UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________________________________________________________
FORM 10-K
ý | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2017
or
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 001-11312
___________________________________________________
COUSINS PROPERTIES INCORPORATED
(Exact name of registrant as specified in its charter)
Georgia | 58-0869052 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
3344 Peachtree Road NE, Suite 1800, Atlanta, Georgia | 30326-4802 |
(Address of principal executive offices) | (Zip Code) |
(404) 407-1000 | |
(Registrant’s telephone number, including area code) | |
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of Exchange on which registered |
Common Stock ($1 par value) | New York Stock Exchange |
___________________________________________________________
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ý No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No ý
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 ý No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý
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 | ý | Accelerated filer | ¨ |
Non-accelerated filer | o (Do not check if a smaller reporting company) | Smaller reporting company | ¨ |
Emerging growth company | ¨ | ||
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý
As of June 30, 2017, the aggregate market value of the common stock of Cousins Properties Incorporated held by non-affiliates was $3,615,199,650 based on the closing sales price as reported on the New York Stock Exchange. As of February 1, 2018, 419,989,466 shares of common stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s proxy statement for the annual stockholders meeting to be held on April 24, 2018 are incorporated by reference into Part III of this Form 10-K.
Table of Contents
PART I | ||
Item 1. | ||
Item 1A. | ||
Item 1B. | ||
Item 2. | ||
Item 3. | ||
Item 4. | ||
Item X. | ||
PART II | ||
Item 5. | ||
Item 6. | ||
Item 7. | ||
Item 7A. | ||
Item 8. | ||
Item 9. | ||
Item 9A. | ||
Item 9B. | ||
PART III | ||
Item 10. | ||
Item 11. | ||
Item 12. | ||
Item 13. | ||
Item 14. | ||
PART IV | ||
Item 15. | ||
FORWARD-LOOKING STATEMENTS
Certain matters contained in this report are “forward-looking statements” within the meaning of the federal securities laws and are subject to uncertainties and risks, as itemized in Item 1A included in the Annual Report on Form 10-K for the year ended December 31, 2017 and as itemized herein. These forward-looking statements include information about possible or assumed future results of the business and our financial condition, liquidity, results of operations, plans, and objectives. They also include, among other things, statements regarding subjects that are forward-looking by their nature, such as:
• | our business and financial strategy; |
•future financing;
•future acquisitions and dispositions of operating assets;
•future acquisitions of land;
•future development and redevelopment opportunities;
•future dispositions of land and other non-core assets;
•future issuances and repurchases of common stock;
•projected operating results;
•market and industry trends;
•future distributions;
•projected capital expenditures;
•interest rates;
• | the impact of the transactions involving us, Parkway Properties, Inc. ("Parkway") and Parkway, Inc. ("New Parkway"), including future financial and operating results, plans, objectives, expectations and intentions; and |
• | all statements that address operating performance, events, or developments that we expect or anticipate will occur in the future — including statements relating to creating value for stockholders. |
Any forward-looking statements are based upon management's beliefs, assumptions, and expectations of our future performance, taking into account information currently available. These beliefs, assumptions, and expectations may change as a result of possible events or factors, not all of which are known. If a change occurs, our business, financial condition, liquidity, and results of operations may vary materially from those expressed in forward-looking statements. Actual results may vary from forward-looking statements due to, but not limited to, the following:
• | the availability and terms of capital; |
• | the ability to refinance or repay indebtedness as it matures; |
• | the failure of purchase, sale, or other contracts to ultimately close; |
• | the failure to achieve anticipated benefits from acquisitions, investments, or dispositions; |
• | the potential dilutive effect of common stock or operating partnership unit issuances; |
• | the availability of buyers and pricing with respect to the disposition of assets; |
• | risks and uncertainties related to national and local economic conditions, the real estate industry, and the commercial real estate markets in which we operate, particularly in Atlanta, Charlotte, Austin, and Phoenix where we have high concentrations of our lease revenue; |
• | changes to our strategy with regard to land and other non-core holdings that require impairment losses to be recognized; |
• | leasing risks, including the ability to obtain new tenants or renew expiring tenants, the ability to lease newly developed and/or recently acquired space, and the risk of declining leasing rates; |
• | the adverse change in the financial condition of one or more of our major tenants; |
• | volatility in interest rates and insurance rates; |
• | competition from other developers or investors; |
• | the risks associated with real estate developments (such as zoning approval, receipt of required permits, construction delays, cost overruns, and leasing risk); |
• | the loss of key personnel; |
• | the potential liability for uninsured losses, condemnation, or environmental issues; |
• | the potential liability for a failure to meet regulatory requirements; |
• | the financial condition and liquidity of, or disputes with, joint venture partners; |
• | any failure to comply with debt covenants under credit agreements; |
• | any failure to continue to qualify for taxation as a real estate investment trust and meet regulatory requirements; |
• | risks associated with litigation resulting from the transactions with Parkway and from liabilities or contingent liabilities assumed in the transactions with Parkway; |
• | risks associated with any errors or omissions in financial or other information of Parkway that has been previously provided to the public; |
• | potential changes to state, local, or federal regulations applicable to our business; |
• | material changes in the dividend rates on securities or the ability to pay dividends on common shares or other securities; |
• | potential changes to the tax laws impacting REITs and real estate in general; and |
• | those additional risks and factors discussed in reports filed with the Securities and Exchange Commission by the Company. |
The words “believes,” “expects,” “anticipates,” “estimates,” “plans,” “may,” “intend,” “will,” or similar expressions are intended to identify forward-looking statements. Although we believe that our plans, intentions, and expectations reflected in any forward-looking statements are reasonable, we can give no assurance that such plans, intentions, or expectations will be achieved. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of future events, new information, or otherwise, except as required under U.S. federal securities laws.
PART I
Item 1. | Business |
Corporate Profile
Cousins Properties Incorporated (the “Registrant” or “Cousins”) is a Georgia corporation, which has elected to be taxed as a real estate investment trust (“REIT”). Cousins conducts substantially all of its business through Cousins Properties LP ("CPLP"), a Delaware limited partnership. Cousins owns approximately 98% of CPLP, and CPLP is consolidated with Cousins for financial reporting purposes. CPLP also owns Cousins TRS Services LLC ("CTRS"), a taxable entity which owns and manages its own real estate portfolio and performs certain real estate related services for other parties. Cousins, CPLP, their subsidiaries, and CTRS combined are hereafter referred to as “we,” “us,” “our,” and the “Company.” Our common stock trades on the New York Stock Exchange under the symbol “CUZ.”
Our operations are conducted through a number of segments based on our method of internal reporting, which classifies operations by property type and geographical area. For financial information related to each of our operating segments, see note 18 to the consolidated financial statements included in this Annual Report on Form 10-K.
Company Strategy
Our strategy is to create value for our stockholders through ownership of the premier urban office portfolio in the Sunbelt markets, with a particular focus on Georgia, Texas, North Carolina, Florida, and Arizona. This strategy is based on a disciplined approach to capital allocation that includes value-add acquisitions, selective development projects, and timely dispositions of non-core assets. This strategy is also based on a simple, flexible, and low-leveraged balance sheet that allows us to pursue investment opportunities at the most advantageous points in the cycle. To implement this strategy, we leverage our strong local operating platforms within each of our major markets.
2017 Activities
During 2017, we repositioned our portfolio of properties by reducing exposure in Atlanta and strategically exiting the Orlando and South Florida markets. During the year, we commenced two new development projects and completed two new development projects. At year-end, we had five development projects in process; our share of the total expected costs of these projects totaled $491 million. We also improved our balance sheet by issuing common equity, repaying four mortgage loans assumed in the merger with Parkway Properties, Inc. ("Parkway") with above market interest rates, and closing a private placement of unsecured debt. The following is a summary of our significant 2017 activities:
Investment Activity
• | Purchased American Airlines' 25.4% interest in the 111 West Rio Building for a purchase price of $19.6 million. |
• | Completed the development and commenced operations of Avalon 8000 in Atlanta, Georgia, a 224,000 square foot office building in Atlanta, Georgia. |
• | Completed the development and commenced operations of Carolina Square, a mixed-use project in Chapel Hill, North Carolina, that contains 158,000 square feet of office space, 44,000 square feet of retail space, and 246 apartment units. The project is owned in a joint venture in which we hold a 50% interest. |
• | Commenced construction of 120 West Trinity, a mixed-use project in Atlanta, Georgia that will contain 33,000 square feet of office space, 19,000 square feet of retail space, and 330 apartments. This project is being developed in a joint venture in which we hold a 20% interest, and the project is expected to be completed in 2019. |
• | Continued development of 864 and 858 Spring Street, two buildings in Atlanta, Georgia totaling 763,000 square feet that will become the world headquarters of NCR. Phase I was completed in January of 2018, and Phase II is expected to be completed in the fourth quarter of 2018. |
• | Continued development of Dimensional Place, a 282,000 square foot building in Charlotte, North Carolina that will become the East Coast headquarters of Dimensional Fund Advisors. This project is being developed in a 50-50 joint venture with Dimensional and expected to be completed in the fourth quarter of 2018. |
• | Commenced development activities on 300 Colorado, a 309,000 square foot office tower in Austin, Texas. The 302,000 square foot office portion is 100% leased to Parsley Energy, and the retail portion is 100% leased to Del Frisco's. 300 Colorado will be developed in a joint venture in which we hold a 50% interest. |
Disposition Activity
• | Sold the American Cancer Society Center, a 996,000 square foot office building in Atlanta, Georgia, for gross proceeds of $166 million. |
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• | Sold Emory Point, a mixed-use project in Atlanta, Georgia, for gross proceeds of $199 million. Emory Point was held by joint ventures in which we held 75% interests. |
• | Exited the Orlando market by selling our three Orlando properties containing 1.0 million square feet in a single transaction for gross proceeds of $208.1 million. |
• | Sold the Company's 20% interest in Courvoisier Centre JV, LLC to our joint venture partner in transaction that valued the Company's interest in the property at $33.9 million. |
Financing Activity
• | Issued 25 million shares of common stock generating in gross proceeds of $212.9 million. |
• | Closed a $350 million private placement of senior unsecured debt, which was drawn in two tranches. The first tranche of $100 million was drawn in April 2017, has a ten-year maturity, and a fixed annual interest rate of 4.09%. The second tranche of $250 million was drawn in July 2017, has an eight-year maturity, and a fixed annual interest rate of 3.91%. |
• | Repaid four mortgage notes totaling $359 million that were assumed in the Parkway merger. |
Portfolio Activity
• | Leased or renewed 2.2 million square feet of office space. |
• | Increased second generation net rent per square foot by 19.6% on a GAAP basis and 6.9% on a cash basis. |
• | Increased same property net operating income by 4.4% on a GAAP basis and 5.3% on a cash basis. |
Environmental Matters
Our business operations are subject to various federal, state, and local environmental laws and regulations governing land, water, and wetlands resources. Among these are certain laws and regulations under which an owner or operator of real estate could become liable for the costs of removal or remediation of certain hazardous or toxic substances present on or in such property. Such laws often impose liability without regard to whether the owner knew of, or was responsible for, the presence of such hazardous or toxic substances. The presence of such substances, or the failure to properly remediate such substances, may subject the owner to substantial liability and may adversely affect the owner’s ability to develop the property or to borrow using such real estate as collateral.
We typically manage this potential liability through performance of Phase I Environmental Site Assessments and, as necessary, Phase II environmental sampling, on properties we acquire or develop, although no assurance can be given that environmental liabilities do not exist, that the reports revealed all environmental liabilities, or that no prior owner created any material environmental condition not known to us. In certain situations, we have also sought to avail ourselves of legal and regulatory protections offered by federal and state authorities to prospective purchasers of property. Where applicable studies have resulted in the determination that remediation was required by applicable law, the necessary remediation is typically incorporated into the acquisition or development activity of the relevant property. We are not aware of any environmental liability that we believe would have a material adverse effect on our business, assets, or results of operations.
Certain environmental laws impose liability on a previous owner of a property to the extent that hazardous or toxic substances were present during the prior ownership period. A transfer of the property does not necessarily relieve an owner of such liability. Thus, although we are not aware of any such situation, we may have such liabilities on properties previously sold. We believe that we and our properties are in compliance in all material respects with applicable federal, state, and local laws, ordinances, and regulations governing the environment.
Competition
We compete with other real estate owners with similar properties located in our markets and distinguish ourselves to tenants/buyers primarily on the basis of location, rental rates/sales prices, services provided, reputation, and the design and condition of the facilities. We also compete with other real estate companies, financial institutions, pension funds, partnerships, individual investors, and others when attempting to acquire and develop properties.
Executive Offices; Employees
Our executive offices are located at 3344 Peachtree Road NE, Suite 1800, Atlanta, Georgia 30326-4802. On December 31, 2017, we employed 261 people.
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Available Information
We make available free of charge on the “Investor Relations” page of our website, www.cousinsproperties.com our reports on Forms 10-K, 10-Q, and 8-K, and all amendments thereto, as soon as reasonably practicable after the reports are filed with, or furnished to, the Securities and Exchange Commission (the “SEC”).
Our Corporate Governance Guidelines, Director Independence Standards, Code of Business Conduct and Ethics, and the Charters of the Audit Committee, the Investment Committee, and the Compensation, Succession, Nominating and Governance Committee of the Board of Directors are also available on the “Investor Relations” page of our website. The information contained on our website is not incorporated herein by reference. Copies of these documents (without exhibits, when applicable) are also available free of charge upon request to us at 3344 Peachtree Road NE, Suite 1800, Atlanta, Georgia 30326-4802, Attention: Investor Relations or by telephone at (404) 407-1898 or by facsimile at (404) 407-1899. In addition, the SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers, including us, that file electronically with the SEC at www.sec.gov.
Item 1A. | Risk Factors |
Set forth below are the risks we believe investors should consider carefully in evaluating an investment in the securities of Cousins Properties Incorporated.
General Risks of Owning and Operating Real Estate
Our ownership of commercial real estate involves a number of risks, the effects of which could adversely affect our business.
General economic and market risks. Our assets are subject to general economic and market risks. As such, in a general economic decline or recessionary climate, our assets may not generate sufficient cash to pay expenses, service debt, or cover maintenance costs, and, as a result, our results of operations and cash flows may be adversely affected. Factors that may adversely affect the economic performance and value of our properties include, among other things:
• | changes in the national, regional, and local economic climate; |
• | local real estate conditions such as an oversupply of rentable space or a reduction in demand for rentable space; |
• | the attractiveness of our properties to tenants or buyers; |
• | competition from other available properties; |
• | changes in market rental rates and related concessions granted to tenants including, but not limited to, free rent, and tenant improvement allowances; |
• | uninsured losses as a result of casualty events; |
• | the need to periodically repair, renovate, and re-lease properties; and |
• | changes in federal and state income tax laws as they affect real estate companies and real estate investors. |
Uncertain economic conditions may adversely impact current tenants in our various markets and, accordingly, could affect their ability to pay rents owed to us pursuant to their leases. In periods of economic uncertainty, tenants are more likely to downsize and/or to declare bankruptcy; and, pursuant to various bankruptcy laws, leases may be rejected and thereby terminated. Furthermore, our ability to sell or lease our properties at favorable rates, or at all, may be negatively impacted by general or local economic conditions.
