HIGHWOODS PROPERTIES, INC.
The Company is a fully integrated office real estate investment trust ("REIT")
that owns, develops, acquires, leases and manages properties primarily in the
best business districts (BBDs) of Atlanta , Charlotte , Nashville , Orlando ,
Pittsburgh , Raleigh , Richmond and Tampa . The Company conducts its activities
through the Operating Partnership . The Operating Partnership is managed by the
Company, its sole general partner. Additional information about us can be found
on our website at www.highwoods.com. Information on our website is not part of
this Quarterly Report.
You should read the following discussion and analysis in conjunction with the accompanying Consolidated Financial Statements and related notes contained elsewhere in this Quarterly Report.
Disclosure Regarding Forward-Looking Statements
Some of the information in this Quarterly Report may contain forward-looking
statements. Such statements include, in particular, statements about our plans,
strategies and prospects under this section. You can identify forward-looking
statements by our use of forward-looking terminology such as "may," "will,"
"expect," "anticipate," "estimate," "continue" or other similar words. Although
we believe that our plans, intentions and expectations reflected in or suggested
by such forward-looking statements are reasonable, we cannot assure you that our
plans, intentions or expectations will be achieved. When considering such
forward-looking statements, you should keep in mind important factors that could
cause our actual results to differ materially from those contained in any
forward-looking statement, including the following:
•buyers may not be available and pricing may not be adequate with respect to planned dispositions of non-core assets;
•comparable sales data on which we based our expectations with respect to the sales price of non-core assets may not reflect current market trends;
•the extent to which the ongoing COVID-19 pandemic impacts our financial condition, results of operations and cash flows depends on future developments, which are highly uncertain and cannot be predicted with confidence, including the scope, severity and duration of the pandemic and its impact on theU.S. economy and potential changes in customer behavior that could adversely affect the use of and demand for office space;
•the financial condition of our customers could deteriorate or further worsen, which could be further exacerbated by the COVID-19 pandemic;
•our assumptions regarding potential losses related to customer financial difficulties due to the COVID-19 pandemic could prove incorrect;
•counterparties under our debt instruments, particularly our revolving credit facility, may attempt to avoid their obligations thereunder, which, if successful, would reduce our available liquidity;
•we may not be able to lease or re-lease second generation space, defined as previously occupied space that becomes available for lease, quickly or on as favorable terms as old leases;
•we may not be able to lease newly constructed buildings as quickly or on as favorable terms as originally anticipated;
•we may not be able to complete development, acquisition, reinvestment, disposition or joint venture projects as quickly or on as favorable terms as anticipated;
•development activity in our existing markets could result in an excessive supply relative to customer demand;
•our markets may suffer declines in economic and/or office employment growth;
•unanticipated increases in interest rates could increase our debt service costs;
•unanticipated increases in operating expenses could negatively impact our operating results;
•natural disasters and climate change could have an adverse impact on our cash flow and operating results;
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•we may not be able to meet our liquidity requirements or obtain capital on
favorable terms to fund our working capital needs and growth initiatives or
repay or refinance outstanding debt upon maturity; and
•the Company could lose key executive officers.
This list of risks and uncertainties, however, is not intended to be exhaustive. You should also review the other cautionary statements we make in "Item 1A. Risk Factors" set forth in our 2020 Annual Report on Form 10-K. Given these uncertainties, you should not place undue reliance on forward-looking statements. We undertake no obligation to publicly release the results of any revisions to these forward-looking statements to reflect any future events or circumstances or to reflect the occurrence of unanticipated events. Executive Summary Highwoods is in the work-placemaking business. We believe that in creating environments and experiences where the best and brightest can achieve together what they cannot apart, Highwoods delivers greater value to our customers, their teammates and, in turn, our stockholders. Our simple strategy is to own and manage high-quality workplaces in the BBDs within our footprint, maintain a strong balance sheet to be opportunistic throughout economic cycles, employ a talented and dedicated team and communicate transparently with all stakeholders. We focus on owning and managing buildings in the most dynamic and vibrant BBDs. BBDs are highly-energized and amenitized workplace locations that enhance our customers' ability to attract and retain talent. They are both urban and suburban. Providing the most talent-supportive workplace options in these environments is core to the Highwoods work-placemaking strategy.
COVID-19
The COVID-19 pandemic has obviously had a significant impact on theU.S. economy sinceMarch 2020 . It is very difficult to predict when, if and to what extent economic activity will return to pre-COVID-19 levels. The COVID-19 pandemic did have somewhat of an impact on our third quarter of 2021 financial results. Our financial results for the remainder of 2021 and future leasing activity could be adversely affected by the COVID-19 pandemic. Factors that could cause actual results to differ materially from our current expectations are set forth under "Disclosure Regarding Forward-Looking Statements." While all buildings and parking facilities have remained open for business, the usage of our assets has continued to remain significantly lower than pre-pandemic levels. As a result, compared to pre-pandemic levels, parking and parking-related revenues have continued to be low, largely offsetting reduced operating expenses, net of expense recoveries. Until usage increases, which will depend on the duration of the COVID-19 pandemic, which is difficult to estimate, we expect that reduced usage will continue to result in reduced parking revenues, which will be partially offset by reduced operating expenses. We currently do not expect usage will meaningfully increase until at least the first quarter of 2022.
Revenues
Our operating results depend heavily on successfully leasing and operating the office space in our portfolio. Economic growth and office employment levels in our core markets are important factors, among others, in predicting our future operating results. The key components affecting our rental and other revenues are average occupancy, rental rates, cost recovery income, new developments placed in service, acquisitions and dispositions. Average occupancy generally increases during times of improving economic growth, as our ability to lease space outpaces vacancies that occur upon the expirations of existing leases. Average occupancy generally declines during times of slower or negative economic growth, when new vacancies tend to outpace our ability to lease space. Asset acquisitions, dispositions and new developments placed in service directly impact our rental revenues and could impact our average occupancy, depending upon the occupancy rate of the properties that are acquired, sold or placed in service. A further indicator of the predictability of future revenues is the expected lease expirations of our portfolio. As a result, in addition to seeking to increase our average occupancy by leasing current vacant space, we also concentrate our leasing efforts on renewing existing leases prior to expiration. For more information regarding our lease expirations, see "Properties - Lease Expirations" in our 2020 Annual Report on Form 10-K. Occupancy in our office portfolio increased from 90.3% atDecember 31, 2020 to 90.4% atSeptember 30, 2021 . We expect average occupancy for our office portfolio to be approximately 90% to 91% for the remainder of 2021. However, average occupancy in the remainder of 2021 will be lower, perhaps significantly lower, if the COVID-19 pandemic causes vacancies and move-outs due to customers that default on their leases, file bankruptcy or otherwise experience significant financial difficulty. Potential changes in customer behavior, such as the continued social acceptance, desirability and perceived economic benefits of work-from-home 35 -------------------------------------------------------------------------------- Table of Contents arrangements, could also materially and negatively impact the future demand for office space, resulting in slower overall leasing and negatively impacting our revenues. Whether or not our rental revenue tracks average occupancy proportionally depends upon whether GAAP rents under signed new and renewal leases are higher or lower than the GAAP rents under expiring leases. Annualized rental revenues from second generation leases expiring during any particular year are typically less than 15% of our total annual rental revenues. The following table sets forth information regarding second generation office leases signed during the third quarter of 2021 (we define second generation office leases as leases with new customers and renewals of existing customers in office space that has been previously occupied under our ownership and leases with respect to vacant space in acquired buildings): New Renewal All Office Leased space (in rentable square feet) 245,199 427,148 672,347 Average term (in years - rentable square foot weighted) 5.8 6.3 6.1 Base rents (per rentable square foot) (1)$ 28.94 $ 33.48 $ 31.82 Rent concessions (per rentable square foot) (1) (1.67) (1.28) (1.42) GAAP rents (per rentable square foot) (1)$ 27.27 $ 32.20 $ 30.40 Tenant improvements (per rentable square foot) (1)$ 5.65 $ 3.74 $ 4.44 Leasing commissions (per rentable square foot) (1)$ 0.99
__________
(1) Weighted average per rentable square foot on an annual basis over the lease term.
Annual combined GAAP rents for new and renewal leases signed in the third
quarter were
We strive to maintain a diverse, stable and creditworthy customer base. We have an internal guideline whereby customers that account for more than 3% of our annualized revenues are periodically reviewed with the Company's Board of Directors. As ofSeptember 30, 2021 , the Federal Government (3.7%) andBank of America (3.6%) accounted for more than 3% of our annualized cash revenues.
Expenses
Our expenses primarily consist of rental property expenses, depreciation and amortization, general and administrative expenses and interest expense. From time to time, expenses also include impairments of real estate assets. Rental property expenses are expenses associated with our ownership and operation of rental properties and include expenses that vary somewhat proportionately to occupancy levels, such as janitorial services and utilities, and expenses that do not vary based on occupancy, such as property taxes and insurance. Depreciation and amortization is a non-cash expense associated with the ownership of real property and generally remains relatively consistent each year, unless we buy, place in service or sell assets, since our properties and related building and tenant improvement assets are depreciated on a straight-line basis over fixed lives. General and administrative expenses consist primarily of management and employee salaries and benefits, corporate overhead and short and long-term incentive compensation.
Net Operating Income
Whether or not we record increasing net operating income ("NOI") in our same
property portfolio typically depends upon our ability to garner higher rental
revenues, whether from higher average occupancy, higher GAAP rents per rentable
square foot or higher cost recovery income, that exceed any corresponding growth
in operating expenses. Same property NOI was $1.9 million , or 1.6%, higher in
the third quarter of 2021 as compared to 2020 due to an increase of $2.5 million
in same property revenues offset by an increase of $0.6 million in same property
expenses. We expect same property NOI to be lower for the remainder of 2021 as
compared to 2020 as an anticipated increase in same property expenses, mostly
from the gradual increase in usage of our assets, is expected to more than
offset higher anticipated same property revenues. We expect same property
revenues to be higher due to higher average GAAP rents per rentable square foot
and higher cost recovery and parking income, partially offset by an anticipated
decrease in average occupancy. Same property NOI could be further negatively
impacted if the COVID-19 pandemic causes losses related to customer
difficulties.
In addition to the effect of same property NOI, whether or not NOI increases
typically depends upon whether the NOI from our acquired properties and
development properties placed in service exceeds the NOI from property
dispositions. NOI was $10.8 million , or 8.7%, higher in the third quarter of
2021 as compared to 2020 primarily due to the acquisitions of real estate
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assets from Preferred Apartment Communities, Inc. (NYSE:APTS) ("PAC") and our
joint venture partner's 75.0% interest in our Highwoods DLF Forum, LLC joint
venture (the "Forum"), development properties placed in service and higher same
property NOI, partially offset by NOI lost from property dispositions. We expect
NOI to be higher for the remainder of 2021 as compared to 2020 due to the
acquisitions of real estate assets from PAC and our joint venture partner's
75.0% interest in the Forum and development properties placed in service,
partially offset by NOI lost from property dispositions and lower same property
NOI. Similar to same property NOI, NOI could be negatively impacted if the
COVID-19 pandemic causes losses related to customer difficulties.
