Item 7. Management’s Discussion and Analysis
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with the selected financial data and the consolidated financial statements and notes.
Overview of 2020 Performance and Company and Industry Trends
Cousins Properties Incorporated ("Cousins") (and collectively, with its subsidiaries, the "Company," "we," "our," or "us") is a publicly traded (NYSE: CUZ), self-administered, and self-managed real estate investment trust, or REIT. Cousins conducts substantially all of its business through Cousins Properties, LP ("CPLP"). Cousins owns in excess of 99% of CPLP and consolidates CPLP. CPLP owns Cousins TRS Services LLC, a taxable entity which owns and manages its own real estate portfolio and performs certain real estate related services for other parties. Our strategy is to create value for our stockholders through ownership of the premier urban office portfolio in the Sun Belt markets, with a particular focus on Atlanta, Austin, Charlotte, Phoenix, Tampa, and Dallas. This strategy is based on a disciplined approach to capital allocation that includes value-add acquisitions, selective development projects, and timely dispositions of non-core assets. This strategy is also based on a simple, flexible, and low-leveraged balance sheet that allows us to pursue compelling growth opportunities at the most advantageous points in the cycle. To implement this strategy, we leverage our strong local operating platforms within each of our major markets.
Consistent with our strategy, on June 14, 2019, we merged with TIER REIT, Inc. (“TIER”) in a stock-for-stock transaction (the "Merger"). As a result, we acquired an interest in nine operating office properties containing 5.8 million square feet of space, two office properties under development that are expected to add 620,000 square feet of space upon completion, and seven strategically located land parcels on which up to 2.5 mil lion square feet of additional space may be developed. As a part of this transaction, we issued $650 million in senior unsecured debt at a weighted average interest rate of 3.88%, which effectively replaced the majority of the TIER debt assumed in the Merger. We believe that this merger created a company with an attractive portfolio of trophy office assets balanced across the premier Sun Belt markets. We believe that the Merger has enhanced our position in our existing markets of Austin and Charlotte, provided a strategic entry into Dallas, and balanced our exposure in Atlanta. The Merger is also enhancing growth and providing value-add opportunities as a result of TIER's active and attractive development portfolio and land bank. As of December 31, 2020, our portfolio of real estate assets consisted of interests in 36 operating properties (35 office and one mixed-use), containing 19.4 million square feet space, and five projects (four office and one mixed-use) under active development.
During 2020, we completed multiple strategic acquisitions in our Charlotte market. During the fourth quarter, we purchased The RailYard, a 329,000 square foot operating property, for $201.3 million, including acquisition costs. In addition to The RailYard, we also acquired South End Station, a 3.4 acre parcel of land, and 303 Tremont, a 2.4 acre parcel of land, in the South End submarket for a combined gross purchase price of $46.9 million. During the second quarter, we purchased a 1,550 space parking garage adjacent to multiple of our properties for $85.3 million, including acquisition costs. We believe that collectively the investments create an advantageous concentration with compelling synergies in one of the best submarkets in the Sun Belt.
During 2020, we completed multiple dispositions of operating properties and interests in joint ventures. The most significant dispositions were as follows:
• In March 2020, we sold Hearst Tower, a 966,000 square foot office property in Charlotte, to Truist Financial Corporation ("Truist") for gross sales proceeds of $455.5 million upon execution of the purchase option included in the 561,000 square foot lease signed with Truist in 2019.
• In March 2020, we sold our interest in Charlotte Gateway Village, LLC ("Gateway"), a 50-50 joint venture with Bank of America Corporation ("BOA"), to BOA for $52.2 million which represented a 17% internal rate of return on our invested capital, as stipulated in the partnership agreement.
• In February 2020, we sold Woodcrest, a 386,000 square foot non-core office property in Cherry Hill, New Jersey that was acquired in the Merger, for a gross sales price of $25.3 million.
In 2020, we leased or renewed 1.4 million square feet of office space. The weighted average net effective rent per square foot, representing base rent less operating expense reimbursements and leasing costs, for new or renewed non-amenity leases with terms greater than one year was $24.50 per square foot. Cash basis net effective rent per square foot increased 13.1% on spaces that had been previously occupied in the past year. Cash basis net effective rent represents net rent at the end of the term paid by the prior tenant compared to the net rent at the beginning of the term paid by the current tenant. Our same property net operating income for the year decreased 0.5% and increased 0.7% on a cash basis. As a result of the COVID-19 pandemic, we have entered into lease amendments with certain tenants to provide payment deferrals without lease extensions.
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In addition, due to state and local regulations responding to the COVID-19 pandemic, we have seen changes in physical occupancy at our properties which is materially impacting net operating income from parking. Our same property cash basis net operating income adjusted for payment deferrals and excluding parking for the year increased 4.5%.
On a regular basis we review and, as appropriate, revise our corporate contingency plan, which addresses the steps necessary to respond to an unexpected interruption of business, including the unavailability of our corporate office space. Since March 2020, in accordance with the advice of the CDC due to the threat presented by the ongoing COVID-19 pandemic, our tenants widely adopted remote working for their office employees, and we increased our janitorial cleaning protocols in our buildings. The rental obligations under our leases have not been materially affected by the COVID-19 pandemic to date, and any requests for rent adjustments are addressed on a case-by-case basis. We also have worked closely with essential vendors, including the contractors and others involved in our development projects, to assess potential impact of appropriate and necessary distancing measures upon our operations and our development delivery timelines.
Although the impact to our business of the COVID-19 pandemic has not been severe to date, the long-term impact of the pandemic on our tenants or prospective tenants and the world-wide economy is uncertain and will depend on the scope, severity, and duration of the pandemic. A prolonged economic downturn resulting from the pandemic could adversely affect many of our tenants or prospective tenants, which could, in turn, adversely impact our business, financial condition, and results of operations.
Market Conditions
We believe that the Sun Belt region, and in particular the six core Sun Belt markets in which we operate, possess some of the most attractive economic and real estate fundamentals in the nation. Our markets are located in states that lead the nation in new job growth and net migration as residents relocate from the Northeast, Midwest, and West Coast to our markets. This migration, when combined with low levels of new supply, has led to steady office absorption and positive rent growth, supporting healthy office fundamentals. We believe that we are well positioned to benefit from, and ultimately outperform in, the current real estate environment.
