S-11/A 1 ds11a.htm AMENDMENT NO. 7 TO FORM S-11 Amendment No. 7 to form S-11
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As filed with the Securities and Exchange Commission on October 4, 2010

Registration Statement No. 333-166799

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Amendment No. 7

to

FORM S-11

FOR REGISTRATION UNDER THE SECURITIES ACT OF 1933

OF SECURITIES OF CERTAIN REAL ESTATE COMPANIES

 

 

US FEDERAL PROPERTIES TRUST, INC.

(Exact name of registrant as specified in its governing instruments)

 

 

4705 Central Street

Kansas City, Missouri 64112

(816) 531-2082

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

 

Richard Baier

Chief Executive Officer

US Federal Properties Trust, Inc.

4705 Central Street

Kansas City, Missouri 64112

(816) 531-2082

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies to:

 

Robert R. Kaplan, Jr., Esq.

Robert R. Kaplan, Esq.

Gregory Kaplan, PLC

7 East Second Street

Richmond, Virginia 23224

(804) 423-7921

 

Edward F. Petrosky, Esq.

J. Gerard Cummins, Esq.

Sidley Austin LLP

787 Seventh Ave.

New York, New York 10019

(212) 839-5300

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after this registration statement becomes effective.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, as amended, check the following box.  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If delivery of this prospectus is expected to be made pursuant to Rule 434, check the following box.  ¨

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  ¨

  Accelerated filer  ¨   Non-accelerated filer   þ   Smaller reporting company  ¨
   

(Do not check if a smaller reporting Company)

 

The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is declared effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

Subject to Completion, Dated October 4, 2010

LOGO

US Federal Properties Trust, Inc.

13,750,000 Shares

Common Stock

 

 

We are a newly organized, internally-managed real estate company formed to continue and grow our business of acquiring, developing, financing, owning and managing properties leased primarily to the United States of America, acting either through the General Services Administration or another federal government agency or department. Upon completion of this offering and our formation transactions, we will own 19 single-tenant properties, located in 11 states, currently containing 812,857 rentable square feet, all of which are 100% leased by the federal government.

This is our initial public offering. We are offering 13,750,000 shares of our common stock. We anticipate that the initial public offering price will be between $19.00 and $21.00 per share. Our common stock has been approved for listing on the New York Stock Exchange, or NYSE, under the symbol “USFP,” subject to official notice of issuance. Currently, no public market exists for our common stock.

We are organized as a Maryland corporation and intend to elect and qualify to be taxed as a real estate investment trust, or REIT, for U.S. federal income tax purposes commencing with our short taxable year ending December 31, 2010. Upon completion of this offering, subject to certain exceptions described in this prospectus, our charter provides that no person may own, or be deemed to own, more than 9.8% by number of shares or value, whichever is more restrictive, of the outstanding shares of our common stock or 9.8% by value of our stock in the aggregate.

Investing in our common stock involves risk. See “Risk Factors” beginning on page 21.

Neither the Securities and Exchange Commission, or the SEC, nor any state securities commission or other regulatory authority has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.

 

     Per Share    Total

Public offering price

   $                 $             

Underwriting discount

   $      $  

Proceeds, before expenses, to US Federal Properties Trust, Inc.

   $      $  

We have granted the underwriters the right to purchase up to 2,062,500 additional shares of our common stock at the public offering price less the underwriting discount within 30 days after the date of this prospectus to cover over-allotments, if any.

The underwriters expect to deliver shares of our common stock on                     , 2010.

 

Deutsche Bank Securities    UBS Investment Bank

 

 

 

KeyBanc Capital Markets   Raymond James     RBC Capital Markets

 

 

 

 

 

Evercore Partners   BB&T Capital Markets   Janney Montgomery Scott   JMP Securities   Oppenheimer & Co.

The date of this prospectus is                    , 2010.


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LOGO


Table of Contents

TABLE OF CONTENTS

 

     Page

Prospectus Summary

   1

Risk Factors

   21

Cautionary Statement Regarding Forward-Looking Statements

   53

Use of Proceeds

   54

Capitalization

   57

Dilution

   58

Distribution Policy

   60

Selected Financial and Pro Forma Financial Information

   64

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

   66

Industry Overview and Market Opportunity

   83

Business and Properties

   88

Management

   129

Policies with Respect to Certain Activities

   142

Principal Stockholders

   149

Certain Relationships and Related Party Transactions

   150

Description of Stock

   158

Material Provisions of Maryland Law and of Our Charter and Bylaws

   163

Our Operating Partnership and the Partnership Agreement

   170

Shares Eligible for Future Sale

   178

U.S. Federal Income Tax Considerations

   180

ERISA Considerations

   204

Underwriting

   205

Legal Matters

   212

Experts

   212

Where You Can Find More Information

   212

Index to Financial Statements

   F-1

You should rely only on the information contained in this prospectus or in any free writing prospectus prepared by us. We have not, and the underwriters have not, authorized any other person to provide you with different or additional information. If anyone provides you with different or additional information, you should not rely on it. We are not, and the underwriters are not, making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should assume that the information appearing in this prospectus is accurate only as of the date on the front cover of this prospectus. Our business, financial condition, liquidity, funds from operations, or FFO, results of operations and prospects may have changed since that date.

Unless the context otherwise requires, references to “company,” “we,” “us” or “our” refer to (1) US Federal Properties Trust, Inc., a Maryland corporation, and its consolidated subsidiaries, including US Federal Properties Partnership, LP, a Delaware limited partnership, which we refer to as “our operating partnership,” and BC Development Co. — USFP, LLC, a Delaware limited liability company that is a subsidiary of our operating partnership, which we refer to as “our development company,” except where it is clear from the context that the term means only the issuer of the shares of our common stock, US Federal Properties Trust, Inc., and (2) with respect to the period prior to this offering, the business of DHS Denver, LLC, or “DHS Denver,” Great Falls Courthouse, LLC, or “Great Falls,” Jacksonville Field Office, LLC, or “Jacksonville Field,” and DHS Salt Lake LLC, or “DHS Salt Lake”; references to “our contribution properties” refer to the properties to be contributed to us by our contributors, consisting of our properties in operation in Denver, Colorado, Great Falls, Montana and Jacksonville, Florida, or “our in-service contribution properties,” and our property under construction in Salt Lake City, Utah, or “our contribution property in development”; references to “our acquisition properties” refer to properties we have contracted to acquire upon completion of this offering; references to “our initial properties” refer to our contribution properties and our acquisition properties, collectively; references to “the option

 

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property” refer to the property in Jacksonville, Florida, to be developed by Jacksonville VA, LLC, or “Jacksonville VA,” the equity interests in which are owned by our contributors, which we will have an option to purchase upon its completion; references to “our contributors” refer to Richard Baier, our promoter, Cathleen M. Baier and Daniel K. Carr in his or her capacity of contributing their equity interests in our contribution properties to us; references to “our predecessor” refer to US Federal Properties Trust Predecessor, which represents a combination of Great Falls and Jacksonville Field; references to “BC Development Co.” refer to the development company that is owned by Daniel K. Carr and Cathleen M. Baier, and which will assign its name to our development company; references to “Lane4 Management” refer to Lane4 Management, Inc., a company majority-owned by Richard Baier and Daniel K. Carr; references to the “minority owner” refer to D’Jac, LLC, the owner of a minority interest in each of DHS Denver, Great Falls and Jacksonville Field; references to “our common stock” refer to common stock, $0.001 par value per share, in US Federal Properties Trust, Inc.; references to “OP units” refer to units of limited partnership interest in our operating partnership that are redeemable for cash or exchangeable, at our option, for shares of our common stock on a one-for-one basis, subject to certain adjustments; “RSUs” refer to our restricted stock units, which are contractual promises to deliver shares of our common stock in the future upon satisfaction of certain conditions; references to “our charter” or “our bylaws” refer to our Articles of Amendment and Restatement or our Bylaws, respectively; references to “annualized base rent,” unless otherwise specified, refer to the base rent payable for June 2010, multiplied by 12, without reference to the annual cost of living adjustment applied to the portion of base rent allocated to operating costs; and references to “weighted-average,” unless otherwise specified, refer to averages weighted by rentable square feet. Unless otherwise indicated, the information contained in this prospectus assumes that (a) the shares of our common stock to be sold in this offering are sold at $20.00 per share, the mid-point of the price range set forth on the cover page of this prospectus, and (b) the underwriters’ over-allotment option is not exercised.

 

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PROSPECTUS SUMMARY

This summary highlights some of the information included elsewhere in this prospectus. It is not complete and does not contain all of the information that you should consider before making a decision to invest in shares of our common stock. In addition to this summary, you also should read carefully the more detailed information set forth under “Risk Factors” and the other information included in this prospectus.

US Federal Properties Trust, Inc.

We are a newly organized, internally-managed real estate company formed to continue and grow our business of acquiring, developing, financing, owning and managing properties leased primarily to the United States of America, acting either through the General Services Administration, or GSA, or another federal government agency or department, carried out through our predecessor and related entities prior to this offering. Our senior management team is led by Richard Baier, the Chairman of our board of directors and our Chief Executive Officer, who, together with Daniel K. Carr, our Executive Vice President, Development, and Cathleen M. Baier, our Executive Vice President, Government Operations, founded our business. In 1998, Messrs. Baier and Carr began pursuing developments of build-to-suit federal government-leased properties. Ms. Baier joined Messrs. Baier and Carr in 2003 and together they developed build-to-suit federal government-leased properties under the name “BC Development.” They have developed eight federal government-leased build-to-suit properties since 2001 and are currently developing one additional such property, containing an aggregate of 605,190 rentable square feet, including all of our contribution properties. We intend to grow our portfolio primarily through acquisitions of federal government-leased properties and by developing build-to-suit federal government-leased properties secured through competitive bidding. We believe that the strong credit quality of the federal government tenant base, combined with our long-term leases, will enable us to generate attractive risk-adjusted returns.

Upon completion of this offering and our formation transactions, we will own 19 single-tenant federal government-leased properties (including our 15 acquisition properties) currently containing 812,857 rentable square feet. One of our initial properties, which we anticipate will contain 69,225 rentable square feet, is currently under development and is targeted for completion in the fall of 2011. We cannot assure you that we will acquire any or all of our acquisition properties on the terms contemplated in the respective purchase agreements, or at all. As of June 30, 2010, the weighted-average age of our initial properties currently in service was 19.5 months, the weighted-average remaining lease term of our initial properties currently in service, assuming the exercise of all early termination rights, was 11.4 years, and the weighted-average remaining lease term of our initial properties currently in service, assuming no early termination rights are exercised, was 13.8 years. All of our initial properties are 100% leased by the federal government on behalf of agencies and departments such as the Federal Bureau of Investigation, or the FBI, the Internal Revenue Service, or the IRS, the federal courts, the Social Security Administration, or the SSA, the Department of Veteran’s Affairs, or the VA, and the Department of Homeland Security, or the DHS.

Our senior management team has considerable experience in developing, financing, owning, managing and leasing Class A office properties, including federal government-leased properties across the U.S. Distinctions between “classes” of real estate properties are subjective and are not determined by any standardized set of criteria. In this prospectus, we use the term “Class A office properties” to refer to newer properties that are well located, have attractive interior and exterior finishes, are constructed from high quality building materials and are well maintained and command competitive rents in their respective markets. Our senior management team has developed a strong network of relationships with the GSA and with real estate owners, developers, operators, brokers and lenders and possesses an in-depth knowledge of the GSA procurement process, GSA requirements and other GSA considerations. Our senior management team, other than our President and Chief Financial Officer, has worked together since 2004 and is led by Richard Baier, the Chairman of our board of directors and our Chief Executive Officer, who has over 30 years of experience in commercial real estate and previously held

 

 

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principal and executive positions at CB Richard Ellis and other real estate organizations and served as the President of the Building Owners and Managers Association International, or BOMA, a real estate industry organization with approximately 17,500 members, including the GSA. Our President and Chief Financial Officer, Kevin T. Kelly, previously served as Chief Financial Officer of Ferrellgas Partners, L.P. (NYSE: FGP), a publicly traded, Fortune 1000 propane distribution company.

We intend to elect and qualify to be taxed as a REIT for U.S. federal income tax purposes commencing with our short taxable year ending December 31, 2010.

Our principal executive offices are located at 4705 Central Street, Kansas City, MO, 64112. Our telephone number is (816) 531-2082. Our website is http://www.usfptrust.com. The contents of our website are not a part of this prospectus. We have included our website address only as an inactive textual reference and do not intend it to be an active link to our website.

 

 

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Our Properties

Upon completion of this offering and our formation transactions, we will own 19 single-tenant federal government-leased properties, including our 18 in-service initial properties containing 812,857 rentable square feet and our contribution property in development. All but one of our initial properties are fully constructed, have been placed in service and are operating. Our Salt Lake City, Utah contribution property, which we anticipate will contain 69,225 rentable square feet, is currently under development and is targeted for completion in the fall of 2011. All of our initial properties are leased pursuant to full service modified gross leases, which require us to pay for maintenance, repairs, base property taxes, utilities and insurance. The federal government is obligated to pay us adjusted rent for changes in certain operating costs (e.g., the costs of cleaning services, supplies, materials, maintenance, trash removal, landscaping, water, sewer charges, heating, electricity, repairs and certain administrative expenses but not including insurance) based on a cost of living index and to reimburse us for increases in real property taxes above a base amount. Information about our initial properties as of June 30, 2010 is set forth in the table below.

 

                Lease information            

Property/Location

 

Type of
Property

  Year
Built(1)
  Rentable
Square
Feet(2)
  Percent
Leased
   

Federal
Government
Occupant

 

Commencement Date,
Early Termination Date
and Expiration Date

  Annualized
Base
Rent(3)
  Annualized
Base Rent
per Leased
Square Foot(3)
  Effective
Annual
Rent(4)
  Effective Annual
Rent per Leased
Square Foot(4)

Our In-Service Contribution Properties

                 

Jacksonville, Florida (FBI)

6061 Gate Parkway Jacksonville, FL

  Office   2009   129,895   100%      FBI  

•February 20, 2009

•No early termination

•February 19, 2024

  $ 4,676,220   $ 36.00   $ 4,878,588   $ 37.56

Denver, Colorado

12445 East Caley Ave.

Centennial, CO

  Office   2009   54,927   100   DHS  

•September 1, 2009

•September 1, 2019(5)

•August 31, 2024

    1,729,113     31.48     1,983,216     36.11

Great Falls, Montana(6)

125 West Central Ave.

Great Falls, MT

  Office   2009   48,411   100%      Federal Courts  

•June 26, 2009

•No early termination

•June 25, 2029

    2,171,717     44.86     2,177,832     44.99
                                     

Subtotal of In-Service Contribution Properties

      233,233         $ 8,577,050   $ 36.77   $ 9,039,636   $ 38.76
                                     

Our Acquisition Properties

                   

Bloomington, Illinois

1201 North Mitsubishi Motorway

Bloomington, IL

  Office / Warehouse   2008   133,512   100%      IRS  

•May 19, 2008

•May 19, 2018(7)

•May 18, 2023

  $ 1,808,297   $ 13.54   $ 1,749,408   $ 13.10

Gloucester, Massachusetts

55 Great Republic Drive

Gloucester, MA

  Office   2008   90,335   100%      National Oceanic and Atmospheric Administration, or the NOAA  

•September 26, 2008

•No early termination

•September 26, 2023

    1,800,038     19.93     1,800,038     19.93

Orlando, Florida

6680 Corporate Centre Boulevard

Orlando, FL

  Office   2008   43,668   100%      U.S. Bureau of Citizenship and Immigration Services, or the CIS  

•September 2, 2008

•August 31, 2018(5)

•August 31, 2023

    1,526,088     34.95     1,526,088     34.95

Alpine, Texas

2450 North Highway 118

Alpine, TX

  Office   2007   39,003   100%      Federal Courts  

•July 15, 2007

•No early termination

•July 14, 2022

    1,941,153     49.77     1,941,153     49.77

Royal Palm Beach, Florida

9300 Belvedere Road

Royal Palm Beach, FL

  Office   2009   38,277   100%      CIS  

•January 20, 2009

•No early termination

•January 19, 2024

    2,056,044     53.71     2,078,484     54.30

Lufkin, Texas

2206 N. John Redditt Dr.

Lufkin, TX

  Medical   2009   37,000   100%      VA  

•August 1, 2009

•No early termination

•July 31, 2029

    636,400     17.20     636,400     17.20

Lawrence, Massachusetts

2 Mill Street

Lawrence, MA

  Office   2009   28,325   100%      CIS  

•June 8, 2009

•June 7, 2019(8)

•June 7, 2024

    1,369,570     48.35     1,369,570     48.35

Richford, Vermont

1629 Saint Albans Road

Richford, VT

  Office   2009   26,456   100%      Border Patrol  

•December 1, 2009

•November 30, 2024(7)

•November 30, 2029

    953,474     36.04     953,474     36.04

Cleveland, Ohio

20637 Emerald Parkway

Cleveland, OH

  Office   2007   24,881   100%      Military Entrance Processing Station, or the MEPS  

•September 14, 2007

•September 13, 2017(7)

•September 13, 2022

    741,798     29.81     741,798     29.81

Durham, North Carolina

301 Roycroft Dr.

Durham, NC

  Office   2008   23,530   100%      CIS  

•March 10, 2008

•March 10, 2018(7)

•March 9, 2023

    966,093     41.06     966,093     41.06

 

 

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                  Lease information                

Property/Location

 

Type of
Property

  Year
Built(1)
    Rentable
Square
Feet(2)
  Percent
Leased
 

Federal
Government
Occupant

 

Commencement Date,
Early Termination Date
and Expiration Date

  Annualized
Base
Rent(3)
    Annualized
Base Rent
per Leased
Square Foot(3)
  Effective
Annual
Rent(4)
    Effective Annual
Rent per Leased
Square Foot(4)

Sevierville, Tennessee

1827 Jack Delozier Dr.

Sevierville, TN

  Office   2008      21,405   100%   U.S. Department of Transportation, or the DOT  

•July 1, 2008

•No early termination

•June 30, 2018

    582,529        27.21     582,529        27.21

San Antonio, Texas

3438 E. Southcross Blvd.

San Antonio, TX

  Office   2008      20,700   100%   SSA  

•February 15, 2008

•February 14, 2018(8)

•February 14, 2023

    550,117        26.58     550,117        26.58

Beaumont, Texas

8455 Dishman Road

Beaumont, TX

  Office   2009      18,609   100%   SSA  

•July 17, 2009

•July 17,  2019(8)

•July 16, 2024

    553,108        29.72     553,108        29.72

Waco, Texas

1700 Lake Air Dr.

Waco, TX

  Office   2009      17,823   100%   SSA  

•August 17, 2009

•August 17, 2019(8)

•August 16, 2024

    617,523        34.65     617,523        34.65

Centerville, Ohio

7747 Clyo Road

Centerville, OH

  Office   2008      16,100   100%   FBI  

•July 1, 2008

•No early termination

•June 30, 2018

    491,464        30.53     491,464        30.53
                                         

Subtotal of Acquisition Properties

      579,624         $ 16,593,696      $ 28.63   $ 16,557,247      $ 28.57
                                         

Total In-Service Contribution Properties and Acquisition Properties

      812,857         $ 25,170,746      $ 30.97   $ 25,596,883      $ 31.49
                                         

Our Contribution Property in Development

  

               

Salt Lake City, Utah

2987 South Decker Lake Dr.

Salt Lake City, UT

  Office   Fall
2011
  
(9) 
  69,225   100%   DHS  

•Date of substantial completion of the building

•Early termination after tenth year(8)

•Fifteen years from commencement date

  $ 1,796,721  (10)    $ 25.95   $ 2,367,495 (11)    $ 34.20
                                         

Total Contribution Properties and Acquisitions Properties

      882,082         $ 26,967,467      $ 30.57   $ 27,964,378      $ 31.70
                                         

 

(1) Year built represents the year in which construction was completed.
(2) Rentable square feet represents total rentable area at the property.
(3) Annualized base rent means the base rent payable under the applicable lease for June 2010, multiplied by 12, without reference to the annual cost of living adjustment applied to the portion of base rent allocated to operating costs under such lease.
(4) Effective annual rent represents the contractual annual base rent for leases in place as of June 30, 2010, calculated on a straight-line basis, without reference to the annual cost of living adjustment applied to the portion of base rent allocated to operating costs under such leases.
(5) Upon 120 days’ notice.
(6) Subject to a ground lease that expires in 2082.
(7) Upon 90 days’ notice.
(8) Upon 60 days’ notice.
(9) Expected completion date; actual completion date may differ.
(10) Initial annual base rent upon completion of construction, including a one-time rent concession to the federal government of $487,704. Initial annual base rent upon completion of construction, excluding the one-time rent concession, would be $2,284,425.
(11) Effective annual rent for our contribution property in development represents contractual annual base rent calculated on a straight-line basis from the date of commencement of the lease, without reference to the annual cost of living adjustment applied to the portion of base rent allocated to operating costs under the lease.

 

 

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The following charts depict the federal government occupant and geographical diversity of our initial properties, other than our Salt Lake City, Utah development property, based on annualized base rent as of June 30, 2010.

 

Federal Government Occupant Diversity

  

Geographical Diversity

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Market Opportunity and Competitive Landscape

The following information only addresses federal government leasing activities conducted under the auspices of the GSA. Certain federal government agencies or departments, such as the Department of Defense or the VA, will lease property directly or through the GSA or both.

Market Opportunity

According to the GSA Government Leasing News Winter 2008 Report, the amount of GSA-owned space remained relatively constant from 1967 (the earliest year for which such information is available to us) to 2007, while the amount of GSA-leased space grew from 46 million square feet to 178 million square feet during the same period. We believe the growth in GSA leasing will continue into the future because federal government budgetary policies generally focus on annual cash expenditures, thereby making it less attractive to budget for the significant long-term capital expenditures that are necessary to develop new federal government-owned properties. Additionally, the buildings in the GSA’s owned portfolio have an average age of 46 years and currently require approximately $5 billion in repairs and alterations, according to the GSA 2009 Agency Financial Report. This may result in GSA utilizing an increasing portion of its public building services budget to repair and maintain its existing owned properties. We believe that the above factors may make it difficult for the GSA to commit to large scale capital investments to develop new GSA-owned properties. We further believe that increased government regulation under the present federal administration, in part to address issues such as financial institution and healthcare reform, may substantially increase the federal government’s demand for leased office space.

The GSA build-to-suit lease procurement process is detailed, requiring in-depth knowledge of GSA policies and procedures. GSA procurement bids are generally awarded on the basis of best-value proposals, not just on the lowest-price basis, but on a combination of technical expertise, cost factors and development experience. Developers need to possess niche construction expertise and exhibit comprehensive knowledge of GSA security standards and “green lease,” Leadership in Energy and Environmental Design, or LEED®, accreditation policies. The above factors contribute to high barriers to entry for new developers in the GSA build-to-suit lease market.

 

 

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Competitive Landscape

Our competitors in the federal government-leasing market include REITs, private equity investors, high net worth individuals and local, regional and national owners and developers. Many of these real estate industry participants currently own federal government-leased properties as part of a broader portfolio of office properties.

Until recently, financing was readily available for project developers in the GSA build-to-suit leased property market. However, we believe that the current credit market conditions have severely impacted the availability of construction debt financing. We believe that this may force many of our competitors that execute GSA build-to-suit development projects to seek financing from sources other than traditional construction lenders to meet their capital needs.

Competitive Strengths

We believe that we distinguish ourselves from other owners, operators and developers of federal government-leased properties through the following competitive strengths:

 

   

Successful and Extensive Track Record Working with the GSA. We have a proven track record of developing federal government build-to-suit properties that we believe enables us to effectively compete for future federal government build-to-suit development contracts. We have developed a strong network of relationships with the GSA and possess an in-depth knowledge of GSA requirements and GSA organizational dynamics, which we believe allows us to effectively navigate the GSA procurement process.

 

   

Experienced Senior Management Team With In-Depth Knowledge of Commercial Real Estate. We have considerable experience in developing, financing, owning, managing and leasing Class A office properties, including federal government-leased properties across the U.S. We also have developed relationships with real estate owners, developers, brokers and lenders and have substantial experience in acquiring commercial real estate properties across the U.S.

 

   

Internally Managed REIT with Strong In-House Capabilities. We are internally managed and possess significant asset management expertise. We believe we will be one of the few companies focused on the federal government real estate market that combines a strong understanding of the evolving real estate needs of the federal government with the capability to acquire large scale assets and develop build-to-suit federal government-leased properties nationally and then, in each case, to oversee the operation of the properties effectively.

 

   

High Quality, Newer Portfolio that is 100% Long-Term Leased to the Federal Government. Upon completion of this offering and our formation transactions, we will own a portfolio consisting of 19 single-tenant federal government-leased properties, all of which are 100% leased by the federal government. As of June 30, 2010, the weighted-average age of our initial properties currently in service was 19.5 months, and the weighted-average remaining lease term of our initial properties currently in service, assuming the exercise of all early termination rights, was 11.4 years, with the earliest lease termination or expiration date being September 13, 2017.

 

   

Strong Credit Quality of Our Federal Government Tenant Base. Our leases are full faith and credit obligations of the United States and are not subject to the risk of government appropriations. The GSA lease market is characterized by high rates of lease renewals. According to data published by the GSA on its website for the 2002 to 2008 period, an average of 94% of GSA leases that were in place at the beginning of those years were in place at the beginning of the following year, and the average renewal rate for expiring leases from that same period was 80%. We believe that the strong credit quality of our federal government tenant base, our long-term leases and our partial operating cost reimbursements contributes to the stability of our operating income.

 

   

Growth Oriented Capital Structure with No Legacy Issues and Access to Financing. We intend to finance future acquisitions and developments with a combination of the remaining net proceeds from this offering, borrowings and equity issuances. We expect that our enhanced access to capital as a public

 

 

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company will provide us with a significant advantage in acquiring federal government-leased properties and securing federal government build-to-suit development contracts, as many of our competitors are private companies. In addition, we believe that the strong credit quality of our federal government tenant base will provide us with greater access to attractive financing opportunities as compared to non-government tenant-focused companies.

Our Business and Growth Strategies

Our objective is to maximize total returns for our stockholders through the pursuit of the following business and growth strategies:

 

   

Focus on Newer Properties Leased Primarily to the Federal Government. Our growth strategy principally focuses on acquiring and developing newer properties leased to key agencies and departments of the federal government. We believe that the anticipated increase in leased properties by these federal government agencies and departments, combined with the strong credit quality of our federal government tenant base, will enable us to generate attractive risk-adjusted returns.

 

   

Pursue Attractive Acquisition Opportunities. We intend to pursue acquisitions through our existing relationships with other developers of federal government properties, the GSA and other federal government agencies and departments and other owners of office properties and industry participants around the country. As a public company, we believe that owners will view us as a more attractive and credible buyer than many private competitors.

 

   

Pursue Development of New Properties Leased in Advance to the Federal Government. We will continue to develop build-to-suit federal government properties through our internal development capabilities and use of our BC Development brand. We believe that our thorough understanding of the federal government’s procurement processes and standards and our long-standing relationships with the GSA and other federal agencies and departments will enable us to compete effectively for federal government development opportunities.

 

   

Form Joint-Development Projects with Third-Party Developers to Acquire Federal Government-Leased Properties. We intend to pursue joint-development projects with third-party developers that have been awarded rights to develop federal government properties. We believe that our experience and access to capital will make us an attractive partner in the highly fragmented market for the development of federal properties, particularly in comparison to small regional and private developers.

 

   

Active Asset Management. We intend to expand our properties, increase our rental rates upon lease renewals, reduce our operating expenses, analyze property values in an effort to decrease real estate tax assessments and selectively pursue strategic acquisitions, developments, redevelopments and dispositions. We expect that these asset management and leasing strategies will enhance property operating results and valuations without the necessity of relying on recovering real estate and general economic market fundamentals.

Summary Risk Factors

An investment in our common stock involves various risks. You should consider carefully the risks discussed below and under “Risk Factors” before making a decision to invest in our common stock.

 

   

Our primary business is currently limited to the ownership and operation of single-tenant federal government-leased properties.

 

   

We were organized recently and our senior management team has no experience in operating a REIT and limited experience in operating a public company.

 

   

We may not be able to consummate the purchase of any or all of our acquisition properties, which could materially and adversely affect us.

 

 

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We must obtain the consent of the federal government in order to assume the rights and obligations of the landlord under the leases of our acquisition properties, and we will need to collect the federal government’s rent payments from the former owners of those properties until that consent is obtained.

 

   

Our growth depends, in part, on successfully identifying and consummating acquisitions of single-tenant federal government-leased properties, and any delay or failure on our part to identify, finance and consummate acquisitions on favorable terms could materially and adversely affect us.

 

   

Developing and redeveloping properties will expose us to additional risks beyond those associated with owning and operating federal government-leased properties and could materially and adversely affect us.

 

   

An increase in the amount of federal government-owned real estate relative to federal government-leased real estate may materially and adversely affect us.

 

   

We are generally required to pay for all maintenance, repairs, base property taxes, utilities and insurance; amounts recoverable under our leases for increased operating costs may be less than the actual costs we incur.

 

   

The departure of any of our key personnel with long-standing business relationships could materially and adversely affect us.

 

   

The tax protection agreement with our contributors and the minority owner could limit our ability to sell or otherwise dispose of our contribution properties or make any such sale or other disposition more costly.

 

   

We may pursue less vigorous enforcement of the terms of our agreements with our contributors and Lane4 Management because of conflicts of interest, which could materially and adversely affect us.

 

   

Our debt obligations may expose us to interest rate fluctuations and the risk of default and may leave us with insufficient cash to meet our debt service requirements and repay our debt, satisfy our operational requirements, pay dividends to our stockholders (including those necessary for our qualification as a REIT) and successfully execute our growth strategy.

 

   

Our organizational documents do not contain any leverage limitations, and, although our target leverage ratio is 50% of the undepreciated historical cost of our properties, we could decide to become more leveraged in the future, which could materially and adversely affect us.

 

   

Our inability to obtain financing on favorable terms, or at all, particularly in light of ongoing conditions in the lending and capital markets, could materially and adversely affect us.

 

   

We did not conduct arm’s-length negotiations with our contributors with respect to the terms of our formation transactions and, accordingly, such terms may not be as favorable to us as if they were so negotiated.

 

   

Our failure to qualify as a REIT would result in higher taxes and reduced cash available for distribution to our stockholders.

 

   

Our ability to pay our estimated initial annual dividend, which represents approximately 101% of our estimated cash available for distribution for the twelve months ending June 30, 2011, depends on our future operating cash flow, and we expect to be required to fund a portion of our estimated initial annual dividend through borrowings or equity issuances, and we cannot assure you that we will be able to obtain such funding on attractive terms or at all, in which case we plan to use a portion of the remaining net proceeds from this offering for such funding, which would make such amounts unavailable for our future development and acquisition of properties, or to fund such dividend in the form of shares of common stock or to eliminate or otherwise reduce such dividend.

 

   

There is currently no public market for our common stock and an active trading market for our common stock may not develop or continue following this offering.

 

 

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Our Organizational Structure

We are the sole general partner of our operating partnership, and our operating partnership is the sole owner of our development company. We will conduct substantially all of our business through our operating partnership and its subsidiaries, including our development company. Upon completion of this offering and our formation transactions, we will own a 96.6% limited partnership interest in our operating partnership. The remaining 3.4% limited partnership interest will be owned by our contributors and the minority owner, as follows:

 

Name

  

OP Units Received(1)

Richard Baier

   184,794 OP units (with a combined aggregate value, assuming the shares of our common stock are sold at $20.00 per share, the mid-point of the price range set forth on the cover page of this prospectus, equal to approximately $3.7 million) in exchange for his interests in DHS Denver, Great Falls, Jacksonville Field and DHS Salt Lake.

