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EX-32.1 - EXHIBIT 32.1 - Equity Commonwealtheqc33117exhibit321.htm
EX-31.2 - EXHIBIT 31.2 - Equity Commonwealtheqc33117exhibit312.htm
EX-31.1 - EXHIBIT 31.1 - Equity Commonwealtheqc33117exhibit311.htm
EX-3.4 - EXHIBIT 3.4 - Equity Commonwealtheqc33117exhibit34.htm

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
 
ý      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
 
o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-9317
EQUITY COMMONWEALTH
(Exact Name of Registrant as Specified in Its Charter)
Maryland
 
04-6558834
(State or Other Jurisdiction of Incorporation or Organization)
 
(IRS Employer Identification No.)
Two North Riverside Plaza, Suite 2100, Chicago, IL
 
60606
(Address of Principal Executive Offices)
 
(Zip Code)
(312) 646-2800
(Registrant’s Telephone Number, Including Area Code)
 
Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ý  No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ý  No o
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 x
 
Accelerated filer o
 
 
 
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
Emerging growth company o
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. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No ý
Number of registrant’s common shares of beneficial interest, $0.01 par value per share, outstanding as of April 30, 2017124,064,195.
 



EQUITY COMMONWEALTH
 
FORM 10-Q
 
March 31, 2017
 
INDEX
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 




 
EXPLANATORY NOTE
 
References in this Quarterly Report on Form 10-Q to the Company, EQC, we, us or our, refer to Equity Commonwealth and its consolidated subsidiaries as of March 31, 2017, unless the context indicates otherwise.


i


PART I.      Financial Information

Item 1.         Financial Statements.

EQUITY COMMONWEALTH
 
CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in thousands, except share data)
(unaudited)
 
March 31,
2017
 
December 31,
2016
 
 
 
(audited)
ASSETS
 
 
 
Real estate properties:
 
 
 
Land
$
269,062

 
$
286,186

Buildings and improvements
2,395,748

 
2,570,704

 
2,664,810

 
2,856,890

Accumulated depreciation
(705,000
)
 
(755,255
)
 
1,959,810

 
2,101,635

Properties held for sale
64,396

 

Acquired real estate leases, net
45,482

 
48,281

Cash and cash equivalents
1,888,537

 
2,094,674

Marketable securities
275,597

 

Restricted cash
6,155

 
6,532

Rents receivable, net of allowance for doubtful accounts of $4,593 and $5,105, respectively
152,081

 
152,031

Other assets, net
126,698

 
122,922

Total assets
$
4,518,756

 
$
4,526,075

 
 
 
 
LIABILITIES AND EQUITY
 
 
 
Senior unsecured debt, net
$
1,064,450

 
$
1,063,950

Mortgage notes payable, net
77,178

 
77,717

Liabilities related to properties held for sale
1,013

 

Accounts payable and accrued expenses
62,518

 
95,395

Assumed real estate lease obligations, net
1,630

 
1,946

Rent collected in advance
18,485

 
18,460

Security deposits
6,957

 
8,160

Total liabilities
1,232,231

 
1,265,628

 
 
 
 
Shareholders' equity:
 
 
 
Preferred shares of beneficial interest, $0.01 par value: 50,000,000 shares authorized;
 
 
 
Series D preferred shares; 6 1/2% cumulative convertible; 4,915,196 shares issued and outstanding, aggregate liquidation preference of $122,880
119,263

 
119,263

Common shares of beneficial interest, $0.01 par value: 350,000,000 shares authorized; 124,064,195 and 123,994,465 shares issued and outstanding, respectively
1,240

 
1,240

Additional paid in capital
4,367,190

 
4,363,177

Cumulative net income
2,590,417

 
2,566,603

Cumulative other comprehensive loss
(1,002
)
 
(208
)
Cumulative common distributions
(3,111,868
)
 
(3,111,868
)
Cumulative preferred distributions
(679,757
)
 
(677,760
)
Total shareholders’ equity
3,285,483

 
3,260,447

Noncontrolling interest
1,042

 

Total equity
3,286,525

 
3,260,447

Total liabilities and equity
$
4,518,756

 
$
4,526,075

See accompanying notes.

1


EQUITY COMMONWEALTH
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in thousands, except per share data)
(unaudited)
 
Three Months Ended March 31,
 
2017
 
2016
Revenues:
 
 
 
Rental income
$
80,205

 
$
109,888

Tenant reimbursements and other income
19,346

 
27,247

Total revenues
99,551

 
137,135

Expenses:
 
 
 
Operating expenses
41,087

 
57,258

Depreciation and amortization
26,915

 
36,251

General and administrative
12,078

 
13,312

Loss on asset impairment
1,286

 

Total expenses
81,366

 
106,821

Operating income
18,185

 
30,314

Interest and other income
4,372

 
1,967

Interest expense (including net amortization of debt discounts, premiums and deferred financing fees of $713 and $983, respectively)
(15,014
)
 
(22,347
)
Loss on early extinguishment of debt

 
(118
)
Foreign currency exchange loss

 
(5
)
Gain on sale of properties, net
16,454

 
36,666

Income before income taxes
23,997

 
46,477

Income tax expense
(175
)
 
(75
)
Net income
23,822

 
46,402

Net income attributable to noncontrolling interest
(8
)
 

Net income attributable to Equity Commonwealth
$
23,814

 
$
46,402

Preferred distributions
(1,997
)
 
(6,981
)
Net income attributable to Equity Commonwealth common shareholders
$
21,817

 
$
39,421

 
 
 
 
Weighted average common shares outstanding — basic
124,047

 
125,840

Weighted average common shares outstanding — diluted
125,150

 
127,522

Earnings per common share attributable to Equity Commonwealth common shareholders:
 
 
 
Basic
$
0.18

 
$
0.31

Diluted
$
0.17

 
$
0.31


See accompanying notes.

2


EQUITY COMMONWEALTH
 
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(amounts in thousands)
(unaudited)
 
Three Months Ended 
 March 31,
 
2017
 
2016
Net income
$
23,822

 
$
46,402

 
 
 
 
Other comprehensive (loss) income, net of tax:
 
 
 
Unrealized (loss) gain on derivative instruments
(153
)
 
673

Unrealized loss on marketable securities
(641
)
 

Total comprehensive income
23,028

 
47,075

Comprehensive income attributable to the noncontrolling interest
(8
)
 

Total comprehensive income attributable to Equity Commonwealth
$
23,020

 
$
47,075


See accompanying notes.


3


EQUITY COMMONWEALTH
 
CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
(amounts in thousands, except share data)
(unaudited)
 
Equity Commonwealth Shareholders
 
 
 
 
 
Preferred Shares
 
Common Shares
 
 
 
 
 
Series D
 
Series E
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Number
of
Shares
 
Preferred
Shares
 
Number
of
Shares
 
Preferred
Shares
 
Cumulative
Preferred
Distributions
 
Number
of
Shares
 
Common
Shares
 
Cumulative
Common
Distributions
 
Additional
Paid
in
Capital
 
Cumulative
Net
Income
 
Cumulative Other Comprehensive Loss
 
Noncontrolling Interest
 
Total
Balance at December 31, 2015
4,915,196

 
$
119,263

 
11,000,000

 
$
265,391

 
$
(650,195
)
 
126,349,914

 
$
1,263

 
$
(3,111,868
)
 
$
4,414,611

 
$
2,333,709

 
$
(3,687
)
 
$

 
$
3,368,487

Net income

 

 

 

 

 

 

 

 

 
46,402

 

 

 
46,402

Unrealized gain on derivative instruments

 

 

 

 

 

 

 

 

 

 
673

 

 
673

Purchase of shares

 

 

 

 

 
(983,789
)
 
(10
)
 

 
(25,553
)
 

 

 

 
(25,563
)
Share-based compensation

 

 

 

 

 
136,623

 
2

 

 
4,351

 

 

 

 
4,353

Distributions

 

 

 

 
(6,981
)
 

 

 

 

 

 

 

 
(6,981
)
Balance at March 31, 2016
4,915,196

 
$
119,263

 
11,000,000

 
$
265,391

 
$
(657,176
)
 
