PIEDMONT OFFICE REALTY TRUST, INC. The following discussion and analysis should be read in conjunction with the accompanying consolidated financial statements and notes thereto ofPiedmont Office Realty Trust, Inc. ("Piedmont," "we," "our," or "us"). See also "Cautionary Note Regarding Forward-Looking Statements" preceding Part I, as well as the consolidated financial statements and accompanying notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year endedDecember 31, 2019 . During the second quarter of 2020, we continued to experience the repercussions of the COVID-19 pandemic including forced closures and other restrictions that have had a material adverse effect on the global economy and the regionalU.S. economies in which we operate. Specifically, the pandemic has negatively impacted the trading price of our common stock and some of our tenants' ability to pay their rent. Further, it has caused changes in Piedmont's typical work practices and operations, including more frequent housekeeping and sanitization procedures. Our employees continue to practice social distancing, with many of them working from home, without disruption, utilizing our cloud-based technology platform. All of our properties remain open and fully operational for each tenant to utilize as they deem appropriate. Given our low-leverage operating model of long-term leases to creditworthy tenants, to date the COVID-19 disruption has not materially impacted our financial condition or results of operations, our overall liquidity position and outlook, or caused material impairments in our portfolio of operating properties. In response to the COVID-19 pandemic, we have completed stress testing of our various financial covenants assuming decreases in rental and parking income as appropriate and determined that we are still well margined with all our covenant ratios. During the second quarter, we collected approximately 99% of our scheduled contractual rents on a monthly basis. We have entered into lease modification agreements with approximately 50 of our tenants, a majority of which are small retail operators, who have experienced disruptions in their business as a result of the pandemic. Most of these agreements typically defer the payment of three months of rent until later in 2020, and in some cases into 2021. In addition, during the three months endedJune 30, 2020 , we took an approximate charge of$1.8 million against rental revenue in recognition of an increase in collectability risk. Further, as a precautionary measure, Piedmont established an approximately$4.9 million general reserve for potential future collectibility issues, which is approximately 1% of our annualized revenue. While the impact of the COVID-19 pandemic on our business has not been severe to date, the long-term impact of the pandemic on our tenants and the global economy is uncertain and will depend on the scope, severity and duration of the pandemic. A prolonged economic downturn or recession resulting from the pandemic could adversely affect many of our tenants which could, in turn, adversely impact our business, financial condition and results of operations. We will continue to work closely with our tenants and address their concerns on a case-by-case basis, seeking solutions that address immediate cash flow interruptions while maintaining long term lease obligations.
Liquidity and Capital Resources
We intend to use cash on hand, cash flows generated from the operation of our properties, net proceeds from the disposition of select properties, and proceeds from our$500 Million Unsecured 2018 Line of Credit as our primary sources of immediate liquidity. OnJune 25, 2020 , we completed the sale of1901 Market Street inPhiladelphia, Pennsylvania for$360 million and used the majority of the net sale proceeds to repay the$160 million mortgage associated with the property and the balance outstanding on our$500 Million Unsecured 2018 Line of Credit. As a result, we had$36.5 million of cash on hand as ofJune 30, 2020 and the full$500 million line of credit capacity was available as of the date of this filing. Although interest rate volatility and movements have made obtaining financing or refinancing debt obligations more challenging in the current environment, when necessary we may seek secured or unsecured borrowings from third party lenders or issue securities as additional sources of capital. The availability and attractiveness of terms for these additional sources of capital will be highly dependent on market conditions at the time. Our most consistent use of capital has historically been, and we believe will continue to be, to fund capital expenditures for our existing portfolio of properties. During the six months endedJune 30, 2020 and 2019 we incurred the following types of capital expenditures (in thousands):
Six Months Ended
Capital expenditures for redevelopment/renovations $
11,966
Other capital expenditures, including building and tenant improvements
42,986 25,609
Total capital expenditures (1) $
54,952
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(1)Of the total amounts paid, approximately$0.6 million and$1.3 million relates to soft costs such as capitalized interest, payroll, and other general and administrative expenses for the six months endedJune 30, 2020 and 2019, respectively. "Capital expenditures for redevelopment/renovations" during the six months endedJune 30, 2020 primarily related to a redevelopment project to upgrade amenities at our 200 South Orange building inOrlando, Florida , as well as a redevelopment master plan project to upgrade common areas, amenities, and parking, at our Galleria buildings inAtlanta, Georgia . Expenditures during the six months endedJune 30, 2019 primarily related to a redevelopment project to upgrade amenities at ourUS Bancorp building inMinneapolis, Minnesota . "Other capital expenditures, including building and tenant improvements" include all other capital expenditures during the period and are typically comprised of tenant and building improvements necessary to lease, maintain, or provide enhancements to our existing portfolio of office properties. Given that our operating model frequently results in leases for large blocks of space to credit-worthy tenants, our leasing success can result in capital outlays which vary from one reporting period to another based upon the specific leases executed. For example, for leases executed during the six months endedJune 30, 2020 , we committed to spend approximately$5.28 per square foot per year of lease term for tenant improvement allowances and lease commissions (net of expiring lease commitments) as compared to$5.12 (net of expired lease commitments) for the six months endedJune 30, 2019 . As ofJune 30, 2020 , we had one individually significant unrecorded tenant allowance commitment of approximately$53.6 million related to the approximately 20-year, 520,000 square foot renewal and expansion of theState of New York's lease at our60 Broad Street building inNew York City that was executed during the fourth quarter of 2019. In addition to the amounts that we have already committed to as a part of executed leases, we also anticipate continuing to incur similar market-based tenant improvement allowances and leasing commissions in conjunction with procuring future leases for our existing portfolio of properties. Both the timing and magnitude of expenditures related to future leasing activity can vary due to a number of factors, including being highly dependent on the competitive market conditions at the time of lease negotiations of the particular office market within which a given lease is signed. In particular, we are currently in the process of negotiating the renewal of a majority of the current 313,000 square foot lease with theCity of New York , at our60 Broad Street building. Depending on the length of the lease term, we anticipate spending significant capital for market-based tenant improvement allowances and leasing commissions over the next several years associated with the renewal. There are other uses of capital that may arise as part of our typical operations. Subject to the identification and availability of attractive investment opportunities and our ability to consummate such acquisitions on satisfactory terms, acquiring new assets consistent with our investment strategy could also be a significant use of capital. We may also use capital resources to repurchase additional shares of our common stock under our stock repurchase program when we believe the stock is trading disparately from our peers and at a significant discount to net asset value. As ofJune 30, 2020 , we had approximately$200 million of board-authorized capacity remaining for future stock repurchases. Finally, although we have no scheduled debt maturities for the remainder of 2020, we may use capital to repay debt obligations when we deem it prudent to refinance various obligations. The amount and form of payment (cash or stock issuance) of future dividends to be paid to our stockholders will continue to be largely dependent upon (i) the amount of cash generated from our operating activities; (ii) our expectations of future cash flows; (iii) our determination of near-term cash needs for debt repayments, development projects, and selective acquisitions of new properties; (iv) the timing of significant expenditures for tenant improvements, building redevelopment projects, and general property capital improvements; (v) long-term dividend payout ratios for comparable companies; (vi) our ability to continue to access additional sources of capital, including potential sales of our properties; and (vii) the amount required to be distributed to maintain our status as a REIT. With the fluctuating nature of cash flows and expenditures, we may periodically borrow funds on a short-term basis to cover timing differences in cash receipts and cash disbursements.
