ITEM 1. BUSINESS
The Company
DCT Industrial Trust Inc. is a leading industrial real estate company that owns, operates and develops high-quality bulk distribution and light industrial properties in high-volume distribution markets in the U.S. and Mexico. As used herein, “DCT Industrial Trust,” “DCT,” “the Company,” “we,” “our” and “us” refer to DCT Industrial Trust Inc. and its consolidated subsidiaries and partnerships except where the context otherwise requires. We were formed as a Maryland corporation in April 2002 and have elected to be treated as a real estate investment trust (“REIT”) for United States (“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 (the “operating partnership”), a Delaware limited partnership, for which DCT Industrial Trust Inc. is the sole general partner. We own our properties through our operating partnership and its subsidiaries. As of December 31, 2011, we owned approximately 90% of the outstanding equity interests in our 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 www.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 functional bulk distribution warehouses and light industrial properties. The properties we target for acquisition or development are generally characterized by convenient access to major transportation arteries, proximity to densely populated markets and quality design standards that allow our customers’ efficient and flexible use of the buildings. In the future, we intend to continue to focus 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 long-term earnings and shareholder value within the context of overall economic conditions, primarily through increasing rents and operating income at existing properties and acquiring and developing high-quality properties in major distribution markets. In addition, we will recycle our capital by disposing of existing 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, 2011, the Company owned interests in, managed or had under development approximately 75.5 million square feet of properties leased to approximately 900 customers, including:
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58.1 million square feet comprising 408 consolidated properties owned in our operating portfolio which were 90.6% occupied;
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0.2 million square feet comprising one consolidated property under redevelopment; and
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17.2 million square feet comprising 52 unconsolidated properties which were 86.3% occupied and one managed-only property operated on behalf of five institutional capital management partners.
As of December 31, 2011, our total consolidated portfolio consisted of 409 properties with an average size of 142,000 square feet and an average age of 20.2 years.
During the year ended December 31, 2011, we acquired 24 buildings comprising 2.8 million square feet and controlling ownership interests in three buildings totaling 0.4 million square feet. These properties, land and
ownership interests were acquired for a total purchase price of approximately $222.6 million, including $9.8 million attributable to the noncontrolling interests’ share. We funded these acquisitions with proceeds from our equity offering, proceeds from asset sales, proceeds from our private placement of senior unsecured notes, borrowings under our senior unsecured revolving credit facility, proceeds from a nonrecourse mortgage financing, issuance of OP units and existing cash balances.
During the year ended December 31, 2011, we sold 16 operating properties totaling approximately 2.7 million square feet to third-parties. The properties were sold for combined gross proceeds of approximately $108.3 million, resulting in gains of $12.0 million and impairment losses of $7.8 million, which represented the difference between the carrying value and the fair value of the assets sold, net of sales costs.
We have a broadly diversified tenant base. As of December 31, 2011, our consolidated operating properties had leases with approximately 900 customers with no single customer accounting for more than 1.7% of the total annualized base rents of our properties. Our ten largest customers occupy approximately 10.6% of our consolidated properties based on square footage and account for approximately 12.8% of the annualized base rents of these properties. We believe that our broad 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 518 Seventeenth Street, Suite 800, Denver, Colorado 80202; our telephone number is (303) 597-2400. We also maintain regional offices in Atlanta, Georgia; Baltimore, Maryland; Cincinnati, Ohio; Dallas, Texas; Houston, Texas; Moonachie, New Jersey; Newport Beach, California; Orlando, Florida; and Monterey, Mexico. 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”), and to maximize the net asset value of our portfolio and total shareholder return. The strategies we intend to execute to achieve these objectives include:
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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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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 indentified certain markets and sub-markets where we focus our efforts on identifying buildings to acquire. Acquisitions may include fully-leased buildings, vacant properties, or land where we think our leasing and development expertise can add value.
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Selectively Pursuing New Development. To meet current tenant demand, we intend to develop new assets in in-fill locations in select markets where rents and vacancy levels demonstrate the need for new construction. During 2011, we acquired five land parcels totaling approximately 102.2 acres. During 2011, we commenced construction of two buildings totaling 178,000 square feet on a 13.3 acre land site in the Dulles Corridor submarket of Washington D.C. which is expected to be completed early in 2012. In 2011, we also entered into a forward purchase commitment with an unrelated third-party to acquire a newly constructed industrial facility totaling approximately 267,000 square feet on a 16.0 acre site in the Northwest submarket of Houston, which is expected to be completed in mid-2012. There is active interest by a number of users for both projects.
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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 2011, we sold $108.3 million of non-strategic assets for deployment into 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 peers. This strategy has provided protection from turmoil in the capital markets during the economic downturn and should keep us well positioned to finance capital deployment opportunities as they arise. In addition, we believe that a conservatively managed balance sheet provides a competitive long-term cost of capital by lowering borrowing costs over time.
Our Competitive Strengths
We believe that we distinguish ourselves from other owners, operators, acquirers and developers of industrial properties. Although our business strategy reflects current market conditions, we believe our long-term success is supported 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 volume markets specifically designed to meet the warehousing needs of regional and national companies. The majority of our properties are specifically designed for use by major distribution users and are readily divisible to meet re-tenanting opportunities. We believe that our concentration of 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 26 years commercial real estate experience and 15 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 63 experienced transaction and property management professionals working in ten regional offices to maximize market opportunities effectively 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.
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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 transactions, both marketed as well as off-market. The average transaction size of our acquisitions in 2010 and 2011 was $12.1 million; demonstrating our ability to access a significant pipeline of smaller acquisitions. Further, consistent with our capital recycling strategy, we have disposed of a cumulative $931.3 million of real estate investments since inception. Our ability to acquire and sell real estate is driven by the experience of our transaction personnel and our extensive network of industry relationships within the brokerage, development and investor communities.
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Extensive Development and Redevelopment Expertise. Our local market teams have significant experience in all facets of value-add activities including build to suit, ground up development and redevelopment capabilities. We believe our teams’ knowledge of our focus markets’ opportunities and relationship with the 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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Strong Industry Relationships. We believe that our extensive network of industry relationships with the brokerage, development and investor communities will allow us to execute successfully our acquisition, development 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 tenants.
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Capital Structure. Our capital structure and business plan provides us with sufficient financial flexibility and capacity to fund future growth. As of December 31, 2011 we had $290.2 million available under our senior unsecured revolving credit facility and 312 of our consolidated operating properties with a gross book value of $2.4 billion were unencumbered.
Operating Segments
During 2011, management reorganized internal reporting whereby the operating results used to assess performance were aggregated into three reportable segments, East, Central and West, which are based on the geographical locations of our properties. This change aligns the markets by which management and their operating teams conduct and monitor business. Management considers rental revenues and property net operating income 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 tenants from other existing assets in proximity to our buildings as well as from proposed new developments. As a result, we may have to provide free rental periods, 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.
Employees
As of December 31, 2011, we had 117 full-time employees.
ITEM 1A.
ITEM 1A. RISK FACTORS
RISKS RELATED TO RECENT ECONOMIC CONDITIONS
Adverse economic conditions will negatively affect our returns and profitability.
Our operating results may be affected by weakness in the national economy as well as in the local economies where our properties are located. Specific impacts may include:
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increased levels of tenant defaults under leases;
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re-leasing may require concessions or reduced rental rates under the new leases due to reduced demand;
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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 tenant defaults, non-renewals under leases or inability of potential buyers to acquire our properties held for sale, including properties held through joint ventures.
Also, to the extent we purchase real estate in an unstable market, we are subject to the risk that if the real estate market ceases to attract the same level of capital investment in the future that it attracts at the time of our purchases, or the number of companies seeking to acquire properties decreases, the value of our investments may not appreciate or may decrease 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.
Constrained credit markets and real estate markets could have a material adverse effect on our results of operations, financial condition and ability to pay distributions to you.
Domestic and international financial markets continue to be constrained, which have impacted the availability of credit and contributed to rising costs associated with obtaining credit. If debt financing is not available on terms and conditions we find acceptable, we may not be able to obtain financing for investments. If the credit markets continue to be constrained, our ability to borrow monies to finance the purchase of, or other activities related to, real estate assets will be negatively impacted. If we are unable to borrow monies on terms and conditions that we find acceptable, we likely will have to reduce the number of properties we can purchase, and the return on the properties we do purchase may be lower. If interest rates are higher when the properties are refinanced, interest expense may increase and our income may be reduced. In addition, if we pay fees to lock-in a favorable interest rate, falling interest rates or other factors could require us to forfeit these fees. Also, if the value of our properties decline we may be unable to refinance all of our debt as it matures. All of these events would have a material adverse effect on our results of operations, financial condition and ability to pay distributions.
Substantial international, national and local government deficits and the weakened financial condition of these governments may adversely impact our business, financial condition and results of operations. In particular, for example, uncertainty about the financial stability of several countries in the European Union, the increasing risk that those countries may default on their sovereign debt and related stresses on financial markets could have an adverse effect on our business, results of operations and financial condition.
The values of, and the cash flows from, the properties we own are affected by developments in global, national and local economies. As a result of the recent severe recession and the significant government interventions, federal, state and local governments have incurred record deficits and assumed or guaranteed liabilities of private financial institutions or other private entities. These increased budget deficits and the weakened financial condition of federal, state and local governments may lead to reduced governmental spending, tax increases, public sector job losses, increased interest rates, currency devaluations, defaults on debt obligations or other adverse economic events, which may directly or indirectly adversely affect our business, financial condition and results of operations.
There can be no assurance that the market disruptions in Europe, including the increased cost of funding for certain governments and financial institutions, will not spread, nor can there be any assurance that future assistance packages will be available or, even if provided, will be sufficient to stabilize the affected countries and markets in Europe or elsewhere. Risks and ongoing concerns about the debt crisis in Europe could have a detrimental impact on the global economic recovery, financial markets and institutions and the availability of debt financing, which may directly or indirectly adversely affect our business, financial condition and results of operations.
RISKS RELATED TO OUR BUSINESS AND OPERATIONS
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 included a more significant portion of other sectors of the real estate industry.
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 could suffer. Our ability to retain our management group or to attract suitable replacements should any member of the management group leave is dependent on the competitive nature of the employment market. The loss of services from key members of the management group or a limitation in their availability could adversely impact our financial condition and cash flows. Further, such a loss could be negatively perceived in the capital markets. We have not obtained and do not expect to obtain key man life insurance on any of our key personnel.
We also believe that, as we expand, our future success depends, in large part, upon our ability to hire and retain highly skilled managerial, investment, financing, operational and marketing personnel. Competition for such personnel is intense, and we cannot assure our stockholders that we will be successful in attracting and retaining such skilled 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 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. Alternatively, pursuant to recent IRS guidance, we may elect to declare certain taxable dividends for the taxable year ended December 31, 2011, that are up to 90% payable in the form of our common stock (with the remainder payable in cash). In this event, stockholders will be required to include the full amount of the dividends in income, and stockholder’s tax liability could exceed the cash portion of their dividend. Additionally, our ability to 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 will 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 divestitures 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.
We may be unable to source off-market deal flow in the future.
A key component of our growth strategy is to continue to acquire additional industrial real estate assets. Properties that are acquired off-market are typically more attractive to us as a purchaser because of the absence of a formal sales process, which could lead to higher prices. If we cannot obtain off-market deal flow in the future, our ability to locate and acquire additional properties at attractive prices could be adversely affected.
Our real estate development strategies may not be successful.
We are involved in the construction and expansion of distribution facilities and we intend to continue to pursue development and renovation activities as opportunities arise. In addition, we have entered into joint ventures to develop, or will self-develop, additional warehouse/distribution buildings on land we already own or control, and we have rights under master development agreements to acquire additional acres of land for future development activities. 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 and ability to pay distributions on, and the market price of, our common stock, including, but not limited to:
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the risk that development projects in which we have invested may be abandoned and the related investment will be impaired;
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the risk that we may not be able to obtain, or may experience delays in obtaining, all necessary zoning, land-use, building, occupancy and other governmental permits and authorizations;
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the risk that we may not be able to obtain additional land on which to develop;
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the risk that we may not be able to obtain financing for development projects on favorable terms;
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the risk that construction costs of a project may exceed the original estimates or that construction may not be concluded on schedule, making the project less profitable than originally estimated or not profitable at all (including the possibility of contract default, the effects of local weather conditions, the possibility of local or national strikes and the possibility of shortages in materials, building supplies or energy and fuel for equipment);
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the risk that, upon completion of construction, we may not be able to obtain, or obtain on advantageous terms, permanent financing for activities that we have financed through construction loans; and
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the risk that occupancy levels and the rents that can be charged for a completed project will not be met, making the project unprofitable.
Our institutional capital management strategy of contributing properties to joint ventures we manage may not allow us to expand our business and operations as quickly or as profitably as we desire.
In general, our ability to contribute properties to joint ventures that are part of our institutional capital management program on advantageous terms will be dependent upon competition from other managers of similar joint ventures, current capital market conditions, including the yield expectations for industrial properties, and other factors beyond our control. Our ability to develop and timely lease properties will impact our ability to contribute these properties. Continued access to private and public debt and equity capital by these joint ventures is necessary in order for us to pursue our strategy of contributing properties to the joint ventures. Should we not have sufficient properties available that meet the investment criteria of current or future joint ventures, or should the joint ventures have limited or no access to capital on favorable terms, then these contributions could be delayed resulting in adverse effects on our liquidity and on our ability to meet projected earnings levels in a particular reporting period. Failure to meet our projected earnings levels in a particular reporting period could have an adverse effect on our results of operations, distributable cash flows and on the value of our common stock. Further, our inability to redeploy the proceeds from our divestitures in accordance with our investment strategy could have an adverse effect on our results of operations, distributable cash flows, and our ability to meet our debt obligations in a timely manner and the value of our common stock in subsequent periods.
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 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 co-member, co-venturer or partner in an investment might become bankrupt, which would mean that we and any other remaining general partners, members or co-venturers would generally remain liable for the partnership’s, limited liability company’s or joint venture’s liabilities;
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that such co-member, co-venturer or 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 co-member, co-venturer or 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 joint venture, limited liability company and partnership agreements often restrict the transfer of a co-venturer’s, member’s or partner’s interest or may otherwise restrict our ability to sell the interest when we desire or on advantageous terms;
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that our relationships with our partners, co-members or co-venturers 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, co-members or co-venturers may result in litigation or arbitration that would increase our expenses and prevent our officers and directors from focusing their time and effort on our business and result in subjecting the properties owned by the applicable partnership, limited liability company or joint venture to additional risk; and
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that we may in certain circumstances be liable for the actions of our partners, co-members or co-venturers.
We generally seek to maintain sufficient control of our partnerships, limited liability companies and joint ventures to permit us to achieve our business objectives; however, we may not be able to do so, and the occurrence of one or more of the events described above 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.
If we invest in a limited partnership as a general partner we could be responsible for all liabilities of such partnership.
In some joint ventures or other investments we may make, if the entity in which we invest is a limited partnership, we may acquire all or a portion of our interest in such partnership as a general partner. As a general partner, we could be liable for all the liabilities of such partnership. Additionally, we may be required to take our interests in other investments as a non-managing general partner. Consequently, we would be potentially liable for all such liabilities without having the same rights of management or control over the operation of the partnership as the managing general partner or partners may have. Therefore, we may be held responsible for all of the liabilities of an entity in which 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.
Investment in us may be subject to additional risks relating to our international investments.
We have operations in Mexico. Our foreign operations could be affected by factors peculiar to the laws and business practices of the jurisdictions in which the properties are located. These laws may expose us to risks that are different from and in addition to those commonly found in the United States. Foreign operations could be subject to the following risks:
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changing governmental rules and policies, including changes in land use and zoning laws;
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enactment of laws relating to the foreign ownership of real property or mortgages and laws restricting the ability of foreign persons or companies to remove profits earned from activities within the country to the person’s or company’s country of origin;
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variations in currency exchange rates;
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adverse market conditions caused by terrorism, civil unrest and changes in national or local governmental or economic conditions;
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the willingness of domestic or foreign lenders to make mortgage loans in certain countries and changes in the availability, cost and terms of mortgage funds resulting from varying national economic policies;
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the imposition of income and other taxes in those jurisdictions and changes in real estate and other tax rates and other operating expenses in particular countries;
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general political and economic instability;
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our limited experience and expertise in Mexico relative to our experience and expertise in the United States; and
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more stringent environmental laws or changes in such laws, or environmental consequences of less stringent environmental management practices in foreign countries relative to the United States.
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.
We may have difficulty funding our distributions with our available cash flows.
To date we have funded our quarterly distributions to investors with available cash flows and, to a lesser extent, with borrowings under our senior credit facility and other borrowings. Our corporate strategy is to fund the payment of quarterly distributions to our stockholders entirely from available cash flows. However, we may continue to fund our quarterly distributions to investors from a combination of available cash flows and proceeds from borrowings. In the event we are unable to consistently fund future quarterly distributions to investors entirely from available cash flows, net of recurring capital expenditures, the value of our shares may be negatively impacted.
Declining real estate valuations and impairment charges could adversely affect our earnings and financial condition.
