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 2021 Performance and Company and Industry Trends
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, Dallas, and Nashville. This strategy is based on a disciplined approach to capital allocation that includes opportunistic acquisitions, selective development projects, and timely dispositions of non-core assets with a goal of maintaining a portfolio of new and efficient properties with lower capital expenditure requirements. 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 utilize our strong local operating platforms within each of our major markets.
During 2021, we completed multiple strategic acquisitions of operating properties and land parcels and entered into two joint ventures. We acquired 725 Ponce, a 372,000 square foot office property in Midtown Atlanta, for a gross price of $300.2 million; Heights Union, a 294,000 square foot office property in Tampa, for a gross price of $144.8 million; and our partners' 50% interest in 300 Colorado, a 369,000 square foot office building in downtown Austin, for a gross price of $162.5 million. We also acquired a 0.7 acre land parcel in Atlanta for a gross price of $10.0 million related to a potential future development in Midtown Atlanta and a 0.2 acre land parcel in Atlanta, adjacent to our 3344, 3348, and 3350 operating properties, for a gross price of $8.0 million that is held in a 95% owned consolidated joint venture. We entered into a 50/50 joint venture to develop Neuhoff, a mixed-use project in Nashville, which will include 448,000 square feet of office and retail space as well as 542 multi-family units, for an estimated investment of $281.3 million at our share. In addition, we entered into a 50/50 joint venture to own 715 Ponce, a land parcel adjacent to 725 Ponce, with an initial contribution of $4.0 million.
During 2021, we completed multiple dispositions of operating properties and interests in joint ventures, using the proceeds to fund the investment activity mentioned above. We sold 816 Congress, a 435,000 square foot office building in downtown Austin, for a gross price of $174.0 million; One South at the Plaza, an 891,000 square foot office property in Charlotte, for a gross price of $271.5 million; Burnett Plaza, a one million square foot office building in Fort Worth, for a gross price of $137.5 million; and a 0.7 acre land parcel in Phoenix, adjacent to our 100 Mill development, to a hotel developer for a gross price of $6.4 million. In addition, we sold our 50% investment in Dimensional Place, a 281,000 square foot office property in Charlotte, for a gross price of $60.8 million. We sold
In 2021, we leased or renewed 2.1 million square feet of office space. The weighted average net effective rent per square foot, representing base rent excluding operating expense reimbursements and leasing costs, for new or renewed non-amenity leases with terms greater than one year, was $25.55 per square foot. Cash-basis net effective rent per square foot increased 15.1% 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% on a straight-line basis and increased 3.5% on a cash-basis.
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. During 2021, many, but not all, of our tenants began to bring employees back to the office at least a few days a week, decreasing the time their teams were working remotely and increasing the physical occupancy at our properties.
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.
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Market Conditions
We believe that the Sun Belt region, and in particular the seven 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 relatively 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 7.9 million square feet, representing 39.8% of our Net Operating Income for the fourth quarter of 2021 and was 89.1% leased at December 31, 2021. Market-wide Class A leasing activity in Atlanta represented 51.3% of total leasing activity in 2021 while representing only 40.7% of total inventory, and construction as a percentage of the total market square footage was 3.0% at December 31, 2021. Atlanta recorded its highest annual total for construction completions in market history, delivering 3.4 million square feet of new product in 2021; of which, 81% has already been leased. We believe our portfolio of operating assets and land holdings for future development, which is well located primarily in the Midtown, Buckhead, and Central Perimeter submarkets, with direct access to mass transit, is well positioned to meet the strong demand in the market.
Our Austin portfolio totals 4.2 million square feet, representing 26.8% of our Net Operating Income for the fourth quarter of 2021 and was 95.5% leased at December 31, 2021. In addition, we have two projects under development in Austin. Domain 9 is a 338,000 square foot project, located in the Domain submarket, and the office portion is 100% leased. 300 Colorado, a 369,000 square foot office property, is located in the central business district and is 88% leased. Market-wide Class A leasing activity in Austin represented 55.8% of total leasing activity in 2021 while representing only 40.9% of total inventory, and construction as a percentage of the total market square footage was 13.1% at December 31, 2021. Our portfolio is predominantly in the central business district and Domain submarket where vacancy is 18.7% and 6.0%, respectively. We believe that our dominant presence in Austin, combined with strong demand for Class A office space, is favorable for our existing portfolio.
