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 third 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 Piedmont operates. Specifically, the pandemic and its impact on theU.S. , as well as the global economy, has negatively impacted the trading price of Piedmont's common stock and some of Piedmont's tenants' ability to pay their rent. During the nine months endedSeptember 30, 2020 , we have entered into approximately 60 agreements with various tenants that primarily defer approximately$6.7 million of 2020 rent payments until either the fourth quarter of 2020 or into 2021. Further, Piedmont has established an approximately$4.8 million general reserve for potential collectibility issues; however, there can be no assurances that this amount will be sufficient to cover any future losses of rental income should these tenants be unable to pay back deferred rents when such rents become due. 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 third quarter, we collected approximately 99% of our billed contractual rents on a monthly basis. While the long-term impacts of the COVID-19 pandemic remain unknown, a prolonged economic downturn or recession resulting from the pandemic could adversely affect many of Piedmont's tenants which could, in turn, adversely impact Piedmont's business, financial condition and results of operations. Piedmont will continue to work closely with its 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. During the third quarter of 2020, we issued$300 million of unsecured senior notes, using the proceeds to fully repay the$300 million unsecured term loan in advance of itsMarch 2021 maturity. As a result, we had approximately$24 million of cash on hand and the full$500 million line of credit capacity was available as ofSeptember 30, 2020 . While we have experienced periods of interest rate volatility and movements which have made obtaining financing or refinancing debt obligations more challenging during 2020, 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 nine months endedSeptember 30, 2020 and 2019 we incurred the following types of capital expenditures (in thousands): Nine Months EndedSeptember 30 ,September 30, 2020 2019 Capital expenditures for redevelopment/renovations $
15,071
Other capital expenditures, including building and tenant improvements
64,936 47,055
Total capital expenditures (1) $
80,007
(1)Of the total amounts paid, approximately$1.1 million and$2.0 million relates to soft costs such as capitalized interest, payroll, and other general and administrative expenses for the nine months endedSeptember 30, 2020 and 2019, respectively. 26 -------------------------------------------------------------------------------- Table of Contents "Capital expenditures for redevelopment/renovations" during the nine months endedSeptember 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 nine months endedSeptember 30, 2019 primarily related to a redevelopment project to upgrade amenities at ourUS Bancorp building inMinneapolis, Minnesota , as well as a redevelopment project to upgrade common areas, amenities, and parking, at ourTwo Pierce Place building inItasca, Illinois . "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 nine months endedSeptember 30, 2020 , we committed to spend approximately$5.90 per square foot per year of lease term for tenant improvement allowances and lease commissions (net of expiring lease commitments) as compared to$5.10 (net of expired lease commitments) for the nine months endedSeptember 30, 2019 . As ofSeptember 30, 2020 , we had one individually significant unrecorded tenant allowance commitment of approximately$44.0 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 ofSeptember 30, 2020 , we had approximately$200 million of board-authorized capacity remaining for future stock repurchases. Finally, although we have no scheduled debt maturities until the third quarter of 2021, 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 endedSeptember 30, 2020 was$8.9 million , or$0.07 per diluted share, as compared with net income applicable to common stockholders of$8.4 million , or$0.07 per diluted share, for the three months endedSeptember 30, 2019 . The increase in net income for the three months endedSeptember 30, 2020 was primarily a result of interest expense savings due to lower interest rates than the prior year, partially offset by a reduction in revenue as a result of lower reimbursable expenses and lower parking revenues at certain properties either as a result of the sale of the property or lower utilization as a result of the COVID-19 pandemic. 27 -------------------------------------------------------------------------------- Table of Contents Comparison of the three months endedSeptember 30, 2020 versus the three months endedSeptember 30, 2019