Results of Operations
Overview
Net income applicable to common stockholders for the three months endedJune 30, 2020 was$192.4 million , or$1.52 per diluted share, as compared with net income applicable to common stockholders of$8.2 million , or$0.06 per diluted share, for the three months endedJune 30, 2019 . The increase is primarily due to the gain on real estate assets recognized on the sale of the1901 Market Street building inPhiladelphia, Pennsylvania of$191.4 million during the current period. 27 -------------------------------------------------------------------------------- Table of Contents Comparison of the three months endedJune 30, 2020 versus the three months endedJune 30, 2019
Income from Continuing Operations
The following table sets forth selected data from our consolidated statements of income for the three months endedJune 30, 2020 and 2019, respectively, as well as each balance as a percentage of total revenues for the same periods presented (dollars in millions): June 30, June 30, 2020 % of Revenues 2019 % of Revenues Variance Revenue: Rental and tenant reimbursement revenue$ 131.2 $ 125.4 $ 5.8 Property management fee revenue 0.6 0.4 0.2 Other property related income 2.8 4.8 (2.0) Total revenues 134.6 100 % 130.6 100 % 4.0 Expense: Property operating costs 53.1 40 % 52.4 40 % 0.7 Depreciation 27.2 20 % 26.3 20 % 0.9 Amortization 24.4 18 % 18.5 14 % 5.9 General and administrative 5.9 4 % 12.4 10 % (6.5) 110.6 109.6 1.0 Other income (expense): Interest expense (14.0) 10 % (15.1) 12 % 1.1 Other income 0.3 - % 0.8 1 % (0.5) Loss on early extinguishment of debt (9.3) 7 % - - (9.3) Gain on sale of real estate assets 191.4 142 % 1.5 1 % 189.9 Net income$ 192.4 143 %$ 8.2 6 %$ 184.2 Revenue
Rental and tenant reimbursement revenue increased approximately
Other property related income decreased approximately$2.0 million for the three months endedJune 30, 2020 as compared to the same period in the prior year. The decrease is primarily attributable to decreased parking revenue during the three months endedJune 30, 2020 due to the sale of the500 West Monroe Street building during the fourth quarter of 2019, as well as lower parking utilization as a result of the COVID-19 pandemic.
Expense
Property operating costs increased approximately$0.7 million for the three months endedJune 30, 2020 , as compared to the same period in the prior year with increases due to net acquisition activity subsequent toApril 1, 2019 largely offset by decreased utility and janitorial costs due to the decreased usage of building utilities and services as a result of the COVID-19 pandemic. Depreciation expense increased approximately$0.9 million for the three months endedJune 30, 2020 as compared to the same period in the prior year. The increase was primarily due to depreciation on additional building and tenant improvements placed in service subsequent toApril 1, 2019 across our existing portfolio of properties. Amortization expense increased approximately$5.9 million for the three months endedJune 30, 2020 as compared to the same period in the prior year. Approximately$8.3 million of the increase was due to the amortization of lease intangible assets associated with properties acquired subsequent toApril 1, 2019 . This increase was partially offset by certain lease intangible 28 -------------------------------------------------------------------------------- Table of Contents assets sold or other deferred costs at our existing properties becoming fully amortized as a result of the expiration of leases subsequent toApril 1, 2019 . General and administrative expense decreased approximately$6.5 million for the three months endedJune 30, 2020 as compared to the three months endedJune 30, 2019 with the current quarter reflecting decreased accruals for stock based compensation and the prior quarter reflecting certain one-time expenses associated with the senior management transition that took place onJune 30, 2019 , resulting in lower executive compensation at the executive level in the current period. Other Income (Expense) Interest expense decreased approximately$1.1 million for the three months endedJune 30, 2020 as compared to the same period in the prior year primarily as a result of lower interest rates during the current year. This variance was partially offset by a decrease in capitalized interest in the current year, as compared to the same period in the prior year, of approximately$0.4 million . The loss on early extinguishment of debt during the three months endedJune 30, 2020 was associated with the early repayment of the $160Million Fixed-Rate Loan which was collateralized by the1901 Market Street building. The property was sold during the three months endedJune 30, 2020 . The loss was comprised of a prepayment penalty and unamortized debt issuance costs and discounts associated with the loan. Gain on sale of real estate assets during the three months endedJune 30, 2020 includes a gain of approximately$191.4 million recognized on the sale of the1901 Market Street building. Gain on sale of real estate assets during the three months endedJune 30, 2019 reflected an adjustment of the gain on the sale of theTwo Independence Square building located inWashington, D.C. related to the reimbursement of certain previously disputed tenant improvement overages. 29
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Comparison of the accompanying consolidated statements of income for the six
months ended
Income from Continuing Operations
The following table sets forth selected data from our consolidated statements of income for the six months endedJune 30, 2020 and 2019, respectively, as well as each balance as a percentage of total revenues for the same period presented (dollars in millions): June 30, June 30, 2020 % of Revenues 2019 % of Revenues Variance Revenue: Rental and tenant reimbursement revenue$ 263.4 $ 251.6 $ 11.8 Property management fee revenue 1.4 2.4 (1.0) Other property related income 7.0 9.6 (2.6) Total revenues 271.8 100 % 263.6 100 % 8.2 Expense: Property operating costs 106.4 39 % 104.2 40 % 2.2 Depreciation 55.1 20 % 52.9 20 % 2.2 Amortization 48.0 18 % 36.1 14 % 11.9 General and administrative 14.6 5 % 21.8 7 % (7.2) 224.1 215.0 9.1 Other income (expense): Interest expense (29.2) 11 % (30.6) 12 % 1.4 Other income 0.5 - % 1.0 - % (0.5) Loss on early extinguishment of debt (9.3) 3 % - - % (9.3) Gain on sale of real estate assets 191.4 70 % 39.4 15 % 152.0 Net income$ 201.1 74 %$ 58.4 22 %$ 142.7 Revenue Rental and tenant reimbursement revenue increased approximately$11.8 million for the six months endedJune 30, 2020 as compared to the same period in the prior year. The favorable variance was primarily due to net acquisition activity subsequent toJanuary 1, 2019 and new leases commencing at