NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2018
(UNAUDITED)
NOTE 1:
NATURE OF BUSINESS
Washington Real Estate Investment Trust (“Washington REIT”), a Maryland real estate investment trust, is a self-administered equity real estate investment trust, successor to a trust organized in 1960. Our business consists of the ownership and operation of income producing real estate properties in the greater Washington metro region. We own a diversified portfolio of office buildings, multifamily buildings and retail centers.
Federal Income Taxes
We believe that we qualify as a real estate investment trust (“REIT”) under Sections 856-860 of the Internal Revenue Code of 1986, as amended (the "Code"), and intend to continue to qualify as such. We have considered the provisions of the Tax Cuts and Jobs Act (the "TCJA"), which was signed into law on December 22, 2017 and which generally takes effect for taxable years beginning on or after January 1, 2018, and do not expect the TCJA to have a material impact on our ability to continue to qualify as a REIT. To maintain our status as a REIT, we are, among other things, required to distribute
90%
of our REIT taxable income (which is, generally, our ordinary taxable income, with certain modifications), excluding any net capital gains and any deductions for dividends paid to our shareholders on an annual basis. When selling a property, we generally have the option of (a) reinvesting the sales proceeds of property sold, in a way that allows us to defer recognition of some or all taxable gain realized on the sale, (b) distributing gains to the shareholders with no tax to us or (c) treating net long-term capital gains as having been distributed to our shareholders, paying the tax on the gain deemed distributed and allocating the tax paid as a credit to our shareholders. During 2018, we sold our interests in Braddock Metro Center, a
356,000
square foot office property in Alexandria, Virginia, and 2445 M Street, a
292,000
square foot office property in Washington, DC (see note 3).
Generally, and subject to our ongoing qualification as a REIT, no provisions for income taxes are necessary except for taxes on undistributed taxable income and taxes on the income generated by our taxable REIT subsidiaries (“TRSs”). Our TRSs are subject to corporate federal and state income tax on their taxable income at regular statutory rates, or as calculated under the alternative minimum tax, as appropriate. As of both
September 30, 2018
and
December 31, 2017
, our TRSs had a deferred tax asset of $1.4 million that was fully reserved. As of both
September 30, 2018
and
December 31, 2017
, we had a deferred state and local tax liability of
$0.6 million
. This deferred tax liability is primarily related to temporary differences in the timing of the recognition of revenue, depreciation and amortization.
NOTE 2:
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND BASIS OF PRESENTATIONS
Significant Accounting Policies
We have prepared our consolidated financial statements using the accounting policies described in our Annual Report on Form 10-K for the year ended
December 31, 2017
.
Pronouncements Adopted
In August 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2017-12,
Derivatives and Hedging:
Targeted Improvements to Accounting for Hedging Activities
. The purpose of this updated guidance is to better align a company’s financial reporting for hedging activities with the economic objectives of those activities. The transition guidance provides companies with the option of early adopting the new standard using a modified retrospective transition method in any interim period after issuance of the update, or alternatively requires adoption for fiscal years beginning after December 15, 2018. We adopted the new standard as of January 1, 2018 and the adoption did not have a material impact on our consolidated financial statements.
In May 2017, the FASB issued ASU 2017-09,
Compensation - Stock Compensation (Topic 718) - Scope of Modification Accounting,
which provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. The new standard is effective for all entities for fiscal years beginning after December 15, 2017 and for interim periods therein, with early adoption permitted. We adopted the new standard as of January 1, 2018 and the adoption did not have a material impact on our consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15,
Classification of Certain Cash Receipts and Cash Payments
,
which provides specific guidance on how cash receipts and payments should be presented and classified in the statement of cash flows for eight specific issues. The new standard is effective for public entities for fiscal years beginning after December 15, 2017 and for interim periods therein, with early adoption permitted. We adopted the new standard as of January 1, 2018 and the adoption did not have a material impact on our consolidated financial statements.
In January 2016, the FASB issued ASU 2016-01,
Recognition and Measurement of Financial Assets and Liabilities
,
which eliminates the requirement for public entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. The new standard is effective for public entities for fiscal years beginning after December 15, 2017 and for interim periods therein. We adopted the new standard as of January 1, 2018 and the adoption did not have a material impact on our consolidated financial statements.
In June 2014, the FASB issued ASU No. 2014-09,
Revenue from Contracts with Customers (Topic 606)
(“ASU 2014-09”), which creates a single source of revenue guidance. The new standard provides accounting guidance for all revenue arising from contracts with customers and affects all entities that enter into contracts to provide goods or services to their customers (unless the contracts are in the scope of other U.S. generally accepted accounting principles (“GAAP”) requirements, such as the leasing literature). The guidance also provides a model for the measurement and recognition of gains and losses on the sale of certain nonfinancial assets, such as property and equipment, including real estate. The new standard is effective for public entities for fiscal years beginning after December 15, 2017 and for interim periods therein. We adopted the new standard for the fiscal year beginning on January 1, 2018. We evaluated the requirements for recognition of revenue from contracts with customers and measuring gains and losses on the sale of properties in accordance with ASU 2014-09 and concluded the adoption of the new standard did not impact in any material respect the amount or timing of our revenue recognition.
