Item 7. Management’s Discussion and Analysis
ITEM 7: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
We provide Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) in addition to the accompanying consolidated financial statements and notes to assist readers in understanding our results of operations and financial condition. We organize the MD&A as follows:
• Overview. Discussion of our business outlook, operating results, investment activity, financing activity and capital requirements to provide context for the remainder of MD&A.
• Results of Operations. Discussion of our financial results comparing 2022 to 2021.
• Liquidity and Capital Resources. Discussion of our financial condition and analysis of changes in our capital structure and cash flows.
• Funds From Operations . Calculation of NAREIT Funds From Operations (“NAREIT FFO”), a non-GAAP supplemental measure to net income.
• Critical Accounting Estimates. Descriptions of accounting policies that reflect significant judgments and estimates used in the preparation of our consolidated financial statements.
When evaluating our financial condition and operating performance, we focus on the following financial and non-financial indicators:
• Net operating income (“NOI”) , calculated as set forth below under the caption "Results of Operations - Net Operating Income." NOI is a non-GAAP supplemental measure to net income.
• Funds From Operations (“NAREIT FFO”) , calculated as set forth below under the caption “Funds from Operations.” NAREIT FFO is a non-GAAP supplemental measure to net income.
• Average occupancy , calculated as average daily occupied apartment homes as a percentage of total apartment homes.
For purposes of evaluating comparative operating performance, we categorize our properties as “same-store” or “non-same-store”. Same-store portfolio properties include properties that were owned for the entirety of the years being compared and exclude properties under redevelopment or development and properties acquired, sold or classified as held for sale during the years being compared. We define development properties as those for which we have planned or ongoing major construction activities on existing or acquired land pursuant to an authorized development plan. Development properties are categorized as same-store when they have reached stabilized occupancy (90%) before the start of the prior year. We define redevelopment properties as those for which we have planned or ongoing significant development and construction activities on existing or acquired buildings pursuant to an authorized plan, which has an impact on current operating results, occupancy and the ability to lease space with the intended result of a higher economic return on the property. We categorize a redevelopment property as same-store when redevelopment activities have been complete for the majority of each year being compared.
Overview
During the third quarter of 2021, we sold twelve office properties (the “Office Portfolio”) and eight retail properties (the “Retail Portfolio”) (see note 3 to the consolidated financial statements) for contract sale prices of $766.0 million and $168.3 million, respectively. Both the Office Portfolio and Retail Portfolio meet the criteria for classification as discontinued operations in our consolidated financial statements. Our remaining office property, Watergate 600, does not meet the qualitative or quantitative criteria for a reportable segment (see note 14 to the consolidated financial statements).
The dispositions of our office and retail properties are part of a strategic shift away from the commercial sector to the residential sector, which simplifies our portfolio to one reportable segment (residential) (the “strategic transformation”). We used the net proceeds from the sales to fund the expansion of our residential platform through acquisitions in Sunbelt markets and to reduce our leverage by repaying outstanding debt. During the third and fourth quarters of 2021, we completed the acquisitions of two apartment communities in Georgia with a combined total of 730 apartment homes for a total contract purchase prices of $154.0 million. During 2022, we completed acquisitions of three apartment communities in Georgia with a combined total of 1,079 apartment homes for a total contract purchase price of $283.2 million. We believe the successful execution of this research-driven strategic shift will lead to greater, more sustainable growth.
In connection with this strategic transformation, we are redesigning our operating model for purposes of more efficiently and effectively supporting residential operations. This operating model redesign includes the internalization of community management
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services currently performed by third-party management companies. Costs related to the strategic transformation, including the allocation of internal costs, consulting, advisory and termination benefits, are included in Transformation costs on our consolidated statements of operations. We recognized $9.7 million and $6.6 million of transformation costs, net of amounts capitalized, on the consolidated statements of operations during 2022 and 2021, respectively, and anticipate incurring approximately $3.0 - $4.0 million of additional transformation costs during 2023. Community onboarding commenced in October 2022 and is expected to be completed in phases in 2023. We expect to realize significant operational benefits from this operating model redesign and complete its implementation in 2023.
In October 2022, the Company changed its name from Washington Real Estate Investment Trust to Elme Communities reflecting the Company’s continued transition into a focused multifamily company, and subsequent geographic expansion into Sunbelt markets. On October 20, 2022, the Company’s ticker symbol on the New York Stock Exchange changed from “WRE” to “ELME.”
Operating Results
The discussion that follows is based on our Operating Results. The ability to compare one period to another is significantly affected
by the strategic transformation in 2021 and other acquisitions completed and dispositions made during 2021 and 2022 (see note 3 to the consolidated financial statements).
Net (loss) income, NOI and NAREIT FFO for the years ended December 31, 2022 and 2021 were as follows (in thousands, except percentage amounts):
Year Ended December 31,
2022 2021 Change % Change
Net (loss) income
$ (30,868) $ 16,384 $ (47,252) (288.4) %
NOI (1)
$ 135,379 $ 108,369 $ 27,010 24.9 %
NAREIT FFO (2)
$ 60,854 $ 65,503 $ (4,649) (7.1) %
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(1) See page 29 of the MD&A for reconciliations of NOI to net (loss) income.
(2) See page 39 of the MD&A for reconciliations of NAREIT FFO to net (loss) income.
The increase in net loss is primarily due to gains on sale of real estate ($46.4 million) in 2021 and lower income from discontinued operations in 2022 ($23.1 million) due to the sales of the Office Portfolio and Retail Portfolio during 2021, higher depreciation and amortization expenses ($19.1 million), lower other income ($3.4 million), higher transformation costs, net of amounts capitalized, ($3.1 million), higher property management expenses ($1.3 million) and higher general and administrative expenses ($0.7 million). These were partially offset by higher NOI ($27.0 million), lower interest expense ($9.1 million), lower loss on extinguishment of debt ($7.8 million) and lower loss on interest rate derivatives ($5.9 million).