higher overall rental rates, partially offset by the recognition of charges against rental revenue for tenant-specific and general collectibility risks related to the COVID-19 pandemic during the six months endedJune 30, 2020 . Property management fee revenue decreased approximately$1.0 million for the six months endedJune 30, 2020 as compared to the same period in the prior year. The decrease was primarily due to construction management fees received in the prior period from one of our formerIndependence Square properties, with such fees varying from period-to-period due to the variability of construction activity. Other property related income consists primarily of parking revenue and it decreased approximately$2.6 million for the six months endedJune 30, 2020 as compared to the same period in the prior year primarily due to the sale of the500 West Monroe Street building during the fourth quarter of 2019, as well as lower parking utilization at our buildings during the second quarter of 2020 as a result of the COVID-19 pandemic. These decreases were partially offset by new parking revenue associated with acquisitions consummated subsequent toJanuary 1, 2019 . Expense Property operating costs increased approximately$2.2 million for the six months endedJune 30, 2020 as compared to the same period in the prior year. The unfavorable variance was primarily due to net acquisition activity subsequent toJanuary 1, 2019 , partially offset by decreased costs due to the decreased usage of building utilities and services as a result of the COVID-19 pandemic. 30
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Depreciation expense increased approximately
Amortization expense increased approximately$11.9 million for the six months endedJune 30, 2020 as compared to the same period in the prior year. Approximately$18.6 million of the increase was due to the amortization of lease intangible assets associated with properties acquired subsequent toJanuary 1, 2019 . This increase was partially offset by certain lease intangible assets sold or other deferred costs at our existing properties becoming fully amortized as a result of the expiration of leases subsequent toJanuary 1, 2019 . General and administrative expenses decreased approximately$7.2 million for the six months endedJune 30, 2020 as compared to the six months endedJune 30, 2019 with the current period reflecting decreased accruals for stock based compensation and the prior period reflecting certain one-time expenses associated with the senior management transition that took place onJune 30, 2019 , resulting in lower compensation at the executive level in the current period.
Other Income (Expense)
Interest expense decreased approximately$1.4 million for the six months endedJune 30, 2020 as compared to the same period in the prior year primarily as a result of lower interest rates during the current year. This variance was partially offset by a decrease in capitalized interest in the current year, as compared to the same period in the prior year, of approximately$0.7 million . The loss on early extinguishment of debt during the six months endedJune 30, 2020 was associated with the early repayment of the $160Million Fixed-Rate Loan which was collateralized by the1901 Market Street building. The property was sold during the six months endedJune 30, 2020 . The loss was comprised of a prepayment penalty and unamortized debt issuance costs and discounts associated with the loan. Gain on sale of real estate assets during the six months endedJune 30, 2020 includes a gain of approximately$191.4 million recognized on the sale of the1901 Market Street building inPhiladelphia, Pennsylvania . Gain on sale of real estate assets during the six months endedJune 30, 2019 includes an approximate$33.2 million gain recognized on the sale of theOne Independence Square building inWashington, D.C. , as well as an approximate$6.1 million adjustment of the gain on sale for theTwo Independence Square building related to the reimbursement of certain previously disputed tenant improvement overages. 31 -------------------------------------------------------------------------------- Table of Contents Issuer and Guarantor Financial Information During the years endedDecember 31, 2013 and 2014, Piedmont, through its wholly-owned subsidiaryPiedmont Operating Partnership, LP ("Piedmont OP" or the "Issuer"), issued senior unsecured notes payable of$350 million and$400 million , respectively (the "Notes"). The Notes are senior unsecured obligations of Piedmont OP and rank equally in right of payment with all of Piedmont OP's other existing and future senior unsecured indebtedness and are effectively subordinated in right of payment to all of Piedmont OP's existing and future mortgage indebtedness and other secured indebtedness (to the extent of the value of the collateral securing such indebtedness) and to all existing and future indebtedness and other liabilities of Piedmont OP's subsidiaries, whether secured or unsecured. The Notes are fully and unconditionally guaranteed byPiedmont Office Realty Trust, Inc. (the "Guarantor"), the parent entity that consolidates Piedmont OP and all other subsidiaries. By execution of the guarantee, the Guarantor guarantees to each holder of the Notes that the principal and interest on the Notes will be paid in full when due, whether at the maturity dates of the respective loans, or upon acceleration, upon redemption, or otherwise, and interest on overdue principal and interest on any overdue interest, if any, on the Notes and all other obligations of the Issuer to the holders of the Notes will be promptly paid in full. The Guarantor's guarantee of the Notes is its senior unsecured obligation and ranks equally in right of payment with all of the Guarantor's other existing and future senior unsecured indebtedness and guarantees. The Guarantor's guarantee of the notes is effectively subordinated in right of payment to all existing and future mortgage indebtedness and other secured indebtedness and secured guarantees of the Guarantor (to the extent of the value of the collateral securing such indebtedness and guarantees); and all existing and future indebtedness and other liabilities, whether secured or unsecured, of the Guarantor's subsidiaries. In the event of the bankruptcy, liquidation, reorganization or other winding up of Piedmont OP or the Guarantor, assets that secure any of their respective secured indebtedness and other secured obligations will be available to pay their respective obligations under the Notes or the guarantee, as applicable, and their other respective unsecured indebtedness and other unsecured obligations only after all of their respective indebtedness and other obligations secured by those assets have been repaid in full.
