XNYS:DREPRO Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2012
OR 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File Number: 1-9044
DUKE REALTY CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
 
Indiana
 
35-1740409
(State or Other Jurisdiction
of Incorporation or Organization)
 
(I.R.S. Employer
Identification Number)
 
 
600 East 96thStreet, Suite 100
Indianapolis, Indiana
 
46240
(Address of Principal Executive Offices)
 
(Zip Code)
Registrant’s Telephone Number, Including Area Code: (317) 808-6000
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.
Yes x    No   ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, 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).
Yes  x    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 definition of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer  x
 
Accelerated filer  o
 
 
Non-accelerated filer  o
 
Smaller reporting company  o
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):    YES  ¨    NO  x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
Class
 
Outstanding at May 4, 2012
Common Stock, $.01 par value per share
 
266,446,952



DUKE REALTY CORPORATION
INDEX
 
 
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2


PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
DUKE REALTY CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except per share amounts)
 
March 31,
2012
 
December 31,
2011
 
(Unaudited)
 
 
 
 
 
 
ASSETS
 
 
 
Real estate investments:
 
 
 
Land and improvements
$
1,209,840

 
$
1,202,872

Buildings and tenant improvements
4,868,066

 
4,766,793

Construction in progress
80,306

 
44,259

Investments in and advances to unconsolidated companies
361,818

 
364,859

Undeveloped land
622,642

 
622,635

 
7,142,672

 
7,001,418

Accumulated depreciation
(1,151,322
)
 
(1,108,650
)
Net real estate investments
5,991,350

 
5,892,768

 
 
 
 
Real estate investments and other assets held-for-sale
19,395

 
55,580

 
 
 
 
Cash and cash equivalents
14,740

 
213,809

Accounts receivable, net of allowance of $2,693 and $3,597
24,045

 
22,255

Straight-line rent receivable, net of allowance of $6,997 and $7,447
111,115

 
105,900

Receivables on construction contracts, including retentions
33,257

 
40,247

Deferred financing costs, net of accumulated amortization of $42,720 and $59,109
39,685

 
42,268

Deferred leasing and other costs, net of accumulated amortization of $311,525 and $292,334
469,936

 
460,881

Escrow deposits and other assets
168,882

 
170,729

 
$
6,872,405

 
$
7,004,437

LIABILITIES AND EQUITY
 
 
 
Indebtedness:
 
 
 
Secured debt
$
1,180,965

 
$
1,173,233

Unsecured notes
2,615,612

 
2,616,063

Unsecured lines of credit
20,293

 
20,293

 
3,816,870

 
3,809,589

 
 
 
 
Liabilities related to real estate investments held-for-sale
643

 
975

 
 
 
 
Construction payables and amounts due subcontractors, including retentions
51,309

 
55,775

Accrued real estate taxes
76,263

 
69,272

Accrued interest
33,675

 
58,904

Other accrued expenses
29,058

 
60,174

Other liabilities
132,734

 
131,735

Tenant security deposits and prepaid rents
46,383

 
38,355

Total liabilities
4,186,935

 
4,224,779

Shareholders’ equity:
 
 
 
Preferred shares ($.01 par value); 5,000 shares authorized; 2,503 and 3,176 shares issued and outstanding
625,638

 
793,910

Common shares ($.01 par value); 400,000 shares authorized; 266,405 and 252,927 shares issued and outstanding
2,664

 
2,529

Additional paid-in capital
3,780,293

 
3,594,588

Accumulated other comprehensive income
1,506

 
987

Distributions in excess of net income
(1,758,467
)
 
(1,677,328
)
Total shareholders’ equity
2,651,634

 
2,714,686

Noncontrolling interests
33,836

 
64,972

Total equity
2,685,470

 
2,779,658

 
$
6,872,405

 
$
7,004,437

See accompanying Notes to Consolidated Financial Statements

3


DUKE REALTY CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations and Comprehensive Income
For the three months ended March 31,
(in thousands, except per share amounts)
(Unaudited)
 
 
Three Months Ended
 
 
2012
 
2011
Revenues:
 
 
 
 
Rental and related revenue
 
$
203,432

 
$
190,986

General contractor and service fee revenue
 
68,968

 
146,547

 
 
272,400

 
337,533

Expenses:
 
 
 
 
Rental expenses
 
37,342

 
40,699

Real estate taxes
 
28,671

 
27,471

General contractor and other services expenses
 
63,921

 
135,664

Depreciation and amortization
 
91,613

 
77,822

 
 
221,547

 
281,656

Other operating activities:
 
 
 
 
Equity in earnings of unconsolidated companies
 
1,509

 
1,073

Gain on sale of properties
 
(277
)
 
67,856

Undeveloped land carrying costs
 
(2,298
)
 
(2,309
)
Other operating expenses
 
(265
)
 
(85
)
General and administrative expenses
 
(11,839
)
 
(11,197
)
 
 
(13,170
)
 
55,338

Operating income
 
37,683

 
111,215

Other income (expenses):
 
 
 
 
Interest and other income, net
 
146

 
87

Interest expense
 
(61,086
)
 
(52,124
)
Acquisition-related activity
 
(580
)
 
(589
)
Income (loss) from continuing operations
 
(23,837
)
 
58,589

Discontinued operations:
 
 
 
 
Loss before gain on sales
 
(749
)
 
(5,403
)
Gain on sale of depreciable properties
 
6,476

 
11,603

Income from discontinued operations
 
5,727

 
6,200

Net income (loss)
 
(18,110
)
 
64,789

Dividends on preferred shares
 
(13,193
)
 
(15,974
)
Adjustments for redemption/repurchase of preferred shares
 
(5,730
)
 
(163
)
Net (income) loss attributable to noncontrolling interests
 
643

 
(1,083
)
Net income (loss) attributable to common shareholders
 
$
(36,390
)
 
$
47,569

Basic net income (loss) per common share:
 
 
 
 
Continuing operations attributable to common shareholders
 
$
(0.16
)
 
$
0.16

Discontinued operations attributable to common shareholders
 
0.02

 
0.03

Total
 
$
(0.14
)
 
$
0.19

Diluted net income (loss) per common share:
 
 
 
 
Continuing operations attributable to common shareholders
 
$
(0.16
)
 
$
0.16

Discontinued operations attributable to common shareholders
 
0.02

 
0.03

Total
 
$
(0.14
)
 
$
0.19

Weighted average number of common shares outstanding
 
258,365

 
252,406

Weighted average number of common shares and potential dilutive securities
 
258,365

 
258,837

 
 
 
 
 
Comprehensive income (loss):
 
 
 
 
Net income (loss)
 
$
(18,110
)
 
$
64,789

Other comprehensive income:
 
 
 
 
Derivative instrument activity
 
519

 
771

Other comprehensive income
 
519

 
771

Comprehensive income (loss)
 
$
(17,591
)
 
$
65,560

See accompanying Notes to Consolidated Financial Statements

4


DUKE REALTY CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the three months ended March 31,
(in thousands)
(Unaudited)
 
2012
 
2011
Cash flows from operating activities:
 
 
 
Net income (loss)
$
(18,110
)
 
$
64,789

Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation of buildings and tenant improvements
63,860

 
67,063

Amortization of deferred leasing and other costs
28,396

 
27,918

Amortization of deferred financing costs
3,246

 
3,644

Straight-line rent adjustment
(5,852
)
 
(6,966
)
Earnings from land and depreciated property sales
(6,199
)
 
(79,459
)
Third-party construction contracts, net
(1,877
)
 
(13,974
)
Other accrued revenues and expenses, net
(43,116
)
 
(42,945
)
Operating distributions received in excess of equity in earnings from unconsolidated companies
4,995

 
7,955

Net cash provided by operating activities
25,343

 
28,025

Cash flows from investing activities:
 
 
 
Development of real estate investments
(29,639
)
 
(37,318
)
Acquisition of real estate investments and related intangible assets
(131,515
)
 
(22,261
)
Acquisition of undeveloped land
(12,180
)
 

Second generation tenant improvements, leasing costs and building improvements
(15,361
)
 
(17,476
)
Other deferred leasing costs
(9,142
)
 
(6,272
)
Other assets
502

 
2,816

Proceeds from land and depreciated property sales, net
63,281

 
437,494

Capital distributions from unconsolidated companies

 
54,730

Capital contributions and advances to unconsolidated companies, net
(3,521
)
 
(6,068
)
Net cash provided by (used for) investing activities
(137,575
)
 
405,645

Cash flows from financing activities:
 
 
 
Proceeds from issuance of common shares, net
146,969

 

Payments for redemption/repurchase of preferred shares
(168,272
)
 
(2,096
)
Payments on unsecured debt
(451
)
 
(42,948
)
Payments on secured indebtedness including principal amortization
(10,455
)
 
(3,897
)
Payments on lines of credit, net

 
(174,717
)
Distributions to common shareholders
(43,922
)
 
(42,892
)
Distributions to preferred shareholders
(9,467
)
 
