Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

x

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

 

 

For the quarterly period ended June 30, 2011

 

OR

 

 

o

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

 

Commission File Number 1-9317

 

COMMONWEALTH REIT

(Exact Name of Registrant as Specified in Its Charter)

 

Maryland

 

04-6558834

(State or Other Jurisdiction of Incorporation or
Organization)

 

(IRS Employer Identification No.)

 

Two Newton Place, 255 Washington Street, Suite 300, Newton, Massachusetts

 

02458-1634

(Address of Principal Executive Offices)

 

(Zip Code)

 

617-332-3990

(Registrant’s Telephone Number, Including Area Code)

 

Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

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

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

Number of registrant’s common shares of beneficial interest, $0.01 par value per share, outstanding as of August 3, 2011: 83,648,686.

 

 

 



Table of Contents

 

COMMONWEALTH REIT

 

FORM 10-Q

 

June 30, 2011

 

INDEX

 

 

 

Page

PART I

Financial Information

 

 

 

 

Item 1.

Financial Statements (unaudited)

 

 

 

 

 

Condensed Consolidated Balance Sheets — June 30, 2011 and December 31, 2010

1

 

 

 

 

Condensed Consolidated Statements of Income — Three and Six Months Ended June 30, 2011 and 2010

2

 

 

 

 

Condensed Consolidated Statements of Cash Flows — Six Months Ended June 30, 2011 and 2010

3

 

 

 

 

Notes to Condensed Consolidated Financial Statements

5

 

 

 

Item 2.

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

19

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

37

 

 

 

Item 4.

Controls and Procedures

39

 

 

 

 

Warning Concerning Forward Looking Statements

40

 

 

 

 

Statement Concerning Limited Liability

42

 

 

 

PART II

Other Information

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

43

 

 

 

Item 6.

Exhibits

43

 

 

 

 

Signatures

44

 

References in this Form 10-Q to “we”, “us” and “our” refers to CommonWealth REIT and its consolidated subsidiaries, unless otherwise noted.

 



Table of Contents

 

PART I          Financial Information

 

Item 1.  Financial Statements

 

COMMONWEALTH REIT

 

CONDENSED CONSOLIDATED BALANCE SHEETS

(amounts in thousands, except share data)

(unaudited)

 

 

 

June 30,

 

December 31,

 

 

 

2011

 

2010

 

ASSETS

 

 

 

 

 

Real estate properties:

 

 

 

 

 

Land

 

$

1,440,845

 

$

1,339,133

 

Buildings and improvements

 

5,446,227

 

5,018,125

 

 

 

6,887,072

 

6,357,258

 

Accumulated depreciation

 

(922,597

)

(850,261

)

 

 

5,964,475

 

5,506,997

 

Properties held for sale

 

51,127

 

114,426

 

Acquired real estate leases, net

 

287,241

 

233,913

 

Equity investments

 

168,871

 

171,464

 

Cash and cash equivalents

 

55,035

 

194,040

 

Restricted cash

 

5,109

 

5,082

 

Rents receivable, net of allowance for doubtful accounts of $12,316 and $12,550, respectively

 

203,304

 

191,237

 

Other assets, net

 

224,837

 

171,380

 

Total assets

 

$

6,959,999

 

$

6,588,539

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Revolving credit facility

 

$

230,000

 

$

 

Senior unsecured debt, net

 

2,687,172

 

2,854,540

 

Mortgage notes payable, net

 

380,597

 

351,526

 

Liabilities related to properties held for sale

 

379

 

1,492

 

Accounts payable and accrued expenses

 

137,357

 

123,842

 

Assumed real estate lease obligations, net

 

69,836

 

65,940

 

Rent collected in advance

 

31,579

 

27,988

 

Security deposits

 

23,284

 

22,523

 

Due to affiliates

 

11,621

 

8,998

 

Total liabilities

 

3,571,825

 

3,456,849

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Preferred shares of beneficial interest, $0.01 par value:

 

 

 

 

 

50,000,000 shares authorized;

 

 

 

 

 

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

 

145,015

 

145,015

 

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

 

368,270

 

368,270

 

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

 

265,804

 

 

Common shares of beneficial interest, $0.01 par value:

 

 

 

 

 

350,000,000 shares authorized; 72,148,686 and 72,138,686 shares issued and outstanding, respectively

 

721

 

721

 

Additional paid in capital

 

3,349,114

 

3,348,849

 

Cumulative net income

 

2,438,913

 

2,372,337

 

Cumulative other comprehensive income

 

18,363

 

4,706

 

Cumulative common distributions

 

(2,748,095

)

(2,675,956

)

Cumulative preferred distributions

 

(449,931

)

(432,252

)

Total shareholders’ equity

 

3,388,174

 

3,131,690

 

Total liabilities and shareholders’ equity

 

$

6,959,999

 

$

6,588,539

 

 

See accompanying notes

 

1



Table of Contents

 

COMMONWEALTH REIT

 

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(amounts in thousands, except per share data)

(unaudited)

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Rental income

 

$

222,181

 

$

195,817

 

$

436,697

 

$

390,896

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Operating expenses

 

90,161

 

81,352

 

180,568

 

162,822

 

Depreciation and amortization

 

51,973

 

45,233

 

105,814

 

90,673

 

General and administrative

 

11,618

 

9,554

 

22,569

 

18,804

 

Loss on asset impairment

 

 

21,491

 

 

21,491

 

Acquisition related costs

 

2,415

 

1,103

 

5,060

 

1,413

 

Total expenses

 

156,167

 

158,733

 

314,011

 

295,203

 

Operating income

 

66,014

 

37,084

 

122,686

 

95,693

 

 

 

 

 

 

 

 

 

 

 

Interest and other income

 

392

 

447

 

1,062

 

1,565

 

Interest expense (including net amortization of debt discounts, premiums and deferred financing fees of $1,920, $1,710, $3,952 and $3,476, respectively)

 

(48,200

)

(44,659

)

(95,614

)

(89,524

)

Equity in earnings of investees

 

2,910

 

2,305

 

5,622

 

4,644

 

Gain on issuance of shares by an equity investee

 

 

 

 

16,418

 

Income (loss) from continuing operations before income tax expense

 

21,116

 

(4,823

)

33,756

 

28,796

 

Income tax expense

 

(90

)

(181

)

(436

)

(363

)

Income (loss) from continuing operations

 

21,026

 

(5,004

)

33,320

 

28,433

 

Discontinued operations:

 

 

 

 

 

 

 

 

 

(Loss) income from discontinued operations

 

(1,062

)

3,498

 

(1,316

)

7,358

 

Gain on sale of properties from discontinued operations

 

 

 

34,572

 

 

Income (loss) before gain on sale of properties

 

19,964

 

(1,506

)

66,576

 

35,791

 

Gain on sale of properties

 

 

11,504

 

 

11,504

 

Net income

 

19,964

 

9,998

 

66,576

 

47,295

 

Preferred distributions

 

(10,500

)

(12,667

)

(19,339

)

(25,334

)

Net income (loss) available for common shareholders

 

$

9,464

 

$

(2,669

)

$

47,237

 

$

21,961

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding — basic

 

72,144

 

64,595

 

72,142

 

60,685

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding — diluted

 

79,442

 

71,893

 

79,440

 

67,983

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted earnings per common share:

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations available for common shareholders

 

$

0.15

 

$

(0.10

)

$

0.19

 

$

0.24

 

(Loss) income from discontinued operations

 

$

 

(0.01

)

$

0.05

 

$

0.46

 

