Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following information should be read in conjunction with our Consolidated Financial Statements and accompanying notes included in Part IV, Item 15 of this Annual Report on Form 10-K.
OVERVIEW (dollars in thousands, except per share and per square foot data)
We are a REIT organized under Maryland law. As of December 31, 2020, our wholly owned properties were comprised of 181 properties and we had noncontrolling ownership interests in three properties totaling approximately 444,000 rentable square feet through two unconsolidated joint ventures in which we own 51% and 50% interests. As of December 31, 2020, our properties are located in 34 states and the District of Columbia and contain approximately 24,889,000 rentable square feet. As of December 31, 2020, our properties were leased to 349 different tenants, with a weighted average remaining lease term (based on annualized rental income) of approximately 5.1 years. The U.S. government is our largest tenant, representing approximately 25.2% of our annualized rental income as of December 31, 2020.
COVID-19 Pandemic
The COVID-19 pandemic and the various governmental and market responses intended to contain and mitigate the spread of the virus and its detrimental public health impact, as well as the general uncertainty surrounding the dangers and impact of the pandemic, continue to have a significant impact on the global economy, including the U.S. economy. To date, the COVID-19 pandemic has not had a significant impact on our business and we believe that our current financial resources, the characteristics of our portfolio, including the diversity of our tenant base, both geographically and by industry, and the financial strength and resources of our tenants, will enable us to withstand the COVID-19 pandemic. However, we have received requests from some of our tenants for rent assistance. As of February 16, 2021, we have granted temporary rent assistance totaling $2,546 to 19 tenants who represent approximately 3.3% of our annualized rental income as of December 31, 2020. This assistance generally entails a deferral of, in most cases, one month of rent pursuant to deferred payment plans which require the deferred rent amounts be payable over a 12-month period, certain of which commenced in 2020. The deferred amounts did not impact our operating results for the year ended December 31, 2020. As of February 16, 2021, we have collected $1,999, or 78.5%, of our granted rent deferrals.
For more information and risks relating to the COVID-19 pandemic on us and our business, see elsewhere in this Annual Report on Form 10-K, including “Warning Concerning Forward-Looking Statements”, Part I, Item1, “Business”, Part I, Item
48
Table of Contents
1A, “Risk Factors” and Note 4 to the Notes to Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K.
Property Operations
Unless otherwise noted, the data presented in this section includes properties classified as held for sale as of December 31, 2020 and excludes three properties owned by two unconsolidated joint ventures in which we own 51% and 50% interests. For more information regarding our properties classified as held for sale and our two unconsolidated joint ventures, see Note 3 to the Notes to Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K.
Occupancy data for our properties as of December 31, 2020 and 2019 was as follows (square feet in thousands):
All Properties (1)
Comparable Properties (2)
December 31, December 31,
2020 2019 2020 2019
Total properties (3)
181 189 177 177
Total rentable square feet (4)
24,889 25,726 24,130 24,224
Percent leased (5)
91.2 % 92.4 % 92.1 % 93.3 %
(1) Based on properties we owned on December 31, 2020 and 2019, respectively.
(2) Based on properties we owned continuously since January 1, 2019; excludes properties classified as held for sale, properties undergoing significant redevelopment, if any, and three properties owned by two unconsolidated joint ventures in which we own 51% and 50% interests.
(3) Includes one leasable land parcel.
(4) Subject to changes when space is remeasured or reconfigured for tenants.
(5) Percent leased includes (i) space being fitted out for tenant occupancy pursuant to our lease agreements, if any, and (ii) space which is leased, but is not occupied or is being offered for sublease by tenants, if any, as of the measurement date.
The average effective rental rate per square foot for our properties for the years ended December 31, 2020 and 2019 are as follows:
Year Ended December 31,
Average effective rental rate per square foot (1) :
2020 2019
All properties (2)
$ 25.93 $ 27.02
Comparable properties (3)
$ 25.87 $ 26.04
(1) Average effective rental rate per square foot represents total rental income during the period specified divided by the average rentable square feet leased during the period specified.
(2) Based on properties we owned on December 31, 2020 and 2019, respectively.
(3) Based on properties we owned continuously since January 1, 2019; excludes properties classified as held for sale, properties undergoing significant redevelopment, if any, and three properties owned by two unconsolidated joint ventures in which we own 51% and 50% interests.
During the year ended December 31, 2020, changes in rentable square feet leased and available for lease at our properties were as follows (square feet in thousands):
Year Ended December 31, 2020
Leased Available
for Lease Total
Beginning of year 23,761 1,965 25,726
Changes resulting from:
Acquisition of properties 150 13 163
Disposition of properties (836) (70) (906)
Lease expirations (2,334) 2,334 —
Lease renewals (1)
1,691 (1,691) —
New leases (1)
274 (274) —
Remeasurements (2)
(1) (93) (94)
End of year 22,705 2,184 24,889
(1) Based on leases entered during the year ended December 31, 2020.
(2) Rentable square feet are subject to changes when space is remeasured or reconfigured for tenants.
49
Table of Contents
Leases at our properties totaling approximately 2,334,000 rentable square feet expired during the year ended December 31, 2020. During the year ended December 31, 2020, we entered leases totaling approximately 1,965,000 rentable square feet, including lease renewals of approximately 1,691,000 rentable square feet and new leases of approximately 274,000 rentable square feet. The weighted (by rentable square feet) average rents were 6.9% above prior rents for the same space and the weighted (by rentable square feet) average lease term for new and renewal leases entered during the year ended December 31, 2020 was 7.3 years.
During the year ended December 31, 2020, commitments made for expenditures, such as tenant improvements and leasing costs, in connection with leasing space at our properties were as follows (square feet in thousands):
Year Ended December 31, 2020
New Leases Renewals Total
Rentable square feet leased 274 1,691 1,965
Tenant leasing costs and concession commitments (1)
$ 21,356 $ 22,048 $ 43,404
Tenant leasing costs and concession commitments per rentable square foot (1)
$ 77.89 $ 13.04 $ 22.09
Weighted (by square feet) average lease term (years) 11.2 6.7 7.3
Total leasing costs and concession commitments per rentable square foot per year (1)
$ 6.94 $ 1.95 $ 3.02
(1) Includes commitments made for leasing expenditures and concessions, such as tenant improvements, leasing commissions, tenant reimbursements and free rent.
During the year ended December 31, 2020, changes in effective rental rates per square foot achieved for new leases and lease renewals at our properties that commenced during the year ended December 31, 2020, when compared to prior effective rental rates per square foot in effect for the same space (and excluding space acquired vacant), were as follows (square feet in thousands):
Year Ended December 31, 2020
Old Effective
Rent Per
Square Foot (1)
New Effective
Rent Per
Square Foot (1)
Rentable
Square Feet
New leases $30.44 $29.28 321
Lease renewals $26.66 $28.43 1,700
Total leasing activity $27.26 $28.57 2,021
(1) Effective rental rate includes contractual base rents from our tenants pursuant to our lease agreements, plus straight line rent adjustments and estimated expense reimbursements to be paid to us, and excluding lease value amortization.
During the years ended December 31, 2020 and 2019, amounts capitalized at our properties for lease related costs, building improvements and development, redevelopment and other activities were as follows:
Year Ended December 31,
2020 2019
Lease related costs (1)
$ 34,972 $ 52,359
Building improvements (2)
41,280 33,383
Recurring capital expenditures 76,252 85,742
Development, redevelopment and other activities (3)
16,858 5,880
Total capital expenditures $ 93,110 $ 91,622
(1) Lease related costs generally include capital expenditures used to improve tenants’ space or amounts paid directly to tenants to improve their space and leasing related costs, such as brokerage commissions and other tenant inducements.
