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

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Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

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

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number 1-9317

 

COMMONWEALTH REIT

(Exact Name of Registrant as Specified in Its Charter)

 

Maryland

 

04-6558834

(State or Other Jurisdiction of Incorporation or
Organization)

 

(IRS Employer Identification No.)

 

Two Newton Place, 255 Washington Street, Suite 300, Newton, Massachusetts 02458-1634

(Address of Principal Executive Offices) (Zip Code)

 

617-332-3990

(Registrant’s Telephone Number, Including Area Code)

 

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 o

 

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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

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

 

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 o  No x

 

Number of registrant’s common shares of beneficial interest, $0.01 par value per share, outstanding as of May 3, 2012: 83,721,736.

 

 

 



Table of Contents

 

COMMONWEALTH REIT

 

FORM 10-Q

 

March 31, 2012

 

INDEX

 

 

 

 

Page

PART I

Financial Information

 

 

 

 

 

 

Item 1.

Financial Statements (unaudited)

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets – March 31, 2012 and December 31, 2011

 

1

 

 

 

 

 

Condensed Consolidated Statements of Income – Three Months Ended March 31, 2012 and 2011

 

2

 

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income – Three Months Ended March 31, 2012 and 2011

 

3

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows – Three Months Ended March 31, 2012 and 2011

 

4

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

 

5

 

 

 

 

Item 2.

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

 

18

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

31

 

 

 

 

Item 4.

Controls and Procedures

 

33

 

 

 

 

 

Warning Concerning Forward Looking Statements

 

34

 

 

 

 

 

Statement Concerning Limited Liability

 

37

 

 

 

 

PART II

Other Information

 

 

 

 

 

 

Item 1A.

Risk Factors

 

38

 

 

 

 

Item 6.

Exhibits

 

38

 

 

 

 

 

Signatures

 

41

 

References in this Quarterly Report on Form 10-Q to “we”, “us” or “our” refer to CommonWealth REIT and its consolidated subsidiaries, including its majority owned consolidated subsidiary, Select Income REIT and its consolidated subsidiaries, or SIR, unless the context indicates otherwise.

 

Select Income REIT is itself a public company having common shares registered under the Securities Act of 1934, as amended.  For further information about SIR, please see SIR’s periodic reports and other filings with the Securities and Exchange Commission, or SEC, which are available at the SEC’s website at www.sec.gov.  References in this Quarterly Report on Form 10-Q to SIR’s filings with the SEC are included as textual references only, and the information in SIR’s filings with the SEC is not incorporated by reference into this Quarterly Report on Form 10-Q, unless otherwise expressly stated herein.

 



Table of Contents

 

PART I.  Financial Information

 

Item 1.  Financial Statements.

 

COMMONWEALTH REIT

 

CONDENSED CONSOLIDATED BALANCE SHEETS

(amounts in thousands, except share data)

(unaudited)

 

 

 

March 31,

 

December 31,

 

 

 

2012

 

2011

 

ASSETS

 

 

 

 

 

Real estate properties:

 

 

 

 

 

Land

 

$

1,498,146

 

$

1,450,154

 

Buildings and improvements

 

5,987,358

 

5,794,078

 

 

 

7,485,504

 

7,244,232

 

Accumulated depreciation

 

(969,903

)

(934,170

)

 

 

6,515,601

 

6,310,062

 

Acquired real estate leases, net

 

374,022

 

343,917

 

Equity investments

 

176,255

 

177,477

 

Cash and cash equivalents

 

193,587

 

192,763

 

Restricted cash

 

17,195

 

7,869

 

Rents receivable, net of allowance for doubtful accounts of $11,835 and $12,575, respectively

 

226,565

 

217,592

 

Other assets, net

 

210,166

 

197,346

 

Total assets

 

$

7,713,391

 

$

7,447,026

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Revolving credit facility

 

$

 

$

100,000

 

SIR revolving credit facility

 

227,000

 

 

Senior unsecured debt, net

 

2,694,780

 

2,845,030

 

Mortgage notes payable, net

 

784,454

 

632,301

 

Accounts payable and accrued expenses

 

140,172

 

158,272

 

Assumed real estate lease obligations, net

 

72,392

 

70,179

 

Rent collected in advance

 

33,872

 

37,653

 

Security deposits

 

24,024

 

23,779

 

Due to related persons

 

13,667

 

11,295

 

Total liabilities

 

3,990,361

 

3,878,509

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Shareholders’ equity attributable to CommonWealth REIT:

 

 

 

 

 

Preferred shares of beneficial interest, $0.01 par value:

 

 

 

 

 

50,000,000 shares authorized;

 

 

 

 

 

Series C preferred shares; 7 1/8% cumulative redeemable since February 15, 2011; 6,000,000 shares issued and outstanding, aggregate liquidation preference $150,000

 

145,015

 

145,015

 

Series D preferred shares; 6 1/2% cumulative convertible; 15,180,000 shares issued and outstanding, aggregate liquidation preference $379,500

 

368,270

 

368,270

 

Series E preferred shares; 7 1/4% cumulative redeemable on or after May 15, 2016; 11,000,000 issued and outstanding, aggregate liquidation preference $275,000

 

265,391

 

265,391

 

Common shares of beneficial interest, $0.01 par value:

 

 

 

 

 

350,000,000 shares authorized; 83,721,736 shares issued and outstanding

 

837

 

837

 

Additional paid in capital

 

3,590,321

 

3,614,079

 

Cumulative net income

 

2,506,001

 

2,482,321

 

Cumulative other comprehensive loss

 

(220

)

(4,709

)

Cumulative common distributions

 

(2,867,891

)

(2,826,030

)

Cumulative preferred distributions

 

(490,300

)

(476,657

)

Total shareholders’ equity attributable to CommonWealth REIT

 

3,517,424

 

3,568,517

 

Noncontrolling interest

 

205,606

 

 

Total shareholders’ equity

 

3,723,030

 

3,568,517

 

Total liabilities and shareholders’ equity

 

$

7,713,391

 

$

7,447,026

 

 

See accompanying notes.

 

1



Table of Contents

 

COMMONWEALTH REIT

 

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(amounts in thousands, except per share data)

(unaudited)

 

 

 

Three Months Ended March 31,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

Rental income

 

$

251,246

 

$

210,673

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

Operating expenses

 

104,090

 

90,397

 

Depreciation and amortization

 

61,351

 

52,289

 

General and administrative

 

12,310

 

10,959

 

Acquisition related costs

 

2,502

 

2,559

 

Total expenses

 

180,253

 

156,204

 

 

 

 

 

 

 

Operating income

 

70,993

 

54,469

 

 

 

 

 

 

 

Interest and other income

 

288

 

708

 

Interest expense (including net amortization of debt discounts, premiums and deferred financing fees of $746 and $2,032, respectively)

 

(49,106

)

(47,414

)

Loss on early extinguishment of debt

 

(67

)

 

Equity in earnings of investees

 

2,958

 

2,712

 

Income from continuing operations before income tax expense

 

25,066

 

10,475

 

Income tax expense

 

(492

)

(346

)

Income from continuing operations

 

24,574

 

10,129

 

Discontinued operations:

 

 

 

 

 

Income from discontinued operations

 

 

1,911

 

Net gain on sale of properties from discontinued operations

 

 

34,572

 

Net income

 

24,574

 

46,612

 

Net income attributable to noncontrolling interest

 

(894

)

 

Net income attributable to CommonWealth REIT

 

23,680

 

46,612

 

Preferred distributions

 

(13,823

)

(8,839

)

Net income available for CommonWealth REIT common shareholders

 

$

9,857

 

$

37,773

 

 

 

 

 

 

 

Amounts attributable to CommonWealth REIT common shareholders:

 

 

 

 

 

Income from continuing operations

 

$

9,857

 

$

1,290

 

Income from discontinued operations

 

 

1,911

 

Net gain on sale of properties from discontinued operations

 

 

34,572

 

Net income

 

$

9,857

 

$

37,773

 

 

 

 

 

 

 

Weighted average common shares outstanding — basic

 

83,722

 

72,139

 

 

 

 

 

 

 

Weighted average common shares outstanding — diluted

 

91,020

 

79,437

 

 

 

 

 

 

 

Basic and diluted earnings per common share attributable to CommonWealth REIT common shareholders:

 

 

 

 

 

Income from continuing operations

 

$

0.12

 

$

0.02

 

Income from discontinued operations

 

$

 

$

0.51

 

Net income available for common shareholders

 

$

0.12

 

$

0.52

 

 

See accompanying notes.