$

0.12

 

Net income (loss) available for common shareholders

 

$

0.13

 

$

(0.04

)

$

0.65

 

$

0.36

 

 

See accompanying notes

 

2



Table of Contents

 

COMMONWEALTH REIT

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(amounts in thousands)

(unaudited)

 

 

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

66,576

 

$

47,295

 

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

 

 

 

 

 

Depreciation

 

80,722

 

79,317

 

Net amortization of debt discounts, premiums and deferred financing fees

 

3,952

 

3,805

 

Amortization of acquired real estate leases

 

20,145

 

15,086

 

Other amortization

 

8,094

 

8,323

 

Loss on asset impairment

 

 

21,491

 

Equity in earnings of investees

 

(5,622

)

(4,644

)

Gain on issuance of shares by an equity investee

 

 

(16,418

)

Distributions of earnings from investees

 

5,539

 

4,696

 

Gain on sale of properties

 

(34,572

)

(11,504

)

Change in assets and liabilities:

 

 

 

 

 

Increase in restricted cash

 

(27

)

(812

)

Increase in rents receivable and other assets

 

(24,215

)

(10,750

)

Increase in accounts payable and accrued expenses

 

12,476

 

282

 

Increase in rent collected in advance

 

2,602

 

101

 

Increase (decrease) in security deposits

 

772

 

(877

)

Increase in due to affiliates

 

2,622

 

787

 

Cash provided by operating activities

 

139,064

 

136,178

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Real estate acquisitions and improvements

 

(548,266

)

(205,443

)

Investment in direct financing lease, net

 

(38,635

)

 

Principal payments received from direct financing lease

 

2,050

 

 

Proceeds from sale of properties, net

 

97,362

 

40,394

 

Distributions in excess of earnings from investees

 

2,720

 

3,264

 

Investment in Affiliates Insurance Company

 

 

(44

)

Cash used in investing activities

 

(484,769

)

(161,829

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of common shares, net

 

 

239,095

 

Proceeds from issuance of preferred shares, net

 

265,804

 

 

Proceeds from borrowings

 

485,000

 

191,000

 

Payments on borrowings

 

(454,596

)

(305,802

)

Deferred financing fees

 

(273

)

(199

)

Distributions to common shareholders

 

(72,139

)

(57,870

)

Distributions to preferred shareholders

 

(17,679

)

(25,334

)

Cash provided by financing activities

 

206,117

 

40,890

 

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

583

 

 

 

 

 

 

 

 

(Decrease) increase in cash and cash equivalents

 

(139,005

)

15,239

 

Cash and cash equivalents at beginning of period

 

194,040

 

18,204

 

Cash and cash equivalents at end of period

 

$

55,035

 

$

33,443

 

 

See accompanying notes

 

3



Table of Contents

 

COMMONWEALTH REIT

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

(amounts in thousands)

(unaudited)

 

 

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

Supplemental cash flow information:

 

 

 

 

 

Interest paid

 

$

91,033

 

$

88,734

 

Taxes paid

 

381

 

586

 

 

 

 

 

 

 

Non-cash investing activities:

 

 

 

 

 

Real estate acquisitions

 

$

(56,235

)

$

 

 

 

 

 

 

 

Non-cash financing activities:

 

 

 

 

 

Issuance of common shares

 

$

265

 

$

223

 

Assumption of mortgage notes payable

 

56,235

 

 

 

See accompanying notes

 

4



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data)

 

Note 1.  Basis of Presentation

 

The accompanying condensed consolidated financial statements of CommonWealth REIT, or CWH, we or us, and its subsidiaries have been prepared without audit.  Certain information and footnote disclosures required by U.S. generally accepted accounting principles, or GAAP, for complete financial statements have been condensed or omitted.  We believe the disclosures made are adequate to make the information presented not misleading.  However, the accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes contained in our Annual Report on Form 10-K for the year ended December 31, 2010, or our Annual Report.  In the opinion of our management, all adjustments, which include only normal recurring adjustments considered necessary for a fair presentation, have been included.  All intercompany transactions and balances with our subsidiaries have been eliminated.  Operating results for interim periods are not necessarily indicative of the results that may be expected for the full year.  Reclassifications have been made to the prior years’ financial statements to conform to the current year’s presentation.

 

Note 2.  Recent Accounting Pronouncements

 

In June 2011, the Financial Accounting Standards Board issued Accounting Standards Update No. 2011-05, Presentation of Comprehensive Income.  This standard eliminates the current option to report other comprehensive income and its components in the statement of shareholders’ equity.  This standard is intended to enhance comparability between entities that report under GAAP and to provide a more consistent method of presenting non-owner transactions that affect an entity’s equity.  This standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.  We do not expect the adoption of this update to cause any material changes to the disclosures in our condensed consolidated financial statements.

 

Note 3.  Real Estate Properties

 

Since January 1, 2011, we acquired 20 properties with approximately 4,039,000 square feet for an aggregate purchase price of $652,852, including the assumption of $56,235 of mortgage debt and excluding closing costs, and we sold seven properties with approximately 838,000 square feet for an aggregate sale price of $98,145, excluding closing costs.  We also funded $39,915 of improvements to our owned properties during the six months ended June 30, 2011.  In addition, we have entered into agreements to acquire four properties with approximately 2,935,000 square feet for an aggregate purchase price of $531,100, including the assumption of $265,000 of mortgage debt and excluding closing costs.  Details of our completed and pending acquisitions and sales during 2011 are as follows:

 

In January 2011, we acquired three office properties located in Boca Raton, FL with a combined 639,830 square feet.  The aggregate purchase price was $171,000, excluding closing costs.  We allocated $15,900 to land, $129,790 to buildings and improvements and $25,310 to acquired real estate leases.

 

In January 2011, we acquired an office property located in Columbia, SC with 115,028 square feet.  The purchase price was $12,025, excluding closing costs.  We allocated $1,180 to land, $8,886 to buildings and improvements, $2,072 to acquired real estate leases and $113 to assumed real estate lease obligations.

 

In January 2011, we acquired an office property located in Chelmsford, MA with 98,048 square feet.  The purchase price was $10,000, excluding closing costs.  We allocated $1,410 to land, $7,322 to buildings and improvements, $1,711 to acquired real estate leases and $443 to assumed real estate lease obligations.

 

In February 2011, we acquired an office property located in Montvale, NJ with 119,089 square feet.  The purchase price was $20,600, excluding closing costs.  We allocated $3,650 to land, $13,726 to buildings and improvements, $3,954 to acquired real estate leases and $730 to assumed real estate lease obligations.

 

In March 2011, we acquired four properties located in Phoenix, AZ with a combined 1,063,364 square feet.  The aggregate purchase price was $136,500, excluding closing costs.  We allocated $30,985 to land, $55,733 to buildings and improvements, $38,635 to investment in direct financing lease, $15,706 to acquired real estate leases, $500 to assumed real estate lease obligations and $4,059 to notes payable.  These allocations are preliminary and are subject to change.

 

5



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

In May 2011, we acquired an office property located in Chicago, IL with 1,070,388 square feet.  The purchase price was $162,202, excluding closing costs.  We allocated $34,300 to land, $110,245 to buildings and improvements, $24,399 to acquired real estate leases and $6,742 to assumed real estate lease obligations.  These allocations are preliminary and are subject to change.

 

In June 2011, we acquired four office properties located in Stafford, VA with a combined 149,023 square feet.  The aggregate purchase price was $25,725, including the assumption of $14,960 of mortgage debt and excluding closing costs.  We allocated $4,150 to land, $21,795 to buildings and improvements, $815 to acquired real estate leases, $101 to assumed real estate lease obligations and $934 to premium on mortgage debt.

