2014 10K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2014
Commission File Number 001-34789
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Hudson Pacific Properties, Inc.
Hudson Pacific Properties, L.P.
(Exact name of Registrant as specified in its charter)
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Hudson Pacific Properties, Inc.
| Maryland (State or other jurisdiction of incorporation or organization) | | 27-1430478 (I.R.S. Employer Identification Number) |
Hudson Pacific Properties, L.P.
| Maryland (State or other jurisdiction of incorporation or organization) | | 80-0579682 (I.R.S. Employer Identification Number) |
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11601 Wilshire Blvd., Sixth Floor, Los Angeles, California 90025
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code: (310) 445-5700
Securities registered pursuant to Section 12(b) of the Act:
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Registrant | | Title of Each Class | | Name of Each Exchange on Which Registered |
Hudson Pacific Properties, Inc. | | Common Stock, $.01 par value | | New York Stock Exchange |
Hudson Pacific Properties, Inc.
| | 8.375% Series B Cumulative Redeemable Preferred Stock, $.01 par value | | New York Stock Exchange
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Securities registered pursuant to Section 12(g) of the Act:
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Registrant | | Title of Each Class | | Name of Each Exchange on Which Registered |
Hudson Pacific Properties, L.P. | | Common Units Representing Limited Partnership Interests | | None |
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Hudson Pacific Properties, Inc. Yes x No o Hudson Pacific Properties, L.P. Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Hudson Pacific Properties, Inc. Yes o No x Hudson Pacific Properties, L.P. Yes x No o
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Hudson Pacific Properties, Inc. Yes x No o Hudson Pacific Properties, L.P. Yes o No x
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Hudson Pacific Properties, Inc. Yes x No o Hudson Pacific Properties, L.P. Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Hudson Pacific Properties, Inc.
Large accelerated filer x Accelerated filer o Non-accelerated filer o Smaller reporting company o
Hudson Pacific Properties, L.P.
Large accelerated filer o Accelerated filer o Non-accelerated filer x Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.)
Hudson Pacific Properties, Inc. Yes o No x Hudson Pacific Properties, L.P. Yes o No x
As of June 30, 2014, the aggregate market value of common stock held by non-affiliates of the registrant (assuming for these purposes, but without conceding, that all executive officers, directors and funds affiliated with Farallon Capital Management, LLC are “affiliates” of the registrant) was $1.4 billion based upon the last sales price on June 30, 2014 for the registrant’s Common Stock.
There is no public trading market for the common units of limited partnership interest of Hudson Pacific Properties, L.P. As a result, the aggregate market value of the common units of limited partnership interest held by non-affiliates of Hudson Pacific Properties, L.P. cannot be determined.
As of February 25, 2015, the number of shares of common stock outstanding was 79,845,880.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the proxy statement for the registrant’s 2015 Annual Meeting of Stockholders to be held May 20, 2015 are incorporated by reference in Part III of this Annual Report on Form 10-K. The proxy statement will be filed by the registrant with the U.S. Securities and Exchange Commission, or the SEC, not later than 120 days after the end of the registrant’s fiscal year.
EXPLANATORY NOTE
This report combines the annual reports on Form 10-K for the year ended December 31, 2014 of Hudson Pacific Properties, Inc., a Maryland corporation, and Hudson Pacific Properties, L.P., a Maryland limited partnership. Unless otherwise indicated or unless the context requires otherwise, all references in this report to “we,” “us,” “our,” or “our company” refer to Hudson Pacific Properties, Inc. together with its consolidated subsidiaries, including Hudson Pacific Properties, L.P. Unless otherwise indicated or unless the context requires otherwise, all references to “our operating partnership” refer to Hudson Pacific Properties, L.P. together with its consolidated subsidiaries.
Our company is a real estate investment trust, or REIT, and the sole general partner of our operating partnership. As of December 31, 2014, we owned approximately 96.6% of the outstanding common units of partnership interest in our operating partnership, or common units. The remaining approximately 3.4% of outstanding common units are owned by certain of our executive officers and directors, certain of their affiliates, and other outside investors, including funds affiliated with Farallon Capital Management, LLC. As the sole general partner of our operating partnership, our company has the full, exclusive and complete responsibility for our operating partnership’s day-to-day management and control.
We believe combining the annual reports on Form 10-K of our company and our operating partnership into this single report results in the following benefits:
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• | enhancing investors’ understanding of our company and our operating partnership by enabling investors to view the business as a whole in the same manner as management views and operates the business; |
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• | eliminating duplicative disclosure and providing a more streamlined and readable presentation because a substantial portion of the disclosure applies to both our company and our operating partnership; and |
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• | creating time and cost efficiencies through the preparation of one combined report instead of two separate reports. |
There are a few differences between our company and our operating partnership, which are reflected in the disclosures in this report. We believe it is important to understand the differences between our company and our operating partnership in the context of how we operate as an interrelated, consolidated company. Our company is a REIT, the only material assets of which are the partnership units of our operating partnership. As a result, our company does not conduct business itself, other than acting as the sole general partner of our operating partnership, issuing equity from time to time and guaranteeing certain debt of our operating partnership. Our company itself does not issue any indebtedness but guarantees some of the debt of our operating partnership. Our operating partnership holds substantially all the assets of our company. Our operating partnership conducts the operations of the business and is structured as a partnership with no publicly traded equity. Except for net proceeds from equity issuances by our company, which are generally contributed to our operating partnership in exchange for units of partnership interest in our operating partnership, our operating partnership generates the capital required by our company’s business through our operating partnership’s operations, our operating partnership’s incurrence of indebtedness or through the issuance of units of partnership interest in our operating partnership.
The presentation of non-controlling interest, stockholders’ equity and partners’ capital are the main areas of difference between the consolidated financial statements of our company and those of our operating partnership. The common units in our operating partnership are accounted for as partners’ capital in our operating partnership’s consolidated financial statements and, to the extent not held by our company, as non-controlling interest in our company’s consolidated financial statements. The differences between stockholders’ equity, partners’ capital and non-controlling interest result from the differences in the equity issued by our company and our operating partnership.
To help investors understand the significant differences between our company and our operating partnership, this report presents the consolidated financial statements separately for our company and our operating partnership. All other sections of this report, including “Selected Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Quantitative and Qualitative Disclosures About Market Risk,” are presented together for our company and our operating partnership.
In order to establish that the Chief Executive Officer and the Chief Financial Officer of each entity have made the requisite certifications and that our company and our operating partnership are compliant with Rule 13a-15 or Rule 15d-15 of the Securities Exchange Act of 1934, or the Exchange Act and 18 U.S.C. §1350, this report also includes separate “Item 9A. Controls and Procedures” sections and separate Exhibit 31 and 32 certifications for each of our company and our operating partnership.
HUDSON PACIFIC PROPERTIES, INC.
HUDSON PACIFIC PROPERTIES, L.P.
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
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Item 15. | | | |
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PART I
Item 1. Business
Company Overview
We are a full-service, vertically integrated real estate company focused on owning, operating and acquiring high-quality office properties and state-of-the-art media and entertainment properties in select growth markets primarily in Northern and Southern California and the Pacific Northwest. Our investment strategy focuses on high barrier-to-entry, in-fill locations with favorable, long-term supply demand characteristics in select markets, including Los Angeles, Orange County, San Diego, San Francisco, Silicon Valley and Seattle, which we refer to as our target markets. As of December 31, 2014, our portfolio included office properties, comprising an aggregate of approximately 5.9 million square feet, and media and entertainment properties, comprising approximately 0.9 million square feet of sound-stage, office and supporting production facilities. We also own undeveloped density rights for approximately 1.4 million square feet of future office space.
We were formed as a Maryland corporation in 2009 to succeed to the business of Hudson Capital, LLC, a Los Angeles-based real estate investment firm founded by Victor J. Coleman, our Chief Executive Officer. On June 29, 2010, we completed our initial public offering. We own our interests in all of our properties and conduct substantially all of our business through our operating partnership, of which we serve as the sole general partner.
Business and Growth Strategies
We focus our investment strategy on office and media and entertainment properties located in high barrier-to-entry submarkets with growth potential as well as on underperforming properties that provide opportunities to implement a value-add strategy to increase occupancy rates and cash flow. This strategy includes active management, aggressive leasing efforts, focused capital improvement programs, the reduction and containment of operating costs and an emphasis on tenant satisfaction. We believe our senior management team’s experience in California and Pacific Northwest markets positions us to improve cash flow from our portfolio, as well as any newly acquired properties.
Our Competitive Position
We believe the following competitive strengths distinguish us from other real estate owners and operators and will enable us to capitalize on opportunities in the market to successfully expand and operate our portfolio.
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• | Experienced Management Team with a Proven Track Record of Acquiring and Operating Assets and Managing a Public Office REIT. Our senior management team has an average of over 20 years of experience in the commercial real estate industry, with a focus primarily on owning, acquiring, developing, operating, financing and selling office properties in California and the Pacific Northwest. |
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• | Committed and Incentivized Management Team. Our senior management team is dedicated to our successful operation and growth, with no competing real estate business interests outside of our company. Additionally, as of December 31, 2014, our senior management team owned approximately 2.3% of our common stock on a fully diluted basis, thereby aligning management’s interests with those of our stockholders. |
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• | California and Pacific Northwest Focus with Local and Regional Expertise. We are primarily focused on acquiring and managing office properties in Northern and Southern California and the Pacific Northwest, where our senior management has significant expertise and relationships. Our markets are supply-constrained as a result of the scarcity of available land, high construction costs and restrictive entitlement processes. We believe our experience, in-depth market knowledge and meaningful industry relationships with brokers, tenants, landlords, lenders and other market participants enhance our ability to identify and capitalize on attractive acquisition opportunities, particularly those that arise in California and the Pacific Northwest. |
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• | Long-Standing Relationships that Provide Access to an Extensive Pipeline of Investment and Leasing Opportunities. We have an extensive network of long-standing relationships with real estate developers, individual and institutional real estate owners, national and regional lenders, brokers, tenants and other participants in the California and Pacific Northwest real estate markets. These relationships have historically provided us with access to attractive acquisition opportunities, including opportunities with limited or no prior marketing by sellers. We believe they will continue to provide us access to an ongoing pipeline of attractive acquisition opportunities and additional growth capital, both of which may not be available to our competitors. Additionally, we focus on establishing strong |
relationships with our tenants in order to understand their long-term business needs, which we believe enhances our ability to retain quality tenants, facilitates our leasing efforts and maximizes cash flows from our properties.
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• | Growth-Oriented, Flexible and Conservative Capital Structure. We have remained well-capitalized since our initial public offering, including through seven offerings (including two public offerings of our 8.375% Series B Cumulative Preferred Stock, four public offerings of our common stock and one private placement of our common stock) and continuous offering under our At-the-Market, or ATM, program for an aggregate total proceeds, of approximately $922.2 million (before underwriters’ discounts and transaction costs) as of December 31, 2014. Available cash on hand and our unsecured credit facility provide us with a significant amount of capital to pursue acquisitions and execute our growth strategy, while maintaining a flexible and conservative capital structure. As of December 31, 2014, we had total borrowing capacity of approximately $300.0 million under our unsecured revolving credit facility, $130.0 million of which had been drawn. Based on the closing price of our common stock of $30.06 on December 31, 2014, we had a debt-to-market capitalization ratio (counting series A preferred units as debt) of approximately 30.2%. We believe our access to capital and flexible and conservative capital structure provide us with an advantage over many of our private and public competitors as we look to take advantage of growth opportunities. |
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• | Irreplaceable Media and Entertainment Assets in a Premier California Submarket. Our Sunset Gower and Sunset Bronson media and entertainment properties are located on Sunset Boulevard, just off of the Hollywood Freeway in the heart of Hollywood. These facilities, which are situated on approximately 15.7 and 10.6 acres, respectively, were originally built in the 1920s as the headquarters of Columbia Pictures and Warner Brothers and represent a unique and irreplaceable assemblage of land in densely populated Los Angeles. We are the largest owner and operator of independent media and entertainment properties in Los Angeles and possess large, modern sound stages and plentiful office space with state-of-the-art telecommunications and data network infrastructure. Our properties are important facilities for major film and television companies and independent producers, most of which outsource a portion of their productions to independent media and entertainment properties. We believe our media and entertainment properties are attractively located and benefit from high barriers to entry, with a limited supply of readily developable land. In addition, there are substantial costs associated with acquiring and developing suitable land and extensive knowledge required to develop and operate such facilities. As a result of these high barriers to entry, there is effectively no new supply of media and entertainment space in the urban core of Los Angeles. We believe the limited supply of media and entertainment properties, coupled with the continued demand for such properties in Los Angeles, which remains the center of the entertainment industry in the United States, will help ensure that these assets remain critical to the industry. |
Proposed Target Property Acquisition
Purchase agreement
On December 6, 2014, we entered into an asset purchase agreement, or the purchase agreement, by and among our company, our operating partnership, or collectively the buyer parties, and certain affiliates of The Blackstone Group L.P., or the seller parties, pursuant to which our operating partnership and/or other subsidiaries of our company will acquire a portfolio of 26 high-quality office assets totaling approximately 8.2 million square feet and two development parcels in the San Francisco Peninsula and Silicon Valley, or the Target Properties, from the seller parties in exchange for a combination of cash and equity consideration.
The consideration to be delivered by the buyer parties to the seller parties for the Target Properties at the closing of the transaction, or the closing, consists of the following cash and equity consideration (each subject to adjustment as described in the purchase agreement):
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• | Cash Consideration. At the closing, our operating partnership will deliver to the seller parties a payment in cash of an aggregate amount equal to $1.75 billion, or the cash consideration. |
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• | Equity Consideration. At the closing, the buyer parties will deliver to the seller parties (or their designated affiliates) an aggregate amount of 63,474,791 newly-issued shares of common stock of our company, and newly-issued common units in our operating partnership, collectively, the equity consideration. The common stock to be issued will represent approximately 9.8% of the outstanding common stock of our company (after giving effect to the issuance of the issued common stock), and the common units to be issued will be in an amount equal to 63,474,791, less the number of shares of common stock to be issued. |
Our issuance of the equity consideration to the seller parties, or the equity issuance, requires the affirmative vote of a majority of votes cast at a meeting of our company’s stockholders, or the requisite stockholder approval, which meeting is currently scheduled to be held on March 5, 2015.
The buyer parties and the seller parties each make certain customary representations, warranties and covenants in the purchase agreement, including, among others, covenants:
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• | to conduct their respective businesses in the ordinary course consistent with past practice during the period between the December 6, 2014 and the closing; |
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• | that we will convene and hold a meeting of our stockholders to consider and vote upon the equity issuance, and subject to certain exceptions, our board of directors will recommend that our stockholders vote to approve the equity issuance; |
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• | subject to certain exceptions, we will not (i) solicit, initiate, cause or knowingly facilitate the making of any inquiry, proposal or offer that constitutes or would reasonably be expected to lead to any “Buyer Acquisition Proposal” (as defined in the purchase agreement), (ii) engage in or otherwise participate in discussions or negotiations with any person with respect to, or that would reasonably be expected to lead to, any Buyer Acquisition Proposal or (iii) furnish any non-public information or afford any person access to our business, properties, assets or personnel in connection with, or for the purpose of facilitating, a Buyer Acquisition Proposal; and |
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• | that the seller parties cause the release and discharge of certain existing liens and encumbrances on the Target Properties, and use reasonable best efforts to obtain acceptable estoppel certificates from tenants under leases at the Target Properties and lessors underground leases to which any Target Properties are subject. |
Subject to the terms and conditions set forth in the purchase agreement, the buyer parties and the seller parties have committed to use their reasonable best efforts to take, or cause to be taken, all actions and to assist and cooperate in doing, all things necessary, proper or advisable under applicable law or pursuant to any contract to consummate the transaction.
The consummation of the transaction is subject to customary conditions, including (i) the receipt of the requisite stockholder approval, (ii) the approval for listing of the issued common stock on the New York Stock Exchange, or NYSE (subject only to official notice of issuance), (iii) the absence of any law or order prohibiting or making illegal the consummation of the transaction, (iv) the issuance of title insurance policies for the underlying land, buildings and other improvements relating to each Target Property (subject to certain qualifications), (v) the receipt of a certain percentage of estoppel certificates from tenants under lease at the Target Properties, (vi) the absence of a material adverse effect on us or the Target Properties, (vii) subject to certain exceptions, the accuracy of the representations and warranties made by the buyer parties and the seller parties, respectively, and compliance by the buyer parties and the seller parties with their respective covenants and (viii) an opinion that our company meets the requirements for qualification and taxation as a REIT under the Internal Revenue Code of 1986, as amended, or the Code.
The purchase agreement may be terminated under certain circumstances by the buyer parties, including, prior to the receipt of the requisite stockholder approval, in order to concurrently enter into a definitive agreement with respect to a “Superior Acquisition Proposal” (as defined in the purchase agreement), so long as the buyer parties comply with certain notice and other requirements set forth in the purchase agreement. In addition, the seller parties may terminate the purchase agreement under certain circumstances and subject to certain restrictions, including if our board of directors effects a “Change of Recommendation” (as defined in the purchase agreement). In the foregoing specified circumstances, the buyer parties would be required to pay the seller parties a termination fee of $60 million, subject to certain adjustments as set forth in the purchase agreement. In addition, the buyer parties would be required to pay the seller parties a termination fee of $120 million, subject to certain adjustments as set forth in the purchase agreement, if the purchase agreement is terminated by the seller parties in circumstances when the conditions to closing are satisfied, the seller parties have irrevocably confirmed to the buyer parties that, among other things, the seller parties are prepared to consummate the closing, and the buyer parties fail to consummate the closing within two business days from the date the closing was required to occur pursuant to the purchase agreement and the seller parties stood ready, willing and able to consummate the closing throughout such two business day period. The purchase agreement contains certain other termination rights for the seller parties, and alternative termination fees and/or expense reimbursements payable by the buyer parties in connection with those other termination rights of up to $14 million and $60 million, depending on the circumstances.
Pursuant to the purchase agreement, effective as of the closing, among other things, (i) our company, our operating partnership and the seller parties (or their designated affiliates) will enter into a stockholders agreement, or the stockholders agreement; (ii) our company and the seller parties (or their designated affiliates) will enter into a registration rights agreement, or the seller parties registration rights agreement; and (iii) our company will enter into a Third Amended and Restated Limited
Partnership Agreement of our operating partnership, or Third Amended and Restated Limited Partnership Agreement, each described below.
Voting Agreement Between the Seller Parties and Farallon Funds
Concurrently with the execution of the purchase agreement, on December 6, 2014, Farallon Capital Partners, L.P., Farallon Capital Institutional Partners, L.P. and Farallon Capital Institutional Partners III, L.P., or collectively the Farallon Funds, entered into a voting agreement, or the voting agreement, with the seller parties, pursuant to which each of the Farallon Funds has agreed that, until the termination of the voting agreement, it will vote in favor of the transaction and against any potential competing transaction or any action that could reasonably be expected to adversely affect the transaction. Each of the Farallon Funds further agreed that until the earlier of the termination of the voting agreement and April 1, 2015, it will not transfer any shares of our common stock or common units in our operating partnership or any interests therein, subject to certain exceptions. In addition, until the termination of the voting agreement the Farallon Funds have agreed not to solicit competing transactions. The voting agreement will terminate upon, among other things, the closing of the transactions contemplated by the purchase agreement, the termination of the purchase agreement in accordance with its terms, a change in our board of director’s recommendations with respect to the approval of equity issuance and 11:59 p.m. New York time on July 3, 2015.
The Stockholders Agreement
The stockholders agreement will set forth various arrangements and restrictions with respect to governance of our company and certain rights of the seller parties (or their designated affiliates), or the sponsor stockholders, with respect to the equity consideration.
Pursuant to the terms of the stockholders agreement, at closing, our board of directors will expand from nine to 12 directors and will elect three nominees designated by the sponsor stockholders to our board of directors. Subject to certain exceptions, our board of directors will continue to include the sponsor stockholders’ nominees in its slate of directors, will continue to recommend such nominees, and will otherwise use its reasonable best efforts to solicit the vote of our stockholders to elect to our board of directors the slate of nominees which includes those nominated by the sponsor stockholders. The sponsor stockholders will have the right to designate three director nominees to our board of directors for so long as the sponsor stockholders continue to beneficially own, in the aggregate, greater than 50% of the equity consideration. If the sponsor stockholders beneficial ownership of equity consideration decreases, then the number of director nominees that the sponsor stockholders will have the right to designate will be reduced (i) to two, if the sponsor stockholders beneficially own greater than or equal 30% but less than or equal to 50% of the equity consideration and (ii) to one, if the sponsor stockholders beneficially own greater than or equal to 15% but less than 30% of the equity consideration. The board of director nomination rights of the sponsor stockholders will terminate at such time as the sponsor stockholders beneficially own less than 15% of the equity consideration or upon written notice of waiver or termination of such rights by the sponsor stockholders. So long as the sponsor stockholders retain the right to designate at least one nominee to our board of directors, our company will not be permitted to increase the total number of directors comprising our board of directors to more than 12 persons.
