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 ofJune 30, 2022 , our wholly owned properties were comprised of 172 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 ofJune 30, 2022 , our properties are located in 32 states and theDistrict of Columbia and contain approximately 22,491,000 rentable square feet. As ofJune 30, 2022 , our properties were leased to 287 different tenants with a weighted average remaining lease term (based on annualized rental income) of approximately 6.2 years. TheU.S. government is our largest tenant, representing approximately 18.5% of our annualized rental income as ofJune 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 ofJune 30, 2022 , plus straight line rent adjustments and estimated recurring expense reimbursements to be paid to us, and excluding lease value amortization. The COVID-19 pandemic and the various governmental and market responses intended to contain and mitigate the spread of the virus and its detrimental public health impact have had a significant impact on the global economy, including theU.S. economy. Many of the restrictions that had been imposed inthe United States during the pandemic have since been lifted and commercial activity inthe United States generally has increasingly returned to pre-pandemic practices and operations. However, certain market practices that have resulted from the pandemic, including increased alternative work arrangements such as work from home, are continuing to be experienced. We are continuing to closely monitor the impact of the COVID-19 pandemic on all aspects of our business. To date, the COVID-19 pandemic has not had a significant adverse impact on our business and we continue to believe that our financial resources, the characteristics of our portfolio, including the diversity of our tenant base, both geographically and by industry, and the financial strength and resources of our tenants, will enable us to withstand the COVID-19 pandemic. TheU.S. Federal Reserve recently raised interest rates in an effort to combat high inflation, which could result in negative consequences in theU.S. economy, and concerns about a potential recession are becoming more pronounced. It is unclear whether theU.S. economy will be able to withstand such challenges and continue sustained growth. A recession 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 and may cause the values of our properties and of our securities to decline. We could also be affected by any overall weakening of, or disruptions in, the financial markets. The ultimate adverse impact of the COVID-19 pandemic, including the extent to which alternative work arrangements such as work from home will be continued and what impact that may have on demand for office space at our properties, and recently rising interest rates, is highly uncertain and subject to change. As a result, we do not yet know the full extent of potential impacts on our business and operations, our tenants' businesses and operations or the global economy as a whole. For more information and risks relating to the COVID-19 pandemic on us and our business, see Part I, Item 1A, "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 ofJune 30, 2022 and excludes three properties owned by two unconsolidated joint ventures in which we own 51% and 50% interests. For more 16
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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 as ofJune 30, 2022 and 2021 was as follows (square feet in thousands): All Properties (1)(2) Comparable Properties (3) June 30, June 30, 2022 2021 2022 2021 Total properties 172 181 153 153 Total rentable square feet (4) 22,491 24,091 19,228 19,226 Percent leased (5) 89.4 % 89.5 % 94.3 % 93.0 % (1)Based on properties we owned onJune 30, 2022 and 2021, respectively. (2)Includes one leasable land parcel. (3)Based on properties we owned continuously sinceJanuary 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.
The average effective rental rate per square foot for our properties for the three and six months ended
Three Months Ended June 30, Six Months Ended June 30,
2022 2021 2022 2021
Average effective rental rate per
square foot (1):
All properties (2) $ 28.80 $
26.46
Comparable properties (3)$ 27.71 $
26.85
(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 onJune 30, 2022 and 2021, respectively. (3)Based on properties we owned continuously sinceApril 1, 2021 andJanuary 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 six months endedJune 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 June 30, 2022 Six Months Ended June 30, 2022 Leased Available for Lease Total Leased Available for Lease Total Beginning of period 20,373 2,568 22,941 20,817 2,454 23,271 Changes resulting from: Disposition of properties (359) (89) (448) (522) (256) (778) Lease expirations (592) 592 - (1,445) 1,445 - Lease renewals (1) 553 (553) - 889 (889) - New leases (1) 126 (126) - 362 (362) - Remeasurements (2) (1) (1) (2) (1) (1) (2) End of period 20,100 2,391 22,491 20,100 2,391 22,491
(1)Based on leases entered within three and six months of completion
Leases at our properties totaling approximately 592,000 and 1,445,000 rentable square feet expired during the three and six months endedJune 30, 2022 , respectively. During the three and six months endedJune 30, 2022 , we entered into new and renewal leases as summarized in the following tables (square feet in thousands): 17
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Three Months are over
New Leases Renewals Total
Rentable square feet leased 126 553 679
Weighted average rental rate change (by rentable 8.7 % 4.0 % 4.9 %
square feet)
Tenant leasing costs and concession commitments (1) $ 11,199
Tenant leasing expenses and concession commitments per rentable square foot (1)
$ 89.01 $ 47.36 $ 55.08 Weighted (by square feet) average lease term (years) 8.3 9.4 9.2
Total leasing expenses and concession commitments per rental square foot per year (1)
$ 10.79 $ 5.05 $ 6.00 Six Months Ended June 30, 2022 New Leases Renewals Total Rentable square feet leased 362 889 1,251 Weighted average rental rate change (by rentable 7.3 % 3.9 % 5.0 % square feet) Tenant leasing costs and concession commitments (1)$ 38,054
Tenant leasing expenses and concession commitments per rentable square foot (1)
$ 105.09 $ 36.10 $ 56.08 Weighted (by square feet) average lease term (years) 9.6 10.0 9.9
Total leasing expenses and concession commitments per rental square foot per year (1)
$ 10.90
(1)Includes commitments made for lease expenditures and concessions, such as tenant improvements, lease commissions, tenant payments and free rent.
