Risk Management and Use of Derivative Financial Instruments

Risk Management

In the normal course of our ongoing business operations, we encounter economic risk. There are four main components of economic risk that impact us: interest rate risk, credit risk, market risk, and foreign currency risk. We are primarily subject to interest rate risk on our interest-bearing liabilities. Credit risk is the risk of default on our operations and our tenants’ inability or unwillingness to make contractually required payments. Market risk includes changes in the value of our properties and related loans, as well as changes in the value of our other investments due to changes in interest rates or other market factors. We own international investments, primarily in Europe, and are subject to risks associated with fluctuating foreign currency exchange rates.

Derivative Financial Instruments

When we use derivative instruments, it is generally to reduce our exposure to fluctuations in interest rates and foreign currency exchange rate movements. We have not entered into, and do not plan to enter into financial instruments for trading or speculative purposes. In addition to entering into derivative instruments on our own behalf, we may also be a party to derivative instruments that are embedded in other contracts. The primary risks related to our use of derivative instruments include: (i) a counterparty to a hedging arrangement defaulting on its obligation and (ii) a downgrade in the credit quality of a counterparty to such an extent that our ability to sell or assign our side of the hedging transaction is impaired. While we seek to mitigate these risks by entering into hedging arrangements with large financial institutions that we deem to be creditworthy, it is possible that our hedging transactions, which are intended to limit losses, could adversely affect our earnings. Furthermore, if we terminate a hedging arrangement, we may be obligated to pay certain costs, such as transaction or breakage fees. We have established policies and procedures for risk assessment, as well as the approval, reporting, and monitoring of derivative financial instrument activities.

We measure derivative instruments at fair value and record them as assets or liabilities, depending on our rights or obligations under the applicable derivative contract. Derivatives that are not designated as hedges must be adjusted to fair value through earnings. For a derivative designated, and that qualified, as a cash flow hedge, the effective portion of the change in fair value of the derivative is recognized in Other comprehensive income until the hedged item is recognized in earnings. For a derivative designated, and that qualified, as a net investment hedge, the effective portion of the change in its fair value and/or the net settlement of the derivative is reported in Other comprehensive income as part of the cumulative foreign currency translation adjustment. The ineffective portion of the change in fair value of any derivative is immediately recognized in earnings.

All derivative transactions with an individual counterparty are governed by a master International Swap and Derivatives Association agreement, which can be considered as a master netting arrangement; however, we report all our derivative instruments on a gross basis on our consolidated financial statements. At both March 31, 2018 and December 31, 2017, no cash collateral had been posted or received for any of our derivative positions.

The following table sets forth certain information regarding our derivative instruments (in thousands):



Derivatives Designated as Hedging Instruments	Balance Sheet Location	Asset Derivatives Fair Value at				Liability Derivatives Fair Value at
Derivatives Designated as Hedging Instruments	Balance Sheet Location	March 31, 2018		December 31, 2017		March 31, 2018			December 31, 2017
Foreign currency forward contracts	Other assets, net	$	1,769	$	2,419	$	—		$	—
Interest rate swaps	Other assets, net	1,133		553		—			—
Foreign currency collars	Other assets, net	11		258		—			—
Interest rate caps	Other assets, net	4		1		—			—
Foreign currency collars	Accounts payable, accrued expenses and other liabilities	—		—		(4,373		)	(3,266		)
Interest rate swaps	Accounts payable, accrued expenses and other liabilities	—		—		(121		)	(698		)
Derivatives Not Designated as Hedging Instruments
Foreign currency collars	Accounts payable, accrued expenses and other liabilities	—		—		(443		)	(366		)
Total		$	2,917	$	3,231	$	(4,937	)	$	(4,330	)

The following tables present the impact of our derivative instruments in the consolidated financial statements (in thousands):



	Amount of Gain (Loss) Recognized on Derivatives in Other Comprehensive Income (Effective Portion)
	Three Months Ended March 31,
Derivatives in Cash Flow Hedging Relationships	2018			2017
Foreign currency collars	$	(1,205	)	$	(235	)
Interest rate swaps	1,157			247
Foreign currency forward contracts	(629		)	(471		)
Interest rate caps	18			2
Derivatives in Net Investment Hedging Relationship ^(a)
Foreign currency collars	(126		)	(10		)
Foreign currency forward contracts	(23		)	(19		)
Total	$	(808	)	$	(486	)

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(a)	The effective portion of the changes in fair value and the settlement of these contracts is reported in the foreign currency translation adjustment section of Other comprehensive income until the underlying investment is sold, at which time we reclassify the gain or loss to earnings.



		Amount of Gain (Loss) on Derivatives Reclassified from Other Comprehensive Income into Income (Effective Portion)
Derivatives in Cash Flow Hedging Relationships	Location of Gain (Loss) Recognized in Income	Three Months Ended March 31,
Derivatives in Cash Flow Hedging Relationships	Location of Gain (Loss) Recognized in Income	2018			2017
Foreign currency forward contracts	Other gains and (losses)	$	222		$	356
Foreign currency collars	Other gains and (losses)	(154		)	92
Interest rate swaps	Interest expense	(83		)	(211		)
Interest rate caps	Interest expense	(31		)	(5		)
Total		$	(46	)	$	232

Amounts reported in Other comprehensive income related to our interest rate swaps will be reclassified to Interest expense as interest payments are made on our variable-rate debt. Amounts reported in Other comprehensive income related to foreign currency derivative contracts will be reclassified to Other gains and (losses) when the hedged foreign currency contracts are settled. At March 31, 2018, we estimated that an additional $0.2 million and $0.1 million will be reclassified as Interest expense and Other gains and (losses), respectively, during the next 12 months.

The following table presents the impact of our derivative instruments in the consolidated financial statements (in thousands):



		Amount of Gain (Loss) on Derivatives Recognized in Income
Derivatives Not in Cash Flow Hedging Relationships	Location of Gain (Loss) Recognized in Income	Three Months Ended March 31,
Derivatives Not in Cash Flow Hedging Relationships	Location of Gain (Loss) Recognized in Income	2018			2017
Foreign currency collars	Other gains and (losses)	$	(151	)	$	(20	)
Interest rate swaps	Interest expense	(6		)	(48		)
Derivatives in Cash Flow Hedging Relationships
Foreign currency collars	Other gains and (losses)	(10		)	1
Interest rate swaps ^(a)	Interest expense	6			3
Total		$	(161	)	$	(64	)

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(a)	Relates to the ineffective portion of the hedging relationship.

Interest Rate Swaps and Caps

We are exposed to the impact of interest rate changes primarily through our borrowing activities. To limit this exposure, we attempt to obtain mortgage financing on a long-term, fixed-rate basis. However, from time to time, we or our joint investment partners have obtained, and may in the future obtain, variable-rate non-recourse mortgage loans and, as a result, we have entered into, and may continue to enter into interest rate swap agreements or interest rate cap agreements with counterparties. Interest rate swaps, which effectively convert the variable-rate debt service obligations of a loan to a fixed rate, are agreements in which one party exchanges a stream of interest payments for a counterparty’s stream of cash flow over a specific period. The notional, or face, amount on which the swaps are based is not exchanged. Interest rate caps limit the effective borrowing rate of variable-rate debt obligations while allowing participants to share in downward shifts in interest rates. Our objective in using these derivatives is to limit our exposure to interest rate movements.

The interest rate swaps and caps that our consolidated subsidiaries had outstanding at March 31, 2018 are summarized as follows (currency in thousands):



Interest Rate Derivatives	Number of Instruments	Notional Amount		Fair Value at March 31, 2018 ^(a)
Interest rate swaps	8	60,601	USD	$	1,020
Interest rate swap	1	10,146	EUR	(8		)
Interest rate caps	3	27,700	USD	4
				$	1,016

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(a)	Fair value amount is based on the exchange rate of the euro at March 31, 2018, as applicable.

Foreign Currency Contracts

We are exposed to foreign currency exchange rate movements, primarily in the euro and, to a lesser extent, the Norwegian krone. We manage foreign currency exchange rate movements by generally placing our debt service obligation on an investment in the same currency as the tenant’s rental obligation to us. This reduces our overall exposure to the net cash flow from that investment. However, we are subject to foreign currency exchange rate movements to the extent that there is a difference in the timing and amount of the rental obligation and the debt service. Realized and unrealized gains and losses recognized in earnings related to foreign currency transactions are included in Other gains and (losses) in the consolidated financial statements.

In order to hedge certain of our foreign currency cash flow exposures, we enter into foreign currency forward contracts and collars. A foreign currency forward contract is a commitment to deliver a certain amount of currency at a certain price on a specific date in the future. By entering into forward contracts and holding them to maturity, we are locked into a future currency exchange rate for the term of the contract. A foreign currency collar guarantees that the exchange rate of the currency will not fluctuate beyond the range of the options’ strike prices. Our foreign currency forward contracts and foreign currency collars have maturities of 74 months or less.

The following table presents the foreign currency derivative contracts we had outstanding and their designations at March 31, 2018 (currency in thousands):



Foreign Currency Derivatives	Number of Instruments	Notional Amount		Fair Value at March 31, 2018
Designated as Cash Flow Hedging Instruments
Foreign currency collars	50	32,720	EUR	$	(4,029	)
Foreign currency forward contracts	21	8,134	EUR	1,189
Foreign currency forward contracts	15	23,532	NOK	542
Foreign currency collars	25	51,790	NOK	(298		)
Not Designated as Hedging Instruments
Foreign currency collars	2	3,000	EUR	(443		)
Designated as Net Investment Hedging Instruments
Foreign currency forward contracts	2	4,504	NOK	38
Foreign currency collars	3	16,750	NOK	(35		)
				$	(3,036	)

Credit Risk-Related Contingent Features

We measure our credit exposure on a counterparty basis as the net positive aggregate estimated fair value of our derivatives, net of any collateral received. No collateral was received as of March 31, 2018. At March 31, 2018, our total credit exposure was $1.1 million and the maximum exposure to any single counterparty was $0.6 million.

Some of the agreements we have with our derivative counterparties contain cross-default provisions that could trigger a declaration of default on our derivative obligations if we default, or are capable of being declared in default, on certain of our indebtedness. At March 31, 2018, we had not been declared in default on any of our derivative obligations. The estimated fair value of our derivatives in a net liability position was $4.9 million and $4.4 million at March 31, 2018 and December 31, 2017, respectively, which included accrued interest and any nonperformance risk adjustments. If we had breached any of these provisions at March 31, 2018 or December 31, 2017, we could have been required to settle our obligations under these agreements at their aggregate termination value of $5.1 million and $4.5 million, respectively.