Easterly Government Properties, Inc. (DEA) FY 2022 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion of our results of operations and financial condition in conjunction with the audited consolidated financial statements and related notes thereto as of December 31, 2022 and 2021 and for the years ended December 31, 2022, 2021 and 2020 and the sections entitled “Risk Factors,” “Forward Looking Statements,” “Business,” and “Properties” contained elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. The forward-looking statements are not historical facts, but rather are based on current expectations, estimates, assumptions and projections about our industry, business and future financial results. Our actual results could differ materially from the results contemplated by these forward-looking statements due to a number of factors, including those discussed in the sections of this Annual Report on Form 10-K entitled “Risk Factors” and “Forward Looking Statements.”
Overview
References 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 herein as our operating partnership. We present certain financial information and metrics “at Easterly Share,” which is calculated on an entity-by-entity basis. “At Easterly Share” information, which we also refer to as being “at share,” “pro rata,” “our pro rata share” or “our share” is not, and is not intended to be, a presentation in accordance with accounting principles generally accepted in the United States of America (“GAAP”).
We are an internally managed 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 properties to such agencies, either directly or through the U.S. General Services Administration, which we refer to herein as the GSA. Our objective is to generate attractive risk-adjusted returns for our stockholders over the long term through dividends and capital appreciation.
We focus on acquiring, developing and managing U.S. Government-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 tenant agency to meet its needs and objectives. As of December 31, 2022, we wholly owned 78 operating properties and eight operating properties through an unconsolidated joint venture (the “JV”) in the United States encompassing approximately 8.7 million leased square feet (8.2 million pro rata), including 85 operating properties that were leased primarily to U.S. Government tenant agencies and one operating property that was entirely leased to a private tenant. As of December 31, 2022, our operating properties were 99% leased. For purposes of calculating percentage leased, we exclude from the denominator total square feet that was unleased and to which we attributed no value at the time of acquisition. In addition, we wholly owned one property under development that we expect will encompass approximately 0.2 million leased square feet upon completion.
Our operating partnership holds substantially all of our assets and conducts substantially all of our business. We are the sole general partner of our operating partnership and owned approximately 88.3% of the aggregate limited partnership interests in our operating partnership, which we refer to herein as common units, as of December 31, 2022. We have elected to be taxed as a REIT and believe that we have operated and have been organized in conformity with the requirements for qualification and taxation as a REIT for U.S. federal income tax purposes commencing with our taxable year ended December 31, 2015.
Acquisitions
On May 10, 2022, we acquired a 161,730 leased square foot National Archives and Record Administration (“NARA”) federal records center in Broomfield, Colorado. The building is a build-to-suit warehouse completed in 2012. The facility is leased to the GSA for beneficial use of the NARA with a lease expiration of May 2032.
40
On May 18, 2022, we acquired a 138,000 leased square foot Federal Bureau of Investigation (“FBI”) field office in Tampa, Florida. The building is a build-to suit property completed in 2005. The facility is leased to the GSA for beneficial use of the FBI with a lease expiration of November 2040.
On August 23, 2022, we acquired a 28,900 leased square foot Judiciary of the U.S. District ("JUD") courthouse in Council Bluffs, Iowa. The building is a build-to-suit facility completed in 2021. The facility is leased to the GSA for beneficial use of the JUD with a lease expiration of December 2041.
Dispositions
On October 12, 2022, we entered into a second amended purchase and sale agreement with a third party to dispose of a portfolio of ten properties totaling approximately 668,000 leased square feet (the “Disposition Portfolio Properties”). We completed the sale of nine of the Disposition Portfolio Properties on October 27, 2022, including: DHA – Aurora, HRSA – Baton Rouge, VA – Baton Rouge, FDA – College Park, MEPCOM – Jacksonville, DOE – Lakewood, ICE – Pittsburgh, OSHA – Sandy, and CBP – Sunburst. On December 28, 2022, we closed on DOI – Billings, the last of the Disposition Portfolio Properties. Net proceeds from the sale of the Disposition Portfolio Properties were approximately $202.4 million and we recognized a gain on the sale of the Disposition Portfolio Properties of approximately $13.6 million for the year ended December 31, 2022.
Investment in unconsolidated real estate venture
On October 13, 2021, we formed the JV with a global investor to fund the acquisition of a portfolio of ten properties anticipated to encompass 1,214,165 leased square feet (the “Portfolio Acquisition”). We own a 53.0% interest in the JV, subject to preferred allocations as provided in the JV agreement. During 2021, the JV closed on four of the ten properties included in the Portfolio Acquisition.
On April 1, 2022, the JV acquired a 77,128 square foot Veterans Affairs (“VA”) outpatient facility located in Birmingham, Alabama. The building is a build-to-suit property that was completed during 2021. The outpatient facility is leased to the VA and has a lease expiration of October 2041.
On May 20, 2022, the JV acquired a 76,882 square foot VA outpatient facility located in Marietta, Georgia. The building is a build-to-suit property that was completed during 2021. The outpatient facility is leased to the VA and has a lease expiration of December 2041.
On July 14, 2022, the JV acquired a 67,793 square foot VA outpatient facility located in Columbus, Georgia. The building is a build-to-suit property that was completed during 2022. The outpatient facility is leased to the VA and has a lease expiration of January 2042.
On November 22, 2022, the JV acquired a 257,294 square foot VA outpatient facility located in Phoenix, Arizona. The building is a build-to-suit property that was completed during 2022. The outpatient facility is leased to the VA and has a lease expiration of February 2042.
We expect the JV to close on the two remaining properties in the Portfolio Acquisition during 2023.
