|
|
ITEM 2.
|
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|
The following discussion and analysis should be read in conjunction with the accompanying consolidated financial statements and notes thereto of Piedmont Office Realty Trust, Inc. (“Piedmont,” "we," "our," or "us"). See also “Cautionary Note Regarding Forward-Looking Statements” preceding Part I, as well as the consolidated financial statements and accompanying notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Amended Annual Report on Form 10-K/A for the year ended December 31, 2016.
Liquidity and Capital Resources
We intend to use cash flows generated from the operation of our properties, proceeds from our $500 Million Unsecured 2015 Line of Credit, and proceeds from selective property dispositions as our primary sources of immediate liquidity. Subsequent to the end of the second quarter, we sold the Two Independence Square building in Washington, D.C. The sale generated net sales proceeds of approximately $352 million, and we used $210 million of such proceeds to pay off the balance outstanding on our $500 Million Unsecured 2015 Line of Credit, as well as to prepay fully the $140 Million WDC Fixed-Rate Loans without penalty on August 1, 2017. As a result, as of the date of this filing, we have available the full capacity under our $500 million line of credit. From time to time, we may also seek additional secured or unsecured borrowings from third-party lenders or issue securities as additional sources of capital. The availability and attractiveness of terms for these additional sources of capital are highly dependent on market conditions.
Our most consistent use of capital has historically been, and we believe will continue to be, to fund capital expenditures for our existing portfolio of properties. During the
six months ended
June 30, 2017
and
2016
we incurred the following types of capital expenditures (in thousands):
|
|
|
|
|
|
|
|
|
|
Six Months Ended
|
|
June 30, 2017
|
|
June 30, 2016
|
|
|
|
|
|
|
|
|
Capital expenditures for new development
|
$
|
4,516
|
|
|
$
|
7,782
|
|
Capital expenditures for redevelopment/renovations
|
634
|
|
|
5,030
|
|
Other capital expenditures, including tenant improvements
|
53,170
|
|
|
41,610
|
|
Total capital expenditures
(1)
|
$
|
58,320
|
|
|
$
|
54,422
|
|
|
|
(1)
|
Of the total amounts paid, approximately
$0.2 million
and
$3.0 million
relates to soft costs such as capitalized interest, payroll, and other general and administrative expenses for the
six months ended
June 30, 2017
and
2016
, respectively.
|
"Capital expenditures for new development" relate to new office development projects. Expenditures during the six months ended June 30, 2017 pertained to 500 TownPark, a 134,000 square foot, 80% pre-leased, four-story office building that was placed into service during the period and is located adjacent to our existing 400 TownPark building in Lake Mary, Florida. During the six months ended June 30, 2016, our active development projects consisted of Enclave Place, our now-complete, 301,000 square foot, 11-story office tower in Houston, Texas, and the previously mentioned 500 TownPark building.
"Capital expenditures for redevelopment/renovations" during both the six months ended June 30, 2017 and 2016 related to a now-complete redevelopment project that converted our 3100 Clarendon Boulevard building in Arlington, Virginia from governmental use into Class A private sector office space.
"Other capital expenditures" include all other capital expenditures during the period and are typically comprised of tenant and building improvements and leasing commissions necessary to lease or maintain our existing portfolio of office properties.
Piedmont classifies its tenant and building improvements into two categories: (i) improvements which maintain the building's existing asset value and its revenue generating capacity (“non-incremental capital expenditures”) and (ii) improvements which incrementally enhance the building's asset value by expanding its revenue generating capacity (“incremental capital expenditures”). Commitments for funding non-incremental capital expenditures for tenant improvements over the next five years related to Piedmont's existing lease portfolio total approximately
$31.4 million
. The timing of the funding of these commitments is largely dependent upon tenant requests for reimbursement; however, we anticipate that a significant portion of these improvement allowances may be requested over the next three years based on when the underlying leases commence. In some instances, these
obligations may expire with the respective lease without further recourse to us. Additionally, commitments for incremental capital expenditures for tenant improvements associated with executed leases totaled approximately
$13.2 million
as of
June 30, 2017
.
In addition to the amounts described above to which we have already committed as a part of executed leases, we anticipate continuing to incur similar market-based tenant improvement allowances and leasing commissions in conjunction with procuring future leases for our existing portfolio of properties, including recently completed development and redevelopment projects. Given that our operating model frequently results in leases for large blocks of space to credit-worthy tenants, our leasing success can result in significant capital outlays. For example, for leases executed during the
six months ended
June 30, 2017
, we committed to spend approximately
$3.53
and
$1.58
per square foot per year of lease term for tenant improvement allowances and leasing commissions, respectively, and for those executed during the
six months ended
June 30, 2016
, we committed to spend approximately $3.02 and $1.26 per square foot per year of lease term for tenant improvement allowances and leasing commissions, respectively. Both the timing and magnitude of expenditures related to future leasing activity are highly dependent on the competitive market conditions of the particular office market at the times a given lease is negotiated and signed.
There are several other uses of capital that may arise as part of our ongoing operations. We expect to use capital to make repayments of our line of credit or other maturing debt obligations as they become due. After repaying the $140 Million WDC Fixed-Rate Loans (mentioned above) in August 2017, we have no other debt maturing until May of 2018. Additionally, subject to the identification and availability of attractive investment opportunities within our targeted sub-markets and our ability to consummate such acquisitions on satisfactory terms, acquiring new assets could also be a significant use of capital. Finally, our Board of Directors has authorized a stock repurchase program, pursuant to which we may use capital resources to repurchase shares of our common stock from time to time.
The amount and form of payment (cash or stock issuance) of future dividends to be paid to our stockholders will continue to be largely dependent upon (i) the amount of cash generated from our operating activities; (ii) our expectations of future cash flows; (iii) our determination of near-term cash needs for debt repayments, development projects, and selective acquisitions of new properties; (iv) the timing of significant expenditures for tenant improvements, building redevelopment projects, and general property capital improvements; (v) long-term payout ratios for comparable companies; (vi) our ability to continue to access additional sources of capital, including potential sales of our properties; and (vii) the amount required to be distributed to maintain our status as a REIT. Additionally, given current attractive real estate values, our net disposition activity is expected to increase in the current year, which may result in large one-time capital gains that cannot be offset by tax deferred structures, such as 1031 exchanges. As a result, we may make special dividend distributions in addition to our normal quarterly distributions. With the fluctuating nature of cash flows and expenditures, we may periodically borrow funds on a short-term basis to cover timing differences in cash receipts and cash disbursements.
Results of Operations
Overview
We recognized net income applicable to common stockholders of $0.16 per fully diluted share for the
three months ended
June 30, 2017
, as compared with net income of $0.50 per fully diluted share for the three months ended
June 30, 2016
. The decrease was primarily due to approximately $6.5 million, or $0.04 per diluted share, in gain on sale of real estate assets recognized during the current period as compared with $73.8 million, or $0.51 per diluted share, of such gains in the prior period. Increased rental income in the current period associated with the commencement of new leases, new properties acquired during 2016, and the non-recurrence of impairment charges partially offset the decrease.
