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 the accompanying audited consolidated financial statements and related notes thereto and Item 1A. “Risk Factors ” appearing elsewhere in this Annual Report on Form 10-K. In this discussion, unless the context suggests otherwise, references to “our Company,” “we,” “us,” and “our” mean Kite Realty Group Trust and its direct and indirect subsidiaries, including Kite Realty Group, L.P.
Overview
In the following overview, we discuss, among other things, the status of our business and properties, the effect that current U.S. economic conditions is having on our retail tenants and us, and the current state of the financial markets and how it impacts our financing strategy.
Our Business and Properties
Kite Realty Group Trust is a publicly held REIT that, through its majority-owned subsidiary, Kite Realty Group, L.P., owns interests in various operating subsidiaries and joint ventures engaged in the ownership, operation, acquisition, development, and redevelopment of high-quality, open-air shopping centers and mixed-use assets that are primarily grocery-anchored and located in high-growth Sun Belt markets and select strategic gateway markets in the United States. Following our merger with RPAI in 2021, we became a top-five open-air shopping center REIT based upon market capitalization. We derive our revenue primarily from the collection of contractual rents and reimbursement payments from tenants under existing lease agreements at each of our properties. Therefore, our operating results depend materially on, among other things, the ability of our tenants to make required lease payments, the health and resilience of the U.S. retail sector, interest rate volatility, stability in the banking sector, job growth, the real estate market, and overall economic conditions.
As of December 31, 2023, we owned interests in 180 operating retail properties totaling approximately 28.1 million square feet and one office property with 0.3 million square feet. Of the 180 operating retail properties, 10 contain an office component. We also owned two development projects under construction as of this date and an additional two properties with future redevelopment opportunities.
Inflation
We believe inflationary concerns could negatively impact consumer confidence and spending and our tenants’ sales and overall health. This could, in turn, continue to put downward pricing pressure on rents that we are able to charge to new or renewing tenants, such that future rent spreads and, in some cases, our percentage rents, could be adversely impacted. Many of our leases contain provisions designed to mitigate the adverse impact of inflation, including stated rent increases and requirements for tenants to pay a share of operating expenses, including common area maintenance, real estate taxes, insurance or other operating expenses related to the maintenance of our properties, with escalation clauses in certain leases. In 2023, we have made significant improvements converting leases to higher fixed rent bumps and including CPI protection. However, the stated rent increases or limits on such tenant’s obligation to pay its share of operating expenses could be lower than the increase in inflation at any given time. Inflation may also increase labor or other general and administrative expenses that cannot be easily reduced.
Portfolio Update
In 2023, demand for open-air retail real estate was strong due to the limited availability of desirable retail space and limited new construction over the previous 15 years. As a result, we experienced our highest quarterly new leasing activity in the Company’s history in the fourth quarter with over 380,000 square feet of new leasing volume. Open-air centers are thriving for a variety of reasons including their ability to function as last mile fulfillment centers and their convenient and affordable nature for retailers and consumers. This includes conveniently located and easily accessible parking fields, lower operating costs as compared to other retail formats, and essential anchors that drive daily trips. In addition, the Company’s property types are particularly suited for retailers’ current and evolving needs, including curbside pick-up and buying online and picking up in store (“BOPIS”), which we believe will benefit from tenant demand for additional space. The strength of the Company’s real estate is further evidenced by our continued strong cash leasing spreads and ABR for the retail portfolio of $20.70 per square foot. The Company has continued to improve its asset quality and through the October 2021 merger with RPAI acquired a refined portfolio of high-quality, open-air shopping centers and mixed-use assets.
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In evaluating potential acquisition, development, and redevelopment opportunities, we look for strong sub-markets where average household income, educational attainment, population density, traffic counts and daytime workforce populations are above the broader market average. We also focus on locations that are benefiting from current population migratory patterns, namely major cities in business-friendly states with no or relatively low income taxes, and mild or temperate climates. In our largest sub-markets, household incomes are significantly higher and state income taxes are relatively lower than the medians for the broader markets.
In addition to targeting sub-markets with strong consumer demographics, we focus on having the most desirable tenant mix at each shopping center. We have aggressively targeted and executed leases with prominent grocers including Publix, Lidl, Aldi, Whole Foods, Trader Joe’s, Sprouts Farmers Market, and The Fresh Market, expanding retailers such as T.J. Maxx, HomeGoods, Ross Dress for Less, Burlington, Old Navy, J.Crew Factory, Dick’s Sporting Goods, and pOpshelf, service and restaurant retailers and other retailers such as Ulta Beauty, REI, Five Below and Total Wine & More. Additionally, we have identified cost-efficient ways to relocate, re-tenant and renegotiate leases at several of our properties, which allows us to attract more suitable tenants.
Capital and Financing Activities
In 2023, we maintained a conservative balance sheet and improved our liquidity to fund future growth. We ended 2023 with approximately $1.1 billion of combined cash and borrowing capacity on the Revolving Facility. In addition, as of December 31, 2023, we had $269.6 million of debt principal scheduled to mature through December 31, 2024, which we expect will be satisfied with proceeds from the Notes Due 2034 that were issued in January 2024.
The three investment grade credit ratings we maintain provide us with access to the unsecured public bond market, which we may continue to use in the future to finance acquisitions, repay maturing debt and fix interest rates.
Results of Operations
As of December 31, 2023, we owned interests in 180 operating retail properties, one office property, two development projects currently under construction, and two additional properties with future redevelopment opportunities. The following table sets forth the total operating properties and development projects we owned as of December 31, 2023, 2022 and 2021:
Number of Properties
2023 2022 2021
Operating retail properties (1)
180 183 180
Office properties 1 1 1
Active development and redevelopment projects 2 3 8
Future development and redevelopment opportunities 2 1 1
(1) Included within operating retail properties are 10, 11, and 11 properties that contain an office component as of December 31, 2023, 2022 and 2021, respectively.
The comparability of results of operations for the year ended December 31, 2023 is affected by our development, redevelopment, and operating property acquisition and disposition activities between 2021 through 2023. Therefore, we believe it is most useful to review the comparisons of our results of operations for these years (as set forth below under “Comparison of Operating Results for the Years Ended December 31, 2023 and 2022”) in conjunction with the discussion of our activities during those periods, which is set forth below.