41
Results of Operations
Comparison of Results of Operations for the Years Ended December 31, 2022 and December 31, 2021
The financial information presented below summarizes the results of operations of our company for the years ended December 31, 2022 and 2021.
| For the years ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (Amounts in thousands) | 2022 | 2021 | Change | |||||||||
| Revenues | ||||||||||||
| Rental income | $ | 284,488 | $ | 267,389 | $ | 17,099 | ||||||
| Tenant reimbursements | 5,920 | 5,187 | 733 | |||||||||
| Asset management income | 1,409 | 136 | 1,273 | |||||||||
| Other income | 1,789 | 2,148 | (359 | ) | ||||||||
| Total revenues | 293,606 | 274,860 | 18,746 | |||||||||
| Expenses | ||||||||||||
| Property operating | 66,781 | 56,693 | 10,088 | |||||||||
| Real estate taxes | 30,900 | 30,429 | 471 | |||||||||
| Depreciation and amortization | 98,254 | 91,266 | 6,988 | |||||||||
| Acquisition costs | 1,370 | 1,939 | (569 | ) | ||||||||
| Corporate general and administrative | 24,785 | 23,522 | 1,263 | |||||||||
| Total expenses | 222,090 | 203,849 | 18,241 | |||||||||
| Other income (expense) | ||||||||||||
| Income from unconsolidated real estate venture | 3,374 | 271 | 3,103 | |||||||||
| Interest expense, net | (47,378 | ) | (38,632 | ) | (8,746 | ) | ||||||
| Gain on the sale of operating properties | 13,590 | 1,307 | 12,283 | |||||||||
| Impairment loss | (5,540 | ) | — | (5,540 | ) | |||||||
| Net income | $ | 35,562 | $ | 33,957 | $ | 1,605 |
Revenues
Total revenues increased $18.7 million to $293.6 million for the year ended December 31, 2022 compared to $274.9 million for the year ended December 31, 2021.
The $17.1 million increase in Rental income is primarily attributable to an increase in revenues from the three operating properties acquired since December 31, 2021, favorable lease renewals and a full period of operations from the eight operating properties acquired during the year ended December 31, 2021, offset by a decrease in revenues attributable to the disposal of ten operating properties since December 31, 2021 and the disposal of two operating properties during the year ended December 31, 2021.
The $0.7 million increase in Tenant reimbursements is primarily attributable to an increase in tenant project reimbursements.
The $1.3 million increase in Asset management income is attributable to the fee earned by us for asset management of the JV from the four properties acquired since December 31, 2021 and a full period of operations from the four properties acquired during the year ended December 31, 2021.
The $0.4 million decrease in Other income is primarily attributable to a decrease in parking and interest income.
Expenses
Total expenses increased by $18.2 million to $222.1 million for the year ended December 31, 2022 compared to $203.8 million for the year ended December 31, 2021.
The $10.1 million increase in Property operating expenses is primarily attributable to an increase in property operating expenses associated with the three operating properties acquired since December 31, 2021 and a full period of operations from the eight operating properties acquired during the year ended December 31, 2021, offset by a decrease in expense attributable to the disposal of ten operating properties since December 31, 2021 and the disposal of two operating properties during the year ended December 31, 2021.
42
The $0.5 million increase in Real estate taxes is also primarily attributable to the three operating properties acquired since December 31, 2021 as well as a full period of operations from the eight operating properties acquired during the year ended December 31, 2021.
Additionally, the $7.0 million increase in Depreciation and amortization is primarily attributable to the three operating properties acquired since December 31, 2021, as well as a full period of operations from the eight operating properties acquired during the year ended December 31, 2021, offset by a decrease in amortization related to fully amortized lease intangibles.
The $1.3 million increase in Corporate and general administrative costs was primarily due to an increase in employee costs.
Income from unconsolidated real estate venture
On October 13, 2021, we formed the JV to fund the acquisition of a portfolio of ten properties in which we own a 53.0% interest. The $3.1 million increase in Income from unconsolidated real estate venture is attributable to our pro rata share of operations from the four operating properties acquired by the JV since December 31, 2021 and a full period of operations from the four operating properties acquired by the JV during the year ended December 31, 2021.
Interest expense, net
Interest expense, net increased by $8.7 million to $47.4 million for the year ended December 31, 2022 compared to $38.6 million for the year ended December 31, 2021. The increase is primarily related to issuances of $250.0 million of outstanding fixed rate, senior unsecured notes in 2021.
Gain on the sale of operating properties
Gain on the sale of operating properties increased by $12.3 million to a $13.6 million gain for the year ended December 31, 2022 compared to a $1.3 million gain for the year ended December 31, 2021. The gain on the sale of operating properties in 2021 of $1.3 million was due to the sale of SSA – Mission Viejo in the second quarter of 2021 and United Technologies – Midland in the third quarter of 2021. Gain on the sale of operating properties in 2022 of $13.6 million was due to the sale of the Portfolio Disposition Properties in the fourth quarter of 2022.
Impairment loss
In the third quarter of 2022, we recognized an impairment loss totaling approximately $5.5 million for our ICE – Otay property and reduced its carrying value to its estimated fair value, which declined due to the changes in expected cash flows related to the existing tenant's lease expiration in 2022. ICE – Otay is a 47,919 rentable square foot office building located in San Diego, California.
Comparison of Results of Operations for the Years Ended December 31, 2021 and December 31, 2020
Information pertaining to fiscal year 2020 was included in our Annual Report on Form 10-K for the year ended December 31, 2021 on page 37 under Part II, Item 7, “Management’s Discussion and Analysis of Financial Position and Results of Operations”, which was filed with the Securities and Exchange Commission, or SEC, on February 28, 2022.