125,502,748

 
$
1,255

 
$
(3,111,868
)
 
$
4,393,409

 
$
2,380,111

 
$
(3,014
)
 
$

 
$
3,387,371

Balance at December 31, 2016
4,915,196

 
$
119,263

 

 
$

 
$
(677,760
)
 
123,994,465

 
$
1,240

 
$
(3,111,868
)
 
$
4,363,177

 
$
2,566,603

 
$
(208
)
 
$

 
$
3,260,447

Net income

 

 

 

 

 

 

 

 

 
23,814

 

 
8

 
23,822

Unrealized loss on derivative instruments

 

 

 

 

 

 

 

 

 

 
(153
)
 

 
(153
)
Unrealized loss on marketable securities

 

 

 

 

 

 

 

 

 

 
(641
)
 

 
(641
)
Purchase of shares

 

 

 

 

 
(6,694
)
 

 

 
(209
)
 

 

 

 
(209
)
Share-based compensation

 

 

 

 

 
76,424

 

 

 
4,999

 

 

 
227

 
5,226

Contributions

 

 

 

 

 

 

 

 

 

 

 
30

 
30

Distributions

 

 

 

 
(1,997
)
 

 

 

 

 

 

 

 
(1,997
)
Adjustment for noncontrolling interest

 

 

 

 

 

 

 

 
(777
)
 

 

 
777

 

Balance at March 31, 2017
4,915,196

 
$
119,263

 

 
$

 
$
(679,757
)
 
124,064,195

 
$
1,240

 
$
(3,111,868
)
 
$
4,367,190

 
$
2,590,417

 
$
(1,002
)
 
$
1,042

 
$
3,286,525


See accompanying notes.

4


EQUITY COMMONWEALTH
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in thousands)
(unaudited)
 
Three Months Ended March 31,
 
2017
 
2016
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
23,822

 
$
46,402

Adjustments to reconcile net income to cash (used in) provided by operating activities:
 
 
 
Depreciation
21,893

 
28,582

Net amortization of debt discounts, premiums and deferred financing fees
713

 
983

Straight line rental income
(4,387
)
 
(3,831
)
Amortization of acquired real estate leases
2,540

 
4,629

Other amortization
3,055

 
4,161

Share-based compensation
5,226

 
4,353

Loss on asset impairment
1,286

 

Loss on early extinguishment of debt

 
118

Foreign currency exchange loss

 
5

Net gain on sale of properties
(16,454
)
 
(36,666
)
Change in assets and liabilities:
 
 
 
Restricted cash
1,311

 
(458
)
Rents receivable and other assets
(18,239
)
 
(15,486
)
Accounts payable and accrued expenses
(24,053
)
 
(6,361
)
Rent collected in advance
416

 
(3,255
)
Security deposits
181

 
(192
)
Cash (used in) provided by operating activities
(2,690
)
 
22,984

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Real estate improvements
(19,889
)
 
(25,963
)
Insurance proceeds received
2,000

 

Proceeds from sale of properties, net
94,138

 
118,391

Purchase of marketable securities
(276,238
)
 

Increase in restricted cash
(934
)
 
(3,487
)
Cash (used in) provided by investing activities
(200,923
)
 
88,941

CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Purchase and retirement of common shares
(209
)
 
(25,563
)
Payments on borrowings
(348
)
 
(139,922
)
Deferred financing fees

 
(52
)
Contributions from holders of noncontrolling interest
30

 

Distributions to preferred shareholders
(1,997
)
 
(6,981
)
Cash used in financing activities
(2,524
)
 
(172,518
)
 
 
 
 
Effect of exchange rate changes on cash

 
(8
)
 
 
 
 
Decrease in cash and cash equivalents
(206,137
)
 
(60,601
)
Cash and cash equivalents at beginning of period
2,094,674

 
1,802,729

Cash and cash equivalents at end of period
$
1,888,537

 
$
1,742,128

See accompanying notes.



5


EQUITY COMMONWEALTH 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(amounts in thousands)
(unaudited)

 
Three Months Ended March 31,
 
2017
 
2016
SUPPLEMENTAL CASH FLOW INFORMATION:
 
 
 
Interest paid
$
22,285

 
$
28,542

Taxes paid (refunded)
335

 
(72
)
 
 
 
 
NON-CASH INVESTING ACTIVITIES:
 
 
 
Increase (decrease) in capital expenditures recorded as liabilities
$
4,266

 
$
(6,312
)

See accompanying notes.


6


EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


Note 1.  Business

Equity Commonwealth (the Company) is a real estate investment trust, or REIT, formed in 1986 under the laws of the State of Maryland. Our primary business is the ownership and operation of real estate, primarily office buildings, throughout the United States.

On November 10, 2016, the Company converted to what is commonly referred to as an umbrella partnership real estate investment trust, or UPREIT, structure. In connection with this conversion, the Company contributed substantially all of its assets to EQC Operating Trust, a Maryland real estate investment trust (the Operating Trust), and the Operating Trust assumed substantially all of the Company’s liabilities pursuant to a contribution and assignment agreement between the Company and the Operating Trust.
 
The Company now conducts and intends to continue to conduct substantially all of its activities through the Operating Trust. The Company beneficially owned 99.97% of the outstanding shares of beneficial interest, designated as units, in the Operating Trust (OP Units) as of March 31, 2017, and the Company is the sole trustee of the Operating Trust.  As the sole trustee, the Company generally has the exclusive power under the declaration of trust of the Operating Trust to manage and conduct the business of the Operating Trust, subject to certain limited approval and voting rights of other holders of OP Units that may be admitted in the future.

At March 31, 2017, our portfolio, excluding properties held for sale, included 28 properties (56 buildings), and one land parcel, with a combined 14.6 million square feet. As of March 31, 2017, we had $2.2 billion of cash and cash equivalents and marketable securities.

Note 2.  Summary of Significant Accounting Policies

Basis of Presentation

The accompanying condensed consolidated financial statements of EQC have been prepared without audit.  Certain information and footnote disclosures required by U.S. generally accepted accounting principles, or GAAP, for complete financial statements have been condensed or omitted.  We believe the disclosures made are adequate to make the information presented not misleading.  However, the accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes contained in our Annual Report on Form 10-K (Annual Report) for the year ended December 31, 2016.  Capitalized terms used, but not defined in this Quarterly Report, have the same meanings as in our Annual Report.

In the opinion of our management, all adjustments, which include only normal recurring adjustments considered necessary for a fair presentation, have been included.  All intercompany transactions and balances with or among our subsidiaries have been eliminated.  Operating results for interim periods are not necessarily indicative of the results that may be expected for the full year.  Reclassifications have been made to the prior years’ financial statements to conform to the current year’s presentation.

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect reported amounts.  Actual results could differ from those estimates.  Significant estimates in the condensed consolidated financial statements include the allowance for doubtful accounts, purchase price allocations, useful lives of fixed assets and impairment of real estate and intangible assets.

Share amounts are presented in whole numbers, except where noted.