The non-Guarantors are separate and distinct legal entities and have no obligation, contingent or otherwise, to pay any amounts due pursuant to the Notes, or to make any funds available therefore, whether by dividends, loans, distributions or other payments.
Pursuant to Rule 13-01 of Regulation S-X, Guarantors and Issuers of Guaranteed Securities Registered or Being Registered, the following tables present summarized financial information for Piedmont OP asIssuer andPiedmont Office Realty Trust, Inc. as Guarantor on a combined basis after elimination of (i) intercompany transactions and balances among the Issuer and the Guarantor and (ii) equity in earnings from and investments in any subsidiary that is a non-Guarantor (in thousands): Combined Balances of Piedmont OP and Piedmont Office As of As of
Due from non-guarantor subsidiary $ 810 $ 810 Total assets$ 378,984 $ 364,734 Total liabilities$ 1,638,850 $ 1,343,881 For the Six Months Ended June 30, 2020 Total revenues $ 20,082 Net loss $ (26,259) 32
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Funds From Operations ("FFO"), Core Funds From Operations ("Core FFO"), and
Adjusted Funds From Operations
("AFFO")
Net income calculated in accordance with GAAP is the starting point for
calculating FFO, Core FFO, and AFFO. These metrics are non-GAAP financial
measures and should not be viewed as an alternative measurement of our operating
performance to net income. Management believes that accounting for real estate
assets in accordance with GAAP implicitly assumes that the value of real estate
assets diminishes predictably over time. Since real estate values have
historically risen or fallen with market conditions, many industry investors and
analysts have considered the presentation of operating results for real estate
companies that use historical cost accounting to be insufficient alone. As a
result, we believe that the additive use of FFO, Core FFO, and AFFO, together
with the required GAAP presentation, provides a more complete understanding of
our performance relative to our competitors and a more informed and appropriate
basis on which to make decisions involving operating, financing, and investing
activities.
We calculate FFO in accordance with the current National Association of Real
Estate Investment Trusts ("NAREIT") definition. NAREIT currently defines FFO as
follows: Net income (computed in accordance with GAAP), excluding gains or
losses from sales of depreciable real estate and impairment charges (including
our proportionate share of gains from sales of property related to investments
in unconsolidated joint ventures), plus the add back of depreciation and
amortization on real estate assets (including our proportionate share of
depreciation and amortization related to investments in unconsolidated joint
ventures). Other REITs may not define FFO in accordance with the NAREIT
definition, or may interpret the current NAREIT definition differently than we
do; therefore, our computation of FFO may not be comparable to such other REITs.
We calculate Core FFO by starting with FFO, as defined by NAREIT, and adjusting
for gains or losses on the extinguishment of swaps and/or debt,
acquisition-related expenses, and any significant non-recurring or infrequent
items. Core FFO is a non-GAAP financial measure and should not be viewed as an
alternative to net income calculated in accordance with GAAP as a measurement of
our operating performance. We believe that Core FFO is helpful to investors as a
supplemental performance measure because it excludes the effects of certain
infrequent or non-recurring items which can create significant earnings
volatility, but which do not directly relate to our core recurring business
operations. As a result, we believe that Core FFO can help facilitate
comparisons of operating performance between periods and provides a more
meaningful predictor of future earnings potential. Other REITs may not define
Core FFO in the same manner as us; therefore, our computation of Core FFO may
not be comparable to that of other REITs.
We calculate AFFO by starting with Core FFO and adjusting for non-incremental
capital expenditures and acquisition-related costs and then adding back non-cash
items including: non-real estate depreciation, straight-line rent adjustments
and fair value lease adjustments, non-cash components of interest expense and
compensation expense, and by making similar adjustments for unconsolidated joint
ventures. AFFO is a non-GAAP financial measure and should not be viewed as an
alternative to net income calculated in accordance with GAAP as a measurement of
our operating performance. We believe that AFFO is helpful to investors as a
meaningful supplemental comparative performance measure of our ability to make
incremental capital investments in new properties or enhancements to existing
properties that improve revenue growth potential. Other REITs may not define
AFFO in the same manner as us; therefore, our computation of AFFO may not be
comparable to that of other REITs.
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Reconciliations of net income to FFO, Core FFO, and AFFO are presented below (in
thousands except per share amounts):
Three Months Ended Six Months Ended
June 30, Per June 30, Per June 30, Per June 30, Per
2020 Share(1) 2019 Share(1) 2020 Share(1) 2019 Share(1)
GAAP net income applicable to common
stock $ 192,427 $ 1.52 $
8,153
0.21 26,128 0.21 54,424 0.43 52,437 0.41
Amortization of lease-related costs 24,336 0.19 18,446 0.15 47,954 0.38 36,131 0.29
Gain on sale of real estate assets (191,369) (1.51) (1,451) (0.01) (191,372) (1.51) (39,338) (0.31)
NAREIT Funds From Operations
applicable to common stock $ 52,267 $ 0.41 $ 51,276 $ 0.41 $ 112,142 $ 0.89 $ 107,591 $ 0.85
Adjustments:
Retirement and separation expenses
associated with senior management
transition in June 2019 - - 3,175 0.02 - - 3,175 0.03
Loss on early extinguishment of debt 9,336 0.08 - - 9,336 0.07 - -
Core Funds From Operations
applicable to common stock $ 61,603 $ 0.49 $ 54,451 $ 0.43 $ 121,478 $ 0.96 $ 110,766 $ 0.88
Adjustments:
Amortization of debt issuance costs,
fair market value adjustments on
notes payable, and discounts on debt 672 525 1,249 1,048
Depreciation of non real estate assets 319 212 644
420
Straight-line effects of lease revenue (7,278) (3,223) (14,063)
(5,906)
Stock-based compensation adjustments 645 2,184 2,945
4,964
Net effect of amortization of above and below-market in-place lease intangibles (3,304) (2,088) (6,277) (4,086) Non-incremental capital expenditures (2) (7,689) (9,691) (42,451) (13,058) Adjusted Funds From Operations applicable to common stock$ 44,968 $ 42,370 $ 63,525 $
94,148
Weighted-average shares outstanding - diluted 126,500 126,491 126,456 126,404
(1)Based on weighted average shares outstanding - diluted.