Acquisitions
In addition to the 100 properties acquired in the October 2021 merger with RPAI, the following operating properties were acquired during the years ended December 31, 2023, 2022 and 2021:
Property Name MSA Acquisition Date GLA
Nora Plaza outparcel Indianapolis, IN December 22, 2021 23,722
Pebble Marketplace Las Vegas, NV February 16, 2022 85,796
MacArthur Crossing two-tenant building Dallas, TX April 13, 2022 56,077
Palms Plaza Miami, FL July 15, 2022 68,976
Prestonwood Place Dallas, TX September 22, 2023 155,975
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Dispositions
The following operating and other properties were sold during the years ended December 31, 2023, 2022 and 2021:
Property Name MSA Disposition Date GLA
Westside Market Dallas, TX October 26, 2021 93,377
Plaza Del Lago (1)
Chicago, IL June 16, 2022 100,016
Lincoln Plaza – Lowe’s (2)
Worcester, MA October 27, 2022 —
Kingwood Commons Houston, TX May 8, 2023 158,172
Pan Am Plaza & Garage Indianapolis, IN June 8, 2023 —
Reisterstown Road Plaza Baltimore, MD September 11, 2023 376,683
Eastside Dallas, TX October 24, 2023 43,640
(1) Plaza Del Lago also contains 8,800 square feet of residential space comprised of 18 multifamily rental units.
(2) We sold the ground lease interest in one tenant at an existing multi-tenant operating retail property. The total number of properties in our portfolio was not affected by this transaction.
Development and Redevelopment Projects
The following properties were under active development or redevelopment during portions of the years ended December 31, 2023, 2022 and 2021 and removed from our operating portfolio during such period:
Project Name MSA Transition to
Development or Redevelopment (1)
Transition to
Operating Portfolio GLA
Active Projects
Carillon MOB (2)
Washington, D.C. October 2021 Pending 126,000
The Corner – IN (2)
Indianapolis, IN December 2015 Pending 24,000
Future Opportunities
Hamilton Crossing Centre (2)(3)
Indianapolis, IN June 2014 Pending 92,283
Edwards Multiplex – Ontario (2)
Los Angeles, CA March 2023 Pending 124,614
Completed Projects
Glendale Town Center Indianapolis, IN March 2019 December 2021 199,021
Eddy Street Commons – Phase III South Bend, IN September 2020 March 2022 18,600
Shoppes at Quarterfield Baltimore, MD October 2021 June 2022 58,000
One Loudoun Downtown – Pads G&H
Residential
Washington, D.C. October 2021 June 2022 —
Circle East Baltimore, MD October 2021 September 2022 82,000
One Loudoun Downtown – Pads G&H
Commercial
Washington, D.C. October 2021 December 2022 67,000
The Landing at Tradition – Phase II Port St. Lucie, FL September 2021 June 2023 39,900
(1) Transition date represents the date the property was transferred from our operating portfolio into redevelopment status. For legacy RPAI projects, the transition date represents the later of the date of the closing of the merger (October 2021) and the date the project was transferred into redevelopment status.
(2) This property has been identified as a redevelopment property and is not included in the operating portfolio or the same property pool. The redevelopment projects at Hamilton Crossing Centre and The Corner – IN will include the creation of a mixed-use development.
(3) Approximately half of the Hamilton Crossing site was sold in January 2022 to Republic Airways Inc. In addition to the sale, the Company entered into a development and construction management agreement for the development of a corporate campus for Republic Airways. Phase I of the corporate campus was completed in 2023.
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Comparison of Operating Results for the Years Ended December 31, 2023 and 2022
The following table reflects changes in the components of our consolidated statements of operations for the years ended December 31, 2023 and 2022 (in thousands) :
Year Ended December 31,
2023 2022 Change
Revenue:
Rental income $ 810,146 $ 782,349 $ 27,797
Other property-related revenue 8,492 11,108 (2,616)
Fee income 4,366 8,539 (4,173)
Total revenue 823,004 801,996 21,008
Expenses:
Property operating 107,958 107,217 741
Real estate taxes 102,426 104,589 (2,163)
General, administrative and other 56,142 54,860 1,282
Merger and acquisition costs — 925 (925)
Depreciation and amortization 426,361 469,805 (43,444)
Impairment charges 477 — 477
Total expenses 693,364 737,396 (44,032)
Gain on sales of operating properties, net 22,601 27,069 (4,468)
Operating income 152,241 91,669 60,572
Other (expense) income:
Interest expense (105,349) (104,276) (1,073)
Income tax expense of taxable REIT subsidiary (533) (43) (490)
Equity in earnings of unconsolidated subsidiaries 33 256 (223)
Other income, net 1,991 240 1,751
Net income (loss) 48,383 (12,154) 60,537
Net income attributable to noncontrolling interests (885) (482) (403)
Net income (loss) attributable to common shareholders $ 47,498 $ (12,636) $ 60,134
Property operating expense to total revenue ratio 13.1 % 13.4 %
Rental income (including tenant reimbursements) increased $27.8 million, or 3.6%, due to the following (in thousands) :
Net change
Year Ended
December 31, 2022 to 2023
Properties or components of properties sold during 2022 or 2023 $ (7,830)
Properties under redevelopment or acquired during 2022 and/or 2023 12,134
Properties fully operational during 2022 and 2023 and other 23,493
Total $ 27,797
The net increase of $23.5 million in rental income for properties that were fully operational during 2022 and 2023 is primarily due to (i) increases in base minimum rent of $14.7 million due to contractual rent changes and tenant reimbursements of $2.9 million due to higher recoverable common area maintenance expenses, (ii) a decrease in bad debt expense of $2.1 million, and (iii) increases in lease termination income of $1.6 million, overage rent of $1.2 million due to improved tenant performance, and $1.0 million in ancillary income. The occupancy of the fully operational properties increased from 91.8% for 2022 to 92.0% for 2023.
We continued to experience strong leasing volumes in 2023 and generate higher base rent on new leases and renewals. The average base rents for new comparable leases signed in 2023 was $27.53 per square foot compared to average expiring base rents of $19.48 per square foot in that period. The average base rents for renewals signed in 2023 was $18.10 per square foot
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compared to average expiring base rents of $16.74 per square foot in that period. For the entire portfolio, the spread between leased and occupied square footage is approximately 280 basis points and represents approximately $31.0 million of NOI, the majority of which is expected to come online in 2024. In addition, the ABR per square foot of our operating retail portfolio continued to improve, as it increased to $20.70 per square foot as of December 31, 2023 from $20.02 per square foot as of December 31, 2022.
Other property-related revenue primarily consists of parking revenues, gains on the sale of land and other miscellaneous activity. This revenue decreased by $2.6 million primarily as a result of lower gains on sales of undepreciated assets of $2.8 million recognized during the year ended December 31, 2023 and a decrease in parking revenue of $1.3 million due to the sale of Pan Am Plaza Garage in June 2023, partially offset by an increase in miscellaneous income of $1.5 million.
We recorded fee income of $4.4 million and $8.5 million during the years ended December 31, 2023 and 2022, respectively, from property management and development services provided to third parties and unconsolidated joint ventures. The decrease in fee income is primarily due to a decrease in development fees earned related to the development of a corporate campus for Republic Airways at Hamilton Crossing Centre.
