Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion and analysis is based on, and should be read in conjunction with, the condensed,
consolidated financial statements and the related notes thereto of the City Office REIT, Inc. contained in this Quarterly Report on Form
10-Q.
As used in this section, unless the context otherwise requires, references to we, our, us, and
our company refer to City Office REIT, Inc., a Maryland corporation, together with our consolidated subsidiaries, including City Office REIT Operating Partnership L.P., a Maryland limited partnership, of which we are the sole general
partner and which we refer to in this section as our Operating Partnership, except where it is clear from the context that the term only means City Office REIT, Inc.
Cautionary Statement Regarding Forward-Looking Statements
This quarterly report on Form
10-Q,
including Item 2. Managements Discussion and Analysis
of Results of Operations and Financial Condition, contains both historical and forward-looking statements. All statements, other than statements of historical fact are, or may be deemed to be, forward looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward looking statements are not based on historical facts, but rather reflect our current expectations and
projections about our future results, performance, prospects and opportunities. These forward looking statements may be identified by the use of words including anticipate, believe, expect, intend,
may, might, plan, estimate, project, should, will, result and similar terms and phrases. These forward looking statements are subject to a number of
known and unknown risks, uncertainties and other factors that are difficult to predict and which could cause our actual future results, performance, prospects or opportunities to differ materially from those expressed in, or implied by, these
forward looking statements. These risks, uncertainties and other factors include, among others
:
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adverse economic or real estate developments in the office sector or the markets in which we operate;
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changes in local, regional, national and international economic conditions;
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our inability to compete effectively;
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our inability to collect rent from tenants or renew tenants leases on attractive terms if at all;
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demand for and market acceptance of our properties for rental purposes;
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defaults on or
non-renewal
of leases by tenants;
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increased interest rates and any resulting increase in financing or operating costs;
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decreased rental rates or increased vacancy rates;
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our failure to obtain necessary financing or access the capital markets on favorable terms or at all;
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changes in the availability of acquisition opportunities;
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availability of qualified personnel;
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our inability to successfully complete real estate acquisitions or dispositions on the terms we expect, or at all;
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our failure to successfully operate acquired properties and operations;
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18
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changes in our business, financing or investment strategy;
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our failure to generate sufficient cash flows to service our outstanding indebtedness;
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environmental uncertainties and risks related to adverse weather conditions and natural disasters;
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our failure to qualify and maintain our status as a real estate investment trust (REIT);
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government approvals, actions and initiatives, including the need for compliance with environmental requirements;
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outcome of claims and litigation involving or affecting us;
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financial market fluctuations;
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changes in real estate, taxation and zoning laws and other legislation and government activity and changes to real property tax rates and the taxation of REITs in general; and
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other factors described in our news releases and filings with the Securities and Exchange Commission (the SEC), including but not limited to those described in our Annual Report on Form
10-K
for the year ended December 31, 2016 under the heading Risk Factors and in our subsequent reports filed with the SEC.
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The forward looking statements included in this report are made only as of the date of this report, and except as otherwise required by
federal securities law, we do not have any obligation to publicly update or revise any forward looking statements to reflect subsequent events or circumstances.
Overview
Company
We were formed as a Maryland corporation on November 26, 2013. On April 21, 2014, we completed our initial public offering
(IPO) of shares of common stock. We contributed the net proceeds of the IPO to our Operating Partnership in exchange for common units in our Operating Partnership. Both we and our Operating Partnership commenced operations upon
completion of the IPO and certain related formation transactions (the Formation Transactions).
The Companys interest in
the Operating Partnership entitles the Company to share in distributions from, and allocations of profits and losses of, the Operating Partnership in proportion to the Companys percentage ownership of common units. As the sole general partner
of the Operating Partnership, the Company has the exclusive power under the Operating Partnerships partnership agreement to manage and conduct the Operating Partnerships business, subject to limited approval and voting rights of the
limited partners.
The Company has elected to be taxed and will continue to operate in a manner that will allow it to qualify as a real
estate investment trust (REIT) under the Code. Subject to qualification as a REIT, the Company will be permitted to deduct dividend distributions paid to its stockholders, eliminating the U.S. federal taxation of income represented by
such distributions at the Company level. REITs are subject to a number of organizational and operational requirements. If the Company fails to qualify as a REIT in any taxable year, the Company will be subject to U.S. federal and state income tax on
its taxable income at regular corporate tax rates and any applicable alternative minimum tax.
On February 1, 2016, the Company
closed on the previously announced Internalization. The Company had previously entered into a Stock Purchase Agreement with certain stockholders of the Companys former external advisor, City Office Real Estate Management Inc. pursuant to which
the Company acquired all of the outstanding stock of the Advisor. Pursuant to this Stock Purchase Agreement, at closing, the Company issued 297,321 shares of its common stock with a fair market value of $3.5 million to the Sellers, which
include the Companys three
19
executive officers and Samuel Belzberg, a former director of the Company. In addition, the Company was required to make cash payments to the Sellers of up to $3.5 million if the
Companys fully diluted market capitalization reached the following thresholds prior to December 31, 2016: $1 million upon the Company achieving a $200 million fully diluted market capitalization, an additional $1 million
upon the Company achieving a $225 million fully diluted market capitalization and an additional $1.5 million upon the Company achieving a $250 million fully diluted market capitalization. The Company paid an additional
$3.5 million in the first quarter of 2016 representing the payments made to the Sellers upon reaching these fully diluted market capitalizations, which, together with the initial payment and professional fees, resulted in a total cost of
$7.0 million in the year ended December 31, 2016. The amount was recorded as an expense in the accompanying condensed consolidated statements of operations as it represented the cost of terminating the relationship.
