Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2013

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number 1-9317

 

COMMONWEALTH REIT

(Exact Name of Registrant as Specified in Its Charter)

 

Maryland

 

04-6558834

(State or Other Jurisdiction of Incorporation or
Organization)

 

(IRS Employer Identification No.)

 

Two Newton Place, 255 Washington Street, Suite 300, Newton, Massachusetts

 

02458-1634

(Address of Principal Executive Offices)

 

(Zip Code)

 

617-332-3990

(Registrant’s Telephone Number, Including Area Code)

 

Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check One):

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

Number of registrant’s common shares of beneficial interest, $0.01 par value per share, outstanding as of August 5, 2013: 118,314,068.

 

 

 



Table of Contents

 

COMMONWEALTH REIT

 

FORM 10-Q

 

June 30, 2013

 

INDEX

 

 

 

Page

PART I

Financial Information

 

 

 

 

Item 1.

Financial Statements (unaudited)

 

 

 

 

 

Condensed Consolidated Balance Sheets — June 30, 2013 and December 31, 2012

1

 

 

 

 

Condensed Consolidated Statements of Operations — Three and Six Months Ended June 30, 2013 and 2012

2

 

 

 

 

Condensed Consolidated Statements of Comprehensive (Loss) Income — Three and Six Months Ended June 30, 2013 and 2012

3

 

 

 

 

Condensed Consolidated Statements of Cash Flows — Six Months Ended June 30, 2013 and 2012

4

 

 

 

 

Notes to Condensed Consolidated Financial Statements

6

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

26

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

45

 

 

 

Item 4.

Controls and Procedures

48

 

 

 

 

Warning Concerning Forward Looking Statements

49

 

 

 

 

Statement Concerning Limited Liability

52

 

 

 

PART II

Other Information

 

 

 

 

Item 1.

Legal Proceedings

53

 

 

 

Item 1A.

Risk Factors

56

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

58

 

 

 

Item 5.

Other Information

58

 

 

 

Item 6.

Exhibits

58

 

 

 

 

Signatures

61

 



Table of Contents

 

References in this Quarterly Report on Form 10-Q to the “Company”, “CWH”, “we”, “us” or “our” refer to CommonWealth REIT and its consolidated subsidiaries, as of June 30, 2013, including its then majority owned consolidated subsidiary, Select Income REIT and its consolidated subsidiaries, or SIR, unless the context indicates otherwise.  On July 2, 2013, SIR completed an underwritten public offering of its common shares, at which time CWH ceased to own a majority of SIR’s common shares.  Accordingly, beginning with the filing of CWH’s Quarterly Report on Form 10-Q for the period ended September 30, 2013, CWH will deconsolidate its investment in SIR and account for its investment in SIR under the equity method.

 

SIR is itself a public company having common shares registered under the Securities Exchange Act of 1934, as amended.  For further information about SIR, please see SIR’s periodic reports and other filings with the Securities and Exchange Commission, or the SEC, which are available at the SEC’s website at www.sec.gov.  References in this Quarterly Report on Form 10-Q to SIR’s filings with the SEC are included as textual references only, and the information in SIR’s filings with the SEC is not incorporated by reference into this Quarterly Report on Form 10-Q unless otherwise expressly stated herein.

 



Table of Contents

 

PART I. Financial Information

 

Item 1.    Financial Statements.

 

COMMONWEALTH REIT

 

CONDENSED CONSOLIDATED BALANCE SHEETS

(amounts in thousands, except share data)

(unaudited)

 

 

 

June 30,

 

December 31,

 

 

 

2013

 

2012

 

ASSETS

 

 

 

 

 

Real estate properties:

 

 

 

 

 

Land

 

$

1,533,543

 

$

1,531,416

 

Buildings and improvements

 

6,446,307

 

6,297,993

 

 

 

7,979,850

 

7,829,409

 

Accumulated depreciation

 

(1,090,928

)

(1,007,606

)

 

 

6,888,922

 

6,821,803

 

Properties held for sale

 

128,529

 

171,832

 

Acquired real estate leases, net

 

394,978

 

427,756

 

Equity investments

 

11,407

 

184,711

 

Cash and cash equivalents

 

77,520

 

102,219

 

Restricted cash

 

18,009

 

16,626

 

Rents receivable, net of allowance for doubtful accounts of $8,769 and $9,962, respectively

 

274,988

 

253,394

 

Other assets, net

 

225,185

 

211,293

 

Total assets

 

$

8,019,538

 

$

8,189,634

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

Revolving credit facility

 

$

135,000

 

$

297,000

 

SIR revolving credit facility

 

235,000

 

95,000

 

Senior unsecured debt, net

 

2,304,465

 

2,972,994

 

Mortgage notes payable, net

 

977,044

 

984,827

 

Liabilities related to properties held for sale

 

1,588

 

2,339

 

Accounts payable and accrued expenses

 

165,449

 

194,184

 

Assumed real estate lease obligations, net

 

62,270

 

69,304

 

Rent collected in advance

 

29,260

 

35,700

 

Security deposits

 

24,031

 

23,860

 

Due to related persons

 

12,954

 

12,958

 

Total liabilities

 

3,947,061

 

4,688,166

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Shareholders’ equity attributable to CommonWealth REIT:

 

 

 

 

 

Preferred shares of beneficial interest, $0.01 par value: 50,000,000 shares authorized;

 

 

 

 

 

Series D preferred shares; 6 1/2% cumulative convertible; 15,180,000 shares issued and outstanding, aggregate liquidation preference $379,500

 

368,270

 

368,270

 

Series E preferred shares; 7 1/4% cumulative redeemable on or after May 15, 2016; 11,000,000 shares issued and outstanding, aggregate liquidation preference $275,000

 

265,391

 

265,391

 

Common shares of beneficial interest, $0.01 par value: 350,000,000 shares authorized; 118,314,068 and 83,804,068 shares issued and outstanding, respectively

 

1,183

 

838

 

Additional paid in capital

 

4,212,182

 

3,585,400

 

Cumulative net income

 

2,431,456

 

2,386,900

 

Cumulative other comprehensive (loss) income

 

(32,576

)

565

 

Cumulative common distributions

 

(3,023,096

)

(2,972,569

)

Cumulative preferred distributions

 

(551,669

)

(529,367

)

Total shareholders’ equity attributable to CommonWealth REIT

 

3,671,141

 

3,105,428

 

Noncontrolling interest in consolidated subsidiary

 

401,336

 

396,040

 

Total shareholders’ equity

 

4,072,477

 

3,501,468

 

Total liabilities and shareholders’ equity

 

$

8,019,538

 

$

8,189,634

 

 

See accompanying notes.

