10-K 1 a08-2526_110k.htm 10-K

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-K

(Mark One)

x

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

 

SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended    December 31, 2007

 

OR

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

 

SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                      to                       .

 

Commission File Number: 1-9044

 

DUKE REALTY CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

Indiana

 

35-1740409

(State or Other Jurisdiction
of Incorporation or Organization)

 

(IRS Employer
Identification Number)

600 East 96th Street, Suite 100

Indianapolis, Indiana

 


46240

(Address of Principal Executive Offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code:  (317) 808-6000

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class:

 

Name of Each Exchange on Which Registered:

Common Stock ($.01 par value)

 

New York Stock Exchange

Depositary Shares, each representing a 1/10 interest in a 6.625%

 

 

 Series J Cumulative Redeemable Preferred Share ($.01 par value)

 

New York Stock Exchange

Depositary Shares, each representing a 1/10 interest in a 6.5%

 

 

 Series K Cumulative Redeemable Preferred Share ($.01 par value)

 

New York Stock Exchange

Depositary Shares, each representing a 1/10 interest in a 6.6%

 

 

 Series L Cumulative Redeemable Preferred Share ($.01 par value)

 

New York Stock Exchange

Depositary Shares, each representing 1/10 interest in a 6.95%

 

 

 Series M Cumulative Redeemable Preferred Share ($.01 par value)

 

New York Stock Exchange

Depositary Shares, each representing 1/10 interest in a 7.25%

 

 

 Series N Cumulative Redeemable Preferred Share ($.01 par value)

 

New York Stock Exchange

Depositary Shares, each representing a 1/10 interest in an 8.375%

 

 

 Series O Cumulative Redeemable Preferred Share ($.01 par value)

 

New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.                Yes x   No o

 

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 o 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 o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 Regulation 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 to this Form 10-K.  o

 

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 definition of  “large accelerated filer”, “accelerated filer” and “smaller reporting company”  in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  x    Accelerated filer  o    Non-accelerated filer  o    Smaller reporting company  o

 

Indicate by check mark whether the registrant is a shell company  (as defined in Rule 12b-2 of the Exchange Act). Yes o   No x

 

The aggregate market value of the voting shares of the registrant’s outstanding common shares held by non-affiliates of the registrant is $4.9 billion based on the last reported sale price on June 30, 2007.

 

The number of common shares,  $.01 par value outstanding as of February 20, 2008 was 146,303,272.

 

DOCUMENTS INCORPORATED BY REFERENCE

Certain portions of Duke Realty Corporation’s Definitive Proxy Statement for its 2008 Annual Meeting of Shareholders (the “Proxy Statement”) to be filed pursuant to Rule 14a-6 of the Securities Exchange Act of 1934, as amended, are incorporated by reference into this Form 10-K. Other than those portions of the Proxy Statement specifically incorporated by reference pursuant to Items 10 through 14 of Part III hereof, no other portions of the Proxy Statement shall be deemed so incorporated.

 



TABLE OF CONTENTS

 

Form 10-K

 

Item No.

 

 

Page(s)

 

 

 

 

PART I

 

 

 

 

1.

Business

2 – 5

 

1A.

Risk Factors

5 – 13

 

1B.

Unresolved Staff Comments

13

 

2.

Properties

13 – 15

 

3.

Legal Proceedings

16

 

4.

Submission of Matters to a Vote of Security Holders

16

 

 

 

 

PART II

 

 

 

 

 

 

5.

Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

16 – 17

 

6.

Selected Financial Data

17 – 18

 

7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

18 – 39

 

7A.

Quantitative and Qualitative Disclosures About Market Risk.

39

 

8.

Financial Statements and Supplementary Data

40

 

9.

Changes In and Disagreements With Accountants on Accountingand Financial Disclosure

40

 

9A.

Controls and Procedures.

40

 

9B.

Other Information

40

 

 

 

 

PART III

 

 

 

 

 

 

10.

Directors and Executive Officers of the Registrant

41

 

11.

Executive Compensation

42

 

12.

Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters

42

 

13.

Certain Relationships and Related Transactions, and Director Independence

42

 

14.

Principal Accountant Fees and Services

42

 

 

 

 

PART IV

 

 

 

 

 

 

15.

Exhibits and Financial Statement Schedules.

42 – 93

 

 

 

 

Signatures

94 – 95

 



 

Cautionary Statement Regarding Forward-Looking Statements

 

Certain statements contained in or incorporated by reference into this Report, including, without limitation, those related to our future operations, constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended. The words “believe,” “estimate,” “expect,” “anticipate,” “intend,” “plan,” “seek”, “may” and similar expressions or statements regarding future periods are intended to identify forward-looking statements.

 

These forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause our actual results, performance or achievements, or industry results, to differ materially from any predictions of future results, performance or achievements that we express or imply in this Report or in the information incorporated by reference into this Report. Some of the risks, uncertainties and other important factors that may affect future results include, among others:

 

·                  Changes in general economic and business conditions, including performance of financial markets;

 

·                  Our continued qualification as a real estate investment trust, or “REIT”, for U.S. federal income tax purposes;

 

·                  Heightened competition for tenants and potential decreases in property occupancy;

 

·                  Potential increases in real estate construction costs;

 

·                  Potential changes in the financial markets and interest rates;

 

·                  Volatility in our stock price and trading volume;

 

·                  Our continuing ability to raise funds on favorable terms through the issuance of debt and equity in the capital markets;

 

·                  Our ability to successfully identify, acquire, develop and/or manage properties on terms that are favorable to us;

 

·                  Our ability to be flexible in the development and operation of joint venture properties;

 

·                  Our ability to successfully dispose of properties on terms that are favorable to us;

 

·                  Inherent risks in the real estate business, including, but not limited to, tenant defaults, potential liability relating to environmental matters and liquidity of real estate investments; and

 

·                  Other risks and uncertainties described herein, as well as, those risks and uncertainties discussed from time to time in our other reports and other public filings with the Securities and Exchange Commission (“SEC”).

 

This list of risks and uncertainties, however, is only a summary of some of the most important factors and is not intended to be exhaustive. Additional information regarding risk factors that may affect us is included under the caption “Risk Factors” in this Report, and is updated by us from time to time in Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other filings that we make with the SEC.

 

Although we presently believe that the plans, expectations and results expressed in or suggested by the forward-looking statements are reasonable, all forward-looking statements are inherently subjective, uncertain and subject to change, as they involve substantial risks and uncertainties beyond our control. New factors emerge from time to time, and it is not possible for us to predict the nature, or assess the potential impact, of each new factor on our business. Given these uncertainties, we caution you not to place undue reliance on these forward-looking statements. We undertake no obligation to update or revise any of our forward-looking statements for events or circumstances that arise after the statement is made, except as otherwise may be required by law.

 

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PART I

 

Item 1.  Business

 

Background

 

We are a self-administered and self-managed real estate investment trust (“REIT”), which began operations upon completion of our initial public offering in February 1986. In October 1993, we completed an additional common shares offering and acquired the rental real estate and service businesses of Duke Associates, whose operations began in 1972. As of December 31, 2007, our diversified portfolio of 726 rental properties (including 38 properties comprising 10.0 million square feet under development) encompass more than 121.1 million rentable square feet and are leased by a diverse and stable base of more than 3,400 tenants whose businesses include manufacturing, retailing, wholesale trade, distribution, healthcare and professional services. We also own or control approximately 7,700 acres of unencumbered land ready for development.

 

Through our Service Operations, we provide, on a fee basis, leasing, property and asset management, development, construction, build-to-suit and other tenant-related services. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8, “Financial Statements and Supplementary Data” for financial information. Our Rental Operations are conducted through Duke Realty Limited Partnership (“DRLP”). In addition, we conduct our Service Operations through Duke Realty Services LLC, Duke Realty Services Limited Partnership and Duke Construction Limited Partnership.  In this Form 10-K Report, the terms “we,” “us” and “our” refer to Duke Realty Corporation and subsidiaries (the “Company”) and those entities owned or controlled by the Company.

 

Our headquarters and executive offices are located in Indianapolis, Indiana. In addition, we have 21 regional offices located in Alexandria, Virginia; Atlanta, Georgia; Austin, Texas; Baltimore, Maryland; Cincinnati, Ohio; Columbus, Ohio; Chicago, Illinois; Dallas, Texas; Houston, Texas; Minneapolis, Minnesota; Nashville, Tennessee; Newport Beach, California; Orlando, Florida; Phoenix, Arizona; Raleigh, North Carolina; St. Louis, Missouri; San Antonio, Texas; Savannah, Georgia; Seattle, Washington; Tampa, Florida; and Weston, Florida. We had approximately 1,400 employees as of December 31, 2007.

 

Business Strategy

 

One of our primary business objectives is to increase Funds From Operations (“FFO”) by (i) maintaining and increasing property occupancy and rental rates through the management of our portfolio of existing properties; (ii) developing and acquiring new properties for our Rental Operations in our existing markets; (iii) expanding geographically by acquiring and developing properties in new markets; (iv) using our construction expertise to act as a general contractor in our existing markets and other domestic markets on a fee basis; (v) developing and repositioning properties in our existing markets and other markets which we will sell through our Service Operations property sale program and (vi) providing a full line of real estate services to our tenants and to third parties. FFO is used by industry analysts and investors as a supplemental operating performance measure of an equity REIT like Duke. FFO is calculated in accordance with the definition that was adopted by the Board of Governors of the National Association of Real Estate Investment Trusts (“NAREIT”).  NAREIT created FFO as a supplemental measure of REIT operating performance that excludes historical cost depreciation, among other items, from net income determined in accordance with United States generally accepted accounting principles (“GAAP”).  FFO is a non-GAAP financial measure developed by NAREIT to compare the operating performance of REITs.  The most comparable GAAP measure is net income (loss).  FFO should not be considered as a substitute for net income or any other measures derived in accordance with GAAP and may not be comparable to other similarly titled measures of other companies.

 

Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen or fallen with market conditions, many industry analysts and investors have considered presentation of operating results for real estate companies that use historical cost accounting to be insufficient by

 

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themselves.  FFO, as defined by NAREIT, represents GAAP net income (loss), excluding extraordinary items as defined under GAAP and gains or losses from sales of previously depreciated real estate assets, plus certain non-cash items such as real estate asset depreciation and amortization, and after similar adjustments for unconsolidated partnerships and joint ventures.

 

Management believes that the use of FFO, combined with the required primary GAAP presentations, improves the understanding of operating results of REITs among the investing public and makes comparisons of REIT operating results more meaningful.  Management believes FFO is a useful measure for reviewing comparative operating and financial performance (although FFO should be reviewed in conjunction with net income which remains the primary measure of performance) because by excluding gains or losses related to sales of previously depreciated real estate assets and excluding real estate asset depreciation and amortization, FFO provides a useful comparison of the operating performance of our real estate between periods or as compared to different companies.

 

As a fully integrated commercial real estate firm, we provide in-house leasing, management, development and construction services which, coupled with our significant base of commercially zoned and unencumbered land in existing business parks, should give us a competitive advantage both as a real estate operator and in future development activities.

 

We believe that the management of real estate opportunities and risks can be done most effectively at regional or local levels. As a result, we intend to continue our emphasis on increasing our market share and effective rents in the primary markets where we own properties. We also expect to utilize approximately 7,700 acres of unencumbered land and our many business relationships with our more than 3,400 commercial tenants to expand our build-to-suit business (development projects substantially pre-leased to a single tenant) and to pursue other development and acquisition opportunities in our primary markets. We believe that this regional focus will allow us to assess market supply and demand for real estate more effectively as well as to capitalize on the strong relationships with our tenant base. In addition, we seek to further capitalize on strong customer relationships to provide third-party construction and build-for-sale services outside our primary markets and to expand into high growth and seaport markets across the United States.

 

Our strategy is to seek to develop and acquire primarily Class A commercial properties located in markets with high growth potential for large national and international companies and other quality regional and local firms. Our industrial and suburban office development focuses on business parks and mixed-use developments suitable for multiple projects on a single site where we can create and control the business environment. These business parks and mixed-use developments often include restaurants and other amenities, which we believe will create an atmosphere that is particularly efficient and desirable. As a fully integrated real estate company, we are able to arrange for or provide to our industrial, office and healthcare customers not only well located and well maintained facilities, but also additional services such as build-to-suit construction, tenant finish construction, and expansion flexibility.

 

All of our properties are located in areas that include competitive properties. Institutional investors, other REITs or local real estate operators generally own such properties; however, no single competitor or small group of competitors is dominant in our current markets. The supply and demand of similar available rental properties may affect the rental rates we will receive on our properties.