In connection with the closing of the Internalization, the Company entered into an amendment to the Advisory Agreement that eliminates the
payment of acquisition fees by the Company to the Advisor. In addition, each of the Companys executive officers entered into an employment agreement with the Company and became employees of the Company, and, at the same time, approximately
eleven additional former employees of the Advisor and its affiliates became employees of the Company.
In connection with the closing of
the transactions under the Stock Purchase Agreement, a subsidiary of the Company entered into an Administrative Services Agreement with Second City Capital II Corporation and Second City Real Estate II Corporation, related entities controlled by
Mr. Belzberg. The Administrative Services Agreement has a three year term and pursuant to the agreement, the Company will provide various administrative services and support to the related entities managing the Second City funds. The
Companys subsidiary will receive annual payments for these services under the Administrative Services Agreement as follows: first 12 months$1.5 million, second 12 months$1.15 million and third 12
months$0.625 million, for a total of $3.275 million over the three-year term.
Indebtedness
For additional information regarding these mortgage loans and the Secured Credit Facility, please refer to Liquidity and Capital
Resources below.
Revenue Base
As of September 30, 2017, we owned 21 properties comprised of 46 office buildings with a total of approximately 5.0 million square
feet of net rentable area (NRA). As of September 30, 2017, our properties were approximately 88.7% occupied.
Office Leases
Historically, most leases for our properties were on a full-service gross or net lease basis, and we expect to continue to use such leases in
the future. A full-service gross lease generally has a base year expense stop, whereby we pay a stated amount of expenses as part of the rent payment while future increases (above the base year stop) in property operating
expenses are billed to the tenant based on such tenants proportionate square footage in the property. The property operating expenses are reflected in operating expenses; however, only the increased property operating expenses above the
base year stop recovered from tenants are reflected as tenant recoveries in our statements of operations. In a triple net lease, the tenant is typically responsible for all property taxes and operating expenses. As such, the base rent payment
does not include any operating expenses, but rather all such expenses are billed to or paid by the tenant. The full amount of the expenses for this lease type is reflected in operating expenses, and the reimbursement is reflected in tenant
recoveries. The tenants in the Lake Vista Pointe, FRP Ingenuity Drive, Sorrento Mesa and Superior Pointe properties have triple net leases. FRP Collection and 2525 McKinnon has triple net leases for three and seven of its respective tenants. We are
also a lessor for a fee simple ground lease at the AmberGlen property. All of our remaining leases are full-service gross leases.
20
Factors That May Influence Our Operating Results and Financial Condition
Business and Strategy
We focus on owning
and acquiring office properties in our target markets. Our target markets generally possess what we believe are favorable economic growth trends, growing populations with above-average employment growth forecasts, a large number of government
offices, large international, national and regional employers across diversified industries, are generally
low-cost
centers for business operations, and exhibit favorable occupancy trends. We utilize our
managements market-specific knowledge and relationships as well as the expertise of local real estate operators and our investment partners to identify acquisition opportunities that we believe will offer cash flow stability and long-term
value appreciation. Our target markets are attractive, among other reasons, because we believe that ownership is often concentrated among local real estate operators that typically do not benefit from the same access to capital as public REITs and
there is a relatively low level of participation of large institutional investors. We believe that these factors result in attractive pricing levels and risk-adjusted returns.
Rental Revenue and Tenant Recoveries
The
amount of net rental revenue generated by our properties will depend principally on our ability to maintain the occupancy rates of currently leased space and to lease currently available space and space that becomes available from lease
terminations. As of September 30, 2017, our properties were approximately 88.7% occupied. The amount of rental revenue generated also depends on our ability to maintain or increase rental rates at our properties. We believe that the average
rental rates for our portfolio of properties are generally
in-line
or slightly below the current average quoted market rates. Negative trends in one or more of these factors could adversely affect our rental
revenue in future periods. Future economic downturns or regional downturns affecting our markets or submarkets or downturns in our tenants industries that impair our ability to renew or
re-let
space and
the ability of our tenants to fulfill their lease commitments, as in the case of tenant bankruptcies, could adversely affect our ability to maintain or increase rental rates at our properties. In addition, growth in rental revenue will also
partially depend on our ability to acquire additional properties that meet our investment criteria.
Our Properties
As of September 30, 2017, we owned 21 office complexes comprised of 46 office buildings with a total of approximately 5.0 million
square feet of NRA in the metropolitan areas of Boise, Dallas, Denver, Orlando, Phoenix, Portland, San Diego and Tampa. The following table presents an overview of our portfolio as of September 30, 2017 (properties listed by descending NRA by
market).
