XNYS:CWH CommonWealth REIT Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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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 June 30, 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 August 6, 2012: 83,732,451.

 

 

 


 


Table of Contents

 

COMMONWEALTH REIT

 

FORM 10-Q

 

June 30, 2012

 

INDEX

 

 

 

Page

PART I

Financial Information

 

 

 

 

Item 1.

Financial Statements (unaudited)

 

 

 

 

 

Condensed Consolidated Balance Sheets — June 30, 2012 and December 31, 2011

1

 

 

 

 

Condensed Consolidated Statements of Income — Three and Six Months Ended June 30, 2012 and 2011

2

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income — Three and Six Months Ended June 30, 2012 and 2011

3

 

 

 

 

Condensed Consolidated Statements of Cash Flows — Six Months Ended June 30, 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

20

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

36

 

 

 

Item 4.

Controls and Procedures

38

 

 

 

 

Warning Concerning Forward Looking Statements

39

 

 

 

 

Statement Concerning Limited Liability

42

 

 

 

PART II

Other Information

 

 

 

 

Item 1A.

Risk Factors

43

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

43

 

 

 

Item 6.

Exhibits

43

 

 

 

 

Signatures

46

 

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.

 

SIR 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)

 

 

 

June 30,

 

December 31,

 

 

 

2012

 

2011

 

ASSETS

 

 

 

 

 

Real estate properties:

 

 

 

 

 

Land

 

$

1,514,341

 

$

1,450,154

 

Buildings and improvements

 

6,127,544

 

5,794,078

 

 

 

7,641,885

 

7,244,232

 

Accumulated depreciation

 

(1,005,517

)

(934,170

)

 

 

6,636,368

 

6,310,062

 

Acquired real estate leases, net

 

364,282

 

343,917

 

Equity investments

 

180,237

 

177,477

 

Cash and cash equivalents

 

138,805

 

192,763

 

Restricted cash

 

14,329

 

7,869

 

Rents receivable, net of allowance for doubtful accounts of $12,427 and $12,575, respectively

 

236,001

 

217,592

 

Other assets, net

 

228,562

 

197,346

 

Total assets

 

$

7,798,584

 

$

7,447,026

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Revolving credit facility

 

$

 

$

100,000

 

SIR revolving credit facility

 

321,000

 

 

Senior unsecured debt, net

 

2,695,152

 

2,845,030

 

Mortgage notes payable, net

 

801,709

 

632,301

 

Accounts payable and accrued expenses

 

158,044

 

158,272

 

Assumed real estate lease obligations, net

 

69,237

 

70,179

 

Rent collected in advance

 

32,163

 

37,653

 

Security deposits

 

24,489

 

23,779

 

Due to related persons

 

14,664

 

11,295

 

Total liabilities

 

4,116,458

 

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 shares 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; 83,730,451 and 83,721,736 shares issued and outstanding, respectively

 

837

 

837

 

Additional paid in capital

 

3,590,410

 

3,614,079

 

Cumulative net income

 

2,522,066

 

2,482,321

 

Cumulative other comprehensive loss

 

(6,073

)

(4,709

)

Cumulative common distributions

 

(2,909,752

)

(2,826,030

)

Cumulative preferred distributions

 

(504,123

)

(476,657

)

Total shareholders’ equity attributable to CommonWealth REIT

 

3,472,041

 

3,568,517

 

Noncontrolling interest

 

210,085

 

 

Total shareholders’ equity

 

3,682,126

 

3,568,517

 

Total liabilities and shareholders’ equity

 

$

7,798,584

 

$

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

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

Rental income

 

$

255,374

 

$

217,938

 

$

506,620

 

$

428,611

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Operating expenses

 

108,093

 

90,623

 

212,183

 

181,020

 

Depreciation and amortization

 

63,552

 

50,394

 

124,903

 

102,683

 

General and administrative

 

13,364

 

11,624

 

25,674

 

22,583

 

Acquisition related costs

 

1,434

 

2,358

 

3,936

 

4,917

 

Total expenses

 

186,443

 

154,999

 

366,696

 

311,203

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

68,931

 

62,939

 

139,924

 

117,408

 

 

 

 

 

 

 

 

 

 

 

Interest and other income

 

413

 

367

 

701

 

1,075

 

Interest expense (including net amortization of debt discounts, premiums and deferred financing fees of $1,005, $1,920, $1,751 and $3,952, respectively)