 

In June 2011, we acquired four office properties located in Folsom, CA with a combined 269,254 square feet.  The aggregate purchase price was $46,300, including the assumption of $41,275 of mortgage debt and excluding closing costs.  We allocated $4,370 to land, $41,748 to buildings and improvements, $3,729 to acquired real estate leases, $262 to assumed real estate lease obligations and $3,285 to premium on mortgage debt.

 

In July 2011, we acquired an office property located in Birmingham, AL with 514,893 square feet.  The purchase price was $68,500, excluding closing costs.

 

In May 2011, we entered an agreement to acquire two office properties located in Chicago, IL with a combined 1,571,386 square feet.  The aggregate purchase price is $390,000, including the assumption of $265,000 of mortgage debt and excluding closing costs.  We expect to acquire these properties during the third quarter of 2011; however, this acquisition is subject to customary closing conditions, including the assumption of existing mortgage debt, and no assurance can be given that we will acquire these properties in that time period or at all.

 

In July 2011, we entered an agreement to acquire an office property located in New Orleans, LA with 1,256,991 square feet.  The purchase price is $107,000, excluding closing costs.  We expect to acquire this property during the third quarter of 2011; however, this acquisition is subject to customary closing conditions and no assurance can be given that we will acquire this property in that time period or at all.

 

In July 2011, we entered an agreement to acquire an office property located in Portland, OR with 106,658 square feet.  The purchase price is $34,100, excluding closing costs.  We expect to acquire this property during the third quarter of 2011; however, this acquisition is subject to customary closing conditions and no assurance can be given that we will acquire this property in that time period or at all.

 

In November 2010, we entered into various agreements to sell 27 properties which are majority leased as medical office, clinic and biotech laboratory buildings to Senior Housing Properties Trust, or SNH, for an aggregate sale price of $470,000, excluding closing costs.  In 2010, we sold 21 of these properties containing approximately 2,066,000 square feet for an aggregate sales price of $374,130, excluding closing costs, and recognized net gains totaling $133,272.  In January 2011, we sold the remaining six properties containing approximately 737,000 square feet for an aggregate sales price of $95,870, excluding closing costs, and recognized gains totaling $34,666.  SNH has continuing rights of first refusal to purchase from us certain additional buildings that are leased to tenants in medical related businesses which we continue to own.

 

In February 2011, we sold an industrial property located in Adairsville, GA with 101,400 square feet for $2,275, excluding closing costs, and recognized a loss of $94.

 

As of June 30, 2011, we had seven office properties with a combined 1,054,000 square feet and 20 industrial & other properties with a combined 1,835,000 square feet classified as held for sale in our consolidated balance sheet.  We are actively marketing these properties for sale and expect to sell them within the next year; however, we can provide no assurance that we will receive acceptable offers to purchase these properties or that we will sell them.

 

6



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

We classify all properties actively marketed, under contract, in active negotiations or otherwise probable for sale within one year as held for sale in our consolidated balance sheets.  Results of operations for properties sold or held for sale are included in discontinued operations in our consolidated statements of income, except for properties sold during 2010 to Government Properties Income Trust, or GOV.  Properties that we sold to GOV are not considered discontinued operations under GAAP because of our retained equity interest in this former subsidiary.  Summarized balance sheet and income statement information for properties sold or held for sale, other than properties sold to GOV, is as follows:

 

Balance Sheets:

 

 

 

June 30,
2011

 

December 31,
2010

 

Real estate properties

 

$

49,795

 

$

105,291

 

Acquired real estate leases

 

114

 

1,104

 

Rents receivable

 

170

 

4,446

 

Other assets, net

 

1,048

 

3,585

 

Properties held for sale

 

$

51,127

 

$

114,426

 

 

 

 

 

 

 

Assumed real estate lease obligations

 

$

7

 

$

7

 

Rent collected in advance

 

196

 

1,187

 

Security deposits

 

176

 

298

 

Liabilities related to properties held for sale

 

$

379

 

$

1,492

 

 

Income Statements:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Rental income

 

$

1,283

 

$

18,152

 

$

3,807

 

$

36,841

 

Operating expenses

 

(2,104

)

(7,852

)

(4,667

)

(15,977

)

Depreciation and amortization

 

 

(4,425

)

 

(8,765

)

General and administrative

 

(241

)

(755

)

(503

)

(1,502

)

Operating (loss) income

 

(1,062

)

5,120

 

(1,363

)

10,597

 

 

 

 

 

 

 

 

 

 

 

Interest and other income

 

 

 

47

 

 

Interest expense

 

 

(1,622

)

 

(3,239

)

(Loss) income from discontinued operations

 

$

(1,062

)

$

3,498

 

$

(1,316

)

$

7,358

 

 

Note 4.  Investment in Direct Financing Lease

 

Our investment in a direct financing lease relates to the triple net lease with a term that exceeds 75% of the useful life of one office tower located within a mixed use property in Phoenix, AZ that we acquired in March 2011. We recognize direct financing lease income using the effective interest method to produce a level yield on funds not yet recovered. Estimated unguaranteed residual values at the date of lease inception represent our initial estimates of the fair value of the leased assets at the expiration of the lease, which do not exceed their original cost. Significant assumptions used in estimating residual values include estimated net cash flows over the remaining lease term and expected future real estate values. The following table summarizes the carrying amount of our net investment in the direct financing lease as of June 30, 2011. The carrying amount of our net investment is included in other assets in our condensed consolidated balance sheet.

 

 

 

June 30,
2011

 

Total minimum lease payments receivable

 

$

43,231

 

Estimated unguaranteed residual value of leased asset

 

4,951

 

Unearned income

 

(11,598

)

Net investment in direct financing lease

 

$

36,584

 

 

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Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

Additionally, we have determined that no allowance for losses related to our direct financing lease was necessary at June 30, 2011.

 

Our direct financing lease has an expiration date in 2045.  Future minimum rentals receivable on this direct financing lease as of June 30, 2011 are $4,048 in 2011, $8,098 in 2012, $8,098 in 2013, $8,098 in 2014, $8,098 in 2015 and $6,791 thereafter.

 

Note 5.  Equity Investments

 

At June 30, 2011 and December 31, 2010, we had the following equity investments in GOV and Affiliates Insurance Company, or AIC:

 

 

 

Ownership Percentage

 

Equity Investments

 

Equity in Earnings (Loss)

 

 

 

June 30,

 

December 31,

 

June 30,

 

December 31,

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

2011

 

2010

 

2011

 

2010

 

GOV

 

24.6

%

24.6

%

$

163,669

 

$

166,388

 

$

2,864

 

$

2,329

 

$

5,539

 

$

4,696

 

AIC

 

14.3

%

14.3

%

5,202

 

5,076

 

46

 

(24

)

83

 

(52

)

 

 

 

 

 

 

$

168,871

 

$

171,464

 

$

2,910

 

$

2,305

 

$

5,622

 

$

4,644

 

 

At June 30, 2011, we owned 9,950,000, or approximately 24.6%, of the common shares of beneficial interest of GOV, with a carrying value of $163,669 and a market value, based on quoted market prices, of $268,849 ($27.02 per share).  GOV is a real estate investment trust, or REIT, which primarily owns properties that are majority leased to government tenants and was our wholly owned subsidiary until its initial public offering, or the GOV IPO, in June 2009 when it became a separate public entity.  In July 2011, GOV issued 6,500,000 common shares in a public offering for $25.40 per common share, raising net proceeds of approximately $157,700 and reducing our ownership percentage from 24.6% prior to this transaction to 21.2% after that transaction.  GOV has granted the underwriters an option to purchase up to an additional 975,000 common shares of beneficial interest to cover overallotments, if any.  If the underwriters exercise their overallotment option in full, we will beneficially own approximately 20.7% of GOV’s common shares of beneficial interest.