 

2



Table of Contents

 

COMMONWEALTH REIT

 

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(amounts in thousands)

(unaudited)

 

 

 

Three Months Ended March 31,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

Net income

 

$

24,574

 

$

46,612

 

 

 

 

 

 

 

Other comprehensive income:

 

 

 

 

 

Unrealized (loss) gain on derivative instruments

 

(37

)

2,045

 

Realized gain on sale of investment in available for sale securities

 

 

(18

)

Foreign currency translation adjustments

 

4,528

 

4,362

 

(Decrease) increase in share of investees’ other comprehensive (loss) income

 

(1

)

4

 

Total comprehensive income

 

29,064

 

53,005

 

 

 

 

 

 

 

Less: comprehensive income attributable to noncontrolling interest

 

(894

)

 

Comprehensive income attributable to CommonWealth REIT

 

$

28,170

 

$

53,005

 

 

See accompanying notes.

 

3



Table of Contents

 

COMMONWEALTH REIT

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(amounts in thousands)

(unaudited)

 

 

 

Three Months Ended March 31,

 

 

 

2012

 

2011

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

24,574

 

$

46,612

 

Adjustments to reconcile net income to cash provided by operating activities:

 

 

 

 

 

Depreciation

 

44,443

 

41,457

 

Net amortization of debt discounts, premiums and deferred financing fees

 

746

 

2,032

 

Straight line rental income

 

(8,092

)

(7,381

)

Amortization of acquired real estate leases

 

14,411

 

9,573

 

Other amortization

 

4,793

 

4,230

 

Loss on early extinguishment of debt

 

67

 

 

Equity in earnings of investees

 

(2,958

)

(2,712

)

Distributions of earnings from investees

 

2,913

 

2,675

 

Net gain on sale of properties

 

 

(34,572

)

Change in assets and liabilities:

 

 

 

 

 

Increase in restricted cash

 

(782

)

(448

)

Increase in rents receivable and other assets

 

(23,170

)

(28,627

)

Decrease in accounts payable and accrued expenses

 

(20,630

)

(10,615

)

(Decrease) increase in rent collected in advance

 

(3,781

)

229

 

Increase in security deposits

 

245

 

219

 

Increase in due to related persons

 

2,372

 

2,493

 

Cash provided by operating activities

 

35,151

 

25,165

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Real estate acquisitions

 

(91,535

)

(295,919

)

Real estate improvements

 

(26,430

)

(14,503

)

Investment in direct financing lease, net

 

 

(38,635

)

Principal payments received from direct financing lease

 

1,632

 

476

 

Principal payments received from real estate mortgage receivable

 

 

70

 

Proceeds from sale of properties, net

 

 

97,362

 

Distributions in excess of earnings from investees

 

1,266

 

1,405

 

Increase in restricted cash

 

(8,544

)

 

Cash used in investing activities

 

(123,611

)

(249,744

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Proceeds from issuance of common shares, net

 

180,954

 

 

Proceeds from borrowings

 

338,500

 

295,000

 

Payments on borrowings

 

(369,082

)

(194,318

)

Deferred financing fees

 

(5,767

)

 

Distributions to common shareholders

 

(41,861

)

(36,070

)

Distributions to preferred shareholders

 

(13,643

)

(8,839

)

Cash provided by financing activities

 

89,101

 

55,773

 

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

183

 

155

 

 

 

 

 

 

 

Increase (decrease) in cash and cash equivalents

 

824

 

(168,651

)

Cash and cash equivalents at beginning of period

 

192,763

 

194,040

 

Cash and cash equivalents at end of period

 

$

193,587

 

$

25,389

 

 

 

 

 

 

 

SUPPLEMENTAL CASH FLOW INFORMATION:

 

 

 

 

 

Interest paid

 

$

66,971

 

$

58,306

 

Taxes paid

 

34

 

160

 

 

 

 

 

 

 

NON-CASH INVESTING ACTIVITIES:

 

 

 

 

 

Real estate acquisitions

 

$

(147,872

)

$

(4,059

)

 

 

 

 

 

 

NON-CASH FINANCING ACTIVITIES:

 

 

 

 

 

Assumption of mortgage note payable

 

$

147,872

 

$

 

Assumption of note payable

 

 

4,059

 

 

See accompanying notes.

 

4



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data)

 

Note 1.  Basis of Presentation

 

The accompanying condensed consolidated financial statements of CommonWealth REIT and its subsidiaries, or CWH, we, us or our, have been prepared without audit.  Certain information and footnote disclosures required by U.S. generally accepted accounting principles, or GAAP, for complete financial statements have been condensed or omitted.  We believe the disclosures made are adequate to make the information presented not misleading.  However, the accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes contained in our Annual Report on Form 10-K for the year ended December 31, 2011, or our Annual Report.  In the opinion of our management, all adjustments, which include only normal recurring adjustments considered necessary for a fair presentation, have been included.  All intercompany transactions and balances with or among our subsidiaries have been eliminated.  Operating results for interim periods are not necessarily indicative of the results that may be expected for the full year.  Reclassifications have been made to the prior years’ financial statements to conform to the current year’s presentation.

 

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect reported amounts.  Actual results could differ from those estimates.  Significant estimates in the condensed consolidated financial statements include the allowance for doubtful accounts, purchase price allocations, useful lives of fixed assets and impairment of real estate and intangible assets.

 

On March 12, 2012, our then wholly owned subsidiary, Select Income REIT, completed an initial public offering of 9,200,000 of its common shares, or the SIR IPO.  We refer to Select Income REIT and its consolidated subsidiaries as SIR.  SIR intends to be taxable as a real estate investment trust, or REIT.  SIR owns substantially all of our commercial and industrial properties located on Oahu, HI as well as 23 suburban office and industrial properties located throughout the mainland United States.  After the SIR IPO, we continue to own 22,000,000 SIR common shares, or approximately 70.5% of SIR’s outstanding common shares, and SIR remains one of our consolidated subsidiaries.  See Note 12 for additional information regarding the SIR IPO.

 

Note 2.  Recent Accounting Pronouncements

 

In January 2012, we adopted the Financial Accounting Standards Board, or FASB, Accounting Standards Update No. 2011-04, Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. GAAP and IFRS.  This update clarified the application of existing fair value measurement requirements.  This update also required reporting entities to disclose additional information regarding fair value measurements categorized within Level 3 of the fair value hierarchy.  This update was effective for interim and annual reporting periods beginning after December 15, 2011.  The implementation of this update did not cause any material changes to the disclosures in, or presentation of, our condensed consolidated financial statements.

 

Additionally, in January 2012, we adopted FASB Accounting Standards Update No. 2011-05, Presentation of Comprehensive Income.  This update eliminated the option to report other comprehensive income and its components in the statement of shareholders’ equity.  This update was intended to enhance comparability between entities that report under GAAP and to provide a more consistent method of presenting non-owner transactions that affect an entity’s equity.  This standard was effective for interim and annual reporting periods beginning after December 15, 2011.  The implementation of this update did not cause any material changes to our condensed consolidated financial statements, other than the presentation of the condensed consolidated statements of comprehensive income.

