Item 1. Business
Background
The General Partner and Partnership collectively specialize in the ownership, management and development of bulk distribution ("industrial") real estate.
The General Partner is a self-administered and self-managed REIT, which began operations upon completion of an initial public offering in February 1986.
The Partnership was formed in October 1993, when the General Partner contributed all of its properties and related assets and liabilities, together with the net proceeds from an offering of additional shares of its common stock, to the Partnership. Simultaneously, the Partnership completed the acquisition of Duke Associates, a full-service commercial real estate firm operating in the Midwest whose operations began in 1972. The General Partner is the sole general partner of the Partnership, owning 99.1% of the Common Units at December 31, 2020. The remaining 0.9% of the Common Units are owned by limited partners. Limited partners have the right to redeem their Limited Partner Units, subject to certain restrictions. Pursuant to the Fifth Amended and Restated Agreement of Limited Partnership, as amended (the "Partnership Agreement"), the General Partner is obligated to redeem the Limited Partner Units in shares of its common stock, unless it determines in its reasonable discretion that the issuance of shares of its common stock could cause it to fail to qualify as a REIT. Each Limited Partner Unit shall be redeemed for one share of the General Partner's common stock, or, in the event that the issuance of shares could cause the General Partner to fail to qualify as a REIT, cash equal to the fair market value of one share of the General Partner's common stock at the time of redemption, in each case, subject to certain adjustments described in the Partnership Agreement. The Limited Partner Units are not required, per the terms of the Partnership Agreement, to be redeemed in registered shares of the General Partner.
At December 31, 2020, we owned or jointly controlled 537 primarily industrial properties which encompassed 159.6 million rentable square feet (including 40 unconsolidated joint venture in-service properties with 11.5 million square feet, 16 consolidated properties under development with 6.9 million square feet and one unconsolidated joint venture property under development with 517,000 square feet). Our properties are leased by a diverse base of more than 800 tenants whose businesses include e-commerce, manufacturing, retailing, wholesale trade, and distribution. We have one tenant, to whom we both lease a significant amount of space and also provide general contractor and construction management services, from whom we derived greater than 10.0% of our total revenues. We also owned, including through ownership interests in unconsolidated joint ventures (with acreage not adjusted for our percentage ownership interest), 1,000 acres of land and controlled an additional 800 acres through purchase options.
Our headquarters and executive offices are located in Indianapolis, Indiana. We additionally have regional offices or significant operations in 19 other geographic or metropolitan areas including Atlanta, Georgia; Chicago, Illinois; Cincinnati, Ohio; Columbus, Ohio; Dallas, Texas; Houston, Texas; Minneapolis/St. Paul, Minnesota; Nashville, Tennessee; Raleigh, North Carolina; Savannah, Georgia; Seattle, Washington; St. Louis, Missouri; Washington D.C./Baltimore, Maryland; Central Florida; New Jersey; Northern and Southern California; Pennsylvania and South Florida.
See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" for information related to our operational, asset and capital strategies.
Competitive Conditions
As a fully integrated commercial real estate firm, we provide in-house leasing, management, development and construction services which we believe, coupled with our significant base of commercially zoned and unencumbered land in existing business parks, should give us a competitive advantage as a real estate operator and in future development activities.
We believe that the management of real estate opportunities and risks can be done most effectively at regional or on local levels. As a result, we intend to continue our emphasis on increasing our market share, to the extent it is in markets that align with our asset strategy (see Item 7), and effective rents in the primary markets where we own properties. We believe that this regional focus will allow us to assess market supply and demand for real estate more effectively as well as to capitalize on the strong relationships with our tenant base. In addition, we seek to further capitalize on our many strong relationships with customers that operate on a national level. As a fully integrated real estate company, we are able to arrange for or provide to our tenants not only well located and well maintained facilities, but also additional services such as build-to-suit construction, tenant finish construction, and expansion flexibility.
All of our properties are located in areas that include competitive properties. Institutional investors, other REITs or local real estate operators generally own such properties; however, no single competitor or small group of competitors is dominant in our current markets. The supply of and demand for similar available rental properties may affect the rental rates we will receive on our properties. Other competitive factors include the attractiveness of the property location, the quality of the property and tenant services provided, and the reputation of the owner and operator.
Corporate Governance
Since our inception, we not only have strived to be a top-performer operationally, but also to lead in issues important to investors such as disclosure and corporate governance. The General Partner's system of governance reinforces this commitment and, as a limited partnership that has one general partner owning over 90% of the Partnership's common interest, the governance of the Partnership is necessarily linked to the corporate governance of the General Partner. Summarized below are the highlights of the General Partner's Corporate Governance initiatives.
Board Composition • The General Partner's board is controlled by a supermajority (92.3%) of "Independent Directors," as such term is defined under the rules of the New York Stock Exchange (the "NYSE")
• 50% of the Independent Directors are female or people of color and the General Partner's compensation and human capital committee is chaired by a female
Board Committees • The General Partner's board committee members are all Independent Directors
Lead Director • The Lead Director serves as the Chairman of the General Partner's corporate governance committee
Board Policies- Proactively amended and restated the General Partner's Bylaws to implement proxy access
- Adopted a Board Diversity and Inclusion Policy
- No Shareholder Rights Plan (Poison Pill)
- Code of Business Ethics applies to all directors and employees of the General Partner, including the Chief Executive Officer and senior financial officers; waivers applied to executive officers require the approval of (i) the General Partner's board of directors or (ii) the General Partner's corporate governance committee
- Orientation program for new directors of the General Partner
- Independence of directors of the General Partner is reviewed annually
- Independent Directors of the General Partner meet at least quarterly in executive sessions
- Independent Directors of the General Partner receive no compensation from the General Partner other than as directors
- Equity-based compensation plans require the approval of the General Partner's shareholders
- Board effectiveness and performance is reviewed annually by the General Partner's corporate governance committee
- Individual director evaluations are performed annually
- The General Partner's corporate governance committee conducts an annual review of the Chief Executive Officer succession plan
- Independent Directors and all board committees of the General Partner may retain outside advisors, as they deem appropriate
- Prohibition on repricing of outstanding stock options of the General Partner
- Directors of the General Partner required to offer resignation upon job change
- Majority voting for election of directors of the General Partner
- Human Rights Policy
- Shareholder Communications Policy
OwnershipMinimum Stock Ownership Guidelines apply to all directors and executive officers of the General Partner
The General Partner's Code of Business Ethics (which applies to all directors and employees of the General Partner, including the Chief Executive Officer and senior financial officers) and the Corporate Governance Guidelines are available in the Investor Relations/Corporate Governance section of the General Partner's website at www.dukerealty.com. A copy of these documents may also be obtained without charge by writing to Duke Realty Corporation, 8711 River Crossing Boulevard, Indianapolis, Indiana 46240, Attention: Investor Relations. If we amend our Code of Business Ethics as it applies to the directors and all executive officers of the General Partner or grant a waiver from any provision of the Code of Business Ethics to any such person, we may, rather than filing a current report on Form 8-K, disclose such amendment or waiver in the Investor Relations/Corporate Governance section of the General Partner's website at www.dukerealty.com.
Human Capital
We had approximately 350 employees at December 31, 2020 and our average associate tenure was 12.7 years. Our compensation and human capital committee, a board committee, reviews associate turnover and diversity, as well as associate development and engagement programs. We also routinely conduct associate engagement surveys and have received numerous awards for being a great place to work. While attracting, developing and retaining our talent, we are dedicated to fair compensation, fostering an inclusive and diverse culture and a dynamic and balanced work environment, which provides associates with opportunities to perform well and derive satisfaction from their
work. The compensation structures of many of our senior employees are directly tied to metrics or other objectives that support our corporate strategy.
We require ethical conduct by our employees and all employees are required to complete annual Code of Business Ethics training sessions, and associates and directors must sign off on our Code of Business Ethics every year.
See more information regarding employee benefits and company programs under Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Business Overview - Environmental, Social and Governance Strategy".
Additional Information
For additional information regarding our investments and operations, see Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Item 8, "Financial Statements and Supplementary Data." For additional information about our business segments, see Item 8, "Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - (10) Segment Reporting."
Available Information
In addition to this Report, we file quarterly and current reports, proxy statements and other information with the SEC. All documents that are filed with the SEC are available free of charge on the General Partner's corporate website, which is www.dukerealty.com. We are not incorporating the information on the General Partner's website into this Report, and the General Partner's website and the information appearing on the General Partner's website is not included in, and is not part of, this Report. You may also access any document filed through the SEC's home page on the Internet (http://www.sec.gov).
Item 1A.
Item 1A. Risk Factors
In addition to the other information contained in this Report, you should carefully consider, in consultation with your legal, financial and other professional advisors, the risks described below, as well as the risk factors and uncertainties discussed in our other public filings with the SEC under the caption "Risk Factors" in evaluating us and our business before making a decision regarding an investment in the General Partner's securities.
The risks contained in this Report are not the only risks that we face. Additional risks that are not presently known, or that we presently deem to be immaterial, also could have a material adverse effect on our financial condition, results of operations, business and prospects. The trading price of the General Partner's securities could decline due to the materialization of any of these risks, and its shareholders and/or the Partnership's unitholders may lose all or part of their investment.
This Report also contains forward-looking statements that may not be realized as a result of certain factors, including, but not limited to, the risks described herein and in our other public filings with the SEC. Please refer to the section in this Report entitled "Cautionary Notice Regarding Forward-Looking Statements" for additional information regarding forward-looking statements.
Risks Related to the COVID-19 Pandemic
The full effects of the COVID-19 pandemic are highly uncertain and cannot be predicted.
An outbreak of COVID-19, a respiratory disease caused by a novel corona virus, has spread internationally, including in the United States where we operate. In March 2020, the World Health Organization declared the outbreak to be a pandemic, and the President of the United States declared it a national emergency. Globally, population movement and trade have been restricted to varying degrees. Within the United States, since the time of its onset, various state and local governmental authorities have enacted measures, to varying degrees, aimed at minimizing the spread of COVID-19. Although there are vaccines that have been approved and are in the early stages of distribution, it cannot be predicted how long it will take before a sufficient percentage of the United States' population is vaccinated to return to normal conditions. Additionally, new and potentially more contagious variants of COVID-19 have been identified, which could further amplify the impact of the pandemic. In general, there is
much uncertainty regarding the COVID-19 pandemic and it may result in prolonged recessionary conditions that could have a further detrimental impact on our tenant base, our ability to lease vacant space and our ability to grow through development and acquisition.
A prolonged COVID-19 outbreak could negatively impact our operations and financial condition.
Should the major public health issues caused by the COVID-19 outbreak persist for an extended period of time, we could be adversely affected by actions limiting trade and population movement, the movement of goods through the supply chain, and other impacts to the general economy, discretionary spending, business and consumer demand that may diminish the demand and rents for our properties. To date, only an insignificant portion of our tenant base has declared bankruptcy as the result of the COVID-19 pandemic. In the event of the default or insolvency of a significant number of our tenants, we may experience a substantial loss of rental revenue and/or delays in collecting rent and incur substantial costs in enforcing our rights as landlord. If a tenant files for bankruptcy protection, a court could allow the tenant to reject and terminate its lease with us.
As a result, our financial condition, results of operations and distributable cash flow would be adversely affected if a significant number of our tenants became unable to meet their obligations to us, became insolvent or declared bankruptcy, and if we are unable to promptly renew the leases or relet the space, or if the rental rates upon such renewal or reletting are significantly lower than current rates.
Our stock price could be negatively impacted by COVID-19.
The COVID-19 outbreak has resulted in significant market volatility, including large swings in global stock prices that have adversely affected trade and global and local economies. These conditions may worsen in future periods and negatively impact our share price.
COVID-19 could adversely affect our ability to finance our operations.
The COVID-19 outbreak has also adversely impacted financial institutions which could, in future periods, negatively impact their willingness to extend credit or result in adverse changes to the terms at which credit is extended. The United States Federal Government has taken certain measures to support continued liquidity and availability of capital, but there is no guarantee that these measures will continue to be successful. These potential risks could negatively impact our future ability to access capital, which would negatively impact our liquidity and our ability to execute our strategic plans.
The ability of our employees to work may be adversely impacted by COVID-19.
Our workforce, including key employees, could be adversely impacted by the outbreak in future periods. Currently, most of our employees are working remotely and some are working on-site. The impacts of the outbreak could, among other things, negatively affect (i) the operation of our properties, (ii) the timeliness of our strategic decision making, (iii) the operation of an effective cyber security function, (iv) the operation of our key information systems, (v) our ability to make timely filings with the SEC and (vi) our ability to maintain an effective control environment.
Risks Related to Our Business
Our use of debt financing could have a material adverse effect on our financial condition.
We are subject to the risks normally associated with debt financing, including the risk that our cash flow will be insufficient to meet required principal and interest payments and the long-term risk that we will be unable to refinance our existing indebtedness, or that the terms of such refinancing will not be as favorable as the terms of existing indebtedness. Additionally, we may not be able to refinance borrowings by our unconsolidated subsidiaries on favorable terms or at all. If our debt cannot be paid, refinanced or extended, we may not be able to make distributions to shareholders and unitholders at expected levels. Further, if prevailing interest rates or other factors at the time of a refinancing result in higher interest rates or other restrictive financial covenants upon the refinancing,
then such refinancing would adversely affect our cash flow and funds available for operation, development and distribution.
We also have incurred, and may incur in the future, indebtedness that bears interest at variable rates. Thus, if market interest rates increase, so will our interest expense, which could reduce our cash flow and our ability to make distributions to shareholders and unitholders at expected levels.
Debt financing may not be available and equity issuances could be dilutive to our shareholders and unitholders.
Our ability to execute our business strategy depends on our access to an appropriate blend of debt financing, including unsecured lines of credit and other forms of secured and unsecured debt, and equity financing, including common equity and, at times, preferred equity issued by the General Partner. Debt financing may not be available over a longer period of time in sufficient amounts, on favorable terms or at all. If the General Partner issues additional equity securities, instead of debt, to manage capital needs, the interests of our existing shareholders and unitholders could be diluted.
Financial and other covenants under existing credit agreements could limit our flexibility and adversely affect our financial condition.
The terms of our various credit agreements and other indebtedness require that we comply with a number of customary financial and other covenants, such as maintaining debt service coverage and leverage ratios and maintaining insurance coverage. These covenants may limit our flexibility in our operations, and breaches of these covenants could result in defaults under the instruments governing the applicable indebtedness even if we have satisfied our payment obligations. As a result, we would also likely be unable to borrow any further amounts under our other debt instruments and other debt obligations may be accelerated, which could adversely affect our ability to fund operations.
Downgrades in our credit ratings could increase our borrowing costs or reduce our access to funding sources in the credit and capital markets.
We have a significant amount of debt outstanding, consisting mostly of unsecured debt. We are currently assigned corporate credit ratings from Moody's Investors Service, Inc. and Standard and Poor's Ratings Group based on their evaluation of our creditworthiness. All of our debt ratings remain investment grade, but there can be no assurance that we will not be downgraded or that any of our ratings will remain investment grade. If our credit ratings are downgraded or other negative action is taken, we could be required, among other things, to pay additional interest and fees on outstanding borrowings under our revolving credit agreement.
Credit rating reductions by one or more rating agencies could also adversely affect our access to funding sources, the cost and other terms of obtaining funding as well as our overall financial condition, operating results and cash flow.
If we are unable to generate sufficient capital and liquidity, then we may be unable to pursue future development projects and other strategic initiatives.
To complete our ongoing and planned development projects, and to pursue our other strategic initiatives, we must continue to generate sufficient capital and liquidity to fund those activities. To generate that capital and liquidity, we rely upon funds from our existing operations, as well as funds that we raise through our capital raising activities. In the event that we are unable to generate sufficient capital and liquidity to meet our long-term needs, or if we are unable to generate capital and liquidity on terms that are favorable to us, then we may not be able to pursue development projects, acquisitions, or our other long-term strategic initiatives.
Our use of joint ventures may negatively impact our jointly-owned investments.
We have, and may continue to develop properties in, or contribute properties to, joint ventures with other persons or entities when circumstances warrant the use of these structures. Our participation in joint ventures is subject to the risks that:
•We could become engaged in a dispute, or have conflicts of interests, with any of our joint venture partners that might affect our ability to develop or operate a property; and
•Our joint venture partners may have different objectives than we have regarding the appropriate timing and terms of any sale or refinancing of properties.
Risks Related to the Real Estate Industry
Our net earnings available for investment or distribution to shareholders and unitholders could decrease as a result of factors related to the ownership and operation of commercial real estate, many of which are outside of our control.
Our business is subject to the risks incident to the ownership and operation of commercial real estate, many of which involve circumstances not within our control. Such risks include the following:
•Changes in the general economic climate;
•The availability of capital on favorable terms, or at all;
•Increases in interest rates;
•Local conditions such as oversupply of property or a reduction in demand;
•Competition for tenants;
•Changes in market rental rates;
•Delay or inability to collect rent from tenants who are bankrupt, insolvent or otherwise unwilling or unable to pay;
•Difficulty in leasing or re-leasing space quickly or on favorable terms;
•Costs associated with periodically renovating, repairing and reletting rental space;
•Our ability to provide adequate maintenance and insurance on our properties;
•Our ability to control variable operating costs;
•Changes in government regulations; and
•Potential liability under, and changes in, environmental, zoning, tax and other laws.
Any one or more of these factors could result in a reduction in our net earnings available for investment or distribution to shareholders and unitholders.
Many real estate costs are fixed, even if income from properties decreases.
Our financial results depend on leasing space in our real estate to tenants on terms favorable to us. Our income and funds available for distribution to our shareholders and unitholders will decrease if a significant number of our tenants cannot meet their lease obligations to us or we are unable to lease properties on favorable terms. In addition, if a tenant does not pay its rent, we may not be able to enforce our rights as landlord without delays and we may incur substantial legal costs. Costs associated with real estate investment, such as real estate taxes, insurance, maintenance costs and our debt service payments, generally are not reduced when circumstances cause a reduction in income from the investment. As a result, we may have a reduction in our net earnings available for investment or distribution to our shareholders and unitholders.
Our real estate development activities are subject to risks particular to development.
We continue to selectively develop new properties for rental operations in our existing markets when accretive returns are present. These development activities generally require various government and other approvals, which we may not receive. In addition, we also are subject to the following risks associated with development activities:
•Unsuccessful development opportunities could result in direct expenses to us;
•Construction costs could increase as the result of trade disputes and tariffs on goods imported in the United States;
•Construction costs of a project may exceed original estimates, possibly making the project less profitable than originally estimated, or possibly unprofitable;
•Time required to complete the construction of a project or to lease up the completed project may be greater than originally anticipated, thereby adversely affecting our cash flow and liquidity;
•Occupancy rates and rents of a completed project may not be sufficient to make the project profitable; and
•Favorable sources to fund our development activities may not be available.
We may be unsuccessful in operating completed real estate projects.
We face the risk that the real estate projects we develop or acquire will not perform in accordance with our expectations. This risk exists because of factors such as the following:
•Prices paid for acquired facilities are based upon a series of market judgments; and
•Costs of any improvements required to bring an acquired facility up to standards to establish the market position intended for that facility might exceed budgeted costs.
As a result, we may develop or acquire projects that are not profitable.
Our investments are concentrated in the industrial sector and our business would be adversely affected by an economic downturn in that sector.
Our investments in real estate assets are concentrated in the industrial sector. This concentration may expose us to the risk of economic downturns in this sector to a greater extent than if our business activities were more diversified.
We are exposed to the risks of defaults by tenants.
Any of our tenants may experience a downturn in their businesses that may weaken their financial condition. In the event of default or the insolvency of a significant number of our tenants, we may experience a substantial loss of rental revenue and/or delays in collecting rent and incur substantial costs in enforcing our rights as landlord. If a tenant files for bankruptcy protection, a court could allow the tenant to reject and terminate its lease with us. Our income and distributable cash flow would be adversely affected if a significant number of our tenants became unable to meet their obligations to us, became insolvent or declared bankruptcy.
We may be unable to renew leases or relet space.
When our tenants decide not to renew their leases upon their expiration, we may not be able to relet the space. Even if our tenants do renew or we are able to relet the space, the terms of renewal or reletting (including the cost of renovations, if necessary) may be less favorable than current lease terms. If we are unable to promptly renew the leases or relet the space, or if the rental rates upon such renewal or reletting are significantly lower than current rates, then our income and distributable cash flow would be adversely affected, especially if we were unable to lease a significant amount of the space vacated by tenants in our properties.
Our insurance coverage on our properties may be inadequate.
We maintain comprehensive insurance on each of our facilities, including property, liability and environmental coverage. We believe this coverage is of the type and amount customarily obtained for real property. However, there are certain types of losses, generally of a catastrophic nature, such as hurricanes, earthquakes and floods or acts of war or terrorism that may be uninsurable or not economically insurable. We use our discretion when determining amounts, coverage limits and deductibles for insurance. These terms are determined based on retaining an acceptable level of risk at a reasonable cost. This may result in insurance coverage that in the event of a substantial loss would not be sufficient to pay the full current replacement cost of the damaged assets. Inflation, changes in building codes and ordinances, environmental considerations, acts of a governmental authority and other factors also may make it unfeasible to collect insurance proceeds to replace a facility after it has been damaged or destroyed. If an uninsured or underinsured loss occurred, we could lose both our investment in and anticipated profits and cash flow from a property, and we would continue to be obligated on any mortgage indebtedness or other obligations related to the property. We are also subject to the risk that our insurance providers may be unwilling or unable to pay our claims when made.
Our acquisition and disposition activity may lead to long-term dilution.
Our asset strategy is to increase our investment concentration in coastal Tier 1 markets. There can be no assurance that we will be able to execute our strategy or that our execution of such strategy will lead to improved results.
Acquired properties may expose us to unknown liability.