The recent economic downturn has generally resulted in lower real estate valuations, which has required us to recognize real estate impairment charges on some of our assets and equity investments. We conduct a comprehensive review of all real estate asset classes 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 - Critical Accounting Estimates”). The principal factor which has led to impairment charges in the recent past was the severe economic deterioration in many markets resulting in a decrease in leasing demand, rental rates, rising vacancies and an increase in capitalization rates.
There can be no assurance that the estimates and assumptions we use to assess impairments are accurate and will reflect actual results. A worsening real estate market or the failure to continue to improve may cause us to reevaluate the assumptions used in our impairment analysis and our intent to hold, sell, develop or contribute properties. Changes in these assumption may result in impairment charges that could adversely affect our financial condition, results of operations and our ability to pay cash dividends to our stockholders and distributions to the OP unitholders and the market price of our stock.
Our decision to dispose of real estate assets would change the holding period assumption in our valuation analyses, which could result in material impairment losses and adversely affect our financial results.
We evaluate real estate assets for impairment based on the projected cash flow of the asset over our anticipated holding period. If we change our intended holding period, due to our intention to sell or otherwise dispose of an asset, then we must reevaluate whether that asset is impaired. Depending on the carrying value of the property at the time we change our intention and the amount that we estimate we would receive on disposal, we may record an impairment loss that would adversely affect our financial results. This loss could be material to our results of operations in the period that it is recognized.
Adverse economic and geopolitical conditions could negatively affect our returns and profitability.
Among others, the following market and economic challenges may adversely affect our operating results:
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poor economic times may result in tenant defaults under our leases and reduced demand for industrial space;
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overbuilding may increase vacancies; and
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maintaining occupancy levels may require increased concessions, tenant improvement expenditures or reduced rental rates.
Our operations could be negatively affected to the extent that an economic downturn is prolonged or becomes more severe.
Events or occurrences that affect areas in which our properties are geographically concentrated may impact financial results.
In addition to general, regional, national and international economic conditions, our operating performance is impacted by the economic conditions of the specific markets in which we have concentrations of properties. We have significant holdings in the following markets of our consolidated portfolio: Atlanta, Baltimore/Washington D.C., Chicago, Cincinnati, Columbus, Dallas, Houston, Memphis, Nashville, Northern California and Southern California. Our operating performance could be adversely affected if conditions become less favorable in any of the markets in which we have a concentration of properties.
Our business could be adversely impacted if we have deficiencies in our disclosure controls and procedures or internal control over financial reporting.
The design and effectiveness of our disclosure controls and procedures and internal control over financial reporting may not prevent all errors, misstatements or misrepresentations. While management will continue to review the effectiveness of our disclosure controls and procedures and internal control over financial reporting, there can be no guarantee that our internal control over financial reporting will be effective in accomplishing all control objectives all of the time. Deficiencies, including any material weakness, in our internal control over financial reporting which may occur in the future could result in misstatements of our results of operations, restatements of our financial statements, a decline in our stock price, or otherwise materially adversely affect our business, reputation, results of operations, financial condition or liquidity.
RISKS RELATED TO CONFLICTS OF INTEREST
Our UPREIT structure may result in potential conflicts of interest.
As of December 31, 2011, we owned 90% of the units of limited partnership interest in our operating partnership, or OP Units, certain unaffiliated limited partners owned 8% of the OP Units and certain of our officers and directors, owned the remaining 2% 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 available from equity investments in real estate depend 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 be adversely affected by:
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changes in general or local economic climate;
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the attractiveness of our properties to potential tenants;
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changes in supply of or demand for similar or competing properties in an area;
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bankruptcies, financial difficulties or lease defaults by our tenants;
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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 operating costs and expenses and our ability to control rents;
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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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changes in the cost or availability of insurance, including coverage for mold or asbestos;
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unanticipated changes in costs associated with known adverse environmental conditions or retained liabilities for such conditions;
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periods of high interest rates and tight money supply;
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tenant turnover;
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general overbuilding or excess supply in the market areas; and
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disruptions in the global supply chain caused by political, regulatory or other factors including terrorism.
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, would 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 tenants, 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, some of which own properties similar to ours in the same markets and submarkets in which our properties are located. If our competitors offer space at rental rates below current market rates or below the rental rates we currently charge our tenants, we may lose potential tenants, and we may be pressured to reduce our rental rates below those we currently charge in order to retain tenants when our tenants’ leases expire. 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 tenants for our revenues.
Our operating results and distributable cash flows would be adversely affected if a significant number of our tenants were unable to meet their lease obligations. In addition, certain of our properties are occupied by a single tenant. As a result, the success of those properties will depend on the financial stability of a single tenant. Lease payment defaults by tenants could cause us to reduce the amount of distributions to stockholders. A default by a tenant on its lease payments could force us to find an alternative source of revenues to pay any mortgage loan on the property. In the event of a tenant 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
operating properties. The number of vacant or partially vacant industrial properties in a market or submarket could adversely affect both our ability to re-lease the space and the rental rates that can be obtained.
A property that incurs a vacancy could be difficult to sell or re-lease.
A property may incur a vacancy either by the continued default of a tenant under its lease or the expiration of one of our leases. We have significant lease expirations in 2012, as outlined in Item 2
ITEM 2. PROPERTIES
Geographic Distribution
The following table describes the geographic diversification of our consolidated properties as of December 31, 2011.
(1) Percent owned is based on ownership weighted by square footage.
(2) Based on leases commenced as of December 31, 2011.
(3) Annualized Base Rent is calculated as monthly contractual base rent (cash basis) per the terms of the lease, as of December 31, 2011, multiplied by 12.
(4) Three of our buildings in this market totaling approximately 0.7 million square feet are subject to ground leases.
Occasionally our leases contain provisions giving the tenant rights to purchase the property, which can take the form of a fixed price purchase option, a fair market value option, a right of first refusal option or a right of first offer option. The following chart summarizes such rights related to our consolidated operating properties as of December 31, 2011.
The following table describes the geographic diversification of our investments in unconsolidated properties as of December 31, 2011.
(1) Percentage owned is based on ownership weighted by square footage, if applicable.
(2) 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.
Property Types
The following table reflects our consolidated portfolio by property type, in terms of square footage, as of December 31, 2011 (square feet in thousands).
(1) Occupancy percentage is based on leases commenced as of December 31, 2011.
Lease Expirations
Our industrial properties are typically leased to tenants for terms ranging from 3 to 10 years with a weighted average remaining term of approximately 3.3 years as of December 31, 2011. Following is a schedule of expiring leases for our consolidated properties by square feet and by annualized minimum base rents as of December 31, 2011 and assuming no exercise of lease renewal options.
(1) Includes contractual rent changes.
(2) Includes leases that are on month-to-month terms.
Customer Diversification
As of December 31, 2011, there were no customers that occupied more than 1.7% of our properties based on annualized base rent. The following table reflects our ten largest customers, based on annualized base rent as of December 31, 2011. These ten customers occupy a combined 6.2 million square feet of our consolidated properties.
Although base rent is supported by long-term lease contracts, tenants who file bankruptcy have the legal right to reject any or all of their leases. In the event that a tenant with a significant number of leases in our properties files bankruptcy and cancels its leases, we could experience a reduction in our revenues and tenant receivables.
Reports have indicated that the parent company, YRC Worldwide, Inc., of one of our top ten tenants, YRC, LLC has encountered financial difficulties and therefore has the potential to file for bankruptcy. YRC, LLC currently leases three truck terminals in infill locations of Los Angeles, at below market rents totaling $13.7 million, net of accumulated amortization as of December 31, 2011. YRC, LLC has paid all rents due and has no balances outstanding through December 31, 2011.
We continuously monitor the financial condition of our tenants. We communicate often with those tenants who have been late on payments or filed bankruptcy. We are not currently aware of the pending bankruptcy of any other tenants beyond those described above that would individually cause a material reduction in our revenues, and no tenant represents more than 5% of our annual base rent.
Industry Diversification
The table below illustrates the diversification of our consolidated portfolio by the industry classification of our tenants as of December 31, 2011, (dollar amounts in thousands).
Indebtedness
As of December 31, 2011, 97 of our 409 consolidated properties, with a combined gross book value of $735.1 million were encumbered by mortgage indebtedness totaling $311.3 million (excluding net premiums). See “Notes to Consolidated Financial Statements, Note 5-Outstanding Indebtedness” and the accompanying Schedule III beginning on page for additional information.
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 DISCLOSURE
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our Common Stock is listed on the New York Stock Exchange, or the NYSE, under the symbol “DCT”. The following table illustrates the high and low sales prices during periods presented.
On February 17, 2012 the closing price of our Common Stock was $5.71 share, as reported on the NYSE and there were 247,088,176 shares of Common Stock outstanding, held by approximately 2,522 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% 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 assets legally available therefore. 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 MGCL 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 as ordinary income, although some portion of our distributions may constitute qualified dividend income, capital gains or a return of capital.
The following table sets forth the distributions that have been declared by our board of directors on our Common Stock during the fiscal years ended December 31, 2011 and 2010.
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, 2006 to December 31, 2011 and assumes that $100 was invested in DCT Industrial Trust Inc. Common Stock and in each index on December 31, 2006 and that all dividends were reinvested.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial data relating to our historical financial condition and results of operations for the years ended December 31, 2011, 2010, 2009, 2008 and 2007. Certain amounts presented for the periods ended December 31, 2010, 2009, 2008 and 2007 have been reclassified to conform to the 2011 presentation. 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 that owns, operates and develops high-quality bulk distribution and light industrial properties in high-volume distribution markets in the U.S. and Mexico. DCT is the sole general partner of, and as of December 31, 2011 owned an approximate 90% ownership interest in DCT Industrial Operating Partnership L.P., a Delaware limited partnership.
Our primary business objectives are to maximize long-term growth in Funds From Operations, or FFO, as defined on page 39, the 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 high quality acquisitions or development 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 in higher growth opportunities.
Outlook
We seek to maximize long-term earnings growth and value within the context of overall economic conditions, primarily through increasing rents and operating income at existing properties and acquiring and developing high-quality properties in major distribution markets.
Fundamentals for industrial real estate continue to modestly improve in response to general improvement in the economy. According to national statistics, net absorption (the net change in total occupied space) of industrial real estate turned positive in the second quarter of 2010 and national occupancy rates have increased each quarter since then. We expect moderate economic growth to continue throughout 2012, which should result in continued positive demand for warehouse space as companies expand their distribution and production platforms. Rental rates in our markets appeared to have bottomed and in a number of markets have begun to increase, although they do remain below peak levels. Consistent with recent experience and based on current market conditions, we expect average GAAP rental rates on most new leases signed to continue to decline in 2012 compared to the rates on expiring leases. However, these declines appear to be moderating. As positive net absorption of warehouse space continues and demand comes more into balance with supply, the rental rate environment should continue to improve. According to a national research company, average market rental rates nationally are expected to increase moderately in 2012 as vacancy rates drop below 10% of available supply.
Further, we continue to expect limited new development of speculative warehouse space until rental rates and other leasing fundamentals improve sufficiently to justify the risks and financial returns necessary for new construction or to obtain project financing. With limited new supply over the next several years, we expect that the operating environment will become increasingly favorable for landlords with meaningful improvement of rental and occupancy rates.
For DCT Industrial, we expect same store net operating income to be slightly higher in 2012 than it was in 2011. The benefit of higher occupancy in 2012 is expected to mostly offset the impact of continued negative GAAP releasing rent spreads.
In terms of capital investment, we will continue to pursue acquisitions of well-located distribution facilities at prices where we can apply our leasing experience and market knowledge to generate attractive returns. During
the year ended December 31, 2011, we acquired 24 buildings comprising 2.8 million square feet and controlling ownership interests in three buildings totaling 0.4 million square feet. We also acquired land totaling approximately 102.2 acres for future development. These properties, land and ownership interests were acquired for a total purchase price of approximately $222.6 million, including $9.8 million attributable to the noncontrolling interests’ share. We will also pursue the acquisition of land and consider selective development of new buildings in markets where we perceive demand and market rental rates will provide attractive financial returns.
As of December 31, 2011, we have $57.7 million of debt principal payments due during 2012, comprised of maturities of $50.0 million of fixed-rate secured borrowings and regularly scheduled principal amortization.
On August 1, 2011, we issued $225.0 million of senior unsecured notes. The proceeds were partially used to pay down borrowings under our senior unsecured revolving credit facility, with the remainder used to pay down expiring mortgage notes and for general corporate purposes. 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 shares, proceeds from asset sales or through additional borrowings. Please see “Liquidity and Capital Resources” for additional discussion.
Inflation
Although the U.S. economy has recently been experiencing a slight increase in inflation rates, and a wide variety of industries and sectors are affected differently by changing commodity prices, inflation has not had a significant impact on us in our markets. Most of our leases require the tenants to pay their share of operating expenses, 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
Significant transactions for the year ended December 31, 2011
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Equity Offering
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On February 18, 2011, we issued 21.9 million shares of common stock in a public offering at a price of $5.35 per share, for net proceeds of $111.9 million. We used the offering proceeds to repay outstanding indebtedness for general corporate purposes, including, the funding of acquisitions.
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Debt Activity
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In April 2011, we refinanced $50.0 million of maturing senior unsecured notes. The new fixed-rate notes bear interest of 5.43%, mature in April 2020 and require quarterly interest payments.
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On June 3, 2011, we entered into a term loan agreement with a syndicate of 12 banks, pursuant to which we borrowed $175.0 million through a senior unsecured loan. The term loan is scheduled to mature on June 3, 2015 and may be prepaid in whole or in part at any time. The term loan agreement provides for a variable interest rate based on either the base rate under the agreement or LIBOR, at our election, plus a margin that is initially based on our leverage ratio. The margins on base rate loans initially may range from 0.80% to 1.65% per annum, and the margins on LIBOR-based loans may range from 1.80% to 2.65% per annum. We used the term loan, together with proceeds from a draw under our senior unsecured revolving credit facility, to repay our existing $200.0 million unsecured term loan that was scheduled to mature on June 6, 2011.
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On June 3, 2011, we entered into an amendment to extend the maturity date of our $300.0 million senior unsecured revolving credit facility from August 19, 2013 until June 3, 2015. This amendment also increased the number of banks included on the facility from nine to twelve and reduced the interest rate payable to either 0.65% to 1.35% over prime or 1.65% to 2.35% over LIBOR, per annum at our election, depending upon the Company’s leverage ratio. The amendment
also provides us the ability, from time to time, to extend the size of the facility by up to an additional $200.0 million, to a total of $500.0 million, subject to lender commitments and certain other conditions.
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On August 1, 2011, we issued $225.0 million of new fixed rate, senior unsecured notes through a private placement. These senior unsecured notes have a weighted average maturity of 8.5 years and a weighted average interest rate of 4.93%. The notes have maturities of 5, 7, 8, 10, 11 or 12 years. Proceeds from these notes were used to repay outstanding indebtedness and for general corporate use.
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On November 4, 2011, we issued a non-recourse mortgage note for $20.0 million in connection with a property acquisition. The note bears interest of 4.25%, requires monthly payments of principal and interest and matures in December 2021.
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During the year ended December 31, 2011, we assumed two non-recourse mortgage notes with outstanding balances of approximately $3.9 million and $3.4 million, respectively, in connection with two property acquisitions. The assumed notes bear interest at rates of 4.96% and 6.0%, respectively, and require monthly payments of principal and interest. The notes mature in August 2023 and April 2014, respectively.
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During the year ended December 31, 2011, we retired $124.7 million of maturing mortgage notes which were repaid using proceeds from our senior unsecured revolving credit facility, our senior unsecured notes issued through the private placement and equity offering, as previously referenced.
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Acquisitions
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During the year ended December 31, 2011, we acquired 24 buildings comprising 2.8 million square feet and controlling ownership interests in three buildings totaling 0.4 million square feet. These properties and controlling interests were acquired for a total purchase price of approximately $196.9 million, including $9.8 million attributable to the noncontrolling interests’ share, using proceeds from our equity offering, proceeds from asset sales, proceeds from our private placement of senior unsecured notes, borrowings under our senior unsecured revolving credit facility, proceeds from a nonrecourse mortgage financing, issuance of OP units and existing cash balances.
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Development
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During 2011, we commenced construction on two buildings totaling 178,000 square feet in the Dulles Corridor submarket of Washington D.C. In addition, we entered into a forward purchase commitment with an unrelated third party to acquire a newly constructed industrial facility totaling 267,000 square feet in the Northwest submarket of Houston. We also acquired five land parcels which totaled approximately 102.2 acres for future development.
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Dispositions
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During the year ended December 31, 2011, we sold 16 operating properties totaling approximately 2.7 million square feet to third-parties. The properties were sold for combined gross proceeds of approximately $108.3 million, resulting in gains of $12.0 million and impairment losses totaling $7.8 million. See “Notes to Consolidated Financial Statements Note 3-Investment in Properties and Note 15-Discontinued Operations” for further information.
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Significant Activity with Joint Ventures
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During the year ended December 31, 2011, in our unconsolidated joint ventures we disposed of three properties in Cincinnati, Kansas City and Northern California for gross proceeds, net of joint venture partners’ interest, of $13.8 million. We recognized deferred gains upon disposition of these properties totaling $0.7 million.
Critical Accounting Estimates
General
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 United States generally accepted accounting principles, or GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities and contingencies as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We evaluate our assumptions and estimates on an on-going basis. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The following discussion pertains to accounting policies management believes are most critical to the portrayal of our financial condition and results of operations that require management’s most difficult, subjective or complex estimates.
Revenue Recognition
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, we record receivables from tenants that we expect to collect over the remaining lease term, which are recorded as a straight-line rent receivable. When we acquire a property, the terms of existing leases are considered to commence as of the acquisition date for the purposes of this calculation.
Tenant recovery income includes payments and amounts due from tenants pursuant to their leases for real estate taxes, insurance and other recoverable property operating expenses and is recognized as “Rental revenues” during the same period the related expenses are incurred.
We maintain an allowance for estimated losses that may result from the inability of our tenants to make required payments. This estimate requires significant judgment related to the lessees ability to fulfill their obligations under the leases. If a tenant is insolvent or files for bankruptcy protection and fails to make contractual payments beyond any allowance, we may recognize additional bad debt expense in future periods equal to the net outstanding balances, which include amounts recognized as straight-line revenue not realizable until future periods.
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. 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 over the shorter of the expected life of such assets and liabilities or the remaining lease term.
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.
We earn revenues from asset management fees, acquisition fees, property management fees and fees for other services pursuant to joint venture and other 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.
Principles of Consolidation
We hold interests in both consolidated and unconsolidated joint ventures. All joint ventures over which we have financial and operating control, and variable interest entities (“VIE’s”) 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 over which we do not have a controlling interest or where we do not exercise significant control over major operating and management decisions but where we exercise significant influence and include our share of earnings or losses of these joint ventures in our consolidated net loss.
We analyze our joint ventures in accordance with GAAP to determine whether they are VIE’s 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, the size of our investment (including loans) and our ability to participate in major decisions. Our ability to correctly assess our influence or control over an entity and the determination of whether the agreement constitutes a VIE includes complex models forecasting of the future expected cash flows, which affects the presentation of these investments in the Consolidated Financial Statements and, consequently, our financial position and results of operations.
Capitalization of Costs
We capitalize costs directly related to the development, predevelopment, 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, insurance and leasing costs, if appropriate. We capitalize indirect costs such as personnel, office, and administrative expenses that are directly related to our projects based on an estimate of the time spent on the construction or development. 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 rates in effect during the period. We also capitalize interest on qualifying investments in unconsolidated joint ventures. Interest is capitalized based on the average capital invested in a venture during the period when development or predevelopment begins until planned principle operations commence, at our weighted average borrowing rates in effect during the period.
Fair Value
The Financial Accounting Standards Board (“FASB”) issued guidance related to accounting for fair value measurements which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. Fair value is defined as the exit price or price at which an asset (in its highest and best use) would be sold or liability assumed by an informed market participant in a transaction that is not distressed and is executed in the most advantageous market. This guidance provides a framework of how to determine such measurements on reported balances which are required or permitted to be measured at fair value under existing accounting pronouncements and emphasizes that fair value is a market-based rather than an entity-specific measurement. Therefore, our fair value measurement is determined based on the assumptions that market participants would use to price the asset or liability. As a basis for considering market participant assumptions in fair value measurements, this guidance establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions based on the best information available in the circumstances (unobservable inputs classified within Level 3 of the hierarchy).
Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates and yield curves that are observable at commonly quoted intervals, and the contracted sales price for assets held for sale. Level 3 inputs are unobservable inputs for the asset or liability that are typically based on management’s own assumptions, as there is little, if any, related observable market activity. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.
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 a 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. We generally do not consider acquisitions of land or unoccupied buildings to be business combinations. Rather, these transactions are treated as asset acquisitions and recorded at cost.
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 which requires significant judgment by management. Management considers Level 3 inputs such as the replacement cost of such assets, appraisals, property condition reports, comparable market rental data and other related information in determining the fair value of the tangible assets. The recorded fair value of intangible lease assets or liabilities includes Level 3 inputs including the value associated with leasing commissions, legal and other costs, as well as the estimated period necessary to lease such property and lease commencement. An intangible asset or liability resulting from in-place leases that are above or below the market rental rates are valued based upon managements estimates of prevailing market rates for similar leases. Intangible lease assets or liabilities are amortized over the estimated, 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. 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 our estimate of the current market rates for similar liabilities in effect at the acquisition date.
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, and tenant improvements, leasehold 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 estimated fair value. Our estimate of the useful life of our assets is evaluated upon acquisition and when circumstances indicate a change in the useful life, which requires significant judgment regarding the economic obsolescence of tangible and intangible assets.
Impairment of Properties
Investments in properties classified as held for use are carried at cost and evaluated for impairment at least annually and when events or changes in circumstances indicate that the carrying amounts of these assets may not be fully recoverable. As we selectively dispose of non-strategic assets and redeploy the proceeds into higher growth assets, our intended hold period may change due to our intention to sell or otherwise dispose of an asset. As a result, we would reevaluate whether that asset is impaired. Depending on the carrying value of the property at that time and the amount that we would receive on disposal, we may record an impairment loss. Other indicators include the point at which we deem a building to be held for sale 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 the estimated future undiscounted cash flows. If the asset carrying value is not recoverable 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 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, market supply and demand factors, historical experience, lease terms, tenant’s 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 many 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 impairments recorded in the Consolidated Financial Statements.
Investments in properties classified as held for sale are measured at the lower of their carrying amount or fair value (typically, the contracted sales price, a Level 2 input) less costs to sell. Impairment of assets held for sale is a component of “Income (loss) from discontinued operations” in the Consolidated Statements of Operations and is further detailed in “Notes to Consolidated Financial Statements Note 15 - Discontinued Operations and Assets Held for Sale.”
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 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.
Investment properties that are contributed to unconsolidated joint ventures are not considered discontinued operations due to our continuing involvement through maintaining an ownership interest in these investment properties and continuing to act as manager of the assets. 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 loss 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 Level 2 and 3 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 property. Should the actual results differ from management’s estimates, the valuation could be negatively affected and may result in additional impairments in the Consolidated Financial Statements.
Derivative Instruments and Hedging Activities
We record derivatives at fair value which are presented on a gross basis in “Other Assets” or “Other Liabilities” in our Consolidated Balance Sheets. 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. 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.
Currently, we use interest rate swaps to manage certain interest rate risk. 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 use valuation experts in determining the fair value of derivative instruments.
Although we have determined that the majority of the inputs used to value our derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with our derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by us and our counterparties.
As of December 31, 2011, our hedge was designated as a cash flow hedge. For derivatives designated as “cash flow” hedges, the effective portion of the changes in the fair value of the derivative is initially reported in “Accumulated other comprehensive loss” in our Consolidated Statements of Stockholders’ Equity, Comprehensive Income (Loss) and Noncontrolling Interests (i.e., not included in earnings) and subsequently reclassified into earnings when the hedged transaction affects earnings or the hedging relationship is no longer effective at which time the ineffective portion of the derivative’s changes in fair value is recognized directly into earnings. 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.
Our objective in using derivatives is to manage our exposure to interest rate volatility associated with our forecasted debt issuances including refinancing of our fixed-rate debt and certain variable rate borrowings. To accomplish this objective, we primarily use treasury locks, forward-starting swaps and interest rate swaps as part of our cash flow hedging strategy. These derivatives are designed to mitigate the risk of future interest rate fluctuations by providing a future fixed interest rate for a limited, pre-determined period of time.
Our agreements with each of our derivative counterparties contain provisions where if we default on the underlying indebtedness, including defaults where repayment of the indebtedness has not been accelerated by the lender, then we could also be declared in default on our derivative obligations. We also have agreements with our derivative counterparties that incorporate the loan covenant provisions of our indebtedness with lender affiliates of the derivative counterparties. Failure to comply with the loan covenant provisions would cause us to be in default on any derivative instrument obligations covered by the agreements.
Stock-Based Compensation
On October 10, 2006, we established the Long-Term Incentive Plan, as amended, to grant restricted stock, 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. LTIP Unit awards granted under the Long Term Incentive Plan are valued on the grant date using a lattice-binomial option-pricing model based on a Monte Carlo simulation using assumptions for the volatility factor and risk-free interest rates. We use valuation experts in determining the fair value of LTIP Units granted.
Results of Operations
The following discussion is based on our Consolidated Financial Statements for the years ended December 31, 2011 and 2010.
Summary of the year ended December 31, 2011 compared to the year ended December 31, 2010
The Company owned interests in, managed or had under development approximately 75.5 million square feet of properties leased to approximately 900 customers, including 17.2 million square feet of unconsolidated properties on behalf of five institutional capital management joint venture partners. As of December 31, 2011, we consolidated 408 operating properties and one redevelopment property. As of December 31, 2010, we consolidated 390 operating properties, seven development properties and one redevelopment properties.
Comparison of the year ended December 31, 2011 to the year ended December 31, 2010
The following table illustrates the changes in rental revenues, rental expenses and real estate taxes, property net operating income, other revenue and other income (loss) and other expenses for the year ended December 31, 2011 compared to the year ended December 31, 2010. Our same store portfolio includes all operating properties that we owned for the entirety of both the current and prior year reporting periods for which the operations had been stabilized. Non-same store operating properties include properties not meeting the same-store criteria and exclude development and redevelopment properties. The same store portfolio for the periods presented totaled 351 operating properties and was comprised of 49.7 million square feet. A discussion of these changes follows the table (in thousands).
(1) For a discussion as to why we view property net operating income to be an appropriate supplemental performance measure see Page 40, above. For a reconciliation of our property net operating income to our reported “Loss From Continuing Operations”, see “Notes to Consolidated Financial Statements, Note 14-Segment Information.”
Rental Revenues
Rental revenues, which is comprised of base rent, straight-line rent, amortization of above and below market rent intangibles, tenant recovery income, early lease termination fees and other rental revenues, increased by approximately $23.5 million, or 10.4%, for the year ended December 31, 2011 as compared to the same period in 2010, primarily due to the following:
•
$25.6 million increase in our non-same store operating properties rental revenues, primarily driven by the net addition of 19 properties, which resulted from the acquisition of 27 properties and completion of development and redevelopment of eight properties, partially offset by disposition of 16 properties. Average occupancy of the non-same store properties increased during 2011 to 85.7% from 42.7% during 2010, which resulted in a significant increase in base rent; partially offset by
•
$1.4 million decrease in our same store revenues due primarily to the following:
•
$2.0 million decrease in base rent resulting from decreased rental rates which more than offset an increase in average occupancy in our same store portfolio of 220 basis points to 89.0% for 2011; and
•
$0.8 million decrease related to a settlement with a tenant in liquidation which was recorded in 2010; partially offset by
•
$0.8 million increase in straight-line rent which is primarily related to increases in free rent periods; and
•
$0.6 million increase in revenues related to above market rent adjustments which have fully amortized; and
•
$0.7 million decrease in rental revenues in our development and redevelopment portfolios as eight properties were placed into operation and whose results are included in our non-same store portfolio.
The following table illustrates the components of our consolidated rental revenues for the years ended December 31, 2011 and 2010 (in thousands).
Rental Expenses and Real Estate Taxes
Rental expenses and real estate taxes increased by approximately $3.1 million, or 4.6%, for the year ended December 31, 2011 as compared to the same period in 2010, primarily due to the following:
•
$4.2 million net increase in rental expenses and real estate taxes related to the properties acquired and development and redevelopment properties placed into operation; partially offset by
•
$1.1 million net decrease in rental expenses and real estate taxes in our same store portfolio, which was primarily driven by decreases in property taxes, repairs, maintenance and non-recoverable expenses, partially offset by increases in property insurance and utilities.
Other Revenue and Other Income (Loss)
Total other revenue and other income (loss) decreased by approximately $0.1 million, or 3.9%, for the year ended December 31, 2011 as compared to the same period in 2010, primarily due to:
•
$0.7 million decrease in interest and other income (expense), primarily as a result of an exchange rate loss from Mexico operations; and
•
$0.4 million decrease in equity in loss of unconsolidated joint ventures primarily as a result of an increase in occupancy at two of our projects in unconsolidated development joint ventures partially offset by an increase in depreciation of properties as development became complete; partially offset by
•
$0.2 million increase in institutional capital management and other fees as a result of a disposition fee earned on the sale of an unconsolidated joint venture property offset in part by lower asset management fees resulting from assets sold out of the ventures.
Other Expenses
Other expenses increased by approximately $14.3 million, or 7.1%, for the year ended December 31, 2011 as compared to the same period in 2010, primarily due to:
•
$13.9 million increase in real estate depreciation and amortization expense resulting from real estate acquisitions and capital additions;
•
$7.4 million increase in interest expense primarily related to higher interest rates on debt which has been refinanced and issued since 2010, as well as higher average debt balances in 2011; and
•
$0.7 million increase in general and administrative expenses, primarily related to an increase in acquisition costs of approximately $0.7 million for the increased number of properties acquired during 2011; which are partially offset by
•
$6.5 million decrease in impairments from a $2.0 million impairment loss recorded on one of our investments in unconsolidated joint ventures and a $0.4 million held for use impairment recorded in 2011 as compared to a $8.7 million impairment recorded on properties held for use and $0.2 million impairment loss on one of our investments in unconsolidated joint ventures recorded in 2010; and
•
$1.2 million decrease in expenses related to a $0.4 million loss on a business combination in 2010 and a $0.8 million decrease in income tax expense in 2011, related to tax benefits recognized in 2011.
Income (Loss) from Discontinued Operations
Income (loss) from discontinued operations increased $8.2 million during the year ended December 31, 2011 as compared to the same period in 2010, which is related to the disposition of 16 properties during 2011, which had income before casualty gains of $2.0 million, casualty gains of $1.3 million, gain on sales totaling $12.0 million and impairment losses of $7.8 million, as compared to the sale of eight properties in 2010, which had income of $0.8 million, gains of $2.1 million and impairment losses of $3.5 million.
Noncontrolling Interests
Net loss attributable to noncontrolling interests decreased by approximately $1.6 million, or 31.2%, during the year ended December 31, 2011 as compared to the same period in 2010, primarily related to a decrease of consolidated net loss period over period. We owned approximately 90.4% and 89.8% of our operating partnership as of December 31, 2011 and 2010, respectively. The change in ownership was primarily due to the equity offering in February 2011, see “Notes to Consolidated Financial Statements, Note 9 - Stockholders’ Equity” for additional information), partially offset by issuance of OP Units in connection with property acquisitions and redemption of OP Units (see “Notes to Consolidated Financial Statements, Note 8-Noncontrolling Interests” for additional information).
Summary of the year ended December 31, 2010 compared to the year ended December 31, 2009
As of December 31, 2010, we consolidated 390 operating properties, seven development properties and one redevelopment properties. As of December 31, 2009, we consolidated 375 operating properties, 15 development properties and four redevelopment properties.
Comparison of the year ended December 31, 2010 to the year ended December 31, 2009
The following table illustrates the changes in rental revenues, rental expenses and real estate taxes, property net operating income, other revenue and other income and other expenses for the year ended December 31, 2010 compared to the year ended December 31, 2009. Our same store portfolio includes all operating properties that we owned for the entirety of both the current and prior year reporting periods. The same store portfolio for the periods presented totaled 345 buildings comprised of approximately 47.8 million square feet. A discussion of these changes follows the table (in thousands).
(1) For a discussion as to why we view property net operating income to be an appropriate supplemental performance measure see Page 40, above. For a reconciliation of our property net operating income to our reported “Loss From Continuing Operations”, see “Notes to Consolidated Financial Statements, Note 14-Segment Information.”
Rental Revenues
Rental revenues which is comprised of base rent, straight-line rent, amortization of above and below market rent intangibles, tenant recovery income, early lease termination fees and other rental revenues, decreased by approximately $4.1 million, or 1.8%, for the year ended December 31, 2010 as compared to the same period in 2009, primarily due to the following:
•
$12.1 million decrease in our same store revenues due primarily to the following:
•
a 250 basis point decrease in average occupancy of 86.3% in our same store portfolio in 2010 as compared to 88.8% in 2009, as well as decreases in rental rates, which resulted in a $12.8 million decrease of base rent;
•
$3.2 million decrease in operating expense recoveries;
•
$2.6 million increase in straight line rents, primarily related to increases in free rent periods;
•
$0.8 million increase related to a settlement of a tenant in liquidation recorded in 2010; and
•
$0.5 million increase in revenues related to above market rent adjustment which have fully amortized;
•
$12.1 million increase in our non-same store operating properties rental revenues, primarily driven by the net addition of 13 properties, which resulted from the acquisition of 12 properties, completion of development and redevelopment of nine properties and disposition of eight properties;
•
$2.7 million decrease in development and redevelopment properties as nine properties were placed into operation and whose results are included in our non-same store portfolio; and
•
$1.4 million decrease in fees paid by tenants related to early terminations.
The following table illustrates the various components of our rental revenues for the years ended December 31, 2010 and 2009 (in thousands):
Rental Expenses and Real Estate Taxes
Rental expenses and real estate taxes increased by approximately $2.5 million, or 3.8%, for the year ended December 31, 2010 compared to the same period in 2009, primarily due to:
•
$3.4 million net increase in rental expenses and real estate taxes related to the properties acquired and development and redevelopment properties placed into operations; partially offset by
•
$0.9 million net decrease in our rental expenses and real estate taxes in our same store portfolio, primarily driven by decreases in property taxes and lower bad debt expense.
