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EX-32.2 - EX-32.2 - FRANKLIN STREET PROPERTIES CORP /MA/fsp-20170331ex3220912ac.htm
EX-32.1 - EX-32.1 - FRANKLIN STREET PROPERTIES CORP /MA/fsp-20170331ex32175950b.htm
EX-31.2 - EX-31.2 - FRANKLIN STREET PROPERTIES CORP /MA/fsp-20170331ex31216d9b9.htm
EX-31.1 - EX-31.1 - FRANKLIN STREET PROPERTIES CORP /MA/fsp-20170331ex3115fe0dc.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10 - Q

 

(Mark One)

 

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

 

For the quarterly period ended March 31, 2017.

 

OR

 

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

 

For the transition period from           to           

 

Commission File Number:  001-32470

 

Franklin Street Properties Corp.

(Exact name of registrant as specified in its charter)

 

 

 

 

Maryland

 

04-3578653

(State or other jurisdiction of incorporation

 

(I.R.S. Employer Identification No.)

or organization)

 

 

 

401 Edgewater Place, Suite 200

Wakefield, MA 01880

(Address of principal executive offices)(Zip Code)

 

(781) 557-1300

(Registrant’s telephone number, including area code)

 

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

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 ☒ NO ☐

 

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 ☒ NO ☐

 

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

 

 

 

 

Large accelerated filer ☒

 

Accelerated filer ☐

 

 

 

Non-accelerated filer ☐

 

Smaller reporting company ☐

(Do not check if a smaller reporting company)

 

 

 

 

Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ☐ NO ☒

 

The number of shares of common stock outstanding as of April 28, 2017 was 107,231,155.

 

 

 


 

Franklin Street Properties Corp.
Form 10-Q

 

Quarterly Report
March 31, 2017

 

Table of Contents

 

 

 

 

 

 

 

 

    

 

    

Page

 

 

 

 

 

Part I. 

 

Financial Information

 

 

 

 

 

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets as of March 31, 2017 and December 31, 2016

 

3

 

 

 

 

 

 

 

 

 

Condensed Consolidated Statements of Income for the three months ended March 31, 2017 and 2016

 

4

 

 

 

 

 

 

 

 

 

Condensed Consolidated Statements of Other Comprehensive Income for the three months ended March 31, 2017 and 2016  

 

5

 

 

 

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2017 and 2016

 

6

 

 

 

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

 

7-17

 

 

 

 

 

 

 

 

Item 2.

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

 

18-33

 

 

 

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

33

 

 

 

 

 

 

 

 

Item 4.

Controls and Procedures

 

35

 

 

 

 

 

Part II. 

 

Other Information

 

 

 

 

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

36

 

 

 

 

 

 

 

 

Item 1A.

Risk Factors

 

36

 

 

 

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

36

 

 

 

 

 

 

 

 

Item 3.

Defaults Upon Senior Securities

 

36

 

 

 

 

 

 

 

 

Item 4.

Mine Safety Disclosures

 

36

 

 

 

 

 

 

 

 

Item 5.

Other Information

 

36

 

 

 

 

 

 

 

 

Item 6.

Exhibits

 

36

 

 

 

 

 

Signatures 

 

37

 

 

 


 

PART I — FINANCIAL INFORMATION

 

Item 1.Financial Statements

 

Franklin Street Properties Corp.

Condensed Consolidated Balance Sheets

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

March 31,

 

December 31,

 

(in thousands, except share and par value amounts)

    

2017

    

2016

 

Assets:

 

 

 

 

 

 

 

Real estate assets:

 

 

 

 

 

 

 

Land

 

$

196,178

 

$

196,178

 

Buildings and improvements

 

 

1,836,073

 

 

1,822,183

 

Fixtures and equipment

 

 

4,600

 

 

4,136

 

 

 

 

2,036,851

 

 

2,022,497

 

Less accumulated depreciation

 

 

350,697

 

 

337,228

 

Real estate assets, net

 

 

1,686,154

 

 

1,685,269

 

Acquired real estate leases, less accumulated amortization of $108,771 and $112,441, respectively

 

 

115,471

 

 

125,491

 

Investment in non-consolidated REITs

 

 

74,423

 

 

75,165

 

Asset held for sale

 

 

 —

 

 

3,871

 

Cash and cash equivalents

 

 

11,143

 

 

9,335

 

Restricted cash

 

 

31

 

 

31

 

Tenant rent receivables, less allowance for doubtful accounts of $100 and $100, respectively

 

 

3,785

 

 

3,113

 

Straight-line rent receivable, less allowance for doubtful accounts of $50 and $50, respectively

 

 

52,304

 

 

50,930

 

Prepaid expenses and other assets

 

 

4,946

 

 

5,231

 

Related party mortgage loan receivables

 

 

81,515

 

 

81,780

 

Other assets: derivative asset

 

 

13,603

 

 

12,907

 

Office computers and furniture, net of accumulated depreciation of $1,315 and $1,277, respectively

 

 

275

 

 

313

 

Deferred leasing commissions, net of accumulated amortization of $19,561 and $18,301, respectively

 

 

34,636

 

 

34,697

 

Total assets

 

$

2,078,286

 

$

2,088,133

 

 

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity:

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

Bank note payable

 

$

295,000

 

$

280,000

 

Term loans payable, less unamortized financing costs of $4,461 and $4,783, respectively

 

 

765,539

 

 

765,217

 

Accounts payable and accrued expenses

 

 

50,529

 

 

57,259

 

Accrued compensation

 

 

1,259

 

 

3,784

 

Tenant security deposits

 

 

5,441

 

 

5,355

 

Other liabilities: derivative liabilities

 

 

4,351

 

 

5,551

 

Acquired unfavorable real estate leases, less accumulated amortization of $8,584 and $8,422, respectively

 

 

8,144

 

 

8,923

 

Total liabilities

 

 

1,130,263

 

 

1,126,089

 

 

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ Equity:

 

 

 

 

 

 

 

Preferred stock, $.0001 par value, 20,000,000 shares authorized, none issued or outstanding

 

 

 

 

 

Common stock, $.0001 par value, 180,000,000 shares authorized, 107,231,155 and 107,231,155 shares issued and outstanding, respectively

 

 

11

 

 

11

 

Additional paid-in capital

 

 

1,356,457

 

 

1,356,457

 

Accumulated other comprehensive loss

 

 

7,351

 

 

5,478

 

Accumulated distributions in excess of accumulated earnings

 

 

(415,796)

 

 

(399,902)

 

Total stockholders’ equity

 

 

948,023

 

 

962,044

 

Total liabilities and stockholders’ equity

 

$

2,078,286

 

$

2,088,133

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

3


 

Franklin Street Properties Corp.

Condensed Consolidated Statements of Income

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three Months Ended March 31,

 

(in thousands, except per share amounts)

    

2017

    

2016

    

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

Rental

 

$

67,376

 

$

58,360

 

Related party revenue:

 

 

 

 

 

 

 

Management fees and interest income from loans

 

 

1,370

 

 

1,433

 

Other

 

 

10

 

 

20

 

Total revenues

 

 

68,756

 

 

59,813

 

Expenses:

 

 

 

 

 

 

 

Real estate operating expenses

 

 

17,308

 

 

15,292

 

Real estate taxes and insurance

 

 

12,403

 

 

9,150

 

Depreciation and amortization

 

 

25,332

 

 

22,445

 

Selling, general and administrative

 

 

3,443

 

 

3,530

 

Interest

 

 

7,579

 

 

6,433

 

Total expenses

 

 

66,065

 

 

56,850

 

 

 

 

 

 

 

 

 

Income before equity in losses of non-consolidated REITs, other and gain (loss) on sale of properties, less applicable income tax and taxes

 

 

2,691

 

 

2,963

 

Equity in losses of non-consolidated REITs

 

 

(397)

 

 

(286)

 

Other

 

 

22

 

 

 —

 

Gain (loss) on sale of properties, less applicable income tax

 

 

2,289

 

 

 —

 

 

 

 

 

 

 

 

 

Income before taxes on income

 

 

4,605

 

 

2,677

 

Taxes on income

 

 

125

 

 

98

 

 

 

 

 

 

 

 

 

Net income

 

$

4,480

 

$

2,579

 

 

 

 

 

 

 

 

 

Weighted average number of shares outstanding, basic and diluted

 

 

107,231

 

 

100,187

 

 

 

 

 

 

 

 

 

Net income per share, basic and diluted

 

$

0.04

 

$

0.03

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

4


 

Franklin Street Properties Corp.