From time to time, we may acquire properties subject to liabilities and without any recourse, or with only limited recourse, with respect to unknown liabilities. As a result, if a liability were asserted against us based upon ownership of those properties, we might have to pay substantial sums to settle or contest it, which could adversely affect our results of operations and cash flow. Unknown liabilities with respect to acquired properties might include:
•liabilities for clean-up of undisclosed environmental contamination;
•claims by tenants, vendors or other persons against the former owners of the properties;
•liabilities incurred in the ordinary course of business; and
•claims for indemnification by general partners, directors, officers and others indemnified by the former owners of the properties.
We could be exposed to significant environmental liabilities as a result of conditions of which we currently are not aware.
As an owner and operator of real property, we may be liable under various federal, state and local laws for the costs of removal or remediation of certain hazardous substances released on or in our property. Such laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the release of the hazardous substances. In addition, we could have greater difficulty in selling real estate on which hazardous substances were present or in obtaining borrowings using such real estate as collateral. It is our general policy to have Phase I environmental audits performed for all of our properties and land by qualified environmental consultants at the time of purchase. These Phase I environmental audits have not revealed any environmental liability that would have a material adverse effect on our business. However, a Phase I environmental audit does not involve invasive procedures such as soil sampling or ground water analysis, and we cannot be sure that the Phase I environmental audits did not fail to reveal a significant environmental liability or that a prior owner did not create a material environmental condition on our properties or land which has not yet been discovered. We could also incur environmental liability as a result of future uses or conditions of such real estate or changes in applicable environmental laws.
We are exposed to the potential impacts of future climate change and climate-change related risks.
We are exposed to potential physical risks from possible future changes in climate. We have a significant investment in properties in coastal markets such as Southern California, Northern California and South Florida and have also targeted those markets for future growth. Those coastal markets have historically experienced severe weather events, such as storms and drought, as well as other natural catastrophes such as wildfires and floods. If the frequency of extreme weather and other natural events increases due to climate change, our exposure to these events could increase. We may also be adversely impacted as a real estate developer in the future by stricter energy and water efficiency standards as well as water access for our buildings.
Risks Related to Our Organization and Structure
If the General Partner were to cease to qualify as a REIT, it would lose significant tax benefits.
The General Partner intends to continue to operate so as to qualify as a REIT under the Internal Revenue Code of 1986, as amended (the "Code"). Qualification as a REIT provides significant tax advantages to the General Partner. However, in order for the General Partner to continue to qualify as a REIT, it must satisfy numerous requirements established under highly technical and complex Code provisions for which there are only limited judicial and administrative interpretations. Satisfaction of these requirements also depends on various factual circumstances not entirely within our control. The fact that the General Partner holds its assets through the Partnership further complicates the application of the REIT requirements. Even a technical or inadvertent mistake could jeopardize the General Partner's REIT status. Although we believe that the General Partner can continue to operate so as to qualify as a REIT, we cannot offer any assurance that it will continue to do so or that legislation, new regulations, administrative interpretations or court decisions will not significantly change the qualification requirements or the federal income tax consequences of qualification. If the General Partner were to fail to qualify as a REIT in any taxable year, it would have the following effects:
•The General Partner would not be allowed a deduction for dividends distributed to shareholders and would be subject to federal corporate income tax (and any applicable state and local income taxes) on its taxable income at regular corporate income tax rates;
•Unless the General Partner was entitled to relief under certain statutory provisions, it would be disqualified from treatment as a REIT for the four taxable years following the year during which it ceased to qualify as a REIT;
•The General Partner's net earnings available for investment or distribution to its shareholders would decrease due to the additional tax liability for the year or years involved; and
•The General Partner would no longer be required to make any distributions to shareholders in order to qualify as a REIT.
As such, the General Partner's failure to qualify as a REIT would likely have a significant adverse effect on the value of the General Partner's securities and, consequently, the Partnership's Units.
REIT distribution requirements limit the amount of cash we have available for other business purposes, including amounts that we need to fund our future capital needs.
To maintain its qualification as a REIT under the Code, the General Partner must annually distribute to its shareholders at least 90% of its REIT taxable income, determined without regard to the dividends-paid deduction and excluding net capital gains. The General Partner intends to continue to make distributions to its shareholders to comply with the 90% distribution requirement. However, this requirement limits our ability to accumulate capital for use for other business purposes. If we do not have sufficient cash or other liquid assets to meet the distribution requirements of the General Partner, we may have to borrow funds or sell properties on adverse terms in order to meet the distribution requirements. If the General Partner fails to satisfy the distribution requirement, it would cease to qualify as a REIT.
U.S. federal income tax treatment of REITs and investments in REITs may change in a manner that could adversely affect us or shareholders.
Legislative, regulatory or administrative changes could be enacted or promulgated at any time, either prospectively or with retroactive effect, and may adversely affect us and/or shareholders.
General Risk Factors
Our business and operations could suffer in the event of system failures or cyber security attacks.
Our systems are vulnerable to damages from any number of sources, including energy blackouts, natural disasters, terrorism, war, telecommunication failures and cyber security attacks, such as computer viruses, computer hacking, acts of vandalism or theft, malware or other malicious codes, phishing, employee error or malfeasance, or other unauthorized access. Any system failure or accident that causes interruptions in our operations could result in a material disruption to our business. We may also incur additional costs to remedy damages caused by such disruptions. Any future significant compromise or breach of our data security, whether external or internal, or misuse of customer, associate, supplier or company data, could result in significant costs, lost sales, fines, lawsuits, and damage to our reputation. Any compromise of our security could also result in a violation of applicable privacy and other laws, unauthorized access to information of ours and others, significant legal and financial exposure, damage to our reputation, loss or misuse of the information and a loss of confidence in our security measures, which could harm our business.
We have programs in place to detect, contain and respond to data security incidents. However, the ever-evolving threats mean we and our third-party service providers and vendors must continually evaluate and adapt our respective systems and processes and overall security environment. Even the most well protected information, networks, systems and facilities remain potentially vulnerable when considering the rapid pace of change in this area. There can be no assurance that our efforts to maintain the security and integrity of our systems will be effective, or that we will be able to maintain our systems free from security breaches, system compromises, misuses of data, or other operational interruptions. Accordingly, we may be unable to prevent major security breaches or entirely mitigate the risk of other system interruptions or failures.
We could also be negatively impacted by similar disruptions to the operations of our vendors or outsourced service providers.
The General Partner's stock price and trading volume may be volatile, which could result in substantial losses to its shareholders and to the Partnership's unitholders, if and when they convert their Limited Partner Units to shares of the General Partner's common stock.
The market price of the General Partner's common stock could change in ways that may or may not be related to our business, our industry or our operating performance and financial condition. In addition, the trading volume in the General Partner's common stock may fluctuate and cause significant price variations to occur. Some of the factors that could negatively affect the General Partner's share price, or result in fluctuations in the price or trading volume of the General Partner's common stock, include uncertainty in the markets, general market and economic conditions, as well as those factors described in these "Risk Factors" and in other reports that we file with the SEC.
Many of these factors are beyond our control, and we cannot predict their potential effects on the price of the General Partner's common stock. If the market price of the General Partner's common stock declines, then its shareholders and the Partnership's unitholders, respectively, may be unable to resell their shares and units upon terms that are attractive to them. We cannot assure that the market price of the General Partner's common stock will not fluctuate or decline significantly in the future. In addition, the securities markets in general may experience considerable unexpected price and volume fluctuations.
We are subject to certain provisions that could discourage change-of-control transactions, which may reduce the likelihood of the General Partner's shareholders receiving a control premium for their shares.
Indiana anti-takeover legislation and certain provisions in our governing documents, as we discuss below, may discourage potential acquirers from pursuing a change-of-control transaction with us. As a result, the General Partner's shareholders may be less likely to receive a control premium for their shares.
Ownership Restriction. Subject to certain exceptions, the General Partner's charter provides that no person or entity may beneficially own, or be deemed to own by virtue of the applicable constructive ownership provisions of the Code, more than 9.8% (in value or by number of shares, whichever is more restrictive) of the General Partner's outstanding common stock or 9.8% in value of its outstanding stock.
Unissued Preferred Stock. The General Partner's charter permits its board of directors to classify unissued preferred stock by setting the rights and preferences of the shares at the time of issuance. This power enables the General Partner's board to adopt a shareholder rights plan, also known as a poison pill. Although the General Partner has repealed its previously existing poison pill and its current board of directors has adopted a policy not to adopt a shareholder rights plan without shareholder approval, the General Partner's board can change this policy at any time. The adoption of a poison pill would discourage a potential bidder from acquiring a significant position in the General Partner without the approval of its board.
Business-Combination Provisions of Indiana Law. The General Partner has not opted out of the business-combination provisions of the Indiana Business Corporation Law. As a result, potential bidders may have to negotiate with the General Partner's board of directors before acquiring 10% of its stock. Without securing board approval of the proposed business combination before crossing the 10% ownership threshold, a bidder would not be permitted to complete a business combination for five years after becoming a 10% shareholder. Even after the five-year period, a business combination with the significant shareholder would either be required to meet certain per share price minimums as set forth in the Indiana Business Corporation Law or to receive the approval of a majority of the disinterested shareholders.
Control-Share-Acquisition Provisions of Indiana Law. The General Partner has not opted out of the provisions of the Indiana Business Corporation Law regarding acquisitions of control shares. Therefore, those who acquire a significant block (at least 20%) of the General Partner's shares may only vote a portion of their shares unless its other shareholders vote to accord full voting rights to the acquiring person. Moreover, if the other shareholders vote to give full voting rights with respect to the control shares and the acquiring person has acquired a majority of the General Partner's outstanding shares, the other shareholders would be entitled to special dissenters' rights.
Supermajority Voting Provisions. The General Partner's charter prohibits business combinations or significant disposition transactions with a holder of 10% of its shares unless:
•The holders of 80% of the General Partner's outstanding shares of capital stock approve the transaction;
•The transaction has been approved by three-fourths of those directors who served on the General Partner's board before the shareholder became a 10% owner; or
•The significant shareholder complies with the "fair price" provisions of the General Partner's charter.
Among the transactions with large shareholders requiring the supermajority shareholder approval are dispositions of assets with a value greater than or equal to $1,000,000 and business combinations.
Operating Partnership Provisions. The limited partnership agreement of the Partnership contains provisions that could discourage change-of-control transactions, including a requirement that holders of at least 90% of the outstanding Common Units approve:
•Any voluntary sale, exchange, merger, consolidation or other disposition of all or substantially all of the assets of the Partnership in one or more transactions other than a disposition occurring upon a financing or refinancing of the Partnership;
•The General Partner's merger, consolidation or other business combination with another entity unless after the transaction substantially all of the assets of the surviving entity are contributed to the Partnership in exchange for Common Units;
•The General Partner's assignment of its interests in the Partnership other than to one of its wholly owned subsidiaries; and
•Any reclassification or recapitalization or change of outstanding shares of the General Partner's common stock other than certain changes in par value, stock splits, stock dividends or combinations.
We are dependent on key personnel.
The General Partner's executive officers and other senior officers have a significant role in the success of our Company. Our ability to retain our management group or to attract suitable replacements should any members of the management group leave our Company is dependent on the competitive nature of the employment market. The loss of services from key members of the management group or a limitation in their availability could adversely impact our financial condition and cash flow. Further, such a loss could be negatively perceived in the capital markets.
Item 1B.
Item 1B. Unresolved Staff Comments
We have no unresolved comments with the SEC staff regarding our periodic or current reports under the Exchange Act.
Item 2.
Item 2. Properties
Product Review
As of December 31, 2020, we own interests in 537 primarily industrial properties encompassing 159.6 million net rentable square feet (including 40 unconsolidated joint venture in-service properties with 11.5 million square feet, 16 consolidated properties under development with 6.9 million square feet and one unconsolidated joint venture property under development with 517,000 square feet).
Industrial Properties: We own interests in 534 industrial properties encompassing 159.4 million square feet (99.9% of our total square feet). These properties are primarily logistics facilities with clear ceiling heights of 28 feet or more.
Non-reportable: We own interests in three buildings, which are not industrial properties and are not presented within our reportable segments, totaling 211,000 square feet (0.1% of our total square feet).
See Consolidated Financial Statement Schedule III - Real Estate Properties and Accumulated Depreciation for a detailed listing of the Company’s properties and related encumbrances.
Land: We own, including through ownership interests in unconsolidated joint ventures (with acreage not adjusted for our percentage ownership interest), 1,000 acres of land and control an additional 800 acres through purchase options. Over 500 acres of the 600 acres of land that we directly own, are intended to be used for the development of industrial properties and can support over 7.3 million square feet of industrial developments. All of our approximately 400 acres of land held by unconsolidated joint ventures, are also intended to be used for the development of industrial properties. We directly own approximately 100 acres of land that we do not consider strategic and that will be sold to the extent that market conditions permit us to achieve what we believe to be acceptable sale prices.
Property Descriptions
The following tables represent the geographic highlights of consolidated and unconsolidated joint venture in-service properties in our primary markets.
Consolidated Properties
Unconsolidated Joint Venture Properties
(1)Represents the average annual base rental payments, on a straight-line basis for the term of each lease, from space leased to tenants as of December 31, 2020, excluding amounts paid by tenants as reimbursement for operating expenses. Unconsolidated joint venture properties are shown at 100% of square feet and net effective rents, without regard to our ownership percentage.
(2)Annual net effective rent per leased square foot.
(3)Represents properties not located in our primary markets.
Item 3.
Item 3. Legal Proceedings
We are not subject to any pending legal proceedings, other than routine litigation arising in the ordinary course of business. We do not expect these legal proceedings to have a material adverse effect on our financial condition, results of operations, or liquidity.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5.
Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information and Holders
The General Partner's common stock is listed for trading on the NYSE under the symbol "DRE." There is no established trading market for the Partnership's Common Units. As of February 17, 2021, there were 4,656 record holders of the General Partner's common stock and 79 record holders of the Partnership's Common Units.
Stock Performance Graph
The following line graph compares the change in the General Partner's cumulative total shareholders' return on shares of its common stock to the cumulative total return of the Standard and Poor's 500 Stock Index ("S&P 500") and the FTSE NAREIT Equity REITs Index ("NAREIT Index") from December 31, 2015 to December 31, 2020. The graph assumes an initial investment of $100 in the common stock of the General Partner and each of the indices on December 31, 2015, and the reinvestment of all dividends. The performance graph is not necessarily indicative of future performance.
This graph and the accompanying text are not “soliciting material,” are not deemed filed with the SEC and are not to be incorporated by reference in any filing by the company under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date hereof and irrespective of any general incorporation language in any such filing.
Tax Characterization of Dividends
A summary of the tax characterization of the dividends paid per common share of the General Partner for the years ended December 31, 2020, 2019 and 2018 follows:
See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Uses of Liquidity - Dividend and Distribution Requirements", below, for more information on our dividend policy.
Sales of Unregistered Securities
The General Partner did not sell any of its securities during the year ended December 31, 2020 that were not registered under the Securities Act.
Issuer Purchases of Equity Securities
From time to time, we may repurchase our securities under a repurchase program that initially was approved by the General Partner's board of directors and publicly announced in October 2001 (the "Repurchase Program").
During 2020 we did not repurchase any equity securities under the Repurchase Program.
On January 27, 2021 the General Partner's board of directors adopted a resolution that amended and restated the Repurchase Program and delegated authority to management to repurchase a maximum of $300.0 million of the General Partner's common shares, $750.0 million of the Partnership's debt securities and $500.0 million of the General Partner's preferred shares, subject to the prior notification of the Chairperson of the finance committee of the board of directors of planned repurchases within these limits.
Item 6.
Item 6. Selected Financial Data
None.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the Consolidated Financial Statements included in Item 15. Exhibits and Financial Statement Schedules of this report and the matters described under Item 1A. Risk Factors.
A discussion regarding our financial condition and results of operations for 2020 compared to 2019 is under the Results of Operations section below. Our financial condition for 2018 and results of operations for 2019 compared to 2018 can be found under Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, which is incorporated herein by this reference to our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, filed with the SEC on February 25, 2020, and is available on the SEC’s website at www.sec.gov and the Investor Relations section of our website at www.dukerealty.com.
Business Overview
The General Partner and Partnership collectively specialize in the ownership, management and development of industrial real estate. The General Partner is a self-administered and self-managed REIT that began operations in 1986 and is the sole general partner of the Partnership. The Partnership is a limited partnership formed in 1993, at which time all of the properties and related assets and liabilities of the General Partner, as well as proceeds from a secondary offering of the General Partner's common shares, were contributed to the Partnership. Simultaneously, the Partnership completed the acquisition of Duke Associates, a full-service commercial real estate firm operating in the Midwest whose operations began in 1972. We operate the General Partner and the Partnership as one enterprise, and therefore, our discussion and analysis refers to the General Partner and its consolidated subsidiaries, including the Partnership, collectively.
Our business operations primarily consist of two reportable operating segments: rental operations of industrial properties and service operations. Rental operations of industrial properties represent the ownership and development of industrial properties and is the primary component of our revenues and earnings. Service operations generate additional revenues from providing various real estate services primarily relating to development, construction management and property management services to customers, unconsolidated joint ventures and third-party owners.
Our overall strategy is to increase our investment in quality industrial properties primarily through development, on both a speculative and build-to-suit basis, supplemented with acquisitions in the markets we believe have the highest growth potential.
At December 31, 2020, we:
•Owned or jointly controlled 537 primarily industrial properties, of which 520 properties with 152.2 million square feet were in service and 17 properties with 7.4 million square feet were under development. The 520 in-service properties were comprised of 480 consolidated properties with 140.7 million square feet and 40 unconsolidated joint venture properties with 11.5 million square feet. The 17 properties under development consisted of 16 consolidated properties with 6.9 million square feet and one unconsolidated joint venture property with 517,000 square feet.
•Owned directly, or through ownership interests in unconsolidated joint ventures (with acreage not adjusted for our percentage ownership interest), approximately 1,000 acres of land and controlled approximately 800 acres through purchase options.
Nationwide demand for industrial properties continues to be strong in the current economic environment as the COVID-19 pandemic has accelerated both consumer acceptance of e-commerce and the requirements of many retailers to increase inventory levels. Our operational focus is to maintain occupancy at high levels and to focus on rental rate growth. The occupancy of our consolidated industrial portfolio increased to 97.4% at December 31, 2020 as compared to 96.6% at December 31, 2019. Our annual net effective rents for both renewals and new second generation leases, on a combined basis, for consolidated properties grew 28.2% in 2020 compared to 2019. In the current environment of rising rental rates for industrial properties in many of the markets in which we operate, we believe there is potential for continued future rental rate growth to the extent we are able to renew or backfill expiring leases and maintain high levels of occupancy.
Operational Strategy
Our operational focus is to drive profitability by maximizing cash from operations as well as NAREIT FFO through (i) maintaining property occupancy, increasing rental rates and prioritizing timely collection of monthly rental payments, while also keeping lease-related capital costs contained, by effectively managing our portfolio of existing properties; (ii) selectively developing new build-to-suit, substantially pre-leased and, in select markets, speculative development projects; and (iii) providing a full line of real estate services to our tenants and to third parties.
Asset Strategy
Our strategic objectives include (i) increasing our investment in quality industrial properties through development, including facilities with sustainable design features that will meet customer needs; (ii) acquiring properties primarily in coastal Tier 1 markets which we believe provide the best potential for future rental growth; and (iii) maintaining an optimal land inventory through selected strategic land acquisitions and new development activity. We are continuing to execute our asset strategy through a disciplined approach by identifying development opportunities, identifying select acquisition targets where the asset quality and pricing meet our objectives and continually evaluating our portfolio for disposition by regularly identifying assets that no longer meet our long-term objectives.
Capital Strategy
Our capital strategy is to maintain a strong balance sheet by actively managing the components of our capital structure in coordination with the execution of our overall operational and asset strategies. We are focused on maintaining our current investment grade ratings from our credit rating agencies. As of December 31, 2020, our senior unsecured notes have been assigned a rating of Baa1 by Moody's Investors Services and BBB+ by Standard & Poor's Ratings Group and we are focused on maintaining such ratings in order to maintain access to liquidity. A securities rating is not a recommendation to buy, sell, or hold securities and is subject to revision or withdrawal at any time by the rating organization.
In support of our capital strategy, we employ an asset disposition program to sell certain real estate assets, which generate proceeds that can be recycled into new property investments that better fit our growth objectives or otherwise manage our capital structure.
We continue to focus on maintaining a balanced and flexible capital structure which includes: (i) extending and sequencing the maturity dates of our outstanding debt obligations; (ii) borrowing primarily at fixed rates; and (iii) issuing common equity as needed to maintain appropriate leverage parameters or support significant strategic developments or acquisitions. With our successes to date and continued focus on maintaining a strong balance sheet, we expect to be in a position to be opportunistic in our investment opportunities.
Environmental, Social and Governance ("ESG") Strategy
We are focused on promoting our growth in a sustainable way, one that succeeds by delivering long-term value for our stakeholders. As part of our vision to continually set the standard for maximizing stakeholder value, we have a long-standing commitment to sustainable practices in environmental, social and corporate governance initiatives. On December 17, 2019, we adopted a Sustainable Development Policy intended to increase the operational efficiency of our buildings and promote sustainable design principles. We are committed to integrating innovative, sustainable building design features in alignment with U.S. Green Building Council’s® Leadership in Energy and Environmental Design (or LEED®), including constructing to LEED® criteria and achieving certification in all new developments where feasible. While we do not control most of the utility usage at our properties, we have been partnering with a third party data management provider since 2018 in order to help monitor and manage the utility usage that we do control. In 2018, we also became a member of GRESB, a leading provider of real estate ESG benchmarking and performance assessments. Since joining, our GRESB score has steadily increased, evidencing our commitment and continued progress. We expect to continue participating in the GRESB benchmarking assessments.