Our Charlotte portfolio totals 1.4 million square feet, representing 9.1% of our Net Operating Income for the fourth quarter of 2021 and was 96.3% leased at December 31, 2021. Class A leasing activity in Charlotte represented 47.4% of total leasing activity in 2021 while representing only 41.5% of total inventory, and construction as a percentage of the total market square footage was 8.1% at December 31, 2021. 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 and South End where approximately 3.0 million square feet is currently under construction.
Our Tampa portfolio totals 2.0 million square feet, representing 9.0% of Net Operating Income for the fourth quarter of 2021 and was 93.1% leased at December 31, 2021. Market-wide Class A leasing activity in Tampa represented 40.9% of total leasing activity in 2021 while representing only 26.5% of total inventory, and construction as a percentage of the total market square footage was 1.0% at December 31, 2021. Metro-wide, the Tampa office market is experiencing low vacancy rates, and the Westshore submarket, where the majority of 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 Phoenix portfolio totals 1.3 million square feet, representing 7.7% of our Net Operating Income for the fourth quarter of 2021 and was 92.2% leased at December 31, 2021. We have one project under development in Phoenix - 100 Mill, a 287,000 square foot project, is 81% leased. Market-wide Class A leasing activity in Phoenix represented 38.3% of total leasing activity in 2021 while representing only 33.6% of total inventory, and construction as a percentage of the total market square footage was 2.2% at December 31, 2021. 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 8.6%.
Our Dallas portfolio totals 516,000 square feet, representing 3.0% of Net Operating Income for the fourth quarter of 2021 and was 91.3% leased at December 31, 2021. Market-wide Class A leasing activity in Dallas represented 49.5% of total leasing activity in 2021 while representing only 44.0% of total inventory, and construction as a percentage of the total market square footage was 3.0% at December 31, 2021.
Our Nashville portfolio includes a mixed-used development of 448,000 square feet of commercial space and 542 residential units located in the Germantown submarket. Market-wide Class A leasing activity in Nashville represented 61.1%
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of total leasing activity in 2021 while representing only 33.1% of total inventory, and construction as a percentage of total market square footage was 10.2%.
Critical Accounting Policies and Estimates
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 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
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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 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.
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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 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.
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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 from cessation of major construction activity. Our judgment of the date the project is substantially complete has a direct impact on our operating expenses and net income for the period.
Results of Operations For The Year Ended December 31, 2021
General
Our financial results for the year ended December 31, 2021 have been affected by the various acquisitions, dispositions, and development activities during 2021 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 2021 and 2020 was $278.6 million and $237.3 million, respectively. We detail below material changes in the components of net income available to common stockholders for the year ended 2021 compared to 2020.
See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations" from our 2020 Annual Report on Form 10-K for a comparison of 2020 to 2019 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 were stabilized and owned by us for the entirety of each comparable reporting periods presented. A stabilized property is one that has achieved 90% economic occupancy or has been substantially complete and owned by us for one year. Same Property amounts for the 2021 versus 2020 comparison are from properties that were stabilized and owned as of January 1, 2020 through December 31, 2021.
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.
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Rental property revenues, rental property operating expenses, and NOI changed between the 2021 and 2020 periods as follows ($ in thousands):
Year Ended December 31,
2021 2020 $ Change % Change
Rental Property Revenues
Same Property $ 610,918 $ 605,765 $ 5,153 1 %
Non-Same Property 123,040 112,283 10,757 10 %
Termination Fee Income 5,105 3,835 1,270 33 %
Total Rental Property Revenues $ 739,063 $ 721,883 $ 17,180 2 %
Rental Property Operating Expenses
Same Property $ 215,361 $ 207,856 $ 7,505 4 %
Non-Same Property 44,100 44,811 (711) (2) %
3344 Peachtree Legal Expense Recovery — (1,817) 1,817 (100) %
Total Rental Property Operating Expenses $ 259,461 $ 250,850 $ 8,611 3 %
Net Operating Income
Same Property NOI $ 395,557 $ 397,909 $ (2,352) (1) %
Non-Same Property NOI 78,940 67,472 11,468 17 %
3344 Peachtree Legal Expense Recovery — 1,817 (1,817) (100) %
Total NOI $ 474,497 $ 467,198 $ 7,299 2 %
Same Property rental property revenues increased between 2021 and 2020 primarily due to the increased occupancy at Corporate Center and 3344 Peachtree, offset by a decrease in occupancy at 3350 Peachtree. Same property rental property operating expenses increased between 2021 and 2020 primarily due to an Atlanta real estate tax credit received in 2020 and an increase in physical occupancy.
Revenues of Non-Same Property increased between 2021 and 2020 primarily as a result of the stabilization of operations at the recently completed developments at the Domain and 10000 Avalon and the addition of The RailYard in December 2020, 725 Ponce in July 2021, Heights Union in October 2021, and 300 Colorado in December 2021, partially offset by the sale of Hearst Tower in 2020 and the sales of One South at the Plaza, Burnett Plaza, and 816 Congress in 2021.
Fee Income
Fee income decreased $2.7 million (14.6%) between 2021 and 2020 primarily driven by timing of fee income related to the 2019 transactions with NS.
General and Administrative Expenses
General and administrative expenses increased $2.3 million (8.5%) between 2021 and 2020 primarily driven by changes in stock compensation expense related to liability-classified awards, most of which became fully earned as of December 31, 2021.
Interest Expense
Interest expense, net of amounts capitalized, increased $6.4 million (10.6%) between 2021 and 2020 primarily due to a decrease in interest capitalized in 2021 as a result of the start of preliminary operational activity for projects completing development in the second and third quarters of 2021 and an increase in interest related to the increased borrowings from the amended and restated Term Loan and an increase in our average outstanding balance on our Line of Credit, partially offset by lower interest rates compared to 2020.
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Depreciation and Amortization
Depreciation and amortization changed between the 2021 and 2020 periods as follows ($ in thousands):
Year Ended December 31,
2021 2020 $ Change % Change
Depreciation and Amortization
Same Property $ 242,352 $ 240,116 $ 2,236 1 %
Non-Same Property 45,117 47,844 (2,727) (6) %
Non-Real Estate Assets 623 688 (65) (9) %
Total Depreciation and Amortization $ 288,092 $ 288,648 $ (556) — %
Depreciation and amortization of Same Property increased between 2021 and 2020 primarily due to the accelerated depreciation of tenant improvements owned by us resulting from an early termination at the Domain.
Depreciation and amortization of Non-Same Property decreased between 2021 and 2020 primarily due to the sales of One South at the Plaza and Burnett Plaza in 2021, partially offset by the recently completed developments at the Domain and 10000 Avalon and the additions of The RailYard in December 2020 and 725 Ponce in July 2021.
Income from Unconsolidated Joint Ventures
Income from unconsolidated joint ventures consisted of the following in 2021 and 2020 ($ in thousands):
Year Ended December 31,
2021 2020 $ Change % Change
Net operating income
Same Property $ 6,203 $ 5,795 $ 408 7 %
Non-Same Property 13,020 13,041 (21) — %
Termination fee income 81 9 72 800 %
Other income 121 61 60 98 %
Depreciation and amortization (9,674) (8,740) (934) (11) %
Interest expense (2,911) (2,071) (840) (41) %
Net gain (loss) on sale of investment property (39) (148) 109 74 %
Income from unconsolidated joint ventures $ 6,801 $ 7,947 $ (1,146) (14) %
Income from unconsolidated joint ventures decreased between 2021 and 2020 primarily due to increased interest from the issuance of the Carolina Square $135.7 million non-recourse mortgage note which was used to fund the repayment in full of its $77.5 million construction loan and an increase in depreciation expense from 300 Colorado which began operations in 2021 prior to being consolidated.
Gain on Sales of Investments in Unconsolidated Joint Ventures
The gain on sales of investments in unconsolidated joint ventures for the year ended December 31, 2021 primarily includes the sale of our interest in the Dimensional Place joint venture. 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.
Gain on Investment Property Transactions
The gain on investment property transactions for the year ended December 31, 2021 primarily includes the sales of 816 Congress in December 2021, One South at the Plaza in July 2021, and Burnett Plaza in April 2021, as well as the gain resulting from the consolidation of 300 Colorado in December 2021. The gain on investment property transactions for the year ended December 31, 2020 primarily includes the sale of Hearst Tower. The combined sales prices of the 816 Congress, One South at the Plaza, and Burnett Plaza dispositions in 2021 and the Hearst Tower and Woodcrest dispositions in 2020 represented weighted average capitalization rates of 5.4% and 5.1%, respectively. Capitalization rates are calculated by dividing projected annualized NOI by the sales price.