Cathleen M. Baier

   59,681 OP units (with a combined aggregate value, assuming the shares of our common stock are sold at $20.00 per share, the mid-point of the price range set forth on the cover page of this prospectus, equal to approximately $1.2 million) in exchange for her interests in DHS Denver, Great Falls, Jacksonville Field and DHS Salt Lake.

Daniel K. Carr

   230,182 OP units (with a combined aggregate value, assuming the shares of our common stock are sold at $20.00 per share, the mid-point of the price range set forth on the cover page of this prospectus, equal to approximately $4.6 million) in exchange for his interests in DHS Denver, Great Falls, Jacksonville Field and DHS Salt Lake.

Minority Owner (D’Jac, LLC)(2)

   16,787 OP units (with a combined value, assuming the shares of our common stock are sold at $20.00 per share, the mid-point of the price range set forth on the cover page of this prospectus, equal to approximately $0.3 million) in exchange for its interest in DHS Denver, Great Falls and Jacksonville Field.

 

(1)

In addition to OP units, Cathleen M. Baier and Daniel K. Carr will each receive $1.5 million in cash from the net proceeds of this offering in exchange for their interests in DHS Salt Lake. See “Use of Proceeds.” In addition, as part of our real estate closing adjustments for our contribution properties, we will remit to our contributors and minority owner any amounts due from tenants in excess of certain accounts payable and accrued expenses as of the date that we acquire our contribution properties.

(2)

Mitchell R. Hoefer and David A. Wysocki share equally the dispositive and investment power of the minority owner.

Formation Transactions

Prior to or concurrently with this offering, we will have engaged in the following formation transactions that are designed to consolidate the ownership of our contribution properties under our operating partnership, facilitate the acquisition of our acquisition properties and enable us to qualify as a REIT for U.S. federal income tax purposes commencing with our short taxable year ending December 31, 2010:

 

   

We will contribute the net proceeds of this offering to our operating partnership in exchange for a number of OP units equal to the number of shares of our common stock sold in this offering.

 

   

Pursuant to the contribution agreement among our contributors, the minority owner, our operating partnership and us:

 

   

our operating partnership will acquire 100% of the ownership interests in our contribution properties in exchange for (1) with respect to our contributors, an aggregate of 474,657 OP units and $3.0 million in cash and (2) with respect to the minority owner, an aggregate of 16,787 OP units, with the cash consideration to be paid using a portion of the net proceeds from this offering;

 

 

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our contributors and the minority owner have severally agreed to indemnify us for a period of one year with respect to the breach of any representation, warranty, covenant or agreement made or to be performed by them contained in the contribution agreement for claims over $50,000 in the aggregate, subject to a cap equal to the value of the OP units issued pursuant to the contribution agreement; and

 

   

we have agreed to indemnify our contributors and the minority owner for a period of one year with respect to the breach of any representation, warranty, covenant or agreement made or to be performed by us or our operating partnership contained in the contribution agreement, and we have also agreed to indemnify our contributors with respect to any failure by us to comply with the development requirements of the lease for our Salt Lake City, Utah property.

 

   

Our operating partnership or its subsidiaries will acquire our 15 acquisition properties for an aggregate purchase price of $152.5 million, which includes the assumption of approximately $15.2 million of indebtedness and the reimbursement of deposits aggregating $1.9 million in respect of our acquisition properties made or required to be made by BC Development Co., and will pay approximately $1.8 million of transaction costs, including the reimbursement of approximately $0.2 million of transaction costs advanced by BC Development Co., in each case in cash with a portion of the net proceeds from this offering.

 

   

We will pay an aggregate of approximately $1.6 million in cash with a portion of the net proceeds from this offering for costs associated with our formation, including the reimbursement of approximately $0.8 million advanced by BC Development Co.

 

   

Effective upon completion of this offering, we will enter into a tax protection agreement with our contributors and the minority owner. See “Benefits to Related Parties—Tax Protection Agreement.”

 

   

Pursuant to an assignment and license agreement between our development company, our contributors and BC Development Co., our development company will acquire the intellectual property rights to the BC Development name and brand in perpetuity. Our development company will license the BC Development name back to BC Development Co. until all outstanding bids have been awarded. See “Benefits to Related Parties—Assignment and License Agreement.”

 

   

We expect to repay all of the outstanding mortgage indebtedness encumbering our three in-service contribution properties, which was $77.7 million as of June 30, 2010, with a portion of the net proceeds from this offering and assume all of the outstanding construction loan indebtedness encumbering our contribution property in development, which was $2.4 million as of June 30, 2010.

 

   

We will enter into a property management agreement with Lane4 Management, a company majority-owned by Richard Baier and David K. Carr, for management of our initial properties and any future properties that we elect to have Lane4 Management manage. See “Benefits to Related Parties—Property Management Agreement.”

 

   

In August 2010, BC Development Co. was awarded the right to develop an approximately 113,000 square foot VA clinic facility to be located in Jacksonville, Florida. Upon completion of this offering, we will enter into an option agreement with our contributors, which will give us the option to purchase Jacksonville VA or the option property at any time after the facility is completed and a right of first offer obligating our contributors to offer to sell us Jacksonville VA or the option property before they are permitted to market it for sale.

 

 

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The following chart reflects the value of consideration (dollars in thousands) to be paid in exchange for each of our contribution properties. The total value of consideration represents cash payments from the net proceeds of this offering, the value of the OP units issued (assuming the shares of our common stock are sold at $20.00 per share, the mid-point of the price range set forth on the cover page of this prospectus) and the amount of the debt assumed or repaid in exchange for 100% of our contributors’ and the minority owner’s interests in our contribution properties. Debt amounts reflect outstanding balances as of June 30, 2010.

 

Property

   Cash
Payments
   Value of
OP Units Issued
   Debt to be
Repaid
Upon
Acquisition
    Debt to be
Assumed
Upon
Acquisition
    Total Value of
Consideration
 

Jacksonville, Florida

   $ —      $ 187    $ 45,155 (1)    $ —        $ 45,342 (1) 

Denver, Colorado

     —        2,864      13,861 (1)      —          16,725 (1) 

Great Falls, Montana

     —        2,073      18,650 (1)      —          20,723 (1) 

Salt Lake City, Utah

     3,000      4,705      —          2,352 (2)      10,057 (2) 
                                      

Total

   $ 3,000    $ 9,829    $ 77,666 (1)    $ 2,352 (2)    $ 92,847 (1)(2) 
                                      

 

 

(1) Excludes the impact of principal amortization payments since June 30, 2010.
(2) Excludes $2,165 of additional debt incurred, for the period from July 1, 2010 through September 15, 2010, pursuant to draws on the construction loan for our Salt Lake City, Utah development property.

The amount of cash, OP units and debt that we will pay, issue or assume, respectively, in exchange for our contribution properties was determined by our senior management team based on a capitalization rate analysis and an assessment of the fair market value of our contribution properties. No single factor was given greater weight than any other in valuing our contribution properties, and the values attributed to our contribution properties do not necessarily bear any relationship to their respective book values. We did not obtain any third-party property appraisals of our contribution properties or any other independent third-party valuations or fairness opinions in connection with our formation transactions. As a result, the consideration we have agreed to pay for our contribution properties in our formation transactions may exceed their fair market value.

 

 

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Consequences of this Offering and Our Formation Transactions

The following diagram depicts our ownership structure and the ownership structure of our operating partnership and our development company after giving effect to this offering and our formation transactions, excluding shares of our common stock, if any, issued upon exercise of the underwriters’ over-allotment option:

LOGO

 

(1) Our senior management team, includes Richard Baier, the Chairman of our board of directors and our Chief Executive Officer, Kevin T. Kelly, our President and Chief Financial Officer, Daniel K. Carr, our Executive Vice President, Development, Cathleen M. Baier, our Executive Vice President, Government Operations, Edwin M. Stanton, our Senior Vice President, Investments, and Nicholas J. Rhodes, our Senior Vice President, Operations.
(2) Includes (a) an aggregate of 206,250 RSUs granted to members of our senior management team under the US Federal Properties Trust, Inc. 2010 Long Term Incentive Plan, or our long term incentive plan, and (b) an aggregate of 5,000 restricted shares of our common stock granted to our independent directors under our long term incentive plan.
(3) Represents an aggregate of 491,444 OP units owned by our contributors and the minority owner and issued as part of our formation transactions.

Benefits to Related Parties

In connection with this offering and our formation transactions, our contributors, our senior management team and members of our board of directors will receive material financial and other benefits, as described below. For a more detailed discussion of these benefits, see “Management” and “Certain Relationships and Related Party Transactions.”

 

 

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Formation Transactions. In connection with our formation transactions, our contributors will exchange their ownership interests in our contribution properties for an aggregate of 474,657 OP units and $3.0 million in cash, and we will pay to BC Development Co. approximately $3.2 million in cash for the reimbursement of advances relating to out of pocket costs associated with our formation, this offering and the purchase of our acquisition properties, in each case, with the cash consideration to be paid using a portion of the net proceeds from this offering. In addition, our Salt Lake City, Utah development property will be contributed to us subject to indebtedness encumbering that property in connection with a construction loan, which has a maximum principal amount of $16.9 million and had an outstanding principal balance of approximately $4.5 million as of September 15, 2010.

Release of Guarantees. Richard Baier and Daniel K. Carr have jointly and severally guaranteed all of the outstanding indebtedness secured by our three in-service contribution properties, which was $77.7 million as of June 30, 2010, and of this indebtedness, the Daniel K. Carr Trust, an affiliate of Mr. Carr, is also a guarantor of the approximately $13.9 million of outstanding indebtedness secured by our Denver, Colorado contribution property. Our repayment of all of the outstanding indebtedness encumbering our three in-service contribution properties with a portion of the net proceeds from this offering will result in the release of these guarantees.

Messrs. Baier and Carr, and Leanne Carr, Mr. Carr’s wife, have jointly and severally guaranteed up to approximately $10.2 million of the indebtedness secured by our Salt Lake City, Utah property. Cathleen M. Baier and the minority owner will have the opportunity to enter into guarantees for up to approximately $2 million in the aggregate related to this construction loan. In connection with the contribution of our Salt Lake City, Utah development property, we will indemnify each of Messrs. Baier and Carr, Ms. Carr, Ms. Baier and the minority owner for any liability incurred pursuant to their guarantees of the construction loan to the extent such liability exceeds approximately $2 million in the aggregate.

Tax Protection Agreement. Effective upon completion of this offering, we will enter into a tax protection agreement with our contributors and the minority owner. Pursuant to the terms of this agreement, if we sell or otherwise dispose of any interest in any of our contribution properties that generates more than the allowable amount (as described in the following sentence) of built-in gain for our contributors and the minority owner, as a group, in any single year through December 31, 2020, we will indemnify our contributors and the minority owner for tax liabilities incurred with respect to an aggregate built-in gain in excess of the allowable amount and tax liabilities incurred as a result of such tax protection payment. The allowable amount of built-in gain for the initial year of the tax protection agreement will equal 10% of the aggregate built-in gain on our contribution properties at the time of this offering, or approximately $1.2 million, and will increase by 10% of the aggregate built-in gain on our contribution properties in each subsequent year. As a result, the required indemnification will decrease ratably over the course of the term of the tax protection agreement, declining to zero by the end of 2020. The aggregate built-in gain on our contribution properties upon completion of this offering is estimated to be approximately $12.0 million. In addition, the tax protection agreement will provide that, during the period from the completion of this offering through December 31, 2020, our operating partnership will offer our contributors and the minority owner, if they continue to hold such OP units, the opportunity to guarantee an aggregate of approximately $2.5 million of our operating partnership’s debt. If we fail to make such opportunities available, we will be required to deliver to each such contributor or minority owner, as the case may be, a cash payment intended to approximate such contributor’s or minority owner’s tax liability resulting from our failure to make such opportunities available to such contributor or minority owner, including any gross up necessary to cover any income tax incurred by such contributor or minority owner as a result of such tax protection payment.

Assignment and License Agreement. Pursuant to an assignment and license agreement between our development company, our contributors and BC Development Co., BC Development Co. will agree that, if any or all of the four bids that it has in process with the GSA are awarded to it, it will designate a special purpose

 

 

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entity wholly owned by our operating partnership to receive each such award. Conditioned upon completion of this offering, we will reimburse BC Development Co. for expenses paid prior to the completion of this offering and relating to the four in-process bids, which as of June 30, 2010 aggregated approximately $58,000.

Indemnification in Connection with Contribution Agreement. We have agreed to indemnify our contributors and the minority owner for a period of one year with respect to the breach of any representation, warranty, covenant or agreement made or to be performed by us or operating partnership contained in the contribution agreement. We have also agreed to indemnify our contributors with respect to any failure by us to comply with the development requirements of the lease for our Salt Lake City, Utah property.

Property Management Agreement. We will enter into a property management agreement with Lane4 Management, a company majority-owned by Richard Baier and Daniel K. Carr, for management of our initial properties and any future properties that we elect to have Lane4 manage. Pursuant to this agreement, we will be obligated to pay Lane4 Management an annual fee equal to $0.50 per rentable square foot of each property managed by Lane4 Management subject to a maximum annual fee of 3% of any such property’s base rent (gross rent less any amortized tenant improvement costs included in gross rent); provided, however, we will be obligated to pay Lane4 Management a minimum of $1,500 per month per property. We will also be obligated to reimburse Lane4 Management for expenses that are included in each Lane4 Management managed property’s budget approved by our nominating and governance committee, and other Lane4 Management expenses that may be approved by us provided that any such other expenses that exceed $5,000 for a Lane4 Management managed property must be approved by our nominating and governance committee. We expect to pay Lane4 Management property management fees aggregating approximately $440,000 on an annualized basis in respect of our in-service initial properties (exclusive of any expense reimbursements) during the term of the property management agreement.

Option Agreement. Upon completion of this offering, we will enter into an option agreement with our contributors, which will give us the option to purchase Jacksonville VA or the option property at any time after the facility is completed and a right of first offer obligating our contributors to offer to sell us Jacksonville VA or the option property before they are permitted to market it for sale.

Employment Agreements. Each member of our senior management team will enter into an employment agreement with us providing such member with salary, severance and other benefits.

Long Term Incentive Plan Grants. Our senior management team will be granted an aggregate of 206,250 RSUs. In particular, Richard Baier will be granted 40,320 RSUs; Kevin T. Kelly will be granted 37,500 RSUs; Daniel K. Carr will be granted 40,319 RSUs; Cathleen M. Baier will be granted 40,319 RSUs; Edwin M. Stanton will be granted 27,792 RSUs; and Nicholas J. Rhodes will be granted 20,000 RSUs.

Director Compensation. Each independent director will be granted 1,250 restricted shares of our common stock upon completion of this offering.

Registration Rights Agreement. We will enter into a registration rights agreement with our contributors and the minority owner pursuant to which we will agree, among other things, to register at any time which is one year after the completion of this offering the resale of any shares of our common stock that are exchanged for OP units issued to them as part of our formation transactions.

New Credit Facility and Debt Capitalization

We anticipate that we will enter into a $125 million three-year secured revolving credit facility shortly following completion of this offering. We expect that we will be able to use this revolving credit facility to fund acquisitions, developments, redevelopments and capital expenditures and for general corporate purposes. We have not received a commitment from the lenders for this facility and there can be no assurance that we will enter into definitive documentation with regard to this facility upon the terms described or at all.

 

 

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Upon completion of this offering and our formation transactions, our only outstanding indebtedness will be the construction loan secured by our Salt Lake City, Utah property, which has a maximum principal amount of $16.9 million and had an outstanding balance of approximately $4.5 million as of September 15, 2010, and approximately $15.2 million of assumed debt secured by our Alpine, Texas acquisition property. The construction loan matures on the earlier of March 1, 2012 or the month following GSA lease payment commencement, subject to extension under certain circumstances to March 2015. The indebtedness secured by our Alpine, Texas acquisition property matures in July 2022.

Restrictions on Ownership and Transfer of Shares

REIT Matters

Our charter, subject to certain exceptions and after the application of certain attribution rules, prohibits any person from directly or indirectly owning more than 9.8% by number of shares or value, whichever is more restrictive, of the outstanding shares of our common stock or 9.8% by value of our outstanding stock in the aggregate, which we refer to in this prospectus collectively as the stock ownership limits. Our charter also prohibits any person from directly or indirectly owning our stock of any class if such ownership would result in us being “closely held” under Section 856(h) of the Internal Revenue Code of 1986, as amended, or the Code, or otherwise cause us to fail to qualify as a REIT.

Our charter generally provides that any stock owned or transferred in violation of the foregoing restrictions will be automatically transferred to a charitable trust for the benefit of a charitable beneficiary, and the purported owner or transferee will acquire no rights in such stock. If the foregoing is ineffective for any reason to prevent a violation of these restrictions, then our charter provides that the transfer of such stock will be void.

No person may transfer our stock or any interest in our stock if the transfer would result in our stock being beneficially owned by fewer than 100 persons. Our charter provides that any attempt to transfer our stock in violation of this minimum will be void.

Registration Rights

We will enter into a registration rights agreement with our contributors and the minority owner pursuant to which we will agree, among other things, to register the resale of any shares of our common stock that are exchanged for OP units issued to them as part of our formation transactions. These registration rights require us to seek to register all shares of our common stock that may be exchanged for OP units effective as of that date which is one year following completion of this offering on a “shelf” registration statement under the Securities Act of 1933, as amended, or the Securities Act. In addition, prior to completion of this offering, we intend to file a registration statement on Form S-8 to register the total number of shares of our common stock that may be issued under our long term incentive plan.

Lockup Agreements

We, our contributors, the other members of our senior management team, the minority owner and our directors have agreed with the underwriters not to offer, sell or otherwise dispose of any shares of our common stock or any securities convertible into, or exercisable or exchangeable for, shares of our common stock (including OP units) or derivatives of our common stock for a period of one year after the date of this prospectus, without the prior written consent of Deutsche Bank Securities Inc. and UBS Securities LLC, subject to limited exceptions.

 

 

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Conflicts of Interest

We are party to the contribution agreement with our contributors and the minority owner pursuant to which they will contribute to us all of the ownership interests in our contribution properties as part of our formation transactions. Our contributors serve either as directors, members of our senior management team or both. We will be entitled to indemnification and damages in the event of the breach of any representation, warranty, covenant or agreement made by our contributors or the minority owner pursuant to the contribution agreement. We will also enter into a tax protection agreement with our contributors. In addition, each of our contributors and other members of our senior management team will enter into an employment agreement that includes a non-competition covenant or requires as a condition of his or her employment that he or she enter into a non-competition agreement with us.

We will enter into a property management agreement with Lane4 Management, a company majority-owned by Richard Baier, the Chairman of our board of directors and our Chief Executive Officer, and Daniel K. Carr, our Executive Vice President, Development, for management of our initial properties and any future properties that we elect to have Lane4 Management manage. We expect to pay Lane4 Management property management fees aggregating approximately $440,000 on an annualized basis in respect of our in-service initial properties (exclusive of any expense reimbursements) during the term of the property management agreement. Prior to Lane4 Management’s engagement under this agreement to manage one or more of our properties acquired or developed in the future, property management services will be competitively bid and reviewed and approved by our nominating and governance committee. Messrs. Baier and Carr have agreed to submit a proposal to our board of directors to internalize all property management services and terminate the property management agreement with Lane4 Management at no cost to us once the size of our portfolio reaches 1.5 million rentable square feet, although no assurance can be given that this size threshold will be reached, that our board of directors will approve any submitted proposal or that any approved proposal will be beneficial to us.

Upon completion of this offering, we will enter into an option agreement with our contributors, which will give us the option to purchase Jacksonville VA or the option property at any time after the facility is completed and a right of first offer obligating our contributors to offer to sell us Jacksonville VA or the option property before they are permitted to market it for sale. Our contributors will oversee the development of the option property. There will be times when the development of the option property requires our contributors to devote a significant amount of their time and attention to such property. Additionally, our contributors will have a personal economic interest in the option property and therefore an incentive to devote time and attention to such property. Therefore, our contributors could limit the time and attention they devote to our business, which could materially and adversely affect us.

These agreements, including any consideration payable by us under each such agreement, were not negotiated at arm’s length, and the terms of these agreements may not be as favorable to us as if they were so negotiated. To the extent that any breach, dispute or ambiguity arises with respect to any of these agreements, we may choose not to enforce, or to enforce less vigorously, our rights under these agreements due to our ongoing relationships with our contributors and other members of our senior management team and the majority ownership of Lane4 Management by Messrs. Baier and Carr.

Distribution Policy

We intend to pay cash dividends to our stockholders on a quarterly basis. We intend to pay a pro rata dividend with respect to the period commencing on completion of this offering and ending December 31, 2010 based on $0.25 per share for a full quarter. On an annualized basis, this would be $1.00 per share, or an annual dividend rate of approximately 5.0% based on the mid-point of the price range set forth on the cover page of this prospectus. Our estimated initial annual dividend per share represents approximately 101% of our estimated cash

 

 

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available for distribution for the twelve months ending June 30, 2011, calculated as described more fully under “Distribution Policy.” Accordingly, we expect that we will be unable to pay our estimated initial annual dividend out of our estimated cash available for distribution for the twelve months ending June 30, 2011. Unless our operating cash flow increases in the future, we will be required to fund approximately $0.2 million of our estimated initial annual dividend through borrowings or equity issuances, and we cannot assure you that we will be able to obtain such funding on attractive terms or at all, in which case we plan to use a portion of the remaining net proceeds from this offering for such funding, which would make such amounts unavailable for our future development and acquisition of properties, or to fund such dividend in the form of shares of common stock or to eliminate or otherwise reduce such dividend.

We intend to maintain our initial dividend rate per share for the twelve-month period following completion of this offering unless our financial condition, cash flows, liquidity, FFO, results of operations or prospects, economic conditions or other factors differ materially from the assumptions used in projecting our initial dividend rate. However, although we anticipate initially making quarterly dividends to our common stockholders, the timing, form and amount of any dividends will be at the sole discretion of our board of directors and will depend upon a number of factors, as to which no assurance can be given. We do not intend to reduce our initial dividend rate per share if the underwriters exercise their over-allotment option.

We generally must distribute at least 90% of our REIT taxable income each year (subject to certain adjustments) to our stockholders in order to qualify as a REIT under the Code. To the extent that, in respect of any calendar year, cash available for distribution to our stockholders is less than our REIT taxable income, in order to qualify as a REIT under the Code we could be required to fund the required distributions in the manner described above or to make a portion of the required distributions in the form of a taxable distribution of our equity securities. We currently do not intend to make taxable distributions of our equity securities. In addition, funding distributions from net proceeds from this offering may constitute a return of capital to our common stockholders, which would have the effect of reducing each common stockholder’s basis in its holdings of shares of our common stock. See “Distribution Policy.”

REIT Qualification

We intend to elect to be treated as a REIT under Sections 856 through 859 of the Code commencing with our short taxable year ending on December 31, 2010. Our qualification as a REIT depends upon our ability to meet on a continuing basis, through actual investment and operating results, various complex requirements under the Code relating to, among other things, the sources of our gross income, the composition and values of our assets, our dividend levels and the diversity of ownership of our stock. We believe that we will be organized in conformity with the requirements for qualification and taxation as a REIT under the Code and that our intended manner of operation will enable us to meet the requirements for qualification and taxation as a REIT.

As a REIT, we generally will not be subject to U.S. federal income tax on our taxable income that we distribute currently to our stockholders. If we fail to qualify as a REIT in any taxable year and do not qualify for certain statutory relief provisions, we will be subject to U.S. federal income tax at regular corporate rates and generally will be precluded from qualifying as a REIT for the subsequent four taxable years following the year during which we lost our REIT qualification. Accordingly, our failure to qualify as a REIT could materially and adversely affect us, including our ability to pay dividends to our stockholders in the future. Even if we qualify as a REIT, we may be subject to some U.S. federal, state and local taxes on our income or property. See “U.S. Federal Income Tax Considerations—Taxation of Our Company.”

 

 

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The Offering

 

Shares of our common stock offered by us

13,750,000 shares(1)

 

Shares of our common stock to be outstanding after this offering

13,961,250 shares(1)(2)

 

Shares of our common stock and OP units to be outstanding after this offering

14,452,694 shares/OP units(1)(2)(3)

 

Use of proceeds

We intend to use the net proceeds from this offering to: repay all of the outstanding indebtedness on our three in-service contribution properties, which as of June 30, 2010 aggregated $77.7 million; pay to our contributors the $3.0 million cash portion of the aggregate purchase price of their interests in our contribution properties; pay the $137.4 million cash portion of the aggregate purchase price of our acquisition properties, including the reimbursement of $1.9 million of advances made or required to be made by BC Development Co. for certain deposits related to our acquisition properties; pay an aggregate of approximately $1.8 million of transaction costs, including the reimbursement of approximately $0.2 million of transaction costs advanced by BC Development Co.; pay an aggregate of approximately $1.6 million relating to costs associated with our formation, including the reimbursement of approximately $0.8 million advanced by BC Development Co.; and for working capital and general corporate purposes, including future acquisitions and developments. See “Use of Proceeds.”

 

NYSE symbol

“USFP”

 

Ownership and transfer restrictions

Our charter, subject to certain exceptions, prohibits any person from directly or indirectly owning more than 9.8% by number of shares or value, whichever is more restrictive, of the outstanding shares of our common stock or 9.8% by value of our stock in the aggregate. See “Description of Stock—Restrictions on Ownership and Transfer.”

 

Risk factors

Investing in shares of our common stock involves a high degree of risk. You should carefully read and consider the information set forth under “Risk Factors” and all other information in this prospectus before making a decision to invest in shares of our common stock.

 

(1) Assumes the underwriters’ over-allotment option to purchase up to an additional 2,062,500 shares of our common stock is not exercised.
(2) Includes (a) an aggregate of 206,250 RSUs granted to members of our senior management team under our long term incentive plan and (b) an aggregate of 5,000 restricted shares of our common stock granted to our independent directors under our long term incentive plan. Excludes 788,750 shares of our common stock available for future grant under our long term incentive plan. Our long term incentive plan provides that a maximum of 1,000,000 shares of our common stock may be issued in connection with awards granted thereunder. See “Management—US Federal Properties Trust, Inc. 2010 Long Term Incentive Plan.”
(3) Includes an aggregate of 491,444 OP units owned by our contributors and the minority owner issued as part of our formation transactions. Excludes OP units held by us.

 

 

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Summary Selected Financial and Pro Forma Financial Information

The following table presents certain historical and pro forma operating, balance sheet and other data of our company and our predecessor. Our predecessor is not a legal entity, but rather a combination of Great Falls and Jacksonville Field, two real estate entities owned primarily by our contributors. Historical data for us (with our operating partnership) are not presented below because we have not had any operating activity since our March 9, 2010 incorporation other than the issuance of 1,000 shares of our common stock in connection with our initial capitalization, which we intend to repurchase upon completion of this offering.

The following historical operating data for the six months ended June 30, 2010 and June 30, 2009 and the balance sheet data as of June 30, 2010 of our predecessor were derived from the combined financial statements of our predecessor, appearing elsewhere in this prospectus, which, in the opinion of management, include all normal recurring adjustments necessary for a fair presentation of the information set forth therein. The following historical operating data for the years ended December 31, 2009, 2008 and 2007 and the balance sheet data as of December 31, 2009 and 2008 of our predecessor were derived from the combined financial statements of our predecessor, appearing elsewhere in this prospectus. The balance sheet data as of December 31, 2007 of our predecessor were derived from the unaudited combined financial statements of our predecessor, which are not included in this prospectus. Our predecessor did not begin revenue producing operations until 2009. The following pro forma operating and balance sheet data were derived from our pro forma financial statements, appearing elsewhere in this prospectus, and reflect the completion of this offering and our formation transactions. The following historical and pro forma data should be read in conjunction with the financial statements and notes thereto, as well as with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Use of Proceeds” and the statements of revenues and certain operating expenses of DHS Denver and the acquisition properties, all appearing elsewhere in this prospectus.

Results for the six months ended June 30, 2010 are not necessarily indicative of our actual results for the year ending December 31, 2010. In addition, the unaudited pro forma financial information in this section is not intended to replace the financial statements of our predecessor or the statements of revenues and certain operating expenses of DHS Denver and the acquisition properties nor does it necessarily reflect what our results of operations, financial position and cash flows would have been if we had previously operated as a stand-alone combined company during all periods presented. Accordingly, the selected historical and pro forma data should not be relied upon as an indicator of our future results of operations, financial position or cash flows.

 

    Six months ended
June 30,
    Year ended December 31,
    Pro Forma
2010
    Historical     Pro Forma
2009
    Historical
      2010     2009       2009     2008     2007
    (in thousands,
except per share data)
    (in thousands,
except per share data)

Operating data

             

Revenues

  $ 13,308     $ 3,599     $ 1,790     $ 20,577      $ 5,378      $ —        $ —  

Expenses:

             

Real estate taxes

    1,068        302       26       924        108        —          —  

Utility expenses

    843        218       153       1,512        398        —          —  

Other operating expenses

    1,543        395       135       2,416        700        —          —  

Depreciation and amortization

    4,141        1,022       481       6,453        1,493        —          —  

General and administrative

    1,485        12       25       2,976        45        —          —  
                                                     

Total expenses

    9,080        1,949       820       14,281        2,744        —          —  
                                                     

Operating income

    4,228        1,650        970       6,296        2,634        —          —  

Unrealized gain (loss) of derivatives

    —          —          394       —          568        (568     —  

Interest expense

    (472     (749 )     (633 )     (972     (1,449     —          —  
                                                     

Net income (loss)

    3,756        901       731       5,324        1,753        (568     —  

Net income attributable to non-controlling interests

    (148     —          —          (209     —          —          —  
                                                     

Net income (loss) attributable to controlling interest

  $ 3,608      $ 901     $ 731     $ 5,115      $ 1,753      $ (568   $ —  
                                                     

Net income per basic and diluted share

    0.30        N/M        N/M        0.42        N/M        N/M        N/M
                                                     

Weighted average shares outstanding

    12,226        N/M        N/M        12,226        N/M        N/M        N/M
                                                     

Other data

             

Funds from operations(1)

  $ 7,897      $ 1,923     $ 1,212     $ 11,777      $ 3,246      $ (568   $ —  
                                                     

 

 

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     As of June 30,     As of December 31,
     Pro Forma
2010
    Historical
2010
    Historical
         2009     2008    2007
     (dollars in thousands)     (dollars in thousands)

Balance sheet data

           

Real estate properties, net

   $ 222,261      $ 63,352      $ 64,160      $ 49,742    $ 12,005

Cash

     32,299        23        249        34      —  

Total assets

     282,802        65,059        65,796        50,191      12,572

Bank loans payable

     16,404 (2)      63,805        63,800        48,104      9,972

Total liabilities

     31,610        66,127        65,975        50,011      12,054

Controlling interest equity

     242,524        (1,068     (179     180      518

Non-controlling interest equity

     8,668        —          —          —        —  

Total stockholders’ equity

     251,192        (1,068     (179     180      518

Other data

           

Number of operating properties(3)

     18        2        2        —        —  

Percentage leased

     100     100     100     N/M      N/M

 

N/M - Not meaningful.
(1) We present FFO because we consider it an important supplemental measure of our operating performance and believe it is frequently used by securities analysts, investors and other interested parties in the evaluation of REITs, many of which present FFO when reporting their operating results. FFO is intended to exclude historical cost depreciation and amortization of real estate and related assets, which assumes that the value of real estate assets diminishes ratably over time. Historically, however, real estate values have risen or fallen with market conditions. Because FFO excludes depreciation and amortization unique to real estate, gains and losses from property dispositions and extraordinary items, it provides a performance measure that, when compared period-over-period, reflects the impact to operations from trends in occupancy rates, rental rates, operating costs, development activities and interest costs, providing perspective not immediately apparent from net income (loss). We compute FFO in accordance with standards established by the Board of Governors of the National Association of Real Estate Investment Trusts, or NAREIT, in its March 1995 White Paper (as amended in November 1999 and April 2002). As defined by NAREIT, FFO represents net income (computed in accordance with U.S. generally accepted accounting principles, or GAAP), excluding gains (or losses) from sales of property, plus real estate related depreciation and amortization (excluding amortization of loan origination costs) and after adjustments for unconsolidated partnerships and joint ventures. Our computation may differ from the methodology for calculating FFO utilized by other equity REITs and, accordingly, may not be comparable to such other REITs. Furthermore, FFO does not represent amounts available for management’s discretionary use because of needed capital replacement or expansion, debt service obligations, or other commitments and uncertainties. FFO should not be considered as an alternative to net income (loss) (computed in accordance with GAAP) as an indicator of our financial performance or to cash flow from operating activities (computed in accordance with GAAP) as an indicator of our liquidity, nor is it indicative of funds available to fund our cash needs, including our ability to pay dividends or make distributions to our stockholders.