 

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

 

During the six months ended June 30, 2011 and 2010, we received cash distributions from GOV totaling $8,259 and $7,960, respectively.

 

8



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

The following summarized financial data of GOV is as reported in GOV’s Quarterly Report on Form 10-Q for the periods ended June 30, 2011.  References in our financial statements to the Quarterly Report on Form 10-Q for GOV are included as textual references only, and the information in GOV’s Quarterly Report on Form 10-Q is not incorporated by reference into our financial statements.

 

 

 

June 30,
2011

 

December 31,
2010

 

Real estate properties, net

 

$

1,036,462

 

$

846,447

 

Acquired real estate leases, net

 

80,075

 

60,097

 

Cash and cash equivalents

 

1,081

 

2,437

 

Rents receivable

 

21,200

 

19,200

 

Other assets, net

 

23,916

 

23,107

 

Total assets

 

$

1,162,734

 

$

951,288

 

 

 

 

 

 

 

Revolving credit facility

 

$

338,000

 

$

118,000

 

Mortgage notes payable

 

45,898

 

46,428

 

Assumed real estate lease obligations, net

 

12,626

 

13,679

 

Other liabilities

 

20,945

 

15,784

 

Shareholders’ equity

 

745,265

 

757,397

 

Total liabilities and shareholders’ equity

 

$

1,162,734

 

$

951,288

 

 

Income Statements:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Rental income

 

$

41,923

 

$

25,940

 

$

80,999

 

$

49,295

 

Operating expenses

 

(15,253

)

(8,460

)

(29,986

)

(16,262

)

Depreciation and amortization

 

(9,097

)

(5,401

)

(17,483

)

(10,281

)

Acquisition related costs

 

(1,009

)

(1,011

)

(1,838

)

(1,855

)

General and administrative

 

(2,566

)

(1,623

)

(4,909

)

(3,082

)

Operating income

 

13,998

 

9,445

 

26,783

 

17,815

 

 

 

 

 

 

 

 

 

 

 

Interest and other income

 

20

 

16

 

35

 

68

 

Interest expense

 

(3,076

)

(1,678

)

(5,613

)

(3,209

)

Equity in earnings (losses) of an investee

 

46

 

(23

)

83

 

(52

)

Income before income tax expense

 

10,988

 

7,760

 

21,288

 

14,622

 

Income tax expense

 

(56

)

(25

)

(102

)

(36

)

Net income

 

$

10,932

 

$

7,735

 

$

21,186

 

$

14,586

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

40,506

 

31,261

 

40,503

 

30,178

 

 

 

 

 

 

 

 

 

 

 

Net income per common share

 

$

0.27

 

$

0.25

 

$

0.52

 

$

0.48

 

 

As of June 30, 2011, we have invested $5,209 in AIC, an insurance company organized by Reit Management & Research LLC, or RMR, and companies to which RMR provides management services.  We may invest additional amounts in AIC in the future if the expansion of this insurance business requires additional capital, but we are not obligated to do so.  At June 30, 2011, we owned approximately 14.3% of AIC with a current carrying value of $5,202.  Although we own less than 20% of AIC, we use the equity method to account for this investment because we believe that we have significant influence over AIC because each of our Trustees is a director of AIC.  Under the equity method, we record our percentage share of net earnings from AIC in our consolidated statements of income.  If we determine there is an “other than temporary” decline in the fair value of this investment, we would record a charge to earnings.  In evaluating the fair value of this investment, we have considered, among other things, the assets and liabilities held by AIC, AIC’s overall financial condition, and the financial condition and prospects for AIC’s insurance business.

 

9



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

In 2010, AIC designed a combination property insurance program for us and other AIC shareholders in which AIC participated as a reinsurer.  Our total premiums paid under this program in 2011 and 2010 were approximately $5,540 and $5,328, respectively.  We are currently investigating the possibilities to expand our insurance relationships with AIC to include other types of insurance. By participating in this insurance business with RMR and the other companies to which RMR provides management services, we expect that we may benefit financially by possibly reducing our insurance expenses or by realizing our pro-rata share of any profits of this insurance business.

 

Note 6.  Real Estate Mortgage Receivable

 

We provided mortgage financing totaling $8,288 at 4.75% per annum in connection with an office property sold in September 2010.  This real estate mortgage requires monthly principal and interest payments and matures on September 30, 2020.  As of June 30, 2011 and December 31, 2010, this mortgage had a carrying value of $7,974 and $8,183, respectively, and was included in other assets in our condensed consolidated balance sheets.

 

Note 7.  Indebtedness

 

We have a $750,000 unsecured revolving credit facility that we use for acquisitions, working capital and general business purposes.  The credit facility matures on August 8, 2013 and includes a conditional option for us to extend the facility for one year to August 8, 2014.  Interest paid under our credit facility is set at LIBOR plus a premium, subject to adjustments based on our credit ratings.  The interest rate on our revolving credit facility averaged 2.2% and 0.8% per annum for the six months ended June 30, 2011 and 2010, respectively.  As of June 30, 2011, we had $230,000 outstanding and $520,000 available under our revolving credit facility.

 

In March 2011, we repaid at maturity all $168,219 of our floating rate senior notes using borrowings under our revolving credit facility.  In June 2011, we repaid at maturity $29,188 of 7.435% mortgage debt using cash on hand.

 

In June 2011, we assumed mortgages on four properties totaling $14,960, which were recorded at a combined fair value of $15,894, in connection with an acquisition.  These debts bear interest at a weighted average rate of 6.35%, require monthly principal and interest payments and mature in 2012 and 2015.  In June 2011, we assumed $41,275 of secured mortgage debt, which was recorded at its fair value of $44,560, in connection with another acquisition.  This mortgage debt bears interest at 5.67%, requires monthly interest payments and matures in 2017.

 

At June 30, 2011, 22 properties costing $625,496 with an aggregate net book value of $512,194 were secured by mortgage notes totaling $380,597 (net of discounts) maturing from 2012 through 2027.

 

Our public debt indentures, our credit facility agreement and our term loan agreement contain a number of financial and other covenants, including a credit facility and term loan covenant that restricts our ability to make distributions under certain circumstances.  At June 30, 2011, we believe we were in compliance with all of our covenants under our public debt indentures, our revolving credit facility and term loan agreements.

 

In July 2011, we prepaid at par plus a premium $23,168 of 8.05% mortgage debt due in 2012 using cash on hand and proceeds from our common share offering completed in July.

 

10



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

Note 8.  Shareholders’ Equity

 

On May 10, 2011, we issued 2,000 common shares, valued at $26.57 per share, the closing price of our common shares on the New York Stock Exchange, or NYSE, on that day, to each of our five trustees as part of their annual compensation.

 

In June 2011, we issued 11,000,000 series E cumulative redeemable preferred shares in a public offering, raising net proceeds of $265,804.  Each series E preferred share has a liquidation preference of $25.00 and requires dividends of $1.8125, 7 ¼% of the liquidation preference per annum, payable in equal quarterly payments.  Our series E preferred shares are redeemable, at our option, for $25.00 each plus accrued and unpaid dividends at any time on or after May 15, 2016.  Net proceeds from this offering were used to reduce amounts outstanding under our revolving credit facility.

