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 2020 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 and those related to our expectations concerning the effects of the COVID-19 pandemic on our future operations and balance sheet, constitute "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. 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: •The impact of the COVID-19 pandemic on our business, our tenants and the economy in general, including the measures taken by governmental authorities to address it; •Changes in general economic and business conditions, including the financial condition of our tenants and the value of our real estate assets; •Changes toU.S. laws, regulations, rules and policies, including changes that may be forthcoming as a result of the change in administration in theU.S. ; •TheGeneral Partner's continued qualification as a REIT forU.S. federal income tax purposes; •Heightened competition for tenants and potential decreases in property occupancy; •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, or at all; •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 trade disputes and tariffs on goods imported inthe United States ; •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"). 23 -------------------------------------------------------------------------------- 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 2020 Annual Report. The risk factors contained in our 2020 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 2020 Annual Report. AtMarch 31, 2021 , we: •Owned or jointly controlled 546 primarily industrial properties, of which 520 properties with 152.0 million square feet were in service and 26 properties with 10.4 million square feet were under development. The 520 in-service properties were comprised of 483 consolidated properties with 141.3 million square feet and 37 unconsolidated joint venture properties with 10.7 million square feet. The 26 properties under development are all consolidated properties with 10.4 million square feet. •Owned directly, or through ownership interests in unconsolidated joint ventures (with acreage not adjusted for our percentage ownership interest), approximately 500 acres of land and controlled approximately 800 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 higher barrier markets with the highest growth potential.
COVID-19
During 2020, the industrial sector remained resilient throughout the pandemic as
an essential business. Leading into 2021, the economy continues to recover due
to higher vaccination rates, government stimulus and support from the United
States Federal Reserve enabling businesses to re-open. Our leasing activity was
substantial during the first quarter, driven by e-commerce demand and higher
inventory levels to reduce potential future supply chain disruptions. We have
continued to start new development projects in early 2021 across the markets in
which we operate, with speculative development focused on coastal infill
markets.
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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 at
March 31, 2021 and 2020, respectively:
Total Square Feet Percent of
(in thousands) Total Square Feet Percent Leased* Average Annual Net Effective Rent**
Type 2021 2020 2021 2020 2021 2020 2021 2020
Industrial 141,087 135,114 99.9 % 99.8 % 97.6 % 96.6 % $5.33 $5.04
Non-reportable Rental Operations 211 211 0.1 % 0.2 % 96.8 % 80.0 % $22.31 $24.36
Total Consolidated 141,298 135,325 100.0 % 100.0 % 97.6 % 96.6 % $5.36 $5.06
Unconsolidated Joint Ventures 10,673 11,109 97.6 % 95.7 % $4.37 Total Including Unconsolidated Joint Ventures 151,971 146,434 97.6 % 96.5 %
* 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 atMarch 31, 2021 , compared toMarch 31, 2020 , was due to leasing up speculative developments. Vacancy Activity The following table sets forth vacancy activity, shown in square feet, from our in-service rental properties for the three months endedMarch 31, 2021 (in thousands): Unconsolidated Joint Total Including Unconsolidated Consolidated Properties Venture Properties Joint Venture Properties Vacant square feet at December 31, 2020 3,716 150 3,866 Vacant space in completed developments 210 - 210 Expirations 1,177 106 1,283 Early lease terminations 42 - 42 Leasing of previously vacant space (1,780) - (1,780) Vacant square feet at March 31, 2021 3,365 256 3,621 25
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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 second
generation 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
2021 2020
New Leasing Activity - First Generation 2,918 1,333
New Leasing Activity - Second Generation 1,253 259
Renewal Leasing Activity 2,737 656
Early Renewal Leasing Activity * 136 58
Short-Term New Leasing Activity ** 50 655
Short-Term Renewal Leasing Activity ** 345 78
Total Consolidated Leasing Activity 7,439 3,039
Unconsolidated Joint Venture Leasing Activity - 975
Total Including Unconsolidated Joint Venture
Leasing Activity 7,439 4,014
* 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.
Second Generation Leases The following table sets forth the estimated costs of tenant improvements and leasing commissions, 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 months endedMarch 31, 2021 and 2020: Square Feet of Leases Percent of Expiring Leases (in thousands) Renewed Average Term in Years Estimated Tenant Improvement Cost per Square Foot Leasing Costs per Square Foot 2021 2020 2021 2020 2021 2020 2021 2020 2021 2020 Three Months Consolidated - New Second Generation 1,253 259 7.3 4.1$1.66 $3.87 $2.93 $1.95 Unconsolidated Joint Ventures - New Second Generation - - - - $- $- $- $- Total - New Second Generation 1,253 259 7.3 4.1$1.66 $3.87 $2.93 $1.95 Consolidated - Renewal 2,737 656 87.9 % 58.4 % 4.7 4.6$0.31 $1.29 $1.39 $1.16 Unconsolidated Joint Ventures - Renewal - 497 - % 87.9 % - 4.4 $-$0.48 $-$1.72 Total - Renewal 2,737 1,153 85.0 % 68.3 % 4.7 4.5$0.31 $0.94 $1.39 $1.40 26
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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, is as follows:
Three Months Ended March 31,
Ownership Type 2021 2020
Consolidated properties 25.3 % 27.8 %
Unconsolidated joint venture properties - % 44.1 %
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