The following table is a reconciliation of our net income to FFO:

 

     Six months ended
June 30,
   Year ended December 31,
     Pro  Forma
2010(3)
   Historical    Pro  Forma
2009(3)
   Historical
        2010    2009       2009    2008     2007
     (dollars in thousands)    (dollars in thousands)

Net income (loss)

   $ 3,756    $ 901    $ 731    $ 5,324    $ 1,753    $ (568   $ —  

Depreciation and amortization

     4,141      1,022      481      6,453      1,493      —          —  
                                                 

FFO

   $ 7,897    $ 1,923    $ 1,212    $ 11,777    $ 3,246    $ (568   $ —  
                                                 

 

(2) This amount is net of a $1.1 million fair value adjustment, related to our Alpine, Texas acquisition property, pursuant to the acquisition method of accounting.
(3) While development of the two contribution properties owned by our predecessor started in 2007, the terms of the operating leases did not commence until February 2009 and June 2009, respectively. The pro forma statements include the results of our 18 in-service initial properties, of which only 9 properties comprising 413,134 rentable square feet, or 50.8% of the aggregate rentable square footage of our in-service initial properties, were in service at January 1, 2009. Our Salt Lake City, Utah contribution property began construction in March 2010.

 

 

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RISK FACTORS

An investment in shares of our common stock involves a high degree of risk. You should carefully consider the risks described below, together with the other information contained in this prospectus, including our historical and pro forma financial statements and the notes thereto, before making a decision to invest in shares of our common stock in this offering. The realization of any of the following risks could materially and adversely affect our business, prospects, financial condition, cash flows, liquidity, FFO, results of operations, share price, ability to service our indebtedness and ability to pay cash dividends to our stockholders (including those necessary to maintain our REIT status) and could cause you to lose all or a significant part of your investment in shares of our common stock. In connection with the forward-looking statements that appear in this prospectus, you should also carefully review the cautionary statement referred to under “Cautionary Statement Regarding Forward-Looking Statements.”

Risks Related to Our Business and Our Properties

Our primary business is currently limited to the ownership and operation of single-tenant federal government-leased properties.

Our current strategy is to acquire, develop, own, operate and manage single-tenant federal government-leased properties. Consequently, we are subject to risks inherent in investments in one sector of the real estate industry. This strategy limits asset diversification of our investment portfolio. Furthermore, because investments in real estate are inherently illiquid, it is difficult to limit our risk in response to economic, market and other conditions. See “—Risks Related to the Real Estate Industry—Illiquidity of real estate investments could impede our ability to change our portfolio, which could materially and adversely affect us” below.

We were organized recently and our senior management team has no experience in operating a REIT and limited experience in operating a public company.

We were organized in March 2010. Therefore, we are subject to the risks associated with the operation of any new organization. Our senior management team does not have any experience operating a REIT and only Mr. Kelly has experience as an officer (as Chief Financial Officer) of a public company. Consequently, you will be unable to fully evaluate our senior management team’s public company operational capabilities and ability to successfully execute our business strategy. Furthermore, as a publicly-traded REIT, we will be required to develop and implement substantial control systems, policies and procedures in order to maintain our REIT status and satisfy our periodic SEC reporting, and NYSE listing, requirements. We cannot assure you that our senior management team’s past experience will be sufficient to successfully develop and implement these systems, policies and procedures and operate our company. Failure to do so could jeopardize our status as a REIT or NYSE-listed company, and the loss of either status would materially and adversely affect us.

We may not be able to consummate the purchase of any or all of our acquisition properties, which could materially and adversely affect us.

As part of our formation transactions, we have contracted to acquire, upon completion of this offering, 15 federal government-leased properties containing 579,624 rentable square feet for an aggregate purchase price of $152.5 million (including the assumption of approximately $15.2 million of debt). We intend to acquire these properties with a portion of the net proceeds from this offering. However, our acquisition of these properties is subject to due diligence, closing and other conditions. Accordingly, we cannot assure you that the acquisition of any one or all of these properties will be consummated, and our failure to acquire one or more of these properties could materially and adversely affect us.

Ten of our fifteen acquisition properties will be purchased as part of two separate portfolio acquisitions, the Rainier portfolio (seven properties containing an aggregate of 231,032 rentable square feet) and the Texas SSA

 

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portfolio (three properties containing an aggregate of 57,132 rentable square feet). Under the portfolio purchase agreements, in the event we determine not to acquire any property in either portfolio, we will not be able to purchase any of the properties in the applicable portfolio.

We must obtain the consent of the federal government in order to assume the rights and obligations of the landlord under the leases of our acquisition properties, and we will need to collect the federal government’s rent payments from the former owners of those properties until that consent is obtained.

The leases associated with our acquisition properties require that we obtain the consent of the federal government in order to transfer the rights and obligations of the landlord from the respective sellers to us. The consent process is time-consuming and not obligatory on the part of the federal government. The federal government will continue to pay rent to the former owners of those properties until the applicable consent is obtained. By virtue of our purchase agreements and the documents to be executed by the sellers when we acquire the acquisition properties, the sellers will assign us the rights to any rent that they receive from the federal government for the time period after we acquire the property. If one or more former owners of our acquisition properties improperly retain rent payments or become subject to bankruptcy, receivership or other insolvency proceedings, we may be unable to recover the rent payable under the federal government leases in a timely manner, or at all, which could materially and adversely affect us.

We may not be able to successfully integrate our acquisition properties or other future property acquisitions and developments into our business.

We do not have operational experience with any of our acquisition properties and will not have operational experience with any subsequent property acquisitions and developments. We have not owned properties in many of the geographic markets in which our acquisition properties reside. In the future, we may acquire or develop other properties in geographic regions within the United States in which we do not currently operate. Accordingly, to the extent we acquire or develop any such properties, we will not possess the same level of familiarity with them and they may fail to perform in accordance with our expectations, as a result of our inability to operate them successfully, our failure to integrate them successfully into our business or our inability to assess their true value in calculating their pricing or otherwise, which could materially and adversely affect us.

We anticipate that our initial properties will be widely dispersed geographically, which may adversely affect our ability to manage them effectively.

We have elected not to limit our acquisition, development or joint-development activities by geography. Upon completion of this offering and our formation transactions, we anticipate that our initial properties will be located in 11 states. As we acquire and develop additional properties, the geographic diversity of our properties may also grow. The costs of property and asset management, as well as the effectiveness of our senior management team, could be affected adversely by the burden of managing assets over an unspecified geographic area in the United States.

Our acquisition properties or other future property acquisitions and developments could result in disruptions to our business and strain our resources.

As part of our formation transactions, we have contracted to acquire, upon completion of this offering, 15 federal government-leased properties containing 579,624 rentable square feet for an aggregate purchase price of $152.5 million (including the assumption of approximately $15.2 million of debt), substantially increasing the number of our properties. The currently contemplated and future growth of our property portfolio could disrupt our business and place a significant strain on our operational, management, administrative and financial resources, particularly if we determine to accelerate the number of properties we pursue and/or consummate or decide to pursue multiple properties at one time.

 

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Our growth depends, in part, on successfully identifying and consummating acquisitions of single-tenant federal government-leased properties, and any delay or failure on our part to identify, finance and consummate acquisitions on favorable terms could materially and adversely affect us.

Our ability to expand through acquisitions is integral to our growth strategy and requires us first to identify suitable acquisition candidates. A key component of our growth strategy is to focus our acquisitions on single- tenant federal government-leased properties. There are a limited number of properties that fit this strategy, and we will have fewer opportunities to grow our portfolio than entities that purchase properties that are primarily leased to state government or non-government tenants. Also, because of the strong credit quality of our federal government tenant base, we face significant competition for acquisitions of single-tenant federal government-leased properties from many investors, including publicly traded REITs, high net worth individuals, commercial developers, real estate companies and institutional investors with more substantial resources and access to capital than we have. This competition may require us to accept less favorable terms (including higher purchase prices) in order to consummate a particular acquisition. In addition, we may identify a portfolio of properties that are owned by one potential seller. It is not uncommon for a seller of a portfolio of properties to be unwilling to allow the carve-out of one or more properties from the portfolio of properties if, for due diligence or other reasons, we do not wish to pursue or complete the purchase of one or more of such properties. As a result, we may be required to purchase an under-performing or otherwise deficient property in order to obtain the valuable properties in a portfolio or forego the entire opportunity. Accordingly, for all of these reasons, we cannot assure you that we will be able to identify single-tenant federal government-leased properties or portfolios of properties available for sale, negotiate and consummate their acquisition on favorable terms, or at all, obtain the most efficient form of financing, or any financing at all, for such acquisitions or have sufficient resources internally to fund such acquisition without external financing. See “—Risks Related to Our Debt Financing—Our inability to obtain financing on favorable terms, or at all, particularly in light of ongoing conditions in the lending and capital markets, could materially and adversely affect us” below. Any delay or failure on our part to identify, negotiate, finance and consummate such acquisitions on favorable terms could materially and adversely affect us.

Developing and redeveloping properties will expose us to additional risks beyond those associated with owning and operating federal government-leased properties and could materially and adversely affect us.

Our future growth will depend, in part, upon our ability to successfully complete the one contribution property that we are currently building and to successfully identify and execute additional development and redevelopment opportunities either on our own or with strategically selected joint-development partners. Our development and redevelopment activities may be adversely affected by:

 

   

abandonment of development opportunities after expending significant cash and other resources to determine feasibility, requiring us to expense costs incurred in connection with the abandoned project;

 

   

construction costs of a project exceeding our original estimates;

 

   

failure to complete a project on schedule or in conformity with building plans and specifications;

 

   

the lack of available construction financing on favorable terms or at all;

 

   

the lack of available permanent financing upon completion of a project initially financed through construction loans on favorable terms or at all;

 

   

failure to obtain, or delays in obtaining, necessary zoning, land use, building, occupancy and other required governmental permits and authorizations;

 

   

liability for injuries and accidents occurring during the construction process and for environmental liabilities, including those that may result from off-site disposal of construction materials;

 

   

revocation of a member of our senior management team’s federal government security clearance;

 

   

our inability to comply with the federal government’s procurement standards and processes in place from time to time;

 

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the federal government’s preference for small business developers; and

 

   

circumstances beyond our control, including: work stoppages, labor disputes, shortages of qualified trades people, such as carpenters, roofers, electricians and plumbers, changes in laws relating to union organizing activity, lack of adequate utility infrastructure and services, our reliance on local subcontractors, who may not be adequately capitalized or insured, and shortages, delay in availability, or fluctuations in prices of, building materials.

Any of these circumstances could give rise to challenges in obtaining federal government build-to-suit development projects or to delays in the start or completion of, or could increase the cost of, developing or redeveloping one or more of our properties. We cannot assure you that we will be able to recover any increased costs by raising our lease rates. Additionally, due to the amount of time required for planning, constructing and leasing of development and redevelopment properties, we may not realize a significant cash return for several years. Furthermore, any of these circumstances could hinder our growth and materially and adversely affect us. In addition, new development and redevelopment activities, regardless of whether or not they are ultimately successful, typically require substantial time and attention from management.

Maintaining our development and redevelopment capabilities involves significant costs, including compensation expense for our personnel and related overhead. To the extent we cease or limit our development or redevelopment activity, these costs will no longer be offset by revenues from properties that we develop or redevelop.

Our failure to timely deliver build-to-suit properties leased to the federal government will subject us to lease termination and other penalties.

In deciding whether to develop or redevelop a particular property, we make certain assumptions regarding the expected future performance of that property. The failure to timely deliver build-to-suit properties leased to the federal government typically results in the release from lease payments for the period of time until the project is complete and may permit the federal government to terminate the lease. In addition, the federal government will be entitled to damages equal to the cost of obtaining a replacement lease. Any substantial, unanticipated delays or expenses could reduce the investment returns from these development or redevelopment projects and otherwise materially and adversely affect us.

Our contribution property located in Salt Lake City, Utah is currently under construction and subject to the risks described above. Upon completion, this property will comprise approximately 8% of the total rentable square feet of our initial properties.

We may develop properties in geographic regions within the United States in which we do not currently operate. To the extent we choose to develop properties in new geographic regions, we will not possess the same level of familiarity with developing and operating properties in these markets, which could adversely affect our ability to develop and operate such properties successfully or at all or to achieve expected performance, which could materially and adversely affect us.

Future acquisitions of state or local government single-tenant properties may expose us to greater credit risk than that associated with our full faith and credit leases to the federal government.

While our primary acquisition focus will be on single-tenant federal government-leased properties, we will consider state and local government single-tenant lease opportunities that we believe offer attractive risk-adjusted returns. We believe that most, if not all, of these opportunities will involve leases to state and local governmental bodies that will be subject to annual appropriations or that will carry credit risk greater than that associated with our full faith and credit leases to the federal government. We have no experience with state and local government-leased opportunities and properties.

 

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We could be materially and adversely affected by our lack of sole decision-making authority in joint-development projects.

Following completion of this offering, we intend to pursue joint-development projects. We could be materially and adversely affected by our lack of sole decision-making authority, our reliance on co-developers’ financial condition and liquidity and disputes between us and our co-developers. In addition, investments in joint-development projects, under certain circumstances, involve risks not present were a third-party not involved, including the possibility that co-developers might become bankrupt or fail to fund their share of required capital contributions. Co-developers may have economic or other business interests or goals which are inconsistent with our business interests or goals and may be in a position to take actions contrary to our policies or objectives. Such investments also may have the potential risk of impasses on decisions, such as a sale, because neither we nor the co-developer would have full control over joint-development project. Disputes between us and co-developers may result in litigation or arbitration that would increase our expenses and prevent our officers and/or directors from focusing their time and efforts on our business. Consequently, actions by or disputes with co-developers might result in subjecting properties owned by the joint-development project to additional risk. In addition, we may in certain circumstances be liable for the actions of our co-developers.

If we are unable to renew leases or re-let space promptly on favorable terms or tenants choose not to exercise any available lease renewal options, we could be materially and adversely affected.

As of June 30, 2010, the weighted-average remaining lease term of our initial properties currently in service, assuming the exercise of all early termination rights, was 11.4 years, and the weighted-average remaining lease term of our initial properties currently in service, assuming no early termination rights are exercised, was 13.8 years. Assuming no early termination rights are exercised, in-service leases representing approximately 4.3% of our annualized base rent as of June 2010 (or approximately 4.6% of our leased square footage) will expire by 2020. Assuming all early termination rights are exercised, in-service leases representing 43.4% of our annualized base rent as of June 2010 (or approximately 49.6% of our leased square footage) will expire or terminate by 2020. Although we expect to seek to renew our leases with the federal government for the current occupant when these leases expire, we can provide no assurance that we will be successful in doing so on favorable or even the same terms (including rental rates), or at all, especially if market conditions are adverse at the relevant time. Our properties are, and we expect will be, primarily single-tenant federal government-leased properties, often built or modified according to specialized needs of federal agencies or departments, including law enforcement and defense/intelligence. Whether designed for specialized needs or for general office needs, if we are unable to renew our leases with current tenants, it may be difficult to find tenants that will lease such facilities and, as a result, we may be unable to re-let any or all of the vacated tenant space promptly upon the expiration or early termination of leases or be required to accept extremely unfavorable lease terms (including lower rental rates), grant significant tenant concessions, incur significant capital expenditures to retrofit the property or incur substantial leasing commissions, any of which could materially and adversely affect us.

Most of our leases include early termination provisions that permit the federal government to terminate its lease with us prior to the lease expiration date.

We expect that all or substantially all of our rents will come from the federal government. Most of our leases include early termination provisions that permit the federal government to terminate its lease with us after a specified date before the lease expiration date with little or no liability. By 2020, early termination rights become exercisable with respect to approximately 39.2% of our annualized base rent from our in-service leases (or approximately 45.0% of the our leased square footage). For fiscal policy reasons, security concerns or other reasons, some or all of these federal government occupants may decide to vacate our properties at or prior to the expiration of their lease term. Furthermore, these properties are often built or modified to specialized needs of particular agencies or departments of the federal government, including law enforcement and defense/intelligence, at considerable cost of development or modification. These additional costs are recovered typically through enhanced rent rates designed to recapture the cost over the full lease term. When we purchase recently

 

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constructed properties, we will likely pay a price that reflects these enhanced rent rates. Should a tenant of one our facilities elect to vacate our properties at or prior to the expiration of their lease term, it is unlikely that we would be able to fully recover our costs by finding a tenant or tenants beyond the federal government willing to pay these enhanced rates. It also would be unlikely to market the property at a price that would be likely to reflect the enhanced rent rates. Accordingly, if a significant number of such vacancies occur, we could be materially and adversely affected.

An increase in the amount of federal government-owned real estate relative to federal government-leased real estate may materially and adversely affect us.

The recently adopted American Recovery and Reinvestment Act of 2009 includes several billion dollars for construction, repair and alteration of federal government-owned buildings. We do not know how expenditure of these funds will impact us. If there is a large increase in the amount of federal government-owned real estate relative to federal government-leased real estate as a consequence of this legislation or otherwise, there will be fewer opportunities to develop and own federal government build-to-suit properties. In addition, certain tenants may relocate from our properties to federal government-owned real estate. Furthermore, it may become more difficult for us to renew our federal government leases when they expire or to locate additional properties that are leased to single federal government occupants in order to grow our business. Any of these matters could materially and adversely affect us.

The federal government’s “green lease” policies may materially and adversely affect us.

In recent years, the federal government has instituted “green lease” policies which allow a government occupant to require LEED® certification in selecting new premises or renewing leases at existing premises. Obtaining such certifications and labels may be costly and time consuming, and our failure to do so may result in our competitive disadvantage in acquiring new, or retaining existing, federal government occupants. As of June 30, 2010, 65.5% of the rentable square footage of our initial properties currently in service has not yet received a LEED® certification. Obtaining such certification could result in enhanced costs not projected by us. The failure to obtain any such certification or satisfy any other “green lease” policies could materially and adversely affect us.

We face significant competition in bidding for the award of build-to-suit development leases from the federal government.

Because of the strong credit quality of the federal government, as well as the “full faith and credit” support of the long-term leases often executed for build-to-suit development, there is usually significant competition for the award of these leases. There is no guaranty that we will be awarded a lease for which we submit a bid. Furthermore, continued general economic uncertainty may increase competition for these leases. Leasing rates to the federal government typically are arrived at by projecting the recovery of the costs of construction, anticipated operating expenses, as well as the desired profit and financing structure, to arrive at the lease rates to be paid over the term of the lease. Our perception of competition for a particular development may cause us to reduce our offered lease rate for such development. If we have inaccurately estimated our costs of construction or anticipated operating expenses, among other variables, it is likely that we will have incorrectly priced our lease rates, and we could be materially and adversely affected.

We may not be able to recover pre-development costs for developments.

The federal government enters into leases for build-to-suit developments on the basis of a competitive award process. As part of that process, each bidder typically is required to locate and secure land for the proposed development, as well as prepare construction plans and engage in other pre-development activities. As such, in the intervening period between a request for proposal and the award of a lease, we may incur significant

 

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pre-development and other costs in order to compete for the award of the particular lease. Ultimately, if we are not awarded the lease, we will not be able to recoup the costs we incurred to date, and the resulting losses could be material.

Unionization or work stoppages could have an adverse effect on us.

At times, our contractors are required to use unionized construction workers or to pay the prevailing wage in a jurisdiction to such workers in connection with the construction of single-tenant federal government-leased properties for which lease awards have been made to us. Because of the labor intensive and price competitive nature of the construction business, the cost of unionization and/or prevailing wage requirements for new developments could be substantial. Unionization and prevailing wage requirements could adversely affect a new development’s profitability. Union activity or a union workforce could increase the risk of a strike or other work stoppage, which would adversely affect our ability to meet our construction timetables and the success of the development.

Federal regulations regarding any of our future large-scale acquisition or construction projects will require the use of a project labor agreement that may impact our pricing, our bids and our ability to comply with other federal regulations regarding the employment of small business contractors.

In connection with acquisition and developments of federal government-leased properties, we are required to comply with the federal regulations regarding large-scale projects. Such regulations include a requirement that (i) we develop a small business plan to ensure that we employ a certain number of small businesses during the development, construction and management of our projects, and (ii) we use a project labor agreement when required by the GSA. A project labor agreement is a pre-hire collective bargaining agreement that establishes the terms and conditions of the employment of our contractors and subcontractors for a specific project. Such an agreement may be required for any future projects that are in excess of $25 million. A project labor agreement will require, among other items that we pay a union wage to all of our contractors and subcontractors. This requirement may impede our ability to actively recruit small businesses. If our ability to actively recruit small business is impeded because of a project labor agreement, we may default on our obligations to the federal government, which may result in the termination of the subject lease and the requirement for us to pay liquidated damages and, therefore, may negatively impact our ability to obtain leases from the GSA in the future, which would materially and adversely affect us.

We are generally required to pay for all maintenance, repairs, base property taxes, utilities and insurance; amounts recoverable under our leases for increased operating costs may be less than the actual costs we incur.

Our leases generally require us to pay for maintenance, repairs, base property taxes, utilities and insurance. Although the federal government is typically obligated to pay us adjusted rent for changes in certain operating costs (e.g., the costs of cleaning services, supplies, materials, maintenance, trash removal, landscaping, water, sewer charges, heating, electricity, repairs and certain administrative expenses but not including insurance), the amount of any adjustment is based on a cost of living index rather than the actual amount of our costs. As a result, to the extent the amount payable to us based upon the cost of living adjustments does not reflect actual changes in our operating costs, our operating results could be adversely affected. Furthermore, the federal government is typically obligated to reimburse us for increases in real property taxes above a base amount but only if we provide the proper documentation in a timely manner. Notwithstanding federal government reimbursement obligations, we remain primarily responsible for the payment of all such costs and taxes.

Federal government-leased properties may have a higher risk of terrorist attack.

Because our primary tenant will be the federal government, our properties may have a higher risk of terrorist attack than similar properties that are leased to non-government tenants. Terrorist attacks may negatively affect

 

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our properties in a manner that materially and adversely affects us. We cannot assure you that there will not be further terrorist attacks against or in the United States or against the federal government. Some of our properties could be considered “high profile” government buildings, which may make these properties more likely to be viewed as terrorist targets. These attacks may directly impact the value of our properties through damage, destruction, loss or increased security costs. Certain losses resulting from these types of events are uninsurable and others may not be covered by our current terrorism insurance. Additional terrorism insurance may not be available at a reasonable price or at all.

The departure of any of our key personnel with long-standing business relationships could materially and adversely affect us.

Our future success depends, to a significant extent, upon the continued services of the members of our senior management team. In particular, the relationships that Richard Baier, the Chairman of our board of directors and our Chief Executive Officer, Daniel K. Carr, our Executive Vice President, Development, Cathleen M. Baier, our Executive Vice President, Government Operations, and other members of our senior management team have developed with the GSA, as well as with existing and prospective developers of federal government-leased properties, and their knowledge of the GSA bidding process for development of single-tenant federal government-leased properties, is critically important to the success of our business. Although we have, or will have prior to the completion of this offering, an employment agreement with each of Messrs. Baier and Carr, Ms. Baier and other members of our senior management team, we cannot assure you that any of them will remain employed with us. The loss of services of Messrs. Baier or Carr, Ms. Baier, or other members of our senior management team, or any difficulty in attracting and retaining other talented and experienced personnel (including personnel to manage the growth of our business), could materially and adversely affect us. We do not currently maintain key person life insurance on any of our officers.

One of our properties is subject to a ground lease; if we lose the right to use a property due to a breach or non-renewal of a ground lease, we could be materially and adversely affected.

Our Great Falls, Montana property is located on land owned by a third-party. Accordingly, we only own a long-term leasehold interest in the property pursuant to a ground lease, which expires in 2082. If we breach the ground lease, we could lose the right to use the property. In addition, unless we can purchase a fee interest in the underlying land and improvements or extend the terms of this ground lease before its expiration, as to which no assurance can be given, we will lose our right to use the property and our interest in the improvements made to the property (including those for which we paid) upon expiration of the lease. If we were to lose the right to use the property due to a breach or non-renewal of this ground lease, we would be unable to derive income from such property and would be required to acquire an interest in other properties to attempt to replace that income, which could materially and adversely affect us. We may acquire properties in the future that are subject to ground leases.

Our ground lease requires that we offer the ground lessor the right of first negotiation with respect to any proposed sale of our interest in the property, which could materially and adversely affect the timing and the price for any sale of the property.

The ground lease encumbering our Great Falls, Montana property contains a provision that requires us to offer the ground lessor the right of first negotiation in the event that we desire to sell that property. If the ground lessor decides to negotiate with us for a sale, we must negotiate with them for the sale of the property. If the ground lessor declines to negotiate with us, we will be entitled to seek a third-party purchaser. As a result of our compliance with this right of first negotiation, we may be delayed in our attempt to sell the Great Falls, Montana property and any such delay could materially and adversely affect our ability to sell the property when desired, as well as the sales price for the property if we are successful in finding a buyer, as to which no assurance can be given.

 

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We will not realize any increase in the value of the land or improvements subject to our ground lease, may not be able to extend any ground lease on favorable terms, or at all, and may only receive a portion of compensation paid in any eminent domain proceeding with respect to the property.

Unless we purchase a fee interest in the land and improvements subject to our ground lease, we will not have any economic interest in the land or improvements at the expiration of our ground lease and therefore we will not share in any increase in value of the land or improvements beyond the term of the ground lease, notwithstanding our capital outlay to purchase our interest in the property or fund improvements thereon and will lose our right to use the property. We may only be able to extend the terms of the ground lease on terms (including rental rate) that are substantially less favorable to us, if at all. Furthermore, if the state or federal government seizes the property subject to the ground lease under its eminent domain power, we may only be entitled to a portion of any compensation awarded for the seizure.

Our Durham, North Carolina acquisition property is encumbered by a right of first refusal with respect to any sale, lease or development of the property, which could materially and adversely affect the timing and terms of any sale, lease or development of the property.

The right of first refusal on our Durham, North Carolina acquisition property encumbers the property until March 22, 2049. We must inform the holder of the right of first refusal of any offer we receive to sell or lease the property or of our intention to develop the property. If we receive an offer to purchase or lease the property, we must give 30 days written notice of such offer to the holder of the right of first refusal during which 30 days the holder has the right to exercise its right to enter into an agreement to purchase or lease the property, as applicable, on the same terms as contained in the offer. Similarly, if we decide to develop the property, we must notify the holder of the right of first refusal, and such holder will then have 30 days to determine the fair market value of the property in accordance with a process set forth in the right of first refusal agreement. Upon completion of such 30 day period, the holder of the right of first refusal then has an additional 30 days to enter into a mutually acceptable agreement to purchase the property for such determined fair market value. As a result of the right of first refusal, we may be delayed in our attempt to sell, enter into a new lease upon expiration or early termination of the current lease or develop the Durham, North Carolina acquisition property, and any such delay could materially and adversely affect our ability to sell, lease or develop the property when any such activities are necessary or desirable, as well as the terms of any such sale, lease or development.

Under certain circumstances, the previous third-party seller of our Salt Lake City, Utah property has a right to repurchase the land, a right of first offer or a right of first refusal.

The previous third-party seller of our Salt Lake City, Utah property has the following rights in connection with the property: (i) if we fail to complete the foundation work (including obtaining any necessary permits) before March 10, 2011, then the previous third-party seller has the right to repurchase the property for the purchase price set forth in the deed; (ii) if, prior to completion of the foundation work described in clause (i), we decide to sell or transfer the Salt Lake City, Utah property or an interest in the entity that owns the Salt Lake City, Utah property, then we are required to give written notice of such intent to sell or transfer to the previous third-party seller and the previous third-party seller has 30 days to elect to repurchase the Salt Lake City, Utah property; (iii) if the previous third-party seller does not elect to exercise the right set forth in clause (ii) and if, at any time prior to completion of the foundation work described in clause (i), we desire to sell or transfer all or any portion of the Salt Lake City, Utah property or if there is a sale or transfer of any ownership interest in the entity that owns the Salt Lake City, Utah property (except with respect to the transfer of the Salt Lake City, Utah property in our formation transactions), then the previous third-party seller has an option for a period of 30 days to elect to purchase the property (or portion thereof) on the same terms as those set forth in any agreement between us and the prospective third-party purchaser. We cannot assure you that we will satisfy the conditions that would eliminate the seller’s rights described above. If the previous third-party seller repurchases the property from us, our lease with the GSA will terminate, which may negatively impact our ability to obtain leasing contracts from the GSA in the future. In addition, as a result of our compliance with these rights, we may be forced to sell our Salt Lake City, Utah property at an undesirable sales price or be delayed in our attempt to sell the property when desired.

 

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We may be unable or choose not to exercise our option to purchase the Jacksonville, Florida (VA) option property.

Our ability to exercise the option to purchase the option property is subject to completion of the facility, which is not assured. See “—Developing and redeveloping properties will expose us to additional risks beyond those associated with owning and operating federal government-leased properties and could materially and adversely affect us.” In order to acquire the land and commence and complete construction of the option property, Jacksonville VA will need to arrange for construction financing. Jacksonville VA has not yet obtained any commitment for such financing, and there can be no assurance that such financing will be obtained or that the facility will be completed as planned or at all. Additionally, certain environmental conditions at the option property have been identified. See “Business and Properties—Option Property: Jacksonville, Florida (VA).” We may choose not to exercise our option if such environmental conditions are not remediated. If we do exercise our option, no assurance can be given that past, current or future environmental conditions at the option property will not materially and adversely affect us.

Risks Related to Our Relationships with Our Contributors and Lane4 Management

The tax protection agreement with our contributors and the minority owner could limit our ability to sell or otherwise dispose of our contribution properties or make any such sale or other disposition more costly.

In connection with our formation transactions, we will enter into a tax protection agreement that will provide that if we sell or otherwise dispose of any interest in any of our contribution properties that generates more than the allowable amount (as described in the following sentence) of built-in gain for our contributors and the minority owner, as a group, in any single year through December 31, 2020, we will indemnify our contributors and the minority owner for tax liabilities incurred with respect to an aggregate built-in gain in excess of the allowable amount and tax liabilities incurred as a result of such tax protection payment. The allowable amount of built-in gain for the initial year of the tax protection agreement will equal 10% of the aggregate built-in gain on our contribution properties at the time of this offering, or approximately $1.2 million, and will increase by 10% of the aggregate built-in gain on our contribution properties in each subsequent year. As a result, the required indemnification will decrease ratably over the term of the tax protection agreement, declining to zero by the end of 2020. Therefore, although it may be in our stockholders’ best interest that we sell or otherwise dispose of one of these properties, it may be economically prohibitive, or at least more costly, for us to do so because of these obligations.

The tax protection agreement may require our operating partnership to maintain certain debt levels that otherwise would not benefit our business.

The tax protection agreement will provide that, during the period from the completion of this offering through December 31, 2020, our operating partnership will offer our contributors and the minority owner, if they continue to hold such OP units, the opportunity to guarantee an aggregate of approximately $2.5 million of our operating partnership’s debt. If we fail to make such opportunities available, we will be required to deliver to each such contributor or minority owner a cash payment intended to approximate such contributor’s or minority owner’s tax liability resulting from our failure to make such opportunities available to such contributor or minority owner, including any gross up necessary to cover any income tax incurred by such contributor or minority owner as a result of such tax protection payment. These obligations may require us to maintain more or different indebtedness than would otherwise benefit our business.

Any sale by our contributors or other members of our senior management team of ownership interests in us and speculation about such possible sales may materially and adversely affect the market price of our common stock.

Upon completion of this offering and our formation transactions, our contributors and other members of our senior management team will own an aggregate of 206,250 RSUs and an aggregate of 474,657 OP units, which collectively represents 4.7% of the outstanding shares of our common stock on a fully-diluted basis, excluding

 

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shares of our common stock, if any, issued upon exercise of the underwriters’ over-allotment option. Neither our contributors nor other members of our senior management team are prohibited from selling any shares of our common stock or securities convertible into, or exchangeable for, shares of our common stock, except that each of them has agreed (subject to certain exceptions) not to sell or transfer any such shares or securities for one year after the date of this prospectus without first obtaining the written consent of Deutsche Bank Securities Inc. and UBS Securities LLC. Any sale by our contributors or other members of our senior management team of ownership interests in us, or speculation by the press, securities analysts, stockholders or others as to their intentions, may materially and adversely affect the market price of our common stock.

We may be assuming unknown or unquantifiable liabilities, including environmental liabilities, associated with our initial properties, and such liabilities could materially and adversely affect us.

As part of our formation transactions, we will assume from our contributors, minority owner and third-party sellers existing liabilities in connection with our initial properties, some of which may be unknown or unquantifiable. These liabilities may include liabilities for undisclosed environmental conditions, tax liabilities, claims of tenants or vendors and accrued but unpaid liabilities. Our contributors and the minority owner and third-party sellers are making limited representations and warranties with respect to our contribution properties and our acquisition properties, respectively. Any unknown or unquantifiable liabilities that we assume from our contributors and the minority owner and third-party sellers in connection with our formation transactions for which we have no or limited recourse could materially and adversely affect us.

We may pursue less vigorous enforcement of the terms of our agreements with our contributors and Lane4 Management because of conflicts of interest, which could materially and adversely affect us.

We are party to agreements with our contributors for acquisition of our contribution properties as part of our formation transactions. Our contributors serve as members of our senior management team and, in the case of Richard Baier and Daniel K. Carr, as members of our board of directors. We will be entitled to indemnification and damages in the event of the breach of any representation, warranty, covenant or agreement made by our contributors pursuant to the contribution agreement. We also will enter into a tax protection agreement with our contributors. In addition, each of our contributors and other members of our senior management team will enter into an employment agreement that includes a non-competition covenant or requires as a condition of his or her respective employment that he or she enter into non-competition agreement with us.

We will enter into a property management agreement with Lane4 Management, a company majority-owned by Richard Baier, the Chairman of our board of directors and our Chief Executive Officer, and Daniel K. Carr, our Executive Vice President, Development, for management of our initial properties and any future properties that we elect to have Lane4 Management manage. Pursuant to this agreement, we will be obligated to pay Lane4 Management an annual fee equal to $0.50 per rentable square foot of each property managed by Lane4 Management subject to a maximum annual fee of 3% of any such property’s base rent (gross rent less any amortized tenant improvement costs included in gross rent); provided, however, we will be obligated to pay Lane4 Management a minimum of $1,500 per month per property. We will also be obligated to reimburse Lane4 Management for expenses that are included in each Lane4 Management managed property’s budget approved by our nominating and governance committee, and other Lane4 Management expenses that may be approved by us provided that any such other expenses that exceed $5,000 for a Lane4 Management managed property must be approved by our nominating and governance committee. We expect to pay Lane4 Management property management fees aggregating approximately $440,000 on an annualized basis in respect of our in-service initial properties (exclusive of any expense reimbursements) during the term of the property management agreement.

These agreements, including any consideration payable by us under each such agreement, were not negotiated at arm’s length, and the terms of these agreements may not be as favorable to us as if they were so negotiated. To the extent that any breach, dispute or ambiguity arises with respect to any of these agreements, we may choose not to enforce, or to enforce less vigorously, our rights under these agreements due to our ongoing relationships with our contributors and other members of our senior management team and the majority ownership of Lane4 Management by Messrs. Baier and Carr.

 

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Messrs. Baier and Carr and Ms. Baier will not devote all of their time and attention to our business, which could materially and adversely affect us.

We will enter into an option agreement with our contributors with respect to the Jacksonville, Florida (VA) property. Our contributors will oversee the development of the option property. There will be times when the development of the option property requires our contributors to devote a significant amount of their time and attention to such property. Additionally, our contributors will have a personal economic interest in the option property and therefore an incentive to devote time and attention to such property. As a result, our contributors could limit the time and attention they devote to our business, which could materially and adversely affect us.

The option agreement, including any consideration payable by us under each such agreement, was not negotiated at arm’s length, and the terms of this agreement may not be as favorable to us as if it was so negotiated. To the extent that any breach, dispute or ambiguity arises with respect to this agreement, we may choose not to enforce, or to enforce less vigorously, our rights under this agreement due to our ongoing relationships with our contributors.

Risks Related to Our Debt Financing

Our debt obligations expose us to interest rate fluctuations and the risk of default and may leave us with insufficient cash to meet our debt service requirements and repay our debt, satisfy our operational requirements, pay dividends to our stockholders (including those necessary for our qualification as a REIT) and successfully execute our growth strategy.

Upon completion of this offering and our formation transactions, our only outstanding indebtedness will be the construction loan secured by our Salt Lake City, Utah development property, which has a maximum principal amount of $16.9 million and had an outstanding balance of approximately $4.5 million as of September 15, 2010, and approximately $15.2 million of assumed debt secured by our Alpine, Texas acquisition property. The Salt Lake City, Utah construction loan bears interest at a variable rate with a current floor of 6.5% per annum, while the interest rate on the Alpine, Texas indebtedness is fixed at 5.621% per annum. We expect to incur or assume additional debt, which may include mortgage indebtedness, in connection with future developments and acquisitions other than our acquisition properties, although no assurance can be given that we will be able to obtain new debt on favorable terms or that any assumed debt will have favorable terms.

Our level of debt and the limitations imposed on us by our financing agreements could have significant adverse consequences on us, including the following:

 

   

our cash flow may be insufficient to meet our debt service requirements and repay our debt, satisfy our operational requirements, pay dividends to our stockholders (including those necessary for our qualification as a REIT) and successfully execute our growth strategy;

 

   

we may be unable to borrow additional funds on favorable terms, or at all, when needed, including to fund developments and acquisitions or pay dividends required to maintain our qualification as a REIT;

 

   

we may be unable to refinance our indebtedness at maturity or the refinancing terms may be less favorable than the terms of our original indebtedness;

 

   

we may be forced to dispose of one or more of our properties, possibly on disadvantageous terms;

 

   

our debt level could place us at a competitive disadvantage compared to our competitors with less debt;

 

   

we may experience increased vulnerability to economic and industry downturns reducing our ability to respond to changing business and economic conditions;

 

   

we may default on our obligations and the lenders or mortgagees may foreclose on our properties that secure their loans and receive an assignment of rents and leases;

 

   

a violation of restrictive covenants in our financing agreements would entitle the lenders to accelerate our debt obligations; and

 

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our default under any one of our mortgage loans with cross-default or cross-collateralization provisions could result in default on other indebtedness or result in the foreclosures of other properties.

Increases in interest rates on our future outstanding indebtedness may increase our interest expense, which would decrease our earnings and cash flows and could harm our liquidity and our ability to pay dividends to our stockholders (including those necessary for our qualification as a REIT). However, while our Salt Lake City indebtedness is subject to variable rate fluctuations, it currently bears interest at the floor rate of 6.5% and a 1.00% or 100 basis point increase in LIBOR would not increase our annual interest costs. In addition, our debt obligations expose us to the risk of default, the occurrence of which could leave us with insufficient cash to meet our debt service requirements and repay our debt, satisfy our operational requirements, pay dividends to our stockholders (including those necessary for our qualification as a REIT) and successfully execute our growth strategy. An increase in interest rates could also decrease the number of buyers willing to pay for our properties, thereby reducing the market value of our properties and limiting our ability to sell properties or to obtain mortgage financing secured by our properties. Furthermore, when market interest rates rise, the market prices of dividend-paying securities often decline, which would likely cause the market price of our common stock to decline.

Our organizational documents do not contain any leverage limitations, and, although our target leverage ratio is 50% of the undepreciated historical cost of our properties, we could decide to become more leveraged in the future, which could materially and adversely affect us.

Neither our charter or bylaws nor the partnership agreement contains any limitations on the amount or percentage of indebtedness that we may incur. Although our target leverage ratio is 50% of the undepreciated historical cost of our properties, we could alter the balance between our total outstanding indebtedness and the value of our portfolio or our market capitalization at any time. If we become more leveraged in the future, the resulting increase in debt service requirements could cause us to default on our obligations, which could materially and adversely affect us.

As a REIT, we generally will be unable to retain sufficient cash flow from operations to meet our debt service requirements and repay our debt, satisfy our operational requirements, pay dividends to our stockholders (including those necessary for our qualification as a REIT) and successfully execute our growth strategy.

We intend to elect and qualify to be taxed as a REIT for U.S. federal income tax purposes commencing with our short taxable year ending December 31, 2010. To qualify for taxation as a REIT, we will be required to distribute at least 90% of our annual REIT taxable income (excluding net capital gains and calculated without regard to the dividends paid deduction) and satisfy a number of organizational and operational requirements to which REITs are subject. Additionally, since we are a newly formed company with no previous operating history, it may be more difficult for us to raise reasonably priced capital than more established companies, many of which have established financing programs and, in some cases, have investment grade credit ratings. Accordingly, we generally will not be able to retain sufficient cash flow from operations to meet our debt service requirements and repay our debt, satisfy our operational requirements, pay dividends to our stockholders (including those necessary for our qualification as a REIT) and successfully execute our growth strategy. Therefore, we will need to raise additional capital for these purposes, and we cannot assure you that a sufficient amount of capital will be available to us on favorable terms, or at all, when needed, which would materially and adversely affect us. A significant portion of net proceeds from this offering will be used to repay debt secured by our in-service contribution properties and to fund the aggregate purchase price of our acquisition properties and, as a result, will not be available for these purposes.

 

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If we enter into a revolving credit facility and borrow funds thereunder to meet operating and financing needs or to pay dividends, we would have less available financing to fund property acquisitions and developments, which could materially and adversely affect our growth.

We may be required to borrow funds under our revolving credit facility, which we intend to enter into shortly following completion of this offering (although no assurance can be given), or otherwise, to meet our operating and financing needs or to pay dividends to our stockholders, including those necessary for our qualification as a REIT. If we borrow funds for these purposes, we would have less available financing to fund property acquisitions and developments, which could materially and adversely affect our growth.

Our inability to obtain financing on favorable terms, or at all, particularly in light of ongoing conditions in the lending and capital markets, could materially and adversely affect us.

Ongoing economic conditions have negatively impacted the lending and capital markets, particularly for real estate. The capital markets have witnessed significant adverse conditions, including a substantial reduction in the availability of, and access to, capital. The risk premium demanded by sources of capital has increased markedly, as they are demanding greater compensation for risk. Lending spreads have widened from recent levels, and underwriting standards are being tightened. In addition, recent failures and consolidations of certain financial institutions have decreased the number of potential lenders, resulting in reduced lending levels available to the market. The continuation of these market conditions, combined with the volatility in the capital markets, may limit our ability to meet our operating and financing needs, pay dividends to our stockholders (including those necessary for our qualification as a REIT) or fund property acquisitions and developments on favorable terms, or at all. We may also be forced to sell properties at inopportune times and on unfavorable terms, or we may be required to rely more heavily on additional equity issuances, which may be dilutive to our current stockholders, or on less efficient forms of debt financing. Furthermore, any financing we are able to obtain may be on terms less favorable than those previously obtained, and we cannot assure you that we would be able to make such sales, issue such equity or incur such debt. As a result of the foregoing, we could be materially and adversely affected.

The failure of a lender or counterparty to one of our financial contracts could materially and adversely affect us.

With the turmoil in the lending and capital markets, an increasing number of financial institutions have sought federal assistance or failed. In the event of a failure of a lender or counterparty to a financial contract, its obligations to us under the financial contract might not be honored and many forms of assets may be at risk and may not be fully returned to us. Should a financial institution fail to fund its committed amounts when contractually obligated to do so, our ability to meet our obligations could be negatively impacted, which could materially and adversely affect us.

The indebtedness associated with our Salt Lake City, Utah and Alpine, Texas properties contain, and any future indebtedness may contain, various covenants, and the failure to comply with those covenants could materially and adversely affect us.

The indebtedness associated with our Salt Lake City, Utah and Alpine, Texas properties contain, and any future indebtedness may contain, certain covenants, which, among other things, restrict our activities, including our ability to sell, assign, convey, transfer or otherwise dispose of or encumber the underlying property or our interest in the underlying property, or the income derived therefrom, without the consent of the holder of such indebtedness, to repay or defease such indebtedness or to engage in mergers or consolidations that result in a change in control of us. We may also be subject to financial and operating covenants. Failure to comply with any of these covenants would likely result in a default under the applicable indebtedness that would permit the acceleration of amounts due thereunder and under other indebtedness and foreclosure of properties, if any, serving as collateral therefor.

 

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Our revolving credit facility will contain covenants, and the failure to comply with those covenants could materially and adversely affect us.

We anticipate that we will enter into a $125 million three-year secured revolving credit facility shortly following completion of this offering. We expect that we will be able to use this revolving credit facility to fund acquisitions, developments, redevelopments and capital expenditures and for general corporate purposes. We have not received a commitment from the lenders for this facility and there can be no assurance that we will enter into definitive documentation with regard to this facility upon the terms described or at all. We expect that our revolving credit facility will include customary negative covenants and other financial and operating covenants. Failure to comply with any of these covenants could result in a default, would permit the lenders to accelerate the repayment of amounts due to them and could permit the acceleration of other indebtedness, any of which could materially and adversely affect us.

Secured indebtedness exposes us to the possibility of foreclosure on our current or future ownership interests in a property.

Incurring mortgage and other secured indebtedness increases our risk of loss of our current or future ownership interests in our underlying properties because defaults under such indebtedness, and the inability to refinance such indebtedness, may result in foreclosure action initiated by lenders. For tax purposes, a foreclosure of any of our properties would be treated as a sale of the property for a purchase price equal to the outstanding balance of the indebtedness secured by such property. If the outstanding balance of the indebtedness secured by such property exceeds our tax basis in the property, we would recognize taxable income on foreclosure without receiving any cash proceeds.

We are subject to risks associated with hedging agreements.

Subject to maintaining our qualifications as a REIT, we may enter into interest rate swap agreements and other interest rate hedging contracts, including caps and floors, to manage our exposure to interest rate volatility or to satisfy lender requirements. These agreements will expose us to certain risks, including a risk that the agreement’s counterparty will not perform. Moreover, there can be no assurance that the hedging agreement will qualify for hedge accounting or that our hedging activities will have the desired beneficial impact on our financial performance and liquidity. Should we choose to terminate a hedging agreement, there could be significant costs and cash requirements involved to fulfill our initial obligation under the hedging agreement.

When a hedging agreement is required under the terms of a mortgage loan, it is often a condition that the hedge counterparty agree to maintain a specified credit rating. With the current volatility in the financial markets, there is a reduced pool of eligible counterparties that are able to meet or are willing to assume these conditions, which has resulted in an increased cost for hedging agreements. This will make it more difficult and costly to enter into hedging agreements in the future. Additionally, due to the current volatility in the financial markets, there is an increased risk that hedge counterparties could have their credit rating downgraded to a level that would not be acceptable under the mortgage loan. If we were unable to renegotiate the credit rating condition with the lender or find an alternative counterparty with an acceptable credit rating, we could be in default under the mortgage loan and the lender could foreclose upon the underlying property.

Risks Related to the Real Estate Industry

Our performance is subject to risks associated with the real estate industry, and the realization of any of these risks could materially and adversely affect us.

Real property investments are subject to varying risks and market fluctuations. These events include, but are not limited to:

 

   

adverse changes in national, regional and local economic and demographic conditions;

 

   

the availability of financing, including financing necessary to extend or refinance debt maturities;

 

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the ability to control operating costs (particularly at our properties where we are not allowed to pass all or even a portion of those costs through to our tenants);

 

   

increases in tenant vacancies, difficulty in re-letting space and the need to offer tenants below-market rents or concessions;

 

   

decreases in rental rates;

 

   

increases in interest rates, which could negatively impact the ability of any non-government tenants to make rental payments;

 

   

an increase in competition for, or a decrease in demand by, tenants, especially the federal government and its agencies and departments;

 

   

the financial strength of tenants and the risk of any non-government tenant bankruptcies and lease defaults;

 

   

an increase in supply or decrease in demand of our property types;

 

   

introduction of a competitor’s property in or in close proximity to one of our properties;

 

   

the adoption on the national, state or local level of more restrictive laws and governmental regulations, including more restrictive zoning, land use or environmental regulations and increased real estate taxes;

 

   

opposition from local community or political groups with respect to the construction or operations at a property;

 

   

adverse changes in the perceptions of prospective tenants or purchasers of the attractiveness, convenience or safety of a property;

 

   

our inability to provide effective and efficient management and maintenance at our properties;

 

   

the investigation, removal or remediation of hazardous materials or toxic substances at a property;

 

   

our inability to collect rent or other receivables;

 

   

the effects of any terrorist activity;

 

   

underinsured or uninsured natural disasters, such as earthquakes, floods or hurricanes; and

 

   

our inability to obtain adequate insurance on favorable terms.

The value of our properties and our performance may decline due to the realization of risks associated with the real estate industry, which could materially and adversely affect us.

Illiquidity of real estate investments could impede our ability to change our portfolio, which could materially and adversely affect us.

Investments in real estate are relatively illiquid and our ability to promptly sell one or more properties or otherwise change our portfolio in response to changed or changing economic, financial and investment conditions is significantly limited. We cannot predict whether we will be able to sell any property for the price or on the terms we seek, if at all, or whether any price or other terms offered by a prospective purchaser would be acceptable to us. This risk may be more pronounced due to the tax protection agreement that covers our contribution properties. See “—Risks Related to Our Relationships with Our Contributors and Lane4 Management—The tax protection agreement with our contributors and the minority owner could limit our ability to sell or otherwise dispose of our contribution properties or make any such sale or other disposition more costly” above. We also cannot predict the length of time needed to find a willing purchaser and to close the sale of a property. In addition, we may be required to expend funds to correct defects or to make improvements before a property can be sold. Our inability to change our portfolio in response to adverse conditions could materially and adversely affect us.

 

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We may become subject to liability relating to environmental matters, which could materially and adversely affect us.

Under various federal, state and local environmental laws, statutes, ordinances, rules and regulations, as an owner or operator of real property, we may be liable for the costs of removal or remediation of certain hazardous or toxic substances, waste or petroleum products at, on, in, under or migrating from our properties. Similarly, as the former owner or operator of real property, we may be liable for contamination on our former properties if we owned or operated them at the time the contamination was caused. These costs could be substantial and liability under these laws may attach whether or not the owner or operator knew of, or was responsible for, the presence of such contamination. Even if more than one person may have been responsible for the contamination, each liable party may be held entirely responsible for all of the clean-up costs incurred. In addition, the government or third parties may sue the owner or operator of a property for damages based on personal injury, natural resource damages or property damage and/or for other costs, including investigation and clean-up costs, resulting from the environmental contamination. The presence of contamination on one of our properties, or the failure to properly remediate a contaminated property, could give rise to a lien in favor of the government for costs it may incur to address the contamination. Moreover, if contamination is discovered on our properties, environmental laws may impose restrictions on the manner in which a property may be used or business may be operated, and these restrictions may require substantial expenditures. Some of our properties, including our Lawrence, Massachusetts property and our Great Falls, Montana property, contain, or have contained, or are adjacent to or near other properties that have contained or currently contain, recognized environmental conditions which may cause or have caused soil contamination, ground and surface water contamination or air pollution. Similarly, some of our properties, including our Lawrence, Massachusetts property and our Great Falls, Montana property, were used in the past for commercial or industrial purposes, or are currently used for commercial purposes, that involve the use of petroleum, petroleum by-products, coal, coal ash, benzene, naphthalene, arsenic, chlorinated solvents, pesticides or other hazardous or toxic substances, or are adjacent to or near to properties that have been or are used for similar commercial or industrial purposes. These operations create a potential for the release of polycyclic aromatic hydrocarbons or other hazardous or toxic substances, and if such a release has occurred or occurs in the future, we may face liability to pay to clean up any contamination. The cost of any required remediation, removal, fines, damages for personal injury or property damages could exceed the value of the property and/or our aggregate assets. In addition, the presence of polycyclic aromatic hydrocarbons or other hazardous or toxic substances, or the failure to properly dispose of or remove those substances, may materially and adversely affect our ability to sell or rent that property or to borrow using that property as collateral. As a result of the foregoing, we could be materially and adversely affected.

From time to time, in connection with the conduct of our business, and prior to the acquisition of any property from a third party or as required by our financing sources, we may authorize the preparation of environmental site assessments with respect to our properties. The purpose of environmental site assessments is to identify the presence or likely presence of environmental contamination on the property. There can be no assurance that the environmental assessments will reveal all environmental conditions at our properties, that we will resolve all environmental conditions revealed by those assessments or that the discovery of previously unknown environmental conditions, activities of tenants and activities related to properties in the vicinity of our properties will not expose us to material liability in the future. In addition, we may acquire properties, or interests in properties, from time to time with known or potential adverse environmental conditions where we believe that the environmental liabilities associated with these conditions are quantifiable and that the acquisition will yield an attractive risk-adjusted return. Similarly, in connection with property dispositions, in addition to potential statutory liability, we may contractually agree to remain responsible for, and to bear the cost of, remediating or monitoring certain environmental conditions on the properties. We cannot assure you that our estimates will not expose us to significant additional expenditures, which could materially and adversely affect us.

Various environmental laws that regulate the handling, use and disposal of regulated substances and wastes will apply to us and our tenants. The properties in our portfolio will also be subject to various federal, state, and local health and safety requirements, such as state and local fire requirements. If we fail to comply with these

 

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various requirements, we might incur governmental fines or private damage awards. In addition, changes in laws could increase the potential for noncompliance and resulting liability. This may result in significant unanticipated expenditures or may otherwise materially and adversely affect us.

Certain environmental conditions at our Lawrence, Massachusetts and Great Falls, Montana properties have been identified.

Pursuant to a Phase I environmental site assessment prepared in April 2008, our Lawrence, Massachusetts property has several known, suspect, current and/or historical recognized environmental conditions which may be indicative of releases or threatened releases of hazardous substances to soils, ground-waters and surface-waters. Specifically, the site was historically used by Washington Mills as a gas works operation, formerly contained underground storage tanks, was formerly listed as a spill site by the Massachusetts Department of Environmental Protection for the release of fuel oil during the removal of an underground storage tank in 1989 and had previous detections of polycyclic aromatic hydrocarbons in the soil and of volatile organic compounds and benzene in the on-site groundwater. The property is currently in the final stages of an environmental regulatory closure process with the Massachusetts Department of Environmental Protection. This closure process relates to a remediation undertaken at the property during the construction of the CIS facility in which approximately 13,353 tons of soil were removed from the property and sent to off-site disposal facilities. In June 2010, two soil borings were completed at the property and several groundwater monitoring wells were installed on the property to determine whether regulatory closure was possible. According to a summary report, while the soil boring tests revealed no volatile organic compounds, one groundwater monitoring well contained an elevated concentration of the volatile organic compound tetrachloroethene. As a result of this finding, additional monitoring of the groundwater must be completed before a closure report can be filed with the Massachusetts Department of Environmental Protection. The summary report concludes that while the source of the contaminant is unknown it appears that the source is not located on the property and that additional testing may confirm that the source of this contamination is located on an upgradient property. A closure report may be filed as early as October 2010, pending the results of additional testing. Nevertheless, because of the presence of polycyclic aromatic hydrocarbons in the soils, any soil excavation and removal from the property could have high disposal costs. Additionally, if we acquire the Lawrence, Massachusetts property without the closure report being finalized, we may incur costs associated with ensuring the seller completes the closure process prior to December 30, 2010.

A Phase I environmental site assessment prepared in March 2006 identified petroleum impacted soil and groundwater on the site of our Great Falls, Montana property. Previously, underground and above ground storage tanks were removed from the property. In 2007, in connection with the construction of the courthouse located on the property, the ground lessor sought and obtained approval of a work plan regarding proposed activities to mitigate the disturbance of subsurface petroleum contamination in connection with proposed utility installations. As part of our ground lease, the ground lessor is required to comply with requirements set forth in the work plan, and we have no obligations under the work plan with respect to any remediation of the site or conformance with the obligations set forth in the work plan, although under applicable law, we may have liability for environmental conditions on the property as the operator thereof. In October of 2008, as a result of soil tests that showed concentrations of petroleum below the Tier 1 Risk-Based Screening Level of the Montana Department of Environmental Quality, a request was made to the Department for confirmation that no additional work was required to address soil contamination at the site. The Remediation Division of the Montana Department of Environmental Quality has reported to us that the ground lessor has completed all tasks requested by the Department of Environmental Quality with respect to the property. Notwithstanding the completion of these tasks, future groundwater monitoring and reporting will still be required at one well location on the property.

No assurance can be given that past, current or future environmental conditions at our Lawrence, Massachusetts or Great Falls, Montana properties will not materially and adversely affect us.

Uninsured losses or losses in excess of insured limits could materially and adversely affect us.

We will carry comprehensive general liability, fire, extended coverage, business interruption and rental loss insurance covering all of the properties in our portfolio under a blanket insurance policy, with policy specifications and insured limits customarily carried for similar properties. However, with respect to those

 

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properties where the leases do not provide for abatement of rent under any circumstances, we may not maintain loss of rent insurance. In addition, there are certain types of losses, such as losses resulting from wars, terrorism or acts of God, against which we generally do not insure because they are either uninsurable or we believe they are not economically insurable. If an uninsured loss or a loss in excess of insured limits occurs, we could lose the capital invested in a property, as well as the anticipated future revenues from a property. In addition, we may still remain obligated for any mortgage indebtedness or other financial obligations related to the property even if damage to the property was irreparable. Any loss of these types could materially and adversely affect us.

We may incur significant costs complying with the Americans with Disabilities Act and similar laws, which could materially and adversely affect us.

Under the Americans with Disabilities Act of 1990, or the ADA, all public accommodations must meet federal requirements related to access and use by disabled persons. We have not conducted an audit or investigation of our properties to determine our compliance with the ADA. If one or more of our properties were not in compliance with the ADA, we would be required to incur additional costs to bring each such property into compliance. Additional federal, state and local laws also may require modifications to our properties or restrict our ability to renovate our properties. We cannot predict the ultimate amount of the cost of compliance with the ADA or other legislation. If we incur substantial costs to comply with the ADA and any other similar laws, we could be materially and adversely affected.

Legislative or regulatory tax changes related to REITs could materially and adversely affect us and our stockholders.

There are a number of issues associated with an investment in a REIT that are related to U.S. federal income tax laws, including, but not limited to, the consequences of a company’s failing to qualify or to continue to qualify as a REIT and the tax rates applicable to REITs and their stockholders. At any time, the U.S. federal income tax laws governing REITs or the administrative interpretations of those laws may be amended or modified. Any new laws or interpretations may take effect retroactively and could materially and adversely affect us and our stockholders.

Changes in accounting rules, assumptions and/or judgments could materially and adversely affect us.

Accounting rules and interpretations for certain aspects of our operations are highly complex and involve significant assumptions and judgment. These complexities could lead to a delay in the preparation and public dissemination of our financial statements. Furthermore, changes in accounting rules and interpretations or in our accounting assumptions and/or judgments, such as asset impairments, could significantly impact our financial statements. Under any of these circumstances, we could be materially and adversely affected.

We may incur significant costs complying with various regulatory requirements, which could materially and adversely affect our financial performance and liquidity.

Our properties are subject to various federal, state and local regulatory requirements, such as state and local fire and life safety requirements. If we fail to comply with these various requirements, we could incur governmental fines or private damage awards. In addition, existing requirements could change and future requirements might require us to make significant unanticipated expenditures, which could materially and adversely affect our financial performance and liquidity.

 

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Risks Related to Our Organization, Structure and Formation

We have not obtained appraisals of our initial properties in connection with our formation transactions and the consideration that we have agreed to pay for our initial properties may exceed their individual fair market values.

We have not obtained appraisals or any other independent third-party valuations or fairness opinions with respect to our initial properties in connection with our formation transactions. The amount of consideration we have agreed to pay to our contributors and the minority owner was determined by our senior management team based on a capitalization rate analysis and an assessment of the value of our contribution properties and not as a result of arms-length negotiations. The consideration we have agreed to pay to the sellers of our acquisition properties was determined as a result of arms-length negotiation; however, there can be no assurance that the consideration to be paid for our acquisition properties would equal their appraised fair market value. Therefore, the consideration we have agreed to pay for our initial properties may exceed their fair market value.

Factors considered in determining the initial offering price of shares of our common stock include our initial property portfolio’s historical and projected operations, the strength and experience of management, our estimated net income, FFO and cash available for distribution, our growth prospects, the quality of our portfolio and the strength of our federal government tenant base and the current state of the office and federal government property sectors, the real estate industry generally and the economy as a whole. The initial public offering price of shares of our common stock was determined in consultation with the underwriters and may not necessarily bear any relationship to the book value or the fair market value of our initial properties. As a result, upon completion of this offering and our formation transactions, our value, represented by the initial public offering price of shares of our common stock, may exceed the fair market value of our initial properties. See also “—Risks Related to Our Business and Our Properties—Our acquisition properties or other future property acquisitions and development could result in disruptions to our business and strain our resources” above.

We did not conduct arm’s-length negotiations with our contributors with respect to the terms of our formation transactions and, accordingly, such terms may not be as favorable to us as if they were so negotiated.

We did not conduct arm’s-length negotiations with our contributors with respect to the terms of our formation transactions, including the terms of the agreements for the acquisition of our contribution properties, or the terms of the employment agreements with our senior management team. The terms of these agreements may not be as favorable to us as if they were so negotiated. In structuring our formation transactions (including our employment agreements), our contributors exercised significant influence on the type and level of benefits that they and our senior management team will receive from us, including the amount of cash and/or number of OP units that our contributors will receive in connection with their contribution to us of our contribution properties and the benefits our senior management team will receive from us under their employment agreements.