 

In July 2011, we issued 11,500,000 common shares in a public offering, raising net proceeds of approximately $263,900.  Net proceeds from this offering were used to repay amounts outstanding under our revolver credit facility and for general business purposes, including funding acquisitions.

 

Other comprehensive income includes unrealized gains or losses on the fair value of our interest rate swap agreements, other investments, and foreign currency translation adjustments.  Our interest rate swap agreements qualify as cash flow hedges and convert the floating interest rate on a $175,000 mortgage note payable to a fixed interest rate.  The following is a reconciliation of net income to total comprehensive income for the three and six months ended June 30, 2011 and 2010:

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

Net income

 

$

19,964

 

$

9,998

 

$

66,576

 

$

47,295

 

Unrealized loss on derivative instrument

 

(4,119

)

(7,941

)

(2,074

)

(10,815

)

Realized gain on sale of investment in available for sale securities

 

 

 

(18

)

 

Foreign currency translation adjustments

 

11,343

 

 

15,705

 

 

Increase in share of investees other comprehensive income

 

40

 

 

44

 

 

Total comprehensive income

 

$

27,228

 

$

2,057

 

$

80,233

 

$

36,480

 

 

Note 9.  Income Taxes

 

We have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended, and as such, are generally not subject to federal and most state income taxation on our operating income provided we distribute our taxable income to our shareholders and meet certain organization and operating requirements.  We are subject to income tax in Australia and certain states despite our REIT status.  During the three and six months ended June 30, 2011, we recognized current tax expense of $499 and $765, respectively, which includes $312 and $476 of foreign taxes, respectively, and $187 and $289 of certain state taxes, respectively.  In addition, during the three and six months ended June 30, 2011, we recognized a deferred tax benefit of $409 and $329, respectively, related to basis differences in our Australian properties.

 

11



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

Note 10.  Fair Value of Assets and Liabilities

 

The table below presents certain of our assets and liabilities measured at fair value during 2011, categorized by the level of inputs used in the valuation of each asset and liability:

 

 

 

 

 

Fair Value at Reporting Date Using

 

Description

 

Total

 

Quoted Prices in Active
Markets for Identical
Assets
(Level 1)

 

Significant Other
Observable Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

 

 

 

 

 

 

 

 

 

 

Recurring Fair Value Measurements:

 

 

 

 

 

 

 

 

 

Effective portion of interest rate contracts (1)

 

$

(9,030

)

$

 

$

(9,030

)

$

 

 


(1)       The fair value of our interest rate swap contracts is determined using the net discounted cash flows of the expected cash flows of each derivative based on the market based interest rate curve (level 2 inputs) and adjusted for our credit spread and the actual and estimated credit spreads of the counterparties (level 3 inputs).  Although we have determined that the majority of the inputs used to value our derivatives fall within level 2 of the fair value hierarchy, the credit valuation adjustments associated with our derivatives utilize level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by us and the counterparties.  As of June 30, 2011, we have assessed the significance of the impact of the credit valuation adjustments on the overall valuation of our derivative positions and have determined that the credit valuation adjustments are not significant to the overall valuation of our derivatives.  As a result, we have determined that our derivative valuations in their entirety are classified as level 2 inputs in the fair value hierarchy.

 

We are exposed to certain risks relating to our ongoing business operations, including the effect of changes in foreign currency exchange rates and interest rates.  The only risk currently managed by using our derivative instruments is a part of our interest rate risk.  Although we have not done so as of June 30, 2011 and have no present intention to do so, we may manage our Australian currency exchange exposure by borrowing in Australian dollars or using derivative instruments in the future, depending on the relative significance of our business activities in Australia at that time.  We may enter into interest rate swaps to manage some of the interest rate risk associated with our floating rate borrowings.  We have interest rate swap agreements to manage our interest rate risk exposure on $175,000 of mortgage notes due 2019, which require interest at a spread over LIBOR.  The interest rate swap agreements utilized by us qualify as cash flow hedges and effectively modify our exposure to interest rate risk by converting our floating interest rate debt to a fixed interest rate basis for this loan through December 1, 2016, thus reducing the impact of interest rate changes on future interest expense.  These agreements involve the receipt of floating interest rate amounts in exchange for fixed rate interest payments over the life of the agreements without an exchange of the underlying principal amount.  The fair value of our derivative instruments decreased by $4,119 and $2,074 during the three and six months ended June 30, 2011, respectively, based primarily on changes in market interest rates.  The fair value of our derivative instruments decreased by $7,941 and $10,815 during the three and six months ended June 30, 2010, respectively, based primarily on changes in market interest rates.  As of June 30, 2011 and December 31, 2010, the fair value of these derivative instruments included in accounts payable and accrued expenses and cumulative other comprehensive income in our consolidated balance sheets totaled ($9,030) and ($6,956), respectively.

 

12



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

In addition to the assets and liabilities described in the above table, our financial instruments include our cash and cash equivalents, rents receivable, equity investments, investment in direct financing lease receivable, real estate mortgage receivable, restricted cash, revolving credit facility, senior notes and mortgage notes payable, accounts payable and accrued expenses, rent collected in advance, security deposits and amounts due to affiliates.  At June 30, 2011 and December 31, 2010, the fair values of these additional financial instruments were not materially different from their carrying values, except as follows:

 

 

 

June 30, 2011

 

December 31, 2010

 

 

 

Carrying
Amount

 

Fair
Value

 

Carrying
Amount

 

Fair
Value

 

Equity investment in GOV

 

$

163,669

 

$

268,849

 

$

166,388

 

$

266,561

 

Senior notes and mortgage notes payable

 

$

2,492,769

 

$

2,699,814

 

$

2,462,847

 

$

2,599,075

 

 

At June 30, 2011 and December 31, 2010, the fair values of our equity investment in GOV are based on quoted market prices of $27.02 and $26.79, respectively.  The fair values of our senior notes and mortgage notes payable are based on estimates using discounted cash flow analyses and currently prevailing interest rates adjusted by credit risk spreads.

 

Other financial instruments that potentially subject us to concentrations of credit risk consist principally of rents receivable; however, none of our tenants are responsible for more than 3% of our total rents.

 

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

 

Note 11.  Earnings Per Common Share

 

As of June 30, 2011, we had 15,180,000 shares of series D cumulative convertible preferred shares that were convertible into 7,298,165 of our common shares.  The effect of our convertible preferred shares on income from continuing operations available for common shareholders per share is anti-dilutive for the periods presented.