Pronouncements Not Yet Adopted
In February 2016, the FASB issued ASU 2016-02,
Leases (Topic 842)
(“ASU 2016-02”)
,
which amends existing lease accounting standards for both lessees and lessors. The standard is effective for fiscal years beginning after December 15, 2018 and for interim periods therein with early adoption permitted. Washington REIT will adopt the standard for the fiscal year beginning on January 1, 2019.
Lessees
For lessees, ASU 2016-02 requires lessees to classify most leases as either finance or operating leases. For lease contracts, or contracts with an embedded lease, with a duration of more than one year in which we are the lessee, the present value of future lease payments will be recognized on our balance sheet as a right-of-use asset and a corresponding lease liability. We are evaluating lease contracts where we are the lessee to determine the impact they may have on Washington REIT’s consolidated financial statements.
Lessors
For lessors, lease contracts currently classified as operating leases will be accounted for similarly to existing guidance. However, under ASU 2016-02, lessors are required to account for each lease and non-lease component, such as common area maintenance or tenant service revenues, of a contract separately. In July 2018, the FASB issued 2018-11,
Leases (Topic 842) - Targeted Improvements
(“ASU 2018-11”), which provides lessors optional transition relief from implementing this aspect of ASU 2016-02 if the following criteria are met: (1) both components have the same timing and pattern of revenue and (2) if accounted for separately, both components would be classified as an operating lease. We currently believe that the leases where we are lessor meet both criteria and we will elect not to bifurcate lease contracts into lease and non-lease components. Accordingly, both lease and non-lease components will be presented in “Real estate rental revenue” in our consolidated financial statements subsequent to adoption.
Also under ASU 2016-02, the FASB determined that only incremental costs or initial direct costs of executing a lease contract qualify for capitalization, while current accounting standards allow for the capitalization of indirect leasing costs.
Transition
Under ASU 2018-11, the FASB offered optional transition relief, if elected as a package, and applied consistently by an entity to all of its leases. Accordingly, upon adoption, we will elect, as a package, the practical expedients for all leases as follows: (1) we will not reassess whether any expired or existing contracts are or contain leases, (2) we will not reassess the lease classification
for any expired or existing leases and (3) we will not reassess initial direct costs for any existing leases. We are currently evaluating the impact ASU 2016-02 may have on our consolidated financial statements.
Under ASU 2016-02, entities are required to implement the standard as of the beginning of the earliest comparative period presented or January 1, 2017 for calendar-year public business entities. Under ASU 2018-11, the FASB offered optional transition relief that permits entities to continue to apply ASC 840, including its disclosure requirements, in the comparative periods presented in the year of adoption. Accordingly, we will make a policy election to apply ASC 840 to comparative periods on January 1, 2019.
In June 2016, the FASB issued ASU 2016-13,
Measurement of Credit Losses on Financial Instruments
,
which requires financial assets measured at an amortized cost basis, including trade receivables, to be presented at the net amount expected to be collected. The new standard is effective for public entities for fiscal years beginning after December 15, 2019 and for interim periods therein with adoption one year earlier permitted. We are currently evaluating the impact the new standard may have on Washington REIT’s consolidated financial statements.
In September 2018, the FASB issued ASU 2018-15,
Intangibles - Goodwill and Other - Internal-Use Software
, which requires a customer in a cloud computing arrangement that is a service contract to follow the internal-use software guidance to determine which implementation costs to capitalize as assets. The standard is effective for public entities for fiscal years beginning after December 31, 2019 and for interim periods threrein, with early adoption permitted. We are currently evaluating the impact the new standard may have on Washington REIT’s consolidated financial statements.
Principles of Consolidation and Basis of Presentation
The accompanying unaudited consolidated financial statements include the consolidated accounts of Washington REIT, our majority-owned subsidiaries and entities in which Washington REIT has a controlling interest. All intercompany balances and transactions have been eliminated in consolidation.
We have prepared the accompanying unaudited financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and note disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to those rules and regulations, although we believe that the disclosures made are adequate to make the information presented not misleading. In addition, in the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the results for the periods presented have been included. These unaudited financial statements should be read in conjunction with the financial statements and notes included in our Annual Report on Form 10-K for the year ended
December 31, 2017
.
Within these notes to the financial statements, we refer to the three months ended
September 30, 2018
and
September 30, 2017
as the “
2018
Quarter” and the “
2017
Quarter,” respectively, and the
nine
months ended
September 30, 2018
and
September 30, 2017
as the “
2018
Period” and the “
2017
Period,” respectively.
Restricted Cash
Restricted cash includes funds escrowed for tenant security deposits, real estate tax, insurance and mortgage escrows and escrow deposits required by lenders on certain of our properties to be used for future building renovations or tenant improvements.
