Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with our consolidated financial statements and related notes in Part IV, Item 15 of this Report. Our results of operations for the year ended December 31, 2020 were affected by a property disposition, a loan refinancing, hedging, and development activity - see Dispositions, Financings and Hedging, Developments and Repositionings further below.
Overview
Douglas Emmett, Inc. is a fully integrated, self-administered and self-managed REIT. Through our interest in our Operating Partnership and its subsidiaries, our consolidated JVs and our unconsolidated Fund, we are one of the largest owners and operators of high-quality office and multifamily properties in Los Angeles County, California and in Honolulu, Hawaii. We focus on owning, acquiring, developing and managing a substantial share of top-tier office properties and premier multifamily communities in neighborhoods that possess significant supply constraints, high-end executive housing and key lifestyle amenities. As of December 31, 2020, our portfolio consisted of the following (including ancillary retail space):
Consolidated Portfolio (1)
Total Portfolio (2)
Office
Class A Properties 69 71
Rentable Square Feet (in thousands) 17,807 18,192
Leased rate 88.6% 88.6%
Occupancy rate 87.4% 87.4%
Multifamily
Properties 12 12
Units 4,287 4,287
Leased rate 98.2% 98.2%
Occupancy rate 94.2% 94.2%
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(1) Our Consolidated Portfolio includes the properties in our consolidated results. Through our subsidiaries, we own 100% of these properties, except for sixteen office properties totaling 4.2 million square feet and one residential property with 350 apartments , which we own through three consolidated JVs. Our Consolidated Portfolio also includes two land parcels from which we receive ground rent from ground leases to the owners of a Class A office building and a hotel.
(2) Our Total Portfolio includes our Consolidated Portfolio as well as two properties totaling 0.4 million square feet owned by our unconsolidated Fund. See Note 6 to our consolidated financial statements in Item 15 of this Report for more information about our unconsolidated Fund.
Revenues by Segment and Location
During the year ended December 31, 2020, revenues from our Consolidated Portfolio was derived as follows:
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Impact of the COVID-19 Pandemic on our Business
Our buildings have remained open and available to our tenants throughout the pandemic. Our rent collections continue to be negatively impacted by the pandemic and our markets' very tenant-oriented lease enforcement moratoriums, which are considerably out of sync with other gateway markets. However, during the third and fourth quarters we did see some incremental improvements in rent collections and leasing activity.
The governmental authorities in the jurisdictions in which we primarily operate, Los Angeles, Beverly Hills and Santa Monica, have passed unusually punitive COVID-19 pandemic ordinances prohibiting evictions and allowing rent deferral for residential, retail, and office tenants, regardless of financial distress. The ordinances cover our residential, retail and office tenants (with some carve outs for large tenants) and generally prohibit landlords not only from evicting tenants but also from imposing any late fees or interest and allow tenants to pay back the deferred rent over a certain period.
At the end of the second, third and fourth quarters, we wrote off certain tenant receivables and deferred rent receivables, and we had a significant decrease in our parking revenues due to lower utilization. For the year ended December 31, 2020, charges for uncollectible amounts related to tenant receivables and deferred rent receivables, which were primarily due to the COVID-19 pandemic, reduced our office revenues by $41.0 million. If we subsequently collect amounts that were previously written off, then the amounts collected will be recorded as an increase to our rental revenues and tenant recoveries in the period they are collected. See "Rental Revenues and Tenant Recoveries" in Note 2 to our consolidated financial statements in Item 15 of this Report. We cannot predict how the COVID-19 pandemic will impact our future collections. During the second, third and fourth quarters, we had savings from variable expenses which partly offset the write-offs of tenant receivables and deferred rent receivables and the decrease in our parking revenues.
While our tenant retention was in-line with long-term averages, our total office portfolio leased percentage declined by 4.7% during 2020 to 88.6% as of December 31, 2020, as new leasing volume remained below pre-COVID-19 levels. As of December 31, 2020, o ur multifamily portfolio remained essentially fully leased at 98%.
Other considerations that could impact our future leasing, rent collections, and revenue include:
• How long the pandemic continues.
• Whether the local governments that have authorized rent deferrals in our markets modify or extend the deferral terms, or alternatively allow them to expire as written.
• Whether more tenants stop paying rent if the impact to their business grows.
• How attendance in our buildings changes and drives parking revenue or rent collection.
• How leasing activity and occupancy will evolve.
On the capital front, construction is continuing on our two large multifamily development projects, although the projects may take a little longer under current conditions.
Overall, we expect the COVID-19 pandemic to continue to adversely impact many parts of our business, and those impacts have been, and will continue, to be material. For more information of the risks to our business, please see Item 1A "Risk Factors" in this Report.
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Dispositions, Financings and Hedging, Developments and Repositionings
Dispositions
In December 2020, we closed on the sale of an 80,000 square foot office property in Honolulu, which was held by a consolidated JV in which we owned a two-thirds capital interest, for a contract price of $21.0 million in cash, resulting in a gain of $6.4 million after transaction costs. We closed a health club that we owned and operated at the respective property shortly before we sold the property.