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Metropolitan
Area
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Property
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Economic
Interest
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NRA
(000s Square
Feet)
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In Place
Occupancy
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Annualized Base
Rent per Square
Foot
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Annualized
Gross Rent per
Square Foot
(1)
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Annualized Base
Rent
(2)
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Tampa, FL
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Park Tower
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94.8%
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473
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79.8%
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$23.66
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$23.66
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$8,917
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(20.6% of NRA)
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City Center
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95.0%
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241
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99.0%
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$24.44
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$24.44
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$5,834
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Intellicenter
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100.0%
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204
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100.0%
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$22.82
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$22.82
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$4,645
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Carillon Point
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100.0%
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124
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100.0%
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$26.77
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$26.77
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$3,325
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Denver, CO
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Cherry Creek
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100.0%
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356
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100.0%
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$18.10
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$18.10
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$6,438
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(19.1%)
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Plaza 25
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100.0%
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196
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53.3%
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$21.63
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$21.63
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$2,254
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DTC Crossroads
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100.0%
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191
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77.2%
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$25.12
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$25.12
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$3,703
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Superior Pointe
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100.0%
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149
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86.3%
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$16.42
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$26.42
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$2,111
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Logan Tower
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100.0%
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70
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91.0%
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$19.90
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$19.90
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$1,273
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San Diego, CA
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Sorrento Mesa
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100.0%
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385
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87.5%
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$22.88
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$27.88
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$7,700
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(13.3%)
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Mission City
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100.0%
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285
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86.7%
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$33.94
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$33.94
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$8,384
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Boise, ID
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Washington Group
Plaza
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100.0%
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581
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83.0%
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$17.64
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$17.64
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$8,504
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(11.5%)
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21
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190 Office Center
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100.0%
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303
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88.6
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%
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$
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23.50
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$
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23.50
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$
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6,317
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Dallas, TX
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(11.5%)
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Lake Vista Pointe
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100.0%
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163
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100.0
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%
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$
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15.00
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$
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23.00
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$
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2,450
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2525 McKinnon
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100.0%
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111
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100.0
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%
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$
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26.29
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$
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36.04
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$
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2,927
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FRP Collection
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95.0%
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272
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82.6
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%
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$
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22.65
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$
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25.03
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$
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5,085
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Orlando, FL
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(11.2%)
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Central Fairwinds
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90.0%
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170
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89.0
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%
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$
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23.92
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$
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23.92
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$
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3,611
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FRP Ingenuity Drive
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100.0%
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125
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100.0
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%
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$
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20.50
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$
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28.50
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$
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2,552
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Phoenix, AZ
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SanTan
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100.0%
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267
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100.0
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%
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$
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26.58
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$
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26.58
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$
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7,085
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(8.8%)
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5090 N 40th St
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100.0%
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176
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89.0
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%
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$
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28.21
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$
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28.21
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$
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4,417
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Portland, OR
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AmberGlen
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76.0%
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201
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96.0
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%
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$
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19.17
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$
|
21.68
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$
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3,702
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(4.0%)
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Total / Weighted Average - September 30, 2017
3
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5,043
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88.7
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%
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$
|
22.66
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$
|
24.30
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$
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101,234
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(1)
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For Superior Pointe, FRP Ingenuity Drive, Lake Vista Pointe, and Sorrento Mesa the annualized base rent per square foot on a triple net basis was increased by $10, $8, $8, and $5 respectively, to estimate a gross
equivalent base rent. AmberGlen has a net lease for one tenant which has been
grossed-up
by $7 on a pro rata basis. FRP Collection has net leases for three tenants which have been grossed up by $8 on a
pro-rata
basis. 2525 McKinnon has net leases for seven tenants which have been grossed up by $14 on a
pro-rata
basis.
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(2)
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Annualized base rent is calculated by multiplying (i) rental payments (defined as cash rents before abatements) for the month ended September 30, 2017 by (ii) 12.
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(3)
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Averages weighted based on the propertys NRA, adjusted for occupancy.
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Operating Expenses
Our operating expenses generally consist of utilities, property and ad valorem taxes, insurance and site maintenance costs. Increases in these
expenses over tenants base years (until the base year is reset at expiration) are generally passed along to tenants in our full-service gross leased properties and are generally paid in full by tenants in our net leased properties.
Conditions in Our Markets
Positive or
negative changes in economic or other conditions in the markets we operate in, including state budgetary shortfalls, employment rates, natural hazards and other factors, may impact our overall performance.
Summary of Significant Accounting Policies
The interim consolidated financial statements follow the same policies and procedures as outlined in the audited consolidated financial
statements for the year ended December 31, 2016 included in our Annual Report on Form
10-K
for the year ended December 31, 2016 except for the adoption of ASU
2017-01
Business Combinations as outlined in Note 2 of the condensed consolidated financial statements.
Results of Operations
Comparison of Three Months
Ended September 30, 2017 to September 30, 2016
Total Revenue.
Revenue includes net rental income,
including parking, signage and other income, as well as the recovery of operating costs and property taxes from tenants. Total revenues increased $6.0 million, or 32%, to $24.8 million for the three months ended September 30, 2017
compared to $18.8 million in the corresponding period in 2016. $0.1 million of this increase was attributed to the acquisition of FRP Collection in July 2016, $2.8 million from the acquisition of Park Tower in November 2016,
$1.2 million from the acquisition of 5090 N 40th St in November 2016, $1.9 million from the acquisition of SanTan in December 2016, $1.4 million from the acquisition of 2525 McKinnon in January 2017 and $0.1 million from the
acquisition of Mission City and Sorrento Mesa (formerly referred to collectively as the San Diego Portfolio) at the end of September 2017. Offsetting these increases AmberGlen decreased by $0.3 million primarily due to the sale of two of the
five buildings in the complex
22
in May 2017, and Plaza 25, 190 Office Center decreased $0.8 million and $0.3 million respectively as a result of lower occupancy. The remaining properties revenues were relatively
unchanged in comparison to three months ended September 30, 2016.