Other Revenue and Other Income (Loss)
Total other revenue and other income (loss) decreased by approximately $5.8 million or 79.3% for the year ended December 31, 2010 as compared to the same period in 2009, primarily due to:
•
$5.7 million decrease in equity in earnings on unconsolidated joint ventures primarily related to a $5.1 million land sale gain recognized in 2009 at the SCLA unconsolidated joint venture and an increase in our losses in unconsolidated joint ventures; and
•
$1.6 million decrease interest and other income resulting from a decrease in interest income on notes paid off in 2010 and costs expensed in 2010 related to debt modifications that were not incurred in 2009; partially offset by
•
$1.4 million increase in institutional capital management fees resulting from property management fees earned in 2010.
Other Expenses
Other expenses increased by approximately $3.6 million, or 1.8%, for the year ended December 31, 2010 as compared to the same period in 2009, primarily due to:
•
$5.5 million increase in depreciation primarily related to real estate acquisitions, completed development and capital additions in 2010;
•
$4.2 million increase in interest expense primarily resulting from a reduction of capitalized interest expense as we completed development activities on eight buildings;
•
$8.6 million increase in impairment losses recorded on properties held for use in 2010; which were partially offset by
•
$9.9 million decrease in loss on business combinations which occurred in 2009;
•
$4.0 million decrease in general and administrative expenses related to a decrease in severance costs; and
•
$0.7 million decrease in income taxes related to activity in our taxable REIT subsidiary associated with income taxes on the land sale gain in 2009.
Income (Loss) from Discontinued Operations
Income (loss) from discontinued operations decreased by $5.3 million during the year ended December 31, 2010 as compared to the same period in 2009, which is related to the disposition of eight properties during 2010, which had income of $0.8 million, gains of $2.1 million and impairment losses of $3.5 million, as compared to the sale of three properties in 2009, which had income of $4.1 million, gains of $1.3 million and impairment losses of $0.7 million.
Noncontrolling Interests
Net loss attributable to noncontrolling interests increased by approximately $2.1 million due to an increase in consolidated net loss, period over period, and an increase of 2% in our ownership of the operating partnership. We owned approximately 90% and 88% of our operating partnership as of December 31, 2010 and 2009, respectively. The change in ownership was primarily due to redemption of OP Units (see “Notes to Consolidated Financial Statements, Note 8-Noncontrolling Interests” for additional information).
Segment Summary for the years ended December 31, 2011, 2010 and 2009
During 2011, management reorganized internal reporting whereby the operating results used to assess performance were aggregated into three reportable segments, East, Central and West, which are based on the geographical locations of our properties. This change aligns the markets by which management and their operating teams conduct and monitor business (see further detail on our Segment reorganization in “Notes to the Consolidated Financial Statements, Note 14-Segment Information”). Management considers rental revenues and property net operating income aggregated by segment to be the appropriate way to analyze performance.
The following table illustrates the changes in our consolidated operating properties in continuing operations by segment as of, and for the years ended, December 31, 2011 compared to December 31, 2010 and December 31, 2009, respectively (dollar amounts and square feet in thousands).
(1) Segment assets include all assets held by operating properties included in a segment, less non-segment cash and cash equivalents.
(2) Segment rental revenues include operating properties only. Revenues from development properties and properties which were sold during the period are not included in these results.
(3) Property net operating income, or property NOI, is defined in “Item 6. Selected Financial Data”. For a reconciliation of our property net operating income to our reported “Income (Loss) from Continuing Operations,” see “Notes to Consolidated Financial Statements, Note 14-Segment Information.”
East Segment
East Segment property NOI increased approximately $8.0 million, for the year ended December 31, 2011 as compared to the same period in 2010 primarily as a result of:
•
$10.2 million increase in rental revenues as a result of the acquisition of seven operating properties and completion of development of five properties which were placed into operations since December 31, 2010; partially offset by
•
$2.2 million increase in operating expenses, primarily as a result of an increase in property taxes and insurance.
East Segment property NOI increased approximately $2.2 million, for the year ended December 31, 2010 as compared to the same period in 2009 primarily as a result of:
•
$3.6 million increase in rental revenues as a result of the acquisition of five operating properties and completion of development of two properties which were placed into operations since December 31, 2009; partially offset by
•
$1.4 million increase in operating expenses, primarily as a result of an increase in property taxes.
Central Segment
Central Segment property NOI increased approximately $1.3 million, for the year ended December 31, 2011 as compared to the same period in 2010 primarily as a result of:
•
$2.6 million increase in rental revenues resulting primarily from:
•
the acquisition of ten operating properties and completion of development of three properties which were placed into operations since December 31, 2010; and
•
320 basis point increase in period end occupancy to 91.5% for the year ended December 31, 2011 as compared to 2010; partially offset by
•
$0.8 million decrease related to a settlement of a tenant in liquidation which was recorded in 2010.
•
$1.3 million increase in operating expenses, including a 7.3% increase in property taxes.
Central Segment property NOI decreased approximately $2.8 million, for the year ended December 31, 2010 as compared to the same period in 2009 primarily as a result of:
•
$3.5 million decrease in rental revenues, despite the addition of seven properties, two from acquisitions and five properties on which development was completed since December 31, 2009, mainly as a result of a 5.1% decrease in base rent period over period; and
•
$0.1 million increase in operating expenses, primarily related to an increase in non-recoverable expenses; partially offset by
•
$0.8 million increase related to a settlement of a tenant in liquidation recorded in 2010.
West Segment
West Segment property NOI increased approximately $10.6 million for year ended December 31, 2011 as compared to the same period in 2010 primarily as a result of:
•
$11.4 million increase in rental revenues as a result of the acquisition of nine operating properties since December 31, 2010; and
•
$0.8 million increase in operating expenses, primarily related to an increase in maintenance costs and insurance.
West Segment property NOI decreased approximately $3.7 million for the year ended December 31, 2010 as compared to the same period in 2009 primarily as a result of:
•
$2.3 million decrease in rental revenues, despite the addition of nine properties, eight from acquisitions and one property on which development was completed since December 31, 2009, mainly as a result of a 5.8% decrease in base rent period over period; and
•
$1.4 million increase in operating expenses, primarily resulting from an increase in property taxes and insurance as a result of property additions.
The following table reflects our total assets, net of accumulated depreciation and amortization, by segment (in thousands).
(1) Total segment assets include all assets held by operating properties included in a segment, less non-segment cash and cash equivalents.
(2) Other non-segment assets primarily consists of corporate assets including investments in and advances to unconsolidated joint ventures, notes receivable, deferred loan costs, straight-line rent and other receivables and other assets.
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 capital recycling, including dispositions and asset contributions;
•
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.
Our sources of capital will be used to meet our liquidity requirements and capital commitments, including operating activities, debt service obligations, equityholder distributions, capital expenditures at our properties, development funding requirements and future acquisitions. We expect to utilize the same sources of capital to meet our short-term and long-term liquidity requirements.
Cash Flows
Year ended December 31, 2011 compared to year ended December 31, 2010
“Cash and cash equivalents” were $12.8 million and $17.3 million as of December 31, 2011 and December 31, 2010, respectively. Net cash provided by operating activities increased by $16.0 million to $107.0 million during the year ended December 31, 2011 compared to $91.0 million during the same period in 2010. This change was
primarily due to an increase in property net operating income and a decrease in cash paid for accounts payable, accrued expenses and other liabilities during the periods.
Net cash used in investing activities increased $40.0 million to $178.3 million during the year ended December 31, 2011 compared to $138.3 million during the same period in 2010. This increase was primarily due to more acquisitions in 2011 than in 2010, which resulted in an increase in cash outflows for real estate acquisitions of $112.8 million. During 2011 there was also a $17.7 million increase in capital expenditures as well as a $17.7 million decrease in proceeds from repayment on notes receivable. These increases were partially offset by a $12.4 million decrease in contributions to unconsolidated joint ventures; a $87.1 million increase in proceeds from dispositions resulting from eight additional property dispositions in 2011 than in 2010; and a $12.4 million increase in distributions of investments in unconsolidated joint ventures resulting from the sale of three properties in our unconsolidated joint ventures.
Net cash provided by financing activities increased $21.3 million to $66.8 million during the year ended December 31, 2011 compared to $45.5 million during the same period in 2010. This change was primarily related to an increase of $90.0 million in net proceeds from issuance and repayments of senior unsecured notes; and an increase of $50.6 million in net proceeds from the issuance of common stock; partially offset by an increase of $102.0 million in net payments on the senior unsecured revolving line of credit; an increase of $9.1 million in net payments on mortgage notes; and an increase of $8.1 million in our dividends paid to common stockholders.
Year ended December 31, 2010 compared to year ended December 31, 2009
“Cash and cash equivalents” were $17.3 million as of December 31, 2010, which was a decrease of $1.8 million from our “Cash and cash equivalents” balance as of December 31, 2009. Net cash provided by operating activities decreased by $18.7 million to $91.0 million during the year ended December 31, 2010 compared to $109.7 million during the same period in 2009. This decrease was primarily due to an increase in the consolidated loss of DCT Industrial Trust Inc., which resulted from overall decreases in revenues, driven by lower rental rates, a decrease in average consolidated occupancy and increases in expenses.
Net cash used in investing activities increased by $120.6 million to $138.3 million during the year ended December 31, 2010 when compared to $17.7 million during the same period in 2009. This change was primarily due to a $74.1 million increase in expenditures on acquisitions of real estate; a $28.0 million increase in investments in unconsolidated joint ventures; a $11.4 million increase in capital expenditures; a $6.6 million decrease in distributions of investments in unconsolidated joint ventures; and a decrease of $9.6 million in proceeds from real estate dispositions; which were partially offset by a $5.5 million increase in repayments received on our notes receivable.
Net cash provided by (used in) financing activities increased $138.1 million to $45.5 million provided by financing activities during the year ended December 31, 2010 when compared to $(92.6) million used in financing activities during the same period in 2009. This change was primarily due to an increase in net draws on our line of credit of $51.0 million; and an increase of net issuances of senior unsecured notes totaling $110.0 million; which were partially offset by decrease in net payments of $23.1 million on mortgage notes; and a decrease of $56.5 million in proceeds from issuance of common stock.
Common Stock
As of December 31, 2011, approximately 245.9 million shares of common stock were issued and outstanding.
On February 18, 2011, we issued 21.9 million shares of common stock in a public offering at a price of $5.35 per share, for net proceeds of $111.9 million before offering expenses.
On March 23, 2010, we registered a “continuous equity” offering program. Pursuant to this offering program, we may sell up to 20 million shares of common stock from time-to-time through March 23, 2013 in “at-the-market”
offerings or certain other transactions. We did not issue any shares through this program during the year ended December 31, 2011. During the year ended December 31, 2010, we issued 12.6 million shares of common stock through this program and raised gross proceeds of $61.2 million. Our proceeds net of offering fees were $60.4 million. We used the proceeds from sale of shares for general corporate purposes, which included funding acquisitions and repaying debt. As of December 31, 2011, 7.4 million shares remain available to be issued under the program.
The net proceeds from the sales of our securities were transferred to our operating partnership for a number of OP Units equal to the shares of common stock sold in our offerings, including the offerings noted above.
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, 2011 and 2010, our board of directors declared distributions to stockholders totaling approximately $76.8 million and $67.9 million, respectively, including distributions to OP unitholders. Existing cash balances, cash provided from operations and borrowings under our credit facility were used for distributions paid during 2011 and 2010.
The payment of quarterly distributions is determined by our board of directors and may be adjusted at its discretion at any time. During February 2012, our board of directors declared a quarterly cash dividend of $0.07 per share, payable on April 18, 2012 to stockholders of record as of April 6, 2012.
Outstanding Indebtedness
As of December 31, 2011, our outstanding indebtedness of $1.3 billion consisted of mortgage notes and senior unsecured notes, excluding $61.7 million representing our proportionate share of debt associated with unconsolidated joint ventures. As of December 31, 2010, our outstanding indebtedness of $1.2 billion consisted of mortgage notes, senior unsecured notes and a senior unsecured revolving credit facility, excluding $62.3 million representing our proportionate share of debt associated with unconsolidated joint ventures. As of December 31, 2011, the gross book value of our consolidated properties was approximately $3.2 billion and the gross book value of all properties securing our mortgage debt was approximately $735.1 million. As of December 31, 2010, the total gross book value of our consolidated properties was approximately $3.0 billion and the gross book value of all properties securing our mortgage debt was approximately $1.0 billion. Our debt has various covenants with which we were in compliance as of December 31, 2011 and 2010.
Our debt instruments require monthly, quarterly or semiannual payments of interest and many 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. During the years ended December 31, 2011 and 2010, our debt payments, including principal, interest and extinguishments, totaled $222.4 million and $383.9 million, respectively.
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 through December 31, 2012.
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 through December 31, 2012.
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
Our charter and our bylaws do not limit the amount of debt we incur, however, we intend to operate so that our financial metrics are generally consistent with our publicly held investment grade REIT peers. The metrics we consider most significant include leverage, fixed charge coverage and net debt to EBITDA. We are also subject to certain covenants which may limit our outstanding indebtedness.
Debt Retirement and Refinancing
During the year ended December 31, 2011, we retired $124.7 million of maturing mortgage notes which were repaid using proceeds from the Company’s senior unsecured revolving credit facility and with proceeds from our senior unsecured notes issued through a private placement discussed below.
In April 2011, we refinanced $50.0 million of maturing senior unsecured notes. The new fixed-rate notes bear interest of 5.43%, mature in April 2020 and require quarterly interest payments.
Debt Issuances
On June 3, 2011, we entered into a term loan agreement with a syndicate of twelve banks, pursuant to which we borrowed $175.0 million through a senior unsecured loan. The term loan is scheduled to mature on June 3, 2015 and may be prepaid in whole or in part at any time. The term loan agreement provides for a variable interest rate based on either the base rate under the agreement or LIBOR, at our election, plus a margin that is initially based on our leverage ratio. The margins on base rate loans initially may range from 0.80% to 1.65% per annum, and the margins on LIBOR-based loans may range from 1.80% to 2.65% per annum. This loan agreement has various covenants with which we are in compliance as of December 31, 2011. We used the term loan, together with proceeds from a draw under our senior unsecured revolving credit facility, to repay our unsecured term loan that was scheduled to mature on June 6, 2011.
On August 1, 2011 we issued $225.0 million of new fixed rate, senior unsecured notes through a private placement. These senior unsecured notes have a weighted average maturity of 8.5 years and a weighted average interest rate of 4.93%. The notes have maturities of 5, 7, 8, 10, 11 or 12 years. The notes and related purchase agreement contain various covenants with which we are in compliance with as of December 31, 2011. Proceeds from these notes were used to repay outstanding indebtedness and for general corporate purposes.
On November 4, 2011, we issued a non-recourse mortgage note for $20.0 million in connection with a property acquisition. The note bears interest at a rate of 4.25%, requires monthly payments of principal and interest and matures in December 2021.
Line of Credit
As of December 31, 2011, we did not have an outstanding balance on our senior unsecured revolving credit facility; however we have issued two letters of credit secured by the unsecured revolving credit facility totaling $9.8 million. As of December 31, 2010 we had $51.0 million outstanding on our senior unsecured revolving credit facility.
On June 3, 2011, we entered in an amendment to extend the maturity date of our $300.0 million senior unsecured revolving credit facility from August 19, 2013 until June 3, 2015. This amendment also increased the number of
banks included on the facility from nine to twelve and reduced the interest rate payable to either 0.65% to 1.35% over prime or 1.65% to 2.35% over LIBOR, per annum at our election, depending upon the Company’s leverage ratio. The amendment also provides us the ability, from time to time, to extend the size of the facility by up to an additional $200.0 million, to a total of $500.0 million, subject to certain lender commitments and other conditions. We incurred a total of approximately $2.1 million in fees paid to the creditor and third-party costs which have been deferred and will be amortized over the life of the new credit facility. Proceeds from draws on the line have been used to repay mortgage notes and senior unsecured notes as they became due, to finance our property acquisitions and for general corporate purposes including payment of distributions. The senior unsecured revolving credit facility agreement contains various covenants with which we are in compliance with as of December 31, 2011.
Debt Assumption
During the year ended December 31, 2011, we assumed two non-recourse notes with outstanding balances of approximately $3.9 million and $3.4 million, respectively, in connection with two property acquisitions. The assumed notes bear interest at rates of 4.96% and 6.00%, respectively, and require monthly payments of principal and interest. The maturity dates of the assumed notes are August 2023 and April 2014, respectively.
Interest rate swap
As of December 31, 2011, we had one forward-starting swap in place to hedge the variability of cash flows associated with forecasted issuances of debt. This derivative has a notional value of $90.0 million, a LIBOR based swap strike rate of 5.43%, an effective date of June 2012 and a maturity date of September 2012. The associated counterparty is PNC Bank, NA. The fair value of the swap was a liability of approximately $26.7 million as of December 31, 2011.
Debt Maturities
The following table sets forth the scheduled maturities of our debt and regularly scheduled principal amortization, excluding unamortized premiums, as of December 31, 2011 (amounts in thousands).
