424B4 1 d803720d424b4.htm 424B4 424B4
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Filed Pursuant to Rule 424(b)(4)
Registration No. 333-201251

PROSPECTUS

 

LOGO

 

12,000,000 Shares

 

Easterly Government Properties, Inc.

 

Common Stock

$15.00 per share

 

 

 

This is the initial public offering of our common stock. We are selling 12,000,000 shares of common stock. The initial public offering price will be $15.00 per share of common stock. We have granted the underwriters an option to purchase up to 1,800,000 additional shares of common stock to cover over-allotments.

 

No public market currently exists for our common stock. Our common stock has been approved for listing, subject to official notice of issuance, on the New York Stock Exchange, or NYSE, under the symbol “DEA.”

 

As described herein, concurrently with the completion of this offering and the formation transactions, two investment funds currently managed by Easterly Partners, LLC that are contributing properties to us in our formation transactions will also purchase 7,033,712 shares of common stock in a private placement at a price per share equal to the public offering price without payment of any underwriting fees, discounts or commissions.

 

We intend to elect to be treated and to qualify as a real estate investment trust, or REIT, for U.S. federal income tax purposes commencing with our taxable year ending December 31, 2015. Shares of our common stock will be subject to the ownership and transfer limitations in our charter, which are intended to assist us in qualifying and maintaining our qualification as a REIT, including, subject to certain exceptions, a 7.1% ownership limit. See “Description of Capital Stock—Restrictions on Ownership and Transfer.”

 

We are an “emerging growth company” under the federal securities laws and will be subject to reduced public company reporting requirements.

 

 

 

Investing in our common stock involves risks. See “Risk Factors” beginning on page 26.

 

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

 

 

     Per
Share
     Total  

Public Offering Price(1)

   $ 15.00       $ 180,000,000   

Underwriting Discount

   $ 0.975       $ 11,700,000   

Proceeds to us (before expenses)

   $ 14.025       $ 168,300,000   

 

(1)   For a description of compensation payable to the underwriters, see “Underwriting.”

 

To the extent that the underwriters sell more than 12,000,000 shares of common stock, the underwriters have the opportunity to purchase an additional 1,800,000 shares from us at the initial offering price less the underwriting discount.

 

The underwriters expect to deliver the shares to purchasers on or about February 11, 2015 through the book-entry facilities of The Depository Trust Company.

 

 

 

Citigroup   Raymond James   RBC Capital Markets

 

 

 

Piper Jaffray   PNC Capital Markets LLC   SunTrust Robinson Humphrey

 

February 5, 2015


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LOGO


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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 take no responsibility for, and can provide no assurance as to the reliability of, any other information that others may give to you. We are not, and the underwriters are not, making an offer to sell these securities in any jurisdiction where the offer or sale thereof 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 or such other date as is specified in this prospectus.

 

 

 

TABLE OF CONTENTS

 

PROSPECTUS SUMMARY

     1   

RISK FACTORS

     26   

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

     53   

USE OF PROCEEDS

     55   

DISTRIBUTION POLICY

     57   

CAPITALIZATION

     60   

DILUTION

     62   

SELECTED CONSOLIDATED HISTORICAL FINANCIAL DATA OF OUR PREDECESSOR

     64   

UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL DATA

     66   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     91   

INDUSTRY AND MARKET DATA

     111   

BUSINESS AND PROPERTIES

     118   

MANAGEMENT

     141   

EXECUTIVE AND DIRECTOR COMPENSATION

     148   

PRINCIPAL STOCKHOLDERS

     153   

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     155   

POLICIES WITH RESPECT TO CERTAIN ACTIVITIES

     160   

STRUCTURE AND FORMATION OF OUR COMPANY

     164   

DESCRIPTION OF CAPITAL STOCK

     171   

DESCRIPTION OF THE PARTNERSHIP AGREEMENT OF EASTERLY GOVERNMENT PROPERTIES LP

     177   

MATERIAL PROVISIONS OF MARYLAND LAW AND OUR CHARTER AND BYLAWS

     183   

SHARES ELIGIBLE FOR FUTURE SALE

     191   

U.S. FEDERAL INCOME TAX CONSIDERATIONS

     194   

UNDERWRITING

     214   

LEGAL MATTERS

     220   

EXPERTS

     220   

WHERE YOU CAN FIND MORE INFORMATION

     220   

INDEX TO FINANCIAL STATEMENTS

     F-1   

 

 

 

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Industry and Market Data

 

We use market data and industry forecasts and projections in this prospectus. Except as specifically noted otherwise, we have obtained market data and industry forecasts and projections from publicly available information and industry publications and from market research regarding renewal rates for GSA leases prepared or obtained, in connection with this offering, by Dr. Dennis Eisen, a nationally recognized expert in government leasing who is publisher and editor of Government Leasing News. Such information is included herein in reliance on Dr. Eisen’s authority as an expert on such matters. See “Experts.” These sources generally state that the information they provide has been obtained from sources believed to be reliable, but that the accuracy and completeness of the information are not guaranteed. The forecasts and projections are based on industry surveys and the preparers’ experience in the industry, and there is no assurance that any of the projections or forecasts will be achieved. We believe that the surveys and market research others have performed are reliable, but we have not independently verified this information.

 

 

 

Definitions

 

Unless the content otherwise requires or indicates, we define certain terms in this prospectus as follows:

 

The term “annualized lease income” means the annualized contractual base rent for the last month in a specified period, plus the annualized straight line rent adjustments for the last month in such period and the annualized expense reimbursements earned by us for the last month in such period.

 

The term “concurrent private placement” refers to a private placement of approximately 7,033,712 shares of common stock concurrently with the completion of this offering and the formation transactions by two investment funds currently managed by Easterly Partners, LLC that are contributing properties to us in the formation transactions at a price per share equal to the public offering price without the payment of any underwriting fees, discounts or commissions.

 

The term “Federal Buildings Fund” means the Federal Buildings Fund of the U.S. Government, which finances the GSA’s acquisition and operation of U.S. Government-owned and leased properties.

 

The term “fully diluted basis” assumes the exchange of all outstanding common units representing limited partnership interests in our operating partnership, or common units, and the exchange of all outstanding LTIP units in our operating partnership for shares of common stock on a one-for-one basis, which is not the same as the meaning of “fully diluted” under GAAP.

 

The term “GAAP” refers to accounting principles generally accepted in the United States.

 

The term “GSA” means the U.S. General Services Administration.

 

The term “rentable square feet” or “RSF” means the total area available for rent at a property measured by square footage.

 

The term “U.S. Government tenant agency” means a tenant that is the government of the United States or any agency or instrumentality thereof.

 

The term “urban CPI” means the Consumer Price Index for Urban Wage Earners and Clerical Workers.

 

When referring to our U.S. Government tenant agencies, we use the following definitions:

 

The term “AOC” or “Administrative Office of the Courts” means Administrative Office of the U.S. Courts.

 

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The term “CBP” or “Customs and Border Protection” means U.S. Customs and Border Protection.

 

The term “DEA” or “Drug Enforcement Administration” means U.S. Drug Enforcement Administration.

 

The term “DOT” or “Department of Transportation” means U.S. Department of Transportation.

 

The term “FBI” or “Federal Bureau of Investigation” means the U.S. Federal Bureau of Investigation.

 

The term “ICE” or “Immigration and Customs Enforcement” means the U.S. Immigration and Customs Enforcement.

 

The term “IRS” or “Internal Revenue Service” means the U.S. Internal Revenue Service.

 

The term “MEPCOM” or “Military Entrance Processing Command” means the Military Entrance Processing Command, which operates Military Entrance Processing Stations.

 

The term “PTO” or “Patent and Trademark Office” means the U.S. Patent and Trademark Office.

 

The term “SSA” or “Social Security Administration” means the U.S. Social Security Administration.

 

The term “USCG” or “U.S. Coast Guard” means the U.S. Coast Guard.

 

The term “USFS” or “U.S. Forest Service” means the U.S. Forest Service.

 

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PROSPECTUS SUMMARY

 

You should read the following summary together with the more detailed information regarding our company and the historical and pro forma financial statements appearing elsewhere in this prospectus. You should carefully review the entire prospectus, including the risk factors, the consolidated financial statements and the notes thereto and the other documents to which this prospectus refers before making an investment decision. References in this prospectus to “Easterly,” “we,” “our,” “us” and “our company” refer to Easterly Government Properties, Inc., a Maryland corporation, together with our consolidated subsidiaries including Easterly Government Properties LP, a Delaware limited partnership, which we refer to in this prospectus as our operating partnership. Unless the context otherwise requires or indicates, this prospectus (i) assumes the formation transactions, as described under the caption “Structure and Formation of Our Company,” including our acquisition of a portfolio of properties from Western Devcon, Inc., a private real estate company and a series of related entities beneficially owned by Michael P. Ibe, which we refer to collectively as Western Devcon, have been completed, (ii) assumes the 12,000,000 shares of common stock to be sold in this offering are sold at $15.00 per share, (iii) assumes 7,033,712 shares of common stock are sold in the concurrent private placement at a price of $15.00 per share without the payment of any underwriting fees, discounts or commissions, (iv) assumes no exercise by the underwriters of their option to purchase up to an additional 1,800,000 shares of common stock to cover over-allotments, or the over-allotment option, (v) presents all property-level information as of September 30, 2014 on a pro forma basis for the formation transactions and (vi) includes pro forma financial or other information presented on the basis, and after making the adjustments, described in our unaudited pro forma condensed consolidated financial statements and related notes thereto appearing elsewhere in this prospectus. The term “our predecessor” means Easterly Partners, LLC and its consolidated subsidiaries, including (i) all entities or interests in U.S. Government Properties Income and Growth Fund L.P., U.S. Government Properties Income and Growth Fund REIT, Inc. and the related feeder and subsidiary entities, which we refer to, collectively, as Easterly Fund I, (ii) all entities or interests in U.S. Government Properties Income and Growth Fund II, LP, USGP II REIT LP, USGP II (Parallel) Fund, LP and their related feeders and subsidiary entities, which we refer to, collectively, as Easterly Fund II and, together with Easterly Fund I, we refer to as the Easterly Funds and (iii) the entities that manage the Easterly Funds, which we refer to as the management entities.

 

Our Company

 

We are a newly organized and internally managed Maryland corporation that intends to qualify as a real estate investment trust, or REIT, focused primarily on the acquisition, development and management of Class A commercial properties that are leased to U.S. Government agencies that serve essential functions. We generate substantially all of our revenue by leasing our initial portfolio to such agencies through the U.S. General Services Administration, or GSA. Our objective is to generate attractive risk-adjusted returns for our stockholders over the long term through dividends and capital appreciation.

 

Upon completion of this offering and the formation transactions, we will wholly own 29 properties in the United States, including 26 properties that are leased primarily to U.S. Government tenant agencies and three properties that are entirely leased to private tenants, encompassing approximately 2.1 million square feet in the aggregate. Our initial portfolio consists of 15 properties contributed by the Easterly Funds and 14 properties contributed by Western Devcon. For more information on our formation transactions, see “Structure and Formation of Our Company.”

 

We focus on acquiring, developing and managing GSA-leased properties that are essential to supporting the mission of the tenant agency and strive to be a partner of choice for the U.S. Government, working closely with the GSA to meet the needs and objectives of the tenant agency. We identify U.S. Government agencies that we believe to have the most enduring missions, including a range of growing federal agencies such as the Federal

 

 

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Bureau of Investigation and the Drug Enforcement Administration, both of which have, in recent years, been the subject of increased priority in the U.S. Government. Such agencies require properties with the type of specialized security, technology, communications and other features that increase the likelihood of long-term lease renewal at positive spreads and increase the long-term value of the leased properties to the agency. We then identify the most critical buildings occupied by these agencies for acquisition or the projects proposed by such agencies for development. Specifically, for our acquisition and development pipeline, we target major federal buildings of Class A construction, at least 85% leased to a single U.S. Government agency, including through the GSA, in excess of 40,000 rentable square feet with expansion potential. Our target market is best summarized by the following illustration:

 

LOGO

 

In order to identify investments within this target market, we underwrite the agency first and then underwrite the relative importance of the building within the hierarchy of the agency. We then focus on properties that are critical to the selected agencies with the following attributes:

 

   

in strategic locations to facilitate the tenant agency’s mission;

 

   

in the case of acquisitions, are less than 20 years old;

 

   

in the case of developments, have a minimum lease term of ten years;

 

   

have build-to-suit features; and

 

   

are focused on environmental sustainability.

 

Our initial portfolio is diversified among U.S. Government tenant agencies, which include a number of the U.S. Government’s largest and most essential agencies, such as the Drug Enforcement Administration, the Federal Bureau of Investigation, the Internal Revenue Service and the Patent and Trademark Office. Our initial portfolio also includes four private tenants, representing less than 5% of our annualized lease income.

 

The GSA-leased real estate asset class possesses a number of positive attributes that we believe will offer our stockholders significant benefits, including a highly creditworthy and very stable tenant base, long-term lease structures and low risk of tenant turnover. GSA leases are backed by the full faith and credit of the U.S. Government, and the GSA has never experienced a financial default in its history. Payment for rents under GSA

 

 

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leases are funded through the Federal Buildings Fund and are not subject to direct federal appropriations, which can fluctuate with federal budget and political priorities. In addition to presenting reduced risk of default, GSA leases typically have long initial terms of ten to 20 years with renewal leases having terms of five to ten years, which limit operational risk. Upon renewal of a GSA lease, base rent is typically reset based on a number of factors, including inflation and the replacement cost of the building at the time of renewal, which we generally expect will increase over the life of the lease. According to Dr. Eisen, historical renewal rates have ranged from 93% to 95% for properties within our target market that are greater than 50,000 rentable square feet and are 100% leased to the U.S. Government.

 

GSA-leased properties generally provide attractive investment opportunities and require specialized knowledge and expertise. Each U.S. Government agency has its own customs, procedures, culture, needs and mission, which translate into different requirements for its leased space. Furthermore, the sector is highly fragmented, as ownership is disparate and there is no national broker or clearinghouse for GSA-leased property. As of October 2014, the largest owner of GSA-leased properties owned approximately 3% of the GSA-leased market by RSF and the ten largest owners of GSA-leased properties collectively owned approximately 15% of the GSA-leased market by RSF. The development of GSA-leased properties also entails a long and complicated procurement process, limiting the number of developers within the market. Long-term relationships and specialized institutional knowledge regarding the agencies, their space needs and the hierarchy and importance of a property to its tenant agency are crucial to understanding which agencies and properties present the greatest likelihood of long-term tenancy, and to identifying and acquiring attractive investment properties.

 

We expect that our extensive knowledge of U.S. Government properties and lease structures will allow us to execute transactions efficiently. Additionally, we believe that our ability to identify and implement building improvements increases the likelihood of lease renewal and enhances the value of our portfolio. Our experienced management team brings specialized insight into the mission and hierarchy of tenant agencies so that we are able to gain a deep understanding of the U.S. Government’s long-term strategy for a particular agency and its resulting space needs. This allows us to target properties for use by agencies that will have enduring criticality and the highest likelihood of lease renewal. Lease duration and the likelihood of renewal are further increased as properties are tailored to meet the specific needs of individual U.S. Government agencies, such as specialized environmental and security upgrades.

 

We have assembled an experienced multidisciplinary senior management team with complementary skills and experience. Our senior management team is comprised of four individuals with experience in identifying, acquiring, developing, financing and managing U.S. Government-leased assets and has developed long-term relationships across the commercial real estate industry, including at all levels of the GSA and at numerous government agencies. Collectively, our senior management team has been responsible for the acquisition of an aggregate of approximately 1.5 million square feet of GSA-leased properties and the development of approximately 1.0 million aggregate square feet of such properties. William C. Trimble, III, our Chief Executive Officer and President and a member of our board of directors, was a co-founder of our predecessor and has over 25 years of experience in investment management, including serving as chief operating officer of an investment management firm specializing in acquiring GSA-leased properties prior to co-founding our predecessor. Darrell W. Crate, our Chairman, was also a co-founder of our predecessor and brings to our team extensive capital markets and listed company experience, having served as chief financial officer of Affiliated Managers Group, Inc., a NYSE listed company, for 13 years. Michael P. Ibe, our Executive Vice President—Development and Acquisitions and a director nominee, brings extensive experience executing the ground-up development of specialized properties that are built to suit the needs of the tenant agency with a particular expertise in specialized facilities such as forensic and other laboratory facilities, high-security facilities and DEA facilities. F. Joseph Moravec, our Executive Vice President—Government Relations, is a U.S. Government policy specialist and has been an integral member of the senior management team of our predecessor since 2011. Mr. Moravec previously served as Commissioner of the Public Buildings Service for the GSA from 2001 to 2005, where he was

 

 

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responsible for the overall asset management, design, construction, leasing, operations and disposal of GSA portfolio properties. For more information on our senior management team, see “Management.”

 

We intend to elect and qualify to be taxed as a REIT for U.S. federal income tax purposes commencing with our taxable year ending December 31, 2015. For more information, see “U.S. Federal Income Tax Considerations.”

 

Our Competitive Strengths

 

We believe that we distinguish ourselves from other owners and operators of office and other commercial properties, including properties leased to the U.S. Government, through the following competitive strengths:

 

   

High Quality Portfolio Leased to Mission-Critical U.S. Government Agencies. We will be the only internally managed public REIT that focuses primarily on the acquisition, development and management of Class A commercial properties that are leased to U.S. Government agencies, primarily through the GSA. Upon completion of this offering and the formation transactions, we will wholly own 29 high quality properties in the United States that are currently 100% leased, including 26 properties leased primarily to government tenant agencies. As of September 30, 2014, the weighted average age of our properties was approximately ten years, and the weighted average remaining lease term was approximately eight years. A majority of our properties are leased to U.S. Government agencies that serve mission-critical functions and are of high importance within the hierarchy of these agencies. These properties generally meet our investment criteria, which target major federal buildings of Class A construction that are less than 20 years old, are at least 85% leased to a single U.S. Government agency, are in excess of 40,000 rentable square feet with expansion potential, are in strategic locations to facilitate the tenant agency’s mission, include build-to-suit features and are focused on environmental sustainability.

 

   

U.S. Government Tenant Base with Strong History of Renewal. Our GSA leases are backed by the full faith and credit of the U.S. Government, are paid for through the Federal Buildings Fund and are not subject to direct federal appropriations. Furthermore, the GSA has never experienced a financial default. In addition to stable rent payments, our GSA leases typically have initial total terms of ten to 20 years with renewal leases having terms of five to ten years. GSA leases governing properties similar to the properties that we target have historically had high renewal rates, which limits operational risk. According to Dr. Eisen, the historical renewal rates for properties within our target market that are greater than 50,000 rentable square feet and are 100% leased to the U.S. Government have ranged from 93% to 95%. We believe that the strong credit quality of our U.S. Government tenant base, our long-term leases, the likelihood of lease renewal and the high tenant recovery rate for our property-related operating expenses contribute to the stability of our operating cash flows and expected distributions.

 

   

Experienced and Aligned Management Team. Our senior management team has a proven track record of sourcing, acquiring, developing and managing properties leased to U.S. Government agencies, primarily through the GSA. Our multidisciplinary team possesses complementary skills and experience that we expect will drive our business and growth strategies and includes the co-founders of our predecessor, the founder and president of a company specializing in the development of build-to-suit properties for the GSA and a former commissioner of the GSA’s Public Buildings Service. Collectively, our senior management team has been responsible for the acquisition of an aggregate of approximately 1.5 million square feet of GSA-leased properties and the development of approximately 1.0 million aggregate square feet of such properties. We believe that our management expertise provides us with a significant advantage over our competitors when pursuing acquisition opportunities and engaging the GSA in property development opportunities and by providing us with superior property management and tenant service capabilities.

 

Upon completion of this offering, the formation transactions and the concurrent private placement, our senior management team will own approximately 18.3% of our common stock on a fully diluted basis, which will help to align their interests with those of our stockholders.

 

 

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Access to Acquisition Opportunities with an Active Pipeline. Our senior management team has an extensive network of longstanding relationships with owners, specialized developers, leasing brokers, lenders and other participants in the GSA-leased property market. Our team has been able to leverage these relationships to access a wide variety of sourcing opportunities, frequently resulting in the acquisition of properties that were not broadly marketed. In addition, we maintain a proprietary database that tracks approximately 8,500 leases totaling approximately 200 million rentable square feet and includes substantially every major U.S. Government-leased property that meets our investment criteria as well as information about the ownership of such properties. We believe that our longstanding industry relationships, coupled with our proprietary database, improve our ability to source and execute attractive acquisition opportunities. Further, these factors enable us to effectively initiate transactions with property owners who may not currently be seeking to sell their property, which we believe gives us a competitive advantage over others bidding in broadly marketed transactions. Our predecessor successfully acquired from sellers, outside of a broad marketing process, eight of the 15 properties that the Easterly Funds will contribute to us through the formation transactions.

 

   

Extensive Development Experience with U.S. Government-Leased Properties. Our senior management team has developed projects comprising approximately 4.2 million square feet, including 36 build-to-suit projects for the GSA as well as other corporate and government tenants. In the aggregate, our senior management team has developed 19 projects for the GSA. Development of government projects, particularly build-to-suit projects, requires expertise in GSA requirements and the needs of tenant agencies. Since 1994, members of our senior management team have developed an average of approximately 52,000 square feet per year of GSA-leased build-to-suit properties. We believe that our thorough understanding of the U.S. Government’s procurement processes and standards, our longstanding relationships with the GSA and other agencies of the U.S. Government, and our differentiated capabilities will enable us to continue to compete effectively for U.S. Government development opportunities.

 

   

Value-Enhancing Asset Management. Our management team focuses on the efficient management of our properties and on improvements to our properties that enhance their value for a tenant agency and improve the likelihood of lease renewal. We work in close partnership with the GSA and tenant agencies to manage the construction of specialized, agency-specific design enhancements. These highly tailored build-outs substantially increase the likelihood of the tenant agency’s renewal and also typically generate a construction management fee paid by the tenant agency to us in the amount of approximately 15% of the actual cost of construction. We also seek to reduce operating costs at all of our properties, often by implementing energy efficiency programs that help the U.S. Government achieve its conservation and efficiency goals. Our asset management team also conducts frequent audits of each of our properties in concert with the GSA and the tenant agency so as to keep each facility in optimal condition, allowing the tenant agency to better perform its stated mission and helping to position us as a GSA partner of choice.

 

   

Growth-Oriented Capital Structure. Upon completion of this offering, the formation transactions and the concurrent private placement, we expect to have approximately $104.8 million of mortgage indebtedness and amounts outstanding under our senior unsecured revolving credit facility for a pro forma debt-to-capitalization ratio of 14.6%. None of our outstanding indebtedness is scheduled to mature until 2019. In connection with the completion of this offering, the formation transactions and the concurrent private placement, we intend to enter into a $400.0 million senior unsecured revolving credit facility with affiliates of certain of the underwriters. This credit facility will have an accordion feature that will provide us with additional capacity, subject to the satisfaction of customary terms and conditions, of up to $250.0 million, for a total facility size of not more than $650.0 million.

 

 

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Our Business and Growth Strategies

 

Our objective is to generate attractive risk-adjusted returns for our stockholders over the long term through dividends and capital appreciation. We intend to pursue the following strategies to achieve these goals:

 

   

Pursue Attractive Acquisition Opportunities. We plan to engage in strategic and disciplined acquisitions of properties that we believe are essential to the mission of select U.S. Government agencies and that, in many cases, contain agency-specific design enhancements that allow each tenant agency to better satisfy its mission. We expect to target for acquisition primarily major federal buildings of Class A construction that are less than 20 years old, are at least 85% leased to a single U.S. Government agency, are in excess of 40,000 rentable square feet with expansion potential, are in strategic locations to facilitate the tenant agency’s mission, include build-to-suit features and are focused on environmental sustainability. We believe that our senior management team’s experience, extensive industry relationships and our proprietary database, together with our anticipated access to capital, including the undrawn portion of our expected new senior unsecured revolving credit facility, position us well to identify and consummate attractive property acquisitions.

 

   

Develop Build-to-Suit U.S. Government Properties. We intend to pursue attractive opportunities to develop build-to-suit properties for use by certain U.S. Government agencies. As U.S. Government agencies expand, they often require additional space tailored specifically to their needs, which may not be available in the agency’s target market and therefore require new construction. The GSA typically solicits proposals from private companies to develop and lease such properties to the agency, rather than developing and owning the property itself. We expect to bid for those property development opportunities published by the GSA that suit our investment criteria. Prior to development of any such properties that we are awarded the contract to build, we would expect to enter into a long-term lease with the GSA that would take effect upon delivery of the building, thus eliminating speculative development risk. We believe that our senior management team’s track record of developing build-to-suit properties for U.S. Government agencies and our disciplined and thorough underwriting process will enable us to effectively compete for federal build-to-suit development contracts that meet our criteria.