 

(50,237

)

(48,200

)

(99,343

)

(95,614

)

Loss on early extinguishment of debt

 

(1,608

)

 

(1,675

)

 

Equity in earnings of investees

 

2,829

 

2,910

 

5,787

 

5,622

 

Income from continuing operations before income tax expense

 

20,328

 

18,016

 

45,394

 

28,491

 

Income tax expense

 

(92

)

(90

)

(584

)

(436

)

Income from continuing operations

 

20,236

 

17,926

 

44,810

 

28,055

 

Discontinued operations:

 

 

 

 

 

 

 

 

 

Income from discontinued operations

 

 

2,038

 

 

3,949

 

Net gain on sale of properties from discontinued operations

 

 

 

 

34,572

 

Income before gain on sale of properties

 

20,236

 

19,964

 

44,810

 

66,576

 

Gain on sale of properties

 

350

 

 

350

 

 

Net income

 

20,586

 

19,964

 

45,160

 

66,576

 

Net income attributable to noncontrolling interest

 

(4,521

)

 

(5,415

)

 

Net income attributable to CommonWealth REIT

 

16,065

 

19,964

 

39,745

 

66,576

 

Preferred distributions

 

(13,823

)

(10,500

)

(27,646

)

(19,339

)

Net income available for CommonWealth REIT common shareholders

 

$

2,242

 

$

9,464

 

$

12,099

 

$

47,237

 

 

 

 

 

 

 

 

 

 

 

Amounts attributable to CommonWealth REIT common shareholders:

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

2,242

 

$

7,426

 

$

12,099

 

$

8,716

 

Income from discontinued operations

 

 

2,038

 

 

3,949

 

Net gain on sale of properties from discontinued operations

 

 

 

 

34,572

 

Net income

 

$

2,242

 

$

9,464

 

$

12,099

 

$

47,237

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding — basic and diluted

 

83,727

 

72,144

 

83,724

 

72,142

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

0.03

 

$

0.10

 

$

0.14

 

$

0.12

 

Income from discontinued operations

 

$

 

$

0.03

 

$

 

$

0.53

 

Net income available for common shareholders

 

$

0.03

 

$

0.13

 

$

0.14

 

$

0.65

 

 

See accompanying notes.

 

2



Table of Contents

 

COMMONWEALTH REIT

 

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(amounts in thousands)

(unaudited)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

20,586

 

$

19,964

 

$

45,160

 

$

66,576

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

Unrealized loss on derivative instruments

 

(2,404

)

(4,119

)

(2,441

)

(2,074

)

Realized gain on sale of investment in available for sale securities

 

 

 

 

(18

)

Foreign currency translation adjustments

 

(3,447

)

11,343

 

1,081

 

15,705

 

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

 

(3

)

40

 

(4

)

44

 

Total comprehensive income

 

14,732

 

27,228

 

43,796

 

80,233

 

 

 

 

 

 

 

 

 

 

 

Less: comprehensive income attributable to noncontrolling interest

 

(4,521

)

 

(5,415

)

 

Comprehensive income attributable to CommonWealth REIT

 

$

10,211

 

$

27,228

 

$

38,381

 

$

80,233

 

 

See accompanying notes.

 

3



Table of Contents

 

COMMONWEALTH REIT

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(amounts in thousands)

(unaudited)

 

 

 

Six Months Ended June 30,

 

 

 

2012 

 

2011 

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

45,160

 

$

66,576

 

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

 

 

 

 

 

Depreciation

 

90,680

 

80,722

 

Net amortization of debt discounts, premiums and deferred financing fees

 

1,751

 

3,952

 

Straight line rental income

 

(17,991

)

(16,017

)

Amortization of acquired real estate leases

 

29,422

 

20,145

 

Other amortization

 

9,815

 

8,094

 

Loss on early extinguishment of debt

 

1,675

 

 

Equity in earnings of investees

 

(5,787

)

(5,622

)

Distributions of earnings from investees

 

5,592

 

5,539

 

Net gain on sale of properties

 

(350

)

(34,572

)

Change in assets and liabilities:

 

 

 

 

 

Increase in restricted cash

 

(4,339

)

(27

)

Increase in rents receivable and other assets

 

(17,943

)

(8,407

)

Increase in accounts payable and accrued expenses

 

2,429

 

