ITEM 1.
BUSINESS
The Company
DCT Industrial Trust Inc. is a leading industrial real estate company specializing in the ownership, acquisition, development, leasing and management of bulk-distribution and light-industrial properties located in high-demand distribution markets in the United States. DCT's actively managed portfolio is strategically located near population centers and well-positioned to take advantage of market dynamics. As used herein, the terms “Company,” “we,” “our” and “us” refer to DCT Industrial Trust Inc. and its subsidiaries, including its operating partnership, DCT Industrial Operating Partnership LP. When we use the term “DCT” or “DCT Industrial,” we are referring to DCT Industrial Trust Inc. by itself, and not including any of its subsidiaries, and when we use the term “Operating Partnership,” we are referring to DCT Industrial Operating Partnership LP by itself, and not including any of its subsidiaries.
DCT was formed as a Maryland corporation in April 2002 and has elected to be treated as a real estate investment trust, or REIT, for U.S. federal income tax purposes. We are structured as an umbrella partnership REIT under which substantially all of our current and future business is, and will be, conducted through a majority owned and controlled subsidiary, DCT Industrial Operating Partnership LP, a Delaware limited partnership, for which DCT is the sole general partner. DCT owns properties through the Operating Partnership and its subsidiaries. As of December 31, 2017, DCT owned approximately 96.6% of the outstanding equity interests in the Operating Partnership.
Available Information
Our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K and any amendments to any of those reports that we file with the Securities and Exchange Commission are available free of charge as soon as reasonably practicable through our website at http://investors.dctindustrial.com. The information contained on our website is not incorporated into this annual report. Our common stock is listed on the New York Stock Exchange under the symbol “DCT”.
Business Overview
Our portfolio primarily consists of high-quality, bulk-distribution and light-industrial warehouses. The properties we target for acquisition or development are generally characterized by convenient access to major transportation arteries, proximity to densely populated urban centers and quality design standards that allow our customers’ efficient and flexible use of the buildings. In the future, we intend to continue focusing on properties that exhibit these characteristics in select U.S. markets where we believe we can achieve favorable returns and leverage our local expertise. We seek to maximize growth in earnings and shareholder value within the context of overall economic conditions, primarily through maintaining high levels of occupancy, increasing rents and operating income at existing properties and acquiring and developing high-quality properties with attractive operating income and value growth prospects. In addition, we will recycle our capital by disposing of non-strategic, lower growth assets and reinvesting the proceeds into newly acquired or developed assets where we believe the returns will be more favorable over time.
As of December 31, 2017, the Company owned interests in approximately 74.8 million square feet of properties leased to approximately 850 customers, including:
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65.1 million square feet comprising 398 consolidated operating properties, including five properties totaling 1.9 million square feet classified as held for sale, that were 97.8% occupied;
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1.0 million square feet comprising six consolidated properties developed by DCT which are shell-construction complete and in lease-up;
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0.1 million square feet comprising one consolidated property under redevelopment;
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1.0 million square feet comprising three consolidated value-add acquisitions; and
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7.6 million square feet comprising 21 unconsolidated properties that were 98.4% occupied and which we operated on behalf of two unconsolidated joint ventures.
In addition, the Company has 19 projects under construction and several projects in pre-development. See “Notes to Consolidated Financial Statements, Note 3 - Investment in Properties” for further details.
As of December 31, 2017, our total consolidated portfolio consisted of 408 properties with an average size of 165,000 square feet and an average age of 22 years.
During the year ended December 31, 2017, we acquired five buildings. These properties were acquired for a total purchase price of approximately $129.0 million. During the year ended December 31, 2017, we sold 12 consolidated operating properties to third-parties for gross proceeds of approximately $115.3 million. We recognized gains of approximately $47.1 million on the disposition of 11 properties and an impairment loss of approximately $0.3 million on one property during 2017.
We have a broadly diversified customer base. As of December 31, 2017, our consolidated properties had leases with approximately 850 customers with no single customer accounting for more than 3.4% of the total annualized base rent of our properties. Our 10 largest customers occupy approximately 16.6% of our consolidated properties based on square footage and account for approximately 18.7% of our annualized base rent as of December 31, 2017. We believe that our national presence in the top U.S. distribution markets provides geographic diversity and is attractive to users of distribution space which allows us to build strong relationships with our customers. Furthermore, we are actively engaged in meeting our customers’ expansion and relocation requirements.
Our principal executive office is located at 555 17th Street, Suite 3700, Denver, Colorado 80202; our telephone number is (303) 597-2400. We also maintain regional offices in Atlanta, Georgia; Chicago, Illinois and Newport Beach, California and market offices in Baltimore, Maryland; Cincinnati, Ohio; Dallas, Texas; Houston, Texas; Miami, Florida; Paramus, New Jersey; Emeryville, California; Orlando, Florida; Philadelphia, Pennsylvania; and Seattle, Washington. Our website address is www.dctindustrial.com.
Business Strategy
Our primary business objectives are to maximize long-term growth in Funds From Operations, or FFO, per share (see definition in “Selected Financial Data”), net asset value of our portfolio and total shareholder returns. In our pursuit of these long-term objectives, we seek to:
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Maximizing Cash Flows From Existing Properties. We intend to maximize the cash flows from our existing properties by active leasing and management, maintaining strong customer relationships, controlling operating expenses and physically maintaining the quality of our properties. Renewing tenants, leasing space and effectively managing expenses are critical to achieving our objectives and are a primary focus of our local real estate teams.
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Selectively Pursuing New Development. To create value and enhance the quality of our portfolio, we expect to continue developing new assets in select markets where strong tenant demand, rents and vacancy levels demonstrate the need for new construction at returns that make sense for the Company. During 2017, we acquired 12 land parcels for development totaling approximately 344.3 acres and we commenced construction on 19 development and redevelopment buildings comprising 4.0 million square feet with a projected investment of approximately $335.4 million. In 2017, we also stabilized six development buildings, three redevelopment buildings and three value-add acquisitions totaling 2.9 million square feet with cumulative costs of approximately $232.8 million. As of December 31, 2017, there were six shell-construction complete buildings under development totaling 1.0 million square feet, 19 projects under construction totaling approximately 4.9 million square feet and three value-add acquisitions in lease-up totaling 1.0 million square feet. All of the buildings under construction are projected to be completed during 2018.
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Profitably Acquiring Properties. We seek to acquire properties that meet our asset, location and financial criteria at prices and potential returns which we believe are attractive. We have selected certain markets and sub-markets where we focus our efforts on identifying buildings to acquire. During the year ended December 31, 2017, we acquired five buildings comprising 1.3 million square feet located in our Chicago, Denver, Northern California, Orlando and Southern California markets for a total purchase price of approximately $129.0 million.
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Recycling Capital. We intend to selectively dispose of non-strategic assets and redeploy the proceeds into higher growth acquisition and development opportunities. In 2017, we sold 12 consolidated operating properties for gross proceeds of approximately $115.3 million. The proceeds have been designated for deployment into new development and higher growth assets.
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Conservatively Managing Our Balance Sheet. We plan to maintain financial metrics, including leverage and coverage ratios on a basis consistent with our investment grade ratings. We believe that a conservatively managed balance sheet provides for a competitive long-term cost of capital.
Our Competitive Strengths
We believe that we distinguish ourselves from other owners, operators, acquirers and developers of industrial properties through the following competitive strengths:
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High-Quality Industrial Property Portfolio. Our portfolio of industrial properties primarily consists of high-quality bulk-distribution facilities in high demand leasing markets. Our properties are specifically designed to meet the warehousing needs of local, regional and national companies. The majority of our properties are readily divisible to take advantage of re-tenanting opportunities. We believe that our concentration of well located, high-quality bulk-distribution properties provides us with a competitive advantage in attracting and retaining distribution users across the markets in which we operate.
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Experienced and Committed Management Team. Our executive management team collectively has an average of nearly 30 years of commercial real estate experience and 19 years of industrial real estate experience. Additionally, our executive management team has extensive public company operating experience.
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Strong Operating Platform. We have a team of approximately 90 experienced transaction and property management professionals working in 13 offices to maximize market opportunities through local expertise, presence and relationships. We believe successfully meeting the needs of our customers and anticipating and responding to market opportunities will result in achieving superior returns from our properties as well as provide opportunities for the sourcing of new acquisitions and development opportunities.
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Extensive Development and Redevelopment Expertise. Our local market teams have significant experience in all facets of value-add activities including development and redevelopment capabilities. We believe our local teams’ knowledge of our markets and their relationships with key market participants, including land owners, users and brokers, combined with the technical expertise required to successfully execute on complex transactions, provides us with an excellent platform to create value while appropriately managing risk.
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Proven Acquisition and Disposition Capabilities. The Company has extensive experience in acquiring industrial real estate, including both smaller transactions as well as larger portfolio acquisitions. Our local market teams are an important advantage in sourcing potential marketed as well as off-market transactions. Further, consistent with our capital recycling strategy, we have disposed of a cumulative $2.2 billion of real estate investments since the inception of the Company.
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Strong Industry Relationships. We believe that our extensive network of industry relationships with the brokerage and investor communities will allow us to execute successfully our development, acquisition and capital recycling strategies. These relationships augment our ability to source acquisitions in off-market transactions outside of competitive marketing processes, capitalize on development opportunities and capture repeat business and transaction activity. Our strong relationships with local and nationally focused brokers aids in attracting and retaining customers.
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Capital Structure. Our capital structure provides us with sufficient financial flexibility and capacity to fund future growth. As of December 31, 2017, we had $164.1 million available under our $400.0 million senior unsecured revolving credit facility, net of two letters of credit totaling $1.9 million. As of December 31, 2017, 366 of our consolidated properties with a gross book value of $4.2 billion were unencumbered. During the year ended December 31, 2017, we also issued approximately 1.8 million shares of common stock through the continuous equity offering program, at a weighted average price of $54.48 per share for proceeds of approximately $95.5 million, net of offering expenses.
Operating Segments
Our operating results used to assess performance are aggregated into three reportable segments, East, Central and West, which are based on the geographical markets where our management and operating teams conduct and monitor business. We consider rental revenues and property net operating income (“NOI”) aggregated by segment to be the appropriate way to analyze performance. See additional information in “Item 2. Properties” and in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Notes to Consolidated Financial Statements, Note 14 - Segment Information.”
Competition
The market for the leasing of industrial real estate is highly competitive. We experience competition for customers from other existing assets in proximity to our buildings as well as from new development. Institutional investors, other REITs and local real estate operators generally own such properties; however, no single competitor or small group of competitors is dominant in our current markets. However, as a result of competition, we may have to provide concessions, incur charges for tenant improvements or offer other inducements, all of which may have an adverse impact on our results of operations.
The market for the acquisition of industrial real estate is also very competitive. We compete for real property investments with other REITs and institutional investors such as pension funds and their advisors, private real estate investment funds, insurance company investment accounts, private investment companies, individuals and other entities engaged in real estate investment activities, some of which have greater financial resources than we do.
Environmental Matters
We are exposed to various environmental risks that may result in unanticipated losses and affect our operating results and financial condition. Either we or the previous owners subjected a majority of the properties we have acquired, including land, to environmental reviews. While some of these assessments have led to further investigation and sampling, none of the environmental assessments has revealed an environmental liability that we believe would have a material adverse effect on our business, financial condition or results of operations. See “Item 1A.
ITEM 1A.
RISK FACTORS
RISKS RELATED TO OUR BUSINESS AND OPERATIONS
Adverse economic conditions could negatively affect our returns and profitability.
Our operating results may be affected by weakness in the national and/or international economy as well as the local economies where our properties are concentrated. Specific impacts, among others, may include:
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increased levels of tenant defaults under, or non-renewals of, leases;
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re-leasing which may require concessions, tenant improvement expenditures or reduced rental rates;
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overbuilding which may increase vacancies;
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adverse capital and credit market conditions may restrict our development and redevelopment activities; and
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reduced access to credit may result in an inability of potential buyers to acquire our properties held for sale.
The value of our investments may not appreciate or may decline significantly below the amount we pay for these investments. The length and severity of any economic slowdown or downturn cannot be predicted. Our operations could be negatively affected to the extent that an economic slowdown or downturn is prolonged or becomes more severe.
Our investments are concentrated in the industrial real estate sector, and our business would be adversely affected by an economic downturn in that sector.
Our investments in real estate assets are primarily concentrated in the industrial real estate 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 depend on key personnel.
Our success depends to a significant degree upon the continued contributions of certain key personnel including, but not limited to, our management group, each of whom would be difficult to replace. If any of our key personnel were to cease employment with us, our operating results, financial condition and cash flows could suffer. Our ability to retain our management group, attract suitable replacements, or to attract new hires as needed, is dependent on the competitive nature of the employment market. Further, the loss of key personnel, or our inability to replace them, could be negatively perceived in the capital markets. We do not carry key man life insurance on any of our personnel.
Our operating results and financial condition could be adversely affected if we do not continue to have access to capital on favorable terms.
As a REIT, we must meet certain annual distribution requirements. Consequently, we are largely dependent on asset sales or external capital to fund our development and acquisition activities. Further, in order to maintain our REIT status and avoid the payment of income and excise taxes, we may need to borrow funds on a short-term basis to meet the REIT distribution requirements even if the then-prevailing market conditions are not favorable for these borrowings. These short-term borrowing needs could result from differences in timing between the actual receipt of cash and inclusion of income for U.S. federal income tax purposes or the effect of non-deductible capital expenditures, the creation of reserves or required debt or amortization payments. Additionally, our ability to sell assets or access capital is dependent upon a number of factors, including general market conditions and competition from other real estate companies. To the extent that capital is not available to acquire or develop properties, profits may not be realized or their realization may be delayed, which could result in an earnings stream that is less predictable than some of our competitors and result in us not meeting our projected earnings and distributable cash flow levels in a particular reporting period. Failure to meet our projected earnings and distributable cash flow levels in a particular reporting period could have an adverse effect on our financial condition and on the market price of our common stock.
Our long-term growth may partially depend upon future acquisitions of properties, and we may be unable to consummate acquisitions on advantageous terms or acquisitions may not perform as we expect.
We acquire and intend to continue to acquire primarily high-quality generic bulk-distribution warehouses and light-industrial properties. The acquisition of properties entails various risks, including the risks that our investments may not perform as we expect, that we may be unable to integrate our new acquisitions into our existing operations quickly and efficiently and that our cost estimates for bringing an acquired property up to market standards may prove inaccurate. Further, we face significant competition for attractive investment opportunities from other well-capitalized real estate investors, including both publicly-traded REITs and private institutional investment funds, and these competitors may have greater financial resources than us and a greater ability to borrow funds to acquire properties. This competition increases as investments in real estate become increasingly attractive relative to other forms of investment. As a result of competition, we may be unable to acquire additional properties as we desire or the purchase price may be significantly elevated. In addition, we expect to finance future acquisitions through a combination of borrowings under our senior unsecured credit facility, proceeds from equity or debt offerings by us or our operating partnership or its subsidiaries and proceeds from property contributions and sales which may not be available and which could adversely affect our cash flows. Any of the above risks could adversely affect our financial condition, results of operations, cash flows and ability to pay distributions on, and the market price of, our common stock.
Our real estate development strategies may not be successful.
We are involved in the construction and renovation of distribution facilities and we intend to continue to pursue development and renovation activities as opportunities arise either on our own or in joint ventures. We will be subject to risks associated with our development and renovation activities that could adversely affect our financial condition, results of operations, cash flows, our ability to pay dividends, and/or the market price of our common stock.
Actions of our joint venture partners could negatively impact our performance.
Our organizational documents do not limit the amount of available funds that we may invest in partnerships, limited liability companies or joint ventures, and we intend to selectively continue to develop and acquire properties through joint ventures, limited liability companies and partnerships with other persons or entities when warranted by the circumstances. Such partners may share certain approval rights over major decisions. Such investments may involve risks not otherwise present with other methods of investment in real estate, including, but not limited to:
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that our partner in an investment might become bankrupt, which could mean that we may be responsible for the joint venture’s liabilities;
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that such partner may at any time have economic or business interests or goals which are or which become inconsistent with our business interests or goals;
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that such partner may be in a position to take action contrary to our instructions or requests or contrary to our policies or objectives, including our current policy with respect to maintaining our qualification as a REIT;
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that, if our partners fail to fund their share of any required capital contributions, we may be required to contribute such capital;
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that a joint venture agreement may restrict our ability to sell our interest therein, or the underlying property, when we desire or on advantageous terms;
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that our relationships with our partners are contractual in nature and may be terminated or dissolved under the terms of the agreements and, in such event, we may not continue to own or operate the interests or assets underlying such relationship or may need to purchase such interests or assets at an above-market price to continue ownership;
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that disputes between us and our partners may result in litigation or arbitration that could increase our expenses and prevent our officers and directors from focusing their time and effort on our business and result in subjecting the underlying property to additional risk;
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that we may in certain circumstances be liable for the actions of our partners; and
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that we may, as a general partner investing in a limited partnership, have liability for all of the liabilities of such partnership, even if we do not have full management rights or control, and our liability may far exceed the amount or value of the investment we initially made or then had in the partnership.
The availability and timing of cash distributions is uncertain.
We expect to continue to pay quarterly distributions to our stockholders. However, we bear all expenses incurred by our operations, and our funds generated by operations, after payment of these expenses, may not be sufficient to cover desired levels of distributions to our stockholders. In addition, our board of directors, in its discretion, may retain any portion of such cash for working capital. We cannot assure our stockholders that sufficient funds will be available to pay distributions.
Declining real estate valuations and impairment charges could adversely affect our earnings and financial condition. We may decide to dispose of select real estate assets, thereby changing the holding period assumption in our valuation analyses for those assets, which could result in material impairment losses and adversely affect our financial results.
Economic conditions could change our intended hold period for a property or have required or could require us to recognize real estate impairment charges on some of our assets and equity investments. We conduct a comprehensive review of all our real estate assets in accordance with our policy of accounting for impairments (see further discussion of our accounting policies in “Notes to the Consolidated Financial Statements, Note 2 -Summary of Significant Accounting Policies” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Polices and Estimates”). The principal factor which has led to impairment charges in the past was the severe economic deterioration in many markets resulting in a decrease in leasing demand, rental rates, rising vacancies and/or an increase in capitalization rates. These possible impairment charges or losses could adversely affect our financial condition, results of operations and/or the market price of our stock.
Our business could be adversely impacted if we have deficiencies in our disclosure controls and procedures or internal control over financial reporting.
Although continuously reviewed, the design and effectiveness of our disclosure controls and procedures and internal control over financial reporting may not prevent all errors, misstatements, misrepresentations or a failure to follow such controls by an employee and could result in a decline in our stock price, or otherwise materially adversely affect our business, reputation, results of operations, financial condition or liquidity.
We face risks associated with security breaches through cyber-attacks, cyber intrusions or otherwise, as well as other significant disruptions of our information technology (IT) networks and related systems.
We face risks associated with security breaches, whether through cyber-attacks or cyber intrusions over the Internet, malware, computer viruses, attachments to e-mails, spoofed e-mails, persons inside our organization or persons with access to systems inside our organization, and other significant disruptions of our IT networks and related systems. The risk of a security breach or disruption, particularly through cyber-attack or cyber intrusion, including by computer hackers, foreign governments and cyber terrorists, has increased as the number, intensity and sophistication of attempted attacks and intrusions from around the world have significantly increased. Our IT networks and related systems are essential to the operation of our business and our ability to perform day-to-day operations and, in some cases, may be critical to the operations of certain of our tenants. Although we make efforts to maintain the security and integrity of these types of IT networks and related systems, provide appropriate training to our employees, and have implemented various measures to manage the risk of a security breach or disruption, even the most well protected information, networks, systems and facilities remain potentially vulnerable because the techniques used in such attempted security breaches evolve and generally are not recognized until launched against a target, and in some cases are designed to not be detected and, in fact, may not be detected. Accordingly, we may be unable to anticipate these techniques or to implement adequate security barriers or other preventative measures, and thus it is impossible for us to entirely mitigate this risk. A security breach or other significant disruption involving our IT networks and related systems could disrupt the proper functioning of our networks and systems; result in misstated financial reports, violations of loan covenants and/or missed reporting deadlines; result in the loss, theft or misappropriation of our property; result in our inability to properly monitor our compliance with the rules and regulations regarding our qualification as a REIT; result in the unauthorized access to, and destruction, loss, theft, misappropriation or release of proprietary, confidential, sensitive or otherwise valuable information of ours or others, which others could use to compete against us or for disruptive, destructive or otherwise harmful purposes and outcomes; require significant management attention and resources to remedy any damages that result; subject us to claims for breach of contract, damages, credits, penalties or termination of leases or other agreements; or damage our reputation among our tenants and investors generally.
RISKS RELATED TO CONFLICTS OF INTEREST
Our UPREIT structure may result in potential conflicts of interest.
As of December 31, 2017, we owned 96.6% of the units of limited partnership interest in our operating partnership, or OP Units, certain unaffiliated limited partners owned 2.5% of the OP Units and certain of our officers, owned the remaining 0.9% of the OP Units. Persons holding OP Units in our operating partnership have the right to vote on certain amendments to the limited partnership agreement of our operating partnership, as well as on certain other matters. Persons holding such voting rights may exercise them in a manner that conflicts with the interests of our stockholders. Furthermore, circumstances may arise in the future when the interest of limited partners in our operating partnership may conflict with the interests of our stockholders. For example, the timing and terms of dispositions of properties held by our operating partnership may result in tax consequences to certain limited partners and not to our stockholders.
GENERAL REAL ESTATE RISKS
Our performance and value are subject to general economic conditions and risks associated with our real estate assets.
The investment returns from equity investments in real estate depend in part on the amount of income earned and capital appreciation generated by the properties, as well as the expenses incurred in connection with the properties. If our properties do not generate income sufficient to meet operating expenses, including debt service and capital expenditures, then our ability to pay distributions to our stockholders could be adversely affected. In addition, there are significant expenditures associated with an investment in real estate (such as mortgage payments, real estate taxes and maintenance costs) that generally do not decline when circumstances reduce the income from the property. Income from, and the value of, our properties may, in addition to risks discussed elsewhere in this section, be adversely affected by:
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changes in supply of or demand for similar or competing properties in an area;
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changes in interest rates and availability of permanent mortgage funds that may render the sale of a property difficult or unattractive or otherwise reduce returns to stockholders;
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changes in or increased costs of compliance with governmental rules, regulations and fiscal policies, including changes in tax, real estate, environmental and zoning laws, and our potential liability thereunder;
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our ability to provide adequate maintenance and insurance;
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customer turnover;
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general overbuilding or excess supply in the market areas;
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disruptions in the global supply chain caused by political, regulatory or other factors including terrorism;
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shifts in space utilization by tenants due to changes in technology; and
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changes in tax policies affecting real estate.
In addition, periods of economic slowdown or recession, rising interest rates or declining demand for real estate, or public perception that any of these events may occur, could result in a general decrease in rents or an increased occurrence of defaults under existing leases, which would adversely affect our financial condition and results of operations. Future terrorist attacks may result in declining economic activity, which could reduce the demand for, and the value of, our properties. To the extent that future attacks impact our customers, their businesses similarly could be adversely affected, including their ability to continue to honor their existing leases.
For these and other reasons, we cannot assure our stockholders that we will be profitable or that we will realize growth in the value of our real estate properties.
Actions by our competitors may decrease or prevent increases in the occupancy and rental rates of our properties.
We compete with other developers, owners and operators of real estate. If our competitors offer space at rental rates or terms more attractive than we currently offer to our customers, we may lose customers or we may be pressured to reduce our rental rates or provide more favorable lease terms. As a result, our financial condition, cash flows, cash available for distribution, trading price of our common stock and ability to satisfy our debt service obligations could be materially adversely affected.
We are dependent on customers for our revenues.
Lease payment or performance defaults by customers could adversely affect our financial condition and cause us to reduce the amount of distributions to stockholders. A default by a customer on its lease payments could force us to find an alternative source of cash flow to pay operating expenses and any mortgage loan on the property. In the event of a customer default, we may experience delays in enforcing our rights as landlord and may incur substantial costs, including litigation and related expenses, in protecting our investment and re-leasing our property. If a lease is terminated, we may be unable to lease the property for the rent previously received or sell the property without incurring a loss.
Our ability to renew leases or re-lease space on favorable terms as leases expire significantly affects our business.
Our results of operations, distributable cash flows and the value of our common stock would be adversely affected if we are unable to lease, on economically favorable terms, a significant amount of space in our properties.
We may be unable to sell or re-lease a property if or when we decide to do so, including as a result of uncertain market conditions or vacancy, which could adversely affect the return on an investment in our common stock.
We expect to hold the various properties in which we invest until such time as we decide that a sale or other disposition is appropriate given our investment objectives. Our ability to dispose of properties on advantageous terms depends on factors beyond our control, including competition from other sellers, the availability of attractive financing for potential buyers of our properties and the rate of occupancy of the property. We cannot predict the various market conditions affecting real estate investments which will exist at any particular time in the future. Due to the uncertainty of market conditions which may affect the future disposition of our properties, we cannot assure our stockholders that we will be able to sell our properties at a profit in the future. Accordingly, the extent to which our stockholders will receive cash distributions and realize potential appreciation on our real estate investments will be dependent upon fluctuating market conditions.
Furthermore, we may be required to expend funds to correct defects or to make improvements before a property can be sold. We cannot assure our stockholders that we will have funds available to correct such defects or to make such improvements. In acquiring a property, we may agree to restrictions that prohibit the sale of that property for a period of time or impose other restrictions, such as a limitation on the amount of debt that can be placed or repaid on that property. These provisions could restrict our ability to sell a property and could affect cash available for distributions to our stockholders, or limit our ability to take other actions that could otherwise be in the best interest of our stockholders.
A property may incur a vacancy either by the continued default of a customer under its lease or the expiration of one of our leases. We have significant lease expirations in 2018 and subsequent years, as outlined in “Item 2, Properties - Lease Expirations.” In addition, certain of the properties we acquire may have some level of vacancy at the time of closing. We may have difficulty obtaining a new customer for any vacant space we have in our properties. If the vacancy continues for a long period of time, we may suffer reduced revenues resulting in less cash available to be distributed to stockholders. In addition, the resale value of a property could be diminished because of vacancy.
The fact that real estate investments are not as liquid as other types of assets may reduce economic returns to investors.
Real estate investments are not as liquid as other types of investments, and this lack of liquidity may limit our ability to react promptly to changes in economic or other conditions. Thus, our ability at any time to sell assets or contribute assets to property funds or other entities in which we have an ownership interest may be restricted by the potential for the imposition of the 100% “prohibited transactions” tax on gains from certain dispositions of property by REIT’s unless a safe harbor exception applies. This lack of liquidity may limit our ability to change our portfolio composition promptly in response to changes in economic or other conditions and, as a result, could adversely affect our financial condition, results of operations, cash flows and our ability to pay distributions on, and the market price of, our common stock.
Delays in acquisition and development of properties may have adverse effects.
Delays we encounter in the selection, acquisition, development and leasing of properties could adversely affect our returns. Where land is acquired for purposes of developing a new property prior to the start of construction, it will typically take 12 to 18 months to complete construction and lease up the newly completed building.
Uninsured losses relating to real property may adversely affect our returns.