Liquidity and Capital Resources
We anticipate that our cash flows from the sources listed below will provide adequate capital for the next 12 months for all anticipated uses, including all scheduled principal and interest payments on our outstanding indebtedness, current and anticipated tenant improvements, planned and possible acquisitions of properties, including the remaining Portfolio Acquisition properties through the JV, stockholder distributions to maintain our qualification as a REIT and other capital obligations associated with conducting our business. At December 31, 2022, we had approximately $17.3 million available in cash and cash equivalents and there was approximately $384.4 million available under our revolving credit facility.
Our primary expected sources of capital are as follows:
•
cash and cash equivalents;
•
operating cash flow;
•
distribution of cash flows from the JV;
43
•
available borrowings under our revolving credit facility;
•
issuance of long-term debt;
•
issuance of equity, including under our ATM Programs (as described below); and
•
asset sales.
Our short-term liquidity requirements consist primarily of funds to pay for the following:
•
development and redevelopment activities, including major redevelopment, renovation or expansion programs at individual properties;
•
property acquisitions under contract, including our JV share of the remaining Portfolio Acquisition properties;
•
tenant improvements allowances and leasing costs;
•
recurring maintenance and capital expenditures;
•
debt repayment requirements;
•
corporate and administrative costs;
•
interest payments on our outstanding indebtedness;
•
interest swap payments;
•
distribution payments; and
•
repurchases of common stock under our share repurchase program.
Our long-term liquidity needs, in addition to recurring short-term liquidity needs as discussed above, consist primarily of funds necessary to pay for acquisitions, non-recurring capital expenditures, and scheduled debt maturities. Although we may be able to anticipate and plan for certain of our liquidity needs, unexpected increases in uses of cash that are beyond our control and which affect our financial condition and results of operations may arise, or our sources of liquidity may be fewer than, and the funds available from such sources may be less than, anticipated or required. As of the date of this filing, there were no known commitments or events that would have a material impact on our liquidity.
Equity
Shelf Registration Statement on Form S-3
On February 25, 2021, we filed an automatic universal shelf registration statement on Form S-3 with the SEC, which was deemed automatically effective and which provides for the registration of unspecified amounts of securities. However, there can be no assurance that we will be able to complete any such offerings of securities in the future.
Offering of Common Stock on a Forward Basis
On August 11, 2021, we and the operating partnership completed an underwritten public offering of 6,300,000 shares of common stock offered on a forward basis. In connection with the offering, we also entered into separate forward sale agreements with each of the forward purchasers (the “Forward Sales Agreements”), pursuant to which the forward purchasers borrowed and sold to the underwriters an aggregate of 6,300,000 shares of our common stock. On December 28, 2021, we issued 3,991,000 shares of our common stock for net proceeds of $85.0 million, which shares were issued in partial settlement of the Forward Sales Agreements entered into in connection with the underwritten public offering. No shares were issued during the year ended December 31, 2022. We expect to physically settle the remaining Forward Sales Agreements and receive proceeds, subject to certain adjustments, from the sale of those shares of common stock upon one or more such physical settlements. During the year ended December 31, 2022, we extended the date by which settlement of the Forward Sales Agreements will occur to August 14, 2023. Although we expect to settle the Forward Sales Agreements entirely by the physical delivery of shares of our common stock for cash proceeds, we may also elect to cash or net-share settle all or a portion of our obligations under the Forward Sales Agreements, in which case, we may receive, or may owe, cash or shares of our common stock from or to the forward purchasers. The Forward Sales Agreements provide for an initial forward price of $21.64 per share, subject to certain adjustments pursuant to the terms of each of the Forward Sales Agreements. The Forward Sales Agreements are subject to early termination or settlement under certain circumstances.
44
ATM Programs
We entered into separate equity distribution agreements on each of December 20, 2019 (the “2019 ATM Program”) and June 22, 2021 (the “2021 ATM Program” and, together with the 2019 ATM Program, the “ATM Programs”) with various financial institutions pursuant to which we may issue and sell shares of our common stock having an aggregate offering price of up to $300.0 million under each ATM Program from time to time in negotiated transactions or transactions that are deemed to be “at the market” offerings as defined in Rule 415 under the Securities Act. Under each of the ATM Programs, we may enter into one or more forward transactions (each, a “forward sale transaction”) under separate master forward sale confirmations and related supplemental confirmations with each of the various financial institutions party to the respective ATM Program for the sale of shares of our common stock on a forward basis.
The following table sets forth certain information with respect to issuances under the 2019 ATM Program in each fiscal quarter for the year ended December 31, 2022 (amounts in thousands except share amounts):
| ATM Program | |||||||
|---|---|---|---|---|---|---|---|
| For the Three Months Ended: | Number of Shares Issued(1) | Net Proceeds(1) | |||||
| March 31, 2022 | 434,925 | $ | 9,409 | ||||
| June 30, 2022 | — | — | |||||
| September 30, 2022 | — | — | |||||
| December 31, 2022 | — | — | |||||
| Total | 434,925 | $ | 9,409 |
(1)
Shares issued by us, which were all issued in settlement of forward sales transactions. Additionally, as of December 31, 2022 we had entered into forward sales transactions under the 2019 ATM Program for the sale of an additional 1,950,000 shares of our common stock that have not yet been settled. Subject to our right to elect net share settlement, we expect to physically settle the forward sales transactions by the maturity dates set forth in each applicable forward sale transaction placement notice, which dates range from June 2023 to January 2024. Assuming the forward sales transactions are physically settled in full utilizing a net weighted average initial forward sales price of $21.82 per share, we expect to receive net proceeds of approximately $42.6 million, after deducting offering costs, subject to adjustments in accordance with the applicable forward sale transaction. We accounted for the forward sale transactions as equity.
No sales of shares of our common stock were made under the 2021 ATM Program during the year ended December 31, 2022.