Our ability to collect rent from tenants may affect our ability to pay for adequate maintenance, insurance, and other operating costs (including real estate taxes). Also, the expense of owning and operating a property is not necessarily reduced when circumstances such as market factors cause a reduction in income from the property. If a property is mortgaged and we are unable to meet the mortgage payments, the lender could foreclose on the mortgage and take title to the property. In addition, interest rates, financing availability, law changes, and governmental regulations (including those governing usage, zoning, and taxes) may adversely affect our financial condition.
Impairment risks. We regularly review our real estate assets for impairment; and based on these reviews, we may record impairment losses that have an adverse effect on our results of operations. Negative or uncertain market and economic conditions, as well as market volatility, increase the likelihood of incurring impairment losses. If we decide to sell a real estate asset rather than holding it for long term investment or if we reduce our estimates of future cash flows on a real estate asset, the risk of impairment increases. The magnitude and frequency with which these charges occur could materially and adversely affect our business, financial condition, and results of operations.
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Leasing risk. Our operating revenues are dependent upon entering into leases with, and collecting rents from, our tenants. Tenants whose leases are expiring may want to decrease the space they lease and/or may be unwilling to continue their lease. When leases expire or are terminated, replacement tenants may not be available upon acceptable terms and market rental rates may be lower than the previous contractual rental rates. Also, our tenants may approach us for additional concessions in order to remain open and operating. The granting of these concessions may adversely affect our results of operations and cash flows to the extent that they result in reduced rental rates, additional capital improvements, or allowances paid to, or on behalf of, the tenants.
Tenant and property concentration risk. As of December 31, 2017, our top 20 tenants represented 31% of our annualized base rental revenues with no single tenant accounting for more than 6% of our annualized base rental revenues. The inability of any of our significant tenants to pay rent or a decision by a significant tenant to vacate their premises prior to, or at the conclusion of, their lease term could have a significant negative impact on our results of operations or financial condition if a suitable replacement tenant is not secured in a timely manner. These events could have a significant adverse impact on our results of operations or financial condition.
For the three months ended December 31, 2017, 33.9% of our net operating income for properties owned as of December 31, 2017 was derived from the metropolitan Atlanta area, 22.4% was derived from the metropolitan Charlotte area, and 19.7% was derived from the metropolitan Austin area. Any adverse economic conditions impacting Atlanta, Charlotte, or Austin could adversely affect our overall results of operations and financial condition.
Uninsured losses and condemnation costs. Accidents, earthquakes, terrorism incidents, and other losses at our properties could adversely affect our operating results. Casualties may occur that significantly damage an operating property, and insurance proceeds may be less than the total loss incurred by us. Although we, or our joint venture partners where applicable, maintain casualty insurance under policies we believe to be adequate and appropriate, including rent loss insurance on operating properties, some types of losses, such as those related to the termination of longer-term leases and other contracts, generally are not insured. Certain types of insurance may not be available or may be available on terms that could result in large uninsured losses. Property ownership also involves potential liability to third parties for such matters as personal injuries occurring on the property. Such losses may not be fully insured. In addition to uninsured losses, various government authorities may condemn all or parts of operating properties. Such condemnations could adversely affect the viability of such projects.
Environmental issues. Environmental issues that arise at our properties could have an adverse effect on our financial condition and results of operations. Federal, state, and local laws and regulations relating to the protection of the environment may require a current or previous owner or operator of real estate to investigate and clean up hazardous or toxic substances or petroleum product releases at a property. If determined to be liable, the owner or operator may have to pay a governmental entity or third parties for property damage and for investigation and clean-up costs incurred by such parties in connection with the contamination, or perform such investigation and clean-up itself. Although certain legal protections may be available to prospective purchasers of property, these laws typically impose clean-up responsibility and liability without regard to whether the owner or operator knew of or caused the presence of the regulated substances. Even if more than one person may have been responsible for the release of regulated substances at the property, each person covered by the environmental laws may be held responsible for all of the clean-up costs incurred. In addition, third parties may sue the owner or operator of a site for damages and costs resulting from regulated substances emanating from that site. We are not currently aware of any environmental liabilities at locations that we believe could have a material adverse effect on our business, assets, financial condition, or results of operations. Unidentified environmental liabilities could arise, however, and could have an adverse effect on our financial condition and results of operations.
Joint venture structure risks. Similar to other real estate companies, we have interests in various joint ventures (including partnerships and limited liability companies) and may in the future invest in real estate through such structures. Our venture partners may have rights to take actions over which we have no control, or the right to withhold approval of actions that we propose, either of which could adversely affect our interests in the related joint ventures, and in some cases, our overall financial condition and results of operations. These structures involve participation by other parties whose interests and rights may not be the same as ours. For example, a venture partner might have economic and/or other business interests or goals which are incompatible with our business interests or goals and that venture partner may be in a position to take action contrary to our interests. In addition, such venture partners may default on their obligations, which could have an adverse impact on the financial condition and operations of the joint venture. Such defaults may result in our fulfilling their obligations that may, in some cases, require us to contribute additional capital to the ventures. Furthermore, the success of a project may be dependent upon the expertise, business judgment, diligence, and effectiveness of our venture partners in matters that are outside our control. Thus, the involvement of venture partners could adversely impact the development, operation, ownership, financing, or disposition of the underlying properties.
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Liquidity risk. Real estate investments are relatively illiquid and can be difficult to sell and convert to cash quickly. As a result, our ability to sell one or more of our properties, whether in response to any changes in economic or other conditions or in response to a change in strategy, may be limited. In the event we want to sell a property, we may not be able to do so in the desired time period, the sales price of the property may not meet our expectations or requirements, and we may be required to record an impairment loss on the property as a result.
Compliance or failure to comply with federal, state, and local regulatory requirements could result in substantial costs.
Our properties are subject to various federal, state, and local regulatory requirements, such as the Americans with Disabilities Act and state and local fire, health, and life safety requirements. Compliance with these regulations may involve upfront expenditures and/or ongoing costs. If we fail to comply with these requirements, we could incur fines or other monetary damages. We do not know whether existing requirements will change or whether compliance with existing or future requirements will require significant unanticipated expenditures that will affect our cash flows and results of operations.
Financing Risks
At certain times, interest rates and other market conditions for obtaining capital are unfavorable, and, as a result, we may be unable to raise the capital needed to invest in acquisition or development opportunities, maintain our properties, or otherwise satisfy our commitments on a timely basis, or we may be forced to raise capital at a higher cost or under restrictive terms, which could adversely affect returns on our investments, our cash flows, and results of operations.
We generally finance our acquisition and development projects through one or more of the following: our unsecured credit facility ("Credit Facility"), unsecured debt, non-recourse mortgages, construction loans, the sale of assets, joint venture equity, the issuance of common stock, and the issuance of units of CPLP. Each of these sources may be constrained from time to time because of market conditions, and the related cost of raising this capital may be unfavorable at any given point in time. These sources of capital, and the risks associated with each, include the following:
• | Credit Facility. Terms and conditions available in the marketplace for unsecured credit facilities vary over time. We can provide no assurance that the amount we need from our Credit Facility will be available at any given time, or at all, or that the rates and fees charged by the lenders will be reasonable. We incur interest under our Credit Facility at a variable rate. Variable rate debt creates higher debt service requirements if market interest rates increase, which would adversely affect our cash flow and results of operations. Our Credit Facility contains customary restrictions, requirements and other limitations on our ability to incur indebtedness, including restrictions on unsecured debt outstanding, restrictions on secured recourse debt outstanding, and requirements to maintain minimum fixed charge coverage ratio. Our continued ability to borrow under our Credit Facility is subject to compliance with these covenants. |
• | Unsecured debt. Terms and conditions available in the marketplace for unsecured debt vary over time. The availability of unsecured debt may vary based upon the lending environment with financial institutions. Unsecured debt generally contains restrictive covenants that may place limitations on our ability to conduct our business similar to those placed upon us by our Credit Facility. |
• | Non-recourse mortgages. The availability of non-recourse mortgages is dependent upon various conditions, including the willingness of mortgage lenders to lend at any given point in time. Interest rates and loan-to-value ratios may also be volatile, and we may from time to time elect not to proceed with mortgage financing due to unfavorable terms offered by lenders. If a property is mortgaged to secure payment of indebtedness and we are unable to make the mortgage payments, the lender may foreclose. Further, at the time a mortgage matures, the property may be worth less than the mortgage amount and, as a result, we may determine not to refinance the mortgage and permit foreclosure, potentially generating defaults on other debt. |
• | Asset sales. Real estate markets tend to experience market cycles. Because of such cycles, the potential terms and conditions of sales, including prices, may be unfavorable for extended periods of time. In addition, our status as a REIT limits our ability to sell properties, which may affect our ability to liquidate an investment. As a result, our ability to raise capital through asset sales could be limited. In addition, mortgage financing on an asset may prohibit prepayment and/or impose a prepayment penalty upon the sale of that property, which may decrease the proceeds from a sale or refinancing or make the sale or refinancing impractical. |
• | Construction loans. Construction loans generally relate to specific assets under construction and fund costs above an initial equity amount deemed acceptable by the lender. Terms and conditions of construction facilities vary, but they generally carry a term of two to five years, charge interest at variable rates, require the lender to be satisfied |
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with the nature and amount of construction costs prior to funding, and require the lender to be satisfied with the level of pre-leasing prior to funding. Construction loans frequently require a portion of the loan to be recourse to us. In addition, construction loans generally require a completion guarantee by the borrower and may require a limited payment guarantee from the Company. There may be times when construction loans are not available, or are only available upon unfavorable terms, which could have an adverse effect on our ability to fund development projects or on our ability to achieve the returns we expect.
• | Joint ventures. Joint ventures, including partnerships or limited liability companies, tend to be complex arrangements, and there are only a limited number of parties willing to undertake such investment structures. There is no guarantee that we will be able to undertake these ventures at the times we need capital. |
• | Common stock. Common stock issuances may have a dilutive effect on our earnings per share and funds from operations per share. The actual amount of dilution, if any, from any future offering of common stock will be based on numerous factors, particularly the use of proceeds and any return generated. The per share trading price of our common stock could decline as a result of sales of a large number of shares of our common stock in the market in connection with an offering, or otherwise, or as a result of the perception or expectation that such sales could occur. We can also provide no assurance that conditions will be favorable for future issuances of common stock when we need capital. |
• | Operating partnership units. The issuance of units of CPLP in connection with property, portfolio, or business acquisitions could be dilutive to our earnings per share and could have an adverse effect on the per share trading price of our common stock. |
As a result of any additional indebtedness incurred to consummate investment activities, we may experience a potential material adverse effect on our financial condition and results of operations.
The incurrence of new indebtedness could have adverse consequences on our business, such as:
• | requiring us to use a substantial portion of our cash flow from operations to service our indebtedness, which would reduce the available cash flow to fund working capital, capital expenditures, development projects, and other general corporate purposes and reduce cash for distributions; |
• | limiting our ability to obtain additional financing to fund our working capital needs, acquisitions, capital expenditures, or other debt service requirements or for other purposes; |
• | increasing our exposure to floating interest rates; |
• | limiting our ability to compete with other companies who have less leverage, as we may be less capable of responding to adverse economic and industry conditions; |
• | restricting us from making strategic acquisitions, developing properties, or capitalizing on business opportunities; |
• | restricting the way in which we conduct our business due to financial and operating covenants in the agreements governing our existing and future indebtedness; |
• | exposing us to potential events of default (if not cured or waived) under covenants contained in our debt instruments that could have a material adverse effect on our business, financial condition, and operating results; |
• | increasing our vulnerability to a downturn in general economic conditions; and |
• | limiting our ability to react to changing market conditions in our industry. |
The impact of any of these potential adverse consequences could have a material adverse effect on our results of operations, financial condition, and liquidity.
Covenants contained in our Credit Facility, senior unsecured notes, term loans and mortgages could restrict our operational flexibility, which could adversely affect our results of operations.
Our Credit Facility, senior unsecured notes, and our unsecured term loan impose financial and operating covenants on us. These covenants may be modified from time to time, but covenants of this type typically include restrictions and limitations on our ability to incur debt, as well as limitations on the amount of our secured debt, unsecured debt and on the amount of joint venture activity in which we may engage. These covenants may limit our flexibility in making business decisions. If we fail to comply with these covenants, our ability to borrow may be impaired, which could potentially make it more difficult to fund our capital and operating needs. Our failure to comply with such covenants could cause a default, and we may then be required to repay our outstanding debt with capital from other sources. Under those circumstances, other sources of capital may not be available to us or may be available only on unattractive terms, which could materially and adversely affect our financial condition
7
and results of operations. In addition, the cross default provisions on the Credit Facility, senior unsecured notes, and term loan may affect business decisions on other debt.
Some of our mortgages contain customary negative covenants, including limitations on our ability, without the lender’s prior consent, to further mortgage that specific property, to enter into new leases, to modify existing leases, or to sell the property. Compliance with these covenants and requirements could harm our operational flexibility and financial condition.
Our degree of leverage could limit our ability to obtain additional financing or affect the market price of our securities.
Total debt as a percentage of either total asset value or total market capitalization and total debt as a multiple of annualized EBITDA is often used by analysts to gauge the financial health of equity REITs such as us. If our degree of leverage is viewed unfavorably by lenders or potential joint venture partners, it could affect our ability to obtain additional financing. In general, our degree of leverage could also make us more vulnerable to a downturn in business or the economy. In addition, increases in our debt to market capitalization ratio, which is in part a function of our stock price, or to other measures of asset value used by financial analysts may have an adverse effect on the market price of common stock.
Real Estate Acquisition and Development Risks
We face risks associated with operating property acquisitions.
Operating property acquisitions contain inherent risks. These risks may include:
• | difficulty in leasing vacant space or renewing existing tenants; |
• | the costs and timing of repositioning or redeveloping acquisitions; |
• | the acquisitions may fail to meet internal projections or otherwise fail to perform as expected; |
• | the acquisitions may be in markets that are unfamiliar to us and could present additional unforeseen business challenges; |
• | the timing of acquisitions may not match the timing of dispositions, leading to periods of time where projects' proceeds are not invested as profitably as we desire or where we increase short-term borrowings until sales proceeds become available; |
• | the inability to obtain financing for acquisitions on favorable terms or at all; |
• | the inability to successfully integrate the operations, maintain consistent standards, controls, policies and procedures, or realize the anticipated benefits of acquisitions within the anticipated time frames or at all; |
• | the inability to effectively monitor and manage our expanded portfolio of properties, retain key employees or attract highly qualified new employees; |
• | the possible decline in value of the acquisitions; |
• | the diversion of our management’s attention away from other business concerns; and |
• | the exposure to any undisclosed or unknown issues, expenses, or potential liabilities relating to acquisitions. |
In addition, we may acquire properties subject to liabilities with no or limited recourse against the prior owners or other third parties. As a result, if a liability were asserted against us based upon ownership of those properties, we might have to pay substantial sums to settle or contest it, which might not be fully covered by owner's title insurance policies or other insurance policies.