(15,974
)
Distributions to noncontrolling interests
(1,033
)
 
(1,145
)
Deferred financing costs
(206
)
 
(1,270
)
Net cash used for financing activities
(86,837
)
 
(284,939
)
Net increase (decrease) in cash and cash equivalents
(199,069
)
 
148,731

Cash and cash equivalents at beginning of period
213,809

 
18,384

Cash and cash equivalents at end of period
$
14,740

 
$
167,115

Non-cash investing and financing activities:
 
 
 
Assumption of indebtedness and other liabilities in real estate acquisitions
$
19,626

 
$
85,955

Contribution of properties to unconsolidated companies
$

 
$
52,110

Conversion of Limited Partner Units to common shares
$
29,460

 
$
933

Issuance of Limited Partner Units for acquisition
$

 
$
28,357

Preferred distributions declared but not paid
$
3,726

 
$

See accompanying Notes to Consolidated Financial Statements


5


DUKE REALTY CORPORATION AND SUBSIDIARIES
Consolidated Statement of Changes in Equity
For the three months ended March 31, 2012
(in thousands, except per share data)
(Unaudited)
 
 
Common Shareholders
 
 
 
 
 
Preferred
Stock
 
Common
Stock
 
Additional
Paid-in
Capital
 
Accumulated
Other
Comprehensive
Income
 
Distributions
in Excess of
Net Income
 
Non-
Controlling
Interests
 
Total
Balance at December 31, 2011
$
793,910

 
$
2,529

 
$
3,594,588

 
$
987

 
$
(1,677,328
)
 
$
64,972

 
$
2,779,658

Net loss

 

 

 

 
(17,467
)
 
(643
)
 
(18,110
)
Other comprehensive income

 

 

 
519

 

 

 
519

Issuance of common shares


 
108

 
146,329

 


 

 


 
146,437

Stock based compensation plan activity

 
4

 
4,209

 

 
(827
)
 

 
3,386

Conversion of Limited Partner Units

 
23

 
29,437

 

 

 
(29,460
)
 

Distributions to preferred shareholders

 

 

 

 
(13,193
)
 

 
(13,193
)
Redemption of preferred shares
(168,272
)
 

 
5,730

 

 
(5,730
)
 

 
(168,272
)
Distributions to common shareholders ($0.17 per share)

 

 

 

 
(43,922
)
 

 
(43,922
)
Distributions to noncontrolling interests

 

 

 

 

 
(1,033
)
 
(1,033
)
Balance at March 31, 2012
$
625,638

 
$
2,664

 
$
3,780,293

 
$
1,506

 
$
(1,758,467
)
 
$
33,836

 
$
2,685,470

See accompanying Notes to Consolidated Financial Statements


6


DUKE REALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
1.    General Basis of Presentation
The interim consolidated financial statements included herein have been prepared by Duke Realty Corporation (the “Company”). The 2011 year-end consolidated balance sheet data included in this Quarterly Report on Form 10-Q (this “Report”) was derived from the audited financial statements in our Annual Report on Form 10-K for the year ended December 31, 2011, but does not include all disclosures required by accounting principles generally accepted in the United States of America (“GAAP”). The financial statements have been prepared in accordance with GAAP for interim financial information and in accordance with Rule 10-01 of Regulation S-X of the Securities Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and revenue and expenses during the reporting period. Our actual results could differ from those estimates and assumptions. These financial statements should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations included herein and the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2011.
We believe that we qualify as a real estate investment trust (“REIT”) under the provisions of the Internal Revenue Code of 1986, as amended (the “Code”). Substantially all of our Rental Operations (see Note 9) are conducted through Duke Realty Limited Partnership (“DRLP”). We owned approximately 98.3% of the common partnership interests of DRLP (“Units”) at March 31, 2012. At the option of the holders, and subject to certain restrictions, the remaining Units are redeemable for shares of our common stock on a one-to-one basis and earn dividends at the same rate as shares of our common stock. If it is determined to be necessary in order to continue to qualify as a REIT, we may elect to purchase the Units for an equivalent amount of cash rather than issuing shares of common stock upon redemption. We conduct our Service Operations (see Note 9) through Duke Realty Services, LLC, Duke Realty Services Limited Partnership and Duke Construction Limited Partnership (“DCLP”), which are consolidated entities that are 100% owned by a combination of us and DRLP. DCLP is owned through a taxable REIT subsidiary. The consolidated financial statements include our accounts and the accounts of our majority-owned or controlled subsidiaries. In this Report, unless the context indicates otherwise, the terms “we,” “us” and “our” refer to the Company and those entities owned or controlled by the Company.
 
2.    Reclassifications
Certain amounts in the accompanying consolidated financial statements for 2011 have been reclassified to conform to the 2012 consolidated financial statement presentation.

3.    Variable Interest Entities
At March 31, 2012, there are three unconsolidated joint ventures that we have determined meet the criteria to be considered variable interest entities (“VIEs”). These three unconsolidated joint ventures were formed with the sole purpose of developing, constructing, leasing, marketing and selling or operating properties. The business activities of these unconsolidated joint ventures have been financed through a combination of equity contributions, partner/member loans, and third-party debt that is guaranteed by both us and the other partner/member of each entity. All significant decisions for these unconsolidated joint ventures, including those decisions that most significantly impact each venture’s economic performance, require unanimous approval of each joint venture’s partners or members. In certain cases, these decisions also require lender approval. Unanimous approval requirements for these unconsolidated joint ventures include entering into new leases, setting annual operating budgets, selling underlying properties, and incurring additional indebtedness. Because no single entity exercises control over the decisions that most significantly affect each joint venture’s economic performance, we determined that the equity method of accounting is appropriate.


7



The following is a summary of the carrying value in our consolidated balance sheet, as well as our maximum loss exposure under guarantees for the three unconsolidated subsidiaries that we have determined to be VIEs as of March 31, 2012 (in millions):
 
Carrying Value
Maximum Loss Exposure
Investment in Unconsolidated Companies
$
33.5

$
33.5

Guarantee Obligations (1)
$
(16.6
)
$
(55.9
)
 
(1)
We are party to guarantees of the third-party debt of these joint ventures and our maximum loss exposure is equal to the maximum monetary obligation pursuant to the guarantee agreements. We have recorded a liability for our probable future obligation under a guarantee to the lender of one of these ventures. Pursuant to an agreement with the lender, we may make partner loans to this joint venture that will reduce our maximum guarantee obligation on a dollar-for-dollar basis. The carrying value of our recorded guarantee obligations is included in other liabilities in our Consolidated Balance Sheets.

4.    Acquisitions and Dispositions

2012 Acquisitions
We acquired seven operating properties during the three months ended March 31, 2012. These acquisitions consisted of one industrial property near Chicago, Illinois, two industrial properties in Columbus, Ohio and four medical office properties in various markets. The following table summarizes our allocation of the fair value of amounts recognized for each major class of assets and liabilities (in thousands) for these acquisitions:
 
 
Real estate assets
$
130,615

Lease related intangible assets
22,451

Other assets
2,829

Total acquired assets
155,895

Secured debt
18,741

Other liabilities
885

Total assumed liabilities
19,626

Fair value of acquired net assets
$
136,269


The leases in the acquired properties had a weighted average remaining life at acquisition of approximately 8.7 years.
Fair Value Measurements
The fair value estimates used in allocating the aggregate purchase price of each acquisition among the individual components of real estate assets and liabilities were determined primarily through calculating the “as-if vacant” value of each building, using the income approach, and relied significantly upon internally determined assumptions. As a result, we have, thus, determined these estimates to have been primarily based upon Level 3 inputs, which are unobservable inputs based on our own assumptions. The range of most significant assumptions utilized in making the lease-up and future disposition estimates used in calculating the “as-if vacant” value of each building acquired during the three months ended March 31, 2012 were as follows: 
 
Low

High

Discount rate
7.19
%
8.78
%
Exit capitalization rate
6.09
%
7.40
%
Lease-up period (months)
9

19

Net rental rate per square foot – Industrial
$2.75
$3.59
Net rental rate per square foot – Medical Office
$16.10
$26.14

8


Dispositions
We disposed of income-producing real estate assets and undeveloped land and received net proceeds of $63.3 million and $437.5 million, respectively, during the three months ended March 31, 2012 and 2011.