In October 2018, the Sustainability Accounting Standards Board issued the Real Estate Sustainability Accounting Standards. The standards are intended to provide a minimum set of sustainability metrics for disclosure in SEC filings, such as this Form 10-K. We understand the importance of reporting comparable, consistent and financially material sustainability metrics. Below is a chart showing our information for the applicable metrics.
TopicAccounting MetricCodeOur Information
Energy ManagementDescription of how building energy management considerations are integrated into property investment analysis and operational strategy
IF-RE-130a.5We integrate energy usage reduction measures on all new developments, incorporating LEED certification requirements and applicable aspects of our own sustainability policies/programs. These measures include energy modeling, high efficiency equipment (HVAC and lighting), and climate zone appropriate design factors. We have an ongoing lighting retrofit program, replacing outdated light fixtures with LED high efficiency fixtures. In 2020 we partnered with solar developers to increase the number of buildings in our portfolio with rooftop solar panels.
Water ManagementDescription of water management risks and discussion of strategies and practices to mitigate those risks
IF-RE-140a.4We integrate water reduction measures on all new developments and renovation, incorporating LEED certification or applicable aspects of our own sustainability policies/programs. These measures include the use of WaterSense® fixtures for all domestic usage, xeriscaping to minimize or eliminate the need for irrigation, and water usage monitoring, where available and appropriate.
Climate Change AdaptationArea of properties located in 100-year flood zones, by property subsectorIF-RE-450a.110.8 million square feet.
In January 2021, we issued $450.0 million of senior unsecured notes with a stated interest rate of 1.75%, which will mature on February 1, 2031. These notes are our second green bond issuance with the first issuance completed in November 2019. The net proceeds will be used to finance future or refinance recently completed “eligible green projects”. These projects may include green buildings, energy efficiency projects, sustainable water and wastewater management systems, renewable energy projects, clean transportation solutions and pollution prevention and control.
In addition to our environmental initiatives, we are committed to fair compensation, fostering a dynamic and balanced work environment and providing employees with developmental opportunities to perform well and derive satisfaction from their work. We encourage our associates to participate in volunteer and community activities and support those who do participate by providing each associate with two paid community days per year. We also have charitable contribution programs, such as our dollars for doers program (matching dollars for volunteer hours spent) and our matching gifts program (matching dollars for employee donations to charities). In addition, we partner with various charitable organizations, including the American Red Cross since 2017. We maintain a formal and structured diversity, equity and inclusion program. We have increased diversity within our board of directors and 50% of the Independent Directors of the board are female or people of color. We implemented a Vendor Code of Conduct that outlines our expectations and standards for how our vendors operate while doing business on our behalf. Through all of these initiatives and others, we endeavor to make a positive impact on the communities in which we conduct business.
We strive to maintain an effective corporate governance structure and comply with applicable laws, rules, regulations and policies. Further, we publish Corporate Responsibility Reports that formally communicate our commitments and leadership around ESG issues. Please see “Item 1 - Corporate Governance” for more information regarding our governance initiatives.
Through all of our environmental, social and governance efforts, we demonstrate that operating and developing commercial real estate can be conducted with a conscious regard for the environment and community, while also benefiting our investors, employees, tenants and the communities in which we operate.
Results of Operations
A summary of our operating results and property statistics for each of the years in the three-year period ended December 31, 2020, is as follows (in thousands, except number of properties and per share or per Common Unit data):
Year in Review
The United States economy in 2020 experienced an unprecedented downturn as a result of the COVID-19 pandemic with the gross domestic product declining by 3.5%. The recession was caused by dramatic changes in consumer behavior linked to business shutdowns, travel restrictions, and social distancing during the pandemic. The magnitude of the declines in gross domestic product and employment in the spring was unprecedented. Since then, economic activity and job growth have begun to recover as parts of the economy reopened, bolstered by the initial dissemination of vaccines and government stimulus, but remain well below pre-pandemic levels. The 10-year treasury yield trended down throughout the year fluctuating from 0.5% to 1.9% and ending the year at 0.9%, down from 1.9% at the end of 2019. While the economy has declined overall during 2020, the industrial real estate sector has been one of the most resilient sectors during the pandemic, which has been largely driven by e-commerce demand and additional demand from suppliers to drive up safety stock. We continued to pursue quality industrial assets in coastal Tier 1 markets during 2020. We resumed speculative development projects in the second half of the year and continued to lease up the speculative space. Despite the global crisis, we were able to execute our asset and capital strategies for the year and had a successful 2020.
The following table shows a reconciliation of net income attributable to common shareholders or common unitholders to the calculation of funds from operations ("FFO") attributable to common shareholders or common unitholders for the years ended December 31, 2020, 2019 and 2018, respectively (in thousands):
(1) FFO is a non-GAAP measure used in the real estate industry and is computed in accordance with standards established by the National Association of Real Estate Investment Trusts ("NAREIT"). NAREIT FFO is used by industry analysts and investors as a supplemental operating performance measure of a REIT. NAREIT FFO is calculated as net income attributable to the common shareholders of the General Partner in accordance with GAAP excluding depreciation and amortization related to real estate, gains and losses on sales of real estate assets (including real estate assets incidental to our business), gains and losses from change in control, impairment charges related to real estate assets (including real estate assets incidental to our business) and similar adjustments for unconsolidated partnerships and joint ventures, all net of related taxes.
The most comparable GAAP measure to NAREIT FFO is net income attributable to common shareholders or common unitholders. Management believes it is a useful indicator of consolidated operating performance, which improves the understanding of operating results of REITs among the investing public, makes comparisons of REIT operating results more meaningful and enables investors and analysts to readily identify the operating results of the long-term assets that form the core of a REIT's activity.
Net income attributable to the common shareholders of the General Partner for the year ended December 31, 2020, was $299.9 million, compared to net income of $429.0 million for the year ended December 31, 2019. Net income attributable to the common unitholders of the Partnership for the year ended December 31, 2020, was $302.6
million, compared to net income of $432.7 million for the year ended December 31, 2019. The decrease in net income in 2020 for the General Partner and the Partnership, when compared to 2019, was primarily the result of lower gains on property sales and higher losses on debt extinguishment during 2020.
NAREIT FFO attributable to common shareholders of the General Partner totaled $521.6 million for the year ended December 31, 2020, compared to $510.5 million for 2019. NAREIT FFO attributable to common unitholders of the Partnership totaled $526.3 million for the year ended December 31, 2020, compared to $514.9 million for 2019. The increase to NAREIT FFO from 2019 for the General Partner and the Partnership was primarily driven by improved occupancy, rental rate growth and new developments being placed into service and leased up, partially offset by debt extinguishment costs recognized during 2020.
In accordance with our strategic plan, we continue to increase our investment in high-quality industrial properties, with build-to-suit developments across all of our markets and most of our speculative development focused in the markets we believe have the best long-term growth potential. Additionally, we continued to maintain high occupancy levels through 2020 and quickly lease a significant portion of our speculative development projects. Highlights of our 2020 strategic and operational activities are as follows:
•We generated $336.3 million of total net cash proceeds from the disposition of seven consolidated buildings and 157 acres of wholly owned undeveloped land.
•We acquired ten industrial properties during the year ended December 31, 2020 with a total asset value of $424.9 million.
•We started new development projects with expected total costs of $795.6 million, which included $78.0 million of expected total costs for development projects started within two unconsolidated joint ventures. The development projects started in 2020 were, in aggregate, 62.0% leased at December 31, 2020.
•We placed 18 newly completed consolidated development projects in service, which totaled 6.8 million square feet with total costs of $693.8 million at December 31, 2020. These properties were 93.7% leased at December 31, 2020. Two newly completed projects owned by unconsolidated joint ventures were also placed in service, totaling 491,000 square feet with total costs of $27.6 million (square feet and costs shown at 100%), during 2020. These properties were 100% leased at December 31, 2020.
•The total estimated cost of our properties under construction at December 31, 2020, with costs for unconsolidated properties shown at 100%, totaled $1.10 billion, with $690.1 million of such costs already incurred. The total estimated cost for the one unconsolidated joint venture property under construction at December 31, 2020 was $57.0 million, with $22.6 million of such costs already incurred. The consolidated properties under construction were 64.5% pre-leased, while the unconsolidated joint venture property under construction was 100% pre-leased.
•Income from continuing operations before income taxes was $297.5 million and $440.9 million for the twelve months ended December 31, 2020 and 2019, respectively.
•Same-property net operating income, on a cash basis, as defined hereafter under "Supplemental Performance Measures", increased by 5.0% for the twelve months ended December 31, 2020, as compared to the same period in 2019.
•As the result of leasing up space in speculative developments throughout 2020, the percentage of total square feet leased for our in-service portfolio of consolidated properties increased from 96.6% at December 31, 2019 to 97.4% at December 31, 2020.
•Total leasing activity for our consolidated properties totaled 25.5 million square feet in 2020 compared to 28.7 million square feet in 2019.
•Total leasing activity for our consolidated and unconsolidated joint venture properties in 2020 included 6.1 million and 1.1 million, respectively, square feet of lease renewals (excludes early renewals and short term renewals), which represented 65.6% and 86.8%, respectively, retention rates on a square foot basis. New
second generation and renewal leases, on a combined basis, executed for consolidated and unconsolidated joint venture properties during the year resulted in 28.2% and 33.8%, respectively, increases to net effective rents ("net effective rents" is defined hereafter in the "Key Performance Indicators" section) when compared to the previous leases of the same space.
We utilized the capital generated from dispositions during the year to reduce debt and to fund our development activities. Highlights of our key financing activities are as follows:
•During 2020, the General Partner issued 4.6 million common shares under its at the market ("ATM") equity program, generating gross proceeds of $177.1 million and, after deducting commissions and other costs, net proceeds of $175.0 million.
•In February 2020, we issued $325.0 million of senior unsecured notes that bear interest at a stated interest rate of 3.05%, have an effective interest rate of 3.19%, and mature on March 1, 2050. Proceeds from the unsecured notes offering were primarily used to repay the $300.0 million of senior unsecured notes bearing a stated interest rate of 4.38% and with a scheduled maturity of 2022. In connection with the early redemption of these notes, we recognized a loss of $17.8 million consisting of a prepayment premium and the write-off of unamortized deferred financing costs.
•In June 2020, we issued $350.0 million of senior unsecured notes, which bear interest at a stated interest rate of 1.75%, have an effective interest rate of 1.85% and mature on July 1, 2030. Proceeds from the unsecured notes offering were primarily used to repurchase and cancel $216.3 million of 3.88% senior unsecured notes due 2022 pursuant to a tender offer completed by the Partnership in June 2020. In connection with the early cancellation of these notes, we recognized a loss of $15.1 million consisting of a prepayment premium and the write-off of unamortized deferred financing costs.
•During 2020, we repaid one fixed rate secured loan, totaling $9.0 million, which had a stated interest rate of 5.61%.
COVID-19
During 2020, in response to the COVID-19 pandemic, we have made various changes to our operations in order to support the health and safety of our associates and the communities in which we operate. Throughout the pandemic, accelerated e-commerce demand drove strong leasing activity, while the pandemic also negatively impacted a relatively small portion of our tenant base that operate in lines of business, such as event planning, that were most acutely impacted by COVID-19. Through December 31, 2020, we executed deferral agreements with certain customers that allowed for $7.4 million of total scheduled rental payments to be deferred and repaid in future periods. The substantial majority of these agreements were short term in nature and required repayment of the deferred amounts within twelve months of their execution. We have collected all amounts due under such short term rent deferral agreements through the end of 2020. We temporarily paused our acquisition, disposition and development activities at the onset of the pandemic but such activities were resumed at an accelerated pace during the second half of the year.
The pandemic's impact on the overall global economy is continuing and the ultimate impact cannot be predicted at this time. Please see Part I, Item 1A, "Risk Factors" for additional information about the potential impacts the pandemic may have on our business and results of operations.
Supplemental Performance Measures
In addition to NAREIT FFO we use (i) Property Level Net Operating Income - Cash Basis ("PNOI") and (ii) Same-Property Net Operating Income - Cash Basis ("SPNOI") as supplemental non-GAAP performance measures. Management believes that the use of PNOI and SPNOI combined with net income (which remains the primary measure of performance), improves the understanding of operating results of REITs among the investing public and makes comparisons of REIT operating results more meaningful. The most comparable GAAP measure to PNOI and SPNOI is income from continuing operations before income taxes.
PNOI and SPNOI each exclude expenses that materially impact our overall results of operations and, therefore, should not be considered as a substitute for income from continuing operations before income taxes, or any other measures derived in accordance with GAAP. Furthermore, these metrics may not be comparable to other similarly titled measures of other companies.
Property Level Net Operating Income - Cash Basis
PNOI is comprised of rental revenues from continuing operations less rental expenses and real estate taxes from continuing operations, along with certain other adjusting items. As a performance metric that consists of only the cash-based revenues and expenses directly related to ongoing real estate rental operations, PNOI is narrower in scope than NAREIT FFO.
PNOI, as we calculate it, may not be directly comparable to similarly titled, but differently calculated, measures for other REITs. We believe that PNOI is another useful supplemental performance measure, as it is an input in many REIT valuation models and it provides a means by which to evaluate the performance of the properties within our Rental Operations segments. The operations of our industrial properties, as well as our non-reportable Rental Operations (our residual non-industrial properties that have not yet been sold, referred to throughout as "non-reportable"), are collectively referred to as "Rental Operations."
The major factors influencing PNOI are occupancy levels, acquisitions and sales, development properties that achieve stabilized operations, rental rate increases or decreases, and the recoverability of operating expenses.
Note 10 to the consolidated financial statements included in Part IV, Item 15 of this Report shows a calculation of our PNOI for the years ended December 31, 2020, 2019 and 2018 and provides a reconciliation of PNOI for our Rental Operations segments to income from continuing operations before income taxes.
Same-Property Net Operating Income - Cash Basis
We also evaluate the performance of our properties, including our share of properties we jointly control, on a "same-property" basis, using a metric referred to as SPNOI. We view SPNOI as a useful supplemental performance measure because it improves comparability between periods by eliminating the effects of changes in the composition of our portfolio.
On an individual property basis, SPNOI is generally computed in a consistent manner as PNOI.
We define our "same-property" population once a year at the beginning of the current calendar year and include buildings that were stabilized (the term "stabilized" means properties that have reached 90% leased or that have been in-service for at least one year since development completion or acquisition) as of January 1 of the prior calendar year. The "same-property" pool is also adjusted to remove properties that were sold subsequent to the beginning of the current calendar year. As such, the "same-property" population for the period ended December 31, 2020 includes all properties that we owned or jointly controlled at January 1, 2020, which had both been owned or jointly controlled and had reached stabilization by January 1, 2019, and have not been sold.
A reconciliation of income from continuing operations before income taxes to SPNOI is presented as follows (in thousands, except percentage data):
The composition of the line items titled "Rental Operations revenues and expenses excluded from PNOI" and "Non-Segment Items" from the table above are shown in greater detail in Note 10 to the consolidated financial statements included in Part IV, Item 15 of this Report.
We believe that the factors that impact SPNOI are generally the same as those that impact PNOI. The following table details the number of properties, square feet, average commencement occupancy and average cash rental rate for the properties included in SPNOI for the respective periods:
Key Performance Indicators
Our operating results depend primarily upon rental income from our Rental Operations. The following discussion highlights the metrics that drive the performance of our Rental Operations, which management uses to operate the business, and that we consider to be critical drivers of future revenues.
Occupancy Analysis
Occupancy is an important metric for management and our investors for understanding our financial performance. Our ability to maintain high occupancy rates is among the principal drivers of maintaining and increasing rental revenue. The following table sets forth percent leased and average net effective rent information regarding our in-service portfolio of rental properties at December 31, 2020 and 2019, respectively:
The increase in occupancy at December 31, 2020 within our industrial portfolio, when compared to December 31, 2019, primarily resulted from leasing up recently delivered speculative developments while renewing or backfilling existing leases to maintain the occupancy level within our existing base of properties.
Vacancy Activity
The following table sets forth vacancy activity, shown in square feet, from our in-service rental properties for the year ended December 31, 2020 (in thousands):
Total Leasing Activity
Our ability to maintain and improve occupancy and net effective rents primarily depends upon our continuing ability to lease vacant space. The volume and quality of our leasing activity is closely scrutinized by management in operation of the business and provides useful information regarding future performance. The initial leasing of development projects or vacant space in acquired properties is referred to as first generation lease activity. The leasing of such space that we have previously held under lease to a tenant is referred to as second generation lease activity. Second generation lease activity may be in the form of renewals of existing leases or new second generation leases of previously leased space. The total leasing activity for our consolidated and unconsolidated industrial rental properties, expressed in square feet of leases signed, is as follows for the years ended December 31, 2020 and 2019 (in thousands):
Second Generation Leases
The following table sets forth the estimated costs of tenant improvements and leasing commissions, on a per square foot basis, that we are obligated to fulfill under the second generation industrial leases signed for our rental properties, during the years ended December 31, 2020 and 2019:
Growth in average annual net effective rents for new second generation and renewal leases, on a combined basis, for our consolidated and unconsolidated rental properties, is as follows for the years ended December 31, 2020 and 2019:
Lease Expirations
The table below reflects our consolidated in-service portfolio lease expiration schedule at December 31, 2020 (in thousands, except percentage data and number of leases):
Building Acquisitions
Our decision process in determining whether or not to acquire a property or portfolio of properties involves several factors, including expected rent growth, multiple yield metrics, property locations and expected demographic growth in each location, current occupancy of the properties, tenant profile and remaining terms of the in-place leases in the properties. It is difficult to predict which markets may present acquisition opportunities that align with our strategy. Because of the numerous factors considered in our acquisition decisions, we do not establish specific target yields for future acquisitions.
We acquired ten buildings during the year ended December 31, 2020 and six buildings during the year ended December 31, 2019. The following table summarizes the acquisition price, percent leased at time of acquisition and in-place yields of industrial building acquisitions (in thousands, except percentage data):
Building Dispositions
We regularly work to identify, consider and pursue opportunities to dispose of properties on an opportunistic basis and on a basis that is generally consistent with our strategic plans. Dispositions of properties is a source of capital to fund future investment.
We sold seven consolidated buildings during the year ended December 31, 2020 and 28 consolidated buildings during the year ended December 31, 2019. The following table summarizes the sales prices, in-place yields and percent leased of industrial building dispositions (in thousands, except percentage data):
Development
We expect to generate future earnings from Rental Operations as development properties are placed in service and leased. Development activities, and our ability to lease those developments, are viewed by management as key indicators of future earnings growth and provide useful information to investors for the same reasons.
We had 7.4 million square feet of property under development with total estimated costs upon completion of $1.10 billion at December 31, 2020 compared to 8.9 million square feet with total estimated costs upon completion of $1.06 billion at December 31, 2019. The square footage and estimated costs include both consolidated properties and unconsolidated joint venture development activity at 100%.
The following table summarizes our properties under development at December 31, 2020 (in thousands, except percentage data):
Comparison of Year Ended December 31, 2020 to Year Ended December 31, 2019
Rental and Related Revenue
The following table sets forth rental and related revenue from continuing operations (in thousands):
The primary reasons for the increase in rental and related revenue from continuing operations were:
•We acquired 16 properties and placed 36 wholly owned developments in service from January 1, 2019 to December 31, 2020, which provided incremental revenues from continuing operations of $66.9 million in the year ended December 31, 2020 when compared to 2019.
•Increased occupancy and rental rates within our "same-property" portfolio, as well as the lease up of properties that were placed in service prior to January 1, 2019 but were not in the "same-property" portfolio, also contributed to the increase to rental and related revenue from continuing operations.
•The increase in rental revenue included a $17.3 million increase in expense recoveries primarily related to higher recoverable real estate taxes compared to 2019.
•The sale of 35 in-service properties since January 1, 2019, which did not meet the criteria to be classified within discontinued operations, resulted in a decrease of $23.3 million to rental and related revenue from continuing operations in the year ended December 31, 2020, as compared to 2019, which partially offset the aforementioned increases to rental and related revenue from continuing operations.
•The increase in rental revenue was also partially offset by a $4.0 million increase in collectability reserves for contractual and straight-line receivables, primarily as a result of current economic conditions caused by the COVID-19 pandemic during 2020.
Rental Expenses and Real Estate Taxes
The following table sets forth rental expenses and real estate taxes from continuing operations (in thousands):
Overall, rental expenses from continuing operations increased by $1.1 million in 2020 compared to 2019. The increase to rental expenses was primarily the result of acquisitions and developments placed in service from January 1, 2019 to December 31, 2020, partially offset by the impact of property sales that did not meet the criteria to be classified within discontinued operations and decreased recoverable snow removal costs in 2020 compared to 2019.
Overall, real estate tax expense from continuing operations increased by $19.8 million in 2020 compared to 2019. The increase to real estate taxes was mainly the result of acquisitions and developments placed in service from January 1, 2019 to December 31, 2020, which have generally been concentrated in markets with higher tax rates and/or assessed values, and increased tax assessments in certain of our markets. These increases were partially offset by the impact of property sales that did not meet the criteria to be classified within discontinued operations.
Service Operations
The following table sets forth the components of net earnings from the Service Operations reportable segment for the years ended December 31, 2020 and 2019, respectively (in thousands):
Service Operations primarily consist of the development, construction management and general contractor services, leasing, property management and asset management for unconsolidated joint venture properties and properties owned by third parties. Service Operations are heavily influenced by the current state of the economy, as construction and development services rely on the expansion of business operations of third-party property owners and joint venture partners, while leasing and property management fees are dependent upon occupancy.
General contractor and service fee revenue, and general contractor and other service expenses, decreased as the result of lower third party construction volume during 2020.
