Item 1A. Risk Factors
ITEM 1A. RISK FACTORS
Other than the addition of the following, there have been no material changes to the risk factors previously disclosed in our Annual Report for the year ended December 31, 2019, filed with the SEC on February 25, 2020.
Risks Related to COVID-19
The current outbreak of COVID-19 has significantly impacted and disrupted our business, and is expected to continue to significantly, and perhaps even materially adversely, impact and cause disruption to, our business, financial performance and condition, operating results and cash flows. Future outbreaks of highly infectious or contagious diseases or other public health crises could have similar adverse effects on our business. Further, the spread of the COVID-19 outbreak has caused severe disruptions in the U.S. and global economy and financial markets and could potentially create widespread business continuity issues of an as yet unknown magnitude and duration.
COVID-19 has disrupted our business and has had a significant adverse effect on our business, financial performance and condition, operating results and cash flows and such effect could be materially adverse in future quarters . Since late February 2020, we have experienced additional cleaning and sanitation costs, reduced revenues from commercial parking, failures by some of our residential and commercial and most of our retail tenants to pay rent, combined with the inability to pursue our rights against many of those tenants due to governmental suspensions of evictions and late fees. We have also experienced slower processes for entitling our future development pipeline due to the inability to hold governmental and community meetings. Income from our interest in the operations of the Crystal City Marriott hotel decreased in the second quarter due to temporary closure during the pandemic. Further, during the second quarter of 2020, we recorded an impairment charge of $6.5 million due to a decline in the fair value of The Marriott Wardman Park hotel and losses incurred during the quarter resulting from its closure in March 2020 due to the effects of COVID-19. Additionally, during the second quarter of 2020 , we experienced a $2.4 million decrease in revenue due to bad debt reserves recorded in connection with the filing for bankruptcy by a parking operator. Additional factors that could negatively impact our ability to successfully operate during or following COVID-19 or another pandemic, or that have otherwise significantly adversely impacted and disrupted our business, financial performance and condition, operating results and cash flows, or otherwise adversely impact our shareholders and may continue to do so include:
● Property rental income, our primary source of operating cash flow, is dependent on a number of factors, including occupancy levels and rental rates, as well as our tenants’ ability and willingness to pay rent, and our ability to continue to collect rents, on a timely basis or at all, without reductions or other concessions, in our commercial and multifamily properties. For the three months ended September 30, 2020, 0.7% on a consolidated basis and 0.6% at our share of our commercial office tenants, 1.4% on a consolidated basis and 1.5% at our share of our multifamily tenants, and 33.5% of our retail tenants on a consolidated basis and 36.9% at our share had not yet paid their rent for the months of July through September;
● We have experienced and continue to experience decreased property rental revenue, due to deferral of rent for tenants that were placed on the cash basis of accounting and increases in uncollectable operating lease receivables. Property rental income may be reduced or eliminated due to delays in enforcing our rights as landlord, including the inability to evict tenants that fail to pay rent, new federal and state governmental regulations related to the pandemic or otherwise. As a result, we may incur substantial costs in protecting our investments, and we can provide no assurances that such efforts will be successful. Furthermore, certain categories of tenants, such as retail, multifamily and certain types of office tenants, such as those that utilize shared spaces and co-working, are particularly hard hit by COVID-19 and the resulting economic disruption ( coworking tenants comprised approximately 2.9% of our total square feet on a consolidated basis and 3.2% at our share as of September 30, 2020 );
● Demand for office space in the Washington, D.C. metropolitan area and nationwide has had and is likely to continue to decline due to the current economic downturn, bankruptcies, downsizing, layoffs, government regulations and restrictions on travel and permitted businesses operations that may be extended in duration and become recurring or potentially recurring, increased usage of teleworking arrangements and cost cutting resulting from the pandemic, which could lead to lower office occupancy (as of September 30, 2020, approximately 3.5% of our commercial and retail leases, based on square footage, were scheduled to expire in 2020 or had month-to-month terms);
● A component of " Third-party real estate services, including reimbursements, " the metric we use to measure and evaluate the performance of our third-party asset management and real estate services business operating segment, may
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decline if we do not receive reimbursements revenue, which represents reimbursements of expenses incurred by us on behalf of third parties, including allocated payroll costs and amounts paid to third-party contractors for construction management projects. Reimbursements revenue decreased in the second and third quarters and may continue to decline where third-party clients cannot or do not reimburse us for such expenses, resulting in us incurring these costs in " General and administrative: third-party real estate services, " but not being reimbursed for them, which could have a material adverse effect on this operating segment ( " General and administrative: third-party real estate services expense " was $86.3 million for the nine months ended September 30, 2020 and $113.5 million for the year ended December 31, 2019, and " reimbursements revenue " was nearly half of total revenue of our third-party asset management and real estate services business – $41.4 million of $83.9 million for the nine months ended September 30, 2020, and $55.4 million of $120.9 million, for the year ended December 31, 2019);
