CITY OFFICE REIT, INC. The following discussion and analysis is based on, and should be read in conjunction with, the condensed, consolidated financial statements and the related notes thereto of theCity Office REIT, Inc. contained in this Quarterly Report on Form 10-Q (this "Report"). As used in this section, unless the context otherwise requires, references to "we," "our," "us," and "our company" refer toCity Office REIT, Inc. , aMaryland corporation, together with our consolidated subsidiaries, includingCity Office REIT Operating Partnership L.P. , aMaryland limited partnership, of which we are the sole general partner and which we refer to in this section as ourOperating Partnership , except where it is clear from the context that the term only meansCity Office REIT, Inc. Cautionary Statement Regarding Forward-Looking Statements This quarterly report on Form 10-Q, including "Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition," contains both historical and forward-looking statements. All statements, other than statements of historical fact are, or may be deemed to be, forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We have used the words "approximately," "anticipate," "assume," "believe," "budget," "contemplate," "continue," "could," "estimate," "expect," "future," "intend," "may," "outlook," "plan," "potential," "predict," "project," "seek," "should," "target," "will" and similar terms and phrases to identify forward-looking statements in this Report. All of our forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those that we are expecting, including:
• adverse economic or real estate developments in the office sector or the
markets in which we operate;
• changes in local, regional, national and international economic
conditions, including as a result of the ongoing
COVID-19
pandemic;
• requests from tenants for rent deferrals, rent abatement or relief from
other contractual obligations, or a failure to pay rent, as a result of
changes in business behavior stemming from the ongoing
COVID-19
pandemic or the availability of government assistance programs;
• our inability to compete effectively;
• our inability to collect rent from tenants or renew tenants' leases on
attractive terms if at all;
• demand for and market acceptance of our properties for rental purposes;
• defaults on or
non-renewal
of leases by tenants, including as a result of the ongoing
COVID-19
pandemic;
• increased interest rates and any resulting increase in financing or
operating costs;
• decreased rental rates or increased vacancy rates, including as a result
of changes in business behavior or market dynamics related to the ongoing
COVID-19
pandemic;
• our failure to obtain necessary financing or access the capital markets
on favorable terms or at all;
• changes in the availability of acquisition opportunities;
• availability of qualified personnel;
• our inability to successfully complete real estate acquisitions or
dispositions on the terms and timing we expect, or at all;
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• our failure to successfully operate acquired properties and operations;
• changes in our business, financing or investment strategy or the markets
in which we operate;
• our failure to generate sufficient cash flows to service our outstanding
indebtedness;
• environmental uncertainties and risks related to adverse weather
conditions and natural disasters;
• our failure to qualify and maintain our status as a real estate
investment trust ("REIT");
• government approvals, actions and initiatives, including the need for
compliance with environmental requirements or actions in response to the
COVID-19
pandemic;
• outcome of claims and litigation involving or affecting us;
• financial market fluctuations;
• changes in real estate, taxation and zoning laws and other legislation
and government activity and changes to real property tax rates and the
taxation of REITs in general; and
• other factors described in our news releases and filings with the
to those described in our Annual Report on Form
10-K
for the year ended
in our subsequent reports filed with the
The forward-looking statements contained in this Report are based on historical performance and management's current plans, estimates and expectations in light of information currently available to us and are subject to uncertainty and changes in circumstances. There can be no assurance that future developments affecting us will be those that we have anticipated. Actual results may differ materially from these expectations due to the factors, risks and uncertainties described above, changes in global, regional or local political, economic, business, competitive, market, regulatory and other factors described in our news releases and filings with theSEC , including but not limited to those described in our Annual Report on Form 10-K for the year endedDecember 31, 2019 under the heading "Risk Factors" and in our subsequent reports filed with theSEC , many of which are beyond our control. Should one or more of these risks or uncertainties materialize, or should any of our assumptions prove to be incorrect, our actual results may vary in material respects from what we may have expressed or implied by these forward-looking statements. We caution that you should not place undue reliance on any of our forward-looking statements. Any forward-looking statement made by us in this Report speaks only as of the date of this Report. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by applicable securities laws. Overview Company We were formed as aMaryland corporation onNovember 26, 2013 . OnApril 21, 2014 , we completed our initial public offering ("IPO") of shares of common stock. We contributed the net proceeds of the IPO to ourOperating Partnership in exchange for common units in ourOperating Partnership . Both we and ourOperating Partnership commenced operations upon completion of the IPO and certain related formation transactions. Revenue Base As ofSeptember 30, 2020 , we owned 25 properties comprised of 65 office buildings with a total of approximately 5.8 million square feet of net rentable area ("NRA"). As ofSeptember 30, 2020 , our properties were approximately 93.1% leased. 20 -------------------------------------------------------------------------------- Table of Contents Office Leases Historically, most leases for our properties were on a full-service gross or net lease basis, and we expect to continue to use such leases in the future. A full-service gross lease generally has a base year expense "stop", whereby we pay a stated amount of expenses as part of the rent payment while future increases (above the base year stop) in property operating expenses are billed to the tenant based on such tenant's proportionate square footage in the property. The property operating expenses are reflected in operating expenses; however, only the increased property operating expenses above the base year stop recovered from tenants are reflected as tenant recoveries within rental and other revenues in our statements of operations. In a triple net lease, the tenant is typically responsible for all property taxes and operating expenses. As such, the base rent payment does not include any operating expenses, but rather all such expenses are billed to or paid by the tenant. The full amount of the expenses for this lease type is reflected in operating expenses, and the reimbursement is reflected in tenant recoveries within rental and other revenues. All tenants in the Lake Vista Pointe, 2525 McKinnon, Sorrento Mesa andCanyon Park properties have triple net leases. Certain tenants at AmberGlen,Cherry Creek , Superior Pointe,Florida Research Park ,Circle Point , The Quad,Cascade Station and Denver Tech have leases on a triple net basis. We are also a lessor for a fee simple ground lease at the AmberGlen property. All of our remaining leases are full-service gross leases. Factors That May Influence Our Operating Results and Financial Condition COVID-19 During the first quarter of 2020, theWorld Health Organization declared the COVID-19 outbreak a pandemic. There have been mandates from international, federal, state and local authorities requiring forced closures of businesses and other facilities, and most of the markets in which our buildings are located are subject to some form of ongoing pandemic-related restrictions. These forced closures and restrictions have had a material adverse effect on the global economy and the regionalU.S. economies in which we operate, including negatively impacting some of our tenants' ability to pay their rent. All of our buildings are open and continue to operate. We have adopted new policies and procedures to incorporate best practices for the safety of our tenants, our vendors and our employees. However, the usage of our assets in the third quarter 2020 was significantly lower than normal. Usage of our assets in the near future depends on the duration of the pandemic and pace of economic re-opening, which is impossible to estimate. We continue to closely monitor the impact of the COVID-19 pandemic on all aspects of our business and geographies. While we did not experience any significant disruptions during the nine months endedSeptember 30, 2020 , as a result of COVID-19 or governmental or tenant actions in response thereto, the Company granted rent relief to nine tenants comprising approximately 1.0% of the Company's NRA, most often in the form of a rent deferral or rent abatement. Subsequent toSeptember 30, 2020 , the Company granted additional rent abatements to two tenantswho previously received relief, which combined comprises approximately 0.1% of the Company's NRA. Although the rent deferrals and rent abatements granted to date did not have a material impact on our net rental revenue, the long-term impact of the pandemic on our tenants and the world-wide economy is uncertain and impossible to estimate, and will depend on the scope, severity and duration of the pandemic. We believe that some of the industries most impacted by COVID-19 are coworking, retail, restaurant and café, travel and accommodation, live event related and energy. We generally have limited exposure to these industries, with these sectors comprising approximately 3% of our portfolio by square footage. However, the impact of COVID-19 extends to all sectors of theU.S. economy and as such, we expect that tenants outside of these select industries will also face significant challenges. Rating agencies have downgraded the credit rating and outlook of many businesses, including one of our ten largest tenants. 