Property operating expenses increased $0.7 million, or 0.7%, due to the following (in thousands) :
Net change
Year Ended
December 31, 2022 to 2023
Properties or components of properties sold during 2022 or 2023 $ (2,227)
Properties under redevelopment or acquired during 2022 and/or 2023 1,236
Properties fully operational during 2022 and 2023 and other 1,732
Total $ 741
The net increase of $1.7 million in property operating expenses for properties that were fully operational during 2022 and 2023 is primarily due to increases of (i) $3.3 million in non-recoverable operating expenses, the majority of which relates to vacancies caused by retailer bankruptcies, (ii) $0.4 million in landscaping and repairs and maintenance expenses, and (iii) $0.2 million in security expenses, partially offset by a $3.0 million decrease in insurance expense. As a percentage of revenue, property operating expenses decreased from 13.4% to 13.1% primarily due to an increase in revenue in 2023.
Real estate taxes decreased $2.2 million, or 2.1%, due to the following (in thousands) :
Net change
Year Ended
December 31, 2022 to 2023
Properties or components of properties sold during 2022 or 2023 $ (1,854)
Properties under redevelopment or acquired during 2022 and/or 2023 2,001
Properties fully operational during 2022 and 2023 and other (2,310)
Total $ (2,163)
The net decrease of $2.3 million in real estate taxes for properties that were fully operational during 2022 and 2023 is primarily due to a decrease in real estate tax assessments at certain properties in the portfolio in 2023, most notably for certain of our Texas and Illinois properties. The majority of real estate tax expense is recoverable from tenants and such recovery is reflected within rental income.
General, administrative and other expenses increased $1.3 million, or 2.3%, primarily due to an increase in transportation expenses and consulting fees, partially offset by a decrease in legal expenses and payroll costs due to lower head count.
The Company did not incur any significant merger and acquisition costs related to the October 2021 merger with RPAI during the year ended December 31, 2023. The Company incurred $0.9 million of merger and acquisition costs during the year ended December 31, 2022, primarily consisting of professional fees and technology costs.
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Depreciation and amortization expense decreased $43.4 million, or 9.2%, due to the following (in thousands) :
Net change
Year Ended
December 31, 2022 to 2023
Properties or components of properties sold during 2022 or 2023 $ (9,444)
Properties under redevelopment or acquired during 2022 and/or 2023 6,218
Properties fully operational during 2022 and 2023 and other (40,218)
Total $ (43,444)
The net increase of $6.2 million in depreciation and amortization at properties under redevelopment or acquired during 2022 and 2023 is primarily due to the reclassification of Edwards Multiplex – Ontario into redevelopment in March 2023 along with the acquisitions of Palms Plaza in July 2022 and Prestonwood Place in September 2023. The net decrease of $40.2 million in depreciation and amortization at properties that were fully operational during 2022 and 2023 is primarily due to certain assets with shorter useful lives acquired in the October 2021 merger with RPAI that became fully depreciated during the prior year.
Based on the results of our evaluations for impairment, we recorded a $0.5 million impairment charge during the year ended December 31, 2023 related to Eastside, a retail operating property in the Dallas MSA that qualified for held-for-sale accounting treatment as of September 30, 2023 and was sold on October 24, 2023. No impairment charges were recorded during the year ended December 31, 2022.
We recorded a net gain on sales of operating properties of $22.6 million for the year ended December 31, 2023 on the sale of Kingwood Commons, the undeveloped land and related parking garage at Pan Am Plaza, Reisterstown Road Plaza, and Eastside compared to a net gain of $27.1 million on the sale of Plaza Del Lago, a portion of Hamilton Crossing Centre and the ground lease interest in Lowe’s at Lincoln Plaza for the year ended December 31, 2022.
Interest expense increased $1.1 million, or 1.0%, primarily due to higher interest costs related to our variable rate debt, including borrowings on the Revolving Facility that were used to repay mortgages payable at maturity, partially offset by favorable interest rate swaps.
Management’s discussion of the financial condition, changes in financial condition and results of operations for the year ended December 31, 2022, with comparison to the year ended December 31, 2021, was included in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2022 .
Net Operating Income and Same Property Net Operating Income
We use property net operating income (“NOI”), a non-GAAP financial measure, to evaluate the performance of our properties. We define NOI as income from our real estate, including lease termination fees received from tenants, less our property operating expenses. NOI excludes amortization of capitalized tenant improvement costs and leasing commissions and certain corporate level expenses, including merger and acquisition costs. We believe that NOI is helpful to investors as a measure of our operating performance because it excludes various items included in net income that do not relate to or are not indicative of our operating performance, such as depreciation and amortization, interest expense, and impairment, if any.
We also use same property NOI (“Same Property NOI”), a non-GAAP financial measure, to evaluate the performance of our properties. Same Property NOI is net income excluding properties that have not been owned for the full periods presented. Same Property NOI also excludes (i) net gains from outlot sales, (ii) straight-line rent revenue, (iii) lease termination income in excess of lost rent, (iv) amortization of lease intangibles, and (v) significant prior period expense recoveries and adjustments, if any. When we receive payments in excess of any accounts receivable for terminating a lease, Same Property NOI will include such excess payments as monthly rent until the earlier of the expiration of 12 months or the start date of a replacement tenant. We believe that Same Property NOI is helpful to investors as a measure of our operating performance because it includes only the NOI of properties that have been owned for the full periods presented. We believe such presentation eliminates disparities in net income due to the acquisition or disposition of properties during the particular periods presented, and thus provides a more consistent metric for the comparison of our properties. Same Property NOI includes the results of properties that have been owned for the entire current and prior year reporting periods.
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NOI and Same Property NOI should not, however, be considered as alternatives to net income (calculated in accordance with GAAP) as indicators of our financial performance. Our computation of NOI and Same Property NOI may differ from the methodology used by other REITs and, therefore, may not be comparable to such other REITs.
When evaluating the properties that are included in the same property pool, we have established specific criteria for determining the inclusion of properties acquired or those recently under development. An acquired property is included in the same property pool when there is a full quarter of operations in both years subsequent to the acquisition date. Development and redevelopment properties are included in the same property pool four full quarters after the properties have been transferred to the operating portfolio. A redevelopment property is first excluded from the same property pool when the execution of a redevelopment plan is likely and we (a) begin recapturing space from tenants or (b) the contemplated plan significantly impacts the operations of the property.
For the year ended December 31, 2023, the same property pool excludes the following:
• properties acquired or placed in service during 2022 and 2023;
• the multifamily rental units and commercial portion at One Loudoun Downtown – Pads G & H;
• Shoppes at Quarterfield, Circle East and The Landing at Tradition – Phase II, which were reclassified from active redevelopment into our operating portfolio in June 2022, September 2022 and June 2023, respectively;
• our active development and redevelopment projects at Carillon medical office building and The Corner – IN;
• Hamilton Crossing Centre and Edwards Multiplex – Ontario, which were reclassified from our operating portfolio into redevelopment in June 2014 and March 2023, respectively;
• properties sold or classified as held for sale during 2022 and 2023; and
• office properties.