The higher NOI is primarily due to the acquisitions of Assembly Eagles Landing ($4.2 million) and The Oxford ($1.1 million) in 2021 and Carlyle of Sandy Spring ($4.0 million), Marietta Crossing ($3.2 million) and Alder Park ($2.2 million) in 2022, higher NOI from same-store properties ($7.9 million), higher NOI from Trove ($3.7 million), which achieved stabilization in the fourth quarter of 2021, and higher NOI at Watergate 600 ($0.7 million). The higher same-store NOI was primarily due to higher rental rates. Residential same-store average occupancy for our portfolio increased to 95.6% as of December 31, 2022 from 95.3% as of December 31, 2021.
The lower NAREIT FFO is primarily due to lower income from discontinued operations, net of depreciation and amortization ($46.0 million), lower other income ($3.4 million), higher transformation costs, net of amounts capitalized, ($3.1 million), higher property management expenses ($1.3 million) and higher general and administrative expenses ($0.7 million). These were partially offset by higher NOI ($27.0 million), lower interest expense ($9.1 million), lower loss on extinguishment of debt ($7.8 million) and lower loss on interest rate derivatives ($5.9 million).
Investment Activity
Significant investment transactions during 2022 included the following:
• Acquisition of Carlyle of Sandy Springs, a 389-unit apartment community in Sandy Springs, Georgia for a contract purchase price of $105.6 million during the first quarter of 2022.
• Acquisition of Marietta Crossing, a 420-unit apartment community in Marietta, Georgia for a contract purchase price of $107.9 million during the second quarter of 2022. We assumed a $42.8 million mortgage with this acquisition.
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• Acquisition of Alder Park, a 270-unit apartment community in Smyrna, Georgia for a contract purchase price of $69.8 million during the second quarter of 2022. We assumed a $33.7 million mortgage with this acquisition.
Financing Activity
Significant financing transactions during 2022 included the following:
• We issued 1.0 million common shares at a weighted average price per share of $26.27 for net proceeds of $26.8 million through our at-the-market program.
• In September 2022, we extinguished the aggregate $76.5 million of mortgages secured by Marietta Crossing and Alder Park through defeasance arrangements, recognizing an aggregate loss on extinguishment of debt of $4.9 million. We partially funded the defeasances with a $65.0 million draw on our unsecured revolving credit facility.
Subsequent to the end of 2022, we entered into a $125.0 million unsecured term loan ("2023 Term Loan") with an interest rate of SOFR (subject to a credit spread adjustment of 10 basis points) plus a margin of 95 basis points. The 2023 Term Loan has a two-year term ending in January 2025, with two one-year extension options. We used the proceeds to prepay the $100.0 million 2018 Term Loan in full and a portion of our borrowings under our unsecured credit facility.
As of December 31, 2022, the interest rate on the $700.0 million unsecured revolving credit facility was one month LIBOR plus 0.85% and the facility fee was 0.20%. The LIBOR was 4.39% as of that date. Subsequent to the end of 2022, we executed an amendment to our revolving credit facility to convert the benchmark interest rate from LIBOR to an adjusted SOFR, with no change in the applicable interest rate margins. As of February 14, 2023, our Revolving Credit Facility has a borrowing capacity of $657.0 million.
Capital Requirements
We do not currently have any debt maturities scheduled for 2023. We expect to have additional capital requirements as set forth on page 37 (Liquidity and Capital Resources - Capital Requirements).
Results of Operations
The discussion that follows is based on our consolidated results of operations for the two years ended December 31, 2022. The ability to compare one period to another is significantly affected by the strategic transformation in 2021, including the resulting classification of certain assets as discontinued operations, and other acquisitions completed and dispositions made during those years (see note 3 to the consolidated financial statements).
Net Operating Income
NOI, defined as real estate rental revenue less direct real estate operating expenses, is a non-GAAP measure. NOI is calculated as net income, less non-real estate revenue and the results of discontinued operations (including the gain or loss on sale, if any), plus interest expense, depreciation and amortization, lease origination expenses, general and administrative expenses, acquisition costs, real estate impairment, casualty gain and losses and gain or loss on extinguishment of debt. NOI does not include management expenses, which consist of corporate property management costs and property management fees paid to third parties. NOI is the primary performance measure we use to assess the results of our operations at the property level. We believe that NOI is a useful performance measure because, when compared across periods, it reflects the impact on operations of trends in occupancy rates, rental rates and operating costs on an unleveraged basis, providing perspective not immediately apparent from net income. NOI excludes certain components from net income in order to provide results more closely related to a property’s results of operations. For example, interest expense is not necessarily linked to the operating performance of a real estate asset. In addition, depreciation and amortization, because of historical cost accounting and useful life estimates, may distort operating performance at the property level. As a result of the foregoing, we provide NOI as a supplement to net income, calculated in accordance with GAAP. NOI does not represent net income or income from continuing operations calculated in accordance with GAAP. As such, NOI should not be considered an alternative to these measures as an indication of our operating performance. A reconciliation of NOI to net income follows.
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2022 Compared to 2021
The following tables reconcile net income to NOI and provide the basis for our discussion of our consolidated results of operations and NOI in 2022 compared to 2021. All amounts are in thousands except percentage amounts.