21 -------------------------------------------------------------------------------- Table of Contents ThroughNovember 2, 2020 , we have collected over 99% of contractually required base rents from our tenants for the three months endedSeptember 30, 2020 and granted rent relief for another approximately 0.5% of contractually required base rents from our tenants for the three months endedSeptember 30, 2020 . The rate of collections in future months may be lower, as the length of the economic downturn continues to impact tenants. We have developed dedicated teams and processes to evaluate non-payments and rent relief requests. We evaluate each tenant rent relief request on an individual basis, considering a number of factors. Not all tenant requests ultimately result in modification agreements, nor are we foregoing our contractual rights under our lease agreements. We believe many of these requests received were from tenantswho had the ability to pay rent at the time and were seeking opportunistic deferral opportunities. We continue to work efficiently to find tailored resolutions in each case where warranted, including potential deferrals of rent, lease term extensions with short-term rent relief, temporary percentage rent opportunities, or, in limited circumstances, rent abatement particularly when the tenant is viewed as an amenity to the building. We may incur additional losses in future periods due to tenants that default on their leases, file for bankruptcy and/or otherwise experience significant financial difficulty as a result of the duration of the COVID-19 pandemic, but the extent of those losses is impossible to predict given the fluidity of the pandemic and its uncertain impact on economic activity. Leasing activity has been slow and we believe it will continue to be impacted by COVID-19. We have experienced and we expect that we will experience slower than originally anticipated speculative new leasing and there remains uncertainty over existing tenants' long-term space requirements. Overall, this would reduce our anticipated rental revenues. In addition, we anticipate that as the COVID-19 pandemic continues, certain tenants in our markets may explore opportunities to sublease all or a portion of their leased square footage to other tenants or third parties. While subleasing generally does not impact the ability to collect payment from the original lessee and will not result in any decrease in the rental revenues expected to be received from the primary tenant, this trend could reduce our ability to lease incremental square footage to new tenants, could increase the square footage of our properties that "goes dark", reduce anticipated rental revenue should tenants determine their long-term needs for square footage are lower than originally anticipated and potentially impact the pricing and competitiveness for lease office space in our markets. Because construction activities have generally been classified as essential activities throughout our markets during the pandemic, we do not currently expect meaningful delays in customers taking occupancy under recently signed leases. Strategically, we have made adjustments to our business operations as a result of COVID-19. We have ceased acquisition activities, allocated capital towards our share repurchase programs and adjusted our common stock dividend which will allow us to operate with lower leverage and higher levels of liquidity than previously planned. For a discussion of the impact of the COVID-19 pandemic on our liquidity and balance sheet, see "Liquidity and Capital Resources" below. The situation surrounding COVID-19 remains fluid and we will continue to monitor and actively manage our response in collaboration with tenants, government officials and other third parties to optimally position the Company. Business and Strategy We focus on owning and acquiring office properties in our target markets. Our target markets generally possess what we believe are favorable economic growth trends, growing populations with above-average employment growth forecasts, a large number of government offices, large international, national and regional employers across diversified industries, are generally low-cost centers for business operations, and exhibit favorable occupancy trends. We utilize our management's market-specific knowledge and relationships as well as the expertise of local real estate operators and our investment partners to identify acquisition opportunities that we believe will offer cash flow stability and long-term value appreciation. Our target markets are attractive, among other reasons, because we believe that ownership is often concentrated among local real estate operators that typically do not benefit from the same access to capital as public REITs and there is a relatively low level of participation of large institutional investors. We believe that these factors result in attractive pricing levels and risk-adjusted returns. Although there have been higher COVID-19 cases in some of our markets, the long-term impact of the pandemic on these markets is uncertain and impossible to estimate, and will depend on the scope, severity and duration of the pandemic. 