 

Note 3.  Real Estate Properties

 

During the three months ended March 31, 2012, we, excluding SIR, acquired two properties with a combined 1,878,335 square feet for an aggregate purchase price of $252,100, including the assumption of $147,872 of mortgage debt and excluding closing costs.  We also funded $23,681 of improvements to our owned properties.  As of May 3, 2012, we have also entered into a previously disclosed agreement to acquire a property with 172,200 square feet for a purchase price of $49,000, including the assumption of approximately $29,200 of mortgage debt and excluding closing costs.  Details of our completed and pending acquisitions during 2012 are as follows:

 

5



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

Completed Acquisitions:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Acquired

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Acquired

 

Real Estate

 

 

 

Premium

 

 

 

 

 

Square

 

Purchase

 

 

 

Buildings and

 

Real Estate

 

Lease

 

Assumed

 

on Assumed

 

 Date

 

Location

 

Feet

 

Price(1)

 

Land

 

Improvements

 

Leases

 

Obligations

 

Debt

 

Debt

 

January 2012

 

Chicago, IL

 

1,009,940

 

$

150,600

 

$

30,400

 

$

115,817

 

$

22,189

 

$

5,348

 

$

147,872

 

$

12,458

 

March 2012

 

Hartford, CT

 

868,395

 

101,500

 

15,930

 

60,312

 

25,542

 

284

 

 

 

 

 

 

 

1,878,335

 

$

252,100

 

$

46,330

 

$

176,129

 

$

47,731

 

$

5,632

 

$

147,872

 

$

12,458

 

 


(1) Purchase price includes the assumption of mortgage debt and excludes closing costs.

 

During the three months ended March 31, 2012, we completed the purchase price allocation on four properties located in Phoenix, AZ with a combined 1,063,364 square feet.  We acquired these properties in March 2011 for an aggregate purchase price of $136,500, excluding closing costs.  Based upon our evaluation of an appraisal prepared by an independent real estate appraisal firm completed in March 2012, we estimated the fair value of the acquired land and buildings and improvements to be $22,614 and $64,104, respectively.  As a result, we retrospectively adjusted the preliminary purchase price allocation by reallocating $8,371 from land to buildings and improvements.  All other allocation amounts were unchanged.

 

Pending Acquisitions:

 

In January 2012, we entered an agreement to acquire an office property located in Austin, TX with 172,200 square feet.  The purchase price is $49,000, including the assumption of approximately $29,200 of mortgage debt and excluding closing costs.  We currently expect to acquire this property during the second quarter of 2012; however, this acquisition is subject to customary closing conditions, including the assumption of existing mortgage debt, and we can provide no assurance that we will acquire this property in that time period or at all.

 

In addition, in April 2012, SIR entered agreements to acquire two properties for an aggregate purchase price of $104,400, excluding closing costs.  We understand that SIR currently expects that it will acquire these properties during the remainder of 2012; however, these acquisitions are subject to SIR’s satisfactory completion of diligence and other customary closing conditions.  Accordingly, we can provide no assurance that SIR will acquire all or any of these properties in that time period or at all.

 

As of March 31, 2012 and December 31, 2011, none of our properties were classified as held for sale.  We classify all properties probable for sale within one year as held for sale in our condensed consolidated balance sheets.  Results of operations for properties sold or held for sale are included in discontinued operations in our condensed consolidated statements of income.  Summarized income statement information for properties sold in 2011 is as follows:

 

Income Statement:

 

 

 

Three Months

 

 

 

Ended

 

 

 

March 31, 2011

 

Rental income

 

$

7,239

 

Operating expenses

 

(3,438

)

Depreciation and amortization

 

(1,552

)

General and administrative

 

(254

)

Acquisition related costs

 

(86

)

Operating income

 

1,909

 

 

 

 

 

Interest income

 

2

 

Income from discontinued operations

 

$

1,911

 

 

6



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

Note 4.  Investment in Direct Financing Lease

 

We have an investment in a direct financing lease that relates to a triple net lease with a term that exceeds 75% of the useful life of an office tower located within a mixed use property in Phoenix, AZ.  We recognize direct financing lease income using the effective interest method to produce a level yield on funds not yet recovered.  Estimated unguaranteed residual values at the date of lease inception represent our initial estimates of the fair value of the leased assets at the expiration of the lease, which do not exceed their original cost.  Significant assumptions used in estimating residual values include estimated net cash flows over the remaining lease term and expected future real estate values.  The carrying amount of our net investment is included in other assets in our condensed consolidated balance sheets.  The following table summarizes the carrying amount of our net investment in this direct financing lease:

 

 

 

March 31,

 

December 31,

 

 

 

2012

 

2011

 

Total minimum lease payments receivable

 

$

37,158

 

$

39,182

 

Estimated unguaranteed residual value of leased asset

 

4,951

 

4,951

 

Unearned income

 

(10,361

)

(10,754

)

Net investment in direct financing lease

 

$

31,748

 

$

33,379

 

 

Additionally, we have determined that no allowance for losses related to our direct financing lease was necessary at March 31, 2012.  Our direct financing lease has an expiration date in 2045.

 

Note 5.  Equity Investments

 

At March 31, 2012 and December 31, 2011, we had the following equity investments in Government Properties Income Trust, or GOV, and Affiliates Insurance Company, or AIC:

 

 

 

Ownership Percentage

 

Equity Investments

 

Equity in Earnings

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

 

March 31,

 

December 31,

 

March 31,

 

December 31,

 

March 31,

 

 

 

2012

 

2011

 

2012

 

2011

 

2012

 

2011

 

GOV

 

21.1

%

21.1

%

$

170,920

 

$

172,186

 

$

2,913

 

$

2,675

 

AIC

 

14.3

%

14.3

%

5,335

 

5,291

 

45

 

37

 

 

 

 

 

 

 

$

176,255

 

$

177,477

 

$

2,958

 

$

2,712

 

 

At March 31, 2012, we owned 9,950,000, or approximately 21.1%, of the common shares of beneficial interest of GOV, with a carrying value of $170,920 and a market value, based on quoted market prices, of $239,895 ($24.11 per share).  GOV is a REIT which primarily owns properties that are majority leased to government tenants and was our wholly owned subsidiary until its initial public offering, or the GOV IPO, in June 2009 when it became a separate public entity.

 

Since the GOV IPO, we have accounted for our investment in GOV using the equity method.  Under the equity method, we record our percentage share of net earnings of GOV in our condensed consolidated statements of income.  Prior to the GOV IPO, the operating results and investments of GOV were included in our results of operations and financial position.  The market value of our GOV common shares on the date of the GOV IPO exceeded our carrying value by $13,824.  We are amortizing the difference between our carrying value of GOV and our share of the underlying equity of GOV over a 30 year period, which approximates the remaining useful lives of the properties that we initially contributed to GOV.  If we determine there is an “other than temporary” decline in the fair value of this investment, we would record a charge to earnings.

 

During the three months ended March 31, 2012 and 2011, we received cash distributions from GOV totaling $4,179 and $4,080, respectively.

 

7



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

The following summarized financial data of GOV is as reported in GOV’s Quarterly Report on Form 10-Q for the period ended March 31, 2012.  References in our financial statements to the Quarterly Report on Form 10-Q for GOV are included as textual references only, and the information in GOV’s Quarterly Report on Form 10-Q is not incorporated by reference into our financial statements.

 

Condensed Consolidated Balance Sheets:

 

 

 

March 31,

 

December 31,

 

 

 

2012

 

2011

 

Real estate properties, net

 

$

1,191,091

 

$

1,198,050

 

Acquired real estate leases, net

 

112,178

 

117,596

 

Cash and cash equivalents

 

9,275

 

3,272

 

Rents receivable, net

 

26,472

 

29,000

 

Other assets, net

 

24,231

 

20,657

 

Total assets

 

$

1,363,247

 

$

1,368,575

 

 

 

 

 

 

 

Unsecured revolving credit facility

 

$

 

$

345,500

 

Unsecured term loan

 

350,000

 

 

Mortgage notes payable

 

94,826

 

95,383

 

Assumed real estate lease obligations, net

 

10,482

 

11,262

 

Other liabilities

 

22,034

 

24,762

 

Shareholders’ equity

 

885,905

 

891,668

 

Total liabilities and shareholders’ equity

 

$

1,363,247

 

$

1,368,575

 

 

Condensed Consolidated Statements of Income:

 

 

 

Three Months Ended March 31,

 

 

 

2012

 

2011

 

Rental income

 

$

50,455

 

$

39,228

 

Operating expenses

 

(18,221

)

(14,885

)

Depreciation and amortization

 

(12,072

)

(8,386

)

Acquisition related costs

 

(49

)

(829

)

General and administrative

 

(3,039

)

(2,343

)

Operating income

 

17,074

 

12,785

 

Interest and other income

 

8

 

15

 

Interest expense

 

(4,023

)

(2,537

)

Equity in earnings of an investee

 

45

 

37

 

Income before income tax expense

 

13,104

 