Rental Income.
Rental income includes net rental
income and income from a ground lease. Total rental income increased $4.9 million, or 29%, to $21.5 million for the three months ended September 30, 2017 compared to $16.6 million for the three months ended September 30,
2016. The increase in rental
income was
primarily due to the acquisitions described above. The acquisitions of Park Tower, 5090 N 40th St, SanTan, 2525 McKinnon and the two San Diego properties contributed an additional
$2.3 million, $1.1 million, $1.9 million, $0.9 million and $0.1 million in rental income, respectively,
to the 2017 period rental income. AmberGlen decreased by $0.4 million primarily due to the sale of two of
the five buildings in the complex in May 2017. Plaza 25 and 190 Office Center decreased $0.8 and $0.2 million as result of lower occupancy.
Expense Reimbursement.
Total expense reimbursement increased $0.7 million, or 41%, to $2.5 million for the three month
period ended September 30, 2017 compared to $1.8 million for the same period in 2016, primarily due to the acquisition of the FRP Collection, Park Tower, and 2525 McKinnon properties described above.
Other.
Other revenue includes parking, signage and other miscellaneous income. Total other revenues increased $0.5 million,
or 121%, to $0.8 million for the three month period ended September 30, 2017 compared to $0.3 million for the same period in 2016. Nominal other income was generated by City Center, Central Fairwinds, Logan Tower, DTC Crossroads, 5090
N 40th St, SanTan, 2525 McKinnon and Park Tower with the largest contribution from City Center and Park Tower parking income.
Operating Expenses
Total Operating Expenses.
Total operating expenses consist of property operating expenses, as well as acquisition costs,
general and administrative expenses and depreciation and amortization. Total operating expenses increased by $4.4 million, or 26%, to $21.6 million for the three months ended September 30, 2017, from $17.2 million for the same
period in 2016, primarily due to acquisitions described above. Total operating expenses increased by $0.2 million, $2.7 million, $0.9 million, $1.7 million, $0.9 million, and $0.2 million, respectively, from the
acquisitions of FRP Collection, Park Tower, 5090 N 40th St, SanTan, 2525 McKinnon and the two San Diego properties. Washington Group Plaza operating expenses decreased by $1.0 million as the property was designated as held for sale during the
quarter at which point the property ceased depreciation. AmberGlen decreased by $0.3 million primarily due to the sale of two of the five buildings in the complex in May 2017. General and administrative expenses decreased $0.4 million due
to lower amortization of stock based compensation expense. The remaining property operating expenses aggregated to an overall $0.3 million decrease in comparison to the prior year.
Property Operating Expenses.
Property operating expenses are comprised mainly of building common area and maintenance expenses,
insurance, property taxes, property management fees, as well as certain expenses that are not recoverable from tenants, the majority of which are related to costs necessary to maintain the appearance and marketability of vacant space. In the normal
course of business, property expenses fluctuate and are impacted by various factors including, but not limited to, occupancy levels, weather, utility costs, repairs, maintenance and
re-leasing
costs. Property
operating expenses increased $3.3 million, or 45%, to $10.7 million for the three months ended September 30, 2017 from $7.4 million for the same period in 2016. The increase in property operating expenses was primarily due to the
acquisitions described above. The acquisition of the FRP Collection, Park Tower, 5090 N 40th St, SanTan and 2525 McKinnon contributed an additional $0.1 million, $1.6 million, $0.4 million, $0.7 million and $0.5 million in
additional property operating expenses, respectively.
Acquisition Costs.
Acquisition costs were $0 for the three month
period ended September 30, 2017 compared to $0.3 million in the prior year. The company early adopted ASU
2017-01
and therefore costs associated with acquisitions are capitalized for the three months
ended September 30, 2017 as part of the purchase price of the assets as required under the accounting for an asset acquisition.
23
General and Administrative.
General and administrative expenses comprise of normal
public company reporting costs and the compensation of our management team and board of directors as well as
non-cash
stock-based compensation expenses. General and administrative expenses decreased
$0.4 million, or 17%, to $1.4 for the three month period ended September 30, 2017 compared to $1.8 million for the same period in 2016. The decrease was primarily attributable to lower amortization of stock based compensation expense.
Included in general and administrative expense for the three months ended September 30, 2017 was $0.3 million of
non-cash
stock-based compensation expense compared to $0.7 million in the same
period in the prior year. Certain prior year amounts related to stock-based compensation expenses have been reclassified to general and administrative expenses to conform to current period presentation.
Depreciation and Amortization.
Depreciation and amortization increased $1.6 million, or 22%, to $9.4 million for the
three month period ended September 30, 2017 compared to $7.8 million for the same period in 2016, primarily due to the addition of the Park Tower, 5090 N 40th St, SanTan and 2525 McKinnon properties offset by a decrease at Washington Group
Plaza which ceased depreciation during the quarter due to the classification as held for sale.
Other Expense (Income)
Interest Expense, Net.