During the three and six months endedJune 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 six months endedJune 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 June 30, 2022 Six Months Ended June 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$ 12.63 $ 20.58 8 $ 8.60 $ 8.26 260 Lease renewals$ 27.90 $ 29.06 536$ 27.68 $ 29.07 1,028 Total leasing activity$ 27.67 $ 28.93 544$ 23.82 $ 24.86 1,288
(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.
Within three and six months completed
Three Months Ended June 30, Six Months Ended June 30,
2022 2021 2022 2021
Lease related costs (1) $ 16,131 $
11,215
Building improvements (2)
4,702 7,765 7,485 12,291 Recurring capital expenditures 20,833 18,980 32,280 30,476 Development, redevelopment and other activities (3) 40,302 12,738 77,826 17,644 Total capital expenditures$ 61,135 $
31,718
(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$1,132 and$2,202 to one of our unconsolidated joint ventures during the three and six months endedJune 30, 2022 , respectively. Also, as ofJune 30, 2022 , we have estimated unspent leasing related obligations of$130,726 , of which we expect to spend$82,543 over the next 12 months. 18
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As ofJune 30, 2022 , we had leases at our properties totaling approximately 1,913,000 rentable square feet that were scheduled to expire throughJune 30, 2023 . As ofJuly 27, 2022 , we expect tenants with leases totaling approximately 817,000 rentable square feet that are scheduled to expire throughJune 30, 2023 , to not renew their leases upon expiration and we cannot be sure as to whether other tenants will renew their leases upon expiration. As a result of the COVID-19 pandemic, its economic impact and the uncertainty of whether certain market practices and trends in response to the pandemic will be sustained or increased, including the extent to which alternative work arrangements such as work from home practices may be continued, overall leasing activity has been volatile and may remain so until office property market conditions meaningfully improve and stabilize for a sustained period. However, we remain focused on proactive dialogues with our existing tenants and 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, and market conditions and our tenants' needs 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 to renew our leases with current tenants or lease our properties to new tenants. As ofJune 30, 2022 , our lease expirations by year are 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 42 944 4.7 % 4.7 %$ 23,716 4.2 % 4.2 % 2023 60 2,305 11.5 % 16.2 % 76,154 13.5 % 17.7 % 2024 51 3,063 15.2 % 31.4 % 79,437 14.1 % 31.8 % 2025 44 2,047 10.2 % 41.6 % 43,419 7.7 % 39.5 % 2026 37 1,670 8.3 % 49.9 % 43,200 7.7 % 47.2 % 2027 37 2,161 10.8 % 60.7 % 53,942 9.6 % 56.8 % 2028 14 1,254 6.2 % 66.9 % 48,954 8.7 % 65.5 % 2029 20 1,038 5.2 % 72.1 % 30,277 5.4 % 70.9 % 2030 19 731 3.6 % 75.7 % 20,800 3.7 % 74.6 % 2031 and thereafter 51 4,887 24.3 % 100.0 % 142,966 25.4 % 100.0 % Total 375 20,100 100.0 %$ 562,865 100.0 % Weighted average remaining lease term (in years) 5.9 6.2 (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 ofJune 30, 2022 , tenants occupying approximately 3.9% of our rentable square feet and responsible for approximately 4.3% of our annualized rental income as ofJune 30, 2022 currently have exercisable rights to terminate their leases before the stated terms of their leases expire. Also, in 2022, 2023, 2024, 2025, 2026, 2027, 2028, 2029, 2030, 2031, 2035, 2037 and 2040, early termination rights become exercisable by other tenants who currently occupy an additional approximately 0.9%, 3.4%, 2.6%, 4.0%, 1.3%, 0.8%, 1.5%, 0.5%, 0.7%, 0.1%, 0.4%, 0.1% and 0.3% of our rentable square feet, respectively, and contribute an additional approximately 0.9%, 4.2%, 2.9%, 7.8%, 1.6%, 1.2%, 1.6%, 1.0%, 0.9%, 0.1%, 0.5%, 0.2% and 0.4% of our annualized rental income, respectively, as ofJune 30, 2022 . In addition, as ofJune 30, 2022 , pursuant to leases with 14 of our tenants, these tenants have rights to terminate their leases if their respective legislature or other funding authority does not appropriate rent amounts in their respective annual budgets. These 14 tenants occupy