4,964

 

(Decrease) increase in rent collected in advance

 

(5,493

)

2,602

 

Increase in security deposits

 

713

 

772

 

Increase in due to related persons

 

3,369

 

2,622

 

Cash provided by operating activities

 

138,703

 

131,343

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Real estate acquisitions

 

(253,710

)

(499,490

)

Real estate improvements

 

(50,636

)

(41,264

)

Investment in direct financing lease, net

 

 

(38,635

)

Principal payments received from direct financing lease

 

3,283

 

2,050

 

Principal payments received from real estate mortgage receivable

 

 

209

 

Proceeds from sale of properties, net

 

338

 

97,362

 

Distributions in excess of earnings from investees

 

2,766

 

2,720

 

Investment in Affiliates Insurance Company

 

(5,335

)

 

Increase in restricted cash

 

(2,121

)

 

Cash used in investing activities

 

(305,415

)

(477,048

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Proceeds from issuance of common shares, net

 

180,814

 

 

Proceeds from issuance of preferred shares, net

 

 

265,804

 

Proceeds from borrowings

 

444,500

 

485,000

 

Payments on borrowings

 

(395,250

)

(454,596

)

Deferred financing fees

 

(6,049

)

(273

)

Distributions to common shareholders

 

(83,722

)

(72,139

)

Distributions to preferred shareholders

 

(27,466

)

(17,679

)

Cash provided by financing activities

 

112,827

 

206,117

 

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

(73

)

583

 

 

 

 

 

 

 

Decrease in cash and cash equivalents

 

(53,958

)

(139,005

)

Cash and cash equivalents at beginning of period

 

192,763

 

194,040

 

Cash and cash equivalents at end of period

 

$

138,805

 

$

55,035

 

 

 

 

 

 

 

SUPPLEMENTAL CASH FLOW INFORMATION:

 

 

 

 

 

Interest paid

 

$

99,227

 

$

91,033

 

Taxes paid

 

536

 

381

 

 

 

 

 

 

 

NON-CASH INVESTING ACTIVITIES:

 

 

 

 

 

Real estate acquisitions

 

$

(176,884

)

$

(60,294

)

Investment in real estate mortgages receivable

 

(1,419

)

 

 

 

 

 

 

 

NON-CASH FINANCING ACTIVITIES:

 

 

 

 

 

Issuance of common shares

 

$

187

 

$

265

 

Assumption of mortgage notes payable

 

176,884

 

56,235

 

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 28 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 13 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

 

In this Note 3, references to we, us, our or CWH refer to CWH and its consolidated subsidiaries other than SIR and its consolidated subsidiaries, unless noted otherwise.

 

During the six months ended June 30, 2012, we (including SIR) acquired five properties with a combined 2,594,248 square feet for an aggregate purchase price of $405,500, including the assumption of $176,884 of mortgage debt and excluding closing costs.  We (including SIR) also funded $47,932 of improvements to our properties during the six months ended June 30, 2012.  In addition, since June 30, 2012, SIR acquired three properties with a combined 412,271 square feet for an aggregate purchase price of $46,575, excluding closing costs.  As of August 6, 2012, we (including SIR) have also entered into agreements to acquire seven properties with

 

5



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

a combined 2,968,822 square feet for an aggregate purchase price of $365,200, including the assumption of approximately $182,600 of mortgage debt and excluding closing costs.  Details of completed acquisitions during 2012 to date are as follows:

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CWH (excluding SIR) Acquisitions:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

May 2012

 

Austin, TX

 

170,052

 

49,000

 

7,900

 

38,533

 

4,733

 

30

 

29,012

 

2,136

 

 

 

 

 

2,048,387

 

301,100

 

54,230

 

214,662

 

52,464

 

5,662

 

176,884

 

14,594

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SIR Acquisitions:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 2012

 

Provo, UT

 

405,699

 

85,500

 

6,700

 

78,800

 

 

 

 

 

June 2012

 

Englewood, CO

 

140,162

 

18,900

 

3,230

 

11,801

 

3,869

 

 

 

 

 

 

 

 

545,861

 

104,400

 

9,930

 

90,601

 

3,869

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2,594,248

 

$

405,500

 

$

64,160

 

$

305,263

 

$

56,333

 

$

5,662

 

$

176,884

 

$

14,594

 

 


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

 

In July 2012, SIR acquired three properties with a combined 412,271 square feet for an aggregate purchase price of $46,575, excluding 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.