Comparison of the
three months ended
June 30, 2017
versus the
three months ended
June 30, 2016
Income from Continuing Operations
The following table sets forth selected data from our consolidated statements of income for the
three months ended
June 30, 2017
and
2016
, respectively, as well as each balance as a percentage of total revenues for the same periods presented (dollars in millions):
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30,
2017
|
|
% of Revenues
|
|
June 30,
2016
|
|
% of Revenues
|
|
Variance
|
Revenue:
|
|
|
|
|
|
|
|
|
|
Rental income
|
$
|
124.3
|
|
|
|
|
$
|
111.8
|
|
|
|
|
$
|
12.5
|
|
Tenant reimbursements
|
24.0
|
|
|
|
|
23.1
|
|
|
|
|
0.9
|
|
Property management fee revenue
|
0.4
|
|
|
|
|
0.4
|
|
|
|
|
—
|
|
Total revenues
|
148.7
|
|
|
100
|
%
|
|
135.3
|
|
|
100
|
%
|
|
13.4
|
|
Expense:
|
|
|
|
|
|
|
|
|
|
Property operating costs
|
55.8
|
|
|
38
|
%
|
|
52.3
|
|
|
39
|
%
|
|
3.5
|
|
Depreciation
|
30.1
|
|
|
20
|
%
|
|
31.6
|
|
|
23
|
%
|
|
(1.5
|
)
|
Amortization
|
19.3
|
|
|
13
|
%
|
|
17.4
|
|
|
13
|
%
|
|
1.9
|
|
Impairment loss on real estate assets
|
—
|
|
|
—
|
%
|
|
10.9
|
|
|
8
|
%
|
|
(10.9
|
)
|
General and administrative
|
8.0
|
|
|
5
|
%
|
|
8.3
|
|
|
6
|
%
|
|
(0.3
|
)
|
Real estate operating income
|
35.5
|
|
|
24
|
%
|
|
14.8
|
|
|
11
|
%
|
|
20.7
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
Interest expense
|
(18.4
|
)
|
|
12
|
%
|
|
(16.4
|
)
|
|
12
|
%
|
|
(2.0
|
)
|
Other income/(expense)
|
—
|
|
|
—
|
%
|
|
(0.1
|
)
|
|
—
|
%
|
|
0.1
|
|
Equity in income of unconsolidated joint ventures
|
0.1
|
|
|
—
|
%
|
|
0.1
|
|
|
—
|
%
|
|
—
|
|
Income/(loss) from continuing operations
|
$
|
17.2
|
|
|
12
|
%
|
|
$
|
(1.6
|
)
|
|
1
|
%
|
|
$
|
18.8
|
|
Gain on sale of real estate assets, net
|
$
|
6.5
|
|
|
|
|
$
|
73.8
|
|
|
|
|
$
|
(67.3
|
)
|
Revenue
Rental income
increased
approximately
$12.5 million
for the
three months ended
June 30, 2017
, as compared to the same period in the prior year. Approximately $6.5 million of the increase is attributable to new leases commencing during 2016 and 2017 across our portfolio, including a new lease at our recently constructed 500 TownPark building which became fully operational in 2017. Additionally, net transactional activity since January 1, 2016 contributed approximately $5.2 million to the increase. The remaining increase is primarily attributable to fees derived from Piedmont-initiated lease restructurings to provide space for new or expanding tenants.
Tenant reimbursements
increased
approximately
$0.9 million
for the
three months ended
June 30, 2017
as compared to the same period in the prior year. The variance was primarily attributable to increased office occupancy and the resulting increase in recoverable operating expenses and, to a lesser extent, the expiration of operating expense abatements for certain of our tenants. The above increases in reimbursement income were partially offset by a $0.6 million decrease due to net transactional activity since April 1, 2016.
Expense
Property operating costs
increased
approximately
$3.5 million
for the
three months ended
June 30, 2017
compared to the same period in the prior year, primarily due to increased office occupancy and the resulting increase in recoverable property tax expense ($1.2 million), repairs and maintenance ($0.6 million), and utilities ($0.4 million). Further, net transactional activity since January 1, 2016 contributed approximately $1.3 million to the increase.
Depreciation expense
decreased
approximately
$1.5 million
for the
three months ended
June 30, 2017
compared to the same period in the prior year. We recognized a decrease of $2.2 million due to the reclassification of our Two Independence Square building as real assets held-for-sale in February 2017. At the time the property was reclassified, depreciation was suspended on the asset.
This decrease was offset by depreciation on additional building and tenant improvements placed in service subsequent to January 1, 2016.
Amortization expense
increased
approximately
$1.9 million
for the
three months ended
June 30, 2017
compared to the same period in the prior year. Of the total variance, approximately $4.1 million of expense is due to additional amortization of intangible lease assets recognized as part of acquiring new properties during 2016. This increase was partially offset by certain lease intangible assets at our existing properties becoming fully amortized subsequent to April 1, 2016.
During the
three months ended
June 30, 2016
, we recognized impairment charges related to our 150 West Jefferson building in Detroit, Michigan, and our 9221 Corporate Boulevard building in Rockville, Maryland totaling approximately
$10.9 million
(see
Note 7
).
General and administrative expenses
decreased
approximately
$0.3 million
for the
three months ended
June 30, 2017
compared to the same period in the prior year, primarily due to decreased accruals for potential performance-based stock compensation.
Other Income (Expense)
Interest expense
increased
approximately
$2.0 million
for the
three months ended
June 30, 2017
as compared to the same period in the prior year. The variance is primarily attributable to a net increase in our average debt outstanding. Additionally, approximately $0.7 million of the increase is due to a reduction in the amount of capitalized interest as three recently completed development projects were placed in service during the first quarter 2017.
Comparison of the accompanying consolidated statements of income for the
six months ended
June 30, 2017
versus the
six months ended
June 30, 2016
Income from Continuing Operations
The following table sets forth selected data from our consolidated statements of income for the
six months ended
June 30, 2017
and
2016
, respectively, as well as each balance as a percentage of total revenues for the same period presented (dollars in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30,
2017
|
|
% of Revenues
|
|
June 30,
2016
|
|
% of Revenues
|
|
Variance
|
Revenue:
|
|
|
|
|
|
|
|
|
|
Rental income
|
$
|
247.7
|
|
|
|
|
$
|
226.5
|
|
|
|
|
$
|
21.2
|
|
Tenant reimbursements
|
48.5
|
|
|
|
|
45.8
|
|
|
|
|
2.7
|
|
Property management fee revenue
|
0.9
|
|
|
|
|
1.0
|
|
|
|
|
(0.1
|
)
|
Total revenues
|
297.1
|
|
|
100
|
%
|
|
273.3
|
|
|
100
|
%
|
|
23.8
|
|
Expense:
|
|
|
|
|
|
|
|
|
|
Property operating costs
|
111.2
|
|
|
38
|
%
|
|
106.6
|
|
|
39
|
%
|
|
4.6
|
|
Depreciation
|
60.8
|
|
|
20
|
%
|
|
63.3
|
|
|
23
|
%
|
|
(2.5
|
)
|
Amortization
|
39.7
|
|
|
13
|
%
|
|
35.2
|
|
|
13
|
%
|
|
4.5
|
|
Impairment loss on real estate assets
|
—
|
|
|
—
|
%
|
|
10.9
|
|
|
4
|
%
|
|
(10.9
|
)
|
General and administrative
|
16.6
|
|
|
6
|
%
|
|
16.1
|
|
|
6
|
%
|
|
0.5
|
|
Real estate operating income
|
68.8
|
|
|
23
|
%
|
|
41.2
|
|
|
15
|
%
|
|
27.6
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
Interest expense
|
(36.5
|
)
|
|
12
|
%
|
|
(32.8
|
)
|
|
12
|
%
|
|
(3.7
|
)
|
Other income/(expense)
|
—
|
|
|
—
|
%
|
|
0.2
|
|
|
—
|
%
|
|
(0.2
|
)
|
Equity in income of unconsolidated joint ventures
|
0.1
|
|
|
—
|
%
|
|
0.2
|
|
|
—
|
%
|
|
(0.1
|
)
|
Income from continuing operations
|
$
|
32.4
|
|
|
11
|
%
|
|
$
|
8.8
|
|
|
3
|
%
|
|
$
|
23.6
|
|
Gain on sale of real estate assets, net
|
$
|
6.4
|
|
|
|
|
$
|
73.8
|
|
|
|
|
$
|
(67.4
|
)
|
Revenue
Rental income
increased
approximately
$21.2 million
for the
six months ended
June 30, 2017
as compared to the same period in the prior year. Approximately $12.6 million of the increase is attributable to new leases commencing during 2016 and 2017 across our portfolio. Additionally, net transactional activity since January 1, 2016 contributed approximately $7.0 million of the increase. The remaining increase is primarily attributable to fees derived from Piedmont-initiated lease restructurings to provide space for new or expanding tenants.