We attempt to ensure that all of our properties are adequately insured to cover casualty losses. However, there are certain losses, including losses from floods and/or wind (Houston, Miami and Orlando), earthquakes (California and Washington State), acts of war, acts of terrorism or riots, that are not generally insured against or that are not generally fully insured against (due to coverage limitations and deductibles that we believe are not commercially reasonable) because it is not deemed economically feasible or prudent to do so. In addition, changes in the cost or availability of insurance could expose us to uninsured losses. In the event that any of our properties incurs a loss that is not fully covered by insurance, the value of our assets will be reduced, and we could experience a significant loss of capital invested and potential revenues in these properties and could potentially remain obligated under any recourse debt associated with the property. Any such losses could adversely affect our financial condition, results of operations, cash flows and ability to pay dividends, and/or the market price of our common stock. In addition, we may have no source of funding to repair or reconstruct the damaged property, and we cannot assure that any such sources of funding will be available to us for such purposes in the future. We evaluate our insurance coverage annually in light of current industry practice through an analysis prepared by outside consultants.
Contingent or unknown liabilities could adversely affect our financial condition.
We have acquired and may in the future acquire properties without any recourse, or with only limited recourse, with respect to unknown or contingent liabilities, including, without limitation, environmental liabilities. As a result, if a claim was asserted against us based upon current or previous ownership of any of these properties or related entities, we might have to pay substantial sums to defend or settle it which could adversely affect our cash flows.
Environmentally hazardous conditions may adversely affect our operating results.
Under various federal, state and local environmental laws, a current or previous owner or operator of real property may be liable for the cost of maintaining, removing or remediating hazardous or toxic substances, including, without limitation, asbestos, on such property. Such laws often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances. Even if more than one person may have been responsible for the contamination, a single person may be held responsible for all of the clean-up costs incurred. In addition, third-parties may sue the owner or operator of a site for damages based on personal injury, natural resources, property damage or other costs, including investigation and clean-up costs, resulting from the environmental contamination. The presence of hazardous or toxic substances on one of our properties, or the failure to properly maintain or remediate a contaminated property, could give rise to a lien in favor of a government entity for costs it may incur to address the contamination, or otherwise could adversely affect our ability to sell or lease the property or borrow using the property as collateral. Environmental laws also may impose restrictions on the manner in which a property may be used or businesses may be operated. A property owner who violates environmental laws may be subject to sanctions enforceable by governmental agencies or, in certain circumstances, private parties. In connection with the acquisition and ownership of our properties, we may be exposed to such costs. The cost of defending environmental claims, of complying with environmental regulatory requirements or of remediating any contaminated property could materially adversely affect our business, assets or results of operations and, consequently, amounts available for distribution to our stockholders.
We invest in properties historically used for industrial, manufacturing and commercial purposes. Some of these properties contain, or may have contained, underground storage tanks for the storage of petroleum products and other hazardous or toxic substances. All of these operations create a potential for the release of petroleum products or other hazardous or toxic substances. Some of our properties are adjacent to or near other properties that may have contained or currently contain underground storage tanks used to store petroleum products, or other hazardous or toxic substances. In addition, previous or current occupants of our properties and adjacent properties may have engaged, or may in the future engage, in activities that may release petroleum products or other hazardous or toxic substances.
We maintain a portfolio environmental insurance policy that provides coverage for potential environmental liabilities, subject to the policy’s coverage conditions and limitations, for most of our properties. From time to time, we may acquire properties or interests in properties, with known adverse environmental conditions where we believe that the environmental liabilities associated with these conditions are quantifiable and that the acquisition will yield a superior risk-adjusted return. In such an instance, we underwrite the costs of environmental investigation, clean-up and monitoring into the cost. Further, in connection with property dispositions, we may agree to remain responsible for, and to bear the cost of, remediating or monitoring certain environmental conditions on the properties.
All of our properties were subject to a Phase I or similar environmental assessment by independent environmental consultants at the time of acquisition. Phase I assessments are intended to discover and evaluate information regarding the environmental condition of the surveyed property and surrounding properties. Phase I assessments generally include a historical review, a public records review, an investigation of the surveyed site and surrounding properties, and preparation and issuance of a written report, but do not include soil sampling or subsurface investigations and typically do not include an asbestos survey. While some of these assessments have led to further investigation and sampling, none of our environmental assessments of our properties have revealed an environmental liability that we believe would have a material adverse effect on our business, financial condition or results of operations taken as a whole. However, we cannot give any assurance that such conditions do not exist or may not arise in the future. Material environmental conditions, liabilities or compliance concerns may arise after the environmental assessment has been completed. Moreover, there can be no assurance that (i) future laws, ordinances or regulations will not impose any material environmental liability or (ii) the current environmental condition of our properties will not be affected by customers, by the condition of land or operations in the vicinity of our properties (such as releases from underground storage tanks), or by third-parties unrelated to us. In addition, the presence of hazardous or toxic substances, or the failure to properly remediate these substances, may adversely affect our ability to sell, rent or pledge such property as collateral for future borrowings.
Costs of complying with governmental laws and regulations may adversely affect our income and the cash available for any distributions.
All real property and the operations conducted on real property are subject to federal, state and local laws and regulations, including environmental laws and regulations and the Americans with Disabilities Act. Customers’ ability to operate and to generate income to pay their lease obligations may be affected by permitting and compliance obligations arising under such laws and regulations. Some of these laws and regulations may impose joint and several liability on customers, owners or operators for the costs of non-compliance, regardless of fault or whether the failure to comply was legal. Leasing properties to customers that engage in industrial, manufacturing, and commercial activities will cause us to be subject to the risk of liabilities under environmental laws and regulations.
Some of these laws and regulations have been amended so as to require compliance with new or more stringent standards as of future dates. Compliance with new or more stringent laws or regulations or stricter interpretation of existing laws may require us to incur material expenditures. Future laws, ordinances or regulations may impose material liability. Additionally, our customers’ operations, the existing condition of land when we buy it, operations in the vicinity of our properties, such as the presence of underground storage tanks, or activities of unrelated third-parties may affect our properties. In addition, there are various local, state and federal fire, health, life-safety and similar regulations with which we may be required to comply and which may subject us to liability in the form of fines or damages for noncompliance. Any material expenditures, fines or damages we must pay could reduce our ability to make distributions and may reduce the value of our common stock.
We could face possible risks associated with climate change.
The physical effects of climate change, were it to occur in a negative manner, could have a material adverse effect on our properties, operations and business. To the extent climate change causes changes in weather patterns, our markets could experience negative impact. This impact could result in declining demand for industrial space in our buildings or our inability to operate the buildings at all. Climate change may also have indirect effects on our business by increasing the cost of (or making unavailable) property insurance on terms we find acceptable, increasing the cost of energy, increasing the cost of building materials, and increasing the cost of snow removal at our properties.
RISKS RELATED TO OUR DEBT FINANCINGS
Our operating results and financial condition could be adversely affected if we are unable to make required payments on our debt.
Our charter and bylaws do not limit the amount or percentage of indebtedness that we may incur, and we are subject to risks normally associated with debt financing, including the risk that our cash flows will be insufficient to meet required payments of principal and interest. There can be no assurance that we will be able to refinance any maturing indebtedness, that such refinancing would be on terms as favorable as the terms of the maturing indebtedness or that we will be able to otherwise obtain funds by selling assets or raising equity to make required payments on maturing indebtedness.
In particular, loans obtained to fund property acquisitions may be secured by first mortgages on such properties. If we are unable to make our debt service payments as required, a lender could foreclose on the property or properties securing its debt. This could cause us to lose part or all of our investment, which in turn could cause the value of our common stock and distributions payable to stockholders to be reduced. Certain of our existing and future indebtedness is and may be cross-collateralized and, consequently, a default on this indebtedness could cause us to lose part or all of our investment in multiple properties.
Increases in interest rates could increase the amount of our debt payments or make it difficult for us to finance or refinance properties, which could reduce the number of properties we can acquire and adversely affect our ability to make distributions to our stockholders.
We have incurred and may continue to incur variable rate debt whereby increases in interest rates raise our interest costs, which reduces our cash flows and our ability to make distributions to our stockholders. If we are unable to refinance our indebtedness at maturity or meet our payment obligations, the amount of our distributable cash flows and our financial condition would be adversely affected, and the property securing such indebtedness may be sold on terms that are not advantageous to us or lost through foreclosure. Similarly, if debt is unavailable at reasonable rates, we may not be able to finance the purchase of properties. In addition, if we need to repay existing debt during periods of rising interest rates, we could be required to liquidate one or more of our investments in properties at times which may not permit realization of the maximum return on such investments.
Covenants in our credit agreements could limit our flexibility and adversely affect our financial condition.
The terms of our bank unsecured credit facilities and other indebtedness require us to comply with a number of customary financial and other covenants, such as covenants with respect to consolidated leverage, net worth and unencumbered assets. 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 of December 31, 2017, we had certain non-recourse, secured loans which are cross-collateralized by multiple properties. If we default on any of these loans we may then be required to repay such indebtedness, together with applicable prepayment charges, to avoid foreclosure on all cross-collateralized properties within the applicable pool. In addition, our senior credit facility contains certain cross-default provisions which are triggered in the event that our other material indebtedness is in default. These cross-default provisions may require us to repay or restructure the senior credit facility in addition to any mortgage or other debt that is in default. If our properties were foreclosed upon, or if we are unable to refinance our indebtedness at maturity or meet our payment obligations, the amount of our distributable cash flows and our financial condition would be adversely affected.
If we enter into financing arrangements involving balloon payment obligations, it may adversely affect our ability to make distributions.
Some of our financing arrangements may require us to make a lump-sum or “balloon” payment at maturity. Our ability to make a balloon payment at maturity is uncertain and may depend upon our ability to obtain additional financing or our ability to sell the property. At the time the balloon payment is due, we may or may not be able to refinance the existing financing on terms as favorable as the original loan or sell the property at a price sufficient to make the balloon payment. The effect of a refinancing or sale could affect the rate of return to stockholders and the projected time of disposition of our assets. In addition, payments of principal and interest made to service our debts may leave us with insufficient cash to pay the distributions that we are required to pay to maintain our qualification as a REIT.
RISKS RELATED TO OUR CORPORATE STRUCTURE
Our charter and Maryland law contain provisions that may delay, defer or prevent a change of control transaction.
Our charter contains a 9.8% ownership limit.
Our charter, subject to certain exceptions, authorizes our directors to take such actions as are necessary and desirable to preserve our qualification as a REIT and to limit any person to actual or constructive ownership of no more than 9.8% by value or number of shares, whichever is more restrictive, of any class or series of our outstanding shares of capital stock. Our board of directors and/or management, in its sole discretion, may exempt, subject to the satisfaction of certain conditions, any person from the ownership limit. However, our board of directors and/or management may not grant an exemption from the ownership limit to any person whose ownership, direct or indirect, in excess of 9.8% by value or number of shares of any class or series of our outstanding shares of capital stock could jeopardize our status as a REIT. These restrictions on transferability and ownership will not apply if our board of directors determines that it is no longer in our best interests to attempt to qualify, or to continue to qualify, as a REIT. The ownership limit may delay or impede a transaction or a change of control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.
Provisions which may limit the ability of a third-party to acquire control of our Company.
Certain provisions of Maryland law may have the effect of inhibiting a third-party from making a proposal to acquire us or of impeding a change of control under certain circumstances that otherwise could provide the holders of shares of our common stock with the opportunity to realize a premium over the then prevailing market price of such shares. Our charter, our bylaws and the limited partnership agreement of our operating partnership may also contain provisions that may delay, defer or prevent a transaction or a change of control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.
Our board of directors can take many actions without stockholder approval.
Our board of directors has overall authority to oversee our operations and determine our major corporate policies. This authority includes significant flexibility. For example, our board of directors can do the following:
•
issue additional shares without obtaining stockholder approval, which could dilute the ownership of our then-current stockholders;
•
amend our charter to increase or decrease the aggregate number of shares of stock or the number of shares of stock of any class or series, without obtaining stockholder approval;
•
classify or reclassify any unissued shares of our common stock or preferred stock and set the preferences, rights and other terms of such classified or reclassified shares, without obtaining stockholder approval;
•
change our investment strategy and enter into new lines of business that are different from, and possibly riskier than, the investments and businesses described elsewhere in this document;
•
direct our resources toward investments that do not ultimately appreciate over time;
•
change creditworthiness standards with respect to third-party customers; and
Some of these actions by our board of directors could delay, defer or prevent a change of control of our Company.
Our rights and the rights of our stockholders to take action against our directors and officers are limited.
Maryland law provides that a director or officer has no liability in that capacity if he or she performs his or her duties in good faith, in a manner he or she reasonably believes to be in our best interests and with the care that an ordinarily prudent person in a like position would use under similar circumstances. In addition, our charter eliminates our directors’ and officers’ liability to us and our stockholders for money damages except for liability resulting from actual receipt of an improper benefit or profit in money, property or services or active and deliberate dishonesty established by a final judgment and which is material to the cause of action. Our bylaws require us to indemnify our directors and officers to the maximum extent permitted by Maryland law for liability actually incurred in connection with any proceeding to which they may be made, or threatened to be made, a party, except to the extent that the act or omission of the director or officer was material to the matter giving rise to the proceeding and was either committed in bad faith or was the result of active and deliberate dishonesty; the director or officer actually received an improper personal benefit in money, property or services; or, in the case of any criminal proceeding, the director or officer had reasonable cause to believe that the act or omission was unlawful. As a result, we and our stockholders may have more limited rights against our directors and officers than might otherwise exist under common law. In addition, we may be obligated to fund the defense costs incurred by our directors and officers.
FEDERAL INCOME TAX RISKS
Failure to qualify as a REIT could adversely affect our operations and our ability to make distributions.
We operate in a manner so as to qualify as a REIT for U.S. federal income tax purposes. Our qualification as a REIT will depend on our satisfaction of numerous requirements (some on an annual and quarterly basis) established under highly technical and complex provisions of the Code for which there are only limited judicial or administrative interpretations, and involves the determination of various factual matters and circumstances not entirely within our control. The fact that we hold substantially all of our assets through our operating partnership and its subsidiaries further complicates the application of the REIT requirements for us. No assurance can be given that we will qualify as a REIT for any particular year. If we were to fail to qualify as a REIT in any taxable year for which a REIT election has been made, we would not be allowed a deduction for dividends paid to our stockholders in computing our taxable income and would be subject to federal income tax, including any applicable alternative minimum tax (which, for corporations, was repealed for tax years beginning after December 31, 2017 under the TCJA, as defined below), on our taxable income at corporate rates unless certain relief provision apply. As a consequence, we would not be compelled to make distributions under the Code. Moreover, unless we were to obtain relief under certain statutory provisions, we would also be disqualified from treatment as a REIT for the four taxable years following the year during which qualification is lost. This treatment would reduce our net earnings available for investment or distribution to our stockholders because of the additional tax liability to us for the years involved. As a result of the additional tax liability, we might need to borrow funds or liquidate certain investments on terms that may be disadvantageous to us in order to pay the applicable tax. If we fail to qualify as a REIT but are eligible for certain relief provisions, then we may retain our status as a REIT but may be required to pay a penalty tax, which could be substantial.
To qualify as a REIT, we must meet annual distribution requirements.
To obtain the favorable tax treatment accorded to REITs, among other requirements, we normally will be required each year to distribute to our stockholders at least 90% of our REIT taxable income, determined without regard to the deduction for dividends paid and by excluding net capital gains. We will be subject to federal income tax on our undistributed taxable income and net capital gain. In addition, if we fail to distribute during each calendar year at least the sum of (a) 85% of our ordinary income for such year, (b) 95% of our capital gain net income for such year, and (c) any undistributed taxable income from prior periods, we will be subject to a 4% excise tax on the excess of the required distribution over the sum of (i) the amounts actually distributed by us, plus (ii) retained amounts on which we pay income tax at the corporate level. We intend to make distributions to our stockholders to comply with the requirements of the Code for REITs and to minimize or eliminate our corporate income tax obligation. However, differences between the recognition of taxable income and the actual receipt of cash could require us to sell assets or borrow funds on a short-term or long-term basis or partially pay dividends in shares of our common stock to meet the distribution requirements of the Code. Certain types of assets generate substantial mismatches between taxable income and available cash. Such assets include rental real estate that has been financed through financing structures which require some or all of available cash flows to be used to service borrowings. As a result, the requirement to distribute a substantial portion of our taxable income could cause us to: (1) sell assets in adverse market conditions, (2) borrow on unfavorable terms or (3) distribute amounts that would otherwise be invested in future acquisitions, capital expenditures or repayment of debt, in order to comply with REIT requirements. Further, amounts distributed will not be available to fund our operations.
Tax legislation or regulatory action could adversely affect us or our investors.
On December 22, 2017, President Trump signed into law H.R. 1, informally titled the Tax Cuts and Jobs Act (the “TCJA”). The TCJA makes major changes to the Code, including a number of provisions of the Code that affect the taxation of REITs and their stockholders. Among the changes made by the TCJA are permanently reducing the generally applicable corporate tax rate, generally reducing the tax rate applicable to individuals and other non-corporate taxpayers for tax years beginning after December 31, 2017 and before January 1, 2026, eliminating or modifying certain previously allowed deductions (including substantially limiting interest deductibility and, for individuals, the deduction for non-business state and local taxes), and, for taxable years beginning after December 31, 2017 and before January 1, 2026, providing for preferential rates of taxation through a deduction of up to 20% (subject to certain limitations) on most ordinary REIT dividends and certain trade or business income of non-corporate taxpayers. The TCJA also imposes new limitations on the deduction of net operating losses, which may result in us having to make additional taxable distributions to our stockholders in order to comply with REIT distribution requirements or avoid taxes on retained income and gains. The effect of the significant changes made by the TCJA is highly uncertain, and administrative guidance will be required in order to fully evaluate the effect of many provisions. The effect of any technical corrections with respect to the TCJA could have an adverse effect on us or our stockholders. Investors should consult their tax advisors regarding the implications of the TCJA on their investment in our common stock or debt securities.
Distributions payable by REITs do not qualify for the reduced tax rates that apply to certain other corporate distributions.
Certain distributions payable by corporations to individuals subject to tax as “qualified dividend income” are subject to reduced tax rates applicable to long-term capital gain. Distributions payable by REITs, however, generally continue to be taxed at the normal rate applicable to the individual recipient rather than the preferential long-term capital gain rate (though under the TCJA, individuals, trusts, and estates generally may deduct up to 20% of ordinary REIT dividends). While the preferential tax rate on certain corporate distributions does not adversely affect the taxation of REITs or dividends paid by REITs, the more favorable rates applicable to regular corporate distributions could cause investors who are individuals to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay distributions, which could adversely affect the value of the stock of REITs, including our common stock.
In certain circumstances, we may be subject to federal and state income taxes, which would reduce our cash available for distribution to our stockholders.
Even if we qualify and maintain our status as a REIT, we may be subject to federal income taxes or state taxes in various circumstances. For example, net income from a “prohibited transaction” will be subject to a 100% tax. In addition, we may not be able to distribute all of our income in any given year, which would result in corporate level taxes, and we may not make sufficient distributions to avoid excise taxes. We may also decide to retain certain gains from the sale or other disposition of our property and pay income tax directly on such gains. In that event, our stockholders would be required to include such gains in income and would receive a corresponding credit for their share of taxes paid by us. We may also be subject to U.S. state and local taxes on our income or property, either directly or at the level of our operating partnership or at the level of the other entities through which we indirectly own our assets. In addition, any net taxable income earned directly by any of our taxable REIT subsidiaries, which we refer to as TRSs, will be subject to federal and state corporate income tax. In addition, we may be subject to federal or state taxes in other various circumstances. Any taxes we pay will reduce our cash available for distribution to our stockholders.
If our operating partnership was classified as a “publicly traded partnership” under the Code, our status as a REIT and our ability to pay distributions to our stockholders could be adversely affected.
Our operating partnership is organized as a partnership for U.S. federal income tax purposes. Even though our operating partnership will not elect to be treated as an association taxable as a corporation, it may be taxed as a corporation if it is deemed to be a “publicly traded partnership.” A publicly traded partnership is a partnership whose interests are traded on an established securities market or are considered readily tradable on a secondary market or the substantial equivalent thereof. We believe and currently take the position that our operating partnership should not be classified as a publicly traded partnership because interests in our operating partnership are not traded on an established securities market, and our operating partnership should satisfy certain safe harbors which prevent a partnership’s interests from being treated as readily tradable on an established securities market or substantial equivalent thereof. No assurance can be given, however, that the IRS would not assert that our operating partnership constitutes a publicly traded partnership or that facts and circumstances will not develop which could result in our operating partnership being treated as a publicly traded partnership. If the IRS were to assert successfully that our operating partnership is a publicly traded partnership, and substantially all of our operating partnership’s gross income did not consist of the specified types of passive income, our operating partnership would be treated as an association taxable as a corporation and would be subject to corporate tax at the entity level. In such event, the character of our assets and items of gross income would change and would result in a termination of our status as a REIT. In addition, the imposition of a corporate tax on our operating partnership would reduce the amount of cash available for distribution to our stockholders.
Certain property transfers may generate prohibited transaction income, resulting in a penalty tax on gain attributable to the transaction.
From time to time, we may transfer or otherwise dispose of some of our properties, including the contribution of properties to our joint venture funds or other commingled investment vehicles. Under the Code, any gain resulting from transfers of properties that we hold as inventory or primarily for sale to customers in the ordinary course of business would be treated as income from a prohibited transaction subject to a 100% penalty tax, unless a safe harbor exception applies. Since we acquire properties for investment purposes, we do not believe that our occasional transfers or disposals of property or our contributions of properties into our joint venture funds, or commingled investment vehicles, are properly treated as prohibited transactions. However, whether property is held for investment purposes is a question of fact that depends on all the facts and circumstances surrounding the particular transaction. The IRS may contend that certain transfers or disposals of properties by us or contributions of properties into our joint venture funds are prohibited transactions if they do not meet the safe harbor requirements. While we believe that the IRS would not prevail in any such dispute, if the IRS were to argue successfully that a transfer or disposition or contribution of property constituted a prohibited transaction, we would be required to pay a 100% penalty tax on any gain allocable to us from the prohibited transaction. In addition, income from a prohibited transaction might adversely affect our ability to satisfy the income tests for qualification as a real estate investment trust for federal income tax purposes.
If a transaction intended to qualify as a Section 1031 exchange is later determined to be taxable, we may face adverse consequences, and if the laws applicable to such transactions are amended or repealed, we may not be able to dispose of properties on a tax deferred basis.
From time to time we may dispose of properties in transactions that are intended to qualify as an exchange pursuant to Section 1031 of the Code (a “Section 1031 Exchange”). It is possible that the qualification of a transaction as a Section 1031 Exchange could be successfully challenged and determined to be currently taxable. In such case, our taxable income and earnings and profits would increase. This could increase the dividend income to our stockholders by reducing any return of capital they received. In some circumstances, we may be required to pay additional dividends or, in lieu of that, corporate income tax, possibly including interest and penalties. As a result, we may be required to borrow funds in order to pay additional dividends or taxes, and the payment of such taxes could cause us to have less cash available to distribute to our stockholders. In addition, if a Section 1031 Exchange were later to be determined to be taxable, we may be required to amend our tax returns for the applicable year in question, including any information reports we sent our stockholders. Moreover, it is possible that legislation could be enacted that could modify or repeal the laws with respect to Section 1031 Exchanges, which could make it more difficult or not possible for us to dispose of properties on a tax deferred basis.
Foreign investors may be subject to the Foreign Investment Real Property Tax Act, or FIRPTA, which would impose tax on certain distributions and on the sale of common stock if we are unable to qualify as a “domestically controlled” REIT or if our stock is not considered to be regularly traded on an established securities market.
A foreign person disposing of a U.S. real property interest, including shares of a U.S. corporation whose assets consist principally of U.S. real property interests or USRPIs is generally subject to a tax, known as FIRPTA tax, on the gain recognized on the disposition. Such FIRPTA tax does not apply, however, to the disposition of stock in a REIT if the REIT is a “domestically controlled qualified investment entity.” A domestically controlled qualified investment entity includes a REIT in which, at all times during a specified testing period, less than 50% of the value of its shares is held directly or indirectly by non-U.S. holders. In the event that we do not constitute a domestically controlled qualified investment entity, a person’s sale of stock nonetheless will generally not be subject to tax under FIRPTA as a sale of a USRPI, provided that (1) the stock owned is of a class that is “regularly traded” as defined by applicable Treasury regulations, on an established securities market, and (2) the selling non-U.S. holder held 10% or less of our outstanding stock of that class at all times during a specified testing period. If we were to fail to so qualify as a domestically controlled qualified investment entity and our common stock were to fail to be “regularly traded,” gain realized by a foreign investor on a sale of our common stock would be subject to FIRPTA tax and applicable withholding. No assurance can be given that we will be a domestically controlled qualified investment entity. Additionally, any distributions we make to our non-U.S. stockholders that are attributable to gain from the sale of any USRPI will also generally be subject to FIRPTA tax and applicable withholdings, unless the recipient non-U.S. stockholder has not owned more than 10% of our common stock at any time during the year preceding the distribution and our common stock is treated as being “regularly traded”.
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2.
PROPERTIES
Geographic Distribution
The following table presents the geographic diversification of our consolidated operating portfolio as of December 31, 2017:
(See footnote definitions on next page)
The following table presents the geographic diversification of our investments in unconsolidated operating portfolio as of December 31, 2017:
(1)
Based on leases commenced as of December 31, 2017.
(2)
Annualized base rent is calculated as monthly contractual base rent (cash basis) per the terms of the lease, as of December 31, 2017, multiplied by 12.
(3)
Excludes total annualized base rent associated with tenants currently in free rent periods of $6.1 million, which excludes free rent related to developments, Redevelopments and Value-Add Acquisitions not stabilized during the three months ended December 31, 2017, based on the first month of cash base rent.
(4)
Includes properties presented in assets held for sale in our Consolidated Balance Sheets.
(5)
The Company exited the Charlotte and Memphis markets upon the disposition of its remaining properties in January 2018.
(6)
As of December 31, 2017, our ownership interest in the Miami and Southern California properties was 99.6% and 95.4%, respectively based on our equity ownership weighted by square feet.
(7)
Percentage owned is based on equity ownership weighted by square feet.
(8)
Our economic interest in unconsolidated joint ventures (as distinct from our legal ownership interest) may fluctuate from time to time and may not wholly align with our legal ownership interests because of provisions in certain joint venture agreements regarding distributions of cash flow, allocations of profits and losses, payments of preferred returns and control over major decisions. Additionally, DCT Industrial does not control our unconsolidated joint ventures and the presentation of certain items, such as assets, liabilities, revenues and expenses, from these unconsolidated joint ventures does not represent our legal claim or obligation for such items.
(9)
Although we contributed 100% of the initial cash equity capital required by the venture, after return of certain preferential distributions on capital invested, profits and losses are generally split 50/50.
Indebtedness
As of December 31, 2017, 42 of our 408 consolidated properties, with a combined gross book value of approximately $0.5 billion, were encumbered by mortgage indebtedness totaling $159.1 million (excluding net premiums and net deferred loan costs). See “Notes to Consolidated Financial Statements, Note 6 - Outstanding Indebtedness” and the accompanying Schedule III beginning on page for additional information.
Lease Expirations
Our industrial properties are leased to customers for terms generally ranging from 3 to 10 years with a weighted average remaining term of approximately 4.1 years as of December 31, 2017. The following table presents a schedule of expiring leases for our consolidated properties by square feet and by annualized base rent as of December 31, 2017, assuming no exercise of lease renewal options, if any (dollar amounts and square feet in thousands):
(1)
Percentage is based on consolidated occupied square feet as of December 31, 2017.
(2)
Annualized base rent includes contractual rents in effect at the date of the lease expiration.
(3)
Includes leases with an initial term of less than one year.
