ITEM 1. BUSINESS --------
Washington Real Estate Investment Trust ("WRIT" or the "Trust") is a self-administered qualified equity real estate investment trust ("REIT"). The Trust's business consists of the ownership of income-producing real estate properties in the Mid-Atlantic Region. The Trust has a fundamental strategy of regional focus, diversified property type ownership and conservative financial management.
WRIT has elected to qualify as a REIT under the Internal Revenue Code ("the Code"). Accordingly, WRIT is relieved of Federal income taxes provided that capital gains and at least 95% of its ordinary income are distributed to shareholders in the form of dividends and that it complies with all REIT related aspects of the Code. Over the last five years dividends paid per share have been $1.07 for 1997, $1.03 for 1996, $.99 for 1995, $.92 for 1994 and $.89 for 1993. The indicated annualized dividend rate for 1998, based upon the March 31, 1998 dividend, is $1.08.
WRIT's geographic focus is based on two basic principles:
1. Real estate is a local business and is much more effectively selected and managed by owners located and expert in the region.
2. Geographic markets deserving of focus must be amongst the nation's best markets with a strong primary industry foundation but be diversified enough to withstand downturns in its primary industry.
WRIT considers markets to be local if they can be reached from Washington, D.C. within two hours by car and have the demographics of a megalopolis. WRIT's ideal geographic market reaches from Philadelphia, Pennsylvania on the north to Richmond, Virginia on the south. While WRIT has historically focused most of its investments in the Greater Washington-Baltimore Region, in order to maximize acquisition opportunities, WRIT will consider investments within the two hour radius described above.
All of WRIT's Trustees, Officers and employees live and work in the Greater Washington-Baltimore region and WRIT's Officers average over 17 years of experience in this region.
The Greater Washington-Baltimore region is the nation's fourth largest with a population exceeding 7.1 million. Combining the Richmond to Philadelphia areas with the Washington-Baltimore area, the total population is approximately 13 million. The Washington-Baltimore region is ranked first in the U.S. in median household income and percentage of population with education at the undergraduate and postgraduate level.
While the Federal government is the foundation of the region's economy, private sector job growth has resulted in total non-farm employment in the Washington area growing 91% from 1.6 million jobs in 1970, to 13.1 million jobs in 1997, while the percentage of Federal government civilian employment in the region decreased from 21.2% to 11.4%. Since January 1980, seasonally-adjusted unemployment in the Washington area has averaged 4.1% with December 1997 unemployment standing at 3.1%.
The Greater Washington-Baltimore region is a leader in the rapidly growing technology/infocom and biotech/health care industries. It is the center of the U.S. Space Commerce/Satellite Industry with Comsat, GTE Spacenet, Intelsat, Lockheed-Martin and NASA all headquartered here in the region. The region has the nation's second highest concentration of technology companies and the third highest concentration of biotech companies.
This region is also the headquarters for several of the largest U.S. and international financial institutions including the World Bank, International Monetary Fund, Inter-American Development Bank, Export-
Import Bank, Federal National Mortgage Association (Fannie Mae), Federal Home Loan Mortgage Corp. (Freddie Mac) and the Student Loan Marketing Association (Sallie Mae).
Other major public companies headquartered in the region include Mobil Oil, MCI, USAirways, Marriott International, Lockheed-Martin, McCormick Spice Co. and Gannett Co. The region is also the second most popular tourist destination in the world. Most importantly, the Mid-Atlantic region is known as a job center, with solid educational opportunities and easy access to leisure time activities.
While the region has clearly diversified beyond the Federal government town of the past, the Federal government is still the foundation of the region's economy. Therefore, it is important to understand how government "cutbacks" have impacted the region.
First, despite a 13.8% decrease in direct Federal civilian employment from 1994 through 1997, the region's unemployment rate never rose above a seasonally adjusted 4.5% and was at 3.1% in December 1997. This is partially due to the strength and diversity of this local economy, and partially due to the fact that accompanying these direct employment decreases were substantial local increases in Federal procurement (purchases of goods and services).
While Federal procurement spending decreased nationally, it became more concentrated and increased in the Greater Washington-Baltimore area because Federal contractors moved closer to their Federal clients in order to better compete for this business. Federal procurement decreased by 3.5% nationally from 1991 to 1997, but increased in the Washington area by over 42.5%.
The Trust currently owns a diversified portfolio consisting of twelve shopping centers, eighteen office buildings, eight apartment buildings and fifteen industrial distribution centers. WRIT's principal objective is to invest in high quality real estate in prime locations and to monitor closely the management of these properties, including active leasing and ongoing capital improvement programs. The percentage of total real estate rental revenue by property group for 1997, 1996 and 1995, and the percent leased as of December 31, 1997 were as follows:
Real Estate Rental Revenue Percent Leased -------------------------- December 31, 1997 1997 1996 1995 ----------------- ---- ---- ---- 96% Office buildings 45% 44% 41% 95% Shopping centers 20% 23% 26% 97% Apartment buildings 23% 22% 22% 93% Industrial distribution 12% 11% 11% --- --- --- 100% 100% 100% === === ===
On a combined basis, WRIT's portfolio was 95% occupied in 1997 and 93% occupied in 1996 and 1995.
Total revenue was $79.4 million for 1997, $65.5 million for 1996 and $52.6 million for 1995. In 1995 through 1997, WRIT acquired six office buildings, one shopping center, three apartment buildings and seven industrial distribution centers for a total of seventeen properties. These acquisitions were the primary reason for the shifting of each group's percentage of total revenue. No single tenant accounted for more than 3.04% of revenue in 1997, 2.39% in 1996 and 2.05% in 1995. Various agencies of the U.S. government are counted separately and include the Department of Commerce, Immigration and Naturalization Service, U.S. Postal Service, Social Security Administration and U.S. Patent Office. All Federal government tenants in the aggregate accounted for approximately 5.13% of WRIT's 1997 total revenue. The larger non-Federal government tenants include TJ Maxx, District of Columbia Metropolitan Police Department, Pepsi Cola, Giant Food, Crestar Bank, CVS, George Washington University, Lockheed-Martin, NationsBank, OAO, Montgomery County and Prince George's County, Maryland and also the State of Maryland.
As of December 31, 1997, 7900 Westpark Office building accounted for 16% of total assets based upon book value. No other single property accounted for more than 10% of total assets. No single property accounted for more than 10% of total revenues.
The actual day-to-day property management functions at the properties owned by the Trust are carried out by an independent management company whose only client is WRIT. WRIT closely monitors the activities of this company to assure the highest quality of service and cost effectiveness. No WRIT Trustee or Officer is a director or owns any interest in the management company.
The Trust expects to continue investing in additional income producing property. WRIT invests only in properties which management believes will continue to increase in income and value. WRIT's properties compete for tenants with other properties throughout the respective areas in which they are located. All properties compete for tenants on the basis of location, quality and rental rates.
Historically, WRIT has acquired 100% ownership in property. However, in 1995 WRIT formed a subsidiary partnership in which WRIT currently owns substantially all of the partnership interests. As of December 31, 1997, the WRIT partnership has acquired fourteen properties for cash contributed or loaned by WRIT.
WRIT intends to use the WRIT partnership to offer property owners an opportunity to contribute properties in exchange for WRIT limited partnership units. Such a transaction will enable property owners to diversify their holdings and to obtain a tax deferred contribution for WRIT limited partnership units rather than make a taxable cash sale. To date, no such exchange transactions have occurred. The terms of the partnership agreement provide that the limited partnership units are entitled to distributions substantially equivalent to the distributions on WRIT shares. A holder of limited partnership units in the WRIT partnership will be entitled to demand that the partnership redeem the holder's units upon 10 business days notice. Upon such demand, WRIT, at its option, may redeem such units for cash or WRIT shares.
WRIT believes that the WRIT partnership will provide WRIT an opportunity to acquire real estate assets which might not otherwise have been offered to it.