 

1



Table of Contents

 

COMMONWEALTH REIT

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(amounts in thousands, except per share data)

(unaudited)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

 

 

 

 

 

 

 

 

Rental income

 

$

274,766

 

$

249,797

 

$

549,814

 

$

493,175

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Operating expenses

 

109,754

 

103,034

 

219,413

 

200,270

 

Depreciation and amortization

 

67,389

 

60,433

 

133,912

 

118,452

 

General and administrative

 

21,653

 

12,595

 

38,919

 

24,131

 

Acquisition related costs

 

145

 

1,434

 

773

 

3,936

 

Total expenses

 

198,941

 

177,496

 

393,017

 

346,789

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

75,825

 

72,301

 

156,797

 

146,386

 

 

 

 

 

 

 

 

 

 

 

Interest and other income

 

250

 

360

 

708

 

645

 

Interest expense (including net amortization of debt discounts, premiums and deferred financing fees of $284, $1,005, $913 and $1,751, respectively)

 

(43,762

)

(50,237

)

(96,106

)

(99,343

)

Loss on early extinguishment of debt

 

 

(1,608

)

(60,027

)

(1,675

)

Equity in earnings of investees

 

159

 

2,829

 

4,421

 

5,787

 

Gain on sale of equity investment

 

 

 

66,293

 

 

Income from continuing operations before income tax expense

 

32,472

 

23,645

 

72,086

 

51,800

 

Income tax expense

 

(754

)

(92

)

(1,742

)

(584

)

Income from continuing operations

 

31,718

 

23,553

 

70,344

 

51,216

 

Discontinued operations:

 

 

 

 

 

 

 

 

 

Loss from discontinued operations

 

(311

)

(3,317

)

(2,223

)

(6,406

)

Loss on asset impairment from discontinued operations

 

(4,589

)

 

(8,535

)

 

Gain on sale of properties from discontinued operations

 

2,099

 

350

 

3,359

 

350

 

Income before gain on sale of properties

 

28,917

 

20,586

 

62,945

 

45,160

 

Gain on sale of properties

 

 

 

1,596

 

 

Net income

 

28,917

 

20,586

 

64,541

 

45,160

 

Net income attributable to noncontrolling interest in consolidated subsidiary

 

(10,028

)

(4,521

)

(19,985

)

(5,415

)

Net income attributable to CommonWealth REIT

 

18,889

 

16,065

 

44,556

 

39,745

 

Preferred distributions

 

(11,151

)

(13,823

)

(22,302

)

(27,646

)

Net income available for CommonWealth REIT common shareholders

 

$

7,738

 

$

2,242

 

$

22,254

 

$

12,099

 

 

 

 

 

 

 

 

 

 

 

Amounts attributable to CommonWealth REIT common shareholders:

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

10,539

 

$

5,209

 

$

29,653

 

$

18,155

 

Loss from discontinued operations

 

(311

)

(3,317

)

(2,223

)

(6,406

)

Loss on asset impairment from discontinued operations

 

(4,589

)

 

(8,535

)

 

Gain on sale of properties from discontinued operations

 

2,099

 

350

 

3,359

 

350

 

Net income

 

$

7,738

 

$

2,242

 

$

22,254

 

$

12,099

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding — basic and diluted

 

118,309

 

83,727

 

106,298

 

83,724

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted earnings per common share attributable to CommonWealth REIT common shareholders:

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

0.09

 

$

0.06

 

$

0.28

 

$

0.22

 

Loss from discontinued operations

 

$

(0.02

)

$

(0.04

)

$

(0.07

)

$

(0.07

)

Net income available for common shareholders

 

$

0.07

 

$

0.03

 

$

0.21

 

$

0.14

 

 

See accompanying notes.

 

2



Table of Contents

 

COMMONWEALTH REIT

 

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

(amounts in thousands)

(unaudited)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

28,917

 

$

20,586

 

$

64,541

 

$

45,160

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive (loss) income:

 

 

 

 

 

 

 

 

 

Unrealized gain (loss) on derivative instruments

 

2,782

 

(2,404

)

3,833

 

(2,441

)

Foreign currency translation adjustments

 

(37,821

)

(3,447

)

(36,848

)

1,081

 

Equity in unrealized loss of an investee

 

(146

)

(3

)

(162

)

(4

)

Total comprehensive (loss) income

 

(6,268

)

14,732

 

31,364

 

43,796

 

 

 

 

 

 

 

 

 

 

 

Less: comprehensive income attributable to noncontrolling interest in consolidated subsidiary

 

(9,996

)

(4,521

)

(19,949

)

(5,415

)

 

 

 

 

 

 

 

 

 

 

Comprehensive (loss) income attributable to CommonWealth REIT

 

$

(16,264

)

$

10,211

 

$

11,415

 

$

38,381

 

 

See accompanying notes.

 

3



Table of Contents

 

COMMONWEALTH REIT

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(amounts in thousands)

(unaudited)

 

 

 

Six Months Ended June 30,

 

 

 

2013

 

2012

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

64,541

 

$

45,160

 

Adjustments to reconcile net income to cash provided by operating activities:

 

 

 

 

 

Depreciation

 

96,006

 

90,680

 

Net amortization of debt discounts, premiums and deferred financing fees

 

913

 

1,751

 

Straight line rental income

 

(19,798

)

(17,991

)

Amortization of acquired real estate leases

 

33,060

 

29,422

 

Other amortization

 

9,806

 

9,815

 

Loss on asset impairment

 

8,535

 

 

Loss on early extinguishment of debt

 

60,027

 

1,675

 

Equity in earnings of investees

 

(4,421

)

(5,787

)

Gain on sale of equity investment

 

(66,293

)

 

Distributions of earnings from investees

 

4,111

 

5,592

 

Gain on sale of properties

 

(4,955

)

(350

)

Change in assets and liabilities:

 

 

 

 

 

Restricted cash

 

966

 

(4,339

)

Rents receivable and other assets

 

(22,449

)

(17,943

)

Accounts payable and accrued expenses

 

(15,737

)

2,429

 

Rent collected in advance

 

(7,730

)

(5,493

)

Security deposits

 

122

 

713

 

Due to related persons

 

(3

)

3,369

 

Cash provided by operating activities

 

136,701

 

138,703

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Real estate acquisitions

 

(165,110

)

(253,710

)

Real estate improvements

 

(53,908

)

(50,636

)

Principal payments received from direct financing lease

 

3,444

 

3,283

 

Proceeds from sale of properties, net

 

33,863

 

338

 

Proceeds from sale of equity investment, net

 

239,576

 

 

Distributions in excess of earnings from investees

 

168

 

2,766

 

Investment in Affiliates Insurance Company

 

 

(5,335

)

Increase in restricted cash

 

(2,349

)

(2,121

)

Cash provided by (used in) investing activities

 

55,684

 

(305,415

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Proceeds from issuance of common shares, net

 

626,809

 

180,814

 

Repurchase and retirement of outstanding debt securities

 

(728,021

)

 

Proceeds from borrowings

 

936,000

 

444,500

 

Payments on borrowings

 

(962,207

)

(395,250

)

Deferred financing fees

 

(1,200

)

(6,049

)

Distributions to common shareholders

 

(50,527

)

(83,722

)

Distributions to preferred shareholders

 

(22,302

)

(27,466

)

Distributions to noncontrolling interest in consolidated subsidiary

 

(14,863

)

 

Cash (used in) provided by financing activities

 

(216,311

)

112,827

 

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

(773

)

(73

)

 

 

 

 

 

 

Decrease in cash and cash equivalents

 

(24,699

)

(53,958

)

Cash and cash equivalents at beginning of period

 

102,219

 

192,763

 

Cash and cash equivalents at end of period

 

$

77,520

 

$

138,805

 

 

See accompanying notes.

 

4



Table of Contents

 

COMMONWEALTH REIT

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

(amounts in thousands)

(unaudited)

 

 

 

Six Months Ended June 30,

 

 

 

2013

 

2012

 

 

 

 

 

 

 

SUPPLEMENTAL CASH FLOW INFORMATION:

 

 

 

 

 

Interest paid

 

$

109,108

 

$

99,227

 

Taxes paid

 

1,134

 

536

 

 

 

 

 

 

 

NON-CASH INVESTING ACTIVITIES:

 

 

 

 

 

Real estate acquisitions

 

$

 

$

(176,884

)

Investment in real estate mortgages receivable

 

(7,688

)

(1,419

)

 

 

 

 

 

 

NON-CASH FINANCING ACTIVITIES:

 

 

 

 

 

Issuance of common shares

 

$

244

 

$

187

 

Assumption of mortgage notes payable

 

 

176,884

 

 

See accompanying notes.