Any of these risks could cause a failure to realize the intended benefits of our acquisitions and could have a material adverse effect on our financial condition, results of operations, and the market price of our common stock.
We face risks associated with the development of real estate.
Development activities contain certain inherent risks. Although we seek to minimize risks from commercial development through various management controls and procedures, development risks cannot be eliminated. Some of the key factors affecting development of commercial property are as follows:
• | Abandoned predevelopment costs. The development process inherently requires that a large number of opportunities be pursued with only a few actually being developed. We may incur significant costs for predevelopment activity for projects that are later abandoned, which would directly affect our results of operations. For projects that are later abandoned, we must expense certain costs, such as salaries, that would have otherwise been capitalized. We have procedures and controls in place that are intended to minimize this risk, but it is likely that we will incur predevelopment expense on subsequently abandoned projects on an ongoing basis. |
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• | Project costs. Construction and leasing of a project involves a variety of costs that cannot always be identified at the beginning of a project. Costs may arise that have not been anticipated or actual costs may exceed estimated costs. These additional costs can be significant and could adversely impact our return on a project and the expected results of operations upon completion of the project. Also, construction costs vary over time based upon many factors, including the cost of building materials. We attempt to mitigate the risk of unanticipated increases in construction costs on our development projects through guaranteed maximum price contracts and pre-ordering of certain materials, but we may be adversely affected by increased construction costs on our current and future projects. |
• | Construction delays. Real estate development carries the risk that a project could be delayed due to a number of issues that may arise including, but not limited to, weather and other forces of nature, availability of materials, availability of skilled labor, and the financial health of general contractors or sub-contractors. Construction delays could cause adverse financial impacts to us which could include higher interest and other carrying costs than originally budgeted, monetary penalties from tenants pursuant to their leases, and higher construction costs. Delays could also result in a violation of terms of construction loans that could increase fees, interest, or trigger additional recourse of a construction loan to us. |
• | Leasing risk. The success of a commercial real estate development project is heavily dependent upon entering into leases with acceptable terms within a predefined lease-up period. Although our policy is to generally achieve pre-leasing goals (which vary by market, product type, and circumstances) before committing to a project, it is expected that not all the space in a project will be leased at the time we commit to the project. If the additional space is not leased on schedule and upon the expected terms and conditions, our returns, future earnings, and results of operations from the project could be adversely impacted. Whether or not tenants are willing to enter into leases on the terms and conditions we project and on the timetable we expect will depend upon a number of factors, many of which are outside our control. These factors may include: |
• | general business conditions in the local or broader economy or in the prospective tenants’ industries; |
• | supply and demand conditions for space in the marketplace; and |
• | level of competition in the marketplace. |
• | Reputation risks. We have historically developed and managed a significant portion of our real estate portfolio and believe that we have built a positive reputation for quality and service with our lenders, joint venture partners, and tenants. If we developed under-performing properties, suffered sustained losses on our investments, defaulted on a significant level of loans or experienced significant foreclosure or deed in lieu of foreclosure of our properties, our reputation could be damaged. Damage to our reputation could make it more difficult to successfully develop or acquire properties in the future and to continue to grow and expand our relationships with our lenders, joint venture partners and tenants, which could adversely affect our business, financial condition, and results of operations. |
• | Governmental approvals. All necessary zoning, land-use, building, occupancy, and other required governmental permits and authorization may not be obtained, may only be obtained subject to onerous conditions or may not be obtained on a timely basis resulting in possible delays, decreased profitability, and increased management time and attention. |
• | Competition. We compete for tenants in major U.S. markets by highlighting our locations, rental rates, services, reputation, and the design and condition of our facilities. As the competition for tenants is intense, we may be required to provide rent abatements, incur charges for tenant improvements and other concessions, or we may not be able to lease vacant space in a timely manner. |
General Business Risks
We are dependent upon the services of certain key personnel, the loss of any of whom could adversely impact our ability to execute our business.
One of our objectives is to develop and maintain a strong management group at all levels. At any given time, we could lose the services of key executives and other employees. None of our key executives or other employees is subject to employment contracts. Further, we do not carry key person insurance on any of our executive officers or other key employees. The loss of services of any of our key employees could have an adverse effect upon our results of operations, financial condition, and our ability to execute our business strategy.
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Our restated and amended articles of incorporation contain limitations on ownership of our stock, which may prevent a change in control that might otherwise be in the best interests of our stockholders.
Our restated and amended articles of incorporation impose limitations on the ownership of our stock. In general, except for certain individuals who owned stock at the time of adoption of these limitations, and except for persons or organizations that are granted waivers by our Board of Directors, no individual or entity may own more than 3.9% of the value of our outstanding stock. We provide waivers to this limitation on a case by case basis, which could result in increased voting control by a shareholder. The ownership limitation may have the effect of delaying, inhibiting, or preventing a transaction or a change in control that might involve a premium price for our stock or otherwise be in the best interest of our stockholders.
The market price of our common stock may fluctuate.
The market prices of shares of our common stock have been, and may continue to be, subject to fluctuation due to many events and factors such as those described in this report including:
• | actual or anticipated variations in our operating results, funds from operations, or liquidity; |
• | the general reputation of real estate as an attractive investment in comparison to other equity securities and/or the reputation of the product types of our assets compared to other sectors of the real estate industry; |
• | material changes in any significant tenant industry concentration; |
• | the general stock and bond market conditions, including changes in interest rates or fixed income securities; |
• | changes in tax laws; |
• | changes to our dividend policy; |
• | changes in market valuations of our properties; |
• | adverse market reaction to the amount of our outstanding debt at any time, the amount of our maturing debt, and our ability to refinance such debt on favorable terms; |
• | any failure to comply with existing debt covenants; |
• | any foreclosure or deed in lieu of foreclosure of our properties; |
• | additions or departures of key executives and other employees; |
• | actions by institutional stockholders; |
• | uncertainties in world financial markets; |
• | the realization of any of the other risk factors described in this report; and |
• | general market and economic conditions, in particular, market and economic conditions of Atlanta, Austin, Charlotte, Tampa, and Phoenix. |
Many of the factors listed above are beyond our control. Those factors may cause market prices of shares of our common stock to decline, regardless of our financial performance, condition, and prospects. The market price of shares of our common stock may fall significantly in the future, and it may be difficult for our stockholders to resell our common stock at prices they find attractive.
If our future operating performance does not meet the projections of our analysts or investors, our stock price could decline.
Independent securities analysts publish quarterly and annual projections of our financial performance. These projections are developed independently by third-party securities analysts based on their own analyses, and we undertake no obligation to monitor, and take no responsibility for, such projections. Such estimates are inherently subject to uncertainty and should not be relied upon as being indicative of the performance that we anticipate for any applicable period. Our actual revenues, net income, and funds from operations may differ materially from what is projected by securities analysts. If our actual results do not meet analysts’ guidance, our stock price could decline significantly.
We face risks associated with security breaches through cyber attacks, cyber intrusions, or otherwise, as well as other significant disruptions of our information technology (IT) networks and related systems.
We face risks associated with security breaches or disruptions, whether through cyber attacks or cyber intrusions over the internet, malware, computer viruses, attachments to emails, persons inside our organization, or persons with access to systems inside our organization, and other significant disruptions of our IT networks and related systems. The risk of a security breach or disruption, particularly through cyber attacks or cyber intrusion, including by computer hackers, foreign governments, and cyber terrorists, has generally increased as the number, intensity, and sophistication of attempted attacks and intrusions from
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around the world have increased. Our IT networks and related systems are essential to the operation of our business and our ability to perform day-to-day operations (including managing our building systems) and, in some cases, may be critical to the operations of certain of our tenants. There can be no assurance that our efforts to maintain the security and integrity of these types of IT networks and related systems will be effective or that attempted security breaches or disruptions would not be successful or damaging. A security breach or other significant disruption involving our IT networks and related systems could adversely impact our financial condition, results of operations, cash flows, liquidity, and the market price of our common stock.
Federal Income Tax Risks
Any failure to continue to qualify as a REIT for federal income tax purposes could have a material adverse impact on us and our stockholders.
We intend to continue to operate in a manner to qualify as a REIT for federal income tax purposes. Qualification as a REIT involves the application of highly technical and complex provisions of the Internal Revenue Code (the “Code”), for which there are only limited judicial or administrative interpretations. Certain facts and circumstances not entirely within our control may affect our ability to qualify as a REIT. In addition, we can provide no assurance that legislation, new regulations, administrative interpretations, or court decisions will not adversely affect our qualification as a REIT or the federal income tax consequences of our REIT status.
If we were to fail to qualify as a REIT, we would not be allowed a deduction for distributions to stockholders in computing our taxable income. In this case, we would be subject to federal income tax on our taxable income at regular corporate rates. Unless entitled to relief under certain Code provisions, we also would be disqualified from operating as a REIT for the four taxable years following the year during which qualification was lost. As a result, we would be subject to federal and state income taxes which could adversely affect our results of operations and distributions to stockholders. Although we currently intend to operate in a manner designed to qualify as a REIT, it is possible that future economic, market, legal, tax, or other considerations may cause us to revoke the REIT election.
In order to qualify as a REIT, under current law, we generally are required each taxable year to distribute to our stockholders at least 90% of our net taxable income (excluding any net capital gain). To the extent that we do not distribute all of our net capital gain or distribute at least 90%, but less than 100%, of our other taxable income, we are subject to tax on the undistributed amounts at regular corporate rates. In addition, we are subject to a 4% nondeductible excise tax to the extent that distributions paid by us during the calendar year are less than the sum of the following:
• | 85% of our ordinary income; |
• | 95% of our net capital gain income for that year; and |
• | 100% of our undistributed taxable income (including any net capital gains) from prior years. |
We generally intend to make distributions to our stockholders to comply with the 90% distribution requirement to avoid corporate-level tax on undistributed taxable income and to avoid the nondeductible excise tax. Distributions could be made in cash, stock or in a combination of cash and stock. Differences in timing between taxable income and cash available for distribution could require us to borrow funds to meet the 90% distribution requirement, to avoid corporate-level tax on undistributed taxable income, and to avoid the nondeductible excise tax.
Certain property transfers may be characterized as prohibited transactions.
From time to time, we may transfer or otherwise dispose of some of our properties. Under the Code, any gains resulting from transfers or dispositions, from other than a taxable REIT subsidiary, that are deemed to be prohibited transactions would be subject to a 100% tax on any gain associated with the transaction. Prohibited transactions generally include sales of assets that constitute inventory or other property held for sale to customers in the ordinary course of business. Since we acquire properties primarily for investment purposes, we do not believe that our occasional transfers or disposals of property are deemed to be prohibited transactions. However, whether or not a transfer or sale of property qualifies as a prohibited transaction depends on all the facts and circumstances surrounding the particular transaction. The Internal Revenue Service may contend that certain transfers or disposals of properties by us are prohibited transactions. While we believe that the Internal Revenue Service would not prevail in any such dispute, if the Internal Revenue Service were to argue successfully that a transfer or disposition of property constituted a prohibited transaction, we would be required to pay a tax equal to 100% of any gain allocable to us from the prohibited transaction. In addition, income from a prohibited transaction might adversely affect our ability to satisfy the income tests for qualification as a REIT for federal income tax purposes.
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We may face risks in connection with Section 1031 exchanges.
If a transaction's gain that is intended to qualify as a Section 1031 deferral is later determined to be taxable, we may face adverse consequences, and if the laws applicable to such transactions are amended or repealed, we may not be able to dispose of properties on a tax-deferred basis.
Recent changes to the U.S. tax laws could have a negative impact on real estate in general and our business operations, financial condition and earnings.
An act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018 commonly known as Tax Cuts and Jobs Act (the "Act"), which generally takes effect for taxable years beginning on or after January 1, 2018 (subject to certain exceptions), makes many significant changes to the U.S. federal income tax laws that will profoundly impact the taxation of individuals and corporations (including both regular C corporations and corporations that have elected to be taxed as REITs). A number of changes that affect noncorporate taxpayers will expire at the end of 2025 unless Congress acts to extend them. These changes will impact us and our shareholders in various ways, some of which are adverse or potentially adverse compared to prior law. To date, the IRS has issued only limited guidance with respect to certain of the new provisions, and there are numerous interpretive issues that will require guidance. It is highly likely that technical corrections legislation will be needed to clarify certain aspects of the new law and give proper effect to Congressional intent. There can be no assurance, however, that technical clarifications or changes needed to prevent unintended or unforeseen tax consequences will be enacted by Congress in the near future. Additional changes to tax laws are likely to continue to occur in the future, and we cannot assure investors that any such changes will not adversely affect the taxation of our stockholders. Any such changes could have an adverse effect on an investment in shares or on the market value or the resale potential of our properties. Investors are urged to consult with their own tax advisor with respect to the impact of recent legislation on ownership of shares and the status of legislative, regulatory, or administrative developments and proposals, and their potential effect on ownership of shares.
Disclosure Controls and Internal Control over Financial Reporting Risks
Our business could be adversely impacted if we have deficiencies in our disclosure controls and procedures or internal control over financial reporting.
The design and effectiveness of our disclosure controls and procedures and internal control over financial reporting may not prevent all errors, misstatements, or misrepresentations. While management will continue to review the effectiveness of our disclosure controls and procedures and internal control over financial reporting, there can be no guarantee that our internal control over financial reporting will be effective in accomplishing all control objectives at all times. Deficiencies, including any material weakness, in our internal control over financial reporting which may occur in the future could result in misstatements of our results of operations, restatements of our financial statements, a decline in our stock price, or otherwise materially adversely affect our business, reputation, results of operations, financial condition, or liquidity.
Item 1B. | Unresolved Staff Comments |
Not applicable.