Contractual Obligations
The following table reflects our contractual obligations as of December 31, 2011; specifically our obligations under long-term debt agreements, operating and ground lease agreements and purchase obligations (amounts 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. Excluded from the total are our estimated construction costs to complete development projects of approximately $8.2 million, none of which is legally committed until work is completed.
(2) Variable interest rate payments are estimated based on the LIBOR rate at December 31, 2011.
(3) Three of our buildings comprised of 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, 2011 and 2010, 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, 2011, 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 believe we have no material exposure to financial guarantees, except as discussed above.
As of December 31, 2011, our proportionate share of the total construction loans of our unconsolidated development joint ventures, including undrawn amounts, was $24.1 million; $13.5 million is scheduled to mature by the end of 2012 and $10.6 million is scheduled to mature by the end of 2013. Our proportionate share of the total construction loans of our unconsolidated development joint ventures includes 50% of the construction loans associated with the SCLA joint venture which are non-recourse to the venture partners.
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 fundings are not required contractually or otherwise. As of December 31, 2011, our proportionate share of non-recourse debt associated with unconsolidated joint ventures is $61.7 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, we primarily use 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. During the years ended December 31, 2011 and 2010, such derivatives were in place to hedge some of the variable cash flows associated with forecasted issuances of debt that are expected to occur during the period from 2010 through 2012, and to mitigate fluctuations in certain variable rate borrowings. 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. As of December 31, 2011, we had one forward-starting swap in place to hedge the variability of cash flows associated with forecasted issuances of debt. This derivative has a notional value of $90 million, a LIBOR based swap strike rate of 5.43%, an effective date of June 2012 and a maturity date of September 2012. The associated counterparty is PNC Bank, NA.
As of December 31, 2011 and 2010 the derivative had a fair value that resulted in a liability of $26.7 million and $10.1 million, respectively, included in “Other liabilities” in our Consolidated Balance Sheet. No ineffectiveness was recorded during the years ended December 31, 2011 and 2010.
The net liability associated with our derivative would increase approximately $1.0 million if the market interest rate of the referenced swap index were to decrease 10 basis points based upon the prevailing market rate as of December 31, 2011.
Similarly, our variable rate debt is subject to risk based upon prevailing market interest rates. As of December 31, 2011, we had approximately $175.0 million of variable rate debt outstanding indexed to LIBOR rates. If there was a 10% change in prevailing market interest rates relevant to our remaining variable rate debt, interest expense during the year ended December 31, 2011 would have increased by approximately $0.6 million. Additionally, if weighted average interest rates on our fixed rate debt were to have changed by 100 basis points due to refinancing, interest expense would have changed by approximately $9.9 million during the year ended December 31, 2011.
As of December 31, 2011, the estimated fair value of our debt was approximately $1.4 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 72 of this 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
Conclusion Regarding the Effectiveness 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, 2011, the end of the period covered by this annual report. Based on this evaluation, our management, including our principal executive officer and our principal financial officer, concluded that our disclosure controls and procedures were effective as of December 31, 2011 to provide reasonable assurance that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. There was no change in our internal controls during the fiscal year ended December 31, 2011 that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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 2011, management conducted an assessment of the internal control over financial reporting reflected in the financial statements, based upon criteria established in the “Internal Control - Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). 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, 2011.
The effectiveness of our internal control over financial reporting as of December 31, 2011 has been audited by Ernst & Young LLP, an independent registered public accounting firm. Their report appears below.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of
DCT Industrial Trust Inc. and subsidiaries:
We have audited DCT Industrial Trust Inc. and subsidiaries (the “Company”) internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). 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 conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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.
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.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the accompanying consolidated balance sheets of the Company as of December 31, 2011 and 2010, and the related consolidated statements of operations, stockholders’ equity, comprehensive income (loss) and noncontrolling interests, and cash flows for each of the three years in the period ended December 31, 2011, and our report dated February 29, 2012 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Denver, Colorado
February 29, 2012
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERANCE
The information required for this Item is incorporated by reference from our definitive Proxy Statement to be filed in connection with our 2012 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 2012 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 2012 annual meeting of stockholders.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required for this Item is incorporated by reference from our definitive Proxy Statement to be filed in connection with our 2012 annual meeting of stockholders.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES 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 2012 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 72 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 72. All other financial statement schedules are not applicable.
B. Exhibits.
The Exhibits required by Item 601 of Regulation S-K are listed in the Index to Exhibits on page E-1 to E-3 of this report, which is incorporated herein by reference.
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.
Date: February 29, 2012
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.
Financial Statements:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2011 and 2010
Consolidated Statements of Operations for the Years Ended December 31, 2011, 2010 and
Consolidated Statements of Stockholders’ Equity, Comprehensive Income (Loss) and Noncontrolling Interests for the Years Ended December 31, 2011, 2010 and 2009
Consolidated Statements of Cash Flows for the Years Ended December 31, 2011, 2010 and
Notes to Consolidated Financial Statements
Financial Statement Schedule:
Schedule III-Real Estate and Accumulated Depreciation
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of
DCT Industrial Trust Inc. and subsidiaries:
We have audited the accompanying consolidated balance sheets of DCT Industrial Trust Inc. and subsidiaries (the “Company”) as of December 31, 2011 and 2010, and the related consolidated statements of operations, stockholders’ equity, comprehensive income (loss) and noncontrolling interests, and cash flows for each of the three years in the period ended December 31, 2011. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
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, 2011 and 2010, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2011, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 29, 2012 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Denver, Colorado
February 29, 2012
DCT INDUSTRIAL TRUST INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except share and per 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 information)
The accompanying notes are an integral part of these Consolidated Financial Statements.
DCT INDUSTRIAL TRUST INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity,
Comprehensive Income (Loss) and Noncontrolling Interests
For the Years Ended December 31, 2011, 2010 and 2009 (in thousands)
(table continued on next page)
The accompanying notes are an integral part of these Consolidated Financial Statements.
The accompanying notes are an integral part of these Consolidated Financial Statements.
DCT INDUSTRIAL TRUST INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity,
Comprehensive Income (Loss) and Noncontrolling Interests
For the Years Ended December 31, 2011, 2009 and 2008 (in thousands)
continued
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 TRUST INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Note 1 - Organization
DCT Industrial Trust Inc. is a leading industrial real estate company that owns, operates and develops high-quality bulk distribution and light industrial properties in high-volume distribution markets in the U.S. and Mexico. As used herein, “DCT Industrial Trust,” “DCT,” “the Company,” “we,” “our” and “us” refer to DCT Industrial Trust Inc. and its consolidated subsidiaries and partnerships except where the context otherwise requires. We were formed as a Maryland corporation in April 2002 and have elected to be treated as a real estate investment trust (“REIT”) for United States (“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 (the “operating partnership”), a Delaware limited partnership, for which DCT Industrial Trust Inc. is the sole general partner. We own our properties through our operating partnership and its subsidiaries. As of December 31, 2011, we owned approximately 90.4% of the outstanding equity interests in our operating partnership.
As of December 31, 2011, the Company owned interests in, managed or had under development approximately 75.5 million square feet of properties leased to approximately 900 customers, including:
•
58.1 million square feet comprising 408 consolidated properties owned in our operating portfolio which were 90.6% occupied;
•
17.2 million square feet comprising 52 unconsolidated properties which were 86.3% occupied and one managed-only property operated on behalf of five institutional capital management partners; and
•
0.2 million square feet comprising one consolidated property under redevelopment.
Note 2 - Summary of Significant Accounting Policies
Basis of Presentation
The accompanying Consolidated Financial Statements include the financial position, results of operations and cash flows of the Company, its wholly-owned qualified REIT and taxable REIT subsidiaries, the operating partnership and its consolidated joint ventures, in which it has a controlling interest. Third-party equity interests in the operating partnership and consolidated joint ventures are reflected as noncontrolling interests in the Consolidated Financial Statements. 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 amounts have been eliminated.
All square feet, acres, occupancy, number of properties and number of customers disclosed in the notes to the Consolidated Financial Statements are unaudited.
Principles of Consolidation
We hold interests in both consolidated and unconsolidated joint ventures. All joint ventures over which we have financial and operating control, and variable interest entities (“VIE’s”) 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 over which we do not have a controlling interest or where we do not exercise significant control over major operating and management decisions but where we exercise significant influence and include our share of earnings or losses of these joint ventures in our consolidated net loss.
We analyze our joint ventures in accordance with GAAP to determine whether they are VIE’s 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, the size of our investment (including loans) and our ability to participate in major decisions. Our ability to correctly assess our influence or control over an entity affects the presentation of these investments in the Consolidated Financial Statements and, consequently, our financial position and results of operations.
Reclassifications
Certain items in our Consolidated Financial Statements for 2010 and 2009 have been reclassified to conform to the 2011 presentation.
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, predevelopment, 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, insurance and leasing costs, if appropriate. We capitalize indirect costs such as personnel, office, and administrative expenses that are directly related to our projects based on an estimate of the time spent on the development activities. 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 rates during the period. Costs incurred for maintaining and repairing our properties, which do not extend their useful lives, are expensed as incurred.
We also capitalize interest on qualifying investments in unconsolidated joint ventures. Interest is capitalized based on the average capital invested in a venture during the period when development or predevelopment begins until planned principle operations commence, at our weighted average borrowing rates during the period.
Discontinued Operations
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 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. The operating results of such properties are presented in “Income (loss) from discontinued operations” in current periods and all comparable periods presented. Depreciation is not recorded on properties held for sale; however, depreciation expense recorded prior to classification as held for sale is included in “Income (loss) from discontinued operations.” Gains on sales of real estate assets are recognized if the specific transaction terms and any continuing involvement in the form of management or financial assistance 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 “Income (loss) from discontinued operations” when recognized.
Fair Value
The Financial Accounting Standards Board (“FASB”) issued guidance related to accounting for fair value measurements which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. Fair value is defined as the exit price or price at which an asset (in its highest and best use) would be sold or liability assumed by an informed market participant in a transaction that is
not distressed and is executed in the most advantageous market. This guidance provides a framework of how to determine such measurements on reported balances which are required or permitted to be measured at fair value under existing accounting pronouncements and emphasizes that fair value is a market-based rather than an entity-specific measurement. Therefore, our fair value measurement is determined based on the assumptions that market participants would use to price the asset or liability. As a basis for considering market participant assumptions in fair value measurements, this guidance establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions based on the best information available in the circumstances (unobservable inputs classified within Level 3 of the hierarchy).
Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates and yield curves that are observable at commonly quoted intervals, and the contracted sales price for assets held for sale. Level 3 inputs are unobservable inputs for the asset or liability that are typically based on management’s own assumptions, as there is little, if any, related observable market activity. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.
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 a 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. We do not consider acquisitions of land or unoccupied buildings to be business combinations. Rather, these transactions are treated as asset acquisitions and recorded at cost.
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 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 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.
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, leasehold 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 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 reflects the standard depreciable lives typically 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 or contribution, in pre-development, or being developed or redeveloped until the building is substantially completed and ready for its intended use, 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 when events or changes in circumstances indicate that the carrying amounts of these assets may not be fully 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 the 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 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, tenant 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 impairments recorded in the Consolidated Financial Statements.
Investments in properties classified as held for sale are measured at the lower of their carrying amount or fair value (typically, the contracted sales price, a Level 2 input) less costs to sell. Impairment of assets held for sale is a component of “Income (loss) from discontinued operations” in the Consolidated Statements of Operations and is further detailed in Note 15-Discontinued Operations and Assets Held for Sale.
During the year ended December 31, 2011, we determined our cost was not recoverable on one operating property in the Atlanta market based upon a change in our future estimated hold period. Based on our analysis, the total carrying amount of the property located in our East operating segment was no longer recoverable by the future estimated undiscounted cash flows. Consequently, we recognized an impairment loss of $0.4 million in our consolidated portfolio based on the estimated fair value (see “Fair Value” discussion above). The property was classified as held-for-use at December 31, 2011.
In June 2010, we entered into a lease with a purchase option with a third-party on an industrial property located in New Jersey classified as held for use which resulted in a reassessment of the probable hold period of the property. Consequently, we determined that the total carrying amount of the property was no longer recoverable by the future estimated undiscounted cash flows and recognized an impairment loss of $4.6 million based on the estimated fair value.
During the year ended December 31, 2010, we determined our cost was not recoverable on certain land parcels held for future development. Based on our analysis, the total carrying amount of three land parcels located in Baltimore/Washington, Orlando and Atlanta markets were no longer recoverable by the future estimated undiscounted cash flows, as a result of changes in the anticipated timing of the commencement of the development. Consequently, we recognized impairment losses of $4.1 million and $0.2 million on properties in our consolidated portfolio and unconsolidated portfolios, respectively, based on their estimated fair values (see “Fair Value” discussion above).
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 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.
Investment properties that are contributed to unconsolidated joint ventures are not considered discontinued operations due to our continuing involvement through maintaining an ownership interest in these investment properties and continuing to act as manager of the assets. 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 income (loss) 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 Level 2 and 3 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 property. 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.
Notes Receivable
As of December 31, 2011 and 2010, we had approximately $1.1 million and $1.2 million in notes receivable outstanding with non-affiliates, respectively. The interest rates on notes receivable range from approximately 7.5% to 10%, and the notes mature on dates ranging from June 2012 to June 2017.
Deferred Loan Costs
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 $3.1 million and $4.2 million as of December 31, 2011 and 2010, respectively. Unamortized deferred loan costs are fully amortized when debt is retired before the maturity. Our interest expense for the years ended December 31, 2011, 2010 and 2009 includes $2.1 million, $2.3 million and $2.3 million for the amortization of loan costs, respectively.
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 tenants to make required payments. If a tenant 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, 2011 and 2010, our allowance for doubtful accounts was $1.3 million and $2.1 million, respectively.
Debt
Debt consists of fixed and variable rate secured mortgage notes, senior unsecured notes and a senior unsecured revolving credit facility. Secured mortgage notes assumed in connection with business combinations includes a premium or discount for the difference between the fair value and face value of assumed notes at the date of acquisition, and is amortized to “Interest expense” over the remaining life of the underlying notes. The aggregated premium balances, net of accumulated amortization, were approximately $2.6 million and $3.6 million as of December 31, 2011 and 2010, respectively.
Derivative Instruments and Hedging Activities
We record derivatives at fair value which are presented on a gross basis in “Other Liabilities” in our Consolidated Balance Sheets. 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.
Currently, we use interest rate swaps to manage certain interest rate risk. 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.
Although we have determined that the majority of the inputs used to value our derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with our derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by us and our counterparties.
As of December 31, 2011, our hedge was designated as a cash flow hedge. For derivatives designated as “cash flow” hedges, the effective portion of the changes in the fair value of the derivative is initially reported in “Accumulated other comprehensive loss” in our Consolidated Statements of Stockholders’ Equity, Accumulated Other Comprehensive Income (Loss) and Noncontrolling Interests (i.e., not included in earnings) and subsequently reclassified into earnings when the hedged transaction affects earnings or the hedging relationship is no longer effective at which time the ineffective portion of the derivative’s changes in fair value is recognized directly into earnings. 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.
Our objective in using derivatives is to manage our exposure to interest rate volatility associated with our forecasted debt issuances including refinancing of our fixed-rate debt and certain variable rate borrowings. To accomplish this objective, we primarily use treasury locks, forward-starting swaps and interest rate swaps as part of our cash flow hedging strategy. These derivatives are designed to mitigate the risk of future interest rate fluctuations by providing a future fixed interest rate for a limited, pre-determined period of time.
Our agreements with each of our derivative counterparties contain provisions where if we default on the underlying indebtedness, including defaults where repayment of the indebtedness has not been accelerated by the lender, then we could also be declared in default on our derivative obligations. We also have agreements with our derivative counterparties that incorporate the loan covenant provisions of our indebtedness with lender affiliates of the derivative counterparties. Failure to comply with the loan covenant provisions would cause us to be in default on any derivative instrument obligations covered by the agreements.
Comprehensive Income (Loss)
We report comprehensive income or loss in our Consolidated Statements of Stockholders’ Equity, Comprehensive Income (Loss) and Noncontrolling Interests. Amounts reported in “Accumulated other comprehensive income (loss)” related to settled hedging transactions will be amortized to “Interest expense” as the hedged forecasted transactions occur. Any ineffectiveness related to our hedging transactions is reported in our Consolidated Statements of Operations. See Note 6-Financial Instruments and Hedging Activities for additional information.
Revenue Recognition
We record rental revenues on a straight-line basis under which contractual rent increases are recognized evenly over the full 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, we record receivables from tenants that we expect to collect over the remaining lease term rather than currently, which are recorded as a straight-line rent receivable. When we acquire a property, the terms of existing leases are considered to commence as of the acquisition date for the purposes of this calculation. The total increase to “Rental revenues” due to straight-line rent adjustments was approximately $9.3 million, $6.0 million and $1.8 million, respectively, for the years ended December 31, 2011, 2010 and 2009.
Tenant recovery income includes payments and amounts due from tenants pursuant to their leases for real estate taxes, insurance and other recoverable property operating expenses and is recognized as “Rental revenues” during the same period the related expenses are incurred. Tenant recovery income recognized as “Rental revenues” was approximately $48.2 million, $44.2 million and $45.7 million, respectively, for the years ended December 31, 2011, 2010 and 2009.