WRIT makes capital improvements on an ongoing basis to its properties for the purpose of maintaining and increasing their value. Major improvements and/or renovations to the properties in 1997 are discussed on page 8.
Further description of the property groups is contained in Item 2, Properties and in Schedule III. Reference is also made to Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations.
The number of persons employed by the Trust was 39 as of February 20, 1998.
ITEM 2.
ITEM 2. PROPERTIES ----------
The schedule on the following page lists the Trust's real estate investment portfolio as of December 31, 1997. The total number of properties was fifty-three (53) at that date.
As of December 31, 1997, the percent leased is the percentage of net rentable space for which fully executed leases exist and may include signed leases for space not yet occupied by the tenant.
Cost information is included in Schedule III to WRIT's financial statements included in this Form 10-K Annual Report.
SCHEDULE OF PROPERTIES ----------------------
*Apartment buildings are presented in gross square feet
OFFICE BUILDINGS - ----------------
WRIT's office building sector was WRIT's strongest performer during 1997 with operating income in the core group of office buildings (excluding 1996 and 1997 acquisitions) increasing 11%. This increase was a result of significant occupancy gains and strong rental rate growth throughout the sector. WRIT's office markets continue to tighten and while there is a substantial amount of office development underway in the market, management anticipates that this sector will continue to be the strong sector for WRIT in 1998.
During 1997, WRIT's office building revenues and operating income increased by 25% and 30% respectively over 1996. These increases were primarily due to 1996 acquisitions (Maryland Trade Centers I & II) and 1997 acquisitions (1600 Wilson Boulevard & 7900 Westpark Drive) combining with the 11% core group operating income increase described above.
Economic occupancy rates for the core group of office buildings averaged 93% in 1997 compared to 90% in 1996. 1901 Pennsylvania Avenue, which underwent a significant renovation in 1996 and 1997, averaged 89% economic occupancy in 1997 compared to 75% in 1996 and 57% in 1995.
Rental rate increases of 4% for the sector were the result of increases at nearly all of the properties. During 1997, WRIT executed office leases for 572,000 square feet of office space at an average face rent increase of 10% on a non-straight line basis. The current average market rate for 357,000 square feet of office space leases expiring during 1998 exceed the average expiring lease rates by over 11% ($2.00 per square foot) on a non-straight line basis.
Further details about the performance of the office building sector in 1996 and 1997 are provided in Management's Discussion and Analysis commencing on page 12.
INDUSTRIAL DISTRIBUTION CENTERS - -------------------------------
During 1997, WRIT's industrial distribution center revenues and operating income both increased by 43% over 1996. These increases were primarily due to 1996 acquisitions (Alban Business Center and the Earhart Building) and 1997 acquisitions (Ammendale Technology Park I & II and the Pickett Industrial Park).
Operating income in WRIT's core group of industrial distribution centers (excluding 1996 and 1997 acquisitions) decreased 5%. Occupancy rates for the core group of industrial distribution centers averaged 95% in 1997 compared to 98% in 1996 and rental rates decreased 0.3% in 1997.
Further details about the performance of the industrial distribution center sector in 1996 and 1997 are provided in Management's Discussion and Analysis commencing on page 12.
SHOPPING CENTERS - ----------------
During 1997, WRIT's shopping center revenues and operating income increased by 2% and 4%, respectively, over 1996. These increases were primarily due to occupancy gains and rental rate growth throughout the sector, partially offset by increased bad debts.
Economic occupancy rates for the shopping center sector averaged 93% in 1997 compared to 91% in 1996. This significant occupancy gain was primarily the result of the 1997 releasing of the vacancies caused by the bankruptcies of Evans Jewelers & Distributors, SoFro Fabrics and F&M Drugs.
Shopping center rental rates increased 4% in 1997 over 1996 as a result of WRIT executing leases for 282,000 square feet of space at an average rental rate increase of over 22%. This increase was the result of increases throughout the sector, the most significant being the 9% rental rate increase at Frederick County Square.
In 1996 and 1997, WRIT capitalized on three opportunities at Frederick County Square. Through bankruptcies and aggressive negotiations, WRIT recaptured over 45,000 square feet of space which had
been subject to long term leases with little or no rental rate growth. These leases were producing a total of approximately $219,000 in annual rent. After recapture and reletting, these spaces now produce over $629,000 in annual rent. This represents a 53% increase in rent on these spaces and a 14% annualized rent increase at the center.
Further details about the performance of the Shopping Center Sector in 1996 and 1997 are provided in Management's Discussion and Analysis commencing on page 12.
APARTMENTS - ----------
During 1997, WRIT's apartment revenues and operating income increased by 23% and 26% respectively over 1996. These increases were primarily due to increased rental rates throughout the sector combining with the 1996 acquisitions of Walker House Apartments and The Ashby at McLean and the 1997 acquisition of Bethesda Hill Apartments.
WRIT's apartment sector continued its four year run of steady growth in core group operating income (excluding Walker House Apartments and The Ashby at McLean acquired in 1996 and Bethesda Hill Apartments acquired in 1997) with an increase of 4%.
This increase was the result of continued high occupancy levels combined with 2% rental rate increases throughout the group. Economic occupancy rates for the core group of apartments (excluding Walker House Apartments and The Ashby at McLean acquired in 1996 and Bethesda Hill Apartments acquired in 1997) averaged 96% in 1997 and 1996.
Further details about the performance of the Apartment Sector in 1996 and 1997 are provided in Management's Discussion and Analysis commencing on page 12.
PROPERTY EXPANSIONS & MAJOR RENOVATIONS - ---------------------------------------
WHEATON PARK SHOPPING CENTER - ----------------------------
In 1997, WRIT completed construction of a 26,000 square foot addition to this Shopping Center. The addition was 98% leased at year end to tenants including Hollywood Video and Crown Books.
51 MONROE STREET - ----------------
This property underwent major renovations from 1995 through 1997 including new elevator controls and HVAC equipment, new energy management, fire alarm and sprinkler systems, as well as major renovations to the main lobby and common areas. Economic occupancy of this property averaged 93% in 1997 as compared to averages of 83% in 1996 and 85% in 1995.
BRADLEE SHOPPING CENTER - -----------------------
This property is expected to undergo a major renovation commencing in 1998. This renovation coincides with the expiration and expected releasing of the space formerly occupied by GC Murphy and the conversion of the free standing Roy Rogers restaurant to a newly constructed McDonalds. WRIT anticipates substantial increases in rents from these two spaces and also believes that the result of the renovation and these transactions will increase traffic and rents on renewals and turnover.
7900 WESTPARK DRIVE - -------------------
In 1998, WRIT expects to commence construction of a 49,000 square foot office space addition to its recently acquired office building located at 7900 Westpark Drive in McLean, Virginia. This addition will be constructed on the top of the existing structured parking deck, similar to the Trust's 1996 addition at 7700 Leesburg Pike. Similar to the 7700 Leesburg Pike addition, the Westpark Drive addition is likely to be 100% preleased.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS -----------------
None.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ---------------------------------------------------
No matters were submitted to a vote of security holders during the fourth quarter of 1997.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND --------------------------------------------- RELATED STOCKHOLDER MATTERS ---------------------------
The Trust's shares have been traded on the American Stock Exchange since 1971, and there are approximately 37,000 shareholders. The Trust's shares were split 3-for-1 in March 1981, 3-for-2 in July 1985, 3-for-2 in December 1988, and 3-for-2 in May 1992.
