LEASES (UNITED DOMINION REALTY, L.P.)

9 Months Ended

Sep. 30, 2020

Entity information

LEASES

6. LEASES

Lessee - Ground Leases

UDR owns six communities that are subject to ground leases, under which UDR is the lessee, expiring between 2043 and 2103, inclusive of extension options we are reasonably certain will be exercised. All of these leases are classified as operating leases through the lease term expiration based on our election of the practical expedient provided by the leasing standard. Rental expense for lease payments related to operating leases is recognized on a straight-line basis over the remaining lease term. We currently do not hold any finance leases. The Company also elected the short-term lease exception provided by the leasing standard and therefore only recognizes right-of-use assets and lease liabilities for leases with a term greater than one year. No leases qualified for the short-term lease exception during the three and nine months ended September 30, 2020 and 2019.

As of September 30, 2020, the Operating lease right-of-use assets was $201.8 million and the Operating lease liabilities was $196.3 million on our Consolidated Balance Sheet related to our ground leases. The value of the Operating lease right-of-use assets exceeds the value of the Operating lease liabilities due to prepaid lease payments and intangible assets for ground leases acquired in the purchase of real estate. The calculation of these amounts includes minimum lease payments over the remaining lease term (described further in the table below). Variable lease payments are excluded from the right-of-use assets and lease liabilities and are recognized in earnings in the period in which the obligation for those payments is incurred.

As the discount rate implicit in the leases was not readily determinable, we determined the discount rate for these leases utilizing the Company’s incremental borrowing rate at a portfolio level, adjusted for the remaining lease term, and the form of underlying collateral.

The weighted average remaining lease term for these leases was 44.1 years at September 30, 2020 and the weighted average discount rate was 5.0% at September 30, 2020.

Future minimum lease payments and total operating lease liabilities from our ground leases as of September 30, 2020 are as follows (dollars in thousands):

	Ground Leases
2020	$	3,109
2021		12,442
2022		12,442
2023		12,442
2024		12,442
Thereafter		455,221
Total future minimum lease payments (undiscounted)		508,098
Difference between future undiscounted cash flows and discounted cash flows		(311,752)
Total operating lease liabilities (discounted)	$	196,346

For purposes of recognizing our ground lease contracts, the Company uses the minimum lease payments, if stated in the agreement. For ground lease agreements where there is a rent reset provision based on a change in an index or a rate (i.e., changes in fair market rental rates or changes in the consumer price index) but that does not include a specified minimum lease payment, the Company uses the current rent over the remainder of the lease term. If there is a contingency upon which some or all of the variable lease payments that will be paid over the remainder of the lease term are based, which is resolved such that those payments now meet the definition of lease payments, the Company will remeasure the right-of-use asset and lease liability on the reset date.

The components of operating lease expenses were as follows (dollars in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2020		2019		2020		2019
Lease expense:
Contractual lease expense	$	3,217	$	1,954	$	9,603	$	6,232
Variable lease expense (a)		33		187		120		469
Total operating lease expense (b)(c)	$	3,250	$	2,141	$	9,723	$	6,701

(a) Variable lease expense includes adjustments such as changes in the consumer price index and payments based on a percentage of income of the lessee.

(b) Lease expense is reported within the line item Other operating expenses on the Consolidated Statements of Operations.

(c) For the nine months ended September 30, 2020, Operating lease right-of-use assets and Operating lease liabilities amortized by $2.5 million and $2.2 million, respectively, and for the nine months ended September 30, 2019 Operating lease right-of-use assets and Operating lease liabilities amortized by $0.6 million and $0.3 million, respectively. Due to the net impact of the amortization, the Company recorded $0.1 million and $0.1 million of total operating lease expense during the three months ended September 30, 2020 and 2019, respectively, and $0.3 million and $0.3 million of total operating lease expense during the nine months ended September 30, 2020 and 2019, respectively. 

Lessor - Apartment Home, Retail and Commercial Space Leases

UDR’s communities and retail and commercial space are leased to tenants under operating leases. As of September 30, 2020, our apartment home leases generally have initial terms of 12 months or less and represent approximately 97.5% of our total lease revenue. As of September 30, 2020, our retail and commercial space leases

generally have initial terms of between 5 and 15 years and represent approximately 2.5% of our total lease revenue. Our apartment home leases are generally renewable at the end of the lease term, subject to potential increases in rental rates, and our retail and commercial space leases generally have renewal options, subject to associated increases in rental rates due to market based or fixed price renewal options and certain other conditions. (See Note 14, Reportable Segments for further discussion around our major revenue streams and disaggregation of our revenue.)

Future minimum lease payments from our retail and commercial leases as of September 30, 2020 are as follows (dollars in thousands):

	Retail and Commercial Leases
2020	$	5,275
2021		22,533
2022		20,692
2023		19,257
2024		17,528
Thereafter		81,856
Total future minimum lease payments (a)	$	167,141

(a)We have excluded our apartment home leases from this table as our apartment home leases generally have initial terms of 12 months or less.

Certain of our leases with retail and commercial tenants provide for the payment by the lessee of additional variable rent based on a percentage of the tenant’s revenue. The amounts shown in the table above do not include these variable percentage rents. The Company recorded variable percentage rents of less than $0.1 million and $0.1 million for the three months ended September 30, 2020 and 2019, respectively, and $0.1 million and $0.3 million during the nine months ended September 30, 2020 and 2019, respectively.

United Dominion Realty L.P.

Entity information

LEASES

5. LEASES

Lessee - Ground and Equipment Leases

The Operating Partnership owns six communities that are subject to ground leases, under which the Operating Partnership is the lessee, expiring between 2043 and 2103, inclusive of extension options we are reasonably certain will be exercised. All of these leases are classified as operating leases through the lease term expiration based on our election of the practical expedient provided by the leasing standard. Rental expense for lease payments related to operating leases is recognized on a straight-line basis over the remaining lease term. In addition, the Operating Partnership leases equipment at six communities from the General Partner, pursuant to leases that expire in 2030. We currently do not hold any finance leases. The Operating Partnership also elected the short-term lease exception provided by the leasing standard and therefore only recognizes right-of-use assets and lease liabilities for leases with a term greater than one year. No leases qualified for the short-term lease exception during the nine months ended September 30, 2020 and 2019.

As of September 30, 2020, the Operating lease right-of-use assets was $203.2 million and the Operating lease liabilities was $197.8 million on our Consolidated Balance Sheets related to our ground and equipment leases. The value of the Operating lease right-of-use assets exceeds the value of the Operating lease liabilities due to prepaid lease payments and intangible assets for ground leases acquired in the purchase of real estate. The calculation of these amounts includes minimum lease payments over the remaining lease term (described further in the table below).

Variable lease payments are excluded from the right-of-use assets and lease liabilities and are recognized in earnings in the period in which the obligation for those payments is incurred.

As the discount rate implicit in the leases was not readily determinable, we determined the discount rate for these leases utilizing the Operating Partnership’s incremental borrowing rate at a portfolio level, adjusted for the remaining lease term, and the form of underlying collateral.

The weighted average remaining lease term for these leases was 43.9 years at September 30, 2020 and the weighted average discount rate was 5.0% at September 30, 2020.

Future minimum lease payments and total operating lease liabilities from our ground and equipment leases as of September 30, 2020 are as follows (dollars in thousands):

	Ground Leases		Equipment Leases		Total
2020	$	3,109	$	41	$	3,150
2021		12,442		164		12,606
2022		12,442		167		12,609
2023		12,442		171		12,613
2024		12,442		174		12,616
Thereafter		455,221		901		456,122
Total future minimum lease payments (undiscounted)		508,098		1,618		509,716
Difference between future undiscounted cash flows and discounted cash flows		(311,752)		(193)		(311,945)
Total operating lease liabilities (discounted)	$	196,346	$	1,425	$	197,771

For purposes of recognizing our ground lease contracts, the Operating Partnership uses the minimum lease payments, if stated in the agreement. For ground lease agreements where there is a rent reset provision based on a change in an index or a rate (i.e., changes in fair market rental rates or changes in the consumer price index) but that does not include a specified minimum lease payment, the Operating Partnership uses the current rent over the remainder of the lease term. If there is a contingency, upon which some or all of the variable lease payments that will be paid over the remainder of the lease term are based, which is resolved such that those payments now meet the definition of lease payments, the Operating Partnership will remeasure the right-of-use asset and lease liability on the reset date.

The components of operating lease expenses from our ground and equipment leases were as follows (dollars in thousands):

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2020		2019		2020		2019
Ground lease expense:
Contractual ground lease rent expense	$	3,217	$	1,954	$	9,603	$	6,232
Variable ground lease expense (a)		33		187		120		469
Total ground lease expense (b)		3,250		2,141		9,723		6,701
Contractual equipment lease expense (b)		39		-		113		-
Total operating lease expense (c)	$	3,289	$	2,141	$	9,836	$	6,701

(a) Variable ground lease expense includes adjustments such as changes in the consumer price index and payments based on a percentage of income of the lessee.

(b) Ground lease and equipment lease expense are reported within the line item Other operating expenses on the Consolidated Statements of Operations.

(c) For the nine months ended September 30, 2020, Operating lease right-of-use assets and Operating lease liabilities amortized by $2.5 million and $2.2 million, respectively. Due to the net impact of the amortization, the Operating Partnership recorded $0.1 million and $0.1 million of total operating lease expense during the three months ended September 30, 2020 and 2019, respectively, and $0.3 million and $0.3 million of total operating lease expense during the nine months ended September 30, 2020 and 2019, respectively. 

Lessor - Apartment Home and Retail and Commercial Leases

The Operating Partnership’s communities and retail and commercial space are leased to tenants under operating leases. As of September 30, 2020, our apartment home leases generally have initial terms of 12 months or less and represent 98.0% of our total lease revenue. As of September 30, 2020, our retail and commercial space leases generally have initial terms between 5 and 15 years and represent approximately 2.0% of our total lease revenue. Our apartment home leases are generally renewable at the end of the lease term, subject to potential increases in rental rates, and our retail and commercial space leases generally have renewal options, subject to associated increases in rental rates and certain other conditions. (See Note 12, Reportable Segments for further discussion around our major revenue streams and disaggregation of our revenue.)

Future minimum lease payments from our retail and commercial leases as of September 30, 2020 are as follows (dollars in thousands):

	Retail and Commercial Leases
2020	$	1,747
2021		6,993
2022		6,365
2023		6,068
2024		5,358
Thereafter		14,047
Total future minimum lease payments (a)	$	40,578

(a) We have excluded our apartment home leases from this table as our apartment home leases generally have initial terms of 12 months of less.

Certain of our leases with retail and commercial tenants provide for the payment by the lessee of additional variable rent based on a percentage of the tenant’s revenue. The amounts shown in the table above do not include these variable percentage rents. The Operating Partnership recorded variable percentage rents of zero and less than $0.1 million during the three months ended September 30, 2020 and 2019, respectively, and less than $0.1 million during both of the nine months ended September 30, 2020 and 2019.