10,300

 

Income tax expense

 

(45

)

(46

)

Net income

 

$

13,059

 

$

10,254

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

47,052

 

40,501

 

 

 

 

 

 

 

Net income per common share

 

$

0.28

 

$

0.25

 

 

As of March 31, 2012, we have invested $5,209 in AIC, an insurance company owned in equal proportion by Reit Management & Research LLC, our business and property manager, or RMR, us and five other companies to which RMR provides management services, including GOV and Senior Housing Properties Trust, or SNH.  We may invest additional amounts in AIC in the future if the expansion of this insurance business requires additional capital, but we are not obligated to do so.  At March 31, 2012, we owned approximately 14.3% of AIC with a current carrying value of $5,335.  Although we own less than 20% of AIC, we use the equity method to account for this investment because we believe that we have significant influence over AIC because all of our Trustees are also directors of AIC.  Under the equity method, we record our percentage share of net earnings from AIC in our

 

8



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

condensed consolidated statements of income.  If we determine there is an “other than temporary” decline in the fair value of this investment, we would record a charge to earnings.  In evaluating the fair value of this investment, we have considered, among other things, the assets and liabilities held by AIC, AIC’s overall financial condition and the financial condition and prospects for AIC’s insurance business.  See Note 12 for additional information about our investment in AIC.

 

Note 6.  Indebtedness

 

In January 2012, we prepaid at par all $150,680 of our then outstanding 6.95% senior notes due 2012, using cash on hand and borrowings under our revolving credit facility.  In connection with this prepayment, we recorded a loss on early extinguishment of debt of $67 from the write off of unamortized discounts and deferred financing fees.

 

In January 2012, we assumed a mortgage totaling $147,872, which was recorded at a fair value of $160,330, in connection with our acquisition of a property.  This mortgage bears interest at a rate of 6.29%, requires monthly principal and interest payments and matures in 2016.

 

In February 2012, we repaid at maturity $5,404 of 7.31% mortgage debt using cash on hand.

 

We have a $750,000 unsecured revolving credit facility that we use for acquisitions, working capital and general business purposes.  The credit facility matures on October 19, 2015 and includes an option for us to extend the facility an additional year to October 19, 2016, subject to payment of a fee and satisfaction of certain conditions.  Interest payable by us under our credit facility is set at LIBOR plus 125 basis points, subject to adjustments based on our credit ratings.  The interest rate on our revolving credit facility averaged 1.5% and 2.3% per annum for the three months ended March 31, 2012 and 2011, respectively.  As of March 31, 2012, we had no borrowings outstanding and $750,000 available under our revolving credit facility.

 

Simultaneous with the SIR IPO on March 12, 2012, SIR entered into a $500,000 revolving credit facility, or the SIR revolving credit facility, which may be used by SIR for general business purposes, including acquisitions.  The SIR revolving credit facility matures on March 11, 2016 and subject to SIR’s payment of a fee and satisfaction of certain other conditions, SIR has the option to extend the stated maturity date by one year.  Interest payable by SIR under its revolving credit facility is set at a rate equal to LIBOR plus premiums, subject to adjustments based on SIR’s leverage.  The interest rate on SIR’s revolving credit facility averaged 1.5% for the three months ended March 31, 2012.  The SIR revolving credit facility is secured by a pledge of the equity of certain of SIR’s subsidiaries.  As of March 31, 2012, SIR had $227,000 outstanding and $273,000 available under the SIR revolving credit facility.

 

Our public debt indentures, our revolving credit facility agreement, our term loan agreement and SIR’s revolving credit facility agreement contain a number of financial and other covenants, including credit facility and term loan covenants that restrict our or SIR’s ability to make distributions under certain circumstances.  At March 31, 2012, we believe we and SIR were in compliance with all of our covenants under our public debt indentures, our revolving credit facility, our term loan and SIR’s revolving credit facility agreements.

 

At March 31, 2012, 22 properties costing $1,055,325 with an aggregate net book value of $934,365 were secured by mortgage notes totaling $784,454 (net of discounts and premiums) maturing from 2012 through 2027.

 

9



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

Note 7.  Shareholders’ Equity

 

The following is a reconciliation of changes in our shareholders’ equity for the three months ended March 31, 2012:

 

 

 

Shareholders’

 

Shareholders’

 

 

 

 

 

Equity

 

Equity

 

 

 

 

 

Attributable to

 

Attributable to

 

Total

 

 

 

CommonWealth

 

Noncontrolling

 

Shareholders’

 

 

 

REIT

 

Interest

 

Equity

 

Balance at December 31, 2011

 

$

3,568,517

 

$

 

$

3,568,517

 

Net income

 

23,680

 

894

 

24,574

 

 

 

 

 

 

 

 

 

Other comprehensive income:

 

 

 

 

 

 

 

Unrealized loss on derivative instrument

 

(37

)

 

(37

)

Foreign currency translation adjustments

 

4,528

 

 

4,528

 

Decrease in share of investees other comprehensive loss

 

(1

)

 

(1

)

Total comprehensive income

 

28,170

 

894

 

29,064

 

 

 

 

 

 

 

 

 

Issuance of shares of subsidiary, net

 

(23,758

)

204,712

 

180,954

 

Distributions

 

(55,505

)

 

(55,505

)

Balance at March 31, 2012

 

$

3,517,424

 

$

205,606

 

$

3,723,030

 

 

Distributions:

 

On February 15, 2012, we paid a distribution on our series C preferred shares of $0.4453 per share, or $2,672, a distribution on our series D preferred shares of $0.4063 per share, or $6,167, and a distribution on our series E preferred shares of $0.4531 per share, or $4,984, all of which were paid to shareholders of record as of February 1, 2012.

 

On February 21, 2012, we paid a distribution on our common shares of $0.50 per share, or $41,861, to shareholders of record on January 20, 2012.

 

In April 2012, we declared a distribution of $0.50 per common share, or approximately $41,900, to be paid on or about May 24, 2012 to shareholders of record on April 23, 2012.  We also announced a distribution on our series C preferred shares of $0.4453 per share, or $2,672, a distribution on our series D preferred shares of $0.4063 per share, or $6,167, and a distribution on our series E preferred shares of $0.4531 per share, or $4,984, all of which we expect to pay on or about May 15, 2012 to our preferred shareholders of record as of May 1, 2012.

 

Note 8.  Income Taxes

 

We have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended, and are generally not subject to federal and state income taxes provided we distribute our taxable income to our shareholders and meet other requirements for qualifying as a REIT.  However, we are subject to certain state, local and Australian taxes without regard to our REIT status.  During the three months ended March 31, 2012, we recognized current tax expense of $492, which includes $350 of foreign taxes and $142 of certain state taxes.  During the three months ended March 31, 2011, we recognized current tax expense of $346, which includes $244 of foreign taxes and $102 of certain state taxes.  At March 31, 2012 and December 31, 2011, we had deferred tax assets of $1,763 and $1,992, respectively, of which $1,412 and $1,414, respectively, related to different carrying amounts for financial reporting and for Australian income tax purposes of our properties in Australia.  At March 31, 2012 and December 31, 2011, we had deferred tax liabilities of $1,318 and $1,214, respectively.  Because we are uncertain of our ability to realize the future benefit of certain Australian loss carry forwards, we have reduced our net deferred income tax assets by a valuation allowance of $168 and $165 as of March 31, 2012 and December 31, 2011, respectively.

 

10



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

Note 9.  Fair Value of Assets and Liabilities

 

The table below presents certain of our assets and liabilities measured at fair value during 2012, categorized by the level of inputs used in the valuation of each asset and liability:

 

 

 

 

 

Fair Value at Reporting Date Using

 

 

 

 

 

Quoted Prices in

 

 

 

Significant

 

 

 

 

 

Active Markets for

 

Significant Other

 

Unobservable

 

 

 

 

 

Identical Assets

 

Observable Inputs

 

Inputs

 

Description 

 

Total

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

 

 

 

 

 

 

 

 

 

 

Recurring Fair Value Measurements:

 

 

 

 

 

 

 

 

 

Effective portion of interest rate contracts (1)

 

$

(15,833

)

$

 

$

(15,833

)

$

 

 


(1)       The fair value of our interest rate swap contracts is determined using the net discounted cash flows of the expected cash flows of each derivative based on the market based interest rate curve (level 2 inputs) and adjusted for our credit spread and the actual and estimated credit spreads of the counterparties (level 3 inputs).  Although we have determined that the majority of the inputs used to value our derivatives fall within level 2 of the fair value hierarchy, the credit valuation adjustments associated with our derivatives utilize level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by us and the counterparties.  As of March 31, 2012, we have assessed the significance of the impact of the credit valuation adjustments on the overall valuation of our derivative positions and have determined that the credit valuation adjustments are not significant to the overall valuation of our derivatives.  As a result, we have determined that our derivative valuations in their entirety are classified as level 2 inputs in the fair value hierarchy.