 

13



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

Note 12.  Segment Information

 

As of June 30, 2011, we owned 279 suburban office properties, 40 Central Business District, or CBD, office properties and 180 industrial & other properties, excluding properties held for sale.  We account for all of these properties in geographic operating segments for financial reporting purposes based on our method of internal reporting.  We account for our properties by property type (i.e. suburban office, CBD office and industrial & other) and by geographic regions.  We define these individual geographic segments as those which currently, or during either of the last two quarters, represent or generate 5% or more of our total square feet, annualized revenues or property net operating income, or NOI, which we define as rental income less operating expenses.  Our geographic segments include Metro Philadelphia, PA, Oahu, HI, Metro Denver, CO, Metro Chicago, IL, Australia, Metro Washington, DC and Other Markets, which includes properties located elsewhere throughout the United States.  Prior periods have been restated to reflect one office property reclassified to discontinued operations during the third quarter of 2010 and 30 office properties and 25 industrial & other properties reclassified to discontinued operations during the fourth quarter of 2010.  Property level information by geographic segment and property type as of and for the three and six months ended June 30, 2011 and 2010 is as follows:

 

 

 

As of June 30, 2011

 

As of June 30, 2010

 

 

 

Suburban
Office

 

CBD
Office

 

Industrial &
Other

 

Totals

 

Suburban
Office

 

CBD
Office

 

Industrial 
& Other

 

Totals

 

Property square feet (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Metro Philadelphia, PA

 

620

 

4,591

 

 

5,211

 

619

 

4,585

 

 

5,204

 

Oahu, HI

 

 

 

17,914

 

17,914

 

 

 

17,914

 

17,914

 

Metro Denver, CO

 

789

 

672

 

553

 

2,014

 

789

 

672

 

553

 

2,014

 

Metro Chicago, IL

 

1,361

 

1,072

 

104

 

2,537

 

730

 

 

104

 

834

 

Australia

 

 

314

 

1,440

 

1,754

 

 

 

 

 

Metro Washington, DC

 

1,216

 

428

 

 

1,644

 

1,287

 

582

 

 

1,869

 

Other markets

 

18,494

 

7,301

 

10,598

 

36,393

 

16,662

 

6,389

 

10,420

 

33,471

 

Totals

 

22,480

 

14,378

 

30,609

 

67,467

 

20,087

 

12,228

 

28,991

 

61,306

 

 

14



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

 

 

Three Months Ended June 30, 2011

 

Three Months Ended June 30, 2010

 

 

 

Suburban
Office

 

CBD
Office

 

Industrial &
 Other

 

Totals

 

Suburban
Office

 

CBD
Office

 

Industrial
 & Other

 

Totals

 

Property rental income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Metro Philadelphia, PA

 

$

1,919

 

$

28,491

 

$

 

$

30,410

 

$

2,685

 

$

27,570

 

$

 

$

30,255

 

Oahu, HI

 

 

 

18,094

 

18,094

 

 

 

18,566

 

18,566

 

Metro Denver, CO

 

3,459

 

5,679

 

2,166

 

11,304

 

3,410

 

5,372

 

2,035

 

10,817

 

Metro Chicago, IL

 

8,112

 

4,079

 

111

 

12,302

 

4,054

 

 

126

 

4,180

 

Australia

 

 

5,757

 

3,195

 

8,952

 

 

 

 

 

Metro Washington, DC

 

6,315

 

3,353

 

 

9,668

 

7,351

 

5,280

 

 

12,631

 

Other markets

 

73,793

 

41,755

 

15,903

 

131,451

 

65,238

 

37,401

 

16,729

 

119,368

 

Totals

 

$

93,598

 

$

89,114

 

$

39,469

 

$

222,181

 

$

82,738

 

$

75,623

 

$

37,456

 

$

195,817

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property net operating income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Metro Philadelphia, PA

 

$

371

 

$

14,808

 

$

 

$

15,179

 

$

1,050

 

$

14,136

 

$

 

$

15,186

 

Oahu, HI

 

 

 

13,802

 

13,802

 

 

 

13,750

 

13,750

 

Metro Denver, CO

 

2,786

 

3,819

 

1,272

 

7,877

 

2,551

 

3,489

 

1,185

 

7,225

 

Metro Chicago, IL

 

4,857

 

2,181

 

103

 

7,141

 

2,649

 

 

102

 

2,751

 

Australia

 

 

4,615

 

2,424

 

7,039

 

 

 

 

 

Metro Washington, DC

 

3,878

 

2,318

 

 

6,196

 

4,230

 

3,574

 

 

7,804

 

Other markets

 

43,228

 

20,848

 

10,710

 

74,786

 

36,820

 

18,274

 

12,655

 

67,749

 

Totals

 

$

55,120

 

$

48,589

 

$

28,311

 

$

132,020

 

$

47,300

 

$

39,473

 

$

27,692

 

$

114,465

 

 

 

 

Six Months Ended June 30, 2011

 

Six Months Ended June 30, 2010

 

 

 

Suburban
Office

 

CBD
Office

 

Industrial &
 Other

 

Totals

 

Suburban
Office

 

CBD
Office

 

Industrial
 & Other

 

Totals

 

Property rental income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Metro Philadelphia, PA

 

$

3,895

 

$

56,610

 

$

 

$

60,505

 

$

4,882

 

$

56,245

 

$

 

$

61,127

 

Oahu, HI

 

 

 

36,682

 

36,682

 

 

 

36,343

 

36,343

 

Metro Denver, CO

 

6,949

 

11,042

 

4,350

 

22,341

 

5,221

 

10,477

 

4,109

 

19,807

 

Metro Chicago, IL

 

17,016

 

4,079

 

236

 

21,331

 

8,545

 

 

251

 

8,796

 

Australia

 

 

10,928

 

6,092

 

17,020

 

 

 

 

 

Metro Washington, DC

 

12,203

 

6,777

 

 

18,980

 

14,900

 

10,371

 

 

25,271

 

Other markets

 

147,522

 

80,945

 

31,371

 

259,838

 

130,706

 

75,970

 

32,876

 

239,552

 

Totals

 

$

187,585

 

$

170,381

 

$

78,731

 

$

436,697

 

$

164,254

 

$

153,063

 

$

73,579

 

$

390,896

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property net operating income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Metro Philadelphia, PA

 

$

787

 

$

29,065

 

$

 

$

29,852

 

$

1,747

 

$

28,955

 

$

 

$

30,702

 

Oahu, HI

 

 

 

27,215

 

27,215

 

 

 

27,027

 

27,027

 

Metro Denver, CO

 

5,554

 

7,319

 

2,480

 

15,353

 

3,626

 

7,117

 

2,391

 

13,134

 

Metro Chicago, IL

 

10,126

 

2,181

 

213

 

12,520

 

5,691

 

 

201

 

5,892

 

Australia

 

 

9,003

 

4,424

 

13,427

 

 

 

 

 

Metro Washington, DC

 

7,421

 

4,927

 

 

12,348

 

8,656

 

7,056

 

 

15,712

 

Other markets

 

83,612

 

40,726

 

21,076

 

145,414

 

73,868

 

37,469

 

24,270

 

135,607

 

Totals

 

$

107,500

 

$

93,221

 

$

55,408

 

$

256,129

 

$

93,588

 

$

80,597

 

$

53,889

 

$

228,074

 

 

15



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

The following table reconciles our calculation of NOI to net income, the most directly comparable financial measure under GAAP reported in our consolidated financial statements.  We consider NOI to be appropriate supplemental information to net income because it helps both investors and management to understand the operations of our properties.  We use NOI internally as a performance measure and believe NOI provides useful information to investors regarding our results of operations because it reflects only those income and expense items that are incurred at the property level and may facilitate comparisons of our operating performance between periods.  Our management also uses NOI to evaluate individual, regional and company wide property level performance.  NOI excludes certain components from net income in order to provide results that are more closely related to our properties’ results of operations.  NOI does not represent cash generated by operating activities in accordance with GAAP and should not be considered an alternative to net income, net income available for common shareholders or cash flow from operating activities as a measure of financial performance.  A reconciliation of NOI to net income for the three and six months ended June 30, 2011 and 2010, is as follows:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Rental income

 

$

222,181

 

$

195,817

 

$

436,697

 

$

390,896

 

Operating expenses

 

(90,161

)

(81,352

)

(180,568

)

(162,822

)

Property net operating income (NOI)