● The potential deterioration of the appeal of our Placemaking model of amenity-rich, walkable Metro-served neighborhoods. Our Placemaking strategies include the delivery of new multifamily and office developments, locally sourced amenity retail and thoughtful improvements to the streetscape, sidewalks, parks and other outdoor gathering spaces. COVID-19 may change how people think about work and residential spaces, as well as the appeal of public transportation, which could have a material adverse effect on our Placemaking model. Furthermore, certain of our properties may be considered less desirable and see their occupancy rates suffer, such as West Half, which was completed in the third quarter of 2019 and was 50.7% leased as of September 30, 2020 and is located adjacent to Nationals Stadium. The extent to which and when fans of professional athletic teams will return to physical stadiums and the appeal of such locations is unclear;
● We may experience reductions in demand for retail space in our submarkets as most of our retail tenants continue to experience diminished revenues and loss of cash flow due to government regulations and restrictions on travel and permitted businesses operations, reduced or eliminated foot traffic and economic uncertainty. Furthermore, our Placemaking model depends in significant part on a retail component, which frequently involves retail assets embedded in or adjacent to our office and/or multifamily assets. Temporary store closures and government mandated physical distancing requirements are significantly affecting our retail tenants’ ability to generate sales and have caused many retailers to, among other things, permanently close stores, decrease the size of new or existing stores, ask for concessions from us or go bankrupt;
● We have incurred and continue to incur unanticipated costs and operating expenses and may continue to experience decreased revenue related to compliance with regulations, such as our inability to sue non-paying tenants, requirements to provide employees with additional mandatory paid time off and increased expenses related to sanitation measures performed at our properties, as well as additional expenses incurred to protect the welfare of our employees, such as expanded access to health services and acquisition of additional technology related to employees working from home;
● We may be susceptible to increased litigation related to, among other things, the financial impacts of COVID-19 on our business, individuals contracting COVID-19 as a result of alleged exposures on our premises or alleging that we have taken insufficient preventative measures, our ability to meet contractual obligations due to the pandemic, employment practices or policies adopted during the pandemic, or otherwise;
● We have incurred and are likely to incur higher general and administrative costs due to anticipated legal expenses incurred for, among other things, litigation with non-paying tenants or otherwise related to the impact of COVID-19 on us, and medical and other employee expenses related to staff being remote;
● Changes to our sources and uses of cash. For instance, as of September 30, 2020, we have construction in progress that will require an additional $34.0 million to complete ($20.2 million related to our consolidated entities and $13.8 million related to our unconsolidated real estate ventures at our share), based on our current plans and estimates, which we anticipate will be primarily expended over the next two years. These expenditures are generally due as the work is performed, and we continue to expect to finance them with debt proceeds, proceeds from asset recapitalizations and sales and available cash over that period, though the relative attractiveness of reliance on debt proceeds and asset recapitalizations may vary and change our reliance on them at any given time;
● Assets that were recently moved from Under-Construction assets to operating assets (including West Half, 4747 Bethesda Avenue, 901 W Street and 900 W Street (formerly collectively referred to as Atlantic Plumbing C)), 1900 N Street and The Wren (formerly referred to as 965 Florida Avenue), totaling approximately 569,000 square feet and 1,154 units in the aggregate as of September 30, 2020 may take longer to stabilize and contribute to NOI;
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● Our current Under-Construction assets may take longer to reach completion and will likely take longer to stabilize;
● The inability to renew leases, lease vacant space or re-let space as leases expire, or a decline in rental rates on new leases due to a deterioration in the economy and market conditions due to the pandemic. We are experiencing and expect to continue to experience depressed near-term leasing activity in both our commercial and multifamily portfolios, including the delay in the lease-up of our recently delivered multifamily assets;
● Difficulty accessing debt and equity capital on attractive terms, or at all, and a severe disruption and instability in the global financial markets or deteriorations in credit and financing conditions may affect our access to capital necessary to fund our liquidity needs, including addressing maturing liabilities;
● The cost and availability of credit may be negatively impacted by the pandemic, which may adversely affect our liquidity and financial condition, including our results of operations, and the liquidity and financial condition of our tenants. Our inability or the inability of our tenants to timely refinance maturing liabilities and access the capital markets to meet liquidity needs may materially affect our financial condition and results of operations and the value of our equity securities and any debt securities we may issue in the future;