 

Our and SIR’s Pending Acquisitions:

 

In May 2012, we entered into an agreement to acquire an office property located in Columbia, SC with 333,708 square feet.  The purchase price is $60,000, including the assumption of approximately $40,600 of mortgage debt and excluding closing costs.  We currently expect to acquire this property during the third 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.

 

Also in May 2012, we entered into an agreement to acquire two office properties located in Indianapolis, IN with a combined 1,058,258 square feet.  The aggregate purchase price is $195,500, including the assumption of approximately $116,000 of mortgage debt and excluding closing costs.  We currently expect to acquire these properties during the third 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 these properties in that time period or at all.

 

In addition, as of August 6, 2012, SIR has entered into agreements to acquire four properties with a combined 1,576,856 square feet for an aggregate purchase price of $109,700, including the assumption of approximately $26,000 of mortgage debt and excluding closing costs.  We understand that SIR currently expects that it will acquire these properties during the remainder of 2012;

 

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Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

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.

 

Property Sales:

 

In April 2012, we sold an office property located in Salina, NY with 12,934 square feet for $575, excluding closing costs.  In connection with this sale, we provided mortgage financing to the buyer, an unrelated third party, totaling $419 at 6.0% per annum and recognized a gain on sale of $158.  In June 2012, we sold an office property located in Santa Fe, NM with 76,978 square feet for $1,250, excluding closing costs.  We provided mortgage financing to the buyer, an unrelated third party, totaling $1,000 at 5.0% per annum and recognized a gain on sale of $192.

 

As of June 30, 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, if such results are material.  Results of operations for the properties sold during 2012 are not material to our consolidated results of operations and are not included in discontinued operations.  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.  Summarized income statement information for the three and six months ended June 30, 2011, for properties sold in 2011 is as follows:

 

Income Statement:

 

 

 

Three Months

 

Six Months

 

 

 

Ended

 

Ended

 

 

 

June 30, 2011

 

June 30, 2011

 

Rental income

 

$

6,614

 

$

13,853

 

Operating expenses

 

(2,706

)

(6,144

)

Depreciation and amortization

 

(1,579

)

(3,131

)

General and administrative

 

(235

)

(489

)

Acquisition related costs

 

(57

)

(143

)

Operating income

 

2,037

 

3,946

 

 

 

 

 

 

 

Interest income

 

1

 

3

 

Income from discontinued operations

 

$

2,038

 

$

3,949

 

 

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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 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 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:

 

 

 

June 30,

 

December 31,

 

 

 

2012

 

2011

 

Total minimum lease payments receivable

 

$

35,133

 

$

39,182

 

Estimated unguaranteed residual value of leased asset

 

4,951

 

4,951

 

Unearned income

 

(9,988

)

(10,754

)

Net investment in direct financing lease

 

$

30,096

 

$

33,379

 

 

Additionally, we have determined that no allowance for losses related to our direct financing lease was necessary at June 30, 2012.  Our direct financing lease has an expiration date in 2045.

 

Note 5.  Equity Investments

 

At June 30, 2012 and December 31, 2011, we had the following equity investments in Government Properties Income Trust, or GOV, and Affiliates Insurance Company, or AIC (including 100% attribution of SIR’s 12.5% equity ownership interest in AIC):

 

 

 

Ownership Percentage

 

Equity Investments

 

Equity in Earnings

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

December 31,

 

June 30,

 

December 31,

 

June 30,

 

June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

2012

 

2011

 

2012

 

2011

 

GOV

 

21.1

%

21.1

%

$

169,421

 

$

172,186

 

$

2,680

 

$

2,864

 

$

5,593

 

$

5,539

 

AIC

 

25.0

%

14.3

%

10,816

 

5,291

 

149

 

46

 

194

 

83

 

 

 

 

 

 

 

$

180,237

 

$

177,477

 

$

2,829

 

$

2,910

 

$

5,787

 

$

5,622

 

 

At June 30, 2012, we owned  9,950,000, or approximately 21.1%, of the common shares of beneficial interest of GOV, with a carrying value of $169,421 and a market value, based on quoted market prices, of $225,069 ($22.62 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 consolidated 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 as of the GOV IPO 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 six months ended June 30, 2012 and 2011, we received cash distributions from GOV totaling $8,358 and $8,259, respectively.