Financings and Hedging
• During the first quarter of 2020, we entered into forward interest rate swaps to hedge future term-loan refinancings. The forward swaps have an initial notional amount of $495.0 million, with effective dates ranging from June 2020 to March 2021, and maturity dates ranging from April 2025 to June 2025, fixing the one-month LIBOR interest rate in a range of 0.74% to 0.91%.
• During the second quarter of 2020, we refinanced a loan for one of our consolidated JVs. We closed a secured, non-recourse $450.0 million interest-only loan, which is scheduled to mature in May 2027. The loan bears interest at LIBOR + 1.35%, which was effectively fixed at 2.26% following the expiration of the current swaps, for an average fixed interest rate of 2.6% per annum through April 2025. We used part of the proceeds to pay off a $400.0 million loan, secured by the same properties, that was scheduled to mature in July 2024.
See Notes 8 and 10 to our consolidated financial statements in Item 15 of this Report for more information regarding our debt and derivatives, respectively.
Developments
• Residential High-Rise Tower, Brentwood, California
In West Los Angeles, we are building a 34 story high-rise apartment building with 376 apartments. The tower is being built on a site that is directly adjacent to an existing office building and a 712 unit residential property, both of which we own. We expect the cost of the development to be approximately $180 million to $200 million, which does not include the cost of the land which we have owned since 1997. As part of the project, we are investing additional capital to build a one acre park on Wilshire Boulevard that will be available to the public and provide a valuable amenity to our surrounding properties and community. Construction continues on the project, although we may face some delays as a result of the impact of the COVID-19 pandemic on permitting and other logistics. We currently expect the first units to be delivered in 2022.
• 1132 Bishop Street, Honolulu, Hawaii
In downtown Honolulu, we are converting a 25 story, 490 thousand square foot office tower into approximately 500 apartments. This project will help address the severe shortage of rental housing in Honolulu and revitalize the central business district. The conversion is occurring in phases over a number of years as the office space is vacated. We currently estimate the construction costs to be approximately $80 million to $100 million, although the inherent uncertainties of development are compounded by the multi-year and phased nature of the conversion and potential impacts from the COVID-19 pandemic. We began leasing the new units during the second quarter of 2020.
Repositionings
We often strategically purchase properties with large vacancies or expected near-term lease roll-over and use our knowledge of the property and submarket to reposition the property for the optimal use and tenant mix. In addition, we may reposition properties already in our portfolio. The work we undertake to reposition a building typically takes months or even years, and could involve a range of improvements from a complete structural renovation to a targeted remodeling of selected spaces. During the repositioning, the affected property may display depressed rental revenue and occupancy levels that impact our results and, therefore, comparisons of our performance from period to period. We have temporarily suspended work on new office repositioning projects due to the COVID-19 pandemic.
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Rental Rate Trends - Total Portfolio
Office Rental Rates
Our office rental rates for 2020 were primarily impacted by the COVID-19 pandemic.
The table below presents the average annual rental rate per leased square foot and the annualized lease transaction costs per leased square foot for leases executed in our total office portfolio during the respective periods:
Year Ended December 31,
2020 2019 2018 2017 2016
Average straight-line rental rate (1)(2)
$45.26 $49.65 $48.77 $44.48 $43.21
Annualized lease transaction costs (3)
$5.11 $6.02 $5.80 $5.68 $5.74
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(1) These average rental rates are not directly comparable from year to year because the averages are significantly affected from period to period by factors such as the buildings, submarkets, and types of space and terms involved in the leases executed during the respective reporting period. Because straight-line rent takes into account the full economic value of each lease, including rent concessions and escalations, we believe that it may provide a better comparison than ending cash rents, which include the impact of the annual escalations over the entire term of the lease.
(2) Reflects the weighted average straight-line Annualized Rent.
(3) Reflects the weighted average leasing commissions and tenant improvement allowances divided by the weighted average number of years for the leases. Excludes leases substantially negotiated by the seller in the case of acquired properties and leases for tenants relocated from space at the landlords request.
Office Rent Roll
The table below presents the rent roll for new and renewed leases per leased square foot executed in our total office portfolio:
Year Ended December 31, 2020
Rent Roll (1)(2)
Expiring
Rate (2)
New/Renewal Rate (2)
Percentage Change
Cash Rent $43.02 $44.16 2.6%
Straight-line Rent $38.71 $45.26 16.9%
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(1) Represents the average annual initial stabilized cash and straight-line rents per square foot on new and renewed leases signed during the year compared to the prior leases for the same space. Excludes leases with a term of twelve months or less, leases where the prior lease was terminated more than a year before signing of the new lease, leases for tenants relocated from space at landlord's request, leases modified by workout agreements, retail leases, and leases in acquired buildings where we believe the information about the prior agreement is incomplete or where we believe base rent reflects other off-market inducements to the tenant.
(2) Our office rent roll can fluctuate from period to period as a result of changes in our submarkets, buildings and term of the expiring leases, making these metrics difficult to predict.
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Multifamily Rental Rates
Our multifamily rental rates for 2020 were primarily impacted by the COVID-19 pandemic.
The table below presents the average annual rental rate per leased unit for new tenants:
Year Ended December 31,
2020 2019 2018 2017 2016
Average annual rental rate - new tenants (1)
$ 28,416 $ 28,350 $ 27,542 $ 28,501 $ 28,435
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(1) These average rental rates are not directly comparable from year to year because of changes in the properties and units included. For example: (i) the average for 2018 decreased from 2017 because we added a significant number of units at our Moanalua Hillside Apartments development in Honolulu, where the rental rates are lower than the average in our portfolio, and (ii) the average for 2019 increased from 2018 because we acquired The Glendon where higher rental rates offset the effect of adding additional units at our Moanalua Hillside Apartments development.
Multifamily Rent Roll
The rent on leases subject to rent change during the year ended December 31, 2020 (new tenants and existing tenants undergoing annual rent review) was 3.4% lower than the prior rent on the same unit.
Occupancy Rates - Total Portfolio
Our occupancy rates for 2020 were primarily impacted by the COVID-19 pandemic.
The tables below present the occupancy rates for our total office portfolio and multifamily portfolio:
December 31,
Occupancy Rates (1) as of:
2020 2019 2018 2017 2016
Office portfolio 87.4 % 91.4 % 90.3 % 89.8 % 90.4 %
Multifamily portfolio (2)
94.2 % 95.2 % 97.0 % 96.4 % 97.9 %
Year Ended December 31,
Average Occupancy Rates (1)(3) :
2020 2019 2018 2017 2016
Office portfolio 89.5 % 90.7 % 89.4 % 89.5 % 90.6 %
Multifamily portfolio (2)
94.2 % 96.5 % 96.6 % 97.2 % 97.6 %
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(1) Occupancy rates include the impact of property acquisitions, most of whose occupancy rates at the time of acquisition were below that of our existing portfolio.
(2) The Occupancy Rate for our multifamily portfolio was impacted by our acquisition of The Glendon property in 2019 and by new units at our Moanalua Hillside Apartments development in Honolulu in 2019 and 2018.
(3) Average occupancy rates are calculated by averaging the occupancy rates at the end of each of the quarters in the period and at the end of the quarter immediately prior to the start of the period.
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Office Lease Expirations
As of December 31, 2020, assuming non-exercise of renewal options and early termination rights, we expect to see expiring square footage in our total office portfolio is as follows:
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(1) Average of the percentage of leases at December 31, 2017, 2018, and 2019 with the same remaining duration as the leases for the labeled year had at December 31, 2020. Acquisitions are included in the prior year average commencing in the quarter after the acquisition.
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Results of Operations
Comparison of 2020 to 2019
Year Ended December 31, Favorable
2020 2019 (Unfavorable) % Commentary
(In thousands)
Revenues
Office rental revenue and tenant recoveries $ 680,359 $ 694,315 $ (13,956) (2.0) % The decrease was primarily due to: (i) a decrease of $58.4 million in rental revenue and tenant recoveries from properties that we owned throughout both periods and (ii) a decrease of $3.5 million in rental revenues and tenant recoveries from a building we are converting from an office building to residential building in Hawaii, partly offset by (a) an increase of $46.4 million of rental revenues and tenant recoveries from a JV we consolidated in November 2019 and (b) an increase of $1.5 million in rental revenues and tenant recoveries from a property that we purchased in June 2019. The decrease in properties that we owned throughout both periods was primarily due to write-offs of uncollectible receivables and deferred rent receivables and lower collections, both as a result of the COVID-19 pandemic.
Office parking and other income $ 90,810 $ 122,440 $ (31,630) (25.8) % The decrease was due to a decrease of $37.5 million in parking and other income from properties we owned throughout both periods, primarily due to a decrease in parking activity as a result of the COVID-19 pandemic, partly offset by an increase of $6.0 million in parking and other income from a JV we consolidated in November 2019.
Multifamily revenue $ 120,354 $ 119,927 $ 427 0.4 % The increase was due to an increase of: (i) $5.0 million in revenue from a property that we purchased in June 2019, (ii) an increase of $1.9 million in revenue from the new apartments at our Moanalua Hillside Apartments development, and (iii) an increase of $1.0 million in revenues from an office building we are converting to a residential building in Hawaii, partly offset by (a) a decrease of $4.7 million in revenues at a property where units are temporarily unoccupied as a result of a fire, and (b) a decrease of $2.8 million in revenues from our other properties, which was primarily due to lower occupancy and collections, both as a result of the COVID-19 pandemic. Multifamily revenues for 2020 included $3.9 million of insurance proceeds related to the fire at one of our properties in January 2020.
Operating expenses
Office rental expenses $ 268,259 $ 264,482 $ (3,777) (1.4) % The increase was due to: (i) $17.4 million in rental expenses from a JV we consolidated in November 2019, and (ii) an increase of $0.7 million in rental expenses from a property we purchased in June 2019, partly offset by (a) a decrease of $1.6 million in rental expenses from an office building we are converting to a residential building in Hawaii, and (b) a decrease of $12.7 million in rental expenses from our other properties, which was primarily due to a decrease in scheduled services expenses, utility expenses, and repairs and maintenance expenses, as a result of lower utilization caused by the COVID-19 pandemic.
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Year Ended December 31, Favorable
2020 2019 (Unfavorable) % Commentary
(In thousands)
Multifamily rental expenses $ 37,154 $ 33,681 $ (3,473) (10.3) % The increase was primarily due to an increase of $2.8 million in rental expenses from the property we purchased in June 2019, and an increase of $0.2 million in rental expenses from the new apartments at our Moanalua Hillside Apartments development.
General and administrative expenses $ 39,601 $ 38,068 $ (1,533) (4.0) % The increase was primarily due to an increase in personnel expenses.
Depreciation and amortization $ 385,248 $ 357,743 $ (27,505) (7.7) % The increase was due to: (i) depreciation and amortization of $31.4 million from a JV we consolidated in November 2019, (ii) an increase of $3.2 million in depreciation and amortization from the property we purchased in June 2019, partly offset by (a) a decrease of $2.8 million in depreciation and amortization from an office building we are converting to a residential building in Hawaii, due to less accelerated depreciation of the building in 2020, and (b) a decrease of $4.4 million for our other properties, which was primarily due to property repositioning activity in 2019.
Non-Operating Income and Expenses
Other income $ 16,288 $ 11,653 $ 4,635 39.8 % The increase was due to a $13.1 million gain from insurance recoveries related to property damage to a building impacted by a fire, partly offset by (i) a decrease of $4.8 million in revenue from a health club in Honolulu that we owned and operated and closed permanently in the fourth quarter of 2020, (ii) a decrease of $1.6 million in income related to our Fund that was consolidated as a JV in November 2019, and (iii) a decrease of $2.1 million in interest income due to lower money market balances and interest rates.
Other expenses $ (2,947) $ (7,216) $ 4,269 59.2 % The decrease was primarily due to a decrease of $3.2 million in expenses for the health club in Honolulu that we closed permanently in the fourth quarter of 2020 and a decrease in expenses of $0.9 million related to our Fund that was consolidated as a JV in November 2019.
Income from unconsolidated Funds $ 430 $ 6,923 $ (6,493) (93.8) % The decrease was primarily due to the consolidation of one of our Funds as a JV in November 2019 and a decrease in income from our remaining Fund in 2020. The decrease in income from our remaining Fund was primarily due to the Fund's lower net income in 2020 as a result of write-offs of uncollectible receivables and deferred rent receivables, lower collections, and a decrease in parking income, which were all as a result of the COVID-19 pandemic.
Interest expense $ (142,872) $ (143,308) $ 436 0.3 % The decrease was primarily due to loan costs expensed in connection with our debt refinancing activities in 2019, partly offset by interest expense from the debt of a JV that was consolidated in November 2019 and interest expense from the debt to finance the property we purchased in June 2019.
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Year Ended December 31, Favorable
2020 2019 (Unfavorable) % Commentary
(In thousands)
Gain on sale of investment in real estate $ 6,393 $ — $ 6,393 100.0 % The increase is due to the sale of an 80,000 square foot office property in Honolulu, which was held by a consolidated JV in which we owned a two-thirds capital interest. We closed on the sale in December 2020 for a contract price of $21.0 million in cash.
Gain from consolidation of JV $ — $ 307,938 $ (307,938) (100.0) % The decrease is due to the gain in 2019 from the consolidation of a JV in November 2019 that was previously accounted for as an unconsolidated Fund using the equity method.
Comparison of 2019 to 2018
See Item 7 of Part II in our Annual Report on Form 10-K for the year ended December 31, 2019 filed with the SEC on February 14, 2020 for a discussion of our results of operations for the year ended December 31, 2019.
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Non-GAAP Supplemental Financial Measure: FFO
Usefulness to Investors
We report FFO because it is a widely reported measure of the performance of equity REITs, and is also used by some investors to identify the impact of trends in occupancy rates, rental rates and operating costs from year to year, excluding the impacts from changes in the value of our real estate, and to compare our performance with other REITs. FFO is a non-GAAP financial measure for which we believe that net income is the most directly comparable GAAP financial measure. FFO has limitations as a measure of our performance because it excludes depreciation and amortization of real estate, and captures neither the changes in the value of our properties that result from use or market conditions, nor the level of capital expenditures, tenant improvements and leasing commissions necessary to maintain the operating performance of our properties, all of which have real economic effect and could materially impact our results from operations. FFO should be considered only as a supplement to net income as a measure of our performance and should not be used as a measure of our liquidity or cash flow, nor is it indicative of funds available to fund our cash needs, including our ability to pay dividends. Other REITs may not calculate FFO in accordance with the NAREIT definition and, accordingly, our FFO may not be comparable to the FFO of other REITs. See "Results of Operations" above for a discussion of the items that impacted our net income.
Comparison of 2020 to 2019
Our FFO results for 2020 were primarily impacted by the COVID-19 pandemic. Our FFO decreased by $52.3 million, or 12.3%, to $372.5 million for 2020 compared to $424.8 million for 2019, which was primarily due to: (i) a decrease in the operating income from our office portfolio (office revenues less office rental expenses), which was primarily due to lower collections, write-offs of uncollectible receivables and deferred rent receivables, and a decrease in parking income, and (ii) a decrease in the operating income from our multifamily portfolio (multifamily revenues less multifamily rental expenses), which was primarily due to an increase in property taxes, insurance premiums and personnel expenses.
Comparison of 2019 to 2018
See Item 7 of Part II in our Annual Report on Form 10-K for the year ended December 31, 2019 filed with the SEC on February 14, 2020 for a discussion of our FFO for the year ended December 31, 2019.
Reconciliation to GAAP
The table below reconciles our FFO (the FFO attributable to our common stockholders and noncontrolling interests in our Operating Partnership - which includes our share of our consolidated JVs and our unconsolidated Funds FFO) to net income attributable to common stockholders computed in accordance with GAAP:
Year Ended December 31,
(In thousands) 2020 2019
Net income attributable to common stockholders $ 50,421 $ 363,713
Depreciation and amortization of real estate assets (1)
385,248 357,743
Net (loss) income attributable to noncontrolling interests (1)
(11,868) 54,985
Adjustments attributable to unconsolidated Funds (1)(2)
2,739 15,815
Adjustments attributable to consolidated JVs (1)(3)
(47,606) (59,505)
Gain on sale of investment in real estate (6,393) —
Gain from consolidation of JV (1)
— (307,938)
FFO $ 372,541 $ 424,813
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(1) We restructured one of our unconsolidated Funds in November 2019 after which it was consolidated as a JV. The various adjustments in the reconciliation of FFO are therefore not directly comparable to the prior period. See Note 6 to our consolidated financial statements in item 15 of this Report for more information.
(2) Adjusts for our share of our unconsolidated Funds depreciation and amortization of real estate assets.
(3) Adjusts for the net income (loss) and depreciation and amortization of real estate assets that is attributable to the noncontrolling interests in our consolidated JVs.
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Non-GAAP Supplemental Financial Measure: Same Property NOI
Usefulness to Investors
We report Same Property NOI to facilitate a comparison of our operations between reported periods. Many investors use Same Property NOI to evaluate our operating performance and to compare our operating performance with other REITs, because it can reduce the impact of investing transactions on operating trends. Same Property NOI is a non-GAAP financial measure for which we believe that net income is the most directly comparable GAAP financial measure. We report Same Property NOI because it is a widely recognized measure of the performance of equity REITs, and is used by some investors to identify trends in occupancy rates, rental rates and operating costs and to compare our operating performance with that of other REITs. Same Property NOI has limitations as a measure of our performance because it excludes depreciation and amortization expense, and captures neither the changes in the value of our properties that result from use or market conditions, nor the level of capital expenditures, tenant improvements and leasing commissions necessary to maintain the operating performance of our properties, all of which have real economic effect and could materially impact our results from operations. Other REITs may not calculate Same Property NOI in the same manner. As a result, our Same Property NOI may not be comparable to the Same Property NOI of other REITs. Same Property NOI should be considered only as a supplement to net income as a measure of our performance and should not be used as a measure of our liquidity or cash flow, nor is it indicative of funds available to fund our cash needs, including our ability to pay dividends.
Comparison of 2020 to 2019:
Our same properties for 2020 included 60 office properties, aggregating 16.1 million Rentable Square Feet, and 8 multifamily properties with an aggregate 1,928 units. The amounts presented reflect 100% (not our pro-rata share). Our Same Property results for 2020 were primarily impacted by the COVID-19 pandemic.
Year Ended December 31, Favorable
2020 2019 (Unfavorable) % Commentary
(In thousands)
Office revenues $ 694,653 $ 789,223 $ (94,570) (12.0) % The decrease was primarily due to: (i) a decrease in rental revenues due to lower collections and write-offs of uncollectible receivables and deferred rent receivables, (ii) a decrease in parking income due to lower activity, and (iii) a decrease in tenant recoveries due to a decrease in
recoverable operating costs and lower collections and write-offs of uncollectible receivables.
Office expenses (239,032) (251,384) 12,352 4.9 % The decrease was primarily due to a decrease in parking expenses, utility expenses, and janitorial expenses.
Office NOI 455,621 537,839 (82,218) (15.3) %
Multifamily revenues 59,286 62,969 (3,683) (5.8) % The decrease was primarily due to a decrease in rental revenues due to lower collections, rental rates and occupancy.
Multifamily expenses (16,319) (16,075) (244) (1.5) % The increase was primarily due to an increase in insurance expenses and personnel expenses.
Multifamily NOI 42,967 46,894 (3,927) (8.4) %
Total NOI $ 498,588 $ 584,733 $ (86,145) (14.7) %
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Reconciliation to GAAP
The table below presents a reconciliation of our Same Property NOI to net income attributable to common stockholders:
Year Ended December 31,
(In thousands) 2020 2019
Same Property NOI $ 498,588 $ 584,733
Non-comparable office revenues 76,516 27,532
Non-comparable office expenses (29,227) (13,098)
Non-comparable multifamily revenues 61,068 56,958
Non-comparable multifamily expenses (20,835) (17,606)
NOI 586,110 638,519
General and administrative expenses (39,601) (38,068)
Depreciation and amortization (385,248) (357,743)
Other income 16,288 11,653
Other expenses (2,947) (7,216)
Income from unconsolidated Funds 430 6,923
Interest expense (142,872) (143,308)
Gain on sale of investment in real estate 6,393 —
Gain from consolidation of JV — 307,938
Net income 38,553 418,698
Less: Net loss (income) attributable to noncontrolling interests 11,868 (54,985)
Net income attributable to common stockholders $ 50,421 $ 363,713
Comparison of 2019 to 2018
See Item 7 of Part II in our Annual Report on Form 10-K for the year ended December 31, 2019 filed with the SEC on February 14, 2020 for a discussion of our same property NOI for the year ended December 31, 2019.
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Liquidity and Capital Resources
Short-term liquidity
During the year ended December 31, 2020, we generated cash from operations of $420.2 million. As of December 31, 2020, we had $172.4 million of cash and cash equivalents, and we had a $75.0 million balance on our $400.0 million revolving credit facility. Our earliest debt maturity is February 28, 2023. Excluding acquisitions, development projects and debt refinancings, we expect to meet our short-term liquidity requirements through cash on hand, cash generated by operations and our revolving credit facility. See Note 8 to our consolidated financial statements in Item 15 of this Report for more information regarding our debt.
Long-term liquidity
Our long-term liquidity needs consist primarily of funds necessary to pay for acquisitions, development projects and debt refinancings. We do not expect to have sufficient funds on hand to cover these long-term cash requirements due to the requirement to distribute a substantial majority of our income on an annual basis imposed by REIT federal tax rules. We plan to meet our long-term liquidity needs through long-term secured non-recourse indebtedness, the issuance of equity securities, including common stock and OP Units, as well as property dispositions and JV transactions. We have an ATM program which would allow us, subject to market conditions, to sell up to $400.0 million of shares of common stock as of the date of this Report.
We only use property level, non-recourse debt. As of December 31, 2020, approximately 41% of our total office portfolio is unencumbered. To mitigate the impact of changing interest rates on our cash flows from operations, we generally enter into interest rate swap agreements with respect to our loans with floating interest rates. These swap agreements generally expire between one to two years before the maturity date of the related loan, during which time we can refinance the loan without any interest penalty. See Notes 8 and 10 to our consolidated financial statements in Item 15 of this Report for more information regarding our debt and derivative contracts, respectively.
Certain Contractual Obligations
See the following notes to our consolidated financial statements in Item 15 of this Report for information regarding our contractual commitments:
• Note 4 - minimum future ground lease payments;
• Note 8 - minimum future principal payments for our secured notes payable and revolving credit facility, and the interest rates that determine our future periodic interest payments; and
• Note 17 - developments, capital expenditure projects and repositionings.
Off-Balance Sheet Arrangements
Unconsolidated Fund's Debt
Our Fund has its own secured non-recourse debt, and we have made certain environmental and other limited indemnities and guarantees covering customary non-recourse carve-outs related to that loan. We have also guaranteed the related swap. Our Fund has agreed to indemnify us for any amounts that we would be required to pay under that agreement. As of December 31, 2020, all of the obligations under the respective loan and swap agreements have been performed in accordance with the terms of those agreements. For information regarding our Fund and our Fund's debt, see Notes 6 and 17, respectively, to our consolidated financial statements in Item 15 of this Report.
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Cash Flows
Comparison of 2020 to 2019
2020 2019 Increase (Decrease) %
(In thousands)
Net cash provided by operating activities (1)
$ 420,218 $ 469,586 $ (49,368) (10.5) %
Net cash used in investing activities (2)
$ (265,175) $ (649,668) $ (384,493) (59.2) %
Cash (used in) provided by financing activities (3)
$ (136,330) $ 187,538 $ (323,868) (172.7) %
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(1) Our cash flows provided by operating activities are primarily dependent upon the occupancy and rental rates of our portfolio, the collectability of rent and recoveries from our tenants, and the level of our operating expenses and general and administrative expenses, and interest expense. The decrease in cash provided by operating activities was primarily due to: (i) a decrease in cash generated by our office portfolio, which was primarily due to a decrease in collections and parking income as a result of the COVID-19 pandemic, (ii) an increase of $8.6 million in cash paid for interest primarily due to the consolidation of one of our Funds as a JV in November 2019, (iii) a decrease of $6.4 million in operating distributions from our unconsolidated real estate funds primarily due to the consolidation of one of our Funds as a JV in November 2019, and (iv) a decrease in cash generated by our multifamily portfolio, which was primarily due to an increase in property taxes, insurance premiums and personnel expenses.
(2) Our cash flows used in investing activities are generally used to fund property acquisitions, developments and redevelopment projects, and Recurring and non-Recurring Capital Expenditures. The decrease in cash used in investing activities was primarily due to: (i) $365.9 million paid for a property that we purchased in June 2019, (ii) a decrease of $84.2 million paid for additional interests in unconsolidated Funds, (iii) a decrease of $33.0 million in capital expenditures for improvements to real estate, and (iv) $20.7 million in net proceeds from the sale of an office property in Honolulu in December 2020, partly offset by (a) an increase of $92.5 million in capital expenditures for developments and (b) $39.2 million of cash assumed from the consolidation of a JV in 2019.
(3) Our cash flows used in financing activities are generally impacted by our borrowings and capital activities, as well as dividends and distributions paid to common stockholders and noncontrolling interests, respectively. The decrease is primarily due to (i) $201.0 million of net proceeds from the issuance of common stock in 2019, (ii) $163.6 million of contributions from noncontrolling interests in consolidated JVs in 2019, and (iii) an increase of $16.7 million in dividends paid to common stockholders, partly offset by (a) an increase of $35.0 million in net borrowings and (b) a decrease of $17.5 million in loan cost payments.
Comparison of 2019 to 2018
See Item 7 of Part II in our Annual Report on Form 10-K for the year ended December 31, 2019 filed with the SEC on February 14, 2020 for a discussion of our cash flows for the year ended December 31, 2019.
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Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with GAAP, which requires us to make estimates of certain items which affect the reported amounts of our assets, liabilities, revenues and expenses. While we believe that our estimates are based upon reasonable assumptions and judgments at the time that they are made, some of our estimates could prove to be incorrect, and those differences could be material. Below is a discussion of our critical accounting policies, which are the policies we believe require the most estimate and judgment. See Note 2 to our consolidated financial statements included in Item 15 of this Report for the summary of our significant accounting policies.
Investment in Real Estate
Acquisitions and Initial Consolidation of VIEs
We account for property acquisitions as asset acquisitions. We allocate the purchase price for asset acquisitions, which includes the capitalized transaction costs, and for the properties upon the initial consolidation of VIEs not determined to be a business, on a relative fair value basis to: (i) land, (ii) buildings and improvements, (iii) tenant improvements and identifiable intangible assets such as in-place at-market leases, (iv) acquired above- and below-market ground and tenant leases, and if applicable (v) assumed debt, based upon comparable sales for land, and the income approach using our estimates of expected future cash flows and other valuation techniques, which include but are not limited to, our estimates of rental rates, revenue growth rates, capitalization rates and discount rates, for other assets and liabilities. We estimate the relative fair values of the tangible assets on an ‘‘as-if-vacant’’ basis. The estimated relative fair value of acquired in-place at-market leases are the estimated costs to lease the property to the occupancy level at the date of acquisition, including the fair value of leasing commissions and legal costs. We evaluate the time period over which we expect such occupancy level to be achieved and include an estimate of the net operating costs (primarily real estate taxes, insurance and utilities) incurred during the lease-up period. Above and below-market ground and tenant leases are recorded as an asset or liability based upon the present value (using an interest rate which reflects the risks associated with the leases acquired) of the difference between the contractual amounts to be paid or received pursuant to the in-place ground or tenant leases, respectively, and our estimate of fair market rental rates for the corresponding in-place leases, over the remaining non-cancelable term of the leases. Assumed debt is recorded at fair value based upon the present value of the expected future payments and current interest rates.
These estimates require judgment, involve complex calculations, and the allocations have a direct and material impact on our results of operations because, for example, (i) there would be less depreciation if we allocate more value to land (which is not depreciated), or (ii) if we allocate more value to buildings than to tenant improvements, the depreciation would be recognized over a much longer time period, because buildings are depreciated over a longer time period than tenant improvements.
Cost capitalization
We capitalize development costs, including predevelopment costs, interest, property taxes, insurance and other costs directly related to the development of real estate. Indirect development costs, including salaries and benefits, office rent, and associated costs for those individuals directly responsible for and who spend their time on development activities are also capitalized and allocated to the projects to which they relate. Development costs are capitalized while substantial activities are ongoing to prepare an asset for its intended use. We consider a development project to be substantially complete when the residential units or office space is available for occupancy but no later than one year after cessation of major construction activity. Costs incurred after a project is substantially complete and ready for its intended use, or after development activities have ceased, are expensed as incurred. Costs previously capitalized related to abandoned developments are charged to earnings. Expenditures for repairs and maintenance are expensed as incurred.
The capitalization of development costs requires judgment, and can directly and materially impact our results of operations because, for example, (i) if we don't capitalize costs that should be capitalized, then our operating expenses would be overstated during the development period, and the subsequent depreciation of the developed real estate would be understated, or (ii) if we capitalize costs that should not be capitalized, then our operating expenses would be understated during the development period, and the subsequent depreciation of the real estate would be overstated. We capitalized development costs of $186.4 million, $75.3 million and $78.7 million during 2020, 2019 and 2018, respectively.
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Impairment of Long-Lived Assets
We assess our investment in real estate for impairment on a periodic basis, and whenever events or changes in circumstances indicate that the carrying value of our investments in real estate may not be recoverable. If the undiscounted future cash flows expected to be generated by the asset are less than the carrying value of the asset, and our evaluation indicates that we may be unable to recover the carrying value, then we would record an impairment loss to the extent that the carrying value exceeds the estimated fair value of the asset. Our estimates of future cash flows are based in part upon assumptions regarding future occupancy, rental rates and operating costs, and could differ materially from actual results. We record real estate held for sale at the lower of carrying value or estimated fair value, less costs to sell, and similarly recognize impairment losses if we believe that we cannot recover the carrying value. Our evaluation of market conditions for assets held for sale requires judgment, and our expectations could differ materially from actual results. Impairment losses would reduce our net income and could be material. Based upon such periodic assessments we did not record any impairment losses for our long-lived assets and Funds during 2020, 2019 or 2018.
In downtown Honolulu, we are converting a 25 story, 490,000 square foot office tower into approximately 500 apartments in phases over a number of years as the office space is vacated. Due to the significant change in planned use of the property, we performed an annual impairment assessment in 2019 by comparing the property's expected undiscounted cash flows to the property's carrying value plus the expected development costs and concluded that there was no impairment loss. We determined the undiscounted cash flows using our estimates of the expected future cash flows which included, but were not limited to, our estimates of property's net operating income, and capitalization rates.
Revenue Recognition - Collectibility of lease payments from office tenants
In accordance with Topic 842, if collectibility of lease payments is not probable at the commencement date, then we limit the lease income to the lesser of the income recognized on a straight-line basis or cash basis. If our assessment of collectibility changes after the commencement date, we record the difference between the lease income that would have been recognized on a straight-line basis and cash basis as a current-period adjustment to lease income. We adopted the complete impairment model guidance within Topic 842. Under this model, commencing on January 1, 2019, we no longer maintain a general reserve related to our receivables, and instead analyze, on a lease-by-lease basis, whether amounts due under the operating lease are deemed probable for collection. We write off tenant and deferred rent receivables as a charge against rental revenue in the period we determine the lease payments are not probable for collection.
Our assessment of the collectibility of lease payments requires judgment and could have a material impact on our results of operations. This assessment involves using a methodology that requires judgment and estimates about matters that are uncertain at the time the estimates are made, including tenant specific factors, specific industry conditions, and general economic trends and conditions. During the year ended December 31, 2020, our results of operations were materially impacted by the COVID-19 pandemic. See "Impacts of the COVID-19 Pandemic on our Business". For the year ended December 31, 2020, charges for uncollectible amounts related to tenant receivables and deferred rent receivables, which were primarily due to the COVID-19 pandemic, reduced our office revenues by $41.0 million.
Revenue Recognition for Tenant Recoveries
Our tenant recovery revenues for recoverable operating expenses are recognized as revenue in the period that the recoverable expenses are incurred. Subsequent to year-end, we perform reconciliations on a lease-by-lease basis and bill or credit each tenant for any differences between the estimated expenses we billed to the tenant and the actual expenses incurred. Estimating tenant recovery revenues requires an in-depth analysis of the complex terms of each underlying lease. Examples of estimates and judgments made when determining the amounts recoverable include:
• estimating the recoverable expenses;
• estimating the impact of changes to expense and occupancy during the year;
• estimating the fixed and variable components of operating expenses for each building;
• conforming recoverable expense pools to those used in the base year for the underlying lease; and
• judging whether an expense or capital expenditure is recoverable pursuant to the terms of the underlying lease.
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These estimates require judgment and involve calculations for each of our office properties. If our estimates prove to be incorrect, then our tenant recovery revenues and net income could be materially and adversely affected in future periods when we perform our reconciliations. The impact of changing our current year tenant recovery billings by 5% would result in a change to our tenant recovery revenues and net income of $2.6 million, $2.6 million and $2.4 million during 2020, 2019 and 2018, respectively.
Stock-Based Compensation
We award stock-based compensation to certain employees and non-employee directors in the form of LTIP Units. We recognize the fair value of the awards over the requisite vesting period, which is based upon service. The fair value of the awards is based upon the market value of our common stock on the grant date and a discount for post-vesting restrictions.
Our estimate of the discount for post-vesting restrictions requires judgment. If our estimate of the discount is too high or too low it would result in the fair value of the awards that we make being too low or too high, respectively, which would result in an under- or over-expense of stock-based compensation, respectively, and this under- or over-expensing of stock-based compensation would result in our net income being overstated or understated, respectively. Stock-based compensation expense was $21.4 million, $18.4 million and $22.3 million for 2020, 2019 and 2018, respectively. The impact of changing the discount rate by 5% would result in a change to our stock-based compensation expense and net income of $1.1 million, $0.9 million and $1.1 million during 2020, 2019 and 2018, respectively.