approximately 6.2% of our rentable square feet and contribute approximately 6.9% of our annualized rental income as ofJune 30, 2022 . (2)Leased square feet is pursuant to leases existing as ofJune 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 these tenants will renew or extend their leases prior to when they expire. However, recent shifts in workplace practices, including as a result of the COVID-19 pandemic, have resulted in a significant increase in alternative work arrangements, including work from home practices. It is uncertain to what extent and how long work from home arrangements may continue, or if other hybrid work arrangements will continue or increase. Despite these shifts in workplace practices, our recent leasing activity and negotiations for vacant or expiring space may suggest that there is an improving demand environment for office space. However, if these 19
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arrangements continue or increase, our tenants may not seek to renew or extend their leases when they expire, or may 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. However, the COVID-19 pandemic and its aftermath have had negative impacts on government budgets and resources. Although there have been indications that certain of those impacts may not have been as negative as originally expected, it is unclear what the effect of these impacts will be on government demand for leasing office space. Given the significant uncertainties, including as to the COVID-19 pandemic and its economic impact and the extent to which certain market trends, such as work from home practices, 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. As ofJune 30, 2022 , we derive 22.1% 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 ofJune 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 11.0% of annualized rental income were subsidiaries of an investment grade rated parent (although these parent entities were not liable for the payment of rents). 20
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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 19.4 % $ 104,402
18.5%
2 Alphabet Inc. (Google) Investment Grade 386 1.9 % 23,713
4.2%
3 Shook, Hardy & Bacon L.L.P. Not Rated 596 3.0 % 19,336
3.4%
4 IG Investments Holdings LLC Not Rated 336 1.7 % 16,594
2.9%
5 Bank of America Corporation Investment Grade 577 2.9 % 15,766 2.8 % 6 State of California Investment Grade 523 2.6 % 15,740 2.8 % 7 Commonwealth of Massachusetts Investment Grade 311 1.5 % 12,260 2.2 % 8 CareFirst Inc. Not Rated 207 1.0 % 11,498 2.0 % 9 Northrop Grumman Corporation Investment Grade 337 1.7 % 11,465 2.0 % 10 Tyson Foods, Inc. Investment Grade 248 1.2 % 11,042 2.0 %
11 Corporation (1) Not Rated 230 1.1 % 10,745
1.9%
12 CommScope Holding Company Inc. Non-Investment Grade
228 1.1 % 9,370 1.7 % 13 State of Georgia Investment Grade 308 1.5 % 7,383 1.3 % 14 PNC Bank Investment Grade 441 2.2 % 6,924 1.2 % 15 Micro Focus International plc Non Investment Grade 215 1.1 % 6,905 1.2 % 16 Compass Group plc Investment Grade 267 1.3 % 6,703 1.2 % 17 ServiceNow, Inc. Investment Grade 149 0.7 % 6,637 1.2 % 18 Allstate Insurance Co. Investment Grade 468 2.3 % 6,479 1.2 % 19 Leidos Holdings Inc. Investment Grade 159 0.8 % 6,117 1.1 %
Automatic Data Processing,
20 Inc. Investment Grade 289 1.4 % 6,087
1.1 %
21 Church & Dwight Co., Inc. Investment Grade 250 1.2 % 6,037 1.1 %
Total 10,419 51.6 % $ 321,203 57.0 %
(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.
Disposition Activities
Within six months completed
In
Based on current real estate market conditions, including rising interest rates, we expect the pace of our 2022 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. As ofJuly 27, 2022 , we have entered into agreements to sell nine properties containing approximately 1,116,000 rentable square feet for an aggregate sales price of$109,800 , excluding closing costs. These sales are expected to occur before the end of the third 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.
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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.
Segment Information
We operate in one business segment: ownership of real estate properties.
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