 

Financing Strategy

 

We seek to maintain a well-balanced, conservative and flexible capital structure by: (i) extending and sequencing the maturity dates of debt; (ii) borrowing primarily at fixed rates by targeting a variable rate component of total debt less than 20%; (iii) pursuing current and future long-term debt financings and refinancing on an unsecured basis;  (iv) maintaining conservative debt service and fixed charge coverage ratios; (v) generating proceeds from the sale of non-strategic properties and (vi) issuing perpetual preferred stock for 5-10% of our total capital structure.

 

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Management believes that these strategies have enabled and should continue to enable us to favorably access capital markets for our long-term requirements such as debt refinancing and financing development and acquisitions of additional rental properties. In addition, as discussed under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” we have a $1.3 billion unsecured line of credit available for short-term funding of development and acquisition of additional rental properties. Further, we pursue favorable opportunities to dispose of assets that no longer meet our long-term investment criteria and recycle the proceeds into new investments that we believe have excellent long-term growth prospects. Our debt to total market capitalization ratio (total market capitalization is defined as the total market value of all outstanding common and preferred shares and units of limited partnership interest (“Units”) in DRLP plus outstanding indebtedness) at December 31, 2007 was 48.4%. Our ratio of earnings to debt service and ratio of earnings to fixed charges for the year ended December 31, 2007 were 1.58x and 1.47x, respectively. In computing the ratio of earnings to debt service, earnings have been calculated by adding interest expense (excluding amortization of debt issuance costs) to income from continuing operations, less preferred dividends, and minority interest in earnings of DRLP. Debt service consists of interest expense and recurring principal amortization (excluding maturities) and excludes amortization of debt issuance costs. In computing the ratio of earnings to fixed charges, earnings have been calculated by adding interest expense and minority interest in earnings from DRLP to income from continuing operations. Fixed charges consist of interest costs, whether expensed or capitalized, the interest component of rental expense and amortization of debt issuance costs.

 

Corporate Governance

 

Since our inception, we not only have strived to be a top-performer operationally, but also to lead in issues important to investors such as disclosure and corporate governance. Our system of governance reinforces this commitment. Summarized below are the highlights of our Corporate Governance initiatives.

 

Board Composition

 

·

Board is controlled by supermajority (91.7%) of Independent Directors as of January 30, 2008 and thereafter

Board Committees

 

·

Board Committee members are all Independent Directors

Lead Director

 

·

The Chairman of the Corporate Governance Committee serves as Lead Director of the Independent Directors

Board Policies

 

·

No Shareholder Rights Plan (Poison Pill)

 

 

·

Code of Conduct applies to all Directors and employees, including the Chief Executive Officer and senior financial officers; waivers require the vote of Independent Directors

 

 

·

Effective orientation program for new Directors

 

 

·

Independence of Directors is reviewed annually

 

 

·

Independent Directors meet at least quarterly in executive session

 

 

·

Independent Directors receive no compensation from Duke other than as Directors

 

 

·

Equity-based compensation plans require shareholder approval

 

 

·

Board effectiveness and performance is reviewed annually by the Corporate Governance Committee

 

 

·

Corporate Governance Committee conducts an annual review of the Chief Executive Officer succession plan

 

 

·

Independent Directors and all Board Committees may retain outside advisors, as they deem appropriate

 

 

·

Policy governing retirement age for Directors

 

 

·

Outstanding stock options may not be repriced

 

 

·

Directors required to offer resignation upon job change

 

 

·

Majority voting for election of Directors

 

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Ownership

 

 

Minimum Stock Ownership Guidelines apply to all Directors and Executive Officers

 

Our Code of Conduct (which applies to all Directors and employees, including the Chief Executive Officer and senior financial officers) and the Corporate Governance Guidelines are available in the investor information/corporate governance section of our website at www.dukerealty.com. A copy of these documents may also be obtained without charge by writing to Duke Realty Corporation, 600 East 96th Street, Suite 100, Indianapolis, Indiana 46240, Attention: Investor Relations.

 

Additional Information

 

For additional information regarding our investments and operations, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 8, “Financial Statements and Supplementary Data.” For additional information about our business segments, see Item 8, “Financial Statements and Supplementary Data.”

 

Available Information and Exchange Certifications

 

In addition to this Annual Report, we file quarterly and special reports, proxy statements and other information with the Securities and Exchange Commission (the “SEC”). All documents that are filed with the SEC are available free of charge on our corporate website, which is www.dukerealty.com. You may also read and copy any document filed at the public reference facilities of the SEC at 100 F Street, N.E., Washington, D.C. 20549. Please call the SEC at (800) SEC-0330 for further information about the public reference facilities. These documents also may be accessed through the SEC’s electronic data gathering, analysis and retrieval system (“EDGAR”) via electronic means, including the SEC’s home page on the Internet (http://www.sec.gov). In addition, since some of our securities are listed on the New York Stock Exchange, you may read SEC filings at the offices of the New York Stock Exchange, 20 Broad Street, New York, New York 10005.

 

The New York Stock Exchange (“NYSE”) requires that the Chief Executive Officer of each listed company certify annually to the NYSE that he or she is not aware of any violation by the company of NYSE corporate governance listing standards as of the date of such certification. We submitted the certification of our Chairman and Chief Executive Officer, Dennis D. Oklak, with our 2007 Annual Written Affirmation to the NYSE on May 16, 2007.

 

We included the certifications of the Chief Executive Officer and the Chief Financial Officer of the Company required by Section 302 of the Sarbanes-Oxley Act of 2002 and related rules, relating to the quality of the Company’s public disclosure, in this report as Exhibits 31.1 and 31.2.

 

Item 1A.  Risk Factors

 

In addition to the other information contained in this Report, you should carefully consider, in consultation with your legal, financial and other professional advisors, the risks described below, as well as the risk factors and uncertainties discussed in our other public filings with the SEC under the caption “Risk Factors” in evaluating us and our business before making a decision regarding an investment in our securities.

 

The risks contained in this Report are not the only risks faced by us. Additional risks that are not presently known, or that we presently deem to be immaterial, also could have a material adverse effect on our financial condition, results of operations, business and prospects. The trading price of our securities could decline due to the materialization of any of these risks, and our shareholders may lose all or part of their investment.

 

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This Report also contains forward-looking statements that may not be realized as a result of certain factors, including, but not limited to, the risks described herein and in our other public filings with the SEC. Please refer to the section in this Report entitled “Cautionary Notice Regarding Forward-Looking Statements” for additional information regarding forward-looking statements.

 

If we were to cease to qualify as a REIT, we and our shareholders would lose significant tax benefits.

 

We intend to continue to operate so as to qualify as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”). Qualification as a REIT provides significant tax advantages to us and our shareholders. However, in order for us to continue to qualify as a REIT, we must satisfy numerous requirements established under highly technical and complex Code provisions for which there are only limited judicial and administrative interpretations. Satisfaction of these requirements also depends on various factual circumstances not entirely within our control. The fact that we hold our assets through an operating partnership and its subsidiaries further complicates the application of the REIT requirements. Even a technical or inadvertent mistake could jeopardize our REIT status. Although we believe that we can continue to operate so as to qualify as a REIT, we cannot offer any assurance that we can continue to do so or that legislation, new regulations, administrative interpretations or court decisions will not significantly change the qualification requirements or the federal income tax consequences of qualification. If we were to fail to qualify as a REIT in any taxable year, it would have the following effects:

 

·                  We would not be allowed a deduction for distributions to shareholders and would be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates;

 

·                  Unless we were entitled to relief under certain statutory provisions, we would be disqualified from treatment as a REIT for the four taxable years following the year during which we ceased to qualify as a REIT;

 

·                  Our net earnings available for investment or distribution to our shareholders would decrease due to the additional tax liability for the year or years involved; and

 

·                  We would no longer be required to make any distributions to shareholders in order to qualify as a REIT.

 

As such, failure to qualify as a REIT would likely have a significant adverse effect on the value of our securities.

 

REIT distribution requirements limit the amount of cash we will have available for other business purposes, including amounts that we need to fund our future growth.

 

To maintain our qualification as a REIT under the Code, we must annually distribute to our shareholders at least 90% of our ordinary taxable income, excluding net capital gains. We intend to continue to make distributions to our shareholders to comply with the 90% distribution requirement. However, this requirement limits our ability to accumulate capital for use for other business purposes. If we do not have sufficient cash or other liquid assets to meet the distribution requirements, we may have to borrow funds or sell properties on adverse terms in order to meet the distribution requirements. If we fail to make a required distribution, we would cease to qualify as a REIT.

 

U.S. federal income tax developments could affect the desirability of investing in us for individual taxpayers.

 

In May 2003, federal legislation was enacted that reduced the maximum tax rate for dividends payable to individual taxpayers generally from 38.6% to 15% (from January 1, 2003 through 2008). However, dividends payable by REITs are not eligible for this treatment, except in limited circumstances. Although

 

6



 

 

this legislation did not have a direct adverse effect on the taxation of REITs or dividends paid by REITs, the more favorable treatment for non-REIT dividends could cause individual investors to consider investments in non-REIT corporations as more attractive relative to an investment in us as a REIT.

 

U.S. federal income tax treatment of REITs and investments in REITs may change, which may result in the loss of our tax benefits of operating as a REIT.

 

The present U.S. federal income tax treatment of a REIT and an investment in a REIT may be modified by legislative, judicial or administrative action at any time. Revisions in U.S. federal income tax laws and interpretations of these laws could adversely affect us and the tax consequences of an investment in our common shares.

 

Our net earnings available for investment or distribution to shareholders could decrease as a result of factors outside of our control.

 

Our business is subject to the risks incident to the ownership and operation of commercial real estate, many of which involve circumstances not within our control. Such risks include the following:

 

·                  Changes in the general economic climate;

 

·                  Increases in interest rates;

 

·                  Local conditions such as oversupply of property or a reduction in demand;

 

·                  Competition for tenants;

 

·                  Changes in market rental rates;

 

·                  Oversupply or reduced demand for space in the areas where our properties are located;

 

·                  Delay or inability to collect rent from tenants who are bankrupt, insolvent or otherwise unwilling or unable to pay;

 

·                  Difficulty in leasing or re-leasing space quickly or on favorable terms;

 

·                  Costs associated with periodically renovating, repairing and reletting rental space;

 

·                  Our ability to provide adequate maintenance and insurance on our properties;

 

·                  Our ability to control variable operating costs;

 

·                  Changes in government regulations;

 

·                  Changes in interest rate levels;

 

·                  The availability of financing on favorable terms; and

 

·                  Potential liability under, and changes in, environmental, zoning, tax and other laws.

 

Further, a significant portion of our costs, such as real estate taxes, insurance and maintenance costs and our debt service payments, are generally not reduced when circumstances cause a decrease in cash flow from our properties.

 

Many real estate costs are fixed, even if income from properties decreases.

 

Our financial results depend on leasing space in our real estate to tenants on terms favorable to us. Our income and funds available for distribution to our stockholders will decrease if a significant number of our tenants cannot pay their rent or we are unable to lease properties on favorable terms. In addition, if a tenant does not pay its rent, we may not be able to enforce our rights as landlord without delays and we may incur substantial legal costs. Costs associated with real estate investment, such as real estate taxes and maintenance costs, generally are not reduced when circumstances cause a reduction in income from the investment.

 

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Our real estate development activities are subject to risks particular to development.

 

We intend to continue to pursue development activities as opportunities arise. These development activities generally require various government and other approvals. We may not receive the necessary approvals. We are subject to the risks associated with development activities. These risks include:

 

·                  Unsuccessful development opportunities could result in direct expenses to us;

 

·                  Construction costs of a project may exceed original estimates, possibly making the project less profitable than originally estimated, or possibly unprofitable;

 

·                  Time required to complete the construction of a project or to lease up the completed project may be greater than originally anticipated, thereby adversely affecting our cash flow and liquidity;

 

·                  Occupancy rates and rents of a completed project may not be sufficient to make the project profitable; and

 

·                  Favorable sources to fund our development activities may not be available.

 

We are exposed to risks associated with entering new markets.

 

We consider entering new markets from time to time. The construction and/or acquisition of properties in new markets involves risks, including the risk that the property will not perform as anticipated and the risk that any actual costs for rehabilitation, repositioning, renovation and improvements identified in the pre-construction or pre-acquisition due diligence process will exceed estimates. There is, and it is expected that there will continue to be, significant competition for investment opportunities that meet our investment criteria as well as risks associated with obtaining financing for acquisition activities, if necessary.

 

We may be unsuccessful in operating completed real estate projects.

 

We face the risk that the real estate projects we develop or acquire will not perform in accordance with our expectations. This risk exists because of factors such as the following:

 

·                  Prices paid for acquired facilities are based upon a series of market judgments; and

 

·                  Costs of any improvements required to bring an acquired facility up to standards to establish the market position intended for that facility might exceed budgeted costs.

 

Further, we can give no assurance that acquisition targets meeting our guidelines for quality and yield will be available when we seek them.

 

Our use of joint ventures may limit our flexibility with jointly owned investments.

 

In appropriate circumstances, we intend to develop and acquire properties in joint ventures with other persons or entities when circumstances warrant the use of these structures. We currently have joint ventures that are not consolidated with our financial statements.  Our participation in joint ventures is subject to the risks that:

 

·                  We could become engaged in a dispute with any of our joint venture partners that might affect our ability to develop or operate a property;

 

·                  Our joint venture partners may have different objectives than we have regarding the appropriate timing and terms of any sale or refinancing of properties; and

 

·                  Our joint venture partners may have competing interests in our markets that could create conflict of interest issues.

 

 

8



 

We are exposed to the risks of defaults by tenants.

 

Any of our tenants may experience a downturn in their businesses that may weaken their financial condition. In the event of default or the insolvency of a significant number of our tenants, we may experience a substantial loss of rental revenue and/or delays in collecting rent and incur substantial costs in enforcing our rights as landlord. If a tenant files for bankruptcy protection, a court could allow the tenant to reject and terminate its lease with us. Our income and distributable cash flow would be adversely affected if a significant number of our tenants became unable to meet their obligations to us, became insolvent or declared bankruptcy.

 

We may be unable to renew leases or relet space.

 

When our tenants decide not to renew their leases upon their expiration, we may not be able to relet the space. Even if our tenants do renew or we are able to relet the space, the terms of renewal or reletting (including the cost of renovations, if necessary) may be less favorable than current lease terms. If we are unable to promptly renew the leases or relet the space, or if the rental rates upon such renewal or reletting are significantly lower than current rates, then our income and distributable cash flow would be adversely affected, especially if we were unable to lease a significant amount of the space vacated by tenants in our properties.

 

Our insurance coverage on our properties may be inadequate.

 

We maintain comprehensive insurance on each of our facilities, including property, liability, fire, flood and extended coverage. We believe this coverage is of the type and amount customarily obtained for real property. However, there are certain types of losses, generally of a catastrophic nature, such as earthquakes, hurricanes and floods or acts of war or terrorism that may be uninsurable or not economically insurable. We use our discretion when determining amounts, coverage limits and deductibles for insurance. These terms are determined based on retaining an acceptable level of risk at a reasonable cost. This may result in insurance coverage that in the event of a substantial loss would not be sufficient to pay the full current market value or current replacement cost of our lost investment. Inflation, changes in building codes and ordinances, environmental considerations and other factors also may make it unfeasible to use insurance proceeds to replace a facility after it has been damaged or destroyed. Under such circumstances, the insurance proceeds we receive may not be adequate to restore our economic position in a property. If an insured loss occurred, we could lose both our investment in and anticipated profits and cash flow from a property, and we would continue to be obligated on any mortgage indebtedness or other obligations related to the property. Although we believe our insurance is with highly rated providers, we are also subject to the risk that such providers may be unwilling or unable to pay our claims when made.

 

Acquired properties may expose us to unknown liability.

 

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

 

·                  liabilities for clean-up of undisclosed environmental contamination;

 

·                  claims by tenants, vendors or other persons against the former owners of the properties;

 

·                  liabilities incurred in the ordinary course of business; and

 

·                  claims for indemnification by general partners, directors, officers and others indemnified by the former owners of the properties.

 

9


 


 

We could be exposed to significant environmental liabilities as a result of conditions of which we currently are not aware.

 

As an owner and operator of real property, we may be liable under various federal, state and local laws for the costs of removal or remediation of certain hazardous substances released on or in our property. Such laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the release of the hazardous substances. In addition, we could have greater difficulty in selling real estate on which hazardous substances were present or in obtaining borrowings using such real estate as collateral. It is our general policy to have Phase I environmental audits performed for all of our properties and land by qualified environmental consultants. These Phase I environmental audits have not revealed any environmental liability that would have a material adverse effect on our business. However, a Phase I environmental audit does not involve invasive procedures such as soil sampling or ground water analysis, and we cannot be sure that the Phase I environmental audits did not fail to reveal a significant environmental liability or that a prior owner did not create a material environmental condition on our properties or land which has not yet been discovered. We could also incur environmental liability as a result of future uses or conditions of such real estate or changes in applicable environmental laws.

 

Certain of our officers hold units in our operating partnership and may not have the same interests as our shareholders with regard to certain tax matters.

 

Certain of our officers own limited partnership units in our operating partnership, Duke Realty Limited Partnership. Owners of limited partnership units may suffer adverse tax consequences upon the sale of certain of our properties, the refinancing of debt related to those properties or in the event we are the subject of a tender offer or merger. As such, owners of limited partnership units, including certain of our officers, may have different objectives regarding the appropriateness of the pricing and timing of these transactions. Though we are the sole general partner of the operating partnership and have the exclusive authority to sell all of our wholly-owned properties or to refinance such properties, officers who hold limited partnership units may influence us not to sell or refinance certain properties even if such sale may be financially advantageous to our shareholders. Adverse tax consequences may also influence the decisions of these officers in the event we are the subject of a tender offer or merger.

 

Our use of debt financing could have a material adverse effect on our financial condition.

 

We are subject to the risks normally associated with debt financing, including the risk that our cash flow will be insufficient to meet required principal and interest payments and the risk that we will be unable to refinance our existing indebtedness, or that the terms of such refinancing will not be as favorable as the terms of our existing indebtedness. If our debt cannot be paid, refinanced or extended, we may not be able to make distributions to shareholders at expected levels or at all. Further, if prevailing interest rates or other factors at the time of a refinancing result in higher interest rates or other restrictive financial covenants upon the refinancing, then such refinancing would adversely affect our cash flow and funds available for operation, development and distribution. We are also subject to financial covenants under our existing debt instruments. Should we fail to comply with the covenants in our existing debt instruments, then we would not only be in breach under the applicable debt instruments but we would also likely be unable to borrow any further amounts under these instruments, which could adversely affect our ability to fund operations. We also have incurred and may incur in the future indebtedness that bears interest at variable rates. Thus, as market interest rates increase, so will our debt expense, affecting our cash flow and our ability to make distributions to shareholders.

 

Financial covenants under existing credit agreements could limit our flexibility and adversely affect our financial condition.

 

10



 

The terms of our various credit agreements and other indebtedness require that we comply with a number of customary financial and other covenants, such as maintaining debt service coverage and leverage ratios and maintaining insurance coverage. These covenants may limit our flexibility in our operations, and breaches of these covenants could result in defaults under the instruments governing the applicable indebtedness even if we have satisfied our payment obligations.  If we are unable to refinance our indebtedness at maturity or meet our payment obligations, the amount of our distributable cash flow would be adversely affected.

 

Debt financing may not be available and equity issuances could be dilutive to the Company’s shareholders.

 

The Company’s ability to execute its business strategy depends on its access to an appropriate blend of debt financing, including unsecured lines of credit and other forms of secured and unsecured debt, and equity financing, including common and preferred equity. Debt financing may not be available in sufficient amounts, or on favorable terms or at all.  If the Company issues additional equity securities to finance developments and acquisitions instead of incurring debt, the interests of existing shareholders could be diluted.

 

Our stock price and trading volume may be volatile, which could result in substantial losses to our shareholders.

 

The equity securities markets have from time to time experienced volatility, creating highly variable and unpredictable pricing of equity securities. The market price of our capital stock could change in ways that may or may not be related to our business, our industry or our operating performance and financial condition. In addition, the trading volume in our common stock may fluctuate and cause significant price variations to occur. Some of the factors that could negatively affect our share price or result in fluctuations in the price or trading volume of our common stock include recent uncertainty in the markets, general market and economic conditions, as well as those factors described in these “Risk Factors” and in other reports that we file with the SEC.

 

Many of these factors are beyond our control, and we cannot predict their potential effects on the price of our securities. If the market price of our securities decline, then our shareholders may be unable to resell their securities upon terms that are attractive to them. We cannot assure that the market price of our securities will not fluctuate or decline significantly in the future. In addition, the securities markets in general can experience considerable unexpected price and volume fluctuations.

 

We may issue debt and equity securities which are senior to our common stock and preferred stock as to distributions and in liquidation, which could negatively affect the value of our common and preferred stock.

 

In the future, we may attempt to increase our capital resources by entering into debt or debt-like financing that is unsecured or secured by certain of our assets, or issuing debt or equity securities, which could include issuances of secured or unsecured commercial paper, medium-term notes, senior notes, subordinated notes, preferred stock or common stock. In the event of our liquidation, our lenders and holders of our debt securities would receive a distribution of our available assets before distributions to the holders of our common stock and preferred stock. Our preferred stock has a preference over our common stock with respect to distributions and upon liquidation, which could further limit our ability to make distributions to our common shareholders. Any additional preferred stock that we may issue may have a preference over our common stock and existing series of preferred stock with respect to distributions and upon liquidation.

 

Our leverage strategy may require us to seek substantial amounts of commercial credit and issue debt securities to support our asset growth. Because our decision to incur debt and issue securities in our future offerings 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 and debt financings. Further, market conditions

 

11



 

could require us to accept less favorable terms for the issuance of our securities in the future. Thus, our shareholders will bear the risk of our future offerings reducing the value of their shares of common stock and diluting their interest in us. We may change this leverage strategy from time to time without shareholder approval.

 

If we are unable to generate sufficient capital and liquidity, then we may be unable to pursue future development projects and other strategic growth initiatives.

 

To complete our ongoing and planned development projects, and to pursue our other strategic  growth initiatives, we must continue to generate sufficient capital and liquidity to fund those activities. To generate that capital and liquidity, we rely upon funds from our existing operations, as well as funds that we raise through our capital raising activities. In the current economic environment, REITs like ours have faced earnings pressures that have made it more difficult to generate capital and liquidity from existing operations. In addition, due to the recent crises in the credit and liquidity markets, it has become increasingly difficult to raise capital and generate liquidity through the sale of equity and/or debt securities on favorable terms, if at all. In the event that we are unable to generate sufficient capital and liquidity to meet our short- and long-term needs, or if we are unable to generate capital and liquidity on terms that are favorable to us, then we may be required to curtail our proposed development projects, as well as our other strategic and growth initiatives.

 

We are subject to certain provisions that could discourage change-of-control transactions, which may reduce the likelihood of our shareholders receiving a control premium for their shares.

 

Indiana anti-takeover legislation and certain provisions in our governing documents, as we discuss below, may discourage potential acquirers from pursuing a change-of-control transaction with us. As a result, our shareholders may be less likely to receive a control premium for their shares.

 

Unissued Preferred Stock.  Our charter permits our board of directors to classify unissued preferred stock by setting the rights and preferences of the shares at the time of issuance. This power enables our board to adopt a shareholder rights plan, also known as a poison pill. Although we have repealed our previously existing poison pill and our current board of directors has adopted a policy not to issue preferred stock as an anti-takeover measure, our board can change this policy at any time. The adoption of a poison pill would discourage a potential bidder from acquiring a significant position in the company without the approval of our board.

 

Business-Combination Provisions of Indiana Law.  We have not opted out of the business-combination provisions of the Indiana Business Corporation Law. As a result, potential bidders may have to negotiate with our board of directors before acquiring 10% of our stock. Without securing board approval of the proposed business combination before crossing the 10% ownership threshold, a bidder would not be permitted to complete a business combination for five years after becoming a 10% shareholder. Even after the five-year period, a business combination with the significant shareholder would require a “fair price” as defined in the Indiana Business Corporation Law or the approval of a majority of the disinterested shareholders.

 

Control-Share-Acquisition Provisions of Indiana Law.  We have not opted out of the provisions of the Indiana Business Corporation Law regarding acquisitions of control shares. Therefore, those who acquire a significant block (at least 20%) of our shares may only vote a portion of their shares unless our other shareholders vote to accord full voting rights to the acquiring person. Moreover, if the other shareholders vote to give full voting rights with respect to the control shares and the acquiring person has acquired a majority of our outstanding shares, the other shareholders would be entitled to special dissenters’ rights.

 

 

12



 

Supermajority Voting Provisions.   Our charter prohibits business combinations or significant disposition transactions with a holder of 10% of our shares unless:

 

·                  The holders of 80% of our outstanding shares of capital stock approve the transaction;

 

·                  The transaction has been approved by three-fourths of those directors who served on the board before the shareholder became a 10% owner; or

 

·                  The significant shareholder complies with the “fair price” provisions of our charter.

 

Among the transactions with large shareholders requiring the supermajority shareholder approval are dispositions of assets with a value greater than or equal to $1,000,000 and business combinations.

 

Operating Partnership Provisions.   The limited partnership agreement of the Operating Partnership contains provisions that could discourage change-of-control transactions, including a requirement that holders of at least 90% of the outstanding partnership units held by us and other unit holders approve:

 

·                  Any voluntary sale, exchange, merger, consolidation or other disposition of all or substantially all of the assets of the Operating Partnership in one or more transactions other than a disposition occurring upon a financing or refinancing of the Operating Partnership;

 

·                  Our merger, consolidation or other business combination with another entity unless after the transaction substantially all of the assets of the surviving entity are contributed to the Operating Partnership in exchange for units;

 

·                  Our transfer of our interests in the Operating Partnership other than to one of our wholly owned subsidiaries; and

 

·                  Any reclassification or recapitalization or change of outstanding shares of our common stock other than certain changes in par value, stock splits, stock dividends or combinations.

 

We are dependent on key personnel.

 

Our executive officers and other senior officers have a significant role in the success of our Company. Our ability to retain our management group or to attract suitable replacements should any members of the management group leave our Company is dependent on the competitive nature of the employment market. The loss of services from key members of the management group or a limitation in their availability could adversely impact our financial condition and cash flow. Further, such a loss could be negatively perceived in the capital markets.

 

Item 1B.  Unresolved Staff Comments

 

We have no unresolved comments with the SEC staff regarding our periodic or current reports under the Exchange Act.

 

Item 2.  Properties

 

Product Review

 

As of December 31, 2007, we own interests in a diversified portfolio of 726 commercial properties encompassing more than 121.1 million net rentable square feet (including 38 properties comprising 10.0 million square feet under development) and approximately 7,700 acres of land for future development.

 

13



 

 

Industrial Properties: We own interests in 411 industrial properties encompassing more than 84.6 million square feet (70% of total square feet) more specifically described as follows:

·                  Bulk Warehouses — Industrial warehouse/distribution buildings with clear ceiling heights of 20 feet or more. We own 358 buildings totaling approximately 81.2 million square feet of such properties.

·                  Service Center Properties — Also known as flex buildings or light industrial, this product type has 12-18 foot clear ceiling heights and a combination of drive-up and dock-height loading access. We own 53 buildings totaling approximately 3.5 million square feet of such properties.

 

Office Properties:  We own interests in 295 office buildings totaling approximately 34.4 million square feet (28% of total square feet). These properties include primarily suburban office properties.

 

Other Properties:  We own interests in 20 healthcare and retail buildings totaling more than 2.1 million square feet (2% of total square feet).

 

Land:  We own or control approximately 7,700 acres of land located primarily in existing business parks. The land is ready for immediate use and is unencumbered. More than 113 million square feet of additional space can be developed on these sites and substantially all of the land is zoned for either office, industrial, healthcare or retail development.

 

Property Descriptions

 

The following schedule represents the geographic highlights of properties in our primary markets.

 

14


 


 

Duke Realty Corporation

Geographic Highlights

In Service Properties as of December 31, 2007

 

 

 

 

Square Feet (1)

 

 

 

Percent of

 

 

 

Industrial

 

Suburban Office

 

Other

 

Overall

 

Percent of
Overall

 

Annual Net
Effective
Rent (2)

 

Annual Net
Effective
Rent

 

Primary Market

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cincinnati

 

10,437,397

 

4,776,368

 

826,597

 

16,040,362

 

14.44

%

$

84,968,472

 

13.57

%

Indianapolis

 

18,016,702

 

2,977,170

 

26,352

 

21,020,224

 

18.91

%

80,951,114

 

12.94

%

Atlanta

 

8,142,383

 

3,942,600

 

389,659

 

12,474,642

 

11.22

%

74,272,067

 

11.87

%

Chicago

 

5,565,486

 

2,829,398

 

74,901

 

8,469,785

 

7.62

%

60,403,525

 

9.65

%

St. Louis

 

3,937,813

 

3,311,455

 

 

7,249,268

 

6.52

%

56,036,367

 

8.95

%

Columbus

 

3,561,480

 

3,321,971

 

 

6,883,451

 

6.19

%

47,889,436

 

7.65

%

Raleigh

 

2,001,449

 

2,697,713

 

 

4,699,162

 

4.23

%

44,088,142

 

7.05

%

Central Florida

 

3,360,479

 

1,464,140

 

 

4,824,619

 

4.34

%

32,879,249

 

5.25

%

Nashville

 

3,118,718

 

1,319,788

 

 

4,438,506

 

3.99

%

29,246,865

 

4.67

%

Minneapolis

 

3,575,125

 

1,067,811

 

 

4,642,936

 

4.18

%

28,454,791

 

4.55

%

Dallas

 

9,182,858

 

152,000

 

 

9,334,858

 

8.40

%

22,636,638

 

3.62

%

Savannah

 

4,393,700

 

 

 

4,393,700

 

3.95

%

14,835,584

 

2.37

%

Cleveland

 

 

1,324,367

 

 

1,324,367

 

1.19

%

14,750,841

 

2.36

%

Washington DC

 

654,918

 

2,265,750

 

 

2,920,668

 

2.63

%

14,265,333

 

2.28

%

South Florida

 

 

773,923

 

 

773,923

 

0.70

%

8,690,496

 

1.39

%

Norfolk

 

466,000

 

 

 

466,000

 

0.42

%

2,290,177

 

0.37

%

Seattle

 

120,000

 

 

 

120,000

 

0.11

%

2,160,000

 

0.35

%

Houston

 

172,000

 

159,175

 

 

331,175

 

0.30

%

1,584,000

 

0.25

%

Other (3)

 

436,139

 

 

294,968

 

731,107

 

0.66

%

5,381,105

 

0.86

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

77,142,647

 

32,383,629

 

1,612,477

 

111,138,753

 

100.00

%

$

625,784,202

 

100.00

%

 

 

69.41

%

29.14

%

1.45

%

100.00

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Occupancy %

 

 

 

 

 

 

 

 

 

Industrial

 

Suburban Office

 

Other

 

Overall

 

 

 

 

 

 

 

Primary Market

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cincinnati

 

90.96

%

90.41

%

94.70

%

90.98

%

 

 

 

 

 

 

Indianapolis

 

95.39

%

95.81

%

81.03

%

95.43

%

 

 

 

 

 

 

Atlanta

 

94.25

%

93.38

%

81.41

%

93.57

%

 

 

 

 

 

 

Chicago

 

97.69

%

94.61

%

96.79

%

96.65

%

 

 

 

 

 

 

St. Louis

 

85.88

%

91.24

%

 

88.33

%

 

 

 

 

 

 

Columbus

 

100.00

%

89.01

%

 

94.69

%

 

 

 

 

 

 

Raleigh

 

96.08

%

95.24

%

 

95.60

%

 

 

 

 

 

 

Central Florida

 

90.77

%

94.05

%

 

91.76

%

 

 

 

 

 

 

Nashville

 

77.12

%

81.05

%

 

78.29

%

 

 

 

 

 

 

Minneapolis

 

94.08

%

73.40

%

 

89.32

%

 

 

 

 

 

 

Dallas

 

94.37

%

100.00

%

 

94.46

%

 

 

 

 

 

 

Savannah

 

100.00

%

 

 

100.00

%

 

 

 

 

 

 

Cleveland

 

 

82.39

%

 

82.39

%

 

 

 

 

 

 

Washington DC

 

97.69

%

90.41

%

 

92.04

%

 

 

 

 

 

 

South Florida

 

 

77.64

%

 

77.64

%

 

 

 

 

 

 

Norfolk

 

100.00

%

 

 

100.00

%

 

 

 

 

 

 

Seattle

 

100.00

%

 

 

100.00

%

 

 

 

 

 

 

Houston

 

100.00

%

 

 

51.94

%

 

 

 

 

 

 

Other (3)

 

100.00

%

 

85.65

%

94.21

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

93.81

%

90.17

%

89.75

%

92.69

%

 

 

 

 

 

 


(1)          Includes all wholly owned and joint venture projects shown at 100% as of report date .

 

(2)          Represents the average annual rental property revenue due from tenants in occupancy as of the date of this report, excluding additional rent due as operating expense reimbursements, landlord allowances for operating expenses and percentage rents.  Joint Venture properties are shown at the Company’s ownership percentage.

 

(3)          Represents properties not located in the Company’s primary markets.  These properties are located in similar midwest or southeast markets.

Note: Excludes buildings that are in the held for sale portfolio.

 

 

15



Item 3.  Legal Proceedings

 

We are not subject to any material pending legal proceedings, other than ordinary routine litigation arising in the ordinary course of business. Our management expects that these ordinary routine legal proceedings will be covered by insurance and does not expect these legal proceedings to have a material adverse effect on our financial condition, results of operations, or liquidity.

 

Item 4.  Submission of Matters to a Vote of Security Holders

 

No matters were submitted to a vote of security holders during the quarter ended December 31, 2007.

 

PART II

 

Item 5.  Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Our common shares are listed for trading on the New York Stock Exchange under the symbol “DRE.” The following table sets forth the high and low sales prices of the common stock for the periods indicated and the dividend paid per share during each such period. Comparable cash dividends are expected in the future. As of February 20, 2008, there were 10,535 record holders of common shares.

 

 

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Quarter Ended

 

High

 

Low

 

Dividend

 

High

 

Low

 

Dividend

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31

 

$

35.40

 

$

24.25

 

$

.480

 

$

44.05

 

$

36.98

 

$

.475

 

September 30

 

37.05

 

29.74

 

.480

 

38.50

 

34.60

 

.475

 

June 30

 

44.90

 

35.22

 

.475

 

37.90

 

32.88

 

.470

 

March 31

 

48.42

 

40.02

 

.475

 

38.55

 

33.32

 

.470

 

 

On January 30, 2008, we declared a quarterly cash dividend of $.480 per share, payable on February 29, 2008, to common shareholders of record on February 14, 2008.

 

A summary of the tax characterization of the dividends paid per common share for the years ended December 31, 2007, 2006 and 2005 follows:

 

 

 

2007

 

2006

 

2005

 

 

 

 

 

 

 

 

 

Common shareholders dividend

 

$

1.91

 

$

1.89

 

$

1.87

 

Common shareholders dividend – special

 

 

 

1.05

 

Total dividends paid per share

 

$

1.91

 

$

1.89

 

$

2.92

 

 

 

 

 

 

 

 

 

Ordinary income

 

63.1

%

64.2

%

44.2

%

Return of capital

 

0

%

5.3

%

0

%

Capital gains

 

36.9

%

30.5

%

55.8

%

 

 

100.0

%

100.0

%

100.0

%

 

Securities Authorized for Issuance Under Equity Compensation Plans

 

The information required by this Item concerning securities authorized for issuance under equity compensation plans is set forth in or incorporated herein by reference to Part III, Item 12 of this Annual Report.

 

Sales of Unregistered Securities

 

We did not sell any of our securities during the three months ended December 31, 2007 that were not registered under the Securities Act.

 

 

16



 

Issuer Purchases of Equity Securities

 

From time to time, we repurchase our common shares under a $750.0 million share repurchase program that initially was approved by the Board of Directors and publicly announced in October 2001 (the “Repurchase Program”).   In July 2005, the Board of Directors authorized management to purchase up to $750.0 million of common shares pursuant to this plan. Under the Repurchase Program, we also execute share repurchases on an ongoing basis associated with certain employee elections under our compensation and benefit programs.

 

The following table shows the share repurchase activity for each of the three months in the quarter ended December 31, 2007:

 

 

 

 

 

 

 

 

 

Maximum Number

 

 

 

 

 

 

 

 

 

(or Approximate

 

 

 

 

 

 

 

Total Number of

 

Dollar Value) of

 

 

 

 

 

 

 

Shares Purchased as

 

Shares that May

 

 

 

Total Number of

 

 

 

Part of Publicly

 

Yet be Purchased

 

 

 

Shares

 

Average Price

 

Announced Plans or

 

Under the Plans or

 

Month

 

Purchased (1)

 

Paid per Share

 

Programs

 

Programs (2)

 

 

 

 

 

 

 

 

 

 

 

October

 

 

N/A

 

 

 

 

November

 

6,443

 

$

26.55

 

6,443

 

 

 

December

 

21,191

 

$

26.64

 

21,191

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

27,634

 

$

26.62

 

27,634

 

 

 


(1) Represents 27,634 common shares swapped to pay the exercise price of stock options.

 

(2) The number of common shares that may yet be repurchased in the open market to fund shares purchased under our Employee Stock Purchase Plan, as amended, was 81,840 on December 31, 2007.  The approximate dollar value of common shares that may yet be purchased under the Repurchase Program was $361.0 million as of December 31, 2007.

 

Item 6.  Selected Financial Data

 

The following sets forth selected financial and operating information on a historical basis for each of the years in the five-year period ended December 31, 2007. The following information should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8, “Financial Statements and Supplementary Data” included in this Form 10-K (in thousands, except per share amounts):

 

 

 

2007

 

2006

 

2005

 

2004

 

2003

 

 

 

 

 

 

 

 

 

 

 

 

 

Results of Operations:

 

 

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

Rental Operations from Continuing Operations

 

$

823,869

 

$

781,552

 

$

631,611

 

$

564,094

 

$

513,404

 

Service Operations from Continuing Operations

 

99,358

 

90,125

 

81,941

 

70,803

 

59,456

 

Total Revenues from Continuing Operations

 

$

923,227

 

$

871,677

 

$

713,552

 

$

634,897

 

$

572,860

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from Continuing Operations

 

$

159,196

 

$

151,363

 

$

132,815

 

$

126,941

 

$

133,022

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Income Available for common shareholders

 

$

217,692

 

$

145,095

 

$

309,183

 

$

151,279

 

$

161,911

 

 

 

 

 

 

 

 

 

 

 

 

 

Per Share Data:

 

 

 

 

 

 

 

 

 

 

 

Basic income per common share:

 

 

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

0.70

 

$

0.69

 

$

0.61

 

$

0.63

 

$

0.70

 

Discontinued operations

 

0.86

 

0.39

 

1.58

 

0.44

 

0.49

 

Diluted income per common share:

 

 

 

 

 

 

 

 

 

 

 

Continuing operations

 

0.69

 

0.68

 

0.60

 

0.63

 

0.70

 

Discontinued operations

 

0.86

 

0.39

 

1.57

 

0.43

 

0.49

 

Dividends paid per common share

 

1.91

 

1.89

 

1.87

 

1.85

 

1.83

 

Dividends paid per common share — special

 

 

 

1.05

 

 

 

Weighted average common shares outstanding

 

139,255

 

134,883

 

141,508

 

141,379

 

135,595

 

Weighted average common shares and potential dilutive common equivalents

 

149,614

 

149,393

 

155,877

 

157,062

 

151,141

 

 

17



 

 

 

 

2007

 

2006

 

2005

 

2004

 

2003

 

Balance Sheet Data (at December 31):

 

 

 

 

 

 

 

 

 

 

 

Total Assets

 

$

7,661,981

 

$

7,238,595

 

$

5,647,560

 

$

5,896,643

 

$

5,561,249

 

Total Debt  (1)

 

4,316,460

 

4,109,154

 

2,600,651

 

2,518,704

 

2,335,536

 

Total Preferred Equity

 

744,000

 

876,250

 

657,250

 

657,250

 

540,508

 

Total Shareholders’ Equity

 

2,750,033

 

2,503,583

 

2,452,798

 

2,825,869

 

2,666,749

 

Total Common Shares Outstanding

 

146,175

 

133,921

 

134,697

 

142,894

 

136,594

 

Other Data:

 

 

 

 

 

 

 

 

 

 

 

Funds From Operations (2)

 

$

384,032

 

$

338,008

 

$

341,189

 

$

352,469

 

$

335,989

 


(1) Includes $147,309 of secured debt classified as liabilities of properties held for sale at December 31, 2006.

 

(2) Funds From Operations (“FFO”) is used by industry analysts and investors as a supplemental operating  performance measure of an equity real estate investment trust (“REIT”) like Duke. FFO is calculated in accordance with the definition that was adopted by the Board of Governors of the National Association of Real Estate Investment Trusts (“NAREIT”). NAREIT created FFO as a supplemental measure of REIT operating performance that excludes historical cost depreciation, among other items, from net income determined in accordance with United States generally accepted accounting principles (“GAAP”).  FFO is a non-GAAP financial measure developed by NAREIT to compare the operating performance of REITs. The most comparable GAAP measure is net income (loss).  FFO should not be considered as a substitute for net income or any other measures derived in accordance with GAAP and may not be comparable to other similarly titled measures of other companies.

 

Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen or fallen with market conditions, many industry analysts and investors have considered the presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves.  FFO, as defined by NAREIT, represents GAAP net income (loss), excluding extraordinary items as defined under GAAP and gains or losses from sales of previously depreciated real estate assets, plus certain non-cash items such as real estate asset depreciation and amortization, and after similar adjustments for unconsolidated partnerships and joint ventures.

 

Management believes that the use of FFO, combined with the required primary GAAP presentations, improves the understanding of operating results of REITs among the investing public and makes comparisons of REIT operating results more meaningful. Management believes FFO is a useful measure for reviewing comparative operating and financial performance (although FFO should be reviewed in conjunction with net income which remains the primary measure of performance) because by excluding gains or losses related to sales of previously depreciated real estate assets and excluding real estate asset depreciation and amortization, FFO provides a useful comparison of the operating performance of our real estate between periods or as compared to different companies.

 

See reconciliation of FFO to GAAP net income under Year in Review section of Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Business Overview

 

We are a self-administered and self-managed REIT that began operations through a related entity in 1972. As of December 31, 2007, we:

·      Owned or jointly controlled 726 industrial, office, healthcare and retail properties (including properties under development), consisting of more than 121.1 million square feet; and

·      Owned or jointly controlled approximately 7,700 acres of unencumbered land with an estimated future development potential of more than 113 million square feet of industrial, office, healthcare and retail properties.

 

We provide the following services for our properties and for certain properties owned by third parties and joint ventures:

 

·  Property leasing;

·  Property management;

·  Asset management;

·  Construction;

·  Development; and

·  Other tenant-related services.

 

 

18



 

Management Philosophy and Priorities

 

Our key business and financial strategies for the future include the following:

 

·      One of our primary business objectives is to increase Funds From Operations (“FFO”) by (i) maintaining and increasing property occupancy and rental rates through the management of our portfolio of existing properties; (ii) developing and acquiring new properties for rental operations in our existing markets; (iii) expanding geographically by acquiring and developing properties in new markets; (iv) using our construction expertise to act as a general contractor or construction manager in our existing markets and other domestic markets on a fee basis; (v) developing and repositioning properties in our existing markets and other markets which we will sell through our Service Operations property sale program; and (vi) providing a full line of real estate services to our tenants and to third parties.

 

·      Our financing strategy is to actively manage the components of our capital structure including common and preferred equity and debt to maintain a conservatively leveraged balance sheet and investment grade ratings from our credit rating agencies. Additionally, we employ a capital recycling program where we utilize sales of operating real estate assets that no longer fit our strategies to generate proceeds that can be recycled into new properties that better fit our current and longer term strategies.  This strategy provides us with the financial flexibility to fund both development and acquisition opportunities. We seek to maintain a well-balanced, conservative and flexible capital structure by: (i) extending and sequencing the maturity dates of debt; (ii) borrowing primarily at fixed rates by targeting a variable rate component of total debt less than 20%; (iii) pursuing current and future long-term debt financings and refinancing generally on an unsecured basis;  (iv) maintaining conservative debt service and fixed charge coverage ratios; (v) generating proceeds from the sale of non-strategic properties and (vi) issuing perpetual preferred stock for 5-10% of our total capital structure.

 

Year in Review

 

During 2007, we continued the execution of our strategy to improve our portfolio of held for investment buildings through our capital recycling program, increasing our development pipeline to over $1.9 billion, and continuing geographic expansion that we anticipate will provide future earnings growth. As a result of these accomplishments, we achieved steady operating results while maintaining a strong balance sheet.

 

Net income available for common shareholders for the year ended December 31, 2007, was $217.7 million, or $1.55 per share (diluted), compared to net income of $145.1 million, or $1.07 per share (diluted) for the year ended 2006. FFO available to common shareholders totaled $384.0 million for the year ended December 31, 2007, compared to $338.0 million for the same period in 2006.  Industry analysts and investors use FFO as a supplemental operating performance measure of an equity real estate investment trust (“REIT”). FFO is calculated in accordance with the definition that was adopted by the Board of Governors of the National Association of Real Estate Investment Trusts (“NAREIT”). FFO, as defined by NAREIT, represents net income (loss) determined in accordance with United States generally accepted accounting principles (“GAAP”), excluding extraordinary items as defined under GAAP and gains or losses from sales of previously depreciated real estate assets, plus certain non-cash items such as real estate asset depreciation and amortization, and after similar adjustments for unconsolidated partnerships and joint ventures.

 

19



 

Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen or fallen with market conditions, many industry analysts and investors have considered presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves. Thus, NAREIT created FFO as a supplemental measure of REIT operating performance that excludes historical cost depreciation, among other items, from GAAP net income. Management believes that the use of FFO, combined with the required primary GAAP presentations, improves the understanding of operating results of REITs among the investing public and makes comparisons of REIT operating results more meaningful. Management believes FFO is a useful measure for reviewing comparative operating and financial performance (although FFO should be reviewed in conjunction with net income which remains the primary measure of performance) because by excluding gains or losses related to sales of previously depreciated real estate assets and excluding real estate asset depreciation and amortization, FFO provides a useful comparison of the operating performance of our real estate between periods or as compared to different companies.

 

The following table summarizes the calculation of FFO for the years ended December 31, 2007, 2006 and 2005, respectively (in thousands):

 

 

 

2007

 

2006

 

2005

 

 

 

 

 

 

 

 

 

Net income available for common shareholders

 

$

217,692

 

$

145,095

 

$

309,183

 

Adjustments:

 

 

 

 

 

 

 

Depreciation and amortization

 

277,691

 

254,268

 

254,170

 

Company share of joint venture depreciation and amortization

 

26,948

 

18,394

 

19,510

 

Earnings from depreciable property sales – wholly owned

 

(121,072

)

(42,089

)

(227,513

)

Earnings from depreciable property sales – share of joint venture

 

(6,244

)

(18,802

)

(11,096

)

Minority interest share of adjustments

 

(10,983

)

(18,858

)

(3,065

)

Funds From Operations

 

$

384,032

 

$

338,008

 

$

341,189

 

 

We continued strategic initiatives to expand geographically, recycle capital from the disposition of operating properties, and create value by leveraging our development, construction and management capabilities as follows:

 

·      As part of our continuing strategy to expand into new markets, we entered the Southern California, Seattle and Eastern Virginia markets in 2007. This follows our geographic expansion initiatives in 2006 into the Washington, D.C., Baltimore, Phoenix and Houston markets.

 

·      Throughout 2007, we completed land acquisitions totaling $321.3 million while generating proceeds of $161.5 million from the disposition of other land parcels. Of our total undeveloped land inventory, $108.1 million was placed under development during 2007 as construction activity commenced.

 

·      In February 2007, we continued our expansion into the health care real estate market by completing the acquisition of Bremner Healthcare Real Estate (“Bremner”), a national health care development and management firm. The initial consideration paid to the sellers totaled $47.1 million, and the sellers may be eligible for further contingent payments over the next three years.

 

·      We disposed of 32 non-strategic wholly owned held for rental properties for $336.7 million of gross proceeds.  Additionally, unconsolidated subsidiaries disposed of 10 properties of which our share of the gross proceeds totaled $30.1 million.  These transactions were a continuation of our long-term strategy of recycling assets into higher yielding new developments.

 

·      We disposed of 15 properties, which were developed with the intent to sell, for $256.6 million of gross proceeds and recognized pre-tax gains on sale of $34.7 million.

 

20



·                  We will continue to develop long-term assets to be held in our portfolio and develop assets to be sold upon, or soon after, completion. With over $1.9 billion (which includes $182.6 million of third-party construction backlog) in our development pipeline at December 31, 2007, we are encouraged about the long-term growth opportunities in our business.  Newly developed properties, with a basis of $593.1 million and occupancy of 59.7% at December 31, 2007, were placed in service during the year.

 

·                  We achieved record leasing activity in 2007 with approximately 22.5 million square feet of new leases and approximately 12.0 million square feet of lease renewals.

 

·                  We have continued to maintain a high occupancy level during this year of portfolio expansion as the overall occupancy percentage of 92.7% on our in-service held for rental portfolio was consistent with the 2006 level of 92.8%.

 

Highlights of our key financing activities in 2007 are as follows:

 

·                  We had $546.1 million outstanding on our lines of credit as of December 31, 2007.  During 2007, the borrowing capacity on our line of credit was increased from $1.0 billion to $1.3 billion while maintaining the interest rate of LIBOR plus 52.5 basis points.

 

·                  We issued $300.0 million of unsecured notes at an effective interest rate of 6.16%.  We retired $200.0 million of unsecured notes with a weighted average effective interest rate of 5.55%.

 

·                  In October 2007, we issued 7.0 million shares of our common stock for net proceeds of $232.7 million.

 

·                  In October 2007, we redeemed all of the outstanding shares of our 7.99% Series B Cumulative Redeemable Preferred Stock at a liquidation amount of $132.3 million.

 

·                  We continue to maintain a conservative balance sheet and investment grade debt ratings from Moody’s Investors Service (Baa1) and Standard & Poor’s Ratings Group (BBB+). Our debt to total market capitalization ratio (total market capitalization is defined as the total market value of all outstanding common and preferred shares and units of limited partner interest in our operating partnership plus outstanding indebtedness) was 48.4% at December 31, 2007 compared to 37.4% at December 31, 2006.

 

Key Performance Indicators

Our operating results depend primarily upon rental income from our industrial, office, and healthcare properties (“Rental Operations”). The following discussion highlights the areas of Rental Operations that we consider critical for future revenue growth. All square footage totals and occupancy percentages reflect both wholly-owned properties and properties in joint ventures.

 

Occupancy Analysis: As discussed above, our ability to maintain favorable occupancy rates is a principal driver of our results of operations. The following table sets forth occupancy information regarding our in-service portfolio of rental properties (excluding in-service properties developed or acquired with the intent to sell — “Service Operations Buildings”) as of December 31, 2007 and 2006, respectively  (in thousands, except percentage data):

 

 

 

Total
Square Feet

 

Percent of
Total Square Feet

 

Percent Occupied

 

Type

 

2007

 

2006

 

2007

 

2006

 

2007

 

2006

 

Industrial

 

77,143

 

75,455

 

69.4

%

69.3

%

93.8

%

93.1

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Office

 

32,384

 

32,481

 

29.1

%

29.8

%

90.2

%

92.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

1,612

 

916

 

1.5

%

0.9

%

89.8

%

96.2

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

111,139

 

108,852

 

100.0

%

100.0

%

92.7

%

92.8

%

 

 

 

21



 

Lease Expiration and Renewals: Our ability to maintain and grow occupancy rates primarily depends upon our continuing ability to re-lease expiring space. The following table reflects our in-service portfolio lease expiration schedule by property type as of December 31, 2007. The table indicates square footage and annualized net effective rents (based on December 2007 rental revenue) under expiring leases (in thousands, except percentage data):

 

 

 

Total Portfolio

 

Industrial

 

Office

 

Other

 

Year of Expiration

 

Square Feet

 

Ann. Rent Revenue

 

% of Revenue

 

Square
Feet

 

Ann. Rent Revenue

 

Square Feet

 

Ann. Rent Revenue

 

Square Feet

 

Ann. Rent
Revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2008

 

12,443

 

$

65,183

 

9

%

9,920

 

$

36,230

 

2,467

 

$

28,205

 

56

 

$

748

 

2009

 

11,780

 

77,664

 

11

%

8,394

 

33,718

 

3,317

 

43,223

 

69

 

723

 

2010

 

13,509

 

99,944

 

14

%

9,240

 

40,039

 

4,256

 

59,718

 

13

 

187

 

2011

 

13,937

 

87,565

 

12

%

10,396

 

39,297

 

3,474

 

47,207

 

67

 

1,061

 

2012

 

10,992

 

77,328

 

11

%

7,531

 

30,108

 

3,412

 

46,338

 

49

 

882

 

2013

 

9,401

 

82,543

 

12

%

5,220

 

22,364

 

4,126

 

59,361

 

55

 

818

 

2014

 

6,486

 

38,275

 

5

%

4,995

 

18,289

 

1,463

 

19,521

 

28

 

465

 

2015

 

8,249

 

60,814

 

8

%

5,988

 

23,622

 

2,261

 

37,192

 

 

 

2016

 

3,994

 

27,347

 

4

%

2,855

 

10,342

 

924

 

14,506

 

215

 

2,499

 

2017

 

6,458

 

44,873

 

6

%

4,572

 

18,166

 

1,539

 

21,988

 

347

 

4,719

 

2018 and Thereafter

 

5,767

 

54,201

 

8

%

3,259

 

16,913

 

1,960

 

29,715

 

548

 

7,573

 

 

 

103,016

 

$

715,737

 

100

%

72,370

 

$

289,088

 

29,199

 

$

406,974

 

1,447

 

$

19,675

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Portfolio Square Feet

 

111,139

 

 

 

 

 

77,143

 

 

 

32,384

 

 

 

1,612

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Percent Occupied

 

92.7

%

 

 

 

 

93.8

%

 

 

90.2

%

 

 

89.8

%

 

 

 

Note:  Excludes buildings that are in the held for sale portfolio.

 

We renewed 79.7% and 79.9% of our leases up for renewal totaling approximately 9.8 million and 7.5 million square feet in 2007 and 2006, respectively. We attained 5.81% growth in net effective rents on these renewals during 2007.  Our lease renewal percentages over the past three years have remained relatively consistent at a 70-80% success rate. We do not presently expect this renewal percentage in 2008 to differ from the past three years.

 

Development: Another source of growth in earnings is the development of additional properties. These properties should provide future earnings through income upon sale or from Rental Operations income as they are placed in service. We had 16.6 million square feet of property under development with total estimated costs upon completion of $1.2 billion at December 31, 2007, compared to 10.6 million square feet and total costs of $1.1 billion at December 31, 2006. We have increased our development pipeline during 2007 and will continue to pursue additional development opportunities, while focusing on pre-leasing as we closely monitor the strength of the national and local market economies.

 

The following table summarizes our properties under development as of December 31, 2007 (in thousands, except percentage data):

 

Anticipated
In-Service
Date

 

Square
Feet

 

Percent
Leased

 

Project
Costs

 

Anticipated
Stabilized
Return

 

Held for Rental Buildings:

 

 

 

 

 

 

 

 

 

1st Quarter 2008

 

3,753

 

32

%

$

174,923

 

9.39

%

2nd Quarter 2008

 

3,843

 

19

%

231,851

 

8.76

%

3rd Quarter 2008

 

1,778

 

23

%

198,615

 

9.22

%

Thereafter

 

633

 

60

%

136,590

 

8.82

%

 

 

10,007

 

28

%

741,979

 

9.04

%

Service Operations Buildings:

 

 

 

 

 

 

 

 

 

1st Quarter 2008

 

1,231

 

70

%

50,999

 

8.69

%

2nd Quarter 2008

 

1,044

 

88

%

85,708

 

8.20

%

3rd Quarter 2008

 

1,252

 

100

%

78,374

 

8.43

%

Thereafter

 

3,045

 

86

%

240,766

 

8.11

%

 

 

6,572

 

86

%

455,847

 

8.25

%

Total

 

16,579

 

51

%

$

1,197,826

 

8.74

%

 

 

 

22



 

 

Acquisition and Disposition Activity: We continued to selectively dispose of non-strategic properties in 2007.  Gross sales proceeds related to the dispositions of wholly owned held for rental properties were $336.7 million, which included the disposition of a portfolio of eight office properties in the Cleveland market and a portfolio of twelve industrial properties in the St. Louis market.  Our share of proceeds from sales of properties within unconsolidated joint ventures, in which we have less than a 100% interest, totaled $30.1 million.  In 2006, proceeds totaled $139.9 million for the disposition of wholly owned held for rental properties and $91.9 million for our share of property sales from unconsolidated joint ventures.  Dispositions of wholly owned properties developed for sale rather than rental resulted in $256.6 million in proceeds in 2007 compared to $188.6 million in 2006.  We intend to continue to identify properties for disposition in order to recycle the proceeds into higher yielding assets. The level of 2008 dispositions will be impacted by the ability of the prospective buyers to obtain favorable financing given the current state of the capital markets.

 

In 2007, in addition to the acquisition of Bremner, we acquired $117.0 million of income producing properties and $321.3 million of undeveloped land compared to $948.4 million of income producing properties and $436.7 million of undeveloped land in 2006.

 

Results of Operations

 

A summary of our operating results and property statistics for each of the years in the three-year period ended December 31, 2007, is as follows (in thousands, except number of properties and per share data):

 

 

 

2007

 

2006

 

2005

 

 

 

 

 

 

 

 

 

Rental Operations revenues from Continuing Operations

 

$

823,869

 

$

781,552

 

$

631,611

 

Service Operations revenues from Continuing Operations

 

99,358

 

90,125

 

81,941

 

Earnings from Continuing Rental Operations

 

109,079

 

125,514

 

110,812

 

Earnings from Continuing Service Operations

 

52,034

 

53,196

 

44,278

 

Operating income

 

123,433

 

142,913

 

124,128

 

Net income available for common shareholders

 

217,692

 

145,095

 

309,183

 

Weighted average common shares outstanding

 

139,255

 

134,883

 

141,508

 

Weighted average common shares and potential dilutive
common equivalents

 

149,614

 

149,393

 

155,877

 

Basic income per common share:

 

 

 

 

 

 

 

Continuing operations

 

$

.70

 

$

.69

 

$

.61

 

Discontinued operations

 

$

.86

 

$

.39

 

$

1.58

 

Diluted income per common share:

 

 

 

 

 

 

 

Continuing operations

 

$

.69

 

$

.68

 

$

.60

 

Discontinued operations

 

$

.86

 

$

.39

 

$

1.57

 

Number of in-service properties at end of year

 

688

 

696

 

660

 

In-service square footage at end of year

 

111,139

 

108,852

 

97,835

 

 

 

Comparison of Year Ended December 31, 2007 to Year Ended December 31, 2006

 

Rental Revenue from Continuing Operations

 

Overall, rental revenue from continuing operations increased from $743.5 million in 2006 to $794.5 million in 2007. The following table reconciles rental revenue from continuing operations by reportable segment to our total reported rental revenue from continuing operations for the years ended December 31, 2007 and 2006, respectively (in thousands):

 

 

 

2007

 

2006

 

 

 

 

 

 

 

Office

 

$

547,478

 

$

534,369

 

Industrial

 

219,080

 

194,670

 

Other

 

27,930

 

14,509

 

Total

 

$

794,488

 

$

743,548

 

 

 

Both of our reportable segments that comprise Rental Operations (office and industrial) are within the real estate industry; however, the same economic and industry conditions do not affect each segment in the same manner. The primary causes of the increase in rental revenue from continuing operations, with specific references to a particular segment when applicable, are summarized below:

 

23



 

·                  In 2007, we acquired six new properties and placed 38 development projects in-service. These acquisitions and developments provided incremental revenues of $2.9 million and $16.6 million, respectively.

 

·                  Acquisitions and developments that were placed in service in 2006 provided $12.4 million and $25.1 million, respectively, of incremental revenue in 2007.

 

·                  We acquired an additional 31 properties in 2006 and later contributed them to an unconsolidated joint venture, resulting in a $40.2 million reduction in revenues for the year ended December 31, 2007, as compared to the same period in 2006.  Of these properties, 23 were contributed in the fourth quarter of 2006, seven were contributed in the second quarter of 2007 and one was contributed in the fourth quarter of 2007.

 

·                  Rental revenue includes lease termination fees.  Lease termination fees relate to specific tenants who pay a fee to terminate their lease obligations before the end of the contractual lease term. Lease termination fees increased from $16.1 million in 2006 to $24.2 million in 2007.

 

·                  The remaining increase in rental revenues is primarily the result of an $18.2 million increase in revenues from reimbursable rental expenses.  This increase is largely offset by a corresponding increase in overall rental expenses.

 

Equity in Earnings of Unconsolidated Companies

 

Equity in earnings represents our ownership share of net income from investments in unconsolidated companies. These joint ventures generally own and operate rental properties and develop properties.  These earnings decreased from $38.0 million in 2006 to $29.4 million in 2007. During 2006, our joint ventures sold 22 non-strategic buildings, with our share of the net gain recorded through equity in earnings totaling $18.8 million, compared to ten joint venture building sales in 2007, with $8.0 million recorded to equity in earnings for our share of the net gains.

 

Rental Expenses and Real Estate Taxes

 

The following table reconciles rental expenses and real estate taxes by reportable segment to our total reported amounts in the statement of operations for the years ended December 31, 2007 and 2006, respectively (in thousands):

 

 

 

2007

 

2006

 

Rental Expenses:

 

 

 

 

 

Office

 

$

144,320

 

$

143,567

 

Industrial

 

23,919

 

21,991

 

Other

 

8,435

 

3,519

 

Total

 

$

176,674

 

$

169,077

 

 

 

 

 

 

 

Real Estate Taxes:

 

 

 

 

 

Office

 

$

63,572

 

$

55,963

 

Industrial

 

27,530

 

21,760

 

Other

 

7,033

 

6,015

 

Total

 

$

98,135

 

$

83,738

 

 

 

Of the overall $7.6 million increase in rental expenses in 2007 compared to 2006, $9.9 million was attributable to properties acquired and developments placed in service from January 1, 2006 through December 31, 2007.  This increase was largely offset by a reduction in rental expenses of $7.6 million resulting from the contribution of 31 properties to an unconsolidated joint venture in 2006 and 2007.  Inclement weather conditions in the first quarter of 2007, an increase in utility rates and volume in the third quarter of 2007 due to unseasonably high temperatures and normal inflationary factors triggered the remaining increase in rental expenses.

 

 

24



 

 

Of the overall $14.4 million increase in real estate taxes in 2007 compared to 2006, $7.7 million was attributable to properties acquired and developments placed in service from January 1, 2006 through December 31, 2007.  The remaining increase in real estate taxes was driven by increases in assessments in some of our markets.

 

Interest Expense

 

Interest expense from continuing operations remained fairly consistent from 2006 to 2007 at $170.5 million in 2006, compared to $168.4 million in 2007.  While we maintained higher outstanding borrowings in 2007 compared to 2006, these higher borrowings were used to fund our increase in development activities and thus, the increased interest costs from these borrowings were capitalized into project costs rather than expensed.

 

Depreciation and Amortization Expense

 

Depreciation and amortization increased from $232.7 million in 2006 to $271.6 million in 2007 due to increases in our held-for-rental asset base from acquisitions and developments placed in service during 2006 and 2007.

 

Service Operations

 

Service Operations primarily consist of sales of properties developed or acquired with the intent to sell within a short period of time and the leasing, management, construction and development services for joint venture properties and properties owned by third parties.  Leasing and management fees are dependent upon occupancy while construction and development services rely on the expansion of business operations of third party property owners. Earnings from Service Operations decreased slightly from $53.2 million in 2006 to $52.0 million in 2007.  The following are the factors related to the decrease in earnings from Service Operations in 2007:

 

·                  Our Service Operations building development and sales program, whereby a building is developed or repositioned by us and then sold soon after completion, is a significant component of earnings from operations and is often a significant driver of fluctuations in earnings from Service Operations between periods. During 2007, we generated pre-tax gains of $34.7 million from the sale of 15 properties compared to $44.6 million from the sale of nine properties in 2006. Partially offsetting the aforementioned decrease was a $2.9 million reduction in income taxes on these gains on sale, with the net effect of decreased gains on sale in 2007 resulting in a $7.0 million decrease in earnings from Service Operations.

·                  Increased net general contractor revenues drove a $9.7 million increase in earnings from Service Operations from 2006 as the result of increased volume and margins and favorable settlement of previously existing warranty reserves.

 

General and Administrative Expense

 

General and administrative expense increased from $35.8 million in 2006 to $37.7 million in 2007. General and administrative expenses are comprised of two components. The first component is direct expenses that are not attributable to specific assets such as legal fees, audit fees, marketing costs, investor relations expenses and other corporate overhead. The second component is the unallocated indirect costs determined to be unrelated to the operation of our owned properties and Service Operations. Those indirect costs not allocated to these operations are charged to general and administrative expenses. There was a $31.7 million increase in the overall pool of overhead costs in 2007 that was necessitated by our overall growth. The majority of this increase in the overall pool of overhead costs was necessary as the result of increased rental and service operations activity and thus, was allocated to rental operations, construction, development and leasing. Approximately $1.5 million of the aforementioned increase in the overall overhead pool was not allocated to operations, which was the primary reason for the overall $1.9 million increase to general and administrative expense.

 

25



 

 

Discontinued Operations

 

The results of operations for properties sold during the year or designated as held-for-sale at the end of the period are required to be classified as discontinued operations. The property specific components of net earnings that are classified as discontinued operations include rental revenues, rental expenses, real estate taxes, allocated interest expense, depreciation expense and minority interest, as well as the net gain or loss on the disposition of properties.

 

We classified the operations of 302 properties as discontinued operations as of December 31, 2007. These 302 properties consist of 253 industrial, 48 office and one retail property. As a result, we classified net income from operations, net of minority interest, of $6.7 million, $10.7 million and $18.6 million as net income from discontinued operations for the years ended December 31, 2007, 2006 and 2005, respectively.

 

Of these properties, 32 were sold during 2007, 21 properties were sold during 2006, 234 properties were sold during 2005, and 15 operating properties are classified as held-for-sale at December 31, 2007. The gains on disposal of these properties, net of impairment adjustment and minority interest, of $113.6 million, $42.1 million and $204.3 million for the years ended December 31, 2007, 2006 and 2005, respectively, are also reported in discontinued operations.

 

Comparison of Year Ended December 31, 2006 to Year Ended December 31, 2005

 

Rental Revenue from Continuing Operations

 

Overall, rental revenue from continuing operations increased from $602.1 million in 2005 to $743.5 million in 2006. The following table reconciles rental revenue from continuing operations by reportable segment to total reported rental revenue from continuing operations for the years ended December 31, 2006 and 2005, respectively (in thousands):

 

 

 

2006

 

2005

 

 

 

 

 

 

 

Office

 

$

534,369

 

$

443,927

 

Industrial

 

194,670

 

148,359

 

Other

 

14,509

 

9,776

 

Total

 

$

743,548

 

$

602,062

 

 

 

Both of our reportable segments that comprise Rental Operations (office and industrial) are within the real estate industry; however, the same economic and industry conditions do not affect each segment in the same manner. The primary causes of the increase in rental revenue from continuing operations, with specific references to a particular segment when applicable, are summarized below:

 

·                  In 2006, we acquired 50 new properties and placed 27 development projects in-service. These 2006 acquisitions and developments are the primary factor in the overall increase in rental revenue for the year ended 2006 compared to 2005 as they provided incremental revenues of $73.8 million and $9.3 million respectively. These acquisitions totaled $948.4 million on 8.6 million square feet and were 99% leased at December 31, 2006.

 

·                  Acquisitions and developments that were placed in service in 2005 provided $15.8 million and $11.2 million, respectively, of incremental revenue in 2006.

 

·                  Rental revenue includes lease termination fees.  Lease termination fees relate to specific tenants who pay a fee to terminate their lease obligations before the end of the contractual lease term. Lease termination fees increased from $7.3 million in 2005 to $16.1 million in 2006.

 

·                  Our in-service occupancy increased from 92.7% at December 31, 2005, to 92.9% at December 31, 2006 and contributed to the remaining increase in rental revenue.

 

 

26



 

 

Equity in Earnings of Unconsolidated Companies

 

Equity in earnings represents our ownership share of net income from investments in unconsolidated companies. These joint ventures generally own and operate rental properties and develop properties.  These earnings increased from $29.5 million in 2005 to $38.0 million in 2006. During 2006, our joint ventures sold 22 non-strategic buildings, with our share of the net gain recorded through equity in earnings totaling $18.8 million.  During the second quarter of 2005, one of our ventures sold three buildings, with our share of the net gain recorded through equity in earnings totaling $11.1 million.

 

Rental Expenses and Real Estate Taxes

 

The following table reconciles rental expenses and real estate taxes by reportable segment to our total reported amounts in the statement of operations for the years ended December 31, 2006 and 2005, respectively (in thousands):

 

 

 

 

2006

 

2005

 

Rental Expenses:

 

 

 

 

 

Office

 

$

143,567

 

$

119,052

 

Industrial

 

21,991

 

18,264

 

Other

 

3,519

 

1,557

 

Total

 

$

169,077

 

$

138,873

 

 

 

 

 

 

 

 

 

 

 

 

 

Real Estate Taxes:

 

 

 

 

 

Office

 

$

55,963

 

$

49,936

 

Industrial

 

21,760

 

17,758

 

Other

 

6,015

 

5,104

 

Total

 

$

83,738

 

$

72,798

 

 

Rental expenses and real estate taxes for 2006 have increased from 2005 by $30.2 million and $10.9 million, respectively, as the result of acquisition and development activity in 2005 and 2006 as well as from an increase in occupancy over the past two years.

 

Interest Expense

 

Interest expense increased from $106.0 million in 2005 to $170.5 million in 2006, as a result of the following:

 

·                  Interest costs on the unsecured line of credit increased by $29.2 million from 2005 as the result of increased borrowings throughout the year, as well as increased interest rates.

·                  Interest costs on unsecured notes increased by $10.2 million as the result of an overall increase in borrowings used mainly to fund acquisitions and development.

·                  Interest costs on secured debt increased by $27.8 million as the result of the increase in borrowings in 2006.

·                  Offsetting the above increases, capitalized interest increased by $26.8 million as the result of increased development activities.

 

Depreciation and Amortization Expense

 

Depreciation and amortization increased from $203.1 million in 2005 to $232.7 million in 2006 as the result of increases in our held-for-rental asset base from acquisitions and developments placed in service during 2005 and 2006.

 

 

27



 

 

Service Operations

 

Service Operations primarily consist of sales of properties developed or acquired with the intent to sell within a short period of time and the leasing, management, construction and development services for joint venture properties and properties owned by third parties. Leasing and management fees are dependent upon occupancy while construction and development services rely on the expansion of business operations of third party property owners. Earnings from Service Operations increased from $44.3 million in 2005 to $53.2 million in 2006. The following are the factors related to the increase in earnings from Service Operations in 2006.

 

·                  Our Service Operations building development and sales program, whereby a building is developed or repositioned by us and then sold soon after completion, is a significant component of earnings from operations and is often a significant driver of fluctuations in earnings from Service Operations between periods. During 2006, we generated pre-tax gains of $44.6 million from the sale of nine properties compared to $29.9 million from the sale of ten properties in 2005. Profit margins on these types of building sales fluctuate by sale depending on the type of property being sold, the strength of the underlying tenant and nature of the sale, such as a pre-contracted purchase price for a primary tenant versus a sale on the open market.

 

·                  Partially offsetting the increased 2006 gains from our Service Operations building development and sales program was the effect of a decreased focus on third-party construction services as well as the fact that in the first quarter of 2005, we recognized $2.7 million of a non-recurring deferred gain associated with the sale of our landscaping operations in 2001.

 

General and Administrative Expense

 

General and administrative expense increased from $31.0 million in 2005 to $35.8 million in 2006. General and administrative expenses are comprised of two components. The first component is direct expenses that are not attributable to specific assets such as legal fees, audit fees, marketing costs, investor relations expenses and other corporate overhead. The second component is the unallocated indirect costs determined to be unrelated to the operation of our owned properties and Service Operations. Those indirect costs not allocated to these operations are charged to general and administrative expenses. The increase in general and administrative expenses from 2005 was largely attributable to an increase in our overall pool of overhead costs to support our current and anticipated future growth.

 

Critical Accounting Policies

 

The preparation of our consolidated financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Our estimates, judgments and assumptions are inherently subjective and based on the existing business and market conditions, and are therefore continually evaluated based upon available information and experience. Note 2 to the Consolidated Financial Statements includes further discussion of our significant accounting policies. Our management has assessed the accounting policies used in the preparation of our financial statements and discussed them with our Audit Committee and independent auditors. The following accounting policies are considered critical based upon materiality to the financial statements, degree of judgment involved in estimating reported amounts and sensitivity to changes in industry and economic conditions:

 

 

28



 

 

Accounting for Joint Ventures: We analyze our investments in joint ventures under Financial Accounting Standards Board (“FASB”) Interpretation No. 46(R), Consolidation of Variable Interest Entities, to determine if the joint venture is considered a variable interest entity and would require consolidation. To the extent that our joint ventures do not qualify as variable interest entities, we further assess under the guidelines of Emerging Issues Task Force (“EITF”) Issue No. 04-5, Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights (“EITF 04-5”); Statement of Position 78-9, Accounting for Investments in Real Estate Ventures (“SOP 78-9”); Accounting Research Bulletin No. 51, Consolidated Financial Statements; and Statement of Financial Accounting Standard (“SFAS”) No. 94,  Consolidation of All Majority-Owned Subsidiaries, to determine if the venture should be consolidated. We have equity interests generally ranging from 10% to 50% in unconsolidated joint ventures that develop, own and operate rental properties and hold land for development. We consolidate those joint ventures that are considered to be variable interest entities where we are the primary beneficiary.  For non-variable interest entities, we consolidate those joint ventures that we control through majority ownership interests or where we are the managing member and our partner does not have substantive participating rights. Control is further demonstrated by the ability of the general partner to manage day-to-day operations, refinance debt and sell the assets of the joint venture without the consent of the limited partner and inability of the limited partner to replace the general partner. We use the equity method of accounting for those joint ventures where we do not have control over operating and financial polices. Under the equity method of accounting, our investment in each joint venture is included on our balance sheet; however, the assets and liabilities of the joint ventures for which we use the equity method are not included on our balance sheet.

 

To the extent that we contribute assets to a joint venture, our investment in joint venture is recorded at our cost basis in the assets that were contributed to the joint venture.  To the extent that our cost basis is different than the basis reflected at the joint venture level, the basis difference is amortized over the life of the related asset and included in our share of equity in net income of the joint venture.  In accordance with the provisions of SOP 78-9 and SFAS No. 66, Accounting for Sales of Real Estate, we recognize gains on the contribution or sale of real estate to joint ventures, relating solely to the outside partner’s interest, to the extent the economic substance of the transaction is a sale.

 

Cost Capitalization: Direct and certain indirect costs, including interest, clearly associated with and incremental to the development, construction, leasing or expansion of real estate investments are capitalized as a cost of the property.

 

We capitalize interest and direct and indirect project costs associated with the initial construction of a property up to the time the property is substantially complete and ready for its intended use. We believe the completion of the building shell is the proper basis for determining substantial completion and that this basis is the most widely accepted standard in the real estate industry. The interest rate used to capitalize interest is based upon our average borrowing rate on existing debt.

 

We also capitalize direct and indirect costs, including interest costs, on vacant space during extended lease-up periods after construction of the building shell has been completed if costs are being incurred to ready the vacant space for its intended use. If costs and activities incurred to ready the vacant space cease, then cost capitalization is also discontinued until such activities are resumed. Once necessary work has been completed on a vacant space, project costs are no longer capitalized. We cease capitalization of all project costs on extended lease-up periods after the shorter of a one-year period after the completion of the building shell or when the property attains 90% occupancy.  In addition, all leasing commissions paid to third parties for new leases or lease renewals are capitalized.

 

 

29



 

 

In assessing the amount of indirect costs to be capitalized, we first allocate payroll costs, on a department-by-department basis, among activities for which capitalization is warranted (i.e., construction, development and leasing) and those for which capitalization is not warranted  (i.e., property management, maintenance, acquisitions and dispositions and general corporate functions). To the extent the employees of a department split their time between capitalizable and non-capitalizable activities, the allocations are made based on estimates of the actual amount of time spent in each activity. Once the payroll costs are allocated, the non-payroll costs of each department are allocated among the capitalizable and non-capitalizable activities in the same proportion as payroll costs.

 

To ensure that an appropriate amount of costs are capitalized, the amount of capitalized costs that are allocated to a specific project are limited to amounts using standards we developed. These standards consist of a percentage of the total development costs of a project and a percentage of the total gross lease amount payable under a specific lease. These standards are derived after considering the amounts that would be allocated if the personnel in the departments were working at full capacity. The use of these standards ensures that overhead costs attributable to downtime or to unsuccessful projects or leasing activities are not capitalized.

 

Impairment of Real Estate Investments: We evaluate our real estate investments upon occurrence of significant changes in the operations, but not less than annually, to assess whether any impairment indications are present that affect the recovery of the recorded value. If any real estate investment is considered to be impaired, a loss is provided to reduce the carrying value of the asset to its estimated fair value. We utilize the guidelines established under SFAS No. 144, Accounting for the Impairment or Disposal of Long Lived Assets (“SFAS 144”), to determine if impairment conditions exist. Under SFAS 144, we review the expected undiscounted cash flows of each property in our held for rental portfolio to determine if there are any indications of impairment of a property. The review of anticipated cash flows involves subjective assumptions of estimated occupancy and rental rates and ultimate residual value. In addition to reviewing anticipated cash flows, we assess other factors such as changes in business climate and legal factors that may affect the ultimate value of the property. These assumptions are subjective and the anticipated cash flows may not ultimately be achieved.

 

Real estate assets to be disposed of are reported at the lower of their carrying value amount or the fair value less estimated cost to sell.

 

Acquisition of Real Estate Property and Related Assets: In accordance with SFAS 141, Business Combinations, we allocate the purchase price of acquired properties to net tangible and identified intangible assets based on their respective fair values.

 

The allocation to tangible assets (buildings, tenant improvements and land) is based upon management’s determination of the value of the property as if it were vacant using discounted cash flow models similar to those used by independent appraisers. Factors considered by management include an estimate of carrying costs during the expected lease-up periods considering current market conditions, and costs to execute similar leases. The remaining purchase price is allocated among three categories of intangible assets consisting of the above or below market component of in-place leases, the value of in-place leases and the value of customer relationships.

 

·                  The value allocable to the above or below market component of an acquired in-place lease is determined based upon the present value (using an interest rate which reflects the risks associated with the lease) of the difference between (i) the contractual amounts to be paid pursuant to the lease over its remaining term and (ii) management’s estimate of the amounts that would be paid using current fair market rates over the remaining term of the lease. The amounts allocated to above market leases are included in deferred leasing and other costs in the balance sheet and below market leases are included in other liabilities in the balance sheet; both are amortized to rental income over the remaining terms of the respective leases.

·                  The total amount of intangible assets is further allocated to in-place lease values and to customer relationship values, based upon management’s assessment of their respective values. These intangible assets are included in deferred leasing and other costs in the balance sheet and are depreciated over the remaining term of the existing lease, or the anticipated life of the customer relationship, as applicable.

 

 

 

30



 

 

Valuation of Receivables: We are subject to tenant defaults and bankruptcies that could affect the collection of outstanding receivables. In order to mitigate these risks, we perform in-house credit reviews and analyses on major existing tenants and all significant leases before they are executed. We have established the following procedures and policies to evaluate the collectibility of outstanding receivables and record allowances:

 

·                  We maintain a tenant “watch list” containing a list of significant tenants for which the payment of receivables and future rent may be at risk. Various factors such as late rent payments, lease or debt instrument defaults, and indications of a deteriorating financial position are considered when determining whether to include a tenant on the watch list.

·                  As a matter of policy, we reserve the entire receivable balance, including straight-line rent, of any tenant with an amount outstanding over 90 days.

·                  Straight-line rent receivables for any tenant on the watch list or any other tenant identified as a potential long-term risk, regardless of the status of rent receivables, are reviewed and reserved as necessary.

 

Construction Contracts: We recognize income on construction contracts where we serve as a general contractor on the percentage of completion method. Using this method, profits are recorded on the basis of our estimates of the overall profit and percentage of completion of individual contracts. A portion of the estimated profits is accrued based upon our estimates of the percentage of completion of the construction contract. Cumulative revenues recognized may be less or greater than cumulative costs and profits billed at any point in time during a contract’s term. This revenue recognition method involves inherent risks relating to profit and cost estimates with those risks reduced through approval and monitoring processes.

 

With regard to critical accounting policies, management has discussed the following with the Audit Committee:

 

·                  Criteria for identifying and selecting;

·                  Methodology in applying; and

·                  Impact on the financial statements.

 

The Audit Committee has reviewed the critical accounting policies we identified.

 

Liquidity and Capital Resources

 

Sources of Liquidity

 

We expect to meet our short-term liquidity requirements over the next twelve months, including payments of dividends and distributions, as well as recurring capital expenditures relating to maintaining our current real estate assets, primarily through the following:

·                  working capital;

·                  net cash provided by operating activities; and

·                  proceeds received from real estate dispositions

 

Although we historically have not used any other sources of funds to pay for recurring capital expenditures on our current real estate investments, we may rely on the temporary use of borrowings needed to fund such expenditures during periods of high leasing volume.

 

We expect to meet long-term liquidity requirements, such as scheduled mortgage and unsecured debt maturities, property acquisitions, financing of development activities and other non-recurring capital improvements, primarily from the following sources:

 

·                  issuance of additional equity, including common and preferred shares;

·                  issuance of additional debt securities;

·                  undistributed cash provided by operating activities; and

·                  proceeds received from real estate dispositions.

 

 

31



We do not believe the state of the credit markets will adversely affect our ability to secure long-term financing.

 

Rental Operations

We believe our principal source of liquidity, cash flows from Rental Operations, provides a stable source of cash to fund operational expenses. We believe this cash-based revenue stream is substantially aligned with revenue recognition (except for periodic straight-line rental income accruals and amortization of above or below market rents) as cash receipts from the leasing of rental properties are generally received in advance of or in a short time following the actual revenue recognition.

 

We are subject to risks of decreased occupancy through market conditions, as well as tenant defaults and bankruptcies, and potential reduction in rental rates upon renewal or re-letting of properties, each of which would result in reduced cash flow from operations. However, we believe that these risks may be mitigated by our relatively strong market presence in most of our markets and the fact that we perform in-house credit reviews and analyses on major tenants and all significant leases before they are executed.

 

Debt and Equity Securities

We had an unsecured line of credit available at December 31, 2007.  During 2007, the borrowing capacity on this line of credit was increased from $1.0 billion to $1.3 billion. Additionally, in July 2007, one of our consolidated majority owned subsidiaries entered into a lending agreement that included an additional unsecured line of credit.  Our unsecured lines of credit as of December 31, 2007 are described as follows (in thousands):

 

Description

 

Borrowing
Capacity

 

Maturity
Date

 

Outstanding Balance
at December 31, 2007

 

Unsecured Line of Credit

 

$

1,300,000

 

January 2010

 

$

543,000

 

Unsecured Line of Credit – Consolidated Subsidiary

 

$

30,000

 

July 2011

 

$

3,067

 

 

We use our line of credit to fund development activities, acquire additional rental properties and provide working capital. This line of credit provides us with an option to obtain borrowings from financial institutions that participate in the line, at rates lower than the stated interest rate, subject to certain restrictions.  The interest rate on the amounts outstanding on the unsecured line of credit as of December 31, 2007 was  LIBOR plus .525%, which for borrowings outstanding at December 31, 2007 ranged  from  5.355% to 5.775%. Our line of credit also contains financial covenants that require us to meet financial ratios and defined levels of performance, including those related to variable interest indebtedness, consolidated net worth and debt-to-market capitalization. As of December 31, 2007, we were in compliance with all covenants under our line of credit.

 

The consolidated subsidiary’s unsecured line of credit allows for borrowings up to $30.0 million at a rate of LIBOR plus .85% (equal to 5.73% for outstanding borrowings as of December 31, 2007).  The unsecured line of credit is used to fund development activities within the consolidated subsidiary.  The consolidated subsidiary’s unsecured line of credit matures in July 2011 with a 12-month extension option.

 

At December 31, 2007, we had on file with the SEC an automatic shelf registration statement on Form S-3, relating to the offer and sale, from time to time, of an indeterminate amount of debt securities (including guarantees thereof), common shares, preferred shares, depository shares, warrants, stock purchase contracts and Units comprised of one or more of the securities described therein.  From time to time, we expect to issue additional securities under this automatic shelf registration statement to fund development and acquisition of additional rental properties and to fund the repayment of the credit facility and other long-term debt upon maturity.

 

 

32



 

In February 2008, we issued $300.0 million of 8.375% Series O Cumulative Redeemable Preferred Shares.

 

The indentures (and related supplemental indentures) governing our outstanding series of notes also require us to comply with financial ratios and other covenants regarding our operations.  We were in compliance with all such covenants as of December 31, 2007.

 

Sale of Real Estate Assets

We utilize sales of real estate assets as an additional source of liquidity. We pursue opportunities to sell real estate assets at favorable prices to capture value created by us as well as to improve the overall quality of our portfolio by recycling sale proceeds into new properties with greater value creation opportunities.

 

Uses of Liquidity

 

Our principal uses of liquidity include the following:

 

·  Property investments;

·  Recurring leasing/capital costs;

·  Dividends and distributions to shareholders and unitholders;

·  Long-term debt maturities; and

·  Other contractual obligations

 

Property Investments

We evaluate development and acquisition opportunities based upon market outlook, supply and long-term growth potential.

 

Recurring Expenditures

One of our principal uses of our liquidity is to fund the recurring leasing/capital expenditures of our real estate investments. The following is a summary of our recurring capital expenditures for the years ended December 31, 2007, 2006 and 2005, respectively (in thousands):

 

 

 

2007

 

2006

 

2005

 

 

 

 

 

 

 

 

 

Recurring tenant improvements

 

$

45,296

 

$

41,895

 

$

60,633

 

Recurring leasing costs

 

32,238

 

32,983

 

33,175

 

Building improvements

 

8,402

 

8,122

 

15,232

 

Totals

 

$

85,936

 

$

83,000

 

$

109,040

 

 

Dividends and Distributions

In order to qualify as a REIT for federal income tax purposes, we must currently distribute at least 90% of our taxable income to shareholders. We paid dividends per share of $1.91, $1.89 and $1.87 for the years ended December 31, 2007, 2006 and 2005, respectively. We also paid a one-time special dividend of $1.05 per share in 2005 as a result of the significant gain realized from an industrial portfolio sale. We expect to continue to distribute taxable earnings to meet the requirements to maintain our REIT status. However, distributions are declared at the discretion of our board of directors and are subject to actual cash available for distribution, our financial condition, capital requirements and such other factors as our board of directors deems relevant.

 

 

33



 

Debt Maturities

Debt outstanding at December 31, 2007 totaled $4.3 billion with a weighted average interest rate of 5.74% maturing at various dates through 2028. We had $3.2 billion of unsecured notes, $546.1 million outstanding on our unsecured lines of credit and $524.4 million of secured debt outstanding at December 31, 2007. Scheduled principal amortization and maturities of such debt totaled $249.8 million for the year ended