 

5



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share data)

 

Note 1.  Basis of Presentation

 

The accompanying condensed consolidated financial statements of CommonWealth REIT and its subsidiaries, or the Company, CWH, we, us or our, have been prepared without audit.  Certain information and footnote disclosures required by U.S. generally accepted accounting principles, or GAAP, for complete financial statements have been condensed or omitted.  We believe the disclosures made are adequate to make the information presented not misleading.  However, the accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes contained in our Annual Report on Form 10-K for the year ended December 31, 2012, or our Annual Report.  In the opinion of our management, all adjustments, which include only normal recurring adjustments considered necessary for a fair presentation, have been included.  All material intercompany transactions and balances with or among our subsidiaries have been eliminated.  Operating results for interim periods are not necessarily indicative of the results that may be expected for the full year.  Reclassifications have been made to the prior years’ financial statements to conform to the current year’s presentation.

 

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect reported amounts.  Actual results could differ from those estimates.  Significant estimates in the condensed consolidated financial statements include the allowance for doubtful accounts, purchase price allocations, useful lives of fixed assets and impairment of real estate and intangible assets.

 

On March 12, 2012, our then wholly owned subsidiary, Select Income REIT, completed an initial public offering of 9,200,000 of its common shares, or the SIR IPO.  We refer to Select Income REIT and its consolidated subsidiaries as SIR.  We understand that SIR intends to be taxable as a real estate investment trust, or REIT, commencing with its taxable year ended December 31, 2012.  As of June 30, 2013, SIR owned substantially all of our industrial and commercial properties located on Oahu, HI as well as 43 office and industrial properties located throughout the mainland United States.  As of June 30, 2013, we owned 22,000,000 SIR common shares, or approximately 56.0% of SIR’s outstanding common shares, and SIR was one of our consolidated subsidiaries.  On July 2, 2013, SIR issued and sold to the public 10,500,000 of its common shares of beneficial interest in a public offering.  After this offering, our 22,000,000 common shares of SIR represented approximately 44.2% of SIR’s outstanding common shares and SIR ceased to be our consolidated subsidiary.  Since our investment in SIR is below 50% after this offering, effective July 2, 2013 and beginning with the filing of our Quarterly Report on Form 10-Q for the period ended September 30, 2013, we will deconsolidate our investment in SIR and account for our investment in SIR under the equity method.   See Note 15 for additional information regarding SIR.

 

Note 2.  Recent Accounting Pronouncements

 

Effective January 2013, we adopted Financial Accounting Standards Board, or FASB, Accounting Standards Update No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.  This update is the culmination of the FASB’s deliberation on reporting reclassification adjustments from accumulated other comprehensive income, or AOCI.  This standard does not change the current requirements for reporting net income or other comprehensive income.  However, it requires disclosure of amounts reclassified out of AOCI in their entirety, by component, on the face of the statement of operations or in the notes thereto.  Amounts that are not required to be reclassified in their entirety to net income must be cross referenced to other disclosures that provide additional detail.  This standard was effective prospectively for interim and annual reporting periods beginning after December 15, 2012.  The implementation of this update did not cause any material changes to the presentation of our condensed consolidated financial statements.

 

6



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

Note 3.  Board of Trustees

 

On February 26, 2013, Corvex Management LP, or Corvex, Related Fund Management, LLC and certain of their affiliates, or together with Corvex, Corvex/Related, publicly disclosed their recent accumulation of the Company’s common shares.  Corvex/Related have since undertaken a series of actions in an effort to influence and control the Company, including publishing “open” letters to our Board of Trustees, announcing conditional, unfinanced purported offers to acquire all the common shares of the Company and running a purported consent solicitation seeking to remove, without cause, all of the members of our Board of Trustees.  Corvex/Related unilaterally, publicly stated that they believed the record date for their purported consent solicitation was April 22, 2013 and solicited consents from our shareholders as of that date to their removal proposal.  On June 21, 2013, Corvex delivered to the Company a letter and enclosed materials that it claimed were written consents from the Company’s shareholders that effectuated the immediate removal of the Company’s entire Board of Trustees.

 

The legal effectiveness of the Corvex/Related purported consent solicitation is the subject of legal proceedings before an arbitration panel.  We believe that the Corvex/Related consent solicitation has no legal effect because, among other things, under our declaration of trust and bylaws, the power to set a record date for a consent solicitation rests with the Company’s Board of Trustees and our Board of Trustees did not set such a record date for the Corvex/Related purported consent solicitation as the Corvex/Related request for a record date did not comply with requirements in our governing documents.  Moreover, our Board of Trustees believes that the removal of all of our Trustees without cause and in one removal action conflicts with our Board of Trustee’s election to be subject to certain provisions of the Maryland Unsolicited Takeovers Act.  On June 24, 2013, the Company responded to the letters from Corvex/Related pointing out that the legal effectiveness of the Corvex/Related consent solicitation is currently the subject of proceedings before an arbitration panel and that the Board of Trustees would continue to manage the Company unless and until the arbitration panel directs otherwise.  To date, no court or arbitration panel has ruled that the Corvex/Related purported consent solicitation is legally effective.

 

We believe that the Corvex/Related consent solicitation has no legal effect.  However, if the arbitration panel determines that the Corvex/Related consent solicitation is legally effective and the entire Board of Trustees has been removed, as proposed by Corvex/Related, such removal may, among other things, disrupt the Company’s business and operations, give rise to preferred shareholder conversion rights and events of default under certain material agreements, affect our ability to pay dividends, borrow money and implement our business plan, and have other effects which may adversely affect us.

 

Note 4.  Real Estate Properties

 

Completed Acquisitions:

 

During the six months ended June 30, 2013, SIR acquired five properties with a combined 779,010 square feet for an aggregate purchase price of $158,320, excluding closing costs, which are consolidated in our financial results.  SIR accounted for these transactions as business combinations (except as noted below) and allocated the purchase prices of these acquisitions based on the estimated fair value of the acquired assets and assumed liabilities.  Details of these completed acquisitions are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Acquired

 

 

 

 

 

Number

 

 

 

 

 

 

 

 

 

Acquired

 

Real Estate

 

 

 

 

 

of

 

Square

 

Purchase

 

 

 

Buildings and

 

Real Estate

 

Lease

 

 Date

 

Location

 

Properties

 

Feet

 

Price(1)

 

Land

 

Improvements

 

Leases

 

Obligations

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SIR Acquisitions through June 30, 2013:

 

 

 

 

 

 

 

 

 

 

 

 

January 2013

 

Addison, TX(2)

 

2

 

553,799

 

$

105,000

 

$

10,107

 

$

94,893

 

$

 

$

 

February 2013

 

Provo, UT

 

2

 

125,225

 

34,720

 

3,400

 

25,938

 

5,382

 

 

March 2013

 

San Antonio, TX

 

1

 

99,986

 

18,600

 

3,197

 

12,175

 

3,507

 

(279

)

 

 

 

 

5

 

779,010

 

$

158,320

 

$

16,704

 

$

133,006

 

$

8,889

 

$

(279

)

 


(1)         Purchase price excludes closing costs.

(2)         This property was acquired and simultaneously leased back to the seller in a sale/leaseback transaction.  SIR accounted for this transaction as an acquisition of assets.  SIR recognized acquisition costs of $226, which SIR capitalized as part of the transaction.

 

7



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

Excluding SIR, we did not make any acquisitions during the six months ended June 30, 2013.

 

In July 2013, SIR acquired an office property located in Richmond, VA with 310,950 square feet for $143,600, excluding closing costs.  This acquisition was accounted for as a business combination, and, due to the timing of the acquisition, the purchase price allocation is not complete.