Certain provisions of Maryland law could inhibit a change in control of us, which, in turn, may negatively affect the market price of our common stock.

Certain provisions of the Maryland General Corporation Law, or the MGCL, may have the effect of inhibiting a third party from making a proposal to acquire us or of impeding a change in control of us under circumstances that otherwise could provide the common stockholders with the opportunity to realize a premium over the then prevailing market price of their shares, including:

 

   

“business combination” provisions of the MGCL that, subject to limitations, prohibit certain business combinations between us and an “interested stockholder” (defined generally as any person who beneficially owns 10% or more of our outstanding voting stock or an affiliate or associate of ours who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of the voting power of our outstanding voting stock) or an affiliate thereof for five years after the

 

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most recent date on which the stockholder becomes an interested stockholder and, thereafter, imposes special appraisal rights and special stockholder voting requirements on these combinations. These provisions of the MGCL do not apply, however, to business combinations that are approved or exempted by the board of directors of a real estate investment trust prior to the time that the interested stockholder becomes an interested stockholder. Pursuant to the statute, our board of directors has by resolution exempted business combinations between us and any other person. This resolution, however, may be altered or repealed in whole or in part at any time. If this resolution is altered or repealed, this statute may discourage others from trying to acquire control of us and increase the difficulty of consummating any offer. See “Material Provisions of Maryland Law and of Our Charter and Bylaws—Business Combinations.”

 

   

“control share acquisition” provisions of the MGCL that provide that “control shares” of our company (defined as shares which, when aggregated with all other shares controlled by the stockholder, entitle the stockholder to exercise voting power in the election of directors within one of three increasing ranges) acquired in a “control share acquisition” (defined as the acquisition of ownership or control of issued and outstanding “control shares,” subject to certain exceptions) have no voting rights except to the extent approved by our stockholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter, excluding votes entitled to be cast by the acquirer of control shares, our officers and our directors who are also our employees. Our bylaws contain a provision exempting from the control share acquisition statute any and all acquisitions by any person of our stock. There can be no assurance that we will not amend or eliminate this provision at any time in the future. See “Material Provisions of Maryland Law and of Our Charter and Bylaws—Control Share Acquisitions.”

 

   

“unsolicited takeover” provisions in Title 3, Subtitle 8, of the MGCL that permit our board of directors, without stockholder approval and regardless of what is currently provided in our charter or bylaws, to implement certain provisions if we have a class of equity securities registered under the Securities Exchange Act of 1934, as amended, or the Exchange Act, which we will have upon completion of this offering, and at least three independent directors. These provisions may have the effect of inhibiting a third party from making an acquisition proposal for us or of delaying, deferring or preventing a change in control of us under circumstances that otherwise could provide the common stockholders with the opportunity to realize a premium over the then current market price. See “Material Provisions of Maryland Law and of Our Charter and Bylaws—Other Anti-Takeover Provisions of Maryland Law.”

Termination of the employment agreements with the members of our senior management team could be costly and prevent a change in control of our company.

We will enter into an employment agreement with each member of our senior management team that provides such member with severance benefits if his or her employment ends as a result of a termination by us without cause. Each such member also has the right to terminate his or her employment agreement for good reason, which includes a change in control. In the case of either such termination, the vesting of his or her RSUs will accelerate. These provisions make it costly to terminate their employment and could delay or prevent a transaction or a change in control of our company that might involve a premium paid for shares of our common stock or otherwise be in the best interests of our stockholders.

Our charter contains provisions that make removal of our directors difficult, which could make it difficult for our stockholders to effect changes to our management.

Our charter provides that, subject to the rights of holders of any series of shares of our preferred stock, a director may be removed only for “cause” (as defined in our charter), and then only by the affirmative vote of at least two-thirds of the votes entitled to be cast generally in the election of directors. Vacancies may be filled only by a majority of the remaining directors in office, even if less than a quorum, for the full remaining term and until their successors are duly elected and qualified. These requirements make it more difficult to change our management by removing and replacing directors and may prevent a change in control of us that is in the best interests of our stockholders.

 

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Our board of directors may create and issue a class or series of shares of our preferred stock without stockholder approval, which may prevent a change in control of us.

Our charter authorizes us to issue additional authorized but unissued shares of our common stock and shares of our preferred stock. In addition, our board of directors may, without stockholder approval, increase the aggregate number of authorized shares of our stock or any class or series thereof, classify or reclassify any unissued shares of our common stock or preferred stock and set the preferences, rights and other terms of the classified or reclassified shares. As a result, among other things, our board of directors may establish a class or series of our common stock or preferred stock that could delay or prevent a transaction or a change in control of us that might involve a premium price for shares of our common stock or otherwise be in the best interests of our stockholders.

Our rights and the rights of our stockholders to take action against our directors and officers are limited, which could limit your recourse in the event of actions taken that are not in your best interest.

Our charter eliminates the liability of our present and former directors and officers to us and our stockholders for money damages to the maximum extent permitted under Maryland law. Under current Maryland law, our present and former directors and officers will not have any liability to us or our stockholders for money damages other than liability resulting from (1) actual receipt of an improper benefit or profit in money, property or services or (2) active and deliberate dishonesty by the director or officer that was established by a final judgment and is material to the cause of action.

Our charter authorizes us, and our bylaws require us, to indemnify our present and former directors and officers for actions taken by them in those capacities to the maximum extent permitted by Maryland law in the defense of any proceeding to which he or she is made, or threatened to be made, a party by reason of his or her service to us.

As a result, we and our stockholders may have limited rights against our present and former directors and officers, which could limit your recourse in the event of actions taken that are not in your best interest.

Our charter generally does not permit ownership in excess of 9.8% of shares of our common stock or 9.8% of shares of our stock, which may delay or prevent a change in control of us.

In order for us to qualify as a REIT under the Code, not more than 50% in value of our outstanding shares of stock may be owned, directly or indirectly, by five or fewer individuals (as defined in the Code to include certain entities) at any time during the last half of each taxable year after our first taxable year. Our charter, with certain exceptions, authorizes our board of directors to take the actions that are necessary and desirable for our qualification as a REIT. Under our charter, no person may own more than 9.8% by number of shares or value, whichever is more restrictive, of outstanding shares of our common stock or more than 9.8% by value of our outstanding shares of stock. However, our board of directors may, in its sole discretion, grant an exemption to the stock ownership limits, subject to certain conditions, representations and undertakings. In addition, our board of directors may change the stock ownership limits as described under “Description of Stock—Restrictions on Ownership and Transfer.” Our charter also prohibits any person from (1) beneficially or constructively owning, as determined by applying certain attribution rules of the Code, our shares that would result in us being “closely held” under Section 856(h) of the Code or that would otherwise cause us to fail to qualify as a REIT or (2) transferring shares if such transfer would result in our shares being owned by fewer than 100 persons. The stock ownership limits applicable to us that are imposed by tax law are based upon direct or indirect ownership by “individuals,” which term includes certain entities. Ownership limitations are common in the organizational documents of REITs and are intended to provide added assurance of compliance with tax law requirements and to minimize administrative burdens. However, the stock ownership limits might also delay or prevent a transaction or a change in control of us that might involve a premium price for shares of our common stock or otherwise be in the best interests of our stockholders.

 

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Our board of directors may from time to time increase certain of the stock ownership limits for one or more persons and may increase or decrease such limits for all other persons. Any decrease in the stock ownership limits generally applicable to all stockholders will not be effective for any person whose percentage ownership of shares of our stock is in excess of such decreased limits until such time as such person’s percentage ownership of shares of our stock equals or falls below such decreased limits, but any further acquisition of shares of our stock in excess of such person’s percentage ownership of shares of our stock will be in violation of the applicable limits. Our board of directors may not increase these limits (whether for one person or all stockholders) if such increase would allow five or fewer persons to beneficially own more than 49.9% in value of our outstanding stock or otherwise cause us to fail to qualify as a REIT.

Our charter’s constructive ownership rules are complex and may cause the outstanding shares of our stock owned by a group of related individuals or entities to be deemed to be constructively owned by one individual or entity. As a result, the acquisition of less than these percentages of the outstanding shares of our stock by an individual or entity could cause that individual or entity to own constructively in excess of these percentages of the outstanding shares of our stock and thus violate the stock ownership limits. Our charter also provides that any attempt to own or transfer shares of our common stock or preferred stock (if and when issued) in excess of the stock ownership limits without the consent of our board of directors or in a manner that would cause us to be “closely held” under Section 856(h) of the Code (without regard to whether the shares are held during the last half of a taxable year) will result in the shares being deemed to be transferred to a trustee for a charitable trust or, if the transfer to the charitable trust is not automatically effective to prevent a violation of the stock ownership limits or the restrictions on ownership and transfer of shares of our stock, any such transfer of shares will be void.

We have fiduciary duties as sole general partner of our operating partnership which may result in conflicts of interest in representing your interests as stockholders of our company.

Upon completion of this offering, conflicts of interest could arise in the future as a result of the relationship between us, on the one hand, and our operating partnership or any partner thereof, on the other. We, as the sole general partner of our operating partnership, will have fiduciary duties to the other limited partners in our operating partnership under Delaware law. At the same time, our directors and officers have duties to our company and our stockholders under applicable Maryland law in connection with their management of our company. Our duties as the sole general partner of our operating partnership may come in conflict with the duties of our directors and officers to our company and our stockholders. For example, those persons holding OP units will have the right to vote on certain amendments to the partnership agreement (which require approval by a majority in interest of the limited partners, including us) and individually to approve certain amendments that would adversely affect their rights. These voting rights may be exercised in a manner that conflicts with the interests of our stockholders. We are unable to modify the rights of limited partners to receive distributions as set forth in the partnership agreement in a manner that adversely affects their rights without their consent, even though such modification might be in the best interest of our stockholders. In the event that a conflict of interest exists between the interests of our stockholders, on one hand, and the interests of the limited partners (including our contributors), on the other, we will endeavor in good faith to resolve the conflict in a manner not adverse to either our stockholders or the limited partners; provided, however, that for so long as we own a controlling interest in our operating partnership, we have agreed to resolve any conflict that cannot be resolved in a manner not adverse to either our stockholders or the limited partners in favor of our stockholders. The limited partners of our operating partnership will expressly acknowledge that in the event of such a determination by us, as the sole general partner of our operating partnership, we will not be liable to the limited partners for losses sustained or benefits not realized in connection with such a determination.

Our board of directors has approved very broad investment guidelines for our company and will not review or approve each investment decision made by our senior management team.

Our senior management team is authorized to follow broad investment guidelines and, therefore, has great latitude in determining the types of properties that are proper investments for us, as well as the individual

 

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investment decisions. Our senior management team may make investments with lower rates of return than those anticipated under current market conditions and/or may make investments with greater risks to achieve those anticipated returns. Our senior management team has the right to pursue acquisitions and developments without the review or approval of our board of directors other than acquisitions exceeding $50 million in purchase price and development projects exceeding $50 million in total estimated costs

We may change our operational policies, investment guidelines and our business and growth strategies without stockholder consent, which may subject us to different and more significant risks in the future.

Our board of directors determines our operational policies, investment guidelines and our business and growth strategies. Our board of directors may make changes to, or approve transactions that deviate from, those policies, guidelines and strategies without a vote of, or notice to, our stockholders. This could result in us conducting operational matters, making investments or pursuing different business or growth strategies than those contemplated in this prospectus. Under any of these circumstances, we may expose ourselves to different and more significant risks in the future, which could materially and adversely affect our business and growth.

We will be subject to the requirements of Section 302 and 404 of the Sarbanes-Oxley Act of 2002, which may be costly and challenging.

Our management will be required to deliver a report that assesses the effectiveness of our internal control over financial reporting, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, as of December 31 subsequent to the year in which the registration statement of which this prospectus forms a part becomes effective. Section 404 of the Sarbanes-Oxley Act of 2002 requires our independent registered public accounting firm to deliver an attestation report on the effectiveness of our internal control over financial reporting in conjunction with their opinion on our audited financial statements as of the same date. Substantial work on our part is required to implement appropriate processes, document the system of internal control over key processes, assess their design, remediate any deficiencies identified and test their operation. This process is expected to be both costly and challenging, and it will require us to recruit, hire and retain additional accounting staff. We cannot give any assurances that material weaknesses or significant deficiencies will not be identified in connection with our compliance with the provisions of Sections 302 and 404 of the Sarbanes-Oxley Act of 2002. The existence of any material weakness would preclude a conclusion by us and our independent registered public accounting firm that we maintained effective internal control over financial reporting. We may be required to devote significant time and incur significant expense to remediate any material weaknesses or significant deficiency that may be discovered and may not be able to remediate any material weaknesses or significant deficiency in a timely manner. The existence of any material weakness or significant deficiency in our internal control over financial reporting could also result in errors in our financial statements that could require us to restate our financial statements, cause us to fail to meet our reporting obligations and cause stockholders to lose confidence in the reliability of our reported financial information, all of which could lead to a substantial decline in the market price of our common stock.

Our predecessor maintained its accounting records on a cash basis and did not prepare financial statements relative to its assets or operations. Consequently, it was necessary to convert our predecessor’s accounting records from a cash basis to an accrual basis of accounting in preparing our predecessor’s financial statements. In the course of the audit of our predecessor’s financial statements, it became necessary to prepare and record adjustments to account balances that were identified as a result of the audit process itself. Because these adjustments might have been otherwise misapplied had it not been for the audit process, our auditors determined there was a material weakness in the internal control over financial reporting of our predecessor.

Prior to completion of this offering, we have not been required to operate in compliance with the foregoing requirements of the Sarbanes-Oxley Act of 2002. We will be required to hire additional staff and design and implement additional controls in order to comply with these requirements. We intend to bring our operations into compliance with Section 404 the Sarbanes-Oxley Act of 2002 by December 31, 2011, but there can be no assurance that such compliance will be achieved or maintained.

 

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Risks Related to Our Taxation as a REIT

Our failure to qualify as a REIT would result in higher taxes and reduced cash available for distribution to our stockholders.

We intend to elect to be taxed as a REIT for federal income tax purposes commencing with our short taxable year ending December 31, 2010. However, qualification as a REIT involves the application of highly technical and complex provisions of the Code, for which only a limited number of judicial and administrative interpretations exist. Even an inadvertent or technical mistake could jeopardize our REIT qualification. Our qualification as a REIT will depend on our satisfaction of certain asset, income, organizational, distribution, stockholder ownership and other requirements on a continuing basis.

Moreover, new tax legislation, administrative guidance or court decisions, in each instance potentially applicable with retroactive effect, could make it more difficult or impossible for us to qualify as a REIT. If we were to fail to qualify as a REIT in any taxable year, we would be subject to federal income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates, and distributions to stockholders would not be deductible by us in computing our taxable income. Any such corporate tax liability could be substantial and would reduce the amount of cash available for distribution to our stockholders, which in turn could have an adverse impact on the value of our capital stock. If, for any reason, we failed to qualify as a REIT and we were not entitled to relief under certain Code provisions, we would be unable to elect REIT status for the four taxable years following the year during which we ceased to so qualify.

Failure to make required distributions would subject us to tax, which would reduce the cash available for distribution to our stockholders.

To qualify as a REIT, we must distribute to our stockholders each calendar year at least 90% of our REIT taxable income (including certain items of non-cash income), determined without regard to the deduction for dividends paid and excluding net capital gain. 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 income. In addition, we will incur a 4% nondeductible excise tax on the amount, if any, by which our distributions in any calendar year are less than the sum of:

 

   

85% of our REIT ordinary income for that year;

 

   

95% of our REIT capital gain net income for that year; and

 

   

any undistributed taxable income from prior years.

We intend to distribute our net taxable income to our stockholders in a manner intended to satisfy the 90% distribution requirement and to avoid both corporate income tax and the 4% nondeductible excise tax. However, if we form a taxable REIT subsidiary, or TRS, in the future, there is no requirement that a TRS distribute its after tax net income to its parent REIT or its stockholders.

Our taxable income may substantially exceed our net income as determined based on GAAP, because, for example, realized capital losses will be deducted in determining our GAAP net income, but may not be deductible in computing our taxable income. Differences in timing between the recognition of income and the related cash receipts or the effect of required debt amortization payments could require us to borrow money or sell assets at prices or at times that we regard as unfavorable or make taxable distributions of our capital stock or debt securities in order to pay out enough of our taxable income to satisfy the distribution requirement and to avoid corporate income tax and the 4% nondeductible excise tax in a particular year.

Complying with REIT requirements may cause us to forego otherwise attractive opportunities or liquidate otherwise attractive investments.

To qualify as a REIT for federal income tax purposes, we must continually satisfy tests concerning, among other things, the sources of our income, the nature and diversification of our assets, the amounts we distribute to

 

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our stockholders and the ownership of our capital stock. In order to meet these tests, we may be required to forego investments we might otherwise make. Thus, compliance with the REIT requirements may hinder our performance.

In particular, we must ensure that at the end of each calendar quarter, at least 75% of the value of our assets consists of cash, cash items, government securities and qualified real estate assets. The remainder of our investment in securities (other than government securities and qualified real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our assets (other than government securities and qualified real estate assets) can consist of the securities of any one issuer, and no more than 25% of the value of our total assets can be represented by the securities of one or more TRSs. If we fail to comply with these requirements at the end of any calendar quarter, we must correct the failure within 30 days after the end of the calendar quarter or qualify for certain statutory relief provisions to avoid losing our REIT qualification and suffering adverse tax consequences. As a result, we may be required to liquidate otherwise attractive investments. These actions could have the effect of reducing our income and amounts available for distribution to our stockholders.

The stock ownership restrictions of the Code applicable to REITs and the 9.8% stock ownership limit in our charter may inhibit market activity in our capital stock and restrict our business combination opportunities.

In order to qualify as a REIT for each taxable year after 2010, five or fewer individuals, as defined in the Code, may not own, actually or constructively, more than 50% in value of our issued and outstanding stock at any time during the last half of a taxable year. Attribution rules in the Code determine if any individual or entity actually or constructively owns our capital stock under this requirement. Additionally, at least 100 persons must beneficially own our capital stock during at least 335 days of a taxable year for each taxable year after 2010. To help insure that we meet these tests, our charter restricts the acquisition and ownership of shares of our capital stock.

Our charter, with certain exceptions, authorizes our directors to take such actions as are necessary and desirable to preserve our qualification as a REIT. Unless exempted by our board of directors, our charter prohibits any person from beneficially or constructively owning more than 9.8% (in value or in number of shares, whichever is more restrictive) of the outstanding shares of our common stock or 9.8% of the value of our outstanding stock. Our board of directors may not grant an exemption from these restrictions to any proposed transferee whose ownership in excess of 9.8% of the value of our outstanding shares would cause us to lose our status as a REIT. These restrictions on transferability and ownership will not apply, however, if our board of directors determines that it is no longer in our best interest to continue to qualify as a REIT.

These ownership limits could delay or prevent a transaction or a change in control that might involve a premium price for our common stock or otherwise be in the best interest of the stockholders.

Under recently issued Internal Revenue Service, or IRS, guidance, we may pay taxable dividends of our common stock and cash, in which case stockholders may sell shares of our common stock to pay tax on such dividends, placing downward pressure on the market price of our common stock.

Under recently issued IRS guidance, we may distribute taxable dividends that are payable in cash and common stock at the election of each stockholder. Under Revenue Procedure 2010-12, up to 90% of any such taxable dividend paid with respect to our 2010 and 2011 taxable years could be payable in shares of our common stock. Taxable stockholders receiving such dividends will be required to include the full amount of the dividend as ordinary income to the extent of our current and accumulated earnings and profits, as determined for federal income tax purposes. As a result, stockholders may be required to pay income tax with respect to such dividends in excess of the cash dividends received. If a U.S. stockholder sells the common stock that it receives as a dividend in order to pay this tax, the sales proceeds may be less than the amount included in income with respect

 

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to the dividend, depending on the market price of our common stock at the time of the sale. Furthermore, with respect to certain non-U.S. stockholders, we may be required to withhold U.S. federal income tax with respect to such dividends, including in respect of all or a portion of such dividend that is payable in common stock. If we utilize Revenue Procedure 2010-12 and a significant number of our stockholders determine to sell shares of our common stock in order to pay taxes owed on dividends, it may put downward pressure on the trading price of our common stock. We do not currently intend to utilize Revenue Procedure 2010-12.

The ability of our board of directors to revoke our REIT qualification without stockholder approval may cause adverse consequences to our stockholders.

Our charter provides that our board of directors may revoke or otherwise terminate our REIT election, without the approval of our stockholders, if it determines that it is no longer in our best interest to continue to qualify as a REIT. If we cease to qualify as a REIT, we would become subject to federal income tax on our taxable income and would no longer be required to distribute most of our taxable income to our stockholders, which may have adverse consequences on our total return to our stockholders.

The prohibited transactions tax may limit our ability to engage in transactions, including dispositions of assets, that would be treated as sales for federal income tax purposes.

A REIT’s net income from prohibited transactions is subject to a 100% tax. In general, prohibited transactions are sales or other dispositions of property, other than foreclosure property, held primarily for sale to customers in the ordinary course of business. We may be subject to the prohibited transaction tax upon a disposition of real property. Although a safe harbor to the characterization of the sale of real property by a REIT as a prohibited transaction is available, we cannot assure you that we can comply with the safe harbor or that we will avoid owning property that may be characterized as held primarily for sale to customers in the ordinary course of business. Consequently, we may choose not to engage in certain sales of real property or may conduct such sales through a TRS.

Complying with the REIT requirements may limit our ability to hedge risk effectively.

The REIT provisions of the Code may limit our ability to hedge our liabilities effectively. In general, income from hedging transactions does not constitute qualifying income for purposes of the 75% and 95% gross income tests applicable to REITs. To the extent, however, that we enter into a hedging contract to reduce interest rate risk or foreign currency risk on indebtedness incurred to acquire or carry real estate assets, any income that we derive from the contract would be excluded from gross income for purposes of calculating the REIT 75% and 95% gross income tests if specified requirements are met. As a result, any income from non-qualifying hedges and other income not generated from qualifying real estate assets is limited to 25% or less of our gross income. In addition, we must limit our aggregate gross income from non-qualifying hedges, fees, and certain other non-qualifying sources to 5% or less of our annual gross income. Consequently, we may have to limit our use of advantageous hedging techniques or implement those hedges through a TRS. This could increase the cost of our hedging activities because a TRS would be subject to tax on gains, or leave us exposed to greater risks associated with changes in interest rates than we would otherwise want to bear.

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

At any time, the federal income tax laws governing REITs or the administrative interpretations of those laws may be amended. We cannot predict when or if any new federal income tax law, regulation, or administrative interpretation, or any amendment to any existing federal income tax law, regulation or administrative interpretation, will be adopted, promulgated or become effective and any such law, regulation, or interpretation may take effect retroactively. We and our stockholders could be adversely affected by any such change in, or any new, federal income tax law, regulation or administrative interpretation.

 

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

The maximum tax rate applicable to income from “qualified dividends” payable to U.S. stockholders that are individuals, trusts and estates has been reduced by legislation to 15% (for taxable years beginning on or before December 31, 2010). Dividends payable by REITs, however, generally are not eligible for the reduced rates. The more favorable rates applicable to regular corporate qualified dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the shares of REITs, including our common stock.

Risks Related to this Offering

Our ability to pay our estimated initial annual dividend, which represents approximately 101% of our estimated cash available for distribution for the twelve months ending June 30, 2011, depends on our future operating cash flow, and we expect to be required to fund a portion of our estimated initial annual dividend through borrowings or equity issuances, and we cannot assure you that we will be able to obtain such funding on attractive terms or at all, in which case we plan to use a portion of the remaining net proceeds from this offering for such funding, which would make such amounts unavailable for our future development and acquisition properties, or to fund such dividend in the form of shares of common stock or to eliminate or otherwise reduce such dividend.

We generally must distribute at least 90% of our REIT taxable income each year (subject to certain adjustments) to our stockholders in order to qualify as a REIT under the Code. We intend to pay cash dividends to our stockholders on a quarterly basis. We intend to pay a pro rata dividend with respect to the period commencing on completion of this offering and ending on December 31, 2010 based on $0.25 per share for a full quarter. On an annualized basis, this would be $1.00 per share, or an annual dividend rate of approximately 5.0% based on the mid-point of the price range set forth on the cover page of this prospectus. Our estimated initial annual dividend per share represents approximately 101% of our estimated cash available for distribution for the twelve months ending June 30, 2011, calculated as described more fully under “Distribution Policy.” Accordingly, we expect that we will be unable to pay our estimated initial annual dividend out of our estimated cash available for distribution for the twelve months ending June 30, 2011. Unless our operating cash flow increases in the future, we will be required to fund approximately $0.2 million of our estimated initial annual dividend through borrowings or equity issuances, and we cannot assure you that we will be able to obtain such funding on attractive terms or at all, in which case we plan to use a portion of the remaining net proceeds from this offering for such funding, which would make such amounts unavailable for our future development and acquisition of properties, or to fund such dividend in the form of shares of common stock or to eliminate or otherwise reduce such dividend.

We intend to maintain our initial dividend rate per share for the twelve-month period following completion of this offering unless our financial condition, cash flows, liquidity, FFO, results of operations or prospects, economic conditions or other factors differ materially from the assumptions used in projecting our initial dividend rate. However, although we anticipate initially making quarterly dividends to our common stockholders, the timing, form and amount of any dividends will be at the sole discretion of our board of directors and will depend upon a number of factors, as to which no assurance can be given. We do not intend to reduce our initial dividend rate per share if the underwriters exercise their over-allotment option.

We may, under certain circumstances, particularly when we are required to report taxable income in advance of the receipt of related cash, pay a dividend only partly in cash and partly as a taxable distribution of shares of our common stock as part of a distribution in which common stockholders may elect to receive shares of our common stock or (subject to a limit measured as a percentage of the total dividend) cash, or in a form other than cash. Among the factors that could impair our ability to pay dividends to our common stockholders are:

 

   

reductions in cash flow resulting from non-government tenants’ failure to pay their rent obligations to us or our failure to renew leases or re-let space upon expiration or termination of leases;

 

   

unanticipated expenses that reduce our cash flow;

 

   

increases in interest rates;

 

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variances between actual and anticipated operating expenses; and

 

   

the need to reduce our leverage.

In addition, any dividends that we do pay to our common stockholders will generally be taxable to our stockholders as ordinary income. However, a portion of our dividends may be designated by us as long-term capital gains to the extent that they are attributable to capital gain income recognized by us or may constitute a return of capital to the extent that they exceed our earnings and profits as determined for tax purposes. A return of capital is not taxable, but has the effect of reducing the basis of a stockholder’s investment in shares of our common stock.

As a result, no assurance can be given that we will pay dividends to our common stockholders at any time or in any particular form in the future or that the level of any dividends we do pay to our common stockholders will be consistent with our anticipated initial annual dividend rate or will increase or even be maintained over time, or achieve a market yield. Any of the foregoing could materially and adversely affect us and the market price of our common stock.

There is currently no public market for our common stock and an active trading market for our common stock may not develop or continue following this offering, which would negatively affect the market price of our common stock and make it more difficult for you to sell your shares on favorable terms, or at all.

Prior to this offering, there was no public market for our common stock. Although our common stock has been approved for listing on the NYSE under the symbol “USFP,” subject to official notice of issuance, no assurance can be given as to:

 

   

the likelihood that an active trading market for our common stock will develop or, if one develops, be maintained;

 

   

the liquidity of any market for our common stock;

 

   

the ability of our stockholders to sell shares of our common stock when desired, or at all; or

 

   

the price, if any, that a stockholder may obtain for the sale of such stockholder’s shares of our common stock.

Even if there is an active trading market for our common stock, the market price for our common stock may be highly volatile and subject to wide fluctuations. Some of the factors that could negatively affect our common stock price include, without limitation:

 

   

actual or projected financial condition, cash flows, liquidity, FFO or results of operations;

 

   

actual or anticipated changes in our and any non-government tenants’ businesses or prospects;

 

   

our ability to successfully execute our growth strategy;

 

   

general market and local, regional and national economic conditions;

 

   

legislative or regulatory changes affecting the GSA or other governmental authorities;

 

   

the current state of the lending and capital markets, and our ability and the ability of any non-government tenants to obtain financing;

 

   

actual or perceived conflicts of interest with our contributors and their affiliated entities and individuals;

 

   

equity issuances by us (including the issuances of OP units), or resales of our common stock by our equity holders (including our contributors), or the perception that such issuances or resales may occur;

 

   

increased competition for single-tenant federal government-leased properties;

 

   

publication of research reports about us, the office sector, any non-government office tenants or the real estate industry;

 

   

our failure to meet, or the lowering of, our earnings estimates or those of any securities analysts;

 

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increases in market interest rates, which may lead investors to demand a higher dividend yield for shares of our common stock, and would result in increased interest expenses on our debt;

 

   

changes in market valuations of similar companies;

 

   

adverse market reaction to the level of leverage we employ;

 

   

failure to maintain our REIT qualification;

 

   

failure to satisfy the listing requirements of the NYSE;

 

   

additions or departures of key personnel, including members of our senior management team;

 

   

actions by significant stockholders, particularly our contributors;

 

   

speculation in the press or investment community;

 

   

price and volume fluctuations in the stock market generally;

 

   

actual, potential or perceived accounting problems;

 

   

failure to comply with the requirements of the Sarbanes-Oxley Act of 2002;

 

   

changes in current or proposed legislation; and

 

   

other events or circumstances which undermine confidence in the financial markets or otherwise have a broad impact on financial markets, such as the sudden instability or collapse of large financial institutions or other significant corporations, terrorist attacks, natural or man-made disasters or threatened or actual armed conflicts.

No assurance can be given that the market price of our common stock will not fluctuate or decline significantly in the future or that our common stockholders will be able to sell their shares when desired on favorable terms, or at all.

Future incurrence of debt, which would rank senior to our common stock upon our liquidation, and future issuances of equity securities (including OP units), which could dilute our existing common stockholders and may be senior to our common stock for the purposes of making distributions, periodically or upon liquidation, may negatively affect the market price of our common stock.

In the future, we may incur debt, in the form of debt securities, secured and unsecured loans and other borrowings, or issue equity securities, including shares of our common stock and OP units as consideration for acquisitions. Upon liquidation, holders of our debt and shares of our preferred stock would receive a distribution of our available assets before common stockholders. We are not required to offer any such additional debt or equity securities to existing stockholders on a preemptive basis. Additional common stock issuances, directly or through convertible or exchangeable securities (including OP units), warrants or options, would dilute the holdings of our existing common stockholders unless any proceeds from such issuances were used in a manner that was accretive, as to which no assurance can be given, and could make subsequent common stock issuances more difficult to execute successfully, or at all. Any series or class of our preferred stock, if issued, would likely have a preference on dividend payments, periodically or upon liquidation, which could eliminate or otherwise limit our ability to pay dividends to common stockholders. Because our decision to incur debt or issue equity securities in the future will depend, in part, on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing, nature or success of our future capital raising efforts. Thus, common stockholders bear the risk that our future incurrence or issuance, or even the perception of our future incurrence or issuance, of debt or equity securities will negatively affect the market price of our common stock.

Subject to applicable law, our board of directors has the authority, without further stockholder approval, to issue additional shares of our common stock and preferred stock or to incur debt on the terms and for the consideration it deems appropriate.