Customer Diversification
As of December 31, 2017, there were no customers that occupied more than 3.4% of our consolidated properties based on annualized base rent. The following table presents our 10 largest customers, based on annualized base rent as of December 31, 2017, who occupy a combined 11.1 million square feet, or 16.6%, of our consolidated properties and 18.7% of annualized base rent.
Although base rent is supported by long-term lease contracts, customers who file bankruptcy generally have the legal right to reject any or all of their leases. In the event that a customer with a significant number of leases in our properties files bankruptcy and cancels its leases, we could experience a reduction in our revenues and an increase in our allowance for doubtful accounts receivable.
We frequently monitor the financial condition of our customers. We communicate often with those customers that have been late on payments or have filed bankruptcy. We are not currently aware of any significant financial difficulties of any tenants that would cause a material reduction in our revenues.
Industry Diversification
The table below presents the diversification of our consolidated portfolio by the industry classification of our customers based upon their NAICS code as of December 31, 2017 (dollar amounts and square feet in thousands):
(1)
Annualized base rent is calculated as monthly contractual base rent (cash basis) per the terms of the lease, as of December 31, 2017, multiplied by 12.
(2)
Based on leases commenced as of December 31, 2017.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
We are a party to various legal actions and administrative proceedings arising in the ordinary course of business, some of which may be covered by liability insurance, and none of which we expect to have a material adverse effect on our consolidated financial condition or results of operations.
ITEM 4.
ITEM 4.
MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
DCT
Common Stock Market Prices
Our common stock is listed on the New York Stock Exchange, or the NYSE, under the symbol “DCT”. The following table presents the high and low sales prices during periods presented:
On February 9, 2018, the closing price of our common stock was $54.38 per share, as reported on the NYSE and there were 93,852,805 shares of common stock outstanding, held by approximately 1,450 stockholders of record. The number of holders does not include individuals or entities who beneficially own shares but whose shares are held of record by a broker or clearing agency, but does include each such broker or clearing agency as one record holder.
Distribution Policy
We intend to continue to elect and qualify to be taxed as a REIT for U.S. federal income tax purposes. U.S. federal income tax law requires that a REIT distribute with respect to each year at least 90% of its annual REIT taxable income, determined without regard to the deduction for dividends paid and excluding any net capital gain. We will not be required to make distributions with respect to income derived from the activities conducted through our taxable REIT subsidiaries that is not distributed to us. To the extent our taxable REIT subsidiaries’ income is not distributed and is instead reinvested in the operations of these entities, the value of our equity interest in our taxable REIT subsidiaries will increase. The aggregate value of the securities that we hold in our taxable REIT subsidiaries may not exceed 25% (20% for tax years beginning after December 31, 2017, in accordance with the PATH Act discussed below) of the total value of our gross assets. Distributions from our taxable REIT subsidiaries to us will qualify for the 95% gross income test but will not qualify for the 75% gross income test.
To satisfy the requirements to qualify as a REIT and generally not be subject to U.S. federal income and excise tax, we intend to make regular quarterly distributions of our taxable net income to holders of our common stock out of legally available assets. Any future distributions we make will be at the discretion of our board of directors and will depend upon our earnings and financial condition, maintenance of REIT qualification, applicable provisions of the Maryland General Corporate Law and such other factors as our board of directors deems relevant.
We anticipate that, for U.S. federal income tax purposes, distributions (including certain part cash, part stock distributions) generally will be taxable to our stockholders and unitholders as ordinary income, although some portion of our distributions may constitute ordinary income, capital gains or a return of capital. The tax characterization of dividends paid on our common stock and OP units for 2017, 2016, and 2015 is as follows (refer to our website for more information on the taxability of our dividends):
The following table presents the distributions that have been declared by our board of directors on our common stock during the fiscal years ended December 31, 2017, and 2016:
Performance Graph
The graph below shows a comparison of cumulative total stockholder returns for DCT Industrial Trust Inc. common stock with the cumulative total return on the Standard and Poor’s 500 Index, the MSCI US REIT Index, and the FTSE NAREIT Equity Industrial Index. The MSCI US REIT Index represents performance of publicly traded REITs while the FTSE NAREIT Equity Industrial Index represents only the performance of our publicly traded industrial REIT peers. Stockholders’ returns over the indicated period are based on historical data and should not be considered indicative of future stockholder returns.
Note: The graph covers the period from December 31, 2012, to December 31, 2017, and assumes that $100 was invested in DCT Industrial Trust Inc. common stock and in each index on December 31, 2012, and that all dividends were reinvested.
Issuer Purchases of Equity Securities
(1)
Represents the common stock surrendered by employees to DCT to satisfy such employees' tax withholding obligations in connection with the vesting of restricted stock.
Operating Partnership
OP Unit Market Prices and Dividends
There is no established public market for our OP Units. On February 9, 2018, there were 3,350,530 OP Units outstanding, held by approximately 190 holders of record.
The following table presents the distributions that have been declared by our board of directors on OP Units outstanding during the fiscal years ended December 31, 2017, and 2016:
Limited partners have the right to require the Company to redeem all or a portion of the OP Units held by the limited partner at a redemption price equal to and in the form of the Cash Amount (as defined in the Partnership Agreement), provided that such OP Units have been outstanding for at least one year. The Company may, in its sole discretion, purchase the OP Units by paying to the limited partner either the Cash Amount or the REIT Shares Amount (generally one share of DCT’s common stock for each OP Unit), as defined in the Partnership Agreement.
During the three months and year ended December 31, 2017, approximately 0.1 million and 0.3 million OP Units were redeemed for approximately $0.1 million and $2.7 million in cash and approximately 0.1 million and 0.3 million shares of DCT common stock, respectively. The OP Unit redemptions exclude LTIP Unit redemptions, see ‘‘Notes to the Consolidated Financial Statements, Note 11 - Equity Based Compensation’’ for further details.
Supplemental Tax Disclosures - Updates to REIT Rules
The Foreign Account Tax Compliance Act, or FATCA, imposes a U.S. federal withholding tax on certain types of payments made to ‘‘foreign financial institutions’’ and certain other non-U.S. entities unless certain due diligence, reporting, withholding, and certification obligation requirements are satisfied. FATCA generally imposes a U.S. federal withholding tax at a rate of 30% on dividends on, and gross proceeds from the sale or other disposition of, its stock if paid to a foreign entity unless either (i) the foreign entity is a ‘‘foreign financial institution’’ that undertakes certain due diligence, reporting, withholding, and certification obligations, or in the case of a foreign financial institution that is a resident in a jurisdiction that has entered into an intergovernmental agreement to implement FATCA, the entity complies with the diligence and reporting requirements of such agreement, (ii) the foreign entity is not a ‘‘foreign financial institution’’ and identifies certain of its U.S. investors, or (iii) the foreign entity otherwise is excepted under FATCA. If we determine withholding is appropriate in respect of our common stock, we may withhold tax at the applicable statutory rate, and we will not pay any additional amounts in respect of such withholding. However, under delayed effective dates provided for in the Treasury Regulations and other IRS guidance, such required withholding will not begin until January 1, 2019 with respect to gross proceeds from a sale or other disposition of our common stock.
If withholding is required under FATCA on a payment related to our common stock, holders of our common stock that otherwise would not be subject to withholding (or that otherwise would be entitled to a reduced rate of withholding) generally will be required to seek a refund or credit from the IRS to obtain the benefit of such exemption or reduction (provided that such benefit is available). Prospective investors should consult their own tax advisors regarding the effect of FATCA on an investment in our common stock, as well as the status of any related federal regulations and any other legislative proposals that may pertain to the ownership and disposition of our common stock.
New Partnership Audit Rules. Under the Code, a partnership that is not treated as a corporation under the publicly traded partnership rules generally is not subject to U.S. federal income tax; instead, each partner is allocated its distributive share of the partnership’s items of income, gain, loss, deduction and credit and is required to take such items into account in determining the partner’s income. However, a law change enacted under the Bipartisan Budget Act of 2015, effective for taxable years beginning after December 31, 2017, requires the partnership to pay the hypothetical increase in partner-level taxes (including interest and penalties) resulting from an adjustment of partnership tax items on audit or in other tax proceedings, unless the partnership elects an alternative method under which the taxes resulting from the adjustment (and interest and penalties) are assessed at the partner level. Many uncertainties remain as to the application of these rules, including the application of the alternative method to partners that are REITs, and the impact they will have on us. However, it is possible, that partnerships in which we invest, including our operating partnership, may be subject to U.S. federal income tax, interest and penalties in the event of a U.S. federal income tax audit as a result of these law changes.
The “Protecting Americans from Tax Hikes Act of 2015” (the “PATH Act”) was enacted on December 18, 2015 and contains several provisions pertaining to REIT qualification and taxation, which are briefly summarized below:
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For taxable years beginning before January 1, 2018, no more than 25% of the value of our assets may consist of stock or securities of one or more TRSs. For taxable years beginning after December 31, 2017, the Act reduces this limit to 20%.
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For purposes of the REIT asset tests for taxable years beginning after December 31, 2015, the PATH Act provides that debt instruments issued by publicly offered REITs will constitute “real estate assets.” However, unless such a debt instrument is secured by a mortgage or otherwise would have qualified as a real estate asset under prior law, (i) interest income and gain from such a debt instrument is not qualifying income for purposes of the 75% gross income test and (ii) all such debt instruments may represent no more than 25% of the value of our total assets.
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For taxable years beginning after December 31, 2015, certain obligations secured by a mortgage on both real property and personal property will be treated as a qualifying real estate asset and give rise to qualifying income for purposes of the 75% gross income test if the fair market value of such personal property does not exceed 15% of the total fair market value of all such property.
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A 100% excise tax is imposed on “redetermined TRS service income,” which is income of a TRS attributable to services provided to, or on behalf of its associated REIT and which would otherwise be increased on distribution, apportionment, or allocation under Section 482 of the Code.
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For distributions made in taxable years beginning after December 31, 2014, the preferential dividend rules no longer to apply to us.
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Additional exceptions to the rules under the Foreign Investment in Real Property Act (“FIRPTA”) were introduced for non-U.S. persons that constitute “qualified shareholders” (within the meaning of Section 897(k)(3) of the Code) or “qualified foreign pension funds” (within the meaning of Section 897(l)(2) of the Code).
•
After February 16, 2016, the FIRPTA withholding rate under Section 1445 of the Code for dispositions of U.S. real property interests is increased from 10% to 15%.
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The PATH Act increases from 5% to 10% the maximum stock ownership of the REIT that a non-U.S. shareholder may have held to avail itself of the FIRPTA exception for shares regularly traded on an established securities market.
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For assets we acquired from a C corporation in a carry-over basis transaction, the Path Act, in conjunction with recently promulgated Treasury Regulations, reduces the recognition period during which we could be subject to corporate tax on any built-in gains recognized on the sale of such assets from 10 years to 5 years.
SUPPLEMENT TO FEDERAL INCOME TAX CONSIDERATIONS
This summary is for general information purposes only and is not tax advice. This discussion does not address all aspects of taxation that may be relevant to particular holders of our securities in light of their personal investment or tax circumstances.
Recent Legislation
The recently enacted “Tax Cuts and Jobs Act” (the “TCJA”), generally applicable for tax years beginning after December 31, 2017, made significant changes to the Code, including a number of provisions of the Code that affect the taxation of businesses and their owners, including REITs and their stockholders, and, in certain cases, that modify the tax rules discussed in the accompanying prospectus.
Among other changes, the TCJA made the following changes:
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For tax years beginning after December 31, 2017 and before January 1, 2026, (i) the U.S. federal income tax rates on ordinary income of individuals, trusts and estates have been generally reduced and (ii) non-corporate taxpayers are permitted to take a deduction for certain pass-through business income, including dividends received from REITs that are not designated as capital gain dividends or qualified dividend income, subject to certain limitations.
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The maximum U.S. federal income tax rate for corporations has been reduced from 35% to 21%, and the alternative minimum tax has been eliminated for corporations, which would generally reduce the amount of U.S. federal income tax payable by our TRSs and by us to the extent we were subject to corporate U.S. federal income tax (for example, if we distributed less than 100% of our taxable income or recognized built-in gains in assets acquired from C corporations). In addition, the maximum withholding rate on distributions by us to non-U.S. stockholders that are treated as attributable to gain from the sale or exchange of a U.S. real property interest is reduced from 35% to 21%.
•
Certain new limitations on the deductibility of interest expense now apply, which limitations may affect the deductibility of interest paid or accrued by us or our TRSs.
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Certain new limitations on net operating losses now apply, which limitations may affect net operating losses generated by us or our TRSs.
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A U.S. tax-exempt stockholder that is subject to tax on its unrelated business taxable income (“UBTI”) will be required to separately compute its taxable income and loss for each unrelated trade or business activity for purposes of determining its UBTI.
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New accounting rules generally require us to recognize income items for federal income tax purposes no later than when we take the item into account for financial statement purposes, which may accelerate our recognition of certain income items.
This summary does not purport to be a detailed discussion of the changes to U.S. federal income tax laws as a result of the enactment of the TCJA. Technical corrections or other amendments to the TCJA or administrative guidance interpreting the TCJA may be forthcoming at any time. We cannot predict the long-term effect of the TCJA or any future law changes on REITs or their stockholders. Investors are urged to consult their own tax advisors regarding the effect of the TCJA based on their particular circumstances.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
The following tables present selected consolidated financial and other information of DCT and the Operating Partnership as of and for the years ended December 31, 2017, 2016, 2015, 2014, and 2013. The financial data in the table should be read in conjunction with “Item 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of results of operations and financial condition should be read in conjunction with the Consolidated Financial Statements and notes thereto appearing elsewhere in this report.
Overview
DCT Industrial Trust Inc. is a leading industrial real estate company specializing in the ownership, acquisition, development, leasing and management of bulk-distribution and light-industrial properties located in high-demand distribution markets in the United States. DCT's actively managed portfolio is strategically located near population centers and well-positioned to take advantage of market dynamics. As used herein, the terms “Company,” “we,” “our” and “us” refer to DCT Industrial Trust Inc. and its subsidiaries, including its operating partnership, DCT Industrial Operating Partnership LP. When we use the term “DCT” or “DCT Industrial,” we are referring to DCT Industrial Trust Inc. by itself, and not including any of its subsidiaries, and when we use the term “Operating Partnership,” we are referring to DCT Industrial Operating Partnership LP by itself, and not including any of its subsidiaries.
DCT was formed as a Maryland corporation in April 2002 and has elected to be treated as a real estate investment trust, or REIT, for U.S. federal income tax purposes. We are structured as an umbrella partnership REIT under which substantially all of our current and future business is, and will be, conducted through a majority owned and controlled subsidiary, DCT Industrial Operating Partnership LP, a Delaware limited partnership, for which DCT is the sole general partner. DCT owns properties through the Operating Partnership and its subsidiaries. As of December 31, 2017, DCT owned approximately 96.6% of the outstanding equity interests in the Operating Partnership.
Our primary business objectives are to maximize long-term growth in Funds From Operations, or FFO, as defined on page 35, net asset value of our portfolio and total shareholder returns. In our pursuit of these long-term objectives, we seek to:
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maximize cash flows from existing properties;
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deploy capital into development and redevelopment opportunities which meet our asset, location and financial criteria; and
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recycle capital by selling assets that no longer fit our investment criteria and reinvesting the proceeds into higher growth opportunities.
Outlook
We seek to maximize long-term earnings growth per share and shareholder value primarily through increasing cash flow at existing properties and developing and acquiring high-quality properties with attractive operating income and value growth prospects. Fundamentals for industrial real estate remain strong, supported by the general improvement in the economy as well as trends that particularly favor industrial assets, including the growth of e-commerce and U.S. based manufacturing. We expect moderate economic growth to continue in 2018, which we expect to result in continued positive demand for warehouse space as companies expand and upgrade their distribution and production platforms.
In response to positive net absorption and lower market vacancy levels, rental rates are increasing in all of our markets. Rental concessions, such as free rent, remain at historically low levels. Consistent with recent experience and based on current market conditions, we expect average net effective rental rates on new leases signed during 2018 to be higher than the rates on expiring leases.
New development, including speculative development, is present in most markets in response to strong tenant demand for high-quality space. However, construction remains rational in relation to net absorption in most markets and generally below historical peak levels. We expect that the operating environment will continue to be favorable for lessors given our favorable outlook for market occupancy levels and rental rate growth.
We expect annual same-store portfolio net operating income to be higher in 2018 than it was in 2017, primarily as a result of the impact of increasing rental rates on leases signed in 2017 and 2018 compared to expiring leases.
In terms of capital investment, we will continue to pursue selective development of new buildings and the opportunistic acquisition of buildings in markets where we perceive demand and market rental rates will provide attractive financial returns.
We anticipate continuing to selectively dispose of non-strategic assets to fund our investment in developments and acquisitions in an effort to enhance long-term growth in our net asset value, earnings and cash flows as well as to improve the overall quality of our portfolio.
We anticipate having sufficient liquidity to fund our operating expenses, including costs to maintain our properties and distributions, though we may finance investments, including acquisitions and developments, with the issuance of new common shares, proceeds from asset sales or through additional borrowings. Please see “Liquidity and Capital Resources” for additional discussion.
Inflation
The U.S. economy has experienced low inflation over the past several years and as a result, inflation has not had a significant impact on our business. Moreover, most of our leases require the customers to pay their share of the cost to operate our properties, including common area maintenance, real estate taxes and insurance, thereby reducing our exposure to increases in costs and operating expenses resulting from inflation. In addition, most of our leases expire within five years which enables us to replace existing leases with new leases at then-existing market rates.
Summary of Significant Transactions and Activities for the Year Ended December 31, 2017
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Acquisitions
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During the year ended December 31, 2017, we acquired five buildings comprising 1.3 million square feet located in our Chicago, Denver, Northern California, Orlando and Southern California markets for a total purchase price of approximately $129.0 million. Weighted average occupancy upon the acquisition of the properties was 31.5%.
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Additionally, during the year ended December 31, 2017, we acquired land totaling approximately 344.3 acres for development in our Atlanta, Dallas, Houston, New Jersey, Northern California, Orlando, Pennsylvania and Seattle markets for approximately $57.0 million.
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Development Activities
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During the year ended December 31, 2017, we stabilized six development buildings, three redevelopment buildings and three value-add acquisitions totaling 2.9 million square feet in our Atlanta, Chicago, Cincinnati, Dallas, Orlando, Seattle and Southern California markets.
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In 2017 we commenced construction on 19 development and redevelopment buildings. As of December 31, 2017, we had completed shell-construction on six buildings in our Chicago, Dallas, Denver and Miami markets totaling 1.0 million square feet with cumulative costs to date of approximately $75.3 million and a total projected investment of approximately $83.4 million. These properties were 39.0% leased based on weighted average square feet as of December 31, 2017.
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Also, as of December 31, 2017, we had 19 projects under construction totaling 4.9 million square feet with cumulative costs to date of approximately $205.2 million and a total projected investment of approximately $404.3 million. These projects were 13.4% pre-leased as of December 31, 2017.
The table below presents a summary of development activities as of December 31, 2017 (square feet and dollar amounts in thousands):
(1)
Percentage owned is based on equity ownership weighted by square feet.
(2)
The completion date represents the date of building shell-construction completion or estimated date of shell-completion.
(3)
Percentage leased is computed as of the date the financial statements were available to be issued.
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Dispositions
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During the year ended December 31, 2017, we sold 12 consolidated operating properties, totaling 1.5 million square feet, located in our Baltimore/Washington D.C., Cincinnati, Dallas, Louisville, Miami, Northern California, Orlando and Phoenix markets to third-parties for gross proceeds of approximately $115.3 million. We recognized gains of approximately $47.1 million on the disposition of 11 properties.
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Debt Activity
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During March 2017, we repaid the remaining $25.0 million outstanding on our $100.0 million term loan maturing April 2017 at par using proceeds from our senior unsecured revolving credit facility.
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During March 2017, the Operating Partnership issued $50.0 million aggregate principal amount of 4.50% senior notes due 2023 at 103.88% of face value in a public offering for net proceeds of approximately $51.2 million after offering costs and excluding accrued interest of approximately $0.9 million. The notes were issued under our indenture dated October 9, 2013 and form part of the same series as our previously issued 4.50% senior notes due 2023. We primarily used the net proceeds to pay down our senior unsecured revolving credit facility and for general corporate purposes.
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During June 2017, we paid-off our $51.0 million senior unsecured note maturing June 2017 at par using proceeds from our senior unsecured revolving credit facility and proceeds from the issuance of common stock under our continuous equity offering program.
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During the year ended December 31, 2017, we paid-off four mortgage notes totaling $34.5 million maturing in 2017 at par using proceeds from our senior unsecured revolving credit facility.
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During December 2017, we amended our existing $200.0 million variable rate senior unsecured term loan, lowering our LIBOR plus a margin 50 bps at the midpoint to between .90% to 1.75% per annum effective January 1, 2018, and based on our public debt credit rating, resulted in a fixed rate of 2.81% beginning on that date.
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As of December 31, 2017, we had $234.0 million outstanding and $164.1 million available under our $400.0 million senior unsecured revolving credit facility, net of two letters of credit totaling $1.9 million
•Activity from Investments in and Advances to Unconsolidated Joint Venture
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During May 2017, the SCLA joint venture entered into a $30.0 million secured fixed rate term note with a maturity date of May 2024. The proceeds were used to pay down a portion of the existing term note maturing in October 2017 and as a return of contributions to the joint venture partners.
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During June 2017, the TRT-DCT Venture III disposed of its three remaining properties. We received approximately $2.7 million for our share of the gross proceeds and recognized our share of the gain on the sale of approximately $1.2 million, which is included in "Equity in earnings of unconsolidated joint ventures, net" in our Consolidated Statements of Operations.
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During July 2017, the SCLA joint venture entered into a $13.5 million secured variable rate term note which bears interest at a variable rate equal to LIBOR plus a margin of 2.50% per annum with a maturity date of July 2024. The proceeds were used to return contributions to the joint venture partners. During August 2017, the SCLA joint venture entered into a pay-fixed, receive-floating interest rate swap which effectively fixed the interest rate on the related debt instrument at 4.55% with a maturity date of July 2024.
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In October 2017, the SCLA joint venture entered into an agreement to extend the maturity date of its $61.0 million secured construction loan from October 2017 to October 2019.
•Equity Activity
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On September 10, 2015, we registered a continuous equity offering program, to replace our continuous equity offering program previously registered on May 29, 2013, whereby the Company may issue 5.0 million shares of common stock, at a par value of $0.01 per share, from time-to-time through September 10, 2018 in “at-the-market” offerings or certain other transactions. During the year ended December 31, 2017, we issued approximately 1.8 million shares of common stock through the continuous equity offering program, at a weighted average price of $54.48 per share for proceeds of approximately $95.5 million, net of offering expenses. The proceeds from the sale of shares of common stock were contributed to the Operating Partnership for an equal number of OP units in the Operating Partnership and were used for general corporate purposes, including funding developments and redevelopments. As of December 31, 2017, approximately 0.7 million shares of common stock remain available to be issued under the current offering.
Critical Accounting Policies and Estimates
General
The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. (“GAAP”) requires management to use judgment in the application of accounting policies, including making estimates and assumptions. If our judgment or interpretation of the facts and circumstances relating to various transactions had been different or different assumptions were made, it is possible that different accounting policies would have been applied, resulting in different financial results or a different presentation of our financial statements. Our discussion and analysis of financial condition and results of operations is based on our Consolidated Financial Statements which have been prepared in accordance with GAAP. Estimates, judgments and assumptions are based on historical experiences that we believe to be reasonable under the circumstances. From time to time we re-evaluate those estimates and assumptions.
The Company’s significant accounting policies are described in “Notes to the Consolidated Financial Statements, Note 2 - Summary of Significant Accounting Policies.” These policies were followed in preparing the Consolidated Financial Statements as of and for the year ended December 31, 2017 and are consistent with the year ended December 31, 2016.
The Company has identified the following significant accounting policies as critical accounting policies. These accounting policies have the most significant impact on our financial condition and results of operations and require management’s most difficult, subjective and/or complex estimates.
Capitalization of Costs
See the Company’s accounting policy for Capitalization of Costs with respect to capitalization of project costs versus the expensing of repair and maintenance costs as described in “Notes to the Consolidated Financial Statements, Note 2 - Summary of Significant Accounting Policies.” As described in our policy, we capitalize costs such as personnel, office and other expenses based on an estimate of the time spent on projects that are directly related to capital projects and acquisition of leases. In February 2016, the Financial Accounting Standards Boards (“FASB”) issued an accounting standard update (“ASU”) that modifies existing accounting standards for lease accounting whereby lessors may only capitalize incremental direct costs and as a result, upon adoption the Company will no longer capitalize initial direct costs. The ASU is effective for the Company on January 1, 2019. Capitalized costs are recorded on the Consolidated Balance Sheets in construction in progress for each specific property.
For all development projects, the Company uses its professional judgment in determining whether such costs meet the criteria for capitalization or must be expensed as incurred. The Company capitalizes interest, real estate taxes, insurance, payroll and costs associated with individuals directly responsible for and who spend their time on development activities. Capitalization is ceased upon substantial completion of the project. These costs are recorded on the Consolidated Balance Sheets in construction in progress for each specific property.
Acquisition of Investment Properties
The Company allocates the purchase price of real estate to identifiable tangible assets such as land, building, land improvements and tenant improvements acquired based on their fair value. In estimating the fair value of each component management considers appraisals, replacement cost, its own analysis of recently acquired and existing comparable properties, market rental data and other related information.
Impairment of Properties
The Company periodically evaluates its long-lived assets, including investments in properties, for indicators of impairment. The judgments regarding the existence of indicators of impairment are based on the operating performance, market conditions, as well as the Company’s ability to hold and its intent with regard to each property. The judgments regarding whether the carrying amounts of these assets may not be recoverable are based on estimates of future undiscounted cash flows from properties which include estimates of future operating performance and market conditions.
Impairment of Investments in and Advances to Unconsolidated Joint Ventures
The Company evaluates investments in and advances to unconsolidated joint ventures for impairment whenever events or changes in circumstances indicate that there may be an other-than-temporary decline in value. The judgments regarding other-than-temporary declines in value are based on operating performance, market conditions and the Company’s ability and intent to hold as well as its ability to influence significant decisions of the venture.
Derivative Instruments and Hedging Activities
Derivative instruments and hedging activities require management to make judgments regarding fair value, the nature of its derivatives and their effectiveness as hedges. These judgments determine if the changes in the fair value of the derivative instruments are reported in our Consolidated Statement of Operations as a component of net income or as a component of other comprehensive income and as a component of accumulated other comprehensive income within equity on the Consolidated Balance Sheets. While management believes its judgments are reasonable, a change in a derivative’s effectiveness as a hedge could materially affect expenses, net income and equity.
Revenue Recognition
At the inception of a new lease arrangement, including new leases that arise from amendments, we assess the terms and conditions to determine the proper lease classification. A lease arrangement is classified as an operating lease if none of the following criteria are met: (i) transfer of ownership to the lessee, (ii) lessee has a bargain purchase option during or at the end of the lease term, (iii) the lease term is equal to 75% or more of the underlying property’s economic life, or (iv) the present value of future minimum lease payments (excluding executory costs) are equal to 90% or more of the excess estimated fair value (over retained investment tax credits) of the leased building. Generally, none of our leases meet any of the above criteria and, as such, are classified as operating leases. If the assumptions utilized in the above classification assessments were different, our lease classification for accounting purposes may have been different; thus the timing and amount of our revenue recognized would have been impacted, which may be material to our Consolidated Financial Statements.
