DRE.3Q.10Q.2011
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|
| |
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2011
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: 1-9044
DUKE REALTY CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
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| | |
Indiana | | 35-1740409 |
(State or Other Jurisdiction of Incorporation or Organization) | | (I.R.S. Employer Identification Number) |
| |
600 East 96thStreet, Suite 100 Indianapolis, Indiana | | 46240 |
(Address of Principal Executive Offices) | | (Zip Code) |
Registrant’s Telephone Number, Including Area Code: (317) 808-6000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No ¨
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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
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| | |
Large accelerated filer x | | Accelerated filer o |
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Non-accelerated filer o | | Smaller reporting company o |
(Do not check if a smaller reporting company) | | |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): YES ¨ NO x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
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| | |
Class | | Outstanding at November 4, 2011 |
Common Stock, $.01 par value per share | | 252,921,718 |
DUKE REALTY CORPORATION
INDEX
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
DUKE REALTY CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except per share amounts)
|
| | | | | | | |
| September 30, 2011 | | December 31, 2010 |
| (Unaudited) | | |
| | | |
ASSETS | | | |
Real estate investments: | | | |
Land and improvements | $ | 1,307,608 |
| | $ | 1,166,409 |
|
Buildings and tenant improvements | 5,601,866 |
| | 5,396,339 |
|
Construction in progress | 41,490 |
| | 61,205 |
|
Investments in and advances to unconsolidated companies | 368,671 |
| | 367,445 |
|
Undeveloped land | 622,254 |
| | 625,353 |
|
| 7,941,889 |
| | 7,616,751 |
|
Accumulated depreciation | (1,413,804 | ) | | (1,290,417 | ) |
Net real estate investments | 6,528,085 |
| | 6,326,334 |
|
| | | |
Real estate investments and other assets held-for-sale | 21,992 |
| | 394,287 |
|
| | | |
Cash and cash equivalents | 16,182 |
| | 18,384 |
|
Accounts receivable, net of allowance of $2,854 and $2,945 | 21,685 |
| | 22,588 |
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Straight-line rent receivable, net of allowance of $7,502 and $7,260 | 140,732 |
| | 125,185 |
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Receivables on construction contracts, including retentions | 44,425 |
| | 7,408 |
|
Deferred financing costs, net of accumulated amortization of $56,105 and $46,407 | 39,449 |
| | 46,320 |
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Deferred leasing and other costs, net of accumulated amortization of $329,325 and $269,000 | 497,594 |
| | 517,934 |
|
Escrow deposits and other assets | 194,517 |
| | 185,836 |
|
| $ | 7,504,661 |
| | $ | 7,644,276 |
|
LIABILITIES AND EQUITY | | | |
Indebtedness: | | | |
Secured debt | $ | 1,184,268 |
| | $ | 1,065,628 |
|
Unsecured notes | 2,783,762 |
| | 2,948,405 |
|
Unsecured lines of credit | 304,293 |
| | 193,046 |
|
| 4,272,323 |
| | 4,207,079 |
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| | | |
Liabilities related to real estate investments held-for-sale | 957 |
| | 14,732 |
|
| | | |
Construction payables and amounts due subcontractors, including retentions | 66,786 |
| | 44,782 |
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Accrued real estate taxes | 123,524 |
| | 83,615 |
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Accrued interest | 35,725 |
| | 62,407 |
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Other accrued expenses | 42,729 |
| | 61,448 |
|
Other liabilities | 128,123 |
| | 129,860 |
|
Tenant security deposits and prepaid rents | 59,551 |
| | 50,450 |
|
Total liabilities | 4,729,718 |
| | 4,654,373 |
|
Shareholders’ equity: | | | |
Preferred shares ($.01 par value); 5,000 shares authorized; 3,176 and 3,618 shares issued and outstanding | 793,910 |
| | 904,540 |
|
Common shares ($.01 par value); 400,000 shares authorized; 252,918 and 252,195 shares issued and outstanding | 2,529 |
| | 2,522 |
|
Additional paid-in capital | 3,591,381 |
| | 3,573,720 |
|
Accumulated other comprehensive income (loss) | 493 |
| | (1,432 | ) |
Distributions in excess of net income | (1,678,484 | ) | | (1,533,740 | ) |
Total shareholders’ equity | 2,709,829 |
| | 2,945,610 |
|
Noncontrolling interests | 65,114 |
| | 44,293 |
|
Total equity | 2,774,943 |
| | 2,989,903 |
|
| $ | 7,504,661 |
| | $ | 7,644,276 |
|
See accompanying Notes to Consolidated Financial Statements
DUKE REALTY CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
For the three and nine months ended September 30,
(in thousands, except per share amounts)
(Unaudited)
|
| | | | | | | | | | | | | | | |
| Three Months Ended | | Nine Months Ended |
| 2011 | | 2010 | | 2011 | | 2010 |
Revenues: | | | | | | | |
Rental and related revenue | $ | 233,555 |
| | $ | 228,299 |
| | $ | 698,619 |
| | $ | 642,489 |
|
General contractor and service fee revenue | 127,708 |
| | 132,351 |
| | 409,617 |
| | 414,391 |
|
| 361,263 |
| | 360,650 |
| | 1,108,236 |
| | 1,056,880 |
|
Expenses: | | | | | | | |
Rental expenses | 49,947 |
| | 47,628 |
| | 153,002 |
| | 143,133 |
|
Real estate taxes | 33,785 |
| | 32,659 |
| | 101,936 |
| | 88,394 |
|
General contractor and other services expenses | 120,547 |
| | 124,653 |
| | 379,180 |
| | 392,433 |
|
Depreciation and amortization | 96,909 |
| | 94,487 |
| | 290,751 |
| | 253,209 |
|
| 301,188 |
| | 299,427 |
| | 924,869 |
| | 877,169 |
|
Other operating activities: | | | | | | | |
Equity in earnings of unconsolidated companies | 3,104 |
| | 580 |
| | 5,890 |
| | 7,525 |
|
Gain on sale of properties | (1,437 | ) | | (125 | ) | | 66,910 |
| | 6,917 |
|
Undeveloped land carrying costs | (2,259 | ) | | (2,359 | ) | | (7,021 | ) | | (7,152 | ) |
Impairment charges | — |
| | (1,860 | ) | | — |
| | (9,834 | ) |
Other operating expenses | (60 | ) | | (580 | ) | | (171 | ) | | (1,002 | ) |
General and administrative expenses | (9,493 | ) | | (8,476 | ) | | (29,231 | ) | | (31,171 | ) |
| (10,145 | ) | | (12,820 | ) | | 36,377 |
| | (34,717 | ) |
Operating income | 49,930 |
| | 48,403 |
| | 219,744 |
| | 144,994 |
|
Other income (expenses): | | | | | | | |
Interest and other income, net | 172 |
| | 149 |
| | 543 |
| | 504 |
|
Interest expense | (66,875 | ) | | (61,491 | ) | | (199,269 | ) | | (175,076 | ) |
Loss on debt transactions | — |
| | (167 | ) | | — |
| | (16,294 | ) |
Acquisition-related activity | (342 | ) | | 57,513 |
| | (1,525 | ) | | 57,513 |
|
Income (loss) from continuing operations before income taxes | (17,115 | ) | | 44,407 |
| | 19,493 |
| | 11,641 |
|
Income tax benefit | 194 |
| | 1,126 |
| | 194 |
| | 1,126 |
|
Income (loss) from continuing operations | (16,921 | ) | | 45,533 |
| | 19,687 |
| | 12,767 |
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Discontinued operations: | | | | | | | |
Income (loss) before gain on sales | (36 | ) | | 375 |
| | (30 | ) | | 2,293 |
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Gain on sale of depreciable properties | 2,088 |
| | 11,527 |
| | 16,405 |
| | 24,383 |
|
Income from discontinued operations | 2,052 |
| | 11,902 |
| | 16,375 |
| | 26,676 |
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Net income (loss) | (14,869 | ) | | 57,435 |
| | 36,062 |
| | 39,443 |
|
Dividends on preferred shares | (14,399 | ) | | (16,726 | ) | | (46,347 | ) | | (53,452 | ) |
Adjustments for redemption/repurchase of preferred shares | (3,633 | ) | | (5,652 | ) | | (3,796 | ) | | (10,144 | ) |
Net (income) loss attributable to noncontrolling interests | 825 |
| | (993 | ) | | 532 |
| | 562 |
|
Net income (loss) attributable to common shareholders | $ | (32,076 | ) | | $ | 34,064 |
| | $ | (13,549 | ) | | $ | (23,591 | ) |
Basic net income (loss) per common share: | | | | | | | |
Continuing operations attributable to common shareholders | $ | (0.14 | ) | | $ | 0.08 |
| | $ | (0.13 | ) | | $ | (0.22 | ) |
Discontinued operations attributable to common shareholders | 0.01 |
| | 0.05 |
| | 0.07 |
| | 0.11 |
|
Total | $ | (0.13 | ) | | $ | 0.13 |
| | $ | (0.06 | ) | | $ | (0.11 | ) |
Diluted net income (loss) per common share: | | | | | | | |
Continuing operations attributable to common shareholders | $ | (0.14 | ) | | $ | 0.08 |
| | $ | (0.13 | ) | | $ | (0.22 | ) |
Discontinued operations attributable to common shareholders | 0.01 |
| | 0.05 |
| | 0.07 |
| | 0.11 |
|
Total | $ | (0.13 | ) | | $ | 0.13 |
| | $ | (0.06 | ) | | $ | (0.11 | ) |
Weighted average number of common shares outstanding | 252,802 |
| | 251,866 |
| | 252,618 |
| | 234,468 |
|
Weighted average number of common shares and potential dilutive securities | 252,802 |
| | 257,383 |
| | 252,618 |
| | 234,468 |
|
See accompanying Notes to Consolidated Financial Statements
DUKE REALTY CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the nine months ended September 30,
(in thousands)
(Unaudited)
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| | | | | | | |
| 2011 | | 2010 |
Cash flows from operating activities: | | | |
Net income | $ | 36,062 |
| | $ | 39,443 |
|
Adjustments to reconcile net income to net cash provided by operating activities: | | | |
Depreciation of buildings and tenant improvements | 204,134 |
| | 201,352 |
|
Amortization of deferred leasing and other costs | 88,295 |
| | 62,734 |
|
Amortization of deferred financing costs | 11,070 |
| | 10,492 |
|
Straight-line rent adjustment | (19,012 | ) | | (12,252 | ) |
Impairment charges | — |
| | 9,834 |
|
Loss on debt extinguishment | — |
| | 16,294 |
|
Gain on acquisitions, net | — |
| | (57,815 | ) |
Earnings from land and depreciated property sales | (83,315 | ) | | (31,300 | ) |
Third-party construction contracts, net | (18,417 | ) | | (16,872 | ) |
Other accrued revenues and expenses, net | 14,586 |
| | 13,293 |
|
Operating distributions received in excess of equity in earnings from unconsolidated companies | 11,681 |
| | 7,649 |
|
Net cash provided by operating activities | 245,084 |
| | 242,852 |
|
Cash flows from investing activities: | | | |
Development of real estate investments | (125,676 | ) | | (82,372 | ) |
Acquisition of real estate investments and related intangible assets, net of cash acquired | (179,047 | ) | | (260,877 | ) |
Acquisition of undeveloped land | (3,825 | ) | | (13,384 | ) |
Second generation tenant improvements, leasing costs and building improvements | (71,732 | ) | | (63,361 | ) |
Other deferred leasing costs | (20,950 | ) | | (26,060 | ) |
Other assets | (4,500 | ) | | (16,847 | ) |
Proceeds from land and depreciated property sales, net | 504,688 |
| | 200,445 |
|
Capital distributions from unconsolidated companies | 54,730 |
| | 3,897 |
|
Capital contributions and advances to unconsolidated companies, net | (28,362 | ) | | (48,410 | ) |
Net cash provided by (used for) investing activities | 125,326 |
| | (306,969 | ) |
Cash flows from financing activities: | | | |
Proceeds from issuance of common shares, net | — |
| | 297,896 |
|
Payments for redemption/repurchase of preferred shares | (110,726 | ) | | (115,849 | ) |
Proceeds from unsecured debt issuance | — |
| | 250,000 |
|
Payments on and repurchases of unsecured debt | (166,346 | ) | | (392,181 | ) |
Proceeds from secured debt financings | — |
| | 3,987 |
|
Payments on secured indebtedness including principal amortization | (24,841 | ) | | (8,814 | ) |
Borrowings on lines of credit, net | 111,247 |
| | 82,210 |
|
Distributions to common shareholders | (128,817 | ) | | (119,116 | ) |
Distributions to preferred shareholders | (46,347 | ) | | (53,452 | ) |
Distributions to noncontrolling interests | (3,952 | ) | | (4,844 | ) |
Deferred financing costs | (2,830 | ) | | (2,193 | ) |
Net cash used for financing activities | (372,612 | ) | | (62,356 | ) |
Net decrease in cash and cash equivalents | (2,202 | ) | | (126,473 | ) |
Cash and cash equivalents at beginning of period | 18,384 |
| | 147,322 |
|
Cash and cash equivalents at end of period | $ | 16,182 |
| | $ | 20,849 |
|
Non-cash investing and financing activities: | | | |
Assumption of indebtedness and other liabilities in real estate acquisitions | $ | 150,042 |
| | $ | 332,982 |
|
Contribution of properties to unconsolidated companies | $ | 53,245 |
| | $ | 7,002 |
|
Investment and advances related to acquisition of previously unconsolidated companies | $ | 5,987 |
| | $ | 134,026 |
|
Conversion of Limited Partner Units to common shares | $ | 3,052 |
| | $ | (7,829 | ) |
Issuance of Limited Partner Units for acquisition | $ | 28,357 |
| | $ | — |
|
See accompanying Notes to Consolidated Financial Statements
DUKE REALTY CORPORATION AND SUBSIDIARIES
Consolidated Statement of Changes in Equity
For the nine months ended September 30, 2011
(in thousands, except per share data)
(Unaudited)
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Common Shareholders | | | | |
| Preferred Stock | | Common Stock | | Additional Paid-in Capital | | Accumulated Other Comprehensive Income (Loss) | | Distributions in Excess of Net Income | | Non- Controlling Interests | | Total |
Balance at December 31, 2010 | $ | 904,540 |
| | $ | 2,522 |
| | $ | 3,573,720 |
| | $ | (1,432 | ) | | $ | (1,533,740 | ) | | $ | 44,293 |
| | $ | 2,989,903 |
|
Comprehensive income: | | | | | | | | | | | | | |
Net income | — |
| | — |
| | — |
| | — |
| | 36,594 |
| | (532 | ) | | 36,062 |
|
Derivative instrument activity | — |
| | — |
| | — |
| | 1,925 |
| | — |
| | — |
| | 1,925 |
|
Comprehensive income | | | | | | | | | | | | | 37,987 |
|
Issuance of Limited Partner Units for acquisition | — |
| | — |
| | — |
| | — |
| | — |
| | 28,357 |
| | 28,357 |
|
Stock based compensation plan activity | — |
| | 4 |
| | 10,912 |
| | — |
| | (2,378 | ) | | — |
| | 8,538 |
|
Conversion of Limited Partner Units | — |
| | 3 |
| | 3,049 |
| | — |
| | — |
| | (3,052 | ) | | — |
|
Distributions to preferred shareholders | — |
| | — |
| | — |
| | — |
| | (46,347 | ) | | — |
| | (46,347 | ) |
Redemption/repurchase of preferred shares | (110,630 | ) | | — |
| | 3,700 |
| | — |
| | (3,796 | ) | | — |
| | (110,726 | ) |
Distributions to common shareholders ($0.51 per share) | — |
| | — |
| | — |
| | — |
| | (128,817 | ) | | — |
| | (128,817 | ) |
Distributions to noncontrolling interests | — |
| | — |
| | — |
| | — |
| | — |
| | (3,952 | ) | | (3,952 | ) |
Balance at September 30, 2011 | $ | 793,910 |
| | $ | 2,529 |
| | $ | 3,591,381 |
| | $ | 493 |
| | $ | (1,678,484 | ) | | $ | 65,114 |
| | $ | 2,774,943 |
|
See accompanying Notes to Consolidated Financial Statements
DUKE REALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. General Basis of Presentation
The interim consolidated financial statements included herein have been prepared by Duke Realty Corporation (the “Company”). The 2010 year-end consolidated balance sheet data included in this Quarterly Report on Form 10-Q (this “Report”) was derived from the audited financial statements in our Annual Report on Form 10-K for the year ended December 31, 2010, but does not include all disclosures required by accounting principles generally accepted in the United States of America (“GAAP”). The financial statements have been prepared in accordance with GAAP for interim financial information and in accordance with Rule 10-01 of Regulation S-X of the Securities Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and revenue and expenses during the reporting period. Our actual results could differ from those estimates and assumptions. These financial statements should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations included herein and the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2010.
We believe that we qualify as a real estate investment trust (“REIT”) under the provisions of the Internal Revenue Code of 1986, as amended (the “Code”). Substantially all of our Rental Operations (see Note 9) are conducted through Duke Realty Limited Partnership (“DRLP”). We owned approximately 97.3% of the common partnership interests of DRLP (“Units”) at September 30, 2011. At the option of the holders, and subject to certain restrictions, the remaining Units are redeemable for shares of our common stock on a one-to-one basis and earn dividends at the same rate as shares of our common stock. If it is determined to be necessary in order to continue to qualify as a REIT, we may elect to purchase the Units for an equivalent amount of cash rather than issuing shares of common stock upon redemption. We conduct our Service Operations (see Note 9) through Duke Realty Services, LLC, Duke Realty Services Limited Partnership and Duke Construction Limited Partnership (“DCLP”). DCLP is owned through a taxable REIT subsidiary. The consolidated financial statements include our accounts and the accounts of our majority-owned or controlled subsidiaries. In this Report, unless the context indicates otherwise, the terms “we,” “us” and “our” refer to the Company and those entities owned or controlled by the Company.
2. Reclassifications
Certain amounts in the accompanying consolidated financial statements for 2010 have been reclassified to conform to the 2011 consolidated financial statement presentation.
3. Variable Interest Entities
At September 30, 2011, there are three unconsolidated joint ventures that we have determined meet the criteria to be considered variable interest entities (“VIEs”). These three unconsolidated joint ventures were formed with the sole purpose of developing, constructing, leasing, marketing and selling or operating properties. The business activities of these unconsolidated joint ventures have been financed through a combination of equity contributions, partner/member loans, and third-party debt that is guaranteed by both us and the other partner/member of each entity. All significant decisions for these unconsolidated joint ventures, including those decisions that most significantly impact each venture’s economic performance, require unanimous approval of each joint venture’s partners or members. In certain cases, these decisions also require lender approval. Unanimous approval requirements for these unconsolidated joint ventures include entering into new leases, setting annual operating budgets, selling underlying properties, and incurring additional indebtedness. Because no single entity exercises control over the decisions that most significantly affect each joint venture’s economic performance, we determined that the equity method of accounting is appropriate.
The following is a summary of the carrying value in our consolidated balance sheet, as well as our maximum loss exposure under guarantees for the three unconsolidated subsidiaries that we have determined to be VIEs as of September 30, 2011 (in millions):
|
| | | | | | |
| Carrying Value | Maximum Loss Exposure |
Investment in Unconsolidated Company | $ | 33.2 |
| $ | 33.2 |
|
Guarantee Obligations (1) | $ | (18.9 | ) | $ | (58.3 | ) |
| |
(1) | We are party to guarantees of the third-party debt of these joint ventures and our maximum loss exposure is equal to the maximum monetary obligation pursuant to the guarantee agreements. In 2009, we recorded a liability for our probable future obligation under a guarantee to the lender of one of these ventures. Pursuant to an agreement with the lender, we may make partner loans to this joint venture that will reduce our maximum guarantee obligation on a dollar-for-dollar basis. The carrying value of our recorded guarantee obligations is included in other liabilities in our Consolidated Balance Sheets. |
4. Acquisitions and Dispositions
Acquisition of Premier Portfolio
We purchased twelve industrial and four office buildings, as well as other real estate assets, during the nine months ended September 30, 2011. These purchases completed our acquisition of a portfolio of buildings in South Florida (the “Premier Portfolio”), which was placed under contract in 2010, and resulted in cash payments to the sellers of $27.4 million, the assumption of secured loans with a face value of $124.4 million and the issuance to the sellers of 2.1 million Units with a fair value at issuance of $28.4 million (Note 6). These units are not convertible until early 2012.
On December 30, 2010, we purchased 38 industrial buildings, one office building and other real estate assets within the Premier Portfolio. The allocation of the fair value of the amounts recognized from this acquisition to buildings and other related assets was preliminary at December 31, 2010. The following table summarizes our allocation of the fair value of amounts recognized for each major class of assets and liabilities related to the 55 properties and other real estate assets from the Premier Portfolio that have been purchased through September 30, 2011 (in thousands):
|
| | | | | | | | | | | |
| Acquired During Year ended December 31, 2010 |
| | Acquired During Nine months ended September 30, 2011 |
| | Total |
|
Real estate assets | $ | 249,960 |
| | $ | 153,656 |
| | $ | 403,616 |
|
Lease-related intangible assets | 31,091 |
| | 25,445 |
| | 56,536 |
|
Other assets | 1,801 |
| | 2,571 |
| | 4,372 |
|
Total acquired assets | 282,852 |
| | 181,672 |
| | 464,524 |
|
Secured debt | 158,238 |
| | 125,003 |
| | 283,241 |
|
Other liabilities | 4,075 |
| | 4,284 |
| | 8,359 |
|
Total assumed liabilities | 162,313 |
| | 129,287 |
| | 291,600 |
|
Fair value of acquired net assets | $ | 120,539 |
| | $ | 52,385 |
| | $ | 172,924 |
|
The leases in the acquired properties had a weighted average remaining life at acquisition of approximately 3.5 years.
Other 2011 Acquisitions
We also acquired 14 additional properties during the nine months ended September 30, 2011. These acquisitions consisted of five bulk industrial properties in Raleigh, North Carolina, two bulk industrial properties in Chicago, Illinois, one bulk industrial property in Dallas, Texas, one bulk industrial property in Southern California, one bulk industrial property in Phoenix, Arizona, one bulk industrial property in Savannah, Georgia, one office property in Raleigh, North Carolina, one office property in Indianapolis, Indiana and one office property in Atlanta, Georgia. Our acquisition accounting is preliminary for seven of the acquired buildings, which were acquired in September 2011. The following table summarizes our allocation of the fair value of amounts recognized for each major class of assets and liabilities (in thousands) for these acquisitions:
|
| | | |
| |
Real estate assets | $ | 161,825 |
|
Lease related intangible assets | 22,879 |
|
Other assets | 338 |
|
Total acquired assets | 185,042 |
|
Secured debt | 20,138 |
|
Other liabilities | 1,588 |
|
Total assumed liabilities | 21,726 |
|
Fair value of acquired net assets | $ | 163,316 |
|
The leases in the acquired properties had a weighted average remaining life at acquisition of approximately 6.8 years.
Fair Value Measurements
The fair value estimates used in allocating the aggregate purchase price of each acquisition among the individual components of real estate assets and liabilities were determined primarily through calculating the “as-if vacant” value of each building, using the income approach, and relied significantly upon internally determined assumptions. As a result, we have, thus, determined these estimates to have been primarily based upon Level 3 inputs, which are unobservable inputs based on our own assumptions. The range of most significant assumptions utilized in making the lease-up and future disposition estimates used in calculating the “as-if vacant” value of each building acquired during the nine months ended September 30, 2011 were as follows:
|
| | | | |
| Low |
| High |
|
Discount rate | 6.40 | % | 10.10 | % |
Exit capitalization rate | 4.80 | % | 9.00 | % |
Lease-up period (months) | 12 |
| 36 |
|
Net rental rate per square foot – Industrial | $2.75 | $6.50 |
Net rental rate per square foot – Office | $8.61 | $16.00 |
Dispositions
We disposed of income-producing real estate assets and undeveloped land and received net proceeds of $504.7 million during the nine months ended September 30, 2011. Included in the building dispositions in the nine months ended September 30, 2011 is the sale, in March 2011, of 13 suburban office buildings, totaling approximately 2.0 million square feet, to an existing 20% owned unconsolidated joint venture. These buildings were sold to the unconsolidated joint venture for $342.8 million and our share of net proceeds totaled $273.7 million.
5. Indebtedness
The following table summarizes the book value and changes in the fair value of our debt for the nine months ended September 30, 2011 (in thousands):
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Book Value at 12/31/10 | | Book Value at 9/30/11 | | Fair Value at 12/31/10 | | Issuances and Assumptions | | Payoffs | | Adjustments to Fair Value | | Fair Value at 9/30/11 |
Fixed rate secured debt | $ | 1,042,722 |
| | $ | 1,162,147 |
| | $ | 1,069,562 |
| | $ | 143,732 |
| | $ | (24,056 | ) | | $ | 75,065 |
| | $ | 1,264,303 |
|
Variable rate secured debt | 22,906 |
| | 22,121 |
| | 22,906 |
| | — |
| | (785 | ) | | — |
| | 22,121 |
|
Unsecured notes | 2,948,405 |
| | 2,783,762 |
| | 3,164,651 |
| | — |
| | (166,345 | ) | | (63,773 | ) | | 2,934,533 |
|
Unsecured lines of credit | 193,046 |
| | 304,293 |
| | 193,224 |
| | 111,248 |
| | — |
| | 4,815 |
| | 309,287 |
|
Total | $ | 4,207,079 |
| | $ | 4,272,323 |
| | $ | 4,450,343 |
| | $ | 254,980 |
| | $ | (191,186 | ) | | $ | 16,107 |
| | $ | 4,530,244 |
|
Fixed Rate Secured Debt
Because our fixed rate secured debt is not actively traded in any marketplace, we utilized a discounted cash flow methodology to determine its fair value. Accordingly, we calculated fair value by applying an estimate of the current market rate to discount the debt’s remaining contractual cash flows. Our estimate of a current market rate, which is the most significant input in the discounted cash flow calculation, is intended to replicate debt of similar maturity and loan-to-value relationship. The estimated rates ranged from 2.70% to 6.20%, depending on the attributes of the specific loans. The current market rates we utilized were internally estimated; therefore, we have concluded that our determination of fair value for our fixed rate secured debt was primarily based upon Level 3 inputs.
We assumed eleven secured loans, in conjunction with our acquisition activity, in the first nine months of 2011. These acquired secured loans had a total face value of $143.7 million and fair value of $145.1 million. The assumed loans carry a weighted average stated interest rate of 5.75% and a weighted remaining term upon acquisition of 5.2 years. We used estimated market rates ranging between 4.40% and 5.81% in determining the fair value of the loans.
Unsecured Notes
In March 2011, we repaid $42.5 million of senior unsecured notes, which had an effective interest rate of 6.96%, at their scheduled maturity date. In August 2011, we repaid $122.5 million of senior unsecured notes, which had an effective interest
rate of 5.69%, at their scheduled maturity date.
All but $21.0 million of our unsecured notes bear interest at fixed rates. We utilized broker estimates in estimating the fair value of our fixed rate unsecured debt. Our unsecured notes are thinly traded and, in certain cases, the broker estimates were not based upon comparable transactions. The broker estimates took into account any recent trades within the same series of our fixed rate unsecured debt, comparisons to recent trades of other series of our fixed rate unsecured debt, trades of fixed rate unsecured debt from companies with profiles similar to ours, as well as overall economic conditions. We reviewed these broker estimates for reasonableness and accuracy, considering whether the estimates were based upon market participant assumptions within the principal and most advantageous market and whether any other observable inputs would be more accurate indicators of fair value than the broker estimates. We concluded that the broker estimates were representative of fair value. We have determined that our estimation of the fair value of our fixed rate unsecured debt was primarily based upon Level 3 inputs, as defined. The estimated trading values of our fixed rate unsecured debt, depending on the maturity and coupon rates, ranged from 100.00% to 115.00% of face value.
The indentures (and related supplemental indentures) governing our outstanding series of notes also require us to comply with financial ratios and other covenants regarding our operations. We were in compliance with all such covenants as of September 30, 2011.
Unsecured Lines of Credit
Our unsecured lines of credit as of September 30, 2011 are described as follows (in thousands):
|
| | | | | | | | | |
Description | Maximum Capacity | | Maturity Date | | Outstanding Balance at September 30, 2011 |
Unsecured Line of Credit - DRLP | $ | 850,000 |
| | February 2013 | | $ | 284,000 |
|
Unsecured Line of Credit - Consolidated Subsidiary | $ | 30,000 |
| | July 2012 | | $ | 20,293 |
|
The DRLP unsecured line of credit has an interest rate on borrowings of LIBOR plus 2.75% (equal to 2.98% for borrowings as of September 30, 2011), and a maturity date of February 2013. Subject to certain conditions, the terms also include an option to increase the facility by up to an additional $200.0 million, for a total of up to $1.05 billion.
This line of credit provides us with an option to obtain borrowings from financial institutions that participate in the line at rates that may be lower than the stated interest rate, subject to certain restrictions.
This line of credit contains financial covenants that require us to meet certain financial ratios and defined levels of performance, including those related to fixed charge coverage and debt-to-asset value (with asset value being defined in the DRLP unsecured line of credit agreement). As of September 30, 2011, we were in compliance with all covenants under this line of credit.
The consolidated subsidiary’s unsecured line of credit allows for borrowings up to $30.0 million at a rate of LIBOR plus 0.85% (equal to 1.09% for outstanding borrowings as of September 30, 2011). This unsecured line of credit is used to fund development activities within the consolidated subsidiary and matures in July 2012.
To the extent that there are outstanding borrowings, we utilize a discounted cash flow methodology in order to estimate the fair value of our unsecured lines of credit. The net present value of the difference between future contractual interest payments and future interest payments based on our estimate of a current market rate represents the difference between the book value and the fair value. Our estimate of a current market rate is based upon the rate, considering current market conditions and our specific credit profile, at which we estimate we could obtain similar borrowings. The current market rate of 1.74% that we utilized was internally estimated; therefore, we have concluded that our determination of fair value for our unsecured lines of credit was primarily based upon Level 3 inputs.
6. Shareholders' Equity
In the first nine months of 2011, we repurchased 80,000 shares of our 8.375% Series O Cumulative Redeemable Preferred Shares (“Series O Shares”). The Series O Shares that we repurchased had a total redemption value of $2.0 million and were repurchased for $2.1 million. An adjustment of approximately $163,000, which included a ratable portion of original issuance costs, was included as a reduction to net income attributable to common shareholders.
In conjunction with the acquisition of the Premier Portfolio (Note 4), we issued 2.1 million Units with a fair value at issuance
of $28.4 million, which are included in noncontrolling interests.
In July 2011, we redeemed all of the outstanding shares of our 7.25% Series N Cumulative Redeemable Preferred Shares at a liquidation amount of $108.6 million. Offering costs of $3.6 million were charged against net income attributable to common shareholders in conjunction with the redemption of these shares.
7. Related Party Transactions
We provide property management, asset management, leasing, construction and other tenant related services to unconsolidated companies in which we have equity interests. We recorded the corresponding fees based on contractual terms that approximate market rates for these types of services and we have eliminated our ownership percentage of these fees in the consolidated financial statements. The following table summarizes the fees earned from these companies for the nine months ended September 30, 2011 and 2010, respectively (in thousands):
|
| | | | | | | |
| Nine Months Ended September 30, |
| 2011 | | 2010 |
Management fees | $ | 7,393 |
| | $ | 5,850 |
|
Leasing fees | 3,627 |
| | 2,143 |
|
Construction and development fees | 4,182 |
| | 6,716 |
|
8. Net Income (Loss) Per Common Share
Basic net income (loss) per common share is computed by dividing net income (loss) attributable to common shareholders, less dividends on share-based awards expected to vest (referred to as “participating securities” and primarily composed of unvested restricted stock units), by the weighted average number of common shares outstanding for the period. Diluted net income (loss) per common share is computed by dividing the sum of basic net income (loss) attributable to common shareholders and the noncontrolling interest in earnings allocable to Units not owned by us (to the extent the Units are dilutive) by the sum of the weighted average number of common shares outstanding and, to the extent they are dilutive, Units outstanding, as well as any potential dilutive securities for the period.
The following table reconciles the components of basic and diluted net income (loss) per common share for the three and nine months ended September 30, 2011 and 2010, respectively (in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2011 | | 2010 | | 2011 | | 2010 |
Net income (loss) attributable to common shareholders | $ | (32,076 | ) | | $ | 34,064 |
| | $ | (13,549 | ) | | $ | (23,591 | ) |
Less: Dividends on participating securities | (811 | ) | | (694 | ) | | (2,416 | ) | | (1,699 | ) |
Basic net income (loss) attributable to common shareholders | (32,887 | ) | | 33,370 |
| | (15,965 | ) | | (25,290 | ) |
Noncontrolling interest in earnings of common unitholders | — |
| | 1,041 |
| | — |
| | — |
|
Diluted net income (loss) attributable to common shareholders | $ | (32,887 | ) | | $ | 34,411 |
| | $ | (15,965 | ) | | $ | (25,290 | ) |
Weighted average number of common shares outstanding | 252,802 |
| | 251,866 |
| | 252,618 |
| | 234,468 |
|
Weighted average partnership Units outstanding | — |
| | 5,517 |
| | — |
| | — |
|
Other potential dilutive shares | — |
| | — |
| | — |
| | — |
|
Weighted average number of common shares and potential dilutive securities | 252,802 |
| | 257,383 |
| | 252,618 |
| | 234,468 |
|
The partnership Units are anti-dilutive for the three and nine months ended September 30, 2011 and the nine months ended September 30, 2010 as a result of the net loss for these periods. In addition, potential shares related to our stock-based compensation plans as well as our 3.75% Exchangeable Senior Notes (“Exchangeable Notes”) are anti-dilutive for all periods presented. The following table summarizes the data that is excluded from the computation of net income (loss) per common share as a result of being anti-dilutive (in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2011 | | 2010 | | 2011 | | 2010 |
Noncontrolling interest in earnings of common unitholders | $ | (868 | ) | | $ | — |
| | $ | (369 | ) | | $ | (620 | ) |
Weighted average partnership Units outstanding | 7,064 |
| | — |
| | 6,887 |
| | 6,172 |
|
Other potential dilutive shares: | | | | | | | |
Anti-dilutive outstanding potential shares under fixed stock option plans | 1,677 |
| | 1,779 |
| | 1,677 |
| | 1,779 |
|
Anti-dilutive potential shares under the Exchangeable Notes | 3,432 |
| | 4,045 |
| | 3,432 |
| | 4,045 |
|
Outstanding participating securities | 4,840 |
| | 4,137 |
| | 4,840 |
| | 4,137 |
|
9. Segment Reporting
We have three reportable operating segments, the first two of which consist of the ownership and rental of (i) office and (ii) industrial real estate investments. The operations of our office and industrial properties, along with our medical office and retail properties, are collectively referred to as “Rental Operations.” Our medical office and retail properties do not by themselves meet the quantitative thresholds for separate presentation as reportable segments. The third reportable segment consists of various real estate services such as property management, asset management, maintenance, leasing, development and construction management to third-party property owners and joint ventures, and is collectively referred to as “Service Operations.” Our reportable segments offer different products or services and are managed separately because each segment requires different operating strategies and management expertise.
Other revenue consists of other operating revenues not identified with one of our operating segments. Interest expense and other non-property specific revenues and expenses are not allocated to individual segments in determining our performance measure.
We assess and measure our overall operating results based upon an industry performance measure referred to as Funds From Operations (“FFO”), which management believes is a useful indicator of our consolidated operating performance. FFO is used by industry analysts and investors as a supplemental operating performance measure of a REIT. The National Association of Real Estate Investment Trusts (“NAREIT”) created FFO as a supplemental measure of REIT operating performance that excludes historical cost depreciation, among other items, from net income determined in accordance with GAAP. FFO is a non-GAAP financial measure. The most comparable GAAP measure is net income (loss) attributable to common shareholders. FFO attributable to common shareholders should not be considered as a substitute for net income (loss) attributable to common shareholders or any other measures derived in accordance with GAAP and may not be comparable to other similarly titled measures of other companies. FFO is calculated in accordance with the definition that was adopted by the Board of Governors of NAREIT. We do not allocate certain income and expenses (“Non-Segment Items”, as shown in the table below) to our operating segments. Thus, the operational performance measure presented here on a segment-level basis represents net earnings, excluding depreciation expense and the Non-Segment Items not allocated, and is not meant to present FFO as defined by NAREIT.
Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen or fallen with market conditions, many industry analysts and investors have considered presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves. FFO, as defined by NAREIT, represents GAAP net income (loss), excluding extraordinary items as defined under GAAP and gains or losses from sales of previously depreciated real estate assets, plus certain non-cash items such as real estate asset depreciation and amortization, and after similar adjustments for unconsolidated partnerships and joint ventures.
Management believes that the use of FFO attributable to common shareholders, combined with net income (which remains the primary measure of performance), improves the understanding of operating results of REITs among the investing public and makes comparisons of REIT operating results more meaningful. Management believes that excluding gains or losses related to sales of previously depreciated real estate assets and excluding real estate asset depreciation and amortization enables investors and analysts to readily identify the operating results of the long-term assets that form the core of a REIT’s activity and assist them in comparing these operating results between periods or between different companies.
The following table shows (i) the revenues for each of the reportable segments and (ii) a reconciliation of FFO attributable to common shareholders to net income (loss) attributable to common shareholders for the three and nine months ended September 30, 2011 and 2010, respectively (in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2011 | | 2010 | | 2011 | | 2010 |
Revenues | | | | | | | |
Rental Operations: | | | | | | | |
Office | $ | 111,376 |
| | $ | 124,397 |
| | $ | 340,483 |
| | $ | 371,206 |
|
Industrial | 98,874 |
| | 84,249 |
| | 290,219 |
| | 212,832 |
|
Non-reportable Rental Operations segments | 20,334 |
| | 16,495 |
| | 59,698 |
| | 49,453 |
|
General contractor and service fee revenue (“Service Operations”) | 127,708 |
| | 132,351 |
| | 409,617 |
| | 414,391 |
|
Total Segment Revenues | 358,292 |
| | 357,492 |
| | 1,100,017 |
| | 1,047,882 |
|
Other Revenue | 2,971 |
| | 3,158 |
| | 8,219 |
| | 8,998 |
|
Consolidated Revenue from continuing operations | 361,263 |
| | 360,650 |
| | 1,108,236 |
| | 1,056,880 |
|
Discontinued Operations | 1,341 |
| | 11,385 |
| | 7,506 |
| | 38,276 |
|
Consolidated Revenue | $ | 362,604 |
| | $ | 372,035 |
| | $ | 1,115,742 |
| | $ | 1,095,156 |
|
Reconciliation of Funds From Operations | | | | | | | |
Net earnings excluding depreciation and Non-Segment Items | | | | | | | |
Office | $ | 62,768 |
| | $ | 72,015 |
| | $ | 191,787 |
| | $ | 213,409 |
|
Industrial | 72,006 |
| | 62,716 |
| | 208,925 |
| | 158,395 |
|
Non-reportable Rental Operations segments | 13,115 |
| | 10,729 |
| | 38,513 |
| | 32,884 |
|
Service Operations | 7,161 |
| | 7,698 |
| | 30,437 |
| | 21,958 |
|
| 155,050 |
| | 153,158 |
| | 469,662 |
| | 426,646 |
|
Non-Segment Items: | | | | | | | |
Interest expense | (66,875 | ) | | (61,491 | ) | | (199,269 | ) | | (175,076 | ) |
Impairment charges | — |
| | (1,860 | ) | | — |
| | (9,834 | ) |
Interest and other income | 172 |
| | 149 |
| | 543 |
| | 504 |
|
Other operating expenses | (60 | ) | | (580 | ) | | (171 | ) | | (1,002 | ) |
General and administrative expenses | (9,493 | ) | | (8,476 | ) | | (29,231 | ) | | (31,171 | ) |
Undeveloped land carrying costs | (2,259 | ) | | (2,359 | ) | | (7,021 | ) | | (7,152 | ) |
Loss on debt transactions | — |
| | (167 | ) | | — |
| | (16,294 | ) |
Acquisition-related activity | (342 | ) | | 57,513 |
| | (1,525 | ) | | 57,513 |
|
Income tax benefit | 194 |
| | 1,126 |
| | 194 |
| | 1,126 |
|
Other non-segment income | 1,934 |
| | 2,552 |
| | 4,456 |
| | 6,274 |
|
Net (income) loss attributable to noncontrolling interests | 825 |
| | (993 | ) | | 532 |
| | 562 |
|
Noncontrolling interest share of FFO adjustments | (2,835 | ) | | (2,018 | ) | | (6,206 | ) | | (6,611 | ) |
Joint venture items | 11,635 |
| | 7,916 |
| | 30,597 |
| | 32,488 |
|
Dividends on preferred shares | (14,399 | ) | | (16,726 | ) | | (46,347 | ) | | (53,452 | ) |
Adjustments for redemption/repurchase of preferred shares | (3,633 | ) | | (5,652 | ) | | (3,796 | ) | | (10,144 | ) |
Discontinued operations | 390 |
| | 3,801 |
| | 1,648 |
| | 13,170 |
|
FFO attributable to common shareholders | 70,304 |
| | 125,893 |
| | 214,066 |
| | 227,547 |
|
Depreciation and amortization on continuing operations | (96,909 | ) | | (94,487 | ) | | (290,751 | ) | | (253,209 | ) |
Depreciation and amortization on discontinued operations | (426 | ) | | (3,426 | ) | | (1,678 | ) | | (10,877 | ) |
Company’s share of joint venture adjustments | (8,531 | ) | | (7,336 | ) | | (24,798 | ) | | (27,271 | ) |
Earnings from depreciated property sales on continuing operations | (1,437 | ) | | (125 | ) | | 66,910 |
| | 6,917 |
|
Earnings from depreciated property sales on discontinued operations | 2,088 |
| | 11,527 |
| | 16,405 |
| | 24,383 |
|
Earnings from depreciated property sales—share of joint venture | — |
| | — |
| | 91 |
| | 2,308 |
|
Noncontrolling interest share of FFO adjustments | 2,835 |
| | 2,018 |
| | 6,206 |
| | 6,611 |
|
Net income (loss) attributable to common shareholders | $ | (32,076 | ) | | $ | 34,064 |
| | $ | (13,549 | ) | | $ | (23,591 | ) |
The assets for each of the reportable segments as of September 30, 2011 and December 31, 2010 are as follows (in thousands):
|
| | | | | | | |
| September 30, 2011 | | December 31, 2010 |
Assets | | | |
Rental Operations: | | | |
Office | $ | 2,759,739 |
| | $ | 3,122,565 |
|
Industrial | 3,388,125 |
| | 3,210,566 |
|
Non-reportable Rental Operations segments | 640,885 |
| | 627,491 |
|
Service Operations | 175,839 |
| | 231,662 |
|
Total Segment Assets | 6,964,588 |
| | 7,192,284 |
|
Non-Segment Assets | 540,073 |
| | 451,992 |
|
Consolidated Assets | $ | 7,504,661 |
| | $ | 7,644,276 |
|
10. Discontinued Operations and Assets Held for Sale
The following table illustrates the number of properties in discontinued operations:
|
| | | | | | | |
| Held for Sale at September 30, 2011 | | Sold in 2011 | | Sold in 2010 | | Total |
| | | |
| | | |
Office | 3 | | 11 | | 11 | | 25 |
Industrial | 0 | | 3 | | 6 | | 9 |
Retail | 0 | | 0 | | 2 | | 2 |
| 3 | | 14 | | 19 | | 36 |
We allocate interest expense to discontinued operations and have included such interest expense in computing income from discontinued operations. Interest expense allocable to discontinued operations includes interest on any secured debt for properties included in discontinued operations and an allocable share of our consolidated unsecured interest expense for unencumbered properties. The allocation of unsecured interest expense to discontinued operations was based upon the gross book value of the unencumbered real estate assets included in discontinued operations as it related to the total gross book value of our unencumbered real estate assets.
The following table illustrates the operations of the buildings reflected in discontinued operations for the three and nine months ended September 30, 2011 and 2010, respectively (in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2011 | | 2010 | | 2011 | | 2010 |
Revenues | $ | 1,341 |
| | $ | 11,385 |
| | $ | 7,506 |
| | $ | 38,276 |
|
Operating expenses | (640 | ) | | (4,675 | ) | | (3,751 | ) | | (15,226 | ) |
Depreciation and amortization | (426 | ) | | (3,426 | ) | | (1,678 | ) | | (10,877 | ) |
Operating income | 275 |
| | 3,284 |
| | 2,077 |
| | 12,173 |
|
Interest expense | (311 | ) | | (2,909 | ) | | (2,107 | ) | | (9,880 | ) |
Income (loss) before gain on sales | (36 | ) | | 375 |
| | (30 | ) | | 2,293 |
|
Gain on sale of depreciable properties | 2,088 |
| | 11,527 |
| | 16,405 |
| | 24,383 |
|
Income from discontinued operations | $ | 2,052 |
| | $ | 11,902 |
| | $ | 16,375 |
| | $ | 26,676 |
|
Dividends on preferred shares and adjustments for the redemption or repurchase of preferred shares are allocated entirely to continuing operations. The following table illustrates the allocation of the income (loss) attributable to common shareholders between continuing operations and discontinued operations, reflecting an allocation of income or loss attributable to noncontrolling interests between continuing and discontinued operations, for the three and nine months ended September 30, 2011 and 2010, respectively (in thousands):
|
| | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2011 | | 2010 | | 2011 | | 2010 |
Income (loss) from continuing operations attributable to common shareholders | $ | (34,072 | ) | | $ | 22,417 |
| | $ | (29,490 | ) | | $ | (49,583 | ) |
Income from discontinued operations attributable to common shareholders | 1,996 |
| | 11,647 |
| | 15,941 |
| | 25,992 |
|
Net income (loss) attributable to common shareholders | $ | (32,076 | ) | | $ | 34,064 |
| | $ | (13,549 | ) | | $ | (23,591 | ) |
At September 30, 2011, we classified three in-service properties as held-for-sale, which were included in discontinued operations, due to our present intention to sell the properties in October 2011. The following table illustrates aggregate balance sheet information of the aforementioned three properties included in discontinued operations at September 30, 2011 (in thousands):
|
| | | |
| |
Real estate investment, net | $ | 18,466 |
|
Other assets | 3,526 |
|
Total assets held-for-sale | $ | 21,992 |
|
| |
Accrued expenses | $ | 666 |
|
Other liabilities | 291 |
|
Total liabilities held-for-sale | $ | 957 |
|
11. Subsequent Events
Declaration of Dividends
Our board of directors declared the following dividends at its regularly scheduled board meeting held on October 26, 2011:
|
| | | | | |
Class | Quarterly Amount/Share | | Record Date | | Payment Date |
Common | $0.17 | | November 16, 2011 | | November 30, 2011 |
Preferred (per depositary share): |
| |
| |
|
Series J | $0.414063 | | November 16, 2011 | | November 30, 2011 |
Series K | $0.406250 | | November 16, 2011 | | November 30, 2011 |
Series L | $0.412500 | | November 16, 2011 | | November 30, 2011 |
Series M | $0.434375 | | December 16, 2011 | | December 31, 2011 |
Series O | $0.523438 | | December 16, 2011 | | December 31, 2011 |
Portfolio Disposition Agreement
On October 20, 2011, we entered into a Purchase and Sale Agreement (the "Purchase Agreement"), pursuant to which we will sell a real estate portfolio consisting of 82 buildings that have an aggregate of 10.1 million square feet and comprise nearly all of our wholly owned office properties located in Atlanta, Chicago, Columbus, Dallas, Minneapolis, Orlando and Tampa. The purchase price, which was determined through arm's length negotiations between us and the buyer, will be $1.08 billion and we expect to recognize a net gain on sale. As of October 20, 2011, the Buyer had paid a nonrefundable earnest money deposit of $40.0 million. The closing of the transactions contemplated by the Purchase Agreement is subject to the satisfaction of certain customary closing conditions. Although there are no assurances that the conditions will be met or that the transaction will be consummated, the parties to the Purchase Agreement anticipate that the closing will occur on or about December 1, 2011.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to help the reader understand our operations and our present business environment. Management’s Discussion and Analysis is provided as a supplement to and should be read in conjunction with our consolidated financial statements and the notes thereto, contained in Part I, Item I of this Quarterly Report on Form 10-Q (this “Report”) and the consolidated financial statements and notes thereto, contained in Part IV, Item 15 of our Annual Report on Form 10-K for the year ended December 31, 2010, as filed with the Securities and Exchange Commission (the “SEC”) on February 25, 2011. As used herein, the terms “we”, “us” and “our” refer to Duke Realty Corporation (the “Company”) and those entities owned or controlled by the Company.
Cautionary Notice Regarding Forward-Looking Statements
Certain statements contained in or incorporated by reference into this Report including, without limitation, those related to our future operations, constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The words “believe,” “estimate,” “expect,” “anticipate,” “intend,” “plan,” “seek,” “may,” and similar expressions or statements regarding future periods are intended to identify forward-looking statements.
These forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause our actual results, performance or achievements, or industry results, to differ materially from any predictions of future results, performance or achievements that we express or imply in this Report. Some of the risks, uncertainties and other important factors that may affect future results include, among others:
| |
• | Changes in general economic and business conditions, including, without limitation, the continuing impact of the economic down-turn, which is having and may continue to have a negative effect on the fundamentals of our business, the financial condition of our tenants, and the value of our real estate assets; |
| |
• | Our continued qualification as a real estate investment trust (“REIT”) for U.S. federal income tax purposes; |
| |
• | Heightened competition for tenants and potential decreases in property occupancy; |
| |
• | Potential changes in the financial markets and interest rates; |
| |
• | Volatility in our stock price and trading volume; |
| |
• | Our continuing ability to raise funds on favorable terms; |
| |
• | Our ability to successfully identify, acquire, develop and/or manage properties on terms that are favorable to us; |
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• | Potential increases in real estate construction costs; |
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• | Our ability to successfully dispose of properties on terms that are favorable to us, including, without limitation, through one or more transactions that are consistent with our previously disclosed strategic plans; |
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• | Our ability to retain our current credit ratings; |
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• | Inherent risks in the real estate business, including, but not limited to, tenant defaults, potential liability relating to environmental matters, climate change and liquidity of real estate investments; and |
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• | Other risks and uncertainties described herein, as well as those risks and uncertainties discussed from time to time in our other reports and other public filings with the SEC. |
Although we presently believe that the plans, expectations and results expressed in or suggested by the forward-looking statements are reasonable, all forward-looking statements are inherently subjective, uncertain and subject to change, as they involve substantial risks and uncertainties beyond our control. New factors emerge from time to time, and it is not possible for us to predict the nature, or assess the potential impact, of each new factor on our business. Given these uncertainties, we caution you not to place undue reliance on these forward-looking statements. We undertake no obligation to update or revise any of our forward-looking statements for events or circumstances that arise after the statement is made, except as otherwise may be required by law.
This list of risks and uncertainties, however, is only a summary of some of the most important factors and is not intended to be exhaustive. Additional information regarding risk factors that may affect us is included under the caption “Risk Factors” in Part II, Item 1A of this Report, and in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010, which we filed with the SEC on February 25, 2011. The risk factors contained in our Annual Report are updated by us from time to time in Quarterly Reports on Form 10-Q and other public filings.
Business Overview
We are a self-administered and self-managed REIT that began operations through a related entity in 1972. A more complete description of our business, and of management’s philosophy and priorities, is included in our 2010 Annual Report on Form 10-K.
As of September 30, 2011, we:
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• | Owned or jointly controlled 807 industrial, office, medical office and other properties, of which 799 properties with approximately 141.3 million square feet are in service and eight properties with more than 1.3 million square feet are under development. The 799 in-service properties are comprised of 672 consolidated properties with approximately 115.8 million square feet and 127 jointly controlled unconsolidated properties with approximately 25.5 million square feet. The eight properties under development consist of six consolidated properties with approximately 666,000 square feet and two jointly controlled unconsolidated properties with approximately 679,000 square feet. |
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• | Owned, including through ownership interests in unconsolidated joint ventures, more than 4,750 acres of land and controlled an additional 1,650 acres through purchase options. |
We have three reportable operating segments, the first two of which consist of the ownership and rental of (i) office and (ii) industrial real estate investments. The operations of our office and industrial properties, along with our medical office and retail properties, are collectively referred to as “Rental Operations.” Our medical office and retail properties do not by themselves meet the quantitative thresholds for separate presentation as reportable segments. The third reportable segment consists of various real estate services such as property management, asset management, maintenance, leasing, development and construction management to third-party property owners and joint ventures, and is collectively referred to as “Service Operations.” Our reportable segments offer different products or services and are managed separately because each segment requires different operating strategies and management expertise.
A key component of our overall strategy is to increase our investment in quality industrial properties in both existing and select new markets, expand our medical office portfolio nationally to take advantage of demographic trends and to reduce our investment in suburban office properties and other non-strategic assets.
Key Performance Indicators
Our operating results depend primarily upon rental income from our Rental Operations. The following discussion highlights the areas of Rental Operations that we consider critical for future revenues.
Occupancy Analysis
Our ability to maintain high occupancy rates is a principal driver of maintaining and increasing rental revenue from continuing operations. The following table sets forth occupancy information regarding our in-service portfolio of consolidated rental properties as of September 30, 2011 and 2010, respectively (in thousands, except percentage data):
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| | | | | | | | | | | | | | | | | |
| Total Square Feet | | Percent of Total Square Feet | | Percent Occupied |
Type | 2011 | | 2010 | | 2011 | | 2010 | | 2011 | | 2010 |
Industrial | 86,746 |
| | 77,495 |
| | 74.9 | % | | 69.8 | % | | 92.9 | % | | 91.2 | % |
Office | 26,059 |
| | 30,734 |
| | 22.5 | % | | 27.7 | % | | 84.6 | % | | 85.8 | % |
Other (Medical Office and Retail) | 2,986 |
| | 2,725 |
| | 2.6 | % | | 2.5 | % | | 86.3 | % | | 83.8 | % |
Total | 115,791 |
| | 110,954 |
| | 100.0 | % | | 100.0 | % | | 90.9 | % | | 89.5 | % |
Lease Expiration and Renewals
Our ability to maintain and improve occupancy rates primarily depends upon our continuing ability to re-lease expiring space. The following table reflects our consolidated in-service portfolio lease expiration schedule by property type as of September 30, 2011. The table indicates square footage and annualized net effective rents (based on September 30, 2011 rental revenue) under expiring leases (in thousands, except percentage data):
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| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Consolidated Portfolio | | Industrial | | Office | | Other |
Year of Expiration | Square Feet | | Ann. Rent Revenue | | % of Revenue | | Square Feet | | Ann. Rent Revenue | | Square Feet | | Ann. Rent Revenue | | Square Feet | | Ann. Rent Revenue |
Remainder of 2011 | 3,623 |
| | $ | 20,942 |
| | 3 | % | | 2,820 |
| | $ | 11,587 |
| | 790 |
| | $ | 9,214 |
| | 13 |
| | $ | 141 |
|
2012 | 7,825 |
| | 55,166 |
| | 8 | % | | 5,276 |
| | 22,387 |
| | 2,492 |
| | 31,782 |
| | 57 |
| | 997 |
|
2013 | 16,498 |
| | 100,582 |
| | 15 | % | | 13,004 |
| | 51,731 |
| | 3,445 |
| | 47,928 |
| | 49 |
| | 923 |
|
2014 | 12,706 |
| | 74,340 |
| | 11 | % | | 9,922 |
| | 37,753 |
| | 2,638 |
| | 33,918 |
| | 146 |
| | 2,669 |
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2015 | 13,370 |
| | 77,006 |
| | 12 | % | | 10,497 |
| | 40,674 |
| | 2,843 |
| | 35,709 |
| | 30 |
| | 623 |
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2016 | 12,496 |
| | 67,315 |
| | 10 | % | | 10,190 |
| | 37,083 |
| | 2,200 |
| | 27,984 |
| | 106 |
| | 2,248 |
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2017 | 9,079 |
| | 55,763 |
| | 8 | % | | 7,079 |
| | 27,649 |
| | 1,693 |
| | 21,651 |
| | 307 |
| | 6,463 |
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2018 | 6,129 |
| | 51,962 |
| | 8 | % | | 3,824 |
| | 15,445 |
| | 1,761 |
| | 23,979 |
| | 544 |
| | 12,538 |
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2019 | 4,163 |
| | 39,582 |
| | 6 | % | | 2,301 |
| | 10,242 |
| | 1,595 |
| | 22,794 |
| | 267 |
| | 6,546 |
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2020 | 6,658 |
| | 43,512 |
| | 7 | % | | 5,286 |
| | 19,901 |
| | 1,000 |
| | 15,904 |
| | 372 |
| | 7,707 |
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2021 and Thereafter | 12,685 |
| | 77,597 |
| | 12 | % | | 10,404 |
| | 40,059 |
| | 1,595 |
| | 21,367 |
| | 686 |
| | 16,171 |
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Total Leased | 105,232 |
| | $ | 663,767 |
| | 100 | % | | 80,603 |
| | $ | 314,511 |
| | 22,052 |
| | $ | 292,230 |
| | 2,577 |
| | $ | 57,026 |
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| | | | | | | | | | | | | | | | | |
Total Portfolio Square Feet | 115,791 |
| | | | | | 86,746 |
| | | | 26,059 |
| | | | 2,986 |
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Percent Occupied | 90.9 | % | | | | | | 92.9 | % | | | | 84.6 | % | | | | 86.3 | % | | |
Within our consolidated properties, we renewed 74.4% and 64.1% of our leases up for renewal in the three and nine months ended September 30, 2011, totaling approximately 2.2 million and 7.2 million square feet, respectively. This compares to renewals of 75.8% and 80.5% for the three and nine months ended September 30, 2010, which totaled approximately 2.7 million and 7.5 million square feet, respectively. Although our lease renewal percentage declined from the same periods in 2010, new leasing activity enabled us to improve occupancy within our consolidated properties. There was a 1.8% increase and a 4.2% decline in average contractual rents on these renewals in the three and nine months ended September 30, 2011, respectively.
The average term of renewals for the three and nine months ended September 30, 2011 was 3.5 and 4.1 years, compared to 5.4 and 6.0 years for the three and nine months ended September 30, 2010, respectively.
Acquisition and Disposition Activity
For the nine months ended September 30, 2011, we acquired 30 properties and other real estate-related assets, for $366.7 million, with 16 of these properties representing the completion of our acquisition of a portfolio of buildings in South Florida (the “Premier Portfolio”). The initial 39 properties from the Premier Portfolio were acquired on December 30, 2010. These acquisitions represent further advancement of our strategy to increase our concentration in industrial properties.
On July 1, 2010, we acquired our joint venture partner's 50% interest in Dugan Realty, L.L.C. ("Dugan"), a real estate joint venture that we had previously accounted for using the equity method, for a payment of $166.3 million. Dugan held $28.1 million of cash at the time of acquisition, which resulted in a net cash outlay of $138.2 million. At the date of acquisition, Dugan owned 106 industrial buildings totaling 20.8 million square feet and 62.6 net acres of undeveloped land located in Midwest and Southeast markets. The total acquisition date fair value of Dugan's assets was $638.2 million and we also assumed liabilities, including secured debt, having a total fair value of $305.7 million.
Additionally, in the nine months ended September 30, 2010, we also acquired six properties for a total purchase price of $185.5 million. These acquisitions consisted of two suburban office properties and two bulk industrial properties in South Florida, one bulk industrial property in Phoenix, Arizona, and one bulk industrial property in Columbus, Ohio. Also, in the first nine months of 2010, one of our unconsolidated joint ventures, in which we have a 20% equity interest, acquired two properties for $42.3 million. We contributed $8.6 million to the joint venture for our share of these acquisitions.
Net cash proceeds related to the dispositions of wholly owned undeveloped land and buildings totaled $504.7 million and $200.4 million for the nine months ended September 30, 2011 and 2010, respectively. Included in the wholly owned building dispositions in the nine months ended September 30, 2011 is the sale of 13 suburban office properties for net proceeds of $273.7 million, totaling approximately 2.0 million square feet, to a joint venture in which we own 20%.
Our share of proceeds from sales of properties within unconsolidated joint ventures in which we have less than a 100% interest totaled $4.7 million for the nine months ended September 30, 2010. There were no such dispositions in the same period in
2011.
We regularly work to identify, consider and pursue opportunities to acquire and dispose of properties on an opportunistic basis and on a basis that is generally consistent with our strategic plans.
Development
At September 30, 2011, we had 1.3 million square feet of property under development with total estimated costs upon completion of $237.4 million compared to 3.5 million square feet with total costs upon completion of $356.1 million at September 30, 2010. We have continued to limit our development projects to build-to-suit or partially pre-leased properties and select medical office developments. The square footage and estimated costs include both consolidated and joint venture development activity at 100%.
The following table summarizes our properties under development as of September 30, 2011 (in thousands, except percentage data):
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| | | | | | | | | | | | | | | |
Ownership Type | Square Feet | | Percent Leased | | Total Estimated Project Costs |
| | Total Incurred to Date |
| | Amount Remaining to be Spent |
|
Consolidated properties | 666 | | 86% | | $ | 128,525 |
| | $ | 25,808 |
| | $ | 102,717 |
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Joint venture properties | 679 | | 100% | | 108,880 |
| | 18,959 |
| | 89,921 |
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Total | 1,345 | | 94% | | $ | 237,405 |
| | $ | 44,767 |
| | $ | 192,638 |
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Funds From Operations
Funds From Operations (“FFO”) is used by industry analysts and investors as a supplemental operating performance measure of a REIT. The National Association of Real Estate Investment Trusts (“NAREIT”) created FFO as a supplemental measure of REIT operating performance that excludes historical cost depreciation, among other items, from net income determined in accordance with accounting principles generally accepted in the United States of America (“GAAP”). FFO is a non-GAAP financial measure. The most comparable GAAP measure is net income (loss) attributable to common shareholders. FFO attributable to common shareholders should not be considered as a substitute for net income (loss) attributable to common shareholders or any other measures derived in accordance with GAAP and may not be comparable to other similarly titled measures of other companies. FFO is calculated in accordance with the definition that was adopted by the Board of Governors of NAREIT.
Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen or fallen with market conditions, many industry analysts and investors have considered presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves. FFO, as defined by NAREIT, represents GAAP net income (loss), excluding extraordinary items as defined under GAAP and gains or losses from sales of previously depreciated real estate assets, plus certain non-cash items such as real estate asset depreciation and amortization, and after similar adjustments for unconsolidated partnerships and joint ventures.
Management believes that the use of FFO attributable to common shareholders, combined with net income (which remains the primary measure of performance), improves the understanding of operating results of REITs among the investing public and makes comparisons of REIT operating results more meaningful. Management believes that excluding gains or losses related to sales of previously depreciated real estate assets and excluding real estate asset depreciation and amortization enables investors and analysts to readily identify the operating results of the long-term assets that form the core of a REIT’s activity and assist them in comparing these operating results between periods or between different companies.
The following table shows a reconciliation of net income (loss) attributable to common shareholders to the calculation of FFO attributable to common shareholders for the three and nine months ended September 30, 2011 and 2010, respectively (in thousands):
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| | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2011 | | 2010 | | 2011 | | 2010 |
Net income (loss) attributable to common shareholders | $ | (32,076 | ) | | $ | 34,064 |
| | $ | (13,549 | ) | | $ | (23,591 | ) |
Adjustments: | | | | | | | |
Depreciation and amortization | 97,335 |
| | 97,913 |
| | 292,429 |
| | 264,086 |
|
Company share of joint venture depreciation and amortization | 8,531 |
| | 7,336 |
| | 24,798 |
| | 27,271 |
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Earnings from depreciable property sales—wholly owned | (651 | ) | | (11,402 | ) | | (83,315 | ) | | (31,300 | ) |
Earnings from depreciable property sales—share of joint venture | — |
| | — |
| | (91 | ) | | (2,308 | ) |
Noncontrolling interest share of adjustments | (2,835 | ) | | (2,018 | ) | | (6,206 | ) | | (6,611 | ) |
Funds From Operations attributable to common shareholders | $ | 70,304 |
| | $ | 125,893 |
| | $ | 214,066 |
| | $ | 227,547 |
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Results of Operations
A summary of our operating results and property statistics for the three and nine months ended September 30, 2011 and 2010, respectively, is as follows (in thousands, except number of properties and per share data): |
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| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2011 | | 2010 | | 2011 | | 2010 |
Rental and related revenue | $ | 233,555 |
| | $ | 228,299 |
| | $ | 698,619 |
| | $ | 642,489 |
|
General contractor and service fee revenue | 127,708 |
| | 132,351 |
| | 409,617 |
| | 414,391 |
|
Operating income | 49,930 |
| | 48,403 |
| | 219,744 |
| | 144,994 |
|
Net income (loss) attributable to common shareholders | (32,076 | ) | | 34,064 |
| | (13,549 | ) | | (23,591 | ) |
Weighted average common shares outstanding | 252,802 |
| | 251,866 |
| | 252,618 |
| | 234,468 |
|
Weighted average common shares and potential dilutive securities | 252,802 |
| | 257,383 |
| | 252,618 |
| | 234,468 |
|
Basic income (loss) per common share: | | | | | | | |
Continuing operations | $ | (0.14 | ) | | $ | 0.08 |
| | $ | (0.13 | ) | | $ | (0.22 | ) |
Discontinued operations | $ | 0.01 |
| | $ | 0.05 |
| | $ | 0.07 |
| | $ | 0.11 |
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Diluted income (loss) per common share: | | | | | | | |
Continuing operations | $ | (0.14 | ) | | $ | 0.08 |
| | $ | (0.13 | ) | | $ | (0.22 | ) |
Discontinued operations | $ | 0.01 |
| | $ | 0.05 |
| | $ | 0.07 |
| | $ | 0.11 |
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Number of in-service consolidated properties at end of period | 672 |
| | 633 |
| | 672 |
| | 633 |
|
In-service consolidated square footage at end of period | 115,791 |
| | 110,954 |
| | 115,791 |
| | 110,954 |
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Number of in-service joint venture properties at end of period | 127 |
| | 108 |
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