 

8


 

 


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 June 30, 2012.  References in our financial statements to the Quarterly Report on Form 10-Q for GOV are included as references to the source of the data 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:

 

 

 

June 30,

 

December 31,

 

 

 

 

 

 

 

2012

 

2011

 

 

 

 

 

Real estate properties, net

 

$

1,211,295

 

$

1,198,050

 

 

 

 

 

Acquired real estate leases, net

 

110,805

 

117,596

 

 

 

 

 

Cash and cash equivalents

 

1,394

 

3,272

 

 

 

 

 

Rents receivable, net

 

27,086

 

29,000

 

 

 

 

 

Other assets, net

 

32,244

 

20,657

 

 

 

 

 

Total assets

 

$

1,382,824

 

$

1,368,575

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unsecured revolving credit facility

 

$

27,000

 

$

345,500

 

 

 

 

 

Unsecured term loan

 

350,000

 

 

 

 

 

 

Mortgage notes payable

 

94,271

 

95,383

 

 

 

 

 

Assumed real estate lease obligations, net

 

10,721

 

11,262

 

 

 

 

 

Other liabilities

 

22,530

 

24,762

 

 

 

 

 

Shareholders’ equity

 

878,302

 

891,668

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

1,382,824

 

$

1,368,575

 

 

 

 

 

 

Condensed Consolidated Statements of Income:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Rental income

 

$

50,273

 

$

42,107

 

$

100,728

 

$

81,335

 

Operating expenses

 

(19,144

)

(15,437

)

(37,365

)

(30,322

)

Depreciation and amortization

 

(12,153

)

(9,097

)

(24,225

)

(17,483

)

Acquisition related costs

 

(245

)

(1,009

)

(294

)

(1,838

)

General and administrative

 

(2,719

)

(2,566

)

(5,758

)

(4,909

)

Operating income

 

16,012

 

13,998

 

33,086

 

26,783

 

 

 

 

 

 

 

 

 

 

 

Interest and other income

 

6

 

20

 

14

 

35

 

Interest expense

 

(4,096

)

(3,076

)

(8,119

)

(5,613

)

Equity in earnings of an investee

 

76

 

46

 

121

 

83

 

Income before income tax expense

 

11,998

 

10,988

 

25,102

 

21,288

 

Income tax expense

 

(44

)

(56

)

(89

)

(102

)

Net income

 

$

11,954

 

$

10,932

 

$

25,013

 

$

21,186

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

47,098

 

40,506

 

47,075

 

40,503

 

 

 

 

 

 

 

 

 

 

 

Net income per common share

 

$

0.25

 

$

0.27

 

$

0.53

 

$

0.52

 

 

As of June 30, 2012, we and SIR have invested $10,544 in AIC, an insurance company owned in equal proportion by Reit Management & Research LLC, our business and property manager, or RMR, us (excluding SIR’s AIC interest), SIR and five other companies to which RMR provides management services, including GOV and Senior Housing Properties Trust, or SNH.  We and SIR may invest additional amounts in AIC in the future if the expansion of this insurance business requires additional capital, but we and SIR are not obligated to do so.  At June 30, 2012, we and SIR each owned 12.5% of AIC with a combined carrying value of $10,816.  We and SIR use the equity method to account for this investment because we and SIR believe that we each have significant influence

 

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Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

over AIC because four of our Trustees and all of SIR’s trustees are also directors of AIC.  Under the equity method, we record our and SIR’s percentage share of net earnings from AIC in our 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 13 for additional information about our and SIR’s investment in AIC.

 

Note 6.  Real Estate Mortgages Receivable

 

We provided mortgage financing totaling $419 at 6.0% per annum in connection with an office property sold in April 2012.  This real estate mortgage requires monthly interest payments and matures on April 30, 2019.  We also provided mortgage financing totaling $1,000 at 5.0% per annum in connection with an office property sold in June 2012.  This real estate mortgage requires monthly interest payments and matures on July 1, 2017.  As of June 30, 2012, these mortgages had a carrying value of $1,419 that was included in other assets in our condensed consolidated balance sheet.

 

Note 7.  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.

 

Also 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.

 

In May 2012, we prepaid at par $12,720 of 6.06% mortgage debt using cash on hand.  In connection with this prepayment, we recorded a loss on early extinguishment of debt of $1,608 from the write off of unamortized discounts and deferred financing fees.