We recognize rental revenues on a straight-line basis under which contractual rent increases are recognized evenly over the lease term when collectability is reasonably assured and the tenant has taken possession or controls the physical use of the property.
Certain properties have leases that provide for tenant occupancy during periods where no rent is due or where minimum rent payments change during the term of the lease. Accordingly, we record receivables from tenants that we expect to collect over the remaining lease term rather than currently, which are recorded on the Consolidated Balance Sheets as a straight-line rent receivable.
If the lease provides for tenant improvements, we determine whether the tenant improvements are owned by the tenant or us. When we are the owner of the tenant improvements, the tenant is not considered to have taken physical possession or have control of the physical leased asset until the tenant improvements are substantially completed. When the Company is the owner of the tenant improvements, any tenant improvements funded by the tenant are treated as lease payments which are deferred and amortized into income over the lease term. When the tenant is the owner of the tenant improvements, we record any tenant improvement allowance funded as a lease incentive and amortize it as a reduction of revenue over the lease term.
Above and below market lease values for acquired properties are recorded as the difference between the contractual amounts to be paid pursuant to each in-place lease and management's estimate of fair market lease rates for each corresponding in-place lease and amortized over the reasonably assured lease term.
In May 2014, the FASB issued ASU 2014-09 Revenue from Contracts with Customers (“ASU 2014-09”), that requires companies to recognize revenue from contracts with customers based upon the transfer of goods or services to customers in amounts that reflect the consideration to which the company expects to be entitled in exchange for those goods or services along with other guidance and clarifications. The guidance is effective for fiscal years beginning after December 15, 2017. See “Notes to the Consolidated Financial Statements, Note 2 - Summary of Significant Accounting Policies, New Accounting Standards” for further details.
In addition, in February 2016, the FASB issued an ASU 2016-02 that modifies existing accounting standards for lease accounting which may impact how revenue is recognized for lessors. Leases in which we are the lessors will be accounted as sales-type leases, direct financing leases or operating leases. The Company plans to adopt the new lease standard effective January 1, 2019 and we expect our operating leases with tenants will continue to qualify as operating leases. Revenue related to lease components will be recognized on a straight-line basis and revenue from non-lease components will be recognized in accordance with the principles of the Revenue from Contracts with Customers standard. See “Notes to the Consolidated Financial Statements, Note 2 - Summary of Significant Accounting Policies, New Accounting Standards” for further details.
Results of Operations
Summary of the year ended December 31, 2017 compared to the year ended December 31, 2016
We are a leading industrial real estate company specializing in the ownership, acquisition, development, leasing and management of bulk-distribution and light-industrial properties located in high-demand distribution markets in the United States. Our actively managed portfolio is strategically located near population centers and well-positioned to take advantage of market dynamics. As of December 31, 2017, the Company owned interests in or had under development approximately 74.8 million square feet of properties leased to approximately 850 customers, including 7.6 million square feet managed on behalf of two unconsolidated joint ventures. As of December 31, 2017, we consolidated 398 operating properties, six development properties, one redevelopment property and three value-add acquisitions totaling 67.2 million square feet. As of December 31, 2016, we consolidated 397 operating properties, four development properties, three redevelopment properties and four value-add acquisitions,
Comparison of the year ended December 31, 2017 to the year ended December 31, 2016
Our annual same-store portfolio includes all consolidated stabilized acquisitions acquired before January 1, 2016 and all consolidated development and redevelopment properties and value-add acquisitions stabilized prior to January 1, 2016. Once a property is included in our annual same-store portfolio, it remains until it is subsequently disposed of or placed into redevelopment. For the year ended December 31, 2017, we had 359 properties classified in our annual same-store portfolio comprising 55.9 million feet and 49 classified as non-same-store, which includes 39 operating properties, six development properties, one redevelopment property and three value-add acquisitions that were not stabilized.
The following table presents the changes in rental revenues, rental expenses and real estate taxes, property net operating income (“NOI”), other revenue and other income, and other expenses for the year ended December 31, 2017 compared to the year ended December 31, 2016 (in thousands):
(1)
For a discussion as to why we view property NOI to be an appropriate supplemental performance measure and a reconciliation of our property NOI to our reported “Net income attributable to common stockholders,” see page 35.
Rental Revenues and Leasing Activity
Rental revenues, which are comprised of base rent, straight-line rent, amortization of above and below market rent intangibles, tenant recovery income, other rental revenues and early lease termination fees, increased $31.7 million for the year ended December 31, 2017 compared to the same period in 2016, primarily due to the following changes:
•
$18.8 million increase in total revenues in our non-same-store portfolio, of which $26.2 million is attributed to eight operating property acquisitions, three value-add acquisitions and 28 development, redevelopment properties and value-add acquisitions placed into our operating portfolio since January 1, 2016, offset in part by a $7.4 million decrease attributed to 27 consolidated property dispositions since January 1, 2016.
•
$11.2 million increase in total revenues in our annual same-store portfolio primarily due to the following:
•
$17.7 million increase in base rent primarily resulting from increased rental rates and a 40 basis point increase in average occupancy period over period;
•
$3.3 million increase in operating expense recoveries related to higher average occupancy and increases in property tax expense; and
•
$1.0 million increase in early lease termination fees in 2017; which was partially offset by
•
$9.7 million decrease in straight-line rental revenue;
•
$0.6 million decrease in miscellaneous income primarily due to higher move-out repairs in 2016 compared to the same period in 2017; and
•
$0.5 million decrease in below market rent adjustments.
•
$1.6 million increase in developments, redevelopments, and value-add acquisitions total revenues primarily attributed to two development properties and two value-add acquisitions that were not stabilized at 61.0% occupancy as of December 31, 2017.
The following table presents the components of our consolidated rental revenues (in thousands):
The following table provides a summary of our leasing activity for the year ended December 31, 2017:
(1)
Reflects leases executed during the periods presented. Excludes leases with a term shorter than one year.
(2)
Net effective rent is the average monthly base rental income over the term of the lease, calculated on a straight-line basis.
(3)
Straight-line basis rent growth reflects the percentage change in net effective rent of the lease executed during the period compared to the net effective rent of the prior lease on the same space (holdover payments are excluded). All net effective rents are compared on a net basis. Net effective rent under gross or similar type leases are converted to net effective rent based on an estimate of the applicable recoverable expenses.
(4)
Assumes no exercise of lease renewal options, if any.
(5)
Turnover costs are comprised of the costs incurred or capitalized for improvements of vacant and renewal spaces, as well as the commissions paid and costs capitalized for leasing transactions. These costs represent the total turnover costs estimated upon execution to be incurred associated with the leases signed during the period and may not ultimately reflect the actual expenditures. The estimated turnover costs associated with leases signed on value-add acquisitions, developments and redevelopments are included in the total projected costs for those investments and are therefore excluded from the leasing statistics.
(6)
Represents the percentage of customers renewing their respective leases weighted by average square feet. Excludes leases signed on value-add acquisitions, developments and redevelopments and leases with a term shorter than one year.
During the year ended December 31, 2017, we signed a total of 206 leases comprising 12.6 million square feet of which 83 leases totaling 5.9 million square feet included concessions of $6.5 million primarily related to free rent periods.
Rental Expenses and Real Estate Taxes
Rental expenses and real estate taxes, which are comprised of insurance, common area maintenance, utilities, property management fees and other rental expenses, and real estate taxes, increased by $6.2 million for the year ended December 31, 2017 compared to the same period in 2016, primarily due to the following:
•
$4.8 million increase in rental expenses and real estate taxes related to our non-same-store portfolio primarily due to a $4.9 million increase in property taxes in our Atlanta, Chicago, Northern California, Seattle and Southern California markets and a $1.9 million increase in common area maintenance, insurance and property management fees attributed to property acquisitions and completion of developments and redevelopments, offset in part by a $2.0 million decrease primarily related to dispositions in our Chicago, Dallas, Indianapolis and Phoenix markets;
•
$0.5 million increase in rental expenses and real estate taxes primarily due to increased property taxes in our Denver market from our development and redevelopment properties and value-add acquisitions that were not stabilized as of December 31, 2017; and
•
$0.9 million increase in rental expenses and real estate taxes period over period in our annual same-store portfolio primarily due to property taxes in our Atlanta, Dallas, Houston and Southern California markets, offset in part by a decrease in snow removal costs.
The following table presents the various components of our rental expenses and real estate taxes (in thousands):
Other Revenue and Other Income
Total other revenue and other income decreased $3.5 million for the year ended December 31, 2017 compared to the same period in 2016, primarily due to the following:
•
$2.8 million decrease in gain on dispositions of real estate interests primarily related to gains of $49.9 million recognized from the disposition of 15 properties in our Chicago, Dallas, Houston, Indianapolis, Louisville and Northern California markets during 2016 compared to gains of $47.1 million recognized from the disposition of 11 properties in the Baltimore/Washington D.C., Cincinnati, Louisville, Miami, Northern California, Orlando and Phoenix markets during 2017;
•
$2.5 million decrease in casualty gain primarily related to insurance settlements from casualty events in our Dallas and Northern California markets during 2016 compared to gains related to an insurance settlement from a casualty event that occurred in 2016 at a property in our Southern California market during 2017; and
•
$0.6 million decrease in interest and other income (expense) primarily related to proceeds received in 2016 from a legal settlement related to damages at several properties located in our Houston market; which was partially offset by
•
$2.3 million increase in equity in earnings of unconsolidated joint ventures, net, primarily related to a $1.2 million gain recognized on the sale of three properties in the TRT-DCT Venture III joint venture, increased earnings from our unconsolidated investments in the SCLA and DCT/SPF Industrial Operating LLC joint ventures during 2017 compared to 2016 and the completion of development activities and stabilization of two buildings in the SCLA joint venture since January 1, 2016.
Other Expenses
Other expenses increased $11.5 million for the year ended December 31, 2017 compared to the same period in 2016, primarily due to the following:
•
$6.9 million increase in depreciation and amortization expense resulting from the following:
•
$12.3 million increase related to real estate acquisitions, development and redevelopment properties and value-add acquisitions, and capital additions; partially offset by
•
$3.4 million decrease related to real estate dispositions; and
•
$2.0 million decrease related to tenant improvements and intangible lease assets that were fully amortized during 2016.
•
$2.0 million increase in interest expense due to the following:
•
$5.5 million increase due to increased average outstanding indebtedness of approximately $99.2 million and a higher weighted average effective interest rate during 2017 compared to the same period in 2016; which was partially offset by
•
$3.1 million decrease due to a $3.1 million increase in capitalized interest primarily related to increased development activities and a higher weighted average effective interest rate during 2017 compared to the same period in 2016; and
•
$0.4 million decrease due to $0.4 million of hedge ineffectiveness recognized during 2016 related to our $200.0 million 2015 term note hedge compared to no hedge ineffectiveness recognized during 2017 upon the adoption of the Derivatives and Hedging ASU in September 2017, see “Notes to Consolidated Financial Statements, Note 2 - Summary of Significant Accounting Policies” for additional information.
•
$1.7 million increase in income tax expense and other taxes primarily as a result of the impact on deferred tax expense from the Tax Cuts and Jobs Act of 2017 corporate tax rate reduction and an increase in the allowance for deferred tax assets;
•
$0.9 million increase in impairment loss on land recognized on one parcel of land during 2017; and
•
$0.3 million increase in impairment loss due to $0.3 million recognized on one property sold during 2017; partially offset by
•
$0.3 million decrease in general and administrative expenses primarily related to personnel and office costs.
Summary of the year ended December 31, 2016 compared to the year ended December 31, 2015
As of December 31, 2016, we consolidated 397 operating properties, four development properties, three redevelopment properties and four value-add acquisitions. As of December 31, 2015, we consolidated 388 operating properties, three development properties, five redevelopment properties, two value-add acquisitions and four consolidated operating properties classified as held for sale.
Comparison of the year ended December 31, 2016 to the year ended December 31, 2015
Our annual same-store portfolio includes all consolidated stabilized acquisitions acquired before January 1, 2015 and all consolidated development and redevelopment properties and value-add acquisitions stabilized prior to January 1, 2015. Once a property is included in our annual same-store portfolio, it remains until it is subsequently disposed of or placed into redevelopment. For the year ended December 31, 2016, we had 344 properties classified in our same-store portfolio comprising 52.5 million square feet and 64 classified as non-same-store which includes 53 operating properties, four development properties, three redevelopment properties and four value-add acquisitions that were not stabilized.
The following table presents the changes in rental revenues, rental expenses and real estate taxes, property NOI, other revenue and other income and other expenses for the year ended December 31, 2016 compared to the year ended December 31, 2015 (in thousands):
(1)
Amounts do not reflect the changes to operating portfolio definition made as of Q1 2017, namely the addition of Value-Add Acquisitions are only considered in the operating portfolio upon stabilization.
(2)
For a discussion as to why we view property NOI to be an appropriate supplemental performance measure and a reconciliation of our property NOI to our reported “Net income attributable to common stockholders,” see page 35.
Rental Revenues and Leasing Activity
Rental revenues, which are comprised of base rent, straight-line rent, amortization of above and below market rent intangibles, tenant recovery income, other rental revenues and early lease termination fees, increased $38.3 million for the year ended December 31, 2016 compared to the same period in 2015, primarily due to the following changes:
•
$25.7 million increase in total revenues in our non-same-store portfolio, of which $46.2 million is attributed to 22 operating property acquisitions and 35 development and redevelopment properties placed into operation since January 1, 2015, offset in part by a $20.5 million decrease attributed to 45 consolidated property dispositions since January 1, 2015.
•
$14.3 million increase in total revenues in our annual same-store portfolio primarily due to the following:
•
$10.1 million increase in base rent primarily resulting from increased rental rates and a 180 basis point increase in average occupancy period over period;
•
$5.1 million increase in operating expense recoveries related to higher average occupancy and increases in property tax expense;
•
$0.6 million increase in straight-line rental revenue; and
•
$0.3 million increase in miscellaneous income from tenants primarily due to move-out repairs; which was partially offset by
•
$1.6 million decrease in early lease termination fees attributable to six tenants in 2015; and
•
$0.2 million decrease in below market rent adjustments.
•
$1.7 million decrease in total revenues primarily attributed to development and redevelopment properties and value-add acquisitions that were in our operating portfolio prior to January 1, 2016.
The following table presents the components of our consolidated rental revenues (in thousands):
The following table provides a summary of our leasing activity for the year ended December 31, 2016:
(1)
Reflects leases executed during the periods presented. Excludes leases with a term shorter than one year.
(2)
Net effective rent is the average monthly base rental income over the term of the lease, calculated on a straight-line basis.
(3)
Straight-line basis rent growth reflects the percentage change in net effective rent of the lease executed during the period compared to the net effective rent of the prior lease on the same space (holdover payments are excluded). All net effective rents are compared on a net basis. Net effective rent under gross or similar type leases are converted to net effective rent based on an estimate of the applicable recoverable expenses.
(4)
Assumes no exercise of lease renewal options, if any.
(5)
Turnover costs are comprised of the costs incurred or capitalized for improvements of vacant and renewal spaces, as well as the commissions paid and costs capitalized for leasing transactions. These costs represent the total turnover costs estimated upon execution to be incurred associated with the leases signed during the period and may not ultimately reflect the actual expenditures. The estimated turnover costs associated with leases signed on value-add acquisitions, developments and redevelopments are included in the total projected costs for those investments and are therefore excluded from the leasing statistics.
(6)
Represents the percentage of customers renewing their respective leases weighted by average square feet. Excludes leases signed on value-add acquisitions, developments and redevelopments and leases with a term shorter than one year.
During the year ended December 31, 2016, we signed a total of 239 leases comprising 14.3 million square feet of which 99 leases totaling 7.0 million square feet included concessions of $10.2 million primarily related to free rent periods.
Rental Expenses and Real Estate Taxes
Rental expenses and real estate taxes, which are comprised of insurance, common area maintenance, utilities, property management fees and other rental expenses, and real estate taxes, increased by $4.6 million for the year ended December 31, 2016 compared to the same period in 2015, primarily due to the following:
•
$2.7 million increase in rental expenses and real estate taxes period over period in our annual same-store portfolio primarily due to an increase in property taxes in our Baltimore/Washington D.C., Chicago, Houston, New Jersey, Northern California and Seattle markets; and
•
$8.1 million increase in rental expenses and real estate taxes related to our non-same-store properties primarily due to an increase in property taxes in our Atlanta, Dallas, Houston, Seattle and Southern California markets; offset in part by
•
$6.2 million decrease primarily related to dispositions in the Chicago, Houston, Indianapolis and New Jersey markets.
The following table presents the various components of our rental expenses and real estate taxes (in thousands):
Other Revenue and Other Income
Total other revenue and other income decreased $31.0 million for the year ended December 31, 2016 compared to the same period in 2015, primarily due to the following:
•
$28.0 million decrease in gain on dispositions of real estate interests primarily related to gains of $49.9 million recognized on the disposition of 15 properties in the Chicago, Dallas, Houston, Indianapolis, Louisville and Northern California markets during 2016, compared to gains of $77.9 million recognized on the disposition of 28 properties in the Atlanta, Houston, Indianapolis, Louisville, Memphis, New Jersey and Pennsylvania markets during 2015;
•
$3.2 million decrease in equity in earnings of unconsolidated joint ventures, net, primarily related to $3.7 million of gain recognized on the sale of one property in the IDI/DCT, LLC joint venture during 2015, offset in part by increased earnings from our unconsolidated investments in the SCLA and DCT/SPF Industrial Operating LLC joint ventures due to increased occupancy; and
•
$2.6 million decrease in development profit, net of taxes related to the completion and sales of 8th & Vineyard C, 8th & Vineyard D and 8th & Vineyard E to third-parties during 2015 with no corresponding activity during 2016; which was partially offset by
•
$2.3 million increase in casualty gain primarily related to $2.8 million in insurance settlements from casualty events in our Dallas and Northern California markets during 2016 compared to $0.4 million of casualty gain related to insurance recoveries received for damages at our properties caused by a series of storms in 2015; and
•
$0.6 million increase in interest and other income (expense) primarily related to proceeds received in 2016 from a legal settlement related to damages at several properties located in the Houston market.
Other Expenses
Other expenses increased $7.6 million for the year ended December 31, 2016 compared to the same period in 2015, primarily due to the following:
•
$10.0 million increase in interest expense due to the following:
•
$5.9 million decrease in capitalized interest primarily related to the cessation of capitalization on 35 developments placed into service compared to the same period in 2015; and
•
$4.5 million increase due to increased average outstanding indebtedness of approximately $88.8 million during 2016 and a higher weighted average effective interest rate during 2016 compared to the same period in 2015; which was partially offset by
•
$0.4 million of hedge ineffectiveness recognized during 2016 related to our $200.0 million 2015 term note hedge.
•
$5.3 million increase in depreciation and amortization expense resulting from a $18.1 million increase related to real estate acquisitions, developments placed in service and capital additions; partially offset by $8.7 million related to real estate dispositions and $4.1 million related to same-store portfolio tenant improvements that were fully amortized during 2015; which was partially offset by
•
$5.3 million decrease in general and administrative expenses primarily related to the following:
•
$3.6 million decrease in severance costs;
•
$2.6 million decrease resulting from an expense in 2015 related to criminal fraud and the associated legal expenses incurred in relation to the investigation of the incident; and
•
$0.9 million decrease in acquisition costs due to lower acquisition activity; which was partially offset by
•
$1.2 million increase in personnel cost;
•
$0.4 million increase in professional service fees due to litigation costs; and
•
$0.2 million increase in general and administrative expenses due to decreased capitalized overhead.
•
$2.3 million decrease in impairments due to $2.3 million recognized on two properties sold during 2015 with no corresponding activity during 2016.
Segment Summary for the years ended December 31, 2017, 2016, and 2015
The Company’s segments are based on our internal reporting of operating results used to assess performance based on our properties’ geographical markets. Our markets are aggregated into three reportable regions or segments, East, Central and West, which are based on the geographical locations of our properties. These regions are comprised of the markets by which management and their operating teams conduct and monitor business (see further detail on our Segments in “Notes to the Consolidated Financial Statements, Note 14 - Segment Information”). Management considers rental revenues and property NOI aggregated by segment to be the appropriate way to analyze performance.
The following table presents the changes in our consolidated properties by segment (dollar amounts and square feet in thousands):
(1)
Segment assets include all assets comprising operating properties included in a segment, less non-segment cash and cash equivalents and other non-segment assets.
(2)
Segment rental revenues include revenue from operating portfolio, development and redevelopment properties and value-add acquisitions.
(3)
For the definition of property NOI, or property NOI, as defined on page 35, and a reconciliation of our property NOI to our reported “Net income attributable to common stockholders” see “Notes to Consolidated Financial Statements, Note 14 - Segment Information.”
The following table presents our total assets, net of accumulated depreciation and amortization, by segment (in thousands):
(1)
Other non-segment assets primarily consist of investments in and advances to unconsolidated joint ventures, deferred loan costs, other receivables, restricted cash and other assets.
East Segment
•
East Segment assets increased by approximately $48.4 million in 2017 due to the acquisition of five land parcels, one property placed into redevelopment and three development properties placed into operation; partially offset by the disposition of three properties since December 31, 2016.
•
East Segment assets increased by approximately $42.1 million in 2016 primarily due to four development properties placed into operation, including one building that was shell-construction complete upon acquisition, and the acquisition of two land parcels since December 31, 2015.
•
East Segment property NOI increased approximately $5.1 million for the year ended December 31, 2017 compared to the same period in 2016, primarily as a result of:
•
$6.8 million increase in NOI, of which a $3.7 million increase is attributed to higher recoveries and rental rates in our annual same-store portfolio and a $3.7 million increase in rental revenues is attributed to the timing of property acquisitions and completion of developments, offset in part by a $0.6 million decrease in rental revenues attributed to property dispositions.
•
$1.7 million decrease in NOI due to increases in operating expenses primarily related to increased property taxes during 2017 compared to 2016.
•
East Segment property NOI increased approximately $13.6 million for the year ended December 31, 2016 compared to the same period in 2015, primarily as a result of:
•
$14.1 million increase in NOI, of which a $14.0 million increase in rental revenues is attributed to the timing of property acquisitions and completion of developments and a $5.6 million increase is attributed to higher rental rates and operating expense recoveries due to increased occupancy in our annual same-store portfolio, offset in part by a $5.5 million decrease in rental revenues due to property dispositions.
•
$0.5 million decrease in NOI due to increases in operating expenses primarily related to increases in common area maintenance and property management fees, partially offset by a decrease in real estate taxes received during 2016 compared to 2015.
Central Segment
•
Central Segment assets increased by approximately $89.2 million in 2017 due to the acquisition of three land parcels and one value-add acquisition, and four development properties placed into operation; partially offset by the disposition of three properties since December 31, 2016.
•
Central Segment assets increased by approximately $7.9 million in 2016 due to the acquisition of four properties and three land parcels, and nine development and redevelopment properties placed into operation; partially offset by the disposition of 14 properties since December 31, 2015.
•
Central Segment property NOI increased approximately $7.9 million for the year ended December 31, 2017 compared to the same period in 2016, primarily as a result of:
•
$8.7 million increase in NOI, of which a $10.7 million increase in rental revenues is attributed to the timing of property acquisitions and completion of developments and a $2.5 million increase attributed to higher rental rates and occupancy in our annual same-store portfolio, offset in part by $4.5 million decrease in rental revenues is attributed to property dispositions; which was partially offset by
•
$0.9 million decrease in NOI, of which a $1.5 million increase in property taxes is primarily attributed to a $2.8 million increase in property taxes driven by the cessation of capitalization on developments placed into operation and property acquisitions, offset in part by a $1.3 million decrease in property taxes attributed to property dispositions, and by a $0.6 million decrease in operating expenses attributed to our annual same-store portfolio.
•
Central Segment property NOI decreased approximately $1.4 million for the year ended December 31, 2016 compared to the same period in 2015, primarily as a result of:
•
$1.8 million decrease in NOI, of which a $14.8 million decrease in rental revenues is attributed to property dispositions, partially offset by a $12.3 million increase attributed to the timing of property acquisitions and completion of developments, and a $0.7 million increase attributed to higher rental rates in our annual same-store portfolio; which was partially offset by
•
$0.4 million decrease in NOI, of which a $4.3 million decrease in rental and property tax expenses primarily attributed to property dispositions; offset by a $2.9 million increase in operating expenses driven by the cessation of capitalization on developments placed into operation and property acquisitions, and $1.0 million increase in operating expenses attributed to our annual same-store portfolio due to increased real estate taxes.
West Segment
•
West Segment assets increased by approximately $80.2 million in 2017 due to the acquisition of two operating properties, one value-add acquisition and four land parcels, and four development properties placed into operation, partially offset by the disposition of six properties since December 31, 2016.
•
West Segment assets increased by approximately $138.1 million in 2016 due to five development properties placed into operation and the acquisition of four properties and two land parcels; partially offset by the disposition of one property since December 31, 2015.
•
West Segment property NOI increased approximately $12.5 million for the year ended December 31, 2017 compared to the same period in 2016, primarily as a result of:
•
$16.2 million increase in NOI, of which an $13.5 million increase in rental revenues is attributed to the timing of property acquisitions and completion of developments and a $5.0 million increase is attributed to increased rental rates at properties in our annual same-store portfolio, offset in part by a $2.3 million decrease in operating expenses attributed to property dispositions; which was partially offset by
•
$3.7 million decrease in NOI, of which a $3.0 million increase in operating expenses is attributed to increased property taxes driven by the cessation of capitalization on developments placed into operation and property acquisitions and a $1.2 million increase in operating expenses in our annual same-store portfolio primarily attributed to increased property taxes and other operating expenses, offset in part by a $0.5 million decrease in rental revenues attributed to property dispositions.
•
West Segment property NOI increased approximately $21.5 million for the year ended December 31, 2016 compared to the same period in 2015, primarily as a result of:
•
$26.0 million increase in NOI, of which an $18.2 million increase in rental revenues is attributed to the timing of property acquisitions and completion of developments, and a $8.0 million increase is attributed to increased rental rates and occupancy in our annual same-store portfolio, offset in part by a $0.2 million decrease due to a property disposition; which was partially offset by
•
$4.5 million decrease in NOI due to a $3.5 million increase in operating expenses primarily due to increased property tax expense driven by the cessation of capitalization on developments placed into operation and property acquisitions, and a $1.1 million increase in our annual same-store portfolio property taxes and other operating expenses.
Liquidity and Capital Resources
Overview
We currently expect that our principal sources of working capital and funding for potential capital requirements for expansions and renovation of properties, developments, acquisitions, and debt service and distributions to shareholders will include:
•
Cash flows from operations;
•
Proceeds from dispositions;
•
Borrowings under our senior unsecured revolving credit facility;
•
Other forms of secured or unsecured financings;
•
Offerings of common stock or other securities;
•
Current cash balances; and
•
Distributions from institutional capital management and other joint ventures.
Year ended December 31, 2017 compared to year ended December 31, 2016
“Cash, cash equivalents and restricted cash” were $25.8 million and $18.1 million as of December 31, 2017 and December 31, 2016, respectively.
Net cash provided by operating activities increased $23.4 million to $244.7 million during the year ended December 31, 2017 compared to $221.3 million during the same period in 2016. This change was primarily due to an increase in property NOI attributable to acquired properties, development and redevelopment properties placed into operation and operating performance at existing properties.