Depreciation and Amortization
Depreciation and amortization expense from continuing operations was $353.0 million and $327.2 million for the years ended December 31, 2020 and 2019, respectively. The increase in depreciation and amortization expense for the year ended December 31, 2020 was primarily the result of continued growth in our portfolio through development and acquisitions placed in service from January 1, 2019 to December 31, 2020, partially offset by the impact of property sales that did not meet the criteria to be classified within discontinued operations.
Equity in Earnings of Unconsolidated Joint Ventures
Equity in earnings of unconsolidated joint ventures represents our ownership share of net income from investments in unconsolidated joint ventures that generally own and operate rental properties. Equity in earnings of unconsolidated joint ventures was $11.9 million and $31.4 million for the years ended December 31, 2020 and 2019, respectively. In 2019, we recorded equity in earnings of $19.4 million related to our share of the gain on sale of five unconsolidated joint venture buildings and equity in earnings of $1.3 million representing our share of gains on involuntary conversion from insurance recoveries related to storm damage in one unconsolidated joint venture.
There were no property sales by unconsolidated joint ventures during 2020.
Gain on Sale of Properties - Continuing Operations
We sold seven properties during 2020 that were classified in continuing operations, recognizing total gains on sale of $127.7 million. These properties did not meet the criteria to be classified within discontinued operations.
We sold 28 properties during 2019 that were classified in continuing operations, recognizing total gains on sale of $234.7 million. These properties did not meet the criteria to be classified within discontinued operations.
Gain on Sale of Land
Gains on sale of land totaled $10.5 million and $7.4 million for the years ended December 31, 2020 and 2019, respectively. We sold 157 acres of undeveloped land in 2020 compared to 110 acres of undeveloped land in 2019.
Impairment Charges
We recognized $5.6 million of impairment charges during the first quarter of 2020, related to writing off pre-acquisition costs, primarily non-refundable purchase deposits, for certain planned purchases of undeveloped land that we elected not to pursue due to the uncertain economic outlook at the onset of the COVID-19 pandemic.
We did not recognize any impairment charges in 2019.
General and Administrative Expenses
General and administrative expenses consist of two components. The first component includes general corporate expenses, and the second component represents the indirect operating costs not allocated to, or absorbed by, either the development, leasing and operation of our consolidated properties or our Service Operations. Such indirect operating costs are primarily comprised of employee compensation, including related costs such as benefits and wage-related taxes, but also include other ancillary costs such as travel and information technology support. Total indirect operating costs, prior to any allocation or absorption, and general corporate expenses are collectively referred to as our overall pool of overhead costs.
Those indirect costs not allocated to or absorbed by these operations are charged to general and administrative expenses. We regularly review our total overhead cost structure relative to our leasing, development and construction volume and adjust the level of total overhead, generally through changes in our level of staffing in various functional departments, as necessary, in order to control overall general and administrative expense.
General and administrative expenses were $62.4 million and $60.9 million for the years ended December 31, 2020 and 2019, respectively. The following table sets forth the factors that led to the increase in general and administrative expenses from 2019 to 2020 (in millions):
(1) We recognized approximately $4.5 million of overhead restructuring charges included within general and administrative expenses. These charges primarily related to benefits provided to certain associates that terminated employment either as part of a voluntary retirement package offered to certain eligible employees during 2020 or in connection with other organizational changes.
(2) We capitalized $6.5 million and $28.8 million of our total overhead costs to leasing and development, respectively, for consolidated properties during 2020, compared to capitalizing $6.8 million and $24.2 million of such costs, respectively, for 2019. Non-capitalizable leasing costs were $12.3 million and $12.4 million for the years ended December 31, 2020 and 2019 (these costs are presented separately in the line item "Non-Incremental Costs Related to Successful Leases" on the Consolidated Statements of Operations). Combined overhead costs capitalized to leasing and development totaled 26.7% and 22.8% of our overall pool of overhead costs for 2020 and 2019, respectively.
(3) The decrease in allocation of costs to Service Operations and Rental Operations resulted from a lower volume of third-party construction projects during 2020.
Interest Expense
Interest expense allocable to continuing operations was $93.4 million and $89.8 million for the years ended December 31, 2020 and 2019, respectively. The increase in interest expense from continuing operations for the year ended December 31, 2020 was largely the result of increased overall borrowings and lower capitalization of interest expense, partially offset by lower average interest rates during 2020 as the result of refinancing certain of our unsecured notes.
We capitalized $24.3 million and $26.5 million of interest costs during 2020 and 2019, respectively.
Debt Extinguishment
During 2020, we redeemed $300.0 million of unsecured notes with a stated interest rate of 4.38% and repurchased and canceled $216.3 million of unsecured notes with a stated interest rate of 3.88% pursuant to a tender offer completed by the Partnership. In connection with redemption and repurchase of these unsecured notes, we recognized a total loss of $32.9 million including the redemption/repayment premium and the write-off of unamortized deferred financing costs.
During 2019, we redeemed $250.0 million of unsecured notes, which had a stated interest rate of 3.88%. We recognized a loss on debt extinguishment of $6.3 million, which included a prepayment premium and the write-off of unamortized deferred financing costs.
Critical Accounting Estimates
The preparation of our consolidated financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Certain estimates, judgments and assumptions are inherently subjective and based on the existing business and market conditions, and are therefore continually evaluated based upon available information and experience. Based on the nature of our business, current economic conditions and the value of our real estate assets, we have concluded that our financial statements for all periods presented have not been materially impacted by individual accounts or classes of transaction that rely on estimates. Further, we have concluded that our financial statements for all periods presented are not materially impacted by estimates of fair value that rely upon non-observable inputs.
We have determined that judgments regarding the impairment of real estate assets represent a critical accounting estimate that has the potential to be material in future periods and has been material in certain periods prior to those presented in this Form 10-K. As the result of the strong demand, and generally appreciating values, for industrial real estate assets, we have not recognized any material impairment charges in any of the periods presented in our consolidated financial statements. As described below in our description of Critical Accounting Policies, determining whether a triggering event has taken place requires an evaluation of assumptions including occupancy levels, rental rates, capitalization rates and anticipated holding periods when evaluating real estate assets for potential impairment. We do not believe that the conclusions we reached regarding the assessment of our real estate assets for impairment, in the current economic and operating environment, would result in a materially different conclusion within any reasonable range of assumptions that could have been applied. Should economic conditions worsen, and the values of industrial assets decline in future periods, then the assumptions and estimates we may make in future impairment analyses, and potential future measurement of impairment charges, could be sensitive and could result in a material change in the range of potential outcomes.
Critical Accounting Policies
Note 2 to the Consolidated Financial Statements includes further discussion of our significant accounting policies. Our management has assessed the accounting policies used in the preparation of our financial statements and discussed them with our audit committee and independent auditors. The following accounting policies are considered critical based upon materiality to the financial statements, and to a lesser extent, the degree of judgment involved in estimating reported amounts and sensitivity to changes in industry and economic conditions:
Cost Capitalization: Direct and certain indirect costs, including interest, clearly associated with the development, construction or expansion of real estate investments are capitalized as a cost of the property.
We capitalize interest and direct and indirect project costs associated with the initial construction of a property up to the time the property is substantially complete and ready for its intended use. We capitalize all such costs through the completion of the building shell. The interest rate used to capitalize interest is based upon our average borrowing rate on existing debt.
We also capitalize direct and indirect costs, including interest costs, on vacant space during extended lease-up periods, after construction of the building shell has been completed, if costs are being incurred to ready the vacant space for its intended use. If costs and activities incurred to ready the vacant space cease, then cost capitalization is also discontinued until such activities are resumed. Once necessary work has been completed on a vacant space, project costs are no longer capitalized. We cease capitalization of all project costs on extended lease-up periods after the shorter of a one-year period after the completion of the building shell or when the property attains 90% occupancy.
In assessing the amount of indirect costs to be capitalized, we first allocate payroll costs, on a department-by-department basis, among activities for which capitalization is warranted (i.e., construction and development and leasing) and those for which capitalization is not warranted (i.e., property management, maintenance, acquisitions, dispositions, non-incremental leasing costs and general corporate functions). To the extent the employees of a department split their time between capitalizable and non-capitalizable activities, the allocations are made based on estimates of the actual amount of time spent in each activity. Once the payroll costs are allocated, the non-payroll costs of each department are allocated among the capitalizable and non-capitalizable activities in the same proportion as payroll costs.
To ensure that an appropriate amount of costs are capitalized, the amount of capitalized construction and development costs that are allocated to a specific project are limited to amounts using standards we developed. These standards are based on a percentage of the total development costs of a project. These standards are derived after considering the amounts that would be allocated if the personnel in the departments were working at full capacity. The use of these standards ensures that overhead costs attributable to downtime or to unsuccessful projects are not capitalized. Additionally, only internal leasing costs that are incremental, which are comprised of success-based leasing payments to our in-house leasing personnel, are capitalized.
Impairment of Real Estate Assets: We evaluate our real estate assets, with the exception of those that are classified as held-for-sale, for impairment whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. If such an evaluation is considered necessary, we compare the carrying amount of that real estate asset, or asset group, with the expected undiscounted cash flows that are directly associated with, and that are expected to arise as a direct result of, the use and eventual disposition of that asset, or asset group. Our estimate of the expected future cash flows used in testing for impairment is based on, among other things, our estimates regarding future market conditions, rental rates, occupancy levels, costs of tenant improvements, leasing commissions and other tenant concessions, assumptions regarding the residual value of our properties at the end of our anticipated holding period and the length of our anticipated holding period and is, therefore, subjective by nature. These assumptions could differ materially from actual results. If our strategy changes or if market conditions otherwise dictate a reduction in the holding period and an earlier sale date, an impairment loss could be recognized and such loss could be material. To the extent the carrying amount of a real estate asset, or asset group, exceeds the associated estimate of undiscounted cash flows, an impairment loss is recorded to reduce the carrying value of the asset to its fair value.
The determination of the fair value of real estate assets is also highly subjective, especially in markets where there is a lack of recent comparable transactions. We primarily utilize the income approach to estimate the fair value of our income producing real estate assets. To the extent that the assumptions used in testing long-lived assets for impairment differ from those of a marketplace participant, the assumptions are modified in order to estimate the fair value of a real estate asset when an impairment charge is measured. In addition to determining future cash flows, which make the estimation of a real estate asset's undiscounted cash flows highly subjective, the selection of the discount rate and exit capitalization rate used in applying the income approach is also highly subjective.
To the extent applicable marketplace data is available, we generally use the market approach in estimating the fair value of undeveloped land that is determined to be impaired.
Real estate assets that are classified as held-for-sale are reported at the lower of their carrying value or their fair value, less estimated costs to sell.
Acquisition of Real Estate Property and Related Assets: We generally account for real estate acquisitions as asset acquisitions as opposed to business combinations. We allocate the purchase price of acquired properties to tangible and identified intangible assets based on their relative fair values, using all pertinent information available at the date of acquisition. The allocation of the purchase price to tangible assets (buildings, tenant improvements and land) is based upon management's determination of the value of the property as if it were vacant. This “as-if vacant” value is estimated using an income, or discounted cash flow, approach that relies upon internally determined assumptions that we believe are consistent with current market conditions for similar properties. The most important assumptions in determining the allocation of the purchase price to tangible assets are the exit capitalization rate, estimated market rents and the fair value of the underlying land.
The purchase price of real estate assets is also allocated to intangible assets consisting of the above or below market component of in-place leases and the value of in-place leases. The value allocable to the above or below market component of an acquired in-place lease is determined based upon the present value (using a discount rate which reflects the risks associated with the acquired leases) of the difference between (i) the contractual amounts to be received pursuant to the lease over its remaining term and (ii) management's estimate of the amounts that would be received using fair market rates over the remaining term of the lease. The amounts allocated to above market leases are included in deferred leasing and other costs in the balance sheet and below market leases are included in other liabilities in the balance sheet; both are amortized to rental income over the remaining terms of the respective leases. Factors considered in determining the value allocable to in-place leases include estimates, during hypothetical lease up periods, related to space that is actually leased at the time of acquisition. These estimates include (i) lost rent at market rates, (ii) fixed operating costs that will be recovered from tenants and (iii) theoretical leasing commissions required to execute similar leases. These intangible assets are included in deferred leasing and other costs in the balance sheet and are amortized over the remaining term of the existing lease.
The audit committee has reviewed the critical accounting policies identified by management.
Liquidity and Capital Resources
Overview
We expect to meet our short-term liquidity requirements over the next 12 months, which include payments of dividends and distributions, completion of development projects that are currently under construction and the capital expenditures needed to maintain our current real estate assets, through working capital, net cash provided by operating activities and short term borrowings on the Partnership's unsecured line of credit. We had $295.0 million outstanding borrowings on the Partnership's $1.20 billion unsecured line of credit, had $6.3 million of cash on hand and held $47.7 million of restricted cash in escrow for future like kind exchange transactions at December 31, 2020.
In addition to our existing sources of liquidity, we expect to meet long-term liquidity requirements, such as scheduled mortgage and unsecured debt maturities, financing of development activities, acquisitions and other capital improvements, through multiple sources of capital including operating cash flow, proceeds from property dispositions and accessing the public debt and equity markets.
Sources of Liquidity
Rental Operations
Cash flows from Rental Operations is our primary source of liquidity and provides a stable source of cash flow to fund operational expenses. We believe that this cash-based revenue stream is substantially aligned with revenue recognition (except for items such as periodic straight-line rental income accruals and amortization of above or below market rents) as cash receipts from the leasing of rental properties are generally received in advance of, or a short time following, the actual revenue recognition.
We are subject to a number of risks, which have intensified as the result of the COVID-19 outbreak, related to general economic conditions, including reduced occupancy, tenant defaults and bankruptcies and potential reduction in rental rates upon renewal or re-letting of properties, any of which would result in reduced cash flow from operations.
Debt and Equity Securities
Our unsecured line of credit at December 31, 2020 is described as follows (in thousands):
The Partnership's unsecured line of credit has a borrowing capacity of $1.20 billion, with an interest rate on borrowings of LIBOR plus 0.875% (equal to 1.03% for our outstanding borrowings at December 31, 2020) and a maturity date of January 30, 2022, with options to extend until January 30, 2023. Subject to certain conditions, the terms also include an option to increase the facility by up to an additional $800.0 million, for a total of up to $2.00 billion. This line of credit provides us with an option to obtain borrowings from financial institutions that participate in the line at rates that may be lower than the stated interest rate, subject to certain restrictions.
This line of credit contains financial covenants that require us to meet certain financial ratios and defined levels of performance, including those related to fixed charge coverage, unsecured interest expense coverage and debt-to-asset value (with asset value being defined in the Partnership's unsecured line of credit agreement). At December 31, 2020, we were in compliance with all covenants under this line of credit.
The Partnership's unsecured line of credit has an interest rate that is indexed to LIBOR. In 2017, the Alternative Reference Rates Committee ("ARRC") proposed that the Secured Overnight Funding Rate ("SOFR") replace LIBOR. ARRC also proposed that the transition to SOFR from LIBOR take place by the end of 2021. As the Partnership's unsecured line of credit agreement has provisions that allow for automatic transition to a new rate and the Partnership has no other material debt arrangements that are indexed to LIBOR, we believe that the transition will not have a material impact on our consolidated financial statements.
At December 31, 2020, we had on file with the SEC an automatic shelf registration statement on Form S-3 relating to the offer and sale, from time to time, of an indeterminate amount of debt and equity securities (including guarantees of the Partnership's debt securities by the General Partner). Equity securities are offered and sold by the General Partner, and the net proceeds of such offerings are contributed to the Partnership in exchange for additional General Partner Units or Preferred Units. From time to time, we expect to issue additional securities under this automatic shelf registration statement to fund the repayment of debt, to fund development and future acquisitions and for other general corporate purposes.
The General Partner has an ATM equity program that allows it to issue new common shares from time to time, with an aggregate offering price of up to $400.0 million. During the three months ended December 31, 2020, the General Partner issued 1.7 million common shares under its ATM equity program, resulting in net proceeds of $65.9 million after paying total compensation of $666,000 to the applicable sales agents. During the year ended December 31, 2020, the General Partner issued 4.6 million common shares under its ATM equity program, generating net proceeds of $175.0 million after paying total compensation of $1.8 million to the applicable sales agents. Other fees related to these issuances, totaling $344,000, were also paid during the year ended December 31, 2020. As of December 31, 2020, the ATM equity program still had $13.4 million worth of new common shares available to issue.
In February 2020, a consolidated joint venture obtained an $18.4 million secured loan from a third party financial institution, with a fixed annual interest rate of 3.41% and a maturity date of March 1, 2035.
Also in February 2020, we issued $325.0 million of senior unsecured notes that bear interest at a stated interest rate of 3.05%, have an effective interest of 3.19%, and mature on March 1, 2050, for gross proceeds of $316.4 million.
In June 2020, we issued $350.0 million of senior unsecured notes that bear interest at a stated interest rate of 1.75%, have an effective interest of 1.85%, and mature on July 1, 2030, for gross proceeds of $346.8 million.
The Partnership has issued debt securities pursuant to certain indentures and related supplemental indentures, which also require us to comply with financial ratios and other covenants regarding our operations. We were in compliance with all such covenants at December 31, 2020.
Sale of Real Estate Assets
We regularly work to identify, consider and pursue opportunities to dispose of properties in a manner that is generally consistent with our strategic plans. Our ability to dispose of such properties on favorable terms, or at all, is dependent upon a number of factors including the availability of credit to potential buyers to purchase properties at prices that we consider acceptable. Although we believe that we have demonstrated our ability to generate significant liquidity through the disposition of non-strategic properties, potential future adverse changes to general market and economic conditions, including the uncertain economic outlook caused by the COVID-19 pandemic, could negatively impact our further ability to dispose of such properties.
Sales of land and properties provided $336.3 million in net proceeds in 2020, compared to $432.7 million in 2019 and $511.4 million in 2018.
Transactions with Unconsolidated Joint Ventures
Transactions with unconsolidated joint ventures also provide a source of liquidity. From time to time we will sell properties to unconsolidated joint ventures, while retaining a continuing interest in that entity, and receive proceeds commensurate to those interests that we do not own. Additionally, unconsolidated joint ventures will from time to time obtain debt financing or sell properties and will then distribute to us, and our joint venture partners, all or a portion of the proceeds from such transactions. There were no material transactions with unconsolidated joint ventures in 2020.
Uses of Liquidity
Our principal uses of liquidity include the following:
•property investment;
•leasing/capital costs;
•dividends and distributions to shareholders and unitholders;
•debt service and maturities;
•opportunistic repurchases of outstanding debt; and
•other contractual obligations.
Property Investment
Our overall strategy is to continue to increase our investment in quality industrial properties, primarily through development, on both a speculative and build-to-suit basis, supplemented with acquisitions in higher barrier markets with the highest growth potential. Pursuant to this strategy, we evaluate development and acquisition opportunities based upon our market outlook, including general economic conditions, supply and long-term growth potential. Our ability to make future property investments is dependent upon identifying suitable acquisition and development opportunities, and our continued access to our longer-term sources of liquidity, including issuances of debt or equity securities as well as generating cash flow by disposing of selected properties.
Leasing/Capital Costs
Tenant improvements and lease-related costs pertaining to our initial leasing of newly completed space, or vacant space in acquired properties, are referred to as first generation expenditures. Such first generation expenditures for tenant improvements are included within "development of real estate investments" in our Consolidated Statements of Cash Flows, while such expenditures for capitalizable lease-related costs are included within "other deferred leasing costs."
Cash expenditures related to the construction of a building's shell, as well as the associated site improvements, are also included within "development of real estate investments" in our Consolidated Statements of Cash Flows.
Tenant improvements and leasing costs to renew or re-let rental space that we previously leased to tenants for second generation leases are referred to as second generation expenditures. Building improvements that are not specific to any tenant, but serve to improve integral components of our real estate properties, are also second generation expenditures. One of the principal uses of our liquidity is to fund the second generation leasing/capital expenditures of our real estate investments.
The following table summarizes our second generation capital expenditures by type of expenditure, as well as capital expenditures for the development of real estate investments and for other deferred leasing costs (in thousands):
We had consolidated properties under development with an expected total cost of $1.04 billion at December 31, 2020, compared to projects with an expected cost of $1.05 billion and $709.7 million at December 31, 2019 and 2018, respectively. We had $374.9 million of remaining costs to complete for consolidated properties under development at December 31, 2020.
The capital expenditures in the table above include the capitalization of internal overhead costs. We capitalized $6.5 million, $6.8 million and $19.0 million of overhead costs that are incremental to executing leases, including both first and second generation leases, during the years ended December 31, 2020, 2019 and 2018, respectively. We capitalized $28.8 million, $24.2 million and $29.8 million of overhead costs related to development activities, including both development and tenant improvement projects on first and second generation space, during the years ended December 31, 2020, 2019 and 2018, respectively. Combined overhead costs capitalized to leasing and development totaled 26.7%, 22.8% and 35.1% of our overall pool of overhead costs at December 31, 2020, 2019 and 2018, respectively. The decrease in the overhead costs capitalized to leasing for 2020 and 2019 compared to 2018 was primarily due to the expense impact of internal costs related to successful leasing which were not capitalizable as a result of the adoption of the new lease standard on January 1, 2019 (see Note 2 to the consolidated financial statements included in Part IV, Item 15 of this Report) and was included in the line item "Non-incremental costs related to successful leases" on the Consolidated Statements of Operations and Comprehensive Income for 2020 and 2019.
Further discussion of the capitalization of overhead costs can be found in the year-to-year comparison of general and administrative expenses and Critical Accounting Policies sections of this Item 7.
In addition to the capitalization of overhead costs, the totals for development of real estate assets in the table above include the capitalization of $24.3 million, $26.5 million and $27.2 million of interest costs in the years ended December 31, 2020, 2019 and 2018, respectively.