Our Atlanta portfolio totals 7.2 million square feet, representing 35.0% of our Net Operating Income for the fourth quarter of 2020 and was 90.7% leased at December 31, 2020. In addition, we h ad two projects under development i n Atlanta at December 31, 2020, one office property and one mixed-use property, in which we hold 90% and 20% interests, respectively. Decline in nonfarm employment in Atlanta for the year ended December 31, 2020 was 3.0%, below the national average of 6.0%, and construction as a percentage of the total market square footage was 2.0% at year end. Our portfolio is well located, primarily in the Midtown, Buckhead, and Central Perimeter submarkets, with direct access to mass transit.
Our Austin portfolio totals 4.4 million square feet, representing 27.1% of our Net Operating Income for the fourth quarter of 2020 and was 94.3% leased at December 31, 2020. In addition, we have two projects under development in Austin, one owned in a 50-50 joint venture and one wholly-owned that together total 658,000 square feet and are a combined 92% leased. Decline in nonfarm employment in Austin for the year ended December 31, 2020 was 1.1%, below the national average of 6.0%, and construction as a percentage of the total market square footage was 7.6%. Our portfolio is predominantly in the central business district and Northwest submarket where vacancy is 10.5% and 9.3%, respectively. We believe that our dominant presence in Austin, combined with strong employment relative to the rest of the nation is favorable for our existing portfolio.
Our Charlotte portfolio totals 2.6 million square feet, representing 11.2% of our Net Operating Income for the fourth quarter of 2020 and was 83.8% leased at December 31, 2020. Decline in nonfarm employment in Charlotte for the year ended December 31, 2020 was 5.4%, below the national average of 6.0%, and construction as a percentage of the total market square footage was 6.1%. Our portfolio is located in the Uptown and South End submarkets where rent growth has significantly surpassed the national average. The overall market has benefited from Charlotte's strong population growth, which has increased at three times the national rate over the past decade. Strong demand and favorable economics have spurred a high level of new development across the market, specifically in Uptown where approximately 2.7 million square feet is currently under construction.
Our Phoenix portfolio totals 1.3 million square feet, representing 7.9% of our Net Operating Income for the fourth quarter of 2020 and was 94.2% leased at December 31, 2020. Decline in nonfarm employment in Phoenix for the year ended December 31, 2020 was 2.6%, below the national average of 6.0%, and construction as a percentage of the total market square footage was 1.5%. Phoenix has experienced population growth at more than twice the national average, more than two-thirds of which was from new residents from outside the metropolitan area. Our portfolio is located in the Tempe submarket, in close proximity to Arizona State University and its 80,000 students, where Class A office vacancy is 5.4%.
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Our Tampa portfolio totals 1.7 million square feet, representing 7.8% of Net Operating Income for the fourth quarter of 2020 and was 93.4% leased at December 31, 2020. Decline in nonfarm employment in Tampa for the year ended December 31, 2020 was 4.0%, below the national average of 6.0%, and construction as a percentage of the total market square footage was 1.3%. Metro-wide, the Tampa office market is experiencing low vacancy rates, and the Westshore submarket, where our portfolio is located, continues to achieve some of the highest rents in the metropolitan area, in part due to its central location and proximity to the Tampa airport.
Our Dallas portfolio totals 516,000 square feet, representing 3.1% of Net Operating Income for the fourth quarter of 2020 and was 94.5% leased at December 31, 2020. Decline in nonfarm employment in Dallas for the year ended December 31, 2020 was 2.5%, below the national average of 6.0%, and construction as a percentage of the total market square footage was 1.9%.
Critical Accounting Policies
Our financial statements are prepared in accordance with GAAP as outlined in the Financial Accounting Standards Board’s ("FASB") Accounting Standards Codification ("ASC"), and the notes to consolidated financial statements include a summary of the significant accounting policies for the Company. The preparation of financial statements in accordance with GAAP requires the use of certain estimates, a change in which could materially affect revenues, expenses, assets, or liabilities. Some of our accounting policies are considered to be critical accounting policies, which are ones that are both important to the portrayal of our financial condition, results of operations, and cash flows, and ones that also require significant judgment or complex estimation processes. Our critical accounting policies are as follows:
Revenue Recognition
Most of our revenues are derived from operating leases and are reflected as rental property revenues on the accompanying consolidated statements of operations. Several judgments and estimates are included in the rental property revenue recognition process including the determination of lease term, ownership of tenant improvements, lease modifications, and lease terminations.
Revenues derived from fixed lease payments, which exclude certain rental property revenue such as percentage rent and revenue related to the recovery of certain operating expenses from our tenants, are recognized on a straight-line basis over the term of the lease. We make significant assumptions and judgments in determining the lease term, including the judgments involved as to when a tenant has the right to use an underlying asset and assumptions when the lease provides the tenant with an extension or early termination option.
Most of our leases involve some form of improvements to leased space. We make significant judgments in reviewing various factors to assist in determining whether we or our tenants own the improvements. Those factors include, but are not limited to, whether or not the:
• Lease agreement’s terms obligate the tenant to construct or install specifically identified assets (i.e., the leasehold improvements);
• Tenant’s failure to make specified improvements is an event of default under which the landlord can require the lessee to make those improvements or otherwise enforce the landlord’s rights to those assets (or a monetary equivalent);
• Tenant is permitted to alter or remove the leasehold improvements without the landlord’s consent or without compensating the landlord for any lost utility or diminution in fair value;
• Tenant is required to provide the landlord with evidence supporting the cost of tenant improvements before the landlord pays the tenant for the tenant improvements;
• Landlord is obligated to fund cost overruns for the construction of leasehold improvements;
• Leasehold improvements are unique to the tenant or could reasonably be used by the lessor to lease to other parties; and
• Economic life of the leasehold improvements is such that a significant residual value of the assets is expected to accrue to the benefit of the landlord at the end of the lease term.
If we determine the improvements are our assets, we capitalize the cost of the improvements and recognize depreciation expense associated with such improvements over the shorter of the estimated useful life or the term of the lease. If the improvements are tenant assets, we defer the cost of improvements funded by us as a lease incentive asset and amortize it as a reduction of rental revenue over the term of the lease. Our determination of whether improvements are our assets or tenant assets also affects when we commence revenue recognition in connection with a lease.
We periodically enter into amendments to our leases. When a lease is amended, we need to determine whether (1) an additional right of use not included in the original lease is being granted as a result of the modification and (2) there is an
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increase in the lease payments that is commensurate with the standalone price for the additional right of use. If both of those conditions are met, the amendment is accounted for as a separate contract. If both of those conditions are not met, the amendment is accounted for as a lease modification. Most of our lease amendments result in a lease modification of our operating leases which will likely require us to reassess both the lease term and fixed lease payments, including considering any prepaid or accrued lease rentals relating to the original lease as a part of the lease payments for the modified lease.
Termination options in some of our leases allow the customer to terminate the lease prior to the end of the lease term under certain circumstances. Termination options require advance notification from the tenant and payment of a termination fee that reimburses us for a portion of the remaining rent under the original lease term and the undepreciated lease inception costs such as commissions, tenant improvements and lease incentives. Termination fee income, included in rental property revenue, is recognized on a straight-line basis from the date of the executed termination agreement through lease expiration when the amount of the fee is determinable and collectability of the fee is reasonably assured. This fee income is reduced on a straight-line basis by any accrued straight-line rent receivable related to the lease projected at the date of tenant vacancy.
Real Estate Carrying Value
The carrying values of our real estate assets are subject to several processes that involve a significant use of judgments and estimates. Those processes primarily include (i) purchase price allocations for acquired assets, (ii) depreciation and amortization and (iii) impairment. The judgments and estimates used in each of these processes have a material impact on our financial condition, results of operations and cash flows.
Purchase Price Allocations for Acquired Assets
We evaluate all real estate acquisitions to determine if the transactions qualify as an acquisition of assets or of a business. In cases where we acquire a pool of properties of varying property types in different markets, we must determine whether the acquisition qualifies as an asset acquisition or an acquisition of a business. For purposes of this review, we separate the assets acquired based on their unique and different risk characteristics, which may be by property type, geographic concentration, or other factors. If we determine that substantially all of the fair value is concentrated in a single identifiable asset or group of similar assets, generally 90% of total fair value of assets acquired, we account for the acquisition as an acquisition of assets. If we determine that there is no single or group of assets that make up substantially all of the fair value of assets acquired, we then evaluate whether the acquired set of assets includes an input and substantial process which create an output. If we determine that an input and substantial process creating an output are present, we account for the acquisition as an acquisition of a business. We use considerable judgment in determining whether the acquisition of a pool of assets is an acquisition of assets or of a business. Because acquisition costs are expensed for an acquisition of a business and capitalized for an acquisition of assets, results of operations could be materially different based on our determinations.
For acquisitions that are accounted for as an acquisition of an asset, we record the acquired tangible and intangible assets and assumed liabilities based on each asset and liability's relative fair value at the acquisition date to the total purchase price plus capitalized acquisition costs. For acquisitions that are accounted for as an acquisition of a business, we record the acquired tangible and intangible assets and assumed liabilities at fair value at the acquisition date. Fair value is based on estimated cash flow projections that utilize available market information and discount and/or capitalization rates as appropriate. Estimates of future cash flows are based on a number of factors including historical operating results, known and anticipated trends, and market and economic conditions. The acquired assets and assumed liabilities for an acquired operating property generally include, but are not limited to: land, buildings, and identified tangible and intangible assets and liabilities associated with in-place leases, including tenant improvements, leasing costs, value of above-market and below-market leases, and value of acquired in-place leases.
The fair value of the above-market or below-market component of an acquired lease is based upon the present value (calculated using a market discount rate) of the difference between the contractual rents to be paid pursuant to the lease over its remaining term and management’s estimate of the rents that would be paid using fair market rental rates and rent escalations at the date of acquisition over the remaining term of the lease. An identifiable intangible asset or liability is recorded if there is an above-market or below-market lease at an acquired property. The amounts recorded for above-market leases are included in other assets on the balance sheets, and the amounts for below-market leases are included in other liabilities on the balance sheets. These amounts are amortized on a straight-line basis as an adjustment to rental income over the remaining term of the applicable leases.
The fair value of acquired in-place leases is derived based on our assessment of lost revenue and costs incurred for the period required to lease the “assumed vacant” property to the occupancy level when purchased. This fair value is based on a variety of considerations including, but not necessarily limited to: (i) the value associated with avoiding the cost of originating the acquired in-place leases; (ii) the value associated with lost revenue related to tenant reimbursable operating
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costs estimated to be incurred during the assumed lease-up period; and (iii) the value associated with lost rental revenue from existing leases during the assumed lease-up period. Factors considered in performing these analyses include an estimate of the carrying costs during the expected lease-up periods, such as real estate taxes, insurance, and other operating expenses, current market conditions, and costs to execute similar leases, such as leasing commissions, legal, and other related expenses. The amounts recorded for in-place leases are included in intangible assets on the balance sheets. These amounts are amortized as an increase to depreciation and amortization expense over the remaining term of the applicable leases.
Depreciation and Amortization
We also depreciate or amortize operating real estate assets over their estimated useful lives using the straight-line method of depreciation. We use judgment when estimating the useful life of real estate assets and when allocating certain indirect project costs to projects under development, which are amortized over the useful life of the property once it becomes operational. Historical data, comparable properties, and replacement costs are some of the factors considered in determining useful lives and cost allocations.
Impairment
We also review our real estate assets on an asset group basis for impairment. We identify an asset group based on the lowest level of identifiable cash flows and take into consideration such things as shared expenses and amenities. This review includes our operating properties, properties under development, and land holdings.
The first step in this process is for us to determine whether an asset is considered to be held and used or held for sale. In order to be considered a real estate asset held for sale, we must, among other things, have the authority to commit to a plan to sell the asset in its current condition, have commenced the plan to sell the asset, and have determined that it is probable that the asset will sell within one year. If we determine that an asset is held for sale, we record an impairment if the fair value less costs to sell is less than the carrying amount. All real estate assets not meeting the held for sale criteria are considered to be held and used.