Income from Continuing Operations
The following table sets forth selected data from our consolidated statements of income for the three months endedSeptember 30, 2020 and 2019, respectively, as well as each balance as a percentage of total revenues for the same periods presented (dollars in millions): September 30, September 30, 2020 % of Revenues 2019 % of Revenues Variance Revenue: Rental and tenant reimbursement revenue$ 128.3 $ 130.6 $
(2.3)
Property management fee revenue 0.7 0.4
0.3
Other property related income 2.7 4.4 (1.7)
Total revenues 131.7 100 % 135.4 100 % (3.7)
Expense:
Property operating costs 53.3 40 % 54.6 40 % (1.3)
Depreciation 28.2 21 % 27.1 20 % 1.1
Amortization 23.0 17 % 19.5 14 % 3.5
Impairment loss on real estate assets - - % 2.0 2 % (2.0)
General and administrative 5.5 4 % 8.0 6 % (2.5)
110.0 111.2 (1.2)
Other income (expense):
Interest expense (12.7) 10 % (16.1) 12 % 3.4
Other income 0.3 - % 0.3 - % -
Loss on early extinguishment of debt - - % - - % -
Gain on sale of real estate assets (0.4) - % - - % (0.4)
Net income $ 8.9 7 % $ 8.4 6 % $ 0.5
Revenue
Rental and tenant reimbursement revenue decreased approximately $2.3 million for
the three months ended September 30, 2020 , as compared to the same period in the
prior year. Tenant reimbursement revenue decreased approximately $5.2 million
compared to the prior period due mainly to lower recoverable operating expenses.
The decrease was partially offset by a $2.9 million increase in rental revenue
due mainly to new leasing activity, most notably at our Enclave Place building
in Houston, Texas and our 60 Broad Street building in New York City .
Property management fee revenue increased approximately $0.3 million for the
three months ended September 30, 2020 as compared to the same period in the
prior year. The increase was primarily due to fees received for managing the 500
West Monroe building which was sold in October 2019 , but property management was
retained by Piedmont.
Other property related income decreased approximately $1.7 million for the three
months ended September 30, 2020 as compared to the same period in the prior
year. The decrease is primarily attributable to decreased parking revenue during
the current period as a result of the sale of the 500 West Monroe Street
building with its 1,300-space parking garage during the fourth quarter of 2019,
as well as lower transient parking utilization due to forced closures and
restrictions in response to the COVID-19 pandemic.
Expense
Property operating costs decreased approximately$1.3 million for the three months endedSeptember 30, 2020 , as compared to the same period in the prior year with increases due to net acquisition activity subsequent toJuly 1, 2019 more than 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. 28 -------------------------------------------------------------------------------- Table of Contents Depreciation expense increased approximately$1.1 million for the three months endedSeptember 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 toJuly 1, 2019 across our existing portfolio of properties. Amortization expense increased approximately$3.5 million for the three months endedSeptember 30, 2020 as compared to the same period in the prior year. Approximately$6.4 million of the increase was due to net acquisition activity subsequent toJuly 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 toJuly 1, 2019 . During the three months endedSeptember 30, 2019 , we recognized an impairment loss on real estate assets of approximately$2.0 million in conjunction with the decision to sell The Dupree building inAtlanta, Georgia . The building was sold inSeptember 2019 .