Both our first and second generation expenditures vary significantly between leases on a per square foot basis, dependent upon several factors including the nature of a tenant's operations, the specific physical characteristics of each individual property and the market in which the property is located.
Dividend and Distribution Requirements
The General Partner is required to meet the distribution requirements of the Code in order to maintain its REIT status. We paid regular dividends or distributions of $0.96, $0.88 and $0.815 per common share or Common Unit for the years ended December 31, 2020, 2019 and 2018, respectively.
We expect to continue to distribute at least an amount equal to our taxable earnings, to meet the requirements to maintain the General Partner's REIT status, and additional amounts as determined by the General Partner's board of directors. Distributions are declared at the discretion of the General Partner's board of directors and are subject to actual cash available for distribution, our financial condition, capital requirements and such other factors as the General Partner's board of directors deems relevant.
Debt Service and Maturities
Debt outstanding at December 31, 2020 had a face value totaling $3.41 billion with a weighted average interest rate of 3.17% and maturities at various dates through 2050. Of this total amount, we had $3.06 billion of unsecured debt, $60.6 million of secured debt and $295.0 million outstanding borrowings on our unsecured line of credit at December 31, 2020. Scheduled principal amortization, maturities and early repayments of such debt totaled $529.7 million for the year ended December 31, 2020.
The following table is a summary of the scheduled future amortization and maturities of our indebtedness at December 31, 2020 (in thousands, except percentage data):
The Partnership’s unsecured line of credit is reflected in the table above as maturing in January 2023, based on the ability to exercise the two six-month extension options from its stated maturity date of January 2022 (see Note 9). In January 2021, we issued $450.0 million of senior unsecured notes that bear a stated interest rate of 1.75%, have an effective interest rate of 1.83%, and mature on February 1, 2031. Proceeds from the unsecured notes offering were initially applied to pay down outstanding borrowings on our line of credit as of December 31, 2020, and we intend to allocate an amount equal to the net proceeds from the offering to the financing or refinancing of eligible green projects.
We anticipate generating capital to fund our debt maturities by using undistributed cash generated from our Rental Operations and property dispositions and by raising additional capital from future debt or equity transactions.
Repayments of Outstanding Debt
To the extent that it supports our overall capital strategy, we may purchase or redeem some of our outstanding unsecured notes prior to their stated maturities.
In March 2020, we redeemed $300.0 million of unsecured notes that were scheduled to mature in June 2022.
In June 2020, we repurchased and canceled $216.3 million of unsecured notes that were scheduled to mature in October 2022 pursuant to a tender offer completed by the Partnership.
During 2020, we repaid one fixed rate secured loan of $9.0 million, which had a stated interest rate of 5.61%.
Lease Commitments
As of December 31, 2020, we have total future payment obligations of $225.2 million on our ground leases and $27.9 million on our office leases and other lease arrangements, over their non-cancellable lease period including applicable lease extension and renewal options when deemed reasonably certain of exercise. See Note 14 to Consolidated Financial Statements for further discussion.
Guarantee Obligations
We are subject to various guarantee obligations in the normal course of business and, in most cases, do not anticipate these obligations to result in significant cash payments. At December 31, 2020, we guaranteed the repayment of $81.3 million of loans associated with two of our unconsolidated joint ventures. In January 2021, we, and the other partner in one of these unconsolidated joint ventures, repaid $69.8 million of such guaranteed loans.
Additionally, as of December 31, 2020, we guaranteed the repayment of $20.1 million of economic development bonds issued by various municipalities in connection with certain commercial developments.
Historical Cash Flows
Cash, cash equivalents and restricted cash were $67.2 million, $121.4 million and $25.5 million at December 31, 2020, 2019, and 2018, respectively. The following table highlights significant changes in net cash associated with our operating, investing and financing activities (in thousands):
Operating Activities
Cash flows from operating activities provide the cash necessary to meet our operational requirements and the receipt of rental income from Rental Operations continues to be our primary source of operating cash flows. The increase in net cash provided by operating activities, compared to 2019, was driven by increasing our asset base through development, financed through equity or low cost debt issuances, and increasing occupancy and rental rates within our existing portfolio.
The increase to cash flow provided by operating activities between 2019 and 2018 was due to the timing of cash receipts and cash payments on third party construction projects as well as increased cash flows from our Rental Operations. These increases in operating cash flows were partially offset by increased cash paid for interest and income taxes as well as the timing of working capital.
Investing Activities
Highlights of significant cash sources and uses are as follows:
•Real estate development costs were $573.5 million, $446.8 million and $577.4 million during 2020, 2019 and 2018, respectively.
•We paid cash of $632.1 million, $598.4 million and $592.4 million, for real estate and undeveloped land acquisitions during 2020, 2019 and 2018, respectively.
•Sales of land and property generated net proceeds of $336.3 million, $432.7 million and $511.4 million during 2020, 2019 and 2018, respectively.
•During 2020, we received repayments of $110.0 million on notes receivable from property sales, compared to $162.6 million and $154.1 million in 2019 and 2018, respectively.
•Second generation tenant improvements, leasing costs and building improvements totaled $41.1 million, $47.5 million and $53.5 million during 2020, 2019 and 2018, respectively.
•We receive capital distributions from unconsolidated joint ventures, either as the result of selling our ownership interests in certain unconsolidated joint ventures or from our share of the proceeds from property sales from unconsolidated joint ventures. In 2020, we received $876,000 in capital distributions primarily from one unconsolidated joint venture from the sale of land. We received $26.3 million in capital distributions from unconsolidated joint ventures during 2019, primarily related to the sale of three properties within three of our unconsolidated joint ventures. We received $23.1 million in capital distributions from unconsolidated joint ventures during 2018, primarily related to the sale of six properties within three of our unconsolidated joint ventures.
•We made capital contributions and advances to unconsolidated joint ventures in the amounts of $6.2 million, $34.5 million and $5.9 million during 2020, 2019 and 2018, respectively.
Financing Activities
The following items highlight significant capital transactions:
•During 2020, the General Partner issued 4.6 million common shares pursuant to its ATM equity programs for net proceeds of $175.0 million, compared to 8.0 million shares of common stock for net proceeds of $263.3 million in 2019 and 990,400 shares of common stock for net proceeds of $28.4 million in 2018.
•We issued $675.0 million, $575.0 million and $450.0 million of senior unsecured notes during 2020, 2019 and 2018, respectively. The 2020 unsecured debt issuances consist of $325.0 million of senior unsecured notes issued in February 2020 for gross proceeds of $316.4 million and $350.0 million of senior unsecured notes issued in June 2020 for gross proceeds of $346.8 million. The 2019 unsecured debt issuances consist of $175.0 million of senior unsecured notes issued in August 2019 for gross proceeds of $182.3 million and $400.0 million of senior unsecured notes issued in November 2019 with a corresponding cash payment of $35.6 million for termination of the five forward starting interest rate swaps entered in 2018 and 2019. We issued $450.0 million of senior unsecured notes in 2018.
•During 2020, the Partnership paid cash of $547.0 million for the early redemption of $300.0 million of senior unsecured notes that were scheduled to mature in June 2022 and the early repurchase and cancellation of $216.3 million of senior unsecured notes due in October 2022. During 2019, the Partnership paid cash of $255.8 million for the early redemption of $250.0 million of senior unsecured notes that were scheduled to mature in February 2021. The Partnership repaid $7.0 million of unsecured debt in 2018.
•In February 2020, a consolidated joint venture of the Partnership obtained a secured loan from a third party financial institution for gross proceeds of $18.4 million. No secured loans were obtained in 2019 or 2018.
•The Partnership repaid one secured loan for $9.0 million during 2020, compared to repayments of three secured loans for $41.7 million in 2019 and three secured loans for $227.1 million in 2018.
•We increased net borrowings on the Partnership's unsecured line of credit by $295.0 million in 2020, decreased net borrowings by $30.0 million in 2019 and increased net borrowings by $30.0 million in 2018.
•We paid regular cash dividends or distributions of $0.96, $0.88 and $0.815 per common share or per Common Unit during the years ended December 31, 2020, 2019 and 2018, respectively.
•Changes in book cash overdrafts are classified as financing activities within our consolidated Statements of Cash Flows. Book cash overdrafts were $16.4 million, $14.4 million and $14.3 million at December 31, 2020, 2019 and 2018, respectively.
•In 2019, we paid off a special assessment bond for $9.9 million, which was reflected within Other Financing Activities on our Consolidated Statements of Cash Flows. We did not make similar significant repayments during 2020 or 2018.
Impact of Changes in Credit Ratings on Our Liquidity
We are currently assigned investment grade corporate credit ratings on our senior unsecured notes from Moody's Investors Service and Standard & Poor's Ratings Group. Our senior unsecured notes have been assigned a rating of Baa1 by Moody's Investors Service. In addition, our senior unsecured notes have been assigned a rating of BBB+ by Standard & Poor's Ratings Group. A securities rating is not a recommendation to buy, sell, or hold securities and is subject to revision or withdrawal at any time by the rating organization.
The ratings of our senior unsecured notes could change based upon, among other things, the impact that prevailing economic conditions may have on our results of operations and financial condition. If our credit ratings are downgraded or other negative action is taken, we could be required, among other things, to pay additional interest and fees on outstanding borrowings under our revolving credit agreement. Credit rating reductions by one or more rating agencies could also adversely affect our access to funding sources, the cost and other terms of obtaining funding, as well as our overall financial condition, operating results and cash flow.
Financial Instruments
We are exposed to capital market risk, such as changes in interest rates. In order to reduce the volatility relating to interest rate risk, we may enter into interest rate hedging arrangements from time to time. We do not utilize derivative financial instruments for trading or speculative purposes.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosure About Market Risks
We are exposed to interest rate changes primarily as a result of our line of credit and long-term borrowings. Our interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash flows and to lower overall borrowing costs. To achieve our objectives, we borrow primarily at fixed rates and may enter into derivative financial instruments such as interest rate swaps in order to mitigate our interest rate risk on a related financial instrument. We do not enter into derivative or interest rate transactions for speculative purposes.
Our interest rate risk is monitored using a variety of techniques. The table below presents the principal amounts (in thousands) of the expected annual maturities, weighted average interest rates for the average debt outstanding in the specified period and fair values (in thousands).
The Partnership’s unsecured line of credit is reflected in the table above as maturing in January 2023, based on the ability to exercise the two six-month extension options from its stated maturity date of January 2022 (see Note 9). As the above table incorporates only those exposures that existed at December 31, 2020, it does not consider those exposures or positions that could arise after that date. As a result, the ultimate impact of interest rate fluctuations will depend on future exposures that arise, our hedging strategies at that time, to the extent we are party to interest rate derivatives, and interest rates. Interest expense on our unsecured line of credit will be affected by fluctuations in the LIBOR indices or applicable replacement rates as well as changes in our credit rating. The interest rate at such point in the future as we may renew, extend or replace our unsecured line of credit will be heavily dependent upon the state of the credit environment.
At December 31, 2020, the face value of our unsecured debt was $3.06 billion and we estimated the fair value of that unsecured debt to be $3.39 billion. At December 31, 2019, the face value of our unsecured debt was $2.90 billion and we estimated the fair value of that unsecured debt to be $3.05 billion.
Item 8.
Item 8. Financial Statements and Supplementary Data
The financial statements and supplementary data are included under Item 15 of this Report and are incorporated herein by reference.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
There was no change or disagreement with our accountants related to our accounting and financial disclosures.
Item 9A.
Item 9A. Controls and Procedures
Controls and Procedures (General Partner)
We conducted an evaluation of the effectiveness of the design and operation of our "disclosure controls and procedures" as of the end of the period covered by this Report. The controls evaluation was done under the supervision and with the participation of management, including the Chief Executive Officer and the Chief Financial Officer.
Attached as exhibits to this Report are certifications of our Chief Executive Officer and Chief Financial Officer, which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934. This Controls and Procedures section includes the information concerning the controls evaluation referred to in the certifications and it should be read in conjunction with the certifications for a more complete understanding of the topics presented.
Disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the "Exchange Act")) are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act, such as this Report, is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures are also designed to ensure that such information is accumulated and communicated to our management, including our principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure.
Based on the disclosure controls and procedures evaluation referenced above, our Chief Executive Officer and Chief Financial Officer have concluded that as of the end of the period covered by this Report, our disclosure controls and procedures were effective.
Management's annual report on internal control over financial reporting and the audit report of our independent registered public accounting firm are included in Item 15 of Part IV under the headings "Management's Report on Internal Control" and "Report of Independent Registered Public Accounting Firm," respectively, and are incorporated herein by reference.
There were no changes in our internal control over financial reporting during the quarter ended December 31, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Controls and Procedures (Partnership)
We conducted an evaluation of the effectiveness of the design and operation of our "disclosure controls and procedures" as of the end of the period covered by this Report. The controls evaluation was done under the supervision and with the participation of management, including the General Partner's Chief Executive Officer and Chief Financial Officer.
Attached as exhibits to this Report are certifications of the General Partner's Chief Executive Officer and Chief Financial Officer, which are required in accordance with Rule 13a-14 of the Securities Exchange Act of 1934. This Controls and Procedures section includes the information concerning the controls evaluation referred to in the certifications and it should be read in conjunction with the certifications for a more complete understanding of the topics presented.
Disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act, such as this Report, is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures are also designed to ensure that such information is accumulated and communicated to management, including the General Partner's principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure.
Based on the disclosure controls and procedures evaluation referenced above, the General Partner's Chief Executive Officer and Chief Financial Officer have concluded that as of the end of the period covered by this Report, our disclosure controls and procedures were effective.
Management's annual report on internal control over financial reporting and the audit report of our independent registered public accounting firm are included in Item 15 of Part IV under the headings "Management's Report on Internal Control" and "Report of Independent Registered Public Accounting Firm," respectively, and are incorporated herein by reference.
There were no changes in our internal control over financial reporting during the quarter ended December 31, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
There was no information required to be disclosed in a report on Form 8-K during the fourth quarter of 2020 for which no Form 8-K was filed.
Our discussion of federal income tax considerations in Exhibit 99.1 attached hereto, which is incorporated herein by reference, supersedes and replaces, in its entirety, (i) the disclosure under the heading “Federal Income Tax Considerations” in the prospectus dated July 25, 2019, which is a part of our Registration Statement on Form S-3 (File No. 333-232816), as amended or supplemented, (ii) the disclosure under the heading “Federal Income Tax Considerations” in the prospectus dated April 30, 2018, which is a part of our Registration Statement on Form S-3 (File No. 333-224538), as amended or supplemented, and (iii) similarly titled sections in the prospectuses contained in our other Registration Statements on Form S-3 (File Nos. 333-128132, 333-108556, 333-70678, 333-59138, 333-51344, 333-39498, 333-35008, 333-85009, 333-82063, 333-66919, 333-50081, 333-26833, 333-24289, and 033-64659), as amended or supplemented. Our updated discussion addresses recent tax law changes.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The following is a summary of the executive officers of the General Partner:
James B. Connor, age 62. Mr. Connor was named the General Partner's Chairman and Chief Executive Officer, commencing April 26, 2017, and joined the General Partner's Board of Directors in 2015. Prior to being named Chairman and Chief Executive Officer, Mr. Connor held various senior management positions with the General Partner, including President and Chief Executive Officer from January 1, 2016 to April 25, 2017; Senior Executive Vice President and Chief Operating Officer from 2013 to 2015; Senior Regional Executive Vice President from 2011 to 2013; Executive Vice President of the Midwest Region from 2003 to 2011; and Senior Vice President between 1998 and 2003. Prior to joining the General Partner in 1998, Mr. Connor held numerous executive and brokerage positions with Cushman & Wakefield, most recently serving as Senior Managing Director for the Midwest area. In 2019, Mr. Connor joined the Board of Trustees of EPR Properties, a publicly traded REIT. Mr. Connor also serves on the Board of Trustees of Roosevelt University and is a member of the Advisory Board of Directors of the Marshall Bennett Institute of Real Estate at Roosevelt.
Mark A. Denien, age 53. Mr. Denien was appointed the General Partner's Executive Vice President and Chief Financial Officer on May 17, 2013. Prior to being named Executive Vice President and Chief Financial Officer, Mr. Denien was Senior Vice President and Chief Accounting Officer from 2009 to 2013 and, prior to that, served as Senior Vice President, Corporate Controller. Prior to joining the General Partner in 2005, Mr. Denien spent 16 years with KPMG LLP. Mr. Denien serves as a director of Goodwill Industries of Central Indiana, Inc.
Steven W. Schnur, age 47. Mr. Schnur has served as the General Partner's Executive Vice President and Chief Operating Officer since September 2019. Prior to being named Executive Vice President and Chief Operating Officer, Mr. Schnur served as Senior Regional Executive Vice President from May 2017 until September 2019; Executive Vice President, Central Region from January 2015 until May 2017; Senior Regional, Senior Vice President from August 2014 until January 2015; Senior Vice President, Midwest Region from December 2013 until August 2014; and Senior Vice President, Chicago from October 2004 until December 2013. Mr. Schnur began his career with the General Partner as a Vice President, Leasing in September 2003. Prior to that, Mr. Schnur was Director of Real Estate for Opus North Corporation.
Nicholas C. Anthony, age 55. Mr. Anthony was appointed the General Partner's Executive Vice President and Chief Investment Officer on June 17, 2013. His responsibilities include overseeing the General Partner's acquisition and disposition activity, as well as the overall management of its joint venture business. Prior to being named Executive Vice President and Chief Investment Officer, Mr. Anthony held various senior management positions with the General Partner, including Senior Vice President, Capital Transactions and Joint Ventures from 2010 until 2013. Mr. Anthony began his career with the General Partner in 1989 as a staff accountant.
Ann C. Dee, age 61. Ms. Dee was appointed the General Partner's Executive Vice President, General Counsel and Corporate Secretary on June 17, 2013. Prior to being named Executive Vice President, General Counsel and Corporate Secretary, Ms. Dee held the position of Senior Vice President, General Counsel and Corporate Secretary from January 1, 2013 until June 17, 2013 and the position of Deputy General Counsel and Senior Vice President from June 23, 2008 until January 1, 2013. Ms. Dee joined the General Partner in 1996 as a Corporate Attorney. Prior to joining the General Partner, Ms. Dee practiced law with law firms in Indianapolis, Indiana and Columbus, Ohio. Ms. Dee serves as a member of the Board of the Center for Performing Arts.
Peter D. Harrington, age 57. Mr. Harrington was named the General Partner's Executive Vice President, Construction on July 1, 2016. Prior to being named Executive Vice President, Construction, Mr. Harrington held various senior management positions with the General Partner, including Senior Vice President, Construction from 2003 to June 30, 2016; Vice President of Construction from 1998 until 2003; and Manager of Preconstruction Services from 1993 to 1998. Prior to joining the General Partner in 1993, Mr. Harrington was employed with Miller-Valentine Group in Dayton, Ohio from 1987 through 1993 as a Project Coordinator and Project Manager.
All other information required by this item will be included in the General Partner's 2021 proxy statement (the "2021 Proxy Statement") for the General Partner's Annual Meeting of Shareholders to be held on April 28, 2021, and is incorporated herein by reference. In addition, the General Partner's Code of Business Ethics (which applies to each of our associates, officers and directors) and the General Partner's Corporate Governance Guidelines are available in the investor information/corporate governance section of our website at www.dukerealty.com. A copy of these documents may also be obtained without charge by writing to Duke Realty Corporation, 8711 River Crossing Boulevard, Indianapolis, Indiana 46240, Attention: Investor Relations.
Item 11.
Item 11. Executive Compensation
The information required by Item 11 of this Report will be included in our 2021 Proxy Statement, which information is incorporated herein by this reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by Item 12 of this Report will be included in our 2021 Proxy Statement, which information is incorporated herein by this reference.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required to be furnished pursuant to Item 13 of this Report will be included in our 2021 Proxy Statement, which information is incorporated herein by this reference.
Item 14.
Item 14. Principal Accountant Fees and Services
The information required to be furnished pursuant to Item 14 of this Report will be included in our 2021 Proxy Statement, which information is incorporated herein by this reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a)The following documents are filed as part of this Annual Report:
1. Consolidated Financial Statements
The following Consolidated Financial Statements, together with the Management's Report on Internal Control and the Report of Independent Registered Public Accounting Firm are listed below:
2. Consolidated Financial Statement Schedules
Duke Realty Corporation and Duke Realty Limited Partnership:
Schedule III - Real Estate and Accumulated Depreciation
3. Exhibits
The exhibits required to be filed with this Report pursuant to Item 601 of Regulation S-K are listed on pages 120 to 123 of this Report and are incorporated herein by reference.
Management's Report on Internal Control
We, as management of Duke Realty Corporation and its subsidiaries (the "General Partner"), are responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended). Pursuant to the rules and regulations of the Securities and Exchange Commission, internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America and includes those policies and procedures that:
•Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of assets of the company;
•Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and
•Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company's assets that could have a material effect on the financial statements.
Management has evaluated the effectiveness of its internal control over financial reporting as of December 31, 2020 based on the control criteria established in a report entitled Internal Control - Integrated Framework (2013), issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on such evaluation, we have concluded that, as of December 31, 2020, our internal control over financial reporting is effective based on these criteria.
The independent registered public accounting firm of KPMG LLP, as auditors of the General Partner's consolidated financial statements, has also issued an audit report on the General Partner's internal control over financial reporting.