Recent Accounting Pronouncements

In February 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2017-01, Clarifying the Definition of a Business, that changes the definition of a business to assist entities with evaluating when a set of transferred assets and activities is a business. This update is effective for fiscal years beginning after December 15,

7


EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


2017, and for interim periods within those fiscal years. We early adopted this ASU effective January 1, 2017, and the adoption of this ASU did not have a material impact on our consolidated financial statements.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which amends FASB Accounting Standards Codification (ASC) Topic 230, Statements of Cash Flows, to add or clarify guidance on the classification and presentation of restricted cash in the statement of cash flows. This update is effective for fiscal years beginning after December 15, 2017, and for interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. We do not expect that the adoption of this ASU will have a material impact on our consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. This update is effective for fiscal years beginning after December 15, 2017, and for interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. We do not expect that the adoption of this ASU will have a material impact on our consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which requires more timely recognition of credit losses associated with financial assets. This update is effective for fiscal years beginning after December 15, 2019, and for interim periods within those fiscal years. Early adoption is permitted for fiscal years, and interim periods within those years, beginning after December 15, 2018. We are currently in the process of evaluating the impact, if any, the adoption of this ASU will have on our consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases, which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e., lessees and lessors). ASU 2016-02 requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase of the leased asset by the lessee. This classification will determine whether the lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases today. ASU 2016-02 supersedes previous leasing standards. ASU 2016-02 is effective for us for reporting periods beginning after December 15, 2018, with early adoption permitted. We are still assessing the impact of adopting ASU 2016-02. For leases where we are the lessor, we expect to account for these leases using an approach that is substantially equivalent to current guidance. However, we expect that certain executory and non-lease components (such as common area maintenance), will need to be accounted for separately from the lease component of the lease with the lease component continuing to be recognized on a straight-line basis over the lease term. We intend to account for the executory and non-lease components under the new revenue recognition guidance in ASU 2014-09, upon our adoption of ASU 2016-02. When the revenue for such activities is not separately stipulated in the lease, we will need to separate the lease components of revenue due under leases from the non-lease components. For leases in which we are the lessee, we expect to recognize a right-of-use asset and a lease liability equal to the present value of the minimum lease payments with rent expense being recognized on a straight-line basis and the right of use asset being reduced when lease payments are made. Subsequent to initial recognition, the lease liability will be re-measured based on the present value of the remaining lease payments with an offset to the right-of-use asset.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers. The objective of ASU 2014-09, as amended, is to establish a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and will supersede most of the existing revenue recognition guidance, including industry-specific guidance. The core principle is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In applying ASU 2014-09, companies will perform a five-step analysis of transactions to determine when and how revenue is recognized. ASU 2014-09 applies to all contracts with customers except those that are within the scope of other topics in the FASB’s ASC, and more particularly lease contracts with customers, which are a scope exception. ASU 2014-09 is effective for the first interim period within annual reporting periods beginning after December 15, 2017, with early adoption permitted. While our consideration of this matter is ongoing, we are not planning to early adopt ASU 2014-09, as amended, and we expect to use the modified retrospective method of adoption that will result in a cumulative effect adjustment as of the date of adoption. We are currently conducting our evaluation of the impact of the guidance. We believe the effects on our existing

8


EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


accounting policies will be associated with our non-leasing revenue components, specifically the amount, timing and presentation of tenant expense reimbursements revenue. We continue to evaluate the potential impact to our consolidated financial statements as a result of this ASU.

Note 3.  Real Estate Properties

During the three months ended March 31, 2017 and 2016, we made improvements, excluding tenant-funded improvements, to our properties totaling $14.2 million and $31.9 million, respectively.

Properties Held For Sale:

We classify all properties that meet the criteria outlined in the Property, Plant and Equipment Topic of the FASB ASC as held for sale on our condensed consolidated balance sheets.  As of December 31, 2016, we had no properties classified as held for sale. As of March 31, 2017, we classified the following properties as held for sale (dollars in thousands):
Asset
 
Date Sold
 
Number of
Properties
 
Number of
Buildings
 
Square
Footage
 
Gross Sales Price
25 S. Charles Street
 
April 2017
 
1

 
1

 
359,254

 
$
24,500

Parkshore Plaza
 
April 2017
 
1

 
4

 
271,072

 
40,000

 
 
 
 
2

 
5

 
630,326

 
$
64,500


Summarized balance sheet information for the properties classified as held for sale is as follows (in thousands):

 
March 31, 2017
Real estate properties
$
61,829

Other assets, net
2,567

Properties held for sale
$
64,396

 
 
Accounts payable and accrued expenses
$
150

Security deposits
863

Liabilities related to properties held for sale
$
1,013


Property Dispositions:

During the three months ended March 31, 2017, we sold the following properties (dollars in thousands):

Asset
 
Date Sold
 
Number of
Properties
 
Number of
Buildings
 
Square
Footage
 
Gross Sales Price
 
Gain (Loss) on Sale
Properties
 
 
 
 
 
 
 
 
 
 
 
 
111 Market Place
 
January 2017
 
1

 
1

 
589,380

 
$
60,100

 
$
(5,968
)
Cabot Business Park Land
 
March 2017
 

 

 

 
575

 
(57
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Portfolios of properties
 
 
 
 
 
 
 
 
 
 
 
 
4515 Seton Center Parkway
 
March 2017
 
1

 
1

 
117,265

 
 
 
 
4516 Seton Center Parkway
 
March 2017
 
1

 
1

 
120,559

 
 
 
 
Seton Center
 
 
 
2

 
2

 
237,824

 
$
52,450

 
$
22,479

 
 
 
 
3

 
3

 
827,204

 
$
113,125

 
$
16,454



9


EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


During the year ended December 31, 2016, we sold 30 properties (62 buildings) with a combined 8.0 million square feet for an aggregate gross sales price of $1.3 billion, excluding closing costs.

Note 4.  Marketable Securities

All of our marketable securities are classified as available-for-sale and consist of United States Treasury notes, which mature in 2019, and common stock. Available-for-sale securities are presented on our condensed consolidated balance sheets at fair value. Changes in values of these securities are recognized in accumulated other comprehensive loss. Realized gains and losses are recognized in earnings only upon the sale of the securities.

We evaluate our marketable securities for impairment each reporting period. For securities with unrealized losses, we review the underlying cause of the decline in value and the estimated recovery period, as well as the severity and duration of the decline. In our evaluation, we consider our ability and intent to hold these investments for a reasonable period of time sufficient for us to recover our cost basis. To the extent an other-than-temporary impairment is deemed to have occurred, an impairment charge is recorded and a new cost basis is established.

Below is a summary of our marketable securities as of March 31, 2017 (in thousands):
 
 
March 31, 2017
 
 
Cost or Amortized Cost
 
Unrealized Losses
 
Estimated Fair Value
Marketable securities
 
$
276,238

 
$
(641
)
 
$
275,597


Note 5.  Indebtedness
 
Unsecured Revolving Credit Facility and Term Loan:
We are party to a credit agreement pursuant to which the lenders agreed to provide a $750.0 million unsecured revolving credit facility, a $200.0 million 5-year term loan facility, and a $200.0 million 7-year term loan facility. The revolving credit facility has a scheduled maturity date of January 28, 2019, which maturity date may be extended for up to two additional periods of six months at our option subject to satisfaction of certain conditions and the payment of an extension fee of 0.075% of the aggregate amount available under the revolving credit facility. The 5-year term loan and the 7-year term loan have scheduled maturity dates of January 28, 2020 and January 28, 2022, respectively.

The credit agreement permits us to utilize up to $100.0 million of the revolving credit facility for the issuance of letters of credit. Amounts outstanding under the credit agreement generally may be prepaid at any time without premium or penalty, subject to certain exceptions. We have the right to request increases in the aggregate maximum amount of borrowings available under the revolving credit facility and term loans up to an additional $1.15 billion, subject to certain conditions.
    
Borrowings under the 5-year term loan and 7-year term loan will, subject to certain exceptions, bear interest at a LIBOR rate plus a margin of 90 to 180 basis points for the 5-year term loan and 140 to 235 basis points for the 7-year term loan, in each case depending on our credit rating. Borrowings under the revolving credit facility will, subject to certain exceptions, bear interest at a rate equal to, at our option, either a LIBOR rate or a base rate plus a margin of 87.5 to 155 basis points for LIBOR rate advances and 0 to 55 basis points for base rate advances, in each case depending on our credit rating. In addition, we are required to pay a facility fee of 12.5 to 30 basis points, depending on our credit rating, on the borrowings available under the revolving credit facility, whether or not utilized.

Borrowings under our revolving credit facility currently bear interest at LIBOR plus a spread, which was 125 basis points as of March 31, 2017.  As of March 31, 2017, the interest rate payable on borrowings under our revolving credit facility was 2.23%.  As of March 31, 2017, we had no balance outstanding and $750.0 million available under our revolving credit facility and the facility fee as of March 31, 2017 was 0.25%. Our term loans currently bear interest at a rate of LIBOR plus a spread, which was 140 and 180 basis points for the 5-year and 7-year term loan, respectively, as of March 31, 2017.  As of March 31, 2017, the interest rates for the amounts outstanding under our 5-year term loan and 7-year term loan were 2.38% and 2.78%, respectively.  As of March 31, 2017, we had $200.0 million outstanding under each of our 5-year and 7-year term loans.


