The following information should be read in conjunction with our consolidated financial statements and accompanying notes included in Part I, Item 1 of this Quarterly Report on Form 10-Q and our 2021 Annual Report.
OVERVIEW (dollars in thousands, except per share and per square foot data)
We are a real estate investment trust, or REIT, organized underMaryland law. As ofSeptember 30, 2022 , our wholly owned properties were comprised of 162 properties and we had noncontrolling ownership interests of 51% and 50% in two unconsolidated joint ventures that own three properties containing approximately 444,000 rentable square feet. As ofSeptember 30, 2022 , our properties are located in 31 states and theDistrict of Columbia and contain approximately 21,211,000 rentable square feet. As ofSeptember 30, 2022 , our properties were leased to 276 different tenants with a weighted average remaining lease term (based on annualized rental income) of approximately 6.3 years. TheU.S. government is our largest tenant, representing approximately 19.1% of our annualized rental income as ofSeptember 30, 2022 . The term annualized rental income as used herein is defined as the annualized contractual base rents from our tenants pursuant to our lease agreements as ofSeptember 30, 2022 , plus straight line rent adjustments and estimated recurring expense reimbursements to be paid to us, and excluding lease value amortization. Certain changes in office space utilization following the COVID-19 pandemic, including increased remote work arrangements, continue to impact the market. The utilization and demand for office space continues to evolve and the ultimate impact of current trends on the demands for office space at our properties remains uncertain and subject to change. Accordingly, we do not yet know the full extent of the impacts on our or our tenants' businesses and operations. In response to inflationary pressures, theU.S. Federal Reserve increased the federal funds rate by 300 basis points over five consecutive meetings fromMarch 2022 toSeptember 2022 and has signaled that further increases are likely to occur. These inflationary pressures and rising interest rates inthe United States and globally have given rise to increasing concerns that theU.S. economy is now in, or may soon enter, an economic recession and they have caused disruptions in the financial markets. Sustained inflationary pressures, increased interest rates, an economic recession or continued or intensified disruptions in the financial markets could adversely affect our financial condition and that of our tenants, could adversely impact the ability of our tenants to renew our leases or pay rent to us, would impair our ability to effectively deploy our capital or realize upon investments on favorable terms, may restrict our access to, and would likely increase our cost of capital, and may cause the values of our properties and of our securities to decline. For more information and risks relating to the COVID-19 pandemic, inflation and changes in market interest rates and their impacts on us and our business, see Part I, Item IA, "Risk Factors", of our 2021 Annual Report.
Property Operations
Unless otherwise noted, the data presented in this section includes properties classified as held for sale as ofSeptember 30, 2022 and excludes three properties owned by two unconsolidated joint ventures in which we own 51% and 50% interests. For more information regarding our properties classified as held for sale and our two unconsolidated joint ventures, see Note 3 to our Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.
Occupancy data for our properties since
All Properties (1)(2) Comparable Properties (3)
September 30, September 30,
2022 2021 2022 2021
Total properties 162 178 150 150
Total rentable square feet (4) 21,211 23,274 19,139 19,144
Percent leased (5) 90.7 % 89.0 % 93.6 % 93.1 %
(1)Based on properties we owned on September 30, 2022 and 2021, respectively.
(2)Includes one leasable land parcel.
(3)Based on properties we owned continuously since January 1, 2021 ; excludes
properties classified as held for sale and properties undergoing significant
redevelopment, if any, and three properties owned by two unconsolidated joint
ventures in which we own 51% and 50% interests.
(4)Subject to changes when space is remeasured or reconfigured for tenants.
(5)Percent leased includes (i) space being fitted out for tenant occupancy
pursuant to our lease agreements, if any, and (ii) space which is leased, but is
not occupied or is being offered for sublease by tenants, if any, as of the
measurement date.
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The average effective rental rate per square foot for our properties for three and nine months ended
Three Months Ended September 30, Nine Months Ended September 30,
2022 2021 2022 2021
Average effective rental rate per
square foot (1):
All properties (2) $ 29.19 $ 28.86 $ 29.44 $ 27.12
Comparable properties (3) $ 29.09 $ 28.84 $ 27.64 $ 27.11
(1)Average effective rental rate per square foot represents annualized total
rental income during the period specified divided by the average rentable square
feet leased during the period specified.