For so long as the sponsor stockholders have the right to designate at least two director nominees, subject to the satisfaction of applicable NYSE independence requirements, the sponsor stockholders will also be entitled to appoint one such nominee then serving on our board of directors to serve on each committee of our board of directors (other than certain specified committees).
The stockholders agreement will also include: (i) standstill provisions, which will, until such time as the sponsor stockholders beneficially own less than 10% of the total number of issued and outstanding common equity of our company on a fully-diluted basis, restrict the sponsor stockholders and Blackstone Real Estate Advisors L.P. from, among other things, acquiring additional equity or debt securities (other than non-recourse debt and certain other debt) of our company and its subsidiaries without our company’s prior written consent; and (ii) transfer restriction provisions, which will restrict the sponsor stockholders from transferring any equity consideration (including shares of common stock of our company that have been exchanged by the sponsor stockholders for common units in our operating partnership) (collectively, the “covered securities”) until November 1, 2015, at which time such transfer restrictions will cease to be applicable to 50% of the covered securities. The transfer restrictions applicable to the remaining 50% of the covered securities will cease to be applicable on March 1, 2016 (or, if earlier, 30 days following written notice of waiver or termination by the sponsor stockholders of their board nomination rights described above). If, prior to November 1, 2015 the sponsor stockholders provide written notice waiving and terminating their board nomination rights described above, the transfer restrictions applicable to all the covered securities will cease to be applicable on November 1, 2015 and, if such written notice of waiver and termination is provided after November 1, 2015, then the transfer restrictions will cease to be applicable 30 days following such written notice.
In addition, pursuant to the stockholders agreement, during the 24 months following the closing, our company is required to obtain the prior written consent of the seller parties prior to issuances of any common equity securities in excess of 15% of the common equity securities at closing taking into account the equity issuance (subject to certain exceptions). Further, under the terms of the stockholders agreement, our company (in its capacity as the general partner of our operating partnership) will waive the minimum holding period required with respect to future redemptions of the issued common units pursuant to the Third Amended and Restated Limited Partnership Agreement and will grant certain additional rights to the seller parties (or their designated affiliates) in connection with such redemptions.
The Registration Rights Agreement
The seller parties registration rights agreement will provide for customary registration rights with respect to the equity consideration, including the following:
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• | Shelf Registration. Our company will prepare and file not later than August 1, 2015 a resale shelf registration statement covering the sponsor stockholders’ shares of common stock of our company and shares issuable upon redemption of common units in our operating partnership, and our company is required to use its reasonable best efforts to cause such resale shelf registration statement to become effective prior to the termination of the transfer restrictions under the stockholders agreement (as described above). |
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• | Demand Registrations. Beginning November 1, 2015 (or earlier if transfer restrictions under the stockholders agreement are terminated earlier), the sponsor stockholders may cause our company to register their shares, or a demand registration, if the foregoing resale shelf registration statement is not effective or if our company is not eligible to file a shelf registration statement. |
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• | Qualified Offerings. Any registered offerings requested by the sponsor stockholders that are to an underwriter on a firm commitment basis for reoffering and resale to the public, in an offering that is a “bought deal” with one or more investment banks or in a block trade with a broker-dealer will be: (i) no more frequent than once in any 120-day period, (ii) subject to underwriter lock-ups from prior offerings then in effect, and (iii) subject to a minimum offering size of $50 million. |
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• | Piggy-Back Rights. Beginning November 1, 2015 (or earlier if transfer restrictions under the stockholders agreement are terminated earlier), the sponsor stockholder will be permitted to, among other things, participate in offerings for our company’s account. If underwriters advise that the success of the proposed offering would be significantly and adversely affected by the inclusion of all securities in an offering for our company’s own account, then the securities proposed to be included by the sponsor stockholders are cut back first. |
Third Amended and Restated Limited Partnership Agreement
The Third Amended and Restated Limited Partnership Agreement will give effect to the rights of certain limited partners of our operating partnership, including the sponsor stockholders. Pursuant to the Third Amended and Restated Limited Partnership Agreement, prior to the date on which the sponsor stockholders own less than 9.8% of the equity consideration, our company (as general partner) may not consummate certain transactions, or a stockholder vote transaction, with respect to which the holders of shares our company’s common stock are entitled to vote, unless the stockholder vote transaction is also approved by the common limited partners of our operating partnership on a “pass through” basis, which generally affords the common limited partners a vote as though the common limited partners held shares of our company’s common stock and voted together with the stockholders of our company with respect to such stockholder vote transactions.
Bridge Facility Commitment Letter
Contemporaneously with the execution of the purchase agreement, our company obtained a debt financing commitment for the transactions contemplated by the purchase agreement, the aggregate proceeds of which will be used by our company to pay a portion or all of the cash consideration to consummate the transaction and to pay related fees and expenses.
Wells Fargo Bank, National Association, Wells Fargo Securities, LLC, Bank of America, N.A., Merrill Lynch, Pierce, Fenner & Smith Incorporated, Goldman Sachs Bank USA, or collectively the bridge facility commitment parties, have committed to provide a 364-day bridge term loan of $1.75 billion, or the bridge loan, to our operating partnership on the terms and conditions set forth in a commitment letter, or the bridge commitment letter, and fee letter, each dated December 6, 2014. Wells Fargo Bank, National Association, Bank of America, N.A., and Goldman Sachs Bank USA have committed to fund the principal amount of the bridge loan as follows: Wells Fargo Bank, National Association, 50%; Goldman Sachs Bank USA, 25%; Bank of America, N.A., 25%.
The obligation of the bridge facility commitment parties to provide financing under the bridge commitment letter are subject to certain conditions, including, without limitation, (i) the negotiation, execution and delivery of definitive loan
documentation for the bridge loan consistent with the bridge commitment letter and otherwise reasonably satisfactory to the bridge facility commitment parties, (ii) a condition that there has not been a “Target Property Material Adverse Effect” (as defined in the bridge commitment letter), (iii) the consummation of the transaction in accordance with the purchase agreement (without giving effect to any amendments to the purchase agreement or any waivers thereof that are materially adverse to the bridge facility commitment parties unless consented to by the bridge facility commitment parties) concurrently with the funding of the bridge loan, (iv) the payment of applicable costs, fees and expenses, and (v) the delivery of certain customary closing documents (including, among other things, opinions from legal counsel). The principal amount of the bridge loan may be reduced in connection with certain equity and debt issuances by us and/or our operating partnership, as well as in connection with certain asset sales.
The bridge commitment letter terminates on July 4, 2015.
For more information regarding this transaction and the risks and uncertainties associated therewith, see “Item 1A. Risk Factors,” “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Note [15] to our consolidated financial statements.
Competition
We compete with a number of developers, owners and operators of office and commercial real estate, many of which own properties similar to ours in the same markets in which our properties are located and some of which have greater financial resources than we do. In operating and managing our portfolio, we compete for tenants based on a number of factors, including location, rental rates, security, flexibility and expertise to design space to meet prospective tenants’ needs and the manner in which the property is operated, maintained and marketed. As leases at our properties expire, we may encounter significant competition to renew or re-let space in light of competing properties within the markets in which we operate. As a result, we may be required to provide rent concessions or abatements, incur charges for tenant improvements and other inducements, including early termination rights or below-market renewal options, or we may not be able to timely lease vacant space. In that case, our financial condition, results of operations and cash flows may be adversely affected.
We also face competition when pursuing acquisition and disposition opportunities. Our competitors may be able to pay higher property acquisition prices, may have private access to acquisition opportunities not available to us and may otherwise be in a better position to acquire a property. Competition may also increase the price required to consummate an acquisition opportunity and generally reduce the demand for commercial office space in our markets. Likewise, competition with sellers of similar properties to locate suitable purchasers may result in us receiving lower proceeds from a sale or in us not being able to dispose of a property at a time of our choosing due to the lack of an acceptable return.
For further discussion of the potential impact of competitive conditions on our business, see “Item 1A: Risk Factors.”
Segment and Geographic Financial Information
We report our results of operations through two segments: (i) office properties and (ii) media and entertainment properties. The office properties reporting segment includes 26 properties totaling approximately 5.9 million square feet strategically located in many of our target markets, while the media and entertainment reporting segment includes two properties, the Sunset Gower property (including 6050 and 6060 Sunset) and the Sunset Bronson property, totaling approximately 0.9 million square feet located in the heart of Hollywood, California. For financial information about our two reportable segments, see Note 13 to our consolidated financial statements.
All of our business is conducted in California and the Pacific Northwest. For information about our revenues and long-lived assets and other financial information, see our consolidated financial statements included in this report and “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations.”
Employees
At December 31, 2014, we had 151 employees. At December 31, 2014, two of our employees were subject to collective bargaining agreements. Both of these employees are on-site employees at the Sunset Bronson property. We believe that relations with our employees are good.
Principal Executive Offices
Our principal executive offices are located at 11601 Wilshire Blvd., Sixth Floor, Los Angeles, California 90025 and our telephone number is (310) 445-5700. We believe that our current facilities are adequate for our present operations.
Regulation
General
Our properties are subject to various covenants, laws, ordinances and regulations, including regulations relating to common areas and fire and safety requirements. We believe that each of the properties in our portfolio has the necessary permits and approvals to operate its business.
Americans With Disabilities Act
Our properties must comply with Title III of the Americans with Disabilities Act, or ADA, to the extent that such properties are “public accommodations” as defined by the ADA. The ADA may require removal of structural barriers to access by persons with disabilities in certain public areas of our properties where such removal is readily achievable. We have developed and undertaken continuous capital improvement programs at certain properties in the past. These capital improvement programs will continue to progress and certain ADA upgrades will continue to be integrated into the planned improvements, specifically at the media and entertainment properties where we are able to utilize in-house construction crews to minimize costs for required ADA-related improvements. However, some of our properties may currently be in noncompliance with the ADA. Such noncompliance could result in the incurrence of additional costs to attain compliance, the imposition of fines or an award of damages to private litigants. The obligation to make readily achievable accommodations is an ongoing one, and we will continue to assess our properties and to make alterations as appropriate in this respect.
Environmental Matters
Under various federal, state and local laws and regulations relating to the environment, as a current or former owner or operator of real property, we may be liable for costs and damages resulting from the presence or discharge of hazardous or toxic substances, waste or petroleum products at, on, in, under, or migrating from such property, including costs to investigate and clean up such contamination and liability for natural resources. Such laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the presence of such contamination, and the liability may be joint and several. These liabilities could be substantial and the cost of any required remediation, removal, fines, or other costs could exceed the value of the property and/or our aggregate assets. In addition, the presence of contamination or the failure to remediate contamination at our properties may expose us to third-party liability for costs of remediation and/or personal or property damage or materially adversely affect our ability to sell, lease or develop our properties or to borrow using the properties as collateral. In addition, environmental laws may create liens on contaminated sites in favor of the government for damages and costs it incurs to address such contamination. Moreover, if contamination is discovered on our properties, environmental laws may impose restrictions on the manner in which property may be used or businesses may be operated, and these restrictions may require substantial expenditures.
Some of our properties contain, have contained, or are adjacent to or near other properties that have contained or currently contain storage tanks for the storage of petroleum products or other hazardous or toxic substances. Similarly, some of our properties were used in the past for commercial or industrial purposes, or are currently used for commercial purposes, that involve or involved the use of petroleum products or other hazardous or toxic substances, or are adjacent to or near properties that have been or are used for similar commercial or industrial purposes. As a result, some of our properties have been or may be impacted by contamination arising from the release of such hazardous substances or petroleum products. Where we have deemed appropriate, we have taken steps to address identified contamination or mitigate risks associated with such contamination; however, we are unable to ensure that further actions will not be necessary. As a result of the foregoing, we could potentially incur material liabilities.
Independent environmental consultants have conducted Phase I Environmental Site Assessments at all of the properties in our portfolio using the American Society for Testing and Materials (ASTM) Practice E 1527-05. A Phase I Environmental Site Assessment is a report prepared for real estate holdings that identifies potential or existing environmental contamination liabilities. Site assessments are intended to discover and evaluate information regarding the environmental condition of the surveyed property and surrounding properties. These assessments do not generally include soil samplings, subsurface investigations or asbestos or lead surveys. None of the recent site assessments identified any known past or present contamination that we believe would have a material adverse effect on our business, assets or operations. However, the
assessments are limited in scope and may have failed to identify all environmental conditions or concerns. A prior owner or operator of a property or historic operations at our properties may have created a material environmental condition that is not known to us or the independent consultants preparing the site assessments. Material environmental conditions may have arisen after the review was completed or may arise in the future, and future laws, ordinances or regulations may impose material additional environmental liability.
Environmental laws also govern the presence, maintenance and removal of asbestos-containing building materials, or ACBM, or lead-based paint, or LBP, and may impose fines and penalties for failure to comply with these requirements or expose us to third party liability (e.g., liability for personal injury associated with exposure to asbestos). Such laws require that owners or operators of buildings containing ACBM and LBP (and employers in such buildings) properly manage and maintain the asbestos and lead, adequately notify or train those who may come into contact with asbestos or lead, and undertake special precautions, including removal or other abatement, if asbestos or lead would be disturbed during renovation or demolition of a building. Some of our properties contain ACBM and/or LBP and we could be liable for such damages, fines or penalties.
In addition, the properties in our portfolio also are subject to various federal, state, and local environmental and health and safety requirements, such as state and local fire requirements. Moreover, some of our tenants routinely handle and use hazardous or regulated substances and waste as part of their operations at our properties, which are subject to regulation. Such environmental and health and safety laws and regulations could subject us or our tenants to liability resulting from these activities. Environmental liabilities could affect a tenant’s ability to make rental payments to us. In addition, changes in laws could increase the potential liability for noncompliance. We sometimes require our tenants to comply with environmental and health and safety laws and regulations and to indemnify us for any related liabilities. But in the event of the bankruptcy or inability of any of our tenants to satisfy such obligations, we may be required to satisfy such obligations. In addition, we may be held directly liable for any such damages or claims regardless of whether we knew of, or were responsible for, the presence or disposal of hazardous or toxic substances or waste and irrespective of tenant lease provisions. The costs associated with such liability could be substantial and could have a material adverse effect on us.
When excessive moisture accumulates in buildings or on building materials, mold growth may occur, particularly if the moisture problem remains undiscovered or is not addressed over a period of time. Some molds may produce airborne toxins or irritants. Indoor air quality issues can also stem from inadequate ventilation, chemical contamination from indoor or outdoor sources, and other biological contaminants such as pollen, viruses and bacteria. Indoor exposure to airborne toxins or irritants above certain levels can be alleged to cause a variety of adverse health effects and symptoms, including allergic or other reactions. As a result, the presence of significant mold or other airborne contaminants at any of our properties could require us to undertake a costly remediation program to contain or remove the mold or other airborne contaminants from the affected property or increase indoor ventilation. In addition, the presence of significant mold or other airborne contaminants could expose us to liability from our tenants, employees of our tenants or others if property damage or personal injury occurs. We are not presently aware of any material adverse indoor air quality issues at our properties.
Available Information
Our internet address is www.hudsonpacificproperties.com. On the Investor Relations page on our Web site, we post the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the SEC: our Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act. All such filings are available to be viewed on our Investor Relations Web page free of charge. Also available on our Investor Relations Web page, free of charge, are our corporate governance guidelines, the charters of the nominating and corporate governance, audit and compensation committees of our board of directors and our code of business conduct and ethics (which applies to all directors and employees, including our principal executive officer, principal financial officer and principal accounting officer). Information contained on or hyperlinked from our Web site is not incorporated by reference into and should not be considered part of this Annual Report on Form 10-K or our other filings with the SEC. A copy of this Annual Report on Form 10-K is available without charge upon written request to: Investor Relations, Hudson Pacific Properties, Inc., 11601 Wilshire Blvd., Sixth Floor, Los Angeles, California 90025.
Item 1A. Risk Factors
Forward-looking Statements
Certain written and oral statements made or incorporated by reference from time to time by us or our representatives in this Annual Report on Form 10-K, other filings or reports filed with the SEC, press releases, conferences, or otherwise, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (set forth in Section 27A of the Securities Act of 1933, as amended, or the Securities Act, as amended, and Section 21E of the Exchange Act). In particular, statements relating to our liquidity and capital resources, portfolio performance and results of operations contain forward-looking statements. Furthermore, all of the statements regarding future financial performance (including anticipated funds from operations, or FFO, market conditions and demographics) are forward-looking statements. We are including this cautionary statement to make applicable and take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 for any such forward-looking statements. We caution investors that any forward-looking statements presented in this Annual Report on Form 10-K, or that management may make orally or in writing from time to time, are based on management’s beliefs and assumptions made by, and information currently available to, management. When used, the words “anticipate,” “believe,” “expect,” “intend,” “may,” “might,” “plan,” “estimate,” “project,” “should,” “will,” “result” and similar expressions that do not relate solely to historical matters are intended to identify forward-looking statements. Such statements are subject to risks, uncertainties and assumptions and may be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated or projected. We expressly disclaim any responsibility to update forward-looking statements, whether as a result of new information, future events or otherwise. Accordingly, investors should use caution in relying on past forward-looking statements, which were based on results and trends at the time they were made, to anticipate future results or trends.
Some of the risks and uncertainties that may cause our actual results, performance, liquidity or achievements to differ materially from those expressed or implied by forward-looking statements include, among others, the following:
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• | adverse economic or real estate developments in our target markets; |
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• | general economic conditions; |
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• | defaults on, early terminations of or non-renewal of leases by tenants; |
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• | fluctuations in interest rates and increased operating costs; |
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• | our failure to obtain necessary outside financing or maintain an investment grade rating; |
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• | our failure to generate sufficient cash flows to service our outstanding indebtedness and maintain dividend payments; |
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• | lack or insufficient amounts of insurance; |
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• | decreased rental rates or increased vacancy rates; |
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• | difficulties in identifying properties to acquire and completing acquisitions; |
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• | our failure to successfully operate acquired properties and operations; |
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• | our failure to maintain our status as a REIT; |
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• | environmental uncertainties and risks related to adverse weather conditions and natural disasters; |
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• | financial market fluctuations; |
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• | risks related to acquisitions generally, including the disruption of management’s attention from ongoing business operations and the impact on customers, tenants, lenders, operating results and business; |
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• | the inability to successfully integrate acquired properties, realize the anticipated benefits of acquisitions or capitalize on value creation opportunities; |
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• | changes in real estate and zoning laws and increases in real property tax rates; and |
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• | other factors affecting the real estate industry generally. |
Set forth below are some (but not all) of the factors that could adversely affect our business and financial performance. Moreover, we operate in a highly competitive and rapidly changing environment. New risk factors emerge from time to time, and it is not possible for management to predict all such risk factors, nor can it assess the impact of all such risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.
Risks Related to Our Properties and Our Business
Our properties are located in California and the Pacific Northwest, and we are susceptible to adverse economic conditions, local regulations and natural disasters affecting those markets.
Our properties are located in California and the Pacific Northwest, which exposes us to greater economic risks than if we owned a more geographically dispersed portfolio. Further, our properties are concentrated in certain submarkets, including Los Angeles, Orange County, San Diego, San Francisco, Silicon Valley, the East Bay, and Seattle, exposing us to risks associated with those specific areas. We are susceptible to adverse developments in the economic and regulatory environments of California and the Pacific Northwest (such as business layoffs or downsizing, industry slowdowns, relocations of businesses, increases in real estate and other taxes, costs of complying with governmental regulations or increased regulation), as well as to natural disasters that occur in our markets (such as earthquakes, wind, landslides, droughts, fires and other events). In addition, the State of California continues to suffer from severe budgetary constraints and is regarded as more litigious and more highly regulated and taxed than many other states, all of which may reduce demand for office space in California. Any adverse developments in the economy or real estate market in California or the Pacific Northwest, or any decrease in demand for office space resulting from the California regulatory or business environment, could adversely impact our financial condition, results of operations, cash flow and the per share trading price of our securities.
We derive a significant portion of our rental revenue from tenants in the media, entertainment, and technology industries, which makes us particularly susceptible to demand for rental space in those industries.
Our Sunset Gower, Sunset Bronson, Technicolor Building, 1455 Market, Rincon, 10950 Washington, 875 Howard, 625 Second Street, 275 Brannan, Pinnacle I, Pinnacle II and Element LA properties are leased to primarily media, entertainment, or technology tenants and a significant portion of our rental revenue is derived from tenants in the media, entertainment, and technology industries. Consequently, we are susceptible to adverse developments affecting the demand by media, entertainment, and technology tenants for office, production and support space in Southern and Northern California, the Pacific Northwest and, more particularly, in Hollywood and the South of Market submarket of San Francisco, such as writer, director and actor strikes, industry slowdowns and the relocation of media, entertainment, and technology businesses to other locations. Although our Technicolor Building property and the 10950 Washington property are principally occupied and suitable for general office purposes, portions of such properties may require modifications prior to or at the commencement of a lease term if these properties were to be re-leased to more traditional office users. Although our Sunset Gower and Sunset Bronson properties contain both sound stages and space suitable for office use, they have historically served the media and entertainment industry and will continue to depend on that sector for future tenancy. In addition, our media and entertainment properties tend to be subject to short-term leases of less than one year. As a result, were there to be adverse developments affecting the demand by media and entertainment tenants for office, production and support space, it could affect the occupancy of our media and entertainment properties more quickly than if we had longer term leases. Any adverse development in the media, entertainment, and technology industries could adversely affect our financial condition, results of operations, cash flow and the per share trading price of our securities.