5.    Indebtedness
The following table summarizes the book value and changes in the fair value of our debt for the three months ended March 31, 2012 (in thousands):
 
Book Value
at 12/31/11
 
Book Value
at 3/31/12
 
Fair Value
at 12/31/11
 
Issuances and
Assumptions
 
Payoffs
 
Adjustments
to Fair Value
 
Fair Value
at 3/31/12
Fixed rate secured debt
$
1,167,188

 
$
1,174,920

 
$
1,256,331

 
$
18,741

 
$
(11,009
)
 
$
(840
)
 
$
1,263,223

Variable rate secured debt
6,045

 
6,045

 
6,045

 

 

 

 
6,045

Unsecured notes
2,616,063

 
2,615,612

 
2,834,610

 

 
(451
)
 
59,227

 
2,893,386

Unsecured lines of credit
20,293

 
20,293

 
20,244

 

 

 
4

 
20,248

Total
$
3,809,589

 
$
3,816,870

 
$
4,117,230

 
$
18,741

 
$
(11,460
)
 
$
58,391

 
$
4,182,902


Fixed Rate Secured Debt
Because our fixed rate secured debt is not actively traded in any marketplace, we utilized a discounted cash flow methodology to determine its fair value. Accordingly, we calculated fair value by applying an estimate of the current market rate to discount the debt’s remaining contractual cash flows. Our estimate of a current market rate, which is the most significant input in the discounted cash flow calculation, is intended to replicate debt of similar maturity and loan-to-value relationship. The estimated rates ranged from 3.50% to 5.40%, depending on the attributes of the specific loans. The current market rates we utilized were internally estimated; therefore, we have concluded that our determination of fair value for our fixed rate secured debt was primarily based upon Level 3 inputs.
We assumed one secured loan in conjunction with our acquisition activity in 2012. This assumed loan had a total face value of $18.1 million and fair value of $18.7 million. This assumed loan carries a stated interest rate of 5.14% and a remaining term upon acquisition of 2.2 years. We used an estimated market rate of 3.50% in determining the fair value of this loan.
Unsecured Notes
All but $21.0 million of our unsecured notes bear interest at fixed rates. We utilized broker estimates in estimating the fair value of our fixed rate unsecured debt. Our unsecured notes are thinly traded and, in certain cases, the broker estimates were not based upon comparable transactions. The broker estimates took into account any recent trades within the same series of our fixed rate unsecured debt, comparisons to recent trades of other series of our fixed rate unsecured debt, trades of fixed rate unsecured debt from companies with profiles similar to ours, as well as overall economic conditions. We reviewed these broker estimates for reasonableness and accuracy, considering whether the estimates were based upon market participant assumptions within the principal and most advantageous market and whether any other observable inputs would be more accurate indicators of fair value than the broker estimates. We concluded that the broker estimates were representative of fair value. We have determined that our estimation of the fair value of our fixed rate unsecured debt was primarily based upon Level 3 inputs, as defined. The estimated trading values of our fixed rate unsecured debt, depending on the maturity and coupon rates, ranged from 102.00% to 124.00% of face value.
The indentures (and related supplemental indentures) governing our outstanding series of notes also require us to comply with financial ratios and other covenants regarding our operations. We were in compliance with all such covenants as of March 31, 2012.
Unsecured Lines of Credit
Our unsecured lines of credit as of March 31, 2012 are described as follows (in thousands):

9


Description
Maximum
Capacity
 
Maturity Date
 
Outstanding
Balance at
March 31, 2012
Unsecured Line of Credit - DRLP
$
850,000

 
December 2015
 
$

Unsecured Line of Credit - Consolidated Subsidiary
$
30,000

 
July 2012
 
$
20,293


The DRLP unsecured line of credit has an interest rate on borrowings of LIBOR plus 1.25%, and a maturity date of December 2015. Subject to certain conditions, the terms also include an option to increase the facility by up to an additional $400.0 million, for a total of up to $1.25 billion.
This line of credit provides us with an option to obtain borrowings from financial institutions that participate in the line at rates that may be lower than the stated interest rate, subject to certain restrictions.
This line of credit contains financial covenants that require us to meet certain financial ratios and defined levels of performance, including those related to fixed charge coverage, unsecured interest expense coverage and debt-to-asset value (with asset value being defined in the DRLP unsecured line of credit agreement). As of March 31, 2012, we were in compliance with all covenants under this line of credit.
The consolidated subsidiary’s unsecured line of credit allows for borrowings up to $30.0 million at a rate of LIBOR plus 0.85% (equal to 1.09% for outstanding borrowings as of March 31, 2012). This unsecured line of credit is used to fund development activities within the consolidated subsidiary and matures in July 2012.
To the extent that there are outstanding borrowings, we utilize a discounted cash flow methodology in order to estimate the fair value of our unsecured lines of credit. The net present value of the difference between future contractual interest payments and future interest payments based on our estimate of a current market rate represents the difference between the book value and the fair value. Our estimate of a current market rate is based upon the rate, considering current market conditions and our specific credit profile, at which we estimate we could obtain similar borrowings. The current market rate of 1.74% that we utilized was internally estimated; therefore, we have concluded that our determination of fair value for our consolidated subsidiary's unsecured line of credit was primarily based upon a Level 3 input.

6.    Shareholders' Equity
In March 2012, we redeemed all of the outstanding shares of our 6.95% Series M Cumulative Redeemable Preferred Shares at a liquidation amount of $168.3 million. Original offering costs of $5.7 million were included as a reduction to net loss attributable to common shareholders in conjunction with the redemption of these shares.
In the first three months of 2012, we issued 10.8 million shares of common stock pursuant to our at the market offering, generating net proceeds of approximately $147.0 million. We paid $3.0 million in commissions related to the sale of these common shares. The proceeds from this offering were contributed to DRLP in exchange for additional Units in DRLP and were used for acquisitions, general corporate purposes and redemption of preferred shares and fixed rate secured debt.
7.    Related Party Transactions
We provide property management, asset management, leasing, construction and other tenant related services to unconsolidated companies in which we have equity interests. We recorded the corresponding fees based on contractual terms that approximate market rates for these types of services and we have eliminated our ownership percentage of these fees in the consolidated financial statements. The following table summarizes the fees earned from these companies for the three months ended March 31, 2012 and 2011, respectively (in thousands): 
                                         

10


 
Three Months Ended March 31,
 
2012
 
2011
Management fees
$
2,731

 
$
1,977

Leasing fees
1,294

 
1,804

Construction and development fees
843

 
1,581


8.    Net Income (Loss) Per Common Share
Basic net income (loss) per common share is computed by dividing net income (loss) attributable to common shareholders, less dividends on share-based awards expected to vest (referred to as “participating securities” and primarily composed of unvested restricted stock units), by the weighted average number of common shares outstanding for the period. Diluted net income (loss) per common share is computed by dividing the sum of basic net income (loss) attributable to common shareholders and the noncontrolling interest in earnings allocable to Units not owned by us (to the extent the Units are dilutive) by the sum of the weighted average number of common shares outstanding and, to the extent they are dilutive, Units outstanding, as well as any potential dilutive securities for the period.
The following table reconciles the components of basic and diluted net income (loss) per common share for the three months ended March 31, 2012 and 2011, respectively (in thousands): 
    
 
Three Months Ended March 31,
 
2012
 
2011
Net income (loss) attributable to common shareholders
$
(36,390
)
 
$
47,569

Less: Dividends on participating securities
(852
)
 
(799
)
Basic net income (loss) attributable to common shareholders
(37,242
)
 
46,770

Noncontrolling interest in earnings of common unitholders

 
1,205

Diluted net income (loss) attributable to common shareholders
$
(37,242
)
 
$
47,975

Weighted average number of common shares outstanding
258,365

 
252,406

Weighted average partnership Units outstanding

 
6,384

Other potential dilutive shares

 
47

Weighted average number of common shares and potential dilutive securities
258,365

 
258,837


The partnership Units are anti-dilutive for the three months ended March 31, 2012 as a result of the net loss for this period. In addition, substantially all potential shares related to our stock-based compensation plans were anti-dilutive for both periods presented and potential shares related to our 3.75% Exchangeable Senior Notes (“Exchangeable Notes”), which were repaid in December 2011, were anti-dilutive for the three months ended March 31, 2011. The following table summarizes the data that is excluded from the computation of net income (loss) per common share as a result of being anti-dilutive (in thousands): 
 
Three Months Ended March 31,
 
2012
 
2011
Noncontrolling interest in earnings of common unitholders
$
(811
)
 
$

Weighted average partnership Units outstanding
5,749

 

Other potential dilutive shares:
 
 
 
Anti-dilutive outstanding potential shares under fixed stock option and other stock-based compensation plans
1,733