The high and low sales price for the Trust's shares for 1997 and 1996, by quarter, and the amount of dividends paid by the Trust are as follows:
Quarterly Share Price Range --------------------------- Dividends Quarter Per Share High Low ------- --------- ---- --- 4 $.27 $17 1/4 $15 1/2 3 .27 18 1/2 15 3/4 2 .27 18 5/8 16 1/4 1 .26 19 5/8 16 7/8
4 $.26 $17 1/2 $15 1/2 3 .26 16 3/4 15 1/4 2 .26 16 3/4 15 1/4 1 .25 17 15 1/4
The Trust has historically paid dividends on a quarterly basis. Dividends are normally paid based on the Trust's cash flow from operating activities. The 1998 indicated annual dividend rate is $1.08 based on the annualization of the March 31, 1998 dividend.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA -----------------------
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ----------------------------------------------------------- AND RESULTS OF OPERATIONS -------------------------
RESULTS OF OPERATIONS - ----------------------
REAL ESTATE RENTAL REVENUE: 1997 VERSUS 1996 - --------------------------------------------
Total revenues for 1997 increased $13.9 million or 21% to $79.4 million from $65.5 million in 1996. The percentage increase in real estate rental revenue from 1996 to 1997 by property type was as follows:
Office Buildings 25% Shopping Centers 2% Apartments 23% Industrial Distribution Centers 43%
During 1997, WRIT's office building revenues and operating income increased by 25% and 30%, respectively, over 1996. These increases were primarily due to 1996 acquisitions (Maryland Trade Centers I & II) and 1997 acquisitions (1600 Wilson Boulevard and 7900 Westpark Drive) combining with increased occupancy levels and rental rates overall for the sector.
During 1997, WRIT's shopping center revenues and operating income increased by 2% and 4%, respectively, over 1996. These increases were primarily due to increased occupancy levels and rental rates overall for the sector partially offset by increased bad debts.
WRIT's apartment revenues and operating income increased by 23% and 26%, respectively, in 1997 over 1996. These increases were primarily due to increased rental rates throughout the sector combining with the 1996 acquisitions of Walker House Apartments and The Ashby at McLean and the 1997 acquisition of Bethesda Hill Apartments.
WRIT's industrial distribution center revenues and operating income each increased by 43% over 1996. These increases were primarily due to the 1996 acquisition of the Alban Business Center and Earhart Business Center and the 1997 acquisitions of Ammendale Technology Parks I & II and the Pickett Industrial Park.
REAL ESTATE RENTAL REVENUE: 1996 VERSUS 1995 - --------------------------------------------
Total revenues for 1996 increased $12.9 million to $65.5 million from $52.6 million in 1995. The percentage increase in real estate rental revenue from 1995 to 1996 by property type was as follows:
Office Buildings 33% Shopping Centers 10% Apartments 28% Industrial Distribution Centers 21%
During 1996, WRIT's office building revenues and operating income increased by 33% and 34%, respectively, over 1995. These increases were primarily due to 1995 acquisitions (6110 Executive Boulevard and 1220 19th Street) and 1996 acquisitions (Maryland Trade Centers I & II), combining with increased rental rates overall for the group.
During 1996, WRIT's shopping center revenues and operating income increased by 10% and 6%, respectively, over 1995. These increases were primarily due to the 1995 acquisition of Frederick County
Square combining with increased rental rates overall for the group. These increases were partially offset by decreased occupancy levels in Concord and Montgomery Village.
WRIT's apartment revenues and operating income increased by 28% and 25%, respectively, in 1996 over 1995. These increases were primarily due to increased rental rates throughout the group combining with the 1996 acquisitions of Walker House Apartments and The Ashby at McLean.
WRIT's industrial distribution center revenues and operating income increased by 21% and 19%, respectively, over 1995. These increases were primarily due to increased rental rates and occupancy levels overall for the group, combining with the 1995 acquisitions (Tech 100 Industrial Park and Crossroads Distribution Center) and the 1996 acquisition of the Alban Business Center. In December of 1996, WRIT also acquired Earhart Building, a 92,300 square foot flex property which is 100% leased.
OPERATING EXPENSES AND OTHER RESULTS OF OPERATIONS - --------------------------------------------------
Real estate operating expenses as a percentage of revenue was 32% for 1997 as compared to 33% for 1996 and 32% for 1995. This decrease is attributable to a revenue increase in the office building segment of WRIT's portfolio of 25% resulting from increases in occupancy levels and rental rates in 1997 combined with only an 18% increase in the office building segment's operating expenses. WRIT's percentage of revenue from office buildings within its entire real estate portfolio has increased to 45% at December 31, 1997 from 44% at December 31, 1996 and 41% at December 31, 1995. The increase over 1995 is attributable to 1996 and 1997 office building acquisitions.
Interest expense increased $4.2 million in 1997 from 1996. This is attributable to an increase in outstanding line of credit advances due to a greater amount of acquisitions in 1997. Additionally, WRIT's $100 million debt securities, issued in August 1996, were outstanding for the entire year in 1997. Interest expense of $5.4 million in 1996 increased $3.3 million over 1995 interest expense. This increase is primarily attributable to the issuance of $100 million in debt securities in August 1996.
General and administrative expenses were $4.2 million for 1997 as compared to $3.1 million for 1996 and $2.9 million for 1995. The increase in general and administrative expenses in 1997, as compared to 1996, is attributable to increased compensation and personnel additions. The majority of the increase in 1996, as compared to 1995, is attributable to personnel additions during 1996 and 1995, partially offset by reduced pension costs and the completion of severance pay in June 1995 to WRIT's former Chairman and Chief Executive Officer, B. Franklin Kahn, who retired in March 1995.
CAPITAL RESOURCES AND LIQUIDITY - -------------------------------
WRIT has utilized the proceeds of share offerings, unsecured debt offerings, medium and long-term fixed interest rate debt, bank lines of credit and cash flow from operations for its capital needs. Management believes that external sources of capital will continue to be available to WRIT from its existing unsecured credit commitments and also believes that additional sources of capital will be available from selling additional shares and/or the sale of medium or long-term unsecured notes. The funds raised would be used to pay off any outstanding advances on WRIT's lines of credit and for new acquisitions and capital improvements.
In August 1997, WRIT received $61.1 million net of underwriting fees from the issuance and sale of 3,750,000 shares. WRIT's underwriting expenses were approximately $200,000 resulting in net proceeds received by the Trust of $60.9 million. Approximately $23.0 million of the net proceeds was used to repay certain borrowings outstanding under the Trust's lines of credit resulting from 1997 property acquisitions. The balance of the net proceeds was used to acquire income producing properties and for capital improvements.
In August 1996, WRIT sold $50 million of 7.125% 7-year unsecured notes due August 13, 2003, and $50 million of 7.25% unsecured 10-year notes due August 13, 2006. The 7-year notes were sold at 99.107% of par and the 10-year notes were sold at 98.166% of par. On August 13, 1996, WRIT received $97.9 million net of underwriting fees from the sale of the notes. WRIT's other underwriting expenses were $302,000 resulting in net
proceeds received by the Trust from the sale of $97.6 million. Approximately $67 million of net proceeds was used to repay all borrowings outstanding under WRIT's lines of credit. Those borrowings were used for various 1995 and 1996 property acquisitions. An additional $25.7 million was used for acquisitions for The Ashby at McLean and the Alban Business Center, subsequent to August 13, 1996. The balance of the net proceeds was used to renovate, expand or improve other Trust properties.
On July 25, 1995, WRIT received $48.9 million net of underwriting fees from the issuance and sale of 3.5 million shares. WRIT's other underwriting expenses were $233,000 resulting in net proceeds received by the Trust of $48.6 million. Approximately $36.0 million of the net proceeds was used to repay certain borrowings outstanding under the Trust's lines of credit resulting from 1994 and 1995 property acquisitions. $7.0 million of the net proceeds in addition to financing was used to acquire Frederick County Square and 1220 19th Street. The balance of the net proceeds was used to renovate, expand or improve other Trust properties.
As of December 31, 1997, WRIT had line of credit commitments in place from commercial banks for up to $75 million with an additional $20.25 million bridge-loan facility. WRIT acquired six properties for total acquisition costs of $138.8 million in 1997 and acquired six properties for total acquisition costs of $69.9 million in 1996. The 1997 acquisitions were financed through line of credit advances and through the issuance in August, 1997 of 3,750,000 shares. The line of credit advances were subsequently repaid with proceeds from the February 1998 issuance of $110 million of medium-term notes. 1996 acquisitions were financed through additional advances on the lines of credit of $39.0 million and were subsequently repaid with proceeds from the issuance of the notes in 1996.