Net cash used in investing activities decreased $16.1 million to $296.8 million during the year ended December 31, 2017 compared to $312.9 million during the same period in 2016, primarily due to the following activities:
•
$51.8 million decrease in cash outflows related to capital expenditures and development activities, as reflected in the table below;
•
$34.9 million increase in cash inflows related to distributions of investments from unconsolidated joint ventures due to increased return of contributions from the SCLA joint venture, proceeds from the sale of three properties in the TRT-DCT Venture III joint venture and increased net cash flow from earnings from our unconsolidated investments in the SCLA and DCT/SPF Industrial Operating LLC joint ventures during 2017; and
•
$3.5 million decrease in cash outflows related to investments in unconsolidated joint ventures due to contributions of $17.8 million in 2016 to the SCLA unconsolidated joint venture to fund the development of one project compared to contributions of $14.3 million in 2017; partially offset by
•
$59.8 million increase in cash outflows related to real estate acquisitions;
•
$11.8 million decrease in cash inflows related to proceeds from dispositions; and
•
$3.2 million decrease in cash inflows from casualty proceeds primarily related to insurance settlements from casualty events in our Dallas and Northern California markets during 2016 compared to an insurance settlement from a casualty event that occurred in 2016 at a property in our Southern California market during 2017.
We pursue the acquisition of buildings and land and consider selective development of new buildings in markets where we perceive that demand and market rental rates will provide attractive financial returns. The amount of cash used related to acquisitions and development and redevelopment investments will vary from period to period based on a number of factors, including, among others, current and anticipated future market conditions impacting the desirability of investments, leasing results with respect to our existing development and redevelopment projects and our ability to locate attractive opportunities. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Summary of Significant Transactions and Activities for the Year Ended December 31, 2017 - Development Activities” for further details regarding projected investment of our current development activities as well as cumulative costs incurred as of December 31, 2017. Our total capital expenditures were comprised of the following (in thousands):
We capitalize costs directly related to the development, pre-development, redevelopment or improvement of our investments in real estate. Building and land improvements comprise capital expenditures related to maintaining our consolidated operating activities. Due diligence capital relates to deferred acquisition costs identified during due diligence that are needed to stabilize an asset and/or bring an asset up to our physical standards.
We capitalize indirect costs such as personnel, office and administrative expenses that are directly related to our development projects, redevelopment projects, successful origination of new leases and probable acquisitions based on an estimate of the time spent on the development, leasing and acquisition activities. The total of these capitalized costs was comprised of the following (in thousands):
In addition, we capitalize interest costs incurred associated with development and construction activities. During the years ended December 31, 2017 and 2016, total interest capitalized was $13.0 million and $9.9 million, respectively.
Net cash provided by financing activities increased $0.1 million to $59.9 million during the year ended December 31, 2017 compared to $59.8 million during the same period in 2016 primarily due to the following activities:
•
$154.0 million net increase in proceeds from our senior unsecured revolving credit facility in 2017 compared to 2016, as borrowings of $330.0 million during 2017 exceeded our borrowings of $248.0 million during 2016; offset by repayments of $171.0 million during 2017 compared to $243.0 million of repayments during 2016;
•
$98.0 million net decrease in cash outflows related to repayments of senior unsecured notes due to the following:
•
$50.0 million repayment of our senior unsecured fixed rate note at par in February 2016;
•
$49.0 million repayment of our senior unsecured fixed rate note in August 2016; and
•
$75.0 million pay down of our $100.0 million term loan in 2016; partially offset by
•
$25.0 million early repayment of the remaining $25.0 million outstanding on our $100.0 million term loan at par in March 2017; and
•
$51.0 million decrease due to the repayment of our $51.0 million senior unsecured note at par in June 2017.
•
$3.3 million decrease in cash outflows attributed to the purchase of our joint venture partner interest during 2016 with no corresponding activity during 2017.
•
$0.7 million decrease in cash outflows for loan costs of $1.8 million related to the issuance of our $250.0 million fixed rate senior unsecured note in August 2016 compared to loan costs of $1.1 million related to the issuance of $50.0 million of our 4.50% senior notes due 2023 in March 2017 and to the amendment of our $200.0 million variable rate senior unsecured term loan in December 2017; and
•
$0.2 million net increase in cash inflows due to contributions from noncontrolling interests as a result of development activities on one building; which was partially offset by
•
$198.1 million net decrease in proceeds from senior unsecured notes due to $250.0 million increase in cash inflows resulting from the issuance of our fixed rate senior unsecured notes in August 2016 compared to a $51.9 million increase in cash inflows resulting from the issuance of our 4.50% senior notes due in 2023 in March 2017;
•
$34.4 million increase in cash outflows due to the following:
•
Repayment of four mortgage notes at par totaling approximately $34.5 million in 2017; partially offset by
•
Scheduled principal payments of mortgage notes totaling approximately $6.6 million during 2017 compared to $6.7 million during 2016.
•
$11.5 million decrease in cash inflows as a result of the issuance of 1.8 million shares of common stock at a weighted average price of $54.48 per share in 2017 under our continuous equity offering program compared to the issuance of 2.5 million shares of common stock at a weighted average price of $43.98 per share in 2016.
•
$11.4 million increase in cash outflows in distributions paid to common stockholders and unitholders as a result of an increase in our dividend rate per share, an increase in our common stock outstanding, operating partnership redemptions and offering costs; and
•
$0.7 million increase in cash outflows due to the net settlement of stock-based awards.
Year ended December 31, 2016, compared to year ended December 31, 2015
“Cash, cash equivalents and restricted cash” were $18.1 million and $49.9 million as of December 31, 2016 and December 31, 2015, respectively.
Net cash provided by operating activities increased $22.0 million to $221.3 million during the year ended December 31, 2016 compared to $199.3 million during the same period in 2015. This change was primarily due to an increase in property NOI attributable to acquired properties, development and redevelopment properties and value-add acquisitions placed into operation and operating performance at existing properties.
Net cash used in investing activities increased $123.1 million to $312.9 million during the year ended December 31, 2016 compared to $189.8 million during the same period in 2015, primarily due to the following activities:
•
$112.0 million decrease in cash inflows from dispositions;
•
$39.0 million increase in cash outflows related to capital expenditures and development activities, as reflected in the table below;
•
$16.2 million increase in cash outflows related to investments in unconsolidated joint ventures due to increased contributions to our SCLA unconsolidated joint venture to fund the development of two properties during 2016;
•
$8.2 million decrease in cash inflows from distributions of investments in unconsolidated joint ventures primarily related to the distribution of proceeds from the sale of one property in the IDI/DCT, LLC joint venture during 2015;
•
$4.7 million increase in cash outflows related to deferred costs and refundable deposits for acquisitions that have not closed as of December 31, 2016; and
•
$2.6 million increase in cash outflows primarily related to furniture purchases and improvements at our offices during 2016; partially offset by
•
$57.4 million decrease in cash outflows from real estate acquisitions; and
•
$1.6 million increase in cash inflows related to proceeds received from casualty gains primarily related to insurance settlements received from casualty events in our Dallas and Northern California markets during 2016 compared to insurance settlements received for damages in our Houston market caused by a series of storms during 2015.
Our total capital expenditures were comprised of the following (in thousands):
The total of our capitalized indirect costs was comprised of the following (in thousands):
During the years ended December 31, 2016, and 2015 total capitalized interest associated with development and construction activities was $9.9 million and $15.8 million, respectively.
Net cash provided by financing activities increased $43.0 million to $59.8 million during the year ended December 31, 2016 compared to $16.8 million during the same period in 2015, primarily due to the following activities:
•
$107.1 million net increase in cash inflows as a result of the issuance of 2.5 million shares of common stock at a weighted average price of $43.98 per share during 2016 under our continuous equity offering program; and
•
$51.8 million decrease in cash outflows on mortgage notes as principal payments of $58.6 million in 2015 exceeded principal payments of $6.7 million in 2016; partially offset by
•
$84.0 million decrease in proceeds from senior unsecured notes due to the following:
•
$50.0 million decrease due to the repayment of our senior unsecured fixed rate note in February 2016;
•
$49.0 million decrease due to the repayment of our senior unsecured fixed rate note in August 2016; and
•
$75.0 million decrease due to the early partial pay down of our $100.0 million term loan in 2016; which was partially offset by
•
$50.0 million net increase in cash inflows resulting from the issuance of our $250.0 million fixed rate senior unsecured notes in August 2016 compared to the issuance of our $200.0 million variable rate senior unsecured term loan in December 2015; and
•
$40.0 million repayment of our senior unsecured note in June 2015.
•
$28.0 million decrease in proceeds from our senior unsecured revolving credit facility, as net borrowings of $33.0 million during 2015 exceeded our $5.0 million of net borrowings during 2016; and
•
$2.9 million increase in cash outflows attributable to operating partnership unit redemptions, distributions to noncontrolling interest holders, increases in the dividend rate per share declared in October 2015 and November 2016 and additional shares of common stock issued under our continuous equity offering program resulting in an increase in our dividends and distributions paid to common stockholders and unitholders.
Common Stock
As of December 31, 2017, approximately 93.7 million shares of common stock were issued and outstanding.
On September 10, 2015, we registered a continuous equity offering program, to replace our continuous equity offering program previously registered on May 29, 2013, whereby the Company may issue 5.0 million shares of common stock, at a par value of $0.01 per share, from time-to-time through September 10, 2018 in “at-the-market” offerings or certain other transactions. During the year ended December 31, 2017, we issued approximately 1.8 million shares of common stock through the continuous equity offering program, at a weighted average price of $54.48 per share for proceeds of approximately $95.5 million, net of offering expenses. The proceeds from the sale of shares of common stock were contributed to the Operating Partnership for an equal number of OP units in the Operating Partnership and were used for general corporate purposes, including funding developments and redevelopments and repaying debt. As of December 31, 2017, approximately 0.7 million shares of common stock remain available to be issued under the current offering.
OP Units
Limited partners have the right to require the Company to redeem all or a portion of the OP Units held by the limited partner at a redemption price equal to and in the form of the Cash Amount (as defined in the Amended and Restated Limited Partnership Agreement of the Operating Partnership (“Partnership Agreement”)). DCT may, in its sole discretion, purchase the OP Units by paying to the limited partner either the Cash Amount or the REIT Shares Amount (generally one share of DCT’s common stock for each OP Unit), as defined in the Partnership Agreement.
During the year ended December 31, 2017, approximately 0.3 million OP Units were redeemed for approximately $2.7 million in cash and approximately 0.3 million shares of DCT common stock. The OP Unit redemptions exclude LTIP Unit redemptions, see “LTIP Units” in “Notes to the Consolidated Financial Statements, Note 11 - Equity Based Compensation” for a summary of LTIP Unit redemptions.
As of December 31, 2017, approximately 3.2 million OP Units were issued, outstanding and held by entities other than DCT including approximately 0.8 million vested LTIP Units issued under our Long-Term Incentive Plan.
As of December 31, 2017, the aggregate redemption value of the then-outstanding OP Units held by entities other than DCT was approximately $191.0 million based on the $58.78 per share closing price of DCT’s common stock on December 31, 2017.
Dividend Reinvestment and Stock Purchase Plan
We offer shares of our common stock through our Dividend Reinvestment and Stock Purchase Plan (the “Plan”). The Plan permits stockholders to acquire additional shares with quarterly dividends and to make additional cash investments to buy shares directly through our third party transfer agent. Shares of common stock may be purchased in the open market or through privately negotiated transactions.
Distributions
During the years ended December 31, 2017, and 2016, our board of directors declared distributions to stockholders and unitholders totaling approximately $124.8 million and $111.7 million, respectively. Existing cash balances, cash provided from operations, borrowings under our senior unsecured revolving credit facility, equity offering proceeds and dispositions were used to pay distributions during 2017 and 2016.
The payment of quarterly distributions is determined by our board of directors and may be adjusted at its discretion at any time. During January 2018, our board of directors declared a quarterly cash dividend of $0.36 per share, payable on April 11, 2018 to stockholders of record as of March 30, 2018.
Outstanding Indebtedness
As of December 31, 2017, our outstanding indebtedness of approximately $1.7 billion consisted of mortgage notes, senior unsecured notes and bank unsecured credit facilities, excluding approximately $51.9 million representing our proportionate share of non-recourse debt associated with unconsolidated joint ventures. As of December 31, 2016, our outstanding indebtedness of approximately $1.6 billion consisted of mortgage notes, senior unsecured notes and bank unsecured credit facilities, excluding approximately $35.2 million representing our proportionate share of non-recourse debt associated with unconsolidated joint ventures.
As of December 31, 2017, the gross book value of our consolidated properties was approximately $4.7 billion and the gross book value of all properties securing our mortgage debt was approximately $0.5 billion. As of December 31, 2016, the total gross book value of our consolidated properties was approximately $4.4 billion and the gross book value of all properties securing our mortgage debt was approximately $0.6 billion. Our debt has various covenants with which we were in compliance as of December 31, 2017 and 2016.
Our debt instruments require monthly, quarterly or semiannual payments of interest and mortgages generally require monthly or quarterly repayments of principal. Currently, cash flows from our operations are sufficient to satisfy these debt service requirements and we anticipate that cash flows from operations will continue to be sufficient to satisfy our debt service excluding principal maturities, which we plan to fund from refinancing and/or new debt.
All of our senior unsecured notes contain certain cross-default provisions which may be triggered in the event that any material indebtedness is in default. These cross-default provisions may require us to repay such senior unsecured debt. We are not in default and do not have any unsecured debt maturities until June 2018.
We have certain non-recourse, secured loans which are cross-collateralized by multiple properties. In the event of a default, we may then be required to repay such indebtedness, together with applicable prepayment charges, to avoid foreclosure on all cross collateralized properties within the applicable pool. We generally have broad substitution rights that afford DCT the opportunity to replace encumbered properties with replacement properties. We are not in default and do not have any cross-collateralized debt maturing until February 2019.
In the event of default or foreclosure, or if we are unable to refinance our indebtedness at maturity or meet our payment obligations, the amount of our distributable cash flows and our financial condition would be adversely affected.
Financing Strategy
We do not have a formal policy limiting the amount of debt we incur, although we currently intend to operate so that our financial metrics are generally consistent with investment grade peers in the real estate industry. We continually evaluate our secured and unsecured leverage and among other relevant metrics, our fixed charge coverage ratio. Our charter and our bylaws do not limit the indebtedness that we may incur. We are, however, subject to certain covenants which may limit our outstanding indebtedness.
Debt Issuance, Payoffs and Refinancing
During March 2017, the Operating Partnership issued $50.0 million aggregate principal amount of 4.50% senior notes due 2023 at 103.88% of face value in a public offering for net proceeds of approximately $51.2 million after offering costs and excluding accrued interest of approximately $0.9 million. The notes were issued under our indenture dated October 9, 2013 and form part of the same series as our previously issued 4.50% senior notes due 2023. We primarily used the net proceeds to pay down our senior unsecured revolving credit facility and for general corporate purposes.
During March 2017, we repaid the remaining $25.0 million outstanding on our $100.0 million term loan maturing April 2017 at par using proceeds from our senior unsecured revolving credit facility.
During June 2017, we paid-off our $51.0 million senior unsecured note maturing June 2017 at par using proceeds from our senior unsecured revolving credit facility and proceeds from the issuance of common stock under our continuous equity offering program.
During the year ended December 31, 2017, we paid-off four mortgage notes totaling $34.5 million maturing in 2017 at par using proceeds from our senior unsecured revolving credit facility.
During December 2017, we amended our existing $200.0 million variable rate senior unsecured term loan, lowering our margin to between .90% to 1.75% per annum effective January 1, 2018, and based on our public debt credit rating, resulted in a fixed rate of 2.81% beginning on that date.
Line of Credit
As of December 31, 2017, we had $234.0 million outstanding and $164.1 million available under our $400.0 million senior unsecured revolving credit facility, net of two letters of credit totaling $1.9 million. As of December 31, 2016, we had $75.0 million outstanding and $323.1 million available under our senior unsecured revolving credit facility, net of two letter of credit totaling $1.9 million.
The senior unsecured revolving credit facility agreement contains various covenants with which we were in compliance as of December 31, 2017, and December 31, 2016.
Debt Maturities
The following table presents the scheduled maturities of our debt and regularly scheduled principal amortization, excluding unamortized premiums, discounts and deferred loan costs, as of December 31, 2017 (in thousands):
(1)
The term loan facilities are presented in “Senior unsecured notes” in our Consolidated Balance Sheets.
Contractual Obligations
The following table presents our contractual obligations as of December 31, 2017, specifically our obligations under long-term debt agreements, operating lease agreements and ground lease agreements (in thousands):
(1)
From time-to-time in the normal course of our business, we enter into various contracts with third parties that may obligate us to make payments, such as maintenance agreements at our properties. Such contracts, in the aggregate, do not represent material obligations, are typically short-term and cancellable within 90 days and are not included in the table above. Also, excluded from the total are our estimated construction costs to complete development and redevelopment projects of approximately $218.0 million.
(2)
Variable interest rate payments are estimated based on the LIBOR rate at December 31, 2017.
(3)
Three of our buildings comprising 0.7 million square feet reside on 38 acres of land which is leased from an airport authority.
Off-Balance Sheet Arrangements
As of December 31, 2017, and 2016, we had no off-balance sheet arrangements, other than those disclosed under contractual obligations, that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors, other than items discussed herein.
As of December 31, 2017, our proportionate share of the total construction loans of our unconsolidated development joint ventures was $51.9 million, which are scheduled to mature in October 2019, May 2024, and July 2024. Our proportionate share of the total construction loans, including undrawn amounts, of our unconsolidated development joint ventures includes 50.0% of the construction loans associated with the SCLA joint venture which are non-recourse to the venture partners.
Indebtedness and Other Off-Balance Sheet Arrangements
There are no lines of credit or side agreements related to, or between, our unconsolidated joint ventures and us, and there are no other derivative financial instruments between our unconsolidated joint ventures and us. In addition, we do not believe we have any material exposure to financial guarantees, except as discussed above.
We may elect to fund additional capital to a joint venture through equity contributions (generally on a basis proportionate to our ownership interests), advances or partner loans, although such funding is not required contractually or otherwise. As of December 31, 2017, our proportionate share of non-recourse debt associated with unconsolidated joint ventures is $51.9 million. The maturities of our proportionate share of the non-recourse debt are summarized in the table below (in thousands):
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the exposure to losses resulting from changes in market prices such as interest rates, foreign currency exchange rates and rental rates. Our future earnings and cash flows are dependent upon prevailing market rates. Accordingly, we manage our market risk by matching projected cash inflows from operating, investing and financing activities with projected cash outflows for debt service, acquisitions, capital expenditures, distributions to stockholders and OP unitholders and other cash requirements. The majority of our outstanding debt has fixed interest rates, which minimizes the risk of fluctuating interest rates.
Interest Rate Risk
Our exposure to market risk includes interest rate fluctuations in connection with our senior unsecured revolving credit facility and other variable rate borrowings and forecasted fixed rate debt issuances, including refinancing of existing fixed rate debt. Interest rate risk may result from many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors that are beyond our control. To manage interest rate risk for variable rate debt and issuances of fixed rate debt, in the past we have primarily used treasury locks and forward-starting swaps as part of our cash flow hedging strategy. These derivatives are designed to mitigate the risk of future interest rate increases by providing a fixed interest rate for a limited, pre-determined period of time. We do not use derivatives for trading or speculative purposes and only enter into contracts with major financial institutions based on their credit rating and other factors.
During June 2013, certain of our consolidated ventures entered into two pay-fixed, receive-floating interest rate swaps to hedge the variability of future cash flows attributable to changes in the 1 month USD LIBOR rates. The pay-fixed, receive-floating interest rate swaps have an effective date of June 2013 and a maturity date of June 2023. These interest rates swaps effectively fix the interest rate on the related debt instruments at 4.72%. As of December 31, 2017, and 2016, we had borrowings payable subject to these pay-fixed, receive-floating interest rate swaps with aggregate principal balances of approximately $6.4 million and $6.6 million, respectively.
During December 2015, we entered into a pay-fixed, receive-floating interest rate swap to hedge the variability of future cash flows attributable to changes in the 1 month USD LIBOR rates on our $200.0 million unsecured term loan. The pay-fixed, receive-floating interest rate swap has an effective date of December 2015 and a maturity date of December 2022. The interest rate swap effectively fixes the interest rate on the related debt instrument at 3.31%, however, there is no floor on the variable interest rate of the swap whereas the current variable rate debt is subject to a 0.0% floor. While LIBOR rates in certain foreign countries have been or are currently negative, USD LIBOR rates in the U.S. have never been negative nor do we expect them to become negative in the future. In the event that USD LIBOR is negative, the Company will make payments to the hedge counterparty equal to the negative spread between USD LIBOR and zero. During the year ended December 31, 2016, we recorded a non-cash charge of approximately $0.4 million of hedge ineffectiveness in earnings attributable to a 0.0% floor mismatch in the hedging relationships (i.e., there is no floor on the variable interest rate of the swap whereas the current variable rate debt from which the hedged forecasted transactions are expected to flow is subject to a 0.0% floor on the USD LIBOR component of the interest rate). No hedge ineffectiveness was recorded in 2015 or 2017. See “Notes to the Consolidated Financial Statements, Note 2 - Summary of Significant Accounting Policies” for the impact to the Consolidated Financial Statements from the adoption of the Derivatives and Hedging ASU in September 2017. As of December 31, 2017, and 2016, the entire $200.0 million principal amount of the term loan was subject to this pay-fixed, receive-floating interest rate swap. During December 2017, we amended the unsecured term loan, lowering our margin to between .90% to 1.75% per annum effective January 1, 2018, and based on our current public debt credit rating, will result in a fixed rate of 2.81% beginning on that date. See “Notes to the Consolidated Financial Statements, Note 6 - Outstanding Indebtedness” for additional information.
Our variable rate debt is subject to risk based upon prevailing market interest rates. As of December 31, 2017, we had approximately $359.0 million of variable rate debt outstanding indexed to LIBOR rates. If the LIBOR rates relevant to our variable rate debt were to increase 10%, we estimate that our interest expense during the year ended December 31, 2017, would have increased approximately $0.5 million based on our outstanding floating-rate debt as of December 31, 2017. Additionally, if weighted average interest rates on our fixed rate debt were to have increased by 100 basis points due to refinancing, interest expense would have increased by approximately $14.0 million during the year ended December 31, 2017.
As of December 31, 2017, the estimated fair value of our debt was approximately $1.8 billion based on our estimate of the then-current market interest rates.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See “Index to Financial Statements” on page 69 of this annual report on Form 10-K.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
DCT Industrial Trust Inc.
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our disclosure controls and procedures; as such term is defined under Rule 13a-15(e) under the Exchange Act, as of December 31, 2017, the end of the period covered by this annual report. Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective as of December 31, 2017 in providing reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
Management’s Report on Internal Control over Financial Reporting
We are responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). In addition, management is required to report their assessment, including their evaluation criteria, on the design and operating effectiveness of our internal control over financial reporting in this Form 10-K.
Our internal control over financial reporting is a process designed under the supervision of our principal executive officer and principal financial officer. During 2017, management conducted an assessment of the internal control over financial reporting based upon criteria established in the “Internal Control - Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on management’s assessment, which included a comprehensive review of the design and operating effectiveness of our internal control over financial reporting, management has concluded that our internal control over financial reporting is effective as of December 31, 2017.
The effectiveness of our internal control over financial reporting as of December 31, 2017 has been audited by Ernst & Young LLP, an independent registered public accounting firm. Their report appears below.
Changes in Internal Control over Financial Reporting
There has been no change in DCT Industrial Inc.’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d 15(f) under the Exchange Act) during the fourth quarter of 2017 that has materially affected, or is reasonably likely to materially affect, DCT Industrial Inc.’s internal control over financial reporting.
DCT Industrial Operating Partnership LP
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of management, including the principal executive officer and principal financial officer of its general partner, the Operating Partnership conducted an evaluation of the effectiveness of its disclosure controls and procedures; as such term is defined under Rule 13a-15(e) under the Exchange Act, as of December 31, 2017, the end of the period covered by this annual report. Based on this evaluation, the principal executive officer and principal financial officer concluded that the Operating Partnership’s disclosure controls and procedures were effective as of December 31, 2017, in providing reasonable assurance that information required to be disclosed by the Operating Partnership in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
Management’s Report on Internal Control over Financial Reporting
We are responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). In addition, management is required to report their assessment, including their evaluation criteria, on the design and operating effectiveness of our internal control over financial reporting in this Form 10-K.
Our internal control over financial reporting is a process designed under the supervision of our principal executive officer and principal financial officer. During 2017, management conducted an assessment of the internal control over financial reporting based upon criteria established in the “Internal Control - Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on management’s assessment, which included a comprehensive review of the design and operating effectiveness of our internal control over financial reporting, management has concluded that our internal control over financial reporting is effective as of December 31, 2017.
Changes in Internal Control over Financial Reporting
There has been no change in the Operating Partnership’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fourth quarter of 2017 that has materially affected, or is reasonably likely to materially affect, the Operating Partnership’s internal control over financial reporting.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of
DCT Industrial Trust Inc. and subsidiaries:
Opinion on Internal Control over Financial Reporting
We have audited DCT Industrial Trust Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, DCT Industrial Inc. and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of DCT Industrial Trust Inc. and subsidiaries (the “Company”) as of December 31, 2017 and 2016, and the related consolidated statements of operations, comprehensive income, changes in equity and cash flows for each of the three years in the period ended December 31, 2017, and the related notes and schedule (collectively referred to as the “financial statements”) and our report dated February 16, 2018 expressed an unqualified opinion thereon.
Basis for Opinion
The Company’s management is responsible 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 over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the 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 audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.
Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
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.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required for this Item is incorporated by reference from our definitive Proxy Statement to be filed in connection with our 2018 annual meeting of stockholders.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
The information required for this Item is incorporated by reference from our definitive Proxy Statement to be filed in connection with our 2018 annual meeting of stockholders.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS
The information required for this Item is incorporated by reference from our definitive Proxy Statement to be filed in connection with our 2018 annual meeting of stockholders.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required for this Item is incorporated by reference from our definitive Proxy Statement to be filed in connection with our 2018 annual meeting of stockholders.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required for this Item is incorporated by reference from our definitive Proxy Statement to be filed in connection with our 2018 annual meeting of stockholders.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
A. Financial Statements and Financial Statement Schedules.
1. Financial Statements.
The Consolidated Financial Statements listed in the accompanying Index to Financial Statements on page 69 are filed as a part of this report.
2. Financial Statement Schedules.
The financial statement schedule required by this Item is filed with this report and is listed in the accompanying Index to Financial Statements on page 69. All other financial statement schedules are not applicable.
B. Exhibits.
EXHIBIT INDEX
The following materials from DCT Industrial Trust Inc. and DCT Industrial Operating Partnership LP’s annual report on Form 10-K for the year ended December 31, 2017 formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Comprehensive Income, (iii) the Consolidated Statements of Changes in Equity/Consolidated Statements of Changes in Capital, (iv) the Consolidated Statements of Cash Flows, (v) related notes to these financial statements and (vi) financial statement schedule III.
+
Filed herewith
++
Furnished herewith
ITEM 16.
FORM 10-K SUMMARY
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
DCT INDUSTRIAL TRUST INC.