General and administrative expense decreased approximately
Other Income (Expense)
Interest expense decreased approximately$3.4 million for the three months endedSeptember 30, 2020 as compared to the same period in the prior year primarily as a result of lower interest rates during the current year as well as the repayment of the$160 million mortgage debt on our1901 Market Street building inJune 2020 . 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$0.4 million . 29
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Comparison of the accompanying consolidated statements of income for the nine
months ended
Income from Continuing Operations
The following table sets forth selected data from our consolidated statements of income for the nine months endedSeptember 30, 2020 and 2019, respectively, as well as each balance as a percentage of total revenues for the same period presented (dollars in millions): September 30, September 30, 2020 % of Revenues 2019 % of Revenues Variance Revenue: Rental and tenant reimbursement revenue$ 391.7 $ 382.2 $
9.5
Property management fee revenue 2.1 2.8
(0.7)
Other property related income 9.7 14.0 (4.3) Total revenues 403.5 100 % 399.0 100 % 4.5 Expense: Property operating costs 159.7 40 % 158.8 40 % 0.9 Depreciation 83.3 21 % 80.0 20 % 3.3 Amortization 71.0 17 % 55.7 14 % 15.3 Impairment loss on real estate assets - - % 2.0 1 %
(2.0)
General and administrative 20.0 5 % 29.7 6 % (9.7)
334.0 326.2 7.8
Other income (expense):
Interest expense (41.9) 10 % (46.8) 12 % 4.9
Other income 0.8 - % 1.3 - % (0.5)
Loss on early extinguishment of debt (9.3) 2 % - - % (9.3)
Gain on sale of real estate assets 191.0 47 % 39.5 10 % 151.5 Net income$ 210.1 52 % $ 66.8 17 %$ 143.3 Revenue Rental and tenant reimbursement revenue increased approximately$9.5 million for the nine months endedSeptember 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. This was partially offset by the recognition of charges against rental revenue for tenant-specific and general collectibility risks related to forced closures and restrictions in response to the COVID-19 pandemic during the nine months endedSeptember 30, 2020 . Additionally, tenant reimbursements decreased due to lower physical occupancy at our properties, resulting in lower recoverable operating expenses, such as utilities and janitorial services, as compared to the same period in the prior year. Property management fee revenue decreased approximately$0.7 million for the nine months endedSeptember 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 such revenue decreased approximately$4.3 million for the nine months endedSeptember 30, 2020 as compared to the same period in the prior year primarily due to the sale of the500 West Monroe Street building with its 1,300-space parking garage during the fourth quarter of 2019, as well as lower transient parking utilization at our buildings during 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
30
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same period in the prior year. This variance was primarily due to net
acquisition activity subsequent to January 1, 2019 , partially offset by lower
costs due to the decreased usage of building utilities and services as a result
of the COVID-19 pandemic.
Depreciation expense increased approximately $3.3 million for the nine months
ended September 30, 2020 as compared to the same period in the prior year. The
increase was due primarily to additional building and tenant improvements placed
in service subsequent to January 1, 2019 , partially offset by a net decrease in
depreciation associated with dispositions subsequent to January 1, 2019 .
Amortization expense increased approximately $15.3 million for the nine months
ended September 30, 2020 as compared to the same period in the prior year.
Approximately $20.8 million of the increase was due to net acquisition activity
subsequent to January 1, 2019 . This increase was partially offset by certain
lease intangible assets or other deferred costs at our existing properties
becoming fully amortized as a result of the expiration of leases subsequent to
January 1, 2019 .
During the nine months ended September 30, 2019 , we recognized an impairment
loss on real estate assets of approximately $2.0 million in conjunction with the
decision to sell The Dupree building in Atlanta, Georgia . The building was sold
in September 2019 .
General and administrative expenses decreased approximately $9.7 million for the
nine months ended September 30, 2020 as compared to the nine months ended
September 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 on
June 30, 2019 , resulting in lower compensation at the executive level in the
current period.
Other Income (Expense)
Interest expense decreased approximately $4.9 million for the nine months ended
September 30, 2020 as compared to the same period in the prior year primarily as
a result of lower interest rates during the current year as well as the
repayment of the $160 million mortgage debt on our 1901 Market Street building
in June 2020 . 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 $1.0 million .
The loss on early extinguishment of debt during the nine months ended
September 30, 2020 was associated with the early repayment of the $160 Million
Fixed-Rate Loan which was collateralized by the 1901 Market Street building. The
property was sold during the nine months ended September 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 nine months ended September 30,
2020 includes a gain of approximately $191.0 million recognized on the sale of
the 1901 Market Street building in Philadelphia, Pennsylvania . Gain on sale of
real estate assets during the nine months ended September 30, 2019 includes an
approximate $33.2 million gain recognized on the sale of the One Independence
Square building in Washington, D.C. , as well as an approximate $6.1 million
adjustment of the gain on sale for the Two Independence Square building related
to the reimbursement of certain previously disputed tenant improvement overages.