On February 20, 1998, WRIT sold $50 million of 7.25% unsecured notes due February 25, 2028 at 98.653% to yield approximately 7.36%. WRIT also sold $60 million of 6.898% unsecured Mandatory Par Put Remarketed Securities ("MOPPRS") at an effective borrowing rate through the remarketing date (February 2008) of approximately 6.74%. WRIT used the proceeds of these notes for general business purposes, including repayment of $95 million, of outstanding advances under its lines of credit. WRIT intends to use the remainder of the proceeds to finance acquisitions and capital improvements to its properties. WRIT had four interest rate lock agreements related to this transaction which settled for $5.4 million and treated that settlement and the cost of a related interest rate cap agreement as transaction costs of the borrowing. These costs will be amortized over the life of the unsecured notes using the effective interest rate method.
Cash flow from operating activities totaled $42.5 million, $37.6 million, and $31.0 million for the years ended December 31, 1997, 1996, and 1995, respectively, including net income of $30.1 million, $28.0 million, and $26.1 million, respectively, and depreciation and amortization of $10.9 million, $7.8 million, and $5.1 million, respectively. The increase in cash flows from operating activities for all years is primarily due to the increase in acquisitions and the resultant increase in net income.
Rental revenue has been the principal source of funds to pay WRIT's operating expenses, interest expense and dividends to shareholders. In 1997, 1996 and 1995, WRIT paid dividends totaling $36.1 million, $32.7 million and $29.7 million, respectively.
Capital improvements of $13.9 million were completed in 1997, including tenant improvements. Capital improvements to WRIT properties in 1996 and 1995 were approximately $12.0 million and $8.1 million, respectively.
The components of WRIT's capital improvement costs for 1997 were as follows:
(In thousands) Acquisition Related $ 2,591 Expansions and Major Renovations 2,054 Tenant Improvements 3,714 Capital Expenditures 5,554 --------- Total $13,913 =========
Acquisition related costs are capital improvements made to properties acquired during 1997, 1996 and 1995, which were planned during the investment underwriting due diligence process.
Management believes that WRIT has the liquidity and the capital resources necessary to meet all of its known obligations and to make additional property acquisitions and capital improvements when appropriate to enhance long-term growth.
Historically, WRIT has acquired 100% ownership in property. However, in 1995 WRIT formed a subsidiary partnership, WRIT Limited Partnership, in which WRIT currently owns 99.9% of the partnership interest. As of December 31, 1997, WRIT Limited Partnership had acquired fourteen properties for cash contributed or loaned to the partnership by WRIT. WRIT intends to use WRIT Limited Partnership to offer property owners an opportunity to contribute properties in exchange for WRIT Limited Partnership units. Such a transaction will enable property owners to diversify their holdings and to obtain a tax deferred contribution for WRIT Limited Partnership units rather than make a taxable cash sale. To date, no such exchange transactions have occurred. WRIT believes that WRIT Limited Partnership will provide WRIT an opportunity to acquire real estate assets which might not otherwise have been offered to it.
On March 23, 1998, WRIT sold the Shirley-I-395 Business Center. The property was sold for approximately $8 million resulting in a gain of approximately $6 million. WRIT intends to use the proceeds from the sale to invest in other real estate.
YEAR 2000 - ---------
WRIT has assessed and continues to assess the impact of the Year 2000 issue on its reporting systems and operations. The Year 2000 issue exists because many computer systems and applications and other systems using computer chips currently use two-digit fields to designate a year. As the century date occurs, date sensitive systems may recognize the year 2000 as 1900 or not at all. This inability to recognize or properly treat the year 2000 may cause the systems to process critical financial and operations information incorrectly.
WRIT has implemented a new reporting system. Implementation of the new system was not done in response to Year 2000 issues but in order to improve reporting processes. The new system is Year 2000 compliant. Management is reviewing the remaining operating systems, including building operations, to determine if there is any Year 2000 issues related to such systems.
FORWARD-LOOKING STATEMENTS - --------------------------
This Annual Report on Form 10-K contains forward-looking statements which involve risks and uncertainties. Such forward looking statements include (a) WRIT's intention to invest in properties that it believes will continue to increase in income and value; (b) WRIT's belief that the WRIT Partnership will provide WRIT an opportunity to acquire real estate assets which might not otherwise have been offered to it; (c) WRIT's belief that the office building sector will continue to lead WRIT's growth in 1998; (d) WRIT's belief that renovations and other changes at the Bradlees Shopping Center will increase traffic and enable it to raise rents; (e) WRIT's belief that external sources of capital will continue to be available and that additional sources of capital will be available from the sale of shares or notes; (f) WRIT's belief that it has the liquidity and capital resources necessary to meet its known obligations and to make additional property acquisitions and capital improvements when appropriate to enhance long-term growth; and (g) other statements preceded by, followed by or that include the words "believes," "expects," "intends," "anticipates," "potential" and other similar expressions.
WRIT claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 for the foregoing statements. The following important factors, in addition to those discussed elsewhere in this Annual Report, could affect WRIT's future results and could cause those results to differ materially from those expressed in the forward-looking statements: (a) the economic health of WRIT's tenants; (b) the economic health of the Washington, D.C. metropolitan region; (c) inflation; (d) consumer confidence; (e) unemployment rates; (f) consumer tastes and preferences; (g) stock price and interest rate fluctuations; (h) WRIT's future capital requirements; (i) competition; (j) compliance with applicable laws, including those concerning the environment and access by persons with disabilities; and (k) weather conditions.
RATIOS OF EARNINGS TO FIXED CHARGES - -----------------------------------
The following table sets forth the Trust's ratios of earnings to fixed charges for the periods shown:
Year Ended December 31, ----------------------- 1997 1996 1995 ---- ---- ---- 4.08x 6.11x 12.95x
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -------------------------------------------
The financial statements and supplementary data listed under Item 14 (a) and filed as part of this report on the pages indicated are incorporated herein by reference.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING ----------------------------------------------------------- AND FINANCIAL DISCLOSURE ------------------------
None.
PART III
Certain information required by Part III is omitted from this Report in that the Registrant will file a definitive proxy statement pursuant to Regulation 14A (the "Proxy Statement") no later than 120 days after the end of the fiscal year covered by this Report, and certain information included therein is incorporated herein by reference. Only those sections of the Proxy Statement which specifically address the items set forth herein are incorporated by reference. Such incorporation does not include the Performance Graph included in the Proxy Statement.
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT --------------------------------------------------
The information required by this Item is hereby incorporated herein by reference to WRIT's 1998 Annual Meeting Proxy Statement.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION ----------------------
The information required by this Item is hereby incorporated herein by reference to WRIT's 1998 Annual Meeting Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT --------------------------------------------------------------
The information required by this Item is hereby incorporated herein by reference to WRIT's 1998 Annual Meeting Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ----------------------------------------------
The information required by this Item is hereby incorporated herein by reference to WRIT's 1998 Annual Meeting Proxy Statement.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM ----------------------------------------------------------- 8-K ---
ITEM 14 (a). The following documents are filed as part of this Report:
1. Financial Statements: The following Financial Statements of Washington Real Estate Investment Trust and Reports of Independent Accountants are included in this report:
Report of Arthur Andersen LLP.
Report of Price Waterhouse LLP.
Consolidated Balance Sheets at December 31, 1997 and 1996.
Consolidated Statements of Income for the years ended December 31, 1997, 1996 and 1995.
Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1997, 1996 and 1995.
Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995.
Notes to Consolidated Financial Statements.
2. Financial Statement Schedules: The following financial statement schedules of Washington Real Estate Investment Trust for the periods indicated are filed as part of this Report and should be read in conjunction with the Financial Statements of Washington Real Estate Investment Trust.
Schedule Page - -------- ----
III Real Estate and Accumulated Depreciation 42
Supplementary Information: Quarterly Financial Results (unaudited) 45
Schedules not listed above have been omitted because they are not applicable or are not required or the information to be set forth therein is included in the Financial Statements or Notes thereto.
3. Exhibits:
3. Declaration of Trust and Bylaws
(a) Declaration of Trust. Incorporated herein by reference to Exhibit 3 to the Trust's registration statement on Form 8-B dated July 10, 1996.
(b) Bylaws. Incorporated herein by reference to Exhibit 4 to the Trust's registration statement on Form 8-B dated July 10, 1996.
4.
(a) Credit agreement dated March 1, 1995 between Washington Real Estate Investment Trust, as borrower, The First National Bank of Chicago, as lender, and The First National Bank of Chicago as agent. Incorporated herein by reference to the Exhibit of the same designation to the Trust's Form 10-K dated March 28, 1996.
(b) Credit agreement dated July 25, 1997, among Washington Real Estate Investment Trust, as borrower, Crestar Bank, as lender, Signet Bank/Virginia, as lender, and Crestar Bank, as agent.
(c) Indenture dated as of August 1, 1996 between Washington Real Estate Investment Trust and The First National Bank of Chicago.*
(d) Officers' Certificate Establishing Terms of the Notes, dated August 8, 1996.*
(e) Form of 2003 Notes.*
(f) Form of 2006 Notes.*
(g) Form of MOPPRS Notes.****
(h) Form of 30 year Notes.****
(i) Remarketing Agreement.****
(j) The Trust is a party to a number of other instruments defining the rights of holders of long-term debt. No such instrument authorizes an amount of securities in excess of 10 percent of the total assets of the Trust and its Subsidiaries on a consolidated basis. On request, the Trust agrees to furnish a copy of each such instrument to the Commission.
10. Management contracts, plans and arrangements
(a) Employment Agreement dated May 11, 1994 with Edmund B. Cronin, Jr.**
(b) 1991 Incentive Stock Option Plan, as amended.**
(c) Nonqualified Stock Option Agreement dated June 27, 1990 with B. Franklin Kahn.**
(d) Nonqualified Stock Option Agreement dated December 14, 1994 with Edmund B. Cronin, Jr.**
(e) Nonqualified Stock Option Agreement dated December 19, 1995 with Edmund B. Cronin, Jr. Incorporated herein by reference to Exhibit 10(e) to the 1995 Form 10-K.
(f) Share Grant Plan.***
(g) Share Option Plan for Trustees.***
21. Subsidiaries of Registrant
In 1995, WRIT formed a subsidiary partnership, WRIT Limited Partnership, a Maryland limited partnership, in which WRIT owns 99.9% of the partnership interest.
22. Consents
(a) Consent of Arthur Andersen LLP
27. Financial Data Schedules
(a) 1997 Financial Data Schedule
(b) 1996 Financial Data Schedule
(c) 1995 Financial Data Schedule
ITEM 14 (b). REPORTS ON FORM 8-K
(1) October 17, 1997- Report pursuant to Item 2 on the acquisition of 1600 Wilson Boulevard and financial statements of the acquired property pursuant to Item 7.
* Incorporated herein by reference to the Exhibit of the same designation to the Trust's Form 8-K filed August 13, 1996.
** Incorporated herein by reference to the Exhibit of the same designation to Amendment No. 2 to the Trust's Registration Statement on Form S-3 filed July 17, 1995.
*** Incorporated herein by reference to the Exhibit of the same designation to the Trust's Registration Statement on Form S-8 filed October 25, 1995.
**** Incorporated herein by reference to the Exhibit of the same designation to the Trust's Registration Statement on Form S-3 filed March 17, 1998.
(2) November 12, 1997- Report pursuant to Item 2 on the acquisition of Bethesda Hill and 7900 Westpark Drive and financial statements of the acquired properties pursuant to Item 7.
SIGNATURES
Pursuant to the requirements of Section 13 and 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
WASHINGTON REAL ESTATE INVESTMENT TRUST
Date: March 30, 1998 By: /s/ Edmund B. Cronin, Jr. ________________________________ Edmund B. Cronin, Jr. President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title Date - --------- ----- ----
/s/ Arthur A. Birney __________________________ Chairman and Trustee March 31, 1998 Arthur A. Birney
/s/ William N. Cafritz __________________________ Trustee March 31, 1998 William N. Cafritz
/s/ John M. Derrick, Jr. __________________________ Trustee March 31, 1998 John M. Derrick, Jr.
/s/ Benjamin H. Dorsey __________________________ Secretary and Trustee March 31, 1998 Benjamin H. Dorsey
/s/ David M. Osnos __________________________ Trustee March 31, 1998 David M. Osnos
/s/ Stanley P. Snyder __________________________ Trustee March 31, 1998 Stanley P. Snyder
/s/ Larry E. Finger __________________________ Senior Vice President and March 31, 1998 Larry E. Finger Chief Financial Officer
/s/ Laura M. Franklin __________________________ Vice President and March 31, 1998 Laura M. Franklin Chief Accounting Officer
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of Washington Real Estate Investment Trust:
We have audited the accompanying consolidated balance sheets of Washington Real Estate Investment Trust (the "Trust," a Maryland real estate investment trust) and Subsidiary as of December 31, 1997 and 1996, and the related consolidated statements of income, shareholders' equity and cash flows for the years then ended. These financial statements are the responsibility of the Trust's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Trust and Subsidiary as of December 31, 1997 and 1996, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The financial statement schedule included on pages 42 through 44 of the Form 10-K is presented for the purpose of complying with the Securities and Exchange Commission's rules and is not a required part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in our audit of the basic financial statements and, in our opinion, is fairly stated in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Washington, D.C. February 20, 1998
REPORT OF INDEPENDENT ACCOUNTANTS
To the Trustees and Shareholders of Washington Real Estate Investment Trust
In our opinion, the financial statements listed in the index appearing under Item 14(a)(1) and (2) on page 17 present fairly, in all material respects, the results of operations and cash flows of Washington Real Estate Investment Trust for the year ended December 31, 1995, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Trust's management; our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for the opinion expressed above. We have not audited the financial statements of Washington Real Estate Investment Trust for any period subsequent to December 31, 1995.
PRICE WATERHOUSE LLP
Washington, D.C. March 27, 1996
WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1997 AND 1996 (IN THOUSANDS)
The accompanying notes are an integral part of these statements.
WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (IN THOUSANDS, EXCEPT PER SHARE DATA)
The accompanying notes are an integral part of these statements.
WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (IN THOUSANDS)
The accompanying notes are an integral part of these statements.
WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (IN THOUSANDS)
*Supplemental schedule of non-cash investing and financing activities - ---------------------------------------------------------------------
On August 22, 1995 WRIT purchased Frederick Square Shopping Center for an acquisition cost of $13.4 million. WRIT assumed a mortgage in the amount of $7.8 million and paid the balance in cash. The $7.8 million is not included in the $51 million amount shown as real estate acquisitions.
The accompanying notes are an integral part of these statements.
WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1. NATURE OF BUSINESS:
Washington Real Estate Investment Trust ("WRIT" or the "Trust") is a self-administered qualified equity real estate investment trust, successor to a trust organized in 1960. The Trust's business consists of the ownership of income-producing real properties in the Mid-Atlantic Region.
WRIT operates in a manner intended to enable it to qualify as a real estate investment trust under the Internal Revenue Code (the "Code"). In accordance with the Code, a trust which distributes its capital gains and at least 95 percent of its taxable income to its shareholders each year, and which meets certain other conditions, will not be taxed on that portion of its taxable income which is distributed to its shareholders. Accordingly, no provision for Federal income taxes is required.