Item 2. | Properties |
The following table sets forth certain information related to operating properties in which we have an ownership interest. Information presented in note 6 to the consolidated financial statements provides additional information related to our unconsolidated joint ventures. Except as noted, all information presented is as of December 31, 2017:
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Operating Properties
Company's Share | |||||||||||||
Office Properties | Rentable Square Feet | Financial Statement Presentation | Company's Ownership Interest | End of Period Leased | Weighted Average Occupancy (1) | % of Total Net Operating Income (2) | Property Level Debt ($000) (3) | Annualized Base Rents (6) | |||||
Northpark (4) | 1,528,000 | Consolidated | 100% | 86.3% | 80.5% | 6.8% | $ | — | |||||
Promenade | 777,000 | Consolidated | 100% | 94.1% | 93.9% | 5.4% | 102,071 | ||||||
One Buckhead Plaza | 461,000 | Consolidated | 100% | 89.6% | 91.3% | 3.7% | — | ||||||
3344 Peachtree | 484,000 | Consolidated | 100% | 91.7% | 88.5% | 2.8% | — | ||||||
3350 Peachtree | 413,000 | Consolidated | 100% | 86.2% | 93.0% | 2.7% | — | ||||||
Terminus 100 | 660,000 | Unconsolidated | 50% | 93.7% | 88.9% | 2.5% | 61,922 | ||||||
Two Buckhead Plaza | 210,000 | Consolidated | 100% | 91.0% | 83.2% | 2.4% | — | ||||||
Terminus 200 | 566,000 | Unconsolidated | 50% | 94.1% | 94.0% | 2.2% | 39,644 | ||||||
3348 Peachtree | 258,000 | Consolidated | 100% | 87.1% | 90.1% | 2.0% | — | ||||||
Meridian Mark Plaza | 160,000 | Consolidated | 100% | 100.0% | 100.0% | 1.5% | 23,970 | ||||||
Emory University Hospital Midtown Medical Office Tower | 358,000 | Unconsolidated | 50% | 99.5% | 96.6% | 1.4% | 35,523 | ||||||
8000 Avalon | 224,000 | Consolidated | 90% | 94.1% | 14.9% | 0.5% | — | ||||||
ATLANTA | 6,099,000 | 90.5% | 84.6% | 33.9% | 263,130 | ||||||||
Hearst Tower | 966,000 | Consolidated | 100% | 98.9% | 98.6% | 9.7% | — | ||||||
Fifth Third Center | 698,000 | Consolidated | 100% | 98.8% | 96.3% | 6.7% | 145,974 | ||||||
NASCAR Plaza | 394,000 | Consolidated | 100% | 98.7% | 98.4% | 3.7% | — | ||||||
Gateway Village (4) | 1,061,000 | Unconsolidated | 50% | 99.4% | 99.4% | 2.3% | — | ||||||
CHARLOTTE | 3,119,000 | 98.9% | 98.2% | 22.4% | 145,974 | ||||||||
San Jacinto Center | 395,000 | Consolidated | 100% | 94.4% | 99.3% | 5.3% | — | ||||||
One Eleven Congress | 519,000 | Consolidated | 100% | 87.8% | 83.8% | 4.8% | — | ||||||
Colorado Tower | 373,000 | Consolidated | 100% | 100.0% | 100.0% | 4.7% | 119,165 | ||||||
816 Congress | 435,000 | Consolidated | 100% | 95.2% | 93.7% | 3.8% | 82,742 | ||||||
Research Park V | 173,000 | Consolidated | 100% | 97.1% | 78.3% | 1.1% | — | ||||||
AUSTIN | 1,895,000 | 94.1% | 91.0% | 19.7% | 201,907 | ||||||||
Hayden Ferry (4) | 789,000 | Consolidated | 100% | 96.2% | 91.6% | 8.0% | — | ||||||
Tempe Gateway | 264,000 | Consolidated | 100% | 98.6% | 98.2% | 2.7% | — | ||||||
111 West Rio | 225,000 | Consolidated | 100% | 100.0% | 100.0% | 1.9% | — | ||||||
PHOENIX | 1,278,000 | 97.3% | 96.6% | 12.6% | — | ||||||||
Corporate Center (4) | 1,224,000 | Consolidated | 100% | 96.7% | 86.8% | 7.3% | — | ||||||
The Pointe | 253,000 | Consolidated | 100% | 93.1% | 92.7% | 1.6% | 22,729 | ||||||
Harborview Plaza | 205,000 | Consolidated | 100% | 99.7% | 97.9% | 1.5% | — | ||||||
TAMPA | 1,682,000 | 96.5% | 92.5% | 10.4% | 22,729 | ||||||||
Carolina Square Office (5) | 158,000 | Unconsolidated | 50% | 74.8% | 11.6% | 0.2% | 10,873 | ||||||
CHAPEL HILL | 158,000 | 74.8% | 11.6% | 0.2% | 10,873 | ||||||||
TOTAL OFFICE PROPERTIES | 14,231,000 | 94.1% | 79.1% | 99.2% | $ | 644,613 | $ | 331,713 | |||||
Other Properties | |||||||||||||
Carolina Square Retail (5) | 44,000 | Unconsolidated | 50% | 81.5% | 49.7% | 0.1% | 3,028 | ||||||
Carolina Square Apartments (246 Units) (5) | 266,000 | Unconsolidated | 50% | 91.1% | 71.2% | 0.7% | 18,305 | ||||||
CHAPEL HILL | 310,000 | 89.7% | 60.5% | 0.8% | 21,333 | ||||||||
TOTAL OTHER PROPERTIES | 310,000 | 89.7% | 60.5% | 0.8% | $ | 21,333 | $ | 2,557 | |||||
TOTAL PROPERTIES | 14,541,000 | 100.0% | $ | 665,946 | $ | 334,270 | |||||||
(1) | Weighted average occupancy represents an average of the square footage occupied during the year. |
(2) | The Company's share of net operating income for the three months ended December 31, 2017. |
(3) | The Company's share of property specific mortgage debt, net of unamortized loan costs, as of December 31, 2017. |
(4) | Contains multiple buildings that are grouped together for reporting purposes. |
(5) | The Company's share of Carolina Square debt has been allocated to office, retail, and apartments based on their relative square footages. |
(6) | Annualized base rent represents the sum of the annualized rent each tenant is paying as of the end of the reporting period. If a tenant is not paying rent due to a free rent concession, annualized base rent is calculated based on the annualized base rent the tenant will pay in the first period it is required to pay rent. Included in this amount is $18.6 million of annualized base rent for tenants in a free rent period. |
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Office Lease Expirations (1)
As of December 31, 2017, our leases expire as follows:
Year of Expiration | Square Feet Expiring | % of Leased Space | Annual Contractual Rents ($000's) (2) | % of Total Annual Contractual Rents | Annual Contractual Rent/Sq. Ft. (2) | ||||||||||||
2018 | 777,011 | 6.5 | % | $ | 21,006 | 5.4 | % | $ | 27.03 | ||||||||
2019 | 892,339 | 7.4 | % | 26,841 | 7.0 | % | 30.08 | ||||||||||
2020 | 871,998 | 7.3 | % | 28,110 | 7.3 | % | 32.24 | ||||||||||
2021 | 1,315,069 | 10.9 | % | 40,888 | 10.6 | % | 31.09 | ||||||||||
2022 | 1,472,160 | 12.2 | % | 44,626 | 11.6 | % | 30.31 | ||||||||||
2023 | 1,076,065 | 8.9 | % | 36,944 | 9.6 | % | 34.33 | ||||||||||
2024 | 945,557 | 7.9 | % | 34,525 | 8.9 | % | 36.51 | ||||||||||
2025 | 1,352,057 | 11.2 | % | 44,389 | 11.5 | % | 32.83 | ||||||||||
2026 & Thereafter | 3,335,996 | 27.7 | % | 108,721 | 28.1 | % | 32.59 | ||||||||||
Total | 12,038,252 | 100.0 | % | $ | 386,050 | 100.0 | % | $ | 32.07 | ||||||||
(1) Company's share. | |||
(2) Annual Contractual Rent shown is the rate in the year of expiration. It includes the minimum contractual rent paid by the tenant which may or may not include a base year of operating expenses depending upon the terms of the lease. | |||
Development Pipeline (1)
As of December 31, 2017, we had the following projects under development ($ in thousands):
Project | Type | Metropolitan Area | Company's Ownership Interest | Actual or Projected Start Date | Number of Square Feet /Apartment Units | Estimated Project Cost (1 ) | Company's Share of Estimated Project Costs | Project Cost Incurred to Date | Company's Share of Project Costs Incurred to Date | Percent Leased | Initial Occupancy (2) / Estimated Stabilization (3) | ||||||||
864 Spring Street (NCR Phase I) | Office | Atlanta, GA | 100% | 3Q15 | 503,000 | $ | 219,000 | $ | 219,000 | $ | 212,628 | $ | 212,628 | 100% | 1Q18 (5) / 1Q18 | ||||
858 Spring Street (NCR Phase II) | Office | Atlanta, GA | 100% | 4Q16 | 260,000 | 120,000 | 120,000 | 68,354 | 68,354 | 100% | 4Q18 / 4Q18 | ||||||||
Dimensional Place | Office | Charlotte, NC | 50% | 4Q16 | 94,000 | 47,000 | 53,199 | 26,600 | |||||||||||
Office | 266,000 | 100% | 4Q18 / 4Q18 | ||||||||||||||||
Retail | 16,000 | —% | 4Q18 / 4Q18 | ||||||||||||||||
120 West Trinity | Mixed | Atlanta, GA | 20% | 1Q17 | 85,000 | 17,000 | 18,066 | 3,613 | |||||||||||
Office | 33,000 | —% | 1Q19 / 1Q20 | ||||||||||||||||
Retail | 19,000 | —% | 1Q19 / 1Q20 | ||||||||||||||||
Apartments | 330 | —% | 1Q19 / 1Q20 | ||||||||||||||||
300 Colorado (4) | Office | Austin, TX | 50% | 4Q18 | 175,000 | 87,500 | — | — | |||||||||||
Office | 302,000 | 100% | 1Q21 / 1Q21 | ||||||||||||||||
Retail | 7,000 | 100% | 1Q21 / 1Q21 | ||||||||||||||||
Total | $ | 693,000 | $ | 490,500 | $ | 352,247 | $ | 311,195 | |||||||||||
(1) | This schedule shows projects currently under active development through the substantial completion of construction. Amounts included in the estimated project cost column represent the estimated costs of the project through stabilization. Significant estimation is required to derive these costs, and the final costs may differ from these estimates. The projected stabilization dates are also estimates and are subject to change as the project proceeds through the development process. | ||||
(2) | The quarter within which the Company estimates the first tenant will take occupancy. | ||||
(3) | Stabilization is the earlier of the quarter within which the Company estimates it will achieve 90% economic occupancy or one year from initial occupancy. | ||||
(4) | The budget is not finalized, and it is subject to change. In January 2018, the joint venture acquired the land for this project, and construction is expected to commence December 2018. | ||||
(5) | Initial occupancy took place on January 1, 2018. | ||||
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Land Holdings
As of December 31, 2017, we owned the following land holdings, either directly, or indirectly, through joint ventures:
Metropolitan Area | Type | Company's Ownership Interest | Total Developable Land (Acres) | Company's Share (Acres) | ||||||||||
Wildwood Office Park | Atlanta | Commercial | 50% | 22 | ||||||||||
North Point | Atlanta | Commercial | 100% | 12 | ||||||||||
The Avenue Forsyth-Adjacent Land | Atlanta | Commercial | 100% | 10 | ||||||||||
10000 Avalon | Atlanta | Commercial | 75% | 3 | ||||||||||
Georgia | 47 | |||||||||||||
Padre Island | Corpus Christi | Residential | 50% | 15 | ||||||||||
Victory Center | Dallas | Commercial | 75% | 3 | ||||||||||
Texas | 18 | |||||||||||||
Corporate Center | Tampa | Commercial | 100% | 7 | ||||||||||
Florida | 7 | |||||||||||||
Total Land Held (Acres) | 72 | 52 | ||||||||||||
Total Land Held (Cost Basis) | $ | 47,902 | $ | 23,254 | ||||||||||
Other Investments
The Company owns a leasehold interest in the air rights over the approximately 365,000 square foot CNN Center parking facility in Atlanta, Georgia, adjoining the headquarters of Turner Broadcasting System, Inc. and Cable News Network. The air rights are developable for additional parking or for certain other uses. The Company's net carrying value of this interest is $0.
Item 3. | Legal Proceedings |
We are subject to various legal proceedings, claims, and administrative proceedings arising in the ordinary course of business, some of which are expected to be covered by liability insurance. Management makes assumptions and estimates concerning the likelihood and amount of any potential loss relating to these matters using the latest information available. We record a liability for litigation if an unfavorable outcome is probable and the amount of loss or range of loss can be reasonably estimated. If an unfavorable outcome is probable and a reasonable estimate of the loss is a range, we accrue the best estimate within the range. If no amount within the range is a better estimate than any other amount, we accrue the minimum amount within the range. If an unfavorable outcome is probable but the amount of the loss cannot be reasonably estimated, we disclose the nature of the litigation and indicate that an estimate of the loss or range of loss cannot be made. If an unfavorable outcome is reasonably possible and the estimated loss is material, we disclose the nature and estimate of the possible loss of the litigation. We do not disclose information with respect to litigation where an unfavorable outcome is considered to be remote or where the estimated loss would not be material. Based on current expectations, such matters, both individually and in the aggregate, are not expected to have a material adverse effect on our liquidity, results of operations, business, or financial condition.
Item 4. | Mine Safety Disclosures |
Not applicable.
Item X. | Executive Officers of the Registrant |
The Executive Officers of the Registrant as of the date hereof are as follows:
Name | Age | Office Held | ||
Lawrence L. Gellerstedt III | 61 | Chairman of the Board, Chief Executive Officer | ||
M. Colin Connolly | 41 | President, Chief Operating Officer | ||
Gregg D. Adzema | 52 | Executive Vice President, Chief Financial Officer | ||
John S. McColl | 55 | Executive Vice President | ||
Pamela F. Roper | 44 | Executive Vice President, General Counsel and Corporate Secretary | ||
John D. Harris, Jr. | 58 | Senior Vice President, Chief Accounting Officer, Treasurer and Assistant Secretary | ||
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Family Relationships
There are no family relationships among the Executive Officers or Directors.
Term of Office
The term of office for all officers expires at the annual stockholders’ meeting. The Board retains the power to remove any officer at any time.
Business Experience
Mr. Gellerstedt was named Chairman of the Board and CEO in July of 2017. From July 2009 to July 2017, Mr. Gellerstedt served as President and Chief Executive Officer and Director. From February 2009 to July 2009, Mr. Gellerstedt served as President and Chief Operating Officer. From May 2008 to February 2009, Mr. Gellerstedt served as Executive Vice President and Chief Development Officer.
Mr. Connolly was appointed President and Chief Operating Officer in July 2017. From July 2016 to July 2017, Mr. Connolly served as Executive Vice President and Chief Operating Officer. From December 2015 to July 2016, Mr. Connolly served as Executive Vice President and Chief Investment Officer.
Mr. Adzema was appointed Executive Vice President and Chief Financial Officer in November 2010. Prior to joining the Company, Mr. Adzema served as Chief Investment Officer of Hayden Harper Inc., an investment advisory and hedge fund company, from October 2009 to November 2010.
Mr. McColl was appointed Executive Vice President in December 2011. From February 2010 to December 2011, Mr. McColl served as Executive Vice President-Development, Office Leasing and Asset Management. From May 1997 to February 2010, Mr. McColl served as Senior Vice President.
Ms. Roper was appointed Executive Vice President, General Counsel and Corporate Secretary in February 2017. From October 2012 to February 2017, Ms. Roper served as Senior Vice President, General Counsel and Corporate Secretary. From February 2008 to October 2012, Ms. Roper served as Senior Vice President, Associate General Counsel and Assistant Secretary.
Mr. Harris was appointed Senior Vice President and Chief Accounting Officer in February 2005. In May 2005, Mr. Harris was appointed Assistant Secretary. In December 2014, Mr. Harris was appointed Treasurer.
PART II
Item 5. Market for Registrant’s Common Stock and Related Stockholder Matters
Market Information
The high and low sales prices for our common stock and cash dividends declared per common share were as follows:
2017 Quarters | 2016 Quarters | ||||||||||||||||||||||||||||||
First | Second | Third | Fourth | First | Second | Third | Fourth | ||||||||||||||||||||||||
High | $ | 8.82 | $ | 9.10 | $ | 9.45 | $ | 9.63 | $ | 10.43 | $ | 11.07 | $ | 11.40 | $ | 10.50 | |||||||||||||||
Low | $ | 7.87 | $ | 7.81 | $ | 8.59 | $ | 8.87 | $ | 7.53 | $ | 10.00 | $ | 10.02 | $ | 7.09 | |||||||||||||||
Dividends | $ | 0.120 | $ | 0.060 | $ | 0.060 | $ | 0.060 | $ | 0.080 | $ | 0.080 | $ | 0.080 | $ | — | |||||||||||||||
Payment Date(s) | 1/19/2017 4/13/2017 | 7/13/2017 | 10/2/2017 | 1/12/2018 | 2/22/2016 | 5/27/2016 | 9/6/2016 | — | |||||||||||||||||||||||
We declared and paid our fourth quarter 2016 common dividend in January 2017 in the amount of $0.06 per share.
Holders
Our common stock trades on the New York Stock Exchange (ticker symbol CUZ). On February 1, 2018, there were 1,821 stockholders of record of our common stock.
Purchases of Equity Securities
There were no purchases of common stock by the Company during the fourth quarter of 2017.
Performance Graph
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The following graph compares the five-year cumulative total return of our common stock with the NYSE Composite Index, the FTSE NAREIT Equity Index, and the SNL US REIT Office Index. The graph assumes a $100 investment in each of the indices on December 31, 2012 and the reinvestment of all dividends.
COMPARISON OF CUMULATIVE TOTAL RETURN OF ONE OR MORE COMPANIES, PEER
GROUPS, INDUSTRY INDICES AND/OR BROAD MARKETS
Fiscal Year Ended | |||||||||||||||||
Index | 12/31/2012 | 12/31/2013 | 12/31/2014 | 12/31/2015 | 12/31/2016 | 12/31/2017 | |||||||||||
Cousins Properties Incorporated | 100.00 | 125.57 | 142.90 | 121.82 | 156.41 | 174.80 | |||||||||||
NYSE Composite Index | 100.00 | 126.28 | 134.81 | 129.29 | 144.73 | 171.83 | |||||||||||
FTSE NAREIT Equity Index | 100.00 | 102.47 | 133.35 | 137.61 | 149.33 | 157.14 | |||||||||||
SNL US REIT Office Index | 100.00 | 106.57 | 134.34 | 135.52 | 151.24 | 155.31 | |||||||||||
Item 6. | Selected Financial Data |
The following selected financial data sets forth consolidated financial and operating information on a historical basis. This data has been derived from our consolidated financial statements and should be read in conjunction with the consolidated financial statements and notes thereto. Prior year disclosures have been restated for discontinued operations as described in note 3 of the consolidated financial statements.
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For the Years Ended December 31, | |||||||||||||||||||
2017 | 2016 | 2015 | 2014 | 2013 | |||||||||||||||
(in thousands, except per share amounts) | |||||||||||||||||||
Revenues: | |||||||||||||||||||
Rental property revenues | $ | 446,035 | $ | 249,814 | $ | 196,244 | $ | 164,123 | $ | 122,672 | |||||||||
Fee income | 8,632 | 8,347 | 7,297 | 12,519 | 10,891 | ||||||||||||||
Other | 11,518 | 1,050 | 828 | 919 | 4,681 | ||||||||||||||
466,185 | 259,211 | 204,369 | 177,561 | 138,244 | |||||||||||||||
Expenses: | |||||||||||||||||||
Rental property operating expenses | 163,882 | 96,908 | 82,545 | 76,963 | 58,949 | ||||||||||||||
Reimbursed expenses | 3,527 | 3,259 | 3,430 | 3,652 | 5,215 | ||||||||||||||
General and administrative expenses | 27,523 | 25,592 | 16,918 | 19,784 | 21,986 | ||||||||||||||
Interest expense | 33,524 | 26,650 | 22,735 | 20,983 | 19,091 | ||||||||||||||
Depreciation and amortization | 196,745 | 97,948 | 71,625 | 62,258 | 47,131 | ||||||||||||||
Acquisition and merger costs | 1,661 | 24,521 | 299 | 1,130 | 3,626 | ||||||||||||||
Other | 1,796 | 5,888 | 1,181 | 3,729 | 4,167 | ||||||||||||||
428,658 | 280,766 | 198,733 | 188,499 | 160,165 | |||||||||||||||
Gain (loss) on extinguishment of debt | 2,258 | (5,180 | ) | — | — | — | |||||||||||||
Income (loss) from continuing operations before benefit for income taxes, income from unconsolidated joint ventures, and gain on sale of investment properties | 39,785 | (26,735 | ) | 5,636 | (10,938 | ) | (21,921 | ) | |||||||||||
Benefit for income taxes from operations | — | — | — | 20 | 23 | ||||||||||||||
Income from unconsolidated joint ventures | 47,115 | 10,562 | 8,302 | 11,268 | 67,325 | ||||||||||||||
Income (loss) from continuing operations before gain on sale of investment properties | 86,900 | (16,173 | ) | 13,938 | 350 | 45,427 | |||||||||||||
Gain on sale of investment properties | 133,059 | 77,114 | 80,394 | 12,536 | 61,288 | ||||||||||||||
Income from continuing operations | 219,959 | 60,941 | 94,332 | 12,886 | 106,715 | ||||||||||||||
Income from discontinued operations: | |||||||||||||||||||
Income from discontinued operations | — | 19,163 | 31,848 | 20,764 | 8,625 | ||||||||||||||
Gain (loss) on sale from discontinued operations | — | — | (551 | ) | 19,358 | 11,489 | |||||||||||||
Income from discontinued operations | — | 19,163 | 31,297 | 40,122 | 20,114 | ||||||||||||||
Net income | 219,959 | 80,104 | 125,629 | 53,008 | 126,829 | ||||||||||||||
Net income attributable to noncontrolling interests | (3,684 | ) | (995 | ) | (111 | ) | (1,004 | ) | (5,068 | ) | |||||||||
Net income attributable to controlling interests | 216,275 | 79,109 | 125,518 | 52,004 | 121,761 | ||||||||||||||
Preferred share original issuance costs | — | — | — | (3,530 | ) | (2,656 | ) | ||||||||||||
Dividends to preferred stockholders | — | — | — | (2,955 | ) | (10,008 | ) | ||||||||||||
Net income available to common stockholders | $ | 216,275 | $ | 79,109 | $ | 125,518 | $ | 45,519 | $ | 109,097 | |||||||||
Net income from continuing operations attributable to controlling interest per common share - basic and diluted | $ | 0.52 | $ | 0.24 | $ | 0.44 | $ | 0.02 | $ | 0.62 | |||||||||
Net income per common share - basic and diluted | $ | 0.52 | $ | 0.31 | $ | 0.58 | $ | 0.22 | $ | 0.76 | |||||||||
Dividends declared per common share | $ | 0.30 | $ | 0.24 | $ | 0.32 | $ | 0.30 | $ | 0.18 | |||||||||
Total assets (at year-end) | $ | 4,204,619 | $ | 4,171,607 | $ | 2,595,320 | $ | 2,664,295 | $ | 2,270,493 | |||||||||
Notes payable (at year-end) | $ | 1,093,228 | $ | 1,380,920 | $ | 718,810 | $ | 789,309 | $ | 627,381 | |||||||||
Stockholders' investment (at year-end) | $ | 2,771,973 | $ | 2,455,557 | $ | 1,683,415 | $ | 1,673,458 | $ | 1,457,401 | |||||||||
Common shares outstanding (at year-end) | 420,021 | 393,418 | 211,513 | 216,513 | 189,666 | ||||||||||||||
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Item 7. | Management's Discussion and Analysis of Financial Condition and Results of Operations |
The following discussion and analysis should be read in conjunction with the selected financial data and the consolidated financial statements and notes.
Overview of 2017 Performance and Company and Industry Trends
Our strategy is to create value for our stockholders through ownership of the premier urban office portfolio in Sunbelt markets, with a particular focus on Georgia, Texas, North Carolina, Florida, and Arizona. This strategy is based on a disciplined approach to capital allocation including value-add acquisition of assets, selective development projects, and timely disposition of non-core assets. This strategy is also based on a simple, flexible and low-leveraged balance sheet that allows us to pursue acquisitions and development opportunities at the most advantageous points in the cycle. To implement this strategy, we leverage our strong local operating platforms within each of our markets.
2017 Activity
During 2017, we repositioned our portfolio of properties by reducing overall exposure to Atlanta and by strategically exiting Orlando and South Florida. During the year, we commenced two new development projects and completed two projects. At year-end, we had five development projects in process; our share of the total expected costs of these projects totaled $491 million. We also improved our balance sheet by issuing common equity, repaying four mortgage loans assumed in the merger with Parkway Properties, Inc. ("Parkway") at above market interest rates, and closing a private placement of unsecured debt. In January 2018, we expanded borrowing capacity under our Credit Facility from $500 million to $1 billion and extended the maturity date from 2019 to 2023. At year-end, we had cash balances (including restricted cash) of $205.7 million, no amounts outstanding under our Credit Facility, and our net debt-to-EBITDA ratio was 3.75.
In 2017, we leased or renewed approximately 2.2 million square feet of office space. The weighted average net effective rent per square foot, representing base rent less operating expense reimbursements and leasing costs, for new or renewed non-amenity leases with terms greater than one year was $22.64 per square foot. Cash basis net effective rent per square foot increased 6.9% on spaces that had been previously occupied in the past year. Cash basis net effective rent represents net rent at the end of the term paid by the prior tenant compared to the net rent at the beginning of the term paid by the current tenant. Our same property net operating income for the year increased by 4.4% on a GAAP basis and 5.3% on a cash basis. The same property leasing percentage increased slightly to 92.6% at year-end.
Market Conditions
We believe that the Sunbelt region, and in particular the five Sunbelt markets in which we operate, possess some of the most attractive economic and real estate fundamentals in the nation. Accelerated job growth, steady office absorption, positive rent growth, and historically low levels of new supply continue to support the healthy office fundamentals and we believe that we are well positioned to benefit and ultimately outperform in the current real estate environment.
Our Atlanta portfolio totals 6.1 million square feet, represented 33.9% of our Net Operating Income for the fourth quarter of 2017 and was 90.5% leased at December 31, 2017. In addition, we had three projects under development in Atlanta totaling 815,000 square feet at December 31, 2017, two of which are 100% leased and one of which became operational in January 2018. Job growth in Atlanta for the year ended December 31, 2017 was 2.1%, above the national average, and construction as a percentage of the total market square footage was a restrained 3.4% at year end. Our portfolio is well located in the Midtown, Buckhead and Central Perimeter submarkets with direct access to mass transit. We believe that the job growth combined with the relatively low levels of new construction activity position our portfolio well within our submarkets.
Our Charlotte portfolio totals 3.1 million square feet, represented 22.4% of our Net Operating Income for the fourth quarter of 2017 and was 98.9% leased at December 31, 2017. In addition, we have one project under development totaling 282,000 square feet that is 100% leased. Job growth in Charlotte for the year ended December 31, 2017 was 1.7% and construction as a percentage of the total market square footage was a reasonable 5.0%. Our portfolio is located in the Uptown submarket where rents have increased to new market highs. While job growth over the past year was only slightly above the national average, Charlotte ranks third in the country for the highest rate of population growth over the last ten years. Strong demand and favorable economics have spurred a higher level of new development this cycle across the market, specifically in Uptown where approximately 850,000 square feet is currently under construction.
Our Austin portfolio totals 1.9 million square feet, represented 19.7% of our Net Operating Income for the fourth quarter of 2017 and was 94.1% leased at December 31, 2017. In addition, we have one project under development totaling 309,000 square feet that is 100% leased. Job growth in Austin for the year ended December 31, 2017 was 2.7% and construction as a percentage of the total market square footage was 10.4%. Our portfolio is predominantly in the central business district where
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new construction is less than 500,000 square feet and is 68% pre-leased. We believe that our dominant presence in the downtown Austin submarket combined with the job growth and low unemployment rate in the city are favorable for our existing portfolio and the new development project that is scheduled for delivery in 2021.
Our Phoenix portfolio totals 1.3 million square feet, represented 12.6% of our Net Operating Income for the fourth quarter of 2017 and was 97.3% leased at December 31, 2017. Job growth in Phoenix for the year ended December 31, 2017 was 2.2% and construction as a percentage of the total market square footage was a restrained 3.2%. Our portfolio is located in the high-growth submarket of Tempe, in close proximity to Arizona State University and its 80,000 students. With the job growth rate steady and new supply limited, vacancy levels have decreased and rental rates have increased.
Our Tampa portfolio totals 1.7 million square feet, represented 10.4% of Net Operating Income for the fourth quarter of 2017 and was 96.5% leased at December 31, 2017. Job growth in Tampa for the year ended December 31, 2017 was 2.3%, and construction as a percentage of the total market square footage was 2.3%. In the Westshore submarket, where our portfolio is located, Class A vacancy has declined to 6.6%, and there are no office projects under development. Metro-wide, the Tampa office market is experiencing low vacancy rates, and Westshore continues to command the top rents in the market, in part due to Westshore's proximity to the Tampa airport.
