ITEM 1.
BUSINESS
General
The terms “Thomas Properties Group,” “TPG”, "TPGI", “we”, “us”, “our Company” and "the Company" refer to Thomas Properties Group, Inc., together with our operating partnership, Thomas Properties Group, L.P. (the “Operating Partnership”). We are a full-service real estate company that owns, acquires, develops and manages primarily office, as well as mixed-use and residential properties on a nationwide basis. Our Company’s primary areas of focus are the acquisition and ownership of premier properties, both on a consolidated basis and through strategic joint ventures, property development and redevelopment, and property management activities. Property operations comprise our primary source of cash flow and provide revenue through rental operations, property management, asset management, leasing and other fee income. Our acquisitions program targets properties purchased both for our own account and that of third parties, targeted at core, core plus, and value-add properties. We engage in property development and redevelopment as market conditions warrant both for our own account and that of third parties. As part of our investment management activities, we earn fees for advising institutional investors on property portfolios.
Our properties are located in Southern California and Sacramento, California; Philadelphia, Pennsylvania; Northern Virginia; Houston, Texas and Austin, Texas. As of December 31, 2012, we own interests in and asset manage 17 operating properties with 10.3 million rentable square feet and provide leasing, asset and/or property management services on behalf of third parties for an additional five operating properties with 2.6 million rentable square feet. We also have direct and indirect ownership interests in developable land with various allowable uses, including office development, totaling approximately 3.4 million square feet.
We were incorporated in the State of Delaware on March 9, 2004. On October 13, 2004, we completed our initial public offering. Our operations are carried on through our Operating Partnership of which we are the sole general partner. The Operating Partnership holds our direct and indirect interests in real estate properties, and it carries on our investment advisory, property management, leasing and real estate development operations.
We maintain offices in Los Angeles and Sacramento, California; Austin and Houston, Texas; Northern Virginia and Philadelphia, Pennsylvania. Our corporate headquarters are located at City National Plaza, 515 South Flower Street, Sixth Floor, Los Angeles, California 90071 and our phone number is (213) 613-1900. Our website is www.tpgre.com. The information contained on our website is not part of this report. We make available free of charge through our website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to such reports filed with or furnished to the Securities and Exchange Commission (“SEC”), as soon as reasonably practicable after we file them with or furnish them to the SEC. You may also read and copy any materials we file with the SEC at the SEC’s Public Reference Room located at 100 F Street NE, Washington, DC 20549. Information on the operations of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. You may also download these materials from the SEC’s website at www.sec.gov.
Business Focus
Portfolio Enhancement: We focus on increasing net revenues from the properties in which we own an interest or which we manage for third parties through proactive management. As part of portfolio management, we maintain strong tenant relationships through our commitment to service in marketing, lease negotiations, building design and property management.
Property Acquisitions: We seek to expand our asset base by acquiring wholly-owned or controlled assets with a focus on maximizing the portfolio's recurring cash flow and net operating income, or NOI, growth. This component of our strategic plan is part of our long-term strategy to potentially convert the Company into a Real Estate Investment Trust, or REIT, in the future.
Property Dispositions: We are focused on disposing developable land, non-core operating assets and non income-producing investments. We intend to use the proceeds to pay down debt where practicable and reinvest in properties generating cash flow.
Partnerships and Joint Ventures: We leverage our property acquisition and development expertise through partnerships and joint ventures. These entities provide us with additional capital for investment, shared risk exposure, and earned fees for asset management, property management, leasing and other services. We are the managing member and hold an ownership interest in
TPG/CalSTRS, LLC (“TPG/CalSTRS”), a joint venture with the California State Teachers’ Retirement System (“CalSTRS”), which as of December 31, 2012, owned six office properties.
TPG and Madison International Realty ("Madison") are members of TPG Austin Partner, LLC, with ownership interests of 66.7% and 33.3%, respectively. TPG Austin Partner, LLC is the managing member of TPG/CalSTRS Austin, LLC, a joint venture with CalSTRS, in which each member has a 50% ownership interest. TPG/CalSTRS Austin, LLC owns eight office properties in Austin, Texas, formerly owned by TPG-Austin Portfolio Syndication Partners JV LP ("Austin Joint Venture Predecessor"), a venture among Lehman Brothers Holdings, Inc (50%), an offshore sovereign wealth fund (25%) and TPG/CalSTRS (25%).
Brandywine Operating Partnership, L.P. ("Brandywine") has a 25% preferred equity interest in One Commerce Square and Two Commerce Square. TPG owns 75% and is the general partner.
Development and Redevelopment: We develop and redevelop projects in diversified geographic markets using pre-leasing, guaranteed maximum cost construction contracts and other measures to reduce development risk. We have land available for development in El Segundo, California; and Houston and Austin, Texas.
Our Fee Services: We provide leasing, asset and/or property management services on behalf of third parties for an additional five operating properties with 2.6 million rentable square feet. From time to time, we also provide development and pre-development services on behalf of third parties.
Recent Developments
Partnerships and Joint Ventures: In January 2012, we completed the sale of Brookhollow Central I, II and III in Houston, Texas, a TPG/CalSTRS joint venture property. TPG/CalSTRS received net proceeds from this transaction of $30.6 million, after closing costs and repayment of mortgage debt, of which TPG's share was $7.7 million. In July 2012, we completed the sale of both Research Park Plaza and Stonebridge Plaza II, both Austin Joint Venture properties in the suburbs of Austin, Texas, resulting in the repayment of $89.0 million of mortgage debt and generating approximately $17.7 million of net proceeds to the Austin Joint Venture.
In September 2012, TPG/CalSTRS Austin, LLC acquired all of the equity interests in an eight building, three million square foot portfolio of office properties in Austin, Texas, formerly owned by Austin Joint Venture Predecessor. The purchase price for the portfolio was $859.1 million. As part of the transaction, TPG/CalSTRS Austin, LLC assumed five existing first mortgage loans totaling $626.0 million. The transaction reduced the existing leverage on the portfolio by repaying approximately$135.6 million owed to Lehman Commercial Paper, Inc. and the three existing partners as a result of loans made by the partners.
In November 2012, TPG/CalSTRS sold a 14.18 acre parcel of land located adjacent to CityWestPlace in Houston, Texas, for $30.9 million. Proceeds from this transaction totaled $29.0 million, after closing costs, of which TPG's share was $7.3 million.
In December 2012, TPG redeemed a 49% partnership interest in 2121 Market Street and sold the adjacent 2100 JFK Boulevard parking lot for total consideration of $12.4 million. Net proceeds to TPG from this transaction totaled $12.1 million. TPG retained a 1.0% limited partnership interest in 2121 Market Street. TPG recorded a deferred gain of $9.6 million related to this transaction. Additionally, TPG issued a guarantee up to a maximum amount of $14.0 million on a mortgage loan secured by a first trust deed on 2121 Market Street, expiring in December 2022.
Consolidated Properties: In January 2012, we completed the sale of a 4,800 square foot retail building at Four Points Centre in Austin, Texas. TPG received net proceeds from this transaction of $1.1 million, after closing costs.
In January and March 2013, TPG completed the sale of certain land parcels totaling 17.5 acres and 27.9 acres, respectively, at Four Points Centre in Austin, Texas, for $4.9 million and $6.4 million, respectively. TPG received net proceeds from these two transactions of $1.1 million (after a $3.7 million paydown of the Four Points Centre mortgage debt) and $2.7 million (after a $3.1 million pay down of the loan), respectively.
On March 8, 2013, we entered into a loan agreement with a lender for a new mortgage on Two Commerce Square in the amount of $112.0 million. The loan, which has a fixed interest rate of 3.96% for a ten year term, funded on March 8, 2013. The loan replaced the existing mortgage on the property that had an outstanding balance of $106.6 million as of December 31, 2012, and a maturity date of May 9, 2013, and was open to prepayment without penalty on and after March 8, 2013.
Competition
The real estate business is highly competitive. There are numerous other acquirers, developers, managers and owners of commercial and mixed-use real estate that compete with us nationally, regionally and locally, some of whom may have greater financial resources. They compete with us for acquisition opportunities, management and leasing revenues, land for development, tenants for properties and prospective investors in partnerships, joint ventures and funds we may establish through our investment advisory business.
Our properties compete for tenants with similar properties primarily on the basis of property quality, location, total occupancy costs (including base rent and operating expenses), services provided, building quality and the design and condition of any planned improvements or tenant improvements we may negotiate. The number and type of competing properties or available rentable space in a particular market or submarket could have a material effect on our ability to lease space and maintain or increase occupancy or rents in our existing properties. We believe, however, that the quality services and individualized attention that we offer our tenants, together with our property management services on site, enhance our ability to attract and retain tenants for the office properties we own an interest in or manage.
In addition, in many of our submarkets, institutional investors and owners and developers of properties (including other real estate operating companies and REITs) compete for the acquisition and development, or redevelopment, of land and buildings. Many of these entities have substantial resources and experience. We may compete for investors in potential partnerships, joint ventures and funds with other property investment managers with larger or more established operations. Additionally, our ability to compete depends upon trends in the economies of our markets in which we operate or own interests in properties, investment alternatives, financial condition and operating results of current and prospective tenants, availability and cost of capital and debt financing, construction and renovation costs, land availability, completion of construction approvals, taxes and governmental regulations.
Regulatory Issues
Environmental Matters
Under various federal, state and local environmental laws and regulations, a current or previous owner, manager or tenant of real estate may be required to investigate and clean up hazardous or toxic substances at the property, and may be held liable to a government entity or to third parties for property damage and for investigation, clean-up and monitoring costs incurred by the parties in connection with the actual or threatened contamination.
Federal regulations require building owners and those exercising control over a building’s management to identify and warn, via signs and labels, of potential hazards posed by workplace exposure to installed asbestos- containing materials and potentially asbestos-containing materials in their building. The regulations also set forth employee training, record keeping and due diligence requirements pertaining to asbestos-containing materials and potentially asbestos-containing materials. Federal, state and local laws and regulations also govern the removal, encapsulation, disturbance, handling and/or disposal of asbestos-containing materials and potentially asbestos-containing materials when the materials are in poor condition or in the event of construction, remodeling or renovation of a building.
Americans with Disabilities Act
Our properties must comply with Title III of the Americans with Disabilities Act, or ADA, to the extent that the properties are “public accommodations” as defined by the ADA. The ADA may require removal of structural barriers to access by persons with disabilities in public areas of our properties where the removal is readily achievable. The obligation to make readily achievable accommodations is an ongoing one, and we assess our properties and make alterations as appropriate.
Insurance
We carry comprehensive liability, fire, flood, extended coverage, wind, earthquake, terrorism, pollution legal liability, business interruption and rental loss insurance under policies covering all of the properties which we own an interest in or manage for third parties, including our development properties (although we carry only liability insurance for the California Environmental Protection Agency (“CalEPA”) headquarters building under our blanket policy because the tenant has the right to provide all other forms of coverage it deems necessary, and it has elected to do so, and we do not insure 816 Congress and Austin Centre under our blanket policy because the third party owner has elected to carry it under its policy). We believe the policy specifications and insured limits are appropriate given the relative risk of loss, the cost of the coverage and industry practice. In our opinion, the properties in our portfolio are adequately insured. Our terrorism insurance on our property and
liability policies is subject to exclusions for loss or damage caused by nuclear substances, pollutants, contaminants, and biological and chemical weapons. However, our environmental policy does not exclude these perils. We carry earthquake insurance on our properties located in seismically active areas, which includes our Southern California properties, wind insurance on our properties located in “tier 1” wind zones, which includes our Houston, Texas properties, and terrorism insurance on all of our properties, in amounts and with deductibles which we believe are commercially reasonable.
Foreign Operations
We do not engage in any non-U.S. operations or derive any revenue from sources outside the United States.
Segment Financial Information
We operate in one business segment: the acquisition, development, ownership and management of commercial and mixed-use real estate. Additionally, we operate in one geographic area: the United States. Our office portfolio generates revenues from the rental of office space to tenants, parking, rental of storage space and other tenant services. Our management activities generate revenues from third parties and joint ventures in which the Operating Partnership is a partner from property and asset management fees, acquisition fees and disposition fees. For a further discussion of segment financial information, see the financial statements in Item 8 of this Report.
Employees
As of December 31, 2012, we had 141 employees. None of our employees are subject to a collective bargaining agreement or represented by a union, and we believe that relations with our employees are good. Our executive management team is based in our Los Angeles and Philadelphia offices.
Forward-Looking Statements
Forward-looking statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from those anticipated and you should not rely on them as predictions of future events. Although information is based on our current estimates, forward-looking statements depend on assumptions, data or methods which may be incorrect or imprecise. You are cautioned not to place undue reliance on this information as we cannot guarantee that any future expectations and events described will happen as described or that they will happen at all. You can identify forward-looking statements by the use of forward-looking terminology such as “believes,” “expects,” “may,” “should,” “seeks,” “approximately,” “intends,” “plans,” “pro forma,” “estimates” or “anticipates” or the negative of these words and phrases or similar words or phrases. You can also identify forward-looking statements by discussions of strategy, plans or intentions.
ITEM 1A.
ITEM 1A.
RISK FACTORS
Risks Related to Our Business and Our Properties
We generate a significant portion of our revenues from our joint venture and our separate account management agreements with CalSTRS, and if we were to lose these relationships, our financial results would be significantly negatively affected.
Our joint venture and separate account management agreement relationships with CalSTRS provide us with substantial fee revenues. For the years ended December 31, 2012, 2011 and 2010, approximately 18.5%, 24.3% and 19.5%, respectively, of our revenue has been derived from fees earned from these relationships.
We cannot assure you that our joint venture and separate account management relationships with CalSTRS will continue, and, if they do not, we may not be able to replace these relationships with other strategic alliances that would provide comparable revenues. Our interest in TPG/CalSTRS is subject to a buy-sell provision, which permits CalSTRS to purchase our interest in TPG/CalSTRS at any time. Under the buy-sell provision either our Operating Partnership or CalSTRS can initiate a buy-out of the other's interest at any time by delivering a notice to the other specifying a purchase price for all the joint venture's assets; the other partner then has the option to sell its joint venture interest or purchase the interest of the initiating venture partner. The purchase price is based on what each partner would receive on liquidation if the joint venture's assets were sold for the specified price and the joint venture's liabilities were paid and the remaining assets distributed to the partners. In addition, TPG Austin Partner, LLC, the entity through which we own our interest in TPG/CalSTRS Austin, LLC, is subject to a forced sale and right of first offer provision, starting on the earlier of the third anniversary of the date of the agreement, September 18, 2015, or the date on which a management committee deadlock occurs after the first anniversary of the date of
this agreement, September 18, 2013, which permits either partner in TPG/CalSTRS Austin, LLC to initiate a sale of one or more of the properties and gives the other partner the right of first offer to purchase.
In addition, upon the occurrence of certain events of default by the Operating Partnership under the TPG/CalSTRS agreement or related management, development and leasing agreements, upon bankruptcy of our Operating Partnership, or upon the death or disability of either James A. Thomas, our Chairman, President and CEO, or John R. Sischo, our Co-Chief Operating Officer, or the failure of either of them to devote the necessary time to perform their duties (unless replaced by an individual approved by CalSTRS) (each, a “Buyout Default”), CalSTRS may elect to purchase our membership interest based on a three percent discount to the appraised fair market value at the time of the Buyout Default.
Upon the occurrence of certain events of default by TPG Austin Partner, LLC, under the TPG/CalSTRS Austin, LLC agreement or by the Operating Partnership under related management, development and leasing agreements, upon bankruptcy of our Operating Partnership, or the Company's senior executive team's failure to devote the time required to perform the duties of the manager under the TPG/CalSTRS Austin, LLC agreement (each, a “TPG/CalSTRS Austin, LLC Buyout Default”), CalSTRS may elect to purchase our membership interest based on a three percent discount to the appraised fair market value at the time of the TPG/CalSTRS Austin, LLC Buyout Default.
The TPG/CalSTRS agreement also prohibits any transfer of securities of the Company or limited partnership units in our Operating Partnership that would result in Mr. Thomas, his immediate family and any entities controlled thereby beneficially owning less than 30.0% of our securities entitled to vote for the election of directors; provided, that in connection with the issuance of additional Company shares in one or more public offerings, Mr. Thomas, his immediate family and controlled entities may reduce their collective beneficial ownership interest to no less than 10% of the total common shares and Operating Partnership units and no less than 15.0 million shares and Operating Partnership units on a collective basis. There is no comparable requirement in the TPG/CalSTRS Austin, LLC agreement. In May 2012, the Company entered into a Common Stock Purchase Agreement, a Stockholders Agreement and a Registration Rights Agreement with affiliates of Madison International Realty (“Madison Agreements”). We issued 8.7 million shares of our common stock to the Madison affiliates in a non-public transaction. Pursuant to the Madison Agreements, during a lock-up period that generally expires with respect to all of such shares in June 2015, Mr. Thomas controls the voting of the shares issued to Madison's affiliates and, therefore, presently has beneficial ownership of more than 40% of our securities entitled to vote for the election of directors. If Mr. Thomas does not acquire beneficial ownership of additional shares of our common stock prior to expiration or earlier termination of such lock-up period or the TPG/CalSTRS agreement is not otherwise amended prior thereto, the termination of the voting control by Mr. Thomas of the shares of common stock issued pursuant to the Madison Agreements may result in a Buyout Default under the TPG/CalSTRS agreement at the final expiration of such lock-up period.
Most of our fee arrangements under our separate account relationship with CalSTRS are terminable on 30 days' notice. Termination of either our joint venture or separate account relationship with CalSTRS would adversely affect our revenue and profitability and our ability to achieve our business plan by reducing our fee income and access to co-investment capital to acquire additional properties.
Our joint venture investments may be adversely affected by our lack of control or input on decisions or shared decision-making authority or disputes with our co-venturers.
Many of our operating properties are owned through a joint venture or partnership with other parties. As a result, we do not exercise sole decision-making authority regarding such joint venture properties, including with respect to cash distributions or the sale of such properties. Furthermore, we may co-invest in the future through other partnerships, joint ventures or other entities, acquiring non-controlling interests or sharing responsibility for managing the affairs of a property, partnership or joint venture. Investments in partnerships, joint ventures, funds or other entities may, under certain circumstances, involve risks, including partners who may have economic or other business interests or goals which are inconsistent with our business interests or goals and may be in a position to take actions contrary to our policies or objectives. These investments may also have the risk of impasses on significant decisions, because neither we nor our partner or co-venturer would have full control over the partnership or joint venture. Future disputes between us and our partners or co-venturers may result in litigation or arbitration that would increase our expenses and prevent our officers and/or directors from focusing their full time and effort on our business. In addition, under the principles of agency and partnership law, we may in certain circumstances be liable for the actions of our third-party partners or co-venturers, such as if a partner or co-venturer became bankrupt and defaulted on its reimbursement and contribution obligations to us, subjecting the property owned by the partnership or joint venture to liabilities in excess of those contemplated by the partnership or joint venture agreement, or incurred debts or liabilities on behalf of the partnership or joint venture in excess of the authority granted by the partnership or joint venture agreement. In some joint ventures or other investments we make, if the entity in which we invest is a limited partnership, we have acquired and may acquire in the future all or a portion of our interest in such partnership as a general partner. In such event, we may be
liable for all the liabilities of the partnership, although we attempt to limit such liability to our investment in such partnership by investing through a subsidiary.
Our joint venture partners have rights under our joint venture agreements that could adversely affect us.
As of December 31, 2012, we held interests in six of our properties through TPG/CalSTRS, and eight of our properties through TPG Austin Partner, LLC, in turn as a member of TPG/CalSTRS Austin, LLC. TPG/CalSTRS requires a unanimous vote of its management committee on certain major decisions, including approval of annual business plans and budgets, financings and refinancings, and additional capital calls not in compliance with an approved annual plan. The management committee currently consists of two members appointed by CalSTRS and one member appointed by the Operating Partnership. All other decisions, including sales of properties, are made based upon a majority decision of the management committee. Thus CalSTRS has the ability to control certain decisions for TPG/CalSTRS that may result in an outcome contrary to our interests. The Operating Partnership has the responsibility and authority to carry out day to day management of TPG/CalSTRS and to implement the annual plans approved by the management committee. In addition to CalSTRS' ability to control certain decisions relating to TPG/CalSTRS, our agreement with CalSTRS includes provisions negotiated for the benefit of CalSTRS that could adversely affect us. Unless otherwise determined by the management committee of TPG/CalSTRS, we are required to use diligent efforts to sell each joint venture property generally within five years of that property reaching stabilization. The TPG/CalSTRS' subsidiaries owning Reflections I and Reflections II did not make the respective debt service payments due in February 2013. The special servicer has issued notices of default, but has not taken further formal action, therefore, the likelihood of these two properties reaching stabilization and their ultimate resolution is uncertain. We have a right of first offer to purchase a TPG/CalSTRS property upon a required sale at a price we propose, and if CalSTRS accepts our offer we must close within 90 days. If we do not exercise the right of first offer and we subsequently fail to effect a sale by the end of the specified holding period, CalSTRS has the right to assume control of the sale process. This may require us to sell one or more of our assets at an inopportune time, or for prices that are lower than could be achieved if we had more flexibility in the timing for effecting sales.
TPG/CalSTRS Austin, LLC requires a unanimous vote of its management committee on certain major decisions, including approval of the holding period, annual business plans and budgets, financings and refinancings, and additional capital calls not in compliance with an approved annual plan. The management committee currently consists of two members appointed by CalSTRS and two members appointed by the Operating Partnership. All other decisions are made based upon a majority decision of the management committee. Through its position as managing member of TPG Austin Partner, LLC, the Operating Partnership has the responsibility and authority to carry out day to day management of TPG/CalSTRS Austin, LLC and to implement the annual plans approved by the management committee. In addition, our interest is subject to a forced sale and right of first offer provision, starting on the earlier of the third anniversary of the date of the agreement, September 18, 2015, or the date on which a management committee deadlock occurs after the first anniversary of the date of the agreement, September 18, 2013, or on an event of default or if three or more of the Company's senior executives, at the same time, are unable to perform duties for two or more months due to death, disability or departure (unless a replacement is reasonably approved by CalSTRS) which permits either partner to initiate a sale of one or more of the properties, and gives the other partner the right of first offer to purchase. This may require us to sell one or more of the Austin assets at an inopportune time, or for prices that are lower than could be achieved if we had more flexibility in the timing for effecting sales.
TPG Austin Partner, LLC has two members, Madison and the Operating Partnership. The agreement permits Madison to require the sale of its direct interest in the limited liability company, subject to a right of first offer in favor of the Operating Partnership. In addition, Madison has a put right, on the earliest of (i) January 1, 2017, (ii) a TPG Change of Control (as defined in the LLC agreement), (iii) the removal of TPG Austin Partner, LLC as manager of TPG/CalSTRS Austin, LLC, or (iv) the exercise by CalSTRS of any of its rights pursuant to the TPG/CalSTRS Austin, LLC agreement, to require the Operating Partnership to purchase all of Madison's ownership interest for a purchase price equal to the put price, which is based on fair market value.
In November 2010, our subsidiaries entered into amended and restated partnership agreements and contribution agreements with Brandywine, with respect to our One Commerce Square and Two Commerce Square buildings in Philadelphia, Pennsylvania. Brandywine contributed capital, and committed to additional capital contributions to the existing owners of the buildings, in return for a 25% limited partnership interest in each building. Our wholly-owned subsidiaries are the general partners of the Commerce Square partnerships, with authority to manage and carry out the day to day business of the partnerships, subject only to approval by Brandywine of certain specified major decisions, including approval of certain capital budgets, leasing budgets and leasing guidelines, financing or refinancing of each building, and certain major leases. We retained sole approval over the operating budgets and other decisions that are not major decisions. Brandywine has the right to purchase all of the Company's interest in each of the buildings subject to the retention of a nominal interest by the Company with an allocation of mortgage debt for a minimum of five years, which right is exercisable between October 31, 2016 and
April 30, 2017. The exercise of such call right triggers certain rights and obligations of the Company, including the right to elect to market our interests in the buildings to third parties to achieve a price for our interests that we deem to be acceptable. If the Company deems a third party bid for our interests to be acceptable, then under certain conditions Brandywine will have a right of first refusal to purchase our interests for the same price and terms offered by the third party. If Brandywine does not exercise, or does not have, such right of first refusal, and if we elect to sell our interests in Commerce Square to a third party, Brandywine has a right to “piggyback” on such sale and sell its interests in Commerce Square to the third party on the same terms. We retain, as general partner, the right to sell the Commerce Square buildings at any time, but Brandywine has certain rights to acquire our interests in Commerce Square in lieu of such a sale of the buildings to a third party, as long as we receive the same amount we would have received on a sale to a third party. Finally, on or after the 10th anniversary of the admission of Brandywine as a partner, either the Company or Brandywine may elect to cause the sale of the Commerce Square buildings and dissolve the partnerships, which will give the other party the right to trigger a buy-sell procedure for the purchase of the electing partner's interest in the partnerships.
We may not receive funding from our joint venture partners in connection with proposed acquisitions, which could adversely affect our growth.
We have entered into, and may enter into in the future, certain joint venture acquisition arrangements with third parties in which we identify potential acquisition properties on behalf of the joint venture, and a portion (in some cases, a substantial portion) of the capital required for each project would be funded by our joint venture partners. Although our joint venture partners have committed to fund property acquisitions, such joint venture partners may decide not to fund a particular or any potential acquisition properties for any number of reasons, including such entities may not have the capital necessary to fund projects at the time of the proposed acquisition. Accordingly, if we identify potential acquisition opportunities in the future for these programs, we may not receive approval and/or funding from joint venture partners, notwithstanding any prior commitments for funding.
We depend on significant tenants, and their failure to pay rent could seriously harm our operating results and financial condition.
As of December 31, 2012, the 20 largest tenants for properties in which we held an ownership interest collectively leased 38.0% of the rentable square feet of space, representing 44.9% of the total annualized rent generated by these properties.
Any of our tenants may experience a downturn in its business, which may weaken such tenant's financial condition. As a result, tenants may delay lease commencement, fail to make rental payments when due, decline to extend a lease upon its expiration, become insolvent, declare bankruptcy or default under their leases. Certain of our tenants also have termination rights under their leases with us, which they might choose to exercise if they experience a downturn in their business. In addition, current economic and market conditions increase the possibility that one or more of our tenants will become insolvent. Any tenant bankruptcy or insolvency, leasing delay, failure to make rental payments when due, or default under a lease could result in the termination of the tenant's lease and material losses to our Company.
In particular, if a significant tenant becomes insolvent, suffers a downturn in its business and decides not to renew its lease or vacates a property, it may seriously harm our business. Failure on the part of a tenant to comply with the terms of a lease may give us the right to terminate the lease, repossess the applicable property and enforce the payment obligations under the lease. In those circumstances, we would be required to find another tenant. We cannot assure you that we would be able to find another tenant without incurring substantial costs, or at all, or that if another tenant were found, we would be able to enter into a new lease on favorable terms to us or at the same rental rates.
Bankruptcy filings by or relating to one of our tenants could bar us from collecting pre-bankruptcy debts from that tenant or their property. A tenant bankruptcy would delay our efforts to collect past due balances under the relevant leases, and could ultimately preclude full collection of these amounts. If a lease is assumed by the tenant in bankruptcy, all pre-bankruptcy amounts due under the lease must be paid to us in full. However, if a lease is rejected by a tenant in bankruptcy, we would have only a general unsecured claim for damages. Any unsecured claim we hold against a bankrupt entity may be paid only to the extent that funds are available and only in the same percentage as is paid to all other holders of unsecured claims. We may recover substantially less than the full value of any unsecured claim in the event of the bankruptcy of a large tenant, which could adversely impact our financial condition.