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. 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 and accelerated amortization due to early lease terminations was a increase of approximately $0.5 million, a decrease of $0.1 million and a decrease of $1.0 million for the years ended December 31, 2011, 2010 and 2009, respectively.
Future minimum base rental payments, i.e., cash monthly contractual rent, due to us from our tenants under the terms of non-cancelable operating leases in effect as of December 31, 2011 were as follows (in thousands):
The schedule 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, 2011, 2010 and 2009, early lease termination fees were $0.6 million, $0.7 million and $2.1 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 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.
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. 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 (including any applicable alternative minimum tax). 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-arms length transactions between us and our taxable REIT subsidiary (“TRS”) 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.
The Company follows FASB issued guidance for accounting for uncertainty in income taxes, which clarifies the accounting and disclosure for uncertainty in tax positions and seeks to reduce the diversity in practice associated with certain aspects of the recognition and measurement related to accounting for income taxes. The Company was subject to the provisions of this guidance as of January 1, 2007, and has analyzed its various federal and state filing positions, including the assertion that the income earned by the Company is not taxable.
The Company recognizes penalties and interest accrued related to unrecognized tax benefits, if any, as income tax expense. To the extent interest and penalties are not assessed with respect to uncertain tax positions, amounts accrued will be reduced and reflected as a reduction of the overall income tax expense. We had no interest expense or penalties related to unrecognized tax benefits for the years ended December 31, 2011, 2010 or 2009. As of December 31, 2011 and 2010, 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 tax returns are subject to examination in various jurisdictions for the calendar years 2007 through 2011.
New Accounting Standards
During the second quarter of 2011, the FASB issued Accounting Standards Update No. 201-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS, which generally aligns the principles for fair value measurements and the related disclosure requirements under US GAAP and International Financial Reporting Standards (“IFRS”). This standard requires new disclosures, with a particular focus on Level 3 measurements, including; quantitative information about the significant unobservable inputs used for all Level 3 measurements; qualitative discussion about the sensitivity of recurring Level 3 measurements to changes in the unobservable inputs disclosed, including the interrelationship between inputs and a description of the company’s valuation processes. This standard also requires disclosure of any transfers between Levels 1 and 2 of the fair value hierarchy; information about when the current use of a non-financial asset measured at fair value differs from its highest and best use and the hierarchy classification for items whose fair value is not recorded on the balance sheet but is disclosed in the notes. This standard is effective for interim and annual periods beginning after December 15, 2011. Early application is not permitted. We plan to adopt this standard during the first quarter of 2012 and do not expect that this standard will have a material effect on our Consolidated Financial Statements.
Also during the second quarter of 2011, the FASB issued Accounting Standards Update No. 2011-05, Presentation of Comprehensive Income, which eliminates the option to report other comprehensive income and its components in the statement of changes in stockholders’ equity. Entities will have the option to present the components of net income and other comprehensive income either in a single continuous statement or in two separate but consecutive statements. This standard requires retrospective application and is effective for interim and annual periods beginning after December 15, 2011. Early application is permitted. We plan to adopt this standard during the first quarter of 2012 and have determined that we will present the components of net income and other comprehensive income in two separate but consecutive statements.
Note 3 - Investment in Properties
Our consolidated investment in properties consist of operating properties, redevelopment properties, properties under development and properties in pre-development including land held for future development or other purposes. The historical cost of our investment in properties was (in thousands):
Acquisition Activity
2011 Acquisition Activity
During the year ended December 31, 2011, we acquired 24 buildings comprising 2.8 million square feet and controlling interests in three buildings totaling 0.4 million square feet. The properties are located in the Southern California, New Jersey, Miami, Orlando, Chicago, Phoenix, Atlanta, Denver, Houston, Seattle, Northern California and Chicago markets. These properties and controlling interests were acquired from unrelated third-parties, except as disclosed in Note 12-Related Party Transactions for a total purchase price of approximately $187.1 million, using proceeds from our equity offering, proceeds from asset sales, proceeds from our private placement of senior unsecured notes, borrowings under our senior unsecured revolving credit facility, proceeds from a nonrecourse mortgage financing, issuance of OP units and existing cash balances. We have consolidated the three properties in which we acquired controlling interests and, as a result, we recorded $196.9 million on our balance sheet, in the aggregate, for these three properties and the 24 other properties that we acquired during the year ended December 31, 2011. This amount included $9.8 million attributable to the noncontrolling interests’ share of these three properties. We expensed as incurred acquisition costs of approximately $1.9 million during the year ended December 31, 2011, included in “General and administrative” in our Consolidated Statement of Operations.
2010 Acquisition Activity
During the year ended December 31, 2010, we acquired ten properties comprising 1.0 million square feet and controlling interests in two buildings totaling 0.5 million square feet. These properties are located in the New Jersey, Southern California, Baltimore/Washington D.C., Houston, Chicago and Seattle markets. These properties and controlling interests were acquired from unrelated third-parties, except as disclosed in Note 12-Related Party Transactions, for a total purchase price of approximately $92.8 million using borrowings under our senior unsecured revolving credit facility, the private placement of our senior unsecured notes and existing cash balances, including those from our equity offering. We have consolidated the two properties in which we acquired controlling interests and, as a result, we recorded $106.8 million on our balance sheet, in the aggregate, for these two properties and the ten other properties that we acquired during the year ended December 31, 2010. This amount included $14.0 million attributable to the noncontrolling interests’ share of these two properties. We expensed as incurred acquisition costs of approximately $1.2 million during the year ended December 31, 2010, included in “General and administrative” in our Consolidated Statement of Operations.
Development Activity
2011 Development Activity
During the year ended December 31, 2011, construction was commenced on two projects located in our Baltimore/Washington D.C. and Houston markets. In Baltimore/Washington D.C. we are constructing two buildings which total 0.2 million square feet and are expected to be completed in 2012. In addition, we have entered into a forward purchase commitment for the construction of a 0.3 million square foot building located in the Houston market where construction is expected to be completed in 2012. (See Note 7-Commitments and Contingencies, for further information related to this forward purchase commitment.) The total costs incurred on these two projects as of December 31, 2011 was $9.6 million.
During the year ended December 31, 2011, we acquired five land parcels which total approximately 102.2 acres located in the Houston, Miami, Cincinnati and Southern California markets. The land parcels were acquired from unrelated third-parties for a total purchase price of $25.7 million, using proceeds from our equity offering, proceeds from asset sales, proceeds from our private placement of senior unsecured notes, borrowings under our senior unsecured revolving credit facility and existing cash balances.
2010 Development Activity
We acquired a 19.3 acre land parcel in Southern California through our 8th and Vineyard joint venture, which is with a related party, for a total purchase price of approximately $4.7 million using borrowings under our senior unsecured revolving credit facility, the private placement of our senior unsecured notes and existing cash balances, including those from our equity offering. (See additional details in Note 12-Related Party Transactions, related to the 8thand Vineyard joint venture.)
Disposition Activity
2011 Disposition Activity
During the year ended December 31, 2011, we sold 16 operating properties totaling approximately 2.7 million square feet to third-parties. The properties, located in the Minneapolis, Kansas City, Nashville, San Antonio and Charlotte markets were sold for combined gross proceeds of approximately $108.3 million. Seven property sales resulted in gains of approximately $12.0 million. Prior to the closing of the remaining property sales, which was a portfolio sale of nine properties in the Charlotte market, we incurred impairment losses totaling $7.8 million, which represented the difference between the carrying value and the fair value of the assets sold, net of sales costs. All gains and impairments associated with these sales are reflected in “Income (loss) from discontinued operations” in the Consolidated Financial Statements.
2010 Disposition Activity
During the year ended December 31, 2010, we sold eight operating properties totaling approximately 0.5 million square feet to third-parties. The properties, located in the Atlanta, Northern California, Miami, Cincinnati and Phoenix markets were sold for combined gross proceeds of approximately $21.6 million. Two property sales resulted in gains of approximately $2.1 million. Prior to the closing of the remaining property sales, we incurred impairment losses totaling $3.5 million, which represented the difference between the carrying value and the fair value of the assets sold, net of sales costs. All gains and impairments associated with these sales are reflected in “Income (loss) from discontinued operations” in the Consolidated Financial Statements.
Intangible Assets
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 $11.5 million, $11.1 million and $17.2 million for the years ended December 31, 2011, 2010 and 2009, respectively.
Our intangible lease assets and liabilities included the following as of December 31, 2011 and 2010 (in thousands):
The following table describes the estimated net amortization of such intangible assets and liabilities for the next five years and thereafter. In addition, the table describes 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
In February 2011, a storm caused significant damage to one of our properties in our Nashville market. The property was insured by the tenant in an amount for storms which was sufficient to cover any losses. In April 2011, we received an initial payment from the tenant of approximately $5.0 million for damages related to this casualty. Our cost of repairing the total damages was approximately $5.1 million. The recoveries received for damages were in excess of the sum of our incurred losses of approximately $3.8 million for clean-up costs and the net book value write-off of the damaged property. All contingencies relating to the casualty have been resolved and we have recorded a casualty gain of approximately $1.3 million which was included in “Income (loss) from discontinued Operations” in the Consolidated Statements of Operations during the year ended December 31, 2011, as the property was sold in the fourth quarter of 2011.
Note 4 - Investments in and Advances to Unconsolidated Joint Ventures
We enter into joint ventures primarily for purposes of developing industrial real estate and to establish funds or other commingled investment vehicles with institutional partners. Our investments in these joint ventures are included in “Investments in and advances to unconsolidated joint ventures” in our Consolidated Balance Sheets. The following describes our unconsolidated joint ventures as of December 31, 2011 and 2010.
(1) Although we contributed 100% of the initial cash equity capital required by the venture, our partners retain certain participation rights in the venture’s available cash flows.
(2) See discussion of impairment recorded on our investment in this unconsolidated joint venture during 2011 below.
(3) During 2011, our unconsolidated joint ventures completed dispositions of three properties in Cincinnati, Kansas City and Northern California for gross proceeds, net of joint venture partners’ interest, of $13.8 million. We recognized deferred gains upon disposition of these properties totaling $0.7 million.
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 United States. Our actual ownership percentage may vary depending on amounts of capital contributed and the timing of contributions and distributions. As of December 31, 2011 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 $3.1 million as of December 31, 2011, which will be recognized through earnings over the weighted average life of the related properties, or upon disposition of the properties to a third-party.
TRT-DCT Industrial Joint Ventures I, II and III
We entered into our first joint venture agreement with Dividend Capital Total Realty Trust Inc. (“DCTRT”) TRT-DCT Venture I on September 1, 2006 that owns and operates industrial properties located in the United States. Our actual ownership percentage may vary depending on amounts of capital contributed and the timing of contributions and distributions. As of December 31, 2011 our ownership interest is 4.4%. As a result of our
contribution of properties into TRT-DCT Venture I in 2006, we have deferred gains of $0.4 million as of December 31, 2011, which will be recognized through earnings over the weighted average life of the related properties, or upon disposition of the properties to a third-party. No further assets are planned to be acquired by the joint venture.
We formed our second joint venture agreement with DCTRT, TRT-DCT Industrial Joint Venture II G.P. (“TRT-DCT Venture II”), on March 27, 2007, that owns and operates industrial properties located in the United States. Our actual ownership percentage may vary depending on amounts of capital contributed and the timing of contributions and distributions. As of December 31, 2011 our ownership interest is 11.4%. As a result of our contribution of properties into TRT-DCT Venture II in 2007, we have deferred gains of $0.6 million as of December 31, 2011, which will be recognized through earnings over the weighted average life of the related properties, or upon disposition of the properties to a third-party.
We formed our third joint venture agreement with DCTRT, TRT-DCT Industrial Joint Venture III, G.P. (“TRT-DCT Venture III”), on September 9, 2008, that owns and operates industrial properties located in the United States. TRT-DCT Venture III is also structured and funded in a manner similar to TRT-DCT Venture I. Our actual ownership percentage may vary depending on amounts of capital contributed and the timing of contributions and distributions. As of December 31, 2011 our ownership interest is 10.0%.
DCT Fund I LLC
On February 21, 2006, we entered into a joint venture with affiliates of Boubyan Bank of Kuwait (“BBK”), an unrelated third-party, to create an institutional fund, DCT Fund I LLC (“Fund I”), that owns and operates industrial properties located in the United States. Our actual ownership percentage may vary depending on amounts of capital contributed and the timing of contributions and distributions. Our actual ownership percentage may vary depending on amounts of capital contributed and the timing of contributions and distributions. As of December 31, 2011 our ownership interest is 20.0%. As a result of our contribution of properties into Fund I in 2006, we have deferred gains of $1.6 million as of December 31, 2011, which will be recognized through earnings over the weighted average life of the related properties, or upon disposition of the properties to a third-party.
Development Projects in Unconsolidated Joint Ventures
SCLA
During 2006, we entered into a joint venture agreement with Stirling Airports International, LLC, or 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 Southern California Logistics Airport (“SCLA”). We refer to this joint venture as the SCLA joint venture. 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 only 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, 2011, the SCLA joint venture had six operating buildings comprised of 2.0 million square feet which were 95.4% occupied and an additional 209 acres of land available for development.
IDI/DCT, LLC
During 2007, we entered into a joint venture agreement with Industrial Developments International, Inc. (“IDI”), an unrelated third-party developer, to acquire approximately 113 acres of land to develop four distribution buildings comprising approximately 1.9 million square feet in the Savannah, GA, Nashville, TN, Chicago, IL, and Stockton, CA markets. DCT has the right of first offer to buy each of the projects and the buildings are operating.
In December of 2010, DCT and IDI entered into an amendment to the LLC agreement and made additional capital contributions of $6.0 million each to reduce the overall debt to equity ratio of IDI/DCT, LLC. Simultaneously, DCT made an additional capital contribution of $24.2 million to pay down our proportionate share of the outstanding debt and accrued interest to zero. At the same time, IDI/DCT, LLC refinanced the remaining $24.1 million of debt, and IDI’s parent guaranteed this debt, including future interest and principal payments.
In June 2011, the joint venture entered into a sale agreement with a third-party for one of its four buildings, which closed in August 2011. As a result of the contracted sales price less costs to sell being lower than the carrying amount of the related real estate assets, the joint venture recognized an impairment loss. Our portion of the impairment loss was approximately $2.0 million, which is included in “Impairment losses from unconsolidated joint ventures” in our Consolidated Statement of Operations for the year ended December 31, 2011.
IDI/DCT Buford, LLC
During 2008, we entered into a joint venture agreement with IDI to form IDI/DCT Buford, LLC. This joint venture was funded for the purpose of developing four distribution buildings comprised of approximately 0.6 million square feet in Atlanta, Georgia on approximately 47 acres contributed to the joint venture by DCT. During the year ended December 31, 2010, we recognized impairment on our investment in the joint venture of $0.2 million as a result of the anticipated timing of the commencement of the development (see further discussion of the land impairment in Note 2-Summary of Significant Accounting Policies).
The following table provides unaudited selected combined financial information for unconsolidated joint ventures as of and for the years ended December 31, 2011, 2010 and 2009 (in thousands).
Our aggregate investment in these partnerships at December 31, 2011 and 2010 of $139.3 million and $138.5 million, respectively, exceeds our share of the underlying equity in net assets of our joint ventures by approximately $16.7 million and $15.8 million, respectively, primarily due to capitalized interest and other costs incurred in connection with the ventures.
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 believe we have no material exposure to financial guarantees.
Note 5-Outstanding Indebtedness
As of December 31, 2011, our outstanding indebtedness of approximately $1.3 billion consisted of mortgage notes and senior unsecured notes, excluding $61.7 million representing our proportionate share of debt associated with unconsolidated joint ventures. As of December 31, 2010, our outstanding indebtedness consisted of mortgage notes, senior unsecured notes and a senior unsecured revolving credit facility and totaled approximately $1.2 billion, excluding $62.3 million representing our proportionate share of debt associated with unconsolidated joint ventures.
As of December 31, 2011, the gross book value of our consolidated properties was approximately $3.2 billion and the gross book value of all properties securing our mortgage debt was approximately $0.7 billion. As of December 31, 2010, the total gross book value of our consolidated properties was approximately $3.0 billion and the gross book value of all properties securing our mortgage debt was approximately $1.0 billion. Our debt has various covenants with which we were in compliance as of December 31, 2011 and 2010.
Our outstanding indebtedness as of December 31, 2011 is summarized below (dollars in thousands).
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(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 2011.
(2) We assigned certain derivative instruments to these notes and the fair value of these derivative instruments are amortized to interest expense over the life of the assigned notes.
(3) The $175.0 million term loan agreement bears interest at either 0.80% to 1.65% over prime or 1.80% to 2.65% over LIBOR, per annum at our election, depending upon our leverage ratio.
(4) Weighted average interest rates are based upon outstanding balances as of December 31, 2011.
(5) Certain mortgages were assumed in conjunction with the acquisition of properties and the difference between the fair value and the face value of these notes at the date of acquisition is reflected as a premium or discount which are amortized to interest expense over the remaining life of the underlying note.
(6) The Company refinanced its $300 million senior unsecured revolving credit facility in June 2011. The new facility expires on June 3, 2015 and bears interest at either 0.65% to 1.35% over prime or 1.65% to 2.35% over LIBOR, per annum at our election, depending upon our leverage ratio. We have issued two letters of credit secured by the senior unsecured credit facility totaling $9.8 million.
Debt Payoffs, Refinancing and Issuance
During the year ended December 31, 2011, we retired $124.7 million of maturing mortgage notes which were repaid using proceeds from the Company’s senior unsecured revolving credit facility and with proceeds from our senior unsecured notes issued through a private placement discussed below.
In April 2011, we refinanced $50.0 million of maturing senior unsecured notes. The new fixed-rate notes bear interest of 5.43%, mature in April 2020 and require quarterly interest payments.
On June 3, 2011, we entered into a term loan agreement with a syndicate of 12 banks, pursuant to which we borrowed $175.0 million through a senior unsecured loan. The term loan is scheduled to mature on June 3, 2015 and may be prepaid in whole or in part at any time. The term loan agreement provides for a variable interest rate based on either the base rate under the agreement or LIBOR, at our election, plus a margin that is initially based on our leverage ratio. The margins on base rate loans initially may range from 0.80% to 1.65% per annum, and the margins on LIBOR-based loans may range from 1.80% to 2.65% per annum. This loan agreement has various covenants with which we are in compliance as of December 31, 2011. We used the term loan, together with proceeds from a draw under our senior unsecured revolving credit facility, to repay our unsecured term loan that was scheduled to mature on June 6, 2011.
On August 1, 2011 we issued $225.0 million of new fixed rate, senior unsecured notes through a private placement. These senior unsecured notes have a weighted average maturity of 8.5 years and a weighted average interest rate of 4.93%. The notes have maturities of 5, 7, 8, 10, 11 or 12 years. Proceeds from these notes were used to repay outstanding indebtedness and for general corporate purposes.
On November 4, 2011, we issued a non-recourse mortgage note for $20.0 million in connection with a property acquisition. The note bears interest of 4.25%, requires monthly payments of principal and interest and matures in December 2021.
In January 2010, we repaid approximately $42.0 million of $112.0 million of debt previously scheduled to mature in 2012. The remaining balance of approximately $70.0 million was refinanced at a fixed rate of 6.11% with a new maturity of 2020 and mortgages on five properties were released. In February 2010, we repaid approximately $49.9 million of $102.9 million of debt previously scheduled to mature in 2011. The remaining balance of approximately $53.0 million was refinanced at a fixed rate of 6.17% with a new maturity of 2019 and mortgages on 11 properties were released. The debt repayments were funded using borrowings under our senior unsecured revolving credit facility and cash flows from operations. These transactions were treated as debt modifications pursuant to GAAP.
On June 6, 2010, we repaid $100.0 million of our senior unsecured term loan using funds borrowed on our senior unsecured revolving credit facility and extended the maturity on the remaining $200 million balance for one year. The $200 million term loan has a new interest rate based on LIBOR plus 1.25% to 1.80% or at prime, at our election and was treated as a debt modification pursuant to GAAP.
On June 22, 2010, we issued $210.0 million of fixed rate, senior unsecured notes to a group of 12 investors in a private placement offering. These notes were issued with a weighted average term of 8.3 years, include five, seven, eight and 11 year maturities and have a weighted average interest rate of approximately 6.46%. Proceeds from the transaction were used to repay amounts outstanding on our senior unsecured revolving credit facility.
Debt Assumptions
During the year ended December 31, 2011, we assumed two non-recourse mortgage notes with outstanding balances of approximately $3.9 million and $3.4 million, respectively, in connection with two property acquisitions. The assumed notes bear interest at 4.96% and 6.0%, respectively, and require monthly payments of principal and interest. The notes mature in August 2023 and April 2014, respectively.
During the year ended December 31, 2010, we assumed secured, non-recourse notes with outstanding balances totaling approximately $19.6 million in connection with three property acquisitions. These assumed notes bear interest at fixed rates ranging from 7.29% to 7.55% and require monthly payments of principal and interest. The maturity dates of the assumed notes range from April 2011 to October 2022. In accordance with GAAP, the difference between the fair value and face value of these assumed notes at the date of acquisition resulted in a premium of approximately $1.5 million, which is amortized to interest expense over the remaining life of the underlying notes.
For the years ended December 31, 2011, 2010 and 2009, the amortization of all premiums/discounts resulted in a reduction of interest expense of approximately $1.1 million, $1.1 million and $1.0 million, respectively.
Line of Credit
On June 3, 2011 we entered in an amendment to extend the maturity date of our $300.0 million senior unsecured revolving credit facility from August 19, 2013 until June 3, 2015. This amendment also increased the number of banks included on the facility from nine to twelve and reduced the interest rate payable to either 0.65% to 1.35% over prime or 1.65% to 2.35% over LIBOR, per annum at our election, depending upon the Company’s leverage ratio. The amendment also provides us the ability, from time to time, to extend the size of the facility by up to an additional $200.0 million, to a total of $500.0 million, subject to receipt of lender commitments and other conditions. We incurred a total of approximately $2.1 million in fees paid to the creditor and third-party costs which have been deferred and will be amortized over the life of the new credit facility. Proceeds from draws on the line have been used to pay off mortgage notes and senior unsecured notes as they became due, to finance our property acquisitions and for general corporate purposes including payment of distributions. See Note 3-Investment in Properties for further detail related to our property acquisitions.
As of December 31, 2011 we had no balance outstanding on our senior unsecured revolving credit facility; however we have issued two letters of credit secured by the senior unsecured revolving credit facility totaling $9.8 million. As of December 31, 2010, we had $51.0 million outstanding on our senior unsecured revolving credit facility.
Capitalized Interest
During the years ended December 31, 2011, 2010 and 2009, we incurred interest expense of approximately $64.3 million, $57.0 million and $52.9 million, respectively, including amounts from discontinued operations. We capitalized approximately $2.7 million, $2.2 million and $6.1 million of interest in 2011, 2010 and 2009, respectively, associated with certain development and redevelopment, and other construction activities.
Debt Maturities
The following table sets forth the scheduled maturities of our debt and regularly scheduled principal amortization, excluding unamortized premiums, as of December 31, 2011 (amounts in thousands).
Note 6 - Financial Instruments and Hedging Activities
Fair Value of Financial Instruments
As of December 31, 2011 and 2010, the fair values of cash and cash equivalents, restricted cash held in escrow, accounts receivable and accounts payable approximated their carrying values because of the short-term nature of these instruments. The estimated 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 for these purposes. Considerable judgment and a high degree of subjectivity are involved in developing these estimates. These are our best estimates; however, they 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 notes receivable and 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 as a result of the difference between the fair value and face value of debt assumed in connection with our acquisition activities.
(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. We also incorporate a credit valuation adjustment, which is derived using unobservable Level 3 inputs, to appropriately reflect both our nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurement. For further discussion on the fair value of our interest rate swap, see Note 2-Significant Accounting Policies.
The following table displays a reconciliation of liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2011 and 2010. During the same periods, we had no assets measured at fair value on a recurring basis. The table also displays gains and losses due to changes in fair value, including both realized and unrealized, recognized in the Consolidated Statements of Operations for Level 3 liabilities. When assets and liabilities are transferred between levels, we recognize the transfer at the beginning of the period.
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. During 2011, 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 the issuances of new debt, as well as refinancing of existing debt upon maturity.
As of December 31, 2011, we had one forward-starting swap in place to hedge the variability of future cash flows associated with forecasted issuances of debt. This derivative has a notional value of $90.0 million, a LIBOR based swap strike rate of 5.43%, an effective date of June 2012 and a maturity date of September 2012. The associated counterparty is PNC Bank, NA.
We measure our derivative at fair value, which was a liability of approximately $26.7 million and $10.1 million as of December 31, 2011 and 2010, respectively, included in “Other liabilities” in our Consolidated Balance Sheets. The fair value of the derivative was determined using Level 2 and 3 inputs. The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in “Accumulated other comprehensive loss” and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings and is recorded as “Interest and other income” in our Consolidated Statements of Operations. During the years ended December 31, 2011, 2010 and 2009, we recorded no ineffectiveness.
During the years ended December 31, 2011 and 2010, we recorded approximately $16.6 million and $7.4 million, respectively, of net unrealized losses, including the noncontrolling interests’ portions of $1.6 million and $0.8 million, respectively, in “Accumulated other comprehensive loss” as a result of the change in fair value of our outstanding hedges. As of December 31, 2011 and 2010, the “Accumulated other comprehensive loss” balances pertaining to the hedges were losses of approximately $32.6 million and $17.0 million, respectively, including the noncontrolling interests’ portion.
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 $2.6 million will be reclassified from “Accumulated other comprehensive loss” to “Interest expense” resulting in an increase in such expense.
Note 7 - Commitments and Contingencies
Forward Purchase Commitment
In August 2011, we entered into a forward purchase commitment with an unrelated third-party developer to acquire a newly constructed industrial facility totaling approximately 267,000 square feet in the Houston market. The forward purchase commitment allows us to acquire the building and related land upon completion of construction, subject to a variety of conditions including the building complying with approved drawings and specifications. The purchase price of $12.4 million includes estimates for allowances for tenant improvements and leasing commissions. The closing under the forward purchase commitment is expected in mid 2012. We made two deposits on the project; the first was in cash totaling $1.0 million and the second was in the form of an unconditional standby letter of credit totaling $3.3 million. The cash deposit and letter of credit will be applied towards the purchase price at closing in accordance with the agreement.
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
We are obligated under non-cancelable office space, ground and equipment operating leases. Approximate minimum annual rentals under operating leases are as follows (in thousands):
Substantially all of the office space and equipment subject to the operating leases described above are for the use at our corporate and regional offices. Rent expense recognized was approximately $1.1 million, $1.2 million and $0.9 million during the years ended December 31, 2011, 2010 and 2009, respectively.
Note 8 - Noncontrolling Interests
Noncontrolling interests are the portion of equity, or net assets, in a subsidiary not attributable, directly or indirectly, to a parent. Our noncontrolling interests primarily represent limited partnership interests in our operating partnership and equity interests held by third-party partners in our consolidated real estate joint ventures. Our noncontrolling interests held by third-party partners in our consolidated joint ventures totaled $11.7 million and $9.2 million as of December 31, 2011 and 2010, respectively.
Noncontrolling interests representing interests in our operating partnership include preferred shares in our Mexico REIT and Cabot REIT, OP Units and LTIP units which are classified as permanent equity in accordance with GAAP and are included in “Noncontrolling interests” in our Consolidated Balance Sheets.
OP Units
As of December 31, 2011 and 2010, we owned approximately 90% of the outstanding equity interests of our operating partnership. Upon redemption by the unitholder, we have the option of redeeming the OP Units with cash or with shares of our common stock on a one-for-one basis, subject to adjustment.
During November 2011, we issued approximately 1.0 million OP units, at a price of $5.20 per share, representing a portion of the purchase price in connection with a property acquisition in the Northern California market.
During the year ended December 31, 2011, 1.0 million OP Units were redeemed for approximately $0.3 million in cash and 0.9 million shares of common stock. As of December 31, 2011, there was a total of 25.1 million OP Units outstanding with a redemption value of approximately $128.5 million based on the closing price of our common stock on December 31, 2011, all of which were redeemable for cash or stock, at our election.
During the year ended December 31, 2010, 2.4 million OP Units were redeemed for approximately $1.0 million in cash and 2.2 million shares of common stock. As of December 31, 2010, there was a total of 25.0 million OP Units outstanding with a redemption value of approximately $132.9 million based on the closing price of our common stock on December 31, 2010.
LTIP Units
We may grant limited partnership interests in our operating partnership called LTIP Units. LTIP Units, which we grant either as free-standing awards or together with other awards under our Long-Term Incentive Plan, are valued by reference to the value of our common stock, and are subject to such conditions and restrictions as our compensation committee may determine, including continued employment or service, computation of financial metrics and/or achievement of pre-established performance goals and objectives. During the years ended December 31, 2011 and 2010, we granted 0.6 million and 0.6 million LTIP Units, respectively, to certain officers and senior executives. The total fair value of these LTIP Units on the date of grant was $3.0 million and $3.0 million, respectively.
During the years ended December 31, 2011 and 2010, 0.1 million and 0.3 million vested LTIP Units, were redeemed on a one-for-one basis into OP Units, respectively. As of December 31, 2011 and 2010, 1.9 million and 1.6 million LTIP Units were outstanding, respectively, of which 0.9 million and 0.3 million were vested, respectively. Our LTIP unit grants are further discussed in Note 11-Equity Based Compensation.
The following table illustrates the noncontrolling interests’ share of our consolidated net income (loss) during the years ended December 31, 2011, 2010 and 2009 (in thousands).
Note 9 - Stockholders’ Equity
Common Stock
As of December 31, 2011 and 2010, approximately 245.9 million and 222.9 million shares of common stock were issued and outstanding, respectively.
On February 18, 2011, we issued 21.9 million shares of common stock in a public offering at a price of $5.35 per share for net proceeds of $111.9 million.
On March 23, 2010, we registered a “continuous equity” offering program. Pursuant to this offering, we may sell up to 20 million shares of common stock from time-to-time through March 23, 2013 in “at-the-market” offerings
or certain other transactions. We intend to use the proceeds from any sale of shares for general corporate purposes, which may include funding acquisitions and repaying debt. We did not issue any shares under this offering during 2011. During the year ended December 31, 2010, we issued approximately 12.6 million shares of common stock through this offering.
During the year ended December 31, 2011, we issued approximately 0.9 million shares of common stock related to the redemption of OP Units (see additional information in Note 8 - Noncontrolling Interests), and approximately 0.2 million shares of common stock related to vested shares of restricted stock, phantom shares and stock option exercises.
During the year ended December 31, 2010, we issued approximately 2.2 million shares of common stock in connection with redemptions of OP Units and approximately 0.1 million shares of common stock related to vested shares of restricted stock, phantom shares and stock option exercises.
The net proceeds from the sales of our securities were transferred to our operating partnership for a number of OP Units equal to the shares of common stock sold in our public and private offerings, including the offerings noted above.
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 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 will not have preemptive rights.
Dividend Reinvestment and Stock Purchase Plan
In April 2007, we began offering 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, 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, 2011 and 2010, we had no outstanding shares of preferred stock.
Shares-in-Trust
Our board of directors, through the articles of incorporation, has the authority to authorize the issuance of 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, 2011 and 2010, we had no outstanding shares-in-trust.
Distributions
Our distributions are calculated based upon the total number of shares of our common stock or limited partnership units of our operating partnership 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 sets forth the distributions that have been paid and/or declared to date by our board of directors.
Note 10 - Earnings per Share
We use the two-class method of computing earnings per common share which is an earnings allocation formula that determines earnings per share for common stock and any participating securities according to dividends declared (whether paid or unpaid) and participation rights in undistributed earnings. Under the two-class method, earnings per common share are computed by dividing the sum of distributed earnings to common stockholders and undistributed earnings allocated to common stockholders by the weighted average number of common shares 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 pursuant to the two-class method. Our 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.
The following table sets forth the computation of our basic and diluted earnings per common share (in thousands except per share information):
Potentially Dilutive Shares
We have excluded from diluted earnings per share the weighted average common share equivalents related to approximately 5.7 million, 5.5 million and 4.1 million stock options, phantom stock and warrants for the years ended December 31, 2011, 2010, and 2009 respectively, because their effect would be anti-dilutive.
Note 11 - Equity Based Compensation
Long-Term Incentive Plan
On October 10, 2006, we adopted, and our stockholders approved, our Long-Term Incentive Plan. We use our Long-Term Incentive Plan to grant restricted stock, stock options and other equity awards to our eligible employees. 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 23.0 million shares and in no event may any optionee receive options for more than 2.0 million shares on an annual basis.
Phantom Shares
Pursuant to the Long-Term Incentive Plan, we may grant phantom shares to our non-employee directors. Our phantom shares typically 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 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. For the years ended December 31, 2011, 2010 and 2009, we incurred approximately $0.3 million, $0.3 million, $0.3 million,
respectively, of such expense which is included in “General and administrative” in our Consolidated Statements of Operations. As of December 31, 2011, approximately $0.1 million of such expense remained unrecognized which reflects the unamortized portion of the value of such shares issued pursuant to the Long-Term Incentive Plan. We expect to recognize such expense over a remaining period of six months.
During the years ended December 31, 2011, 2010 and 2009, we issued 46,054, 17,390 and 15,970 shares of common stock for vested phantom stock, respectively. Based on the share’s fair value at grant date for each grant, the total fair value of phantom stock vested in 2011, 2010 and 2009 was $0.3 million, $0.3 million and $0.3 million, respectively. As of December 31, 2011, 2010 and 2009 we had 120,895, 112,324 and 75,562 phantom shares outstanding.
Restricted Stock
Our restricted stock is recorded at fair value on the date of grant and amortized on a straight-line basis over the service period during which term the stock fully vests. Our restricted stock typically vests ratably over a period of four to five years, depending on the grant. For the years ended December 31, 2011, 2010 and 2009, we incurred approximately $0.7 million, $0.6 million and $0.7 million, respectively, of such expense which is included in “General and administrative” in our Consolidated Statements of Operations. As of December 31, 2011, approximately $1.2 million of such expense remained unrecognized which reflects the unamortized portion of the value of such shares issued pursuant to the Long-Term Incentive Plan. We expect to recognize such expense over a weighted average remaining period of 2.3 years.
During the years ended December 31, 2011, 2010 and 2009, we issued 119,984, 84,887 and 65,490 shares of common stock for vested restricted stock. Based on the share’s fair value at grant date for each grant, the total fair value of restricted stock vested in 2011, 2010 and 2009 was $0.6 million, $0.4 million and $0.6 million, respectively.
LTIP Units
Pursuant to our Long-Term Incentive Plan, we may grant newly established limited partnership interests in our operating partnership called LTIP Units (“LTIP Units”). LTIP Units, which we grant either as free-standing awards or together with other awards under our Long-Term Incentive Plan, are valued by reference to the value of our common stock, and are subject to such conditions and restrictions as our compensation committee may determine, including continued employment or service, computation of financial metrics and/or achievement of pre-established performance goals and objectives. Our LTIP Units typically vest ratably over a period of four to five years, depending on the grant. Vested LTIP Units can be redeemed for OP Units on a one-for-one basis.
During the year ended December 31, 2011, 0.6 million LTIP Units were granted to senior executives which vest over a period of four to five years. The total fair value of the LTIP Units granted was $3.0 million at their respective grant dates. The fair value for each grant was determined using a lattice-binomial option-pricing model based on a Monte Carlo simulation using volatility factors ranging from 67% to 71% and risk-free interest rates ranging from 0.85% to 2.18%.
During the year ended December 31, 2010, we granted 0.6 million LTIP Units to senior executives which vest over a period of three to four years. The total fair value of the LTIP Units granted was $3.0 million at their respective grant dates. The fair value for each grant was determined using a lattice-binomial option-pricing model based on a Monte Carlo simulation using volatility factors ranging from 61% to 62% and risk-free interest rates ranging from 2.39% to 2.55%.
During the year ended December 31, 2009, we granted 0.4 million LTIP Units in total to certain senior executives which vest 25% annually over four years and had a total fair value of $1.5 million at the date of grant as determined by a lattice-binomial option-pricing model based on a Monte Carlo simulations using a volatility factor of 48% and a risk-free interest rate of 1.79%.
Our LTIP Units 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 units fully vest. We incurred approximately $2.9 million, $2.9 million and $4.6 million including $0.9 million due to a change in our estimated forfeiture rate, of such expense for the years ended December 31, 2011, 2010 and 2009, respectively, which is included in “General and administrative expense” in our Consolidated Statements of Operations. As of December 31, 2011, approximately $3.4 million of such expense remained unrecognized which reflects the unamortized portion of the value of such LTIP Units which we expect to recognize over a remaining weighted average period of 3.1 years.
During the years ended December 31, 2011, 2010, and 2009, 0.1 million, 0.3 million and 0.2 million vested LTIP Units were redeemed for OP Units and converted to common stock on a one for one basis, respectively. Based on the LTIP Unit’s fair value at grant date for each grant, the fair value of LTIP Units vested in 2011, 2010, and 2009 was $4.6 million, $0.4 million and $3.8 million, respectively. As of December 31, 2011, 2010 and 2009, we had 1.9 million, 1.6 million and 1.3 million LTIP Units outstanding, respectively.
The following table summarizes additional information concerning our unvested phantom shares, restricted stock and LTIP Units (shares in thousands).
Stock Options
We may grant stock options to certain employees pursuant to our Long-Term Incentive Plan. 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 prior to 2007. During the year ended December 31, 2011, we issued approximately 50,000 shares of common stock upon the exercise of options to purchase our common stock by certain employees.
During the years ended December 31, 2011, 2010 and 2009, options issued under the Long-Term Incentive Plan were valued using the Black-Scholes option pricing model. The table below sets forth the assumptions used in valuing such options.
(1) We use the simplified method to determine the estimated life of our option awards as sufficient historical exercise data is unavailable. Under the simplified method the expected term is calculated as the midpoint between the vesting and the end of the contractual term of the option.
Multi-Year Outperformance Program
On January 11, 2010, we adopted a multi-year outperformance program, which is a long-term incentive compensation program, and granted awards under the program to certain officers and senior executives.
The awards entitle participants to receive shares of common stock with a maximum value of $10 million based on the absolute and relative total return to stockholders during the three-year performance period beginning on December 31, 2009. Half of the awards are based on our absolute total return to stockholders during the performance period and the other half are based on our relative total return to stockholders during the performance period compared to the performance of the MSCI US REIT Index during the same period.
Each participant’s award is designated as a specified percentage of the aggregate award value earned during the performance period, and participants are also entitled to a share of any unallocated portion of the aggregate award value. At the end of the performance period, each participant will be issued shares of our common stock with a value equal to that participant’s share of the aggregate award value. Half of the shares of common stock issued will be fully vested upon issuance at the end of the performance period and the remaining half will vest on the first anniversary of that date based on continued employment. We may also permit participants to elect to receive their awards in the form of LTIP Units or other equivalent forms of equity in lieu of shares of common stock.
We did not grant any awards under the program during 2011. The grant date fair value of the awards granted under the program during the year ended December 31, 2010 was approximately $1.6 million. During the years ended December 31, 2011 and 2010 we recognized approximately $0.1 million and $0.5 million of expense which is included in “General and administrative” in our Consolidated Statement of Operations related the amortization of these awards.
2006 Outperformance Program
On December 13, 2006, we adopted an outperformance program which provided for certain grants to be made under (and subject to) our Long-Term Incentive Plan, under which LTIP Units (as described above) are earned by selected senior executives if certain pre-established performance targets related to our compound annual stockholder return are met. Pursuant to the outperformance program, participating executives could share in a “performance pool” if our total stockholder return for the three year performance period, beginning December 13, 2006, exceeded the greater of an absolute compound annual total stockholder return of 10% or 110% of the compound annual return of the MSCI US REIT Index. The size of the pool for the initial program was 10% of the outperformance amount in excess of the performance hurdle, subject to a maximum amount of $40 million. Each executive’s award under the program was designated as a specified percentage of the aggregate
performance pool and such awards were to be made in the form of LTIP Units. These LTIP Units were not entitled to distributions until and unless the performance pool is established. Half of the LTIP Units earned awards under the program (i.e. the number of LTIP Units earned) were scheduled to vest at the end of the three-year performance period, if the performance pool was established, after which the other half would vest ratably over the following two-year period. In October 2009, the outperformance program was canceled.
The LTIP Units associated with the program were originally recorded at their fair value of $2.9 million on the date of grant as determined by a lattice-binomial option-pricing model based on a Monte Carlo simulation using a volatility factor of 16.31% and a risk-free interest rate of 4.62%, and amortized on a straight-line basis over the period during which the grant of such units fully vest. During the year ended December 31, 2009, we incurred approximately $2.1 million expense, which includes $1.4 million in accelerated amortization resulting from the program’s cancellation, which is included in “General and administrative” in our Consolidated Statements of Operations.
Employee Option Plan
Prior to October 6, 2006, we issued stock options under the Employee Option Plan, which was designed to enable us, our Former Advisor and its affiliates to obtain or retain the services of employees (not to include our directors) of our Former Advisor and its affiliates considered essential to our long-term success and the success of our Former Advisor and its affiliates by offering such employees an opportunity to participate in our growth through ownership of our shares. The Employee Option Plan was administered by our compensation committee, which was authorized to grant “non-qualified” stock options (the “Employee Options”) to certain employees of our Former Advisor and its affiliates. The compensation committee set the exercise price for the Employee Options in its discretion, which could not be less than the greater of (1) $11.00 per share or (2) the fair market value of the shares on the date the Employee Option was granted. A total of 1.0 million shares were authorized and reserved for issuance under the Employee Option Plan. The compensation committee set the term of Employee Options in its discretion, which could not exceed the later of five years from the date of grant or five years from the date of a listing of our common stock. Our compensation committee set the period during which the right to exercise an Employee Option fully vests at three years from the date of grant. Since the adoption of the Long-Term Incentive Plan on October 6, 2006, no further grants were made pursuant to the Employee Option Plan.
During the year ended December 31, 2007, options issued under the Employee Option Plan were valued using the Black-Scholes option pricing model. No employee options were granted under this plan subsequent to 2006.
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. We granted non-qualified stock options to purchase 10,000 shares to each independent director pursuant to the Independent Director Option Plan effective upon the later of (1) the sale of 0.2 million shares in our first continuous public offering, and (2) the independent director becoming a member of our board of directors. These options vest 20% upon grant date and 20% each year for the following four years and have an exercise price of $12.00 per share. In addition, we issued options to purchase 5,000 shares to each independent director then in office on the date of each annual stockholder’s meeting and these options vest 100% upon the second anniversary from the grant date and have an exercise price equal to the greater of (1) $12.00 per share or (2) the fair market value of the shares on the date they are granted. Options granted under the Independent Director Option Plan shall lapse on the first to occur of (1) the tenth anniversary of the date we grant them, (2) the removal the independent director for cause, or (3) three months following the date the independent director ceases to be a director for any reason, other than death or disability. Since the adoption of the Long-Term Incentive Plan, no further grants were made pursuant to the Independent Director Option Plan. During the years ended December 31, 2007, options issued under the Independent Director Option Plan were valued using the Black-Scholes option pricing model. No options were issued under this plan subsequent to 2006.
Stock Options Summary Table
Stock options granted under the Long-Term Incentive Plan, the Employee Option Plan 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. For the years ended December 31, 2011, 2010 and 2009 we incurred approximately $0.6 million, $0.6 million, and $1.0 million, respectively, of such expense which is included in “General and administrative” in our Consolidated Statements of Operations. As of December 31, 2011, approximately $0.8 million of such expense remained unrecognized which reflects the unamortized portion of the value of such options issued pursuant to the aforementioned plans. We expect to recognize such expense over a remaining weighted average period of 2.4 years.
The following table describes the total options outstanding, granted, exercised, expired and forfeited as of and during the years ended December 31, 2011, 2010, 2009, as well as the total options exercisable as of December 31, 2011.
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 one of our executives, 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.
Southern California Consolidated Ventures
We entered into four agreements, two in December 2010 and two in January 2011, whereby we acquired a weighted average controlling interest, based on square feet, of approximately 48.4% in five bulk industrial buildings located in the Southern California market. One of our executives has a weighted average noncontrolling 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. DCT has controlling rights including management of the operations of the properties and we have consolidated the properties and accounted for the transactions as business combinations. The total acquisition price of $46.3 million was determined to be at fair value.
Shared services agreement
During 2009, we had a shared services agreement with Overhead Services, Inc., formerly DC Services, LLC, (“Overhead Services”), an affiliate of Dividend Capital Advisors Group LLC (“DCAG”) whereby we received enumerated services (including IT services, human resources and payroll services) for a monthly fee payable to Overhead Services, which totaled approximately $0.6 million during the year ended December 31, 2009. Effective October 2009, we no longer had a related party relationship with DCAG.
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 Internal Revenue Code Section 856 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 in the Internal Revenue 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. As of December 31, 2011, 2010 and 2009 we had recorded a $0.7 million benefit, a $0.3 million benefit, and a $0.7 million expense in provisions for federal and state income taxes on our taxable REIT subsidiaries, respectively. We are also subject to state and local taxes and recorded $0.8 million, $1.1 million and $1.0 million of such tax expenses during the years ended December 31, 2011, 2010 and 2009, respectively.
Foreign income taxes are accrued for foreign countries in which DCT operates in accordance with the applicable local laws and regulations, taking into account provisions of applicable double tax treaties. During the years ended December 31, 2011, 2010, and 2009, we incurred $20,000, $0.1 million and $0.1 million of foreign income tax expenses, respectively, resulting from our operations in Mexico.
Note 14 - Segment Information
During 2011, management reorganized internal reporting whereby the operating results used to assess performance were aggregated into four operating regions or segments to align the markets by which management and their operating teams conduct and monitor business. We manage our operations based on four operating
segments and have aggregated our operations into three reportable segments (East, Central and West, which are based on the geographical locations of our properties). Management considers rental revenues and property net operating income aggregated by segment to be the appropriate way to analyze performance. Certain reclassifications have been made to prior year results to conform to the current presentation, related to discontinued operations and our reorganization resulting in three reportable segments. The following segment disclosures exclude the results from discontinued operations (see Note 15-Discontinued Operations and Assets Held for Sale for additional information).
The following table reflects our total assets, net of accumulated depreciation and amortization, by segment, as of December 31, 2011 and 2010 (in thousands).
(1) Other non-segment assets primarily consists of corporate assets including investments in and advances to unconsolidated joint ventures, notes receivable, deferred loan costs, straight-line rent and other receivables and other assets.
The following table sets forth the rental revenues of our segments in continuing operations and a reconciliation of our segment rental revenues to our reported consolidated total revenues for the years ended December 31, 2011, 2010 and 2009 (in thousands).
The following table sets forth property net operating income of our segments in continuing operations and a reconciliation of our property NOI to our reported “Loss from continuing operations” for the years ended December 31, 2011, 2010 and 2009 (in thousands).
(2) Property net operating income (“property NOI”) is defined as rental revenues, including reimbursements, less rental expenses and real estate taxes, which excludes depreciation, amortization, impairment, general and administrative expenses and interest expense. 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 property such as depreciation, amortization, impairment, general and administrative expenses, and interest expense. 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 (loss) attributable to common stockholders, as defined by GAAP, to be the most appropriate measure to evaluate our overall financial performance.
Included in the Central operating segment rental revenues for the years ended December 31, 2011, 2010 and 2009 was approximately $7.0 million, $5.4 million and $5.0 million, respectively, attributable to the Mexico operations. Included in the Central operating segment net assets as of December 31, 2011 and 2010 was approximately $77.0 million and $76.5 million, respectively, attributable to the Mexico operations.
Note 15 - Discontinued Operations and Assets Held for Sale
We report results of operations from real estate assets that meet the definition of a component of an entity and have been sold, or meet the criteria to be classified as held for sale, as discontinued operations. During the year ended December 31, 2011, we sold 16 operating properties to unrelated third-parties. Six of these properties were in the Central operating segment and ten were in the East operating segment, together totaling approximately 2.7 million square feet. These sales resulted in gains of approximately $12.0 million and impairment losses totaling $7.8 million.
During the year ended December 31, 2010, we sold eight operating properties to unrelated third-parties. Two of the properties sold were in the West operating segment, five were in the East operating segment and one was in the Central operating segment, together totaling approximately 0.5 million square feet, and resulted in gains of approximately $2.1 million and impairment losses of $3.5 million.
During the year ended December 31, 2009, we sold three operating properties to unrelated third-parties. These three properties were in our Central operating segment and totaled approximately 0.9 million square feet. We also sold two land parcels in the East segment comprised of approximately 4.3 acres. These sales resulted in gains of approximately $1.3 million and impairment losses totaling $0.7 million.
For the years ended December 31, 2011, 2010 and 2009 income from discontinued operations includes the results of operations of these properties prior to the date of sale. We included all results of these discontinued operations in a separate component of income in our Consolidated Statements of Operations under the heading “Income (loss) from discontinued operations.” This treatment resulted in certain reclassifications of financial statement amounts for the years ended December 31, 2011, 2010 and 2009. For further details of our policy on discontinued operations, impairment of assets held for sale and related fair value measurements, see Note 2-Summary of Significant Accounting Policies.
The following is a summary of the components of income (loss) from discontinued operations for the years ended December 31, 2011, 2010 and 2009 (in thousands).
Note 16 - Quarterly Results (Unaudited)
The following table presents selected unaudited quarterly financial data for each quarter during the year ended December 31, 2011 (in thousands except per share information).
The following table presents selected unaudited quarterly financial data for each quarter during the year ended December 31, 2010 (in thousands except per share information).
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, 2011
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION-(Continued)
December 31, 2011
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION-(Continued)
December 31, 2011
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION-(Continued)
December 31, 2011
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION-(Continued)
December 31, 2011
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION-(Continued)
December 31, 2011
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION-(Continued)
December 31, 2011
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION-(Continued)
December 31, 2011
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION-(Continued)
December 31, 2011
(1) Included in Building & Improvements are intangible lease assets.
(2) Generally these reductions in basis include one or more of the following: i) payments received 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) writeoffs of fixed asset balances due to early lease terminations by contracted customers; iii) writeoffs of fully amortized lease related intangible assets and improvements; iv) writeoffs of fully amortized tenant leasing costs; and v) other miscellaneous basis adjustments.
(3) As of December 31, 2011, the aggregate cost for federal income tax purposes of investments in real estate was approximately $2.9 billion.
(4) Reconciliation of total debt to consolidated balance sheet caption as of December 31, 2011:
(5) A summary of activity for real estate and accumulated depreciation for the year ended December 31, 2011 is as follows:
(6) Occasionally our leases contain certain provisions giving the tenant rights to purchase the property, which can take the form of a fixed price purchase option, a fair market value option, a right of first refusal option or a right of first offer option. These buildings, or a building included in the business park are subject to such an agreement.
EXHIBIT INDEX
E-1
E-2
+ Filed herewith.
++ Furnished herewith
E-3