Interest expense increased $1.4 million, or 39%, to $4.9 million for the three month period
ended September 30, 2017, compared to $3.5 million for the corresponding period in 2016. The increase was primarily due to interest expense related to acquisitions. Interest expense for the Carillon Point, FRP Collection, 5090 N 40
th
St, SanTan and 2525 McKinnon property level debt increased by $0.1 million, $0.2 million, $0.2 million, $0.4 million and $0.3 million respectively in 2017. A new mortgage
placed on Central Fairwinds also increased interest expense by a further $0.2 million over the prior year.
Comparison of Nine Months Ended
September 30, 2017 to Nine Months Ended September 30, 2016
Total Revenue.
Revenue includes net rental
income, including parking, signage and other income, as well as the recovery of operating costs and property taxes from tenants. Total revenues increased $24.1 million, or 47%, to $75.3 million for the nine month period ended
September 30, 2017 compared to $51.2 million in the corresponding period in 2016. $1.8 million of this increase was attributed to the acquisition of Carillon Point in June 2016, $3.0 million from the acquisition of FRP Collection
in July 2016, $8.3 million from the acquisition of Park Tower in November 2016, $3.5 million from the acquisition of 5090 N 40th St in November 2016, $5.8 million from the acquisition of SanTan in December 2016, $3.7 million from
the acquisition of 2525 McKinnon in January 2017 and $0.1 million from the acquisition of two San Diego properties, Mission City and Sorrento Mesa, at the end of September 2017. Further contributing to the increase, Washington Group Plaza
increased by $1.4 million due to the downtime in the prior year associated with tenant improvement work for new tenants at the property replacing a tenant who departed on December 31, 2015. Offsetting these increases, Corporate Parkway
decreased by $1.3 million due to the sale of the property in June 2016, Plaza 25 and 190 Office Center decreased $1.4 million and $0.8 million, respectively, as a result of lower occupancy. The remaining properties revenues were
relatively unchanged in comparison to three months ended September 30, 2016.
Rental Income.
Rental income includes net
rental income and income from a ground lease. Total rental income increased $20.5 million, or 46%, to $65.4 million for the nine month period ended September 30, 2017 compared to $44.9 million for the nine months ended
September 30, 2016. The increase in rental
income was
primarily due to the acquisitions described above. The acquisitions of Carillon Point, FRP Collection, Park Tower, 5090 N 40th St, SanTan and 2525 McKinnon contributed an
additional $1.7 million, $2.4 million, $7.2 million, $3.2 million, $5.5 million and $2.5 million in rental income, respectively,
to the 2017 period rental income. Washington Group Plaza also increased by
$1.3 million due to the increased occupancy described above.
Corporate Parkway decreased by $1.3 million due to the sale of the property in June 2016. Plaza 25 and 190 Office Center decreased $1.3 million and $0.7 million
as result of lower occupancy.
Expense Reimbursement.
Total expense reimbursement increased $2.6 million, or 49%, to
$7.7 million for the nine month period ended September 30, 2017 compared to $5.1 million for the same period in 2016, primarily due to the acquisition of the FRP Collection, Park Tower, 5090 N 40th St, SanTan and 2525 McKinnon
properties described above. The remaining increase relates predominantly to increased occupancy at Amberglen.
24
Other.
Other revenue includes parking, signage and other miscellaneous income.
Total other revenues increased $1.1 million, or 104%, to $2.2 million compared to $1.1 million for the same period in 2016. Nominal other income was generated by City Center, Central Fairwinds, Plaza 25, Logan Tower, DTC Crossroads
and Park Tower with the largest contribution from City Center and Park Tower parking income.
Operating Expenses
Total Operating Expenses.
Total operating expenses consist of property operating expenses, as well as acquisition costs, base
management fees, external advisor acquisition costs, general and administrative expenses and depreciation and amortization. Total operating expenses increased by $12.7 million, or 24%, to $65.3 million for the nine month period ended
September 30, 2017, from $52.6 million for the same period in 2016, primarily due to the property acquisitions described above offset by the external advisor acquisition costs of $7.0 million which occurred on February 1, 2016.
Total operating expenses increased by $1.3 million, $3.4 million, $7.3 million, $2.6 million, $4.9 million, $2.6 million and $0.2 million, respectively, from the acquisitions of Carillon Point, FRP Collection, Park
Tower, 5090 N 40th St, SanTan, 2525 McKinnon and San Diego properties. Corporate Parkway decreased operating expenses by $1.1 million due to the sale of the property in June 2016. Total operating expenses were also reduced by $1.5 million
related to the sale of AmberGlen 1400 and 1600 buildings and the Washington Group Plaza property classified as held for sale. The remaining property operating expenses were relatively unchanged, in comparison to the prior year.
Property Operating Expenses.
Property operating expenses are comprised mainly of building common area and maintenance expenses,
insurance, property taxes, property management fees, as well as certain expenses that are not recoverable from tenants, the majority of which are related to costs necessary to maintain the appearance and marketability of vacant space. In the normal
course of business, property expenses fluctuate and are impacted by various factors including, but not limited to, occupancy levels, weather, utility costs, repairs, maintenance and
re-leasing
costs. Property
operating expenses increased $11.2 million, or 57%, to $31.0 million for the nine month period ended September 30, 2017 from $19.8 million for the same period in 2016. The increase in property operating expenses was primarily due
to the acquisitions described above. The acquisition of the Carillon Point, FRP Collection, Park Tower, 5090 N 40th St, SanTan and 2525 McKinnon properties contributed an additional $0.7 million, $1.2 million, $4.0 million,
$1.3 million, $2.0 million, and $1.4 million in additional property operating expenses, respectively. Washington Group Plaza also increased property operating expenses by $0.6 million due to higher occupancy over prior year.