10


EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


Debt Covenants:
 
Our public debt indenture and related supplements and our credit agreement contain a number of financial and other covenants, including covenants that restrict our ability to incur indebtedness or to make distributions under certain circumstances and require us to maintain financial ratios and a minimum net worth.  At March 31, 2017, we believe we were in compliance with all of our respective covenants under our public debt indenture and related supplements and our credit agreement.

Senior Unsecured Notes:

At March 31, 2017, we had senior unsecured notes of $675.0 million (excluding net discounts and unamortized deferred financing fees) maturing from 2018 through 2042.

Mortgage Notes Payable:
 
At March 31, 2017, four of our properties (7 buildings) with an aggregate net book value of $102.2 million had secured mortgage notes totaling $77.2 million (including net premiums and unamortized deferred financing fees) maturing from 2017 through 2026.

Note 6.  Shareholders’ Equity
 
Common Share Issuances:

See Note 11 for information regarding equity issuances related to share-based compensation.

Common Share Repurchases:

On March 17, 2016, our Board of Trustees authorized the repurchase of up to $150.0 million of our outstanding common shares over the twelve month period following the date of authorization. In March 2017, this share repurchase authorization, of which $106.6 million was not utilized, expired. On March 15, 2017, our Board of Trustees authorized the repurchase of up to an additional $150.0 million of our outstanding common shares over the twelve month period following the date of authorization. During the three months ended March 31, 2017, we did not purchase any common shares.

During the three months ended March 31, 2017, certain of our employees surrendered 6,694 common shares owned by them to satisfy their statutory tax withholding obligations in connection with the vesting of such common shares under the Equity Commonwealth 2015 Omnibus Incentive Plan (the 2015 Incentive Plan).

Preferred Share Redemption:

On May 15, 2016, we redeemed all of our 11,000,000 outstanding series E preferred shares at a price of $25.00 per share, for a total of $275.0 million, plus any accrued and unpaid dividends. The redemption payment occurred on May 16, 2016 (the first business day following the redemption date).

Preferred Share Distributions:

In 2017, our Board of Trustees declared distributions on our series D preferred shares to date as follows:

Declaration Date
 
Record Date
 
Payment Date
 
Series D Dividend Per Share
January 12, 2017
 
January 30, 2017
 
February 15, 2017
 
$
0.40625

April 10, 2017
 
April 28, 2017
 
May 15, 2017
 
$
0.40625



11


EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


Note 7.  Noncontrolling Interest

Noncontrolling interest represents the portion of the units in the Operating Trust not beneficially owned by the Company. An operating partnership unit (OP Unit) and a share of our common stock have essentially the same economic characteristics. Distributions with respect to OP Units will generally mirror distributions with respect to the Company’s common shares. Unitholders (other than the Company) generally have the right, commencing six months from the date of issuance of such OP Units, to cause the Operating Trust to redeem their OP Units in exchange for cash or, at the option of the Company, common shares of the Company on a one-for-one basis. As sole trustee, the Company will have the sole discretion to elect whether the redemption right will be satisfied by the Company in cash or the Company’s common shares. As a result, the Noncontrolling interest is classified as permanent equity. As of March 31, 2017, the portion of the Operating Trust not beneficially owned by the Company is in the form of LTIP Units (see Note 11 for a description of LTIP Units). LTIP Units may be subject to additional vesting requirements.

The following table presents the changes in Equity Commonwealth’s issued and outstanding common shares and units for the three months ended March 31, 2017:
 
 
Common Shares
 
LTIP Units
 
Total
Outstanding at January 1, 2017
 
123,994,465

 

 
123,994,465

Restricted share and time-based LTIP Unit grants, net of forfeitures
 
69,730

 
39,364

 
109,094

Outstanding at March 31, 2017
 
124,064,195

 
39,364

 
124,103,559

Noncontrolling ownership interest in the Operating Trust
 


 


 
0.03
%

The carrying value of the Noncontrolling interest is allocated based on the number of LTIP Units in proportion to the number of LTIP Units plus the number of common shares. We adjust the noncontrolling interest balance at the end of each period to reflect the noncontrolling partners’ interest in the net assets of the Operating Trust. Net income is allocated to the Noncontrolling interest in the Operating Trust based on the weighted average ownership percentage during the period. Equity Commonwealth’s weighted average ownership interest in the Operating Trust was 99.97% for the three months ended March 31, 2017.

Note 8.  Cumulative Other Comprehensive Loss
 
The following table presents the amounts recognized in cumulative other comprehensive loss for the three months ended March 31, 2017 (in thousands):
 
 
 
Unrealized Loss on Derivative Instruments
 
Unrealized Loss on Marketable Securities
 
Total
Balance as of January 1, 2017
 
$
(208
)
 
$

 
$
(208
)
 
 
 
 
 
 
 
Other comprehensive loss before reclassifications
 
(154
)
 
(641
)
 
(795
)
Amounts reclassified from cumulative other comprehensive loss to net income
 
1

 

 
1

Net current period other comprehensive loss
 
(153
)
 
(641
)
 
(794
)
 
 
 
 
 
 
 
Balance as of March 31, 2017
 
$
(361
)
 
$
(641
)
 
$
(1,002
)
 
 

12


EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


The following table presents reclassifications out of cumulative other comprehensive loss for the three months ended March 31, 2017 (in thousands):
 
 
 
Amounts Reclassified from Cumulative Other Comprehensive Loss to Net Income
Details about Cumulative Other Comprehensive Loss Components
 
Three Months Ended March 31, 2017
 
Affected Line Items in the Statement of Operations
Interest rate cap contract
 
$
1

 
Interest expense
 
Note 9.  Income Taxes
 
We have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended, and are generally not subject to federal and state income taxes provided we distribute a sufficient amount of our taxable income to our shareholders and meet other requirements for qualifying as a REIT.  We are also subject to certain state and local taxes without regard to our REIT status. We have a net operating loss carryforward from prior years and we have fully reserved the associated deferred tax assets due to the uncertainty of our ability to utilize the net operating losses in the future.

Our provision for income taxes consists of the following (in thousands):
 
Three Months Ended March 31,
 
2017
 
2016
Current:
 
 
 
State
$
170

 
$
75

Federal
5

 

Income tax expense
$
175

 
$
75


Note 10.  Derivative Instruments

Risk Management Objective of Using Derivatives

We are exposed to certain risks relating to our ongoing business operations, including the effect of changes in interest rates.  The only risk we currently manage by using derivative instruments is related to our interest rate risk. 

We may use derivative financial instruments, including interest rate swaps, caps, options, floors and other interest rate derivative contracts, to hedge all or a portion of the interest rate risk associated with our borrowings. The principal objective of such arrangements is to minimize the risks and/or costs associated with our operating and financial structure as well as to hedge specific anticipated transactions. We do not intend to utilize derivatives for speculative or other purposes other than interest rate risk management. The use of derivative financial instruments carries certain risks, including the risk that the counterparties to these contractual arrangements are not able to perform under the agreements. To mitigate this risk, we only enter into derivative financial instruments with counterparties with high credit ratings or with major financial institutions with which we and our affiliates may also have other financial relationships. We do not anticipate that any of the counterparties will fail to meet their obligations.

Cash Flow Hedges of Interest Rate Risk

Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposure to interest rate movements. To accomplish this objective, we use interest rate caps, as part of our interest rate risk management strategy. Interest rate caps designated as cash flow hedges involve the receipt of variable-rate amounts if interest rates rise above the cap strike rate.

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in cumulative other comprehensive loss and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During 2017, such derivatives were used to hedge the variable cash flows associated with variable-rate debt. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings.

13


EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)



Amounts reported in cumulative other comprehensive loss 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 $97,000 will be reclassified from cumulative other comprehensive loss as an increase to interest expense.