In June 1996, WRIT changed its domicile from the District of Columbia to the State of Maryland. Issued and outstanding shares were assigned a par value of $.01 per share.
2. ACCOUNTING POLICIES:
BASIS OF PRESENTATION
In 1995 WRIT formed a subsidiary partnership, WRIT Limited Partnership, a Maryland limited partnership, in which WRIT currently owns 99.9 percent of the partnership interest. WRIT Limited Partnership's financial statements are consolidated with WRIT's financial statements. All significant intercompany balances and transactions have been eliminated. Minority interests are included in other income and accounts payable and other liabilities on the accompanying consolidated statements.
REVENUE RECOGNITION
Residential properties are leased under operating leases with terms of generally one year or less, and commercial properties are leased under operating leases with average terms of three to five years. WRIT recognizes rental income from its residential and commercial leases when earned and accounts for all rental abatements on a straight-line basis.
DEFERRED FINANCING COSTS
Costs associated with the issuance of senior subordinated notes and draws on lines of credit are capitalized and amortized using the effective interest rate method over the term of the related notes.
REAL ESTATE AND DEPRECIATION
Real estate assets are recorded at cost. Buildings are depreciated on a straight-line basis over estimated useful lives not exceeding 50 years. Effective January 1, 1995, WRIT revised its estimate of useful lives for major capital improvements to real estate. All capital improvement expenditures associated with replacements, improvements or major repairs to real property are depreciated using the straight-line method over their estimated useful lives ranging from 3 to 30 years. All tenant improvements are amortized using the straight-line method over 5 years or the term of the lease if it differs significantly from 5 years. Capital improvements placed in service prior to January 1, 1995 will continue to be depreciated on a straight-line basis over their previously estimated useful lives not exceeding 30 years. Maintenance and repair costs are expensed as incurred. Depreciation expense for Federal income tax purposes differs from that reported for financial statement purposes by $2.5 million in 1997 and $2.8 million in 1996 due to the use of different lives and depreciation methods. Additionally, net assets as reported in WRIT's financial statements exceed the net basis for Federal income tax purposes by $17.1 million in 1997 and $14.6 million in 1996 due to a lower basis of certain real estate assets acquired by tax-free exchanges.
WRIT quarterly evaluates the carrying value of its long-lived assets in accordance with Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." In cases where management is holding for sale particular properties, the Company assesses impairment based on whether the net realizable value (estimated sales price less costs of disposal) of each individual property to be sold is less than the net book value. A property is considered to be held for sale when the Company has made the decision to dispose of the property. Otherwise, the Company assesses impairment of its real estate properties based on whether it is probable that undiscounted future cash flows from each individual property will be less than its net book value. If a property is impaired, its basis is adjusted to its fair market value. There were no property impairments recognized during the three year period ending December 31, 1997.
CASH AND TEMPORARY INVESTMENTS
Cash and temporary investments include investments readily convertible to known amounts of cash with original maturities of 90 days or less.
INTEREST RATE PROTECTION AGREEMENTS
WRIT has entered into a series of interest rate protection agreements to reduce its exposure to interest rate risk on anticipated borrowings. The costs (if any) of such agreements which qualify for hedge accounting are included in other assets and are amortized over the interest rate agreement term. To qualify for hedge accounting, the interest rate protection agreement must meet two criteria: (i) the debt to be hedged exposes WRIT to interest rate risk and (ii) the interest rate protection agreement reduces WRIT's exposure to interest rate risk. In the event that interest rate protection agreements that qualify for hedge accounting are terminated or are closed out, the associated gain or loss is deferred and amortized over the term of the underlying hedged asset or liability. Amounts to be paid or received under interest rate cap agreements are accrued currently and are netted with interest expense for financial statement presentation
purposes. Additionally, in the event that interest rate protection agreements do not qualify as hedges, such agreements are reclassified to be investments accounted for at fair value, with any gain or loss included as a component of income.
EARNINGS PER COMMON SHARE
In the fourth quarter of 1997, WRIT adopted SFAS No. 128, "Earnings per Share." This statement requires the computation and reporting of both "basic" and "diluted" earnings per share.
"Basic earnings per share" is computed as net income divided by the weighted average common shares outstanding. "Diluted earnings per share" is computed as net income divided by the total weighted average common shares outstanding and the effect of dilutive common equivalent shares outstanding for the period. Dilutive common equivalent shares reflect the assumed issuance of additional common shares pursuant to certain of the Trust's share based compensation plans (see Note 9) that could potentially reduce or "dilute" earnings per share, based on the treasury stock method.
The weighted average number of shares outstanding for the year ended December 31, 1997, 1996 and 1995 was 33.4, 31.8 and 29.8 million shares, respectively.
The impact of dilution of common equivalent shares on the basic weighted average shares outstanding is immaterial.
USE OF ESTIMATES IN THE FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
NEW STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS
During 1997, WRIT adopted the provisions of SFAS No. 129, "Disclosure of Information about Capital Structure." The adoption of SFAS No. 129 did not have a material effect on WRIT's financial statements.
WRIT also adopted the provisions of SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." This statement establishes standards for the way that
public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. See Note 14 for WRIT's segment disclosures.
In February 1998, SFAS No. 132 "Employers' Disclosure about Pension and Other Postretirement Benefits" was issued. This Statement revises employers' disclosures about pension and other postretirement benefit plans. It does not change the measurement or recognition of those plans. It standardizes the disclosure requirements for pensions and other postretirement benefits to the extent practicable, requires additional information on changes in the benefit obligations and fair values of plan assets that will facilitate financial analysis, and eliminates certain disclosures previously required. This Statement is effective for fiscal years beginning after December 15, 1997 and is not expected to have a material effect on the financial statements.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current year presentation.
3. REAL ESTATE INVESTMENTS:
WRIT's real estate investment portfolio, at cost, consists of properties located in Maryland, Washington, D.C., Virginia and Delaware as follows:
December 31, ------------------- 1997 1996 ---- ---- (In thousands)
Office buildings $268,977 $163,192 Shopping centers 87,618 60,694 Apartment buildings 80,173 84,060 Industrial distribution centers 67,547 44,633 -------- -------- $504,315 $352,579 ======== ========
WRIT's results of operations are dependent on the overall economic health of its tenants and the specific segments in which WRIT holds properties, as well as the overall economic health of the Washington, D.C. metropolitan region. These segments include commercial, residential, retail, and industrial properties. Although all sectors are affected by external factors, such as inflation, consumer confidence, unemployment rates, and consumer tastes and preferences, the retail segment is particularly sensitive to such factors. A decline in the retail segment could reduce merchant sales, which could adversely affect the operating results of WRIT. As of December 31, 1997, 7900 Westpark office building accounted for 16% of total assets. No other single property accounted for more than 10% of total assets. As of December 31, 1997, 1996 and 1995, no single tenant or property accounted for more than 10 percent of total revenues.
Properties acquired by WRIT during the year ending December 31, 1997 are as follows:
*Apartment buildings are presented in gross square feet.
WRIT accounted for each acquisition using the purchase method of accounting.
4. MORTGAGE NOTE PAYABLE:
On August 22, 1995, WRIT assumed a $7.8 million mortgage note payable as partial consideration for its acquisition of Frederick County Square. The mortgage bears interest at 9 percent. Principal and interest are payable monthly until January 1, 2003, at which time all unpaid principal and interest are payable in full. Annual maturities of principal as of December 31, 1997, are as follows:
(In thousands) --------------
1998 $ 140 1999 153 2000 167 2001 183 2002 200 Thereafter 6,618 ------ $7,461 ======
5. UNSECURED LINES OF CREDIT PAYABLE:
WRIT currently maintains two unsecured lines of credit: a $25 million line of credit ("Credit Facility No. 1") and a $50 million line of credit ("Credit Facility No. 2"). Both lines of credit require monthly interest payments, in arrears, on the unpaid principal balances.
