10-K 1 fpo201610-k.htm 10-K Document


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
 
FORM 10-K
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2016
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission File Number 1-31824
 
 
FIRST POTOMAC REALTY TRUST
(Exact name of registrant as specified in its charter)
 
MARYLAND
 
37-1470730
(State of incorporation)
 
(I.R.S. Employer Identification No.)
7600 Wisconsin Avenue, 11th Floor, Bethesda, MD
(Address of principal executive offices)
20814
(Zip Code)
(301) 986-9200
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
 
Name of Each Exchange upon Which Registered
Common Shares of beneficial interest, $0.001 par value per share
 
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
 
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of Securities Act.    YES  ¨    NO  x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    YES  ¨    NO  x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO  ¨
Indicated by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulations S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company (see the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act).
Large Accelerated Filer
x
 
Accelerated Filer
o
Non-Accelerated Filer
o
 
Smaller Reporting Company
o
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2 of the Act)    YES  ¨    NO  x
The aggregate fair value of the registrant’s common shares of beneficial interest, $0.001 par value per share, at June 30, 2016, held by those persons deemed by the registrant to be non-affiliates was $526,679,042.
As of February 22, 2017, there were 58,698,267 common shares of beneficial interest, par value $0.001 per share, outstanding.
Documents Incorporated By Reference
Portions of the Company’s definitive proxy statement relating to the 2017 Annual Meeting of Shareholders, to be filed with the Securities and Exchange Commission, are incorporated by reference in Part III, Items 10-14 of this Annual Report on Form 10-K as indicated herein.
 

1



FIRST POTOMAC REALTY TRUST
FORM 10-K
INDEX
 
Part I
 
Page
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
 
 
Part II
 
 
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
 
 
 
Part III
 
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
 
 
Part IV
 
 
Item 15.
 
 
 
Item 16.
 
 
 
 

2



SPECIAL NOTE ABOUT FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements, including statements regarding the execution of our strategic plan, potential dispositions and the timing of such dispositions, and future acquisitions and growth opportunities, within the meaning of the federal securities laws. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Company, are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project” or similar expressions. The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain.

Certain factors that could cause actual results, performance or achievements to differ materially from the Company’s expectations include, among others, the following:

changes in general or regional economic conditions;

the Company’s ability to timely lease or re-lease space at current or anticipated rents;

changes in interest rates;

changes in operating costs;

the Company’s ability to complete acquisitions and dispositions on acceptable terms, or at all;

the Company’s ability to manage its current debt levels and repay or refinance its indebtedness upon maturity or other required payment dates;

the Company’s ability to maintain financial covenant compliance under its debt agreements;

the Company’s ability to maintain effective internal controls over financial reporting and disclosure controls and procedures;

the Company’s ability to obtain debt and/or financing on attractive terms, or at all; and

other risks detailed under “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K and in the other documents the Company files with the Securities and Exchange Commission (“SEC”), which are accessible on the SEC’s website at www.sec.gov.


The risks set forth above are not exhaustive. Other sections of this report may include additional factors that could adversely affect the Company’s business and financial performance. Moreover, the Company operates in a very competitive and rapidly changing environment. Many of these factors are beyond the Company’s ability to control or predict. Forward-looking statements are not guarantees of performance. For forward-looking statements herein, the Company claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. The Company assumes no obligation to update or supplement forward-looking statements that become untrue because of subsequent events. We do not intend to, and expressly disclaim any duty to, update or revise the forward-looking statements in this discussion to reflect changes in underlying assumptions or factors, new information, future events, or otherwise, after the date hereof, except as may be required by law. In light of these risks and uncertainties, you should not rely upon these forward-looking statements after the date of this report and should keep in mind that any forward-looking statement made in this discussion, or elsewhere, might not occur.
 


3



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

PART I

ITEM 1.
BUSINESS

Overview

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

We conduct our business through First Potomac Realty Investment Limited Partnership, our operating partnership (the “Operating Partnership”). We are the sole general partner of, and, as of December 31, 2016, owned 95.8% of the common interest in the Operating Partnership. The remaining common interests in the Operating Partnership, which are presented as noncontrolling interests in the Operating Partnership in the accompanying consolidated financial statements, are limited partnership interests that are owned by unrelated parties.

At December 31, 2016, we wholly owned properties totaling 6.7 million square feet and had a noncontrolling ownership interest in properties totaling an additional 0.9 million square feet through five unconsolidated joint ventures. We also owned land that can support 0.6 million square feet of additional development. Our consolidated properties were 92.6% occupied by 384 tenants at December 31, 2016. We do not include square footage of properties in development or redevelopment in our occupancy calculation. At December 31, 2016, none of the 6.7 million square feet owned through our properties was in development or redevelopment. We derive substantially all of our revenue from leases of space within our properties. As of December 31, 2016, our largest tenant was the U.S. Government, which accounted for 16% of our total annualized cash basis rent, and the U.S. Government combined with government contractors accounted for 27% of our total annualized cash basis rent as of December 31, 2016. We operate so as to qualify as a real estate investment trust (“REIT”) for federal income tax purposes.

For the year ended December 31, 2016, we had consolidated total revenues of $160.3 million and consolidated total assets of $1.3 billion. Financial information related to our four reporting segments is set forth in note 17, Segment Information, to our consolidated financial statements.

Our corporate headquarters are located at 7600 Wisconsin Avenue, 11th Floor, Bethesda, Maryland 20814, and we believe our current space is sufficient to meet our current needs. We do not own the building in which we lease space for our corporate headquarters. As of December 31, 2016, we had four other offices for our property management operations, which occupy approximately 18,000 square feet within buildings we own.

Our History

The Operating Partnership was formed in 1997 to focus on the acquisition, development and redevelopment of industrial properties and business parks, primarily in the suburban markets of the greater Washington, D.C. region. The Company was formed as a Maryland trust in 2003, and we completed our initial public offering in October 2003. At December 31, 2003, we owned properties totaling 2.9 million square feet and had total assets of $244.1 million. By the beginning of 2010, we had grown our portfolio to over 12 million square feet and had total assets of $1.1 billion. In 2010, we entered the office market in Washington, D.C. with the acquisition of four office properties, including one property purchased through an unconsolidated joint venture, and thereafter continued our focus on acquiring office properties. We updated our strategic and capital plan in 2013, which, among other things, included a capital recycling strategy to divest of lower quality assets. During 2013, we sold the majority of our industrial portfolio and decided to strategically focus on office properties and business parks. In 2016, we completed an extensive underwriting of our business, our portfolio and our team, and based on this underwriting, we began implementing a new strategic plan, the focus of which is to de-risk the portfolio, de-lever the balance sheet and maximize asset values (the “Strategic Plan”). See “Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations — Strategic Plan” for a

4



detailed discussion of the Strategic Plan’s key action items and the measures we have taken to complete these strategic objectives during 2016.

Description of Business

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

Our investment strategy focuses on properties in our target markets that generally meet the following investment criteria:
 
high barrier-to-entry submarkets;
amenity rich and transportation friendly;
institutional quality, demonstrating liquidity in most points of the real estate cycle;
known employment areas; and/or
in-place cash flow.

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

Competitive Advantages

We believe that our business strategy and operating model distinguish us from other owners, operators and acquirers of rental property in a number of ways, which include:
 
Experienced Management Team. Our three executive officers have over 50 years of cumulative real estate experience in the greater Washington, D.C. region;
Focused Strategy. We focus primarily on high-quality, multi-story office properties in the greater Washington, D.C. region. We believe that the greater Washington, D.C. region historically has been one of the largest, most stable markets in the U.S. for assets of this type;
Value-Add Management Approach. Through our hands-on approach to management, leasing, renovation and repositioning, we endeavor to add significant value to the properties that we acquire by improving tenant quality and increasing occupancy rates and net rent per square foot;
Local Market Knowledge. We have established relationships with local real estate owners, the brokerage community, prospective tenants and property managers in our markets. We believe that our market knowledge enhances our efforts to identify attractive acquisition opportunities and lease space in our properties; and
Diverse Tenant Mix. We believe our tenant base is highly diverse. Approximately 55% of our annualized cash basis rent is generated from our 25 largest tenants, and our largest 100 tenants generate approximately 79% of our annualized cash basis rent. The balance of our tenants, which is comprised of over 250 different companies, generates the remaining 21% of our annualized cash basis rent. We believe that our diversified tenant base provides a desirable mix of stability, diversity and growth potential.


5



Our Markets

We operate, acquire, develop and redevelop, office and business park properties in the greater Washington, D.C. region. Within this area, our primary market is the Washington, D.C. metropolitan statistical area (“MSA”), which includes Washington D.C., Northern Virginia and suburban Maryland. Additionally, we own and operate office and business park properties in the Virginia Beach-Norfolk-Newport News MSA, where our Southern Virginia properties are located, as well as in the Baltimore-Columbia-Towson MSA where the remainder of our Maryland properties are located (Annapolis and Columbia). We derive approximately 74.1% of our annualized cash basis rent from the Washington, D.C. MSA, 19.6% from Virginia Beach-Norfolk-Newport News MSA, and the remaining 6.3% of our annualized cash basis rent comes from properties within the Baltimore-Columbia-Towson MSA.

According to data from Transwestern, a commercial real estate services provider, the Washington, D.C. MSA contains approximately 423 million square feet of office property and is the second largest office market in the country behind New York. The Washington, D.C. MSA office market totaled 2.3 million square feet of positive net absorption during 2016. The region also contains approximately 402 million square feet of flex/business park/industrial property, which is the smallest amongst the nation’s largest metro areas.

In 2016, the Washington, D.C. MSA was the sixth largest job market in the United States behind Los Angeles, New York, Dallas, San Francisco and Atlanta. Through November 2016, the D.C. MSA added more than 65,500 jobs, primarily in professional & business services, education & health, state & local government, and leisure & hospitality, according to the Transwestern / Delta Associates’ publication “TrendLines 2017, Investing in the Future”. The publication also stated that the Washington, D.C. MSA is estimated to add an annual average of 43,600 jobs from 2017 to 2021, with private sector firms leading the way. As of November 2016, the Washington D.C. MSA had an unemployment rate of 3.7%, the fifth lowest among its peer metropolitan areas, trailing only Boston, Denver, Dallas and San Francisco according to the Transwestern / Delta Associates’ publication.

The Virginia Beach-Norfolk-Newport News MSA is our second largest market when measured by annualized cash basis rent and square footage. We own approximately 2 million square feet in the region and derive 19.6% of our annualized cash basis rent from the market. Norfolk is home to the largest military installation in the world, according to the United States Navy, and remains heavily invested in the defense and shipping industries, as it is the only NATO command on U.S. soil. In addition, the Norfolk port is the third largest port on the East Coast of the United States, has the deepest, obstruction-free channels available on the East Coast, and is the only East Coast port with Congressional authorization for 55-foot depth channels, according to the Virginia Port Authority.

The Baltimore-Columbia-Towson MSA is our smallest market when measured by annualized cash basis rent and square footage. We own approximately 470,000 square feet in the region and derive 6.3% of our annualized cash basis rent from the market. The properties that we own in the Baltimore-Columbia-Towson MSA are located in Columbia and Annapolis, Maryland. Columbia is a planned community that benefits from its strategic location between the cities of Washington, D.C. and Baltimore, Maryland. Columbia has consistently ranked in the top ten of CNN Money's “Best Places to Live in America”. Annapolis is the Maryland state capital and home to the U.S. Naval Academy.

Competition

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

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


6



Environmental Matters

Under various federal, state and local environmental laws and regulations, a current or previous owner, operator or tenant of rental property may be required to investigate and clean up hazardous or toxic substances or petroleum product releases or threats of releases at such property, and may be held liable to a government entity or to third parties for natural resource damages, personal injury, property damage and for investigation, clean up and monitoring costs incurred by such parties in connection with the actual or threatened contamination. Such laws typically impose clean up responsibility and liability without regard to fault, or whether or not the owner, operator or tenant knew of or caused the presence of the contamination. The liability under such laws may be joint and several for the full amount of the investigation, clean-up and monitoring costs incurred or to be incurred or actions to be undertaken. These costs may be substantial, and can exceed the fair value of the property. The presence of contamination or the failure to properly remediate contamination on such property may adversely affect the ability of the owner, operator or tenant to sell or rent such property or to borrow using such property as collateral, and may adversely impact our investment in a property.

Federal and state regulations require building owners and those exercising control over a building’s management to identify and warn, via signs and labels, of potential hazards posed by workplace exposure to installed asbestos-containing materials and potentially asbestos-containing materials in their building. The regulations also set forth employee training, record keeping and due diligence requirements pertaining to asbestos-containing materials and potentially asbestos-containing materials. Significant fines can be assessed for violation of these regulations. Building owners and those exercising control over a building’s management may be subject to an increased risk of personal injury lawsuits by workers and others exposed to asbestos-containing materials and potentially asbestos-containing materials. Federal, state and local environmental laws and regulations also govern the removal, encapsulation, disturbance, handling and/or disposal of asbestos-containing materials. Such laws may impose liability for improper handling, exposure to or a release to the environment of asbestos-containing materials.

We also may incur liability arising from mold growth in the buildings we own or operate. When excessive moisture accumulates in buildings or on building materials, mold growth may occur, particularly if the moisture problem remains undiscovered or is not addressed over a period of time. Some molds may produce airborne toxins or irritants. Indoor air quality issues can also stem from inadequate ventilation, chemical contamination from indoor or outdoor sources, and other biological contaminants such as pollen, viruses and bacteria. Indoor exposure to airborne toxins or irritants can be alleged to cause a variety of adverse health effects and symptoms, including allergic or other reactions. As a result, the presence of significant mold or other airborne contaminants at any of our properties could require us to undertake a costly remediation program to contain or remove the mold or other airborne contaminants or increase ventilation. In addition, the presence of significant mold or other airborne contaminants could expose us to liability from our tenants, employees of our tenants, and others if property damage or personal injury occurs.

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

We believe that our properties are in compliance in all material respects with all federal, state and local environmental laws and regulations regarding hazardous or toxic substances and other environmental matters. We have not been notified by any governmental authority of any material non-compliance, liability or claim relating to hazardous or toxic substances or other environmental matter in connection with any of our properties. See Item 1a, Risk Factors, for more information regarding potential environmental liabilities.

Employees

We had 120 employees as of February 17, 2017. We believe that relations with our employees are good.

Availability of Reports Filed with the Securities and Exchange Commission

A copy of this Annual Report on Form 10-K, as well as our quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are available, free of charge, on our Internet Web site (www.first-potomac.com). All of these reports are made available on our Web site as soon as reasonably practicable after they are electronically filed with or furnished

7



to the Securities and Exchange Commission (the “SEC”). Our Governance Guidelines and Code of Business Conduct and Ethics and the charters of the Audit, Finance and Investment, Compensation, and Nominating and Governance Committees of our Board of Trustees are also available on our Web site at www.first-potomac.com under the section “Investors—Corporate Governance”, and are available in print to any shareholder upon written request to First Potomac Realty Trust, c/o Investor Relations, 7600 Wisconsin Avenue, 11th Floor, Bethesda, MD 20814. The information on or accessible through our Web site is not, and shall not be deemed to be, a part of this report or incorporated into any other filing we make with the SEC.

8



ITEM 1A. RISK FACTORS

An investment in our securities involves various risks, including the risk that an investor might lose its entire investment. The following discussion concerns the material risks associated with our business. These risks are interrelated and should be considered collectively. The risks described below are not the only risks that may affect us. Additional risks and uncertainties not presently known to us or not identified below, may also materially and adversely affect our business, financial condition, results of operations and ability to make distributions to our security holders. Some statements in this Annual Report on Form 10-K, including statements in the following risk factors, constitute forward-looking statements. Please refer to the section entitled “Special Note About Forward-Looking Statements” at the beginning of this Annual Report on Form 10-K.

Risks Related to Our Business and Properties

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

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

downturns in the national, regional and local economic conditions (particularly in the greater Washington, D.C. region, where substantially all of our properties are located);
declines in the financial condition of our tenants (including tenant bankruptcies) and our ability to collect rents from our tenants;
local real estate market conditions, such as oversupply or reduction in demand for office space;
decreases in rent and/or occupancy rates due to competition, oversupply, adverse changes to the areas surrounding our properties, or other factors;
changes in market rental rates and related concessions granted to tenants including, but not limited to, free rent and tenant improvement allowances;
competition from similar asset type properties;
increased competition for public capital from new or expanding market participants;
changes in space utilization by our tenants that may adversely affect future demand due to technology, telecommuting and overall shift in business culture;
increases in operating costs such as real estate taxes, insurance premiums, site maintenance (including snow removal costs) and utilities;
vacancies and the need to periodically repair, renovate and re-lease space, or other significant capital expenditures;
reduced capital investment in or demand for real estate in the future;
costs of remediation and liabilities associated with environmental conditions and laws;
earthquakes and other natural disasters, civil disturbances, or terrorist acts or acts of war, which may result in uninsured or underinsured losses;
decreases in the underlying value of our real estate;
changes in interest rates and the availability of financing;
inflation; and
changes in laws and governmental regulations, including those governing real estate usage, zoning and taxes.

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

Substantially all of our properties are located in the greater Washington, D.C. region, exposing us to greater risks than if we owned properties in multiple geographic regions. Economic conditions in the greater Washington, D.C. region may significantly affect the occupancy and rental rates of our properties. A decline in occupancy and rental rates, in turn, may significantly adversely affect our profitability and our ability to satisfy our financial obligations. Further, the economic condition of the region may also depend on one or more industries and, therefore, an economic downturn in one of these industry sectors may adversely affect our results of operations. For example, the U.S. Government, which has a large presence in our markets, accounted for 16% of our total annualized cash basis rent as of December 31, 2016, and the U.S. Government combined with government contractors accounted for 27% of our total annualized cash basis rent as of December 31, 2016.

9



Therefore, we are directly affected by decreases in federal government spending (either directly through the potential loss of a U.S. Government tenant or indirectly if the businesses of tenants that contract with the U.S. Government are negatively impacted). In particular, the office market in the Washington, D.C. metropolitan area was negatively impacted by uncertainty regarding the potential for significant reductions in spending by the U.S. Government and may be impacted by the uncertainty regarding policy changes under the new administration. In addition to actual economic conditions, investor perception of risks associated with real estate in the Washington, D.C. metropolitan area as a result of its perceived dependence on the U.S. Government, and the impact of sequestration (defined below) or anticipated policy changes, may make potential investors less likely to invest in our shares, which could have a material adverse effect on the price of our shares.

We may also be subject to changes in the region’s regulatory environment (such as increases in real estate and other taxes, costs of complying with government regulations or increased regulation and other factors) or other adverse conditions or events (such as natural disasters). Certain policy changes under the new federal administration may increase costs to our tenants, or may cause certain government contractors to lose their contract with the U.S. Government or limit their ability to expand or renew space. Thus, adverse developments and/or conditions in the greater Washington, D.C. region could reduce demand for space, impact the credit-worthiness of our tenants or force our tenants to curtail operations, which could impair their ability to meet their rent obligations to us and, accordingly, could have a material adverse effect on our results of operations.

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

At December 31, 2016, 19.0%, 8.6% and 9.3% of our annualized cash basis rent was scheduled to expire in 2017, 2018 and 2019, respectively. In particular, we own two single-tenant buildings that have leases expiring in 2017 (540 Gaither Road - Department of Health and Human Services, and 500 First Street, NW - Bureau of Prisons). Together, these two leases represent approximately $8 million of annual net operating income. Current tenants may not renew their leases upon the expiration of their terms and may attempt to terminate their leases prior to the expiration of their current terms. The amount of annualized cash basis rent scheduled to expire in 2017 includes 5.1% of our total annualized cash basis rent that is related to CACI International, which fully leased One Fair Oaks pursuant to a lease that expired on December 31, 2016. We subsequently sold One Fair Oaks on January 9, 2017 for net proceeds of $13.3 million. In addition, as discussed in the risk factor titled “A decrease in federal government spending, or the threat thereof, as a result of sequestration cuts or otherwise, could have a material adverse effect on our results of operations and cash flow, and could cause an impairment of the value of some of our properties”, our leases with the U.S. Government include favorable tenant termination provisions. For example, in October 2015, we received notice from the Department of Health and Human Services, which fully leases the building at 540 Gaither Road, that it will be exercising its early termination right, which will be effective in March 2017. In addition, the Bureau of Prisons, which fully leases 500 First Street, NW, has a lease that is scheduled to expire on July 31, 2017. Currently, we are evaluating various strategies with respect to these properties (and, in certain instances have engaged third parties to assist in evaluating such strategies), which includes repositioning 540 Gaither Road and 500 First Street, NW and gauging new tenant interest to lease these properties, all with the ultimate goal of maximizing value upon the expiration of these leases. However, we can provide no assurances regarding the outcome of these or any other alternative strategies for properties with expiring leases.

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

The U.S. Government accounted for 16% of our total annualized cash basis rent as of December 31, 2016, and the U.S. Government combined with government contractors accounted for 27% of our total annualized cash basis rent as of December 31, 2016. A significant reduction in federal government spending could affect the ability of these tenants to fulfill lease obligations or decrease the likelihood that they will renew their leases with us. Further, economic conditions in the greater Washington, D.C. region, particularly the Washington, D.C. and Norfolk, VA metropolitan areas, are significantly dependent upon the level of federal government spending in the region, and uncertainty regarding the potential for future reduction in government spending could also decrease or delay leasing activity from the U.S. Government and government contractors. Moreover, the Budget Control Act, which was passed in 2011 and imposed caps on the federal budget in order to achieve targeted spending levels over the 2013-2021 fiscal years (commonly referred to as “sequestration”), has fueled further uncertainty regarding future government spending reductions. The reductions in U.S. federal government spending imposed by the Budget Control Act went into effect on March 1, 2013, which lead to significant reductions in U.S. federal government spending in 2013 through 2015, with similar cuts scheduled through 2021. Overall, the sequester imposed by the Budget Control Act lowers spending by a total of approximately $1.1 trillion versus pre-sequester levels over the period from 2013 to 2021. As a result of the scheduled reductions in U.S. federal government spending, there could be negative economic

10



changes in our region, which could adversely impact the ability of our tenants to perform their financial obligations under our leases or decrease the likelihood of their lease renewal. In addition, some of our leases with the U.S. Government are for relatively short terms or provide for early termination rights, including termination for convenience or in the event of a budget shortfall. Further, on July 31, 2003, the United States Department of Defense issued the Unified Facilities Criteria (the “UFC”), which established minimum antiterrorism standards for the design and construction of new and existing buildings leased by the departments and agencies of the Department of Defense. The loss of the federal government as a tenant resulting from reductions in federal government spending, exercise of the government’s contractual termination rights, our inability to comply with the UFC standards or for any other reason would have a material adverse effect on our results of operations. A reduction or elimination of rent from the U.S. Government or other significant tenants would also materially reduce our cash flow and materially adversely affect our results of operations and ability to make distributions to our security holders.

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

Our properties face significant competition, which could adversely affect our results of operations or financial condition.

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

One aspect of our Strategic Plan, which is substantially complete, includes focusing on our portfolio of high-quality office properties in the Washington, D.C. metropolitan region, and disposing of properties that are no longer a strategic fit. The execution of this phase of the business plan has reduced the size of our overall portfolio and increased the concentration of our portfolio in office properties. If the proceeds of the remaining dispositions contemplated under our Strategic Plan are not what we expect, or if we cannot timely and effectively deploy the remaining proceeds, there could be a material adverse effect on our results of operations and financial condition.

One aspect of our Strategic Plan, which is substantially complete, includes focusing on our portfolio of high-quality office properties in the Washington, D.C. metropolitan region, and disposing of those properties that are no longer a strategic fit, properties in submarkets where we do not have asset concentration or operating efficiencies and/or properties where we believe we cannot further maximize value. As of the date of this filing, we have sold $294.6 million of non-core assets toward our previously stated goal of $350 million. We have used or intend to use the proceeds generated from the $350 million of property dispositions to, among other things, repay outstanding indebtedness, reposition or redevelop certain properties where we believe we can increase profitability, redeem all of our previously outstanding 7.750% Series A Cumulative Redeemable Perpetual Preferred Shares (the “Series A Preferred Shares”) and acquire additional high-quality office properties in the Washington, D.C. metropolitan region. We can provide no assurance that we will be able to dispose of any additional properties under our business plan for the amounts of proceeds we expect, or at all. In addition, if we are able to dispose of any additional properties, we can provide no assurance that we will be able to use the capital in a timely or more efficient manner. Furthermore, although we intend to acquire additional office properties, we face significant competition for acquisitions in the office market and we may not be able or have the opportunity to make suitable investments on favorable terms. As such, we may not be able to adequately time any decrease in revenues from the sale of properties with a corresponding increase in revenues associated with the redevelopment or acquisition of properties. The failure to dispose of properties under our business plan, or to timely and more efficiently apply the proceeds from any disposition of properties could have a material adverse effect on our financial condition and results of operations.


11



Our strategic shift and decision to focus on office properties in the Washington, D.C. metropolitan region exposes us to a number of risks, including risks related to the reduced size of our overall portfolio and the further concentration of our portfolio in office properties.

As part of our strategic and capital plan announced in January 2013, we disposed of our industrial portfolio in June 2013 and our current Strategic Plan contemplates disposing of properties that are no longer a strategic fit (including a significant portion of our business park properties), properties in submarkets where we do not have asset concentration or operating efficiencies and/or properties where we believe we cannot further maximize value. Pursuant to our Strategic Plan, we have disposed of an additional $294.6 million of non-core assets since December 2015 in order to focus on office properties in the Washington, D.C. metropolitan area. As such, the size of our overall portfolio has been and may continue to be significantly reduced, and therefore any adverse developments at any one of our remaining properties may have a greater negative impact on our results of operations. Although we intend to acquire additional office properties in the near future, we face significant competition for acquisitions in the office market and we may not be able or have the opportunity to make suitable investments on favorable terms. See “-Competition for acquisitions may impede our growth and may result in increased prices for property acquisitions.” As such, the resulting decrease in our net income attributable to the disposed properties likely will not be completely offset by income from the reinvestment of disposition proceeds. In addition, a further concentration of our portfolio in office properties exposes us to the risk of a downturn in the office market to a greater extent than if our portfolio remained more diversified in office, business park and industrial properties.

Redevelopment, development and construction risks could materially adversely affect our results of operations and growth prospects.

One aspect of our Strategic Plan includes repositioning or redeveloping certain properties where we believe we can increase profitability. Our renovation, redevelopment, development and related construction activities may subject us to the following risks:

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

Additionally, the time frame required for development, construction and lease-up of these properties means that we may have to wait years for a significant cash return. Any of these conditions could materially adversely affect our results of operations and growth prospects.

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

Our business strategy contemplates expansion through acquisitions, redevelopments and developments, which acquisitions initially may be dilutive to our net income. In deciding whether to acquire or develop a particular property, we make assumptions regarding the expected future performance of that property. In particular, we estimate the return on our investment based on expected occupancy and rental rates, as well as expected development costs and leasing costs. We have acquired, and in the future may acquire, properties not fully leased, and the cash flow from existing operations of such properties may be insufficient

12



to pay the operating expenses and debt service associated with such properties until they are more fully leased at favorable rental rates. Moreover, operating expenses related to acquired properties may be greater than anticipated, particularly if we provide tenant improvements or other concessions or additional services in order to maintain or attract new tenants. We also may experience unanticipated costs or difficulties integrating newly acquired properties into our existing portfolio or hiring and retaining sufficient operational staff to manage such properties. If our estimated return on investment for the property proves to be inaccurate and the property is unable to achieve the expected occupancy and rental rates, it may fail to perform as we projected (including, without limitation, as a result of tenant bankruptcies, increased tenant improvements and other concessions, increased capital expenditures, our inability to collect rents and higher than anticipated operating costs), thereby having a material adverse effect on our results of operations. This risk may be particularly pronounced for properties placed into development or acquired shortly before the recent economic downturn, where we estimated occupancy and rental rates without the benefit of knowing how those assumptions might be impacted by the changing economic conditions that followed.

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

Our acquisition activities and the success of such acquisitions are subject to the following additional risks:

we may have difficulty finding properties that are consistent with our strategies and that meet our standards;
even if we enter into an acquisition agreement for a property, the acquisition agreement will likely contain conditions to closing, including completion of due diligence investigations to our satisfaction or other conditions that are not within our control, which may not be satisfied;
we may be unable to complete the acquisition after making a non-refundable deposit and incurring certain other acquisition-related costs;
we may be unable to obtain or assume financing for acquisitions on favorable terms or at all;
acquired properties may fail to perform as expected;
we may acquire real estate through the acquisition of the ownership entity subjecting us to the risks of that entity;
the timing of property acquisitions may lag the timing of property dispositions, leading to periods of time where projects' proceeds are not invested as profitably as we desire;
the actual returns realized on acquired properties may not exceed our cost of capital; and
we could experience a decline in value of the acquired assets after acquisition.

Competition for acquisitions may impede our growth and may result in increased prices for property acquisitions.

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

Acquired properties may expose us to unknown liabilities.

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

liabilities for clean-up of 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.


13



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

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

Moreover, we rely on third-party sources to fund our capital needs. We may not be able to obtain the financing on favorable terms, in the time period we desire, or at all. Our access to third-party sources of capital depends, in part, on:

general market conditions;
the market’s view of the quality of our assets;
the market’s perception of our growth potential;
our current debt levels;
our current and expected future earnings;
our cash flow and cash distributions; and
the market price of our common shares.

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

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

Illiquidity of real estate investments could significantly impede our ability to complete our Strategic Plan or respond to adverse changes in the performance of our properties, which may have a material adverse effect on our results of operations, financial condition and cash flow.

Because real estate investments are relatively illiquid, our ability to promptly sell one or more properties in our portfolio in order to realize their value or in response to adverse changes in the performance of such properties may be limited. We cannot predict whether we will be able to sell any property for the price or on the terms set by us, or whether any price or other terms offered by a prospective purchaser would be acceptable to us. We may be required to expend funds to correct defects or to make improvements before a property can be sold and we cannot assure you that we will have funds available to correct those defects or to make those improvements. We also cannot predict the length of time needed to find a willing purchaser and to close the sale of a property. Failure to dispose of properties and to timely and more efficiently apply the proceeds from any disposition of properties could have a material adverse effect on our financial condition and results of operations.

Moreover, the REIT rules governing property sales and agreements that we may enter into with joint venture partners or contributors to our Operating Partnership not to sell certain properties for a period of time may interfere with our ability to dispose of properties on a timely basis without incurring significant additional costs. In addition, when acquiring a property, we may agree to lock-out provisions that materially restrict us from selling that property for a period of time or impose other restrictions, such as a limitation on the amount of debt that can be placed or repaid on that property. We may also acquire properties that are subject to mortgage loans that may limit our ability to sell those properties prior to the applicable loan’s maturity. These factors and any others that would impede our ability to execute our business plan or to respond to adverse changes in the performance of our properties could have a material adverse effect on our results of operations, financial condition, cash flow and our ability to make distributions with respect to, and the market price of, our securities.

We may experience a decline in the fair value of our assets, which may have a material impact on our financial condition, liquidity and results of operations and adversely impact the market value of our securities.

A decline in the fair market value of our assets may require us to recognize an other-than-temporary impairment against such assets under GAAP if we were to determine that we do not have the ability and intent to hold any assets in unrealized loss positions to maturity or for a period of time sufficient to allow for recovery to the amortized cost of such assets. In such event, we would recognize unrealized losses through earnings and write down the amortized cost of such assets to a new cost

14



basis, based on the fair value of such assets on the date they are considered to be other-than-temporarily impaired. Such impairment charges reflect non-cash losses at the time of recognition. Subsequent disposition or sale of such assets could further affect our future losses or gains, as they are based on the difference between the sale price received and adjusted amortized cost of such assets at the time of sale, which may adversely affect our financial condition, liquidity and results of operations. There can be no assurance that we will not take charges in the future related to the impairment of our assets or investments. Any future impairment could have a material adverse effect on our results of operations in the period in which the charge is taken.

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

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

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

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

As of December 31, 2016, our total consolidated debt was $743.4 million, consisting principally of our mortgage debt and amounts outstanding under our consolidated credit agreement (including our unsecured revolving credit facility and unsecured term loans included therein). In addition, we will incur additional indebtedness in the future in connection with, among other things, our acquisition, redevelopment, development and operating activities. Our current degree of leverage, or an increase in our leverage levels, may make it difficult to obtain additional financing for working capital, capital expenditures, acquisitions, development or other general corporate purposes, or to refinance existing debt on favorable terms or at all. Failure to obtain additional financing could impede our ability to grow and develop our business through, among other things, acquisitions, redevelopments and developments, and a failure to refinance our existing debt as it matures could have a material adverse effect on our financial condition, liquidity and ability to make distributions to our shareholders. Our leverage levels also could make us more vulnerable to a downturn in business or the economy generally and may adversely affect the market price of our securities if an investment in our common shares is perceived to be more risky than an investment in our peers.

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

We rely on debt financing to fund acquisitions, redevelopment and development activities, and for general corporate purposes. Our use of debt financing creates risks, including risks that:

our cash flow will be insufficient to make required payments of principal and interest, including “balloon” payments due at maturity;
we will be unable to refinance some or all of our indebtedness or that any refinancing will not be on terms as favorable as those of the existing indebtedness;

15



required debt payments will not be reduced if the economic performance of any property declines;
debt service obligations will reduce funds available for distribution to our security holders and funds available for acquisitions, development and redevelopment;
most of our secured debt obligations require the lender to be made whole to the extent we decide to pay off the debt prior to the maturity date; and
any default on our indebtedness, including as a result of a failure to maintain certain financial and operating covenants in our consolidated credit agreement, could result in acceleration of those obligations and possible cross defaults under other indebtedness and/or loss of property to foreclosure.

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

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

Our consolidated credit agreement (which contains our unsecured revolving credit facility and unsecured term loans) and our construction loans contain certain and varying restrictions on the amount of debt we are allowed to incur and other restrictions and requirements on our operations (including, among other things, requirements to maintain a minimum tangible net worth and specified coverage ratios (e.g., a maximum of total indebtedness to gross asset value, a maximum of secured indebtedness to gross asset value, a minimum fixed charge coverage ratio (defined as the ratio of adjusted EBITDA to fixed charges), a maximum unencumbered leverage ratio (defined as the ratio of unsecured debt to the value of certain unencumbered properties) and a minimum unencumbered interest coverage ratio (defined as the ratio of the adjusted net operating income of certain unencumbered properties to interest expense on unsecured debt)) and other financial covenants, and limitations on our ability to make distributions, enter into joint ventures, develop properties and engage in certain business combination transactions). See “Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations —Liquidity and Capital Resources.” These restrictions, particularly if we are at or near the required ratios or thresholds, could prevent or inhibit our ability to make distributions to our shareholders and to pursue some business initiatives or effect certain transactions that may otherwise be beneficial to our company, which could adversely affect our financial condition and results of operations. Moreover, our continued ability to borrow under our revolving credit facility is subject to compliance with these financial and operating covenants and our failure to comply with such covenants could cause a default under the credit facility, and we may then be required to repay such debt with capital from other sources. Under those circumstances, other sources of capital may not be available to us, or be available only on unattractive terms. In addition, if we breach covenants in our debt agreements, the lenders can declare a default and, if the debt is secured, take possession of the property securing the defaulted loan. Although we were in compliance with all of the financial and operating covenants of our outstanding debt agreements as of December 31, 2016, we can provide no assurance that we will be able to continue to comply with these covenants in future periods.

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

Our variable rate debt subjects us to interest rate risk.

As of December 31, 2016, we had a consolidated credit agreement consisting of a $300.0 million unsecured revolving credit facility and a $300.0 million unsecured term loan facility, a $32.2 million construction loan (440 First Street, NW), a $34.6 million construction loan (Northern Virginia build-to-suit) and certain other debt, some of which is unhedged, that bear interest at variable rates. In addition, we may incur additional variable rate debt in the future. As of December 31, 2016, we had $510.8 million of variable rate debt, of which, $240.0 million was hedged through nine interest rate swap agreements. Our $510.8 million of variable rate debt includes $60.0 million of unhedged debt under the unsecured term loan facility (which bears an interest rate of one-month LIBOR plus 1.45%), our $32.2 million construction loan at 440 First Street, NW (which bears interest at a rate of one-month LIBOR plus 2.50%), our $34.6 million construction loan for the Northern Virginia development project (which bears interest at a rate of one-month LIBOR plus 1.85%) and the $144.0 million outstanding under our unsecured revolving credit facility (which bears interest at LIBOR plus 1.50%). One-month LIBOR was 0.77% at

16



December 31, 2016. Increases in interest rates on variable rate debt would increase our interest expense, if not hedged effectively or at all, which would adversely affect net earnings and cash available for payment of our debt obligations and distributions to our security holders.  For example, if market rates of interest on our unhedged variable rate debt outstanding as of December 31, 2016 increased by 1%, or 100 basis points, the increase in interest expense on our existing unhedged variable rate debt would decrease future earnings and cash flow by approximately $2.7 million annually.

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

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

available interest rate hedging may not correspond directly with the interest rate risk for which we seek protection;
the duration of the hedge may not match the duration of the related liability;
the party owing money in the hedging transaction may default on its obligation to pay;
the credit quality of the party owing money on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction; and
the value of derivatives used for hedging may be adjusted from time to time in accordance with accounting rules to reflect changes in fair value. Such downward adjustments, or “mark-to-market losses,” would reduce our equity.

Hedging involves risk and typically involves costs, including transaction costs that may reduce our overall returns on our investments. These costs increase as the period covered by the hedging increases and during periods of rising and volatile interest rates. These costs will also limit the amount of cash available for distribution to shareholders. We generally intend to hedge as much of the interest rate risk as management determines is in our best interests given the cost of such hedging transactions. REIT qualification rules may limit our ability to enter into hedging transactions that might otherwise be advantageous by, among other things, requiring us to limit our income from hedges, or may cause us to implement those hedges through a taxable REIT subsidiary. This could increase the cost of our hedging activities because our taxable REIT subsidiary would be subject to tax on gains or expose us to greater risks associated with changes in interest rates than we would otherwise want to bear. In addition, losses in our taxable REIT subsidiary will generally not provide any current tax benefit, except to the extent that they may be carried back to prior years or forward to future years and offset against taxable income in the taxable REIT subsidiary. If we are unable to hedge effectively because of the REIT rules, we will face greater interest rate exposure.

Moreover, there can be no assurance that our hedging arrangements will qualify as highly effective cash flow hedges under Financial Accounting Standards Board ("FASB"), Accounting Standards Codification ("ASC") Topic 815, Derivatives and Hedging, or that our hedging activities will have the desired beneficial impact on our results of operations. Should we desire to terminate a hedging agreement, there could be significant costs and cash requirements involved to fulfill our obligation under the hedging agreement


17



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

In certain instances, we retain third parties to manage and/or lease certain of our properties and, in connection with such arrangements, we would be dependent on them and their key personnel who provide services to us and we may not find a suitable replacement if the agreements are terminated, or if key personnel leave or otherwise become unavailable to us. In particular, we retained a third-party management company in 2014 to operate our Southern Virginia portfolio pursuant to individual property management agreements. While we believe this management structure provides operating efficiencies, we could be materially and adversely affected if our third-party manager fails to provide quality services and amenities, fails to maintain a quality brand name or otherwise fails to manage our properties in our best interest. In addition, from time to time, disputes may arise between us and our third-party manager regarding its performance or compliance with the terms of the property management agreements, which in turn could adversely affect our results of operations. We generally will attempt to resolve any such disputes through discussions and negotiations; however, if we are unable to reach satisfactory results through discussions and negotiations, we may choose to terminate our management agreement (which we are permitted to do upon 30-days’ notice), litigate the dispute or submit the matter to third-party dispute resolution, the outcome of which may be unfavorable to us. In the event that we terminate any of our management agreements, we can provide no assurances that we could find a replacement manager in a timely manner, or at all, or that any replacement manager will be successful in operating such properties.

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

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

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

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

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

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

The occurrence of one or more of the events described above could adversely affect our financial condition, results of operations, cash flow and ability to make distributions with respect to, and the market price of, our securities.

18




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

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Any material weakness in our internal control over financial reporting could prevent us from accurately reporting our results of operations, result in material misstatements in our financial statements or cause us to fail to meet our reporting obligations. This could prevent or inhibit our ability to access third party sources of capital, which could adversely affect our liquidity and financial condition, and could cause investors to lose confidence in our reported financial information, thereby adversely affecting the perception of our business and the market price of our securities.

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

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

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

Environmental liability for contamination may include the following, without limitation: investigation and feasibility study costs, remediation costs, litigation costs, oversight costs, monitoring costs, institutional control costs, penalties from state and federal agencies, natural resource damages and third-party claims. Moreover, operations on-site may be required to be suspended until certain environmental contamination is remediated and/or permits are received and environmental laws can impose permanent restrictions on the manner in which a property may be used depending on the extent and nature of the contamination. This may result in a default of the terms of the lease entered into with our tenants. Environmental laws also may create liens on contaminated sites in favor of the government for damages and costs it incurs to address such contamination. In addition, the presence of hazardous substances at, on, under or from a property may adversely affect our ability to lease or sell the property, or borrow using the property as collateral, thus harming our financial condition. Environmental laws also may impose liability on persons who arrange for the disposal or treatment of hazardous substances, and such persons may incur the cost of removal or remediation of hazardous substances at disposal or treatment facilities, regardless of whether or not they owned or operated such facility.

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

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

Our properties are subject to various federal, state and local environmental laws. Non-compliance with these environmental laws could subject us or our tenants to liability and changes in these laws could increase the potential costs of compliance or increase liability for noncompliance. Although our leases generally require our tenants to operate in compliance with all applicable laws and to indemnify us against any environmental liabilities arising from a tenant’s activities on the property, we could nonetheless be subject to liability by virtue of our ownership or operation interests for environmental liabilities created by our tenants, and we cannot be sure that our tenants would satisfy their indemnification obligations under the applicable lease. Moreover, these environmental liabilities could affect our tenants’ ability to make rental payments to us. Non-compliance with environmental laws at our properties could have a material adverse effect on our results of operations, financial condition, cash flow and our ability to make distributions to our security holders.


19



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

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

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

When excessive moisture accumulates in buildings or on building materials, mold growth may occur, particularly if the moisture problem remains undiscovered or is not addressed over a period of time. Some molds may produce airborne toxins or irritants. Indoor air quality issues can also stem from inadequate ventilation, chemical contamination from indoor or outdoor sources, and other biological contaminants such as pollen, viruses and bacteria. Concern about indoor exposure to airborne toxins or irritants, including mold, has been increasing as exposure to these airborne contaminants have been alleged to cause a variety of adverse health effects and symptoms, including allergic or other reactions. As a result, the presence of significant mold or other airborne contaminants at any of our properties could require us to undertake a costly remediation program to contain or remove the mold or other airborne contaminants from the affected property or to increase ventilation. In addition, the presence of significant mold or other airborne contaminants could expose us to liability from our tenants, employees of our tenants, and others if property damage or health concerns arise. The occurrence of any of these risks could have a material adverse effect on our results of operations, financial condition and cash flow.

We may be subject to litigation, which could have a material adverse effect on our financial condition.

We may be subject to litigation, including claims relating to our assets and operations that are otherwise in the ordinary course of business. Some of these claims may result in significant defense costs and potentially significant judgments against us, some of which we may not be insured against. We may also incur significant costs to seek indemnification and contribution from third parties, which costs may not be reimbursed. We generally intend to vigorously defend ourselves against such claims. However, we cannot be certain of the ultimate outcomes of claims that may be asserted. Resolution of these types of matters against us may result in our management having to dedicate significant time to those matters and in the company having to pay significant fines, judgments, or settlements, which, if uninsured, or if the fines, judgments, and settlements exceed insured levels, would adversely impact our earnings and cash flows, thereby impacting our ability to service debt and make quarterly distributions to our shareholders. Certain litigation or the resolution of certain litigation may affect the availability or cost of some of our insurance coverage, which could adversely impact our financial condition and results of operations, expose us to increased risks that would be uninsured, and/or adversely impact our ability to attract officers and trustees.

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

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

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

20




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

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

We previously have and may in the future again engage in lending activities, including mezzanine financing activities. Such mezzanine loans may be secured by a portion of the owners’ interest in a property and be effectively subordinate to a senior mortgage loan on the property. These types of loans involve a higher degree of risk than long-term senior mortgage lending secured by income-producing real property, because the loan may become unsecured as a result of foreclosure by the senior lender. In addition, mezzanine loans may have higher loan-to-value ratios than conventional mortgage loans, resulting in less equity in the property and increasing the risk of loss of principal. If a borrower defaults on our mezzanine loan or debt senior to our loan, or in the event of a borrower bankruptcy, our mezzanine loan would be satisfied only after the senior debt is paid in full. Where debt senior to our loan exists, the presence of intercreditor arrangements between the holder of the mortgage loan and us, as the mezzanine lender, may limit our ability to amend our loan documents, assign our loans, accept prepayments, exercise our remedies and control decisions made in bankruptcy proceedings relating to borrowers. As a result, we may not recover some or all of our investment, which could result in losses. In addition, even if we are able to foreclose on the underlying collateral following a default on a mezzanine loan, we would be substituted for the defaulting borrower and, to the extent income generated on the underlying property is insufficient to meet outstanding debt obligations on the property, may need to commit substantial additional capital to stabilize the property and prevent additional defaults to lenders with existing liens on the property. Significant losses related to mezzanine loans could have a material adverse effect on our results of operations and our ability to make distributions to our shareholders.

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

Effective for the District’s taxable year beginning October 1, 2014, Washington, D.C. implemented a new methodology for assessing office property values, which are used to determine the amount of property taxes for which office property owners are liable to the city. The new methodology will use market values to determine property values in lieu of the current system, which analyzes rent, occupancy and other operating data. As of December 31, 2016, we own interests in seven office properties (including one property owned through an unconsolidated joint venture) in Washington, D.C., which total approximately 1.0 million square feet. Pursuant to typical leases between office property owners and their tenants, property owners may recover property tax expenses from tenants. As a result, increases in property tax liabilities may increase the cost to our tenants of leasing office space in Washington, D.C. This could cause our current, as well as potential future tenants, to seek to lease office space in other markets, which could negatively impact our ability to lease and re-lease space in our Washington, D.C. office buildings at current rates or at all. In addition, if we are unable to recover all of the increased property tax expense from our tenants, the increase in property tax liabilities could have a material adverse effect on our results of operations, financial condition and cash flow.

We face risks associated with short-term liquid investments which could adversely affect our results of operations or financial condition.

We periodically have significant cash balances that we invest in a variety of short-term investments that are intended to preserve principal value and maintain a high degree of liquidity while providing current income. From time to time, these investments may include (either directly or indirectly):

direct obligations issued by the U.S. Treasury;
obligations issued or guaranteed by the U.S. government or its agencies;
taxable municipal securities;
obligations (including certificates of deposit) of banks and thrifts;
commercial paper and other instruments consisting of short-term U.S. dollar denominated obligations issued by corporations and banks;
repurchase agreements collateralized by corporate and asset-backed obligations;

21



registered and unregistered money market funds; and
other highly-rated short-term securities.

Investments in these securities and funds are not insured against loss of principal. Under certain circumstances, we may be required to redeem all or part of our investment, and our right to redeem some or all of our investment may be delayed or suspended. In addition, there is no guarantee that our investments in these securities or funds will be redeemable at par value. A decline in the value of our investment or a delay or suspension of our right to redeem may have a material adverse effect on our results of operations or financial condition.

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

All of our properties are required to comply with Title III of the Americans with Disabilities Act, or the ADA. The ADA has separate compliance requirements for “public accommodations” and “commercial facilities” that are not public accommodations, but it generally requires that buildings be made accessible to people with disabilities. Compliance with the ADA requirements could require, for example, removal of access barriers and non-compliance could result in the imposition of fines by the U.S. Government or an award of damages to private litigants, or both. While the tenants to whom we lease properties are obligated by law to comply with the ADA provisions, and typically under our leases are obligated to cover costs associated with compliance, under the law we are also legally responsible for our properties’ ADA compliance. If required changes involve greater expenditures than anticipated, or if the changes must be made on a more accelerated basis than anticipated, the ability of our tenants to cover costs could be adversely affected and we could be required to expend our own funds to comply with the provisions of the ADA, which could adversely affect our results of operations and financial condition and our ability to make distributions to security holders. State and local laws may also require modifications to our properties related to access by disabled persons. In addition, we are required to operate our properties in compliance with fire and safety regulations, building codes and other land use regulations, as they may be adopted by governmental agencies and bodies and become applicable to our properties. We may be required to make substantial capital expenditures to comply with those requirements and these expenditures could have a material adverse effect on our cash flow and ability to make distributions to our security holders.

Failure to comply with Federal government contractor requirements could result in substantial costs and loss of substantial revenue.

We are subject to compliance with a wide variety of complex legal requirements because we are a Federal government contractor. These laws regulate how we conduct business, require us to administer various compliance programs and require us to impose compliance responsibilities on some of our contractors. Our failure to comply with these laws could subject us to fines, penalties and damages, cause us to be in default of our leases and other contracts with the Federal government and bar us from entering into future leases and other contracts with the Federal government. There can be no assurance that these potential costs and losses of revenue will not have a material adverse effect on our results of operations, financial condition and cash flow.

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

We carry insurance coverage on our properties of types and in amounts and with deductibles that we believe are in line with coverage customarily obtained by owners of similar properties. In particular, we have obtained comprehensive liability, casualty, earthquake, flood and rental loss insurance policies on our properties. All of these policies may, depending on the nature of the loss, involve substantial deductibles and certain exclusions. In addition, under the terms and conditions of most of the leases currently in force on our properties, our tenants generally are required to indemnify and hold us harmless from liabilities resulting from injury to persons, air, water, land or property, on or off the premises, due to activities conducted on the properties, except for claims arising from the negligence or intentional misconduct of us or our agents. Furthermore, tenants are generally required, at the tenant’s expense, to obtain and keep in full force during the term of the lease, liability and full replacement value property damage insurance policies. However, our largest tenant, the federal government, is not required to maintain property insurance at all. In addition, we cannot assure you that our tenants will properly maintain their insurance policies or have the ability to pay the deductibles.

Should a loss occur that is uninsured or in an amount exceeding the combined aggregate limits for the policies noted above, or in the event of a loss that is subject to a substantial deductible under an insurance policy, we could lose all or part of our capital invested in, and anticipated revenue from, one or more of the properties. Depending on the specific circumstances of

22



the affected property, it is possible that we could be liable for any mortgage indebtedness or other obligations related to the property. Any such loss could have a material adverse effect on our results of operations, financial condition, cash flow and our ability to make distributions to our security holders.

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

Actual or threatened terrorist attacks may negatively affect our business and our results of operations. In particular, because of our concentration of properties in the Washington, D.C. metropolitan area, which has been and may in the future be the target of actual or threatened terrorist attacks, some tenants in our market may choose to relocate their businesses to other markets. This could result in an overall decrease in the demand for commercial space in this market generally, which could increase vacancies in our properties or necessitate that we lease our properties on less favorable terms, or both. In addition, future terrorist attacks or armed conflicts may directly impact the value of our properties through damage, destruction, loss or increased security costs, or cause losses that materially exceed our insurance coverage. As a result of the foregoing, our ability to generate revenues and the value of our properties could decline materially, which would negatively affect our business and our results of operations. See also “-An uninsured loss or a loss that exceeds the policies on our properties could have a material adverse effect on our results of operations, financial condition and cash flow.” 

In response to the uncertainty in the insurance market following the terrorist attacks of September 11, 2001, the Federal Terrorism Risk Insurance Act (as amended, “TRIA”) was enacted in November 2002 to require regulated insurers to make available coverage for “certified” acts of terrorism (as defined by the statute). TRIA was renewed in January 2015 until 2020 by the Terrorism Risk Insurance Program Reauthorization Act of 2015; however, we can provide no assurance that TRIA will be extended beyond 2020. Currently, our property insurance coverage includes acts of terrorism certified under TRIA other than nuclear, biological, chemical or radiological terrorism. The terrorism insurance that we obtain may not be sufficient to cover loss for damages to our properties as a result of terrorist attacks. In addition, certain losses resulting from these types of events are uninsurable and others would not be covered by our current terrorism insurance. Additional terrorism insurance may not be available at a reasonable price or at all. If the properties in which we invest are unable to obtain sufficient and affordable insurance coverage, the value of those investments could decline, and in the event of an uninsured loss, we could lose all or a portion of an investment. Furthermore, the United States may enter into armed conflicts in the future. The consequences of any armed conflicts are unpredictable, and we may not be able to foresee events that could have an adverse effect on our business.

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

We face risks associated with security breaches through cyber attacks, cyber intrusions or otherwise, as well as other significant disruptions of our information technology (IT) networks and related systems.

We face risks associated with security breaches, whether through cyber attacks or cyber intrusions over the Internet, malware, computer viruses, attachments to e-mails, persons inside our organization or persons with access to systems inside our organization, and other significant disruptions of our IT networks and related systems. The risk of a security breach or disruption, particularly through cyber attack or cyber intrusion, including by computer hackers, foreign governments and cyber terrorists, has generally increased as the number, intensity and sophistication of attempted attacks and intrusions from around the world have increased. Our IT networks and related systems are essential to the operation of our business and our ability to perform day-to-day operations (including managing our building systems) and, in some cases, may be critical to the operations of certain of our tenants. Although we make efforts to maintain the security and integrity of these types of IT networks and related systems, and we have implemented various measures to manage the risk of a security breach or disruption, there can be no assurance that our security efforts and measures will be effective or that attempted security breaches or disruptions would not be successful or damaging. Even the most well protected information, networks, systems and facilities remain potentially vulnerable because the techniques used in such attempted security breaches evolve and generally are not recognized until launched against a target, and in some cases are designed not be detected and, in fact, may not be detected. Accordingly, we may be unable to anticipate these techniques or to implement adequate security barriers or other preventative measures, and thus it is impossible for us to entirely mitigate this risk.


23



A security breach or other significant disruption involving our IT networks and related systems could:

disrupt the proper functioning of our networks and systems and therefore our operations and/or those of certain of our tenants;
result in misstated financial reports, violations of loan covenants, and/or missed reporting deadlines;
result in our inability to properly monitor our compliance with the rules and regulations regarding our qualification as a REIT;
result in the unauthorized access to, and destruction, loss, theft, misappropriation or release of proprietary, confidential, sensitive or otherwise valuable information of ours or others, which others could use to compete against us or for disruptive, destructive or otherwise harmful purposes and outcomes;
result in our inability to maintain the building systems relied upon by our tenants for the efficient use of their leased space;
require significant management attention and resources to remedy any damages that result;
subject us to claims for breach of contract, damages, credits, penalties or termination of leases or other agreements; or
damage our reputation among our tenants and investors generally.

Any or all of the foregoing could have a material adverse effect on our financial condition, results of operations, cash flow and ability to make distributions with respect to, and the market price of, our securities.

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

Despite system redundancy and the implementation of a disaster recovery plan and security measures for our IT networks and related systems, our systems are vulnerable to damages from any number of sources, including computer viruses, energy blackouts, natural disasters, terrorism, war, and telecommunication failures. We rely on our IT networks and related systems, including the Internet, to process, transmit and store electronic information and to manage or support a variety of our business processes, including financial transactions and keeping of records, which may include personal identifying information of tenants and lease data. We rely on commercially available systems, software, tools and monitoring to provide security for processing, transmitting and storing confidential tenant information, such as individually identifiable information relating to financial accounts. Any failure to maintain proper function, security and availability of our IT networks and related systems could interrupt our operations, damage our reputation, subject us to liability claims or regulatory penalties and could have a material adverse effect on our operations. Further, we are dependent on our personnel and, although we recently implemented a formal disaster recovery plan to assist our employees, or to facilitate their maintaining continuity of operations after events such as energy blackouts, natural disasters, terrorism, war, and telecommunication failures, we can provide no assurances that any of the foregoing events would not have a material adverse effect on our results of operations.

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

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

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

Electricity and natural gas, the most common sources of energy used by commercial buildings, are subject to significant price volatility. In recent years, energy costs, including energy generated by natural gas and electricity, have fluctuated significantly. Some of our properties may be subject to leases that require our tenants to pay all utility costs while other leases may provide that tenants will reimburse us for utility costs in excess of a base year amount. It is possible that some or all of our tenants will not fulfill their lease obligations and reimburse us for their share of any significant energy rate increases and that we will not be able to retain or replace our tenants if energy price fluctuations continue. Also, to the extent under a lease we agree to pay for such costs, rising energy prices could have an adverse effect on our results of operations.

We face possible risks associated with the physical effects of climate change.

24




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

Changes in accounting pronouncements could adversely affect our operating results, in addition to the reported financial performance of our tenants. 

Accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. Uncertainties posed by various initiatives of accounting standard-setting by the Financial Accounting Standards Board and the Securities and Exchange Commission, which create and interpret applicable accounting standards for U.S. companies, may change the financial accounting and reporting standards or their interpretation and application of these standards that govern the preparation of our financial statements. Changes include, but are not limited to, changes in lease accounting and the adoption of accounting standards likely to require the increased use of “fair-value” measures. 

These changes could have a material impact on our reported financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in potentially material restatements of prior period financial statements. Similarly, these changes could have a material impact on our tenants’ reported financial condition or results of operations or could affect our tenants’ preferences regarding leasing real estate.

Risks Related to Our Organization and Structure

Our executive officers have agreements that provide them with benefits if their employment is terminated without cause or if such agreements are not renewed by the Company (including within two years of a change in control of the Company), which could prevent or deter a change in control of the Company.

We have entered into employment agreements with our three executive officers, Robert Milkovich, Andrew P. Blocher and Samantha S. Gallagher, which provide them with severance benefits if terminated without cause, if the executive officer resigns for “good reason” as defined in the employment agreements or if their employment ends under certain circumstances following a change in control of the Company. These benefits could increase the cost to a potential acquirer of the Company and thereby prevent or deter a change in control of the Company that might involve a premium price for our securities or otherwise be in the interests of our security holders.

Conflicts of interest may arise between our executive officers relating to their duties to us and our duties to our Operating Partnership.

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

We depend on key personnel, particularly Robert Milkovich, with long-standing business relationships, the loss of whom could threaten our ability to operate our business successfully.

Our future success depends, to a significant extent, upon the continued services of our senior management team, including Robert Milkovich. In particular, the extent and nature of the relationships that Mr. Milkovich has developed in the real estate community in our markets is critically important to the success of our business. Although we have employment agreements with Mr. Milkovich and our other executive officers, there is no guarantee that Mr. Milkovich or our other executive officers will remain employed with us. We do not maintain key person life insurance on any of our officers. The loss of services of one or more members of our senior management team, particularly Mr. Milkovich, could harm our business and prospects.

25



Further, loss of a member of our senior management team could be negatively perceived in the capital markets, which could have an adverse effect on the market price of our securities.

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

Maryland law generally provides that a trustee has no liability for actions taken as a trustee, but may not be relieved of any liability to the company or its security holders for actions taken in bad faith, with willful misfeasance, gross negligence or reckless disregard for his or her duties. Our amended and restated declaration of trust authorizes us to indemnify, and to pay or reimburse reasonable expenses to, our trustees and officers for actions taken by them in those capacities to the maximum extent permitted by Maryland law. In addition, our declaration of trust limits the liability of our trustees and officers for money damages, except as otherwise prohibited by Maryland law or for liability resulting from:

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

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

We are a holding company with no direct operations and, as such, we rely on funds received from our Operating Partnership to pay liabilities, and the interests of our shareholders are structurally subordinated to all liabilities and obligations of our Operating Partnership and its subsidiaries.

We are a holding company and conduct substantially all of our operations through our Operating Partnership. We do not have, apart from an interest in our Operating Partnership, any independent operations. As a result, we rely on distributions from our Operating Partnership to pay any dividends we might declare on our common shares. We also rely on distributions from our Operating Partnership to meet our obligations, including any tax liability on taxable income allocated to us from our Operating Partnership. In addition, because we are a holding company, claims of our equity holders will be structurally subordinated to all existing and future liabilities and obligations (whether or not for borrowed money) of our Operating Partnership and its subsidiaries. Therefore, in the event of our bankruptcy, liquidation or reorganization, our assets and those of our Operating Partnership and its subsidiaries will be available to satisfy the claims of our shareholders only after all of our and our Operating Partnership’s and its subsidiaries’ liabilities and obligations have been paid in full.

Our ownership limitations may restrict business combination opportunities.

To maintain our qualification as a REIT under the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”), no more than 50% of the value of our outstanding shares of beneficial interest may be owned, directly or under applicable attribution rules, by five or fewer individuals (as defined to include certain entities) during the last half of each taxable year. To preserve our REIT qualification, our declaration of trust generally prohibits direct or indirect beneficial ownership (as defined under the Internal Revenue Code) by any person of (i) more than 8.75% of the number or value (whichever is more restrictive) of our outstanding common shares or (ii) more than 8.75% of the value of our outstanding shares of all classes. Generally, shares owned by affiliated owners will be aggregated for purposes of the ownership limitation. Our declaration of trust has created an ownership limitation for the group comprised of Louis T. Donatelli and Douglas J. Donatelli, former trustees and, in the case of Douglas J. Donatelli, a former executive officer of the Company, and certain related persons, which prohibits such group from acquiring direct or indirect ownership (as defined under the Internal Revenue Code) of (i) more than 14.9% of the number or value (whichever is more restrictive) of our outstanding common shares or (ii) more than 14.9% of the value of all of our outstanding shares of all classes. Unless the applicable ownership limitation is waived by our board of trustees prior to transfer, any transfer of our shares that would violate the ownership limitation will be null and void, and the intended transferee will acquire no rights in such shares. Shares that would otherwise be held in violation of the ownership limit will be designated as “shares-in-trust” and transferred automatically to a trust effective on the day before the purported transfer or other event giving rise to such excess ownership. The beneficiary of the trust will be one or more charitable organizations named by us. The ownership limitation provisions could have the effect of delaying, deterring or preventing a change in control or other transaction in which holders of shares might receive a premium for their shares over the then current market price or that such holders might believe to be otherwise in their best interests. The

26



ownership limitation provisions also may make our common shares an unsuitable investment vehicle for any person seeking to obtain, either alone or with others as a group, ownership of shares that would violate the ownership limitation provisions.

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

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

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

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

Maryland law may discourage a third party from acquiring us.

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

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

Potential future issuances of preferred shares may have terms that may limit our ability to maximize value to common shareholders.

Our declaration of trust permits our board of trustees to issue up to 50 million preferred shares, issuable in one or more classes or series. Our board of trustees may increase the number of preferred shares authorized by our declaration of trust without shareholder approval. Our board of trustees may also classify or reclassify any unissued preferred shares and establish the preferences and rights (including the right to vote, to participate in earnings and to convert into securities) of any such preferred shares, which rights may be superior to those of our common shares. Thus, our board of trustees could authorize the issuance of preferred shares with terms and conditions that could have the effect of discouraging a takeover or other transaction in which holders of some or a majority of the common shares might receive a premium for their shares over the then current market price of our common shares.

27




Tax Risks of our Business and Structure

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

We elected to be taxed as a REIT under the Internal Revenue Code commencing with our short taxable year ended December 31, 2003. The requirements for qualification as a REIT are complex and interpretations of the federal income tax laws governing REITs are limited. The REIT qualification rules are even more complicated for a REIT that invests through an operating partnership, in various joint ventures, in other REITs and in both equity and debt investments. Our qualification as a REIT depends on our ability to meet various requirements concerning, among other things, the ownership of our outstanding shares of beneficial interest, the nature of our assets, the sources of our income and the amount of our distributions to our shareholders. If we fail to meet these requirements and do not qualify for certain statutory relief provisions, our distributions to our shareholders will not be deductible by us and we will be subject to a corporate level tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates, substantially reducing our cash available to make distributions to our shareholders. In addition, if we fail to maintain our qualification as a REIT, we would no longer be required to make distributions for federal income tax purposes. Incurring corporate income tax liability might cause us to borrow funds, liquidate some of our investments or take other steps that could negatively affect our operating results. Moreover, if our REIT status is terminated because of our failure to meet a REIT qualification requirement or if we voluntarily revoke our election, unless relief provisions applicable to certain REIT qualification failures apply, we would be disqualified from electing treatment as a REIT for the four taxable years following the year in which REIT status is lost. We may not qualify for relief provisions for REIT qualification failures and even if we can qualify for such relief, we may be required to make penalty payments, which could be significant in amount.

Certain subsidiaries might fail to qualify or fail to remain qualified as a REIT

We own substantially all of the outstanding stock of a subsidiary which we consolidate for financial reporting purposes but which is treated as a separate REIT for federal income tax purposes (the “Subsidiary REIT”).  To qualify as a REIT, the Subsidiary REIT must independently satisfy all of the REIT qualification requirements under the Code, together with all other rules applicable to REITs.  Provided that the Subsidiary REIT qualifies as a REIT, our interests in the Subsidiary REIT will be treated as qualifying real estate assets for purposes of the REIT asset tests.  If the Subsidiary REIT fails to qualify as a REIT in any taxable year, the Subsidiary REIT will be subject to federal and state income taxes and may not be able to qualify as a REIT for the four subsequent taxable years.  Any such failure could have an adverse effect on our ability to comply with the REIT income and asset tests, and thus our ability to qualify as a REIT, unless we are able to avail ourselves of certain relief provisions.

Even if we qualify as a REIT, we may face other tax liabilities that reduce the cash available for distribution to our shareholders.

Even if we maintain our qualification as a REIT, we are subject to any applicable federal, state and local taxes on our income, property or net worth, including taxes on any undistributed income, tax on income from some activities conducted as a result of a foreclosure, and state or local income, property and transfer taxes. Moreover, if we have net income from “prohibited transactions,” that income will be subject to a 100% tax. In general, prohibited transactions are sales or other dispositions of property held primarily for sale to customers in the ordinary course of business. The determination as to whether a particular sale is a prohibited transaction depends on the facts and circumstances related to that sale. While we will undertake sales of assets if those assets become inconsistent with our long-term strategic or return objectives, we do not believe that those sales should be considered prohibited transactions, but there can be no assurance that the Internal Revenue Service would not contend otherwise. The need to avoid prohibited transactions could cause us to forego or defer sales of properties that might otherwise be in our best interest to sell. In addition, we could, in certain circumstances, be required to pay an excise or penalty tax (which could be significant in amount) in order to utilize one or more relief provisions under the Internal Revenue Code to maintain our qualification as a REIT. Any of these taxes would decrease cash available for the payment of our debt obligations and distributions to shareholders. Our taxable REIT subsidiary generally will be subject to U.S. federal corporate income tax on its net taxable income.

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


28



We believe that our Operating Partnership is organized and operated in a manner so as to be treated as a partnership and not an association or a publicly traded partnership taxable as a corporation, for federal income tax purposes. Failure of our Operating Partnership (or a subsidiary partnership) to be treated as a partnership for federal income tax purposes would have serious adverse consequences to our shareholders. If the Internal Revenue Service were to successfully challenge the federal income tax status of our Operating Partnership and treat our Operating Partnership as an association or publicly traded partnership taxable as a corporation for federal income tax purposes, we would fail to meet the gross income tests and certain of the asset tests applicable to REITs and, accordingly, would cease to qualify as a REIT. Also, the failure of the Operating Partnership to qualify as a partnership would cause it to become subject to federal corporate income tax, which would reduce significantly the amount of its cash available for distribution to its partners, including us.

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

One aspect of our Strategic Plan includes disposing of those properties that are no longer a strategic fit, properties in submarkets where we do not have asset concentration or operating efficiencies and/or properties where we believe we cannot further maximize value. If we dispose of a property directly or through an entity that is treated for federal income tax purposes as a partnership or a disregarded entity, and such sale is deemed to be a sale of dealer property or inventory, such sale may be deemed to be a “prohibited transaction” under the federal income tax laws applicable to REITs, in which case our gain, or our share of the gain, from the sale would be subject to a 100% penalty tax. If we believe that a sale of a property might be treated as a prohibited transaction, we may seek to conduct that sales activity through a taxable REIT subsidiary, in which case the gain from the sale would be subject to corporate income tax but not the 100% prohibited transaction tax. We cannot assure you, however, that the Internal Revenue Service will not assert successfully that sales of properties that we make directly or through an entity that is treated as a partnership or a disregarded entity, for federal income tax purposes are sales of dealer property or inventory, in which case the 100% penalty tax would apply.

Moreover, we have entered and may enter into agreements with joint venture partners or contributors to our Operating Partnership that require us to indemnify, in whole or in part, such joint venture partners or such contributors for their tax obligations resulting from the recognition of gain in the case of taxable sales of certain contributed properties or a failure to maintain certain property-level indebtedness on certain contributed properties for a period of years.

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

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

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

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

At any time, the federal income tax laws or regulations governing REITs or the administrative interpretations of those laws or regulations may be amended. Legislative and regulatory changes, including comprehensive tax reform, may be more likely in the 115th Congress, which convened in January 2017, because the Presidency and both Houses of Congress will be controlled by the same political party. We cannot predict when or if any new federal income tax law, regulation or administrative

29



interpretation, or any amendment to any existing federal income tax law, regulation or administrative interpretation, will be adopted, promulgated or become effective and any such law, regulation or interpretation may take effect retroactively. We and our shareholders, as well as the market price of our securities, could be adversely affected by any such change in, or any new, federal income tax law, regulation or administrative interpretation.

Dividends payable by REITs generally do not qualify for the reduced tax rates available for some dividends.

The maximum federal income tax rate currently applicable to income from “qualified dividends” payable by corporations to U.S. shareholders taxed at individual rates is 20% (excluding the 3.8% net investment income tax). Dividends payable by REITs, however, generally are not eligible for the reduced tax rates. Although such reduced tax rates do not adversely affect the taxation of REITs or dividends payable by REITs, the more favorable tax rates applicable to regular corporate qualified dividends could cause investors who are taxed at individual rates to perceive investments in REITs to be relatively less attractive than investments in shares of non-REIT corporations that pay dividends, which could adversely affect the market price of shares of REITs, including our shares.

Complying with REIT requirements may force us to forego and/or sell otherwise attractive investments.

To maintain our qualification as a REIT, we must satisfy certain requirements with respect to the character of our assets.  If we fail to comply with these requirements at the end of any calendar quarter, we must correct such failure within 30 days after the end of the calendar quarter (by, possibly, selling assets notwithstanding their prospects as an investment) to avoid losing our REIT status.  If we fail to comply with these requirements at the end of any calendar quarter, and the failure exceeds a de minimis threshold, we may be able to preserve our REIT status if (a) the failure was due to reasonable cause and not to willful neglect, (b) we dispose of the assets causing the failure within six months after the last day of the quarter in which we identified the failure, (c) we file a schedule with the Internal Revenue Service describing each asset that caused the failure, and (d) we pay an additional tax of the greater of $50,000 or the product of the highest applicable tax rate multiplied by the net income generated on those assets.  As a result, we may be required to liquidate or forego otherwise attractive investments. These actions could have the effect of reducing our income and amounts available for distribution to our shareholders.

In addition to the asset test requirements mentioned above, to qualify as a REIT we must continually satisfy tests concerning, among other things, the sources of our income, the amounts we distribute to our shareholders and the ownership of our stock. We may be unable to pursue investments that would be otherwise advantageous to us in order to satisfy the source-of-income or asset-diversification requirements for qualifying as a REIT. Thus, compliance with the REIT requirements may hinder our ability to make certain attractive investments.

Risks Related to an Investment in Our Equity Securities

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

Our common shares experience relatively limited trading volume; many investors, particularly institutions, may not be interested (or be permitted) in owning our common shares because of the inability to acquire or sell a substantial block of our common shares at one time. This illiquidity could have an adverse effect on the market price of our common shares. In addition, a shareholder may not be able to borrow funds using our common shares as collateral because lenders may be unwilling to accept the pledge of common shares having a limited market, thereby making our common shares a less attractive investment for some investors.

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

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


30



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

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

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

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

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

We have not established a minimum dividend payment level and our ability to make distributions may be adversely affected by the risk factors described in this Annual Report on Form 10-K and any risk factors in our subsequent filings with the SEC. For example, in 2016, we reduced our targeted annualized common share dividend to $0.40 per share, which represents a 33% reduction from the previous annualized dividend rate of $0.60 per share. All distributions are made at the discretion of our board of trustees and their payment and amount will depend on our earnings, our financial condition, maintenance of our REIT status, compliance with our debt covenants and other factors as our board of trustees may deem relevant from time to time. We cannot assure you of our ability to make distributions in the future or that the distributions will be made in amounts similar to our current distributions. In particular, our outstanding debt, and the limitations imposed on us by our debt agreements, could make it more difficult for us to satisfy our obligations with respect to our equity securities, including paying dividends. See “Risk Factors - Risks Related to Our Business and Properties - Covenants in our debt agreements could adversely affect our liquidity and financial condition.” Further, future offerings of preferred shares could have a preference on liquidating distributions or a preference on dividend payments or both that could limit our ability to make a dividend distribution to the holders of our common shares. In addition, some of our distributions may include a return of capital or may be taxable distributions of our shares or debt securities.

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

In the future, particularly as we seek to acquire and develop additional real estate assets consistent with our growth strategy, we may attempt to increase our capital resources through debt offerings or additional equity offerings, including senior or

31



subordinated notes and series of preferred shares or common shares. Any preferred shares that we issue will rank junior to all of our existing and future debt and to other non-equity claims on us and our assets available to satisfy claims against us, including claims in bankruptcy, liquidation or similar proceedings. Further, upon liquidation, holders of our debt securities and preferred shares and lenders with respect to other borrowings will receive a distribution of our available assets prior to the holders of our common shares.

Additional equity offerings may dilute the holdings of our existing shareholders, reduce the market price of our equity securities, or have a dilutive effect on our earnings per share and funds from operations per share. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings or the actual amount of dilution, if any. Thus, holders of our equity securities bear the risk of our future offerings reducing the market price of our equity securities and diluting their share holdings in us.

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

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

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

ITEM 1B.
UNRESOLVED STAFF COMMENTS

None.


32



ITEM 2.
PROPERTIES

The following sets forth certain information about our properties by segment as of December 31, 2016 (including properties in development and redevelopment, dollars in thousands):

WASHINGTON, D.C. REGION
 
Property
 
Buildings
 
Sub-Market(1)
 
Square Feet
 
Annualized
Cash Basis
Rent(2)
 
Leased at
December 31,
2016
 
Occupied at
December 31,
2016
 
 
 
 
 
 
 
 
 
 
 
 
 
Office
 
 
 
 
 
 
 
 
 
 
 
 
11 Dupont Circle, NW(3)
 
1

 
CBD
 
151,144

 
$
5,086

 
88.1
%
 
88.1
%
440 First Street, NW(3)
 
1

 
Capitol Hill
 
138,603

 
3,856

 
81.5
%
 
81.5
%
500 First Street, NW
 
1

 
Capitol Hill
 
129,035

 
4,638

 
100.0
%
 
100.0
%
840 First Street, NE(3)
 
1

 
NoMA
 
248,536

 
7,719

 
100.0
%
 
100.0
%
1211 Connecticut Avenue, NW(3)
 
1

 
CBD
 
131,665

 
3,706

 
92.1
%
 
92.1
%
1401 K Street, NW(3)
 
1

 
East End
 
119,283

 
3,155

 
79.3
%
 
74.5
%
Total/Weighted Average
 
6

 
 
 
918,266

 
28,160

 
91.4
%
 
90.8
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Unconsolidated Joint Venture
 
 
 
 
 
 
 
 
 
 
 
 
1750 H Street, NW(3)
 
1

 
CBD
 
113,131

 
4,123

 
94.6
%
 
91.1
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Region Total/Weighted Average
 
7

 
 
 
1,031,397

 
$
32,283

 
91.8
%
 
90.8
%
 
(1) 
CBD refers to Central Business District; NoMA refers to North of Massachusetts Avenue.
(2) 
Annualized cash basis rent at the end of the year, which is calculated as the contractual rent due under the terms of the lease, without taking into account rent abatements, is reflected on a triple-net equivalent basis, by deducting estimated operating expense reimbursements that are included, along with base rent, in the contractual payments of our full service leases. This amount does not include items such as rent abatement, unreimbursed expenses, non-recurring revenues and expenses, differences in leased vs. occupied space, and timing differences related to tenant activity.
(3) 
Properties are encumbered by mortgage debt or a construction loan as of December 31, 2016. See note 10, Debt, for more information on debt encumbering the Washington D.C. office properties and note 5, Investment in Affiliates, for more information on the debt encumbering 1750 H Street, NW in the notes to our accompanying financial statements.




33



MARYLAND REGION
 
Property
 
Buildings
 
Location
 
Square Feet
 
Annualized
Cash Basis
Rent(1)
 
Leased at
December 31,
2016
 
Occupied at
December 31,
2016
 
 
 
 
 
 
 
 
 
 
 
 
 
Office
 
 
 
 
 
 
 
 
 
 
 
 
Annapolis Business Center
 
2

 
Annapolis
 
101,113

 
$
1,758

 
100.0
%
 
100.0
%
Cloverleaf Center
 
4

 
Germantown
 
173,916

 
2,626

 
89.8
%
 
89.8
%
Hillside I and II
 
2

 
Columbia
 
87,267

 
991

 
87.6
%
 
82.3
%
Metro Park North
 
4

 
Rockville
 
191,211

 
2,942

 
87.3
%
 
87.3
%
Redland II and III(2)(3)
 
2

 
Rockville
 
349,267

 
9,737

 
100.0
%
 
100.0
%
Redland I(2)
 
1

 
Rockville
 
133,895

 
2,711

 
100.0
%
 
100.0
%
TenThreeTwenty
 
1

 
Columbia
 
138,950

 
2,153

 
94.4
%
 
94.4
%
Total Office
 
16

 
 
 
1,175,619

 
22,918

 
94.8
%
 
94.5
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Business Park
 
 
 
 
 
 
 
 
 
 
 
 
Ammendale Business Park(4)
 
7

 
Beltsville
 
312,846

 
3,699

 
80.5
%
 
80.5
%
Gateway 270 West
 
6

 
Clarksburg
 
252,295

 
3,242

 
92.9
%
 
89.2
%
Snowden Center
 
5

 
Columbia
 
145,423

 
2,241

 
99.1
%
 
96.5
%
Total Business Park
 
18

 
 
 
710,564

 
9,182

 
88.7
%
 
86.8
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Total Consolidated
 
34

 
 
 
1,886,183

 
32,100

 
92.5
%
 
91.6
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Unconsolidated Joint Ventures
 
 
 
 
 
 
 
 
 
 
 
 
Aviation Business Park (5)
 
3

 
Glen Burnie
 
120,284

 
1,458

 
79.3
%
 
69.8
%
Rivers Park I and II (3)(5)
 
6

 
Columbia
 
307,984

 
3,711

 
82.9
%
 
82.9
%
Total Joint Ventures
 
9

 
 
 
428,268

 
5,169

 
81.9
%
 
79.2
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Region Total/Weighted Average
 
43

 
 
 
2,314,451

 
$
37,269

 
90.6
%
 
89.3
%
 
(1) 
Annualized cash basis rent at the end of the year, which is calculated as the contractual rent due under the terms of the lease, without taking into account rent abatements, is reflected on a triple-net equivalent basis, by deducting operating expense reimbursements that are included, along with base rent, in the contractual payments of our full service leases. This amount does not include items such as rent abatement, unreimbursed expenses, non-recurring revenues and expenses, differences in leased vs. occupied space, and timing differences related to tenant activity.
(2) 
Redland II and III (520 and 530 Gaither Road, respectively) and Redland I (540 Gaither Road) are collectively referred to as Redland.
(3) 
These properties were encumbered by mortgage debt as of December 31, 2016. See note 10, Debt, for more information on the debt encumbering Redland II and III and note 5, Investment in Affiliates, for more information on the debt encumbering Rivers Park I and II in the notes to our accompanying consolidated financial statements.
(4) 
Ammendale Business Park consists of the following properties: Ammendale Commerce Center and Indian Creek Court.
(5) 
In January 2017, the unconsolidated joint ventures that own these properties entered into a binding contract to sell Aviation Business Park and Rivers Park I and II, which are all located in Maryland. We anticipate completing the sale in March 2017; however, we can provide no assurances regarding the timing or pricing of such sale, or that such sale will ultimately occur.





34



NORTHERN VIRGINIA REGION
 
Property
 
Buildings
 
Location
 
Square Feet
 
Annualized
Cash Basis
Rent(1)
 
Leased at
December 31,
2016
 
Occupied at
December 31,
2016
 
 
 
 
 
 
 
 
 
 
 
 
 
Office
 
 
 
 
 
 
 
 
 
 
 
 
Atlantic Corporate Park
 
2

 
Sterling
 
218,250

 
$
3,964

 
96.2
%
 
96.2
%
NOVA build-to-suit(2)
 
1

 
Not Disclosed
 
167,440

 
4,050

 
100.0
%
 
100.0
%
One Fair Oaks (3)
 
1

 
Fairfax
 
214,214

 
5,707

 
100.0
%
 
100.0
%
Three Flint Hill
 
1

 
Oakton
 
180,699

 
3,714

 
97.9
%
 
97.9
%
1775 Wiehle Avenue
 
1

 
Reston
 
129,982

 
2,973

 
95.5
%
 
95.5
%
Total Office
 
6

 
 
 
910,585

 
20,409

 
98.0
%
 
98.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Business Park
 
 
 
 
 
 
 
 
 
 
 
 
Sterling Park Business Center(4)
 
7

 
Sterling
 
472,543

 
4,390

 
92.1
%
 
85.4
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Industrial
 
 
 
 
 
 
 
 
 
 
 
 
Plaza 500 (5)
 
2

 
Alexandria
 
502,830

 
5,089

 
90.5
%
 
90.5
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Total Consolidated
 
15

 
 
 
1,885,958

 
29,887

 
94.5
%
 
92.8
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Unconsolidated Joint Venture
 
 
 
 
 
 
 
 
 
 
 
 
Prosperity Metro Plaza(2)
 
2

 
Merrifield
 
326,197

 
8,816

 
100.0
%
 
100.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Region Total/Weighted Average
 
17

 
 
 
2,212,155

 
$
38,703

 
95.3
%
 
93.9
%
 
(1) 
Annualized cash basis rent at the end of the year, which is calculated as the contractual rent due under the terms of the lease, without taking into account rent abatements, is reflected on a triple-net equivalent basis, by deducting operating expense reimbursements that are included, along with base rent, in the contractual payments of our full service leases. This amount does not include items such as rent abatement, unreimbursed expenses, non-recurring revenues and expenses, differences in leased vs. occupied space, and timing differences related to tenant activity.
(2) 
These properties were encumbered by mortgage debt or a construction loan as of December 31, 2016. See note 10, Debt, for more information on the debt encumbering the NOVA build-to-suit and note 5, Investment in Affiliates, for more information on the debt encumbering Prosperity Metro Plaza in the notes to our accompanying consolidated financial statements.
(3) 
On January 9, 2017, we sold One Fair Oaks for net proceeds of $13.3 million.
(4) 
Sterling Park Business Center consists of the following properties: 403/405 Glenn Drive, Davis Drive and Sterling Park Business Center.
(5) 
On February 17, 2017, we sold Plaza 500 for net proceeds of $72.5 million.





35



SOUTHERN VIRGINIA REGION
 
Property
 
Buildings
 
Location
 
Square Feet
 
Annualized
Cash Basis
Rent(1)
 
Leased at
December 31,
2016
 
Occupied at
December 31,
2016
 
 
 
 
 
 
 
 
 
 
 
 
 
Office
 
 
 
 
 
 
 
 
 
 
 
 
Greenbrier Towers
 
2

 
Chesapeake
 
171,766

 
$
1,949

 
90.6
%
 
88.7
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Business Park
 
 
 
 
 
 
 
 
 
 
 
 
Battlefield Corporate Center(2)
 
1

 
Chesapeake
 
96,720

 
861

 
100.0
%
 
100.0
%
Crossways Commerce Center(3)
 
9

 
Chesapeake
 
1,082,461

 
11,825

 
96.1
%
 
94.9
%
Greenbrier Business Park(4)
 
4

 
Chesapeake
 
411,237

 
4,569

 
94.0
%
 
92.0
%
Norfolk Commerce Park(5)
 
3

 
Norfolk
 
261,674

 
2,716

 
96.1
%
 
96.1
%
Total Business Park
 
17

 
 
 
1,852,092

 
19,971

 
95.8
%
 
94.7
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Region Total/Weighted Average
 
19

 
 
 
2,023,858

 
$
21,920

 
95.4
%
 
94.2
%

(1) 
Annualized cash basis rent at the end of the year, which is calculated as the contractual rent due under the terms of the lease, without taking into account rent abatements, is reflected on a triple-net equivalent basis, by deducting operating expense reimbursements that are included, along with base rent, in the contractual payments of our full service leases. This amount does not include items such as rent abatement, unreimbursed expenses, non-recurring revenues and expenses, differences in leased vs. occupied space, and timing differences related to tenant activity.
(2) 
This property was encumbered by mortgage debt as of December 31, 2016. See note 10, Debt, in the notes to our accompanying consolidated financial statements for more information.
(3) 
Crossways Commerce Center consists of the following properties: Coast Guard Building, Crossways Commerce Center I, Crossways Commerce Center II, Crossways Commerce Center IV and 1434 Crossways Boulevard.
(4) 
Greenbrier Business Park consists of the following properties: Greenbrier Technology Center I, Greenbrier Technology Center II and Greenbrier Circle Corporate Center.
(5) 
Norfolk Commerce Park consists of the following properties: Norfolk Business Center, Norfolk Commerce Park II and Gateway II.



36



Lease Expirations

At December 31, 2016, 19.0% of our annualized cash basis rent was scheduled to expire in 2017, which includes 5.1% of our annualized cash basis rent that is related to CACI International (whose lease expired on December 31, 2016), the sole tenant at One Fair Oaks, which was sold on January 9, 2017. We expect replacement rents on leases expiring in 2017 to increase slightly on a cash basis relative to the current rental rates being paid by tenants. Current tenants are not obligated to renew their leases upon the expiration of their terms. If non-renewals or terminations occur, we may not be able to locate qualified replacement tenants and, as a result, could lose a significant source of revenue while remaining responsible for the payment of our financial obligations. For new tenants or upon lease expiration for existing tenants, we generally must make improvements and pay other leasing costs for which we may not receive increased rents. We may also make building-related capital improvements for which tenants may not reimburse us. Moreover, the terms of a renewal or new lease, including the amount of rent, may be less favorable to us than the current lease terms, or we may be forced to provide tenant improvements at our expense or provide other concessions or additional services to maintain or attract tenants. We continually strive to increase our portfolio occupancy, and the amount of vacant space in our portfolio at any given time may impact our willingness to reduce rental rates or provide greater concessions to retain existing tenants and attract new tenants. We continually monitor our portfolio on a regional and per property basis to assess market trends, including vacancy, comparable deals and transactions, and other business and economic factors that may influence our leasing decisions. Prior to signing a lease with a tenant, we generally assess the prospective tenant’s credit quality through review of its financial statements and tax returns, and the result of that review is a factor in establishing the rent to be charged and/or level of security deposit required. Over the course of our leases, we monitor our tenants to stay aware of any material changes in credit quality. The metrics we use to evaluate a significant tenant’s liquidity and creditworthiness depend on facts and circumstances specific to that tenant and to the industry in which it operates and include the tenant’s credit history and economic conditions related to the tenant, its operations and the markets in which it operates.  These factors may change over time. In addition, our property management personnel have regular contact with tenants and tenant employees, and, where the terms of the lease permit and we deem it prudent, we may request tenant financial information for periodic review, review publicly-available financial statements in the case of public company tenants and monitor news and rating agency reports regarding our tenants (or their parent companies) and their underlying businesses. In addition, we regularly analyze account receivable balances as part of the ongoing monitoring of the timeliness of rent collections from tenants.

During 2016, we had a tenant retention rate of 74% and had positive net absorption of 135,000 square feet. After reflecting all of the renewal leases on a triple-net basis to allow for comparability, the weighted average rental rate of our renewed leases in 2016 increased 6.9% on a U.S. generally accepted accounting principles (“GAAP”) basis, compared with expiring leases. During 2016, we executed new leases for approximately 299,000 square feet, and the majority of the new leases (based on square footage) contained rent escalations. After reflecting all leases on a triple-net basis to allow for comparability, the weighted average rental rate of our new leases increased 3.4% on a GAAP basis, compared with expiring leases.

At December 31, 2016, we owned three single-tenant buildings that had leases expiring in 2017 (One Fair Oaks - CACI International, 540 Gaither Road - Department of Health and Human Services and 500 First Street, NW - Bureau of Prisons).

CACI International, which fully leased One Fair Oaks in our Northern Virginia reporting segment, had a lease that terminated on December 31, 2016. In connection with our fourth quarter reporting for 2015, we evaluated the potential loss of cash flow at One Fair Oaks and the anticipated challenges of re-leasing the property, and as a result, we recorded an impairment charge of $33.9 million to bring the property to its estimated fair value. On January 9, 2017, we sold One Fair Oaks for net proceeds of $13.3 million.

In October 2015, we received notice from the Department of Health and Human Services, which fully leases the building at 540 Gaither Road within our Redland property in our Maryland reporting segment, that it will be exercising its early termination right, which is in March 2017. We underwrote the Department of Health and Human Services exercising its termination right when we acquired the building in 2013. During the second quarter of 2016, we re-leased two floors at 540 Gaither Road, which totaled 45,000 square feet, or approximately 34% of the building’s total square footage. We anticipate that the new tenant at 540 Gaither Road will take occupancy in early 2018; however, we can provide no assurances regarding the timing of when the tenant will take occupancy. We have begun repositioning the property, gauging new tenant interest to lease the property and, upon the expiration of the current tenant’s lease in March 2017, will place 540 Gaither Road into redevelopment, all with the ultimate goal of maximizing value upon the expiration of the lease; however, we can provide no assurances regarding the outcome of these or any other alternative strategies for the property.

The Bureau of Prisons, which fully leases 500 First Street, NW in our Washington, D.C. reporting segment, was subject to a lease that was scheduled to expire in July 2016. During the second quarter of 2016, we entered into a one-year lease extension with the Bureau of Prisons, which is set to expire in July 2017, and we believe there is a likelihood that the tenant will elect to

37



further extend the expiration date of the lease; however, we can provide no assurances regarding the length of such extension or that such extension will occur at all. Currently, we are evaluating various strategies with respect to 500 First Street, NW, which include repositioning 500 First Street, NW and gauging new tenant interest to lease this property, all with the ultimate goal of maximizing value upon the expiration of the lease; however, we can provide no assurances regarding the outcome of these or any other alternative strategies for the property.

The following table sets forth tenant improvement and leasing commission costs on a rentable square foot basis for all new and renewal leases signed during the year ended December 31, 2016:

 
New
 
Renewal
Tenant improvements (per rentable square foot)
$21.28
 
$6.56
Leasing commissions (per rentable square foot)
$10.43
 
$2.19

The following table sets forth a summary schedule of the lease expirations at our consolidated properties for leases in place as of December 31, 2016, assuming no tenant exercises renewal options or early termination rights (dollars in thousands, except per square foot data):
Year of Lease Expiration(1)
 
Number of
Leases
Expiring
 
Leased
Square Feet
 
% of Leased
Square Feet
 
Annualized
Cash Basis
Rent(2)
 
% of
Annualized
Cash Basis
Rent
 
Average Base
Rent per
Square
Foot(3)
2017(4)
 
61

 
964,882

 
15.3
%
 
$
21,313

 
19.0
%
 
$
22.09

2018
 
63

 
651,458

 
10.3
%
 
9,602

 
8.6
%
 
14.74

2019
 
60

 
725,573

 
11.5
%
 
10,442

 
9.3
%
 
14.39

2020
 
56

 
968,619

 
15.4
%
 
15,446

 
13.8
%
 
15.95

2021
 
48

 
505,811

 
8.0
%
 
7,319

 
6.5
%
 
14.47

2022
 
50

 
699,816

 
11.1
%
 
9,547

 
8.5
%
 
13.64

2023
 
16

 
479,800

 
7.6
%
 
11,289

 
10.1
%
 
23.53

2024
 
21

 
519,230

 
8.2
%
 
9,524

 
8.5
%
 
18.34

2025
 
15

 
250,193

 
4.0
%
 
4,547

 
4.1
%
 
18.17

2026
 
14

 
147,358

 
2.3
%
 
3,269

 
2.9
%
 
22.18

Thereafter
 
17

 
384,981

 
6.1
%
 
9,771

 
8.7
%
 
25.38

Total / Weighted Average
 
421

 
6,297,721

 
100.0
%
 
$
112,067

 
100.0
%
 
$
17.79

(1) 
We classify leases that expired or were terminated on the last day of the quarter as leased square footage since the tenant is contractually entitled to the space.
(2) 
Annualized cash basis rent at the end of the year, which is calculated as the contractual rent due under the terms of the lease, without taking into account rent abatements, is reflected on a triple-net equivalent basis, by deducting estimated operating expense reimbursements that are included, along with base rent, in the contractual payments of our full-service leases. The operating expense reimbursements primarily relate to real estate taxes and insurance expenses. This amount does not include items such as rent abatement, unreimbursed expenses, non-recurring revenues and expenses, differences in leased and occupied space and timing differences related to tenant activity.
(3) 
Represents annualized cash basis rent at December 31, 2016, divided by the square footage of the expiring leases.
(4) 
Includes the contractual expiration of the CACI International lease at One Fair Oaks on December 31, 2016 (presented as a first quarter 2017 expiration), which was sold on January 9, 2017. Also includes the contractual expiration of the Department of Health and Human Services lease at Redland Corporate Center on March 22, 2017 and the Bureau of Prisons lease at 500 First Street, NW on July 31, 2017.


38



Our average effective annual rental rate per square foot on a cash basis for each of the previous five years is as follows:
 
Weighted Average
Base Rent per
Square Foot(1)
2012
$
11.83

2013
13.58

2014
15.22

2015
16.41

2016
17.38

(1) 
Represents the weighted average of quarterly annualized cash basis rent during the respective year, divided by the total square footage under the terms of the respective leases from which the annualized cash basis rent is derived (including leased spaces that are not yet occupied). Annualized cash basis rent at the end of each quarter, which is calculated as the contractual rent due under the terms of the lease, without taking into account rent abatements, is reflected on a triple-net equivalent basis, by deducting estimated operating expense reimbursements that are included, along with base rent, in the contractual payments of our full-service leases. The operating expense reimbursements primarily relate to real estate taxes and insurance expenses. This amount does not include items such as rent abatement, unreimbursed expenses, non-recurring revenues and expenses, differences in leased and occupied space and timing differences related to tenant activity.

Our weighted average occupancy rates for each of the previous five years are summarized as follows:
 
 
Weighted Average
Occupancy Rates
2012
83.3
%
2013
84.6
%
2014
86.5
%
2015
89.0
%
2016
91.4
%

ITEM 3.
LEGAL PROCEEDINGS

We are subject to legal proceedings and claims arising in the ordinary course of our business. In the opinion of our management, as of December 31, 2016, we are not involved in any material litigation, nor, to management’s knowledge, is any material litigation threatened against us or the Operating Partnership.

ITEM 4.
MINE SAFETY DISCLOSURES

Not applicable.


39



PART II

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

Market Information

Our common shares are listed on the New York Stock Exchange (“NYSE”) under the symbol “FPO.” Our common shares began trading on the NYSE upon the closing of our initial public offering in October 2003. At February 8, 2017, there were 47 common shareholders of record; however, because many of our common shares are held by brokers and other institutions on behalf of shareholders, we believe there are substantially more beneficial holders of our common shares than record holders.

The following table sets forth the high and low sales prices for our common shares and the dividends paid per common share for 2016 and 2015.

 
Price Range
 
Dividends
Per Share
2016
High
 
Low
 
Fourth Quarter
$
10.97

 
$
8.01

 
$
0.10

Third Quarter
10.47

 
8.83

 
0.10

Second Quarter
9.77

 
8.26

 
0.10

First Quarter
11.46

 
7.90

 
0.15

 
Price Range
 
Dividends
Per Share
2015
High
 
Low
 
Fourth Quarter
$
12.11

 
$
10.79

 
$
0.15

Third Quarter
11.89

 
10.18

 
0.15

Second Quarter
12.06

 
9.88

 
0.15

First Quarter
13.29

 
11.16

 
0.15


On January 24, 2017, we declared a dividend of $0.10 per common share, equating to an annualized dividend of $0.40 per common share. The dividend was paid on February 15, 2017 to common shareholders of record as of February 8, 2017. As part of our Strategic Plan, we reduced our targeted annualized common share dividend from $0.60 to $0.40 per common share in 2016, which we believe will enable us to improve our balance sheet and finance future growth, including through redevelopment.

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

Sales of Unregistered Equity Securities and Issuer Repurchases

We did not sell any unregistered equity securities during the year ended December 31, 2016. During the year ended December 31, 2016, 73,467 common Operating Partnership units were redeemed with available cash. No common Operating Partnership units were redeemed for common shares during the year ended December 31, 2016.


40



Issuer Purchases of Equity Securities
 
During the three months ended December 31, 2016, we did not repurchase any equity securities registered pursuant to Section 12 of the Exchange Act.

41



 Share Return Performance

The following graph compares the cumulative total return on our common shares with the cumulative total return of the S&P 500 Stock Index and The MSCI US REIT Index for the period from December 31, 2011 through December 31, 2016 assuming the investment of $100 in each of us and the two indices, on December 31, 2011, and the reinvestment of common dividends. The performance reflected in the graph is not necessarily indicative of future performance. We will not make or endorse any predictions as to our future share performance.

COMPARISON OF CUMULATIVE TOTAL RETURNS FOR THE PERIOD
DECEMBER 31, 2011 THROUGH DECEMBER 31, 2016
FIRST POTOMAC REALTY TRUST COMMON STOCK AND S&P 500 AND
THE MSCI US REIT INDEX (RMS)
 
fpo201510-k_chartx28637a01.jpg
 
    
 
Total Return Index from 12/31/11
to the Period Ended
Index
12/31/11
 
12/31/12
 
12/31/13
 
12/31/14
 
12/31/15
 
12/31/16
First Potomac Realty Trust
100.00

 
100.97

 
99.30

 
110.59

 
107.45

 
108.73

MSCI US REIT (RMS)
100.00

 
117.77

 
120.68

 
157.34

 
161.30

 
175.17

S&P 500
100.00

 
116.00

 
153.57

 
174.60

 
177.01

 
198.18


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

42



ITEM 6.
SELECTED FINANCIAL DATA

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

The following financial information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.
 
 
Year Ended December 31,
(amounts in thousands, except per share amounts)
2016
 
2015
 
2014
 
2013
 
2012
 
 
 
 
 
 
 
(unaudited)
Operating Data:
 
 
 
 
 
 
 
 
 
Total revenues
$
160,334

 
$
172,846

 
$
161,652

 
$
148,815

 
$
142,962

(Loss) income from continuing operations
(1,569
)
 
(34,417
)
 
15,559

 
(10,761
)
 
(24,324
)
(Loss) income from discontinued operations

 
(607
)
 
1,484

 
21,742

 
15,943

Net (loss) income
(1,569
)
 
(35,024
)
 
17,043

 
10,981

 
(8,381
)
Less: Net loss (income) attributable to noncontrolling interests
502

 
2,058

 
(199
)
 
93

 
986

Net (loss) income attributable to First Potomac Realty Trust
(1,067
)
 
(32,966
)
 
16,844

 
11,074

 
(7,395
)
Less: Dividends on preferred shares
(3,053
)
 
(12,400
)
 
(12,400
)
 
(12,400
)
 
(11,964
)
Less: Issuance costs on redeemed preferred shares
(5,515
)
 

 

 

 

Net (loss) income attributable to common shareholders
$
(9,635
)
 
$
(45,366
)
 
$
4,444

 
$
(1,326
)
 
$
(19,359
)
Basic and diluted earnings per common share:
 
 
 
 
 
 
 
 
 
(Loss) income from continuing operations
$
(0.17
)
 
$
(0.78
)
 
$
0.05

 
$
(0.41
)
 
$
(0.70
)
(Loss) income from discontinued operations

 
(0.01
)
 
0.02

 
0.38

 
0.30

Net (loss) income
$
(0.17
)
 
$
(0.79
)
 
$
0.07

 
$
(0.03
)
 
$
(0.40
)
Cash dividends declared and paid per common share
$
0.45

 
$
0.60

 
$
0.60

 
$
0.60

 
$
0.80

 
At December 31,
(amounts in thousands)
2016
 
2015
 
2014
 
2013
 
2012
Balance Sheet Data:
 
 
 
 
 
 
 
 
 
Total assets(1)
$
1,260,247

 
$
1,442,406

 
$
1,612,300

 
$
1,494,883

 
$
1,713,033

Debt(1)(2)
737,171

 
724,250

 
807,477

 
666,070

 
929,149

Series A Preferred Shares(3)

 
160,000

 
160,000

 
160,000

 
160,000


(1) 
Total assets and debt have been restated in accordance with Accounting Standards Update No. 2015-03, Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03”), which requires debt issuance costs to be presented in the balance sheet as a direct deduction from the carrying value of the respective debt liability and which is applied on a retrospective basis.
(2) 
Includes the mortgage debt balance of our rental properties that were classified as held-for-sale at December 31, 2016 and December 31, 2015 and are reflected in “Liabilities held-for-sale on our consolidated balance sheets. For more information, see note 9, Dispositions, in the notes to our accompanying consolidated financial statements.
(3) 
Our 7.750% Series A Preferred Shares were redeemed and delisted from the New York Stock Exchange in 2016.




43



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

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

Overview

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

We conduct our business through First Potomac Realty Investment Limited Partnership, our operating partnership (the “Operating Partnership”). We are the sole general partner of, and, as of December 31, 2016, owned 95.8% of the common interest in the Operating Partnership. The remaining common interests in the Operating Partnership, which are presented as noncontrolling interests in the Operating Partnership in the accompanying consolidated financial statements, are limited partnership interests that are owned by unrelated parties.

At December 31, 2016, we wholly owned properties totaling 6.7 million square feet and had a noncontrolling ownership interest in properties totaling an additional 0.9 million square feet through five unconsolidated joint ventures. We also owned land that can support 0.6 million square feet of additional development. Our consolidated properties were 92.6% occupied by 384 tenants at December 31, 2016. We do not include square footage of properties in development or redevelopment in our occupancy calculation. At December 31, 2016, none of the 6.7 million square feet owned through our properties was in development or redevelopment. We derive substantially all of our revenue from leases of space within our properties.

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

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

Strategic Plan Update

As previously disclosed in our Form 10-K for the year ended December 31, 2015 and our Form 10-Q for the quarters ended March 31, 2016, June 30, 2016 and September 30, 2016, we completed an extensive underwriting of our business, our portfolio and our team in early 2016. Based on this underwriting, we began implementing our previously

44



announced Strategic Plan, the focus of which is to de-risk the portfolio, de-lever the balance sheet and maximize asset values. As we near completion of the Strategic Plan, the key action items of the Strategic Plan and our results on the action items are as follows:

Improve our portfolio composition by disposing of approximately $350 million of non-core assets.

From December 2015 through the date of this filing, we have sold $294.6 million of non-core assets identified as part of our Strategic Plan, which includes sales of the following properties (dollars in thousands):

 
 
Reporting
Segment
 
Disposition Date
 
Contractual Sales Price(1)
Plaza 500
 
Northern Virginia
 
February 17, 2017
 
$
75,000

One Fair Oaks
 
Northern Virginia
 
January 9, 2017
 
13,700

Storey Park
 
Washington, D.C.
 
July 25, 2016
 
54,500

NOVA Non-Core Portfolio (2)
 
Northern Virginia
 
March 25, 2016
 
91,600

Cedar Hill I and III
 
Northern Virginia
 
December 23, 2015
 
27,300

Newington Business Park Center
 
Northern Virginia
 
December 17, 2015
 
32,500

Total
 
 
 
 
 
$
294,600

(1) Represents the contractual sales price for the properties, not the net proceeds received. For more information, including net proceeds received on the assets sales, see note 9, Dispositions, in the notes to our accompanying consolidated financial statements.
(2) Consists of Van Buren Office Park, Herndon Corporate Center, Windsor at Battlefield, Reston Business Campus, Enterprise Center, Gateway Centre Manassas, Linden Business Center and Prosperity Business Center (collectively, the “NOVA Non-Core Portfolio”).

In addition, in January 2017, the unconsolidated joint ventures that own Aviation Business Park and Rivers Park I and II entered into a binding contract to sell such properties, which are all located in Maryland. We anticipate completing the sale in March 2017; however, we can provide no assurances regarding the timing or pricing of such sale, or that such sale will ultimately occur.

Address three large upcoming lease expirations at single-tenant buildings through the sale of One Fair Oaks and the repositioning of 500 First Street, NW and 540 Gaither Road at Redland.

On January 9, 2017, we sold One Fair Oaks, which was located in our Northern Virginia reporting segment, for net proceeds of $13.3 million. CACI International, which fully leased One Fair Oaks, had a lease that terminated on December 31, 2016.

We currently own two other single-tenant buildings that have leases expiring in 2017 (540 Gaither Road - Department of Health and Human Services and 500 First Street, NW - Bureau of Prisons).

In October 2015, we received notice from the Department of Health and Human Services, which fully leases the building at 540 Gaither Road within our Redland property in our Maryland reporting segment, that it will be exercising its early termination right, which is in March 2017. We underwrote the Department of Health and Human Services exercising its termination right when we acquired the building in 2013. During the second quarter of 2016, we re-leased two floors at 540 Gaither Road, which totaled 45,000 square feet, or approximately 34% of the building’s total square footage. We anticipate that the new tenant at 540 Gaither Road will take occupancy in early 2018; however, we can provide no assurances regarding the timing of when the tenant will take occupancy. We have begun repositioning the property, gauging new tenant interest to lease the property and, upon the expiration of the current tenant’s lease in March 2017, will place 540 Gaither Road into redevelopment, all with the ultimate goal of maximizing value upon the expiration of the lease; however, we can provide no assurances regarding the outcome of these or any other alternative strategies for the property.

The Bureau of Prisons, which fully leases 500 First Street, NW in our Washington, D.C. reporting segment, was subject to a lease that was scheduled to expire in July 2016. During the second quarter of 2016, we entered into a one-year lease extension with the Bureau of Prisons, which is set to expire in July 2017, and we believe there is a likelihood that the tenant will elect to further extend the expiration date of the lease; however, we can provide no assurances regarding the length of such extension or that such extension will occur at all. Currently, we are evaluating various strategies with respect to 500 First Street, NW, which include repositioning 500 First Street, NW and gauging new

45



tenant interest to lease this property, all with the ultimate goal of maximizing value upon the expiration of the lease; however, we can provide no assurances regarding the outcome of these or any other alternative strategies for the property.

Strengthen the balance sheet and improve liquidity by reducing leverage, limiting our floating rate debt exposure over time and extending our debt maturities to better match our capital structure with our assets.

We have been diligently working to improve our balance sheet leverage and increase our liquidity. At December 31, 2016, our debt plus preferred shares over the undepreciated book value of our real estate assets was 57.1% compared with 66.6% at December 31, 2015. During 2016, we redeemed all 6.4 million shares of our outstanding 7.750% Series A Preferred Shares with proceeds from property dispositions and from the prepayment of a note receivable. The 7.750% Series A Preferred Shares (NYSE: FPO-PA) were delisted from trading on the New York Stock Exchange upon redemption of the final outstanding shares on July 6, 2016. The dividend rate on the 7.750% Series A Preferred Shares was significantly higher than the weighted average interest rate of our total debt, which was 3.5% at December 31, 2016. As of the date of this filing, we have $150.9 million available under our unsecured revolving credit facility compared with $114.0 million available at the time of filing our Form 10-K for the year ended December 31, 2015.

Manage our cost structure by reducing corporate overhead and general and administrative expenses.

We have focused on reducing our corporate overhead costs. For the year ended December 31, 2016, our corporate overhead expense (which is allocated between property operating and general and administrative expenses) was $23.4 million compared with $33.5 million for the same period in 2015, which included $6.5 million of separation costs recorded during 2015 (primarily related to the departure of our former Chief Executive Officer and former Chief Investment Officer in November 2015). Excluding the separation costs recorded in 2015, corporate overhead expense decreased 14% for the year ended December 31, 2016 compared with the same period in 2015. The portion of our corporate overhead expense recorded as general and administrative expense was $17.0 million compared with $25.5 million for the same period in 2015. The aforementioned $6.5 million of separation costs were recorded as general and administrative expense in 2015 and, excluding these costs, our general and administrative expense decreased 11% in 2016 compared with the same period in 2015.

Reduce our targeted annualized common share dividend from $0.60 to $0.40.

As previously disclosed, on April 26, 2016, our Board of Trustees declared a reduction of our dividend rate by 33% from $0.15 per common share to $0.10 per common share, which equates to an annualized dividend of $0.40 per common share and was effective for the dividends paid on and after May 16, 2016. During 2016, we paid a combined $27.3 million in dividends on our common shares and distributions on our Operating Partnership units compared with a combined $36.7 million paid in 2015.

Significant 2016 Activity

Increased occupied percentage to 92.6% from 90.3% at December 31, 2015.
Reached $294.6 million of asset sales that were identified as part of our Strategic Plan to dispose of at least $350 million of non-core assets, which includes the sale of One Fair Oaks in January 2017 and the sale of Plaza 500 in February 2017.
Redeemed all 6.4 million outstanding 7.750% Series A Preferred Shares, consistent with our Strategic Plan.
Completed construction of the 167,000 square foot build-to-suit office building in Northern Virginia (the “NOVA build-to-suit”) and commenced revenue recognition in the third quarter of 2016.

Our total assets were $1.3 billion at December 31, 2016 compared with $1.4 billion at December 31, 2015.


Development and Redevelopment Activity

We will place completed development and redevelopment assets in-service upon the earlier of one year after major construction activity is deemed to be substantially complete or upon occupancy. We construct office buildings and/or business parks on a build-to-suit basis or with the intent to lease upon completion of construction. At

46



December 31, 2016, we owned developable land that can accommodate 0.6 million square feet of additional building space, of which 34 thousand is located in the Washington, D.C. reporting segment, 0.1 million in the Maryland reporting segment, 0.4 million in the Northern Virginia reporting segment and 0.1 million in the Southern Virginia reporting segment.
 
During the third quarter of 2014, we signed a lease for the NOVA build-to-suit in our Northern Virginia reporting segment on vacant land that we had in our portfolio. We substantially completed construction of the new building in the first quarter of 2016, and we substantially completed construction of the tenant improvements during the third quarter of 2016. We commenced revenue recognition in August 2016, at which time the building was placed in-service. As of December 31, 2016, our total investment in the newly constructed building was $54.1 million, which includes tenant improvements (net of reimbursements), costs to construct the building, the original cost basis of the applicable portion of the vacant land of $5.2 million and leasing commissions.

On August 4, 2011, we formed a joint venture, in which we had a 97% interest, with an affiliate of Perseus Realty, LLC to acquire Storey Park in our Washington, D.C. reporting segment. At the time, the site was leased to Greyhound Lines, Inc. (“Greyhound”), which subsequently relocated its operations. Greyhound’s lease expired on August 31, 2013, at which time the property was placed into development with the anticipation of developing a mixed-use project on the 1.6 acre site, which could accommodate up to 712,000 square feet. On July 25, 2016, our consolidated joint venture sold Storey Park for a contractual purchase price of $54.5 million, which generated net proceeds of $52.7 million. In June 2016, we recorded a $2.8 million impairment charge based on the sales price, less estimated selling costs. On January 1, 2016, we ceased capitalizing expenses associated with the development project as we began marketing the property for sale. See note 9, Dispositions, in the notes to our accompanying consolidated financial statements for more information.

During 2016, other than the NOVA build-to-suit, we did not place in-service any completed development or redevelopment space. At December 31, 2016, we did not have any completed development or redevelopment space that had yet to be placed in-service.

Critical Accounting Policies and Estimates

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

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

Revenue Recognition

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

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

47




In May 2014, FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers and will replace most existing revenue recognition guidance when it becomes effective. In July 2015, the FASB deferred by one year the mandatory effective date of ASU 2014-09 from January 1, 2017 to January 1, 2018. Early adoption is permitted, but not prior to the original effective date of January 1, 2017. ASU 2014-09 permits the use of either the retrospective or cumulative effect transition method. We have begun to evaluate each of the revenue streams under the new model and the pattern of recognition is not expected to change significantly. We have not yet selected a transition method and are evaluating the impact that ASU 2014-09 will have on our consolidated financial statements and related disclosures.

In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (“ASU 2016-02”), which requires a lessee to record on the balance sheet a right-of-use asset with a corresponding lease liability created by lease terms of more than 12 months. Additional qualitative and quantitative disclosures will also be required. The guidance will become effective for periods beginning after December 15, 2018 and will be applied using a modified retrospective transition method. We are currently evaluating the impact that ASU 2016-02 will have on our consolidated financial statements and related disclosures.

Accounts Receivable

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

Investments in Rental Property and Rental Property Entities

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

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


48



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

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

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

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

We capitalize interest costs incurred on qualifying expenditures for real estate assets under development or redevelopment, which include our investments in assets owned through unconsolidated joint ventures that are under development or redevelopment, while being readied for their intended use in accordance with accounting requirements regarding capitalization of interest. We will capitalize interest when qualifying expenditures for the asset have been made, activities necessary to get the asset ready for its intended use are in progress and interest costs are being incurred. Capitalized interest also includes interest associated with expenditures incurred to acquire developable land while development activities are in progress. We also capitalize direct compensation costs of our construction personnel who manage the development and redevelopment projects, but only to the extent the employee’s time can be allocated to a project. Any portion of construction management costs not directly attributable to a specific project are recognized as general and administrative expense in the period incurred. We do not capitalize any other general and administrative costs such as office supplies, office rent expense or an overhead allocation to our development or redevelopment projects. Capitalized compensation costs were immaterial during 2016, 2015 and 2014. Capitalization of interest ends when the asset is substantially complete and ready for its intended use, but no later than one year from completion of major construction activity, if the property is not occupied. We place redevelopment and development assets into service at this time and commence depreciation upon the substantial completion of tenant improvements and the recognition of revenue. Capitalized interest is depreciated over the useful life of the underlying assets, commencing when those assets are placed into service.

Purchase Accounting

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

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

the fair value of above and below-market in-place leases based on the present value (using a discount rate that reflects the risks associated with the acquired leases) of the difference between the contractual rent amounts to be paid under the assumed lease and the estimated market lease rates for the corresponding spaces

49



over the remaining non-cancelable terms of the related leases, which range from one to fourteen years; and

the fair value of intangible tenant or customer relationships.

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

Derivative Instruments

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

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

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

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

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

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

Share-Based Payments

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


50



Results of Operations

Comparison of the Years Ended December 31, 2016, 2015 and 2014

The term “Comparable Portfolio” refers to all consolidated properties owned by us and in-service, with operating results reflected in our continuing operations, for the entirety of the periods presented. The Comparable Portfolio includes One Fair Oaks, which was classified as held-for-sale at December 31, 2016.

The term “Non-Comparable Properties” refers to properties that we have acquired, sold, placed in-service, or placed in development or redevelopment during the periods presented.

For purposes of comparing the years ended December 31, 2016 and 2015, the Non-Comparable Properties are comprised of the following properties:

Storey Park, a development site that was located in our Washington, D.C. reporting segment and was owned by our 97% consolidated joint venture, which was sold in July 2016 (we ceased capitalizing expenses related to Storey Park at the beginning of 2016 as we began marketing the property for sale); the NOVA Non-Core Portfolio, which was comprised of eight properties and was sold in March 2016; and Rumsey Center, Newington Business Park Center and Cedar Hill I and III, which were sold during 2015. For the Results of Operations discussion below with respect to the comparison of the years ended December 31, 2016 and 2015, these twelve properties are collectively referred to as the “Disposed Properties”. The operating results of these properties are reflected in continuing operations in our consolidated statements of operations for each of the periods presented; and
The NOVA build-to-suit, which was fully placed in-service during the third quarter of 2016.

For purposes of comparing the years ended December 31, 2015 and 2014, the Non-Comparable Properties are comprised of the following properties:

11 Dupont Circle, NW (acquired September 24, 2014), 1775 Wiehle Avenue (acquired June 25, 2014) and 1401 K Street, NW (acquired April 8, 2014), which were acquired for an aggregate purchase price of $188.0 million. For the Results of Operations discussion below with respect to the comparison of the years ended December 31, 2015 and 2014, these three properties are collectively referred to as the “Acquired Properties”. We did not acquire any properties during 2015;
Rumsey Center, Newington Business Park Center and Cedar Hill I and III, which were sold during 2015, and Corporate Campus at Ashburn Center and Owings Mills Business Park, which were sold during 2014. For the Results of Operations discussion below with respect to the comparison of the years ended December 31, 2015 and 2014, these five properties are collectively referred to as the “Disposed Properties”. The operating results of these properties are reflected in continuing operations in our consolidated statements of operations for each of the periods presented;
440 First Street, NW, which was fully placed in service in October 2014. The redevelopment of 440 First Street, NW was substantially completed in October 2013; and
Storey Park, which was in development for the entirety of 2015 and 2014.

The operating results for the Richmond, Virginia portfolio, which included Chesterfield Business Center, Hanover Business Center, Park Central, Virginia Technology Center and a three-acre parcel of undeveloped land (the “Richmond Portfolio”), and which was sold during the first quarter of 2015, as well as the properties disposed of in 2014 (excluding Corporate Campus at Ashburn Center and Owings Mills Business Park, which have operating results reflected within continuing operations), are reflected as discontinued operations in our consolidated statement of operations for 2015 and 2014, as applicable.

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

Due to the timing of acquisitions and dispositions in 2017, which may or may not occur, we cannot determine if property operating revenues or expenses, or depreciation expense will increase or decrease during 2017 compared with 2016.
    
In the tables below, we do not present year-over-year percentage changes that we deem to be non-meaningful as such balances for the respective periods presented are considered to be non-comparable.

51




Total Revenues

Total revenues are summarized as follows:
 
 
Year Ended December 31,
 
 
 
Percent
Change
 
Year Ended December 31,
 
 
 
Percent
Change
(dollars in thousands)
2016
 
2015
 
Change
 
 
2015
 
2014
 
Change
 
Rental
$
129,225

 
$
139,006

 
$
(9,781
)
 
(7
)%
 
$
139,006

 
$
128,226

 
$
10,780

 
8
%
Tenant reimbursements and other
$
31,109

 
$
33,840

 
$
(2,731
)
 
(8
)%
 
$
33,840

 
$
33,426

 
$
414

 
1
%

Rental Revenue

Rental revenue is comprised of contractual rent, the impact of straight-line revenue, the amortization of deferred lease incentive costs and deferred tenant improvement reimbursement revenue, and the amortization of deferred market rent assets and liabilities representing above and below market rate leases at acquisition. Rental revenue decreased $9.8 million in 2016 compared with 2015. For the Comparable Portfolio, rental revenue increased $3.2 million in 2016 compared with 2015 due to an increase in occupancy in the Comparable Portfolio, partially offset by a $1.4 million write-off of unamortized lease incentives and rent abatement related to a defaulted tenant at 840 First Street, NE. The weighted average occupancy of the Comparable Portfolio was 92.3% for 2016 compared with 90.3% for 2015. Rental revenue for the Non-Comparable Properties decreased by $13.0 million in 2016 compared with 2015 due to the following:

a $14.5 million decrease from the Disposed Properties; and
a $1.5 million increase from the NOVA build-to-suit.

Rental revenue increased $10.8 million in 2015 compared with 2014. For the Comparable Portfolio, rental revenue increased $3.3 million in 2015 compared with 2014 due to an increase in occupancy in the Comparable Portfolio. The weighted average occupancy of the Comparable Portfolio was 89.6% for 2015 compared with 87.8% for 2014. Rental revenue for the Non-Comparable Properties increased by $7.5 million in 2015 compared with 2014 due to the following:

an $8.1 million increase from the Acquired Properties;
a $2.0 million increase from 440 First Street, NW; and
a $2.6 million decrease from the Disposed Properties.


Rental revenue increased (decreased) for each reporting segment during the periods presented, due to the factors discussed above, as follows:

 
Reporting Segment
(dollars in thousands)
Washington, D.C.
 
Maryland
 
Northern Virginia
 
Southern Virginia
 
Total
Increase (decrease) in rental revenue:
 
 
 
 
 
 
 
 
 
2016 compared with 2015
$
226

 
$
571

 
$
(11,834
)
 
$
1,256

 
$
(9,781
)
2015 compared with 2014
$
9,756

 
$
(453
)
 
$
733

 
$
744

 
$
10,780



Significant increases or decreases within reporting segments primarily relate to acquisitions or dispositions, unless otherwise noted.
 
Tenant Reimbursements and Other Revenues

Tenant reimbursements and other revenues include operating and common area maintenance costs reimbursed by our tenants as well as other incidental revenues, such as lease termination payments, parking revenue and joint venture and construction related management fees. Tenant reimbursements and other revenues decreased $2.7 million

52



in 2016 compared with 2015. For the Comparable Portfolio, tenant reimbursements and other revenues increased by $0.4 million in 2016 compared with 2015, primarily due to an increase in operating expense recoveries related to increases in occupancy. Tenant reimbursements and other revenues for the Non-Comparable Properties decreased by $3.1 million in 2016 compared with 2015 due to the following:

a $4.0 million decrease from the Disposed Properties; and
a $0.9 million increase from the NOVA build-to-suit.

Tenant reimbursements and other revenues increased $0.4 million in 2015 compared with 2014. For the Comparable Portfolio, tenant reimbursements and other revenues decreased by $0.2 million, primarily due to a decrease in termination fee income. Tenant reimbursements and other revenues for the Non-Comparable Properties increased by $0.6 million in 2015 compared with 2014 due to the following:

a $1.2 million increase from the Acquired Properties;
a $0.1 million increase from 440 First Street, NW; and
a $0.7 million decrease from the Disposed Properties.

Tenant reimbursements and other revenue increased (decreased) for each reporting segment during the periods presented, due to the factors discussed above, as follows:

 
Reporting Segment
(dollars in thousands)
Washington, D.C.
 
Maryland