 

We are exposed to certain risks relating to our ongoing business operations, including the effect of changes in foreign currency exchange rates and interest rates.  The only risk currently managed by using our derivative instruments is a part of our interest rate risk.  Although we have not done so as of March 31, 2012 and have no present intention to do so, we may manage our Australian currency exchange exposure by borrowing in Australian dollars or using derivative instruments in the future, depending on the relative significance of our business activities in Australia at that time.  We have interest rate swap agreements to manage our interest rate risk exposure on $175,000 of mortgage notes due 2019, with interest payable at a rate equal to a spread over LIBOR.  The interest rate swap agreements utilized by us qualify as cash flow hedges and effectively modify our exposure to interest rate risk by converting our floating interest rate debt to a fixed interest rate basis for this loan through December 1, 2016, thus reducing the impact of interest rate changes on future interest expense.  These agreements involve the receipt of floating interest rate amounts in exchange for fixed rate interest payments over the life of the agreements without an exchange of the underlying principal amount.  The fair value of our derivative instruments decreased by $37 during the three months ended March 31, 2012 and increased by $2,045 during the three months ended March 31, 2011, based primarily on changes in market interest rates.  As of March 31, 2012 and December 31, 2011, the fair value of these derivative instruments included in accounts payable and accrued expenses and cumulative other comprehensive loss in our condensed consolidated balance sheets totaled ($15,833) and ($15,796), respectively. We may enter additional interest rate swaps or hedge agreements from time to time to manage some of our additional interest rate risk associated with our floating rate borrowings.

 

In addition to the liabilities described in the above table, our financial instruments include our cash and cash equivalents, rents receivable, equity investments, investment in direct financing lease receivable, restricted cash, revolving credit facilities, senior notes and mortgage notes payable, accounts payable and accrued expenses, rent collected in advance, security deposits and amounts due to related persons.  At March 31, 2012 and December 31, 2011, the fair values of these additional financial instruments were not materially different from their carrying values, except as follows:

 

11



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

 

 

March 31, 2012

 

December 31, 2011

 

 

 

Carrying

 

Fair

 

Carrying

 

Fair

 

 

 

Amount

 

Value

 

Amount

 

Value

 

Equity investment in GOV

 

$

170,920

 

$

239,895

 

$

172,186

 

$

224,373

 

Senior notes and mortgage notes payable

 

$

2,747,234

 

$

2,892,845

 

$

2,745,331

 

$

2,924,141

 

 

At March 31, 2012 and December 31, 2011, the fair values of our equity investment in GOV are based on quoted market prices of $24.11 and $22.55, respectively (level 1 inputs).  The fair values of our senior notes and mortgage notes payable are based on estimates using discounted cash flow analyses and currently prevailing interest rates adjusted by credit risk spreads (level 3 inputs).

 

Other financial instruments that potentially subject us to concentrations of credit risk consist principally of rents receivable; however, as of March 31, 2012, no single tenant of ours was responsible for more than 3% of our total annualized rents.

 

We maintain derivative financial instruments, including interest rate swaps, with major financial institutions and monitor the amount of credit exposure to any one counterparty.

 

Note 10.  Earnings Per Common Share

 

As of March 31, 2012, we had 15,180,000 shares of series D cumulative convertible preferred shares that were convertible into 7,298,165 of our common shares.  The effect of our convertible preferred shares on income from continuing operations attributable to CommonWealth REIT common shareholders per share is anti-dilutive for the periods presented.

 

12



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

Note 11.  Segment Information

 

As of March 31, 2012, we owned 47 Central Business District, or CBD, office properties, 272 suburban office properties and 199 industrial & other properties.  We account for all of these properties in geographic operating segments for financial reporting purposes based on our method of internal reporting.  We account for our properties by property type (i.e. CBD office, suburban office and industrial & other) and by geographic regions.  We define these individual geographic segments as those which currently, or during either of the last two quarters, represent or generate 5% or more of our total square feet, annualized revenues or property net operating income, or NOI, which we define as rental income less operating expenses.  Our geographic segments include Metro Philadelphia, PA, Oahu, HI, Metro Chicago, IL, Metro Denver, CO, Metro Washington, DC and Other Markets, which includes properties located elsewhere throughout the United States and Australia.  Prior periods have been restated to reflect 12 office properties and one industrial property reclassified to discontinued operations from continuing operations during the third quarter of 2011, which were sold in 2011, and seven office properties and 20 industrial properties reclassified to continuing operations from discontinued operations during the fourth quarter of 2011.  Property level information by geographic segment and property type as of and for the three months ended March 31, 2012 and 2011 is as follows:

 

 

 

As of March 31, 2012

 

As of March 31, 2011

 

 

 

CBD

 

Suburban

 

Industrial &

 

 

 

CBD

 

Suburban

 

Industrial &

 

 

 

 

 

Office

 

Office

 

Other

 

Totals

 

Office

 

Office

 

Other

 

Totals

 

Property square feet (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Metro Philadelphia, PA

 

4,591

 

462

 

 

5,053

 

4,592

 

462

 

 

5,054

 

Oahu, HI

 

 

 

17,876

 

17,876

 

 

 

17,914

 

17,914

 

Metro Chicago, IL

 

3,591

 

1,164

 

104

 

4,859

 

 

1,163

 

104

 

1,267

 

Metro Denver, CO

 

672

 

789

 

553

 

2,014

 

672

 

788

 

553

 

2,013

 

Metro Washington, DC

 

428

 

1,220

 

 

1,648

 

428

 

1,067

 

 

1,495

 

Other Markets

 

10,416

 

18,515

 

13,744

 

42,675

 

7,781

 

18,265

 

13,761

 

39,807

 

Totals

 

19,698

 

22,150

 

32,277

 

74,125

 

13,473

 

21,745

 

32,332

 

67,550

 

 

 

 

Three Months Ended March 31, 2012

 

Three Months Ended March 31, 2011

 

 

 

CBD

 

Suburban

 

Industrial &

 

 

 

CBD

 

Suburban

 

Industrial &

 

 

 

 

 

Office

 

Office

 

Other

 

Totals

 

Office

 

Office

 

Other

 

Totals

 

Property rental income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Metro Philadelphia, PA

 

$

29,300

 

$

1,104

 

$

 

$

30,404

 

$

28,273

 

$

1,357

 

$

 

$

29,630

 

Oahu, HI

 

 

 

19,895

 

19,895

 

 

 

18,596

 

18,596

 

Metro Chicago, IL

 

24,575

 

5,863

 

111

 

30,549

 

 

7,793

 

126

 

7,919

 

Metro Denver, CO

 

5,554

 

3,498

 

2,095

 

11,147

 

5,363

 

3,490

 

2,184

 

11,037

 

Metro Washington, DC

 

4,019

 

6,867

 

 

10,886

 

3,456

 

5,925

 

 

9,381

 

Other Markets

 

57,773

 

70,969

 

19,623

 

148,365

 

44,887

 

70,254

 

18,969

 

134,110

 

Totals

 

$

121,221

 

$

88,301

 

$

41,724

 

$

251,246

 

$

81,979

 

$

88,819

 

$

39,875

 

$

210,673

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property net operating income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Metro Philadelphia, PA

 

$

15,584

 

$

103

 

$

 

$

15,687

 

$

14,256

 

$

156

 

$

 

$

14,412

 

Oahu, HI

 

 

 

15,514

 

15,514

 

 

 

13,421

 

13,421

 

Metro Chicago, IL

 

12,378

 

2,963

 

104

 

15,445

 