On March 4, 2016, we purchased an interest rate cap with a LIBOR strike price of 2.50%. The interest rate cap, effective April 1, 2016, has a notional amount of $400.0 million and a maturity date of March 1, 2019.

As of March 31, 2017, we had the following outstanding interest rate derivative that was designated as a cash flow hedge of interest rate risk:
Interest Rate Derivative
 
Number of Instruments
 
Notional Amount (in thousands)
Interest rate cap
 
1

 
$
400,000


The table below presents the fair value of our derivative financial instrument as well as its classification on the condensed consolidated balance sheets as of March 31, 2017 and December 31, 2016 (amounts in thousands):
 
 
 
 
Fair Value as of
Interest Rate Derivative Designated as Hedging Instrument
 
Balance Sheet Location
 
March 31,
2017
 
December 31,
2016
Interest rate cap
 
Other assets
 
$
161

 
$
314


The table below details the location in the financial statements of the gain or loss recognized on interest rate derivatives designated as cash flow hedges for the three months ended March 31, 2017 and 2016 (amounts in thousands):
 
Three Months Ended March 31,
 
2017
 
2016
Amount of loss recognized in cumulative other comprehensive loss
$
(154
)
 
$
(445
)
Amount of loss reclassified from cumulative other comprehensive loss into interest expense
1

 
1,118


Credit-risk-related Contingent Features

As of March 31, 2017, we did not have any derivatives in a net liability position including accrued interest but excluding any adjustment for nonperformance risk.

Note 11. Share-Based Compensation
Equity Commonwealth 2015 Omnibus Incentive Plan

Recipients of the Company’s restricted shares have the same voting rights as any other common shareholder. During the period of restriction, the Company’s unvested restricted shareholders are eligible to receive dividend payments on their shares at the same rate and on the same date as any other common shareholder.  The restricted shares are service based awards and vest over a four-year period.

Recipients of the Company’s restricted stock units (RSUs) are entitled to receive dividends with respect to the common shares underlying the RSUs if and when the RSUs are earned, at which time the recipient will be entitled to receive an amount in cash equal to the aggregate amount of cash dividends that would have been paid in respect of the common shares underlying the recipient’s earned RSUs had such common shares been issued to the recipient on the first day of the performance period. To the extent that an award does not vest, the dividends related to unvested RSUs will be forfeited. The RSUs are market based awards with a service condition and recipients may earn RSUs based on the Company’s total shareholder return (TSR) relative to the TSRs of the companies that comprise the NAREIT Office Index over a three year performance period. Following the end of the performance period, the number of earned awards will be determined. The earned awards vest in two tranches with 50% of the earned award vesting at the end of the performance period and the remaining 50% of the earned award vesting one year after the end of the performance period, subject to the grant recipient’s continued employment. Compensation expense for the

14


EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


RSUs is determined using a Monte Carlo simulation model and is recognized ratably from the grant date to the vesting date of each tranche.

LTIP Units are a class of beneficial interests in the Operating Trust that may be issued to employees, officers, or trustees of the Operating Trust, the Company or their subsidiaries (LTIP Units). Time-based LTIP Units have the same general characteristics as restricted shares and market-based LTIP Units have the same general characteristics as RSUs. Each LTIP Unit will convert automatically into an OP Unit on a one-for-one basis when the LTIP Unit becomes vested and its capital account is equalized with the per-unit capital account of the OP Units. Holders of LTIP Units generally will be entitled to receive the same per-unit distributions as the other outstanding OP Units in the Operating Trust, except that market-based LTIP Units will not participate in distributions until expiration of the applicable performance period, at which time any earned market-based LTIP Units generally will become entitled to receive a catch-up distribution for the periods prior to such time.
2017 Equity Award Activity

On January 24, 2017, the Compensation Committee (the Committee) approved a grant of 119,288 LTIP Units (which includes time-based LTIP Units and market-based LTIP Units), 76,424 restricted shares and 155,168 RSUs at target (386,756 RSUs at maximum) to the Company’s officers, certain employees and to Mr. Zell, the Chairman of our Board of Trustees, as part of their compensation for fiscal year 2016. The LTIP Unit grant includes 39,364 time-based LTIP Units and 79,924 market-based LTIP Units at target (199,211 market-based LTIP Units at maximum).

The restricted shares and time-based LTIP Units were granted on January 24, 2017 and were valued at $31.47 per share, the closing price of our common shares on the NYSE on that day. The assumptions and fair values for the RSUs and market-based LTIP Units granted for the three months ended March 31, 2017 are included in the following table on a per share and unit basis.
 
2017
Fair value of RSUs and market-based LTIP units granted
$
39.81

Expected term (years)
4

Expected volatility

Expected dividend yield
1.59
%
Risk-free rate
1.49
%
2016 Equity Award Activity

On January 26, 2016, the Committee approved a grant of 136,623 restricted shares and 277,386 RSUs at target (691,385 RSUs at maximum) to the Company’s officers, certain employees and to Mr. Zell, the Chairman of our Board of Trustees, as part of their compensation for fiscal year 2015.

Outstanding Equity Awards
As of March 31, 2017, the estimated future compensation expense for all unvested restricted share and time-based LTIP Units was $14.2 million. Compensation expense for the restricted share and time-based LTIP Unit awards is being recognized on a straight-line basis over the requisite service period for each separately vesting portion of the award. The weighted average period over which the future compensation expense will be recorded for the restricted shares and time-based LTIP units is approximately 2.4 years.
As of March 31, 2017, the estimated future compensation expense for all unvested RSUs and market-based LTIP Units was $25.2 million. The weighted average period over which the future compensation expense will be recorded for the RSUs and market-based LTIP Units is approximately 2.3 years.
During the three months ended March 31, 2017 and 2016, we recorded $5.2 million and $4.4 million, respectively, of compensation expense, net of forfeitures, in general and administrative expense for grants to our Trustees and employees related to our 2015 Omnibus Incentive Plan (as amended, the 2015 Incentive Plan). At March 31, 2017, 1,656,709 common shares remain available for issuance under the 2015 Incentive Plan.

15


EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


Note 12.  Fair Value of Assets and Liabilities
 
The table below presents assets measured at fair value during 2017, categorized by the level of inputs used in the valuation of the assets (dollars in thousands): 
 
 
 
 
Fair Value at March 31, 2017 Using
 
 
 
 
Quoted Prices in Active Markets for
Identical Assets
 
Significant Other
Observable Inputs
 
Significant Unobservable
Inputs
Description
 
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Recurring Fair Value Measurements:
 
 
 
 
 
 
 
 
Interest rate cap contract
 
$
161

 
$

 
$
161

 
$

Marketable securities
 
$
275,597

 
$
275,597

 
$

 
$


Interest Rate Cap Contract

The fair value of our interest rate cap contract is determined using the net discounted cash flows of the derivative based on the market based interest rate curve (level 2 inputs) and adjusted for our credit spread and the actual and estimated credit spreads of the counterparties (level 3 inputs).  Although we have determined that the majority of the inputs used to value our derivative fall within level 2 of the fair value hierarchy, the credit valuation adjustments associated with our derivative utilize level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by us and the counterparties.  As of March 31, 2017, we have assessed the significance of the impact of the credit valuation adjustments on the overall valuation of our derivative position and have determined that the credit valuation adjustments are not significant to the overall valuation of our derivative.  As a result, we have determined that our derivative valuation in its entirety is classified as level 2 inputs in the fair value hierarchy.

Properties Held and Used

As part of our office repositioning strategy, and pursuant to our accounting policy, in 2017, we evaluated the recoverability of the carrying values of each of the real estate assets that comprised our portfolio and determined that due to the shortening of the expected periods of ownership as a result of the office repositioning strategy and current estimates of market value less estimated costs to sell, it was necessary to reduce the net book value of a portion of the real estate assets in our portfolio to their estimated fair values. We anticipate the potential disposition of certain properties prior to the end of their remaining useful lives. As a result, in the first quarter of 2017, we recorded an impairment charge related to 25 S. Charles Street of $1.3 million for the three months ended March 31, 2017 in accordance with our impairment analysis procedures. We determined this impairment based on third party offer prices and independent third party broker information, which are level 2 inputs according to the fair value hierarchy established in ASC 820. We reduced the aggregate carrying value of this property from $24.6 million to its estimated fair value less estimated costs to sell of $23.3 million. This property was sold in April 2017 (see Note 3 for additional information). We evaluated each of our properties and determined there were no additional valuation adjustments necessary at March 31, 2017.

Financial Instruments

In addition to the assets and liabilities described in the above table, our financial instruments include our cash and cash equivalents, real estate mortgages receivable, restricted cash, marketable securities, senior unsecured debt and mortgage notes payable.  At March 31, 2017 and December 31, 2016, the fair value of these additional financial instruments were not materially different from their carrying values, except as follows (in thousands):  
 
March 31, 2017
 
December 31, 2016
 
Carrying Amount
 
Fair Value
 
Carrying Amount
 
Fair Value
Senior unsecured debt and mortgage notes payable
$
1,151,286

 
$
1,175,642

 
$
1,151,634

 
$
1,167,031

 
The fair values of our senior notes and mortgage notes payable are based on estimates using discounted cash flow analyses and currently prevailing interest rates adjusted by credit risk spreads (level 3 inputs).


16


EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


Other financial instruments that potentially subject us to concentrations of credit risk consist principally of rents receivable; however, as of March 31, 2017, no single tenant of ours is responsible for more than 6.0% of our total annualized rents.
 
Our derivative financial instruments, including interest rate swaps and cap, are entered with major financial institutions and we monitor the amount of credit exposure to any one counterparty.

Note 13.  Earnings Per Common Share

The following table sets forth the computation of basic and diluted earnings per share (amounts in thousands except per share amounts):
 
Three Months Ended March 31,
 
2017
 
2016
Numerator for earnings per common share - basic:
 
 
 
Net income
$
23,822

 
$
46,402

Net income attributable to noncontrolling interest
(8
)
 

Preferred distributions
(1,997
)
 
(6,981
)
Numerator for net income per share - basic
$
21,817


$
39,421

 
 
 
 
Numerator for earnings per common share - diluted:
 
 
 
Net income
$
23,822

 
$
46,402

Preferred distributions
(1,997
)
 
(6,981
)
Numerator for net income per share - diluted
$
21,825

 
$
39,421

 
 
 
 
Denominator for earnings per common share - basic and diluted:
 
 
 
Weighted average number of common shares outstanding - basic
124,047

 
125,840

RSUs
1,023

 
1,682

LTIP Units
80

 

Weighted average number of common shares outstanding - diluted(1)
125,150

 
127,522

 
 
 
 
Net income per common share attributable to Equity Commonwealth common shareholders:
 
 
 
Basic
$
0.18

 
$
0.31

Diluted
$
0.17

 
$
0.31

 
 
 
 
Anti-dilutive securities:
 
 
 
Effect of Series D preferred shares; 6 1/2% cumulative convertible(2)
2,363

 
2,363


(1)
As of March 31, 2017, we had granted RSUs and LTIP Units to certain employees, officers, and the chairman of the Board of Trustees.  The RSUs and LTIP Units contain service and market-based vesting components.  None of the RSUs or LTIP Units have vested. If the market-based vesting component of these awards was measured as of March 31, 2017, and 2016, 1,165 and 1,754 common shares would be issued, respectively. Using a weighted average basis, 1,103 and 1,682 common shares are reflected in diluted earnings per share for the three months ended March 31, 2017 and 2016, respectively.
(2)
The Series D preferred shares are excluded from the diluted earnings per share calculation because including the Series D preferred shares would also require that the preferred distributions be added back to net income, resulting in anti-dilution during the periods presented.


17


EQUITY COMMONWEALTH
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


Note 14.  Segment Information
 
Our primary business is the ownership and operation of office properties, and we currently have one reportable segment.  More than 95% of our revenues for the three months ended March 31, 2017 are from office properties. 

Note 15.  Related Person Transactions
 
The following discussion includes a description of our related person transactions for the three months ended March 31, 2017 and 2016.

Two North Riverside Plaza Joint Venture Limited Partnership: We have a lease with Two North Riverside Plaza Joint Venture Limited Partnership, an entity associated with Mr. Zell, our Chairman, to occupy office space on the twentieth and twenty-first floors of Two North Riverside Plaza in Chicago, Illinois (20th/21st Floor Office Lease). The initial term of the lease is approximately five years, with one 5-year renewal option. We have completed improvements to the office space utilizing the $0.7 million tenant improvement allowance pursuant to the lease. In connection with the 20th/21st Floor Office Lease, we also have a lease with Two North Riverside Plaza Joint Venture Limited Partnership for storage space in the basement of Two North Riverside Plaza. The lease expires December 31, 2020; however, each party has the right to terminate on 30 days' prior written notice. During the three months ended March 31, 2017 and 2016, we recognized expense of $0.2 million and $0.2 million, respectively, pursuant to the 20th/21st Floor Office Lease and the related storage space.

Related/Corvex: On July 31, 2014, at our 2014 annual meeting of shareholders, our shareholders voted to approve the reimbursement of approximately $33.5 million of verified expenses incurred by Related Fund Mangement, LLC and Corvex Management LP (Related/Corvex) beginning February 2013 in connection with their consent solicitations to remove our former Trustees, elect the new Board of Trustees and to engage in related litigation. We paid approximately $16.7 million during the year ended December 31, 2014.  Approximately $8.4 million was to be reimbursed only if the average closing price of our common shares was at least $26.00 (as adjusted for any share splits or share dividends) during the one year period after the date on which the reimbursement was approved by shareholders, and up to $8.4 million was to be reimbursed only if the average closing price of our common shares was at least $26.00 (as adjusted for any share splits or share dividends) during the one year period between the first and second anniversaries of the date on which the reimbursement was approved by shareholders. The average closing price of our common shares was at least $26.00 during both the first and second one year periods after the date on which the reimbursement was approved by shareholders, and as a result, in August 2016 and 2015 we paid an $8.2 million final payment and $8.4 million, respectively, to Related/Corvex.

Note 16.  Subsequent Events
 
In April 2017, we sold two properties (Parkshore Plaza and 25 S. Charles Street) (five buildings), with 630,326 square feet for $64.5 million, excluding closing costs. These properties were classified as held for sale as of March 31, 2017 (see Note 3).

In April 2017, we repaid at par $41.3 million of mortgage debt at Parkshore Plaza in connection with the sale of the property.

18


Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
The following discussion should be read in conjunction with our consolidated financial statements and accompanying notes included in this Quarterly Report, and in our Annual Report.

FORWARD-LOOKING STATEMENTS
 
Some of the statements contained in this Quarterly Report constitute forward-looking statements within the meaning of the federal securities laws. Any forward-looking statements contained in this Quarterly Report are intended to be made pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Forward-looking statements relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. In particular, statements pertaining to our capital resources, portfolio performance and results of operations contain forward-looking statements. Likewise, all of our statements regarding anticipated growth in market conditions are forward-looking statements. In some cases, you can identify forward-looking statements by the use of forward-looking terminology such as “may,” “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” or “potential” or the negative of these words and phrases or similar words or phrases which are predictions of or indicate future events or trends and which do not relate solely to historical matters. You can also identify forward-looking statements by discussions of strategy, plans or intentions.
 
The forward-looking statements contained in this Quarterly Report reflect our current views about future events and are subject to numerous known and unknown risks, uncertainties, assumptions and changes in circumstances that may cause our actual results to differ significantly from those expressed in any forward-looking statement. We do not guarantee that the transactions and events described will happen as described (or that they will happen at all). We disclaim any obligation to publicly update or revise any forward-looking statement to reflect changes in underlying assumptions or factors, of new information, data or methods, future events or other changes. For a further discussion of these and other factors that could cause our future results to differ materially from any forward-looking statements, see the section entitled “Risk Factors” in our Annual Report on Form 10-K.

OVERVIEW
 
We are an internally managed and self-advised REIT engaged in the ownership and operation primarily of office buildings throughout the United States. We were formed in 1986 under Maryland law. On November 10, 2016, we converted to what is commonly referred to as an umbrella partnership real estate investment trust, or UPREIT, structure. Substantially all of the Company’s assets and liabilities are now held in an Operating Trust through which the Company conducts its business.

At March 31, 2017, our portfolio, excluding properties held for sale, included 28 properties (56 buildings) and one land parcel, with a combined 14.6 million square feet for a total investment of $2.7 billion at cost and a depreciated book value of $2.0 billion. As of March 31, 2017, we had $2.2 billion of cash and cash equivalents and marketable securities.

As of March 31, 2017, our overall portfolio was 89.0% leased. During the three months ended March 31, 2017, we entered into leases for 331,000 square feet, including lease renewals for 264,000 square feet and new leases for 67,000 square feet.  Renewal leases entered into during the three months ended March 31, 2017 had weighted average cash and GAAP rental rates that were approximately 7.2% lower and 22.8% higher, respectively, as compared to prior rental rates for the same space, and new leases entered into during the three months ended March 31, 2017 had weighted average cash and GAAP rental rates that were approximately 8.4% higher and 15.8% higher, respectively, than prior rental rates for the same space.  The change in GAAP rents is different than the change in cash rents due to differences in the amount of rent abatements, the magnitude and timing of contractual rent increases over the lease term, and the years of term for the newly executed leases compared to the prior leases.

During the year ended December 31, 2016, we sold 30 properties (62 buildings) with a combined 8.0 million square feet for an aggregate gross sales price of $1.3 billion, excluding closing costs. During the three months ended March 31, 2017, we sold three properties (three buildings) and one land parcel with a combined 0.8 million square feet for an aggregate gross sales price of $113.1 million, excluding closing costs. We have generated significant proceeds from our dispositions to date and have a cash balance of $1.9 billion as of March 31, 2017. In April 2017, we sold two properties (five buildings), with 630,326 square feet for $64.5 million, excluding closing costs. These properties were classified as held for sale as of March 31, 2017. For more information regarding these transactions, see Notes 3 and 16 to the notes to our condensed consolidated financial

19


statements included in Part I, Item 1 of this Quarterly Report. In addition, as our real estate investments have decreased, our income from operations has also declined.

In connection with our office portfolio, in December 2016, our Board of Trustees adopted an office repositioning strategy to own and acquire at a discount to replacement cost high-quality, multi-tenant office assets in markets and sub-markets with favorable long-term supply and demand fundamentals. Our efforts within our office portfolio will primarily be focused on larger buildings in central business districts and major urban areas that offer an attractive quality of life, including opportunities for tenants to live and play in close proximity to where they work, with a preference for markets that have above average limitations on new supply.

While executing this strategy, depending on market conditions, we may sell additional properties and are seeking to acquire attractive properties in markets meeting the criteria above. With the progress we have had executing dispositions, and the strength and liquidity of our balance sheet, we are in a position today to increasingly shift our focus to capital allocation. We seek to reinvest the capital received from dispositions to purchase new properties, repay debt, buy back common shares or make other investments or distributions that further our long-term strategic goals and the repositioning strategy adopted by our Board of Trustees.

As we continue to reposition our portfolio, we expect our efforts will be balanced among leasing assets to create value, selling assets when we are able to achieve attractive pricing, and evaluating a wide range of opportunities to deploy capital. However, we may not be able to make suitable acquisitions or other investments with the proceeds from the dispositions.

As part of the office repositioning strategy noted above, and pursuant to our accounting policy, in 2017, we evaluated the recoverability of the carrying values of each of the real estate assets that comprised our portfolio and determined that due to the shortening of the expected periods of ownership as a result of our office repositioning strategy and current estimates of market value, it was necessary to reduce the net book value of a portion of the real estate assets in our portfolio to their estimated fair values less estimated costs to sell. As a result, we recorded an impairment charge of $1.3 million for the three months ended March 31, 2017 in accordance with our impairment analysis procedures.

We have engaged CBRE, Inc. (CBRE) to provide property management services for our properties. We pay CBRE a property-by-property management fee and may engage CBRE from time-to-time to perform project management services, such as coordinating and overseeing the completion of tenant improvements and other capital projects at the properties. We reimburse CBRE for certain expenses incurred in the performance of its duties, including certain personnel and equipment costs.

For the three months ended March 31, 2017 and 2016, we incurred expenses of $5.2 million and $7.5 million, respectively, related to our property management agreement with CBRE, for property management fees, typically calculated as a portion of the properties' revenues, and salary and benefits reimbursements for property personnel, such as property managers, engineers and maintenance staff.  As of March 31, 2017 and December 31, 2016, we had amounts payable pursuant to these services of $2.2 million and $2.7 million, respectively.

Property Operations

Leased occupancy data for 2017 and 2016 are as follows (square feet in thousands):
 
 
All Properties(1)
 
Comparable Properties(2)
 
As of March 31,
 
As of March 31,
 
2017
 
2016
 
2017
 
2016
Total properties
28

 
60

 
28

 
28

Total square feet
14,593

 
23,037

 
14,593

 
14,578

Percent leased(3)
89.0
%
 
91.4
%
 
89.0
%
 
91.6
%

(1)
Excludes properties sold or classified as held for sale in the period. 
(2)
Based on properties owned continuously from January 1, 2016 through March 31, 2017, and excludes properties sold or classified as held for sale during the period.
(3)
Percent leased includes (i) space being fitted out for occupancy pursuant to existing leases and (ii) space which is leased but is not occupied or is being offered for sublease by tenants.
 

20


The weighted average lease term based on square feet for leases entered into during the three months ended March 31, 2017 was 11.8 years.  Commitments made for leasing expenditures and concessions, such as tenant improvements and leasing commissions, for leases entered into during the three months ended March 31, 2017 totaled $9.7 million, or $28.88 per square foot on average (approximately $2.44 per square foot per year of the lease term).
 
As of March 31, 2017, approximately 3.6% of our leased square feet and 3.6% of our annualized rental revenue, determined as set forth below, are included in leases scheduled to expire through December 31, 2017.  Renewed and new leases and rental rates at which available space may be relet in the future will depend on prevailing market conditions at the times these leases are negotiated.  We believe that the in-place cash rents for leases expiring for the remainder of 2017 are below market. Lease expirations by year, as of March 31, 2017, are as follows (square feet and dollars in thousands):
Year
 
Number
of Tenants Expiring
 
Leased Square
 Feet Expiring(1)
 
% of Leased
Square Feet Expiring(1)
 
Cumulative
% of Leased Square
Feet Expiring(1)
 
Annualized Rental
Revenue Expiring(2)
 
% of
Annualized Rental
Revenue Expiring
 
Cumulative
% of
Annualized Rental Revenue Expiring
2017
 
87

 
464

 
3.6
%
 
3.6
%
 
$
12,253

 
3.6
%
 
3.6
%
2018
 
75

 
557

 
4.3
%
 
7.9
%
 
17,469

 
5.2
%
 
8.8
%
2019
 
85

 
1,230

 
9.5
%
 
17.4
%
 
36,342

 
10.8
%
 
19.6
%
2020
 
77

 
2,144

 
16.5
%
 
33.9
%
 
50,940

 
15.1
%
 
34.7
%
2021
 
63

 
1,053

 
8.1
%
 
42.0
%
 
31,770

 
9.4
%
 
44.1
%
2022
 
42

 
693

 
5.3
%
 
47.3
%
 
25,598

 
7.6
%
 
51.7
%
2023
 
42

 
1,459

 
11.2
%
 
58.5
%
 
44,024

 
13.1
%
 
64.8
%
2024
 
15

 
217

 
1.7
%
 
60.2
%
 
7,264

 
2.2
%
 
67.0
%
2025
 
20

 
758

 
5.8
%
 
66.0
%
 
20,238

 
6.0
%
 
73.0
%
2026
 
13

 
677

 
5.2
%
 
71.2
%
 
22,593

 
6.7
%
 
79.7
%
Thereafter
 
64

 
3,739

 
28.8
%
 
100.0
%
 
68,765

 
20.3
%
 
100.0
%
 
 
583

 
12,991

 
100.0
%
 
 
 
