Financial Instruments and Fair Values

Derivative Financial Instruments

We use derivative financial instruments primarily to manage interest rate risk and such derivatives are not considered speculative. These derivative instruments are typically in the form of interest rate swap and forward agreements and the primary objective is to minimize interest rate risks associated with investing and financing activities. The counterparties of these arrangements are major financial institutions with which we may also have other financial relationships. We are exposed to credit risk in the event of non-performance by these counterparties; however, we currently do not anticipate that any of the counterparties will fail to meet their obligations.

We have agreements with our derivative counterparties that contain a provision where if we either default or are capable of being declared in default on any of our indebtedness, then we could also be declared in default on our derivative obligations. As of June 30, 2017, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $12.0 million. If we had breached any of these provisions at June 30, 2017, we could have been required to settle our obligations under the agreements at their termination value of $12.0 million.

As of June 30, 2017, we had interest rate LIBOR swaps with an aggregate notional value of $790.0 million. The notional value does not represent exposure to credit, interest rate or market risks. As of June 30, 2017, the fair value of these derivative instruments amounted to ($11.9 million) which is included in accounts payable and accrued expenses on the condensed consolidated balance sheet. As of December 31, 2016, the fair value of these derivative instruments amounted to $0.6 million which is included in prepaid expenses and other assets and ($5.6 million) which was included in accounts payable and accrued expenses on the condensed consolidated balance sheet. These interest rate swaps have been designated as cash flow hedges and hedge the future cash outflows on our mortgage debt and also on our term loan facility that is subject to a floating interest rate. As of June 30, 2017 and 2016, these cash flow hedges are deemed effective and a net unrealized loss of $(14.4) million and $(10.9) million for the three months ended June 30, 2017 and 2016, respectively, and a net unrealized loss of $(13.0) million and $(30.2) million for the six months ended June 30, 2017 and 2016, respectively, are reflected in the condensed consolidated statements of comprehensive income (loss). Amounts reported in accumulated other comprehensive income (loss) related to derivatives will be reclassified to interest expense as interest payments are made on the debt. We estimate that $2.5 million of the current balance held in accumulated other comprehensive income (loss) will be reclassified into interest expense within the next 12 months relating to the interest rate swap contracts in effect as of June 30, 2017.

The table below summarizes the terms of agreements and the fair values of our derivative financial instruments as of June 30, 2017 and December 31, 2016 (dollar amounts in thousands):



	As of June 30, 2017						June 30, 2017					December 31, 2016
Derivative	Notional Amount		Receive Rate	Pay Rate	Effective Date	Expiration Date	Asset		Liability			Asset		Liability
Interest rate swap	$	265,000	1 Month LIBOR	2.1485%	August 31, 2017	August 24, 2022	$	—	$	(3,338	)	$	—	$	(1,634	)
Interest rate swap ⁽¹⁾	100,000		3 Month LIBOR	2.5050%	July 5, 2017	July 5, 2027	—		—			—		(684		)
Interest rate swap (1) (2)	80,000		3 Month LIBOR	2.5050%	July 5, 2017	July 5, 2027	—		—			—		(685		)
Interest rate swap	100,000		3 Month LIBOR	2.4860%	January 5, 2018	January 5, 2028	—		(1,207		)	224		—
Interest rate swap	100,000		3 Month LIBOR	2.4860%	January 5, 2018	January 5, 2028	—		(1,207		)	223		—
Interest rate swap	75,000		3 Month LIBOR	2.4860%	January 5, 2018	January 5, 2028	—		(905		)	167		—
Interest rate swap	75,000		3 Month LIBOR	2.7620%	June 1, 2018	June 1, 2028	—		(2,387		)	—		(1,295		)
Interest rate swap	75,000		3 Month LIBOR	2.7620%	June 1, 2018	June 1, 2028	—		(2,386		)	—		(1,293		)
Interest rate swap	100,000		3 Month LIBOR	2.4625%	June 1, 2018	June 1, 2028	—		(517		)	—		—
							$	—	$	(11,947	)	$	614	$	(5,591	)


(1)	During June 2017, these swaps aggregating $180.0 million were terminated in connection with the refinancing of several of our mortgage debt (see Note 4 Debt). As of June 30, 2017, the deferred net losses from these terminated hedges amounted to $6.0 million which is included in accumulated other comprehensive loss relating to net unrealized loss from derivative financial instruments.

(2)

During March 2017, $20.0 million of an original notional amount of $100.0 million was terminated. In connection with the partial termination and re-designation of the related cash flow hedges, $0.3 million is recognized as a loss from derivative financial instruments and included in Other Expense on the condensed consolidated statement of income for the six months ended June 30, 2017. There was no loss from derivative financial instruments for the three and six months ended June 30, 2016.

The table below shows the effect of our derivative financial instruments designated as cash flow hedges for the three and six months ended June 30, 2017 and 2016 (amounts in thousands):



	Three Months Ended						Six Months Ended
Effects of Cash Flow Hedges	June 30, 2017			June 30, 2016			June 30, 2017			June 30, 2016
Amount of gain (loss) recognized in other comprehensive income (loss) - effective portion	$	(14,367	)	$	(10,864	)	$	(12,973	)	$	(30,235	)
Amount of gain (loss) reclassified from accumulated other comprehensive income (loss) into interest expense - effective portion	(43		)	—			(43		)	—
Amount of gain (loss) recognized in other expense - ineffective portion	(42		)	—			(289		)	—

Fair Valuation

The estimated fair values at June 30, 2017 and December 31, 2016 were determined by management, using available market information and appropriate valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts we could realize on disposition of the financial instruments. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

The fair value of our senior unsecured notes - Exchangeable was derived from quoted prices in active markets and is classified as Level 2 since trading volumes are low.

The fair value of derivative instruments is determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative. Although the majority of the inputs used to value our derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with our derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by ourselves and our counterparties. The impact of such credit valuation adjustments, determined based on the fair value of each individual contract, was not significant to the overall valuation. As a result, all of our derivatives were classified as Level 2 of the fair value hierarchy.

The fair value of our mortgage notes payable, senior unsecured notes - Series A, B and C, and unsecured term loan facility which are determined using Level 3 inputs, are estimated by discounting the future cash flows using current interest rates at which similar borrowings could be made to us.

The following tables summarize the carrying and estimated fair values of our financial instruments as of June 30, 2017 and December 31, 2016 (amounts in thousands):



	June 30, 2017
			Estimated Fair Value
	Carrying Value		Total		Level 1		Level 2		Level 3
Interest rate swaps included in prepaid expenses and other assets	$	—	$	—	$	—	$	—	$	—
Interest rate swaps included in accounts payable and accrued expenses	11,947		11,947		—		11,947		—
Mortgage notes payable	724,312		712,213		—		—		712,213
Senior unsecured notes - Exchangeable	243,106		282,878		—		282,878		—
Senior unsecured notes - Series A, B, and C	348,967		345,258		—		—		345,258
Unsecured term loan facility	263,114		265,000		—		—		265,000



	December 31, 2016
			Estimated Fair Value
	Carrying Value		Total		Level 1		Level 2		Level 3
Interest rate swaps included in prepaid expenses and other assets	$	614	$	614	$	—	$	614	$	—
Interest rate swaps included in accounts payable and accrued expenses	5,591		5,591		—		5,591		—
Mortgage notes payable	759,016		755,640		—		—		755,640
Senior unsecured notes - Exchangeable	241,474		282,435		—		282,435		—
Senior unsecured notes - Series A, B, and C	348,914		339,274		—		—		339,274
Unsecured term loan facility	262,927		265,000		—		—		265,000

Disclosure about the fair value of financial instruments is based on pertinent information available to us as of June 30, 2017 and December 31, 2016. Although we are not aware of any factors that would significantly affect the reasonable fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and current estimates of fair value may differ significantly from the amounts presented herein.