(2) Building improvements generally include expenditures to replace obsolete building components and expenditures that extend the useful life of existing assets.
(3) Development, redevelopment and other activities generally include capital expenditure projects that reposition a property or result in new sources of revenue.
As of December 31, 2020, we have estimated unspent leasing related obligations of $51,913, of which we expect to spend $19,179 over the next 12 months.
50
Table of Contents
As of December 31, 2020, we had leases at our properties totaling approximately 3,657,000 rentable square feet that were scheduled to expire during 2021. As of February 18, 2021, we expect tenants with leases totaling approximately 2,614,000 rentable square feet that are scheduled to expire through December 31, 2021, to not renew their leases upon expiration and we cannot be sure as to whether other tenants will renew their leases upon expiration. Of the approximately 2,614,000 rentable square feet that is expiring and expected to not renew in 2021, 1,371,000 rentable square feet is currently under agreement to be sold and 340,000 rentable square feet is in the planning stage for a potential redevelopment. As a result of the COVID-19 pandemic and its economic impact, overall new leasing volume slowed in 2020 and may further slow or remain at a reduced level until market conditions meaningfully improve for a sustained period. However, we remain focused on proactive dialogue with our existing tenants and overall tenant retention. Prevailing market conditions and government and other tenants’ needs at the time we negotiate and enter leases or lease renewals will generally determine rental rates and demand for leased space at our properties, and market conditions and our tenants’ needs are beyond our control. Whenever we renew or enter into new leases for our properties, we intend to seek rents which are equal to or higher than our historical rents for the same properties; however, our ability to maintain or increase the rents for our current properties will depend in large part upon market conditions, which are beyond our control. We cannot be sure of the rental rates which will result from our ongoing negotiations regarding lease renewals or any new or renewed leases we may enter; also, we may experience material declines in our rental income due to vacancies upon lease expirations or early terminations.
As of December 31, 2020, our lease expirations by year are as follows (square feet in thousands):
Year (1)
Number of Leases Expiring Leased Square Feet Expiring (2)
Percent of Total Cumulative Percent of Total Annualized Rental Income Expiring Percent of Total Cumulative Percent of Total
2021 82 3,657 16.1% 16.1% $ 69,903 12.1% 12.1%
2022 74 1,944 8.6% 24.7% 54,821 9.5% 21.6%
2023 65 2,403 10.6% 35.3% 76,436 13.2% 34.8%
2024 58 3,858 17.0% 52.3% 101,530 17.6% 52.4%
2025 54 2,030 8.9% 61.2% 43,585 7.5% 59.9%
2026 31 1,724 7.6% 68.8% 45,837 7.9% 67.8%
2027 31 2,027 8.9% 77.7% 52,385 9.1% 76.9%
2028 15 901 4.0% 81.7% 25,858 4.5% 81.4%
2029 15 934 4.1% 85.8% 24,798 4.3% 85.7%
2030 and thereafter 39 3,227 14.2% 100.0% 82,865 14.3% 100.0%
Total 464 22,705 100.0% $ 578,018 100.0%
Weighted average remaining lease term (in years)
5.0 5.1
(1) The year of lease expiration is pursuant to current contract terms. Some of our leases allow the tenants to vacate the leased premises before the stated expirations of their leases with little or no liability. As of December 31, 2020, tenants occupying approximately 7.4% of our rentable square feet and responsible for approximately 9.2% of our annualized rental income as of December 31, 2020, currently have exercisable rights to terminate their leases before the stated terms of their leases expire. Also, in 2021, 2022, 2023, 2024, 2025, 2026, 2027, 2028, 2029 and 2035 early termination rights become exercisable by other tenants who currently occupy an additional approximately 1.3%, 2.8%, 1.5%, 1.1%, 2.1%, 1.0%, 0.6%, 1.1%, 0.1% and 0.3% of our rentable square feet, respectively, and contribute an additional approximately 1.6%, 2.9%, 1.7%, 1.7%, 3.5%, 1.3%, 1.1%, 1.3%, 0.2% and 0.4% of our annualized rental income, respectively, as of December 31, 2020. In addition, as of December 31, 2020, pursuant to leases with 13 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 13 tenants occupy approximately 5.0% of our rentable square feet and contribute approximately 5.9% of our annualized rental income as of December 31, 2020.
(2) Leased square feet is pursuant to leases existing as of December 31, 2020, and includes (i) space being fitted out for tenant occupancy pursuant to our lease agreements, if any, and (ii) space which is leased, but is not occupied or is being offered for sublease by tenants, if any. Square feet measurements are subject to changes when space is remeasured or reconfigured for new tenants.
We generally will seek to renew or extend the terms of leases in our single tenant properties when they expire. Because of the capital many of the tenants in these properties have invested in the properties and because many of these properties appear to be of strategic importance to the tenants’ businesses, we believe that it is likely that these tenants will renew or extend their leases prior to when they expire. If we are unable to extend or renew our leases, it may be time consuming and expensive to relet some of these properties.
We believe that recent government budgetary and spending priorities and enhancements in technology have resulted in a decrease in government office use for employees. Furthermore, over the past several years, government tenants have reduced their space utilization per employee and consolidated government tenants into existing government owned properties. This activity has reduced the demand for government leased space. Our historical experience with respect to properties of the type we own that are majority leased to government tenants has been that government tenants frequently renew leases to avoid the
51
Table of Contents
costs and disruptions that may result from relocating their operations. However, efforts to manage space utilization rates may result in our tenants exercising early termination rights under our leases, vacating our properties upon expiration of our leases in order to relocate, or renewing their leases for less space than they currently occupy. Also, our government tenants’ desire to reconfigure leased office space to manage utilization per employee may require us to spend significant amounts for tenant improvements, and tenant relocations are often more prevalent in those circumstances. Increasing uncertainty with respect to government agency budgets and funding to implement relocations, consolidations and reconfigurations has resulted in delayed decisions by some of our government tenants and their reliance on short term lease renewals; however, recent activity prior to the outbreak of the COVID-19 pandemic suggested that the U.S. government had begun to shift its leasing strategy to include longer term leases and was actively exploring 10 to 20 year lease terms at renewal, in some instances. It is also possible that as a result of the COVID-19 pandemic, government tenants may seek to manage space utilization rates in order to provide greater physical distancing for employees, which may require us to spend significant amounts for tenant improvements, mostly with lease renewals. However, the COVID-19 pandemic and its aftermath have had negative impacts on government budgets and resources and it is unclear what the effect of these impacts will be on government demand for leasing office space. In addition, the new presidential administration may result in a change in the federal government’s policy priorities, which may impact leasing at our government leased properties. Given the significant uncertainties, including as to the COVID-19 pandemic, its economic impact and its aftermath and the new presidential administration, we are unable to reasonably project what the financial impact of market conditions or changing government circumstances will be on our financial results for future periods.
As of December 31, 2020, we derive 23.5% of our annualized rental income from our properties located in the metropolitan Washington, D.C. market area, which includes Washington, D.C., Northern Virginia and suburban Maryland. A downturn in economic conditions in this area, including as a result of the COVID-19 pandemic, could result in reduced demand from tenants for our properties or reduce the rents that our tenants in this area are willing to pay when our leases expire or terminate and when renewal or new terms are negotiated. Additionally, in recent years there has been a decrease in demand for new leased office space by the U.S. government in the metropolitan Washington, D.C. market area, and that could increase competition for government tenants and adversely affect our ability to retain government tenants when our leases expire.
Our manager, RMR LLC, employs a tenant review process for us. RMR LLC assesses tenants on an individual basis based on various applicable credit criteria. In general, depending on facts and circumstances, RMR LLC evaluates the creditworthiness of a tenant based on information concerning the tenant that is provided by the tenant and, in some cases, information that is publicly available or obtained from third party sources. RMR LLC also often uses a third party service to monitor the credit ratings, both actual and implied, of our existing tenants. We consider investment grade tenants to include: (a) investment grade rated tenants; (b) tenants with investment grade rated parent entities that guarantee the tenant’s lease obligations; and/or (c) tenants with investment grade rated parent entities that do not guarantee the tenant’s lease obligations. As of December 31, 2020, tenants contributing 56.7% of annualized rental income were investment grade rated (or their payment obligations were guaranteed by an investment grade rated parent) and tenants contributing an additional 8.1% of annualized rental income were subsidiaries of an investment grade rated parent (although these parent entities were not liable for the payment of rents).
52
Table of Contents
As of December 31, 2020, tenants representing 1% or more of our total annualized rental income were as follows:
Tenant Credit Rating Sq. Ft. % of Leased Sq. Ft. Annualized
Rental Income % of Total Annualized Rental Income
1 U.S. Government Investment Grade 5,316 23.4 % $ 145,916 25.2 %
2 Shook, Hardy & Bacon L.L.P. Not Rated 596 2.6 % 19,199 3.3 %
3 State of California Investment Grade 648 2.9 % 19,142 3.3 %
4 Bank of America Corporation Investment Grade 617 2.7 % 16,520 2.9 %
5 WestRock Company (1)
Investment Grade 311 1.4 % 12,871 2.2 %
6 F5 Networks, Inc. Not Rated 299 1.3 % 12,777 2.2 %
7 Commonwealth of Massachusetts Investment Grade 311 1.4 % 11,953 2.1 %
8 CareFirst Inc. Not Rated 207 0.9 % 11,684 2.0 %
9 Northrop Grumman Corporation Investment Grade 337 1.5 % 11,320 2.0 %
10 Tyson Foods, Inc. Investment Grade 248 1.1 % 11,011 1.9 %
11 Micro Focus International plc Non Investment Grade 406 1.8 % 8,710 1.5 %
12 CommScope Holding Company Inc Non Investment Grade 228 1.0 % 8,097 1.4 %
13 State of Georgia Investment Grade 308 1.4 % 7,094 1.2 %
14 PNC Bank Investment Grade 441 1.9 % 6,902 1.2 %
15 ServiceNow, Inc. Investment Grade 149 0.7 % 6,481 1.1 %
16 Allstate Insurance Co. Investment Grade 468 2.1 % 6,473 1.1 %
17 Compass Group plc Investment Grade 267 1.2 % 6,386 1.1 %
18 Automatic Data Processing, Inc. Investment Grade 289 1.3 % 6,047 1.0 %
19 Church & Dwight Co., Inc. Investment Grade 250 1.1 % 6,019 1.0 %
20 Tailored Brands, Inc. (2)
Non Investment Grade 206 0.9 % 5,898 1.0 %
11,902 52.6 % $ 340,500 58.7 %
(1) This tenant occupied a property located in Richmond, VA that was classified as held for sale as of December 31, 2020 and sold in January 2021.
(2) In August 2020, Tailored Brands, Inc. filed for Chapter 11 bankruptcy. The tenant has paid its rental obligations to us through December 31, 2020. On January 25, 2021, the lease was assumed in bankruptcy court. As a condition to this lease being assumed, we entered into a lease amendment with the tenant as of January 25, 2021 that includes a reduction of approximately 104,000 square feet. As a result of this lease restructure, this tenant will no longer represent 1% or more of our annualized rental income.
53
Table of Contents
Acquisition Activities
During the year ended December 31, 2020, we acquired two properties containing a combined approximately 163,000 square feet for an aggregate purchase price of $46,625, excluding acquisition related costs.
In November 2020, we entered into an agreement to acquire a property adjacent to a property we own in Boston, MA for $26,975, excluding acquisition related costs. This acquisition is expected to take place before the end of the first quarter. However, this acquisition is subject to conditions; accordingly, we cannot be sure that we will complete this acquisition or that this acquisition will not be delayed or the terms will not change.
For more information about our acquisition activities, see “Business —Acquisition Policies” in Part 1, Item 1 of this Annual Report on Form 10-K and Note 3 to the Notes to Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K.
Disposition Activities
During the year ended December 31, 2020, we sold 10 properties containing a combined approximately 906,000 rentable square feet for an aggregate sales price of $110,463, excluding closing costs and including the repayment of one mortgage note with an outstanding principal balance of $13,095, an annual interest rate of 5.9% and a maturity date in August 2021. Since January 1, 2021, we have sold both of the properties classified as held for sale as of December 31, 2020 for an aggregate sales price of $130,845, excluding closing costs. We sold these properties pursuant to our capital recycling program. Through our capital recycling program, we seek to selectively sell certain properties from time to time to fund future acquisitions and to maintain leverage consistent with our current investment grade ratings with a goal of (1) improving the asset quality of our portfolio by reducing the average age of our properties, lengthening the weighted average term of our leases and increasing the likelihood of retaining our tenants and (2) increasing our cash available for distribution.
In February 2021, we entered into an agreement to sell a property located in Huntsville, AL containing approximately 1,371,000 rentable square feet for a sales price of $39,000, excluding closing costs. This sale is expected to occur before the end of the second quarter. However, this sale is subject to conditions; accordingly, we cannot be sure that we will complete this sale or that this sale will not be delayed or the terms will not change.
For more information about our disposition activities, see “Business —Disposition Policies” in Part 1, Item 1 of this Annual Report on Form 10-K and Note 3 to the Notes to Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K.
Financing Activities
Senior Unsecured Note Issuances
In June and July 2020, we issued an aggregate of $162,000 of 6.375% senior unsecured notes due 2050 in an underwritten public offering. Our aggregate net proceeds from this offering were $156,226, after underwriters’ discounts and offering expenses, which we used to repay amounts outstanding under our revolving credit facility and for general business purposes. These notes require quarterly payments of interest only through maturity and may be repaid at par (plus accrued and unpaid interest) on or after June 23, 2025.
In September 2020, we issued $250,000 of our 4.50% senior unsecured notes due 2025 in an underwritten public offering. These notes were a further issuance of our existing $400,000 of senior unsecured notes due 2025 that were initially issued by SIR in February 2015, which we assumed in connection with the SIR Merger. The public offering price of these notes was 101.414% of the principal amount, raising net proceeds of $251,214, after underwriters’ discounts and offering expenses, which we used to repay amounts outstanding under our revolving credit facility and for general business purposes. These notes require semi-annual payments of interest only through maturity.
Senior Unsecured Note Redemption
In January 2020, we redeemed, at par plus accrued interest, all $400,000 of our 3.60% senior unsecured notes due 2020 using cash on hand, proceeds from property sales and borrowings under our revolving credit facility.
Mortgage Note Repayments
In March 2020, in connection with the sale of one property, we prepaid, at a premium plus accrued interest, a mortgage note secured by that property with an outstanding principal balance of $13,095, an annual interest rate of 5.9% and a maturity
54
Table of Contents
date in August 2021, which was classified in liabilities of properties held for sale in our consolidated balance sheet as of December 31, 2019.
Also in March 2020, we prepaid, at a premium plus accrued interest, a mortgage note secured by one property with an outstanding principal balance of $66,780, an annual interest rate of 4.0% and a maturity date in September 2030 using cash on hand and borrowings under our revolving credit facility.
In April 2020, we prepaid, at par plus accrued interest, a mortgage note secured by one property with an outstanding principal balance of $32,677, an annual interest rate of 5.7% and a maturity date in July 2020 using cash on hand and borrowings under our revolving credit facility.
In August 2020, we repaid at maturity, at par plus accrued interest, a mortgage note secured by one property with an outstanding principal balance of $39,635 and an annual interest rate of 2.2% using cash on hand and borrowings under our revolving credit facility.
For more information about our financing activities, see “Business —Our Financing Policies” in Part 1, Item 1 of this Annual Report on Form 10-K and Note 8 to the Notes to Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K.
Segment Information
We operate in one business segment: ownership of real estate properties.
55
Table of Contents
RESULTS OF OPERATIONS (amounts in thousands, except per share amounts)
Year Ended December 31, 2020, Compared to Year Ended December 31, 2019
Non-Comparable
Properties Results
Comparable Properties Results (1)
Year Ended Consolidated Results
Year Ended December 31, December 31, Year Ended December 31,
2020 2019 $
Change %
Change 2020 2019 2020 2019 $
Change %
Change
Rental income $ 572,419 $ 582,497 $ (10,078) (1.7 %) $ 15,500 $ 95,907 $ 587,919 $ 678,404 $ (90,485) (13.3 %)
Operating expenses:
Real estate taxes 63,066 63,146 (80) (0.1 %) 2,053 10,571 65,119 73,717 (8,598) (11.7 %)
Utility expenses 24,859 29,047 (4,188) (14.4 %) 525 5,255 25,384 34,302 (8,918) (26.0 %)
Other operating expenses
102,596 104,316 (1,720) (1.6 %) 2,869 16,627 105,465 120,943 (15,478) (12.8 %)
Total operating expenses
190,521 196,509 (5,988) (3.0 %) 5,447 32,453 195,968 228,962 (32,994) (14.4 %)
Net operating income (2)
$ 381,898 $ 385,988 $ (4,090) (1.1 %) $ 10,053 $ 63,454 391,951 449,442 (57,491) (12.8 %)
Other expenses:
Depreciation and amortization 251,566 289,885 (38,319) (13.2 %)
Loss on impairment of real estate 2,954 22,255 (19,301) (86.7 %)
Acquisition and transaction related costs 232 682 (450) (66.0 %)
General and administrative 28,443 32,728 (4,285) (13.1 %)
Total other expenses 283,195 345,550 (62,355) (18.0 %)
Gain on sale of real estate 10,855 105,131 (94,276) (89.7 %)
Dividend income — 1,960 (1,960) n/m
Loss on equity securities, net — (44,007) 44,007 n/m
Interest and other income 779 1,045 (266) (25.5 %)
Interest expense (108,303) (134,880) 26,577 (19.7 %)
Loss on early extinguishment of debt (3,839) (769) (3,070) n/m
Income before income tax expense and equity in net losses of investees 8,248 32,372 (24,124) (74.5 %)
Income tax expense (377) (778) 401 (51.5 %)
Equity in net losses of investees (1,193) (1,259) 66 (5.2 %)
Net income $ 6,678 $ 30,335 $ (23,657) (78.0 %)
Weighted average common shares outstanding (basic and diluted) 48,124 48,062 62 0.1 %
Per common share amounts (basic and diluted):
Net income $ 0.14 $ 0.63 $ (0.49) (77.8 %)
n/m - not meaningful
(1) Comparable properties consists of 177 properties we owned on December 31, 2020 and which we owned continuously since January 1, 2019 and excludes properties classified as held for sale, properties undergoing significant redevelopment, if any, and three properties owned by two unconsolidated joint ventures in which we own 51% and 50% interests.
(2) Our definition of net operating income, or NOI, and our reconciliation of net income to NOI are included below under the heading “Non-GAAP Financial Measures.”
References to changes in the income and expense categories below relate to the comparison of consolidated results for the year ended December 31, 2020, compared to the year ended December 31, 2019. For a comparison of consolidated results for the year ended December 31, 2019 compared to the year ended December 31, 2018, see Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.
56
Table of Contents
Rental income. The decrease in rental income reflects decreases in rental income of $74,411 as a result of property disposition activities, $10,078 related to comparable properties and $6,204 related to a property undergoing significant redevelopment that became vacant in September 2019, offset by an increase in rental income of $208 related to acquired properties. The decrease in rental income for comparable properties is primarily due to reductions in occupied space at certain of our properties in 2020, certain below market lease intangibles becoming fully amortized, termination fee revenue totaling $1,543 recorded at certain of our comparable properties in 2019, reductions in reimbursement income due to reductions in expenses that are reimbursable to us by our tenants as a result of the COVID-19 pandemic and resulting decrease in space utilization, and decreased parking revenue at certain of our comparable properties due to lower parking activity resulting from the COVID-19 pandemic. Rental income includes non-cash straight line rent adjustments totaling $16,079 in 2020 and $27,507 in 2019, and amortization of acquired leases and assumed lease obligations totaling ($5,440) in 2020 and ($2,710) in 2019.
Real estate taxes. The decrease in real estate taxes reflects a decrease in real estate taxes of $7,765 as a result of property disposition activities, a decrease of $803 for a property undergoing significant redevelopment and a decrease of $80 for comparable properties, offset by increases in real estate taxes of $50 for acquired properties. Real estate taxes for comparable properties declined primarily due to the effect of lower real estate tax valuation assessments resulting from successful real estate tax appeals at certain of our properties since January 1, 2019.
Utility expenses. The decrease in utility expenses reflects a decrease in utility expenses of $4,796 as a result of property disposition activities and a decrease in utility expenses for comparable properties of $4,188, offset by an increase in utility expenses for a property undergoing significant redevelopment of $66. Utility expenses for comparable properties declined primarily due to a decrease in electricity and water usage resulting from cost savings initiatives implemented by our manager, RMR LLC, in response to decreased space utilization at our properties as a result of the COVID-19 pandemic, as well as the implementation of real time energy management programs at certain of our properties in 2020.
Other operating expenses. Other operating expenses consist of salaries and benefit costs of property level personnel, repairs and maintenance expense, cleaning expense, other direct costs of operating our properties and property management fees. The decrease in other operating expenses reflects a decrease of $13,448 as a result of property disposition activities, a decrease of $1,720 for comparable properties and a decrease of $436 related to a property undergoing significant redevelopment, offset by an increase in other operating expenses related to acquired properties of $126. Other operating expenses for comparable properties declined primarily due to lower net cleaning costs resulting from cost savings initiatives implemented by our manager, RMR LLC, in response to decreased space utilization at our properties as a result of the COVID-19 pandemic, which were partially offset by an increase in cleaning costs related to more frequent cleaning and sanitizing practices at our properties to help mitigate the spread of COVID-19, lower snow removal costs and lower parking garage maintenance costs due to lower parking activity at certain of our properties resulting from the COVID-19 pandemic, partially offset by higher insurance costs in 2020.
Depreciation and amortization. The decrease in depreciation and amortization primarily reflects a decrease of $23,092 as a result of property disposition activities, a decrease for comparable properties of $12,891 and a decrease related to a property undergoing significant redevelopment of $2,567, offset by an increase related to acquired properties of $231. Depreciation and amortization for comparable properties and the property undergoing significant redevelopment declined due to certain leasing related assets becoming fully depreciated in 2020, partially offset by depreciation and amortization of improvements made to certain of our properties during 2019 and 2020.
Loss on impairment of real estate. We recorded a $2,954 loss on impairment of real estate in 2020 to reduce the carrying value of four properties to their estimated fair value less costs to sell. We recorded a $22,255 loss on impairment of real estate in 2019 to reduce the carrying value of 45 properties to their estimated fair value less costs to sell.
Acquisition and transaction related costs. Acquisition and transaction related costs incurred in 2020 represent costs related to an acquisition opportunity we terminated in November 2020. Acquisition and transaction related costs incurred in 2019 represent costs incurred in connection with the SIR Merger, comprised of certain post-merger activity costs incurred during 2019. For more information regarding the SIR Merger, see Notes 1, 3, 11 and 12 to the Notes to Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K.
General and administrative. General and administrative expenses consist of fees pursuant to our business management agreement, equity compensation expense, legal and accounting fees, Trustees’ fees and expenses, securities listing and transfer agency fees and other costs relating to our status as a publicly traded company. The decrease in general and administrative expenses is primarily the result of a decrease in business management fees in 2020 mostly as a result of property sales during 2019 and 2020 and declines in our share price in 2020 during the COVID-19 pandemic, as well as lower legal expenses and audit fees.
57
Table of Contents
Gain on sale of real estate. We recorded a $10,855 net gain on sale of real estate in 2020 resulting from the sale of 10 properties. We recorded a $105,131 net gain on sale of real estate in 2019 resulting from the sale of 17 properties.
Dividend income. Dividend income in 2019 consists of distributions received in connection with our former investment in RMR Inc. that we sold on July 1, 2019.
Loss on equity securities, net. Loss on equity securities, net represents a realized loss in 2019 from the sale of our 2.8 million shares of class A common stock of RMR Inc. on July 1, 2019.
Interest and other income. The decrease in interest and other income is primarily due to lower returns on cash invested and the June 2020 payoff of a mortgage note receivable in connection with a property we sold in 2016, partially offset by a settlement we received in 2020 resulting from a dispute with a vendor.
Interest expense. The decrease in interest expense is primarily due to lower average outstanding debt balances in 2020 resulting from debt repayment activity in 2019 and 2020, including the repayment of $388,000 outstanding on our term loans during 2019, the redemption of all $350,000 of our 3.75% senior unsecured notes in July 2019, the redemption of all $400,000 of our 3.60% senior unsecured notes in January 2020 and the repayment of four mortgage notes with an aggregate principal balance of $152,187 in 2020, as well as lower weighted average interest rates on borrowings outstanding during 2020 compared to 2019, partially offset by an increase in interest expense resulting from the issuance of $162,000 of our 6.375% senior unsecured notes in June and July 2020 and $250,000 of our 4.50% senior unsecured notes in September 2020.
Loss on early extinguishment of debt . We recorded a loss on early extinguishment of debt of $3,839 in 2020 from prepayment fees incurred and the write off of unamortized discounts, premiums and debt issuance costs associated with the prepayment of three mortgage notes and a loss on the settlement of a mortgage note receivable that was repaid in 2020 related to a property sold in 2016. We recorded a loss on early extinguishment of debt of $769 in 2019 from the write off of unamortized debt issuance costs and discounts associated with the repayment of our term loans and redemption of our senior unsecured notes due 2019.
Income tax expense. The decrease in income tax expense reflects lower operating income in certain jurisdictions in 2020 where we are subject to state income taxes.
Equity in net losses of investees. Equity in net losses of investees represents our proportionate share of earnings and losses from our investments in two unconsolidated joint ventures and, in the 2019 period, our former investment in Affiliates Insurance Company.
Net income. Our net income and net income per basic and diluted common share decreased in 2020 compared to 2019 primarily as a result of the changes noted above.
Non-GAAP Financial Measures
We present certain "non-GAAP financial measures" within the meaning of applicable SEC rules, including the calculations below of NOI, as well as funds from operations, or FFO, and normalized funds from operations, or Normalized FFO. These measures do not represent cash generated by operating activities in accordance with GAAP and should not be considered alternatives to net income (loss) as indicators of our operating performance or as measures of our liquidity. These measures should be considered in conjunction with net income (loss) as presented in our consolidated statements of comprehensive income (loss). We consider these non-GAAP measures to be appropriate supplemental measures of operating performance for a REIT, along with net income (loss). We believe these measures provide useful information to investors because by excluding the effects of certain historical amounts, such as depreciation and amortization expense, they may facilitate a comparison of our operating performance between periods and with other REITs and, in the case of NOI, reflecting only those income and expense items that are generated and incurred at the property level may help both investors and management to understand the operations of our properties.
Net Operating Income
The calculation of NOI excludes certain components of net income (loss) in order to provide results that are more closely related to our property level results of operations. We calculate NOI as shown below. We define NOI as income from our rental of real estate less our property operating expenses. NOI excludes amortization of capitalized tenant improvement costs and leasing commissions that we record as depreciation and amortization expense. We use NOI to evaluate individual and company-wide property level performance. Other real estate companies and REITs may calculate NOI differently than we do.
The following table presents the reconciliation of net income to NOI for the years ended December 31, 2020 and 2019.
58
Table of Contents
Year Ended December 31,
2020 2019
Net income $ 6,678 $ 30,335
Equity in net losses of investees 1,193 1,259
Income tax expense 377 778
Income before income tax expense and equity in net losses of investees 8,248 32,372
Loss on early extinguishment of debt 3,839 769
Interest expense 108,303 134,880
Interest and other income (779) (1,045)
Loss on equity securities, net — 44,007
Dividend income — (1,960)
Gain on sale of real estate (10,855) (105,131)
General and administrative 28,443 32,728
Acquisition and transaction related costs 232 682
Loss on impairment of real estate 2,954 22,255
Depreciation and amortization 251,566 289,885
NOI $ 391,951 $ 449,442
Funds From Operations and Normalized Funds From Operations
We calculate FFO and Normalized FFO as shown below. FFO is calculated on the basis defined by The National Association of Real Estate Investment Trusts, which is net income (loss), calculated in accordance with GAAP, plus real estate depreciation and amortization of consolidated properties and our proportionate share of the real estate depreciation and amortization of unconsolidated joint venture properties, but excluding impairment charges on real estate assets, any gain or loss on sale of real estate and equity securities, as well as certain other adjustments currently not applicable to us. In calculating Normalized FFO, we adjust for the other items shown below and include business management incentive fees, if any, only in the fourth quarter versus the quarter when they are recognized as an expense in accordance with GAAP due to their quarterly volatility not necessarily being indicative of our core operating performance and the uncertainty as to whether any such business management incentive fees will be payable when all contingencies for determining such fees are known at the end of the calendar year. FFO and Normalized FFO are among the factors considered by our Board of Trustees when determining the amount of distributions to our shareholders. Other factors include, but are not limited to, requirements to maintain our qualification for taxation as a REIT, limitations in our credit agreement and public debt covenants, the availability to us of debt and equity capital, our expectation of our future capital requirements and operating performance and our expected needs for and availability of cash to pay our obligations. Other real estate companies and REITs may calculate FFO and Normalized FFO differently than we do.
59
Table of Contents
The following table presents the reconciliation of net income to FFO and Normalized FFO for the years ended December 31, 2020 and 2019.
Year Ended December 31,
2020 2019
Net income $ 6,678 $ 30,335
Add (less): Depreciation and amortization:
Consolidated properties 251,566 289,885
Unconsolidated joint venture properties 4,803 5,903
Loss on impairment of real estate 2,954 22,255
Gain on sale of real estate (10,855) (105,131)
Loss on equity securities, net — 44,007
FFO 255,146 287,254
Add (less): Acquisition and transaction related costs 232 682
Loss on early extinguishment of debt 3,839 769
Normalized FFO $ 259,217 $ 288,705
Weighted average common shares outstanding (basic and diluted) 48,124 48,062
FFO per common share (basic and diluted) $ 5.30 $ 5.98
Normalized FFO per common share (basic and diluted) $ 5.39 $ 6.01
LIQUIDITY AND CAPITAL RESOURCES
Our Operating Liquidity and Resources (dollar amounts in thousands)
Our principal sources of funds to meet operating and capital expenses, pay debt service obligations and make distributions to our shareholders are the operating cash flows we generate from our properties, net proceeds from property sales and borrowings under our revolving credit facility. We believe that these sources of funds will be sufficient to meet our operating and capital expenses, pay debt service obligations and make distributions to our shareholders for the next 12 months and for the foreseeable future thereafter. Our future cash flows from operating activities will depend primarily upon:
• our ability to collect rent from our tenants;
• our ability to maintain or increase the occupancy of, and the rental rates at, our properties;
• our ability to control operating and capital expenses at our properties;
• our ability to successfully sell properties that we market for sale;
• our ability to develop or redevelop properties to produce cash flows in excess of our cost of capital; and
• our ability to purchase additional properties which produce cash flows from operations in excess of our cost of acquisition capital and property operating expenses and capital expenses.
With $750,000 available under our revolving credit facility as of February 18, 2021 and no significant debt maturities until 2022, we believe that we are well positioned to weather the present disruptions facing the real estate industry and the economy generally. As a result of the COVID-19 pandemic, we have received requests from some of our tenants for rent assistance. As of February 16, 2021, we have granted temporary rent assistance totaling $2,546 to 19 tenants who represent approximately 3.3% of our annualized rental income as of December 31, 2020. This assistance generally entails a deferral of, in most cases, one month of rent pursuant to deferred payment plans which require the deferred rent amounts be payable over a 12-month period, certain of which commenced in 2020. As of February 16, 2021, we have collected $1,999, or 78.5%, of our granted rent deferrals. Although some of our tenants have sought temporary rent assistance, we remain focused on proactive dialogue with our existing tenants and overall tenant retention. Also, we believe we will benefit from the approximately 64.8% of our annualized rental income as of December 31, 2020 paid by investment grade tenants, the majority of which is made up of government tenants, and the diversity of our tenant base, both geographically and by industry, which may help mitigate the economic impact of the COVID-19 pandemic.
60
Table of Contents
On January 14, 2021, we announced a regular quarterly cash distribution of $0.55 per common share ($2.20 per common share per year), maintaining our previous distribution rate. At this time, we continue to expect that the quarterly distribution rate will remain unchanged. We determine our distribution payout ratio with consideration for our expected capital expenditures as well as cash flows from operations and debt obligations.
In early 2020, we completed our previously announced disposition program and transitioned to a capital recycling program through which we expect to accretively grow our property portfolio. Pursuant to our capital recycling program, we plan to sell certain properties from time to time to fund future acquisitions and to maintain leverage consistent with our current investment grade ratings with a goal of (1) improving the asset quality of our portfolio by reducing the average age of our properties, lengthening the weighted average term of our leases and increasing the likelihood of retaining our tenants and (2) increasing our cash available for distribution. During the year ended December 31, 2020, pursuant to our capital recycling program, we sold 10 properties for an aggregate sales price of $110,463, excluding closing costs, and acquired two properties for an aggregate purchase price of $46,625, excluding acquisition related costs. In November 2020, we entered into an agreement to acquire a property for a purchase price of $26,975, excluding acquisition related costs. Since January 1, 2021, we sold two additional properties for an aggregate sales price of $130,845, excluding closing costs. Given the current economic conditions, we continue to carefully consider our capital allocation strategy and believe we are well positioned to continue to opportunistically recycle and deploy capital.
Our future purchases of properties cannot be accurately projected because such purchases depend upon purchase opportunities which come to our attention and our ability to successfully complete the acquisitions. We generally do not intend to purchase “turn around” properties, or properties which do not generate positive cash flows.
The following is a summary of our sources and uses of cash flows for the periods presented, as reflected in our consolidated statements of cash flows:
Year Ended December 31,
2020 2019
Cash, cash equivalents and restricted cash at beginning of period $ 100,696 $ 38,943
Net cash provided by (used in):
Operating activities 233,628 215,329
Investing activities (22,987) 877,819
Financing activities (254,482) (1,031,395)
Cash, cash equivalents and restricted cash at end of period $ 56,855 $ 100,696
The increase in cash provided by operating activities for the year ended December 31, 2020 compared to the prior year is the result of favorable changes in working capital in 2020 compared to the prior year, offset by the net impact of disposition activities. The decrease in cash provided by investing activities for the year ended December 31, 2020 compared to the prior year is primarily due to lower cash proceeds received from our sales of properties in 2020 compared to the prior year, the sale of our 2.8 million shares of Class A common stock of RMR Inc. in 2019 and higher real estate acquisition and improvement activities in 2020. The decrease in cash used in financing activities for the year ended December 31, 2020 compared to the prior year is primarily due to the issuance of $162,000 of our 6.375% senior unsecured notes due 2050 and $250,000 of our 4.50% senior unsecured notes due 2025 in 2020 and a decrease in net debt repayment activity, due to repayments of our unsecured term loans, the redemption of all $350,000 of our 3.75% senior unsecured notes and net repayment activity on our revolving credit facility using cash on hand and proceeds from sales of properties in the prior year, compared to increased borrowings under our revolving credit facility in 2020 in order to facilitate the repayment of other debts, including the redemption of all $400,000 of our 3.60% senior unsecured notes and the repayment of $152,187 of mortgage debt.
Our Investment and Financing Liquidity and Resources (dollar amounts in thousands, except per share and per square foot amounts)
In order to fund acquisitions and to meet cash needs that may result from our desire or need to make distributions or pay operating or capital expenses, we maintain a $750,000 revolving credit facility. The maturity date of our revolving credit facility is January 31, 2023 and, subject to our payment of an extension fee and meeting certain other conditions, we have the option to extend the stated maturity date of our revolving credit facility by two additional six month periods. We can borrow, repay and reborrow funds available under our revolving credit facility until maturity, and no principal repayment is due until maturity. We are required to pay interest at a rate of LIBOR plus a premium, which was 110 basis points per annum at December 31, 2020, on the amount outstanding under our revolving credit facility, if any. We also pay a facility fee on the total
61
Table of Contents
amount of lending commitments under our revolving credit facility, which was 25 basis points per annum at December 31, 2020. Both the interest rate premium and facility fee are subject to adjustment based upon changes to our credit ratings. As of December 31, 2020, the annual interest rate payable on borrowings under our revolving credit facility was 1.2%. As of December 31, 2020 and February 18, 2021, we had no amounts outstanding under our revolving credit facility and $750,000 available for borrowing.
Our credit agreement includes a feature under which the maximum borrowing availability may be increased to up to $1,950,000 in certain circumstances.
Our credit agreement provides that, with certain exceptions, a subsidiary of ours is required to guaranty our obligations under our $750,000 revolving credit facility only if that subsidiary has separately incurred debt (other than nonrecourse debt), within the meaning specified in our credit agreement, or provided a guarantee of debt incurred by us or any of our other subsidiaries.
During the year ended December 31, 2020, we completed the following senior unsecured notes and mortgage notes transactions:
Senior Unsecured Note Issuances
In June and July 2020, we issued an aggregate of $162,000 of 6.375% senior unsecured notes due 2050 in an underwritten public offering. Our aggregate net proceeds from this offering were $156,226, after underwriters’ discounts and offering expenses, which we used to repay amounts outstanding under our revolving credit facility and for general business purposes. These notes require quarterly payments of interest only through maturity and may be repaid at par (plus accrued and unpaid interest) on or after June 23, 2025.
In September 2020, we issued $250,000 of our 4.50% senior unsecured notes due 2025 in an underwritten public offering. These notes are a further issuance of our existing $400,000 of senior unsecured notes due 2025 that were initially issued by SIR in February 2015, which we assumed in connection with the SIR Merger. The public offering price of these notes was 101.414% of the principal amount, raising net proceeds of $251,214, after underwriters’ discounts and offering expenses, which we used to repay amounts outstanding under our revolving credit facility and for general business purposes. These notes require semi-annual payments of interest only through maturity.
Senior Unsecured Note Redemption
In January 2020, we redeemed, at par plus accrued interest, all $400,000 of our 3.60% senior unsecured notes due 2020 using cash on hand, proceeds from property sales and borrowings under our revolving credit facility.
Mortgage Note Repayments
In March 2020, in connection with the sale of one property, we prepaid, at a premium plus accrued interest, a mortgage note secured by that property with an outstanding principal balance of $13,095, an annual interest rate of 5.9% and a maturity date in August 2021, which was classified in liabilities of properties held for sale in our consolidated balance sheet as of December 31, 2019.
Also in March 2020, we prepaid, at a premium plus accrued interest, a mortgage note secured by one property with an outstanding principal balance of $66,780, an annual interest rate of 4.0% and a maturity date in September 2030 using cash on hand and borrowings under our revolving credit facility.
In April 2020, we prepaid, at par plus accrued interest, a mortgage note secured by one property with an outstanding principal balance of $32,677, an annual interest rate of 5.7% and a maturity date in July 2020 using cash on hand and borrowings under our revolving credit facility.
In August 2020, we repaid at maturity, at par plus accrued interest, a mortgage note secured by one property with an outstanding principal balance of $39,635 and an annual interest rate of 2.2% using cash on hand and borrowings under our revolving credit facility.
62
Table of Contents
As of December 31, 2020, our debt maturities (other than our revolving credit facility), consisting of senior unsecured notes and mortgage notes, are as follows:
Year Debt Maturities
2021 $ 1,540
2022 625,518
2023 143,784
2024 350,000
2025 650,000
Thereafter 472,000
Total $ 2,242,842
None of our unsecured debt obligations require sinking fund payments prior to their maturity dates. Our $170,842 in mortgage debts generally require monthly payments of principal and interest through maturity.
In addition to our debt obligations, as of December 31, 2020, we have estimated unspent leasing related obligations of $51,913, of which we expect to spend $19,179 over the next 12 months.
We are currently in the planning stage for a potential redevelopment project at a property located in Washington, D.C containing approximately 340,000 rentable square feet. This redevelopment project may require significant capital expenditures and time to complete.
We currently expect to use cash balances, borrowings under our revolving credit facility, net proceeds from property sales, incurrences or assumptions of mortgage debt and net proceeds from offerings of debt or equity securities to fund our future operations, capital expenditures, distributions to our shareholders and property acquisitions. When significant amounts are outstanding under our revolving credit facility or the maturities of our indebtedness approach, we expect to explore refinancing alternatives. Such alternatives may include incurring term debt, issuing debt or equity securities, extending the maturity date of our revolving credit facility and entering into a new revolving credit facility. We may assume additional mortgage debt in connection with our acquisitions or elect to place new mortgages on properties we own as a source of financing. We may also seek to participate in additional joint venture or other arrangements that may provide us with additional sources of financing. Although we cannot be sure that we will be successful in consummating any particular type of financing, we believe that we will have access to financing, such as debt and equity offerings, to fund future acquisitions and capital expenditures and to pay our obligations. We currently have an effective shelf registration statement that allows us to issue public securities on an expedited basis, but it does not assure that there will be buyers for such securities.
Our ability to obtain, and the costs of, our future debt financings will depend primarily on credit market conditions and our creditworthiness. We have no control over market conditions. Potential investors and lenders likely will evaluate our ability to pay distributions to shareholders, fund required debt service and repay debts when they become due by reviewing our business practices and plans to balance our use of debt and equity capital so that our financial profile and leverage ratios afford us flexibility to withstand any reasonably anticipated adverse changes. Similarly, our ability to raise equity capital in the future will depend primarily upon equity capital market conditions and our ability to conduct our business to maintain and grow our operating cash flows. We intend to conduct our business in a manner that will afford us reasonable access to capital for investment and financing activities, but we cannot be sure that we will be able to successfully carry out this intention. For instance, it is uncertain what the duration and severity of the current economic impact resulting from the COVID-19 pandemic will be. A protracted and extensive economic recession may cause a decline in financing availability and increased costs for financings. Further, such conditions could also disrupt capital markets and limit our access to financing from public sources.
During the year ended December 31, 2020, we paid quarterly distributions to our shareholders totaling $106,121 using cash on hand and borrowings under our revolving credit facility. On January 14, 2021, we declared a regular quarterly distribution payable to shareholders of record on January 25, 2021 in the amount of $0.55 per share, or $26,575. We paid this distribution on February 18, 2021 using cash on hand. For more information regarding the distributions we paid during 2020, see Note 10 to the Notes to Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K.
63
Table of Contents
We own 51% and 50% interests in two unconsolidated joint ventures which own three properties. The properties owned by these joint ventures are encumbered by an aggregate $82,000 principal amount of mortgage indebtedness. We do not control the activities that are most significant to these joint ventures and, as a result, we account for our investments in these joint ventures under the equity method of accounting. For more information on the financial condition and results of operations of these joint ventures, see Note 3 to the Notes to Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K. Other than these joint ventures, as of December 31, 2020, we had no off balance sheet arrangements that have had or that we expect would be reasonably likely to have a material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Debt Covenants (dollars in thousands)
Our principal debt obligations at December 31, 2020 consisted of an aggregate outstanding principal balance of $2,072,000 of public issuances of senior unsecured notes and mortgage notes with an aggregate outstanding principal balance of $170,842 that were assumed in connection with certain of our acquisitions. Also, the three properties owned by two joint ventures in which we own 51% and 50% interests secure two additional mortgage notes. Our publicly issued senior unsecured notes are governed by indentures and their supplements. Our credit agreement and our senior unsecured notes indentures and their supplements provide for acceleration of payment of all amounts outstanding upon the occurrence and continuation of certain events of default, such as, in the case of our credit agreement, a change of control of us, which includes RMR LLC ceasing to act as our business and property manager. Our credit agreement and our senior unsecured notes indentures and their supplements also contain a number of covenants, including those that restrict our ability to incur debts, including debts secured by mortgages on our properties, in excess of calculated amounts, require us to comply with certain financial covenants and, in the case of our credit agreement, restrict our ability to make distributions to our shareholders under certain circumstances. As of December 31, 2020, we believe we were in compliance with the terms and conditions of our respective covenants under our credit agreement and senior unsecured notes indentures and their supplements. Our mortgage notes are non-recourse, subject to certain limited exceptions, and do not contain any material financial covenants.
Neither our credit agreement nor our senior unsecured notes indentures and their supplements contain provisions for acceleration which could be triggered by our credit ratings. However, under our credit agreement our highest senior credit rating is used to determine the fees and interest rates we pay. Accordingly, if that credit rating is downgraded, our interest expense and related costs under our credit agreement would increase.
Our credit agreement has cross default provisions to other indebtedness that is recourse of $25,000 or more and indebtedness that is non-recourse of $50,000 or more. Similarly, our senior unsecured notes indentures and their supplements contain cross default provisions to any other debts of more than $25,000 (or up to $50,000 in certain circumstances).
Related Person Transactions
We have relationships and historical and continuing transactions with RMR LLC, RMR Inc. and others related to them. For more information about these and other such relationships and related person transactions, see Notes 1, 5, 6 and 11 to the Notes to Consolidated Financial Statements included in Part IV, Item 15 of this Annual Report on Form 10-K, which are incorporated herein by reference and our other filings with the SEC, including our definitive Proxy Statement for our 2021 Annual Meeting of Shareholders, or our definitive Proxy Statement, to be filed with the SEC within 120 days after the fiscal year ended December 31, 2020. For more information about the risks that may arise as a result of these and other related person transactions and relationships, see elsewhere in this Annual Report on Form 10-K, including “Warning Concerning Forward-Looking Statements,” Part I, Item 1, “Business” and Part I, Item 1A, “Risk Factors.” We may engage in additional transactions with related persons, including businesses to which RMR LLC or its subsidiaries provide management services.
Critical Accounting Estimates
Our critical accounting policies are those that will have the most impact on the reporting of our financial condition and results of operations and those requiring significant judgments and estimates. We believe that our judgments and estimates have been and will be consistently applied and produce financial information that fairly presents our results of operations. Our most critical accounting policies involve our investments in real property. These policies affect our:
• allocation of purchase prices between various asset categories, including allocations to above and below market leases and the related impact on the recognition of rental income and depreciation and amortization expenses; and
• assessment of the carrying values and impairments of long lived assets.
64
Table of Contents
We allocate the acquisition cost of each property investment to various property components such as land, buildings and improvements and intangibles based on their fair values, and each component generally has a different useful life. For acquired real estate, we record building, land and improvements, and, if applicable, the value of in place leases, the fair market value of above or below market leases and tenant relationships at fair value. For transactions that qualify as business combinations, we allocate the excess, if any, of the consideration over the fair value of assets acquired to goodwill. We base purchase price allocations and the determination of useful lives on our estimates and, under some circumstances, studies from independent real estate appraisers to provide market information and evaluations, which may involve estimated cash flows that are based on a number of factors, including capitalization rates and discount rates, among others, that are relevant to our purchase price allocations and determinations of useful lives; however, our management is ultimately responsible for the purchase price allocations and determination of useful lives.
We compute depreciation expense using the straight line method over estimated useful lives of up to 40 years for buildings and improvements, and up to 12 years for personal property. We do not depreciate the allocated cost of land. We amortize capitalized above market lease values as a reduction to rental income over the terms of the respective leases. We amortize capitalized below market lease values as an increase to rental income over the terms of the respective leases. We amortize the value of acquired in place leases exclusive of the value of above market and below market acquired leases to expense over the periods of the respective leases. If a lease is terminated prior to its stated expiration, all unamortized amounts relating to that lease are written off. Purchase price allocations require us to make certain assumptions and estimates. Incorrect assumptions and estimates may result in inaccurate depreciation and amortization charges over future periods.
We periodically evaluate our properties for impairment. Impairment indicators may include declining tenant occupancy, our concerns about a tenant’s financial condition (which may be endangered by a rent default or other information which comes to our attention) or our decision to dispose of an asset before the end of its estimated useful life and legislative, as well as market or industry changes that could permanently reduce the value of a property. If indicators of impairment are present, we evaluate the carrying value of the related property by comparing it to the expected future undiscounted cash flows to be generated from that property. If the sum of these expected future cash flows is less than the carrying value, we reduce the net carrying value of the property to its fair value. This analysis requires us to judge whether indicators of impairment exist and to estimate likely future cash flows. The future net undiscounted cash flows are subjective and are based in part on assumptions regarding hold periods, market rents and terminal capitalization rates. If we misjudge or estimate incorrectly or if future tenant operations, market or industry factors differ from our expectations we may record an impairment charge that is inappropriate or fail to record a charge when we should have done so, or the amount of any such charges may be inaccurate.
These accounting policies involve significant judgments made based upon our experience and the experience of our management and our Board of Trustees, including judgments about current valuations, ultimate realizable value, estimated useful lives, salvage or residual value, the ability and willingness of our tenants to perform their obligations to us, current and future economic conditions and competitive factors in the markets in which our properties are located. Competition, economic conditions, changing government priorities and other factors may cause occupancy declines in the future. In the future, we may need to revise our carrying value assessments to incorporate information which is not now known, and such revisions could increase or decrease our depreciation expense related to properties we own or decrease the carrying values of our assets.
Impact of Climate Change
Concerns about climate change have resulted in various treaties, laws and regulations that are intended to limit carbon emissions and address other environmental concerns. These and other laws may cause energy or other costs at our properties to increase. We do not expect the direct impact of these increases to be material to our results of operations, because the increased costs either would be the responsibility of our tenants directly or in the longer term, passed through and paid by tenants of our properties. Although we do not believe it is likely in the foreseeable future, laws enacted to mitigate climate change may make some of our properties obsolete or cause us to make material investments in our properties, which could materially and adversely affect our financial condition or the financial condition of our tenants and their ability to pay rent to us.
In an effort to reduce the effects of any increased energy costs in the future, we continuously study ways to improve the energy efficiency at all of our properties. Our property manager, RMR LLC, is a member of the ENERGY STAR program, a joint program of the U.S. Environmental Protection Agency and the U.S. Department of Energy that is focused on promoting energy efficiency at commercial properties through its “ENERGY STAR” program, and a member of the U.S. Green Building Council, a nonprofit organization focused on promoting energy efficiency at commercial properties through its LEED® green building program. Additionally, in July 2020, RMR LLC released its first annual Sustainability Report, which summarizes the environmental, social and governance initiatives RMR LLC and its client companies, including OPI, employ. RMR LLC’s Sustainability Report may be accessed on RMR Inc.’s website at www.rmrgroup.com/corporate-sustainability/default.aspx. The information on or accessible through RMR Inc.’s website is not incorporated by reference into this Annual Report on Form 10-K.
65
Table of Contents
Some observers believe severe weather in different parts of the world over the last few years is evidence of global climate change. Severe weather may have an adverse effect on certain properties we own. Rising sea levels could cause flooding at some of our properties, which may have an adverse effect on individual properties we own. We mitigate these risks by procuring, or requiring our tenants to procure, insurance coverage we believe adequate to protect us from material damages and losses resulting from the consequences of losses caused by climate change. However, we cannot be sure that our mitigation efforts will be sufficient or that future storms, rising sea levels or other changes that may occur due to future climate change could not have a material adverse effect on our financial results.