The following table presents Same Property NOI and a reconciliation to net income (loss) attributable to common shareholders for the years ended December 31, 2023 and 2022 (unaudited) (dollars in thousands) :
Year Ended December 31,
2023 2022 Change
Number of properties in same property pool for the period (1)
175 175
Leased percentage at period end (2)
94.0 % 95.4 %
Economic occupancy percentage at period end (2)
91.2 % 92.5 %
Economic occupancy percentage (3)
92.0 % 91.8 %
Same Property NOI $ 555,396 $ 530,021 4.8 %
Reconciliation of Same Property NOI to most
directly comparable GAAP measure:
Net operating income – same properties $ 555,396 $ 530,021
Net operating income – non-same activity (4)
52,858 51,630
Total property NOI 608,254 581,651 4.6 %
Other income, net 5,857 8,992
General, administrative and other (56,142) (54,860)
Merger and acquisition costs — (925)
Impairment charges (477) —
Depreciation and amortization (426,361) (469,805)
Interest expense (105,349) (104,276)
Gain on sales of operating properties, net 22,601 27,069
Net income attributable to noncontrolling interests (885) (482)
Net income (loss) attributable to common shareholders $ 47,498 $ (12,636)
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(1) Same Property NOI excludes the following: (i) properties acquired or placed in service during 2022 and 2023; (ii) the multifamily rental units and commercial portion at One Loudoun Downtown – Pads G & H, (iii) Shoppes at Quarterfield, Circle East and The Landing at Tradition – Phase II, which were reclassified from active redevelopment into our operating portfolio in June 2022, September 2022 and June 2023, respectively, (iv) our active development and redevelopment projects at Carillon medical office building and The Corner – IN, (v) Hamilton Crossing Centre and Edwards Multiplex – Ontario, which were reclassified from our operating portfolio into redevelopment in June 2014 and March 2023, respectively; (vi) properties sold or classified as held for sale during 2022 and 2023; and (vii) office properties.
(2) Decrease in leased and economic occupancy percentages is primarily attributable to the Bed Bath & Beyond Inc. bankruptcy.
(3) Excludes leases that are signed but for which tenants have not yet commenced the payment of cash rent; calculated as a weighted average based on the timing of cash rent commencement and expiration during the period.
(4) Includes non-cash activity across the portfolio as well as NOI from properties not included in the same property pool, including properties sold during both periods.
Our Same Property NOI increased 4.8% in 2023 compared to 2022 primarily due to contractual rent growth, higher base rent driven by positive new and renewal leasing spreads, lower bad debt expense, and an increase in overage rent from certain tenants.
Funds From Operations
Funds from Operations (“FFO”) is a widely used performance measure for real estate companies and is provided here as a supplemental measure of our operating performance. We calculate FFO, a non-GAAP financial measure, in accordance with the best practices described in the April 2002 National Policy Bulletin of the National Association of Real Estate Investment Trusts (“NAREIT”), as restated in 2018. The NAREIT white paper defines FFO as net income (calculated in accordance with GAAP), excluding (i) depreciation and amortization related to real estate, (ii) gains and losses from the sale of certain real estate assets, (iii) gains and losses from change in control, and (iv) impairment write-downs of certain real estate assets and investments in entities when the impairment is directly attributable to decreases in the value of depreciable real estate held by the entity.
Considering the nature of our business as a real estate owner and operator, the Company believes that FFO is helpful to investors in measuring our operational performance because it excludes various items included in net income that do not relate to or are not indicative of our operating performance, such as gains or losses from sales of depreciated property and depreciation and amortization, which can make periodic and peer analyses of operating performance more difficult. FFO excludes the 2021 gain on sale of the ground lease portfolios as these sales were part of our capital strategy distinct from our ongoing operating strategy of selling individual land parcels from time to time. FFO (a) should not be considered as an alternative to net income (calculated in accordance with GAAP) for the purpose of measuring our financial performance, (b) is not an alternative to cash flow from operating activities (calculated in accordance with GAAP) as a measure of our liquidity, and (c) is not indicative of funds available to satisfy our cash needs, including our ability to make distributions. Our computation of FFO may not be comparable to FFO reported by other REITs that do not define the term in accordance with the current NAREIT definition or that interpret the current NAREIT definition differently than we do.
From time to time, the Company may report or provide guidance with respect to “FFO, as adjusted,” which removes the impact of certain non-recurring and non-operating transactions or other items the Company does not consider to be representative of its core operating results including, without limitation, (i) gains or losses associated with the early extinguishment of debt, (ii) gains or losses associated with litigation involving the Company that is not in the normal course of business, (iii) merger and acquisition costs, (iv) the impact on earnings from employee severance, (v) the excess of redemption value over carrying value of preferred stock redemption, and (vi) in 2022 and 2021, the impact of prior period bad debt or the collection of accounts receivable previously written off (“prior period collection impact”) due to the recovery from the COVID-19 pandemic, which are not otherwise adjusted in the Company’s calculation of FFO.
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Our calculations of FFO and reconciliation to net income and FFO, as adjusted, for the years ended December 31, 2023, 2022 and 2021 (unaudited) are as follows (dollars in thousands) :
Year Ended December 31,
2023 2022 2021
Net income (loss) $ 48,383 $ (12,154) $ (81,722)
Less: net income attributable to noncontrolling interests in properties (257) (623) (514)
Less: gain on sales of operating properties, net (22,601) (27,069) (31,209)
Add: impairment charges 477 — —
Add: depreciation and amortization of consolidated and
unconsolidated entities, net of noncontrolling interests
427,335 471,086 201,834
FFO of the Operating Partnership (1)
453,337 431,240 88,389
Less: Limited Partners’ interests in FFO
(6,447) (5,395) (1,945)
FFO attributable to common shareholders (1)
$ 446,890 $ 425,845 $ 86,444
FFO per share of the Operating Partnership – diluted $ 2.03 $ 1.94 $ 0.78
FFO of the Operating Partnership (1)
$ 453,337 $ 431,240 $ 88,389
Add: merger and acquisition costs — 925 86,522
Less: prior period collection impact — (2,556) (3,707)
FFO, as adjusted, of the Operating Partnership $ 453,337 $ 429,609 $ 171,204
FFO, as adjusted, per share of the Operating Partnership – diluted $ 2.03 $ 1.93 $ 1.50
(1) “FFO of the Operating Partnership” measures 100% of the operating performance of the Operating Partnership’s real estate properties. “FFO attributable to common shareholders” reflects a reduction for the redeemable noncontrolling weighted average diluted interest in the Operating Partnership.
