10-K 1 fpo201410-k.htm 10-K FPO 2014 10-K
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
 
FORM 10-K
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2014
Commission File Number 1-31824
 
 
FIRST POTOMAC REALTY TRUST
(Exact name of registrant as specified in its charter)
 
MARYLAND
 
37-1470730
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
7600 Wisconsin Avenue, 11th Floor, Bethesda, MD
(Address of principal executive offices)
20814
(Zip Code)
(301) 986-9200
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
 
Name of Each Exchange upon Which Registered
Common Shares of beneficial interest, $0.001 par value per share
 
New York Stock Exchange
7.750% Series A Cumulative Redeemable Perpetual Preferred shares of beneficial interest, $0.001 par value per share
 
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
 
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of Securities Act.    YES  x    NO  ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    YES  ¨    NO  x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO  ¨
Indicated by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulations S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company (see the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act).
Large Accelerated Filer
x
Accelerated Filer
¨
 
 
 
 
Non-Accelerated Filer
¨
Smaller Reporting Company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2 of the Act)    YES  ¨    NO  x
The aggregate fair value of the registrant’s common shares of beneficial interest, $0.001 par value per share, at June 30, 2014, held by those persons deemed by the registrant to be non-affiliates was $756,133,139.
As of February 17, 2015, there were 58,798,488 common shares of beneficial interest, par value $0.001 per share, outstanding.
Documents Incorporated By Reference
Portions of the Company’s definitive proxy statement relating to the 2015 Annual Meeting of Shareholders, to be filed with the Securities and Exchange Commission, are incorporated by reference in Part III, Items 10-14 of this Annual Report on Form 10-K as indicated herein.
 

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FIRST POTOMAC REALTY TRUST
FORM 10-K
INDEX
 
Part I
 
Page
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
 
 
Part II
 
 
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
 
 
 
Part III
 
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
 
 
Part IV
 
 
Item 15.
 
 
 
 

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SPECIAL NOTE ABOUT FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements, including statements regarding potential sales and the timing of such sales, and future acquisition and growth opportunities, within the meaning of the federal securities laws. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Company, are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project” or similar expressions. The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Certain factors that could cause actual results to differ materially from the Company’s expectations include changes in general or regional economic conditions; the Company’s ability to timely lease or re-lease space at current or anticipated rents; changes in interest rates; changes in operating costs; the Company’s ability to complete acquisitions on acceptable terms; the Company’s ability to manage its current debt levels and repay or refinance its indebtedness upon maturity or other required payment dates; the Company’s ability to maintain financial covenant compliance under its debt agreements; the Company’s ability to maintain effective internal controls over financial reporting and disclosure controls and procedures; any impact of the informal inquiry initiated by the U.S. Securities and Exchange Commission (the “SEC”); the Company’s ability to obtain debt and/or financing on attractive terms, or at all; and other risks detailed under “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K and in the other documents the Company files with the SEC. Many of these factors are beyond the Company’s ability to control or predict. Forward-looking statements are not guarantees of performance. For forward-looking statements herein, the Company claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. The Company assumes no obligation to update or supplement forward-looking statements that become untrue because of subsequent events. We have no duty to, and do not intend to, update or revise the forward-looking statements in this discussion after the date hereof, except as may be required by law. In light of these risks and uncertainties, you should keep in mind that any forward-looking statement made in this discussion, or elsewhere, might not occur.
 

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References in this Annual Report on Form 10-K to “we,” "us," “our,” the “Company” or “First Potomac,” refer to First Potomac Realty Trust and its subsidiaries, on a consolidated basis, unless the context indicates otherwise.

PART I

ITEM 1.
BUSINESS

Overview

We are a leader in the ownership, management, development and redevelopment of office and business park properties in the greater Washington, D.C. region. We strategically focus on acquiring and redeveloping properties that we believe can benefit from our intensive property management, leasing expertise, market knowledge and established relationships, and seek to reposition these properties to increase their profitability and value. Our portfolio primarily contains a mix of single-tenant and multi-tenant office properties and business parks. Office properties are single-story and multi-story buildings that are primarily for office use; and business parks contain buildings with office features combined with some industrial property space. We separate our properties into four distinct reporting segments, which we refer to as the Washington, D.C., Maryland, Northern Virginia and Southern Virginia reporting segments.

We conduct our business through First Potomac Realty Investment Limited Partnership, our operating partnership (the “Operating Partnership”). We are the sole general partner of, and, as of December 31, 2014, owned 100% of the preferred interest and 95.7% of the common interest in the Operating Partnership. The remaining common interests in the Operating Partnership, which are presented as noncontrolling interests in the Operating Partnership in the accompanying consolidated financial statements, are limited partnership interests, some of which are owned by two of our executive officers who contributed properties and other assets to us upon our formation, and the remainder of which are owned by other unrelated parties.

At December 31, 2014, we wholly owned or had a controlling interest in properties totaling 8.8 million square feet and had a noncontrolling ownership interest in properties totaling an additional 0.9 million square feet through five unconsolidated joint ventures. We also owned land that can support 1.4 million square feet of additional development. Our consolidated properties were 87.9% occupied by 582 tenants at December 31, 2014. We did not include square footage that was in development or redevelopment, which totaled 0.2 million square feet at December 31, 2014, in our occupancy calculation. We derive substantially all of our revenue from leases of space within our properties.

For the year ended December 31, 2014, we had consolidated total revenues of $161.7 million and consolidated total assets of $1.6 billion. Financial information related to our four reporting segments is set forth in note 18, Segment Information, to our consolidated financial statements.

Our corporate headquarters are located at 7600 Wisconsin Avenue, 11th Floor, Bethesda, Maryland 20814, and believe our current space is sufficient to meet our current needs. We do not own the building in which we lease space for our corporate headquarters. As of December 31, 2014, we had five other offices for our property management operations, which occupy approximately 28,000 square feet within buildings we own.

Our History

The Operating Partnership was formed in December 1997 by Louis T. Donatelli, our former Chairman, Douglas J. Donatelli, our current Chairman and Chief Executive Officer, and Nicholas R. Smith, our Executive Vice President and Chief Investment Officer, to focus on the acquisition, redevelopment and development of industrial properties and business parks, primarily in the suburban markets of the greater Washington, D.C. region. The Company was formed as a Maryland trust in July 2003 and completed its initial public offering (“IPO”) in October 2003, raising net proceeds of approximately $118 million. At December 31, 2003, we owned 17 properties totaling approximately 2.9 million square feet and had revenues of $18.4 million and total assets of $244.1 million. Through our business strategy and operating model, by December 31, 2006, we had almost quadrupled the square footage we owned and had more than quadrupled our revenues and total assets. During 2007 and 2008, our management team chose not to expand our portfolio given the increase in asset prices. We therefore focused on maximizing the value of our assets under management and maintaining a flexible balance sheet. In 2009, we began seeing attractive acquisition opportunities and determined that it was the appropriate time to begin growing our portfolio again, expanding our platform to include more multi-story office properties. In 2010, we entered the office market in Washington, D.C., with the acquisition of four properties, including one property purchased through an unconsolidated joint venture. In 2011, we continued to acquire office buildings in Washington, D.C. with the acquisition of three properties, including one through a consolidated joint venture and one through an unconsolidated joint venture. In 2012, our management team did not pursue any acquisitions in order to focus on maximizing the value of our

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assets under management, increasing liquidity and deleveraging. In 2013, we made substantial progress executing on our previously disclosed strategic and capital plan, which included completing the sale of the majority of our industrial portfolio, acquiring a high-quality office property in Maryland, implementing targeted portfolio management initiatives, increasing liquidity and balance sheet flexibility, reducing leverage and reducing our quarterly dividend. In 2014, we acquired two office buildings in Washington, D.C. and one office building in Northern Virginia, and continued to execute on our previously disclosed capital recycling strategy by selling six properties and actively marketed our Richmond, Virginia portfolio for sale.

Narrative Description of Business

We have used our management team’s knowledge of and experience in the greater Washington, D.C. region to transform our Company into a leading owner of office and business park properties in the region. We believe that we are well positioned for growth given our reputation in the region and access to capital, together with the large number of properties that we believe meet our investment criteria.

Our acquisition strategy focuses on properties in our target markets that generally meet the following investment criteria:
 
•
established or emerging locations;
•
potential for conversion, in whole or in part, to a higher use:
•
amenity rich and transportation friendly; and/or
•
below-market rents.

We use our contacts, relationships and local market knowledge to identify and opportunistically acquire office buildings and business park properties. We also believe that our reputation for professional property management and our transparency as a public company allow us to attract high-quality tenants to the properties that we acquire, leading, in some cases, to increased profitability and value for our properties. We also target properties that we believe can be converted, in whole or in part, to a higher use.

Significant 2014 Activity
 
•
Executed 1.6 million square feet of leases, including 0.8 million square feet of new leases;
•
Increased leased percentages year-over-year from 88.1% to 91.3% and occupied percentages from 85.8% to 87.9%;
•
Acquired three office buildings, which totaled 401,000 square feet, for an aggregate purchase price of $188.0 million; and
•
Sold six properties, which totaled 811,000 square feet, for aggregate net proceeds of $97.7 million.


Our total assets were $1.6 billion at December 31, 2014 compared with $1.5 billion at December 31, 2013.


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Competitive Advantages

We believe that our business strategy and operating model distinguish us from other owners, operators and acquirers of rental property in a number of ways, which include:
 
•
Experienced Management Team. Our executive officers average more than 25 years of real estate experience in the greater Washington, D.C. region.
•
Focused Strategy. We focus primarily on high-quality, multi-story office properties in the greater Washington, D.C. region. We believe that the greater Washington, D.C. region historically has been one of the largest, most stable markets in the U.S. for assets of this type.
•
Value-Added Management Approach. Through our hands-on approach to management, leasing, renovation and repositioning, we endeavor to add significant value to the properties that we acquire by improving tenant quality and increasing occupancy rates and net rent per square foot.
•
Local Market Knowledge. We have established relationships with local real estate owners, the brokerage community, prospective tenants and property managers in our markets. We believe that these relationships enhance our efforts to identify attractive acquisition opportunities and lease space in our properties.
•
Diverse Tenant Mix. We believe our tenant base is highly diverse. Approximately 48.3% of our annualized cash basis rent is generated from our 25 largest tenants, and our largest 100 tenants generate approximately 71% of our annualized cash basis rent. The balance of our tenants, which is comprised of over 500 different companies, generates the remaining 29% of our annualized cash basis rent. We believe that our diversified tenant base, provides a desirable mix of stability, diversity and growth potential.

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Our Markets

We operate, invest in, and develop, office and business park properties in the greater Washington, D.C. region. Within this area, our primary markets are the Washington, D.C. metropolitan statistical area (“MSA”), which includes Washington D.C., Northern Virginia and suburban Maryland, as well as the Richmond and Norfolk MSAs. We derive 72.3% of our annualized cash basis rent from the Washington, D.C. MSA, 21.0% from the Richmond and Norfolk MSAs combined, and the remaining 6.7% of our annualized cash basis rent comes from properties within the Baltimore, Maryland MSA.

According to data from Transwestern, a commercial real estate services provider, the Washington, D.C. MSA contains approximately 421 million square feet of office property, and is the fourth largest office market in the country behind New York, Los Angeles and Chicago. The region also contains approximately 402 million square feet of flex/business park/industrial property, and is the 11th largest market in the nation.

The Washington, D.C. MSA was the fifth largest job market in the United States behind New York, Los Angeles, Chicago, and Dallas. Through November 2014, the D.C. MSA added more than 18,900 jobs, primarily in state and local government, professional & business services, financial services and construction, according to the Transwestern / Delta Associates’ publication “TrendLines 2015, Trends in Washington Commercial Real Estate: The Next Generation of Growth”. The publication also stated that the Washington, D.C. MSA is estimated to add an annual average of 40,700 payroll jobs from 2014 to 2018, with private sector firms leading the way. As of November 2014, the Washington D.C. MSA had an unemployment rate of 4.5%, which is the lowest unemployment rate among the nation’s largest metro areas, according to the Transwestern / Delta Associates’ publication.

Norfolk, Virginia is our second largest market when measured by annualized cash basis rent and square footage. We own approximately 2 million square feet in Norfolk and derive approximately 16.2% of our annualized cash basis rent from the market. Norfolk is home to the largest military installation in the world, according to the United States Navy, and remains heavily invested in the defense and shipping industries. In addition, the Norfolk port is the third largest port on the East Coast of the United States, has the deepest, obstruction-free channels available on the East Coast, and is the only East Coast port with Congressional authorization for 55-foot depth channels, according to the Virginia Port Authority. Occupancy levels have slowly recovered in this market and, in order to improve the attractiveness of the market, developers and Norfolk officials began construction on a convention center, created plans for updated streetscapes, and revealed images for the new Waterside Live redevelopment, according to the fourth quarter 2014 Hampton Roads Report published by JLL.

We own 828,000 square feet in Richmond, Virginia, and derive approximately 5.0% of our annualized cash basis rent from the market. As previously disclosed, consistent with our capital recycling strategy, we are currently in the process of selling our Richmond portfolio, which includes Chesterfield Business Center, Hanover Business Center, Park Central and Virginia Technology Center and in the aggregate is comprised of 19 buildings totaling 828,000 square feet (as well as a three-acre undeveloped land parcel). Specifically, effective as of February 9, 2015, we entered into a binding contract to sell the Richmond portfolio. The sale is expected to be completed in the first half of 2015; however, we can provide no assurances regarding the timing or pricing of the sale, or that such sale will occur at all.

Competition

We compete with other real estate investment trusts (“REITs”), public and private real estate companies, private real estate investors and lenders, both domestic and foreign, in acquiring and developing properties. Many of these entities have greater resources than we do or other competitive advantages. We also face competition in leasing or subleasing available properties to prospective tenants.

We believe that our management’s experience and relationships in, and local knowledge of, the markets in which we operate put us at a competitive advantage when seeking acquisitions. However, many of our competitors have greater resources than we do, or may have a more flexible capital structure when seeking to finance acquisitions. We also face competition in leasing or subleasing available properties to prospective tenants. Some real estate operators may be willing to enter into leases at lower contractual rental rates (particularly if tenants, due to the economy, seek lower rents). However, we believe that our intensive management services are attractive to tenants and serve as a competitive advantage.

Environmental Matters

Under various federal, state and local environmental laws and regulations, a current or previous owner, operator or tenant of rental property may be required to investigate and clean up hazardous or toxic substances or petroleum product releases or threats of releases at such 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 such parties in connection with the actual or threatened contamination.

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Such laws typically impose clean up responsibility and liability without regard to fault, or whether or not the owner, operator or tenant knew of or caused the presence of the contamination. The liability under such laws 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. These costs may be substantial, and can exceed the fair value of the property. The presence of contamination or the failure to properly remediate contamination on such property may adversely affect the ability of the owner, operator or tenant to sell or rent such property or to borrow using such property as collateral, and may adversely impact our investment in a property.

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. Significant fines can be assessed for violation of these regulations. Building owners and those exercising control over a building’s management may be subject to an increased risk of personal injury lawsuits by workers and others exposed to asbestos-containing materials and potentially asbestos-containing materials as a result of the regulations. Federal, state and local environmental laws and regulations also govern the removal, encapsulation, disturbance, handling and/or disposal of asbestos-containing materials. Such laws may impose liability for improper handling or a release to the environment of asbestos-containing materials.

We also may incur liability arising from mold growth in the buildings we own or operate. 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 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 or increase 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 personal injury occurs.

Prior to closing any property acquisition, if appropriate, we obtain such environmental assessments as may be prudent in order to attempt to identify potential environmental concerns at such properties. These assessments are carried out in accordance with an appropriate level of due diligence and generally may include a physical site inspection, a review of relevant federal, state and local environmental and health agency database records, one or more interviews with appropriate site-related personnel, review of the property’s chain of title and review of historic aerial photographs. We may also conduct limited subsurface investigations and test for substances of concern where the results of the first phase of the environmental assessments or other information, indicates possible contamination or where our consultants recommend such procedures.

We believe that our properties are in compliance in all material respects with all federal, state and local environmental laws and regulations regarding hazardous or toxic substances and other environmental matters. We have not been notified by any governmental authority of any material non-compliance, liability or claim relating to hazardous or toxic substances or other environmental matter in connection with any of our properties.

Employees

We had 170 employees as of February 9, 2015. We believe that relations with our employees are good.

Availability of Reports Filed with the Securities and Exchange Commission

A copy of this Annual Report on Form 10-K, as well as our quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are available, free of charge, on our Internet Web site (www.first-potomac.com). All of these reports are made available on our Web site as soon as reasonably practicable after they are electronically filed with or furnished to the Securities and Exchange Commission (the “SEC”). Our Governance Guidelines and Code of Business Conduct and Ethics and the charters of the Audit, Finance and Investment, Compensation, and Nominating and Governance Committees of our Board of Trustees are also available on our Web site at www.first-potomac.com, and are available in print to any shareholder upon written request to First Potomac Realty Trust, c/o Investor Relations, 7600 Wisconsin Avenue, 11th Floor, Bethesda, MD 20814. The information on or accessible through our Web site is not, and shall not be deemed to be, a part of this report or incorporated into any other filing we make with the SEC.

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ITEM 1A. RISK FACTORS

An investment in our common or preferred shares involves various risks, including the risk that an investor might lose its entire investment. The following discussion concerns the material risks associated with our business. These risks are interrelated and should be considered collectively. The risks described below are not the only risks that may affect us. Additional risks and uncertainties not presently known to us or not identified below, may also materially and adversely affect our business, financial condition, results of operations and ability to make distributions to our security holders.

Risks Related to Our Business and Properties

Real estate investments are inherently risky, which could materially adversely affect our results of operations and cash flow.

Real estate investments are subject to varying degrees of risk. If we acquire or develop properties and they do not generate sufficient operating cash flow to meet operating expenses, including debt service, capital expenditures and tenant improvements, our results of operations, cash flow and ability to make distributions to our security holders will be materially adversely affected. Income from properties may be adversely affected by, among other things:

•
downturns in the national, regional and local economic conditions (particularly in the greater Washington, D.C. region, where our properties are located);
•
declines in the financial condition of our tenants (including tenant bankruptcies) and our ability to collect rents from our tenants;
•
decreases in rent and/or occupancy rates due to competition, oversupply, adverse changes to the areas surrounding our properties, or other factors;
•
changes in space utilization by our tenants that may adversely affect future demand due to technology, telecommuting and overall shift in business culture;
•
increases in operating costs such as real estate taxes, insurance premiums, site maintenance (including snow removal costs) and utilities;
•
vacancies and the need to periodically repair, renovate and re-lease space, or other significant capital expenditures;
•
reduced capital investment in or demand for real estate in the future;
•
costs of remediation and liabilities associated with environmental conditions and laws;
•
earthquakes and other natural disasters, civil disturbances, or terrorist acts or acts of war, which may result in uninsured or underinsured losses;
•
decreases in the underlying value of our real estate;
•
changes in interest rates and the availability of financing;
•
inflation; and
•
changes in laws and governmental regulations, including those governing real estate usage, zoning and taxes.

All of our properties are located in the greater Washington D.C. region, making us vulnerable to changes in economic, regulatory or other conditions in that region that could have a material adverse effect on our results of operations.

All of our properties are located in the greater Washington D.C. region, exposing us to greater risks than if we owned properties in multiple geographic regions. Economic conditions in the greater Washington D.C. region may significantly affect the occupancy and rental rates of our properties. A decline in occupancy and rental rates, in turn, may significantly adversely affect our profitability and our ability to satisfy our financial obligations. Further, the economic condition of the region may also depend on one or more industries and, therefore, an economic downturn in one of these industry sectors may adversely affect our results of operations. For example, the U.S. Government, which has a large presence in our markets, accounted for 14% of our total annualized cash basis rent as of December 31, 2014, and the U.S. Government combined with government contractors accounted for 26% of our total annualized cash basis rent as of December 31, 2014. Therefore, we are directly affected by decreases in federal government spending (either directly through the potential loss of a U.S. Government tenant or indirectly if the businesses of tenants that contract with the U.S. Government are negatively impacted). In particular, the office market in the Washington, D.C. metropolitan area has been negatively impacted by uncertainty regarding the potential for significant reductions in spending by the U.S. Government. In addition to actual economic conditions, investor perception of risks associated with real estate in the Washington D.C. metropolitan area as a result of its perceived dependence on the U.S. Government, and the impact of sequestration, may make potential investors less likely to invest in our shares, which could have a material adverse effect on the price of our shares.

We may also be subject to changes in the region’s regulatory environment (such as increases in real estate and other taxes, costs of complying with government regulations or increased regulation and other factors) or other adverse conditions or events (such as natural disasters). Thus, adverse developments and/or conditions in the greater Washington D.C. region could reduce

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demand for space, impact the credit-worthiness of our tenants or force our tenants to curtail operations, which could impair their ability to meet their rent obligations to us and, accordingly, could have a material adverse effect on our results of operations.

A decrease in federal government spending, or the threat thereof, as a result of sequestration cuts or otherwise, could have a material adverse effect on our results of operations and cash flow, and could cause an impairment of the value of some of our properties.

The U.S. Government accounted for 14% of our total annualized cash basis rent as of December 31, 2014, and the U.S. Government combined with government contractors accounted for 26% of our total annualized cash basis rent as of December 31, 2014. A significant reduction in federal government spending could affect the ability of these tenants to fulfill lease obligations or decrease the likelihood that they will renew their leases with us. Further, economic conditions in the greater Washington, D.C. region, particularly the Washington, D.C. and Norfolk, VA metropolitan areas, are significantly dependent upon the level of federal government spending in the region, and uncertainty regarding the potential for future reduction in government spending could also decrease or delay leasing activity from the U.S. Government and government contractors. Moreover, the Budget Control Act, which was passed in 2011 and imposed caps on the federal budget in order to achieve targeted spending levels over the 2013-2021 fiscal years (commonly referred to as “sequestration”), has fueled further uncertainty regarding future government spending reductions. The reductions in U.S. federal government spending imposed by the Budget Control Act went into effect on March 1, 2013, which lead to significant reductions in U.S. federal government spending in 2013, with similar cuts scheduled for years 2014 through 2021. Overall, the sequester imposed by the Budget Control Act lowers spending by a total of approximately $1.1 trillion versus pre-sequester levels over the period from 2013 to 2021. As a result of the scheduled reductions in U.S. federal government spending, there could be negative economic changes in our region, which could adversely impact the ability of our tenants to perform their financial obligations under our leases or decrease the likelihood of their lease renewal. In addition, some of our leases with the U.S. Government are for relatively short terms or provide for early termination rights, including termination for convenience or in the event of a budget shortfall. Further, on July 31, 2003, the United States Department of Defense issued the Unified Facilities Criteria (the “UFC”), which establish minimum antiterrorism standards for the design and construction of new and existing buildings leased by the departments and agencies of the Department of Defense. The loss of the federal government as a tenant resulting from reductions in federal government spending, exercise of the government’s contractual termination rights, our inability to comply with the UFC standards or for any other reason would have a material adverse effect on our results of operations. A reduction or elimination of rent from the U.S. Government or other significant tenants would also materially reduce our cash flow and materially adversely affect our results of operations and ability to make distributions to our security holders.

In addition, a significant economic downturn due to a significant reduction in federal government spending over a period of time could result in an event or change in circumstances that results in an impairment in the value of one or more of our properties.  An impairment loss is recognized if the carrying value of the asset (i) is not recoverable over its expected holding period and (ii) exceeds the estimated fair value of the asset. There can be no assurance that we will not take charges in the future related to the impairment of our assets or investments. Any future impairment could have a material adverse effect on our results of operations in the period in which the charge is taken.

We intend to increase the size of our portfolio through acquisitions and developments, which initially may be dilutive and/or may not produce the returns that we expect, which could materially adversely affect our results of operations and growth prospects.

Our long-term business strategy contemplates expansion through acquisitions and developments, which initially may be dilutive to our net income. In deciding whether to acquire or develop a particular property, we make assumptions regarding the expected future performance of that property. In particular, we estimate the return on our investment based on expected occupancy and rental rates, as well as expected development costs and leasing costs. We have acquired, and in the future may acquire, properties not fully leased, and the cash flow from existing operations of such properties may be insufficient to pay the operating expenses and debt service associated with such properties until they are more fully leased at favorable rental rates. Moreover, operating expenses related to acquired properties may be greater than anticipated, particularly if we provide tenant improvements or other concessions or additional services in order to maintain or attract new tenants. We also may experience unanticipated costs or difficulties integrating newly acquired properties into our existing portfolio or hiring and retaining sufficient operational staff to manage such properties. If our estimated return on investment for the property proves to be inaccurate and the property is unable to achieve the expected occupancy and rental rates, it may fail to perform as we projected in originally analyzing the investment (including, without limitation, as a result of tenant bankruptcies, increased tenant improvements and other concessions, our inability to collect rents and higher than anticipated operating costs), thereby having a material adverse effect on our results of operations. This risk may be particularly pronounced for properties placed into development or acquired shortly before the recent economic downturn, where we estimated occupancy and rental rates without the benefit of knowing how those assumptions might be impacted by the changing economic conditions that followed. For example, 440 First Street, NW, which was 100% vacant at the time of acquisition in the fourth quarter of 2010, was 36.3% occupied and 56.8% leased at December 31, 2014.

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In addition, when we acquire certain properties that are significantly under-leased, we often plan to reposition or redevelop them with the goal of increasing profitability. Our estimate of the costs of repositioning or redeveloping such properties may prove to be inaccurate, which may result in our failure to meet our profitability goals. Moreover, we may be unsuccessful in leasing up such properties after repositioning or redeveloping them and if one or more of these new properties do not perform as expected, our results of operations may be materially adversely affected.

One aspect of our strategic and capital plan includes growing our portfolio of high-quality office properties in the Washington, D.C. metropolitan region, and disposing of those properties that are no longer a strategic fit. If the proceeds of our capital recycling plan are not what we expect, or if we cannot responsibly and timely deploy the proceeds, there could be a material adverse effect on our results of operations and financial condition.

One aspect of our strategic and capital plan includes growing our portfolio of high-quality office properties in the Washington, D.C. metropolitan region, and disposing of those properties that are no longer a strategic fit, properties in submarkets where we do not have asset concentration or operating efficiencies, and/or properties where we believe we cannot further maximize value. We then intend to use the proceeds generated from any potential disposition of those properties to acquire additional high-quality office properties in the Washington, D.C. metropolitan region. We can provide no assurance that we will be able to dispose of properties under our capital recycling plan for the amounts of proceeds we expect, or at all. In addition, if we are able to dispose of those properties, we can provide no assurance that we will be able to use the capital in a timely or more efficient manner. As such, we may not be able to adequately time any decrease in revenues from the sale of properties with a corresponding increase in revenues associated with the acquisition of properties. The failure to dispose of properties under our capital recycling plan, or to timely and more efficiently apply the proceeds from any disposition of properties to attractive acquisition opportunities could have a material adverse effect on our financial condition and results of operations.

Our strategic shift and decision to focus on office properties in the Washington, D.C. metropolitan region, together with our disposition of our industrial portfolio, is subject to a number of risks, including that such disposition reduced the size of our overall portfolio and led to a further concentration of our portfolio in office properties.

Our strategic and capital plan called for the disposition of the majority of our industrial properties in a portfolio sale, and continued focus on office properties in the Washington, D.C. metropolitan region. At that time, the industrial portfolio represented 16% of the total revenues of our portfolio. We consummated the sale of our industrial portfolio in June 2013. As such, the size of our overall portfolio has been significantly reduced, and therefore any adverse developments at any one of our remaining properties may have a greater negative impact on our results of operations. Although we intend to acquire additional office properties in the future, we face significant competition for acquisitions in the office market and we may not be able or have the opportunity to make suitable investments on favorable terms. See “-We compete with other parties for tenants and property acquisitions.” As such, the resulting decrease in our net income attributable to the industrial properties may not be completely offset by income from the reinvestment of disposition proceeds. In addition, a further concentration of our portfolio in office properties exposes us to the risk of a downturn in the office market to a greater extent than if our portfolio remained more diversified in office and industrial properties.

We compete with other parties for tenants and property acquisitions.

Our long-term business strategy contemplates expansion through acquisitions. The commercial real estate industry is highly competitive, and we compete with substantially larger companies, including substantially larger REITs and institutional investment funds, which may have better access to lower cost capital for the acquisition, development and leasing of properties. As a result, we may not be able or have the opportunity to make suitable investments on favorable terms in the future, which may impede our growth and have a material adverse effect on our results of operations. In addition, competition for acquisitions may significantly increase the purchase price and/or require us to, among other things, make concessions to sellers and/or agree to higher non-refundable deposits, which could require us to agree to acquisition terms less favorable to us.


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We also face significant competition for tenants in our properties from owners and operators of business park and office properties that may be more willing to make space available to prospective tenants at lower prices and with greater tenant improvements and other concessions than comparable spaces in our properties, especially in difficult economic times. Thus, competition could negatively affect our ability to attract and retain tenants and may reduce the rents we are able to charge and increase the tenant improvements and other concessions that we offer, which could materially and adversely affect our results of operations.

Acquired properties may expose us to unknown liabilities.

We may acquire properties subject to liabilities and without any recourse, or with only limited recourse, against the prior owners or other third parties with respect to unknown liabilities. As a result, if a liability were asserted against us based upon ownership of those properties, we might have to pay substantial sums to settle or contest it, which could adversely affect our results of operations and cash flow. Unknown liabilities with respect to acquired properties might include:

•
liabilities for clean-up of undisclosed or undiscovered environmental contamination
•
claims by tenants, vendors or other persons against the former owners of the properties;
•
liabilities incurred in the ordinary course of business; and
•
claims for indemnification by general partners, directors, officers and others indemnified by the former owners of the properties.

We may not be able to access adequate cash to fund our business or growth strategy, which could have a material adverse effect on our results of operations, financial condition and cash flow.

Our business requires access to adequate cash to finance our operations, distributions, capital expenditures, debt service obligations, development and redevelopment costs and property acquisition costs, if any, and to refinance or repay maturing debt.  We may not be able to generate sufficient cash to fund our business, particularly if we are unable to renew leases, lease vacant space or re-lease space as leases expire according to expectations. This risk may be even more pronounced given the ongoing challenges and uncertainties in the current economic environment.

Moreover, we rely on third-party sources to fund our capital needs. We may not be able to obtain the financing on favorable terms, in the time period we desire, or at all. Our access to third-party sources of capital depends, in part, on:
 
•
general market conditions;
•
the market's view of the quality of our assets;
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the market's perception of our growth potential;
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our current debt levels;
•
our current and expected future earnings
•
our cash flow and cash distributions; and
•
the market price of our common shares.

If we cannot obtain capital from third-party sources, we may not be able to acquire or develop properties when strategic opportunities exist, satisfy our principal and interest obligations or make distributions to our shareholders.

In addition, our access to funds under our revolving credit facility depends on the ability of the lenders that are parties to such facility to meet their funding commitment to us. If our lenders are not able to meet their funding commitment to us, our business, results of operations, cash flow and financial condition could be materially adversely affected.

Our Storey Park redevelopment project is subject to a number of risks, including those related to financing, leasing, development and construction. In addition, if we are not successful in finding an additional capital partner for the redevelopment of Storey Park, we will be carrying a significant investment in a non-income producing property, which could adversely affect our financial condition and cash flow.

The Greyhound lease at Storey Park terminated in August 2013 and we placed the property into development. Although we are exploring options related to this site, including bringing in an additional capital partner, we can provide no assurance that we will be successful in finding an additional capital partner for the redevelopment project. Additionally, we may be unable to engage an additional joint venture capital partner for the redevelopment of Storey Park without the consent of our current joint venture partner for that property. If we are unable to find an additional capital partner, but we find a key tenant willing to commit to the property, we may consider undertaking the redevelopment project without an additional capital partner. Regardless of whether we find an additional capital partner, we may be unable to obtain financing on acceptable terms, or at all, the key tenant may fail to

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complete its obligations to us, or we may be unable to successfully redevelop the property within the time or cost we expect. Each of these risks, if realized, could adversely affect our financial condition and, in the event we elect to undertake the redevelopment project without an additional capital partner, we would bear the substantial majority (97%) of these risks and related costs.

In addition, the Storey Park development project is a “mixed-use” development, which means that, in addition to the development of office space, the project also includes space for residential, retail and other commercial purposes. We have limited experience in developing and managing residential real estate. As a result, we may seek to sell the rights to that component to a third-party developer with experience in that use or we may seek to partner with such a developer. If we do not sell the rights or partner with such a developer, or if we choose to develop the other component ourselves, we would be exposed not only to those risks typically associated with the development of commercial real estate generally, but also to specific risks associated with the development and ownership of residential real estate. In addition, even if we sell the rights to develop the other component or elect to participate in the development through a new joint venture, we may be exposed to the risks associated with the failure of the other party to complete the development as expected. These include the risk that the other party would default on its obligations necessitating that we complete the other component ourselves (including providing any necessary financing). In the case of residential properties, these risks include competition for prospective residents from other operators whose properties may be perceived to offer a better location or better amenities or whose rent may be perceived as a better value given the quality, location and amenities that the resident seeks.

Further, until we find an additional capital partner for the project, Storey Park is a sizable non-income producing property and we are required to cover interest payments on the debt secured by the property and other costs related to owning the property from other sources, which could have an adverse effect on our financial condition and cash flow.

Development and construction risks could materially adversely affect our results of operations and growth prospects.

Our renovation, redevelopment, development and related construction activities may subject us to the following risks:

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we may be unable to obtain, or suffer delays in obtaining, necessary zoning, land-use, building, occupancy and other required governmental permits and authorizations, which could result in increased costs or our abandonment of these projects.
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we may incur construction costs for a property that exceed our original estimates due to increased costs for materials or labor or other costs that we did not anticipate;
•
we may not be able to obtain financing on favorable terms, if at all, especially with respect to large scale developments and redevelopments, which may render us unable to proceed with our development activities;
•
we may abandon development opportunities after we begin to explore them and as a result we may lose deposits or fail to recover expenses already incurred;
•
we may expend funds on and devote management’s time to projects which we do not complete;
•
we may be unable to complete construction and lease-up of a property on schedule, which could result in increased debt service expense or construction costs; and
•
we may suspend development projects after construction has begun due to changes in economic conditions or other factors, and this may result in the write-off of costs, payment of additional costs or increases in overall costs when the development project is restarted.

Additionally, the time frame required for development, construction and lease-up of these properties means that we may have to wait years for a significant cash return. Because we are required to make cash distributions to our shareholders, if the cash flow from operations or refinancing is not sufficient, we may be forced to borrow additional money to fund such distributions. Any of these conditions could materially adversely affect our results of operations and growth prospects.

Our degree of leverage may have a negative impact on our results of operations, financial condition, cash flow and our ability to pursue growth through acquisitions and development projects.

As of December 31, 2014, our total consolidated debt was $813.6 million, consisting principally of our mortgage debt, term loans and amounts outstanding under our credit facility. In addition, we will incur additional indebtedness in the future in connection with, among other things, our acquisition, development and operating activities. Our current degree of leverage, or an increase in our leverage levels, may make it difficult to obtain additional financing based on our current portfolio or to refinance existing debt on favorable terms or at all. Failure to obtain additional financing could impede our ability to grow and develop our business through, among other things, acquisitions and developments, and a failure to refinance our existing debt as it matures could have a material adverse effect on our financial condition, liquidity and ability to make distributions to our shareholders. Our leverage levels also could make us more vulnerable to a downturn in business or the economy generally and may adversely affect the market

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price of our securities if an investment in our common or preferred shares is perceived to be more risky than an investment in our peers.

We face risks associated with the use of debt, including refinancing risk.

Our use of debt financing creates risks, including risks that:

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our cash flow will be insufficient to make required payments of principal and interest;
•
we will be unable to refinance some or all of our indebtedness or that any refinancing will not be on terms as favorable as those of the existing indebtedness;
•
required debt payments will not be reduced if the economic performance of any property declines;
•
debt service obligations will reduce funds available for distribution to our security holders and funds available for acquisitions, development and redevelopment;
•
most of our secured debt obligations require the lender to be made whole to the extent we decide to pay off the debt prior to the maturity date; and
•
any default on our indebtedness, including as a result of a failure to maintain certain financial and operating covenants in our credit facility and term loans, could result in acceleration of those obligations and possible cross defaults under other indebtedness and/or loss of property to foreclosure.

If the economic performance of any of our properties declines, our ability to make debt service payments would be adversely affected. If a property is mortgaged to secure payment of indebtedness and we are unable to meet mortgage payments, we may lose that property to lender foreclosure with a resulting loss of income and asset value.

Covenants in our debt agreements could adversely affect our liquidity and financial condition.

Our unsecured revolving credit facility, unsecured term loan, our construction loan and our Storey Park land loan contain certain and varying restrictions on the amount of debt we are allowed to incur and other restrictions and requirements on our operations (including, among other things, requirements to maintain a minimum tangible net worth and specified coverage ratios (e.g., a maximum of total indebtedness to gross asset value, a maximum of secured indebtedness to gross asset value, a minimum fixed charge coverage ratio (defined as the ratio of adjusted EBITDA to fixed charges), a maximum unencumbered pool leverage ratio (defined as the ratio of unsecured debt to the value of the unencumbered pool of properties) and a minimum unencumbered pool interest coverage ratio (defined as the ratio of the adjusted net operating income of the unencumbered pool properties to interest on unsecured debt)) and other financial covenants, and limitations on our ability to make distributions, enter into joint ventures, develop properties and engage in certain business combination transactions). See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.” These restrictions, particularly if we are at or near the required ratios or thresholds, could prevent or inhibit our ability to make distributions to our shareholders and to pursue some business initiatives or effect certain transactions that may otherwise be beneficial to our company, which could adversely affect our financial condition and results of operations. Moreover, our continued ability to borrow under our revolving credit facility is subject to compliance with these financial and operating covenants and our failure to comply with such covenants could cause a default under the credit facility. Although we were in compliance with all of the financial and operating covenants of our outstanding debt agreements as of December 31, 2014, we can provide no assurance that we will be able to continue to comply with these covenants in future periods.

Our debt agreements also contain cross-default provisions that would be triggered if we are in default under other loans in excess of certain amounts. Moreover, even if a secured debt instrument is below the cross default threshold for non-recourse secured debt under our unsecured debt agreements, a default under such secured debt instrument may still cause a cross default under our unsecured debt agreements because such secured debt instrument may not qualify as “non-recourse” under the definition in our unsecured debt agreements. In the event of a default or cross default, the lenders could accelerate the timing of payments under the debt obligations and we may be required to repay such debt with capital from other sources, which may not be available to us on attractive terms, or at all, which would have a material adverse effect on our liquidity, financial condition, results of operations and ability to make distributions to our shareholders.

We may be unable to renew expiring leases or re-lease vacant space on a timely basis or on attractive terms, which could have a material adverse effect on our results of operations and cash flow.

Approximately 7%, 11% and 16% of our annualized cash basis rent is scheduled to expire in 2015, 2016 and 2017, respectively, excluding month-to-month leases. Current tenants may not renew their leases upon the expiration of their terms and may attempt to terminate their leases prior to the expiration of their current terms. For example, as discussed in the risk factor titled “A decrease in federal government spending, or the threat thereof, as a result of sequestration cuts or otherwise, could have a material adverse

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effect on our results of operations and cash flow, and could cause an impairment of the value of some of our properties”, our leases with the U.S. Government include favorable tenant termination provisions. If non-renewals or terminations occur, we may not be able to locate qualified replacement tenants and, as a result, we could lose a significant source of revenue while remaining responsible for the payment of our financial obligations. Moreover, the terms of a renewal or new lease, including the amount of rent, may be less favorable to us than the current lease terms, or we may be forced to provide tenant improvements at our expense or provide other concessions or additional services to maintain or attract tenants. Any of these factors could cause a decline in lease revenue or an increase in operating expenses, which would have a material adverse effect on our results of operations and cash flow.

We are subject to the credit risk of our tenants, which may declare bankruptcy or otherwise fail to make lease payments, which could have a material adverse effect on our results of operations and cash flow.

We are subject to the credit risk of our tenants. We cannot assure you that our tenants will not default on their leases and fail to make rental payments to us. In particular, disruptions in the financial and credit markets, local economic conditions and other factors affecting the industries in which our tenants operate may affect our tenants’ ability to obtain financing to operate their businesses or continue to profitability execute their business plans. This, in turn, may cause our tenants to be unable to meet their financial obligations, including making rental payments to us, which may result in their bankruptcy or insolvency. We cannot evict a tenant solely because of its bankruptcy. On the other hand, a tenant in bankruptcy may be able to restrict our ability to collect unpaid rent and interest during the bankruptcy proceeding and may reject the lease. In such case, our claim against the bankrupt tenant for unpaid and future rent would be subject to a statutory cap that might be substantially less than the remaining rent actually owed under the lease. As a result, our claim for unpaid rent likely would not be paid in full. This shortfall could adversely affect our cash flow and results of operations. Furthermore, in the event of the tenant’s breach of its obligations to us or its rejection of the lease in bankruptcy proceedings, we may be unable to locate a replacement tenant in a timely manner or on comparable or better terms. The loss of rental revenues from any of our larger tenants, a number of our smaller tenants or any combination thereof, combined with our inability to replace such tenants on a timely basis, may materially adversely affect our results of operations and cash flow.

A majority of our tenants hold leases covering less than 10,000 square feet. Many of these tenants are small companies with nominal net worth and, therefore, may be challenged in operating their businesses during economic downturns. In addition, certain of our properties are, and may be in the future be, substantially leased to a single tenant and, therefore, such property’s operating performance and our ability to service the property’s debt is particularly exposed to the economic condition of the tenant. The loss of rental revenues from any of our larger tenants or a number of our smaller tenants may materially adversely affect our results of operations and cash flow.

Our variable rate debt subjects us to interest rate risk.

As of December 31, 2014, we had an unsecured revolving credit facility, a $300.0 million unsecured term loan, and a $32.2 million construction loan and certain other debt, some of which is unhedged, that bears interest at a variable rate. In addition, we may incur additional variable rate debt in the future. As of December 31, 2014, we had $559.2 million of variable rate debt, of which, $300.0 million was hedged through eleven interest rate swap agreements. Our $559.2 million of variable rate debt includes our $22.0 million land loan that encumbers Storey Park, which bears interest at a rate of one-month LIBOR plus 2.50%. One-month LIBOR was 0.17% at December 31, 2014. Increases in interest rates on variable rate debt would increase our interest expense, if not hedged effectively or at all, which would adversely affect net earnings and cash available for payment of our debt obligations and distributions to our security holders.  For example, if market rates of interest on our unhedged variable rate debt outstanding as of December 31, 2014 increased by 1%, or 100 basis points, the increase in interest expense on our existing unhedged variable rate debt would decrease future earnings and cash flow by approximately $2.6 million annually.

We have and may continue to engage in hedging transactions, which can limit our gains and increase exposure to losses.

We have and may continue to enter into hedging transactions to attempt to protect us from the effects of interest rate fluctuations on floating rate debt, or in some cases, prior to a proposed debt issuance. Our hedging transactions may include interest rate swap agreements or interest rate cap or floor agreements, or other interest rate exchange contracts. Hedging activities may not have the desired beneficial impact on our results of operations or financial condition. No hedging activity can completely insulate us from the risks associated with changes in interest rates. Moreover, interest rate hedging could fail to protect us and could adversely affect us because, among other things:

•
available interest rate hedging may not correspond directly with the interest rate risk for which we seek protection;

•
the duration of the hedge may not match the duration of the related liability;

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•
the party owing money in the hedging transaction may default on its obligation to pay;

•
the credit quality of the party owing money on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction; and

•
the value of derivatives used for hedging may be adjusted from time to time in accordance with accounting rules to reflect changes in fair value. Such downward adjustments, or “mark-to-market losses,” would reduce our equity.

Hedging involves risk and typically involves costs, including transaction costs that may reduce our overall returns on our investments. These costs increase as the period covered by the hedging increases and during periods of rising and volatile interest rates. These costs will also limit the amount of cash available for distribution to shareholders. We generally intend to hedge as much of the interest rate risk as management determines is in our best interests given the cost of such hedging transactions. REIT qualification rules may limit our ability to enter into hedging transactions by, among other things, requiring us to limit our income from hedges. If we are unable to hedge effectively because of the REIT rules, we will face greater interest rate exposure.

Failure to succeed in new markets may limit our growth and/or have a material adverse effect on our results of operations.

We may make selected acquisitions outside our current geographic market from time to time as appropriate opportunities arise. Our historical experience is in the greater Washington D.C. region, and we may not be able to operate successfully in other market areas where we have limited or no experience. We may be exposed to a variety of risks if we choose to enter new markets. These risks include, among others:

•
a lack of market knowledge and understanding of the local economies;
•
an inability to identify promising acquisition or development opportunities;
•
an inability to identify and cultivate relationships that, similar to our relationships in the greater Washington D.C. region, are important to successfully effecting our business plan;
•
an inability to employ construction trades people; and
•
a lack of familiarity with local government and permitting procedures.

Any of these factors could adversely affect the profitability of projects outside our current markets and limit the success of our acquisition and development strategy. If our acquisition and development strategy is negatively affected, our growth may be impeded and our results of operations materially adversely affected.

We rely, in certain instances, on third-party vendors to manage and lease certain of our properties and could be materially and adversely affected if such third-party vendors do not manage and/or lease our properties in our best interests.

In certain instances, we retain third parties to manage and/or lease certain of our properties and, in connection with such arrangements, we would be dependent on them and their key personnel who provide services to us and we may not find a suitable replacement if the agreements are terminated, or if key personnel leave or otherwise become unavailable to us. In particular, we recently retained a third-party management company to operate our Southern Virginia portfolio pursuant to individual property management agreements. While we believe this management structure provides operating efficiencies, we could be materially and adversely affected if our third-party manager fails to provide quality services and amenities, fail to maintain a quality brand name or otherwise fail to manage our properties in our best interest. In addition, from time to time, disputes may arise between us and our third-party manager regarding their performance or compliance with the terms of the property management agreements, which in turn could adversely affect our results of operations. We generally will attempt to resolve any such disputes through discussions and negotiations; however, if we are unable to reach satisfactory results through discussions and negotiations, we may choose to terminate our management agreement (which we are permitted to do upon 30-days’ notice), litigate the dispute or submit the matter to third-party dispute resolution, the outcome of which may be unfavorable to us. In the event that we terminate any of our management agreements, we can provide no assurances that we could find a replacement manager in a timely manner, or at all, or that any replacement manager will be successful in operating such properties.

In addition, we retain third-party vendors to lease certain of our properties pursuant to listing agreements and, as such, are dependent on such third parties and their key personnel. If these third-party leasing agents fail to provide quality services to us or otherwise fail to act in our best interest, it could have a material adverse effect on our business and results of operations.

Failure to maintain effective internal control over financial reporting could have a material adverse effect on our business, liquidity and financial condition and the market price of our securities.

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Our management is responsible for establishing and maintaining adequate internal control over financial reporting. As previously disclosed, management identified a material weakness in our internal control over financial reporting as of December 31, 2011 relating to our monitoring and oversight of compliance with financial covenants under our debt agreements. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.

Although we remediated the material weakness as of December 31, 2012, we cannot assure you that our internal control over financial reporting will not be subject to additional material weaknesses in the future. Any material weakness in our internal control over financial reporting could prevent us from accurately reporting our results of operations, result in material misstatements in our financial statements or cause us to fail to meet our reporting obligations. This could prevent or inhibit our ability to access third party sources of capital, which could adversely affect our liquidity and financial condition, and could cause investors to lose confidence in our reported financial information, thereby adversely affecting the perception of our business and the market price of our securities.

We have been informed that the SEC has initiated an informal inquiry relating to the matters that were the subject of our Internal Investigation regarding the material weakness previously identified in our Annual Report on Form 10-K for the year ended December 31, 2011, which could have a material adverse impact on our business, financial condition, results of operations and cash flow.

As previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2012, we have been informed that the SEC has initiated an informal inquiry relating to the matters that were the subject of our Internal Investigation regarding the material weakness previously identified in our Annual Report on Form 10-K for the year ended December 31, 2011.  We have been, and intend to continue, voluntarily cooperating fully with the SEC. We cannot reasonably estimate the timing, scope or outcome of this informal inquiry and are unable to predict whether a formal investigation will be initiated or what consequences any further investigation may have on us. The informal inquiry, or any formal investigation that may be initiated, may result in the incurrence of significant legal expense, both directly and as the result of our indemnification obligations to our trustees and current and former employees. In addition, the informal inquiry, or any formal investigation that may be initiated, may divert management’s attention from our ordinary business operations and may limit our ability to obtain financing to fund our on-going operating requirements. Adverse findings by the SEC or the incurrence of costs, fees, fines or penalties that are not reimbursed by insurance policies, in connection with or as a result of this informal inquiry (or any formal investigation that may be initiated), could have a material adverse impact on our business, financial condition, results of operations and cash flow.

Our mezzanine loan investments are subject to significant risks, and losses related to these investments could have a material adverse effect on our results of operations and ability to make distributions to our shareholders.

In 2010 and 2011, we structured separate investments in two Washington, D.C. office properties in the form of loans to the owners of the property: a $25.0 million loan (to the owners of 950 F Street, NW, a ten-story office/retail building in Washington, D.C.) that bore interest at a rate of 12.5% per annum, is interest only and matures on April 1, 2017; and a $30.0 million loan (to the owners of America’s Square, a 461,000 square foot office complex in Washington, D.C.) that bears interest at a rate of 9.0% per annum that matures on May 1, 2016 and required monthly interest-only payments until May 2013, at which time the loan began requiring monthly principal and interest payments through its maturity date. On January 10, 2014, we amended and restated the $25.0 million mezzanine loan to increase the outstanding balance to $34.0 million, and reduced the fixed interest rate from 12.5% to 9.75%. Each loan is secured by a portion of the owners’ interest in the respective property and is effectively subordinate to a senior mortgage loan on the property. On January 27, 2015, we received a prepayment notice from the borrower under the $30.0 million America’s Square mezzanine loan, indicating their intention to prepay the loan. We anticipate the prepayment will be made on or about February 24, 2015. The outstanding balance of loan was $29.7 million at December 31, 2014. We expect to receive a yield maintenance payment of $2.4 million in connection with the prepayment of such loan. We may engage in additional lending activities in the future, including mezzanine financing activities. These types of loans involve a higher degree of risk than long-term senior mortgage lending secured by income-producing real property, because the loan may become unsecured as a result of foreclosure by the senior lender. In addition, mezzanine loans may have higher loan-to-value ratios than conventional mortgage loans, resulting in less equity in the property and increasing the risk of loss of principal. If a borrower defaults on our mezzanine loan or debt senior to our loan, or in the event of a borrower bankruptcy, our mezzanine loan will be satisfied only after the senior debt is paid in full. Where debt senior to our loan exists, the presence of intercreditor arrangements between the holder of the mortgage loan and us, as the mezzanine lender, may limit our ability to amend our loan documents, assign our loans, accept prepayments, exercise our remedies and control decisions made in bankruptcy proceedings relating to borrowers. As a result, we may not recover some or all of our investment, which could result in losses. In addition, even if we are able to foreclose on the underlying collateral following a default on a mezzanine loan, we would be substituted for the defaulting borrower and, to the

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extent income generated on the underlying property is insufficient to meet outstanding debt obligations on the property, may need to commit substantial additional capital to stabilize the property and prevent additional defaults to lenders with existing liens on the property. Significant losses related to mezzanine loans could have a material adverse effect on our results of operations and our ability to make distributions to our shareholders.