(2)Based on properties we owned on September 30, 2022 and 2021, respectively.
(3)Based on properties we owned continuously since July 1, 2021 and January 1,
2021 , respectively; excludes properties classified as held for sale and
properties undergoing significant redevelopment, if any, and three properties
owned by two unconsolidated joint ventures in which we own 51% and 50%
interests.
During the three and nine months ended September 30, 2022 , changes in rentable
square feet leased and available for lease at our properties were as follows
(square feet in thousands):
Three Months Ended September 30, 2022
Nine Months ended
Leased Available for Lease Total Leased Available for Lease Total
Beginning of period 20,100 2,391 22,491 20,817 2,454 23,271
Changes resulting from:
Disposition of properties (827) (472) (1,299) (1,349) (728) (2,077)
Lease expirations (643) 643 - (2,088) 2,088 -
Lease renewals (1) 383 (383) - 1,272 (1,272) -
New leases (1) 223 (223) - 585 (585) -
Remeasurements (2) - 19 19 (1) 18 17
End of period 19,236 1,975 21,211 19,236 1,975 21,211
(1)Based on leases entered during the three and nine months ended September 30,
2022 .
(2)Rentable square feet are subject to changes when space is remeasured or
reconfigured for tenants.
Leases at our properties totaling approximately 643,000 and 2,088,000 rentable
square feet expired during the three and nine months ended September 30, 2022 ,
respectively. During the three and nine months ended September 30, 2022 , we
entered into new and renewal leases as summarized in the following tables
(square feet in thousands):
Three
The months are over
New Leases Renewals Total
Rentable square feet leased 223 383 606
Weighted average rental rate change (by rentable 59.1 % 0.2 % 21.6 %
square feet)
Tenant leasing costs and concession commitments (1) $ 33,957
Tenant leasing expenses and concession commitments per rentable square foot (1)
$ 152.13 $ 23.66 $ 70.98 Weighted (by square feet) average lease term (years) 9.9 5.5 7.2
Total leasing expenses and concession commitments per rental square foot per year (1)
$ 15.33
Nine
The months are over
New Leases Renewals Total
Rentable square feet leased 585 1,272 1,857
Weighted average rental rate change (by rentable 27.8 % 2.7 % 11.0 %
square feet)
Tenant leasing costs and concession commitments (1) $ 72,011
Tenant leasing expenses and concession commitments per rentable square foot (1)
$ 123.03 $ 32.35 $ 60.94 Weighted (by square feet) average lease term (years) 9.8 8.6 9.0
Total leasing expenses and concession commitments per rental square foot per year (1)
$ 12.62
(1)Includes commitments made for lease expenditures and concessions, such as tenant improvements, lease commissions, tenant payments and free rent.
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During the three and nine months endedSeptember 30, 2022 , changes in effective rental rates per square foot achieved for new leases and lease renewals at our properties that commenced during the three and nine months endedSeptember 30, 2022 , when compared to prior effective rental rates per square foot in effect for the same space (and excluding space acquired vacant), were as follows (square feet in thousands): Three Months Ended September 30, 2022 Nine Months Ended September 30, 2022 Old Effective Old Effective Rent Per New Effective Rent Rent Per New Effective Rent Square Foot (1) Per Square Foot (1) Rentable Square Feet Square Foot (1) Per Square Foot (1) Rentable Square Feet New leases$ 30.67 $ 32.73 108$ 15.07 $ 15.43 368 Lease renewals$ 29.38 $ 29.97 328$ 28.08 $ 29.28 1,356 Total leasing activity$ 29.70 $ 30.65 436$ 25.30 $ 26.32 1,724
(1) Effective rental rates include base contractual rents from our tenants pursuant to our lease agreements, including straight-line rent adjustments and estimated expense payments payable in us, and does not include amortization in the lease amount.