Earnings before Interest, Tax, Depreciation, and Amortization (“EBITDA”)
We define EBITDA, a non-GAAP financial measure, as net income before interest expense, income tax expense of the TRS, and depreciation and amortization. For informational purposes, we also provide Adjusted EBITDA, which we define as EBITDA less (i) Adjusted EBITDA from unconsolidated entities, (ii) gains on sales of operating properties or impairment charges, (iii) merger and acquisition costs, (iv) other income and expense, (v) noncontrolling interest Adjusted EBITDA, and (vi) other non-recurring activity or items impacting comparability from period to period. Annualized Adjusted EBITDA is Adjusted EBITDA for the most recent quarter multiplied by four. Net Debt to Adjusted EBITDA is our share of net debt divided by Annualized Adjusted EBITDA. EBITDA, Adjusted EBITDA, Annualized Adjusted EBITDA and Net Debt to Adjusted EBITDA, as calculated by us, are not comparable to EBITDA and EBITDA-related measures reported by other REITs that do not define EBITDA and EBITDA-related measures exactly as we do. EBITDA, Adjusted EBITDA and Annualized Adjusted EBITDA do not represent cash generated from operating activities in accordance with GAAP and should not be considered alternatives to net income as an indicator of performance or as alternatives to cash flows from operating activities as an indicator of liquidity.
Considering the nature of our business as a real estate owner and operator, we believe that EBITDA, Adjusted EBITDA and the ratio of Net Debt to Adjusted EBITDA are helpful to investors in measuring our operational performance because they exclude various items included in net income that do not relate to or are not indicative of our operating performance, such as gains or losses from sales of depreciated property and depreciation and amortization, which can make periodic and peer analyses of operating performance more difficult. For informational purposes, we also provide Annualized Adjusted EBITDA, adjusted as described above. We believe this supplemental information provides a meaningful measure of our operating performance. We believe presenting EBITDA and the related measures in this manner allows investors and other interested parties to form a more meaningful assessment of our operating results.
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The following table presents a reconciliation of our EBITDA, Adjusted EBITDA and Annualized Adjusted EBITDA to net income (the most directly comparable GAAP measure) and a calculation of Net Debt to Adjusted EBITDA (in thousands) :
Three Months Ended
December 31, 2023
Net income $ 8,164
Depreciation and amortization 102,898
Interest expense 27,235
Income tax expense of taxable REIT subsidiary 449
EBITDA 138,746
Unconsolidated Adjusted EBITDA 828
Gain on sales of operating properties, net (133)
Other income and expense, net (540)
Noncontrolling interests (189)
Adjusted EBITDA 138,712
Annualized Adjusted EBITDA (1)
$ 554,849
Company share of Net Debt:
Mortgage and other indebtedness, net $ 2,829,202
Plus: Company share of unconsolidated joint venture debt 55,911
Less: Partner share of consolidated joint venture debt (2)
(9,849)
Less: cash, cash equivalents, and restricted cash (43,986)
Less: debt discounts, premiums and issuance costs, net (26,261)
Company share of Net Debt $ 2,805,017
Net Debt to Adjusted EBITDA 5.1x
(1) Represents Adjusted EBITDA for the three months ended December 31, 2023 (as shown in the table above) multiplied by four.
(2) Partner share of consolidated joint venture debt is calculated based upon the partner’s pro rata ownership of the joint venture, multiplied by the related secured debt balance.
Liquidity and Capital Resources
Overview
Our primary finance and capital strategy is to maintain a strong balance sheet with sufficient flexibility to fund our operating and investment activities in a cost-effective manner. We consider a number of factors when evaluating our level of indebtedness and making decisions regarding additional borrowings or equity offerings, including the interest or dividend rate, the maturity date and the Company’s debt maturity ladder, the impact of financial metrics such as overall Company leverage levels and coverage ratios, and the Company’s ability to generate cash flow to cover debt service. We continuously monitor the capital markets and may consider raising additional capital through the issuance of our common or preferred shares, unsecured debt securities, or other securities.
As of December 31, 2023, we had approximately $36.4 million in cash and cash equivalents on hand, $5.0 million in restricted cash and escrow deposits, $1.1 billion of remaining availability under the Revolving Facility, and $269.6 million of debt maturities due in 2024. During the year ended December 31, 2023, we originated a 10-year $95.1 million mortgage payable at a fixed interest rate of 5.36% secured by the multifamily rental portion of the expansion project at One Loudoun Downtown – Pads G & H and repaid the $95.0 million principal balance of the 4.23% senior unsecured notes due 2023 using available cash on hand. In January 2024, we issued $350.0 million aggregate principal amount of 5.50% senior unsecured notes due 2034, which we expect will be used to satisfy all 2024 debt maturities. We believe we will have adequate liquidity over the next 12 months and beyond to operate our business and meet our cash requirements.
We derive the majority of our revenue from tenants who lease space from us under existing lease agreements at each of our properties. Therefore, our ability to generate cash from operations is dependent on the rents that we are able to charge and collect from our tenants. While we believe that the nature of the properties in which we typically invest—primarily neighborhood and community shopping centers—provides a relatively stable revenue flow, an economic downturn, instability
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in the banking sector, tenant bankruptcies, inflation, labor shortages, supply chain constraints, and/or increasing energy prices and interest rates, among other events, could adversely affect the ability of some of our tenants to meet their lease obligations.
Our Principal Capital Resources
For a discussion of cash generated from operations, see “Cash Flows” beginning on page 46. In addition to cash generated from operations, our other principal capital resources are discussed below.
Over the last several years, we have made substantial progress in enhancing our liquidity position and reducing our leverage and borrowing costs. We continue to focus on a balanced approach to growth and staggering debt maturities in order to retain our financial flexibility.
As of December 31, 2023, we had approximately $1.1 billion available under the Revolving Facility for future borrowings. We also had $36.4 million in cash and cash equivalents as of December 31, 2023.
We were in compliance with all applicable financial covenants under the Revolving Facility, unsecured term loans and senior unsecured notes as of December 31, 2023.
On November 16, 2021, the Company filed with the SEC a shelf registration statement on Form S-3, which is effective for a term of three years, relating to the offer and sale, from time to time, of an indeterminate amount of equity and debt securities. Equity securities may be offered and sold by the Parent Company, and the net proceeds of any such offerings would be contributed to the Operating Partnership in exchange for additional General Partner Units. Debt securities may be offered and sold by the Operating Partnership with the Operating Partnership receiving the proceeds. From time to time, we may issue securities under this shelf registration statement for general corporate purposes, which may include acquisitions of additional properties, repayment of outstanding indebtedness, capital expenditures, the expansion, redevelopment, and/or improvement of properties in our portfolio, working capital and other general purposes.
On February 23, 2021, the Company and the Operating Partnership entered into an Equity Distribution Agreement (the “Equity Distribution Agreement”) with each of BofA Securities, Inc., Citigroup Global Markets Inc., KeyBanc Capital Markets Inc. and Raymond James & Associates, Inc., pursuant to which the Company may sell, from time to time, up to an aggregate sales price of $150.0 million of its common shares of beneficial interest, $0.01 par value per share under an at-the-market offering program (the “ATM Program”). On November 30, 2021, the Company and the Operating Partnership amended the Equity Distribution Agreement to reflect their filing of a shelf registration statement on November 16, 2021 with the SEC. The Operating Partnership intends to use the net proceeds, if any, to repay borrowings under the Revolving Facility and other indebtedness and for working capital and other general corporate purposes. The Operating Partnership may also use the net proceeds for acquisitions of operating properties and the development or redevelopment of properties, although there are currently no understandings, commitments or agreements to do so. As of December 31, 2023, the Company has not sold any common shares under the ATM Program.
In the future, we will continue to monitor the capital markets and may consider raising additional capital through the issuance of our common or preferred shares or other securities. We may also raise capital by disposing of properties, land parcels or other assets that are no longer core components of our growth strategy. The sale price may differ from our carrying value at the time of sale.
Our Principal Liquidity Needs
Short-Term Liquidity Needs
Near-Term Debt Maturities . As of December 31, 2023, we had no secured debt, excluding scheduled monthly principal payments, and $269.6 million of unsecured debt scheduled to mature in 2024. We believe we have sufficient liquidity to repay these obligations with proceeds from the Notes Due 2034, available cash on hand, and borrowings on the Revolving Facility.
Other Short-Term Liquidity Needs. The requirements for qualifying as a REIT and for a tax deduction for some or all of the dividends paid to shareholders necessitate that we distribute at least 90% of our taxable income on an annual basis. Such requirements cause us to have substantial liquidity needs over both the short and long term. Our short-term liquidity needs consist primarily of funds necessary to pay operating expenses associated with our operating properties, scheduled interest and principal payments on our debt of approximately $125 million and $5.1 million, respectively, in 2024, expected dividend payments to our common shareholders and common unitholders, and recurring capital expenditures.
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In February 2024, our Board of Trustees declared a cash distribution of $0.25 per common share and Common Unit for the first quarter of 2024, which is expected to be paid on April 12, 2024 to common shareholders and common unitholders of record as of April 5, 2024. Future distributions, if any, are at the discretion of the Board of Trustees, who will continue to evaluate our sources and uses of capital, liquidity position, operating fundamentals, maintenance of our REIT qualification and other factors they may deem relevant. We believe we have sufficient liquidity to pay any dividend from available cash on hand and borrowings on the Revolving Facility.
Other short-term liquidity needs include expenditures for tenant improvements, external leasing commissions and recurring capital expenditures. During the year ended December 31, 2023, we incurred $26.9 million for recurring capital expenditures on operating properties and $92.3 million for tenant improvements and external leasing commissions, which includes costs to re-lease anchor space at our operating properties related to tenants open and operating as of December 31, 2023 (excluding development and redevelopment properties). We currently anticipate incurring approximately $100 million of additional major tenant improvement costs related to leasing activity for space that is currently vacant at a number of our operating properties over the next 12 to 24 months. We believe we have the ability to fund these costs through cash flows from operations or borrowings on the Revolving Facility. In 2023, certain retailers have filed for bankruptcy protection including Bed Bath & Beyond Inc., a tenant that, as of December 31, 2022, occupied 613,000 square feet across 23 locations in our portfolio and generated $8.3 million of annualized base rent. As part of its bankruptcy process, three of Bed Bath & Beyond’s leases were acquired by other retailers and the remaining leases were rejected. Re-leasing costs may be significant for the leases that were rejected, and we could experience a significant reduction in our revenues from those properties over the next 12 to 18 months.
During the year ended December 31, 2023, we completed major development construction activities at The Landing at Tradition – Phase II and placed this project in service. In addition, we began redevelopment activities at Edwards Multiplex – Ontario and reclassified this property from our operating portfolio into redevelopment. As of December 31, 2023, we had development projects under construction at Carillon medical office building and The Corner – IN. Our share of total estimated costs for the two projects is $91.6 million, of which our share of the expected funding requirement is estimated to be $59.7 million. As of December 31, 2023, we have incurred $29.6 million of these costs. We anticipate incurring the majority of the remaining costs for these projects over the next 12 months and believe we have the ability to fund these projects through cash flows from operations or borrowings on the Revolving Facility.
Share Repurchase Program
In February 2021, our Board of Trustees approved a share repurchase program under which the Company may repurchase, from time to time, up to an aggregate of $150.0 million of its common shares. In April 2022, our Board of Trustees authorized a $150.0 million increase to the size of the share repurchase program, authorizing share repurchases up to an aggregate of $300.0 million of its common shares (the “Share Repurchase Program”). The Company intends to fund any future repurchases under the Share Purchase Program with cash on hand or availability under the Revolving Facility, subject to any applicable restrictions. The timing of share repurchases and the number of common shares to be repurchased under the Share Repurchase Program will depend upon prevailing market conditions, regulatory requirements, and other factors. In February 2024, the Company extended the Share Repurchase Program for an additional year to February 28, 2025, if not terminated or extended prior to that date. As of December 31, 2023, the Company has not repurchased any shares under the Share Repurchase Program.
Long-Term Liquidity Needs
Our long-term liquidity needs consist primarily of funds necessary to pay for any new development projects, redevelopment of existing properties, non-recurring capital expenditures, acquisitions of properties, payment of indebtedness at maturity and obligations under ground leases.
Selective Acquisitions, Developments and Joint Ventures . We may selectively pursue the acquisition, development and redevelopment of other properties, which would require additional capital. It is unlikely that we would have sufficient funds on hand to meet these long-term capital requirements; therefore, we would have to satisfy these needs through additional borrowings, sales of common or preferred shares, issuance of Operating Partnership units, cash generated through property dispositions and/or participation in joint venture arrangements. We cannot be certain that we would have access to these sources of capital on satisfactory terms, if at all, to fund our long-term liquidity requirements. We evaluate all future opportunities against pre-established criteria including, but not limited to, location, demographics, expected return, tenant credit quality, tenant relationships, and the amount of existing retail space. Our ability to access the capital markets will depend on a number of factors, including general capital market conditions.
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Potential Debt Repurchases. We may from time to time, depending on market conditions and prices, contractual restrictions, our financial liquidity and other factors, seek to repurchase our senior unsecured notes maturing at various dates through March 2034 in open market transactions, by tender offer or otherwise, as market conditions warrant.
Commitments under Ground Leases. We are obligated under 12 ground leases for approximately 98 acres of land as of December 31, 2023. Most of these ground leases require fixed annual rent payments and the expiration dates of the remaining initial terms of these ground leases range from 2025 to 2092. Assuming we exercise all available options to extend the terms of our ground leases, our ground leases will expire between 2043 and 2115.
Capital Expenditures on Consolidated Properties
The following table summarizes cash capital expenditures for our development and redevelopment projects and other capital expenditures for the year ended December 31, 2023 (in thousands) :
Year Ended
December 31, 2023
Active development and redevelopment projects $ 28,083
Recurring operating capital expenditures (primarily tenant improvements) and other 114,495
Total $ 142,578
We capitalize certain indirect costs such as interest, payroll, and other general and administrative costs related to these development activities. If we had experienced a 10% reduction in development and redevelopment activities, without a corresponding decrease in indirect project costs, we would have recorded additional expense of $0.4 million for the year ended December 31, 2023.
Impact of Changes in Credit Ratings on Our Liquidity
We have received investment grade corporate credit ratings from three nationally recognized credit rating agencies. These ratings did not change in 2023. We received a positive credit rating outlook from one of the rating agencies in 2023.
In the future, these ratings could change based upon, among other things, the impact that prevailing economic conditions may have on our results of operations and financial condition. Credit rating reductions by one or more rating agencies could also adversely affect our access to funding sources, the cost and other terms of obtaining funding, as well as our overall financial condition, operating results and cash flow.
Cash Flows
As of December 31, 2023, we had cash, cash equivalents and restricted cash of $41.4 million. We may be subject to concentrations of credit risk with regards to our cash and cash equivalents. We place our cash and short-term investments with highly rated financial institutions. While we attempt to limit our exposure at any point in time, occasionally such cash and investments may temporarily exceed the Federal Deposit Insurance Corporation (“FDIC”) and the Securities Investor Protection Corporation (“SIPC”) insurance limits. We also maintain certain compensating balances in several financial institutions in support of borrowings from those institutions. Such compensating balances were not material to the accompanying consolidated balance sheets.
Comparison of the Year Ended December 31, 2023 to the Year Ended December 31, 2022
Our cash flow activities are summarized as follows (in thousands) :
Year Ended December 31,
2023 2022 Change
Net cash provided by operating activities $ 394,648 $ 379,283 $ 15,365
Net cash used in investing activities (81,731) (45,149) (36,582)
Net cash used in financing activities (393,457) (312,527) (80,930)
(Decrease) increase in cash, cash equivalents and restricted cash (80,540) 21,607 (102,147)
Cash, cash equivalents and restricted cash, beginning of year 121,970 100,363
Cash, cash equivalents and restricted cash, end of year $ 41,430 $ 121,970
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Cash provided by operating activities was $394.6 million for the year ended December 31, 2023 and $379.3 million for the same period of 2022. The cash flows were positively impacted by an increase in net operating income.
Cash used in investing activities was $81.7 million for the year ended December 31, 2023 and $45.1 million for the same period of 2022. Highlights of significant cash sources and uses in investing activities are as follows:
• We received net proceeds of $140.9 million from the sale of Kingwood Commons, the undeveloped land and related parking garage at Pan Am Plaza, Reisterstown Road Plaza, Eastside, and other land parcels in 2023 compared to net proceeds of $80.4 million from the sale of Plaza Del Lago, a portion of Hamilton Crossing Centre and other land parcels in 2022;
• We acquired Prestonwood Place in 2023 for $78.3 million compared to the acquisitions of Pebble Marketplace, the two-tenant building adjacent to MacArthur Crossing and Palms Plaza in 2022 for $100.1 million;
• We received the proceeds from a $125.0 million short-term deposit that matured on April 7, 2022 during the year ended December 31, 2022; and
• Capital expenditures decreased by $16.0 million primarily related to the timing of capital projects along with a change in construction payables of $2.1 million in 2023.
Cash used in financing activities was $393.5 million for the year ended December 31, 2023 and $312.5 million for the same period of 2022. Highlights of significant cash sources and uses in financing activities are as follows:
• We borrowed $274.0 million on the Revolving Facility and received proceeds of $95.1 million from the origination of a mortgage payable in 2023 compared to borrowings of $155.0 million on the Revolving Facility and entering into a seven-year $300.0 million unsecured term loan in 2022;
• We repaid (i) $274.0 million of borrowings on the Revolving Facility, (ii) $175.4 million of mortgages payable, and (iii) the $95.0 million principal balance of the 4.23% senior unsecured notes in 2023 compared to repayments of (i) $210.0 million of borrowings on the Revolving Facility, (ii) a $200.0 million unsecured term loan that was scheduled to mature in 2023, and (iii) $159.0 million of mortgages payable in 2022; and
• We made distributions to common shareholders and holders of common partnership interests in the Operating Partnership of $213.5 million in 2023 compared to distributions of $182.2 million in 2022.
Management’s discussion of the cash flows for the year ended December 31, 2021, with comparison to the year ended December 31, 2022, was included in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2022.
Other Matters
Financial Instruments
We are exposed to capital market risk, such as changes in interest rates. In order to reduce the volatility related to interest rate risk, we may enter into interest rate hedging arrangements from time to time. We do not use derivative financial instruments for trading or speculative purposes.
Obligations in Connection with Projects Under Construction
We are obligated under various completion guarantees with certain lenders and lease agreements with tenants to complete all or portions of a development project and tenant-specific space currently under construction. We believe we currently have sufficient financing in place to fund these projects and expect to do so primarily through free cash flow or borrowings on the Revolving Facility.
In addition, we have provided a repayment guaranty on a $33.8 million construction loan associated with the development of the Embassy Suites at the University of Notre Dame, consistent with our 35% ownership interest. Our portion of the repayment guaranty is limited to $5.9 million and the guaranty’s term is through July 1, 2024, the maturity date of the construction loan. As of December 31, 2023, the outstanding loan balance was $32.7 million, of which our share was $11.4 million.
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We also provide repayment and completion guaranties on loans totaling $66.2 million associated with the development of The Corner mixed-use project in the Indianapolis MSA. As of December 31, 2023, the outstanding balance of the loans was $61.0 million, of which our share was $30.5 million.
Our share of estimated future costs for under construction and future developments and redevelopments is further discussed beginning on page 44 in the “Short- and Long-Term Liquidity Needs” sections.
Outstanding Indebtedness
The following table provides details on our outstanding consolidated indebtedness as of December 31, 2023 and 2022 (in thousands) :
December 31, 2023 December 31, 2022
Senior unsecured notes $ 1,654,635 $ 1,749,635
Senior exchangeable notes – fixed rate 175,000 175,000
Unsecured revolving line of credit — —
Unsecured term loans 820,000 820,000
Mortgages payable – fixed rate 136,306 205,328
Mortgages payable – variable rate 17,000 28,293
Debt discounts, premiums and issuance costs, net 26,261 32,043
Mortgage and other indebtedness, net $ 2,829,202 $ 3,010,299
Consolidated indebtedness, including weighted average interest rates and weighted average maturities as of December 31, 2023, considering the impact of interest rate swaps, is summarized below (dollars in thousands) :
Amount
Outstanding Ratio Weighted Average
Interest Rate Weighted
Average Years
to Maturity
Fixed rate debt (1)
$ 2,630,941 94 % 3.98 % 3.6
Variable rate debt (2)
172,000 6 % 9.15 % 2.7
Debt discounts, premiums and issuance costs, net 26,261 N/A N/A N/A
Mortgage and other indebtedness, net $ 2,829,202 100 % 4.30 % 3.6
(1) Fixed rate debt includes the portion of variable rate debt that has been hedged by interest rate swaps. As of December 31, 2023, $820.0 million in variable rate debt is hedged to a fixed rate for a weighted average of 1.7 years.