Critical Accounting Policies
Our financial statements are prepared in accordance with GAAP as outlined in the Financial Accounting Standards Board’s ("FASB") Accounting Standards Codification ("ASC"), and the notes to consolidated financial statements include a summary of the significant accounting policies for the Company. The preparation of financial statements in accordance with GAAP requires the use of certain estimates, a change in which could materially affect revenues, expenses, assets, or liabilities. Some of the our accounting policies are considered to be critical accounting policies, which are ones that are both important to the portrayal of our financial condition, results of operations, and cash flows, and ones that also require significant judgment or complex estimation processes. Our critical accounting policies are as follows:
Real Estate Assets
Cost Capitalization. We are involved in all stages of real estate ownership, including development. Prior to the point a project becomes probable of being developed (defined as more likely than not), we expense predevelopment costs. After we determine a project is probable, all subsequently incurred predevelopment costs, as well as interest, real estate taxes, and certain internal personnel and associated costs directly related to the project under development, are capitalized in accordance with accounting rules. If we abandon development of a project that had earlier been deemed probable, we charge all previously capitalized costs to expense. If this occurs, our predevelopment expenses could rise significantly. The determination of whether a project is probable requires judgment. If we determine that a project is probable, interest, general and administrative, and other expenses could be materially different than if we determine the project is not probable.
During the predevelopment period of a probable project and the period in which a project is under construction, we capitalize all direct and indirect costs associated with planning, developing, leasing, and constructing the project. Determination of what costs constitute direct and indirect project costs requires us, in some cases, to exercise judgment. If we determine certain costs to be direct or indirect project costs, amounts recorded in projects under development on the balance sheet and amounts recorded in general and administrative and other expenses on the statements of operations could be materially different than if we determine these costs are not directly or indirectly associated with the project.
Once a certain project is constructed and deemed substantially complete and held for occupancy, carrying costs, such as real estate taxes, interest, internal personnel costs, and associated costs, are expensed as incurred. Determination of when construction of a project is substantially complete and held available for occupancy requires judgment. We consider projects and/or project phases to be both substantially complete and held for occupancy at the earlier of the date on which the project or phase reached economic occupancy of 90% or one year after it's initial occupancy. Our judgment of the date the project is substantially complete has a direct impact on our operating expenses and net income for the period.
Real Estate Property Acquisitions. Upon acquisition of an operating property, we record the acquired tangible and intangible assets and assumed liabilities at fair value at the acquisition date. Fair value is based on estimated cash flow projections that utilize available market information and discount and/or capitalization rates as appropriate. Estimates of future cash flows are based on a number of factors including historical operating results, known and anticipated trends, and market and economic conditions. The acquired assets and assumed liabilities for an acquired operating property generally include, but are not limited to: land, buildings, and identified tangible and intangible assets and liabilities associated with in-place leases, including tenant improvements, leasing costs, value of above-market and below-market leases, and value of acquired in-place leases.
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The fair value of land is derived from comparable sales of land within the same submarket and/or region. The fair value of buildings, tenant improvements, and leasing costs are based upon current market replacement costs and other relevant market rate information.
The fair value of the above-market or below-market component of an acquired in-place lease is based upon the present value (calculated using a market discount rate) of the difference between (i) the contractual rents to be paid pursuant to the lease over its remaining term and (ii) management’s estimate of the rents that would be paid using fair market rental rates and rent escalations at the date of acquisition over the remaining term of the lease. An identifiable intangible asset or liability is recorded if there is an above-market or below-market lease at an acquired property.
The fair value of acquired in-place leases is derived based on our assessment of lost revenue and costs incurred for the period required to lease the “assumed vacant” property to the occupancy level when purchased. This fair value is based on a variety of considerations including, but not necessarily limited to: (1) the value associated with avoiding the cost of originating the acquired in-place leases; (2) the value associated with lost revenue related to tenant reimbursable operating costs estimated to be incurred during the assumed lease-up period; and (3) the value associated with lost rental revenue from existing leases during the assumed lease-up period. Factors considered in performing these analyses include an estimate of the carrying costs during the expected lease-up periods, such as real estate taxes, insurance, and other operating expenses, current market conditions, and costs to execute similar leases, such as leasing commissions, legal, and other related expenses.
The amounts recorded for above-market and in-place leases are included in other assets on the balance sheets, and the amounts for below-market leases are included in other liabilities on the balance sheets. These amounts are amortized on a straight-line basis as an adjustment to rental income over the remaining term of the applicable leases.
The determination of the fair value of the acquired tangible and intangible assets and assumed liabilities of operating property acquisitions requires significant judgment about the numerous inputs discussed above. The use of different assumptions in these fair value calculations could significantly affect the reported amounts of the allocation of the acquisition related assets and liabilities and the related amortization and depreciation expense recorded for such assets and liabilities. In addition, since the values of above-market and below-market leases are amortized as either a reduction or increase to rental income, respectively, the judgments for these intangibles could have a significant impact on reported rental revenues and results of operations.
Depreciation and Amortization. We depreciate or amortize operating real estate assets over their estimated useful lives using the straight-line method of depreciation. We use judgment when estimating the life of real estate assets and when allocating certain indirect project costs to projects under development. Historical data, comparable properties, and replacement costs are some of the factors considered in determining useful lives and cost allocations. The use of different assumptions for the estimated useful life of assets or cost allocations could significantly affect depreciation and amortization expense and the carrying amount of our real estate assets.
Impairment. We review our real estate assets on a property-by-property basis for impairment. This review includes our operating properties and land holdings.
The first step in this process is for us to determine whether an asset is considered to be held and used or held for sale, in accordance with accounting guidance. In order to be considered a real estate asset held for sale, we must, among other things, have the authority to commit to a plan to sell the asset in its current condition, have commenced the plan to sell the asset, and have determined that it is probable that the asset will sell within one year. If we determine that an asset is held for sale, we must record an impairment loss if the fair value less costs to sell is less than the carrying amount. All real estate assets not meeting the held for sale criteria are considered to be held and used.
In the impairment analysis for assets held and used, we must use judgment to determine whether there are indicators of impairment. For operating properties, these indicators could include a decline in a property’s leasing percentage, a current period operating loss or negative cash flows combined with a history of losses at the property, a decline in lease rates for that property or others in the property’s market, or an adverse change in the financial condition of significant tenants. For land holdings, indicators could include an overall decline in the market value of land in the region, a decline in development activity for the intended use of the land or other adverse economic and market conditions.
If we determine that an asset that is held and used has indicators of impairment, we must determine whether the undiscounted cash flows associated with the asset exceed the carrying amount of the asset. If the undiscounted cash flows are less than the carrying amount of the asset, we must reduce the carrying amount of the asset to fair value.
In calculating the undiscounted net cash flows of an asset, we must estimate a number of inputs. For operating properties, we must estimate future rental rates, expenditures for future leases, future operating expenses, and market capitalization rates for residual values, among other things. For land holdings, we must estimate future sales prices as well as operating income,
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carrying costs, and residual capitalization rates for land held for future development. In addition, if there are alternative strategies for the future use of the asset, we must assess the probability of each alternative strategy and perform a probability-weighted undiscounted cash flow analysis to assess the recoverability of the asset. We must use considerable judgment in determining the alternative strategies and in assessing the probability of each strategy selected.
In determining the fair value of an asset, we exercise judgment on a number of factors. We may determine fair value by using a discounted cash flow calculation or by utilizing comparable market information. We must determine an appropriate discount rate to apply to the cash flows in the discounted cash flow calculation. We must use judgment in analyzing comparable market information because no two real estate assets are identical in location and price.
The estimates and judgments used in the impairment process are highly subjective and susceptible to frequent change. If we determine that an asset is held and used, the results of operations could be materially different than if we determine that an asset is held for sale. Different assumptions we use in the calculation of undiscounted net cash flows of a project, including the assumptions associated with alternative strategies and the probabilities associated with alternative strategies, could cause a material impairment loss to be recognized when no impairment is otherwise warranted. Our assumptions about the discount rate used in a discounted cash flow estimate of fair value and our judgment with respect to market information could materially affect the decision to record impairment losses or, if required, the amount of the impairment losses.
Investment in Joint Ventures
We hold ownership interests in a number of joint ventures with varying structures. We evaluate all of our joint ventures and other variable interests to determine if the entity is a variable interest entity (“VIE”), as defined in accounting rules. If the venture is a VIE, and if we determine that we are the primary beneficiary, we consolidate the assets, liabilities, and results of operations of the VIE. We quarterly reassess our conclusions as to whether the entity is a VIE and whether consolidation is appropriate as required under the rules. For entities that are not determined to be VIEs, we evaluate whether or not we have control or significant influence over the joint venture to determine the appropriate consolidation and presentation. Generally, entities under our control are consolidated, and entities over which we can exert significant influence, but do not control, are accounted for under the equity method of accounting.
We use judgment to determine whether an entity is a VIE, whether we are the primary beneficiary of the VIE, and whether we exercise control over the entity. If we determine that an entity is a VIE and we are the primary beneficiary or if we conclude that we exercise control over the entity, the balance sheets and statements of operations would be significantly different than if we concluded otherwise. In addition, VIEs require different disclosures in the notes to the financial statements than entities that are not VIEs. We may also change our conclusions and, thereby, change our balance sheets, statements of comprehensive income, and notes to the financial statements, based on facts and circumstances that arise after the original consolidation determination is made. These changes could include additional equity contributed to entities, changes in the allocation of cash flow to entity partners, and changes in the expected results within the entity.
We perform an impairment analysis of the recoverability of our investments in joint ventures on a quarterly basis. As part of this analysis, we first determine whether there are any indicators of impairment in any joint venture investment. If indicators of impairment are present for any of our investments in joint ventures, we calculate the fair value of the investment. If the fair value of the investment is less than the carrying value of the investment, we must determine whether the impairment is temporary or other than temporary, as defined by GAAP. If we assesses the impairment to be temporary, we do not record an impairment charge. If we conclude that the impairment is other than temporary, we record an impairment charge.
We use considerable judgment in the determination of whether there are indicators of impairment present and in the assumptions, estimations, and inputs used in calculating the fair value of the investment. These judgments are similar to those outlined above in the impairment of real estate assets. We also use judgment in making the determination as to whether the impairment is temporary or other than temporary by considering, among other things, the length of time that the impairment has existed, the financial condition of the joint venture, and the ability and intent of the holder to retain the investment long enough for a recovery in market value. Our judgment as to the fair value of the investment or on the conclusion of the nature of the impairment could have a material impact on our financial condition, results of operations, and cash flows.
Recoveries from Tenants
Recoveries from tenants for operating expenses are determined on a calendar year and on a lease-by-lease basis. The most common types of cost reimbursements in our leases are utility expenses, building operating expenses, real estate taxes, and insurance, for which the tenant pays its pro rata share in excess of a base year amount, if applicable. The computation of these amounts is complex and involves numerous judgments, including the interpretation of lease terms and other customer lease provisions. Leases are not uniform in dealing with such cost reimbursements and there are many variations in the computation. We accrue income related to these payments each month. We make monthly accrual adjustments, positive or negative, to recorded
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amounts to our best estimate of the annual amounts to be billed and collected with respect to the cost reimbursements. After the end of the calendar year, we compute each customer's final cost reimbursements and, after considering amounts paid by the tenant during the year, issue a bill or credit for the appropriate amount to the tenant. The differences between the amounts billed less previously received payments and the accrual adjustments are recorded as increases or decreases to revenues when the final bills are prepared, which occurs during the first half of the subsequent year.
Stock-based Compensation
We have several types of stock-based compensation plans. These plans are described in note 13, as are the accounting policies by type of award. Compensation cost for all stock-based awards requires measurement at estimated fair value on the grant date, and compensation cost is recognized over the service vesting period, which represents the requisite service period. For compensation plans that contain market performance measures, we must estimate the fair value of the awards on a quarterly basis and must adjust compensation expense accordingly. The fair values of these awards are estimated using complex pricing valuation models that require a number of estimates and assumptions. For awards that are based on our future earnings, we must estimate future earnings and adjust the estimated fair value of the awards accordingly.
We use considerable judgments in determining the fair value of these awards. Compensation expense associated with these awards could vary significantly based upon these estimates.
Discussion of New Accounting Pronouncements
In May 2014, the FASB issued ASU 2014-09 ("ASC 606"), "Revenue from Contracts with Customers." Under the new guidance, companies will recognize revenue when the seller satisfies a performance obligation, which would be when the buyer takes control of the good or service. ASU 2015-14 (collectively with ASU 2014-09, "ASC 606"), "Revenue from Contracts with Customers," was subsequently issued modifying the effective date to periods beginning after December 15, 2017, with early adoption permitted for periods beginning after December 15, 2016. The standard allows for either "full retrospective" adoption, meaning the standard is applied to all of the periods presented, or "modified retrospective" adoption, meaning the standard is applied only to the most recent period presented in the financial statements. The Company adopted this guidance using the “modified retrospective” method effective January 1, 2018. The classification of certain non-lease components of revenue from leases may be impacted by the new revenue standard upon the adoption of the new leasing standard beginning January 1, 2019 (see below). The Company has determined that the adoption of ASC 606 will not require any material adjustments to the consolidated financial statements but will result in additional disclosures related to disaggregation of revenue streams beginning in the first quarter of 2018.
In February 2016, the FASB issued ASU 2016-02, "Leases," which amends the existing standards for lease accounting by requiring lessees to recognize most leases on their balance sheets and making targeted changes to lessor accounting and reporting. The new standard will require lessees to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months and classify such leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase of the leased asset by the lessee. This classification will determine whether the lease expense is recognized based on an effective interest method (finance leases) or on a straight-line basis over the term of the lease (operating leases). Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases. The new standard requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales-type leases, direct financing leases, and operating leases. ASU 2016-02 supersedes previous leasing standards. The guidance is effective for the fiscal years beginning after December 15, 2018, with early adoption permitted. The Company expects to adopt this guidance using the "modified retrospective" method effective January 1, 2019, and is currently assessing the potential impact of adopting the new guidance.
In August 2016, the FASB issued ASU 2016-15, "Classification of Certain Cash Receipts and Cash Payments" ("ASU 2016-15") which updated ASC Topic 230, "Statement of Cash Flows." ASU 2016-15 clarifies guidance on the classification of certain cash receipts and payments in the statement of cash flows to reduce diversity in practice with respect to (i) debt prepayment or debt extinguishment costs, (ii) settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing, (iii) contingent consideration payments made after a business combination, (iv) proceeds from the settlement of insurance claims, (v) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies, (vi) distributions received from equity method investees, (vii) beneficial interests in securitization transactions, and (viii) separately identifiable cash flows and application of the predominance principle. ASU 2016-15 is effective for interim and annual reporting periods in fiscal years beginning after December 15, 2017, with early adoption permitted. The Company adopted this standard in the fourth quarter of 2017 with retrospective application to the consolidated statements of cash flows. The Company elected to use the nature of distributions approach, for distributions from its equity method investments, under which it classifies the distribution received on the basis of the nature of the activity that generated the distribution. The adoption of this new approach resulted in an increase in net cash
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provided by operating activities and a decrease in net cash provided by investing activities of $6.4 million and $2.9 million for the years ended December 31, 2016 and 2015, respectively.