We may be unable to identify and complete acquisitions of properties that meet our criteria, which may impede our growth.
Our business strategy includes the acquisition of underperforming office properties. These activities require us to identify suitable acquisition candidates or investment opportunities that meet our criteria and are compatible with our growth strategies. We continue to evaluate the market of available properties and may attempt to acquire properties when strategic opportunities exist. However, we may be unable to acquire any of the properties that we may identify as potential acquisition opportunities in the future. Our ability to acquire properties on favorable terms, or at all, may be exposed to the following significant risks:
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• | potential inability to acquire a desired property because of competition from other real estate investors with significant capital, including publicly traded REITs, private equity investors and institutional investment funds, which may be able to accept more risk than we can prudently manage, including risks with respect to the geographic proximity of investments and the payment of higher acquisition prices; |
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• | we may incur significant costs and divert management attention in connection with evaluating and negotiating potential acquisitions, including ones that we are subsequently unable to complete; |
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• | even if we enter into agreements for the acquisition of properties, these agreements are typically subject to customary conditions to closing, including the satisfactory completion of our due diligence investigations; and |
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• | we may be unable to finance the acquisition on favorable terms or at all. |
If we are unable to finance property acquisitions or acquire properties on favorable terms, or at all, our financial condition, results of operations, cash flow and the per share trading price of our securities could be adversely affected. In addition, failure to identify or complete acquisitions of suitable properties could slow our growth.
Our future acquisitions may not yield the returns we expect.
Our future acquisitions and our ability to successfully operate the properties we acquire in such acquisitions may be exposed to the following significant risks:
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• | even if we are able to acquire a desired property, competition from other potential acquirers may significantly increase the purchase price; |
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• | we may acquire properties that are not accretive to our results upon acquisition, and we may not successfully manage and lease those properties to meet our expectations; |
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• | our cash flow may be insufficient to meet our required principal and interest payments; |
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• | we may spend more than budgeted amounts to make necessary improvements or renovations to acquired properties; |
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• | we may be unable to quickly and efficiently integrate new acquisitions, particularly acquisitions of portfolios of properties, into our existing operations, and as a result our results of operations and financial condition could be adversely affected; |
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• | market conditions may result in higher than expected vacancy rates and lower than expected rental rates; and |
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• | we may acquire properties subject to liabilities and without any recourse, or with only limited recourse, with respect to unknown liabilities such as liabilities for clean-up of undisclosed environmental contamination, claims by tenants, vendors or other persons dealing with the former owners of the properties, liabilities incurred in the ordinary course of business and claims for indemnification by general partners, directors, officers and others indemnified by the former owners of the properties. |
If we cannot operate acquired properties to meet our financial expectations, our financial condition, results of operations, cash flow and the per share trading price of our securities could be adversely affected.
We may acquire properties or portfolios of properties through tax deferred contribution transactions, which could result in stockholder dilution and limit our ability to sell such assets.
In the future we may acquire properties or portfolios of properties through tax deferred contribution transactions in exchange for partnership interests in our operating partnership, which may result in stockholder dilution. This acquisition structure may have the effect of, among other things, reducing the amount of tax depreciation we could deduct over the tax life of the acquired properties, and may require that we agree to protect the contributors’ ability to defer recognition of taxable gain through restrictions on our ability to dispose of the acquired properties and/or the allocation of partnership debt to the
contributors to maintain their tax bases. These restrictions could limit our ability to sell an asset at a time, or on terms, that would be favorable absent such restrictions.
Our growth depends on external sources of capital that are outside of our control and may not be available to us on commercially reasonable terms or at all.
In order to maintain our qualification as a REIT, we are required to meet various requirements under the Code including that we distribute annually at least 90% of our net taxable income, excluding any net capital gain. In addition, we will be subject to income tax at regular corporate rates to the extent that we distribute less than 100% of our net taxable income, including any net capital gains. Because of these distribution requirements, we may not be able to fund future capital needs, including any necessary acquisition financing, from operating cash flow. Consequently, we intend to rely on third-party sources to fund our capital needs. We may not be able to obtain the financing on favorable terms or at all. Any additional debt we incur will increase our leverage and likelihood of default. Our access to third-party sources of capital depends, in part, on:
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• | general market conditions; |
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• | the market’s perception of our growth potential; |
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• | our current debt levels; |
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• | our current and expected future earnings; |
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• | our cash flow and cash distributions; and |
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• | the market price per share of our common stock. |
The credit markets can experience significant disruptions. If we cannot obtain capital from third-party sources, we may not be able to acquire or develop properties when strategic opportunities exist, meet the capital and operating needs of our existing properties, satisfy our debt service obligations or make the cash distributions to our stockholders necessary to maintain our qualification as a REIT.
Failure to hedge effectively against interest rate changes may adversely affect our financial condition, results of
operations, cash flow, cash available for distribution, including cash available for payment of dividends on and the per share trading price of our securities.
If interest rates increase, then so will the interest costs on our unhedged variable rate debt, which could adversely affect our cash flow and our ability to pay principal and interest on our debt and our ability to make distributions to our stockholders. Further, rising interest rates could limit our ability to refinance existing debt when it matures. We seek to manage our exposure to interest rate volatility by using interest rate hedging arrangements that involve risk, such as the risk that counterparties may fail to honor their obligations under these arrangements, and that these arrangements may not be effective in reducing our exposure to interest rate changes. Failure to hedge effectively against interest rate changes may materially adversely affect our financial condition, results of operations, cash flow, cash available for distribution, including cash available for payment of dividends on and the per share trading price of our securities. In addition, while such agreements are intended to lessen the impact of rising interest rates on us, they also expose us to the risk that the other parties to the agreements will not perform, we could incur significant costs associated with the settlement of the agreements, the agreements will be unenforceable and the underlying transactions will fail to qualify as highly-effective cash flow hedges under Financial Accounting Standards Board, or FASB, Accounting Standards Codification, or ASC, Topic 815, Derivative and Hedging.
Mortgage debt obligations expose us to the possibility of foreclosure, which could result in the loss of our investment in a property or group of properties subject to mortgage debt.
Incurring mortgage and other secured debt obligations increases our risk of property losses because defaults on indebtedness secured by properties may result in foreclosure actions initiated by lenders and ultimately our loss of the property securing any loans for which we are in default. Any foreclosure on a mortgaged property or group of properties could adversely affect the overall value of our portfolio of properties. For tax purposes, a foreclosure of any of our properties that is subject to a nonrecourse mortgage loan would be treated as a sale of the property for a purchase price equal to the outstanding balance of the debt secured by the mortgage. If the outstanding balance of the debt secured by the mortgage exceeds our tax basis in the property, we would recognize taxable income on foreclosure, but would not receive any cash proceeds.
Our unsecured revolving credit facility restricts our ability to engage in some business activities.
Our unsecured revolving credit facility contains customary negative covenants and other financial and operating covenants that, among other things:
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• | restrict our ability to incur additional indebtedness; |
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• | restrict our ability to make certain investments; |
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• | restrict our ability to merge with another company; |
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• | restrict our ability to make distributions to stockholders; and |
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• | require us to maintain financial coverage ratios. |
These limitations restrict our ability to engage in some business activities, which could adversely affect our financial condition, results of operations, cash flow, cash available for distributions to our stockholders, and per share trading price of our securities. In addition, failure to meet any of these covenants, including the financial coverage ratios, could cause an event of default under and/or accelerate some or all of our indebtedness, which would have a material adverse effect on us. Furthermore, our unsecured revolving credit facility contains specific cross-default provisions with respect to specified other indebtedness, giving the lenders the right to declare a default if we are in default under other loans in some circumstances.
Adverse economic and geopolitical conditions and dislocations in the credit markets could have a material adverse effect on our financial condition, results of operations, cash flow and per share trading price of our securities.
In the United States, market and economic conditions continue to be challenging with stricter regulations and modest growth. While recent economic data reflects moderate economic growth in the United States, there continues to be concern regarding the stability of the economy and credit markets generally. Volatility in the U.S. and international capital markets and concern over a return to recessionary conditions in global economies, and the California economy in particular, may adversely affect our financial condition, results of operations, cash flow and the per share trading price of our securities as a result of the following potential consequences, among others:
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• | significant job losses in the financial and professional services industries may occur, which may decrease demand for our office space, causing market rental rates and property values to be negatively impacted; |
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• | our ability to obtain financing on terms and conditions that we find acceptable, or at all, may be limited, which could reduce our ability to pursue acquisition and development opportunities and refinance existing debt, reduce our returns from our acquisition and development activities and increase our future interest expense; |
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• | reduced values of our properties may limit our ability to dispose of assets at attractive prices or to obtain debt financing secured by our properties and may reduce the availability of unsecured loans; and |
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• | one or more lenders under our unsecured revolving credit facility could refuse to fund their financing commitment to us or could fail and we may not be able to replace the financing commitment of any such lenders on favorable terms, or at all. |
We have a limited operating history with respect to some of our properties and may not be able to operate them successfully.
Our Merrill Place, 3402 Pico and 12655 Jefferson properties have only been under our management since they were acquired on February 12, 2014, February 28, 2014, and October 17, 2014, respectively. These properties may have characteristics or deficiencies unknown to us that could affect such properties’ valuation or revenue potential. In addition, there can be no assurance that the operating performance of the properties will not decline under our management. We cannot assure you that we will be able to operate these properties successfully.
We face significant competition, which may decrease or prevent increases of the occupancy and rental rates of our properties.
We compete with numerous developers, owners and operators of office properties, many of which own properties similar to ours in the same submarkets in which our properties are located. If our competitors offer space at rental rates below current market rates, or below the rental rates we currently charge our tenants, we may lose existing or potential tenants and we may be pressured to reduce our rental rates below those we currently charge or to offer more substantial rent abatements, tenant improvements, early termination rights or below-market renewal options in order to retain tenants when our tenants’ leases expire. As a result, our financial condition, results of operations, cash flow and the per share trading price of our securities could be adversely affected.
We depend on significant tenants, and many of our properties are single-tenant properties or are currently occupied by single tenants.
As of December 31, 2014, the 15 largest tenants in our office portfolio represented approximately 57.0%
of the total annualized base rent generated by our office properties. The inability of a significant tenant to pay rent or the bankruptcy or insolvency of a significant tenant may adversely affect the income produced by our properties. If a tenant becomes bankrupt or insolvent, federal law may prohibit us from evicting such tenant based solely upon such bankruptcy or insolvency. In addition, a bankrupt or insolvent tenant may be authorized to reject and terminate its lease with us. Any claim against such tenant for unpaid, future rent would be subject to a statutory cap that might be substantially less than the remaining rent owed under the lease. As of December 31, 2014, our two largest tenants were Square and Salesforce.com, which together accounted for 13.4% of our annualized base rent and therefore represented a significant credit concentration. If Square and Salesforce.com were to experience a downturn or a weakening of financial condition resulting in a failure to make timely rental payments or causing a lease default, we may experience delays in enforcing our rights as landlord and may incur substantial costs in protecting our investment. Any such event described above could have an adverse effect on our financial condition, results of operations, cash flow and the per share trading price of our securities.
Furthermore, Saatchi & Saatchi leases 100% of the Del Amo Office property under the terms of an office lease that permits Saatchi & Saatchi to terminate the lease as to all of the leased premises by December 31, 2016, upon nine months prior notice and in exchange for payment of an early termination fee estimated to be approximately $3.0 million for 2016. As of December 31, 2014, the Saatchi & Saatchi lease comprised approximately 2.0% of our annualized office base rent. To the extent that Saatchi & Saatchi exercises its early termination right, our financial condition, results of operations and cash flow will be adversely affected, and we can provide no assurance that we will be able to generate an equivalent amount of net rental revenue by leasing the vacated space to new third-party tenants. Our financial condition, results of operations, cash flow and the per share trading price of our securities could be adversely affected if any of our significant tenants were to become unable to pay their rent or become bankrupt or insolvent.
We may be unable to renew leases, lease vacant space or re-let space as leases expire.
As of December 31, 2014, approximately 13.6% of the square footage of the office properties in our portfolio was available (taking into account uncommenced leases signed as of December 31, 2014), and an additional approximately 5.4% of the square footage of the office properties in our portfolio is scheduled to expire in 2015 (including leases scheduled to expire as of, but including, December 31, 2014). Furthermore, substantially all of the square footage of the media and entertainment properties in our portfolio (other than the KTLA lease of the KTLA facility at Sunset Bronson) will expire in 2015 and 2016. We cannot assure you that leases will be renewed or that our properties will be re-let at net effective rental rates equal to or above the current average net effective rental rates or that substantial rent abatements, tenant improvements, early termination rights or below-market renewal options will not be offered to attract new tenants or retain existing tenants. If the rental rates for our properties decrease, our existing tenants do not renew their leases or we do not re-let a significant portion of our available space and space for which leases will expire, our financial condition, results of operations, cash flow and per share trading price of our securities could be adversely affected.
We may be required to make rent or other concessions and/or significant capital expenditures to improve our properties in order to retain and attract tenants, causing our financial condition, results of operations, cash flow and per share trading price of our securities to be adversely affected.
To the extent adverse economic conditions continue in the real estate market and demand for office space remains low, we expect that, upon expiration of leases at our properties, we will be required to make rent or other concessions to tenants, accommodate requests for renovations, build-to-suit remodeling and other improvements or provide additional services to our tenants. As a result, we may have to make significant capital or other expenditures in order to retain tenants whose leases expire
and to attract new tenants in sufficient numbers. Additionally, we may need to raise capital to make such expenditures. If we are unable to do so or capital is otherwise unavailable, we may be unable to make the required expenditures. This could result in non-renewals by tenants upon expiration of their leases, which could cause an adverse effect to our financial condition, results of operations, cash flow and the per share trading price of our securities.
The actual rents we receive for the properties in our portfolio may be less than our asking rents, and we may experience lease roll-down from time to time.
As a result of various factors, including competitive pricing pressure in our submarkets, adverse conditions in the Northern or Southern California or the Pacific Northwest real estate markets, a general economic downturn and the desirability of our properties compared to other properties in our submarkets, we may be unable to realize the asking rents across the properties in our portfolio. In addition, the degree of discrepancy between our asking rents and the actual rents we are able to obtain may vary both from property to property and among different leased spaces within a single property. If we are unable to obtain rental rates that are on average comparable to our asking rents across our portfolio, then our ability to generate cash flow growth will be negatively impacted. In addition, depending on asking rental rates at any given time as compared to expiring leases in our portfolio, from time to time rental rates for expiring leases may be higher than starting rental rates for new leases.
Some of our properties are subject to ground leases, the termination or expiration of which could cause us to lose our interest in, and the right to receive rental income from, such properties.
The 9300 Wilshire Boulevard property, 0.59 acres of the Sunset Gower property and a portion representing 64% of the building area of the 222 Kearny Street property (excluding the 180 Sutter building) are subject to ground leases. If any of these ground leases are terminated following a default or expire without being extended, we may lose our interest in the related property and may no longer have the right to receive any of the rental income from such property, which would adversely affect our financial condition, results of operations, cash flow and the per share trading price of our securities.
The ground sublease for the Del Amo Office property is subject and subordinate to a ground lease, the termination of which could result in a termination of the ground sublease.
The property on which the Del Amo Office building is located is subleased by Del Amo Fashion Center Operating Company, L.L.C., or Del Amo, through a long-term ground sublease. The ground sublease is subject and subordinate to the terms of a ground lease between the fee owner of the Del Amo Office property and the sub-landlord under the ground sublease. The fee owner has not granted to the subtenant under the ground sublease any rights of non-disturbance. Accordingly, a termination of the ground lease for any reason, including a rejection thereof by the ground tenant under the ground lease in a bankruptcy proceeding, could result in a termination of the ground sublease. In the event of a termination of the ground sublease, we may lose our interest in the Del Amo Office building and may no longer have the right to receive any of the rental income from the Del Amo Office building. In addition, our lack of any non-disturbance rights from the fee owner may impair our ability to obtain financing for the Del Amo Office building.
Our success depends on key personnel whose continued service is not guaranteed.
Our continued success and our ability to manage anticipated future growth depend, in large part, upon the efforts of key personnel who have extensive market knowledge and relationships and exercise substantial influence over our operational, financing, acquisition and disposition activity. Many of our other senior executives have extensive experience and strong reputations in the real estate industry, which aid us in identifying opportunities, having opportunities brought to us, and negotiating with tenants and build-to-suit prospects. The loss of services of one or more members of our senior management team, or our inability to attract and retain highly qualified personnel, could adversely affect our business, diminish our investment opportunities and weaken our relationships with lenders, business partners, existing and prospective tenants and industry personnel, which could adversely affect our financial condition, results of operations, cash flow and the per share trading price of our securities.
Potential losses, including from adverse weather conditions, natural disasters and title claims, may not be covered by insurance.
We carry commercial property (including earthquake), liability and terrorism coverage on all the properties in our portfolio (most are covered under a blanket insurance policy while a few are under individual policies), in addition to other coverages, such as trademark and pollution coverage, that may be appropriate for certain of our properties. We have selected policy specifications and insured limits that we believe to be appropriate and adequate given the relative risk of loss, the cost of the coverage and industry practice. However, we do not carry insurance for losses such as loss from riots or war because such
coverage is not available or is not available at commercially reasonable rates. Some of our policies, like those covering losses due to terrorism or earthquakes, are insured subject to limitations involving large deductibles or co-payments and policy limits that may not be sufficient to cover losses, which could affect certain of our properties that are located in areas particularly susceptible to natural disasters. All of the properties we currently own are located in California and the Pacific Northwest, areas especially susceptible to earthquakes. In addition, we may discontinue earthquake, terrorism or other insurance on some or all of our properties in the future if the cost of premiums for any such policies exceeds, in our judgment, the value of the coverage discounted for the risk of loss. As a result, we may be required to incur significant costs in the event of adverse weather conditions and natural disasters. If we or one or more of our tenants experiences a loss that is uninsured or that exceeds policy limits, we could lose the capital invested in the damaged properties as well as the anticipated future cash flows from those properties. In addition, if the damaged properties are subject to recourse indebtedness, we would continue to be liable for the indebtedness, even if these properties were irreparably damaged. Furthermore, we may not be able to obtain adequate insurance coverage at reasonable costs in the future as the costs associated with property and casualty renewals may be higher than anticipated. In the event that we experience a substantial or comprehensive loss of one of our properties, we may not be able to rebuild such property to its existing specifications. Further reconstruction or improvement of such a property would likely require significant upgrades to meet zoning and building code requirements.
Future terrorist activity or engagement in war by the U.S. may have an adverse effect on our financial condition and operating results.
Terrorist attacks in the U.S. and other acts of terrorism or war may result in declining economic activity, which could harm the demand for and the value of our properties. A decrease in demand could make it difficult for us to renew or re-lease our properties at these sites at lease rates equal to or above historical rates. Terrorist activities also could directly impact the value of our properties through damage, destruction, or loss, and the availability of insurance for these acts may be less, and cost more, which could adversely affect our financial condition. To the extent that our tenants are impacted by future attacks, their businesses similarly could be adversely affected, including their ability to continue to honor their existing leases.
Terrorist attacks and engagement in war by the U.S. also may adversely affect the markets in which our securities trade and may cause further erosion of business and consumer confidence and spending and may result in increased volatility in national and international financial markets and economies. Any one of these events may cause decline in the demand for our office and media and entertainment leased space, delay the time in which our new or renovated properties reach stabilized occupancy, increase our operating expenses, such as those attributable to increased physical security for our properties, and limit our access to capital or increase our cost of raising capital.
We may become subject to litigation, which could have an adverse effect on our financial condition, results of operations, cash flow and the per share trading price of our securities.
In the future we may become subject to litigation, including claims relating to our operations, offerings, and otherwise in the ordinary course of business. Some of these claims may result in significant defense costs and potentially significant judgments against us, some of which are not, or cannot be, insured against. We generally intend to vigorously defend ourselves; however, we cannot be certain of the ultimate outcomes of any claims that may arise in the future. Resolution of these types of matters against us may result in our having to pay significant fines, judgments or settlements, which, if uninsured, or if the fines, judgments and settlements exceed insured levels, could adversely impact our earnings and cash flows, thereby having an adverse effect on our financial condition, results of operations, cash flow and per share trading price of our securities. Certain litigation or the resolution of certain litigation may affect the availability or cost of some of our insurance coverage, which could adversely impact our results of operations and cash flows, expose us to increased risks that would be uninsured, and/or adversely impact our ability to attract officers and directors.
Joint venture investments could be adversely affected by our lack of sole decision-making authority, our reliance on co-venturers’ financial condition and disputes between us and our co-venturers.
As described more fully in Item 7 below, on November 8, 2012, we entered into a joint venture with M. David Paul & Associates/Worthe Real Estate Group, or MDP/Worthe, to acquire The Pinnacle, a two-building (Pinnacle I and Pinnacle II), 625,640 square-foot office property located in Burbank, California. On January 7, 2015, we entered into a joint venture with Canada Pension Plan Investment Board (CPPIB), through which CPPIB purchased a 45% interest in our 1455 Market Street office property. In addition to our joint ventures with MDP/Worthe and CPPIB, we may co-invest in the future with other third parties through partnerships, joint ventures or other entities, acquiring non-controlling interests in or sharing responsibility for managing the affairs of a property, partnership, joint venture or other entity. These investments may, under certain circumstances, involve risks not present were a third party not involved, including the possibility that partners or co-venturers might become bankrupt or fail to fund their share of required capital contributions. Partners or co-venturers may have economic
or other business interests or goals which are inconsistent with our business interests or goals, and may be in a position to take actions contrary to our policies or objectives, and they may have competing interests in our markets that could create conflict of interest issues. Such investments may also have the potential risk of impasses on decisions, such as a sale, because neither we nor the partner or co-venturer would have full control over the partnership or joint venture. In addition, prior consent of our joint venture partners may be required for a sale or transfer to a third party of our interests in the joint venture, which would restrict our ability to dispose of our interest in the joint venture. If we become a limited partner or non-managing member in any partnership or limited liability company and such entity takes or expects to take actions that could jeopardize our status as a REIT or require us to pay tax, we may be forced to dispose of our interest in such entity. Disputes between us and partners or co-venturers may result in litigation or arbitration that would increase our expenses and prevent our officers and/or directors from focusing their time and effort on our business. Consequently, actions by or disputes with partners or co-venturers might result in subjecting properties owned by the partnership or joint venture to additional risk. In addition, we may in certain circumstances be liable for the actions of our third-party partners or co-venturers. Our joint ventures may be subject to debt and, in the current volatile credit market, the refinancing of such debt may require equity capital calls.
If we fail to maintain an effective system of integrated internal controls, we may not be able to accurately report our financial results.
Effective internal and disclosure controls are necessary for us to provide reliable financial reports and effectively prevent fraud and to operate successfully as a public company. If we cannot provide reliable financial reports or prevent fraud, our reputation and operating results would be harmed. As part of our ongoing monitoring of internal controls we may discover material weaknesses or significant deficiencies in our internal controls. As a result of weaknesses that may be identified in our internal controls, we may also identify certain deficiencies in some of our disclosure controls and procedures that we believe require remediation. If we discover weaknesses, we will make efforts to improve our internal and disclosure controls. However, there is no assurance that we will be successful. Any failure to maintain effective controls or timely effect any necessary improvement of our internal and disclosure controls could harm operating results or cause us to fail to meet our reporting obligations, which could affect our ability to remain listed with the NYSE. Ineffective internal and disclosure controls could also cause investors to lose confidence in our reported financial information, which would likely have a negative effect on the per share trading price of our securities.
Risk Factors Related to the Acquisition of the Target Properties
The issuance of shares of our common stock in the transaction or upon exchange of common units received in the transaction will have a dilutive effect on our common stock and will reduce your percentage interest in our earnings, voting power and market value.
The equity consideration consists of up to an aggregate of 63,474,791 shares of our common stock and common units (subject to adjustment as described below). The number of shares of our common stock to be issued to the seller parties upon completion of the transaction will be equal to approximately 9.8% of the then total issued and outstanding shares of our common stock and the remainder of the equity consideration will consist of common units. The issuance of shares of our common stock in the transaction will have a dilutive effect on our common stock and will reduce the relative percentage interests of current common stockholders in our earnings, voting power and market value.
Additionally, part of the equity consideration will be paid in common units, which may have a dilutive effect on our common stock. Holders of common units have the right to require the redemption of part or all of their outstanding common units for cash, or, at our election, shares of our common stock, based upon the fair market value of an equivalent number of shares of our common stock at the time of the redemption, subject to certain restrictions on ownership and transfer of our common stock. If the seller parties exercise their redemption rights and part or all of their outstanding common units are exchanged for shares of our common stock, such exchange will have a dilutive effect on our common stock and reduce the relative percentage interests of existing common stockholders in our earnings, voting power and market value.
The public resale by the seller parties of common stock issued in the transaction or issuable upon exchange of common units received in the transaction, or the perception that such resales could occur, could adversely affect the per share trading price of our common stock following completion of the transaction.
None of the shares of common stock or common units that will be issued to the seller parties upon completion of the transaction will initially be registered under the Securities Act, and such securities will only be able to be resold pursuant to an effective registration statement or an applicable exemption from registration under federal and state securities laws. Upon the completion of the transaction, the seller parties will enter into the stockholders agreement with us and our operating partnership, pursuant to which they will agree generally to not to transfer or sell any shares of common stock or common units
to be issued in connection with the transaction prior to November 1, 2015. The restrictions on transfer and sale contained in the stockholders agreement will terminate with respect to 50% of the securities to be issued to the seller parties on November 1, 2015 and with respect to the remaining 50% of such securities on March 1, 2016. In the event that the seller parties elect to terminate their right to designate nominees for election as directors to our board of directors (i) prior to November 1, 2015, the restriction on transfer and sale contained in the stockholders agreement will terminate on November 1, 2015 with respect to all securities issued to the seller parties in connection with the transaction, or (ii) after November 1, 2015 but before March 1, 2016, any remaining restrictions on transfer or sale will terminate on the earlier of March 1, 2016 or thirty days following the seller parties’ election.
Upon the completion of the transaction, we will enter into the registration rights agreement with the seller parties or their designated affiliates receiving the equity consideration, pursuant to which we will agree to register for resale all of the shares of common stock to be issued to the seller parties or such designated affiliates and any shares of common stock issuable upon the exchange of common units issued in the transaction. In addition, if we propose to register the offer and sale of our common stock under the Securities Act, in connection with the public offering of such common stock, the seller parties will be entitled to certain “piggyback” registration rights allowing them to include their shares in such registration, subject to certain marketing and other limitations.
If all or a substantial portion of the shares of our common stock issued in the transaction or shares of common stock issuable upon exchange of common units issued in the transaction are resold into the public markets or if there is a perception that such resales could occur, the per share trading price of our common stock could be adversely affected, and our ability to raise additional capital through the sale of our equity securities in the future may be adversely affected.
If the transaction does not occur, we may incur payment obligations to the seller parties.
If the purchase agreement is terminated because our stockholders do not approve the equity issuance, we will be obligated to pay the seller parties up to $14 million in expense reimbursement. If the purchase agreement is terminated under certain other circumstances, we will be obligated to pay the seller parties a termination fee of up to $120 million, net of certain expense reimbursements.
Failure to complete the transaction in a timely manner could negatively affect our ability to achieve the benefits associated with the transaction and could negatively affect our share price and future business and financial results.
The transaction is currently expected to close during the first half of 2015, assuming that all of the conditions in the purchase agreement are satisfied or waived. The purchase agreement provides that either the buyer parties or the seller parties may terminate the purchase agreement if the closing of the transaction has not occurred by 11:59 p.m. New York time on July 3, 2015. Certain events outside our control may delay or prevent the consummation of the transaction. Delays in consummating the transaction or the failure to consummate the transaction at all may result in our incurring significant additional costs in connection with such delay or termination of the purchase agreement and/or failing to achieve the anticipated benefits associated with the transaction. We cannot assure you that the conditions to the completion of the transaction will be satisfied or waived or that any adverse effect, event, development or change will not occur, and we cannot provide any assurances as to whether or when the transaction will be completed.
To complete the transaction, our stockholders must approve the equity issuance. In addition, the purchase agreement contains additional closing conditions, which may not be satisfied or waived. Delays in consummating the transaction or the failure to consummate the transaction at all could negatively affect our future business and financial results, and, in that event, the market price of our common stock may decline significantly, particularly to the extent that the current market price reflects a market assumption that the transaction will be consummated. If the transaction is not consummated for any reason, our ongoing business could be adversely affected, and we will be subject to several risks, including:
•the payment by us of certain costs, including termination fees and expense reimbursements ranging from $14 million to $120 million under certain circumstances as well as costs relating to the transaction, such as legal, accounting, financial advisory, filing, printing and mailing fees; and
•the diversion of management focus and resources from operational matters and other strategic opportunities while working to consummate the transaction.
If the transaction is not consummated, we will not achieve the expected benefits thereof and will be subject to the risks described above, any of which could affect our share price and future business and financial results.
The pendency of the transaction could adversely affect our business and operations and those of the Target Properties.
In connection with the pending transaction, some current or prospective tenants, lenders, joint venture partners or vendors of ours or the seller parties may delay or defer decisions, which could negatively impact the revenues, earnings, cash flows and expenses of ours and of the Target Properties, regardless of whether the transaction is completed. In addition, under the purchase agreement, both the buyer parties and the seller parties are subject to certain restrictions on the conduct of their respective businesses prior to completing the transaction. These restrictions may prevent the parties from pursuing certain strategic transactions, undertaking certain significant capital projects, undertaking certain significant financing transactions and otherwise pursuing other actions that are not in the ordinary course of business, even if such actions would prove beneficial.
We will incur significant non-recurring costs in connection with the transaction.
We expect to incur a number of non-recurring costs associated with transferring and integrating the Target Properties into our business, including any planned renovation, development or lease-up of such properties. Under the terms of the purchase agreement we are obligated to pay all expenses incurred in connection with the transaction at closing (subject to certain exceptions). The majority of non-recurring expenses relating to the transaction are comprised of transaction costs, costs of transferring the Target Properties and costs related to formulating integration plans. We expect that approximately $50.6 million will be incurred to complete the transaction although additional unanticipated costs may be incurred in the integration of the Target Properties into our business. As of December 31, 2014, we have incurred $12.4 million in non-recurring costs in connection with the transaction which does not include any fees for which we will need to reimburse the seller parties or others at the closing of the transaction.
There can be no assurance that we will be able to obtain financing for the funds necessary to pay the cash portion of the transaction consideration on acceptable terms, in a timely manner, or at all.
Our obligation under the purchase agreement to consummate the transaction is not conditioned on us obtaining any financing for the transaction. In connection with the transaction, we have obtained commitments for up to $1.75 billion under a 364-day senior unsecured bridge loan facility to finance the cash portion of the transaction consideration, subject to certain conditions. We are also pursuing a number of financing options, and anticipate that the funds needed to complete the transaction will be derived from a combination of (i) our available cash on hand and/or that of our operating partnership,(ii) proceeds from the sale of equity interests in, or assets of, certain wholly or partially owned subsidiaries, (iii) the issuance and sale of our common and/or preferred stock and/or limited partnership interests in our operating partnership and (iv) debt financing, which may include, without limitation, some combination of the following: (a) a senior unsecured bridge loan facility, (b) the issuance of senior unsecured notes or other debt securities, (c) borrowings under our operating partnership’s existing corporate credit facility and/or an upsizing thereof, including pursuant to the incremental feature thereof, (d) secured asset level financing and/or (e) other commercial or institutional bank loans.
There can be no assurance that we will satisfy the conditions needed to enter into the committed 364-day senior unsecured bridge loan facility, or that we will be able to obtain alternative financing on acceptable terms, in a timely manner or at all. If we utilize the committed 364-day senior unsecured bridge loan facility, we would need to refinance such indebtedness within one year and there can be no assurance that we would be able to do so on acceptable terms, in a timely manner or at all, particularly since we would only utilize our committed 364-day senior unsecured bridge facility if alternative financing on better terms was not available to us. Our committed 364-day senior unsecured bridge facility contains provisions that are not favorable to us, including a duration fee that is payable every 90 days after the funding of the bridge and that steps up over time as well as mandatory prepayment requirements for, among other things, debt and equity issuances and asset sales. If we are unable to obtain the funds necessary to pay the cash portion of the transaction consideration, we may not be able to complete the transaction and may be required to pay the seller parties a termination fee of up to $120 million.
The equity consideration will not be adjusted in the event of any change in our stock price.
The equity consideration consists of an aggregate of up to 63,474,791 shares of our common stock and common units, subject to reduction as set forth in the purchase agreement. The number of shares of our common stock to be delivered to the seller parties upon completion of the transaction will be equal to approximately 9.8% of the total issued and outstanding shares of our common stock, and the remainder of the equity consideration will consist of common units. The aggregate number of shares of common stock and common units will not be adjusted for changes in the market price of our common stock. Changes in the market price of our common stock, which may result from a variety of factors (many of which are beyond our control), will affect the value of the transaction consideration that the seller parties will receive upon consummation of the transaction. As a result, prior to the consummation of the transaction, you will not know the exact value of the shares of common stock and the common units that the seller parties will receive upon the consummation of the transaction.
Certain of the Target Properties are subject to ground leases, pursuant to which the lessors have consent rights that if not granted may prevent us from acquiring such properties.
Certain of the Target Properties are subject to ground leases with unaffiliated third party ground lessors, pursuant to which such lessors have consent rights that, if not granted or waived, may prevent us from acquiring such properties. There can be no assurance that the seller parties will be able to obtain the consents required to consummate the transfer of such properties to us pursuant to the purchase agreement. In the event that we are unable to acquire the properties that are subject to ground leases due to a failure to obtain ground lessor consent, the total consideration to be paid in the transaction will be adjusted; however, such reduction in consideration may not be commensurate with the lost actual or anticipated benefits of acquiring such properties. In addition, if we are unable to acquire one or more of the Target Properties for the reasons described above, we may not realize the operating efficiencies that may otherwise be achieved and the overall size, geographic footprint, tenant mix and other attributes of the portfolio of properties to be acquired in the transaction may not be as we anticipated.
The Target Properties may be subject to environmental liabilities, for which we may become responsible.
Certain of the Target Properties that are ground-leased from Stanford University have been subject to environmental investigation and remediation for many years, including soil removal, groundwater remediation and monitoring. These activities are ongoing at certain sites and will continue into the foreseeable future. At other sites, only monitoring is required. At present, these activities do not interfere with the leasing and operation of the properties, but could do so if agency requirements or remediation requirements change. Also, these activities could cause additional expense if the properties are redeveloped or renovated by us. The parties responsible for remediation are typically former tenants that engaged in electronic manufacturing and caused the release of chlorinated compounds and other contaminants. If the responsible parties become unable to meet these remediation obligations, it is possible that we could become responsible for them.
Screening for vapor intrusion is underway on several of the Target Properties. These screenings are monitored by either the San Francisco Regional Water Quality Control Board or the Department of Toxic Substances Control and are the responsibility of prior tenants. If the responsible parties are unable to meet any required remediation obligations, it is possible that we could become responsible for them. Also, we could be the subject of claims associated with indoor air exposure. Further, certain of the Target Properties have known asbestos-containing materials. We could incur abatement costs associated with testing for and remediating any asbestos issues and could be subject of claims associated with exposure to asbestos.
We cannot assure you that costs or liabilities incurred as a result of environmental issues will not affect our ability to make distributions to our stockholders or that such costs or other remedial measures will not have an adverse effect on our financial condition, results of operations, cash flow and the per share trading price of our securities. If we do incur material environmental liabilities in the future, we may face significant remediation costs, and we may find it difficult to sell any affected properties.
Risks Following the Transaction
The sponsor stockholders may exercise significant influence over us.
Upon completion of the transaction, the sponsor stockholders are expected to beneficially own 9.8% of our outstanding common stock and an approximate 43.6% interest in our company on a fully diluted basis (including common units). Consequently, the sponsor stockholders may be able to significantly influence the outcome of matters submitted for stockholder action, including approval of significant corporate transactions, such as amendments to our governing documents, business combinations, consolidations and mergers. In addition, concurrently with the completion of the transaction, the partnership agreement of our operating partnership will be amended to, among other things, provide that holders of common units will be entitled to vote to approve the consummation of certain change of control and other transactions that are required to be approved by our stockholders. The right of the holders of common units to vote to approve any such transactions will remain in effect for so long as the sponsor stockholders own at least 9.8% of the aggregate number of shares of common stock and common units that the sponsor stockholders receive as the equity consideration in the transaction.
Further, under the purchase agreement, we have agreed to increase the size of our board of directors from nine to twelve members, and if the transaction is consummated, entities controlled by the sponsor stockholders will have the right to designate three of our director nominees for so long as those entities beneficially own more than 50% of the total number of shares of common stock and common units to be acquired as the equity consideration in the transaction. This right to designate director nominees (i) will be reduced to two directors on the first date on which those entities beneficially own greater than or equal to 30% but less than or equal to 50% of the total number of shares of common stock and common units to be acquired as the equity consideration in the transaction, (ii) will be reduced to one director on the first date on which those entities
beneficially own greater than or equal to 15% but less than 30% of the total number of shares of common stock and common units to be acquired as the equity consideration in the transaction, and (iii) will cease altogether on the date on which those entities beneficially own less than 15% of the total number of shares of common stock and common units to be acquired as the equity consideration in the transaction. For so long as those entities have the right to designate at least two director nominees, the sponsor stockholders will also be entitled to appoint one such nominee then serving on the board of directors to serve on each committee of the board of directors (other than certain specified committees). As a result, the sponsor stockholders will have substantial influence on us and could exercise its influence in a manner that conflicts with the interests of other stockholders. The presence of a significant stockholder and the addition to the board of directors the sponsor stockholders' nominees may also have the effect of making it more difficult for a third party to acquire us or for our board of directors to discourage a third party form seeking to acquire us.
In connection with the transaction, we will incur significant additional indebtedness in order to finance the acquisition of the Target Properties, which could adversely affect us, including by decreasing our business flexibility and increasing our interest expense.
Our consolidated indebtedness as of December 31, 2014 was approximately $957.5 million (before loan premium) including debt related to our first financial property. After giving effect to the transaction and the anticipated incurrence of indebtedness in connection therewith (and assuming the transaction were to be consummated on December 31, 2014), our indebtedness would be approximately $2.8 billion (before loan premium), assuming we finance the entire cash consideration (before closing costs, prorations, and credits) with indebtedness. We will have substantially increased indebtedness following completion of the transaction, which could have the effect, among other things, of reducing our flexibility to respond to changing business and economic conditions and increasing our interest expense. We will also incur various costs and expenses associated with the financing of the transaction. The amount of cash required to pay interest on our increased indebtedness levels following completion of the transaction and thus the demands on our cash resources will be greater than the amount of cash flows required to service our indebtedness prior to the transaction. The increased levels of indebtedness following completion of the transaction could (i) reduce access to capital, (ii) increase borrowing costs generally or for any additional indebtedness, (iii) reduce funds available for working capital, capital expenditures, acquisitions and other general corporate purposes, (iv) create competitive disadvantages for us relative to other companies with lower debt levels, (v) reduce the amount of cash available to pay dividends on our common stock and (vi) increase our vulnerability to general adverse economic and industry conditions. If we do not achieve the expected benefits and cost savings from the transaction, then our ability to service our indebtedness may be adversely impacted.
Certain of the indebtedness that may be incurred in connection with the transaction could bear interest at variable interest rates. If interest rates increase, such variable rate debt would create higher debt service requirements, which could adversely affect our cash flows, our ability to pay principal and interest on our debt, our cost of refinancing our debt when it becomes due and our ability to make or sustain distributions to stockholders. Additionally, if we choose to hedge our interest rate risk, we cannot guarantee that the hedge will be effective or that the hedging counterparty will meet its obligations to us.
Moreover, we may be required to raise substantial additional financing to fund working capital, capital expenditures, acquisitions or other general corporate requirements. Our ability to arrange additional financing will depend on, among other factors, our financial position and performance, as well as prevailing market conditions and other factors beyond our control. We cannot assure you that we will be able to obtain additional financing on terms acceptable to us or at all.
Our future results will suffer if we do not effectively integrate the Target Properties and any retained employees following the transaction.
Following the transaction, we may be unable to integrate successfully the Target Properties and any retained employees and realize the anticipated benefits of the transaction or do so within the anticipated timeframe. The integration process could distract management, disrupt our ongoing business or result in inconsistencies in our operations, services, standards, controls, procedures and policies, any of which could adversely affect our ability to maintain relationships with our tenants, lenders, joint venture partners, vendors and employees or to achieve all or any of the anticipated benefits of the transaction.
The market price of our common stock may decline as a result of the transaction.
The market price of our common stock may decline as a result of the transaction if we do not achieve the perceived benefits of the transaction as rapidly or to the extent anticipated by financial or industry analysts, or the effect of the transaction on our financial results is not consistent with the expectations of financial or industry analysts. The transaction is expected to be accretive to funds from operations per share, or FFO per share, in 2015. The extent and duration of any accretion will depend
on several factors, including the amount of transaction-related expenses that are charged against our earnings. If expenses charged against earnings are higher than we expected, the amount of accretion in 2015 could be less than currently anticipated and the transaction may not turn out to be accretive (or may be less accretive than currently anticipated). In such event, the price of our common stock could decline.
In addition, if the transaction is consummated, we will own and operate a significantly larger portfolio than at present, with a different mix of properties, geographic concentration, risks and liabilities. Current holders of our common stock may not wish to continue to invest in us if the transaction is consummated or for other reasons may wish to dispose of some or all of their investment. If, following the consummation of the transaction, there is selling pressure on our common stock that exceeds demand at the market price, the price of our common stock could decline.
The agreements that will govern the indebtedness to be incurred or assumed in connection with the transaction are expected to contain various covenants imposing restrictions on us and certain of our subsidiaries that may affect our ability to operate our businesses.
The agreements that will govern the indebtedness to be incurred or assumed in connection with the transaction are expected to contain various affirmative and negative covenants that may, subject to certain significant exceptions, restrict our ability and that of certain of our subsidiaries to, among other things, have liens on property, incur additional indebtedness, make loans, advances or other investments, make non-ordinary course asset sales, and/or merge or consolidate with any other person or sell or convey certain of our assets to any one person. In addition, some of the agreements that govern the debt financing are expected to contain financial covenants that will require us to maintain certain financial ratios. Our ability to comply with these provisions may be affected by events beyond our control. Failure to comply with these covenants could result in an event of default, which, if not cured or waived, could accelerate our repayment obligations.
We cannot assure you that we will be able to continue paying dividends at the current rate.
We intend to make distributions each taxable year (not including a return of capital for United States federal income tax purposes) equal to at least 90% of our taxable income and intend to pay regular quarterly dividends to our stockholders. However, holders of our common stock may not receive the same quarterly dividends following the transaction for various reasons, including the following:
•as a result of the transaction and the issuance of the common stock and common units in connection with the transaction, the total amount of cash required for us to pay dividends at our current rate will increase; and
•we may not have enough cash to pay such distributions due to changes in our cash requirements, indebtedness, interest costs, capital spending plans, cash flows or financial position.
The risks associated with implementing our long-term business plan and strategy following the transaction may be different from the risks related to our business with respect to our existing property portfolio.
Our ability to execute our long-term business plan and strategy following the acquisition of the Target Properties may be different from the execution risks related to our business solely with respect to our existing real property portfolio. Such risks may include unforeseen delays or an inability to renew leases, lease vacant spaces or re-let spaces as leases expire. In addition, we may be required to make rent or other concessions and/or incur significant capital expenditures to improve both our existing properties as well as the Target Properties in order to retain and attract tenants, causing our financial condition, results of operation, cash flow and trading price of our common stock to be adversely affected.
Risks Related to the Real Estate Industry
Our performance and value are subject to risks associated with real estate assets and the real estate industry.
Our ability to pay expected dividends to our stockholders depends on our ability to generate revenues in excess of expenses, scheduled principal payments on debt and capital expenditure requirements. Events and conditions generally applicable to owners and operators of real property that are beyond our control may decrease cash available for distribution and the value of our properties. These events include many of the risks set forth above under “—Risks Related to Our Properties and Our Business,” as well as the following:
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• | local oversupply or reduction in demand for office or media and entertainment-related space; |
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• | adverse changes in financial conditions of buyers, sellers and tenants of properties; |
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• | vacancies or our inability to rent space on favorable terms, including possible market pressures to offer tenants rent abatements, tenant improvements, early termination rights or below-market renewal options, and the need to periodically repair, renovate and re-let space; |
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• | increased operating costs, including insurance premiums, utilities, real estate taxes and state and local taxes; |
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• | civil unrest, acts of war, terrorist attacks and natural disasters, including earthquakes and floods, which may result in uninsured or underinsured losses; |
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• | decreases in the underlying value of our real estate; and |
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• | changing submarket demographics. |
In addition, periods of economic downturn or recession, rising interest rates or declining demand for real estate, or the public perception that any of these events may occur, could result in a general decline in rents or an increased incidence of defaults under existing leases, which would adversely affect our financial condition, results of operations, cash flow and per share trading price of our securities.
Illiquidity of real estate investments could significantly impede our ability to respond to adverse changes in the performance of our properties and harm our financial condition.
The real estate investments made, and to be made, by us are relatively difficult to sell quickly. As a result, our ability to promptly sell one or more properties in our portfolio in response to changing economic, financial and investment conditions is limited. Return of capital and realization of gains, if any, from an investment generally will occur upon disposition or refinancing of the underlying property. We may be unable to realize our investment objectives by sale, other disposition or refinancing at attractive prices within any given period of time or may otherwise be unable to complete any exit strategy. In particular, our ability to dispose of one or more properties within a specific time period is subject to certain limitations imposed by our tax protection agreements, as well as weakness in or even the lack of an established market for a property, changes in the financial condition or prospects of prospective purchasers, changes in national or international economic conditions, such as the current economic downturn, and changes in laws, regulations or fiscal policies of jurisdictions in which the property is located.
In addition, the Code imposes restrictions on a REIT’s ability to dispose of properties that are not applicable to other types of real estate companies. In particular, the tax laws applicable to REITs effectively require that we hold our properties for investment, rather than primarily for sale in the ordinary course of business, which may cause us to forgo or defer sales of properties that otherwise would be in our best interest.
Therefore, we may not be able to vary our portfolio in response to economic or other conditions promptly or on favorable terms, which may adversely affect our financial condition, results of operations, cash flow and per share trading price of our securities.
We could incur significant costs related to government regulation and litigation over environmental matters.
Under various federal, state and local laws and regulations relating to the environment, as a current or former owner or operator of real property, we may be liable for costs and damages resulting from the presence or discharge of hazardous or toxic substances, waste or petroleum products at, on, in, under or migrating from such property, including costs to investigate, clean up such contamination and liability for harm to natural resources. Such laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the presence of such contamination, and the liability may be joint and several. These liabilities could be substantial and the cost of any required remediation, removal, fines or other costs could exceed the value of the property and/or our aggregate assets. In addition, the presence of contamination or the failure to remediate contamination at our properties may expose us to third-party liability for costs of remediation and/or personal or property damage or materially adversely affect our ability to sell, lease or develop our properties or to borrow using the properties as collateral. In addition, environmental laws may create liens on contaminated sites in favor of the government for damages and costs it incurs to address such contamination. Moreover, if contamination is discovered on our properties, environmental laws may impose restrictions on the manner in which property may be used or businesses may be operated, and these restrictions may require substantial expenditures. Some of our properties have been or may be impacted by contamination arising from current or prior uses of the property, or adjacent properties, for commercial or industrial purposes. Such contamination may arise from spills of petroleum or hazardous substances or releases from tanks used to store such materials.
As a result, we could potentially incur material liability for these issues, which could adversely impact our financial condition, results of operations, cash flow and the per share trading price of our securities.
Environmental laws also govern the presence, maintenance and removal of ACBM and LBP and may impose fines and penalties for failure to comply with these requirements or expose us to third-party liability (e.g., liability for personal injury associated with exposure to asbestos or lead). Such laws require that owners or operators of buildings containing ACBM and LBP (and employers in such buildings) properly manage and maintain the asbestos and lead, adequately notify or train those who may come into contact with asbestos or lead, and undertake special precautions, including removal or other abatement, if asbestos or lead would be disturbed during renovation or demolition of a building. Some of our properties contain ACBM and/or LBP and we could be liable for such damages, fines or penalties.
In addition, the properties in our portfolio also are subject to various federal, state and local environmental and health and safety requirements, such as state and local fire requirements. Moreover, some of our tenants routinely handle and use hazardous or regulated substances and wastes as part of their operations at our properties, which are subject to regulation. Such environmental and health and safety laws and regulations could subject us or our tenants to liability resulting from these activities. Environmental liabilities could affect a tenant’s ability to make rental payments to us. In addition, changes in laws could increase the potential liability for noncompliance. This may result in significant unanticipated expenditures or may otherwise materially and adversely affect our operations, or those of our tenants, which could in turn have an adverse effect on us.
We cannot assure you that costs or liabilities incurred as a result of environmental issues will not affect our ability to make distributions to our stockholders or that such costs or other remedial measures will not have an adverse effect on our financial condition, results of operations, cash flow and the per share trading price of our securities. If we do incur material environmental liabilities in the future, we may face significant remediation costs, and we may find it difficult to sell any affected properties.
Our properties may contain or develop harmful mold or suffer from other air quality issues, which could lead to liability for adverse health effects and costs of remediation.
When excessive moisture accumulates in buildings or on building materials, mold growth may occur, particularly if the moisture problem remains undiscovered or is not addressed over a period of time. Some molds may produce airborne toxins or irritants. Indoor air quality issues can also stem from inadequate ventilation, chemical contamination from indoor or outdoor sources, and other biological contaminants such as pollen, viruses and bacteria. Indoor exposure to airborne toxins or irritants above certain levels can be alleged to cause a variety of adverse health effects and symptoms, including allergic or other reactions. As a result, the presence of significant mold or other airborne contaminants at any of our properties could require us to undertake a costly remediation program to contain or remove the mold or other airborne contaminants from the affected property or increase indoor ventilation. In addition, the presence of significant mold or other airborne contaminants could expose us to liability from our tenants, employees of our tenants or others if property damage or personal injury is alleged to have occurred.
We may incur significant costs complying with various federal, state and local laws, regulations and covenants that are applicable to our properties.
The properties in our portfolio are subject to various covenants and federal, state and local laws and regulatory requirements, including permitting and licensing requirements. Local regulations, including municipal or local ordinances, zoning restrictions and restrictive covenants imposed by community developers may restrict our use of our properties and may require us to obtain approval from local officials or restrict our use of our properties and may require us to obtain approval from local officials of community standards organizations at any time with respect to our properties, including prior to acquiring a property or when undertaking renovations of any of our existing properties. Among other things, these restrictions may relate to fire and safety, seismic or hazardous material abatement requirements. There can be no assurance that existing laws and regulatory policies will not adversely affect us or the timing or cost of any future acquisitions or renovations, or that additional regulations will not be adopted that increase such delays or result in additional costs. Our growth strategy may be affected by our ability to obtain permits, licenses and zoning relief. Our failure to obtain such permits, licenses and zoning relief or to comply with applicable laws could have an adverse effect on our financial condition, results of operations, cash flow and per share trading price of our securities.
In addition, federal and state laws and regulations, including laws such as the ADA, impose further restrictions on our properties and operations. Under the ADA, all public accommodations must meet federal requirements related to access and use by disabled persons. Some of our properties may currently be in non-compliance with the ADA. If one or more of the
properties in our portfolio is not in compliance with the ADA or any other regulatory requirements, we may be required to incur additional costs to bring the property into compliance and we might incur governmental fines or the award of damages to private litigants. In addition, we do not know whether existing requirements will change or whether future requirements will require us to make significant unanticipated expenditures that will adversely impact our financial condition, results of operations, cash flow and per share trading price of our securities.
We are exposed to risks associated with property development.
We may engage in development and redevelopment activities with respect to certain of our properties. To the extent that we do so, we will be subject to certain risks, including the availability and pricing of financing on favorable terms or at all; construction and/or lease-up delays; cost overruns, including construction costs that exceed our original estimates; contractor and subcontractor disputes, strikes, labor disputes or supply disruptions; failure to achieve expected occupancy and/or rent levels within the projected time frame, if at all; and delays with respect to obtaining or the inability to obtain necessary zoning, occupancy, land use and other governmental permits, and changes in zoning and land use laws. These risks could result in substantial unanticipated delays or expenses and, under certain circumstances, could prevent completion of development activities once undertaken, any of which could have an adverse effect on our financial condition, results of operations, cash flow and per share trading price of our securities.
Risks Related to Our Organizational Structure
As of December 31, 2014, the Farallon Funds owned an approximate 15.2% beneficial interest in our company on a fully diluted basis and have the ability to exercise significant influence on our company.
As of December 31, 2014, investment funds affiliated with Farallon Capital Management, L.L.C., or Farallon, which we refer to as the Farallon Funds, owned an approximate 15.2% beneficial interest in our company on a fully diluted basis. Consequently, the Farallon Funds may be able to significantly influence the outcome of matters submitted for stockholder action, including the election of our board of directors and approval of significant corporate transactions, including business combinations, consolidations and mergers. In addition, one member of our board of directors is a managing member of Farallon. As a result, the Farallon Funds have substantial influence on us and could exercise their influence in a manner that conflicts with the interests of other stockholders.
The series A preferred units that were issued to some contributors in connection with our initial public offering in exchange for the contribution of their properties have certain preferences, which could limit our ability to pay dividends or other distributions to the holders of our securities or engage in certain business combinations, recapitalizations or other fundamental changes.
In exchange for the contribution of properties to our portfolio in connection with our initial public offering, some contributors received series A preferred units in our operating partnership, which units have an aggregate liquidation preference of approximately $10.2 million and have a preference as to distributions and upon liquidation that could limit our ability to pay dividends on our series B preferred stock and our common stock. The series A preferred units are senior to any other class of securities our operating partnership may issue in the future without the consent of the holders of the series A preferred units. As a result, we will be unable to issue partnership units in our operating partnership senior to the series A preferred units without the consent of the holders of series A preferred units. Any preferred stock in our company that we issue will be subordinate to the series A preferred units. In addition, we may only engage in a fundamental change, including a recapitalization, a merger and a sale of all or substantially all of our assets, as a result of which our common stock ceases to be publicly traded or common units cease to be exchangeable (at our option) for publicly traded shares of our stock, without the consent of holders of series A preferred units if following such transaction we will maintain certain leverage ratios and equity requirements, and pay certain minimum tax distributions to holders of our outstanding series A preferred units. Alternatively, we may redeem all or any portion of the then outstanding series A preferred units for cash (at a price per unit equal to the redemption price). If we choose to redeem the outstanding series A preferred units in connection with a fundamental change, this could reduce the amount of cash available for distribution to holders of our series B preferred stock and our common stock. In addition, these provisions could increase the cost of any such fundamental change transaction, which may discourage a merger, combination or change of control that might involve a premium price for our common stock or that our stockholders otherwise believe to be in their best interests.
Our common stock is ranked junior to our series B preferred stock.
Our common stock is ranked junior to our series B preferred stock. Our outstanding series B preferred stock also has or will have a preference upon our dissolution, liquidation or winding up in respect of assets available for distribution to our
stockholders. Holders of our common stock are not entitled to preemptive rights or other protections against dilution. In the future, we may attempt to increase our capital resources by making additional offerings of equity securities, including classes or series of additional preferred stock. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offering. Thus, our stockholders bear the risk of our future offerings reducing the per share trading price of our common stock and diluting their interest in us.
Conflicts of interest exist or could arise in the future between the interests of our stockholders and the interests of holders of units in our operating partnership, which may impede business decisions that could benefit our stockholders.
Conflicts of interest exist or could arise in the future as a result of the relationships between us and our affiliates, on the one hand, and our operating partnership or any partner thereof, on the other. Our directors and officers have duties to our company under applicable Maryland law in connection with their management of our company. At the same time, we, as the general partner of our operating partnership, have fiduciary duties and obligations to our operating partnership and its limited partners under Maryland law and the partnership agreement of our operating partnership in connection with the management of our operating partnership. Our fiduciary duties and obligations as general partner to our operating partnership and its partners may come into conflict with the duties of our directors and officers to our company.
Additionally, the partnership agreement provides that we and our directors and officers will not be liable or accountable to our operating partnership for losses sustained, liabilities incurred or benefits not derived if we, or such director or officer acted in good faith. The partnership agreement also provides that we will not be liable to the operating partnership or any partner for monetary damages for losses sustained, liabilities incurred or benefits not derived by the operating partnership or any limited partner, except for liability for our intentional harm or gross negligence. Moreover, the partnership agreement provides that our operating partnership is required to indemnify us and our directors, officers and employees, officers and employees of the operating partnership and our designees from and against any and all claims that relate to the operations of our operating partnership, except (1) if the act or omission of the person was material to the matter giving rise to the action and either was committed in bad faith or was the result of active and deliberate dishonesty, (2) for any transaction for which the indemnified party received an improper personal benefit, in money, property or services or otherwise, in violation or breach of any provision of the partnership agreement or (3) in the case of a criminal proceeding, if the indemnified person had reasonable cause to believe that the act or omission was unlawful. No reported decision of a Maryland appellate court has interpreted provisions similar to the provisions of the partnership agreement of our operating partnership that modify and reduce our fiduciary duties or obligations as the general partner or reduce or eliminate our liability for money damages to the operating partnership and its partners, and we have not obtained an opinion of counsel as to the enforceability of the provisions set forth in the partnership agreement that purport to modify or reduce the fiduciary duties that would be in effect were it not for the partnership agreement.
We may pursue less vigorous enforcement of terms of the contribution and other agreements with members of our senior management and our affiliates because of our dependence on them and conflicts of interest.
Each of Victor J. Coleman and affiliates of the Farallon Funds are parties to contribution agreements with us pursuant to which we have acquired interests in our properties and assets. In addition, Mr. Coleman is party to an employment agreement with us. We may choose not to enforce, or to enforce less vigorously, our rights under these agreements because of our desire to maintain our ongoing relationship with a member of our senior management and the Farallon Funds, with possible negative impact on stockholders.
Our charter and bylaws, the partnership agreement of our operating partnership and Maryland law contain provisions that may delay, defer or prevent a change of control transaction, even if such a change in control may be in your interest, and as a result may depress the market price of our securities.
Our charter contains certain ownership limits. Our charter contains various provisions that are intended to preserve our qualification as a REIT and, subject to certain exceptions, authorize our directors to take such actions as are necessary or appropriate to preserve our qualification as a REIT. For example, our charter prohibits the actual, beneficial or constructive ownership by any person of more than 9.8% in value or number of shares, whichever is more restrictive, of the outstanding shares of each of our common stock and series B preferred stock, and more than 9.8% in value of the aggregate outstanding shares of all classes and series of our stock. Our board of directors, in its sole and absolute discretion, may exempt a person, prospectively or retroactively, from these ownership limits if certain conditions are satisfied. In connection with past offerings of our common stock and the offering of our series B preferred stock, our board of directors granted to the Farallon Funds and certain of their affiliates, which we refer to collectively as the Farallon excepted holders, and to certain other persons, exemptions from the ownership limits, subject to various conditions and limitations. In connection with the acquisition of the
Target Properties, our board of directors has also agreed to grant to certain affiliates of The Blackstone Group L.P. exemptions from the ownership limits, subject to various conditions and limitations. The restrictions on ownership and transfer of our stock may:
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• | discourage a tender offer or other transactions or a change in management or of control that might involve a premium price for our common stock or series B preferred stock or that our stockholders otherwise believe to be in their best interests; or |
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• | result in the transfer of shares acquired in excess of the restrictions to a trust for the benefit of a charitable beneficiary and, as a result, the forfeiture by the acquirer of the benefits of owning the additional shares. |
We could increase the number of authorized shares of stock, classify and reclassify unissued stock and issue stock without stockholder approval. Subject to the rights of holders of series B preferred stock to approve the classification or issuance of any class or series of stock ranking senior to the series B preferred stock, our board of directors has the power under our charter to amend our charter to increase the aggregate number of shares of stock or the number of shares of stock of any class or series that we are authorized to issue, to authorize us to issue authorized but unissued shares of our common stock or preferred stock and to classify or reclassify any unissued shares of our common stock or preferred stock into one or more classes or series of stock and set the terms of such newly classified or reclassified shares. Although our board of directors has no such intention at the present time, it could establish a class or series of preferred stock that could, depending on the terms of such series, delay, defer or prevent a transaction or a change of control that might involve a premium price for our securities or that our stockholders otherwise believe to be in their best interest.
Certain provisions of Maryland law could inhibit changes in control, which may discourage third parties from conducting a tender offer or seeking other change of control transactions that our stockholders otherwise believe to be in their best interest. Certain provisions of the Maryland General Corporation Law, or MGCL, may have the effect of inhibiting a third party from making a proposal to acquire us or of impeding a change of control under circumstances that otherwise could be in the best interest of our stockholders, including:
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• | “business combination” provisions that, subject to limitations, prohibit certain business combinations between us and an “interested stockholder” (defined generally as any person who beneficially owns 10% or more of the voting power of our shares or an affiliate thereof or an affiliate or associate of ours who was the beneficial owner, directly or indirectly, of 10% or more of the voting power of our then outstanding voting stock at any time within the two-year period immediately prior to the date in question) for five years after the most recent date on which the stockholder becomes an interested stockholder, and thereafter impose fair price and/or supermajority and stockholder voting requirements on these combinations; and |
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• | “control share” provisions that provide that “control shares” of our company (defined as shares that, when aggregated with other shares controlled by the stockholder, entitle the stockholder to exercise one of three increasing ranges of voting power in electing directors) acquired in a “control share acquisition” (defined as the direct or indirect acquisition of ownership or control of issued and outstanding “control shares”) have no voting rights except to the extent approved by our stockholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter, excluding all interested shares. |
As permitted by the MGCL, we have elected, by resolution of our board of directors, to exempt from the business combination provisions of the MGCL, any business combination that is first approved by our disinterested directors and, pursuant to a provision in our bylaws, to exempt any acquisition of our stock from the control share provisions of the MGCL. However, our board of directors may by resolution elect to repeal the exemption from the business combination provisions of the MGCL and may by amendment to our bylaws opt into the control share provisions of the MGCL at any time in the future.