Our operating results depend upon the regional economies in which our properties are located and the demand for office and other mixed-use space, and unique or disproportionate economic downturns or adverse regulatory or taxation policies in any of these regions could harm our operating results.
Our operating and development properties are located in three geographic regions of the United States: the West Coast, Southwest and Mid-Atlantic regions. Historically, the largest part of our revenues has been derived from our ownership and management of properties consisting primarily of office buildings.
A decrease in the demand for office space in these geographic regions, and for Class A office space in particular, may have a greater adverse effect on our business and financial condition than if we owned a more diversified real estate portfolio. We are also susceptible to disproportionate or unique adverse developments in these regions and in the national office market generally, such as business layoffs or downsizing, industry slowdowns, relocations of businesses, changing demographics, terrorist targeting of high-rise structures, infrastructure quality, increases in real estate and other taxes, costs of complying with government regulations or increased regulation, oversupply of or reduced demand for office space, and other factors. Some of the regional issues we face include the more highly regulated and taxed economy of Southern California and high local and municipal taxes for our Philadelphia properties. Any adverse economic or real estate developments in one or more of our regions, or any decrease in demand for office space resulting from the local regulatory environment, business climate or energy or fiscal problems, could adversely impact our revenue and profitability, thereby causing a significant decline in our financial condition, results of operations, cash flow, the trading price of our common stock and impairing our ability to satisfy our debt service obligations.
Our need for additional debt financing, our existing level of debt and the limitations imposed by our debt agreements could have significant adverse consequences on us.
We may seek to incur additional debt to finance future acquisition and development activities; however debt financing may not be available to us on acceptable terms under current market conditions. In addition, it is possible the required payments of principal and interest on borrowings may leave us with insufficient cash to operate our properties profitably. Our need for debt financing, our existing level of debt and the limitations imposed on us by our debt agreements could have significant adverse consequences, including the following:
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our cash flow may be insufficient to meet our required principal and interest payments or to pay dividends;
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we may be unable to borrow additional funds as needed or on favorable terms;
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we may be unable to refinance our indebtedness at maturity or the refinancing terms may be less favorable than the terms of our original indebtedness;
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we may be unable to distribute funds from a property to our Operating Partnership or apply such funds to cover expenses related to another property;
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we could be required to dispose of one or more of our properties, possibly on disadvantageous terms and/or at disadvantageous times;
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we could default on our obligations and the lenders or mortgagees may foreclose on our properties that secure their loans and receive an assignment of rents and leases;
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we could violate covenants in our loan documents or our joint venture agreements, including provisions that may limit our ability to further mortgage a property, make distributions, acquire additional properties, repay indebtedness prior to a set date without payment of a premium or other pre-payment penalties, all of which would entitle the lenders to accelerate our debt obligations;
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because we have agreed to use commercially reasonable efforts to maintain certain debt levels to provide the ability for Mr. Thomas and entities controlled by him to guarantee debt of $210.0 million, we may not be able to refinance our debt when it would otherwise be advantageous to do so or to reduce our indebtedness when our board of directors determines it is prudent.
If any one or more of these events were to occur, our revenue and profitability could be adversely impacted, causing a significant downturn in our financial condition, results of operations, cash flow, and the trading price of our common stock, and could impair our ability to satisfy our debt service obligations.
We may be unable to complete acquisitions necessary to grow our business, and even if consummated, we may fail to successfully operate these acquired properties.
Our planned growth strategy includes the acquisition of additional properties as opportunities arise with a focus in the southwest and western regions of the United States. We regularly evaluate approximately seven major markets in the United
States for strategic opportunities to acquire office, mixed-use and other properties. Our ability to acquire properties on favorable terms and successfully operate them is subject to the following significant risks:
•
we may be unable to generate sufficient cash from operations, or obtain the necessary debt or equity to consummate an acquisition or, if obtainable, such financing may not be on favorable terms;
•
we may need to spend more than budgeted amounts to make necessary improvements or renovations to acquired properties;
•
we may be unable to acquire a desired property because of competition from other real estate investors with more available capital, including other real estate operating companies, real estate investment trusts and investment funds;
•
competition from other potential acquirers may significantly increase the purchase price, even if we are able to acquire a desired property;
•
agreements for the acquisition of office properties are typically subject to customary conditions to closing, including satisfactory completion of due diligence investigations, and we may spend significant time and money on a potential acquisition we eventually decide not to pursue;
•
we may be unable to quickly and efficiently integrate new acquisitions, particularly acquisitions of portfolios of properties, into our existing operations;
•
market conditions may result in higher than expected vacancy rates and lower than expected rental rates; and
•
we may acquire properties subject to liabilities without any recourse, or with only limited recourse, for unknown liabilities such as clean-up of undisclosed environmental contamination, claims by tenants, vendors or other persons dealing with the former owners of the properties and claims for indemnification by general partners, directors, officers and others indemnified by the former owners of the properties.
If we cannot complete property acquisitions on favorable terms or at all, or operate acquired properties to meet our expectations, our revenue and profitability could be adversely impacted.
Any real estate acquisitions that we consummate may result in disruptions to our business as a result of the burden of integrating operations placed on our management.
Our business strategy includes acquisitions and investments in real estate on an ongoing basis as market conditions warrant. These acquisitions may cause disruptions in our operations and divert management's attention from our other day-to-day operations, which could impair our relationships with our current tenants and employees. If we acquire real estate by acquiring another entity, we may be unable to effectively integrate the operations and personnel of the acquired business. In addition, we may be unable to train, retain and motivate any key personnel from the acquired business. If our management is unable to effectively implement our acquisition strategy, we may experience disruptions to our business, which could harm our results of operations.
We may be unable to successfully complete and operate properties under development, which would impair our financial condition and operating results.
Part of our business is devoted to the development of office, mixed-use and other properties, and the redevelopment of core plus and value-add properties. Our development and redevelopment activities involve the following significant risks:
•
we may be unable to obtain financing on favorable terms or at all;
•
if we finance projects through construction loans, we may be unable to obtain permanent financing at all or on advantageous terms;
•
we may not complete projects on schedule or within budgeted amounts;
•
we may underestimate the expected costs and time necessary to achieve the desired result with a redevelopment project;
•
we may discover structural, environmental or other feasibility issues with properties acquired as redevelopment projects following our acquisition, which may render the redevelopment as planned not possible;
•
we may encounter delays or refusals in obtaining all necessary zoning, land use, building, occupancy, and other required governmental permits and authorizations;
•
occupancy rates and rents may fluctuate depending on a number of factors, including market and economic conditions, and may result in our investment not being profitable;
•
adverse weather that damages the project or causes delays;
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unanticipated changes to the plans or specifications;
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unanticipated shortages of materials and skilled labor;
•
unanticipated increases in material and labor costs; and
•
fire, flooding and other natural disasters.
If we are not successful in our property development and redevelopment initiatives, it could adversely impact our financial condition, results of operations, and the trading price of our common stock.
We face significant competition, which may decrease or prevent increases of the occupancy and rental rates of our properties.
We face significant competition from other managers and owners of office and mixed-use real estate, many of which own or manage properties similar to ours in the same regional markets in which our properties are located. We also compete with other diversified real estate companies and companies focused solely on offering property investment management and brokerage services. A number of our competitors are larger and better able to take advantage of efficiencies created by size, have better financial resources, or increased access to capital at lower costs, and may be better known in regional markets in which we compete. Our smaller size as compared to some of our competition may increase our susceptibility to economic downturns and pressures on rents. Our failure to compete successfully in our industry would materially affect our business prospects and operating results.
We may be unable to renew leases, lease vacant space or re-lease space as leases expire resulting in increased vacancy rates, lower revenue and an adverse effect on our operating results.
As of December 31, 2012, leases representing 5.1% and 11.1% of the rentable square feet of the office and retail space of our consolidated and unconsolidated properties will expire in 2013 and 2014, respectively. Further, an additional 13.9% of the square feet of these properties was available for lease as of December 31, 2012. Current economic conditions have resulted in depressed leasing activity recently in certain markets as a result of tenant unwillingness to make long term leasing commitments, and it is unclear how long this market condition may continue. If the rental rates for our properties decrease, our existing tenants do not renew their leases or we do not re-lease a significant portion of our available space and space for which leases will expire, our revenue and profitability could be adversely impacted, causing a significant downturn in our financial condition, results of operations, cash flow, and the trading price of our common stock and impairing our ability to satisfy our debt service obligations.
Our growth depends on external sources of capital, some of which are outside of our control. If we are unable to access capital from external sources, we may not be able to implement our business strategy.
Our business strategy requires us to rely significantly on third-party sources to fund our capital needs. We may not be able to obtain debt or equity on favorable terms or at all. Any additional debt we incur will increase our leverage and may impose operating restrictions on us. Any issuance of equity by our Company to fund our portion of equity capital requirements could be dilutive to our existing stockholders, and could have a negative impact on our stock price. Our access to third-party sources of capital depends, in part, on:
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our current debt levels, which were $281.4 million of consolidated debt and $1.4 billion of unconsolidated debt, of which our share was $335.8 million as of December 31, 2012;
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our ability to generate consistent cash flow from operating activities, which used cash of $5.3 million for the year ended December 31, 2012;
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our current and expected future earnings;
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the market's perception of our growth potential;
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the market price of our common stock;
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the perception of the value of an investment in our common stock; and
•
general market conditions.
If we cannot obtain capital from third-party sources when needed, we may not be able to acquire or develop properties when strategic opportunities exist, or to repay existing debt as it matures.
As a result of the limited time which we have to perform due diligence of many of our acquired properties, we may become subject to significant unexpected liabilities and our properties may not meet projections.
When we enter into an agreement to acquire a property or portfolio of properties, we often have limited time to complete our due diligence prior to acquiring the property. To the extent we underestimate or fail to investigate or identify risks and liabilities associated with the properties we acquire, we may incur unexpected liabilities or the properties may fail to perform as we expected. If we do not accurately assess the liabilities associated with properties prior to their acquisition, we may pay a purchase price that exceeds the current fair value of the net identifiable assets of the acquired property. As a result, intangible assets would be required to be recorded, which could result in significant accounting charges in future periods. These charges, in addition to the financial impact of significant liabilities that we may assume, and any failure of properties to perform as expected, could adversely impact our revenue and profitability, causing a significant downturn in our financial condition, results of operations and the trading price of our common stock and impairing our ability to satisfy our debt service obligations.
As the current or previous owner or operator of real property, we could become subject to liability for environmental contamination, regardless of whether we caused such contamination.
Under various federal, state and local environmental laws, regulations and ordinances, a current or previous owner or operator (e.g., tenant or manager) of real property may be liable for the cost to remove or remediate contamination resulting from the presence or discharge of hazardous or toxic substances, wastes or petroleum products on, under, from or in such property. These costs could be substantial and liability under these laws may attach without regard to fault, or whether the owner or operator knew of, or was responsible for, the presence of the contamination. The liability may be joint and several for the full amount of the investigation, clean-up and monitoring costs incurred or to be incurred or actions to be undertaken, although a party held jointly and severally liable may obtain contributions from other identified, solvent, responsible parties of their fair share toward these costs to the extent such contributions are possible to obtain. In addition, the current or previous owner or operator of property may be subject to damage awards for personal injury or property damage resulting from contamination at or migrating from its property. Previous owners used some of our properties for industrial and retail purposes, so those properties may contain some level of environmental contamination. In addition, the presence of contamination, or the failure to properly remediate contamination on a property may limit the ability of the owner or operator to sell, develop or rent that property or to borrow using the property as collateral, and may cause our investment in that property to decline in value.
As the owner of real property, we could become subject to liability for asbestos-containing building materials in the buildings on our property.
Some of our properties may contain asbestos-containing materials. Environmental laws require that owners or operators of buildings with asbestos-containing building materials properly manage and maintain these materials, adequately inform or train those who may come into contact with asbestos and undertake special precautions, including removal or other abatement, in the event that asbestos is disturbed during building renovation or demolition. These laws may impose fines and penalties on building owners or operators for failure to comply with these requirements. In addition, these laws may also allow third parties to seek recovery from owners or operators for personal injury associated with exposure to asbestos-containing building materials.
Our properties may contain or develop harmful mold or suffer from other adverse conditions, which could lead to liability for adverse health effects and costs of remediation.
When excessive moisture accumulates in buildings or on building materials, mold growth may occur, particularly if the moisture problem remains undiscovered or is not addressed over a period of time. Some molds may produce airborne toxins or irritants. Indoor air quality issues can also stem from inadequate ventilation, chemical contamination from indoor or outdoor sources and other biological contaminants such as pollen, viruses and bacteria. Indoor exposure to airborne toxins or irritants above certain levels can be alleged to cause a variety of adverse health effects and symptoms, including allergic or other reactions. As a result, the presence of significant mold or other airborne contaminants at any of our properties could require us to undertake a costly remediation program to contain or remove the mold or other airborne contaminants from the affected
property or increase indoor ventilation. In addition, the presence of significant mold or other airborne contaminants could expose us to liability from our tenants, employees of our tenants and others if property damage or health concerns arise.
As the owner of real property, we could become subject to liability for failure to comply with environmental requirements regarding the handling and disposal of regulated substances and wastes or for non-compliance with health and safety requirements.
Environmental laws and regulations regarding the handling of regulated substances and wastes apply to our properties. The properties in our portfolio are also subject to various federal, state and local health and safety requirements, such as state and local fire requirements. If we or our tenants fail to comply with these various requirements, we might incur governmental fines or private damage awards. Moreover, we do not know whether existing requirements will change or whether future requirements will require us to make significant unanticipated expenditures that will materially adversely impact our financial condition, results of operations, cash flow, cash available for distribution, the per share trading price of our common stock and our ability to satisfy our debt service obligations. Environmental noncompliance liability could also affect a tenant's ability to make rental payments to us.
Tax indemnification obligations that may arise in the event we or our Operating Partnership sell an interest in either of two of our properties could limit our operating flexibility.
We and our Operating Partnership agreed at the time of our initial public offering in 2004 to indemnify Mr. Thomas against adverse direct and indirect tax consequences in the event that our Operating Partnership or the underlying property owner directly or indirectly sells, exchanges or otherwise disposes (including by way of merger, sale of assets or otherwise) of any portion of its interests, in a taxable transaction, in either One Commerce Square or Two Commerce Square. These two assets represented 95.9% of annualized rent for our consolidated properties as of December 31, 2012. The indemnification obligation currently expires October 13, 2013, which may be further extended to October 13, 2016 provided Mr. Thomas and his controlled entities collectively retain at least 50% of the Operating Partnership units received by them in connection with our formation transactions at the time of our initial public offering.
We agreed at the time of the initial public offering to use commercially reasonable efforts to make an aggregate of approximately $210.0 million of debt available to be guaranteed by entities controlled by Mr. Thomas. We agreed to make this debt available for guarantee in order to assist Mr. Thomas in preserving his tax position after his contribution at the time of our initial public offering.
The current economic environment for real estate companies may significantly adversely impact our results of operations and business prospects.
The success of our business and profitability of our operations are dependent on continued investment in the real estate markets and access to capital and debt financing. A long term crisis of confidence in real estate investing and lack of available credit for acquisitions would be likely to constrain our business growth. As part of our business goals, we intend to grow our properties portfolio with strategic acquisitions of core properties at advantageous prices, and core plus and value added properties where we believe we can bring necessary expertise to bear to increase property values. In order to pursue acquisitions, we need access to equity capital and also property-level debt financing. Conditions in the financial markets may adversely impact the availability and cost of credit in the near future. Our ability to make scheduled payments or to refinance our obligations with respect to indebtedness depends on our operating and financial performance, which in turn is subject to prevailing economic conditions.
Illiquidity of real estate investments and the susceptibility of the real estate industry to economic conditions could significantly impede our ability to respond to adverse changes in the performance of our properties.
Our ability to achieve desired and projected results for growth of our business depends on our ability to generate revenues in excess of expenses, and make scheduled principal payments on debt and fund capital expenditure requirements. Events and conditions generally applicable to owners and operators of real property that are beyond our control may adversely impact our results of operations and the value of our properties. These events include:
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vacancies or our inability to rent space on favorable terms;
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inability to collect rent from tenants;
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difficulty in accessing credit in the present economic environment, in particular for larger mortgage loans;
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inability to finance property development and acquisitions on favorable terms;
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increased operating costs, including real estate taxes, insurance premiums and utilities;
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local oversupply, increased competition or reduction in demand for office space;
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fluctuating condominium prices and absorption rates;
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costs of complying with changes in governmental regulations;
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the relative illiquidity of real estate investments;
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changing submarket demographics; and
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the significant transaction costs related to property sales.
In addition, periods of economic slowdown or recession, rising interest rates or declining demand for real estate, or the public perception that any of these events may occur, could result in a general decline in rents or an increased incidence of defaults under existing leases. If any of these events were to happen, our revenue and profitability could be impaired, causing a significant downturn in our financial condition, results of operations, cash flow, and the trading price of our common stock, and our ability to satisfy our debt service obligations could be impaired.
Compliance with the Americans with Disabilities Act and fire, safety and other regulations may require us to make unintended expenditures that adversely impact our financial condition.
All of our commercial properties are required to comply with the Americans with Disabilities Act, or ADA. The ADA has separate compliance requirements for “public accommodations” and “commercial facilities,” but generally requires that buildings be made accessible to people with disabilities. The obligation to make readily achievable accommodations is an ongoing one, and we assess our properties and make alterations as appropriate. Compliance with the ADA requirements could require removal of access barriers.
If one or more of our properties is not in compliance with the ADA, we would be required to incur additional costs to bring the property or properties into compliance. In addition, non-compliance could result in imposition of fines by the U.S. government or an award of damages to private litigants, or both. Typically, we are responsible for changes to a building structure that are required by the ADA, which can be costly. In addition, we are required to operate our properties in compliance with fire and safety regulations, building codes and other land use regulations. We may be required to make substantial capital expenditures to comply with these requirements thereby limiting the funds available to operate, develop and redevelop our properties and acquire additional properties. As a result, these expenditures could negatively impact our revenue and profitability.
Potential losses to our properties may not be covered by insurance and may result in our inability to repair damaged properties; as a result we could lose invested capital.
We carry comprehensive liability, fire, flood, extended coverage, wind, earthquake, terrorism, pollution legal liability, business interruption and rental loss insurance under policies covering all of the properties in which we own an interest in or manage for third parties, including our development properties (although we carry only liability insurance for the California Environmental Protection Agency (“CalEPA”) headquarters building because the tenant has the right to provide all other forms of coverage it deems necessary, and it has elected to do so, and we do not insure 816 Congress and Austin Centre because the third party owner has elected to insure those properties under its policy). We believe the policy specifications and insured limits are appropriate and adequate given the relative risk of loss, the cost of the coverage and industry practice.
We either own or manage two properties in Southern California, an area especially prone to earthquakes. We carry earthquake insurance on our properties located in these seismically active areas, wind insurance on our properties located in “tier 1” wind zones, which includes our Houston, Texas properties, and terrorism insurance on all of our properties. Our terrorism insurance is subject to exclusions for loss or damage caused by nuclear substances, pollutants, contaminants, and biological and chemical weapons as more specifically excluded under the actual terrorism policies. Some of our policies, like those covering losses due to earthquakes and terrorism, are subject to limitations involving deductibles and policy limits which may not be sufficient to cover potential losses.
Under their leases, our tenants are generally required to indemnify us against liabilities resulting from injury to persons, air, water, land or property, on or off the premises due to activities conducted by them on our properties. There is generally an exception for claims arising from the negligence or intentional misconduct by us or our agents. Additionally, tenants are generally required, with the exception of governmental entities and other entities that are self-insured, to obtain at their own
expense and keep in force during the term of the lease both liability and property damage insurance policies issued by companies holding ratings at a minimum level at their own expense.
Although we have not experienced such a loss to date, if we experience a loss that is uninsured or that exceeds policy limits, we could lose the capital invested in the damaged property as well as the anticipated future cash flows from that property, including lost revenue from unpaid rent from tenants. In addition, if the damaged property is subject to recourse indebtedness, we would continue to be liable for the indebtedness, even if the property was irreparably damaged. In the event of a significant loss at one or more of the properties covered by our policies, the remaining insurance under the policy, if any, could be insufficient to adequately insure our remaining properties. In this event, securing additional insurance, if possible, could be significantly more expensive than our current policy.
Risks Related to Our Organization and Structure
Our senior management has existing conflicts of interest with us and our public stockholders that could result in decisions adverse to our Company.
In addition to the common stock owned by Mr. Thomas as of December 31, 2012, he owned or controlled a significant interest in our Operating Partnership consisting of 12,313,331 units, or a 21% interest in the Operating Partnership as of such date. In addition, our senior executive officers, excluding Mr. Thomas, collectively held an interest in incentive units (vested and unvested) representing an aggregate 2.8% equity interest in the Operating Partnership.
Members of senior management could make decisions that could have different implications for our Operating Partnership and for us, our stockholders, and our senior executive officers. For example, dispositions of interests in One Commerce Square or Two Commerce Square could trigger our tax indemnification obligations with respect to Mr. Thomas.
We have a holding company structure and rely upon funds received from our Operating Partnership to pay liabilities.
We are a holding company. Our primary asset is our general partnership interest in our Operating Partnership. We have no independent means of generating revenues. To the extent we require funds to pay taxes or other liabilities incurred by us, to pay dividends or for any other purpose, we must rely on funds received from our Operating Partnership. If our Operating Partnership should become unable to distribute funds to us, we would be unable to continue operations after a short period. Most of the properties owned by our subsidiaries and joint ventures are encumbered by loans. These loans generally contain lockbox arrangements and reserve requirements that may affect the amount of cash available for distribution from the subsidiaries that own the properties to the Operating Partnership. Some of the loans include cash sweep and other restrictions and provisions that prior to an event of default may prevent the distribution of funds from the subsidiaries who own these properties to our Operating Partnership. In the event of a default under any of these loans, the defaulting subsidiary or joint venture would be prohibited from distributing cash to our Operating Partnership. As a result, our Operating Partnership may be unable to distribute funds to us and we may be unable to use funds from one property to support the operation of another property. As we acquire new properties and refinance our existing properties, we may finance these properties with new loans that contain similar provisions. Some of the loans to our subsidiaries and joint ventures may contain provisions that restrict us from loaning funds to our other subsidiaries or joint ventures. If we are permitted to loan funds to our subsidiaries or joint ventures, our loans generally will be subordinated to the existing debt on our properties.
Mr. Thomas has a significant vote in certain matters as a result of his control of 100% of our limited voting stock.
Each entity that received Operating Partnership units in our formation transactions received shares of our limited voting stock that are paired with units in our Operating Partnership on a one-for-one basis. All of these entities are directly or indirectly controlled by Mr. Thomas, and, as a result, Mr. Thomas controls 100% of our outstanding limited voting stock, and 42.1% of our outstanding voting stock (including outstanding shares of common stock owned by Mr. Thomas and his affiliates as well as 8,695,653 shares owned by Madison and subject to a lock-up period and voting agreement in favor of Mr. Thomas which generally expires with respect to all of such Madison shares in June 2015) as of December 31, 2012. The limited voting shares are entitled to vote in the election of directors, for the approval of certain extraordinary transactions including any merger, sale or liquidation of the Company, amendments to our certificate of incorporation and any other matter required to be submitted to a separate class vote under Delaware law. Mr. Thomas may have interests that differ from that of our public stockholders, including by reason of his interests held in Operating Partnership units, and may accordingly vote as a stockholder in ways that may not be consistent with the interests of our public stockholders. This significant voting influence over certain matters may have the effect of delaying, preventing or deterring a change of control of our Company, or could deprive our stockholders of an opportunity to receive a premium for their common stock as part of a sale of our Company. Pursuant to the Madison Agreements, subject to certain exceptions, during the period from the sixth anniversary of the issuance of shares to Madison's affiliates until the ninth anniversary of such date, Mr. Thomas has agreed to vote (and to cause his
affiliated entities to vote) all of his controlled group's shares of common stock and limited voting stock in a manner that is in direct proportion to the manner in which other holders of the common stock vote on a proposed company sale transaction. This vote neutralization provision will not apply, however, if Madison's affiliates no longer beneficially own at least 10.0% of the our total voting securities or if the volume-weighted average price of our common stock is at least $12.5 per share during the six month period prior to the sixth anniversary of the issuance of the shares to Madison's affiliates (or at least $10.0 per share if our common stock has met certain trading volume tests).
Some provisions of our certificate of incorporation and bylaws may deter takeover attempts, which may limit the opportunity of our stockholders to sell their shares at a favorable price.
Some of the provisions of our certificate of incorporation and bylaws could make it more difficult for a third party to acquire us, even if doing so might be beneficial to our stockholders by potentially providing them with the opportunity to sell their shares at a premium over the then market price. Our certificate of incorporation and bylaws contain provisions which may deter takeover attempts, including the following:
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vacancies on our board of directors may only be filled by the remaining directors;
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only the board of directors can change the number of directors;
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there is no provision for cumulative voting for directors;
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directors may only be removed for cause; and
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our stockholders are not permitted to act by written consent.
In addition, our certificate of incorporation authorizes the board of directors to issue up to 25,000,000 shares of preferred stock. The preferred stock may be issued in one or more series, the terms of which will be determined at the time of issuance by our board of directors without further action by our stockholders. These terms may include voting rights, including the right to vote as a series on particular matters, preferences as to dividends and liquidation, conversion rights, redemption rights and sinking fund provisions. The issuance of any preferred stock could diminish the rights of holders of our common stock, and therefore could reduce the value of our common stock. In addition, specific rights granted to future holders of preferred stock could be used to restrict our ability to merge with, or sell assets to, a third party. The ability of our board of directors to issue preferred stock could make it more difficult, delay, discourage, prevent or make it more costly to acquire or effect a change in control, thereby preserving the current stockholders' control of our Company.
Finally, we are also subject to Section 203 of the Delaware General Corporation Law which, subject to certain exceptions, prohibits a Delaware corporation from engaging in any business combination with any "interested stockholder" for a period of three years following the date that such stockholder became an interested stockholder.
The provisions of our certificate of incorporation and bylaws, described above, as well as Section 203 of the Delaware General Corporation Law, could discourage potential acquisition proposals, delay or prevent a change of control and prevent changes in our management, even if these events would be in the best interests of our stockholders.
We could authorize and issue stock without stockholder approval, which could cause our stock price to decline and which could dilute the holdings of our existing stockholders.
Our certificate of incorporation authorizes our board of directors to issue authorized but unissued shares of our common stock or preferred stock to classify or reclassify any unissued shares of our preferred stock and to set the preferences, rights and other terms of the classified or unclassified shares. Our board of directors could establish a series of preferred stock that could, depending on the terms of the series, delay, defer or prevent a transaction or a change of control that might involve a premium price for our common stock or otherwise be in the best interests of our stockholders.
The payment of dividends on our common stock is at the discretion of our board of directors and subject to various restrictions and considerations and, consequently, may be changed or discontinued at any time.
Although we historically paid quarterly cash dividends on our common stock after our initial public offering until December 2009, and since December 2011 have resumed paying a quarterly cash dividend, the payment of cash dividends in the future, if any, will be at the discretion of our board of directors and will depend upon such factors as earnings levels, capital requirements, our overall financial condition, and any other factors deemed relevant by our board of directors. There is no guarantee that dividend payments will continue. Without dividend payments, the only opportunity to achieve a positive return on an investment in our common stock is if the market price of our common stock appreciates.
