DUKE REALTY CORPORATION The following Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to help the reader understand our operations and our present business environment. Management's Discussion and Analysis is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the notes thereto contained in Part I, Item 1 of this Report, and the consolidated financial statements and notes thereto contained in Part IV, Item 15 of our 2021 Annual Report.
Cautionary Notice Regarding Forward-Looking Statements
Certain statements contained in or incorporated by reference into this Report, including, without limitation, those related to our future operations, constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act. The words "believe," "estimate," "expect," "anticipate," "intend," "plan," "strategy," "continue," "seek," "may," "could" and similar expressions or statements regarding future periods are intended to identify forward-looking statements, although not all forward-looking statements may contain such words. These forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause our actual results, performance or achievements, or industry results, to differ materially from any predictions of future results, performance or achievements that we express or imply in this Report or in the information incorporated by reference into this Report. Some of the risks, uncertainties and other important factors that may affect future results include, among others: •Changes in general economic and business conditions, including the financial condition of our tenants and the value of our real estate assets; •Risks associated with our ability to consummate the Mergers with Prologis and the timing and closing of the Mergers including, among other things, the ability of the General Partner to obtain shareholder approval required to consummate the Mergers, the satisfaction or waiver of other conditions to closing in the Merger Agreement, unanticipated difficulties or expenditures relating to the Mergers, the response of tenants to the announcement of the Mergers, potential difficulties in employee retention as a result of the Mergers, the occurrence of any event, change or other circumstances that could give rise to the termination of the Mergers and the outcome of legal proceedings instituted against the General Partner, its directors and others related to the Mergers; •Changes toU.S. laws, regulations, rules and policies; •TheGeneral Partner's continued qualification as a REIT forU.S. federal income tax purposes; •Heightened competition for tenants and potential decreases in property occupancy; •Adverse events concerning our major tenants; •Potential changes in the financial markets and interest rates; •Volatility in the General Partner's stock price and trading volume; •Our continuing ability to raise funds on favorable terms; •Our ability to successfully identify, acquire, develop and/or manage properties on terms that are favorable to us; •Potential increases in real estate construction costs including construction cost increases as the result of inflation and supply chain constraints; •Our real estate asset concentration in the industrial sector and potential volatility in this sector; •Our ability to successfully dispose of properties on terms that are favorable to us; •Our ability to successfully integrate our acquired properties; •Our ability to retain our current credit ratings; •Inherent risks related to disruption of information technology networks and related systems and cyber security attacks; •Inherent risks in the real estate business, including, but not limited to, tenant defaults, potential liability relating to environmental matters and liquidity of real estate investments; and •Other risks and uncertainties described herein, as well as those risks and uncertainties discussed from time to time in our other reports and other public filings with theSecurities and Exchange Commission (the "SEC"). 24 -------------------------------------------------------------------------------- Although we presently believe that the plans, expectations and anticipated results expressed in or suggested by the forward-looking statements contained in or incorporated by reference into this Report are reasonable, all forward-looking statements are inherently subjective, uncertain and subject to change, as they involve substantial risks and uncertainties, including those beyond our control. New factors emerge from time to time, and it is not possible for us to predict the nature, or assess the potential impact, of each new factor on our business. Given these uncertainties, we caution you not to place undue reliance on these forward-looking statements. We undertake no obligation to update or revise any of our forward-looking statements for events or circumstances that arise after the statement is made, except as otherwise may be required by law. The above list of risks and uncertainties is only a summary of some of the most important factors and is not intended to be exhaustive. Additional information regarding risk factors that may affect us is included in our 2021 Annual Report and in Part II, Item 1A, "Risk Factors" in this Report. The risk factors contained in our 2021 Annual Report are updated by us from time to time in Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other filings that we make with theSEC . Business Overview
The General Partner and Partnership collectively specialize in the ownership, management and development of industrial real estate.