By:
/s/ Philip L. Hawkins
Philip L. Hawkins,
President and Chief Executive Officer
Date: February 16, 2018
Pursuant to the requirements of the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
DCT INDUSTRIAL OPERATING PARTNERSHIP LP
By:
/s/ Philip L. Hawkins
Philip L. Hawkins,
President and Chief Executive Officer
Date: February 16, 2018
Pursuant to the requirements of the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
DCT INDUSTRIAL OPERATING PARTNERSHIP LP
/S/ PHILIP L. HAWKINS
President, Chief Executive Officer and Director (Principal Executive Officer) of DCT Industrial Trust Inc., the sole general partner of DCT Industrial Operating Partnership LP
February 16, 2018
Philip L. Hawkins
/S/ MATTHEW T. MURPHY
Chief Financial Officer and Treasurer (Principal Financial Officer) of DCT Industrial Trust Inc., the sole general partner of DCT Industrial Operating Partnership LP
February 16, 2018
Matthew T. Murphy
/S/ MARK E. SKOMAL
Chief Accounting Officer (Principal Accounting Officer) of DCT Industrial Trust Inc., the sole general partner of DCT Industrial Operating Partnership LP
February 16, 2018
Mark E. Skomal
/S/ MARILYN A. ALEXANDER
Director, of DCT Industrial Trust Inc. the sole general partner of DCT Industrial Operating Partnership LP
February 16, 2018
Marilyn A. Alexander
/S/ THOMAS F. AUGUST
Director, of DCT Industrial Trust Inc. the sole general partner of DCT Industrial Operating Partnership LP
February 16, 2018
Thomas F. August
/S/ JOHN S. GATES, JR.
Director, of DCT Industrial Trust Inc. the sole general partner of DCT Industrial Operating Partnership LP
February 16, 2018
John S. Gates, Jr.
/S/ RAYMOND B. GREER
Director, of DCT Industrial Trust Inc. the sole general partner of DCT Industrial Operating Partnership LP
February 16, 2018
Raymond B. Greer
/S/ TRIPP H. HARDIN
Director, of DCT Industrial Trust Inc. the sole general partner of DCT Industrial Operating Partnership LP
February 16, 2018
Tripp H. Hardin
/S/ TOBIAS HARTMANN
Director, of DCT Industrial Trust Inc. the sole general partner of DCT Industrial Operating Partnership LP
February 16, 2018
Tobias Hartmann
/S/ JOHN C. O’KEEFFE
Director, of DCT Industrial Trust Inc. the sole general partner of DCT Industrial Operating Partnership LP
February 16, 2018
John C. O’Keeffe
/S/ MARCUS L. SMITH
Director, of DCT Industrial Trust Inc. the sole general partner of DCT Industrial Operating Partnership LP
February 16, 2018
Marcus L. Smith
DCT INDUSTRIAL TRUST INC. AND SUBSIDIARIES
DCT INDUSTRIAL OPERATING PARTNERSHIP LP AND SUBSIDIARIES
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of
DCT Industrial Trust Inc. and subsidiaries:
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of DCT Industrial Trust Inc. and subsidiaries (the “Company”) as of December 31, 2017 and 2016, and the related consolidated statements of operations, comprehensive income, changes in equity and cash flows for each of the three years in the period ended December 31, 2017, and the related notes and schedule (collectively referred to as the “financial statements”). In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at December 31, 2017 and 2016, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2017, in conformity with U.S. generally accepted accounting principles.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 16, 2018 expressed an unqualified opinion thereon.
Basis for Opinion
The financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the 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 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 financial statements. We believe that our audits provide a reasonable basis for our opinion.
Report of Independent Registered Public Accounting Firm
The Partners of
DCT Industrial Operating Partnership LP and subsidiaries:
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of DCT Industrial Operating Partnership LP and subsidiaries (the “Partnership”) as of December 31, 2017 and 2016, and the related consolidated statements of operations, comprehensive income, changes in capital and cash flows for each of the three years in the period ended December 31, 2017, and the related notes and schedule (collectively referred to as the “financial statements”). In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Partnership at December 31, 2017 and 2016, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2017, in conformity with U.S. generally accepted accounting principles.
Basis for Opinion
The financial statements are the responsibility of the Partnership’s management. Our responsibility is to express an opinion on the Partnership’s financial statements based on our audits. We are a public accounting firm registered with the 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the 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 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 financial statements. We believe that our audits provide a reasonable basis for our opinion.
DCT INDUSTRIAL TRUST INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except share information)
The accompanying notes are an integral part of these Consolidated Financial Statements.
DCT INDUSTRIAL TRUST INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(in thousands, except per share data)
The accompanying notes are an integral part of these Consolidated Financial Statements.
DCT INDUSTRIAL TRUST INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(in thousands)
The accompanying notes are an integral part of these Consolidated Financial Statements.
DCT INDUSTRIAL TRUST INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Equity
(in thousands)
The accompanying notes are an integral part of these Consolidated Financial Statements.
DCT INDUSTRIAL TRUST INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
The accompanying notes are an integral part of these Consolidated Financial Statements.
DCT INDUSTRIAL OPERATING PARTNERSHIP LP AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except unit information)
The accompanying notes are an integral part of these Consolidated Financial Statements.
DCT INDUSTRIAL OPERATING PARTNERSHIP LP AND SUBSIDIARIES
Consolidated Statements of Operations
(in thousands, except per unit information)
The accompanying notes are an integral part of these Consolidated Financial Statements.
DCT INDUSTRIAL OPERATING PARTNERSHIP LP AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(in thousands)
The accompanying notes are an integral part of these Consolidated Financial Statements.
DCT INDUSTRIAL OPERATING PARTNERSHIP LP AND SUBSIDIARIES
Consolidated Statement of Changes in Capital
(in thousands)
The accompanying notes are an integral part of these Consolidated Financial Statements.
DCT INDUSTRIAL OPERATING PARTNERSHIP LP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
The accompanying notes are an integral part of these Consolidated Financial Statements.
DCT INDUSTRIAL TRUST INC. AND SUBSIDIARIES
DCT INDUSTRIAL OPERATING PARTERNSHIP LP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Note 1 - Organization
DCT Industrial Trust Inc. is a leading industrial real estate company specializing in the ownership, acquisition, development, leasing and management of bulk-distribution and light-industrial properties located in high-demand distribution markets in the United States. DCT's actively managed portfolio is strategically located near population centers and well-positioned to take advantage of market dynamics. As used herein, the terms “Company,” “we,” “our” and “us” refer to DCT Industrial Trust Inc. and its subsidiaries, including its operating partnership, DCT Industrial Operating Partnership LP. When we use the term “DCT” or “DCT Industrial,” we are referring to DCT Industrial Trust Inc. by itself, and not including any of its subsidiaries, and when we use the term “Operating Partnership,” we are referring to DCT Industrial Operating Partnership LP by itself, and not including any of its subsidiaries.
DCT was formed as a Maryland corporation in April 2002 and has elected to be treated as a real estate investment trust, or REIT, for U.S. federal income tax purposes. We are structured as an umbrella partnership REIT under which substantially all of our current and future business is, and will be, conducted through a majority owned and controlled subsidiary, DCT Industrial Operating Partnership LP, a Delaware limited partnership, for which DCT is the sole general partner. DCT owns properties through the Operating Partnership and its subsidiaries. As of December 31, 2017, DCT owned approximately 96.6% of the outstanding equity interests in the Operating Partnership.
As of December 31, 2017, the Company owned interests in approximately 74.8 million square feet of properties leased to approximately 850 customers, including:
•
65.1 million square feet comprising 398 consolidated operating properties, including five properties totaling 1.9 million square feet classified as held for sale, that were 97.8% occupied;
•
1.0 million square feet comprising six consolidated properties developed by DCT which are shell-construction complete and in lease-up;
•
0.1 million square feet comprising one consolidated property under redevelopment;
•
1.0 million square feet comprising three consolidated value-add acquisitions; and
•
7.6 million square feet comprising 21 unconsolidated properties that were 98.4% occupied and which we operated on behalf of two unconsolidated joint ventures.
In addition, the Company has 19 projects under construction and several projects in pre-development. See “Note 3 - Investment in Properties” for further details related to our development activity.
Note 2 - Summary of Significant Accounting Policies
Basis of Presentation and Principles of Consolidation
The accompanying Consolidated Financial Statements include the financial position, results of operations and cash flows of the Company, the Operating Partnership, their wholly-owned qualified REIT subsidiaries and taxable REIT subsidiaries, and their consolidated joint ventures, in which they have a controlling interest.
Equity interests in the Operating Partnership held by entities other than DCT are classified within partners’ capital in the Operating Partnership’s financial statements and as noncontrolling interests in DCT’s financial statements. Equity interests in entities consolidated into the Operating Partnership that are held by third parties are reflected in our accompanying balance sheets as noncontrolling interests. We also have noncontrolling partnership interests in unconsolidated institutional capital management and other joint ventures, which are accounted for under the equity method. All significant intercompany transactions and balances have been eliminated in consolidation.
All square feet, acres, occupancy, number of properties, number of customers and total projected investment disclosed in the notes to the Consolidated Financial Statements are unaudited.
We hold interests in both consolidated and unconsolidated joint ventures for the purposes of operating and developing industrial
real estate. All joint ventures over which we have financial and operating control, and variable interest entities (“VIEs”) in which we have determined that we are the primary beneficiary, are included in the Consolidated Financial Statements. We use the equity method of accounting for joint ventures where we exercise significant influence, but do not have control over major operating and management decisions and we include our share of earnings or losses of these joint ventures in our consolidated results of operations.
We analyze our joint ventures in accordance with U.S. generally accepted accounting principles (“GAAP”) to determine whether they are VIEs and, if so, whether we are the primary beneficiary. Our judgment with respect to our level of influence or control over an entity and whether we are the primary beneficiary of a VIE involves consideration of various factors including the form of our ownership interest, our representation on the entity’s board of directors (or equivalent body), the size of our investment (including loans), our obligation or right to absorb its losses or receive its benefits and our ability to participate in major decisions.
If a joint venture does not meet the characteristics of a VIE, we apply the voting interest model to determine whether the entity should be consolidated. Our ability to assess our influence or control over an entity affects the presentation of these investments in the Consolidated Financial Statements and our financial position and results of operations.
As described below in “New Accounting Standards,” in 2016 we concluded our Operating Partnership meets the criteria of a VIE as the Operating Partnership’s limited partners do not have the right to remove the general partner and do not have substantive participating rights in the operations of the Operating Partnership. Under the Amended and Restated Limited Partnership Agreement of the Operating Partnership (the “Partnership Agreement”), DCT is the primary beneficiary of the Operating Partnership as we have the obligation to absorb losses and receive benefits, and the power to control substantially all the activities which most significantly impact the economic performance of the Operating Partnership. Accordingly, the Operating Partnership is consolidated within DCT’s financial statements.
Use of Estimates
The preparation of the Consolidated Financial Statements in accordance with GAAP requires management 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 Consolidated Financial Statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Capitalization of Costs
We capitalize costs directly related to the development, pre-development, redevelopment or improvement of our investment in real estate, referred to as capital projects and other activities included within this paragraph. Costs associated with our capital projects are capitalized as incurred. If the project is abandoned, these costs are expensed during the period in which the project is abandoned. Costs considered for capitalization include, but are not limited to, construction costs, interest, real estate taxes and insurance, if appropriate. We capitalize indirect costs such as personnel, office and administrative expenses that are directly related to our development projects based on an estimate of the time spent on the construction and development activities. These costs are capitalized only during the period in which activities necessary to ready an asset for its intended use are in progress and such costs are incremental and identifiable to a specific activity to get the asset ready for its intended use. We determine when the capitalization period begins and ends through communication with project and other managers responsible for the tracking and oversight of individual projects. In the event that the activities to ready the asset for its intended use are suspended, the capitalization period will cease until such activities are resumed. In addition, we capitalize initial direct costs incurred for successful origination of new leases. Costs incurred for maintaining and repairing our properties, which do not extend their useful lives, are expensed as incurred.
Interest is capitalized based on actual capital expenditures from the period when development or redevelopment commences until the asset is ready for its intended use, at the weighted average borrowing rate during the period. We also capitalize interest on our qualifying investments in unconsolidated joint ventures based on the average capital invested in a venture during the period when the venture has activities in progress necessary to commence its planned principal operations, at our weighted average borrowing rate during the period. A “qualifying investment” is an investment in an unconsolidated joint venture provided that our investee’s activities include the use of funds to acquire qualifying assets, such as development or pre-development activities, and planned principal operations have not commenced.
Assets Held for Sale
We classify certain properties and related assets and liabilities as held for sale when certain criteria are met. At such time, the respective assets and liabilities are presented separately on our Consolidated Balance Sheets. We include liabilities related to assets held for sale that will be transferred or settled in the transaction in “Liabilities related to assets held for sale.” Assets held for sale are reported at the lower of carrying value or estimated fair value less estimated costs to sell.
Gains on sales of real estate assets are recognized if the specific transaction terms meet the various sale recognition criteria as defined by GAAP. If the criteria are not met, we defer the gain until such time that the criteria for sale recognition have been met. Net gains on sales and any impairment losses associated with assets held for sale are presented in continuing operations when recognized.
Fair Value
GAAP establishes a framework for measuring fair value and requires disclosures about fair value measurements. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants. The guidance establishes a hierarchy for inputs used in measuring fair value based on observable and unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are based on market data obtained from sources independent of DCT. Unobservable inputs are inputs that reflect our assumptions of pricing the asset or liability based on the best information available in the circumstances. The hierarchy is broken down into three levels as follows:
Level 1: Inputs that reflect unadjusted quoted prices for identical assets or liabilities in active markets;
Level 2: Inputs include quoted prices for similar assets and liabilities in active or inactive markets or that are observable either directly or indirectly for the asset or liability; and
Level 3: Unobservable inputs are typically based on management’s own assumptions, as there is little, if any, related observable market activity.
DCT’s assets and liabilities that are measured at fair value are classified in their entirety based on the lowest level of input that is significant to their fair value measurement. 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.
Investment in Properties
We record the assets, liabilities and noncontrolling interests associated with property acquisitions which qualify as business combinations at their respective acquisition date fair values which are derived using a market, income or replacement cost approach, or combination thereof. Acquisition related costs associated with business combinations are expensed as incurred. As defined by GAAP, a business is an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs or other economic benefits directly to investors or other owners, members or participants.
The fair value of identifiable tangible assets such as land, building, building and land improvements, and tenant improvements is determined on an “as-if-vacant” basis. Management considers Level 3 fair value inputs such as the replacement cost of such assets, appraisals, property condition reports, market data and other related information in determining the fair value of the tangible assets. The difference between the fair value and the face value of debt assumed in connection with an acquisition is recorded as a premium or discount and amortized to “Interest expense” over the life of the debt assumed. The valuation of assumed liabilities is based on the current market rate for similar liabilities. The recorded fair value of intangible lease assets includes Level 3 fair value inputs and represents the value associated with in-place leases which include leasing commissions, legal and other costs, as well as an intangible asset or liability resulting from in-place leases being above or below the market rental rates over the lease term on the date of the acquisition. Intangible lease assets or liabilities are amortized over the reasonably assured lease term of the remaining in-place leases as an adjustment to “Rental revenues” or “Real estate related depreciation and amortization” depending on the nature of the intangible.
Due to the adoption of the Accounting Standard Updates (“ASU”) in 2017, we expect most acquisitions to be acquisition of assets rather than a business combination as as our typical acquisitions consist of properties whereby substantially all the fair value of gross assets acquired is concentrated in a single asset (land, building and in-place leases), which under the new standard, will be treated as an asset acquisition. Asset acquisitions are recorded at the cumulative acquisition costs and allocated to the assets acquired and liabilities assumed on a relative fair value basis.
We have certain properties which we have acquired or removed from service with the intention to redevelop the property. Buildings under redevelopment require significant construction activities prior to being placed back into service. We generally do not depreciate properties classified as redevelopment until the date that the redevelopment properties are ready for their intended use.
Real estate, including land, building, building and land improvements, tenant improvements, leasing costs and intangible lease assets and liabilities are stated at historical cost less accumulated depreciation and amortization, unless circumstances indicate that the cost cannot be recovered, in which case, the carrying value of the property is reduced to its estimated fair value.
Depreciation and Useful Lives of Real Estate Assets
Depreciation and amortization are computed on a straight-line basis over the estimated useful lives of the related assets or liabilities. Our ability to assess the useful lives of our real estate assets accurately is critical to the determination of the appropriate amount of depreciation and amortization expense recorded and the carrying values of the underlying assets. Any change to the estimated depreciable lives of these assets would have an impact on the depreciation and amortization expense we recognize.
The following table presents the standard depreciable lives generally used to compute depreciation and amortization. However, such depreciable lives may be different based on the estimated useful life of such assets or liabilities. The carrying value of assets sold or retired and the related accumulated depreciation and/or amortization is derecognized and the resulting gain or loss, if any, is recorded during the period in which such sale or retirement occurs.
Depreciation is not recorded on real estate assets currently held for sale, in pre-development, or being developed or redeveloped until the building is substantially completed and ready for its intended use, and not later than one year from cessation of major construction activity.
Impairment of Properties
Investments in properties classified as held for use are carried at cost and evaluated for impairment at least annually and whenever events or changes in circumstances indicate that the carrying amounts of these assets may not be recoverable. Examples of such changes in circumstances include the point at which we deem a building to be held for sale, our intended hold period changes, or when a building remains vacant significantly longer than expected. For investments in properties that we intend to hold long-term, the recoverability is based on estimated future undiscounted cash flows. If the asset carrying value is not supported on an undiscounted cash flow basis, the amount of impairment is measured as the difference between the carrying value and the fair value of the asset and is reflected in “Impairment losses” on the Consolidated Statements of Operations. The determination of fair value of real estate assets to be held for use is derived using the discounted cash flow method and involves a number of management assumptions relating to future economic events that could materially affect the determination of the ultimate value, and therefore, the carrying amounts of our real estate. Such assumptions are Level 3 fair value inputs and include, but are not limited to, projected vacancy rates, rental rates, property operating expenses and capital expenditures. The capitalization rate is also a significant driving factor in determining the property valuation and requires management’s judgment of factors such as market knowledge, historical experience, lease terms, customer financial strength, economy, demographics, environment, property location, visibility, age, physical condition and expected return requirements, among other things. The aforementioned factors are taken as a whole by management in determining the valuation of investment property. The valuation is sensitive to the actual results of any of these uncertain factors, either individually or taken as a whole. Should the actual results differ from management’s estimates, the valuation could be negatively affected and may result in additional impairment losses recorded in the Consolidated Financial Statements.
For the years ended December 31, 2017 and 2015, we recognized impairment losses of approximately $0.3 million on the disposition of one property in our Central operating segment and $2.3 million on the disposition of two properties in our East operating segments, respectively. The estimated fair values of the impaired properties were based upon the contractual sales price, a Level 2 fair value measurement. No impairment losses were recognized during the year ended December 31, 2016.
Investments in and Advances to Unconsolidated Joint Ventures
We account for our investments in and advances to unconsolidated joint ventures under the equity method because we exercise significant influence over, but do not control, these entities. Under the equity method, these investments (including advances to joint ventures) are initially recorded at cost and are subsequently adjusted to reflect our proportionate share of net earnings or losses of each of the joint ventures, distributions received, contributions made and certain other adjustments, as appropriate. Such investments are included in “Investments in and advances to unconsolidated joint ventures” in our Consolidated Balance Sheets. Distributions from these investments that are related to cash earnings from operations are included as operating activities and distributions that are related to capital transactions are included as investing activities in our Consolidated Statements of Cash Flows.
We recognize any gains from the contribution of investment properties into an unconsolidated joint venture if the recognition criteria have been met and the cash received is not required to be reinvested. Such gains are recognized to the extent of the outside ownership interest in the joint venture in our Consolidated Statements of Operations under the heading of “Gain on dispositions of real estate interests.” Any gain related to the remaining proceeds reduces our basis in the investment in the unconsolidated joint venture, and is recognized into earnings over the weighted average life of the related property’s real estate assets. We recognize our proportionate share of the ongoing earnings or losses of each unconsolidated joint venture in “Equity in earnings of unconsolidated joint ventures, net” in our Consolidated Statements of Operations.
Impairment of Investments in and Advances to Unconsolidated Joint Ventures
We evaluate our investments in unconsolidated entities for impairment whenever events or changes in circumstances indicate that there may be an other-than-temporary decline in value. To do so, we calculate the estimated fair value of the investment using a market, income or replacement cost approach, or combination thereof. The amount of impairment recognized, if any, would be the excess of the investment’s carrying amount over its estimated fair value. We consider various factors to determine if a decline in the value of the investment is other-than-temporary. These factors are qualitative and quantitative Level 2 and 3 fair value inputs and include but are not limited to, age of the venture, our intent and ability to retain our investment in the entity, the financial condition and long-term prospects of the entity, expected term of the investment and the relationships with the other joint venture partners and its lenders. If we believe that the decline in the fair value is temporary, no impairment is recorded. The aforementioned factors are taken as a whole by management in determining the valuation of our investment. Should the actual results differ from management’s estimates, the valuation could be negatively affected and may result in a negative impact on the Consolidated Financial Statements. See “Note 4 - Investments in and Advances to Unconsolidated Joint Ventures” for additional information.
Cash and Cash Equivalents
Cash and cash equivalents include cash held in financial institutions and other highly liquid short-term investments with original maturities of three months or less. We have not realized any losses in our cash and cash equivalents and believe that these short-term instruments are not exposed to any significant credit risk.
Restricted Cash
Restricted cash consists of escrow deposits held by lenders for real estate taxes, insurance and capital replacement reserves, security deposits and amounts held by intermediary agents to be used for tax-deferred, like-kind exchange transactions. For the years ended December 31, 2017, and December 31, 2016, approximately $9.8 million and $4.8 million, respectively, of restricted cash was included in “Cash, Cash Equivalents and Restricted Cash” in our Consolidated Statements of Cash Flows related to tax deferred, like-kind exchange transactions. The funds that had been obtained in tax deferred, like-kind exchange transactions during the year ended December 31, 2016, were utilized during the year ended December 31, 2017.
The following table presents a reconciliation of cash, cash equivalents and restricted cash reported within our Consolidated Balance Sheets to amounts reported within our Consolidated Statements of Cash Flows (in thousands):
(1)
Includes cash balances presented in assets held for sale in our Consolidated Balance Sheets.
Straight-line Rent and Other Receivables
Straight-line rent and other receivables include all straight-line rent and current accounts receivable, net of allowances. We maintain an allowance for estimated losses that may result from the inability of our customers to make required payments. If a customer fails to make contractual payments beyond any allowance, we may recognize additional bad debt expense in future periods equal to the net outstanding balances. As of December 31, 2017, and 2016, our allowance for doubtful accounts was approximately $0.4 million and $0.4 million, respectively.
Debt
Debt consists of fixed and variable rate secured mortgage notes, senior unsecured notes and bank unsecured credit facilities. Discounts and premiums to the principal amounts are included in the carrying value of debt and amortized to “Interest expense” over the remaining life of the underlying debt. As of December 31, 2017, and 2016, the aggregated premium balance, net of accumulated amortization, was approximately $1.3 million and $0.1 million, respectively. For the years ended December 31, 2017, 2016, and 2015, the amortization of all premiums/discounts resulted in a reduction of interest expense of approximately $0.8 million, $1.5 million and $2.8 million, respectively.
Debt issuance costs related to a recognized liability are presented in the balance sheet as a direct deduction from the carrying amount of the debt liability. Debt issuance costs related to line-of-credit arrangements are presented as an asset regardless of whether there are any outstanding borrowings on the line-of-credit arrangement.
Deferred loan costs include fees and costs incurred to obtain long-term financing. These fees and costs are amortized to “Interest expense” over the terms of the related loans. Accumulated amortization of deferred loan costs was approximately $7.5 million and $5.8 million as of December 31, 2017, and 2016, respectively. Our interest expense for the years ended December 31, 2017, 2016, and 2015, includes approximately $2.4 million, $2.5 million and $2.3 million for the amortization of loan costs, respectively.
Derivative Instruments and Hedging Activities
We may use interest rate swaps to manage certain interest rate risk. We record derivatives at fair value which are presented on a gross basis in “Other assets, net” or “Other liabilities” in our Consolidated Balance Sheets. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. We incorporate credit valuation adjustments to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of our derivative contracts for the effect of nonperformance risk, we have considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts and guarantees.
We have determined that the majority of the inputs used to value our derivatives fall within Level 2 of the fair value hierarchy. Although, the credit valuation adjustments associated with our derivatives utilize Level 3 fair value inputs for estimates of current credit spreads to evaluate the likelihood of default by us and our counterparties, the overall impact of this input to the overall fair value measurement is not significant, and thus our interest rate swaps are classified as Level 2 in the fair value hierarchy.
For derivatives designated as “cash flow” hedges, the change in the fair value of the derivative is initially reported in “Accumulated other comprehensive loss” in our Consolidated Balance Sheets (i.e., not included in earnings) and subsequently reclassified into earnings when the hedged transaction affects earnings or the hedging relationship is no longer highly effective. We assess the effectiveness of each hedging relationship whenever financial statements are issued. We do not use derivatives for trading or speculative purposes.
Comprehensive Income
We report comprehensive income in our Consolidated Statements of Comprehensive Income. Amounts reported in “Accumulated other comprehensive loss” related to settled hedging transactions will be amortized to “Interest expense” as the hedged forecasted transactions occur. See “Note 5 - Financial Instruments and Hedging Activities” for additional information. See “New Accounting Standards” below for additional information related to our adoption of the Derivatives and Hedging ASU.
Revenue Recognition
At the inception of a new lease arrangement, including new leases that arise from amendments, we assess the terms and conditions to determine the proper lease classification. A lease arrangement is classified as an operating lease if none of the following criteria are met: (i) transfer of ownership to the lessee, (ii) lessee has a bargain purchase option during or at the end of the lease term, (iii) the lease term is equal to 75% or more of the underlying property’s economic life, or (iv) the present value of future minimum lease payments (excluding executory costs) are equal to 90% or more of the excess estimated fair value (over retained investment tax credits) of the leased building. Generally our leases do not meet any of the other criteria above and accordingly are classified as operating leases. The Company’s weighted average lease term based on square feet is 6.3 years.
We record rental revenues on a straight-line basis under which contractual rent increases are recognized evenly over the lease term. Certain properties have leases that provide for tenant occupancy during periods where no rent is due or where minimum rent payments change during the term of the lease. Accordingly, receivables from tenants that we expect to collect over the remaining lease term are recorded on the balance sheet as straight-line rent receivables. The total increase to “Rental revenues” due to straight-line rent adjustments was approximately $5.1 million, $20.7 million and $7.1 million, respectively, for the years ended December 31, 2017, 2016, and 2015.
If the lease provides for tenant improvements, we determine whether the tenant improvements are owned by us or the tenant. When we are the owner of the tenant improvements, the tenant is not considered to have taken physical possession or have control of the leased asset until the tenant improvements are substantially complete. 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 into rental revenues over the lease term. When the tenant is the owner of the tenant improvements, we record any tenant improvement allowance funded as a lease incentive and amortize it as a reduction of rental revenue over the lease term.
Tenant recovery income includes reimbursements due from tenants pursuant to their leases for real estate taxes, insurance, repairs and maintenance and other recoverable property operating expenses and is recognized as “Rental revenues” during the period the related expenses are incurred. The reimbursements are recognized and presented on a gross basis, as the Company is generally the primary obligor and, with respect to purchasing goods and services from third party suppliers, has discretion in selecting the supplier and bears the associated credit risk. Tenant recovery income recognized as “Rental revenues” was approximately $102.7 million, $92.0 million and $82.3 million, respectively, for the years ended December 31, 2017, 2016, and 2015.
In connection with property acquisitions qualifying as business combinations, we may acquire leases with rental rates above or below the market rental rates. Such differences are recorded as an intangible lease asset or liability and amortized to “Rental revenues” over the reasonably assured term of the related leases. We consider a reasonably assured term to be the measurement period equal to the remaining non-cancelable term of the lease for above-market leases and the initial term plus the term of any below-market fixed rate renewal options for below-market leases. The unamortized balances of these assets and liabilities associated with the early termination of leases are fully amortized to their respective revenue line items in our Consolidated Statements of Operations on a straight-line basis over the estimated remaining contractual lease term. The total net impact to “Rental revenues” due to the amortization of above and below market rents was an increase of approximately $2.9 million, $2.9 million and $3.0 million for the years ended December 31, 2017, 2016, and 2015, respectively.