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.
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ITEM 2.
ITEM 2.
PROPERTIES
Our Ownership Interest Properties
Our properties are located in the West Coast, Southwest, and Mid-Atlantic regions of the United States, consisting primarily of office space and also including mixed-use, multi-family and retail properties. The limited partnership interests held by subsidiaries of Brandywine in One Commerce Square and Two Commerce Square are reflected as noncontrolling interests. We have an ownership interest of 25% in TPG/CalSTRS (except for City National Plaza as to which our ownership is 7.9% interest). TPG/CalSTRS holds a 100% ownership interest in six properties in Los Angeles, Northern Virginia and Houston, Texas. We have an ownership interest of 66.7% in TPG Austin Partner, LLC. TPG Austin Partner, LLC owns a 50% interest in TPG/CalSTRS Austin, LLC which owns eight properties in Austin, Texas. The eight properties were acquired from the Austin Joint Venture Predecessor.
An overview of these operating properties as of December 31, 2012 is presented below:
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(1)
For purposes of the tables above, both on-site and off-site parking is excluded. Total portfolio square footage includes office properties and mixed-use space (including retail).
(2)
Percent leased represents the sum of the square footage of the existing leases as a percentage of rentable area described in (1) above.
(3)
Annualized net rent represents the annualized monthly contractual rent under existing leases as of December 31, 2012 (represents 100% of the existing leases even for properties for which our percentage interest is less than 100%). For any tenant under a partial gross lease (which requires the tenant to reimburse the landlord for its pro-rata share of operating expenses in excess of a stated expense stop) or under a full gross lease (which does not require the tenant to reimburse the landlord for any operating expenses), the unreimbursed portion of current year operating expenses (which may be estimates as of such date) are subtracted from gross rent. Annualized net rent excludes parking and other revenues, future rent increases, the effect of recognizing rental income on the straight-line method of accounting in accordance with GAAP, lease inducement amortization, and above/below market rent amortization.
(4)
Annualized net rent per leased square foot represents annualized net rent as computed above, divided by the total square footage under lease as of the same date.
(5)
We have entered into a purchase and sale agreement for the sale of this property. The buyer is performing due diligence, and has the right to cancel the contract.
(6)
The borrower on the mortgage loans secured by these properties did not make the debt service payment due in February 2013. The special servicer has issued notices of default, but has not taken any further action in response. On a net basis TPG's equity investment balance in these properties is not material.
Significant Tenants
As of December 31, 2012, our portfolio of consolidated properties consists of office space at One Commerce Square, Two Commerce Square and Four Points Centre, and is leased to 88 tenants, many of which are nationally recognized firms in the financial services, accounting and legal sectors. The following table sets forth information regarding significant tenants in our office portfolio, which is any tenant representing greater than 5% of the portfolio, based on total annualized rent for our portfolio as of December 31, 2012:
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(1) Annualized net rent represents the annualized monthly contractual rent under existing leases as of December 31, 2012 (represents 100% of the existing leases even for properties for which our percentage interest is less than 100%). For any tenant under a partial gross lease (which requires the tenant to reimburse the landlord for its pro-rata share of operating expenses in excess of a stated expense stop) or under a full gross lease (which does not require the tenant to reimburse the landlord for any operating expenses), the unreimbursed portion of current year operating expenses (which may be estimates as of such date) are subtracted from gross rent. Annualized net rent excludes parking and other revenues, future rent increases, the effect of recognizing rental income on the straight-line method of accounting in accordance with GAAP, lease inducement amortization, and above/below market rent amortization.
Lease Expirations
The following table presents a summary of lease expirations for our consolidated properties (excluding our unconsolidated properties) for leases in place at December 31, 2012, plus available space, for each of the ten calendar years beginning January 1, 2013. This table assumes that none of our tenants exercise renewal options or early termination rights, if any, at or prior to their scheduled expirations.
The following table presents a summary of lease expirations for our unconsolidated properties (excluding our consolidated properties) for leases in place at December 31, 2012, plus available space, for each of the ten calendar years beginning January 1, 2013. This table assumes that none of the tenants exercise renewal options or early termination rights, if any, at or prior to the scheduled expirations.
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(1)
Annualized net rent represents the annualized monthly contractual rent under existing leases as of December 31, 2012 (represents 100% of the existing leases even for properties for which our percentage interest is less than 100%). For any tenant under a partial gross lease (which requires the tenant to reimburse the landlord for its pro-rata share of operating expenses in excess of a stated expense stop) or under a full gross lease (which does not require the tenant to reimburse the landlord for any operating expenses), the unreimbursed portion of current year operating expenses (which may be
estimates as of such date) are subtracted from gross rent. Annualized net rent excludes parking and other revenues, future rent increases, the effect of recognizing rental income on the straight-line method of accounting in accordance with GAAP, lease inducement amortization, and above/below market rent amortization.
(2)
Current net rent per square foot represents the annualized rent as computed above divided by total square footage under the lease as of the same date.
(3)
Rent per square foot at expiration represents the annualized rent that will be in place at lease expiration.
Historical Tenant Improvements and Leasing Commissions (1)
The following table sets forth certain historical information regarding tenant improvement and leasing commission costs for tenants in our portfolio of consolidated properties for 2012, 2011, and 2010. The information presented assumes all tenant improvements and leasing commissions are paid in the calendar year in which the lease was executed, which may be different from the year in which the lease commences or in which they are actually paid.
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(1)
Based on leases executed during the period. Excludes short-term leases one year or less.
(2)
Includes retained tenants that have relocated or expanded into new space.
Development Properties
An overview of our development properties as of December 31, 2012 is presented below.
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(1)
Inclusive of any capitalized interest and net of any impairment charges.
(2)
The 23.9 acres at Campus El Segundo are under contract to be sold including a marketing center building and athletic facility naming rights. The buyer is performing due diligence, and has the right to cancel the contract. The amount reflected above under "costs incurred to date" excludes costs associated with the marketing center and naming rights.
(3)
In January and March 2013, TPG completed the sale of certain land parcels totaling 17.5 acres and 27.9 acres, respectively, at Four Points Centre in Austin, Texas, for $4.9 million and $6.4 million, respectively. TPG received net proceeds from these transactions of $1.1 million (after a $3.7 million pay down of the Four Points Centre mortgage loan) and $2.7 million (after a $3.1 million pay down of the loan), respectively. As a result of these sales, there are 19.9 developable acres remaining. As of December 31, 2012, the 17.5 acres that were sold in January 2013 are reflected in Assets associated with land held for sale on the consolidated balance sheets.
(4)
Average cost per square foot on CityWestPlace land is based on total costs incurred to date of $6.1 million, including TPGI's share of $1.5 million.
(5)
We consolidate our Murano residential condominium project which we control. Our unaffiliated partner's interest is reflected in our consolidated balance sheets under the "Noncontrolling Interests" caption. Our partner has a stated ownership interest of 27%. After full repayment of the Murano mortgage loan, which has a balance of $6.9 million at December 31, 2012, net proceeds from the project will be distributed, to the extent available, based on an order of preferences described in the partnership agreement. The Company anticipates that we will receive distributions, if any, in excess of our stated 73% ownership interest according to these distribution preferences.
(6)
Of the 51 units remaining to sell as of December 31, 2012, 47 units are on high-rise floors with superior views. Subsequent to December 31, 2012, we entered into contracts for sale for five additional units. Some of these contracts are subject to a buyer rescission period.
(7)
The average list price per square foot is $677.
Parking
Our portfolio in which we presently have an ownership interest includes approximately 16,465 vehicle spaces which are revenue generating within on-site and off-site parking facilities. The following table presents an overview of these garage properties as of December 31, 2012.
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(1)
Includes vehicle spaces provided to tenants under lease agreements.
(2)
Includes garage space at One Commerce Square and Two Commerce Square in which we have a 75.0% ownership interest; San Felipe Plaza, CityWestPlace, and Fair Oaks Plaza, in which we have an indirect 25.0% ownership interest; City National Plaza in which we have an ownership interest of 7.9%; and San Jacinto Center, Frost Bank Tower, One Congress Plaza, One American Center, and 300 West 6thStreet, in which we have an indirect 33.3% ownership interest.
(3)
Includes off-site garage space for City National Plaza in which we have an indirect 7.9% ownership interest.
Our Managed Properties
In addition to our portfolio of operating and development properties in which we hold an ownership interest, we provide asset and/or property management services for five properties on a fee basis for third parties. We provide asset and property management and leasing services to two properties, 800 South Hope Street and 1835 Market Street, through our separate account relationship with CalSTRS. We developed and continue to provide property management services for the CalEPA headquarters building, and we provide property management and leasing services for 816 Congress and Austin Centre on behalf of an affiliate of Lehman. The table below presents an overview of those properties which we manage for third parties as of December 31, 2012.
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(1)
For purposes of the table above, both on-site and off-site parking are excluded. Total rentable square feet includes office properties and retail space.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
We are involved in various litigation and other legal matters from time to time, including personal injury claims and administrative proceedings, which we are addressing or defending in the ordinary course of business. Management believes that any liability that may potentially result upon resolution of such matters will not have a material adverse effect on our business, financial condition or results of operations.
In June 2012, the Company commenced litigation contesting a consultant's claim of approximately $5.1 million for incentive compensation pursuant to a consulting agreement. At the same time, the consultant commenced an action against the Company for breach of contract due to the Company's failure to pay the consultant's invoice. The Company intends to
vigorously defend against the consultant's claim. Management believes that any liability that may potentially result upon resolution of this matter will not have a material adverse effect on our business or financial condition but may have a material adverse effect on our results of operations.
ITEM 4.
ITEM 4.
MINE SAFETY DISCLOSURES
Not applicable.
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EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information regarding our current executive officers.
James A. Thomas serves as our Chairman of the Board, President and Chief Executive Officer. Mr. Thomas has served on our Board of Directors since the Company was organized in March 2004. Mr. Thomas founded our predecessor group of entities, and served as the Chairman of the Board and Chief Executive Officer of our predecessor group of entities from 1996 to the commencement of our operations in October 2004. Prior to founding our predecessor group of entities, Mr. Thomas served as a co-managing partner of Maguire Thomas Partners, a national full-service real estate Operating Company from 1983 to 1996. In 1996, Maguire Thomas Partners was divided into two companies with Mr. Thomas forming our predecessor group of entities with other key members of the former executive management at Maguire Thomas Partners. Mr. Thomas also served as Chief Executive Officer and principal owner of the Sacramento Kings National Basketball Association team and the ARCO Arena from 1992 until 1999. He is a member of the Real Estate Roundtable and the National Association of Real Estate Investment Trusts (NAREIT). Mr. Thomas is a current member and a former Chairman of the board of directors of Town Hall Los Angeles, and serves on the board of directors of the SOS Coral Trees, and the National Advisory Council of the Cleveland Marshall School of Law. He serves on the board of trustees of the Ralph M. Parsons Foundation and I Have a Dream Foundation in Los Angeles, Baldwin Wallace College in Cleveland, and St. John’s Health Center Foundation in Santa Monica, California. Mr. Thomas also serves on the board of governors of the Music Center of Los Angeles County. He is a member of the Chairman's Council of the Weingart Center Association, the Colonial Williamsburg National Council, and the Fisher Center Policy Advisory Board. Additionally, Mr. Thomas is the Founder and Chairman of Fixing Angelenos Stuck in Traffic (F.A.S.T.). Mr. Thomas received his Bachelor of Arts degree in economics and political science with honors from Baldwin Wallace College in 1959. He graduated magna cum laude with a juris doctorate degree in 1963 from Cleveland Marshall Law School.
Thomas S. Ricci has served us as an Executive Vice President since April 2004. He served as Senior Vice President of our predecessor group of entities from May 1998 with oversight of business development and development services. From February 1992 through May 1998, Mr. Ricci was the vice president of planning and entitlements at Maguire Thomas Partners, Playa Capital Company division. As a senior executive at Maguire Thomas Partners, Mr. Ricci worked on several large mixed-use and commercial projects. Prior to joining Maguire Thomas Partners in 1987, Mr. Ricci was a Captain in the U.S. Air Force, where he was involved in planning, programming, design and construction of medical facilities at locations in the United States and abroad. Mr. Ricci is currently involved in various civic and professional organizations and serves on the Board of Directors and Executive Committee of the Los Angeles Area Chamber of Commerce and the Board of Trustees of Marymount College in Rancho Palos Verdes, California. Mr. Ricci holds a bachelor of science degree and a bachelor of architecture degree with honors from the New York Institute of Technology.
Paul S. Rutter serves us as Co-Chief Operating Officer and General Counsel. Mr. Rutter joined our Company in September 2008. After practicing law with James A. Thomas from 1978 to 1983, Mr. Rutter cofounded Gilchrist & Rutter Professional Corporation, a real estate law firm in Los Angeles, in 1983 and served as Managing Shareholder of the firm until 2006. His law practice included negotiating, structuring and documenting transactions and joint ventures involving commercial real estate development, financing, leasing, acquisitions and dispositions. In 2006, he became Executive Vice President, Major Transactions, at Maguire Properties, a NYSE listed real estate investment trust, where he was a member of the Executive Management Committee and oversaw the leasing, acquisition and financing transactions of that company. Mr. Rutter is active in several real estate organizations and has served on the boards of several charitable and non-profit organizations. Mr. Rutter currently is a member of the Board of Advisors of University of California, Los Angeles School of Law and is on the Advisory Board of the UCLA Ziman Center for Real Estate. Mr. Rutter earned his A.B. degree (magna cum laude) from the University of California, Los Angeles, where he received Dean's List honors, and was Pi Gamma Mu and Phi Beta Kappa. Mr. Rutter received his Juris Doctor degree (Order of the Coif) from the University of California, Los Angeles School of Law, where he
served as Topic and Comment Editor for the U.C.L.A. Law Review. He is admitted to the bars of the State of California, the U.S. Tax Court, the U.S. Court of Federal Appeals and the United States Supreme Court.
Randall L. Scott serves us as an Executive Vice President and Director. Mr. Scott has been a member of our Board of Directors since April 2004. Mr. Scott directed asset management operations nationally and East Coast development activity for our predecessor group of entities from its inception in 1996 until the commencement of our operations in October 2004. Prior to the formation of our predecessor group of entities, Mr. Scott was with Maguire Thomas Partners from July 1986 to August 1996. As a senior executive at Maguire Thomas Partners, Mr. Scott worked on several large-scale development projects, including One Commerce Square in Philadelphia and The Gas Company Tower in Los Angeles. Mr. Scott was also on the pre-development team for the CalEPA project in Sacramento and served in a general business development capacity. Mr. Scott is currently involved in various civic and professional organizations and serves on the board of directors of the Center City District, a Philadelphia non-profit special services organization and the board of trustees of Magee Rehabilitation Hospital, a Philadelphia-based specialty hospital providing medical rehabilitation services to people with physical disabilities. Mr. Scott holds a bachelor's degree in business administration from Butler University in Indianapolis.
John R. Sischo serves us as Co-Chief Operating Officer of Thomas Properties Group, Inc. Mr. Sischo has been a member of our Board of Directors since April 2004. Mr. Sischo leads the company's acquisition, investment and finance efforts in addition to managing investor relationships which includes major pension funds and financial institutions. As a founding partner of the company, he has lead the firm's effort in the acquisition of approximately $3.8 billion of operating properties and built the company's investment management platform, through the financing of new and existing operating and development properties and fund investment programs, which has resulted in the creation of investment vehicles totaling approximately $1.0 billion of equity capital. Mr. Sischo joined Thomas Properties Group in 1998 as Chief Financial Officer after eight years leading Bankers Trust's real estate practice in Los Angeles. He has executed over $10 billion in real estate transactions both public and private during his 27 year career. He started his real estate banking career with Merrill Lynch Capital Markets and then moved to Security Pacific Corporation. Mr. Sischo received a bachelor's degree in political science from the University of California at Los Angeles.
Diana M. Laing serves as our Chief Financial Officer and Secretary, which positions she has held since May 2004. She is responsible for financial reporting oversight, capital markets transactions and investor relations. Prior to becoming a member of our senior management team, Ms. Laing served as Chief Financial Officer of Triple Net Properties, LLC from January 2004 through April 2004. From December 2001 to December 2003, Ms. Laing served as Chief Financial Officer of New Pacific Realty Corporation, and held this position at Firstsource Corp. from July 2000 to May 2001. Previously, Ms. Laing was Executive Vice President and Chief Financial Officer of Arden Realty, Inc., a publicly-traded REIT, from August 1996 to July 2000. From 1982 to August 1996, she was Chief Financial Officer of Southwest Property Trust, Inc., a publicly-traded multi-family REIT. She is a member of the board of directors, chairman of the audit committee and a member of the compensation committee for The Macerich Company, a publicly-traded REIT. Ms. Laing holds a bachelor of science degree in accounting from Oklahoma State University.
Robert D. Morgan serves us as a Senior Vice President responsible for accounting and administration. He served us as a Vice President from April 2004 to December 2006 in the same capacity. Mr. Morgan joined our predecessor group of entities in March 2000 from Arthur Andersen LLP, where he spent 10 years in the real estate services group. At Arthur Andersen, Mr. Morgan was a Senior Manager specializing in providing audit and transaction due diligence services to real estate developers, owners, lenders and operators. Mr. Morgan earned a bachelor of science degree in business administration with a concentration in accounting from California Polytechnic State University at San Luis Obispo. Mr. Morgan is a certified public accountant, licensed by the State of California.
Todd L. Merkle serves us as our Chief Investment Officer. Prior to joining the Company as a Vice President in 2004, Mr. Merkle spent ten years in the investment banking business at the firms of Merrill Lynch, Lehman Brothers and Houlihan Lokey Howard & Zukin, having been based in both New York, NY and Los Angeles, CA. In this capacity, Mr. Merkle was involved in a variety of investment banking transactions on behalf of both public and private real estate clients, including buy-side and sell-side mergers and acquisitions, special committee representations, fairness opinions, asset and portfolio sales, and public and private equity and debt financings. Mr. Merkle also spent two years as a corporate finance associate at the Irvine Company in Newport Beach, CA. Mr. Merkle received a BS in Applied Economics and Management from Cornell University.
Code of Ethics
We have adopted a Code of Business Conduct and Ethics that applies to all of our directors, officers and employees. This code is publicly available on our web site at www.tpgre.com. Any substantive amendments to the code and any grant of waiver from a provision of the code requiring disclosure under applicable SEC or NASDAQ rules will be disclosed by us in a report on Form 8-K.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock trades on the NASDAQ Global Market under the symbol “TPGI”. As of March 7, 2013, there were thirteen stockholders of record. This figure does not reflect the beneficial ownership of shares held in the name of CEDE & Co. The following table sets forth, for the period indicated, the intra-day high and low per share sales prices in dollars on the NASDAQ Global Market for our common stock.
The closing price of our common stock as of March 7, 2013 was $5.28.
In 2012 we paid quarterly dividends of $0.015 per common share for the first three quarters of the year and $0.02 per common share in the last quarter of the year. The actual amount and timing of distributions is at the discretion of our board of directors and depends upon our financial condition, and no assurance can be given as to the amounts or timing of future distributions. Factors that could influence our ability to declare and pay dividends are discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources.”
There were no issuer purchases of equity securities during the quarter ended December 31, 2012.
Equity compensation plan information is discussed in Item 12 of this report under the heading “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Performance Measurement Comparison
The information below shall not be deemed to be incorporated by reference into any filing under the Securities Act and Exchange Act or deemed to be “soliciting material” or to be “filed” with the U.S. Securities and Exchange Commission or subject to Regulation 14A or 14C, other than as provided in Item 201 of Regulation S-K, or to the liabilities of Section 18 of the Exchange Act, except to the extent we specifically request that such information be treated as soliciting material or specifically incorporate it by reference into a filing under the Securities Act or the Exchange Act.
The following graph provides a comparison of cumulative total stockholder return for the period from December 31, 2007 through December 31, 2012, for the common stock of our Company, NASDAQ Composite Index and the Dow Jones US Real Estate Investments & Services TSM. The stock performance graph assumes an investment of $100.00 in each of our common stock and the two indices, and the reinvestment of any dividends. The historical information reflected in the graph is not necessarily indicative of future performance. The data shown is based on the closing share prices or index values, as applicable, at the end of the last day of each year shown.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected consolidated financial and operating data on a historical basis for our Company.
The following data should be read in conjunction with our financial statements and notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Form 10-K.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report. We make statements in this section that are forward-looking statements within the meaning of the federal securities laws. For a complete discussion of forward-looking statements, see the section in this Form 10-K entitled “Forward-Looking Statements.” Certain risk factors may cause our actual results, performance or achievements to differ materially from those expressed or implied by the following discussion. For a discussion of such risk factors, see the section in this report entitled “Risk Factors.”
When you read the financial statements and the information included in this report, you should be aware that our operations are significantly affected by both macro and micro economic forces. Our operations are directly affected by actual and perceived trends in various national and regional economic conditions that affect national and regional markets for commercial real estate services, including interest rates, the availability of credit to finance commercial real estate transactions, and the impact of tax laws affecting real estate. Periods of economic slowdown or recession, rising interest rates, tightening of the credit markets, declining demand for or increased supply of real estate, or the public perception that any of these events may occur can adversely affect our business. These conditions could result in a general decline in rents, which in turn would reduce revenue from property management fees and brokerage commissions derived from leases. In addition, these conditions could lead to a decline in property values as well as a decline in funds invested in commercial real estate and related assets, which in turn may reduce revenues from investment advisory, property management, leasing and development fees.
Overview and Background
We are a full-service real estate operating company that owns, acquires, develops and manages primarily office, as well as mixed-use and residential properties on a nationwide basis. Our company’s primary areas of focus are the acquisition and ownership of interests in premier properties, property development and redevelopment, and investment and property management activities. We conduct our business through our Operating Partnership, of which we own 78.7% as of December 31, 2012 and have control over the major decisions of the Operating Partnership.
The properties we own interests in or manage on behalf of third parties are located in Southern California and Sacramento, California; Philadelphia, Pennsylvania; Northern Virginia; Houston, Texas; and Austin, Texas. As of December 31, 2012, we own interests in and asset manage 17 operating properties with 10.3 million rentable square feet and provide leasing, asset and/or property management services on behalf of third parties for an additional five operating properties with 2.6 million rentable square feet. We also have direct and indirect ownership interests in developable land with various allowable uses, including office development, totaling approximately 3.4 million square feet. Additionally, we developed Murano, a 302- unit high-rise residential condominium project in downtown Philadelphia, in which we have closed sales on 251 units as of December 31, 2012.
Dispositions
Three primary objectives of our strategic plan are selling non-core assets that have achieved their maximum value, reducing the size of our development portfolio as a percentage of our total portfolio value and continuing to reduce leverage on our portfolio. During the year ended December 31, 2012 and subsequent to year-end, we have continued to make progress toward the achievement of these objectives through targeted dispositions.
TPG/CalSTRS Properties:
In January 2012, we closed on the sale of Brookhollow Central I, II, and III, a TPG/CalSTRS joint venture office property in Houston, Texas, which sale resulted in net proceeds of $7.7 million to TPG. In November 2012, we closed on the sale of a 14.18 acre land parcel at CityWestPlace, a TPG/CalSTRS joint venture property in Houston Texas, resulting in gains of $14.2 million and net proceeds of $7.3 million to TPG.
Austin Joint Venture Predecessor Properties:
In July 2012, we completed the sale of both Research Park Plaza and Stonebridge Plaza II, Austin Joint Venture Predecessor assets. These transactions resulted in the repayment of $89.0 million of mortgage debt and generated approximately $17.7 million of net proceeds to the Austin Joint Venture Predecessor, after costs, including a disposition fee of $0.6 million to the Company. The net proceeds were distributed to the Company and the other partners/lenders in partial satisfaction of amounts loaned under the Austin Priority Credit Facility.
Partnership Redemption:
In December 2012, TPG redeemed a 49% interest in 2121 Market Street and sold the adjacent 2100 JFK Boulevard parking lot for total consideration of $12.4 million. Net proceeds to TPG from this transaction totaled $12.1 million. TPG retained a 1.0% limited partnership interest in 2121 Market Street and recorded a deferred gain of $9.6 million related to this transaction. Additionally, TPG issued a guarantee up to a maximum amount of $14.0 million on a mortgage loan secured by a first trust deed on 2121 Market Street, expiring in December 2022.
Consolidated Properties:
In January 2012, we closed on the sale of a 4,800 square foot retail building at Four Points Centre in Austin, Texas, which resulted in net proceeds to us of $1.1 million. Additionally, in January and March 2013, TPG completed the sale of certain land parcels totaling 17.5 acres and 27.9 acres, respectively, at Four Points Centre in Austin, Texas, for $4.9 million and $6.4 million, respectively. TPG received net proceeds from these two transactions of $1.1 million (after a $3.7 million paydown of the Four Points Centre mortgage debt) and $2.7 million (after a $3.1 million pay down of the loan), respectively.
As a result of the consolidated and unconsolidated property dispositions mentioned in the previous paragraphs and summarized in the table below (in thousands), TPG's share of net proceeds was approximately $34.9 million and TPG's share of mortgage debt was reduced by approximately $30.5 million. Our plan is to redeploy net sales proceeds by acquiring institutional quality assets in high barrier to entry markets to generate recurring cash flow and net operating income growth.
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Summary of Property Dispositions
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(1) These land parcels were sold subsequent to year-end. The proceeds reflected in the table are net of pay down on a mortgage loan.
(2) TPG redeemed a 49% interest in the 2121 Market Street partnership and sold the adjacent 2100 JFK Boulevard parking lot, a previously consolidated asset, to our unaffiliated partner.
(3) We recorded a deferred gain of $9.6 million, which is reflected in the Deferred Revenue caption on our consolidated balance sheets.
(4) The TPG/CalSTRS subsidiary, which owned Brookhollow Central I, II and III, recorded an impairment charge of $7.8 million in the quarter ended December 31, 2011. That impairment charge is not reflected in this table.
Acquisitions
On September 18, 2012, an entity owned by TPG and CalSTRS, acquired all of the equity interests in an eight building, three million square foot portfolio of office properties in Austin, Texas, formerly owned by Austin Joint Venture Predecessor. The purchase price for the portfolio was $859.1 million. As part of the transaction, TPG/CalSTRS Austin, LLC assumed five existing first mortgage loans totaling $626.0 million. The transaction reduced the existing leverage on the portfolio by repaying approximately $135.6 million owed to Lehman Commercial Paper, Inc. and the three existing partners as a result of loans made by the partners. TPG retains all operating responsibilities for the properties and the existing Austin leasing and management team remains in place.
Refinancing
On March 8, 2013, we entered into a loan agreement with a lender for a new mortgage on Two Commerce Square in the amount of $112.0 million. The loan, which has a fixed interest rate of 3.96% for a ten year term, funded on March 8, 2013. The loan replaced the existing mortgage on the property that had an outstanding balance of $106.6 million as of December 31, 2012, and a maturity date of May 9, 2013, and was open to prepayment without penalty on and after March 8, 2013.
