Item 1A. Risk Factors
Item 1A. Risk Factors
Our business faces many risks, a number of which are described under the caption “Risk Factors” in our 2019 Annual Report. The COVID-19 pandemic may subject us to additional risks that are described below. The risks described in our 2019 Annual Report and below may not be the only risks we face. Other risks of which we are not yet aware, or that we currently believe are not material, may also materially and adversely impact our business operations or financial results. If any of the events or circumstances described in the risk factors contained in our 2019 Annual Report or described below occurs, our business, financial condition or results of operations could be adversely impacted and the value of an investment in our securities could decline. Investors and prospective investors should consider the risks described in our 2019 Annual Report and below, and the information contained under the caption “Warning Concerning Forward-Looking Statements” and elsewhere in this Quarterly Report on Form 10-Q before deciding whether to invest in our securities.
The COVID-19 pandemic has resulted in a global economic recession that may materially adversely impact our business, operations, financial results and liquidity.
The viral disease outbreak known as COVID-19 has been declared a pandemic by the World Health Organization and in response to the outbreak, the U.S. Health and Human Services Secretary has declared a public health emergency in the United States and many states and municipalities have declared public health emergencies. The COVID-19 pandemic has had a devastating impact on the global economy, including the U.S. economy, and has resulted in a global economic recession.
Economic downturns and recessions in the United States have historically negatively impacted the commercial office real estate market, including by causing increased tenant defaults, decreased occupancies and reduced rental rates. We expect that the current economic conditions may have similar negative impacts on our business and that the extent of those negative consequences will depend to a large extent on the duration and depth of the economic downturn in the United States and the strength and sustainability of any economic recovery that may follow.
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While we have not yet experienced a material adverse impact on our occupancy resulting from the COVID-19 pandemic as of the date of this Quarterly Report on Form 10-Q, if the outbreak continues to weaken national, regional and local economies, it could negatively impact our occupancy levels and result in significant tenant defaults in the payment of rent owed to us. Although, as of June 30, 2020 , 35.1% of our total annualized rental income was from leases with governmental agencies, including 25.2% of our total annualized rental income from leases with the U.S. federal government, the balance of our rents comes from nongovernmental tenants. Further, as of June 30, 2020 , tenants occupying approximately 11.5% of our rentable square feet and responsible for approximately 8.6% of our annualized rental income as of June 30, 2020 currently have exercisable rights to terminate their leases before the stated terms of their leases expire. Also, during the second half of 2020 and in 2021 and 2022 , early termination rights become exercisable by other tenants who currently occupy an additional approximately 2.3% , 1.6% and 2.3% of our rentable square feet, respectively, and contribute an additional approximately 2.8% , 1.8% and 2.4% of our annualized rental income, respectively, as of June 30, 2020 . In addition, as of June 30, 2020 , pursuant to leases with 14 of our tenants, these tenants have rights to terminate their leases if their respective legislature or other funding authority does not appropriate rent amounts in their respective annual budgets. These 14 tenants occupy approximately 5.4% of our rentable square feet and contribute approximately 5.8% of our annualized rental income as of June 30, 2020 . Additionally, we typically conduct aspects of our leasing activity at our properties. Reductions in the ability and willingness of prospective tenants to visit our properties due to the COVID-19 outbreak, or the extent to which federal, state and municipal orders limit the extent to which our manager’s employees can visit our properties, could have an impact on our leasing activity which could reduce rental income and tenant reimbursements and other income produced by our properties. We have experienced a slowdown in our leasing activity thus far in 2020 due to the COVID-19 pandemic and expect this slowdown may continue until market conditions improve for a sustained period. Concerns relating to such an outbreak could also cause on-site personnel not to report for work at our properties, which could adversely affect the management of our properties.