 

In addition, during the six months ended June 30, 2013, we also made improvements totaling $47,356 to our properties.

 

Property Sales:

 

During the six months ended June 30, 2013, we sold 24 properties with a combined 2,265,228 square feet and two land parcels for an aggregate sale price of $42,612, excluding closing costs.  Details of these completed sales are as follows:

 

·                  In January 2013, we sold 18 suburban office and industrial properties in industrial suburbs of Detroit with a combined 1,060,026 square feet for $10,250, excluding closing costs.  In connection with the sale of these properties, we provided mortgage financing to the buyer, an unrelated third party, totaling $7,688 at 6.0% per annum and recognized a gain on sale of $1,277.

 

·                  As a result of an eminent domain taking in March 2013, we sold a land parcel adjacent to one of our central business district, or CBD, office buildings located in Boston, MA for $1,806, excluding closing costs, and recognized a gain on sale of $1,596.

 

·                  In April 2013, we sold an industrial property with 618,000 square feet for $830, excluding closing costs.

 

·                  In May 2013, we sold a suburban office property with 57,250 square feet for $4,025, excluding closing costs.

 

·                  In June 2013, we sold two suburban office properties with a combined 356,045 square feet for an aggregate sale price of $16,300, excluding closing costs.

 

·                  Also in June 2013, we sold a suburban office property with 30,105 square feet for $1,600, excluding closing costs, and recognized a gain on sale of $317.

 

·                  Also in June 2013, we sold a suburban office property with 143,802 square feet for $5,250, excluding closing costs.

 

·                  Also in June 2013, we sold a parcel of land in Tukwila, WA for $2,551, excluding closing costs, and recognized a gain on sale of $1,765.

 

As of June 30, 2013, we had 30 office properties and 40 industrial properties with a combined 4,408,623 square feet held for sale.  As of August 6, 2013, we have 49 of these properties with a combined 2,283,345 square feet under agreement to sell for an aggregate sale price of $67,500, excluding closing costs.  We expect to complete the sale of the 49 properties currently under agreement and the remaining 21 properties listed for sale during 2013; however, no assurance can be given that these properties will be sold in that time period or at all.  As of December 31, 2012, we had 37 office properties and 57 industrial properties with a combined 6,673,851 square feet held for sale.  We classify all properties that meet the criteria outlined in the Property, Plant and Equipment Topic of the FASB Accounting Standards CodificationTM, or the Codification, as held for sale in our condensed consolidated balance sheets.  Results of operations for properties sold or held for sale are included in discontinued operations in our condensed consolidated statements of operations once the criteria for discontinued operations in the Presentation of

 

8



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

Financial Statements Topic of the Codification are met.  Summarized balance sheet information for all properties classified as held for sale and income statement information for properties held for sale or sold is as follows:

 

Balance Sheets:

 

 

 

June 30, 2013

 

December 31,
2012

 

Real estate properties

 

$

122,095

 

$

164,041

 

Acquired real estate leases

 

453

 

453

 

Rents receivable

 

2,569

 

2,791

 

Other assets, net

 

3,412

 

4,547

 

Properties held for sale

 

$

128,529

 

$

171,832

 

 

 

 

 

 

 

Assumed real estate lease obligations

 

$

21

 

$

21

 

Rent collected in advance

 

248

 

854

 

Security deposits

 

1,319

 

1,464

 

Liabilities related to properties held for sale

 

$

1,588

 

$

2,339

 

 

Statements of Operations:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Rental income

 

$

4,625

 

$

5,577

 

$

9,432

 

$

13,445

 

Operating expenses

 

(4,379

)

(5,059

)

(10,414

)

(11,913

)

Depreciation and amortization

 

 

(3,119

)

 

(6,451

)

General and administrative

 

(565

)

(769

)

(1,249

)

(1,543

)

Operating loss

 

(319

)

(3,370

)

(2,231

)

(6,462

)

 

 

 

 

 

 

 

 

 

 

Interest and other income

 

8

 

53

 

8

 

56

 

Loss from discontinued operations

 

$

(311

)

$

(3,317

)

$

(2,223

)

$

(6,406

)

 

9



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

Note 5.  Investment in Direct Financing Lease

 

We have an investment in a direct financing lease that relates to a lease with a term that exceeds 75% of the useful life of an office tower located within a mixed use property in Phoenix, AZ.  We recognize income using the effective interest method to produce a level yield on funds not yet recovered.  Estimated unguaranteed residual values at the date of lease inception represent our initial estimates of the fair value of the leased assets at the expiration of the lease, which do not exceed their original cost.  Significant assumptions used in estimating residual values include estimated net cash flows over the remaining lease term and expected future real estate values.  The carrying amount of our net investment is included in other assets in our condensed consolidated balance sheets.  The following table summarizes the carrying amount of our net investment in this direct financing lease:

 

 

 

June 30,

 

December 31,

 

 

 

2013

 

2012

 

Total minimum lease payments receivable

 

$

27,035

 

$

31,084

 

Estimated unguaranteed residual value of leased asset

 

4,951

 

4,951

 

Unearned income

 

(8,697

)

(9,302

)

Net investment in direct financing lease

 

$

23,289

 

$

26,733

 

 

We monitor the payment history and credit profile of the tenant and have determined that no allowance for losses related to our direct financing lease was necessary at June 30, 2013 and December 31, 2012.  Our direct financing lease has an expiration date in 2045.

 

Note 6.  Equity Investments

 

At June 30, 2013 and December 31, 2012, we had the following equity investments in Government Properties Income Trust, or GOV, and Affiliates Insurance Company, or AIC (including 100% attribution of SIR’s 12.5% equity ownership interest in AIC):

 

 

 

Ownership Percentage

 

Equity Investments

 

Equity in Earnings

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

December 31,

 

June 30,

 

December 31,

 

June 30,

 

June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

2013

 

2012

 

2013

 

2012

 

GOV

 

%

18.2

%

$

 

$

173,452

 

$

 

$

2,680

 

$

4,111

 

$

5,593

 

AIC

 

25.0

%

25.0

%

11,407

 

11,259

 

159

 

149

 

310

 

194

 

 

 

 

 

 

 

$

11,407

 

$

184,711

 

$

159

 

$

2,829

 

$

4,421

 

$

5,787

 

 

On March 15, 2013, we sold all 9,950,000 common shares that we owned of GOV in a public offering for $25.20 per common share, raising gross proceeds of $250,740 ($239,576 after deducting underwriters’ discounts and commissions and expenses).  We recognized a gain on this sale of an equity investment of $66,293 as a result of the per share sales price of this transaction being above our per share carrying value.  GOV is a REIT which primarily owns properties that are majority leased to government tenants and was our wholly owned subsidiary until its initial public offering in June 2009 when it became a separate public entity.

 

During the six months ended June 30, 2013 and 2012, we received cash distributions from GOV totaling $4,279 and $8,358, respectively.

 

As of June 30, 2013, we and SIR have invested a total of $10,544 in AIC, an insurance company owned in equal proportion by Reit Management & Research LLC, our business and property manager, or RMR, us (excluding SIR’s AIC interest), SIR and five other companies to which RMR provides management services, including GOV.  We and SIR may invest additional amounts in AIC in the future if the expansion of this insurance business requires additional capital, but we and SIR are not obligated to do so.  At June 30, 2013, we (without SIR) and SIR each owned 12.5% of AIC with a combined carrying value of $11,407.  We and SIR use the equity method to account for this investment because we and SIR believe that we each have significant influence over AIC because all

 

10



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

of our Trustees and all of SIR’s trustees are also directors of AIC.  Under the equity method, we record our and SIR’s percentage share of net earnings from AIC in our condensed consolidated statements of operations.  If we determine there is an “other than temporary” decline in the fair value of this investment, we would record a charge to earnings.  In evaluating the fair value of this investment, we have considered, among other things, the assets and liabilities held by AIC, AIC’s overall financial condition and the financial condition and prospects for AIC’s insurance business.  See Note 15 for additional information about our and SIR’s investment in AIC.