In three and nine months completed
Three Months Ended September 30, Nine Months Ended September 30,
2022 2021 2022 2021
Lease related costs (1) $ 17,297
Building improvements (2)
8,585 9,267 16,070 21,558 Recurring capital expenditures 25,882 26,341 58,162 56,817 Development, redevelopment and other activities (3) 36,811 13,272 114,637 30,916 Total capital expenditures $ 62,693
(1)Lease related costs generally include capital expenditures used to improve tenants' space or amounts paid directly to tenants to improve their space and leasing related costs, such as brokerage commissions and other tenant inducements. (2)Building improvements generally include expenditures to replace obsolete building components and expenditures that extend the useful life of existing assets. (3)Development, redevelopment and other activities generally include capital expenditure projects that reposition a property or result in new sources of revenue. In addition to the capital expenditures described above, we contributed$712 and$2,914 to one of our unconsolidated joint ventures during the three and nine months endedSeptember 30, 2022 , respectively. Also, as ofSeptember 30, 2022 , we had estimated unspent leasing related obligations of$137,420 , of which we expect to spend$77,251 over the next 12 months. As ofSeptember 30, 2022 , we had leases at our properties totaling approximately 1,596,000 rentable square feet that were scheduled to expire throughSeptember 30, 2023 . As ofOctober 26, 2022 , we expect tenants with leases totaling approximately 696,000 rentable square feet that are scheduled to expire throughSeptember 30, 2023 , not to renew their leases upon expiration and we cannot be sure as to whether other tenants will renew their leases upon expiration. However, we continue to proactively engage with our existing tenants and are focused on our overall tenant retention. Prevailing market conditions and government and other tenants' needs at the time we negotiate and enter leases or lease renewals will generally determine rental rates and demand for leased space at our properties, all of which factors are beyond our control. Whenever we renew or enter into new leases for our properties, we intend to seek rents which are equal to or higher than our historical rents for the same properties; however, our ability to maintain or increase the rents for our current properties will depend in large part upon market conditions, which are beyond our control. We cannot be sure of the rental rates which will result from our ongoing negotiations regarding lease renewals or any new or renewed leases we may enter. Also, we may experience material declines in our rental income due to vacancies upon lease expirations or early terminations or lower rents upon lease renewal or reletting. Additionally, we may incur significant costs and make significant concessions to renew our leases with current tenants or lease our properties to new tenants. 19
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As ofSeptember 30, 2022 , our lease expirations by year were as follows (square feet in thousands): Annualized Number of Leases Leased Percent of Cumulative Rental Income Percent of Cumulative Year (1) Expiring Square Feet Expiring (2) Total Percent of Total Expiring Total Percent of Total 2022 17 160 0.8 % 0.8 %$ 4,443 0.8 % 0.8 % 2023 64 2,374 12.3 % 13.1 % 77,045 14.0 % 14.8 % 2024 50 3,028 15.7 % 28.8 % 79,495 14.4 % 29.2 % 2025 43 2,036 10.6 % 39.4 % 43,564 7.9 % 37.1 % 2026 36 1,565 8.1 % 47.5 % 41,418 7.5 % 44.6 % 2027 35 2,055 10.7 % 58.2 % 52,053 9.5 % 54.1 % 2028 17 1,282 6.7 % 64.9 % 49,042 8.9 % 63.0 % 2029 18 732 3.8 % 68.7 % 22,550 4.1 % 67.1 % 2030 22 839 4.4 % 73.1 % 24,585 4.5 % 71.6 % 2031 and thereafter 57 5,165 26.9 % 100.0 % 156,408 28.4 % 100.0 % Total 359 19,236 100.0 %$ 550,603 100.0 % Weighted average remaining lease term (in years) 6.0 6.3 (1)The year of lease expiration is pursuant to current contract terms. Some of our leases allow the tenants to vacate the leased premises before the stated expirations of their leases with little or no liability. As ofSeptember 30, 2022 , tenants occupying approximately 3.6% of our rentable square feet and responsible for approximately 3.5% of our annualized rental income as ofSeptember 30, 2022 had exercisable rights to terminate their leases before the stated terms of their leases expire. Also, in 2023, 2024, 2025, 2026, 2027, 2028, 2029, 2030, 2031, 2035, 2037 and 2040, early termination rights become exercisable by other tenants who occupied an additional approximately 5.4%, 2.8%, 4.5%, 0.9%, 0.9%, 1.6%, 0.8%, 0.7%, 0.1%, 0.4%, 0.1% and 0.3% of our rentable square feet, respectively, and contributed an additional approximately 6.4%, 3.0%, 8.3%, 1.2%, 1.3%, 1.7%, 1.3%, 0.9%, 0.1%, 0.5%, 0.2% and 0.4% of our annualized rental income, respectively, as ofSeptember 30, 2022 . In addition, as ofSeptember 30, 2022 , pursuant to leases with 10 of our tenants, these tenants had rights to terminate their leases if their respective legislature or other funding authority does not appropriate rent amounts in their respective annual budgets. These 10 tenants occupied approximately 5.4% of our rentable square feet and contributed approximately 6.1% of our annualized