 

4,689

 

110

 

4,799

 

Metro Denver, CO

 

3,763

 

3,093

 

1,242

 

8,098

 

3,500

 

2,768

 

1,208

 

7,476

 

Metro Washington, DC

 

3,161

 

4,515

 

 

7,676

 

2,609

 

3,543

 

 

6,152

 

Other Markets

 

32,051

 

39,843

 

12,842

 

84,736

 

24,085

 

38,183

 

11,748

 

74,016

 

Totals

 

$

66,937

 

$

50,517

 

$

29,702

 

$

147,156

 

$

44,450

 

$

49,339

 

$

26,487

 

$

120,276

 

 

13



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

The following table reconciles our calculation of NOI to net income, the most directly comparable financial measure under GAAP reported in our condensed consolidated financial statements.  We define NOI as rental income from real estate including lease termination fees received from tenants less our property operating expenses including property marketing costs.  NOI excludes capitalized tenant improvement costs and leasing commissions.  We consider NOI to be appropriate supplemental information to net income because it may help both investors and management to understand the operations of our properties.  We use NOI internally to evaluate individual, regional and company wide property level performance and we believe NOI provides useful information to investors regarding our results of operations because it reflects only those income and expense items that are incurred at the property level and may facilitate comparisons of our operating performance between periods.  The calculation of NOI excludes certain components of net income in order to provide results that are more closely related to our properties’ results of operations.  This measure does not represent cash generated by operating activities in accordance with GAAP and should not be considered as an alternative to net income, net income attributable to CommonWealth REIT, net income available for CommonWealth REIT common shareholders, operating income or cash flow from operating activities determined in accordance with GAAP, or as an indicator of our financial performance or liquidity, nor is this measure necessarily indicative of sufficient cash flow to fund all of our needs.  We believe that this data may facilitate an understanding of our consolidated historical operating results.  This measure should be considered in conjunction with net income, net income attributable to CommonWealth REIT, net income available for CommonWealth REIT common shareholders, operating income and cash flow from operating activities as presented in our condensed consolidated statements of income and condensed consolidated statements of cash flows.  Other REITs and real estate companies may calculate NOI differently than us.  A reconciliation of NOI to net income for the three months ended March 31, 2012 and 2011 is as follows:

 

 

 

Three Months Ended March 31,

 

 

 

2012

 

2011

 

Rental income

 

$

251,246

 

$

210,673

 

Operating expenses

 

(104,090

)

(90,397

)

Property net operating income (NOI)

 

$

147,156

 

$

120,276

 

 

 

 

 

 

 

Property NOI

 

$

147,156

 

$

120,276

 

Depreciation and amortization

 

(61,351

)

(52,289

)

General and administrative

 

(12,310

)

(10,959

)

Acquisition related costs

 

(2,502

)

(2,559

)

Operating income

 

70,993

 

54,469

 

 

 

 

 

 

 

Interest and other income

 

288

 

708

 

Interest expense

 

(49,106

)

(47,414

)

Loss on early extinguishment of debt

 

(67

)

 

Equity in earnings of investees

 

2,958

 

2,712

 

Income from continuing operations before income tax expense

 

25,066

 

10,475

 

Income tax expense

 

(492

)

(346

)

Income from continuing operations

 

24,574

 

10,129

 

Income from discontinued operations

 

 

1,911

 

Net gain on sale of properties from discontinued operations

 

 

34,572

 

Net income

 

$

24,574

 

$

46,612

 

 

Note 12.  Related Person Transactions

 

We have no employees.  Personnel and various services we require to operate our business are provided to us by RMR.  We have two agreements with RMR to provide management and administrative services to us: (1) a business management agreement and (2) a property management agreement.  Management and administrative services to SIR and its subsidiaries are provided by RMR under separate business management and property management agreements with SIR, described below.  Under our business

 

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Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

management agreement with RMR, we acknowledge that RMR also provides management services to other companies, which include SNH, GOV and SIR.  One of our Managing Trustees, Mr. Barry Portnoy, is Chairman, majority owner and an employee of RMR.  Our other Managing Trustee, Mr. Adam Portnoy, who is also our President, is the son of Mr. Barry Portnoy, and an owner, President, Chief Executive Officer and a director of RMR.  Each of our other executive officers is also an officer of RMR.  SNH’s, GOV’s and SIR’s executive officers are officers of RMR and SNH’s President and Chief Operating Officer is also a director of RMR.  Our Independent Trustees also serve as independent directors or independent trustees of other public companies to which RMR provides management services.  Mr. Barry Portnoy serves as a managing director or managing trustee of those companies and Mr. Adam Portnoy serves as a managing trustee of a majority of those companies.

 

Pursuant to our business management agreement with RMR and the business management agreement between SIR and RMR (as described below), we incurred expenses of $10,383 and $9,228 for the three months ended March 31, 2012 and 2011, respectively.  These amounts are included in general and administrative expenses and income from discontinued operations, as appropriate, in our condensed consolidated financial statements.  In connection with our property management agreement with RMR and the property management agreement between SIR and RMR (as described below), we incurred property management and construction supervision fees of $7,924 and $6,842 for the three months ended March 31, 2012 and 2011, respectively.  These amounts are included in operating expenses or have been capitalized, as appropriate, in our condensed consolidated financial statements.

 

SNH was formerly our 100% owned subsidiary.  It was spun off to our shareholders in 1999.  As previously reported, we previously granted SNH a right of first refusal to purchase certain of our properties if we sought to sell them.  Between November 2010 and January 2011, we sold 27 properties (approximately 2,803,000 square feet), which were majority leased as medical office, clinic and biotech laboratory buildings, to SNH for an aggregate sale price of $470,000, excluding closing costs.  We recognized net gains totaling approximately $168,272 from these sales, including net gains totaling approximately $34,666 during the first quarter of 2011.  In September 2011, we sold to SNH 13 additional properties (approximately 1,310,000 square feet), which were located in eight states and majority leased as medical office buildings and to tenants in medical related businesses, for an aggregate sale price of $167,000, excluding closing costs, and we recognized net gains totaling $7,846 from these sales.  Certain of the properties included in these sales were subject to SNH’s right of first refusal referred to above.  In connection with our September 2011 sale of 13 properties to SNH, we and SNH terminated the existing SNH right of first refusal, as substantially all of the properties that were subject to that right of first refusal had been purchased by SNH.

 

As of the date of this report, SNH owned 250,000 of our common shares.  Our two Managing Trustees, Mr. Barry Portnoy and Mr. Adam Portnoy, are also managing trustees of SNH.  In addition, one of our Independent Trustees, Mr. Frederick Zeytoonjian, is also an independent trustee of SNH.

 

GOV was formerly our 100% owned subsidiary.  We are GOV’s largest shareholder and, as of the date of this report, we owned 9,950,000 common shares of GOV, which represented approximately 21.1% of GOV’s outstanding common shares.  Our two Managing Trustees, Mr. Barry Portnoy and Mr. Adam Portnoy, are also managing trustees of GOV, and our President, Mr. Adam Portnoy, was the President of GOV from its formation in 2009 until January 2011.

 

In 2009, GOV completed the GOV IPO pursuant to which GOV ceased to be a majority owned subsidiary of ours.  In connection with the GOV IPO, we and GOV entered into a transaction agreement which governs our separation from and relationship with GOV.  Pursuant to this transaction agreement, among other things, we granted GOV the right of first refusal to acquire any property owned by us that we determine to divest, if the property is then majority leased to a government tenant, including 15 properties we sold to GOV during 2010.

 

SIR was formerly our 100% owned subsidiary.  We are SIR’s largest shareholder and SIR continues to be one of our consolidated subsidiaries.  As of the date of this report, we owned 22,000,000 common shares of SIR, which represented approximately 70.5% of SIR’s outstanding common shares.  Our SIR common shares had a market value, based on quoted market prices, of $496,760 ($22.58 per share) as of March 31, 2012.  Our two Managing Trustees, Mr. Barry Portnoy and Mr. Adam Portnoy, are also managing trustees of SIR, and Mr. John Popeo, our Treasurer and Chief Financial Officer, also serves as the treasurer and chief financial officer of SIR.  In addition, one of our Independent Trustees, Mr. William Lamkin, is an independent trustee of SIR.