/s/ James B. Connor
James B. Connor
Chairman and Chief Executive Officer
/s/ Mark A. Denien
Mark A. Denien
Executive Vice President and Chief Financial Officer
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors
Duke Realty Corporation:
Opinions on the Consolidated Financial Statements and Internal Control Over Financial Reporting
We have audited the accompanying consolidated balance sheets of Duke Realty Corporation and subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of operations and comprehensive income, cash flows, and changes in equity for each of the years in the three-year period ended December 31, 2020, and the related notes and financial statement schedule III - real estate and accumulated depreciation (collectively, the consolidated financial statements). We also have audited the Company's internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Basis for Opinions
The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control. Our responsibility is to express an opinion on the Company’s consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Evaluation of real estate assets for potential impairment
As discussed in Note 8 to the consolidated financial statements, buildings, land and improvements as of December 31, 2020 was $8,695,678 thousand. As discussed in Note 2 to the consolidated financial statements, the Company evaluates its real estate assets for potential impairment whenever events or changes in circumstances indicate that the carrying value of real estate assets may not be recoverable. The evaluation of real estate assets for potential impairment is subject to certain assumptions which includes the anticipated holding period for a real estate asset.
We identified the evaluation of real estate assets for potential impairment as a critical audit matter. Subjective and challenging auditor judgment was required to evaluate the Company’s intent and ability to hold real estate assets for particular periods of time. A shortening of the anticipated holding period could indicate a potential impairment.
The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of an internal control over the Company’s process to evaluate potential impairment triggering events, including evaluation of holding period. We compared the Company’s historical holding period for similar assets to the holding period assumed in the Company’s analysis. We inquired of Company officials and inspected documents, such as meeting minutes of the board of directors and sub-committees, investment committee, and regional investment committees to evaluate the Company’s intent and ability to hold real estate assets for particular periods of time. We read external communications with investors and analysts in order to identify information regarding potential sales of the Company’s real estate assets.
Management's Report on Internal Control
We, as management of Duke Realty Limited Partnership and its subsidiaries (the "Partnership"), are responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended). Pursuant to the rules and regulations of the Securities and Exchange Commission, internal control over financial reporting is a process designed by, or under the supervision of the principal executive and principal financial officers, or persons performing similar functions, of Duke Realty Corporation (the "General Partner"), and effected by the General Partner's board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America and includes those policies and procedures that:
•Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of assets of the Partnership;
•Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the General Partner; and
•Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Partnership's assets that could have a material effect on the financial statements.
Management has evaluated the effectiveness of its internal control over financial reporting as of December 31, 2020 based on the control criteria established in a report entitled Internal Control - Integrated Framework (2013), issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on such evaluation, we have concluded that, as of December 31, 2020, our internal control over financial reporting is effective based on these criteria.
The independent registered public accounting firm of KPMG LLP, as auditors of the Partnership's consolidated financial statements, has also issued an audit report on the Partnership's internal control over financial reporting.
/s/ James B. Connor
James B. Connor
Chairman and Chief Executive Officer
of the General Partner
/s/ Mark A. Denien
Mark A. Denien
Executive Vice President and Chief Financial Officer
of the General Partner
Report of Independent Registered Public Accounting Firm
To the Unitholders of Duke Realty Limited Partnership and the Board of Directors of Duke Realty Corporation:
Opinions on the Consolidated Financial Statements and Internal Control Over Financial Reporting
We have audited the accompanying consolidated balance sheets of Duke Realty Limited Partnership and subsidiaries (the Partnership) as of December 31, 2020 and 2019, the related consolidated statements of operations and comprehensive income, cash flows, and changes in equity for each of the years in the three-year period ended December 31, 2020, and the related notes and financial statement schedule III - real estate and accumulated depreciation (collectively, the consolidated financial statements). We also have audited the Partnership's internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Partnership as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Partnership maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Basis for Opinions
The Partnership’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control. Our responsibility is to express an opinion on the Partnership’s consolidated financial statements and an opinion on the Partnership’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Partnership in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Evaluation of real estate assets for potential impairment
As discussed in Note 8 to the consolidated financial statements, buildings, land and improvements as of December 31, 2020 was $8,695,678 thousand. As discussed in Note 2 to the consolidated financial statements, the Partnership evaluates its real estate assets for potential impairment whenever events or changes in circumstances indicate that the carrying value of real estate assets may not be recoverable. The evaluation of real estate assets for potential impairment is subject to certain assumptions which includes the anticipated holding period for a real estate asset.
We identified the evaluation of real estate assets for potential impairment as a critical audit matter. Subjective and challenging auditor judgment was required to evaluate the Partnership’s intent and ability to hold real estate assets for particular periods of time. A shortening of the anticipated holding period could indicate a potential impairment.
The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of an internal control over the Partnership’s process to evaluate potential impairment triggering events, including evaluation of holding period. We compared the Partnership’s historical holding period for similar assets to the holding period assumed in the Partnership’s analysis. We inquired of Partnership officials and inspected documents, such as meeting minutes of the General Partner’s board of directors and sub-committees, investment committee, and regional investment committees to evaluate the Partnership’s intent and ability to hold real estate assets for particular periods of time. We read external communications with investors and analysts in order to identify information regarding potential sales of the Partnership’s real estate assets.
DUKE REALTY CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
As of December 31,
(in thousands, except per share amounts)
See accompanying Notes to Consolidated Financial Statements.
DUKE REALTY CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations and Comprehensive Income
For the Years Ended December 31,
(in thousands, except per share amounts)
See accompanying Notes to Consolidated Financial Statements.
DUKE REALTY CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Years Ended December 31,
(in thousands)
See accompanying Notes to Consolidated Financial Statements.
DUKE REALTY CORPORATION AND SUBSIDIARIES
Consolidated Statements of Changes in Equity
(in thousands, except per share data)
See accompanying Notes to Consolidated Financial Statements.
DUKE REALTY LIMITED PARTNERSHIP AND SUBSIDIARIES
Consolidated Balance Sheets
As of December 31,
(in thousands)
See accompanying Notes to Consolidated Financial Statements.
DUKE REALTY LIMITED PARTNERSHIP AND SUBSIDIARIES
Consolidated Statements of Operations and Comprehensive Income
For the Years Ended December 31,
(in thousands, except per unit amounts)
See accompanying Notes to Consolidated Financial Statements.
DUKE REALTY LIMITED PARTNERSHIP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Years Ended December 31,
(in thousands)
See accompanying Notes to Consolidated Financial Statements.
DUKE REALTY LIMITED PARTNERSHIP AND SUBSIDIARIES
Consolidated Statements of Changes in Equity
(in thousands, except per unit data)
See accompanying Notes to Consolidated Financial Statements.
DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1)The Company
The General Partner was formed in 1985, and we believe that it qualifies as a REIT under the provisions of the Code. The Partnership was formed on October 4, 1993, when the General Partner contributed all of its properties and related assets and liabilities, together with the net proceeds from an offering of additional shares of its common stock, to the Partnership. Simultaneously, the Partnership completed the acquisition of Duke Associates, a full-service commercial real estate firm operating in the Midwest whose operations began in 1972.
The General Partner is the sole general partner of the Partnership, owning approximately 99.1% of the Common Units at December 31, 2020. The remaining 0.9% of the Common Units are owned by limited partners. As the sole general partner of the Partnership, the General Partner has full, exclusive and complete responsibility and discretion in the day-to-day management and control of the Partnership. The General Partner and the Partnership are operated as one enterprise. The management of the General Partner consists of the same members as the management of the Partnership. As the sole general partner with control of the Partnership, the General Partner consolidates the Partnership for financial reporting purposes, and the General Partner does not have any significant assets other than its investment in the Partnership. Therefore, the assets and liabilities of the General Partner and the Partnership are substantially the same.
Limited partners have the right to redeem their Limited Partner Units, subject to certain restrictions. Pursuant to the Partnership Agreement, the General Partner is obligated to redeem the Limited Partner Units in shares of its common stock, unless it determines in its reasonable discretion that the issuance of shares of its common stock could cause it to fail to qualify as a REIT. Each Limited Partner Unit shall be redeemed for one share of the General Partner's common stock, or, in the event that the issuance of shares could cause the General Partner to fail to qualify as a REIT, cash equal to the fair market value of one share of the General Partner's common stock at the time of redemption, in each case, subject to certain adjustments described in the Partnership Agreement. The Limited Partner Units are not required, per the terms of the Partnership Agreement, to be redeemed in registered shares of the General Partner.
As of December 31, 2020, we owned and operated a portfolio primarily consisting of industrial properties and provided real estate services to third-party owners.
Substantially all of our Rental Operations (see Note 10) are conducted through the Partnership. We conduct our Service Operations (see Note 10) through Duke Realty Services, LLC, Duke Realty Services Limited Partnership and Duke Construction Limited Partnership ("DCLP"), which are consolidated entities that are 100% owned by a combination of the General Partner and the Partnership. DCLP is owned through a taxable REIT subsidiary.
(2)Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include our accounts and the accounts of our majority-owned or controlled subsidiaries. The equity interests in these controlled subsidiaries not owned by us are reflected as noncontrolling interests in the consolidated financial statements. All significant intercompany balances and transactions have been eliminated in the consolidated financial statements. Investments in entities that we do not control, and variable interest entities ("VIEs") in which we are not the primary beneficiary (to the extent applicable), are not consolidated and are reflected as investments in unconsolidated joint ventures under the equity method of reporting.
Due to the fact that the Limited Partners do not have kick out rights, or substantive participating rights, the Partnership is a VIE. Because the General Partner holds majority ownership and exercises control over every aspect of the Partnership's operations, the General Partner has been determined as the primary beneficiary of the Partnership and, therefore, consolidates the Partnership.
The assets and liabilities of the General Partner and the Partnership are substantially the same, as the General Partner does not have any significant assets other than its investment in the Partnership.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Reclassifications
There have been no amounts in the accompanying consolidated financial statements reclassified to conform to the 2020 consolidated financial statement presentation.
Real Estate Investments
Rental real property, including land, land improvements, buildings and tenant improvements, are included in real estate investments and are generally stated at cost. Construction in process and undeveloped land are included in real estate investments and are stated at cost. Real estate investments also include our equity interests in unconsolidated joint ventures that own and operate rental properties and hold land for development.
Depreciation
Buildings and land improvements are depreciated on the straight-line method over their estimated lives not to exceed 40 and 15 years, respectively, for properties that we develop, and not to exceed 30 and 10 years, respectively, for acquired properties. Tenant improvement costs are depreciated using the straight-line method over the shorter of the useful life of the asset or term of the related lease.
Cost Capitalization
Direct and certain indirect costs, including interest, clearly associated with the development, construction or expansion of real estate investments are capitalized as a cost of the property. Direct costs include all leasing commissions paid to third parties for new leases or lease renewals. We capitalize a portion of our indirect costs associated with our construction and development efforts. In assessing the amount of direct and indirect costs to be capitalized, allocations are made based on estimates of the actual amount of time spent in each activity. We do not capitalize any costs attributable to downtime or to unsuccessful projects.
Effective on January 1, 2019, only costs that are incremental to executing a lease are capitalizable. Prior to January 1, 2019, we capitalized a portion of our indirect costs associated with our leasing efforts based on the amount of time spent on leasing activities.
We capitalize interest and direct and indirect project costs associated with the initial construction of a property up to the time the property is substantially complete and ready for its intended use. In addition, we capitalize costs, including real estate taxes, insurance and utilities, that have been allocated to vacant space based on the square footage of the portion of the building not held available for immediate occupancy during the extended lease-up periods after construction of the building shell has been completed if costs are being incurred to ready the vacant space for its intended use. If costs and activities incurred to ready the vacant space cease, then cost capitalization is also discontinued until such activities are resumed. Once necessary work has been completed on a vacant space, project costs are no longer capitalized.
We cease capitalization of all project costs on extended lease-up periods when significant activities have ceased, which does not exceed the shorter of a one-year period after the completion of the building shell or when the property attains 90% occupancy.
Impairment
We evaluate our real estate assets, with the exception of those that are classified as held-for-sale, for impairment whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. If such an evaluation is considered necessary, we compare the carrying amount of that real estate asset, or asset group, with the expected undiscounted cash flows that are directly associated with, and that are expected to arise as a direct result of, the use and eventual disposition of that asset, or asset group. Our estimate of the expected future cash flows used in testing for impairment is based on, among other things, our estimates regarding future market conditions, rental rates, occupancy levels, costs of tenant improvements, leasing commissions and other tenant concessions, assumptions regarding the residual value of our properties at the end of our anticipated holding period and the length of our anticipated holding period and is, therefore, subjective by nature. These assumptions could differ materially from actual results. If our strategy changes or if market conditions otherwise dictate a reduction in
DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
the holding period and an earlier sale date, an impairment loss could be recognized and such loss could be material. To the extent the carrying amount of a real estate asset, or asset group, exceeds the associated estimate of undiscounted cash flows, an impairment loss is recorded to reduce the carrying value of the asset to its fair value.
The determination of the fair value of real estate assets is also highly subjective, especially in markets where there is a lack of recent comparable transactions. We primarily utilize the income approach to estimate the fair value of our income producing real estate assets. We utilize marketplace participant assumptions to estimate the fair value of a real estate asset when an impairment charge is required to be measured. The estimation of future cash flows, as well as the selection of the discount rate and exit capitalization rate used in applying the income approach, are highly subjective measures in estimating fair value.
Real estate assets classified as held-for-sale are reported at the lower of their carrying value or their fair value, less estimated costs to sell. Once a property is designated as held-for-sale, no further depreciation expense is recorded.
Purchase Accounting
Our acquisitions of properties have been accounted for as asset acquisitions as they have not met the definition of a business. Transaction costs related to asset acquisitions are capitalized. To the extent that an acquired property meets the definition of a business, we expense acquisition related costs immediately as period costs.
To the extent that we gain control of real estate properties that are accounted for as asset acquisitions, as opposed to business combinations, we accumulate the costs of pre-existing equity interest and consideration paid for additional interest acquired and we do not remeasure our pre-existing equity interest. Generally contingencies arising from an asset acquisition are only recognized when the contingency is paid or becomes payable.
We allocate the purchase price of asset acquisitions that meet the definition of a business to tangible and identified intangible assets based on their relative fair values, using all pertinent information available at the date of acquisition. Capitalized acquisition costs are also included in the total cost basis of acquired properties that are asset acquisitions. The allocation to tangible assets (buildings, tenant improvements and land) is based upon management's determination of the value of the property as if it were vacant. This “as-if vacant” value is estimated using an income, or discounted cash flow, approach that relies upon internally determined assumptions that we believe are consistent with current market conditions for similar properties. The most important assumptions in determining the allocation of the purchase price to tangible assets are the exit capitalization rate, estimated market rents and the fair value of the underlying land. The purchase price of real estate assets is also allocated to intangible assets consisting of the above or below market component of in-place leases and the value of in-place leases.
The value allocable to the above or below market component of an acquired in-place lease is determined based upon the present value (using a discount rate which reflects the risks associated with the acquired leases) of the difference between (i) the contractual amounts to be received pursuant to the lease over its remaining term and (ii) management's estimate of the amounts that would be received using fair market rates over the remaining term of the lease. The amounts allocated to above market leases are included in deferred leasing and other costs in the balance sheet and below market leases are included in other liabilities in the balance sheet; both are amortized to rental income over the remaining terms of the respective leases.
Factors considered in determining the value allocable to in-place leases include estimates, during hypothetical expected lease-up periods, of space that is actually leased at the time of acquisition, of lost rent at market rates, fixed operating costs that will be recovered from tenants and theoretical leasing commissions required to execute similar leases. These intangible assets are included in deferred leasing and other costs in the balance sheet and are amortized over the remaining term of the existing lease.
DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Joint Ventures
We have equity interests in unconsolidated joint ventures that primarily own and operate rental properties or hold land for development. These unconsolidated joint ventures are primarily engaged in the operation and development of industrial real estate properties.
We consolidate joint ventures that are considered to be VIEs where we are the primary beneficiary. We analyze our investments in joint ventures to determine if the joint venture is considered a VIE and would require consolidation. We (i) evaluate the sufficiency of the total equity investment at risk, (ii) review the voting rights and decision-making authority of the equity investment holders as a group and whether there are limited partners (or similar owning entities) that lack substantive participating or kick out rights, guaranteed returns, protection against losses, or capping of residual returns within the group and (iii) establish whether activities within the venture are on behalf of an investor with disproportionately few voting rights in making this VIE determination.
To the extent that we own interests in a VIE and we (i) have the power to direct the activities that most significantly impact the economic performance of the VIE and (ii) have the obligation or rights to absorb losses or receive benefits that could potentially be significant to the VIE, then we would be determined to be the primary beneficiary and would consolidate the VIE. To the extent that we own interests in a VIE, then at each reporting period, we re-assess our conclusions as to which, if any, party within the VIE is considered the primary beneficiary. Consolidated joint ventures that are VIE's were not significant in any period presented in these consolidated financial statements.
To the extent that our joint ventures do not qualify as VIEs, they are consolidated if we control them through majority ownership interests or if we are the managing entity (general partner or managing member) and our partner does not have substantive participating rights. Control is further demonstrated by our ability to unilaterally make significant operating decisions, refinance debt and sell the assets of the joint venture without the consent of the non-managing entity and the inability of the non-managing entity to remove us from our role as the managing entity. Consolidated joint ventures that are not VIEs are not significant in any period presented in these consolidated financial statements.
We use the equity method of accounting for those joint ventures where we exercise significant influence but do not have control. Under the equity method of accounting, our investment in each joint venture is included on our balance sheet; however, the assets and liabilities of the joint ventures for which we use the equity method are not included on our balance sheet.
To the extent that we contribute assets to a joint venture, our investment in the joint venture is recorded at our cost basis in the assets that were contributed to the joint venture. To the extent that our cost basis is different than the basis reflected at the joint venture level, the basis difference is amortized over the life of the related asset and included in our share of equity in net income of the joint venture. We recognize gains on the contribution or sale of real estate to joint ventures, relating solely to the outside partner's interest, to the extent the economic substance of the transaction is a sale.
When circumstances indicate there may have been a reduction in the value of an equity investment, we evaluate whether the loss in value is other than temporary. If we conclude it is other than temporary, we recognize an impairment charge to reflect the equity investment at fair value.
There were no unconsolidated joint ventures, in which we have any recognized assets or liabilities or have retained any economic exposure to loss at December 31, 2020 that met the criteria to be considered VIEs.
Cash Equivalents
Investments with an original maturity of three months or less are classified as cash equivalents.
Valuation of Receivables
Upon the adoption of ASC 842 on January 1, 2019, our determination of the adequacy of our allowances for tenant receivables includes a binary assessment of whether or not the amounts due under a tenant’s lease agreement are probable of collection. For such amounts that are deemed probable of collection, revenue continues to be recorded
DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
on a straight-line basis over the lease term. For such amounts that are deemed not probable of collection, revenue is recorded as the lesser of (i) the amount which would be recognized on a straight-line basis or (ii) cash that has been received from the tenant, with any tenant and deferred rent receivable balances charged as a direct write-off against rental income in the period of the change in the collectability determination.
Deferred Costs
Deferred Financing Costs
Costs incurred in connection with obtaining financing are deferred and are amortized to interest expense over the term of the related loan. The costs for issuing debt, other than lines of credit, are presented on the consolidated balance sheets as a direct deduction from the debt's carrying value, while debt issuance costs related to the Partnership's unsecured line of credit are presented as assets on the consolidated balance sheets, as part of other escrow deposits and other assets.
Lease Related Costs and Acquired Lease-Related Intangible Assets
Effective on January 1, 2019, only costs that are directly incremental to executing a lease are capitalized.
Acquired lease-related intangible assets consist of above market lease assets and the value allocable to in-place leases. Above market lease assets are amortized as a reduction to rental income over the remaining terms of the respective leases. In-place lease intangible assets are amortized on a straight-line basis and included within depreciation and amortization in the consolidated statements of operations and comprehensive income.
Deferred leasing costs and acquired lease-related intangible assets at December 31, 2020 and 2019, excluding amounts classified as held-for-sale, were as follows (in thousands):
Amounts recorded related to amortization expense for in-place leases for the years ended December 31, 2020, 2019 and 2018 totaled $19.5 million, $22.0 million and $25.0 million, respectively. Charges to rental income related to the amortization of above market lease assets for the years ended December 31, 2020, 2019 and 2018 totaled $639,000, $703,000 and $777,000, respectively.
DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The expected future amortization, or charge to rental income, of acquired lease-related intangible assets is summarized in the table below (in thousands):
Noncontrolling Interests
Noncontrolling interests relate to the minority ownership interests in the Partnership and interests in consolidated property partnerships that are not wholly owned by the General Partner or the Partnership. Noncontrolling interests are subsequently adjusted for additional contributions, distributions to noncontrolling holders and the noncontrolling holders' proportionate share of the net earnings or losses of each respective entity. We report noncontrolling interests as a component of total equity.
When a Common Unit of the Partnership is redeemed (Note 1), the change in ownership is treated as an equity transaction by the General Partner and there is no effect on its earnings or net assets.
Revenue Recognition
On January 1, 2018, we concurrently adopted ASC 606, Revenue from Contracts with Customers ("ASC 606") and ASC 610-20, Other Income: Gains and Losses from the De-recognition of Non-financial Assets ("ASC 610-20") using a modified retrospective ("cumulative effect") method of adoption. ASC 606 has superseded nearly all existing GAAP revenue recognition guidance, although its scope excludes lease contracts, which represent our primary source of revenue. The standard’s core principle is that a company will recognize revenue when it satisfies performance obligations, by transferring promised goods or services to customers, in an amount that reflects the consideration to which the company expects to be entitled in exchange for fulfilling those performance obligations.
There was no cumulative adjustment recognized to beginning retained earnings as of January 1, 2018 as the result of adopting ASC 606 and ASC 610-20.
Rental and Related Revenue
Rental income from leases is recognized on a straight-line basis. If a lease provides for tenant improvements, we determine whether we or the tenant is the owner of the tenant improvements. When we are the owner of the tenant improvements, any tenant improvements funded by the tenant are treated as lease payments which are deferred and amortized as revenue over the lease term. When the tenant is the owner of the tenant improvements, and we fund such improvements, we record such tenant improvement allowances as lease incentives and amortize as a reduction of revenue over the lease term.