● Our outstanding debt was $2.1 billion and $1.6 billion as of September 30, 2020 and December 31, 2019. The $473.4 million increase in outstanding debt was primarily from four separate mortgage loans with an aggregate principal balance of $560.0 million, collateralized by 4747 Bethesda Avenue, The Bartlett, 1221 Van Street and 220 20 th Street, and the remaining $100.0 million draw under our Tranche A-1 Term Loan, partially offset by the repayment of the revolving credit facility. Increased indebtedness and decreased operating revenues could increase our risk of default;
● A delay or reversal of the anticipated rebound in our 2020 NOI that we had anticipated from the combined effects of (i) the burn off of free rent associated with lease renewals we executed in 2017 and 2018 to stabilized levels, (ii) delivery on or ahead of schedule of our Under-Construction assets and (iii) acquisition of F1RST Residences;
● The continued service and availability of personnel, including our executive officers and other leaders that are part of our management team and our ability to recruit, attract and retain skilled personnel to the extent our management or personnel are impacted in significant numbers or in other significant ways by the outbreak of pandemic or epidemic disease and are not available or allowed to conduct work;
● There can be no assurance that losses incurred by us will be covered by the general liability, all-risk property and rental value insurance policies that we maintain;
● Risks related to holding assets through partnership or real estate investments, including the risk that we could be required to fund capital contributions required of our partners or co-venturers, make contributions to maintain the value of such assets, be forced to sell our interest, or acquire our partners’ or our co-venturers’ interest, or to sell the underlying asset, either on unfavorable terms or at a time when we otherwise would not have initiated such a transaction and potentially being forced to dispose of our interest in that entity, including by contributing it to a subsidiary of ours that is subject to corporate-level income tax. In addition, we may in certain circumstances be liable for the actions of our third-party partners or co-venturers. Our real estate ventures may be subject to debt, and the refinancing of such debt may require equity capital calls. As of September 30, 2020, approximately 11.7% of our assets measured by total square feet were held through real estate ventures, and we expect to co-invest in the future with other third parties through partnerships, real estate ventures or other entities, acquiring noncontrolling interests in or sharing responsibility for managing the affairs of a property, partnership, real estate venture or other entity;
● The continued volatility of our share price;
● The continued attractiveness, feasibility or prudence of paying quarterly dividends;
● The scaling back or delay of a significant amount of planned capital expenditures, including planned renovation projects, which could adversely affect the value of our properties. For example, we have deferred planned discretionary capital expenditures for our operating assets of approximately $69 million on a consolidated basis and $73 million at our share;
● Increased risk of the occurrence of a cyber incident and of disruptions to our internal control procedures due to the significant number of our employees that are currently teleworking due to the pandemic and restrictions on travel and
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permitted businesses operations, and the processes, procedures and controls that we have implemented to help mitigate cyber risks may not be sufficient or that our internal control procedures may experience challenges or delays;
● Construction or redevelopment costs for our projects may exceed original estimates. Also, we have experienced and may continue to experience supply chain and/or labor delays and disruptions as a result of new job site procedures or for other reasons, such as insufficient construction personnel, delays in advancing entitlements, or the inability to obtain necessary permits;
● Our cash flow from operations may be materially reduced if our tenants fail to pay rent, a risk heightened by COVID-19, and as a result, we may be unable to satisfy our covenants or maintain the required financial ratios under our debt agreements. Failure to comply with our covenants could cause a default under one of our debt instruments, which may require us to repay such debt with capital from other sources or give possession of a property to the lender;
● The extent and duration of the COVID-19-related restrictions on travel and the types of businesses that may continue to operate will have an effect on estimates used in the preparation of the underlying cash flows used in assessing our long-lived assets for impairment and the assessment of the collectability of receivables from tenants, including deferred rent receivables, due to the effects of COVID-19 on their financial position. We have made what we believe to be appropriate accounting estimates based on the facts and circumstances available as of the reporting date. To the extent these estimates differ from actual results, our consolidated financial statements may be materially affected; and
● The significance, extent and duration of the impact of COVID-19 on our business remains largely uncertain and dependent on future developments that cannot be accurately predicted at this time, such as the continued severity, duration, transmission rate and geographic spread of COVID-19 in the United States, the extent and effectiveness of the containment measures taken, and the response of the overall economy, the financial markets and the population, particularly in areas in which we operate, once the current containment measures are lifted.
Moreover, the impact of COVID-19 may also exacerbate many of the risks identified under the section entitled " Risk Factors " in our Annual Report on Form 10-K for the year ended December 31, 2019. The rapid development and fluidity of this situation precludes any prediction as to the ultimate adverse impact of COVID-19. As a result, we cannot provide an estimate of the overall impact of COVID-19 on our business or when, or if, we will be able to resume normal operations. Nevertheless, COVID-19 presents material uncertainty and risk with respect to our business, financial performance and condition, operating results and cash flows.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.