Certain provisions of the MGCL permit our board of directors, without stockholder approval and regardless of what is currently provided in our charter or bylaws, to implement certain corporate governance provisions, some of which (for example, a classified board) are not currently applicable to us. These provisions may have the effect of limiting or precluding a third party from making an unsolicited acquisition proposal for us or of delaying, deferring or preventing a change in control of us under circumstances that otherwise could be in the best interest of our stockholders. Our charter contains a provision whereby we have elected to be subject to the provisions of Title 3, Subtitle 8 of the MGCL relating to the filling of vacancies on our board of directors.
Certain provisions in the partnership agreement of our operating partnership may delay or prevent unsolicited acquisitions of us. Provisions in the partnership agreement of our operating partnership may delay or make more difficult
unsolicited acquisitions of us or changes of our control. These provisions could discourage third parties from making proposals involving an unsolicited acquisition of us or change of our control, although some stockholders might consider such proposals, if made, desirable. These provisions include, among others:
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• | redemption rights of qualifying parties; |
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• | transfer restrictions on units; |
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• | our ability, as general partner, in some cases, to amend the partnership agreement and to cause the operating partnership to issue units with terms that could delay, defer or prevent a merger or other change of control of us or our operating partnership without the consent of the limited partners; |
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• | the right of the limited partners to consent to transfers of the general partnership interest and mergers or other transactions involving us under specified circumstances; and |
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• | restrictions on debt levels and equity requirements pursuant to the terms of our series A preferred units, as well as required distributions to holders of series A preferred units of our operating partnership, following certain changes of control of us. |
Our charter, bylaws, the partnership agreement of our operating partnership and Maryland law also contain other provisions that may delay, defer or prevent a transaction or a change of control that our stockholders otherwise believe to be in their best interest.
Our board of directors may change our investment and financing policies without stockholder approval and we may become more highly leveraged, which may increase our risk of default under our debt obligations.
Our investment and financing policies are exclusively determined by our board of directors. Accordingly, our stockholders do not control these policies. Further, our organizational documents do not limit the amount or percentage of indebtedness, funded or otherwise, that we may incur. Our board of directors may alter or eliminate our current policy on borrowing at any time without stockholder approval. If this policy changed, we could become more highly leveraged which could result in an increase in our debt service. Higher leverage also increases the risk of default on our obligations. In addition, a change in our investment policies, including the manner in which we allocate our resources across our portfolio or the types of assets in which we seek to invest, may increase our exposure to interest rate risk, real estate market fluctuations and liquidity risk. Changes to our policies with regards to the foregoing could adversely affect our financial condition, results of operations, cash flow and per share trading price of our securities.
Our rights and the rights of our stockholders to take action against our directors and officers are limited.
Our charter eliminates the liability of our directors and officers to us and our stockholders for money damages, except for liability resulting from:
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• | actual receipt of an improper benefit or profit in money, property or services; or |
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• | a final judgment based upon a finding of active and deliberate dishonesty by the director or officer that was material to the cause of action adjudicated. |
In addition, our charter authorizes us to obligate our company, and our bylaws require us, to indemnify our directors and officers for actions taken by them in those and certain other capacities to the maximum extent permitted by Maryland law. As a result, we and our stockholders may have more limited rights against our directors and officers than might otherwise exist. Accordingly, in the event that actions taken in good faith by any of our directors or officers impede the performance of our company, your ability to recover damages from such director or officer will be limited.
Tax protection agreements could limit our ability to sell or otherwise dispose of certain properties.
In connection with our formation transactions for our IPO, we entered into tax protection agreements with certain third-party contributors that provide that if we dispose of any interest with respect to certain properties in a taxable transaction during the period from the closing of our initial public offering on June 29, 2010 through certain specified dates ranging until 2027, we will indemnify the third-party contributors for certain tax liabilities payable as a result of the sale (as well as tax liabilities payable as a result of the reimbursement payment). Certain contributors’ rights under the tax protection agreements with respect to these properties will, however, expire at various times (depending on the rights of such partner) during the
period beginning in 2017 and prior to the expiration, in 2027, of the maximum period for indemnification. If we were to trigger the tax protection provisions under these agreements, we would be required to pay damages, if any, in the amount of certain taxes payable by these contributors (plus additional damages in the amount of the taxes incurred as a result of such payment). In addition, although it may otherwise be in our stockholders’ best interest that we sell one of these properties, it may be economically prohibitive for us to do so because of these obligations.
Our tax protection agreements may require our operating partnership to maintain certain debt levels that otherwise would not be required to operate our business.
Our tax protection agreements provide that during the period from the closing of our initial public offering on June 29, 2010, through certain specified dates ranging from 2017 to 2027, our operating partnership will offer certain holders of units who continue to hold the units received in respect of the formation transactions the opportunity to guarantee debt. If we fail to make such opportunities available, we will be required to indemnify such holders for certain tax liabilities, if any, resulting from our failure to make such opportunities available to them (and any tax liabilities payable as a result of the indemnity payment). We agreed to these provisions in order to assist certain contributors in deferring the recognition of taxable gain as a result of and after the formation transactions. These obligations may require us to maintain more or different indebtedness than we would otherwise require for our business.
We are a holding company with no direct operations and, as such, we rely on funds received from our operating partnership to pay liabilities, and the interests of our stockholders are structurally subordinated to all liabilities and obligations of our operating partnership and its subsidiaries.
We are a holding company and conduct substantially all of our operations through our operating partnership. We do not have, apart from an interest in our operating partnership, any independent operations. As a result, we rely on distributions from our operating partnership to pay any dividends we might declare on our common stock and on shares of our series B preferred stock. We also rely on distributions from our operating partnership to meet our obligations, including any tax liability on taxable income allocated to us from our operating partnership. In addition, because we are a holding company, claims of our equity holders will be structurally subordinated to all existing and future liabilities and obligations (whether or not for borrowed money) of our operating partnership and its subsidiaries and subordinate to the rights of holders of series A preferred units. Therefore, in the event of our bankruptcy, liquidation or reorganization, our assets and those of our operating partnership and its subsidiaries will be available to satisfy the claims of our stockholders only after all of our and our operating partnership’s and its subsidiaries’ liabilities and obligations have been paid in full.
Risks Related to Our Status as a REIT
Failure to qualify as a REIT would have significant adverse consequences to us and the value of our stock.
We have elected to be taxed as a REIT for federal income tax purposes commencing with our taxable year ended December 31, 2010. We believe that we have operated in a manner that has allowed us to qualify as a REIT for federal income tax purposes commencing with such taxable year, and we intend to continue operating in such manner. We have not requested and do not plan to request a ruling from the Internal Revenue Service, or IRS, that we qualify as a REIT, and the statements in this Annual Report are not binding on the IRS or any court. Therefore, we cannot assure you that we have qualified as a REIT, or that we will remain qualified as such in the future. If we lose our REIT status, we will face serious tax consequences that would substantially reduce the funds available for distribution to you for each of the years involved because:
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• | we would not be allowed a deduction for distributions to stockholders in computing our taxable income and would be subject to federal income tax at regular corporate rates; |
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• | we also could be subject to the federal alternative minimum tax and possibly increased state and local taxes; and |
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• | unless we are entitled to relief under applicable statutory provisions, we could not elect to be taxed as a REIT for four taxable years following the year during which we were disqualified. |
Any such corporate tax liability could be substantial and would reduce our cash available for, among other things, our operations and distributions to stockholders. In addition, if we fail to qualify as a REIT, we would not be required to make distributions to our stockholders. As a result of all these factors, our failure to qualify as a REIT also could impair our ability to expand our business and raise capital, and could materially and adversely affect the value of our securities.
Qualification as a REIT involves the application of highly technical and complex Code provisions for which there are only limited judicial and administrative interpretations. The complexity of these provisions and of the applicable Treasury regulations that have been promulgated under the Code, or the Treasury Regulations, is greater in the case of a REIT that, like us, holds its assets through a partnership. The determination of various factual matters and circumstances not entirely within our control may affect our ability to qualify as a REIT. In order to qualify as a REIT, we must satisfy a number of requirements, including requirements regarding the ownership of our stock and requirements regarding the composition of our assets and our gross income. Also, we must make distributions to stockholders aggregating annually at least 90% of our net taxable income, excluding net capital gains. We own and may acquire direct or indirect interests in one or more entities that have elected or will elect to be taxed as REITs under the Code (each, a “Subsidiary REIT”). A Subsidiary REIT is subject to the various REIT qualification requirements and other limitations described herein that are applicable to us. If a Subsidiary REIT were to fail to qualify as a REIT, then (i) that Subsidiary REIT would become subject to federal income tax, (ii) shares in such Subsidiary REIT would cease to be qualifying assets for purposes of the asset tests applicable to REITs, and (iii) it is possible that we would fail certain of the asset tests applicable to REITs, in which event we would fail to qualify as a REIT unless we could avail ourselves of certain relief provisions. In addition, legislation, new regulations, administrative interpretations or court decisions may materially adversely affect our investors, our ability to qualify as a REIT for federal income tax purposes or the desirability of an investment in a REIT relative to other investments.
Even if we qualify as a REIT for federal income tax purposes, we may be subject to some federal, state and local income, property and excise taxes on our income or property and, in certain cases, a 100% penalty tax, in the event we sell property as a dealer. In addition, our taxable REIT subsidiaries will be subject to tax as regular corporations in the jurisdictions they operate.
If our operating partnership failed to qualify as a partnership for federal income tax purposes, we would cease to qualify as a REIT and suffer other adverse consequences.
We believe that our operating partnership is properly treated as a partnership for federal income tax purposes. As a partnership, our operating partnership is not subject to federal income tax on its income. Instead, each of its partners, including us, is allocated, and may be required to pay tax with respect to, its share of our operating partnership’s income. We cannot assure you, however, that the IRS will not challenge the status of our operating partnership or any other subsidiary partnership in which we own an interest as a partnership for federal income tax purposes, or that a court would not sustain such a challenge. If the IRS were successful in treating our operating partnership or any such other subsidiary partnership as an entity taxable as a corporation for federal income tax purposes, we would fail to meet the gross income tests and certain of the asset tests applicable to REITs and, accordingly, we would likely cease to qualify as a REIT. Also, the failure of our operating partnership or any subsidiary partnerships to qualify as a partnership would cause it to become subject to federal and state corporate income tax, which could reduce significantly the amount of cash available for debt service and for distribution to its partners, including us.
The tax imposed on REITs engaging in “prohibited transactions” may limit our ability to engage in transactions that would be treated as sales for federal income tax purposes.
A REIT’s net income from prohibited transactions is subject to a 100% penalty tax. In general, prohibited transactions are sales or other dispositions of property, other than foreclosure property, held primarily for sale to customers in the ordinary course of business. Although we do not intend to hold any properties that would be characterized as held for sale to customers in the ordinary course of our business, such characterization is a factual determination and we cannot assure you that the IRS would agree with our characterization of our properties or that we will always be able to make use of the available safe harbors, which, if met, would prevent any such sales from being treated as prohibited transactions.
Our ownership of taxable REIT subsidiaries is subject to certain restrictions, and we will be required to pay a 100% penalty tax on certain income or deductions if our transactions with our taxable REIT subsidiaries are not conducted on arm’s length terms.
We currently own an interest in one taxable REIT subsidiary and may acquire securities in additional taxable REIT subsidiaries in the future. A taxable REIT subsidiary is a corporation other than a REIT in which a REIT directly or indirectly holds stock, and that has made a joint election with such REIT to be treated as a taxable REIT subsidiary. If a taxable REIT subsidiary owns more than 35% of the total voting power or value of the outstanding securities of another corporation, such other corporation will also be treated as a taxable REIT subsidiary. Other than some activities relating to lodging and health care facilities, a taxable REIT subsidiary may generally engage in any business, including the provision of customary or non-customary services to tenants of its parent REIT. A taxable REIT subsidiary is subject to federal income tax as a regular C corporation. In addition, a 100% excise tax will be imposed on certain transactions between a taxable REIT subsidiary and its
parent REIT that are not conducted on an arm’s length basis. A REIT’s ownership of securities of a taxable REIT subsidiary is not subject to the 5% or 10% asset tests applicable to REITs. Not more than 25% of our total assets may be represented by securities, including securities of taxable REIT subsidiaries, other than those securities includable in the 75% asset test. We anticipate that the aggregate value of the stock and securities of any taxable REIT subsidiaries and other nonqualifying assets that we own will be less than 25% of the value of our total assets, and we will monitor the value of these investments to ensure compliance with applicable ownership limitations. In addition, we intend to structure our transactions with any taxable REIT subsidiaries that we own to ensure that they are entered into on arm’s length terms to avoid incurring the 100% excise tax described above. There can be no assurance, however, that we will be able to comply with the 25% limitation or to avoid application of the 100% excise tax discussed above.
To maintain our REIT status, we may be forced to borrow funds during unfavorable market conditions.
To qualify as a REIT, we generally must distribute to our stockholders at least 90% of our net taxable income each year, excluding net capital gains, and we will be subject to regular corporate income taxes to the extent that we distribute less than 100% of our net taxable income each year. In addition, we will be subject to a 4% nondeductible excise tax on the amount, if any, by which distributions paid by us in any calendar year are less than the sum of 85% of our ordinary income, 95% of our capital gain net income and 100% of our undistributed income from prior years. In order to maintain our REIT status and avoid the payment of income and excise taxes, we may need to borrow funds to meet the REIT distribution requirements even if the then prevailing market conditions are not favorable for these borrowings. These borrowing needs could result from, among other things, differences in timing between the actual receipt of cash and inclusion of income for federal income tax purposes, or the effect of non-deductible capital expenditures, the creation of reserves or required debt or amortization payments. These sources, however, may not be available on favorable terms or at all. Our access to third-party sources of capital depends on a number of factors, including the market’s perception of our growth potential, our current debt levels, the market price of our common stock, and our current and potential future earnings. We cannot assure you that we will have access to such capital on favorable terms at the desired times, or at all, which may cause us to curtail our investment activities and/or to dispose of assets at inopportune times, and could adversely affect our financial condition, results of operations, cash flow, cash available for distributions to our stockholders, and per share trading price of our securities.
Complying with REIT requirements may affect our profitability and may force us to liquidate or forgo otherwise attractive investments.
To qualify as a REIT, we must continually satisfy tests concerning, among other things, the nature and diversification of our assets, the sources of our income and the amounts we distribute to our stockholders. We may be required to liquidate or forgo otherwise attractive investments in order to satisfy the asset and income tests or to qualify under certain statutory relief provisions. We also may be required to make distributions to stockholders at disadvantageous times or when we do not have funds readily available for distribution. As a result, having to comply with the distribution requirement could cause us to: (i) sell assets in adverse market conditions; (ii) borrow on unfavorable terms; or (iii) distribute amounts that would otherwise be invested in future acquisitions, capital expenditures or repayment of debt. Accordingly, satisfying the REIT requirements could have an adverse effect on our business results, profitability and ability to execute our business plan. Moreover, if we are compelled to liquidate our investments to meet any of these asset, income or distribution tests, or to repay obligations to our lenders, we may be unable to comply with one or more of the requirements applicable to REITs or may be subject to a 100% tax on any resulting gain if such sales constitute prohibited transactions.
Dividends payable by REITs do not qualify for the reduced tax rates available for some dividends.
Income from “qualified dividends” payable to U.S. stockholders that are individuals, trusts and estates are generally subject to tax at preferential rates. Dividends payable by REITs, however, generally are not eligible for the preferential tax rates applicable to qualified dividend income. Although these rules do not adversely affect the taxation of REITs or dividends payable by REITs, to the extent that the preferential rates continue to apply to regular corporate qualified dividends, investors who are individuals, trusts and estates may perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could materially and adversely affect the value of the shares of REITs, including the per share trading price of our securities.
The power of our board of directors to revoke our REIT election without stockholder approval may cause adverse consequences to our stockholders and unitholders.
Our charter provides that our board of directors may revoke or otherwise terminate our REIT election, without the approval of our stockholders, if it determines that it is no longer in our best interest to continue to qualify as a REIT. If we cease to qualify as a REIT, we would become subject to U.S. federal income tax on our taxable income and would no longer be
required to distribute most of our taxable income to our stockholders and accordingly, distributions Hudson Pacific Properties, L.P. makes to its unitholders could be similarly reduced.
Legislative or other actions affecting REITs could have a negative effect on us.
The rules dealing with federal income taxation are constantly under review by persons involved in the legislative process and by the IRS and the U.S. Department of the Treasury. Changes to the tax laws, with or without retroactive application, could adversely affect our investors or us. We cannot predict how changes in the tax laws might affect our investors or us. New legislation, Treasury Regulations, administrative interpretations or court decisions could significantly and negatively affect our ability to qualify as a REIT or the federal income tax consequences of such qualification.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
As of December 31, 2014, our portfolio consisted of 28 properties (26 wholly-owned properties and two properties owned by a joint venture), located in eight California submarkets and Seattle, Washington, containing a total of approximately 6.8 million square feet, which we refer to as our portfolio. The following table presents an overview of our portfolio, based on information as of December 31, 2014. Rental data presented in the table below for office properties reflects annualized base rent on leases in place as of December 31, 2014 and does not reflect actual cash rents historically received because such data does not reflect abatements or tenant reimbursements for real estate taxes, insurance, common area or other operating expenses. Rental data presented in the table below for media and entertainment properties reflects actual cash base rents, excluding tenant reimbursements, received during the 12 months ended December 31, 2014. Leases at our media and entertainment properties are typically short-term leases of one year or less, and other than the KTLA lease at our Sunset Bronson property, substantially all of the current in-place leases at our media and entertainment properties will expire in 2015 and 2016.