 

Also, in May 2012, we assumed a mortgage totaling $29,012, which was recorded at a fair value of $31,148, in connection with an acquisition of a property.  This mortgage bears interest at a rate of 5.69%, requires monthly principal and interest payments and matures in 2021.

 

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 2.2% per annum for the six months ended June 30, 2012 and 2011, respectively.  As of June 30, 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, that is available to SIR for general business purposes, including acquisitions.  The SIR revolving credit facility is scheduled to mature on March 11, 2016 and subject to SIR’s payment of a fee and meeting certain other conditions, SIR has the option to extend the stated maturity date by one year.  Interest under the SIR revolving credit facility is calculated at floating rates based upon LIBOR plus premiums that vary depending upon certain factors, including SIR’s leverage.  The interest rate on the SIR revolving credit facility averaged 1.5% for the six months ended June 30, 2012.  As of June 30, 2012, SIR had $321,000 outstanding and $179,000 available under the SIR revolving credit facility.  In July 2012, SIR amended the SIR revolving credit facility to terminate the pledge of equity of certain of SIR’s subsidiaries.

 

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

 

10



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

or SIR’s ability to make distributions under certain circumstances.  At June 30, 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 June 30, 2012, 21 properties costing $1,064,267 with an aggregate net book value of $944,552 were secured by mortgage notes totaling $801,709 (net of discounts and premiums) maturing from 2012 through 2026.

 

In July 2012, we prepaid at par all $190,980 of our 6.50% unsecured senior notes due 2013, using cash on hand and borrowings under our revolving credit facility.

 

Also in July 2012, we issued $175,000 of unsecured senior notes in a public offering, raising net proceeds of approximately $169,100.  These notes bear interest at 5.75%, require quarterly interest payments and mature in August 2042.  We used the net proceeds from these notes to repay amounts outstanding under our revolving credit facility and deposited the excess proceeds in short term investments.  Shortly after the closing of this transaction, we issued a notice to redeem all 6,000,000 of our 7 1/8% series C preferred shares for $25.00 each plus accrued and unpaid distributions.  We expect to fund this redemption in August 2012 with cash on hand and borrowings under our revolving credit facility.

 

Also in July 2012, SIR entered into a five year $350,000 unsecured term loan, or the SIR term loan, with a group of institutional lenders.  The SIR term loan matures on July 11, 2017 and is prepayable without penalty at any time.  In addition, the SIR term loan includes a feature under which maximum borrowings may be increased to up to $700,000 in certain circumstances.  SIR used the net proceeds of the SIR term loan to repay amounts outstanding under the SIR revolving credit facility and for general business activities, including acquisitions.  Interest on the SIR term loan will be calculated at floating rates based upon LIBOR plus premiums that vary based upon certain factors, including SIR’s leverage.

 

Note 8.  Shareholders’ Equity

 

The following is a reconciliation of changes in our shareholders’ equity for the six months ended June 30, 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

 

39,745

 

5,415

 

45,160

 

 

 

 

 

 

 

 

 

Other comprehensive income:

 

 

 

 

 

 

 

Unrealized loss on derivative instrument

 

(2,441

)

 

(2,441

)

Foreign currency translation adjustments

 

1,081

 

 

1,081

 

Decrease in share of investees other comprehensive loss

 

(4

)

 

(4

)

Total comprehensive income

 

38,381

 

5,415

 

43,796

 

 

 

 

 

 

 

 

 

Issuance of shares of subsidiary, net

 

(23,856

)

204,670

 

180,814

 

Share grants

 

187

 

 

187

 

Distributions

 

(111,188

)

 

(111,188

)

Balance at June 30, 2012

 

$

3,472,041

 

$

210,085

 

$

3,682,126

 

 

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.

 

11



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

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.

 

On May 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 May 1, 2012.

 

On May 24, 2012, we paid a distribution on our common shares of $0.50 per share, or $41,861, to shareholders of record on April 23, 2012.

 

In July 2012, we declared a distribution of $0.50 per common share, or approximately $41,900, to be paid on or about August 24, 2012 to shareholders of record on July 26, 2012.  We also announced in July 2012 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 August 15, 2012 to our preferred shareholders of record as of August 1, 2012.