22 -------------------------------------------------------------------------------- Table of Contents Rental Revenue and Tenant Recoveries The amount of net rental revenue generated by our properties will depend principally on our ability to maintain the occupancy rates of currently leased space and to lease currently available space and space that becomes available from lease terminations. The amount of rental revenue generated also depends on our ability to maintain or increase rental rates at our properties. We believe that the average rental rates for our portfolio of properties are generally in-line or slightly below the current average quoted market rates. Negative trends in one or more of these factors could adversely affect our rental revenue in future periods. Future economic downturns or regional downturns affecting our markets or submarkets or downturns in our tenants' industries, including as a result of the COVID-19 pandemic, that impair our ability to renew or re-let space and the ability of our tenants to fulfill their lease commitments, as in the case of tenant bankruptcies, could adversely affect our ability to maintain or increase rental rates at our properties. In addition, growth in rental revenue will also partially depend on our ability to acquire additional properties that meet our investment criteria. 23 -------------------------------------------------------------------------------- Table of Contents Our Properties As ofSeptember 30, 2020 , we owned 25 properties comprised of 65 office buildings with a total of approximately 5.8 million square feet of NRA in the metropolitan areas ofDallas ,Denver ,Orlando ,Phoenix ,Portland ,San Diego ,Seattle andTampa . The following table presents an overview of our portfolio as ofSeptember 30, 2020 . Annualized NRA Annualized Gross Base Rent In Place Annualized Base Rent per Square (2) Economic (000s Square Rent per Square Foot Metropolitan Area Property Interest Feet) Occupancy Foot (1) ($000s) Phoenix, AZ (20.8% of NRA) Pima Center 100.0 % 272 85.0 % $ 27.58 $ 27.58$ 6,371 SanTan 100.0 % 267 93.1 % $ 28.75 $ 28.75$ 7,133 5090 N 40 th St 100.0 % 175 95.8 % $ 29.79 $ 29.79$ 4,998 Camelback Square 100.0 % 174 79.8 % $ 29.50 $ 29.50$ 4,098 The Quad 100.0 % 163 100.0 % $ 30.11 $ 30.43$ 4,909 Papago Tech 100.0 % 163 90.9 % $ 22.63 $ 22.63$ 3,347 Denver, CO (19.9%) Cherry Creek 100.0 % 356 100.0 % $ 18.95 $ 19.67$ 6,740 Circle Point 100.0 % 272 94.3 % $ 18.16 $ 32.16$ 4,658 Denver Tech (3) 100.0 % 381 93.7 % $ 23.02 $ 27.08$ 8,213 Superior Pointe 100.0 % 151 94.6 % $ 18.16 $ 30.62$ 2,600 Tampa, FL (17.9%) Park Tower 94.8 % 471 88.3 % $ 26.47 $ 26.47$ 11,015 City Center 95.0 % 242 90.3 % $ 26.26 $ 26.26$ 5,748 Intellicenter 100.0 % 204 100.0 % $ 24.53 $ 24.53$ 4,993 Carillon Point 100.0 % 124 100.0 % $ 28.77 $ 28.77$ 3,572 Orlando, FL Florida Research Park (12.4%) (4) 96.6 % 397 98.5 % $ 23.44 $ 26.87$ 9,147 Central Fairwinds 97.0 % 168 90.5 % $ 26.20 $ 26.20$ 3,990 Greenwood Blvd 100.0 % 155 100.0 % $ 23.25 $ 23.25$ 3,605 San Diego, CA (9.9%) Sorrento Mesa 100.0 % 296 85.3 % $ 26.02 $ 34.02$ 6,570 Mission City 100.0 % 281 91.1 % $ 36.35 $ 36.35$ 9,316 Dallas, TX (9.9%) 190 Office Center 100.0 % 303 81.2 % $ 25.65 $ 25.65$ 6,313 Lake Vista Pointe 100.0 % 163 100.0 % $ 16.50 $ 25.50$ 2,695 2525 McKinnon 100.0 % 111 91.6 % $ 28.60 $ 45.60$ 2,918 Portland, OR (5.7%) AmberGlen 76.0 % 203 98.4 % $ 22.01 $ 24.55$ 4,388 Cascade Station 100.0 % 128 100.0 % $ 27.12 $ 28.49$ 3,457 Seattle, WA (3.5%) Canyon Park 100.0 % 207 100.0 % $ 21.84 $ 29.84$ 4,515 Total / Weighted Average -September 30, 2020 (5) 5,827 93.1 % $ 24.95 $ 27.91$ 135,309
(1) Annualized gross rent per square foot includes adjustment for estimated
expense reimbursements of triple net leases for the year ended
2020.
(2) Annualized base rent is calculated by multiplying (i) rental payments
(defined as cash rents before abatements) for the month ended
2020 by (ii) 12.
(3) Denver Tech is comprised of 7601 Tech and 7595 Tech (formerly "DTC
Crossroads").
(4)
(5) Averages weighted based on the property's NRA, adjusted for occupancy.
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Operating Expenses
Our operating expenses generally consist of utilities, property and ad valorem
taxes, insurance and site maintenance costs. Increases in these expenses over
tenants' base years (until the base year is reset at expiration) are generally
passed along to tenants in our full-service gross leased properties and are
generally paid in full by tenants in our net leased properties.
Conditions in Our Markets
Positive or negative changes in economic or other conditions in the markets we
operate in, including state budgetary shortfalls, employment rates, natural
hazards and other factors, may impact our overall performance. In addition, the
recent
COVID-19
pandemic has caused significant disruption in global financial markets and
economies. This global disruption could have a material impact on the markets in
which we operate, our tenants and our ability to successfully execute our
business strategy. The extent to which
COVID-19
will impact the Company is highly uncertain and is not reasonably estimable at
this time. Refer to "Item 1A. Risk Factors" in this Report for further
information.
Summary of Significant Accounting Policies
The interim condensed consolidated financial statements follow the same policies
and procedures as outlined in the audited consolidated financial statements for
the year ended December 31, 2019 included in our Annual Report on Form
10-K
for the year ended December 31, 2019 .
Results of Operations
Comparison of Three Months Ended September 30, 2020 to Three Months Ended
September 30, 2019
Rental and Other Revenues.
Revenue includes net rental income, including parking, signage and other income,
as well as the recovery of operating costs and property taxes from tenants.
Rental and other revenues increased $2.4 million , or 6%, to $41.3 million for
the three months ended September 30, 2020 compared to $38.9 million for the
three months ended September 30, 2019 . Of this increase, $1.1 million was
attributable to the acquisition of the 7601 Tech property, part of our Denver
Tech property, in September 2019 . Rental Revenue also benefited from higher
straight-line rent at our Denver Tech and Sorrento Mesa properties. Denver Tech
revenue increased by $0.5 million due to the occupancy of a major tenant at the
beginning of July who is in a free rent period and Sorrento Mesa revenue
increased by $0.8 million due to a significant lease renewal at higher rental
rates relative to the expiring leases, which the tenant will begin paying in the
fourth quarter of 2020. Our Cherry Creek property also benefited from a
$0.5 million lease termination fee payment during the three months ended
September 30, 2020 . Partially offsetting these increases, rental revenue
decreased by $0.3 million for the three months ended September 30, 2020 as a
result of the sale of the Logan Tower property in December 2019 . Further rental
revenue decreases were a result of lower occupancy at the 190 Office Center and
Pima Center properties which resulted in aggregate revenue decreases of
$0.3 million , and $0.3 million , respectively. The remaining properties' rental
and other revenues were relatively unchanged.
Operating Expenses
Total Operating Expenses.
Total operating expenses consist of property operating expenses, general and
administrative expenses and depreciation and amortization. Total operating
expenses increased by $0.4 million , or 1%, to $32.6 million for the three months
ended September 30, 2020 , from $32.2 million for the three months ended
September 30, 2019 . Total operating expenses increased by $0.7 million due to
the acquisition of the 7601 Tech property, part of our Denver Tech property in
September 2019 . Partially offsetting this increase, operating expenses were
$0.3 million lower due to the sale of the Logan Tower property in December 2019
and $0.3 million lower due to lower general and administrative expenses. The
remaining expenses were marginally higher in comparison to the prior-year
period.
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Property Operating Expenses.
Property operating expenses are comprised mainly of building common area and
maintenance expenses, insurance, property taxes, property management fees, as
well as certain expenses that are not recoverable from tenants, the majority of
which are related to costs necessary to maintain the appearance and
marketability of vacant space. In the normal course of business, property
expenses fluctuate and are impacted by various factors including, but not
limited to, occupancy levels, weather, utility costs, repairs, maintenance and
re-leasing
costs. Property operating expenses increased by $0.5 million , or 3%, to
$14.9 million for the three months ended September 30, 2020 , from $14.4 million
for the three months ended September 30, 2019 . Total operating expenses
increased by $0.4 million , due to the acquisition of the 7601 Tech property,
part of our Denver Tech property in September 2019 . Partially offsetting these
increases, property operating expenses decreased by $0.2 million due to the sale
of the Logan Tower property in December 2019 . The remaining expenses were
marginally higher in comparison to the prior-year period.
General and Administrative.
General and administrative expenses are comprised of public company reporting
costs and the compensation of our management team and board of directors, as
well as
non-cash
stock-based compensation expenses. General and administrative expenses decreased
$0.3 million , or 8%, to $2.5 million for the three months ended September 30,
2020 , from $2.8 million for the three months ended September 30, 2019 . General
and administrative expenses were lower primarily due to lower payroll, travel
and professional expenses due to
COVID-19.
Depreciation and Amortization.
Depreciation and amortization increased $0.2 million , or 1%, to $15.2 million
for the three months ended September 30, 2020 , from $15.0 million for the three
months ended September 30, 2019 , primarily due to the acquisition of the 7601
Tech property, part of our Denver Tech property in September 2019 . This increase
was partially offset by a decrease due to the sale of the Logan Tower property.
Other Expense (Income)
Interest Expense.
Interest expense decreased $0.8 million , or 10%, to $6.9 million for the three
months ended September 30, 2020 , from $7.7 million for the three months ended
September 30, 2019 . The decrease was primarily attributable to a decrease of
interest expense on our Unsecured Credit Facility (as defined herein) primarily
as a result of repayments using the net proceeds of the equity raises in the
second half of 2019.
Net Gain on the Sale of Real Estate Property.
We recorded a net gain on the sale of real estate property of $1.3 million for
the three months ended September 30, 2020 related to the sale of the land parcel
at the Circle Point property in July 2020 . The gross gain on sale was reduced by
disposal-related costs and taxes paid by our taxable REIT subsidiary.
Comparison of Nine Months Ended September 30, 2020 to Nine Months Ended
September 30, 2019
Rental and Other Revenues.
Revenue includes net rental income, including parking, signage and other income,
as well as the recovery of operating costs and property taxes from tenants.
Rental and other revenues increased $3.8 million , or 3%, to $121.0 million for
the nine months ended September 30, 2020 compared to $117.2 million for the nine
months ended September 30, 2019 . Of this increase, the acquisitions of 7601
Tech, Cascade Station and Canyon Park contributed increases of $3.8 million ,
$1.7 million and $1.3 million , respectively. Our Cherry Creek property also
benefited from a $0.9 million lease termination fee payment during the nine
months ended September 30, 2020 . Partially offsetting these increases, other
revenues benefited from a
one-time
payment of $2.6 million in the prior-year period received as consideration for
the assignment of a purchase contract. The assignment fee originated through our
administrative services relationship. Increases in rental revenue for the nine
months ended September 30, 2020 were also partially offset as a result of the
sale of Logan Tower in December 2019 , the 10455 Pacific Center building in our
Sorrento Mesa portfolio in May 2019 and Plaza 25 in February 2019 , which
decreased overall revenue by $1.0 million , $0.4 million and $0.2 million ,
respectively. The remaining properties' rental and other revenues were
relatively unchanged.
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Operating Expenses
Total Operating Expenses.
Total operating expenses consist of property operating expenses, general and
administrative expenses and depreciation and amortization. Total operating
expenses increased by $1.7 million , or 2%, to $96.9 million for the nine months
ended September 30, 2020 , from $95.2 million for the nine months ended
September 30, 2019 . Total operating expenses increased by $2.8 million ,
$1.2 million and $1.0 million , respectively, from the acquisitions of 7601 Tech,
Cascade Station and Canyon Park properties. Partially offsetting these
increases, total operating expenses decreased by $1.0 million , $0.4 million and
$0.2 million , respectively, due to the sale of Logan Tower , the 10455 Pacific
Center building in our Sorrento Mesa portfolio and Plaza 25 properties.
Operating expenses at our San Diego properties decreased by a combined
$0.3 million primarily due to a property tax refund received during the nine
months ended September 30, 2020 related to a prior-year appeal. General and
administrative expenses were also lower in the current year period primarily
because in the prior-year period, there were $1.1 million of
one-time
expenses incurred as a result of the assignment fee income earned during the
prior-year period. The remaining expenses were marginally lower in comparison to
the prior-year period.
Property Operating Expenses.
Property operating expenses are comprised mainly of building common area and
maintenance expenses, insurance, property taxes, property management fees, as
well as certain expenses that are not recoverable from tenants, the majority of
which are related to costs necessary to maintain the appearance and
marketability of vacant space. In the normal course of business, property
expenses fluctuate and are impacted by various factors including, but not
limited to, occupancy levels, weather, utility costs, repairs, maintenance and
re-leasing
costs. Property operating expenses increased by $0.9 million , or 2%, to
$43.7 million for the nine months ended September 30, 2020 , from $42.8 million
for the nine months ended September 30, 2019 . Property operating expenses
increased by $1.6 million , $0.5 million and $0.5 million , respectively, from the
acquisitions of 7601 Tech, Cascade Station and Canyon Park properties. Partially
offsetting these increases, property operating expenses decreased by
$0.6 million , $0.2 million and $0.2 million , respectively, due to the sale of
Logan Tower , the 10455 Pacific Center building in our Sorrento Mesa portfolio
and Plaza 25. Operating expenses at our San Diego properties decreased by a
combined $0.3 million primarily due to a property tax refund received during the
nine months ended September 30, 2020 related to a prior-year appeal. The
remaining expenses were marginally lower in comparison to the prior-year period.
General and Administrative.
General and administrative expenses are comprised of public company reporting
costs and the compensation of our management team and board of directors, as
well as
non-cash
stock-based compensation expenses. General and administrative expenses decreased
$0.4 million , or 5%, to $8.0 million for the nine months ended September 30,
2020 , from $8.4 million for the nine months ended September 30, 2019 . The
decrease was primarily because in the prior-year period, there were $1.1 million
of
one-time
expenses incurred as a result of the assignment fee income partially offset by
higher payroll and stock-based compensation costs for the current year.
Depreciation and Amortization.
Depreciation and amortization increased $1.1 million , or 3%, to $45.2 million
for the nine months ended September 30, 2020 , from $44.1 million for the nine
months ended September 30, 2019 , primarily due to the addition of the Canyon
Park , Cascade Station and 7601 Tech properties. These increases were partially
offset by a decrease at Logan Tower and the 10455 Pacific Center building of the
Sorrento Mesa portfolio due to the sale of those properties.
Other Expense (Income)
Interest Expense.
Interest expense decreased $2.2 million , or 10%, to $20.8 million for the nine
months ended September 30, 2020 , from $23.0 million for the nine months ended
September 30, 2019 . The decrease was primarily attributable to a decrease of
interest expense on our Unsecured Credit Facility (as defined herein) primarily
as a result of the repayments using the net proceeds of the equity raises during
the second half of 2019.
Net Gain on the Sale of Real Estate Property.
We recorded a net gain on the sale of real estate property of $1.3 million for
the nine months ended September 30, 2020 related to the sale of the land parcel
at the Circle Point property in July 2020 . The gross gain on sale was reduced by
disposal-related costs and taxes paid by our taxable REIT subsidiary. Net gain
on the sale of real estate property of $0.5 million for the nine months ended
September 30, 2019 related to the sale of the 10455 Pacific Center building of
the Sorrento Mesa property in May 2019 .
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Cash Flows
Comparison of Nine Months Ended September 30, 2020 to Nine Months Ended
September 30, 2019
Cash, cash equivalents and restricted cash were $56.4 million and $32.5 million
as of September 30, 2020 and September 30, 2019 , respectively.
Cash flow from operating activities.
Net cash provided by operating activities increased by $10.3 million to
$47.6 million for the nine months ended September 30, 2020 compared to
$37.3 million for the same period in 2019. The increase was primarily
attributable to increased operating cash flows from acquired properties and
changes in working capital.
Cash flow to investing activities.
Net cash used in investing activities decreased by $75.5 million to
$15.2 million for the nine months ended September 30, 2020 compared to
$90.7 million for the same period in 2019. The decrease in cash used in
investing activities was primarily due to no acquisitions of real estate and
lower proceeds from the sale of real estate during the nine months ended
September 30, 2020 compared to aggregate $108.4 million of acquisitions and
aggregate $33.9 million of dispositions for the same period in 2019.
Cash flow to financing activities.
Net cash used in financing activities increased by $116.4 million to
$63.5 million for the nine months ended September 30, 2020 compared to
$52.9 million provided by financing activities for the same period in 2019. The
increase in cash used in financing activities was primarily due to repurchases
of our common stock and no proceeds from sale of our common stock for the nine
months ended September 30, 2020 . The increase was partially offset by higher net
proceeds from our Unsecured Credit Facility borrowings in 2020 compared to 2019.
Liquidity and Capital Resources
Analysis of Liquidity and Capital Resources
We had approximately $38.4 million of cash and cash equivalents and
$18.0 million of restricted cash as of September 30, 2020 .
On March 15, 2018, the Company entered into a credit agreement for the
Unsecured Credit Facility (our "Unsecured Credit Facility") that provided for
commitments of up to $250 million , which includes an accordion feature that
allows the Company to borrow up to $500 million , subject to customary terms and
conditions. The Company's previous secured credit facility was replaced and
repaid in full from the proceeds of our Unsecured Credit Facility. Our Unsecured
Credit Facility matures in March 2022 and may be extended to March 2023 at the
Company's option upon meeting certain conditions. Borrowings under our Unsecured
Credit Facility bear an interest at a rate equal to the LIBOR rate plus a margin
of between 140 to 225 basis points depending upon the Company's consolidated
leverage ratio. As of September 30, 2020 , we had approximately $75.0 million
outstanding under our Unsecured Credit Facility and a $7.0 million letter of
credit to satisfy escrow requirements for a mortgage lender.
On September 27, 2019 , the Company entered into the five-year $50 million Term
Loan (the "Term Loan"), increasing its authorized borrowings under the Company's
Unsecured Credit Facility from $250 million to $300 million . Borrowings under
the Term Loan bear interest at a rate equal to the LIBOR rate plus a margin
between 125 to 215 basis points depending upon the Company's consolidated
leverage ratio. In conjunction with the Term Loan, the Company also entered into
the five-year interest rate swap for a notional amount of $50 million (the
"Interest Rate Swap"). Pursuant to the Interest Rate Swap, the Company will pay
a fixed rate of approximately 1.27% of the notional amount annually, payable
monthly, and receive floating rate
30-day
LIBOR payments.
On June 16, 2017 , the Company and the Operating Partnership previously entered
into equity distribution agreements (collectively, the "Initial Agreements")
with each of KeyBanc Capital Markets Inc. , Raymond James & Associates, Inc. and
BMO Capital Markets Corp. , (collectively, the "Initial Sales Agents"), pursuant
to which the Company may issue and sell from time to time shares of common stock
and the Company's 6.625% Series A Preferred Stock ("Series A Preferred Stock")
through the Initial Sales Agents, acting as agents or principals (the "Prior ATM
Program"). On November 1, 2018 , the Company and the Operating Partnership
entered into amendments (the "Initial Amendments") to the Initial Agreements (as
amended by the Amendments, the "Prior EDAs") with each of the Initial Sales
Agents to increase the number of shares of common stock issuable under the Prior
ATM Program. The Company terminated the Prior EDAs effective February 25, 2020 .
The Company did not issue any shares of common stock or Series A Preferred Stock
under the Prior ATM Program for the period beginning on January 1, 2020 through
the date the Prior EDAs were terminated or during the nine months ended
September 30, 2020 .
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On
equity distribution agreements (collectively, the "Agreements") with each ofKeyBanc Capital Markets Inc. ,Raymond James & Associates, Inc. ,BMO Capital Markets Corp. ,RBC Capital Markets, LLC ,B. Riley FBR, Inc. ,D.A. Davidson & Co. andJanney Montgomery Scott LLC (the "Sales Agents") pursuant to which the Company may issue and sell from time to time up to 15,000,000 shares common stock and up to 1,000,000 Series A Preferred Stock through the Sales Agents, acting as agents or principals (the "ATM Program"). The Company did not issue any shares of common stock or Series A Preferred Stock under the ATM Program during the nine months endedSeptember 30, 2020 . Our short-term liquidity requirements primarily consist of operating expenses and other expenditures associated with our properties, distributions to our limited partners and distributions to our stockholders required to qualify for REIT status, capital expenditures and, potentially, acquisitions. We expect to meet our short-term liquidity requirements through net cash provided by operations, reserves established from existing cash, proceeds from our public offerings, including under our at the market issuance program, and borrowings under our mortgage loans and our Unsecured Credit Facility. Our long-term liquidity needs consist primarily of funds necessary for the repayment of debt at maturity, property acquisitions and non-recurring capital improvements. We expect to meet our long-term liquidity requirements with net cash from operations, long-term secured and unsecured indebtedness and the issuance of equity and debt securities. We also may fund property acquisitions and non-recurring capital improvements using our Unsecured Credit Facility pending longer term financing. We believe we have access to multiple sources of capital to fund our long-term liquidity requirements, including the incurrence of additional debt and the issuance of additional equity securities. However, we cannot assure you that this is or will continue to be the case. Our ability to incur additional debt is dependent on a number of factors, including our degree of leverage, the value of our unencumbered assets and borrowing restrictions that may be imposed by lenders. Our ability to access the equity capital markets is dependent on a number of factors as well, including general market conditions for REITs and market perceptions about us. Contractual Obligations and Other Long-Term Liabilities The following table provides information with respect to our commitments as ofSeptember 30, 2020 , including any guaranteed or minimum commitments under contractual obligations. The table does not reflect available debt extension options. Payments Due by Period (in thousands) More than Contractual Obligations Total 2020 2021-2022 2023-2024 5 years Principal payments on mortgage loans$ 682,585 $ 1,571 $ 170,885 $ 173,254 $ 336,875 Interest payments (1) 119,184 6,425 44,222 37,089 31,448 Tenant-related commitments 7,467 2,310 5,157 - - Lease obligations 29,665 52 1,669 1,264 26,680 Total$ 838,901 $ 10,358 $ 221,933 $ 211,607 $ 395,003
(1) Contracted interest on the floating rate borrowings under our Unsecured
Credit Facility was calculated based on the balance and interest rate at
on the Interest Rate Swap rate fixing the LIBOR component of the borrowing
rate to approximately 1.27%.
Off-Balance
Sheet Arrangements As ofSeptember 30, 2020 , we had a$7.0 million letter of credit outstanding under our Unsecured Credit Facility to satisfy escrow requirements for a mortgage lender. 29 -------------------------------------------------------------------------------- Table of Contents Inflation Substantially all of our office leases provide for real estate tax and operating expense escalations. In addition, most of the leases provide for fixed annual rent increases. We believe that inflationary increases may be at least partially offset by these contractual rent increases and expense escalations. 30
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