The following table sets forth certain information relating to each of the office and media and entertainment properties owned as of December 31, 2014.
|
| | | | | | | | | | | | | | | | | | |
Property | | City | | Year Built/ Renovated | | Square Feet(1) | | Percent Leased(2) | | Annualized Base Rent/ Annual Base Rent(3) | | Annualized Base Rent/ Annual Base Rent Per Leased Square Foot(4) |
OFFICE PROPERTIES | | | | | | | | | | |
First & King | | Seattle | | 1904/2009 | | 472,223 |
| | 96.6 | % | | $ | 10,213,811 |
| | $ | 22.60 |
|
Met Park North | | Seattle | | 2000 | | 190,748 |
| | 95.4 |
| | 4,835,979 |
| | 26.58 |
|
Northview | | Seattle | | 1991 | | 182,009 |
| | 84.5 |
| | 3,027,250 |
| | 19.94 |
|
Merrill Place | | Seattle | | Various | | 193,153 |
| | 70.7 |
| | 3,407,501 |
| | 24.96 |
|
Rincon Center | | San Francisco | | 1985 | | 580,850 |
| | 90.7 |
| | 21,784,049 |
| | 41.62 |
|
1455 Market Street | | San Francisco | | 1977 | | 1,025,833 |
| | 99.4 |
| | 25,777,928 |
| | 27.29 |
|
875 Howard Street | | San Francisco | | Various | | 286,270 |
| | 99.4 |
| | 7,404,370 |
| | 26.03 |
|
222 Kearny Street | | San Francisco | | Various | | 148,797 |
| | 92.2 |
| | 4,829,812 |
| | 38.35 |
|
625 Second Street | | San Francisco | | 1905 | | 138,080 |
| | 73.8 |
| | 4,707,950 |
| | 46.22 |
|
275 Brannan Street | | San Francisco | | 1906 | | 54,673 |
| | 100.0 |
| | 2,984,599 |
| | 54.59 |
|
901 Market Street | | San Francisco | | 1912 | | 206,199 |
| | 100.0 |
| | 7,771,318 |
| | 46.92 |
|
Technicolor Building | | Hollywood (LA) | | 2008 | | 114,958 |
| | 100.0 |
| | 4,549,302 |
| | 39.57 |
|
Del Amo Office Building | | Torrance (LA) | | 1986 | | 113,000 |
| | 100.0 |
| | 3,069,070 |
| | 27.16 |
|
9300 Wilshire | | Beverly Hills | | 1965/2001 | | 61,224 |
| | 95.3 |
| | 2,439,729 |
| | 41.81 |
|
10950 Washington | | Culver City | | Various | | 159,024 |
| | 100.0 |
| | 5,376,405 |
| | 33.81 |
|
604 Arizona | | Santa Monica | | 1950 | | 44,260 |
| | 100.0 |
| | 1,867,878 |
| | 42.20 |
|
6922 Hollywood | | Hollywood (LA) | | 1965 | | 205,523 |
| | 92.2 |
| | 8,300,620 |
| | 43.81 |
|
10900 Washington | | Culver City | | 1973 | | 9,919 |
| | 100.0 |
| | 456,657 |
| | 46.04 |
|
Element LA | | Los Angeles | | Various | | 284,037 |
| | 100.0 |
| | — |
| | — |
|
Pinnacle I | | Burbank | | 2002 | | 393,777 |
| | 97.4 |
| | 15,947,196 |
| | 41.60 |
|
Pinnacle II | | Burbank | | 2005 | | 231,864 |
| | 99.2 |
| | 8,789,091 |
| | 38.21 |
|
3401 Exposition | | Santa Monica | | 1961 | | 63,376 |
| | 100.0 |
| | 2,547,715 |
| | 40.20 |
|
3402 Pico | | Los Angeles | | 1950 | | 39,136 |
| | — |
| | — |
| | — |
|
12655 Jefferson(5) | | Los Angeles | | 1985 | | 88,215 |
| | — |
| | — |
| | — |
|
Icon(6) | | Hollywood (LA) | | 2016 | | 413,000 |
| | — |
| | — |
| | — |
|
Total/Weighted Average Office Properties: | | | | 5,700,148 |
| | 92.8 | % | | $ | 150,088,230 |
| | $ | 33.44 |
|
MEDIA & ENTERTAINMENT PROPERTIES | | | | | | | | |
Sunset Gower | | Hollywood (LA) | | Various | | 570,470 |
| | 69.1 | % | | $ | 12,907,268 |
| | $ | 32.72 |
|
Sunset Bronson | | Hollywood (LA) | | Various | | 299,098 |
| | 76.2 |
| | 8,918,814 |
| | 37.61 |
|
Total/Weighted Average Media & Entertainment Properties: | | 869,568 |
| | 71.6 | % | | $ | 21,826,082 |
| | $ | 34.56 |
|
Subtotal - Operating Properties | | | | 6,569,716 |
| | | | | | |
HELD-FOR-SALE | | | | | | | | | | | | |
First Financial | | Encino (LA) | | 1986 | | 223,679 |
| | 93.2 | % | | $ | 7,197,502 |
| | $ | 34.53 |
|
Total/Weighted Average Held-For-Sale Properties: | | | | 223,679 |
| | 93.2 | % | | $ | 7,197,502 |
| | $ | 34.53 |
|
Total Office, M&E and Held-for-Sale Properties: | | | | 6,793,395 |
| | | | | | |
LAND | | | | | | | | | | | | |
Merrill Place | | Seattle | | N/A | | 140,000 |
| | | | | | |
Sunset Bronson—Lot A | | Hollywood (LA) | | N/A | | 273,913 |
| | | | | | |
Sunset Gower— Redevelopment | | Hollywood (LA) | | N/A | | 423,396 |
| | | | | | |
Element LA | | West Los Angeles | | N/A | | 500,000 |
| | | | | | |
3402 Pico | | West Los Angeles | | N/A | | 110,000 |
| | | | | | |
Total Land Assets: | | | | | | 1,447,309 |
| | | | | | |
Portfolio Total: | | | | | | 8,240,704 |
| | | | | | |
| |
(1) | Square footage for office properties and media and entertainment properties has been determined by management based upon estimated leasable square feet, which may be less or more than the Building Owners and Managers Association, or BOMA, rentable area. Square footage may change over time due to re-measurement, re-leasing, acquisition, or development. On September 21, 2012, we acquired an office property located at 1455 Gordon Street totaling approximately 6,000 square feet, which was added to the Sunset Gower property. As of December 31, 2014, the square footage for media and entertainment properties totaled 869,568 square feet, including this acquisition. Square footage for land assets represents management’s estimate of developable square feet, the majority of which remains subject to entitlement approvals that have not yet been obtained. |
| |
(2) | Percent leased for office properties is calculated as (i) square footage under commenced and uncommenced leases as of December 31, 2014, divided by (ii) total square feet, expressed as a percentage. Percent leased for media and entertainment properties is the average percent leased for the 12 months ended December 31, 2014. As a result of the short-term nature of the leases into which we enter at our media and entertainment properties, and because entertainment industry tenants generally do not shoot on weekends due to higher costs, we believe stabilized occupancy rates at our media and entertainment properties are lower than those rates achievable at our traditional office assets, where tenants enter into longer-term lease arrangements. |
| |
(3) | We present rent data for office properties on an annualized basis, and for media and entertainment properties on an annual basis. Annualized base rent for office properties is calculated by multiplying (i) base rental payments (defined as cash base rents (before abatements)) under commenced leases as of December 31, 2014 by (ii) 12. Annual base rent for media and entertainment properties reflects actual base rent for the 12 months ended December 31, 2014, excluding tenant reimbursements. |
| |
(4) | Annualized base rent per leased square foot for the office properties is calculated as (i) annualized base rent divided by (ii) square footage under commenced lease as of December 31, 2014. Annual base rent per leased square foot for the media and entertainment properties is calculated as (i) actual base rent for the 12 months ended December 31, 2014, excluding tenant reimbursements, divided by (ii) average square feet under lease for the 12 months ended December 31, 2014. |
| |
(5) | Tenant signed a termination agreement and the building is vacant. As such, this asset is now treated as a redevelopment property and annualized base rent of $30.24 received from vacated tenant is being capitalized. |
| |
(6) | We are recognizing this as a development property anticipated to be completed by 2016. |
Office Portfolio
Our office portfolio consists of 26 office properties comprising an aggregate of approximately 5.9 million square feet. As of December 31, 2014, our stabilized office properties were approximately 94.6% leased (giving effect to leases signed but not commenced as of that date). All of our office properties are located in California and the Pacific Northwest. As of December 31, 2014, the weighted average remaining lease term for our stabilized office portfolio was 6.4 years.
Tenant Diversification of Office Portfolio
Our office portfolio is currently leased to a variety of companies. The following table sets forth information regarding the 15 largest tenants in our office portfolio based on annualized base rent as of December 31, 2014.
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| | | | | | | | | | | | | | | | | |
Tenant | | Property | | Lease Expiration(1) | | Total Leased Square Feet | | Percentage of Office Portfolio Square Feet | | Annualized Base Rent(2) | | Percentage of Office Portfolio Annualized Base Rent |
Square | | 1455 Market Street | | 9/27/2023 | | 333,216 |
| | 6.0 | % | | $ | 10,571,764 |
| | 6.7 | % |
Salesforce.com(2) | | Rincon Center | | Various | | 234,699 |
| | 4.3 |
| | 10,488,009 |
| | 6.7 |
|
Warner Bros. Entertainment | | Pinnacle II | | 12/31/2021 | | 230,000 |
| | 4.2 |
| | 8,789,091 |
| | 5.6 |
|
Warner Music Group | | Pinnacle I | | 12/31/2019 | | 195,166 |
| | 3.5 |
| | 8,038,801 |
| | 5.1 |
|
EMC Corporation(3) | | Various | | Various | | 294,756 |
| | 5.3 |
| | 7,254,744 |
| | 4.6 |
|
AIG | | Rincon Center | | 7/31/2017 | | 132,600 |
| | 2.4 |
| | 5,967,000 |
| | 3.8 |
|
Uber Technologies, Inc.(4) | | Various | | Various | | 145,774 |
| | 2.6 |
| | 5,458,402 |
| | 3.5 |
|
GSA(5) | | 1455 Market Street | | Various | | 172,517 |
| | 3.1 |
| | 5,452,819 |
| | 3.5 |
|
NFL Enterprises(6) | | Various | | 6/30/2019 | | 137,305 |
| | 2.5 |
| | 4,983,416 |
| | 3.2 |
|
Clear Channel | | Pinnacle I | | 9/30/2016 | | 109,323 |
| | 2.0 |
| | 4,569,640 |
| | 2.9 |
|
Technicolor Creative Services USA, Inc. | | Technicolor Building | | 5/31/2020 | | 114,958 |
| | 2.1 |
| | 4,549,302 |
| | 2.9 |
|
Amazon | | Met Park North | | 11/30/2023 | | 139,824 |
| | 2.5 |
| | 3,772,659 |
| | 2.4 |
|
Capital One | | First & King | | 2/28/2019 | | 133,148 |
| | 2.4 |
| | 3,367,424 |
| | 2.1 |
|
Fox Interactive Media, Inc.(7) | | 625 Second Street | | Various | | 69,746 |
| | 1.3 |
| | 3,205,814 |
| | 2.0 |
|
Saatchi & Saatchi North America, Inc. | | Del Amo Office Building | | 12/31/2019 | | 113,000 |
| | 2.1 |
| | 3,069,070 |
| | 2.0 |
|
Total | | | | | | 2,556,032 |
| | 46.3 | % | | $ | 89,537,955 |
| | 57.0 | % |
_____________
| |
(1) | Annualized base rent is calculated by multiplying (i) base rental payments (defined as cash base rents (before abatements)) under commenced leases as of December 31, 2014, by (ii) 12. Annualized base rent does not reflect tenant reimbursements. |
| |
(2) | Salesforce.com is expected to take possession of an additional: (1) 2,868 square feet during the third quarter of 2015; and (2) 4,144 square feet during the second quarter of 2017. Expirations by square footage: (1) 83,016 square feet expiring on July 31, 2025; (2) 59,689 square feet expiring on April 30, 2027; (3) 93,028 square feet expiring on October, 31, 2028; and (4) 5,978 square feet of MTM storage space. |
| |
(3) | EMC expirations by property and square footage: (1) 66,510 square feet at 875 Howard Street expiring on June 30, 2019; (2) 185,292 square feet at First & King expiring on October 18, 2021; and (3) 42,954 square feet at First & King expiring on December 31, 2023. |
| |
(4) | Uber is expected to take possession of an additional 74,689 square feet during the first quarter of 2015. |
| |
(5) | GSA expirations by property and square footage: (1) 22,390 square feet at 1455 Market expiring on December 31, 2014; (2) 71,729 square feet at 1455 Market Street expiring on February 19, 2017; (3) 5,906 square feet at 901 Market Street expiring on April 30, 2017; (4) 28,993 square feet at Northview expiring on April 4, 2020; and (5) 43,499 square feet at 901 Market Street expiring on July 31, 2021. |
| |
(6) | NFL Enterprises expiration by property and square footage: (1) 127,386 square feet at 10950 Washington expiring on June 30, 2019 and (2) 9,919 square feet at 10900 Washington expiring on June 30, 2019. |
| |
(7) | Fox Interactive Media, Inc. expirations by square footage: (1) 35,151 square feet early terminating on March 31, 2015 and (2) 34,595 square feet expiring on March 31, 2017. |
Lease Distribution of Office Portfolio
The following table sets forth information relating to the distribution of leases in our office portfolio, based on net rentable square feet under lease as of December 31, 2014.
|
| | | | | | | | | | | | | | | | | | | |
Square Feet Under Lease | | Number of Leases | | Percentage of All Leases | | Total Leased Square Feet | | Percentage of Office Portfolio Leased Square Feet | | Annualized Base Rent(1) | | Percentage of Office Portfolio Annualized Base Rent |
2,500 or less | | 71 |
| | 30.2 | % | | 87,129 |
| | 1.7 | % | | $ | 3,304,743 |
| | 1.8 | % |
2,501-10,000 | | 70 |
| | 29.8 |
| | 372,265 |
| | 7.3 |
| | 14,178,079 |
| | 8.0 |
|
10,001-20,000 | | 20 |
| | 8.5 |
| | 289,688 |
| | 5.7 |
| | 10,176,111 |
| | 5.7 |
|
20,001-40,000 | | 24 |
| | 10.2 |
| | 714,389 |
| | 14.0 |
| | 23,659,750 |
| | 13.3 |
|
40,001-100,000 | | 17 |
| | 7.2 |
| | 1,019,866 |
| | 19.9 |
| | 37,726,939 |
| | 21.2 |
|
Greater than 100,000 | | 14 |
| | 6.0 |
| | 2,190,201 |
| | 42.8 |
| | 68,240,110 |
| | 38.3 |
|
Building management use | | 9 |
| | 3.8 |
| | 23,358 |
| | 0.4 |
| | — |
| | — |
|
Uncommenced leases | | 10 |
| | 4.3 |
| | 420,372 |
| | 8.2 |
| | 20,891,485 |
| | 11.7 |
|
Office Portfolio Total: | | 235 |
| | 100.0 | % | | 5,117,268 |
| | 100.0 | % | | $ | 178,177,217 |
| | 100.0 | % |
_____________
| |
(1) | Annualized base rent is calculated by multiplying (i) base rental payments (defined as cash base rents (before abatements)), including uncommenced leases, as of December 31, 2014 (ii) by 12. Annualized base rent does not reflect tenant reimbursements. |
Lease Expirations of Office Portfolio
The following table sets forth a summary schedule of the lease expirations for leases in place as of December 31, 2014 plus available space, for each of the ten full calendar years beginning January 1, 2014 at the properties in our office portfolio. Unless otherwise stated in the footnotes, the information set forth in the table assumes that tenants exercise no renewal options.
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| | | | | | | | | | | | | | | | | | | | | |
Year of Lease Expiration | | Number of Expiring Leases | | Square Footage of Expiring Leases(1) | | Percentage of Office Portfolio Square Feet | | Annualized Base Rent(2) | | Percentage of Office Portfolio Annualized Base Rent | | Annualized Base Rent Per Leased Square Foot |
Vacant | | | | 806,559 |
| | 13.6 | % | |
| |
| |
|
2014 | | 4 |
| | 61,586 |
| | 1.0 |
| | 2,470,358 |
| | 1.4 |
| | 40.11 |
|
2015 | | 42 |
| | 321,510 |
| | 5.4 |
| | 8,136,184 |
| | 4.6 |
| | 25.31 |
|
2016 | | 34 |
| | 375,680 |
| | 6.4 |
| | 12,387,858 |
| | 6.9 |
| | 32.97 |
|
2017 | | 33 |
| | 567,454 |
| | 9.6 |
| | 18,467,065 |
| | 10.4 |
| | 32.54 |
|
2018 | | 29 |
| | 315,205 |
| | 5.3 |
| | 9,333,215 |
| | 5.2 |
| | 29.61 |
|
2019 | | 24 |
| | 741,200 |
| | 12.5 |
| | 26,370,326 |
| | 14.8 |
| | 35.58 |
|
2020 | | 10 |
| | 394,338 |
| | 6.7 |
| | 14,671,229 |
| | 8.2 |
| | 37.2 |
|
2021 | | 14 |
| | 708,102 |
| | 12.0 |
| | 21,933,729 |
| | 12.3 |
| | 30.98 |
|
2022 | | 4 |
| | 18,906 |
| | 0.3 |
| | 633,208 |
| | 0.4 |
| | 33.49 |
|
2023 | | 12 |
| | 634,297 |
| | 10.7 |
| | 19,729,036 |
| | 11.1 |
| | 31.10 |
|
Thereafter | | 10 |
| | 535,260 |
| | 9.0 |
| | 23,153,522 |
| | 13.0 |
| | 43.26 |
|
Building management use | | 9 |
| | 23,358 |
| | 0.4 |
| | — |
| | — |
| | — |
|
Signed leases not commenced | | 10 |
| | 420,372 |
| | 7.1 |
| | 20,891,485 |
| | 11.7 |
| | 49.7 |
|
Office Portfolio Total/Weighted Average: | | 235 |
| | $ | 5,923,827 |
| | 100.0 | % | | $ | 178,177,215 |
| | 100.0 | % | | $ | 34.82 |
|
____________
| |
(1) | Assumes Bank of America exercises the early termination rights. The following summarizes Bank of America’s early termination rights by square footage as of December 31, 2014: (1) 114,322 square feet at December 31, 2015 and (2) 137,809 square feet at December 31, 2017. |
| |
(2) | Annualized base rent is calculated by multiplying (i) base rental payments (defined as cash base rents (before abatements)), including uncommenced leases, as of December 31, 2014, by (ii) 12. Annualized base rent does not reflect tenant reimbursements. |
Historical Office Tenant Improvements and Leasing Commissions
The following table sets forth certain historical information regarding tenant improvement and leasing commission costs for tenants at the properties in our total office portfolio:
|
| | | | | | | | | | | | |
| | Year Ended December 31, |
| | 2014 | | 2013 | | 2012 |
Renewals (1) | | | | | | |
Number of leases | | 22 |
| | 32 |
| | 25 |
|
Square feet | | 233,332 |
| | 232,967 |
| | 197,980 |
|
Tenant improvement costs per square foot (2)(3) | | $ | 0.70 |
| | $ | 2.86 |
| | $ | 4.77 |
|
Leasing commission costs per square foot (2) | | 2.82 |
| | 5.42 |
| | 3.13 |
|
Total tenant improvement and leasing commission costs (2) | | $ | 3.52 |
| | $ | 8.28 |
| | $ | 7.90 |
|
| | | | | | |
New leases (4) | | | | | | |
Number of leases | | 29 |
| | 28 |
| | 38 |
|
Square feet | | 398,402 |
| | 716,178 |
| | 956,926 |
|
Tenant improvement costs per square foot (2)(3) | | $ | 43.26 |
| | $ | 52.52 |
| | $ | 42.99 |
|
Leasing commission costs per square foot (2) | | 13.21 |
| | 22.87 |
| | 14.57 |
|
Total tenant improvement and leasing commission costs (2) | | $ | 56.47 |
| | $ | 75.39 |
| | $ | 57.56 |
|
| | | | | | |
Total | | | | | | |
Number of leases | | 51 |
| | $ | 60 |
| | $ | 63 |
|
Square feet | | 631,734 |
| | 949,145 |
| | 1,154,906 |
|
Tenant improvement costs per square foot (2)(3) | | $ | 27.54 |
| | $ | 40.33 |
| | $ | 36.44 |
|
Leasing commission costs per square foot (2) | | 9.38 |
| | 18.59 |
| | 12.61 |
|
Total tenant improvement and leasing commission costs (2) | | $ | 36.92 |
| | $ | 58.92 |
| | $ | 49.05 |
|
______________________________________________________
| |
(1) | Includes retained tenants that have relocated or expanded into new space within our portfolio. |
| |
(2) | Assumes all tenant improvement and leasing commissions are paid in the calendar year in which the lease is executed, which may be different than the year in which they were actually paid. |
| |
(3) | Tenant improvement costs are based on negotiated tenant improvement allowances set forth in leases, or, for any lease in which a tenant improvement allowance was not specified, the aggregate cost originally budgeted, at the time the lease commenced. |
| |
(4) | Excludes retained tenants that have relocated or expanded into new space within our portfolio. |
Historical Office Leasing Activity
The following table sets forth certain historical information regarding leasing activity for our total office portfolio:
|
| | | | | | | | | |
| | Total Square Feet |
| | Year Ended December 31, |
| | 2014 | | 2013 | | 2012 |
Vacant space available at the beginning of period | | 311,164 |
| | 477,077 |
| | 321,387 |
|
Expirations as of the last day of the prior period | | 208,299 |
| | 58,089 |
| | 5,781 |
|
Adjustment for remeasured square footage on new leases | | 491 |
| | 4,408 |
| | 1,966 |
|
Properties acquired vacant space | | 183,972 |
| | 184,122 |
| | 253,203 |
|
Properties placed in-service | | 413,000 |
| | — |
| | — |
|
Properties disposed vacant space | | (8,900 | ) | | (19,408 | ) | | — |
|
Leases expiring or terminated during the period | | 241,494 |
| | 624,382 |
| | 406,753 |
|
Total Space Available for Lease | | 1,349,520 |
| | 1,328,670 |
| | 989,090 |
|
Leases with new tenants | | 359,077 |
| | 334,842 |
| | 136,687 |
|
Lease renewals | | 47,549 |
| | 69,694 |
| | 145,840 |
|
Leases signed (uncommenced) at the end of the period | | 136,335 |
| | 612,970 |
| | 229,486 |
|
Total Space Leased | | 542,961 |
| | 1,017,506 |
| | 512,013 |
|
Vacant Space Available for Lease at the End of the Period | | 806,559 |
| | 311,164 |
| | 477,077 |
|
Media and Entertainment Portfolio
Our portfolio of operating properties includes two properties that we consider to be media and entertainment properties, encompassing an aggregate of 869,568 square feet. We define our media and entertainment properties as those properties in our portfolio that are primarily used for the physical production of media content, such as television programs, feature films, commercials, music videos and photographs. These properties generally also feature a traditional office component that is leased to production companies and content providers. For the 12 months ended December 31, 2014, our media and entertainment properties were approximately 71.6% leased. Our media and entertainment properties are located in prime Southern California submarkets.