Critical Accounting Policies and Estimates
Accounting estimates. The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses for the relevant reporting periods. Certain accounting policies are considered to be critical accounting estimates, as these policies require us to make assumptions about matters that are highly uncertain at the time the estimate is made and changes in the accounting estimate are reasonably likely
to occur from period to period. We believe the following accounting policies reflect the more significant estimates used in the preparation of our financial statements. For a summary of significant accounting policies, see Note 2 to our consolidated financial statements, included elsewhere in this report.
Investments in real estate. The price that we pay to acquire a property is impacted by many factors including the condition of the buildings and improvements, the occupancy of the building, the existence of above and below market tenant leases, the creditworthiness of the tenants, favorable or unfavorable financing, and numerous other factors. Accordingly, we are required to make subjective assessments related to our estimates of the assets acquired and liabilities assumed. This includes determining the value of the buildings and improvements, land, any ground leases, tenant improvements, in-place tenant leases, tenant relationships, the value (or negative value) of above (or below) market leases and any debt assumed from the seller or loans made by the seller to us. Each of these estimates requires a great deal of judgment and some of the estimates involve complex calculations. Our calculation methodology is summarized in Note 2 to our consolidated financial statements. These estimates have a direct impact on our results of operations because if we were to allocate more value to land there would be no depreciation with respect to such amount or if we were to record more value to the buildings as opposed to recording the value of tenant leases, this amount would be recognized as an expense over a much longer period of time, since the amounts recorded to buildings are depreciated over the estimated lives of the buildings whereas amounts recorded to tenant leases are amortized over the terms of the leases. Additionally, the amortization of value (or negative value) assigned to non-market rate leases is recorded as an adjustment to rental revenue as compared to amortization of the value of in-place leases and tenant relationships, which is included in depreciation and amortization in our consolidated statements of operations.
We are required to make subjective assessments as to the useful lives of our properties for purposes of determining the amount of depreciation to record on an annual basis with respect to our investments in real estate. These assessments have a direct impact on our net income because if we were to shorten the expected useful lives of our investments in real estate we would depreciate such investments over fewer years, resulting in more depreciation expense and lower net income on an annual basis.
We evaluate a property for potential impairment when events or changes in circumstances indicate that the current book value of the property may not be recoverable. Indicators of potential impairment include among other things: declining occupancy levels; declining rental rates; increasing number of tenants unable to pay their rent; deterioration in the local rental market; declining market values; and our inability or change of intent to hold the property.
In the event that these periodic assessments result in a determination that the carrying amount of a property exceeds the sum of the undiscounted cash flows (excluding interest) that are expected to result from the use and eventual disposition of the property, we would recognize an impairment loss to the extent the carrying amount exceeded the estimated fair value of the property. Estimates of expected future net cash flows are inherently uncertain and are based on assumptions dependent upon future and current market conditions and events that affect the ultimate value of the property. These estimates are highly subjective and require us to make assumptions relating to, among other things: future rental rates; tenant allowances; operating expenditures; property taxes; capital improvements; occupancy levels; the estimated proceeds generated from the future sale of the property or inability to sell the property; holding periods; market conditions; accessibility of capital and credit markets; recent sales activity of similar properties in the same market; our liquidity and ability and intent to hold the properties; development and construction costs; and discount rates. These estimates can change significantly between reporting periods. Due to the fact that estimates included in cash flow models are based on historical results and projected trends, unexpected changes in market conditions may lead to additional impairment charges in the future that cannot be anticipated.
We use the equity method of accounting to account for investments in real estate entities over which we have significant influence, but not control over major decisions. In these situations, the unit of account for measurement purposes is the equity investment and not the real estate. Accordingly, if our joint venture investments meet the other-than-temporary criteria of Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 323, “Investments-Equity Method and Joint Ventures” ("ASC 323"), we would recognize an impairment loss to the extent the carrying amount exceeded the estimated fair value of our investment.
With respect to condominium units held for sale, we would recognize an impairment loss to the extent the carrying amount exceeded the estimated fair value less costs to sell the project. Estimates of fair value are often based on expected future net cash flows, which are inherently uncertain and are based on assumptions dependent upon future and current market conditions and events that affect the ultimate value of the project. These estimates require us to make assumptions relating to, among other things, sales absorption rates, selling prices and discount rates.
Refer to the impairment loss discussion in the sections titled "Comparison of the year ended December 31, 2012 to the year ended December 31, 2011" and “Comparison of the year ended December 31, 2011 to the year ended December 31, 2010” found elsewhere herein for further information on the impairment losses recorded in those years.
Revenue recognition. Leases with tenants are accounted for as operating leases. Rental income is recognized as earned based upon the contractual terms of the leases with tenants. Minimum annual rents are recognized on a straight-line basis over the lease term regardless of when the payments are made. The deferred rents asset on our balance sheets represents the aggregate excess rental revenue recognized on a straight-line basis over the cash received under the applicable lease provisions. Our leases generally contain provisions that require tenants to reimburse us for a portion of property operating expenses and real estate related taxes associated with the property. These reimbursements are recognized as revenues in the period the related expenses are incurred. We generally record income on real estate commissions on leases after we satisfy all obligations under the commission agreement. A typical commission agreement provides that we earn 50% of the lease commission upon the execution of the lease agreement by the tenant. The remaining 50% of the lease commission is earned at a later date, usually upon tenant occupancy. The existence of any significant future contingencies will delay recognition of commission revenue until those contingencies are satisfied. In addition, we eliminate lease commissions we charge on our ownership share of rental properties. Investment advisory, property management and development services fees are recognized when earned under the provisions of the related agreements.
We have one high-rise condominium project for which we used the percentage of completion accounting method to recognize costs and sales during the construction period, up through and including June 30, 2009. Commencing with the third quarter of 2009, we applied the deposit method of accounting to recognize sales revenue and costs. Under the provisions of FASB ASC 360-20, “Property, Plant and Equipment” subsection “Real Estate and Sales”, revenue and costs for projects are recognized when all parties are bound by the terms of the contract, all consideration has been exchanged, any permanent financing for which the seller is responsible has been arranged and all conditions precedent to closing have been performed. This results in profit from the sale of condominium units recognized at the point of settlement as compared to the point of sale. Revenue is recognized on the contract price of individual units. Total estimated costs, net of impairment charges, are allocated to individual units which have closed on a relative value basis. Total estimated revenue and construction costs are reviewed periodically, and any change is applied to current and future periods.
Allowances for uncollectible current tenant receivables and unbilled deferred rents receivable. Tenant receivables and unbilled deferred rent receivables are carried net of the allowances for estimated uncollectible tenant receivables and unbilled deferred rent. Our determination of the adequacy of these allowances requires significant judgments and estimates. Unbilled deferred rents receivable represents the amount that the cumulative straight-line rental revenue recorded to date exceeds cash rents billed to date under the lease agreements. Given the longer-term nature of these types of receivables, our determination of the adequacy of the allowance for unbilled deferred rents receivables is based primarily on historical loss experience. We evaluate the allowance for unbilled deferred rents receivable using a specific identification methodology for our Company’s significant tenants, assessing a tenant’s financial condition and the tenant’s ability to meet its lease obligations. In addition, the allowance includes a reserve based upon our historical experience and current and anticipated future economic conditions that are not associated with any specific tenant.
Depreciable lives of leasing costs. We incur certain capital costs in connection with leasing our properties. These costs consist primarily of lease commissions and tenant improvements. Lease costs are amortized on the straight-line method over the shorter of the estimated useful life of the asset or the estimated remaining term of the lease, ranging from one to 15 years. We reevaluate the remaining useful life of these costs as the creditworthiness of our tenants changes. If we determine that the estimated remaining life of the respective lease has changed, we adjust the amortization period and, therefore, the amortization or depreciation expense recorded each period may fluctuate. If we experience increased levels of amortization or depreciation expense due to changes in the estimated useful lives of leasing costs, our results of operations may be adversely affected.
Income taxes. We are subject to federal income taxes in the United States, and also in states and local jurisdictions in which we operate. We account for income taxes according to FASB ASC 740, “Income Taxes” ("ASC 740"). ASC 740 requires the recognition of deferred tax assets, net of applicable reserves, related to net operating loss carryforwards and certain temporary differences. The standard requires recognition of a future tax benefit to the extent that realization of such benefit is more likely than not. Otherwise, a valuation allowance is applied.
ASC 740-10-25 clarifies the accounting for uncertainty in tax positions and requires that we recognize the impact of a tax position in our financial statements if that position would more likely than not be sustained on audit, based on the technical merits of the position. ASC 740 provides that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. ASC 740 also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. We recognize tax liabilities in accordance with ASC 740 and we adjust these liabilities when our judgment changes as a result of the evaluation of new information not previously available. Due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that
is materially different from our current estimate of the tax liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which they are determined.
Factors That May Influence Future Results of Operations
The following is a summary of the more significant factors we believe may affect our results of operations. For a more detailed discussion regarding the factors that you should consider before making a decision to acquire shares of our common stock, see the information under the caption “Risk Factors” elsewhere in this report.
Rental income. The amount of net rental income generated by our properties depends principally on our ability to maintain the occupancy rates of currently leased space, to lease currently available space as well as space in newly developed or redeveloped properties and space available from unscheduled lease terminations. The amount of rental income we generate also depends on our ability to maintain or increase rental rates in the submarkets where our properties are located.
Los Angeles, Philadelphia, Austin, and Houston-Submarket Information. A significant portion of our income is derived from properties located in Los Angeles, Philadelphia, Austin and Houston. The market conditions in these submarkets have a significant impact on our results of operations.
Development. We continually evaluate the size, timing and scope of our development initiatives to determine if we are able to lease committed development properties at expected rental rates or within projected time frames or complete projects on schedule or within budgeted amounts. The inability to achieve these outcomes could adversely affect our financial condition, results of operations and cash flows. We currently have sole ownership interest in two development projects, Campus El Segundo and Four Points Centre as of December 31, 2012, in which we have incurred, on a consolidated basis, approximately $57.9 million of costs related to land acquisition, predevelopment and infrastructure that are reflected in "Land Improvements - Development Properties" on our consolidated balance sheet. We are targeting one or more parcels at each of these two projects for potential sale. To the extent that we do not proceed with projects as planned or do not achieve sufficient proceeds from any contemplated disposition, development costs would need to be evaluated for impairment.
Results of Operations
The results of operations reflect the consolidation of the affiliates that own One Commerce Square, Two Commerce
Square, Murano, Four Points Centre, Campus El Segundo and our investment advisory, property management, leasing and real estate development operations. The following properties are accounted for using the equity method of accounting (the date of acquisition is listed for each) :
• City National Plaza (as of January 2003)
• Reflections I (as of October 2004)
• Reflections II (as of October 2004)
• San Felipe Plaza (as of August 2005)
• CityWestPlace (as of June 2006)
• Fair Oaks Plaza (as of January 2007)
TPG Austin Partner, LLC, a limited liability company formed in September 2012 by TPG and Madison, owns a 50% interest in TPG/CalSTRS Austin, LLC which owns the following properties that were acquired from the Austin Joint Venture Predecessor, a venture among Lehman Brothers Holdings Inc. (50%), an offshore sovereign wealth fund (25%) and TPG/CalSTRS, LLC (25%). TPG Austin Partner, LLC accounts for the following properties using the equity method of accounting:
• San Jacinto Center (acquired September 2012)
• Frost Bank Tower (acquired September 2012)
• One Congress Plaza (acquired September 2012)
• One American Center (acquired September 2012)
• 300 West 6th Street (acquired September 2012)
• Park Centre (acquired September 2012)
• Great Hills Plaza (acquired September 2012)
• Westech 360 I-IV (acquired September 2012)
The following properties were disposed by TPG/CalSTRS or Austin Joint Venture Predecessor during 2012 or 2011, and were accounted for using the equity method of accounting for the periods presented:
• Four Falls Corporate Center (as of March 2005, disposed of October 2011)
• Oak Hill Plaza (as of March 2005, disposed of October 2011)
• Walnut Hill Plaza (as of March 2005, disposed of October 2011)
• 2500 CityWest (as of August 2005, disposed of November 2011)
• 2500 CityWest land (as of December 2005, disposed of November 2011)
• Centerpointe I & II (as of January 2007, disposed of December 2011)
• Brookhollow Central I, II and III (as of August 2005, disposed of January 2012)
• Stonebridge Plaza II (as of June 2007, disposed of July, 2012)
• Research Park Plaza I & II (as of June 2007, disposed of July, 2012)
• CityWestPlace land - certain land parcels (as of June 2006, disposed of November 2012)
This information should be read in conjunction with the accompanying consolidated financial statements and notes included elsewhere in this report.
Comparison of the year ended December 31, 2012 to the year ended December 31, 2011
Overview
The main drivers of our consolidated results of operations are (1) two high-rise office towers, commonly referred to as Commerce Square, located in Philadelphia, Pennsylvania, (2) Four Points Centre, two office buildings located in Austin, Texas (3) Murano, a high-rise condominium project, also located in Philadelphia, and (4) our investment advisory, management, leasing and development services business. The table below reflects the change in leasing status of our three consolidated office properties from 2012 to 2011.
We have sold 251 units at Murano as of December 31, 2012. Revenue from unit settlements increased from 14 units settled in the year ended December 31, 2011 as compared to 15 units in the year end December 31, 2012. The average revenue per unit sold in 2012 and 2011 was $0.7 million and $0.5 million, respectively. Fee revenue from our investment advisory, management, leasing and development services business decreased $6.1 million or 23.1% for the year ended December 31, 2012 compared to the same period for 2011. This decrease was primarily due to an incentive fee of $4.4 million paid to us in 2011 by CalSTRS related to the disposition of a separate account asset. There was no corresponding incentive fee in 2012. The decrease was also attributable to lower fee revenue from unconsolidated properties due to asset sales in 2011 and 2012.
Revenues
Total revenues decreased by approximately $4.4 million, or 4.6%, to $90.6 million for the year ended December 31, 2012 from $95.0 million for the same period for 2011. The decrease in total revenues was primarily due to a decrease of $6.1 million in investment advisory, management, leasing and development services. This decrease was primarily due to (1) an incentive fee of $4.4 million paid to us in 2011 by CalSTRS related to the disposition of a separate account asset (there was no corresponding fee in 2012), (2) one-time success fee of $0.7 million earned on the Wilshire Grand development project, which we managed on behalf of a third party in 2011, and (3) a decrease in fees earned in 2012 on managed properties that have been disposed.
Expenses
Total expenses increased $9.9 million, or 8.9%, to $120.7 million during the year ended December 31, 2012 in comparison to $110.8 million in the same period in 2011. The expense for impairment charges increased $4.6 million in 2012 compared to 2011. We recorded impairment charges on our Campus El Segundo and Four Points Centre projects of $12.0
million and $0.7 million, respectively. In 2011, we recorded an impairment charge related to our Metropolitan Transportation Authority (MTA) project of $8.0 million. Our cost of condominium sales increased $3.0 million as 15 units, including the first two penthouse units, were sold in 2012, compared to 14 units during the same period in 2011. Additionally, general and administrative expenses increased $2.3 million, primarily due to higher consultant expenses, and depreciation and amortization expenses increased $2.1 million, primarily due to new building and tenant improvement projects. These increases are offset by decreases of $1.1 million in interest expense due primarily to a decreasing loan balance and lower interest rate after the refinancing of our loan on the Murano project, as well as in reimbursable property personnel costs of $0.6 million and investment advisory expenses of $0.3 million.
Gain on sale of real estate
Gain on sale of real estate of $1.3 million in 2011 was due to the sale of a 2.2 acre land parcel at Campus El Segundo. There was no corresponding gain for the current year.
Equity in net income (loss) of unconsolidated real estate entities
Equity in net income (loss) of unconsolidated real estate entities decreased by $23.7 million, or 118.5%, to a loss of $3.7 million from income of $20.0 million in the prior year. This was primarily as a result of the gains and losses on sale or disposition of five TPG/CalSTRS joint venture properties. In 2012, the Company's share of the loss on the sale of the Austin Joint Venture Predecessor portfolio to another affiliate of the Company was $1.9 million, offset by our share of the gain on the sale of a fourteen acre land parcel adjacent to CityWestPlace in Houston of $3.6 million. Additionally, the Company's share of the impairment charge for Fair Oaks Plaza was $0.6 million. Finally, the Company's share of the Austin Joint Venture Predecessor portfolio's operating loss increased in the fourth quarter as a result of the transaction addressed above. In 2011, the Company's share of gain on sale of 2500 City West and the adjacent land parcels, and Centerpointe I & II was $12.4 million and $5.3 million, respectively. As a result of the foreclosure, by stipulation with the lender, of Oak Hill Plaza, Walnut Hill Plaza and Four Falls Corporate Center in suburban Philadelphia in October 2011, our Company's share of gain was $7.2 million. These gains were offset by our share of impairment charges for Fair Oaks Plaza of $1.6 million, Reflections II of $1.6 million and Brookhollow Central I-III of $1.9 million.
Set forth below is a summary of the combined financial information for the unconsolidated real estate entities, our share of net income (loss) and our equity in net income (loss), after intercompany eliminations, for the years ended December 31, 2012 and 2011 (in thousands):
Aggregate revenues for the unconsolidated real estate entities for the year ended December 31, 2012 increased approximately $9.2 million, or 3.6%, to $264.7 million compared to $255.5 million for the year ended December 31, 2011. The increase is primarily due to higher tenant reimbursement revenue from all properties due to the increase in real estate tax expense, as well as higher revenues within TPG/CalSTRS resulting from increased occupancy and rental rates throughout the portfolio.
Operating and other expenses, including real estate taxes, for unconsolidated real estate entities increased by $10.4 million, or 7.8%, to $143.3 million for the year ended December 31, 2012 compared to $132.9 million for the year ended December 31, 2011. The increase was due primarily to increases in the property tax expense for all properties resulting from higher assessed values in 2012, as well as increases at CityWestPlace, primarily for cafeteria expenses and windstorm insurance, and City National Plaza, primarily for contract cleaning, earthquake insurance, and parking operations. Interest expense increased by approximately $1.0 million, or 1.0%, to $96.8 million for the year ended December 31, 2012 as compared to $95.8 million for the year ended December 31, 2011. The increase was due primarily to higher interest rates and greater outstanding loan balances on the Austin Portfolio Bank Term Loan and the Austin Senior Secured Priority Facility, both of which were paid off at par in September 2012.
Income (loss) associated with discontinued operations decreased by approximately $97.9 million, or 104.9%, to a loss of $4.6 million for the year ended December 31, 2012 compared to a gain of $93.3 million for the year ended December 31, 2011, primarily due to the gain on disposition of real estate (2500 City West, Centerpointe I & II, Oak Hill Plaza, Walnut Hill Plaza and Four Falls Corporate Center) and the gain on the extinguishment of debt at Centerpointe during the year ended December 31, 2011.
Benefit (provision) for income taxes
For the year ended December 31, 2012, there was a benefit for income taxes of $0.4 million, a decrease from a benefit of $1.4 million for the same period in 2011. This change is primarily due to a difference in the amount of accrued interest that was reversed on certain unrecognized tax benefits due to the expiration of statute of limitation periods and an adjustment regarding state taxes recorded in 2011.
Comparison of the year ended December 31, 2011 to the year ended December 31, 2010
(The amounts and narratives in the sections below are as reported in the 2011 10-K and have not been reclassified for discontinued operations that occurred during 2012.)
Overview
We sold 234 units at Murano as of December 31, 2011. Unit sales decreased from 29 units in 2010 to 14 units in 2011. Fee revenue from our investment advisory, management, leasing and development services business increased $2.2 million or 9.1% for the year ended December 31, 2011 compared to the same period for 2010. Additionally, our net income increased by $17.4 million in 2011 primarily as a result of our share of gain on the sale of two properties by our TPG/CalSTRS joint venture and the gain on extinguishment of debt related to the foreclosure by stipulation with the lender of three properties by our TPG/CalSTRS joint venture.
Revenues
Total revenues decreased by approximately $2.7 million, or 2.8%, to $95 million for the year ended December 31, 2011 from $97.7 million for the year ended December 31, 2010. The decrease was primarily due to the sale of 14 condominium units for the year ended December 31, 2011 compared to the sale of 29 condominium units for the same period in the prior year, which resulted in a decrease of $7.3 million of revenue from condominium sales. This revenue decrease was partially offset by a $2.2 million increase in tenant reimbursements related to a significant tenant at Commerce Square which transitioned from a gross lease to a net lease as well as a new significant tenant also at Commerce Square. Additionally, there was an increase of $2.2 million in revenues from our investment advisory business, primarily as a result of a deferred incentive fee payment related to the sale of Valencia Town Center, a managed property. Finally, our reduced ownership interests in City National Plaza and Centerpointe I & II allowed us to recognize greater fee revenue from these properties.
Expenses
Total expenses decreased by approximately $2.2 million primarily as a result of the decrease in condominium unit sales, partially offset by an increase in asset impairment charges. In connection with the termination of the MetroStudios@Lankershim development project during the year ended December 31, 2011, we recorded an $8.0 million impairment charge representing the balance of the capitalized expenditures for the project.
Gain on sale of real estate
Gain on sale of real estate of $1.3 million for the year ended December 31, 2011 was due to the sale of a 2.2 acre land parcel at Campus El Segundo. There was no corresponding gain for the previous year.
Equity in net income (loss) of unconsolidated real estate entities
Equity in net income (loss) of unconsolidated real estate entities increased by $21.2 million, or 1,766.7%, primarily as a result of the gains on sale or disposition of five TPG/CalSTRS joint venture properties in 2011. The Company's share of gain on sale of 2500 CityWest and the adjacent land parcels, and Centerpointe I & II was $12.4 million and $5.3 million, respectively. As a result of the foreclosure, by stipulation with the lender, of Oak Hill Plaza, Walnut Hill Plaza and Four Falls Corporate Center in suburban Philadelphia in October 2011, our Company's share of gain was $7.2 million. These gains were offset by our share of impairment charges for Fair Oaks Plaza of $1.6 million, Reflections II of $1.6 million and Brookhollow Central I-III of $1.9 million.
Set forth below is a summary of the combined financial information for the unconsolidated real estate entities, our share of net income (loss) and our equity in net income (loss), after intercompany eliminations, for the years ended December 31, 2011 and 2010 (in thousands):
Benefit (provision) for income taxes
Benefit for income taxes increased by approximately $1.0 million to a benefit of $1.4 million for the year ended December 31, 2011 compared to a benefit of $0.4 million for the year ended December 31, 2010. This change is primarily attributable to the release in the current year of the valuation allowance related to the expected utilization of net operating loss carry-forward which had a full valuation allowance as of December 31, 2010.
Liquidity and Capital Resources
Analysis of liquidity and capital resources
As of December 31, 2012, we have unrestricted cash and cash equivalents of $76.7 million. We believe that we will have sufficient capital to satisfy our liquidity needs over the next 12 months through cash on hand, cash flows from operations and proceeds from condominium and property sales. We expect to meet our long-term liquidity requirements, including debt service, property acquisitions and additional future development and redevelopment activity, through cash flow from operations, additional secured and unsecured long-term borrowings, proceeds from dispositions of non-strategic assets, and the potential issuance of additional debt, or common or preferred equity securities, including convertible securities.
During the year ended December 31, 2012, we sold several joint venture properties as well as wholly-owned land parcels. These sales are summarized in the table below.
Summary of Property Dispositions:
_______________
(1) These land parcels were sold subsequent to year-end. The proceeds reflected in the table are net of pay down on a mortgage loan.
(2) TPG redeemed a 49% interest in the 2121 Market Street partnership and sold the adjacent 2100 JFK Boulevard parking lot, a previously consolidated asset, to our unaffiliated partner.
(3) We recorded a deferred gain of $9.6 million, which is reflected in the Deferred Revenue caption on our consolidated balance sheets.
(4) The TPG/CalSTRS subsidiary, which owned Brookhollow Central I, II and III, recorded an impairment charge of $7.8 million in the quarter ended December 31, 2011. That impairment charge is not reflected in this table.
There are two loans in our portfolio with maturity dates in 2013 neither of which has an extension option. The Two Commerce Square mortgage loan with a $106.6 million balance as of December 31, 2012, was scheduled to mature on May 9, 2013. On March 8, 2013, we entered into a loan agreement with a lender for a new mortgage on Two Commerce Square in the amount of $112.0 million. The loan, which has a fixed interest rate of 3.96% for a ten year term, funded on March 8, 2013. The loan replaced the existing mortgage on the property, which was open to prepayment without penalty on and after March 8, 2013. The Murano loan with a balance of $6.9 million as of December 31, 2012, matures on December 15, 2013. Repayment of this loan is being made with proceeds from the sales of condominium units. If all pending sales close, the loan balance will be reduced to $3.3 million.
We have $11.5 million of scheduled principal payments on consolidated debt in 2013 and $1.9 million in 2014. We believe that we will have sufficient capital to satisfy these obligations when due.
During the year ended December 31, 2012, we paid quarterly dividends of $0.015 per common share for the first three quarters of the year and $0.02 per common share in the last quarter of the year. The availability of funds to pay dividends is impacted by property-level restrictions on cash flows. With respect to our investments in properties, we do not solely control decision making with respect to these properties, and may not be able to obtain monies from these properties even if funds are available for distribution to us. In addition, we may enter future financing arrangements that contain restrictions on our use of cash generated from our properties. The payment of cash dividends in the future, if any, will be at the discretion of our board of directors and will depend upon such factors as earnings levels, capital requirements, our overall financial condition, and any other factors deemed relevant by our board of directors.
As of December 31, 2012, we have unfunded capital commitments to TPG/CalSTRS of $10.9 million. We are obligated to fund tenant improvements and other capital improvements for properties that were acquired prior to June 1, 2007. We estimate we will fund approximately $7.5 million in 2013 and $1.6 million between 2014 and 2017 to satisfy our share of contractual obligations existing at December 31, 2012 for capital improvements, tenant improvements and leasing commissions.
During July 2012, Research Park Plaza I & II and Stonebridge Plaza II were sold by the Austin Joint Venture Predecessor, an unconsolidated real estate entity. Mortgage loans on these properties, were paid in full from the proceeds of the sales. Additionally, a subsidiary of TPG/CalSTRS made a payment of $19.3 million, of which our share was $1.5 million, in July 2012 on a note payable to a former partner in the City National Plaza partnership.
In September 2012, an entity owned by TPG and CalSTRS, acquired all of the equity interests in an eight building, three million square foot portfolio of office properties in Austin, Texas, formerly owned by the Austin Joint Venture Predecessor, a venture among Lehman Brothers Holdings, Inc (50%), an offshore sovereign wealth fund (25%) and TPG/CalSTRS, LLC (25%). The purchase price for the portfolio was $859.1 million. As part of the transaction, TPG/CalSTRS Austin, LLC assumed five existing first mortgage loans totaling $626.0 million. The transaction reduced the existing leverage on the portfolio by repaying approximately $135.6 million owed to Lehman Commercial Paper, Inc. and the three existing partners as a result of loans made by the partners. TPG contributed approximately $75.5 million of the required equity. TPG's share of the unfunded capital commitment is approximately $9.6 million as of December 31, 2012.
Development
We own two development projects, Campus El Segundo and Four Points Centre. TPG/CalSTRS owns one development project, CityWestPlace, which is comprised of 9.9 acres. If we decide to develop any of these land holdings, we anticipate seeking to mitigate our development risk by obtaining significant pre-leasing and guaranteed maximum cost construction contracts. The amount and timing of costs associated with our development projects is inherently uncertain due to market and economic conditions. We presently intend to fund development expenditures, if any, primarily through construction and permanent financing.