In the impairment analysis for assets held and used, we must determine whether there are indicators of impairment. For operating properties, these indicators could include a reduction in our estimated hold period, a significant decline in a property’s leasing percentage, a current period operating loss or negative cash flows combined with a history of losses at the property, a significant decline in lease rates for that property or others in the property’s market, a significant change in the market value of the property, or an adverse change in the financial condition of significant tenants. For land holdings, indicators could include an overall decline in the market value of land in the region, a decline in development activity for the intended use of the land, or other adverse economic and market conditions. For projects under development, indicators could include material budget overruns without a corresponding funding source, significant delays in construction, occupancy, or stabilization schedule, regulatory changes or economic trends that have a significant impact on the market, or an adverse change in the financial condition of a significant future tenant.
If we determine that an asset that is held and used has indicators of impairment, we must determine whether the undiscounted cash flows associated with the asset exceed the carrying amount of the asset. If the undiscounted cash flows are less than the carrying amount of the asset, we reduce the carrying amount of the asset to fair value.
In calculating the undiscounted net cash flows of an asset, we must estimate a number of inputs. We must estimate future rental rates, future capital expenditures, future operating expenses, and market capitalization rates for residual values, among other things. In addition, if there are alternative strategies for the future use of the asset, we assess the probability of each alternative strategy and perform a probability-weighted undiscounted cash flow analysis to assess the recoverability of the asset. We use considerable judgment in determining the alternative strategies and in assessing the probability of each strategy selected.
In determining the fair value of an asset, we exercise judgment on a number of factors. We may determine fair value by using a discounted cash flow calculation or by utilizing comparable market information. We must determine an appropriate discount rate to apply to the cash flows in the discounted cash flow calculation. We use judgment in analyzing comparable market information because no two real estate assets are identical in location and price. The estimates and judgments used in the impairment process are highly subjective and susceptible to frequent change.
In addition to our real estate assets, we review each of our investments in unconsolidated joint ventures for impairment. As part of this analysis, we first determine whether there are any indicators of impairment at any property held in a joint venture investment. If indicators of impairment are present for any of our investments in joint ventures, we calculate the fair value of the investment. If the fair value of the investment is less than the carrying value of the investment, we determine whether the impairment is temporary or other than temporary. If we assess the impairment to be temporary, we do not record
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an impairment charge. If we conclude that the impairment is other than temporary, we record an impairment charge. We use considerable judgment in the determination of whether there are indicators of impairment present and in the assumptions, estimations, and inputs used in calculating the fair value of the investment.
Development Cost Capitalization
We are involved in all stages of real estate ownership, including development. Prior to the point at which a project becomes probable of being developed (defined as more likely than not), we expense predevelopment costs. After we determine a project is probable, all subsequently incurred predevelopment costs, as well as interest and real estate taxes on qualifying assets and certain internal personnel and associated costs directly related to the project under development, are capitalized in accordance with accounting rules. If we abandon development of a project that had earlier been deemed probable, we charge all previously capitalized costs to expense. If this occurs, our predevelopment expenses could rise significantly. The determination of whether a project is probable requires judgment. If we determine that a project is probable, interest, general and administrative, and other expenses could be materially different than if we determine the project is not probable.
During the predevelopment period of a probable project and the period in which a project is under construction, we capitalize all direct and indirect costs associated with planning, developing, and constructing the project. Determination of what costs constitute direct and indirect project costs requires us, in some cases, to exercise judgment. If we determine certain costs to be direct or indirect project costs, amounts recorded in projects under development on the balance sheet and amounts recorded in general and administrative and other expenses on the statements of operations could be materially different than if we determine these costs are not directly or indirectly associated with the project.
Once a certain project is constructed and deemed substantially complete and ready for occupancy, carrying costs, such as real estate taxes, interest, internal personnel costs, and associated costs, are expensed as incurred. Determination of when construction of a project is substantially complete and held available for occupancy requires judgment. We consider projects and/or project phases to be both substantially complete and held for occupancy at the earlier of the date on which the project or phase reached economic occupancy of 90% or one year after its initial occupancy. Our judgment of the date the project is substantially complete has a direct impact on our operating expenses and net income for the period.
Stock-based Compensation
We have several types of stock-based compensation plans. For market-based awards, we are required to estimate fair values on the grant date (for equity-classified awards) and at each quarter-end (for liability-classified awards). The fair values of these awards are estimated using complex pricing valuation models that require a number of estimates and assumptions. For performance-based awards contingent on our future earnings, we must estimate future earnings quarterly and adjust the compensation costs accordingly.
We use considerable judgments in determining the fair value of market-based awards as well as estimating our progress towards performance-based awards. Compensation expense associated with these awards could vary significantly based upon these estimates.
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Results of Operations For The Year Ended December 31, 2020
General
Our financial results for the year ended December 31, 2020 have been affected by the various acquisitions, dispositions, and completed developments during 2020 as well as the Merger and transactions with Norfolk Southern Railway Company ("NS") in 2019. Net income available to common stockholders for the year ended 2020 and 2019 was $237.3 million and $150.4 million, respectively. We detail below material changes in the components of net income available to common stockholders for the year ended 2020 compared to 2019.
See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations" from our 2019 Annual Report on Form 10-K for a comparison of 2019 to 2018 financial results.
Rental Property Revenues and Rental Property Operating Expenses
The following results include the performance of our Same Property portfolios. Our Same Property portfolios include office properties that have been fully operational in each of the comparable reporting periods. A fully operational property is one that has achieved 90% economic occupancy for each of the periods presented or has been substantially complete and owned by us for each of the periods presented. Same Property amounts for the 2020 versus 2019 comparison are from properties that were owned as of January 1, 2019 through December 31, 2020.
We use Net Operating Income ("NOI"), a non-GAAP financial measure, to measure the operating performance of our properties. NOI is also widely used by industry analysts and investors to evaluate performance. NOI, which is rental property revenues (excluding termination fees) less rental property operating expenses, excludes certain components from net income in order to provide results that are more closely related to a property's results of operations. Certain items, such as interest expense, while included in net income, do not affect the operating performance of a real estate asset and are often incurred at the corporate level as opposed to the property level. As a result, we use only those income and expense items that are incurred at the property level to evaluate a property's performance. Depreciation, amortization, and impairment are also excluded from NOI. Same Property NOI allows analysts, investors, and management to analyze continuing operations and evaluate the growth trend of our portfolio.