Leasing Characteristics of Media and Entertainment Properties
The duration of typical lease terms for tenants of media and entertainment properties tends to be shorter than those of traditional office properties. Generally, terms of the media and entertainment leases are one year or less, as tenants are never certain as to whether their productions will continue to be carried by networks or cable channels. However, historically, many entertainment tenants have exercised renewal options such that their actual tenancy is extended for multiple years. As an example, productions such as Judge Judy, Judge Joe Brown and Let’s Make a Deal have been tenants at Sunset Studios for between three and 15 years. At Sunset Gower Studios, NBC’s Heroes was a tenant for four years prior to its cancellation and Showtime’s Dexter was a tenant for six years prior to the show ending. Additionally, occupancy levels for sound stage space and office and support space tend to run in parallel, as a majority of stage users also require office and support space. In addition, we require tenants at our media and entertainment properties to use our facilities for items such as lighting, equipment rental, parking, power, HVAC and telecommunications (telephone and internet). As a result, our other property-related revenues tend to track overall occupancy of our media and entertainment properties. As a result of the short-term nature of the leases into which we enter at our media and entertainment properties, and because entertainment industry tenants generally do not shoot on weekends due to higher costs, we believe stabilized occupancy rates at our media and entertainment properties are lower than those rates achievable at our traditional office assets, where tenants enter into longer-term lease arrangements.
Description of Our Media and Entertainment Properties
Sunset Gower, Hollywood, California
Sunset Gower is a 15.7-acre media and entertainment property located in the heart of Hollywood, four blocks west of the Hollywood (101) Freeway. The property encompasses almost an entire city block, bordered by Sunset Boulevard to the north, Gower Street to the west, Gordon Street to the east and Fountain Avenue to the south. The property, a fixture in the Los Angeles-based entertainment industry since it was built in the 1920s, served as Columbia Pictures’ headquarters through 1972 and is now one of the largest independent media and entertainment properties in the United States. Sunset Gower provides a fully-integrated environment for its media and entertainment-focused tenants within which they can access creative and technical talent for film and television production as well as post-production. Sunset Gower typically serves as home to single-camera television and motion picture production tenants. The property comprises 394,910 square feet of office and support space, along with 12 sound stage facilities totaling 175,560 square feet. In addition, there are 1,450 parking spaces situated in both surface and structured parking lots. Included in the total office square footage are three buildings, known as 6050 Sunset and 1455 Beachwood (acquired on December 16, 2011) and 1455 Gordon (acquired on September 21, 2012), that comprise approximately 26,761 square feet. The 1455 Beachwood and 1455 Gordon buildings are currently being renovated. For the year ended December 31, 2014, Sunset Gower was approximately 69.1% leased.
An approximately 0.59-acre portion of the site is subject to ground leases, expiring March 31, 2060, by and between Sunset Gower Entertainment Properties, LLC and the Chadwick 1994 Family Trust and Richard S. Chadwick. The remaining portion of the Sunset Gower property is owned by Sunset Gower Entertainment Properties in fee.
In addition to Sunset Gower’s existing facilities, the current zoning designation for Sunset Gower, M1-1—Limited Industrial, City of Los Angeles, permits a floor area ratio, or FAR, of 1.5x, which implies a maximum allowable density of 1,022,933 square feet, or an incremental 423,436 square feet above the existing 599,497 floor area ratio, including the Technicolor Building. However, as of December 31, 2014, we had no immediate plans to develop additional facilities on the property.
Sunset Gower Primary Tenants
The following table summarizes information regarding the primary tenants of Sunset Gower for the year ended December 31, 2014:
|
| | | | | | | | | | | | | | | | | | | | | | |
Tenant | | Principal Nature of Business | | Lease Expiration | Renewal Options | | Total Leased Square Feet(1) | | Percentage of Property Square Feet | | Annual Base Rent(2) | | Annual Base Rent Per Leased Square Foot(3) | | Percentage of Property Annual Base Rent |
FTP Productions (Scandal) | | Television/Entertainment | | 5/31/2015 | — | | 98,307 |
| | 17.2 | % | | $ | 3,413,906 |
| | $ | 34.73 |
| | 26.5 | % |
ABC (How to Get Away with Murder) | | Television/Entertainment | | 5/31/2015 | — | | 66,227 |
| | 11.6 |
| | 1,436,504 |
| | 36.35 |
| | 11.1 |
|
Farnsworth Entertainment(Newsroom) | | Television/Entertainment | | 9/30/2014 | — | | 54,872 |
| | 9.6 |
| | 1,356,503 |
| | 32.96 |
| | 10.5 |
|
Total/Weighted Average: | | | | | | | 219,406 |
| | 38.5 | % | | $ | 6,206,913 |
| | $ | 34.68 |
| | 48.1 | % |
_____________
| |
(1) | Reflects average square feet under lease to such tenant for the year ended December 31, 2014. |
| |
(2) | Annual base rent reflects actual base rent for the year ended December 31, 2014, excluding tenant reimbursements. |
| |
(3) | Annual base rent per leased square foot is calculated as actual rent for the year ended December 31, 2014, excluding tenant reimbursements, divided by average square feet under lease for the year ended December 31, 2014. |
Sunset Gower Percent Leased and Base Rent
The following table sets forth the percentage leased, annual base rent per leased square foot and annual net effective base rent per leased square foot for Sunset Gower as of the dates indicated below:
|
| | | | | | | | | | | |
Date | | Percent Leased(1) | | Annual Base Rent Per Leased Square Foot(2) | | Annual Net Effective Base Rent Per Leased Square Foot(3) |
December 31, 2014 | | 69.1 | % | | $ | 32.72 |
| | $ | 32.59 |
|
December 31, 2013 | | 65.3 |
| | 32.92 |
| | 33.01 |
|
December 31, 2012 | | 71.2 |
| | 30.49 |
| | 30.61 |
|
December 31, 2011 | | 66.6 |
| | 30.88 |
| | 30.98 |
|
December 31, 2010 | | 70.9 |
| | 30.27 |
| | 30.27 |
|
_____________
| |
(1) | Percent leased is the average percent leased for the year that ended on the dates indicated above. As a result of the short-term nature of the leases into which we enter at our media and entertainment properties, and because entertainment industry tenants generally do not shoot on weekends due to higher costs, we believe stabilized occupancy rates at our media and entertainment properties are lower than those rates achievable at our traditional office assets, where tenants enter into longer-term lease arrangements. |
| |
(2) | Annual base rent per leased square foot is calculated as actual base rent, excluding tenant reimbursements, for the year that ended on the dates indicated above divided by average square feet under lease for the year that ended on the dates indicated above. |
| |
(3) | Annual net effective base rent per leased square foot represents (i) actual base rent, excluding tenant reimbursements, for the year that ended on the dates indicated above, calculated on a straight-line basis to amortize free rent periods and abatements, but without regard to tenant improvement allowances and leasing commissions, divided by (ii) the average square feet under lease for the year that ended on the dates indicated above. |
Sunset Bronson, Hollywood, California
Sunset Bronson is a 10.6 acre media and entertainment property located in the heart of Hollywood, one block west of the Hollywood (101) Freeway and in close proximity to the Sunset Gower property. The property encompasses a full city block, bordered by Sunset Boulevard to the north, Bronson Avenue to the west, Van Ness Avenue to the east and Fernwood Avenue to the south. The property, which was built in phases from 1924 through 1981, formerly served as Warner Brothers Studios’ headquarters and has been continuously operated as a media and entertainment property since the 1920s. The property includes a Historical-Cultural Monument designation for the Site of the Filming of the First Talking Film (The Jazz Singer) that is specific to the building structure that fronts Sunset Boulevard. Similar to nearby Sunset Gower, Sunset Bronson is a multi-use property with a full complement of production, post-production and support facilities that enable its media and entertainment focused tenants to conduct their business in a collaborative and efficient setting. In contrast to Sunset Gower, which typically serves single-camera television and motion picture productions, Sunset Bronson caters to multi-camera television productions, such as game shows, talk shows or courtroom shows that record in video and require a control room to manage and edit the productions’ multiple cameras. Excluding the KTLA portion of the property, which is described below, Sunset Bronson consists of approximately 86,108 square feet of office and support space and nine sound stage facilities with approximately 137,109 square feet, along with 455 parking spaces. The property has three digital control rooms, one of which has high-definition technology, which allow tenants to edit productions filmed with high-definition cameras. For the year ended December 31, 2014, Sunset Bronson was approximately 76.2% leased.
Sunset Bronson also includes the KTLA facility, which is a multi-use office, broadcasting and production facility located on the Sunset Bronson property described above. The KTLA facility is 100% leased by KTLA Channel 5, one of the largest independent television stations in Los Angeles and has served as KTLA’s only broadcast facility and its primary office and production location for over 50 years. In connection with the acquisition of the Sunset Bronson property, KTLA, Inc., a subsidiary of Tribune Company, entered into a five-year lease for approximately 90,506 square feet, which includes 83,531 square feet of office and support space and 6,975 square feet encompassing two sound stages. At the time of the closing of the acquisition of the Sunset Bronson property, our predecessor received a prepayment of $16.3 million from KTLA in prepayment of its rents for the initial five-year term of its lease. On December 8, 2008, Tribune Company and several of its affiliates, including KTLA, Inc., filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code. On June 25, 2009, KTLA assumed its lease for the KTLA facility and cured all outstanding pre-petition amounts due us.
We entered into an amendment to the KTLA lease that extends the lease term through January 31, 2016. Net rents were approximately $2,707,940 for the period February 1, 2013 through January 31, 2014. Net rents are expected to be $2,789,178 for the period February 1, 2014 through January 31, 2015 and $2,872,853 for the period February 1, 2015 through January 31, 2016.
In addition to Sunset Bronson’s existing facilities, the current zoning designation for Sunset Bronson, M1-1—Limited Industrial, City of Los Angeles, permits a FAR of 1.5x, which implies a maximum allowable density of 689,565 square feet or an incremental 391,836 square feet above the existing 297,729 total FAR, including the KTLA portion of the property.
Sunset Bronson Primary Tenants
The following table summarizes information regarding the primary tenants of Sunset Bronson as of December 31, 2014:
|
| | | | | | | | | | | | | | | | | | | | | | | |
Tenant | | Principal Nature of Business | | Lease Expiration | | Renewal Options | | Total Leased Square Feet(1) | | Percentage of Property Square Feet | | Annual Base Rent(2) | | Annual Base Rent Per Leased Square Foot(3) | | Percentage of Property Annual Base Rent |
KTLA | | Television/ Entertainment | | 1/31/2016 | | — | | 90,506 |
| | 29.1 | % | | $ | 2,085,113 |
| | $ | 23.04 |
| | 23.4 | % |
3 Doors Productions (Let's Make a Deal) | | Television/Entertainment | | 12/31/2014 | | — | | 51,596 |
| | 16.6 |
| | 1,928,708 |
| | 37.38 |
| | 21.6 |
|
CBS Studios (Judge Judy) | | Television/Entertainment | | 4/30/2016 | | — | | 19,916 |
| | 6.4 |
| | 1,028,170 |
| | 51.62 |
| | 11.5 |
|
Total/Weighted Average: | | | | | | | | 162,018 |
| | 52.1 | % | | $ | 5,041,991 |
| | $ | 31.12 |
| | 56.5 | % |
______________
| |
(1) | Reflects average square feet under lease to such tenant for the year ended December 31, 2014. |
| |
(2) | Annual base rent reflects actual base rent for the year ended December 31, 2014, excluding tenant reimbursements. As of February 1, 2015, annualized base rent for KTLA will be $2,872,853, subject to an abatements of $718,213. |
| |
(3) | Annual base rent per leased square foot is calculated as actual base rent for the year ended December 31, 2014, excluding tenant reimbursements, divided by average square feet under lease for the year ended December 31, 2014. |
Sunset Bronson Percent Leased and Base Rent
The following table sets forth the percentage leased, annual base rent per leased square foot and annual net effective base rent per leased square foot for the Sunset Bronson property as of the dates indicated below:
|
| | | | | | | | | | | |
Date | | Percent Leased(1) | | Annual Base Rent Per Leased Square Foot(2) | | Annual Net Effective Base Rent Per Leased Square Foot(3) |
December 31, 2014 | | 76.2 | % | | $ | 37.61 |
| | $ | 40.34 |
|
December 31, 2013 | | 78.1 |
| | 35.63 |
| | 38.31 |
|
December 31, 2012 | | 78.1 |
| | 42.16 |
| | 40.02 |
|
December 31, 2011 | | 76.3 |
| | 40.77 |
| | 38.58 |
|
December 31, 2010 | | 75.5 |
| | 40.18 |
| | 37.97 |
|
_________________
| |
(1) | Percent leased is the average percent leased for the year that ended on the dates indicated above. As a result of the short-term nature of the leases into which we enter at our media and entertainment properties, and because entertainment industry tenants generally do not shoot on weekends due to higher costs, we believe stabilized occupancy rates at our media and entertainment properties are lower than those rates achievable at our traditional office assets, where tenants enter into longer-term lease arrangements. |
| |
(2) | Annual base rent per leased square foot is calculated as actual base rent, excluding tenant reimbursements, for the year that ended on the dates indicated above divided by average square feet under lease for the year that ended on the dates indicated above. |
| |
(3) | Annual net effective base rent per leased square foot represents (i) actual base rent, excluding tenant reimbursements, for the year that ended on the dates indicated above, calculated on a straight-line basis to amortize free rent periods and abatements, but without regard to tenant improvement allowances and leasing commissions, divided by (ii) the average square feet under lease for the year that ended on the dates indicated above. |
On February 11, 2011, we closed a five-year term loan totaling $92.0 million with Wells Fargo Bank, N.A. secured by our Sunset Gower and Sunset Bronson media and entertainment campuses.
Sunset Bronson Lot A
In connection with our purchase of Sunset Bronson in 2008, we acquired a 67,381 square-foot undeveloped lot located on the northwest corner of Sunset Boulevard and Bronson Avenue. The lot is located two blocks west of the I-101 Freeway, between the Sunset Gower and Sunset Bronson properties. The site is currently used as a surface parking lot and can be developed to include up to 60,855 square feet of retail and office space based on current zoning, with the opportunity to add additional developable square footage through certain municipal land entitlement approvals. We estimate that with further
entitlements, we could increase the developable square footage to approximately 273,913 square feet. While we are holding this property for its development potential, we do not currently have any plans for its development.
Item 3. Legal Proceedings
Following the December 8, 2014 announcement that our company and operating partnership had entered into the asset purchase agreement with the sponsor stockholders, a punitive class action lawsuit was filed on January 22, 2015 in the Superior Court of the State of California, County of San Francisco, captioned Fundamental Partners, v. Hudson Pacific Properties, Inc. et al., Case No. CGC-15-543775. The complaint names as defendants, among other parties, our company and the members of our board of directors, and alleges, among other claims, that our directors breached their fiduciary duties by “effectively” selling control to the sponsor stockholders and by failing to disclose purportedly material information to stockholders in connection with the purchase agreement. The complaint seeks, among other things, an order enjoining or rescinding the purchase agreement and an award of attorneys’ fees and other costs. We believe the complaint has no merit and intend to vigorously defend against plaintiff’s allegations.
In addition, from time to time, we are a party to various lawsuits, claims and other legal proceedings arising out of, or incident to, our ordinary course of business. We are not currently a party, as plaintiff or defendant, to any legal proceedings that we believe to be material or that, individually or in the aggregate, would be expected to have a material adverse effect on our business, financial condition, results of operations or cash flows if determined adversely to us.
Item 4. Mine Safety Disclosures.
Not applicable.
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Overview
As of February 25, 2015, we had approximately 79,845,880 shares of common stock outstanding, including unvested restricted stock grants. Our common stock has traded on the NYSE under the symbol “HPP” since June 24, 2010. The quarterly high, low and closing prices of our common stock from January 1, 2013 through December 31, 2014, as reported by the NYSE, are set forth below for the periods indicated.
As of February 25, 2015, our operating partnership had 81,684,736 common operating partnership units outstanding, that were not owned by us. There is no active trading market for our operating partnership units.
Distributions
We intend to make distributions each taxable year (not including a return of capital for federal income tax purposes) equal to at least 90% of our taxable income. We intend to pay regular quarterly dividend distributions to our stockholders. Currently, we pay distributions to our stockholders each March, June, September and December. Dividends are made to those stockholders who are stockholders as of the dividend record date. Dividends are paid at the discretion of our board of directors and dividend amounts depend on our available cash flows, financial condition and capital requirements, the annual distribution requirements under the REIT provisions of the Code and such other factors as our board of directors deem relevant.
On December 31, 2014, the reported closing sale price per share of our common stock on the NYSE was $30.06. The following table shows our dividends declared, and the high, low and closing sales prices for our common stock as reported by the NYSE for the periods indicated:
|
| | | | | | | | | | | | | | | | |
Fiscal year 2014 | | High | | Low | | Close | | Per Share of Common Stock Dividends Declared |
First quarter | | $ | 23.61 |
| | $ | 19.13 |
| | $ | 23.07 |
| | $ | 0.125 |
|
Second quarter | | 25.96 |
| | 22.13 |
| | 25.34 |
| | 0.125 |
|
Third quarter | | 27.19 |
| | 24.33 |
| | 24.66 |
| | 0.125 |
|
Fourth quarter | | 30.61 |
| | 24.45 |
| | 30.06 |
| | 0.125 |
|
| | | | | | | | |
Fiscal year 2013 | | | | | | | | |
First quarter | | 21.78 |
| | 21.64 |
| | 21.75 |
| | 0.125 |
|
Second quarter | | 21.37 |
| | 20.80 |
| | 21.28 |
| | 0.125 |
|
Third quarter | | 19.70 |
| | 19.39 |
| | 19.45 |
| | 0.125 |
|
Fourth quarter | | 22.15 |
| | 21.80 |
| | 21.87 |
| | 0.125 |
|
The closing share price for our common stock on February 25, 2015, as reported by the NYSE, was $31.11. As of February 25, 2015, there were 38 stockholders of record of our common stock.
Recent Sales of Unregistered Securities
None.
Issuer Purchases of Equity Securities
None.
Equity Compensation Plan Information
Our equity compensation plan information required by this item is incorporated by reference to the information in Part III, Item 12 of this Annual Report on Form 10-K.
Market for Hudson Pacific Properties, L.P., Common Capital, Related Unitholder Matters and Issuer Purchases of Units
There is no established public trading market for our operating partnership’s common units. As of the date this report was filed, there were 38 holders of record of common units (including through our general partnership interest).
The following table reports the distributions per common unit declared during the years ended December 31, 2014 and 2013, respectively.
|
| | | | |
Fiscal year 2014 | | Per Common Unit Distributions Declared |
First quarter | | $ | 0.125 |
|
Second quarter | | 0.125 |
|
Third quarter | | 0.125 |
|
Fourth quarter | | 0.125 |
|
| | |
Fiscal year 2013 | | |
First quarter | | 0.125 |
|
Second quarter | | 0.125 |
|
Third quarter | | 0.125 |
|
Fourth quarter | | 0.125 |
|
Stock Performance Graph
The information below shall not be deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C, other than as provided in Item 201 of Regulation S-K , or to the liabilities of Section 18 of the Exchange Act, except to the extent we specifically request that such information be treated as soliciting material or specifically incorporate it by reference into a filing under the Securities Act or the Exchange Act.
The following graph shows our cumulative total stockholder return for the period beginning with the initial listing of our common stock on the NYSE on June 24, 2010 and ending on December 31, 2014. The graph assumes a $100 investment in each of the indices on June 24, 2010 and the reinvestment of all dividends. The graph also shows the cumulative total returns of the Standard & Poor’s 500 Stock Index, or S&P Index, and an industry peer group. Our stock price performance shown in the following graph is not indicative of future stock price performance.
|
| | | | | | | | | | | | |
| Period Ending |
Index | 06/23/10 | 12/31/10 |
| 12/31/11 |
| 12/31/12 |
| 12/31/13 |
| 12/31/14 |
|
Hudson Pacific Properties, Inc. | 100.00 |
| 89.63 |
| 87.40 |
| 133.75 |
| 142.15 |
| 199.24 |
|
S&P 500 | 100.00 |
| 116.38 |
| 118.84 |
| 137.86 |
| 182.51 |
| 207.49 |
|
SNL US RE $1B-$2B Imp Cap | 100.00 |
| 122.55 |
| 116.85 |
| 153.00 |
| 179.17 |
| 209.16 |
|
Item 6. Selected Financial Data
The following tables set forth, on a historical basis, selected financial and operating data. The financial information has been derived from our consolidated balance sheets and statements of operations. The following data should be read in conjunction with our financial statements and notes thereto and "Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations" included below in this report.
HUDSON PACIFIC PROPERTIES Inc. And Hudson Pacific Properties, L.P. (in thousands, except share, per share, square footage and occupancy data) Year Ended December 31,
|
| | | | | | | | | | | | | | | | | | | |
| Consolidated | | Combined |
| 2014 | | 2013 | | 2012 | | 2011 | | 2010 |
Statements of Operations Data: | | | | | | | | | |
Revenues | | | | | | | | | |
Office | | | | | | | | | |
Rental | $ | 156,806 |
| | $ | 124,839 |
| | $ | 88,459 |
| | $ | 69,145 |
| | $ | 15,485 |
|
Tenant recoveries | 34,509 |
| | 25,870 |
| | 22,029 |
| | 21,954 |
| | 2,883 |
|
Parking and other | 22,471 |
| | 14,732 |
| | 9,840 |
| | 5,643 |
| | 999 |
|
Total office revenues | $ | |