 
1,711

Anti-dilutive potential shares under the Exchangeable Notes

 
3,432

Outstanding participating securities
5,051

 
4,752



11


9.    Segment Reporting
We have four reportable operating segments at March 31, 2012, the first three of which consist of the ownership and rental of (i) industrial, (ii) office and (iii) medical office real estate investments. The operations of our industrial, office and medical office properties, along with our retail properties, are collectively referred to as “Rental Operations.” Our retail properties, as well as any other properties not included in our reportable segments, do not by themselves meet the quantitative thresholds for separate presentation as a reportable segment. The fourth reportable segment consists of various real estate services such as property management, asset management, maintenance, leasing, development and construction management to third-party property owners and joint ventures, and is collectively referred to as “Service Operations.” Our reportable segments offer different products or services and are managed separately because each segment requires different operating strategies and management expertise.
As of March 31, 2012, one of the quantitative thresholds was triggered, which required our medical office property operating segment to be presented as a separate reportable segment. As such, our medical office properties are presented as a separate reportable segment for the three-month period ended March 31, 2012 as well as for the comparative prior period.
Other revenue consists of other operating revenues not identified with one of our operating segments. Interest expense and other non-property specific revenues and expenses are not allocated to individual segments in determining our performance measure.
We assess and measure our overall operating results based upon an industry performance measure referred to as Funds From Operations (“FFO”), which management believes is a useful indicator of our consolidated operating performance. FFO is used by industry analysts and investors as a supplemental operating performance measure of a REIT. The National Association of Real Estate Investment Trusts (“NAREIT”) created FFO as a supplemental measure of REIT operating performance that excludes historical cost depreciation, among other items, from net income determined in accordance with GAAP. FFO is a non-GAAP financial measure. The most comparable GAAP measure is net income (loss) attributable to common shareholders. FFO attributable to common shareholders should not be considered as a substitute for net income (loss) attributable to common shareholders or any other measures derived in accordance with GAAP and may not be comparable to other similarly titled measures of other companies. FFO is calculated in accordance with the definition that was adopted by the Board of Governors of NAREIT. We do not allocate certain income and expenses (“Non-Segment Items”, as shown in the table below) to our operating segments. Thus, the operational performance measure presented here on a segment-level basis represents net earnings, excluding depreciation expense and the Non-Segment Items not allocated, and is not meant to present FFO as defined by NAREIT.
Historical cost 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 instead have historically risen or fallen with market conditions, many industry analysts and investors have considered presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves. FFO, as defined by NAREIT, represents GAAP net income (loss), excluding extraordinary items as defined under GAAP and gains or losses from sales of previously depreciated real estate assets, impairment charges related to depreciable real estate assets, plus certain non-cash items such as real estate asset depreciation and amortization, and after similar adjustments for unconsolidated partnerships and joint ventures.
Management believes that the use of FFO attributable to common shareholders, combined with net income (which remains the primary measure of performance), improves the understanding of operating results of REITs among the investing public and makes comparisons of REIT operating results more meaningful. Management believes that excluding gains or losses related to sales of previously depreciated real estate assets, impairment charges related to depreciable real estate assets and real estate asset depreciation and amortization enables investors and analysts to readily identify the operating results of the long-term assets that form the core of a REIT’s activity and assist them in comparing these operating results between periods or between different companies.



12


The following table shows (i) the revenues for each of the reportable segments and (ii) a reconciliation of FFO attributable to common shareholders to net income (loss) attributable to common shareholders for the three months ended March 31, 2012 and 2011, respectively (in thousands): 
 
 
Three Months Ended March 31,
 
 
2012
 
2011
Revenues
 
 
 
 
Rental Operations:
 
 
 
 
Industrial
 
$
108,487

 
$
94,262

Office
 
67,417

 
75,602

Medical Office
 
20,741

 
13,484

Non-reportable Rental Operations
 
5,658

 
5,655

General contractor and service fee revenue (“Service Operations”)
 
68,968

 
146,547

Total Segment Revenues
 
271,271

 
335,550

Other Revenue
 
1,129

 
1,983

Consolidated Revenue from continuing operations
 
272,400

 
337,533

Discontinued Operations
 
1,234

 
52,170

Consolidated Revenue
 
$
273,634

 
$
389,703

Reconciliation of Funds From Operations
 
 
 
 
Net earnings excluding depreciation and Non-Segment Items
 
 
 
 
Industrial
 
$
79,902

 
$
66,726

Office
 
39,490

 
43,100

Medical Office
 
13,667

 
7,802

Non-reportable Rental Operations
 
4,008

 
4,207

Service Operations
 
5,047

 
10,883

 
 
142,114

 
132,718

Non-Segment Items:
 
 
 
 
Interest expense
 
(61,086
)
 
(52,124
)
Interest and other income
 
146

 
87

Other operating expenses
 
(265
)
 
(85
)
General and administrative expenses
 
(11,839
)
 
(11,197
)
Undeveloped land carrying costs
 
(2,298
)
 
(2,309
)
Acquisition-related activity
 
(580
)
 
(589
)
Other non-segment income
 
352

 
981

Net (income) loss attributable to noncontrolling interests
 
643

 
(1,083
)
Noncontrolling interest share of FFO adjustments
 
(2,060
)
 
(569
)
Joint venture items
 
10,095

 
8,610

Dividends on preferred shares
 
(13,193
)
 
(15,974
)
Adjustments for redemption/repurchase of preferred shares
 
(5,730
)
 
(163
)
Discontinued operations
 
(106
)
 
11,756

FFO attributable to common shareholders
 
56,193

 
70,059

Depreciation and amortization on continuing operations
 
(91,613
)
 
(77,822
)
Depreciation and amortization on discontinued operations
 
(643
)
 
(17,159
)
Company’s share of joint venture adjustments
 
(8,586
)
 
(7,628
)
Earnings from depreciated property sales on continuing operations
 
(277
)
 
67,856

Earnings from depreciated property sales on discontinued operations
 
6,476

 
11,603

Earnings from depreciated property sales—share of joint venture
 

 
91

Noncontrolling interest share of FFO adjustments
 
2,060

 
569

Net income (loss) attributable to common shareholders
 
$
(36,390
)
 
$
47,569


13


The assets for each of the reportable segments as of March 31, 2012 and December 31, 2011 are as follows (in thousands): 
 
March 31,
2012
 
December 31,
2011
Assets
 
 
 
Rental Operations:
 
 
 
Industrial
$
3,634,930

 
$
3,586,250

Office
1,683,691

 
1,742,196

Medical Office
674,298

 
580,177

Non-reportable Rental Operations
202,139

 
209,056

Service Operations
162,468

 
167,382

Total Segment Assets
6,357,526

 
6,285,061

Non-Segment Assets
514,879

 
719,376

Consolidated Assets
$
6,872,405

 
$
7,004,437


10.    Discontinued Operations and Assets Held for Sale
The following table illustrates the number of properties in discontinued operations:
 
 
Held for Sale at March 31, 2012
 
Sold in 2012
 
Sold in 2011
 
Total
 
 
 
 
 
 
 
 
Office
0
 
7
 
93
 
100
Industrial
2
 
6
 
7
 
15
Retail
1
 
0
 
1
 
2
 
3
 
13
 
101
 
117
We allocate interest expense to discontinued operations and have included such interest expense in computing income from discontinued operations. Interest expense allocable to discontinued operations includes interest on any secured debt for properties included in discontinued operations and an allocable share of our consolidated unsecured interest expense for unencumbered properties. The allocation of unsecured interest expense to discontinued operations was based upon the gross book value of the unencumbered real estate assets included in discontinued operations as it related to the total gross book value of our unencumbered real estate assets.
The following table illustrates the operations of the buildings reflected in discontinued operations for the three months ended March 31, 2012 and 2011, respectively (in thousands): 
 
Three Months Ended March 31,
 
2012
 
2011
Revenues
$
1,234

 
$
52,170

Operating expenses
(815
)
 
(25,273
)
Depreciation and amortization
(643
)
 
(17,159
)
Operating income (loss)
(224
)
 
9,738

Interest expense
(525
)
 
(15,141
)
Loss before gain on sales
(749
)
 
(5,403
)
Gain on sale of depreciable properties
6,476

 
11,603

Income from discontinued operations
$
5,727

 
$
6,200




14


Dividends on preferred shares and adjustments for the redemption or repurchase of preferred shares are allocated entirely to continuing operations. The following table illustrates the allocation of the income (loss) attributable to common shareholders between continuing operations and discontinued operations, reflecting an allocation of income or loss attributable to noncontrolling interests between continuing and discontinued operations, for the three months ended March 31, 2012 and 2011, respectively (in thousands):
 
 
Three Months Ended March 31,
 
 
2012
 
2011
Income (loss) from continuing operations attributable to common shareholders
 
$
(41,992
)
 
$
41,522

Income from discontinued operations attributable to common shareholders
 
5,602

 
6,047

Net income (loss) attributable to common shareholders
 
$
(36,390
)
 
$
47,569


At March 31, 2012, we classified three in-service properties as held-for-sale, which were included in discontinued operations, due to our present intention to sell the properties in the second quarter. The following table illustrates aggregate balance sheet information of the aforementioned three properties included in discontinued operations at March 31, 2012 (in thousands):
 
 
Real estate investment, net
$
18,159

Other assets
1,236

    Total assets held-for-sale
$
19,395

 
 
Accrued expenses
$
434

Other liabilities
209

    Total liabilities held-for-sale
$
643


11.    Subsequent Events
Declaration of Dividends
Our board of directors declared the following dividends at its regularly scheduled board meeting held on April 25, 2012:
 
Class
Quarterly
Amount/Share
 
Record Date
 
Payment Date
Common
$0.17
 
May 16, 2012
 
May 31, 2012
Preferred (per depositary share):

 

 

Series J
$0.414063
 
May 16, 2012
 
May 31, 2012
Series K
$0.406250
 
May 16, 2012
 
May 31, 2012
Series L
$0.412500
 
May 16, 2012
 
May 31, 2012
Series O
$0.523437
 
June 15, 2012
 
July 2, 2012

 

15


Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to help the reader understand our operations and our present business environment. Management’s Discussion and Analysis is provided as a supplement to and should be read in conjunction with our consolidated financial statements and the notes thereto, contained in Part I, Item I of this Quarterly Report on Form 10-Q (this “Report”) and the consolidated financial statements and notes thereto, contained in Part IV, Item 15 of our Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the Securities and Exchange Commission (the “SEC”) on February 24, 2012. As used herein, the terms “we”, “us” and “our” refer to Duke Realty Corporation (the “Company”) and those entities owned or controlled by the Company.
Cautionary Notice Regarding Forward-Looking Statements
Certain statements contained in or incorporated by reference into this Report including, without limitation, those related to our future operations, 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. The words “believe,” “estimate,” “expect,” “anticipate,” “intend,” “plan,” “seek,” “may,” and similar expressions or statements regarding future periods are intended to identify forward-looking statements.
These forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause our actual results, performance or achievements, or industry results, to differ materially from any predictions of future results, performance or achievements that we express or imply in this Report. Some of the risks, uncertainties and other important factors that may affect future results include, among others:
Changes in general economic and business conditions, including the financial condition of our tenants and the value of our real estate assets;
Our continued qualification as a real estate investment trust (“REIT”) for U.S. federal income tax purposes;
Heightened competition for tenants and potential decreases in property occupancy;
Potential changes in the financial markets and interest rates;
Volatility in our stock price and trading volume;
Our continuing ability to raise funds on favorable terms;
Our ability to successfully identify, acquire, develop and/or manage properties on terms that are favorable to us;
Potential increases in real estate construction costs;
Our ability to successfully dispose of properties on terms that are favorable to us, including, without limitation, through one or more transactions that are consistent with our previously disclosed strategic plans;
Our ability to retain our current credit ratings;
Inherent risks in the real estate business, including, but not limited to, tenant defaults, potential liability relating to environmental matters, climate change and liquidity of real estate investments; and
Other risks and uncertainties described herein, as well as those risks and uncertainties discussed from time to time in our other reports and other public filings with the SEC.
Although we presently believe that the plans, expectations and results expressed in or suggested by the forward-looking statements are reasonable, all forward-looking statements are inherently subjective, uncertain and subject to change, as they involve substantial risks and uncertainties beyond our control. New factors emerge from time to time, and it is not possible for us to predict the nature, or assess the potential impact, of each new factor on our business. Given these uncertainties, we caution you not to place undue reliance on these forward-looking statements. We undertake no obligation to update or revise any of our forward-looking statements for events or circumstances that arise after the statement is made, except as otherwise may be required by law.
This list of risks and uncertainties, however, is only a summary of some of the most important factors and is not intended to be exhaustive. Additional information regarding risk factors that may affect us is included under the caption “Risk Factors” in Part II, Item 1A of this Report, and in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, which we filed with the SEC on February 24, 2012. The risk factors contained in our Annual Report are updated by us from time to time in Quarterly Reports on Form 10-Q and other public filings. 

16


Business Overview
We are a self-administered and self-managed REIT that began operations through a related entity in 1972. A more complete description of our business, and of management’s philosophy and priorities, is included in our 2011 Annual Report on Form 10-K.
As of March 31, 2012, we:
Owned or jointly controlled 747 industrial, office, medical office and other properties, of which 738 properties with more than 136.5 million square feet are in service and nine properties with more than 2.4 million square feet are under development. The 738 in-service properties are comprised of 612 consolidated properties with more than 111.2 million square feet and 126 jointly controlled unconsolidated properties with approximately 25.3 million square feet. The nine properties under development consist of seven consolidated properties with approximately 1.8 million square feet and two jointly controlled unconsolidated properties with approximately 650,000 square feet.
Owned, including through ownership interests in unconsolidated joint ventures, more than 4,800 acres of land and controlled more than 1,600 acres through purchase options.
A key component of our overall strategy is to increase our investment in quality industrial properties in both existing and select new markets, expand our medical office portfolio nationally to take advantage of demographic trends and to reduce our investment in suburban office properties and other non-strategic assets.
We have four reportable operating segments at March 31, 2012, the first three of which consist of the ownership and rental of (i) industrial, (ii) office and (iii) medical office real estate investments. The operations of our industrial, office and medical office properties, along with our retail properties, are collectively referred to as “Rental Operations.” Our retail properties, as well as any other properties not included in our reportable segments, do not by themselves meet the quantitative thresholds for separate presentation as a reportable segment. The fourth reportable segment consists of various real estate services such as property management, asset management, maintenance, leasing, development and construction management to third-party property owners and joint ventures, and is collectively referred to as “Service Operations.” Our reportable segments offer different products or services and are managed separately because each segment requires different operating strategies and management expertise.
As of March 31, 2012, one of the quantitative thresholds was triggered, which required our medical office property operating segment to be presented as a separate reportable segment. As such, our medical office properties are presented as a separate reportable segment for the three-month period ended March 31, 2012 as well as for the comparative prior period.

Key Performance Indicators
Our operating results depend primarily upon rental income from our Rental Operations. The following discussion highlights the areas of Rental Operations that we consider critical for future revenues.
Occupancy Analysis
Our ability to maintain high occupancy rates is a principal driver of maintaining and increasing rental revenue. The following table sets forth occupancy information regarding our in-service portfolio of consolidated rental properties, including properties classified within both continuing and discontinued operations, as of March 31, 2012 and 2011 respectively (in thousands, except percentage data):
 

17


 
Total Square Feet
 
Percent of
Total Square Feet
 
Percent Occupied
Type
2012
 
2011
 
2012
 
2011
 
2012
 
2011
Industrial
91,551

 
82,252

 
82.3
%
 
73.8
%
 
93.7
%
 
89.8
%
Office
15,767

 
26,295

 
14.2
%
 
23.6
%
 
83.8
%
 
84.6
%
Medical Office
3,076

 
2,069

 
2.8
%
 
1.9
%
 
90.2
%
 
86.4
%
Other
823

 
847

 
0.7
%
 
0.7
%
 
89.2
%
 
87.6
%
Total
111,217

 
111,463

 
100.0
%
 
100.0
%
 
92.1
%
 
88.5
%
Leasing activity and acquisitions within our industrial properties, coupled with significant dispositions of office properties, drove the overall increase in occupancy from March 31, 2011.
Lease Expiration and Renewals
Our ability to maintain and improve occupancy rates primarily depends upon our continuing ability to re-lease expiring space. The following table reflects our consolidated in-service portfolio lease expiration schedule by property type as of March 31, 2012. The table indicates square footage and annualized net effective rents (based on March 31, 2012 rental revenue) under expiring leases (in thousands, except percentage data):
 
Total Consolidated Portfolio
 
Industrial
 
Office
 
Medical Office
 
Other
Year of
Expiration
Square
Feet
 
Ann. Rent
Revenue
 
% of
Revenue
 
Square
Feet
 
Ann. Rent
Revenue
 
Square
Feet
 
Ann. Rent
Revenue
 
Square
Feet
 
Ann.  Rent Revenue
 
Square
Feet
 
Ann.  Rent Revenue
Remainder of 2012
4,860

 
$
27,976

 
5
%
 
3,835

 
$
15,827

 
960

 
$
11,151

 
54

 
$
766

 
11

 
$
232

2013
15,335

 
78,465

 
14
%
 
13,480

 
52,446

 
1,780

 
24,754

 
42

 
599

 
33

 
666

2014
12,235

 
64,652

 
11
%
 
10,478

 
40,653

 
1,590

 
21,178

 
146

 
2,416

 
21

 
405

2015
12,967

 
65,812

 
11
%
 
11,176

 
43,411

 
1,740

 
21,384

 
27

 
461

 
24

 
556

2016
11,086

 
58,369

 
10
%
 
9,318

 
34,669

 
1,666

 
21,616

 
81

 
1,592

 
21

 
492

2017
10,676

 
58,835

 
10
%
 
8,984

 
33,555

 
1,274

 
16,718

 
233

 
4,471

 
185

 
4,091

2018
6,939

 
51,553

 
9
%
 
4,974

 
19,740

 
1,397

 
18,878

 
366

 
7,634

 
202

 
5,301

2019
5,925

 
37,127

 
6
%
 
4,679

 
17,467

 
976

 
13,050

 
192

 
4,196

 
78

 
2,414

2020
7,016

 
41,865

 
7
%
 
5,936

 
23,230

 
681

 
10,525

 
359

 
7,239

 
40

 
871

2021
5,627

 
34,248

 
6
%
 
4,686

 
18,785

 
586

 
7,009

 
325

 
7,747

 
30

 
707

2022 and Thereafter
9,811

 
60,055

 
11
%
 
8,220

 
28,173

 
554

 
8,960

 
948

 
21,320

 
89

 
1,602

Total Leased
102,477

 
$
578,957

 
100
%
 
85,766

 
$
327,956

 
13,204

 
$
175,223

 
2,773

 
$
58,441

 
734

 
$
17,337

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total Portfolio Square Feet
111,217

 
 
 
 
 
91,551

 
 
 
15,767

 
 
 
3,076

 
 
 
823

 
 
Percent Occupied
92.1
%
 
 
 
 
 
93.7
%
 
 
 
83.8
%
 
 
 
90.2
%
 
 
 
89.2
%
 
 
Within our consolidated properties, we renewed 83.1% and 69.2% of our leases up for renewal in the three months ended March 31, 2012 and 2011, respectively, totaling more than 2.7 million and approximately 2.9 million square feet, respectively. There was a 2.5% increase in average contractual rents on renewals during the three months ended March 31, 2012 compared to a 7.3% decline in average contractual rents on renewals during the three months ended March 31, 2011.
The average term of renewals was 4.4 years for the three months ended March 31, 2011 compared to 4.6 years for the three months ended March 31, 2012.


18


Acquisition and Disposition Activity
For the three months ended March 31, 2012, we acquired seven properties and other real estate-related assets with a total acquisition-date value of $153.1 million. For the three months ended March 31, 2011, we acquired 13 properties for $132.2 million, which represented continued activity in our acquisition of a portfolio of buildings in South Florida (the “Premier Portfolio”), of which the initial 39 properties were acquired on December 30, 2010.
Net cash proceeds related to the dispositions of wholly owned buildings and undeveloped land totaled $63.3 million and $437.5 million for the three months ended March 31, 2012 and 2011, respectively. Included in the wholly owned building dispositions in the three months ended March 31, 2011 is the sale of 13 suburban office properties for net proceeds of $273.7 million, totaling approximately 2.0 million square feet, to a joint venture in which we own 20%.
We regularly work to identify, consider and pursue opportunities to acquire and dispose of properties on an opportunistic basis and on a basis that is generally consistent with our strategic plans.
Development
At March 31, 2012, we had 2.4 million square feet of property under development with total estimated costs upon completion of $349.0 million compared to 3.4 million square feet with total costs upon completion of $181.0 million at March 31, 2011. We have continued to limit our development projects to build-to-suit or substantially pre-leased properties and select medical office developments. The square footage and estimated costs include both consolidated and joint venture development activity at 100%.
The following table summarizes our properties under development as of March 31, 2012 (in thousands, except percentage data): 
Ownership Type
Square
Feet
 
Percent
Leased
 
Total
Estimated
Project
Costs

 
Total
Incurred
to Date

 
Amount
Remaining
to be Spent

Consolidated properties
1,772

 
95%
 
$
245,237

 
$
73,622

 
$
171,615

Joint venture properties
650

 
100%
 
103,803

 
13,833

 
89,970

Total
2,422

 
96%
 
$
349,040

 
$
87,455

 
$
261,585


Funds From Operations
Funds From Operations (“FFO”) is used by industry analysts and investors as a supplemental operating performance measure of a REIT. The National Association of Real Estate Investment Trusts (“NAREIT”) created FFO as a supplemental measure of REIT operating performance that excludes historical cost depreciation, among other items, from net income determined in accordance with accounting principles generally accepted in the United States of America (“GAAP”). FFO is a non-GAAP financial measure. The most comparable GAAP measure is net income (loss) attributable to common shareholders. FFO attributable to common shareholders should not be considered as a substitute for net income (loss) attributable to common shareholders or any other measures derived in accordance with GAAP and may not be comparable to other similarly titled measures of other companies. FFO is calculated in accordance with the definition that was adopted by the Board of Governors of NAREIT.
Historical cost 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 instead have historically risen or fallen with market conditions, many industry analysts and investors have considered presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves. FFO, as defined by NAREIT, represents GAAP net income (loss), excluding extraordinary items as defined under GAAP and gains or losses from sales of previously depreciated real estate assets, impairment charges related to depreciable real estate assets, plus certain non-cash items such as real estate asset depreciation and amortization, and after similar adjustments for unconsolidated partnerships and joint ventures.

19


Management believes that the use of FFO attributable to common shareholders, combined with net income (which remains the primary measure of performance), improves the understanding of operating results of REITs among the investing public and makes comparisons of REIT operating results more meaningful. Management believes that excluding gains or losses related to sales of previously depreciated real estate assets, impairment charges related to depreciable real estate assets and real estate asset depreciation and amortization enables investors and analysts to readily identify the operating results of the long-term assets that form the core of a REIT’s activity and assist them in comparing these operating results between periods or between different companies.
The following table shows a reconciliation of net income (loss) attributable to common shareholders to the calculation of FFO attributable to common shareholders for the three months ended March 31, 2012 and 2011, respectively (in thousands):
 
 
Three Months Ended March 31,
 
2012
 
2011
Net income (loss) attributable to common shareholders
$
(36,390
)
 
$
47,569

Adjustments:
 
 
 
Depreciation and amortization
92,256

 
94,981

Company share of joint venture depreciation and amortization
8,586

 
7,628

Earnings from depreciable property sales—wholly owned
(6,199
)
 
(79,459
)
Earnings from depreciable property sales—share of joint venture

 
(91
)
Noncontrolling interest share of adjustments
(2,060
)
 
(569
)
Funds From Operations attributable to common shareholders
$
56,193

 
$
70,059


Results of Operations
A summary of our operating results and property statistics for the three months ended March 31, 2012 and 2011, respectively, is as follows (in thousands, except number of properties and per share data):
 
Three Months Ended March 31,
 
2012
 
2011
Rental and related revenue
$
203,432

 
$
190,986

General contractor and service fee revenue
68,968

 
146,547

Operating income
37,683

 
111,215

Net income (loss) attributable to common shareholders
(36,390
)
 
47,569

Weighted average common shares outstanding
258,365

 
252,406

Weighted average common shares and potential dilutive securities
258,365

 
258,837

Basic income (loss) per common share:
 
 
 
Continuing operations
$
(0.16
)
 
$
0.16

Discontinued operations
$
0.02

 
$
0.03

Diluted income (loss) per common share:
 
 
 
Continuing operations
$
(0.16
)
 
$
0.16

Discontinued operations
$
0.02

 
$
0.03

Number of in-service consolidated properties at end of period
612

 
658

In-service consolidated square footage at end of period
111,217

 
111,463

Number of in-service joint venture properties at end of period
126

 
128

In-service joint venture square footage at end of period
25,294

 
25,166





20


Comparison of Three Months Ended March 31, 2012 to Three Months Ended March 31, 2011
Rental and Related Revenue
The following table sets forth rental and related revenue from continuing operations by reportable segment for the three months ended March 31, 2012 and 2011, respectively (in thousands): 
 
Three Months Ended March 31,
 
2012
 
2011
Rental and Related Revenue:
 
 
 
Industrial
$
108,487

 
$
94,262

Office
67,417

 
75,602

Medical Office
20,741

 
13,484

Non-reportable segments
6,787

 
7,638

Total Rental and Related Revenue from Continuing Operations
$
203,432

 
$
190,986

The following factors contributed to these results:
We acquired 64 properties, of which 43 were industrial, and placed six developments in service from January 1, 2011 to March 31, 2012, which provided incremental revenues of $19.2 million in the first quarter of 2012, as compared to the same period in 2011.
We sold 13 office properties to an unconsolidated joint venture in late March 2011, resulting in a $10.0 million decrease in rental and related revenue from continuing operations in the three months ended March 31, 2012.
The remaining increase in rental and related revenues is primarily due to improved results within the properties that have been in service for all of 2011 and the first quarter of 2012. Improved occupancy, coupled with slight increases in renewal rates, drove the overall improvement within these properties.
The overall shift of revenues and income from office properties to industrial properties is consistent with our continuing strategy to increase our asset concentration in industrial properties while reducing our overall investment in office properties.
Rental Expenses and Real Estate Taxes
The following table sets forth rental expenses and real estate taxes by reportable segment for the three months ended March 31, 2012 and 2011, respectively (in thousands):
 
Three Months Ended March 31,
 
2012
 
2011
Rental Expenses:
 
 
 
Industrial
$
11,480

 
$
12,481

Office
19,375

 
22,215

Medical Office
5,042

 
4,358

Non-reportable segments
1,445

 
1,645

Total Rental Expenses from Continuing Operations
$
37,342

 
$
40,699

Real Estate Taxes:
 
 
 
Industrial
$
17,105

 
$
15,055

Office
8,552

 
10,287

Medical Office
2,032

 
1,324

Non-reportable segments
982

 
805

Total Real Estate Tax Expense from Continuing Operations
$
28,671

 
$
27,471




21


We sold 13 office properties to an unconsolidated joint venture in late March 2011, which resulted in a $2.7 million decrease in rental expenses in the first quarter of 2012 as compared to the same period in 2011. Partially offsetting the impact of this sale of properties to an unconsolidated joint venture was an increase to rental expenses of $2.0 million associated with the additional 64 properties acquired (of which 43 were industrial) and six developments placed in service since January 1, 2011. The remaining decrease in rental expenses was primarily attributable to a reduction in snow removal costs, which was a result of the mild winter our markets experienced in the first quarter of 2012.
We recognized incremental real estate tax expense of $2.6 million associated with the additional 64 properties acquired and six developments placed in service since January 1, 2011. This increase was partially offset by a decrease of $1.6 million related to the 13 properties that were sold to a joint venture during the first quarter of 2011.
Service Operations
The following table sets forth the components of the Service Operations reportable segment for the three months ended March 31, 2012 and 2011, respectively (in thousands):
 
 
Three Months Ended March 31,
 
2012
 
2011
Service Operations:
 
 
 
General contractor and service fee revenue
$
68,968

 
$
146,547

General contractor and other services expenses
(63,921
)
 
(135,664
)
Total
$
5,047

 
$
10,883


Service Operations primarily consist of the leasing, property management, asset management, development, construction management and general contractor services for joint venture properties and properties owned by third parties. Service Operations are heavily influenced by the current state of the economy, as leasing and property management fees are dependent upon occupancy, while construction and development services rely on the expansion of business operations of third-party property owners and joint venture partners. A significant decrease in total construction volume from the first quarter of 2011 drove the decrease in our earnings from Service Operations.
Depreciation and Amortization
Depreciation and amortization expense increased from $77.8 million during the first quarter of 2011 to $91.6 million for the same period in 2012, primarily due to depreciation related to additions to our asset base from properties acquired and developments placed in service in 2011 and 2012.
Gain on Sale of Properties
We recognized gains on sale of properties of $67.9 million for the three months ended March 31, 2011 compared to cost of sale adjustments of $277,000 for the same period in 2012. The sales in the first quarter of 2011 were comprised of 15 properties that did not meet the criteria for classification within discontinued operations. The cost of sales adjustments recognized in the first quarter of 2012, which resulted in a net reduction to the original gains on sale, represented changes in contingencies associated with properties that were sold in a prior period and not classified within discontinued operations.
General and Administrative Expense
General and administrative expenses increased from $11.2 million for the first quarter of 2011 to $11.8 million for the same period in 2012. General and administrative expenses consist of two components. The first component includes general corporate expenses and the second component includes the indirect operating costs not allocated to the development or operations of our wholly-owned properties and Service Operations. Those indirect costs not allocated to or absorbed by these operations are charged to general and administrative expenses. While our overall

22


pool of overhead expenses declined as a result of overhead reductions that took place near the end of 2011, the amount of such costs absorbed by development and other activities also declined, thus driving a slight increase in indirect costs charged to general and administrative expenses in the first quarter of 2012. The decrease in the absorption of costs by other areas was primarily a result of less construction activity that was partially offset by an increase in leasing activity.
Interest Expense
Interest expense allocable to continuing operations increased from $52.1 million in the first quarter of 2011 to $61.1 million in the first quarter of 2012. We had $15.1 million of interest expense allocated to discontinued operations in the first quarter of 2011, as the result of disposing of properties with a gross book value of $2.0 billion during 2011, compared to only $525,000 for the same period in 2012. Thus, total interest expense combined for continuing and discontinued operations decreased from $67.3 million to $61.6 million. This overall interest savings was primarily a result of carrying reduced average borrowings in the first quarter of 2012.
Discontinued Operations
Subject to certain criteria, the results of operations for properties sold during the year to unrelated parties or classified as held-for-sale at the end of the period are required to be classified as discontinued operations. The property specific components of earnings that are classified as discontinued operations include rental revenues, rental expenses, real estate taxes, allocated interest expense and depreciation expense, as well as the net gain or loss on the disposition of properties. The significant volume of building sales during the latter part of 2011 was the driving factor of there being $52.2 million in rental and related revenues classified within discontinued operations for the three months ended March 31, 2011, compared to only $1.2 million for the three months ended March 31, 2012.
The operations of 117 buildings are classified as discontinued operations for both the three months ended March 31, 2012 and March 31, 2011. These 117 buildings consist of 100 office, fifteen industrial, and two retail properties. As a result, we classified a loss, before gain on sales, of $749,000 and $5.4 million in discontinued operations for the three months ended March 31, 2012 and 2011, respectively.
Of these properties, 13 were sold during the first quarter of 2012 and nine were sold during the first quarter of 2011. The gains on disposal of $6.5 million and $11.6 million for the three months ended March 31, 2012 and 2011, respectively, are reported in discontinued operations.
Liquidity and Capital Resources
Sources of Liquidity
We expect to meet our short-term liquidity requirements over the next twelve months, including payments of dividends and distributions as well as capital expenditures needed to maintain our current real estate assets, primarily through working capital, net cash provided by operating activities and proceeds received from real estate dispositions. We had no outstanding borrowings on DRLP’s $850.0 million unsecured line of credit at March 31, 2012, which allows us significant additional flexibility for temporary financing of either short-term obligations or strategic acquisitions.
In addition to our existing sources of liquidity, we expect to meet long-term liquidity requirements, such as scheduled mortgage and unsecured debt maturities, property acquisitions, financing of development activities and other capital improvements, through multiple sources of capital including operating cash flow, proceeds from property dispositions and accessing the public debt and equity markets.
Rental Operations
Cash flows from Rental Operations is our primary source of liquidity and provides a stable source of cash flow to fund operational expenses. We believe that this cash-based revenue stream is substantially aligned with revenue recognition (except for periodic straight-line rental income accruals and amortization of above or below market

23


rents) as cash receipts from the leasing of rental properties are generally received in advance of, or a short time following, the actual revenue recognition.
We are subject to a number of risks as a result of general economic conditions, including reduced occupancy, tenant defaults and bankruptcies and potential reduction in rental rates upon renewal or re-letting of properties, any of which would result in reduced cash flow from operations.
Unsecured Debt and Equity Securities
We use the DRLP unsecured line of credit as a temporary source of capital to fund development activities, acquire additional rental properties and provide working capital.
At March 31, 2012, we had on file with the SEC an automatic shelf registration statement on Form S-3 relating to the offer and sale, from time to time, of an indeterminate amount of DRLP’s debt securities (including guarantees thereof) and the Company’s common shares, preferred shares and other securities. From time to time, we expect to issue additional securities under this automatic shelf registration statement to fund the repayment of long-term debt upon maturity and for other general corporate purposes.
On February 11, 2010, we entered into an at the market equity program that allowed us to issue new shares of our common stock, from time to time, with an aggregate offering price of up to $150.0 million. In the first three months of 2012, we issued 10.8 million shares of common stock under this at the market program. We paid $3.0 million in commissions related to the sales of these common shares, resulting in net proceeds of approximately $147.0 million.
The indentures (and related supplemental indentures) governing our outstanding series of notes require us to comply with financial ratios and other covenants regarding our operations. We were in compliance with all such covenants, as well as applicable covenants under our unsecured line of credit, as of March 31, 2012.
Sale of Real Estate Assets
We regularly work to identify, consider and pursue opportunities to dispose of non-strategic properties on an opportunistic basis and on a basis that is generally consistent with our strategic plans. Our ability to dispose of such properties on favorable terms, or at all, is dependent upon a number of factors including the availability of credit to potential buyers to purchase properties at prices that we consider acceptable. Although we believe we have demonstrated our ability to generate significant liquidity through the disposition of non-strategic properties, potential future adverse changes to general market and economic conditions could negatively impact our further ability to dispose of such properties.
Transactions with Unconsolidated Entities
Transactions with unconsolidated partnerships and joint ventures also provide a source of liquidity. From time to time we will sell properties to unconsolidated entities, while retaining a continuing interest in that entity, and receive proceeds commensurate to those interests that we do not own. Additionally, unconsolidated entities will from time to time obtain debt financing and will distribute to us, and our joint venture partners, all or a portion of the proceeds from such debt financing.
We have a 20% equity interest in an unconsolidated joint venture (“Duke/Hulfish”) which, along with its subsidiary entities, has acquired 35 properties from us since its formation in May 2008. We have received cumulative net sale and financing proceeds of approximately $847.2 million through March 31, 2012. We are party to an agreement that allows Duke/Hulfish a right of first offer to acquire future build-to-suit or speculative developments on certain specified parcels of our undeveloped land.




24


Uses of Liquidity
Our principal uses of liquidity include the following:
accretive property investment;
leasing/capital costs;
dividends and distributions to shareholders and unitholders;
long-term debt maturities;
opportunistic repurchases of outstanding debt and preferred stock; and
other contractual obligations.
Property Investment
We continue to pursue an asset repositioning strategy that involves increasing our investment concentration in industrial and medical office properties while reducing our investment concentration in suburban office properties. Pursuant to this strategy, we evaluate development and acquisition opportunities based upon market outlook, supply and long-term growth potential. Our ability to make future property investments, along with being dependent upon identifying suitable acquisition and development opportunities, is also dependent upon our continued access to our longer-term sources of liquidity, including issuances of debt or equity securities as well as generating cash flow by disposing of selected properties.
In light of current economic conditions, management continues to evaluate our investment priorities and remains focused on long-term accretive growth.
Leasing/Capital Costs
Tenant improvements and leasing commissions related to the initial leasing of newly completed or acquired properties are referred to as first generation expenditures. Such expenditures are included within development of real estate investments and other deferred leasing costs in our Consolidated Statements of Cash Flows.
Tenant improvements and leasing costs to re-let rental space that had been previously under lease to tenants are referred to as second generation expenditures. Building improvements that are not specific to any tenant but serve to improve integral components of our real estate properties are also second generation expenditures.
One of the principal uses of our liquidity is to fund the second generation leasing/capital expenditures of our real estate investments.
The following is a summary of our second generation capital expenditures by type of expenditure (in thousands):
 
Three Months Ended March 31,
 
2012
 
2011
Second generation tenant improvements
$
6,346

 
$
7,989

Second generation leasing costs
8,338

 
8,554

Building improvements
677

 
933

Totals
$
15,361

 
$
17,476


The following is a summary of our second generation capital expenditures by reportable operating segment (in thousands):
 
Three Months Ended March 31,
 
2012
 
2011
Industrial
$
8,289

 
$
7,461

Office
6,882

 
9,914

Medical Office
163


101

Non-reportable segments
27

 

Totals
$
15,361

 
$
17,476


25


Both our first and second generation expenditures vary significantly between leases on a per square foot basis, dependent upon several factors including the product type, nature of a tenant's operations, the specific physical characteristics of each individual property as well as the market in which the property is located.
Dividend and Distribution Requirements
We are required to meet the distribution requirements of the Internal Revenue Code of 1986, as amended (the “Code”), in order to maintain our REIT status. Because depreciation is a non-cash expense, cash flow will typically be greater than operating income. We paid distributions of $0.17 per common share in the first quarter of 2012 and our board of directors declared dividends of $0.17 per share for the second quarter of 2012. Our future dividends will be declared at the discretion of our board of directors and will be subject to our future capital needs and availability.
At March 31, 2012, we had four series of preferred stock outstanding. The annual dividend rates on our preferred shares range between 6.5% and 8.375% and are paid in arrears quarterly. In March 2012, we redeemed all of our 6.95% Series M Cumulative Redeemable Preferred Shares (“Series M Shares”) for a total payment of $168.3 million, thus reducing our future quarterly dividend commitments by $2.9 million.
Debt Maturities
Debt outstanding at March 31, 2012 had a face value totaling $3.8 billion with a weighted average interest rate of 6.42% and matures at various dates through 2028. Of this total amount, we had $2.6 billion of unsecured debt, $20.3 million outstanding on the unsecured line of credit of a consolidated subsidiary and $1.2 billion of secured debt outstanding at March 31, 2012. Scheduled principal amortization and maturities of such debt totaled $10.9 million for the three months ended March 31, 2012.
The following is a summary of the scheduled future amortization and maturities of our indebtedness at March 31, 2012 (in thousands, except percentage data):
 
 
Future Repayments
 
 
Year
Scheduled
Amortization

 
Maturities

 
Total

 
Weighted Average Interest Rate of
Future Repayments

Remainder of 2012
$
12,957

 
$
330,071

 
$
343,028

 
5.31
%
2013
16,730

 
521,644

 
538,374

 
6.27
%
2014
15,590

 
301,000

 
316,590

 
6.16
%
2015
14,015

 
358,381

 
372,396

 
6.81
%
2016
12,001

 
506,690

 
518,691

 
6.11
%
2017
9,908

 
544,932

 
554,840

 
5.95
%
2018
7,937

 
300,000

 
307,937

 
6.08
%
2019
6,936

 
518,438

 
525,374

 
7.97
%
2020
5,381

 
250,000

 
255,381

 
6.73
%
2021
3,416

 
9,047

 
12,463

 
5.59
%
2022
3,611

 

 
3,611

 
5.57
%
Thereafter
14,178

 
50,000

 
64,178

 
6.93
%
 
$
122,660

 
$
3,690,203

 
$
3,812,863

 
6.42
%
We anticipate generating capital to fund our debt maturities by using undistributed cash generated from our Rental Operations and property dispositions, and by raising additional capital from future debt or equity transactions.
Repurchases of Outstanding Debt and Preferred Stock
We paid $168.3 million in March 2012 to redeem our Series M Shares at par value.
To the extent that it supports our overall capital strategy, we may purchase certain of our outstanding unsecured debt prior to its stated maturity or redeem or repurchase certain of our outstanding series of preferred stock.

26


Historical Cash Flows
Cash and cash equivalents were $14.7 million and $167.1 million at March 31, 2012 and 2011, respectively. The following highlights significant changes in net cash associated with our operating, investing and financing activities (in millions): 
 
Three Months Ended March 31,
 
2012
 
2011
Net Cash Provided by Operating Activities
$
25.3

 
$
28.0

Net Cash Provided by (Used for) Investing Activities
$
(137.6
)
 
$
405.6

Net Cash Used for Financing Activities
$
(86.8
)
 
$
(284.9
)

Operating Activities
The receipt of rental income from Rental Operations continues to be our primary source of operating cash flows. For the three months ended March 31, 2012, cash provided by operating activities decreased to $25.3 million from $28.0 million in the same period in 2011.
Investing Activities
Investing activities are one of the primary uses of our liquidity. Development and acquisition activities typically generate additional rental revenues and provide cash flows for operational requirements. Highlights of significant cash sources and uses are as follows:
During the three months ended March 31, 2012, we paid cash of $131.5 million for real estate acquisitions and $12.2 million for undeveloped land acquisitions, compared to $22.3 million for real estate acquisitions in the same period in 2011.
Real estate development costs decreased to $29.6 million for three months ended March 31, 2012 from $37.3 million for the same period in 2011. The change in development activity is consistent with our strategy to limit new development starts to properties with significant pre-leasing or in product lines and markets that we believe will provide future growth.
Sales of land and depreciated property provided $63.3 million in net proceeds for the three months ended March 31, 2012, compared to $437.5 million for the same period in 2011.
During the three months ended March 31, 2011, we received a $54.7 million cash distribution, which represented our share of the net proceeds from a loan obtained by one of our unconsolidated joint ventures. We received no such capital distributions from unconsolidated companies during the same period in 2012.
Financing Activities
The following items highlight some of the factors that account for the difference in net cash flow related to financing activities in the first three months of 2012 compared to the same period in 2011:
In March 2012, we redeemed all of the outstanding shares of our Series M Shares for a total payment of $168.3 million.
During the three months ended March 31, 2012, we issued 10.8 million shares of common stock for net proceeds of $147.0 million.
In March 2011, we repaid $42.5 million of senior unsecured notes with an effective rate of 6.96% on their scheduled maturity date.
For the three months ended March 31, 2011, we decreased net borrowings on DRLP’s $850.0 million line of credit by $175.0 million, completely repaying the outstanding balance, compared to no net change in borrowings for the same period in 2012.

Contractual Obligations
Aside from changes in long-term debt, there have not been material changes in our outstanding commitments since December 31, 2011, as previously discussed in our 2011 Annual Report on Form 10-K.


27


Off Balance Sheet Arrangements - Investments in Unconsolidated Companies
We analyze our investments in unconsolidated joint ventures to determine if they meet the criteria for classification as a variable interest entity (a “VIE”) and would require consolidation. We (i) evaluate the sufficiency of the total equity at risk, (ii) review the voting rights and decision-making authority of the equity investment holders as a group, and whether there are any guaranteed returns, protection against losses, or capping of residual returns within the group and (iii) establish whether activities within the venture are on behalf of an investor with disproportionately few voting rights in making this VIE determination. We would consolidate a venture that is determined to be a VIE if we were the primary beneficiary. To the extent that our joint ventures do not qualify as VIEs, we further assess each joint venture partner’s substantive participating rights to determine if the venture should be consolidated.
We have equity interests in unconsolidated partnerships and limited liability companies that primarily own and operate rental properties and hold land for development. These unconsolidated joint ventures are primarily engaged in the operations and development of industrial, office and medical office real estate properties. These investments provide us with increased market share and tenant and property diversification. The equity method of accounting is used for these investments in which we have the ability to exercise significant influence, but not control, over operating and financial policies. As a result, the assets and liabilities of these entities are not included on our balance sheet. Our investments in and advances to unconsolidated subsidiaries represented approximately 5% of our total assets as of both March 31, 2012 and December 31, 2011. Total assets of our unconsolidated subsidiaries wer