In November 2016, the FASB issued ASU 2016-18, "Restricted Cash" ("ASU 2016-18") which updated ASC Topic 230, "Statement of Cash Flows." ASU 2016-18 requires companies to include restricted cash and restricted cash equivalents with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. This update is effective for interim and annual reporting periods in fiscal years beginning after December 15, 2017, with early adoption permitted. The Company has early adopted this standard in the fourth quarter of 2017, which resulted in an increase in net cash provided by investing activities by $11.3 million for the year ended December 31, 2016 and a decrease in net cash provided by operating and investing activities by $263,000 and $475,000, respectively, for the year ended December 31, 2015.
Effective January 1, 2017, the Company adopted ASU 2016-09, "Improvements to Employee Share-Based Payment Accounting." Under this ASU, the additional paid-in capital pool is eliminated, and an entity recognizes all excess tax benefits and tax deficiencies as income tax expense or benefit in the income statement. This ASU also eliminated the requirement to defer recognition of an excess tax benefit until all benefits are realized through a reduction to taxes payable. In the first quarter of 2017, the Company changed the treatment of excess tax benefits as operating cash flows in the statement of cash flows. This ASU also stipulates that cash payments to tax authorities in connection with shares withheld to meet statutory tax withholding requirements be presented as a financing activity in the statement of cash flows. This ASU was adopted prospectively, prior periods have not been restated to conform to the current period presentation.
In January 2017, the FASB issued ASU 2017-01, "Clarifying the Definition of a Business," which provides a more narrow definition of a business to be used in determining the accounting treatment of an acquisition. As a result, many acquisitions that previously qualified as business combinations will be treated as asset acquisitions. For asset acquisitions, acquisition costs may be capitalized, and the purchase price may be allocated on a relative fair value basis. ASU 2017-01 is effective prospectively for the Company on January 1, 2018, with early adoption permitted. The Company adopted this standard in 2017 and expects that most of its future acquisitions will qualify as asset acquisitions.
In February 2017, the FASB issued ASU No. 2017-05, “Other Income - Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets” (“ASU 2017-05”). ASU 2017-05 updates the definition of an “in substance nonfinancial asset” and clarifies the derecognition guidance for nonfinancial assets to conform with the new revenue recognition standard. Among other things, ASU 2017-05 requires companies to recognize 100% of the gain on the transfer of a nonfinancial asset to an entity in which it has a noncontrolling interest. ASU 2017-05 is effective for interim and annual reporting periods in fiscal years beginning after December 15, 2017. The Company adopted this guidance using the "modified retrospective" method effective January 1, 2018. As a result of the adoption of ASU 2017-05, the Company recorded a cumulative effect from change in accounting principle which credited distributions in excess of cumulative net income by $24.3 million. This cumulative effect adjustment resulted from the 2013 transfer of a wholly-owned property to an entity in which it had a noncontrolling interest.
In May 2017, FASB issued ASU 2017-09, "Scope of Modification Accounting," which amends the scope of modification accounting for share-based payment arrangements and provides guidance on the types of changes to the terms or conditions of share-based payment awards to which an entity would be required to apply modification accounting under ASC 718. This update is effective for interim and annual reporting periods in fiscal years beginning after December 15, 2017, with early adoption permitted. The Company adopted this standard on January 1, 2018. The Company does not believe that the adoption of this standard will have a material impact on its financial statements.
Results of Operations For The Three Years Ended December 31, 2017
General
Our financial results for the three years ended December 31, 2017 have been significantly affected by the merger with Parkway (the "Merger") and the spin-off of the combined companies' Houston business to New Parkway (the "Spin-Off") (collectively, the "Parkway Transactions") that occurred in October 2016. Our financial results have also been affected by various dispositions during the periods. During 2015, we sold 2100 Ross, The Points at Waterview, and three of our North Point properties (collectively, the "2015 Dispositions"). During 2016, we sold 100 North Point Center East and One Ninety One Peachtree (collectively, the "2016 Dispositions"). During 2017, we sold the American Cancer Society Center (the "ACS Center"), Bank of America Center, Citrus Center, and One Orlando Centre (collectively, the "2017 Dispositions"). Accordingly, our historical financial statements may not be indicative of future operating results.
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Net Operating Income
The following results include the performance of our Same Property portfolio. Our Same Property portfolio includes office properties that have been fully operational in each of the comparable reporting periods. A fully operational property is one that has achieved 90% economic occupancy for each of the periods presented or has been substantially complete and owned by us for each of the periods presented. Same Property amounts for the 2017 versus 2016 comparison are from properties that were owned as of January 1, 2016 through December 31, 2017. Same Property amounts for the 2016 versus 2015 comparison are from properties that were owned as of January 1, 2015 through December 31, 2016. This information includes revenues and expenses of only consolidated properties.
We use Net Operating Income ("NOI"), a non-GAAP financial measure, to measure the operating performance of our properties. NOI is also widely used by industry analysts and investors to evaluate performance. NOI, which is rental property revenues less rental property operating expenses, excludes certain components from net income in order to provide results that are more closely related to a property's results of operations. Certain items, such as interest expense, while included in net income, do not affect the operating performance of a real estate asset and are often incurred at the corporate level as opposed to the property level. As a result, we use only those income and expense items that are incurred at the property level to evaluate a property's performance. Depreciation and amortization are also excluded from NOI. Same Property NOI allows analysts, investors, and management to analyze continuing operations and evaluate the growth trend of our portfolio.
NOI increased $129.2 million between the 2017 and 2016 periods as follows (dollars in thousands):
Year Ended December 31, | ||||||||||||||
2017 | 2016 | $ Change | % Change | |||||||||||
Rental Property Revenues | ||||||||||||||
Same Property | $ | 142,087 | $ | 135,371 | $ | 6,716 | 5.0 | % | ||||||
Non-Same Property | 303,948 | 114,443 | 189,505 | 165.6 | % | |||||||||
$ | 446,035 | $ | 249,814 | $ | 196,221 | 78.5 | % | |||||||
Rental Property Operating Expenses | ||||||||||||||
Same Property | $ | 52,174 | $ | 49,284 | $ | 2,890 | 5.9 | % | ||||||
Non-Same Property | 111,708 | 47,624 | 64,084 | 134.6 | % | |||||||||
$ | 163,882 | $ | 96,908 | $ | 66,974 | 69.1 | % | |||||||
Same Property NOI | $ | 89,913 | $ | 86,087 | $ | 3,826 | 4.4 | % | ||||||
Non-Same Property NOI | 192,240 | 66,819 | 125,421 | 187.7 | % | |||||||||
Total NOI | $ | 282,153 | $ | 152,906 | $ | 129,247 | 84.5 | % | ||||||
The increase in Same Property NOI was primarily driven by increases in revenues as a result of higher occupancy at 816 Congress and Fifth Third Center, offset by a decrease in occupancy at Northpark. Same Property operating expense increased due to these higher occupancy levels. The increase in Non-Same Property NOI is primarily due to the Parkway Transactions offset by the 2017 and 2016 Dispositions.
NOI increased $39.2 million between the 2016 and 2015 periods as follows (dollars in thousands):
Year Ended December 31, | ||||||||||||||
2016 | 2015 | $ Change | % Change | |||||||||||
Rental Property Revenues | ||||||||||||||
Same Property | $ | 71,802 | $ | 69,012 | $ | 2,790 | 4.0 | % | ||||||
Non-Same Property | 178,012 | 127,232 | 50,780 | 39.9 | % | |||||||||
$ | 249,814 | $ | 196,244 | $ | 53,570 | 27.3 | % | |||||||
Rental Property Operating Expenses | ||||||||||||||
Same Property | $ | 30,783 | $ | 30,402 | $ | 381 | 1.3 | % | ||||||
Non-Same Property | 66,125 | 52,143 | 13,982 | 26.8 | % | |||||||||
$ | 96,908 | $ | 82,545 | $ | 14,363 | 17.4 | % | |||||||
Same Property NOI | $ | 41,019 | $ | 38,610 | $ | 2,409 | 6.2 | % | ||||||
Non-Same Property NOI | 111,887 | 75,089 | 36,798 | 49.0 | % | |||||||||
Total NOI | $ | 152,906 | $ | 113,699 | $ | 39,207 | 34.5 | % | ||||||
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The increase in Same Property NOI was primarily driven by increases in revenues as a result of higher occupancy at 816 Congress and Promenade. Same Property operating expense increased due to these higher occupancy levels. The increase in Non-Same Property NOI is primarily due to the Parkway Transactions offset by the 2016 and 2015 Dispositions.
Other Income
Other income increased $10.5 million between 2017 and 2016 primarily as a result of 2017 termination fees at 3350 Peachtree, NASCAR Plaza, Hayden Ferry, Fifth Third Center, and Northpark.
Fee Income
Fee income increased $1.1 million (14.4%) between 2016 and 2015 as a result of the recognition of additional development and leasing fees from joint venture properties.
General and Administrative Expenses
General and administrative expenses increased $1.9 million (7.5%) between 2017 and 2016 and increased $8.7 million (51.3%) between 2016 and 2015 primarily as a result of fluctuations in stock-based compensation expense due to the volatility in our stock price relative to office peers included in the SNL US Office REIT Index.
Interest Expense
Interest expense increased $6.9 million (25.8%) between 2017 and 2016 primarily as a result of the term loan that the Company closed in late 2016 and the senior notes that the Company closed in 2017, partially offset by the repayment of five mortgage loans in 2017. Interest expense increased $3.9 million (17.2%) between 2016 and 2015 primarily as a result of mortgage loans assumed in the Parkway Transactions and as a result of our obtaining new mortgage loans on Colorado Tower and Fifth Third Center.
Depreciation and Amortization
Depreciation and amortization increased $98.8 million (100.9%) between 2017 and 2016 and increased $26.3 million (36.8%) between 2016 and 2015 primarily due to the Parkway Transactions.
Acquisition and Related Costs
Included in acquisition and related costs in 2017 and 2016 are the costs associated with the Parkway Transactions. These costs included legal, accounting, and financial advisory fees as well as the cost of due diligence work and the costs of combining the operations of Parkway with the Company. We do not expect to incur any material additional expenses associated with the Parkway Transactions.
Other Expense
Other expense decreased $4.1 million between 2017 and 2016 and increased $4.7 million between 2016 and 2015 primarily as a result of an impairment loss recorded on residential land in 2016.
Income from Unconsolidated Joint Ventures
Income from unconsolidated joint ventures consisted of the following in 2017, 2016, and 2015 (in thousands):
Year Ended December 31, | |||||||||||
2017 | 2016 | 2015 | |||||||||
Net operating income | $ | 31,053 | $ | 28,784 | $ | 24,335 | |||||
Other income | 2,062 | 4,106 | 787 | ||||||||
Depreciation and amortization | (13,191 | ) | (13,905 | ) | (11,645 | ) | |||||
Interest expense | (7,859 | ) | (8,423 | ) | (7,455 | ) | |||||
Net gain on sales | 35,050 | — | 2,280 | ||||||||
Income from unconsolidated joint ventures | $ | 47,115 | $ | 10,562 | $ | 8,302 | |||||
Net operating income increased $2.3 million (7.9%) between 2017 and 2016 primarily due to a change in the partnership structure at Gateway Village whereby we began receiving 50% of cash flows versus a preferred return, effective December 1, 2016, and the addition of Courvoisier Centre JV, LLC, which was acquired in the Merger. These increases were offset by the sale of properties owned by EP I, LLC and EP II, LLC (“Emory Point I and II”) in the second quarter of 2017 and the sale of
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our interest in Courvoisier Centre JV, LLC in the fourth quarter of 2017. Other income decreased $2.0 million primarily due to lower termination fees in 2017, offset by the sale of mineral rights at CL Realty. Net gain on sales of $35.1 million in 2017 resulted from gains on the sales of Emory Point I and II and of our interest in Courvoisier Centre JV, LLC, offset by a loss on the purchase of the remaining 25.4% interest in the 111 West Rio building and the related consolidation of the building immediately following the purchase.
Income from unconsolidated joint ventures increased between 2016 and 2015 primarily due to an increase in net operating income resulting from two unconsolidated joint ventures acquired as a part of the Parkway Transactions and an increase in lease termination fees, offset by increases in depreciation and amortization expense and interest expense due to the Parkway Transactions.
Gain on Sale of Investment Properties
Included in gain on sale of investment properties in 2017 are gains recognized on the 2017 Dispositions. The combined sales prices of the 2017 Dispositions represented a weighted average capitalization rate of 7.3%. Included in gain on sale of investment properties in 2016 are gains recognized on the 2016 Dispositions as well as the sale of 20 acres of commercial land in our Northpoint project. The combined sales prices of the 2016 Dispositions represented a weighted average capitalization rate of 6.7%. Included in gain on sale of investment properties in 2015 are gains recognized on the 2015 Dispositions. The combined sales prices of the 2015 Dispositions represented a weighted average capitalization rate of 6.5%. Capitalization rates are calculated by dividing projected annualized NOI by the sales price.
Discontinued Operations
Discontinued operations contains the operations of Post Oak Central and Greenway Plaza (the "Houston Properties"), two of our properties that were included in the Spin-Off. Because we decided to exit the Houston market in connection with the Parkway Transactions, the Spin-Off represents a strategic shift that has a significant impact on our operations. As such, these properties qualify for discontinued operations treatment. The operations of the Houston Properties have been reclassified into discontinued operations for all periods presented. Income from discontinued operations decreased in 2016, compared to 2015, because the Spin-Off occurred in October 2016.
Net Income Attributable to Noncontrolling Interests
Net income attributable to noncontrolling interests includes the outside parties' share of the net income of CPLP as well as that of certain other consolidated entities.
Funds from Operations
The table below shows Funds from Operations Available to Common Stockholders (“FFO”), a non-GAAP financial measure, and the related reconciliation to net income available to common stockholders for the Company. The Company calculates FFO in accordance with the National Association of Real Estate Investment Trusts’ ("NAREIT") definition, which is net income available to common stockholders (computed in accordance with GAAP), excluding extraordinary items, cumulative effect of change in accounting principle and gains on sale or impairment losses on depreciable property, plus depreciation and amortization of real estate assets, and after adjustments for unconsolidated partnerships and joint ventures to reflect FFO on the same basis.
FFO is used by industry analysts and investors as a supplemental measure of a REIT’s operating performance. Historical cost accounting for real estate assets implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen or fallen with market conditions, many industry investors and analysts have considered presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves. Thus, NAREIT created FFO as a supplemental measure of REIT operating performance that excludes historical cost depreciation, among other items, from GAAP net income. The use of FFO, combined with the required primary GAAP presentations, has been fundamentally beneficial, improving the understanding of operating results of REITs among the investing public and making comparisons of REIT operating results more meaningful. Our management evaluates operating performance in part based on FFO. Additionally, our management uses FFO, along with other measures, to assess performance in connection with evaluating and granting incentive compensation to our officers and other key employees.
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The reconciliation of net income available to common stockholders to FFO is as follows for the years ended December 31, 2017, 2016, and 2015 (in thousands, except per share information):
Year Ended December 31, | ||||||||||||
2017 | 2016 | 2015 | ||||||||||
Net Income Available to Common Stockholders | $ | 216,275 | $ | 79,109 | $ | 125,518 | ||||||
Depreciation and amortization of real estate assets: | ||||||||||||
Consolidated properties | 194,869 | — | 96,583 | 70,003 | ||||||||
Share of unconsolidated joint ventures | 13,191 | 13,904 | 11,645 | |||||||||
Discontinued properties | — | 47,345 | 63,791 | |||||||||
Partners' share of real estate depreciation | (23 | ) | (3,564 | ) | — | |||||||
(Gain) loss on sale of depreciated properties: | ||||||||||||
Consolidated properties | (133,043 | ) | (73,533 | ) | (78,759 | ) | ||||||
Share of unconsolidated joint ventures | (35,050 | ) | — | — | ||||||||
Discontinued properties | — | — | 551 | |||||||||
Non-controlling interest related to unit holders | 3,681 | 784 | — | |||||||||
Funds From Operations | $ | 259,900 | $ | 160,628 | $ | 192,749 | ||||||
Per Common Share — Diluted: | ||||||||||||
Net Income Available | $ | 0.52 | $ | 0.31 | $ | 0.58 | ||||||
Funds From Operations | $ | 0.61 | $ | 0.63 | $ | 0.89 | ||||||
Weighted Average Shares — Diluted | 423,297 | 256,023 | 215,979 | |||||||||
Net Operating Income
Company management evaluates the performance of its property portfolio in part based on NOI. NOI represents rental property revenues less rental property operating expenses. NOI is not a measure of cash flows or operating results as measured by GAAP, is not indicative of cash available to fund cash needs and should not be considered an alternative to cash flows as a measure of liquidity. All companies may not calculate NOI in the same manner. The Company considers NOI to be an appropriate supplemental measure to net income as it helps both management and investors understand the core operations of the Company's operating assets. NOI excludes corporate general and administrative expenses, interest expense, depreciation and amortization, impairments, gains/loss on sales of real estate, and other non-operating items.
The following reconciles NOI to Net Income each of the periods presented (in thousands):
Year Ended December 31, | |||||||||||
2017 | 2016 | 2015 | |||||||||
Net income | $ | 219,959 | $ | 80,104 | $ | 125,629 | |||||
Fee income | (8,632 | ) | (8,347 | ) | (7,297 | ) | |||||
Other income | (11,518 | ) | (1,050 | ) | (828 | ) | |||||
Reimbursed expenses | 3,527 | 3,259 | 3,430 | ||||||||
General and administrative expenses | 27,523 | 25,592 | 16,918 | ||||||||
Interest expense | 33,524 | 26,650 | 22,735 | ||||||||
Depreciation and amortization | 196,745 | 97,948 | 71,625 | ||||||||
Acquisition and transaction costs | 1,661 | 24,521 | 299 | ||||||||
Other expenses | 1,796 | 5,888 | 1,181 | ||||||||
(Gain) loss on extinguishment of debt | (2,258 | ) | 5,180 | — | |||||||
Income from unconsolidated joint ventures | (47,115 | ) | (10,562 | ) | (8,302 | ) | |||||
Gain on sale of investment properties | (133,059 | ) | (77,114 | ) | (80,394 | ) | |||||
Income from discontinued operations | — | (19,163 | ) | (31,297 | ) | ||||||
Net Operating Income | $ | 282,153 | $ | 152,906 | $ | 113,699 | |||||
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Liquidity and Capital Resources
Our primary short-term and long-term liquidity needs include the following:
• | property and land acquisitions; |
• | expenditures on development projects; |
• | building improvements, tenant improvements, and leasing costs; |
• | principal and interest payments on indebtedness; and |
• | operating partnership distributions and common stock dividends. |
We may satisfy these needs with one or more of the following:
• | net cash from operations; |
• | proceeds from the sale of assets; |
• | borrowings under our credit facilities; |
• | proceeds from mortgage notes payable; |
• | proceeds from construction loans; |
• | proceeds from unsecured loans; |
• | proceeds from offerings of debt or equity securities; and |
• | joint venture formations. |
Financial Condition
A key component of our strategy is to maintain a conservative balance sheet with leverage and liquidity that enables us to be positioned for future growth. Our conservative balance sheet was a factor in our ability to complete the Parkway Transactions. Our net debt to EBITDA ratio at December 31, 2017 was 3.75, and as of December 31, 2016, it was 5.22. As of December 31, 2017, we had no amounts outstanding under our Credit Facility and $1 million drawn under our letters of credit, with the ability to borrow an additional $499 million under our Credit Facility. We also had $205.7 million in cash, cash equivalents, and restricted cash on hand and available for future investment at December 31, 2017. Subsequent to year end, we closed a new revolving Credit Facility under which we may borrow up to $1 billion that replaced the existing Credit Facility. On January 22, 2018, the Term Loan was amended to make the financial covenants consistent with those of the New Credit Facility.
Contractual Obligations and Commitments
At December 31, 2017, we were subject to the following contractual obligations and commitments (in thousands):
Total | Less than 1 Year | 1-3 Years | 3-5 Years | More than 5 Years | |||||||||||||||
Contractual Obligations: | |||||||||||||||||||
Company debt: | |||||||||||||||||||
Mortgage notes payable | $ | 498,764 | $ | 9,347 | $ | 66,876 | $ | 108,300 | $ | 314,241 | |||||||||
Unsecured Senior Notes | 350,000 | — | — | — | 350,000 | ||||||||||||||
Interest commitments (1) | 204,645 | 31,876 | 61,359 | 51,588 | 59,822 | ||||||||||||||
Term Loan | 250,000 | — | — | 250,000 | — | ||||||||||||||
Ground leases | 207,450 | 2,321 | 4,660 | 4,748 | 195,721 | ||||||||||||||
Other operating leases | 833 | 348 | 383 | 102 | — | ||||||||||||||
Unsecured Credit Facility | — | — | — | — | — | ||||||||||||||
Total contractual obligations | $ | 1,511,692 | $ | 43,892 | $ | 133,278 | $ | 414,738 | $ | 919,784 | |||||||||
Commitments: | |||||||||||||||||||
Unfunded development and tenant improvement commitments | $ | 46,832 | $ | 44,563 | $ | 2,269 | $ | — | $ | — | |||||||||
Performance bonds | 2,498 | 2,498 | — | — | — | ||||||||||||||
Letters of credit | 1,000 | 1,000 | — | — | — | ||||||||||||||
Total commitments | $ | 50,330 | $ | 48,061 | $ | 2,269 | $ | — | $ | — | |||||||||
(1) | Interest on variable rate obligations is based on rates effective as of December 31, 2017. |
In addition, we have several standing or renewable service contracts mainly related to the operation of our buildings. These contracts were entered into in the ordinary course of business and are generally one year or less. These contracts are not included in the above table and are usually reimbursed in whole or in part by tenants.
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Other Mortgage Loan Information
In 2017, we had the following mortgage loan activity:
• | Repaid in full, without penalty, the $128.0 million One Eleven Congress mortgage note. |
• | Repaid in full, without penalty, the $101.0 million San Jacinto Center mortgage note. |
• | Repaid in full, without penalty, the $52.0 million Two Buckhead Plaza mortgage note. |
• | Repaid in full, without penalty, the $77.9 million 3344 Peachtree mortgage note. |
• | Used the proceeds from the sale of the ACS Center to repay in full, without penalty, the $127.0 million ACS Center mortgage note. |
In 2016, we had the following mortgage loan activity:
• | Entered into a $120.0 million non-recourse mortgage loan secured by Colorado Tower, a 373,000 square foot office building in Austin, Texas. The mortgage bears interest at a fixed annual rate of 3.45% and matures September 1, 2026. |
• | Entered into a $150.0 million non-recourse mortgage loan secured by Fifth Third Center, a 698,000 square foot office building in Charlotte, North Carolina. The mortgage bears interest at a fixed annual rate of 3.37% and matures October 1, 2026. |
• | Repaid in full the $98.1 million 191 Peachtree Tower mortgage loan in connection with a sale of the building and paid a $3.7 million prepayment penalty. |
• | Assumed $635.2 million of mortgage debt in connection with the Merger at a weighted average stated interest rate of 5.2%. |
• | Repaid $251.9 million of the assumed mortgage debt, which included the legal defeasance of a $20.2 million mortgage loan. |
Our existing mortgage debt is primarily non-recourse, fixed-rate mortgage loans secured by various real estate assets. Many of our non-recourse mortgages contain covenants which, if not satisfied, could result in acceleration of the maturity of the debt. We expect to either refinance the non-recourse mortgage loans at maturity or repay the mortgage loans with proceeds from other financings. As of December 31, 2017, the weighted average interest rate on our consolidated debt was 3.61%.
Credit Facility Information
Our $500 million Credit Facility was scheduled to mature in May 2019. Interest on the Credit Facility was based on the London Interbank Offered Rate (“LIBOR”) plus a spread, based on our leverage ratio, as defined in the Credit Facility. At December 31, 2017, we had no amounts drawn on the facility and a total available borrowing capacity of $499 million. The amount that we may draw is a defined calculation based on our unencumbered assets and other factors and is reduced by both letters of credit and borrowings outstanding.
The Credit Facility included customary events of default, including, but not limited to, the failure to pay any interest or principal when due, the failure to perform under covenants of the credit agreement, incorrect or misleading representations or warranties, insolvency or bankruptcy, change of control, the occurrence of certain ERISA events and certain judgment defaults. The Credit Facility contained restrictive covenants pertaining to our operations, including limitations on the amount of debt that may be incurred, the sale of assets, transactions with affiliates, dividends and distributions. The Credit Facility also included certain financial covenants (as defined in the agreement) that required, among other things, the maintenance of an unencumbered interest coverage ratio of at least 2.00; a fixed charge coverage ratio of 1.50; and a leverage ratio of no more than 60%.
On January 3, 2018, we entered into a Fourth Amended and Restated Credit Agreement (the "New Credit Facility") under which we may borrow up to $1 billion if certain conditions are satisfied. The New Credit Facility recasts the Credit Facility by:
• | Increasing the size from $500 million to $1 billion; |
• | Extending the maturity date from May 28, 2019 to January 3, 2023; |
• | Reducing certain per annum variable interest rate spreads and other fees; |
• | Providing for the expansion of the facility by an additional $500 million for total availability of $1.5 billion, subject to receipt of additional commitments from lenders and other customary conditions; |
• | Decreasing the minimum spread over LIBOR from 1.10% to 1.05%; |
• | Removing the $90 million investment entity cap; |
• | Removing the Unsecured Debt Limit removed and replacing it with an unsecured leverage ratio limit; |
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• | Removing the minimum shareholder's equity requirement; |
• | Decreasing the Consolidated Unencumbered Interest coverage ratio from 2.0 to 1.75; and |
• | Removing the Consolidated Secured Recourse debt limitation and replacing it with maintaining a Secured Leverage Ratio of 40% or less. |
Unsecured Senior Notes
In 2017, we closed a $350 million private placement of senior unsecured notes, which were funded in two tranches. The first tranche of $100 million was funded in April 2017, has a 10-year maturity, and has a fixed annual interest rate of 4.09%. The second tranche of $250 million was funded in July 2017, has an 8-year maturity, and has a fixed annual interest rate of 3.91%. We used the proceeds from the private placement to repay mortgages that were set to mature during 2017.
Term Loan
During 2016, we obtained a $250 million Term Loan that matures on December 2, 2021. The Term Loan contains financial covenants substantially consistent with those of the Credit Facility. The Term Loan bears interest at the London Interbank Offered Rate (“LIBOR”) plus a spread, based on our leverage ratio, as defined in the Term Loan. On January 22, 2018, the Term Loan was amended to make the financial covenants consistent with those of the New Credit Facility.
Future Capital Requirements
Over the long term, we intend to actively manage our portfolio of properties and strategically sell assets to exit our non-core holdings, reposition our portfolio of income-producing assets geographically, and generate capital for future investment activities. We expect to continue to utilize indebtedness to fund future commitments as well as utilize construction facilities for some development assets, if available and under appropriate terms.
We may also generate capital through the issuance of securities that include common or preferred stock, warrants, debt securities, depositary shares or the issuance of CPLP limited partnership units. In January 2017, we filed a shelf registration statement to allow for the issuance from time to time of such securities. Management will continue to evaluate all public equity sources and select the most appropriate options as capital is required.
Our business model is dependent upon raising or recycling capital to meet obligations. If one or more sources of capital are not available when required, we may be forced to reduce the number of projects we acquire or develop and/or raise capital on potentially unfavorable terms, or may be unable to raise capital, which could have an adverse effect on our financial position or results of operations.
Cash Flows
We report and analyze our cash flows based on operating activities, investing activities and financing activities. Cash and cash equivalents, including restricted cash, were $205.7 million, $51.3 million, and $6.3 million at December 31, 2017, 2016, and 2015, respectively. The following table sets forth the changes in cash flows (in thousands):
Year Ended December 31, | 2017 to 2016 Change | 2016 to 2015 Change | |||||||||||||||||
2017 | 2016 | 2015 | |||||||||||||||||
Net cash provided by operating activities | $ | 211,649 | $ | 117,702 | $ | 154,302 | $ | 93,947 | $ | (36,600 | ) | ||||||||
Net cash provided by investing activities | 112,110 | 465,849 | 35,103 | (353,739 | ) | 430,746 | |||||||||||||
Net cash used in financing activities | (169,335 | ) | (538,537 | ) | (188,140 | ) | 369,202 | (350,397 | ) | ||||||||||
The reasons for significant increases and decreases in cash flows between the periods are as follows:
Cash Flows from Operating Activities. Cash provided by operating activities increased $93.9 million between the 2017 and 2016 periods primarily as a result of the operations related to the properties added in the Parkway Transactions, offset by the loss of operating cash flow from assets sold in 2016 and 2017. Cash provided by operating activities decreased $36.6 million between the 2016 and 2015 periods primarily as a result of payment of expenses associated with the Parkway Transactions and the timing of payment of property expenses.
Cash Flows from Investing Activities. Cash flows provided by investing activities decreased $353.7 million between the 2017 and 2016 periods primarily from a decrease in cash provided by investment property sales, an increase in cash used in development and tenant improvement expenditures, and cash and restricted cash acquired in the merger with Parkway in 2016.
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These decreases were offset by an increase in cash generated from unconsolidated joint ventures. Cash flows from investing activities increased $430.7 million between the 2016 and 2015 periods primarily from an increase in cash provided by investment property sales and in cash and re