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Issuer and Guarantor Financial Information
During the years ended December 31, 2013 and 2014, and during the nine months
ended September 30, 2020 , Piedmont, through its wholly-owned subsidiary Piedmont
Operating Partnership, LP ("Piedmont OP" or the "Issuer"), issued senior
unsecured notes payable of $350 million , $400 million , and $300 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 by Piedmont 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
December 31, 2019
Due from non-guarantor subsidiary $ 810 $ 810
Total assets $ 362,594 $ 364,734
Total liabilities $ 1,617,051 $ 1,343,881
For the Nine Months
Ended September 30,
2020
Total revenues $ 31,486
Net loss $ (37,209)
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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 Nine Months Ended
September 30, Per September 30, Per September 30, Per September 30, Per
2020 Share(1) 2019 Share(1) 2020 Share(1) 2019 Share(1)
GAAP net income applicable to common
stock $ 8,943 $ 0.07
27,960 0.22 26,909 0.21 82,384 0.65 79,346 0.63
Amortization of lease-related costs 22,976 0.18 19,491 0.15 70,930 0.56 55,622 0.44
Impairment loss on real estate
assets - - 1,953 0.02 - - 1,953 0.01
(Gain)/loss on sale of real estate
assets 340 0.01 (32) - (191,032) (1.51) (39,370) (0.31)
NAREIT Funds From Operations
applicable to common stock $ 60,219 $ 0.48 Retirement and separation expenses associated with senior management transition in June 2019 - - - - - - 3,175 0.03 Loss on early extinguishment of debt - - - - 9,336 0.08 - - Core Funds From Operations applicable to common stock$ 60,219 $ 0.48 $ 56,743 $ 0.45 $ 181,697 $ 1.44 $ 167,509 $ 1.33 Adjustments: Amortization of debt issuance costs, fair market value adjustments on notes payable, and discounts on debt 931 526 2,180 1,574 Depreciation of non real estate assets 286 214 930 634 Straight-line effects of lease revenue (6,315) (1,531) (20,378) (7,437) Stock-based compensation adjustments 1,336 (3,015) 4,281 1,949 Net effect of amortization of above and below-market in-place lease intangibles (3,240) (1,923) (9,517) (6,009) Non-incremental capital expenditures (2) (15,611) (14,352) (58,062) (27,410) Adjusted Funds From Operations applicable to common stock$ 37,606 $ 36,662 $ 101,131 $ 130,810 Weighted-average shares outstanding - diluted 126,385 126,240 126,302 126,190
(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 nine months ended September 30, 2020 includes the
significant leasing commission of approximately $16 million 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 endedSeptember 30, 2020 and 2019, respectively (in thousands): Cash Basis Accrual Basis Three Months Ended Three Months Ended September 30, September 30, September 30, September 30, 2020 2019 2020 2019
Net income applicable to Piedmont (GAAP basis)
8,422
Net loss applicable to noncontrolling interest (3) (3) (3) (3) Interest expense 12,725 16,145 12,725 16,145 Depreciation 28,247 27,124 28,247 27,124 Amortization 22,976 19,491 22,976 19,491 Impairment loss on real estate assets - 1,953 - 1,953 (Gain)/loss on sale of real estate assets 340 (32) 340 (32) EBITDAre(1) and Core EBITDA (2)$ 73,228 $
73,100
General & administrative expenses 5,469 7,950 5,469 7,950 Management fee revenue (3) (422) (203) (422) (203) Other income (104) (47) (104) (47) Non-cash general reserve for uncollectible accounts (33)
-
Straight-line rent effects of lease revenue (6,315)
(1,531)
Amortization of lease-related intangibles (3,240) (1,923) Property NOI$ 68,583 $ 77,346 $ 78,171 $ 80,800 Net operating income from: Acquisitions (4) (10,165) (2,771) (14,222) (3,627) Dispositions (5) (56) (11,800) (56) (12,740) Other investments (6) 18 (896) (80) (889) Same Store NOI$ 58,380 $ 61,879 $ 63,813 $ 63,544 Change period over period in Same Store NOI (5.7) % N/A 0.4 % 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. (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 36 -------------------------------------------------------------------------------- Table of Contents 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 nine months endedSeptember 30, 2020 and 2019 (in thousands): Cash Basis Accrual Basis Nine Months Ended Nine Months Ended September 30, September 30, September 30, September 30, 2020 2019 2020 2019
Net income applicable to Piedmont (GAAP basis)
66,783
Net loss applicable to noncontrolling interest (2) (3) (2) (3) Interest expense 41,942 46,750 41,942 46,750 Depreciation 83,315 79,982 83,315 79,982 Amortization 70,930 55,622 70,930 55,622 Impairment loss on real estate assets - 1,953 - 1,953 Gain on sale of real estate assets (191,032) (39,370) (191,032) (39,370) EBITDAre(1)$ 215,232 $
211,717
9,336 - 9,336 -
Retirement and separation expenses associated
with senior management transition in June 2019 - 3,175 - 3,175
Core EBITDA(2) $ 224,568 $
214,892
20,049 26,561 20,049 26,561
Management fee revenue (3) (1,098) (2,226) (1,098) (2,226)
Other expense/(income) (170) (165) (170) (165)
Non-cash general reserve for uncollectible
accounts 4,831 -
Straight-line rent effects of lease revenue (20,378)
(7,437)
Amortization of lease-related intangibles (9,517) (6,009) Property NOI$ 218,285 $ 225,616 $ 243,349 $ 239,062 Net operating income from: Acquisitions (4) (28,379) (3,691) (38,008) (4,782) Dispositions (5) (9,035) (38,977) (10,711) (40,566) Other investments (6) (288) (1,181) (319) (1,158) Same Store NOI$ 180,583 $ 181,767 $ 194,311 $ 192,556 Change period over period in Same Store NOI (0.7) % N/A 0.9 % 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. The loss in early extinguishment of debt relates to the early payoff of the mortgage on1901 Market Street which was sold for gain onJune 25, 2020 . (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 ofSeptember 30, 2020 , our average lease is approximately 15,000 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 88% leased as ofSeptember 30, 2020 , as compared to 91% leased as ofSeptember 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 followingSeptember 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 ofSeptember 30, 2020 , we had approximately 6% of our total rentable square feet in some form of rental and/or operating expense abatement; consisting of 314,000 square feet of executed leases related to currently vacant space that had not yet commenced, and approximately 893,000 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 nine months endedSeptember 30, 2020 , we experienced a 4.8% and 11.3% roll up in cash and accrual rents, respectively, on leases executed during the period for space vacant one year or less. Despite anticipated growth during the nine months endedSeptember 30, 2020 as compared to the nine months endedSeptember 30, 2019 , Same Store NOI was relatively flat as compared to the same period in the prior year, decreasing by 0.7% 39 -------------------------------------------------------------------------------- Table of Contents on a cash basis, and increasing by 0.9% on an accrual basis, primarily due to agreements for rent deferrals granted to tenants as a result of the COVID-19 pandemic. Property NOI and Same Store NOI comparisons for any given period 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 ofSeptember 30, 2020 , we had no off-balance sheet arrangements. For further information regarding our commitments under our debt obligations, see the Contractual Obligations table below.
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 nine months endedSeptember 30, 2020 . 40 -------------------------------------------------------------------------------- Table of Contents Accounting Pronouncements Adopted during the Nine Months EndedSeptember 30, 2020 Reference Rate Reform Relief Accounting Standards Update No. 2020-04, Reference Rate Reform (Topic 848) ("ASU 2020-04"), was issued inMarch 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 nine months endedSeptember 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 nine months endedSeptember 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 of our approximately 60 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 nine months ended September 30, 2020 as detailed in Note 4 to our accompanying consolidated financial statements. As such, our contractual obligations related to long-term debt as ofSeptember 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)$ 1,627,976 $ 27,976 $ 650,000 $ 650,000 $ 300,000
(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 ofSeptember 30, 2020 . (2)Amounts include principal payments only and balances outstanding as ofSeptember 30, 2020 , not including approximately$11.1 million of net 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$41.8 million during the nine months endedSeptember 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. 41
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Table of Contents 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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