(2) Variable rate debt includes the portion of fixed rate debt that has been hedged by interest rate swaps. As of December 31, 2023, $155.0 million in fixed rate debt is hedged to a floating rate for a weighted average of 1.7 years.
Mortgage indebtedness is collateralized by certain real estate properties and leases and is generally repaid in monthly installments of principal and interest with maturities over various terms through 2033.
The variable interest rate on mortgage indebtedness is based on the Bloomberg Short Term Bank Yield Index (“BSBY”) plus 215 basis points as of December 31, 2023. As of December 31, 2023, the one-month BSBY interest rate was 5.44%. Fixed interest rates on mortgages payable range from 3.75% to 5.73%.
Critical Accounting Estimates
Our significant accounting policies are more fully described in Note 2 to the accompanying consolidated financial statements. As disclosed in Note 2 , the preparation of financial statements in accordance with accounting principles generally accepted in the United States (“GAAP”) requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. We believe that the following discussion addresses our most critical accounting policies, which are those that are most important to the compilation of our financial condition and results of operations and, in some cases, require management’s most difficult, subjective or complex judgments.
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Acquisition of Investment Properties
Real estate assets are recognized on our consolidated balance sheets at historical cost, less accumulated depreciation and amortization. Upon acquisition of real estate operating properties, we estimate the fair value of acquired identifiable tangible assets (consisting of land, buildings and improvements) and identified intangible assets and liabilities (consisting of above-market and below-market leases and in-place leases), assumed debt, and any noncontrolling interest in the acquiree at the date of acquisition based on an evaluation of information and estimates available at the acquisition date. Based on these estimates, we record the estimated fair value to the applicable assets and liabilities. In making estimates of fair value, a number of sources are used, including information obtained as a result of pre-acquisition due diligence, marketing and leasing activities. The estimates of fair value were determined to have primarily relied upon Level 2 and Level 3 inputs, as defined below.
Fair value is determined for tangible assets and intangibles, including:
• the fair value of the building on an as-if-vacant basis and the fair value of land determined either by comparable market data, real estate tax assessments, independent appraisals or other relevant data;
• above-market and below-market in-place lease values for acquired properties, which are based on the present value (using an interest rate that reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) management’s estimate of fair market lease rates for the corresponding in-place leases, measured over the remaining non-cancelable term of the leases. Any below-market renewal options are also considered in the in-place lease values. The capitalized above-market and below-market lease values are amortized as a reduction of, or addition to, rental income over the term of the leases. Should a tenant vacate, terminate its lease, or otherwise notify us of its intent to do so, the unamortized portion of the lease intangibles would be charged or credited to income as applicable;
• the value of having a lease in place at the acquisition date. We use independent and internal sources for our estimates to determine the respective in-place lease values. Our estimates of value use methods similar to those used by independent appraisers. Factors we consider in our analysis include an estimate of costs to execute similar leases, including tenant improvements, leasing commissions and foregone costs related to the reimbursement of property operating expenses, and fair market rent received during the estimated lease-up period as if the space was vacant. The value of in-place leases is amortized to depreciation and amortization expense over the remaining initial terms of the respective leases; and
• the fair value of any assumed financing that is determined to be above- or below-market terms. We use third party and independent sources for our estimates to determine the respective fair value of each mortgage and other indebtedness, including related derivative instruments, assumed. The fair market value of each is amortized to interest expense over the remaining initial terms of the respective instruments.
We also consider whether there is any value to in-place leases that have a related customer relationship intangible value. Characteristics we consider in determining these values include the nature and extent of existing business relationships with the tenant, growth prospects for developing new business with the tenant, the tenant’s credit quality, and expectations of lease renewals, among other factors. To date, we have not developed a tenant relationship that we consider to have a current intangible value.
Valuation of Investment Properties
Management reviews our operating and development projects, land parcels and intangible assets for impairment on a property-by-property basis whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable. This review for possible impairment requires certain assumptions, estimates, and significant judgment. Examples of situations considered to be impairment indicators for both operating properties and development projects include, but are not limited to:
• a substantial decline in or continued low occupancy rate or cash flow;
• expected significant declines in occupancy in the near future;
• continued difficulty in leasing space;
• a significant concentration of financially troubled tenants;
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• a reduction in the anticipated holding period;
• a cost accumulation or delay in the project completion date significantly above and beyond the original development or redevelopment estimate;
• a significant decrease in the market price not in line with general market trends; and
• any other quantitative or qualitative events or factors deemed significant by the Company’s management or Board of Trustees.
Impairment losses for investment properties and intangible assets are measured when the undiscounted cash flows estimated to be generated by the investment properties during the expected holding period are less than the carrying amounts of those assets. The evaluation of impairment is subject to certain management assumptions, including projected net operating income, anticipated holding period, expected capital expenditures and the capitalization rate used to estimate the property’s residual value. Impairment losses are recorded as the excess of the carrying value over the estimated fair value of the asset. Our impairment review for land and development properties assumes we have the intent and ability to complete the developments or projected uses for the land parcels. If we determine those plans will not be completed or our assumptions with respect to operating assets are not realized, an impairment loss may be appropriate.
Depreciation may be accelerated for a redevelopment project, including partial demolition of existing structures, after the asset is assessed for impairment.
The Company classifies an operating property as held for sale only when the property is available for immediate sale in its present condition and for which management believes it is probable that a sale of the property will be completed within one year, among other factors. An operating property classified as held for sale is carried at the lower of cost or fair value less estimated costs to sell. Depreciation and amortization are suspended during the held-for-sale period.
Revenue Recognition
As a lessor of real estate assets, the Company retains substantially all of the risks and benefits of ownership and accounts for its leases as operating leases.
Contractual minimum base rent, percentage rent, and expense reimbursements from tenants for common area maintenance costs, insurance and real estate taxes are our principal sources of revenue. Base minimum rents are recognized on a straight-line basis over the terms of the respective leases. Certain lease agreements contain provisions that provide for additional rents based on a tenant’s sales volume (contingent overage rent). Overage rent is recognized when tenants achieve the specified sales targets as defined in their lease agreements. If we determine that collectibility is probable, we recognize income from rentals based on the methodology described above. If we determine that collectibility is not probable, we recognize income only to the extent that cash has been received from the tenant. We have accounts receivable due from tenants and are subject to the risk of tenant defaults and bankruptcies, which may affect the collection of outstanding receivables. These receivables are reduced for credit loss, which is recognized as a reduction to rental income. We regularly evaluate the collectibility of these lease-related receivables by analyzing past due account balances and consider such factors as the credit quality of the tenant, historical write-off experience, tenant creditworthiness and current economic trends when evaluating the collectibility of rental income. Although we estimate uncollectible receivables and provide for them through charges against income, actual experience may differ from those estimates.
We recognize the sale of real estate when control transfers to the buyer. As part of our ongoing business strategy, we will, from time to time, sell properties, land parcels and outlots, some of which are ground-leased to tenants.
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