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 March 31, 2019, 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 $10.4 million. If we had breached any of these provisions at March 31, 2019, we could have been required to settle our obligations under the agreements at their termination value of $10.4 million.

As of March 31, 2019 and December 31, 2018, we had interest rate LIBOR swaps with an aggregate notional value of $515.0 million and $515.0 million, respectively. The notional value does not represent exposure to credit, interest rate or market risks. As of March 31, 2019, the fair value of our derivative instruments amounted to $(10.3) million which is included in accounts payable and accrued expenses on the condensed consolidated balance sheet. As of December 31, 2018, the fair value of our derivative instruments amounted to $2.5 million which is included in prepaid expenses and other assets and $(5.2) million which is 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 variability in future cash flows associated with our existing variable-rate term loan facility and with a forecast refinancing of our exchangeable senior notes.

As of March 31, 2019 and 2018, our cash flow hedges are deemed highly effective and a net unrealized gain (loss) of $(7.2) million and $4.8 million for the three months ended March 31, 2019 and 2018, respectively, relating to both active and terminated hedges of interest rate risk, are reflected in the condensed consolidated statements of comprehensive income. 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 $(2.0) million net loss of the current balance held in accumulated other comprehensive income (loss) will be reclassified into interest expense within the next 12 months.

The table below summarizes the terms of agreements and the fair values of our derivative financial instruments as of March 31, 2019 and December 31, 2018 (dollar amounts in thousands):



							March 31, 2019					December 31, 2018
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	$	—		$	2,536	$	—
Interest rate swap	125,000		3 Month LIBOR	2.9580%	July 1, 2019	July 1, 2026	—		(5,168		)	—		(2,623		)
Interest rate swap	125,000		3 Month LIBOR	2.9580%	July 1, 2019	July 1, 2026	—		(5,168		)	—		(2,620		)
							$	3	$	(10,336	)	$	2,536	$	(5,243	)

The table below shows the effect of our derivative financial instruments designated as cash flow hedges on accumulated other comprehensive income (loss) for the three months ended March 31, 2019 and 2018 (amounts in thousands):



	Three Months Ended
Effects of Cash Flow Hedges	March 31, 2019			March 31, 2018
Amount of gain (loss) recognized in other comprehensive income (loss)	$	(7,390	)	$	4,180
Amount of gain (loss) reclassified from accumulated other comprehensive income (loss) into interest expense	(149		)	(599		)

The table below shows the effect of our derivative financial instruments designated as cash flow hedges on the condensed consolidated statements of income for the three months ended March 31, 2019 and 2018 (amounts in thousands):



	Three Months Ended
Effects of Cash Flow Hedges	March 31, 2019			March 31, 2018
Total interest (expense) presented in the condensed consolidated statements of income in which the effects of cash flow hedges are recorded	$	(20,689	)	$	(17,591	)
Amount of gain (loss) reclassified from accumulated other comprehensive income (loss) into interest expense	(149		)	(599		)

Fair Valuation

The estimated fair values at March 31, 2019 and December 31, 2018 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, C, D, E and F, unsecured term loan facility and ground lease liabilities 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 March 31, 2019 and December 31, 2018 (amounts in thousands):



	March 31, 2019
			Estimated Fair Value
	Carrying Value		Total		Level 1		Level 2		Level 3
Interest rate swaps included in prepaid expenses and other assets	$	3	$	3	$	—	$	3	$	—
Interest rate swaps included in accounts payable and accrued expenses	10,336		10,336		—		10,336		—
Mortgage notes payable	607,823		609,901		—		—		609,901
Senior unsecured notes - Exchangeable	248,745		248,750		—		248,750		—
Senior unsecured notes - Series A, B, C, D, E and F	798,333		813,490		—		—		813,490
Unsecured term loan facility	264,271		265,000		—		—		265,000
Ground lease liabilities	29,452		29,452		—		—		29,452



	December 31, 2018
			Estimated Fair Value
	Carrying Value		Total		Level 1		Level 2		Level 3
Interest rate swaps included in prepaid expenses and other assets	$	2,536	$	2,536	$	—	$	2,536	$	—
Interest rate swaps included in accounts payable and accrued expenses	5,243		5,243		—		5,243		—
Mortgage notes payable	608,567		597,424		—		—		597,424
Senior unsecured notes - Exchangeable	247,930		250,625		—		250,625		—
Senior unsecured notes - Series A, B, C, D, E and F	798,289		795,662		—		—		795,662
Unsecured term loan facility	264,147		265,000		—		—		265,000

Disclosure about the fair value of financial instruments is based on pertinent information available to us as of March 31, 2019 and December 31, 2018. 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.