 

   

Renew Existing Leases at Positive Spreads. We intend to renew leases at our GSA-leased properties at positive spreads upon expiration. Upon lease renewal, GSA rental rates are typically reset based on a number of factors, including inflation, the replacement cost of the building at the time of renewal and enhancements to the property since the date of the prior lease. During the term of a GSA lease, we work in close partnership with the GSA to implement improvements at our properties to enhance the U.S. Government tenant agency’s ability to perform its stated mission, thereby increasing the importance of the building to the tenant agency and the probability of an increase in rent upon lease renewal. Between 2006 and 2014, the average rental increase for GSA leases within our target market upon renewal was approximately 18% for leases with initial terms of ten to 15 years and approximately 26% for leases with initial terms of 15 years or more. The average initial term of our GSA leases is 16.6 years, and GSA leases expiring on or before December 31, 2018 represented approximately 23% of our total annualized lease income as of September 30, 2014.

 

   

Reduce Property-Level Operating Expenses. We intend to manage our properties to increase our income by continuing to reduce property-level operating costs. We manage our properties in a cost efficient manner so as to eliminate any excess spending and streamline our operating costs. When we acquire a property, we review all property-level operating expenditures to determine whether and how the property can be managed more efficiently. We have historically been able to materially reduce operating costs on certain of our acquired properties, for example, by reducing electricity costs through lighting retrofits, engaging energy consultants to enter into price lock contracts and using economies of scale to lower insurance premiums without reducing coverage.

 

 

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Our Initial Portfolio Summary

 

Upon completion of the formation transactions, we will wholly own 29 properties, including 26 properties with approximately 1.8 million rentable square feet that are leased primarily to U.S. Government tenants and three properties with approximately 257,000 rentable square feet that are entirely leased to private tenants. As of September 30, 2014, our properties were 100% leased with a weighted average annualized lease income per leased square foot of $32.48 and a weighted average age of approximately ten years.

 

Information about the properties in our initial portfolio as of September 30, 2014 is set forth in the table below:

 

Property Name

  Location   Property
Type
  Tenant  Lease
Expiration
Year(1)
    Rentable
Square
Feet
   

Annualized
Lease
Income

  Percentage
of Total
Annualized
Lease
Income
   

Annualized
Lease
Income per
Leased
Square
Foot

U.S. Government

Leased Properties

             

IRS - Fresno

  Fresno, CA   Office     2018              180,481      $7,374,373     10.9   $40.86

PTO - Arlington

  Arlington, VA   Office     2019 / 2020(2)        189,871      6,503,160     9.6      34.25

FBI - San Antonio

  San Antonio, TX   Office     2021              148,584      4,920,622     7.3      33.12

FBI - Omaha

  Omaha, NE   Office     2024              112,196      4,656,373     6.9      41.50

ICE - Charleston(3)

  North Charleston, SC   Office     2019 / 2027(4)        86,733      3,652,723     5.4      42.11

DOT - Lakewood

  Lakewood, CO   Office     2024              122,225      3,351,928     4.9      27.42

DEA - Vista

  Vista, CA   Laboratory     2020              54,119      2,717,230     4.0      50.21

USFS II - Albuquerque

  Albuquerque, NM   Office     2026(5)           98,720      2,663,110     3.9      26.98

AOC - El Centro(6)

  El Centro, CA   Courthouse/
Office
    2019              46,813      2,590,426     3.8      55.34

USFS I - Albuquerque

  Albuquerque, NM   Office     2021(7)           92,455      2,585,450     3.8      27.96

AOC - Del Rio(6)

  Del Rio, TX   Courthouse/
Office
    2024              89,880      2,557,459     3.8      28.45

CBP - Savannah

  Savannah, GA   Laboratory     2033              35,000      2,171,063     3.2      62.03

FBI - Little Rock

  Little Rock, AR   Office     2021              101,977      2,127,768     3.1      20.87

MEPCOM - Jacksonville

  Jacksonville, FL   Office     2025              30,000      2,127,444     3.1      70.91

DEA - Santa Ana

  Santa Ana, CA   Office     2024              39,905      2,047,124     3.0      51.30

DEA - Dallas

  Dallas, TX   Office     2021              71,827      1,794,872     2.6      24.99

CBP - Chula Vista

  Chula Vista, CA   Office     2018              59,397      1,770,706     2.6      29.81

DEA - North Highlands

  Sacramento, CA   Office     2017              37,975      1,707,978     2.5      44.98

CBP - Sunburst

  Sunburst, MT   Office     2028              33,000      1,568,378     2.3      47.53

USCG - Martinsburg

  Martinsburg, WV   Office     2027              59,547      1,561,837     2.3      26.23

DEA - Otay(8)

  San Diego, CA   Office     2017              32,560      1,277,773     1.9      39.24

DEA - Riverside

  Riverside, CA   Office     2017              34,354      1,249,744     1.8      36.38

DEA - Albany

  Albany, NY   Office     2015(9)           31,976      1,130,698     1.7      35.36

SSA - Mission Viejo

  Mission Viejo, CA   Office     2020              11,590      567,830     0.8      48.99

SSA - San Diego

  San Diego, CA   Office     2015              11,743      441,042     0.7      37.56

DEA - San Diego

  San Diego, CA   Warehouse     2016              16,100      364,056     0.5      22.61
       

 

 

   

 

 

 

 

   

 

Subtotal

          1,829,028      $65,481,166     96.6 %    $35.80

Privately Leased

             

2650 SW 145th Avenue - Parbel of Florida

  Miramar, FL   Warehouse/
Distribution
    2022(10)           81,721      1,392,274     2.1      17.04

5998 Osceola Court - United Technologies

  Midland, GA   Manufacturing     2023(11)           105,641      498,208     0.7      4.72

501 East Hunter Street - Lummus Corporation

  Lubbock, TX   Warehouse/
Distribution
    2028(12)           70,078      399,168     0.6      5.70
       

 

 

   

 

 

 

 

   

 

Subtotal

          257,440     

$2,289,650

    3.4  

$8.89

       

 

 

   

 

 

 

 

   

 

Total / Weighted Average

          2,086,468     

$67,770,815

    100.0  

$32.48

       

 

 

   

 

 

 

 

   

 

 

(1)   The year of lease expiration does not include renewal options. All leases with renewal options are noted in the following footnotes to this table.
(2)   168,468 rentable square feet leased to the PTO will expire on March 31, 2019, and 21,403 rentable square feet leased to the PTO will expire on January 7, 2020.

 

 

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(3)   This property is only partially leased to the U.S. Government. LifePoint, Inc. occupies 21,609 rentable square feet.
(4)   21,609 rentable square feet leased to LifePoint, Inc. will expire on September 30, 2019, and 65,124 rentable square feet leased to ICE will expire on January 31, 2027.
(5)   Lease contains one five-year renewal option.
(6)   A portion of this property is occupied by the U.S. Marshals Service to provide security and otherwise support the mission of the Administrative Office of the Courts. Because of the interrelated nature of the U.S. Marshals Service and the Administrative Office of the Courts, we have not separately addressed occupancy by the U.S. Marshals Service.
(7)   Lease contains one five-year renewal option.
(8)   ICE occupies 5,813 rentable square feet.
(9)   We have a nonbinding agreement of terms with the tenant for a new lease with a term through January 31, 2025.
(10)   Lease contains three five-year renewal options.
(11)   Lease contains three five-year renewal options.
(12)   Lease contains two five-year renewal options.

 

Our initial assets are located across the United States, including the following regions, as defined by the GSA: Pacific Rim (11 properties), Greater Southwest (seven properties), Southeast Sunbelt (five properties), Rocky Mountain (two properties), Northeast & Caribbean (one property), Mid-Atlantic (one property), The Heartland (one property) and National Capital (one property). The three properties entirely leased to private tenants are located in the Southeast Sunbelt (two properties) and Greater Southwest regions. The following chart sets forth the geographic diversification of the properties in our initial portfolio by GSA-defined region as of September 30, 2014:

 

Annualized Lease Income by Market

 

LOGO

 

 

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Our initial portfolio has a stable tenant base that is diversified among U.S. Government agencies. Our U.S. Government tenant agencies include a number of the U.S. Government’s largest and most essential agencies, such as the DEA, FBI and CBP. Our private tenants are Parbel of Florida, a subsidiary of L’Oreal SA, United Technologies, LifePoint, Inc. and Lummus Corporation. As of September 30, 2014, our properties were 100% occupied by 16 tenants. The following table provides information about the tenants that occupied our properties as of September 30, 2014:

 

Tenant

  Number
of
Properties
    Number
of
Leases
    Weighted
Average
Remaining
Lease Term(1)
    Leased Square
Feet
    Percentage
of Leased
Square
Feet
    Annualized
Lease
Income
    Percentage
of Total
Annualized
Lease
Income
 

U.S. Government

             

Drug Enforcement Administration(2)

    8        8        4.8        313,003        15.0   $ 12,061,352        17.8

Federal Bureau of Investigation

    3        3        7.8        362,757        17.4     11,704,763        17.3

Internal Revenue Service

    1        1        4.2        180,481        8.7     7,374,373        10.9

Patent and Trademark Office

    1        2        4.6        189,871        9.1     6,503,160        9.6

Customs and Border Protection

    3        3        10.5        127,397        6.1     5,510,146        8.1

U.S. Forest Service

    2        2        9.4        191,175        9.2     5,248,561        7.7

Administrative Office of the Courts

    2        2        7.9        136,693        6.6     5,147,886        7.6

Immigration and Customs Enforcement(2)

    1        1        11.6        70,937        3.4     3,418,085        5.0

Department of Transportation

    1        1        9.7        122,225        5.9     3,351,928        4.9

Military Entrance Processing Command

    1        1        11.0        30,000        1.4     2,127,444        3.1

U.S. Coast Guard

    1        1        13.2        59,547        2.9     1,561,837        2.3

Social Security Administration

    2        2        3.7        23,333        1.1     1,008,871        1.5
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

    26        27        7.4        1,807,419        86.6   $ 65,018,405        95.9
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Private Tenants

             

Parbel of Florida

    1        1        8.2        81,721        3.9   $ 1,392,274        2.1

United Technologies

    1        1        9.3        105,641        5.1     498,208        0.7

LifePoint, Inc.

    0        1        5.0        21,609        1.0     462,761        0.7

Lummus Corporation

    1        1        13.8        70,078        3.4     399,168        0.6
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Subtotal

    3        4        9.8        279,049        13.4   $ 2,752,411        4.1
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total / Weighted Average

    29        31        7.7        2,086,468        100.0   $ 67,770,815        100.0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)   Weighted based on square feet.
(2)   The DEA-Otay property is primarily occupied by the DEA. However, ICE occupies approximately 18% of the total leased square footage of the property. The weighted average remaining lease term, leased square feet, annualized lease income and percentage of total annualized lease income have been adjusted accordingly.

 

 

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As of September 30, 2014, less than ten percent of our leases, based on square footage and total annualized lease income, were scheduled to expire before 2018. Certain of our leases are currently in the “soft-term” period of the lease, meaning that the U.S. Government tenant agency has the right to terminate the lease prior to its stated lease end date. In recent years the GSA has increasingly entered into leases with “soft-term” periods. We believe that, from the GSA’s perspective, leases with such provisions are helpful for budgetary purposes. While some of our leases are contractually subject to early termination, we do not believe that our tenant agencies are likely to terminate these leases early given the build-to-suit features at the properties subject to the leases, the average age of these properties (approximately 12 years), the mission-critical focus of the properties subject to the leases and the current level of operations at such properties. The following table sets forth a schedule of lease expirations for leases in place as of September 30, 2014. The information set forth in the table assumes that tenants do not exercise renewal options or early termination rights as of September 30, 2014.

 

Year of Lease Expiration(1)

   Number of
Leases
Expiring
     Square
Footage of
Leases
Expiring
     Percent of
Portfolio
Square
Footage of
Leases
Expiring
    Annualized
Lease
Income
     Percentage
of Total
Annualized
Lease
Income
    Annualized
Lease
Income per
Leased
Square
Foot
 

Available

     0         N/A         N/A        N/A         N/A        N/A   

Signed leases not commenced

     0         N/A         N/A        N/A         N/A        N/A   

2014

     0         N/A         N/A        N/A         N/A        N/A   

2015

     2         43,719         2.1   $ 1,571,739         2.3   $ 35.95   

2016

     1         16,100         0.8     364,056         0.5     22.61   

2017

     3         104,889         5.0     4,235,495         6.2     40.38   

2018

     2         239,878         11.5     9,145,079         13.5     38.12   

2019

     3         236,890         11.4     8,792,258         13.0     37.12   

2020

     3         87,112         4.2     4,049,149         6.0     46.48   

2021

     4         414,843         19.9     11,428,713         16.9     27.55   

2022

     1         81,721         3.9     1,392,274         2.1     17.04   

2023

     1         105,641         5.1     498,208         0.7     4.72   

2024

     4         364,206         17.5     12,612,884         18.6     34.63   

Thereafter

     7         391,469         18.8     13,680,961         20.2     34.95   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total / Weighted Average

     31         2,086,468         100.0   $ 67,770,815         100.0   $ 32.48   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

 

(1)   The year of lease expirations is pursuant to current contract terms. Some tenants have the right to vacate their space during a specified period, or “soft term,” before the stated terms of their leases expire. As of the date of this prospectus, seven tenants occupying approximately 20.5% of our rentable square feet and contributing approximately 23.0% of our annualized lease income have currently exercisable rights to terminate their leases before the stated term of their lease expires. In the remainder of 2014, 2015, 2016 and 2017, early termination rights become exercisable by other tenants who currently occupy an additional approximately 0.0%, 0.0%, 0.0% and 4.5% of our rentable square feet, respectively, and contribute an additional approximately 0.0%, 0.0%, 0.0% and 2.9% of our annualized lease income, respectively.

 

Acquisition and Development Pipeline

 

We maintain an active pipeline of potential acquisition opportunities, which we have targeted using our proprietary database of GSA-leased assets, compiling data on such assets, including information pertaining to leases and operating costs. We believe that our senior management team’s extensive network of longstanding relationships with commercial real estate participants will continue to provide us with an information advantage and access to attractive acquisition opportunities, many of which may not be available to our competitors. Within our target market we are tracking properties we estimate to be worth over $700 million and are actively evaluating the acquisition of approximately $200 million of this pipeline. We are also currently evaluating several potential development projects.

 

We cannot assure you that we will acquire or develop any of the properties in our acquisition or development pipeline because the acquisition or development of any property in our pipeline may be subject to a number of factors,

 

 

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including the negotiation and execution of definitive purchase and sale agreements, our completion of satisfactory due diligence with respect to the property and satisfaction of customary closing conditions, including the receipt of third-party consents and approvals.

 

Recent Developments

 

On January 23, 2015, our predecessor entered into a purchase and sale agreement for the purchase of a 115,650 RSF property located in Lakewood, Colorado for a purchase price of $20.3 million. The building was constructed in 1999 and is 100% leased to the GSA and occupied by the U.S. Department of Energy under a 15-year lease that expires in November 2029. We are in the process of conducting due diligence and underwriting as part of our evaluation of this potential acquisition, which is subject to significant outstanding conditions, including the successful completion of our diligence process, and we may terminate this purchase and sale agreement for any reason without cost prior to February 17, 2015. We cannot assure you that we will acquire this property on the terms described above or at all.

 

Industry and Market Information

 

We focus primarily on the acquisition, development and management of Class A commercial properties that are leased to U.S. Government agencies that serve essential functions. The GSA acts as the real estate intermediary for a wide range of U.S. Government entities, including the Drug Enforcement Administration, Federal Bureau of Investigation, Immigration and Customs Enforcement, Internal Revenue Service, Administrative Office of the Courts, Department of Justice, Department of Homeland Security, Department of the Treasury, Department of State and Central Intelligence Agency.

 

The GSA is divided into two principal divisions, the Federal Acquisition Service, or FAS, and the Public Buildings Service, or PBS. The FAS provides comprehensive solutions for products and services across the U.S. Government. The PBS acquires and manages thousands of federal properties and provides management, leasing, acquisition and disposal services to suit the U.S. Government’s real estate needs. The PBS provides more than 370 million square feet of workspace for more than 1.1 million federal workers in approximately 9,000 properties nationwide. Within the PBS portfolio, properties are either under the full custody and control of the GSA (i.e., U.S. Government-owned) or leased from the private sector and include assets such as office buildings, courthouses, land ports of entry, warehouses, laboratories and parking structures.

 

 

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GSA Leasing Dynamics

 

Over the 45-year period from 1968 to 2013, the GSA’s total portfolio of leased space grew at an average annual rate of 3.1%. From 1998 to 2013, the GSA’s leased inventory experienced substantially faster growth than the GSA-owned inventory, growing by 30.1% in the aggregate as compared to (1.5%) in the aggregate for GSA-owned inventory over the same 15-year period. The GSA’s leased inventory now comprises over 50% of the GSA’s total inventory in terms of rentable square feet. The overall growth of the GSA’s leased inventory can be seen in the chart below:

 

GSA Portfolio

 

LOGO

 

A leasing model allows the GSA the flexibility to accommodate each federal agency’s needs by accounting for both the scope and urgency of its respective space requirements. Although the GSA typically utilizes a uniform lease agreement, the build-out and building security requirements for each tenant vary according to that agency’s specific mission and hierarchy of the property within the agency. In many cases, existing U.S. Government-owned properties cannot accommodate tenant needs, and the upfront cost and complexity of constructing a new U.S. Government-owned building can be prohibitive. The average age of the U.S. Government-owned properties is 47 years. As a result, the GSA’s reliance on privately owned office space has escalated. We believe this is due in part to the fact that the full cost of each construction project must be recognized in a single fiscal year budget, whereas a newly leased building only requires recognition of annual payments in the applicable agency’s annual budget. Thus, given recent federal budget constraints, we believe it is likely that the U.S. Government will continue to grow its leased portfolio of assets, strengthening its reliance on leasing over ownership.

 

Attributes of the GSA-Leased Asset Class

 

The GSA-leased asset class possesses several positive attributes:

 

U.S. Government Tenant Credit: Leases are backed by the full faith and credit of the U.S. Government, and the GSA has never experienced a financial default. Even during the U.S. Government “shutdown” of 2013, the GSA continued to pay its rent to private landlords through the Federal Buildings Fund that is not subject to direct appropriations. As such, we believe that there is limited risk of tenant default.

 

 

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Limited Renewal Risk: The historical renewal rate for GSA-leased properties has been approximately 77% and, according to Dr. Eisen, properties within our target market, in excess of 50,000 rentable square feet that are 100% leased to the U.S. Government, have historical renewal rates in the range of 93% to 95%. Our strategy seeks to increase the likelihood of renewal by acquiring or constructing projects based on the following:

 

   

Having specialized knowledge and insight into the mission and hierarchy of a tenant agency or property prior to purchasing the asset.

 

   

Focusing on the market segment that is most likely to renew: major federal buildings of Class A construction that are less than 20 years old, are at least 85% leased to a single U.S. Government tenant, including through the GSA, are in excess of 40,000 square feet with expansion potential, include build-to-suit features and are focused on environmental sustainability.

 

Long-Term Lease Structures: A typical initial GSA lease has a term of ten to 20 years, limiting operational risk. A renewal lease typically has a term of five to ten years.

 

Strong Rent Growth Upon Renewal: When a GSA lease expires, the new base rent is typically reset based on a number of factors, including inflation, the replacement cost of the building at the time of renewal, which we generally expect will increase over the life of the lease, and enhancements to the property since the date of the prior lease. Between 2006 and 2014, the average rental increase for GSA leases within our target market upon renewal was approximately 18% for leases with terms of ten to 15 years and approximately 26% for leases with terms of 15 years or more.

 

Low Market Correlation: We believe that the GSA-leased real estate asset class is less correlated to macro cycles than traditional commercial real estate. The U.S. Government remains the largest employer in the world, the largest office tenant in the United States and the primary catalyst of the U.S. economy. Finally, given our expectation for continuing budgetary constraints, the U.S. Government’s increased reliance on leasing over ownership is expected to continue.

 

Fragmented Market: The largest owner of GSA-leased assets owns approximately 3% of the GSA-leased market by RSF as of October 2014. The ten largest owners of GSA-leased assets collectively own approximately 15% of the GSA-leased market by RSF as of October 2014. Additionally, there is no national broker or clearinghouse for GSA-leased properties. We believe that all of these factors work in concert to create a fragmented market that requires acquirers and developers to have specialized knowledge and expertise to navigate the landscape.

 

All of these market dynamics combine to yield a strong climate for investment opportunities and to drive stable cash flows within the GSA-leased property market.

 

Summary Risk Factors

 

An investment in our common stock involves various risks, and prospective investors are urged to carefully consider the matters discussed under “Risk Factors” prior to making an investment in common stock. The following is a list of some of these risks.

 

   

We depend on the U.S. Government and its agencies for substantially all of our revenues and any failure by the U.S. Government and its agencies to perform their obligations under their leases or renew their leases upon expiration could have a material adverse effect on our business, financial condition and results of operations.

 

   

Some of our leases with U.S. Government tenant agencies permit the tenant agency to vacate the property and discontinue paying rent prior to their lease expiration date.

 

   

We may be unable to renew leases or lease vacating space on favorable terms or at all as leases expire, which could adversely affect our business, financial condition and results of operations.

 

 

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We are exposed to risks associated with property development and redevelopment, including new developments for anticipated tenant agencies and build-to-suit renovations for existing tenant agencies.

 

   

We depend on the members of our senior management team and the loss of any of their services, or an inability to attract and retain highly qualified personnel, could have a material adverse effect on our business, financial condition and results of operations.

 

   

Unfavorable market and economic conditions in the United States and globally could adversely affect occupancy levels, rental rates, rent collections, operating expenses and the overall market value of our assets and have a material adverse effect on our business, financial condition and results of operations.

 

   

Our properties are leased to a limited number of U.S. Government tenant agencies, and a change to any of these agencies’ missions could have a material adverse effect on our business, financial condition and results of operations.

 

   

Capital and credit market conditions may adversely affect our access to various sources of capital or financing and/or the cost of capital, which could impact our business activities, dividends, earnings and common stock price, among other things.

 

   

We may be unable to identify and successfully complete acquisitions and, even if acquisitions are identified and completed, we may fail to successfully operate acquired properties, which could adversely affect us and impede our growth.

 

   

Because our principal tenants are agencies of the U.S. Government, our properties have a higher risk of terrorist attack than similar properties leased to non-governmental tenants.

 

   

Competition could limit our ability to acquire attractive investment opportunities and to attract and retain tenants, which may adversely affect us, including our profitability and impede our growth.

 

   

We may be subject to unknown or contingent liabilities related to properties or businesses that we acquire, including as part of the formation transactions, for which we may have limited recourse against the sellers.

 

   

Upon completion of this offering, the formation transactions and the concurrent private placement, Michael P. Ibe, a director nominee and our Executive Vice President—Development and Acquisitions, will own an approximate 15.2% beneficial interest in our company on a fully diluted basis and the Easterly Funds and the owner of Easterly Partners, LLC, which are all controlled by Darrell W. Crate, our Chairman, will own an approximate 53.1% beneficial interest in our company on a fully diluted basis and each will have the ability to exercise significant influence on our company.

 

   

We may not have sufficient cash flow to meet the required payments of principal and interest on our debt or to pay distributions on our shares at expected levels.

 

   

High mortgage rates and/or unavailability of mortgage debt may make it difficult for us to finance or refinance properties, which could reduce the number of properties we can acquire, our net income and the amount of cash distributions we can make.

 

   

We may owe certain taxes notwithstanding our qualification as a REIT.

 

   

REIT distribution requirements could adversely affect our liquidity and ability to execute our business plan.

 

Pro Forma Indebtedness

 

Upon completion of this offering, the formation transactions and the concurrent private placement, we expect to have approximately $104.8 million of indebtedness, which consists of debt and amounts outstanding under our senior unsecured revolving credit facility for a pro forma debt-to-capitalization ratio of 14.6%. Our mortgage indebtedness will have staggered maturities with a weighted average debt maturity of approximately

 

 

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13.3 years and a weighted average interest rate of 4.1% per annum all of which is fixed rate debt. In the future, overall leverage will depend on how we choose to finance our portfolio, including future acquisitions, and the cost of leverage. Neither our charter nor our investment policies restrict the amount of leverage that we may incur.

 

In connection with the completion of this offering, the formation transactions and the concurrent private placement, we intend to enter into a $400.0 million senior unsecured revolving credit facility with affiliates of certain of the underwriters. This credit facility will have an accordion feature that will provide us with additional capacity, subject to the satisfaction of customary terms and conditions, of up to $250.0 million, for a total facility size of not more than $650.0 million. We intend to use the senior unsecured revolving credit facility to repay indebtedness, fund acquisitions, development and redevelopment opportunities, capital expenditures and the costs of securing new and renewal leases and provide working capital. We expect $35.4 million will be drawn upon completion of this offering.

 

Structure and Formation of Our Company

 

Our Company

 

Upon completion of this offering, the formation transactions and the concurrent private placement, we will wholly own 29 properties in the United States, including 26 properties that are leased primarily to U.S. Government tenant agencies and three properties that are entirely leased to private tenants, encompassing approximately 2.1 million square feet in the aggregate. Our initial portfolio consists of 15 properties contributed by the Easterly Funds and 14 properties contributed by Western Devcon. For more information on our formation transactions, see “Structure and Formation of Our Company.”

 

Our Predecessor

 

The term “our predecessor” refers to Easterly Partners, LLC and its consolidated subsidiaries, including the Easterly Funds, which hold 100% of the fee interests in the entities that own 15 of the properties, or the property-owning subsidiaries, that will be contributed to us in the formation transactions, as well as the management entities.

 

Formation Transactions

 

Each property that will be in our initial portfolio is currently owned by the Easterly Funds or by Western Devcon. Each of the Easterly Funds and the owner of the management entities, which is in turn owned by Darrell W. Crate, our Chairman, have entered into a contribution agreement with us and our operating partnership pursuant to which they will contribute their interests in their property-owning subsidiaries to our operating partnership in exchange for 3,308,000 shares of common stock and 9,771,120 common units of our operating partnership. Western Devcon has entered into a contribution agreement with us and our operating partnership pursuant to which it will contribute its interest in 14 properties to our operating partnership in exchange for 5,759,819 common units of our operating partnership.

 

Concurrent Private Placement

 

Concurrently with this offering and the formation transactions, the Easterly Funds will acquire 7,033,712 shares of common stock in a private placement at a price per share equal to the public offering price. We refer to such share issuance as the concurrent private placement. No fees, discounts or selling commissions will be paid to the underwriters in connection with any sale of common stock through the concurrent private placement. The shares that will be issued in the concurrent private placement will be in addition to the shares sold in this offering.

 

 

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Our Organizational and Ownership Structure

 

The following diagram depicts our expected ownership structure upon completion of this offering, the formation transactions and the concurrent private placement.

 

LOGO

 

(1)   Includes 26,655 shares of common stock and 6,897,838 common units to be issued to our executive officers, employee directors and their affiliates in the formation transactions and the concurrent private placement, including indirectly by Darrell W. Crate through his ownership interest in one of the Easterly Funds and grants of 26,667 shares of restricted stock granted to our non-employee directors pursuant to our 2015 Equity Incentive Plan in connection with this offering.
(2)   In this prospectus, we refer to the Easterly Funds and the owner of the management entities as our continuing investors. Until 15 months following the completion of this offering, the Easterly Funds will directly hold 3,308,000 shares of our common stock and 8,635,714 common units in our operating partnership received in exchange for the property-owning entities contributed as part of our formation transactions. On or about 15 months following the completion of this offering, we expect that the Easterly Funds will liquidate and certain of our executive officers, directors and their affiliates will become the beneficial owners of a portion of the shares of common stock and common units in our operating partnership formerly held by each of the Easterly Funds. These shares and common units will be valued based on the volume weighted average closing price of our shares of common stock for the 30 trading-day period prior to the liquidation and distributed in accordance with the terms of the respective Easterly Funds’ partnership agreement, which provide for the payment of incentive distributions to the general partners of the Easterly Funds that will in turn be allocated to certain of our executive officers, directors and their affiliates at such time. Our executive officers who will be entitled to receive incentive distributions are William C. Trimble, III, our Chief Executive Officer and President, Darrell W. Crate, our Chairman, Alison M. Bernard, our Executive Vice President and Chief Financial Officer and F. Joseph Moravec, our Executive Vice President — Government Relations. We will not be able to determine the number of shares and common units that these executive officers will directly or indirectly receive as a result of such incentive distributions until the completion of the liquidation of the Easterly Funds.
(3)   Excludes an aggregate of 26,655 shares of common stock and an aggregate of 1,138,020 common units to be issued to Darrell W. Crate, our Chairman, indirectly through his ownership interest in one of the Easterly Funds in the formation transactions and the concurrent private placement.

 

 

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Benefits to Related Parties

 

In connection with this offering, the formation transactions and the concurrent private placement, Western Devcon, certain of our executive officers, directors, director nominees and continuing investors will receive material financial and other benefits, including those set forth below.

 

   

In exchange for the contribution by Western Devcon of its interests in the properties being contributed as part of the formation transactions, Western Devcon, or its beneficial owner, Michael P. Ibe, a director nominee and our Executive Vice President—Development and Acquisitions, will receive 5,759,819 common units in our operating partnership. As a result, Western Devcon, or its beneficial owner, Michael P. Ibe, will own approximately 15.2% of our outstanding common stock on a fully diluted basis, or 14.5% on a fully diluted basis if the underwriters’ over-allotment option is exercised in full.

 

   

The Easterly Funds will receive as consideration for the contribution of the property-owning subsidiaries an aggregate of 3,308,000 shares of common stock and 8,635,714 common units in our operating partnership and will purchase an aggregate of 7,033,712 shares of common stock in the concurrent private placement. As a result, the Easterly Funds will own approximately 50.1% of our outstanding common stock on a fully diluted basis, or 47.8% on a fully diluted basis if the underwriters’ over-allotment option is exercised in full.

 

   

Darrell W. Crate, our Chairman, will beneficially own an aggregate of 26,655 shares of common stock and 1,138,020 common units in our operating partnership as consideration for the contribution of the management entities and as a result of his investment in the Easterly Funds. As a result, Darrell W. Crate will own directly or indirectly through the Easterly Funds, approximately 3.1% of our common stock on a fully diluted basis, or 2.9% on a fully diluted basis if the underwriters’ over-allotment option is exercised in full.

 

   

We will enter into a tax protection agreement with Michael P. Ibe, a director nominee and our Executive Vice President—Development and Acquisitions, under which we will agree to indemnify Mr. Ibe for any taxes incurred as a result of a taxable sale of the properties contributed by Western Devcon in the formation transactions for a period of eight years after the closing.

 

   

We will enter into one or more registration rights agreements pursuant to which our continuing investors and Michael P. Ibe will have the right to cause us to register with the Securities and Exchange Commission, or the SEC, the resale of the shares of common stock that they receive in the formation transactions and the concurrent private placement or the resale or primary issuance of the shares of common stock that they may receive in exchange for common units and facilitate the offering and sale of such shares.

 

   

We will enter into a director nomination agreement with Michael P. Ibe providing Mr. Ibe with the right to nominate one member of our board of directors and the right to designate one board observer who may attend meetings of the board of directors for so long as he owns shares of our common stock and common units representing at least 10% of our common stock on a fully diluted basis.

 

   

We currently anticipate that we will enter into employment agreements with certain of our executive officers that will take effect upon completion of this offering.

 

   

We will enter into indemnification agreements with each of our executive officers, directors and director nominees, whereby we will agree to indemnify our executive officers, directors and director nominees against all expenses and liabilities and pay or reimburse their reasonable expenses in advance of final disposition of a proceeding to the fullest extent permitted by Maryland law if they are made or threatened to be made a party to the proceeding by reason of their service to our company, subject to limited exceptions.

 

   

We will issue an aggregate of 26,667 shares of restricted common stock to our non-employee directors pursuant to the 2015 Equity Incentive Plan.

 

   

In connection with the formation transactions and the concurrent private placement, we will grant waivers from the ownership limit contained in our charter to Michael P. Ibe, Easterly Fund I and Easterly Fund II to own up to approximately 21%, 22% and 28%, respectively, of our outstanding common stock in the aggregate.

 

 

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Our Tax Status

 

We intend to elect to be treated and to qualify as a REIT for U.S. federal income tax purposes beginning with our taxable year ending December 31, 2015. We believe we have been organized, have operated and will continue to be organized and operate in a manner that permits us to satisfy the requirements for taxation as a REIT under the applicable provisions of the Internal Revenue Code of 1986, as amended, or the Code. To maintain REIT status, we must meet a number of organizational and operational requirements, including a requirement that we annually distribute at least 90% of our taxable income to our stockholders, computed without regard to the dividends paid deduction and excluding our net capital gain, plus 90% of our net income after tax from foreclosure property (if any), minus the sum of various items of excess non-cash income.

 

In any year in which we qualify as a REIT, we generally will not be subject to U.S. federal income tax on that portion of our taxable income or capital gain that is distributed to stockholders. If we lose our REIT status, and the statutory relief provisions of the Code do not apply, we will be subject to entity-level income tax, including any applicable alternative minimum tax, on our taxable income at regular U.S. corporate tax rates. Even if we qualify as a REIT, we will be subject to certain U.S. federal, state and local taxes on our income and property and on taxable income that we do not distribute to our stockholders. See “U.S. Federal Income Tax Considerations.”

 

Distribution Policy

 

We intend to pay regular quarterly distributions to holders of common stock. We intend to pay a pro rata initial distribution with respect to the period commencing on the completion of this offering and ending on the last day of the then current fiscal quarter, based on $0.21 per share for a full quarter. On an annualized basis, this would be $0.83 per share, or an annual distribution rate of approximately 5.5%. We intend to maintain a distribution rate for the 12 months following completion of this offering that is at or above our initial distribution rate unless actual results of operations, economic conditions or other factors differ materially from the assumptions used in our estimate. We do not intend to reduce the expected distributions per share if the underwriters exercise their over-allotment option to purchase additional shares of common stock. Any future distributions we make will be at the discretion of our board of directors and will be dependent upon a number of factors, including prohibitions or restrictions under financing agreements or applicable law and other factors described herein. We anticipate distributing all of our taxable income.

 

Restrictions on Ownership of Our Common Stock

 

Due to limitations on the concentration of ownership of REIT stock imposed by the Code, among other restrictions, our charter prohibits any person or entity from actually or constructively owning shares in excess of 7.1% (in value or in number of shares, whichever is more restrictive) of the outstanding shares of any class of stock or series of stock, or 7.1% in value of the aggregate of the outstanding shares of all classes and series of our stock. In connection with the formation transactions and the concurrent private placement, we will grant waivers from the ownership limit contained in our charter to Michael P. Ibe, Easterly Fund I and Easterly Fund II to own up to approximately 21%, 22% and 28%, respectively, of our outstanding common stock in the aggregate.

 

Restrictions on Transfer and Certain Indemnity Obligations for Holders of Common Stock and Units

 

We, our executive officers, directors and director nominees, Western Devcon and the continuing investors that are receiving shares of our common stock or common units in the formation transactions and the concurrent private placement have agreed not to sell or transfer any common stock or securities convertible into, exchangeable for, exercisable for, or repayable with common stock, including common units, for 180 days after the date of this prospectus without first obtaining the written consent of each of Citigroup Global Markets Inc., Raymond James & Associates, Inc. and RBC Capital Markets, LLC, subject to certain exceptions. See “Description of Capital Stock—Restrictions on Ownership and Transfer.”

 

 

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Conflicts of Interest

 

Conflicts of interest may exist or could arise in the future as a result of the relationships between us and our affiliates, on the one hand, and our operating partnership or any partner thereof, on the other. Our directors and officers have duties to our company under applicable Maryland law in connection with their management of our company. At the same time, we, as the general partner of our operating partnership, have fiduciary duties and obligations to our operating partnership and its other partners under Delaware law and the partnership agreement in connection with the management of our operating partnership. Our fiduciary duties and obligations, as the general partner of our operating partnership, may come into conflict with the duties of our directors and officers to our company and our stockholders. In particular, the consummation of certain business combinations, the sale of any properties or a reduction of indebtedness could have adverse tax consequences to holders of common units, which would make those transactions less desirable to them.

 

We intend to adopt policies that are designed to reduce certain potential conflicts of interests. See “Policies with Respect to Certain Activities—Conflict of Interest Policies.”

 

Emerging Growth Company Status

 

We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act, and we are eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growth companies,” including not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. We have not yet made a decision as to whether we will take advantage of any or all of these exemptions. If we do take advantage of any of these exemptions, we do not know if some investors will find our common stock less attractive as a result. The result may be a less active trading market for our common stock and our stock price may be more volatile.

 

In addition, the JOBS Act also provides that an “emerging growth company” can take advantage of the extended transition period provided in the Securities Act of 1933, as amended, or the Securities Act, for complying with new or revised accounting standards. In other words, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. However, we have chosen to “opt out” of this extended transition period, and, as a result, we will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for all public companies that are not emerging growth companies. Our decision to opt out of the extended transition period for complying with new or revised accounting standards is irrevocable.

 

We will remain an “emerging growth company” until the earliest to occur of (i) the last day of the fiscal year during which our total annual revenue equals or exceeds $1.0 billion (subject to adjustment for inflation), (ii) the last day of the fiscal year following the fifth anniversary of this offering, (iii) the date on which we have, during the previous three-year period, issued more than $1.0 billion in non-convertible debt or (iv) the date on which we are deemed to be a “large accelerated filer” under the Securities Exchange Act of 1934, as amended, or the Exchange Act.

 

Corporate Information

 

Our principal executive offices are located at 2101 L Street NW, Suite 750, Washington, D.C. 20037. Our telephone number is (202) 595-9500. We maintain a website at www.easterlyreit.com. Information contained on, or accessible through, our website is not incorporated by reference into and does not constitute a part of this prospectus or any other reports or documents we file with or furnish to the SEC.

 

 

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This Offering

 

Common stock offered by us in this offering

12,000,000 shares

 

Common stock to be outstanding after completion of this offering, the formation transactions and the concurrent private placement

22,368,379 shares(1)

 

Common units to be outstanding after completion of this offering, the formation transactions and the concurrent private placement

37,899,318 common units(2)

 

Use of Proceeds

We estimate that the net proceeds to us from this offering, after deducting underwriting discounts and commissions and estimated offering expenses, will be approximately $166.5 million ($191.7 million if the underwriters exercise their option to purchase up to 1,800,000 additional shares of common stock in full to cover over-allotments). We expect that the net proceeds to us from the concurrent private placement will be approximately $105.5 million. We will contribute the net proceeds from this offering and the concurrent private placement to our operating partnership in exchange for common units. We expect our operating partnership to use the net proceeds received from us and a portion of the borrowings under the senior unsecured revolving credit facility to repay approximately $272.9 million in outstanding indebtedness and any applicable repayment costs, defeasance costs, settlement of interest rate swap liabilities and other costs and fees associated with such repayments and costs related to our acquisition of Western Devcon. We expect to use any remaining net proceeds for general corporate purposes, including capital expenditures and potential future acquisition, development and redevelopment opportunities. See “Use of Proceeds.”

 

Risk Factors

Investing in our common stock involves a high degree of risk. You should carefully read and consider the information set forth under the heading “Risk Factors” beginning on page 26 and other information included in this prospectus before investing in our common stock.

 

NYSE Symbol

“DEA”

 

(1)   Includes (a) 12,000,000 shares of common stock to be issued in this offering, (b) 3,308,000 shares of common stock to be issued in connection with the formation transactions, (c) 7,033,712 shares of common stock to be issued in the concurrent private placement, (d) 26,667 shares of restricted common stock to be granted to our non-employee directors concurrently with the completion of this offering. Excludes (a) 1,800,000 shares of common stock issuable upon the exercise in full of the underwriters’ option to cover over-allotments, (b) 2,247,292 shares of common stock available for future issuance under our 2015 Equity Incentive Plan and (c) 15,530,939 shares of common stock that may be issued, at our option, upon exchange of 15,530,939 common units to be issued in the formation transactions.
(2)   Includes 15,530,939 common units expected to be issued in the formation transactions.

 

 

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Summary Consolidated Historical and Pro Forma Financial Data

 

The following table sets forth summary historical consolidated financial data and other operating data of our predecessor and our summary condensed consolidated pro forma financial information as of the dates and for the periods presented. We have not presented historical information for Easterly Government Properties, Inc. because it has not had any operating activity since its formation on October 9, 2014, other than the issuance of 1,000 shares of its common stock as part of its initial capitalization and activity in connection with our formation transactions, the concurrent private placement and this offering, and because we believe that a presentation of the results of Easterly Government Properties, Inc. would not be meaningful.

 

The term “our predecessor” refers to Easterly Partners, LLC and its consolidated subsidiaries, including the Easterly Funds and the management entities.

 

The summary historical consolidated financial information as of September 30, 2014 and for the nine months ended September 30, 2014 and 2013 presented below has been derived from our predecessor’s unaudited consolidated financial statements included elsewhere in this prospectus. The summary historical consolidated financial information as of December 31, 2013 and 2012 and for the years ended December 31, 2013 and 2012 presented below has been derived from our predecessor’s audited consolidated financial statements included elsewhere in this prospectus.

 

The Easterly Funds use investment company accounting and, accordingly, account for their investments based on fair value. For further information, see Note 1 in the “Notes to the Unaudited Pro Forma Condensed Consolidated Financial Statements” appearing elsewhere in this prospectus. Going forward we will account for the properties owned by the Easterly Funds using historical cost accounting instead of investment company accounting. Moving from investment company accounting to historical cost accounting will result in significant changes in the presentation of our consolidated financial statements following the formation transactions. Our future financial condition and results of operations will differ significantly from, and will not be comparable with, the historical financial position and results of operations of our predecessor.

 

Our unaudited pro forma condensed consolidated balance sheet as of September 30, 2014 gives effect to the formation transactions, the concurrent private placement, the initial public offering, our new senior unsecured revolving credit facility and the use of proceeds therefrom as if these events had occurred on September 30, 2014. The unaudited pro forma condensed consolidated statement of operations for the nine months ended September 30, 2014 and for the year ended December 31, 2013 give effect to the formation transactions, the concurrent private placement, the initial public offering, our new senior unsecured revolving credit facility and the use of proceeds therefrom as if these events had occurred on January 1, 2013.

 

Our pro forma financial information is not necessarily indicative of what our actual financial position and results of operations would have been if the formation transactions, the concurrent private placement, the initial public offering, our new senior unsecured revolving credit facility and the use of proceeds occurred on the date or at the beginning of the period indicated, nor does it purport to represent our future financial position or results of operations. The unaudited pro forma adjustments are based on information and assumptions that we consider reasonable and factually supportable.

 

Since the information presented below is only a summary and does not provide all of the information contained in the historical consolidated financial statements of our predecessor or our pro forma financial statements, including the related notes, you should read the following in conjunction with the information contained in “—Pro Forma Indebtedness,” “Structure and Formation of Our Company,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the consolidated financial statements and unaudited pro forma condensed consolidated financial statements and related notes thereto appearing elsewhere in this prospectus.

 

 

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     Predecessor Historical  
     For the Nine Months
Ended September 30,
    For the Year Ended
December 31,
 
     2014     2013     2013     2012  
     (amounts in thousands)  

Statement of Operations Data:

        

Income from real estate investments

   $ 4,601      $ 2,814      $ 4,006      $ 1,785   

Other income

     —          —          —          202   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total income

     4,601        2,814        4,006        1,987   
  

 

 

   

 

 

   

 

 

   

 

 

 

Fund general and administrative

     714        1,037        1,299        518   

Corporate general and administrative

     4,586        3,049        4,281        2,663   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

     5,300        4,086        5,580        3,181   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net investment gain (loss)

     (699     (1,272     (1,574     (1,194

Net unrealized gain on investments

     71,865        15,693        27,641        10,841   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net increase in capital resulting from operations

     71,166        14,421        26,067        9,647   

Capital increases attributable to non-controlling interests

     75,830        17,492        30,381        12,290   
  

 

 

   

 

 

   

 

 

   

 

 

 

Capital increases attributable to Easterly Partners, LLC

   $ (4,664   $ (3,071   $ (4,314   $ (2,643
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash Flows Provided By (Used in):

        

Operating activities

   $ (24,869   $ (44,533   $ (44,546   $ (32,690

Financing activities

     54,563        47,206        47,189        32,338   

Statement of Assets, Liabilities and Capital Data
(As of End of Period):

        

Real estate investments, at fair value

   $ 271,377        $ 173,099      $ 102,753   

Cash and cash equivalents

     33,057          3,363        720   

Total assets

     305,314          177,902        103,871   

Total liabilities

     2,901          1,218        443   

Total capital

     302,413          176,684        103,428   

 

 

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      Company Pro Forma(1)  
      For the
Nine Months Ended
September 30, 2014
    For the
Year Ended
December 31, 2013
 
     (amounts in thousands)  

Statement of Operations Data:

    

Revenues

    

Rental income

   $ 49,560      $ 64,229   

Tenant reimbursements

     3,906        5,068   

Other income

     92        172   
  

 

 

   

 

 

 

Total revenues

     53,558        69,469   
  

 

 

   

 

 

 

Expenses

    

Property operating

     10,041        12,814   

Real estate taxes

     4,521        6,092   

Depreciation and amortization

     24,125        34,509   

Corporate general and administrative

     5,938        6,880   
  

 

 

   

 

 

 

Total expenses

     44,625        60,295   
  

 

 

   

 

 

 

Operating income (loss)

     8,933        9,174   

Interest expense

     (4,147     (5,535
  

 

 

   

 

 

 

Net income (loss)

     4,786        3,639   

Non-controlling interest in operating partnership

     1,962        1,491   
  

 

 

   

 

 

 

Net income (loss) available to common stockholders

   $ 2,824      $ 2,148   
  

 

 

   

 

 

 

Pro forma income per share

    

Basic

   $ 0.13      $ 0.10   
  

 

 

   

 

 

 

Diluted

   $ 0.13      $ 0.10   
  

 

 

   

 

 

 

Pro forma weighted average common shares outstanding

    

Basic

     22,368,379        22,368,379   

Diluted

     37,899,318        37,899,318   

Other Data:

    

FFO(2)

   $ 28,911      $ 38,148   

FFO, as Adjusted(2)

     26,716        35,268   

EBITDA(3)

     33,058        43,683   

Adjusted EBITDA(3)

     31,200        40,803   

Balance Sheet Data (As of End of Period)(4)

    

Real estate properties

   $ 625,036     

Cash and cash equivalents

     13,662     

Total assets

     756,518     

Total debt

     104,794     

Total liabilities

     141,937     

Total stockholders’ equity

     614,581     

 

(1)   The unaudited pro forma condensed consolidated financial information for the nine months ended September 30, 2014 and for the year ended December 31, 2013 gives effect to the formation transactions, the initial public offering, the concurrent private placement, our new senior unsecured revolving credit facility and the use of proceeds therefrom assuming such transactions occurred on January 1, 2013. See the unaudited pro forma condensed consolidated financial statements appearing elsewhere in this prospectus.

 

 

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(2)   Funds from Operations, or FFO, is a supplemental measure of our performance. We present FFO calculated in accordance with the current National Association of Real Estate Investment Trusts, or NAREIT, definition. In addition, we present FFO, as Adjusted for certain other adjustments that we believe enhance the comparability of our FFO across periods and to the FFO reported by other publicly traded REITs. FFO and FFO, as Adjusted are supplemental performance measures that are commonly used in the real estate industry to assist investors and analysts in comparing results of REITs.

 

       FFO is generally defined by NAREIT as net income (loss), calculated in accordance with GAAP, excluding gains or losses from sales of property, and adding back real estate depreciation. We present FFO because we consider it an important supplemental measure of our operating performance, and we 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 results.

 

       We adjust FFO to present FFO, as Adjusted as an alternative measure of our operating performance, which, when applicable, excludes the impact of straight-line rent, above-/below-market leases and/or non-cash compensation. In future periods, we may also exclude other items from FFO, as Adjusted that we believe may help investors compare our results.

 

       FFO and FFO, as Adjusted are presented as supplemental financial measures and do not fully represent our operating performance. Other REITs may use different methodologies for calculating FFO and FFO, as Adjusted or use other definitions of FFO and FFO, as Adjusted and, accordingly, our presentation of these measures may not be comparable to those presented by other REITs. Neither FFO nor FFO, as Adjusted is intended to be a measure of cash flow or liquidity. Please refer to our financial statements, prepared in accordance with GAAP for purposes of evaluating our financial condition, results of operations and cash flows.

 

       The following table sets forth a reconciliation of our pro forma net income to FFO and FFO, as Adjusted for the nine months ended September 30, 2014 and the year ended December 31, 2013 on a pro forma basis:

 

     Company Pro Forma  
     For the
Nine Months Ended
September 30, 2014
    For the
Year Ended
December 31, 2013
 
     (amounts in thousands)  

Pro Forma Net income (loss)

   $ 4,786      $ 3,639   

Depreciation and amortization

     24,125        34,509   
  

 

 

   

 

 

 

Funds from Operations

   $ 28,911      $ 38,148   

Adjustments to FFO:

    

Straight-line rent

     (161     (192

Above-/below-market leases

     (2,556     (3,425

Non-cash compensation

     522        737   
  

 

 

   

 

 

 

Funds from Operations, as Adjusted

   $ 26,716      $ 35,268   
  

 

 

   

 

 

 

 

(3)   EBITDA is calculated as the sum of net income (loss) before interest expense, income taxes, depreciation and amortization. Adjusted EBITDA represents EBITDA as adjusted for (i) acquisition-related costs, (ii) non-cash compensation and (iii) other one-time non-cash charges and items.

 

      

Given the nature of our business as a real estate owner and operator, we believe that the use of EBITDA and Adjusted EBITDA in various financial ratios is helpful to investors as a measure of our operational performance because EBITDA and Adjusted EBITDA exclude various items that do not relate to or are not indicative of our operating performance such as gains (losses) from sales of real estate and depreciation and amortization on real estate assets. Accordingly, we believe that the use of EBITDA and Adjusted EBITDA

 

 

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in various ratios provides a meaningful performance measure, but should not be considered as an alternative to net income (determined in accordance with GAAP) as an indicator of our financial performance and are not alternatives to cash flows from operating activities (determined in accordance with GAAP) as a measure of our liquidity. In addition, our computation of EBITDA and Adjusted EBITDA may differ in certain respects from the methodology utilized by other REITS to calculate EBITDA and Adjusted EBITDA and, therefore, may not be comparable to the measures presented by such other REITS. Investors are cautioned that items excluded from EBITDA and Adjusted EBITDA are significant components in understanding and addressing our financial performance.

 

       The following table presents a reconciliation of net income to pro forma EBITDA and Adjusted EBITDA and Adjusted EBITDA for the nine months ended September 30, 2014 and the year ended December 31, 2013 on a pro forma basis:

 

     Company Pro Forma  
     For the
Nine Months Ended
September 30, 2014
     For the
Year Ended
December 31, 2013
 
     (amounts in thousands)  

Pro forma net income (loss)

   $ 4,786       $ 3,639   

Depreciation and amortization

     24,125         34,509   

Interest expense

     4,147         5,535   
  

 

 

    

 

 

 

EBITDA

   $ 33,058       $ 43,683   

Adjustments to EBITDA:

     

Acquisition costs

     337         —     

Straight-line rent

     (161      (192

Above-/below-market leases

     (2,556      (3,425

Non-cash compensation

     522         737   
  

 

 

    

 

 

 

Adjusted EBITDA

   $ 31,200       $ 40,803   
  

 

 

    

 

 

 

 

(4)   The unaudited pro forma condensed consolidated balance sheet information as of September 30, 2014 gives effect to the formation transactions, the initial public offering, the concurrent private placement, our new senior unsecured revolving credit facility and the use of proceeds therefrom assuming such transactions occurred on September 30, 2014. See the unaudited pro forma condensed consolidated financial statements appearing elsewhere in this prospectus.

 

 

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RISK FACTORS

 

An investment in our common stock involves a high degree of risk. You should carefully consider the following material risks, as well as the other information contained in this prospectus, before making an investment in our company. If any of the following risks actually occur, our business, financial condition or results of operations could be materially and adversely affected. In such an event, the trading price of our common stock could decline and you could lose part or all of your investment.

 

Risks Related to Real Estate

 

We depend on the U.S. Government and its agencies for substantially all of our revenues and any failure by the U.S. Government and its agencies to perform their obligations under their leases or renew their leases upon expiration could have a material adverse effect on our business, financial condition and results of operations.

 

Substantially all of our current rents come from U.S. Government tenant agencies, including rents paid through the GSA. Following the completion of this offering and the formation transactions, our U.S. Government tenant agencies will account for more than 95% of our annualized lease income. We expect that leases to agencies of the U.S. Government will continue to be the primary source of our revenues for the foreseeable future. Due to such concentration, any failure by the U.S. Government to perform its obligations under its leases or a failure to renew its leases upon expiration, could cause interruptions in the receipt of lease revenue or result in vacancies, or both, which would reduce our revenue until the affected properties are leased, and could decrease the ultimate value of the affected property upon sale and have a material adverse effect on our business, financial condition and results of operations.

 

Some of our leases with U.S. Government tenant agencies permit the tenant agency to vacate the property and discontinue paying rent prior to their lease expiration date.

 

Some of our leases are currently in the soft-term period of the lease and tenants under such leases have the right to vacate their space during a specified period before the stated terms of their leases expire. As of the date of this prospectus, tenants occupying approximately 20.5% of our rentable square feet and contributing approximately 23.0% of our annualized lease income currently have exercisable rights to terminate their leases before the stated soft term of their lease expires. In the remainder of 2014, 2015, 2016 and 2017, early termination rights become exercisable by other tenants who currently occupy an additional approximately 0.0%, 0.0%, 0.0% and 4.5% of our rentable square feet, respectively, and contribute an additional approximately 0.0%, 0.0%, 0.0% and 2.9% of our total annualized lease income, respectively. In particular, seven tenants currently have an exercisable right to terminate their lease before the soft term expires, including the lease at our IRS— Fresno property, which accounted for approximately 10.9% of our total annualized lease income as of September 30, 2014. For fiscal policy reasons, security concerns or other reasons, some or all of our U.S. Government tenant agencies under leases within the soft-term period may decide to exercise their termination rights before the stated term of their lease expires. Such events, if they were to occur and we were not able to lease to the vacant space to another tenant in a timely manner or at all, could have a material adverse effect on our business, financial condition and results of operations.

 

We may be unable to renew leases or lease vacating space on favorable terms or at all as leases expire, which could adversely affect our business, financial condition and results of operations.

 

As of September 30, 2014, leases representing approximately 22.6% of our total annualized lease income and approximately 19.4% of the square footage of the properties in our initial portfolio will expire by the end of 2018. We may be unable to renew such expiring leases or our properties may not be released at net effective rental rates equal to or above the current average net effective rental rates.

 

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In addition, when we renew leases or lease to new tenants, especially U.S. Government tenant agencies, we may spend substantial amounts for leasing commissions, tenant fit-outs or other tenant inducements. As part of our strategy, we may design build-to-suit property improvements designed to enhance the agency’s mission-critical capabilities. Because these properties have been designed or physically modified to meet the needs of a particular tenant agency, if the current lease is terminated or not renewed, we may be required to renovate the property at substantial costs, decrease the rent we intend to charge or provide other concessions in order to lease the property to another tenant, which could adversely affect our business, financial condition and results of operations.

 

We are exposed to risks associated with property development and redevelopment, including new developments for anticipated tenant agencies and build-to-suit renovations for existing tenant agencies.

 

We intend to engage in development and redevelopment activities with respect to our properties, including build-to-suit renovations for existing U.S. Government tenant agencies and new developments for anticipated tenant agencies and will be subject to certain risks, which could adversely affect us, including our financial condition and results of operations. These risks include:

 

   

the availability and pricing of financing on favorable terms or at all;

 

   

development costs may be higher than anticipated;

 

   

cost overruns and untimely completion of construction (including risks beyond our control, such as weather or labor conditions, or material shortages);

 

   

the potential that we may expend funds on and devote management time to projects that we do not complete; and

 

   

the inability to complete construction and leasing of a property on schedule, resulting in increased debt service expense and development and renovation costs.

 

These risks could result in substantial unanticipated delays or expenses and could prevent the initiation or the completion of development and renovation activities, any of which could have a material adverse effect on our business, financial condition and results of operations.

 

We depend on the members of our senior management team and the loss of any of their services, or an inability to attract and retain highly qualified personnel, could have a material adverse effect on our business, financial condition and results of operations.

 

Our senior management team is comprised of four individuals with experience in identifying, acquiring, developing, financing and managing U.S. Government-leased assets and has developed long-term relationships across the commercial real estate industry, including at all levels of the GSA and at numerous government agencies. Each of these individuals brings specialized knowledge and skills in the GSA-leased property sector. The loss of services of one or more of these members of our senior management team, or our inability to attract and retain highly qualified personnel, could have a material adverse effect on our business, financial condition and results of operations and weaken our relationships with lenders, business partners, industry participants, the GSA and U.S. Government agencies.

 

Unfavorable market and economic conditions in the United States and globally could adversely affect occupancy levels, rental rates, rent collections, operating expenses and the overall market value of our assets and have a material adverse effect on our business, financial condition and results of operations.

 

Unfavorable market conditions in the geographic markets in which we operate and unfavorable economic conditions in the United States and globally may significantly affect our occupancy levels, rental rates, rent collections, operating expenses, the market value of our assets and our ability to strategically acquire, dispose of, recapitalize or refinance our properties on economically favorable terms or at all. Our ability to lease our properties at favorable rates may be adversely affected by increases in supply of office space and is dependent

 

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upon overall economic conditions, which are adversely affected by, among other things, job losses and unemployment levels, recession, stock market volatility and uncertainty about the future. Some of our major expenses, including mortgage payments and real estate taxes, generally do not decline when related rents decline. Any declines in our occupancy levels, rental revenues or the values of our buildings would cause us to have less cash available to pay our indebtedness, fund necessary capital expenditures and to make distributions to our stockholders, which could negatively affect our financial condition and the market value of our securities. Our business may be affected by the volatility and illiquidity in the financial and credit markets, a general global economic recession and other market or economic challenges experienced by the real estate industry or the U.S. economy as a whole.

 

Our business may also be adversely affected by local economic conditions in the areas in which we operate. Factors that may affect our occupancy levels, our rental revenues, our net operating income, or NOI, our funds from operations or the value of our properties include the following, among others:

 

   

downturns in global, national, regional and local economic conditions;

 

   

possible reduction of the U.S. Government workforce; and

 

   

economic conditions that could cause an increase in our operating expenses, such as increases in property taxes (particularly as a result of increased local, state and national government budget deficits and debt and potentially reduced federal aid to state and local governments), utilities, insurance, compensation of on-site associates and routine maintenance.

 

Our properties are leased to a limited number of U.S. Government tenant agencies, and a change to any of these agencies’ missions could have a material adverse effect on our business, financial condition and results of operations.

 

As of September 30, 2014, three of our U.S. Government tenant agencies, the DEA, FBI and IRS, accounted for an aggregate of approximately 41.0% of our total rentable square feet and an aggregate of approximately 45.9% of our total annualized lease income. Each U.S. Government agency has its own customs, procedures, culture, needs and mission, which translate into different requirements for its leased space, and we work with the tenant agency to design and construct specialized, agency-specific enhancements. In addition, under the terms of our GSA leases, the GSA generally has the right to designate another U.S. Government agency to occupy all or a portion of the leased property. Therefore, a change in the mission of any one of these agencies, a significant reduction in the agency workforce, a relocation of personnel resources, other internal reorganization or a change in the tenant agency occupying the leased space, could affect our lease renewal opportunities and have a material adverse effect on our business, financial condition and results of operations.

 

We currently have a concentration of properties located in California and are exposed to changes in market conditions and natural disasters in this state.

 

Eleven of the 29 properties in our initial portfolio are located in California, accounting for approximately 25% of our total rentable square feet and approximately 33% of our total annualized lease income as of September 30, 2014. As a result of this concentration, a material portion of our portfolio may be exposed to the effects of economic and real estate conditions in California markets, such as the supply of competing properties, general levels of employment and economic activity. In addition, historically, California has been vulnerable to natural disasters and we are therefore susceptible to the risks of natural disasters, such as earthquakes, wildfires, floods and mudslides. To the extent that weak economic or real estate conditions or natural disasters affect California more severely than other areas of the country, our business, financial condition and results of operations could be negatively impacted.

 

We are subject to risks from natural disasters and climate change.

 

Natural disasters and severe weather such as earthquakes, tornadoes, hurricanes or floods may result in significant damage to our properties. The extent of our casualty losses and loss in operating income in connection

 

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with such events is a function of the severity of the event and the total amount of exposure in the affected area. When we have geographic concentration of exposures, a single catastrophe, such as an earthquake affecting our properties in California, or destructive weather event, such as a tornado affecting our property in Nebraska, may have a significant negative effect on our business, financial condition and results of operations. As a result, our operating and financial results may vary significantly from one period to the next. Our financial results may be adversely affected by our exposure to losses arising from natural disasters or severe weather. We also are exposed to risks associated with inclement winter weather, particularly on the Atlantic coast, a region in which some of our properties are located, including increased need for maintenance and repair of our buildings.

 

As a result of climate change, we may also experience extreme weather and changes in precipitation and temperature, all of which may result in physical damage or a decrease in demand for our properties located in the areas affected by these conditions. Should the impact of climate change be material in nature, our financial condition or results of operations would be adversely affected. In addition, changes in federal and state legislation and regulation on climate change could result in increased capital expenditures to improve the energy efficiency of our existing properties in order to comply with such regulations.

 

A U.S. Government tenant agency could institute condemnation proceedings against us and seek to take our property, or a leasehold interest therein, through its power of eminent domain.

 

A U.S. Government tenant agency could institute condemnation proceedings against us and seek to take our property, or a leasehold interest therein, through its power of eminent domain. The procedures for settling a dispute with a U.S. Government tenant or seeking to evict a U.S. Government tenant in default may be costly, time consuming and may divert the attention of management from the operations of our business as the process requires first appealing to a GSA-assigned officer or through the Civilian Board of Contract Appeals and ultimately before the U.S. Court of Federal Claims. Furthermore, we may not be able to successfully appeal a condemnation proceeding brought by a U.S. Government tenant agency which could have a material adverse effect on our business, financial condition and results of operations.

 

An increase in the amount of U.S. Government-owned real estate may adversely affect us.

 

If there is a large increase in the amount of U.S. Government-owned real estate as a consequence of Congress enacting legislation such as the American Recovery and Reinvestment Act of 2009, which included several billion dollars for construction, repair and alteration of U.S. Government-owned buildings, certain U.S. Government tenant agencies may relocate from our properties to U.S. Government-owned real estate at the expiration of their respective leases. Similarly, it may become more difficult for us to renew our leases with U.S. Government tenant agencies when they expire or to locate additional properties that are leased to U.S. Government tenant agencies in order to grow our business. Therefore, an increase in the amount of U.S. Government-owned real estate could have a material adverse effect on our business, financial condition and results of operations.

 

We may be required to make significant capital expenditures to improve our properties in order to retain and attract tenants, including U.S. Government tenant agencies.

 

Under our leases, including our leases with U.S. Government tenant agencies, we retain certain obligations with respect to the property, including, among other things, the responsibility for maintenance and repair of the property, the provision of adequate parking, maintenance of common areas, responsibility for capital improvements such as roof replacement and major structural improvements and compliance with other affirmative covenants in the lease. The expenditure of any sums in connection therewith will reduce the cash available for distribution and may require us to fund deficits resulting from operating a property. No assurance can be given that we will have funds available to make such repairs or improvements. If we were to fail to meet these obligations, then the applicable tenant may abate rent or terminate the applicable lease, which may result in a loss of capital invested in, and anticipated profits and, in turn, have a material adverse effect on our business, financial condition and results of operations.

 

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Capital and credit market conditions may adversely affect our access to various sources of capital or financing or the cost of capital, which could impact our business activities, dividends, earnings and common stock price, among other things.

 

In periods when the capital and credit markets experience significant volatility, the amounts, sources and cost of capital available to us may be adversely affected. Upon completion of this offering, the formation transactions and the concurrent private placement, we expect to have approximately $104.8 million of indebtedness outstanding on a pro forma basis, including amounts outstanding under our senior unsecured revolving credit facility, and we expect to have approximately $364.6 million of available borrowing capacity under the new senior unsecured revolving credit facility that we intend to enter into in connection with this offering. If sufficient sources of external financing are not available to us on cost effective terms, we could be forced to limit our acquisition, development and renovation activities or take other actions to fund our business activities and repayment of debt, such as selling assets, reducing our cash dividend or paying out a smaller percentage of our taxable income. To the extent that we are able or choose to access capital at a higher cost than we have experienced in recent years, as reflected in higher interest rates for debt financing or a lower stock price for equity financing, our earnings per share and cash flow could be adversely affected. In addition, the price of common stock may fluctuate significantly or decline in a high interest rate or volatile economic environment. If economic conditions deteriorate, the ability of lenders to fulfill their obligations under working capital or other credit facilities that we may have in the future may be adversely impacted.

 

We may be unable to identify and successfully complete acquisitions and, even if acquisitions are identified and completed, we may fail to successfully operate acquired properties.

 

We may be unable to acquire additional properties and grow our business and any acquisitions we make may prove unsuccessful. Our ability to identify and acquire properties on favorable terms and successfully operate or renovate them may be exposed to significant risks. Agreements for the acquisition of properties are subject to customary conditions to closing, including completion of due diligence investigations and other conditions that are not within our control that may not be satisfied. In this event, we may be unable to complete an acquisition after incurring certain acquisition-related costs. In addition, if mortgage debt is unavailable at reasonable rates, we may be unable to finance the acquisition on favorable terms in the time period we desire, or at all. We may spend more than budgeted to make necessary improvements or renovations to acquired properties and may not be able to obtain adequate insurance coverage for new properties. Further, acquired properties may be located in markets where we may face risks associated with a lack of market knowledge or understanding of the local economy, lack of business relationships in the area and unfamiliarity with local governmental and permitting procedures. We may also be unable to integrate new acquisitions into our existing operations quickly and efficiently, and as a result, our results of operations and financial condition could be adversely affected. Any delay or failure on our part to identify, negotiate, finance and consummate such acquisitions in a timely manner and on favorable terms, or operate acquired properties to meet our financial expectations, could impede our growth and have an adverse effect on us, including our financial condition, results of operations, cash flow and the market value of our securities.

 

Certain of our properties are leased to private tenants and we may be unable to collect balances due from private tenants that file for bankruptcy protection.

 

If a private tenant or lease guarantor files for bankruptcy, we will become a creditor of such entity, but may not be able to collect all pre-bankruptcy amounts owed by that party. In addition, a tenant that files for bankruptcy protection may terminate its lease with us under federal law, in which event we would have a general unsecured claim against such tenant that would likely be worth less than the full amount owed to us for the remainder of the lease term, which could adversely affect our business, financial condition and results of operations.

 

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Because our principal tenants are agencies of the U.S. Government, our properties have a higher risk of terrorist attack than similar properties leased to non-governmental tenants.

 

Terrorist attacks may materially adversely affect our operations, as well as directly or indirectly damage our assets, both physically and financially. Because our principal tenants are, and are expected to continue to be, agencies of the U.S. Government, our properties are presumed to have a higher risk of terrorist attack than similar properties that are leased to non-governmental tenants. Further, some of our properties may be considered “high profile” targets because of the particular U.S. Government tenant (e.g., the DEA and FBI). Terrorist attacks, to the extent that these properties are uninsured or underinsured, could have a material adverse effect on our business, financial condition and results of operations.

 

Competition could limit our ability to acquire attractive investment opportunities and to attract and retain tenants.

 

We compete with numerous developers, real estate companies and other owners of commercial properties for acquisition and pursuing buyers for dispositions. We expect that other real estate investors, including insurance companies, private equity funds, sovereign wealth funds, pension funds, other REITs and other well-capitalized investors will compete with us to acquire existing properties and to develop new properties. In addition, U.S. Government tenants are viewed as desirable tenants by other landlords because of their strong credit profile and properties leased to U.S. Government tenant agencies often attract many potential buyers. This competition could increase prices for properties of the type we may pursue and adversely affect our profitability and impede our growth. In addition, substantially all of our properties face competition for tenants. Some competing properties may be newer, better located or more attractive to tenants. Competing properties may have lower rates of occupancy than our properties, which may result in competing owners offering available space at lower rents than we offer at our properties. This competition may affect our ability to attract and retain tenants, may reduce the rents we are able to charge and could have a material adverse effect on our business, financial condition and results of operations.

 

We may be subject to increased costs of insurance and limitations on coverage, particularly regarding acts of terrorism.

 

We maintain comprehensive insurance coverage for general liability, property and other risks on all of our properties, including coverage for acts of terrorism. Future changes in the insurance industry’s risk assessment approach and pricing structure may increase the cost of insuring our properties and decrease the scope of insurance coverage, either of which could adversely affect our financial position and operating results. Most of our loan agreements contain customary covenants requiring us to maintain insurance. We may not be able to obtain an appropriate amount of coverage at reasonable costs, or at all, in the future. In addition, if lenders insist on greater insurance coverage than we are able to obtain, it could adversely affect our ability to finance or refinance our properties and execute our growth strategies, which, in turn, could have a material adverse effect on our business, financial condition and results of operations.

 

We may become subject to liability relating to environmental and health and safety matters, which could have a material adverse effect on our business, financial condition and results of operations.

 

Under various federal, state or local laws, ordinances and regulations, as a current or former owner or operator of real property, we may be liable for costs and damages resulting from the presence or release of hazardous substances, waste or petroleum products at, on, in, under or from such property, including costs for investigation or remediation, natural resource damages or third-party liability for personal injury or property damage. These laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the presence or release of such materials, and the liability may be joint and several. Some of our properties may be impacted by contamination arising from current uses of the property or from adjacent properties used for commercial, industrial or other purposes. Such contamination may arise from spills of petroleum or hazardous substances or releases from tanks used to store such materials. We also may be liable for

 

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the costs of remediating contamination at off-site disposal or treatment facilities when we arrange for disposal or treatment of hazardous substances at such facilities, without regard to whether we comply with environmental laws in doing so. The presence of contamination or the failure to remediate contamination on our properties may adversely affect our ability to attract or retain tenants and our ability to develop or sell or borrow against those properties. In addition to potential liability for cleanup costs, private plaintiffs may bring claims for personal injury, property damage or for similar reasons. Environmental laws also may create liens on contaminated sites in favor of the U.S. Government for damages and costs it incurs to address such contamination. Moreover, if contamination is discovered on our properties, environmental laws may impose restrictions on the manner in which that property may be used or how businesses may be operated on that property. See “Business and Properties—Regulation— Environmental and Related Matters.”

 

Some of our properties are, and may be adjacent to or near other properties, used for industrial or commercial purposes. These properties may have contained or currently contain underground storage tanks used to store petroleum products or other hazardous or toxic substances. Releases from these properties could impact our properties.

 

In addition, our properties are subject to various federal, state and local environmental and health and safety laws and regulations. Noncompliance with these environmental and health and safety laws and regulations could subject us or our tenants to liability. These liabilities could affect a commercial tenant’s ability to make rental payments to us. Moreover, changes in laws could increase the potential costs of compliance with such laws and regulations or increase liability for noncompliance. This may result in significant unanticipated expenditures or may otherwise adversely affect our operations, or those of our tenants, which could in turn have an adverse effect on us. As the owner or operator of real property, we may also incur liability based on various building conditions.

 

In addition, our properties may contain or develop harmful mold or suffer from other indoor air quality issues. Indoor air quality issues also can stem from inadequate ventilation, chemical contamination from indoor or outdoor sources and other biological contaminants such as pollen, viruses and bacteria. Indoor exposure to airborne toxins or irritants can be alleged to cause a variety of adverse health effects and symptoms, including allergic or other reactions. As a result, the presence of significant mold or other airborne contaminants at any of our properties could require us to undertake a costly remediation program to contain or remove the mold or other airborne contaminants or to increase ventilation. In addition, the presence of significant mold or other airborne contaminants could expose us to liability from our tenants or others if property damage or personal injury occurs.

 

The costs or liabilities incurred as a result of environmental issues may affect our ability to make distributions to our stockholders and could have a material adverse effect on our business, financial condition and results of operations.

 

Our development activities may be subject to risks relating to various local, state and federal statutes, ordinances, rules and regulations concerning zoning, building design, construction and similar matters, including local regulations that impose restrictive zoning requirements.

 

Our development activities may be subject to risks relating to various local, state and federal statutes, ordinances, rules and regulations concerning zoning, building design, construction and similar matters, including local regulations that impose restrictive zoning requirements. In addition, we will be subject to registration and filing requirements in connection with these developments in certain states and localities in which we operate even if all necessary U.S. Government approvals have been obtained. We may also be subject to periodic delays or may be precluded entirely from developing properties due to building moratoriums that could be implemented in the future in certain states in which we intend to operate. These risks could result in substantial unanticipated delays or expenses and, under certain circumstances, could prevent completion of development activities once undertaken.

 

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Real estate investments are relatively illiquid and may limit our flexibility.

 

Equity real estate investments are relatively illiquid, which may tend to limit our ability to react promptly to changes in economic or other market conditions. Our ability to dispose of assets in the future will depend on prevailing economic and market conditions. Our inability to sell our properties on favorable terms or at all could have an adverse effect on our sources of working capital and our ability to satisfy our debt obligations. In addition, real estate can at times be difficult to sell quickly at prices we find acceptable. The Code also imposes restrictions on REITs, which are not applicable to other types of real estate companies, with respect to the disposition of properties. These potential difficulties in selling real estate in our markets may limit our ability to change or reduce the properties in our portfolio promptly in response to changes in economic or other conditions.

 

We will acquire properties or portfolios of properties through tax-deferred contribution transactions, which could result in stockholder dilution and limit our ability to sell such assets.

 

In connection with the Easterly Funds’ and Western Devcon’s contributions of their portfolio of properties to our operating partnership, we expect that the tax depreciation from those assets will be less than what it would have been had we acquired the assets in a taxable transaction. Further, we expect to agree not to sell the Western Devcon properties for eight years, or otherwise we will be required to pay the taxes of Michael P. Ibe pursuant to our tax protection agreement. Similarly, in the future we may acquire properties or portfolios of properties through tax-deferred contribution transactions in exchange for partnership interests in our operating partnership, which may result in stockholder dilution upon exchange for common stock. As with the acquisition of the Easterly Funds’ and Western Devcon’s properties, this acquisition structure may have the effect of, among other things, reducing the amount of tax depreciation we could deduct over the tax life of the acquired properties. We may also agree to protect the contributors’ ability to defer recognition of taxable gain through restrictions on our ability to dispose of the acquired properties or the allocation of partnership debt to the contributors to maintain their tax bases. These restrictions could limit our ability to sell an asset at a time, or on terms that would be favorable absent such restrictions.

 

Our properties may be subject to impairment charges.

 

On a quarterly basis, we will assess whether there are any indicators that the value of our properties may be impaired. A property’s value is considered to be impaired only if the estimated aggregate future cash flows (undiscounted and without interest charges) to be generated by the property are less than the carrying value of the property. In our estimate of cash flows, we will consider factors such as expected future operating income, trends and prospects, the effects of demand, competition and other factors. If we are evaluating the potential sale of an asset or development alternatives, the undiscounted future cash flows analysis will consider the most likely course of action at the balance sheet date based on current plans, intended holding periods and available market information. We will be required to make subjective assessments as to whether there are impairments in the value of our properties. These assessments may be influenced by factors beyond our control, such as early vacating by a tenant or damage to properties due to earthquakes, tornadoes, hurricanes and other natural disasters, fire, civil unrest, terrorist acts or acts of war. These assessments may have a direct impact on our earnings because recording an impairment charge results in an immediate negative adjustment to earnings. There can be no assurance that we will not take impairment charges in the future related to the impairment of our properties. Any such impairment could have a material adverse effect on our business, financial condition and results of operations in the period in which the charge is taken.

 

We may from time to time be subject to litigation, which could have a material adverse effect on our business, financial condition and results of operations.

 

We may be a party to various claims and routine litigation arising in the ordinary course of business. Some of these claims or others to which we may be subject from time to time may result in defense costs, settlements, fines or judgments against us, some of which are not, or cannot be, covered by insurance. Payment of any such costs, settlements, fines or judgments that are not insured could have an adverse impact on our financial position

 

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and results of operations. In addition, certain litigation or the resolution of certain litigation may affect the availability or cost of some of our insurance coverage, which could adversely impact our results of operations and cash flow, expose us to increased risks that would be uninsured, or adversely impact our ability to attract officers and directors.

 

We may be subject to unknown or contingent liabilities related to properties or businesses that we acquire, including as part of the formation transactions, for which we may have limited recourse against the sellers.

 

Assets and entities that we have acquired or may acquire in the future, including as part of the formation transactions, may be subject to unknown or contingent liabilities for which we may have limited recourse against the sellers. Unknown or contingent liabilities might include liabilities for clean-up or remediation of environmental conditions, claims of customers, vendors or other persons dealing with the acquired entities, tax liabilities and other liabilities whether incurred in the ordinary course of business or otherwise. In the future we may enter into transactions with limited representations and warranties or with representations and warranties that do not survive the closing of the transactions, in which event we would have no or limited recourse against the sellers of such properties. While we usually require the sellers to indemnify us with respect to breaches of representations and warranties that survive, such indemnification is often limited and subject to various materiality thresholds, a significant deductible or an aggregate cap on losses. As a result, there is no guarantee that we will recover any amounts with respect to losses due to breaches by the sellers of their representations and warranties. In addition, the total amount of costs and expenses that we may incur with respect to liabilities associated with acquired properties and entities may exceed our expectations, which may adversely affect our business, financial condition and results of operations. Finally, indemnification agreements between us and the sellers typically provide that the sellers will retain certain specified liabilities relating to the assets and entities acquired by us.

 

As part of the formation transactions, we will acquire the properties and assets from the Easterly Funds and certain other assets from Western Devcon, subject to existing liabilities, some of which may be unknown at the time this offering is consummated. As part of the formation transactions, the Easterly Funds and Western Devcon will make representations, warranties and covenants to us regarding the entities and assets that we are acquiring in the formation transactions and we will be indemnified in an amount up to 5% of the consideration received by the party responsible for the representation, warranty or covenant for claims made within one year of the completion of this offering with respect to breaches of such representations, warranties or covenants. Because many liabilities, including tax liabilities, may not be identified within such period, we may have no recourse for such liabilities. Any unknown or unquantifiable liabilities that we assume in connection with the formation transactions for which we have no or limited recourse could adversely affect us.

 

One property being contributed in the formation transactions is encumbered by a right of first refusal with respect to a sale of the property, which could materially and adversely affect the timing and terms of any sale of the property.

 

One property being contributed in the formation transactions is encumbered by a right of first refusal with respect to a sale of the property, which could materially and adversely affect the timing and terms of any sale of the property. A right of first refusal encumbers our DEA—Dallas property until the earlier of January 7, 2025, or the date on which two bona fide third-party sales have occurred for which the right of first refusal has not been exercised. As a result of this right of first refusal, we may be delayed in our attempt to sell this property if and when any such disposition is necessary or desirable.

 

One of our tenants has an option to purchase the property during the term of its lease, which if exercised could have a material adverse effect on our business, financial condition and results of operations.

 

Lummus Corporation, the private tenant leasing our property located in Lubbock, Texas has an option to purchase the property during the term of its lease. The option may first be exercised in August 2018. The purchase price upon the exercise of this option decreases over the term of the lease, ranging from $4.2 million to

 

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$3.0 million. If Lummus Corporation exercises its option to purchase the property, we would lose the associated rental income, which could have a material adverse effect on our business, financial condition and results of operations.

 

We rely on information technology in our operations, and any material failure, inadequacy, interruption or security failure of that technology could harm our business.

 

We rely on information technology networks and systems, including the Internet, to process, transmit and store electronic information and to manage or support a variety of our business processes, including financial transactions and maintenance of records, which may include confidential information of tenants and lease data. We rely on commercially available systems, software, tools and monitoring to provide security for processing, transmitting and storing confidential tenant information, such as individually identifiable information relating to financial accounts. Although we have taken steps to protect the security of the data maintained in our information systems, it is possible that our security measures will not be able to prevent the systems’ improper functioning, or the improper disclosure of personally identifiable information such as in the event of cyber attacks. Security breaches, including physical or electronic break-ins, computer viruses, attacks by hackers and similar breaches, can create system disruptions, shutdowns or unauthorized disclosure of confidential information. Any failure to maintain proper function, security and availability of our information systems could interrupt our operations, damage our reputation, subject us to liability claims or regulatory penalties and could materially and adversely affect us.

 

We may need to borrow funds or dispose of assets to meet our distribution requirements.

 

We may need to borrow funds or dispose of assets to meet our distribution requirements. In order for us to continue to qualify as a REIT, we are required to make annual distributions generally equal to at least 90% of our taxable income, computed without regard to the dividends paid deduction and excluding net capital gain. In addition, as a REIT, we will be subject to U.S. federal income tax to the extent that we distribute less than 100% of our taxable income (including capital gains) and will be subject to a 4% nondeductible excise tax on the amount by which our distributions in any calendar year are less than a minimum amount specified by the Code. Under some circumstances, we may be required to pay distributions in excess of cash available for distribution in order to meet these distribution requirements or to avoid or minimize the imposition of tax, and we may need to borrow funds or dispose of assets to make such distributions, which could have a material adverse effect on our financial condition, results of operations, cash flow and trading price of our common stock.

 

Our subsidiaries may be prohibited from making distributions and other payments to us.

 

All of our properties are owned, and all of our operations are conducted, by our operating partnership and our other subsidiaries. As a result, we depend on distributions and other payments from our operating partnership and our other subsidiaries in order to satisfy our financial obligations and make payments to our investors. The ability of our subsidiaries to make such distributions and other payments depends on their earnings and cash flow and may be subject to statutory or contractual limitations. As an equity investor in our subsidiaries, our right to receive assets upon their liquidation or reorganization will be effectively subordinated to the claims of their creditors. To the extent that we are recognized as a creditor of such subsidiaries, our claims may still be subordinate to any security interest in or other lien on their assets and to any of such subsidiaries’ debt or other obligations that are senior to our claims.

 

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Risks Related to Our Organization and Structure

 

The ability of stockholders to control our policies and effect a change of control of our company is limited by certain provisions of our charter and bylaws and by Maryland law.

 

There are provisions in our charter and bylaws that may discourage a third party from making a proposal to acquire us, even if some of our stockholders might consider the proposal to be in their best interests. These provisions include the following:

 

Our charter authorizes our board of directors to amend our charter to increase or decrease the aggregate number of authorized shares of stock, to authorize us to issue additional shares of our common stock or preferred stock and to classify or reclassify unissued shares of our common stock or preferred stock and thereafter to authorize us to issue such classified or reclassified shares of stock. We believe these charter provisions will provide us with increased flexibility in structuring possible future financings and acquisitions and in meeting other needs that might arise. The additional classes or series, as well as the additional authorized shares of our common stock, will be available for issuance without further action by our stockholders, unless such action is required by applicable law or the rules of any stock exchange or automated quotation system on which our securities may be listed or traded. Although our board of directors does not currently intend to do so, it could authorize us to issue a class or series of stock that could, depending upon the terms of the particular class or series, delay, defer or prevent a transaction or a change of control of our company that might involve a premium price for holders of our common stock or that our common stockholders otherwise believe to be in their best interests.

 

In order to qualify as a REIT, not more than 50% in value of our outstanding stock may be owned, directly or indirectly, by or for five or fewer individuals (as defined in the Code to include certain entities such as private foundations) at any time during the last half of any taxable year (beginning with our second taxable year as a REIT). In addition, if the owners of 50% or more of either Easterly Fund REIT were to own 50% or more in value of our capital stock, we would be treated as a successor to the Easterly Fund REIT, and our ability to elect REIT status for a certain period would depend on that Easterly Fund REIT’s qualification as a REIT. In order to help us qualify as a REIT and not be treated as a successor to an Easterly Fund REIT, our charter generally prohibits (A) any person or entity from actually or being deemed to own by virtue of the applicable constructive ownership provisions of the Code, (i) more than 7.1% (in value or in number of shares, whichever is more restrictive) of the issued and outstanding shares of any class or series of our stock or (ii) more than 7.1% in value of the aggregate of the outstanding shares of all classes and series of our stock (the “ownership limits)” and (B) the owners of 50% or more of an Easterly Fund REIT from owning 50% or more of us, applying certain attribution of ownership rules. These ownership restrictions may prevent or delay a change in control and, as a result, could adversely affect our stockholders’ ability to realize a premium for their shares of our common stock. In connection with the formation transactions and the concurrent private placement, our board of directors will grant waivers from the ownership limit contained in our charter to Michael P. Ibe, Easterly Fund I and Easterly Fund II to own up to approximately 21%, 22% and 28%, respectively, of our outstanding common stock in the aggregate.

 

In addition, certain provisions of the Maryland General Corporation Law, or MGCL, may have the effect of inhibiting a third party from making a proposal to acquire us or of impeding a change of control under circumstances that otherwise could provide the holders of shares of our common stock with the opportunity to realize a premium over the then-prevailing market price of such shares, including the Maryland business combination and control share provisions. See “Material Provisions of Maryland Law and Our Charter and Bylaws.”

 

As permitted by the MGCL, our board of directors has adopted a resolution exempting any business combinations between us and any other person or entity from the business combination provisions of the MGCL. Our bylaws provide that this resolution or any other resolution of our board of directors exempting any business combination from the business combination provisions of the MGCL may only be revoked, altered or amended, and our board of directors may only adopt any resolution inconsistent with any such resolution (including an

 

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amendment to that bylaw provision), which we refer to as an-opt in to the business combination provisions, with the affirmative vote of a majority of the votes cast on the matter by holders of outstanding shares of our common stock. In addition, as permitted by the MGCL, our bylaws contain a provision exempting from the control share acquisition provisions of the MGCL any and all acquisitions by any person of shares of our stock. This bylaw provision may be amended, which we refer to as an opt-in to the control share acquisition provisions, only with the affirmative vote of a majority of the votes cast on such an amendment by holders of outstanding shares of our common stock.

 

Subtitle 8 of Title 3 of the MGCL permits a board of directors, without stockholder approval and regardless of what is currently provided in our charter or bylaws, to implement certain takeover defenses, including adopting a classified board or increasing the vote required to remove a director. We have elected in our charter to be subject to the provision of Subtitle 8 that provides that vacancies on our board of directors may be filled only by the remaining directors. We have not elected to be subject to any of the other provisions of Subtitle 8, including the provisions that would permit us to classify our board of directors or increase the vote required to remove a director without stockholder approval. Moreover, our charter provides that, without the affirmative vote of a majority of the votes cast on the matter by our stockholders entitled to vote generally in the election of directors, we may not elect to be subject to any of these additional provisions of Subtitle 8.

 

Such takeover defenses 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 the circumstances that otherwise could provide our common stockholders with the opportunity to realize a premium over the then current market price. In addition, the provisions of our charter on the removal of directors and the advance notice provisions of our bylaws, among others, could delay, defer or prevent a transaction or a change of control of our company that might involve a premium price for holders of our common stock or otherwise be in their best interest. Each item discussed above may delay, deter or prevent a change in control of our company, even if a proposed transaction is at a premium over the then-current market price for our common stock. Further, these provisions may apply in instances where some stockholders consider a transaction beneficial to them. As a result, our stock price may be negatively affected by these provisions.

 

Certain provisions in the partnership agreement of our operating partnership may delay or prevent acquisitions of us.

 

Provisions in the partnership agreement of our operating partnership may delay, or make more difficult, acquisitions of us or changes of our control. These provisions could discourage third parties from making proposals involving an acquisition of us or change of our control, although some holders of common stock might consider such proposals, if made, desirable. These provisions include

 

   

redemption rights for holders of common units beginning 15 months after the completion of this offering;

 

   

a requirement that we may not be removed as the general partner of our operating partnership without our consent;

 

   

transfer restrictions on common units; and

 

   

our ability, as general partner, in some cases, to amend the partnership agreement and to cause the operating partnership to issue units with terms that could delay, defer or prevent a merger or other change of control of us or our operating partnership without the consent of the limited partners.

 

In addition, Easterly Government Properties, Inc. may not transfer any of its interest in our operating partnership, withdraw as general partner of our operating partnership or consummate a fundamental transaction, including mergers, consolidations and sales of all or substantially all of its assets, subject to certain limited exceptions, without partnership approval, as such term is defined in the partnership agreement of our operating partnership. Partnership approval is obtained when the sum of (a) the number of common units issued in the formation transactions and consenting to the transaction that are held by Western Devcon and our continuing

 

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investors, plus (b) the product of (x) the number of common units held by Easterly Government Properties, Inc. and its subsidiaries multiplied by (y) the percentage of the votes that were cast in favor of the transaction by the holders of shares of our common stock, exceeds 50% of the aggregate number of common units issued in the formation transactions and common units held by Easterly Government Properties, Inc. and its subsidiaries outstanding at such time. This right to vote by certain holders of common units on a transfer or assignment of Easterly Government Properties, Inc.’s interest in our operating partnership, withdrawal as general partner of our operating partnership and consummation of a fundamental transaction will permanently terminate at such time as we own more than 85% of the aggregate of (a) the outstanding common units held by us and (b) the common units issued in the formation transactions that are held by our continuing investors, Western Devcon, their respective affiliates and direct or indirect investors. Following the completion of the formation transactions, the concurrent private placement and this offering, our continuing investors and Western Devcon will own an aggregate of 41.0% of the outstanding common units and Easterly Government Properties, Inc. will own 59.0% of the outstanding common units.

 

We may decide to change our investment strategy without stockholder approval and acquire and develop properties outside of our target market, which could have a material adverse effect on our business, financial condition and results of operations.

 

We may decide to change our investment strategy without stockholder approval and seek to acquire and develop properties that are not leased to U.S. Government tenant agencies. Any change to our investment strategy, including the making of investments outside our target market, could have a material adverse effect on our business, financial condition and results of operations.

 

Our board of directors may change our policies without stockholder approval.

 

Our policies, including any policies with respect to investments, leverage, financing, growth, debt and capitalization, will be determined by our board of directors or those committees or officers to whom our board of directors may delegate such authority. Our board of directors will also establish the amount of any dividends or other distributions that we may pay to our stockholders. Our board of directors or the committees or officers to which such decisions are delegated will have the ability to amend or revise these and our other policies at any time without stockholder vote. Accordingly, our stockholders will not be entitled to approve changes in our policies.

 

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 that you do not believe are in your best interests.

 

Maryland law provides that a director has no liability in that capacity if he or she satisfies his or her duties to us and our stockholders. Upon completion of this offering, as permitted by the MGCL, our charter will limit the liability of our directors and officers to us and our stockholders for money damages, except for liability resulting from:

 

   

actual receipt of an improper benefit or profit in money, property or services; or

 

   

a final judgment based upon a finding of active and deliberate dishonesty by the director or officer that was material to the cause of action adjudicated.

 

In addition, our charter will authorize us to obligate us, and our bylaws will require us, to indemnify our directors for actions taken by them in those capacities to the maximum extent permitted by Maryland law. Our charter and bylaws will also authorize us to indemnify our officers for actions taken by them in those capacities to the maximum extent permitted by Maryland law and indemnification agreements that we have entered into with our executive officers will require us to indemnify such officers for actions taken by them in those capacities to the maximum extent permitted by Maryland law. As a result, we and our stockholders may have more limited rights against our directors and officers than might otherwise exist. Accordingly, in the event that actions taken in good faith by any of our directors or officers impede the performance of our company, your ability to recover damages from such director or officer will be limited with respect to directors and may be limited with respect to officers. In

 

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addition, we will be obligated to advance the defense costs incurred by our directors and our executive officers pursuant to indemnification agreements, and may, in the discretion of our board of directors, advance the defense costs incurred by our officers, our employees and other agents, in connection with legal proceedings.

 

Conflicts of interest may exist or could arise in the future between the interests of our stockholders and the interests of holders of common units, which may impede business decisions that could benefit our stockholders.

 

Conflicts of interest may exist or could arise in the future as a result of the relationships between us and our affiliates, on the one hand, and our operating partnership or any of its partners, on the other. Our directors and officers have duties to our company under Maryland law in connection with their management of our company. At the same time, we will have duties and obligations to our operating partnership and its limited partners under Delaware law as modified by the partnership agreement of our operating partnership in connection with the management of our operating partnership as the sole general partner. The limited partners of our operating partnership expressly will acknowledge that the general partner of our operating partnership will be acting for the benefit of our operating partnership, the limited partners and our stockholders collectively. When deciding whether to cause our operating partnership to take or decline to take any actions, the general partner will be under no obligation to give priority to the separate interests of (i) the limited partners of our operating partnership (including the tax interests of our limited partners, except as provided in a separate written agreement) or (ii) our stockholders. Nevertheless, the duties and obligations of the general partner of our operating partnership may come into conflict with the duties of our directors and officers to our company and our stockholders.

 

Upon completion of this offering, the formation transactions and the concurrent private placement, Michael P. Ibe, a director nominee and our Executive Vice PresidentDevelopment and Acquisitions, will own an approximate 15.2% beneficial interest in our company on a fully diluted basis and the Easterly Funds and the owner of Easterly Partners, LLC, which are all controlled by Darrell W. Crate, our Chairman, will own an approximate 53.1% beneficial interest in our company on a fully diluted basis and each will have the ability to exercise significant influence on our company.

 

Upon completion of this offering, the formation transactions and the concurrent private placement, Michael P. Ibe, a director nominee and our Executive Vice President – Development and Acquisitions, will own approximately 15.2% of our outstanding common units. The Easterly Funds and the owner of Easterly Partners, LLC, which are all controlled by Darrell W. Crate, our Chairman, will own approximately 46.2% of our outstanding shares of common stock and 62.9% of our outstanding common units which represent an approximate aggregate 53.1% of our company’s common stock on a fully diluted basis. Consequently, Mr. Ibe and the Easterly Funds may be able to significantly influence the outcome of matters submitted for stockholder action, including the election of our board of directors and approval of significant corporate transactions, including business combinations, consolidations and mergers. As a result, Mr. Ibe and the Easterly Funds could exercise their influence in a manner that conflicts with the interests of other stockholders.

 

Certain members of our senior management team exercised significant influence with respect to the terms of the formation transactions and the concurrent private placement, including the economic benefits they will receive, as a result of which the consideration given by us may exceed the fair market value of the properties.

 

We did not conduct arm’s-length negotiations with the continuing investors that are members of our senior management team with respect to all of the terms of the formation transactions and the concurrent private placement. In the course of structuring the formation transactions, certain members of our senior management team had the ability to influence the type and level of benefits that they and our other officers will receive from us. In addition, certain members of our senior management team had substantial pre-existing ownership interests in our predecessor and will receive substantial economic benefits as a result of the formation transactions and the concurrent private placement. As a result, the terms of the formation transactions and the concurrent private placement may not be as favorable to us as if they were negotiated at arm’s length.

 

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In addition, certain members of our senior management team will continue to own interests in Easterly Fund I and Easterly Fund II, each of which will remain outstanding as holders of shares of our common stock and common units to be issued in the formation transactions and the concurrent private placement until 15 months following the completion of this offering. At such time, shares of our common stock and common units in our operating partnership held by each of Easterly Fund I and Easterly Fund II will be distributed to investors in Easterly Fund I and Easterly Fund II, and, in connection with such distribution, certain of our directors and executive officers may be entitled to receive incentive distributions. These incentive distributions may cause certain of our directors and executive officers to take actions that are not aligned with the interests of our stockholders by attempting to maximize our short-term stock price to receive a higher incentive distribution 15 months following the completion of this offering. This could cause us to take on increased risk, which could have a material adverse effect on our business, financial condition and results of operations.

 

If there are deficiencies in our disclosure controls and procedures or internal control over financial reporting, we may be unable to accurately present our financial statements, which could materially and adversely affect us, including our business, reputation, results of operations, financial condition or liquidity.

 

As a publicly-traded company, we will be required to report our financial statements on a consolidated basis. Effective internal controls are necessary for us to accurately report our financial results. Section 404 of the Sarbanes-Oxley Act of 2002 will require us to evaluate and report on our internal control over financial reporting. There can be no guarantee that our internal control over financial reporting will be effective in accomplishing all control objectives all of the time. Furthermore, as we grow our business, our internal controls will become more complex, and we may require significantly more resources to ensure our internal controls remain effective. Deficiencies, including any material weakness, in our internal control over financial reporting that may occur in the future could result in misstatements of our results of operations that could require a restatement, failing to meet our public company reporting obligations and causing investors to lose confidence in our reported financial information. These events could materially and adversely affect us, including our business, reputation, results of operations, financial condition or liquidity.

 

We did not negotiate the value of our properties at arm’s length as part of the formation transactions, and the consideration given by us in exchange for them may exceed their fair market value.

 

We did not negotiate the value of our properties at arm’s length as part of the formation transactions. In addition, the value of the shares of our common stock and the common units that we will issue in exchange for contributed property interests and other assets, will increase or decrease if our common stock price increases or decreases. The initial public offering price of shares of common stock was determined in consultation with the underwriters. The initial public offering price does not necessarily bear any relationship to our book value or the fair market value of our assets. As a result, our value, represented by the initial public offering price of shares of common stock, may exceed the fair market value of our individual properties.

 

We may pursue less vigorous enforcement of terms of the formation transaction agreements because of conflicts of interest with certain members of our senior management team, which could have a material adverse effect on our business, financial condition and results of operations.

 

Certain members of our senior management team have ownership interests in properties that we will acquire in the formation transactions from the Easterly Funds and Western Devcon upon completion of this offering. As part of the formation transactions, we will be indemnified for certain claims made with respect to breaches of such representations, warranties or covenants by certain contributing entities following the completion of this offering. Such indemnification is limited, however, and we are not entitled to any other indemnification in connection with the formation transactions. We may choose not to enforce, or to enforce less vigorously, our rights under these agreements because of our desire to maintain our ongoing relationship with our executive

 

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officers and their significant knowledge of our business, relationships with our customers and significant equity ownership in us, and this could have a material adverse effect on our business, financial condition and results of operations.

 

We do not own the Easterly name, but will enter into a license agreement with Easterly Capital, LLC, which we refer to as Easterly Capital, consenting to our use of the Easterly logo and name. Use of the name by other parties or the termination of our license agreement may have a material adverse effect on our business, financial condition and results of operations.

 

Upon completion of this offering, we will enter into a perpetual license agreement with Easterly Capital pursuant to which it will grant us a perpetual, royalty-free license to use the Easterly logo and the Easterly name and variations thereof, which license is exclusive to business activities involving properties to be leased to or developed for governmental entities, including properties leased to the GSA. We will have a right to use this logo and name for so long as we are not in breach of the terms of the license agreement. Easterly Capital will retain the right to continue using the Easterly name. We will be unable to preclude Easterly Capital from licensing or transferring the ownership of the Easterly name to third parties, except in the limited circumstance where our license is exclusive. Consequently, we will be unable to prevent any damage to goodwill that may occur as a result of the activities of Easterly Capital or others. Furthermore, in the event the license agreement is terminated, we will be required to change our name and cease using the Easterly name. Any of these events could disrupt our recognition in the market place, damage any goodwill we may have generated and have a material adverse effect on our business, financial condition and results of operations.

 

We must obtain the consent of the U.S. Government in order to assume the rights and obligations of the landlord under the leases of certain properties being contributed to us in the formation transactions, and we will need to collect the U.S. Government’s rent payments from the contributors of those properties until that consent is obtained.

 

The leases associated with some of the properties being contributed to us in the formation transactions require that we obtain the consent of the U.S. Government in order to transfer the rights and obligations of the landlord from the respective contributors to us. The consent process will occur after the closing of the formation transactions and this offering, and is time-consuming and not obligatory on the part of the U.S. Government. The U.S. Government will continue to pay rent to the former owners of those properties until the applicable consent is obtained. If one or more contributors of our properties improperly retain rent payments or become subject to bankruptcy, receivership or other insolvency proceedings, we may be unable to recover all or a portion the rent payable by the U.S. Government under such leases in a timely manner, or at all, which could materially and adversely affect our business, financial condition and results of operations.

 

Risks Related to Our Indebtedness and Financing

 

We have a substantial amount of indebtedness that may limit our financial and operating activities and may adversely affect our ability to incur additional debt to fund future needs.

 

Upon completion of this offering, the formation transactions and the concurrent private placement, we expect to have approximately $104.8 million of indebtedness outstanding on a pro forma basis, including amounts outstanding under our $400.0 million senior unsecured revolving credit facility with affiliates of certain of the underwriters. Payments of principal and interest on borrowings may leave us with insufficient cash resources to operate our properties, fully implement our capital expenditure, acquisition and redevelopment activities, or meet the REIT distribution requirements imposed by the Code. Our level of debt and the limitations imposed on us by our debt agreements could have significant adverse consequences, including the following:

 

   

require us to dedicate a substantial portion of cash flow from operations to the payment of principal, and interest on, indebtedness, thereby reducing the funds available for other purposes;

 

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make it more difficult for us to borrow additional funds as needed or on favorable terms, which could, among other things, adversely affect our ability to meet operational needs;

 

   

force us to dispose of one or more of our properties, possibly on unfavorable terms (including the possible application of the 100% tax on income from prohibited transactions, discussed in the section of this prospectus entitled “U.S. Federal Income Tax Considerations”) or in violation of certain covenants to which we may be subject;

 

   

subject us to increased sensitivity to interest rate increases;

 

   

make us more vulnerable to economic downturns, adverse industry conditions or catastrophic external events;

 

   

limit our ability to withstand competitive pressures;

 

   

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

 

   

reduce our flexibility in planning for or responding to changing business, industry and economic conditions; or

 

   

place us at a competitive disadvantage to competitors that have relatively less debt than we have.

 

If any one of these events were to occur, our financial condition, results of operations, cash flow and trading price of our common stock could be adversely affected. Furthermore, foreclosures could create taxable income without accompanying cash proceeds, which could hinder our ability to meet the REIT distribution requirements imposed by the Code.

 

We may be unable to refinance current or future indebtedness on favorable terms, if at all.

 

We may be unable to refinance existing debt on terms as favorable as the terms of existing indebtedness, or at all, including as a result of increases in interest rates or a decline in the value of our portfolio or portions thereof. If principal payments due at maturity cannot be refinanced, extended or paid with proceeds from other capital transactions, such as new equity capital, our operating cash flow will not be sufficient in all years to repay all maturing debt. As a result, certain of our other debt may cross default, we may be forced to postpone capital expenditures necessary for the maintenance of our properties, we may have to dispose of one or more properties on terms that would otherwise be unacceptable to us or we may be forced to allow the mortgage holder to foreclose on a property. We also may be forced to limit distributions and may be unable to meet the REIT distribution requirements imposed by the Code. Foreclosure on mortgaged properties or an inability to refinance existing indebtedness would likely have a negative impact on our financial condition and results of operations and could adversely affect our ability to make distributions to our stockholders.

 

We may not have sufficient cash flow to meet the required payments of principal and interest on our debt or to pay distributions on our shares at expected levels.

 

In the future, our cash flow could be insufficient to meet required payments of principal and interest or to pay distributions on our shares at expected levels. In this regard, we note that in order for us to continue to qualify as a REIT, we are required to make annual distributions generally equal to at least 90% of our taxable income, computed without regard to the dividends paid deduction and excluding net capital gain. In addition, as a REIT, we will be subject to U.S. federal income tax to the extent that we distribute less than 100% of our taxable income (including capital gains) and will be subject to a 4% nondeductible excise tax on the amount by which our distributions in any calendar year are less than a minimum amount specified by the Code. These requirements and considerations may limit the amount of our cash flow available to meet required principal and interest payments. If we are unable to make required payments on indebtedness that is secured by a mortgage on our property, the asset may be transferred to the lender with a resulting loss of income and value to us, including adverse tax consequences related to such a transfer.

 

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Certain of our debt agreements include restrictive covenants, requirements to maintain financial ratios and default provisions, which could limit our flexibility, our ability to make distributions and require us to repay the indebtedness prior to its maturity.

 

Certain mortgages on our properties contain customary negative covenants that, among other things, limit our ability, without the prior consent of the lender, to further mortgage the property and to reduce or change insurance coverage. As of September 30, 2014, on a pro forma basis, we had $69.4 million of combined U.S. property mortgages and other secured debt. Additionally, our debt agreements contain customary covenants that, among other things, restrict our ability to incur additional indebtedness and, in certain instances, restrict our ability to engage in material asset sales, mergers, consolidations and acquisitions, and restrict our ability to make capital expenditures. These debt agreements, in some cases, also subject us to guarantor and liquidity covenants and our future senior unsecured revolving credit facility will, and other future debt may, require us to maintain various financial ratios. Some of our debt agreements contain certain cash flow sweep requirements and mandatory escrows, and our property mortgages generally require certain mandatory prepayments upon disposition of underlying collateral. Early repayment of certain mortgages may be subject to prepayment penalties.

 

Variable rate debt is subject to interest rate risk that could increase our interest expense, increase the cost to refinance and increase the cost of issuing new debt.

 

Upon the completion of this offering, the formation transactions and the concurrent private placement, we expect to have, on a pro forma basis, $35.4 million of our outstanding consolidated debt subject to instruments, which bear interest at variable rates, and we expect that we may also borrow additional money at variable interest rates in the future. Unless we have made arrangements that hedge against the risk of rising interest rates, increases in interest rates would increase our interest expense under these instruments, increase the cost of refinancing these instruments or issuing new debt, and adversely affect cash flow and our ability to service our indebtedness and make distributions to our stockholders, which could adversely affect the market price of our common stock.

 

Hedging activity may expose us to risks, including the risks that a counterparty will not perform and that the hedge will not yield the economic benefits we anticipate, which could adversely affect us.

 

We may, in a manner consistent with our qualification as a REIT, seek to manage our exposure to interest rate volatility by using interest rate hedging arrangements that involve risk, such as the risk that counterparties may fail to honor their obligations under these arrangements, and that these arrangements may not be effective in reducing our exposure to interest rate changes. Moreover, there can be no assurance that our hedging arrangements will qualify for hedge accounting or that our hedging activities will have the desired beneficial impact on our results of operations. Should we desire to terminate a hedging agreement, there could be significant costs and cash requirements involved to fulfill our obligation under the hedging agreement. Failure to hedge effectively against interest rate changes may adversely affect our results of operations.

 

When a hedging agreement is required under the terms of a mortgage loan, it is often a condition that the hedge counterparty maintains a specified credit rating. With 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 loan provisions. If we were unable to renegotiate the credit rating condition with the lender or find an alternative counterparty with acceptable credit rating, we could be in default under the loan and the lender could seize that property through foreclosure, which could adversely affect us.

 

Complying with REIT requirements may limit our ability to hedge effectively and may cause us to incur tax liabilities.

 

The REIT provisions of the Code limit our ability to hedge our liabilities. Generally, income from a hedging transaction we enter into either to manage risk of interest rate changes with respect to borrowings incurred or to be incurred to acquire or carry real estate assets, or to manage the risk of currency fluctuations with respect to any item of income or gain (or any property that generates such income or gain) that constitutes “qualifying

 

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income” for purposes of the 75% or 95% gross income tests applicable to REITs, does not constitute “gross income” for purposes of the 75% or 95% gross income tests, provided that we properly identify the hedging transaction pursuant to the applicable sections of the Code and Treasury Regulations. To the extent that we enter into other types of hedging transactions, the income from those transactions is likely to be treated as non-qualifying income for purposes of both gross income tests. As a result of these rules, we may need to limit our use of otherwise advantageous hedging techniques or implement those hedges through a “Taxable REIT Subsidiary,” or TRS. The use of a TRS could increase the cost of our hedging activities (because our TRS would be subject to tax on income or gain resulting from hedges entered into by it) or expose us to greater risks than we would otherwise want to bear. In addition, net losses in any of our TRSs will generally not provide any tax benefit except for being carried forward for use against future taxable income in the TRSs.

 

Mortgage debt obligations expose us to the possibility of foreclosure, which could result in the loss of our investment in a property or group of properties subject to mortgage debt.

 

Incurring mortgage and other secured debt obligations increases our risk of property losses because defaults on indebtedness secured by properties may result in foreclosure actions initiated by lenders and ultimately our loss of the property securing any loans for which we are in default. Any foreclosure on a mortgaged property or group of properties could adversely affect the overall value of our portfolio of properties. For tax purposes, a foreclosure of any of our properties that is subject to a nonrecourse mortgage loan would be treated as a sale of the property for a purchase price equal to the outstanding balance of the debt secured by the mortgage. If the outstanding balance of the debt secured by the mortgage exceeds our tax basis in the property, we would recognize taxable income on foreclosure, but would not receive any cash proceeds, which could hinder our ability to meet the distribution requirements applicable to REITs under the Code.

 

High mortgage rates or unavailability of mortgage debt may make it difficult for us to finance or refinance properties, which could reduce the number of properties we can acquire, our net income and the amount of cash distributions we can make.

 

If mortgage debt is unavailable at reasonable rates, we may not be able to finance the purchase of properties. If we place mortgage debt on properties, we may be unable to refinance the properties when the loans become due, or to refinance on favorable terms. If interest rates are higher when we refinance our properties, our income could be reduced. If any of these events occur, our cash flow could be reduced. This, in turn, could reduce cash available for distribution to our stockholders and may hinder our ability to raise more capital by issuing more stock or by borrowing more money. In addition, payments of principal and interest made to service our debts may leave us with insufficient cash to make distributions necessary to meet the distribution requirements imposed on REITs under the Code.

 

Risks Related to this Offering

 

There has been no public market for our common stock and an active trading market for our common stock may not develop or be sustained following this offering.

 

There has not been any public market for our common stock, and an active trading market may not develop or be sustained. Shares of our common stock may not be able to be resold at or above the initial public offering price. Our common stock has been approved for listing, subject to official notice of issuance, on the NYSE under the symbol “DEA.” The initial public offering price of our common stock has been determined in consultation with the underwriters, but our common stock may trade below the initial public offering price following the completion of this offering. See “Underwriting.” The market value of our common stock could be substantially affected by general market conditions, including the extent to which a secondary market develops for our common stock following the completion of this offering, the extent of institutional investor interest in us, the general reputation of REITs and the attractiveness of their equity securities in comparison to other equity securities (including securities issued by other real estate-based companies), our financial performance and general stock and bond market conditions.

 

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The market price and trading volume of our common stock may be volatile following this offering.

 

Even if an active trading market develops for our common stock, the trading price of our common stock may be volatile. In addition, the trading volume in our common stock may fluctuate and cause significant price variations to occur. If the trading price of our common stock declines significantly, you may be unable to resell your shares at or above the public offering price. Some of the factors that could negatively affect our share price or result in fluctuations in the price or trading volume of our common stock include:

 

   

actual or anticipated variations in our quarterly operating results or dividends;

 

   

changes in guidance related to financial performance;

 

   

publication of research reports about us or the real estate industry;

 

   

increases in market interest rates that lead purchasers of our shares to demand a higher yield;

 

   

changes in market valuations of similar companies;

 

   

adverse market reaction to any additional debt we incur in the future;

 

   

additions or departures of key management personnel;

 

   

actions by institutional stockholders;

 

   

speculation in the press or investment community;

 

   

the realization of any of the other risk factors presented in this prospectus;

 

   

the extent of investor interest in our securities;

 

   

the general reputation of REITs and the attractiveness of our equity securities in comparison to other equity securities, including securities issued by other real estate-based companies;

 

   

our underlying asset value;

 

   

investor confidence in the stock and bond markets, generally;

 

   

changes in tax laws;

 

   

future equity issuances;

 

   

failure to meet guidance related to financial performance;

 

   

failure to meet and maintain REIT qualifications; and

 

   

general market and economic conditions.

 

In the past, securities class-action litigation has often been instituted against companies following periods of volatility in the price of their common stock. This type of litigation could result in substantial costs and divert our management’s attention and resources, which could have an adverse effect on our financial condition, results of operations, cash flow and trading price of our common stock.

 

We are an “emerging growth company,” and we cannot be certain if the reduced reporting requirements applicable to emerging growth companies will make our common stock less attractive to investors.

 

We are an “emerging growth company” as defined in the JOBS Act. We will remain an “emerging growth company” until the earliest to occur of (i) the last day of the fiscal year during which our total annual revenue equals or exceeds $1 billion (subject to adjustment for inflation), (ii) the last day of the fiscal year following the fifth anniversary of this offering, (iii) the date on which we have, during the previous three-year period, issued more than $1 billion in non-convertible debt or (iv) the date on which we are deemed to be a “large accelerated filer” under the Exchange Act. We may take advantage of exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies, including, but not limited to, reduced disclosure

 

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obligations regarding executive compensation in our periodic reports and proxy statements and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. We cannot predict if investors will find our common stock less attractive because we may rely on these exemptions and benefits under the JOBS Act. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and the market price of our common stock may be more volatile and decline significantly.

 

If you invest in this offering, you will experience immediate dilution.

 

We expect the initial public offering price of shares of our common stock to be higher than the pro forma net tangible book value per share of the outstanding shares of our common stock. Purchasers of our common stock in this offering will experience immediate dilution of approximately $0.77 in the pro forma net tangible book value per share of common stock. This means that investors who purchase shares of common stock will pay a price per share that exceeds the pro forma net tangible book value of our assets after subtracting our liabilities. See “Dilution.”

 

The form, timing or amount of dividend distributions in future periods may vary and be impacted by economic and other considerations.

 

The form, timing or amount of dividend distributions will be declared at the discretion of our board of directors and will depend on actual cash from operations, our financial condition, capital requirements, the annual distribution requirements applicable to REITs under the Code and other factors as our board of directors may consider relevant.

 

The market value of our common stock may decline due to the large number of our shares eligible for future sale.

 

The market value of our common stock could decline as a result of sales of a large number of shares of common stock in the market after this offering or the perception that such sales could occur. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell shares of common stock in the future at a time and at a price that we deem appropriate. Upon completion of this offering, the formation transactions and the concurrent private placement, we will have a total of 22,341,712 shares of common stock outstanding (or 24,141,712 shares of common stock assuming the underwriters exercise in full their option to purchase additional shares of common stock in full to cover over-allotments), excluding shares of restricted common stock intended to be granted to our non-employee directors pursuant to the 2015 Equity Incentive Plan. The shares of common stock sold in this offering (or shares of common stock assuming the underwriters exercise their option to purchase additional shares of common stock in full to cover over-allotments) will be freely transferable without restriction or further registration under the Securities Act, by persons other than our directors, director nominees and executive officers and the continuing investors. See “Shares Eligible for Future Sale.”

 

The remaining shares of common stock that will be held by our continuing investors immediately following the completion of the offering, the formation transactions and the concurrent private placement will be “restricted securities” within the meaning of Rule 144 under the Securities Act and may not be sold in the absence of registration under the Securities Act unless an exemption from registration is available, including the exemptions contained in Rule 144. All of these shares of our common stock will be eligible for future sale following the expiration of the 180-day lock-up period, and certain of such shares held by our continuing investors will have registration rights pursuant to registration rights agreements that we will enter into with those investors. When the restrictions under the lock-up arrangements expire or are waived, the related shares of common stock or securities convertible into, exchangeable for, exercisable for, or repayable with common stock will be available for sale or resale, as the case may be, and such sales or resales, or the perception of such sales or resales, could depress the market price for our common stock. In addition, from and after 15 months following the closing of

 

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this offering, limited partners of our operating partnership, other than us, will have the right to require our operating partnership to redeem part or all of their common units for cash, based upon the value of an equivalent number of shares of our common stock at the time of the election to redeem, or, at our election, shares of our common stock on a one-for-one basis. See “Shares Eligible For Future Sale—Registration Rights” and “Certain Relationships and Related Transactions—Registration Rights.”

 

In addition, future sales of shares of common stock may be dilutive to existing stockholders.

 

Risks Related to Our Status as a REIT

 

Failure to qualify or to maintain our qualification as a REIT would have significant adverse consequences to the value of our common stock.

 

We intend to elect and to operate in a manner that will allow us to qualify as a REIT commencing with our taxable year ending December 31, 2015. The Code generally requires that a REIT distribute at least 90% of its taxable income (without regard to the dividends paid deduction and excluding net capital gains) to stockholders annually, and a REIT must pay income tax, including any applicable alternative minimum tax, at regular corporate rates to the extent that it distributes less than 100% of its taxable income (including capital gains) in a given year. In addition, a REIT is required to pay a 4% nondeductible excise tax on the amount, if any, by which the distributions it makes in a calendar year are less than the sum of 85% of its ordinary income, 95% of its capital gain net income and 100% of its undistributed income from prior years. To avoid entity-level U.S. federal income and excise taxes, we anticipate distributing at least 100% of our taxable income.

 

We believe that we have been and will continue to be owned and organized, and have operated and will operate, in a manner that will allow us to qualify as a REIT commencing with our taxable year ending December 31, 2015. However, we cannot assure you that we have been and will continue to be owned and organized and have operated and will operate as such. Qualification as a REIT involves the application of highly technical and complex provisions of the Code as to which there may only be limited judicial and administrative interpretations and involves the determination of facts and circumstances not entirely within our control. We have not requested and do not intend to request a ruling from the IRS that we qualify as a REIT. The complexity of these provisions and of the applicable Treasury Regulations is greater in the case of a REIT that, like us, holds its assets through one or more partnerships. Moreover, in order to qualify as a REIT, we must meet, on an ongoing basis, various tests regarding the nature and diversification of our assets and our income, the ownership of our outstanding stock, the absence of inherited retained earnings from non-REIT periods and the amount of our distributions. Our ability to satisfy the asset tests imposed on REITs depends upon our analysis of the characterization and fair market values of our assets, some of which are not susceptible to a precise determination, and for which we will not obtain independent appraisals. Our compliance with the REIT gross income and quarterly asset requirements also depends upon our ability to manage successfully the composition of our gross income and assets on an ongoing basis. Future legislation, new regulations, administrative interpretations or court decisions may significantly change the tax laws or the application of the tax laws with respect to qualification as a REIT for U.S. federal income tax purposes or the U.S. federal income tax consequences of such qualification. Accordingly, it is possible that we may not meet the requirements for qualification as a REIT.

 

If, with respect to any taxable year, we fail to maintain our qualification as a REIT, we would not be allowed to deduct distributions to stockholders in computing our taxable income. If we were not entitled to relief under the relevant statutory provisions, we would also be disqualified from treatment as a REIT for the four subsequent taxable years. If we fail to qualify as a REIT, we would be subject to entity-level income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate tax rates. As a result, the amount available for distribution to holders of our common stock would be reduced for the year or years involved, and we would no longer be required to make distributions. In addition, our failure to qualify as a REIT could impair our ability to expand our business and raise capital, and adversely affect the value of our common stock.

 

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The opinion of our tax counsel regarding our status as a REIT does not guarantee our ability to qualify as a REIT.

 

Our tax counsel, Goodwin Procter LLP, has rendered an opinion to us to the effect that our prior and proposed organization, ownership and method of operation as represented by management have enabled and will enable us to satisfy the requirements for qualification and taxation as a REIT commencing with our taxable year ending December 31, 2015. This opinion was based on representations made by us as to certain factual matters relating to our ownership, organization and our prior and intended or expected manner of operation, including a representation that our current and future ownership will not cause us to be a successor of either of the Easterly Fund REITs, as defined below. Goodwin Procter LLP has not verified those representations, and their opinion assumes that such representations and covenants are accurate and complete, that we have been owned, organized and operated and will be owned, organized and will continue to operate in accordance with such representations and covenants and that we will take no action inconsistent with our status as a REIT. In addition, this opinion was based on the law existing and in effect as of its date and does not cover subsequent periods. Our qualification and taxation as a REIT will depend on our ability to meet on a continuing basis, through actual operating results, asset composition, distribution levels, diversity of share ownership and the various other qualification tests imposed under the Code. See “U.S. Federal Income Tax Considerations.” Goodwin Procter LLP has not reviewed and will not review our compliance with these tests on a continuing basis. Accordingly, the opinion of our tax counsel does not guarantee our ability to qualify as or remain a REIT, and no assurance can be given that we will satisfy such tests for our taxable year ending December 31, 2015 or for any future period. Also, the opinion of Goodwin Procter LLP is not binding on the IRS or any court, and could be subject to modification or withdrawal based on future legislative, judicial or administrative changes to U.S. federal income tax laws, any of which could be applied retroactively. Goodwin Procter LLP will have no obligation to advise us or the holders of our stock of any subsequent change in the matters stated, represented or assumed in its opinion or of any subsequent change in applicable law.

 

We may owe certain taxes notwithstanding our qualification as a REIT.

 

Even if we qualify as a REIT, we will be subject to certain U.S. federal, state and local taxes on our income and property, on taxable income that we do not distribute to our stockholders, on net income from certain “prohibited transactions,” and on income from certain activities conducted as a result of foreclosure. We may, in certain circumstances, be required to pay an excise or penalty tax (which could be significant in amount) in order to utilize one or more relief provisions under the Code to maintain our qualification as a REIT. In addition, we may provide services that are not customarily provided by a landlord, hold properties for sale and engage in other activities (such as a management business) through TRSs and the income of those subsidiaries will be subject to U.S. federal income tax at regular corporate rates. Furthermore, to the extent that we conduct operations outside of the United States, our operations would subject us to applicable foreign taxes, regardless of our status as a REIT for U.S. tax purposes.

 

If our operating partnership is treated as a corporation for U.S. federal income tax purposes, we will cease to qualify as a REIT.

 

We believe our operating partnership qualifies and will continue to qualify as a partnership for U.S. federal income tax purposes. Assuming that it qualifies as a partnership for U.S. federal income tax purposes, our operating partnership will not be subject to U.S. federal income tax on its income. Instead, its partners, including us, generally are required to pay tax on their respective allocable share of our operating partnership’s income. No assurance can be provided, however, that the IRS will not challenge our operating partnership’s status as a partnership for U.S. federal income tax purposes, or that a court would not sustain such a challenge. If the IRS were successful in treating our operating partnership as a corporation for U.S. federal income tax purposes, we would fail to meet the gross income tests and certain of the asset tests applicable to REITs and, therefore, cease to qualify as a REIT, and our operating partnership would become subject to U.S. federal, state and local income tax. The payment by our operating partnership of income tax would reduce significantly the amount of cash

 

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available to our partnership to satisfy obligations to make principal and interest payments on its debt and to make distribution to its partners, including us.

 

Our acquisition of common units from certain REITs controlled by the Easterly Funds may involve certain tax risks.

 

After 15 months following this offering, we expect that certain entities included in the Easterly Funds that are intended to qualify for taxation as REITs, each of which we refer to as an Easterly Fund REIT, may tender common units held by them for redemption and liquidate. If we elect to issue shares of our common stock to acquire the common units tendered by one of the Easterly Fund REITs, the acquisition and liquidation may qualify as a tax-deferred corporate reorganization for U.S. federal income tax purposes. In that case, we would inherit the tax basis of the Easterly Fund REIT in the common units that we acquire. As a result of such a carryover tax basis, we may be allocated less depreciation, and additional gain on sale, with respect to our properties, than would be the case if we acquired such common units in a taxable transaction. In addition, if the acquisition of common units from the Easterly Fund REIT in exchange for shares of our common stock qualified as a tax-deferred reorganization, but the Easterly Fund REIT failed to qualify as a REIT prior to the acquisition, we could be subject to a corporate level tax if we sell properties held by us at the time of the acquisition of common units from the Easterly Fund REIT in a taxable transaction within ten years following the tax deferred reorganization. The corporate tax applies to the lesser of (i) our gain on such sale, or (ii) that portion of the built-in gain at the time of the acquisition from the Easterly Fund REIT that is attributable to the common units acquired from such Easterly Fund REIT. Gain from a sale of such an asset occurring after the 10-year period ends would not be subject to this tax. In such circumstances we also would inherit any undistributed non-REIT earnings and profits of the Easterly Fund REIT, which we would need to distribute by the end of the year of the acquisition.

 

If the owners of 50% or more of one of the Easterly Fund REITs were to acquire 50% or more of our stock, in connection with or following the liquidation or merger of such Easterly Fund REIT, we could be deemed a “successor” to such Easterly Fund REIT for purposes of the REIT rules. Successor treatment would mean that our election to be taxed as a REIT could be terminated if it were determined that the applicable Easterly Fund REIT had failed to qualify as a REIT for periods prior to its liquidation or merger. We do not intend to issue stock in exchange for common units held by an Easterly Fund REIT if we believe it could cause us to be treated as its successor, which may require us to redeem common units for cash when we otherwise would prefer to pay in shares of our common stock. Our charter contains ownership restrictions that will prevent any overlapping ownership that would cause us to be a successor of an Easterly Fund REIT, and we intend to enforce such provisions.

 

Dividends payable by REITs generally do not qualify for reduced tax rates.

 

The maximum U.S. federal income tax rate for certain qualified dividends payable to U.S. stockholders that are individuals, trusts and estates generally is 20%. Dividends payable by REITs, however, are generally not eligible for the reduced rates and therefore may be subject to a 39.6% maximum U.S. federal income tax rate on ordinary income when paid to such stockholders. The more favorable rates applicable to regular corporate dividends could cause investors who are individuals, trusts and estates or are otherwise sensitive to these lower rates to perceive investments in REITs to be relatively less attractive than investments in the stock of non-REIT corporations that pay dividends, which could adversely affect the value of the shares of REITs, including our common stock.

 

A portion of our distributions may be treated as a return of capital for U.S. federal income tax purposes, which could reduce the basis of a stockholder’s investment in shares of our common stock and may trigger taxable gain.

 

A portion of our distributions may be treated as a return of capital for U.S. federal income tax purposes. As a general matter, a portion of our distributions will be treated as a return of capital for U.S. federal income tax

 

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purposes if the aggregate amount of our distributions for a year exceeds our current and accumulated earnings and profits for that year. To the extent that a distribution is treated as a return of capital for U.S. federal income tax purposes, it will reduce a holder’s adjusted tax basis in the holder’s shares, and to the extent that it exceeds the holder’s adjusted tax basis will be treated as gain resulting from a sale or exchange of such shares. See “U.S. Federal Income Tax Considerations.”

 

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

 

To qualify as a REIT for U.S. 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 our stockholders and the ownership of our stock. We may be required to make distributions to our stockholders at disadvantageous times or when we do not have funds readily available for distribution. Thus, compliance with the REIT requirements may, for instance, hinder our ability to make certain otherwise attractive investments or undertake other activities that might otherwise be beneficial to us and our stockholders, or may require us to borrow or liquidate investments in unfavorable market conditions and, therefore, may hinder our investment performance. As a REIT, at the end of each calendar quarter, at least 75% of the value of our assets must consist of cash, cash items, U.S. Government securities and qualified “real estate assets.” The remainder of our investments in securities (other than cash, cash items, U.S. Government securities, securities issued by a TRS 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 total assets (other than cash, cash items, U.S. Government securities, securities issued by a TRS 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 securities can be represented by securities of one or more TRSs. After meeting these requirements at the close of a calendar quarter, if we fail to comply with these requirements at the end of any subsequent 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. As a result, we may be required to liquidate from our portfolio or forego otherwise attractive investments. These actions could have the effect of reducing our income and amounts available for distribution to our stockholders.

 

We may be subject to a 100% penalty tax on any prohibited transactions that we enter into, or may be required to forego certain otherwise beneficial opportunities in order to avoid the penalty tax on prohibited transactions.

 

If we are found to have held, acquired or developed property primarily for sale to customers in the ordinary course of business, we may be subject to a 100% “prohibited transactions” tax under U.S. federal tax laws on the gain from disposition of the property unless the disposition qualifies for one or more safe harbor exceptions for properties that have been held by us for at least two years and satisfy certain additional requirements (or the disposition is made through a TRS and, therefore, is subject to corporate U.S. federal income tax). Under existing law, whether property is held primarily for sale to customers in the ordinary course of a trade or business is a question of fact that depends on all the facts and circumstances. We intend to hold, and, to the extent within our control, to have any joint venture to which our operating partnership is a partner hold, properties for investment with a view to long-term appreciation, to engage in the business of acquiring, owning, operating and developing the properties, and to make sales of our properties and other properties acquired subsequent to the date hereof as are consistent with our investment objectives. Based upon our investment objectives, we believe that overall, our properties should not be considered property held primarily for sale to customers in the ordinary course of business. However, it may not always be practical for us to comply with one of the safe harbors, and, therefore, we may be subject to the 100% penalty tax on the gain from dispositions of property if we otherwise are deemed to have held the property primarily for sale to customers in the ordinary course of business. The potential application of the prohibited transactions tax could cause us to forego potential dispositions of other property or to forego other opportunities that might otherwise be attractive to us, or to hold investments or undertake such dispositions or other opportunities through a TRS, which would generally result in corporate income taxes being incurred.

 

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REIT distribution requirements could adversely affect our liquidity and adversely affect our ability to execute our business plan.

 

In order to maintain our qualification as a REIT and to meet the REIT distribution requirements, we may need to modify our business plans. Our cash flow from operations may be insufficient to fund required distributions, for example, as a result of differences in timing between our cash flow, the receipt of income for GAAP purposes and the recognition of income for U.S. federal income tax purposes, the effect of non-deductible capital expenditures, the creation of reserves, payment of required debt service or amortization payments, or the need to make additional investments in qualifying real estate assets. The insufficiency of our cash flow to cover our distribution requirements could require us to (i) sell assets in adverse market conditions, (ii) borrow on unfavorable terms, (iii) distribute amounts that would otherwise be invested in future acquisitions or capital expenditures or used for the repayment of debt, (iv) pay dividends in the form of “taxable stock dividends” or (v) use cash reserves, in order to comply with the REIT distribution requirements. As a result, compliance with the REIT distribution requirements could adversely affect the market value of our common stock. The inability of our cash flow to cover our distribution requirements could have an adverse impact on our ability to raise short and long-term debt or sell equity securities. In addition, if we are compelled to liquidate our assets to repay obligations to our lenders or make distributions to our stockholders, we may be subject to a 100% tax on any resultant gain if we sell assets that are treated as property held primarily for sale to customers in the ordinary course of business.

 

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 be a REIT, we will not be allowed a deduction for dividends paid to stockholders in computing our taxable income and will be subject to U.S. federal income tax at regular corporate rates, as well as state and local taxes, which may have adverse consequences on our total return to our stockholders.

 

Our ability to provide certain services to our tenants may be limited by the REIT rules, or may have to be provided through a TRS.

 

As a REIT, we generally cannot provide services to our tenants other than those that are customarily provided by landlords, nor can we derive income from a third party that provides such services. If we forego providing such services to our tenants, we may be at disadvantage to competitors who are not subject to the same restrictions. However, we can provide such non-customary services to tenants or share in the revenue from such services if we do so through a TRS, though income earned through the TRS will be subject to corporate income taxes.

 

We expect to earn fees from certain tenant improvement services and other non-customary services we will provide to our tenants. Gross income from such services generally may only constitute qualifying income for purposes of the 75% and 95% gross income tests to the extent that it is attributable to services provided to our tenants in connection with the entering into or renewal of a lease. In addition, services provided to our tenants other than in such circumstances might constitute non-customary services. As a result, to the extent that we provide tenant improvement services to tenants other than in connection with the entering into or renewal of a lease, we expect to provide such services through a TRS, which will be subject to full corporate tax with respect to such income.

 

Although our use of TRSs may partially mitigate the impact of meeting certain requirements necessary to maintain our qualification as a REIT, there are limits on our ability to own and engage in transactions with TRSs, and a failure to comply with the limits would jeopardize our REIT qualification and may result in the application of a 100% excise tax.

 

A REIT may own up to 100% of the stock of one or more TRSs. A TRS may hold assets and earn income that would not be qualifying assets or income if held or earned directly by a REIT. Both the subsidiary and the

 

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REIT must jointly elect to treat the subsidiary as a TRS. A corporation of which a TRS directly or indirectly owns more than 35% of the voting power or value of the stock will automatically be treated as a TRS. Overall, no more than 25% of the value of a REIT’s assets may consist of securities of one or more TRSs. In addition, rules limit the deductibility of interest paid or accrued by a TRS to its parent REIT to assure that the TRS is subject to an appropriate level of corporate taxation. Rules also impose a 100% excise tax on certain transactions between a TRS and its parent REIT that are treated as not being conducted on an arm’s-length basis. We intend to jointly elect with one or more subsidiaries for those subsidiaries to be treated as TRSs for U.S. federal income tax purposes. These subsidiaries and any other TRSs that we form will pay U.S. federal, state and local income tax on their taxable income, and their after-tax net income will be available for distribution to us but is not required to be distributed to us. Although we will monitor the aggregate value of the securities of such TRSs and intend to conduct our affairs so that such securities will represent less than 25% of the value of our total assets, there can be no assurance that we will be able to comply with the TRS limitation in all market conditions.

 

Possible legislative, regulatory or other actions could adversely affect our stockholders and us.

 

The rules dealing with U.S. federal, state and local income taxation are constantly under review by persons involved in the legislative process and by the IRS and the U.S. Treasury Department. Changes to tax laws (which changes may have retroactive application) could adversely affect our stockholders or us. In recent years, many such changes have been made and changes are likely to continue to occur in the future. We cannot predict whether, when, in what form, or with what effective dates, tax laws, regulations and rulings may be enacted, promulgated or decided, which could result in an increase in our, or our stockholders’, tax liability or require changes in the manner in which we operate in order to minimize increases in our tax liability. A shortfall in tax revenues for states and municipalities in which we operate may lead to an increase in the frequency and size of such changes. If such changes occur, we may be required to pay additional taxes on our assets or income or be subject to additional restrictions. These increased tax costs could, among other things, adversely affect our financial condition, the results of operations and the amount of cash available for the payment of dividends.

 

Stockholders are urged to consult with their own tax advisors with respect to the impact that recent legislation may have on their investment and the status of legislative, regulatory or administrative developments and proposals and their potential effect on their investment in our shares. In particular, certain members of Congress recently circulated a draft of proposed legislative changes to the REIT rules that, if ultimately adopted, could adversely affect our REIT status, including reducing the maximum amount of our gross asset value in TRSs from 25% to 20%.

 

Our property taxes on certain properties could increase due to property tax rate changes or reassessment, which could adversely affect our financial condition, results of operations, cash flow, per share trading price of our common stock and our ability to satisfy our principal and interest obligations and to make distributions to our stockholders.

 

Even if we qualify as a REIT for U.S. federal income tax purposes, we will be required to pay state and local taxes on our properties. The real property taxes on our properties may increase as property tax rates change or as our properties are assessed or reassessed by taxing authorities. In particular, our portfolio of properties may be reassessed as a result of this offering. While the GSA is generally required to reimburse us for increases in real estate taxes under the terms of the GSA leases, the amount of property taxes we pay on these properties in the future may increase substantially from what we have paid in the past. Additionally, the tax bases of ten of our properties in California are likely to be reassessed in connection with the completion of the formation transactions. A reassessment would likely cause the respective tax bases of these properties and, consequently, our property taxes thereon to increase, although the amount of any such increase is not reasonably determinable at this time. We will not be reimbursed by our tenants for any such increase in property taxes resulting from such a reassessment under California law. If the property taxes we pay that are not subject to reimbursement increase, our financial condition, results of operations, cash flow, per share trading price of our common stock and our ability to satisfy our principal and interest obligations and to make distributions to our stockholders could be adversely affected.

 

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

This prospectus contains forward-looking statements that are subject to risks and uncertainties. In particular, statements relating to our liquidity and capital resources, portfolio performance and results of operations contain forward-looking statements. Furthermore, all of the statements regarding future financial performance (including market conditions and demographics) are forward-looking statements. We caution investors that any forward-looking statements presented in this prospectus are based on management’s beliefs and assumptions made by, and information currently available to, management. When used, the words “anticipate,” “believe,” “expect,” “intend,” “may,” “might,” “plan,” “estimate,” “project,” “should,” “will,” “would,” “result” and similar expressions that do not relate solely to historical matters are intended to identify forward-looking statements. You can also identify forward-looking statements by discussions of strategy, plans or intentions.

 

Forward-looking statements are subject to risks, uncertainties and assumptions and may be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated or projected. We caution you therefore against relying on any of these forward-looking statements.

 

Some of the risks and uncertainties that may cause our actual results, performance, liquidity or achievements to differ materially from those expressed or implied by forward-looking statements include, among others, the following:

 

   

risks associated with our dependence on the U.S. Government and its agencies for substantially all of our revenues, including credit risk and risk that the U.S. Government reduces its spending on real estate or that it changes it preference away from leased properties;

 

   

risks associated with ownership and development of real estate;

 

   

decreased rental rates or increased vacancy rates;

 

   

loss of key personnel;

 

   

general volatility of the capital and credit markets and the market price of our common stock;

 

   

the risk we may lose one or more major tenants;

 

   

failure of acquisitions or development projects to yield anticipated results;

 

   

risks associated with actual or threatened terrorist attacks;

 

   

intense competition in the real estate market that may limit our ability to attract or retain tenants or re-lease space;

 

   

insufficient amounts of insurance or exposure to events that are either uninsured or underinsured;

 

   

uncertainties and risks related to adverse weather conditions, natural disasters and climate change;

 

   

exposure to liability relating to environmental and health and safety matters;

 

   

limited ability to dispose of assets because of the relative illiquidity of real estate investments and the nature of our assets;

 

   

exposure to litigation or other claims;

 

   

risks associated with breaches of our data security;

 

   

risks associated with our indebtedness;

 

   

failure to refinance current or future indebtedness on favorable terms, or at all;

 

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failure to meet the restrictive covenants and requirements in our existing and new debt agreements;

 

   

fluctuations in interest rates and increased costs to refinance or issue new debt;

 

   

risks associated with derivatives or hedging activity; and

 

   

risks associated with mortgage debt or unsecured financing or the unavailability thereof, which could make it difficult to finance or refinance properties and could subject us to foreclosure.

 

While forward-looking statements reflect our good faith beliefs, they are not guarantees of future performance. They are based on estimates and assumptions only as of the date of this prospectus. We undertake no obligation to update or revise any forward-looking statement to reflect changes in underlying assumptions or factors, new information, data or methods, future events or other changes, except as required by applicable law.

 

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USE OF PROCEEDS

 

We estimate that we will receive gross proceeds from this offering of approximately $180.0 million, or approximately $207.0 million if the underwriters’ over-allotment option is exercised in full. After deducting the underwriting discount and commissions and estimated offering expenses of approximately $13.5 million, we expect to receive net proceeds from this offering of approximately $166.5 million, or approximately $191.7 million if the underwriters’ over-allotment option is exercised in full. In addition, concurrently with the completion of this offering, we will issue 7,033,712 shares of common stock to the Easterly Funds in the concurrent private placement at the public offering price without payment of any underwriting fees, discounts or commissions. We expect to receive proceeds from the concurrent private placement of approximately $105.5 million.

 

We will contribute the net proceeds from this offering and the concurrent private placement to our operating partnership in exchange for common units. We expect our operating partnership to use the net proceeds received from us and a portion of the borrowings under the senior unsecured revolving credit facility to repay $272.9 million in outstanding indebtedness and any applicable repayment costs, defeasance costs, settlement of interest rate swap liabilities and other costs and fees associated with such repayments and $1.1 million of costs related to our acquisition of Western Devcon. Exact payment amounts may differ from estimates due to amortization of principal, additional borrowings and incurrence of additional transaction expenses.

 

The following table describes the mortgage indebtedness that we intend to repay with the net proceeds from this offering and the concurrent private placement and amounts borrowed by us under our new senior unsecured revolving credit facility at the closing of this offering.

 

Property

   Fixed/Floating    Interest Rate   Maturity Date    Repayment  
                   (amounts in
thousands)
 

2650 SW 145th Avenue - Parbel of Florida

   Floating    Prime   January 2015    $ 12,091   

DEA - Otay

   Fixed    8.00%   September 2015      4,211   

DEA - San Diego

   Fixed    7.63%   October 2015      258   

AOC - Del Rio

   Fixed    5.31%   December 2015      14,486   

DEA - Dallas

   Floating    LIBOR +  3.00%(1)   December 2015      7,640   

CBP - Chula Vista

   Floating    LIBOR + 2.25%   May 2016      5,711   

SSA - Mission Viejo

   Fixed    6.29%   May 2016      3,318   

USFS I - Albuquerque

   Fixed    6.05%   June 2016      14,409   

SSA - San Diego

   Floating    LIBOR + 2.50%   July 2016      1,683   

DEA - Albany

   Floating    LIBOR +  3.15%(2)   February 2017      5,000   

FBI - Little Rock

   Fixed    5.80%   May 2017      13,650   

DEA - Riverside

   Fixed    7.00%   December 2017      5,333   

DEA - North Highlands

   Fixed    5.92%   May 2018      3,611   

IRS - Fresno

   Floating    LIBOR +  2.50%(3)   November 2018      27,460   

DEA - Santa Ana

   Fixed    6.34%   July 2019      9,872   

AOC - El Centro

   Fixed    5.28%   September 2019      9,466   

FBI - Omaha

   Floating    LIBOR +  2.25%(4)   October 2020      27,743   

PTO - Arlington

   Floating    LIBOR +  1.70%(5)   February 2020      33,000   

DEA - Vista

   Fixed    6.80%   January 2021      8,964   

DOT - Lakewood

   Fixed    4.35%   December 2021      17,000   

501 East Hunter Street - Lummus Corporation

   Fixed    4.68%   August 2022      3,543   

FBI - San Antonio

   Fixed    6.07%   October 2022      21,631   

5998 Osceola Court - United Technologies

   Fixed    4.95%   November 2023      4,700   

USGC - Martinsburg

   Floating    LIBOR +  2.00%(6)   December 2027      9,175   

CBP - Sunburst

   Fixed    6.90%   November 2028      8,900   
          

 

 

 

Total principal repayment

             272,855   
          

 

 

 

Settlement of interest rate swap liabilities

             2,376   

Debt repayment fees

             20,282   
          

 

 

 

Total repayment and associated costs

           $ 295,513   
          

 

 

 

 

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(1)   This loan has an interest rate swap that results in a fixed rate of 3.92%.
(2)   This loan has an interest rate swap that results in a fixed rate of 4.23%.
(3)   This loan has an interest rate swap that results in a fixed rate of 4.03%.
(4)   This loan has an interest rate swap that results in a fixed rate of 4.47%.
(5)   This loan has an interest rate swap that results in a fixed rate of 3.92%.
(6)   This loan has an interest rate swap that results in a fixed rate of 5.55%.

 

We expect to use any remaining net proceeds from this offering and the concurrent private placement for general corporate purposes, including capital expenditures and potential future acquisition, development and redevelopment opportunities. Pending the application of the net proceeds, we will invest the net proceeds in interest-bearing accounts and short-term, interest-bearing securities in a manner that is consistent with our qualification as a REIT.

 

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DISTRIBUTION POLICY

 

We intend to pay regular quarterly distributions to holders of our common stock. We intend to pay a pro rata initial distribution with respect to the period commencing on the completion of this offering and ending on the last day of the then current fiscal quarter, based on a rate of $0.21 per share for a full quarter. On an annualized basis, this would be $0.83 per share, or an annual distribution rate of approximately 5.5% based on the initial public offering price. This initial annual distribution rate will represent approximately 90.0% of pro forma cash available for distribution for the 12 months ended September 30, 2015, as adjusted to exclude certain items we do not expect to recur during the 12 months following September 30, 2014, and reflect certain assumptions regarding our future cash flows during this period as presented in the table and footnotes below.

 

Estimated cash available for distribution for the 12 months ending September 30, 2015, as adjusted, does not include the effect of any changes in our working capital. This number also does not reflect the amount of cash to be used for investing, acquisition and other activities during the 12 months following September 30, 2014, other than a reserve for contractual tenant improvements and other maintenance capital expenditures. It also does not reflect the amount of cash to be used for financing activities during the 12 months following September 30, 2014, other than scheduled loan principal amortization payments on indebtedness that will be outstanding upon completion of this offering. Any such investing and/or financing activities may have a material effect on our cash available for distribution. Because we have made the assumptions set forth above in calculating cash available for distribution for the 12 months ending September 30, 2015, as adjusted, we do not intend this number to be a projection or forecast of our actual results of operations, FFO, as Adjusted or our liquidity, and have calculated this number for the sole purpose of determining our estimated initial annual distribution rate. Our estimated cash available for distribution for the 12 months ending September 30, 2015, as adjusted, should not be considered as an alternative to cash flow from operating activities, as computed in accordance with GAAP, or as an indicator of our liquidity or our ability to pay dividends or make other distributions. In addition, the methodology upon which we made the adjustments described below is not necessarily intended to be a basis for determining future dividends or other distributions.

 

We intend to maintain a distribution rate for the 12 months following completion of this offering that is at or above our initial distribution rate unless actual results of operations, economic conditions or other factors differ materially from the assumptions used in determining our initial distribution rate. Any future distributions we make will be at the discretion of our board of directors and will be dependent upon a number of factors, including prohibitions or restrictions under financing agreements or applicable law and other factors described below. We do not intend to reduce the expected distributions per share if the underwriters’ option to purchase additional shares of common stock is exercised to cover over-allotments. We will be subject to prohibitions on distributions if we are in default under the senior unsecured revolving credit facility we intend to enter into in connection with this offering as described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

 

We cannot assure you that our estimated distributions will be made or sustained or that our board of directors will not change our distribution policy in the future. Any distributions we pay in the future will depend upon our actual results of operations, liquidity, cash flows, financial conditions, economic conditions, debt service requirements and other factors that could differ materially from our current expectations. Our actual results of operations, liquidity, cash flows and financial conditions will be affected by a number of factors, including the revenue we receive from our properties, our operating expenses, interest expense, the ability of our tenants to meet their obligations and unanticipated expenditures. For example, certain of our properties in California are likely to be reassessed in connection with the completion of the formation transactions. A reassessment would likely cause the respective tax bases of these properties and, consequently, our property taxes thereon to increase, although the amount of any such increase is not reasonably determinable at this time. In addition, as a public company our annual corporate general and administrative expenses are anticipated to be meaningfully higher than our predecessor due to legal, insurance, accounting, audit and other expenses related to corporate governance, SEC reporting, other compliance matters and the costs of operating as a public company. For more information regarding risk factors that could materially adversely affect our ability to pay dividends and make other distributions to our stockholders, see “Risk Factors.”

 

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U.S. federal income tax law requires that a REIT distribute annually at least 90% of its taxable income (without regard to the dividends paid deduction and excluding net capital gains) and that it pay U.S. federal income tax at regular corporate rates to the extent that it distributes annually less than 100% of its taxable income (including capital gains). In addition, a REIT is required to pay a 4% nondeductible excise tax on the amount, if any, by which the distributions it makes in a calendar year are less than the sum of 85% of its ordinary income, 95% of its capital gain net income and 100% of its undistributed income from prior years. For more information, see “U.S. Federal Income Tax Considerations.” We anticipate that our cash available for distribution will be sufficient to enable us to meet the annual distribution requirements applicable to REITs and to avoid or minimize the imposition of U.S. federal income and excise taxes. However, under some circumstances, we may be required to pay distributions in excess of cash available for distribution in order to meet these distribution requirements or to avoid or minimize the imposition of tax, and we may need to borrow funds or dispose of assets to make such distributions.

 

It is possible that, at least initially, our distributions will exceed our then current and accumulated earnings and profits as determined for U.S. federal income tax purposes. Therefore, a portion of our distributions may represent a return of capital for U.S. federal income tax purposes. That portion of our distributions in excess of our current and accumulated earnings and profits will not be taxable to a taxable U.S. stockholder under current U.S. federal income tax law to the extent that portion of our distributions do not exceed the stockholder’s adjusted tax basis in the stockholder’s common stock, but rather will reduce the adjusted basis of the common stock. As a result, the gain recognized on a subsequent sale of that common stock or upon our liquidation will be increased (or a loss decreased) accordingly. To the extent those distributions exceed a taxable U.S. stockholder’s adjusted tax basis in his, her or its common stock, they generally will be treated as a capital gain realized from the taxable disposition of those shares. The percentage of our stockholder distributions that exceeds our current and accumulated earnings and profits may vary substantially from year to year. For a more complete discussion of the tax treatment of distributions to holders of our common stock, see “U.S. Federal Income Tax Considerations.”

 

The following table describes our pro forma net income/loss for the 12 months ended September 30, 2014, and the adjustments we have made to calculate our pro forma cash available for distribution for the 12 months ending September 30, 2015, as adjusted (amounts in thousands, except per share amounts):

 

Pro forma net income / (loss) for the 12 months ended December 31, 2013

   $ 3,639   

Less: Pro forma net income / (loss) for the 9 months ended September 30, 2013

     (1,960

Add: Pro forma net income / (loss) for the 9 months ended September 30, 2014

     4,786   
  

 

 

 

Pro forma net income / (loss) for the 12 months ended September 30, 2014

     6,465   

Add: Pro forma real estate depreciation and amortization

     32,263   

Add: Net increases in contractual rental income(1)

     330   

Less: Net effects of straight-lining rental income(2)

     (215

Less: Net effects of above-/below-market rent adjustments(3)

     (3,412

Add: Net increases in contractual tenant reimbursements(4)

     280   

Add: Net effects of non-cash interest(5)

     916   

Add: Non-cash compensation expense(6)

     741   
  

 

 

 

Estimated cash flow from operating activities for the 12 months ended September 30, 2015

     37,368   

Less: Estimated annual provision for contractual tenant improvements(7)

     (14

Less: Estimated annual provision for maintenance capital expenditures(8)

     (72

Less: Scheduled debt principal payments(9)

     (2,334
  

 

 

 

Estimated cash available for distribution for the 12 months ended September 30, 2015

   $ 34,948   
  

 

 

 

Total estimated initial annual distribution to holders of common units

     12,889   

Total estimated initial annual distribution to holders of common stock

     18,564   

Total estimated initial annual distribution to holders of common stock and common units

   $ 31,453   
  

 

 

 

Estimated initial annual distributions per share of common stock(10)

     0.83   

Payout ratio based on our share of estimated cash available for distribution(11)

     90

 

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(1)   Represents the net increases in contractual rental income from (i) existing leases, (ii) new leases that were not in effect for the entire 12 months ended September 30, 2014, (iii) the renewal of our one lease that expired on September 30, 2014 and has been renewed through September 30, 2019 and (iv) the renewal of our one lease that expires in the 12 months ending September 30, 2015 where we have a nonbinding agreement of terms with the tenant. If our one lease that expires in the 12 months ending September 30, 2015 is not renewed, our estimated cash availability for distributions for the 12 months ended September 30, 2015 could decrease by $0.9 million. No net decreases in contractual rental income are anticipated.
(2)   Represents the conversion of estimated rental revenues for the 12 months ended September 30, 2014 from a straight-line accrual basis to a cash basis recognition.
(3)   Represents the elimination of non-cash adjustments for above-/below-market leases for the 12 months ended September 30, 2014.
(4)   Represents the increase in tenant reimbursements from (i) growth in urban CPI equivalent to the annualized growth rate experienced in the years ended December 31, 2011, 2012 and 2013 and the 9 months ended September 30, 2014 and (ii) the renewal of our one lease that expired on September 30, 2014 and has been renewed through September 30, 2019 and (iii) the renewal of our one lease that expires in the 12 months ending September 30, 2015 where we have a nonbinding agreement of terms with the tenant.

 

The following table sets forth growth in urban CPI:

 

     Year Ended December 31,     Nine  Months
Ended

September 30, 2014
    Weighted Average
January 1, 2011 -

September 30, 2014
 
     2011     2012     2013      

Urban CPI growth, annualized

     3.6     2.1     1.4     1.7     2.2

 

(5)   Represents non-cash interest expense related to loan premium/discount amortization as well as deferred financing fee amortization.
(6)   Represents non-cash compensation expense related to carried interest granted from Easterly Fund I and Easterly Fund II to our executive officers, certain of our other employees and certain other persons for the 12 months ended September 30, 2014.
(7)   Provision for contractual tenant improvements that includes $14,067 in committed tenant improvement costs to be paid or incurred for the 12 months ending September 30, 2015 related to any existing leases as of September 30, 2014. There were no tenant improvement costs in association with the renewal of our one lease that expired on September 30, 2014 and that has been renewed through September 30, 2019. There will be no tenant improvement costs in association with the renewal of our one lease that expires in the 12 months ending September 30, 2015 where we have a nonbinding agreement of terms with the tenant.
(8)   Represents weighted average maintenance capital expenditures per square foot of our predecessor for the years ended December 31, 2011, 2012 and 2013 and the 9 months ended September 30, 2014 multiplied by the square footage in our initial portfolio. Maintenance capital expenditures is defined as expenditures made in respect of a property for maintenance of such property and replacement of items due to ordinary wear and tear. The following table sets forth our predecessor’s maintenance capital expenditures:

 

     Year Ended December 31,      Nine Months
Ended
    

Weighted Average

January 1, 2011 -

 
     2011      2012      2013      September 30, 2014      September 30, 2014  

Maintenance capital expenditures per square foot

   $ 0.04       $ 0.00       $ 0.06       $ 0.04       $ 0.03   

 

(9)   Represents scheduled principal amortization for the 12 months ending September 30, 2015 after giving effect to the repayment of $272.9 million of debt principal that we intend to repay using net proceeds from this offering.
(10)   Based on a total of 22,368,379 shares of common stock and 15,530,939 common units to be outstanding after this offering.
(11)   Calculated as estimated initial annual distribution per share of common stock divided by our share of estimated cash available for distribution per share for the 12 months ending September 30, 2015.

 

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CAPITALIZATION

 

The following table sets forth our cash and capitalization as of September 30, 2014:

 

   

on a historical basis reflecting the cash and capitalization of our predecessor;

 

   

on a pro forma basis giving effect to:

 

   

the formation and capitalization of Easterly Government Properties, Inc.;

 

   

the distribution of cash to the Easterly Funds related to the disposal of one property by our predecessor in August 2014; and

 

   

the formation transactions, which include:

 

   

the contribution of the Easterly Funds’ interest in 15 property-owning subsidiaries and the contribution of the management entities to our operating partnership in exchange for an aggregate of 13,079,120 shares of the company’s common stock and common units in our operating partnership; and

 

   

the acquisition of the interest in 14 Western Devcon properties from Western Devcon in exchange for 5,759,819 common units in our operating partnership;

 

   

on a pro forma as adjusted basis giving effect to (1) the items noted above, (2) the sale by us of 12,000,000 shares of common stock in this offering at the public offering price of $15.00 per share, and our receipt of the estimated net proceeds from this offering after deducting the underwriting discounts and commission, and estimated offering expenses (assuming no exercise of the underwriters’ option to purchase up to 1,800,000 additional shares of common stock to cover over-allotments), (3) the sale by us of 7,033,712 shares of common stock in the concurrent private placement, at the public offering price of $15.00 per share, without payment of any underwriting fees, discounts or commissions (4) the closing of our new $400.0 million senior unsecured revolving credit facility, upon the completion of this offering, of which we expect $35.4 million will be drawn at completion of this offering and (5) the use of proceeds from this offering and the concurrent private placement.

 

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You should read this table in conjunction with “Use of Proceeds,” “Prospectus Summary—Summary Consolidated Historical and Pro Forma Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Business and Properties—Pro Forma Indebtedness” and “Structure and Formation of Our Company” and the consolidated financial statements and unaudited pro forma condensed consolidated financial statements and related notes thereto appearing elsewhere in this prospectus.

 

    As of September 30, 2014  
    Historical     Pro Forma     Pro Forma as
Adjusted
 
    (amounts in thousands, except share and per share data)  

Cash

  $ 33,057      $ 38,994      $ 13,662   
 

 

 

   

 

 

   

 

 

 

Debt

     

Mortgage notes payable

  $ —        $ 349,798      $ 69,377   

Revolving credit facility

    —          —          35,417   
 

 

 

   

 

 

   

 

 

 

Total debt(1)

    —          349,798        104,794   

Members’ capital/Stockholders’ equity

     

Members’ capital

    4,612        —          —     

Preferred stock, par value $0.01 per share 50,000,000 shares authorized; no shares issued and outstanding

    —         

Common stock, par value $0.01 per share 200,000,000 shares authorized; 3,309,000 shares issued and outstanding, pro forma; 22,368,379 shares issued and outstanding, pro forma as adjusted

      33        224   

Additional paid-in capital

    —          29,140        370,456   

Accumulated deficit

    —          (756     (7,951

Non-controlling interest in operating partnership

    —          359,638        251,852   

Non-controlling interest in predecessor

    297,801        —          —     
 

 

 

   

 

 

   

 

 

 

Total Members’ capital/Stockholders’ equity

    302,413        388,055        614,581   
 

 

 

   

 

 

   

 

 

 

Total Capitalization

    $302,413        $737,853        $719,375   
 

 

 

   

 

 

   

 

 

 

 

(1)   The company expects to enter into a $400.0 million senior unsecured revolving credit facility with an accordion feature that will provide the company with additional capacity, subject to the satisfaction of customary terms and conditions, of up to $250.0 million, for a total facility size of $650.0 million.

 

The number of common shares outstanding on a pro forma as adjusted basis in the table above excludes:

 

   

1,800,000 shares of common stock issuable upon the exercise in full of the underwriters’ option to cover over-allotments;

 

   

2,247,292 shares of common stock available for future issuance under our 2015 Equity Incentive Plan; and

 

   

15,530,939 shares of common stock that may be issued, at our option upon exchange of common units in our operating partnership.

 

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DILUTION

 

If you invest in our common stock offered by this prospectus, your interest will be diluted immediately to the extent of the difference between the initial public offering price of our common stock and the pro forma as adjusted net tangible book value per share of our common stock immediately after the completion of this offering and the concurrent private placement.

 

Our pro forma net tangible book value as of September 30, 2014 was approximately $312.5 million, or $16.59 per share of common stock, assuming the exchange of 15,530,939 common units into the same number of shares of common stock. Pro forma net tangible book value represents the amount of total tangible assets less total tangible liabilities, after giving effect to the formation and capitalization of our company and the formation transactions. Pro forma net tangible book value per share represents pro forma net tangible book value divided by the number of shares outstanding, assuming the exchange of 15,530,939 common units into the same number of shares of common stock after giving effect to the formation and capitalization of the company and the formation transactions.

 

After giving effect to the sale of 12,000,000 shares of common stock in this offering at an initial public offering price of $15.00 per share, and after deducting underwriting discounts and commissions, and estimated offering expenses, the sale of 7,033,712 shares of common stock at the public offering price in the concurrent private placement without payment of any underwriting fees, discounts or commissions, the closing of our new $400.0 million senior unsecured revolving credit facility, of which $35.4 was drawn at completion of this offering, and the use of proceeds of our offering as described under “Use of Proceeds,” our pro forma, as adjusted, net tangible book value as of September 30, 2014 would have been $539.3 million, or $14.23 per share of common stock. This represents an immediate dilution of $0.77 per share of common stock in pro forma as adjusted net tangible book value to new investors purchasing common stock in this offering. Dilution per share to new investors is determined by subtracting pro forma as adjusted net tangible book value per share after this offering from the initial public offering price per share paid by new investors. The following table illustrates this dilution on a per share basis:

 

Initial offering price per share

     $ 15.00   

Pro forma net tangible book value per share as of September 30, 2014

   $ 16.59     

Decrease in pro forma net tangible book value per share attributable to investors in this offering and the concurrent private placement

     (2.36  
  

 

 

   

Pro forma as adjusted net tangible book value per share as of September 30, 2014 (after giving effect to this offering and the concurrent private placement)

       14.23   
    

 

 

 

Dilution in pro forma as adjusted net tangible book value per share to new investors participating in this offering

     $ 0.77   
    

 

 

 

 

If the underwriters exercise their over-allotment option, you will experience further dilution.

 

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The table below summarizes (1) the difference between the number of shares of common stock and common units in our operating partnership to be received by the continuing investors and Western Devcon in the formation transactions and the concurrent private placement and the number of shares of common stock to be received by new investors purchasing shares in this offering, and (2) the difference between our pro forma net tangible book value as of September 30, 2014 after giving effect to the formation transactions and the concurrent private placement and other pro forma adjustments but prior to this offering and the total consideration paid in cash by the new investors purchasing shares in this offering on an aggregate and per share/unit basis.

 

     Shares/Common  Units
Issued
    Total Consideration     Average
Price
Per
Share
 
     Number      Percentage     Amount      Percentage    

Continuing investors and Western Devcon

     25,872,651         68.3   $ 388,089,767         68.3   $ 15.00   

Shares of restricted stock to be granted to non-employee directors in connection with the offering

     26,667         0.1     400,000         0.1   $ 15.00   

New investors

     12,000,000         31.7     180,000,000         31.7   $ 15.00   
  

 

 

    

 

 

   

 

 

    

 

 

   

Total

     37,899,318         100.0     568,489,767         100.0  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

The table above assumes no exercise of the underwriters’ over-allotment option. If the underwriters exercise their option to purchase up to 1,800,000 additional shares of common stock in full, the following will occur:

 

   

the number of shares of common stock purchased by new investors participating in this offering will increase to 13,800,000, or approximately 34.8% of the total number of shares of common stock outstanding; and

 

   

the immediate dilution experienced by new investors participating in this offering will be $0.78 per share and the pro forma net tangible book value per share will be $14.22 per share.

 

The number of common shares outstanding on a pro forma as adjusted basis above excludes:

 

   

1,800,000 shares of common stock issuable upon the exercise in full of the underwriters’ option to cover over-allotments;

 

   

2,247,292 shares of common stock available for future issuance under our 2015 Equity Incentive Plan; and

 

   

15,530,939 shares of common stock that may be issued, at our option upon exchanged common units in our operating partnership.

 

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SELECTED CONSOLIDATED HISTORICAL FINANCIAL DATA OF OUR PREDECESSOR

 

The following table sets forth selected consolidated historical financial data and other operating data of our predecessor as of the dates and for the periods presented. We have not presented historical information for Easterly Government Properties, Inc. because it has not had any activity since its formation on October 9, 2014, other than the issuance of 1,000 shares of its common stock as part of its initial capitalization and activity in connection with our formation transactions, this offering and the concurrent private placement, and because we believe that a presentation of the results of Easterly Government Properties, Inc. would not be meaningful.

 

The term “our predecessor” refers to the consolidation of Easterly Partners, LLC and its subsidiaries, including the Easterly Funds and the management entities.

 

The selected consolidated historical financial information as of September 30, 2014 and for the nine months ended September 30, 2014 and 2013 has been derived from our predecessor’s unaudited consolidated financial statements included elsewhere in this prospectus. The selected consolidated historical financial information as of December 31, 2013 and 2012 and for the years ended December 31, 2013 and 2012 has been derived from our predecessor’s audited consolidated financial statements included elsewhere in this prospectus.

 

The Easterly Funds use investment company accounting and, accordingly, account for their investments based on fair value. For further information, see Note 1 in the “Unaudited Pro Forma Consolidated Financial Statements” appearing elsewhere in this prospectus. Going forward we will account for the properties owned by the Easterly Funds using historical cost accounting instead of investment company accounting. Moving from investment company accounting to historical cost accounting will result in significant changes in the presentation of our consolidated financial statements following the formation transactions. Our future financial condition and results of operations will differ significantly from, and will not be comparable with, the historical financial position and results of operations of our predecessor.

 

Since the information presented below is only a summary and does not provide all of the information contained in the historical consolidated financial statements of our predecessor, including the related notes, you should read the following in conjunction with the information contained in “Structure and Formation of Our Company,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the consolidated financial statements and unaudited pro forma condensed consolidated financial statements and related notes thereto appearing elsewhere in this prospectus.

 

     Predecessor Historical  
     Nine Months  Ended
September 30,
    Year Ended
December  31,
 
     2014     2013     2013     2012  
     (amounts in thousands)  

Statement of Operations Data:

        

Income

        

Income from real estate investments

   $ 4,601      $ 2,814      $ 4,006      $ 1,785   

Other income

     —          —          —          202   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total income

     4,601        2,814        4,006        1,987   
  

 

 

   

 

 

   

 

 

   

 

 

 

Expenses

        

Fund general and administrative

     714        1,037        1,299        518   

Corporate general and administrative

     4,586        3,049        4,281        2,663   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total expenses

     5,300        4,086        5,580        3,181   

Net investment gain/loss

     (699     (1,272     (1,574     (1,194

Net unrealized gain on investments

     71,865        15,693        27,641        10,841   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net increase in capital resulting from operations

   $ 71,166      $ 14,421      $ 26,067      $ 9,647   

Capital attributable to non-controlling interests

     75,830        17,492        30,381        12,290   
  

 

 

   

 

 

   

 

 

   

 

 

 

Capital attributable to Easterly Partners, LLC

   $ (4,664   $ (3,071   $ (4,314   $ (2,643
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents
     Predecessor Historical  
     Nine  Months
Ended

September 30,
2014
     Year Ended
December  31,
 
        2013      2012  
     (amounts in thousands)  

Statement of Assets, Liabilities and Capital Data (As of End of Period)

        

Real estate investments, at fair value

   $ 271,377       $ 173,099       $ 102,753   

Cash and cash equivalents

     33,057         3,363         720   

Total assets

     305,314         177,902         103,871   

Total liabilities

     2,901         1,218         443   

Total capital

     302,413         176,684         103,428   

 

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UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL DATA

 

The following discussion sets forth the unaudited pro forma condensed consolidated balance sheet as of September 30, 2014 and the unaudited pro forma condensed consolidated statements of operations for the nine months ended September 30, 2014 and for the year ended December 31, 2013 for Easterly Government Properties, Inc. (together with its consolidated subsidiaries, the “company,” “we,” “our” or “us”). The term “our predecessor” refers to Easterly Partners, LLC and its consolidated subsidiaries, including the Easterly Funds and the management entities.

 

We have not had any operating activities since our formation on October 9, 2014. Easterly Government Properties LP, which we refer to as our operating partnership, was formed as a Delaware limited partnership on October 10, 2014. Upon the completion of this offering, the formation transactions and the concurrent private placement, as defined below, substantially all of our assets will be held by, and substantially all of our operations will be conducted through, our operating partnership, either directly or through its subsidiaries, and we will be the sole general partner of our operating partnership. At such time, we will own 59.0% of, and will have control of, our operating partnership. Accordingly, the company will consolidate the assets, liabilities and results of operations of the operating partnership and its subsidiaries.

 

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The pro forma condensed consolidated balance sheet and the pro forma condensed consolidated statements of operations reflect:

 

      Pro Forma  Condensed
Consolidated
Balance Sheet Column
   Pro Forma Condensed
Consolidated Statement
of Operations Column

•   the financial statements of Easterly Government Properties, Inc., reflecting the formation and capitalization of the company;

   A    AA

•   the financial results of our predecessor;

   B    BB

•   the sale of one property owned by the Easterly Funds and included in our predecessor, which was sold prior to the completion of this offering;

   C    CC

•   the formation transactions, which include

     

•the contribution of the Easterly Funds’ interest in the subsidiaries that own 15 properties, which we refer to as the Easterly properties, and the contribution of the management entities to our operating partnership in exchange for an aggregate of 3,308,000 shares of common stock and 9,771,120 common units in our operating partnership, which results in the cessation of investment company accounting used by our predecessor, which we refer to as the Easterly formation transactions,

   D, H    DD, HH

•the contribution of 14 properties from Western Devcon, which we refer to as Western Devcon properties, for 5,759,819 common units in our operating partnership, which we refer to as, collectively with the Easterly formation transactions, the formation transactions;

   E, H    EE, HH

•   the closing of our $400.0 million new senior unsecured revolving credit facility upon completion of this offering; and

   F    FF

•   the completion of this offering and the concurrent private placement, and the use of proceeds therefrom.

   G, H    GG, HH

 

In addition, these condensed consolidated pro forma financial statements reflect the impact of the above adjustments on pro forma earnings per share as depicted in adjustment (II).

 

Our unaudited pro forma condensed consolidated financial statements do not purport to (1) represent our financial position had the formation transactions and the concurrent private placement, the closing of the new senior unsecured revolving credit facility, the completion of this offering and the use of proceeds therefrom occurred on September 30, 2014, (2) represent our results of operations that would have actually occurred had the formation transactions, the concurrent private placement, the closing of the new senior unsecured revolving credit facility, the completion of this offering and the use of proceeds therefrom occurred on January 1, 2013 or (3) project our financial position or results of operations as of any future date or for any future period, as applicable.

 

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Easterly Government Properties, Inc.

Unaudited Pro Forma Condensed Consolidated Balance Sheet

As of September 30, 2014

(Amounts in thousands except share and per share data)

 

    Easterly
Government
Properties,
Inc.
    Easterly
Partners,
LLC
    Sale of
Property
    Cessation of
Investment
Company
Accounting
    Western
Devcon
Acquisition
    Company
Pro Forma
Prior to
Offering
    Credit
Facility
    The
Offering
and
Concurrent
Private
Placement
    Other
Adjustments
    Company
Pro Forma
 
    (A)     (B)     (C)     (D)     (E)           (F)     (G)     (H)        

Assets

                   

Real estate properties:

                   

Land

  $       —      $       —      $       —      $ 43,809      $ 35,571      $ 79,380      $       —      $       —      $       —      $ 79,380   

Buildings and improvements

                         409,327        106,922        516,249                             516,249   

Tenant improvements

                         26,337        3,070        29,407                             29,407   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
                         479,473        145,563        625,036                             625,036   

Less: accumulated depreciation

                                                                     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Real estate properties, net

                         479,473        145,563        625,036                             625,036   

Real estate investments, at fair value

           271,377        (516     (270,861                                          

Cash and cash equivalents

    1        33,057        516        5,420               38,994        32,016        (57,348            13,662   

Restricted cash

                         1,878               1,878                             1,878   

Accounts receivable

                         5,583               5,583                             5,583   

Intangible assets

                         74,487        31,277        105,764                             105,764   

Prepaid expenses and other assets

           880               653               1,533        3,401        (339            4,595   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

  $ 1      $ 305,314      $      $ 296,633      $ 176,840      $ 778,788      $ 35,417      $ (57,687   $      $ 756,518   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

Easterly Government Properties, Inc.

Unaudited Pro Forma Condensed Consolidated Balance Sheet (continued)

As of September 30, 2014

(Amounts in thousands except share and per share data)

 

    Easterly
Government
Properties,
Inc.
    Easterly
Partners,
LLC
    Sale of
Property
    Cessation of
Investment
Company
Accounting
    Western
Devcon
Acquisition
    Company
Pro Forma
Prior to
Offering
    Credit
Facility
    The
Offering
and
Concurrent
Private
Placement
    Other
Adjustments
    Company
Pro Forma
 
    (A)     (B)     (C)     (D)     (E)           (F)     (G)     (H)        

Liabilities and Stockholders’ Equity

                   

Liabilities:

                   

Mortgage notes payable

  $      $      $      $ 260,335      $ 89,463      $ 349,798      $       —      $ (280,421   $       —      $ 69,377   

Accounts payable and accrued liabilities

           2,901               4,371        756        8,028               (1,416            6,612   

Revolving credit facility

                                              35,417                      35,417   

Interest rate swap liabilities

                         2,376               2,376               (2,376              

Intangible liabilities

                         29,546        980        30,526                             30,526   

Other liabilities

                         5               5                             5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

           2,901               296,633        91,199        390,733        35,417        (284,213            141,937   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Stockholders’ equity:

                   

Common stock

                         33               33               191               224   

Additional paid-in capital

    1                      29,139               29,140               239,051        102,265        370,456   

Retained earnings (deficit)

                                (756     (756            (12,716     5,521        (7,951

Predecessor capital

           4,612               (4,612                                          

Non-controlling interest in predecessor

           297,801               (297,801                                          

Non-controlling interest in operating partnership

                         273,241        86,397        359,638                      (107,786     251,852   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total stockholders’ equity

    1        302,413                      85,641        388,055               226,526               614,581   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities and stockholders’ equity

  $ 1      $ 305,314      $      $ 296,633      $ 176,840      $ 778,788      $ 35,417      $ (57,687   $      $ 756,518   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Easterly Government Properties, Inc.

Unaudited Pro Forma Condensed Consolidated Statement of Operations

For the Nine Months Ended September 30, 2014

(Amounts in thousands except share and per share data)

 

    Easterly
Government
Properties,
Inc.
    Easterly
Partners,
LLC
    Sale of
Property
    Cessation
of
Investment
Company
Accounting
    Western
Devcon
Acquisition
    Company
Pro
Forma
Prior to
Offering
    Credit
Facility
    The
Offering
and
Concurrent
Private
Placement
    Other
Adjustments
    Company
Pro Forma
 
    (AA)     (BB)     (CC)     (DD)     (EE)           (FF)     (GG)     (HH)     (II)  

Revenues

                   

Income from real estate investments

  $      $ 4,601      $ (10   $ (4,591   $     —      $     —      $     —      $     —      $     —      $     —   

Rental income

                         36,124        13,436        49,560                             49,560   

Tenant reimbursements

                         3,051        855        3,906                             3,906   

Other income

                         91        1        92                             92