rental income as ofSeptember 30, 2022 . (2)Leased square feet is pursuant to leases existing as ofSeptember 30, 2022 , and includes (i) space being fitted out for tenant occupancy pursuant to our lease agreements, if any, and (ii) space which is leased, but is not occupied or is being offered for sublease by tenants, if any. Square feet measurements are subject to changes when space is remeasured or reconfigured for new tenants. We generally will seek to renew or extend the terms of leases at properties with tenants when they expire. Because of the capital many of our single tenants have invested in the properties they lease from us and because many of these properties appear to be of strategic importance to such tenants' businesses, we believe that it is likely that most of these tenants will renew or extend their leases prior to when they expire. However, increases in remote work and changes in space utilization may cause our tenants not to renew or extend their leases when they expire, or to seek to renew their leases for less space than they currently occupy. If we are unable to extend or renew our leases, or we renew leases for reduced space, it may be time consuming and expensive to relet some of these properties. We believe that recent government budgetary and spending priorities and enhancements in technology have resulted in a decrease in government office use for employees. Furthermore, over the past several years, government tenants have reduced their space utilization per employee and consolidated government tenants into existing government owned properties. This activity has reduced the demand for government leased space. Our historical experience with respect to properties of the type we own that are majority leased to government tenants has been that government tenants frequently renew leases to avoid the costs and disruptions that may result from relocating their operations. However, efforts to manage space utilization rates may result in our tenants exercising early termination rights under our leases, vacating our properties upon expiration of our leases in order to relocate, or renewing their leases for less space than they currently occupy. Also, our government tenants' desire to reconfigure leased office space to manage utilization per employee may require us to spend significant amounts for tenant improvements, and tenant relocations are often more prevalent in those circumstances. Increasing uncertainty with respect to government agency budgets and funding to implement relocations, consolidations and reconfigurations has resulted in delayed decisions by some of our government tenants and their reliance on short term lease renewals; however, activity prior to the outbreak of the COVID-19 pandemic suggested that theU.S. government had begun to shift its leasing strategy to include longer term leases and was actively exploring 10 to 20 year lease terms at renewal, in some instances. Given the significant uncertainties, including the extent to which remote or alternative work arrangements may continue or increase, we are unable to reasonably project what the financial impact of market conditions or changing government circumstances will be on the demand for leased space at our properties and our financial results for future periods. 20
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As ofSeptember 30, 2022 , we derived 22.4% of our annualized rental income from our properties located in the metropolitanWashington, D.C. market area, which includesWashington, D.C. ,Northern Virginia and suburbanMaryland . A downturn in economic conditions in this area could result in reduced demand from tenants for our properties or reduce the rents that our tenants in this area are willing to pay when our leases expire or terminate and when renewal or new terms are negotiated. Additionally, in recent years there has been a decrease in demand for new leased office space by theU.S. government in the metropolitanWashington, D.C. market area, and that could increase competition for government tenants and adversely affect our ability to retain government tenants when our leases expire. Our manager, RMR, employs a tenant review process for us. RMR assesses tenants on an individual basis based on various applicable credit criteria. In general, depending on facts and circumstances, RMR evaluates the creditworthiness of a tenant based on information concerning the tenant that is provided by the tenant and, in some cases, information that is publicly available or obtained from third party sources. We consider investment grade tenants to include: (a) investment grade rated tenants; (b) tenants with investment grade rated parent entities that guarantee the tenant's lease obligations; and/or (c) tenants with investment grade rated parent entities that do not guarantee the tenant's lease obligations. As ofSeptember 30, 2022 , tenants contributing 52.4% of annualized rental income were investment grade rated (or their payment obligations were guaranteed by an investment grade rated parent) and tenants contributing an additional 10.6% of annualized rental income were subsidiaries of an investment grade rated parent (although these parent entities were not liable for the payment of rents).