Under some of our leases, tenants have the right to terminate prior to the scheduled expiration of the lease, which could have a material adverse effect on our results of operations and cash flow.

Some leases at our properties provide tenants with the right to terminate prior to the scheduled expiration of the lease. If a tenant terminates its lease with us prior to the expiration of the term, we may be unable to re-lease that space on as favorable terms, or at all, which could materially adversely affect our results of operations, cash flow and our ability to make distributions to our security holders.

Property owned through joint ventures, or in limited liability companies and partnerships in which we are not the sole equity holder, may limit our ability to act exclusively in our interests.

We have, and may in the future, make investments through partnerships, limited liability companies or joint ventures, some of which may be significant in size. In particular, during 2010 and 2011, we entered a number of joint ventures in connection with our acquisition and development of various real estate assets. Partnership, limited liability company or joint venture investments may involve various risks, including the following:

•
our partners or co-members might become bankrupt (in which event we and any other remaining general partners or co-members would generally remain liable for the liabilities of the partnership or joint venture) or default on their obligations necessitating that we fulfill their obligation ourselves;
•
our partners or co-members might at any time have economic or other business interests or goals that are inconsistent with our business interests or goals;
•
our partners or co-members may have competing interests in our markets that could create conflicts of interest;
•
our partners or co-members may be structured differently than us for tax purposes and this could create conflicts of interest;
•
our partners or co-members may be in a position to take action contrary to our instructions, requests, policies, or objectives, including our current policy with respect to maintaining our qualification as a real estate investment trust;
•
our partners or co-members may be in a position to withhold consent necessary for us take certain actions with respect to our jointly owned investments, including rights with respect to development; and
•
agreements governing joint ventures, limited liability companies and partnerships often contain restrictions on the transfer of a member’s or partner’s interest or “buy-sell” or other provisions that may result in a purchase or sale of the interest at a disadvantageous time or on disadvantageous terms.

The occurrence of one or more of the events described above could adversely affect our financial condition, results of operations, cash flow and ability to make distributions with respect to, and the market price of, our securities.
 
Illiquidity of real estate investments could significantly impede our ability to respond to adverse changes in the performance of our properties and have a material adverse effect on our results of operations, financial condition and cash flow.

Because real estate investments are relatively illiquid, our ability to promptly sell one or more properties in our portfolio in response to adverse changes in the performance of such properties may be limited. The real estate market is affected by many factors that are beyond our control, including those described in the risk factor above under “Real estate investments are inherently risky, which could materially adversely affect our results of operations and cash flow.” We cannot predict whether we will be able to sell any property for the price or on the terms set by us, or whether any price or other terms offered by a prospective purchaser would be acceptable to us. We also cannot predict the length of time needed to find a willing purchaser and to close the sale of a property. Moreover, the REIT rules governing property sales and agreements that we may enter into with joint venture partners or contributors to our Operating Partnership not to sell certain properties for a period of time may interfere with our ability to dispose of properties on a timely basis without incurring significant additional costs.

We may be required to expend funds to correct defects or to make improvements before a property can be sold. We cannot assure you that we will have funds available to correct those defects or to make those improvements. In acquiring a property, we may agree to lock-out provisions that materially restrict us from selling that property for a period of time or impose other restrictions, such as a limitation on the amount of debt that can be placed or repaid on that property. We may also acquire properties that are subject to mortgage loans that may limit our ability to sell those properties prior to the applicable loan’s maturity. These factors

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and any others that would impede our ability to respond to adverse changes in the performance of our properties could have a material adverse effect on our results of operations, financial condition, cash flow and our ability to make distributions to our security holders.

Effective for the District’s taxable year beginning October 1, 2014, Washington, D.C. implemented a new methodology for assessing office property values, and such methodology may increase the assessed values of office properties in Washington, D.C., thereby increasing office property owners’ tax liabilities and making Washington, D.C. a less attractive market for potential tenants, from whom property tax payments are often recoverable pursuant to market lease terms.

Effective for the District’s taxable year beginning October 1, 2014, Washington, D.C. implemented a new methodology for assessing office property values, which are used to determine the amount of property taxes for which office property owners are liable to the city. The new methodology will use market values to determine property values in lieu of the current system, which analyzes rent, occupancy and other operating data. As of December 31, 2014, we own interests in seven office properties (including one property owned through an unconsolidated joint venture) in Washington, D.C., which total 1.0 million square feet. Pursuant to typical leases between office property owners and their tenants, property owners may recover property tax expenses from tenants. As a result, increases in property tax liabilities may increase the cost to our tenants of leasing office space in Washington, D.C. This could cause our current, as well as potential future tenants, to seek to lease office space in other markets, which could negatively impact our ability to lease and re-lease space in our Washington, D.C. office buildings at current rates or at all. In addition, if we are unable to recover all of the increased property tax expense from our tenants, the increase in property tax liabilities could have a material adverse effect on our results of operations, financial condition and cash flow.

Liabilities under environmental laws for contamination could have a material adverse effect on our results of operations, financial condition and cash flow.

Our operating expenses could be higher than anticipated due to liability created under existing or future federal, state or local environmental laws and regulations for contamination. An owner or operator of real property can face strict, joint and several liability for environmental contamination created by the presence or discharge of hazardous substances, including petroleum-based products at, on, under or from the property. Similarly, a former owner or operator of real property can face the same liability for the disposal of hazardous substances that occurred during the time of ownership or operation. We may face liability regardless of:

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our lack of knowledge of the contamination;
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the extent of the contamination;
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the timing of the release of the contamination; or
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whether or not we caused the contamination.

Environmental liability for contamination may include the following, without limitation: investigation and feasibility study costs, remediation costs, litigation costs, oversight costs, monitoring costs, institutional control costs, penalties from state and federal agencies, and third-party claims. Moreover, operations on-site may be required to be suspended until certain environmental contamination is remediated and/or permits are received and environmental laws can impose permanent restrictions on the manner in which a property may be used depending on the extent and nature of the contamination. This may result in a default of the terms of the lease entered into with our tenants. Environmental laws also may create liens on contaminated sites in favor of the government for damages and costs it incurs to address such contamination. In addition, the presence of hazardous substances at, on, under or from a property may adversely affect our ability to sell the property or borrow using the property as collateral, thus harming our financial condition.

There may be environmental liabilities associated with our properties of which we are unaware. For example, some of our properties contain, or may have contained in the past, underground tanks for the storage of hazardous substances, petroleum-based or waste products, or some of our properties have been used, or may have been used, historically to conduct industrial operations, and any of these circumstances could create a potential for release of hazardous substances. Such liabilities could have a material adverse effect on our results of operations, financial condition and cash flow.

Non-compliance with environmental laws at our properties could have a material adverse effect on our results of operations, financial condition and cash flow.

Our properties are subject to various federal, state and local environmental laws. Non-compliance with these environmental laws could subject us or our tenants to liability and changes in these laws could increase the potential costs of compliance or increase liability for noncompliance. Although our leases generally require our tenants to operate in compliance with all applicable

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laws and to indemnify us against any environmental liabilities arising from a tenant’s activities on the property, we could nonetheless be subject to strict liability by virtue of our ownership interest for environmental liabilities created by our tenants, and we cannot be sure that our tenants would satisfy their indemnification obligations under the applicable sales agreement or lease. Moreover, these environmental liabilities could affect our tenants’ ability to make rental payments to us. Non-compliance with environmental laws at our properties could have a material adverse effect on our results of operations, financial condition, cash flow and our ability to make distributions to our security holders.

Liabilities arising from the presence of hazardous building materials at our properties could have a material adverse effect on our results of operations, financial condition and cash flow.

As the owner or operator of real property, we may also incur liability based on various building conditions. For example, buildings and other structures on properties that we currently own or operate or those we acquire or operate in the future contain, may contain, or may have contained, asbestos-containing material, or ACM. Environmental, health and safety laws require that ACM be properly managed and maintained and may impose fines or penalties on owners, operators or employers for non-compliance with those requirements. These requirements include special precautions, such as removal, abatement or air monitoring, if ACM would be disturbed during maintenance, renovation or demolition of a building, potentially resulting in substantial costs. In addition, we may be subject to liability for personal injury or property damage sustained as a result of exposure to ACM or releases of ACM into the environment. As a result, such liabilities arising from the presence of ACM or other hazardous building materials at our properties could have a material adverse effect on our results of operations, financial condition and cash flow.

Our properties may contain or develop harmful mold or suffer from other indoor air quality issues, which could lead to liability for adverse health effects, property damage or remediation costs and have a material adverse effect on our results of operations, financial condition and cash flow.

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. Concern about indoor exposure to airborne toxins or irritants, including mold, has been increasing as exposure to these airborne contaminants have been 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 to increase 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. The occurrence of any of these risks could have a material adverse effect on our results of operations, financial condition and cash flow.

Compliance with the Americans with Disabilities Act and fire, safety and other regulations may require us to make unintended expenditures that materially adversely impact our cash flow.

All of our properties are required to comply with the Americans with Disabilities Act, or the 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. Compliance with the ADA requirements could require removal of access barriers and non-compliance could result in the imposition of fines by the U.S. Government or an award of damages to private litigants, or both. While the tenants to whom we lease properties are obligated by law to comply with the ADA provisions, and typically under our leases are obligated to cover costs associated with compliance, if required changes involve greater expenditures than anticipated, or if the changes must be made on a more accelerated basis than anticipated, the ability of these tenants to cover costs could be adversely affected and we could be required to expend our own funds to comply with the provisions of the ADA, which could adversely affect our results of operations and financial condition and our ability to make distributions to security holders. In addition, we are required to operate our properties in compliance with fire and safety regulations, building codes and other land use regulations, as they may be adopted by governmental agencies and bodies and become applicable to our properties. We may be required to make substantial capital expenditures to comply with those requirements and these expenditures could have a material adverse effect on our cash flow and ability to make distributions to our security holders.

An uninsured loss or a loss that exceeds the policies on our properties could have a material adverse effect on our results of operations, financial condition and cash flow.

We carry insurance coverage on our properties of types and in amounts and with deductibles that we believe are in line with coverage customarily obtained by owners of similar properties. In particular, we have obtained comprehensive liability, casualty, earthquake, flood and rental loss insurance policies on our properties. All of these policies may, depending on the nature of the

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loss, involve substantial deductibles and certain exclusions. In addition, under the terms and conditions of most of the leases currently in force on our properties, our tenants generally are required to indemnify and hold us harmless from liabilities resulting from injury to persons, air, water, land or property, on or off the premises, due to activities conducted on the properties, except for claims arising from the negligence or intentional misconduct of us or our agents. Furthermore, tenants are generally required, at the tenant’s expense, to obtain and keep in full force during the term of the lease, liability and full replacement value property damage insurance policies. However, our largest tenant, the federal government, is not required to maintain property insurance at all. In addition, we cannot assure you that our tenants will properly maintain their insurance policies or have the ability to pay the deductibles.

Should a loss occur that is uninsured or in an amount exceeding the combined aggregate limits for the policies noted above, or in the event of a loss that is subject to a substantial deductible under an insurance policy, we could lose all or part of our capital invested in, and anticipated revenue from, one or more of the properties. Depending on the specific circumstances of the affected property, it is possible that we could be liable for any mortgage indebtedness or other obligations related to the property. Any such loss could have a material adverse effect on our results of operations, financial condition, cash flow and our ability to make distributions to our security holders.

Terrorist attacks and other acts of violence or war may affect any market on which our securities trade, the markets in which we operate, our business and our results of operations.

Actual or threatened terrorist attacks may negatively affect our business and our results of operations. In particular, because of our concentration of properties in the Washington D.C. metropolitan area and our largest tenant is the U.S. Government (accounting for 14% of our total annualized cash basis rent at December 31, 2014), which has been and may in the future be the target of actual or threatened terrorist attacks, some tenants in our market may choose to relocate their businesses to other markets. This could result in an overall decrease in the demand for commercial space in this market generally, which could increase vacancies in our properties or necessitate that we lease our properties on less favorable terms, or both. In addition, future terrorist attacks or armed conflicts may directly impact the value of our properties through damage, destruction, loss or increased security costs, or cause losses that materially exceed our insurance coverage.

In response to the uncertainty in the insurance market following the terrorist attacks of September 11, 2001, the Federal Terrorism Risk Insurance Act (as amended, “TRIA”) was enacted in November 2002 to require regulated insurers to make available coverage for “certified” acts of terrorism (as defined by the statute). TRIA lapsed on December 31, 2014, but was renewed on January 12, 2015 until 2020 by the Terrorism Risk Insurance Program Reauthorization Act of 2015. Currently, our property insurance coverage includes acts of terrorism certified under TRIA other than nuclear, biological, chemical or radiological terrorism. The terrorism insurance that we obtain may not be sufficient to cover loss for damages to our properties as a result of terrorist attacks. In addition, certain losses resulting from these types of events are uninsurable and others would not be covered by our current terrorism insurance. Additional terrorism insurance may not be available at a reasonable price or at all. If the properties in which we invest are unable to obtain sufficient and affordable insurance coverage, the value of those investments could decline, and in the event of an uninsured loss, we could lose all or a portion of an investment. Furthermore, the United States may enter into armed conflicts in the future. The consequences of any armed conflicts are unpredictable, and we may not be able to foresee events that could have an adverse effect on our business.

Any of these events could result in increased volatility in or damage to the United States and worldwide financial markets and economy. They also could result in a continuation of the current economic uncertainty in the United States or abroad. Adverse economic conditions could affect the ability of our tenants to pay rent, which could have a material adverse effect on our operating results and financial condition, as well as our ability to make distributions to our security holders, and may adversely affect and/or result in volatility in the market price for our securities.

We face risks associated with security breaches through cyber attacks, cyber intrusions or otherwise, as well as other significant disruptions of our information technology (IT) networks and related systems.
 
We face risks associated with security breaches, whether through cyber attacks or cyber intrusions over the Internet, malware, computer viruses, attachments to e-mails, persons inside our organization or persons with access to systems inside our organization, and other significant disruptions of our IT networks and related systems. The risk of a security breach or disruption, particularly through cyber attack or cyber intrusion, including by computer hackers, foreign governments and cyber terrorists, has generally increased as the number, intensity and sophistication of attempted attacks and intrusions from around the world have increased. Our IT networks and related systems are essential to the operation of our business and our ability to perform day-to-day operations (including managing our building systems) and, in some cases, may be critical to the operations of certain of our tenants. Although we make efforts to maintain the security and integrity of these types of IT networks and related systems, and we have implemented various measures to manage the risk of a security breach or disruption, there can be no assurance that our security efforts and

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measures will be effective or that attempted security breaches or disruptions would not be successful or damaging. Even the most well protected information, networks, systems and facilities remain potentially vulnerable because the techniques used in such attempted security breaches evolve and generally are not recognized until launched against a target, and in some cases are designed not be detected and, in fact, may not be detected. Accordingly, we may be unable to anticipate these techniques or to implement adequate security barriers or other preventative measures, and thus it is impossible for us to entirely mitigate this risk.
 
A security breach or other significant disruption involving our IT networks and related systems could:
 
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disrupt the proper functioning of our networks and systems and therefore our operations and/or those of certain of our tenants;
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result in misstated financial reports, violations of loan covenants, missed reporting deadlines and/or missed permitting deadlines;
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result in our inability to properly monitor our compliance with the rules and regulations regarding our qualification as a REIT;
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result in the unauthorized access to, and destruction, loss, theft, misappropriation or release of proprietary, confidential, sensitive or otherwise valuable information of ours or others, which others could use to compete against us or for disruptive, destructive or otherwise harmful purposes and outcomes;
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result in our inability to maintain the building systems relied upon by our tenants for the efficient use of their leased space;
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require significant management attention and resources to remedy any damages that result;
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subject us to claims for breach of contract, damages, credits, penalties or termination of leases or other agreements; or
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damage our reputation among our tenants and investors generally.
 
Any or all of the foregoing could have a material adverse effect on our financial condition, results of operations, cash flow and ability to make distributions to our security holders.

Our business and operations would suffer in the event of system failures.

Despite system redundancy and the implementation of security measures for our IT networks and related systems, our systems are vulnerable to damages from any number of sources, including computer viruses, energy blackouts, natural disasters, terrorism, war, and telecommunication failures. We rely on our IT networks and related systems, including the Internet, to process, transmit and store electronic information and to manage or support a variety of our business processes, including financial transactions and keeping of records, which may include personal identifying information of tenants and lease data. We rely on commercially available systems, software, tools and monitoring to provide security for processing, transmitting and storing confidential tenant information, such as individually identifiable information relating to financial accounts. Any failure to maintain proper function, security and availability of our IT networks and related systems could interrupt our operations, damage our reputation, subject us to liability claims or regulatory penalties and could have a material adverse effect on our operations. Further, we are dependent on our personnel and, beyond standard emergency procedures in our headquarters office building, we have not fully implemented a formal disaster recovery plan to assist our employees, or to facilitate their maintaining continuity of operations after events such as energy blackouts, natural disasters, terrorism, war, and telecommunication failures. As such, any of the foregoing events could have a material adverse effect on our results of operations.

We face risks associated with our tenants being designated “Prohibited Persons” by the Office of Foreign Assets Control.

Pursuant to Executive Order 13224 and other laws, the Office of Foreign Assets Control of the U.S. Department of the Treasury, or OFAC, maintains a list of persons designated as terrorists or who are otherwise blocked or banned, or Prohibited Persons. OFAC regulations and other laws prohibit conducting business or engaging in transactions with Prohibited Persons. Certain of our loan and other agreements may require us to comply with these OFAC requirements. If a tenant or other party with whom we contract is placed on the OFAC list, we may be required by the OFAC requirements to terminate the lease or other agreement. Any such termination could result in a loss of revenue or a damage claim by the other party that the termination was wrongful.

Rising energy costs could have an adverse effect on our results of operations.

Electricity and natural gas, the most common sources of energy used by commercial buildings, are subject to significant price volatility. In recent years, energy costs, including energy generated by natural gas and electricity, have fluctuated significantly. Some of our properties may be subject to leases that require our tenants to pay all utility costs while other leases may provide that tenants will reimburse us for utility costs in excess of a base year amount. It is possible that some or all of our tenants will not fulfill their lease obligations and reimburse us for their share of any significant energy rate increases and that we will not be able

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to retain or replace our tenants if energy price fluctuations continue. Also, to the extent under a lease we agree to pay for such costs, rising energy prices could have an adverse effect on our results of operations.

We face possible risks associated with the physical effects of climate change.
 
We cannot assert with certainty whether climate change is occurring and, if so, at what rate. However, the physical effects of climate change could have a material adverse effect on our properties, operations and business. For example, all of our properties are located along the East coast, with many of those in the Central Business Districts of Washington, D.C. To the extent climate change causes changes in weather patterns, our markets could experience increases in storm intensity and rising sea-levels. Over time, these conditions could result in declining demand for office space in our buildings or our inability to operate the buildings at all. Climate change may also have indirect effects on our business by increasing the cost of (or making unavailable) property insurance on terms we find acceptable, increasing the cost of energy and increasing the cost of snow removal at our properties. There can be no assurance that climate change will not have a material adverse effect on our properties, operations or business.

Risks Related to Our Organization and Structure

Our executive officers have agreements that provide them with benefits in the event of a change in control of the Company and certain of our executive officers have agreements that provide them with benefits if their employment is terminated without cause or not renewed, which could prevent or deter a change in control of the Company.

We have entered into employment agreements with two of our executive officers, including Douglas J. Donatelli and Nicholas R. Smith, which provide them with severance benefits if their employment ends under certain circumstances following a change in control of the Company, terminated without cause, or if the executive officer resigns for “good reason” as defined in the employment agreements. In addition, our three other executive officers, Andrew P. Blocher, Robert Milkovich and Samantha S. Gallagher, have agreements with the Company that provide them with severance benefits if they are terminated by the Company without cause or if they resign for good reason (including a resignation for good reason within 12 months of a change in control of the Company). These benefits could increase the cost to a potential acquirer of the Company and thereby prevent or deter a change in control of the Company that might involve a premium price for our securities or otherwise be in the interests of our security holders.

We may experience conflicts of interest with some of our executive officers relating to their ownership of units of our Operating Partnership.

Some of our executive officers may have conflicting duties because, in their capacities as our executive officers, they have a duty to the Company and its shareholders, and in the Company’s capacity as general partner of our Operating Partnership, they have a fiduciary duty to the limited partners, and some executive officers are themselves limited partners and own a significant number of units of limited partner interest in our Operating Partnership. Conflicts may arise when the interests of our shareholders and the limited partners of our Operating Partnership diverge, particularly in circumstances in which there may be an adverse tax consequence to the limited partners, such as upon the sale of assets or the repayment of indebtedness. These conflicts of interest could lead to decisions that are not in the best interests of the Company and its shareholders.

We depend on key personnel, particularly Douglas J. Donatelli, with long-standing business relationships, the loss of whom could threaten our ability to operate our business successfully and have other negative implications under certain of our indebtedness.

Our future success depends, to a significant extent, upon the continued services of our senior management team, including Douglas J. Donatelli. In particular, the extent and nature of the relationships that Mr. Donatelli has developed in the real estate community in our markets is critically important to the success of our business. Although we have employment agreements with Mr. Donatelli and one of our other executive officers, there is no guarantee that Mr. Donatelli or our other key executive officers will remain employed with us. We do not maintain key person life insurance on any of our officers. The loss of services of one or more members of our senior management team, particularly Mr. Donatelli, would harm our business and prospects. Further, loss of a member of our senior management team could be negatively perceived in the capital markets, which could have an adverse effect on the market price of our securities.

Our rights and the rights of our security holders to take action against our trustees and officers are limited, which could limit your recourse in the event of actions not in your best interests.

Maryland law generally provides that a trustee has no liability for actions taken as a trustee, but may not be relieved of any liability to the company or its security holders for actions taken in bad faith, with willful misfeasance, gross negligence or reckless disregard for his or her duties. Our amended and restated declaration of trust authorizes us to indemnify, and to pay or reimburse

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reasonable expenses to, our trustees and officers for actions taken by them in those capacities to the maximum extent permitted by Maryland law. In addition, our declaration of trust limits the liability of our trustees and officers for money damages, except as otherwise prohibited by Maryland law or for liability resulting from:

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actual receipt of an improper benefit or profit in money, property or services; or
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a final judgment or other final adjudication based upon a finding of active and deliberate dishonesty by the trustee or officer that was material to the cause of action adjudicated.

As a result, we and our security holders may have more limited rights against our trustees than might otherwise exist. Our amended and restated bylaws require us to indemnify each trustee or officer who has been successful, on the merits or otherwise, in the defense of any proceeding to which he or she is made a party by reason of his or her service to us. In addition, we may be obligated to fund the defense costs incurred by our trustees and officers.

Our Series A Preferred Shares have, and future issuances of our preferred shares may have, terms that may discourage a third party from acquiring us.

We have 6.4 million shares of our Series A Cumulative Redeemable Perpetual Preferred Shares issued and outstanding. Our Series A Preferred Shares have certain conversion and redemption features that could be triggered upon a change of control, which may make it more difficult for or discourage a party from taking over our company. In addition, our declaration of trust permits our board of trustees to issue up to 50 million preferred shares, issuable in one or more classes or series. Our board of trustees may increase the number of preferred shares authorized by our declaration of trust without shareholder approval. Our board of trustees may also classify or reclassify any unissued preferred shares and establish the preferences and rights (including the right to vote, to participate in earnings and to convert into securities) of any such preferred shares, which rights may be superior to those of our common shares. Thus, in addition to our Series A Preferred Shares, our board of trustees could authorize the issuance of preferred shares with terms and conditions that could have the effect of discouraging a takeover or other transaction in which holders of some or a majority of the common shares might receive a premium for their shares over the then current market price of our common shares.

Our ownership limitations may restrict business combination opportunities.

To maintain our qualification as a REIT under the Internal Revenue Code, no more than 50% of the value of our outstanding shares of beneficial interest may be owned, directly or under applicable attribution rules, by five or fewer individuals (as defined to include certain entities) during the last half of each taxable year. To preserve our REIT qualification, our declaration of trust generally prohibits direct or indirect beneficial ownership (as defined under the Code) by any person of (i) more than 8.75% of the number or value of our outstanding common shares or (ii) more than 8.75% of the value of our outstanding shares of all classes. Generally, shares owned by affiliated owners will be aggregated for purposes of the ownership limitation. Our declaration of trust has created an ownership limitation for the group comprised of Louis T. Donatelli, Douglas J. Donatelli and certain related persons, which prohibits such group from acquiring direct or indirect ownership (as defined under the Code) of (i) more than 14.9% of the number or value of our outstanding common shares or (ii) more than 14.9% of the value of all of our outstanding shares of all classes. In addition, pursuant to the Articles Supplementary setting forth the terms of our Series A Preferred Shares, no person may own, or be deemed to own by virtue of the attribution provisions of the Code, more than 9.8% (by value or number of shares, whichever is more restrictive) of our Series A Preferred Shares. Unless the applicable ownership limitation is waived by our board of trustees prior to transfer, any transfer of our shares that would violate the ownership limitation will be null and void, and the intended transferee will acquire no rights in such shares. Shares that would otherwise be held in violation of the ownership limit will be designated as “shares-in-trust” and transferred automatically to a trust effective on the day before the purported transfer or other event giving rise to such excess ownership. The beneficiary of the trust will be one or more charitable organizations named by us. The ownership limitation could have the effect of delaying, deterring or preventing a change in control or other transaction in which holders of shares might receive a premium for their shares over the then current market price or that such holders might believe to be otherwise in their best interests. The ownership limitation provisions also may make our common shares an unsuitable investment vehicle for any person seeking to obtain, either alone or with others as a group, ownership of shares that would violate the ownership limitation provisions.

Our board of trustees may change our investment and operational policies and practices without a vote of our security holders, which limits your control of our policies and practices.

Our major policies, including our policies and practices with respect to investments, financing, growth, debt capitalization, REIT qualification and distributions, are determined by our board of trustees. Although we have no present intention to do so, our board of trustees may amend or revise these and other policies from time to time without a vote of our security holders. Accordingly, our security holders have limited control over changes in our policies.

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Our declaration of trust and bylaws do not limit the amount of indebtedness that we or our Operating Partnership may incur. If we become highly leveraged, then the resulting increase in debt service could adversely affect our ability to make payments on our outstanding indebtedness and harm our financial condition.

Our declaration of trust contains provisions that make removal of our trustees difficult, which could make it difficult for our shareholders to effect changes to our management.

Our declaration of trust provides that a trustee may be removed, with or without cause, only upon the affirmative vote of holders of a majority of our outstanding common shares. Vacancies may be filled by the board of trustees. This requirement makes it more difficult to change our management by removing and replacing trustees.

Our bylaws may only be amended by our board of trustees, which could limit your control of certain aspects of our corporate governance.

Our board of trustees has the sole authority to amend our bylaws. Thus, the board is able to amend the bylaws in a way that may be detrimental to your interests.

Maryland law may discourage a third party from acquiring us.

Maryland law provides broad discretion to our board of trustees with respect to their duties as trustees in considering a change in control of our Company, including that our board is subject to no greater level of scrutiny in considering a change in control transaction than with respect to any other act by our board.

The Maryland Business Combination Act restricts mergers and other business combinations between our Company and an interested shareholder for five years after the most recent date on which the shareholder becomes an interested shareholder, and thereafter imposes special shareholder voting requirements on these combinations. An “interested shareholder” is defined as any person who is the beneficial owner of 10% or more of the voting power of our common shares and also includes any of our affiliates or associates that, at any time within the two year period prior to the date of a proposed merger or other business combination, was the beneficial owner of 10% or more of our voting power. Additionally, the “control shares” provisions of the Maryland General Corporation Law, or MGCL, are applicable to us as if we were a corporation. These provisions eliminate the voting rights of issued and outstanding shares acquired in quantities so as to constitute “control shares,” as defined under the MGCL, unless our shareholders approve such voting rights by the affirmative vote of at least two-thirds of all votes entitled to be cast on the matter, excluding all interested shares and shares held by our trustees and officers. “Control shares” are generally defined as shares which, when aggregated with other shares controlled by the shareholder, entitle the shareholder to exercise one of three increasing ranges of voting power in electing trustees. Our amended and restated declaration of trust and/or bylaws, provide that we are not bound by the Maryland Business Combination Act or the control share acquisition statute. However, in the case of the control share acquisition statute, our board of trustees may opt to make this statute applicable to us at any time by amending our bylaws, and may do so on a retroactive basis. We could also opt to make the Maryland Business Combination Act applicable to us by amending our declaration of trust by a vote of a majority of our outstanding common shares. Finally, the “unsolicited takeovers” provisions of the MGCL permit our board of trustees, without shareholder approval and regardless of what is currently provided in our declaration of trust or bylaws, to implement certain provisions that may have the effect of inhibiting a third party from making an acquisition proposal for our Company or of delaying, deferring or preventing a change in control of our Company under circumstances that otherwise could provide the holders of our common shares with the opportunity to realize a premium over the then current market price or that shareholders may otherwise believe is in their best interests.


Tax Risks of our Business and Structure

If we fail to remain qualified as a REIT for federal income tax purposes, we will not be able to deduct our distributions, and our income will be subject to taxation, which would reduce the cash available for distribution to our shareholders.

We elected to be taxed as a REIT under the Internal Revenue Code commencing with our short taxable year ended December 31, 2003. The requirements for qualification as a REIT, however, are complex and interpretations of the federal income tax laws governing REITs are limited. The REIT qualification rules are even more complicated for a REIT that invests through an operating partnership, in various joint ventures, in other REITs and in both equity and debt investments. Our continued qualification as a REIT will depend on our ability to meet various requirements concerning, among other things, the ownership of our outstanding shares of beneficial interest, the nature of our assets, the sources of our income and the amount of our distributions to our shareholders. If we fail to meet these requirements and do not qualify for certain statutory relief provisions, our distributions to

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our shareholders will not be deductible by us and we will be subject to a corporate level tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates, substantially reducing our cash available to make distributions to our shareholders. In addition, if we failed to maintain our qualification as a REIT, we would no longer be required to make distributions for federal income tax purposes. Incurring corporate income tax liability might cause us to borrow funds, liquidate some of our investments or take other steps that could negatively affect our operating results. Moreover, if our REIT status is terminated because of our failure to meet a REIT qualification requirement or if we voluntarily revoke our election, unless relief provisions applicable to certain REIT qualification failures apply, we would be disqualified from electing treatment as a REIT for the four taxable years following the year in which REIT status is lost. We may not qualify for relief provisions for REIT qualification failures and even if we can qualify for such relief, we may be required to make penalty payments, which could be significant in amount.

Even if we maintain our qualification as a REIT, we are subject to any applicable state, local or foreign taxes and our taxable REIT subsidiaries are subject to federal, state and local income taxes at regular corporate rates.

Failure of our Operating Partnership to be treated as a partnership for federal income tax purposes would result in our failure to maintain our qualification as a REIT.

Failure of our Operating Partnership (or a subsidiary partnership) to be treated as a partnership for federal income tax purposes would have serious adverse consequences to our shareholders. If the IRS were to successfully challenge the federal income tax status of our Operating Partnership or any of its subsidiary partnerships, our Operating Partnership or the affected subsidiary partnership would be taxable as a corporation. In such event, we would fail to meet the gross income tests and certain of the asset tests applicable to REITs and, accordingly, would cease to qualify as a REIT.

Distribution requirements relating to qualification as a REIT for federal income tax purposes limit our flexibility in executing our business plan.

Our long-term business plan contemplates growth through acquisitions. To maintain our qualification as a REIT for federal income tax purposes, we generally are required to distribute to our shareholders at least 90% of our REIT taxable income (determined without regard to the deduction for dividends paid and by excluding net capital gains) for each of our taxable years. To the extent that we satisfy the 90% distribution requirement, but distribute less than 100% of our taxable income, we will be subject to federal corporate income tax on our undistributed taxable income. In addition, we are required to pay a 4% nondeductible excise tax on the amount, if any, by which actual distributions we pay with respect to any calendar year are less than the sum of 85% of our ordinary income for that calendar year, 95% of our capital gain net income for the calendar year and any amount of our undistributed taxable income required to be distributed from prior years.

We have distributed, and intend to continue to distribute, to our shareholders all or substantially all of our REIT taxable income each year in order to comply with the distribution requirements of the Internal Revenue Code and to eliminate all federal income tax liability at the REIT level and liability for the 4% nondeductible excise tax. Our distribution requirements limit our ability to accumulate capital for other business purposes, including funding acquisitions, debt maturities and capital expenditures. Thus, our ability to grow through acquisitions will be limited if we are unable to obtain debt or equity financing. In addition, differences in timing between the receipt of income and the payment of expenses in arriving at REIT taxable income and the effect of required debt amortization payments could require us to borrow funds or make a taxable distribution of our shares or debt securities to meet the distribution requirements that are necessary to achieve the tax benefits associated with qualifying as a REIT.

Our disposal of properties may have negative implications, including unfavorable tax consequences.

If we make a sale of a property directly or through an entity that is treated for federal income tax purposes as a partnership or a disregarded entity, and such sale is deemed to be a sale of dealer property or inventory, such sale may be deemed to be a “prohibited transaction” under the federal income tax laws applicable to REITs, in which case our gain, or our share of the gain, from the sale would be subject to a 100% penalty tax. If we believe that a sale of a property might be treated as a prohibited transaction, we may seek to conduct that sales activity through a taxable REIT subsidiary, in which case the gain from the sale would be subject to corporate income tax but not the 100% prohibited transaction tax. We cannot assure you, however, that the Internal Revenue Service will not assert successfully that sales of properties that we make directly or through an entity that is treated as a partnership or a disregarded entity, for federal income tax purposes are sales of dealer property or inventory, in which case the 100% penalty tax would apply. Moreover, we have entered and may enter into agreements with joint venture partners or contributors to our Operating Partnership that require us to indemnify, in whole or in part, such joint venture partners or such contributors for their tax obligations resulting from the recognition of gain in the case of taxable sales of certain contributed properties or a failure to maintain certain property-level indebtedness on certain contributed properties for a period of years.


26

We may be subject to adverse legislative or regulatory tax changes that could reduce the market price of our securities.

At any time, the federal income tax laws or regulations governing REITs or the administrative interpretations of those laws or regulations may be amended. We cannot predict when or if any new federal income tax law, regulation or administrative interpretation, or any amendment to any existing federal income tax law, regulation or administrative interpretation, will be adopted, promulgated or become effective and any such law, regulation or interpretation may take effect retroactively. We and our shareholders, as the well as the market price of our securities, could be adversely affected by any such change in, or any new, federal income tax law, regulation or administrative interpretation.
Dividends payable by REITs do not qualify for the reduced tax rates available for some dividends.
The maximum federal income tax rate applicable to income from “qualified dividends” payable to U.S. shareholders taxed at individual rates is 20%. Dividends payable by REITs, however, generally are not eligible for the reduced tax rates. Although such reduced tax rates do not adversely affect the taxation of REITs or dividends payable by REITs, the more favorable tax rates applicable to regular corporate qualified dividends could cause investors who are taxed at individual rates to perceive investments in REITs to be relatively less attractive than investments in shares of non-REIT corporations that pay dividends, which could adversely affect the market price of shares of REITs, including our shares.
Complying with REIT requirements may force us to sell otherwise attractive investments.
To maintain our qualification as a REIT, we must satisfy certain requirements with respect to the character of our assets.  If we fail to comply with these requirements at the end of any calendar quarter, we must correct such failure within 30 days after the end of the calendar quarter (by, possibly, selling assets notwithstanding their prospects as an investment) to avoid losing our REIT status.  If we fail to comply with these requirements at the end of any calendar quarter, and the failure exceeds a de minimis threshold, we may be able to preserve our REIT status if (a) the failure was due to reasonable cause and not to willful neglect, (b) we dispose of the assets causing the failure within six months after the last day of the quarter in which we identified the failure, (c) we file a schedule with the Internal Revenue Service describing each asset that caused the failure, and (d) we pay an additional tax of the greater of $50,000 or the product of the highest applicable tax rate multiplied by the net income generated on those assets.  As a result, we may be required to liquidate otherwise attractive investments.

If we or our predecessor entity failed to qualify as an S corporation for any of our tax years prior to our initial public offering, we may fail to qualify as a REIT.

To qualify and to maintain our qualification as a REIT, we may not have at the close of any year undistributed “earnings and profits” accumulated in any non-REIT year, including undistributed “earnings and profits” accumulated in any non-REIT year for which we or our predecessor, First Potomac Realty Investment Trust, Inc., did not qualify as an S corporation. Although we believe that we and our predecessor corporation qualified as an S corporation for federal income tax purposes for all tax years prior to our initial public offering, if it is determined that we or our predecessor did not so qualify, we would not have qualified as a REIT for our short taxable year ended December 31, 2003. Any such failure to qualify may also prevent us from maintaining our qualification as a REIT for any of the following four tax years.

If First Potomac Management, Inc. failed to qualify as an S corporation during any of its tax years, we may be responsible for any entity level taxes due.

We believe First Potomac Management, Inc. qualified as an S corporation for federal and state income tax purposes from the time of its incorporation in 1997 through the date it merged into our Company in 2006. However, the Company may be responsible for any entity-level taxes imposed on First Potomac Management, Inc. if it did not qualify as an S corporation at any time prior to the merger. First Potomac Management, Inc.’s former shareholders have severally indemnified us against any such loss; however, in the event one or more of its former shareholders is unable to fulfill its indemnification obligation, we may not be reimbursed for a portion of any taxes owed.

Risks Related to an Investment in Our Equity Securities

Our common and preferred shares trade in a limited market, which could hinder your ability to sell our common or preferred shares.

Our common shares experience relatively limited trading volume; many investors, particularly institutions, may not be interested (or be permitted) in owning our common shares because of the inability to acquire or sell a substantial block of our common shares

27

at one time. This illiquidity could have an adverse effect on the market price of our common shares. In addition, a shareholder may not be able to borrow funds using our common shares as collateral because lenders may be unwilling to accept the pledge of common shares having a limited market, thereby making our common shares a less attractive investment for some investors. In addition, an active trading market on the NYSE for our Series A Preferred Shares issued in January 2011 (which was our first issuance of preferred shares) and March 2012 may not develop or, if it does develop, may not last, in which case the trading price of our Series A Preferred Shares could be adversely affected or trade at prices lower than the initial offering price.

The market price and trading volume of our common and preferred shares may be volatile.

The market price of our common shares has been and may continue to be more volatile than in prior years and subject to wide fluctuations. In addition, the trading volume in our common and preferred shares may fluctuate and cause significant price variations to occur. We cannot assure you that the market price of our common and preferred shares will not fluctuate or decline significantly in the future, including as a result of factors unrelated to our operating performance or prospects.

Some of the factors that could negatively affect our share price or result in fluctuations in the price or trading volume of our common and preferred shares include:

•
actual or anticipated declines in our quarterly operating results or distributions;
•
reductions in our funds from operations;
•
declining occupancy rates or increased tenant defaults;
•
general market and economic conditions, including continued volatility in the financial and credit markets;
•
increases in market interest rates that lead purchasers of our securities to demand a higher dividend yield;
•
the general reputation of REITs and the attractiveness of our equity securities in comparison to other equity securities, including securities issued by other real estate-based companies;
•
changes in market valuations of similar companies;
•
adverse market reaction to any increased indebtedness we incur in the future;
•
additions or departures of key management personnel;
•
actions by institutional shareholders;
•
our issuance of additional debt or preferred equity securities;
•
speculation in the press or investment community; and
•
unanticipated charges due to the vesting of equity based compensation awards upon achievement of certain performance measures that cause our operating results to decline or fail to meet market expectations.

An increase in market interest rates may have an adverse effect on the market price of our common shares.

One of the factors that investors may consider in deciding whether to buy or sell our common shares is our distribution rate as a percentage of our share price, relative to market interest rates. If market interest rates increase, prospective investors may desire a higher distribution rate on our common shares or seek securities paying higher dividends or interest. The market price of our common shares likely will be based primarily on the earnings that we derive from rental income with respect to our properties and our related distributions to shareholders, and not from the underlying appraised value of the properties themselves. As a result, interest rate fluctuations and capital market conditions can affect the market price of our common shares. For instance, if interest rates rise without an increase in our distribution rate, the market price of our common shares could decrease because potential investors may require a higher yield on our common shares as market rates on interest-bearing securities, such as bonds, rise. In addition, rising interest rates would result in increased interest expense on our non-hedged variable rate debt, thereby adversely affecting cash flow and our ability to service our indebtedness and make distributions to our shareholders.

We have not established a minimum dividend payment level and we cannot assure you of our ability to pay dividends in the future or the amount of any dividends.

We have not established a minimum dividend payment level and our ability to make distributions may be adversely affected by the risk factors described in this Annual Report on Form 10-K and any risk factors in our subsequent filings with the SEC. For example, we significantly reduced our quarterly common share dividend during 2009 and, in January 2013, announced a further reduction in our quarterly common share dividend to $0.15 per share, which represents a 25% reduction from the previous dividend rate of $0.20 per share. All distributions will be made at the discretion of our board of trustees and their payment and amount will depend on our earnings, our financial condition, maintenance of our REIT status, compliance with our debt covenants and other factors as our board of trustees may deem relevant from time to time. We cannot assure you of our ability to make distributions in the future or that the distributions will be made in amounts similar to our current distributions. In particular, our outstanding debt, and the limitations imposed on us by our debt agreements, could make it more difficult for us to satisfy our obligations with respect to our equity securities, including paying dividends. See “Risk Factors - Risks Related to Our Business and Properties -

28

Covenants in our debt agreements could adversely affect our liquidity and financial condition.” Further, distributions with respect to our common shares are subject to our ability to first satisfy our obligations to pay distributions to the holders of our Series A Preferred Shares, and future offerings of preferred shares could have a preference on liquidating distributions or a preference on dividend payments or both that could limit our ability to make a dividend distribution to the holders of our common shares. In addition, some of our distributions may include a return of capital or may be taxable distributions of our shares or debt securities.

Future offerings of debt securities, which would rank senior to our common and preferred shares upon liquidation, and future offerings of equity securities, which would dilute our existing shareholders and may be senior to our common shares or senior to or on parity with our preferred shares for the purposes of dividend and liquidating distributions, may adversely affect the market price of our equity securities.

In the future, particularly as we seek to acquire and develop additional real estate assets consistent with our growth strategy, we may attempt to increase our capital resources through debt offerings or additional equity offerings, including senior or subordinated notes and series of preferred shares or common shares. For example, between 2010 and 2013, we sold approximately 25.3 million common shares and 6.4 million preferred shares in underwritten public offerings and approximately 1.0 million common shares through our controlled equity program.

Our preferred shares will rank junior to all of our existing and future debt and to other non-equity claims on us and our assets available to satisfy claims against us, including claims in bankruptcy, liquidation or similar proceedings. Further, upon liquidation, holders of our debt securities and preferred shares and lenders with respect to other borrowings will receive a distribution of our available assets prior to the holders of our common shares. Additional equity offerings may dilute the holdings of our existing shareholders or reduce the market price of our equity securities, or both. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, holders of our equity securities bear the risk of our future offerings reducing the market price of our equity securities and diluting their share holdings in us.

Shares eligible for future sale may have adverse effects on our share price.

We cannot predict the effect, if any, of future sales of common shares, or the availability of shares for future sales, on the market price of our common shares. Sales of substantial amounts of common shares, including common shares issuable upon the redemption of units of our Operating Partnership and exercise of options, or the perception that these sales could occur, may adversely affect prevailing market prices for our common shares and impede our ability to raise capital. Any substantial sale of our common shares could have a material adverse effect on the market price of our common shares.

We also may issue from time to time additional common shares or preferred shares or units of our Operating Partnership in connection with the acquisition of properties, and we may grant demand or piggyback registration rights in connection with these issuances. For example, in 2011, we issued approximately 2.0 million units in our Operating Partnership in connection with the acquisition of an office property in Washington, D.C. (and subsequently granted an additional approximately 39,000 units pursuant to the contingent consideration obligation in connection with such acquisition) and granted the holders of those units registration rights. Sales of substantial amounts of securities or the perception that these sales could occur may adversely affect the prevailing market price for our securities. In addition, the sale of these shares could impair our ability to raise capital through a sale of additional equity securities.

Holders of Series A Preferred Shares have extremely limited voting rights.

 
Holders of our Series A Preferred Shares have extremely limited voting rights. Our common shares are the only class of our equity securities carrying full voting rights. Voting rights for holders of Series A Preferred Shares exist primarily with respect to the ability to appoint additional trustees to our Board of Trustees in the event that six quarterly dividends (whether or not consecutive) payable on our Series A Preferred Shares are in arrears, and with respect to voting on amendments to our declaration of trust or our Series A Preferred Shares Articles Supplementary that materially and adversely affect the rights of Series A Preferred Shares holders or create additional classes or series of preferred shares that are senior to our Series A Preferred Shares. Other than very limited circumstances, holders of Series A Preferred Shares will not have voting rights.

ITEM 1B.
UNRESOLVED STAFF COMMENTS

None.


29

ITEM 2.
PROPERTIES

The following sets forth certain information about our properties by segment as of December 31, 2014 (including properties in development and redevelopment, dollars in thousands):

WASHINGTON, D.C. REGION
 
Property
Buildings
 
Sub-Market(1)
 
Square Feet
 
Annualized
Cash Basis
Rent(2)
 
Leased at
December 31,
2014
 
Occupied at
December 31,
2014
Office
 
 
 
 
 
 
 
 
 
 
 
11 Dupont Circle, NW
1

 
CBD
 
153,018

 
$
5,395

 
100.0
%
 
100.0
%
440 First Street, NW(3)
1

 
Capitol Hill
 
138,554

 
2,444

 
56.8
%
 
36.3
%
500 First Street, NW
1

 
Capitol Hill
 
129,035

 
5,711

 
100.0
%
 
100.0
%
840 First Street, NE
1

 
NoMA
 
248,536

 
7,177

 
97.7
%
 
97.7
%
1211 Connecticut Avenue, NW
1

 
CBD
 
129,573

 
3,692

 
97.3
%
 
68.1
%
1401 K Street, NW
1

 
East End
 
118,292

 
3,367

 
86.7
%
 
84.0
%
Total/Weighted Average
6

 
 
 
917,008

 
27,786

 
90.7
%
 
83.2
%
Development
 
 
 
 
 
 
 
 
 
 
 
Storey Park(4)
—

 
NoMA
 
—

 
—

 
 
 
 
 


 
 
 


 


 
 
 
 
Unconsolidated Joint Venture
 
 
 
 
 
 
 
 
 
 
 
1750 H Street, NW
1

 
CBD
 
113,235

 
3,964

 
100.0
%
 
95.8
%
Region Total/Weighted Average
7

 
 
 
1,030,243

 
$
31,750

 
91.8
%
 
84.6
%
 
(1) 
CBD refers to Central Business District; NoMA refers to North of Massachusetts Avenue.
(2) 
Annualized cash basis rent, which is calculated as the contractual rent due under the terms of the lease, without taking into account rent abatements, is reflected on a triple-net equivalent basis, by deducting operating expense reimbursements that are included, along with base rent, in the contractual payments of our full-service leases. The operating expense reimbursements primarily relate to real estate taxes and insurance expenses. Includes leased spaces that are not yet occupied.
(3) 
In October 2013, we substantially completed the redevelopment of the property. During the fourth quarter of 2014, we placed all the vacant space into service.
(4) 
The property was acquired through a consolidated joint venture in which we have a 97% controlling economic interest. The property was placed into development on September 1, 2013. The joint venture anticipates developing a mixed-used project on the 1.6 acre site, which can accommodate up to 712,000 square feet. We are currently exploring our options related to this property; however, until a definitive plan for the property has been reached and we begin significant development activities, we cannot determine the total cost of the project or the anticipated completion date.

30

MARYLAND REGION
 
Property
Buildings
 
Location
 
Square Feet
 
Annualized
Cash Basis
Rent(1)
 
Leased at
December 31,
2014
 
Occupied at
December 31,
2014
Business Park
 
 
 
 
 
 
 
 
 
 
 
Ammendale Business Park(2)
7

 
Beltsville
 
312,846

 
$
4,208

 
100.0
%
 
100.0
%
Gateway 270 West
6

 
Clarksburg
 
253,916

 
3,137

 
88.5
%
 
74.0
%
Rumsey Center
4

 
Columbia
 
135,047

 
1,421

 
94.7
%
 
94.7
%
Snowden Center
5

 
Columbia
 
145,267

 
2,315

 
100.0
%
 
100.0
%
Total Business Park
22

 
 
 
847,076

 
11,081

 
95.7
%
 
91.4
%
Office
 
 
 
 
 
 
 
 
 
 
 
Annapolis Business Center
2

 
Annapolis
 
101,113

 
1,985

 
100.0
%
 
100.0
%
Metro Park North
4

 
Rockville
 
191,211

 
2,782

 
87.3
%
 
87.3
%
Cloverleaf Center
4

 
Germantown
 
173,721

 
2,192

 
73.0
%
 
73.0
%
Hillside I and II(3)
2

 
Columbia
 
64,195

 
838

 
84.0
%
 
61.7
%
TenThreeTwenty
1

 
Columbia
 
138,854

 
1,989

 
96.0
%
 
84.5
%
Redland Corporate Center
3

 
Rockville
 
483,162

 
12,248

 
100.0
%
 
100.0
%
Total Office
16

 
 
 
1,152,256

 
22,034

 
92.5
%
 
89.8
%
Total Consolidated
38

 
 
 
1,999,332

 
33,115

 
93.8
%
 
90.5
%
Unconsolidated Joint Ventures
 
 
 
 
 
 
 
 
 
 
 
Aviation Business Park
3

 
Glen Burnie
 
120,285

 
1,194

 
66.2
%
 
66.2
%
Rivers Park I and II
6

 
Columbia
 
307,984

 
3,807

 
85.6
%
 
85.6
%
Total Joint Ventures
9

 
 
 
428,269

 
5,001

 
80.2
%
 
80.2
%
Region Total/Weighted Average
47

 
 
 
2,427,601

 
$
38,116

 
91.4
%
 
88.7
%
 
(1) 
Annualized cash basis rent, which is calculated as the contractual rent due under the terms of the lease, without taking into account rent abatements, is reflected on a triple-net equivalent basis, by deducting operating expense reimbursements that are included, along with base rent, in the contractual payments of our full-service leases. The operating expense reimbursements primarily relate to real estate taxes and insurance expenses. Includes leased spaces that are not yet occupied.
(2) 
Ammendale Business Park consists of the following properties: Ammendale Commerce Center and Indian Creek Court.
(3) 
Excludes 21,922 square feet of space that was placed into redevelopment during the first quarter of 2014.




31

NORTHERN VIRGINIA REGION
 
Property
Buildings
 
Location
 
Square Feet
 
Annualized
Cash Basis
Rent(1)
 
Leased at
December 31,
2014
 
Occupied at
December 31,
2014
Business Park
 
 
 
 
 
 
 
 
 
 
 
Gateway Centre Manassas
3

 
Manassas
 
102,446

 
856

 
86.6
%
 
86.6
%
Linden Business Center
3

 
Manassas
 
109,809

 
1,066

 
97.3
%
 
96.2
%
Prosperity Business Center
1

 
Merrifield
 
71,373

 
846

 
100.0
%
 
92.5
%
Sterling Park Business Center(2)
7

 
Sterling
 
471,835

 
4,438

 
97.1
%
 
96.4
%
Total Business Park
14

 
 
 
755,463

 
7,205

 
96.0
%
 
94.6
%
Office
 
 
 
 
 
 
 
 
 
 
 
Atlantic Corporate Park(3)
2

 
Sterling
 
219,374

 
3,191

 
81.3
%
 
43.9
%
Cedar Hill
2

 
Tysons Corner
 
102,632

 
2,163

 
100.0
%
 
100.0
%
Enterprise Center
4

 
Chantilly
 
189,331

 
2,910

 
87.7
%
 
84.4
%
Herndon Corporate Center
4

 
Herndon
 
128,335

 
1,326

 
70.1
%
 
70.1
%
One Fair Oaks
1

 
Fairfax
 
214,214

 
5,422

 
100.0
%
 
100.0
%
Reston Business Campus
4

 
Reston
 
82,398

 
822

 
66.1
%
 
66.1
%
Three Flint Hill
1

 
Oakton
 
180,819

 
3,407

 
96.3
%
 
96.3
%
Van Buren Office Park
5

 
Herndon
 
106,873

 
877

 
66.7
%
 
66.7
%
1775 Wiehle Avenue
1

 
Reston
 
130,048

 
2,880

 
100.0
%
 
100.0
%
Windsor at Battlefield
2

 
Manassas
 
155,511

 
2,044

 
92.0
%
 
92.0
%
Total Office
26

 
 
 
1,509,535

 
25,041

 
87.7
%
 
81.9
%
Industrial
 
 
 
 
 
 
 
 
 
 
 
Newington Business Park Center
7

 
Lorton
 
255,567

 
2,277

 
81.4
%
 
80.8
%
Plaza 500
2

 
Alexandria
 
500,944

 
5,508

 
98.5
%
 
95.9
%
Total Industrial
9

 
 
 
756,511

 
7,785

 
92.7
%
 
90.8
%
Total Consolidated
49

 
 
 
3,021,509

 
40,031

 
91.0
%
 
87.3
%
 
 
 
 
 
 
 
 
 
 
 
 
Development
 
 
 
 
 
 
 
 
 
 
 
Northern Virginia land(4)
—

 
 
 
—

 
—

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unconsolidated Joint Venture
 
 
 
 
 
 
 
 
 
 
 
Prosperity Metro Plaza
2

 
Merrifield
 
326,573

 
7,226

 
90.3
%
 
90.3
%
Region Total/Weighted Average
51

 
 
 
3,348,082

 
$
47,257

 
91.0
%
 
87.6
%
 
(1) 
Annualized cash basis rent, which is calculated as the contractual rent due under the terms of the leases, without taking into account rent abatements, is reflected on a triple-net equivalent basis, by deducting operating expense reimbursements that are included, along with base rent, in the contractual payments of our full-service leases. The operating expense reimbursements primarily relate to real estate taxes and insurance expenses. Includes leased spaces that are not yet occupied.
(2) 
Sterling Park Business Center consists of the following properties: 403/405 Glenn Drive, Davis Drive and Sterling Park Business Center.
(3) 
In March 2014, we signed a lease for 82,000 square feet with a government tenant to occupy the majority of one building, which was vacant at acquisition. We currently expect the tenant to move into the space in the first half of 2015.
(4) 
During the third quarter of 2014, we signed a lease for 167,000 square feet at a to-be-constructed building in Northern Virginia on vacant land that we have in our portfolio. We currently expect to complete construction of the new building in the fourth quarter of 2016. However, we can provide no assurance regarding the timing, costs or results of the project.


32

SOUTHERN VIRGINIA REGION
 
Property
Buildings
 
Location
 
Square Feet
 
Annualized
Cash Basis
Rent(1)
 
Leased at
December 31,
2014
 
Occupied at
December 31,
2014
RICHMOND(2)
 
 
 
 
 
 
 
 
 
 
 
Business Park
 
 
 
 
 
 
 
 
 
 
 
Chesterfield Business Center(3)
11

 
Richmond
 
320,189

 
$
1,833

 
86.2
%
 
86.2
%
Hanover Business Center
4

 
Ashland
 
184,057

 
908

 
76.2
%
 
74.8
%
Park Central
3

 
Richmond
 
204,696

 
2,184

 
93.3
%
 
93.3
%
Virginia Technology Center
1

 
Glen Allen
 
118,983

 
1,276

 
85.3
%
 
79.1
%
Total Richmond
19

 
 
 
827,925

 
6,201

 
85.6
%
 
84.4
%
NORFOLK
 
 
 
 
 
 
 
 
 
 
 
Business Park
 
 
 
 
 
 
 
 
 
 
 
Battlefield Corporate Center
1

 
Chesapeake
 
96,720

 
828

 
100.0
%
 
100.0
%
Crossways Commerce Center(4)
9

 
Chesapeake
 
1,082,753

 
11,341

 
94.8
%
 
94.8
%
Greenbrier Business Park(5)
4

 
Chesapeake
 
411,259

 
4,222

 
86.2
%
 
78.6
%
Norfolk Commerce Park(6)
3

 
Norfolk
 
262,010

 
2,647

 
96.4
%
 
94.0
%
Total Business Park
17

 
 
 
1,852,742

 
19,037

 
93.4
%
 
91.3
%
Office
 
 
 
 
 
 
 
 
 
 
 
Greenbrier Towers
2

 
Chesapeake
 
171,631

 
1,626

 
76.5
%
 
72.6
%
Total Office
2

 
 
 
171,631

 
1,626

 
76.5
%
 
72.6
%
Total Norfolk
19

 
 
 
2,024,373

 
20,663

 
91.9
%
 
89.8
%
Region Total/Weighted Average
38

 
 
 
2,852,298

 
$
26,864

 
90.1
%
 
88.2
%

(1) 
Annualized cash basis rent, which is calculated as the contractual rent due under the terms of the leases, without taking into account rent abatements, is reflected on a triple-net equivalent basis, by deducting operating expense reimbursements that are included, along with base rent, in the contractual payments of our full-service leases. The operating expense reimbursements primarily relate to real estate taxes and insurance expenses. Includes leased spaces that are not yet occupied.
(2) 
Effective as of February 9, 2015, we entered into a binding contract to sell our Richmond, Virginia portfolio. We anticipate closing the sale in the first half of 2015. However, we can provide no assurances regarding the timing or pricing of the sale of the Richmond Portfolio, or that the sale will occur at all.
(3) 
Chesterfield Business Center consists of the following properties: Airpark Business Center, Chesterfield Business Center and Pine Glen.
(4) 
Crossways Commerce Center consists of the following properties: Coast Guard Building, Crossways Commerce Center I, Crossways Commerce Center II, Crossways Commerce Center IV and 1434 Crossways Boulevard.
(5) 
Greenbrier Business Park consists of the following properties: Greenbrier Technology Center I, Greenbrier Technology Center II and Greenbrier Circle Corporate Center.
(6) 
Norfolk Commerce Park consists of the following properties: Norfolk Business Center, Norfolk Commerce Park II and Gateway II.



33

Lease Expirations

Approximately 7.1% of our annualized cash basis rent, excluding month-to-month leases (which represent 0.3% of our annualized cash basis rent), is scheduled to expire in 2015. We expect replacement rents on leases expiring in 2015 to decrease on a cash basis relative to the current rental rates being paid by tenants. Current tenants are not obligated to renew their leases upon the expiration of their terms. If non-renewals or terminations occur, we may not be able to locate qualified replacement tenants and, as a result, could lose a significant source of revenue while remaining responsible for the payment of our financial obligations. Moreover, the terms of a renewal or new lease, including the amount of rent, may be less favorable to us than the current lease terms, or we may be forced to provide tenant improvements at our expense or provide other concessions or additional services to maintain or attract tenants. We continually strive to increase our portfolio occupancy, and the amount of vacant space in our portfolio at any given time may impact our willingness to reduce rental rates or provide greater concessions to retain existing tenants and attract new tenants. We continually monitors our portfolio on a regional and per property basis to assess market trends, including vacancy, comparable deals and transactions, and other business and economic factors that may influence our leasing decisions. Prior to signing a lease with a tenant, we generally assess the prospective tenant’s credit quality through review of its financial statements and tax returns, and the result of that review is a factor in establishing the rent to be charged and/or level of security deposit required. Over the course of our leases, we monitor our tenants to stay aware of any material changes in credit quality. The metrics we use to evaluate a significant tenant’s liquidity and creditworthiness depend on facts and circumstances specific to that tenant and to the industry in which it operates and include the tenant’s credit history and economic conditions related to the tenant, its operations and the markets in which it operates.  These factors may change over time. In addition, our property management personnel have regular contact with tenants and tenant employees, and, where the terms of the lease permit and we deem it prudent we may request tenant financial information for periodic review, review publicly-available financial statements in the case of public company tenants and monitor news and rating agency reports regarding our tenants (or their parent companies) and their underlying businesses. In addition, we regularly analyze account receivable balances as part of the ongoing monitoring of the timeliness of rent collections from tenants.

During 2014, we delivered positive net absorption of 0.3 million square feet, and had a tenant retention rate of 69%. After reflecting all the renewal leases on a triple-net basis to allow for comparability, the weighted average rental rate of our renewed leases in 2014 increased 3.4%, compared with the expiring leases on a U.S. generally accepted accounting principles (“GAAP”) basis. During 2014, we executed new leases for 0.8 million square feet, the majority of the new leases (based on square footage) contained rent escalations.

The following table sets forth tenant improvement and leasing commission costs on a rentable square foot basis for all new and renewal leases signed during the twelve months ended December 31, 2014:

 
New
 
Renewal
Tenant improvements (per rentable square foot)
$31.88
 
$4.93
Leasing commissions (per rentable square foot)
$8.78
 
$2.05

The following table sets forth a summary schedule of the lease expirations at our consolidated properties for leases in place as of December 31, 2014 (dollars in thousands, except per square foot data):

34

Year of Lease Expiration(1)
Number of
Leases
Expiring
 
Leased
Square Feet
 
% of Leased
Square Feet
 
Annualized
Cash Basis
Rent(2)
 
% of
Annualized
Cash Basis
Rent
 
Average Base
Rent per
Square
Foot(2)(3)
MTM
6

 
31,971

 
0.4
%
 
$
404

 
0.3
%
 
$
12.62

2015
88

 
598,526

 
7.5
%
 
9,072

 
7.1
%
 
15.16

2016
97

 
766,234

 
9.5
%
 
13,977

 
10.9
%
 
18.24

2017
110

 
1,315,904

 
16.4
%
 
20,083

 
15.7
%
 
15.26

2018
91

 
952,444

 
11.9
%
 
13,920

 
10.9
%
 
14.61

2019
89

 
1,026,173

 
12.8
%
 
13,713

 
10.7
%
 
13.36

2020
68

 
1,211,539

 
15.1
%
 
17,107

 
13.4
%
 
14.12

2021
31

 
305,176

 
3.8
%
 
4,164

 
3.3
%
 
13.65

2022
27

 
283,822

 
3.5
%
 
4,184

 
3.3
%
 
14.74

2023
15

 
533,296

 
6.6
%
 
11,747

 
9.2
%
 
22.03

2024
25

 
462,715

 
5.8
%
 
8,522

 
6.7
%
 
18.42

Thereafter
46

 
540,775

 
6.7
%
 
10,901

 
8.5
%
 
20.16

Total / Weighted Average
693

 
8,028,575

 
100.0
%
 
$
127,794

 
100.0
%
 
$
15.92

 
(1) 
We classify leases that expired or were terminated on the last day of the quarter as leased square footage since the tenant is contractually entitled to the space.
(2) 
Annualized Cash Basis Rent, which is calculated as the contractual rent due under the terms of the lease, without taking into account rent abatements, is reflected on a triple-net equivalent basis, by deducting operating expense reimbursements that are included, along with base rent, in the contractual payments of our full-service leases. The operating expense reimbursements primarily relate to real estate taxes and insurance expenses. Includes leased spaces that are not yet occupied.
(3) 
Represents Annualized Cash Basis Rent at December 31, 2014, divided by the square footage of the expiring leases.

Our average effective annual rental rate per square foot on a cash basis for each of the previous five years is as follows:
 
 
Weighted Average
Base Rent per
Square Foot(1)
2010
$
10.61

2011
11.84

2012
11.83

2013
13.58

2014
15.22

 
(1) 
Annualized cash basis rent, which is calculated as the contractual rent due under the terms of the lease, without taking into account rent abatements, is reflected on a triple-net equivalent basis, by deducting operating expense reimbursements that are included, along with base rent, in the contractual payments of our full-service leases. The operating expense reimbursements primarily relate to real estate taxes and insurance expenses. The annualized cash basis rent is divided by the total square footage under the terms of the respective leases from which the annualized cash basis rent is derived. Includes leased spaces that are not yet occupied.

Our weighted average occupancy rates for each of the previous five years are summarized as follows:
 
 
Weighted Average
Occupancy Rates
2010
84.1
%
2011
81.3
%
2012
83.3
%
2013
84.6
%
2014
86.5
%


35

ITEM 3.
LEGAL PROCEEDINGS

We are subject to legal proceedings and claims arising in the ordinary course of our business. In the opinion of our management, as of December 31, 2014, we are not involved in any material litigation, nor, to management’s knowledge, is any material litigation threatened against us or the Operating Partnership.

ITEM 4.
MINE SAFETY DISCLOSURES

Not applicable.


36

PART II

ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

Our common shares are listed on the New York Stock Exchange (“NYSE”) under the symbol “FPO.” Our common shares began trading on the NYSE upon the closing of our initial public offering in October 2003. At December 31, 2014, there were 50 common shareholders of record. However, because many of our common shares are held by brokers and other institutions on behalf of shareholders, we believe there are substantially more beneficial holders of our common shares than record holders.

The following table sets forth the high and low sales prices for our common shares and the dividends paid per common share for 2014 and 2013.
 
 
Price Range
 
Dividends
Per Share
2014
High
 
Low
 
Fourth Quarter
$
12.79

 
$
11.53

 
$
0.15

Third Quarter
13.52

 
11.70

 
0.15

Second Quarter
13.61

 
12.36

 
0.15

First Quarter
13.13

 
11.47

 
0.15

 
Price Range
 
Dividends
Per Share
2013
High
 
Low
 
Fourth Quarter
$
13.01

 
$
10.96

 
$
0.15

Third Quarter
14.63

 
12.19

 
0.15

Second Quarter
16.13

 
12.11

 
0.15

First Quarter
14.90

 
12.55

 
0.15


On January 27, 2015, we declared a dividend of $0.15 per common share, equating to an annualized dividend of $0.60 per common share. The dividend was paid on February 17, 2015 to common shareholders of record as of February 10, 2015. We continue to believe that this annualized dividend amount is consistent with our strategic and capital plan, and will enable us to improve our balance sheet and finance future growth.

On a quarterly basis, our management team recommends a distribution amount that must then be approved by our Board of Trustees in its sole discretion. Our ability to make future cash distributions will be dependent upon, among other things (i) the taxable income and cash flow generated by our operating activities; (ii) cash generated by, or used in, our financing and investing activities; and (iii) the annual distribution requirements under the REIT provisions of the Internal Revenue Code described in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Distributions” and such other factors as the Board of Trustees deems relevant. Our ability to make cash distributions will also be limited by the covenants contained in our Operating Partnership agreement and our financing arrangements as well as limitations imposed by state law and any agreements governing any future indebtedness. See “Item 1A – Risk Factors – Risks Related to Our Business and Properties – Covenants in our debt agreements could adversely affect our liquidity and financial condition” and “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources.” Historically, we have generated sufficient cash flows from operating activities to fund distributions. We may rely on borrowings under our unsecured revolving credit facility or may make taxable distributions of our shares or securities to make any distributions in excess of cash available from operating activities.

Sales of Unregistered Equity Securities and Issuer Repurchases

Other than as set forth below in connection with satisfying a contingent consideration obligation, we did not sell any unregistered equity securities during the twelve months ended December 31, 2014. During 2014, no common Operating Partnership units were redeemed with available cash and no common Operating Partnership units were redeemed for common shares.


37

During 2014, we issued 3,125 common Operating Partnership units to the seller of 840 First Street, NE, which we acquired in 2011. The issuance of the 3,125 common Operating Partnership units satisfied our remaining contingent consideration obligation to the seller of 840 First Street, NE. These common Operating Partnership units were issued in reliance upon exemptions from registration under Section 4(2) of the Securities Act of 1933, as amended (the “Securities Act”), and/or Regulation D promulgated under the Securities Act (“Regulation D”). Each of the limited partners represented to the Operating Partnership that it was an “accredited investor” as defined in Regulation D and that it was acquiring the common Operating Partnership units for investment purposes. The Operating Partnership issued the units only to the former owners of the property and did not engage in a general solicitation in connection with the issuance.

Issuer Purchases of Equity Securities

During the quarter ended December 31, 2014, certain employees surrendered common shares owned by them to satisfy their statutory minimum federal income tax obligation associated with the vesting of restricted common shares of beneficial interest issued under our 2009 Equity Compensation Plan, as amended.

The following table summarizes all of the repurchases during the fourth quarter of 2014.
 
Period
Total Number of
Shares
Purchased
 
Average Price
Paid Per Share(1)
 
Total Number Of
Shares Purchased
As Part Of Publicly
Announced Plans
Or Programs
 
Maximum Number
Of Shares That May
Yet Be Purchased
Under The Plans Or
Programs
October 1, 2014 through October 31, 2014
8,613

 
$
12.08

 
N/A
 
N/A
November 1, 2014 through November 30, 2014
—

 
—

 
N/A
 
N/A
December 1, 2014 through December 31, 2014
—

 
—

 
N/A
 
N/A
Total
8,613

 
$
12.08

 
N/A
 
N/A
 
(1) 
The price paid per share is based on the closing price of our common shares as of the date of the determination of the statutory minimum federal income tax.

38

Share Return Performance

The following graph compares the cumulative total return on our common shares with the cumulative total return of the S&P 500 Stock Index and The MSCI US REIT Index for the period from December 31, 2009 through December 31, 2014 assuming the investment of $100 in each of us and the two indices, on December 31, 2009, and the reinvestment of common dividends. The performance reflected in the graph is not necessarily indicative of future performance. We will not make or endorse any predictions as to our future share performance.

COMPARISON OF CUMULATIVE TOTAL RETURNS FOR THE PERIOD
DECEMBER 31, 2009 THROUGH DECEMBER 31, 2014
FIRST POTOMAC REALTY TRUST COMMON STOCK AND S&P 500 AND
THE MSCI US REIT INDEX (RMS)
 
 
 
Total Return Index from 12/31/09
to the Period Ended
Index
12/31/09
 
12/31/10
 
12/31/11
 
12/31/12
 
12/31/13
 
12/31/14
First Potomac Realty Trust
100.00

 
140.95

 
115.31

 
116.42

 
114.50

 
127.52

MSCI US REIT (RMS)
100.00

 
128.48

 
139.65

 
164.46

 
168.52

 
219.72

S&P 500
100.00

 
115.06

 
117.49

 
136.30

 
180.44

 
205.14


The foregoing graph and chart shall not be deemed incorporated by reference by any general statement incorporating by reference this Annual Report on Form 10-K into any filing under the Securities Act of 1933, as amended, or under the Securities Exchange Act of 1934, as amended, except to the extent we specifically incorporate this information by reference, and shall not be deemed filed under those acts.


39

ITEM 6.
SELECTED FINANCIAL DATA

The following table presents selected financial information of our Company and our subsidiaries. The financial information has been derived from the consolidated balance sheets and consolidated statements of operations.

The following financial information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.
 
 
Years Ended December 31,
(amounts in thousands, except per share amounts)
2014
 
2013
 
2012
 
2011
 
2010
 
 
 
 
 
 
 
(unaudited)
Operating Data:
 
 
 
 
 
 
 
 
 
Total revenues
$
161,652

 
$
148,815

 
$
142,962

 
$
123,668

 
$
87,913

Income (loss) from continuing operations
15,559

 
(10,761
)
 
(24,324
)
 
(15,474
)
 
(20,524
)
Income from discontinued operations
1,484

 
21,742

 
15,943

 
6,722

 
8,849

Net income (loss)
17,043

 
10,981

 
(8,381
)
 
(8,752
)
 
(11,675
)
Less: Net (income) loss attributable to noncontrolling interests
(199
)
 
93

 
986

 
688

 
232

Net income (loss) attributable to First Potomac Realty Trust
16,844

 
11,074

 
(7,395
)
 
(8,064
)
 
(11,443
)
Less: Dividends on preferred shares
(12,400
)
 
(12,400
)
 
(11,964
)
 
(8,467
)
 
—

Net income (loss) attributable to common shareholders
$
4,444

 
$
(1,326
)
 
$
(19,359
)
 
$
(16,531
)
 
$
(11,443
)
Basic and diluted earnings per common share:
 
 
 
 
 
 
 
 
 
Income (loss) from continuing operations
$
0.05

 
$
(0.41
)
 
$
(0.70
)
 
$
(0.48
)
 
$
(0.56
)
Income from discontinued operations
0.02

 
0.38

 
0.30

 
0.13

 
0.23

Net income (loss)
$
0.07

 
$
(0.03
)
 
$
(0.40
)
 
$
(0.35
)
 
$
(0.33
)
Cash dividends declared and paid per common share
$
0.60

 
$
0.60

 
$
0.80

 
$
0.80

 
$
0.80

 
At December 31,
(amounts in thousands)
2014
 
2013
 
2012
 
2011
 
2010
Balance Sheet Data:
 
 
 
 
 
 
 
 
 
Total assets
$
1,618,460

 
$
1,502,460

 
$
1,717,748

 
$
1,739,752

 
$
1,396,682

Debt(1)
813,637

 
673,648

 
933,864

 
945,023

 
725,032

Series A Preferred Shares
160,000

 
160,000

 
160,000

 
115,000

 
—


(1) 
Includes the mortgage debt balance of our rental properties that have been classified as held-for-sale at December 31, 2014 and is reflected in "Liabilities held-for-sale" on our consolidated balance sheets. For more information, see note 10, Dispositions.



40

ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this Annual Report on Form 10-K. The discussion and analysis is derived from the consolidated operating results and activities of First Potomac Realty Trust. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” or elsewhere in this Annual Report on Form 10-K. See “Risk Factors” and “Special Note About Forward-Looking Statements.”

Overview

We are a leader in the ownership, management, development and redevelopment of office and business park properties in the greater Washington, D.C. region. We strategically focus on acquiring and redeveloping properties that we believe can benefit from our intensive property management, leasing expertise, market knowledge and established relationships, and seek to reposition these properties to increase their profitability and value. Our portfolio primarily contains a mix of single-tenant and multi-tenant office properties and business parks. Office properties are single-story and multi-story buildings that are primarily for office use; and business parks contain buildings with office features combined with some industrial property space. We separate our properties into four distinct reporting segments, which we refer to as the Washington, D.C., Maryland, Northern Virginia and Southern Virginia reporting segments.

At December 31, 2014, we wholly owned or had a controlling interest in properties totaling 8.8 million square feet and had a noncontrolling ownership interest in properties totaling an additional 0.9 million square feet through five unconsolidated joint ventures. We also owned land that can support 1.4 million square feet of additional development. Our consolidated properties were 87.9% occupied by 582 tenants at December 31, 2014. We did not include square footage that was in development or redevelopment, which totaled 0.2 million square feet at December 31, 2014, in our occupancy calculation. We derive substantially all of our revenue from leases of space within our properties.

The primary source of our revenue is rent received from tenants under long-term (generally three to ten years) operating leases at our properties, including reimbursements from tenants for certain operating costs. Additionally, we may generate earnings from the sale of assets to third parties or contributed into joint ventures.

Our long-term growth will principally be driven by our ability to:
 
•
maintain and increase occupancy rates and/or increase rental rates at our properties;
•
continue to grow our portfolio through acquisitions of new properties, potentially through joint ventures;
•
sell non-core assets to third parties, or contribute properties to joint ventures, at favorable prices;
 
•
develop and redevelop existing assets; and
•
execute initiatives designed to increase balance sheet capacity and expand the potential sources of capital.

Significant 2014 Activity

•
Executed 1.6 million square feet of leases, including 0.8 million square feet of new leases;
•
Increased leased percentages year-over-year from 88.1% to 91.3% and occupied percentages from 85.8% to 87.9%;
•
Acquired three office buildings, which totaled 401,000 square feet, for an aggregate purchase price of $188.0 million; and
•
Sold six properties, which totaled 811,000 square feet, for aggregate net proceeds of $97.7 million.


Our total assets were $1.6 billion at December 31, 2014 compared with $1.5 billion at December 31, 2013.


41

Richmond Portfolio Sale
Consistent with our previously disclosed capital recycling strategy, effective as of February 9, 2015, we entered into a binding contract to sell our Richmond, Virginia portfolio, which includes Chesterfield Business Center, Hanover Business Center, Park Central, Virginia Technology Center and a three-acre parcel of undeveloped land, and in the aggregate is comprised of 19 buildings totaling 828,000 square feet. We anticipate closing the sale in the first half of 2015. However, we can provide no assurances regarding the timing or pricing of the sale of the Richmond Portfolio, or that the sale will occur at all. With the sale of our Richmond portfolio, we will no longer own any properties in the Richmond area and will have made a strategic shift away from the Richmond market. In accordance with ASU 2014-08, which we prospectively adopted in the second quarter of 2014, our Richmond portfolio was classified as held-for-sale at December 31, 2014 and the operating results are reflected within discontinued operations for each of the periods presented in this Annual Report on Form 10-K.

Development and Redevelopment Activity

We will place completed development and redevelopment assets in service upon the earlier of one year after major construction activity is deemed to be substantially complete or upon occupancy. We construct office buildings and/or business parks on a build-to-suit basis or with the intent to lease upon completion of construction. We own developable land that can accommodate 1.4 million square feet of additional building space, of which, 0.7 million is located in the Washington, D.C. reporting segment, 0.1 million in the Maryland reporting segment, 0.5 million in the Northern Virginia reporting segment and 0.1 million in the Southern Virginia reporting segment.

During the third quarter of 2014, we signed a lease for 167,000 square feet at a to-be-constructed building in our Northern Virginia reporting segment on vacant land that we have in our portfolio. We currently anticipate investing approximately $36 million to construct the new building, which excludes approximately $11 million of tenant improvements and approximately $2 million of combined leasing commissions and capitalized interest costs. We currently expect to complete construction of the new building in the fourth quarter of 2016. However, we can provide no assurance regarding the timing, costs or results of the project. At December 31, 2014, our total investment in the development project was $6.9 million, which included the original cost basis of the applicable portion of the vacant land of $5.2 million. The majority of the costs incurred as of December 31, 2014 in excess of the original cost basis of the land relate to site preparation costs.

On August 4, 2011, we formed a joint venture with an affiliate of Perseus Realty, LLC to acquire Storey Park in our Washington, D.C. reporting segment. At the time, the site was leased to Greyhound Lines, Inc. (“Greyhound”), which subsequently relocated its operations. Greyhound’s lease expired on August 31, 2013, at which time the property was placed into development. The joint venture anticipates developing a mixed-use project on the 1.6 acre site, which can accommodate up to 712,000 square feet. At December 31, 2014, our total investment in the development project was $55.4 million, which included the original cost basis of the property of $43.3 million. The majority of the costs in excess of the original cost basis relate to capitalized architectural fees and site preparation costs. We are currently exploring our options related to this property; however, until a definitive plan for the property has been reached and we begin significant development activities, we cannot determine the total cost of the project or the anticipated completion date.

On December 28, 2010, we acquired 440 First Street, NW, a vacant eight-story office building in our Washington, D.C. reporting segment. In October 2013, we substantially completed the redevelopment of the 139,000 square foot property. At December 31, 2014, the property was 56.8% leased and 36.3% occupied. During the fourth quarter of 2014, all vacant space at the property was placed in-service. At December 31, 2014, our total investment in the redevelopment project was $55.5 million, which included the original cost basis of the property of $23.6 million.

We did not place-in service any development efforts during 2014. At December 31, 2014, we had no completed redevelopment efforts that have yet to be placed in service.

Informal SEC Inquiry

As previously disclosed in our Annual Reports on Form 10-K for the years ended December 31, 2013 and 2012, we were informed that the SEC initiated an informal inquiry relating to the matters that were the subject of the Audit Committee’s internal investigation regarding the material weakness previously identified in our Annual Report on Form 10-K for the year ended December 31, 2011. The SEC staff has informed us that this inquiry should not be construed as an indication by the SEC or its staff that any violations of law have occurred, nor considered a reflection upon any person, entity or security. We have been, and intend to continue, voluntarily cooperating fully with the SEC. The scope and outcome of this matter cannot be determined at this time.


42


Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with GAAP that require us to make certain estimates and assumptions. Critical accounting policies and estimates are those that require subjective or complex judgments and are the policies and estimates that we deem most important to the portrayal of our financial condition, results of operations and cash flows. It is possible that the use of different reasonable estimates or assumptions in making these judgments could result in materially different amounts being reported in our consolidated financial statements. Our critical accounting policies and estimates relate to revenue recognition, including evaluation of the collectability of accounts and notes receivable, impairment of long-lived assets, purchase accounting for acquisitions of rental property, derivative instruments and share-based compensation.

The following is a summary of certain aspects of these critical accounting policies and estimates.

Revenue Recognition

We generate substantially all of our revenue from leases on our properties. We recognize rental revenue on a straight-line basis over the term of our leases, which includes fixed-rate renewal periods leased at below market rates at acquisition or inception. Accrued straight-line rents represent the difference between rental revenue recognized on a straight-line basis over the term of the respective lease agreements and the rental payments contractually due for leases that contain abatement or fixed periodic increases. We consider current information, credit quality, historical trends, economic conditions and other events regarding the tenants’ ability to pay their obligations in determining if amounts due from tenants, including accrued straight-line rents, are ultimately collectible. The uncollectible portion of the amounts due from tenants, including accrued straight-line rents, is charged to property operating expense in the period in which the determination is made.

Tenant leases generally contain provisions under which the tenants reimburse us for a portion of property operating expenses and real estate taxes incurred by us. Such reimbursements are recognized in the period in which the expenses are incurred. We record a provision for losses on estimated uncollectible accounts receivable based on our analysis of risk of loss on specific accounts. Lease termination fees are recognized on the date of termination when the related lease or portion thereof is cancelled, the collectability of the fee is reasonably assured and we have possession of the terminated space.

In May 2014, FASB issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. ASU 2014-09 will replace most existing revenue recognition guidance when it becomes effective on January 1, 2017. Early adoption is not permitted. ASU 2014-09 permits the use of either the retrospective or cumulative effect transition method. We have not yet selected a transition method and are evaluating the impact that ASU 2014-09 will have on our consolidated financial statements and related disclosures.

Accounts and Notes Receivable

We must make estimates of the collectability of our accounts and notes receivable related to minimum rent, deferred rent, tenant reimbursements, lease termination fees and interest and other income. We specifically analyze accounts receivable and historical bad debt experience, tenant concentrations, tenant creditworthiness and current economic trends when evaluating the adequacy of our allowance for doubtful accounts receivable. These estimates have a direct impact on our net income as a higher required allowance for doubtful accounts receivable will result in lower net income. The uncollectible portion of the amounts due from tenants, including straight-line rents, is charged to property operating expense in the period in which the determination is made. We consider similar criteria in assessing impairment associated with outstanding loans or notes receivable and whether any allowance for anticipated credit loss is appropriate.

Investments in Rental Property and Rental Property Entities

Rental property is initially recorded at fair value, if acquired in a business combination, or initial cost when constructed or acquired in an asset purchase. Improvements and replacements are capitalized at cost when they extend the useful life, increase capacity or improve the efficiency of the asset. Repairs and maintenance are charged to expense when incurred. Depreciation and amortization are recorded on a straight-line basis over the estimated useful lives of the assets. The estimated useful lives of our assets, by class, are as follows:


43

 
Buildings
 
39 years
Building improvements
 
5 to 20 years
Furniture, fixtures and equipment
 
5 to 15 years
Lease related intangible assets
 
The term of the related lease
Tenant improvements
 
Shorter of the useful life of the asset or the term of the related lease

We regularly review market conditions for possible impairment of a property’s carrying value. When circumstances such as adverse market conditions, changes in management’s intended holding period or potential sale to a third party indicate a possible impairment of the carrying value of a property, an impairment analysis is performed. We assess potential impairments based on an estimate of the future undiscounted cash flows (excluding interest charges) expected to result from the property’s use and eventual disposition. This estimate is based on projections of future revenues, expenses, capital improvement costs to maintain the operating capacity, expected holding periods and capitalization rates. These cash flows consider factors such as expected market trends and leasing prospects, as well as the effects of leasing demand, competition and other factors. If impairment exists due to the inability to recover the carrying value of a real estate investment based on forecasted undiscounted cash flows, an impairment loss is recorded to the extent that the carrying value exceeds the estimated fair value of the property. Further, we will record an impairment loss if we expect to dispose of a property, in the near term, at a price below carrying value. In such an event, we will record an impairment loss based on the difference between a property’s carrying value and its projected sales price less any estimated costs to sell.
We will classify a building as held-for-sale in accordance with GAAP in the period in which we have made the decision to dispose of the building, our Board of Trustees or a designated delegate has approved the sale, there is a high likelihood a binding agreement to purchase the property will be signed under which the buyer will be required to commit a significant amount of nonrefundable cash and no significant financing contingencies exist that could cause the transaction not to be completed in a timely manner. We will cease recording depreciation on a building once it has been classified as held-for-sale. In the second quarter of 2014, we prospectively adopted ASU 2014-08, which impacts the presentation of operations and gains or losses from disposed properties and properties classified as held-for-sale. For more information, see note 2(q), Summary of Significant Accounting Policies - Application of New Accounting Standards, in the notes to our consolidated financial statements.
If the building does not qualify as a discontinued operation under ASU 2014-08 we will classify the building’s operating results, together with any impairment charges and any gains or losses on the sale of the building, in continuing operations for all periods presented in our consolidated statements of operations. We will classify the assets and liabilities related to the building as held-for-sale in our consolidated balance sheet for the period the held-for-sale criteria were met.
If the building does qualify as a discontinued operation under ASU 2014-08, we will classify the building’s operating results, together with any impairment charges and any gains or losses on the sale of the building, in discontinued operations in our consolidated statements of operations for all periods presented and classify the assets and liabilities related to the building as held-for-sale in our consolidated balance sheets for the periods presented. Interest expense is reclassified to discontinued operations only to the extent the disposed or held-for-sale property is secured by specific mortgage debt and the mortgage debt will not be assigned to another property owned by us after the disposition.

We recognize the fair value, if sufficient information exists to reasonably estimate the fair value, of any liability for conditional asset retirement obligations when assumed or incurred, which is generally upon acquisition, construction, development or redevelopment and/or through the normal operation of the asset.

We capitalize interest costs incurred on qualifying expenditures for real estate assets under development or redevelopment, which include our investments in assets owned through unconsolidated joint ventures that are under development or redevelopment, while being readied for their intended use in accordance with accounting requirements regarding capitalization of interest. We will capitalize interest when qualifying expenditures for the asset have been made, activities necessary to get the asset ready for its intended use are in progress and interest costs are being incurred. Capitalized interest also includes interest associated with expenditures incurred to acquire developable land while development activities are in progress. We also capitalize direct compensation costs of our construction personnel who manage the development and redevelopment projects, but only to the extent the employee’s time can be allocated to a project. Any portion of construction management costs not directly attributable to a specific project are recognized as general and administrative expense in the period incurred. We do not capitalize any other general and administrative costs such as office supplies, office rent expense or an overhead allocation to our development or redevelopment projects. Capitalized compensation costs were immaterial during 2014, 2013 and 2012. Capitalization of interest ends when the asset is substantially complete and ready for its intended use, but no later than one year from completion of major construction activity, if the property is not occupied. We place redevelopment and development

44

assets into service at this time and commence depreciation upon the substantial completion of tenant improvements and the recognition of revenue. Capitalized interest is depreciated over the useful life of the underlying assets, commencing when those assets are placed into service.

Purchase Accounting

Acquisitions of rental property, including any associated intangible assets, are measured at fair value at the date of acquisition. Any liabilities assumed or incurred are recorded at their fair value at the time of acquisition. The fair value of the acquired property is allocated between land and building (on an as-if vacant basis) based on management’s estimate of the fair value of those components for each type of property and to tenant improvements based on the depreciated replacement cost of the tenant improvements, which approximates their fair value. The fair value of the in-place leases is recorded as follows:

•
the fair value of leases in-place on the date of acquisition is based on absorption costs for the estimated lease-up period in which vacancy and foregone revenue are avoided due to the presence of the acquired leases;

•
the fair value of above and below-market in-place leases based on the present value (using a discount rate that reflects the risks associated with the acquired leases) of the difference between the contractual rent amounts to be paid under the assumed lease and the estimated market lease rates for the corresponding spaces over the remaining non-cancelable terms of the related leases, which range from one to fourteen years; and

•
the fair value of intangible tenant or customer relationships.

Our determination of these fair values requires us to estimate market rents for each of the leases and make certain other assumptions. These estimates and assumptions affect the rental revenue, and depreciation and amortization expense recognized for these leases and associated intangible assets and liabilities.

Derivative Instruments

We are exposed to certain risks arising from business operations and economic factors. We use derivative financial instruments to manage exposures that arise from business activities in which our future exposure to interest rate fluctuations is unknown. The objective in the use of an interest rate derivative is to add stability to interest expenses and manage exposure to interest rate changes. We do not use derivatives for trading or speculative purposes and we intend to enter into derivative agreements only with counterparties that we believe have a strong credit rating to mitigate the risk of counterparty default or insolvency. No hedging activity can completely insulate us from the risks associated with changes in interest rates. Moreover, interest rate hedging could fail to protect us or adversely affect us because, among other things:

•
available interest rate hedging may not correspond directly with the interest rate risk for which we seek protection;
•
the duration of the hedge may not match the duration of the related liability;
•
the party owing money in the hedging transaction may default on its obligation to pay; and
•
the credit quality of the party owing money on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign its side of the hedging transaction.

We may designate a derivative as either a hedge of the cash flows from a debt instrument or anticipated transaction (cash flow hedge) or a hedge of the fair value of a debt instrument (fair value hedge). All derivatives are recognized as assets or liabilities at fair value. For effective hedging relationships, the effective portion of the change in the fair value of the assets or liabilities is recorded within equity (cash flow hedge) or through earnings (fair value hedge). Ineffective portions of derivative transactions will result in changes in fair value recognized in earnings. For a cash flow hedge, we record our proportionate share of unrealized gains or losses on our derivative instruments associated with our unconsolidated joint ventures within equity and “Investment in affiliates.” We incorporate credit valuation adjustments to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of our derivative contracts for the effect of nonperformance risk, we have considered the impact of netting any applicable credit enhancements, such as collateral postings, thresholds, mutual inputs and guarantees.
Share-Based Payments


We measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. For options awards, we use a Black-Scholes option-pricing model. Expected volatility is based on an assessment of our realized volatility over the preceding period that is equivalent to the award’s expected life. The expected

45

term represents the period of time the options are anticipated to remain outstanding as well as our historical experience for groupings of employees that have similar behavior and considered separately for valuation purposes. For non-vested share awards that vest over a predetermined time period, we use the outstanding share price at the date of issuance to fair value the awards. For non-vested shares awards that vest based on performance conditions, we use a Monte Carlo simulation (risk-neutral approach) to determine the value and derived service period of each tranche. The expense associated with the share-based awards will be recognized over the period during which an employee is required to provide services in exchange for the award - the requisite service period (usually the vesting period). The fair value for all share-based payment transactions are recognized as a component of income or loss from continuing operations.

Results of Operations

Comparison of the Years Ended December 31, 2014, 2013 and 2012

During 2014, we acquired 11 Dupont Circle, NW, 1775 Wiehle Avenue and 1401 K Street, NW for an aggregate purchase price of $188.0 million. During 2013, we acquired a building at Redland Corporate Center for $30.0 million. We did not acquire any properties in 2012. For the discussion below, these four properties will collectively be referred to as the “Acquired Properties.”

We sold Corporate Campus at Ashburn Center and Owings Mills Business Park in June 2014 and October 2014, respectively, which were both subsequent to our adoption of ASU 2014-08. In accordance with ASU 2014-08, the operating results and gain on sale of Corporate Campus at Ashburn Center and the operating results of and impairment charge with respect to Owings Mills Business Park are reflected in continuing operations in our consolidated statements of operations for each of the periods presented. In August 2013, we placed Storey Park into development at the conclusion of its sole tenant’s lease. In October 2013, we substantially completed the redevelopment of 440 First Street, NW, a 139,000 square foot property. For purposes of comparison of the years ended December 31, 2014 and 2013, Corporate Campus at Ashburn Center, Owings Mills Business Park, Storey Park and 440 First Street, NW are collectively referred to as the "Non-Comparable Properties."

During 2012, we placed redevelopment projects at Three Flint Hill and Davis Drive into service. For purposes of comparison of the years ended December 31, 2013 and 2012, Storey Park, 440 First Street, NW, Three Flint Hill and Davis Drive are collectively referred to as the “Non-Comparable Properties.”

The term “Comparable Portfolio” refers to all consolidated properties owned by us and in-service, with operating results reflected in our continuing operations, for the entirety of the periods presented. The operating results for our disposed properties (excluding Corporate Campus at Ashburn Center and Owings Mills Business Park, which have operating results reflected within continuing operations) and the Richmond Portfolio (Chesterfield Business Center, Hanover Business Center, Park Central and Virginia Technology Center), which was classified as held-for-sale at December 31, 2014, are reflected as discontinued operations for all the periods presented.

For discussion of the operating results of our reporting segments, the terms “Washington, D.C.”, “Maryland”, “Northern Virginia” and “Southern Virginia” will be used to describe the respective reporting segments.

Due to the timing of acquisitions and dispositions in 2015, which may or may not occur, we cannot determine if property operating revenues or expenses will increase during 2015 compared with 2014.
    
In the tables below, the designation “NM” is used to refer to a percentage that is not meaningful.

Total Revenues

Total revenues are summarized as follows:
 
 
Year Ended December 31,
 
 
 
Percent
Change
 
Year Ended December 31,
 
 
 
Percent
Change
(dollars in thousands)
2014
 
2013
 
Change
 
 
2013
 
2012
 
Change
 
Rental
$
128,226

 
$
118,337

 
$
9,889

 
8
%
 
$
118,337

 
$
114,032

 
$
4,305

 
4
%
Tenant reimbursements and other
$
33,426

 
$
30,478

 
$
2,948

 
10
%
 
$
30,478

 
$
28,930

 
$
1,548

 
5
%

46


Rental Revenue

Rental revenue is comprised of contractual rent, the impact of straight-line revenue and the amortization of deferred market rent assets and liabilities representing above and below market rate leases at acquisition. Rental revenue increased $9.9 million in 2014 compared with 2013. The Acquired Properties contributed $10.4 million of additional rental revenue during 2014 compared with 2013. The increase in rental revenue was partially offset by a decrease in rental revenue for the Non-Comparable Properties, which decreased $2.4 million during 2014 compared with 2013 due to a decline in rental revenue from Storey Park, as the property became vacant at the end of August 2013, at which time the property was placed into development, and the sale of both Corporate Campus at Ashburn Center and Owings Mills Business Park. The decrease in rental revenue form the Non-Comparable Properties was partially offset by an increase in rental revenue at 440 First Street, NW due to placing portions of the property in service during 2014 and 2013. Rental revenue for the Comparable Portfolio increased $1.9 million in 2014 compared with 2013 due to an increase in occupancy in the Comparable Portfolio. The weighted average occupancy of the Comparable Portfolio was 87.6% during 2014 compared with 85.2% during 2013. The increase in rental revenue in 2014 compared with 2013 includes $5.4 million for Washington, D.C., $2.6 million for Maryland, $1.5 million for Northern Virginia, and $0.4 million for Southern Virginia.

Rental revenue increased $4.3 million in 2013 compared with 2012. Rental revenue for the Comparable Portfolio increased $1.9 million in 2013 compared with 2012 due to an increase in occupancy in the Comparable Portfolio. The weighted average occupancy of the Comparable Portfolio was 85.2% during 2013 compared with 82.9% during 2012. The Non-Comparable Properties contributed $1.6 million of additional rental revenue during 2013 compared with 2012, primarily due to an increase in occupancy at Three Flint Hill, which increased to 82.9% at December 31, 2013 from 54.2% at December 31, 2012. The increase in rental revenue for the Non-Comparable Properties was partially offset by a decline in rental revenue from Storey Park, as the property became vacant at the end of August 2013, at which time, the property was placed into development. The Acquired Properties contributed $0.8 million of additional rental revenue in 2013 compared with 2012. The increase in rental revenue in 2013 compared with 2012 includes $0.6 million for Maryland, $3.6 million for Northern Virginia and $0.7 million for Southern Virginia. Rental revenue for Washington, D.C. decreased $0.6 million in 2013 compared with 2012.

Tenant Reimbursements and Other Revenues

Tenant reimbursements and other revenues include operating and common area maintenance costs reimbursed by our tenants as well as other incidental revenues such as lease termination payments, parking revenue and joint venture and construction related management fees. Tenant reimbursements and other revenues increased $2.9 million in 2014 compared with 2013. For the Comparable Portfolio, tenant reimbursements and other revenues increased $1.9 million in 2014 compared with 2013 primarily due to an increase in termination fee income and recoverable snow and ice removal costs in the first quarter of 2014. The Acquired Properties contributed $1.7 million of additional tenant reimbursements and other revenues in 2014 compared with 2013. The increase in tenant reimbursements and other revenues was partially offset by a decrease of $0.7 million for the Non-Comparable Properties during 2014 compared with 2013 due to the tenant vacating Storey Park in 2013, prior to the property being placed into development. The increase in tenant reimbursements and other revenues in 2014 compared with 2013 includes $0.3 million for Washington, D.C., $1.5 million for Maryland, $0.3 million for Northern Virginia, and $0.8 million for Southern Virginia.

Tenant reimbursements and other revenues increased $1.5 million in 2013 compared with 2012, primarily due to the Non-Comparable Properties, which contributed $1.2 million of additional tenant reimbursements and other revenues in 2013 compared with 2012. For the Comparable Portfolio, tenant reimbursements and other revenues remained relatively flat in 2013 compared with 2012 as an increase in occupancy, which led to higher recoverable operating expenses, was offset by a decrease in termination fee income due to a $1.0 million termination fee received from a tenant in Maryland in the second quarter of 2012. In addition, the Acquired Properties contributed additional tenant reimbursements and other revenues of $0.3 million in 2013 compared with 2012. The increase in tenant reimbursements and other revenues in 2013 compared with 2012 includes $1.6 million for Washington, D.C. and $1.0 million for Northern Virginia. Tenant reimbursements and other revenues decreased $1.1 million for Maryland and remained flat for Southern Virginia in 2013 compared with 2012.

Total Expenses

Property Operating Expenses

Property operating expenses are summarized as follows:
 

47

 
Year Ended December 31,
 
 
 
Percent
Change
 
Year Ended December 31,
 
 
 
Percent
Change
(dollars in thousands)
2014
 
2013
 
Change
 
 
2013
 
2012
 
Change
 
Property operating
$
43,252

 
$
38,280

 
$
4,972

 
13
%
 
$
38,280

 
$
34,322

 
$
3,958

 
12
%
Real estate taxes and insurance
$
17,360

 
$
16,074

 
$
1,286

 
8
%
 
$
16,074

 
$
14,185

 
$
1,889

 
13
%

Property operating expenses increased $5.0 million in 2014 compared with 2013, primarily due to the Acquired Properties, which contributed $3.8 million of additional property operating expenses in 2014 compared with 2013. The Non-Comparable Properties contributed $0.7 million of additional property operating expenses in 2014 compared with 2013 due to placing the majority of redevelopment space at 440 First Street, NW into service during 2014. In addition, the Comparable Portfolio contributed $0.5 million of additional property operating expenses in 2014 compared with 2013 due to an increase in snow and ice removal costs during the first quarter of 2014. The increase in property operating expenses in 2014 compared with 2013 includes $2.2 million for Washington, D.C., $1.7 million for Maryland, $0.8 million for Northern Virginia and $0.3 million for Southern Virginia.

Property operating expenses increased $4.0 million in 2013 compared with 2012. The increase is primarily due to the Comparable Portfolio, which contributed $3.6 million of additional property operating expenses in 2013 compared with 2012, due to an increase in occupancy, which resulted in higher variable operating expenses and reserves for anticipated bad debt expense. The increase in property operating expenses for the Comparable Portfolio was also due to an increase in snow and ice removal costs in 2013 compared with 2012. The Non-Comparable Properties contributed additional property operating expenses of $0.3 million in 2013 compared with 2012. In addition, the Acquired Properties contributed additional property operating expenses of $0.1 million in 2013 compared with 2012. The increase in property operating expenses in 2013 compared with 2012 includes $1.9 million for Washington, D.C., $0.2 million for Maryland, $1.1 million for Northern Virginia and $0.8 million for Southern Virginia.

Real estate taxes and insurance expense increased $1.3 million in 2014 compared with 2013 due to the Acquired Properties, which contributed $1.6 million of additional real estate taxes and insurance. For the Comparable Portfolio, real estate taxes and insurance expense increased $0.2 million in 2014 compared with 2013 due to higher real estate tax assessments, particularly in the Maryland region. Real estate taxes and insurance for the Non-Comparable Properties decreased $0.5 million in 2014 compared with 2013 due to capitalizing a full-year of real estate taxes and insurance expense in 2014 for Storey Park, which was placed in development at the end of August 2013. The increase in real estate taxes and insurance expense in 2014 compared with 2013 includes $0.8 million for Washington, D.C., $0.5 million for Washington, D.C. and $0.1 million for Southern Virginia. For Northern Virginia, real estate taxes and insurance decreased $0.1 million in 2014 compared with 2013.

Real estate taxes and insurance expense increased $1.9 million in 2013 compared with 2012. The increase is primarily due to the Non-Comparable Properties, which contributed $1.0 million of additional real estate taxes and insurance expense in 2013 compared with 2012. For the Comparable Portfolio, real estate taxes and insurance expense increased $0.8 million in 2013 compared with 2012 due to higher real estate tax assessments. In addition, the Acquired Properties contributed additional real estate taxes and insurance expense of $0.1 million in 2013 compared with 2012. The increase in real estate taxes and insurance expense in 2013 compared with 2012 includes $0.9 million for Washington, D.C., $0.3 million for Maryland and $0.7 million for Northern Virginia. Real estate taxes and insurance expense remained flat for Southern Virginia in 2013 compared with 2012.

Other Operating Expenses

General and administrative expenses are summarized as follows:
 
 
Year Ended December 31,
 
 
 
Percent
Change
 
Year Ended December 31,
 
 
 
Percent
Change
(dollars in thousands)
2014
 
2013
 
Change
 
 
2013
 
2012
 
Change
 
 
$
21,156

 
$
21,979

 
$
(823
)
 
(4
)%
 
$
21,979

 
$
23,568

 
$
(1,589
)
 
(7
)%

General and administrative expenses decreased $0.8 million during 2014 compared with 2013 due to $1.8 million of personnel separation costs and $0.3 million of legal fees associated with an informal SEC inquiry, both of which were incurred during 2013. The decrease in general and administrative expenses in 2014 compared with 2013 was partially offset by an increase in employee compensation costs. We currently anticipate that general and administrative expenses for 2015 will be

48

flat or will slightly decrease compared with 2014. However, as discussed in “Item 1A—Risk Factors,” the informal inquiry initiated by the SEC could result in increased legal and/or accounting fees in 2015.

General and administrative expenses decreased $1.6 million during 2013 compared with 2012 as legal and accounting fees decreased $3.6 million in 2013, primarily due to approximately $4.5 million of fees incurred in connection with our internal investigation, which was completed in 2012, as well as personnel separation costs incurred in 2012. The decrease in general and administrative expenses in 2013 was partially offset by a $0.6 million increase in personnel separation costs in 2013 compared with 2012. In addition, we incurred $0.4 million of legal fees associated with an informal SEC inquiry during 2013 and experienced an increase in corporate rent expense in 2013 compared with 2012, due to a full-year impact of the expansion of our corporate offices. 

Acquisition costs are summarized as follows:
 
 
Year Ended December 31,
 
 
 
Percent
Change
 
Year Ended December 31,
 
 
 
Percent
Change
(dollars in thousands)
2014
 
2013
 
Change
 
 
2013
 
2012
 
Change
 
 
$
2,681

 
$
602

 
$
2,079

 
345
%
 
$
602

 
$
49

 
$
553

 
NM

Acquisition costs increased $2.1 million during 2014 compared with 2013. During 2014, we acquired three office buildings (two in Washington, D.C. and one in Northern Virginia) for an aggregate purchase price of $188.0 million. During 2013, we acquired an office building at Redland Corporate Center for $30.0 million.

Acquisition costs increased $0.6 million during 2013 compared with 2012 due to the acquisition of an office building at Redland Corporate Center in October 2013. We did not acquire any properties in 2012.


Depreciation and amortization expense is summarized as follows:
 
 
Year Ended December 31,
 
 
 
Percent
Change
 
Year Ended December 31,
 
 
 
Percent
Change
(dollars in thousands)
2014
 
2013
 
Change
 
 
2013
 
2012
 
Change
 
 
$
61,796

 
$
54,567

 
$
7,229

 
13
%
 
$
54,567

 
$
51,457

 
$
3,110

 
6
%

Depreciation and amortization expense includes depreciation of rental property and the amortization of intangible assets and leasing commissions. Depreciation and amortization expense increased $7.2 million in 2014 compared with 2013 due to the Acquired Properties, which contributed $7.1 million of additional depreciation and amortization expense in 2014. For the Comparable Portfolio, depreciation and amortization expense increased $1.4 million in 2014 compared with 2013 due to additional leasing and tenant improvement costs related to the increase in occupancy in our portfolio. Depreciation and amortization expense related to the Non-Comparable Properties decreased $1.3 million in 2014 compared with 2013 due to the sales of Corporate Campus at Ashburn Center and Owings Mills Business Park, and placing Storey Park in development at the end of August 2013, at which time we ceased recording depreciation on the building.

Depreciation and amortization expense increased $3.1 million in 2013 compared with 2012. The Non-Comparable Properties contributed additional depreciation and amortization expense of $1.6 million in 2014 compared with 2013 as redevelopment projects at Three Flint Hill and Davis Drive were placed into service during the third quarter of 2012. Depreciation and amortization expense attributable to the Comparable Portfolio increased $1.0 million in 2013 compared with 2012 primarily due to additional leasing costs incurred plus the placing into service of additional tenant and construction improvements. In addition, the Acquired Properties contributed additional depreciation and amortization expense of $0.5 million in 2013 compared with 2012.

Impairment of rental property is summarized as follows:
 
 
Year Ended December 31,
 
 
 
Percent
Change
 
Year Ended December 31,
 
 
 
Percent
Change
(dollars in thousands)
2014
 
2013
 
Change
 
 
2013
 
2012
 
Change
 
 
$
3,956

 
$
—

 
$
3,956

 
—

 
$
—

 
$
2,444

 
$
(2,444
)
 
(100
)%



49

In October 2014, we sold Owings Mills Business Park, a four-building business park located in our Maryland reporting segment. We recorded an impairment charge of $4.0 million on the four buildings at Owings Mills Business Park in the second quarter of 2014 based on the fair value of the property, less selling costs. We had previously recorded an impairment charge of $2.4 million in 2012 related to the four buildings at Owings Mills Business Park, which was based on the sale of two separate buildings at Owings Mills Business Park in 2012. We did not record any other impairment charges within continuing operations during 2014, 2013 or 2012.

Contingent consideration related to acquisition of property is summarized as follows:
 
 
Year Ended December 31,
 
 
 
Percent
Change
 
Year Ended December 31,
 
 
 
Percent
Change
(dollars in thousands)
2014
 
2013
 
Change
 
 
2013
 
2012
 
Change
 
 
$
—

 
$
(213
)
 
$
213

 
(100
)%
 
$
(213
)
 
$
152

 
$
(365
)
 
NM

On March 25, 2011, we acquired 840 First Street, NE, in Washington, D.C. for an aggregate purchase price of $90.0 million, with up to $10.0 million of additional consideration payable in common Operating Partnership units upon the terms of a lease renewal by the building’s sole tenant or the re-tenanting of the property through November 2013. Based on an assessment of the probability of renewal and anticipated lease rates, we recorded a contingent consideration obligation of $9.4 million at acquisition. In July 2011, the building’s sole tenant renewed its lease and, as a result, we issued 544,673 common Operating Partnership units to fulfill $7.1 million of our contingent consideration obligation. During the second quarter of 2013, we entered into an agreement to lease additional space at the property (which lease commenced in the fourth quarter of 2013) and, as a result, issued 35,911 common Operating Partnership units to the seller in the fourth quarter of 2013 in accordance with the terms of the purchase agreement. The $0.2 million reduction in contingent consideration recorded in 2013 is related to a reduction in the obligation as the period to re-tenant the property had expired. During the fourth quarter of 2013, we entered into an agreement to lease additional space at the property and, as a result, issued 3,125 common Operating Partnership units to the seller in February 2014 to fulfill the obligation.

As part of the consideration for our 2009 acquisition of Corporate Campus at Ashburn Center, we recorded a contingent consideration obligation arising from a fee agreement entered into with the seller pursuant to which we were obligated to pay additional consideration if certain returns were achieved over the five-year term of the agreement or if the property was sold within the term of the five-year agreement. In 2012, we recorded a $152 thousand increase in our contingent consideration liability related to Corporate Campus at Ashburn Center that reflected a reduction of the period to achieve the established returns. During June 2013, we achieved the specified returns and increased our liability to the seller. We paid the seller of Corporate Campus at Ashburn Center $1.7 million during the third quarter of 2013 to fulfill the obligation. The property was subsequently sold in June 2014.

Other (Income) Expenses

Interest expense is summarized as follows:
 
 
Year Ended December 31,
 
 
 
Percent
Change
 
Year Ended December 31,
 
 
 
Percent
Change
(dollars in thousands)
2014
 
2013
 
Change
 
 
2013
 
2012
 
Change
 
 
$
24,696

 
$
32,803

 
$
(8,107
)
 
(25
)%
 
$
32,803

 
$
40,602

 
$
(7,799
)
 
(19
)%


Interest expense decreased $8.1 million in 2014 compared with 2013 due to a lower outstanding debt balance and a lower applicable weighted average interest rate since January 1, 2013. Since January 1, 2013, we have lowered both our outstanding debt balance by $120.3 million and the applicable weighted average interest rate by 90 basis points. We amended and restated our unsecured revolving credit facility and unsecured term loan in October 2013, which reduced our LIBOR spreads to current market rates. In 2014, our weighted average borrowings under the unsecured revolving credit facility and the unsecured term loan totaled $436.1 million with a weighted average interest rate of 1.8%, compared with weighted average borrowings of $363.8 million with a weighted average interest rate of 3.0% in 2013. We anticipate interest expense will increase in 2015 compared with 2014 as a result of higher overall outstanding debt balances.
  
Interest expense decreased $7.8 million in 2013 compared with 2012, primarily due to reducing our outstanding debt by over $260 million in 2013. During 2013, we repaid outstanding debt with proceeds from the sale of our industrial portfolio, the issuance of 7.5 million common shares in May 2013, and amending and restating our unsecured revolving credit facility

50

and unsecured term loan in October 2013, which reduced our LIBOR spreads to current market rates. In 2013, our weighted average borrowings under the unsecured revolving credit facility and the unsecured term loan totaled $363.8 million with a weighted average interest rate of 3.0%, compared with weighted average borrowings of $394.8 million with a weighted average interest rate of 3.2% in 2012.
 
Interest and other income are summarized as follows:
 
 
Year Ended December 31,
 
 
 
Percent
Change
 
Year Ended December 31,
 
 
 
Percent
Change
(dollars in thousands)
2014
 
2013
 
Change
 
 
2013
 
2012
 
Change
 
 
$
6,799

 
$
6,373

 
$
426

 
7
%
 
$
6,373

 
$
6,047

 
$
326

 
5
%

In December 2010, we provided a $25.0 million mezzanine loan to the owners of 950 F Street, NW, a ten-story, 287,000 square-foot office/retail building located in Washington, D.C., which is secured by a portion of the owners’ interest in the property. On January 10, 2014, we amended and restated the loan to increase the outstanding balance to $34.0 million, and reduced the fixed interest rate from 12.5% to 9.75%. As part of amending the loan, we wrote-off $0.1 million of unamortized financing fees related to the origination of the mezzanine loan, which increased interest and other income in 2014 compared with 2013. In April 2011, we provided a $30.0 million mezzanine loan to the owners of America’s Square, a 461,000 square foot office complex in Washington, D.C., which has a fixed interest rate of 9.0%. In May 2013, the loan began requiring monthly principal payments, which reduced the outstanding balance of the loan. We recorded interest and other income related to these loans of $6.3 million during 2014 and $6.0 million during both 2013 and 2012. On January 27, 2015, the owners of America's Square gave notice of their intent to prepay, on or about February 24, 2015, the $29.7 million outstanding balance of the mezzanine loan. We expect to receive a yield maintenance payment of $2.4 million with the repayment of the loan.

In January 2013, we subleased 5,000 square feet of our corporate headquarters, and subleased an additional 2,700 square feet of our corporate headquarters at the end of the first quarter of 2014. During 2014 and 2013, we recognized $0.3 million and $0.2 million, respectively, of income associated with these subleases, which is reflected within “Interest and other income” in our consolidated statements of operations. We did not recognize any sublease income in 2012.

We anticipate that interest and other income will remain relatively flat in 2015 compared with 2014 as the expected yield maintenance payment of $2.4 million associated with the prepayment of the America's Square mezzanine loan in February 2015 will primarily offset the reduction in interest income associated with the prepaid loan.

Equity in (earnings) losses of affiliates is summarized as follows:
 
 
Year Ended December 31,
 
 
 
Percent
Change
 
Year Ended December 31,
 
 
 
Percent
Change
(dollars in thousands)
2014
 
2013
 
Change
 
 
2013
 
2012
 
Change
 
 
$
(775
)
 
$
47

 
$
(822
)
 
NM
 
$
47

 
$
(40
)
 
$
87

 
NM

Equity in (earnings) losses of affiliates reflects our aggregate ownership interest in the operating results of the properties in which we do not have a controlling interest.

The increase in income from our unconsolidated joint ventures in 2014 compared with 2013 was due to an increase in income from Prosperity Metro Plaza, which was due to an increase in occupancy in 2014, and Aviation Business Park, which recorded a gain in 2014 from the reversal of a potential contingent consideration obligation as the time period contractually prescribed to achieve the metric creating the obligation had expired.

Gain on sale of investment is summarized as follows:
 
 
Year Ended December 31,
 
 
 
Percent
Change
 
Year Ended December 31,
 
 
 
Percent
Change
(dollars in thousands)
2014
 
2013
 
Change
 
 
2013
 
2012
 
Change
 
 
$
—

 
$
—

 
$
—

 
—

 
$
—

 
$
2,951

 
$
(2,951
)
 
(100
)%

On August 24, 2012, we sold our 95% interest in an unconsolidated joint venture that owned an office building at 1200 17th Street, NW in Washington, D.C. for $43.7 million, which after repayment of the mortgage loan encumbering the property

51

resulted in net proceeds to us of $25.7 million. We reported a $3.0 million gain on the sale of this interest in the third quarter of 2012.

Loss on debt extinguishment / modification is summarized as follows:
 
 
Year Ended December 31,
 
 
 
Percent
Change
 
Year Ended December 31,
 
 
 
Percent
Change
(dollars in thousands)
2014
 
2013
 
Change
 
 
2013
 
2012
 
Change
 
 
$
—

 
$
1,810

 
$
(1,810
)
 
(100
)%
 
$
1,810

 
$
13,687

 
$
(11,877
)
 
(87
)%

On October 16, 2013, we and our bank lenders amended and restated our unsecured revolving credit facility and unsecured term loan. As part of the amendments, we, among other things, reduced our LIBOR spreads to current market rates, eliminated the prepayment lock-outs for the unsecured term loan, eliminated prepayment penalties associated with two tranches of the unsecured term loan, decreased the capitalization rates used to calculate gross asset value in the covenant calculations, and moved to a covenant package more closely aligned with our strategic plan. During the fourth quarter of 2013, we incurred $1.5 million of debt modification charges related to amending and restating our unsecured revolving credit facility and unsecured term loan. On September 30, 2013, we repaid a $53.9 million mortgage loan that encumbered 840 First Street, NE, which was scheduled to mature on October 1, 2013. 840 First Street, NE is subject to a tax protection agreement, which requires that we maintain a specified minimum amount of debt on the property through March 2018. As a result of this requirement, simultaneously with the repayment of the mortgage debt, we encumbered 840 First Street, NE with a $37.3 million mortgage loan that had previously encumbered 500 First Street, NW. During the third quarter of 2013, we incurred $0.1 million in debt modification charges related to the transfer of the loan and the collateral under such loan. During the second quarter of 2013, we recorded a loss on debt extinguishment / modification of $0.2 million that was associated with the prepayment of our secured term loan, our secured bridge loan and a $16.4 million mortgage loan encumbered by Cloverleaf Center.

On May 10, 2012, we and our bank lenders amended our unsecured revolving credit facility, unsecured term loan and secured term loan to, among other things, revise certain financial and other covenants that provided additional operating flexibility for us to execute our business strategy and clarify the treatment of certain covenant compliance-related definitions. As a result of the amendments, we expensed $0.6 million in fees paid to the bank lenders and $2.2 million in unamortized financing costs associated with the unsecured term loan. On June 11, 2012, we prepaid the entire $75.0 million principal amount outstanding under our Senior Notes. As a result of the prepayment, we paid a $10.2 million make-whole amount to the holders of the Senior Notes and expensed $0.2 million of unamortized deferred financing costs associated with our Senior Notes. In addition, we incurred a $0.5 million charge in 2012 related to our defeasance of a mortgage loan that encumbered four buildings at Owings Mills Business Park, of which, two buildings were sold in November 2012 and the four remaining buildings were sold in October 2014.

Gain on sale of rental property is summarized as follows:
 
 
Year Ended December 31,
 
 
 
Percent
Change
 
Year Ended December 31,
 
 
 
Percent
Change
(dollars in thousands)
2014
 
2013
 
Change
 
 
2013
 
2012
 
Change
 
 
$
21,230

 
$
—

 
$
21,230

 
—

 
$
—

 
$
—

 
$
—

 
—


On June 26, 2014, we sold Corporate Campus at Ashburn Center, a three-building, 194,000 square foot single-story business park, which is located in Ashburn, Virginia, for net proceeds of $39.9 million and reported a gain on the sale of the property of $21.2 million in the second quarter of 2014. We used the net proceeds from the sale, together with available cash, to acquire 1775 Wiehle Avenue. In accordance with the new accounting standards that we prospectively adopted in the second quarter of 2014, the operating results and gain on the sale of the Corporate Campus at Ashburn Center are reflected in continuing operations in our consolidated statements of operations in 2014. We did not record any gain on sale of rental property within continuing operations in 2013 and 2012.

Benefit from Income Taxes

Benefit from income taxes is summarized as follows:
 

52

 
Year Ended December 31,
 
 
 
Percent
Change
 
Year Ended December 31,
 
 
 
Percent
Change
(dollars in thousands)
2014
 
2013
 
Change
 
 
2013
 
2012
 
Change
 
 
$
—

 
$
—

 
$
—

 
—

 
$
—

 
$
4,142

 
$
(4,142
)
 
(100
)%

We own properties in Washington, D.C. that were subject to income-based franchise taxes as a result of conducting business in Washington, D.C. Benefit from income taxes decreased $4.1 million for 2013 compared with 2012 due to a third quarter 2012 change in tax regulations in the District of Columbia that required us to file a unitary tax return, which allowed for a deduction for dividends paid to shareholders. The change in tax regulations resulted in our prospectively measuring all of our deferred tax assets and deferred tax liabilities using the effective tax rate (0%) expected to be in effect as these timing differences reverse. Therefore, we did not record a benefit from income taxes in 2014 and 2013.

Income from Discontinued Operations

Income from discontinued operations is summarized as follows:
 
 
Year Ended December 31,
 
 
 
Percent
Change
 
Year Ended December 31,
 
 
 
Percent
Change
(dollars in thousands)
2014
 
2013
 
Change
 
 
2013
 
2012
 
Change
 
 
$
1,484

 
$
21,742

 
$
(20,258
)
 
(93
)%
 
$
21,742

 
$
15,943

 
$
5,799

 
36
%

Discontinued operations for the periods presented reflect the Richmond Portfolio, which was classified within discontinued operations after our adoption of ASU 2014-08, due to our strategic shift away from the Richmond market, as well as disposed properties that were previously classified as discontinued operations in previously filed consolidated financial statements prior to our adoption of ASU 2014-08. We recorded gains on the sale of rental property of $1.3 million, $19.4 million and $0.2 million in 2014, 2013 and 2012, respectively. The operating results of the disposed and held-for-sale properties classified within discontinued operations were adversely affected by impairment charges totaling $4.1 million and $1.1 million in 2013 and 2012, respectively. We did not record any impairment charges within discontinued operations in 2014. We have had, and will have, no continuing involvement with these properties subsequent to their disposal. For more information about our discontinued operations, see note 10 – Dispositions, in the notes to our consolidated financial statements.

Net (income) loss attributable to noncontrolling interests

Net (income) loss attributable to noncontrolling interests is summarized as follows:

 
Year Ended December 31,
 
 
 
Percent
Change
 
Year Ended December 31,
 
 
 
Percent
Change
(dollars in thousands)
2014
 
2013
 
Change
 
 
2013
 
2012
 
Change
 
 
$
(199
)
 
$
93

 
$
(292
)
 
NM
 
$
93

 
$
986

 
$
(893
)
 
(91
)%

Net (income) loss attributable to noncontrolling interests reflects the ownership interests in our net income or loss, less amounts owed to our preferred shareholders, attributable to parties other than us. We had net income of $17.0 million and $11.0 million during 2014 and 2013, respectively. The weighted average percentage of the common Operating Partnership units held by third parties was 4.3% and 4.4% for 2014 and 2013, respectively.

Prior to the fourth quarter of 2013, we consolidated two joint ventures in which we had a controlling interest. On November 8, 2013, we acquired the remaining interest in a consolidated partnership for $4.6 million. At December 31, 2014, we consolidated the operating results of one joint venture and recognized our joint venture partner’s percentage of gains or losses within net (income) loss attributable to noncontrolling interests. The joint venture partners’ aggregate share of earnings in the operating results of our consolidated joint ventures was immaterial during 2014 and $19,000 in 2013.

During 2013, we had net income of $11.0 million compared with a net loss of $8.4 million in 2012. The weighted average percentage of the common Operating Partnership units held by third parties decreased in 2013 to 4.4% compared with 5.1% in 2012, as we issued 7.5 million common shares in May 2013. The joint venture partners’ aggregate share of earnings in the operating results of our consolidated joint ventures was $19,000 in 2013 compared to a net loss of $65,000 in 2012.

 
Same Property Net Operating Income

53


Same Property Net Operating Income (“Same Property NOI”), defined as operating revenues (rental, tenant reimbursements and other revenues) less operating expenses (property operating expenses, real estate taxes and insurance) from the properties whose period-over-period operations can be viewed on a comparative basis (i.e., those consolidated properties owned and in-service for the entirety of the periods presented), is a primary performance measure we use to assess the results of operations at our properties. Same Property NOI is a non-GAAP measure. As an indication of our operating performance, Same Property NOI should not be considered an alternative to net income calculated in accordance with GAAP. A reconciliation of our Same Property NOI to net income from our consolidated statements of operations is presented below. The Same Property NOI results exclude corporate-level expenses, as well as certain transactions, such as the collection of termination fees, as these items vary significantly period-over-period and thus impact trends and comparability. Also, we eliminate depreciation and amortization expense, which are property level expenses, in computing Same Property NOI because these are non-cash expenses that are based on historical cost accounting assumptions and management believes these expenses do not offer the investor significant insight into the operations of the property. This presentation allows management and investors to distinguish whether growth or declines in net operating income are a result of increases or decreases in property operations or the acquisition of additional properties. While this presentation provides useful information to management and investors, the results below should be read in conjunction with the results from the consolidated statements of operations to provide a complete depiction of total Company performance.











































54


2014 Compared with 2013

The following tables of selected operating data provide the basis for our discussion of Same Property NOI in 2014 compared with 2013:

CONSOLIDATED
(dollars in thousands)
Year Ended December 31,
 
 
 
 
2014
 
2013
 
$ Change
 
% Change
Number of buildings(1)
111

 
111

 
—

 
—

Same property revenues
 
 
 
 
 
 
 
Rental
$
113,416

 
$
111,513

 
$
1,903

 
1.7

Tenant reimbursements and other
28,374

 
26,699

 
1,675

 
6.3

Total same property revenues
141,790

 
138,212

 
3,578

 
2.6

Same property operating expenses
 
 
 
 
 
 
 
Property
35,494

 
34,788

 
706

 
2.0

Real estate taxes and insurance
14,852

 
14,490

 
362

 
2.5

Total same property operating expenses
50,346

 
49,278

 
1,068

 
2.2

Same property net operating income
$
91,444

 
$
88,934

 
$
2,510

 
2.8

Reconciliation to net income:
 
 
 
 
 
 
 
Same property net operating income
$
91,444

 
$
88,934

 
 
 
 
Non-comparable net operating income(2)
9,596

 
5,527

 
 
 
 
General and administrative expenses
(21,156
)
 
(21,979
)
 
 
 
 
Depreciation and amortization
(61,796
)
 
(54,567
)
 
 
 
 
Other(3)
(2,529
)
 
(28,676
)
 
 
 
 
Discontinued operations
1,484

 
21,742

 
 
 
 
Net income
$
17,043

 
$
10,981

 
 
 
 
 
 
Full Year
Weighted Average Occupancy
 
2014
 
2013
Same Properties
87.6
%
 
85.2
%
Total
86.5
%
 
84.2
%
 
(1) 
Same-property comparisons are based upon those consolidated properties owned and in-service for the entirety of the periods presented. Same-property results exclude the results of the following non-comparable properties: 440 First Street, NW, Storey Park, 1401 K Street, NW, 1775 Wiehle Avenue, 11 Dupont Circle, NW, a building at Redland Corporate Center and the Richmond Portfolio (Chesterfield Business Center, Hanover Business Center, Park Central and Virginia Technology Center), which was classified as held-for-sale as of December 31, 2014.
(2) 
Non-comparable property NOI has been adjusted to reflect a normalized management fee percentage in lieu of an administrative overhead allocation for comparative purposes.
(3) 
Combines acquisition costs, impairment of rental property, contingent consideration related to acquisition of property and total other (income) expenses from our consolidated statements of operations.

Same Property NOI increased $2.5 million for the twelve months ended December 31, 2014 compared with the same period in 2013. Total same property revenues increased $3.6 million in 2014 compared with 2013, primarily due to an increase in occupancy and an increase in recoverable snow and ice removal costs that were incurred in the first quarter of 2014. Total same property operating expenses increased $1.1 million in 2014 compared with 2013 due to higher occupancy and an increase in snow and ice removal costs that were incurred in the first quarter of 2014.






55


Washington, D.C.
 
(dollars in thousands)
Year Ended December 31,
 
 
 
 
2014
 
2013
 
$ Change
 
% Change
Number of buildings(1)
3

 
3

 
—

 
—

Same property revenues
 
 
 
 
 
 
 
Rental
$
17,550

 
$
17,665

 
$
(115
)
 
(0.7
)
Tenant reimbursements and other
7,893

 
7,972

 
(79
)
 
(1.0
)
Total same property revenues
25,443

 
25,637

 
(194
)
 
(0.8
)
Same property operating expenses
 
 
 
 
 
 
 
Property
5,981

 
5,826

 
155

 
2.7

Real estate taxes and insurance
4,185

 
4,121

 
64

 
1.6

Total same property operating expenses
10,166

 
9,947

 
219

 
2.2

Same property net operating income
$
15,277

 
$
15,690

 
$
(413
)
 
(2.6
)
Reconciliation to total property operating income:
 
 
 
 
 
 
 
Same property net operating income
$
15,277

 
$
15,690

 
 
 
 
Non-comparable net operating income(2)
3,416

 
1,033

 
 
 
 
Total property operating income
$
18,693

 
$
16,723

 
 
 
 
 
 
Full Year
Weighted Average Occupancy
 
2014
 
2013
Same Properties
90.8
%
 
96.3
%
Total
89.3
%
 
96.5
%
 
(1) 
Same-property comparisons are based upon those consolidated properties owned and in-service for the entirety of the periods presented. Same-property results exclude the operating results of the following non-comparable properties: 440 First Street, NW, Storey Park, 1401 K Street, NW and 11 Dupont Circle, NW.
(2) 
Non-comparable property NOI has been adjusted to reflect a normalized management fee percentage in lieu of an administrative overhead allocation for comparative purposes.

Same Property NOI for the Washington, D.C. properties decreased $0.4 million for the twelve months ended December 31, 2014 compared with the same period in 2013. Total same property revenues decreased $0.2 million during 2014 compared with 2013 as a result of a decrease in occupancy at 1211 Connecticut Avenue, NW, a portion of the vacant space has been re-leased with lease terms commencing in 2015. Total same property operating expenses increased $0.2 million during 2014 compared with 2013 due to reimbursable repair and maintenance costs associated a tenant, which was partially offset by a decrease in other recoverable operating expenses as a result of a decrease in occupancy.















56


Maryland
 
(dollars in thousands)
Year Ended December 31,
 
 
 
 
2014
 
2013
 
$ Change
 
% Change
Number of buildings(1)
41

 
41

 
—

 
—

Same property revenues
 
 
 
 
 
 
 
Rental
$
33,212

 
$
32,305

 
$
907

 
2.8

Tenant reimbursements and other
5,596

 
5,232

 
364

 
7.0

Total same property revenues
38,808

 
37,537

 
1,271

 
3.4

Same property operating expenses
 
 
 
 
 
 
 
Property
9,195

 
9,398

 
(203
)
 
(2.2
)
Real estate taxes and insurance
3,196

 
2,900

 
296

 
10.2

Total same property operating expenses
12,391

 
12,298

 
93

 
0.8

Same property net operating income
$
26,417

 
$
25,239

 
$
1,178

 
4.7

Reconciliation to total property operating income:
 
 
 
 
 
 
 
Same property net operating income
$
26,417

 
$
25,239

 
 
 
 
Non-comparable net operating income(2)
3,961

 
2,481

 
 
 
 
Total property operating income
$
30,378

 
$
27,720

 
 
 
 
 
 
Full Year
Weighted Average Occupancy
 
2014
 
2013
Same Properties
87.8
%
 
85.4
%
Total
86.1
%
 
81.7
%
 
(1) 
Same-property comparisons are based upon those consolidated properties owned and in-service for the entirety of the periods presented. Same-property results exclude the operating results of the following non-comparable property: a building at Redland Corporate Center.
(2) 
Non-comparable property NOI has been adjusted to reflect a normalized management fee percentage in lieu of an administrative overhead allocation for comparative purposes.

Same Property NOI for the Maryland properties increased $1.2 million for the twelve months ended December 31, 2014 compared with the same period in 2013. Total same property revenues increased $1.3 million during 2014 compared with 2013 due to an increase in occupancy. In addition, total same property revenues increased due to an increase in recoverable snow and ice removal costs in the first quarter of 2014. Total same property operating expenses increased $0.1 million in 2014 compared with 2013 due to higher real estate tax assessments.


57

Northern Virginia
 
(dollars in thousands)
Year Ended December 31,
 
 
 
 
2014
 
2013
 
$ Change
 
% Change
Number of buildings(1)
48

 
48

 
—

 
—

Same property revenues
 
 
 
 
 
 
 
Rental
$
39,332

 
$
38,573

 
$
759

 
2.0

Tenant reimbursements and other
10,036

 
9,454

 
582

 
6.2

Total same property revenues
49,368

 
48,027

 
1,341

 
2.8

Same property operating expenses
 
 
 
 
 
 
 
Property
12,138

 
11,709

 
429

 
3.7

Real estate taxes and insurance
5,207

 
5,316

 
(109
)
 
(2.1
)
Total same property operating expenses
17,345

 
17,025

 
320

 
1.9

Same property net operating income
$
32,023

 
$
31,002

 
$
1,021

 
3.3

Reconciliation to total property operating income:
 
 
 
 
 
 
 
Same property net operating income
$
32,023

 
$
31,002

 
 
 
 
Non-comparable net operating income(2)
2,678

 
2,505

 
 
 
 
Total property operating income
$
34,701

 
$
33,507

 
 
 
 
 
 
Full Year
Weighted Average Occupancy
 
2014
 
2013
Same Properties
85.7
%
 
81.2
%
Total
86.4
%
 
82.8
%

(1) 
Same-property comparisons are based upon those consolidated properties owned and in-service for the entirety of the periods presented. Same-property results exclude the operating results of the following non-comparable property: 1775 Wiehle Avenue.
(2) 
Non-comparable property NOI has been adjusted to reflect a normalized management fee percentage in lieu of an administrative overhead allocation for comparative purposes.

Same Property NOI for the Northern Virginia properties increased $1.0 million for the twelve months ended December 31, 2014 compared with the same period in 2013. Total same property revenues increased $1.3 million during 2014 compared with 2013 due to an increase in occupancy and an increase in recoverable snow and ice removal costs in the first quarter of 2014. Total same property operating expenses increased $0.3 million during 2014 compared with 2013 due to an increase in snow and ice removal costs in the first quarter of 2014. The increase in total same property operating expenses was partially offset by lower real estate tax assessments of $0.2 million in 2014 compared with 2013.


58

Southern Virginia
 
(dollars in thousands)
Year Ended December 31,
 
 
 
 
2014
 
2013
 
$ Change
 
% Change
Number of buildings(1)
19

 
19

 
—

 
—

Same property revenues
 
 
 
 
 
 
 
Rental
$
23,322

 
$
22,970

 
$
352

 
1.5

Tenant reimbursements and other
4,849

 
4,041

 
808

 
20.0

Total same property revenues
28,171

 
27,011

 
1,160

 
4.3

Same property operating expenses
 
 
 
 
 
 
 
Property
8,180

 
7,855

 
325

 
4.1

Real estate taxes and insurance
2,264

 
2,153

 
111

 
5.2

Total same property operating expenses
10,444

 
10,008

 
436

 
4.4

Same property net operating income
$
17,727

 
$
17,003

 
$
724

 
4.3

Reconciliation to total property operating income:
 
 
 
 
 
 
 
Same property net operating income
$
17,727

 
$
17,003

 
 
 
 
Non-comparable net operating loss(2)
(459
)
 
(492
)
 
 
 
 
Total property operating income
$
17,268

 
$
16,511

 
 
 
 
 
 
Full Year
Weighted Average Occupancy
 
2014
 
2013
Same Properties
89.3
%
 
87.6
%
Total
86.3
%
 
85.7
%
 
(1) 
Same-property comparisons are based upon those consolidated properties owned and in-service for the entirety of the periods presented. Same-property results exclude the operating results of the following non-comparable properties: the Richmond Portfolio (Chesterfield Business Center, Hanover Business Center, Park Central, and Virginia Technology Center), which was classified as held-for-sale as of December 31, 2014.
(2) 
Non-comparable property NOI has been adjusted to reflect a normalized management fee percentage in lieu of an administrative overhead allocation for comparative purposes.

Same Property NOI for the Southern Virginia properties increased $0.7 million for the twelve months ended December 31, 2014 compared with 2013. Total same property revenues increased $1.1 million during 2014 compared with 2013 due to an increase in recoverable operating expenses, including recoverable snow and ice removal costs incurred in the first quarter of 2014. Total same property operating expenses increased $0.4 million during 2014 compared with 2013 due to an increase in anticipated bad debt expense and an increase in snow and ice removal costs in the first quarter of 2014.



59

2013 Compared with 2012

The following tables of selected operating data provide the basis for our discussion of Same Property NOI in 2013 compared with 2012:

CONSOLIDATED
(dollars in thousands)
Year Ended December 31,
 
 
 
 
2013
 
2012
 
$ Change
 
% Change
Number of buildings(1)
112

 
112

 
—

 
—

Same property revenues
 
 
 
 
 
 
 
Rental
$
111,730

 
$
109,581

 
$
2,149

 
2.0

Tenant reimbursements and other
27,467

 
25,526

 
1,941

 
7.6

Total same property revenues
139,197

 
135,107

 
4,090

 
3.0

Same property operating expenses
 
 
 
 
 
 
 
Property
34,259

 
32,755

 
1,504

 
4.6

Real estate taxes and insurance
14,616

 
13,808

 
808

 
5.9

Total same property operating expenses
48,875

 
46,563

 
2,312

 
5.0

Same property net operating income
$
90,322

 
$
88,544

 
$
1,778

 
2.0

Reconciliation to net income (loss):
 
 
 
 
 
 
 
Same property net operating income
$
90,322

 
$
88,544

 
 
 
 
Non-comparable net operating income(2)
4,139

 
10,053

 
 
 
 
General and administrative expenses
(21,979
)
 
(23,568
)
 
 
 
 
Depreciation and amortization
(54,567
)
 
(51,457
)
 
 
 
 
Other(3)
(28,676
)
 
(47,896
)
 
 
 
 
Discontinued operations
21,742

 
15,943

 
 
 
 
Net income (loss)
$
10,981

 
$
(8,381
)
 
 
 
 
 
 
Full Year
Weighted Average Occupancy
 
2013
 
2012
Same Properties
85.2
%
 
82.9
%
Total
84.2
%
 
83.0
%
 
(1) 
Same-property comparisons are based upon those consolidated properties owned and in-service for the entirety of the periods presented. Same-property results exclude the operating results of the following non-comparable properties: Davis Drive, Three Flint Hill, 440 First Street, NW, Storey Park, a building at Redland Corporate Center, and the Richmond Portfolio (Chesterfield Business Center, Hanover Business Center, Park Central, and Virginia Technology Center), which was classified as held-for-sale as of December 31, 2014.
(2) 
Non-comparable property NOI has been adjusted to reflect a normalized management fee percentage in lieu of an administrative overhead allocation for comparative purposes.
(3) 
Combines acquisition costs, impairment of rental property, contingent consideration related to acquisition of property, total other (income) expenses, and benefit from income taxes from our consolidated statements of operations.

Same Property NOI increased $1.8 million for the twelve months ended December 31, 2013 compared with the same period in 2012. Total same property revenues increased $4.1 million in 2013 compared with 2012 due to an increase in occupancy and recoverable operating expenses. Same property operating expenses increased by $1.5 million for 2013 compared with 2012 due to higher operating expenses, as a result of higher occupancy. Real estate taxes and insurance expense increased $0.8 million in 2013 compared with 2012 due to higher real estate tax assessments.

60

Washington, D.C.
 
(dollars in thousands)
Year Ended December 31,
 
 
 
 
2013
 
2012
 
$ Change
 
% Change
Number of buildings(1)
3

 
3

 
—

 
—

Same property revenues
 
 
 
 
 
 
 
Rental
$
17,665

 
$
17,555

 
$
110

 
0.6

Tenant reimbursements and other
7,972

 
7,293

 
679

 
9.3

Total same property revenues
25,637

 
24,848

 
789

 
3.2

Same property operating expenses
 
 
 
 
 
 
 
Property
5,826

 
5,702

 
124

 
2.2

Real estate taxes and insurance
4,121

 
3,875

 
246

 
6.3

Total same property operating expenses
9,947

 
9,577

 
370

 
3.9

Same property net operating income
$
15,690

 
$
15,271

 
$
419

 
2.7

Reconciliation to total property operating income:
 
 
 
 
 
 
 
Same property net operating income
$
15,690

 
$
15,271

 
 
 
 
Non-comparable net operating income(2)
1,033

 
3,273

 
 
 
 
Total property operating income
$
16,723

 
$
18,544

 
 
 
 
 
 
Full Year
Weighted Average Occupancy
 
2013
 
2012
Same Properties
96.3
%
 
99.3
%
Total
96.5
%
 
99.4
%
 
(1) 
Same-property comparisons are based upon those consolidated properties owned and in-service for the entirety of the periods presented. Same-property results exclude the operating results of the following non-comparable properties: 440 First Street, NW and Storey Park.
(2) 
Non-comparable property NOI has been adjusted to reflect a normalized management fee percentage in lieu of an administrative overhead allocation for comparative purposes.

Same property NOI for the Washington D.C. properties increased $0.4 million for the twelve months ended December 31, 2013 compared with the same period in 2012. Total same property revenues increased $0.8 million during 2013 compared with 2012 as a result of higher recoveries of tenant reimbursable expenses. Total same property operating expense increased $0.4 million during 2013 compared with 2012, primarily due to an increase in real estate taxes.


61

Maryland
 
(dollars in thousands)
Year Ended December 31,
 
 
 
 
2013
 
2012
 
$ Change
 
% Change
Number of buildings(1)
41

 
41

 
—

 
—

Same property revenues
 
 
 
 
 
 
 
Rental
$
33,663

 
$
33,507

 
$
156

 
0.5

Tenant reimbursements and other
5,503

 
5,146

 
357

 
6.9

Total same property revenues
39,166

 
38,653

 
513

 
1.3

Same property operating expenses
 
 
 
 
 
 
 
Property
9,887

 
9,500

 
387

 
4.1

Real estate taxes and insurance
3,124

 
2,952

 
172

 
5.8

Total same property operating expenses
13,011

 
12,452

 
559

 
4.5

Same property net operating income
$
26,155

 
$
26,201

 
$
(46
)
 
(0.2
)
Reconciliation to total property operating income:
 
 
 
 
 
 
 
Same property net operating income
$
26,155

 
$
26,201

 
 
 
 
Non-comparable net operating income(2)
1,565

 
2,493

 
 
 
 
Total property operating income
$
27,720

 
$
28,694

 
 
 
 
 
 
Full Year
Weighted Average Occupancy
 
2013
 
2012
Same Properties
85.4
%
 
83.6
%
Total
81.7
%
 
81.6
%
 
(1) 
Same-property comparisons are based upon those consolidated properties owned and in-service for the entirety of the periods presented. Same-property results exclude the operating results of the following non-comparable properties: A building at Redland Corporate Center.
(2) 
Non-comparable property NOI has been adjusted to reflect a normalized management fee percentage in lieu of an administrative overhead allocation for comparative purposes.

Same Property NOI for the Maryland properties decreased slightly for the twelve months ended December 31, 2013 compared with the same period in 2012. Total same property revenues increased $0.5 million during 2013 primarily due to an increase in recoverable operating expenses. Total same property operating expenses for the Maryland properties increased $0.6 million for the twelve months ended December 31, 2013 compared with 2012 due to an increase in snow and ice removal costs and real estate taxes.


62

Northern Virginia
 
(dollars in thousands)
Year Ended December 31,
 
 
 
 
2013
 
2012
 
$ Change
 
% Change
Number of buildings(1)
49

 
49

 
—

 
—
Same property revenues
 
 
 
 
 
 
 
Rental
$
37,433

 
$
36,182

 
$
1,251

 
3.5
Tenant reimbursements and other
9,967

 
9,146

 
821

 
9.0
Total same property revenues
47,400

 
45,328

 
2,072

 
4.6
Same property operating expenses
 
 
 
 
 
 
 
Property
10,848

 
10,350

 
498

 
4.8
Real estate taxes and insurance
5,221

 
4,871

 
350

 
7.2
Total same property operating expenses
16,069

 
15,221

 
848

 
5.6
Same property net operating income
$
31,331

 
$
30,107

 
$
1,224

 
4.1
Reconciliation to total property operating income:
 
 
 
 
 
 
 
Same property net operating income
$
31,331

 
$
30,107

 
 
 
 
Non-comparable net operating income(2)
2,176

 
561

 
 
 
 
Total property operating income
$
33,507

 
$
30,668

 
 
 
 
 
 
Full Year
Weighted Average Occupancy
 
2013
 
2012
Same Properties
81.2
%
 
77.1
%
Total
82.8
%
 
80.0
%
 
(1) 
Same-property comparisons are based upon those consolidated properties owned and in-service for the entirety of the periods presented. Same-property results exclude the operating results of the following non-comparable-properties: Three Flint Hill and Davis Drive.
(2) 
Non-comparable property NOI has been adjusted to reflect a normalized management fee percentage in lieu of an administrative overhead allocation for comparative purposes.

Same property NOI for the Northern Virginia properties increased $1.2 million for the twelve months ended December 31, 2013 compared with the same period in 2012. Total same property revenues increased $2.1 million during the twelve months ended December 31, 2013 compared with 2012 primarily due to higher occupancy. During 2013, total same property operating expenses increased $0.9 million compared with 2012 due an increase in real estate taxes and snow and ice removal costs.

63

Southern Virginia
 
(dollars in thousands)
Year Ended December 31,
 
 
 
 
2013
 
2012
 
$ Change
 
% Change
Number of buildings(1)
19

 
19

 
—

 
—
Same property revenues
 
 
 
 
 
 
 
Rental
$
22,969

 
$
22,337

 
$
632

 
2.8
Tenant reimbursements and other
4,025

 
3,941

 
84

 
2.1
Total same property revenues
26,994

 
26,278

 
716

 
2.7
Same property operating expenses
 
 
 
 
 
 
 
Property
7,698

 
7,203

 
495

 
6.9
Real estate taxes and insurance
2,150

 
2,110

 
40

 
1.9
Total same property operating expenses
9,848

 
9,313

 
535

 
5.7
Same property net operating income
$
17,146

 
$
16,965

 
$
181

 
1.1
Reconciliation to total property operating income:
 
 
 
 
 
 
 
Same property net operating income
$
17,146

 
$
16,965

 
 
 
 
Non-comparable net operating loss(2)
(635
)
 
(416
)
 
 
 
 
Total property operating income
$
16,511

 
$
16,549

 
 
 
 
 
 
Full Year
Weighted Average Occupancy
 
2013
 
2012
Same Properties
87.6
%
 
85.7
%
Total
85.7
%
 
84.3
%
 
(1) 
Same-property comparisons are based upon those consolidated properties owned and in-service for the entirety of the periods presented. Same-property results exclude the operating results of the following non-comparable properties: the Richmond Portfolio (Chesterfield Business Center, Hanover Business Center, Park Central, and Virginia Technology Center), which was classified as held-for-sale as of December 31, 2014.
(2) 
Non-comparable property NOI has been adjusted to reflect a normalized management fee percentage in lieu of an administrative overhead allocation for comparative purposes.


Same property NOI for the Southern Virginia properties increased $0.2 million for the twelve months ended December 31, 2013 compared with the same period in 2012. Total same property revenues increased $0.7 million primarily due to an increase in occupancy and an increase in recoverable operating expenses. Total same property operating expenses increased approximately $0.5 million during 2013 compared with 2012 due to an increase in anticipated bad debt reserves and an increase in snow and ice removal costs.

64

Liquidity and Capital Resources

Overview

We seek to maintain a flexible balance sheet, with an appropriate balance of cash, debt, equity and available funds under our unsecured revolving credit facility, to readily provide access to capital given the volatility of the market and to position us to take advantage of potential growth opportunities. In January 2013, we provided an updated strategic and capital plan, which included the marketing of our industrial properties, the execution of steps designed to increase balance sheet flexibility, reduce leverage and a rightsizing of our quarterly dividend. We have executed on several key components of our updated strategic and capital plan, including the industrial portfolio sale, which generated total gross proceeds of $259.0 million; the issuance of 7.5 million common shares, the net proceeds of which were primarily used to repay outstanding debt; and a 25% reduction in the quarterly dividend beginning in the first quarter of 2013. Consistent with our previously disclosed capital recycling strategy, effective as of February 9, 2015, we entered a binding contract to sell our Richmond, Virginia portfolio. We anticipate closing the sale in the first half of 2015. However, we can provide no assurances regarding the timing or pricing of the sale, or that the sale will occur at all. We intend to use net proceeds from the potential sale of the Richmond Portfolio to pay down debt.

At December 31, 2014, we had $205.0 million outstanding under our unsecured revolving credit facility. As of the date of this filing, we had $218.0 million outstanding and $79.0 million of availability under our unsecured revolving credit facility. In the next 12 months, we have $64.3 million of consolidated debt maturing, all of which matures in August 2015. In conjunction with the sale of the Richmond Portfolio, which is expected to be sold in the first half of 2015, we anticipate repaying five mortgage loans, which had an aggregate outstanding balance of $3.5 million at December 31, 2014.

Over the next twelve months, we believe that we will generate sufficient cash flow from operations and have access to the capital resources, through debt and equity markets, necessary to expand and develop our business, to fund our operating and administrative expenses, to continue to meet our debt service obligations and to pay distributions in accordance with REIT requirements. However, our cash flow from operations and ability to access the debt and equity markets could be adversely affected due to uncertain economic factors and volatility in the financial and credit markets. In particular, we cannot assure that our tenants will not default on their leases or fail to make full rental payments if their businesses are challenged due to, among other things, the economic conditions (particularly if the tenants are unable to secure financing to operate their businesses). This may be particularly true for our tenants that are smaller companies. Further, approximately 7.1% of our annualized cash basis rent (excluding month-to-month leases) is scheduled to expire during the next twelve months and, if we are unable to renew these leases or re-lease the space, our cash flow could be negatively impacted.
We also believe, based on our historical experience and forecasted operations, that we will have sufficient cash flow or access to capital to meet our obligations over the next five years. We intend to meet our long-term funding requirements for property acquisitions, development, redevelopment and other non-recurring capital improvements through net cash provided from operations, long-term secured and unsecured indebtedness, including borrowings under our unsecured revolving credit facility and unsecured term loan, proceeds from disposal of strategically identified assets (outright or through joint ventures) and the issuance of equity and debt securities. In the process of exploring different financing options, we actively monitor the impact that each potential financing decision will have on our financial covenants in order to avoid any issues of non-compliance with the terms of our existing financial covenants.
Our ability to raise funds through sales of debt and equity securities and access other third party sources of capital in the future will be dependent on, among other things, general economic conditions, general market conditions for REITs, rental rates, occupancy levels, market perceptions and the trading price of our shares. We will continue to analyze which sources of capital are most advantageous to us at any particular point in time, but the capital markets may not be consistently available on terms we deem attractive, or at all.

Financing Activity

Land Loan

On October 16, 2014, our 97% owned consolidated joint venture that owns Storey Park repaid a $22.0 million loan that encumbered the Storey Park land and was subject to a 5.0% interest rate floor. Simultaneously with the repayment, the joint venture entered into a new $22.0 million land loan with a variable interest rate of LIBOR plus 2.50%. The new loan matures on October 16, 2016, with a one-year extension at our option, and is repayable in full without penalty at any time during the term of the loan. Per the terms of the loan agreement, $6.0 million of the outstanding principal balance and all of the outstanding

65

accrued interest is recourse to us. As of December 31, 2014, we were in compliance with all the financial covenants of the Storey Park land loan.
  
Construction Loan

On June 5, 2013, we entered into a construction loan (the “Construction Loan”) that is collateralized by our 440 First Street, NW property, which underwent a major redevelopment that was substantially completed in October 2013. The Construction Loan has a borrowing capacity of up to $43.5 million, of which we initially borrowed $21.7 million in the second quarter of 2013 and borrowed an additional $10.5 million in 2014. The Construction Loan has a variable interest rate of LIBOR plus a spread of 2.50% and matures in May 2016, with two one-year extension options at our discretion. We can repay all or a portion of the Construction Loan, without penalty, at any time during the term of the loan. At December 31, 2014, per the terms of the loan agreement, 50% of the outstanding principal balance and all of the outstanding accrued interest were recourse to us. The percentage of outstanding principal balance that is recourse to us can be reduced upon the property achieving certain operating thresholds. As of December 31, 2014, we were in compliance with all the financial covenants of the Construction Loan.

Mortgage Debt

We have originated or assumed the following mortgage loans since January 1, 2013 (dollars in thousands):
 
Month
 
Year      
 
Property
 
Effective
Interest
Rate
 
Principal
Amount
 
October
 
2014
 
Storey Park Land Loan(1)
 
LIBOR + 2.50%

 
$
22,000

(1) 
April
 
2014
 
1401 K Street, NW
 
4.93
%
 
37,269

 
June
 
2013
 
440 First Street, NW Construction Loan(2)
 
5.00
%
 
21,699

(2) 
 
(1) 
We have a 97% ownership interest in the property through a consolidated joint venture. The loan balance in the chart above reflects the entire loan balance, which is reflected in our consolidated balance sheets.
(2) 
At December 31, 2014, 50% of the outstanding principal balance and all of the outstanding accrued interest on the 440 First Street, NW Construction Loan were recourse to us.


We have repaid the following mortgage loans since January 1, 2013 (dollars in thousands):
 
Month
 
Year      
 
Property
 
Effective
Interest
Rate
 
Principal
Balance
Repaid
October
 
2014
 
Storey Park Land Loan
 
5.80
%
 
$
22,000

May
 
2014
 
Annapolis Business Center
 
6.25
%
 
8,027

September
 
2013
 
840 First Street, NE
 
6.05
%
 
53,877

September
 
2013
 
Linden Business Center
 
5.58
%
 
6,622

June
 
2013
 
Cloverleaf Center
 
6.75
%
 
16,427

June
 
2013
 
Mercedes Center – Note 1
 
6.04
%
 
4,799

June
 
2013
 
Mercedes Center – Note 2
 
6.30
%
 
9,260

June
 
2013
 
Jackson National Life Loan -Northridge
 
5.19
%
 
6,985

May
 
2013
 
Jackson National Life Loan - I-66 Commerce Center
 
5.19
%
 
21,695

February
 
2013
 
1434 Crossways Boulevard, Building I
 
5.38
%
 
7,597

February
 
2013
 
TenThreeTwenty
 
7.29
%
 
13,273

February
 
2013
 
Cedar Hill
 
6.58
%
 
15,364

January
 
2013
 
Prosperity Business Center
 
5.75
%
 
3,242



66

On September 30, 2013, we repaid a $53.9 million mortgage loan that encumbered 840 First Street, NE, which was scheduled to mature on October 1, 2013. 840 First Street is subject to a tax protection agreement, which requires that we maintain a specified minimum amount of debt on the property through March 2018. As a result of this requirement, simultaneously with the repayment of the mortgage debt, we encumbered 840 First Street, NE with a $37.3 million mortgage loan that had previously encumbered 500 First Street, NW. The transfer of the mortgage loan did not impact any of the terms of the loan agreement. During the third quarter of 2013, we incurred $0.1 million in debt modification charges related to the transfer.


Distributions

We are required to distribute at least 90% of our REIT taxable income to our shareholders in order to maintain qualification as a REIT, including some types of taxable income we recognize for tax purposes but with regard to which we do not receive corresponding cash. In addition, we must distribute 100% of our taxable income to our shareholders to eliminate our U.S. federal income tax liability. The funds we use to pay dividends on our common and preferred shares are provided through distributions from the Operating Partnership. For each of our common and preferred shares, the Operating Partnership has issued a corresponding common and preferred unit to us. We are the sole general partner of and, as of December 31, 2014, owned 100% of the preferred interest and 95.7% of the common interest in the Operating Partnership. The remaining common interests in the Operating Partnership are limited partnership interests, some of which are owned by two of our executive officers who contributed properties and other assets to us upon our formation, and the remainder of which are owned by other unrelated parties. The Operating Partnership is required to make cash distributions to us in an amount sufficient to meet our distribution requirements. The cash distributions by the Operating Partnership reduce the amount of cash that is available for general corporate purposes, which includes repayment of debt, funding acquisitions or construction activities, and for other corporate operating activities.
On a quarterly basis, our management team recommends a distribution amount that must then be approved by our Board of Trustees in its sole discretion. The amount of future distributions will be at the discretion of our Board of Trustees and will be based on, among other things: (i) the taxable income and cash flow generated by our operating activities; (ii) cash generated by, or used in, our financing and investing activities; (iii) the annual distribution requirements under the REIT provisions of the Internal Revenue Code; and (iv) such other factors as the Board of Trustees deems relevant. Our ability to make cash distributions will also be limited by the covenants contained in our Operating Partnership agreement and our financing arrangements as well as limitations imposed by state law and the agreements governing any future indebtedness. See “Item 1A – Risk Factors – Risks Related to Our Business and Properties – Covenants in our debt agreements could adversely affect our liquidity and financial condition” and “—Financial Covenants” below for additional information regarding the financial covenants.

Cash Flows

Due to the nature of our business, we rely on working capital and net cash provided by operations and, if necessary, borrowings under our unsecured revolving credit facility to fund our short-term liquidity needs. Net cash provided by operations is substantially dependent on the continued receipt of rental payments and other expenses reimbursed by our tenants. The ability of tenants to meet their obligations, including the payment of rent contractually owed to us, and our ability to lease space to new or replacement tenants on favorable terms, could affect our cash available for short-term liquidity needs. We intend to meet short and long term funding requirements for debt maturities, interest payments, dividend distributions and capital expenditures through cash flow provided by operations, long-term secured and unsecured indebtedness, including borrowings under our unsecured revolving credit facility, proceeds from asset disposals and the issuance of equity and debt securities. However, we may not be able to obtain capital from such sources on favorable terms, in the time period we desire, or at all. In addition, our continued ability to borrow under our existing debt instruments is subject to compliance with our financial and operating covenants and a failure to comply with such covenants could cause a default under the applicable debt agreement. In the event of a default, we may be required to repay such debt with capital from other sources, which may not be available on attractive terms, or at all.

We may also fund building acquisitions, development, redevelopment and other non-recurring capital improvements through additional borrowings, issuance of common Operating Partnership units or sales of assets, outright or through joint ventures.

Consolidated cash flow information is summarized as follows:
 

67

 
Year Ended December 31,
 
Change
(amounts in thousands)
2014
 
2013
 
2012
 
2014 vs. 2013
 
2013 vs. 2012
Cash provided by operating activities
$
62,953

 
$
55,292

 
$
47,839

 
$
7,661

 
$
7,453

Cash (used in) provided by investing activities
(111,556
)
 
160,331

 
(33,013
)
 
(271,887
)
 
193,344

Cash provided by (used in) financing activities
53,186

 
(216,257
)
 
(22,201
)
 
269,443

 
(194,056
)

Comparison of the Years Ended December 31, 2014 and 2013

Net cash provided by operating activities increased $7.7 million for the twelve months ended December 31, 2014 compared with same period in 2013 primarily due to an increase in same property net operating income. Additionally, net cash provided by operating activities increased in 2014 compared with 2013 due an increase in rents received in advance and a decrease in cash paid for interest expense. The increase in cash provided by operating activities for the twelve months ended December 31, 2014 compared with 2013 was partially offset by a reduction in net operating income, primarily as a result of selling our industrial portfolio in June 2013.

Net cash used in investing activities was $111.6 million for the twelve months ended December 31, 2014 compared with net cash provided by investing activities of $160.3 million for the same period in 2013. During 2014, we acquired three properties for an aggregate net cash purchase price of $150.7 million, which excludes the assumption of a $37.3 million mortgage loan in connection with our acquisition of 1401 K Street, NW, and we sold six properties for aggregate net cash proceeds of $97.7 million. During 2013, we purchased a building for $30.0 million and we sold 28 properties for aggregate net cash proceeds of $263.5 million, of which we placed $28.2 million of the net proceeds in an escrow account held by a qualified intermediary in order to facilitate a potential tax-free exchange, which was used to fund the majority of the 2013 acquisition. During the twelve months ended December 31, 2014, we increased our loan to the owners of 950 F Street, NW by $9.0 million, which was funded through a draw under our unsecured revolving credit facility. Additionally, during the twelve months ended December 31, 2014, cash used for construction activities and additions to rental properties decreased $17.2 million compared with the same period in 2013 due to substantially completing the redevelopment of 440 First Street, NW in the third quarter of 2013 and a decline in amounts spent on tenant improvements.

Net cash provided by financing activities was $53.2 million in 2014 compared with net cash used in financing activities of $216.3 million in 2013. During the twelve months ended December 31, 2014, we issued $250.5 million of debt and repaid $147.6 million of debt compared with the issuance of $152.2 million of debt and repayment of $412.4 million of outstanding debt during the twelve months ended December 31, 2013. During 2013, we paid $8.3 million toward the deferred purchase price obligation related to the acquisition of Storey Park in 2011 and a $0.7 million payment made to the seller of Corporate Campus at Ashburn Center to satisfy the contingent consideration obligation that was established at acquisition. We sold Corporate Campus at Ashburn Center in 2014. During 2013, we also issued 7.5 million common shares for net proceeds of $105.1 million. The increase in outstanding common shares resulted in an increase in dividends paid to common shareholders of $2.3 million for the twelve months ended December 31, 2014 compared with the same period in 2013.

Comparison of the Years Ended December 31, 2013 and 2012

Net cash provided by operating activities increased $7.5 million in 2013 compared with 2012, which was primarily attributable to a $10.2 million make-whole payment that was paid in June 2012 as part of the prepayment of our $37.5 million Series A Senior Notes and $37.5 million Series B Senior Notes. Additionally, net cash provided by operating activities increased in 2013 compared with 2012 due a decrease in accounts and other receivables, a decline in deferred costs and a lower amount of straight-line revenue recorded. The increase in cash provided by operating activities in 2013 compared with 2012 was partially offset by a decline in accounts payable and accrued expenses.

Net cash provided by investing activities was $160.3 million in 2013 compared with net cash used in investing activities of $33.0 million in 2012. During 2013, we received aggregate net proceeds of $263.5 million from the sale of Worman’s Mill Court, 4200 Tech Court, Triangle Business Center, 4212 Tech Court and 24 industrial properties, of which we placed $28.2 million of the net proceeds from the sale of the industrial properties in an escrow account held by a qualified intermediary in order to facilitate a potential tax-free exchange. In 2012, we sold four properties and a joint venture interest for aggregate net proceeds of $40.0 million. On October 1, 2013, we utilized the $28.2 million of escrowed proceeds and $1.8 million of available cash, to purchase 540 Gaither Road (Redland I). During the fourth quarter of 2013, we acquired the remaining interest in the first two buildings at Redland Corporate Center from our joint venture partner for $4.6 million. During 2013, cash used for

68

construction activities and additions to rental properties decreased $2.5 million compared with 2012 due to a reduction in amounts spent on tenant improvements.

Net cash used in financing activities was $216.3 million in 2013 compared with net cash used in financing activities of $22.2 million in 2012. During 2013, we issued $152.2 million of debt and repaid $412.4 million of its outstanding debt compared with the issuance of $445.4 million of debt and the repayment of $456.1 million of outstanding debt during 2012. The increase in cash used in financing activities in 2013 compared with 2012 was also due to an $8.3 million payment made in August 2013 toward the deferred purchase price obligation related to the acquisition of Storey Park in 2011 and a $0.7 million payment made to the seller of Ashburn Center to satisfy the contingent consideration obligation that was established at acquisition. During 2013, we issued common shares for net proceeds of $105.1 million compared with the issuance of preferred and common shares for net proceeds of $43.5 million and $3.6 million, respectively, during 2012. In the first quarter of 2013, we reduced our quarterly dividend by 25%, which resulted in a $7.8 million reduction in dividends paid to common shareholders in 2013 compared with 2012.


Property Acquisitions and Dispositions

We acquired three properties in 2014 and one property in 2013. Below is a summary of our acquisitions and dispositions during 2014 and 2013 (in thousands, except square feet and percentages):
 
Acquisitions
Reporting Segment
 
Acquisition Date
 
Property
Type
 
Square
Feet
 
Purchase
Price
 
Capitalization
Rate(1)
 
 
11 Dupont Circle, NW
Washington, D.C.
 
9/24/2014
 
Office
 
155,713

 
$
89,000

 
6.2
%
 
 
1775 Wiehle Avenue
Northern Virginia
 
6/25/2014
 
Office
 
130,048

 
41,000

 
6.9
%
 
 
1401 K Street, NW
Washington, D.C.
 
4/8/2014
 
Office
 
117,243

 
58,000

 
5.3
%
 
 
540 Gaither Road
Maryland
 
10/1/2013
 
Office
 
133,895

 
30,000

 
8.9
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Dispositions
Reporting Segment
 
Disposition Date
 
Property
Type
 
Square
Feet
 
Net Sale
Proceeds
 
Gain on Sale
 
Capitalization
Rate(2)
Owings Mills Business Park(3)
Maryland
 
10/16/2014
 
Business Park
 
180,475

 
$
12,417

 
$
—

 
4.4
%
Corporate Campus at Ashburn Center(3)
Northern Virginia
 
6/26/2014
 
Business Park
 
194,184

 
39,910

 
21,230

 
7.0
%
Patrick Center
Maryland
 
4/16/2014
 
Office
 
66,269

 
10,888

 
1,338

 
8.1
%
West Park
Maryland
 
4/2/2014
 
Office
 
28,333

 
2,871

 
—

 
6.9
%
Girard Business Center and Gateway Center
Maryland
 
1/29/2014
 
Business Park and Office
 
341,973

 
31,616

 
—

 
8.4
%
Worman’s Mill Court
Maryland
 
11/19/2013
 
Office
 
40,099

 
3,362

 
—

 
10.8
%
Triangle Business Center
Maryland
 
9/27/2013
 
Business 
Park
 
74,429

 
2,732

 
—

 
7.2
%
4200 Tech Court
Northern Virginia
 
8/15/2013
 
Office
 
33,875

 
3,210

 
509

 
9.2
%
Industrial Portfolio(4)
Various
 
May/June 2013
 
Industrial
 
4,280,985

 
176,569

 
18,789

 
7.2
%
4212 Tech Court
Northern Virginia
 
6/5/2013
 
Office
 
32,055

 
2,469

 
65

 
6.3
%
 
(1) 
Capitalization rates for acquisitions are calculated based on annual anticipated net operating income divided by the purchase price.
(2) 
Capitalization rates for dispositions are calculated based on annual net operating income divided by the selling price.
(3) 
The operating results and gain on sale of Corporate Campus at Ashburn Center and the operating results and impairment charge related to Owings Mills Business Park are reflected in continuing operations in our consolidated statements of operations.
(4) 
During the second quarter of 2013, we sold 24 industrial properties, which consisted of two separate transactions. On May 7, 2013, we sold I-66 Commerce Center, a 236,000 square foot industrial property in Haymarket, Virginia. On June 18, 2013, we completed the sale of the remaining 23 industrial properties.


69

Outstanding Debt

The following table sets forth certain information with respect to our outstanding indebtedness at December 31, 2014 (dollars in thousands):
 
Effective
Interest Rate
 
Balance at December 31, 2014
 
Annualized
Debt
Service
 
Maturity
Date
 
Balance at
Maturity
Fixed-Rate Debt
 
 
 
 
 
 
 
 
 
Encumbered Properties
 
 
 
 
 
 
 
 
 
Jackson National Life Loan(1)
5.19
%
 
$
64,943

 
$
4,577

  
8/1/2015
 
$
64,230

Hanover Business Center Building D(2)(3)
6.63
%
 
104

 
161

  
8/1/2015
 
13

Chesterfield Buildings C, D, G and H(2)(3)
6.63
%
 
302

 
414

  
9/1/2015
 
34

Gateway Centre Manassas Building I(2)
5.88
%
 
432

 
239

  
11/1/2016
 
—

Hillside I and II(2)
4.62
%
 
12,949

 
945

  
12/6/2016
 
12,160

Redland Corporate Center Buildings II and III
4.64
%
 
65,816

 
4,014

  
11/1/2017
 
62,064

Hanover Business Center Building C(2)(3)
6.63
%
 
505

 
186

  
12/1/2017
 
13

840 First Street, NE
6.01
%
 
36,539

 
2,722

  
7/1/2020
 
32,000

Battlefield Corporate Center
4.40
%
 
3,692

 
320

  
11/1/2020
 
2,618

Chesterfield Buildings A, B, E and F(2)(3)
6.63
%
 
1,674

 
318

  
6/1/2021
 
26

Airpark Business Center(2)(3)
6.63
%
 
913

 
173

  
6/1/2021
 
14

1211 Connecticut Avenue, NW
4.47
%
 
29,691

 
1,823

  
7/1/2022
 
24,668

1401 K Street, NW
4.93
%
 
36,861

 
2,392

 
6/1/2023
 
30,414

Total Fixed-Rate Debt
5.02
%
(4)  
$
254,421

 
$
18,284

  
 
 
$
228,254

Unamortized fair value adjustments
 
 
(443
)
 
 
 
 
 
 
Total Principal Balance
 
 
$
253,978

 
 
 
 
 
 
Variable-Rate Debt(5)
 
 
 
 
 
 
 
 
 
440 First Street, NW Construction Loan(6)
LIBOR+2.50%

 
$
32,216

 
$
860

  
5/30/2016
 
$
32,216

Storey Park Land Loan(7)
LIBOR+2.50%

 
22,000

 
587

  
10/16/2016
 
22,000

Unsecured Revolving Credit Facility
LIBOR+1.70%

 
205,000

 
3,834

  
10/16/2017
 
205,000

Unsecured Term Loan
 
 
 
 
 
 
 
 
 
Tranche A
LIBOR+1.65%

 
100,000

 
1,820

  
10/16/2018
 
100,000

Tranche B
LIBOR+1.80%

 
100,000

 
1,970

  
10/16/2019
 
100,000

Tranche C
LIBOR+2.05%

 
100,000

 
2,220

  
10/16/2020
 
100,000

Total Variable-Rate Debt
2.95
%
(4)(8)  
$
559,216

 
$
11,291

  
 
 
$
559,216

Total Debt at December 31, 2014
3.60
%
(4)(8)  
$
813,637

 
$
29,575

(9) 
 
 
$
787,470


(1) 
At December 31, 2014, the loan was secured by the following properties: Plaza 500, Van Buren Office Park, Rumsey Center, Snowden Center, Greenbrier Technology Center II, and Norfolk Business Center. The terms of the loan allow us to substitute collateral, as long as certain debt-service coverage and loan-to-value ratios are maintained, or to prepay a portion of the loan, with a prepayment penalty, subject to a debt service yield.
(2) 
The balance includes the fair value impacts recorded at acquisition upon assumption of the mortgages encumbering these properties.
(3) 
We anticipate repaying the mortgage loans that encumber the Richmond Portfolio, which is expected to be sold in the first half of 2015. The mortgage loans are classified within "Liabilities-held-for-sale" on our consolidated balance sheets.
(4) 
Represents the weighted average interest rate.
(5) 
All of our variable rate debt is based on one-month LIBOR. For the purposes of calculating the annualized debt service and the effective interest rate, we used the one-month LIBOR rate at December 31, 2014, which was 0.17%.
(6) 
The loan matures in May 2016, with two one-year extension options at our discretion and has a borrowing capacity of up to $43.5 million. We can repay all or a portion of the Construction Loan, without penalty, at any time during the term of the loan.
(7) 
The loan matures in October 2016, with a one-year extension at our option, and is repayable in full without penalty at any time during the term of the loan.
(8) 
At December 31, 2014, we had fixed LIBOR on $300.0 million of our variable rate debt through eleven interest rate swap agreements. The effective interest rate reflects the impact of our interest rate swap agreements.
(9) 
During 2014, we paid approximately $5.6 million in principal payments on our consolidated mortgage debt, which excludes $8.0 million related to mortgage debt that was repaid in 2014.


70


All of our outstanding debt contains customary, affirmative covenants including financial reporting, standard lease requirements and certain negative covenants. We are also subject to cash management agreements with most of our mortgage lenders. These agreements require that revenue generated by the subject property be deposited into a clearing account and then swept into a cash collateral account for the benefit of the lender from which cash is distributed only after funding of improvement, leasing and maintenance reserves and payment of debt service, insurance, taxes, capital expenditures and leasing costs.

Financial Covenants

Our outstanding corporate debt agreements contain specific financial covenants that may impact future financing decisions made by us or may be impacted by a decline in operations. As of December 31, 2014, we were in compliance with the covenants of our amended and restated unsecured term loan, amended and restated unsecured revolving credit facility, Construction Loan and Storey Park Land Loan.

Our continued ability to borrow under the amended and restated unsecured revolving credit facility is subject to compliance with financial and operating covenants, and a failure to comply with any of these covenants could result in a default under the credit facility. These debt agreements also contain cross-default provisions that would be triggered if we are in default under other loans, including mortgage loans, in excess of certain amounts. In the event of a default, the lenders could accelerate the timing of payments under the debt obligations and we may be required to repay such debt with capital from other sources, which may not be available on attractive terms, or at all, which would have a material adverse effect on our liquidity, financial condition, results of operations and ability to make distributions to our shareholders.

Below is a summary of certain financial covenants associated with these debt agreements at December 31, 2014 (dollars in thousands):

Unsecured Revolving Credit Facility, Unsecured Term Loan, Construction Loan and Storey Park Land Loan
 
Covenants
Quarter Ended December 31, 2014
 
Covenant
Consolidated Total Leverage Ratio(1)
47.2%
 
≤ 60%
Tangible Net Worth(1)
$970,974
 
≥ $601,202
Fixed Charge Coverage Ratio(1)
2.17x
 
≥ 1.50x
Maximum Dividend Payout Ratio
68.2%
 
≤ 95%
Restricted Investments:
 
 
 
Joint Ventures
5.2%
 
≤ 15%
Real Estate Assets Under Development
0.6%
 
≤ 15%
Undeveloped Land
1.0%
 
≤ 5%
Structured Finance Investments
3.5%
 
≤ 5%
Total Restricted Investments
5.0%
 
≤ 25%
Restricted Indebtedness:
 
 
 
Maximum Secured Debt
19.4%
 
≤ 40%
Unencumbered Pool Leverage(1)
46.8%
 
≤ 60%
Unencumbered Pool Interest Coverage Ratio(1)
5.72x
 
≥ 1.75x
 
(1) 
These are the only covenants that apply to both our 440 First Street, NW construction loan and our Storey Park land loan, which are calculated in accordance with the amended and restated unsecured revolving credit facility.

Derivative Financial Instruments

We are exposed to certain risks arising from business operations and economic factors. We use derivative financial instruments to manage exposures that arise from business activities in which our future exposure to interest rate fluctuations is unknown. The objective in the use of an interest rate derivative is to add stability to interest expenses and manage exposure to interest rate changes. We do not use derivatives for trading or speculative purposes and intend to enter into derivative agreements only with counterparties that we believe have a strong credit rating to mitigate the risk of counterparty default or

71

insolvency. No hedging activity can completely insulate us from the risks associated with changes in interest rates. Moreover, interest rate hedging could fail to protect us or adversely affect us because, among other things:

•
available interest rate hedging may not correspond directly with the interest rate risk for which we seek protection;
•
the duration of the hedge may not match the duration of the related liability;
•
the party owing money in the hedging transaction may default on its obligation to pay; and
•
the credit quality of the party owing money on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction.

We enter into interest rate swap agreements to hedge our exposure on our variable rate debt against fluctuations in prevailing interest rates. The interest rate swap agreements fix LIBOR to a specified interest rate; however, the swap agreements do not affect the contractual spreads associated with each variable debt instrument’s applicable interest rate.

At December 31, 2014, we had fixed LIBOR at a weighted average interest rate of 1.5% on $300.0 million of our variable rate debt through eleven interest rate swap agreements that are summarized below (dollars in thousands):
 
Maturity Date
 
Notional
Amount
 
Interest Rate
Contractual
Component
 
Fixed LIBOR
Interest Rate
July 2016
 
$
35,000

 
LIBOR
 
1.754
%
July 2016
 
25,000

 
LIBOR
 
1.763
%
July 2017
 
30,000

 
LIBOR
 
2.093
%
July 2017
 
30,000

 
LIBOR
 
2.093
%
July 2018
 
30,000

 
LIBOR
 
1.660
%
July 2018
 
25,000

 
LIBOR
 
1.394
%
July 2017
 
25,000

 
LIBOR
 
1.129
%
July 2017
 
12,500

 
LIBOR
 
1.129
%
July 2018
 
12,500

 
LIBOR
 
1.383
%
July 2017
 
50,000

 
LIBOR
 
0.955
%
July 2018
 
25,000

 
LIBOR
 
1.135
%
Total/Weighted Average
 
$
300,000

 
 
 
1.505
%

Off-Balance Sheet Arrangements

We are secondarily liable for $2.8 million of mortgage debt, which represents our proportionate share of the mortgage debt that is secured by two properties we own through two unconsolidated joint ventures. Management believes the fair value of the potential liability to us is inconsequential as the likelihood of our need to perform under the debt agreement is remote. We sold our 95% interest in 1200 17th Street, NW during the third quarter of 2012. See note 6, Investment in Affiliates, in the notes to our consolidated financial statements for more information.

72


Disclosure of Contractual Obligations

The following table summarizes known material contractual obligations as of December 31, 2014 (dollars in thousands):
 
 
 
 
Payments due by period
Contractual Obligations
Total
 
Less than 1
year
 
1-3 Years
 
3 -5 Years
 
More than
5 Years
Mortgage loans(1)(2)
$
308,194

 
$
69,553

 
$
136,761

 
$
5,640

 
$
96,240

Unsecured term loan
300,000

 
—

 
—

 
200,000

 
100,000

Unsecured revolving credit facility
205,000

 
—

 
205,000

 
—

 
—

Interest expense(3)
99,941

 
26,439

 
42,195

 
19,878

 
11,429

Operating leases(4)
10,598

 
1,450

 
3,018

 
3,906

 
2,224

Construction in progress
1,375

 
1,375

 
—

 
—

 
—

Capital expenditures
1,575

 
1,575

 
—

 
—

 
—

Tenant improvements(5)
10,244

 
10,244

 
—

 
—

 
—

Total
$
936,927

 
$
110,636

 
$
386,974

 
$
229,424

 
$
209,893

 
(1) 
Excludes the unamortized fair value adjustments recorded at acquisition upon the assumption of mortgage loans.
(2) 
Includes five mortgage loans totaling $3.5 million that will be repaid upon the sale of the Richmond Portfolio, which is expected to close in the first half of 2015. The mortgage loans were classified within “Liabilities held-for-sale” on our consolidated balance sheets.
(3) 
Interest expense for our fixed rate obligations represents the amount of interest that is contractually due under the terms of the respective loans. Interest expense for our variable rate obligations and our interest rate swap obligations are calculated using the outstanding balance and applicable interest rate at December 31, 2014 over the life of the obligation.
(4) 
Reflects the lease obligation on our corporate headquarters, net of sublease income.
(5) 
Includes leasehold improvement and space refurbishment costs.


As of December 31, 2014, we had contractual construction in progress obligations, which included amounts accrued at December 31, 2014, of $1.4 million. The amount of contractual construction in progress obligations are primarily related to development activities at Storey Park, which is located in our Washington, D.C. reporting segment. As of December 31, 2014, we had contractual rental property and furniture, fixtures and equipment obligations of $11.8 million outstanding, which included amounts accrued at December 31, 2014. The amount of contractual rental property and furniture, fixtures and equipment obligations at December 31, 2014 included significant tenant improvement costs for a new lease at Atlantic Corporate Park, which is located in our Northern Virginia reporting segment. We anticipate meeting our contractual obligations related to our construction activities with cash from our operating activities. In the event cash from our operating activities is not sufficient to meet our contractual obligations, we can access additional capital through our unsecured revolving credit facility.
We remain liable, solely to the extent of our proportionate ownership percentage, to fund any capital shortfalls or commitments from properties owned through unconsolidated joint ventures.

We have various obligations to certain local municipalities associated with our development projects that will require completion of specified site improvements, such as sewer and road maintenance, grading and other general landscaping work. As of December 31, 2014, we remained liable to those local municipalities for $2.6 million in the event that we do not complete the specified work. We intend to complete the improvements in satisfaction of these obligations.

We had no other material contractual obligations as of December 31, 2014.

Funds From Operations

Funds from operations (“FFO”) is a non-GAAP measure used by many investors and analysts that follow the public real estate industry. We consider FFO a useful measure of performance for an equity REIT because it facilitates an understanding of the operating performance of our properties without giving effect to real estate depreciation and amortization, which assume that the value of rental property diminishes predictably over time. Since real estate values have historically risen or fallen with market conditions, we believe that FFO provides a meaningful indication of our performance. We also consider FFO an appropriate supplemental performance measure given its wide use by and relevance to investors and analysts. FFO, reflecting

73

the assumption that real estate asset values rise or fall with market conditions, principally adjusts for the effects of GAAP depreciation and amortization of real estate assets, which assume that the value of real estate diminishes predictably over time.
FFO, as defined by the National Association of Real Estate Investment Trusts (“NAREIT”), represents net income (computed in accordance with GAAP), excluding gains (losses) on sales of rental property and impairments of rental property, plus real estate-related depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures. We compute FFO in accordance with NAREIT’s definition, which may differ from the methodology for calculating FFO, or similarly titled measures, used by other companies and this may not be comparable to those presentations. Our methodology for computing FFO adds back noncontrolling interests in the income from our Operating Partnership in determining FFO. We believe this is appropriate as common Operating Partnership units are presented on an as-converted, one-for-one basis for shares of stock in determining FFO per diluted share.
FFO does not represent amounts available for management’s discretionary use because of needed capital replacement or expansion, debt service obligations or other commitments and uncertainties, nor is it indicative of funds available to fund our cash needs, including our ability to make distributions. We present FFO per diluted share calculations that are based on the outstanding dilutive common shares plus the outstanding common Operating Partnership units for the periods presented. Our presentation of FFO in accordance with NAREIT’s definition, or as adjusted by us, should not be considered as an alternative to net income (computed in accordance with GAAP) as an indicator of our financial performance or to cash flow from operating activities (computed in accordance with GAAP) as an indicator of our liquidity.
The following table presents a reconciliation of net income (loss) attributable to common shareholders to FFO available to common shareholders and unitholders (dollars in thousands):

 
Year Ended December 31,
 
2014
 
2013
 
2012
Net income (loss) attributable to First Potomac Realty Trust
$
16,844

 
$
11,074

 
$
(7,395
)
Less: Dividends on preferred shares
(12,400
)
 
(12,400
)
 
(11,964
)
Net income (loss) attributable to common shareholders
4,444

 
(1,326
)
 
(19,359
)
Add: Depreciation and amortization:
 
 
 
 
 
Rental property
61,796

 
54,567

 
51,457

Discontinued operations
3,662

 
8,937

 
14,958

Unconsolidated joint ventures
4,466

 
5,323

 
5,883

Consolidated joint ventures
—

 
(163
)
 
(177
)
Impairment of rental property(1)
3,957

 
4,092

 
3,516

Gain on sale(2)
(22,568
)
 
(19,363
)
 
(3,091
)
Net income (loss) attributable to noncontrolling interests in the Operating Partnership
199

 
(74
)
 
(1,051
)
FFO available to common shareholders and unitholders
55,956

 
51,993

 
52,136

Dividends on preferred shares
12,400

 
12,400

 
11,964

FFO
$
68,356

 
$
64,393

 
$
64,100

Weighted average common shares and Operating Partnership units outstanding – diluted
60,851

 
57,706

 
52,921

 
(1) 
Impairment charges of $4.0 million for the year ended December 31, 2014 and $2.4 million for the year ended December 31, 2012 are included in continuing operations in our consolidated statements of operations. The remaining impairment charges for the years ended December 31, 2013 and 2012 are included in discontinued operations in our consolidated statements of operations.
(2) 
During 2014, we recorded a $21.2 million gain on the sale of Corporate Campus at Ashburn Center, which is reflected in continuing operations in our consolidated statements of operations. During 2012, we recorded a $2.9 million gain, which is reflected within continuing operations in our consolidated statements of operations, on the sale of our interest in a joint venture. During 2014, 2013, and 2012, we recorded gains on the sale of properties totaling $1.3 million, $19.4 million, and $0.2 million, respectively, which are reflected in discontinued operations in our consolidated statements of operations.



74

ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our future income, cash flows and fair values relevant to financial instruments are dependent upon prevailing market interest rates. In the normal course of business, we are exposed to the effect of interest rate changes. We have historically entered into derivative agreements to mitigate exposure to unexpected changes in interest. Market risk refers to the risk of loss from adverse changes in market interest rates. We periodically use derivative financial instruments to seek to manage, or hedge, interest rate risks related to our borrowings. We do not use derivatives for trading or speculative purposes and only enter into contracts with major financial institutions based on their credit rating and other factors. We intend to enter into derivative agreements only with counterparties that we believe have a strong credit rating to mitigate the risk of counterparty default or insolvency.
.
We had $813.6 million of debt outstanding at December 31, 2014, of which $254.4 million was fixed rate debt and $300.0 million was hedged variable rate debt. The remainder of our debt, $259.2 million, was unhedged variable rate debt that consisted of $205.0 million under the unsecured revolving credit facility, a $22.0 million loan that encumbers the Storey Park land and the $32.2 million outstanding balance under a construction loan. At December 31, 2014, both the Storey Park land loan and the construction loan had a contractual interest rate of LIBOR plus 2.50%. At December 31, 2014, LIBOR was 0.17%. A change in interest rates of 1% would result in an increase or decrease of $2.6 million in interest expense on our unhedged variable rate debt on an annualized basis.

The table below summarizes our interest rate swap agreements as of December 31, 2014 (dollars in thousands):
 
Maturity Date
 
Notional Amount
 
Interest Rate
Contractual
Component
 
Fixed LIBOR
Interest Rate
July 2016
  
$
35,000

 
LIBOR
 
1.754
%
July 2016
  
25,000

 
LIBOR
 
1.763
%
July 2017
  
30,000

 
LIBOR
 
2.093
%
July 2017
  
30,000

 
LIBOR
 
2.093
%
July 2018
  
30,000

 
LIBOR
 
1.660
%
July 2018
  
25,000

 
LIBOR
 
1.394
%
July 2017
  
25,000

 
LIBOR
 
1.129
%
July 2017
  
12,500

 
LIBOR
 
1.129
%
July 2018
  
12,500

 
LIBOR
 
1.383
%
July 2017
  
50,000

 
LIBOR
 
0.955
%
July 2018
  
25,000

 
LIBOR
 
1.135
%
Total/Weighted Average
 
$
300,000

 
 
 
1.505
%

For fixed rate debt, changes in interest rates generally affect the fair value of our debt but not our earnings or cash flow. See note 13, Fair Value Measurements, in the notes to our consolidated financial statements for more information on the fair value of our debt.


75

Our projected long-term debt obligations, principal cash flows by anticipated maturity and weighted average interest rates at December 31, 2014, for each of the succeeding five years are as follows (dollars in thousands):
 
 
2015
 
2016
 
2017
 
2018
 
2019
 
Thereafter
 
Total
 
Fair Value
Fixed Rate Debt
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage debt(1)(2)(3)
$
69,553

 
$
16,546

 
$
65,999

 
$
2,746

 
$
2,894

 
$
96,240

 
$
253,978

 
$
238,666

Weighted average interest rate
5.00
%
 
4.96
%
 
5.00
%
 
5.18
%
 
5.17
%
 
4.87
%
 
 
 
 
Variable Rate Debt
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Land loan
$
—

 
$
22,000

 
$
—

 
$
—

 
$
—

 
$
—

 
$
22,000

 
$
22,000

Construction loan
—

 
32,216

 
—

 
—

 
—

 
—

 
32,216

 
32,216

Unsecured term loan
—

 
—

 
—

 
100,000

 
100,000

 
100,000

 
300,000

 
300,000

Credit facility
—

 
—

 
205,000

 
—

 
—

 
—

 
205,000

 
205,000

Weighted average interest rate
2.02
%
 
1.99
%
 
1.96
%
 
2.02
%
 
2.11
%
 
2.22
%
 
$
559,216

 
$
559,216

Interest Rate Swaps
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Variable to fixed(4)
—

 
60,000

 
147,500

 
92,500

 
—

 
—

 
$
300,000

 
$
(3,437
)
Average pay rate
3.35
%
 
3.35
%
 
3.34
%
 
3.46
%
 
—

 
—

 
 
 
 
Weighted average receive rate
2.02
%
 
2.02
%
 
2.07
%
 
2.22
%
 
—

 
—

 
 
 
 


(1) 
Excludes the unamortized fair value adjustments recorded at acquisition upon the assumption of mortgage loans.
(2) 
Includes mortgage loans that will be repaid upon the sale of the Richmond Portfolio, which is expected to be sold in the first half of 2015.
(3) 
Excludes a $22.0 million land loan which encumbers Storey Park and the $32.2 million outstanding balance under a Construction Loan. Both the land loan and the Construction Loan have a contractual interest rate of LIBOR plus 2.50%. At December 31, 2014, LIBOR was 0.17%.
(4) 
Represents the notional amounts of the hedged debt. At December 31, 2014, we had fixed LIBOR on $300.0 million of our variable rate debt though eleven interest rate swap agreements.

ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements and supplementary data required by this Item 8 are filed with this Annual Report on Form 10-K immediately following the signature page of this Annual Report on Form 10-K and are incorporated herein by reference.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

76

ITEM 9A.
CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that are designed to ensure that information required to be disclosed in our periodic reports pursuant to the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required financial disclosure.

We carried out an evaluation, under the supervision and with the participation of our management, including the principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(e) as of the end of the period covered by this report. Based upon this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is a process designed under the supervision of our principal executive officer and principal financial officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our consolidated financial statements for external reporting purposes in accordance with GAAP.

Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures are being made only in accordance with authorizations of our management and trustees; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on our consolidated financial statements.

Management conducted an assessment of the effectiveness of our internal control over financial reporting as of December 31, 2014 based on the framework established in the updated Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management has determined that our internal control over financial reporting was effective as of December 31, 2014.

The effectiveness of our internal control over financial reporting as of December 31, 2014 has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their attestation report appearing on page 78 of this Annual Report on Form 10-K. KPMG’s report expresses an unqualified opinion on the effectiveness of our internal control over financial reporting as of December 31, 2014.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during the quarter ended December 31, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
OTHER INFORMATION

None.


77

Report of Independent Registered Public Accounting Firm

The Board of Trustees and Shareholders
First Potomac Realty Trust:

We have audited First Potomac Realty Trust’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). First Potomac Realty Trust’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting (Item 9A(2)). 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, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included 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, First Potomac Realty Trust maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of First Potomac Realty Trust and subsidiaries as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive income (loss), equity, and cash flows for each of the years in the three-year period ended December 31, 2014, and our report dated February 19, 2015 expressed an unqualified opinion on those consolidated financial statements.
/s/ KPMG LLP
McLean, Virginia
February 19, 2015


78

PART III

ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Executive Officers of the Company

The following table sets forth information with respect to our executive officers:
Name
Age
Position and Background
Douglas J. Donatelli
53
Chairman of the Board of Trustees and Chief Executive Officer
Douglas J. Donatelli is a founder of the Company and has served as Chairman since May 2007 and Chief Executive Officer and trustee of the Company since its predecessor’s founding in 1997. Mr. Donatelli previously was Executive Vice President of Donatelli & Klein, Inc. (now Donatelli Development, Inc. (“DDI”)), a real estate development and investment firm located in Washington, D.C., and from 1985 to 1991, President of D&K Broadcasting, a communications subsidiary of DDI that owned Fox network affiliated television stations. Mr. Donatelli is active in many business, community and charitable organizations. He is a member of the Urban Land Institute, the Real Estate Roundtable and the National Association of Real Estate Investment Trusts (“NAREIT”). He serves as Chairman of the Board of Directors of Catholic Charities of the Archdiocese of Washington. Mr. Donatelli holds a Bachelor of Science degree in Business Administration from Wake Forest University.
Andrew P. Blocher
50
Executive Vice President and Chief Financial Officer
Andrew P. Blocher joined the Company in 2012 as Executive Vice President and Chief Financial Officer. Mr. Blocher has over 20 years of finance and capital markets experience, including 15 years in the public REIT sector. Prior to joining the Company, Mr. Blocher was the Chief Financial Officer at Federal Realty Investment Trust (“NYSE: FRT”), joining FRT in 2000 as Vice President, Investor Relations; Mr. Blocher was promoted to Senior Vice President in 2007 and to Chief Financial Officer in 2008. Mr. Blocher had served as Director, Structured Finance Marketing and Modeling, at Freddie Mac, as well as Vice President of Capital Markets for CRIIMI MAE Inc., a mortgage REIT. Mr. Blocher currently serves on the Board of Directors for Make-A-Wish® Mid-Atlantic, where he chairs the Audit and Finance committee and serves on the Executive Committee. Mr. Blocher received his Bachelor of Science degree in Finance from Indiana University in Bloomington and his Masters of Business Administration in Finance from the George Washington University.
Nicholas R. Smith
50
Executive Vice President and Chief Investment Officer
Nicholas R. Smith is one of the founders of the Company and has served as Executive Vice President and Chief Investment Officer since the founding of our predecessor in 1997. He has over 25 years of experience in commercial real estate in the Washington, D.C. area, including seven years with DDI and D&K Management. Prior to joining DDI, Mr. Smith was with Garrett & Smith, Inc., a real estate investment and development firm based in Mclean, Virginia and Transwestern (formerly Barrueta & Associates, Inc.), a Washington, D.C.-based commercial real estate brokerage and property management firm. He currently serves on the Council of Advisors for the University of Maryland’s School of Architecture, Planning and Preservation Graduate Programs in Real Estate and is Vice Chairman of the Board of Directors of the Choral Arts Society of Washington. He is also a member of NAIOP, the Urban Land Institute and NAREIT. Mr. Smith received his Bachelor of Arts degree from The Catholic University of America.
Robert Milkovich
55
Executive Vice President and Chief Operating Officer                                                                                                                                                                                                                                                     
Robert Milkovich joined the Company in June 2014 as Executive Vice President and Chief Operating Officer. Mr. Milkovich has over 25 years of leadership in the greater Washington, D.C. commercial real estate industry and in certain other parts of the country. Prior to joining the Company, he served, since 2012, as President and Head of the Investment Committee of Spaulding & Slye Investments, a comprehensive real estate services and investment company that is a wholly owned subsidiary of JLL. He also served as Regional Director of Archon Group, L.P., an investment arm of the merchant banking division of Goldman Sachs, which he joined in 2004, and served as Market Managing Director for CarrAmerica Realty Corporation, a then publicly traded office REIT headquartered in Washington, D.C. He currently serves as a Director and Investment Committee member for the University System of Maryland Foundation. Mr. Milkovich is on the Board and Membership Committee of the Economic Club of Washington, D.C. and is a member of the Urban Land Institute’s Office Development Counsel, and was a past president of The Real Estate Group in Washington, D.C. Mr. Milkovich graduated with a B.S. in Business Administration from the University of Maryland.

79

Samantha Sacks Gallagher
38
Executive Vice President, General Counsel and Secretary                                                                                                                                                                               
Samantha Sacks Gallagher joined the Company in October 2014 as the Executive Vice President, General Counsel and Secretary. She serves as the Company’s chief legal officer and leads the Company's corporate legal function. In her role, she has leadership responsibility for corporate governance matters, SEC and NYSE compliance, structuring of corporate-level transactions, overseeing litigation, as well as managing outside counsel. Prior to joining the Company, she served as a Partner at Arnold & Porter LLP in the firm’s Corporate and Securities Practice.  She also previously served as a Partner at Hogan Lovells US LLP in the firm’s Corporate, Capital Markets and REIT practice groups (having joined Hogan as a corporate attorney in 2001). While in private practice, Ms. Gallagher focused on capital markets transactions, joint ventures, mergers and acquisitions and strategic investments, as well as advising companies in a variety of corporate and securities law matters. In particular, she has extensive experience representing REITs and other real estate companies and financial institutions.  She currently serves on the Board of Directors for Make-A-Wish® Mid-Atlantic, where she is also a member of its Governance Committee. Ms. Gallagher received her J.D. from Georgetown University Law Center and her A.B. from Princeton University.

The information appearing in our definitive proxy statement to be filed in connection with our Annual Meeting of Shareholders to be held on May 21, 2015 (the “Proxy Statement”) under the headings “Proposal 1: Election of Trustees,” “Corporate Governance and Board Matters,” “Executive Officers” and “Section 16(a) Beneficial Ownership Reporting Compliance” is incorporated by reference herein.

80

ITEM 11.
EXECUTIVE COMPENSATION

The information in the Proxy Statement under the headings “Compensation of Trustees,” “Executive Compensation,” “Compensation Committee Interlocks and Insider Participation” and “Compensation Committee Report” is incorporated by reference herein.
 
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information in the Proxy Statement under the headings “Share Ownership of Trustees and Executive Officers,” “Share Ownership by Certain Beneficial Owners” and “Executive Compensation – Equity Compensation Plan Information” is incorporated by reference herein.
 
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information in the Proxy Statement under the headings “Certain Relationships and Related Transactions” and “Corporate Governance and Board Matters” is incorporated by reference herein.
 
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES

The information in the Proxy Statement under the heading “Principal Accountant Fees and Services” is incorporated by reference herein.
 

81

PART IV

ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

Financial Statements and Schedules

Reference is made to the Index to Financial Statements and Schedules on page 84 for a list of the financial statements and schedules included in this report.

Exhibits

The exhibits required by Item 601 of Regulation S-K are listed in the Exhibit Index beginning page 133 of this report, which is incorporated by reference herein.


82

SIGNATURES

Pursuant to the requirements of Section 13 and 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, in the state of Maryland on February 19, 2015.
 
 
 
FIRST POTOMAC REALTY TRUST
 
 
 
 
 
/s/ Douglas J. Donatelli
 
 
Douglas J. Donatelli
 
 
Chairman of the Board and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities indicated on February 19, 2015.
 
Signature
  
Title
 
 
/s/ Douglas J. Donatelli
 
 
Douglas J. Donatelli
  
Chairman of the Board of Trustees and Chief Executive Officer (principal executive officer)
 
 
/s/ Andrew P. Blocher
 
 
Andrew P. Blocher
  
Executive Vice President and Chief Financial Officer (principal financial officer)
 
 
/s/ Michael H. Comer
 
 
Michael H. Comer
  
Senior Vice President and Chief Accounting Officer (principal accounting officer)
 
 
/s/ Robert H. Arnold
 
 
Robert H. Arnold
  
Trustee
 
 
/s/ Richard B. Chess
 
 
Richard B. Chess
  
Trustee
 
 
/s/ J. Roderick Heller, III
 
 
J. Roderick Heller, III
  
Trustee
 
 
/s/ R. Michael McCullough
 
 
R. Michael McCullough
  
Trustee
 
 
/s/ Alan G. Merten
 
 
Alan G. Merten
  
Trustee
 
 
/s/ Terry L. Stevens
 
 
Terry L. Stevens
  
Trustee
 
 
/s/ Thomas E. Robinson
 
 
Thomas E. Robinson
  
Trustee


83

FIRST POTOMAC REALTY TRUST
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES

The following consolidated financial statements and schedule of First Potomac Realty Trust and Subsidiaries and report of our independent registered public accounting firm thereon are attached hereto:


All other schedules are omitted because they are not applicable, or because the required information is included in the consolidated financial statements or notes thereto.


84

Report of Independent Registered Public Accounting Firm
The Board of Trustees and Shareholders
First Potomac Realty Trust:
We have audited the accompanying consolidated balance sheets of First Potomac Realty Trust and subsidiaries (the Company) as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive income (loss), equity, and cash flows for each of the years in the three‑year period ended December 31, 2014. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule of real estate and accumulated depreciation. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Potomac Realty Trust and subsidiaries as of December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the years in the three‑year period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the consolidated 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), First Potomac Realty Trust’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 19, 2015 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
As discussed in Note 2 to the consolidated financial statements, the Company has elected to adopt ASU 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, in 2014.

/s/ KPMG LLP
McLean, Virginia
February 19, 2015



85


FIRST POTOMAC REALTY TRUST AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2014 and 2013
(Amounts in thousands, except per share amounts)
 
 
2014
 
2013
Assets:
 
 
 
Rental property, net
$
1,288,873

 
$
1,144,455

Assets held-for-sale
59,717

 
106,468

Cash and cash equivalents
13,323

 
8,740

Escrows and reserves
2,986

 
7,673

Accounts and other receivables, net of allowance for doubtful accounts of $1,207 and $1,181, respectively
10,587

 
12,384

Accrued straight-line rents, net of allowance for doubtful accounts of $104 and $92, respectively
34,226

 
29,531

Notes receivable, net
63,679

 
54,696

Investment in affiliates
47,482

 
49,150

Deferred costs, net
43,991

 
42,311

Prepaid expenses and other assets
7,712

 
8,261

Intangible assets, net
45,884

 
38,791

Total assets
$
1,618,460

 
$
1,502,460

Liabilities:
 
 
 
Mortgage loans
$
305,139

 
$
270,167

Unsecured term loan
300,000

 
300,000

Unsecured revolving credit facility
205,000

 
99,000

Liabilities held-for-sale
4,562

 
5,541

Accounts payable and other liabilities
41,113

 
41,296

Accrued interest
1,720

 
1,663

Rents received in advance
7,971

 
5,898

Tenant security deposits
5,891

 
4,861

Deferred market rent, net
2,827

 
1,522

Total liabilities
874,223

 
729,948

Noncontrolling interests in the Operating Partnership
33,332

 
33,221

Equity:
 
 
 
Preferred Shares, $0.001 par value, 50,000 shares authorized;

 

Series A Preferred Shares, $25 per share liquidation preference, 6,400 shares issued and outstanding
160,000

 
160,000

Common shares, $0.001 par value, 150,000 shares authorized; 58,815 and 58,704 shares issued and outstanding, respectively
59

 
59

Additional paid-in capital
913,282

 
911,533

Noncontrolling interests in a consolidated partnership
898

 
781

Accumulated other comprehensive loss
(3,268
)
 
(3,836
)
Dividends in excess of accumulated earnings
(360,066
)
 
(329,246
)
Total equity
710,905

 
739,291

Total liabilities, noncontrolling interests and equity
$
1,618,460

 
$
1,502,460


See accompanying notes to consolidated financial statements.

86

FIRST POTOMAC REALTY TRUST AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended December 31, 2014, 2013 and 2012
(Amounts in thousands, except per share amounts)
 
2014
 
2013
 
2012
Revenues:
 
 
 
 
 
Rental
$
128,226

 
$
118,337

 
$
114,032

Tenant reimbursements and other
33,426

 
30,478

 
28,930

Total revenues
161,652

 
148,815

 
142,962

Operating expenses:
 
 
 
 
 
Property operating
43,252

 
38,280

 
34,322

Real estate taxes and insurance
17,360

 
16,074

 
14,185

General and administrative
21,156

 
21,979

 
23,568

Acquisition costs
2,681

 
602

 
49

Depreciation and amortization
61,796

 
54,567

 
51,457

Impairment of rental property
3,956

 
—

 
2,444

Contingent consideration related to acquisition of property
—

 
(213
)
 
152

Total operating expenses
150,201

 
131,289

 
126,177

Operating income
11,451

 
17,526

 
16,785

Other (income) expenses:
 
 
 
 
 
Interest expense
24,696

 
32,803

 
40,602

Interest and other income
(6,799
)
 
(6,373
)
 
(6,047
)
Equity in (earnings) losses of affiliates
(775
)
 
47

 
(40
)
Gain on sale of investment
—

 
—

 
(2,951
)
Loss on debt extinguishment / modification
—

 
1,810

 
13,687

Gain on sale of rental property
(21,230
)
 
—

 
—

Total other (income) expenses
(4,108
)
 
28,287

 
45,251

Income (loss) from continuing operations before income taxes
15,559

 
(10,761
)
 
(28,466
)
Benefit from income taxes
—

 
—

 
4,142

Income (loss) from continuing operations
15,559

 
(10,761
)
 
(24,324
)
Discontinued operations:
 
 
 
 
 
Income from operations
146

 
6,793

 
15,782

Loss on debt extinguishment
—

 
(4,414
)
 
—

Gain on sale of rental property
1,338

 
19,363

 
161

Income from discontinued operations
1,484

 
21,742

 
15,943

Net income (loss)
17,043

 
10,981

 
(8,381
)
Less: Net (income) loss attributable to noncontrolling interests
(199
)
 
93

 
986

Net income (loss) attributable to First Potomac Realty Trust
16,844

 
11,074

 
(7,395
)
Less: Dividends on preferred shares
(12,400
)
 
(12,400
)
 
(11,964
)
Net income (loss) attributable to common shareholders
$
4,444

 
$
(1,326
)
 
$
(19,359
)
Basic and diluted earnings per common share:
 
 
 
 
 
Income (loss) from continuing operations
$
0.05

 
$
(0.41
)
 
$
(0.70
)
Income from discontinued operations
0.02

 
0.38

 
0.30

Net income (loss)
$
0.07

 
$
(0.03
)
 
$
(0.40
)
Weighted average common shares outstanding – basic
58,150

 
55,034

 
50,120

Weighted average common shares outstanding - diluted
58,220

 
55,034

 
50,120

See accompanying notes to consolidated financial statements.

87

FIRST POTOMAC REALTY TRUST AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income (Loss)
Years ended December 31, 2014, 2013 and 2012
(Amounts in thousands)
 
 
2014
 
2013
 
2012
Net income (loss)
$
17,043

 
$
10,981

 
$
(8,381
)
Unrealized gain on derivative instruments
1,289

 
7,423

 
295

Unrealized loss on derivative instruments
(696
)
 
—

 
(5,629
)
Total comprehensive income (loss)
17,636

 
18,404

 
(13,715
)
Net (income) loss attributable to noncontrolling interests
(199
)
 
93

 
986

Net (gain) loss from derivative instruments attributable to noncontrolling interests
(25
)
 
(342
)
 
266

Comprehensive income (loss) attributable to First Potomac Realty Trust
$
17,412

 
$
18,155

 
$
(12,463
)

See accompanying notes to consolidated financial statements.


88

FIRST POTOMAC REALTY TRUST AND SUBSIDIARIES
Consolidated Statements of Equity
Years ended December 31, 2014, 2013 and 2012
(Amounts in thousands)
 
 
Series A
Preferred Shares
 
Common
Shares
 
Additional
Paid-in Capital
 
Noncontrolling
Interests in
Consolidated
Partnerships
 
Accumulated 
Other
Comprehensive
Loss
 
Dividends in
Excess
of Accumulated
Earnings
 
Total Equity
Balance at December 31, 2011
$
115,000

 
$
50

 
$
798,171

 
$
4,245

 
$
(5,849
)
 
$
(235,126
)
 
$
676,491

Net loss
—

 
—

 
—

 
—

 
—

 
(8,381
)
 
(8,381
)
Net unrealized loss on derivative instruments
—

 
—

 
—

 
—

 
(5,334
)
 
—

 
(5,334
)
Net loss attributable to noncontrolling interests
—

 
—

 
—

 
—

 
266

 
986

 
1,252

Dividends paid to common shareholders
—

 
—

 
—

 
—

 
—

 
(40,730
)
 
(40,730
)
Dividends on preferred shares
—

 
—

 
—

 
—

 
—

 
(11,702
)
 
(11,702
)
Shares issued in exchange for common Operating Partnership units
—

 
1

 
4,064

 
—

 
—

 
—

 
4,065

Restricted stock expense
—

 
—

 
2,961

 
—

 
—

 
—

 
2,961

Exercise of stock options
—

 
—

 
71

 
—

 
—

 
—

 
71

Stock option and employee stock purchase plan expense
—

 
—

 
611

 
—

 
—

 
—

 
611

Issuance of common stock, net of net settlements
—

 
—

 
2,114

 
—

 
—

 
—

 
2,114

Issuance of preferred stock
45,000

 
—

 
(1,482
)
 
—

 
—

 
—

 
43,518

Adjustment of common Operating Partnership units to fair value
—

 
—

 
(1,926
)
 
—

 
—

 
—

 
(1,926
)
Net distributions to noncontrolling interest in consolidated joint ventures
—

 
—

 
—

 
(582
)
 
—

 
—

 
(582
)
Income attributable to noncontrolling interest in consolidated joint ventures
—

 
—

 
—

 
65

 
—

 
—

 
65

Balance at December 31, 2012
160,000

 
51

 
804,584

 
3,728

 
(10,917
)
 
(294,953
)
 
662,493

Net income
—

 
—

 
—

 
—

 
—

 
10,981

 
10,981

Net unrealized gain on derivative instruments
—

 
—

 
—

 
—

 
7,423

 
—

 
7,423

Net income attributable to noncontrolling interests
—

 
—

 
—

 
—

 
(342
)
 
93

 
(249
)
Dividends paid to common shareholders
—

 
—

 
—

 
—

 
—

 
(32,917
)
 
(32,917
)
Dividends on preferred shares
—

 
—

 
—

 
—

 
—

 
(12,400
)
 
(12,400
)
Accrued common dividends
—

 
—

 
—

 
—

 
—

 
(50
)
 
(50
)
Restricted stock expense
—

 
—

 
3,863

 
—

 
—

 
—

 
3,863

Exercise of stock options
—

 
—

 
163

 
—

 
—

 
—

 
163

Stock option and employee stock purchase plan expense
—

 
—

 
549

 
—

 
—

 
—

 
549

Issuance of common stock, net of net settlements
—

 
8

 
103,581

 
—

 
—

 
—

 
103,589

Acquisition of remaining interests in consolidated joint venture
—

 
—

 
(1,387
)
 
(3,178
)
 
—

 
—

 
(4,565
)
Adjustment of common Operating Partnership units to fair value
—

 
—

 
180

 
—

 
—

 
—

 
180

Net contributions from noncontrolling interest in consolidated joint ventures
—

 
—

 
—

 
250

 
—

 
—

 
250

Loss attributable to noncontrolling interest in consolidated joint ventures
—

 
—

 
—

 
(19
)
 
—

 
—

 
(19
)
Balance at December 31, 2013
160,000

 
59

 
911,533

 
781

 
(3,836
)
 
(329,246
)
 
739,291

Net income
—

 
—

 
—

 
—

 
—

 
17,043

 
17,043

Net unrealized gain on derivative instruments
—

 
—

 
—

 
—

 
593

 
—

 
593

Net income attributable to noncontrolling interests
—

 
—

 
—

 
—

 
(25
)
 
(199
)
 
(224
)
Dividends paid to common shareholders
—

 
—

 
—

 
—

 
—

 
(35,198
)
 
(35,198
)
Dividends on preferred shares
—

 
—

 
—

 
—

 
—

 
(12,400
)
 
(12,400
)
Accrued common dividends
—

 
—

 
—

 
—

 
—

 
(66
)
 
(66
)
Restricted stock expense
—

 
—

 
2,860

 
—

 
—

 
—

 
2,860

Exercise of stock options
—

 
—

 
174

 
—

 
—

 
—

 
174

Stock option and employee stock purchase plan expense
—

 
—

 
536

 
—

 
—

 
—

 
536

Issuance of common stock, net of net settlements
—

 
—

 
(397
)
 
—

 
—

 
—

 
(397
)
Adjustment of common Operating Partnership units to fair value
—

 
—

 
(1,424
)
 
—

 
—

 
—

 
(1,424
)
Net contributions from noncontrolling interest in consolidated joint venture
—

 
—

 
—

 
117

 
—

 
—

 
117

Balance at December 31, 2014
$
160,000

 
$
59

 
$
913,282

 
$
898

 
$
(3,268
)
 
$
(360,066
)
 
$
710,905


See accompanying notes to consolidated financial statements.


89

FIRST POTOMAC REALTY TRUST AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 2014, 2013 and 2012
(Amounts in thousands)
 
2014
 
2013
 
2012
Cash flow from operating activities:
 
 
 
 
 
Net income (loss)
$
17,043

 
$
10,981

 
$
(8,381
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
 
 
Discontinued operations:
 
 
 
 
 
Gain on sale of rental property
(1,338
)
 
(19,363
)
 
(161
)
Loss on debt extinguishment / modification
—

 
192

 
—

Depreciation and amortization
3,665

 
8,937

 
14,958

Impairment of rental property
—

 
4,092

 
1,072

Depreciation and amortization
62,843

 
55,581

 
52,855

Stock based compensation
3,731

 
4,412

 
3,572

Bad debt expense
1,110

 
800

 
702

Deferred income taxes
—

 
—

 
(3,533
)
Amortization of deferred market rent
(14
)
 
76

 
195

Amortization of financing costs and discounts
1,445

 
2,851

 
2,397

Equity in (earnings) of affiliates
(775
)
 
47

 
(40
)
Distributions from investments in affiliates
1,356

 
2,064

 
1,796

Contingent consideration related to acquisition of property
—

 
(213
)
 
152

Contingent consideration payments in excess of fair value at acquisition date
—

 
(987
)
 
—

Impairment of rental property
3,956

 
—

 
2,444

Gain on sale of rental property
(21,230
)
 
—

 
—

Gain on sale of investment
—

 
—

 
(2,951
)
Loss on debt extinguishment / modification
—

 
223

 
2,379

Changes in assets and liabilities:
 
 
 
 
 
Escrows and reserves
4,693

 
6,256

 
5,889

Accounts and other receivables
1,475

 
1,763

 
(4,152
)
Accrued straight-line rents
(7,968
)
 
(8,078
)
 
(10,343
)
Prepaid expenses and other assets
326

 
1,074

 
(348
)
Tenant security deposits
677

 
1,022

 
289

Accounts payable and accrued expenses
1,227

 
(2,340
)
 
3,444

Accrued interest
56

 
(990
)
 
(129
)
Rents received in advance
1,984

 
(3,616
)
 
(1,603
)
Deferred costs
(11,309
)
 
(9,492
)
 
(12,664
)
Total adjustments
45,910

 
44,311

 
56,220

Net cash provided by operating activities
62,953

 
55,292

 
47,839

Cash flows from investing activities:
 
 
 
 
 
Investment in note receivable
(9,000
)
 
—

 
—

Principal payments from note receivable
176

 
104

 
—

Proceeds from sale of rental property
97,701

 
263,469

 
14,341

Proceeds from sale of investment
—

 
—

 
25,705

Change in escrow and reserve accounts
—

 
(10
)
 
(61
)
Additions to rental property and furniture, fixtures and equipment
(39,338
)
 
(48,125
)
 
(58,371
)
Additions to construction in progress
(11,451
)
 
(19,877
)
 
(12,115
)
Acquisition of rental property and associated intangible assets
(150,731
)
 
(30,000
)
 
—

Acquisition of noncontrolling interest in consolidated joint venture
—

 
(4,565
)
 
—

Investment in affiliates
(1,988
)
 
(665
)
 
(2,512
)
Distributions from investments in affiliates
3,075

 
—

 
—

Net cash (used in) provided by investing activities
(111,556
)
 
160,331

 
(33,013
)
Cash flows from financing activities:
 
 
 
 
 
Financing costs
(870
)
 
(5,568
)
 
(3,932
)
Issuance of debt
250,518

 
152,199

 
445,400

Issuance of common shares, net
—

 
105,085

 
3,599

Issuance of preferred shares, net
—

 
—

 
43,518

Payment of deferred acquisition costs and contingent consideration
—

 
(9,036
)
 
—

Contributions from consolidated joint venture partners
213

 
250

 
—

Distributions to consolidated joint venture partners
(96
)
 
—

 
(592
)
Repayments of debt
(147,577
)
 
(412,381
)
 
(456,109
)
Dividends to common shareholders
(35,198
)
 
(32,917
)
 
(40,730
)
Dividends to preferred shareholders
(12,400
)
 
(12,400
)
 
(11,267
)
Distributions to noncontrolling interests
(1,578
)
 
(1,557
)
 
(2,159
)
Operating partnership unit redemptions
—

 
(95
)
 
—

Proceeds from stock option exercises
174

 
163

 
71

Net cash provided by (used in) financing activities
53,186

 
(216,257
)
 
(22,201
)
Net increase (decrease) in cash and cash equivalents
4,583

 
(634
)
 
(7,375
)
Cash and cash equivalents, beginning of year
8,740

 
9,374

 
16,749

Cash and cash equivalents, end of year
$
13,323

 
$
8,740

 
$
9,374

See accompanying notes to consolidated financial statements.

90

FIRST POTOMAC REALTY TRUST AND SUBSIDIARIES
Consolidated Statements of Cash Flows - Continued
Years ended December 31, 2014, 2013 and 2012
 
Supplemental disclosure of cash flow information is as follows (amounts in thousands):
 
2014
 
2013
 
2012
Cash paid for interest, net
$
23,083

 
$
32,116

 
$
40,769

Cash paid for income based franchise taxes
—

 
—

 
714

Non-cash investing and financing activities:
 
 
 
 
 
Debt assumed in connection with the acquisition of rental property
37,269

 
—

 
—

Value of common shares retired to settle employee income tax obligation
487

 
1,348

 
1,252

Change in fair value of the outstanding common Operating Partnership units
1,424

 
(215
)
 
2,074

Conversion of common Operating Partnership units for common shares
—

 
—

 
4,064

Issuance of common Operating Partnership units in connection with the acquisition of rental property
40

 
418

 
—

Change in accruals:
 
 
 
 
 
Additions to rental property and furniture, fixtures and equipment
653

 
(4,959
)
 
1,988

Additions to development and redevelopment
(275
)
 
(3,118
)
 
3,705


Cash paid for interest on indebtedness is net of capitalized interest of $3.2 million, $2.5 million and $2.4 million in 2014, 2013 and 2012, respectively.

During the twelve months ended December 31, 2014, we acquired three properties at an aggregate purchase price of $188.0 million, including the assumption of a mortgage loan with a fair value of $37.3 million at acquisition.

During 2014, 2013 and 2012, certain of our employees surrendered common shares owned by them valued at $0.5 million, $1.3 million and $1.3 million, respectively, to satisfy their statutory minimum federal income tax obligations associated with the vesting of restricted common shares of beneficial interest.

Noncontrolling interests are presented at the greater of their fair value or their cost basis, which is comprised of their fair value at issuance, subsequently adjusted for the noncontrolling interests’ share of net income or losses available to common shareholders, other comprehensive income or losses, distributions received or additional contributions. We account for issuances of common Operating Partnership units individually, which could result in some portion of our noncontrolling interests being carried at fair value with the remainder being carried at historical cost. At December 31, 2014 and 2013, we recorded adjustments of $4.7 million and $3.3 million, respectively, to present certain common Operating Partnership units at the greater of their carrying value or redemption value.

No common Operating Partnership units were redeemed for an equivalent number of our common shares during both 2014 and 2013. During 2012, 322,302 common Operating Partnership units were redeemed for an equivalent number of our common shares.

During the twelve months ended December 31, 2014 and 2013, we issued 3,125 and 35,911 common Operating Partnership units at a fair value of $40 thousand and $0.4 million, respectively, to the seller of 840 First Street, NE to satisfy our contingent consideration obligation related to the acquisition of the property. No common Operating Partnership units were required to be issued to satisfy our contingent consideration obligation during the twelve months ended December 31, 2012.

At December 31, 2014, 2013 and 2012, we accrued $9.3 million, $8.5 million and $13.2 million, respectively, of capital expenditures related to rental property and furniture, fixtures and equipment in accounts payable. During 2014, 2013 and 2012, we accrued $1.3 million, $1.5 million and $4.6 million, respectively, of capital expenditures related to development and redevelopment in accounts payable.

91

FIRST POTOMAC REALTY TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1) Description of Business

First Potomac Realty Trust (the “Company”) is a leader in the ownership, management, development and redevelopment of office and business park properties in the greater Washington, D.C. region. The Company strategically focuses on acquiring and redeveloping properties that it believes can benefit from its intensive property management, leasing expertise, market knowledge and established relationships, and seeks to reposition these properties to increase their profitability and value. The Company’s portfolio primarily contains a mix of single-tenant and multi-tenant office properties and business parks. Office properties are single-story and multi-story buildings that are primarily for office use; and business parks contain buildings with office features combined with some industrial property space. The Company separates its properties into four distinct reporting segments, which it refers to as the Washington, D.C., Maryland, Northern Virginia and Southern Virginia reporting segments.

References in these consolidated financial statements to “we,” “our,” "us," "the Company" or "First Potomac," refer to the Company and its subsidiaries, on a consolidated basis, unless the context indicates otherwise.

We conduct our business through First Potomac Realty Investment Limited Partnership, our operating partnership (the “Operating Partnership”). We are the sole general partner of, and, as of December 31, 2014, owned 100% of the preferred interest and 95.7% of the common interest in the Operating Partnership. The remaining common interests in the Operating Partnership, which are presented as noncontrolling interests in the Operating Partnership in the accompanying consolidated financial statements, are limited partnership interests, some of which are owned by two of our executive officers who contributed properties and other assets to us upon our formation, and the remainder of which are owned by other unrelated parties.

At December 31, 2014, we wholly owned or had a controlling interest in properties totaling 8.8 million square feet and had a noncontrolling ownership interest in properties totaling an additional 0.9 million square feet through five unconsolidated joint ventures. We also owned land that can support 1.4 million square feet of additional development. Our consolidated properties were 87.9% occupied by 582 tenants at December 31, 2014. We did not include square footage that was in development or redevelopment, which totaled 0.2 million square feet at December 31, 2014, in our occupancy calculation. We derive substantially all of our revenue from leases of space within our properties. As of December 31, 2014, our largest tenant was the U.S. Government, which accounted for 14% of our total annualized cash basis rent, and the U.S. Government combined with government contractors, accounted for 26% of our total annualized cash basis rent as of December 31, 2014. We operate so as to qualify as a real estate investment trust (“REIT”) for federal income tax purposes.

For the year ended December 31, 2014, we had consolidated total revenues of $161.7 million and consolidated total assets of $1.6 billion. Financial information related to our four reporting segments is set forth in note 18, Segment Information, to our consolidated financial statements.

(2) Summary of Significant Accounting Policies

(a) Principles of Consolidation

Our consolidated financial statements include our accounts and the accounts of our Operating Partnership and the subsidiaries in which we or our Operating Partnership has a controlling interest, which includes First Potomac Management LLC, a wholly owned subsidiary that manages the majority of our properties. All intercompany balances and transactions have been eliminated in consolidation.

(b) Use of Estimates

The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires our management team to make a number of estimates and assumptions relating to the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. Estimates include the amount of accounts receivable that may be uncollectible; recoverability of notes receivable, future cash flows, discount and capitalization rate assumptions used to fair value acquired properties and to test impairment of certain long-lived assets and goodwill; derivative valuations; market lease rates, lease-up periods, leasing and tenant improvement costs used to fair value intangible assets acquired and probability weighted cash flow analysis used to fair value contingent liabilities. Actual results could differ from those estimates.



(c) Revenue Recognition and Accounts Receivable

We generate substantially all of our revenue from leases on our properties. We recognize rental revenue on a straight-line basis over the term of our leases, which includes fixed-rate renewal periods leased at below market rates at acquisition or inception. Accrued straight-line rents represent the difference between rental revenue recognized on a straight-line basis over the term of the respective lease agreements and the rental payments contractually due for leases that contain abatement or fixed periodic increases. We consider current information, credit quality, historical trends, economic conditions and other events regarding the tenants’ ability to pay their obligations in determining if amounts due from tenants, including accrued straight-line rents, are ultimately collectible. The uncollectible portion of the amounts due from tenants, including accrued straight-line rents, is charged to Property operating expense in our consolidated statements of operations in the period in which the determination is made and to allowance for doubtful accounts in either Accounts and other receivables or Accrued straight-line rents on our consolidated balance sheets. During 2014, 2013 and 2012, we incurred charges of $1.1 million, $0.8 million and $0.7 million, respectively, related to anticipated uncollectible amounts from tenants, including accrued straight-line rents. We consider similar criteria in assessing impairment associated with outstanding loans or notes receivable and whether any allowance for anticipated credit loss is appropriate.

Tenant leases generally contain provisions under which the tenants reimburse us for a portion of property operating expenses and real estate taxes incurred by us. Such reimbursements are recognized in the period in which the expenses are incurred. We record a provision for losses on estimated uncollectible accounts receivable based on our analysis of risk of loss on specific accounts. Lease termination fees are recognized on the date of termination when the related lease or portion thereof is cancelled, the collectability of the fee is reasonably assured and we have possession of the terminated space. We recognized lease termination fees included in “Tenant reimbursements and other revenues” in our consolidated statements of operations of $1.1 million, $1.0 million and $2.0 million for the years ended December 31, 2014, 2013 and 2012, respectively.

(d) Cash and Cash Equivalents

We consider all highly liquid investments with a maturity of 90 days or less at the date of purchase to be cash equivalents.

(e) Escrows and Reserves

Escrows and reserves represent cash restricted for debt service, real estate taxes, insurance, leasing commissions and tenant improvements. We reflect cash inflows and outflows from our escrows and reserves accounts related to debt service, real estate taxes, insurance and leasing commissions within net cash provided by operating activities and our cash inflows and outflows related tenant improvements within net cash used by investing activities on our consolidated statements of cash flows.

(f) Deferred Costs

Financing costs related to long-term debt are deferred and amortized over the remaining life of the debt using the effective interest method. Leasing costs related to the execution of tenant leases and lease incentives are deferred and amortized ratably over the term of the related leases. Accumulated amortization of these combined costs was $24.8 million and $20.7 million at December 31, 2014 and 2013, respectively.


93

The following table sets forth scheduled future amortization for deferred financing and leasing costs at December 31, 2014 (amounts in thousands):
 
 
Deferred
Financing(1)
 
Deferred
Leasing(1)(2)
 
Deferred
Lease Incentive
2015
$
1,905

 
$
5,446

 
$
637

2016
1,533

 
4,977

 
637

2017
1,153

 
4,181

 
552

2018
836

 
3,593

 
518

2019
308

 
2,828

 
443

Thereafter
425

 
7,849

 
1,627

 
$
6,160

 
$
28,874

 
$
4,414

 
(1) 
Includes amounts from properties that were classified as held-for-sale at December 31, 2014.
(2) 
Excludes the amortization of $5.6 million of leasing costs that have yet to be placed in-service as the associated tenants have not moved into their related spaces and, therefore, the period over which the leasing costs will be amortized has yet to be determined.

(g) Rental Property

Rental property is initially recorded at fair value, if acquired in a business combination, or initial cost when constructed or acquired in an asset purchase. Improvements and replacements are capitalized at cost when they extend the useful life, increase capacity or improve the efficiency of the asset. Repairs and maintenance are charged to expense when incurred. Depreciation and amortization are recorded on a straight-line basis over the estimated useful lives of the assets. The estimated useful lives of our assets, by class, are as follows:
 
 
Buildings
  
39 years
 
Building improvements
  
5 to 20 years
 
Furniture, fixtures and equipment
  
5 to 15 years
 
Tenant improvements
  
Shorter of the useful life of the asset or the term of the related lease

We regularly review market conditions for possible impairment of a property’s carrying value. When circumstances such as adverse market conditions, changes in management’s intended holding period or potential sale to a third party indicate a possible impairment of the carrying value of a property, an impairment analysis is performed. We assess potential impairments based on an estimate of the future undiscounted cash flows (excluding interest charges) expected to result from the property’s use and eventual disposition. This estimate is based on projections of future revenues, expenses, capital improvement costs to maintain the operating capacity, expected holding periods and capitalization rates. These cash flows consider factors such as expected market trends and leasing prospects, as well as the effects of leasing demand, competition and other factors. If impairment exists due to the inability to recover the carrying value of a real estate investment based on forecasted undiscounted cash flows, an impairment loss is recorded to the extent that the carrying value exceeds the estimated fair value of the property. Further, we will record an impairment loss if we expect to dispose of a property, in the near term, at a price below carrying value. In such an event, we will record an impairment loss based on the difference between a property’s carrying value and its projected sales price less any estimated costs to sell.

We will classify a building as held-for-sale in accordance with GAAP in the period in which we have made the decision to dispose of the building, our Board of Trustees or a designated delegate has approved the sale, there is a high likelihood a binding agreement to purchase the property will be signed under which the buyer will be required to commit a significant amount of nonrefundable cash and no significant financing contingencies exist that could cause the transaction not to be completed in a timely manner. We will cease recording depreciation on a building once it has been classified as held-for-sale. In the second quarter of 2014, we prospectively adopted ASU 2014-08, which impacts the presentation of operations and gains or losses from disposed properties and properties classified as held-for-sale. For more information, see note 2(q), Summary of Significant Accounting Policies - Application of New Accounting Standards.


94

If the building does not qualify as a discontinued operation under ASU 2014-08, we will classify the building's operating results, together with any impairment charges and any gains or losses on the sale of the building, in continuing operations for all periods presented in our consolidated statements of operations. We will classify the assets and liabilities related to the building as held-for-sale in our consolidated balance sheet for the period the held-for-sale criteria were met.

If the building does qualify as a discontinued operation under ASU 2014-08, we will classify the building's operating results, together with any impairment charges and any gains or losses on the sale of the building, in discontinued operations in our consolidated statements of operations for all periods presented and classify the assets and liabilities related to the building as held-for-sale in our consolidated balance sheets for the periods presented. Interest expense is reclassified to discontinued operations only to the extent the disposed or held-for-sale property is secured by specific mortgage debt and the mortgage debt will not be assigned to another property owned by us after the disposition.

We recognize the fair value, if sufficient information exists to reasonably estimate the fair value, of any liability for conditional asset retirement obligations when assumed or incurred, which is generally upon acquisition, construction, development or redevelopment and/or through the normal operation of the asset.

We capitalize interest costs incurred on qualifying expenditures for real estate assets under development or redevelopment, which include our investments in assets owned through unconsolidated joint ventures that are under development or redevelopment, while being readied for their intended use in accordance with accounting requirements regarding capitalization of interest. We will capitalize interest when qualifying expenditures for the asset have been made, activities necessary to get the asset ready for its intended use are in progress and interest costs are being incurred. Capitalized interest also includes interest associated with expenditures incurred to acquire developable land while development activities are in progress. We also capitalize direct compensation costs of our construction personnel who manage the development and redevelopment projects, but only to the extent the employee’s time can be allocated to a project. Any portion of construction management costs not directly attributable to a specific project are recognized as general and administrative expense in the period incurred. We do not capitalize any other general and administrative costs such as office supplies, office rent expense or an overhead allocation to our development or redevelopment projects. Capitalized compensation costs were immaterial during 2014, 2013 and 2012. Capitalization of interest ends when the asset is substantially complete and ready for its intended use, but no later than one year from completion of major construction activity, if the property is not occupied. We place redevelopment and development assets into service at this time and commence depreciation upon the substantial completion of tenant improvements and the recognition of revenue. Capitalized interest is depreciated over the useful life of the underlying assets, commencing when those assets are placed into service.

(h) Purchase Accounting

Acquisitions of rental property, including any associated intangible assets, are measured at fair value at the date of acquisition. Any liabilities assumed or incurred are recorded at their fair value at the time of acquisition. The fair value of the acquired property is allocated between land and building (on an as-if vacant basis) based on management’s estimate of the fair value of those components for each type of property and to tenant improvements based on the depreciated replacement cost of the tenant improvements, which approximates their fair value. The fair value of the in-place leases is recorded as follows:
•
the fair value of leases in-place on the date of acquisition is based on absorption costs for the estimated lease-up period in which vacancy and foregone revenue are avoided due to the presence of the acquired leases;
•
the fair value of above and below-market in-place leases based on the present value (using a discount rate that reflects the risks associated with the acquired leases) of the difference between the contractual rent amounts to be paid under the assumed lease and the estimated market lease rates for the corresponding spaces over the remaining non-cancelable terms of the related leases, which range from one to fourteen years; and
•
the fair value of intangible tenant or customer relationships.

Our determination of these fair values requires us to estimate market rents for each of the leases and make certain other assumptions. These estimates and assumptions affect the rental revenue, and depreciation and amortization expense recognized for these leases and associated intangible assets and liabilities.

(i) Investment in Affiliates

We may continue to grow our portfolio by entering into ownership arrangements with third parties for which we do not have a controlling interest. The structure of the arrangement may affect our accounting treatment as the entities may qualify as variable interest entities (“VIE”) based on disproportionate voting to equity interests, or other factors. In determining whether to consolidate an entity, we assess the structure and intent of the entity relationship as well its power to direct major decisions regarding the

95

entity’s operations. When our investment in an entity meets the requirements for the equity method of accounting, we will record our initial investment in our consolidated balance sheets as “Investment in affiliates.” The initial investment in the entity is adjusted to recognize our share of earnings, losses, distributions received from the entity or additional contributions. Basis differences, if any, are recognized over the life of the venture as an adjustment to “Equity in (earnings) losses of affiliates” in our consolidated statements of operations. Our respective share of all earnings or losses from the entity will be recorded in our consolidated statements of operations as “Equity in (earnings) losses of affiliates.”

When we are deemed to have a controlling interest in a partially-owned entity, we will consolidate all of the entity’s assets, liabilities, operating results and cash flows within our consolidated financial statements. The cash contributed to the consolidated entity by the third party, if any, will be reflected in the permanent equity section of our consolidated balance sheets to the extent the associated ownership interests are not mandatorily redeemable. The amount will be recorded based on the third party’s initial investment in the consolidated entity and will be adjusted to reflect the third party’s share of earnings or losses in the consolidated entity and for any distributions received or additional contributions made by the third party. The earnings or losses from the entity attributable to the third party will be recorded in our consolidated statements of operations as a component of “Net loss attributable to noncontrolling interests.”

(j) Sales of Rental Property

We account for sales of rental property in accordance with the requirements for full profit recognition, which occurs when the sale is consummated, the buyer has made adequate initial and continuing investments in the property, our receivable is not subject to future subordination, and we do not have substantial continuing involvement with the property. Once the requirements for full profit recognition are achieved, the related assets and liabilities are removed from the balance sheet and the resultant gain or loss is recorded in the period the sale is consummated. For sales transactions that do not meet the criteria for full profit recognition, we account for the transactions as partial sales or financing arrangements required by GAAP. For sales transactions with continuing involvement after the sale, if the continuing involvement with the property is limited by the terms of the sales contract, profit is recognized at the time of sale and is reduced by the maximum exposure to loss related to the nature of the continuing involvement. Sales to entities in which we have or receive an interest are accounted for as partial sales.

For sales transactions that do not meet sale criteria, we evaluate the nature of the continuing involvement, including put and call provisions, if present, and accounts for the transaction as a financing arrangement, profit-sharing arrangement, leasing arrangement or other alternate method of accounting rather than as a sale, based on the nature and extent of the continuing involvement. Some transactions may have numerous forms of continuing involvement. In those cases, we determine which method is most appropriate based on the substance of the transaction.

(k) Intangible Assets

Intangible assets include the fair value of acquired tenant or customer relationships and the fair value of in-place leases at acquisition. Customer relationship fair values are determined based on our evaluation of the specific characteristics of each tenant’s lease and our overall relationship with the tenant. Characteristics we consider include the nature and extent of our existing business relationships with the tenant, growth prospects for developing new business with the tenant, the tenant’s credit quality and expectations of lease renewals. The fair value of customer relationship intangible assets is amortized to expense over the lesser of the initial lease term and any expected renewal periods or the remaining useful life of the building. We determine the fair value of the in-place leases at acquisition by estimating the leasing commissions avoided by having in-place tenants and the operating income that would have not been recognized during the estimated time required to lease the space occupied by existing tenants at the acquisition date. The fair value attributable to existing tenants is amortized to expense over the initial term of the respective leases. Should a tenant terminate its lease, the unamortized portion of the in-place lease fair value is charged to expense by the date of termination.

Deferred market rent liability consists of the acquired leases with below-market rents at the date of acquisition. The fair value attributed to deferred market rent assets, which consist of above-market rents at the date of acquisition, is recorded as a component of deferred costs. Above and below-market lease fair values are determined on a lease-by-lease basis based on the present value (using a discounted rate that reflects the risks associated with the acquired leases) of the difference between the contractual rent amounts to be paid under the lease and the estimated market lease rates for the corresponding spaces over the remaining non-cancelable terms of the related leases including any below-market fixed rate renewal periods. The capitalized below-market lease fair values are amortized as an increase to rental revenue over the initial term and any below-market fixed-rate renewal periods of the related leases. Capitalized above-market lease fair values are amortized as a decrease to rental revenue over the initial term of the related leases.


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In conjunction with our initial public offering and related formation transactions, First Potomac Management, Inc. contributed all of the capital interests in First Potomac Management LLC. The $2.1 million fair value of the in-place workforce acquired has been classified as goodwill and is included as a component of "Intangible assets, net" on the consolidated balance sheets. In 2011, we recognized additional goodwill of $4.8 million representing the residual difference between the consideration transferred for the purchase of 840 First Street, NE, which was acquired in March 2011, and the acquisition date fair value of the identifiable assets acquired and liabilities assumed and deferred taxes representing the difference between the fair value of acquired assets at acquisition and the carryover basis used for income tax purposes. In accordance with accounting requirements regarding goodwill and other intangibles, all acquired goodwill that relates to the operations of a reporting unit and is used in determining the fair value of a reporting unit is allocated to our appropriate reporting unit in a reasonable and consistent manner.

We assess goodwill for impairment annually at the end of our fiscal year and in interim periods if certain events occur indicating the carrying value may be impaired. We perform our analysis for potential impairment of goodwill in accordance with GAAP and are permitted to make a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the two-step goodwill impairment test for that reporting unit. We assess the impairment of our goodwill based on such qualitative factors as general economic conditions, industry and market conditions, market competiveness, overall financial performance (such as negative cash flows) and other entity specific events. As of December 31, 2014, we concluded that it was more likely than not that the fair value of our reporting units exceeded its carrying value, and as a result, we determined that it was unnecessary to perform any additional testing for goodwill impairment. No goodwill impairment losses were recognized during 2014, 2013 and 2012.

(l) Derivative Instruments

We are exposed to certain risks arising from business operations and economic factors. We use derivative financial instruments to manage exposures that arise from business activities in which our future exposure to interest rate fluctuations is unknown. The objective in the use of an interest rate derivative is to add stability to interest expenses and manage exposure to interest rate changes. We do not use derivatives for trading or speculative purposes and we intend to enter into derivative agreements only with counterparties that we believe have a strong credit rating to mitigate the risk of counterparty default or insolvency. No hedging activity can completely insulate us from the risks associated with changes in interest rates. Moreover, interest rate hedging could fail to protect us or adversely affect us because, among other things:
•
available interest rate hedging may not correspond directly with the interest rate risk for which we seek protection;
•
the duration of the hedge may not match the duration of the related liability;
•
the party owing money in the hedging transaction may default on its obligation to pay; and
•
the credit quality of the party owing money on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign its side of the hedging transaction.

We may designate a derivative as either a hedge of the cash flows from a debt instrument or anticipated transaction (cash flow hedge) or a hedge of the fair value of a debt instrument (fair value hedge). All derivatives are recognized as assets or liabilities at fair value. For effective hedging relationships, the effective portion of the change in the fair value of the assets or liabilities is recorded within equity (cash flow hedge) or through earnings (fair value hedge). Ineffective portions of derivative transactions will result in changes in fair value recognized in earnings. For a cash flow hedge, we record our proportionate share of unrealized gains or losses on our derivative instruments associated with our unconsolidated joint ventures within equity and “Investment in affiliates.” We incorporate credit valuation adjustments to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of our derivative contracts for the effect of nonperformance risk, we have considered the impact of netting any applicable credit enhancements, such as collateral postings, thresholds, mutual inputs and guarantees.

(m) Income Taxes

We have elected to be taxed as a REIT. To maintain our status as a REIT, we are required to distribute at least 90% of our ordinary taxable income annually to our shareholders and meet other organizational and operational requirements. As a REIT, we will not be subject to federal income tax and any non-deductible excise tax if we distribute at least 100% of our REIT taxable income to our shareholders. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax on our taxable income at regular corporate tax rates. We have certain subsidiaries, including a taxable REIT subsidiary (“TRS”) and an entity that has elected to be taxed as a REIT (which indirectly owns 500 First Street, NW) that may be subject to federal, state or local taxes, as applicable. A designated REIT will not be subject to federal income tax so long as it meets the REIT qualification requirements and distributes 100% of its REIT taxable income to its shareholders. Our TRS was inactive in 2014, 2013 and 2012. See note 9, Income Taxes, for further information.

97


We account for deferred income taxes using the asset and liability method. Under this method, deferred income taxes are recognized for temporary differences between the financial reporting basis of assets and liabilities and their respective tax bases and for operating losses, capital losses and tax credit carryovers based on tax rates to be effective when amounts are realized or settled. We will recognize deferred tax assets only to the extent that it is more likely than not that they will be realized based on available evidence, including future reversals of existing temporary differences, future projected taxable income and tax planning strategies. We may recognize a tax benefit from an uncertain tax position when it is more-likely-than-not (defined as a likelihood of more than 50%) that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. If a tax position does not meet the more-likely-than-not recognition threshold, despite our belief that our filing position is supportable, the benefit of that tax position is not recognized in the statements of operations. We recognize interest and penalties, as applicable, related to unrecognized tax benefits as a component of income tax expense. We recognize unrecognized tax benefits in the period that the uncertainty is eliminated by either affirmative agreement of the uncertain tax position by the applicable taxing authority, or by expiration of the applicable statute of limitation. For the years ended December 31, 2014, 2013 and 2012, we did not have any uncertain tax positions.

(n) Share-Based Payments

We measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. For options awards, we use a Black-Scholes option-pricing model. Expected volatility is based on an assessment of our realized volatility over the preceding period that is equivalent to the award’s expected life. The expected term represents the period of time the options are anticipated to remain outstanding as well as our historical experience for groupings of employees that have similar behavior and considered separately for valuation purposes. For non-vested share awards that vest over a predetermined time period, we use the outstanding share price at the date of issuance to fair value the awards. For non-vested shares awards that vest based on performance conditions, we use a Monte Carlo simulation (risk-neutral approach) to determine the value and derived service period of each tranche. The expense associated with the share-based awards will be recognized over the period during which an employee is required to provide services in exchange for the award – the requisite service period (usually the vesting period). The fair value for all share-based payment transactions are recognized as a component of income or loss from continuing operations.

(o) Notes Receivable

We provide loans to the owners of real estate properties, which can be collateralized by interest in the real estate property. We records these loans as “Notes receivable, net” in our consolidated balance sheets. The loans are recorded net of any discount or issuance costs, which are amortized over the life of the respective note receivable using the effective interest method. We record interest earned from notes receivable and amortization of any discount costs or issuance costs within “Interest and other income” in our consolidated statements of operations.

We will establish a provision for anticipated credit losses associated with our notes receivable when we anticipate that we may be unable to collect any contractually due amounts. This determination is based upon such factors as delinquencies, loss experience, collateral quality and current economic or borrower conditions. Our collectability of our notes receivable may be adversely impacted by the financial stability of the Washington, D.C. region and the ability of the underlying assets to keep current tenants or attract new tenants. Estimated losses are recorded as a charge to earnings to establish an allowance for credit losses that we estimate to be adequate based on these factors. Based on the review of the above criteria, we did not record an allowance for credit losses for our notes receivable during 2014, 2013 and 2012.

(p) Reclassifications

Certain prior year amounts have been reclassified to conform to the current year presentation as a result of reclassifying the operating results of several properties as discontinued operations. For more information, see note 10, Dispositions. In the second quarter of 2014, we prospectively adopted the requirements under ASU 2014-08, which impacts the presentation of operations and gains or losses from disposed or held-for-sale properties. For more information, see note 2(q), Summary of Significant Accounting Policies - Application of New Accounting Standards.

(q) Application of New Accounting Standards

In April 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity (“ASU 2014-08”), which states that a disposal of a component of an entity or a group of components of an entity is required to be reported in discontinued operations only if the

98

disposal represents a strategic shift that has, or will have, a major effect on an entity’s operations and financial results. ASU 2014-08 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2014. Early adoption is permitted, but only for a disposal (or classification as held-for-sale) that has not been reported in financial statements previously issued or available for issuance. ASU 2014-08 must be applied prospectively. We adopted ASU 2014-08 in the second quarter of 2014. The adoption of ASU 2014-08 did not have a material impact on our consolidated financial statements, though it did and will continue to impact the extent and frequency of presenting discontinued operations within our consolidated statements of operations and note disclosures. The operations of all properties that were sold prior to the adoption of ASU 2014-08 and two other properties, West Park and Patrick Center, which were classified as held-for-sale in previously issued financial statements prior to our adoption of ASU 2014-08 and were subsequently sold, are reflected within discontinued operations in our consolidated statements of operations for all periods presented. For more information, see note 10, Dispositions. All property operations that have been classified as discontinued operations will remain classified within discontinued operations in any future presentation of our consolidated statements of operations.
In May 2014, FASB issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. ASU 2014-09 will replace most existing revenue recognition guidance when it becomes effective on January 1, 2017. Early adoption is not permitted. ASU 2014-09 permits the use of either the retrospective or cumulative effect transition method. We have not yet selected a transition method and are evaluating the impact that ASU 2014-09 will have on our consolidated financial statements and related disclosures.
In August 2014, the FASB issued Accounting Standards Update 2014-15, Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern (“ASU 2014-15”), which requires an entity to evaluate whether conditions or events, in the aggregate, raise substantial doubt about the entity's ability to continue as a going concern for one year from the date the financial statements are issued or are available to be issued. The guidance will become effective January 1, 2017. The adoption of ASU 2014-15 is not expected to have an impact on our consolidated financial position, results of operations or cash flows.
In January 2015, the FASB issued Accounting Standards Update 2015-01, Income Statement - Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items ("ASU 2015-01"), which eliminates the concept of extraordinary items from U.S. GAAP and the requirement that an entity separately report extraordinary items in the income statement. ASU 2015-01 also requires that entities continue to evaluate whether items are unusual in nature or infrequent in occurrence for presentation and disclosure purposes. ASU 2015-01 applies to all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted and the guidance may be applied prospectively or retrospectively to all prior periods presented in the consolidated financial statements. We believe that the adoption of ASU 2015-01 will not have a material impact on our consolidated statements of operations and related disclosures.


(3) Earnings Per Common Share

Basic earnings or loss per common share (“EPS”) is calculated by dividing net income or loss attributable to common shareholders by the weighted average common shares outstanding for the periods presented. Diluted EPS is computed after adjusting the basic EPS computation for the effect of dilutive common equivalent shares outstanding during the periods presented, which include stock options, non-vested shares and preferred shares. We apply the two-class method for determining EPS as our outstanding unvested shares with non-forfeitable dividend rights are considered participating securities. Our excess of distributions over earnings related to participating securities are shown as a reduction in total earnings attributable to common shareholders in our computation of EPS.















99

The following table sets forth the computation of our basic and diluted earnings per common share (amounts in thousands, except per share amounts):
 
 
2014
 
2013
 
2012
Numerator for basic and diluted earnings per common share:
 
 
 
 
 
Income (loss) from continuing operations
$
15,559

 
$
(10,761
)
 
$
(24,324
)
Income from discontinued operations
1,484

 
21,742

 
15,943

Net income (loss)
17,043

 
10,981

 
(8,381
)
Less: Net (income) loss from continuing operations attributable to noncontrolling interests
(135
)
 
1,047

 
1,780

Less: Net income from discontinued operations attributable to noncontrolling interests
(64
)
 
(954
)
 
(794
)
Net income (loss) attributable to First Potomac Realty Trust
16,844

 
11,074

 
(7,395
)
Less: Dividends on preferred shares
(12,400
)
 
(12,400
)
 
(11,964
)
Net income (loss) attributable to common shareholders
4,444

 
(1,326
)
 
(19,359
)
Less: Allocation to participating securities
(314
)
 
(388
)
 
(620
)
Net income (loss) attributable to common shareholders
$
4,130

 
$
(1,714
)
 
$
(19,979
)
Denominator for basic and diluted earnings per common share:
 
 
 
 
 
Weighted average common shares outstanding – basic
58,150

 
55,034

 
50,120

Weighted average common shares outstanding – diluted
58,220

 
55,034

 
50,120

Basic and diluted earnings per common share:
 
 
 
 
 
Income (loss) from continuing operations
$
0.05

 
$
(0.41
)
 
$
(0.70
)
Income from discontinued operations
0.02

 
0.38

 
0.30

Net income (loss)
$
0.07

 
$
(0.03
)
 
$
(0.40
)

In accordance with GAAP regarding earnings per common share, we did not include the following potential weighted average common shares in our calculation of diluted earnings per common share as they are anti-dilutive for the periods presented (amounts in thousands):
 
 
2014
 
2013
 
2012
Stock option awards
1,122

 
1,369

 
1,462

Non-vested share awards
398

 
471

 
553

Series A Preferred Shares(1)
12,616

 
12,076

 
12,162

 
14,136

 
13,916

 
14,177

 
(1) 
In March 2012, we issued an additional 1.8 million Series A Preferred Shares, which are only convertible into our common shares upon certain changes in control of our Company. The dilutive shares are calculated as the daily average of the face value of the Series A Preferred Shares divided by the outstanding common share price.


100

(4) Rental Property

Rental property represents buildings and related improvements, net of accumulated depreciation, and developable land that are wholly owned or owned by an entity in which we have a controlling interest. All of our rental properties are located within the greater Washington, D.C. region. Rental property consists of the following at December 31 (amounts in thousands):
 
 
2014 (1)
 
2013 (1)
Land and land improvements
$
325,214

 
$
287,015

Buildings and improvements
949,683

 
807,198

Construction in progress
69,181

 
93,174

Tenant improvements
159,867

 
138,543

Furniture, fixtures and equipment
427

 
4,250

 
1,504,372

 
1,330,180

Less: accumulated depreciation
(215,499
)
 
(185,725
)
 
$
1,288,873

 
$
1,144,455

 
(1) 
Excludes rental property related to properties held-for-sale totaling $57.7 million and $102.4 million at December 31, 2014 and 2013, respectively. For more information, see note 10, Dispositions.

Depreciation of rental property is computed on a straight-line basis over the estimated useful lives of the assets. The estimated lives of our assets range from 5 to 39 years or, in the case of tenant improvements, the shorter of the useful life of the asset or the term of the underlying lease.

Development and Redevelopment Activity

We will place completed development and redevelopment assets in service upon the earlier of one year after major construction activity is deemed to be substantially complete or upon occupancy. We construct office buildings and/or business parks on a build-to-suit basis or with the intent to lease upon completion of construction. We own developable land that can accommodate 1.4 million square feet of additional building space, of which, 0.7 million is located in the Washington, D.C. reporting segment, 0.1 million in the Maryland reporting segment, 0.5 million in the Northern Virginia reporting segment and 0.1 million in the Southern Virginia reporting segment.

During the third quarter of 2014, we signed a lease for 167,000 square feet at a to-be-constructed building in our Northern Virginia reporting segment on vacant land that we have in our portfolio. We currently expect to complete construction of the new building in the fourth quarter of 2016. At December 31, 2014, our total investment in the development project was $6.9 million, which included the original cost basis of the applicable portion of the vacant land of $5.2 million. The majority of the costs incurred as of December 31, 2014 in excess of the original cost basis of the land relate to site preparation costs.

On August 4, 2011, we formed a joint venture with an affiliate of Perseus Realty, LLC to acquire Storey Park in our Washington, D.C. reporting segment. At the time, the site was leased to Greyhound Lines, Inc. (“Greyhound”), which subsequently relocated its operations. Greyhound’s lease expired on August 31, 2013, at which time the property was placed into development. The joint venture anticipates developing a mixed-use project on the 1.6 acre site, which can accommodate up to 712,000 square feet. At December 31, 2014, our total investment in the development project was $55.4 million, which included the original cost basis of the property of $43.3 million. The majority of the costs in excess of the original cost basis relate to capitalized architectural fees and site preparation costs. We are currently exploring our options related to this property; however, until a definitive plan for the property has been reached and we begin significant development activities, we cannot determine the total cost of the project or the anticipated completion date.

On December 28, 2010, we acquired 440 First Street, NW, a vacant eight-story office building in our Washington, D.C. reporting segment. In October 2013, we substantially completed the redevelopment of the 139,000 square foot property. At December 31, 2014, the property was 56.8% leased and 36.3% occupied. During the fourth quarter of 2014, all vacant space at the property was placed in-service. At December 31, 2014, our total investment in the redevelopment project was $55.5 million, which included the original cost basis of the property of $23.6 million.


101

We did not place-in service any development efforts during 2014. At December 31, 2014, we had no completed development or redevelopment efforts that have yet to be placed in service.



(5) Acquisitions

During 2014 and 2013, we acquired the following properties (dollars in thousands):
Property
Reporting Segment
Acquisition Date
Property Type
Square Feet
Contractual Purchase Price
11 Dupont Circle, NW(1)
Washington, DC
September 24, 2014
Office
153,018
$89,000
1775 Wiehle Avenue(2)
Northern Virginia
June 25, 2014
Office
130,048
$41,000
1401 K Street, NW(3)
Washington, DC
April 8, 2014
Office
118,292
$58,000
540 Gaither Road(4)
Maryland
October 1, 2013
Office
133,895
$30,000

(1) The acquisition was funded with a draw under our unsecured revolving credit facility.
(2) The acquisition was funded with the net proceeds from the sale of Corporate Campus at Ashburn Center and available cash.
(3) The acquisition was funded with the assumption of a $37.3 million mortgage loan and a draw under our unsecured revolving credit facility.
(4) The acquisition was funded with $28.2 million of proceeds from the sale of our industrial portfolio in June 2013 that was previously placed with a qualified intermediary to facilitate a tax-free exchange, as well as available cash.

For 2014, we included $8.8 million of revenues and $2.0 million of net loss in our consolidated statements of operations related to the acquisition of 1401 K Street, NW, 1775 Wiehle Avenue and 11 Dupont Circle, NW. We incurred $2.7 million and $0.6 million of acquisition-related due diligence and closing costs during 2014 and 2013, respectively.

The fair values of the net assets acquired in 2014 are as follows (amounts in thousands):
 
 
2014
 
2013
Land
$
48,792

 
$
6,458

Acquired tenant improvements
10,857

 
1,669

Building and improvements
111,173

 
18,162

In-place leases
12,540

 
2,886

Acquired leasing commissions
4,681

 
580

Legal leasing fees
360

 
2

Above-market leases acquired
2,397

 
243

Total assets acquired
190,800

 
30,000

Below-market leases assumed
(2,800
)
 
—

Debt assumed
(37,269
)
 
—

Net assets acquired
$
150,731

 
$
30,000


The fair values for the assets acquired in 2014 are preliminary as we continue to finalize their acquisition date fair value determination.

At December 31, 2014, our consolidated intangible assets acquired in 2014 were comprised of the following categories: acquired tenant improvements; in-place leases; acquired leasing commissions; legal expenses; and above-market leases, which had an aggregate weighted average amortization period of 4.3 years. During the fourth quarter of 2014, we accelerated the amortization of lease-level assets and liabilities associated with a tenant at 1401 K Street, NW, who vacated effective January 2015. The accelerated amortization for the three months ended December 31, 2014 resulted in a net increase in depreciation and amortization expense of $0.1 million, which included a $0.6 million decrease in depreciation and amortization related to the aggregate deferred market assets and liabilities.
 



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Pro Forma Financial Information (unaudited)

The unaudited pro forma financial information set forth below presents results for the twelve months ended December 31, 2014 and 2013 as if all of our 2014 and 2013 acquisitions (1401 K Street, NW, 1775 Wiehle Avenue, 11 Dupont Circle, NW and 540 Gaither Road), and related financings, had occurred on January 1, 2013. The pro forma information is not necessarily indicative of the results that actually would have occurred nor does it intend to indicate future operating results (amounts in thousands, except per share amounts):
 
 
2014
 
2013
Pro forma total revenues
$
171,686

 
$
170,800

Pro forma net income
$
19,461

 
$
5,572

Pro forma net income (loss) per share – basic and diluted
$
0.12

 
$
(0.12
)

(6) Investment in Affiliates
We own an interest in several joint ventures that own properties. We do not control the activities that are most significant to the joint ventures. As a result, the assets, liabilities and operating results of these noncontrolled joint ventures are not consolidated within our consolidated financial statements. Our investments in these joint ventures are recorded as “Investment in affiliates” in our consolidated balance sheets. Our investment in affiliates consisted of the following at December 31 (dollars in thousands):
 
 
 
 
2014
 
Reporting Segment
 
Ownership
Interest
 
Company
Investment
 
Debt
 
Recourse
Debt(1)
Prosperity Metro Plaza
Northern Virginia
 
51
%
 
$
24,651

 
$
50,000

(2) 
$
—

1750 H Street, NW
Washington, D.C.
 
50
%
 
14,834

 
32,000

(2) 
—

Aviation Business Park
Maryland
 
50
%
 
5,748

 
—

  
—

Rivers Park I and II(3)
Maryland
 
25
%
 
2,249

 
28,000

(2) 
2,800

 
 
 
 
 
$
47,482

 
$
110,000

  
$
2,800

 
 
 
 
 
 
 
 
 
 
 
 
 
2013
 
Reporting Segment
 
Ownership
Interest
 
Company
Investment
 
Debt
 
Recourse
Debt(1)
Prosperity Metro Plaza
Northern Virginia
 
51
%
 
$
24,735

 
$
48,991

(4) 
$
—

1750 H Street, NW
Washington, D.C.
 
50
%
 
16,780

 
28,413

(4) 
—

Aviation Business Park
Maryland
 
50
%
 
5,008

 
—

  
—

Rivers Park I and II(3)
Maryland
 
25
%
 
2,627

 
28,000

 
7,000

 
 
 
 
 
$
49,150

 
$
105,404

  
$
7,000

 
(1) 
We believe the fair value of the potential liability to us related to the recourse debt is inconsequential as the likelihood of our need to perform under the debt agreement is remote.
(2) 
During 2014, the mortgage loans that encumbered Prosperity Metro Plaza and 1750 H Street, NW matured and were replaced with new mortgage loans and the mortgage loan that encumbered Rivers Park I and II was refinanced. See below for details.
(3) 
Rivers Park I and Rivers Park II are owned through two separate joint ventures.
(4) 
Excludes the unamortized fair value adjustments recorded at acquisition upon the assumption of the mortgage loans.

On November 12, 2014, our 51% owned unconsolidated joint venture repaid a $48.3 million mortgage loan that encumbered Prosperity Metro Plaza, a two-building, 327,000 square-foot office building located in Merrifield, Virginia. Simultaneously with the repayment, the joint venture entered into a new $50.0 million mortgage loan that has a fixed-interest rate of 3.91%. The new loan requires interest only payments through December 2024, at which time the loan requires principal and interest payments through its maturity date. The loan has a maturity date of December 1, 2029 and is repayable in full without penalty on or after June 1, 2029.


103

On September 26, 2014, our 25% owned unconsolidated joint venture amended a $28.0 million mortgage loan that encumbers Rivers Park I and II, a six-building, 308,000 square-foot business park located in Columbia, Maryland. The amended mortgage loan reduced the variable interest rate spread by 60 basis points and reduced the amount of outstanding principal recourse to us from 25% to 10%. The amended loan matures on September 26, 2017 and is repayable in full without penalty at any time during the term of the loan.

On July 10, 2014, our 50% owned unconsolidated joint venture repaid a $27.9 million mortgage loan that encumbered 1750 H Street, NW, a ten-story, 113,000 square-foot office building located in Washington, D.C. Simultaneously with the repayment, the joint venture entered into a new $32.0 million mortgage loan that has a fixed interest rate of 3.92%, a maturity date of August 1, 2024, and is repayable in full without penalty on or after August 1, 2021. The new loan requires monthly interest-only payments with a constant interest rate over the life of the loan.

The net assets of our unconsolidated joint ventures consisted of the following at December 31 (dollars in thousands):
 
2014
 
2013
Assets:
 
 
 
Rental property, net
$
193,533

 
$
194,240

Cash and cash equivalents
4,567

 
3,680

Other assets
16,748

 
15,585

Total assets
214,848

 
213,505

Liabilities:
 
 
 
Mortgage loans(1)
110,000

 
106,384

Other liabilities
7,256

 
5,046

Total liabilities
117,256

 
111,430

Net assets
$
97,592

 
$
102,075


(1) 
The 2013 figures include the unamortized fair value adjustments recorded at acquisition upon the assumption of mortgage loans. During 2014, the mortgage loans that encumbered Prosperity Metro Plaza and 1750 H Street, NW matured and were replaced with new mortgage loans and the mortgage loan that encumbered Rivers Park I and II was refinanced. See above for details.

Our share of earnings or losses related to our unconsolidated joint ventures is recorded in our consolidated statements of operations as “Equity in (earnings) losses of affiliates.”

The following table summarizes the results of operations of our unconsolidated joint ventures at December 31, which due to our varying ownership interests in the joint ventures and the varying operations of the joint ventures may or may not be reflective of the amounts recorded in our consolidated statements of operations (amounts in thousands):
 
 
2014
 
2013
 
2012
Total revenues
$
23,285

 
$
24,017

 
$
24,945

Total operating expenses
(7,408
)
 
(7,753
)
 
(7,377
)
Net operating income
15,877

 
16,264

 
17,568

Depreciation and amortization
(9,893
)
 
(11,551
)
 
(12,564
)
Interest expense, net
(3,890
)
 
(4,222
)
 
(4,326
)
Provision for income taxes
(63
)
 
(83
)
 
(21
)
Contingent consideration charge
126

 
—

 
—

Net income
$
2,157

 
$
408

 
$
657


We earn various fees from several of our joint ventures, which include management fees, leasing commissions and construction management fees. We recognize fees only to the extent of the third party ownership interest in our unconsolidated joint ventures. We recognized fees from our unconsolidated joint ventures of $0.7 million, $0.6 million and $0.5 million in 2014, 2013 and 2012, respectively, which are reflected within “Tenant reimbursements and other revenues” in our consolidated statements of operations.

104


(7) Notes Receivable

Below is a summary of our notes receivable for our outstanding mezzanine loans at December 31, 2014 and 2013 (dollars in thousands):
 
 
Balance at December 31, 2014
 
 
Property
Face Amount
 
Unamortized
Origination Fees
 
Balance
 
Interest Rate
950 F Street, NW
$
34,000

 
$
—

 
$
34,000

 
9.75
%
America's Square
29,720

 
(41
)
 
29,679

 
9.0
%
 
$
63,720

 
$
(41
)
 
$
63,679

 
 
 
 
Balance at December 31, 2013
 
 
Property
Face Amount
 
Unamortized
Origination Fees
 
Balance
 
Interest Rate
950 F Street, NW
$
25,000

 
$
(130
)
 
$
24,870

 
12.5
%
America's Square
29,896

 
(70
)
 
29,826

 
9.0
%
 
$
54,896

 
$
(200
)
 
$
54,696

 
 

We provided the owners of America Square, a 461,000 square foot office complex located in Washington, D.C., a $30.0 million loan in April 2011. On January 27, 2015, the owners of America’s Square gave notice of their intent to prepay the mezzanine loan which has an outstanding balance of $29.7 million. We anticipate the loan will be repaid on or about February 24, 2015. The loan, which was secured by a portion of the owners’ interest in the property, required monthly interest-only payments until May 2013, at which time the loan began requiring monthly principal and interest payments through its maturity date. The loan had a May 1, 2016 maturity date and was repayable in full at any time, subject to yield maintenance. We expect to receive a yield maintenance payment of $2.4 million with the repayment of the loan. The proceeds from the loan repayment will be used to pay down a portion of the outstanding balance under our unsecured revolving credit facility.

In December 2010, we provided a $25.0 million mezzanine loan to the owners of 950 F Street, NW, a ten-story, 287,000 square-foot, office/retail building located in Washington, D.C. that is secured by a portion of the owners’ interest in the property. The loan requires monthly interest-only payments with a constant interest rate over the life of the loan. On January 10, 2014, we amended the loan to increase the outstanding balance to $34.0 million and reduce the fixed interest rate from 12.5% to 9.75%. The amended mezzanine loan matures on April 1, 2017 and is repayable in full on or after December 21, 2015. The $9.0 million increase in the loan was provided by a draw under our unsecured revolving credit facility.

We recorded interest income related to our notes receivable of $6.1 million during 2014 and $5.9 million during both 2013 and 2012, which is included within “Interest and other income” in our consolidated statements of operations. Payments under both loans were current at December 31, 2014.

We recorded income from the amortization of origination fees of $32 thousand in 2014 and $0.1 million for both 2013 and 2012. During the first quarter of 2014, we wrote-off $0.1 million of unamortized fees related to the original 950 F Street, NW mezzanine loan. The amortization and write-off of origination fees are recorded within “Interest and other income” in our consolidated statements of operations.


105

(8) Intangible Assets and Deferred Market Rent Liabilities

Intangible assets and deferred market rent liabilities consisted of the following at December 31 (amounts in thousands):
 
 
2014(1)
 
2013(1)
 
Gross
Intangibles
 
Accumulated
Amortization
 
Net
Intangibles
 
Gross
Intangibles
 
Accumulated
Amortization
 
Net
Intangibles
In-place leases
$
51,258

 
$
(22,443
)
 
$
28,815

 
$
44,772

 
$
(18,843
)
 
$
25,929

Customer relationships
906

 
(654
)
 
252

 
1,002

 
(591
)
 
411

Leasing commissions
11,335

 
(4,272
)
 
7,063

 
7,796

 
(3,361
)
 
4,435

Legal leasing fees
377

 
(118
)
 
259

 
137

 
(83
)
 
54

Deferred market rent assets
3,906

 
(1,309
)
 
2,597

 
2,485

 
(1,348
)
 
1,137

Goodwill
6,930

 
—

 
6,930

 
6,930

 
—

 
6,930

 
$
74,712

 
$
(28,796
)
 
$
45,916

 
$
63,122

 
$
(24,226
)
 
$
38,896

Deferred market rent liability
$
5,193

 
$
(2,348
)
 
$
2,845

 
$
4,381

 
$
(2,767
)
 
$
1,614

 
(1) 
Includes amounts from properties that were classified as held-for-sale at December 31, 2014 and 2013.

We recognized $10.3 million, $8.3 million and $10.7 million of amortization expense on intangible assets for the years ended December 31, 2014, 2013 and 2012, respectively. We recognized $14 thousand of additional rental revenue through the net amortization of deferred market rent assets and deferred market rent liabilities for the year ended December 31, 2014. For the years ended December 31, 2013 and 2012, we recognized a reduction of rental revenue of $0.1 million and $0.2 million, respectively, through the net amortization of deferred market rent assets and deferred market rent liabilities. Losses due to termination of tenant leases and defaults, which resulted in the write-offs of all lease-level and intangible assets, were $1.1 million, $1.0 million and $1.1 million during 2014, 2013 and 2012, respectively.

The projected net amortization of intangible assets and deferred market liabilities as of December 31, 2014, including amounts from properties that were classified as held-for-sale at December 31, 2014, are as follows (amounts in thousands):
 
2015
$
10,747

2016
8,745

2017
4,275

2018
2,707

2019
2,393

Thereafter
7,274

 
$
36,141


(9) Income Taxes

We own properties in Washington, D.C. that are subject to income-based franchise taxes at an effective rate of 9.975% as a result of conducting business in Washington, D.C. Our deferred tax assets and liabilities associated with our properties were primarily associated with differences in the GAAP and tax basis of rental property, particularly acquisition costs, but also included intangible assets and deferred market rent assets and liabilities that were associated with properties located in Washington, D.C. We will recognize deferred tax assets only to the extent that it is more likely than not that deferred tax assets will be realized based on consideration of available evidence, including future reversals of existing taxable temporary differences, future projected taxable income and tax planning strategies.

During the third quarter of 2012, there was a change in tax regulations in the District of Columbia that required us to file a unitary tax return, which allowed for a deduction for dividends paid to shareholders. The change in tax regulations resulted in us prospectively measuring all of our deferred tax assets and deferred tax liabilities using the effective tax rate 0% expected to be in effect as these timing differences reverse; therefore, we did not record a benefit from income taxes during 2014 or 2013. We recognized a benefit from income taxes of $4.1 million during 2012. At December 31, 2014 and 2013, we recorded a $1.0 million receivable within “Accounts and other receivables” in our consolidated balance sheets for an expected tax refund associated with our 2011 tax payments and the estimated payments made in 2012 arising from the change in regulations in 2012. At December 31,

106

2014 and 2013, we did not have any recorded deferred tax assets or deferred tax liabilities. We also have interests in an unconsolidated joint venture that owns rental property in Washington, D.C. that is subject to the franchise tax. The impact for income taxes related to this unconsolidated joint venture is reflected within “Equity in (earnings) losses of affiliates” in our consolidated statements of operations.

We did not record a valuation allowance against our deferred tax assets for any period presented. We did not recognize any deferred tax assets or liabilities as a result of uncertain tax positions and had no material net operating loss, capital loss or alternative minimum tax carryovers. There was no benefit or provision for income taxes associated with our discontinued operations for any period presented.

As we believe we both qualify as a REIT and will not be subject to federal income tax, a reconciliation between the income tax provision calculated at the statutory federal income tax rate and the actual income tax provision has not been provided.

(10) Dispositions

During the second quarter of 2014, we prospectively adopted ASU 2014-08, which states that a component of an entity or a group of components of an entity is required to be reported in discontinued operations only if the disposal represents a strategic shift that has, or will have, a major effect on an entity’s operations and financial results. All other disposed properties will have their operating results reflected within continuing operations on our consolidated statements of operations for all periods presented. For more information, see note 2(q), Summary of Significant Accounting Policies - Application of New Accounting Standards.

(a) Disposed or Held-for-Sale Properties within Continuing Operations

The following table is a summary of completed property dispositions whose operating results are included in continuing operations in our consolidated statements of operations for the periods presented (dollars in thousands):

 
Reporting
Segment
Disposition Date
Property Type
Square Feet
Net Sale Proceeds
Owings Mills Business Park
Maryland
10/16/2014
Business Park
180,475

$
12,417

Corporate Campus at Ashburn Center
Northern Virginia
6/26/2014
Business Park
194,184

39,910


In accordance with ASU 2014-08, which we prospectively adopted during the second quarter of 2014, the operating results and gain on sale of Corporate Campus at Ashburn Center and the operating results and impairment of Owings Mills Business Park are reflected in continuing operations in our consolidated statements of operations for each of the periods presented. The following table summarizes the aggregate results of operations for the two properties that are included in continuing operations for the periods presented (dollars in thousands):

 
2014
 
2013
 
2012
Revenues
$
2,920

 
$
5,223

 
$
5,363

Property operating expenses
(1,172
)
 
(1,521
)
 
(1,375
)
Depreciation and amortization
(1,047
)
 
(1,424
)
 
(1,517
)
Interest expense, net of interest income
—

 
—

 
(230
)
Impairment of rental property
(3,956
)
 
—

 
(3,246
)
(Loss) income from operations of disposed property
(3,255
)
 
2,278

 
(1,005
)
Loss on debt extinguishment
—

 
—

 
(466
)
Gain on sale of rental property
21,230

 
—

 
—

Net income (loss) from continuing operations
$
17,975

 
$
2,278

 
$
(1,471
)

(b) Discontinued Operations
Effective as of February 9, 2015, we entered into a binding contract to sell our Richmond, Virginia portfolio, which is located in our Southern Virginia reporting segment. The Richmond Portfolio consists of Chesterfield Business Center, Hanover Business Center, Park Central, Virginia Technology Center and a three-acre parcel of undeveloped land, and in the aggregate is comprised of 19 buildings totaling 827,900 square feet. We anticipate closing the sale in the first half of 2015. However, we can provide no

107

assurances regarding the timing or pricing of the sale of the Richmond Portfolio, or that the sale will occur at all. With the sale of our Richmond Portfolio, we will no longer own any properties in the Richmond, Virginia area and will have strategically exited the Richmond market. As such, in accordance with ASU 2014-08, our Richmond Portfolio was classified as held-for-sale at December 31, 2014 and the operating results of the Richmond Portfolio are reflected within discontinued operations for each of the periods presented.

At December 31, 2014, the Richmond Portfolio met our held-for-sale criteria and, therefore, the assets of the buildings were classified within “Assets held-for-sale” and the liabilities of the buildings, along with five mortgage loans that will be repaid, were classified within “Liabilities-held-for-sale” in our consolidated balance sheet. The majority of the assets classified within “Assets held-for sale” at December 31, 2014, consisted of $7.7 million in land, $62.0 million in buildings, $8.5 million in tenant improvements, $0.1 million in construction in progress and accumulated depreciation of $20.6 million.  The remaining $2.0 million classified within “Assets held-for sale” consisted of accrued straight-line rents, net of allowance for doubtful accounts, deferred costs, net of accumulated amortization, prepaid expenses and other assets, and intangible assets, net of accumulated amortization. The majority of "Liabilities held-for-sale" at December 31, 2014 consisted of $3.5 million of mortgage debt. The remaining $1.1 million classified within "Liabilities held-for-sale" consisted of prepaid rent and security deposits.
In addition to the Richmond Portfolio, all properties sold prior to our adoption of ASU 2014-08 or classified as held-for-sale in previously issued consolidated financial statements prior to our adoption of ASU 2014-08, are classified within discontinued operations.

As of December 31, 2013, the assets of the Richmond Portfolio, together with the Patrick Center, West Park, Girard Business Center and Gateway Center properties were classified within “Assets held-for-sale” and the liabilities of the buildings, along with the Richmond Portfolio mortgage debt that will be repaid, were classified within “Liabilities-held-for-sale” in our consolidated balance sheet. The majority of the assets classified within “Assets held-for sale” as of December 31, 2013, consisted of $21.4 million in land, $97.5 million in building, $12.8 million in tenant improvements, $0.1 million in construction in progress and accumulated depreciation of $29.4 million.  The remaining $4.1 million classified within “Assets held-for sale” consisted of accrued straight-line rents, net of allowance for doubtful accounts, deferred costs, net of accumulated amortization, prepaid expenses and other assets, and intangible assets, net of accumulated amortization. The majority of "Liabilities held-for-sale" at December 31, 2013, consisted of $4.5 million of mortgage debt. The remaining $1.0 million classified within "Liabilities held-for-sale" consisted of prepaid rent and security deposits. At December 31, 2013, the Richmond Portfolio did not meet our held-for-sale criteria and, therefore, we did not cease recording depreciation until December 31, 2014, when the property met our held-for-sale criteria. We classified the assets and liabilities as held-for-sale on our December 31, 2013 consolidated balance sheet in accordance with the standards set forth in ASU 2014-08.

The following table is a summary of completed and anticipated property dispositions whose operating results are reflected as discontinued operations in our consolidated statements of operations for the periods presented (dollars in thousands):

 
Reporting Segment
 
Disposition
Date
 
Property Type
 
Square
Feet
 
Net Sale
Proceeds
Richmond Portfolio(1)
Southern Virginia
 
TBD
 
Business Park
 
827,900

 
$ N/A

Patrick Center
Maryland
 
4/16/2014
 
Office
 
66,269

 
10,888

West Park
Maryland
 
4/2/2014
 
Office
 
28,333

 
2,871

Girard Business Center and Gateway Center
Maryland
 
1/29/2014
 
Business Park and Office
 
341,973

 
31,616

Worman’s Mill Court
Maryland
 
11/19/2013
 
Office
 
40,099

 
3,362

Triangle Business Center
Maryland
 
9/27/2013
 
Business Park
 
74,429

 
2,732

4200 Tech Court
Northern Virginia
 
8/15/2013
 
Office
 
33,875

 
3,210

Industrial Portfolio(2)
Various
 
May/June 2013
 
Industrial
 
4,280,985

 
176,569

4212 Tech Court
Northern Virginia
 
6/5/2013
 
Office
 
32,055

 
2,469

Owings Mills Business Park(3)
Maryland
 
11/7/2012
 
Business Park
 
38,779

 
3,472

Goldenrod Lane
Maryland
 
5/31/2012
 
Office
 
23,518

 
2,663

Woodlands Business Center
Maryland
 
5/8/2012
 
Office
 
37,887

 
2,885

Airpark Place Business Center
Maryland
 
3/22/2012
 
Business Park
 
82,429

 
5,153


108

 
(1) 
Effective as of February 9, 2015, we entered a binding contract to sell the Richmond Portfolio, which we anticipate closing in the first half of 2015. However, we can provide no assurances regarding the timing or pricing of the sale of the Richmond Portfolio, or that the sale will occur at all. We classified the Richmond Portfolio as held-for-sale at December 31, 2014.
(2) 
During the second quarter of 2013, we sold 24 industrial properties, which consisted of two separate transactions. On May 7, 2013, we sold I-66 Commerce Center, a 236,000 square foot industrial property in Haymarket, Virginia. On June 18, 2013, we completed the sale of the remaining 23 industrial properties.
(3) 
In November 2012, we sold two of the six buildings at Owings Mills Business Park. The remaining four buildings at Owings Mills Business Park were sold in October 2014 and their results of operations are included in continuing operations in our consolidated statements of operations. See note 10(a) Dispositions - Disposed or Held-for-Sale Properties within Continuing Operations.

We have had, and will have, no continuing involvement with any of our disposed properties subsequent to their disposal. The operations of the disposed properties were not subject to any income based taxes. We did not dispose of or enter into any binding agreements to sell any other properties during 2014, 2013 and 2012.

The following table summarizes the results of operations of properties included in discontinued operations for the years ended December 31 (dollars in thousands):
 

2014

2013

2012
Revenues
$
7,688


$
31,654


$
50,985

Property operating expenses
(3,612
)

(10,564
)

(16,226
)
Depreciation and amortization
(3,662
)

(8,937
)

(14,958
)
Interest expense, net of interest income
(268
)

(1,268
)

(2,947
)
Impairment of rental property
—


(4,092
)

(1,072
)
Income from operations of disposed property
146


6,793


15,782

Loss on debt extinguishment
—


(4,414
)

—

Gain on sale of rental property
1,338


19,363


161

Net income from discontinued operations
$
1,484


$
21,742


$
15,943


(11) Debt

Our borrowings consisted of the following at December 31 (dollars in thousands):
 
 
2014
 
2013
Mortgage loans, effective interest rates ranging from 4.40% to 6.63%, maturing at various dates through June 2023(1)(2)
$
308,637

 
$
274,648

Unsecured term loan, effective interest rates ranging from LIBOR plus 1.65% to LIBOR plus 2.05%, with staggered maturity dates ranging from October 2018 to October 2020(1)
300,000

 
300,000

Unsecured revolving credit facility, effective interest rate of LIBOR plus 1.70%, maturing October 2017(1)
205,000

 
99,000

 
$
813,637

 
$
673,648


(1) 
At December 31, 2014, LIBOR was 0.17%. All references to LIBOR in the consolidated financial statements refer to one-month LIBOR.
(2) 
Includes five mortgage loans that will be repaid upon the sale of the Richmond Portfolio, which is expected to be sold in the first half of 2015. At December 31, 2014 and 2013, the mortgage loans had an aggregate principal balance of $3.5 million and $4.5 million, respectively, and were classified within “Liabilities held-for-sale” on our consolidated balance sheets for the periods presented.



109

(a) Mortgage Loans

The following table provides a summary of our mortgage debt at December 31, 2014 and 2013 (dollars in thousands):
 
Encumbered Property
Contractual
Interest Rate
 
Effective
Interest
Rate
 
Maturity
Date
 
December 31, 2014
 
December 31, 2013
Annapolis Business Center(1)
5.74
%
 
6.25
%
 
June 2014
 
$
—

 
$
8,076

Jackson National Life Loan(2)
5.19
%
 
5.19
%
 
August 2015
 
64,943

 
66,116

440 First Street, NW Construction Loan(3)(4)
LIBOR + 2.50%

 
LIBOR + 2.50%

 
May 2016
 
32,216

 
21,699

Storey Park Land Loan(3)(5)
LIBOR + 2.50%

 
LIBOR + 2.50%

 
October 2016
 
22,000

 
22,000

Gateway Centre Manassas Building I
7.35
%
 
5.88
%
 
November 2016
 
432

 
638

Hillside I and II
5.75
%
 
4.62
%
 
December 2016
 
12,949

 
13,349

Redland Corporate Center Buildings II & III
4.20
%
 
4.64
%
 
November 2017
 
65,816

 
67,038

840 First Street, NE
5.72
%
 
6.01
%
 
July 2020
 
36,539

 
37,151

Battlefield Corporate Center
4.26
%
 
4.40
%
 
November 2020
 
3,692

 
3,851

1211 Connecticut Avenue, NW
4.22
%
 
4.47
%
 
July 2022
 
29,691

 
30,249

1401 K Street, NW
4.80
%
 
4.93
%
 
June 2023
 
36,861

 
—

 
 
 
4.75
%
(6) 
 
 
305,139

 
270,167

Unamortized fair value adjustments
 
 
 
 
 
 
(370
)
 
(554
)
Principal balance
 
 
 
 
 
 
304,769

 
269,613

 
 
 
 
 
 
 
 
 
 
Richmond Portfolio(7)
 
 
 
 
 
 
 
 
 
   Hanover Business Center Building D
8.88
%
 
6.63
%
 
August 2015
 
104

 
252

   Chesterfield Business Center Buildings C,D,G and H
8.50
%
 
6.63
%
 
September 2015
 
302

 
681

   Hanover Business Center Building C
7.88
%
 
6.63
%
 
December 2017
 
505

 
653

   Chesterfield Business Center Buildings A,B,E and F
7.45
%
 
6.63
%
 
June 2021
 
1,674

 
1,873

   Airpark Business Center
7.45
%
 
6.63
%
 
June 2021
 
913

 
1,022

 
 
 
 
 
 
 
3,498

 
4,481

Total unamortized fair value adjustments - Richmond(3)
 
 
 
 
 
 
(73
)
 
(109
)
Total principal balance - Richmond(3)
 
 
 
 
 
 
$
3,425

 
$
4,372

 
 
 
 
 
 
 
 
 
 
Total principal balance
 
 
4.75
%
(6)  
 
 
$
308,194

 
$
273,985

 
(1) 
The loan was prepaid, without penalty, on May 1, 2014 with borrowings under our unsecured revolving credit facility.
(2) 
At December 31, 2014, the loan was secured by the following properties: Plaza 500, Van Buren Office Park, Rumsey Center, Snowden Center, Greenbrier Technology Center II and Norfolk Business Center. The terms of the loan allow us to substitute collateral, as long as certain debt-service coverage and loan-to-value ratios are maintained, or to prepay a portion of the loan, with a prepayment penalty, subject to a debt-service yield.
(3) 
At December 31, 2014, LIBOR was 0.17%.
(4) 
At December 31, 2014, 50% of the principal balance and any unpaid accrued interest on the 440 First Street, NW construction loan were recourse to us. In 2014, we borrowed an additional $10.5 million under the construction loan.
(5) 
The loan was repaid on October 16, 2014. Simultaneously with the repayment, our 97% owned consolidated joint venture entered into a new $22.0 million land loan with an applicable interest rate of LIBOR plus 2.50%, which matures on October 16, 2016, with a one-year extension at our option.
(6) 
Weighted average interest rate on total mortgage debt.
(7) 
The mortgage loans that encumber properties within the Richmond Portfolio were classified within “Liabilities held-for-sale” on our consolidated balance sheets for the periods presented and will be repaid upon the sale of the Richmond Portfolio, which is expected to be sold in the first half of 2015.


Land Loan
On October 16, 2014, our 97% owned consolidated joint venture that owns Storey Park repaid a $22.0 million loan that encumbered the Storey Park land and was subject to a 5.0% interest rate floor. Simultaneously with the repayment, the joint venture entered into a new $22.0 million land loan with a variable interest rate of LIBOR plus 2.50%. The new loan matures on October 16, 2016, with a one-year extension at our option, and is repayable in full without penalty at any time during the term of the loan. Per

110

the terms of the loan agreement, $6.0 million of the outstanding principal balance and all of the outstanding accrued interest is recourse to us. As of December 31, 2014, we were in compliance with all the financial covenants of the Storey Park land loan.

Construction Loan

On June 5, 2013, we entered into a construction loan (the “Construction Loan”) that is collateralized by our 440 First Street, NW property, which underwent a major redevelopment that was substantially completed in October 2013. The Construction Loan has a borrowing capacity of up to $43.5 million, of which we initially borrowed $21.7 million in the second quarter of 2013 and borrowed an additional $10.5 million in 2014. The Construction Loan has a variable interest rate of LIBOR plus a spread of 2.50% and matures in May 2016, with two one-year extension options at our discretion. We can repay all or a portion of the Construction Loan, without penalty, at any time during the term of the loan. At December 31, 2014, per the terms of the loan agreement, 50% of the outstanding principal balance and all of the outstanding accrued interest were recourse to us. The percentage of outstanding principal balance that is recourse to us can be reduced upon the property achieving certain operating thresholds. As of December 31, 2014, we were in compliance with all the financial covenants of the Construction Loan.

With the exception of the specific debt instruments identified in the above table, our mortgage debt is recourse solely to specific assets. We had 18 consolidated properties that secured mortgage debt at December 31, 2014 and 2013.

We have originated or assumed the following mortgage loans since January 1, 2013 (dollars in thousands):
 
Month
 
Year
 
Property
 
Effective
Interest
Rate
 
Principal
Amount
October
 
2014
 
Storey Park Land Loan(1)
 
LIBOR + 2.50%

 
$
22,000

(1) 
April
 
2014
 
1401 K Street, NW
 
4.93
%
 
37,269

 
June
 
2013
 
440 First Street, NW Construction Loan(2)
 
5.00
%
 
21,699

(2) 
 
(1) 
We have a 97% ownership interest in the property through a consolidated joint venture. The loan balance in the chart above reflects the entire loan balance, which is reflected in our consolidated balance sheets.
(2) 
At December 31, 2014, 50% of the principal balance and any unpaid accrued interest on the 440 First Street, NW construction loan were recourse to us. In 2014, we borrowed an additional $10.5 million under the construction loan.

We have repaid the following mortgage loans since January 1, 2013 (dollars in thousands):
 
Month
 
Year
 
Property
 
Effective
Interest
Rate
 
Principal
Balance
Repaid
October
 
2014
 
Storey Park Land Loan
 
5.80
%
 
$
22,000

May
 
2014
 
Annapolis Business Center
 
6.25
%
 
8,027

September
 
2013
 
840 First Street, NE(1)
 
6.05
%
 
53,877

September
 
2013
 
Linden Business Center
 
5.58
%
 
6,622

June
 
2013
 
Cloverleaf Center
 
6.75
%
 
16,427

June
 
2013
 
Mercedes Center – Note 1
 
6.04
%
 
4,799

June
 
2013
 
Mercedes Center – Note 2
 
6.30
%
 
9,260

June
 
2013
 
Jackson National Life Loan -Northridge
 
5.19
%
 
6,985

May
 
2013
 
Jackson National Life Loan - I-66 Commerce Center
 
5.19
%
 
21,695

February
 
2013
 
1434 Crossways Boulevard, Building I
 
5.38
%
 
7,597

February
 
2013
 
TenThreeTwenty
 
7.29
%
 
13,273

February
 
2013
 
Cedar Hill
 
6.58
%
 
15,364

January
 
2013
 
Prosperity Business Center
 
5.75
%
 
3,242


(1) 
On September 30, 2013, we repaid a $53.9 million mortgage loan that encumbered 840 First Street, NE, which was scheduled to mature on October 1, 2013. Simultaneously with the repayment of the mortgage debt, we encumbered 840 First Street, NE with a $37.3 million mortgage loan that had previously encumbered 500 First Street, NW.

111


(b) Unsecured Term Loan


The table below shows the outstanding balances and the interest rates of the three tranches of the $300.0 million unsecured term loan at December 31, 2014 (dollars in thousands):
 
Maturity Date
 
Amount
 
Interest Rate(1)
Tranche A
October 2018
 
$
100,000

 
LIBOR, plus 165 basis points
Tranche B
October 2019
 
100,000

 
LIBOR, plus 180 basis points
Tranche C
October 2020
 
100,000

 
LIBOR, plus 205 basis points
 
 
 
$
300,000

 
 
(1) 
At December 31, 2014, LIBOR was 0.17%. The interest rate spread is subject to change based on our maximum total indebtedness ratio. For more information, see note 11(e) Debt – Financial Covenants.
The term loan agreement contains various restrictive covenants substantially identical to those contained in our unsecured revolving credit facility, including with respect to liens, indebtedness, investments, distributions, mergers and asset sales. In addition, the agreement requires that we satisfy certain financial covenants that are also substantially identical to those contained in our unsecured revolving credit facility. The agreement also includes customary events of default, the occurrence of which, following any applicable cure period, would permit the lenders to, among other things, declare the principal, accrued interest and other obligations of our Company under the agreement to be immediately due and payable. As of December 31, 2014, we were in compliance with all the financial covenants of the unsecured term loan.

(c) Unsecured Revolving Credit Facility

The weighted average borrowings outstanding under the unsecured revolving credit facility were $136.1 million with a weighted average interest rate of 1.7% during 2014 compared with $139.4 million and 2.6%, respectively, during 2013. Our maximum outstanding borrowings were $216.0 million and $245.0 million during 2014 and 2013, respectively. At December 31, 2014, outstanding borrowings under the unsecured revolving credit facility were $205.0 million with a weighted average interest rate of 1.9%. At December 31, 2014, LIBOR was 0.17% and the applicable spread on our unsecured revolving credit facility was 170 basis points. The available capacity under the unsecured revolving credit facility was $79.0 million as of the date of this filing. We are required to pay an annual commitment fee of 0.25% based on the amount of unused capacity under the unsecured revolving credit facility. For more information, see note 11(e) Debt – Financial Covenants. As of December 31, 2014, we were in compliance with all the financial covenants of the unsecured revolving credit facility.

(d) Interest Rate Swap Agreements

At December 31, 2014, we fixed LIBOR, at a weighted average interest rate of 1.5%, on $300.0 million of our variable rate debt through eleven interest rate swap agreements. In January 2014, an interest rate swap that fixed LIBOR on $50.0 million of variable rate debt expired. See note 12, Derivative Instruments, for more information about our interest rate swap agreements.

(e) Financial Covenants

Our outstanding corporate debt agreements contain specific financial covenants that may impact future financing decisions made by us or may be impacted by a decline in operations. These covenants relate to our allowable leverage, minimum tangible net worth, fixed charge coverage and other financial metrics. As of December 31, 2014, we were in compliance with the covenants of our unsecured term loan and unsecured revolving credit facility and any such financial covenants of our mortgage debt (including the Construction Loan and the Storey Park land loan).

Our continued ability to borrow under the unsecured revolving credit facility is subject to compliance with financial and operating covenants, and a failure to comply with any of these covenants could result in a default under the credit facility. These debt agreements also contain cross-default provisions that would be triggered if we were in default under other loans, including mortgage loans, in excess of certain amounts. In the event of a default, the lenders could accelerate the timing of payments under the debt obligations and we may be required to repay such debt with capital from other sources, which may not be available on attractive terms, or at all, which would have a material adverse effect on our liquidity, financial condition, results of operations and ability to make distributions to our shareholders.



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Our unsecured revolving credit facility and unsecured term loan are subject to interest rate spreads that float based on the quarterly measurement of our maximum consolidated total indebtedness to gross asset value ratio. Based on our leverage ratio at December 31, 2014, the applicable interest rate spreads on the unsecured revolving credit facility and the unsecured term loan will be unchanged.    

(f) Aggregate Debt Maturities

Our aggregate debt maturities as of December 31, 2014, including amounts from properties that were classified as held-for-sale at December 31, 2014, are as follows (dollars in thousands):
 
2015
 
$
69,553

2016
 
70,763

2017
 
270,999

2018
 
102,746

2019
 
102,894

Thereafter
 
196,239

 
 
813,194

Unamortized fair value adjustments
 
443

Total contractual principal balance
 
$
813,637




(12) Derivative Instruments

Our interest rate swap agreements are designated as cash flow hedges and we record the effective portion of any unrealized gains associated with the change in fair value of the swap agreements within “Accumulated other comprehensive loss” and “Prepaid expenses and other assets” and the effective portion of any unrealized losses within “Accumulated other comprehensive loss” and “Accounts payable and other liabilities” on our consolidated balance sheets. We record our proportionate share of any unrealized gains or losses on our cash flow hedges associated with our unconsolidated joint ventures within “Accumulated other comprehensive loss” and “Investment in affiliates” on our consolidated balance sheets. We record any gains or losses incurred as a result of each interest rate swap agreement’s fixed rate deviating from our respective loan’s contractual rate within “Interest expense” in our consolidated statements of operations. We did not have any material ineffectiveness associated with our cash flow hedges in 2014, 2013 and 2012.

We enter into interest rate swap agreements to hedge our exposure on our variable rate debt against fluctuations in prevailing interest rates. The interest rate swap agreements fix LIBOR to a specified interest rate; however, the swap agreements do not affect the contractual spreads associated with each variable debt instrument’s applicable interest rate. At December 31, 2014, we fixed LIBOR at a weighted average interest rate of 1.5% on $300.0 million of our variable rate debt through eleven interest rate swap agreements that are summarized below (dollars in thousands):
 

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Maturity Date
 
Notional
Amount
 
Interest Rate
Contractual
Component
 
Fixed LIBOR
Interest Rate
July 2016
 
$
35,000

 
LIBOR
 
1.754
%
July 2016
 
25,000

 
LIBOR
 
1.763
%
July 2017
 
30,000

 
LIBOR
 
2.093
%
July 2017
 
30,000

 
LIBOR
 
2.093
%
July 2018
 
30,000

 
LIBOR
 
1.660
%
July 2018
 
25,000

 
LIBOR
 
1.394
%
July 2017
 
25,000

 
LIBOR
 
1.129
%
July 2017
 
12,500

 
LIBOR
 
1.129
%
July 2018
 
12,500

 
LIBOR
 
1.383
%
July 2017
 
50,000

 
LIBOR
 
0.955
%
July 2018
 
25,000

 
LIBOR
 
1.135
%
Total/Weighted Average
 
$
300,000

 
 
 
1.505
%
 
Amounts reported in accumulated other comprehensive loss related to derivatives will be reclassified to “Interest expense” on our consolidated statements of operations as interest payments are made on our variable-rate debt. We reclassified accumulated other comprehensive loss as an increase to interest expense of $4.1 million, $4.6 million and $4.2 million in 2014, 2013 and 2012, respectively. As of December 31, 2014, we estimate that $3.3 million of our accumulated other comprehensive loss will be reclassified as an increase to interest expense over the following twelve months.

(13) Fair Value Measurements

We apply GAAP that outlines a valuation framework and creates a fair value hierarchy, which distinguishes between assumptions based on market data (observable inputs) and a reporting entity’s own assumptions about market data (unobservable inputs). The required disclosures increase the consistency and comparability of fair value measurements and the related disclosures. Fair value is identified, under the standard, as the price that would be received to sell an asset or paid to transfer a liability between willing third parties at the measurement date (an exit price). In accordance with GAAP, certain assets and liabilities must be measured at fair value, and we provide the necessary disclosures that are required for items measured at fair value as outlined in the accounting requirements regarding fair value.

Financial assets and liabilities, as well as those non-financial assets and liabilities requiring fair value measurement, are measured using inputs from three levels of the fair value hierarchy.

The three levels are as follows:

Level 1 - Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access at the measurement date. An active market is defined as a market in which transactions for the assets or liabilities occur with sufficient frequency and volume to provide pricing information on an ongoing basis.

Level 2 - Inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active (markets with few transactions), inputs other than quoted prices that are observable for the asset or liability (i.e., interest rates, yield curves, etc.), and inputs derived principally from or corroborated by observable market data correlation or other means (market corroborated inputs).

Level 3 - Unobservable inputs, only used to the extent that observable inputs are not available, reflect our assumptions about the pricing of an asset or liability.

In accordance with accounting provisions and the fair value hierarchy described above, the following table shows the fair value of our consolidated assets and liabilities that are measured on a non-recurring and recurring basis as of December 31, 2014 and 2013 (amounts in thousands):
 

114

 
Balance at December 31, 2014
 
Level 1
 
Level 2
 
Level 3
Recurring Measurements:
 
 
 
 
 
 
 
Derivative instrument-swap assets
$
133

 
$
—

 
$
133

 
$
—

Derivative instrument-swap liabilities
3,569

 
—

 
3,569

 
—

 
 
Balance at December 31, 2013
 
Level 1
 
Level 2
 
Level 3
Non-recurring Measurements:
 
 
 
 
 
Impaired real estate assets
$
2,909

 
$
—

 
$
2,909

 
$
—

Recurring Measurements:
 
 
 
 
 
 
 
Derivative instrument-swap assets
551

 
—

 
551

 
—

Derivative instrument-swap liabilities
4,576

 
—

 
4,576

 
—


With the exception of a contingent consideration obligation, which totaled $39 thousand at December 31, 2013, we did not re-measure or complete any transactions involving non-financial assets or non-financial liabilities that are measured at fair value on a recurring basis during the years ended December 31, 2014 and 2013. During the first quarter of 2014, we issued 3,125 common Operating Partnership units to the seller of 840 First Street, NE to satisfy our contingent consideration obligation. Also, no transfers into or out of fair value measurement levels for assets or liabilities that are measured on a recurring basis occurred during the years ended December 31, 2014 and 2013.

Impairment of Rental Property

We regularly review market conditions for possible impairment of a property’s carrying value. When circumstances such as adverse market conditions, changes in management’s intended holding period or potential sale to a third party indicate a possible impairment of a property, an impairment analysis is performed.

During the fourth quarter of 2013, we were in negotiations with a buyer to sell our West Park property, which was located in our Maryland reporting segment. Based on the anticipated sales price, we recorded an impairment charge of $2.2 million in the fourth quarter of 2013. In April 2014, we sold our West Park property.

We incurred impairment charges of $4.0 million, $4.1 million and $3.5 million during 2014, 2013 and 2012, respectively. Of the total impairment charges, $4.0 million and $2.4 million incurred during 2014 and 2012, respectively, were related to four buildings at Owings Mills Business Park, and are reflected within continuing operations in our consolidated statements of operations. The impairment charges incurred during 2013 and the remaining impairment charges incurred during 2012 relate to properties that were subsequently disposed of at December 31, 2014 and are recorded within discontinued operations in our consolidated statements of operations. See note 10, Dispositions for more information.

Interest Rate Derivatives

At December 31, 2014, we had hedged $300.0 million of our variable rate debt through eleven interest rate swap agreements. See note 12, Derivative Instruments, for more information about our interest rate swap agreements.

The interest rate derivatives are fair valued based on prevailing market yield curves on the measurement date and also incorporate credit valuation adjustments to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of our derivative contracts for the effect of nonperformance risk, we have considered the impact of netting any applicable credit enhancements, such as collateral postings, thresholds, mutual inputs and guarantees. We use a third party to assist in valuing our interest rate swap agreements. A daily “snapshot” of the market is taken to obtain close of business rates. The snapshot includes over 7,500 rates including LIBOR fixings, Eurodollar futures, swap rates, exchange rates, treasuries, etc. This market data is obtained via direct feeds from Bloomberg and Reuters and from Inter-Dealer Brokers. The selected rates are compared to their historical values. Any rate that has changed by more than normal mean and related standard deviation would be considered an outlier and flagged for further investigation. The rates are then compiled through a valuation process that generates daily valuations, which are used to value our interest rate swap agreements. Our interest rate swap derivatives are effective cash flow hedges and the effective portion of the change in fair value is recorded in the equity section of our consolidated balance sheets as “Accumulated other comprehensive loss.”


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Financial Instruments

The carrying amounts of cash equivalents, accounts and other receivables, accounts payable and other liabilities, with the exception of any items listed above, approximate their fair values due to their short-term maturities. We determine the fair value of our notes receivable and debt instruments by discounting future contractual principal and interest payments using prevailing market rates for securities with similar terms and characteristics at the balance sheet date. We deem the fair value measurement of our debt instruments as a Level 2 measurement as we use quoted interest rates for similar debt instruments to value our debt instruments. We also use quoted market interest rates for similar notes to value our notes receivable, which we consider a Level 2 measurement as we do not believe notes receivable trade in an active market.

The carrying amount and estimated fair value of our notes receivable and debt instruments at December 31 are as follows (amounts in thousands):
 
 
2014
 
2013
 
Carrying
Value
 
Fair
Value
 
Carrying
Value
 
Fair
Value
Financial Assets:
 
 
 
 
 
 
 
Notes receivable(1)
$
63,679

 
$
63,720

 
$
54,696

 
$
56,812

Financial Liabilities:
 
 
 
 
 
 
 
Mortgage debt(2)
$
308,637

 
$
292,882

 
$
274,648

 
$
262,873

Unsecured term loan
300,000

 
300,000

 
300,000

 
300,000

Unsecured revolving credit facility
205,000

 
205,000

 
99,000

 
99,000

Total
$
813,637

 
$
797,882

 
$
673,648

 
$
661,873

 
(1) 
The principal amount of our notes receivable was $63.7 million and $54.9 million at December 31, 2014 and 2013, respectively. On January 27, 2015, the owners of America’s Square, a 461,000 square foot office complex located in Washington, D.C., gave notice of their intent to prepay, on or about February 24, 2015, a mezzanine loan, which has an outstanding $29.7 million balance of the $30.0 million mezzanine loan that we provided them in April 2011.
(2) 
Includes the mortgage debt balance of our Richmond portfolio properties, which have been classified as held-for-sale and is reflected in "Liabilities held-for-sale" on our consolidated balance sheets.

(14) Commitments and Contingencies

(a) Operating Leases

Our rental properties are subject to non-cancelable operating leases generating future minimum contractual rent payments due from tenants, which as of December 31, 2014 are as follows (dollars in thousands):
 
 
Future minimum
contractual
rent payments
2015
$
133,834

2016
127,967

2017
104,975

2018
90,376

2019
76,520

Thereafter
214,378

 
$
748,050


Our consolidated properties were 87.9% occupied by 582 tenants at December 31, 2014. We did not include square footage that was in development or redevelopment, which totaled 0.2 million square feet at December 31, 2014, in our occupancy calculation.

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We rent office space for our corporate headquarters under a non-cancelable operating lease, which we entered into in 2005. During the fourth quarter of 2011, we entered into a new lease agreement at our corporate headquarters, which expanded our corporate office space by an additional 19,000 square feet. We received an allowance of $1.3 million for tenant improvements to renovate the office space, which was completed prior to us taking occupancy in the fourth quarter of 2012. The lease agreement will expire on January 31, 2021. During the first quarter of 2012, we entered into a lease agreement for approximately 6,000 square feet in Washington, D.C., which served as the location for our Washington, D.C. office. The lease expired in December 2014, at which time, our Washington, D.C. office relocated to our 1211 Connecticut Avenue, NW property in Washington, D.C. and occupied approximately 4,900 square feet.

During the fourth quarter of 2012, we subleased 5,000 square feet of our corporate office space to one tenant, which commenced in January 2013. During the fourth quarter of 2013, the subtenant amended its lease to include an additional 2,700 square feet, which the subtenant occupied in March 2014. The subtenant’s lease will expire in January 2018 and the lease has a termination option in January 2016.

Rent expense incurred under the terms of the corporate office leases, net of subleased revenue, was $1.8 million for both the years ended December 31, 2014 and 2013 and $1.4 million for the year ended December 31, 2012.

Future minimum rental payments under our corporate office leases as of December 31, 2014 are summarized as follows, net of sublease revenue (dollars in thousands):
 
 
Future minimum
rent payments
2015
$
1,450

2016
1,489

2017
1,529

2018
1,911

2019
1,995

Thereafter
2,224

 
$
10,598



(b) Legal Proceedings

We are subject to legal proceedings and claims arising in the ordinary course of our business, for which, we carry various forms of insurance to protect the Company. In the opinion of our management and legal counsel, the amount of ultimate liability with respect to these claims will not have a material impact on our financial position, results of operations or cash flows.

(c) Capital Commitments

As of December 31, 2014, we had contractual construction in progress obligations, which included amounts accrued at December 31, 2014, of $1.4 million. The amount of contractual construction in progress obligations are primarily related to development activities at Storey Park, which is located in our Washington, D.C. reporting segment. As of December 31, 2014, we had contractual rental property and furniture, fixtures and equipment obligations of $11.8 million outstanding, which included amounts accrued at December 31, 2014. The amount of contractual rental property and furniture, fixtures and equipment obligations at December 31, 2014 included significant tenant improvement costs for a tenant' space at Atlantic Corporate Park, which is located in our Northern Virginia reporting segment. We anticipate meeting our contractual obligations related to our construction activities with cash from our operating activities. In the event cash from our operating activities is not sufficient to meet our contractual obligations, we can access additional capital through our unsecured revolving credit facility.
We remain liable, solely to the extent of our proportionate ownership percentage, to fund any capital shortfalls or commitments from properties owned through unconsolidated joint ventures.

We have various obligations to certain local municipalities associated with our development projects that will require completion of specified site improvements, such as sewer and road maintenance, grading and other general landscaping work. As of December 31, 2014, we remained liable to those local municipalities for $2.6 million in the event that we do not complete the specified work. We intend to complete the improvements in satisfaction of these obligations.

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(d) Insurance

We carry insurance coverage on our properties with policy specifications and insured limits that we believe are adequate given the relative risk of loss, cost of the coverage and standard industry practice. However, certain types of losses (such as from terrorism, earthquakes and floods) may be either uninsurable or not economically insurable. Further, certain of the properties are located in areas that are subject to earthquake activity and floods. Should a property sustain damage as a result of a terrorist act, earthquake or flood, we may incur losses due to insurance deductibles, co-payments on insured losses or uninsured losses. Should an uninsured loss occur, we could lose some or all of our capital investment, cash flow and anticipated profits related to one or more properties.



(15) Equity

On May 24, 2013, we completed the public offering of 7.5 million common shares at a public offering price of $14.70 per share, which generated net proceeds of $105.1 million, after deducting the underwriting discount and offering costs. We used a portion of the net proceeds to repay our $10.0 million secured term loan and our $37.5 million secured bridge loan and to pay down $53.0 million of the outstanding balance under our unsecured revolving credit facility. The remaining net proceeds were utilized for general corporate purposes.

We declared and paid dividends of $0.60 per common share to common shareholders during 2014 and 2013 and $0.80 per common share during 2012. We declared and paid dividends of $1.9375 per share on our Series A Preferred Shares during 2014, 2013 and 2012. On January 27, 2015, we declared a dividend of $0.15 per common share, equating to an annualized dividend of $0.60 per common share. The dividend was paid on February 17, 2015 to common shareholders of record as of February 10, 2015. We also declared a dividend on January 27, 2015 of $0.484375 per share on our Series A Preferred Shares. The dividend was paid on February 17, 2015 to preferred shareholders of record as of February 10, 2015. Dividends on all non-vested share awards are recorded as a reduction of shareholders’ equity. For each dividend paid by us on our common and preferred shares, the Operating Partnership distributes an equivalent distribution on our common and preferred Operating Partnership units, respectively.
Our unsecured revolving credit facility, unsecured term loan, the Construction Loan, and the Storey Park land loan contain certain restrictions that include, among other things, requirements to maintain specified coverage ratios and other financial covenants, which may limit our ability to make distributions to our common and preferred shareholders. Further, distributions with respect to our common shares are subject to our ability to first satisfy our obligations to pay distributions to the holders of our Series A Preferred Shares.

For federal income tax purposes, dividends paid to shareholders may be characterized as ordinary income, return of capital or capital gains. The characterization of the dividends declared on our common and preferred shares for 2014, 2013 and 2012 are as follows:
 
 
Common Shares
 
Preferred Shares
 
2014
 
2013
 
2012
 
2014
 
2013
 
2012(2)
Ordinary income(1)
72.42
%
 
13.53
%
 
—

 
100.00
%
 
100.00
%
 
19.83
%
Return of capital
27.58
%
 
86.47
%
 
100.00
%
 
—

 
—

 
27.27
%
Capital gains
—

 
—

 
—

 
—

 
—

 
52.90
%
 
(1) 
The dividends classified above as ordinary income do not represent “qualified dividend income” and, therefore, are not eligible for reduced rates.
(2) 
Figures are estimates.

(16) Noncontrolling Interests

(a) Noncontrolling Interests in the Operating Partnership

Noncontrolling interests relate to the common interests in the Operating Partnership not owned by us. Interests in the Operating Partnership are owned by limited partners who contributed buildings and other assets to the Operating Partnership in exchange for common Operating Partnership units. Limited partners have the right to tender their units for redemption in exchange for, at

118

our option, our common shares on a one-for-one basis or cash based on the fair value of our common shares at the date of redemption. Unitholders receive a distribution per unit equivalent to the dividend per common share. Differences between amounts paid to redeem noncontrolling interests and their carrying values are charged or credited to equity. As a result of the redemption feature of the Operating Partnership units, the noncontrolling interests are recorded outside of permanent equity.

Noncontrolling interests are presented at the greater of their fair value or their cost basis, which is comprised of their fair value at issuance, subsequently adjusted for the noncontrolling interests’ share of net income or losses available to common shareholders, other comprehensive income or losses, distributions received or additional contributions. We account for issuances of common Operating Partnership units individually, which could result in some portion of our noncontrolling interests being carried at fair value with the remainder being carried at historical cost. Based on the closing price of our common shares at December 31, 2014, the cost to acquire, through cash purchase or issuance of our common shares, all of the outstanding common Operating Partnership units not owned by us would be approximately $32.5 million. At December 31, 2014 and 2013, we recorded adjustments of $4.7 million and $3.3 million, respectively, to present certain common Operating Partnership units at the greater of their carrying value or redemption value.

We owned 95.7% of the outstanding common Operating Partnership units at both December 31, 2014 and 2013 and 95.2% at December 31, 2012.

At December 31, 2014, 2,630,577 of the total common Operating Partnership units, or 4.3%, were not owned by us. During the first quarter of 2014, we issued 3,125 common Operating Partnership units at a fair value of $40 thousand to the seller of 840 First Street, NE to satisfy our contingent consideration obligation related to the acquisition of the property. There were no common Operating Partnership units redeemed for common shares in either 2014 or 2013. During 2012, 322,302 common Operating Partnership units were redeemed for 322,302 common shares. During 2013, 6,718 common Operating Partnership units were redeemed with available cash. There were no common Operating Partnership units redeemed for cash in 2014 or 2012.

The redeemable noncontrolling interests in the Operating Partnership for the three years ended December 31 are as follows (amounts in thousands):
 
 
Redeemable
noncontrolling
interests
Balance at December 31, 2012
$
34,367

Net loss
(74
)
Changes in ownership, net
143

Distributions to owners
(1,557
)
Other comprehensive income
342

Balance at December 31, 2013
33,221

Net income
199

Changes in ownership, net
1,465

Distributions to owners
(1,578
)
Other comprehensive income
25

Balance at December 31, 2014
$
33,332


(b) Noncontrolling Interests in the Consolidated Partnerships

When we are deemed to have a controlling interest in a partially-owned entity, we will consolidate all of the entity’s assets, liabilities and operating results within our consolidated financial statements. The net assets contributed to the consolidated entity by the third party, if any, will be reflected within permanent equity in our consolidated balance sheets to the extent they are not mandatorily redeemable. The amount will be recorded based on the third party’s initial investment in the consolidated entity and will be adjusted to reflect the third party’s share of earnings or losses in the consolidated entity and any distributions received or additional contributions made by the third party. The earnings or losses from the entity attributable to the third party are recorded as a component of “Net (income) loss attributable to noncontrolling interests” in our consolidated statements of operations.

On August 4, 2011, we formed a joint venture, in which we have a 97% interest, with an affiliate of Perseus Realty, LLC to acquire Storey Park in our Washington, D.C. reporting segment. At the time, the site was leased to Greyhound, which subsequently

119

relocated its operations. Greyhound’s lease expired on August 31, 2013, at which time the property was placed into development. The joint venture anticipates developing a mixed-use project on the 1.6 acre site, which can accommodate up to 712,000 square feet. At December 31, 2014, our total investment in the development project was $55.4 million, which included the original cost basis of the property of $43.3 million. The majority of the costs in excess of the original cost basis relate to capitalized architectural fees and site preparation costs. We are currently exploring our options related to this property; however, until a definitive plan for the property has been reached and we begin significant development activities, we cannot determine the total cost of the project or the anticipated completion date.

On October 16, 2014, our 97% own consolidated joint venture repaid a $22.0 million loan that was subject to a 5.0% interest rate floor. The loan encumbered the Storey Park land which is located in Washington, D.C. Simultaneously with the repayment, the joint venture entered into a new $22.0 million loan with a variable-interest rate of LIBOR plus 2.50%.

In November 2010, we acquired two buildings (Redland II and III) at Redland Corporate Center in a joint venture with Perseus Realty, LLC (“Perseus”) and had a 97% controlling interest in the joint venture. On September 26, 2012, we placed a $68.4 million mortgage loan on Redland II and III. Our joint venture partner received their proportionate share of the proceeds from the mortgage loan. We used our share of the proceeds from the mortgage loan to repay a portion of the outstanding balance under the unsecured revolving credit facility. On November 8, 2013, we acquired the remaining interest in Redland II and III from Perseus for $4.6 million. At December 31, 2013, we eliminated the noncontrolling interests in the consolidated partnership and recorded the excess of cash paid over the noncontrolling interests as “Additional paid-in capital” in our consolidated balance sheets.

(17) Benefit Plans

(a) Share-Based Payments

We issued share-based payments in the form of stock options and non-vested shares as permitted in our 2003 Equity Compensation Plan (the “2003 Plan”), which was amended in 2005, 2007 and July 2013, and expired in September 2013. We have also issued share-based compensation in the form of stock options and non-vested shares as permitted in our 2009 Equity Compensation Plan (the “2009 Plan”), which was amended in 2010, 2011 and 2013. In 2011, we received shareholder approval to authorize an additional 4.5 million shares for issuance under the 2009 Plan. The compensation plans provide for the issuance of options to purchase common shares, share awards, share appreciation rights, performance units and other equity-based awards. Stock options granted under the plans are non-qualified, and all employees and non-employee trustees are eligible to receive grants. Under the terms of the amendment to the 2009 Plan, every stock option granted by us reduces the awards available for issuance on a one-for-one basis. However, for every restricted award issued, the awards available for issuance are reduced by 3.44 awards. At December 31, 2014, we had 7.4 million share equity awards authorized under the 2009 Plan and, of those awards, 2.8 million common share equity awards remained available for issuance by us.

We record costs related to our share-based compensation based on the grant-date fair value calculated in accordance with GAAP. We recognize share-based compensation costs on a straight-line basis over the requisite service period for each award and these costs are recorded within “General and administrative expense” or “Property operating expense” in our consolidated statements of operations based on the employee’s job function.

Stock Options Summary

As of December 31, 2014, 2.2 million stock options have been awarded of which 1.1 million stock options remained outstanding. During the first quarter of 2014, we issued 135,250 stock options to our non-officer employees. The stock options vest 25% on the first anniversary of the date of grant and 6.25% in each subsequent calendar quarter. The awards described above have a ten-year contractual life. We recognized $0.5 million of compensation expense associated with stock option awards for both years ended December 31, 2014 and 2013, and $0.6 million for the year ended December 31, 2012.


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A summary of our stock option activity for the three years ended December 31 is presented below:
 
Options
 
Weighted
Average
Exercise Price
 
Weighted Average
Remaining
Contractual Term
 
Aggregate
Intrinsic
Value
Outstanding at December 31, 2011
887,168

 
$
16.76

 
4.4 years
 
$
293,930

Granted
627,500

 
14.70

 
 
 
 
Exercised
(7,326
)
 
9.63

 
 
 
 
Forfeited
(123,336
)
 
16.25

 
 
 
 
Outstanding at December 31, 2012
1,384,006

 
15.91

 
5.9 years
 
$
174,763

Granted
124,250

 
12.73

 
 
 
 
Exercised
(14,733
)
 
11.05

 
 
 
 
Expired
(298,469
)
 
15.00

 
 
 
 
Forfeited
(105,762
)
 
16.17

 
 
 
 
Outstanding at December 31, 2013
1,089,292

 
15.83

 
6.6 years
 
$
109,151

Granted
135,250

 
11.61

 
 
 
 
Exercised
(17,171
)
 
10.10

 
 
 
 
Expired
(57,500
)
 
19.08

 
 
 
 
Forfeited
(98,512
)
 
14.49

 
 
 
 
Outstanding at December 31, 2014
1,051,359

 
$
15.33

 
6.3 years
 
$
181,352

Exercisable at December 31:
 
 
 
 
 
 
 
2014
552,620

 
$
16.49

 
5.1 years
 
$
102,039

2013
521,723

 
17.25

 
4.9 years
 
109,151

2012
693,854

 
17.01

 
2.9 years
 
162,593

Options expected to vest, subsequent to December 31, 2014
485,733

 
$
14.11

 
7.5 years
 
$
71,358


The following table summarizes information about our stock options at December 31, 2014:
 
 
 
Options Outstanding
 
Options Exercisable
Year
Issued
Range of
Exercise Prices
 
Options
 
Weighted Average
Remaining
Contractual Life
 
Weighted
Average
Exercise Price
 
Options
 
Weighted
Average
Exercise Price
2005
 $22.42 - 22.54

 
59,000

 
0.0 years
 
$
22.44

 
59,000

 
$
22.44

2006
26.6

 
17,350

 
1.0 year
 
26.60

 
17,350

 
26.60

2007
 29.11 - 29.24

 
31,500

 
2.0 years
 
29.13

 
31,500

 
29.13

2008
17.29

 
39,000

 
3.0 years
 
17.29

 
39,000

 
17.29

2009
9.30

 
33,346

 
4.0 years
 
9.30

 
33,346

 
9.30

2010
12.57

 
42,705

 
5.0 years
 
12.57

 
42,705

 
12.57

2011
 15.17 - 17.12

 
77,188

 
6.1 years
 
16.36

 
72,664

 
16.37

2012
 13.54 - 15.00

 
566,533

 
7.0 years
 
14.83

 
219,678

 
14.68

2013
12.73

 
78,987

 
8.0 years
 
12.73

 
37,377

 
12.73

2014
11.61

 
105,750

 
9.0 years
 
11.61

 
—

 
—

 
 
 
1,051,359

 
6.3 years
 
15.33

 
552,620

 
16.49


As of December 31, 2014, we had $1.4 million of unrecognized compensation cost, net of estimated forfeitures, related to stock option awards. We anticipate this cost will be recognized over a weighted-average period of approximately 4.2 years. We calculate the grant date fair value of option awards using a Black-Scholes option-pricing model. Expected volatility is based on an assessment of our realized volatility over the preceding period that is equivalent to the award’s expected life, which in our opinion, gives an accurate indication of future volatility. The expected term represents the period of time the options are anticipated to remain outstanding as well as our historical experience for groupings of employees that have similar behavior and are considered separately for valuation purposes. The risk-free rate is based on the U.S. Treasury rate at the time of grant for instruments of similar term.

121

The weighted average assumptions used in the fair value determination of stock options granted to employees for the years ended December 31 are summarized as follows:
 
 
2014
 
2013
 
2012
Risk-free interest rate
1.72
%
 
0.76
%
 
1.28
%
Expected volatility
39.0
%
 
49.7
%
 
45.6
%
Expected dividend yield
4.66
%
 
4.92
%
 
5.71
%
Weighted average expected life of options
5.0 years

 
5.0 years

 
6.6 years


The weighted average grant date fair value of the stock options issued in 2014, 2013 and 2012 was $2.67, $3.61 and $3.27, respectively.

Option Exercises

We received $174 thousand, $163 thousand and $71 thousand from the exercise of stock options during 2014, 2013 and 2012, respectively. Shares issued as a result of stock option exercises are provided by the issuance of new shares. The total intrinsic value of options exercised was $43 thousand in both 2014 and 2013, and $25 thousand in 2012.

Non-Vested Share Awards

We issue non-vested common share awards that either vest over a specific time period that is identified at the time of issuance or vest upon the achievement of specific performance goals that are identified at the time of issuance. We issue new common shares, subject to restrictions, upon each grant of non-vested common share awards. In February 2014, we granted a total of 103,075 non-vested common shares in two separate awards to our officers. The first award of 91,466 non-vested common shares, which was granted to all of our officers, will vest ratably on the date of issuance over a three-year term. The second award of 11,609 non-vested common shares was granted to our Chief Executive Officer and vested on February 19, 2015, one year after issuance. In addition, we granted a total of 31,808 non-vested common shares in two separate awards to two new executive officers in connection with each of their respective appointments in 2014. The first award of 15,128 non-vested common shares was granted to our new Chief Operating Officer in June 2014 and the second award of 16,680 non-vested common shares was granted to our new General Counsel in October 2014. Both common share awards will vest ratably on an annual basis over a three-year period from the date of grant.
 
We recognized $2.8 million, $3.5 million and $2.6 million of compensation expense associated with our non-vested common share awards in 2014, 2013 and 2012, respectively. Compensation expense associated with our non-vested common shares during 2013 and 2012 included $1.2 million and $0.7 million, respectively, of expense related to the accelerated vesting of the restricted shares associated with the departure of our former officers. Dividends on all non-vested common share awards are recorded as a reduction of equity. We apply the two-class method for determining EPS as our outstanding non-vested common shares with non-forfeitable dividend rights are considered participating securities. Our excess of dividends over earnings related to participating securities are shown as a reduction in net income or loss attributable to common shareholders in our computation of EPS.

Independent members of our Board of Trustees received annual grants of restricted common shares as a component of compensation for serving on our Board of Trustees. In May 2014, we granted 29,792 non-vested common shares to our non-employee trustees, all of which will vest on the earlier of the first anniversary of the grant date or the date of our 2015 annual meetings of our shareholders, subject to continued service by the trustee until that date. We recognized $0.4 million of compensation expense associated with trustee restricted share awards for both the years ended December 31, 2014 and 2013, and $0.3 million for the year ended December 2012.

A summary of our non-vested common share awards at December 31, 2014 is as follows:
 

122

 
Non-vested
Shares
 
Weighted Average
Grant Date
Fair Value
Non-vested at December 31, 2011
748,968

 
$
12.67

Granted
355,612

 
13.87

Vested
(309,605
)
 
13.52

Expired
(61,944
)
 
11.36

Forfeited
(59,203
)
 
15.03

Non-vested at December 31, 2012
673,828

 
12.83

Granted
313,086

 
12.14

Vested
(297,778
)
 
12.89

Expired
(45,049
)
 
11.42

Forfeited
(6,425
)
 
14.01

Non-vested at December 31, 2013
637,662

 
13.33

Granted
164,675

 
12.84

Vested
(137,924
)
 
14.21

Expired
(29,514
)
 
10.21

Forfeited
(11,478
)
 
13.04

Non-vested at December 31, 2014
623,421

 
$
13.16


As of December 31, 2014, we had $3.9 million of unrecognized compensation cost related to non-vested common shares. We anticipate this cost will be recognized over a weighted-average period of 2.2 years.

We value our non-vested time-based awards issued in 2014, 2013 and 2012 at the grant date fair value, which is the market price of our common shares. For the non-vested performance-based share awards issued in 2013, we used a Monte Carlo Simulation (risk-neutral approach) to determine the number of shares that may be issued pursuant to the award. The risk-free interest rate assumptions used in the Monte Carlo Simulation were determined based on the zero coupon risk-free rate for the time frame of 0.25 years to 3.0 years, which ranged from 0.11% to 0.4%, respectively. The volatility used for our common share price in the Monte Carlo Simulation varied between 24.31% and 29.11%. We did not issue any non-vested performance-based awards in 2014 or 2012.

The weighted average grant date fair value of the shares issued in 2014, 2013 and 2012 were $12.84, $12.14 and $13.87, respectively. The total fair value of shares vested were $2.0 million, $3.8 million and $4.2 million at December 31, 2014, 2013 and 2012, respectively. We issue new shares, subject to restrictions, upon each grant of non-vested common share awards.

(b) 401(k) Plan

We have a 401(k) defined contribution plan covering all employees in accordance with the Internal Revenue Code. The maximum employer or employee contribution cannot exceed the IRS limits for the plan year. In 2014, we amended the eligibility requirements of the plan, allowing employees to contribute after 60 days of consecutive service. Employee contributions vest immediately. Employer contributions begin one year after the employee's start of service and vest ratably over four years. For the three years ended December 31, 2014, 2013 and 2012, we matched up to 6% of each employee’s contributions. We pay for administrative expenses and matching contributions with available cash. Our plan does not allow for us to make additional discretionary contributions. Our contributions were $0.6 million for both the years ended December 31, 2014 and 2013, and $0.5 million for the year ended December 31, 2012. The employer match payable to the 401(k) plan was fully funded as of December 31, 2014.


123

(c) Employee Share Purchase Plan

In 2009, our common shareholders approved the First Potomac Realty Trust 2009 Employee Share Purchase Plan (“the Plan”). The Plan allows participating employees to acquire our common shares, at a discounted price, through payroll deductions or cash contributions. Under the Plan, a total of 200,000 common shares may be issued and the offering periods of the Plan will not exceed five years. Each offering period will commence on the first day of each calendar quarter (offering date) and will end on the last business day of the calendar quarter (purchase date) in which the offering period commenced. The purchase price at which common shares will be sold in any offering period will be the lower of: a) 85 percent of the fair value of common shares on the offering date or b) 85 percent of the fair value of the common shares on the purchase date. The first offering period began during the fourth quarter of 2009. We issued common shares of 8,950, 11,007 and 14,470 under the Plan during the years ended December 31, 2014, 2013 and 2012, respectively, which resulted in compensation expense totaling $20 thousand, $26 thousand and $42 thousand, respectively.

(18) Segment Information

Our reportable segments consist of four distinct reporting and operational segments within the greater Washington, D.C. region in which we operate: Washington, D.C., Maryland, Northern Virginia and Southern Virginia. We evaluate the performance of our segments based on the operating results of the properties located within each segment, which excludes large non-recurring gains and losses, gains or losses from sale of rental property, interest expense, general and administrative costs, acquisition costs or any other indirect corporate expense to the segments. In addition, the segments do not have significant non-cash items other than straight-line and deferred market rent amortization reported in their operating results. There are no inter-segment sales or transfers recorded between segments.




124

The results of operations for our four reporting segments for the three years ended December 31 are as follows (dollars in thousands):
 
 
2014
 
Washington, D.C.
 
Maryland
 
Northern Virginia
 
Southern Virginia
 
Consolidated
Number of buildings(1)
6

 
38

 
49

 
38

 
131

Square feet(1)
917,008

 
1,999,332

 
3,021,509

 
2,852,298

 
8,790,147

Total revenues
$
33,959

  
$
45,767

 
$
53,645

 
$
28,281

 
$
161,652

Property operating expense
(9,683
)
 
(11,482
)
 
(13,352
)
 
(8,735
)
 
(43,252
)
Real estate taxes and insurance
(5,583
)
 
(3,907
)
 
(5,592
)
 
(2,278
)
 
(17,360
)
Total property operating income
$
18,693

  
$
30,378

 
$
34,701

 
$
17,268

 
101,040

Depreciation and amortization expense

 

 

 

 
(61,796
)
General and administrative

 

 

 

 
(21,156
)
Acquisition costs

 

 

 

 
(2,681
)
Impairment of rental property

 

 

 

 
(3,956
)
Other income

 

 

 

 
4,108

Income from discontinued operations

 

 

 

 
1,484

Net income

 

 

 

 
$
17,043

Total assets(2)(3)
$
505,842

  
$
360,470

 
$
439,833

 
$
228,306

 
$
1,618,460

Capital expenditures(4)
$
23,422

  
$
10,185

 
$
7,816

 
$
8,436

 
$
50,789


 
2013
 
Washington, D.C.
 
Maryland
 
Northern Virginia
 
Southern Virginia
 
Consolidated
Number of buildings(1)(5)
4

 
53

 
51

 
38

 
146

Square feet(1)(5)
522,605

 
2,638,988

 
3,086,057

 
2,852,471

 
9,100,121

Total revenues
$
28,208

  
$
41,735

 
$
51,787

 
$
27,085

 
$
148,815

Property operating expense
(6,693
)
 
(10,579
)
 
(12,601
)
 
(8,407
)
 
(38,280
)
Real estate taxes and insurance
(4,792
)
 
(3,436
)
 
(5,679
)
 
(2,167
)
 
(16,074
)
Total property operating income
$
16,723

  
$
27,720

 
$
33,507

 
$
16,511

 
94,461

Depreciation and amortization expense

 

 

 

 
(54,567
)
General and administrative

 

 

 

 
(21,979
)
Acquisition costs

 

 

 

 
(602
)
Contingent consideration related to acquisition of property

 

 

 

 
213

Other expenses

 

 

 

 
(28,287
)
Income from discontinued operations

 

 

 

 
21,742

Net income

 

 

 

 
10,981

Total assets(2)(3)
$
344,739

  
$
430,498

 
$
423,839

 
$
230,175

 
$
1,502,460

Capital expenditures(4)
$
26,910

  
$
16,216

 
$
13,685

 
$
10,106

 
$
68,002

 

125

 
2012
 
Washington, D.C.
 
Maryland
 
Northern Virginia
 
Southern Virginia
 
Consolidated
Number of buildings(6)
3

 
62

 
56

 
57

 
178

Square feet(6)
531,714

 
3,781,379

 
3,654,527

 
5,483,781

 
13,451,401

Total revenues
$
27,718

 
$
41,726

 
$
47,207

 
$
26,311

 
$
142,962

Property operating expense
(5,298
)
 
(9,862
)
 
(11,519
)
 
(7,643
)
 
(34,322
)
Real estate taxes and insurance
(3,876
)
 
(3,170
)
 
(5,020
)
 
(2,119
)
 
(14,185
)
Total property operating income
$
18,544

  
$
28,694

 
$
30,668

 
$
16,549

 
94,455

Depreciation and amortization expense

 

 

 

 
(51,457
)
General and administrative

 

 

 

 
(23,568
)
Acquisition costs

 

 

 

 
(49
)
Contingent consideration related to acquisition of property

 

 

 

 
(152
)
Impairment of rental property
 
 
 
 
 
 
 
 
(2,444
)
Other expenses

 

 

 

 
(45,251
)
Benefit from income taxes

 

 

 

 
4,142

Income from discontinued operations

 

 

 

 
15,943

Net loss

 

 

 

 
$
(8,381
)
Total assets(2)(3)
$
321,875

  
$
493,267

 
$
462,667

 
$
364,514

 
$
1,717,748

Capital expenditures(4)
$
12,023

  
$
23,163

 
$
20,959

 
$
12,897

 
$
70,486

 
(1) 
Excludes Storey Park from our Washington, D.C. reporting segment, which was placed in development in the third quarter of 2013.
(2) 
Total assets include our investment in properties that are owned through joint ventures that are not consolidated within our consolidated financial statements. For more information on our unconsolidated investments, including location within our reportable segments, see note 6, Investment in Affiliates.
(3) 
Corporate assets not allocated to any of our reportable segments totaled $84,009, $73,209 and $75,425 at December 31, 2014, 2013 and 2012, respectively.
(4) 
Capital expenditures for corporate assets not allocated to any of our reportable segments totaled $930, $1,085 and $1,444 at December 31, 2014, 2013 and 2012, respectively.
(5) 
Includes occupied space at 440 First Street, NW in our Washington, D.C. reporting segment, which was substantially completed in the third quarter of 2013. In 2014, the property was placed in service.
(6) 
Our Washington, D.C. reporting segment excludes 440 First Street, NW, which was in redevelopment during 2012.


126

(19) Quarterly Financial Information (unaudited)
 
 
2014(1)
 
First
 
Second
 
Third
 
Fourth
(amounts in thousands, except per share amounts)
Quarter
 
Quarter
 
Quarter
 
Quarter
Revenues
$
39,363

 
$
39,307

 
$
40,055

 
$
42,928

Operating expenses
35,744

 
39,579

 
36,283

 
38,595

Operating income (loss)
3,619

 
(272
)
 
3,772

 
4,333

(Loss) income from continuing operations
(586
)
 
16,796

 
(248
)
 
(402
)
(Loss) income from discontinued operations
(857
)
 
1,538

 
297

 
505

Less: Net loss (income) attributable to noncontrolling interests
195

 
(652
)
 
131

 
128

Net (loss) income attributable to First Potomac Realty Trust
(1,248
)
 
17,682

 
180

 
231

Less: Dividends on preferred shares
(3,100
)
 
(3,100
)
 
(3,100
)
 
(3,100
)
Net (loss) income attributable to common shareholders
$
(4,348
)
 
$
14,582

 
$
(2,920
)
 
$
(2,869
)
Basic and diluted earnings per common share:
 
 
 
 
 
 
 
(Loss) income from continuing operations
$
(0.07
)
 
$
0.22

 
$
(0.05
)
 
$
(0.06
)
(Loss) income from discontinued operations
(0.01
)
 
0.03

 
—

 
0.01

Net (loss) income
$
(0.08
)
 
$
0.25

 
$
(0.05
)
 
$
(0.05
)
 
 
2013(1)
 
First
 
Second
 
Third
 
Fourth
(amounts in thousands, except per share amounts)
Quarter
 
Quarter
 
Quarter
 
Quarter
Revenues
$
37,179

 
$
36,915

 
$
37,206

 
$
37,517

Operating expenses
32,508

 
31,221

 
33,663

 
33,899

Operating income
4,671

 
5,694

 
3,543

 
3,618

Loss from continuing operations
(3,638
)
 
(2,192
)
 
(2,509
)
 
(2,421
)
Income (loss) from discontinued operations
5,601

 
16,668

 
792

 
(1,320
)
Less: Net loss (income) attributable to noncontrolling interests
59

 
(466
)
 
211

 
288

Net income (loss) attributable to First Potomac Realty Trust
2,022

 
14,010

 
(1,506
)
 
(3,453
)
Less: Dividends on preferred shares
(3,100
)
 
(3,100
)
 
(3,100
)
 
(3,100
)
Net (loss) income attributable to common shareholders
$
(1,078
)
 
$
10,910

 
$
(4,606
)
 
$
(6,553
)
Basic and diluted earnings per common share:
 
 
 
 
 
 
 
Loss from continuing operations
$
(0.13
)
 
$
(0.10
)
 
$
(0.09
)
 
$
(0.09
)
Income (loss) from discontinued operations
0.11

 
0.30

 
0.01

 
(0.02
)
Net (loss) income
$
(0.02
)
 
$
0.20

 
$
(0.08
)
 
$
(0.11
)
 
(1) 
These figures are rounded to the nearest thousand, which may impact cross-footing in reconciling to full year totals.

We did not sell any common shares in 2014 and sold 7.5 million common shares in 2013. The sum of the basic and diluted earnings per common share for the four quarters in the periods presented differs from the annual earnings per common share calculation due to the required method of computing the weighted average number of common shares in the respective periods.


127

SCHEDULE III
FIRST POTOMAC REALTY TRUST
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2014
(Amounts in thousands)
Property
Location(1)
 
Date Acquired
 
Property Type(2)
 
Encumbrances at
December 31, 2014(3)
Maryland
 
 
 
 
 
 
 
Rumsey Center
Columbia
 
Oct 2002
 
BP
 
$
8,160

Snowden Center
Columbia
 
Oct 2002
 
BP
 
11,081

Metro Park North
Rockville
 
Dec 2004
 
Office
 
—

Gateway 270 West
Clarksburg
 
Jul 2006
 
BP
 
—

Indian Creek Court
Beltsville
 
Aug 2006
 
BP
 
—

Ammendale Commerce Center
Beltsville
 
Mar 2007
 
BP
 
—

Annapolis Business Center
Annapolis
 
Jun 2007
 
Office
 
—

Cloverleaf Center
Germantown
 
Oct 2009
 
Office
 
—

Redland Corporate Center Buildings II & III
Rockville
 
Nov 2010
 
Office
 
65,816

TenThreeTwenty
Columbia
 
Feb 2011
 
Office
 
—

Hillside I and II
Columbia
 
Nov 2011
 
Office
 
12,949

540 Gaither Road (Redland I)
Rockville
 
Oct 2013
 
Office
 
—

Total Maryland
 
 
 
 
 
 
98,006

Washington, D.C.
 
 
 
 
 
 
 
500 First Street, NW
Capitol Hill
 
Jun 2010
 
Office
 
—

440 First Street, NW
Capitol Hill
 
Dec 2010
 
Office
 
32,216

1211 Connecticut Ave, NW
CBD
 
Dec 2010
 
Office
 
29,691

840 First Street, NE
NoMA
 
Mar 2011
 
Office
 
36,539

Storey Park
NoMA
 
Aug 2011
 
Office
 
22,000

1401 K Street, NW
East End
 
Apr 2014
 
Office
 
36,861

11 Dupont Circle, NW
CBD
 
Sep 2014
 
Office
 
—

Total Washington, D.C.
 
 
 
 
 
 
157,307

Northern Virginia
 
 
 
 
 
 
 
Plaza 500
Alexandria
 
Dec 1997
 
I
 
30,277

Van Buren Office Park
Herndon
 
Dec 1997
 
Office
 
6,790

Newington Business Park Center
Lorton
 
Dec 1999
 
I
 
—

Herndon Corporate Center
Herndon
 
Apr 2004
 
Office
 
—

Windsor at Battlefield
Manassas
 
Dec 2004
 
Office
 
—

Reston Business Campus
Reston
 
Mar 2005
 
Office
 
—

Enterprise Center
Chantilly
 
Apr 2005
 
Office
 
—

Gateway Centre Manassas
Manassas
 
Jul 2005
 
BP
 
432

403/405 Glenn Drive
Sterling
 
Oct 2005
 
BP
 
—

Linden Business Center
Manassas
 
Oct 2005
 
BP
 
—

Prosperity Business Center
Merrifield
 
Nov 2005
 
BP
 
—

Sterling Park Business Center
Sterling
 
Feb 2006
 
BP
 
—

Davis Drive
Sterling
 
Aug 2006
 
BP
 
—

Three Flint Hill
Oakton
 
Dec 2009
 
Office
 
—

Atlantic Corporate Park
Sterling
 
Apr 2010
 
Office
 
—

Cedar Hill
Tyson’s Corner
 
Nov 2010
 
Office
 
—

One Fair Oaks
Fairfax
 
Feb 2011
 
Office
 
—

1775 Wiehle Avenue
Reston
 
Apr 2011
 
Office
 
—

Total Northern Virginia
 
 
 
 
 
 
37,499

Southern Virginia
 
 
 
 
 
 
 

128

Property
Location(1)
 
Date Acquired
 
Property Type(2)
 
Encumbrances at
December 31, 2014(3)
Crossways Commerce Center
Chesapeake
 
Dec 1999
 
BP
 
—

Greenbrier Technology Center II
Chesapeake
 
Oct 2002
 
BP
 
4,452

Norfolk Business Center
Norfolk
 
Oct 2002
 
BP
 
4,183

Crossways II
Chesapeake
 
Oct 2004
 
BP
 
—

Norfolk Commerce Park II
Norfolk
 
Oct 2004
 
BP
 
—

1434 Crossways Boulevard
Chesapeake
 
Aug 2005
 
BP
 
—

Crossways I
Chesapeake
 
Feb 2006
 
BP
 
—

Crossways Commerce Center IV
Chesapeake
 
May 2006
 
BP
 
—

Gateway II
Norfolk
 
Nov 2006
 
BP
 
—

Greenbrier Circle Corporate Center
Chesapeake
 
Jan 2007
 
BP
 
—

Greenbrier Technology Center I
Chesapeake
 
Jan 2007
 
BP
 
—

Battlefield Corporate Center
Chesapeake
 
Oct 2010
 
BP
 
3,692

Greenbrier Towers
Chesapeake
 
Jul 2011
 
Office
 
—

Total Southern Virginia
 
 
 
 
 
 
12,327

Land held for future development
 
 
 
 
 
 
—

Other
 
 
 
 
 
 
—

Total Consolidated Portfolio
 
 
 
 
 
 
$
305,139


129

Initial Costs
 
Gross Amount at End of Year
Land
 
Building and
Improvements
 
Since Acquisition(4)
 
Land
 
Building and
Improvements
 
Total
 
Accumulated
Depreciation
$
2,675

 
$
10,196

 
$
3,705

 
$
2,675

 
$
13,901

 
$
16,576

 
$
5,502

3,404

 
12,824

 
4,238

 
3,404

 
17,062

 
20,466

 
6,165

9,220

 
32,056

 
2,997

 
9,220

 
35,053

 
44,273

 
8,671

18,302

 
20,562

 
5,708

 
18,302

 
26,270

 
44,572

 
5,850

5,673

 
17,168

 
12,862

 
5,673

 
30,030

 
35,703

 
7,563

2,398

 
7,659

 
6,116

 
2,398

 
13,775

 
16,173

 
5,805

6,101

 
12,602

 
469

 
6,101

 
13,071

 
19,172

 
2,469

7,097

 
14,211

 
433

 
7,097

 
14,644

 
21,741

 
2,322

17,272

 
63,480

 
13,869

 
17,272

 
77,349

 
94,621

 
12,014

2,041

 
5,327

 
11,894

 
2,041

 
17,221

 
19,262

 
2,209

3,302

 
10,926

 
968

 
3,302

 
11,894

 
15,196

 
827

6,458

 
19,831

 
94

 
6,457

 
19,926

 
26,383

 
1,271

83,943

 
226,842

 
63,353

 
83,942

 
290,196

 
374,138

 
60,668

25,806

 
33,883

 
410

 
25,806

 
34,293

 
60,099

 
4,918

—

 
15,300

 
45,601

 
9,118

 
51,783

 
60,901

 
913

27,077

 
17,520

 
9,734

 
27,077

 
27,254

 
54,331

 
2,286

16,846

 
60,905

 
11,020

 
16,846

 
71,925

 
88,771

 
7,715

43,672

 
4,194

 
7,578

 
—

 
55,444

 
55,444

 
—

29,506

 
23,269

 
(105
)
 
29,506

 
23,165

 
52,671

 
987

15,744

 
64,832

 
3,381

 
15,744

 
68,214

 
83,958

 
588

158,651

 
219,903

 
77,619

 
124,097

 
332,078

 
456,175

 
17,407

6,265

 
35,433

 
6,499

 
6,268

 
41,929

 
48,197

 
17,897

3,592

 
7,652

 
5,446

 
3,607

 
13,083

 
16,690

 
5,084

3,135

 
10,354

 
4,094

 
3,135

 
14,448

 
17,583

 
5,798

4,082

 
14,651

 
1,666

 
4,082

 
16,317

 
20,399

 
4,670

3,228

 
11,696

 
3,444

 
3,228

 
15,140

 
18,368

 
5,384

1,996

 
8,778

 
3,501

 
1,996

 
12,279

 
14,275

 
2,961

3,727

 
27,274

 
4,221

 
3,728

 
31,494

 
35,222

 
8,992

3,015

 
6,734

 
1,524

 
3,015

 
8,258

 
11,273

 
2,406

3,940

 
12,547

 
4,371

 
3,940

 
16,918

 
20,858

 
4,716

4,829

 
10,978

 
1,233

 
4,829

 
12,211

 
17,040

 
3,258

5,881

 
3,495

 
667

 
5,881

 
4,162

 
10,043

 
1,118

19,897

 
10,750

 
20,600

 
15,614

 
35,633

 
51,247

 
6,728

1,614

 
3,611

 
3,402

 
1,646

 
6,981

 
8,627

 
1,610

—

 
13,653

 
24,459

 
4,181

 
33,931

 
38,112

 
5,092

5,895

 
11,655

 
13,495

 
5,895

 
25,150

 
31,045

 
3,451

5,306

 
13,554

 
3,173

 
5,306

 
16,727

 
22,033

 
2,688

5,688

 
43,176

 
6,332

 
5,688

 
49,508

 
55,196

 
7,098

3,542

 
30,575

 
—

 
3,542

 
30,575

 
34,117

 
687

85,632

 
276,566

 
108,127

 
85,581

 
384,744

 
470,325

 
89,638

5,160

 
23,660

 
13,517

 
5,160

 
37,177

 
42,337

 
14,030

1,365

 
5,119

 
1,042

 
1,365

 
6,161

 
7,526

 
2,195

1,323

 
4,967

 
952

 
1,324

 
5,918

 
7,242

 
2,186

1,036

 
6,254

 
1,165

 
1,036

 
7,419

 
8,455

 
2,182

1,221

 
8,693

 
4,364

 
1,221

 
13,057

 
14,278

 
4,123

4,447

 
24,739

 
3,211

 
4,815

 
27,582

 
32,397

 
6,457

2,657

 
11,597

 
2,810

 
2,646

 
14,418

 
17,064

 
3,647


130

Initial Costs
 
Gross Amount at End of Year
Land
 
Building and
Improvements
 
Since Acquisition(4)
 
Land
 
Building and
Improvements
 
Total
 
Accumulated
Depreciation
1,292

 
3,899

 
700

 
1,292

 
4,599

 
5,891

 
1,390

1,320

 
2,293

 
818

 
1,320

 
3,111

 
4,431

 
801

4,164

 
18,984

 
4,101

 
4,164

 
23,085

 
27,249

 
5,375

2,024

 
7,960

 
1,703

 
2,024

 
9,663

 
11,687

 
2,614

1,860

 
6,071

 
786

 
1,881

 
6,836

 
8,717

 
926

2,997

 
9,173

 
3,849

 
2,997

 
13,022

 
16,019

 
1,775

30,866

 
133,409

 
39,018

 
31,245

 
172,048

 
203,293

 
47,701

343

 
—

 
371

 
349

 
—

 
349

 
—

—

 
—

 
92

 
—

 
92

 
92

 
85

$
359,435

 
$
856,720

 
$
288,580

 
$
325,214

 
$
1,179,158

 
$
1,504,372

 
$
215,499

 
(1) 
CBD=Central Business District; NoMA=North of Massachusetts Avenue
(2) 
I=Industrial; BP=Business Park
(3) 
Includes the unamortized fair value adjustments recorded at acquisition upon the assumption of mortgage loans.
(4) 
We placed Storey Park into development on September 1, 2013. At December 31, 2014, the land and building assets associated with Storey Park are included in construction in progress, which is reflected in Building and Improvements in the above table.

Depreciation of rental property is computed on a straight-line basis over the estimated useful lives of the assets. The estimated lives of our assets range from 5 to 39 years or to the term of the underlying lease. The tax basis of our rental property assets was $1,576 million and $1,667 million at December 31, 2014 and 2013, respectively.

















131

(a) Reconciliation of Real Estate(1) 

The following table reconciles the rental property investments for the years ended December 31 (amounts in thousands):
 
 
2014
 
2013
 
2012
Beginning balance
$
1,330,180

 
$
1,605,722

 
$
1,553,802

Acquisitions of rental property(2)
170,823

 
26,289

 
—

Capital expenditures(3)
49,860

 
66,808

 
69,042

Impairments
(3,956
)
 
(4,069
)
 
(3,401
)
Dispositions of rental property
(30,916
)
 
(290,777
)
 
(10,963
)
Assets held-for-sale
(643
)
 
(55,767
)
 
(1,183
)
Other(4)
(10,976
)
 
(18,026
)
 
(1,575
)
Ending balance
$
1,504,372

 
$
1,330,180

 
$
1,605,722


(b) Reconciliation of Accumulated Depreciation(1) 

The following table reconciles the accumulated depreciation on the rental property investments for the years ended December 31 (amounts in thousands):
 
 
2014
 
2013
 
2012
Beginning balance
$
185,725

 
$
215,154

 
$
175,083

Depreciation of rental property
47,625

 
48,638

 
49,333

Assets held-for-sale
(1,631
)
 
(13,470
)
 
(2,014
)
Dispositions of rental property
(5,712
)
 
(54,377
)
 
(2,173
)
Other(4)
(10,508
)
 
(10,220
)
 
(5,075
)
Ending balance
$
215,499

 
$
185,725

 
$
215,154

 
(1) 
Effective as of February 9, 2015, we entered into a binding contract to sell our Richmond, Virginia portfolio for sale, which is located in our Southern Virginia reporting segment. The Richmond Portfolio consists of Chesterfield Business Center, Hanover Business Center, Park Central, Virginia Technology Center and a three-acre parcel of undeveloped land. We anticipate closing the sale in the first half of 2015. However, we can provide no assurances regarding the timing or pricing of the sale of the Richmond Portfolio, or that the sale will occur at all. With the sale of our Richmond Portfolio, we will no longer own any properties in the Richmond, Virginia area and will have strategically exited the Richmond market. As such, in accordance with ASU 2014-08, our Richmond Portfolio was classified as held-for-sale at December 31, 2014 and the assets and liabilities of the Richmond Portfolio are reflected within "Assets held-for-sale" and "Liabilities held-for-sale," respectively, in our consolidated balance sheets for each of the periods presented. The rental property and applicable accumulated depreciation related to the Richmond Portfolio have been removed from all years presented in this table.
(2) 
For more information on our acquisitions, including the assumption of liabilities and other non-cash items, see the supplemental disclosure of cash flow information accompanying our consolidated statements of cash flows.
(3) 
Represents cash paid for capital expenditures.
(4) 
Includes accrued increases to rental property investments, fully depreciated assets that were written-off during the year and other immaterial transactions.



132

Exhibit Index

Exhibit
Description of Document
3.1
First Amended and Restated Declaration of Trust of the Company (Incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-11 (Registration No. 333-107172) filed on October 1, 2003).
3.2
Articles Supplementary designating the Company’s 7.750% Series A Cumulative Redeemable Perpetual Preferred Shares, liquidation preference $25.00 per share, par value $0.001 per share (Incorporated by reference to Exhibit 3.2 to the Company’s Registration Statement on Form 8-A filed on January 18, 2011 (File No. 001-31824)).
3.3
Articles Supplementary establishing additional shares of the Company’s 7.750% Series A Cumulative Redeemable Perpetual Preferred Shares, liquidation preference $25.00 per share, par value $0.001 per share (Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on March 14, 2012 (File No. 001-31824)).
3.4
Amended and Restated Bylaws of the Company (Incorporated by reference to Exhibit 3.2 to the Company’s Registration Statement on Form S-11 (Registration No. 333-107172) filed on October 1, 2003).
4.1
Form of share certificate evidencing the Company’s Common Shares (Incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-3 (Registration No. 333-120821) filed on November 30, 2004).
4.2
Form of share certificate evidencing the Company’s 7.750% Series A Cumulative Redeemable Perpetual Preferred Shares, liquidation preference $25.00 per share, par value $0.001 per share (Incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form 8-A filed on January 18, 2011 (File No. 001-31824)).
10.1
Amended and Restated Limited Partnership Agreement of First Potomac Realty Investment Limited Partnership dated September 15, 2003 (Incorporated by reference to Exhibit 3.3 to the Company’s Registration Statement on Form S-11 (Registration No. 333-107172) filed on October 1, 2003).
10.2
Amendment No. 13 to Amended and Restated Limited Partnership Agreement of First Potomac Realty Investment Limited Partnership dated January 18, 2011 (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on January 19, 2011(File No. 001-31824)).
10.3
Amendment No. 14 to Amended and Restated Limited Partnership Agreement of First Potomac Realty Investment Limited Partnership dated March 24, 2011 (Incorporated by reference to Exhibit 4.3 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2011 (File No. 001-31824)).
10.4
Amendment No. 15 to Amended and Restated Limited Partnership Agreement of First Potomac Realty Investment Limited Partnership dated March 25, 2011 (Incorporated by reference to Exhibit 4.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2012 (File No. 001-31824)).
10.5
Amendment No. 16 to Amended and Restated Limited Partnership Agreement of First Potomac Realty Investment Limited Partnership dated March 25, 2011 (Incorporated by reference to Exhibit 4.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2012 (File No. 001-31824)).
10.6
Amendment No. 17 to Amended and Restated Limited Partnership Agreement of First Potomac Realty Investment Limited Partnership dated January 6, 2012 (Incorporated by reference to Exhibit 4.3 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2012 (File No. 001-31824)).
10.7
Amendment No. 18 to Amended and Restated Limited Partnership Agreement of First Potomac Realty Investment Limited Partnership dated March 14, 2012 (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on March 14, 2012 (File No. 001-31824)).
10.8†
Employment Agreement, dated October 8, 2003, by and between Douglas J. Donatelli and First Potomac Realty Investment Limited Partnership (Incorporated by reference to Exhibit 10.19 to the Company’s Registration Statement on Form S-11 (Registration No. 333-107172) filed on October 14, 2003).
10.9†
Employment Agreement, dated October 8, 2003, by and between Nicholas R. Smith and First Potomac Realty Investment Limited Partnership (Incorporated by reference to Exhibit 10.20 to the Company’s Registration Statement on Form S-11 (Registration No. 333-107172) filed on October 14, 2003).
10.10†
Amendment to Employment Agreement, dated December 19, 2008, by and between Douglas J. Donatelli and First Potomac Realty Investment Limited Partnership (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed on December 24, 2008 (File No. 001-31824)).
10.11†
Employment Term Sheet and Statement of Severance Benefits, dated September 16, 2014, by and between Samantha Sacks Gallagher and First Potomac Realty Trust (Incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2014 (File No. 001-31824)).
10.12†
Employment Term Sheet, dated August 23, 2012, by and between Andrew Blocher and the Company (Incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2012 (File No. 001-31824)).

133

10.13†
Employment Term Sheet and Statement of Severance Benefits, dated May 7, 2014, by and between Robert Milkovich and First Potomac Realty Trust (Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2014 (File No. 001-31824)).
10.14†
Form of Amendment dated December 19, 2008 to Employment Agreement by and between First Potomac Realty Investment Limited Partnership and certain executive officers of the Company (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed on December 24, 2008 (File No. 001-31824)).
10.15†
2003 Equity Compensation Plan (Incorporated by reference to Exhibit 10.24 to the Company’s Registration Statement on Form S-11 (Registration No. 333-107172) filed on October 14, 2003).
10.16†
2009 Equity Compensation Plan (Incorporated by reference to Exhibit A to the Company’s definitive proxy statement on Schedule 14A filed on April 8, 2009 (File No. 001-31824)).
10.17†
2009 Employee Share Purchase Plan (Incorporated by reference to Exhibit B to the Company’s definitive proxy statement on Schedule 14A filed on April 8, 2009 (File No. 001-31824)).
10.18†
Amendment No. 1 to the Company’s 2003 Equity Compensation Plan (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on October 20, 2005 (File No. 001-31824)).
10.19†
Amendment No. 2 to the Company’s 2003 Equity Compensation Plan (Incorporated by reference to Exhibit A to the Company’s definitive proxy statement on Schedule 14A filed on April 11, 2007 (File No. 001-31824)).
10.20†
Amendment No. 1 to the Company’s 2009 Equity Compensation Plan (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on May 21, 2010 (File No. 001-31824)).
10.21†
Amendment No. 2 to the Company’s 2009 Equity Compensation Plan (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on May 23, 2011 (File No. 001-31824)).
10.22†
Form of 2009 Restricted Stock Agreement for Officers (Performance-Vesting) (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on May 27, 2009 (File No. 001-31824)).
10.23†
Form of 2010 Restricted Stock Agreement for Officers (Performance-Vesting) (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on March 1, 2010 (File No. 001-31824)).
10.24†
Form of 2003 Plan Restricted Share Agreement for Officers (Incorporated by reference to Exhibit 10.37 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 (File No. 001-31824)).
10.25†
Form of 2003 Plan Nonqualified Share Option Agreement (Incorporated by reference to Exhibit 10.39 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 (File No. 001-31824)).
10.26†
Form of 2009 Plan Restricted Share Agreement for Officers (Incorporated by reference to Exhibit 10.40 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 (File No. 001-31824)).
10.27†
Form of 2009 Plan Restricted Share Agreement for Trustees (Incorporated by reference to Exhibit 10.41 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 (File No. 001-31824)).
10.28†
Form of 2009 Plan Nonqualified Share Option Agreement (Incorporated by reference to Exhibit 10.42 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 (File No. 001-31824)).
10.29†
Description of Long-Term Incentive Award Program (“LTI Program”) (Incorporated by reference to Item 5.02 of the Company’s Current Report on Form 8-K filed on April 3, 2013 (File No. 001-31824)).
10.30
Purchase and Sale Agreement, dated as of May 17, 2013, by and among certain subsidiaries of First Potomac Realty Investment Limited Partnership and BRE/Industrial Acquisition Holdings 1, L.L.C. (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on May 20, 2013 (File No. 001-31824)).
10.31
Loan Agreement, by and between Jackson National Life Insurance Company, as Lender, and Rumsey First LLC, Snowden First LLC, GTC II First LLC, Norfolk First LLC, Bren Mar, LLC, Plaza 500, LLC and Van Buren, LLC, as the Borrowers, dated July 18, 2005 (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on July 22, 2005 (File No. 001-31824)).
10.32
Amended and Restated Revolving Credit Agreement, dated as of October 16, 2013, by and among First Potomac Realty Investment Limited Partnership, First Potomac Realty Trust, KeyBank National Association, as a lender and administrative agent, and the other lenders and agents party thereto. (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on October 22, 2013 (File No. 001-31824)).

134

10.33
Guaranty, dated as of October 16, 2013, by First Potomac Realty Trust in favor of KeyBank National Association, in its capacity as administrative agent for the lenders under the Amended and Restated Revolving Credit Agreement, dated as of October 16, 2013. (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on October 22, 2013 (File No. 001-31824)).
10.34
Amended and Restated Term Loan Agreement, dated as of October 16, 2013, by and among First Potomac Realty Investment Limited Partnership, First Potomac Realty Trust, KeyBank National Association, as a lender and administrative agent, and the other lenders and agents party thereto. (Incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed on October 22, 2013 (File No. 001-31824)).
10.35
Guaranty, dated as of October 16, 2013, by First Potomac Realty Trust in favor of KeyBank National Association, in its capacity as administrative agent for the lenders under the Amended and Restated Term Loan Agreement, dated as of October 16, 2013. (Incorporated by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed on October 22, 2013 (File No. 001-31824)).
12*
Statement Regarding Computation of Ratios.
21*
Subsidiaries of the Company.
23*
Consent of KPMG LLP (independent registered public accounting firm).
31.1*
Section 302 Certification of Chief Executive Officer.
31.2*
Section 302 Certification of Chief Financial Officer.
32.1**
Section 906 Certification of Chief Executive Officer.
32.2**
Section 906 Certification of Chief Financial Officer.
101*
XBRL (Extensible Business Reporting Language). The following materials from First Potomac Realty Trust’s Annual Report on Form 10-K for the year ended December 31, 2014, formatted in XBRL: (i) Consolidated balance sheets as of December 31, 2014 and 2013; (ii) Consolidated statements of operations for the years ended December 31, 2014, 2013 and 2012; (iii) Consolidated statements of comprehensive income (loss) and equity for the years ended December 31, 2014, 2013 and 2012; (iv) Consolidated statements of cash flows for the years ended December 31, 2014, 2013 and 2012; and (iv) Notes to condensed consolidated financial statements.


† 
Indicates management contract or compensatory plan or arrangement.
*
Filed herewith
**
Furnished herewith


135