Acquisition Costs.
Acquisition costs were $0 for the nine month period ended September 30, 2017 compared to
$0.3 million in the prior year. The company early adopted ASU
2017-01
and therefore costs associated with acquisitions are capitalized for the nine months ended September 30, 2017 as part of the
purchase price of the assets as required under the accounting for an asset acquisition.
Base Management Fee.
Base
Management Fee was $0 for the nine month period ended September 30, 2017 compared to $0.1 million for the nine months ended September 30, 2016 representing the fee paid to our former external advisor. Effective February 1, 2016,
with the acquisition of the external advisor, no base management fees will be paid going forward.
General and
Administrative.
General and administrative expenses increased $0.7 million, or 15%, to $5.2 million for the nine month period ended September 30, 2017 from $4.5 million for the same period in 2016. compared to the same
period in 2016. The increase is primarily attributable to payroll and other costs which the external advisor paid prior to February 1, 2016 and which the Company will pay going forward following the Internalization. Included in general and
administrative expense for the nine months ended September 30, 2017 was $1.4 million of
non-cash
stock-based compensation expense. Certain prior year amounts related to stock-based compensation
expenses have been reclassified to general and administrative expenses to conform to current period presentation.
25
Depreciation and Amortization.
Depreciation and amortization increased
$8.3 million, or 40%, to $29.1 million for the nine month period ended September 30, 2017 compared to $20.8 million for the same period in 2016, primarily due to the addition of the Carillon Point, FRP Collection, Park Tower,
5090 N 40th St, SanTan and 2525 McKinnon properties offset by a decrease at Washington Group Plaza which ceased depreciation during the quarter due to the classification as held for sale and Corporate Parkway sold in June 2016.
Other Expense (Income)
Interest
Expense, Net.
Interest expense increased $3.1 million, or 28%, to $14.0 million for the nine month period ended September 30, 2017, compared to $10.9 million for the corresponding period in 2016. The increase was
primarily due to interest expense related to acquisitions. Interest expense for the Carillon Point, FRP Collection, 5090 N 40
th
St, SanTan and 2525 McKinnon property level debt increased by
$0.5 million, $0.8 million, $0.6 million, $1.1 million and $0.7 million respectively in 2017. Offsetting these increase, Corporate Parkway interest expense decreased $0.4 million due to the sale of the property in June
2016 and Secured Credit Facility interest decreased by $0.7 million due to the capital raise which occurred in January 2017. The mortgages placed on Central Fairwinds and DTC Crossroads, also increased interest expense by a further
$0.2 million and $0.3 million, respectively, over the prior year.
Net Gain on the Sale of Real Estate Property.
Net
gain on the sale of real estate property relates to the sale of 2 buildings in our AmberGlen complex in May 2017. In the prior year, amounts relate to the sale of Corporate Parkway in June 2016.
Change in Fair Value of Contingent Consideration.
On June 28, 2017 we received a $2 million refund from a third party
escrow account related to the Park Tower acquisition when certain leasing thresholds were not achieved as a condition to that purchase in the prior year. No similar arrangements were in place in the prior year.
Cash Flows
Comparison of Nine Months Ended
September 30, 2017 to Nine Months Ended September 30, 2016
Cash and cash equivalents were $18.9 million and
$12.0 million as of September 30, 2017 and September 30, 2016, respectively.
Cash flow from operating activities.
Net cash provided by operating activities increased by $12.7 million to $25.5 million for the nine months ended September 30, 2017 compared to $12.8 million for the same period in 2016. The increase was mainly
attributable to an increase in operating cash flows from the new acquisitions, offset by payment of the fair value of
earn-out.
Cash flow to investing activities.
Net cash used in investing activities increased by $167.8 million to $208.0 million
used for the nine months ended September 30, 2017 compared to $40.2 million used in investing activities for the same period in 2016. The increase was primarily due to the of the acquisitions described above.
Cash flow from financing activities.
Net cash provided by financing activities increased by $156.4 million to
$187.7 million for the nine months ended September 30, 2017 compared to $31.3 million provided by the same period in 2016. Cash flow from financing activities increased primarily due to proceeds from a public offering of our common
stock that closed in January 2017, proceeds from new mortgage payables and proceeds from draws on our Secured Credit Facility.
Liquidity and Capital
Resources
Analysis of Liquidity and Capital Resources
We had approximately $18.9 million of cash and cash equivalents and $25.0 million of restricted cash as of September 30, 2017.
26
On January 4, 2017, the Company closed on a $22.0 million loan secured by a first
mortgage lien on the 5090 N 40th St property in Phoenix, Arizona. The loan matures in January 2027. Interest is payable at a fixed rate of 3.92% per annum.
On January 12, 2017, the Company, through a wholly-owned subsidiary of the Operating Partnership closed on the acquisition of 2525
McKinnon, an approximately 111,000 square foot tower located in Dallas, Texas, for $46.8 million, exclusive of closing costs.
On
January 13, 2017, the Company completed a public offering pursuant to which the Company sold 5,750,000 shares of its common stock to the public at a price of $12.40 per share, inclusive of the overallotment option. The Company raised
$71.3 million in gross proceeds, resulting in net proceeds to us of approximately $68.0 million after deducting $3.3 million in underwriting discounts and other expenses related to the offering.
On February 9, 2017, the Company closed on a $35.1 million loan secured by a first mortgage lien on the SanTan property in Phoenix,
Arizona. The loan matures in March 2027. Interest is payable at a fixed rate of 4.56% per annum.
On March 10, 2017, the Company
closed on a $27.0 million loan secured by a first mortgage lien on the 2525 McKinnon property in Dallas, Texas. The loan matures in April 2027. Interest is payable at a fixed rate of 4.24% per annum.
On May 2, 2017, in conjunction with the sale of the 1400 and 1600 buildings at the AmberGlen property, the Company repaid the outstanding
debt secured on the property of $24.1 million plus closing costs and subsequently closed on a $20 million loan secured by a first mortgage lien on the remaining buildings. The loan matures in May 2027. Interest is payable at a fixed rate
of 3.69% per annum.
On June 5, 2017, the Company closed on a $15.2 million loan secured by a first mortgage lien on the Central
Fairwinds property in Orlando, Florida. The loan matures in June 2024. Interest is payable at a fixed rate of 4.00% per annum. In connection with the financing Central Fairwinds was removed as collateral on the Secured Credit Facility.
On June 16, 2017, the Company and the Operating Partnership entered into separate equity distribution agreements (the Sales
Agreements) with each of KeyBanc Capital Markets Inc., Raymond James & Associates, Inc. and BMO Capital Markets Corp. (collectively, the Sales Agents), pursuant to which the Company may issue and sell from time to time up
to 6,000,000 shares of its common stock, $0.01 par value per share, and up to 1,000,000 shares of its 6.625% Series A Cumulative Redeemable Preferred Stock, $0.01 par value per share (collectively, the Shares), through the Sales Agents,
acting as agents or principals (the ATM Program). In connection with the ATM Program, the Company filed Articles Supplementary pursuant to which the Company increased the authorized number of shares of 6.625% Series A Cumulative
Redeemable Preferred Stock to 5,600,000.
Subsequent to quarter end, on October 5, 2017, the Company closed on a $47 million
loan secured by a first mortgage lien on the Mission City property in San Diego, California. The loan was used to pay down the Secured Credit Facility drawn to initially acquire the property. The loan matures in October 2027. Interest is payable at
a fixed rate of 3.78% per annum.
Pursuant to the Sales Agreements, the Shares may be offered and sold through the Sales Agents in
transactions that are deemed to be at the market offerings as defined in Rule 415 under the Securities Act including sales made directly on the New York Stock Exchange or sales made to or through a market maker other than on an exchange
or, with the prior consent of the Company, in privately negotiated transactions. The Sales Agents will be entitled to compensation of up to 2.0% of the gross proceeds of Shares sold through the Sales Agents from time to time under the Sales
Agreements. The Company has no obligation to sell any of the Shares under the Sales Agreements and may at any time suspend solicitations and offers under, or terminate, the Sales Agreements.
27
During the nine month period ended September 30, 2017, we did not sell any Shares under the
ATM Program.
Our short-term liquidity requirements primarily consist of operating expenses and other expenditures associated with our
properties, distributions to our limited partners and distributions to our stockholders required to qualify for REIT status, capital expenditures and, potentially, acquisitions. We expect to meet our short-term liquidity requirements through net
cash provided by operations, reserves established from existing cash, proceeds from our public offerings, including under our ATM program, and borrowings under our mortgage loans and Secured Credit Facility.
Our long-term liquidity needs consist primarily of funds necessary for the repayment of debt at maturity, property acquisitions and
non-recurring
capital improvements. We expect to meet our long-term liquidity requirements with net cash from operations, long-term secured and unsecured indebtedness and the issuance of equity and debt securities.
We also may fund property acquisitions and
non-recurring
capital improvements using our Secured Credit Facility pending longer term financing.
We believe we have access to multiple sources of capital to fund our long-term liquidity requirements, including the incurrence of additional
debt and the issuance of additional equity securities. However, we cannot assure you that this is or will continue to be the case. Our ability to incur additional debt is dependent on a number of factors, including our degree of leverage, the value
of our unencumbered assets and borrowing restrictions that may be imposed by lenders. Our ability to access the equity capital markets is dependent on a number of factors as well, including general market conditions for REITs and market perceptions
about us.
Consolidated Indebtedness as of September 30, 2017
As of September 30, 2017, we had approximately $536.9 million of outstanding consolidated indebtedness, 77.3% of which is fixed rate
debt. The following table sets forth information as of September 30, 2017 with respect to our outstanding indebtedness (in thousands).
|
|
|
|
|
|
|
|
|
|
|
|
|
Debt
|
|
September 30, 2017
|
|
|
Interest Rate as of
September 30, 2017
|
|
|
Maturity Date
|
|
Secured Credit Facility
(1)
|
|
$
|
122,000
|
|
|
|
LIBOR
(2)
+2.25%
|
|
|
|
June 2018
|
|
Washington Group Plaza
(3)
|
|
|
32,469
|
|
|
|
3.85
|
|
|
|
July 2018
|
|
AmberGlen Mortgage Loan
(4)
|
|
|
|
|
|
|
4.38
|
|
|
|
May 2019
|
|
Midland Life Insurance
(5)
|
|
|
88,974
|
|
|
|
4.34
|
|
|
|
May 2021
|
|
Lake Vista
Pointe
(3)
|
|
|
18,435
|
|
|
|
4.28
|
|
|
|
August 2024
|
|
FRP Ingenuity Drive
(3)(6)
|
|
|
17,000
|
|
|
|
4.44
|
|
|
|
December 2024
|
|
Plaza
25
(3)(7)
|
|
|
16,954
|
|
|
|
4.10
|
|
|
|
July 2025
|
|
190 Office Center
(7)
|
|
|
41,250
|
|
|
|
4.79
|
|
|
|
October 2025
|
|
Intellicenter
(7)
|
|
|
33,563
|
|
|
|
4.65
|
|
|
|
October 2025
|
|
FRP Collection
(7)
|
|
|
30,317
|
|
|
|
3.85
|
|
|
|
September 2023
|
|
Carillon Point
(7)
|
|
|
16,754
|
|
|
|
3.50
|
|
|
|
October 2023
|
|
5090 N 40th St
|
|
|
22,000
|
|
|
|
3.92
|
|
|
|
January 2027
|
|
SanTan
(7)
|
|
|
35,100
|
|
|
|
4.56
|
|
|
|
March 2027
|
|
2525 McKinnon
|
|
|
27,000
|
|
|
|
4.24
|
|
|
|
April 2027
|
|
AmberGlen
(7)
|
|
|
20,000
|
|
|
|
3.69
|
|
|
|
May 2027
|
|
Central Fairwinds
(7)
|
|
|
15,174
|
|
|
|
4.00
|
|
|
|
June 2024
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
536,990
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
At September 30, 2017 the Secured Credit Facility had $150 million authorized and $122 million drawn. The Credit Agreement has a maturity date of June 26, 2018, which may be extended to June 26,
2019 at the Companys option upon meeting certain conditions. The Secured Credit Facility requires the Company to maintain a fixed charge coverage ratio of no less than 1.60x. At September 30, 2017, the Secured Credit Facility was
cross-collateralized by Logan Tower, Superior Pointe, Park Tower and Sorrento Mesa. On September 1, 2017, the Company exercised its option under the Secured Credit Facility to utilize the accordion feature to increase the authorized borrowing
capacity under the Secured Credit Facility from $100 million to $150 million. During 2016 the authorized borrowing capacity was increased from $75 million to $100 million.
|
28
(2)
|
As of September 30, 2017, the one month LIBOR rate was 1.23%.
|
(3)
|
Interest on mortgage loan is payable monthly plus principal based on 360 months of amortization.
|
(4)
|
We are required to maintain a minimum net worth of $25 million and a minimum liquidity of $2 million. On May 2, 2017, in conjunction with the sale of the 1400 and 1600 buildings at the AmberGlen property,
the Company repaid the outstanding debt secured on the property of $24.1 million plus closing costs and subsequently closed on a $20 million loan secured by a first mortgage lien on the remaining buildings.
|
(5)
|
The mortgage loan is cross-collateralized by DTC Crossroads, Cherry Creek and City Center. Interest on mortgage loan is payable monthly plus principal based on 360 months of amortization. The loan bears a fixed interest
rate of 4.34% and matures on May 6, 2021. Upon the sale of Corporate Parkway on June 15, 2016, $4 million of the loan was paid down and DTC Crossroads was substituted as collateral property.
|
(6)
|
We are required to maintain a minimum net worth of $17 million, minimum liquidity of $1.7 million and a debt service coverage ratio of no less than 1.15x.
|
(7)
|
We are required to maintain a debt service coverage ratio of no less than 1.45x, 1.15x, 1.20x, 1.40x, 1.35x,1.20x, 1.15x and 1.35x respectively for each of Plaza 25, 190 Office Center, Intellicenter, FRP Collection,
Carillon Point, SanTan, AmberGlen and Central Fairwinds.
|
Contractual Obligations and Other Long-Term Liabilities
The following table provides information with respect to our commitments as of September 30, 2017, including any guaranteed or minimum
commitments under contractual obligations. The table does not reflect available debt extension options.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period
(in thousands)
|
|
Contractual Obligation
|
|
Total
|
|
|
2017
|
|
|
2018-2019
|
|
|
2020-2021
|
|
|
More than
5 years
|
|
Principal payments on debt
|
|
$
|
536,990
|
|
|
$
|
1,014
|
|
|
$
|
163,254
|
|
|
$
|
94,196
|
|
|
$
|
278,526
|
|
Interest payments
|
|
|
114,475
|
|
|
|
5,345
|
|
|
|
35,039
|
|
|
|
29,445
|
|
|
|
44,646
|
|
Tenant-related commitments
(1)
|
|
|
8,950
|
|
|
|
7,765
|
|
|
|
1,171
|
|
|
|
14
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
660,415
|
|
|
$
|
14,124
|
|
|
$
|
199,464
|
|
|
$
|
123,655
|
|
|
$
|
323,172
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Consists principally of commitments for tenant improvements.
|
Off-Balance
Sheet Arrangements
As of September 30, 2017, we did not have any
off-balance
sheet arrangements.
Inflation
Substantially all of our
office leases provide for real estate tax and operating expense escalations. In addition, most of the leases provide for fixed annual rent increases. We believe that inflationary increases may be at least partially offset by these contractual rent
increases and expense escalations.