We used the net proceeds received from such sales for general corporate purposes. As of December 31, 2022, we had approximately $300.0 million of gross sales of our common stock available under the 2021 ATM Program and $87.4 million of gross sales of our common stock available under the 2019 ATM Program.
Share Repurchase Program
On April 28, 2022, our board of directors authorized a share repurchase program whereby we may repurchase up to 4,538,994 shares of our common stock, or approximately 5% of our outstanding shares as of the authorization date. We are not required to purchase shares under the share repurchase program, but may choose to do so in the open market or through privately negotiated transactions at times and amounts based on our evaluation of market conditions and other factors.
No repurchases of shares of our common stock were made under the share repurchase program during the year ended December 31, 2022.
Contribution of Property for Common Units
On May 10, 2022, we acquired NARA – Broomfield for which we issued, as partial consideration, 827,791 common units. The issuance of common units was effected in reliance upon an exemption from registration provided by Section 4(a)(2) under the Securities Act.
45
Debt
Indebtedness Outstanding
The following table sets forth certain information with respect to our outstanding indebtedness as of December 31, 2022 (dollars in thousands):
| Principal Outstanding | Interest | Current | ||||||
|---|---|---|---|---|---|---|---|---|
| Loan | December 31, 2022 | Rate (1) | Maturity | |||||
| Revolving credit facility: | ||||||||
| Revolving credit facility (2) | $ | 65,500 | S + 145bps | July 2025 (3) | ||||
| Total revolving credit facility | 65,500 | |||||||
| Term loan facilities: | ||||||||
| 2016 term loan facility | 100,000 | 2.82% (5) | March 2024 | |||||
| 2018 term loan facility (4) | 150,000 | 3.98% (6) | July 2026 | |||||
| Total term loan facilities | 250,000 | |||||||
| Less: Total unamortized deferred financing fees | (1,028 | ) | ||||||
| Total term loan facilities, net | 248,972 | |||||||
| Notes payable: | ||||||||
| 2017 series A senior notes | 95,000 | 4.05% | May 2027 | |||||
| 2017 series B senior notes | 50,000 | 4.15% | May 2029 | |||||
| 2017 series C senior notes | 30,000 | 4.30% | May 2032 | |||||
| 2019 series A senior notes | 85,000 | 3.73% | September 2029 | |||||
| 2019 series B senior notes | 100,000 | 3.83% | September 2031 | |||||
| 2019 series C senior notes | 90,000 | 3.98% | September 2034 | |||||
| 2021 series A senior notes | 50,000 | 2.62% | October 2028 | |||||
| 2021 series B senior notes | 200,000 | 2.89% | October 2030 | |||||
| Total notes payable | 700,000 | |||||||
| Less: Total unamortized deferred financing fees | (3,948 | ) | ||||||
| Total notes payable, net | 696,052 | |||||||
| Mortgage notes payable: | ||||||||
| DEA - Pleasanton | 15,700 | L + 150bps (7)(8) | October 2023 | |||||
| VA - Golden | 8,644 | 5.00% (7) | April 2024 | |||||
| USFS II - Albuquerque | 13,438 | 4.46% (7) | July 2026 | |||||
| ICE - Charleston | 13,441 | 4.21% (7) | January 2027 | |||||
| VA - Loma Linda | 127,500 | 3.59% (7) | July 2027 | |||||
| CBP - Savannah | 10,389 | 3.40% (7) | July 2033 | |||||
| USCIS - Kansas City | 51,500 | 3.68% (7) | August 2024 | |||||
| Total mortgage notes payable | 240,612 | |||||||
| Less: Total unamortized deferred financing fees | (1,405 | ) | ||||||
| Less: Total unamortized premium/discount | 1,640 | |||||||
| Total mortgage notes payable, net | 240,847 | |||||||
| Total debt | $ | 1,251,371 |
(1)
At December 31, 2022 the one-month SOFR (“S”) was 4.36% and the one-month LIBOR ("L") was 4.39%. The current interest rate is not adjusted to include the amortization of deferred financing fees or debt issuance costs incurred in obtaining debt or any unamortized fair market value premiums. The spread over the applicable rate for each of our revolving credit facility, our 2018 term loan facility and our 2016 term loan facility (each as defined below) is based on our consolidated leverage ratio, as set forth in the respective loan agreements.
(2)
Our revolving credit facility had available capacity of $384.4 million at December 31, 2022, with an accordion feature that permits us to request additional lender commitments for up to $250.0 million of additional capacity, subject to the satisfaction of customary terms and conditions.
(3)
Our revolving credit facility has two six-month as-of-right extension options subject to certain conditions and the payment of an extension fee.
(4)
Our 2018 term loan facility has undrawn capacity up to $50.0 million of which is available during a delayed draw period.
46
(5)
Entered into two interest rate swaps with an effective date of March 29, 2017 with an aggregate notional value of $100.0 million to effectively fix the interest rate at 2.82% annually, based on our consolidated leverage ratio, as defined in our 2016 term loan facility agreement. We transitioned the two interest rate swaps from LIBOR to SOFR effective November 29, 2022.
(6)
Entered into four interest rate swaps with an effective date of December 13, 2018 with an aggregate notional value of $150.0 million to effectively fix the interest rate at 3.98% annually, based on our consolidated leverage ratio, as defined in our 2018 term loan facility agreement. We transitioned the four interest rate swaps from LIBOR to SOFR effective December 23, 2022.
(7)
Effective interest rates are as follows: DEA – Pleasanton 1.80%, VA – Golden 5.03%, USFS II – Albuquerque 3.92%, ICE – Charleston 3.93%, VA – Loma Linda 3.78%, CBP – Savannah 4.12%, USCIS – Kansas City 2.05%.