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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 $426,000 (51.0%) between 2021 and 2020 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 2021.
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 Nareit's 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, 2021 and 2020 (in thousands, except per share information):
Year Ended December 31,
2021 2020
Dollars Weighted Average Common Shares Per Share Amount Dollars Weighted Average Common Shares Per Share Amount
Net Income Available to Common Stockholders $ 278,586 148,666 $ 1.87 $ 237,278 148,277 $ 1.60
Noncontrolling interest related to unitholders 56 25 — 315 297 —
Conversion of stock options — 1 — — 8 —
Conversion of unvested restricted stock units — 199 — — 54 —
Net Income — Diluted 278,642 148,891 1.87 237,593 148,636 1.60
Depreciation and amortization of real estate assets:
Consolidated properties 287,469 — 1.93 287,960 — 1.94
Share of unconsolidated joint ventures 9,674 — 0.06 8,740 — 0.06
Partners' share of real estate depreciation (929) — (0.01) (742) — —
Loss (gain) on sale of depreciated properties:
Consolidated properties (152,611) — (1.01) (90,105) — (0.61)
Share of unconsolidated joint ventures 39 — — (450) — —
Investments in unconsolidated joint ventures (13,083) — (0.09) (44,578) — (0.31)
Impairment — — — 14,829 — 0.10
Funds From Operations $ 409,201 148,891 $ 2.75 $ 413,247 148,636 $ 2.78
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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 to NOI for consolidated properties for each period (in thousands):
Year Ended December 31,
2021
2020
Net Income $ 278,996 $ 238,114
Fee income (15,559) (18,226)
Termination fee income (5,105) (3,835)
Other income (451) (231)
Reimbursed expenses 2,476 1,580
General and administrative expenses 29,321 27,034
Interest expense 67,027 60,605
Impairment — 14,829
Depreciation and amortization 288,092 288,648
Transaction costs — 428
Other expenses 2,131 2,091
Income from unconsolidated joint ventures (6,801) (7,947)
Gain on sale of investment in unconsolidated joint ventures (13,083) (45,767)
Gain on investment property transactions (152,547) (90,125)
Net Operating Income $ 474,497 $ 467,198
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.
Our material cash needs for 2022 include $223.8 million of unfunded tenant improvements and construction obligations and $102.4 million of debt maturities. Those and other 2022 cash needs are expected to be met by a combination of some or all of the sources noted above.
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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, 2021, 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, 2021, we had $228.5 million outstanding under our Credit Facility with the ability to borrow an additional $771.5 million. We also had $10.2 million in cash, cash equivalents, and restricted cash on hand at December 31, 2021.
The following table sets forth information as of December 31, 2021 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 $ 228,500 $ — $ 228,500 $ — $ —
Unsecured senior notes 1,000,000 — — 250,000 750,000
Term loan 350,000 — 350,000 — —
Mortgage notes payable 911,525 102,401 332,242 476,882 —
Interest commitments (1) 302,347 59,703 146,722 85,059 10,863
Ground leases 189,228 2,083 4,183 4,288 178,675
Total contractual obligations $ 2,981,600 $ 164,187 $ 1,061,647 $ 816,229 $ 939,538
Commitments:
Unfunded tenant improvements and construction obligations $ 255,634 $ 223,849 $ 31,785 $ — $ —
Total commitments $ 255,634 $ 223,849 $ 31,785 $ — $ —
(1) Interest on variable rate obligations is based on rates effective as of December 31, 2021.
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. We expect to negotiate a new credit facility prior to the current maturity date which will have a borrowing capacity that meets or exceeds the current facility and extends the maturity date.
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, 2021, 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 $771.5 million at December 31, 2021.
Term Loan
On June 28, 2021, we entered into an Amended and Restated Term Loan Agreement (the "Term Loan") that amended the former term loan agreement. Under the Term Loan, we have borrowed $350 million that matures on August 30, 2024 with options to, on up to four successive occasions, extend the maturity date for an additional 180 days. The Term Loan has financial covenants consistent with those of the Credit Facility. The interest rate applicable to the Term Loan varies according to our leverage ratio and may, at our election, be determined based on either (1) the Eurodollar Rate Loans plus a spread of between 1.05% and 1.65%, (2) the current LIBOR Daily Floating plus a spread of between 1.05% and 1.65%, or (3) the
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interest rate applicable to Base Rate Loans plus a spread of between 0.05% and 0.65%. At December 31, 2021, the Term Loan's spread over LIBOR was 1.05%. We are in compliance with all covenants of the Term Loan.