 

Note 7.  Real Estate Mortgages Receivable

 

We provided mortgage financing totaling $7,688 at 6.0% per annum in connection with 18 office and industrial properties sold in January 2013.  This real estate mortgage requires monthly interest payments and matures on January 24, 2023.  As of June 30, 2013 and December 31, 2012, we had total real estate mortgages receivable with an aggregate carrying value of $9,107 and $1,419, respectively, included in other assets in our condensed consolidated balance sheets.

 

Note 8.  Shareholders’ Equity

 

The following is a reconciliation of changes in shareholders’ equity for the six months ended June 30, 2013:

 

 

 

Shareholders’

 

Shareholders’

 

 

 

 

 

Equity

 

Equity

 

 

 

 

 

Attributable to

 

Attributable to

 

Total

 

 

 

CommonWealth

 

Noncontrolling

 

Shareholders’

 

 

 

REIT

 

Interest

 

Equity

 

Balance at December 31, 2012

 

$

3,105,428

 

$

396,040

 

$

3,501,468

 

Net income

 

44,556

 

19,985

 

64,541

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

Unrealized gain on derivative instruments

 

3,833

 

 

3,833

 

Foreign currency translation adjustments

 

(36,848

)

 

(36,848

)

Equity in unrealized loss of an investee

 

(126

)

(36

)

(162

)

Total comprehensive income

 

11,415

 

19,949

 

31,364

 

 

 

 

 

 

 

 

 

Issuance of common shares, net

 

626,851

 

(42

)

626,809

 

Share grants

 

276

 

252

 

528

 

Distributions

 

(72,829

)

(14,863

)

(87,692

)

Balance at June 30, 2013

 

$

3,671,141

 

$

401,336

 

$

4,072,477

 

 

In the remainder of this Note 8, references to we, us, our or CWH refer to CWH and its consolidated subsidiaries other than SIR and its consolidated subsidiaries, unless noted otherwise.

 

CWH Common Share Issuance:

 

In March 2013, we issued 34,500,000 common shares (including 4,500,000 common shares sold pursuant to the underwriters’ option to purchase additional shares) in a public offering for $19.00 per common share, raising gross proceeds of $655,500 ($626,904 after deducting underwriters’ discounts and commissions and expenses).  Net proceeds from this offering were used to repay indebtedness, including amounts borrowed under our revolving credit facility to fund, in part, the purchase of the senior notes that were tendered in the tender offer discussed in Note 10.

 

On May 14, 2013, we granted 2,000 common shares of beneficial interest, par value $0.01 per share, valued at $20.13 per share, the closing price of our common shares on the New York Stock Exchange, or NYSE, on that day, to each of our five Trustees as part of their annual compensation.

 

11



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

CWH Common and Preferred Share Distributions:

 

On each of February 15, 2013 and May 15, 2013, we paid quarterly distributions on our series D preferred shares of $0.4063 per share, or $6,167, and quarterly distributions on our series E preferred shares of $0.4531 per share, or $4,984, both of which were paid to shareholders of record as of February 1, 2013 and May 1, 2013, respectively.

 

On February 21, 2013, we paid a quarterly distribution on our common shares of $0.25 per share, or $20,951, to shareholders of record on January 22, 2013.  On May 22, 2013, we paid a quarterly distribution on our common shares of $0.25 per share, or $29,576, to shareholders of record on April 23, 2013.

 

In July 2013, we declared a distribution of $0.25 per common share, or approximately $29,600, to be paid on or about August 23, 2013 to shareholders of record on July 26, 2013.  We also announced in July 2013 a quarterly distribution on our series D preferred shares of $0.4063 per share, or $6,167, and a quarterly distribution on our series E preferred shares of $0.4531 per share, or $4,984, both of which we expect to pay on or about August 15, 2013 to our preferred shareholders of record as of August 1, 2013.  Our revolving credit facility agreement and term loan agreement contain a number of financial and other covenants, including a covenant which restricts our ability to make distributions under certain circumstances.

 

SIR Common Share Issuance:

 

On May 13, 2013, SIR granted 2,000 of its common shares of beneficial interest, par value $0.01 per share, valued at $27.61 per share, the closing price of SIR’s common shares on the NYSE on that day, to each of its trustees as part of their annual compensation.

 

SIR Common Share Distributions:

 

On February 19, 2013, SIR paid a quarterly distribution on its common shares of $0.42 per share, or $16,499, to SIR’s shareholders of record on January 22, 2013.  On May 20, 2013, SIR paid a quarterly distribution on its common shares of $0.44 per share, or $17,284, to SIR’s shareholders of record on April 23, 2013.

 

In July 2013, SIR declared a distribution on its common shares of $0.44 per share, or approximately $21,900, to be paid on or about August 20, 2013 to SIR’s shareholders of record on July 24, 2013.  SIR’s revolving credit facility agreement and term loan agreement contain a number of financial and other covenants, including a covenant which restricts SIR’s ability to make distributions under certain circumstances.

 

12



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

Note 9.  Cumulative Other Comprehensive (Loss) Income

 

The following table presents a roll forward of amounts recognized in cumulative other comprehensive (loss) income by component for the three and six months ended June 30, 2013:

 

 

 

Three Months Ended June 30, 2013

 

 

 

Unrealized

 

Foreign

 

Equity in

 

 

 

 

 

Gain (Loss)

 

Currency

 

Unrealized

 

 

 

 

 

on Derivative

 

Translation

 

Gain (Loss) of

 

 

 

 

 

Instruments

 

Adjustments

 

an Investee

 

Total

 

 

 

 

 

 

 

 

 

 

 

Balance as of March 31, 2013

 

$

(15,573

)

$

18,044

 

$

106

 

$

2,577

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss) before reclassifications

 

1,546

 

(37,821

)

(110

)

(36,385

)

Amounts reclassified from cumulative other comprehensive income (loss) to net income

 

1,236

 

 

(4

)

1,232

 

Net current period other comprehensive income (loss)

 

2,782

 

(37,821

)

(114

)

(35,153

)

 

 

 

 

 

 

 

 

 

 

Balance as of June 30, 2013

 

$

(12,791

)

$

(19,777

)

$

(8

)

$

(32,576

)

 

 

 

Six Months Ended June 30, 2013

 

 

 

Unrealized

 

Foreign

 

Equity in

 

 

 

 

 

Gain (Loss)

 

Currency

 

Unrealized

 

 

 

 

 

on Derivative

 

Translation

 

Gain (Loss) of

 

 

 

 

 

Instruments

 

Adjustments

 

an Investee

 

Total

 

 

 

 

 

 

 

 

 

 

 

Balance as of December 31, 2012

 

$

(16,624

)

$

17,071

 

$

118

 

$

565

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss) before reclassifications

 

1,361

 

(36,848

)

(109

)

(35,596

)

Amounts reclassified from cumulative other comprehensive income (loss) to net income

 

2,472

 

 

(17

)

2,455

 

Net current period other comprehensive income (loss)

 

3,833

 

(36,848

)

(126

)

(33,141

)

 

 

 

 

 

 

 

 

 

 

Balance as of June 30, 2013

 

$

(12,791

)

$

(19,777

)

$

(8

)

$

(32,576

)

 

13



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

The following table presents reclassifications out of cumulative other comprehensive income (loss) for the three and six months ended June 30, 2013:

 

Three Months Ended June 30, 2013

 

 

 

Amounts Reclassified from

 

 

 

Details about Cumulative Other

 

Cumulative Other Comprehensive

 

Affected Line Items in the

 

Comprehensive Income (Loss) Components

 

Income (Loss) to Net Income

 

Statement of Operations

 

 

 

 

 

 

 

Interest rate swap contracts

 

$

1,236

 

Interest expense

 

 

 

 

 

 

 

Unrealized gains and losses on available for sale securities

 

(4

)

Equity in earnings of investees

 

 

 

$

1,232

 

 

 

 

Six Months Ended June 30, 2013

 

 

 

Amounts Reclassified from

 

 

 

Details about Cumulative Other

 

Cumulative Other Comprehensive

 

Affected Line Items in the

 

Comprehensive Income (Loss) Components

 

Income (Loss) to Net Income

 

Statement of Operations

 

 

 

 

 

 

 

Interest rate swap contracts

 

$

2,472

 

Interest expense

 

 

 

 

 

 

 

Unrealized gains and losses on available for sale securities

 

 

 

 

 

 

 

(17

)

Equity in earnings of investees

 

 

 

$

2,455

 

 

 

 

14



Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

Note 10.  Indebtedness

 

In this Note 10, references to we, us, our or CWH refer to CWH and its consolidated subsidiaries other than SIR and its consolidated subsidiaries, unless noted otherwise.

 

CWH Prepayments:

 

In March 2013, we purchased a total of $670,295 of the outstanding principal amount of the following senior notes for $726,151, excluding transaction costs, pursuant to a tender offer:

 

Senior Note

 

Principal

 

Purchase
Price

 

5.75% Senior Notes due February 15, 2014

 

$

145,612

 

$

148,746

 

6.40% Senior Notes due February 15, 2015

 

152,560

 

164,140

 

5.75% Senior Notes due November 1, 2015

 

111,227

 

121,047

 

6.25% Senior Notes due August 15, 2016

 

260,896

 

292,218

 

 

 

$

670,295

 

$

726,151

 

 

In connection with the purchase of these senior notes, we recognized a combined loss on early extinguishment of debt totaling $60,027, which includes the write off of unamortized discounts and deferred financing fees and estimated expenses.

 

CWH Unsecured Revolving Credit Facility and Unsecured Term Loan:

 

We have a $750,000 unsecured revolving credit facility that is available for general business purposes, including acquisitions.  The maturity date of our revolving credit facility is October 19, 2015 and, subject to the payment of an extension fee and meeting certain other conditions, includes an option for us to extend the stated maturity date of our revolving credit facility by one year to October 19, 2016.  In addition, our revolving credit facility includes a feature under which maximum borrowings may be increased to up to $1,500,000 in certain circumstances.  Borrowings under our revolving credit facility bear interest at LIBOR plus a premium, which was 150 basis points as of June 30, 2013.  We also pay a facility fee of 35 basis points per annum on the total amount of lending commitments under our revolving credit facility.  Both the interest rate premium and the facility fee are subject to adjustment based upon changes to our credit ratings.  As of June 30, 2013, the interest rate payable on borrowings under our revolving credit facility was 1.7%.  The weighted average interest rate for borrowings under our revolving credit facility was 1.7% for both the three and six months ended June 30, 2013, and 1.5% for the six months ended June 30, 2012.  We had no amounts outstanding under our revolving credit facility during the three months ended June 30, 2012.  As of June 30, 2013, we had $135,000 outstanding and $615,000 available under our revolving credit facility.

 

We also have a $500,000 unsecured term loan that matures in December 2016 and is prepayable without penalty at any time.  Our term loan includes a feature under which maximum borrowings may be increased to up to $1,000,000 in certain circumstances.  Our term loan bears interest at a rate of LIBOR plus a premium, which was 185 basis points as of June 30, 2013.  The interest rate premium is subject to adjustment based upon changes to our credit ratings.  As of June 30, 2013, the interest rate for the amount outstanding under our term loan was 2.1%.  The weighted average interest rate for the amount outstanding under our term loan was 2.1% for both the three and six months ended June 30, 2013, and 1.8% for both the three and six months ended June 30, 2012.

 

Our revolving credit facility agreement and our term loan agreement provide for acceleration of payment of all amounts due thereunder upon the occurrence and continuation of certain events of default, including a change of control of us and the termination of our business management or property management agreements with RMR.  As stated in Note 3 above, we believe that the Corvex/Related consent solicitation has no legal effect.  However, if the arbitration panel determines that the Corvex/Related consent solicitation is legally effective and the entire Board of Trustees has been removed, as proposed by Corvex/Related, such removal would constitute an event of default under the Company’s revolving credit facility and term loan agreements and may also constitute an event of default under certain mortgage loans.

 

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COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

SIR Unsecured Revolving Credit Facility and Unsecured Term Loan:

 

SIR has a $750,000 revolving credit facility that is available to SIR for general business purposes, including acquisitions.  The maturity date of the SIR revolving credit facility is March 11, 2016 and, subject to the payment by SIR of an extension fee and SIR meeting certain other conditions, includes an option for SIR to extend the stated maturity date of the SIR revolving credit facility by one year to March 11, 2017.  In February 2013, SIR increased the available borrowing amount under the SIR revolving credit facility from $500,000 to $750,000.  Borrowings under the SIR revolving credit facility bear interest at LIBOR plus a premium, which was 130 basis points as of June 30, 2013.  SIR also pays a facility fee of 30 basis points per annum on the total amount of lending commitments under the SIR revolving credit facility.  Both the interest rate premium and the facility fee are subject to adjustment based upon changes to SIR’s leverage or credit ratings.  As of June 30, 2013, the interest rate payable on borrowings under the SIR revolving credit facility was 1.5%.  The weighted average interest rate for borrowings under the SIR revolving credit facility was 1.5% for both the three and six months ended June 30, 2013, and 1.5% for both the three months ended June 30, 2012 and for the period from March 12, 2012 to June 30, 2012.  As of June 30, 2013, SIR had $235,000 outstanding and $515,000 available under the SIR revolving credit facility.

 

SIR also has a $350,000 unsecured term loan.  The SIR term loan matures on July 11, 2017 and is prepayable without penalty at any time.  In addition, the SIR term loan includes a feature under which maximum borrowings may be increased to up to $700,000 in certain circumstances.  The SIR term loan bears interest at a rate of LIBOR plus a premium, which was 155 basis points as of June 30, 2013.  The interest rate premium is subject to adjustment based upon changes to SIR’s leverage or credit ratings.  As of June 30, 2013, the interest rate for the amount outstanding under the SIR term loan was 1.8%.  The weighted average interest rate for the amount outstanding under the SIR term loan was 1.8% for both the three and six months ended June 30, 2013.

 

The SIR revolving credit facility agreement and the SIR term loan agreement provide for acceleration of payment of all amounts due thereunder upon the occurrence and continuation of certain events of default, including a change of control of SIR and the termination of SIR’s business management or property management agreements with RMR.

 

Credit Facility and Term Loan Debt Covenants:

 

Our public debt indentures and related supplements, our revolving credit facility agreement and our term loan agreement contain a number of financial and other covenants, including covenants that restrict our ability to incur indebtedness or to make distributions under certain circumstances and require us to maintain financial ratios and a minimum net worth.  The SIR revolving credit facility agreement and the SIR term loan agreement also contain a number of financial and other covenants, including covenants that restrict SIR’s ability to incur indebtedness or to make distributions under certain circumstances and require SIR to maintain financial ratios and a minimum net worth.  At June 30, 2013, we believe we and SIR, as applicable, were in compliance with all of our respective covenants under our public debt indentures, our revolving credit facility, our term loan, SIR’s revolving credit facility and SIR’s term loan agreements.