$
337,256

 
100.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted average remaining lease term (in years):
 
 
 
6.8

 
 
 
 
 
6.2

 
 
 
 

(1)
Square footage is pursuant to existing leases as of March 31, 2017, excluding leases related to properties classified as held for sale, and includes (i) space being fitted out for occupancy and (ii) space which is leased but is not occupied or is being offered for sublease. 
(2)
Annualized rental revenue is annualized contractual rents from our tenants pursuant to leases which have commenced as of March 31, 2017, plus estimated recurring expense reimbursements; includes triple net lease rents and excludes lease value amortization, straight line rent adjustments, abated (free) rent periods and parking revenue. We calculate annualized rental revenue by aggregating the recurring billings outlined above for the most recent month during the quarter reported, adding abated rent, and multiplying the sum by 12 to provide an estimation of near-term potentially-recurring revenues.  Annualized rental revenue is a forward-looking non-GAAP measure.  Annualized rental revenue cannot be reconciled to a comparable GAAP measure without unreasonable efforts, primarily due to the fact that it is calculated from the billings of tenants in the most recent month at the most recent rental rates during the quarter reported, whereas historical GAAP measures include billings from a potentially different group of tenants over multiple months at potentially different rental rates.
 

21


A principal source of funds for our operations is rents from tenants at our properties.  Rents are generally received from our tenants monthly in advance, except from our government tenants, who usually pay rents monthly in arrears.  As of March 31, 2017, tenants representing 1.5% or more of our total annualized rental revenue were as follows (square feet in thousands):
Tenant(1)
 
Square Feet(2)
 
% of Total Square Feet(2)
 
% of Annualized Rental Revenue(3)
 
Weighted Average Remaining Lease Term
1.
Expedia, Inc.
 
427

 
2.9
%
 
6.0
%
 
2.7
2.
Office Depot, Inc.
 
651

 
4.5
%
 
5.1
%
 
6.5
3.
Groupon, Inc. (4)
 
376

 
2.6
%
 
3.6
%
 
8.8
4.
PNC Financial Services Group
 
363

 
2.5
%
 
3.3
%
 
9.7
5.
Flextronics International Ltd.
 
1,051

 
7.2
%
 
3.2
%
 
12.8
6.
Ballard Spahr LLP
 
217

 
1.5
%
 
2.4
%
 
12.9
7.
RE/MAX Holdings, Inc.
 
248

 
1.7
%
 
2.2
%
 
11.1
8.
University of Pennsylvania Health System
 
267

 
1.8
%
 
2.1
%
 
8.6
9.
Georgetown University
 
240

 
1.6
%
 
1.9
%
 
2.5
10.
Willis Towers Watson
 
251

 
1.7
%
 
1.9
%
 
3.1
11.
Echo Global Logistics, Inc.
 
226

 
1.5
%
 
1.8
%
 
10.5
12.
West Corporation
 
336

 
2.3
%
 
1.7
%
 
11.9
13.
Wm. Wrigley Jr. Company
 
150

 
1.0
%
 
1.7
%
 
4.8
 
Total
 
4,803

 
32.8
%
 
36.9
%
 
8.7

(1)
Tenants located in properties classified as held for sale are excluded.
(2)
Square footage is pursuant to existing leases as of March 31, 2017, and includes (i) space being fitted out for occupancy and (ii) space which is leased but is not occupied or is being offered for sublease. 
(3)
Annualized rental revenue is annualized contractual rents from our tenants pursuant to leases which have commenced as of March 31, 2017, plus estimated recurring expense reimbursements; includes triple net lease rents and excludes lease value amortization, straight line rent adjustments, abated (free) rent periods and parking revenue. We calculate annualized rental revenue by aggregating the recurring billings outlined above for the most recent month during the quarter reported, adding abated rent, and multiplying the sum by 12 to provide an estimation of near-term potentially-recurring revenues.  Annualized rental revenue is a forward-looking non-GAAP measure.  Annualized rental revenue cannot be reconciled to a comparable GAAP measure without unreasonable efforts, primarily due to the fact that it is calculated from the billings of tenants in the most recent month at the most recent rental rates during the quarter reported, whereas historical GAAP measures include billings from a potentially different group of tenants over multiple months at potentially different rental rates.
(4)
Groupon, Inc. statistics include 207,536 square feet that are sublet from Bankers Life and Casualty Company.
 



22


RESULTS OF OPERATIONS 

Three Months Ended March 31, 2017, Compared to Three Months Ended March 31, 2016
 
Comparable Properties Results(1)
 
Other Properties Results(2)
 
Consolidated Results
 
Three Months Ended March 31,
 
2017
 
2016
 
$ Change
 
% Change
 
2017
 
2016
 
2017
 
2016
 
$ Change
 
% Change
 
(in thousands)
Rental income
$
73,646

 
$
71,372

 
$
2,274

 
3.2
%
 
$
6,559

 
$
38,516

 
$
80,205

 
$
109,888

 
$
(29,683
)
 
(27.0
)%
Tenant reimbursements and other income
18,625

 
17,573

 
1,052

 
6.0
%
 
721

 
9,674

 
19,346

 
27,247

 
(7,901
)
 
(29.0
)%
Operating expenses
(38,435
)
 
(36,878
)
 
(1,557
)
 
4.2
%
 
(2,652
)
 
(20,380
)
 
(41,087
)
 
(57,258
)
 
16,171

 
(28.2
)%
Net operating income(3)
$
53,836

 
$
52,067

 
$
1,769

 
3.4
%
 
$
4,628

 
$
27,810

 
58,464

 
79,877

 
(21,413
)
 
(26.8
)%
Other expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Depreciation and amortization
 
 
 
 
 
 
 
 
 
 
 
26,915

 
36,251

 
(9,336
)
 
(25.8
)%
General and administrative
 
 
 
 
 
 
 
 
 
 
 
 
12,078

 
13,312

 
(1,234
)
 
(9.3
)%
Loss on asset impairment
 
 
 
 
 
 
 
 
 
1,286

 

 
1,286

 
100.0
 %
Total other expenses
 
 
 
 
 
 
 
 
 
 
 
40,279

 
49,563

 
(9,284
)
 
(18.7
)%
Operating income
 
 
 
 
 
 
 
 
 
 
 
 
18,185

 
30,314

 
(12,129
)
 
(40.0
)%
Interest and other income
 
 
 
 
 
 
 
 
 
 
 
 
4,372

 
1,967

 
2,405

 
122.3
 %
Interest expense
 
 
 
 
 
 
 
 
 
 
 
 
(15,014
)
 
(22,347
)
 
7,333

 
(32.8
)%
Loss on early extinguishment of debt
 
 
 
 
 
 
 
 
 

 
(118
)
 
118

 
(100.0
)%
Foreign currency exchange loss
 
 
 
 
 
 
 
 
 
 
 

 
(5
)
 
5

 
(100.0
)%
Gain on sale of properties, net
 
 
 
 
 
 
 
 
 
 
 
16,454

 
36,666

 
(20,212
)
 
(55.1
)%
Income before income taxes
 
 
 
 
 
 
 
 
 
23,997

 
46,477

 
(22,480
)
 
(48.4
)%
Income tax expense
 
 
 
 
 
 
 
 
 
 
 
(175
)
 
(75
)
 
(100
)
 
133.3
 %
Net income
 
 
 
 
 
 
 
 
 
 
 
 
23,822

 
46,402

 
(22,580
)
 
(48.7
)%
Net income attributable to noncontrolling interest
 
 
 
 
 
 
 
(8
)
 

 
(8
)
 
100.0
 %
Net income attributable to Equity Commonwealth
 
 
 
 
 
 
 
 
 
23,814

 
46,402

 
(22,588
)
 
(48.7
)%
Preferred distributions
 
 
 
 
 
 
 
 
 
 
 
 
(1,997
)
 
(6,981
)
 
4,984

 
(71.4
)%
Net income attributable to Equity Commonwealth common shareholders