Condensed Consolidated Statements of Other Comprehensive Income (Loss)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

For the

 

 

 

Three Months Ended

 

 

 

March 31,

 

(in thousands)

    

2017

    

2016

 

 

 

 

 

 

 

 

 

Net income

 

$

4,480

 

$

2,579

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

Unrealized gain (loss) on derivative financial instruments

 

 

1,873

 

 

(6,115)

 

 

 

 

 

 

 

 

 

Total other comprehensive income (loss)

 

 

1,873

 

 

(6,115)

 

 

 

 

 

 

 

 

 

Comprehensive income (loss)

 

$

6,353

 

$

(3,536)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

5


 

Franklin Street Properties Corp.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

 

 

 

 

 

 

 

 

 

For the Three Months Ended March 31,

(in thousands)

    

2017

    

2016

Cash flows from operating activities:

 

 

 

 

 

 

Net income

 

$

4,480

 

$

2,579

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

 

 

 

 

 

 

Depreciation and amortization expense

 

 

25,937

 

 

22,962

Amortization of above and below market leases

 

 

(168)

 

 

81

Hedge ineffectiveness

 

 

(22)

 

 

 —

(Gain) loss on sale of properties, 

  less applicable income tax

 

 

(2,289)

 

 

 —

Equity in losses of non-consolidated REITs

 

 

397

 

 

286

Changes in operating assets and liabilities:

 

 

 

 

 

 

Restricted cash

 

 

 —

 

 

13

Tenant rent receivables

 

 

(672)

 

 

(793)

Straight-line rents

 

 

(1,082)

 

 

(1,275)

Lease acquisition costs

 

 

(292)

 

 

(199)

Prepaid expenses and other assets

 

 

 1

 

 

(791)

Accounts payable, accrued expenses and other items

 

 

(10,219)

 

 

(10,374)

Accrued compensation

 

 

(2,525)

 

 

(2,452)

Tenant security deposits

 

 

86

 

 

(396)

Payment of deferred leasing commissions

 

 

(1,606)

 

 

(1,825)

Net cash provided by operating activities

 

 

12,026

 

 

7,816

Cash flows from investing activities:

 

 

 

 

 

 

Property improvements, fixtures and equipment

 

 

(11,615)

 

 

(6,699)

Office computers and furniture

 

 

 —

 

 

(21)

Distributions in excess of earnings from non-consolidated REITs

 

 

346

 

 

27

Repayment of related party mortgage receivable

 

 

265

 

 

39,066

Proceeds received on sales of real estate assets

 

 

6,160

 

 

 —

Net cash provided by (used in) investing activities

 

 

(4,844)

 

 

32,373

Cash flows from financing activities:

 

 

 

 

 

 

Distributions to stockholders

 

 

(20,374)

 

 

(19,036)

Borrowings under bank note payable

 

 

30,000

 

 

15,000

Repayments of bank note payable

 

 

(15,000)

 

 

(40,000)

Net cash used in financing activities

 

 

(5,374)

 

 

(44,036)

Net increase (decrease) in cash and cash equivalents

 

 

1,808

 

 

(3,847)

Cash and cash equivalents, beginning of year

 

 

9,335

 

 

18,163

Cash and cash equivalents, end of period

 

$

11,143

 

$

14,316

 

 

 

 

 

 

 

Non-cash investing and financing activities:

 

 

 

 

 

 

Accrued costs for purchases of real estate assets

 

$

8,719

 

$

1,887

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

6


 

Franklin Street Properties Corp.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

 

1.  Organization, Properties, Basis of Presentation, Financial Instruments and Recent Accounting Standards

 

Organization

 

Franklin Street Properties Corp. (“FSP Corp.” or the “Company”), holds, directly and indirectly, 100% of the interest in FSP Investments LLC, FSP Property Management LLC, FSP Holdings LLC and FSP Protective TRS Corp.  FSP Property Management LLC provides asset management and property management services.  The Company also has a non-controlling common stock interest in seven corporations organized to operate as real estate investment trusts (“REIT”) and a non-controlling preferred stock interest in two of those REITs.  Collectively, the seven REITs are referred to as the “Sponsored REITs”.

 

As of March 31, 2017, the Company owned and operated a portfolio of real estate consisting of 35 operating properties, one property that is in redevelopment and seven managed Sponsored REITs; and held five promissory notes secured by mortgages on real estate owned by Sponsored REITs, including two mortgage loans and three revolving lines of credit.  From time-to-time, the Company may acquire, develop or redevelop real estate, make additional secured loans or acquire a Sponsored REIT.  The Company may also pursue, on a selective basis, the sale of its properties in order to take advantage of the value creation and demand for its properties, or for geographic or property specific reasons.

 

Properties

 

The following table summarizes the Company’s number of operating properties and rentable square feet of real estate.  In January 2016, the Company classified one property as a redevelopment, which is excluded as of March 31, 2017.

 

 

 

 

 

 

 

 

As of March 31,

 

 

    

2017

    

2016

 

Commercial real estate:

 

 

 

 

 

Number of properties

 

35

 

35

 

Rentable square feet

 

10,118,112

 

9,325,249

 

 

Basis of Presentation

 

The unaudited condensed consolidated financial statements of the Company include all of the accounts of the Company and its majority-owned subsidiaries.  All significant intercompany balances and transactions have been eliminated. These financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for its fiscal year ended December 31, 2016, as filed with the Securities and Exchange Commission.

 

The accompanying interim financial statements are unaudited; however, the financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information and in conjunction with the rules and regulations of the Securities and Exchange Commission.  Accordingly, they do not include all of the disclosures required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting solely of normal recurring matters) necessary for a fair presentation of the financial statements for these interim periods have been included.  Operating results for the three months ended March 31, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017 or for any other period.

 

Financial Instruments

 

As disclosed in Note 4, the Company’s derivatives are recorded at fair value using Level 2 inputs.  The Company estimates that the carrying values of cash and cash equivalents, restricted cash, receivables and tenant security deposits approximate

7


 

their fair values based on their short-term maturity and the loan receivable, bank note and term loans payable approximate their fair values as they bear interest at variable interest rates at spreads that approximate market. 

 

Recent Accounting Standards

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, Revenue from Contracts with Customers (“Topic 606”), which provides guidance for revenue recognition.  The standard’s core principle is that a company will recognize revenue when promised goods or services are transferred to customers in an amount that reflects the consideration to which a company expects to be entitled in exchange for those goods or services.  This update is effective for interim and annual reporting periods beginning after December 15, 2017.  A substantial portion of our revenue consists of rental income from leasing arrangements, which is specifically excluded from Topic 606.  We are continuing to evaluate Topic 606; however, we do not believe there will be a material impact on the timing of our revenue recognition in the consolidated financial statements.  We currently expect to adopt the standard using the modified retrospective approach.

 

In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements – Going Concern: Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern.  This update requires an entity to evaluate whether there are conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the financial statements are available to be issued when applicable) and to provide related footnote disclosures in certain circumstances.  This update is effective for the annual period ending after December 15, 2016, and for annual and interim periods thereafter with early adoption permitted.  The implementation of this update did not cause any significant changes to the consolidated financial statements.

 

In February 2015, the FASB issued ASU 2015-02, “Consolidation (Topic 810): Amendments to the Consolidation Analysis” (“ASU 2015-02”). ASU 2015-02 affects reporting entities that are required to evaluate whether they should consolidate certain legal entities. ASU 2015-02 modifies the evaluation of whether limited partnerships and similar legal entities are variable interest entities (“VIEs”) or voting interest entities, eliminates the presumption that a general partner should consolidate a limited partnership and affects the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships. ASU 2015-02 is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015. A reporting entity may apply the amendments in ASU 2015-02 using: (a) a modified retrospective approach by recording a cumulative-effect adjustment to equity as of the beginning of the fiscal year of adoption; or (b) by applying the amendments retrospectively. The implementation of this update did not cause any material changes to the consolidated financial statements.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), (“ASU 2016-02).  ASU 2016-02 requires lessees to establish a lease liability for the obligation to make lease payments and a right-of-use asset for the right to use the underlying asset for the lease term on their balance sheets.  Lessees will continue to recognize lease expenses on their income statements in a manner similar to current accounting. The guidance also eliminates current real estate-specific provisions for all entities. For lessors, the guidance modifies the classification criteria and the accounting for sales-type and direct financing leases.  This new standard is effective for annual periods beginning after December 15, 2018, and interim periods thereafter with early adoption permitted.  The Company is currently evaluating the potential changes from Topic 842 to future financial reporting and disclosures.  The Company expects that the adoption of this standard in 2019 will increase our assets and liabilities by approximately $3 million for the addition of right-of-use assets and lease liabilities related to an operating lease for office space; however, we do not expect the adoption of this standard to have a material impact to our results of operations or liquidity. 

 

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which clarifies how reporting entities present and classify certain cash receipts and cash payments in the statement of cash flows. ASU No. 2016-15 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. We are currently assessing the potential impact that adoption of ASU No. 2016-15 will have in our consolidated financial statements. 

 

In November 2016, the FASB issued ASU No. 2016-18, Restricted Cash, which clarifies how reporting entities should present restricted cash and restricted cash equivalents. Reporting entities will show the changes in the total of cash, cash equivalents, restricted cash and restricted cash equivalents in the statement of cash flows. The new standard requires a

8


 

reconciliation of the totals in the statement of cash flows to the related captions in the balance sheets. ASU No. 2016-18 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. We are currently assessing the potential impact the adoption of ASU No. 2016-18 will have in our consolidated financial statements. 

 

In January 2017, the FASB issued ASU No. 2017-01, Clarifying the Definition of a Business, which provides additional guidance on evaluating whether transactions should be accounted for as an acquisition (or disposal) of assets or of a business.  The update defines three requirements for a set of assets and activities (collectively referred to as a “set”) to be considered a business: inputs, processes and outputs.  ASU No. 2017-01 is effective for annual periods beginning after December 15, 2017, including interim periods within those fiscal years.  This update will be applied prospectively to any transactions occurring within the period of adoption.  We are currently assessing the impact of the update; however, subsequent to adoption we believe certain property acquisitions which under previous guidance would have been accounted for as business combinations will be accounted for as acquisitions of assets.  In an acquisition of assets, certain acquisition costs are capitalized as opposed to expensed under business combination guidance. 

   

 

2.  Related Party Transactions and Investments in Non-Consolidated Entities

 

Investment in Sponsored REITs:

 

At March 31, 2017 and December 31, 2016, the Company held a common stock interest in seven and seven Sponsored REITs, respectively.  The Company holds a non-controlling preferred stock investment in two of these Sponsored REITs, FSP 303 East Wacker Drive Corp. (“East Wacker”) and FSP Grand Boulevard Corp. (“Grand Boulevard”), from which it continues to derive economic benefits and risks.

 

During the year ended December 31, 2016, properties owned by two Sponsored REITs were sold and, thereafter, liquidating distributions for their preferred shareholders were declared and issued. The Company held a mortgage loan with one of these entities, which was secured by the property owned by FSP 385 Interlocken Development Corp. (“385 Interlocken”).  The loan with 385 Interlocken in the principal amount of $37,500,000 was repaid by the proceeds of the sale. 

Equity in losses of investment in non-consolidated REITs:

 

The following table includes equity in losses of investments in non-consolidated REITs

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

(in thousands)

    

2017

    

2016

 

 

 

 

 

 

 

 

 

Equity in losses of East Wacker

 

$

142

 

$

257

 

Equity in losses of Grand Boulevard

 

 

255

 

 

29

 

 

 

$

397

 

$

286

 

 

Equity in losses of investments in non-consolidated REITs is derived from the Company’s share of income or loss in the operations of those entities.  The Company exercises influence over, but does not control these entities, and investments are accounted for using the equity method.

 

Equity in losses of East Wacker is derived from the Company’s preferred stock investment in the entity.  In December 2007, the Company purchased 965.75 preferred shares or 43.7% of the outstanding preferred shares of East Wacker for $82,813,000 (which represented $96,575,000 at the offering price net of commissions of $7,726,000, loan fees of $5,553,000 and acquisition fees of $483,000 that were excluded).

 

Equity in losses of Grand Boulevard is derived from the Company’s preferred stock investment in the entity.  In May 2009, the Company purchased 175.5 preferred shares or 27.0% of the outstanding preferred shares of Grand Boulevard for $15,049,000 (which represented $17,550,000 at the offering price net of commissions of $1,404,000, loan fees of $1,009,000 and acquisition fees of $88,000 that were excluded).

9


 

 

The Company recorded distributions of $346,000 and $27,000 from non-consolidated REITs during the three months ended March 31, 2017 and 2016, respectively. 

 

Management fees and interest income from loans:

 

Asset management fees range from 1% to 5% of collected rents and the applicable contracts are cancelable with 30 days notice.  Asset management fee income from non-consolidated entities amounted to approximately $156,000 and $154,000 for the three months ended March 31, 2017 and 2016, respectively.

 

From time to time the Company may make secured loans (“Sponsored REIT Loans”) to Sponsored REITs in the form of mortgage loans or revolving lines of credit to fund construction costs, capital expenditures, leasing costs and for other purposes. The Company reviews Sponsored REIT loans for impairment each reporting period. A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts recorded on the balance sheet. The Company applies normal loan review and underwriting procedures (as may be implemented or modified from time to time) in making that judgment. None of the Sponsored REIT loans have been impaired.  

 

The Company anticipates that each Sponsored REIT Loan will be repaid at maturity or earlier from long term financings of the underlying properties, cash flows from the underlying properties or some other capital event.  Each Sponsored REIT Loan is secured by a mortgage on the underlying property and has a term of approximately one to three years.  Except for two mortgage loans which bear interest at a fixed rate, advances under each Sponsored REIT Loan bear interest at a rate equal to the 30-day LIBOR rate plus an agreed upon amount of basis points and also require a 50 basis point draw fee.

 

The following is a summary of the Sponsored REIT Loans outstanding as of March 31, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

    

    

    

    

Maximum

    

Amount

    

 

    

    

    

    

Interest

 

(dollars in thousands)

    

 

 

Maturity

 

Amount

 

Drawn at

 

Interest

 

Draw

 

Rate at

 

Sponsored REIT

    

Location

 

Date

 

of Loan

 

31-Mar-17

 

Rate (1)

 

Fee (2)

 

31-Mar-17

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Secured revolving lines of credit

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FSP Satellite Place Corp. (3)

 

Duluth, GA

 

31-Dec-19

 

$

5,500

 

$

2,915

 

L+

4.4

%  

0.5

%  

5.21

%

FSP 1441 Main Street Corp. (3)

 

Columbia, SC

 

31-Mar-19

 

 

10,800

 

 

9,000

 

L+

4.4

%  

0.5

%  

5.21

%

FSP Energy Tower I Corp.

 

Houston, TX

 

30-Jun-17

 

 

20,000

 

 

15,600

 

L+

5.0

%  

0.5

%  

5.81

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage loan secured by property

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FSP Monument Circle LLC (4)

 

Indianapolis, IN

 

7-Dec-18

 

 

21,000

 

 

21,000

 

 

4.90

%  

n/a

 

4.90

%

FSP Energy Tower I Corp. (5)

 

Houston, TX

 

30-Jun-17

 

 

33,000

 

 

33,000

 

 

6.41

%  

n/a

 

6.41

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

90,300

 

$

81,515

 

 

 

 

 

 

 

 

 


(1)

The interest rate is 30-day LIBOR rate plus the additional rate indicated, otherwise a fixed rate.

(2)

The draw fee is a percentage of each new advance, and is paid at the time of each new draw.

(3)

These revolving lines of credit were extended on March 30, 2017. 

(4)

This mortgage loan includes an origination fee of $164,000 and an exit fee of $38,000 when repaid by the borrower.

(5)

This mortgage loan includes an annual extension fee of $108,900 paid by the borrower. 

 

The Company recognized interest income and fees from the Sponsored REIT Loans of approximately $1,214,000 and $1,279,000 for the three months ended March 31, 2017 and 2016, respectively.

 

10


 

Non-consolidated REITs:

 

The balance sheet data below for 2017 and 2016 includes the 7 and 7 Sponsored REITs the Company held an interest in as of March 31, 2017 and December 31, 2016, respectively.  The operating data below for 2017 and 2016 include the operations of the 7 and 9 Sponsored REITs in which the Company held an interest in during the three months ended March 31, 2017 and 2016, respectively.

 

Summarized financial information for these Sponsored REITs is as follows:

 

 

 

 

 

 

 

 

 

 

    

March 31,

    

December 31,

 

(in thousands)

 

2017

 

2016

 

 

 

 

 

 

 

 

 

Balance Sheet Data (unaudited):

 

 

 

 

 

 

 

Real estate, net

 

$

343,056

 

$

345,532

 

Other assets

 

 

82,147

 

 

86,594

 

Total liabilities

 

 

(160,810)

 

 

(164,820)

 

Shareholders’ equity

 

$

264,393

 

$

267,306

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three Months Ended

 

 

 

March 31,

 

(in thousands)

    

2017

    

2016

 

 

 

 

 

 

 

 

 

Operating Data (unaudited):

 

 

 

 

 

 

 

Rental revenues

 

$

13,875

 

$

13,415

 

Other revenues

 

 

 2

 

 

10

 

Operating and maintenance expenses

 

 

(7,176)

 

 

(7,576)

 

Depreciation and amortization

 

 

(5,316)

 

 

(4,510)

 

Interest expense

 

 

(2,119)

 

 

(2,197)

 

Gain on sale, less applicable income tax

 

 

 —

 

 

19,748

 

Net income (loss)

 

$

(734)

 

$

18,890

 

 

 

3.  Bank Note Payable and Term Note Payable

 

JPM Term Loan

 

On November 30, 2016, the Company entered into a Credit Agreement with JPMorgan Chase Bank, N.A., as administrative agent and lender, and the other lending institutions party thereto (“JPM Credit Agreement”), to provide a single unsecured bridge loan in the aggregate principal amount of $150 million (the “JPM Term Loan”) that remains fully advanced and outstanding.  The JPM Term Loan has a two year term that matures on November 30, 2018. 

 

The JPM Term Loan bears interest at either (i) a number of basis points over the Eurodollar Rate depending on the Company’s credit rating (135.0 basis points over the Eurodollar Rate at March 31, 2017) or (ii) a number of basis points over the base rate depending on the Company’s credit rating (35.0 basis points over the base rate at March 31, 2017).

 

Based upon the Company’s credit rating, as of March 31, 2017, the weighted average interest rate on the JPM Term Loan was 2.35% per annum.  The weighted average interest rate on the JPM Term Loan during the three months ended March 31, 2017 was approximately 2.16% per annum.  The weighted average interest rate on the JPM Term Loan during the year ended December 31, 2016 was approximately 1.99% per annum. 

 

The JPM Credit Agreement contains customary affirmative and negative covenants for credit facilities of this type.  The JPM Credit Agreement also contains financial covenants that require the Company to maintain a minimum tangible net worth, a minimum fixed charge coverage ratio, a maximum secured leverage ratio, a maximum leverage ratio, a maximum

11


 

unencumbered leverage ratio, a minimum unsecured interest coverage and a maximum ratio of certain investments to total assets. The Company was in compliance with the JPM Term Loan financial covenants as of March 31, 2017.

 

The Company used the net proceeds of the JPM Term Loan to acquire the property located at 600 17th Street, Denver, Colorado on December 1, 2016 and for other general business purposes.   

 

BMO Term Loan

 

On July 21, 2016, the Company entered into a First Amendment (the “BMO First Amendment”) to the Amended and Restated Credit Agreement dated October 29, 2014 (among the Company, the lending institutions party thereto and Bank of Montreal, as administrative agent ( as amended by the BMO First Amendment, the “BMO Credit Agreement”). The BMO Credit Agreement provides for a single, unsecured term loan borrowing in the amount of $220 million (the “BMO Term Loan”) that remains fully advanced and outstanding. The BMO Term Loan matures on August 26, 2020. The BMO Credit Agreement also includes an accordion feature that allows up to $50 million of additional loans, subject to receipt of lender commitments and satisfaction of certain customary conditions.

 

The BMO Term Loan bears interest at either (i) a number of basis points over LIBOR depending on the Company’s credit rating (165 basis points over LIBOR at March 31, 2017) or (ii) a number of basis points over the base rate depending on the Company’s credit rating (65 basis points over the base rate at March 31, 2017).    

 

Although the interest rate on the BMO Term Loan is variable, the Company fixed the base LIBOR interest rate by entering into an interest rate swap agreement.  On August 26, 2013, the Company entered into an ISDA Master Agreement with Bank of Montreal that fixed the base LIBOR interest rate on the BMO Term Loan at 2.32% per annum for seven years, until the August 26, 2020 maturity date.  Accordingly, based upon the Company’s credit rating, as of March 31, 2017, the effective interest rate on the BMO Term Loan was 3.97% per annum. 

 

The BMO Credit Agreement contains customary affirmative and negative covenants for credit facilities of this type.  The BMO Credit Agreement also contains financial covenants that require the Company to maintain a minimum tangible net worth, a maximum leverage ratio, a maximum secured leverage ratio, a minimum fixed charge coverage ratio, a maximum unencumbered leverage ratio, minimum unsecured interest coverage and a maximum ratio of certain investments to total assets. The Company was in compliance with the BMO Term Loan financial covenants as of March 31, 2017.

 

The Company may use the proceeds of the loans under the BMO Credit Agreement to finance the acquisition of real properties and for other permitted investments; to finance investments associated with Sponsored REITs, to refinance or retire indebtedness and for working capital and other general business purposes, in each case to the extent permitted under the BMO Credit Agreement. 

 

BAML Credit Facility

 

On July 21, 2016, the Company entered into a First Amendment (the “BAML First Amendment”) to the Second Amended and Restated Credit Agreement dated October 29, 2014 among the Company, the lending institutions party thereto and Bank of America, N.A., as administrative agent, L/C Issuer and Swing Line Lender (as amended by the BAML First Amendment, the “BAML Credit Facility”) that continued an existing unsecured revolving line of credit (the “BAML Revolver”) and extended the maturity of a term loan (the “BAML Term Loan”). 

 

BAML Revolver Highlights

 

·

The BAML Revolver is for borrowings, at the Company’s election, of up to $500 million.  Borrowings made pursuant to the BAML Revolver may be revolving loans, swing line loans or letters of credit, the combined sum of which may not exceed $500 million outstanding at any time.

·

Borrowings made pursuant to the BAML Revolver may be borrowed, repaid and reborrowed from time to time until the initial maturity date of October 29, 2018.  The Company has the right to extend the initial

12


 

maturity date of the BAML Revolver by an additional 12 months, or until October 29, 2019, upon payment of a fee and satisfaction of certain customary conditions.

·

The BAML Credit Facility includes an accordion feature that allows for an aggregate amount of up to $350 million of additional borrowing capacity applicable to the BAML Revolver and/or the BAML Term Loan subject to receipt of lender commitments and satisfaction of certain customary conditions.

 

As of March 31, 2017, there were borrowings of $295 million outstanding under the BAML Revolver.  The BAML Revolver bears interest at either (i) a margin over LIBOR depending on the Company’s credit rating (1.25% over LIBOR at March 31, 2017) or (ii) a margin over the base rate depending on the Company’s credit rating (0.25% over the base rate at March 31, 2017). The BAML Credit Facility also obligates the Company to pay an annual facility fee in an amount that is also based on the Company’s credit rating (0.25% at March 31, 2017). The facility fee is assessed against the total amount of the BAML Revolver, or $500 million.

 

Based upon the Company’s credit rating, as of March 31, 2017, the weighted average interest rate on the BAML Revolver was 2.07% per annum. As of December 31, 2016, the weighted average interest rate on the BAML Revolver was 1.88% per annum and there were borrowings of $280 million outstanding. The weighted average interest rate on all amounts outstanding on the BAML Revolver during the three months ended March 31, 2017 was approximately 2.03% per annum. The weighted average interest rate on all amounts outstanding on the BAML Revolver during the year ended December 31, 2016 was approximately 1.73% per annum.

 

BAML Term Loan Highlights

 

·

The BAML Term Loan is for $400 million.

·

The BAML Term Loan matures on September 27, 2021.

·

The BAML Credit Facility includes an accordion feature that allows for an aggregate amount of up to $350 million of additional borrowing capacity applicable to the BAML Revolver and/or the BAML Term Loan, subject to receipt of lender commitments and satisfaction of certain customary conditions. 

·

On September 27, 2012, the Company drew down the entire $400 million and such amount remains fully advanced and outstanding under the BAML Credit Facility.

 

The BAML Term Loan bears interest at either (i) a margin over LIBOR depending on the Company’s credit rating (1.45% over LIBOR at March 31, 2017) or (ii) a margin over the base rate depending on the Company’s credit rating (0.45% over the base rate at March 31, 2017).

 

Although the interest rate on the BAML Credit Facility is variable, the Company fixed the base LIBOR interest rate on the BAML Term Loan by entering into an interest rate swap agreement. On September 27, 2012, the Company entered into an ISDA Master Agreement with Bank of America, N.A. that fixed the base LIBOR interest rate on the BAML Term Loan at 0.75% per annum until September 27, 2017.  On July 22, 2016, the Company entered into ISDA Master Agreements with a group of banks that fixed the base LIBOR interest rate on the BAML Term Loan at 1.12% per annum for the period beginning on September 27, 2017 and ending on September 27, 2021.  Accordingly, based upon the Company’s credit rating, as of March 31, 2017, the effective interest rate on the BAML Term Loan was 2.20% per annum.

 

BAML Credit Facility General Information

 

The BAML Credit Facility contains customary affirmative and negative covenants for credit facilities of this type.  The BAML Credit Facility also contains financial covenants that require the Company to maintain a minimum tangible net worth, a maximum leverage ratio, a maximum secured leverage ratio, a minimum fixed charge coverage ratio, a maximum unencumbered leverage ratio, minimum unsecured interest coverage and a maximum ratio of certain investments to total assets. The Company was in compliance with the BAML Credit Facility financial covenants as of March 31, 2017.

 

The Company may use the proceeds of the loans under the BAML Credit Facility to finance the acquisition of real properties and for other permitted investments; to finance investments associated with Sponsored REITs, to refinance or retire

13


 

indebtedness and for working capital and other general business purposes, in each case to the extent permitted under the BAML Credit Facility.

 

4.  Financial Instruments: Derivatives and Hedging

 

On July 22, 2016, the Company fixed the interest rate for the period beginning on September 27, 2017 and ending on September 27, 2021 on the BAML Term Loan with multiple interest rate swap agreements (the “2017 Interest Rate Swap”).  On August 26, 2013, the Company fixed the interest rate until August 26, 2020 on the BMO Term Loan with an interest rate swap agreement (the “BMO Interest Rate Swap”).  On September 27, 2012, the Company fixed the interest rate until September 27, 2017 on the BAML Term Loan with an interest rate swap agreement (the “BAML Interest Rate Swap”). The variable rates that were fixed under the 2017 Interest Rate Swap, the BMO Interest Rate Swap and the BAML Interest Rate Swap are described in Note 3.

 

The 2017 Interest Rate Swap, the BMO Interest Rate Swap and the BAML Interest Rate Swap qualify as cash flow hedges and have been recognized on the consolidated balance sheet at fair value.  If a derivative qualifies as a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will either be offset against the change in fair value of the hedged asset, liability, or firm commitment through earnings, or recognized in other comprehensive income until the hedged item is recognized in earnings.  The ineffective portion of a derivative’s change in fair value will be immediately recognized in earnings, which may increase or decrease reported net income and stockholders’ equity prospectively, depending on future levels of interest rates and other variables affecting the fair values of derivative instruments and hedged items, but will have no effect on cash flows.

 

The following table summarizes the notional and fair value of our derivative financial instruments at March 31, 2017. The notional value is an indication of the extent of our involvement in these instruments at that time, but does not represent exposure to credit, interest rate or market risks.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Notional

    

Strike

  

Effective

    

Expiration

    

Fair

 

(in thousands)

 

Value

 

Rate

 

Date

 

Date

 

Value

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2017 Interest Rate Swap

 

$

400,000

 

1.12

%  

Sep-17

 

Sep-21

 

$

12,925

 

BMO Interest Rate Swap

 

$

220,000

 

2.32

%  

Aug-13

 

Aug-20

 

$

(4,351)

 

BAML Interest Rate Swap

 

$

400,000

 

0.75

%  

Sep-12

 

Sep-17

 

$

678

 

 

On March 31, 2017, the 2017 Interest Rate Swap was reported an asset at its fair value of approximately $12.9 million, the BMO Interest Rate Swap was reported as a liability at its fair value of approximately $4.4 million and the BAML Interest Rate Swap was reported as an asset at its fair value of approximately $0.7 million.  These are included in other liabilities: derivative liability and other assets: derivative asset on the consolidated balance sheet at March 31, 2017, respectively.  Offsetting adjustments are reported as unrealized gains or losses on derivative financial instruments in accumulated other comprehensive income of $1.9 million.  During the three months ended March 31, 2017, $0.8 million was reclassified out of other comprehensive income and into interest expense.

 

Over time, the unrealized gains and losses held in accumulated other comprehensive income will be reclassified into earnings as an increase or reduction to interest expense in the same periods in which the hedged interest payments affect earnings.  We estimate that approximately $3.6 million of the current balance held in accumulated other comprehensive income will be reclassified into earnings within the next 12 months.

 

The Company is hedging the exposure to variability in anticipated future interest payments on existing debt.

 

The fair value of the Company’s derivative instruments are determined using the net discounted cash flows of the expected cash flows of the derivative based on the market based interest rate curve and are adjusted to reflect credit or nonperformance risk.  The risk is estimated by the Company using credit spreads and risk premiums that are observable in the market. These financial instruments were classified within Level 2 of the fair value hierarchy and were classified as an asset or liability on the condensed consolidated balance sheets.

 

14


 

The Company’s derivatives are recorded at fair value in other liabilities in the condensed consolidated balance sheets and the effective portion of the derivatives’ fair value is recorded to other comprehensive income in the condensed consolidated statements of other comprehensive income (loss) and the ineffective portion of the derivatives’ fair value is recognized directly into earnings as other in the condensed consolidated statements of income.  

 

The interest rate swaps effectively fix the interest rate on the BAML Term Loan and BMO Term Loan; however, there is no floor on the variable interest rate of the swaps whereas the BAML Term Loan and BMO Term Loan are subject to a zero percent floor. As a result there is a mismatch and the ineffective portion of the derivatives’ changes in fair value are recognized directly into earnings.

 

During the three months ended March 31, 2017, the Company recorded $22,000 of hedge ineffectiveness in earnings, which is included in “Other” in the condensed consolidated statements of income. 

 

In the event that LIBOR is negative, the Company will make payments to the hedge counterparty equal to the spread between LIBOR and zero, which will be included in interest expense in on our condensed consolidated statements of income. 

 

 

5.  Net Income Per Share

 

Basic net income per share is computed by dividing net income by the weighted average number of Company shares outstanding during the period.  Diluted net income per share reflects the potential dilution that could occur if securities or other contracts to issue shares were exercised or converted into shares.  There were no potential dilutive shares outstanding at March 31, 2017 and 2016, respectively.

 

6.  Stockholders’ Equity

 

On August 16, 2016, the Company completed an underwritten public offering of 7,043,750 shares of its common stock (including 918,750 shares issued as a result of the full exercise of an overallotment option by the underwriter) at a price to the public of $12.35 per share. The proceeds from this public offering, net of underwriter discounts and offering costs, totaled approximately $82.9 million. 

 

As of March 31, 2017, the Company had 107,231,155 shares of common stock outstanding.  The Company declared and paid dividends as follows (in thousands, except per share amounts):

 

 

 

 

 

 

 

 

 

 

 

Dividends Per

 

Total

 

Quarter Paid

    

Share

    

Dividends

 

 

 

 

 

 

 

 

 

First quarter of 2017

 

$

0.19

 

$

20,374

 

 

 

 

 

 

 

 

 

First quarter of 2016

 

$

0.19

 

$

19,036

 

 

 

 

7.  Income Taxes

 

General

 

The Company has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”). As a REIT, the Company generally is entitled to a tax deduction for distributions paid to its shareholders, thereby effectively subjecting the distributed net income of the Company to taxation at the shareholder level only.  The Company must comply with a variety of restrictions to maintain its status as a REIT.  These restrictions include the type of income it can earn, the type of assets it can hold, the number of shareholders it can have and the concentration of their ownership, and the amount of the Company’s taxable income that must be distributed annually.

 

15


 

One such restriction is that the Company generally cannot own more than 10% of the voting power or value of the securities of any one issuer unless the issuer is itself a REIT or a taxable REIT subsidiary (“TRS”).  In the case of TRSs, the Company’s ownership of securities in all TRSs generally cannot exceed 25% of the value of all of the Company’s assets and, when considered together with other non-real estate assets, cannot exceed 25% of the value of all of the Company’s assets.  FSP Investments LLC and FSP Protective TRS Corp. are the Company’s taxable REIT subsidiaries operating as taxable corporations under the Code.

 

Income taxes are recorded based on the future tax effects of the difference between the tax and financial reporting bases of the Company’s assets and liabilities.  In estimating future tax consequences, potential future events are considered except for potential changes in income tax law or in rates.

 

The Company adopted an accounting pronouncement related to uncertainty in income taxes effective January 1, 2007, which did not result in recording a liability, nor was any accrued interest and penalties recognized with the adoption.  Accrued interest and penalties will be recorded as income tax expense, if the Company records a liability in the future.  The Company’s effective tax rate was not affected by the adoption.  The Company and one or more of its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state jurisdictions.  The statute of limitations for the Company’s income tax returns is generally three years and as such, the Company’s returns that remain subject to examination would be primarily from 2013 and thereafter.

 

The Company is subject to a business tax known as the Revised Texas Franchise Tax.  Some of the Company’s leases allow reimbursement by tenants for these amounts because the Revised Texas Franchise Tax replaces a portion of the property tax for school districts.  Because the tax base on the Revised Texas Franchise Tax is derived from an income based measure, it is considered an income tax.  The Company recorded a provision for the Revised Texas Franchise Tax of $89,000 and $87,000 for the three months ended March 31, 2017 and 2016, respectively.

 

Net operating losses

 

Section 382 of the Code restricts a corporation’s ability to use net operating losses (“NOLs”) to offset future taxable income following certain “ownership changes.” Such ownership changes occurred with past mergers and accordingly a portion of the NOLs incurred by the Sponsored REITs available for use by the Company in any particular future taxable year will be limited. To the extent that the Company does not utilize the full amount of the annual NOLs limit, the unused amount may be carried forward to offset taxable income in future years. NOLs expire 20 years after the year in which they arise, and the last of the Company’s NOLs will expire in 2027. A valuation allowance is provided for the full amount of the NOLs as the realization of any tax benefits from such NOLs is not assured.  The gross amount of NOLs available to the Company was $13,041,000 as of each of March 31, 2017 and December 31, 2016.

 

Income Tax Expense

 

The income tax expense reflected in the condensed consolidated statements of income relates primarily to a franchise tax on our Texas properties.  FSP Protective TRS Corp. provides taxable services to tenants at some of the Company’s properties and the tax expenses associated with these activities are reported as Other Taxes in the table below:

 

 

 

 

 

 

 

 

 

 

 

For the Three Months Ended March 31,

 

(Dollars in thousands)

    

2017

    

2016

 

 

 

 

 

 

 

 

 

Revised Texas franchise tax

 

$

89

 

$

87

 

Other Taxes

 

 

36

 

 

11

 

Taxes on income

 

$

125

 

$

98

 

 

Taxes on income are a current tax expense.  No deferred income taxes were provided as there were no material temporary differences between the financial reporting basis and the tax basis of the TRSs.

 

16


 

8.  Dispositions of properties

 

During the three months ended December 31, 2016, we reached an agreement to sell an office property located in Milpitas, California.  The property was classified as an asset held for sale at December 31, 2016 and was sold on January 6, 2017 at approximately a $2.3 million gain.

 

During the year ended December 31, 2016, the Company sold an office property located in Maryland Heights, Missouri on April 5, 2016, at a $4.2 million gain.  During the three months ended June 30, 2016, the Company reached a decision to classify its office property located in Federal Way, Washington, as an asset held for sale.  In evaluating the Federal Way, Washington property, management considered various subjective factors.  The Company concluded that selling the property was the more prudent decision and outweighed the potential future benefit of continuing to hold the property.   The property was expected to sell within one year at a loss, which was recorded as a provision for loss on a property held for sale net of applicable income taxes and was classified as an asset held for sale.  The Company sold the property on December 16, 2016 for $7.3 million of net proceeds resulting in a total loss of $7.1 million, net of applicable income taxes. 

 

The disposals did not represent a strategic shift that has a major effect on the Company's operations and financial results.  Accordingly, the properties remain classified within continuing operations for all periods presented. 

 

9.  Subsequent Events

 

On April 7, 2017, the Board of Directors of the Company declared a cash distribution of $0.19 per share of common stock payable on May 11, 2017 to stockholders of record on April 21, 2017.

 

  

   

17


 

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

 

The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report and in our Annual Report on Form 10-K for the year ended December 31, 2016.  Historical results and percentage relationships set forth in the condensed consolidated financial statements, including trends which might appear, should not be taken as necessarily indicative of future operations.  The following discussion and other parts of this Quarterly Report on Form 10-Q may also contain forward-looking statements based on current judgments and current knowledge of management, which are subject to certain risks, trends and uncertainties that could cause actual results to differ materially from those indicated in such forward-looking statements.  Accordingly, readers are cautioned not to place undue reliance on forward-looking statements.  Investors are cautioned that our forward-looking statements involve risks and uncertainty, including without limitation, economic conditions in the United States, disruptions in the debt markets, economic conditions in the markets in which we own properties, risks of a lessening of demand for the types of real estate owned by us, uncertainties relating to fiscal policy, changes in government regulations and regulatory uncertainty, geopolitical events, and expenditures that cannot be anticipated such as utility rate and usage increases, unanticipated repairs, additional staffing, insurance increases and real estate tax valuation reassessments.  See Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2016 and Part II, Item 1A. “Risk Factors” below.  Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.  We may not update any of the forward-looking statements after the date this Quarterly Report on Form 10-Q is filed to conform them to actual results or to changes in our expectations that occur after such date, other than as required by law.

 

Overview

 

FSP Corp., or we or the Company, operates in a single reportable segment: real estate operations.  The real estate operations market involves real estate rental operations, leasing, secured financing of real estate and services provided for asset management, property management, property acquisitions, dispositions and development.  Our current strategy is to invest in select urban infill and central business district properties, with primary emphasis on our top five markets of Atlanta, Dallas, Denver, Houston and Minneapolis.  We believe that our top five markets have macro-economic drivers that have the potential to increase occupancies and rents.  We will also monitor other markets for opportunistic investments.  We seek value-oriented investments with an eye towards long-term growth and appreciation, as well as current income.

 

As of March 31, 2017, approximately 7.6 million square feet, or approximately 75.5% of our total owned portfolio, was located in our top five markets.  From time-to-time we may dispose of our smaller, suburban office assets and replace them with larger urban infill and central business district office assets located primarily in our top five markets.  As we execute this strategy, short term operating results could be adversely impacted.  However, we believe that the transformed portfolio has the potential to provide higher profit and asset value growth over a longer period of time.

 

The main factor that affects our real estate operations is the broad economic market conditions in the United States.  These market conditions affect the occupancy levels and the rent levels on both a national and local level.  We have no influence on broader economic/market conditions.  We look to acquire and/or develop quality properties in good locations in order to lessen the impact of downturns in the market and to take advantage of upturns when they occur.

 

Critical Accounting Policies

 

We have certain critical accounting policies that are subject to judgments and estimates by our management and uncertainties of outcome that affect the application of these policies.  We base our estimates on historical experience and on various other assumptions we believe to be reasonable under the circumstances.  On an on-going basis, we evaluate our estimates.  In the event estimates or assumptions prove to be different from actual results, adjustments are made in subsequent periods to reflect more current information.  The accounting policies that we believe are most critical to the understanding of our financial position and results of operations, and that require significant management estimates and judgments, are discussed in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2016.

 

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Critical accounting policies are those that have the most impact on the reporting of our financial condition and results of operations and those requiring significant judgments and estimates.  We believe that our judgments and assessments are consistently applied and produce financial information that fairly presents our results of operations.  No changes to our critical accounting policies have occurred since the filing of our Annual Report on Form 10-K for the year ended December 31, 2016.

 

Recent Accounting Standards

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, Revenue from Contracts with Customers (“Topic 606”), which provides guidance for revenue recognition.  The standard’s core principle is that a company will recognize revenue when promised goods or services are transferred to customers in an amount that reflects the consideration to which a company expects to be entitled in exchange for those goods or services.  This update is effective for interim and annual reporting periods beginning after December 15, 2017.  A substantial portion of our revenue consists of rental income from leasing arrangements, which is specifically excluded from Topic 606.  We are continuing to evaluate Topic 606: however, we do not believe there will be a material impact on the timing of our revenue recognition in the consolidated financial statements.  We currently expect to adopt the standard using the modified retrospective approach.

 

In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements – Going Concern: Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern.  This update requires an entity to evaluate whether there are conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the financial statements are available to be issued when applicable) and to provide related footnote disclosures in certain circumstances.  This update is effective for the annual period ending after December 15, 2016, and for annual and interim periods thereafter with early adoption permitted.  The implementation of this update did not cause any significant changes to the consolidated financial statements.

 

In February 2015, the FASB issued ASU 2015-02, “Consolidation (Topic 810): Amendments to the Consolidation Analysis” (“ASU 2015-02”). ASU 2015-02 affects reporting entities that are required to evaluate whether they should consolidate certain legal entities. ASU 2015-02 modifies the evaluation of whether limited partnerships and similar legal entities are variable interest entities (“VIEs”) or voting interest entities, eliminates the presumption that a general partner should consolidate a limited partnership and affects the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships. ASU 2015-02 is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015. A reporting entity may apply the amendments in ASU 2015-02 using: (a) a modified retrospective approach by recording a cumulative-effect adjustment to equity as of the beginning of the fiscal year of adoption; or (b) by applying the amendments retrospectively. The implementation of this update did not cause any material changes to the consolidated financial statements.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), (“ASU 2016-02).  ASU 2016-02 requires lessees to establish a lease liability for the obligation to make lease payments and a right-of use-asset for the right to use the underlying asset for the lease term on their balance sheets.  Lessees will continue to recognize lease expenses on their income statements in a manner similar to current accounting. The guidance also eliminates current real estate-specific provisions for all entities. For lessors, the guidance modifies the classification criteria and the accounting for sales-type and direct financing leases.  This new standard is effective for annual periods beginning after December 15, 2018, and interim periods thereafter with early adoption permitted.  The Company is currently evaluating the potential changes from Topic 842 to future financial reporting and disclosures.  The Company expects that the adoption of this standard in 2019 will increase our assets and liabilities by approximately $3 million for the addition of right-of-use assets and lease liabilities related to an operating lease for office space; however, we do not expect the adoption of this standard to have a material impact to our results of operations or liquidity.  

 

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which clarifies how reporting entities present and classify certain cash receipts and cash payments in the statement of cash flows. ASU No. 2016-15 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. We are currently assessing the potential impact that adoption of ASU No. 2016-15 will have in our consolidated financial statements. 

 

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In November 2016, the FASB issued ASU No. 2016-18, Restricted Cash, which clarifies how reporting entities should present restricted cash and restricted cash equivalents. Reporting entities will show the changes in the total of cash, cash equivalents, restricted cash and restricted cash equivalents in the statement of cash flows. The new standard requires a reconciliation of the totals in the statement of cash flows to the related captions in the balance sheets. ASU No. 2016-18 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. We are currently assessing the potential impact the adoption of ASU No. 2016-18 will have in our consolidated financial statements. 

 

In January 2017, the FASB issued ASU No. 2017-01, Clarifying the Definition of a Business, which provides additional guidance on evaluating whether transactions should be accounted for as an acquisition (or disposal) of assets or of a business.  The update defines three requirements for a set of assets and activities (collectively referred to as a “set”) to be considered a business: inputs, processes and outputs.  ASU No. 2017-01 is effective for annual periods beginning after December 15, 2017, including interim periods within those fiscal years.  This update will be applied prospectively to any transactions occurring within the period of adoption.  We are currently assessing the impact of the update; however, subsequent to adoption we believe certain property acquisitions which under previous guidance would have been accounted for as business combinations will be accounted for as acquisitions of assets.  In an acquisition of assets, certain acquisition costs are capitalized as opposed to expensed under business combination guidance.

 

Trends and Uncertainties

 

Economic Conditions

 

The economy in the United States is continuing to experience a period of slow economic growth, with continued declining unemployment rates, which directly affects the demand for office space, our primary income producing asset.  The broad economic market conditions in the United States are affected by numerous factors, including but not limited to, inflation and employment levels, energy prices, the pace of economic growth and/or recessionary concerns, uncertainty about government fiscal and tax policy, changes in currency exchange rates, geopolitical events, the regulatory environment, the availability of credit and interest rates.  In addition, the Federal Reserve Bank has indicated that it is likely to continue to raise interest rates in 2017.  Any increase in interest rates could result in increased borrowing costs to us.  However, we could also benefit from any further improved economic fundamentals and increasing levels of employment.  We believe that the economy is in a cyclically-slower but prolonged broad-based upswing.  However, future economic factors may negatively affect real estate values, occupancy levels and property income.

 

Real Estate Operations

 

Leasing

 

Our real estate portfolio was approximately 89.6% leased as of March 31, 2017, an increase from 89.3% as of December 31, 2016.  The 0.3% increase in leased space was a result of increased leasing completed net of lease expirations and terminations during the three months ended March 31, 2017.  As of March 31, 2017, we had approximately 1,047,000 square feet of vacancy in our portfolio compared to approximately 1,086,00,000 square feet of vacancy at December 31, 2016.  During the three months ended March 31, 2017, we leased approximately 206,000 square feet of office space, of which approximately 144,000 square feet were with existing tenants, at a weighted average term of 5.6 years.  On average, tenant improvements for such leases were $23.02 per square foot, lease commissions were $8.32 per square foot and rent concessions were approximately three months of free rent.  Average GAAP base rents under such leases were $28.36 per square foot, or 7.4% higher than average rents in the respective properties as applicable compared to the year ended December 31, 2016.

 

In January 2016, our property at 801 Marquette Avenue in Minneapolis, Minnesota, with approximately 170,000 square feet of space, became vacant and we are redeveloping the property.  After extensive costing analysis with our potential development partners and outside professionals, we decided to redevelop the existing building ourselves, rather than raze it and build a new, mixed use tower with outside development partners.  Interior demolition and construction work commenced during the three months ended September 30, 2016.  We estimate the total redevelopment cost to be approximately $20 million, including leasing costs.  Delivery of the completed project is expected by the end of the second quarter of 2017.  Upon completion, we expect the redevelopment to result in approximately 128,000 net rental square feet and for the property

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to attain rents of approximately $17 to $19 net rent per square foot compared to previously expired net rent of approximately $4.75 per square foot.

 

As of March 31, 2017, leases for approximately 5.1% and 12.1% of the square footage in our portfolio are scheduled to expire during 2017 and 2018, respectively.  As the second quarter of 2017 begins, we believe that our property portfolio is well stabilized, with a balanced lease expiration schedule, and that existing vacancy is being actively marketed to numerous potential tenants.  We believe that most of our largest property markets are now experiencing generally steady or improving rental conditions.  We anticipate continued positive leasing activity within the portfolio in 2017.

 

While we cannot generally predict when an existing vacancy in our real estate portfolio will be leased or if existing tenants with expiring leases will renew their leases or what the terms and conditions of the lease renewals will be, we expect to renew or sign new leases at then-current market rates for locations in which the buildings are located, which could be above or below the expiring rates.  Also, we believe the potential for any of our tenants to default on its lease or to seek the protection of bankruptcy exists.  If any of our tenants defaults on its lease, we may experience delays in enforcing our rights as a landlord and may incur substantial costs in protecting our investment.  In addition, at any time, a tenant of one of our properties may seek the protection of bankruptcy laws, which could result in the rejection and termination of such tenant’s lease and thereby cause a reduction in cash available for distribution to our stockholders.

 

Real Estate Acquisition and Investment Activity

 

During 2017:

 

·

during the three months ended March 31, we received approximately $0.3 million in cash from FSP Satellite Place Corp., as partial prepayment of a Sponsored REIT Loan; and

·

we have continued to actively explore additional potential real estate investment opportunities and anticipate further real estate investments in the future.

 

 

During 2016:

 

·

on January 19, we received approximately $37.5 million in cash from FSP 385 Interlocken Development Corp. as repayment in full of a Sponsored REIT Loan;

·

during the year ended December 31, we received approximately $2.3 million in cash from FSP Satellite Place Corp., as partial prepayment of a Sponsored REIT Loan;

·

on June 6, we acquired an office property with approximately 325,800 rentable square feet for $82 million located in Minneapolis, Minnesota;

·

on August 10, we acquired an office property with approximately 160,000 rentable square feet for $45.5 million located in Atlanta, Georgia; and

·

on December 1, we acquired an office property with approximately 613,000 rentable square feet for $154.2 million located in Denver, Colorado. 

 

 

Dispositions of Properties and Asset Held for Sale

 

During the three months ended December 31, 2016, we reached an agreement to sell an office property located in Milpitas, California.  The property was classified as an asset held for sale at December 31, 2016 and was sold on January 6, 2017 at a $2.3 million gain. 

 

During the year ended December 31, 2016, we sold an office property located in Maryland Heights, Missouri on April 5, 2016, at a $4.2 million gain.  During the three months ended June 30, 2016, we reached a decision to classify its office property located in Federal Way, Washington, as an asset held for sale.  In evaluating the Federal Way, Washington property, management considered various subjective factors.  We concluded that selling the property was the more prudent decision and outweighed the potential future benefit of continuing to hold the property.   The property was expected to sell within one year at a loss, which was recorded as a provision for loss on a property held for sale net of applicable income taxes and was classified as an asset held for sale.  We sold the property on December 16, 2016 for $7.3 million of net proceeds resulting in a total loss of $7.1 million, net of applicable income taxes.   

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We will continue to evaluate our portfolio, and in the future may decide to dispose of additional properties from time-to-time in the ordinary course of business.  We believe that the current property sales environment continues to improve in many markets relative to both liquidity and pricing.  We believe that both improving office property fundamentals as well as attractive financing availability will likely be required to continue improvement in the marketplace for potential property dispositions.  As an important part of our total return strategy, we intend to be active in property dispositions when we believe that market conditions warrant such activity and, as a consequence, we continuously review and evaluate our portfolio of properties for potentially advantageous dispositions.

 

Results of Operations

 

The following table shows financial results for the three months ended March 31, 2017 and 2016:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended  March 31,

 

(in thousands)

    

2017

    

2016

    

Change

 

Revenues:

 

 

 

 

 

 

 

 

 

 

Rental

 

$

67,376

 

$

58,360

 

$

9,016

 

Related party revenue:

 

 

 

 

 

 

 

 

 

 

Management fees and interest income from loans

 

 

1,370

 

 

1,433

 

 

(63)

 

Other

 

 

10

 

 

20

 

 

(10)

 

Total revenues

 

 

68,756

 

 

59,813

 

 

8,943

 

Expenses:

 

 

 

 

 

 

 

 

 

 

Real estate operating expenses

 

 

17,308

 

 

15,292

 

 

2,016

 

Real estate taxes and insurance

 

 

12,403

 

 

9,150

 

 

3,253

 

Depreciation and amortization

 

 

25,332

 

 

22,445

 

 

2,887

 

Selling, general and administrative

 

 

3,443

 

 

3,530

 

 

(87)

 

Interest

 

 

7,579

 

 

6,433

 

 

1,146

 

Total expenses

 

 

66,065

 

 

56,850

 

 

9,215

 

 

 

 

 

 

 

 

 

 

 

 

Income before equity in losses of non-consolidated REITs, other, gain (loss) on sale of properties and property held for sale, less applicable income tax and taxes

 

 

2,691

 

 

2,963

 

 

(272)

 

Equity in losses of non-consolidated REITs

 

 

(397)

 

 

(286)

 

 

(111)

 

Other

 

 

22

 

 

 —

 

 

22

 

Gain (loss) on sale of properties and property held for sale, less applicable income tax

 

 

2,289

 

 

 —

 

 

2,289

 

 

 

 

 

 

 

 

 

 

 

 

Income before taxes on income

 

 

4,605

 

 

2,677

 

 

1,928

 

Taxes on income

 

 

125

 

 

98

 

 

27

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

4,480

 

$

2,579

 

$

1,901

 

 

Comparison of the three months ended March 31, 2017 to the three months ended March 31, 2016:

 

Revenues

 

Total revenues increased by $8.9 million to $68.8 million for the three months ended March 31, 2017, as compared to the three months ended March 31, 2016.  The increase was primarily a result of:

 

·

An increase in rental revenue of approximately $9.0 million arising primarily from rental revenue for properties that we acquired on each of June 6, 2016, August 10, 2016 and December 1, 2016, which was partially offset by the loss of revenue from the disposition of three other properties during 2016 and 2017.  We sold a property on each of April 5, 2016, December 16, 2016 and January 6, 2017. In addition, our leased space increased 0.3% to 89.6% at March 31, 2017 compared to 89.3% at December 31, 2016. 

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      This increase was partially offset by:

 

·

A decrease in interest income from loans to Sponsored REITs of approximately $0.1 million as a result of repayments of Sponsored REIT Loans, which was partially offset by higher interest rates in 2017 compared to 2016 and the funding of an advance on a Sponsored REIT Loan we made in December 2016. 

 

Expenses

 

Total expenses increased by $9.2 million to $66.1 million for the three months ended March 31, 2017, as compared to the three months ended March 31, 2016.  The increase was primarily a result of:

 

·

An increase in real estate operating expenses and real estate taxes and insurance of approximately $5.3 million and an increase in depreciation and amortization of approximately $2.9 million, which were attributable to the acquisition of properties on June 6, 2016, August 10, 2016 and December 1, 2016, and were partially offset by decreases as a result of the disposition of three properties during 2016 and 2017.

·

An increase in interest expense of approximately $1.1 million to $7.6 million for the three months ended March 31, 2017 compared to the same period in 2016.  The increase was primarily attributable to higher interest rates, additional borrowings under the JPM Term Loan (as defined below) we entered into on November 30, 2016 and an increase in amortization of deferred financing costs during the three months ended March 31, 2017 as compared to the same period in 2016.   

·

An decrease in selling, general and administrative expenses of $0.1 million as a result of decreases in personnel and information technology expenses.  We had 39 and 40 employees as of March 31, 2017 and 2016, respectively.   

 

 

Equity in losses of non-consolidated REITs

 

Equity in losses from non-consolidated REITs increased approximately $0.1 million during the three months ended March 31, 2017 compared to the same period in 2016.  The increase was primarily attributable to equity in the loss from our preferred stock investment in a Sponsored REIT, FSP Grand Boulevard Corp., which we refer to as Grand Boulevard, which increased during the three months ended March 31, 2017 compared to the same period in 2016.

 

Other

 

Other expense was reduced by $22,000 for the three months ended March 31, 2017, which is attributable to hedge ineffectiveness from our derivatives’ fair value.  The ineffective portion of the derivatives’ fair value are recognized directly into earnings each quarter as hedge ineffectiveness. 

 

Gain on sale of property and provision for loss on property held for sale

 

During the three months ended December 31, 2016, we reached an agreement to sell an office property located in Milpitas, California.  The property was classified as an asset held for sale at December 31, 2016 and was sold on January 6, 2017 at a $2.3 million gain. 

 

Taxes on income

 

Included in income taxes is the Revised Texas Franchise Tax, which is a tax on revenues from Texas properties, and other income taxes, which increased by $2,000 and $25,000 for the three months ended March 31, 2017, respectively, compared to the three months ended March 31, 2016.

 

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Net Income

 

Net Income for the three months ended March 31, 2017 was $4.5 million compared to $2.6 million for the three months ended March 31, 2016, for the reasons described above.

24


 

Non-GAAP Financial Measures

 

Funds From Operations

 

The Company evaluates performance based on Funds From Operations, which we refer to as FFO, as management believes that FFO represents the most accurate measure of activity and is the basis for distributions paid to equity holders.  The Company defines FFO as net income (computed in accordance with GAAP), excluding gains (or losses) from sales of property, hedge ineffectiveness and acquisition costs of newly acquired properties that are not capitalized, plus depreciation and amortization, including amortization of acquired above and below market lease intangibles and impairment charges on properties or investments in non-consolidated REITs, and after adjustments to exclude equity in income or losses from, and, to include the proportionate share of FFO from, non-consolidated REITs.

 

FFO should not be considered as an alternative to net income (determined in accordance with GAAP), nor as an indicator of the Company’s financial performance, nor as an alternative to cash flows from operating activities (determined in accordance with GAAP), nor as a measure of the Company’s liquidity, nor is it necessarily indicative of sufficient cash flow to fund all of the Company’s needs.

 

Other real estate companies and the National Association of Real Estate Investment Trusts, or NAREIT may define this term in a different manner.  We have included the NAREIT FFO definition as of May 17, 2016 in the table and note that other REITs may not define FFO in accordance with the NAREIT definition or may interpret the current NAREIT definition differently than we do.

 

We believe that in order to facilitate a clear understanding of the results of the Company, FFO should be examined in connection with net income and cash flows from operating, investing and financing activities in the consolidated financial statements.

The calculations of FFO are shown in the following table:

 

 

 

 

 

 

 

 

 

 

 

 

March 31,

 

 

(in thousands):

    

2017

    

2016

 

 

Net income

 

$

4,480

$

 

2,579

 

 

(Gain) loss on sale of properties,

  less applicable income tax

 

 

(2,289)

 

 —

 

 

Equity in losses of non-consolidated REITs

 

 

397

 

 

286

 

 

FFO from non-consolidated REITs

 

 

791

 

 

645

 

 

Depreciation and amortization

 

 

25,163

 

 

22,527

 

 

NAREIT FFO

 

 

28,542

 

 

26,037

 

 

Hedge ineffectiveness

 

 

(22)

 

 

 —

 

 

Acquisition costs of new properties

 

 

 8

 

 

 —