the three and six months ended June 30, 2019 and 2018 (unaudited), (iv) Consolidated Statements of Changes in Stockholders’ Equity and Noncontrolling Interests for the three and six months ended June 30, 2019 and 2018 (unaudited), (v) Consolidated Statements of Cash Flows for the six months ended June 30, 2019 and 2018 (unaudited), and (vi) Notes to Consolidated Financial Statements (unaudited)
Pursuant to the requirements 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, on July 30,
2019.