CREDIT FACILITY NO. 1
WRIT had $25 million and $4 million outstanding as of December 31, 1997 and 1996, respectively, related to Credit Facility No. 1.
The following advances have been made under this commitment:
All new advances and interest rate adjustments upon the expiration of WRIT's interest lock-in dates will bear interest at LIBOR plus a spread based on WRIT's public debt rating. All unpaid interest and principal can be prepaid prior to the expiration of WRIT's interest rate lock-in periods subject to a yield maintenance obligation and all unpaid principal and interest are due January 31, 1999.
This $25 million credit commitment requires WRIT to pay the lender an unused commitment fee at the rate of 0.15% per annum in the first year, .20% per annum through August 1996, and .175% thereafter, on the amount that the $25 million commitment exceeds the balance of outstanding advances and term loans. At December 31, 1997 and 1996, $0 and $21.0 million, respectively, of this commitment was unused and available for subsequent acquisitions or capital improvements. This fee is paid quarterly beginning in March 1995 until January 1999. This commitment also contains certain financial and non-financial covenants that WRIT has met as of December 31, 1997.
CREDIT FACILITY NO. 2
WRIT had $50 million and $1 million outstanding as of December 31, 1997 and 1996, respectively, related to Credit Facility No. 2.
The following advances have been made under this commitment:
All unpaid interest and principal are due July 25, 1998 and can be prepaid prior to this date without any prepayment fee or yield maintenance obligation. WRIT has the option to extend this agreement until July 25, 1999. Any new advances shall bear interest at LIBOR plus a spread based on WRIT's public debt rating.
Credit Facility No. 2 provides WRIT the option to convert any advances or portions thereof into a term loan at any time after January 25, 1998, and prior to July 25, 1998, or July 25, 1999, if extended. The principal amount of each term loan, if any, shall be repaid on July 25, 2011. Such term loan(s) may be prepaid subject to a prepayment fee.
This $50 million credit commitment requires WRIT to pay the lender an unused commitment fee at the rate of 0.175% per annum on the amount that the $50 million commitment exceeds the balance of outstanding advances and term loans. At December 31, 1997 and 1996, $0 and $49 million, respectively, of this commitment was unused. This fee is paid quarterly in arrears. This commitment also contains certain financial and non-financial covenants that WRIT has met as of December 31, 1997.
BRIDGE LOAN
During 1997, WRIT temporarily expanded one of its lines of credit to provide up to an additional $20.25 million through February 27, 1998, all of which was outstanding at December 31, 1997. The bridge loan accrued interest at LIBOR plus .70%. At December 31, 1997, the interest rate was 6.64%. WRIT was required to pay a commitment fee equal to .10% of the commitment. The bridge loan also requires WRIT to pay the lender an unused commitment fee at the rate of .175% on the amount that the $20.25 million commitment exceeds the balance of outstanding advances. This fee is paid quarterly in arrears. This commitment also contains financial and non-financial covenants that WRIT has met as of December 31, 1997. The bridge loan was repaid on February 27, 1998.
Information related to short-term borrowings are as follows (in thousands):
1997 1996 ---- ---- Maximum Amount Outstanding $95,250 $67,000 Average Amount Outstanding 23,000 31,000 Weighted Average Interest Rate 6.51% 6.18%
6. SENIOR NOTES PAYABLE:
On August 8, 1996, WRIT entered into an underwriting agreement to sell $50 million in 7.125 percent 7-year unsecured notes due August 13, 2003, and $50 million in 7.25 percent unsecured 10-year notes due August 13, 2006. This transaction closed on August 13, 1996. The 7-year notes were sold at 99.107 percent of par and the 10-year notes were sold at 98.166 percent of par. Net proceeds to the Trust after deducting underwriting expenses were $97.6 million. The 7-year notes bear an effective interest rate of 7.46 percent, and the 10-year notes bear an effective interest rate of 7.49 percent, for a combined effective interest rate of 7.47 percent. In 1996, WRIT used the proceeds of these notes to pay down its lines of credit and to finance acquisitions and capital improvements to its properties. This commitment also contains certain financial and non-financial covenants which WRIT has met as of December 31, 1997.
7. INTEREST RATE PROTECTION AGREEMENTS:
In the second and third quarter of 1997, WRIT entered into a series of interest rate protection agreements to partially limit the adverse effects of rising interest rates on its anticipated unsecured note offering (see Note 15). Interest rate caps provide protection to WRIT to the extent interest rates, based on a readily determinable interest rate index, increase above the stated interest rate cap, in which case, WRIT would receive payments based on the difference between the index and the cap. The cost to acquire the cap was approximately $114,000. The cap expired in December 1997 but was replaced prior to expiration by an interest rate lock agreement. Interest rate lock agreements provide protection to WRIT to the extent interest rates rise above the specified lock level based on a readily determinable interest rate index in which case WRIT is paid the present value (based on the change in value of the Reference Security for each one basis point change in the yield to maturity of such Reference Security) of the increase in interest rates above that locked interest rate times the notional value of the underlying agreement. If interest rates do not rise above the locked interest rate WRIT is obligated to pay to the counterparty the present value (based on the change in value of the Reference Security for each one basis point change in the yield to maturity of such Reference Security) of the difference in interest rates below the locked interest rate times the notional value of the underlying agreement. None of WRIT's caps or rate locks are held for trading purposes. At December 31, 1997, WRIT held interest rate protection locks with a notional amount of $100 million.
WRIT is exposed to credit loss in the event of non-performance by the counterparties to the interest rate protection agreements should interest rates exceed the caps or the rate established in the rate lock agreement. However, management does not anticipate non-
performance by any of the counterparties. All of the counterparties have long-term debt ratings of A+ or above by Standard and Poor's and Al or above by Moody's. Management believes that these caps are highly liquid. The caps and rate locks could be sold or transferred with the consent of the counterparties. Management does not believe that this consent would be withheld. Although none of WRIT's caps and rate locks are exchange-traded, there are a number of financial institutions which enter into these types of transactions as part of their day-to-day activities.
8. SHARES OF BENEFICIAL INTEREST AND DIVIDENDS:
In August 1997, WRIT received $61.1 million from the issuance and sale of 3,750,000 shares. WRIT's underwriting expenses were approximately $200,000 resulting in net proceeds received by the Trust of $60.9 million. Approximately $23.0 of the net proceeds was used to repay certain borrowings outstanding under the Trust's lines of credit resulting from 1997 property acquisitions. The balance of the net proceeds was used to acquire income producing properties and for capital improvements.
The following is a breakdown of the taxable percentage of WRIT's dividends for 1997, 1996, and 1995, respectively:
Ordinary Income Return of Capital --------------- -----------------
1997 93% 7% 1996 91% 9% 1995 89% 11%
9. SHARE OPTIONS:
WRIT maintains a Share Option Plan ("the Plan"), which includes qualified and non-qualified options. As of December 31, 1997, 1.5 million shares may be awarded to eligible employees. Under the Plan, options, which are issued at market price on the date of grant, vest after not more than two years and expire ten years following the date of grant. Options may be granted under the Plan at any time prior to June 25, 2001. Activity under the Plan is summarized below:
173,000 of the options outstanding at December 31, 1997, have exercise prices between $12.410 and $20.625, with a weighted average exercise price of $15.839 and a weighted average remaining contractual life of 7.29 years. All of these options are exercisable. The remaining 236,000 options have exercise prices between $15.50 and $16.1875, with a weighted average exercise price of $16.002 and a remaining contractual life of 9.53 years.
The fair value of each option granted is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 1997; risk-free interest rates of 5.75 percent for the Plan options, expected dividend yields of 4.60 percent, expected lives of 7 years, and expected volatility of 31 percent.
On December 16, 1997, 101,000 non-qualified share options were granted at $16.125, the per share market price that day. Of those share, 55,000 were granted to Mr. Edmund B. Cronin, President and Chief Executive Officer, of WRIT. The remainder of the options were granted to various other employees.
On December 17, 1996 and December 19, 1995 non-qualified share options were granted to Mr. Cronin for 20,000 and 13,333 shares, respectively, at $16.1875 and $14.625, the per share market price that day. All options are 50 percent exercisable after the first anniversary date and 100 percent exercisable after the second anniversary date. As of December 31, 1997, 33,000 shares are exercisable.
WRIT accounts for its Incentive Share Option Plan and the non-qualified share options granted under APB Opinion No. 25, under which no compensation cost has been recognized. Had compensation cost for these plans been determined consistent with SFAS No. 123, "Accounting for Stock-Based Compensation," WRIT's net income and earnings per share would have been reduced to the following pro forma amounts:
1997 1996 --------- ------- Net Income: As Reported $30,136 $27,964 Pro Forma 29,392 27,522 Basic Earnings Per Share: As Reported 0.90 0.88 Pro Forma 0.88 0.87
Because the method of accounting has not been applied to options granted prior to January 1, 1995, the resulting pro forma compensation may not be representative of that to be expected in future years.
WRIT has computed basic earnings per share. The calculation of diluted earnings per share is immaterial and therefore not presented.
10. PENSION PLAN AND OTHER BENEFIT PLANS:
WRIT maintained a noncontributory defined benefit pension plan for all eligible employees through December 31, 1995. At December 31, 1995, all benefit accruals under the plan were frozen and thus the projected benefit obligation ("PBO") and the accumulated benefit obligation
("ABO") became equal. WRIT anticipates terminating the plan no later than December 31, 1999. Since there are no further benefit accruals provided under the plan, WRIT has substantially reduced its funding obligation and there will be no further increases in the ABO or PBO. Benefits under the plan were generally based on years of service and final average pay. Pension costs are accrued and funded annually from plan entry date in the plan to projected retirement date and include service costs for benefits earned during the period and interest costs on the projected benefit obligation less the return on plan assets.
Pension costs are accrued and funded annually from plan entry date in the plan to projected retirement date and includes the following components (in thousands).
The assumed long-term rate of return is 7.00 percent in 1997 and 1996 and 8.00 percent for 1995. Plan obligations in excess of amounts permitted under the Tax Equity and Fiscal Responsibility Act of 1982 are accrued as a liability of WRIT and included in total pension cost. The funded status of the plan is as follows:
The plan assets are invested in bonds and certificates of deposit.
The liabilities are calculated using an assumed discount rate of 7.00 percent for December 31, 1997 and 1996, and an assumed compensation increase of 5 percent for 1995.
In 1995, annuity contracts were purchased with plan assets for two participants who retired during 1995, one being WRIT's former Chairman and Chief Executive Officer B. Franklin Kahn. The cost of said annuities was $1,593,000 and the reduction in the PBO was $1,632,000.
In 1997, WRIT implemented a Retirement Savings Plan (the "Savings Plan"). It was established so that participants in the Savings Plan may elect to contribute a portion of their earnings to the Savings Plan and WRIT may, at its discretion, make a voluntary contribution to the Savings Plan.
During 1996, management adopted an Incentive Compensation Plan ("the Compensation Plan") for its senior personnel which is intended to align their compensation growth with shareholders' interests. Essentially, the Compensation Plan limits future salary increases and provides cash bonus incentives and stock option grants under the Incentive Share Option Plan based on performance. The financial incentives to management are earned after WRIT has achieved a prescribed growth. This plan is effective for the 1997 and 1996 years and will be reviewed by the Board of Trustees' Compensation Committee each year.
11. FAIR VALUE OF FINANCIAL INSTRUMENTS:
Statement of Financial Accounting Standards No. 107 requires disclosure about the fair value of financial instruments. Based on the current interest rate environment and management estimates, the carrying values of the mortgage note payable, lines of credit payable, mortgage note receivable and senior subordinated notes approximates their fair values.
The fair value of WRIT's interest rate protection agreements are as follows:
Index Book Value Fair Value ----- ---------- ---------- 5.838% $ - 0 - $ (182,000) 6.1475% $ - 0 - $ (758,000) 6.439% $ - 0 - $(1,732,000) 6.384% $ - 0 - $(1,536,000)
The fair value for the interest rate protection agreements represent the cost to WRIT to cancel the agreements. As noted in Note 7, the above agreements matured on February 23, 1998.
12. RENTALS UNDER OPERATING LEASES:
Noncancellable commercial operating leases provide for minimum rental income during each of the next five years of approximately $68.2, $59.1, $48.4, $35.6, $21.0 and $39.2 million thereafter. Apartment leases are not included as they are generally for one year. Most of these commercial rentals increase in future years are based on changes in the Consumer Price Index or agreed-upon percentages. Contingent rentals from the shopping centers, based on a percentage of tenants' gross sales, were $351,000, $483,000, and $496,000 in 1997, 1996 and 1995, respectively.
13. ENVIRONMENTAL MATTERS:
During 1995, WRIT retained the services of an environmental consulting firm to test for asbestos in 29 of its properties built before 1981, in accordance with Occupational Safety and Health
Administration standards. In the second quarter of 1996, asbestos containing materials were identified for remediation at 11 properties for an estimated cost of $295,000. Of this amount, WRIT had incurred $261,000 relating to this matter as of December 31, 1997.
14. SEGMENT INFORMATION:
WRIT has four reportable segments: Apartment Buildings, Office Buildings, Shopping Centers and Industrial Distribution Centers. Apartment Buildings represent 23 percent of real estate rental revenue. These properties provide housing for families throughout the Washington Metropolitan area. Office Buildings represent 45 percent and provide office space for various types of businesses. Shopping Centers represent 20 percent and are retail outlets for a variety of stores. Industrial Distribution Centers represent the remaining 12 percent and are used for warehousing and distribution.
The accounting policies of the segments are the same as those described in the summary of significant accounting policies. WRIT evaluates performance based upon income from real estate from the combined properties in each segment.
WRIT's reportable segments are a consolidation of related properties which offer different products. They are managed separately because each segment requires different operating, pricing and leasing strategies. All of the properties have been acquired separately and are incorporated into the applicable segment.
15. SUBSEQUENT EVENT:
On February 20, 1998, WRIT sold $50 million of 7.25% unsecured notes due February 25, 2028 at 98.653% to yield approximately 7.36%. WRIT also sold $60 million in unsecured Mandatory Par Put Remarketed Securities ("MOPPRS") at an effective borrowing rate through the remarketing date (February 2008) of approximately 6.74%. WRIT used the proceeds of these notes for general business purposes, including repayment of outstanding advances under its lines of credit and to finance acquisitions and capital improvements to its properties. WRIT settled the interest rate lock agreements for $5.4 million and treated that settlement and the cost of the interest rate caps as a transaction cost of the borrowing. These costs will be amortized over the life of the unsecured notes using the effective interest rate method.
SCHEDULE III
WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARY
SUMMARY OF REAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION
SCHEDULE III (Continued)
WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARY
SUMMARY OF REAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION
Notes: (a) The site of Munson Hill Towers is rented under a lease requiring annual payments of $22,600 until the expiration of the lease in 2060. (b) The purchase of real estate investments has been divided between land and buildings and improvements on the basis of valuations by the Trust. (c) The useful life shown is for the main structure. Buildings and improvements are depreciated over various useful lives ranging from 3 to 50 years. (d) At December 31, 1997 total land, buildings and improvements are carried at $489,744,000 for federal income tax purposes. (e) At December 31, 1997, the only mortgage encumbrance was the $7,461,000 mortgage note payable on Frederick County Square. (f) Residential properties are presented in gross square feet.
SCHEDULE III (Continued)
WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARY
SUMMARY OF REAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION (IN THOUSANDS)
The following is a reconciliation of real estate assets and accumulated depreciation for the years ended December 31, 1997, 1996 and 1995:
WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARY
SUPPLEMENTARY INFORMATION: QUARTERLY FINANCIAL RESULTS (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA)