Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with Item 6, Selected Financial Data , above and our audited consolidated financial statements and notes thereto as of December 31, 2020 and 2019, and for the years ended December 31, 2020, 2019, and 2018, included elsewhere in this Annual Report on Form 10-K. See also “ Cautionary Note Regarding Forward-Looking Statements ” preceding Part I of this report and “ Risk Factors ” set forth in Item 1A. of this report.
During 2020, all of our properties remained open and fully operational for tenants to utilize as they deemed appropriate. Given our low-leverage operating model of long-term leases to creditworthy tenants, to date the COVID-19 pandemic has not materially impacted our financial condition or results of operations, our overall liquidity position and outlook, or caused material impairments in our portfolio of operating properties. Our revenues increased year over year; several capital transactions were successfully completed; and our Core Funds From Operations increased approximately 6% in 2020 compared to the prior year. In response to the COVID-19 pandemic, we have completed stress testing of our various financial covenants assuming decreases in rental and parking income as appropriate and determined that we still have significant capacity with respect to all our covenant ratios. During the fourth quarter of 2020, we collected approximately 99% of our billed contractual rents on a monthly basis.
We continued to experience the repercussions of the COVID-19 pandemic during the fourth quarter of 2020, including the residual effect of forced closures and other restrictions that have had a material adverse effect on the global economy and the regional U.S. economies in which Piedmont operates. Specifically, the pandemic and its impact on the U.S., as well as the global economy, has negatively impacted the trading price of Piedmont's common stock and some of Piedmont's tenants' ability to pay their rent. As of the date of this filing, we have entered into approximately 70 agreements with various tenants that primarily deferred approximately $7.1 million of 2020 rent payments into fourth quarter of 2020 or the year ending December 31, 2021. The vast majority of tenants in repayment periods for prior deferrals have been performing well, with approximately $1.3 million of the $7.1 million already collected. Nonetheless, Piedmont has established an approximately $4.6 million general reserve for potential collectibility issues. There can be no assurances that this amount will be sufficient to cover any future losses of rental income should these tenants be unable to pay back deferred rents when such rents become due. The long-term impacts of the COVID-19 pandemic remain unknown. A prolonged economic downturn or recession resulting from the pandemic could adversely affect many of Piedmont's tenants which could, in turn, adversely impact Piedmont's business, financial condition and results of operations.
Piedmont will continue to work closely with its tenants and address their concerns on a case-by-case basis, seeking solutions that address immediate cash flow interruptions while maintaining long term lease obligations.
Liquidity and Capital Resources
We intend to use cash on hand, cash flows generated from the operation of our properties, net proceeds from the disposition of select properties, and proceeds from our $500 Million Unsecured 2018 Line of Credit as our primary sources of immediate liquidity. During the fourth quarter of 2020, we sold our last three properties in New Jersey (consisting of 600 Corporate Drive and 200 and 400 Bridgewater Crossing, collectively the "New Jersey Portfolio"), and used a portion of the proceeds to purchase an asset in downtown Orlando, Florida. We have approximately $462 million of capacity on our $500 million line of credit available as of filing. When necessary, we may seek new secured or unsecured borrowings from third party lenders or issue securities as additional sources of capital. The nature and timing of these additional sources of capital will be highly dependent on market conditions.
Our most consistent use of capital has historically been, and we believe will continue to be, to fund capital expenditures for our existing portfolio of properties. During the years ended December 31, 2020 and 2019, we incurred the following types of capital expenditures (in thousands):
December 31, 2020 December 31, 2019
Capital expenditures for redevelopment/ renovations $ 18,600 $ 11,901
Other capital expenditures, including building and tenant improvements 93,980 91,652
Total capital expenditures (1)
$ 112,580 $ 103,553
(1) Of the total amounts paid, approximately $0.6 million and $2.7 million related to soft costs such as capitalized interest, payroll, and other general and administrative expenses for the year ended December 31, 2020 and 2019, respectively.
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"Capital expenditures for redevelopment/renovations" during the year ended December 31, 2020 primarily related to a redevelopment project to upgrade amenities at our 200 South Orange building in Orlando, Florida, as well as a redevelopment master plan project to upgrade common areas, amenities, and parking, at our Galleria buildings in Atlanta, Georgia. Expenditures during the year ended December 31, 2019 primarily related to a redevelopment project to upgrade amenities at our US Bancorp building in Minneapolis, Minnesota, as well as a redevelopment project to upgrade common areas, amenities, and parking, at our Two Pierce Place building in Itasca, Illinois.
"Other capital expenditures, including building and tenant improvements" include all other capital expenditures during the period and are typically comprised of tenant and building improvements necessary to lease, maintain, or provide enhancements to our existing portfolio of office properties, including tenant improvements totaling approximately $13.4 million for the 520,000 square foot, 20-year renewal and expansion of the State of New York at our 60 Broad Street building in New York City incurred during the year ended December 31, 2020.
Given that our operating model frequently results in leases for large blocks of space to credit-worthy tenants, our leasing success can result in capital outlays which vary from one reporting period to another based upon the specific leases executed. For example, for leases executed during the year ended December 31, 2020, we committed to spend approximately $5.79 per square foot per year of lease term for tenant improvement allowances and lease commissions (net of expired lease commitments) as compared to $5.86 (net of expired lease commitments) for the year ended December 31, 2019. As of December 31, 2020, we had one individually significant unrecorded tenant allowance commitment outstanding of approximately $38.2 million related to the State of New York's lease at our 60 Broad Street building mentioned above.
In addition to the amounts that we have already committed to as a part of executed leases, we also anticipate continuing to incur similar market-based tenant improvement allowances and leasing commissions in conjunction with procuring future leases for our existing portfolio of properties. Both the timing and magnitude of expenditures related to future leasing activity can vary due to a number of factors, including being highly dependent on the competitive market conditions at the time of lease negotiations of the particular office market within which a given lease is signed. For example, we anticipate negotiating the long-term renewal of a majority of the City of New York's 313,000 square foot lease at our 60 Broad Street building. Depending on the length of the lease term, we anticipate committing to spend significant capital for market-based tenant improvement allowances and leasing commissions associated with the renewal.
There are other uses of capital that may arise as part of our typical operations. Subject to the identification and availability of attractive investment opportunities and our ability to consummate such acquisitions on satisfactory terms, acquiring new assets consistent with our investment strategy could also be a significant use of capital. We may also use capital resources to repurchase additional shares of our common stock under our stock repurchase program when we believe the stock is trading disparately from our peers and at a significant discount to net asset value. As of December 31, 2020 , we had approximately $169.3 million of board-authorized capacity remaining for future stock repurchases. Finally, although we have no scheduled debt maturities until the third quarter of 2021, we may use capital to repay debt obligations when we deem it prudent to refinance various obligations.
The amount and form of payment (cash or stock issuance) of future dividends to be paid to our stockholders will continue to be largely dependent upon (i) the amount of cash generated from our operating activities; (ii) our expectations of future cash flows; (iii) our determination of near-term cash needs for debt repayments, development projects, and selective acquisitions of new properties; (iv) the timing of significant expenditures for tenant improvements, building redevelopment projects, and general property capital improvements; (v) long-term dividend payout ratios for comparable companies; (vi) our ability to continue to access additional sources of capital, including potential sales of our properties; and (vii) the amount required to be distributed to maintain our status as a REIT. With the fluctuating nature of cash flows and expenditures, we may periodically borrow funds on a short-term basis to cover timing differences in cash receipts and cash disbursements.
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Results of Operations (2020 vs. 2019)
Overview
Net income applicable to common stockholders for the year ended December 31, 2020 was $232.7 million, or $1.85 per diluted share, as compared with net income applicable to common stockholders of $229.3 million, or $1.82 per diluted share, for the year ended December 31, 2019. Results for the year ended December 31, 2020 included approximately $205.7 million of gains on sales of real estate assets, whereas the prior year included approximately $188.1 million of gains on sales of real estate assets net of impairment losses, a $0.14 per diluted share increase from the prior year. However, the increase was mostly offset by an increase in amortization expense related to acquired lease intangible assets as part of the net property acquisition activity subsequent to January 1, 2019.
Comparison of the accompanying consolidated statements of income for the year ended December 31, 2020 vs. the year ended December 31, 2019.
The following table sets forth selected data from our consolidated statements of income for the years ended December 31, 2020 and 2019, respectively, as well as each balance as a percentage of total revenues for the years presented (dollars in millions):
December 31, 2020 % of Revenues December 31, 2019 % of Revenues Variance
Revenue:
Rental and tenant reimbursement revenue $ 519.9 $ 511.9 $ 8.0
Property management fee revenue 2.9 3.4 (0.5)
Other property related income 12.2 17.9 (5.7)
Total revenues 535.0 100 % 533.2 100 % 1.8
Expense:
Property operating costs 214.9 40 % 211.4 40 % 3.5
Depreciation 110.6 21 % 106.0 19 % 4.6
Amortization 93.3 17 % 76.7 14 % 16.6
Impairment losses on real estate assets — — % 8.9 2 % (8.9)
General and administrative 27.5 5 % 37.9 7 % (10.4)
446.3 440.9 5.4
Other income (expense):
Interest expense (55.0) 10 % (61.6) 12 % 6.6
Other income 2.6 — % 1.6 — % 1.0
Loss on extinguishment of debt (9.3) 2 % — — % (9.3)
Gain on sale of real estate assets 205.7 38 % 197.0 37 % 8.7
Net income $ 232.7 43 % $ 229.3 43 % $ 3.4
Revenue
Rental and tenant reimbursement revenue increased approximately $8.0 million for the year ended December 31, 2020 as compared to the same period in the prior year. The favorable variance was primarily due to capital transaction activity subsequent to January 1, 2019 and new leases commencing at higher overall rental rates. These increases were partially offset by the establishment of receivable reserves as a result of the COVID-19 pandemic during the year ended December 31, 2020, along with decreased portfolio occupancy.
Property management fee revenue decreased approximately $0.5 million for the year ended December 31, 2020 as compared to the same period in the prior year. The decrease was primarily due to construction management fees received in the prior year from one of our former Independence Square properties, with such fees varying from period-to-period due to the variability of construction activity.
Other property related income decreased approximately $5.7 million for the year ended December 31, 2020 as compared to the same period in the prior year primarily due to the sale of the 500 West Monroe Street building with its 1,300-space parking
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garage during the fourth quarter of 2019, as well as lower transient parking utilization at our buildings during 2020 as a result of the COVID-19 pandemic. These decreases were partially offset by new parking revenue associated with acquisitions consummated subsequent to January 1, 2019.
Expense
Property operating costs increased approximately $3.5 million for the year ended December 31, 2020 as compared to the same period in the prior year. This variance was primarily due to capital transaction activity subsequent to January 1, 2019, and higher property tax expense in certain markets, partially offset by lower utility and janitorial costs as a result of reduced building utilization across our portfolio as a result of the pandemic, along with decreased portfolio occupancy.
Depreciation expense increased approximately $4.6 million for the year ended December 31, 2020 compared to the same period in the prior year. The increase was due primarily to additional building and tenant improvements placed in service subsequent to January 1, 2019, partially offset by a decrease in depreciation associated with capital transaction activity subsequent to January 1, 2019.
Amortization expense increased approximately $16.6 million for the year ended December 31, 2020 compared to the same period in the prior year. Approximately $23.2 million of the increase was due to capital transaction activity completed subsequent to January 1, 2019. This increase was partially offset by certain lease intangible assets or other deferred costs at our existing properties becoming fully amortized as a result of the expiration of leases subsequent to January 1, 2019.
During the prior year ended December 31, 2019, we recognized impairment losses on real estate assets totaling approximately $8.9 million related to our 600 Corporate Drive asset in Lebanon, New Jersey, as well as an impairment loss recognized in conjunction with the disposition of The Dupree building in September 2019 (see Note 7 and Note 13 to the accompanying consolidated financial statements for more details). No impairment losses on real estate assets were recorded during the year ended December 31, 2020.
General and administrative expenses decreased approximately $10.4 million for the year ended December 31, 2020 as compared to the same period in the prior year with the current period reflecting decreased accruals for incentive and stock based compensation and the prior period reflecting certain one-time expenses associated with the senior management transition that took place on June 30, 2019, resulting in lower compensation at the executive level in the current period.
Other Income (Expense)
Interest expense decreased approximately $6.6 million for the year ended December 31, 2020 as compared to the same period in the prior year primarily as a result of lower interest rates during the current year, as well as the repayment of the $160 million mortgage debt in conjunction with our sale of the 1901 Market Street building in June 2020. This variance was partially offset by a decrease in capitalized interest in the current year, as compared to the prior year, of approximately $1.2 million.
Other income increased approximately $1.0 million for the year ended December 31, 2020 as compared to the same period in the prior year. The variance is primarily attributable to interest income recognized on notes receivable extended to the purchaser of our New Jersey Portfolio. The notes receivable mature in October 2023 (see Note 13 to the accompanying consolidated financial statements for more details) and are secured by the 200 and 400 Bridgewater Crossing properties.
The loss on extinguishment of debt for the year ended December 31, 2020 was associated with the early repayment of the $160 Million Fixed-Rate Loan which was collateralized by the 1901 Market Street building. The property was sold in June 2020. The loss was comprised of a prepayment penalty and the write-off of unamortized debt issuance costs and discounts associated with the loan.
Gain on sale of real estate assets during the year ended December 31, 2020 includes a gain of approximately $191.0 million recognized on the sale of the 1901 Market Street building in Philadelphia, Pennsylvania and a gain of approximately $14.6 million recognized on the sale of the New Jersey Portfolio. Gain on sale of real estate assets during the year ended December 31, 2019 includes approximately $33.2 million gain recognized on the sale of the One Independence Square building in Washington, D.C., an approximately $6.1 million adjustment of the gain on sale for the Two Independence Square building related to the reimbursement of certain previously disputed tenant improvement overages, and an approximately $157.7 million gain recognized on the sale of the 500 West Monroe Street building in Chicago, Illinois.
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Results of Operations (2019 vs. 2018)
Please refer to "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations (2019 vs. 2018)" in our Annual Report on Form 10-K for the year ended December 31, 2019, as filed with the SEC on February 19, 2020, for a discussion of the results of operations for the year ended December 31, 2019 as compared to the year ended December 31, 2018.
Issuer and Guarantor Financial Information
During the years ended December 31, 2013 and 2014 and 2020, Piedmont, through its wholly-owned subsidiary Piedmont Operating Partnership, LP ("Piedmont OP" or the "Issuer"), issued senior unsecured notes payable of $350 million, $400 million, and $300 million, respectively (collectively, the "Notes"). The Notes are senior unsecured obligations of Piedmont OP and rank equally in right of payment with all of Piedmont OP's other existing and future senior unsecured indebtedness and are effectively subordinated in right of payment to all of Piedmont OP’s existing and future mortgage indebtedness and other secured indebtedness (to the extent of the value of the collateral securing such indebtedness) and to all existing and future indebtedness and other liabilities of Piedmont OP’s subsidiaries, whether secured or unsecured.
The Notes are fully and unconditionally guaranteed by Piedmont Office Realty Trust, Inc. (the "Guarantor"), the parent entity that consolidates Piedmont OP and all other subsidiaries. By execution of the guarantee, the Guarantor guarantees to each holder of the Notes that the principal and interest on the Notes will be paid in full when due, whether at the maturity dates of the respective loans, or upon acceleration, upon redemption, or otherwise, and interest on overdue principal and interest on any overdue interest, if any, on the Notes and all other obligations of the Issuer to the holders of the Notes will be promptly paid in full. The Guarantor's guarantee of the Notes is its senior unsecured obligation and ranks equally in right of payment with all of the Guarantor's other existing and future senior unsecured indebtedness and guarantees. The Guarantor’s guarantee of the notes is effectively subordinated in right of payment to all existing and future mortgage indebtedness and other secured indebtedness and secured guarantees of the Guarantor (to the extent of the value of the collateral securing such indebtedness and guarantees); and all existing and future indebtedness and other liabilities, whether secured or unsecured, of the Guarantor’s subsidiaries.
In the event of the bankruptcy, liquidation, reorganization or other winding up of Piedmont OP or the Guarantor, assets that secure any of their respective secured indebtedness and other secured obligations will be available to pay their respective obligations under the Notes or the guarantee, as applicable, and their other respective unsecured indebtedness and other unsecured obligations only after all of their respective indebtedness and other obligations secured by those assets have been repaid in full.
The non-Guarantors are separate and distinct legal entities and have no obligation, contingent or otherwise, to pay any amounts due pursuant to the Notes, or to make any funds available therefore, whether by dividends, loans, distributions or other payments.
Pursuant to Rule 13-01 of Regulation S-X, Guarantors and Issuers of Guaranteed Securities Registered or Being Registered , the following tables present summarized financial information for Piedmont OP as Issuer and Piedmont Office Realty Trust, Inc. as Guarantor on a combined basis after elimination of (i) intercompany transactions and balances among the Issuer and the Guarantor and (ii) equity in earnings from and investments in any subsidiary that is a non-Guarantor (in thousands):
Combined Balances of Piedmont OP and Piedmont Office Realty Trust, Inc. as Issuer and Guarantor, respectively As of
December 31, 2020
As of
December 31, 2019
Due from non-guarantor subsidiary $ 810 $ 810
Total assets $ 347,757 $ 364,734
Total liabilities $ 1,654,009 $ 1,343,881
For the Year Ended December 31, 2020
Total revenues $ 43,193
Net loss $ (50,803)
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Net Operating Income by Geographic Segment
The chief operating decision maker ("CODM"), who is our President and Chief Executive Officer, evaluates our portfolio and assesses the ongoing operations and performance of our properties utilizing the following geographic segments: Dallas, Atlanta, Washington, D.C., Minneapolis, Boston, Orlando, and New York. These operating segments are also Piedmont’s reportable segments. Additionally, as of December 31, 2020, Piedmont owns two properties in Houston and one property in Chicago that do not meet the definition of an operating or reportable segment as the CODM does not regularly review these properties for purposes of allocating resources or assessing performance, and Piedmont does not maintain a significant presence or anticipate further investment in these markets. These three properties are included in "Corporate and other" below. See Note 17 , Segment Information , to the accompanying consolidated financial statements for additional information and a reconciliation of Net income applicable to Piedmont to Net Operating Income ("NOI").
The following table presents NOI by geographic segment (in thousands):
Years Ended December 31,
2020 2019
Dallas $ 59,845 $ 29,438
Atlanta 60,276 47,287
Washington, D.C. 36,696 41,167
Minneapolis 33,588 35,610
Boston 41,722 44,016
Orlando 34,427 35,433
New York 38,990 44,036
Total reportable segments 305,544 276,987
Corporate and other 13,915 43,637
Total NOI $ 319,459 $ 320,624
Comparison of the Year Ended December 31, 2020 Versus the Year Ended December 31, 2019
Dallas
NOI increased primarily as a result of the purchase of the Dallas Galleria Office Towers in February 2020.
Atlanta
NOI increased primarily due to a full year of operating income at the Galleria 400 and 600 buildings, as well as the commencement of leases across the Atlanta market.
Washington, D.C.
NOI decreased largely due to the sale of the One Independence Square property in February 2019, as well as the write-off of certain lease-related assets at our 3100 Clarendon Boulevard building during the year ended December 31, 2020.
New York
NOI decreased primarily due to the sale of the New Jersey Portfolio in October 2020.
Corporate and other
NOI decreased primarily as a result of the sale of 1901 Market Street building in Philadelphia, Pennsylvania in June 2020, as well as the sale of the 500 West Monroe Street building in Chicago, Illinois in October 2019.
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Funds From Operations ("FFO"), Core Funds From Operations ("Core FFO"), and Adjusted Funds From Operations (“AFFO”)
Net income calculated in accordance with GAAP is the starting point for calculating FFO, Core FFO, and AFFO. These metrics are non-GAAP financial measures and should not be viewed as an alternative measurement of our operating performance to net income. Management believes that accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values have historically risen or fallen with market conditions, many industry investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting alone to be insufficient. As a result, we believe that the additive use of FFO, Core FFO, and AFFO, together with the required GAAP presentation, provides a more complete understanding of our performance relative to our competitors and a more informed and appropriate basis on which to make decisions involving operating, financing, and investing activities.
We calculate FFO in accordance with the current National Association of Real Estate Investment Trusts ("NAREIT") definition. NAREIT currently defines FFO as follows: Net income (computed in accordance with GAAP), excluding gains or losses from sales of depreciable real estate and impairment charges, plus the add back of depreciation and amortization on real estate assets. Other REITs may not define FFO in accordance with the NAREIT definition, or may interpret the current NAREIT definition differently than we do; therefore, our computation of FFO may not be comparable to such other REITs.
We calculate Core FFO by starting with FFO, as defined by NAREIT, and adjusting for gains or losses on the extinguishment of swaps and/or debt, acquisition-related expenses, and any significant non-recurring or infrequent items. Core FFO is a non-GAAP financial measure and should not be viewed as an alternative to net income calculated in accordance with GAAP as a measurement of our operating performance. We believe that Core FFO is helpful to investors as a supplemental performance measure because it excludes the effects of certain infrequent or non-recurring items which can create significant earnings volatility, but which do not directly relate to our core recurring business operations. As a result, we believe that Core FFO can help facilitate comparisons of operating performance between periods and provides a more meaningful predictor of future earnings potential. Other REITs may not define Core FFO in the same manner as us; therefore, our computation of Core FFO may not be comparable to that of other REITs.
We calculate AFFO by starting with Core FFO and adjusting for non-incremental capital expenditures and acquisition-related costs and then adding back non-cash items including: non-real estate depreciation, straight-line rent adjustments and fair value lease adjustments, non-cash components of interest expense and compensation expense. AFFO is a non-GAAP financial measure and should not be viewed as an alternative to net income calculated in accordance with GAAP as a measurement of our operating performance. We believe that AFFO is helpful to investors as a meaningful supplemental comparative performance measure of our ability to make incremental capital investments in new properties or enhancements to existing properties that improve revenue growth potential. Other REITs may not define AFFO in the same manner as us; therefore, our computation of AFFO may not be comparable to that of other REITs.
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Reconciliations of net income to FFO, Core FFO, and AFFO for the years ended December 31, 2020, 2019, and 2018, respectively, are presented below (in thousands except per share amounts):
2020 Per
Share (1)
2019 Per
Share (1)
2018 Per
Share (1)
GAAP net income applicable to common stock $ 232,688 $ 1.85 $ 229,261 $ 1.82 $ 130,296 $ 1.00
Depreciation of real assets
109,326 0.86 105,111 0.83 107,113 0.82
Amortization of lease-related costs
93,242 0.74 76,610 0.61 63,235 0.48
Impairment loss on real estate assets
— — 8,953 0.07 — —
Gain on sale- wholly-owned properties
(205,666) (1.63) (197,010) (1.56) (75,691) (0.58)
NAREIT Funds From Operations applicable to common stock
$ 229,590 $ 1.82 $ 222,925 $ 1.77 $ 224,953 $ 1.72
Adjustments:
Retirement and separation expenses associated with senior management transition in June 2019
— — 3,175 0.02 — —
Loss on extinguishment of debt
9,336 0.07 — — 1,680 0.01
Core Funds From Operations applicable to common stock
$ 238,926 $ 1.89 $ 226,100 $ 1.79 $ 226,633 $ 1.73
Adjustments:
Amortization of debt issuance costs, fair market adjustments on notes payable, and discounts on debt
2,833 2,101 2,083
Depreciation of non real estate assets
1,216 872 813
Straight-line effects of lease revenue
(22,601) (10,411) (13,980)
Stock-based compensation adjustments
7,014 5,030 7,528
Net effect of amortization of above and below-market in-place lease intangibles
(12,284) (8,323) (7,615)
Non-incremental capital expenditures (2)
(77,682) (49,653) (44,004)
Adjusted Funds From Operations applicable to common stock
$ 137,422 $ 165,716 $ 171,458
Weighted-average shares outstanding – diluted 126,104 126,182 130,636
(1) Based on weighted-average shares outstanding—diluted.
(2) We define non-incremental capital expenditures as capital expenditures of a recurring nature related to tenant improvements, leasing commissions, and building capital that do not incrementally enhance the underlying assets' income generating capacity. Tenant improvements, leasing commissions, building capital and deferred lease incentives incurred to lease space that was vacant at acquisition, leasing costs for spaces vacant for greater than one year, leasing costs for spaces at newly acquired properties for which in-place leases expire shortly after acquisition, improvements associated with the expansion of a building, and renovations that either enhance the rental rates of a building or change the property's underlying classification, such as from a Class B to a Class A property, are excluded from this measure. Non-incremental capital expenditures for the year ended December 31, 2020 includes a $16 million leasing commission for the approximately 20-year, 520,000-square-foot renewal and expansion of the State of New York's lease at our 60 Broad Street building in New York City that was executed during the fourth quarter of 2019.
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Property and Same Store Net Operating Income
Property Net Operating Income ("Property NOI") is a non-GAAP measure which we use to assess our operating results. We calculate Property NOI beginning with Net income (computed in accordance with GAAP) before interest, income-related federal, state, and local taxes, depreciation and amortization and removing any impairment losses, gains or losses from sales of any property and other significant infrequent items that create volatility within our earnings and make it difficult to determine the earnings generated by our core ongoing business. Furthermore, we remove general and administrative expenses, income associated with property management performed by us for other organizations, and other income or expense items such as interest income from loan investments or costs from the pursuit of non-consummated transactions. For Property NOI (cash basis), the effects of straight-lined rents and fair value lease revenue are also eliminated; while such effects are not adjusted in calculating Property NOI (accrual basis). Property NOI is a non-GAAP financial measure and should not be viewed as an alternative to net income calculated in accordance with GAAP as a measurement of our operating performance. We believe that Property NOI, on either a cash or accrual basis, is helpful to investors as a supplemental comparative performance measure of income generated by our properties alone without our administrative overhead. Other REITs may not define Property NOI in the same manner as we do; therefore, our computation of Property NOI may not be comparable to that of other REITs.
We calculate Same Store Net Operating Income ("Same Store NOI") as Property NOI applicable to the properties owned or placed in service during the entire span of the current and prior year reporting periods. Same Store NOI is a non-GAAP financial measure and should not be viewed as an alternative to net income calculated in accordance with GAAP as a measurement of our operating performance. We believe that Same Store NOI, on either a cash or accrual basis is helpful to investors as a supplemental comparative performance measure of the income generated from the same group of properties from one period to the next. Other REITs may not define Same Store NOI in the same manner as we do; therefore, our computation of Same Store NOI may not be comparable to that of other REITs.
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The following table sets forth a reconciliation from net income calculated in accordance with GAAP to EBITDAre, Core EBITDA, Property NOI, and Same Store NOI on both a cash and accrual basis, for the years ended December 31, 2020 and 2019, respectively (in thousands):
Cash Basis Accrual Basis
December 31,
2020 December 31,
2019 December 31,
2020 December 31,
2019
Net income applicable to Piedmont (GAAP basis) $ 232,688 $ 229,261 $ 232,688 $ 229,261
Net loss applicable to noncontrolling interest
(3) (5) (3) (5)
Interest expense
54,990 61,594 54,990 61,594
Depreciation
110,542 105,985 110,542 105,985
Amortization
93,242 76,610 93,242 76,610
Depreciation and amortization attributable to noncontrolling interests 85 87 85 87
Impairment loss on real estate assets
— 8,953 — 8,953
Gain on sale of real estate assets
(205,666) (197,010) (205,666) (197,010)
EBITDAre (1)
285,878 285,475 285,878 285,475
Loss on extinguishment of debt
9,336 — 9,336 —
Retirement and separation expenses associated with senior management transition in June 2019
— 3,175 — 3,175
Core EBITDA (2)
295,214 288,650 295,214 288,650
General & administrative expenses
27,464 34,720 27,464 34,720
Management fee revenue (3)
(1,495) (2,518) (1,495) (2,518)
Other income
(1,724) (228) (1,724) (228)
Non-cash general reserve for uncollectible accounts 4,553 —
Straight-line rent effects of lease revenue
(22,601) (10,411)
Straight-line effects of lease revenue attributable to noncontrolling interests (16) (9)
Amortization of lease-related intangibles
(12,284) (8,323)
Property NOI 289,111 301,881 319,459 320,624
Net operating income from:
Acquisitions (4)
(40,696) (8,229) (52,448) (10,769)
Dispositions (5)
(21,049) (61,423) (22,113) (63,730)
Other investments (6)
(248) (1,204) (340) (1,142)
Same Store NOI $ 227,118 $ 231,025 $ 244,558 $ 244,983
Change period over period in Same Store NOI (1.7) % N/A (0.2) % N/A
(1) We calculate Earnings Before Interest, Taxes, Depreciation, and Amortization- Real Estate ("EBITDAre") in accordance with the current National Association of Real Estate Investment Trusts (“NAREIT”) definition. NAREIT currently defines EBITDAre as net income (computed in accordance with GAAP) adjusted for gains or losses from sales of property, impairment losses, depreciation on real estate assets, amortization on real estate assets, interest expense and taxes. Some of the adjustments mentioned can vary among owners of identical assets in similar conditions based on historical cost accounting and useful-life estimates. EBITDAre is a non-GAAP financial measure and should not be viewed as an alternative to net income calculated in accordance with GAAP as a measurement of our operating performance. We believe that EBITDAre is helpful to investors as a supplemental performance measure because it provides a metric for understanding our results from ongoing operations without taking into account the effects of non-cash expenses (such as depreciation and amortization) and capitalization and capital structure expenses (such as interest expense and taxes). We also believe that EBITDAre can help facilitate comparisons of operating performance between periods and
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with other REITs. However, other REITs may not define EBITDAre in accordance with the NAREIT definition, or may interpret the current NAREIT definition differently than us; therefore, our computation of EBITDAre may not be comparable to that of such other REITs.
(2) We calculate Core Earnings Before Interest, Taxes, Depreciation, and Amortization ("Core EBITDA") as net income (computed in accordance with GAAP) before interest, taxes, depreciation and amortization and incrementally removing any impairment losses, gains or losses from sales of property and other significant infrequent items that create volatility within our earnings and make it difficult to determine the earnings generated by our core ongoing business. Core EBITDA is a non-GAAP financial measure and should not be viewed as an alternative to net income calculated in accordance with GAAP as a measurement of our operating performance. We believe that Core EBITDA is helpful to investors as a supplemental performance measure because it provides a metric for understanding the performance of our results from ongoing operations without taking into account the effects of non-cash expenses (such as depreciation and amortization), as well as items that are not part of normal day-to-day operations of our business. Other REITs may not define Core EBITDA in the same manner as us; therefore, our computation of Core EBITDA may not be comparable to that of other REITs.
(3) Presented net of related operating expenses incurred to earn such management fee revenue.
(4) Acquisitions consist of Galleria 100 in Atlanta, Georgia, purchased on May 6, 2019; Galleria 400 and Galleria 600 in Atlanta, Georgia, purchased on August 23, 2019; One Galleria Tower, Two Galleria Tower and Three Galleria Tower in Dallas, Texas, purchased on February 12, 2020; and 222 South Orange Avenue in Orlando, Florida, purchased on October 29, 2020.
(5) Dispositions consist of One Independence Square in Washington, D.C., sold on February 28, 2019; The Dupree in Atlanta, Georgia, sold on September 4, 2019; 500 West Monroe Street in Chicago, Illinois, sold on October 28, 2019; 1901 Market Street in Philadelphia, Pennsylvania, sold on June 25, 2020; and the New Jersey Portfolio sold on October 28, 2020 (consisting of 200 and 400 Bridgewater Crossing in Bridgewater, New Jersey, and 600 Corporate Drive in Lebanon, New Jersey).
(6) Other investments consist of active redevelopment and development projects, land, and recently completed redevelopment and development projects for which some portion of operating expenses were capitalized during the current and/or prior year reporting periods. The operating results from Two Pierce Place in Itasca, Illinois and 222 South Orange Avenue in Florida are included in this line item.
Overview
Our portfolio is a geographically diverse group of properties located primarily in select sub-markets within seven major Eastern U.S. office markets, with a majority of our ALR being generated from the Sunbelt. We typically lease space to large, credit-worthy corporate or governmental tenants on a long-term basis. As of December 31, 2020, our average lease is between 15,000 and 20,000 square feet with six years of lease term remaining. Consequently, leased percentage, as well as rent roll ups and roll downs, which we experience as a result of re-leasing, can fluctuate widely between buildings and between tenants, depending on when a particular lease is scheduled to commence or expire.
Leased Percentage
On a same store basis, our portfolio was approximately 88% leased as of December 31, 2020, as compared to 91% leased as of December 31, 2019. Other than the City of New York's 313,000 square foot lease that is currently in holdover status at 60 Broad Street in New York, we have no leases greater than 1% of our ALR expiring during the eighteen month period following December 31, 2020. We remain in advanced discussions for the renewal of substantially all of the City of New York's leased square footage. To the extent new leases for currently vacant space outweigh or fall short of scheduled expirations, such leases would increase or decrease our overall leased percentage, respectively.
Impact of Downtime, Abatement Periods, and Rental Rate Changes
Commencement of new leases typically occurs 6-18 months after the lease execution date, after refurbishment of the space is completed. The downtime between a lease expiration and the new lease's commencement can negatively impact Property NOI and Same Store NOI comparisons (both accrual and cash basis). In addition, office leases, both new and renewal, often contain upfront rental and/or operating expense abatement periods which delay the cash flow benefits of the lease even after the new lease or renewal has commenced and will continue to negatively impact Property NOI and Same Store NOI on a cash basis until such abatements expire. As of December 31, 2020, we had approximately 1 million square feet of executed leases for vacant space yet to commence or under rental abatement.
If we are unable to replace expiring leases with new or renewal leases at rental rates equal to or greater than the expiring rates, rental rate roll downs could occur and negatively impact Property NOI and Same Store NOI comparisons. As mentioned above, our geographically diverse portfolio and the magnitude of some of our tenant's leased space can result in rent roll ups and roll downs that can fluctuate widely on a building-by-building and a quarter-to-quarter basis. During the year ended December 31, 2020, we experienced a 3.5% and 10.2% roll up in cash and accrual rents, respectively, on leases executed during the period for space vacant one year or less.
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Same Store NOI decreased by 1.7% and 0.2% on a cash and accrual basis, respectively, for the year ended December 31, 2020 as compared to the year ended December 31, 2019. The decrease in cash basis Same Store NOI was primarily attributable to the deferral, net of subsequent collections, of approximately $5.8 million of 2020 rental payments. Additional contributors to the decreases were a reduction in transient parking revenue as a result of the pandemic and decreased portfolio occupancy in 2020 when compared to 2019. Property NOI and Same Store NOI comparisons for any given period fluctuate as a result of the mix of net leasing activity in individual properties during the respective period.
Election as a REIT
We have elected to be taxed as a REIT under the Code and have operated as such beginning with our taxable year ended December 31, 1998. To qualify as a REIT, we must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of our adjusted REIT taxable income, computed without regard to the dividends-paid deduction and by excluding net capital gains attributable to our stockholders, as defined by the Code. As a REIT, we generally will not be subject to federal income tax on income that we distribute to our stockholders. If we fail to qualify as a REIT in any taxable year, we may be subject to federal income taxes on our taxable income for that year and for the four years following the year during which qualification is lost and/or penalties, unless the IRS grants us relief under certain statutory provisions. Such an event could materially adversely affect our net income and net cash available for distribution to our stockholders. However, we believe that we are organized and operate in such a manner as to qualify for treatment as a REIT and intend to continue to operate in the foreseeable future in such a manner that we will remain qualified as a REIT for federal income tax purposes. We have elected to treat POH, a wholly-owned subsidiary of Piedmont, as a taxable REIT subsidiary. POH performs non-customary services for tenants of buildings that we own, including solar power generation and real estate and non-real estate related-services. Any earnings related to such services performed by our taxable REIT subsidiary are subject to federal and state income taxes. In addition, for us to continue to qualify as a REIT, our investments in taxable REIT subsidiaries cannot exceed 20% of the value of our total assets.
Inflation
We are exposed to inflation risk, as income from long-term leases is the primary source of our cash flows from operations. There are provisions in the majority of our tenant leases that are intended to protect us from, and mitigate the risk of, the impact of inflation. These provisions include rent steps, reimbursement billings for operating expense pass-through charges, real estate tax, and insurance on a per square-foot basis, or in some cases, annual reimbursement of operating expenses above certain per square-foot allowances. However, due to the long-term nature of the leases, the leases may not readjust their reimbursement rates frequently enough to fully cover inflation.
Off-Balance Sheet Arrangements
We are not dependent on off-balance sheet financing arrangements for liquidity, and do not currently have any off-balance sheet arrangements. For further information regarding our commitments under operating lease obligations, see the notes of our accompanying consolidated financial statements, as well as the table found in Contractual Obligations below.
Application of Critical Accounting Policies
Our accounting policies have been established to conform with GAAP. The preparation of financial statements in conformity with GAAP requires management to use judgment in the application of accounting policies, including making estimates and assumptions. These judgments affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. If our judgment or interpretation of the facts and circumstances relating to various transactions had been different, it is possible that different accounting policies would have been applied, thus, resulting in a different presentation of the financial statements. Additionally, other companies may utilize different estimates that may impact comparability of our results of operations to those of companies in similar businesses. The critical accounting policies outlined below have been discussed with members of the Audit Committee of the Board of Directors.
Valuation of Real Estate Assets
We continually monitor events and changes in circumstances that could indicate that the carrying amounts of the real estate and related intangible assets, both operating properties and properties under construction, in which we have an ownership interest, either directly or through investments in joint ventures, may not be recoverable. When indicators of potential impairment are present, we assess whether the respective carrying values will be recovered from the undiscounted future operating cash flows expected from the use of the asset and its eventual disposition for assets held for use, or from the estimated fair value, less costs
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to sell, for assets held for sale. In the event that the expected undiscounted future cash flows for assets held for use or the estimated fair value, less costs to sell, for assets held for sale do not exceed the respective asset carrying value, we adjust such assets to the respective estimated fair values and recognize an impairment loss.
Projections of expected future cash flows require that we estimate future market rental income amounts subsequent to the expiration of current lease agreements, property operating expenses, the number of months it takes to re-lease the property, and the number of years the property is held for investment, among other factors. The subjectivity of assumptions used in the future cash flow analysis, including capitalization and discount rates, could result in an incorrect assessment of the property’s estimated fair value and, therefore, could result in the misstatement of the carrying value of our real estate and related intangible assets and our reported net income attributable to Piedmont.
Rental Revenue Recognition
Rental income for office properties is our principal source of revenue. The timing of rental revenue recognition is largely dependent on our conclusion as to whether we, or our tenant, are the owner of tenant improvements at the leased property. The determination of whether we, or our tenant, are the owner of tenant improvements for accounting purposes is subject to significant judgment. In making that determination, we consider numerous factors and perform an evaluation of each individual lease. No one factor is determinative in reaching a conclusion. The factors we evaluate include but are not limited to the following:
• whether the tenant is obligated by the terms of the lease agreement to construct or install the leasehold improvements as a condition of the lease;
• whether the landlord can require the lessee to make specified improvements or otherwise enforce its economic rights to those assets;
• whether the tenant is required to provide the landlord with documentation supporting the cost of tenant improvements prior to reimbursement by the landlord;
• whether the landlord is obligated to fund cost overruns for the construction of leasehold improvements;
• whether the leasehold improvements are unique to the tenant or could reasonably be used by other parties; and
• whether the estimated economic life of the leasehold improvements is long enough to allow for a significant residual value that could benefit the landlord at the end of the lease term.
When we conclude that we are the owner of tenant improvements, we record the cost to construct the tenant improvements as an asset and commence rental revenue recognition when the tenant takes possession of or controls the finished space, which is typically when the improvements being recorded as our asset are substantially complete, and our landlord obligation has been materially satisfied. When we conclude that our tenant is the owner of certain tenant improvements, we record our contribution towards those improvements as a lease incentive, which is amortized as a reduction to rental and tenant reimbursement revenue on a straight-line basis over the term of the related lease, and the recognition of rental revenue begins when the tenant takes possession of or controls the space.
In addition, we also record the cost of certain tenant improvements paid for or reimbursed by tenants when we conclude that we are the owner of such tenant improvements using the factors discussed above. For these tenant-funded tenant improvements, we record the amount funded or reimbursed by tenants as deferred revenue, which is amortized and recognized as rental revenue over the term of the related lease beginning upon substantial completion of the leased premises. Consequently, our determination as to whether we, or our tenant, are the owner of tenant improvements for accounting purposes has a significant impact on both the amount and timing of rental revenue that we record related to tenant-funded tenant improvements.
Accounting Pronouncements Adopted during the Year Ended December 31, 2020
Reference Rate Reform Relief
Accounting Standards Update No. 2020-04, Reference Rate Reform (Topic 848) ("ASU 2020-04"), was issued in March 2020. ASU 2020-04 contains practical expedients for reference rate reform related activities that impact debt, leases, derivatives and other contracts. The guidance in ASU 2020-04 is optional and may be elected over time as reference rate reform activities occur. During the year ended December 31, 2020, we elected to apply the hedge accounting expedients related to probability and the assessments of effectiveness for future LIBOR-indexed cash flows to assume that the index upon which future hedged transactions will be based matches the index on the corresponding derivatives. Application of these expedients preserves the presentation of derivatives consistent with past presentation. We continue to evaluate the impact of the guidance and may apply other elections as applicable as additional changes in the market occur.
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Financial Instruments- Credit Loss Amendments
On January 1, 2020, we adopted ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments , as well as ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, and ASU No. 2019-05, Financial Instruments- Credit Losses: Targeted Transition Relief (collectively the "Credit Loss Amendments"). The provisions of the Credit Loss Amendments replace the "incurred loss" approach with an "expected loss" model for impairing trade and other receivables, held-to-maturity debt securities, net investment in leases, and off-balance-sheet credit exposures, which will generally result in earlier recognition of allowances for credit losses. However, the Financial Accounting Standards Board (the "FASB") also issued ASU No. 2018-19 Codification Improvements to Topic 326, Financial Instruments - Credit Losses, which is effective concurrent with the Credit Loss Amendments, and excludes receivables arising from operating leases from the scope of the Credit Loss Amendments and affirms that such receivables should be evaluated for collectibility as prescribed by Accounting Standards Codification 842 Leases . As s ubstantially all of our receivables are operating lease receivables there was no material impact to our accompanying consolidated financial statements or disclosures as a result of adoption of the Credit Loss Amendments.
During the year ended December 31, 2020, the FASB issued a Staff Q&A on Topic 842 and Topic 840 (lease accounting guidance): Accounting for lease concessions related to the effects of the COVID-19 pandemic . Generally, changes to payment terms not contemplated by the lease contract should be accounted for under Topic 842 as a lease modification. The FASB staff has provided relief from this modification guidance through an accounting policy election, provided that changes to the payment terms do not result in a substantial increase in the rights of either the lessee or the lessor under the lease. We have elected not to apply the relief provided by the FASB Staff, and have instead accounted for all rent relief agreements as result of COVID-19 as lease modifications. See further details concerning rent relief agreements with our tenants in Note 8 to our accompanying consolidated financial statements.
Related-Party Transactions and Agreements
There were no related-party transactions during the three years ended December 31, 2020, other than a consulting agreement with our former Chief Investment Officer ("CIO"), Raymond L. Owens. Mr. Owens retired effective June 30, 2017, and remained a consultant for us until June 30, 2020, earning $18,500 per month. During the years ended December 31, 2020, 2019, and 2018, Piedmont recognized approximately $ 0.1 million, $ 0.2 million, and $ 0.3 million, respectively, of expense related to this consulting agreement. Additionally, during the year ended December 31, 2019, we entered into employment or retirement agreements with certain of our current and former executive officers as more fully described in our Definitive Proxy Statement and Current Report on Form 8-K filed on March 19, 2019.
Contractual Obligations
Our contractual obligations as of December 31, 2020 were as follows (in thousands):
Payments Due by Period
Contractual Obligations (1)
Total Less than
1 year 1-3 years 3-5 years More than
5 years
Long-term debt (2)
$ 1,632,610 $ 327,610 $ 355,000 (3)
$ 650,000 $ 300,000
(1) Contractual obligations do not include amounts committed for tenant or capital improvements under leases where Piedmont is the lessor. However, see Note 8 to our accompanying consolidated financial statements for details concerning our material lease commitments, the timing of which may fluctuate. Additionally, Piedmont does not have material obligations as lessee under operating lease agreements as of December 31, 2020.
(2) Amounts include principal payments only and balances outstanding as of December 31, 2020, not including approximately $10.6 million of net unamortized issuance discounts, debt issuance costs paid to lenders, or estimated fair value adjustments. We made interest payments, including payments under our interest rate swaps, of approximately $50.7 million during the year ended December 31, 2020, and expect to pay interest in future periods on outstanding debt obligations based on the rates and terms disclosed herein and in Note 4 to our accompanying consolidated financial statements.
(3) Includes the balance outstanding as of December 31, 2020 of the $500 Million Unsecured 2018 Line of Credit. However, we may extend the term for up to one additional year (through two available six month extensions to a final extended maturity date of September 29, 2023) provided we are not then in default and upon payment of extension fees.
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