Number of
% of Total
% of Leased Annualized Annualized Rental
Tenant Credit Rating Sq. Ft. Sq. Ft. Rental Income Income
1 U.S. Government Investment Grade 3,894 20.2 % $ 105,440
19.1 %
2 Alphabet Inc. (Google) Investment Grade 386 2.0 % 23,713
4.3%
3 Shook, Hardy & Bacon L.L.P. Not Rated 596 3.1 % 19,336
3.5%
4 IG Investments Holdings LLC Not Rated 338 1.8 % 16,788
3.0%
5 Bank of America Corporation Investment Grade 577 3.0 % 15,766 2.9 % 6 State of California Investment Grade 523 2.7 % 15,762 2.9 % 7 Commonwealth of Massachusetts Investment Grade 311 1.6 % 12,260 2.2 % 8 CareFirst Inc. Not Rated 207 1.1 % 11,498 2.1 % 9 Northrop Grumman Corporation Investment Grade 337 1.8 % 11,465 2.1 % 10 Tyson Foods, Inc. Investment Grade 248 1.3 % 11,042 2.0 %
11 Corporation (1) Not Rated 230 1.2 % 10,745
2.0%
12 CommScope Holding Company Inc Non Investment Grade 228 1.2 % 9,370
1.7%
13 Sonoma Biotherapeutics, Inc. (2) Not Rated 84 0.4 % 7,468 1.4 % 14 State of Georgia Investment Grade 308 1.6 % 7,383 1.3 % 15 PNC Bank Investment Grade 441 2.3 % 6,924 1.3 % 16 Micro Focus International plc Non Investment Grade 215 1.1 % 6,905 1.3 % 17 Compass Group plc Investment Grade 267 1.4 % 6,703 1.2 % 18 ServiceNow, Inc. Investment Grade 149 0.8 % 6,637 1.2 % 19 Allstate Insurance Co. Investment Grade 468 2.4 % 6,479 1.2 % 20 Leidos Holdings Inc. Investment Grade 159 0.8 % 6,117 1.1 % 21 Automatic Data Processing, Inc. Investment Grade 289 1.5 % 6,087
1.1%
22 Church & Dwight Co., Inc. Investment Grade 250 1.3 % 6,037 1.1 %
Total 10,505 54.6 % $ 329,925 60.0 %
(1)In June 2021 , we entered into a 30-year lease with Sonesta. The lease relates
to the redevelopment of a property we own in Washington, D.C to a mixed use and
Sonesta's lease relates to the planned hotel component of the property. The term
of the lease commences upon our delivery of the completed hotel, which is
estimated to occur in the second quarter of 2023. For more information about our
lease with Sonesta, see Note 10 to our Condensed Consolidated Financial
Statements included in Part I, Item I of this Quarterly Report on Form 10-Q.
(2)In August 2022 , we entered into an approximately 10-year lease with Sonoma
Biotherapeutics, Inc. at a property we own in Seattle, WA that is currently
undergoing redevelopment. The term of the lease is estimated to commence in the
fourth quarter of 2023.
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Table of Contents Disposition Activities
Within nine months completed
Based on current real estate market conditions, including rising interest rates, we expect the pace of our dispositions to moderate. However, we continue to evaluate our portfolio to strategically recycle capital and are currently in various stages of marketing certain of our properties for sale, and we may decide to seek to sell additional properties in the future. As ofOctober 26, 2022 , we have entered into agreements to sell five properties, including one leasable land parcel, containing approximately 338,000 rentable square feet for an aggregate sales price of$20,450 , excluding closing costs. These sales are expected to occur before the end of the fourth quarter of 2022. However, these sales are subject to conditions; accordingly, we cannot be sure that we will complete these sales or that these sales will not be delayed or the terms will not change.
For more information about our disposition activities, see Note 3 to our Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.
Funding Activities
In
InJune 2022 , we redeemed, at par plus accrued interest, all$300,000 of our 4.00% senior unsecured notes dueJuly 2022 using cash on hand and borrowings under our revolving credit facility. InOctober 2022 , we prepaid, at a discounted amount of$22,176 plus accrued interest, a mortgage note secured by one property with an outstanding principal balance of$22,901 , an annual interest rate of 4.80% and a maturity date inJune 2023 using cash on hand and borrowings under our revolving credit facility.
Segment Information
We operate in one business segment: ownership of real estate properties.
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