(8)
On January 26, 2023, we used $15.7 million of available cash to extinguish the $15.7 million mortgage note obligation on DEA – Pleasanton.
On February 3, 2023, we entered three SOFR-based interest rate swaps each with a notional value of $100.0 million that were designated as cash flow hedges of interest rate risk. These interest rate swaps will become effective as our existing swaps mature in June and September 2023 and will mature in 2024 and 2025.
Our revolving credit facility, term loan facilities, notes payable, and mortgage notes payable are subject to ongoing compliance with a number of financial and other covenants. As of December 31, 2022, we were in compliance with all applicable financial covenants.
The chart below details our debt capital structure as of December 31, 2022 (dollars in thousands):
| Debt Capital Structure | December 31, 2022 | |||
|---|---|---|---|---|
| Total principal outstanding | $ | 1,256,112 | ||
| Weighted average maturity | 5.6 years | |||
| Weighted average interest rate | 3.7 | % | ||
| % Variable debt | 6.5 | % | ||
| % Fixed debt (1) | 93.5 | % | ||
| % Secured debt | 19.0 | % |
(1)
Our 2016 term loan facility and 2018 term loan facility are swapped to be fixed and as such are included as fixed rate debt in the table above
Senior Unsecured Credit Facility and 2016 Term Loan Facility
We are parties to a second amended and restated senior credit agreement, which provides for a senior unsecured credit facility with a total borrowing capacity of $650.0 million, consisting of two components: (i) a $450.0 million revolving credit facility, which we refer to as the revolving credit facility, and (ii) a $200.0 million term loan facility, which we refer to as the 2018 term loan facility, up to $50.0 million of which will be available for a delayed draw period. The revolving credit facility also includes 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. We also have a $100.0 million senior unsecured term loan facility, which we refer to as the 2016 term loan facility.
On July 22, 2022, we entered into the first amendment to our second amended and restated senior credit agreement, pursuant to which we extended the deadline for the $50.0 million delayed draw portion of the 2018 term loan facility to July 24, 2023 (from July 22, 2022).
On November 23, 2022, we entered into a second amendment to our second amended and restated senior credit agreement and on November 29, 2022, we entered into a fifth amendment to our senior unsecured term loan agreement (together, the “LIBOR-transition amendments”).
The LIBOR-transition amendments replaced the LIBOR-based floating interest rate option with a term SOFR-based floating interest rate option as a benchmark rate for borrowings denominated in U.S. dollars for all purposes under our revolving credit facility, our 2018 term loan facility and our 2016 term loan facility, including a credit spread adjustment of 0.10%. Other than the foregoing, the material terms of our revolving credit facility, our 2018 term loan facility and our 2016 term loan facility remain unchanged.
The LIBOR transition amendments relate to the replacement of the reference rate only in accordance with Accounting Standards Codification 848 - Reference Rate Reform. There were no other changes to the swaps or hedged interest payments including no change to principal/notional, maturity date, floor, prepayment feature, or any other change that impacts the timing or amount of cash flows.
47
See Note 5 to the Consolidated Financial Statements for additional information on our revolving credit facility, our 2018 term loan facility and our 2016 term loan facility.
Mortgage Note Payoffs
On October 27, 2022, we used $5.8 million of proceeds from the sale of the Disposition Portfolio Properties to extinguish the $5.8 million mortgage note obligation on MEPCOM – Jacksonville.
On January 26, 2023, we used $15.7 million of available cash to extinguish the $15.7 million mortgage note obligation on DEA – Pleasanton.
Material Cash Commitments
The following table shows our material cash commitments as of December 31, 2022:
| Payments due by period | |||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Total | 2023 | 2024 | 2025 | 2026 | 2027 | Thereafter | |||||||||||||||||||||
| Mortgage principal and interest | $ | 271,310 | $ | 29,144 | $ | 71,511 | $ | 10,319 | $ | 15,470 | $ | 138,367 | $ | 6,499 | |||||||||||||
| Revolving credit facility principal and interest | 77,312 | 4,611 | 4,611 | 68,090 | — | — | — | ||||||||||||||||||||
| Term loan facilities principal and interest | 275,087 | 8,889 | 106,746 | 6,052 | 153,400 | — | — | ||||||||||||||||||||
| Senior unsecured notes payable principal and interest | 891,406 | 24,885 | 24,885 | 24,885 | 24,885 | 117,579 | 674,287 | ||||||||||||||||||||
| Development property obligations (1) | 3,978 | 2,541 | 1,437 | — | — | — | — | ||||||||||||||||||||
| Total | $ | 1,519,093 | $ | 70,070 | $ | 209,190 | $ | 109,346 | $ | 193,755 | $ | 255,946 | $ | 680,786 |
(1)
Due to the long-term nature of certain construction and development contracts included in this line, the amounts reported in the table represent our estimate of the timing for the related obligations being paid.
Unconsolidated Real Estate Venture
We consolidate entities in which we have a controlling interest or are the primary beneficiary in a variable interest entity. From time to time, we may have off-balance sheet unconsolidated real estate ventures and other unconsolidated arrangements with varying structures.
As of December 31, 2022, our investment in the JV was $271.6 million. As of December 31, 2022, we committed capital, net of return of over committed capital, to the JV totaling $274.1 million and have a remaining capital commitment of $64.2 million. None of the properties owned by the JV are encumbered by mortgage indebtedness.
Portfolio Disposition
On October 27, 2022, we completed the sale of nine of the ten Disposition Portfolio Properties. Concurrent with closing, proceeds from the sale were used to extinguish the mortgage debt at MEPCOM – Jacksonville. On December 28, 2022, we closed on the final Disposition Portfolio Property, DOI – Billings. During the three months ended December 31, 2022, we used proceeds to pay down amounts outstanding under our revolving credit facility.