The General Partner is a self-administered and self-managed REIT that began operations in 1986 and is the sole general partner of the Partnership. The Partnership is a limited partnership formed in 1993, at which time all of the properties and related assets and liabilities of the General Partner, as well as proceeds from a secondary offering of the General Partner's common shares, were contributed to the Partnership. Simultaneously, the Partnership completed the acquisition ofDuke Associates , a full-service commercial real estate firm operating in the Midwest whose operations began in 1972. We operate the General Partner and the Partnership as one enterprise, and therefore, our discussion and analysis refers to the General Partner and its consolidated subsidiaries, including the Partnership, collectively. A more complete description of our business, and of management's philosophy and priorities, is included in our 2021 Annual Report. AtJune 30, 2022 , we: •Owned or jointly controlled 561 primarily industrial properties, of which 522 properties totaling 154.9 million square feet were in service and 39 properties totaling 12.6 million square feet were under development. The 522 in-service properties were comprised of 479 consolidated properties totaling 139.7 million square feet and 43 unconsolidated joint venture properties totaling 15.2 million square feet. The 39 properties under development consisted of 36 consolidated properties totaling 10.9 million square feet and three unconsolidated joint venture properties totaling 1.7 million square feet. •Owned directly, or through ownership interests in unconsolidated joint ventures (with acreage not adjusted for our percentage ownership interest), approximately 450 acres of undeveloped land and controlled approximately 900 undeveloped acres through purchase options.
Our overall strategy is to continue to increase our investment in quality industrial properties primarily through development, on both a speculative and build-to-suit basis, supplemented with acquisitions in Coastal Tier 1 markets.
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Proposed Merger with Prologis
OnJune 11, 2022 , the General Partner entered into the Merger Agreement with Prologis by which Prologis will acquire the General Partner in an all-stock transaction. The respective boards of directors of the General Partner and Prologis have unanimously approved the Mergers and related transactions. Under the terms of the Merger Agreement, shareholders of the General Partner and holders of Limited Partner Units in the Partnership will receive 0.475 of a Prologis share or limited partnership interests in Prologis OP, respectively, for each common share of the General Partner or each Limited Partner Unit in the Partnership that they own. The transaction, which is currently expected to close in the fourth quarter of 2022, is subject to the approval of the General Partner's and Prologis's shareholders and other customary closing conditions.
Key Performance Indicators
Our operating results depend primarily upon rental income from our Rental Operations. The following discussion highlights the metrics that drive the performance of our Rental Operations, which management uses to operate the business, and that we consider to be critical drivers of future revenues.
Occupancy Analysis
Occupancy is an important metric for management and our investors for understanding our financial performance. Our ability to maintain high occupancy rates is among the principal drivers of maintaining and increasing rental revenue. The following table sets forth percent leased and average net effective rent information regarding our in-service portfolio of rental properties atJune 30, 2022 and 2021, respectively: Total Square Feet Percent of (in thousands) Total Square Feet Percent Leased* Average Annual Net Effective Rent** Type 2022 2021 2022 2021 2022 2021 2022 2021 Industrial 139,534 141,835 99.8 % 99.9 % 99.7 % 98.0 %$6.07 $5.43 Non-reportable Rental Operations 211 211 0.2 % 0.1 % 93.8 % 93.1 %$22.64 $22.63 Total Consolidated 139,745 142,046 100.0 % 100.0 % 99.6 % 98.0 %$6.10 $5.46 Unconsolidated Joint Ventures 15,154 10,315 100.0 % 97.1 %$4.87
Total Including Unconsolidated Joint Ventures 154,899 152,361 99.7 % 97.9 %
* Represents the percentage of total square feet leased based on executed leases and without regard to whether the leases have commenced. **Average annual net effective rent represents average annual base rental payments per leased square foot, on a straight-line basis for the term of each lease, from space leased to tenants at the end of the most recent reporting period. This amount excludes additional amounts paid by tenants as reimbursement for operating expenses.