 

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A significant number of shares of our common stock will be available for resale upon completion of this offering and our formation transactions, which could negatively affect the market price of our common stock.

Upon completion of this offering and our formation transactions, we will have 14,452,694 shares of our common stock outstanding on a fully-diluted basis, including an aggregate of 491,444 OP units issued to our contributors and the minority owner in exchange for their respective ownership interests in our contribution properties, an aggregate of 206,250 RSUs granted to our senior management team and an aggregate of 5,000 restricted shares of our common stock granted to our independent directors under our long term incentive plan, or 16,515,194 shares of our common stock outstanding on a fully diluted basis if the underwriters’ over-allotment option is exercised in full. Additionally, in the future we may issue up to a maximum of 788,750 shares of our common stock in connection with awards under our long term incentive plan to our directors, executive officers and other employees. Our contributors, the other members of our senior management team, the minority owner and our directors have agreed, subject to certain exceptions, not to offer, sell, contract to sell or otherwise dispose of, or enter into any transaction that is designed, or could reasonably be expected, to result in the disposition of any shares of our common stock or securities convertible into, or exchangeable or exercisable for, shares of our common stock (including OP units) or derivatives of our common stock for a period of one year after the date of this prospectus without the prior written consent of Deutsche Bank Securities Inc. and UBS Securities LLC. These consents may be given at any time without public notice. We have entered into a similar agreement with the underwriters except that without such consents we may grant options and sell shares of our common stock pursuant to our long term incentive plan and sell shares of our common stock pursuant to the exercise of option awards granted pursuant to our long term incentive plan, and we may issue a limited amount of shares of our common stock in connection with an acquisition, strategic partnership or joint venture or collaboration, all of which shall also be subject to the above-described restrictions.

We will enter into a registration rights agreement with our contributors and the minority owner pursuant to which we will agree, among other things, to register the resale of any shares of our common stock that are exchanged for OP units issued to them as part of our formation transactions. These registration rights require us to seek to register all shares of our common stock that may be exchanged for OP units effective as of that date which is one year following completion of this offering on a “shelf” registration statement under the Securities Act. We will also grant such holders the right to include such shares of our common stock in any registration statements we may file in connection with any future public equity offerings, subject to the terms of the lockup arrangements described herein and subject to the right of the underwriters of those offerings to reduce the total number of such shares of our common stock to be sold by selling stockholders in those offerings.

In addition, prior to completion of this offering, we intend to file a registration statement on Form S-8 to register the total number of shares of our common stock that may be issued under our long term incentive plan. See “Shares Eligible for Future Sale—Registration Rights.”

After completion of this offering, we may issue additional shares of our common stock and securities convertible into, or exchangeable or exercisable for, shares of our common stock under our long term incentive plan. Subject to the terms of the lockup agreements described above, we also may issue from time to time additional shares of our common stock or OP units in connection with property, portfolio or business acquisitions and may grant additional demand or piggyback registration rights in connection with such issuances.

Resales, or the perception of resales, of our equity securities may negatively affect the market price for our common stock.

Purchasers of shares of our common stock in this offering will experience immediate and substantial dilution from the purchase of the shares of our common stock sold in this offering.

The initial public offering price of shares of our common stock in this offering is substantially higher than what our pro forma net tangible book value per share will be immediately after this offering. Purchasers of shares

 

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of our common stock in this offering will incur immediate dilution of approximately $3.75 in our pro forma net tangible book value per share, based on the mid-point of the price range set forth on the cover page of this prospectus, or $3.46 per share if the underwriters exercise their over-allotment option in full.

In addition to the underwriting discount to be received by Deutsche Bank Securities Inc., UBS Securities LLC and the other underwriters, they may receive other benefits from this offering.

In addition to the underwriting discount to be received by Deutsche Bank Securities Inc. and UBS Securities LLC, we expect that affiliates of Deutsche Bank Securities Inc., UBS Securities LLC, KeyBanc Capital Markets Inc., Raymond James & Associates, Inc., RBC Capital Markets Corporation and BB&T Capital Markets, a division of Scott & Stringfellow, LLC will be lenders under the secured revolving credit facility that we expect to enter into shortly following completion of this offering. This transaction creates a potential conflict of interest because Deutsche Bank Securities Inc., UBS Securities LLC and such other underwriters may have an interest in the successful completion of this offering beyond the underwriting discount they will receive. These interests may influence the decision regarding the terms and circumstances under which this offering and our formation transactions are completed.

The underwriters, including Deutsche Bank Securities Inc., UBS Securities LLC and/or their respective affiliates, have engaged in commercial and investment banking transactions with our contributors in the ordinary course of their business and may in the future engage in commercial and investment banking transactions with us and/or our affiliates in the ordinary course of their business. They have received, and expect to receive, customary compensation and expense reimbursement for these commercial and investment banking transactions.

The combined financial statements of our predecessor and our unaudited pro forma financial statements may not be representative of our financial statements as a publicly traded company.

The combined financial statements of our predecessor and our unaudited pro forma financial statements that are included in this prospectus do not necessarily reflect what our results of operations, financial position or cash flows would have been had we been an independent entity during the periods presented. Furthermore, this financial information is not necessarily indicative of what our results of operations, financial position or cash flows will be in the future. It is impossible for us to accurately estimate all adjustments reflecting all the significant changes that will occur in our cost structure, funding and operations as a result of our being a publicly traded company. For additional information, see “Selected Financial and Pro Forma Financial Information” and the combined financial statements of our predecessor and our unaudited pro forma financial statements, as well as “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” appearing elsewhere in this prospectus.

 

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains certain forward-looking statements that are subject to various risks and uncertainties. Forward-looking statements are generally identifiable by use of forward-looking terminology such as “may,” “will,” “should,” “potential,” “intend,” “expect,” “outlook,” “seek,” “anticipate,” “estimate,” “approximately,” “believe,” “could,” “project,” “predict,” or other similar words or expressions. Forward-looking statements are based on certain assumptions, discuss future expectations, describe future plans and strategies, contain financial and operating projections or state other forward-looking information. Our ability to predict results or the actual effect of future events, actions, plans or strategies is inherently uncertain. Although we believe that the expectations reflected in our forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth or anticipated in our forward-looking statements. Factors that could have a material adverse effect on our forward-looking statements and upon our business, results of operations, financial condition, funds derived from operations, cash available for distribution, cash flows, liquidity and prospects include, but are not limited to:

 

   

the factors referenced in this prospectus, including those set forth under the section captioned “Risk Factors”;

 

   

our ability to acquire our acquisition properties or additional properties that are leased to the federal government;

 

   

our ability to raise additional capital at reasonable costs to repay our debt, invest in our properties, fund acquisitions of federal government-leased facilities or fund the development costs of any new GSA facilities for which we bid and which are awarded to us, including our ability to enter into our revolving credit facility referred to herein;

 

   

the degree and nature of our competition;

 

   

our ability to retain the federal government as the tenant of our properties in certain instances where the federal government has a right of early termination or to renew its leases at our properties at the end of the lease term;

 

   

unanticipated increases in financing and other costs, including a rise in interest rates;

 

   

changes in the debt or equity markets, the general economy or the real estate industry, whether the result of market events or otherwise;

 

   

actual and potential conflicts of interest with our directors, executive officers or the partners of our partnership and their respective affiliates;

 

   

changes in personnel or the lack of availability of qualified personnel;

 

   

changes in governmental regulations, accounting rules, tax rates and similar matters;

 

   

legislative and regulatory changes, including changes to the Code and related rules, regulations and interpretations governing the taxation of REITs; and

 

   

limitations imposed on our business and our ability to satisfy complex rules in order for us and, if applicable, certain of our subsidiaries to qualify as a REIT for U.S. federal income tax purposes and the ability of certain of our subsidiaries to qualify as TRSs for U.S. federal income tax purposes, and our ability and the ability of our subsidiaries to operate effectively within the limitations imposed by these rules.

When considering forward-looking statements, you should keep in mind the risk factors and other cautionary statements in this prospectus. Readers are cautioned not to place undue reliance on any of these forward-looking statements, which reflect our views as of the date of this prospectus. The matters summarized under “Risk Factors” and elsewhere in this prospectus could cause our actual results and performance to differ materially from those set forth or anticipated in forward-looking statements. Accordingly, we cannot guarantee future results or performance. Furthermore, except as required by law, we are under no duty to, and we do not intend to, update any of our forward-looking statements after the date of this prospectus, whether as a result of new information, future events or otherwise.

 

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USE OF PROCEEDS

Assuming an initial public offering price of $20.00 per share of our common stock based upon the mid-point of the price range set forth on the cover page of this prospectus, we estimate we will receive gross proceeds from this offering of $275.0 million (or approximately $316.3 million if the underwriters’ over-allotment option is exercised in full). After deducting the underwriting discount and estimated expenses of this offering payable by us, we expect net proceeds from this offering of approximately $253.8 million (or approximately $292.1 million if the underwriters’ over-allotment option is exercised in full).

We will contribute the net proceeds from this offering to our operating partnership. Assuming no exercise of the underwriters’ over-allotment option, we intend to use the net proceeds from this offering to: repay all of the outstanding indebtedness on our three in-service contribution properties, which as of June 30, 2010 aggregated $77.7 million; pay to our contributors the $3.0 million cash portion of the aggregate purchase price of their interests in our contribution properties; pay the $137.4 million cash portion of the aggregate purchase price of our acquisition properties, including the reimbursement of $1.9 million of advances made or required to be made by BC Development Co. for certain deposits related to our acquisition properties; pay an aggregate of approximately $1.8 million of transaction costs, including the reimbursement of approximately $0.2 million of transaction costs advanced by BC Development Co.; pay an aggregate of approximately $1.6 million relating to costs associated with our formation, including the reimbursement of approximately $0.8 million advanced by BC Development Co.; and for working capital and general corporate purposes, including future acquisitions and developments. We will also use $1,000 to repurchase the shares of our common stock acquired by our contributors and the minority owner in connection with our initial capitalization. In the event that we do not have sufficient operating cash flow increases in the future, we may use a portion of the remaining net proceeds from this offering to fund our initial annual dividend.

If the underwriters’ over-allotment option is exercised, we expect to use the additional net proceeds (which, if the underwriters’ over-allotment is exercised in full, will be approximately $38.4 million (based upon the mid-point of the price range set forth on the cover page of this prospectus)) for working capital and general corporate purposes, including future acquisitions and developments.

Pending application of any portion of the net proceeds from this offering, we will invest it in interest-bearing accounts and short-term, interest-bearing securities as is consistent with our intention to qualify for taxation as a REIT for federal income tax purposes. Such investments may include, for example, obligations of the U.S. federal government and governmental agency securities, certificates of deposit and interest-bearing bank deposits.

 

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The following table provides information related to the expected sources and use of the proceeds from this offering, assuming the underwriters’ over-allotment option is not exercised.

 

        Sources        

       

          Uses          

    
(in thousands)         (in thousands)     

Gross offering proceeds(1)

   $ 275,000    Offering expenses:   
     

Underwriting discount

   $ 19,250
     

Other fees and expenses(2)

     1,979
            
           21,229
     

Repayment of indebtedness on our in-service contribution properties(3)

     77,666
     

Cash payment to our contributors to acquire interests in our contribution properties

     3,000
     

Cash payments to purchase our acquisition
properties(2)

     137,384
     

Payment of transaction costs related to the purchase of our acquisition properties(2)

     1,830
     

Payment of costs associated with our formation(2)

     1,621
            
     

Subtotal

     242,730
            
     

Proceeds for working capital and general corporate purposes, including future acquisitions and developments

     32,270
            

Total Sources

   $ 275,000   

Total Uses

   $ 275,000
                

 

(1) This dollar amount assumes 13,750,000 shares of our common stock are sold in this offering and will increase or decrease depending upon whether such shares are sold above or below $20.00 per share (the mid-point of the price range set forth on the cover page of this prospectus).
(2) Includes reimbursement to BC Development Co. of $3,246, including offering expenses of $363, purchase price deposits for our acquisition properties of $1,850, transaction costs of $236, and formation costs of $797.
(3) As of June 30, 2010, this indebtedness bore interest at a weighted-average annual rate of 2.4% and had a weighted-average maturity of 10.4 months. As of June 30, 2010, (i) the loan secured by our Jacksonville, Florida contribution property had an outstanding principal amount of $45,155, an interest rate of one month LIBOR plus 1.65% and a maturity date of March 31, 2011, (ii) the loan secured by our Great Falls, Montana contribution property had an outstanding principal amount of $18,650, an interest rate of one month LIBOR plus 1.65% and a maturity date of March 31, 2011, and (iii) the loan secured by our Denver, Colorado contribution property had an outstanding principal amount of $13,861, an interest rate of daily LIBOR plus 4.00% and a maturity date of November 30, 2011. The proceeds of all such loans were used to develop and to fund certain operating expenses of DHS Denver, Great Falls and Jacksonville Field.

 

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The following table sets forth the consideration we have agreed to pay for our contribution and acquisition properties (dollars in thousands). Debt amounts reflect outstanding balances as of June 30, 2010.

 

Property/Location

   Cash
Payments
    Value of OP
Units Issued
   Debt to be
Repaid
Upon
Acquisition
    Debt to be
Assumed
Upon
Acquisition
    Total Value
of
Consideration
 

Contribution Properties

           

Jacksonville, FL

   $ —       $ 187    $ 45,155 (1)    $ —       $ 45,342 (1) 

Centennial, CO

     —          2,864      13,861 (1)      —          16,725 (1) 

Great Falls, MT

     —          2,073      18,650 (1)      —          20,723 (1) 

Salt Lake City, UT

     3,000        4,705      —          2,352 (2)      10,057 (2) 
                                       

Subtotal — Contribution Properties

   $ 3,000      $ 9,829    $ 77,666 (1)    $ 2,352 (2)    $ 92,847 (1)(2) 

Acquisition Properties

           

Bloomington, IL

   $ 17,700      $ —      $ —        $ —        $ 17,700   

Gloucester, MA

     14,000        —        —          —          14,000   

Orlando, FL

     13,800        —        —         —         13,800   

Alpine, TX

     5,246 (3)      —        —          15,154 (3)      20,400   

Royal Palm Beach, FL

     21,000        —        —          —          21,000   

Lufkin, TX

     6,450        —        —          —          6,450   

Lawrence, MA

     13,481        —        —          —          13,481   

Richford, VT

     8,622        —        —          —          8,622   

Cleveland, OH

     4,566        —        —          —          4,566   

Durham, NC

     8,315        —        —          —          8,315   

Sevierville, TN

     5,169        —        —          —          5,169   

San Antonio, TX

     4,350        —        —          —          4,350   

Beaumont, TX

     4,824        —        —          —          4,824   

Waco, TX

     5,514        —        —          —          5,514   

Centerville, OH

     4,347        —        —          —          4,347   
                                       

Subtotal — Acquisition Properties

   $ 137,384 (4)    $ —      $ —       $ 15,154      $ 152,538   
                                       

Total

   $ 140,384      $ 9,829    $ 77,666      $ 17,506      $ 245,385   
                                       

 

(1) Excludes the impact of principal amortization payments since June 30, 2010.
(2) Excludes $2,165 of additional debt incurred, for the period from July 1, 2010 through September 15, 2010, pursuant to draws on the construction loan for our Salt Lake City, Utah development property.
(3) The aggregate purchase price for our Alpine, Texas acquisition property is $20,400. A portion of the purchase price for this property will be paid pursuant to the assumption of the outstanding indebtedness secured by the property. As of June 30, 2010, such outstanding indebtedness had an outstanding principal amount of $15,154; however, the outstanding principal of the indebtedness secured by this property is currently being repaid on a 15 year amortization schedule. Any reduction in the outstanding principal of the indebtedness secured by this acquisition property and to be assumed by us at the closing will not reduce the aggregate purchase price for the this property but will cause an increase in the cash portion payable by us. For purposes of our pro forma financial statements, the debt to be assumed relating to our Alpine, Texas acquisition property is $14,052 (which is net of a $1,102 fair value adjustment pursuant to the acquisition method of accounting).
(4) Includes approximately $1,900 of advances made or required to be made by BC Development Co. for certain deposits related to our acquisition properties for which we have agreed to reimburse BC Development Co.

 

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CAPITALIZATION

The following table sets forth, as of June 30, 2010, (i) the historical capitalization of our predecessor, (ii) our pro forma capitalization reflecting solely the completion of our formation transactions and (iii) our pro forma capitalization adjusted to reflect the completion of this offering and our formation transactions. You should read this table in conjunction with “Use of Proceeds,” “Selected Financial and Pro Forma Financial Information,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the more detailed information contained in the historical and pro forma financial statements and notes thereto included elsewhere in this prospectus.

 

     As of June 30, 2010  
     Our
Predecessor
    Pro Forma
Solely for
Formation
Transactions
    Pro Forma
as adjusted
 
     (in thousands)  

Cash

   $ 23      $ 29      $ 32,299 (1) 
                        

Bank loans payable

   $ 63,805      $ 94,070      $ 16,404 (2) 
                        

Consideration payable(3)

     —          140,485        101   
                        

Stockholders’ equity:

      

Common stock
$.001 par value; 300,000,000 shares authorized; 13,755,000 shares issued and outstanding on a pro forma as adjusted basis(4)

     N/A        N/A        14 (1) 

Additional paid in capital

     N/A        N/A        242,510 (1) 
            

Controlling interest equity

     N/A        N/A        242,524   

Non-controlling interest equity

     N/A        N/A        8,668   
                        

Total stockholders’ equity

   $ (1,068   $ (907   $ 251,192   
                        

Total capitalization

   $ 62,737      $ 233,648      $ 267,697   
                        

 

(1) This dollar amount assumes that 13,750,000 shares of our common stock are sold in this offering and will increase or decrease depending upon whether such shares are sold above or below $20.00 per share (the mid-point of the price range set forth on the cover page of this prospectus).
(2) This amount is net of a $1,102 fair value adjustment, related to our Alpine, Texas acquisition property, pursuant to the acquisition method of accounting.
(3) Represents the consideration payable for our initial properties.
(4) This amount does not include (a) any shares of our common stock that may be issued pursuant to underwriters’ over-allotment option to purchase up to an additional 2,062,500 shares of our common stock, (b) an aggregate of 206,250 RSUs granted to our senior management team and (c) an aggregate of 491,444 OP units owned by our contributors and the minority owner issued as part of our formation transactions. This amount includes 5,000 restricted shares of our common stock granted to our independent directors under our long term incentive plan.

 

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DILUTION

Purchasers of shares of our common stock in this offering will experience an immediate and substantial dilution of the net tangible book value of their shares of our common stock from the assumed initial public offering price based on the mid-point of the price range set forth on the cover page of this prospectus of $20.00 per share. Net tangible book value excludes the impact of certain assets and liabilities, including deferred leasing costs, deferred financing costs, deferred leasing intangibles, in-place leases and tenant relationships and deferred leasing obligations. As of June 30, 2010, completion of the formation transactions and this offering will result in an immediate increase in net tangible book value of $26.40 per share to our contributors and the minority owner with respect to their interest in our predecessor and an immediate dilution in pro forma net tangible book value of $3.75 per share from the assumed initial public offering price based on the mid-point of the price range set forth on the cover page of this prospectus of $20.00 per share to purchasers of shares of our common stock in this offering. The following table illustrates this per share dilution:

 

Assumed initial public offering price based on the mid-point of the price range set forth on the cover page of this prospectus

        $ 20.00

Net tangible book value per share of our predecessor(1)

      $ (10.15  

Net decrease in pro forma net tangible book value per share after our formation transactions but prior to this offering

      $ (14.41  
             

Pro forma net tangible book value per share after our formation transactions but prior to this offering(2)

      $ (24.56  

Net increase in pro forma net tangible book value per share attributable to this offering(3)

      $ 40.81     
             

Pro forma net tangible book value per share after our formation transactions and this offering(4)

        $ 16.25
           

Dilution to purchasers of shares of our common stock in this offering(4)

        $ 3.75
             

 

(1) Net tangible book value per share of our predecessor is computed by dividing (a) the net tangible book value deficit of our predecessor ($1.1 million) by (b) the number of shares of our common stock (113,021 shares) that would result by exchanging, on a one-for-one basis, the number of OP units issued to our contributors and the minority owner for our predecessor’s properties.
(2) Pro forma net tangible book value per share after our formation transactions but prior to this offering is determined by dividing (a) the pro forma net tangible book value of our contribution properties and our acquisition properties (aggregating to ($17.3 million)) by (b) the sum of the number of shares of our common stock (491,444 shares) that would result by exchanging, on a one-for-one basis, the number of OP units issued to our contributors and the minority owner in exchange for our contribution properties, 206,250 shares of our common stock deliverable upon vesting in full of the RSUs granted to our senior management team and 5,000 restricted shares of our common stock granted to our independent directors, as if both were fully vested.
(3) Net increase in pro forma net tangible book value per share attributable to this offering is calculated after deducting the underwriting discount and estimated expenses of this offering payable by us.
(4) Pro forma net tangible book value per share after our formation transactions and this offering and the resulting dilution is determined by dividing (a) our pro forma net tangible book value of $234.9 million by (b) the sum of 13,750,000 shares of our common stock issued in this offering, 491,444 shares of our common stock issuable upon exchange of outstanding OP units, 206,250 shares of our common stock deliverable upon vesting in full of the RSUs granted to our senior management team and 5,000 restricted shares of our common stock granted to our independent directors, as if both were fully vested. If the underwriters fully exercise their over-allotment option to purchase an additional 2,062,500 shares of our common stock, the dilution to purchasers of shares of our common stock in this offering would be $3.46 per share.

The table below summarizes, as of June 30, 2010, on a pro forma basis after giving effect to our formation transactions and this offering, the difference between the price per share paid in cash by the new investors purchasing shares of our common stock in this offering and the net book value of the shares of our common stock and OP units issued in connection with our formation transactions.

 

     Shares/Units
Issued/Granted
    Net Book Value
Of Contribution/Cash
    Average
Price per
Share/OP
Unit
     Number     Percentage     Amount    Percentage    
     (in millions)

Shares of our common stock and OP units issued in connection with our formation transactions

   702,694 (1)    4.9   $ 4.2    1.5   $ 6.02

Purchasers in this offering

   13,750,000 (2)    95.1        275.0    98.5        20.00
                               

Total

   14,452,694      100.0   $ 279.2    100.0   $ 19.32
                               

 

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(1) Includes (a) 491,444 OP units owned by our contributors and the minority owner and issued as part of our formation transactions and (b) 5,000 restricted shares of our common stock granted to our independent directors under our long term incentive plan and 206,250 shares of our common stock deliverable upon vesting in full of the RSUs granted to our senior management team, as if both were fully vested.
(2) Does not include any shares of our common stock that may be issued pursuant to underwriters’ over-allotment option to purchase up to an additional 2,062,500 shares of our common stock.

If the underwriters fully exercise their over-allotment option, the number of shares of our common stock held by our contributors and the minority owner will be reduced to 4.3% of the aggregate number of shares of our common stock outstanding after this offering, and the number of shares of our common stock held by purchasers in this offering will be increased to 15,812,500, or 95.7% of the aggregate number of shares of our common stock outstanding after this offering, in both cases assuming the exchange of OP units held by our contributors and the minority owner into shares of our common stock on a one-for-one basis and the delivery of shares of our common stock upon vesting in full of the RSUs granted to our senior management team and including restricted shares of our common stock granted to our independent directors.

 

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DISTRIBUTION POLICY

To qualify as a REIT so that U.S. federal income tax generally does not apply to our earnings to the extent distributed to stockholders, we must, in addition to meeting other requirements, annually distribute to our stockholders an amount at least equal to (1) 90% of our REIT taxable income (determined before the deduction for dividends paid and excluding any net capital gain), plus (2) 90% of the excess of our net income from foreclosure property (as defined in the Code) over the tax imposed on such income by the Code, less (3) the sum of certain items of non-cash income (as determined under Section 857 of the Code). We are subject to income tax on income that is not distributed to our stockholders and to a nondeductible excise tax to the extent that certain percentages of our income are not distributed to our stockholders by specified dates.

To the extent that, in respect of any calendar year, cash available for distribution to our stockholders is less than our REIT taxable income, in order to qualify as a REIT under the Code we could be required to fund the required distributions by selling assets, incurring debt or issuing equity securities or to make a portion of the required distributions in the form of a taxable distribution of our equity securities. We currently do not intend to make taxable distributions of our equity securities. In addition, prior to the time we have fully invested the net proceeds of this offering, we may choose to fund our distributions out of such net proceeds. Funding distributions from such net proceeds may constitute a return of capital to our common stockholders, which would have the effect of reducing each stockholder’s basis in its holdings of shares of our common stock. We will generally not be required to make distributions with respect to activities conducted through any domestic TRS that we form following completion of this offering. See “U.S. Federal Income Tax Considerations—Distribution Requirements.” The REIT distribution requirements will, however, generally apply to all taxable income allocated to us from our operating partnership. Income as computed for purposes of the foregoing tax rules will not necessarily correspond to our income as determined for financial reporting purposes.

We intend to make dividends to our stockholders in cash to the extent that cash is available for such purpose. We may, however, in the sole discretion of our board of directors, make a distribution of assets or a taxable distribution of our shares (as part of a distribution in which stockholders may elect to receive shares or, subject to a limit measured as a percentage of the total distribution, cash).

We anticipate that distributions generally will be taxable as ordinary income to our non-exempt stockholders, although a portion of such distributions may be designated by us as long-term capital gain or qualified dividend income or may constitute a return of capital. To the extent that we decide to make distributions in excess of our earnings and profits, such excess distributions generally will be considered a return of capital. We expect that approximately 60% of our estimated initial annual distribution will represent a return of capital for federal income tax purposes. The percentage of our stockholder distributions that exceeds our current and accumulated earnings and profits may vary substantially from year to year.

We intend to pay cash dividends to our stockholders on a quarterly basis. We intend to pay a pro rata dividend with respect to the period commencing on completion of this offering and ending December 31, 2010 based on $0.25 per share for a full quarter. On an annualized basis, this would be $1.00 per share, or an annual dividend rate of approximately 5.0% based on the mid-point of the price range set forth on the cover page of this prospectus. Our estimated initial annual dividend per share represents approximately 101% of our estimated cash available for distribution for the twelve months ending June 30, 2011, calculated as described more fully below. Accordingly, we expect that we will be unable to pay our estimated initial annual dividend out of our estimated cash available for distribution for the twelve months ending June 30, 2011. Unless our operating cash flow increases in the future, we will be required to fund approximately $0.2 million of our estimated initial annual dividend through borrowings or equity issuances, and we cannot assure you that we will be able to obtain such funding on attractive terms or at all, in which case we plan to use a portion of the remaining net proceeds from this offering for such funding, which would make such amounts unavailable for our future development and acquisition of properties, or to fund such dividend in the form of shares of common stock or to eliminate or otherwise reduce such dividend.

We intend to maintain our initial dividend rate per share for the twelve-month period following completion of this offering unless our financial condition, cash flows, liquidity, FFO, results of operations or prospects,

 

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economic conditions or other factors (as to some of which we have no control) differ materially from the assumptions used in projecting our initial dividend rate. We do not intend to reduce our initial dividend rate per share if the underwriters exercise their over-allotment option.

We have estimated our annual cash available for distribution to our stockholders for the twelve months ending June 30, 2011 and annualized return of capital for federal income tax purposes based on adjustments to our pro forma net income available to stockholders for the twelve months ended June 30, 2010. This estimate was based upon the historical operating results of our properties and does not take into account any investments or their associated cash flows, other than capital expenditures for routine maintenance of our properties, as they cannot be estimated at this time. The estimate does not take into account any financing activities, or their associated cash flows, as they cannot be estimated at this time. The estimate also does not take account of other currently unanticipated expenditures we may have to make.

In estimating our cash available for distribution to our stockholders, we have made certain assumptions as reflected in the table and notes below. For example, our estimate of cash available for distribution does not include the effect of any changes in our working capital and includes the reduction in interest expense from the repayment of our debt that will be funded with offering proceeds.

Following the closing of this offering, we may undertake other investing or financing activities that may have a material effect on our estimate of cash available for distribution to our stockholders. Because we have made the assumptions set forth above in estimating cash available for distribution, we do not intend this estimate to be a projection or forecast of our actual results of operations or cash flows, and we have estimated cash available for distribution for the sole purpose of determining the expected amount of our initial annual dividend rate. Our estimate of cash available for distribution should not be considered as an alternative to cash flow from operating activities (computed in accordance with GAAP) or as an indicator of our liquidity or our ability to pay dividends. In addition, the calculations set forth below may not be the basis upon which our board of directors may determine future dividends. No assurance can be given that our estimates will prove accurate, and any actual dividends therefore may be significantly different from the estimated dividends.

The timing, form and amount of any dividends to our stockholders will be at the sole discretion of our board of directors and will depend upon a number of factors, including, but not limited to:

 

   

our actual and projected FFO, results of operations, liquidity, cash flows and financial condition;

 

   

our business and prospects;

 

   

our operating expenses;

 

   

our capital expenditures, tenant improvements and leasing commissions;

 

   

our debt service requirements;

 

   

restrictive covenants in our financing or other contractual arrangements;

 

   

prohibitions or restrictions under Maryland law;

 

   

the timing of the investment of our capital;

 

   

our taxable income;

 

   

the annual distribution requirements under the REIT provisions of the Code; and

 

   

such other factors as our board of directors deems relevant.

As a result, no assurance can be given that we will pay dividends to our common stockholders at any time or in any particular form in the future or that the level of any dividends we do pay to our common stockholders will be consistent with our anticipated initial annual dividend rate or will increase or even be maintained over time, or achieve a market yield. Any of the foregoing could materially and adversely affect us and the market price of our common stock.

 

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The following table describes our adjusted pro forma net income before non-controlling interests for the twelve months ended June 30, 2010, and the adjustments we have made in order to estimate our cash available for distribution to the holders of our common stock and OP units for the twelve months ending June 30, 2011 (amounts in thousands, except per share data). The table reflects our consolidated information, including the OP units. Each OP unit is redeemable for cash or exchangeable, at our option, for a share of our common stock on a one-for-one basis, beginning 12 months after completion of this offering.

 

Operating Cash Flows:

  

Pro forma net income for the 12 months ended December 31, 2009

   $ 5,324   

Less: Pro forma net income for the six months ended June 30, 2009

     (2,236

Add: Pro forma net income for the six months ended June 30, 2010

     3,756   
        

Pro forma net income for the 12 months ended June 30, 2010

     6,844   

Add: Adjustment to pro forma net income for properties placed in service after June 30, 2009 to reflect a full 12 months of operation ended June 30, 2010 (1)

     647   
        

Adjusted Pro forma net income for the 12 months ended June 30, 2010

     7,491   

Non-cash impacts in adjusted pro forma net income for the 12 months ended June 30, 2010

  

Add: Depreciation and amortization (2)

     8,009   

Add: Amortization of fair value adjustment related to debt (3)

     82   

Less: Straight-line rent adjustments and above/below market lease intangibles and obligations (4)

     (2,458

Add: non-cash stock-based compensation expense (5)

     1,094   
        

Pro forma cash provided by operations for the 12 months ended June 30, 2010

     14,218   

Add: Net increases in rental and related revenue (6)

     906   

Add: Decrease in interest expense (7)

     39   
        

Total estimated cash provided by operating activities for the 12 months ending June 30, 2011

     15,163   
        

Investing Cash Flows:

  

Capital expenditures on construction project (8)

     (8,771

Estimated annual provision for recurring capital expenditures (9)

     (203
        

Total estimated cash used in investing activities for the 12 months ending June 30, 2011

     (8,974
        

Financing Cash Flows:

  

Borrowings on construction loans (8)

     8,771   

Scheduled debt principal payments (7)

     (715
        

Total estimated cash provided by in financing activities for the 12 months ending June 30, 2011

     8,056   
        

Estimated cash available for distribution for the 12 months ending June 30, 2011

   $ 14,245   
        

Estimated annual distribution for the 12 months ending June 30, 2011 . . . . . . . . . . . . . . .

   $ 14,453   
        

Estimated distribution per OP unit for the 12 months ending June 30, 2011 (10)

   $ 1.00   

Estimated distribution per share for the 12 months ending June 30, 2011 (10)

   $ 1.00   

Payout ratio based on estimated cash available for distribution to our holders of common stock/ OP units (11)

     101 %  (12) 

 

     Our calculation of Pro Forma Net Income before Non-Controlling Interests and Pro Forma Cash Flows for the 12 months ended June 30, 2010 and Estimated Cash Flows, Estimated Cash Available for Distribution, and Estimated Annual Distribution for the 12 months ending June 30, 2011 included in the table above has been prepared by our management. Our independent auditors have not examined, compiled, or otherwise applied procedures to such calculations and, accordingly, do not express an opinion or any other form of assurance thereon.

 

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(1) The following table reflects an adjustment to pro forma net income for the 12 months ended June 30, 2010 resulting from a full year’s operation for newly developed properties that had lease dates commencing after June 30, 2009 (based upon days in service from July 1, 2009 through June 30, 2010):

 

          For the 12 months ended June 30, 2010

Property

  

Lease
commencement date

   Revenue    Annualized
revenue
   Operating
expenses
   Annualized
operating
expenses
   Impact on
pro forma
net income

Beaumont, Texas

   7/17/09    $ 520    $ 543    $ 116    $ 121    $ 18

Lufkin, Texas

   8/1/09      773      843      202      221      51

Waco, Texas

   8/17/09      521      595      111      127      58

Denver, Colorado

   9/1/09      1,588      1,905      413      496      234

Richford, Vermont

   12/1/09      581      997      183      313      286
                     
                  $ 647
                     

 

(2) Represents depreciation and amortization for the 12 months ended June 30, 2010.
(3) Represents $82 of amortization of the fair value adjustment related to the debt on our Alpine, Texas acquisition property.
(4) Includes approximately $1,781 of straight-line rent adjustment and approximately $677 of net above/below market lease intangible amortization.
(5) Represents non-cash compensation expense related to restricted stock and RSU awards.
(6) Net increases in rental and related revenue consists of contractual increases in rental and related revenue for the 12 months ending June 30, 2011 from our initial properties.
(7) Decrease in interest expense and scheduled debt principal payments relate to the amortizing debt on our Alpine, Texas acquisition property.
(8) Capital expenditures on construction projects and borrowings on construction loans relate to our Salt Lake City, Utah development property.
(9) Because our in-service initial properties have a weighted average age of 19.5 months as of June 30, 2010, we do not have meaningful historical data concerning recurring capital expenditures. As a result, our estimated annual provision for recurring capital expenditures is based on management’s estimate of $0.25 per rentable square foot. Management’s estimate of this amount is based upon an assessment of the recurring capital expenditures anticipated for the contribution properties and property condition assessment reports prepared with respect to each of the acquisition properties by third-party consultants retained by us. Actual recurring capital expenditures may differ materially.
(10) Estimated distribution per share for the 12 months ending June 30, 2011 is based on 13,961,250 shares outstanding following the completion of this offering and estimated distribution per OP unit for the 12 months ending June 30, 2011 is based on 491,444 OP units outstanding following the completion of this offering. The table excludes shares issuable upon exercise of the underwriters’ over-allotment option, but includes (a) an aggregate of 206,250 RSUs granted to members of our senior management team under our long term incentive plan and (b) an aggregate of 5,000 restricted shares of our common stock granted to our independent directors under our long term incentive plan.
(11) Payout ratio based on estimated cash available for distribution to our stockholders (including holders of RSUs) and holders of OP units is calculated as the estimated annual distribution for the 12 months ending June 30, 2011 divided by the estimated cash available for distribution for the 12 months ending June 30, 2011.
(12) Unless our operating cash flow increases in the future, we will be required to fund approximately $0.2 million of our estimated initial annual dividend through borrowings or equity issuances, and we cannot assure you that we will be able to obtain such funding on attractive terms or at all, in which case we plan to use a portion of the remaining net proceeds from this offering for such funding, which would make such amounts unavailable to fund acquisitions or developments, or to fund such dividend in the form of shares of common stock or to eliminate or otherwise reduce such dividend.

The above table does not include (a) any revenues or costs associated with additional properties acquired subsequent to the completion of this offering, or (b) any additional costs not currently determinable that we may incur as a public company, such as additional office, audit, accounting and legal expenses.

 

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SELECTED FINANCIAL AND PRO FORMA FINANCIAL INFORMATION

The following table presents certain historical and pro forma operating, balance sheet and other data of our company and our predecessor. Our predecessor is not a legal entity, but rather a combination of Great Falls and Jacksonville Field, two real estate entities owned primarily by our contributors. Historical data for us (with our operating partnership) are not presented below because we have not had any operating activity since our March 9, 2010 incorporation other than the issuance of 1,000 shares of our common stock in connection with our initial capitalization, which we intend to repurchase upon completion of this offering.

The following historical operating data for the six months ended June 30, 2010 and June 30, 2009 and the balance sheet data as of June 30, 2010 of our predecessor were derived from the combined financial statements of our predecessor, appearing elsewhere in this prospectus, which, in the opinion of management, include all normal recurring adjustments necessary for a fair presentation of the information set forth therein. The following historical operating data for the years ended December 31, 2009, 2008 and 2007 and the balance sheet data as of December 31, 2009 and 2008 of our predecessor were derived from the combined financial statements of our predecessor, appearing elsewhere in this prospectus. The balance sheet data as of December 31, 2007 of our predecessor were derived from the unaudited combined financial statements of our predecessor, which are not included in this prospectus. Our predecessor did not begin revenue producing operations until 2009. The following pro forma operating and balance sheet data were derived from our pro forma financial statements, appearing elsewhere in this prospectus, and reflect the completion of this offering and our formation transactions. The following historical and pro forma data should be read in conjunction with the financial statements and notes thereto, as well as with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Use of Proceeds” and the statements of revenues and certain operating expenses of DHS Denver and the acquisition properties, all appearing elsewhere in this prospectus.

Results for the six months ended June 30, 2010 are not necessarily indicative of our actual results for the year ending December 31, 2010. In addition, the unaudited pro forma financial information in this section is not intended to replace the financial statements of our predecessor or the statements of revenues and certain operating expenses of DHS Denver and the acquisition properties nor does it necessarily reflect what our results of operations, financial position and cash flows would have been if we had previously operated as a stand-alone combined company during all periods presented. Accordingly, the selected historical and pro forma data should not be relied upon as an indicator of our future results of operations, financial position or cash flows.

 

    Six months ended
June 30,
    Year ended December 31,
    Pro Forma
2010
    Historical     Pro Forma
2009
    Historical
      2010     2009       2009     2008     2007
    (in thousands,
except per share data)
    (in thousands,
except per share data)

Operating data

             

Revenues

  $ 13,308     $ 3,599     $ 1,790     $ 20,577      $ 5,378      $ —        $ —  

Expenses:

             

Real estate taxes

    1,068        302       26       924        108        —          —  

Utility expenses

    843        218       153       1,512        398        —          —  

Other operating expenses

    1,543        395       135       2,416        700        —          —  

Depreciation and amortization

    4,141        1,022       481       6,453        1,493        —          —  

General and administrative

    1,485        12       25       2,976        45        —          —  
                                                     

Total expenses

    9,080        1,949       820       14,281        2,744        —          —  
                                                     

Operating income

    4,228        1,650       970       6,296        2,634        —          —  

Unrealized gain (loss) of derivatives

    —          —          394       —          568        (568     —  

Interest expense

    (472     (749 )     (633 )     (972     (1,449     —          —  
                                                     

Net income (loss)

    3,756        901       731       5,324        1,753        (568     —  

Net income attributable to non-controlling interests

    (148     —          —          (209     —          —          —  
                                                     

Net income (loss) attributable to controlling interest

  $ 3,608      $ 901     $ 731     $ 5,115      $ 1,753      $ (568   $ —  
                                                     

Net income per basic and diluted share

    0.30        N/M        N/M        0.42        N/M        N/M        N/M
                                                     

Weighted average shares outstanding

    12,226        N/M        N/M        12,226        N/M        N/M        N/M
                                                     

Other data

             

Funds from operations(1)

  $ 7,897      $ 1,923     $ 1,212     $ 11,777      $ 3,246      $ (568   $ —  
                                                     

 

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     As of June 30,     As of December 31,
     Pro Forma
2010
    Historical
2010
    Historical
         2009     2008    2007
     (dollars in thousands)     (dollars in thousands)

Balance sheet data

           

Real estate properties, net

   $ 222,261      $ 63,352      $ 64,160      $ 49,742    $ 12,005

Cash

     32,299        23        249        34      —  

Total assets

     282,802        65,059        65,796        50,191      12,572

Bank loans payable

     16,404 (2)      63,805        63,800        48,104      9,972

Total liabilities

     31,610        66,127        65,975        50,011      12,054

Controlling interest equity

     242,524        (1,068     (179     180      518

Non-controlling interest equity

     8,668        —          —          —        —  

Total stockholders’ equity

     251,192        (1,068     (179     180      518

Other data

           

Number of operating properties(3)

     18        2        2        —        —  

Percentage leased

     100     100     100     N/M      N/M

 

N/M - Not meaningful.
(1) We present FFO because we consider it an important supplemental measure of our operating performance and believe it is frequently used by securities analysts, investors and other interested parties in the evaluation of REITs, many of which present FFO when reporting their operating results. FFO is intended to exclude historical cost depreciation and amortization of real estate and related assets, which assumes that the value of real estate assets diminishes ratably over time. Historically, however, real estate values have risen or fallen with market conditions. Because FFO excludes depreciation and amortization unique to real estate, gains and losses from property dispositions and extraordinary items, it provides a performance measure that, when compared period-over-period, reflects the impact to operations from trends in occupancy rates, rental rates, operating costs, development activities and interest costs, providing perspective not immediately apparent from net income (loss). We compute FFO in accordance with standards established by the Board of Governors of NAREIT in its March 1995 White Paper (as amended in November 1999 and April 2002). As defined by NAREIT, FFO represents net income (computed in accordance with GAAP), excluding gains (or losses) from sales of property, plus real estate related depreciation and amortization (excluding amortization of loan origination costs) and after adjustments for unconsolidated partnerships and joint ventures. Our computation may differ from the methodology for calculating FFO utilized by other equity REITs and, accordingly, may not be comparable to such other REITs. Furthermore, FFO does not represent amounts available for management’s discretionary use because of needed capital replacement or expansion, debt service obligations, or other commitments and uncertainties. FFO should not be considered as an alternative to net income (loss) (computed in accordance with GAAP) as an indicator of our financial performance or to cash flow from operating activities (computed in accordance with GAAP) as an indicator of our liquidity, nor is it indicative of funds available to fund our cash needs, including our ability to pay dividends or make distributions to our stockholders.

The following table is a reconciliation of our net income to FFO:

 

     Six months ended
June 30,
   Year ended December 31,
     Pro  Forma
2010(3)
   Historical    Pro  Forma
2009(3)
   Historical
        2010    2009       2009    2008     2007
     (dollars in thousands)    (dollars in thousands)

Net income (loss)

   $ 3,756    $ 901    $ 731    $ 5,324    $ 1,753    $ (568   $ —  

Depreciation and amortization

     4,141      1,022      481      6,453      1,493      —          —  
                                                 

FFO

   $ 7,897    $ 1,923    $ 1,212    $ 11,777    $ 3,246    $ (568   $ —  
                                                 

 

(2) This amount is net of a $1.1 million fair value adjustment, related to our Alpine, Texas acquisition property, pursuant to the acquisition method of accounting.
(3) While development of the two contribution properties owned by our predecessor started in 2007, the terms of the operating leases did not commence until February 2009 and June 2009, respectively. The pro forma statements include the results of our 18 in-service initial properties, of which only 9 properties comprising 413,134 rentable square feet, or 50.8% of the aggregate rentable square footage of our in-service initial properties, were in service at January 1, 2009. Our Salt Lake City, Utah contribution property began construction in March 2010.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

The following discussion of our financial condition and results of operations should be read together with the historical and pro forma financial statements and related notes that are included elsewhere in this prospectus. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results and performance may differ materially from those set forth or anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” or elsewhere in this prospectus. See “Risk Factors” and “Cautionary Statement Regarding Forward-Looking Statements.”

We have included in this prospectus the audited balance sheet of our company at June 30, 2010, together with the combined financial statements of our predecessor as of and for the six months ended June 30, 2010 and 2009 (unaudited) and as of and for the years ended December 31, 2009 and 2008 (audited). Our predecessor’s financial statements reflect the combined financial position, cash flows and results of operations for our contribution properties located in Great Falls, Montana and Jacksonville, Florida. The contribution of the two contribution properties that constitute our predecessor will be reflected at carryover basis since the initial ownership of our company and our predecessor is identical. Additionally, after formation, the financial statements of our predecessor will constitute our pre-formation period financial statements. We have also included in this prospectus our pro forma financial information as of June 30, 2010, for the six months ended June 30, 2010, and for the year ended December 31, 2009, which reflects the financial position and results of operations for the two contribution properties that constitute our predecessor together with our two contribution properties located in Denver, Colorado and Salt Lake City, Utah, our fifteen acquisition properties, the remainder of our formation transactions and this offering.

Overview and Market Opportunity

We are a newly organized, internally-managed real estate company formed to continue and grow our business of acquiring, developing, financing, owning and managing properties leased primarily to the United States, acting either through the GSA or another federal government agency or department, carried out through our predecessor and related entities prior to this offering. We intend to grow our portfolio primarily through acquisitions of federal government-leased properties and by developing build-to-suit federal government-leased properties secured through competitive bidding. We were formed as a Maryland corporation on March 9, 2010, and our operating partnership, of which we are the sole general partner, was formed as a Delaware limited partnership on April 21, 2010. Upon completion of this offering and our formation transactions, we will own a 96.6% limited partnership interest in our operating partnership. We intend to elect and qualify to be taxed as a REIT for U.S. federal income tax purposes commencing with our short taxable year ending December 31, 2010.

Upon completion of this offering and our formation transactions, we will own 19 single-tenant federal government-leased properties (including our 15 acquisition properties) currently containing 812,857 rentable square feet. One of our initial properties, which we anticipate will contain 69,225 rentable square feet, is currently under development and is targeted for completion in the fall of 2011. We cannot assure you that we will acquire any or all of our acquisition properties on the terms contemplated in the respective purchase agreements, or at all.

From 1967 (the earliest year for which such information is available to us) to June 2010, the amount of GSA leased space grew from 46 million square feet to 189 million square feet. We believe the growth in GSA leasing will continue into the future because federal government budgetary policies generally focus on annual cash expenditures, thereby making it less attractive to budget for the significant long-term capital expenditures that are necessary to develop new federal government-owned properties. We further believe that increased government regulation under the present federal administration, in part to address issues such as financial institution and healthcare reform, may substantially increase the federal government’s demand for leased office space.

 

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We believe that, due to the economic downturn and the related increase in the U.S. unemployment rate, many owners of federal government-leased properties that own these properties as part of a wider portfolio of office properties are facing financial distress. Higher vacancy rates combined with downward pressure on lease rates have resulted in lower cash flows and made it increasingly difficult for these owners, especially those with significant leverage on their portfolios, to repay or refinance their debt obligations. Accordingly, we believe these owners may be forced to dispose of certain of these properties, including federal government-leased properties, at attractive valuations for buyers.

We generate revenues primarily from rents received from the federal government under long-term leases of our properties. As of June 30, 2010, the weighted-average age of our initial properties currently in service was 19.5 months, the weighted-average remaining lease term of our initial properties currently in service, assuming the exercise of all early termination rights, was 11.4 years, and the weighted-average remaining lease term of our initial properties currently in service, assuming no early termination rights are exercised, was 13.8 years. All of our initial properties are 100% leased by the federal government on behalf of agencies and departments such as the FBI, the IRS, the federal courts, the SSA, the VA and the DHS. The earliest lease termination or expiration date is September 13, 2017.

We believe that certain aspects of our business model present less risk than a typical real estate acquirer, developer, owner and operator. All of our initial properties are leased to the federal government, thereby minimizing tenant credit risk. Furthermore, our leases have long remaining terms and the GSA generally has a high renewal history upon expiration, thereby reducing tenant rollover risk and re-tenanting costs.

Following this offering, we intend to pay regular quarterly dividends to our common stockholders in amounts that meet or exceed the requirements for our qualification as a REIT. We intend to pay dividends to our common stockholders in cash to the extent that cash is available for such purpose. We may, however, in the sole discretion of our board of directors, make a distribution of assets or a taxable distribution of our shares (as part of a distribution in which stockholders may elect to receive shares or, subject to a limit measured as a percentage of the total distribution, cash). See “Distribution Policy.”

Income Taxation

We intend to elect to be treated as a REIT under Sections 856 through 859 of the Code commencing with our short taxable year ending on December 31, 2010. Our qualification as a REIT depends upon our ability to meet on a continuing basis, through actual investment and operating results, various complex requirements under the Code relating to, among other things, the sources of our gross income, the composition and values of our assets, our dividend levels and the diversity of ownership of our stock. We believe that we will be organized in conformity with the requirements for qualification and taxation as a REIT under the Code and that our intended manner of operation will enable us to meet the requirements for qualification and taxation as a REIT.

As a REIT, we generally will not be subject to U.S. federal income tax on our taxable income that we distribute currently to our stockholders. If we fail to qualify as a REIT in any taxable year and do not qualify for certain statutory relief provisions, we will be subject to U.S. federal income tax at regular corporate rates and generally will be precluded from qualifying as a REIT for the subsequent four taxable years following the year during which we lost our REIT qualification. Accordingly, our failure to qualify as a REIT could materially and adversely affect us, including our ability to pay dividends to our stockholders in the future. Even if we qualify as a REIT, we may be subject to some U.S. federal, state and local taxes on our income or property. See “U.S. Federal Income Tax Consequences—Taxation of Our Company.”

Factors That May Influence Future Results of Operations

Acquisition and Development

We intend to grow our portfolio primarily through acquisitions of federal government-leased properties and by developing build-to-suit federal government-leased properties that we obtain through competitive bidding. Our senior management team has a proven track record in federal government build-to-suit property development

 

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that we believe provides us with a significant advantage over other developers in competing for future federal government build-to-suit development contracts. We currently have four in-process bids with the GSA in various stages. In the assignment and license agreement among BC Development Co., our contributors and our development company, BC Development Co. will agree that, if any or all of these bids are awarded to it, it will designate a special purpose entity wholly owned by our operating partnership to receive such award. BC Development Co. has incurred approximately $58,000 in expenses in pursuing these bids as of June 30, 2010. Pursuant to the assignment and license agreement, and conditioned upon completion of this offering, we will be required to reimburse BC Development Co. for bid expenses paid by BC Development Co. prior to the completion of this offering related to its four ongoing bids. Furthermore, we believe there are attractive property acquisition opportunities in the market for properties leased primarily to the federal government that will generate attractive risk-adjusted returns. We have entered into purchase agreements for our 15 acquisition properties, and we cannot ensure you that we will acquire any or all of these properties or the terms contemplated in the respective purchase agreement or at all. Since we will not have any operational experience with our acquisition properties and other future property acquisitions and developments, they may fail to perform in accordance with expectations, including those relating to operational (including leasing), geographical or other synergies with our other properties, as a result of our failure to integrate them successfully into our business or otherwise. In addition, our Salt Lake City, Utah development property, as well as any future development properties or properties we may acquire with a view to redevelopment and/or repositioning, may subject us to unanticipated financing issues, costs, complications and delays, including delays or refusals in obtaining all necessary zoning, land use, building, occupancy and other governmental permits and authorizations.

In August 2010, BC Development Co. was awarded the right to develop an approximately 113,000 square foot VA clinic facility to be located in Jacksonville, Florida. Jacksonville VA has executed a lease with the VA for the entire facility. Upon completion of this offering, we will enter into an option agreement with our contributors, which will give us the option to purchase Jacksonville VA or the option property at any time after the facility is completed and a right of first offer obligating our contributors to offer to sell us Jacksonville VA or the option property before they are permitted to market it for sale. Any decision to exercise the option or accept our contributors’ offer under the right of first offer will be made solely by our independent directors.

In connection with development, leasing rates payable by the federal government over the term of the lease typically are arrived at by projecting the recovery of the costs of construction, anticipated operating expenses, as well as the desired profit and financing structure. Our perception of competition for a particular development may cause us to reduce our offered lease rate for such development. If we have inaccurately estimated our costs of construction or anticipated operating expenses, among other variables, we may have incorrectly priced our lease rates, and we could be materially and adversely affected.

Although our development activities expose us to a variety of risks, certain risks are limited in our business model as compared to companies engaged in development other than for the federal government. For example, we do not engage in speculative development; we only engage in build-to-suit developments once we have obtained a signed lease from the federal government. Furthermore, risks concerning land acquisition and carry costs are mitigated as a direct result of the GSA development bid and award process. This process does not require the bidder to have land inventory. The land site selection is identified by the GSA and can be either optioned by the bidder or directly by the GSA for transfer to the winning bidder. The land acquisition does not occur until the bid is awarded and the GSA has executed a lease for the specific site. This process eliminates the need for a bidder to acquire and carry land and the risk of disposal of land that may later be determined to be unsuitable to the GSA.

Achievement of Our Acquisition Strategy

Our ability to expand through acquisitions is integral to our growth strategy and will allow us to scale our portfolio with quality properties in a controlled and manageable format. We will primarily focus our acquisition efforts on newer single-tenant federal government-leased properties. The increase in private sector development and

 

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ownership of federally-leased properties will provide an ample market for us to pursue these acquisitions directly from developers and owners as well as through the investment brokerage community. Furthermore, we believe that an increase in the mandates of certain agencies and departments, particularly those related to homeland security, will result in a greater number of opportunities to acquire properties as they are built. Through the course of our experience, we have built relationships with owners and developers and have compiled a complete database of all federally-leased properties in the U.S., which will allow us to target specific agencies and departments and properties for acquisition. However, we will have fewer opportunities to purchase properties than entities that have a broader investment strategy that focus on purchasing properties other than those leased to the federal government.

Given the strong credit quality of the federal government, federal government-leased properties are appealing to many investors, including publicly traded REITs, high net worth individuals, commercial developers, real estate companies and institutional investors. This may result in our need to participate in an auction style bid process for certain quality properties that have been marketed to the investment community on a regional or national basis. We believe our expertise in leasing and operating federal government-leased properties along with our ability to move expeditiously through the acquisition process gives us a competitive advantage in acquiring quality properties that we believe will benefit our portfolio. Additionally, it is not uncommon to find acquisition opportunities that are part of a portfolio of properties. In certain circumstances, the acquisition of a portfolio is contingent upon the purchase of all of the properties in the portfolio, and the portfolio may include one or more properties that do not fit our investment strategy. In such cases, when we feel that the strength of the overall portfolio warrants proceeding with the acquisition, we may seek to sell, at a later date, the properties in the portfolio that do not meet our investment strategy.

Leasing

Our initial properties are, and we anticipate that properties that we acquire or develop will be, leased to the federal government on a long-term basis. As of June 30, 2010, each of our initial properties was 100% leased, including our contribution property in development, for which rent will commence upon substantial completion of the building. The earliest lease termination or expiration date is September 13, 2017. The GSA lease market is characterized by high rates of lease renewals. According to data published by the GSA on its website for the 2002 to 2008 period, an average of 94% of GSA leases that were in place at the beginning of those years were in place at the beginning of the following year, and the average renewal rate for expiring leases from that same period was 80%. We will attempt to renew the leases when they expire. Our management team includes members with prior experience working for the GSA. We believe that their knowledge of the GSA and its processes will have a positive impact on our lease renewal negotiations with the federal government. Additionally, we believe that we are well-positioned to be successful in renewing our leases, as we believe that the number of alternative properties that the federal government will be able to consider will be significantly limited due to the following factors:

 

   

our initial properties are, and we expect our future properties will be, single-tenant federal government-leased properties that were built to suit the specific needs of the federal government occupant;

 

   

the federal government’s “green lease” polices limit the number of properties it can consider to those that can meet certain environmental requirements;

 

   

many of the federal government agencies and departments that occupy our initial properties have, and we expect that many of the federal government agencies and departments that will occupy our future properties will have, significant security requirements, including a secured perimeter, progressive collapse, reinforced glass, etc.;

 

   

in our experience, the federal government often makes significant investments of its own capital for improvements to its properties; and

 

   

we intend to focus on properties occupied by federal government agencies and departments that we believe have a long-term mission and stable or growing levels of funding.

We believe that these factors contribute to attractive lease rates for our properties compared to other properties in our markets that do not benefit from these factors. In the event that we are unable to re-let our properties to a federal government occupant upon expiration or earlier termination, we will attempt to lease such properties to

 

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state or local government or non-government tenants. However, the attributes of our properties may not be valued by these potential tenants in the same manner as they are by the federal government and, as a result, potential tenants may be unwilling to lease properties at similar lease rates.

Operating Expenses

A key focus of our property operations strategy is controlling operating expenses while providing the best possible tenant experience. We believe that our leases are consistent with the leases generally entered into by the federal government. Our leases generally require us to pay for maintenance, repairs, base property taxes, utilities and insurance. However, the federal government is typically obligated to pay us adjusted rent for increases in certain operating costs (e.g., the costs of cleaning services, supplies, materials, maintenance, trash removal, landscaping, water, sewer charges, heating, electricity, repairs and certain administrative expenses but not including insurance), which is increased annually based on a cost of living index rather than the actual amount of

our costs. As a result, the amount payable to us based upon the cost of living increase may be less than, or may exceed, any actual increased operating costs. Furthermore, the federal government is typically obligated to reimburse us for increases in real property taxes above a base amount if we provide the proper documentation in a timely manner. Notwithstanding federal government reimbursement obligations, we remain primarily responsible for the payment of all such costs and taxes.

Our management plan includes establishing strong relationships with the federal government occupant and the GSA personnel responsible for the property. We believe this results in increased tenant satisfaction, may decrease our operating expenses, and may increase our ability to predict whether the GSA will renew the lease upon expiration.

General and Administrative Expenses

Our predecessor’s financial statements include minimal general and administrative expenses. Following completion of this offering, we will incur significant general and administrative expenses, including salaries, rent, professional fees and other corporate level activity associated with operating a public company. Specifically, we will incur additional compensation expense, legal, accounting and other expenses related to corporate governance, public reporting and compliance with various provisions of the Sarbanes-Oxley Act of 2002. Our pro forma statements of operations reflect certain contractual costs that we will incur as a public company. In addition to the costs included in our pro forma statements of operations, we anticipate incurring other costs as a public company, such as additional office, audit, accounting, and legal fees, that are not currently determinable. Such costs will reduce our pro forma net income and may be material. Since we have not operated previously as a publicly traded company, there can be no assurance that our general and administrative expense will not significantly exceed our current estimates. In addition, maintaining our development and redevelopment capabilities involves significant costs, including compensation expense for our personnel and related overhead. To the extent we cease or limit our development or redevelopment activity, these costs will no longer be offset by revenues from properties that we develop or redevelop.

Results of Operations

Explanatory Note

Our predecessor consists of two contribution properties located in Jacksonville, Florida and Great Falls, Montana that were developed from 2007 to 2009 and began operations in February 2009 and June 2009, respectively. As a result, our predecessor does not have results of operations for 2007 or 2008 that provide a meaningful basis for comparison to its results of operations in 2009. Furthermore, we have not had any corporate activity since our formation, other than the issuance of 1,000 shares of common stock in connection with our initial capitalization and activities in preparation for this offering and our formation transactions. Accordingly, we believe that a year-to-year comparison of our results of operations would not be meaningful.

 

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Operating Results

Our Jacksonville, Florida property contains 129,895 rentable square feet and is 100% occupied by the FBI under a lease that expires on February 19, 2024, with no early termination option. Our Great Falls, Montana property contains 48,411 rentable square feet and is 100% occupied by the federal courts under a lease that expires on June 25, 2029, with no early termination option. Our predecessor’s results of operations for the six months ended June 30, 2010 and 2009 and the year ended December 31, 2009 were as follows (in thousands):

 

     Six months
ended

June 30,
    Year ended
December 31,
 
     2010     2009     2009  

Rental income

   $ 3,599     $ 1,790     $ 5,378   

Real estate tax, utilities and other operating expenses

     915       314       1,206   

Depreciation and amortization

     1,022       481       1,493   

General and administrative expenses

     12       25       45   
                        

Operating income

     1,650       970       2,634   
                        

Unrealized gain on derivatives

     —          394       568   

Interest expense

     (749 )     (633 )     (1,449
                        

Net income

   $ 901     $ 731     $ 1,753   
                        

As described in the explanatory note above, our predecessor had no operating results for 2008 or 2007 because the development of its two contribution properties was completed in 2009 with Jacksonville and Great Falls lease commencement of February 20, 2009 and June 26, 2009, respectively. Annualized base rent as of June 30, 2010 for these two properties totaled approximately $6.8 million. Because the interest rate swap that created the unrealized gain on derivatives in 2009 has terminated, no such unrealized gains or losses are expected in 2010. We intend to repay all of the outstanding indebtedness related to these two properties with a portion of the net proceeds from this offering, thereby eliminating interest expense associated with these properties.

In addition to the two contribution properties that constitute our predecessor, our contribution properties also include our Denver, Colorado property and our Salt Lake City, Utah property, which are being contributed to us by our contributors and the minority owner as part of our formation transactions. Our Denver, Colorado property contains 54,927 rentable square feet and is 100% occupied by the DHS under a lease that expires on August 31, 2024 and is subject to early termination on September 1, 2019. Annualized base rent as of June 30, 2010 for our Denver, Colorado property is approximately $1.7 million. Our Salt Lake City, Utah property is currently under development, which we expect will be completed in the fall of 2011. We expect that our Salt Lake City, Utah property will contain 69,225 rentable square feet and will be 100% occupied by the DHS under a 15 year lease that is subject to early termination after the tenth year of the lease. We expect that the initial base rent upon completion of our Salt Lake City, Utah property will be approximately $2.3 million, excluding a one-time rent concession to the federal government of $487,704.

Certain of our contributors also own BC Development Co., a development company through which our three in-service contribution properties were developed and one of our contribution properties is being developed. In 2009 and during the six months ended June 30, 2010, BC Development Co. incurred approximately $78,000 and $47,000, respectively, in failed bid costs related to GSA projects. These amounts are not included in the historical operating results of our predecessor. We may incur increased failed bid costs in the future to the extent we are involved in the bidding process for a greater number of properties and such bids are unsuccessful.

The combination of our four contribution properties and BC Development Co. generally represent the historical business managed by our contributors through June 30, 2010. In addition to our historical business, our future operating results will include the results of our 15 acquisition properties, as well as any other properties acquired or developed subsequent to this offering.

 

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Cash Flows

Our predecessor consists of two contribution properties that were developed from 2007 to 2009 and began operations on February 20, 2009 and June 26, 2009, respectively. Our predecessor’s cash flows for the six months ended June 30, 2010 and 2009 and the years ended December 31, 2009, 2008 and 2007 were as follows (in thousands):

 

     Six months ended June 30,      Year ended December 31,  
     2010      2009      2009      2008      2007  

Cash flows from operating activities

   $ 1,820       $ 1,334       $ 2,467       $ —         $ —     

Cash flows from investing activities

   $ (213    $ (11,008 )    $ (15,837    $ (38,160    $ (9,781

Cash flows from financing activities

   $ (1,833 )    $ 10,445       $ 13,585       $ 38,194       $ 9,781   

Comparison of Six Months Ended June 30, 2010 and 2009

Operating Activities. Net cash provided by operating activities for the six months ended June 30, 2010 was primarily due to six months of net income from the operations of the two contribution properties that constitute our predecessor plus noncash depreciation and amortization expense less noncash straight line rent adjustments—a total of $1.9 million, offset by the use of $0.1 million of cash due to changes in operating working capital. Net cash provided by operating activities for the six months ended June 30, 2009 was primarily due to net income from the operations of our Jacksonville, Florida contribution property whose lease commencement occurred on February 20, 2009, plus noncash depreciation and amortization expense less noncash straight line rent adjustment and unrealized gain on derivatives—a total of $0.6 million, plus $0.7 million of cash provided by changes in operating working capital.

Investing Activities. Net cash used in investing activities for each of the six months ended June 30, 2010 and 2009 primarily represents costs of developing the two contribution properties that constitute our predecessor. Construction of our Jacksonville, Florida property began in July 2007 and concluded in February 2009, and construction costs totaled approximately $46.0 million. Construction of our Great Falls, Montana property began in December 2007 and concluded in June 2009, and construction costs totaled approximately $19.8 million.

Financing Activities. Net cash provided by financing activities for the six months ended June 30, 2009 primarily represents borrowings under our construction loans to finance the development of the two contribution properties that constitute our predecessor. Borrowings were $5,000 and $10.5 million during the six months ended June 30, 2010 and 2009, respectively. In addition, for the six months ended June 30, 2010 and 2009, we made distributions to our contributors of $1.8 million and $69,000, respectively and received contributions of $56,000 and $31,000, respectively.

Comparison of Years Ended December 31, 2009, 2008 and 2007

Operating Activities. Net cash provided by operating activities in 2009 was primarily due to net income from the initial operations of the two contribution properties that constitute our predecessor plus noncash depreciation and amortization expense less noncash straight line rent adjustment and unrealized gain on derivatives—a total of $2.3 million, in addition to $0.2 million of cash due to changes in operating working capital during the year as the properties commenced operations. There were no operating activities in 2008 or 2007.

Investing Activities. Net cash used in investing activities for each of the three years primarily represents costs of developing the two contribution properties that constitute our predecessor. Construction of our Jacksonville, Florida property began in July 2007 and concluded in February 2009, and construction costs totaled approximately $45.8 million. Construction of our Great Falls, Montana property began in December 2007 and concluded in June 2009, and construction costs totaled approximately $19.8 million. These amounts for Jacksonville, Florida and Great Falls, Montana include capitalized interest that have been funded under the respective construction loan.

 

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Financing Activities. Net cash provided by financing activities for each of the three years ended December 31, 2009 primarily represents borrowings under our construction loans to finance the development of the two contribution properties that constitute our predecessor. Borrowings were $15.7 million, $38.1 million and $10.0 million during 2009, 2008 and 2007, respectively. In addition, during 2009, 2008 and 2007, we made distributions to our contributors of $2.7 million, $0.3 million and $1,000, respectively and we received contributions from our contributors of $0.6 million, $0.5 million and $0.3 million, respectively. Financing activities also include the payment of fees associated with our construction loans of $0.2 million in 2008 and $0.4 million in 2007.

Liquidity and Capital Resources

As a REIT, we are required to distribute at least 90% of our taxable income to our stockholders on an annual basis. Therefore, as a general matter, it is unlikely that we will have any substantial cash balances that could be used to meet our liquidity needs. Instead, we will need to meet these needs from cash generated from operations and external sources of capital. In addition, our liquidity may be negatively impacted by unanticipated increases in project development costs (including the cost of labor and materials and construction delays) and rising interest rates.

We believe that this offering and our formation transactions will improve our financial performance through changes in our capital structure, including an expansion of our assets, an increase in cash from operations and a reduction in our indebtedness.

Our senior management team will continue to utilize their experience in acquiring and developing properties leased to the federal government. This offering will provide the capital to acquire our 15 acquisition properties. Additionally, on a pro forma basis as if this offering and our formation transactions were completed on June 30, 2010, we would have had approximately $32.3 million of net proceeds from this offering available for the acquisition and development of additional properties and general corporate and working capital purposes. In the event that we do not have sufficient operating cash flow increases in the future, we may use a portion of the remaining net proceeds from this offering to fund our initial annual dividend.

Upon completion of our formation transactions and this offering, our only indebtedness will be our construction loan on our Salt Lake City, Utah property that as of June 30, 2010 had an outstanding balance of approximately $2.4 million, and approximately $15.2 million of assumed debt secured by our Alpine, Texas acquisition property. We currently estimate the construction costs for the Salt Lake City, Utah property will be $15.7 million. The Salt Lake City, Utah construction loan with Zion’s First National Bank has a maximum borrowing capacity of $16.9 million and a maturity date of the earlier of March 1, 2012 and the month following GSA lease payment commencement, subject to extension to March 1, 2015 if the loan is converted to a term loan. The loan has a variable interest rate based on the three-month London Interbank Offered Rate, or LIBOR, plus 3.50% during the construction period with a floor of 6.5%, which is subject to reduction to the three month LIBOR plus 3.00% with a floor of 5.5% if the loan is extended and converted to a term loan after the earlier of the construction period end date or March 1, 2012. The indebtedness secured by our Alpine, Texas acquisition property has a fixed interest rate of 5.621% per annum, requires monthly principal and interest payments of approximately $129,000 and matures in July, 2022 with a balloon payment at maturity of $3.3 million. There is a pre-payment penalty associated with the loan equal to the greater of one percent of the then outstanding principal balance of the loan and the excess of the discounted value equal to 0.25% over the yield to maturity of the then remaining principal and interest payments over the then outstanding principal balance of the loan.

We anticipate that we will enter into a three-year, $125 million secured revolving credit facility shortly following completion of this offering. Although we have not obtained a commitment from the lenders for this facility, we are in negotiations to finalize the terms of the credit agreement for this facility. We expect that this facility will have an “accordion feature,” which would provide that we may increase the size of this facility by up to $50 million if new or additional commitments are obtained. We also expect that this facility, including the

 

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“accordion feature,” should it be exercised in the future, will be secured by all of our initial properties other than our Salt Lake City contribution property and our Alpine, Texas acquisition property. We expect that affiliates of Deutsche Bank Securities Inc. will act as administrative agent and collateral agent, affiliates of Deutsche Bank Securities Inc. and UBS Securities LLC will act as co-lead arrangers and joint book-running managers, an affiliate of UBS Securities LLC will act as syndication agent, affiliates of KeyBanc Capital Markets Inc., Raymond James & Associates, Inc. and RBC Capital Markets Corporation will act as co-documentation agents and affiliates of Deutsche Bank Securities Inc., UBS Securities LLC, KeyBanc Capital Markets Inc., Raymond James & Associates, Inc., RBC Capital Markets Corporation and BB&T Capital Markets, a division of Scott & Stringfellow, LLC (together with other financial institutions) will act as lenders under this facility. We expect that we will be able to use this facility to fund acquisitions, developments, redevelopments and capital expenditures and for general corporate purposes.

We expect that the amount available for us to borrow under this facility will be based on a percentage of the appraised value of our properties that secure borrowings under this facility, subject to limitations based on the net operating income of those properties. Our ability to borrow under this facility will be subject to the receipt of appraisals of our properties by the lenders. We expect that, at our option, we will be able to prepay this facility in whole or in part without penalty.

We expect that amounts outstanding under this facility will bear interest at a floating rate equal to, at our election, LIBOR (subject to a floor of 1.50%) or the Base Rate (each as defined in our revolving credit facility) plus a spread. Additionally, we expect that we will be able to select one, two, three or six month index maturities for LIBOR-based borrowings. We expect that the Base Rate will be the highest of (i) the prime rate, (ii) the federal funds rate plus 0.50% and (iii) one month LIBOR plus 1.00% and that the spread will depend upon our leverage ratio and will range from 3.00% to 3.75% for LIBOR-based borrowings and from 2.00% to 2.75% for Base Rate-based borrowings. We expect that we will also be required to pay a fee to the lenders based on the unused portion of this facility.

We expect that our ability to borrow under this facility will be subject to our ongoing compliance with a number of customary affirmative and negative covenants, including limitations on liens, acquisitions, dispositions, investments, capital expenditures, restricted payments such as stock repurchases, leases, sale-leasebacks and affiliate transactions, as well as financial covenants, including:

 

   

a maximum leverage ratio (as measured by our consolidated indebtedness to our gross asset value) of 65%;

 

   

a minimum fixed charge coverage ratio (as measured by our consolidated earnings before interest, taxes, depreciation and amortization to our consolidated fixed charges) of 1.60 to 1;

 

   

a minimum tangible net worth equal to the sum of 80% of our tangible net worth at the closing of this facility plus an amount equal to 80% of the proceeds of any issuances of common stock after this offering; and

 

   

a maximum distribution payout ratio of the greater of (i) 95% of our FFO or (ii) the amount required for us to qualify and maintain our status as a REIT.

We expect that this facility will provide for acceleration of payment of all amounts outstanding thereunder upon the occurrence and continuation of an event of default. If a default or event of default occurs and is continuing, we expect that we will be precluded from making distributions on shares of our common stock (other than those required to allow us to qualify and maintain our status as a REIT, so long as such default or event of default does not arise from a payment default or event of insolvency).

We expect that our operating partnership will be the borrower under this facility and that borrowings under the facility will be guaranteed by us and any subsidiary of our operating partnership that owns or leases property that serves as collateral under this facility. We expect that we will have the option to remove properties from the collateral pool and to add different properties which meet pre-established criteria and are acceptable to the lenders. In addition to first priority mortgages on properties, we expect that this facility will be secured by

 

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pledges of personal property associated with, and assignment of rents from, our properties that will collateralize this facility, pledges of equity in our operating partnership and property-owning subsidiaries of our operating partnership and other ancillary customary collateral.

We have not received a commitment from the lenders for this facility and there can be no assurance that we will enter into definitive documentation with regard to this facility upon the terms described herein or at all.

Short-Term Liquidity

Our short-term liquidity requirements include the costs to complete the development of our Salt Lake City, Utah property, which we expect to be completed in the fall of 2011, future distributions, interest expense, principal payments on the debt secured by our Alpine, Texas property, operating costs of properties and certain non-recurring capital expenditures, which expenditures to date have not been material. We expect to meet our short-term liquidity requirements through the construction loan for our Salt Lake City, Utah property, net cash provided by operations, the net proceeds from this offering, and, to the extent necessary, by incurring additional indebtedness. Upon completion of this offering and our formation transactions, we expect that cash from operations and our available capital sources will be sufficient to meet our short-term liquidity needs.

Long-Term Liquidity

Our long-term liquidity requirements primarily consist of the costs to fund additional property developments and acquisitions, scheduled debt maturities and non-recurring capital expenditures. Our development activities have historically required us to fund pre-development expenditures such as architectural fees, engineering fees, earnest money deposits, and marketing costs. We typically incur these pre-development expenditures before a development award has been granted and before a financing commitment has been obtained, and, accordingly, we bear the risk of loss if we do not receive the award or financing cannot be arranged on acceptable terms. For the year ended December 31, 2009 and six months ended June 30, 2010, BC Development Co. incurred approximately $78,000 and $47,000, respectively, in pre-development expenditures that did not result in a winning bid. In addition, our acquisition activities historically have required us to fund pre-acquisition expenditures such as legal fees, engineering and environmental report fees and earnest money deposits before we approve an acquisition and before financing for the acquisition has been obtained, and, accordingly, we bear the risk of loss if we do not approve the acquisition or financing cannot be arranged on acceptable terms. For the year ended December 31, 2009 and six months ended June 30, 2010, we did not have any losses related to pre-acquisition expenditures.

We expect to meet our long-term liquidity requirements primarily with bank borrowings, the issuance of equity (including OP units) and debt securities in the capital markets (subject to prevailing market conditions), mortgage indebtedness and short-term construction loans.

In view of our strategy to grow our portfolio over time, we do not, in general, expect to meet our long-term liquidity needs through sales of our properties. In the event that, notwithstanding our expectation, we were to consider sales of our properties from time to time, our ability to sell certain of our properties could be adversely affected by obligations under the tax protection agreement and the general illiquidity of real estate. In addition, we are subject to a right of first negotiation with the ground lessor of our Great Falls, Montana property until 2082, and our Durham, North Carolina property is subject to a right of first refusal held by a third party until March 22, 2049, which may inhibit our ability to sell these properties.

 

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Commitments and Contingencies

As of June 30, 2010, each of our contribution properties was encumbered by construction loans as follows:

 

Property / Location

 

Lender

  Amount of
Debt

Outstanding
   

Interest Rate

 

Maturity Date

Jacksonville, Florida

  M & I Marshall & Ilsley Bank   $ 45,155,263 (1)   

One month LIBOR plus 1.65%

through 8/1/2010 and thereafter one month LIBOR plus 3.75% with a minimum all-in interest rate of 5.00%(1)

  3/31/2011(2)

Great Falls, Montana

  M & I Marshall & Ilsley Bank     18,650,044 (1)   

One month LIBOR plus 1.65%

through 8/1/2010 and thereafter one month LIBOR plus 3.75% with a minimum all-in interest rate of 5.00%(1)

  3/31/2011(2)

Denver, Colorado

  Bank of America, N.A.     13,861,405(1)      Daily LIBOR plus 4.00% through 11/30/2010 and thereafter LIBOR plus 5.00% through the maturity date   11/30/2011

Salt Lake City, Utah

  Zion’s First National Bank     2,352,422(3)      Three month LIBOR plus 3.50% with a floor of 6.5%, subject to reduction to LIBOR plus 3.00% with a floor of 5.5% if loan extended and converted  

The earlier of 3/1/2012 and the month following GSA lease payment commencement,

subject to extension to 3/1/2015 if loan converted to a term loan

 

(1) Excludes the impact of principal amortization payments since June 30, 2010.
(2) Reflects the terms of loan modifications committed to by the lender in May 2010.
(3) Excludes approximately $2,165,000 of additional debt incurred, for the period from July 1, 2010 through September 15, 2010, pursuant to draws on the construction loan for our Salt Lake City, Utah development property.

The Salt Lake City, Utah construction loan has a borrowing capacity of $16.9 million and will remain in-place after this offering to fund the construction costs of this project. Following completion of this construction, we intend to pay off this construction loan with borrowings under our revolving credit facility, mortgage indebtedness or the issuance of debt or equity securities in the capital markets.

We intend to acquire our acquisition properties with a portion of the net proceeds of this offering. A portion of the purchase price for any of our acquisition properties encumbered by indebtedness, other than our Alpine, Texas property, will be paid directly to the related lenders to retire such indebtedness in full. Accordingly, we do not plan to assume or otherwise incur any indebtedness in respect of our acquisition properties, other than the approximately $15.2 million of indebtedness secured by our Alpine, Texas property as of June 30, 2010. See “Business and Properties—Our Initial Properties—Financing Arrangements.”

Commitments

The following table summarizes amounts due in connection with contractual obligations of our predecessor as of December 31, 2009 (in thousands):

 

Contractual Obligations

   Total    Less than
1 Year
   1-3 Years    3-5 Years    More than
5 Years

Long-Term Debt Obligations(1)

   $ 63,805    $ 625    $ 63,180    $ —      $ —  

Interest on Long-Term Debt Obligations

     2,749      1,885      864      —        —  

Operating Lease Obligations(2)

     7,271      90      180      180      6,821

Purchase Obligations(3)

     —        —        —        —        —  

Other Long-Term Liabilities

     —        —        —        —        —  
                                  

Total

   $ 73,825    $ 2,600    $ 64,224    $ 180    $ 6,821
                                  

 

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(1) Since the contractual obligations listed in the table above relate solely to our predecessor, such table does not reflect long-term debt obligations of our Salt Lake City, Utah and Alpine, Texas properties. The Salt Lake City property, with a total loan commitment of $16,900, is currently under development and therefore the debt obligation will not be determinable until the construction is complete. The long-term debt obligation, including interest and principal, for the Alpine, Texas property totals $22,600.
(2) Our Great Falls, Montana property is subject to a ground lease for a term of 75 years, beginning July 4, 2007. The initial lease rate of $7,500 per month is subject to annual increases based on the increase in the Consumer Price Index. The rent increases an additional 0.5% per year following the 20th year of the lease term.
(3) The above table does not reflect construction commitments, totaling $15.7 million as of December 31, 2009, for our Salt Lake City, Utah property, which is not part of our predecessor.

Off-Balance Sheet Arrangements

As of June 30, 2010, we did not have any off-balance sheet arrangements.

Pro Forma Funds From Operations

We present FFO because we consider it an important supplemental measure of our operating performance and believe it is frequently used by securities analysts, investors and other interested parties in the evaluation of REITs, many of which present FFO when reporting their operating results. FFO is intended to exclude historical cost depreciation and amortization of real estate and related assets, which assumes that the value of real estate assets diminishes ratably over time. Historically, however, real estate values have risen or fallen with market conditions. Because FFO excludes depreciation and amortization unique to real estate, gains and losses from property dispositions and extraordinary items, it provides a performance measure that, when compared period-over-period, reflects the impact to operations from trends in occupancy rates, rental rates, operating costs, development activities and interest costs, providing perspective not immediately apparent from net income (loss). We compute FFO in accordance with standards established by the Board of Governors of NAREIT in its March 1995 White Paper (as amended in November 1999 and April 2002). As defined by NAREIT, FFO represents net income (computed in accordance with GAAP), excluding gains (or losses) from sales of property, plus real estate related depreciation and amortization (excluding amortization of loan origination costs) and after adjustments for unconsolidated partnerships and joint ventures. Our computation may differ from the methodology for calculating FFO utilized by other equity REITs and, accordingly, may not be comparable to such other REITs. Furthermore, FFO does not represent amounts available for management’s discretionary use because of needed capital replacement or expansion, debt service obligations, or other commitments and uncertainties. FFO should not be considered as an alternative to net income (loss) (computed in accordance with GAAP) as an indicator of our financial performance or to cash flow from operating activities (computed in accordance with GAAP) as an indicator of our liquidity, nor is it indicative of funds available to fund our cash needs, including our ability to pay dividends or make distributions to our stockholders.

The following table presents a reconciliation of our pro forma FFO for the period presented (in thousands):

 

     Pro Forma
Six Months Ended
June 30, 2010
   Pro Forma
Year Ended
December 31, 2009

Net income

   $ 3,756    $ 5,324

Depreciation and amortization

     4,141      6,453
             

FFO

   $ 7,897    $ 11,777
             

Our pro forma FFO reflects certain contractual costs that we will incur as a public company. In addition to the costs included in our pro forma FFO, we anticipate incurring other costs as a public company, such as additional office, audit, accounting, and legal fees, that are not currently determinable. Such costs will reduce our pro forma FFO and may be material.

Quantitative and Qualitative Disclosures About Market Risk

Upon completion of this offering and the formation transactions, the only variable rate indebtedness we expect to have outstanding is variable-rate construction loan related to the Salt Lake City, Utah property. The

 

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Salt Lake City construction loan has a maximum borrowing capacity of $16.9 million and a maturity date of March 1, 2012, subject to extension to March 1, 2015 if the loan is converted to a term loan. The loan has a variable interest rate based on the three month LIBOR plus 3.50% with a floor of 6.5% during the construction period and the three month LIBOR plus 3.00% with a floor of 5.5% after the earlier of the construction period end date or March 1, 2012. As of June 30, 2010, the outstanding balance on this loan was $2.4 million and was incurring interest at the floor rate of 6.5%. If market rates of interest on our variable rate debt outstanding as of June 30, 2010 (on a pro forma basis) increased by 1.00%, or 100 basis points, the interest incurred on our variable rate debt would not increase due to the interest rate floor mechanism. This interest is capitalized in the cost of the development and not treated as interest expense and, since it is paid from our construction loan, it does not impact our cash flows.

We anticipate that we will enter into a $125 million three-year secured revolving credit facility shortly following completion of this offering. We expect that we will be able to use this revolving credit facility to fund acquisitions, developments, redevelopments and capital expenditures and for general corporate purposes. We have not received a commitment from the lenders for this facility and there can be no assurance that we will enter into definitive documentation with regard to this facility upon the terms described or at all. Our exposure to fluctuations in interest rates will increase or decrease in the future with increases or decreases in the outstanding amount of our revolving credit facility and any other floating rate debt that we may incur.

Impact of Inflation

Inflation might have both positive and negative impacts upon us. Inflation might cause the value of our real estate to increase. Inflation might also cause our costs of equity and debt capital and operating costs to increase. An increase in our capital costs or in our operating costs will result in decreased earnings unless it is offset by increased revenues. Our federal government-leases generally provide for annual rent increases based on a cost of living index for the locality in which the particular property is located, which should offset any increased costs as a result of inflation.

To mitigate the adverse impact of any increased cost of debt capital in the event of material inflation, we may enter into interest rate hedge arrangements in the future, but we have no present intention to do so. The decision to enter into these agreements will be based on the amount of our floating rate debt outstanding, our belief that material interest rate increases are likely to occur and requirements of our borrowing arrangements.

Critical Accounting Policies

Our critical accounting policies are those that will have the most impact on the reporting of our financial condition and results of operations and those requiring significant judgments and estimates. We believe that our judgments and estimates will be applied consistently and produce financial information that fairly presents our results of operations and financial condition. Our most critical accounting policies involve our investments in real property. These policies affect our:

 

   

allocation of purchase price and development costs between various asset categories and the related impact on the recognition of rental income and depreciation and amortization expense;

 

   

assessment of the carrying values and impairment of long lived assets; and

 

   

classification of leases.

Real Estate

Our portfolio will consist of properties acquired from third parties, which have already been built or are nearing completion and are subject to existing federal government-leases, as well as properties developed by us under leases negotiated by our officers and employees with the GSA or other federal government departments or

 

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agencies that lease properties directly rather than through the GSA. The accounting policies relating to each of these properties are substantially similar, but certain distinctions are noted below.

Purchase Price Allocation

The purchase prices for properties acquired from third parties are allocated to land, building and improvements and identified tangible and intangible net assets, and each asset component generally has a different useful life. Identified intangible assets and liabilities generally include the value of above market and below market leases, the value of in-place leases and the value of tenant relationships. Purchase price allocations and the determination of useful lives are based on estimates, information obtained about each property as a result of our due diligence, marketing and leasing activities and, under some circumstances, studies from independent real estate appraisal firms.

Purchase price allocations to land, building and improvements are based on a determination of the relative fair values of these assets assuming the property is vacant. We determine the fair value of a property using methods that we believe are similar to those used by independent appraisers including a discounted cash flow analysis, capitalization rate analysis and internal rate of return analysis. Purchase price allocations to above-market and below-market leases are based on the estimated present value (using an interest rate that reflects our assessment of the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) our estimate of fair market lease rates for the corresponding leases, measured over a period equal to the remaining terms of the respective leases. Purchase price allocations to in-place leases and tenant relationships are determined as the excess of (i) the purchase price paid for a property after adjusting existing in-place leases to estimated market rental rates over (ii) the estimated fair value of the property as if vacant. This aggregate value is allocated between in-place lease values and tenant relationships, based on our evaluation of the specific characteristics of each tenant’s lease; however, the value of tenant relationships has not been separated from in-place lease value for our properties, because such value is immaterial for acquisitions reflected in the historical financial statements. Factors we consider in performing these analyses include estimates of carrying costs during any expected lease-up periods for properties not occupied at purchase by an agency or agencies of the federal government, including real estate taxes, insurance and other operating income and expenses and costs to execute similar leases in current market conditions, such as leasing commissions, legal and other related costs. If the value of tenant relationships is material in the future, those amounts will be allocated separately and amortized over the estimated lives of the relationships.

Projects Developed by Us

All development projects and related carrying costs are capitalized and reported on our combined balance sheet as construction in progress. As each project is completed and becomes available for occupancy by the agency or agencies of the federal government for which the property has been leased, the total cost of the project is depreciated over the estimated useful life. Interest and personnel support cost directly related to the development are capitalized as part of the real estate under development to the extent that such charges do not cause the carrying value of the asset to exceed its net realizable value.

Pre-development expenditures such as architectural fees, permits and deposits associated with the pursuit of owned development projects are expensed as incurred, until such time that management believes it is probable that the lease will be executed and/or construction will commence. Because we frequently incur these pre-development expenditures before a federal government-lease is signed, or a financing commitment and/or required permits and authorizations have been obtained, we bear the risk of loss of these pre-development expenditures if we are not selected by the federal government as the landlord, or financing cannot ultimately be arranged on acceptable terms or we are unable to successfully obtain the required permits and authorizations. As such, management evaluates the status of owned projects that have not yet commenced construction on a periodic basis and expenses any deferred costs related to projects, the current status of which indicates the commencement of construction is unlikely and/or the costs may not provide future value to us in the form of revenues. Such

 

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write-offs will be included in general and administrative expenses on the accompanying combined statements of operations. To date, however, such costs typically have been borne by BC Development Co.

Revenue Recognition

We recognize rental revenue on the straight-line method over the non-cancelable terms of the related lease agreements for new leases and the remaining non-cancelable terms of existing leases for acquired properties. Differences between rental income earned and amounts due per the respective lease agreements are credited or charged, to deferred rent receivables or deferred rent income, as applicable, on the combined balance sheets. These differences are attributable to rent concessions and contracted monthly rental payment changes over the non-cancelable lease term. Rental payments received prior to their recognition as income are classified as deferred rental income on the consolidated balance sheets. Our leases are generally only subject to annual inflation increases, measured by the increase in the cost of living in the locality wherein the property is located, year-over-year. Our leases generally contain provisions under which the tenant reimburses us for real estate taxes incurred by us over a specified base amount. Such amounts are recognized as tenant reimbursement revenue in the period in which the real estate tax expenses over the specified base amount are incurred.

We evaluate the collectability of our accounts receivable related to rent, expense reimbursements and other revenue. We specifically analyze accounts receivable and historical bad debts, tenant concentrations, tenant credit worthiness, geographic concentrations and current economic trends when evaluating the adequacy of the allowance for doubtful accounts receivable. These estimates have a direct impact on our net income, because a higher bad debt allowance will result in lower net income. Because the leases on our properties are, and are expected to be, full faith and credit obligations of the federal government and not subject to budget appropriations, it is anticipated that these allowances will be minimal.

Depreciation and Amortization Expense

We compute depreciation expense using the straight line method over estimated useful lives of up to 39 years for buildings and improvements, and up to 12 years for personal property. The allocated cost of land is not depreciated. Capitalized above market lease values are amortized as a reduction to rental income over the remaining non-cancelable terms of the respective leases. Deferred below market lease values are amortized as an increase to rental income over the remaining non-cancelable terms of the respective leases. There are no bargain renewal periods within the leases to consider in determining below-market lease values. The value of in-place leases, exclusive of the value of above market and below market in-place leases, is amortized to expense over the remaining non-cancelable periods of the respective leases. If a lease is terminated prior to its stated expiration, all unamortized amounts relating to that lease are written off. Purchase price allocations will require us to make certain assumptions and estimates. Incorrect assumptions and estimates may result in inaccurate depreciation and amortization charges over future periods. We must estimate the useful lives of our properties for purposes of determining the amount of depreciation to record on an annual basis with respect to our investments in real estate. These assessments have a direct impact on our net income, because if we were to shorten the expected useful lives of our investments in real estate, then we would depreciate these investments over fewer years, resulting in more depreciation expense and lower net income on an annual basis.

Impairment

We will periodically evaluate our properties for impairment. Impairment indicators may include declining tenant occupancy, legislative changes, economic or market changes that could permanently reduce the value of a property or our decision to dispose of an asset before the end of its estimated useful life. If indicators of impairment are present, we will evaluate the carrying value of the related property by comparing it to the expected future undiscounted cash flows to be generated from that property. If the sum of these expected future, cash flows is less than the carrying value, then we will reduce the net carrying value of the property to its fair value. This analysis will require us to judge whether indicators of impairment exist and to estimate likely future

 

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cash flows. If we misjudge or estimate incorrectly or if future tenant operations, market or industry factors differ from our expectations, then we may record an impairment charge that is inappropriate or fail to record a charge when we should have done so, or the amount of any such charges may be inaccurate.

These policies involve making significant judgments based upon experience, including judgments about current valuations, ultimate realizable value, estimated useful lives, salvage or residual value, the ability and willingness of our tenants to perform their obligations to us, current and future economic conditions and competitive factors in the markets in which our properties are located. Competition, economic conditions and other factors may cause occupancy declines in the future. In the future, we may need to revise our carrying value assessments to incorporate information that is not now known, and such revisions could increase or decrease our depreciation expense related to properties we own, result in the classification of our leases as other than operating leases or decrease the carrying values of our assets.

Capital Expenditures

We distinguish between capital expenditures necessary for the ongoing operations of our properties or required under the terms of existing leases and acquisition-related improvements incurred within one to two years of acquisition of the related property. (Acquisition-related improvements are expenditures that have been identified at the time the property is acquired, and which we intended to incur in order to position the property to be consistent with our intended use of the property). We capitalize non-recurring expenditures for additions and betterments to buildings and land improvements. In addition, we generally capitalize expenditures for exterior painting, roofing, and other major maintenance projects that substantially extend the useful life of the existing assets. The cost of ordinary repairs and maintenance that do not improve the value of an asset or extend its useful life are charged to expense when incurred. Planned major repair, maintenance and improvement projects are capitalized when performed.

Recent Accounting Pronouncements

Business Combinations

In December 2008, the Financial Accounting Standards Board, or FASB, issued new guidance included in FASB Accounting Standard Codification, or ASC, ASC 805 “Business Combinations.” ASC 805 retains the fundamental requirements of the previous pronouncement requiring that the purchase method be used for all business combinations. ASC 805 defines the acquirer as the entity that obtains control of one or more businesses in the business combination, establishes the acquisition date as the date that the acquirer achieves control and requires the acquirer to recognize the assets and liabilities assumed and any non-controlling interest at their fair values as of the acquisition date. ASC 805 requires, among other things, that the acquisition related costs be recognized separately from the acquisition. ASC 805 applies to business combinations for which the acquisition date is on or after January 1, 2009. The adoption of this standard will impact any future acquisitions.

Fair Value Measurements

In September 2006, the FASB issued new guidance included in ASC 820-10 “Fair Value Measurements” which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. In November 2008, the FASB agreed to a one-year deferral of the effective date of ASC 820-10 for all non-financial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis. ASC 820-10 was effective for us beginning on January 1, 2008 for financial assets and liabilities. On January 1, 2009, we adopted the remaining aspects of ASC 820-10 that had been deferred.

The adoption of this standard did not have a material effect on our predecessor’s combined financial statements other than additional disclosures. Under the standard, fair value refers to the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The standard establishes a fair value hierarchy giving the highest priority to quoted market

 

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prices in active markets and the lowest priority to unobservable data. ASC 820-10 requires fair value measurements to be separately disclosed by level within the fair value hierarchy and establishes three levels of inputs that may be used to measure fair value.

 

Level 1 —