Unsecured Senior Notes
At December 31, 2021, 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 are consistent with those of our Credit Facility. 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.
Secured Mortgage Notes
In June 2021, the Company executed a collateral substitution for the mortgage previously secured by the Company's 816 Congress property in Austin. The mortgage is now secured by the Company's Domain 10 property in Austin. All other terms of the note were unchanged.
On February 3, 2020, the Company prepaid in full, without penalty, the $23.0 million Meridian Mark Plaza mortgage note.
As of December 31, 2021, the Company had $661.5 million outstanding on seven non-recourse mortgage notes. All interest rates on the secured mortgage notes are fixed. Assets with depreciated carrying values of $1.1 billion were pledged as security on these mortgage notes payable.
Joint Venture Commitments and Debt
We have a number of off balance sheet joint ventures with varying structures, as described in note 7 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.
At December 31, 2021, our unconsolidated joint ventures had aggregate outstanding indebtedness to third parties of $225.6 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.
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 sources, 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, SOFR, or other indexes as allowed as a benchmark for establishing the rate. LIBOR has been the subject of regulatory guidance and proposals for reform and in March 2021, 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 June 30, 2023. 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 as mentioned above.
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 2022 and work with
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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.
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. We expect to continue to utilize cash retained from operations as well as 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, depository shares or the issuance of CPLP limited partnership units.
Our business model also includes raising or recycling capital which can assist in meeting obligations and funding 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 $10.2 million and $6.1 million at December 31, 2021 and 2020, respectively. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Cash Flows" from our 2020 Annual Report on Form 10-K for a discussion of the changes in cash flows between 2020 and 2019 . The following table sets forth the changes in cash flows (in thousands):
Year Ended December 31, $ Change
2021 2020
Net cash provided by operating activities $ 389,478 $ 351,088 $ 38,390
Net cash used in investing activities (191,066) (132,463) (58,603)
Net cash used in financing activities (194,382) (230,095) 35,713
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 $38.4 million between the 2021 and 2020 periods primarily due to net cash received from operations at the recently stabilized developments at the Domain and 10000 Avalon and the addition of The RailYard in November 2020, 725 Ponce in July 2021, Heights Union in October 2021, and 300 Colorado in December 2021 partially offset by the sale of Hearst Tower in 2020 and the sales of One South at the Plaza, Burnett Plaza, and 816 Congress in 2021.
Cash Flows from Investing Activities. Cash used in investing activities increased $58.6 million between the 2021 and 2020 periods primarily due to cash used in the purchase of 725 Ponce, Heights Union, and our partners interest in 300 Colorado, partially offset by the cash received from the sales of 816 Congress, Burnett Plaza, and One South at the Plaza in 2021.
Cash Flows from Financing Activities. Cash flows used in financing activities decreased $35.7 million between the 2021 and 2020 periods primarily due to the $250 million repayment of our prior Term Loan and issuance of the $350 million Amended and Restated Term Loan in 2021 offset partially by repayment of the 300 Colorado construction loan assumed in the acquisition.
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.
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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, 2021 and 2020 are as follows (in thousands):
2021 2020
Acquisition of properties $ 524,271 $ 285,606
Projects under development 93,867 43,902
Operating properties—building improvements 60,281 139,247
Operating properties—leasing costs 92,902 40,744
Purchase of land held for investment 18,267 64,001
Capitalized interest 6,257 14,324
Capitalized salaries 7,332 6,033
Accrued capital expenditures adjustment (15,367) 25,745
Total property acquisition, development and tenant asset expenditures $ 787,810 $ 619,602
Capital expenditures increased $168.2 million between December 31, 2021 and 2020 primarily due to the acquisitions of 725 Ponce, Heights Union, our partners' interest in 300 Colorado, and the start of development of a new office property at the Domain, partially offset by a decrease in building improvements at operating properties and decrease in land purchases. 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 2021 and 2020 was as follows:
2021 2020
New leases $10.58 $12.04
Renewal leases $6.90 $5.46
Expansion leases $11.23 $8.62
The amounts of tenant improvement and leasing costs on a per square foot basis vary by lease and by market.
Dividends. We paid common dividends of $182.8 million and $176.3 million in 2021 and 2020, 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.
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