The higher leased percentage in our industrial portfolio at
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--------------------------------------------------------------------------------Vacancy Activity
The following table sets forth vacancy activity, shown in square feet, from our in-service rental properties for the six months endedJune 30, 2022 (in thousands): Unconsolidated Joint Total Including Unconsolidated Consolidated Properties Venture Properties Joint Venture Properties Vacant square feet at December 31, 2021 2,626 257 2,883 Vacant space in acquisitions 75 - 75 Expirations 2,015 125 2,140 Early lease terminations 297 - 297 Property structural changes/other 1 - 1 Leasing of previously vacant space (4,524) (382) (4,906) Vacant square feet at June 30, 2022 490 - 490 Total Leasing Activity Our ability to maintain and improve occupancy and net effective rents primarily depends upon our continuing ability to lease vacant space. The volume and quality of our leasing activity is closely scrutinized by management in operation of the business and provides useful information regarding future performance. The initial leasing of development projects or vacant space in acquired properties is referred to as first generation lease activity. The leasing of such space that we have previously held under lease to a tenant is referred to as second generation lease activity. Second generation lease activity may be in the form of renewals of existing leases or new leases of previously leased space. The total leasing activity for our consolidated and unconsolidated industrial rental properties, expressed in square feet of leases signed, is as follows (in thousands): Three Months Ended June 30, Six Months Ended June 30, 2022 2021 2022 2021 New Leasing Activity - First Generation 1,563 330 4,518 3,248 New Leasing Activity - Second Generation 2,361 1,424 2,940 2,677 Renewal Leasing Activity 4,588 3,404 6,983 6,141 Early Renewal Leasing Activity * 1,206 908 1,396 1,044 Short-Term New Leasing Activity ** 7 168 157 218 Short-Term Renewal Leasing Activity ** 62 1,218 535 1,563Non-Reportable Rental Operations Leasing Activity 12 - 12 - Total Consolidated Leasing Activity 9,799 7,452 16,541 14,891Unconsolidated Joint Venture Leasing Activity 67 185 1,047 185 Total Including Unconsolidated Joint Venture Leasing Activity 9,866 7,637 17,588 15,076
* Early renewals represent renewals executed more than two years in advance of a lease's originally scheduled end date. ** Short-term leases represent leases with a term of less than twelve months.
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--------------------------------------------------------------------------------Second Generation Leases
The following table sets forth the estimated costs of tenant improvements and leasing costs, on a per square foot basis, that we are obligated to fulfill under the second generation industrial leases signed for our rental properties during the three and six months endedJune 30, 2022 and 2021: Square Feet of Leases Percent of Expiring Leases (in thousands) Renewed Average Term in Years Estimated Tenant Improvement Cost per Square Foot Leasing Commissions per Square Foot
Leasing Concessions per Square Foot
2022 2021 2022 2021 2022 2021 2022 2021 2022 2021 2022 2021
Three Months
Consolidated - New Second Generation 2,361 1,424 5.6 4.3 $1.66 $1.35 $2.83 $2.66 $- $-
Unconsolidated Joint Ventures - New
Second Generation - 14 - 8.3 - 10.89 - 5.28 - -
Total - New Second Generation 2,361 1,438 5.6 4.3 $1.66 $1.44 $2.83 $2.69 $- $-
Consolidated - Renewal 4,588 3,404 77.8 % 77.3 % 5.6 6.6 $0.65 $0.67 $2.01 $1.84 $0.02 $0.32
Unconsolidated Joint Ventures - Renewal 67 40 100.0 % 100.0 % 5.0 5.0 1.00 2.49 2.62 2.96 - -
Total - Renewal 4,655 3,444 78.1 % 77.5 % 5.6 6.6 $0.66 $0.69 $2.02 $1.86 $0.02 $0.31
Six Months
Consolidated - New Second Generation 2,940 2,677 6.2 5.7 $1.93 $1.49 $3.34 $2.79 $- $0.17
Unconsolidated Joint Ventures - New
Second Generation 382 14 10.3 8.3 2.71 10.89 4.34 5.28 - -
Total - New Second Generation 3,322 2,691 6.6 5.7 $2.02 $1.54 $3.45 $2.80 $- $0.17
Consolidated - Renewal 6,983 6,141 80.4 % 81.7 % 5.5 5.7 $0.76 $0.51 $1.87 $1.64 $0.05 $0.26
Unconsolidated Joint Ventures - Renewal 91 40 42.0 % 27.3 % 5.0 5.0 0.80 2.49 2.59 2.96 - -
Total - Renewal 7,074 6,181 79.4 % 80.6 % 5.5 5.7 $0.76 $0.52 $1.88 $1.65 $0.05 $0.25 Growth in average annual net effective rents for new second generation and renewal leases, on a combined basis, for our consolidated and unconsolidated industrial rental properties at our ownership share, is as follows:
Three Months Ended June 30, Six Months Ended June 30,
Ownership Type 2022 2021 2022 2021
Consolidated properties 68.9 % 36.4 % 63.3 % 31.7 %
Unconsolidated joint venture properties 104.8 % 17.4 % 53.3 % 17.4 %
Total 69.0 % 36.2 % 63.1 % 31.7 %
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