 

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COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

On March 12, 2012, SIR completed the SIR IPO, in which it issued 9,200,000 of its common shares (including 1,200,000 common shares sold pursuant to the underwriters’ over allotment option) for net proceeds (after deducting underwriters’ discounts and commissions and estimated expenses) of $180,954.  SIR applied those net proceeds, along with proceeds from drawings under SIR’s $500,000 revolving credit facility, to repay in full a $400,000 demand promissory note that we received from SIR on February 16, 2012.  SIR issued the $400,000 demand promissory note, along with 22,000,000 SIR common shares, in exchange for our transfer to SIR of 251 properties (approximately 21,400,000 rentable square feet).  SIR also reimbursed us for costs that we incurred in connection with SIR’s organization and preparation for the SIR IPO.  In connection with the SIR IPO, we and SIR entered into a transaction agreement that governs our separation from and relationship with SIR.  The transaction agreement provides that, among other things, (1) the current assets and liabilities of the 251 properties that we transferred to SIR, as of the time of closing of the SIR IPO, were settled between us and SIR so that we will retain all pre-closing current assets and liabilities and SIR will assume all post-closing current assets and liabilities and (2) SIR will indemnify us with respect to any liability relating to any property transferred by us to SIR, including any liability which relates to periods prior to SIR’s formation other than the pre-closing current assets and current liabilities that we retained with respect to the 251 transferred properties.

 

SIR is a party to a business management agreement and a property management agreement with RMR, under which RMR provides management and administrative services to SIR and its subsidiaries comparable to those provided to us.  Pursuant to its business management agreement with RMR, SIR incurred expenses of $247 for the period beginning on March 12, 2012, the date on which SIR entered into the agreement, through March 31, 2012.  These amounts are included in general and administrative expenses in our condensed consolidated financial statements.  In connection with its property management agreement with RMR, SIR incurred property management and construction supervision fees of $158 for the period beginning on March 12, 2012, the date on which SIR entered into the agreement, through March 31, 2012.  These amounts are included in operating expenses or have been capitalized, as appropriate, in our condensed consolidated financial statements.  At the time of the SIR IPO, our agreements with RMR were amended to avoid any payments by us for services rendered by RMR to SIR despite the fact that SIR’s operations are consolidated with us under GAAP.

 

We, RMR, SNH, GOV and three other companies to which RMR provides management services each currently own approximately 14.3% of AIC, an Indiana insurance company.  All of our Trustees, all of the trustees and directors of the other publicly held AIC shareholders and nearly all of the directors of RMR currently serve on the board of directors of AIC.  RMR provides management and administrative services to AIC pursuant to a management and administrative services agreement with AIC.  Although we own less than 20% of AIC, we use the equity method to account for this investment because we believe that we have significant influence over AIC because all of our Trustees are also directors of AIC.  We may invest additional amounts in AIC in the future if the expansion of this insurance business requires additional capital, but we are not obligated to do so.  In June 2010, we and the other shareholders of AIC purchased property insurance providing $500,000 of coverage pursuant to an insurance program arranged by AIC and with respect to which AIC is a reinsurer of certain coverage amounts.  This program was modified and extended in June 2011 for a one year term and we paid a premium of $5,540 in connection with that renewal, which amount may be adjusted from time to time in response to our acquisition and disposition of properties that are included in this program.  We currently expect that we will renew this program, as it may be modified, in June 2012.  We are also currently investigating the possibilities to expand our insurance relationships with AIC to include other types of insurance.  By participating in this insurance business with RMR and the other companies to which RMR provides management services, we expect that we may benefit financially by possibly reducing our insurance expenses or by realizing our pro-rata share of any profits of this insurance business.

 

For further information about these and other such relationships and related person transactions, please see elsewhere in this Quarterly Report on Form 10-Q, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Related Person Transactions” in Part I, Item 2 and “Warning Concerning Forward Looking Statements,” and our Annual Report, our Proxy Statement for our 2012 Annual Meeting of Shareholders dated February 28, 2012, or our Proxy Statement, our Current Report on Form 8-K dated March 12, 2012, or the March 12 Current Report, and our other filings with the SEC, including Note 9 to our Consolidated Financial Statements included in our Annual Report, the sections captioned “Business” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Related Person Transactions” and “Warning Concerning Forward Looking Statements” of our Annual Report and the section captioned “Related Person Transactions and Company Review of Such Transactions” and the information regarding our Trustees and executive officers in our Proxy Statement and Item 1.01 of the March 12 Current Report.  In addition, please see the section captioned “Risk Factors” of our Annual Report for a description of risks that may arise from these transactions and relationships.  Our filings with the SEC, including our

 

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Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

Annual Report and our Proxy Statement, are available at the SEC’s website at www.sec.gov.  In addition, copies of certain of our agreements with these parties, including our business management agreement and property management agreement with RMR and various agreements we have with SNH, GOV and SIR and our shareholder agreement with AIC and its shareholders, are also publicly available as exhibits to our public filings with the SEC and accessible at the SEC’s website.

 

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Table of Contents

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

The following discussion should be read in conjunction with our condensed consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q and our Annual Report.

 

OVERVIEW

 

The majority of our wholly owned properties are office and industrial buildings in CBD and suburban locations throughout the United States.  Our wholly owned property portfolio also includes 12.3 million square feet of industrial and other space and 1.8 million square feet of office and industrial buildings located in Australia.  Our consolidated subsidiary, SIR, owns 21.4 million square feet of primarily triple net leased, single tenant office and industrial properties, including 17.8 million square feet of leased industrial and commercial lands located on Oahu, Hawaii.

 

Property Operations

 

As of March 31, 2012, 84.8% of our total consolidated square feet was leased, compared to 84.3% leased as of March 31, 2011.  These results reflect stable occupancy at properties we owned continuously since January 1, 2011 and property acquisitions during 2011 and 2012.  Occupancy data for 2012 and 2011 is as follows (square feet in thousands):

 

 

 

All Properties

 

Comparable Properties(1)

 

 

 

As of the Three Months

 

As of the Three Months

 

 

 

Ended March 31,

 

Ended March 31,

 

 

 

2012

 

2011

 

2012

 

2011

 

Total properties

 

518

 

517

 

494

 

494

 

Total square feet

 

74,125

 

67,550

 

65,554

 

65,554

 

Percent leased(2)

 

84.8

%

84.3

%

83.9

%

83.9

%

 


(1)       Based on properties owned continuously since January 1, 2011.

(2)       Percent leased includes (i) space being fitted out for occupancy pursuant to existing leases and (ii) space which is leased but is not occupied or is being offered for sublease by tenants.

 

The average effective rental rate per square foot, as defined below, for our properties for the three months ended March 31, 2012 and 2011 are as follows:

 

 

 

Average Effective Rental Rate

 

 

 

Per Square Foot(1)

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2012

 

2011

 

CBD office buildings

 

$

29.55

 

$

29.15

 

Suburban office buildings

 

$

21.17

 

$

21.24

 

Industrial properties (including Hawaii land leases)

 

$

5.93

 

$

5.67

 

Consolidated portfolio

 

$

16.41

 

$

15.02

 

 


(1)       Average effective rental rate per square foot represents total rental income during the period specified adjusted for tenant concessions including free rent and tenant reimbursements divided by the average rentable square feet occupied during the period specified.

 

During the three months ended March 31, 2012, we renewed leases for 904,000 square feet and entered new leases for 1,021,000 square feet, at weighted average rental rates that were 8% below rents previously charged for the same space.  The average lease term for leases entered during 2012 was 6.3 years.  Commitments for tenant improvements, leasing costs and concessions for leases entered during 2012 totaled $37.3 million, or $19.39 per square foot on average (approximately $3.08/sq. ft. per year of the lease term).

 

During the past twelve months, leasing market conditions in the majority of our markets appear to be stabilizing but remain weak.  Required landlord funded tenant build outs, or tenant improvements, leasing commissions payable by landlords to tenant

 

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Table of Contents

 

brokers for new leases and lease renewals and concessions granted to tenants, such as free rent, have increased in certain markets since 2008.  Tenant improvements and leasing commissions are generally amortized during the terms of the affected leases.  We believe that the current high unemployment rate and weak leasing market conditions in the U.S. may lead to decreases in occupancy and effective rents, or gross rents less amortization of landlord funded tenant improvements and leasing costs, at our properties through the majority of 2012, but we expect our occupancy may begin to improve in late 2012 and 2013.  However, there are too many variables for us to reasonably project what the financial impact of changing market conditions will be on our occupancy or financial results for future periods.