 

Mortgage Debt:

 

At June 30, 2013, 25 of our and SIR’s properties costing $1,333,240 with an aggregate net book value of $1,184,274 secured mortgage notes totaling $977,044 (including net premiums and discounts) maturing from 2014 through 2026.

 

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COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

Note 11.  Income Taxes

 

We have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended, and are generally not subject to federal and state income taxes provided we distribute a sufficient amount of our taxable income to our shareholders and meet other requirements for qualifying as a REIT.  However, we are subject to certain state, local and Australian taxes without regard to our REIT status.  Our provision for income taxes for the three and six months ended June 30, 2013 and 2012 consists of the following:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Current:

 

 

 

 

 

 

 

 

 

State

 

$

162

 

$

107

 

$

325

 

$

249

 

Foreign

 

519

 

 

1,382

 

 

 

 

681

 

107

 

1,707

 

249

 

 

 

 

 

 

 

 

 

 

 

Deferred:

 

 

 

 

 

 

 

 

 

Foreign

 

73

 

(15

)

35

 

335

 

 

 

73

 

(15

)

35

 

335

 

 

 

 

 

 

 

 

 

 

 

Income tax provision

 

$

754

 

$

92

 

$

1,742

 

$

584

 

 

At June 30, 2013 and December 31, 2012, we had deferred tax assets of $1,995 and $2,329, respectively, of which $1,896 and $2,181, respectively, related to different carrying amounts for financial reporting and for Australian income tax purposes of our properties in Australia.  At June 30, 2013 and December 31, 2012, we had deferred tax liabilities of $3,204 and $3,643, respectively.  Because we are uncertain of our ability to realize the future benefit of certain Australian loss carry forwards, we have reduced our net deferred income tax assets by a valuation allowance of $535 and $598 as of June 30, 2013 and December 31, 2012, respectively.

 

Note 12.  Fair Value of Assets and Liabilities

 

The table below presents certain of our assets and liabilities measured at fair value during 2013, categorized by the level of inputs used in the valuation of each asset and liability:

 

 

 

 

 

Fair Value at Reporting Date Using

 

 

 

 

 

Quoted Prices in

 

 

 

Significant

 

 

 

 

 

Active Markets for

 

Significant Other

 

Unobservable

 

 

 

 

 

Identical Assets

 

Observable Inputs

 

Inputs

 

Description

 

Total

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

 

 

 

 

 

 

 

 

 

 

Recurring Fair Value Measurements:

 

 

 

 

 

 

 

 

 

Effective portion of interest rate swap contracts(1)

 

$

(12,791

)

$

 

$

(12,791

)

$

 

 

 

 

 

 

 

 

 

 

 

Non-Recurring Fair Value Measurements:

 

 

 

 

 

 

 

 

 

Properties held for sale(2)

 

$

127,504

 

$

 

$

 

$

127,504

 

 

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COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 


(1)         The fair value of our interest rate swap contracts is determined using the net discounted cash flows of the expected cash flows of each derivative based on the market based interest rate curve (level 2 inputs) and adjusted for our credit spread and the actual and estimated credit spreads of the counterparties (level 3 inputs).  Although we have determined that the majority of the inputs used to value our derivatives fall within level 2 of the fair value hierarchy, the credit valuation adjustments associated with our derivatives utilize level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by us and the counterparties.  As of June 30, 2013, we have assessed the significance of the impact of the credit valuation adjustments on the overall valuation of our derivative positions and have determined that the credit valuation adjustments are not significant to the overall valuation of our derivatives.  As a result, we have determined that our derivative valuations in their entirety are classified as level 2 inputs in the fair value hierarchy.

(2)         As of June 30, 2013, we recorded a net loss on asset impairment totaling $6,940 for one property in our CBD Office segment, 29 properties in our Suburban Office segment and 40 properties in our Industrial & Other segment to reduce the aggregate carrying value of these properties from $134,444 to their estimated fair value less costs to sell of $127,504.  All of these properties were classified as held for sale as of June 30, 2013 and December 31, 2012.  We used updated broker information, including recent purchase offers, for all 70 properties (level 3 inputs) in determining the fair value of these properties.  The valuation techniques and significant unobservable inputs used for our level 3 fair value measurements at June 30, 2013 were as follows:

 

Description

 

Fair Value
at June 30,
2013

 

Valuation
Techniques

 

Unobservable
Inputs

 

Range

 

Properties held for sale for which we recognized impairment losses

 

$

127,504

 

Purchase Offers

 

N/A

 

N/A

 

 

We are exposed to certain risks relating to our ongoing business operations, including the effect of changes in foreign currency exchange rates and interest rates.  The only risk we currently manage by using derivative instruments is a part of our interest rate risk.  Although we have not done so as of June 30, 2013, and have no present intention to do so, we may manage our Australian currency exchange exposure by borrowing in Australian dollars or using derivative instruments in the future, depending on the relative significance of our business activities in Australia at that time.  We have interest rate swap agreements to manage our interest rate risk exposure on $174,074 of mortgage debt due 2019, which require interest at a premium over LIBOR.  The interest rate swap agreements utilized by us qualify as cash flow hedges and effectively modify our exposure to interest rate risk by converting our floating interest rate debt to a fixed interest rate basis for this loan through December 1, 2016, thus reducing the impact of interest rate changes on future interest expense.  These agreements involve the receipt of floating interest rate amounts in exchange for fixed rate interest payments over the life of the agreements without an exchange of the underlying principal amount.  The fair value of our derivative instruments increased by $2,782 and $3,833 during the three and six months ended June 30, 2013, respectively, based primarily on changes in market interest rates.  The fair value of our derivative instruments decreased by $2,404 and $2,441 during the three and six months ended June 30, 2012, respectively, based primarily on changes in market interest rates.  As of June 30, 2013 and December 31, 2012, the fair value of these derivative instruments included in accounts payable and accrued expenses and cumulative other comprehensive (loss) income in our condensed consolidated balance sheets totaled ($12,791) and ($16,624), respectively. We may enter additional interest rate swaps or hedge agreements to manage some of our additional interest rate risk associated with our floating rate borrowings.  The table below presents the effects of our interest rate derivatives in our condensed consolidated statements of operations and condensed consolidated statements of comprehensive (loss) income for the three and six months ended June 30, 2013 and 2012:

 

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COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Balance at beginning of period

 

$

(15,573

)

$

(15,833

)

$

(16,624

)

$

(15,796

)

Amount of income (loss) recognized in cumulative other comprehensive (loss) income

 

1,546

 

(3,641

)

1,361

 

(4,890

)

Amount of loss reclassified from cumulative other comprehensive (loss) income into interest expense

 

1,236

 

1,237

 

2,472

 

2,449

 

Unrealized gain (loss) on derivative instruments

 

2,782

 

(2,404

)

3,833

 

(2,441

)

Balance at end of period

 

$

(12,791

)

$

(18,237

)

$

(12,791

)

$

(18,237

)

 

Over the next 12 months, we estimate that approximately $4,820 will be reclassified from cumulative other comprehensive income as an increase to interest expense.