 

$

132,020

 

$

114,465

 

$

256,129

 

$

228,074

 

 

 

 

 

 

 

 

 

 

 

Property NOI

 

$

132,020

 

$

114,465

 

$

256,129

 

$

228,074

 

Depreciation and amortization

 

(51,973

)

(45,233

)

(105,814

)

(90,673

)

General and administrative

 

(11,618

)

(9,554

)

(22,569

)

(18,804

)

Loss on asset impairment

 

 

(21,491

)

 

(21,491

)

Acquisition related costs

 

(2,415

)

(1,103

)

(5,060

)

(1,413

)

Operating income

 

66,014

 

37,084

 

122,686

 

95,693

 

 

 

 

 

 

 

 

 

 

 

Interest and other income

 

392

 

447

 

1,062

 

1,565

 

Interest expense

 

(48,200

)

(44,659

)

(95,614

)

(89,524

)

Equity in earnings of investees

 

2,910

 

2,305

 

5,622

 

4,644

 

Gain on issuance of shares by an equity investee

 

 

 

 

16,418

 

Income (loss) from continuing operations before income tax expense

 

21,116

 

(4,823

)

33,756

 

28,796

 

Income tax expense

 

(90

)

(181

)

(436

)

(363

)

Income (loss) from continuing operations

 

21,026

 

(5,004

)

33,320

 

28,433

 

(Loss) income from discontinued operations

 

(1,062

)

3,498

 

(1,316

)

7,358

 

Gain on sale of properties from discontinued operations

 

 

 

34,572

 

 

Income (loss) before gain on sale of properties

 

19,964

 

(1,506

)

66,576

 

35,791

 

Gain on sale of properties

 

 

11,504

 

 

11,504

 

Net income

 

$

19,964

 

$

9,998

 

$

66,576

 

$

47,295

 

 

16



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

Note 13.  Related Person Transactions

 

As discussed in Note 5, we own 9,950,000, or approximately 24.6%, of the common shares of beneficial interest of GOV, with a carrying value of $163,669 and a market value, based on quoted market prices, of $268,849 ($27.02 per share) as of June 30, 2011.  GOV is a REIT which primarily owns properties that are majority leased to government tenants and was our wholly owned subsidiary until the GOV IPO in June 2009 when it became a separate publicly owned entity.  In connection with the GOV IPO, we and GOV entered into a transaction agreement in which, among other things, we granted GOV the right of first refusal to acquire any property owned by us that we determine to divest, if the property is then majority leased to a government tenant, including 15 properties we sold to GOV during 2010.  Both we and GOV are managed by RMR, and Barry Portnoy and Adam Portnoy are Managing Trustees of both us and GOV.  As a result, the transactions between us and GOV described above were negotiated and approved by special committees of each company’s board of trustees comprised solely of Independent Trustees who were not also Trustees of the other party to these agreements.

 

We have no employees.  Instead, services that might be provided to us by employees are provided to us by RMR.  RMR provides both business and property management services to us under a business management agreement and a property management agreement.  Pursuant to our business management agreement with RMR, we recognized expenses of $9,188 and $8,689 for the three months ended June 30, 2011 and 2010, respectively, and $17,982 and $17,172 for the six months ended June 30, 2011 and 2010, respectively.  These amounts are included in general and administrative expenses and income (loss) from discontinued operations in our condensed consolidated financial statements.  Pursuant to our property management agreement with RMR, we recognized property management and construction supervision fees of $6,856 and $6,926 for the three months ended June 30, 2011 and 2010, respectively, and $13,720 and $13,286 for the six months ended June 30, 2011 and 2010, respectively.  The property management and construction supervision fees are included in operating expenses or have been capitalized, as appropriate, in our condensed consolidated financial statements.

 

SNH was formerly our 100% owned subsidiary.  It was spun off to our shareholders in 1999.  At the time of SNH’s spin off, we and SNH entered into a transaction agreement which, among other things, prohibited SNH from purchasing medical office, clinic and biotech laboratory buildings.  In May 2008, we agreed to sell 47 medical office, clinic and biomedical laboratory buildings (approximately 2,161,000 square feet of rental space) to SNH for $562,000, and we and SNH entered into an amendment to the transaction agreement to permit SNH, rather than us, to invest in medical office, clinic and biomedical, pharmaceutical and laboratory buildings.  We also entered into a right of first refusal agreement under which we granted SNH a right of first refusal to purchase certain additional identified properties (approximately 4,598,000 square feet of rental space) that we owned and which are leased to tenants in medical related businesses in the event that we determine to sell those properties or in the event of an indirect sale as a result of a change of control of us or a change of control of our subsidiary which owns those properties.

 

In November 2010, we agreed to sell 27 properties (approximately 2,803,000 square feet of rental space) which are majority leased as medical office, clinic and biotech laboratory buildings to SNH for an aggregate sales price of $470,000, excluding closing costs.  These properties were subject to the right of first refusal referred to above.  As of January 26, 2011, we had completed the sale of all 27 of these properties.  We continue to own certain properties that remain subject to SNH’s right of first refusal.

 

Both we and SNH are managed by RMR; Barry Portnoy and Adam Portnoy are Managing Trustees of both us and SNH; and Frederick N. Zeytoonjian is an Independent Trustee of both us and SNH.  As a result, the transactions between us and SNH described above were negotiated and approved by special committees of each company’s board of trustees comprised solely of Independent Trustees who were not also Independent Trustees of the other party to these agreements.

 

As of June 30, 2011, we had invested $5,209 in AIC, an insurance company that is owned by RMR and companies to which RMR provides management services.  We own approximately 14.3% of AIC which has a carrying value of $5,202 as of June 30, 2011.  In 2011 and 2010, we, RMR and other owners of AIC purchased property insurance pursuant to a combined program arranged and partially reinsured by AIC.

 

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Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

For more information about the relationships among us, our Trustees and executive officers, RMR, GOV, SNH, AIC and other companies to which RMR provides management services, and about the risks which may arise from these relationships, please refer to our Annual Report and our other filings with the Securities and Exchange Commission, or the SEC, including the sections captioned “Business,” “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Related Person Transactions” in our Annual Report, the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Related Person Transactions” in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2011, or our Quarterly Report, and the information regarding our Trustees and executive officers and the section captioned “Related Person Transactions and Company Review of Such Transactions” in our Proxy Statement dated February 25, 2011 relating to our 2011 Annual Shareholders Meeting, or our Proxy Statement.  Our filings with the SEC, including our Annual Report, our Quarterly Report and our Proxy Statement, are available at the SEC’s website: www.sec.gov.

 

Note 14.  Subsequent Events

 

In July 2011, we declared a distribution of $0.50 per common share, or approximately $36,100, to be paid on or about August 25, 2011 to shareholders of record on July 11, 2011.  We also announced a distribution on our series C preferred shares of $0.4453 per share, or $2,672, a distribution on our series D preferred shares of $0.4063 per share, or $6,167, and a distribution on our series E preferred shares of $0.3726 per share, or $4,099, which we expect to pay on or about August 15, 2011 to our preferred shareholders of record as of August 1, 2011.  Other subsequent events have been disclosed within other notes to these condensed consolidated financial statements.

 

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Table of Contents

 

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

 

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

 

OVERVIEW

 

We primarily own office and industrial buildings in suburban and CBD locations throughout the United States.  We also own 17.9 million square feet of leased industrial and commercial lands located in Oahu, Hawaii and 1.8 million square feet of office and industrial buildings located in Australia.