Tenant reimbursements
increased
approximately
$2.7 million
for the
six months ended
June 30, 2017
as compared to the same period in the prior year. The variance was primarily attributable to increased office occupancy and the resulting increase in recoverable operating expenses and, to a lesser extent, the expiration of operating expense abatements for certain of our tenants. In addition, tenant reimbursements for the six months ended June 30, 2017 includes the settlement receipt of approximately $0.6 million of prior period reimbursements as a result of a recent favorable court ruling on a tenant dispute. The above increases in reimbursement income were partially offset by a $1.1 million decrease due to net transactional activity during 2016.
Expense
Property operating costs
increased
approximately
$4.6 million
for the
six months ended
June 30, 2017
as compared to the same period in the prior year, primarily due to increased office occupancy and the resulting increase in recoverable property tax expense ($2.0 million), repairs and maintenance ($1.2 million) and tenant requested services ($0.4 million). Further, net transactional activity since January 1, 2016 contributed approximately $0.9 million to the increase.
Depreciation expense
decreased
approximately
$2.5 million
for the
six months ended
June 30, 2017
as compared to the same period in the prior year. Approximately $3.6 million of the decrease was due to the reclassification of our Two Independence Square building to assets held-for-sale in February 2017. At the time the property was reclassified, depreciation was suspended on the asset. Additionally, approximately $1.7 million of the decrease was attributable to net transactional activity during 2016. These decreases were offset by depreciation on additional building and tenant improvements placed in service subsequent to January 1, 2016.
Amortization expense
increased
approximately
$4.5 million
for the
six months ended
June 30, 2017
as compared to the same period in the prior year. Of the total variance, approximately $8.5 million of expense is due to additional amortization of intangible lease assets recognized as part of acquiring new properties during 2016. Increases in expense as a result of accelerated amortization for lease terminations/modifications of approximately $0.7 million also contributed to the variance. These increases were offset by certain lease intangible assets at our existing properties becoming fully amortized subsequent to January 1, 2016.
During the
six months ended
June 30, 2016
, we recognized impairment charges related to our 150 West Jefferson building and our 9221 Corporate Boulevard building totaling approximately
$10.9 million
(see
Note 7
).
General and administrative expenses
increased
approximately
$0.5 million
for the
six months ended
June 30, 2017
as compared to the same period in the prior year, primarily due to higher legal and stockholder communication costs.
Other Income (Expense)
Interest expense
increased
approximately
$3.7 million
for the
six months ended
June 30, 2017
as compared to the same period in the prior year. Approximately $1.8 million of the increase is due to placing our development projects into service in 2017, which causes associated interest to be expensed rather than be capitalized as part of the development. The remainder of the variance is due to a net increase in our average debt outstanding.
Other income/(expense) decreased approximately
$0.2 million
for the
six months ended
June 30, 2017
as compared to the same period in the prior year. The variance is primarily attributable to the sale of solar energy credits during the prior year that has not been repeated in 2017.
Funds From Operations (“FFO”), Core FFO, and Adjusted Funds from Operations (“AFFO”)
Net income calculated in accordance with U.S. generally accepted accounting principles ("GAAP") is the starting point for calculating FFO, Core FFO, and AFFO. These metrics are non-GAAP financial measures and should not be viewed as an alternative measurement of our operating performance to net income. Management believes that accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values have historically risen or fallen with market conditions, many industry investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves. As a result, we
believe that the additive use of FFO, Core FFO, and AFFO, together with the required GAAP presentation, provides a more complete understanding of our performance relative to our competitors and a more informed and appropriate basis on which to make decisions involving operating, financing, and investing activities.
We calculate FFO in accordance with the current National Association of Real Estate Investment Trusts ("NAREIT") definition. NAREIT currently defines FFO as follows: Net income (computed in accordance with GAAP), excluding gains or losses from sales of property and impairment charges (including our proportionate share of any impairment charges and/or gains or losses from sales of property related to investments in unconsolidated joint ventures), plus depreciation and amortization on real estate assets (including our proportionate share of depreciation and amortization related to investments in unconsolidated joint ventures). Other REITs may not define FFO in accordance with the NAREIT definition, or may interpret the current NAREIT definition differently than we do; therefore, our computation of FFO may not be comparable to such other REITs.
We calculate Core FFO by starting with FFO, as defined by NAREIT, and adjusting for gains or losses on the extinguishment of swaps and/or debt, acquisition-related expenses, and any significant non-recurring items. Core FFO is a non-GAAP financial measure and should not be viewed as an alternative to net income calculated in accordance with GAAP as a measurement of our operating performance. We believe that Core FFO is helpful to investors as a supplemental performance measure because it excludes the effects of certain items which can create significant earnings volatility, but which do not directly relate to our core recurring business operations. As a result, we believe that Core FFO can help facilitate comparisons of operating performance between periods and provides a more meaningful predictor of future earnings potential. Other REITs may not define Core FFO in the same manner as us; therefore, our computation of Core FFO may not be comparable to that of other REITs.
We calculate AFFO by starting with Core FFO and adjusting for non-incremental capital expenditures and acquisition-related costs and then adding back non-cash items including: non-real estate depreciation, straight-lined rents and fair value lease adjustments, non-cash components of interest expense and compensation expense, and by making similar adjustments for unconsolidated partnerships and joint ventures. AFFO is a non-GAAP financial measure and should not be viewed as an alternative to net income calculated in accordance with GAAP as a measurement of our operating performance. We believe that AFFO is helpful to investors as a meaningful supplemental comparative performance measure of our ability to make incremental capital investments. Other REITs may not define AFFO in the same manner as us; therefore, our computation of AFFO may not be comparable to that of other REITs.
Reconciliations of net income to FFO, Core FFO, and AFFO are presented below (in thousands except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Six Months Ended
|
|
June 30, 2017
|
|
Per
Share
(1)
|
|
June 30, 2016
|
|
Per
Share
(1)
|
|
June 30, 2017
|
|
Per
Share
(1)
|
|
June 30, 2016
|
|
Per
Share
(1)
|
GAAP net income applicable to common stock
|
$
|
23,710
|
|
|
$
|
0.16
|
|
|
$
|
72,278
|
|
|
$
|
0.50
|
|
|
$
|
38,814
|
|
|
$
|
0.27
|
|
|
$
|
82,650
|
|
|
$
|
0.57
|
|
Depreciation of real estate assets
(2)
|
29,932
|
|
|
0.21
|
|
|
31,442
|
|
|
0.21
|
|
|
60,561
|
|
|
0.41
|
|
|
63,081
|
|
|
0.43
|
|
Amortization of lease-related costs
(2)
|
19,315
|
|
|
0.13
|
|
|
17,418
|
|
|
0.12
|
|
|
39,721
|
|
|
0.27
|
|
|
35,240
|
|
|
0.24
|
|
Impairment loss on real estate assets
|
—
|
|
|
—
|
|
|
10,950
|
|
|
0.08
|
|
|
—
|
|
|
—
|
|
|
10,950
|
|
|
0.08
|
|
Gain on sale - wholly-owned properties, net
|
(6,492
|
)
|
|
(0.04
|
)
|
|
(73,835
|
)
|
|
(0.51
|
)
|
|
(6,439
|
)
|
|
(0.04
|
)
|
|
(73,815
|
)
|
|
(0.51
|
)
|
NAREIT Funds From Operations applicable to common stock
|
$
|
66,465
|
|
|
$
|
0.46
|
|
|
$
|
58,253
|
|
|
$
|
0.40
|
|
|
$
|
132,657
|
|
|
$
|
0.91
|
|
|
$
|
118,106
|
|
|
$
|
0.81
|
|
Adjustments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Acquisition costs
|
—
|
|
|
—
|
|
|
5
|
|
|
—
|
|
|
6
|
|
|
—
|
|
|
17
|
|
|
—
|
|
Core Funds From Operations applicable to common stock
|
$
|
66,465
|
|
|
$
|
0.46
|
|
|
$
|
58,258
|
|
|
$
|
0.40
|
|
|
$
|
132,663
|
|
|
$
|
0.91
|
|
|
$
|
118,123
|
|
|
$
|
0.81
|
|
Adjustments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of debt issuance costs, fair market adjustments on notes payable, and discount on debt
|
628
|
|
|
|
|
643
|
|
|
|
|
1,258
|
|
|
|
|
1,290
|
|
|
|
Depreciation of non real estate assets
|
184
|
|
|
|
|
175
|
|
|
|
|
379
|
|
|
|
|
379
|
|
|
|
Straight-line effects of lease revenue
(2)
|
(6,634
|
)
|
|
|
|
(3,127
|
)
|
|
|
|
(12,337
|
)
|
|
|
|
(10,975
|
)
|
|
|
Stock-based and other non-cash compensation
|
911
|
|
|
|
|
1,477
|
|
|
|
|
2,952
|
|
|
|
|
3,405
|
|
|
|
Net effect of amortization of above and below-market in-place lease intangibles
|
(1,611
|
)
|
|
|
|
(1,290
|
)
|
|
|
|
(3,170
|
)
|
|
|
|
(2,528
|
)
|
|
|
Acquisition costs
|
—
|
|
|
|
|
(5
|
)
|
|
|
|
(6
|
)
|
|
|
|
(17
|
)
|
|
|
Non-incremental capital expenditures
(3)
|
(9,073
|
)
|
|
|
|
(6,455
|
)
|
|
|
|
(16,745
|
)
|
|
|
|
(16,451
|
)
|
|
|
Adjusted Funds From Operations applicable to common stock
|
$
|
50,870
|
|
|
|
|
$
|
49,676
|
|
|
|
|
$
|
104,994
|
|
|
|
|
$
|
93,226
|
|
|
|
Weighted-average shares outstanding – diluted
|
145,813
|
|
|
|
|
145,699
|
|
|
|
|
145,780
|
|
|
|
|
145,765
|
|
|
|
|
|
(1)
|
Based on weighted average shares outstanding – diluted.