Leasing, Tenant Improvement and Capital Needs
In addition to our development projects, our One Commerce Square and Two Commerce Square properties require capital expenditures as well as leasing commissions and tenant improvement costs. The level of these expenditures varies from year to year based on several factors, including lease expirations. There are commitments to incur expenditures of approximately $9.1 million in capital improvements, tenant improvements and leasing commissions for Commerce Square during 2013. Additionally, we have spent and will continue to spend additional amounts in connection with a value-enhancement program at Commerce Square.
During November 2010, subsidiaries of TPG and Brandywine entered into two partnership arrangements with respect to our One Commerce Square and Two Commerce Square properties. Brandywine committed to contribute $25.0 million of preferred equity by December 31, 2012 in return for a 25% limited partnership interest in each property. The preferred equity contributions of $19.1 million as of December 31, 2012 have been invested in the value-enhancement program designed to increase rental rates and occupancy at Commerce Square, and the remaining contributions of $5.9 million, which were funded subsequent to December 31, 2012, will be used to partially fund the $9.1 million of existing commitments described above.
Annual capital expenditures may fluctuate in response to the nature, extent and timing of improvements required to maintain our properties. Tenant improvements and leasing costs may also fluctuate depending upon other factors, including the type of property involved, the existing tenant base, terms of leases, types of leases, the involvement of leasing agents and overall market conditions.
Contractual Obligations
A summary of our contractual obligations at December 31, 2012 is as follows (in thousands):
__________________________________________________
(1)
Included within these balloon payments is $106.4 million due under the Two Commerce Square mortgage loan, which was scheduled to mature on May 9, 2013. On March 8, 2013, we entered into a loan agreement with a lender for a new mortgage on Two Commerce Square in the amount of $112.0 million. The loan, which has a fixed interest rate of 3.96% for a ten year term, funded on March 8, 2013. The loan replaced the existing mortgage on the property, which was open to prepayment without penalty on and after March 8, 2013.
(2)
Included within these balloon payments are amounts due under the Four Points Centre mortgage loan. We have provided a guarantee for a portion of principal and interest payable. We have also provided collateral of approximately 65.3 acres of fully entitled unimproved land (reduced to 19.9 acres due to land sales subsequent to December 31, 2012), which is immediately adjacent to our Four Points Centre office buildings. The loan is scheduled to mature on July 31, 2014, with a one-year extension option subject to certain conditions. The option to extend is subject to (1) a loan-to-value ratio and a minimum appraised land ratio of 62.5%, and (2) the adjusted net operating income of the property and improvements as a percentage of the outstanding principal balance must be at least 10.0%. If these requirements are not met, we can pay down the principal balance in an amount sufficient to satisfy these requirements. The debt yield is calculated by dividing the net operating income of the property by the outstanding principal balance of the loan. Through December 31, 2012, the property has been generating net operating losses. Beginning in August, 2014, we are required to pay down the loan balance by $42,000 each month. The loan has an unfunded balance of $4.2 million which is available to fund any remaining project costs. The balance of the loan as of December 31, 2012 was $26.5 million.
(3)
The Murano mortgage loan has a balance of $6.9 million as of December 31, 2012. The loan is scheduled to mature on December 15, 2013. On June 30, 2013, the loan is subject to a maximum balance of $4.3 million. The loan principal is being amortized with proceeds from the sale of condominium units. If all pending sales close, the loan balance will be reduced to approximately $3.3 million. TPG gave the lender a limited guaranty which (i) guarantees repayment of the loan in the event of certain bankruptcy events affecting the borrower, (ii) guarantees payment of the lender's damages from customary “bad boy” actions of the borrower or TPG (such as fraud, physical waste of the property, misappropriation of funds and similar bad acts); and (iii) guarantees payment of the amount, if any, by which the loan
balance at the time exceeds 80.0% of the bulk sale value of the collateral upon an acceleration of the loan triggered by a borrower default.
(4)
The Campus El Segundo mortgage loan has a balance of $14.5 million as of December 31, 2012 and an October 31, 2013 maturity date with one remaining twelve month extension. The loan is subject to a $2.5 million principal paydown on April 30, 2013. We have guaranteed this loan.
(5)
As of December 31, 2012, 83.0% of our debt was at contractually fixed rates ranging from 5.67% to 6.30%. The information in the table above reflects our projected interest obligations for the fixed-rate payments based on the contractual interest rates and scheduled maturity dates. The remaining 17.0% of our debt bears interest at variable rates based on LIBOR plus a spread that ranges from 3.50% to 3.75%. The interest payments on the variable rate debt have not been reported in the table above because we cannot reasonably determine the future interest obligations on our variable rate debt as we cannot predict what LIBOR rates will be in the future. As of December 31, 2012, one-month LIBOR was 0.21%.
(6)
Capital commitments of our Company and consolidated subsidiaries include approximately $9.1 million of tenant improvements and leasing commissions for certain tenants in One Commerce Square and Two Commerce Square, of which $9.0 million is expected to be paid in 2013. Our partner, Brandywine, through preferred equity contributions, will partially fund these capital commitments with their remaining capital commitment of $5.9 million, which they funded in January 2013. The amount funded by Brandywine in 2013 is not reflected on the Contractual Obligations table. Additionally, our Company and consolidated subsidiaries have capital commitments of approximately $3.5 million of tenant improvements and leasing commissions for certain tenants in Four Points Centre of which the entire amount is expected to be funded by additional borrowings available under the loan and paid in 2013. We have an unfunded capital commitment of $10.9 million to TPG/CalSTRS, of which we estimate we will fund $7.5 million in 2013 for contractual obligations existing as of December 31, 2012. We are not obligated to fund our share for the acquisition of any new project, but we are obligated to fund tenant improvements and other capital improvements for projects that were acquired prior to June 1, 2007.
(7)
Represents the future minimum lease payments on our operating lease for our corporate office at City National Plaza, which expires in May 2014. The table does not reflect available extension options.
(8)
The obligations associated with uncertain tax positions in the table above should represent amounts associated with uncertain tax positions related to temporary book-tax differences. However, reasonable estimates cannot be made about the amount and timing of payment, if any, for these obligations. As of December 31, 2012, $8.0 million of unrecognized tax benefits have been recorded as liabilities in accordance with FASB ASC 740, and we are uncertain as to if and when such amounts may be settled. We have not recorded any penalties with respect to unrecognized tax benefits.
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Off-Balance Sheet Arrangements-Indebtedness of Unconsolidated Real Estate Entities
As of December 31, 2012, our Company had investments in entities owning unconsolidated properties with stated ownership percentages ranging from 7.9% to 33.3%. We account for these investments using the equity method of accounting.
The table below summarizes the outstanding debt for these properties as of December 31, 2012 (in thousands). None of these loans are recourse to us. Some of the loans listed in the table below subject TPG/CalSTRS to customary non-recourse carve out obligations. There are no extension options on these loans as of December 31, 2012.
The 30 day LIBOR rate for the loans above was 0.21% at December 31, 2012.
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(1) Balance represents senior mortgage indebtedness.
(2) Balance represents subordinate mortgage indebtedness.
(3) The borrower under mortgage loans secured by these properties did not make the debt service payment due in February 2013. The special servicer has issued notices of default, but has not taken any further action in response. On a net basis, TPG's equity investment balance in these properties is not material.
Cash Flows
Comparison of year ended December 31, 2012 to year ended December 31, 2011
Cash and cash equivalents were $76.7 million and $79.3 million at December 31, 2012 and 2011, respectively, representing an increase of $2.6 million. The increase was a result of the following changes in cash flows:
Our cash flows from operating activities are primarily dependent upon the occupancy level of our portfolio, the rental rates achieved on our leases, the collectability of rent and recoveries from our tenants, revenues generated and collected from our investment advisory, management, leasing and development services and the level of operating expenses and other general and administrative costs. Net cash used in operating activities was $5.3 million for the year ended December 31, 2012, which represented a decrease of $9.2 million from the net cash provided by operations of $3.8 million for the year ended December 31, 2011. This increased use of cash was primarily due to three factors: (1) The Company recorded a net loss of $33.3 million in 2012 compared to net income of $6.9 million in 2011 representing a change, or decrease, of $40.1 million. After making adjustments for non-cash amounts included in net income (loss) and before making adjustments for changes in operating assets and liabilities, the change between years is a decrease of $3.6 million. (2) Cash used for leasing costs increased by $3.5 million in 2012 compared to 2011. (3) Cash used for the settlement of accounts payable and other liabilities increased by $2.1 million in 2012 compared to 2011.
Our net cash generated by or used in investing activities is generally impacted by the sale of condominium units at Murano, contributions and distributions related to our investments in unconsolidated real estate entities, the funding of development and redevelopment projects and recurring and non-recurring capital expenditures. Net cash used in investing activities increased by $121.7 million to an use of cash of $81.2 million for the year ended December 31, 2012 compared to source of cash of $40.5 million for the year ended December 31, 2011. The increased use was due to the investment in TPG/CalSTRS Austin, LLC of $110.6 million in the third quarter by TPG Austin Partner, LLC, a limited liability company owned by TPG and Madison, in connection with the September 2012 acquisition of the eight Austin portfolio properties. In addition, there were non-recurring development cost reimbursements of $8.6 million that were received in 2011 related to the termination of the MetroStudios@Lankershim development project. There were no such cost reimbursements in 2012.
Our net cash provided by or used in financing activities is generally impacted by our borrowings, and capital activities, net of dividends and distributions paid to common stockholders and non-controlling interests. Net cash provided by financing activities increased by $91.2 million to $83.9 million for the year ended December 31, 2012 compared to $7.3 million used in financing activities for the year ended December 31, 2011. This increase was primarily due to net proceeds of $49.3 million generated from our private placement of common stock in the second quarter of 2012, and contributions by partners holding non-controlling interests of $35.1 million by Madison and $12.6 million by Brandywine (which was $9.6 million more than their contributions in 2011). This was offset by an increase of $2.8 million in dividend payments to common stockholders.
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Comparison of year ended December 31, 2011 to year ended December 31, 2010
Cash and cash equivalents were $79.3 million as of December 31, 2011 and $42.4 million as of December 31, 2010. The increase was a result of the following changes in cash flows
Net cash provided by operating activities was $3.8 million for the year ended December 31, 2011, which represented an increase of $4.3 million from the net cash used in operations of $0.5 million for the year ended December 31, 2010. The increase was primarily the result of a decrease of $1.2 million in the cash expended on deferred leasing costs, a decrease of $1.0 million in receivables from unconsolidated real estate entities, a decrease of $0.7 million in accounts payable, and an increase of $0.7 million in tenant prepaid rents.
Net cash provided by investing activities increased by $33.9 million to $40.5 million provided by investing activities for the year ended December 31, 2011 compared to $6.6 million provided by investing activities for the year ended December 31, 2010. The increase was primarily due to higher distributions from our unconsolidated real estate entities of $21.3 million resulting from asset sales during the current year in addition to lower contributions to our unconsolidated real estate entities of $11.8 million during the current year. Further, we received a cash breakup fee of $8.5 million in 2011 related to the termination of the MetroStudios@Lankershim development project, and we received proceeds from the sale of a 2.2 acre land parcel at Campus El Segundo. Finally, these cash increases were offset by diminished proceeds of $6.7 million due to 15 fewer condominium unit sales in 2011.
Net cash used in financing activities increased by $7.7 million to $7.3 million for the year ended December 31, 2011 compared to $0.4 million provided by financing activities for the year ended December 31, 2010. The increase was primarily the result of net proceeds of $15.3 million from our “at-the-market” equity offering program during 2010, with no corresponding proceeds during 2011. This increase was partially offset by a reduction in principal payments on the Murano loan, as $6.9 million in cash was used in 2011 to pay down the loan using proceeds from the sales of condominium units, compared to the $14.7 million used in 2010.
Inflation
Substantially all of our office leases provide for tenants to reimburse us for increases in real estate taxes and operating expenses related to the leased space at the applicable property. In addition, many of the leases provide for increases in fixed base rent. We believe that inflationary increases in real estate taxes and operating expenses may be partially offset by the contractual rent increases and expense reimbursements as described above.
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Non-GAAP Supplemental Financial Measure: After Tax Cash Flow ("ATCF")
The Company's management considers ATCF to be a key performance indicator. We define ATCF as net income (loss) excluding the following items: i) deferred income tax expense (benefit); ii) noncontrolling interests; iii) non-cash charges for depreciation, amortization and asset impairment; iv) amortization of loan costs; v) non-cash compensation expense; vi) the adjustment to recognize rental revenues using the straight-line method; vii) the adjustments to rental revenue to reflect the fair market value of rent; and viii) gain from extinguishment of debt. Our management utilizes ATCF data in assessing performance of our business operations in period to period comparisons and for financial planning purposes. ATCF should be considered only as a supplement to net income as a measure of our performance. ATCF should not be used as a measure of our liquidity, nor is it indicative of funds available to fund our cash needs. ATCF also should not be used as a substitute for cash flow from operating activities (computed in accordance with GAAP).
Reconciliation of Net Income (Loss) to ATCF:
_____________________
(1) Based on an interest in our operating partnership of 77.03% and 74.71% for the twelve months ended December 31, 2012 and 2011, respectively.
TPGI's share of ATCF for the year ended December 31, 2012 was $7.4 million, or $0.18 per share, compared to ATCF of $27.2 million, or $0.74 per share, for the year ended December 31, 2011. The decrease in ATCF per share for the year ended December 31, 2012 compared to the year ended December 31, 2011 was primarily the result of the overall reduction in consolidated net income for the year ended December 31, 2012 compared to the prior year, and the increased number of shares of our common stock outstanding resulting from the issuance of common stock in 2012.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
A primary market risk faced by our Company is interest rate risk. Our strategy is to match as closely as possible the expected holding periods and income streams of our assets with the terms of our debt. In general, we use floating rate debt on assets with higher growth prospects and less stability to their income streams. Correspondingly, with respect to stabilized assets with lower growth rates, we will generally use longer-term fixed-rate debt. As of December 31, 2012, our Company had $47.9 million of outstanding consolidated floating rate debt, which is not subject to an interest rate cap.
Our fixed and variable rate consolidated long-term debt at December 31, 2012 consisted of the following (in thousands):
We utilize sensitivity analyses to assess the potential effect on interest costs of our variable rate debt. At December 31, 2012, our variable rate long-term debt represents 17.0% of our total long-term debt. If interest rates were to increase by 75 basis points, or by approximately 19.4% of the weighted average variable rate at December 31, 2012, the net impact would be increased interest costs of $0.4 million per year.
Our estimates of the fair value of debt instruments at December 31, 2012 and 2011, respectively, were determined by performing discounted cash flow analyses using an appropriate market discount rate. Considerable judgment is necessary to interpret market data and develop the estimated fair value. The use of different market assumptions or estimation methods may have a material effect on the estimated fair value amounts.
As of December 31, 2012 and 2011, the estimated fair value of our consolidated mortgage loans aggregate $286.2 million and $284.1 million, respectively, compared to the aggregate carrying value of $281.4 million and $289.5 million, respectively.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
All information required by this item is listed in the Index to Financial Statements in Part IV, Item 15(a).
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We have adopted and maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (“SEC”) and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
As required by Rule 13a-15(b), promulgated by the SEC under the Exchange Act, we have carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms.
Management’s Annual Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)). Our management evaluated the effectiveness of our internal control over financial reporting based on the framework set forth in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2012. Ernst & Young LLP, our independent registered public accounting firm, has audited our internal control over financial reporting as of December 31, 2012 and their attestation report is included in this Annual Report on Form 10-K.
Changes in Internal Controls over Financial Reporting
There were no changes in our internal control over financial reporting as defined in Rules 13a-15(f) or 15(d)-15(f) under the Exchange Act that occurred during the quarter ended December 31, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Limitations on Controls
Management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all error and fraud. Any control system, no matter how well designed and operated, is based upon certain assumptions and can provide only reasonable, not absolute, assurance that its objectives will be met. Further, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Thomas Properties Group, Inc.
We have audited Thomas Properties Group, Inc. and subsidiaries' internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“the COSO criteria”). Thomas Properties Group, Inc. and subsidiaries' 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 Annual 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, Thomas Properties Group, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, 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 Thomas Properties Group, Inc. and subsidiaries as of December 31, 2012 and 2011, and the related consolidated statements of operations, equity and noncontrolling interests, and cash flows for each of the three years in the period ended December 31, 2012 of Thomas Properties Group, Inc. and subsidiaries and our report dated March 11, 2013 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Los Angeles, California
March 11, 2013
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
On March 8, 2013, we entered into a loan agreement with Northwestern Mutual Life Insurance Company for a new mortgage loan on Two Commerce Square in the principal amount of $112.0 million. The loan, which has a fixed interest rate of 3.96 % for a ten year term of monthly interest payments and a balloon payment of principal at maturity, funded on March 8, 2013. The loan may be accelerated upon certain customary events of default contained in the mortgage and security agreement and promissory note related thereto, including defaults in payments, prohibited transfers and compliance with other agreements therein, subject to applicable cure periods and exceptions. The loan replaced the existing mortgage on the property that had an outstanding balance of $106.6 million as of December 31, 2012, and a maturity date of May 9, 2013.
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PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by Item 10 concerning our directors and nominees, our nominating committee process, our audit committee members including our audit committee financial expert(s), and our Section 16(a) beneficial ownership reporting compliance will be included in our definitive Proxy Statement to be filed for our 2013 Annual Meeting of Stockholders (the “2013 Proxy Statement”) and is incorporated herein by reference. Information relating to our executive officers is contained under the caption “Executive Officers of the Registrant” in Part I of this Form 10-K.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
The information concerning our executive compensation and director compensation required by Item 11 will be included in the 2013 Proxy Statement and is incorporated herein by reference.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information concerning our security ownership of certain beneficial owners and management required by Item 12 will be included in the 2013 Proxy Statement and is incorporated herein by reference.
Securities Authorized for Issuance Under Equity Incentive Plans
Equity Compensation Plan Information
The following table sets forth information with respect to our 2004 Equity Incentive Plan (“Incentive Plan”) and our Non-employee Directors Restricted Stock Plan under which equity incentives of our Company and our Operating Partnership are authorized for issuance. The Incentive Plan provides incentives to our employees and is intended to attract, reward and retain personnel. Our Incentive Plan permits the granting of awards in the form of options to purchase common stock, restricted shares of common stock and restricted incentive units in our Operating Partnership. Our Non-employee Directors Restricted Stock Plan provides for initial and annual grants to our non-employee directors.
Under the Incentive Plan, a total of 3,361,906 shares were reserved for grant and as of December 31, 2012, 411,608 shares remain available for grant. Under our Non-Employee Directors Restricted Stock Plan (“the Non-Employee Directors Plan”) a total of 60,000 shares were reserved for grant and as of December 31, 2012, 29,065 shares remain available for grant. Restricted shares granted under each of our plans entitle the holder to full voting rights and the holder will receive any dividends paid. Each of the Non-Employee Directors Plan and the Incentive Plan, including all amendments to the Incentive Plan, have been approved by our stockholders.
We have no equity compensation plans that were not approved by our security holders.
_________________________
(1)
In addition there were 168,317 vested incentive units outstanding and 55,783 unvested incentive units outstanding in our Operating Partnership under our Incentive Plan as of December 31, 2012.
(2)
Consists of 411,608 shares remaining available for grant under the Incentive Plan as of December 31, 2012 and 29,065 shares remaining available for grant under the Non-employee director plan as of December 31, 2012.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information concerning certain relationships and related transactions and director independence required by Item 13 will be included in the 2013 Proxy Statement and is incorporated herein by reference.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
The information concerning our principal accounting fees and services required by Item 14 will be included in the 2013 Proxy Statement and is incorporated herein by reference.
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PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Financial Statements and Financial Statement Schedules
The following consolidated financial information is included as a separate section of this report on Form 10-K:
(b) Exhibits
In accordance with SEC Release 33-8212, the following exhibits are being furnished, and are not being filed as part of this report or as a separate disclosure document, and are not being incorporated by reference into any registration statement filed under the Securities Act of 1933.
_________________________
(1)
Incorporated by reference from the Registrant’s Report on Form 8-K filed October 18, 2004.
(2)
Incorporated by reference from the Registrant’s Report on Form 8-K filed January 4, 2008.
(3)
Incorporated by reference from the Registrant’s Report Post Effective Amendment No. 1 to Form S-3 filed October 16, 2009.
(4)
Incorporated by reference from the Registrant’s Definitive Proxy Statement filed April 29, 2008.
(5)
Incorporated by reference from the Registrant’s Report on Form 10-Q filed November 22, 2004.
(6)
Incorporated by reference from Registration Statement file number 333-114527.
(7)
Incorporated by reference from the Registrant’s Report on Form 8-K filed December 24, 2008.
(8)
Incorporated by reference from the Registrant’s Report on Form 10-K filed March 30, 2005.
(9)
Incorporated by reference from the Registrant’s Report on Form 8-K filed January 5, 2006.
(10)
Incorporated by reference from the Registrant’s Report on Form 10-Q filed August 9, 2006.
(11)
Incorporated by reference from the Registrant’s Report on Form 10-K filed April 2, 2007.
(12)
Incorporated by reference from the Registrant’s Report on Form 10-Q filed August 9, 2007.
(13)
Incorporated by reference from the Registrant’s Report on Form 10-K filed March 18, 2008.
(14)
Incorporated by reference from the Registrant’s Report on Form 8-K filed September 5, 2008.
(15)
Incorporated by reference from the Registrant’s Report on Form 8-K filed June 10, 2008.
(16)
Incorporated by reference from the Registrant’s Report on Form 10-K filed on March 23, 2009.
(17)
Incorporated by reference from the Registrant’s Report on Form 10-Q filed November 2, 2009.
(18)
Incorporated by reference from the Registrant’s Report on Form 8-K filed on March 5, 2010.
(19)
Incorporated by reference from the Registrant's Report on Form 10-K filed on March 22, 2010.
(20)
Incorporated by reference from the Registrant's Report on Form 8-K filed on May 19, 2010.
(21)
Incorporated by reference from the Registrant's Report on Form 8-K filed on July 12, 2010.
(22)
Incorporated by reference from the Registrant's Report on Form 8-K filed on July 27, 2010.
(23)
Incorporated by reference from the Registrant's Report on Form 8-K filed on October 15, 2010.
(24)
Incorporated by reference from the Registrant's Report on Form 8-K filed on October 26, 2010.
(25)
Incorporated by reference from the Registrant's Report on Form 10-Q filed on November 12, 2010.
(26)
Incorporated by reference from the Registrant’s Report on Form 8-K filed on April 1, 2011.
(27)
Incorporated by reference from the Registrant's Report on Form 10-Q filed on May 10, 2011.
(28)
In accordance with Rule 406T of Regulation S-T, the information in these exhibits is furnished and deemed not filed or part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.
(29)
Incorporated by reference from the Registrant's Report on Form 8-K filed on May 31, 2012.
(30)
Incorporated by reference from the Registrant's Report on Form 8-K filed on September 21, 2012.
(31)
Incorporated by reference from the Registrant's Report on Form 10-Q filed on November 9, 2012.
(32)
Incorporated by reference from the Registrant's Report on Form 10-K filed on March 11, 2013.
+
Certain portions of this document have been omitted pursuant to a grant of confidential treatment by the SEC.
*
Managerial compensatory plan or arrangement.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Thomas Properties Group, Inc.
We have audited the accompanying consolidated balance sheets of Thomas Properties Group, Inc. and subsidiaries as of December 31, 2012 and 2011, and the related consolidated statements of operations, equity and noncontrolling interests, and cash flows for each of the three years in the period ended December 31, 2012. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule 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 Thomas Properties Group, Inc. and subsidiaries at December 31, 2012 and 2011, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2012, 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), Thomas Properties Group, Inc. and subsidiaries' internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 11, 2013 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Los Angeles, California
March 11, 2013
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
December 31, 2012 and 2011
See accompanying notes to consolidated financial information.
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
See accompanying notes to consolidated financial information.
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EQUITY AND NONCONTROLLING INTERESTS
(In thousands, except share data)
Years Ended December 31, 2012, 2011 and 2010
See accompanying notes to consolidated financial information.
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
See accompanying notes to consolidated financial information.
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(continued)
See accompanying notes to consolidated financial information.
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION
Years Ended December 31, 2012, 2011 and 2010
(Tabular amounts in thousands, except share and per share amounts)
1.
Organization and Description of Business
The terms “Thomas Properties”, “TPG”, “us”, “we”, “our” and "the Company" as used in this report refer to Thomas Properties Group, Inc. together with our Operating Partnership, Thomas Properties Group, L.P. (the “Operating Company”).
We own, manage, lease, acquire and develop real estate, consisting primarily of office properties and related parking garages, located in Southern California; Sacramento, California; Philadelphia, Pennsylvania; Northern Virginia; Houston, Texas and Austin, Texas.
We were incorporated in the State of Delaware on March 9, 2004. On October 13, 2004, we completed our initial public offering. Our operations are carried on through our Operating Partnership of which we are the sole general partner. The Operating Partnership holds our direct and indirect interests in real estate properties, and it carries on our investment advisory, property management, leasing and real estate development operations. As of December 31, 2012, we held a 78.7% interest in the Operating Partnership which we consolidate, as we have control over the major decisions of the Operating Partnership.
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THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
As of December 31, 2012, we were invested in the following real estate properties:
_______________
(1)
Certain undeveloped land parcels are being targeted for sale.
(2)
The Company is under contract to sell all 23.9 acres including a marketing center and athletic facility naming rights. The buyer is performing due diligence, and has the right to cancel the contract.
(3)
In September 2012, TPG/CalSTRS Austin, LLC acquired eight properties formerly owned by TPG-Austin Portfolio Syndication Partners JV LP ("Austin Joint Venture Predecessor"), a venture among Lehman Brothers Holdings, Inc (50%), an offshore sovereign wealth fund (25%) and TPG/CalSTRS (25%). See Note 3 Unconsolidated Real Estate Entities for further discussion.
(4)
These properties are under contract to be sold. The buyer is performing due diligence, and has the right to cancel the contract.
The City National Plaza property includes an off-site garage that provides parking for City National Plaza and other properties. The office properties typically include on-site parking, retail and storage space.
As of December 31, 2012, we wholly own both Four Points Centre and Campus El Segundo.
We have the responsibility for the day-to-day operations of the California Environmental Protection Agency (“CalEPA”) building, but have no ownership interest in the property. We provide investment advisory services for the California State
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
Teachers' Retirement System (“CalSTRS”) with respect to two properties that are wholly owned by CalSTRS- 800 South Hope Street (Los Angeles, CA) and 1835 Market Street (Philadelphia, PA). In addition, we provide property management, leasing and development services to 800 South Hope Street and 1835 Market Street; two properties wholly owned by an affiliate of Lehman Brothers Inc., 816 Congress (Austin, TX) and Austin Centre (Austin, TX); and the properties owned by the TPG/CalSTRS and TPG/CalSTRS Austin, LLC joint ventures.
2.
Summary of Significant Accounting Policies
Principles of Consolidation and Combination
We evaluate each entity to determine if the entity is deemed a variable interest entity ("VIE"), and if the Company is the primary beneficiary of the VIE based on whether the Company has both (i) the power to direct those matters that most significantly impact the activities of the VIE and (ii) the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. Our determination of the primary beneficiary of a VIE considers all relationships between us and the VIE, including management agreements. When an entity is not deemed to be a VIE, the Company considers the provisions of the accounting standards to determine whether a general partner, or the general partners as a group, controls a limited partnership or similar entity when the limited partners have certain rights. The Company consolidates (i) entities that are VIEs and of which the Company is deemed to be the primary beneficiary and (ii) entities that are non-VIEs and controlled by the Company and in which the limited partners neither have the ability to dissolve the entity or remove the Company without cause nor any substantive participating rights.
We continuously reassess our determination of whether an entity is a VIE and who the primary beneficiary is, and whether or not the limited partners in an entity have substantive rights, more particularly if certain events occur that are likely to cause a change in the original determinations. There have been no changes during 2012 in previous conclusions about whether an entity qualifies as a VIE or whether we are the primary beneficiary of any previously identified VIE.
The equity method of accounting is utilized to account for investments in real estate entities that are VIEs and of which the Company is not deemed to be the primary beneficiary and entities that are non-VIEs which the Company does not control, but over which the Company has the ability to exercise significant influence. All significant intercompany balances and transactions have been eliminated in the consolidated financial statements.
Commerce Square - Brandywine
During the year ended December 31, 2010, subsidiaries of Thomas Properties and Brandywine Operating Partnership, L.P. ("Brandywine") entered into two partnerships with respect to our One Commerce Square and Two Commerce Square properties. Brandywine has contributed $25.0 million of preferred equity in return for a 25% limited partnership interest in each property. As of December 31, 2012, Brandywine had contributed $19.1 million. Subsequent to December 31, 2012, the commitment was fully funded. The preferred equity, which earns a preferred return of 9.25% has been invested in a value-enhancement program designed to increase rental rates and occupancy at Commerce Square. The 25% preferred equity interests in One Commerce Square and Two Commerce Square, owned by Brandywine are reflected under the "Noncontrolling Interests" caption on our consolidated balance sheets.
One Commerce Square and Two Commerce Square are deemed to be variable interest entities for which we are considered the primary beneficiary. The total amount of anticipated fees earned from the service contracts by our Company is expected to be significant relative to the total amount of the properties' anticipated economic performance, and are also expected to absorb a significant amount of the variability associated with the properties anticipated economic performance. Therefore, the benefits our Company receives from the service contracts puts us in a position where the combined economic benefits of our 75% equity interest are significantly greater than our voting interest. We have the power to direct the activities that most significantly impact the economic performance of One Commerce Square and Two Commerce Square and we have the obligation to absorb losses or the right to receive benefits of these properties that could potentially be significant to the properties.
Murano
We also consolidate our Murano residential condominium project which we control. Our unaffiliated partner's interest is reflected on our consolidated balance sheets under the "Noncontrolling Interests" caption. Our partner has a stated ownership interest of 27%. After full repayment of the Murano mortgage loan, which has a balance of $6.9 million at December 31, 2012,
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net proceeds from the project will be distributed, to the extent available, based on an order of preferences described in the partnership agreement. The Company may receive distributions, if any, in excess of our stated 73% ownership interest if certain return thresholds are met.
Austin - Madison International Realty
TPG Austin Partner, LLC was deemed to be variable interest entity because the total equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support provided by the members, TPG has a controlling financial interest in this entity and the members have disproportionate voting rights. TPG is considered the primary beneficiary because it has the power to direct the activities that most significantly impact the economic performance of entity. The 33.3% equity interest in TPG Austin Partner, LLC owned by Madison International Realty ("Madison") is reflected under the "Noncontrolling Interests" caption on our consolidated balance sheets. We consolidate this entity, which has a 50% interest in TPG/CalSTRS Austin, LLC, and which is further discussed in Note 3, because we have a controlling financial interest.
Refer to Note 3 for discussion of the TPG/CalSTRS, TPG/CalSTRS Austin LLC, and the Austin Portfolio Joint Venture Predecessor, which were determined to be variable interest entities for which we are not considered the primary beneficiary.
Included in total assets on TPG's consolidated balance sheets are the following assets for each listed investment in which a noncontrolling interest is held by an unaffiliated partner. The assets of each listed entity can only be used to settle the liabilities of that entity as follows (in thousands):
Cash Equivalents
Cash and cash equivalents consist of highly liquid investments with original maturities of three months or less when acquired.
Restricted Cash
Restricted cash consists of security deposits from tenants and deposits from prospective condominium buyers as well as funds required under the terms of certain secured notes payable. There are restrictions on our ability to withdraw these funds other than for their specified usage. See Note 4 for additional information on restrictions under the terms of certain secured notes payable.
Investments in Real Estate
Investments in real estate are stated at cost, less accumulated depreciation, amortization and impairment charges. Depreciation and amortization are recorded on a straight-line basis over the estimated useful lives as follows:
Improvements and replacements are capitalized when they extend the useful life, increase capacity or improve the efficiency of the asset. Repairs and maintenance are charged to expense as incurred.
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Costs related to the acquisition, development, construction and improvement of properties are capitalized. Interest, real estate taxes, insurance and other development related costs incurred during construction periods are capitalized and depreciated on the same basis as the related assets. Included in investments in real estate is capitalized interest of $6.8 million and $17.1 million as of December 31, 2012 and 2011, respectively. There was $0.03 million interest capitalized for the year ended December 31, 2011. There was no interest capitalized for the year ended December 31, 2012.
FASB ASC 805-10, “Business Combinations” ("ASC 805"), requires a company to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquired entity to be measured at their fair values as of the acquisition date. ASC 805-10 also requires companies to recognize the fair value of assets acquired, the liabilities assumed and any noncontrolling interest in acquisitions of less than a one hundred percent interest when the acquisition constitutes a change in control of the acquired entity. In addition, ASC 805-10 requires that acquisition-related costs and restructuring costs be recognized separately from the business combination and expensed as incurred. Refer to Purchase Accounting for Acquisition of Interests in Real Estate Entities elsewhere in this Note 2 for further details.
We consider assets to be held for sale pursuant to the provisions of FASB ASC 360, “Property, Plant and Equipment" ("ASC 360"). We evaluate the held for sale classification of real estate owned each quarter.
Unconsolidated Real Estate Entities
Investments in unconsolidated real estate entities are accounted for using the equity method of accounting whereby our investments in partnerships and limited liability companies are recorded at cost and the investment accounts are adjusted for our share of the entities’ income or loss and for distributions and contributions.
We use the equity method to account for our unconsolidated real estate entities since we have significant influence, but not control over the entities, and we are not considered to be the primary beneficiary.
Impairment of Long-Lived Assets
We assess whether there has been impairment in the value of our long-lived assets whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount to the future net cash flows, undiscounted and without interest, expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets.
Assets to be disposed of are reported at the lower of the carrying amount or fair value, less costs to sell. We use the equity method of accounting to account for investments in real estate entities over which we have significant influence, but not control over major decisions. In these situations, the unit of account for measurement purposes is the equity investment and not the real estate. Accordingly, if our joint venture investments meet the other-than-temporary criteria of FASB ASC 323, “Investments-Equity Method and Joint Ventures” ("ASC 323"), we would recognize an impairment loss to the extent the carrying amount exceeded the estimated fair value of our investment.
We generally estimate the fair value of rental properties utilizing a discounted cash flow analysis, which is a level 3 valuation under FASB ASC 820, "Fair Value Measurements and Disclosures" ("ASC 820"), that includes projections of future revenues, expenses and capital improvement costs, similar to the income approach that is commonly utilized by appraisers. We also use quoted prices for identical instruments in active markets (level 1), and quoted prices for similar instruments in active and/or inactive markets (level 2) as part of our fair value considerations under ASC 820.
For the year ended December 31, 2012, we recorded a $12.0 million impairment charge to reduce the book value of Campus El Segundo to its estimated fair value which was based on the pending contract price to sell this development project and is considered a level 1 valuation. Additionally, we recorded a $0.7 million impairment charge to reduce the book value of certain Four Points Centre land parcels to estimated net sales proceeds under pending contracts to sell these land parcels which were also considered level 1 valuations.
For the year ended December 31, 2011, we recorded an $8.0 million impairment charge representing the balance of the capitalized expenditures for the MetroStudio@Lankershim project. This was a potential development site in Los Angeles, California. We received a breakup fee of $9.0 million from NBCU Universal ("NBCU") in connection with the termination of
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this project, which consisted of a $0.5 million credit related to a previous payment by NBCU to TPG and a lump sum payment of $8.5 million paid in the fourth quarter of 2011. Additionally, the consolidated net income for the year ended December 31, 2011 included a $0.1 million impairment charge related to Four Points Centre to reflect the fair value of a retail building that was held for sale. The sale closed in January 2012, and we received net proceeds of $1.1 million.
Included in the consolidated net losses for the year ended December 31, 2010 , are pre-tax, non-cash impairment charges of $4.5 million , related to our Murano condominium project whose units are held for sale. We are required to record the condominium units at the lower of the carrying amount or estimated fair value as the condominium units meet the held for sale criteria of ASC 360. The impairment charge is included in the “Impairment loss” line item in our consolidated statements of operations. There were no corresponding impairment charges for the Murano for the years ended December 31, 2012 and 2011.
Also included in “Equity in net income (loss) of unconsolidated real estate entities” in our consolidated statements of operations for the years ended December 31, 2012 and 2011 are pre-tax, non-cash impairment charges of $0.6 million and $5.1 million, respectively, related to our joint venture investments summarized in the table below. There was no corresponding non-cash impairment charge for the year ended December 31, 2010. We recorded our share of the impairment loss at the joint venture level as these investments met the other-than-temporary impairment criteria of ASC 323.
Summary of impairment charges at unconsolidated real estate entities (in thousands except square footage amounts):
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(1)
Included in Equity in net income (loss) of unconsolidated real estate entities in the Consolidated Statement of Operations.
(2)
Property sold in January 2012.
(3)
The sole tenant that occupied the property in 2011 vacated the building in 2012, and as of December 31, 2012, the property is vacant.
Deferred Leasing and Loan Costs
Deferred leasing commissions and other direct costs associated with the acquisition of tenants are capitalized and amortized on a straight-line basis over the terms of the related leases. Costs associated with unsuccessful leasing opportunities are expensed. Leasing costs, net of related amortization, totaled $10.0 million and $11.2 million as of December 31, 2012 and 2011, respectively, and are included in deferred leasing and loan costs, net of accumulated amortization, in the accompanying consolidated balance sheets. For the years ended 2012, 2011 and 2010, amortization of leasing costs were $3.0 million, $2.2 million, and $2.3 million respectively.
Loan costs are capitalized and amortized to interest expense over the terms of the related loans using a method that approximates the effective-interest method. Loan costs, net of related amortization, totaled $0.7 million and $1.1 million as of December 31, 2012 and 2011, respectively, and are included in deferred leasing and loan costs, net of accumulated amortization, in the accompanying consolidated balance sheets.
Deferred leasing and loan costs also include the carrying value of acquired in-place leases, which are discussed below.
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Purchase Accounting for Acquisition of Interests in Real Estate Entities
Purchase accounting was applied, on a pro rata basis, to the assets and liabilities related to real estate entities for which we acquired interests, based on the percentage interest acquired. For purchases of additional interests that were consummated subsequent to January 1, 2009, the effective date of FASB ASC 805, “Business Combinations”, the acquired tangible assets, consisting of land, building, tenant and site improvements, and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases, other value of in-place leases and value of tenant relationships, are recorded based in each case on their fair values.
The fair value of the tangible assets of an acquired property (which includes land, building, tenant and site improvements) is determined by valuing the property as if it were vacant, and the “as-if-vacant” value is then recorded to land, building, tenant and site improvements based on management’s determination of the relative fair values of these assets. Management determines the as-if-vacant fair value of a property using methods similar to those used by independent appraisers. Factors considered by management in performing these analyses include an estimate of carrying costs during the expected lease-up periods considering current market conditions and costs to execute leases. In estimating carrying costs, management includes real estate taxes, insurance and other operating expenses and estimates of lost rental revenue during the expected lease-up periods based on current market demand. Management also estimates costs to execute leases including leasing commissions, legal and other related costs.
In recording the fair value of the identified intangible assets and liabilities of an acquired property, above-market and below-market in-place lease values are recorded based on the present value (using an interest rate which reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) management’s estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining non-cancelable term of the lease. The capitalized above-market lease values, included in other assets, are amortized as a reduction of rental income over the remaining non-cancelable terms of the respective leases. The capitalized below-market lease values, included in other liabilities, are accreted as an increase to rental income over the terms in the respective leases. As of December 31, 2012 and 2011, we had an asset related to above market leases of $0.2 million and $0.4 million, respectively, net of accumulated amortization of $1.7 million and $1.5 million, respectively, and a liability related to below market leases of $0.1 million and $0.3 million, respectively, net of accumulated accretion of $1.5 million and $1.5 million, respectively. The weighted average amortization period for our above and below market leases was approximately 1.5 years and 3.2 years, respectively as of December 31, 2012 compared to 2.2 years and 2.4 years for the above and below market leases as of December 31, 2011.
The aggregate value of other acquired intangible assets, consisting of in-place leases and tenant relationships, is measured by the excess of (i) the purchase price paid for a property after adjusting existing in-place leases to market rental rates over (ii) the estimated fair value of the property as if vacant, determined as set forth above. This aggregate value is recorded between in-place lease values and tenant relationships based on management’s evaluation of the specific characteristics of each tenant’s lease; however, the value of tenant relationships has not been separated from in-place lease value for the additional interests in real estate entities acquired by us because such value and its consequence to amortization expense is immaterial for these particular acquisitions. Should future acquisitions of properties result in recording material amounts to the value of tenant relationships, an amount would be separately recorded and amortized over the estimated life of the relationship. The value of in-place leases exclusive of the value of above-market and below-market in-place leases is amortized to depreciation and amortization expense over the remaining non-cancelable periods of the respective leases. If a lease were to be terminated prior to its stated expiration, all unamortized amounts relating to that lease would be written off.
The table below presents the expected amortization (accretion) related to the acquired in-place lease value and acquired above and below market leases at December 31, 2012 (in thousands):
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Noncontrolling Interests and Mandatorily Redeemable Financial Instruments
In accordance with ASC 810, the Company reports arrangements with noncontrolling interests as a component of equity separate from the parent's equity. The Company accounts for purchases or sales of equity interests that do not result in a change in control as equity transactions. In addition, net income attributable to the noncontrolling interest is included in consolidated net income on the face of the consolidated statement of operations and, upon a gain or loss of control, the interest purchased or sold, as well as any interest retained, is recorded at its estimated fair value with any gain or loss recognized in earnings.
Accounting for mandatorily redeemable financial instruments, among other things, requires that in specific instances they are classified as liabilities and recorded at their estimated settlement value each reporting period. Certain consolidated joint ventures of the Company have limited-lives and are not considered to be mandatorily redeemable upon final or other specified liquidation events. As of December 31, 2012, the Company has no mandatorily redeemable financial instruments.
Noncontrolling Interests of Unitholders in the Operating Partnership
Noncontrolling interests of unitholders in the Operating Partnership represent the interests in the Operating Partnership units which are held primarily by entities affiliated with Mr. Thomas. The ownership percentage of the noncontrolling interests is determined by dividing the number of Operating Partnership units by the total number of shares of common stock and Operating Partnership units outstanding. Net income (loss) is allocated based on the ownership percentages. The issuance of additional shares of common stock or Operating Partnership units results in changes to the noncontrolling interests of the Operating Partnership percentage as well as the total net assets to the Company. As a result, all common transactions result in an allocation between equity and noncontrolling interests of the Operating Partnership in the accompanying consolidated balance sheets to account for the change in the noncontrolling interests of the Operating Partnership ownership percentage as well as the change in total net assets of the Company.
Noncontrolling Interests of Partners in Consolidated Real Estate Entities
Noncontrolling interest of partners in consolidated real estate entities represents the other partners' proportionate share of equity in the partnerships and limited liability companies that we consolidate. Capital contributions, distributions, and profits and losses of the real estate entities are allocated in accordance with the terms of the applicable partnership and limited liability company agreements. Such allocations may differ from the stated ownership percentage interests in such entities as a result of preferred returns and allocation formulas as described in the partnership and limited liability company agreements.
Revenue Recognition
All leases are classified as operating leases and minimum rents are recognized on a straight-line basis over the terms of the leases. The impact of the straight line rent adjustment increased revenue by $0.2 million, $0.1 million, and $1.4 million for the years ended December 31, 2012, 2011 and 2010, respectively. Additionally, the net impact of the amortization of acquired above market leases and acquired below market leases decreased revenue by $72,000, $22,800, and $2,000 for the years ended December 31, 2012, 2011 and 2010, respectively. The excess of rents recognized over amounts contractually due pursuant to the underlying leases is included in deferred rents in the accompanying consolidated balance sheets and contractually due but unpaid rents are included in rents and other receivables. We also maintain an allowance for doubtful accounts for estimated losses resulting from the inability of tenants to make required rent payments. The computation of this allowance is based on the tenants’ payment history and current credit status, as well as certain industry or specific credit considerations. If estimates of collectability differ from the cash received, then the timing and amount of our reported revenue could be impacted. The credit risk is mitigated by the high quality of the existing tenant base, reviews of prospective tenant’s risk profiles prior to lease execution and continual monitoring of our tenant portfolio to identify potential problem tenants.
Tenant reimbursements for real estate taxes, common area maintenance and other recoverable costs are recognized in the period that the expenses are incurred. Amounts allocated to tenants based on relative square footage are included in the tenant reimbursements caption on the consolidated statements of operations. Revenues generated from requests from tenants, which result in over-standard usage of services are directly billed to the tenants and are also included in the tenant reimbursements caption on the consolidated statements of operations. Lease termination fees, which are included in other income in the accompanying consolidated statements of operations, are recognized when the related leases are canceled and we have no continuing obligation to provide services to such former tenants.
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We recognize gains on sales of real estate when the recognition criteria in FASB ASC 360-20-40, “Property, Plant and Equipment”, subsection “Real Estate Sales” have been met, generally at the time title is transferred and we no longer have substantial continuing involvement with the real estate asset sold. If the criteria for profit recognition under the full-accrual method are not met, we defer gain recognition and account for the continued operations of the property by applying the deposit or percentage of completion method, as appropriate, until the appropriate criteria are met.
TPG's redemption of a 49% partnership interest in 2121 Market Street did not meet the criteria for profit recognition under the full-accrual method as described in FASB ASC 360-20-40-3 as a result of the guarantee provided by TPG of up to $14.0 million on a mortgage loan secured by a first trust deed on the property. As such, a $9.6 million deferred gain related to this transaction is reflected in the Deferred Revenue caption on our consolidated balance sheets.
We have one high-rise condominium project for which we used the percentage of completion accounting method to recognize sales revenue and costs during the construction period, up through and including June 30, 2009. Commencing with the third quarter of 2009, we applied the deposit method of accounting to recognize costs and sales. Under the provisions of FASB ASC 360-20, “Property, Plant and Equipment” subsection “Real Estate and Sales”, revenue and costs for projects are recognized when all parties are bound by the terms of the contract, all consideration has been exchanged, any permanent financing for which the seller is responsible has been arranged and all conditions precedent to closing have been performed. This results in profit from the sale of condominium units recognized at the point of settlement as compared to the point of sale. Revenue is recognized on the contract price of individual units. Total estimated costs, net of impairment charges, are allocated to individual units which have closed on a relative value basis. Total estimated revenue and construction costs are reviewed periodically, and any change is applied to current and future periods.
Forfeited customer deposits are recognized as revenue in the period in which we determine that the customer will not complete the purchase of the condominium unit and when we determine that we have the right to keep the deposit. There were no forfeitures in for the years ended December 31, 2012, 2011 and 2010.
Investment advisory fees are based on either a percentage of net operating income earned by a property under management or a percentage of the real estate under management, as measured on a fair value basis, and are recorded on a monthly basis as earned. Property management fees are based on a percentage of the revenue earned by a property under management and are recorded on a monthly basis as earned. Generally, 50% of leasing fees are recognized upon the execution of the lease and the remainder upon tenant occupancy unless significant future contingencies exist. Development fees are recognized as the real estate development services are rendered using the percentage-of-completion method of accounting based on total project costs incurred to total estimated costs.
Equity Offering Costs
Underwriting commissions and costs and expenses from our offerings are reflected as a reduction to additional paid-in-capital. In addition, share registration expenses related to the redemption of incentive units as well as other costs of raising capital are reflected as a reduction to additional paid-in-capital.
Income Taxes
We account for income taxes using the asset and liability approach, the objective of which is to establish deferred tax assets and liabilities for the temporary differences between the financial reporting basis and the tax basis of our assets and liabilities, as measured by applying currently enacted tax laws.
FASB ASC 740-10-30-17 “Accounting for Income Taxes” subsection "Initial Measurement" requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some or all of the deferred tax asset will not be realized. Future realization of the deferred tax asset is dependent on the reversal of existing taxable temporary differences, carryback potential, tax-planning strategies and on us generating sufficient taxable income in future years. As of the years ended December 31, 2012 and 2011, the Company recorded a full valuation allowance of $17.7 million and $9.6 million, respectively, on its net deferred tax assets in excess of its liability for unrecognized tax benefits, due to uncertainty of future realization.
FASB ASC 740-10-25 "Accounting for Income Taxes" subsection "Recognition" clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with FASB ASC 740. The interpretation prescribes a recognition threshold and measurement attribute criteria for the financial statement recognition and measurement of a tax
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position taken or expected to be taken in a tax return. The interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.
Earnings (loss) per share
Basic earnings per share, or EPS, is computed by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted EPS assumes the conversion, exercise or issuance of all potential common stock equivalents unless the effect is to reduce a loss or increase the income per share.
On January 1, 2009, the Company adopted FASB ASC 260-10-45, “Earnings Per Share”, which addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing basic earnings per share under the two-class method. The two-class method is an earnings allocation method for calculating earnings per share when a company’s capital structure includes either two or more classes of common stock or common stock and participating securities. Basic earnings per share under the two-class method is calculated based on dividends declared on common shares and other participating securities (“distributed earnings”) and the rights of participating securities in any undistributed earnings, which represents net income remaining after deduction of dividends accruing during the period. The undistributed earnings are allocated to all outstanding common shares and participating securities based on the relative percentage of each security to the total number of outstanding participating securities. Basic earnings per share represents the summation of the distributed and undistributed earnings per share class divided by the total number of shares.
Stock-based Compensation
We recognize stock based compensation in accordance with FASB ASC 718, “Compensation-Stock Compensation” ("ASC 718"). In accordance with ASC 718, we determine the fair value of the stock based compensation grants on the respective grant dates, and recognize to expense the fair value of the grants over the employees’ requisite service periods, which are generally the vesting periods. Our stock based compensation grants include grants of incentive partnership units, restricted stock and stock options. The fair value of incentive partnership units and restricted stock are generally based on the fair value of the Company’s common stock price on the date of grant. Certain of our incentive partnership units and restricted stock grants include performance and market based conditions. Performance based targets are based on individual employee and Company targets, and market based conditions are based on the performance of our stock price. We obtain third party valuations to determine the fair values of the respective performance and market condition based grants. We used the Black-Scholes option pricing model to determine the fair value of our stock options granted in prior years.
Management’s Estimates and Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
We have identified certain critical accounting policies that affect management’s more significant judgments and estimates used in the preparation of the consolidated financial statements. On an ongoing basis, we evaluate estimates related to critical accounting policies, including those related to revenue recognition and the allowance for doubtful accounts receivable and investments in real estate and asset impairment. The estimates are based on information that is currently available to us and on various other assumptions that we believe are reasonable under the circumstances.
We must make estimates related to the collectability of accounts receivable related to minimum rent, deferred rent, expense reimbursements, lease termination fees and other income. We specifically analyze accounts receivable and historical bad debts, tenant concentrations, tenant creditworthiness, and current economic trends when evaluating the adequacy of the allowance for doubtful accounts receivable. These estimates have a direct impact on our net income, because a higher bad debt allowance would result in lower net income.
We are required to make subjective assessments as to the useful lives of the properties for purposes of determining the amount of depreciation to record on an annual basis with respect to our investments in real estate. These assessments have a direct impact on our net income because if we were to shorten the expected useful lives of our investments in real estate, we
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would depreciate such investments over fewer years, resulting in more depreciation expense and lower net income on an annual basis.
We are required to make subjective assessments as to whether there are impairments in the values of our investments in real estate, including real estate held by the unconsolidated real estate entities accounted for using the equity method. These assessments have a direct impact on our net income because recording an impairment loss results in a negative adjustment to net income.
We are required to make subjective assessments as to the fair value of assets and liabilities in connection with purchase accounting related to interests in real estate entities acquired by us. These assessments have a direct impact on our net income subsequent to the acquisition of the interests as a result of depreciation and amortization being recorded on these assets and liabilities over the expected lives of the related assets and liabilities. We estimate the fair value of rental properties utilizing a discounted cash flow analysis, which is a level 3 valuation under ASC 820, that includes projections of future revenues, expenses and capital improvement costs, similar to the income approach that is commonly utilized by appraisers.
Recent Accounting Pronouncements
Changes to U.S. generally accepted accounting principles (“GAAP”) are established by the FASB in the form of accounting standards updates (ASUs) to the FASB's Accounting Standards Codification. We consider the applicability and impact of all ASUs. Newly issued ASUs not listed below are expected to have no impact on our consolidated financial position and results of operations, because either the ASU is not applicable or the impact is expected to be immaterial.
In May 2011, the FASB issued ASU No. 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards" ("ASU No. 2011-04"). ASU No. 2011-04 provides a consistent definition of fair value to ensure that the fair value measurement and disclosure requirements are similar between U.S. GAAP and International Financial Reporting Standards. ASU 2011-04 was effective for the Company beginning January 1, 2012. The adoption of this update did not have a material impact on our financial position or results of operations.
In June 2011, the FASB issued ASU No. 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income" (“ASU No. 2011-05”). ASU No. 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of stockholders’ equity. It requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In December 2011, the FASB issued ASU 2011-12, “Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in ASU 2011-05” ("ASU No. 2011-12"), to defer the effective date of the specific requirement to present items that are reclassified out of accumulated other comprehensive income to net income alongside their respective components of net income and other comprehensive income. All other provisions of this update, which are to be applied retrospectively, are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company does not have any material transactions resulting in reportable comprehensive income (loss).
In December 2011, the FASB issued ASU 2011-10, "Derecognition of in Substance Real Estate - a Scope Clarification (Topic 360)" ("ASU 2011-10"). This ASU modifies ASC 360-20, which specifies circumstances under which the parent (reporting entity) of an “in substance real estate” entity derecognizes that in substance real estate. Generally, if the parent ceases to have a controlling financial interest (as described under ASC 810-10) in the subsidiary as a result of a default on the subsidiary’s nonrecourse debt, then the subsidiary’s in substance real estate and related debt, as well as the corresponding results of operations, will continue to be included in the consolidated financial statements and not be removed from the consolidated results until legal title to the real estate is transferred. ASU 2011-10 is effective for fiscal years, and interim periods within those years, beginning on or after June 15, 2012. The adoption of ASU 2011-10 did not have a material effect on our financial position or results of operations.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current year presentation for unconsolidated real estate entities and for activity associated with real estate held for disposition, with no effect to previously reported net income and equity.
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Segment Disclosure
FASB ASC 280, “Segment Reporting”, established standards for disclosure about operating segments and related disclosures about products and services, geographic areas and major customers. We currently operate in one operating segment: the acquisition, development, ownership, and management of commercial real estate. Additionally, we operate in one geographic area: the United States.
Our office portfolio includes revenues from the rental of office space to tenants, parking, rental of storage space and other tenant services.
Concentration of Credit Risk
Financial instruments that subject us to credit risk consist primarily of cash and accounts receivable. We maintain our unrestricted cash and restricted cash on deposit with high quality financial institutions. Some account balances exceed Federal Deposit Insurance Corporation (“FDIC”) insurance coverage or are not eligible for FDIC insurance coverage, and, as a result, there is a concentration of credit risk related to amounts on deposit in excess of or not covered by FDIC insurance. Our cash equivalents are typically invested in AAA-rated short-term instruments, which provide daily liquidity.
We have two operating properties and one unconsolidated operating property located in downtown Philadelphia, Pennsylvania. In addition, the Murano residential high-rise project consists of condominium units held for sale in downtown Philadelphia, Pennsylvania. The ability of the tenants to honor the terms of their respective leases, and the ability of prospective buyers to close on the acquisition of a condominium unit, is dependent upon the economic, regulatory and social factors affecting the communities in which the tenants operate and buyers reside.
We generally require either a security deposit, letter of credit or a guarantee from our tenants. We typically require a 15% cumulative deposit of prospective buyers of our Murano condominium project, which is essentially non-refundable except in cases of our non-performance.
3.
Unconsolidated Real Estate Entities
The unconsolidated real estate entities include our share of the entities that own 2121 Market Street, the TPG/CalSTRS properties, TPG/CalSTRS Austin, LLC properties and the Austin Portfolio Joint Venture Predecessor properties. TPG/CalSTRS owns the following properties as of December 31, 2012:
•
City National Plaza (acquired January 2003)
•
Reflections I (acquired October 2004)
•
Reflections II (acquired October 2004)
•
San Felipe Plaza (acquired August 2005)
•
CityWestPlace land (acquired June 2006)
•
CityWestPlace (acquired June 2006)
•
Fair Oaks Plaza (acquired January 2007)
The following properties were disposed by TPG/CalSTRS during 2011 and 2012:
•
Four Falls Corporate Center (acquired March 2005, disposed of October 2011)
•
Oak Hill Plaza (acquired March 2005, disposed of October 2011)
•
Walnut Hill Plaza (acquired March 2005, disposed of October 2011)
•
2500 CityWest and two adjacent land parcels (acquired August 2005, disposed of November 2011)
•
Centerpointe I and II (acquired January 2007, disposed of December 2011)
•
Brookhollow Central I, II and III (acquired August 2005, disposed of January 2012)
•
CityWestPlace land - certain land parcels (acquired June 2006, disposed of November 2012)
TPG Austin Partner, LLC, a limited liability company formed in September 2012 by TPG and Madison, owns a 50% interest in TPG/CalSTRS Austin, LLC, which owns the following properties that were acquired from Austin Joint Venture Predecessor:
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
•
San Jacinto Center (acquired September 2012)
•
Frost Bank Tower (acquired September 2012)
•
One Congress Plaza (acquired September 2012)
•
One American Center (acquired September 2012)
•
300 West 6th Street (acquired September 2012)
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Park Centre (acquired September 2012)
•
Great Hills Plaza (acquired September 2012)
•
Westech 360 I-IV (acquired September 2012)
The following properties were disposed by the Austin Joint Venture Predecessor in 2012:
•
Research Park Plaza I & II (acquired June 2007, disposed of July 2012)
•
Stonebridge Plaza II (acquired June 2007, disposed of July 2012)
Capital contributions, distributions, and profits and losses of the real estate entities are allocated in accordance with the terms of the applicable partnership and limited liability company agreements. Such allocations may differ from the stated ownership percentage interests in such entities as a result of preferred returns and allocation formulas as described in the partnership and limited liability company agreements. Following are the stated ownership percentages, prior to any preferred or special allocations, as of December 31, 2012.
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(1) TPG Austin Partner, LLC, a limited liability company owned by TPG and Madison, a noncontrolling interest partner, owns 50% of TPG/CalSTRS Austin, LLC. The effective ownership of TPG and Madison in the underlying eight properties of TPG/CalSTRS Austin, LLC is 33.3% and 16.7%, respectively.
We review the facts and circumstances of each distribution from unconsolidated entities to determine how
to classify it on the consolidated statements of cash flows. Distributions received from unconsolidated entities that
represent returns on the Company's investment are reported as cash flows from operating activities, consistent with ASC
230-10-45-16. Cash distributions from unconsolidated entities that represent returns of the Company's investment are
reported as cash flows from investing activities, consistent with ASC 230-10-45-12.
Distributions are deemed to be returns on the Company's investment, and recorded as operating inflows, unless the
cumulative distributions exceed the cumulative equity in earnings recognized by the Company. The excess distributions
are deemed to be returns of the investment and are classified as investing cash flows. Distributions received in excess of
cumulative contributions are deemed a return on investment and classified as operating cash flows.
We evaluated unconsolidated investments with negative carrying amounts to determine if the equity method
of accounting is still appropriate, consistent with ASC 323-10-35-19 through 26. The Company's investment in 2121 Market
Street had a negative carrying amount of $0.3 million and $2.5 million as of December 31, 2012 and 2011, respectively. The Company reduced its investment balance below zero due to the receipt of distributions and recording of our share of investee losses in excess of our investment, because we had guaranteed up to a maximum of $14.0 million and $3.3 million of 2121 Market Street's outstanding mortgage loan as December 31, 2012 and 2011, respectively. During the year ended December 31, 2012, we redeemed a 49% interest in 2121 Market Street and retained a 1% limited partnership interest.
With respect to the Company's investment in TPG/CalSTRS, we had a positive carrying amount as of December 31,
2011, of approximately $3.5 million, and a negative carrying amount of approximately $9.8 million as of December 31, 2012.
The Company made a commitment to fund tenant improvements, other capital improvements, debt repayment or debt
repurchase of properties owned by TPG/CalSTRS up to $10.9 million and $13.9 million as of December 31, 2012 and
2011, respectively. In addition, the Company made a commitment to fund temporary operating cash shortfalls,
not more frequently than once a month, up to $1.25 million in the aggregate for all the TPG/CalSTRS properties.
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
Investments in unconsolidated real estate entities as of December 31, 2012 and 2011 are as follows (in thousands):
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
The following is a summary of the net investments in unconsolidated real estate entities for the years ended December 31, 2012, 2011 and 2010 (in thousands):
TPG/CalSTRS was formed to acquire office properties on a nationwide basis classified as moderate risk (core plus) and high risk (value add) properties. Core plus properties consist of under-performing properties that we believe can be brought to market potential through improved management. Value-add properties are characterized by unstable net operating income for an extended period of time, occupancy less than 90% and/or physical or management problems which we believe can be positively impacted by introduction of new capital and/or management.
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
The total capital commitment to TPG/CalSTRS was $511.7 million as of December 31, 2012, of which approximately $2.9 million and $10.9 million was unfunded by CalSTRS and us, respectively.
A buy-sell provision may be exercised by either CalSTRS or us. Under this provision, the initiating party sets a price for its interest in TPG/CalSTRS, and the other party has a specified time to elect to either buy the initiating party's interest or to sell its own interest to the initiating party. Upon the occurrence of certain events, CalSTRS also has a buy-out option to purchase our interest in TPG/CalSTRS. The buyout price is based upon a 3% discount to the appraised fair market value.
On March 6, 2010, an aggregate of $96.5 million in mortgage loans owed by subsidiaries of TPG/CalSTRS (the “borrowers”) on unconsolidated properties at Four Falls Corporate Center, Oak Hill Plaza, and Walnut Hill Plaza in suburban Philadelphia matured and became due in full. The borrowers elected not to make payment on these loans. These loans were non-recourse to the borrowers and the Company. In June 2011, the Court of Common Pleas of Montgomery County, PA approved the appointment of a Receiver. In October 2011, a foreclosure sale, by stipulation with the lender, occurred whereby TPG/CalSTRS was relieved of the obligation to pay the remaining debt on Oak Hill Plaza, Walnut Hill Plaza and Four Falls Corporate Center. TPG/CalSTRS recognized a $28.7 million gain on extinguishment of debt upon disposition of these properties, of which TPG's share was $7.2 million.
In November 2011, we completed the sale of 2500 CityWest and two adjacent land parcels in Houston, Texas, each a TPG/CalSTRS joint venture property. TPG/ CalSTRS received net proceeds from this transaction of $61.3 million, after closing costs and assumption of mortgage debt, of which TPG's share was $15.3 million. TPG/ CalSTRS recorded a gain on sale of $49.7 million, of which TPG's share was $12.4 million.
In December 2011, we completed the sale of Centerpointe I & II whereby TPG/CalSTRS received net proceeds of $54.4 million of which TPG's share was $5.8 million. TPG/CalSTRS recorded a gain on sale of $21.0 million, of which TPG's share was $5.3 million.
In January 2012, we completed the sale of Brookhollow Central I, II and III in Houston, Texas, a TPG/CalSTRS joint venture property. TPG/CalSTRS received net proceeds from this transaction of $30.6 million, after closing costs and repayment of mortgage debt, of which TPG's share was $7.7 million. During the fourth quarter of 2011, TPG/CalSTRS recorded a $7.8 million impairment charge to reduce the book value of the property to the net sales proceeds. TPG's share of the impairment charge was $1.9 million.
As of December 31, 2012 and 2011, we recorded impairment charges of $2.4 million and $6.2 million, respectively, on Fair Oaks Plaza, a TPG/CalSTRS joint venture property, to reduce the book value of the property to the estimated fair value. TPG's share of each impairment charge was $0.6 million and $1.6 million, respectively. As of December 31, 2011, we recorded an impairment charge of $6.4 million to reduce the book value of Reflections II, a TPG/CalSTRS joint venture property, to the estimated fair value. TPG's share of the impairment charge was $1.6 million.
The TPG/CalSTRS joint venture is deemed to be a variable interest entity for which we are not considered to be the primary beneficiary. CalSTRS and TPG acting together are considered to have the power to direct the activities of the joint venture that most significantly impact the joint venture economic performance and therefore neither TPG nor CalSTRS is considered to be the primary beneficiary. We determined the key activities that drive the economic performance of the joint venture to be (1) the acquisition and development of real estate (including capital improvements), (2) financing, and (3) leasing. In connection with these key activities, the TPG/CalSTRS venture agreement requires unanimous approval by the two members.
In connection with TPG/CalSTRS Austin, LLC, TPG Austin Partner, LLC is not considered to be the primary beneficiary due to the fact that the power to direct the activities of the limited liability company is shared with CalSTRS such that no one party has the power to direct the activities that most significantly impact the limited liability company's economic performance. In connection with TPG/CalSTRS Austin, LLC, we determined the key activities that drive the economic performance to be (1) the acquisition and development of real estate (including capital improvements), (2) financing, and (3) leasing. In connection with these key activities, TPG/CalSTRS Austin, LLC agreement requires either unanimous or majority approval of decisions by the respective partners.
In connection with the Austin Portfolio Joint Venture Predecessor, TPG/CalSTRS was not considered to be the primary beneficiary due to the fact that the power to direct the activities of the joint venture was shared among multiple unrelated parties such that no one party had the power to direct the activities of the joint venture that most significantly impact the joint venture's
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
economic performance. In connection with the Austin Portfolio Joint Venture Predecessor, we determined the key activities that determined the economic performance of the joint venture to be (1) the acquisition and development of real estate (including capital improvements), (2) financing, and (3) leasing. In connection with these key activities, the Austin Portfolio Joint Venture Predecessor partnership agreement required either unanimous or majority approval of decisions by the respective partners. We therefore determined the power to direct the activities to be shared amongst the partners so that no one partner had the power to direct the activities that most significantly impact the partnership's economic performance. This portfolio was acquired by TPG/CalSTRS Austin, LLC in September 2012.
As of December 31, 2012, our total maximum exposure to loss to TPG/CalSTRS and the TPG/CalSTRS Austin, LLC is:
(1)
Our net equity investment in the various properties controlled by TPG/CalSTRS and TPG/CalSTRS Austin, LLC as of December 31, 2012, was $96.1 million, as presented earlier in this note.
(2)
The potential loss of future fee revenues which we earn in connection with the management and leasing agreements with the various properties controlled by the respective limited liability companies. We earn fee revenues in connection with those management and leasing agreements for services such as property management, leasing, asset management and property development. The management and leasing agreements with the various properties generally expire on an annual basis and are automatically renewed for successive periods of one year each, unless we elect not to renew the agreements. As of December 31, 2012, we had total receivables of $1.7 million and $0.5 million related to TPG/CalSTRS and the TPG/CalSTRS Austin, LLC, respectively.
(3)
Unfunded capital commitments to the TPG/CalSTRS was $10.9 million as of December 31, 2012.
(4)
TPG/CalSTRS Austin, LLC owns the eight Austin properties and TPG, together with Madison, have unfunded capital commitments of approximately $14.4 million. Of that amount, TPG's unfunded capital commitment is approximately $9.6 million or 66.67% as of December 31, 2012.
Following is summarized financial information for the unconsolidated real estate entities as of December 31, 2012 and 2011 and for the years ended December 31, 2012, 2011 and 2010 (in thousands):
Summarized Balance Sheets
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
Summarized Statements of Operations
Included in the preceding summarized balance sheets as of December 31, 2012 and 2011, are the following balance sheets of TPG/CalSTRS, LLC (in thousands) (unaudited):
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
Included in the preceding summarized balance sheet as of December 31, 2012 is the following balance sheet of TPG/CalSTRS Austin, LLC (in thousands) (unaudited):
Following is summarized financial information by real estate entity for the years ended December 31, 2012, 2011 and 2010 and includes TPG/CalSTRS Austin, LLC from inception, September 11, 2012 (in thousands) :
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
For the year ended December 31, 2012, one tenant accounted for approximately 12.0% of rent and tenant reimbursements (excluding tenant reimbursement for over-standard usage of certain operating expenses) of TPG/CalSTRS. The lease expire in 2021. For the years ended December 31, 2011 and 2010, there were no tenants accounting for 10% or more, of rent and tenant reimbursements of TPG/CalSTRS.
For the year ended December 31, 2012, there were no tenants accounting for 10% or more, of rent and tenant reimbursements (excluding tenant reimbursement for over-standard usage of certain operating expenses) of TPG/CalSTRS Austin, LLC.
Following is a reconciliation of our share of owners’ equity of the unconsolidated real estate entities as shown above to amounts recorded by us as of December 31, 2012 and 2011:
4. Mortgage Loans
A summary of the outstanding mortgage loans as of December 31, 2012 and 2011 is as follows (in thousands). None of these loans are recourse to us, except that we have guaranteed the Campus El Segundo mortgage loan, partially guaranteed the Four Points Centre mortgage loan, under which our liability is currently limited to a maximum of $12.3 million, and provided a limited guaranty for the Murano mortgage loan. See footnote 5 to the table below for further details regarding the Murano limited guaranty. In connection with some of the loans listed in the table below, our operating partnership is subject to customary non-recourse carve out obligations.
The 30 day LIBOR rate for the loans above was 0.21% at December 31, 2012.
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(1)
The mortgage loan may be defeased, and is subject to yield maintenance payments for any prepayments prior to October 2015.
(2)
On March 8, 2013, we entered into a loan agreement with a lender for a new mortgage on Two Commerce Square in the amount of $112.0 million. The loan, which has a fixed interest rate of 3.96% for a ten year term, funded on March 8, 2013. The loan replaced the existing mortgage on the property that had an outstanding balance of $106.6 million as of December 31, 2012, and a maturity date of May 9, 2013, and was open to prepayment without penalty on and after March 8, 2013.
(3)
The interest rate as of December 31, 2012 was 4.00% per annum. The Campus El Segundo mortgage loan has an October 31, 2013 maturity date with one remaining twelve month extension. A $2.5 million principal paydown is due April 30, 2013. We have guaranteed this loan. We have agreed to certain financial covenants on this loan as the guarantor, which we were in compliance with as of December 31, 2012.
(4)
The interest rate as of December 31, 2012 was 3.75% per annum. As of December 31, 2012, $4.2 million was available to be drawn to fund tenant improvement costs and certain other project costs related to two office buildings. The loan has a
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
one-year extension option at our election subject to certain conditions. The option to extend is subject to (1) a loan-to-value ratio and a minimum appraised land ratio of 62.5% , and (2) the adjusted net operating income of the property and improvements as a percentage of the outstanding principal balance must be at least 10.0%. If the loan-to-value ratio or the minimum debt yield is not met, we can pay down the principal balance in an amount sufficient to satisfy the requirement. The debt yield is calculated by dividing the net operating income of the property by the outstanding principal balance of the loan.
Beginning in August, 2014, we are required to pay down the loan balance by $42,000 each month. As of December 31, 2012, the property had a net operating loss. We have guaranteed completion of the tenant improvements and 46.5% of the balance of the outstanding principal balance and interest payable on the loan, which results in a maximum guarantee of $12.3 million as of December 31, 2012. We have agreed to certain financial covenants on this loan as the guarantor, which we were in compliance with as of December 31, 2012. We have also provided additional collateral of fully entitled unimproved land, which is immediately adjacent to the office buildings.
Subsequent to December 31, 2012, we sold certain land parcels at Four Points Centre, resulting in paydowns of $6.9 million on the loan. The remaining collateral of fully entitled unimproved land adjacent to the office buildings is approximately 19.9 acres.
(5)
The interest rate as of December 31, 2012 was 4.00% per annum and the loan matures on December 15, 2013. Repayment of this loan is being made with proceeds from the sales of condominium units. On June 30, 2013, the loan is subject to a maximum balance of $4.3 million. TPG gave the lender a limited guaranty which (i) guarantees repayment of the loan in the event of certain bankruptcy events affecting the borrower, (ii) guarantees payment of the lender's damages from customary “bad boy” actions of the borrower or TPG (such as fraud, physical waste of the property, misappropriation of funds and similar bad acts); and (iii) guarantees payment of the amount, if any, by which the loan balance at the time exceeds 80.0% of the bulk sale value of the collateral upon an acceleration of the loan triggered by a borrower default. Based on two units that have settled subsequent to December 31, 2012, and five additional units scheduled to settle in February and March, 2013, the loan will be reduced to approximately $3.3 million.
The loan agreements for One Commerce Square and Two Commerce Square require that all receipts collected from these properties be deposited in lockbox accounts under the control of the lenders to fund reserves such as capital improvements, taxes, insurance, leasing commissions, debt service and operating expenditures. Included in restricted cash on our consolidated balance sheets at December 31, 2012 and 2011, are lockbox, reserve funds and/or security deposits as follows (in thousands):
As of December 31, 2012, subject to certain extension options exercisable by the Company, principal payments due for the secured outstanding debt are as follows (in thousands):
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
5.
Earnings (Loss) per Share
Under FASB ASC 260-10-45, "Earnings Per Share", the Company uses the two-class method to calculate earning per share. Basic earnings per share is calculated based on dividends declared on common shares and other participating securities (“distributed earnings”) and the rights of common shares and participating securities in any undistributed earnings, which represents net income remaining after deduction of dividends accrued during the respective period. Participating securities, which include restricted stock, incentive units and stock options, are included in the computation of earnings per share pursuant to the two-class method. The undistributed earnings are allocated to all outstanding common shares and participating securities based on the relative percentage of each security to the total number of outstanding securities. Basic earnings per common share and participating securities, including restricted stock, incentive units and stock options, represent the summation of the distributed and undistributed earnings per common share and participating security divided by the total weighted average number of common shares outstanding and the total weighted average number of participating securities outstanding during the respective periods. We only present the earnings per share attributable to the common shareholders.
Net losses, after deducting the dividends to participating securities, are allocated in full to the common shares since the participating security holders do not have an obligation to share in the losses, based on the contractual rights and obligations of the participating securities. Because we incurred losses for the years ended December 31, 2012 and 2010, all potentially dilutive instruments are anti-dilutive and have been excluded from our computation of weighted average dilutive shares outstanding.
In November 2011, the board of directors reinstated dividend payments and a quarterly dividend of $0.015 per common share which was paid in December 2011. During 2012, the board of directors declared and paid three quarterly dividends of $0.015 per common share to common stockholders and a quarterly dividend of $0.02 per common share in the fourth quarter.
The following is a summary of the elements used in calculating basic and diluted income (loss) per share for the years ended December 31, 2012, 2011 and 2010 (in thousands except share and per share amounts):
(1) Basic and diluted shares are calculated in accordance with GAAP, and include common shares plus dilutive equity instruments, as appropriate. For the years ended December 31, 2012 and 2010, all potentially dilutive instruments have been excluded from the computation of weighted average dilutive shares outstanding because they were anti-dilutive.
6.
Equity
Common Stock and Operating Partnership Units
The holders of common stock are entitled to one vote per share on all matters to be voted upon by the stockholders. Holders of our common stock vote together as a single class with holders of our limited voting stock on those matters upon which the holders of limited voting stock are entitled to vote. Subject to preferences that may be applicable to any outstanding shares of preferred stock, the holders of common stock are entitled to receive ratably any dividends when, if, and as may be declared by the board of directors out of funds legally available for dividend payments. In the event of our liquidation, dissolution or winding up, the holders of our common stock are entitled to share ratably in all assets remaining after payment of liabilities and the liquidation preferences of any outstanding shares of preferred stock. Holders of common stock have no preemptive, conversion, subscription or other rights. There are no redemption or sinking fund provisions applicable to the common stock. An Operating Partnership unit and a share of our common stock have essentially the same economic
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
characteristics as they share equally in the total net income or loss and distributions of the Operating Partnership. An Operating Partnership unit may be redeemed by the holder in exchange for cash or shares of common stock at our election, on a one-for-one basis. As of December 31, 2012 and 2011, we held a 78.7% and 74.7% interest in the Operating Partnership respectively.
Issuances of Common Stock
In June 2012, the Company sold in a private placement an aggregate of 8,695,653 shares of common stock at a price of $5.75 per share, for aggregate gross proceeds of $50.0 million. The Company did not pay any underwriting discounts or commissions with respect to the sale of the common stock, but the Company agreed to reimburse the investors for certain transaction expenses totaling $0.5 million. In connection with the transaction, on August 2, 2012, the Company's Board of Directors elected Bradley H. Carroll to the Board. The Company also granted certain registration rights to the investor group generally requiring the company to register their shares with the Securities and Exchange Commission within 24 months of May 2012.
In April 2010, we established an “at the market” (ATM) stock offering program through which we may sell from time to time up to an aggregate of $30.0 million of common stock through a sales agent. During the year ended December 31, 2010, we sold 4.3 million shares of common stock at prices ranging from $3.67 to $5.03 per share in our “at-the-market” equity offering program. These sales resulted in gross proceeds of $15.9 million and net proceeds of $15.5 million, which were used for general corporate purposes. There were no ATM sales in 2012 and 2011. As of December 31, 2012, the ATM offering program was inactive.
See also Exchange of Noncontrolling Operating Partnership Units below for information regarding a redemption during the years ended December 31, 2012 and 2010.
Limited Voting Stock
Each Operating Partnership unit issued in connection with the formation of our Operating Partnership at the time of our initial public offering in 2004 was paired with one share of limited voting stock. Operating Partnership units issued under other circumstances, including upon the conversion of incentive units granted under the Incentive Plan, are not paired with shares of limited voting stock. These shares of limited voting stock are not transferable separate from the limited partnership units they are paired with, and each Operating Partnership unit is redeemable together with one share of limited voting stock by its holder for cash, or, at our election, one share of our common stock. Each share of limited voting stock entitles its holder to one vote on the election of directors, certain extraordinary transactions, including a merger or sale of our Company, and amendments to our certificate of incorporation. Shares of limited voting stock are not entitled to any regular or special dividend payments or other distributions, including any dividends or other distributions declared or paid with respect to shares of our common stock or any other class or series of our stock, and are not entitled to receive any distributions in the event of liquidation or dissolution of our Company. Shares of limited voting stock have no class voting rights, except to the extent required by Delaware law. Any redemption of a unit in our Operating Partnership will be redeemed together with a share of limited voting stock in accordance with the redemption provisions of the Operating Partnership agreement, and the share of limited voting stock will be canceled and not subject to reissuance. As of December 31, 2012, there were 12,313,331 limited voting stock outstanding.
Incentive Partnership Units
We have issued a total of 1,377,714 incentive units as of December 31, 2012 to certain executives. Incentive units represent a profits interest in the Operating Partnership and generally will be treated as regular Operating Partnership units in the Operating Partnership and rank pari passu with the Operating Partnership units as to payment of distributions, including distributions of assets upon liquidation. Incentive units are subject to vesting, forfeiture and additional restrictions on transfer as may be determined by us as general partner of the Operating Partnership. The holder of an incentive unit has the right to convert all or a part of his vested incentive units into Operating Partnership units, but only to the extent of the incentive units’ economic capital account balance. As general partner, we may also cause any number of vested incentive units to be converted into Operating Partnership units to the extent of the incentive units’ economic capital account balance. We had 46,126,481 shares of common stock and 12,313,331 Operating Partnership units outstanding as of December 31, 2012, and 224,100 vested and unvested incentive units outstanding which were issued under our Incentive Plan. The share of the Company owned by the Operating Partnership unit holders is reflected as a separate component under the "Noncontrolling Interests" caption in the equity section of our consolidated balance sheets.
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
Exchange of Noncontrolling Operating Partnership Units
During the year ended December 31, 2010, 1.5 million noncontrolling Operating Partnership units were redeemed for shares of the Company’s common stock on a one-for-one basis. Neither the Company nor the Operating Partnership received any proceeds from the issuance of the common stock to the noncontrolling Operating Partnership unitholders. For the year ended December 31, 2012, 135,834 vested incentive units were redeemed for the Company's common stock. There were no redemptions during the year ended December 31, 2011.
Stock Compensation
We adopted the 2004 Equity Incentive Plan of Thomas Properties Group, Inc. as amended, (the“ Incentive Plan”) effective upon the closing of our initial public offering and amended it in May 2007 and June 2008 to increase the shares reserved under the plan. The Incentive Plan provides incentives to our employees and is designed to attract, reward and retain personnel. We may issue up to 3,361,906 shares as either stock option awards, restricted stock awards or incentive unit awards of which 411,608, remain available for grant as of December 31, 2012 (see table below for details). In addition, under our Non-Employee Directors Restricted Stock Plan (“the Non-Employee Directors Plan”) a total of 60,000 shares are reserved for grant, of which 29,065 remain available for grant.
Restricted Stock
Under our Incentive Plan, we have issued the following restricted shares to executives of the Company:
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(1) In January 2009, we issued 410,000 restricted shares to executives which vest over a period of five years. Fifty percent of the restricted shares vest based on stock performance. The other fifty percent are discretionary vesting shares based on individual and Company goals, which are currently reserved and will be considered granted upon vesting. As of December 31, 2012, there was 82,000 performance based and 123,000 discretionary based shares fully vested and 123,000 performance based and 82,000 discretionary based shares remain unvested.
(2) In January 2011, we issued 151,601 restricted shares to executives which vest over a period of two years. Fifty percent of the restricted shares vest based on stock performance. The other fifty percent are discretionary vesting shares based on individual and Company goals, which are currently reserved and will be considered granted upon vesting. As of
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
December 31, 2012, there was 37,898 discretionary based shares fully vested and 75,802 performance based and 37,901 discretionary based shares remain unvested.
(3) In February 1, 2012, we issued 199,999 restricted shares to executives which vest over a period of two years. Fifty percent of the restricted shares vest based on stock performance and had a total fair market value of approximately $0.2 million. The other fifty percent are discretionary vesting shares based on goals determined by the Compensation Committee, which are currently reserved and will be considered granted and fully expensed upon vesting. As of December 31, 2012, there was 100,001 performance based and 99,998 discretionary based shares that remain unvested.
(4) Aggregate fair value as of grant date for the shares that vest based on stock performance and discretionary shares that have vested.
The fair value of the restricted stock grants is determined based on the Company’s common stock price at the date of grant. The fair value of restricted stock grants with market conditions is adjusted for the effect of those market conditions; this is estimated by a third-party valuation consultant. Holders of restricted stock have full voting rights and receive any dividends paid.
Under our Non-Employee Directors Plan, we have issued 30,935 shares of outstanding restricted shares to our non-employee directors. These shares are fully vested as of December 31, 2012 and the aggregate value of these shares is $0.4 million.
We recognized non-cash compensation expense and the related income tax benefit for the vesting of restricted stock grants for the years ended December 31, 2012, 2011 and 2010 as follows (in thousands). For the years ended December 31, 2012, 2011, and 2010, a full valuation allowance was recorded against the applicable income tax benefit.
The weighted-average grant date fair value of restricted stock granted to executives during the year ended December 31, 2012 was $2.07 per share. No grants of restricted stock were made to non-employee directors during the years ended December 31, 2012 and 2011. As of December 31, 2012, there was $86,000 of total unrecognized compensation cost related to the unvested performance based restricted stock under the Incentive Plan. The unrecognized compensation expense is expected to be recognized over a weighted average period of 0.9 year.
Incentive Partnership Units
Under our Incentive Plan, we have issued the following incentive units to certain executives:
(1) During September 2012, the remaining 12,918 incentive units subject to market based performance measures vested.
(2) In January 2011, we issued 74,378 incentive units, which vest over a two year period. At issuance date, 37,189 units were subject to market based performance measures and 37,189 units were reserved and would be considered granted upon vesting, which would occur when it was determined that certain individual and Company goals have been met. During February 2012, 18,595 units subject to discretionary measures vested. Of the remaining incentive units, 37,189 units are subject to market based performance measures and 18,594 units are subject to discretionary measures.
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
(3) Aggregate fair value as of grant date for the shares that vest based on stock performance and discretionary shares that have vested.
The fair value of the incentive unit grants is determined based on the Company’s common stock price at the date of grant and a discount for post-vesting restrictions estimated by a third-party valuation consultant.
For the years ended December 31, 2012, 2011 and 2010, we recorded compensation expense for the vesting of the incentive unit grants totaling $183,000, $199,000 and $90,000, respectively. As of December 31, 2012, compensation expense related to performance based incentive units had been fully expensed.
Stock options
Under our Incentive Plan, we have 373,829 stock options outstanding as of December 31, 2012. There were no stock option grants for the years ended December 31, 2012, 2011 and 2010. The options vest at the rate of one third per year over three years and expire ten years after the date of commencement of vesting. The fair market value of each option granted was estimated on the date of the grant using the Black-Scholes option pricing model. Below is a summary of the methodologies the Company utilized to estimate the assumptions used in the Black-Scholes option pricing model:
Expected Term-The expected term represents the period that the Company’s stock-based awards are expected to be outstanding.
Expected Stock Price Volatility-The Company estimates its volatility factor by using the historical average volatility of its common stock price over a period equal to the expected term.
Expected Dividend Yield-The dividend yield is based on the Company’s expected future dividend payments.
Risk-Free Interest Rate-The Company bases the risk-free interest rate used on the implied yield currently available on the U.S. Treasury zero-coupon issues with an equivalent remaining term.
Estimated Forfeitures-When estimating forfeitures, the Company considers voluntary termination behavior as well as an analysis of actual option forfeitures. As stock-based compensation expense recognized in the consolidated statements of operations is based on awards ultimately expected to vest, it should be reduced for estimated forfeitures. FASB ASC 718 “Compensation-Stock Compensation” requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Pre-vesting forfeitures were estimated based on historical experience.
The following is a summary of stock option activity under our Incentive Plan:
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
We recognized compensation expense and the related income tax benefit for stock options for the years ended December 31, 2012, 2011 and 2010 as follows (in thousands). For the years ended December 31, 2011 and 2010, a full valuation allowance was recorded against the applicable income tax benefit.
As of December 31, 2012, all stock options have vested and have been fully recognized. There were no stock options granted or exercised during years ended December 31, 2012, 2011 and 2010.
Phantom Shares
During 2011, a Phantom Share Plan was approved by the compensation committee of the board of directors and adopted by the full board of directors. The purpose of the Plan is to reward and retain senior executive officers of the Company. This Plan is an incentive award plan that pays cash or, if the stockholders of the Company approve and authorize the issuance of additional shares, common stock. Generally, the recipient must still be employed with the Company to receive the cash or stock. There were 677,933 phantom shares granted under the plan in 2011 with a total grant date fair value of approximately $1.0 million. Each phantom share award vests upon the earlier of (i) ratably, one-third on each anniversary of the grant date, subject to achievement of (x) with respect to 50% of each award, a Company stock appreciation target rate of up to 12% pro-rated, and (y) with respect to 50% of each award, other goals determined by the Compensation Committee, in each case only to the extent that at or after such time the Company's stockholders have approved the issuance of sufficient shares of common stock under the Company's 2004 Equity Incentive Plan, as amended, or any successor thereto, to settle awards under the Plan in common stock, and (ii) the fifth anniversary of the grant date, subject to such grantee's continued employment with the Company and achievement of the Company and other goals. During the first quarter of 2012, an additional 437,950 phantom shares were granted under the plan with the same terms as the 2011 grants with a total grant date fair value of approximately $0.9 million.
We have determined these grants should be treated as liability awards rather than equity awards in accordance with ASC 718 "Compensation - Stock Compensation", and as such, the obligation is reflected in the accounts payable and other liabilities caption on our consolidated balance sheet.
The fair value of the phantom share grants is estimated by a third-party valuation consultant. Holders of phantom shares do not have voting rights. We reassess the fair value at the end of each quarter. The weighted average grant date fair value of the 2011 and 2012 phantom share grants were approximately $3.05 and $4.32 respectively.
There were no vested, forfeited or expired grants during the year ended December 31, 2012. As of December 31, 2012, there was $2.0 million of unrecognized compensation expense related to phantom shares. The unrecognized compensation expense is expected to be recognized over a weighted average period of 2.3 years.
We recognized non-cash compensation expense and the related income tax benefit for phantom shares for the years ended December 31, 2012, 2011 and 2010 as follows (in thousands). For the years ended December 31, 2012, 2011, and 2010, a full valuation allowance was recorded against the applicable income tax benefit.
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
Noncontrolling Interests
FASB ASC 810-10 “Consolidation”, provides that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. FASB ASC 810-10 also requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the noncontrolling interest and requires disclosure, on the face of the consolidated statement of income, of the amounts of consolidated net income attributable to the parent and to the noncontrolling interest. In addition, FASB ASC 810-10 establishes a single method of accounting for changes in a parent’s ownership interest in a subsidiary that does not result in deconsolidation and requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated. As a result of the issuance of FASB ASC 810-10, the guidance in FASB ASC 480-10, “Classification and Measurement of Redeemable Securities”, was amended to include redeemable noncontrolling interests within its scope. If noncontrolling interests are determined to be redeemable, they are to be carried at their redemption value as of the balance sheet date and reported as temporary equity.
Noncontrolling Interests - Unitholders in the Operating Partnership
Noncontrolling interests - Unitholders in the Operating Partnership on our consolidated balance sheets relate solely to the partnership and incentive units in the Operating Partnership that are not owned by the Company. In conjunction with the formation of the Company, certain persons and entities contributing interests in properties to the Operating Partnership received Operating Partnership units. In addition, certain employees of the Operating Partnership have received incentive units in connection with services rendered or to be rendered to the Operating Partnership. Limited partners who have been issued incentive units have the right to require the Operating Partnership to redeem part or all of their incentive units upon vesting of the incentive units, if applicable. The Company may elect to acquire those incentive units in exchange for shares of the Company’s common stock on a one-for-one basis, subject to adjustment in the event of stock splits, stock dividends, issuance of stock rights, specified extraordinary distributions and similar events, or pay cash based upon the fair market value of an equivalent number of shares of the Company’s common stock at the time of redemption.
In accordance with FASB ASC 810-10, the Company has determined the Operating Partnership units should be classified as noncontrolling interests within the permanent equity section in the accompanying consolidated balance sheets. The Company periodically evaluates individual noncontrolling interests for the ability to continue to recognize the noncontrolling interest as permanent equity. Any noncontrolling interest that fails to qualify as permanent equity will be reclassified as temporary equity and adjusted to the greater of (a) the carrying amount, or (b) its redemption value as of the end of the period in which the determination is made.
The redemption value of the 224,100 outstanding and not yet redeemed incentive units at December 31, 2012 was approximately $1.2 million based on the closing price of the Company’s common stock of $5.41 per share as of December 31, 2012.
Noncontrolling Interests - Partners in Consolidated Real Estate Entities
Noncontrolling interest - Partners in Consolidated Real Estate Entities represents the proportionate share of equity in the partnerships and limited liability companies listed below held by non-affiliated partners. Capital contributions, distributions, and profits and losses of the real estate entities are allocated in accordance with the terms of the applicable partnership and limited liability company agreements. Such allocations may differ from the stated ownership percentage interests in such entities as a result of preferred returns and allocation formulas as described in the partnership and limited liability company agreements. Following are the stated ownership percentages of the unaffiliated partners in these consolidated entities, prior to any preferred or special allocations, as of December 31, 2012.
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
7.
Related Party Transactions
We provide certain property management, leasing, development and investment advisory services in connection with service agreements with certain of our consolidated subsidiaries and unconsolidated entities. The following is a summary of fee revenue and expenses related to these services for the years ended December 31, 2012, 2011 and 2010 (in thousands):
Reconciliation of total fees to consolidated statement of operations:
Total fees as presented in the consolidated statement of operations:
8.
Income Taxes
All operations are carried on through the Operating Partnership and its subsidiaries which are pass-through entities that are generally not subject to federal or state income taxation, as all of the taxable income, gains, losses, deductions, and credits are passed through to its partners. However, the Operating Partnership and some of its subsidiaries are subject to income taxes in Texas. We are responsible for our share of taxable income or loss of the Operating Partnership allocated to us in accordance with the Operating Partnership’s Agreement of Limited Partnership. As of December 31, 2012, 2011 and 2010, we held a respective 78.7%, 74.7% and 74.7% capital interest in the Operating Partnership. For the years ended December 31, 2012, 2011 and 2010, we were allocated 77.0% , 74.7%, and 70.9%, respectively, of the weighted average income and losses from the Operating Partnership.
Our effective tax rate is 1.1%, 26.4% and 2.2%, respectively, for the years ended December 31, 2012, 2011 and 2010. The resulting tax rate is primarily due to income attributable to the noncontrolling interests as a result of our adoption of FASB ASC 810, reversal of accrued interest relating to unrecognized tax benefits for which the statute of limitations period has lapsed, and change in the valuation allowance primarily related to income (loss) from the Company's interest in the Operating Partnership.
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
The provision for income taxes is based on reported income before income taxes. Deferred income tax assets and liabilities reflect the impact of temporary differences between the amounts of assets and liabilities recognized for financial reporting purposes and the amount recognized for tax purposes, as measured by applying the currently enacted tax laws.
The benefit (provision) for income taxes consists of the following for the years ended December 31, 2012, 2011 and 2010 (in thousands):
A reconciliation of the benefit (provision) for income taxes with amounts determined by applying the statutory U.S. federal income tax rate to income (loss) before income taxes for the years ended December 31, 2012, 2011 and 2010 are as follows (in thousands):
The significant components of the net deferred tax (asset), which is included in "other assets" on the Company's balance sheet, as of December 31, 2012 and 2011 are as follows (in thousands):
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
FASB ASC 740-10-30-17 “Accounting for Income Taxes,” requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some or all of the deferred tax asset will not be realized. Future realization of the deferred tax asset is dependent on the reversal of existing taxable temporary differences, carryback potential, tax-planning strategies and on us generating sufficient taxable income in future years. As of December 31, 2012, a valuation allowance of approximately $17.7 million had been established against the net deferred income tax assets to an amount that will more likely than not be realized. During 2012, the valuation allowance increased by $8.1 million, resulting from an increase in the net deferred tax assets primarily related to income (loss) from the Company's interest in the Operating Partnership. Accordingly, the net deferred tax asset of $8.0 million and $13.7 million, for the years ended December 31, 2012 and 2011 respectively, relates to the Company's uncertain tax positions.
FASB ASC 740-10-25 clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements. The interpretation prescribes a recognition threshold and measurement attribute criteria for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.
As of December 31, 2012, 2011 and 2010, the Company has recorded unrecognized tax benefits of approximately $8.0 million, $13.7 million, and $13.4 million, respectively, and if recognized, would not affect our effective tax rate. The Company’s policy is to recognize interest and penalties related to unrecognized tax benefits as a component of income tax expense. For the years ended December 31, 2012, 2011 and 2010, we recorded $(0.3) million, $(0.7) million, and $(1.1) million, respectively, of interest related to unrecognized tax benefits as a component of income tax expense. Additionally, for the years ended December 31, 2012, 2011 and 2010, we recorded a reversal of accrued interest relating to unrecognized tax benefits for which the statute of limitations period has lapsed in the amount of $0.3 million, $0.8 million, and $1.7 million, respectively, which is recorded as a reduction of income tax expense. As of December 31, 2012, 2011 and 2010, the Company has recorded $0, $0.3 million, and $1.0 million, respectively, of accrued interest with respect to unrecognized tax benefits. We have not recorded any penalties with respect to unrecognized tax benefits.
A reconciliation of the Company’s unrecognized tax benefits as of December 31, 2012, 2011 and 2010 are as follows (in thousands):
We do not anticipate any significant increases or decreases to the amounts of unrecognized tax benefits and related accrued interest within the next twelve months.
In 2007, an ownership change pursuant to Internal Revenue Code Section 382 (“Section 382”) occurred. The Company's federal and state net operating loss carryforwards in existence at that time were subject to a gross annual limitation of $9.9 million. Net operating loss carryforwards generated subsequent to the 2007 deemed ownership change were not subject to the Section 382 limitation. On June 12, 2012, as a result of the acquisition of 8,695,653 shares of common stock by affiliates of Madison International Realty, the Company believes a second change in ownership pursuant to Section 382 occurred. Accordingly, as of June 12, 2012, the Company’s federal and state net operating loss carryforwards and, potentially, certain post June 12, 2012 deductions and losses (to the extent such losses are considered recognized built-in losses and to the extent of the company’s net unrealized built-in loss (if any) under Section 382) are subject to an annual Section 382 limitation of approximately $5.7 million. As the new annual limitation is less than the previous $9.9 million annual limitation imposed on 2007 and prior net operating losses, the new annual limitation of $5.7 million is now applied against all federal and state net operating loss carryforwards in existence as of June 12, 2012. Net operating losses generated after June 12, 2012 are generally not subject to the Section 382 limitation. As of the year ended December 31, 2012, the Company anticipates having net operating loss carryforwards of $54.0 million for federal purposes and $48.0 million for state purposes. The Company’s net operating loss carryforwards are subject to varying expirations from 2020 through 2032.
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
The Company files U.S. federal income tax returns and returns in various state jurisdictions. For federal and state purposes, the years ended December 31, 2009 through 2012 remain subject to examination by the respective tax jurisdictions.
9.
Fair Value of Financial Instruments
Our estimates of the fair value of financial instruments as of December 31, 2012 were determined using available market information and appropriate valuation methods. Considerable judgment is necessary to interpret market data and develop estimated fair value. The use of different market assumptions or estimation methods may have a material effect on the estimated fair value amounts. A fair value measurement is based on the assumptions that market participants would use in pricing an asset or liability. The hierarchy consists of three broad levels as follows:
1.Level 1 Inputs - Quoted prices in active markets for identical assets or liabilities
2.
Level 2 Inputs - Significant other observable inputs (can include quoted prices for similar assets or liabilities in active markets, as well as inputs that are observable for the asset or liability, such as discounts and borrowing rates with similar terms and maturities)
3.
Level 3 Inputs - Significant unobservable inputs (based on an entity's own assumptions, since there is little, if any, related market activity)
The carrying amounts for cash and cash equivalents, restricted cash, rent and other receivables, accounts payable and other liabilities approximate fair value due to the short-term nature of these instruments.
The Company uses a discounted cash flow analysis to estimate the fair value of our mortgage loans. The inputs used in preparing the discounted cash flows include actual maturity dates and scheduled interest and principal payments as well as estimates for market loan-to-value ratios and discount rates. The discount rate, which is the most significant input, is estimated based on our knowledge of the market including discussions with market participants. As this input has more attributes of a Level 3 input than a Level 2 input, we classify it as such.
As of December 31, 2012 and December 31, 2011, the book and fair values of our mortgage loans were as follows (in thousands):
10.
Minimum Future Lease Rentals
We have entered into various lease agreements with tenants as of December 31, 2012. The minimum future cash rents receivable under non-cancelable operating leases in each of the next five years and thereafter are as follows (in thousands):
The leases generally also require reimbursement of the tenant’s proportional share of common area, real estate taxes and other operating expenses, which are not included in the amounts above.
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
11.
Revenue Concentrations
Rental revenue concentrations
For the year ended December 31, 2012, rental revenue from three tenants represented approximately 13.0%, 14.0%, and 10.0%, respectively, of the Company's total rental revenues and tenant reimbursements (excluding tenant reimbursements for over-standard usage of certain operating expenses). The leases expire in 2015, 2020, and 2022, respectively. For the year ended December 31, 2011, rental revenue and tenant reimbursements from two tenants represented approximately 14.9% and 13.7%, respectively, of the Company's rental revenues and tenant reimbursements (excluding tenant reimbursements for over-standard usage of certain operating expenses). The leases expire in 2020 and 2015, respectively. For year ended December 31, 2010, rental revenue and tenant reimbursements from two tenants represented approximately 16.4% and 14.0%, respectively, of the Company's rental revenues and tenant reimbursements (excluding tenant reimbursements for over-standard usage of certain operating expenses). The leases expire in 2020 and 2015, respectively.
Concentrations related to investment advisory, property management, leasing and development services revenue
Under agreements with CalSTRS, we provide property acquisition, investment advisory, property management, leasing and development services for CalSTRS under a separate account relationship and through a joint venture relationship. At both December 31, 2012 and 2011, there were two office properties subject to the separate account relationship. At December 31, 2012 and 2011, there were 14 and 17 office properties, respectively, subject to the joint venture relationship. We asset manage all of these properties.
Under the separate account relationship, we earn acquisition fees over the first three years after a property is acquired, if the property meets or exceeds the pro forma operating results that were submitted at the time of acquisition and a performance index associated with the region in which the property is located. The two properties under the separate account relationship are no longer eligible for acquisition fees. Under the TPG/CalSTRS joint venture relationship, we are paid acquisition fees at the time a property is acquired, as a percent of the total acquisition price. We did not earn any acquisition fees during the years ended December 31, 2012, 2011 and 2010.
Under the separate account relationship, we earn asset management fees paid on a quarterly basis, based on the annual net operating income of the properties. Under the joint venture relationship, asset management fees are paid on a monthly basis, initially based upon a percentage of a property’s annual appraised value for properties that are unstabilized at the time of acquisition. At the point of stabilization of the property, asset management fees are calculated based on net operating income.
We perform property management and leasing services for two separate account properties and six joint venture properties under agreements between TPG and CalSTRS. We are entitled to property management fees ranging from 2% to 3% of the gross revenues of the particular property, paid on a monthly basis. In addition, we are reimbursed for compensation paid to certain of our employees and direct out-of-pocket expenses. The management and leasing agreements expire on the third anniversary of each property’s acquisition. The agreements are automatically renewed for successive periods of one year each, unless we elect not to renew the agreements.
For properties in which we are responsible for the leasing and development services, we are entitled to receive market leasing commissions and development fees as defined in the agreements with CalSTRS.
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
For the years ended December 31, 2012, 2011 and 2010, we earned fees under agreements with CalSTRS as follows, which are shown net of elimination for our ownership share (in thousands):
___________________
(1) These reimbursements represent primarily the cost of on-site property management personnel incurred on behalf of the managed properties.
Under the separate account relationship, we receive incentive compensation based upon performance above a minimum hurdle rate, at which time we begin to participate in cash flow from the relevant property. Incentive compensation is paid at the time an investment is sold. In connection with the ten year anniversary of our separate account relationship with CalSTRS and the final performance accounting for Valencia Town Center, Reflections I and Reflections II, we were paid an incentive fee by CalSTRS of $4.4 million in 2011. No incentive compensation was earned during the years ended ended December 31, 2012 and 2010.
Under the joint venture relationship, incentive compensation is based on a minimum return on investment to CalSTRS, following which we participate in cash flow above the stated return, subject to a clawback provision if returns for a property fall below the stated return. We did not earn any incentive compensation under the joint venture agreement during the years ended December 31, 2012, 2011 and 2010.
At December 31, 2012 and 2011, we had accounts receivable, including amounts generated under the above agreements, of $2.7 million and $3.0 million, respectively, including receivables of $1.7 million and $0.5 million related to TPG/CalSTRS and the TPG/CalSTRS Austin, LLC, respectively for 2012 and $2.0 million due from TPG/CalSTRS in 2011.
12.
Commitments and Contingencies
Pending Litigation
In June 2012, the Company commenced litigation contesting a consultant's claim of approximately $5.1 million for incentive compensation pursuant to a consulting agreement. At the same time, the consultant commenced an action against the Company for breach of contract due to the Company's failure to pay the consultant's invoice. The Company intends to vigorously defend against the consultant's claim. Management believes that any liability that may potentially result upon resolution of this matter will not have a material adverse effect on our business or financial condition but may have a material adverse effect on our results of operations.
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
General
We have been named as a defendant in a number of premises liability claims in the ordinary course of business. We believe that the ultimate resolution of these claims will not have a material adverse effect on our financial position and results of operations.
We sponsor a 401(k) plan for our employees. Our contributions were $55,000, $47,000 and $40,000 for the years ended December 31, 2012, 2011 and 2010, respectively.
We are a tenant in City National Plaza through May 2014 and in One Commerce Square through February 2016. For the years ended December 31, 2012, 2011 and 2010, we incurred rent expense of $0.5 million, $0.5 million and $0.5 million, respectively, to City National Plaza. The rent expense related to One Commerce Square is eliminated in consolidation. The minimum future rents payable as of December 31, 2012 are $0.7 million under the City National Plaza lease.
In connection with the ownership, operation and management of the real estate properties, we may be potentially liable for costs and damages related to environmental matters. We have not been notified by any governmental authority of any non-compliance, liability or other claim in connection with any of the properties, and we are not aware of any other existing environmental condition with respect to any of the properties that management believes will have a material adverse effect on our assets or results of operations.
A mortgage loan secured by a first trust deed on 2121 Market Street is guaranteed by our Operating Partnership, up to a maximum amount of $14.0 million expiring in December 2022. 2121 Market Street is an unconsolidated real estate entity in which we have a 1.0% limited partnership interest. See Note 4 for disclosure of guarantees related to our consolidated debt.
In connection with our Campus El Segundo mortgage loan (see Note 4), we have guaranteed and promised to pay the principal, interest and any other sum payable under the loan in the event the borrower, a wholly-owned entity of our Operating Partnership, does not do so.
In connection with our Murano construction loan (see Note 4), TPG gave the lender a limited guaranty which (i) guarantees repayment of the loan in the event of certain bankruptcy events affecting the borrower, (ii) guarantees payment of the lender's damages from customary “bad boy” actions of the borrower or TPG (such as fraud, physical waste of the property, misappropriation of funds and similar bad acts); and (iii) guarantees payment of the amount, if any, by which the loan balance at the time exceeds 80% of the bulk sale value of the collateral upon an acceleration of the loan triggered by a borrower default.
In connection with our Four Points Centre construction loan (see Note 4), we have guaranteed in favor of and promised to pay to the lender 46.5% of the principal, interest and any other sum payable under the loan in the event the borrower, a wholly-owned entity of our Operating Partnership, does not do so. At December 31, 2012, the outstanding balance was $26.5 million, which results in a maximum guarantee amount based on 46.5% of $12.3 million. Upon the occurrence of certain events, as defined in the repayment and completion guaranty agreement, our maximum liability as guarantor will be reduced to 31.5% of all sums payable under the loan, and upon the occurrence of even further events, as defined, our maximum liability as guarantor will be reduced to 25.0% of all sums payable under the loan. Furthermore, we agreed to guarantee the completion of the construction improvements including tenant improvements, as defined in the agreement, in the event of any default of the borrower. The borrower has completed the core and shell construction. If the borrower fails to complete the remaining required work, the guarantor agrees to perform timely all of the completion obligations, as defined in the agreement.
Insurance
We maintain general liability insurance with limits of $200 million per occurrence and all risk property and rental value insurance with limits of $1.25 billion per occurrence (except for a limit of $600 million per occurrence for one particular asset grouping), with terrorism limits of $1.15 billion per occurrence (except for a limit of $600 million per occurrence for one particular asset grouping), and flood insurance with a limit of $200 million per occurrence. Our California properties have earthquake insurance with coverage of $200 million per occurrence, subject to a deductible in the amount of 5% of the value of the affected property.
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
13.
Subsequent Events
In January and March 2013, TPG completed the sale of certain land parcels totaling 17.5 acres and 27.9 acres, respectively, at Four Points Centre in Austin, Texas, for $4.9 million and $6.4 million, respectively. TPG received net proceeds from these two transactions of $1.1 million (after a $3.7 million paydown of the Four Points Centre mortgage debt) and $2.7 million (after a $3.1 million pay down of the loan), respectively.
On March 8, 2013, we entered into a loan agreement with a lender for a new mortgage on Two Commerce Square in the amount of $112.0 million. The loan, which has a fixed interest rate of 3.96% for a ten year term, funded on March 8, 2013. The loan replaced the existing mortgage on the property that had an outstanding balance of $106.6 million as of December 31, 2012, and a maturity date of May 9, 2013, and was open to prepayment without penalty on and after March 8, 2013.
THOMAS PROPERTIES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL INFORMATION-(Continued)
14.
Quarterly Financial Information-Unaudited
The tables below reflect the selected quarterly information for us for the years ended December 31, 2012 and 2011. Certain prior year amounts have been reclassified to conform to the current year presentation (in thousands, except for share and per share amounts).
SCHEDULE III-INVESTMENTS IN REAL ESTATE
(In thousands)
_________________________
(1)
Included in the total are write-offs for fully depreciated tenant improvements.
(2)
The depreciable life for buildings ranges from 40 to 50 years, 5 to 40 years for building improvements, and the shorter of the useful lives or the terms of the related leases for tenant improvements.
(3)
Four Points Centre consists of developable land as well as two office buildings, which were completed in 2008.
The aggregate gross cost of our investments in real estate for federal income tax purposes approximated $419.9 million as of December 31, 2012 (unaudited).
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Dated: March 11, 2013
THOMAS PROPERTIES GROUP, INC.
By:
/s/ James A. Thomas
James A. Thomas
Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each individual whose signature appears below constitutes and appoints James A. Thomas and Diana M. Laing, his or her true and lawful attorneys-in-fact each acting alone, with full power of substitution and re-substitution, for him or her and in his or her name, place and stead in any and all capacities to sign any or all amendments to this report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact, or their substitutes, each acting alone, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities indicated below.