For a more complete description of the Disposition Portfolio Properties, see “Overview – Dispositions” above.
Dividend Policy
In order to qualify as a REIT, we are required to distribute to our stockholders, on an annual basis, at least 90% of our REIT taxable income, determined without regard to the deduction for dividends paid and excluding net capital gains. We anticipate distributing all of our taxable income. We expect to make quarterly distributions to our stockholders in a manner intended to satisfy this requirement. Prior to making any distributions for U.S. federal tax purposes or otherwise, we must first satisfy our operating and debt service obligations. It is possible that it would be necessary to utilize cash reserves, liquidate assets at unfavorable prices or incur
48
additional indebtedness in order to make required distributions. It is also possible that our board of directors could decide to make required distributions in part by using shares of our common stock.
A summary of dividends declared by the board of directors per share of common stock and per common unit of our operating partnership at the date of record is as follows:
| Quarter | Declaration Date | Record Date | Pay Date | Dividend | |||||
|---|---|---|---|---|---|---|---|---|---|
| Q1 2022 | April 27, 2022 | May 13, 2022 | May 25, 2022 | 0.265 | |||||
| Q2 2022 | July 27, 2022 | August 11, 2022 | August 23, 2022 | 0.265 | |||||
| Q3 2022 | October 26, 2022 | November 11, 2022 | November 23, 2022 | 0.265 | |||||
| Q4 2022 | February 22, 2023 | March 9, 2023 | March 21, 2023 | 0.265 |
We use long-term investment partnership units in our operating partnership, which we refer to herein as LTIP units, as a form of performance-based award and service-based award for annual long-term incentive equity compensation. LTIP units are convertible into common units upon the satisfaction of certain conditions. Prior to the end of the performance period as set forth in the applicable LTIP unit award, holders of performance-based LTIP units are entitled to receive dividends per LTIP unit equal to 10% of the dividend paid per common unit of our operating partnership. After the end of the performance period, the number of LTIP units, both vested and unvested, that LTIP award recipients have earned, if any, are entitled to receive dividends in an amount per LTIP unit equal to dividends, both regular and special, payable per common unit of our operating partnership. Holders of LTIP units that are not subject to the attainment of performance goals are entitled to receive dividends per LTIP unit equal to 100% of the dividend paid per common unit beginning on the grant date.
Cash Flow
Comparison of Cash Flow for the Years Ended December 31, 2022 and December 31, 2021
The following table sets forth a summary of cash flows for our company for the years ended December 31, 2022 and 2021:
| For the years ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | Change | ||||||||||
| (Amounts in thousands) | ||||||||||||
| Net cash provided by (used in): | ||||||||||||
| Operating activities | $ | 125,941 | $ | 118,344 | $ | 7,597 | ||||||
| Investing activities | (69,103 | ) | (363,042 | ) | 293,939 | |||||||
| Financing activities | (59,707 | ) | 250,172 | (309,879 | ) |
Operating Activities
We generated $125.9 million and $118.3 million of cash from operating activities during the years ended December 31, 2022 and 2021, respectively. Net cash provided by operating activities for the year ended December 31, 2022 included $121.4 million in net cash from rental activities net of expenses and distributions from investment in unconsolidated real estate venture of $6.4 million offset by $1.9 million related to the changes in tenant accounts receivables, prepaid expense and other assets, deferred revenue associated with operating leases, principal payments on operating lease obligations and accounts payable, accrued expenses and other liabilities. Net cash provided by operating activities for the year ended December 31, 2021 included $116.4 million in net cash from rental activities net of expenses and $2.0 million related to the changes in tenant accounts receivables, prepaid expense and other assets, deferred revenue associated with operating leases, principal payments on operating lease obligations and accounts payable, accrued expenses and other liabilities.
Investing Activities
We used $69.1 million and $363.0 million in cash for investing activities during the years ended December 31, 2022 and 2021, respectively. Net cash used in investing activities for the year ended December 31, 2022 primarily included $143.8 million in investment in unconsolidated real estate venture, $93.7 million in real estate acquisitions and deposits, $22.6 million in additions to operating properties and $12.4 million in additions to development properties, offset by $202.4 million in proceeds from sale of operating properties, net and $1.0 million in distributions from investment in unconsolidated real estate venture. Net cash used in investing activities for the year ended December 31, 2021 primarily included $214.7 million in real estate acquisitions, $131.6 million in investment in unconsolidated real estate venture, $17.9 million in additions to operating properties and $6.2 million in additions to development properties, offset by $7.3 million in proceeds from sale of operating properties, net.
49
Financing Activities
We used $59.7 million and generated $250.2 million in cash from financing activities during the years ended December 31, 2022 and 2021, respectively. Net cash used in financing activities for the year ended December 31, 2022 included $109.2 million in dividends, $10.9 million in mortgage debt repayment, and $0.1 million in payment of deferred offering costs offset by $51.0 million in net draws under the revolving credit facility and $9.5 million in gross proceeds from issuance of shares of our common stock. Net cash provided by financing activities for the year ended December 31, 2021 included $250.0 million in gross proceeds from the issuance of our senior unsecured notes and $175.9 million in gross proceeds from issuance of shares of our common stock, offset by $100.0 million in dividends, $64.8 million in net paydowns under the revolving credit facility, $5.3 million in deferred financing costs, $4.2 million in mortgage debt repayment, and $1.5 million in payment of deferred offering costs.
Comparison of Cash Flow for the Years Ended December 31, 2021 and December 31, 2020
Information pertaining to fiscal year 2020 was included in our Annual Report on Form 10-K for the year ended December 31, 2021 on page 46 under Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, which was filed with SEC on February 28, 2022.