We record lease termination fees when a tenant has executed a definitive termination agreement with us and the payment of the termination fee is not subject to any material conditions that must be met or waived before the fee is due to us.
DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
General Contractor and Service Fee Revenue
Effective on January 1, 2018, general contractor and service fee revenues, as presented on the Consolidated Statements of Operations, are accounted for within the scope of ASC 606. General contractor and service fee revenues are comprised primarily of construction and development related revenues earned from third parties while acting in capacity of a developer, as a general contractor or a construction manager. There are other ancillary streams of revenue included in general contractor and service fee revenues (see Note 10), such as management fees earned from unconsolidated joint ventures, which are not significant.
Our construction arrangements are typically structured with only one performance obligation, which generally represents an obligation either to construct a new building or to construct fixtures in an existing building, and these single performance obligations are satisfied over time as construction progresses. We recognize revenue as we satisfy such performance obligations using the percentage of completion method, which is an input method allowed under ASC 606. Using this method, profits are recorded based on our estimates of the percentage of completion of individual contracts, commencing when the work performed under the contracts reaches a point where the final costs can be estimated with reasonable accuracy. The percentage of completion estimates are based on a comparison of the contract expenditures incurred to the estimated final costs. We believe the percentage of completion method is a faithful depiction of the transfer of goods and services as changes in job performance and estimated profitability, which result in revisions to costs and income and are recognized in the period in which the revisions are determined, have not historically been significant. We typically receive regular progress payments on the majority of our construction arrangements and such arrangements generally have an original duration of less than one year. As the result of the relatively short duration of our construction arrangements, we have elected to apply the optional disclosure exemptions, included in ASC 606, related to our remaining performance obligations for our in-process construction projects, for which any future variable consideration is not material. Changes in job performance, job conditions and estimated profitability may result in revisions to costs and income and are recognized in the period in which the revisions are determined. To the extent that a fixed-price contract is estimated to result in a loss, the loss is recorded immediately.
Opening and closing balances of construction receivables are presented separately on the Consolidated Balance Sheets. Under billed and over billed receivables on construction contracts totaled $16.6 million and $105,000, respectively, at December 31, 2020 and $16.5 million and $159,000, respectively, at December 31, 2019. Over billed receivables are included in other liabilities in the Consolidated Balance Sheets. We generally do not have any contract assets associated with our construction arrangements.
Management fees are based on a percentage of rental receipts of properties managed and are recognized as the rental receipts are collected. Maintenance fees are based upon established hourly rates and are recognized as the services are performed.
Property Sales
Only disposals representing a strategic shift in operations (for example, a disposal of a major geographic area or a major line of business) should be presented as discontinued operations in accordance with ASC 205-20, without consideration of significant continuing involvement.
Effective on January 1, 2018, gains on sales of properties, including partial sales, of non-financial assets (and in-substance non-financial assets) to non-customers are recognized in accordance with ASC 610-20, while the sale of non-financial assets with customers are governed by ASC 606. The only difference in the treatment of sales to customers and non-customers is the presentation in the Consolidated Statements of Operations (revenue and expense is reported when the sale is to a customer and net gain or loss is reported when the sale is to a non-customer). Based on the nature of our business, our property sales generally represent transactions with non-customers. In the typical course of our business, sales of non-financial assets represent only one performance obligation and are recognized when an enforceable contract is in place, collectability is ensured and control is transferred to the buyer.
DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Under ASC 610-20 we are required to recognize a full gain or loss in a partial sale of non-financial assets, to the extent control is not retained. Any noncontrolling interest retained by the seller would, accordingly, be measured at fair value. We have primarily disposed of property and land in all cash transactions with no contingencies and no future involvement in the operations, and therefore, the adoption of ASC 610-20 has not significantly impacted the recognition of property and land sales.
Leases
On January 1, 2019, we adopted the new lease standard, ASC 842, on a prospective basis. ASC 842 has superseded all previous GAAP guidance for accounting for leases.
As part of adoption, we elected the package of practical expedients available for implementation, which included: (i) relief from re-assessing whether an expired or existing contract meets the definition of a lease, (ii) relief from re-assessing the classification of expired or existing leases at the adoption date and (iii) allowing previously capitalized initial direct leasing costs to continue to be amortized. Due in large part to electing these practical expedients, the adoption of ASC 842 did not result in recording a cumulative adjustment to the opening balance of distributions in excess of net income.
As a lessor, our primary business is the development, acquisition, and operation of industrial real estate properties that are held for investment and leased to tenants. We manage residual risk through investing in properties that we believe will appreciate in value over time. We also perform a credit analysis for tenants prior to leases being executed, and on an ongoing basis, to ensure collectability is probable prior to recognizing lease revenues on an accrual basis.
For lessors, the accounting under ASC 842 remains largely unchanged with the notable exception that ASC 842 requires that lessors expense certain initial direct costs, which were capitalizable under prior leasing standards, as incurred. Under ASC 842, only the incremental costs of signing a lease are capitalizable. Non-incremental costs attributable to successful leases represent internal costs allocable to successful leasing activities and exclude estimated costs related to downtime and/or unsuccessful deals. These costs primarily consist of compensation and other benefits for internal leasing and legal personnel. These costs are not capitalizable "incremental costs" in the context of the applicable lease accounting rules, but we believe separate presentation on the Consolidated Statements of Operations provides useful information for purposes of comparability with economically similar success-based costs incurred by other organizations that outsource their leasing functions, which are generally capitalizable.
ASC 842 also requires lessors to exclude certain lessor costs, such as real estate taxes and insurance, that are paid directly by lessees to third parties from rental revenue and the associated rental expense. Lessor costs that are paid by the lessor and reimbursed by the lessee continue to be recorded through rental revenue and the associated rental expense.
ASC 842 allows lessors an additional practical expedient to not separate rental recovery revenue related to lease-related services from the associated rental revenue related to the lease when certain criteria are met. The lease-related services provided to our tenants include property management, common area maintenance ("CAM") and utilities. We assessed the applicable criteria, concluding that the timing and straight-line pattern of transfer to the lessees for rental recovery revenue from our lease-related services and revenue from the underlying leases are the same and that lease classification does not change, and elected to apply this additional practical expedient.
As a lessee, ASC 842 requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase of the leased asset by the lessee. This classification determines whether the lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease. A lessee is also required to record a right-of-use ("ROU") asset and a lease liability for all leases with a term of greater than 12 months regardless of classification.
See Note 3 for further disclosure on our leases as a lessor and lessee.
DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Net Income Per Common Share or Common Unit
Basic net income per common share or Common Unit is computed by dividing net income attributable to common shareholders or common unitholders, less dividends or distributions on share-based awards expected to vest (referred to as "participating securities" and primarily composed of unvested restricted stock units), by the weighted average number of common shares or Common Units outstanding for the period.
Diluted net income per common share is computed by dividing the sum of net income attributable to common shareholders and the noncontrolling interest in earnings allocable to Limited Partner Units (to the extent the Limited Partner Units are dilutive), less dividends or distributions on participating securities that are anti-dilutive, by the sum of the weighted average number of common shares outstanding and, to the extent they are dilutive, weighted average number of Limited Partner Units outstanding and any potential dilutive securities for the period. Diluted net income per Common Unit is computed by dividing the net income attributable to common unitholders, less dividends or distributions on participating securities that are anti-dilutive, by the sum of the weighted average number of Common Units outstanding and any potential dilutive securities for the period.
The following table reconciles the components of basic and diluted net income per common share or Common Unit (in thousands):
The following table summarizes the data that is excluded from the computation of net income per common share or Common Unit as a result of being anti-dilutive (in thousands):
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Federal Income Taxes
General Partner
The General Partner has elected to be taxed as a REIT under the Code, as amended. To qualify as a REIT, the General Partner must meet a number of organizational and operational requirements, including a requirement to distribute at least 90% of its REIT taxable income to its shareholders. Management intends to continue to adhere to these requirements and to maintain the General Partner's REIT status. As a REIT, the General Partner is entitled to a tax deduction for the dividends it pays to shareholders. Accordingly, the General Partner generally will not be subject to federal income taxes as long as it currently distributes to shareholders an amount equal to or in excess of its taxable income. The General Partner is, however, generally subject to federal income taxes on any taxable income that is not currently distributed to its shareholders. If the General Partner fails to qualify as a REIT in any taxable year, it will be subject to federal income taxes and may not be able to qualify as a REIT for four subsequent taxable years.
REIT qualification reduces, but does not eliminate, the amount of state and local taxes we pay. In addition, our financial statements include the operations of taxable corporate subsidiaries that are not entitled to a dividends paid deduction and are subject to federal, state and local income taxes. As a REIT, the General Partner may also be subject to certain federal excise taxes if it engages in certain types of transactions.
The following table reconciles the General Partner's net income to taxable income before the dividends paid deduction, and subject to the 90% distribution requirement, for the years ended December 31, 2020, 2019 and 2018 (in thousands):
The General Partner's dividends paid deduction is summarized below (in thousands):
Our tax return for the year ended December 31, 2020 has not been filed. The taxability information presented for our dividends paid in 2020 is based upon management’s estimate. Consequently, the taxability of dividends is subject to change. A summary of the designated tax characterization of the dividends paid by the General Partner for the years ended December 31, 2020, 2019 and 2018 is as follows:
DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Partnership
For the Partnership, the allocated share of income and loss other than the operations of its taxable REIT subsidiary is included in the income tax returns of its partners; accordingly the only federal income taxes included in the accompanying consolidated financial statements of the Partnership are in connection with its taxable REIT subsidiary.
Deferred Tax Assets
A valuation allowance is in place for substantially all of the deferred tax assets of the taxable REIT subsidiary for all periods presented. Based primarily on the projections of taxable income pursuant to our current operating strategy, management believes that it is more likely than not that the taxable REIT subsidiary will not generate sufficient taxable income to realize these deferred tax assets. Income taxes are not material to our operating results or financial position. Our taxable REIT subsidiary has no significant net deferred income tax positions or unrecognized tax benefit items.
Cash Paid for Income Taxes
We received income tax refunds, net of federal, state and local income tax payments, of $308,000 in 2020. We paid federal, state and local income taxes, net of income tax refunds, of $7.8 million and $3.7 million in 2019 and 2018, respectively.
Fair Value Measurements
We estimate fair value using available market information and valuation methodologies. Assets and liabilities recorded at fair value on the consolidated balance sheets are categorized based on the inputs to the valuation techniques as follows:
Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities to which we have access.
Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates and yield curves that are observable at commonly quoted intervals.
Level 3 inputs are unobservable inputs for the asset or liability, which are typically based on an entity's own assumptions, as there is little, if any, related market activity.
In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.
Derivative Financial Instruments
We periodically enter into certain interest rate protection agreements to effectively convert or cap floating rate debt to a fixed rate, and to hedge anticipated future financing transactions, both of which qualify for cash flow hedge accounting treatment. We do not utilize derivative financial instruments for trading or speculative purposes. The entire effect of any hedging instruments and hedged items are presented in the same income statement line item.
If a derivative qualifies as a cash flow hedge, the gain or loss on the derivative is recorded in accumulated other comprehensive income or loss and subsequently reclassified into interest expense in the same period during which the hedged forecasted transaction affects earnings. For all hedging relationships, we formally document the hedging relationship and its risk-management objective and strategy for undertaking the hedge, the hedging instrument, the hedged item, the nature of the risk being hedged and how the hedging instrument’s effectiveness in offsetting the hedged risk will be assessed prospectively and retrospectively.
DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Use of Estimates
The preparation of the financial statements requires management to make a number of estimates and assumptions that affect the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates.
(3)Leases
Lease Income
Our leases generally include scheduled rent increases, but do not include variable payments based on indexes. Our rental revenue is primarily based on fixed, non-cancelable leases. Our variable rental revenue primarily consists of amounts recovered from lessees for property tax, insurance and CAM.
All revenues related to lease and lease-related services are included in, and comprise substantially all of, the caption "Rental and Related Revenue" on the Consolidated Statements of Operations and Comprehensive Income. The components of Rental and Related Revenue are as follows (in thousands):
(1) Primarily includes tenant recoveries for real estate taxes, insurance and CAM.
The future minimum rents due to us under non-cancelable operating leases are as follows (in thousands):
Lessee Accounting
As of December 31, 2020, our lease arrangements, where we are the lessee, primarily consisted of office and ground leases. For these lease arrangements, we recognized ROU assets and the corresponding lease liabilities representing the discounted value of future lease payments required under ASC 842. In determining these amounts, we elected an available practical expedient that allows us, as a lessee, to not separate lease and non-lease components. Expenses recognized on these leases for the year ended December 31, 2020 were not material.
All of our office leases are classified as operating leases under ASC 842. Ground leases that were classified as operating leases prior to adoption of ASC 842 continue to be accounted for as operating leases by electing the practical expedient under ASC 842. In July 2020, we entered into a long-term ground lease which met the criteria to be classified as a finance lease. In December 2020, we entered into another long-term ground lease, for which a ROU asset and associated liability will be recognized when our construction commences in early 2021.
DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2020, a $38.9 million ROU asset associated with operating leases was included within Other Escrow Deposits and Other Assets and a corresponding lease liability of $42.9 million was included in Other Liabilities on our Consolidated Balance Sheets. As of December 31, 2019, total ROU assets and liabilities for operating leases were $40.5 million and $46.9 million, respectively. The following table summarizes the future lease payments (in thousands) to be made under non-cancellable operating lease arrangements:
The weighted average remaining lease term for our operating lease arrangements, on a combined basis as of December 31, 2020, was 33.7 years. The weighted average discount rate for our operating lease arrangements as of December 31, 2020 was 4.43%. As the discount rates implied in our operating lease arrangements were not readily determinable, we utilized our current credit ratings and credit yields observed from market traded securities with similar credit ratings to form a reasonable basis to establish secured borrowing rates when determining the present value of future operating lease payments.
As of December 31, 2020, a $19.2 million ROU asset associated with the finance lease was included within Other Escrow Deposits and Other Assets and a corresponding $19.4 million lease liability was included within Other Liabilities on our Consolidated Balance Sheets. The future lease payments (in thousands) under our finance lease as of December 31, 2020 for five years and thereafter are as follows:
The ground lease payment obligation is subject to an annual consumer price index increase limited within a minimum 2% and a maximum 3% increase. The contractual obligations for this lease included above assume the minimum annual increase for the remainder of the lease term since we cannot predict future adjustments. The remaining lease term on this finance lease as of December 31, 2020 was 49.6 years prior to any impact of lease extension options or purchase options. The discount rate in the finance lease agreement was determined to be 5.30%, which was the lessor's implicit rate in the lease that was readily determinable when the lease commenced.
DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(4)Restricted Cash
The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the Consolidated Balance Sheets that sum to the total of the same such amounts shown in the Consolidated Statements of Cash Flows (in thousands):
Restricted cash held in escrow for like-kind exchange on the Consolidated Balance Sheets includes cash received from the property dispositions but restricted only for qualifying like-kind exchange transactions.
(5)Acquisitions and Dispositions
Acquisitions and dispositions for the periods presented were completed in accordance with our strategy to reposition our investment concentration among the markets in which we operate and to increase our overall investments in quality industrial projects. Transaction costs related to asset acquisitions are capitalized and transaction costs related to business combinations and dispositions are expensed.
2020 Acquisitions
We paid cash of $383.7 million for asset acquisitions during the year ended December 31, 2020.
We acquired ten properties during the year ended December 31, 2020. We determined that these ten properties did not meet the definition of a business and, accordingly, we accounted for them as asset acquisitions as opposed to business combinations.
The following table summarizes amounts recognized for each major class of assets and liabilities (in thousands) for these acquisitions during the year ended December 31, 2020:
The leases in the acquired properties had a weighted average remaining life at acquisition of approximately 6.4 years.
2019 Acquisitions
We paid cash of $210.2 million for asset acquisitions during the year ended December 31, 2019.
We acquired six properties during the year ended December 31, 2019. We determined that these six properties did not meet the definition of a business and, accordingly, we accounted for them as asset acquisitions as opposed to business combinations.
The following table summarizes amounts recognized for each major class of assets (in thousands) for these acquisitions during the year ended December 31, 2019:
DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The leases in the acquired properties had a weighted average remaining life at acquisition of approximately 6.5 years.
2018 Acquisitions
We paid cash of $348.1 million for asset acquisitions during the year December 21, 2018.
We acquired nine properties during the year ended December 31, 2018. We determined that these nine properties did not meet the definition of a business and, accordingly, we accounted for them as asset acquisitions as opposed to business combinations.
The following table summarizes amounts recognized for each major class of asset and liability (in thousands) for these acquisitions during the year ended December 31, 2018:
The leases in the acquired properties had a weighted average remaining life at acquisition of approximately 11.3 years.
Fair Value Measurements
We determine the fair value of the individual components of real estate asset acquisitions primarily through calculating the "as-if vacant" value of a building, using an income approach, which relies significantly upon internally determined assumptions. We have determined that these estimates primarily rely on Level 3 inputs, which are unobservable inputs based on our own assumptions. The most significant assumptions used in calculating the "as-if vacant" value for acquisition activity during 2020 and 2019, respectively, are as follows:
Capitalized acquisition costs were insignificant and the fair value of the ten properties acquired during the year ended December 31, 2020 was substantially the same as the cost of acquisition.
Dispositions
Dispositions of buildings (see Note 8 for the number of buildings sold in each year, as well as for their classification between continuing and discontinued operations) and undeveloped land generated net cash proceeds of $336.3 million, $432.7 million and $511.4 million in 2020, 2019 and 2018, respectively.
During 2020, we collected the remaining $110.0 million of principal on our outstanding notes receivable, which was related to the sale of our medical office portfolio during 2017.
In September 2019, we completed the sale of 18 non-strategic industrial properties for $217.5 million in proceeds and recorded a gain on sale of $146.3 million. These properties totaled 4.1 million square feet and were located in primarily Midwest markets.
All other dispositions were not individually material.
DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(6)Related Party Transactions
We provide property management, asset management, leasing, construction and other tenant-related services to unconsolidated joint ventures in which we have equity interests. We recorded the corresponding fees based on contractual terms that approximate market rates for these types of services and have eliminated our ownership percentage of these fees in the consolidated financial statements. The following table summarizes the fees earned from these joint ventures, prior to elimination, for the years ended December 31, 2020, 2019 and 2018, respectively (in thousands):
(7)Investments in Unconsolidated Joint Ventures
Summarized Financial Information
As of December 31, 2020, we had equity interests in nine unconsolidated joint ventures that primarily own and operate rental properties and hold land for development.
Combined summarized financial information for the unconsolidated joint ventures at December 31, 2020 and 2019, and for the years ended December 31, 2020, 2019 and 2018, are as follows (in thousands):
(1) Differences between the net investment in our unconsolidated joint ventures and our underlying equity in the net assets of the ventures are primarily a result of basis differences associated with the sales of properties to joint ventures in which we retained an ownership interest. These adjustments have resulted in an aggregate difference reducing our investments in unconsolidated joint ventures by $2.7 million and $2.5 million as of December 31, 2020 and 2019, respectively. Differences between historical cost basis and the basis reflected at the joint venture level (other than loans and impairments) are typically depreciated over the life of the related asset.
DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The scheduled principal payments of long term debt for the unconsolidated joint ventures, at our ratable ownership percentage, for each of the next five years and thereafter as of December 31, 2020 are as follows (in thousands):
In January 2021 we, and the other partner in one of our unconsolidated joint ventures, repaid the substantial majority (see Note 14) of the future repayments scheduled for 2021.
(8)Real Estate Assets, Discontinued Operations and Assets Held-for-Sale
Real Estate Assets
Real estate assets, excluding assets held-for-sale, consisted of the following (in thousands):
(1) Includes underutilized in-fill sites, which may have had buildings/structures on site when we acquired them, that are either (i) under lease to a third party and, after the lease ends, are expected to be redeveloped or will require significant capital expenditures before re-leasing; or (ii) industrial/logistics properties that we intend to re-lease after significant retrofitting and/or environmental remediation is completed.
Allocation of Noncontrolling Interests - General Partner
The following table illustrates the General Partner's share of the income attributable to common shareholders from continuing operations and discontinued operations, reduced by the allocation of income between continuing and discontinued operations to noncontrolling interests, for the years ended December 31, 2020, 2019 and 2018, respectively (in thousands):
Allocation of Noncontrolling Interests - Partnership
Substantially all of the income from discontinued operations for all periods presented in the Partnership's Consolidated Statements of Operations and Comprehensive Income is attributable to the common unitholders.
Assets Held-for-Sale
The following table illustrates the number of sold or held-for-sale properties:
DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 2020, two in-service properties were classified as held-for-sale, but did not meet the criteria to be classified within discontinued operations. The following table illustrates aggregate balance sheet information for properties held-for-sale (in thousands):
(9)Indebtedness
All debt is issued directly or indirectly by the Partnership. The General Partner does not have any indebtedness, but does guarantee some of the unsecured debt of the Partnership.
Indebtedness at December 31, 2020 and 2019 consists of the following (in thousands):
Secured Debt
At December 31, 2020, our secured debt was collateralized by rental properties with a carrying value of $160.3 million and by a letter of credit in the amount of $1.6 million.
The fair value of our fixed rate secured debt at December 31, 2020 was $65.8 million. Because our fixed rate secured debt is not actively traded in any marketplace, we utilized a discounted cash flow methodology to determine its fair value. Accordingly, we calculated fair value by applying an estimate of the current market rate to discount the debt's remaining contractual cash flows. Our estimate of a current market rate, which is the most significant input in the discounted cash flow calculation, is intended to replicate debt of similar maturity and loan-to-value relationship. The estimated market rates for all of our current fixed rate secured debt are between 1.90% and 2.70%, depending on the attributes of the specific loans. The current market rates we utilized were internally estimated; therefore, we have concluded that our determination of fair value for our fixed rate secured debt was primarily based upon Level 3 inputs.