 

Also in July 2012, SIR declared a distribution of $0.49 per SIR common share, or approximately $15,300, to be paid on or about August 20, 2012 to SIR shareholders of record on July 24, 2012.  This distribution includes a regular quarterly distribution of $0.40 per SIR common share ($1.60 per SIR common share per year) with respect to the quarter ended June 30, 2012, plus an additional $0.09 per SIR common share reflecting SIR’s first 20 days as a public company during the prior quarter.

 

Share Issuances:

 

On May 8, 2012, pursuant to our equity compensation plan we issued 2,000 common shares of beneficial interest, par value $0.01 per share, valued at $18.74 per share, the closing price of our common shares on the New York Stock Exchange, or NYSE, on that day, to each of our five then Trustees as part of their annual compensation.  In addition, on July 18, 2012, pursuant to our equity compensation plan we issued 2,000 common shares of beneficial interest, par value $0.01 per share, valued at $19.27 per share, the closing price of our common shares on the NYSE on that day, to a new Trustee, who was elected to our Board that day, as part of his annual compensation.

 

Note 9.  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 and six months ended June 30, 2012, we recognized current state tax expense of $107 and $249, respectively.  In addition, during the three and six months ended June 30, 2012, we recognized a deferred tax (benefit) expense of ($15) and $335, respectively, related to basis differences in our Australian properties.  During the three and six months ended June 30, 2011, we recognized current tax expense of $499 and $765, respectively, which includes $312 and $476 of foreign taxes, respectively, and $187 and $289 of certain state taxes, respectively.  In addition, during the three and six months ended June 30, 2011, we recognized a deferred tax (benefit) of ($409) and ($329), respectively, related to basis differences in our Australian properties.  At June 30, 2012 and December 31, 2011, we had deferred tax assets of $3,610 and $1,992, respectively, of which $2,639 and $1,414, respectively, related to different carrying amounts for financial reporting and for Australian income tax purposes of our properties in Australia.  At June 30, 2012 and December 31, 2011, we had deferred tax liabilities of $3,170 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 $590 and $165 as of June 30, 2012 and December 31, 2011, respectively.

 

12



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

Note 10.  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)

 

$

(18,237

)

$

 

$

(18,237

)

$

 

 


(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 June 30, 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 June 30, 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 payable 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 $2,404 and $2,441 during the three and six months ended June 30, 2012, respectively, based primarily on changes in market interest rates.  The fair value of our derivative instruments decreased by $4,119 and $2,074 during the three and six months ended June 30, 2011 based primarily on changes in market interest rates.  As of June 30, 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 ($18,237) 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, real estate mortgages 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 June 30, 2012 and December 31, 2011, the fair values of these additional financial instruments were not materially different from their carrying values, except as follows:

 

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Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

 

 

June 30, 2012

 

December 31, 2011

 

 

 

Carrying

 

Fair

 

Carrying

 

Fair

 

 

 

Amount

 

Value

 

Amount

 

Value

 

Equity investment in GOV

 

$

169,421

 

$

225,069

 

$

172,186

 

$

224,373

 

Senior notes and mortgage notes payable

 

$

2,764,861

 

$

2,916,469

 

$

2,745,331

 

$

2,924,141

 

 

At June 30, 2012 and December 31, 2011, the fair values of our equity investment in GOV are based on quoted market prices of $22.62 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 June 30, 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 11.  Earnings Per Common Share

 

As of June 30, 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 all periods presented.

 

14



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

Note 12.  Segment Information

 

As of June 30, 2012, we owned 48 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 Chicago, IL, Metro Philadelphia, PA, Oahu, HI, 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 and six months ended June 30, 2012 and 2011 is as follows:

 

 

 

As of June 30, 2012

 

As of June 30, 2011

 

 

 

CBD

 

Suburban

 

Industrial &

 

 

 

CBD

 

Suburban

 

Industrial &

 

 

 

 

 

Office

 

Office

 

Other

 

Totals

 

Office

 

Office

 

Other

 

Totals

 

Property square feet (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Metro Chicago, IL

 

3,592

 

1,164

 

104

 

4,860

 

1,072

 

1,164

 

103

 

2,339

 

Metro Philadelphia, PA

 

4,596

 

462

 

 

5,058

 

4,592

 

462

 

 

5,054

 

Oahu, HI

 

 

 

17,876

 

17,876

 

 

 

17,914

 

17,914

 

Metro Denver, CO

 

672

 

789

 

553

 

2,014

 

672

 

789

 

553

 

2,014

 

Metro Washington, DC

 

428

 

1,221

 

 

1,649

 

428

 

1,216

 

 

1,644

 

Other Markets

 

10,586

 

18,966

 

13,744

 

43,296

 

7,780

 

18,534

 

13,765

 

40,079

 

Totals

 

19,874

 

22,602

 

32,277

 

74,753

 

14,544

 

22,165

 

32,335

 

69,044

 

 

15



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

 

 

Three Months Ended June 30, 2012

 

Three Months Ended June 30, 2011

 

 

 

CBD

 

Suburban

 

Industrial &

 

 

 

CBD

 

Suburban

 

Industrial &

 

 

 

 

 

Office

 

Office

 

Other

 

Totals

 

Office

 

Office

 

Other

 

Totals

 

Property rental income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Metro Chicago, IL

 

$

26,472

 

$

6,748

 

$

111

 

$

33,331

 

$

4,226

 

$

7,134

 

$

110

 

$

11,470

 

Metro Philadelphia, PA

 

29,287

 

1,206

 

 

30,493

 

28,637

 

1,222

 

 

29,859

 

Oahu, HI

 

 

 

18,298

 

18,298

 

 

 

18,117

 

18,117

 

Metro Denver, CO

 

4,815

 

2,883

 

2,357

 

10,055

 

5,679

 

3,459

 

2,166

 

11,304

 

Metro Washington, DC

 

3,646

 

6,763

 

 

10,409

 

3,384

 

6,356

 

 

9,740

 

Other Markets

 

62,041

 

71,366

 

19,381

 

152,788

 

48,103

 

69,761

 

19,584

 

137,448

 

Totals

 

$

126,261

 

$

88,966

 

$

40,147

 

$

255,374

 

$

90,029

 

$

87,932

 

$

39,977

 

$

217,938

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property net operating income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Metro Chicago, IL

 

$

13,909

 

$

3,660

 

$

103

 

$

17,672

 

$

2,181

 

$

4,415

 

$

103

 

$

6,699

 

Metro Philadelphia, PA

 

16,193

 

128

 

 

16,321

 

14,809

 

(19

)

 

14,790

 

Oahu, HI

 

 

 

14,171

 

14,171

 

 

 

13,825

 

13,825

 

Metro Denver, CO

 

3,066

 

2,168

 

1,454

 

6,688

 

3,819

 

2,786

 

1,272

 

7,877

 

Metro Washington, DC

 

2,431

 

4,194

 

 

6,625

 

2,318

 

3,878

 

 

6,196

 

Other Markets

 

31,663

 

40,178

 

13,963

 

85,804

 

25,277

 

39,885

 

12,766

 

77,928

 

Totals

 

$

67,262

 

$

50,328

 

$

29,691

 

$

147,281

 

$

48,404

 

$

50,945

 

$

27,966

 

$

127,315

 

 

 

 

Six Months Ended June 30, 2012

 

Six Months Ended June 30, 2011

 

 

 

CBD

 

Suburban

 

Industrial &

 

 

 

CBD

 

Suburban

 

Industrial &

 

 

 

 

 

Office

 

Office

 

Other

 

Totals

 

Office

 

Office

 

Other

 

Totals

 

Property rental income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Metro Chicago, IL

 

$

51,047

 

$

12,611

 

$

222

 

$

63,880

 

$

4,226

 

$

14,927

 

$

236

 

$

19,389

 

Metro Philadelphia, PA

 

58,587

 

2,310

 

 

60,897

 

56,910

 

2,579

 

 

59,489

 

Oahu, HI

 

 

 

38,193

 

38,193

 

 

 

36,713

 

36,713

 

Metro Denver, CO

 

10,369

 

6,381

 

4,452

 

21,202

 

11,042

 

6,949

 

4,350

 

22,341

 

Metro Washington, DC

 

7,665

 

13,630

 

 

21,295

 

6,840

 

12,281

 

 

19,121

 

Other Markets

 

119,814

 

142,335

 

39,004

 

301,153

 

92,990

 

140,015

 

38,553

 

271,558

 

Totals

 

$

247,482

 

$

177,267

 

$

81,871

 

$

506,620

 

$

172,008

 

$

176,751

 

$

79,852

 

$

428,611

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property net operating income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Metro Chicago, IL

 

$

26,287