 

In addition to the assets and liabilities described in the above table, our financial instruments include our cash and cash equivalents, rents receivable, investment in direct financing lease receivable, real estate mortgages receivable, restricted cash, revolving credit facilities, senior notes and mortgage notes payable, accounts payable and accrued expenses, rent collected in advance, security deposits and amounts due to related persons.  At June 30, 2013 and December 31, 2012, the fair values of these additional financial instruments were not materially different from their carrying values, except as follows:

 

 

 

June 30, 2013

 

December 31, 2012

 

 

 

Carrying

 

Fair

 

Carrying

 

Fair

 

 

 

Amount

 

Value

 

Amount

 

Value

 

Senior notes and mortgage notes payable

 

$

2,257,435

 

$

2,364,479

 

$

2,932,951

 

$

3,181,522

 

 

The fair values of our senior notes and mortgage notes payable are based on estimates using discounted cash flow analyses and currently prevailing interest rates adjusted by credit risk spreads (level 3 inputs).

 

Other financial instruments that potentially subject us to concentrations of credit risk consist principally of rents receivable; however, as of June 30, 2013, no single tenant of ours is responsible for more than 2% of our total annualized rents.

 

We maintain derivative financial instruments, including interest rate swaps, with major financial institutions and monitor the amount of credit exposure to any one counterparty.

 

Note 13.  Earnings Per Common Share

 

Assuming no fundamental change (as described below) has occurred, as of June 30, 2013, we had 15,180,000 shares of series D cumulative convertible preferred shares that were convertible into 7,298,165 of our common shares and the effect of our convertible preferred shares on income from continuing operations attributable to CommonWealth REIT common shareholders per share is anti-dilutive for all periods presented.

 

As stated in Note 3 above, we believe that the Corvex/Related consent solicitation has no legal effect.  However, if the arbitration panel determines that the Corvex/Related consent solicitation is legally effective and the entire Board of Trustees has been removed, such removal would constitute a fundamental change under our 6.5% series D cumulative convertible preferred shares giving holders of such shares the option to convert these shares into common shares at a ratio based on 98% of the average closing market price for a period before such removal is effective unless the Company repurchases these shares for their par value plus accrued and unpaid distributions.  This issuance of such a large number of common shares as a result of the exercise of this conversion

 

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Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

right may have a dilutive effect on income from continuing operations attributable to CommonWealth REIT common shareholders per share.

 

Note 14.  Segment Information

 

Our primary business is the ownership and operation of a nationwide portfolio of commercial properties.  We account for each of our individual properties as separate operating segments.  We have aggregated our separate operating segments into three reportable segments based on our primary method of internal reporting: CBD office properties, suburban office properties and industrial & other properties.  Each of our reportable segments includes properties with similar operating and economic characteristics that are subject to unique supply and demand conditions.  Our operating segments (i.e., our individual properties) are managed and operated consistently in accordance with our standard operating procedures, and our management responsibilities do not vary significantly from location to location based on the size of the property or geographic location within each primary reporting segment.  In addition to our three reportable segments, we aggregate our operating segments into geographic regions for financial reporting purposes.  We define these individual geographic regions as those which currently, or during either of the last two quarters, represent or generate 5% or more of our total square feet, annualized rental income or property net operating income, or NOI, which we define as income from our real estate including lease termination fees received from tenants less our property operating expenses, which expenses include property marketing costs.  NOI excludes amortization of capitalized tenant improvement costs and leasing commissions.

 

As of June 30, 2013, we owned 54 CBD office properties, 246 suburban office properties and 145 industrial & other properties, excluding properties classified as held for sale.  Our geographic regions include Metro Chicago, IL, Oahu, HI, Metro Philadelphia, PA, and Other Markets, which includes properties located elsewhere throughout the United States and Australia.  Prior periods have been restated to reflect 40 office properties and 57 industrial properties reclassified to discontinued operations from continuing operations as of December 31, 2012 and three properties reclassified from our Suburban Office segment to our CBD Office segment as of March 31, 2013.

 

Property level information by geographic region and property type as of June 30, 2013 and for the three and six months ended June 30, 2013 and 2012, is as follows:

 

 

 

As of June 30, 2013

 

As of June 30, 2012

 

 

 

CBD

 

Suburban

 

Industrial &

 

 

 

CBD

 

Suburban

 

Industrial &

 

 

 

 

 

Office

 

Office

 

Other

 

Totals

 

Office

 

Office

 

Other

 

Totals

 

Property square feet (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Metro Chicago, IL

 

3,601

 

1,166

 

104

 

4,871

 

3,592

 

1,164

 

104

 

4,860

 

Oahu, HI

 

 

 

17,914

 

17,914

 

 

 

17,876

 

17,876

 

Metro Philadelphia, PA

 

4,597

 

255

 

 

4,852

 

4,596

 

255

 

 

4,851

 

Other Markets

 

13,853

 

18,927

 

12,300

 

45,080

 

12,306

 

17,244

 

10,733

 

40,283

 

Totals

 

22,051

 

20,348

 

30,318

 

72,717

 

20,494

 

18,663

 

28,713

 

67,870

 

 

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Table of Contents

 

COMMONWEALTH REIT

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(dollars in thousands, except per share data)

 

 

 

Three Months Ended June 30, 2013

 

Three Months Ended June 30, 2012

 

 

 

CBD

 

Suburban

 

Industrial
&

 

 

 

CBD

 

Suburban

 

Industrial
&

 

 

 

 

 

Office

 

Office

 

Other

 

Totals

 

Office

 

Office

 

Other

 

Totals

 

Property rental income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Metro Chicago, IL

 

$

25,747

 

$

6,200

 

$

111

 

$

32,058

 

$

26,472

 

$

6,748

 

$

111

 

$

33,331

 

Oahu, HI

 

 

 

20,976

 

20,976

 

 

 

18,298

 

18,298

 

Metro Philadelphia, PA

 

25,503

 

893

 

 

26,396

 

29,287

 

940

 

 

30,227

 

Other Markets

 

88,555

 

82,684

 

24,097

 

195,336

 

77,492

 

69,453

 

20,996

 

167,941

 

Totals

 

$

139,805

 

$

89,777

 

$

45,184

 

$

274,766

 

$

133,251

 

$

77,141

 

$

39,405

 

$

249,797

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Property NOI:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Metro Chicago, IL

 

$

13,411

 

$

3,155

 

$

102

 

$

16,668

 

$

13,909

 

$

3,660

 

$

103

 

$

17,672

 

Oahu, HI

 

 

 

16,624

 

16,624

 

 

 

14,171

 

14,171

 

Metro Philadelphia, PA

 

12,905

 

249

 

 

13,154

 

16,193

 

227

 

 

16,420

 

Other Markets

 

48,810

 

51,307

 

18,449

 

118,566

 

42,265

 

41,273

 

14,962

 

98,500

 

Totals

 

$

75,126

 

$

54,711

 

$

35,175

 

$

165,012

 

$

72,367

 

$

45,160

 

$

29,236

 

$

146,763

 

 

 

 

Six Months Ended June 30, 2013

 

Six Months Ended June 30, 2012

 

 

 

CBD

 

Suburban

 

Industrial
&

 

 

 

CBD

 

Suburban

 

Industrial
&

 

 

 

 

 

Office

 

Office

 

Other

 

Totals

 

Office

 

Office

 

Other

 

Totals

 

Property rental income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Metro Chicago, IL

 

$

50,896

 

$

12,791

 

$

222

 

$

63,909

 

$

51,047

 

$

12,611

 

$

222

 

$

63,880

 

Oahu, HI

 

 

 

42,187

 

42,187

 

 

 

38,193

 

38,193

 

Metro Philadelphia, PA

 

54,634

 

1,768

 

 

56,402

 

58,587

 

1,784

 

 

60,371

 

Other Markets

 

177,026

 

162,351

 

47,939

 

387,316

 

151,756

 

137,889

 

41,086

 

330,731

 

Totals

 

$

282,556

 

$

176,910

 

$

90,348

 

$

549,814

 

$

261,390

 

$

152,284

 

$

79,501

 

$

493,175