We cannot predict the extent and duration of the COVID-19 pandemic or the severity and duration of its economic impact. Potential consequences of the current unprecedented measures taken in response to the spread of the virus that causes COVID-19, and current market disruptions and volatility affecting us include, but are not limited to:
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continued sudden and/or severe declines in the market price of our common shares;
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possible significant declines in the value of our properties;
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our inability to accurately or reliably value our portfolio;
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our inability to comply with financial covenants contained in our debt agreements that could result in our defaulting under such agreements;
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our need to reduce or eliminate the distributions we pay to our shareholders and our need to maintain such reduction or elimination for an extended period of time;
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our failure to pay interest and principal when due under our outstanding debt, which may result in the acceleration of payment for our outstanding debt and our possible loss of our revolving credit facilities;
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our inability to access debt and equity capital on attractive terms, or at all;
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increased risk of default or bankruptcy of our tenants;
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increased risk of our tenants being unable to weather an extended cessation of normal economic activity and thereby impairing their ability to continue functioning as a going concern;
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downgrades of our credit ratings by nationally recognized credit rating agencies;
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our inability to sell properties we may identify for sale due to a general decline in business activity and demand for real estate transactions and, as a result, our inability to redeploy our capital into investments we believe are more beneficial to us;
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our inability to make improvements to our properties due to a construction moratorium or decrease in available construction workers or construction activity, including required inspectors and governmental personnel for permitting and other requirements, and due to our need to maintain our liquidity; and
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reduced economic demand resulting from mass employee layoffs or furloughs in response to governmental action taken to slow the spread of the virus that causes COVID-19, which could impact the continued viability of our tenants and the demand for office space at our properties.
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Further, the extent and strength of any economic recovery after the COVID-19 pandemic abates, including following any “second wave” or other intensifying of the pandemic, are uncertain and subject to various factors and conditions. Our business, operations and financial position may continue to be negatively impacted after the COVID-19 pandemic abates and may remain at depressed levels compared to prior to the outbreak of the COVID-19 pandemic and those conditions may continue for an extended period.
Future distributions to our shareholders may be reduced or eliminated as a result of the uncertainty and materially adverse impact of the COVID-19 pandemic and related economic downturn and the form of payment could change.
We currently intend to continue to make regular quarterly distributions to our shareholders. However:
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our ability to make or sustain the rate of distributions may be adversely affected by the negative impact of the COVID-19 pandemic and its aftermath on our business, results of operations and liquidity;
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our making of distributions is subject to compliance with restrictions contained in our credit agreement and may be subject to restrictions in future debt obligations we may incur; during the continuance of any event of default under our credit agreement, we may be limited or in some cases prohibited from making distributions to our shareholders; and
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our distribution rates are set and reset from time to by our Board of Trustees. Our Board of Trustees considers many factors when setting distribution rates including our historical and projected income, Normalized FFO, cash available for distribution, the then current and expected needs and availability of cash to pay our obligations and fund our investments, distributions which may be required to be paid to maintain our qualification for taxation as a REIT and other factors deemed relevant by our Board of Trustees. Accordingly, future distribution rates may be increased or decreased and there is no assurance as to the rate at which future distributions will be paid.
For these reasons, among others, our distribution rate may decline or we may cease making distributions to our shareholders.
In addition, in order to preserve liquidity, we may elect to pay distributions to our shareholders in part in a form other than cash, such as issuing additional common shares of ours to our shareholders, as permitted by the applicable tax rules.
Some of our tenants have requested assistance from their obligations to pay us rent in response to the current economic conditions resulting from the COVID-19 pandemic and we expect to receive additional similar requests in the future; we have provided certain limited assistance in response to these requests and may determine to grant additional assistance in the future if we determine it prudent or appropriate to do so.
The current economic conditions resulting from the COVID-19 pandemic significantly negatively impacted certain of our tenants’ businesses, operations and liquidity. As a result of the COVID-19 pandemic, we have received requests from some of our tenants for rent assistance. As of July 27, 2020, we have granted temporary rent assistance totaling $2,475 to 23 tenants who represent approximately 3.7% of our annualized rental income as of June 30, 2020 . This assistance generally entails a deferral of, in most cases, one month of rent until September 2020 when the deferred rent amounts will begin to be payable over a 12-month period. We expect to receive additional similar requests in the future, and we may determine to grant additional assistance in the future, which may vary from the type of assistance we have granted to date, and could include more substantial assistance, if we determine it prudent or appropriate to do so. If conditions do not sufficiently and sustainably improve for these tenants, they may be unable to pay deferred or other rent owed to us when due or otherwise. In addition, if any of our tenants are unable to continue as going concerns as a result of the current economic conditions or otherwise, we will experience a reduction in rents received and we may be unable to find suitable replacement tenants for an extended period or at all and the terms of our leases with those replacement tenants may not be as favorable to us as the terms of our agreements with our existing tenants.
The COVID-19 pandemic may have significant impacts on workplace practices and those changes could be detrimental to our business.
Temporary closures of businesses and stay in place orders and the resulting remote working arrangements for nonessential personnel in response to the COVID-19 pandemic may result in long-term changed work practices that could negatively impact us and our business. For example, the increased adoption of and familiarity with remote work practices could result in decreased demand for office space. If so, our business, operating results, financial condition and prospects may be materially adversely impacted.
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