|
|
|
(2)
|
Includes amounts for wholly-owned properties, as well as such amounts for our proportionate ownership in unconsolidated joint ventures.
|
|
|
(3)
|
Piedmont defines non-incremental capital expenditures as capital expenditures of a recurring nature related to tenant improvements, leasing commissions, and building capital that do not incrementally enhance the underlying assets' income generating capacity. Tenant improvements, leasing commissions, building capital and deferred lease incentives incurred to lease space that was vacant at acquisition, leasing costs for spaces vacant for greater than one year, leasing costs for spaces at newly acquired properties for which in-place leases expire shortly after acquisition, improvements associated with the expansion of a building, and renovations that either enhance the rental rates of a building or change the property's underlying classification, such as from a Class B to a Class A property, are excluded from this measure.
|
Property and Same Store Net Operating Income
Property Net Operating Income ("Property NOI") is a non-GAAP measure which we use to assess our operating results. We calculate Property NOI beginning with Net income (computed in accordance with GAAP) before interest, taxes, depreciation and amortization and incrementally removing any impairment losses, gains or losses from sales of property and other significant infrequent items that create volatility within our earnings and make it difficult to determine the earnings generated by our core ongoing business. Furthermore, we adjust for general and administrative expense, income associated with property management performed by us for other organizations, and other income or expense items such as interest income from loan investments or costs from the pursuit of non-consummated transactions. For Property NOI (cash basis), the effects of straight-lined rents and fair value lease revenue are also eliminated; while such effects are not adjusted in calculating Property NOI (accrual basis). Property NOI is a non-GAAP financial measure and should not be viewed as an alternative to net income calculated in accordance with GAAP as a measurement of our operating performance. We believe that Property NOI, on either a cash or accrual basis, is helpful to investors as a supplemental comparative performance measure of income generated by our properties alone without our administrative overhead. Other REITs may not define Property NOI in the same manner as we do; therefore, our computation of Property NOI may not be comparable to that of other REITs.
We calculate Same Store Net Operating Income ("Same Store NOI") as Property NOI applicable to the properties owned or placed in service during the entire span of the current and prior year reporting periods. Same Store NOI also excludes amounts applicable to unconsolidated joint venture assets. Same Store NOI is a non-GAAP financial measure and should not be viewed as an alternative to net income calculated in accordance with GAAP as a measurement of our operating performance. We believe that Same Store NOI, on either a cash or accrual basis is helpful to investors as a supplemental comparative performance measure of the income generated from the same group of properties from one period to the next. Other REITs may not define Same Store NOI in the same manner as we do; therefore, our computation of Same Store NOI may not be comparable to that of other REITs.
The following table sets forth a reconciliation from Net income calculated in accordance with GAAP to Property NOI, on both a cash and accrual basis, and Same Store NOI, on both a cash and accrual basis, for the
three months ended
June 30, 2017
and
2016
, respectively (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash Basis
|
|
Accrual Basis
|
|
Three Months Ended
|
|
Three Months Ended
|
|
June 30,
2017
|
|
June 30,
2016
|
|
June 30,
2017
|
|
June 30,
2016
|
|
|
|
|
|
|
|
|
Net income applicable to Piedmont (GAAP basis)
|
$
|
23,710
|
|
|
$
|
72,278
|
|
|
$
|
23,710
|
|
|
$
|
72,278
|
|
|
|
|
|
|
|
|
|
Net income/(loss) applicable to noncontrolling interest
|
(3
|
)
|
|
3
|
|
|
(3
|
)
|
|
3
|
|
Interest expense
|
18,421
|
|
|
16,413
|
|
|
18,421
|
|
|
16,413
|
|
Depreciation
(1)
|
30,116
|
|
|
31,617
|
|
|
30,116
|
|
|
31,617
|
|
Amortization
(1)
|
19,315
|
|
|
17,418
|
|
|
19,315
|
|
|
17,418
|
|
Acquisition costs
|
—
|
|
|
5
|
|
|
—
|
|
|
5
|
|
Impairment loss on real estate assets
(1)
|
—
|
|
|
10,950
|
|
|
—
|
|
|
10,950
|
|
Loss from casualty events
|
(26
|
)
|
|
—
|
|
|
(26
|
)
|
|
—
|
|
Gain on sale of real estate assets, net
(1)
|
(6,492
|
)
|
|
(73,835
|
)
|
|
(6,492
|
)
|
|
(73,835
|
)
|
General & administrative expenses
(1)
|
8,059
|
|
|
8,351
|
|
|
8,059
|
|
|
8,351
|
|
Management fee revenue
|
(168
|
)
|
|
(224
|
)
|
|
(168
|
)
|
|
(224
|
)
|
Other (income)/expense
(1)
|
(12
|
)
|
|
543
|
|
|
(12
|
)
|
|
543
|
|
Straight-line rent effects of lease revenue
(1)
|
(6,634
|
)
|
|
(3,127
|
)
|
|
|
|
|
Amortization of lease-related intangibles
(1)
|
(1,611
|
)
|
|
(1,290
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Property NOI
|
$
|
84,675
|
|
|
$
|
79,102
|
|
|
$
|
92,920
|
|
|
$
|
83,519
|
|
|
|
|
|
|
|
|
|
Net operating loss/(income) from:
|
|
|
|
|
|
|
|
Acquisitions
(2)
|
(3,317
|
)
|
|
—
|
|
|
(7,061
|
)
|
|
—
|
|
Dispositions
(3)
|
(128
|
)
|
|
(4,412
|
)
|
|
(81
|
)
|
|
(4,528
|
)
|
Other investments
(4)
|
384
|
|
|
52
|
|
|
(657
|
)
|
|
(118
|
)
|
|
|
|
|
|
|
|
|
Same Store NOI
|
$
|
81,614
|
|
|
$
|
74,742
|
|
|
$
|
85,121
|
|
|
$
|
78,873
|
|
|
|
|
|
|
|
|
|
Change period over period in Same Store NOI
|
9.2
|
%
|
|
N/A
|
|
|
7.9
|
%
|
|
N/A
|
|
|
|
(1)
|
Includes amounts applicable to consolidated properties and our proportionate share of amounts applicable to unconsolidated joint ventures.
|
|
|
(2)
|
Acquisitions consist of CNL Center I and CNL Center II in Orlando, Florida, purchased on August 1, 2016; One Wayside Road in Burlington, Massachusetts, purchased on August 10, 2016; Galleria 200 in Atlanta, Georgia, purchased on October 7, 2016; and 750 West John Carpenter Freeway in Irving, Texas, purchased on November 30, 2016.