Non-GAAP Financial Measures
We use and present Funds From Operations, or FFO, and FFO, as Adjusted as supplemental measures of our performance. The summary below describes our use of FFO and FFO, as Adjusted, provides information regarding why we believe these measures are meaningful supplemental measures of our performance and reconciles these measures from net income (loss), presented in accordance with GAAP.
Funds From Operations and Funds From Operations, as Adjusted
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 set forth in the Nareit FFO White Paper – Restatement 2018. FFO includes the REIT’s share of FFO generated by unconsolidated affiliates. 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 is a supplemental performance measure that is commonly used in the real estate industry to assist investors and analysts in comparing results of REITs.
FFO is defined by Nareit as net income, (calculated in accordance with GAAP), excluding:
•
Depreciation and amortization related to real estate.
•
Gains and losses from the sale of certain real estate assets.
•
Gains and losses from change in control.
•
Impairment write-downs of certain real estate assets and investments in entities when the impairment is directly attributable to decreases in the value of depreciable real estate held by the entity.
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 losses on extinguishment of debt, depreciation of non-real estate assets, acquisition costs, straight-line rent and other non-cash adjustments, amortization of deferred revenue (which results from landlord assets funded by tenants), non-cash interest expense, non-cash compensation, amortization of above-/below-market leases, and the unconsolidated real estate venture’s allocated share of these adjustments. By excluding these income and expense items from FFO, as Adjusted, we believe we provide useful information as these items have no cash impact. In addition, by excluding acquisition related costs we believe FFO, as Adjusted provides useful information that is comparable across periods and more accurately reflects the operating performance of our properties.
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 other REITs. Neither FFO nor
50
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 net income to FFO and FFO, as Adjusted for the years ended December 31, 2022, 2021, and 2020 (dollars in thousands):
| For the years ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2022 | 2021 | 2020 | ||||||||||
| Net income | $ | 35,562 | $ | 33,957 | $ | 13,528 | ||||||
| Depreciation of real estate assets | 97,262 | 91,189 | 93,803 | |||||||||
| (Gain) loss on the sale of operating properties | (13,590 | ) | (1,307 | ) | 3,995 | |||||||
| Impairment loss | 5,540 | — | — | |||||||||
| Unconsolidated real estate venture allocated share of above adjustments | 4,937 | 362 | — | |||||||||
| FFO | 129,711 | 124,201 | 111,326 | |||||||||
| Adjustments to FFO: | ||||||||||||
| Loss on extinguishment of debt | 20 | — | — | |||||||||
| Depreciation of non-real estate assets | 992 | 77 | — | |||||||||
| Acquisition costs | 1,370 | 1,939 | 2,087 | |||||||||
| Straight-line rent and other non-cash adjustments | (410 | ) | (4,417 | ) | (3,432 | ) | ||||||
| Amortization of deferred revenue | (5,797 | ) | (5,616 | ) | (3,528 | ) | ||||||
| Non-cash interest expense | 934 | 1,369 | 1,441 | |||||||||
| Non-cash compensation | 6,536 | 5,050 | 4,093 | |||||||||
| Amortization of above-/below-market leases | (3,105 | ) | (4,589 | ) | (5,894 | ) | ||||||
| Unconsolidated real estate venture allocated share of above adjustments | (1,323 | ) | (54 | ) | — | |||||||
| FFO, as Adjusted | $ | 128,928 | $ | 117,960 | $ | 106,093 |
Factors That May Influence Future Results of Operations
Revenue
Our revenues primarily arise from the rental of space to tenants in our properties and tenant reimbursements, which include reimbursement for operating expenses, which are determined by the base year operating expenses and are subject to reimbursement in subsequent years based on changes in the Consumer Price Index for Urban Wage Earners and Clerical Workers. Our revenue also includes amounts due from tenants for real estate taxes, projects and other reimbursements. Real estate taxes over the base year are reimbursed by the tenant.
Substantially all of our rental income comes from U.S. Government tenants. We expect that leases to agencies of the U.S. Government will continue to be our primary source of revenues for the foreseeable future. Due to such concentration, adverse events or conditions that affect the U.S. Government could have a more negative effect on our financial condition and operations than if our tenant base was more diverse. However, positive or negative changes in conditions in local markets, such as changes in economic or other conditions, employment rates, local tax and budget conditions, recession, competition for real property investments in these markets, uncertainty about the future and other factors are significantly less likely to impact our overall performance.
Operating Expenses
Our operating expenses generally consist of repairs and maintenance, utilities, roads and grounds, property management fees, insurance, janitorial and other operating expenses. Factors that may impact our ability to control these operating expenses include increases in utilities, increases in third party management expenses, increases in insurance premiums, increases in repair and maintenance costs and expenses related to inclement weather. Additionally, the cost of compliance with zoning and building codes as well as local, state and federal tax laws may impact our expenses. As a public company our annual general and administrative expenses are meaningfully higher 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. Increases in costs from any of the foregoing factors may adversely affect our future results and cash flows. Circumstances such as declines in market rental rates or increased competition may cause revenues to decrease, although the expenses of owning and operating a property will not necessarily decline. For certain of our properties, expenses may vary with occupancy, while costs arising from our property investments, interest expense and general maintenance will not be materially reduced even if a property is not fully occupied. As a result, our future cash flow and results of operations may be adversely affected and losses could be incurred if revenues decrease in the future.
51
Cost of Funds and Interest Rates
We expect future changes in interest rates will impact our overall performance. We manage and may continue to manage our market risk on variable rate debt by entering into interest rate swap agreements or similar instruments, subject to maintaining our qualification as a REIT for U.S. federal income tax purposes. Although we may seek to cost-effectively manage our exposure to future rate increases through such means, a portion of our overall debt may at various times float at then current rates.