 

As of March 31, 2012, approximately 16.9% of our leased square feet and 18.0% of our annualized rents, determined as set forth below, are included in leases scheduled to expire through December 31, 2013.  Lease renewals and rental rates at which available space may be relet in the future will depend on prevailing market conditions at the times these renewals are negotiated.  Lease expirations by year, as of March 31, 2012, are as follows (square feet and dollars in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cumulative

 

 

 

 

 

 

 

 

 

 

 

 

 

% of

 

% of

 

 

 

 

 

 

 

 

 

Cumulative

 

Annualized

 

Annualized

 

Annualized

 

 

 

Number

 

Square

 

% of

 

% of Square

 

Rental

 

Rental

 

Rental

 

 

 

of Tenants

 

Feet

 

Square Feet

 

Feet

 

Income

 

Income

 

Income

 

Year

 

Expiring

 

Expiring(1)

 

Expiring

 

Expiring

 

Expiring(2)

 

Expiring

 

Expiring

 

2012

 

592

 

4,980

 

7.9

%

7.9

%

$

88,229

 

8.6

%

8.6

%

2013

 

425

 

5,642

 

9.0

%

16.9

%

96,298

 

9.4

%

18.0

%

2014

 

337

 

4,869

 

7.7

%

24.6

%

78,165

 

7.6

%

25.6

%

2015

 

341

 

5,128

 

8.2

%

32.8

%

113,324

 

11.0

%

36.6

%

2016

 

307

 

6,750

 

10.7

%

43.5

%

109,399

 

10.6

%

47.2

%

2017

 

208

 

3,986

 

6.3

%

49.8

%

97,914

 

9.5

%

56.7

%

2018

 

82

 

3,806

 

6.1

%

55.9

%

81,407

 

7.9

%

64.6

%

2019

 

75

 

3,968

 

6.3

%

62.2

%

51,867

 

5.1

%

69.7

%

2020

 

59

 

2,938

 

4.7

%

66.9

%

77,295

 

7.5

%

77.2

%

2021

 

55

 

2,330

 

3.7

%

70.6

%

42,556

 

4.1

%

81.3

%

Thereafter

 

204

 

18,470

 

29.4

%

100.0

%

192,251

 

18.7

%

100.0

%

 

 

2,685

 

62,867

 

100.0

%

 

 

$

1,028,705

 

100.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average remaining lease term (in years):

 

 

 

7.8

 

 

 

 

 

6.2

 

 

 

 

 

 


(1)             Square feet is pursuant to existing leases as of March 31, 2012, and includes (i) space being fitted out for occupancy and (ii) space which is leased but is not occupied or is being offered for sublease by tenants.

(2)             Annualized rental income is rents pursuant to existing leases as of March 31, 2012, plus estimated expense reimbursements; includes some triple net lease rents and excludes lease value amortization.

 

RMR employs a tenant review process for us.  RMR assesses tenants on an individual basis and does not employ a uniform set of credit criteria.  In general, depending on facts and circumstances, RMR evaluates the creditworthiness of a tenant based on information concerning the tenant that is provided by the tenant and, in some cases, information that is publicly available or obtained from third party sources.  RMR also often uses a third party service to monitor the credit ratings of debt securities of our existing tenants whose debt securities are rated by a nationally recognized statistical rating organization.

 

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Table of Contents

 

Our principal source of funds for our operations is rents from tenants at our properties.  Rents are generally received from our tenants monthly in advance, except from our government tenants, who usually pay rents monthly in arrears.  As of March 31, 2012, tenants responsible for 1% or more of our total annualized rental income were as follows (square feet in thousands):

 

 

 

 

 

 

 

 

 

% of

 

 

 

 

 

 

 

 

 

 

 

Annualized

 

 

 

 

 

 

 

Square

 

% of Total

 

Rental

 

 

 

Tenant

 

Feet(1)

 

Square Feet

 

Income(2)

 

Expiration

 

 

 

 

 

 

 

 

 

 

 

 

 

1.

 

Telstra Corporation Limited

 

311

 

0.5

%

2.0

%

2020

 

2.

 

U.S. Government(3)

 

635

 

1.0

%

1.8

%

2012 to 2032

 

3.

 

Expedia, Inc.

 

365

 

0.6

%

1.7

%

2018

 

4.

 

Office Depot, Inc.

 

651

 

1.0

%

1.7

%

2016 and 2023

 

5.

 

John Wiley & Sons, Inc.

 

342

 

0.5

%

1.6

%

2017

 

6.

 

PNC Financial Services Group

 

593

 

0.9

%

1.5

%

2012 to 2021

 

7.

 

Wells Fargo Bank

 

569

 

0.9

%

1.4

%

2012 to 2022

 

8.

 

GlaxoSmithKline plc

 

607

 

1.0

%

1.4

%

2013

 

9.

 

United Healthcare Services Inc.

 

555

 

0.9

%

1.2

%

2012 to 2023

 

10.

 

Royal Dutch Shell plc

 

631

 

1.0

%

1.2

%

2012 and 2016

 

11.

 

The Bank of New York Mellon Corp.

 

393

 

0.6

%

1.1

%

2015 to 2021

 

12.

 

Jones Day (law firm)

 

403

 

0.6

%

1.1

%

2012 and 2026

 

Total

 

6,055

 

9.5

%

17.7

%

 

 

 


(1)       Square feet is pursuant to existing leases as of March 31, 2012, and includes (i) space being fitted out for occupancy and (ii) space which is leased but is not occupied or is being offered for sublease by tenants.

(2)       Annualized rental income is rents pursuant to existing leases as of March 31, 2012, plus estimated expense reimbursements; includes some triple net lease rents and excludes lease value amortization.

(3)       Including our 21.1% pro rata ownership of GOV as of March 31, 2012, the U.S. Government represents 1,865 square feet, or 2.9% of our total square feet, and 4.4% of our total rental income.

 

Investment Activities

 

Since January 1, 2012, we have acquired two office properties with a combined 1,878,335 square feet for an aggregate purchase price of $252.1 million, including the assumption of $147.9 million of mortgage debt and excluding closing costs.  At the time of acquisition, these properties were 96.1% leased for a weighted average (by rents) term of 6.2 years and at rents which yielded approximately 9.1% of the aggregate gross purchase price, based on estimated annual NOI, which we define as GAAP rental income, excluding adjustments for above and below market lease value amortization, less property operating expenses, on the date of closing.

 

SIR was formerly our 100% owned subsidiary.  On March 12, 2012, SIR completed the SIR IPO, in which it issued 9,200,000 of its common shares (including 1,200,000 common shares sold pursuant to the underwriters’ over allotment option) for net proceeds (after deducting underwriters’ discounts and commissions and estimated expenses) of $181.0 million.  We are SIR’s largest shareholder and, as of the date of this report, we owned 22,000,000 common shares of SIR, which represented approximately 70.5% of SIR’s outstanding common shares.  Our SIR common shares had a market value, based on quoted market prices, of $496.8 million ($22.58 per share) as of March 31, 2012.

 

Since completing the SIR IPO on March 12, 2012, SIR has entered agreements to acquire two properties for an aggregate purchase price of $104.4 million, excluding closing costs.  We understand that SIR currently expects that it will acquire these properties during the remainder of 2012; however, these acquisitions are subject to SIR’s satisfactory completion of diligence and other customary closing conditions.  Accordingly, we can provide no assurance that SIR will acquire all or any of these properties in that time period or at all.

 

Financing Activities

 

In January 2012, we prepaid at par all $150.7 million of our 6.95% senior notes due 2012, using cash on hand and borrowings under our revolving credit facility.  In connection with this prepayment, we recorded a loss on early extinguishment of debt of $67,000 from the write off of unamortized discounts and deferred financing fees.

 

In February 2012, we repaid at maturity $5.4 million of 7.31% mortgage debt using cash on hand.