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(2)We define non-incremental capital expenditures as capital expenditures of a
recurring nature related to tenant improvements, leasing commissions, and
building capital that do not incrementally enhance the underlying assets' income
generating capacity. Tenant improvements, leasing commissions, building capital
and deferred lease incentives incurred to lease space that was vacant at
acquisition, leasing costs for spaces vacant for greater than one year, leasing
costs for spaces at newly acquired properties for which in-place leases expire
shortly after acquisition, improvements associated with the expansion of a
building, and renovations that either enhance the rental rates of a building or
change the property's underlying classification, such as from a Class B to a
Class A property, are excluded from this measure. Non-incremental capital
expenditures for the six months ended June 30, 2020 includes the leasing
commission for the approximately 20-year, 520,000-square-foot renewal and
expansion of the State of New York's lease at our 60 Broad Street building in
New York City that was executed during the fourth quarter of 2019.
Property and Same Store Net Operating Income
Property Net Operating Income ("Property NOI") is a non-GAAP measure which we
use to assess our operating results. We calculate Property NOI beginning with
Net income (computed in accordance with GAAP) before interest, income-related
federal, state, and local taxes, depreciation and amortization and removing any
impairment losses, gains or losses from sales of any property and other
significant infrequent items that create volatility within our earnings and make
it difficult to determine the earnings generated by our core ongoing business.
Furthermore, we remove general and administrative expenses, income associated
with property management performed by us for other organizations, and other
income or expense items such as interest income from loan investments or costs
from the pursuit of non-consummated transactions. For Property NOI (cash basis),
the effects of straight-lined rents and fair value lease revenue are also
eliminated; while such effects are not adjusted in calculating Property NOI
(accrual basis). Property NOI is a non-GAAP financial measure and should not be
viewed as an alternative to net income calculated in accordance with GAAP as a
measurement of our operating performance. We believe that Property NOI, on
either a cash or accrual basis, is helpful to investors as a supplemental
comparative performance measure of income generated by our properties alone
without our administrative overhead. Other REITs may not define Property NOI in
the same manner as we do; therefore, our computation of Property NOI may not be
comparable to that of other REITs.
We calculate Same Store Net Operating Income ("Same Store NOI") as Property NOI
applicable to the properties owned or placed in service during the entire span
of the current and prior year reporting periods. Same Store NOI is a non-GAAP
financial measure and should not be viewed as an alternative to net income
calculated in accordance with GAAP as a measurement of our operating
performance. We believe that Same Store NOI, on either a cash or accrual basis
is helpful to investors as a supplemental comparative performance measure of the
income generated from the same group of properties from one period to the next.
Other REITs may not define Same Store NOI in the same manner as we do;
therefore, our computation of Same Store NOI may not be comparable to that of
other REITs.
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The following table sets forth a reconciliation from net income calculated in accordance with GAAP to Property NOI, on both a cash and accrual basis, and Same Store NOI, on both a cash and accrual basis, for the three months endedJune 30, 2020 and 2019, respectively (in thousands): Cash Basis Accrual Basis Three Months Ended Three Months Ended June 30, June 30, June 30, June 30, 2020 2019 2020 2019
Net income applicable to Piedmont (GAAP basis)
Net loss applicable to noncontrolling interest (1) (1) (1) (1) Interest expense 13,953 15,112 13,953 15,112 Depreciation 27,192 26,340 27,192 26,340 Amortization 24,336 18,446 24,336 18,446 Gain on sale of real estate assets (191,369) (1,451) (191,369) (1,451) EBITDAre(1)$ 66,538 $ 66,599 $ 66,538 $ 66,599 Loss on early extinguishment of debt 9,336 - 9,336 - Retirement and separation expenses associated with senior management transition - 3,175 - 3,175 Core EBITDA(2)$ 75,874 $ 69,774 $ 75,874 $ 69,774 General & administrative expenses 5,937 9,244 5,937 9,244 Management fee revenue (3) (282) (201) (282) (201) Other income (134) (56) (134) (56) Non-cash general reserve for uncollectible accounts 4,865 -
Straight-line rent effects of lease revenue (7,278) (3,223) Amortization of lease-related intangibles (3,304) (2,088)
Property NOI$ 75,678 $ 73,450 $ 81,395 $ 78,761 Net operating income from: Acquisitions (4) (10,109) (921) (13,518) (1,155) Dispositions (5) (4,384) (12,320) (5,195) (13,424) Other investments (6) (224) (246) (177) (220) Same Store NOI$ 60,961 $ 59,963
Change period over period in Same Store NOI 1.7 % N/A (2.3) % N/A (1)We calculate Earnings Before Interest, Taxes, Depreciation, andAmortization- Real Estate ("EBITDAre") in accordance with the currentNational Association of Real Estate Investment Trusts ("NAREIT") definition. NAREIT currently defines EBITDAre as net income (computed in accordance with GAAP) adjusted for gains or losses from sales of property, impairment losses, depreciation on real estate assets, amortization on real estate assets, interest expense and taxes, along with the same adjustments for unconsolidated partnerships and joint ventures. Some of the adjustments mentioned can vary among owners of identical assets in similar conditions based on historical cost accounting and useful-life estimates. EBITDAre is a non-GAAP financial measure and should not be viewed as an alternative to net income calculated in accordance with GAAP as a measurement of our operating performance. We believe that EBITDAre is helpful to investors as a supplemental performance measure because it provides a metric for understanding our results from ongoing operations without taking into account the effects of non-cash expenses (such as depreciation and amortization) and capitalization and capital structure expenses (such as interest expense and taxes). We also believe that EBITDAre can help facilitate comparisons of operating performance between periods and with other REITs. However, other REITs may not define EBITDAre in accordance with the NAREIT definition, or may interpret the current NAREIT definition differently than us; therefore, our computation of EBITDAre may not be comparable to that of such other REITs. 36 -------------------------------------------------------------------------------- Table of Contents (2)We calculate Core Earnings Before Interest, Taxes, Depreciation, and Amortization ("Core EBITDA") as net income (computed in accordance with GAAP) before interest, taxes, depreciation and amortization and incrementally removing any impairment losses, gains or losses from sales of property and other significant infrequent items that create volatility within our earnings and make it difficult to determine the earnings generated by our core ongoing business. Core EBITDA is a non-GAAP financial measure and should not be viewed as an alternative to net income calculated in accordance with GAAP as a measurement of our operating performance. We believe that Core EBITDA is helpful to investors as a supplemental performance measure because it provides a metric for understanding the performance of our results from ongoing operations without taking into account the effects of non-cash expenses (such as depreciation and amortization), as well as items that are not part of normal day-to-day operations of our business. Other REITs may not define Core EBITDA in the same manner as us; therefore, our computation of Core EBITDA may not be comparable to that of other REITs. (3)Presented net of related operating expenses incurred to earn such management fee revenue. (4)Acquisitions consist of Galleria 100 and land inAtlanta, Georgia , purchased onMay 6, 2019 ; Galleria 400, Galleria 600 and land inAtlanta, Georgia , purchased onAugust 23, 2019 ; andOne Galleria Tower ,Two Galleria Tower ,Three Galleria Tower and land inDallas, Texas , purchased onFebruary 12, 2020 . (5)Dispositions consist ofOne Independence Square inWashington, D.C. , sold onFebruary 28, 2019 ; The Dupree inAtlanta, Georgia , sold onSeptember 4, 2019 ;500 West Monroe Street inChicago, Illinois , sold onOctober 28, 2019 ; and1901 Market Street inPhiladelphia, Pennsylvania , sold onJune 25, 2020 . (6)Other investments consist of active redevelopment and development projects, land, and recently completed redevelopment and development projects for which some portion of operating expenses were capitalized during the current and/or prior year reporting periods. The operating results fromTwo Pierce Place inItasca, Illinois , are included in this line item. 37 -------------------------------------------------------------------------------- Table of Contents The following table sets forth a reconciliation of net income calculated in accordance with GAAP to EBITDAre, Core EBITDA, Property NOI, and Same Store NOI, on both a cash and accrual basis, for the six months endedJune 30, 2020 and 2019 (in thousands): Cash Basis Accrual Basis Six Months Ended Six Months Ended June 30, June 30, June 30, June 30, 2020 2019 2020 2019
Net income applicable to Piedmont (GAAP basis)
Net income applicable to noncontrolling interest 1 - 1 - Interest expense 29,217 30,605 29,217 30,605 Depreciation 55,069 52,858 55,069 52,858 Amortization 47,954 36,131 47,954 36,131 Gain on sale of real estate assets (191,372) (39,338) (191,372) (39,338) EBITDAre(1)$ 142,005 $
138,617
9,336 - 9,336 -
Retirement and separation expenses associated
with senior management transition in June 2019 - 3,175 - 3,175
Core EBITDA(2) $ 151,341 $
141,792
14,580 18,611 14,580 18,611
Management fee revenue (3) (677) (2,023) (677) (2,023)
Other expense/(income) (67) (118) (67) (118)
Non-cash general reserve for uncollectible
accounts 4,865 -
Straight-line rent effects of lease revenue (14,063) (5,906)
Amortization of lease-related intangibles (6,277)
(4,086)
Property NOI$ 149,702 $
148,270
Net operating income from: Acquisitions (4) (18,214) (920) (23,786) (1,155) Dispositions (5) (8,979) (27,177) (10,655) (27,826) Other investments (6) (306) (285) (239) (270) Same Store NOI$ 122,203 $ 119,888 $ 130,497 $ 129,011 Change period over period in Same Store NOI 1.9 % N/A 1.2 % N/A (1)We calculate Earnings Before Interest, Taxes, Depreciation, andAmortization- Real Estate ("EBITDAre") in accordance with the currentNational Association of Real Estate Investment Trusts ("NAREIT") definition. NAREIT currently defines EBITDAre as net income (computed in accordance with GAAP) adjusted for gains or losses from sales of property, impairment losses, depreciation on real estate assets, amortization on real estate assets, interest expense and taxes, along with the same adjustments for unconsolidated partnerships and joint ventures. Some of the adjustments mentioned can vary among owners of identical assets in similar conditions based on historical cost accounting and useful-life estimates. EBITDAre is a non-GAAP financial measure and should not be viewed as an alternative to net income calculated in accordance with GAAP as a measurement of our operating performance. We believe that EBITDAre is helpful to investors as a supplemental performance measure because it provides a metric for understanding our results from ongoing operations without taking into account the effects of non-cash expenses (such as depreciation and amortization) and capitalization and capital structure expenses (such as interest expense and taxes). We also believe that EBITDAre can help facilitate comparisons of operating performance between periods and with other REITs. However, other REITs may not define EBITDAre in accordance with the NAREIT definition, or may interpret the current NAREIT definition differently than us; therefore, our computation of EBITDAre may not be comparable to that of such other REITs. 38 -------------------------------------------------------------------------------- Table of Contents (2)We calculate Core Earnings Before Interest, Taxes, Depreciation, and Amortization ("Core EBITDA") as net income (computed in accordance with GAAP) before interest, taxes, depreciation and amortization and incrementally removing any impairment losses, gains or losses from sales of property and other significant infrequent items that create volatility within our earnings and make it difficult to determine the earnings generated by our core ongoing business. Core EBITDA is a non-GAAP financial measure and should not be viewed as an alternative to net income calculated in accordance with GAAP as a measurement of our operating performance. We believe that Core EBITDA is helpful to investors as a supplemental performance measure because it provides a metric for understanding the performance of our results from ongoing operations without taking into account the effects of non-cash expenses (such as depreciation and amortization), as well as items that are not part of normal day-to-day operations of our business. Other REITs may not define Core EBITDA in the same manner as us; therefore, our computation of Core EBITDA may not be comparable to that of other REITs. (3)Presented net of related operating expenses incurred to earn such management fee revenue. (4)Acquisitions consist of Galleria 100 and land inAtlanta, Georgia , purchased onMay 6, 2019 ; Galleria 400, Galleria 600 and land inAtlanta, Georgia , purchased onAugust 23, 2019 ; andOne Galleria Tower ,Two Galleria Tower ,Three Galleria Tower and land inDallas, Texas , purchased onFebruary 12, 2020 . (5)Dispositions consist ofOne Independence Square inWashington, D.C. , sold onFebruary 28, 2019 ; The Dupree inAtlanta, Georgia , sold onSeptember 4, 2019 ;500 West Monroe Street inChicago, Illinois , sold onOctober 28, 2019 ; and1901 Market Street inPhiladelphia, Pennsylvania , sold onJune 25, 2020 . (6)Other investments consist of active or recently completed redevelopment and development projects for which some portion of operating expenses were capitalized during the current and/or prior year reporting periods and land. The operating results fromTwo Pierce Place inItasca, Illinois , are included in this line item. Overview Our portfolio is a geographically diverse group of properties primarily located in select sub-markets within seven majorEastern U.S. office markets. We typically lease space to large, credit-worthy corporate or governmental tenants on a long-term basis. As ofJune 30, 2020 , our average lease is approximately 20,000 square feet with over six years of lease term remaining. Consequently, leased percentage, as well as rent roll ups and roll downs, which we experience as a result of re-leasing, can fluctuate widely between buildings and between tenants, depending on when a particular lease is scheduled to commence or expire.
Leased Percentage
On a same store basis, our portfolio was approximately 90% leased as ofJune 30, 2020 , as compared to 92% leased as ofJune 30, 2019 . Other than theCity of New York's 313,000 square foot lease that is currently in holdover status at60 Broad Street inNew York , we have no leases greater than 1% of our Annualized Lease Revenue expiring during the eighteen month period followingJune 30, 2020 . We remain in advanced discussions for the renewal of substantially all of theCity of New York's leased square footage. To the extent new leases for currently vacant space outweigh or fall short of scheduled expirations, such leases would increase or decrease our overall leased percentage, respectively.
Impact of Downtime, Abatement Periods, and Rental Rate Changes
Commencement of new leases typically occurs 6-18 months after the lease execution date, after refurbishment of the space is completed. The downtime between a lease expiration and the new lease's commencement can negatively impact Property NOI and Same Store NOI comparisons (both accrual and cash basis). In addition, office leases, both new and lease renewals, often contain upfront rental and/or operating expense abatement periods which delay the cash flow benefits of the lease even after the new lease or renewal has commenced and will continue to negatively impact Property NOI and Same Store NOI on a cash basis until such abatements expire. As ofJune 30, 2020 , we had approximately 8% of our total rentable square feet in some form of rental and/or operating expense abatement; consisting of 349,000 square feet of executed leases related to currently vacant space that had not yet commenced, and approximately 1.1 million square feet of commenced leases that were in abatement. If we are unable to replace expiring leases with new or renewal leases at rental rates equal to or greater than the expiring rates, rental rate roll downs could occur and negatively impact Property NOI and Same Store NOI comparisons. As mentioned above, our geographically diverse portfolio and the magnitude of some of our tenant's leased space can result in rent roll ups and roll downs that can fluctuate widely on a building-by-building and a quarter-to-quarter basis. During the six months endedJune 30, 2020 , we experienced a 4.5% and 11.7% roll up in cash and accrual rents, respectively, on leases executed during the quarter for space vacant one year or less, as compared to a 13.1% and 18.0% roll up in cash and accrual rents, respectively, on leases executed during the quarter for space vacant one year or less for the six months endedJune 30, 2019 .
Same Store NOI increased 1.9% and 1.2% on a cash and accrual basis,
respectively, for the six months ended
39
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expiration of lease abatements. The increase in accrual basis Same Store NOI was
related to the commencement of leases with higher straight-line rents during the
three months ended June 30, 2020 , offset by down times between leases at certain
assets, and lower same store occupancy levels. Property NOI and Same Store NOI
comparisons for any given period may still fluctuate as a result of the mix of
net leasing activity in individual properties during the respective period.
Election as a REIT
We have elected to be taxed as a REIT under the Code and have operated as such beginning with our taxable year endedDecember 31, 1998 . To qualify as a REIT, we must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of our adjusted REIT taxable income, computed without regard to the dividends-paid deduction and by excluding net capital gains attributable to our stockholders, as defined by the Code. As a REIT, we generally will not be subject to federal income tax on income that we distribute to our stockholders. If we fail to qualify as a REIT in any taxable year, we may be subject to federal income taxes on our taxable income for that year and for the four years following the year during which qualification is lost and/or penalties, unless theIRS grants us relief under certain statutory provisions. Such an event could materially adversely affect our net income and net cash available for distribution to our stockholders. However, we believe that we are organized and operate in such a manner as to qualify for treatment as a REIT and intend to continue to operate in the foreseeable future in such a manner that we will remain qualified as a REIT for federal income tax purposes. We have elected to treat POH, a wholly-owned subsidiary of Piedmont, as a taxable REIT subsidiary. POH performs non-customary services for tenants of buildings that we own, including solar power generation, real estate and non-real estate related-services; however, any earnings related to such services performed by our taxable REIT subsidiary are subject to federal and state income taxes. In addition, for us to continue to qualify as a REIT, our investments in taxable REIT subsidiaries cannot exceed 20% of the value of our total assets.
Inflation
We are exposed to inflation risk, as income from long-term leases is the primary source of our cash flows from operations. There are provisions in the majority of our tenant leases that are intended to protect us from, and mitigate the risk of, the impact of inflation. These provisions include rent steps, reimbursement billings for operating expense pass-through charges, real estate tax, and insurance reimbursements on a per square-foot basis, or in some cases, annual reimbursement of operating expenses above certain per square-foot allowances. However, due to the long-term nature of the leases, the leases may not readjust their reimbursement rates frequently enough to fully cover inflation.
Off-Balance Sheet Arrangements
We are not dependent on off-balance sheet financing arrangements for liquidity.
As of
Application of Critical Accounting Policies
Our accounting policies have been established to conform with GAAP. The preparation of financial statements in conformity with GAAP requires management to use judgment in the application of accounting policies, including making estimates and assumptions. These judgments affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. If our judgment or interpretation of the facts and circumstances relating to various transactions had been different, it is possible that different accounting policies would have been applied, thus, resulting in a different presentation of the financial statements. Additionally, other companies may utilize different estimates that may impact comparability of our results of operations to those of companies in similar businesses. Refer to our Annual Report on Form 10-K for the year endedDecember 31, 2019 for a discussion of our critical accounting policies. There have been no material changes to these policies during the six months endedJune 30, 2020 . 40 -------------------------------------------------------------------------------- Table of Contents Accounting Pronouncements Adopted during the Six Months EndedJune 30, 2020
Reference Rate Reform Relief
Accounting Standards Update No. 2020-04, Reference Rate Reform (Topic 848) ("ASU
2020-04"), was issued in March 2020 . ASU 2020-04 contains practical expedients
for reference rate reform related activities that impact debt, leases,
derivatives and other contracts. The guidance in ASU 2020-04 is optional and may
be elected over time as reference rate reform activities occur. During the six
months ended June 30, 2020 , we elected to apply the hedge accounting expedients
related to probability and the assessments of effectiveness for future
LIBOR-indexed cash flows to assume that the index upon which future hedged
transactions will be based matches the index on the corresponding derivatives.
Application of these expedients preserves the presentation of derivatives
consistent with past presentation. We continue to evaluate the impact of the
guidance and may apply other elections as applicable as additional changes in
the market occur.
Financial Instruments- Credit Loss Amendments
OnJanuary 1, 2020 , we adopted ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments, as well as ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, and ASU No. 2019-05, Financial Instruments- Credit Losses: Targeted Transition Relief (collectively the "Credit Loss Amendments"). The provisions of the Credit Loss Amendments replace the "incurred loss" approach with an "expected loss" model for impairing trade and other receivables, held-to-maturity debt securities, net investment in leases, and off-balance-sheet credit exposures, which will generally result in earlier recognition of allowances for credit losses. However, theFinancial Accounting Standards Board (the "FASB") also issued ASU No. 2018-19 Codification Improvements to Topic 326, Financial Instruments - Credit Losses, which is effective concurrent with the Credit Loss Amendments, and excludes receivables arising from operating leases from the scope of the Credit Loss Amendments and affirms that such receivables should be evaluated for collectibility as prescribed by Accounting Standards Codification 842 Leases. As substantially all of our receivables are operating lease receivables there was no material impact to our accompanying consolidated financial statements or disclosures as a result of adoption of the Credit Loss Amendments. During the six months endedJune 30, 2020 , the FASB issued a Staff Q&A on Topic 842 and Topic 840 (lease accounting guidance): Accounting for lease concessions related to the effects of the COVID-19 pandemic. Generally, changes to payment terms not contemplated by the lease contract should be accounted for under Topic 842 as a lease modification. The FASB staff has provided relief from this modification guidance through an accounting policy election, provided that changes to the payment terms do not result in a substantial increase in the rights of either the lessee or the lessor under the lease. We have elected not to apply the relief provided by the FASB Staff, and have instead accounted for all rent relief agreements as result of COVID-19 as lease modifications. See further details concerning rent relief agreements with our tenants in Note 7 to our accompanying consolidated financial statements. Contractual Obligations We have had significant changes to our debt structure during the six months ended June 30, 2020 as detailed in Note 4 to our accompanying consolidated financial statements. As such, our contractual obligations related to long-term debt as ofJune 30, 2020 were as follows (in thousands):
Payments Due by Period
Less than More than
Contractual Obligations(1) Total 1 year 1-3 years 3-5 years 5 years
Long-term debt (2) $ 1,628,245 $ 301,102 (3) $ 677,143 $ 650,000 $ -
(1)Contractual obligations do not include amounts committed for tenant or capital improvements under leases where Piedmont is the lessor. However, see
Note 7 to our accompanying consolidated financial statements for details concerning our individually material lease commitments, the timing of which may fluctuate. Additionally, Piedmont does not have any ground leases, nor does Piedmont have any material obligations as lessee under operating lease agreements as ofJune 30, 2020 . (2)Amounts include principal payments only and balances outstanding as ofJune 30, 2020 , not including unamortized issuance discounts, debt issuance costs paid to lenders, or estimated fair value adjustments. We made interest payments, including payments under our interest rate swaps, of approximately$29.0 million during the six months endedJune 30, 2020 , and expect to pay interest in future periods on outstanding debt obligations based on the rates and terms disclosed herein and in Note 4 to our accompanying consolidated financial statements. (3)Includes the balance outstanding as ofJune 30, 2020 of the new$300 Million Unsecured 2020 Term Loan. However, we may extend the term for up to one additional year (through two available six month extensions to a final extended maturity date ofMarch 11, 2022 ) provided we are not then in default and upon payment of extension fees. 41
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Commitments and Contingencies We are subject to certain commitments and contingencies with regard to certain transactions. Refer to Note 7 to our consolidated financial statements for further explanation. Examples of such commitments and contingencies include: •Commitments Under Existing Lease Agreements; •Contingencies Related to Tenant Audits/Disputes; and •Contingencies Related to the COVID-19 Pandemic.
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