|
|
|
(3)
|
Dispositions consist of 1055 East Colorado Boulevard in Pasadena, California, sold on April 21, 2016; Fairway Center II in Brea, California, sold on April 28, 2016; 1901 Main Street in Irvine, California, sold on May 2, 2016; 9221 Corporate Boulevard in Rockville, Maryland, sold on July 27, 2016; 150 West Jefferson in Detroit, Michigan, sold on July 29, 2016; 9200 and 9211 Corporate Boulevard in Rockville, Maryland, sold on September 28, 2016; 11695 Johns Creek Parkway in Johns Creek, Georgia, sold on December 22, 2016; Braker Pointe III in Austin, Texas, sold on December 29, 2016; and Sarasota Commerce Center II in Sarasota, Florida, sold on June 16, 2017.
|
|
|
(4)
|
Other investments consist of our investments in unconsolidated joint ventures, active redevelopment and development projects, land, and recently completed redevelopment and development projects for which some portion of operating expenses were capitalized during the current and/or prior year reporting periods. The operating results from 3100 Clarendon Boulevard in Arlington, Virginia, Enclave Place in Houston, Texas, and 500 TownPark in Lake Mary, Florida, are included in this line item.
|
The following table sets forth a reconciliation from Net income calculated in accordance with GAAP to Property NOI, on both a cash and accrual basis, and Same Store NOI, on both a cash and accrual basis, for the
six months ended
June 30, 2017
and
2016
, respectively (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash Basis
|
|
Accrual Basis
|
|
Six Months Ended
|
|
Six Months Ended
|
|
June 30,
2017
|
|
June 30,
2016
|
|
June 30,
2017
|
|
June 30,
2016
|
|
|
|
|
|
|
|
|
Net income applicable to Piedmont (GAAP basis)
|
$
|
38,814
|
|
|
$
|
82,650
|
|
|
$
|
38,814
|
|
|
$
|
82,650
|
|
|
|
|
|
|
|
|
|
Net income/(loss) applicable to noncontrolling interest
|
(6
|
)
|
|
7
|
|
|
(6
|
)
|
|
7
|
|
Interest expense
|
36,478
|
|
|
32,798
|
|
|
36,478
|
|
|
32,798
|
|
Depreciation
(1)
|
60,940
|
|
|
63,460
|
|
|
60,940
|
|
|
63,460
|
|
Amortization
(1)
|
39,721
|
|
|
35,240
|
|
|
39,721
|
|
|
35,240
|
|
Acquisition costs
|
6
|
|
|
17
|
|
|
6
|
|
|
17
|
|
Impairment loss on real estate assets
(1)
|
—
|
|
|
10,950
|
|
|
—
|
|
|
10,950
|
|
Loss from casualty events
|
32
|
|
|
—
|
|
|
32
|
|
|
—
|
|
Gain on sale of real estate assets, net
(1)
|
(6,439
|
)
|
|
(73,815
|
)
|
|
(6,439
|
)
|
|
(73,815
|
)
|
General & administrative expenses
(1)
|
16,660
|
|
|
16,128
|
|
|
16,660
|
|
|
16,128
|
|
Management fee revenue
|
(484
|
)
|
|
(515
|
)
|
|
(484
|
)
|
|
(515
|
)
|
Other (income)/expense
(1)
|
25
|
|
|
236
|
|
|
25
|
|
|
236
|
|
Straight-line rent effects of lease revenue
(1)
|
(12,337
|
)
|
|
(10,975
|
)
|
|
|
|
|
Amortization of lease-related intangibles
(1)
|
(3,170
|
)
|
|
(2,528
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Property NOI
|
$
|
170,240
|
|
|
$
|
153,653
|
|
|
$
|
185,747
|
|
|
$
|
167,156
|
|
|
|
|
|
|
|
|
|
Net operating loss/(income) from:
|
|
|
|
|
|
|
|
Acquisitions
(2)
|
(8,084
|
)
|
|
—
|
|
|
(14,115
|
)
|
|
—
|
|
Dispositions
(3)
|
(764
|
)
|
|
(10,052
|
)
|
|
(662
|
)
|
|
(10,660
|
)
|
Other investments
(4)
|
664
|
|
|
(19
|
)
|
|
(1,043
|
)
|
|
(212
|
)
|
|
|
|
|
|
|
|
|
Same Store NOI
|
$
|
162,056
|
|
|
$
|
143,582
|
|
|
$
|
169,927
|
|
|
$
|
156,284
|
|
|
|
|
|
|
|
|
|
Change period over period in Same Store NOI
|
12.9
|
%
|
|
N/A
|
|
|
8.7
|
%
|
|
N/A
|
|
|
|
(1)
|
Includes amounts applicable to consolidated properties and our proportionate share of amounts applicable to unconsolidated joint ventures.
|
|
|
(2)
|
Acquisitions consist of CNL Center I and CNL Center II in Orlando, Florida, purchased on August 1, 2016; One Wayside Road in Burlington, Massachusetts, purchased on August 10, 2016; Galleria 200 in Atlanta, Georgia, purchased on October 7, 2016; and 750 West John Carpenter Freeway in Irving, Texas, purchased on November 30, 2016.
|
|
|
(3)
|
Dispositions consist of 1055 East Colorado Boulevard in Pasadena, California, sold on April 21, 2016; Fairway Center II in Brea, California, sold on April 28, 2016; 1901 Main Street in Irvine, California, sold on May 2, 2016; 9221 Corporate Boulevard in Rockville, Maryland, sold on July 27, 2016; 150 West Jefferson in Detroit, Michigan, sold on July 29, 2016; 9200 and 9211 Corporate Boulevard in Rockville, Maryland, sold on September 28, 2016; 11695 Johns Creek Parkway in Johns Creek, Georgia, sold on December 22, 2016; Braker Pointe III in Austin, Texas, sold on December 29, 2016; and Sarasota Commerce Center II in Sarasota, Florida, sold on June 16, 2017.
|
|
|
(4)
|
Other investments consist of our investments in unconsolidated joint ventures, active redevelopment and development projects, land, and recently completed redevelopment and development projects for which some portion of operating expenses were capitalized during the current and/or prior year reporting periods. The operating results from 3100 Clarendon Boulevard in Arlington, Virginia, Enclave Place in Houston, Texas, and 500 TownPark in Lake Mary, Florida, are included in this line item.
|
Overview
Our portfolio is a diverse geographical portfolio primarily located in select sub-markets within eight major office markets located in the Eastern-half of the U.S. We typically lease space to large, credit-worthy corporate or governmental tenants on a long-term basis. Our average lease is approximately 22,000 square feet with
6.7 years
of lease term remaining as of
June 30, 2017
. As a result, leased percentage, as well as rent roll ups and roll downs, which we experience as a result of re-leasing, can fluctuate widely between markets, between buildings, and between tenants within a given market depending on when a particular lease is scheduled to expire.
Leased Percentage
Excluding one property owned through an unconsolidated joint venture, our current in-service portfolio of
67
office properties was
91.0%
leased as of
June 30, 2017
, down slightly from
91.4%
leased as of June 30, 2016, primarily as a result of placing three development/re-development properties totaling 700,000 square feet in service during the current year. As of
June 30, 2017
, scheduled lease expirations for the portfolio as a whole for the remainder of 2017 and 2018 were 3.7% and 7.4%, respectively, of our ALR. To the extent new leases for currently vacant space outweigh or fall short of scheduled expirations, such leases would increase or decrease our leased percentage, respectively. Our leased percentage may also fluctuate from the impact of various occupancy levels in our net acquisition and disposition activity.
Impact of Downtime, Abatement Periods, and Rental Rate Changes
Commencement of new leases typically occurs 6-18 months from the lease execution date, after refurbishment of the space is completed. The downtime between a lease expiration and the new lease's commencement can negatively impact Property NOI and Same Store NOI comparisons (both accrual and cash basis). In addition, office leases, both new and lease renewals, often contain upfront rental and/or operating expense abatement periods which delay the cash flow benefits of the lease even after the new lease or renewal has commenced and will continue to negatively impact Property NOI and Same Store NOI on a cash basis until such abatements expire. As of
June 30, 2017
, we had approximately 238,000 square feet of executed leases related to vacant space that had not yet commenced and approximately 1.3 million square feet of commenced leases that were still in some form of abatement.
If we are unable to replace expiring leases with new or renewal leases at rental rates equal to or greater than the expiring rates, rental rate roll downs can also negatively impact Property NOI and Same Store NOI comparisons. As mentioned above, our geographically diverse portfolio and large block tenant model result in rent roll ups and roll downs that can fluctuate widely on a building-by-building and a quarter-to-quarter basis.
Same Store NOI increased
9.2%
and
7.9%
on a cash and accrual basis, respectively, during the three months ended
June 30, 2017
and
12.9%
and
8.7%
on a cash and accrual basis, respectively, during the
six months ended
June 30, 2017
, as compared to the same periods in the prior year. These increases are primarily the result of lease commencements (accrual basis) and the expiration of rental abatements associated with new leases (cash basis). In addition, Same Store NOI on both an accrual and cash basis were favorably impacted by the receipt of one-time restructuring fees and the recovery of prior year reimbursement income as a result of the resolution of a tenant dispute during the six months ended June 30, 2017. Property NOI and Same Store NOI comparisons for any given period may still fluctuate as a result of the mix of net leasing activity in individual properties during the respective period.
Election as a REIT
We have elected to be taxed as a REIT under the Code and have operated as such beginning with our taxable year ended December 31, 1998. To qualify as a REIT, we must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of our adjusted REIT taxable income, computed without regard to the dividends-paid deduction and by excluding net capital gains attributable to our stockholders, as defined by the Code. As a REIT, we generally will not be subject to federal income tax on income that we distribute to our stockholders. If we fail to qualify as a REIT in any taxable year, we may be subject to federal income taxes on our taxable income for that year and for the four years following the year during which qualification is lost and/or penalties, unless the IRS grants us relief under certain statutory provisions. Such an event could materially adversely affect our net income and net cash available for distribution to our stockholders. However, we believe that we are organized and operate in such a manner as to qualify for treatment as a REIT and intend to continue to operate in the foreseeable future in such a manner that we will remain qualified as a REIT for federal income tax purposes. We have elected to treat POH, a wholly-owned subsidiary of Piedmont, as a taxable REIT subsidiary. POH performs non-customary services for tenants of buildings that we own, including solar power generation, real estate and non-real estate related-services; however, any earnings related to such services performed by our taxable REIT subsidiary are subject to federal and state income taxes. In addition, for us to continue to qualify
as a REIT, our investments in taxable REIT subsidiaries cannot exceed 25% (20% for taxable years beginning after 2017) of the value of our total assets.
Inflation
We are exposed to inflation risk, as income from long-term leases is the primary source of our cash flows from operations. There are provisions in the majority of our tenant leases that are intended to protect us from, and mitigate the risk of, the impact of inflation. These provisions include rent steps, reimbursement billings for operating expense pass-through charges, real estate tax, and insurance reimbursements on a per square-foot basis, or in some cases, annual reimbursement of operating expenses above certain per square-foot allowances. However, due to the long-term nature of the leases, the leases may not readjust their reimbursement rates frequently enough to fully cover inflation.
Off-Balance Sheet Arrangements
We are not dependent on off-balance sheet financing arrangements for liquidity. As of
June 30, 2017
, our off-balance sheet arrangements consist of one investment in an unconsolidated joint venture and operating lease obligations related to a ground lease at one of our properties. The unconsolidated joint venture in which we hold an investment is prohibited by its governing documents from incurring debt. For further information regarding our commitments under operating lease obligations, see the Contractual Obligations table below.
Application of Critical Accounting Policies
Our accounting policies have been established to conform with GAAP. The preparation of financial statements in conformity with GAAP requires management to use judgment in the application of accounting policies, including making estimates and assumptions. These judgments affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. If our judgment or interpretation of the facts and circumstances relating to various transactions had been different, it is possible that different accounting policies would have been applied, thus, resulting in a different presentation of the financial statements. Additionally, other companies may utilize different estimates that may impact comparability of our results of operations to those of companies in similar businesses. The critical accounting policies outlined below have been discussed with members of the Audit Committee of the Board of Directors.
Investment in Real Estate Assets
We are required to make subjective assessments as to the useful lives of our depreciable assets. We consider the period of future benefit of the asset to determine the appropriate useful lives. These assessments have a direct impact on net income applicable to Piedmont. The estimated useful lives of our assets by class are as follows:
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|
|
Buildings
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40 years
|
Building improvements
|
5-25 years
|
Land improvements
|
20-25 years
|
Tenant allowances
|
Lease term
|
Furniture, fixtures, and equipment
|
3-5 years
|
Intangible lease assets
|
Lease term
|
Fair Value of Assets and Liabilities of Acquired Properties
Upon the acquisition of real properties, we record the relative fair value of properties to acquired tangible assets, consisting of land and buildings, and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases and the value of in-place leases, based on their estimated fair values.
The estimated fair values of the tangible assets of an acquired property (which includes land and building) are determined by valuing the property as if it were vacant, and the “as-if-vacant” value is then allocated to land and building based on management’s determination of the relative fair value of these assets. We rely on a sales comparison approach using closed land sales and listings in determining the land value, and determine the as-if-vacant estimated fair value of a property using methods similar to those used by independent appraisers. Factors considered by management in performing these analyses include an estimate of carrying costs during the expected lease-up periods considering current market conditions and costs to execute similar leases. In estimating
carrying costs, management includes real estate taxes, insurance, and other operating expenses and estimates of lost rental revenue during the expected lease-up periods based on current market demand. We also estimate the cost to execute similar leases including leasing commissions, legal, and other related costs.
The estimated fair values of above-market and below-market in-place leases are recorded based on the present value (using an interest rate which reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) management’s estimate of market rates for the corresponding in-place leases, measured over a period equal to the remaining terms of the leases, taking into consideration the probability of renewals for any below-market leases. The capitalized above-market and below-market lease values are recorded as intangible lease assets or liabilities and amortized as an adjustment to rental revenues over the remaining terms of the respective leases.
The estimated fair values of in-place leases include an estimate of the direct costs associated with obtaining the acquired or "in place" tenant, estimates of opportunity costs associated with lost rentals that are avoided by acquiring an in-place lease. The amount capitalized as direct costs associated with obtaining a tenant include commissions, tenant improvements, and other direct costs and are estimated based on management’s consideration of current market costs to execute a similar lease. These direct lease origination costs are included in deferred lease costs in the accompanying consolidated balance sheets and are amortized to expense over the remaining terms of the respective leases. The value of opportunity costs is calculated using the contractual amounts to be paid pursuant to the in-place leases over a market absorption period for a similar lease. These lease intangibles are included in intangible lease assets in the accompanying consolidated balance sheets and are amortized to expense over the remaining terms of the respective leases.
Estimating the fair values of the tangible and intangible assets requires us to estimate market lease rates, property operating expenses, carrying costs during lease-up periods, discount and capitalization rates, market absorption periods, and the number of years the property is held for investment. The use of inappropriate estimates would result in an incorrect assessment of our purchase price allocations, which would impact the amount of our reported net income attributable to Piedmont.
Valuation of Real Estate Assets and Investments in Joint Ventures which Hold Real Estate Assets
We continually monitor events and changes in circumstances that could indicate that the carrying amounts of the real estate and related intangible assets, both operating properties and properties under construction, in which we have an ownership interest, either directly or through investments in joint ventures, may not be recoverable. For wholly owned properties, when indicators of potential impairment are present, or when a sale in the near term is considered more than 50% probable, we assess whether the respective carrying values will be recovered from the undiscounted future operating cash flows expected from the use of the asset and its eventual disposition for assets held for use, or from the estimated fair value, less costs to sell, for assets held for sale. In the event that the expected undiscounted future cash flows for assets held for use or the estimated fair value, less costs to sell, for assets held for sale do not exceed the respective asset carrying value, we adjust such assets to the respective estimated fair values and recognize an impairment loss. For our investments in unconsolidated joint ventures, we assess the estimated fair value of our investment, as compared to our carrying amount. If we determine that the carrying value is greater than the estimated fair value at any measurement date, we must also determine if such a difference is temporary in nature. Value fluctuations which are “other than temporary” in nature are then recorded to adjust the carrying value to the estimated fair value amount.
Projections of expected future cash flows require that we estimate future market rental income amounts subsequent to the expiration of current lease agreements, property operating expenses, the number of months it takes to re-lease the property, and the number of years the property is held for investment, among other factors. The subjectivity of assumptions used in the future cash flow analysis, including capitalization and discount rates, could result in an incorrect assessment of the property’s estimated fair value and, therefore, could result in the misstatement of the carrying value of our real estate and related intangible assets and our reported net income attributable to Piedmont.
Goodwill
Goodwill is the excess of cost of an acquired entity over the amounts specifically assigned to assets acquired and liabilities assumed in purchase accounting for business combinations, as well as costs incurred as part of the acquisition. We test the carrying value of our goodwill for impairment on an annual basis, or on an interim basis if an event occurs or circumstances change that would indicate the carrying amount may be impaired. Such interim circumstances may include, but are not limited to, significant adverse changes in legal factors or in the general business climate, adverse action or assessment by a regulator, unanticipated competition, the loss of key personnel, or persistent declines in an entity’s stock price below carrying value of the entity. We have the option, should we choose to use it, to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the estimated fair value of the reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, we conclude that the estimated fair value is greater than the carrying amount, then performing the two-step impairment test is unnecessary. However, if we chose to forgo the availability of the qualitative
analysis, the test prescribed by authoritative accounting guidance is a two-step test. The first step involves comparing the estimated fair value of the entity to its carrying value, including goodwill. Estimated fair value is determined by adjusting the trading price of the stock for a control premium, if necessary, multiplied by the common shares outstanding. If such calculated estimated fair value exceeds the carrying value, no further procedures or analysis is required. However, if the carrying value exceeds the calculated fair value, goodwill is potentially impaired and step two of the analysis would be required. Step two of the test involves calculating the implied fair value of goodwill by deducting the estimated fair value of all tangible and intangible net assets of the entity from the entity’s estimated fair value calculated in step one of the test. If the implied value of the goodwill (the remainder left after deducting the estimated fair values of the entity from its calculated overall estimated fair value in step one of the test) is less than the carrying value of goodwill, an impairment loss would be recognized. We have determined through the process noted above that there are no issues of impairment related to our goodwill as of
June 30, 2017
.
Investment in Variable Interest Entities
Variable Interest Entities (“VIEs”) are defined by GAAP as entities in which equity investors do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. If an entity is determined to be a VIE, it must be consolidated by the primary beneficiary. The primary beneficiary is the enterprise that has the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance, absorbs the majority of the entity’s expected losses, or receives a majority of the entity’s expected residual returns. Generally, expected losses and expected residual returns are the anticipated negative and positive variability, respectively, in the estimated fair value of the VIE’s net assets. When we make an investment, we assess whether the investment represents a variable interest in a VIE and, if so, whether we are the primary beneficiary of the VIE. Incorrect assumptions or assessments may result in an inaccurate determination of the primary beneficiary. The result could be the consolidation of an entity acquired or formed in the future that would otherwise not have been consolidated or the non-consolidation of such an entity that would otherwise have been consolidated.
We evaluate each investment to determine whether it represents variable interests in a VIE. Further, we evaluate the sufficiency of the entities’ equity investment at risk to absorb expected losses, and whether as a group, the equity has the characteristics of a controlling financial interest. See
Note 4
to our accompanying consolidated financial statements for further detail on our investment in variable interest entities.
Interest Rate Derivatives
We periodically enter into interest rate derivative agreements to hedge our exposure to changing interest rates on variable rate debt instruments. As required by GAAP, we record all derivatives on the balance sheet at estimated fair value. We reassess the effectiveness of our derivatives designated as cash flow hedges on a regular basis to determine if they continue to be highly effective and also to determine if the forecasted transactions remain highly probable. Currently, we do not use derivatives for trading or speculative purposes.
The changes in estimated fair value of interest rate swap agreements designated as effective cash flow hedges are recorded in other comprehensive income (“OCI”), and subsequently reclassified to earnings when the hedged transactions occur. Changes in the estimated fair values of derivatives designated as cash flow hedges that do not qualify for hedge accounting treatment, if any, would be recorded as gain/(loss) on interest rate swap in the consolidated statements of income. The estimated fair value of the interest rate derivative agreement is recorded as interest rate derivative asset or as interest rate derivative liability in the accompanying consolidated balance sheets. Amounts received or paid under interest rate derivative agreements are recorded as interest expense in the consolidated income statements as incurred. When Piedmont settles forward starting swap agreements for gains/losses, the result is recorded as accumulated other comprehensive income and is amortized as an offset/increase to interest expense over the term of the respective notes on a straight line basis (which approximates the effective interest method). All of our interest rate derivative agreements as of
June 30, 2017
are designated as effective cash flow hedges. See
Note 5
to our accompanying consolidated financial statements for further detail on our interest rate derivatives.
Stock-based Compensation
We have issued stock-based compensation in the form of restricted stock to our employees and directors. For employees, such compensation has been issued pursuant to our Long-term Incentive Compensation ("LTIC") program. The LTIC program is comprised of an annual deferred stock grant component and a multi-year performance share component. Awards granted pursuant to the annual deferred stock component are considered equity awards and expensed straight-line over the vesting period, with issuances recorded as a reduction to additional paid in capital. Awards granted pursuant to the performance share component are considered liability awards and are expensed over the service period, with issuances recorded as a reduction to accrued expense. The compensation expense recognized related to both of these award types is recorded as property operating costs for those employees whose job is related to property operation and as general and administrative expense for all other employees and
directors in the accompanying consolidated statements of income. See
Note 10
to our accompanying consolidated financial statements for further detail on our stock-based compensation.
Recent Accounting Pronouncements
The Financial Accounting Standards Board (the "FASB") has issued Accounting Standards Update No. 2014-09,
Revenue from Contracts with Customers (Topic 606)
("ASU 2014-09") and Accounting Standards Update No. 2016-08,
Revenue from Contracts with Customers (Topic 606) Principal versus Agent Considerations (Reporting Revenue Gross versus Net)
("ASU 2016-08"). The amendments in ASU 2014-09, which are further clarified in ASU 2016-08, as well as Accounting Standards Update 2016-10, Accounting Standards Update 2016-12, and Accounting Standards Update 2016-20 (collectively the "Revenue Recognition Amendments"), change the criteria for the recognition of certain revenue streams to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services using a five-step determination process. Steps 1 through 5 involve (i) identifying contracts with a customer, (ii) identifying the performance obligations in the contract, (iii) determining the transaction price, (iv) allocating the transaction price to the performance obligations, and (v) recognizing revenue as an entity satisfies a performance obligation. The revenues impacted by the Revenue Recognition Amendments include a portion of our tenant reimbursement revenues and property management fee revenues. Lease contracts and reimbursement revenues associated with property taxes and insurance are specifically excluded from the Revenue Recognition Amendments. The Revenue Recognition Amendments are effective in the first quarter of 2018 for us. Management has substantially completed its initial assessment of the impact of adoption of the Revenue Recognition Amendments. Approximately
90%
of our total revenues are derived from either long-term leases with our tenants or reimbursement of property tax and insurance expenses, which are excluded from the scope of the Revenue Recognition Amendments. In addition, based on management's assessment to date, we do not expect the timing of the recognition of reimbursement revenue and revenue from management agreements to change as a result of the new guidance, though certain classifications will change between rental revenue and tenant reimbursements. Finally, management has determined, and the FASB has confirmed, that the evaluation of non-lease components under the new Revenue Recognition Amendments will not be effective until Accounting Standards Update No. 2016-02,
Leases (Topic 842),
("ASU 2016-02") becomes effective (see further discussion below), which will be first quarter of 2019 for us. As a result, although management continues to evaluate the guidance and disclosures required by the Revenue Recognition Amendments, we do not anticipate any material impact to our consolidated financial statements as a result of adoption.
The FASB has issued Accounting Standards Update No. 2017-05,
Other Income—Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets
("ASU 2017-05"). The provisions of ASU 2017-05 define the term "in substance nonfinancial asset" as a financial asset promised to a counterparty in a contract if substantially all of the fair value of the assets (recognized and unrecognized) is concentrated in nonfinancial assets. Further, it states that nonfinancial assets should be derecognized once the counterparty obtains control. Finally, the amendments provide clarification for partial sales of nonfinancial assets. ASU 2017-05 is effective concurrent with the Revenue Recognition Amendments (detailed above), which will be the first quarter of 2018 for us. Although management continues to evaluate the guidance and disclosures required by ASU 2017-05, we do not anticipate a material change in how we recognize the disposition of real estate in our consolidated financial statements as a result of adoption.
The FASB has issued Accounting Standards Update No. 2016-01,
Financial Instruments - Overall (Subtopic 825-10), Recognition and Measurement of Financial Assets and Financial Liabilities
("ASU 2016-01"). The amendments in ASU 2016-01 require equity investments, except those accounted for under the equity method of accounting, to be measured at estimated fair value with changes in fair value recognized in net income. Additionally, ASU 2016-01 simplifies the impairment assessment of equity investments, and eliminates certain disclosure requirements. The amendments in ASU 2016-01 are effective in the first quarter of 2018, and we do not anticipate any material impact to our consolidated financial statements as a result of adoption.
The FASB has issued Accounting Standards Update No. 2016-18,
Statement of Cash Flows (Topic 230),
Restricted Cash (a consensus of the FASB Emerging Issues Task Force)
("ASU 2016-18"). The provisions of ASU 2016-18 require entities to show changes in restricted cash and cash equivalents in addition to cash and cash equivalents in the statement of cash flows. As a result, entities will no longer present transfers between restricted and unrestricted cash in the statement of cash flows. Disclosures are required to reconcile the amount presented on the statement of cash flows to the balance sheet, as well as disclosing the nature of restriction on the restricted cash balances. ASU 2016-18 is effective for us in the first quarter of 2018, with early adoption permitted. We do not anticipate any material impact to our consolidated financial statements as a result of adoption.
The FASB has issued ASU 2016-02, which fundamentally changes the definition of a lease, as well as the accounting for operating leases by requiring lessees to recognize assets and liabilities which arise from the lease, consisting of a liability to make lease payments (the lease liability) and a right-of-use asset, representing the right to use the leased asset over the term of the lease. Accounting for leases by lessors is substantially unchanged from prior practice as lessors will continue to recognize lease revenue on a straight-line basis; however, ASU 2016-02 defines certain tenant reimbursements as non-lease components which will be
subject to the guidance under ASU 2014-09. The amendments in ASU 2016-02 are effective in the first quarter of 2019, and we are currently evaluating the potential impact of adoption.
The FASB has issued Accounting Standards Update No. 2016-13,
Financial Instruments—Credit Losses (Topic 326),
Measurement of Credit Losses on Financial Instruments
("ASU 2016-13"). The provisions of ASU 2016-13 replace the "incurred loss" approach with an "expected loss" model for impairing trade and other receivables, held-to-maturity debt securities, net investment in leases, and off-balance-sheet credit exposures, which will generally result in earlier recognition of allowances for credit losses. Additionally, the provisions change the classification of credit losses related to available-for-sale securities to an allowance, rather than a direct reduction of the amortized cost of the securities. ASU 2016-13 is effective in the first quarter of 2020, with early adoption permitted as of January 1, 2019. We are currently evaluating the potential impact of adoption.
The FASB has issued Accounting Standards Update No. 2017-04,
Intangibles—Goodwill and Other (Topic 350),
Simplifying the Test for Goodwill Impairment
("ASU 2017-04"). The provisions of ASU 2017-04 simplify how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test, which is generally performed annually unless events or circumstances arise which would necessitate evaluating the carrying value for impairment in the interim. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a entity’s goodwill with the carrying amount of that goodwill by determining the fair value of its assets and liabilities (including unrecognized assets and liabilities) following the procedures that would be required in a business combination. Under the provisions of ASU 2017-04, an entity would instead recognize an impairment charge for the amount by which the carrying amount exceeds the entity’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that entity. ASU 2017-04 is effective in the first quarter of 2020, with early adoption permitted as of the first interim or annual impairment test of goodwill after January 1, 2017. We are currently evaluating the potential impact of adoption.
Related-Party Transactions and Agreements
There were no related-party transactions during the
three and six months ended
June 30, 2017
.
Contractual Obligations
Our contractual obligations as of
June 30, 2017
were as follows (in thousands):
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|
|
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|
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|
|
|
|
|
|
|
|
|
|
|
|
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Payments Due by Period
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|
Contractual Obligations
|
Total
|
|
Less than
1 year
|
|
1-3 years
|
|
3-5 years
|
|
More than
5 years
|
|
Long-term debt
(1)
|
$
|
2,061,132
|
|
|
$
|
310,858
|
|
(2)
|
$
|
812,029
|
|
(3)(4)(5)(6)
|
$
|
28,245
|
|
|
$
|
910,000
|
|
|
Operating lease obligations
(7)
|
2,858
|
|
|
93
|
|
|
186
|
|
|
187
|
|
|
2,392
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|
|
Total
|
$
|
2,063,990
|
|
|
$
|
310,951
|
|
|
$
|
812,215
|
|
|
$
|
28,432
|
|
|
$
|
912,392
|
|
|
|
|
(1)
|
Amounts include principal payments only and balances outstanding as of
June 30, 2017
, not including unamortized issuance discounts, debt issuance costs paid to lenders, or estimated fair value adjustments. We made interest payments, including payments under our interest rate swaps, of approximately
$36.0 million
during the
six months ended
June 30, 2017
, and expect to pay interest in future periods on outstanding debt obligations based on the rates and terms disclosed herein and in
Note 3
of our accompanying consolidated financial statements.
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(2)
|
Subsequent to June 30, 2017, Piedmont utilized its prepayment option and fully repaid the
$140
Million WDC Fixed-Rate Loans without penalty.
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|
(3)
|
Subsequent to June 30, 2017, Piedmont repaid the entire balance of the
$500 Million
Unsecured 2015 Line of Credit.
|
|
|
(4)
|
Includes the $300 Million Unsecured 2013 Term Loan which has a stated variable rate; however, we have entered into interest rate swap agreements which effectively fix, exclusive of changes to our credit rating, the rate on this facility to
2.78%
through maturity. As such, we estimate incurring, exclusive of changes to our credit rating, approximately $8.3 million per annum in total interest (comprised of combination of variable contractual rate and settlements under interest rate swap agreements) through maturity in January 2019.
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|
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(5)
|
Includes the $300 Million Unsecured 2011 Term Loan which has a stated variable rate; however, we have entered into interest rate swap agreements which effectively fix, exclusive of changes to our credit rating, the rate on this facility to
3.35%
through maturity. As such, we estimate incurring, exclusive of changes to our credit rating, approximately $10.1 million per annum in total interest (comprised of combination of variable contractual rate and settlements under interest rate swap agreements) through maturity in January 2020.
|
|
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(6)
|
Includes the balance outstanding as of
June 30, 2017
of the $500 Million Unsecured 2015 Line of Credit. However, Piedmont may extend the term for up to one additional year (through two available six month extensions to a final extended maturity date of June 18, 2020) provided Piedmont is not then in default and upon payment of extension fees.
|
|
|
(7)
|
The 2001 NW 64th Street building in Ft. Lauderdale, Florida is subject to a ground lease with an expiration date in 2048. The aggregate remaining payments required under the terms of this operating lease as of
June 30, 2017
are presented above.
|
Commitments and Contingencies
We are subject to certain commitments and contingencies with regard to certain transactions. Refer to
Note 8
of our consolidated financial statements for further explanation. Examples of such commitments and contingencies include:
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|
•
|
Commitments Under Existing Lease Agreements; and
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|
|
•
|
Contingencies Related to Tenant Audits/Disputes.
|