 

Property Operations

 

As of June 30, 2011, 87.5% of our total square feet was leased, compared to 88.0% leased as of June 30, 2010.  These results reflect a 1.3 percentage point decrease in occupancy at properties we owned continuously since January 1, 2010, partially offset by property acquisitions.  Occupancy data for 2011 and 2010 is as follows (square feet in thousands):

 

 

 

All Properties (1)

 

Comparable Properties (2)

 

 

 

As of June 30,

 

For the Six Months
Ended June 30,

 

 

 

2011

 

2010

 

2011

 

2010

 

Total properties

 

499

 

466

 

439

 

439

 

Total square feet

 

67,467

 

61,306

 

58,523

 

58,523

 

Percent leased (3)

 

87.5

%

88.0

%

86.7

%

88.0

%

 


(1)     Excludes properties classified in discontinued operations as of June 30, 2011.

(2)     Based on properties owned continuously since January 1, 2010, and excludes properties classified in discontinued operations as of June 30, 2011.

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

 

During the three months ended June 30, 2011, we signed lease renewals for 712,000 square feet and new leases for 549,000 square feet, at weighted average rental rates which were 2% above rents previously charged for the same space.  The average lease term for leases signed during the three months ended June 30, 2011 was 6.2 years.  Commitments for tenant improvement and leasing costs for leases signed during the three months ended June 30, 2011 totaled $19.8 million, or $15.71 per square foot on average (approximately $2.53/sq. ft. per year of the lease term).

 

During the past twelve months, leasing market conditions in the majority of our markets appear to be stabilizing but remain weak.  As a result, the amount of leasing activity within our portfolio has slowed and our occupancy has declined.  Required landlord funded tenant build outs and leasing commissions payable to tenant brokers for new leases and lease renewals have increased in certain markets since 2008.  These build out costs and leasing commissions are generally amortized as a reduction of our income during the terms of the affected leases.  We believe that the current high unemployment rate and weak leasing market conditions in the U.S. may lead to a continued decrease in occupancy and effective rents at our properties through the end of 2011, but we expect our occupancy may begin to improve in late 2011 and 2012.  However, there are too many variables for us to reasonably project what the financial impact of changing market conditions will be on our occupancy or financial results for future periods.

 

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Table of Contents

 

Approximately 15.3% of our leased square feet and 17.5% of our rents are included in leases scheduled to expire through December 31, 2012.  Lease renewals and rental rates at which available space may be relet in the future will depend on prevailing market conditions at the times these renewals and rates are negotiated.  Lease expirations by year, as of June 30, 2011, are as follows (square feet and dollars in thousands):

 

 

 

Square
Feet

 

% of
Square Feet

 

Cumulative
% of Square
Feet

 

Annualized
Rental
Income

 

% of
Annualized
Rental
Income

 

Cumulative
% of
Annualized
Rental
Income

 

Year 

 

Expiring (1)

 

Expiring

 

Expiring

 

Expiring (2)

 

Expiring

 

Expiring

 

2011

 

3,584

 

6.1

%

6.1

%

$

55,947

 

6.0

%

6.0

%

2012

 

5,446

 

9.2

%

15.3

%

104,822

 

11.3

%

17.3

%

2013

 

5,444

 

9.2

%

24.5

%

98,183

 

10.6

%

27.9

%

2014

 

4,642

 

7.9

%

32.4

%

73,842

 

8.0

%

35.9

%

2015

 

4,248

 

7.2

%

39.6

%

91,940

 

9.9

%

45.8

%

2016

 

5,090

 

8.6

%

48.2

%

80,023

 

8.6

%

54.4

%

2017

 

3,080

 

5.2

%

53.4

%

81,574

 

8.8

%

63.2

%

2018

 

3,102

 

5.3

%

58.7

%

64,752

 

7.0

%

70.2

%

2019

 

3,650

 

6.2

%

64.9

%

44,854

 

4.8

%

75.0

%

2020

 

2,762

 

4.7

%

69.6

%

70,717

 

7.6

%

82.6

%

Thereafter

 

17,980

 

30.4

%

100.0

%

161,746

 

17.4

%

100.0

%

 

 

59,028

 

100.0

%

 

 

$

928,400

 

100.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average remaining lease term (in years):

 

8.0

 

 

 

 

 

6.1

 

 

 

 

 

 


(1) Square feet is pursuant to signed leases as of June 30, 2011, and includes (i) space being fitted out for occupancy and (ii) space which is leased but is not occupied or is being offered for sublease by tenants. Excludes properties classified in discontinued operations.

(2) Annualized rental income is rents pursuant to signed leases as of June 30, 2011, plus estimated expense reimbursements; includes some triple net lease rents and excludes lease value amortization. Excludes properties classified in discontinued operations.

 

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Table of Contents

 

Our principal source of funds for our operations is rents from tenants at our properties.  Rents are generally received from our tenants monthly in advance, except from our government tenants, who pay rents monthly in arrears.  As of June 30, 2011, tenants responsible for 1% or more of our total rent were as follows (square feet in thousands):

 

Tenant

 

Square
Feet 
(1)

 

% of Total
Square Feet 
(1)

 

% of
Annualized
Rental
Income 
(2)

 

Expiration

 

1.

Telstra Corporation Limited

 

311

 

0.5

%

2.2

%

2020

 

2.

U. S. Government (3)

 

629

 

1.1

%

1.9

%

2011 to 2031

 

3.

Office Depot, Inc.

 

651

 

1.1

%

1.9

%

2016 and 2023

 

4.

Expedia, Inc.

 

357

 

0.6

%

1.8

%

2018

 

5.

PNC Financial Services Group

 

613

 

1.0

%

1.7

%

2012 to 2021

 

6.

John Wiley & Sons, Inc

.

342

 

0.6

%

1.7

%

2017

 

7.

GlaxoSmithKline plc

 

608

 

1.0

%

1.6

%

2013

 

8.

Wells Fargo Bank

 

485

 

0.8

%

1.4

%

2011 to 2022

 

9.

The Bank of New York Mellon Corp.

 

393

 

0.7

%

1.2

%

2011 to 2021

 

10.

Jones Day (law firm)

 

407

 

0.7

%

1.2

%

2012 and 2019

 

11.

Ballard Spahr Andrews & Ingersoll (law firm)

 

269

 

0.5

%

1.1

%

2012 and 2015

 

12.

Flextronics International Ltd.

 

894

 

1.5

%

1.0

%

2014

 

13.

JDA Software Group, Inc.

 

283

 

0.5

%

1.0

%

2012

 

14.

ING

 

410

 

0.7

%

1.0

%

2011 and 2018

 

 

Total

 

6,652

 

11.3

%

20.7

%

 

 

 


(1)

Square feet is pursuant to signed leases as of June 30, 2011, and includes (i) space being fitted out for occupancy and (ii) space which is leased but is not occupied or is being offered for sublease by tenants. Excludes properties classified in discontinued operations.

(2)

Annualized rental income is rents pursuant to signed leases as of June 30, 2011, plus estimated expense reimbursements. Includes some triple net lease rents and excludes lease value amortization. Excludes properties classified in discontinued operations.

(3)

Including our 24.6% pro rata ownership of GOV as of June 30, 2011, the U.S. Government represents 2,020 square feet, or 3.3% of total square feet, and 5.2% of total rental income.

 

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Table of Contents

 

Investment Activities

 

Since January 1, 2011, we have acquired 20 office properties with a combined 4,039,000 square feet for an aggregate purchase price of $652.9 million, including the assumption of $56.2 million of mortgage de