Rental property revenues, rental property operating expenses, and NOI changed between the 2020 and 2019 periods as follows ($ in thousands):
Year Ended December 31,
2020 2019 $ Change % Change
Rental Property Revenues
Same Property $ 442,692 $ 454,560 $ (11,868) (3) %
Legacy TIER Properties 207,302 113,115 94,187 83 %
Other Non-Same Property 71,889 61,076 10,813 18 %
$ 721,883 $ 628,751 $ 93,132 15 %
Rental Property Operating Expenses
Same Property $ 152,871 $ 162,746 $ (9,875) (6) %
Legacy TIER Properties 76,238 42,441 33,797 80 %
Other Non-Same Property 21,741 16,959 4,782 28 %
$ 250,850 $ 222,146 $ 28,704 13 %
Same Property NOI $ 287,509 $ 289,309 $ (1,800) (1) %
Legacy TIER Property NOI 130,874 70,071 60,803 87 %
Non-Same Property NOI 48,815 39,997 8,818 22 %
Total NOI $ 467,198 $ 399,377 $ 67,821 17 %
Same property rental property revenues decreased between 2020 and 2019 primarily due to a decrease in 2020 parking revenues resulting from decreased physical occupancy at our properties. Same property rental property operating expenses decreased between 2020 and 2019 primarily due to a decrease in expenses at properties resulting from lower physical occupancy in 2020.
Revenues and expenses for Legacy TIER properties represent amounts recorded for the properties acquired in the June 2019 Merger.
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Revenues and expenses of Other Non-Same Property increased between 2020 and 2019 primarily as a result of the addition of 1200 Peachtree in March 2019 and of Terminus, which was consolidated in October 2019 when we purchased our partner's interest in Terminus Office Holdings LLC ("TOH"), partially offset by the sale of Hearst Tower in March of 2020.
Fee Income
Fee income decreased $10.3 million (36.1%) between 2020 and 2019 primarily driven by timing of fee income related to the 2019 transactions with NS.
General and Administrative Expenses
General and administrative expenses decreased $10.0 million (26.9%) between 2020 and 2019 primarily driven by long-term compensation expense decreases as a result of fluctuations in our common stock price for our liability-classified awards.
Interest Expense
Interest expense, net of amounts capitalized, increased $6.6 million (12.3%) between 2020 and 2019 primarily due to interest incurred on the unsecured senior notes issued in June 2019.
Depreciation and Amortization
Depreciation and amortization changed between the 2020 and 2019 periods as follows ($ in thousands):
Year Ended December 31,
2020 2019 $ Change % Change
Depreciation and Amortization
Same Property $ 157,752 $ 164,317 $ (6,565) (4) %
Legacy TIER Properties 100,247 55,192 45,055 82 %
Other Non-Same Property 30,649 37,640 (6,991) (19) %
Total Depreciation and Amortization $ 288,648 $ 257,149 $ 31,499 12 %
Depreciation and amortization for Legacy TIER properties represent amounts recorded on the properties acquired in the June 2019 Merger.
Depreciation and amortization of Other Non-Same Property decreased between 2020 and 2019 primarily as a result of the sale of Hearst in the first quarter of 2020; offset by Terminus, which was consolidated in the fourth quarter of 2019 when we purchased our partner's interest in TOH.
Transaction Costs
Included in transaction costs in both 2020 and 2019 are the costs associated with the Merger. These costs included legal, accounting, and financial advisory fees as well as the cost of due diligence work and the costs of combining the operations of TIER with the Company.
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Income from Unconsolidated Joint Ventures
Income from unconsolidated joint ventures consisted of the following in 2020 and 2019 ($ in thousands):
Year Ended December 31,
2020 2019 $ Change % Change
Net operating income $ 18,836 $ 32,413 $ (13,577) (42) %
Termination fee income 9 16 (7) (44) %
Other income 61 148 (87) (59) %
Depreciation and amortization (8,740) (14,158) 5,418 38 %
Interest expense (2,071) (5,738) 3,667 64 %
Net loss on sale of investment property (148) (15) (133) (887) %
Income from unconsolidated joint ventures $ 7,947 $ 12,666 $ (4,719) (37) %
Net operating income, depreciation and amortization, and interest expense from unconsolidated joint ventures decreased between 2020 and 2019 primarily due to the consolidation of Terminus in October 2019 when we purchased our partner's interest in TOH and the sale of our interest in Gateway Village in March of 2020.
Gain on Sales of Investments in Unconsolidated Joint Ventures
The gain on investment property transactions for the year ended December 31, 2020 primarily includes the sale of our interests in the Wildwood Associates and Gateway Village joint ventures. The capitalization rate of Gateway Village was not a determinant of the sales price as, per the joint venture agreement, our interest was valued at a 17% internal rate of return on our invested capital. There was no capitalization rate associated with the sale of our interest in the Wildwood Associates joint venture as the underlying asset was land.
Gain on Investment Property Transactions
The gain on investment property transactions for the year ended December 31, 2020 includes the sale of Hearst Tower. The combined sales prices of the Heart Tower and Woodcrest dispositions represented a weighted average capitalization rate of 5.1%. Capitalization rates are calculated by dividing projected annualized NOI by the sales price.
Net Income Attributable to Noncontrolling Interests
Net income attributable to noncontrolling interests includes the outside parties' share of the net income of CPLP as well as that of certain other consolidated entities. Net income attributable to noncontrolling interests decreased $1.4 million (63.1%) between 2020 and 2019 primarily driven by the redemption of 1.7 million limited partnership units in CPLP completed in the first quarter of 2020, partially offset by the increase in net income in 2020.
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Funds from Operations
The table below shows Funds from Operations Available to Common Stockholders (“FFO”), a non-GAAP financial measure, and the related reconciliation to net income available to common stockholders for the Company. The Company calculates FFO in accordance with the National Association of Real Estate Investment Trusts’ ("NAREIT") definition, which is net income available to common stockholders (computed in accordance with GAAP), excluding extraordinary items, cumulative effect of change in accounting principle and gains on sale or impairment on depreciable property, plus depreciation and amortization of real estate assets, and after adjustments for unconsolidated partnerships and joint ventures to reflect FFO on the same basis.
FFO is used by industry analysts and investors as a supplemental measure of a REIT’s operating performance. Historical cost accounting for real estate assets 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 investors and analysts have considered presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves. Thus, NAREIT created FFO as a supplemental measure of REIT operating performance that excludes historical cost depreciation, among other items, from GAAP net income. The use of FFO, combined with the required primary GAAP presentations, has been fundamentally beneficial, improving the understanding of operating results of REITs among the investing public and making comparisons of REIT operating results more meaningful. Our management evaluates operating performance in part based on FFO. Additionally, our management uses FFO, along with other measures, to assess performance in connection with evaluating and granting incentive compensation to our officers and other key employees. The reconciliations of net income available to common stockholders to FFO and earnings per share to FFO per share are as follows for the years ended December 31, 2020 and 2019 (in thousands, except per share information):
Year Ended December 31,
2020 2019
Dollars Weighted Average Common Shares Per Share Amount Dollars Weighted Average Common Shares Per Share Amount
Net Income Available to Common Stockholders $ 237,278 148,277 $ 1.60 $ 150,418 128,060 $ 1.17
Noncontrolling interest related to unitholders 315 297 — 1,952 1,744 —
Conversion of stock options — 8 — — 27 —
Conversion of unvested restricted stock units — 54 — — — —
Net Income — Diluted 237,593 148,636 1.60 152,370 129,831 1.17
Depreciation and amortization of real estate assets:
Consolidated properties 287,960 — 1.94 255,349 — 1.97
Share of unconsolidated joint ventures 8,740 — 0.06 14,158 — 0.11
Partners' share of real estate depreciation (742) — — (521) — —
(Gain)/loss on sale of depreciated properties:
Consolidated properties (90,105) — (0.61) (92,578) — (0.72)
Share of unconsolidated joint ventures (450) — — 15 — —
Investments in unconsolidated joint ventures (44,578) — (0.31) — — —
Impairment 14,829 — 0.09 — — —
Funds From Operations $ 413,247 148,636 $ 2.77 $ 328,793 129,831 $ 2.53
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Table of C ontents
Net Operating Income
Company management evaluates the performance of its property portfolio in part based on NOI. NOI represents rental property revenues (excluding termination fees) less rental property operating expenses. NOI is not a measure of cash flows or operating results as measured by GAAP, is not indicative of cash available to fund cash needs, and should not be considered an alternative to cash flows as a measure of liquidity. All companies may not calculate NOI in the same manner. The Company considers NOI to be an appropriate supplemental measure to net income as it helps both management and investors understand the core operations of the Company's operating assets. NOI excludes corporate general and administrative expenses, interest expense, depreciation and amortization, impairments, gains/loss on sales of real estate, and other non-operating items.
The following table reconciles net income (loss) to NOI for consolidated properties for each periods (in thousands):
Year Ended December 31,
2020
2019
Net Income $ 238,114 $ 152,683
Fee income (18,226) (28,518)
Termination fee income (3,835) (7,228)
Other income (231) (246)
Reimbursed expenses 1,580 4,004
General and administrative expenses 27,034 37,007
Interest expense 60,605 53,963
Impairment 14,829 —
Depreciation and amortization 288,648 257,149
Transaction costs 428 52,881
Other expenses 2,091 1,109
Income from unconsolidated joint ventures (7,947) (12,666)
Gain on sale of investment in unconsolidated joint ventures (45,767) —
Gain on investment property transactions (90,125) (110,761)
Net Operating Income $ 467,198 $ 399,377
Liquidity and Capital Resources
Our primary short-term and long-term liquidity needs include the following:
• property and land acquisitions;
• expenditures on development projects;
• building improvements, tenant improvements, and leasing costs;
• principal and interest payments on indebtedness;
• general and administrative costs; and
• common stock dividends and distributions to outside unitholders of CPLP.
We may satisfy these needs with one or more of the following:
• cash and cash equivalents on hand;
• net cash from operations;
• proceeds from the sale of assets;
• borrowings under our Credit Facility;
• proceeds from mortgage notes payable;
• proceeds from construction loans;
• proceeds from unsecured loans;
• proceeds from offerings of equity securities; and
• joint venture formations.
While we expect to have sufficient liquidity to meet our obligations for the foreseeable future, the COVID-19 pandemic and associated responses could adversely impact our future cash flows and financial condition.
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Table of C ontents
Financial Condition
A key component of our strategy is to maintain a conservative balance sheet with leverage and liquidity that enables us to be positioned for future growth. Our leverage metrics at December 31, 2020, which include net debt to EBITDA re , net debt to undepreciated assets, and net debt to total market capitalization, were among the strongest within our sector of public office REITS. As of December 31, 2020, we had $232.4 million outstanding under our Credit Facility with the ability to borrow an additional $767.6 million. We also had $6.1 million in cash, cash equivalents, and restricted cash on hand at December 31, 2020.
Contractual Obligations and Commitments
The following table sets forth information as of December 31, 2020 with respect to our outstanding contractual obligations and commitments (in thousands):
Total Less than 1 Year 1-3 Years 3-5 Years More than 5 Years
Contractual Obligations:
Company debt:
Unsecured credit facility $ 232,400 $ — $ 232,400 $ — $ —
Unsecured senior notes 1,000,000 — — 250,000 750,000
Term loan 250,000 250,000 — — —
Mortgage notes payable 677,893 16,368 355,557 85,842 220,127
Interest commitments (1) 365,112 63,336 109,710 96,145 95,921
Ground leases 215,172 3,121 5,610 8,852 197,589
Other operating leases 211 149 62 — —
Total contractual obligations $ 2,740,788 $ 332,974 $ 703,339 $ 440,839 $ 1,263,637
Commitments:
Unfunded tenant improvements and construction obligations $ 153,546 $ 140,263 $ 13,283 $ — $ —
Performance bonds 577 577 — — —
Total commitments $ 154,123 $ 140,840 $ 13,283 $ — $ —
(1) Interest on variable rate obligations is based on rates effective as of December 31, 2020.
In addition, we have several standing or renewable service contracts mainly related to the operation of our buildings. These contracts were entered into in the ordinary course of business and are generally one year or less. These contracts are not included in the above table and are usually reimbursed in whole or in part by tenants.
Debt Associated with the Merger
In connection with the Merger, we assumed and immediately repaid $679.0 million in unsecured variable rate debt of TIER with our credit facility. We also assumed the Legacy Union One mortgage note with a $66.0 million principal balance and a fixed interest rate of 4.24%. Subsequent to the Merger, we closed a $650 million private placement of unsecured senior notes which were issued in three tranches with maturities from eight to ten years and a weighted average fixed interest rate of 3.88%. Proceeds from the unsecured senior notes were used to repay amounts outstanding under the credit facility incurred in the Merger.
Other Loan Activity
In February 2020, we prepaid in full the $23.0 million Meridian Mark Plaza mortgage note, without penalty.
In 2019, we purchased our partner's interest in TOH. With this transaction, we consolidated TOH and recorded the assets and liabilities at fair value, assuming the venture's mortgage notes. Terminus 100 has a $115.0 million mortgage note, which is due in 2023 and has a 5.25% fixed interest rate. Terminus 200 has a $74.4 million mortgage note, which is due in 2023 and has a 3.79% fixed interest rate.
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Credit Facility
Our $1 billion Credit Facility matures on January 3, 2023. The Credit Facility contains financial covenants that require, among other things, the maintenance of an unencumbered interest coverage ratio of at least 1.75x; a fixed charge coverage ratio of at least 1.50x; a secured leverage ratio of no more than 40%; and an overall leverage ratio of no more than 60%. The Credit Facility also contains customary representations and warranties and affirmative and negative covenants, as well as customary events of default. The amounts outstanding under the Credit Facility may be accelerated upon the occurrence of any events of default. We are in compliance with all covenants of the Credit Facility.
The interest rate applicable to the Credit Facility varies according to our leverage ratio, and may, at our election, be determined based on either (1) the current LIBOR plus a spread of between 1.05% and 1.45%, or (2) the greater of Bank of America's prime rate, the federal funds rate plus 0.50%, or the one-month LIBOR plus 1.0% (the "Base Rate"), plus a spread of between 0.10% or 0.45%, based on leverage.
At December 31, 2020, the Credit Facility's spread over LIBOR was 1.05%. The amount that we may draw under the Credit Facility is a defined calculation based on the Company's unencumbered assets and other factors. The total available borrowing capacity under the Credit Facility was $767.6 million at December 31, 2020.
Unsecured Senior Notes
At December 31, 2020, we had $1 billion in unsecured senior notes outstanding that were issued in five tranches with maturity dates that range from 2025 to 2029. The weighted average fixed interest rates on these notes is 3.91%.
The unsecured senior notes contain financial covenants that require, among other things, the maintenance of an unencumbered interest coverage ratio of at least 1.75x; a fixed charge coverage ratio of at least 1.50x; an overall leverage ratio of no more than 60%; and a secured leverage ratio of no more than 40%. The senior notes also contain customary representations and warranties and affirmative and negative covenants, as well as customary events of default. We are in compliance with all covenants of the unsecured senior notes.
Term Loan
We have a $250 million term loan that matures on December 2, 2021 (the "Term Loan"). The Term Loan contains financial covenants consistent with those of the Credit Facility. The Term Loan bears interest at LIBOR plus a spread, based on our leverage ratio, as defined in the Term Loan.
Other Debt Information
Our existing mortgage debt is primarily non-recourse, fixed-rate mortgage notes secured by various real estate assets. We expect to either refinance our non-recourse mortgage loans at maturity or repay the mortgage loans with other capital resources, includin g ou r credit facility, unsecured debt, non-recourse mortgages, construction loans, the sale of assets, joint venture equity, the issuance of common stock, the issuance of preferred stock, or the issuance of units of CPLP. Many of our non-recourse mortgages contain covenants which, if not satisfied, could result in acceleration of the maturity of the debt. We expect to either refinance the non-recourse mortgages at maturity or repay the mortgages with proceeds from asset sales, debt, or other capital sources. We are in compliance with all covenants of our existing non-recourse mortgages.
75% of our debt bears interest at a fixed rate. Our variable-interest debt instruments, including our Credit Facility and Term Loan, may use LIBOR as a benchmark for establishing the rate. LIBOR has been the subject of regulatory guidance and proposals for reform and in July 2017, the United Kingdom's Financial Conduct Authority (the authority that regulates LIBOR) announced it intends to stop compelling banks to submit rates for the calculation of LIBOR after 2021. These reforms may cause LIBOR to no longer be provided or to perform differently than in the past. Recent proposals for LIBOR reforms may result in the establishment of new methods of calculating LIBOR or the establishment of one or more alternative benchmark rates. If LIBOR is no longer widely available, or otherwise at our option, our variable-interest debt instruments, including our Credit Facility and term loan facilities, provide for alternate interest rate calculations.
There can be no assurances as to what alternative interest rates may be and whether such interest rates will be more or less favorable than LIBOR and any other unforeseen impacts of the potential discontinuation of LIBOR. The Company intends to continue monitoring the developments with respect to the planned phasing out of LIBOR after 2021 and work with its lenders to ensure any transition away from LIBOR will have minimal impact on its financial condition, but can provide no assurances regarding the impact of the discontinuation of LIBOR.
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Future Capital Requirements
To meet capital requirements for future investment activities over the long-term, we intend to actively manage our portfolio of properties and strategically sell assets to exit our non-core holdings and reposition our portfolio of income-producing assets geographically. We expect to continue to utilize cash retained from operations as well third-party sources of capital such as indebtedness to fund future commitments as well as utilize construction facilities for some development assets, if available and under appropriate terms.
We may also generate capital through the issuance of securities that include common or preferred stock, warrants, debt securities, depositary shares or the issuance of CPLP limited partnership units.
Our business model is dependent upon raising or recycling capital to meet obligations and to fund development and acquisition activity. If one or more sources of capital are not available when required, we may be forced to reduce the number of projects we acquire or develop and/or raise capital on potentially unfavorable terms, or we may be unable to raise capital, which could have an adverse effect on our financial position or results of operations.
Cash Flows
We report and analyze our cash flows based on operating activities, investing activities, and financing activities. Cash, cash equivalents, and restricted cash totaled $6.1 million and $17.6 million at December 31, 2020 and 2019, respectively. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Cash Flows" from our 2019 Annual Report on Form 10-K for a discussion of the changes in cash flows between 2019 and 2018. The following table sets forth the changes in cash flows (in thousands):
Year Ended December 31, $ Change
2020 2019
Net cash provided by operating activities $ 351,088 $ 303,177 $ 47,911
Net cash used in investing activities (132,463) (357,424) 224,961
Net cash provided by (used in) financing activities (230,095) 69,160 (299,255)
The reasons for significant increases and decreases in cash flows between the periods are as follows:
Cash Flows from Operating Activities. Cash provided by operating activities increased $47.9 million between the 2020 and 2019 periods primarily due to net cash received from operations of properties acquired in the Merger in June 2019, of 1200 Peachtree, which was acquired in March 2019, of Terminus, which was consolidated in October 2019 when we purchased our partner's interest in TOH, and of The RailYard, which was acquired in December 2020. The increases are partially offset by the disposition of operations at Hearst Tower, Woodcrest, and the Gateway Village joint venture which were sold in the first quarter of 2020, and by decreased parking revenue earned at properties resulting from decreased physical occupancy at our properties.
Cash Flows from Investing Activities. Cash used in investing activities decreased $225.0 million between the 2020 and 2019 periods primarily due to cash received from the sales of the Hearst Tower and Woodcrest operating properties, combined with the sales of our interests in the Gateway Village and Wildwood Associates joint ventures, which partially offsets the acquisitions of The RailYard and a parking garage in Charlotte as well as an increase in building and tenant improvements.
Cash Flows from Financing Activities. Cash flows from financing activities decreased $299.3 million between the 2020 and 2019 periods primarily due to funding of the Unsecured Senior Notes in 2019.
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Capital Expenditures. We incur capital expenditures related to our real estate assets that include the acquisition of properties, the development of new properties, the redevelopment of existing or newly purchased properties, leasing costs for new or replacement tenants and ongoing property repairs and maintenance.
Capital expenditures for assets we develop or acquire and then hold and operate are included in the property acquisition, development, and tenant asset expenditures line item within investing activities on the statements of cash flows. Components of expenditures included in this line item for the years ended December 31, 2020 and 2019 are as follows (in thousands):
2020 2019
Acquisition of properties $ 285,606 $ 221,686
Projects under development 43,902 118,301
Operating properties—building improvements 139,247 27,970
Operating properties—leasing costs 40,744 91,726
Purchase of land held for investment 64,001 10,290
Capitalized interest 14,324 11,220
Capitalized salaries 6,033 6,331
Accrued capital expenditures adjustment 25,745 (4,891)
Total property acquisition, development and tenant asset expenditures $ 619,602 $ 482,633
Capital expenditures increased $137.0 million between December 31, 2020 and 2019 primarily due to continued building and tenant improvements at Domain 12, which began recognizing income in the second quarter of 2020, and due to tenant improvements at Terminus, Northpark, 10000 Avalon, and Corporate Center. These increases were partially offset by a decrease in development expenditures at 120 West Trinity, 10000 Avalon, and Domain 10 which have begun preliminary operational activity and are in the final stages of development. Tenant improvements and leasing costs, as well as related capitalized personnel costs, are a function of the number and size of executed new leases or renewals of existing leases. The amount of tenant improvements and leasing costs on a per square foot basis for 2020 and 2019 were as follows:
2020 2019
New leases $12.04 $6.29
Renewal leases $5.46 $6.24
Expansion leases $8.62 $8.64
The amounts of tenant improvement and leasing costs on a per square foot basis vary by lease and by market. Average leasing costs during 2020 increased for new leases primarily due to a 2019 full-building lease at 1200 Peachtree with NS that has lower than average tenant improvement and leasing costs, and due to a 2020 multi-floor, longer term lease that has higher than average tenant improvements and leasing costs.
Dividends. We paid common dividends of $176.3 million and $142.9 million in 2020 and 2019, respectively. We funded these dividends with cash provided by operating activities. We expect to fund our future quarterly common dividends with cash provided by operating activities, also using proceeds from investment property sales, distributions from unconsolidated joint ventures, and indebtedness, if necessary.
On a quarterly basis, we review the amount of our common dividend in light of current and projected future cash provided by operating activities and also consider the requirements needed to maintain our REIT status. In addition, we have certain covenants under our Credit Facility which could limit the amount of common dividends paid. In general, common dividends of any amount can be paid as long as leverage, as defined in our credit agreements, is less than 60% and we are not in default under our facility. Certain conditions also apply in which we can still pay common dividends if leverage is above that amount. We routinely monitor the status of our common dividend payments in light of the covenants of our credit agreements.
Effects of Inflation. We attempt to minimize the effects of inflation on income from operating properties by providing periodic fixed-rent increases and/or pass-through of certain operating expenses of properties to tenants or, in certain circumstances, rents tied to tenants’ sales.
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Off Balance Sheet Arrangements
General. We have a number of off balance sheet joint ventures with varying structures, as described in note 8 to our consolidated financial statements. The joint ventures in which we have an interest are involved in the ownership and/or development of real estate. A venture will fund capital requirements or operational needs with cash from operations or financing proceeds. If additional capital is deemed necessary, a venture may request a contribution from the partners, and we will evaluate such request. Except as previously discussed, based on the nature of the activities conducted in these ventures, management cannot estimate with any degree of accuracy amounts that we may be required to fund in the short or long-term. However, management does not believe that additional funding of these ventures will have a material adverse effect on our financial condition or results of operations.
Debt. At December 31, 2020, our unconsolidated joint ventures had aggregate outstanding indebtedness to third parties of $230.3 million. This debt represents mortgage or construction loans, most of which are non-recourse to us. In addition, in certain instances, we provide “non-recourse carve-out guarantees” on these non-recourse loans. We guarantee 12.5% of the loan amount related to the Carolina Square construction loan, which has a lending capacity of $79.7 million, and $77.0 million outstanding at December 31, 2020.