In February 2020, a consolidated joint venture obtained an $18.4 million secured loan from a third party financial institution, with a fixed annual interest rate of 3.41% and a maturity date of March 1, 2035.
DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In September 2020, we assumed two secured loans in conjunction with a two-building asset acquisition. These assumed loans had a total face value of $21.5 million and fair value of $25.5 million. These assumed loans had a weighted average remaining term at acquisition of 11.8 years and carried a weighted average stated interest rate of 4.54%. The difference between the fair value and the face value of loans assumed in connection with the acquisition is recorded as a premium and amortized to interest expense over the life of the loans assumed. We used an estimated market interest rate of 2.50% in determining the fair values of these loans.
During 2020, we repaid one fixed rate secured loan, totaling $9.0 million, which had a stated interest rate of 5.61%.
During 2019, we repaid three loans, totaling $41.7 million, which had a weighted average stated rate of 7.76%.
Unsecured Debt
At December 31, 2020, all of our unsecured debt bore interest at fixed rates and primarily consisted of unsecured notes that are publicly traded. We utilized broker estimates in estimating the fair value of our fixed rate unsecured debt. Our unsecured notes are thinly traded and, in certain cases, the broker estimates were not based upon comparable transactions. The broker estimates took into account any recent trades within the same series of our fixed rate unsecured debt, comparisons to recent trades of other series of our fixed rate unsecured debt, trades of fixed rate unsecured debt from companies with profiles similar to ours, as well as overall economic conditions. We reviewed these broker estimates for reasonableness and accuracy, considering whether the estimates were based upon market participant assumptions within the principal and most advantageous market and whether any other observable inputs would be more accurate indicators of fair value than the broker estimates. We concluded that the broker estimates were representative of fair value. We have determined that our estimation of the fair value of our fixed rate unsecured debt was primarily based upon Level 3 inputs. The estimated trading values of our fixed rate unsecured debt, depending on the maturity and coupon rates, ranged from 101.00% to 138.00% of face value.
The indentures (and related supplemental indentures) governing our outstanding series of notes also require us to comply with financial ratios and other covenants regarding our operations. We were in compliance with all such financial covenants at December 31, 2020.
We took the following actions during 2020 and 2019 as they pertain to our unsecured indebtedness:
•In June 2020, we issued $350.0 million of senior unsecured notes, which bear interest at a stated interest rate of 1.75%, have an effective interest rate of 1.85% and mature on July 1, 2030. Proceeds from the unsecured notes offering were primarily used to repurchase and cancel $216.3 million of 3.88% senior unsecured notes due 2022 pursuant to a tender offer completed by the Partnership in June 2020. In connection with the early cancellation of these notes, we recognized a loss of $15.1 million consisting of a repayment premium and the write-off of unamortized deferred financing costs.
•In February 2020, we issued $325.0 million of senior unsecured notes that bear interest at a stated interest rate of 3.05%, have an effective interest rate of 3.19%, and mature on March 1, 2050. Proceeds from the unsecured notes offering were primarily used to repay the $300.0 million of senior unsecured notes bearing a stated interest rate of 4.38% due 2022. In connection with the early redemption of these notes, we recognized a loss of $17.8 million consisting of a prepayment premium and the write-off of unamortized deferred financing costs.
•In November 2019, we issued $400.0 million of senior unsecured notes that bear interest at a stated interest rate of 2.88%, have an effective interest rate of 3.96% when including the impact of interest rate swap amortization from accumulated other comprehensive loss, and mature on November 15, 2029.
•In October 2019, we redeemed $250.0 million of senior unsecured notes that had a scheduled maturity date of February 15, 2021 and bore a stated interest rate of 3.88% and an effective rate of 3.91%. We recognized a loss on debt extinguishment of $6.3 million, which included a prepayment premium and the write-off of unamortized deferred financing costs.
•In August 2019, we issued $175.0 million of senior unsecured notes that bear interest at a stated interest rate of 3.38%, have an effective interest rate of 2.80%, and mature on December 15, 2027. Proceeds from the unsecured notes offering were primarily used to repay the borrowings under the unsecured line of credit.
DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unsecured Line of Credit
Our unsecured line of credit at December 31, 2020 is described as follows (in thousands):
The Partnership's unsecured line of credit has an interest rate on borrowings of LIBOR plus 0.875% (equal to 1.03% for our outstanding borrowings at December 31, 2020) and a maturity date of January 30, 2022, with options to extend until January 30, 2023. Subject to certain conditions, the terms also include an option to increase the facility by up to an additional $800.0 million, for a total of up to $2.00 billion. This line of credit provides us with an option to obtain borrowings from financial institutions that participate in the line at rates that may be lower than the stated interest rate, subject to certain restrictions.
This line of credit contains financial covenants that require us to meet certain financial ratios and defined levels of performance, including those related to fixed charge coverage, unsecured interest expense coverage and debt-to-asset value (with asset value being defined in the Partnership's unsecured line of credit agreement). At December 31, 2020, we were in compliance with all financial covenants under this line of credit.
We utilized a discounted cash flow methodology in order to estimate the fair value of outstanding borrowings on our unsecured line of credit. To the extent that credit spreads have changed since the origination of the line of credit, the net present value of the difference between future contractual interest payments and future interest payments based on our estimate of a current market rate would represent the difference between the book value and the fair value. This estimate of a current market rate is based upon the rate, considering current market conditions and our specific credit profile, at which we estimate we could obtain similar borrowings. As our credit spreads have not changed appreciably, we believe that the contractual interest rate and the current market rate on any outstanding borrowings on the line of credit are the same. The current market rate is internally estimated and therefore is primarily based upon a Level 3 input.
Changes in Fair Value
As all of our fair value debt disclosures relied primarily on Level 3 inputs, the following table summarizes the book value and changes in the fair value of our debt for the year ended December 31, 2020 (in thousands):
DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Scheduled Maturities and Interest Paid
At December 31, 2020, the scheduled amortization and maturities of all indebtedness, excluding fair value adjustment, for the next five years and thereafter were as follows (in thousands):
The Partnership’s unsecured line of credit is reflected in the table above as maturing in January 2023, based on the ability to exercise the two six-month extension options from its stated maturity date of January 2022. The amount of interest paid in 2020, 2019 and 2018 was $104.6 million, $111.8 million and $108.2 million, respectively. The amount of interest capitalized in 2020, 2019 and 2018 was $24.3 million, $26.5 million and $27.2 million, respectively.
(10)Segment Reporting
Reportable Segments
As of December 31, 2020, we had two reportable operating segments, the first consisting of the ownership and rental of industrial real estate investments. We continue to increase our investments in quality industrial properties largely based on anticipated geographic trends in supply and demand for industrial buildings, as well as the real estate needs of our major tenants that operate on a national level. We treat our industrial properties as a single operating and reportable segment based on our method of internal reporting. Properties not included in our reportable segment, because they are not industrial properties and do not by themselves meet the quantitative thresholds for separate presentation as a reportable segment, are generally referred to as non-reportable Rental Operations. Our non-reportable Rental Operations primarily include our remaining office properties and medical office property at December 31, 2020. The operations of our industrial properties, as well as our non-reportable Rental Operations, are collectively referred to as "Rental Operations."
Our second reportable segment consists of various real estate services such as development, general contracting, construction management, property management, asset management, maintenance and leasing to third-party property customers, owners and joint ventures, and is collectively referred to as "Service Operations." The Service Operations segment is identified as one single operating segment because the lowest level of financial results reviewed by our chief operating decision maker are the results for the Service Operations segment in total. Further, our reportable segments are managed separately because each segment requires different operating strategies and management expertise.
DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Revenues by Reportable Segment
The following table shows the revenues for each of the reportable segments, as well as a reconciliation to consolidated revenues, for the years ended December 31, 2020, 2019 and 2018 (in thousands):
Major Customer
The table below shows the revenues from a major customer from each of our reportable segments (in thousands):
We generated more than 10% of our total revenues from this customer for the year ended December 31, 2020. Revenues from Rental Operations relate to leasing properties to this customer. Revenues from Service Operations for this customer pertained primarily to general contractor services, and the construction costs paid to subcontractors and the associated revenues from billing this customer for those costs are recorded on a gross basis.
Supplemental Performance Measure
PNOI is the non-GAAP supplemental performance measure that we use to evaluate the performance of, and to allocate resources among, the real estate investments in the reportable and operating segments that comprise our Rental Operations. PNOI for our Rental Operations segments is comprised of rental revenues from continuing operations less rental expenses and real estate taxes from continuing operations, along with certain other adjusting items (collectively referred to as "Rental Operations revenues and expenses excluded from PNOI," as shown in the following table). Additionally, we do not allocate interest expense, depreciation expense and certain other non-property specific revenues and expenses (collectively referred to as "Non-Segment Items," as shown in the following table) to our individual operating segments.
DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
We evaluate the performance of our Service Operations reportable segment using net income or loss, as allocated to that segment ("Earnings from Service Operations").The following table shows a reconciliation of our segment-level measures of profitability to consolidated income from continuing operations before income taxes, for the years ended December 31, 2020, 2019 and 2018 (in thousands and excluding discontinued operations):
The most comparable GAAP measure to PNOI is income from continuing operations before income taxes. PNOI excludes expenses that materially impact our overall results of operations and, therefore, should not be considered as a substitute for income from continuing operations before income taxes or any other measures derived in accordance with GAAP. Furthermore, PNOI may not be comparable to other similarly titled measures of other companies.
Assets by Reportable Segment
The assets for each of the reportable segments at December 31, 2020 and 2019 were as follows (in thousands):
DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In addition to revenues and PNOI, we also review our second generation capital expenditures in measuring the performance of our individual Rental Operations segments. We review these expenditures to determine the costs associated with re-leasing vacant space and maintaining the condition of our properties. Our second generation capital expenditures are included within "second generation tenant improvements, leasing costs and building improvements" in our consolidated statements of Cash Flows and are primarily attributable to the industrial segment for the years ended December 31, 2020, 2019 and 2018.
(11)Employee Benefit Plans
We maintain a 401(k) plan for our eligible employees. We make matching contributions of 50% of the employee salary deferral contributions up to 6% of eligible compensation and may also make annual discretionary contributions. A discretionary contribution was declared at the end of 2020, 2019 and 2018. The total expense recognized for this plan was $2.2 million, $2.1 million and $1.8 million for the years ended December 31, 2020, 2019 and 2018, respectively.
(12)Shareholders' Equity of the General Partner and Partners' Capital of the Partnership
General Partner
The General Partner has an ATM equity program that allows it to issue and sell its common shares through sales agents from time to time. Actual sales under the ATM equity program depend on a variety of factors to be determined by the General Partner, including, among others, market conditions, the trading price of the General Partner’s common stock, determinations by the General Partner of the appropriate sources of funding and potential uses of funding available.
In August 2019, the General Partner terminated its previous equity distribution agreement for the ATM equity program and entered into a new equity distribution agreement to sell shares of its common stock, $0.01 par value per share, from time to time, up to an aggregate offering price of $400.0 million.
During 2020, the General Partner issued 4.6 million common shares pursuant to its ATM equity program, generating gross proceeds of $177.1 million and, after deducting commissions and other costs, net proceeds of $175.0 million. The proceeds from these offerings were contributed to the Partnership and used to fund development activities.
During 2019, the General Partner issued 8.0 million common shares pursuant to its ATM equity programs, generating gross proceeds of $266.3 million and, after deducting commissions and other costs, net proceeds of $263.3 million. The proceeds from these offerings were contributed to the Partnership and used to fund development activities.
During 2018, the General Partner issued 990,400 common shares pursuant to its ATM equity program, generating gross proceeds of approximately $29.0 million and, after deducting commissions and other costs, net proceeds of approximately $28.4 million. The proceeds from these offerings were contributed to the Partnership and used to fund development activities.
Partnership
For each common share or preferred share that the General Partner issues, the Partnership issues a corresponding General Partner Unit or Preferred Unit, as applicable, to the General Partner in exchange for the contribution of the proceeds from the stock issuance. Similarly, when the General Partner redeems or repurchases common shares or preferred shares, the Partnership redeems the corresponding General Partner Units or Preferred Units held by the General Partner at the same price.
DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(13)Stock Based Compensation
We are authorized to issue up to 10.3 million shares of the General Partner's common stock under our stock-based employee and non-employee compensation plans. Executive officers may elect to receive Long-Term Incentive Plan Units ("LTIP Units"), which represent an interest in the Partnership, in lieu of stock based compensation awards denominated in the General Partner's common stock.
Restricted Stock Units ("RSUs")
Under our 2015 Long-Term Incentive Plan, which was approved by the General Partner's shareholders in April 2015, and our 2015 Non-Employee Directors Compensation Plan (collectively, the "Compensation Plans"), RSUs may be granted to non-employee directors, executive officers and selected employees. An RSU is economically equivalent to a share of the General Partner's common stock, and RSUs are valued based on the market price of the General Partner's common stock on the date of the award. Amounts disclosed below include both RSUs and any elected LTIP Units, which have the same vesting schedule as RSUs.
RSUs granted to employees from 2015 to 2020 vest ratably in most cases over a three-year period and are payable in shares of our common stock with a new share of such common stock issued upon each RSU's vesting. RSUs granted to existing non-employee directors vest 100% over one year and have contractual lives of one year.
To the extent that a recipient of an RSU grant is not determined to be retirement eligible, as defined by the Compensation Plans, we recognize expense on a straight-line basis over the vesting period. Expense is recognized immediately at the date of grant to the extent a recipient is retirement eligible and expense is accelerated to the extent that a participant will become retirement eligible prior to the end of the contractual life of granted RSUs.
The following table summarizes transactions for our unvested RSUs, excluding dividend equivalents, for 2020:
Compensation cost recognized for RSUs totaled $12.1 million, $11.0 million and $11.9 million for the years ended December 31, 2020, 2019 and 2018, respectively.
As of December 31, 2020, there was $6.5 million of total unrecognized compensation expense related to nonvested RSUs granted under the Plan, which is expected to be recognized over a weighted average period of 1.7 years.
The total intrinsic value (which is equal to the value of a share of the General Partner's common stock on the date of vesting) of RSUs vested during the years ended December 31, 2020, 2019 and 2018 was $15.4 million, $17.7 million and $18.3 million, respectively.
The weighted average grant-date fair value of RSUs granted during 2019 and 2018 was $29.98 and $25.38, respectively.
The weighted average grant-date fair value of nonvested RSUs as of December 31, 2018 was $23.36.
DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Performance-Based Awards
A portion of the annual stock-based compensation awards granted to our executive officers annually include performance conditions, measured over a three-year performance period, based on pre-established goals for growth in a defined adjusted funds from operations (“AFFO”) metric. These performance-based awards disclosed below include awards denominated in both common shares of the General Partner or LTIP Units. The total number of instruments issued at the end of each performance period may be earned in a range from 0% to 200% of the target value of the award depending on our AFFO performance relative to the pre-established goals.
To the extent that a recipient of these performance-based awards is not determined to be retirement eligible, as defined by the Compensation Plans, we recognize expense on a straight-line basis over the performance period based on the most likely payout percentage at each reporting period for each grant to the extent that a payout is determined to be probable. Expense is recognized immediately at the date of grant, based on the most likely payout percentage to the extent that a payout is determined to be probable, when a recipient is retirement eligible, and expense is accelerated to the extent that a participant will become retirement eligible prior to the end of the performance period of an award.
Details on the unvested amounts of these annual grants by performance period are as follows:
To the extent that performance-based awards are denominated in LTIP units, the above target component of such awards that vest are subject to an additional two year holding period. A summary of vested awards still subject to the two year holding period is as follows:
Compensation cost recognized for these performance-based awards totaled $7.8 million, $6.2 million and $5.7 million for the years ended December 31, 2020, 2019 and 2018, respectively.
As of December 31, 2020, there was $913,000 of total unrecognized compensation expense related to nonvested performance-based awards, which is expected to be recognized over a weighted average period of 1.5 years.
The weighted average grant-date fair value, per instrument, for these performance-based awards granted during 2019 and 2018 was $29.98 and $25.37.
The weighted average grant-date fair value of these nonvested performance-based awards as of December 31, 2018 was $25.32.
DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(14)Commitments and Contingencies
The Partnership has guaranteed the repayment of $20.1 million of economic development bonds issued by various municipalities in connection with certain commercial developments. We may be required to make payments under our guarantees to the extent that incremental taxes from specified developments are not sufficient to pay the bond debt service. Management does not believe that it is probable that we will be required to make any significant payments in satisfaction of these guarantees.
The Partnership also has guaranteed the repayment of loans associated with two of our unconsolidated joint ventures. At December 31, 2020, the maximum guarantee exposure for these loans was approximately $81.3 million. In January 2021, we, and the other partner in one of these unconsolidated joint ventures, repaid one of these guaranteed loans, totaling $69.8 million, which was scheduled to mature in November 2021.
We lease certain land positions with lease terms extending to April 1, 2082, and a total future payment obligation of $225.2 million at December 31, 2020. No payments on these ground leases are material in any individual year.
In addition to ground leases, we are party to other operating leases as part of conducting our business, including leases of office space from third parties, with a total future payment obligation of $27.9 million at December 31, 2020. No future payments on these leases are material in any individual year.
We are subject to various legal proceedings and claims that arise in the ordinary course of business. In the opinion of management, the amount of any ultimate liability with respect to these actions is not expected to materially affect our consolidated financial statements or results of operations.
We own certain parcels of land that are subject to special property tax assessments levied by quasi municipal entities. To the extent that such special assessments are fixed and determinable, the discounted value of the full assessment is recorded as a liability. We have $961,000 of such special assessment liabilities, which are included within other liabilities on our Consolidated Balance Sheets as of December 31, 2020.
(15)Subsequent Events
Declaration of Dividends/Distributions
The General Partner's board of directors declared the following dividends/distributions at its regularly scheduled board meeting held on January 27, 2021:
Issuance of Senior Unsecured Notes
In January 2021, we issued $450.0 million of senior unsecured notes that bear a stated interest rate of 1.75%, have an effective interest rate of 1.83%, and mature on February 1, 2031. Proceeds from the unsecured notes offering were initially applied to pay down outstanding borrowings on the line of credit as of December 31, 2020, and we intend to allocate an amount equal to the net proceeds from the offering to the financing or refinancing of eligible green projects.
(1)The tax basis (in thousands) of our real estate assets at December 31, 2020 was approximately $8,168,875 (unaudited) for federal income tax purposes.
(2)Depreciation of real estate is computed using the straight-line method not to exceed 40 years for buildings and 15 years for land improvements for properties that we develop, and not to exceed 30 years for buildings and 10 years for land improvements for properties that we acquire. Tenant improvements are depreciated over shorter periods based on lease terms (generally 3 to 10 years).
See Accompanying Notes to Independent Auditors' Report
Item 16. Form 10-K Summary
Not applicable.
The following exhibits are filed with this Form 10-K or incorporated herein by reference to the listed document previously filed with the SEC. Previously unfiled documents are noted with an asterisk (*).
10.8Amended and Restated Revolving Credit Agreement, dated October 11, 2017, by and among the Partnership, the General Partner, J.P. Morgan Chase Bank, N.A., Wells Fargo Securities, LLC, the Bank of Nova Scotia, Regions Capital Markets, Division of Regions bank and the several banks, financial institutions and other entities from time to time parties thereto as lenders (filed as Exhibit 10.1 to the combined Current Report on Form 8-K of the General Partner and the Partnership as filed with the SEC on October 12, 2017, and incorporated herein by this reference).
10.9Amended and Restated Guaranty, dated October 11, 2017 by the General Partner (filed as Exhibit 10.2 to the Combined Current Report on Form 8-K of the General Partner and the Partnership as filed with the SEC on October 12, 2017, and incorporated herein by this reference).
10.10Equity Distribution Agreement, dated August 2, 2019, by and among the General Partner, the Partnership, BTIG LLC, Citigroup Global Markets Inc., Jefferies LLC, Morgan Stanley & Co. LLC, Regions Securities LLC, SunTrust Robinson Humphrey, Inc., UBS Securities LLC, and Wells Fargo Securities, LLC (filed as Exhibit 1.1 to the combined Current Report on Form 8-K of the General Partner and the Partnership as filed with the SEC on August 2, 2019, and incorporated herein by this reference).
# Represents management contract or compensatory plan or arrangement.
* Filed herewith.
** The certifications attached as Exhibits 32.1, 32.2, 32.3 and 32.4 accompany this Report and are "furnished" to the Securities and Exchange Commission pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed "filed" by the General Partner or the Partnership, respectively, for purposes of Section 18 of the Securities Exchange Act of 1934, as amended.
We will furnish to any security holder, upon written request, copies of any exhibit incorporated by reference, for a fee of 15 cents per page, to cover the costs of furnishing the exhibits. Written requests should include a representation that the person making the request was the beneficial owner of securities entitled to vote at the Annual Meeting of Shareholders.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
DUKE REALTY CORPORATION
/s/ James B. Connor
James B. Connor
Chairman and Chief Executive Officer
(Principal Executive Officer)
/s/ Mark A. Denien
Mark A. Denien
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
DUKE REALTY LIMITED PARTNERSHIP
By: DUKE REALTY CORPORATION, its general partner
/s/ James B. Connor
James B. Connor
Chairman and Chief Executive Officer of the General Partner
(Principal Executive Officer)
/s/ Mark A. Denien
Mark A. Denien
Executive Vice President and Chief Financial Officer of the General Partner
(Principal Financial and Accounting Officer)
Date:February 19, 2021
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
* By James B. Connor, Attorney-in-Fact/s/ James B. Connor