Year Ended December 31,
2022 2021 $ Change % Change
Net (loss) income $ (30,868) $ 16,384 $ (47,252) (288.4) %
Adjustments:
Property management expense 7,436 6,133 1,303 21.2 %
General and administrative expense 28,258 27,538 720 2.6 %
Transformation costs 9,686 6,635 3,051 46.0 %
Real estate depreciation and amortization 91,722 72,656 19,066 26.2 %
Interest expense 24,940 34,063 (9,123) (26.8) %
Loss on interest rate derivatives — 5,866 (5,866) (100.0) %
Loss on extinguishment of debt, net 4,917 12,727 (7,810) (61.4) %
Other income (712) (4,109) 3,397 (82.7) %
Discontinued operations:
Income from operations of properties sold or held for sale — (23,083) 23,083 (100.0) %
Gain on sale of real estate, net — (46,441) 46,441 (100.0) %
Total net operating income (NOI) $ 135,379 $ 108,369 $ 27,010 24.9 %
Residential revenue:
Same-store portfolio $ 151,547 $ 141,301 $ 10,246 7.3 %
Acquisitions (1)
27,370 2,262 25,108 1,110.0 %
Development (2)
10,510 6,375 4,135 64.9 %
Non-residential (3)
1,073 1,027 46 4.5 %
Total 190,500 150,965 39,535 26.2 %
Residential expenses:
Same-store portfolio 53,449 51,112 2,337 4.6 %
Acquisitions 11,308 865 10,443 1,207.3 %
Development 3,697 3,258 439 13.5 %
Non-residential 281 292 (11) (3.8) %
Total 68,735 55,527 13,208 23.8 %
Residential NOI:
Same-store portfolio 98,098 90,189 7,909 8.8 %
Acquisitions 16,062 1,397 14,665 1,049.7 %
Development 6,813 3,117 3,696 118.6 %
Non-residential 792 735 57 7.8 %
Total 121,765 95,438 26,327 27.6 %
Other NOI (4)
13,614 12,931 683 5.3 %
Total NOI $ 135,379 $ 108,369 $ 27,010 24.9 %
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(1) Acquisitions:
2021: The Oxford and Assembly Eagles Landing
2022: Carlyle of Sandy Springs, Alder Park, Marietta Crossing
(2) Development/redevelopment: Trove, Riverside Development (multifamily development adjacent to Riverside Apartments)
(3) Non-residential: Includes revenues and expenses from retail operations at residential properties.
(4) Other (classified as continuing operations): Watergate 600
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(5) Discontinued operations:
2021 Office - 1901 Pennsylvania Avenue, 515 King Street, 1220 19th Street, 1600 Wilson Boulevard, Silverline Center, Courthouse Square, 2000 M Street, 1140 Connecticut Avenue, Army Navy Club, 1775 Eye Street, Fairgate at Ballston and Arlington Tower
2021 Retail - Takoma Park, Westminster, Concord Centre, Chevy Chase Metro Plaza, 800 S. Washington Street, Randolph Shopping Center, Montrose Shopping Center and Spring Valley Village
Real Estate Rental Revenue
Real estate rental revenue from our apartment communities is comprised of (a) rent from operating leases of residential apartments with terms of approximately one year or less, recognized on a straight-line basis, (b) revenue from the recovery of operating expenses from our residents, (c) credit losses on lease related receivables, (d) revenue from leases of retail space at our apartment communities and (e) parking and other tenant charges.
Real estate rental revenue from same-store residential properties increased $10.2 million, or 7.3%, to $151.5 million for 2022, compared to $141.3 million for 2021, primarily due to higher rental income ($8.2 million), lower rent abatements ($1.6 million) and higher fee income ($0.4 million).
Real estate rental revenue from acquisitions increased $25.1 million due to the acquisition of Carlyle of Sandy Springs ($6.6 million) during the first quarter of 2022, Marietta Crossing ($4.9 million) and Alder Park ($3.4 million) during the second quarter of 2022, Assembly Eagles Landing ($7.6 million) during the fourth quarter of 2021 and The Oxford ($2.6 million) during the third quarter of 2021.
Real estate rental revenue from development properties increased due to the continued lease-up of the Trove development ($4.1 million). We placed the remainder of the Trove development costs into service during the first quarter of 2021 and achieved stabilization during the fourth quarter of 2021.
Average occupancy for residential properties for 2022 and 2021 was as follows:
December 31, 2022 December 31, 2021 Increase
Same-Store Non-Same-Store Total Same-Store Non-Same-Store Total Same-Store Non-Same-Store Total
95.6 % 94.5 % 95.3 % 95.3 % 71.0 % 93.4 % 0.3 % 23.5 % 1.9 %
The increase in same-store average occupancy was primarily due to higher average occupancy at The Kenmore, 3801 Connecticut Avenue, Assembly Germantown and Assembly Herndon, partially offset by lower average occupancy at Roosevelt Towers and Clayborne Apartments.
Real Estate Expenses
Residential real estate expenses as a percentage of residential revenue for 2022 and 2021 were 36.1% and 36.8%, respectively.
Real estate expenses from same-store residential properties increased $2.3 million, or 4.6%, to $53.4 million for 2022, compared to $51.1 million for 2021, primarily due to higher administrative ($0.7 million), real estate tax ($0.6 million), utilities ($0.5 million), insurance ($0.3 million) and contract maintenance and supplies ($0.2 million) expenses.
Real estate expenses from acquisitions increased $10.4 million due to the acquisitions of Carlyle of Sandy Springs ($2.6 million) during the first quarter of 2022, Marietta Crossing ($1.7 million) and Alder Park ($1.2 million) during the second quarter of 2022, Assembly Eagles Landing ($3.4 million) during the fourth quarter of 2021, and The Oxford ($1.5 million) during the third quarter of 2021.
Other NOI
Other NOI classified as continuing operations increased due to higher NOI at Watergate 600 ($0.7 million).
Other Income and Expenses
Property management expenses: Increase of $1.3 million primarily due to the acquisitions of The Oxford and Assembly Eagles Landing during the third and fourth quarters of 2021, the acquisitions of Carlyle of Sandy Springs, Marietta Crossing and Alder Park in 2022 and Trove reaching stabilization during the fourth quarter of 2021.
General and administrative expenses : Increase of $0.7 million primarily due to corporate overhead no longer being allocated to
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office management due to the sales of the Office and Retail Portfolios in 2021 ($1.9 million), higher legal fees ($0.9 million), higher office rent ($0.6 million) from the commencement of the corporate office lease during the third quarter of 2021 and higher shareholder expenses ($0.3 million) in 2022. These increases were partially offset by lower short-term incentive compensation expense ($1.8 million), lower leasing expenses ($0.7 million) and lower deferred tax expense ($0.5 million) in 2022.
Transformation costs: Increase of $3.1 million primarily due to higher employee time allocations ($1.5 million) related to the strategic transformation, higher consulting costs ($1.1 million), higher software depreciation ($0.9 million) and higher software costs ($0.8 million), partially offset by lower severance expenses ($1.6 million).
Depreciation and amortization : Increase of $19.1 million primarily due to the acquisitions of Assembly Eagles Landing ($5.3 million), Carlyle of Sandy Springs ($5.8 million), Marietta Crossing ($5.2 million), Alder Park ($3.1 million) and The Oxford ($0.3 million) and higher depreciation and amortization at Watergate 600 ($0.9 million). These increases were partially offset by lower depreciation and amortization at same-store residential properties ($1.4 million) and Trove ($0.1 million).
Interest Expense : Interest expense by debt type for the year ended December 31, 2022 and 2021 was as follows (in thousands):
Year Ended December 31,
Debt Type 2022 2021 $ Change % Change
Notes payable $ 20,458 $ 31,652 $ (11,194) (35.4) %
Mortgage notes payable 1,014 — 1,014 100.0 %
Line of credit 3,751 3,161 590 18.7 %
Capitalized interest (283) (750) 467 62.3 %
Total $ 24,940 $ 34,063 $ (9,123) (26.8) %
• Notes payable : Decrease primarily due to the prepayment of $300.0 million of unsecured notes during the third quarter of 2021 that had been scheduled to mature in October 2022 and the prepayment of a $150.0 million portion of the 2018 Term Loan during the third quarter of 2021.
• Mortgage notes payable : Increase due to the mortgages of $42.8 million and $33.7 million assumed in the acquisitions of Marietta Crossing and Alder Park, respectively, in the second quarter of 2022. In September 2022, we extinguished the liabilities associated with these mortgages though defeasance arrangements.
• Line of credit : Increase primarily due to a weighted average interest rate of 4.2% and weighted average borrowings of $21.6 million in 2022, as compared to a weighted average interest rate of 1.1% and weighted average borrowings of $34.8 million in 2021.
• Capitalized interest : Decrease primarily due to ceasing capitalization of interest on spending related to the multifamily development adjacent to Riverside Apartments due to a pause in development activities.
Loss on interest rate derivatives : We terminated five interest rate swap arrangements with an aggregate notional value of $150.0 million and recognized a $5.8 million loss on interest rate derivatives during 2021 (see note 8 to the consolidated financial statements).
Loss on extinguishment of debt: During 2022, we extinguished the liabilities associated with mortgage notes payable for Marietta Crossing and Alder Park through defeasance arrangements, recognizing aggregate losses on extinguishment of debt of $4.9 million. During the third quarter of 2021 we recognized a $12.3 million loss on extinguishment of debt related to the prepayment of the $300.0 million of unsecured notes that were originally scheduled to mature in October 2022, a $0.2 million loss on extinguishment of debt related to the prepayment of a $150.0 million portion of the $250.0 million 2018 Term Loan and a $0.2 million loss on extinguishment of debt related to the renewal of our Revolving Credit Facility, all of which were repaid in connection with our strategic transformation, using the proceeds from the sales of the Office Portfolio and Retail Portfolio.
Other income : Income during 2022 relates to real estate tax refunds ($0.7 million) received on previously sold commercial properties. Other income in 2021 primarily consists of a legal settlement ($1.3 million), a real estate tax refund for an office property sold in 2018 ($1.3 million), a gain on life insurance ($1.0 million) and a construction easement at a retail property ($0.4 million).
Discontinued operations
Income from properties sold or held for sale: Decrease due to the sale of the Office Portfolio and the Retail Portfolio during 2021.
Gain on sale of real estate, net: The net gain during 2021 is due to the gain on sale of the Retail Portfolio ($57.7 million), partially offset by the loss on sale of the Office Portfolio ($11.2 million).
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Liquidity and Capital Resources
We believe we will have adequate liquidity over the next twelve months to operate our business and to meet our cash requirements, which include meeting our debt obligations, capital commitments and contractual obligations, as well as the payment of dividends, and funding possible growth opportunities. Through our Office Portfolio and Retail Portfolio sales, which had a combined sale price of approximately $934.3 million, we executed strategic transactions that allowed us to expand into the Sunbelt regions. In connection with our strategic transformation, we are redesigning our operating model for purposes of more efficiently and effectively supporting residential operations. We recognized $9.7 million and $6.6 million of transformation costs, net of amounts capitalized, on the consolidated statements of operations during 2022 and 2021, respectively. Upon completion of the implementation in 2023, w e expect to realize significant operational benefits from this operating model redesign. We also believe we have adequate liquidity beyond 2023, with only $155.0 million of scheduled debt maturities prior to 2027.
We will continue to assess the payment of our dividends on a quarterly basis. Future determinations regarding the declaration and payment of dividends, if any, will be at the discretion of our board of trustees which considers, among other factors, trends in our levels of funds from operations and ongoing capital requirements to achieve a targeted payout ratio.
Capital Structure
We manage our capital structure to reflect a long-term investment approach, generally seeking to match the cash flow of our assets with a mix of equity and various debt instruments. We expect that our capital structure will allow us to obtain additional capital from diverse sources that could include additional equity offerings of common shares, public and private secured and unsecured debt financings, asset dispositions, operating units and joint venture equity. Our ability to raise funds through the incurrence of debt and issuance of equity securities is dependent on, among other things, general economic conditions including general market conditions for REITs, our operating performance, our debt rating, the current trading price of our common shares and other capital market conditions. We analyze which source of capital we believe to be most advantageous to us at any particular point in time.
As of February 14, 2023, we had cash and cash equivalents of approximately $15.8 million and availability under our Revolving Credit Facility of $657.0 million. We currently expect that our potential sources of liquidity for acquisitions, development, redevelopment, expansion and renovation of properties, and operating and administrative expenses, may include:
• Cash flow from operations;
• Borrowings under our Revolving Credit Facility or other new short-term facilities;
• Issuances of our equity securities and/or common units in operating partnerships;
• Issuances of preferred shares;
• Proceeds from long-term secured or unsecured debt financings, including construction loans and term loans, or the issuance of debt securities;
• Investment from joint venture partners; and
• Net proceeds from the sale of assets.
During 2023, we expect that we will have significant capital requirements, including the following:
• Funding dividends and distributions to our shareholders (which we intend to continue to pay at or about current levels);
• Approximately $15.0 - $20.0 million to invest in our existing portfolio of operating assets;
• Less than $1.0 million to invest in our development and redevelopment projects; and
• Funding for potential property acquisitions throughout 2023, offset by proceeds from potential property dispositions.
There can be no assurance that our capital requirements will not be materially higher or lower than the above expectations. We currently believe that we will have enough cash on hand and/or will generate sufficient cash flow from operations and potential property sales and have access to the capital resources necessary to fund our requirements in 2023. However, as a result of general market conditions in the greater Washington, DC metro and Sunbelt regions, economic conditions affecting the ability to attract and retain residents and tenants or achieve anticipated rental rates, declines in our share price, unfavorable changes in the supply of competing properties, or our properties not performing as expected, we may not generate sufficient cash flow from operations and property sales or otherwise have access to capital on favorable terms, or at all. If we are unable to obtain capital from other sources, we may need to alter capital spending to be materially different than what is stated in the prior paragraph. If capital were not available, we may be unable to satisfy the distribution requirement applicable to REITs, make required principal and interest payments, make strategic acquisitions or make necessary and/or routine capital improvements or
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undertake improvement/redevelopment opportunities with respect to our existing portfolio of operating assets.
Debt Financing
We generally use unsecured or secured, corporate-level debt, including unsecured notes, our Revolving Credit Facility, bank term loans and mortgages, to meet our borrowing needs. Long-term, we generally use fixed rate debt instruments in order to match the returns from our real estate assets. If we issue unsecured debt in the future, we will seek to ladder the maturities of our debt to mitigate exposure to interest rate risk in any particular future year. We also utilize variable rate debt for short-term financing purposes. At times, our mix of variable and fixed rate debt may not suit our needs. At those times, we may use derivative financial instruments including interest rate swaps and caps, forward interest rate options or interest rate options in order to assist us in managing our debt mix. We may either hedge our variable rate debt to give it an effective fixed interest rate or hedge fixed rate debt to give it an effective variable interest rate.
As of December 31, 2022, our future debt principal payments are scheduled as follows (in thousands):
Year Unsecured Notes Payable/Term Loans Revolving Credit Facility Total Debt Average Interest Rate
2023 $ 100,000 (1) $ — $ 100,000 2.3 %
2024 — — — — %
2025 — 55,000 55,000 5.2 %
2026 — — — — %
2027 — — — — %
Thereafter 400,000 — 400,000 4.5 %
Scheduled principal payments 500,000 55,000 555,000 4.2 %
Premiums and discounts, net (116) — (116)
Debt issuance costs, net (2,525) — (2,525)
Total $ 497,359 $ 55,000 $ 552,359 4.2 %
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(1) Elme Communities entered into an interest rate swap to effectively fix a LIBOR plus 110 basis points floating interest rate to a 2.31% all-in fixed rate for the remaining $100.0 million portion of the 2018 Term Loan. The interest rates were fixed through the term loan maturity of July 2023. Subsequent to the end of 2022, we prepaid the 2018 Term Loan with proceeds from a $125.0 million unsecured term loan which matures in 2025 ("2023 Term Loan"). The 2023 Term Loan has an interest rate of SOFR (subject to a credit spread adjustment of 10 basis points) plus a margin of 95 basis points. The interest rate swap effectively fixes a $100.0 million potion of the 2023 Term Loan at 2.16% through the interest rate swap's expiration date of July 21, 2023.
The weighted average maturity for our debt was 5.9 years as of December 31, 2022. If principal amounts due at maturity cannot
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be refinanced, extended or paid with proceeds of other capital transactions, such as new equity capital, our cash flow may be insufficient to repay all maturing debt. Prevailing interest rates or other factors at the time of a refinancing, such as possible reluctance of lenders to make commercial real estate loans, may result in higher interest rates and increased interest expense or inhibit our ability to finance our obligations.
From time to time, we may seek to repurchase and cancel our outstanding unsecured notes and term loans through open market purchases, privately negotiated transactions or otherwise. Such repurchases, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.
Debt Covenants
Pursuant to the terms of our Revolving Credit Facility, our term loans and unsecured notes, we are subject to customary operating covenants and maintenance of various financial ratios.
Failure to comply with any of the covenants under our Revolving Credit Facility, our term loans, unsecured notes or other debt instruments could result in a default under one or more of our debt instruments. This could cause our lenders to accelerate the timing of payments and could therefore have a material adverse effect on our business, operations, financial condition and liquidity. In addition, our ability to draw on our Revolving Credit Facility or incur other unsecured debt in the future could be restricted by the debt covenants.
As of December 31, 2022, we were in compliance with the covenants related to our Revolving Credit Facility, 2018 Term Loan and unsecured notes.
Common Equity
We have authorized for issuance 150.0 million common shares, of which approximately 87.5 million shares were outstanding at December 31, 2022.
On February 17, 2021, we entered into separate amendments to each of our existing equity distribution agreements (“Original Equity Distribution Agreements”) with each of Wells Fargo Securities, LLC, BNY Mellon Capital Markets, LLC, Capital One Securities, Inc., Citigroup Global Markets Inc., Goldman Sachs & Co. LLC, J.P. Morgan Securities LLC, KeyBanc Capital Markets Inc. and Truist Securities, Inc. (f/k/a SunTrust Robinson Humphrey, Inc.), each dated May 4, 2018 (collectively, as amended, the “Equity Distribution Agreements”) for our at-the-market program. Also on February 17, 2021, we entered into a separate equity distribution agreement with BTIG, LLC on the same terms as the Amended Equity Distribution Agreements (the “BTIG Equity Distribution Agreement”). On September 22, 2021, BTIG, LLC notified us that it was terminating the BTIG Equity Distribution Agreement, effective as of September 27, 2021. Pursuant to the Equity Distribution Agreements, we may sell, from time to time, up to an aggregate price of $550.0 million of our common shares of beneficial interest, $0.01 par value per share. Issuances of our common shares are made at market prices prevailing at the time of issuance. We may use net proceeds from the issuance of common shares under this program for general business purposes, including, without limitation, working capital, the acquisition, renovation, expansion, improvement, development or redevelopment of income producing properties or the repayment of debt.
Our issuances and net proceeds on the Equity Distribution Agreements in 2022 and 2021 and the Original Equity Distribution Agreements in 2020, respectively, were as follows (in thousands, except per share data):
Year Ended December 31,
2022 2021 2020
Issuance of common shares 1,032 1,636 2,046
Weighted average price per share $ 26.27 $ 25.44 $ 23.86
Net proceeds $ 26,849 40,462 $ 48,355
We have a dividend reinvestment program, whereby shareholders may use their dividends and optional cash payments to purchase common shares. The common shares sold under this program may either be common shares issued by us or common shares purchased in the open market.
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Our issuances and net proceeds on the dividend reinvestment program for the three years ended December 31, 2022 were as follows (in thousands; except per share data):
Year Ended December 31,
2022 2021 2020
Issuance of common shares 47 75 90
Weighted average price per share $ 22.40 $ 23.37 $ 24.12
Net proceeds $ 1,030 $ 1,744 $ 2,121
Preferred Equity
Our board of trustees can, at its discretion, authorize the issuance of up to 10.0 million preferred shares. The ability to issue preferred equity provides Elme Communities an additional financing tool that may be used to raise capital for future acquisitions or other business purposes. As of December 31, 2022, no preferred shares are issued and outstanding.
Capital Commitments
We will require capital for development and redevelopment projects currently underway and in the future. We are currently engaged in predevelopment activities for the ground-up development of a residential property on land adjacent to Riverside Apartments. As of December 31, 2022, we had no outstanding contractual commitments related to our development and redevelopment projects and expect to fund less than $1.0 million of total development and redevelopment spending during 2023.
In addition to our development and redevelopment projects, we anticipate funding approximately $30.0 - $35.0 million on several major renovation projects at our residential communities during 2023.
These projects include unit renovations, property technology initiatives, common area and mechanical upgrades, pool deck renovations, facade and retaining wall restorations and fire system and roof replacements. Not all of the anticipated spending had been committed via executed construction contracts at December 31, 2022. We expect to fund these projects using cash generated by our real estate operations, through borrowings on our Revolving Credit Facility, or raising additional debt or equity capital in the public market.
Contractual Obligations
As of December 31, 2022, certain contractual obligations will require significant capital as follows (in thousands):
Payments due by Period
Total Less than 1
year 1-3 years 4-5 years After 5
years
Long-term debt (1)
$ 694,269 $ 120,740 $ 111,318 $ 84,150 $ 378,061
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(1) See notes 6 and 7 of the consolidated financial statements. Amounts include principal, interest and facility fees.
In addition to our long-term debt, we have committed building capital expenditures of $4.9 million in 2023 based on contracts in place as of December 31, 2022, along with other various standing or renewable contracts with vendors. The majority of these contracts can be canceled with immaterial or no cancellation penalties, with the exception of our elevator maintenance agreements and our electricity and gas purchase agreements. Contract terms on leases that can be canceled are generally one year or less.
Historical Cash Flows
Cash flows from operations are an important factor in our ability to sustain our dividend at its current rate. If our cash flows from operations were to decline significantly, we may have to reduce our dividend. Consolidated cash flows for the three years ended December 31, 2022 were as follows (in thousands):
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Year ended December 31, Variance
2022 2021 2020 2022 vs. 2021 2021 vs. 2020
Cash provided by operating activities $ 73,211 $ 89,156 $ 112,978 $ (15,945) $ (23,822)
Cash (used in) provided by investing activities (241,163) 702,170 65,760 (943,333) 636,410
Cash used in financing activities (56,416) (565,396) (185,199) 508,980 (380,197)
Net cash provided by operating activities decreased in 2022 as compared to 2021 and in 2021 as compared to 2020 primarily due to the sales of the Office Portfolio and the Retail Portfolio during 2021 (see note 3 to the consolidated financial statements) and costs associated with our strategic transformation.
Net cash (used in) provided by investing activities decreased in 2022 as compared to 2021 and increased in 2021 as compared to 2020 primarily due to the sales of the Office Portfolio and the Retail Portfolio during 2021. These were partially offset by the acquisitions of The Oxford and Assembly Eagles Landing during 2021 and acquisitions of Marietta Crossing, Alder Park and Carlyle of Sandy Springs during 2022.
Net cash used in financing activities decreased in 2022 as compared to 2021 primarily due to a higher volume of debt repayments during 2021 and higher net proceeds from equity issuances and lower dividends paid in 2022. Net cash used in financing activities increased in 2021 as compared to 2020 primarily due to the repayment of $300.0 million of unsecured notes and higher net repayments on the Revolving Credit Facility during 2021.
Capital Improvements and Development Costs
Our capital improvement, development and redevelopment costs for the three years ended December 31, 2022 were as follows (in thousands):
Year Ended December 31,
2022 2021 2020
Accretive capital improvements and development costs:
Acquisition related improvements $ 5,236 $ 7,218 $ 10,487
Expansions and major renovations 21,476 17,096 16,561
Development/redevelopment 698 8,406 28,812
Tenant improvements (including first generation leases) 1,337 2,427 21,785
Total accretive capital improvements (1)
28,747 35,147 77,645
Other capital improvements: 8,464 5,669 9,262
Total $ 37,211 $ 40,816 $ 86,907
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(1) We consider these capital improvements to be accretive to revenue and not necessarily to net income.
Included in the capital improvement and development costs listed above are capitalized interest in the amount of $0.3 million, $0.8 million and $2.2 million for the three years ended December 31, 2022, respectively, and capitalized employee compensation in the amount of $1.1 million, $1.6 million and $2.0 million for the three years ended December 31, 2022, respectively.
Accretive Capital Improvements
Acquisition Related Improvements: Acquisition related improvements are capital improvements to properties acquired during the preceding three years which were anticipated at the time we acquired the properties. These types of improvements were made in 2022 to the Carlyle of Sandy Springs, Assembly Eagles Landing and The Oxford.
Expansions and Major Renovations: Expansion projects increase the rentable area of a property, while major renovation projects are improvements sufficient to increase the income otherwise achievable at a property. Expansions and major renovations during 2022 included unit, hallway, retaining walls renovations and SmartRent and wifi installations at Assembly Alexandria; retail space conversion into additional units and plaza restoration at The Ashby; unit renovations, roof and heating system replacement at Assembly Dulles; unit and facade renovations and fire alarm system replacement at Riverside Apartments; unit renovations and SmartRent installations at Assembly Manassas and unit renovations, roof awnings and
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heating system replacement at The Wellington.
Development/Redevelopment: Development costs represent expenditures for ground up development of new operating properties. Redevelopment costs represent expenditures for improvements intended to reposition properties in their markets and generate more income than would be otherwise achievable. Development/redevelopment costs in 2022 include predevelopment costs for a future residential development adjacent to Riverside Apartments.
Other Capital Improvements
Other capital improvements, also referred to as recurring capital improvements, are those not included in the above categories. Over time these costs will be recurring in nature to maintain a property's income and value. This category includes improvements made as needed upon vacancy of an apartment. Such improvements totaled $6.7 million in 2022, averaging approximately $1,860 per unit for the 41% of units which turned over relative to our total portfolio of apartment homes. Aside from improvements related to apartment turnover, these improvements include facade repairs, installation of new heating and air conditioning equipment, asphalt replacement, permanent landscaping, new lighting and new finishes. In addition, we incurred repair and maintenance expense of $5.0 million during 2022 to maintain the quality of our buildings.
Off Balance Sheet Arrangements
We have no off-balance sheet arrangements as of December 31, 2022 that are reasonably likely to have a current or future material effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Forward-Looking Statements
Some of the statements contained in this Form 10-K constitute forward-looking statements within the meaning of federal securities laws. Forward-looking statements relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. In some cases, you can identify forward-looking statements by the use of forward-looking terminology such as “may,” “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” or “potential” or the negative of these words and phrases or similar words or phrases which are predictions of or indicate future events or trends and which do not relate solely to historical matters. Such statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance, or achievements of Elme Communities to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Additional factors which may cause the actual results, performance or achievements of Elme Communities to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements include, but are not limited to:
(a) the risks associated with ownership of real estate in general and our real estate assets in particular;
(b) the economic health of the areas in which our properties are located, particularly with respect to greater Washington, DC metro and Sunbelt region;
(c) risks associated with our ability to execute on our strategies, including new strategies with respect to our operations and our portfolio, including our ability to realize any anticipated operational benefits from our internalization of community management functions;
(d) the risk of failure to enter into and/or complete contemplated acquisitions and dispositions, or at all, within the price ranges anticipated and on the terms and timing anticipated;
(e) changes in the composition of our portfolio, including the acquisition of apartment homes in the Sunbelt markets;
(f) risks related to changes in interest rates, including the future of the reference rate used in our existing floating rate debt instruments;
(g) reductions in or actual or threatened changes to the timing of federal government spending;
(h) the risks related to use of third-party providers;
(i) the economic health of our residents;
(j) the ultimate duration of the COVID-19 global pandemic, including any mutations thereof, the actions taken to contain the pandemic or mitigate its impact, and the direct and indirect economic effects of the pandemic and containment measures, the effectiveness and willingness of people to take COVID-19 vaccines, and the duration of associated immunity and efficacy of the vaccines against emerging variants of COVID-19;
(k) the impact from macroeconomic factors (including inflation, increases in interest rates, potential economic slowdown or a recession and geopolitical conflicts);
(l) compliance with applicable laws and corporate social responsibility goals, including those concerning the environment
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and access by persons with disabilities;
(m) the risks related to not having adequate insurance to cover potential losses;
(n) changes in the market value of securities;
(o) terrorist attacks or actions and/or cyber-attacks;
(p) whether we will succeed in the day-to-day property management and leasing activities that we have previously outsourced;
(q) the availability and terms of financing and capital and the general volatility of securities markets;
(r) the risks related to our organizational structure and limitations of share ownership;
(s) failure to qualify and maintain our qualification as a REIT and the risks of changes in laws affecting REITs; and
(t) other factors discussed under the caption “Risk Factors.”
While forward-looking statements reflect our good faith beliefs, they are not guarantees of future performance. For a further discussion of these and other factors that could cause our future results to differ materially from any forward-looking statements, see the section entitled “Risk Factors.” We undertake no obligation to update our forward-looking statements or risk factors to reflect new information, future events, or otherwise.
Funds From Operations
NAREIT FFO is a widely used measure of operating performance for real estate companies. In its 2018 NAREIT FFO White Paper Restatement, the National Association of Real Estate Investment Trusts, Inc. (“NAREIT”) defines NAREIT FFO as net income (computed in accordance with GAAP) excluding gains (or losses) associated with sales of properties; impairments of depreciable real estate, and real estate depreciation and amortization. We consider NAREIT FFO to be a standard supplemental measure for REITs, and believe it is a useful metric because it facilitates an understanding of the operating performance of our properties without giving effect to real estate depreciation and amortization, which historically assumes that the value of real estate assets diminishes predictably over time. Since real estate values have instead historically risen or fallen with market conditions, we believe that NAREIT FFO more accurately provides investors an indication of our ability to incur and service debt, make capital expenditures and fund other needs. Our NAREIT FFO may not be comparable to FFO reported by other REITs. These other REITs may not define the term in accordance with the current NAREIT definition or may interpret the current NAREIT definition differently.
The following table provides the calculation of our NAREIT FFO and a reconciliation of NAREIT FFO to net income for the three years ended December 31, 2022 (in thousands):
Year Ended December 31,
2022 2021 2020
Net (loss) income $ (30,868) $ 16,384 $ (15,680)
Adjustments:
Depreciation and amortization 91,722 72,656 70,336
Loss on sale of depreciable real estate, net — — 15,009
Discontinued operations:
Depreciation and amortization — 22,904 49,694
Gain on sale of depreciable real estate, net — (46,441) —
NAREIT FFO $ 60,854 $ 65,503 $ 119,359
Critical Accounting Estimates
We base the discussion and analysis of our financial condition and results of operations upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We evaluate these estimates on an on-going basis, including those related to estimated useful lives of real estate assets, estimated fair value of acquired leases, cost reimbursement income, bad debts, contingencies and litigation. We base the estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We cannot assure you that actual results will not differ from those estimates.
We believe the following accounting estimates are the most critical to aid in fully understanding our reported financial results,
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and they require our most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain.
Accounting for Asset Acquisitions
We allocate the purchase price, including transaction costs, of acquired assets, including physical assets and in-place leases, and assumed liabilities, based on their fair values. We determine the estimated fair values of the assets and liabilities in accordance with current GAAP fair value provisions. We determine the fair values of acquired buildings on an “as-if-vacant” basis considering a variety of factors, including the replacement cost of the property, estimated rental and absorption rates, estimated future cash flows and valuation assumptions consistent with current market conditions. We determine the fair value of land acquired based on comparisons to similar properties that have been recently marketed for sale or sold.
The fair value of in-place leases is based upon our evaluation of the specific characteristics of the leases. Factors considered in the fair value analysis include the estimated cost to replace the leases, including foregone rents and expense reimbursements during hypothetical expected lease-up periods (referred to as “absorption cost”), consideration of current market conditions and costs to execute similar leases. We classify absorption costs as other assets and amortize absorption costs as amortization expense on a straight-line basis over the remaining life of the underlying leases.
Real Estate Impairment
We recognize impairment losses on long-lived assets used in operations, development assets or land held for future development, if indicators of impairment are present and the net undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. Estimates of undiscounted cash flows are based on forward-looking assumptions, including annual and residual cash flows and our estimated holding period for each property. Such assumptions involve a high degree of judgment and could be affected by future economic and market conditions. When determining if a property has indicators of impairment, we evaluate the property's occupancy, our expected holding period for the property, strategic decisions regarding the property's future operations or development and other market factors. If such carrying amount is in excess of the estimated undiscounted cash flows from the operation and disposal of the property, we would recognize an impairment loss equivalent to an amount required to adjust the carrying amount to its estimated fair value, calculated in accordance with current GAAP fair value provisions. Assets held for sale are recorded at the lower of cost or fair value less costs to sell.
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