Use of Estimates in the Financial Statements
The preparation of financial statements in conformity with GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
NOTE 3:
REAL ESTATE
Acquisition
Our current strategy includes recycling legacy assets that lack the income growth potential we seek and to invest in high-quality assets with compelling value-add returns through redevelopment opportunities in our existing portfolio and acquisitions that meet our stringent investment criteria. We focus on properties inside the Washington metro region’s Beltway, near major transportation nodes and in areas with strong employment drivers and superior growth demographics. We acquired the following property during the 2018 Period (the “2018 acquisition”):
|
|
|
|
|
|
|
|
|
|
|
|
Acquisition Date
|
|
Property
|
|
Type
|
|
Net Rentable
Square Feet
|
|
Contract Purchase Price (In thousands)
|
January 18, 2018
|
|
Arlington Tower
|
|
Office
|
|
391,000
|
|
$
|
250,000
|
|
The results of operations from the 2018 acquisition are included in the condensed consolidated statements of income from the acquisition date and are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2018
|
|
Nine Months Ended September 30, 2018
|
Real estate rental revenue
|
$
|
5,947
|
|
|
$
|
16,485
|
|
Net income
|
843
|
|
|
2,457
|
|
We accounted for the 2018 acquisition as an asset acquisition. Accordingly, we capitalized
$0.6 million
of costs directly associated with the acquisition. We measured the value of the acquired physical assets (land and building), in-place leases (tenant origination costs, leasing commissions, absorption costs and lease intangible assets/liabilities), and any other liabilities by allocating the total cost of the acquisition on a relative fair value basis.
We have recorded the total cost of the 2018 acquisition as follows (in thousands):
|
|
|
|
|
Land
|
$
|
63,970
|
|
Building
|
142,900
|
|
Tenant origination costs
|
13,625
|
|
Leasing commissions/absorption costs
|
27,465
|
|
Lease intangible assets
|
3,142
|
|
Lease intangible liabilities
|
(545
|
)
|
Total
|
$
|
250,557
|
|
The weighted remaining average life for the 2018 acquisition components above, other than land and building, are
74 months
for tenant origination costs,
64 months
for leasing commissions/absorption costs,
66 months
for lease intangible assets and
81 months
for lease intangible liabilities.
The difference in the total contract purchase price of
$250.0 million
for the 2018 acquisition and cash paid for the acquisition per the consolidated statements of cash flows of
$106.4 million
is primarily due to a mortgage note assumed and repaid at settlement (
$135.5 million
), an acquisition deposit made during 2017 (
$6.3 million
) and a net credit to the buyer for certain expenditures (
$1.8 million
).
Development/Redevelopment
We have properties under development/redevelopment and held for current or future development as of
September 30, 2018
.
In the multifamily segment, we have The Trove, a multifamily development adjacent to The Wellington, and own land held for future multifamily development adjacent to Riverside Apartments. As of
September 30, 2018
, we had invested
$52.7 million
and
$22.4 million
, including the costs of acquiring the land, in The Trove and the development adjacent to Riverside Apartments, respectively.
In the retail segment, we currently have a redevelopment project to add rentable space at Spring Valley Village. As of
September 30, 2018
, we had invested
$6.4 million
in the redevelopment.
Properties Sold and Held for Sale
We intend to hold our properties for investment with a view to long-term appreciation, to engage in the business of acquiring, developing and owning our properties, and to make occasional sales of the properties that no longer meet our long-term strategy or return objectives and where market conditions for sale are favorable. The proceeds from the sales may be reinvested into other properties, used to fund development operations or to support other corporate needs, or distributed to our shareholders. Depreciation on these properties is discontinued when classified as held for sale, but operating revenues, other operating expenses and interest continue to be recognized until the date of sale.
We sold our interests in the following properties in
2018
and
2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Disposition Date
|
|
Property Name
|
|
Segment
|
|
Rentable Square Feet/ Number of Units
|
|
Contract
Sales Price
(in thousands)
|
|
Gain on Sale
(in thousands)
|
January 19, 2018
|
|
Braddock Metro Center
|
|
Office
|
|
356,000
|
|
$
|
93,000
|
|
|
$
|
—
|
|
June 28, 2018
|
|
2445 M Street
|
|
Office
|
|
292,000
|
|
101,600
|
|
|
2,495
|
|
|
|
|
|
Total 2018
|
|
648,000
|
|
$
|
194,600
|
|
|
$
|
2,495
|
|
|
|
|
|
|
|
|
|
|
|
|
October 23, 2017
|
|
Walker House Apartments
|
|
Multifamily
|
|
212
|
|
$
|
32,200
|
|
|
$
|
23,838
|
|
We have fully transferred control of the assets associated with these disposed properties.
During the first quarter of 2018, we sold Braddock Metro Center, a
356,000
square foot office property in Alexandria, Virginia, for a contract sales price of
$93.0 million
. Due to then-ongoing negotiations to sell the property, we evaluated Braddock Metro Center for impairment and recognized a
$9.1 million
impairment charge during 2017 in order to reduce the carrying value of the property to its estimated fair value, less selling costs. We based this fair value on the expected sale price from a potential sale. There are few observable market transactions for similar properties. This fair valuation falls into Level 2 of the fair value hierarchy due to its reliance on a quoted price in a market that is not active.
During the first quarter of 2018, we executed a purchase and sale agreement to sell 2445 M Street, a
292,000
square foot office property in Washington, DC, for a contract sales price of
$100.0 million
, with settlement originally scheduled for the third quarter of 2018. During 2017, we evaluated 2445 M Street for impairment and recognized a
$24.1 million
impairment charge in order to reduce the carrying value of the property to its estimated fair value. Upon execution of the purchase and sale agreement, the property met the criteria for classification as held for sale. Due to the property’s classification as held for sale, we recorded an additional impairment charge of
$1.9 million
in the first quarter of 2018 in order to reduce the carrying value of the property to its estimated fair value, less estimated selling costs. We based this fair value on the expected sales price from a potential sale. There are few observable market transactions for similar properties. This fair valuation falls into Level 2 of the fair value hierarchy due to its reliance on a quoted price in a market that is not active. During the second quarter of 2018, we executed an amendment to the purchase and sale agreement which increased the contract sales price to
$101.6 million
and advanced the settlement date. On June 28, 2018, we sold 2445 M Street, recognizing a gain on sale of real estate of
$2.5 million
.
NOTE 4:
MORTGAGE NOTES PAYABLE
In
August 2018
, we prepaid without penalty the remaining
$31.7 million
of the mortgage note secured by Kenmore Apartments.
NOTE 5:
UNSECURED LINE OF CREDIT PAYABLE
During the first quarter of 2018, we entered into an amended and restated credit agreement (“Credit Agreement”) which provides for a
$700.0 million
unsecured revolving credit facility (“Revolving Credit Facility”), the continuation of an existing
$150.0 million
unsecured term loan (“2015 Term Loan”) and an additional
$250.0 million
unsecured term loan (“2018 Term Loan”). The Revolving Credit Facility has a
four
-year term ending in
March 2022
, with
two
six
-month extension options, and expands our prior
$600.0 million
unsecured revolving credit facility that was set to expire in
June 2019
. The Credit Agreement has an accordion feature that allows us to increase the aggregate facility to
$1.5 billion
, subject to the extent lenders agree to provide additional revolving loan commitments or term loans.
The Revolving Credit Facility bears interest at a rate of either
one month
LIBOR plus a margin ranging from
0.775%
to
1.55%
or the base rate plus a margin ranging from
0.0%
to
0.55%
(in each case depending upon Washington REIT’s credit rating). The base rate is the highest of the administrative agent’s prime rate, the federal funds rate plus
0.50%
and the LIBOR market index rate plus
1.0%
. In addition, the Revolving Credit Facility requires the payment of a facility fee ranging from
0.10%
to
0.30%
(depending on Washington REIT’s credit rating) on the
$700.0 million
committed revolving loan capacity, without regard to usage. As of
September 30, 2018
, the interest rate on the Revolving Credit Facility is one month LIBOR plus
1.00%
, the one month LIBOR is
2.26%
and the facility fee is
0.20%
.
The 2018 Term Loan increases and replaces the
$150.0 million
unsecured term loan, initially entered into on
July 22, 2016
(“2016 Term Loan”), that was set to mature in
July 2023
. The 2018 Term Loan matures in
July 2023
and bears interest at a rate of either one month LIBOR plus a margin ranging from
0.85%
to
1.75%
or the base rate plus a margin ranging from
0.0%
to
0.75%
(in each case depending upon Washington REIT’s credit rating). We used the
$100.0 million
of additional proceeds from the 2018 Term Loan primarily to repay outstanding borrowings on the Revolving Credit Facility.
We had previously used interest rate derivatives to effectively fix the interest rate of the 2016 Term Loan. These interest rate derivatives now effectively fix the interest rate on a
$150.0 million
portion of the 2018 Term Loan at
2.31%
. In March 2018, we entered into interest rate derivatives that commenced on
June 29, 2018
to effectively fix the interest rate on the remaining
$100.0 million
of the 2018 Term Loan at
3.71%
.
The amount of the Revolving Credit Facility’s unsecured line of credit unused and available at
September 30, 2018
is as follows (in thousands):
|
|
|
|
|
Committed capacity
|
$
|
700,000
|
|
Borrowings outstanding
|
(183,000
|
)
|
Unused and available
|
$
|
517,000
|
|
We executed borrowings and repayments on the Revolving Credit Facility during the
2018
Period as follows (in thousands):
|
|
|
|
|
Balance at December 31, 2017
|
$
|
166,000
|
|
Borrowings
|
397,000
|
|
Repayments
|
(380,000
|
)
|
Balance at September 30, 2018
|
$
|
183,000
|
|
NOTE 6:
DERIVATIVE INSTRUMENTS
On
September 15, 2015
, we entered into
two
interest rate swap arrangements with a total notional amount of
$150.0 million
to swap the floating interest rate under the 2015 Term Loan (see note
5
) to an all-in fixed interest rate of
2.72%
starting on
October 15, 2015
and extending until the maturity of the 2015 Term Loan on
March 15, 2021
.
On
July 22, 2016
, we entered into
two
forward interest rate swap arrangements with a total notional amount of
$150.0 million
to swap the floating interest rate under the 2016 Term Loan to an all-in fixed interest rate of
2.86%
starting on
March 31, 2017
and extending until the maturity of the 2016 Term Loan on
July 21, 2023
. On March 29, 2018, we entered into the 2018 Term Loan, a
$250.0 million
floating interest rate term loan maturing on July 21, 2023, which increased and replaced the 2016 Term Loan. The interest rate swap arrangements that had effectively fixed the 2016 Term Loan now effectively fix the interest rate on a
$150.0 million
portion of the 2018 Term Loan at
2.31%
. On March 29, 2018, we entered into
four
interest rate swap arrangements with a total notional amount of
$100.0 million
to effectively fix the interest rate on the remaining
$100.0 million
of the 2018 Term Loan at
3.71%
, that commenced on
June 29, 2018
and extending until the maturity of the 2018 Term Loan on
July 21, 2023
.
The interest rate swaps qualify as cash flow hedges and are recorded at fair value in accordance with GAAP, based on discounted cash flow methodologies and observable inputs. We record the total change in fair value of the interest rate swap arrangements associated with our cash flow hedges in other comprehensive income. The resulting unrealized gain (loss) of the cash flow hedges was the only activity in other comprehensive income during the periods presented in our consolidated financial statements. We assess the effectiveness of our cash flow hedges both at inception and on an ongoing basis. The cash flow hedges were effective for all periods presented.
The fair values of the interest rate swaps as of
September 30, 2018
and
December 31, 2017
, are as follows (in thousands):
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|
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|
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|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value
|
|
|
|
|
Derivative Assets
|
Derivative Instrument
|
Aggregate Notional Amount
|
Effective Date
|
Maturity Date
|
September 30, 2018
|
|
December 31, 2017
|
Interest rate swaps
|
$
|
150,000
|
|
October 15, 2015
|
March 15, 2021
|
$
|
4,392
|
|
|
$
|
1,987
|
|
Interest rate swaps
|
150,000
|
|
March 31, 2017
|
July 21, 2023
|
11,484
|
|
|
7,432
|
|
Interest rate swaps
|
100,000
|
|
June 29, 2018
|
July 21, 2023
|
1,305
|
|
|
—
|
|
|
$
|
400,000
|
|
|
|
$
|
17,181
|
|
|
$
|
9,419
|
|
We record interest rate swaps on our consolidated balance sheets within prepaid expenses and other assets when in a net asset position and within accounts payable and other liabilities when in a net liability position. The interest rate swaps have been effective since inception. The net gains or losses on the effective swaps are recognized in other comprehensive income, as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Unrealized gain (loss) on interest rate hedges
|
$
|
1,474
|
|
|
$
|
(9
|
)
|
|
$
|
7,762
|
|
|
$
|
(763
|
)
|
Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on our variable-rate debt. During the next twelve months, we estimate that an additional
$3.6 million
will be reclassified as a decrease to interest expense.
We have agreements with each of our derivative counterparties that contain a provision whereby we could be declared in default on our derivative obligations if repayment of the underlying indebtedness is accelerated by the lender due to our default on the indebtedness. As of
September 30, 2018
, the fair value of derivatives is in a net asset position of
$17.2 million
, which includes accrued interest but excludes any adjustment for nonperformance risk. As of
September 30, 2018
, we have not posted any collateral related to these agreements.
Derivative instruments expose us to credit risk in the event of non-performance by the counterparty under the terms of the interest rate hedge agreement. We believe that we minimize our credit risk on these transactions by dealing with major, creditworthy financial institutions. We monitor the credit ratings of counterparties and our exposure to any single entity, thus minimizing our credit risk concentration.
NOTE 7:
FAIR VALUE DISCLOSURES
Assets and Liabilities Measured at Fair Value
For assets and liabilities measured at fair value on a recurring basis, quantitative disclosures about the fair value measurements are required to be disclosed separately for each major category of assets and liabilities, as follows:
Level 1: Quoted prices in active markets for identical assets
Level 2: Significant other observable inputs
Level 3: Significant unobservable inputs
The only assets or liabilities we had at
September 30, 2018
and
December 31, 2017
that are recorded at fair value on a recurring basis are the assets held in the Supplemental Executive Retirement Plan (“SERP”), which primarily consist of investments in mutual funds, and the interest rate swaps (see note
6
).
We base the valuations related to the SERP on assumptions derived from significant other observable inputs and accordingly these valuations fall into Level 2 in the fair value hierarchy.
The valuation of the interest rate swaps is determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each interest rate swap. This analysis reflects the contractual terms of the interest rate swaps, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed
cash payments (or receipts) and the discounted expected variable cash receipts (or payments). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. To comply with the provisions of ASC 820,
Fair Value Measurement
, we incorporate credit valuation adjustments in the fair value measurements to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk. These credit valuation adjustments were concluded to not be significant inputs for the fair value calculations for the periods presented. In adjusting the fair value of our derivative contracts for the effect of nonperformance risk, we have considered the impact of netting and any applicable credit enhancements, such as the posting of collateral, thresholds, mutual puts and guarantees. The valuation of interest rate swaps fall into Level 2 in the fair value hierarchy.
The fair values of these assets and liabilities at
September 30, 2018
and
December 31, 2017
were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
December 31, 2017
|
|
Fair
Value
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Fair
Value
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SERP
|
$
|
1,364
|
|
|
$
|
—
|
|
|
$
|
1,364
|
|
|
$
|
—
|
|
|
$
|
1,858
|
|
|
$
|
—
|
|
|
$
|
1,858
|
|
|
$
|
—
|
|
Interest rate swaps
|
17,181
|
|
|
—
|
|
|
17,181
|
|
|
—
|
|
|
9,419
|
|
|
—
|
|
|
9,419
|
|
|
—
|
|
Financial Assets and Liabilities Not Measured at Fair Value
The following disclosures of estimated fair value were determined by management using available market information and established valuation methodologies, including discounted cash flow models. Many of these estimates involve significant judgment. The estimated fair value disclosed may not necessarily be indicative of the amounts we could realize on disposition of the financial instruments. The use of different market assumptions or estimation methodologies could have an effect on the estimated fair value amounts. In addition, fair value estimates are made at a point in time and thus, estimates of fair value subsequent to
September 30, 2018
may differ significantly from the amounts presented. The valuations of cash and cash equivalents and restricted cash fall into Level 1 in the fair value hierarchy and the valuations of debt instruments fall into Level 3 in the fair value hierarchy.
As of
September 30, 2018
and
December 31, 2017
, the carrying values and estimated fair values of our financial instruments were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2018
|
|
December 31, 2017
|
|
Carrying Value
|
|
Fair Value
|
|
Carrying Value
|
|
Fair Value
|
Cash and cash equivalents
|
$
|
4,810
|
|
|
$
|
4,810
|
|
|
$
|
9,847
|
|
|
$
|
9,847
|
|
Restricted cash
|
1,352
|
|
|
1,352
|
|
|
2,776
|
|
|
2,776
|
|
Mortgage notes payable, net
|
60,541
|
|
|
60,482
|
|
|
95,141
|
|
|
97,181
|
|
Line of credit
|
183,000
|
|
|
183,000
|
|
|
166,000
|
|
|
166,000
|
|
Notes payable, net
|
995,130
|
|
|
1,014,067
|
|
|
894,358
|
|
|
931,377
|
|
NOTE 8:
STOCK BASED COMPENSATION
Washington REIT maintains short-term (“STIP”) and long-term (“LTIP”) incentive plans that allow for stock based awards to officers and non-officer employees. Stock based awards are provided to officers and non-officer employees, as well as trustees, under the Washington Real Estate Investment Trust 2016 Omnibus Incentive Plan which allows for awards in the form of restricted shares, restricted share units, options and other awards up to an aggregate of
2,400,000
shares over the
ten
-year period in which the plan will be in effect. Restricted share units are converted into shares of our stock upon full vesting through the issuance of new shares.
During the first quarter of 2018, we amended the LTIP for executive officers to eliminate the absolute total shareholder return (“TSR”) component and only utilize relative TSR in the measurement of market condition performance. Under the amended LTIP, relative TSR will be evaluated
50%
relative to a defined population of peer companies and
50%
relative to the FTSE NAREIT Diversified Index. Prior to this amendment, the LTIP utilized both absolute TSR and relative TSR, with each component having a
50%
weighting, and relative TSR was evaluated relative only to a defined population of peer companies. The amendment is effective for
three
-year performance periods commencing on or after January 1, 2018.
Total Compensation Expense
Total compensation expense recognized in the consolidated financial statements for all outstanding share based awards was
$1.7 million
and
$1.2 million
for the
2018
Quarter and
2017
Quarter, respectively, and
$5.1 million
and
$3.6 million
for the
2018
Period and
2017
Period, respectively.
Restricted Share Awards
The total fair values of restricted share awards vested was
$1.1 million
and
$2.0 million
for the
2018
Period and
2017
Period, respectively.
The total unvested restricted share awards at
September 30, 2018
was
479,262
shares, which had a weighted average grant date fair value of
$28.58
per share. As of
September 30, 2018
, the total compensation cost related to unvested restricted share awards was
$9.1 million
, which we expect to recognize over a weighted average period of
28
months.
NOTE 9:
EARNINGS PER COMMON SHARE
We determine “Basic earnings per share” using the two-class method as our unvested restricted share awards and units have non-forfeitable rights to dividends, and are therefore considered participating securities. We compute basic earnings per share by dividing net income attributable to the controlling interest less the allocation of undistributed earnings to unvested restricted share awards and units by the weighted-average number of common shares outstanding for the period.
We also determine “Diluted earnings per share” as the more dilutive of the two-class method or the treasury stock method with respect to the unvested restricted share awards. We further evaluate any other potentially dilutive securities at the end of the period and adjust the basic earnings per share calculation for the impact of those securities that are dilutive. Our dilutive earnings per share calculation includes the dilutive impact of operating partnership units under the if-converted method and our share based awards with performance conditions prior to the grant date and all market condition awards under the contingently issuable method.
The computations of basic and diluted earnings per share for the
three and nine months ended September 30, 2018 and 2017
were as follows (in thousands, except per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2018
|
|
2017
|
|
2018
|
|
2017
|
Numerator:
|
|
|
|
|
|
|
|
Net income
|
$
|
5,893
|
|
|
$
|
2,813
|
|
|
$
|
19,942
|
|
|
$
|
17,275
|
|
Net loss attributable to noncontrolling interests in subsidiaries
|
—
|
|
|
20
|
|
|
—
|
|
|
56
|
|
Allocation of earnings to unvested restricted share awards
|
(144
|
)
|
|
(107
|
)
|
|
(432
|
)
|
|
(291
|
)
|
Adjusted net income attributable to the controlling interests
|
$
|
5,749
|
|
|
$
|
2,726
|
|
|
$
|
19,510
|
|
|
$
|
17,040
|
|
Denominator:
|
|
|
|
|
|
|
|
Weighted average shares outstanding – basic
|
79,076
|
|
|
77,291
|
|
|
78,695
|
|
|
76,292
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
Operating partnership units
|
12
|
|
|
12
|
|
|
12
|
|
|
8
|
|
Employee restricted share awards
|
150
|
|
|
120
|
|
|
95
|
|
|
115
|
|
Weighted average shares outstanding – diluted
|
79,238
|
|
|
77,423
|
|
|
78,802
|
|
|
76,415
|
|
|
|
|
|
|
|
|
|
Basic net income attributable to the controlling interests per common share
|
$
|
0.07
|
|
|
$
|
0.04
|
|
|
$
|
0.25
|
|
|
$
|
0.22
|
|
Diluted net income attributable to the controlling interests per common share
|
$
|
0.07
|
|
|
$
|
0.04
|
|
|
$
|
0.25
|
|
|
$
|
0.22
|
|
NOTE 10:
SEGMENT INFORMATION
We have
three
reportable segments: office, multifamily and retail. Office properties provide office space for various types of businesses and professions. Multifamily properties provide rental housing for individuals and families throughout the greater Washington metro region. Retail properties are typically grocery store-anchored neighborhood centers that include other small shop tenants or regional power centers with several junior box tenants.
We evaluate performance based upon net operating income from the combined properties in each segment. Our reportable operating segments are consolidations of similar properties. GAAP requires that segment disclosures present the measure(s) used by the chief operating decision maker for purposes of assessing each segment’s performance. Net operating income is a key measurement of our segment profit and loss. Net operating income is defined as real estate rental revenue less real estate expenses.
The following tables present revenues, net operating income, capital expenditures and total assets for the three and
nine
months ended
September 30, 2018
and
2017
from these segments, and reconcile net operating income of reportable segments to net income attributable to the controlling interests as reported (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2018
|
|
Office
|
|
Retail
|
|
Multifamily
|
|
Corporate and Other
|
|
Consolidated
|
Real estate rental revenue
|
$
|
42,438
|
|
|
$
|
16,111
|
|
|
$
|
23,953
|
|
|
$
|
—
|
|
|
$
|
82,502
|
|
Real estate expenses
|
15,368
|
|
|
3,906
|
|
|
9,297
|
|
|
—
|
|
|
28,571
|
|
Net operating income
|
$
|
27,070
|
|
|
$
|
12,205
|
|
|
$
|
14,656
|
|
|
$
|
—
|
|
|
$
|
53,931
|
|
Depreciation and amortization
|
|
|
|
|
|
|
|
|
(30,272
|
)
|
General and administrative
|
|
|
|
|
|
|
|
|
(5,267
|
)
|
Interest expense
|
|
|
|
|
|
|
|
|
(12,499
|
)
|
Net income
|
|
|
|
|
|
|
|
|
5,893
|
|
Less: Net loss attributable to noncontrolling interests in subsidiaries
|
|
|
|
|
|
|
|
|
—
|
|
Net income attributable to the controlling interests
|
|
|
|
|
|
|
|
|
$
|
5,893
|
|
Capital expenditures
|
$
|
8,537
|
|
|
$
|
1,098
|
|
|
$
|
5,708
|
|
|
$
|
161
|
|
|
$
|
15,504
|
|
Total assets
|
$
|
1,246,026
|
|
|
$
|
344,358
|
|
|
$
|
785,397
|
|
|
$
|
40,736
|
|
|
$
|
2,416,517
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30, 2017
|
|
Office
|
|
Retail
|
|
Multifamily
|
|
Corporate
and Other
|
|
Consolidated
|
Real estate rental revenue
|
$
|
42,982
|
|
|
$
|
15,604
|
|
|
$
|
24,233
|
|
|
$
|
—
|
|
|
$
|
82,819
|
|
Real estate expenses
|
16,246
|
|
|
3,687
|
|
|
9,713
|
|
|
—
|
|
|
29,646
|
|
Net operating income
|
$
|
26,736
|
|
|
$
|
11,917
|
|
|
$
|
14,520
|
|
|
$
|
—
|
|
|
$
|
53,173
|
|
Depreciation and amortization
|
|
|
|
|
|
|
|
|
(27,941
|
)
|
General and administrative
|
|
|
|
|
|
|
|
|
(5,327
|
)
|
Interest expense
|
|
|
|
|
|
|
|
|
(12,176
|
)
|
Other income
|
|
|
|
|
|
|
|
|
84
|
|
Real estate impairment
|
|
|
|
|
|
|
|
|
(5,000
|
)
|
Net income
|
|
|
|
|
|
|
|
|
2,813
|
|
Less: Net loss attributable to noncontrolling interests in subsidiaries
|
|
|
|
|
|
|
|
|
20
|
|
Net income attributable to the controlling interests
|
|
|
|
|
|
|
|
|
$
|
2,833
|
|
Capital expenditures
|
$
|
5,934
|
|
|
$
|
305
|
|
|
$
|
5,024
|
|
|
$
|
1,356
|
|
|
$
|
12,619
|
|
Total assets
|
$
|
1,231,576
|
|
|
$
|
346,374
|
|
|
$
|
769,873
|
|
|
$
|
36,471
|
|
|
$
|
2,384,294
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2018
|
|
Office
|
|
Retail
|
|
Multifamily
|
|
Corporate
and Other
|
|
Consolidated
|
Real estate rental revenue
|
$
|
135,258
|
|
|
$
|
47,563
|
|
|
$
|
71,168
|
|
|
$
|
—
|
|
|
$
|
253,989
|
|
Real estate expenses
|
48,031
|
|
|
11,932
|
|
|
28,012
|
|
|
—
|
|
|
87,975
|
|
Net operating income
|
$
|
87,227
|
|
|
$
|
35,631
|
|
|
$
|
43,156
|
|
|
$
|
—
|
|
|
$
|
166,014
|
|
Depreciation and amortization
|
|
|
|
|
|
|
|
|
(90,119
|
)
|
General and administrative
|
|
|
|
|
|
|
|
|
(16,737
|
)
|
Interest expense
|
|
|
|
|
|
|
|
|
(38,647
|
)
|
Real estate impairment
|
|
|
|
|
|
|
|
|
(1,886
|
)
|
Gain on sale of real estate
|
|
|
|
|
|
|
|
|
2,495
|
|
Loss on extinguishment of debt
|
|
|
|
|
|
|
|
|
(1,178
|
)
|
Net income
|
|
|
|
|
|
|
|
|
19,942
|
|
Less: Net loss attributable to noncontrolling interests in subsidiaries
|
|
|
|
|
|
|
|
|
—
|
|
Net income attributable to the controlling interests
|
|
|
|
|
|
|
|
|
$
|
19,942
|
|
Capital expenditures
|
$
|
17,926
|
|
|
$
|
2,443
|
|
|
$
|
13,068
|
|
|
$
|
626
|
|
|
$
|
34,063
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30, 2017
|
|
Office
|
|
Retail
|
|
Multifamily
|
|
Corporate
and Other
|
|
Consolidated
|
Real estate rental revenue
|
$
|
125,118
|
|
|
46,821
|
|
|
$
|
71,837
|
|
|
$
|
—
|
|
|
$
|
243,776
|
|
Real estate expenses
|
46,513
|
|
|
11,147
|
|
|
28,540
|
|
|
—
|
|
|
86,200
|
|
Net operating income
|
$
|
78,605
|
|
|
$
|
35,674
|
|
|
$
|
43,297
|
|
|
$
|
—
|
|
|
$
|
157,576
|
|
Depreciation and amortization
|
|
|
|
|
|
|
|
|
(83,271
|
)
|
General and administrative
|
|
|
|
|
|
|
|
|
(16,712
|
)
|
Interest expense
|
|
|
|
|
|
|
|
|
(35,634
|
)
|
Other income
|
|
|
|
|
|
|
|
|
209
|
|
Real estate impairment
|
|
|
|
|
|
|
|
|
(5,000
|
)
|
Income tax benefit
|
|
|
|
|
|
|
|
|
107
|
|
Net income
|
|
|
|
|
|
|
|
|
17,275
|
|
Less: Net loss attributable to noncontrolling interests in subsidiaries
|
|
|
|
|
|
|
|
|
56
|
|
Net income attributable to the controlling interests
|
|
|
|
|
|
|
|
|
$
|
17,331
|
|
Capital expenditures
|
$
|
16,753
|
|
|
$
|
551
|
|
|
$
|
17,882
|
|
|
$
|
3,306
|
|
|
$
|
38,492
|
|
NOTE 11:
SHAREHOLDERS' EQUITY
On May 4, 2018, we entered into
eight
separate equity distribution agreements (collectively, the “Equity Distribution Agreements”) with each of Wells Fargo Securities, LLC, BNY Mellon Capital Markets, LLC, Capital One Securities, Inc., Citigroup Global Markets Inc., Goldman Sachs & Co. LLC, J.P. Morgan Securities LLC, KeyBanc Capital Markets Inc. and SunTrust Robinson Humphrey, Inc. relating to the issuance of up to
$250.0 million
of our common shares from time to time. Issuances of our common shares are made at market prices prevailing at the time of issuance. We may use net proceeds from the issuance of common shares under this program for general corporate purposes, including, without limitation, working capital, the acquisition, renovation, expansion, improvement, development or redevelopment of income producing properties or the repayment of debt. During the 2018 Quarter and 2018 Period, we issued
1.2 million
common shares under the Equity Distribution Agreements at an average price of
$31.18
per share, raising
$35.5 million
in net proceeds.
The Equity Distribution Agreements replaced our previous equity distribution agreements with Wells Fargo Securities, LLC, BNY Mellon Capital Markets, LLC, Citigroup Global Markets Inc. and RBC Capital Markets LLC, dated June 23, 2015. During the 2018 Period, we did not issue common shares under the previous equity distribution agreements.
We have a dividend reinvestment program, whereby shareholders may use their dividends and optional cash payments to purchase common shares. The common shares sold under this program may either be common shares issued by us or common shares purchased in the open market. During the 2018 Quarter, we issued approximately
18,000
common shares under this program at a weighted average price of
$30.68
per share, raising
$0.6 million
in net proceeds. During the 2018 Period, we issued approximately
74,000
common shares under the dividend reinvestment program at a weighted average price of
$29.29
per share, raising
$1.8 million
in net proceeds.