Development Activities
As of December 31, 2022, we had one property under development. We intend to continue to engage in development and redevelopment activities with respect to our properties, including build-to-suit new developments and redevelopments for existing U.S. Government tenant agencies. These development activities may include some risks such as:
•
the availability and timely receipt of zoning and other regulatory approvals;
•
development costs exceeding expectations;
•
cost overruns and untimely completion of construction (including risks beyond our control, such as weather or labor conditions, or material shortages);
•
the inability to complete construction and leasing of a property on schedule, resulting in increased debt service expense and development and redevelopment costs; and
•
the availability and pricing of financing on favorable terms or at all.
Inflation
Substantially all of our leases provide for operating expense escalation. We believe inflationary increases in expenses may be at least partially offset by the contractual expense escalations described above. We do not believe inflation has had a material impact on our historical financial position or results of operations.
Critical Accounting Estimates
The preparation of financial statements in conformity with GAAP requires management to use judgment in the application of accounting policies, including making estimates and assumptions. We base these estimates, judgments, and assumptions on historical experience, current trends, and various other factors that we believe to be reasonable under the circumstances. If our judgment or interpretation of the facts and circumstances relating to various transactions had been different, or different assumptions were made, it is possible that different accounting policies would have been applied, resulting in different financial results or a different presentation of our financial statements.
Below is a discussion of the accounting policies that we consider critical to an understanding of our financial condition and operating results that may require complex or significant judgment in their application or require estimates about matters which are inherently uncertain. A discussion of our significant accounting policies, which utilize these critical accounting estimates, can be found in Note 2, “Significant Accounting Policies,” of our consolidated financial statements.
Real Estate Properties Acquired
When we acquire properties, we allocate the purchase price to numerous tangible and intangible components. Our process for determining the allocation to these components requires many estimates and assumptions, including the following: (1) determination of market land, rental, discount and capitalization rates; (2) estimation of leasing and tenant improvement costs associated with the remaining term of acquired leases; (3) assumptions used in determining the in-place lease and if-vacant value including the rental rates, period of time that it would take to lease vacant space and estimated tenant improvement and leasing costs; (4) renewal probabilities; and (5) allocation of the if-vacant value between land and building. A change in any of the above key assumptions can materially change not only the presentation of acquired properties in our consolidated financial statements but also our reported results of operations.
We completed acquisitions of three wholly owned properties for an aggregate purchase price of $108.1 million during the year ended December 31, 2022. We completed acquisitions of eight wholly owned properties for an aggregate purchase price of $287.6 million during the year ended December 31, 2021. These transactions were accounted for as asset acquisitions, and the purchase price of each was allocated based on the relative fair value of the asset acquired and liabilities assumed.
52
Impairment of Long-Lived Assets
We regularly evaluate whether events or changes in circumstances have occurred that could indicate an impairment in the value of long-lived assets. If there is an indication that the carrying value of an asset is not recoverable, we estimate the projected undiscounted cash flows to determine whether an asset may be impaired. We estimate fair value through an evaluation of recent financial performance and projected discounted cash flows using standard industry valuation techniques. Fair value estimates are made as of a specific point in time, are subjective in nature and involve uncertainties and matters of significant judgement. We determine the amount of any impairment loss by comparing the historical carrying value to estimated fair value. Upon determination that an impairment has occurred, a write-down is recognized to reduce the carrying amount to its estimated fair value.
In addition to consideration of impairment upon the events or changes in circumstances described above, we regularly evaluate the remaining lives of our long-lived assets. If we change our estimate of the remaining lives, we allocate the carrying value of the affected assets over their revised remaining lives.
On a quarterly basis, we assess the recoverability of the carrying amount of our real estate and related intangibles. Our assessment resulted in the remeasurement of ICE – Otay in the third quarter of 2022, which was written down to its estimated fair value and was classified as Level 3 in the fair value hierarchy. Our estimate of the fair value was based on a combination of a pending offer from a third party to acquire the property and a discounted cash flow analysis. We used two significant unobservable inputs in the various scenarios, which were the cash flow discount rate (ranging from 6.25%-9.00%) and average price per square foot of comparable sales in the market ($109.08-$185.90). There is no assurance that we will sell ICE – Otay on the terms proposed or at all. The remeasurement resulted in an impairment loss of $5.5 million, which is included in "Impairment loss" in our Consolidated Statements of Operations.
As of December 31, 2021, no impairment related to our long-lived assets was identified.
Impairment of Unconsolidated Real Estate Venture
We account for our investment in the unconsolidated real estate venture under the equity method. Under the equity method of accounting, we initially recognize our investment at cost and subsequently adjust the carrying amount of the investment for our share of the earnings or losses, distributions received, and other-than-temporary impairments.
Our unconsolidated real estate venture is evaluated for impairment when conditions exist that may indicate that the decrease in the carrying amount of our investment has occurred and is other than temporary. Triggering events or impairment indicators for our unconsolidated real estate venture include, recurring operating losses of an investee, absence of an ability to recover the carrying amount of the investee, the ability of an investee to sustain an earnings capacity and a carrying amount that exceeds the fair value of the investment. Upon determination that an other-than-temporary impairment has occurred, a write-down is recognized to reduce the carrying amount of investment to its estimated fair value. Fair value estimates are made as of a specific point in time, are subjective in nature and involve uncertainties and matters of significant judgement.
As of December 31, 2022, the carrying amount of our investment in our unconsolidated real estate venture was $271.6 million, or approximately 9.6% of our total assets. As of December 31, 2021, the carrying amount of our investment in our unconsolidated real estate venture was $131.8 million, or approximately 4.7% of our total assets. During the year ended December 31, 2022 and 2021, no other-than-temporary impairment related to our unconsolidated real estate venture was identified.