Cash Flows
In calculating net cash related to operating activities, depreciation and amortization, which are non-cash expenses, are added back to net income. We have historically generated a positive amount of cash from operating activities. From period to period, cash flow from operations depends primarily upon changes in our net income, as discussed more fully below under "Results of Operations," changes in receivables and payables and net additions or decreases in our overall portfolio. Net cash related to investing activities generally relates to capitalized costs incurred for leasing and major building improvements and our acquisition, development, disposition and joint venture activity. During periods of significant net acquisition and/or development activity, our cash used in such investing activities will generally exceed cash provided by investing activities, which typically consists of cash received upon the sale of properties and distributions from our joint ventures. Net cash related to financing activities generally relates to distributions, incurrence and repayment of debt, and issuances, repurchases or redemptions of Common Stock, Common Units and Preferred Stock. We use a significant amount of our cash to fund distributions. Whether or not we have increases in the outstanding balances of debt during a period depends generally upon the net effect of our acquisition, disposition, development and joint venture activity. We generally use our revolving credit facility for daily working capital purposes, which means that during any given period, in order to minimize interest expense, we may record significant repayments and borrowings under our revolving credit facility.
For a discussion regarding dividends and distributions, see "Liquidity and Capital Resources - Dividends and Distributions."
Liquidity and Capital Resources
We continue to maintain a conservative and flexible balance sheet and believe we have ample liquidity to fund our operations and growth prospects. As ofOctober 19, 2021 , we had$155.0 million drawn on our$750.0 million revolving credit facility, which is scheduled to mature inMarch 2025 . Assuming we are in compliance with our covenants, we have an option to extend the maturity for two additional six-month periods. AtSeptember 30, 2021 , our leverage ratio, as measured by the ratio of our mortgages and notes payable and outstanding preferred stock to the undepreciated book value of our assets, was 41.0% and there were 107.2 million diluted shares of Common Stock outstanding. Rental and other revenues are our principal source of funds to meet our short-term liquidity requirements. Other sources of funds for short-term liquidity needs include available working capital and borrowings under our revolving credit facility. Our short-term liquidity requirements primarily consist of operating expenses, interest and principal amortization on our debt, distributions and capital expenditures, including building improvement costs, tenant improvement costs and lease commissions. Building improvements are capital costs to maintain or enhance existing buildings not typically related to a specific customer. Tenant improvements are the costs required to customize space for the specific needs of customers. We anticipate that our available cash and cash equivalents and cash provided by operating activities and planned financing activities, including borrowings under our revolving credit facility, will be adequate to meet our short-term liquidity requirements. We use our revolving credit facility for working capital purposes and for the short-term funding of our development and acquisition activity and, in certain instances, the repayment of other debt. Continued ability to borrow under our revolving credit facility allows us to quickly capitalize on strategic opportunities at short-term interest rates. We generally believe existing cash and rental and other revenues will continue to be sufficient to fund short-term liquidity needs such as funding operating and general and administrative expenses, paying interest expense, maintaining our existing quarterly dividend and funding existing portfolio capital expenditures, including building improvement costs, tenant improvement costs and lease commissions.
Our long-term liquidity uses generally consist of the retirement or refinancing of debt upon maturity, funding of building improvements, new building developments and land infrastructure projects and funding acquisitions of buildings and
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development land. Additionally, we may, from time to time, retire outstanding
equity and/or debt securities through redemptions, open market repurchases,
privately negotiated acquisitions or otherwise.
We expect to meet our long-term liquidity needs through a combination of:
•cash flow from operating activities;
•bank term loans and borrowings under our revolving credit facility;
•the issuance of unsecured debt;
•the issuance of secured debt;
•the issuance of equity securities by the Company or the
•the disposition of non-core assets.
We have no material debt scheduled to mature until the fourth quarter of 2022.
We generally believe we will be able to satisfy these obligations with existing
cash, borrowings under our revolving credit facility, new bank term loans,
issuance of other unsecured debt, mortgage debt and/or proceeds from the sale of
additional non-core assets.
Investment Activity
A key tenet of our strategic plan is to continuously upgrade the quality of our
office portfolio through acquisitions, dispositions and development. We
generally seek to acquire and develop office buildings that improve the average
quality of our overall portfolio and deliver consistent and sustainable value
for our stockholders over the long-term. Whether or not an asset acquisition or
new development results in higher per share net income or funds from operations
("FFO") in any given period depends upon a number of factors, including whether
the NOI for any such period exceeds the actual cost of capital used to finance
the acquisition or development. Additionally, given the length of construction
cycles, development projects are not placed in service until, in some cases,
several years after commencement. Sales of non-core assets could result in lower
per share net income or FFO in any given period in the event the resulting use
of proceeds does not exceed the capitalization rate on the sold properties.
During the third quarter of 2021, we closed the acquisition of a portfolio of
real estate assets from PAC. The portfolio consists of the following assets:
Asset Market Submarket/BBD Square Footage
150 Fayetteville Raleigh CBD 560,000
CAPTRUST Towers Raleigh North Hills 300,000
Capitol Towers Charlotte SouthPark 479,000
Morrocroft Centre Charlotte SouthPark 291,000
Galleria 75 Redevelopment Site
Our total purchase price, net of closing credits and cash acquired, was$653.6 million , including$4.5 million of capitalized acquisition costs. The acquisition included the assumption of four secured loans recorded at fair value of$403 million in the aggregate, with a weighted average effective interest rate of 3.54% and a weighted average maturity of 10.7 years. We incurred$3.5 million of debt issuance costs related to these assumptions. With respect to non-core assets we had previously agreed to acquire from PAC, the mezzanine loan related to a recently constructed office building inAtlanta was paid off in full by the third party borrower and PAC sold Armour Yards, a multi-building creative office project inAtlanta , to a third party. 38
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Results of Operations
Three Months Ended
Rental and Other Revenues
Rental and other revenues were$14.5 million , or 8.0%, higher in the third quarter of 2021 as compared to 2020 primarily due to the acquisitions of real estate assets from PAC and our joint venture partner's 75.0% interest in the Forum, development properties placed in service and higher same property revenues, which increased rental and other revenues by$15.0 million ,$2.7 million and$2.5 million , respectively. Same property rental and other revenues were higher primarily due to higher average GAAP rents per rentable square foot, higher parking income and lower credit losses, partially offset by a decrease in average occupancy. These increases were partially offset by lost revenue of$6.0 million from property dispositions. We expect rental and other revenues to be higher for the remainder of 2021 as compared to 2020 for similar reasons. Rental and other revenues could be negatively impacted if the COVID-19 pandemic causes losses related to customer difficulties.
Operating Expenses
Rental property and other expenses were$3.7 million , or 6.5%, higher in the third quarter of 2021 as compared to 2020 primarily due to the acquisitions of real estate assets from PAC and our joint venture partner's 75.0% interest in the Forum, higher same property operating expenses and development properties placed in service, which increased operating expenses by$4.0 million ,$0.6 million and$0.4 million , respectively. Same property operating expenses were higher primarily due to higher contract services, repairs and maintenance and utilities as a result of the gradual increase in the usage of our assets. These increases were partially offset by a$1.8 million decrease in operating expenses from property dispositions. We expect rental property and other expenses to be higher for the remainder of 2021 as compared to 2020 for similar reasons. Depreciation and amortization was$6.2 million , or 10.4%, higher in the third quarter of 2021 as compared to 2020 primarily due to the acquisitions of real estate assets from PAC and our joint venture partner's 75.0% interest in the Forum, development properties placed in service and higher same property lease related depreciation and amortization, partially offset by fully amortized acquisition-related intangible assets and property dispositions. We expect depreciation and amortization to be higher for the remainder of 2021 as compared to 2020 for similar reasons. General and administrative expenses were$1.2 million , or 13.1%, higher in the third quarter of 2021 as compared to 2020 due to higher incentive compensation, partially offset by lower salaries and benefits. We experienced lower salaries in 2021 as a result of the reduction in the number of employees throughout 2020 primarily due to our exiting of theGreensboro andMemphis markets and the subsequent closing of those division offices and the resulting synergies garnered from the ongoing simplification of our business. We expect general and administrative expenses to be relatively consistent for the remainder of 2021 as compared to 2020 due to higher incentive compensation offset by lower salaries, severance and early retirement costs.
Interest Expense
Interest expense was$2.1 million , or 10.6%, higher in the third quarter of 2021 as compared to 2020 primarily due to higher average debt balances, partially offset by higher capitalized interest and lower average interest rates. We expect interest expense to be higher for the remainder of 2021 as compared to 2020 due to higher average debt balances and lower capitalized interest.
Other Income/(Loss)
Other income/(loss) was income of$0.4 million in the third quarter of 2021 as compared to a loss of$3.3 million in the third quarter of 2020 primarily due to losses on debt extinguishment in 2020.
Gains on Disposition of Property
Gains on disposition of property were$28.6 million higher in the third quarter of 2021 as compared to 2020 due to the net effect of the disposition activity in such periods. 39 -------------------------------------------------------------------------------- Table of Contents Equity in Earnings of Unconsolidated Affiliates Equity in earnings of unconsolidated affiliates was$0.3 million , or 33.7%, lower in the third quarter of 2021 as compared to 2020 primarily due to the acquisition of our joint venture partner's 75.0% interest in the Forum. We expect equity in earnings of unconsolidated affiliates to be lower for the remainder of 2021 as compared to 2020 for the same reason. Equity in earnings of unconsolidated affiliates could be negatively impacted if the COVID-19 pandemic causes losses related to customer difficulties.
Earnings Per Common Share - Diluted
Diluted earnings per common share was$0.30 higher in the third quarter of 2021 as compared to 2020 due to an increase in net income for the reasons discussed above.
Nine Months Ended
Rental and Other Revenues
Rental and other revenues were$7.8 million , or 1.4%, higher in the nine months endedSeptember 30, 2021 as compared to 2020 primarily due to the acquisitions of real estate assets from PAC and our joint venture partner's 75.0% interest in the Forum, development properties placed in service, the recognition of deferred leasing commission income that was received in connection with the Forum acquisition and higher same property revenues, which increased rental and other revenues by$22.6 million ,$5.0 million ,$1.5 million and$0.3 million , respectively. Same property rental and other revenues were higher primarily due to higher average GAAP rents per rentable square foot and lower credit losses, partially offset by a decrease in average occupancy. These increases were partially offset by lost revenue of$21.4 million from property dispositions.
Operating Expenses
Rental property and other expenses were$1.2 million , or 0.7%, lower in the nine months endedSeptember 30, 2021 as compared to 2020 primarily due to property dispositions and lower same property operating expenses, which decreased operating expenses by$7.7 million and$0.5 million , respectively. Same property operating expenses were lower primarily due to lower utilities and contract services as a result of reduced usage of our assets because of the COVID-19 pandemic. These decreases were partially offset by the acquisitions of real estate assets from PAC and our joint venture partner's 75.0% interest in the Forum and development properties placed in service, which increased operating expenses by$5.7 million and$0.8 million , respectively. Depreciation and amortization was$8.5 million , or 4.7%, higher in the nine months endedSeptember 30, 2021 as compared to 2020 primarily due to the acquisition s of real estate assets from PAC and our joint venture partner's 75.0% interest in the Forum, development properties placed in service and higher same property lease related depreciation and amortization, partially offset by fully amortized acquisition-related intangible assets and property dispositions.
We recorded an impairment of real estate assets of
General and administrative expenses were$0.2 million , or 0.8%, higher in the nine months endedSeptember 30, 2021 as compared to 2020 primarily due to higher incentive compensation, partially offset by lower salaries, benefits, severance and early retirement costs. We experienced lower salaries and benefits in 2021 as a result of the reduction in the number of employees throughout 2020 primarily due to our exiting of theGreensboro andMemphis markets and the subsequent closing of those division offices and the resulting synergies garnered from the ongoing simplification of our business.
Interest Expense
Interest expense was
Other Income/(Loss)
Other income/(loss) was income of
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Gains on Disposition of Property
Gains on disposition of property were
Equity in Earnings of Unconsolidated Affiliates
Equity in earnings of unconsolidated affiliates was
Earnings Per Common Share - Diluted
Diluted earnings per common share was
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