Future minimum base rental payment, i.e., cash received for monthly contractual rent, due to us from our customers under the terms of non-cancelable operating leases that have commenced as of December 31, 2017 were as follows (in thousands):
The schedule above does not reflect future rental revenues from the potential renewal or replacement of existing and future leases and excludes tenant recovery income. Additionally, leases where the tenant can terminate the lease with short-term notice are not included.
Early lease termination fees are recorded in “Rental revenues” on a straight-line basis over the estimated remaining contractual lease term or upon collection if collectability is not assured. During the years ended December 31, 2017, 2016, and 2015, early lease termination fees were approximately $1.5 million, $0.9 million and $2.5 million, respectively.
We earn revenues from asset management fees, acquisition fees, property management fees and fees for other services pursuant to joint venture and other third-party agreements. These are included in our Consolidated Statements of Operations in “Institutional capital management and other fees.” We recognize revenues from asset management fees, acquisition fees, property management fees and fees for other services when the related fees are earned and are realized or realizable.
We develop certain properties for specific buyers, called build-to-suit projects. We make certain judgments based on the specific terms of each project as to the amount and timing of recognition of profits from the project. Projects are generally accounted for using the percentage of completion method or full accrual method. Profits under the percentage of completion method are 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. Changes in job performance, job conditions and estimated profitability may result in revisions to the costs and income and are recognized in the period in which the revisions are determined. If the sale recognition criteria for using the percentage of completion or full accrual methods are not met, we apply another recognition method provided by GAAP, such as the installment or cost recovery methods. The profit recognized from these projects is reported net of estimated taxes, when applicable, and is included in “Development profit, net of taxes” in our Consolidated Statements of Operations.
Stock-Based Compensation
On October 10, 2006, we established the Long-Term Incentive Plan, as amended, to grant restricted stock, LTIP Units, stock options and other awards to our personnel and directors. Awards granted under this plan are measured at fair value on the grant date and amortized to compensation expense on a straight-line basis over the service period during which the awards fully vest. Such expense is included in “General and administrative” expense in our Consolidated Statements of Operations. Options issued under the Long-Term Incentive Plan are valued using the Black-Scholes option pricing model, which relies on assumptions we make related to the expected term of the options, volatility, dividend yield and risk-free interest rate.
Income and Other Taxes
We have elected to be taxed as a REIT, as defined under the Internal Revenue Code of 1986, as amended (the “Code”). As a REIT, we generally will not be subject to U.S. federal income taxes on our net income that is distributed to our stockholders if we distribute at least 90% of our REIT taxable income to our stockholders. REITs are also subject to a number of other organizational and operational requirements. If we fail to qualify as a REIT in any taxable year, our taxable income will be subject to U.S. federal income tax at regular corporate rates. Even if we qualify as a REIT, we may be subject to certain U.S. federal, state and local and non-U.S. income taxes. We also will be required to pay a 100% tax on non-arm’s length transactions between us and our taxable REIT subsidiary, any redetermined TRS service income and on any net income from gain on property that was held for sale to customers in the ordinary course of business.
Certain of our operations (property management, asset ownership or management, sales of certain assets, etc.) may be conducted through taxable REIT subsidiaries, which are subsidiaries of the operating partnership and each of which we refer to as a TRS. A TRS is a C-corporation for which a REIT and its subsidiary C-corporation have jointly elected for the C-corporation to be a taxable REIT subsidiary of the REIT and therefore is subject to U.S. federal corporate income tax.
For our taxable REIT subsidiaries, deferred income taxes result from temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for U.S. federal income tax purposes, as well as interest and loss carryforwards, and are measured using current enacted tax rates and laws that are expected to be in effect when the differences reverse. We reduce deferred tax assets by recording a valuation allowance when we determine based on available evidence that it is more likely than not that the assets will not be realized.
We recognize tax benefits of uncertain tax positions only if it is more likely than not that the tax position will be sustained, based solely on its technical merits, with the taxing authority having full knowledge of all relevant information. The measurement of a tax benefit for an uncertain tax position that meets the “more likely than not” threshold is based on a cumulative probability model under which the largest amount of tax benefit recognized is the amount with a greater than 50% likelihood of being realized upon ultimate settlement with the taxing authority having full knowledge of all the relevant information. As of December 31, 2017 and 2016, there were no unrecognized tax benefits. We do not anticipate a significant change to the total amount of unrecognized tax benefits within the next 12 months. Our federal income tax returns and income tax returns for various state and local jurisdictions are subject to examination by the Internal Revenue Service for the year ended December 31, 2013 and subsequent years.
New Accounting Standards
New Accounting Standards Adopted
In February 2015, the Financial Accounting Standards Boards (“FASB”) issued an ASU that modifies the evaluation of whether limited partnerships and similar legal entities are VIEs, eliminates the presumption that a general partner should consolidate a limited partnership and affects the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships. The guidance is effective for fiscal years beginning after December 15, 2015. We adopted this standard effective January 1, 2016. We concluded the Operating Partnership meets the criteria of a VIE and DCT is the primary beneficiary. Accordingly, the Operating Partnership is consolidated within DCT’s financial statements. As the Operating Partnership was previously consolidated, the adoption of the ASU did not result in any changes to our conclusions regarding consolidation or deconsolidation of entities. In October 2016, the FASB issued an update to this ASU that modifies the evaluation method for an entity determining whether it is the primary beneficiary of a VIE. The guidance is effective for fiscal years beginning after December 15, 2016, and we adopted this guidance retrospectively in 2016. The adoption of the ASU did not result in any changes to our conclusions regarding consolidation or deconsolidation of entities and did not have an impact in our Consolidated Financial Statements.
In March 2016, the FASB issued an ASU that simplifies the accounting for share-based payment transactions, including income tax consequences, the classification of awards as either equity or liabilities, and the classification on the statement of cash flows. The guidance is effective for fiscal years beginning after December 15, 2016, and effective January 1, 2017, we elected to account for forfeitures as they occur, rather than estimate expected forfeitures. The adoption of the guidance was applied prospectively and did not have a significant impact on our Consolidated Financial Statements.
In August 2016, the FASB issued an ASU that clarifies how companies should classify certain cash receipts and payments on the statement of cash flows, including equity method investee distributions, insurance proceed settlements and contingent consideration payments made following a business combination. The new standard also clarifies the predominance principle applied when cash receipts and payments have aspects of more than one class of cash flows. The guidance is effective for fiscal years beginning after December 15, 2017. Early adoption is permitted, and we adopted this guidance retrospectively in 2016. The adoption of the guidance did not have an impact on our Consolidated Financial Statements.
In November 2016, the FASB issued an ASU that requires companies to combine restricted cash and restricted cash equivalents with cash and cash equivalents when reconciling the beginning and end of period total amounts on the statement of cash flows. The guidance is effective for fiscal years beginning after December 15, 2017. Early adoption is permitted, and we adopted this guidance retrospectively in 2016. As a result, we have included restricted cash and restricted cash equivalents with cash and cash equivalents when reconciling the beginning and end of period total amounts on our Consolidated Statements of Cash Flows. The effects of this standard were applied retrospectively to all prior annual periods presented within these Consolidated Financial Statements. For the year ended December 31, 2015, the effect of the change in accounting principle was the reduction in cash provided by operating activities of $1.3 million and the increase in cash used in investing activities of $28.7 million on our Consolidated Statements of Cash Flows.
In January 2017, the FASB issued an ASU that clarifies the definition of a business. The ASU is effective for reporting periods beginning after December 15, 2017, with early adoption permitted. We adopted this standard prospectively effective January 1, 2017. As a result, we anticipate that fewer of our acquisitions made in the normal course of business will meet the definition of a business, as our typical acquisitions consist of properties whereby substantially all the fair value of gross assets acquired is concentrated in a single asset (land, building and in-place leases).
In August 2017, the FASB issued an ASU that modifies existing accounting standards for hedging to better align a company's financial reporting for hedging activities with its economic objectives. The new standard changes the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results, expands and refines hedge accounting for both nonfinancial and financial risk components, and aligns the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. The ASU is effective for reporting periods beginning after December 15, 2018. Early adoption is permitted, and we adopted this standard using the modified retrospective transition method in September 2017. The adoption of this standard resulted in a cumulative effect adjustment of $0.4 million recorded as a decrease to “Accumulated Other Comprehensive Loss” and an increase to “Distributions in Excess of Earnings” as of January 1, 2017. Additionally, the effects of this standard were applied to the current period resulting in an immaterial impact to our Consolidated Financial Statements for the year ended December 31, 2017.
New Accounting Standards Issued but not yet Adopted
In May 2014, the FASB issued ASU 2014-09 Revenue from Contracts with Customers (“ASU 2014-09”), that requires companies to recognize revenue from contracts with customers based upon the transfer of goods or services to customers in amounts that reflect the consideration to which the company expects to be entitled in exchange for those goods or services. The new standard also results in enhanced disclosures about revenue, provides guidance for transactions that were not previously addressed comprehensively and improves guidance for multiple-element arrangements. The FASB subsequently issued additional ASUs which improve guidance and provide clarification of the new standard. The guidance is effective for fiscal years beginning after December 15, 2017, and the Company adopted the standard effective January 1, 2018 utilizing the modified retrospective transition method.
Accordingly, the guidance will be applied prospectively to contracts which were not completed as of the date of adoption. Based on our analysis, no material change to the amount or timing of revenues recognized occurred, including those derived from institutional capital management fees, as our primary revenue stream is from relatively short-term operating leases with tenants. Additionally, our historical property dispositions have been cash sales with no contingencies and no future involvement in the property operations.
As a result of adoption, the total impact to our financial statements in the first quarter of 2018 will be a cumulative adjustment recorded as an increase of $2.3 million to “Investments in and advances to unconsolidated joint ventures” and a decrease “Distributions in excess of earnings” related to the de-recognition of deferred gains related to a previous contributions of real estate properties into our joint ventures. No other material impacts to the Consolidated Financial Statements, related disclosures or internal control environment were identified.
In February 2016, the FASB issued an ASU that modifies existing accounting standards for lease accounting. The new standard requires a lessee to record a lease asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease. Revenue related to lease components will be recognized on a straight-line basis and revenue from non-lease components will be recognized in accordance with the principles of the Revenue from contracts with customers standard. Leases in which we are the lessors will be accounted as sales-type leases, direct financing leases or operating leases. The guidance is effective for fiscal years beginning after December 15, 2018, with early adoption permitted for fiscal years beginning after December 15, 2016. The Company plans to adopt the new lease standard effective January 1, 2019 and we expect our operating leases with tenants will continue to qualify as operating leases. Revenue related to lease components will be recognized on a straight-line basis and revenue from non-lease components will be recognized in accordance with the principles of the Revenue from Contracts with Customers standard.
Upon adoption, we expect leases in which we are the lessor will continue to be accounted for as operating leases with minimal impact on the Company's financial condition or results of operation; however, this standard may impact the timing of recognition and disclosures related to our tenant recovery income earned from leasing our consolidated operating properties. Additionally, the standard only allows for lessors to capitalize incremental direct costs. As a result, the Company will no longer be able to capitalize initial direct costs related to the successful origination of new leases. During the year ended December 31, 2017, we capitalized $3.1 million of initial direct costs related to successful origination of new leases. The standard requires a modified retrospective transition approach for all capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with an option to elect certain transition relief.
Note 3 - Investment in Properties
Our consolidated investment in properties consists of our operating portfolio, properties under development, properties in pre-development, properties under redevelopment, value-add acquisitions and land held for development or other purposes. The historical cost of our investment in properties was (in thousands):
(1)
Prior year amounts recasted to conform to changes to operating portfolio definition made as of Q1 2017, namely the addition of Value-Add Acquisitions are only considered in the operating portfolio upon stabilization.
(2)
Represents properties out of service while significant physical renovation of the property is underway or while the property is in lease-up subsequent to such renovation. May include properties taken out of service to change the properties' use and/or enhance its functionality.
(3)
Consolidated properties that were acquired and upon acquisition met either of the following criteria:
•
Occupancy of less than 75% upon acquisition; or
•
Occupancy of less than 75% expected to occur due to known move-outs within 24 months of the acquisition date.
Consolidated properties that were acquired vacant or with known move-outs within 24 months of the acquisition date with the intention to have the property out of service for significant physical renovations are classified as redevelopment properties.
(4)
Land held that is not intended to be improved or developed in the near future.
Acquisition Activity
2017 Acquisition Activity
During the year ended December 31, 2017, we acquired five buildings totaling approximately 1.3 million square feet for a total purchase price of approximately $129.0 million. As a result of our early adoption of the ASU that clarifies the definition of a business, our acquisitions are typically considered asset acquisitions as they consist of properties whereby substantially all the fair value of gross assets acquired is concentrated in the properties acquired. Acquisition costs incurred during the year ended December 31, 2017, include cumulative pre-acquisition costs that were expensed prior to January 1, 2017. The table below presents a summary of our acquisitions during 2017:
2016 Acquisition Activity
During the year ended December 31, 2016, we acquired eight buildings totaling approximately 1.0 million square feet for a total purchase price of $84.3 million. Related to these acquisitions, we incurred acquisition costs of approximately $1.1 million during the year ended December 31, 2016, included in “General and administrative expense” in our Consolidated Statements of Operations. The table below presents a summary of our acquisitions during 2016:
Development Activity
2017 Development Activity
Our properties under development include the following:
•
Six buildings totaling approximately 1.0 million square feet that we had completed shell-construction on as of December 31, 2017, with cumulative costs to date of approximately $75.3 million. These properties were 39.0% occupied based on weighted average square feet; and
•
Nineteen projects under construction totaling approximately 4.9 million square feet with cumulative costs to date of approximately $205.2 million. These properties were 13.4% leased based on weighted average square feet as of December 31, 2017.
During the year ended December 31, 2017, we acquired land totaling approximately 344.3 acres for development in our Atlanta, Dallas, Houston, New Jersey, Northern California, Orlando, Pennsylvania and Seattle markets for approximately $57.0 million.
2016 Development Activity
Our properties under development included the following:
•
Four buildings totaling approximately 1.2 million square feet that we had completed shell-construction on as of December 31, 2016. As of December 31, 2017, these buildings have been stabilized.
•
Ten projects under construction totaling 2.6 million square feet.
During the year ended December 31, 2016, we acquired land totaling approximately 130.5 acres for development in our Baltimore/Washington D.C., Chicago, Dallas, Denver, Miami and Seattle markets for approximately $43.8 million that are under construction or held for development.
Disposition Activity
2017 Disposition Activity
During the year ended December 31, 2017, we sold 12 consolidated operating properties, totaling approximately 1.5 million square feet, to third-parties for gross proceeds of approximately $115.3 million. We recognized gains of approximately $47.1 million on the disposition of 11 properties and an impairment loss of approximately $0.3 million on one property during 2017. The impairment loss is included in “Consolidated net income of DCT Industrial Trust Inc.” in the Consolidated Statements of Operations. The table below presents a summary of our dispositions during 2017:
2016 Disposition Activity
During the year ended December 31, 2016, we sold 15 consolidated operating properties, totaling approximately 2.9 million square feet, to third-parties for gross proceeds of approximately $128.7 million. We recognized gains of approximately $49.9 million on the disposition of the properties. The table below presents a summary of our dispositions during 2016:
Impairment Loss on Land
In 2017, the Company recognized a $0.9 million impairment loss on land held and used. Located in Reno, Nevada, the land was being held for future development. During 2017, the company marketed the land for sale and entered into a contract to sell, however, the purchaser ultimately canceled the contract. Based on the Company’s intent to sell and the contracted price, we recorded an impairment to recognize the land at estimated fair value, which was primarily based on level 3 fair value inputs.
Intangible Lease Assets and Liabilities
Aggregate amortization expense for intangible lease assets recognized in connection with property acquisitions (excluding assets and liabilities related to above and below market rents; see “Note 2 - Summary of Significant Accounting Policies” for additional information) was approximately $11.0 million, $11.9 million and $14.5 million for the years ended December 31, 2017, 2016, and 2015, respectively.
Our intangible lease assets and liabilities included the following (in thousands):
The following table presents the estimated net amortization of such intangible assets and liabilities and the net impact to rental revenues due to the amortization of above and below market rents for the next five years and thereafter (in thousands):
Casualty Events
During 2017, we recorded casualty gains in our Consolidated Statements of Operations of approximately $0.3 million primarily related to an insurance settlement from a casualty event that occurred in 2016 at a property in our Southern California market.
During 2016, we recorded casualty gains in our Consolidated Statements of Operations of approximately $2.8 million primarily related to insurance settlements from casualty events in our Dallas and Northern California markets.
During 2015, a series of storms caused damage to some of our properties which were covered by insurance for all losses, subject to our deductibles. The recoveries received for damages were in excess of the sum of our incurred losses for clean-up costs and the net book value written off for the damaged property. After all contingencies relating to the casualties were resolved, we recorded casualty gains of approximately $0.4 million in our Consolidated Statements of Operations.
Note 4 - Investments in and Advances to Unconsolidated Joint Ventures
We enter into joint ventures primarily for purposes of operating and developing industrial real estate. Our investments in these joint ventures are included in “Investments in and advances to unconsolidated joint ventures” in our Consolidated Balance Sheets.
During May 2017, the Southern California Logistics Airport (“SCLA”) joint venture entered into a $30.0 million secured fixed rate term note with a maturity date of May 2024. The proceeds were used to pay down a portion of the existing term note maturing in October 2017 and as a return of contributions to the joint venture partners.
During June 2017, the TRT-DCT Venture III disposed of its three remaining properties. We received approximately $2.7 million for our share of the gross proceeds and recognized our share of the gain on the sale of approximately $1.2 million, which is included in “Equity in earnings of unconsolidated joint ventures, net” in our Consolidated Statements of Operations.
During June 2017, the SCLA joint venture completed development activities and stabilized one building totaling 0.4 million square feet.
During July 2017, the SCLA joint venture entered into a $13.5 million secured variable rate term note which bears interest at a variable rate equal to LIBOR plus a margin of 2.50% per annum with a maturity date of July 2024. The proceeds were used to return contributions to the joint venture partners. During August 2017, the SCLA joint venture entered into a pay-fixed, receive-floating interest rate swap which effectively fixed the interest rate on the related debt instrument at 4.55% with a maturity date of July 2024.
In October 2017, the SCLA joint venture entered into an agreement to extend the maturity date of its $61.0 million secured construction loan from October 2017 to October 2019.
During September 2016, the TRT-DCT Venture III disposed of one property. We received distributions of approximately $0.5 million from our share of the gross proceeds and recognized our share of the gain on the sale of approximately $0.1 million, which is included in “Equity in earnings of unconsolidated joint ventures, net” in our Consolidated Statements of Operations.
During September 2016, the SCLA joint venture completed development activities and stabilized one building totaling 0.4 million square feet.
During December 2016, the DCT/SPF Industrial Operating LLC joint venture acquired a 10.8 acre parking lot adjacent to a property located in the Cincinnati market owned by the venture. Our share of the purchase price was approximately $0.5 million.
The following table summarizes our unconsolidated joint ventures (dollars in thousands):
(1)
Although we contributed 100% of the initial cash equity capital required by the venture, after return of certain preferential distributions on capital invested, profits and losses are generally split 50/50.
Our aggregate investment in these unconsolidated joint ventures at December 31, 2017, and 2016, of approximately $72.2 million and $95.6 million, respectively, exceeds our share of the underlying equity in the net assets of the joint ventures by approximately $12.8 million and $13.0 million, respectively, primarily due to costs incurred in connection with the ventures and capitalized interest prior to commencement of planned principal operations.
Institutional Capital Management Joint Ventures
DCT/SPF Industrial Operating LLC
During 2007, we entered into a joint venture agreement with Industrial Acquisition LLC (“JP Morgan”), an entity advised by JPMorgan Asset Management, to form DCT/SPF Industrial Operating LLC (“JP Morgan Venture”) that owns and operates industrial properties located in the U.S. Our actual ownership percentage may vary depending on amounts of capital contributed and the timing of contributions and distributions. As of December 31, 2017, our ownership interest is 20.0%. As a result of our contribution of properties into the JP Morgan Venture in 2007, we have deferred gains of $2.3 million as of December 31, 2017,
which have previously been recognized through earnings over the weighted average life of the related properties; however, the remaining deferred gain will be fully de-recognized upon the adoption of ASU 2014-09 effective January 1, 2018. See “Note 2 - Summary of Significant Accounting Policies, New Accounting Standards” for additional information.
TRT-DCT Industrial Joint Ventures III
We formed a joint venture with DCDPF, TRT-DCT Industrial Joint Venture III, G.P. (“TRT-DCT Venture III”), on September 9, 2008. Our ownership percentage may vary depending on amounts of capital contributed and the timing of contributions and distributions. As of December 31, 2017, our ownership interest is 10%, however, we disposed of its three remaining properties during 2017 as discussed above.
Development Projects in Unconsolidated Joint Ventures
SCLA
During 2006, we entered into a joint venture agreement with Stirling Airports International, LLC, (“Stirling”), an unrelated third-party, to be the master developer of up to 4,350 acres in Victorville, California, part of the Inland Empire submarket in Southern California. The development project is located at the former George Air Force Base which closed in 1992 and is now known as SCLA. Stirling entered into two master development agreements which gave it certain rights to be the exclusive developer of the SCLA development project through 2019 (including certain extensions) and assigned these rights to the SCLA joint venture upon the closing of the venture. While our exact share of the equity interests in the SCLA joint venture will depend on the amount of capital we contribute and the timing of contributions and distributions, the SCLA joint venture contemplates an equal sharing between us and Stirling of residual profits and cash flows after all priority distributions. As of December 31, 2017, the SCLA joint venture owned eight operating buildings comprised of 3.0 million square feet which were 99.9% occupied, an additional 165.5 acres of land available for development.
Guarantees
There are no lines of credit or side agreements related to, or between, our unconsolidated joint ventures and us, and there are no derivative financial instruments between our unconsolidated joint ventures and us. In addition, we do not believe we have any material exposure to financial guarantees.
Note 5 - Financial Instruments and Hedging Activities
Fair Value of Financial Instruments
As of December 31, 2017 and 2016, the fair values of cash and cash equivalents, restricted cash, accounts receivable and accounts payable approximated their carrying values due to the short-term nature of settlement of these instruments. The fair values of other financial instruments subject to fair value disclosures were determined based on available market information and valuation methodologies we believe to be appropriate estimates for these purposes. Considerable judgment and a high degree of subjectivity are involved in developing these estimates. Our estimates may differ from the actual amounts that we could realize upon disposition. The following table summarizes these financial instruments (in thousands):
(1)
The fair values of our borrowings were estimated using a discounted cash flow methodology. Credit spreads and market interest rates used to determine the fair value of these instruments are based on unobservable Level 3 inputs which management has determined to be its best estimate of current market values.
(2)
The carrying amount of our fixed rate debt includes premiums and discounts and excludes deferred loan costs.
(3)
The fair value of our interest rate swap is determined using the market standard methodology of netting the discounted future fixed cash flows and the discounted expected variable cash flows based on an expectation of future interest rates derived from Level 2 observable market interest rate curves. The asset or liability is included in “Other assets, net” or “Other liabilities,” respectively, in our Consolidated Balance Sheets.
Hedging Activities
To manage interest rate risk for variable rate debt and issuances of fixed rate debt, we primarily use treasury locks and interest rate swaps as part of our cash flow hedging strategy. These derivatives are designed to mitigate the risk of future interest rate increases by providing a fixed interest rate for a limited, pre-determined period of time. Such derivatives have been used to hedge the variability in existing and future interest expense associated with existing variable rate borrowings and forecasted issuances of debt, which may include issuances of new debt, as well as refinancing of existing debt upon maturity.
Accounting for changes in the fair value of derivatives depends on the intended use of the derivative and the designation of the derivative, whether we have elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Derivatives may also be designated as hedges of the foreign currency exposure of a net investment in a foreign operation. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge.
For derivatives designated as “cash flow” hedges, the change in the fair value of the derivative is initially reported in “Other comprehensive income” (“OCI”) in our Consolidated Statements of Comprehensive Income (i.e., not included in earnings) and subsequently reclassified into “Interest expense” when the hedged transaction affects earnings or the hedging relationship is no longer highly effective. We assess the effectiveness of each hedging relationship whenever financial statements are issued or earnings are reported and at least every three months. We do not use derivatives for trading or speculative purposes.
During June 2013, certain of our consolidated ventures entered into two pay-fixed, receive-floating interest rate swaps to hedge the variability of future cash flows attributable to changes in the 1 month USD LIBOR rates. The pay-fixed, receive-floating interest rate swaps have an effective date of June 2013 and a maturity date of June 2023. These interest rates swaps effectively fix the interest rate on the related debt instruments at 4.72%. As of December 31, 2017 and 2016, we had borrowings payable subject to these pay-fixed, receive-floating interest swaps with aggregate principal balances of approximately $6.4 million and $6.6 million, respectively.
During December 2015, we entered into a pay-fixed, receive-floating interest rate swap to hedge the variability of future cash flows attributable to changes in the 1 month USD LIBOR rates on our $200.0 million unsecured term loan. The pay-fixed, receive-floating interest rate swap has an effective date of December 2015 and a maturity date of December 2022. The interest rate swap effectively fixes the interest rate on the related debt instrument at 3.31%, however, there is no floor on the variable interest rate of the swap whereas the current variable-rate debt is subject to a 0.0% floor. In the event that USD LIBOR is negative, the Company will make payments to the hedge counterparty equal to the negative spread between USD LIBOR and zero. During the year ended December 31, 2016, we recorded a non-cash charge of approximately $0.4 million of hedge ineffectiveness in earnings attributable to a 0.0% floor mismatch in the hedging relationships (i.e., there is no floor on the variable interest rate of the swap whereas the current variable rate debt from which the hedged forecasted transactions are expected to flow is subject to a 0.0% floor on the USD LIBOR component of the interest rate). See “Note 2 - Summary of Significant Accounting Policies” for the impact to the Consolidated Financial Statements from the adoption of the Derivatives and Hedging ASU in September 2017. As of December 31, 2017 and 2016, the entire $200.0 million principal amount of the term loan was subject to this pay-fixed, receive-floating interest swap.
The following table presents the effect of our derivative financial instruments on our accompanying Consolidated Financial Statements (in thousands):
Amounts reported in “Accumulated other comprehensive loss” related to derivatives will be amortized to “Interest expense” as interest payments are made on our current debt and anticipated debt issuances. During the next 12 months, we estimate that approximately $3.8 million will be reclassified from “Accumulated other comprehensive loss” to “Interest expense” resulting in an increase in interest expense.
Note 6 - Outstanding Indebtedness
As of December 31, 2017, our outstanding indebtedness of approximately $1.7 billion consisted of mortgage notes, senior unsecured notes and bank unsecured credit facilities, excluding approximately $51.9 million representing our proportionate share of non-recourse debt associated with unconsolidated joint ventures. As of December 31, 2016, our outstanding indebtedness of $1.6 billion consisted of mortgage notes, senior unsecured notes and bank unsecured credit facilities, excluding approximately $35.2 million representing our proportionate share of non-recourse debt associated with unconsolidated joint ventures.
As of December 31, 2017, the gross book value of our consolidated properties was approximately $4.7 billion and the gross book value of all properties securing our mortgage debt was approximately $0.5 billion. As of December 31, 2016, the total gross book value of our consolidated properties was approximately $4.4 billion and the gross book value of all properties securing our mortgage debt was approximately $0.6 billion. Our debt has various covenants with which we were in compliance as of December 31, 2017 and 2016.
Our outstanding indebtedness is summarized below (in thousands, see footnotes on following page):
(1)
Interest rates for fixed rate debt are stated rates. Interest rates for variable rate debt are the interest rate charged as of the last payment in 2017.
(2)
We settled certain derivative instruments related to these notes and the settlement amount of these derivative instruments are amortized to interest expense over the life of the assigned notes.
(3)
Reflects the effective interest rate as a result of pay-fixed, receive-floating interest swaps as described in “Note 5 - Financial Instruments and Hedging Activities.”
(4)
Excludes deferred loan costs for line-of-credit arrangements, net of amortization, of approximately $1.2 million and $2.2 million as of December 31, 2017 and 2016, respectively.
(5)
Weighted average interest rates are based upon outstanding balances as of December 31, 2017.
Debt Issuance, Payoffs and Refinancing
During December 2015, we entered into a $200.0 million variable rate senior unsecured term loan which matures on December 10, 2022, and bears interest at a variable rate equal to 1 month USD LIBOR, plus a margin, depending on our public debt credit rating, of between 1.45% to 2.40% per annum or, at our election, an alternate base rate plus a margin of between 0.45% to 1.40% per annum. We primarily used the proceeds to pay down the senior unsecured revolving credit facility and for general corporate purposes. On December 11, 2015, we entered into a pay-fixed, receive-floating interest rate swap which effectively fixes the interest rate on the term loan at 3.31% through maturity, however, there is no floor on the variable interest rate of the swap whereas the current variable-rate debt is subject to a 0.0% floor. In the event that USD LIBOR was negative, the Company would make payments to the hedge counterparty equal to the spread between USD LIBOR and zero. During December 2017, we amended the senior unsecured term loan, lowering our margin to between .90% to 1.75% per annum effective January 1, 2018, and based on our public debt credit rating, resulted in a fixed rate of 2.81% beginning on that date.
During March 2017, the Operating Partnership issued $50.0 million aggregate principal amount of 4.50% senior notes due 2023 at 103.88% of face value in a public offering for net proceeds of approximately $51.2 million after offering costs and excluding accrued interest of approximately $0.9 million. The notes were issued under our indenture dated October 9, 2013, and form part of the same series as our previously issued 4.50% senior notes due 2023. We primarily used the net proceeds to pay down our senior unsecured revolving credit facility and for general corporate purposes.
During March 2017, we repaid the remaining $25.0 million outstanding on our $100.0 million term loan maturing April 2017 at par using proceeds from our senior unsecured revolving credit facility.
During June 2017, we paid-off our $51.0 million senior unsecured note at par maturing June 2017 using proceeds from our senior unsecured revolving credit facility and proceeds from the issuance of common stock under our continuous equity offering program.
During the year ended December 31, 2017, we paid-off four mortgage notes totaling $34.5 million maturing in 2017 at par using proceeds from our senior unsecured revolving credit facility.
During August 2016, we issued $250.0 million of fixed rate senior unsecured notes in a private placement offering. The notes have an average term of 10 years, a weighted average interest rate of 3.90% and require semi-annual interest payments. We primarily used the proceeds to pay down our senior unsecured revolving credit facility, payoff a $49.0 million senior unsecured note at maturity and for the early payoff of a $75.0 million portion of our $100.0 million senior unsecured term loan maturing in April 2017.
Line of Credit
As of December 31, 2017, we had $234.0 million outstanding and $164.1 million available under our $400.0 million senior unsecured revolving credit facility, net of two letters of credit totaling $1.9 million. As of December 31, 2016, we had $75.0 million outstanding and $323.1 million available under our senior unsecured revolving credit facility, net of two letter of credit totaling $1.9 million.
Guarantee of Debt
DCT has guaranteed the Operating Partnership’s obligations with respect to the senior unsecured notes and the bank unsecured credit facilities.
Interest Expense and Capitalized Interest
During the years ended December 31, 2017, 2016, and 2015, we incurred interest expense of approximately $79.1 million, $73.9 million and $69.9 million, respectively. We capitalized approximately $13.0 million, $9.9 million and $15.8 million of interest in 2017, 2016, and 2015, respectively, associated with certain development, redevelopment and other construction activities.
Debt Maturities
The following table presents the scheduled maturities of our debt and regularly scheduled principal amortization, excluding unamortized premiums, discounts and deferred loan costs as of December 31, 2017 (in thousands):
(1)
The term loan facilities are presented in “Senior unsecured notes” in our Consolidated Balance Sheets.
Note 7 - Commitments and Contingencies
Legal Matters
We are a party to various legal actions and administrative proceedings arising in the ordinary course of business, some of which may be covered by liability insurance, and none of which we expect to have a material adverse effect on our consolidated financial condition or results of operations.
Operating Leases
The following table presents our contractual obligations as of December 31, 2017, specifically our obligations under operating lease agreements and ground lease agreements (in thousands):
Substantially all of the office space and equipment subject to the operating leases are for the use at our corporate, regional and market offices. Rent expense recognized was approximately $1.4 million, $1.2 million and $1.1 million during the years ended December 31, 2017, 2016, and 2015, respectively.
Note 8 - Noncontrolling Interests
DCT
Noncontrolling interests are the portion of equity, or net assets, in a subsidiary not attributable, directly or indirectly, to a parent. Noncontrolling interests of DCT primarily represent limited partnership interests in the Operating Partnership and equity interests held by third party partners in consolidated real estate investments, including related parties as discussed in “Note 12 - Related Party Transactions.” Our noncontrolling interests held by third-party partners in our consolidated joint ventures totaled $15.1 million and $13.1 million as of December 31, 2017, and 2016, respectively. Our noncontrolling interests’ share of consolidated net income totaled $5.0 million, $5.0 million and $8.9 million for the years ended December 31, 2017, 2016, and 2015, respectively.
Operating Partnership
Equity interests in the Operating Partnership held by third parties and LTIP Units, as defined in “Note 9 - Stockholders’ Equity of DCT and Partners’ Capital of the Operating Partnership,” are classified as permanent equity of the Operating Partnership and as noncontrolling interests of DCT in the Consolidated Balance Sheets.
All income attributable to noncontrolling interest holders for all periods presented in the Operating Partnership’s Consolidated Statements of Operations is income from continuing operations.
Note 9 - Stockholders’ Equity of DCT and Partners’ Capital of the Operating Partnership
DCT
Common Stock
As of December 31, 2017, and 2016, approximately 93.7 million and 91.5 million shares of common stock were issued and outstanding, respectively.
On September 10, 2015, we registered a continuous equity offering program, to replace our continuous equity offering program previously registered on May 29, 2013, whereby the Company may issue 5.0 million shares of common stock, at a par value of $0.01 per share, from time-to-time through September 10, 2018, in “at-the-market” offerings or certain other transactions. During the years ended December 31, 2017, and 2016, we issued approximately 1.8 million and 2.5 million shares of common stock through the continuous equity offering program, at a weighted average price of $54.48 and $43.98 per share for proceeds of approximately $95.5 million and $107.0 million, net of offering costs, during each respective period. The proceeds from the sale of shares of common stock were contributed to the Operating Partnership for an equal number of OP units in the Operating Partnership and were used for general corporate purposes, including funding developments and redevelopments. As of December 31, 2017, approximately 0.7 million shares of common stock remain available to be issued under the current offering.
During the years ended December 31, 2017, 2016, and 2015, we issued approximately 0.1 million, 0.1 million and 0.1 million, respectively, shares of common stock related to vested shares of restricted stock, phantom shares and stock option exercises.
The holders of shares of our common stock are entitled to one vote per share on all matters voted on by stockholders, including election of our directors. Our articles of incorporation, as amended, do not provide for cumulative voting in the election of our directors. Therefore, the holders of the majority of the outstanding shares of common stock can elect the entire board of directors. Subject to any preferential rights of any outstanding series of our preferred stock and to the distribution of specified amounts upon liquidation with respect to shares-in-trust, the holders of our common stock are entitled to such distributions as may be declared from time to time by our board of directors out of legally available funds and, upon liquidation, are entitled to receive all assets available for distribution to stockholders. All shares issued in our public offerings are fully paid and non-assessable shares of common stock. Holders of our common stock do not have preemptive rights.
Operating Partnership
OP Units
For each share of common stock issued by DCT, the Operating Partnership issues a corresponding OP Unit to DCT in exchange for the contribution of the proceeds from the stock issuances.
As of December 31, 2017, and 2016, DCT owned approximately 96.6% and 96.3%, respectively, of the outstanding equity interests in the Operating Partnership. The remaining common partnership interests in the Operating Partnership were owned by executives of the Company and non-affiliated limited partners.
Limited partners have the right to require the Company to redeem all or a portion of the OP Units held by the limited partner at a redemption price equal to and in the form of the Cash Amount (as defined in the Partnership Agreement), provided that such OP Units have been outstanding for at least one year. The Company may, in its sole discretion, purchase the OP Units by paying to the limited partner either the Cash Amount or the REIT Shares Amount (generally one share of DCT’s common stock for each OP Unit), as defined in the Partnership Agreement.
During the years ended December 31, 2017, 2016, and 2015, approximately 0.3 million, 0.7 million and 0.3 million OP Units were redeemed for approximately $2.7 million, $5.2 million and $4.1 million in cash and approximately 0.3 million, 0.6 million and 0.2 million shares of DCT common stock, respectively. The OP Unit redemptions exclude LTIP Unit redemptions, see “LTIP Units” within “Note 11 - Equity Based Compensation” for further details.
As of December 31, 2017, 2016, and 2015, there were approximately 3.2 million, 3.5 million and 4.0 million outstanding OP Units in each corresponding period held by entities other than DCT and redeemable, with an aggregate redemption value of approximately $191.0 million, $168.9 million and $150.9 million based on the $58.78, $47.88 and $37.37 per share closing price of DCT’s common stock on December 31, 2017, 2016, and 2015, respectively. As of December 31, 2017, 2016 and 2015, included in OP Units were approximately 0.8 million, 0.7 million and 0.6 million vested LTIP Units issued under our Long-Term Incentive Plan, respectively.
Allocations of Net Income and Net Losses to Partners
The Operating Partnership’s net income and loss will generally be allocated to the general partner and the limited partners in accordance with the respective percentage interests in the OP Units issued by the Operating Partnership.
Dividend Reinvestment and Stock Purchase Plan
We offer shares of common stock through the Dividend Reinvestment and Stock Purchase Plan (the “Plan”). The Plan permits stockholders to acquire additional shares with quarterly dividends and to make additional cash investments to buy shares directly. Shares of common stock may be purchased in the open market, through privately negotiated transactions, or directly from us as newly issued shares of common stock. All shares issued under the Plan were either acquired in the open market or newly issued.
Preferred Shares
Our board of directors, through the articles of incorporation, as amended, has the authority to authorize the issuance of 50,000,000 preferred shares of any class or series. The rights and terms of such preferred shares will be determined by our board of directors. However, the voting rights of preferred stockholders shall never exceed the voting rights of common stockholders. As of December 31, 2017, and 2016, we had no outstanding shares of preferred stock.
Shares-in-Trust
Our board of directors, through the articles of incorporation, as amended, has the authority to authorize the issuance of 100,000,000 shares-in-trust which are shares that are automatically exchanged for common or preferred shares as a result of an event that would cause an investor to own, beneficially or constructively, a number of shares in excess of certain limitations. As of December 31, 2017, and 2016, we had no outstanding shares-in-trust.
Distributions
Our distributions are calculated based upon the total number of shares of our common stock and OP Units outstanding on the distribution record date as declared by our board of directors. We accrue and pay distributions on a quarterly basis. The following table presents the distributions that have been paid and/or declared to date by our board of directors:
Note 10 - Net Earnings per Share/Unit
We use the two-class method of computing net earnings per common share/unit which is an earnings allocation formula that determines net earnings per share/unit for common stock/unit and any participating securities according to dividends declared (whether paid or unpaid) and participation rights in undistributed earnings. Under the two-class method, net earnings per common share/unit are computed by dividing the sum of distributed earnings to common stockholders/OP Unitholders and undistributed earnings allocated to common stockholders/OP Unitholders by the weighted average number of common shares/units outstanding for the period.
A participating security is defined by GAAP as an unvested share-based payment award containing non-forfeitable rights to dividends and must be included in the computation of earnings per share/unit pursuant to the two-class method. Nonvested restricted stock and LTIP Units are considered participating securities as these share-based awards contain non-forfeitable rights to dividends irrespective of whether the awards ultimately vest or expire.
DCT
The following table presents the computation of basic and diluted weighted average common shares outstanding (in thousands):
Operating Partnership
The following table presents the computation of basic and diluted weighted average OP Units outstanding (in thousands):
DCT and the Operating Partnership
Potentially Dilutive Shares
For the years ended December 31, 2017, 2016, and 2015, DCT excluded from diluted earnings per share the weighted average common share equivalents related to 3.5 million, 3.9 million and 4.2 million OP Units, respectively, because their effect would be anti-dilutive.
Note 11 - Equity Based Compensation
Long-Term Incentive Plan
On October 10, 2006, the Company established the Long-Term Incentive Plan, as amended, to grant restricted stock, stock options and other awards to our personnel and directors, as defined in the plan. Subject to adjustment upon certain corporate transactions or events, the total number of shares of our common stock subject to such awards may not exceed 5.8 million shares and in no event may any optionee receive options for more than 0.5 million shares on an annual basis.
Phantom Shares
Pursuant to the Long-Term Incentive Plan, as amended, the Company may grant phantom shares to non-employee directors. Phantom shares generally vest upon the first anniversary of the grant date, depending on the grant. Once vested and at the discretion of the grantee, the phantom stock can be converted into either cash or DCT common stock at the option of the Company. Phantom shares are recorded at their fair value on the date of grant and are amortized on a straight-line basis over the service period during which term the shares fully vest.
Restricted Stock
Restricted stock is recorded at fair value on the date of grant, based the closing price of our common stock, and amortized on a straight-line basis over the service period during which the stock vests. Restricted stock generally vests ratably over a period of four to five years, depending on the grant. Restricted stock represents the right to receive one share of DCT common stock in the future, have no exercise price, and receive distributions equally along with common shares.
LTIP Units
Pursuant to the Long-Term Incentive Plan, as amended, the Company may grant limited partnership interests in the Operating Partnership called LTIP Units. Vested LTIP Units may be redeemed by the Company in cash or DCT common stock, at the discretion of the Company, on a one-for-one basis with common shares, subject to certain restrictions of the Partnership Agreement. LTIP Units receive distributions equally along with common shares. LTIP Units generally vest ratably over a period of four to five years, depending on the grant. LTIP Unit equity compensation is amortized into expense over the service period during which the units vest.
During the year ended December 31, 2017, approximately 0.1 million LTIP Units were granted to certain senior executives, which vest over a four year period with a total fair value of $5.9 million at the date of grant as determined by a lattice-binomial option-pricing model based on a Monte Carlo simulation using a weighted average volatility factor of 19% and a weighted average risk-free interest rate of 1.93%.
During the year ended December 31, 2016, approximately 0.2 million LTIP Units were granted to certain senior executives, which vest over a four year period with a total fair value of $6.3 million at the date of grant as determined by a lattice-binomial option-pricing model based on a Monte Carlo simulation using a weighted average volatility factor of 23% and a weighted average risk-free interest rate of 1.28%.
During the year ended December 31, 2015, approximately 0.2 million LTIP Units were granted to certain senior executives, which vest over a four year period with a total fair value $7.3 million at the date of grant as determined by a lattice-binomial option-pricing model based on a Monte Carlo simulation using a weighted average volatility factor of 26% and a weighted average risk-free interest rates of 1.28%.
Additionally, in December 2015, we entered into a resignation agreement and consulting agreement with a senior executive. We recognized $3.6 million of expense for the year ended December 31, 2015, in “General and administrative” expense in our Consolidated Statement of Operations related to the following equity grants. Approximately 61,000 LTIP Units were granted, of which approximately 35,000 LTIP Units vested immediately and 26,000 LTIP Units vest over a one year period. The fair value of the awards was $2.1 million as determined by a lattice-binomial option-pricing model based on a Monte Carlo simulation using a volatility factor of 23% and a weighted average risk-free rate of 1.76%. Additionally, vesting was accelerated on approximately 38,000 of unvested LTIP Units and approximately 6,000 LTIP Units were accelerated to vest within one year resulting in an additional $1.5 million of expense for the year ended December 31, 2015.
The following table summarizes the number of awards redeemed and converted to DCT’s common stock on a one for one basis, the fair value at vesting date for the awards vested during the period and the number of awards outstanding at period end related to phantom shares, restricted stock and LTIP Units:
(1)
During the years ended December 31, 2017, 2016, and 2015, approximately 81,000, 13,000 and 8,000 LTIP Units were redeemed for approximately $4.5 million, $0.5 million and $0.3 million in cash during each respective period.
The following table summarizes additional information concerning our unvested phantom shares, restricted stock and LTIP Units (shares in thousands):
Stock Options
The Company may grant stock options to certain employees pursuant to our Long-Term Incentive Plan, as amended. The term of such options is 10 years from the date of grant unless forfeited earlier and the period during which the right to exercise such options fully vests ranges from four to five years from the date of grant. No stock options were granted under our Long-Term Incentive Plan, as amended, prior to 2007. During the year ended December 31, 2017, we issued approximately 21,000 shares of common stock upon the exercise of options to purchase DCT’s common stock by certain employees. There were no options granted during the years ended December 31, 2017, 2016, and 2015.
Independent Director Option Plan
Prior to October 6, 2006, we granted stock options under the Independent Director Option Plan, which we used in an effort to attract and retain qualified independent directors. No options were issued under this plan subsequent to 2006.
Stock Options Summary Table
Stock options granted under the Long-Term Incentive Plan, as amended, and the Independent Director Option Plan are amortized on a straight-line basis over the service period during which the right to exercise such options fully vests.
The following table presents total options outstanding, granted, exercised, and expired or forfeited, as well as the total options exercisable as of December 31, 2017 (number of options and intrinsic value in thousands):
(1)
During the year ended December 31, 2017, approximately 79,000 stock options were used to net settle taxable amounts due upon the exercise of options to purchase DCT common stock by certain employees.
Equity Compensation Expense
The following table summarizes the amount recorded in “General and administrative” expense in our Consolidated Statement of Operations for the amortization of phantom shares, restricted stock, LTIP Units and stock options (in millions):
The following table summarizes the remaining unrecognized expense and remaining period over which we expect to amortize the expense as of December 31, 2017, related to phantom shares, restricted stock, LTIP Units and stock options (dollars in millions):
Note 12 - Related Party Transactions
8th and Vineyard Consolidated Joint Venture
In May 2010 we entered into the 8th and Vineyard joint venture with Iowa Investments, LLC, an entity owned by our former president, to purchase 19.3 acres of land held for development in Southern California. Pursuant to the joint venture agreement, we will first receive a return of all capital along with a preferred return. Thereafter, Iowa Investments, LLC will receive a return of all capital along with a promoted interest. The land parcel acquired by 8th and Vineyard was purchased from an entity in which the same executive had a minority ownership. The total acquisition price of $4.7 million was determined to be at fair value.
As of December 31, 2015, we completed the construction and disposition of five buildings and 0.8 acres of land in the joint venture to third-parties resulting in the disposition of all of the joint venture’s assets. The joint venture has liquidated the partnership as of December 31, 2016. We received a preferred return on our capital contributions of approximately $3.0 million and Iowa Investments, LLC received approximately $3.8 million which was recorded as non-controlling interest in our Consolidated Statement of Operations during 2016.
Southern California Consolidated Ventures
We previously entered into four agreements with entities also controlled by our former president, two in December 2010 and two in January 2011, whereby we acquired a weighted average ownership interest, based on square feet, of approximately 48.4% in five bulk-industrial buildings located in the Southern California market. The former executive has a weighted average ownership interest in these properties of approximately 43.7%, based on square feet, and the remaining 7.9% is held by a third-party. Each venture partner will earn returns in accordance with their ownership interests. We have controlling rights including management of the operations of the properties and we have consolidated the properties in accordance with GAAP. The total acquisition price of $46.3 million was determined to be at fair value.
Note 13 - Income and Other Taxes
We operate and expect to continue to operate in a manner to meet all the requirements to qualify for REIT status. We have made our REIT election under Section 856 of the Code for the taxable year ended December 31, 2003 and have not revoked such election. In order for a former C corporation to elect to be a REIT, it must distribute 100% of its C corporation earnings and profits and agree to be subject to federal tax at the corporate level to the extent of any subsequently recognized built-in gains within a 10 year period. We did not have any built-in gains at the time of our conversion to REIT status. As a REIT, we generally will not be subject to federal income taxation at the corporate level to the extent we annually distribute 100% of our REIT taxable income, as defined under the Code, to our stockholders and satisfy other requirements. To continue to qualify as a REIT for federal tax purposes, we must distribute at least 90% of our REIT taxable income annually.
Enacted Changes in Tax Laws
On December 22, 2017, the Tax Cuts and Jobs Act (the “TCJA”) was enacted with an effective date of January 1, 2018. The TCJA makes major changes to the Code, including a number of provisions of the Code that affect the taxation of REITs and their stockholders. Among the relevant changes made by the TCJA are permanently reducing the generally applicable corporate statutory tax rate from 35% to 21% and eliminating or modifying certain previously allowed deductions (including substantially limiting interest deductibility). As a result of the reduction in the corporate statutory rate and in accordance with ASC 740, we re-measured our deferred tax accounts as of the enactment date using the new federal statutory tax rate, which resulted in a one-time non-cash adjustment that decreased our deferred tax asset balance by $2.0 million with a corresponding increase to income tax expense.
Summary of Current and Deferred Income Taxes
Components of the provision (benefit) for income taxes were as follows (in thousands):
Deferred Income Taxes
Deferred income taxes represent the tax effect of temporary differences between the book and tax basis of assets and liabilities. As of December 31, 2017, we had recorded a $0.7 million deferred tax asset, net of valuation allowance of $2.2 million, included in the Consolidated Balance Sheets in “Other assets, net,” and a $0.6 million deferred tax liability, included in the Consolidated Balance Sheets in “Other liabilities,” for federal and state income taxes on our taxable REIT subsidiaries. As of December 31, 2016, we had recorded $2.6 million of deferred tax asset, net of valuation allowance of $1.6 million and a $0.8 million deferred tax liability for federal and state income taxes on our taxable REIT subsidiaries.
During the years ended December 31, 2017, 2016, and 2015 $1.7 million of deferred income tax expense, $0.1 million of deferred income tax benefit and $0.2 million of deferred income tax expense, respectively, is included in “Income tax expense and other taxes” in our Consolidated Statements of Operations. During the year ended December 31, 2015, $0.6 million of tax benefit is included in “Development profit, net of taxes” in our Consolidated Statements of Operations. Deferred tax assets (liabilities) were as follows (in thousands):
Note 14 - Segment Information
The Company’s segments are based on our internal reporting of operating results used to assess performance based on our properties’ geographical markets. Our markets are aggregated into three reportable regions or segments, East, Central and West, which are based on the geographical locations of our properties. Management considers rental revenues and property net operating income (“NOI”) aggregated by segment to be the appropriate way to analyze performance.
The following table presents our total assets, net of accumulated depreciation and amortization, by segment (in thousands):
(1)
Other non-segment assets primarily consist of investments in and advances to unconsolidated joint ventures, deferred loan costs, other receivables and other assets.
The following table presents the rental revenues of our segments and a reconciliation of our segment rental revenues to our reported consolidated total revenues (in thousands):
The following table presents a reconciliation of our reported “Net income attributable to common stockholders” to our property NOI and property NOI of our segments (in thousands):
(1)
Property NOI is defined as rental revenues, which includes expense reimbursements, less rental expenses and real estate taxes, and excludes institutional capital management fees, depreciation, amortization, casualty and involuntary conversion gain (loss), development profit, net of taxes, gain on disposition of real estate interests, impairment, general and administrative expenses, equity in earnings (loss) of unconsolidated joint ventures, interest expense, interest and other income and income tax benefit (expense) and other taxes, and net income attributable to noncontrolling interests. We consider property NOI to be an appropriate supplemental performance measure because property NOI reflects the operating performance of our properties and excludes certain items that are not considered to be controllable in connection with the management of the properties such as amortization, depreciation, impairment, interest expense, interest and other income, income tax expense and other taxes and general and administrative expenses. However, property NOI should not be viewed as an alternative measure of our financial performance since it excludes expenses which could materially impact our results of operations. Further, our property NOI may not be comparable to that of other real estate companies, as they may use different methodologies for calculating property NOI. Therefore, we believe net income, as defined by GAAP, to be the most appropriate measure to evaluate our overall financial performance.
Note 15 - Assets Held for Sale
Assets Held for Sale
As of December 31, 2017, three properties in our East operating segment and two properties in our West operating segment were classified as held for sale and recorded at carrying amounts in our Consolidated Balance Sheets, as this was less than fair value less costs to sell. We completed the sale of these properties in January 2018.
Note 16 - Quarterly Results (Unaudited)
DCT
The following tables present selected unaudited quarterly financial data for each quarter during the years ended December 31, 2017 and 2016 (in thousands except per share information):
(See footnote definition on next page)
Operating Partnership
The following tables present selected unaudited quarterly financial data for each quarter during the years ended December 31, 2017 and 2016 (in thousands except per share information):
(1)
Quarterly amounts for earnings per common share and OP unit may not total to annual amounts due to rounding and changes in the number of weighted common shares and OP units outstanding included in the calculation of diluted common shares and OP units.
Note 17 - Subsequent Events
GAAP requires an entity to disclose events that occur after the balance sheet date but before financial statements are issued or are available to be issued (“subsequent events”) as well as the date through which an entity has evaluated subsequent events. There are two types of subsequent events. The first type consists of events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements, (“recognized subsequent events”). The second type consists of events that provide evidence about conditions that did not exist at the date of the balance sheet but arose subsequent to that date (“nonrecognized subsequent events”). No significant recognized or nonrecognized subsequent events were noted.
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2017
(dollar amounts in thousands)
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2017
(dollar amounts in thousands)
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2017
(dollar amounts in thousands)
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2017
(dollar amounts in thousands)
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2017
(dollar amounts in thousands)
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2017
(dollar amounts in thousands)
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2017
(dollar amounts in thousands)
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2017
(dollar amounts in thousands)
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2017
(dollar amounts in thousands)
(See footnotes on next page)
(1)
Included in Building & Improvements are intangible lease assets and construction in progress.
(2)
Generally these reductions in basis include one or more of the following: i) payments received from seller under master lease agreements and pursuant to GAAP, rental and expense recovery payments under master lease agreements are reflected as a reduction of the basis of the underlying property rather than revenues; ii) write-offs of fixed asset balances due to early lease terminations by contracted customers; iii) write-offs of fully amortized lease related intangible assets and improvements; iv) write-offs of fully amortized tenant leasing costs; and v) other miscellaneous basis adjustments.
(3)
As of December 31, 2017, the aggregate cost for federal income tax purposes of investments in real estate was approximately $4.3 billion.
(4)
For properties developed by DCT, development costs capitalized prior to substantial completion of the properties are included in Initial Costs to Company.
(5)
Reconciliation of total debt to consolidated balance sheet caption as of December 31, 2017:
(6)
A summary of activity for real estate and accumulated depreciation for the year ended December 31, 2017 is as follows: