ITEM 1. BUSINESS.
THE COMPANY
As used herein, the terms "we," "us," "our," "EOP Partnership" "Operating Partnership" or the "Company" refer to EOP Operating Limited Partnership, a Delaware limited partnership, individually or together with its subsidiaries and predecessors. Together with our sole managing general partner, Equity Office Properties Trust, a Maryland real estate investment trust ("Equity Office" or the "Trust"), we were formed to continue and expand the national office property business organized by Mr. Samuel Zell, the Chairman of the Board of Equity Office, and to complete the consolidation of our predecessors. We are a fully integrated, self-managed real estate company engaged in acquiring, owning, managing and leasing office properties and parking facilities.
As of December 31, 1999, we owned or had an interest in 294 office properties containing approximately 77.0 million rentable square feet of office space (the "Office Properties") and owned 20 stand-alone parking facilities containing approximately 20,506 parking spaces (the "Parking Facilities" and, together with the Office Properties, The "Properties"). The weighted average occupancy for the Office Properties at December 31, 1999 was approximately 93.7%. The Office Properties are located in 81 submarkets in 35 markets in 23 states and the District of Columbia. The Office Properties, by rentable square feet, are located approximately 52% in central business districts ("CBDs") and 48% in suburban markets.
Equity Office has elected to be taxed as a real estate investment trust, or "REIT", for federal income tax purposes. To facilitate maintenance of Equity Office's qualification as a REIT for federal income tax purposes, we generally conduct the management of properties that are not wholly owned by us and our subsidiaries and certain other business activities through taxable corporations in which we own substantially all of the equity but little or no voting stock. We refer to these corporations as our "noncontrolled subsidiaries."
Our executive offices are located at Two North Riverside Plaza, Suite 2100, Chicago, Illinois 60606, and our telephone number is (312) 466-3300.
ACQUISITION ACTIVITY
During the period from 1987 through 1999, we invested approximately $12.9 billion, averaging $2.2 billion annually for the five years ended December 31, 1999, calculated on a cost basis, in acquisitions of institutional quality office properties and parking facilities throughout the United States. During the year ended December 31, 1999, we completed six acquisition transactions in which we acquired ten office properties, containing an aggregate of approximately 1.9 million square feet of rentable space and one parking facility containing 589 spaces. The aggregate consideration we paid for these acquisitions during 1999 was approximately $393.2 million, comprised of $315.5 million in cash, $24.5 million in units of limited partnership interest in EOP Partnership and $53.2 million in assumed liabilities.
PROPOSED ACQUISITION OF CORNERSTONE PROPERTIES LIMITED PARTNERSHIP
On February 11, 2000, Equity Office, EOP Partnership, Cornerstone Properties Inc. ("Cornerstone") and Cornerstone Properties Limited Partnership ("Cornerstone Partnership") entered into a merger agreement where Cornerstone will merge with and into Equity Office and Cornerstone Partnership will merge with and into EOP Partnership. The total merger consideration will be approximately $4.6 billion, including the assumption of approximately $1.8 billion in debt, the payment of $1.1 billion in cash and the issuance of approximately 63.6 million new Equity Office common shares and EOP Partnership units. Cornerstone common stockholders may elect to receive $18.00 per share in cash, plus any accrued but unpaid dividends, or 0.7009 of an Equity Office common share based on a prevailing transaction price of $25.68125 per Equity Office common share, subject to proration. Cornerstone's convertible preferred stockholders will receive $18.00 per share in cash. Cornerstone Partnership unitholders will receive 0.7009 units of EOP Partner-
ship, plus any accrued but unpaid distributions. We intend to finance the $1.1 billion cash portion of the purchase price by obtaining additional term loans, issuing unsecured notes or amending our existing line of credit.
The merger is expected to be completed in the third quarter of 2000 and is subject to the approval of Equity Office shareholders and Cornerstone stockholders and other customary conditions. Cornerstone is a fully integrated REIT and currently owns 86 office properties in the U.S. totaling over 18.5 million square feet, and has an additional $884 million of projects under development. If the merger is completed, we will own approximately 380 office properties consisting of approximately 95.5 million square feet.
RECENT FINANCING TRANSACTION
On March 21, 2000, EOP Partnership issued $500 million in unsecured notes due March 2006. The $500 million notes have a fixed coupon rate of approximately 8.4% per annum and an effective rate of approximately 8.5% per annum. We received net proceeds of approximately $496.2 million, which were used to paydown our line of credit.
BUSINESS AND GROWTH STRATEGIES
Our primary business objective is to achieve sustainable long-term growth in cash flow and portfolio value. We intend to achieve this objective by owning and operating institutional quality office buildings and providing a superior level of service to tenants across the United States. We have historically supplemented this strategy through our ownership of Parking Facilities and intend, in the future, to supplement further this strategy through Access, a strategic business service unit that provides office space customers access to business products and services.
INTERNAL GROWTH. We believe that our future internal growth will come from (a) lease up of vacant space, (b) tenant roll-over at increased rents where market conditions permit, (c) repositioning of certain properties which have not yet achieved stabilization, (d) ancillary revenues generated from providing business products and services to tenants through Access, (e) reduction of various expenses as a percentage of revenues, and (f) capital market efficiencies.
As of December 31, 1999, 4.9 million rentable square feet of our office property space was vacant. During the period from December 31, 1999 through December 31, 2004, 5,364 leases for 44.8 million rentable square feet of space are scheduled to expire. As of December 31, 1999, the average rent for this space was $24.55 per square foot. The actual rental rates at which available space will be relet will depend on prevailing market factors at the time.
We own various undeveloped land on which office space could be developed, assuming our receipt of all necessary permits and licenses. Our policy is to develop land only when market conditions warrant. Although we may develop certain properties ourselves, a portion of this activity may be conducted with joint venture partners.
EXTERNAL GROWTH. Assuming that capital is available to us on reasonable terms, we expect to actively pursue, over the long term, acquisitions of additional office properties. Properties may be acquired separately or as part of a portfolio, and may be acquired for cash and/or in exchange for our equity or debt securities. Such acquisitions may be customary real estate transactions, joint ventures, and/or mergers or other business combinations.
EMPLOYEES
As of December 31, 1999, we had approximately 1,733 employees providing in-house expertise in:
- property management - real estate services - leasing - finance - tax - acquisition - development - disposition - marketing - accounting - information systems - law
Our five most senior executives have an average tenure of 9.5 years with us or our affiliates and an average of 21 years experience in the real estate industry.
EXECUTIVE AND SENIOR OFFICERS OF EQUITY OFFICE
The following executive and senior officers of Equity Office currently hold the offices indicated.
Timothy H. Callahan has been a trustee, Chief Executive Officer and President of Equity Office since October 1996. Mr. Callahan served on the Board of Managers and was the Chief Executive Officer of Equity Office Holdings, L.L.C ("EOH"), and Equity Office Properties, L.L.C. ("EOP LLC"), predecessors of the Company, from August 1996 until October 1997. Mr. Callahan was Executive Vice President and Chief
Financial Officer of Equity Group Investments, Inc. ("EGI"), an owner, manager and financier of real estate and corporate investments, from January 1995 until August 1996, was Executive Vice President of EGI from November 1994 through January 1995 and was Senior Vice President of EGI from July 1992 until November 1994. Mr. Callahan was Vice President -- Finance of the Edward J. DeBartolo Corporation, a developer, owner and operator of shopping centers, in Youngstown, Ohio, from July 1988 until July 1992. Mr. Callahan was employed by Chemical Bank, a commercial bank located in New York, New York, from July 1973 until March 1987.
Richard D. Kincaid has been Executive Vice President and Chief Financial Officer of Equity Office since March 1997 and was Senior Vice President and Chief Financial Officer of the Company from October 1996 until March 1997. Mr. Kincaid was Senior Vice President and Chief Financial Officer of EOH from July 1995 until October 1997. Mr. Kincaid was Senior Vice President of EGI from February 1995 until July 1995. Mr. Kincaid was Senior Vice President of the Yarmouth Group, a real estate investment company in New York, New York, from August 1994 until February 1995. Mr. Kincaid was Senior Vice President -- Finance for EGI from December 1993 until July 1994. Mr. Kincaid was Vice President -- Finance for EGI from August 1990 until December 1993. Mr. Kincaid was Vice President for Barclays Bank PLC, a commercial bank located in Chicago, Illinois, from August 1987 until August 1990.
Michael A. Steele has been Executive Vice President -- Real Estate Operations and Chief Operating Officer for Equity Office since March 1998 and was Executive Vice President -- Real Estate Operations of the Company from October 1996 until February 1998. Mr. Steele was President and Chief Operating Officer of EOP LLC from July 1995 until October 1997. Mr. Steele was Executive Vice President of EOH from July 1995 until October 1997. Mr. Steele was President and Chief Operating Officer of Equity Office Properties, Inc., a subsidiary of EGI which provided real estate property management services ("EOP, Inc."), from November 1993 through October 1995. Mr. Steele was President and Chief Executive Officer of First Office Management, a former division of Equity Property Management, Inc., that provided real estate property management services ("FOM"), from June 1992 until October 1993. Mr. Steele was Senior Vice President and regional director for Rubloff, Inc., a full service real estate company in Chicago, Illinois, from April 1987 until June 1992.
Stanley M. Stevens has been Executive Vice President, Chief Legal Counsel and Secretary of the Equity Office since October 1996. Mr. Stevens was Executive Vice President and General Counsel of EOH from September 1996 until October 1997. Mr. Stevens was a vice president of Rosenberg & Liebentritt, P.C., a law firm in Chicago, Illinois, from December 1993 until September 1996. Mr. Stevens was a partner at Rudnick & Wolfe, a national law firm based in Chicago, Illinois, from October 1987 until December 1993.
David A. Helfand has been Executive Vice President -- New Business Development of Equity Office since February 2000 and was its Senior Vice President -- New Business Development from July 1998 to February 2000. Mr. Helfand was Managing Director of Equity International Properties, Ltd. from December 1997 until July 1998. Mr. Helfand was Chief Executive Officer of Manufactured Home Communities, Inc. from August 1996 until December 1997 and was President of Manufactured Home Communities, Inc. from January 1995 until July 1996. From December 1992 until February 1995, Mr. Helfand was Chief Financial Officer and from March 1994 until January 1995, he was Vice President of Manufactured Home Communities, Inc. Since May 1995, Mr. Helfand has been a member of the Board of Directors of Manufactured Home Communities, Inc.
Peter H. Adams has been Senior Vice President -- Pacific Region of Equity Office since March 1998 and was Regional Vice President -- Pacific Region of the Company from March 1997 until February 1998. Mr. Adams was Vice President - -- Group Manager of EOH from July 1994 until July 1995, and Vice President -- Regional Manager from July 1995 until March 1997. Mr. Adams was President of Adams Equities, a private real estate consulting firm, from 1990 to 1994.
Stephen M. Briggs has been Senior Vice President -- Accounting and Financial Reporting of Equity Office since April 1999. Mr. Briggs was Vice President -- Accounting and Financial Reporting of the Company from July 1997 until March 1999. Mr. Briggs was Vice President -- Financial Accounting of EOP, Inc. from November 1993 until July 1997.
Sybil J. Ellis has been Senior Vice President -- Real Estate Investments of Equity Office since December 1999. Ms. Ellis was Senior Vice President -- Acquisitions of the Company from March 1997 until December 1999. Ms. Ellis was Senior Vice President -- Acquisitions of EOH from July 1995 until October 1997. Ms. Ellis was Senior Vice President -- Acquisitions of EOP, Inc. from July 1994 through July 1995 and was Vice President -- Acquisitions of EOP, Inc. from November 1993 until July 1994. Ms. Ellis was Vice President -- Acquisitions of EAM from March 1990 until October 1993.
Maureen O. Fear has been Senior Vice President -- Treasurer of Equity Office since November 1998. Ms. Fear was Assistant Treasurer of Comdisco, Inc. from 1992 until November 1998. From 1989 until 1992, Ms. Fear was Cash Manager of Comdisco, Inc. and from 1984 until 1989, Ms. Fear was Transaction Analyst, Private Placement Group of Comdisco, Inc.
Debra L. Ferruzzi has been Senior Vice President and Executive Advisor of Equity Office since June 1998. Ms. Ferruzzi was Senior Vice President -- Finance for EGI from December 1995 until June 1998. Ms. Ferruzzi was Vice President of EAM from December 1992 until December 1995. She was employed by EGI from 1982 until May 1998.
Frank Frankini has been Senior Vice President -- Design and Construction of Equity Office since March 1997. Mr. Frankini was Senior Vice President -- Design and Construction of EOP LLC from July 1995 until October 1997. Mr. Frankini was Senior Vice President -- Engineering and Operations of EOP, Inc. from November 1993 until July 1995. Mr. Frankini was Senior Vice President -- Engineering and Operations of FOM from October 1990 until October 1993. Mr. Frankini was National Director of Engineering and Operations for Rubloff, Inc., a full service real estate company in Chicago, Illinois, from October 1984 until October 1990.
Peter D. Johnston has been Senior Vice President -- Southwest Region of Equity Office since March 1998 and was Regional Vice President -- Southwest Region from January 1998 until February 1998. Mr. Johnston was Senior Vice President -- National Accounts from April 1993 until February 1998.
Kim J. Koehn has been Senior Vice President -- West Region of Equity Office since March 1998 and was Regional Vice President -- West Region from March 1997 until February 1998 and was also Regional Vice President Southwest Region from March 1997 until December 1997. Mr. Koehn was Senior Vice President -- Asset Management of EOH from December 1995 to February 1997. Mr. Koehn was a Vice President of EOH from June 1993 until December 1995.
Frances P. Lewis has been Senior Vice President -- Corporate Communications of Equity Office since April 1997. Ms. Lewis was Vice President -- Corporate Communications of EGI from November 1994 until April 1997. Ms. Lewis was Vice President -- Publications of EGI from September 1988 until October 1994.
Anita A. Loch has been Senior Vice President -- Human Resources of Equity Office since January 1999. Ms. Loch was Vice President of Human Resources of Moore Corporation, Ltd., a manufacturer, seller and distributor of business communication products, from 1997 until December 1998. From 1992 until 1997, Ms. Loch was Vice President of Human Resources of Continental Can Europe, White Cap, Inc. Division.
Gregory S. Mancuso has been Senior Vice President -- Information Systems of Equity Office since October 1998. Mr. Mancuso was Senior Vice President, Business Systems Integration Group of ERE Yarmouth, an international real estate consulting company, from 1997 until September 1998. Mr. Mancuso was Senior Vice President/CIO of The Yarmouth Group, Inc., from 1994 until 1997, and was Senior Vice President of The Yarmouth Group, Inc. from 1991 until 1994. Mr. Mancuso held various positions at The Yarmouth Group, Inc. from 1982 through 1997.
Diane M. Morefield has been Senior Vice President -- Investor Relations since January 1999 and was Senior Vice President -- Finance/Capital Markets of Equity Office from July 1997 until December 1998. Ms. Morefield was Senior Manager in the Corporate Finance practice of Deloitte & Touche, a public accounting and consulting firm, from November 1994 until July 1997. Ms. Morefield was Executive Vice President of the Fordham Company, a real estate development company located in Chicago, Illinois, from
November 1993 until November 1994. Ms. Morefield was Vice President and Team Leader for the Real Estate Group division, in the Midwest, of Barclays Bank PLC from August 1983 until November 1993.
Christopher P. Mundy has been Senior Vice President -- Northeast Region of Equity Office since March 1998, and was Regional Vice President -- Northeast Region from July 1997 until February 1998. Mr. Mundy was Vice President -- Leasing of EOH from November 1991 until July 1997.
David H. Naus has been Senior Vice President -- Real Estate Investments of Equity Office since December 1999. Mr. Naus was Senior Vice President -- Acquisitions of the Company from March 1997 until December 1999. Mr. Naus was Senior Vice President -- Acquisitions for EOH from December 1995 until October 1997. Mr. Naus was Vice President -- Acquisitions of EOH from July 1995 until December 1995. Mr. Naus was Vice President -- Acquisitions of EOP, Inc. from November 1993 until July 1995. Mr. Naus was Vice President -- Acquisitions of EAM from November 1992 until November 1993. Mr. Naus was Vice President of EAM from October 1988 until November 1992.
Arvid A. Povilaitis has been Senior Vice President -- Central Region of Equity Office since March 1998 and was Regional Vice President -- Central Region from March 1997 until February 1998. Mr. Povilaitis was Vice President -- Asset Management of EOH from August 1994 until February 1997. Mr. Povilaitis was Vice President Investment Properties of Strategic Realty Advisors, Inc., a real estate and advisory company, from January 1994 until August 1994. Mr. Povilaitis was employed at VMS Realty Partners, a sponsor of public and private real estate limited partnerships, from January 1983 until January 1994, most recently serving as Second Vice President.
John C. Schneider has been Senior Vice President -- Legal and Associate General Counsel for Property Operations of Equity Office since July 1998. From January 1997 until June 1998, Mr. Schneider was a Vice President of the Company. From January 1994 until December 1996, Mr. Schneider was a vice president of Rosenberg & Liebentritt, P.C.
Mark E. Scully has been Senior Vice President -- Southeast Region of Equity Office since March 1998 and was Regional Vice President for the Southeast Region from March 1997 until February 1998. Mr. Scully was Vice President -- Regional Leasing Director of EOH from January 1995 until February 1997. Mr. Scully was Regional Leasing Director of EOH from September 1991 until December 1994.
Michael E. Sheinkop has been Senior Vice President -- Real Estate Services of the Company since January 1999 and was Senior Vice President -- Portfolio Management of the Company from November 1997 until December 1998. Mr. Sheinkop was Senior Vice President -- Divisional Manager of EOH from March 1997 until October 1997 and for the Company from March 1997 through December 1997. Mr. Sheinkop was Senior Vice President -- Asset Management of EOH from December 1995 until February 1997. Mr. Sheinkop was Vice President -- Asset Management of EOH from July 1995 until December 1995. Mr. Sheinkop was Vice President -- Asset Management of EOP, Inc. from November 1993 until July 1995. Mr. Sheinkop was Vice President of EAM from March 1990 until November 1993.
RISK FACTORS
Set forth below are the risks that we believe are material to investors who purchase or own our units of limited partnership interest. Our units of limited partnership interest are redeemable on a one-for-one basis for Equity Office common shares or their cash equivalent, at the election of Equity Office. We refer to our units as our "securities" and the investors who own units as our "securityholders."
WE MAY BE UNABLE TO MANAGE EFFECTIVELY OUR RAPID GROWTH AND EXPANSION INTO NEW MARKETS. We have grown rapidly since Equity Office's initial public offering in July 1997. As of December 31, 1999, we owned interests in 294 office properties containing 77.0 million square feet. On a square footage basis, our office portfolio grew by 139%, from the time of our initial public offering in July 1997 through the end of 1999. If we do not effectively manage our rapid growth, we may not be able to make expected distributions to our securityholders and the market value of our securities may decline.
OUR PERFORMANCE AND SECURITIES VALUE ARE SUBJECT TO RISKS ASSOCIATED WITH THE REAL ESTATE INDUSTRY. If we do not generate income sufficient to pay our expenses, service our debt and maintain our properties, we may not be able to make expected distributions to our securityholders. As a real estate company, we are susceptible to the following real estate industry risks:
- downturns in the national, regional and local economic conditions where our properties are located;
- local conditions such as an oversupply of office properties or a reduction in demand for office properties;
- the attractiveness of our properties to tenants;
- competition from other available office properties;
- changes in market rental rates and the need to periodically repair, renovate and relet space;
- our ability to collect rent from tenants; and
- our ability to pay for adequate maintenance, insurance and other operating costs, including real estate taxes that may increase over time as markets stabilize, and that are not necessarily reduced when circumstances such as market factors and competition cause a reduction in income from the property.
WE MAY BE UNABLE TO RENEW LEASES OR RELET SPACE AS LEASES EXPIRE. When our tenants decide not to renew their leases upon expiration, we may not be able to relet the space. Even if the tenants do renew or we can relet the space, the terms of renewal or reletting, including the cost of required renovations, may be less favorable than current lease terms or less favorable than the market has anticipated in the valuation of our securities. From now through December 31, 2004, leases will expire on a total of 62% of the currently occupied rentable square feet at our properties. If we are unable to promptly renew the leases or relet this space, or if the rental rates upon a renewal or reletting are significantly lower than expected rates, then our cash flow and ability to service debt and make distributions to securityholders would be adversely affected.
NEW ACQUISITIONS MAY FAIL TO PERFORM AS EXPECTED. Assuming we are able to obtain capital on commercially reasonable terms, we intend to continue to actively acquire office properties. Newly acquired properties may fail to perform as expected. We may underestimate the costs necessary to bring an acquired property up to standards established for its intended market position.
COMPETITION FOR ACQUISITIONS COULD RESULT IN INCREASED PRICES FOR PROPERTIES. We expect other major real estate investors with significant capital to compete with us for attractive investment opportunities. These competitors include publicly traded REITs, private REITs, investment banking firms and private institutional investment funds. This competition could increase prices for office properties.
BECAUSE REAL ESTATE INVESTMENTS ARE ILLIQUID, WE MAY NOT BE ABLE TO SELL PROPERTIES WHEN APPROPRIATE. Real estate investments generally cannot be sold quickly. We may not be able to vary our portfolio promptly in response to economic or other conditions. This inability to respond to changes in the performance of our investments could adversely affect our ability to service debt and make distributions to our securityholders. In addition, our ability to realize the full economic value from the sale of some of our assets may be limited by
potential adverse tax consequences to us or to Equity Office or by agreements that we have entered into in connection with the acquisition of some of our properties that may limit our ability to sell our assets.
SOME POTENTIAL LOSSES ARE NOT COVERED BY INSURANCE. We carry comprehensive liability, fire, extended coverage and rental loss insurance on all of our properties. There are, however, some types of losses, such as lease and other contract claims, that generally are not insured. Should an uninsured loss or a loss in excess of insured limits occur, we could lose all or a portion of the capital we have invested in a property, as well as the anticipated future revenue from the property. Nevertheless, we might remain obligated for any mortgage debt or other financial obligations related to the property.
We carry earthquake insurance on all of our properties, including those located in California. Our earthquake policies are subject, however, to coverage limitations. We cannot guarantee that material losses in excess of insurance proceeds will not occur in the future.
WE DO NOT CONTROL THE DECISIONS OF JOINT VENTURES OR PARTNERSHIPS IN WHICH WE HOLD LESS THAN A CONTROLLING INTEREST. We from time to time invest in joint ventures or partnerships in which we do not hold a controlling interest. These investments involve risks that are not present with assets in which we own a controlling interest, including the possibility that our co-venturers or partners might at any time have economic or other business interests or goals that are inconsistent with our business interests or goals. Because we lack a controlling interest, our co-venturers or partners may be in a position to take action contrary to our instructions or requests or contrary to our policies or objectives. There is no limitation under our organizational documents as to the amount of available funds that we may invest in joint ventures or partnerships.
SCHEDULED DEBT PAYMENTS COULD ADVERSELY AFFECT OUR FINANCIAL CONDITION. Our business is subject to risks normally associated with debt financing. If principal payments due at maturity cannot be refinanced, extended or paid with proceeds of other capital transactions, such as new equity capital, our cash flow will not be sufficient in all years to repay all maturing debt. If prevailing interest rates or other factors at the time of refinancing, such as the possible reluctance of lenders to make commercial real estate loans, result in higher interest rates, increased interest expense would adversely affect cash flow and our ability to service debt and make distributions to our securityholders.
WE ARE OBLIGATED TO COMPLY WITH FINANCIAL COVENANTS IN OUR DEBT THAT COULD RESTRICT OUR RANGE OF OPERATING ACTIVITIES. The mortgages on our properties contain customary negative covenants, including limitations on our ability, without the prior consent of the lender, to further mortgage the property, to enter into new leases outside of stipulated guidelines or to materially modify existing leases. In addition, our credit facility contains customary requirements to, and restrictions and other limitations on our ability to incur debt, including debt to assets ratios, secured debt to total assets ratios, debt service coverage ratios and minimum ratios of unencumbered assets to unsecured debt. The indenture under which our senior unsecured debt is issued contains financial and operating covenants including coverage ratios and limitations on our ability to incur secured and unsecured debt. These covenants will reduce our flexibility in conducting our operations and create a risk of default on our debt if we cannot continue to satisfy them.
OUR DEGREE OF LEVERAGE COULD LIMIT OUR ABILITY TO OBTAIN ADDITIONAL FINANCING. Our debt to market capitalization ratio, which we calculate as total debt as a percentage of total debt plus the value of our preferred units and the market value of our units, was approximately 43.3% as of December 31, 1999. Our leverage could have important consequences to our securityholders, including affecting our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions, development or other general corporate purposes and making us more vulnerable to a downturn in business or the economy generally.
RISING INTEREST RATES COULD ADVERSELY AFFECT OUR CASH FLOW. Advances under our credit facility bear interest at a variable rate based upon LIBOR. We may borrow additional money with variable interest rates in the future, and may enter into other transactions to limit our exposure to rising interest rates as we determine to be appropriate and cost effective. Increases in interest rates, or the loss of the benefits of hedging agreements, would increase our interest expenses, which would adversely affect cash flow and our ability to service our debt and make distributions to our securityholders.
WE DO NOT CONTROL OUR MANAGEMENT AND SERVICES BUSINESSES. To facilitate maintenance of Equity Office's REIT qualification, we have "noncontrolled subsidiaries" that provide management and other services for properties that we do not wholly own. While we generally own at least 95% of the economic interest in the noncontrolled subsidiaries, their voting stock is owned directly or indirectly by private companies controlled by Mr. Zell or in the case of Real State Insurance Corporation and Equity Business Centers Corp., key officers of Equity Office. Therefore, we do not control the timing or amount of distributions, the management, business policies, or operation of the noncontrolled subsidiaries. As of December 31, 1999, we had seven active noncontrolled subsidiaries, including:
- Equity Office Properties Management Corp. and Beacon Property Management Corporation, referred to as the "management companies," which manage several properties that we do not wholly own;
- Beacon Construction Company, Inc., which provides third-party construction services;
- Beacon Design Corp., which holds a partnership interest in the Riverside development project;
- EOP Office Company, which owns a noncontrolling interest in Wright Runstad Associates Limited Partnership, a provider of third-party development and management services;
- Real State Insurance Corporation which provides risk management and insurance services for our properties and whose voting stock is owned directly or indirectly by Tim Callahan, Michael Steele, Richard Kincaid, Stanley Stevens and David Helfand; and
- Equity Business Centers Corp., whose voting stock is owned directly or indirectly by Tim Callahan, Michael Steele, Richard Kincaid and Stanley Stevens, which owns an interest in Regus Equity Business Centers Corp., which operates business centers in our properties.
MR. ZELL'S AFFILIATES CONTROL OUR MANAGEMENT AND SERVICES BUSINESSES AND SOME OF THE PROPERTIES WHICH WE MANAGE BUT DO NOT OWN. The management companies provide property management services and asset management services to several properties, some of which are owned or controlled by affiliates of Mr. Zell. Most of these management contracts were not negotiated on an arm's length basis. While we believe that the management fees received from these properties are at current market rates, we cannot assure our securityholders that these management fees will equal at all times those fees that would be charged by an unaffiliated third party. In this regard, Mr. Zell controls and has a substantial interest in the private company which has voting control of the management companies.
MR. ZELL AND HIS AFFILIATES CONTINUE TO BE INVOLVED IN OTHER INVESTMENT ACTIVITIES. Although Mr. Zell entered into a noncompetition agreement at the time of Equity Office's initial public offering, he and his affiliates have a broad and varied range of investment interests, including interests in other real estate investment companies. Mr. Zell's continued involvement in other investment activities could result in competition for us as well as management decisions which might not reflect the interests of our securityholders. Mr. Zell's noncompetition agreement does not apply to activities outside the United States.
ENVIRONMENTAL PROBLEMS ARE POSSIBLE AND CAN BE COSTLY. Federal, state and local laws and regulations relating to the protection of the environment may require a current or previous owner or operator of real estate to investigate and clean up hazardous or toxic substances or petroleum product releases at that property. If unidentified environmental problems arise, we may have to make substantial payments which could adversely affect our cash flow and our ability to make distributions to our securityholders because:
- the owner or operator may have to pay a governmental entity or third parties for property damage and for investigation and clean-up costs incurred by these parties in connection with the contamination;
- these laws typically impose clean-up responsibility and liability without regard to whether the owner or operator knew or caused the presence of the contaminants;
- even if more that one person may have been responsible for the contamination, each person covered by the environmental laws may be held responsible for all of the clean-up costs incurred; and
- third parties may sue the owner or operator of a site for damages and costs resulting from environmental contamination emanating from that site.
Environmental laws also govern the presence, maintenance and removal of asbestos. These laws require that owners or operators of buildings containing asbestos:
- properly manage and maintain the asbestos;
- notify and train those who may come into contact with asbestos; and
- undertake special precautions, including removal or other abatement, if asbestos would be disturbed during renovation or demolition of a building. These laws may impose fines and penalties on building owners or operators who fail to comply with these requirements and may allow third parties to seek recovery from owners or operators for personal injury associated with exposure to asbestos fibers.
Independent environmental consultants have conducted Phase I environmental site assessments at all of our properties. These assessments included, at a minimum, a visual inspection of the properties and the surrounding areas, an examination of current and historical uses of the properties and the surrounding areas and a review of relevant state, federal and historical documents. Where appropriate, on a property by property basis, these consultants have conducted additional testing, including sampling for asbestos, for lead in drinking water, for soil contamination where underground storage tanks are or were located or where other past site usages create a potential environmental problem, and for contamination in groundwater.
These environmental assessments have not revealed any environmental liabilities at the properties that would require us to make payments of amounts material to our business, nor are we aware of any material environmental liability. A number of the office properties contain asbestos, but most of these buildings contain only minor amounts. We believe this asbestos is in good condition and almost none of it is easily crumbled so as to cause the release of asbestos fibers. We are currently properly managing and maintaining all of the asbestos and are following other requirements relating to asbestos. The presence of asbestos should not present a significant risk as long as compliance with these requirements continues.
For a few of our properties, the environmental assessments note potential offsite sources of contamination such as underground storage tanks. For some of the properties, the environmental assessments note previous uses, such as the former presence of underground storage tanks. In most of these cases, follow-up soil and/or groundwater sampling has not identified evidence of significant contamination. In the few cases where contamination has been found, existing plans to mitigate and monitor the sites and/or financial commitments from some prior owners and tenants to cover costs related to mitigation should prevent the contamination from becoming a significant liability for us.
WE ARE DEPENDENT ON KEY PERSONNEL. We depend on the efforts of Mr. Zell and Equity Office's executive officers, particularly Mr. Callahan. If they were to resign, our operations could be adversely affected. Equity Office does not have employment agreements with Mr. Zell or any of its executive officers.
CONTINGENT OR UNDISCLOSED LIABILITIES ACQUIRED IN MERGERS OR SIMILAR TRANSACTIONS COULD REQUIRE US TO MAKE SUBSTANTIAL PAYMENTS. The properties which we acquired in our formation and in our 1997 merger with Beacon Properties L.P. were acquired subject to liabilities and without any recourse with respect to unknown liabilities. In addition, we have acquired numerous other properties where we have only limited recourse with respect to unknown liabilities. As a result, if liabilities were asserted against us based upon any of those properties, we might have to pay substantial sums to settle it, which could adversely affect our cash flow and our ability to service debt and make distributions to our securityholders. Unknown liabilities with respect to properties acquired might include:
- liabilities for clean-up or remediation of undisclosed environmental conditions;
- unasserted claims of 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.
WE ARE DEPENDENT ON EXTERNAL SOURCES OF CAPITAL FOR FUTURE GROWTH. To qualify as a REIT, Equity Office must distribute to its shareholders each year at least 95% of its net taxable income, excluding any net capital gain. For taxable years beginning after December 31, 2000, this REIT distribution requirement will be 90%. Our partnership agreement generally requires us to distribute substantially all of our net cash revenues each quarter and to make reasonable efforts to distribute to Equity Office enough cash for it to meet the 95% distribution requirement. Because of these distribution requirements, it is not likely that we will be able to fund all future capital needs, including for acquisitions, from income from operations. Therefore, we will have to rely on third-party sources of capital which may or may not be available on favorable terms or at all. Our access to third-party sources of capital depends on a number of things, including the market's perception of our growth potential and our current and potential future earnings. Moreover, additional equity offerings may result in substantial dilution of our shareholders' interests, and additional debt financing may substantially increase our leverage.
EQUITY OFFICE INTENDS TO QUALIFY AS A REIT, BUT WE CANNOT GUARANTEE THAT IT WILL QUALIFY. We believe that Equity Office has qualified for taxation as a REIT for federal income tax purposes since 1997. Equity Office plans to continue to meet the requirements for taxation as a REIT, but we cannot guarantee that it will qualify as a REIT. Many of the REIT requirements are highly technical and complex. The determination that Equity Office is a REIT requires an analysis of various factual matters and circumstances that may not be totally within its control. For example, to qualify as a REIT, at least 95% of Equity Office's gross income must come from sources that are itemized in the REIT tax laws. It is also required to distribute to shareholders at least 95% of its REIT taxable income, excluding capital gains. For taxable years beginning after December 31, 2000, this REIT distribution requirement will be 90%. The fact that Equity Office holds its assets through us and our subsidiaries further complicates the application of the REIT requirements. Even a technical or inadvertent mistake could jeopardize Equity Office's REIT status. Furthermore, Congress and the IRS might make changes to the tax laws and regulations, and the courts might issue new rulings that make it more difficult, or impossible, for Equity Office to remain qualified as a REIT. We do not believe, however, that any pending or proposed tax law changes would jeopardize Equity Office's REIT status.
If Equity Office failed to qualify as a REIT, Equity Office would be subject to federal income tax at regular corporate rates. Also, unless the IRS granted relief under statutory provisions, Equity Office would remain disqualified as a REIT for the four years following the year it first failed to qualify. If Equity Office failed to qualify as a REIT, it would have to pay significant income taxes. This would likely have a significant adverse effect on the value of its securities. In addition, Equity Office would no longer be required to make any distributions to its shareholders, but we would still be required to distribute quarterly substantially all of our net cash revenues to our securityholders, including Equity Office.
EQUITY OFFICE PAYS SOME TAXES. Even if Equity Office qualifies as a REIT, it may still be required to pay some federal, state and local taxes on its income and property. In addition, any net taxable income earned directly by the noncontrolled subsidiaries is subject to federal, state and local corporate tax. We expect that some or all of the noncontrolled subsidiaries will elect, under recently enacted REIT tax laws, to be treated as "taxable REIT subsidiaries" after December 31, 2000. A taxable REIT subsidiary will be a fully taxable corporation and will be limited in its ability to deduct interest payments made to us. In addition, Equity Office will be subject to a 100% penalty tax on its share of some payments that we receive if the economic arrangements between Equity Office, us, our tenants, and the taxable REIT subsidiary are not comparable to similar arrangements between unrelated parties.
WE INTEND TO QUALIFY AS A PARTNERSHIP, BUT CANNOT GUARANTEE THAT WE WILL QUALIFY. We intend to qualify as a partnership for federal income tax purposes. However, we will be treated as a corporation for federal income tax purposes if we are a "publicly traded partnership," unless at least 90% of our income is qualifying income as defined in the tax code. Qualifying income for the 90% test generally includes passive income, such as real property rents, dividends and interest. The income requirements applicable to REITs and the definition of qualifying income for purposes of this 90% test are similar in most respects. We believe that we would meet this qualifying income test, but cannot guarantee that we would. If we were to be taxed as a corporation, we would incur substantial tax liabilities, Equity Office would fail to qualify as a REIT for tax purposes and Equity Office's and our ability to raise additional capital would be impaired.
ITEM 2.
ITEM 2. PROPERTIES
All capitalized terms used herein and not otherwise defined shall have the meaning given in the Financial Statements set forth in Item 8.
GENERAL
The Company's portfolio (based on revenue and square footage) is the largest portfolio of office properties of any publicly traded, full-service office company in the United States. As of December 31, 1999, the Company owned or had an interest in 294 Office Properties containing approximately 77.0 million rentable square feet of office space and owned 20 stand-alone Parking Facilities containing approximately 20,506 parking spaces. The Office Properties are located in 81 submarkets in 35 markets in 23 states and the District of Columbia. The Office Properties, by rentable square feet, are located approximately 52% in CBDs and 48% in suburban markets. As of December 31, 1999, the Office Properties were, on a weighted average basis, 93.7% occupied by a total of 6,347 tenants, with no single tenant accounting for more than 1.6% of the Company's aggregate annualized rent (except for the U.S. General Services Administration, which accounted for 3.2% of annualized rent).
All property data is as of December 31, 1999.
OFFICE PROPERTIES BY REGION
(a) Annualized Rent is the monthly contractual rent under existing leases as of December 31, 1999, multiplied by 12. This amount reflects total base rent before any rent abatements, but includes expense reimbursements, which may be estimates. Total rent abatements for leases in effect as of December 31, 1999, for the 12 months ending December 31, 2000, are approximately $7.0 million.
OFFICE PROPERTY STATISTICS
- --------------- (a) Annualized Rent is the monthly contractual rent under existing leases as of December 31, 1999, multiplied by 12. This amount reflects total base rent before any rent abatements, but includes expense reimbursements, which may be estimates. Total rent abatements for leases in effect as of December 31, 1999, for the 12 months ending December 31, 2000, are approximately $7.0 million. (b) All or a portion of this Office Property is held subject to a ground lease with the exception of Denver Post Tower which is subject to an air rights lease. (c) This Office Property is held in a private real estate investment trust in which the Company and the Trust owns 51.6% of the outstanding shares. (d) This Office Property is held in a partnership with an unaffiliated third party and, in the case of San Felipe Plaza and Sunset North Corporate Campus, an affiliated party. (e) This Office Property was a development project placed in-service in November 1998. It is currently 78.0% occupied. (f) This Office Property completed a major redevelopment in June 1999. The property currently is 51.8% occupied and 64.3% leased, with occupancy to take place some time in the future. (g) The Company's interest in the amenities component of this Office Property is primarily attributable to its ownership of mortgage indebtedness encumbering the theatre/plaza, retail, health club and parking facilities associated therewith. (h) The Company acquired a first mortgage note secured by this Office Property. In accordance with certain agreements concerning the first mortgage note, the Company controls financial and operational decisions for the Property and is entitled to substantially all cash flow and residual profit. Accordingly, the Company consolidated the financial position and results of operations of the Property. (i) This Office Property was a development project purchased and placed in-service in July 1999. It is currently 26.9% occupied and 57.9% leased, with occupancy to take place some time in the future. (j) This was a development project that was placed in-service in May 1999. It is currently 85.7% occupied and 95.0% leased, with occupancy to take place some time in the future. (k) This Office Property was purchased in conjunction with the purchase of One Phoenix Plaza for the sole purpose of providing additional parking for the tenants of One Phoenix Plaza. (l) This Office Property is 100% leased to a single tenant on a triple net basis, whereby the tenant pays for certain operating expenses directly rather than reimbursing the Company. The amounts shown above for annualized rent include the amounts of reimbursement of expenses paid by the Company but do not make any adjustments for expenses paid directly by the tenant.
(m) This Office Property was a development project placed in-service in December 1999. It is currently 55.6% occupied and 96.9% leased with occupancy to take place some time in the future. (n) This Office Property is held subject to an interest in the improvements at the Property held by an unaffiliated third party. In addition, the Company has a mortgage interest in such improvements.
PARKING FACILITIES
- --------------- (a) Each of these parking Facilities is operated by the designated third-party service companies (each, a "Service Company") under a lease agreement whereby the Company and the Service Company share the gross receipts from the parking operation or the Company receives a fixed payment from the Service Company, and the Company bears none of the operational expenses.
(b) Each of these Parking Facilities is held in a partnership with an unaffiliated third party. The Company or a Subsidiary is the managing general partner of each such partnership.
(c) This Parking Facility is held subject to a ground lease.
(d) The Company acquired a leasehold interest in this parking facility. The lease is for a term of 50 years with four five-year options to renew. Pursuant to the lease, the Company is required to make annual rent payments of $172,500, and is required to make certain capital improvements to the garages of approximately $10.0 million during the first ten years of the lease. The Company has accounted for this transaction as a capital lease.
(e) The Company has a 50% membership interest in a portfolio of four Parking Facilities serving the St. Louis, Missouri area.
TENANTS
As of December 31, 1999, the Office Properties were leased to 6,347 tenants; no single tenant accounted for more than 1.6% of the Company's aggregate annualized rent or 1.2% of the aggregate occupied square feet (except for the U.S. General Services Administration, acting on behalf of various agencies or departments of the U.S. government, which accounted for 3.2% of the annualized rent and 3.2% of the occupied square feet).
LEASE EXPIRATION
- --------------- (1) Total net rentable square feet represented by expiring leases.
(2) Percentage of total net rentable feet represented by expiring leases.
(3) Annualized Rent is the monthly contractual rent under existing leases as of December 31, 1999 multiplied by 12. This amount reflects total base rent before any rent abatements, but includes expense reimbursements. Total rent abatements for leases in effect as of December 31, 1999 for the 12 months ending December 31, 2000 are approximately $7.0 million.
LEASE EXPIRATIONS -- TOTAL PORTFOLIO
The following table sets forth a summary schedule of the lease expirations for the Office Properties for leases in place as of December 31, 1999, assuming that none of the tenants exercise renewal options or termination rights, if any, at or prior to the scheduled expirations:
- --------------- (1) Based on current payable rent. (2) Represents lease expirations from January 1, 2000 to December 31, 2000 and month-to-month leases. (3) Reconciliation for total net rentable square footage is as follows:
LEASE DISTRIBUTION
The following table sets forth information relating to the distribution of the Office Property leases, based on rentable square feet under lease, as of December 31, 1999.
OCCUPANCY
The table below sets forth weighted average occupancy rates, based on square footage occupied, of the Office Properties owned by the Company at the indicated date:
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Neither the Company nor any of its Properties is presently subject to material litigation nor, to the Company's knowledge, is any litigation threatened against the Company or any of the Properties, other than routine actions for negligence and other claims and administrative proceedings arising in the ordinary course of business, some of which are expected to be covered by liability insurance and all of which collectively are not expected to have a material adverse effect on the liquidity, results of operations, or business or financial condition of the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
There is no established public trading market for the Units. The Trust's Common Shares are traded on the New York Stock Exchange ("NYSE") under the symbol EOP. The following table sets forth, for the periods indicated, the high and low closing prices of the Trust's Common Shares and the distributions paid on the Company's Units:
The number of holders of record of Units on March 1, 1999 was 269. The number of outstanding Units was 281,452,852 as of March 1, 2000.
ISSUANCE OF UNREGISTERED SECURITIES. Any Units issued by the Company are convertible into Common Shares of the Trust on a one-for-one basis, or the cash equivalent thereof, subject to certain restrictions.
In October 1999, the Company acquired an Office Property from an affiliated party for approximately $78.3 million. Of this amount, the Company issued, in a private placement of securities in reliance on an exemption from the registration requirements of the Securities Act pursuant to Section 4(2) and Rule 506 of Regulation D promulgated thereunder, 1,035,389 Units at a price of $29.50 per Unit. The Units were recorded at $23.64 each for a total of $24.5 million for accounting purposes.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
EOP OPERATING LIMITED PARTNERSHIP SELECTED FINANCIAL DATA(1)
The following sets forth selected consolidated and combined financial and operating information on a historical basis for EOP Operating Limited Partnership and the Company's predecessors ("Equity Office Predecessors") (the "Company"). The following information should be read in conjunction with the consolidated and combined financial statements and notes thereto of the Company and Equity Office Predecessors included elsewhere in this Form 10-K.
- ---------------
(1) The selected financial data at December 31, 1999, 1998, 1997, 1996 and 1995 and for the five years ended December 31, 1999 has been derived from the historical consolidated or combined financial statements of the Company and Equity Office Predecessors, audited by Ernst & Young LLP, independent auditors.
(2) Property operating expenses includes real estate taxes, insurance, repairs and maintenance and other property operating expenses.
(3) The White Paper on Funds from Operations approved by the Board of Governors of the National Association of Real Estate Investment Trusts ("NAREIT") in March 1995 defines Funds from Operations as net income (loss) (computed in accordance with GAAP), excluding gains (or losses) from debt restructuring and sales of properties, plus real estate related depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures. The Company believes that Funds from Operations is helpful to investors as a measure of the performance of an equity REIT because, along with cash flow from operating, investing and financing activities, it provides investors with an indication of the ability of the Company to incur and service debt, to make capital expenditures and to fund other cash needs. The Company computes Funds from Operations in accordance with standards established by NAREIT, which may not be comparable to Funds from Operations reported by other REITs that do not define the term in accordance with the current NAREIT definition or that interpret the current NAREIT definition differently than the Company. Funds from Operations does not represent cash generated from operating activities in accordance with GAAP, nor does it represent cash available to pay distributions and should not be considered as an alternative to net income (determined in accordance with GAAP) as
an indication of the Company's financial performance or to cash flow from operating activities (determined in accordance with GAAP) as a measure of the Company's liquidity, nor is it indicative of funds available to fund the Company's cash needs, including its ability to make cash distributions. For a reconciliation of net income to Funds from Operations, see "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Funds from Operations".
(4) Property Net Operating Income is defined as rental income including tenant reimbursements, parking and other income less property operating expenses including real estate taxes, insurance, repairs and maintenance and other property operating expenses.
(5) Earnings before interest, taxes, depreciation and amortization ("EBITDA") is defined as net income excluding interest expense, taxes, depreciation and amortization, net gain/(loss) on sales of real estate, gains/losses from extraordinary items and income from investment in unconsolidated joint ventures plus the Company's share of EBITDA for the unconsolidated joint ventures. EBITDA is presented because the Company believes this data is used by some investors to evaluate the Company's ability to meet debt service requirements. The Company considers EBITDA to be an indicative measure of its operating performance due to the significance of the Company's long-lived assets and because this data can be used to measure the Company's ability to service debt, fund capital expenditures and expand its business. However, this data should not be considered as an alternative to net income, operating profit, cash flows from operations or any other operating or liquidity performance measure prescribed by GAAP. In addition, EBITDA as calculated by the Company may not be comparable to similarly titled measures reported by other companies. Interest expense, taxes, depreciation and amortization, which are not reflected in the presentation of EBITDA, have been, and will be, incurred by the Company. Investors are cautioned that these excluded items are significant components in understanding and assessing the Company's financial performance.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
OVERVIEW
The following discussion and analysis of the consolidated financial condition and consolidated and combined results of operations should be read in conjunction with the Consolidated Financial Statements of the Company and the Combined Financial Statements of Equity Office Predecessors, and Notes thereto contained herein. All references to activities prior to the Trust's initial public offering ("IPO") on July 11, 1997, contained in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" refer to the activities of Equity Office Predecessors. Terms employed herein as defined terms, but without definition, shall have the meaning set forth in the financial statements. Statements contained in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" including without limitation, the "Market Risk" and "Developments" disclosures, which are not historical facts may be forward-looking statements. Such statements are subject to certain risks and uncertainties which could cause actual results to differ materially from those projected or anticipated. Readers are cautioned not to place undue reliance on these forward-looking statements which speak only as of December 31, 1999. Among the factors that the Company has made assumptions are the following:
- Future economic conditions which may impact upon the demand for office space and tenant ability to pay rent, either at current or at increased levels.
- Prevailing interest rates.
- The extent of any inflation on operating expenses.
- The Company's ability to reduce various expenses as a percentage of revenues.
- The Company's continuing ability to pay amounts due to its noteholders and preferred unitholders prior to any distribution to holders of its Units.
- The cost to complete and lease-up pending developments.
- The Company's continued access to adequate credit facilities on acceptable terms, including any amounts required for the Cornerstone Merger.
- The demand from the Company's customers for office-related services.
1999 HIGHLIGHTS:
- Acquired ten Office Properties containing approximately 1.9 million square feet and one Parking Facility for approximately $393.2 million in the aggregate.
- Invested approximately $73.9 million in mezzanine debt financing on the SunAmerica Center office property.
- Sold four Office Properties containing .7 million square feet in non-core markets and one redevelopment property for approximately $98.0 million.
- Sold a partial interest in twelve Office Properties for net proceeds of approximately $480 million to Lend Lease Australia/U.S. Properties.
- Issued the $1.0 Billion Notes in three tranches due in three, five and ten years with an effective overall interest rate of 6.8% per annum and issued the $200 Million Notes due in 30 years with an effective interest rate of 7.6% per annum.
- Repaid the $328 Million Credit Facility and the $200 Million Credit Facility.
- Introduced Access, a strategic business service unit providing additional products and services to Equity Office customers. The initial offerings include telecom, office suites, ATMs, training tools, and informational and advertising venues.
- The Trust received a Private Letter Ruling from the Internal Revenue Service allowing participation in the delivery of telecommunications services to customers without violation of REIT rules.
RESULTS OF OPERATIONS
GENERAL
The following discussion is based primarily on the Consolidated Financial Statements of the Company and the Combined Financial Statements of Equity Office Predecessors, as applicable, as of December 31, 1999 and 1998, and for the years ended December 31, 1999, 1998 and 1997.
The Company receives income primarily from rental revenue from Office Properties (including reimbursements from tenants for certain operating costs) and from parking revenue from Office Properties and Parking Facilities.
Below is a summary of the Company's acquisition and disposition activity since January 1, 1998. The buildings and total square feet shown include Properties the Company owns in joint ventures with other partners and reflects the total square footage of the Properties. Excluding the joint venture partner's share of the square feet of these Properties, the Company effectively owned approximately 72.9 million square feet of office space as of December 31, 1999.
- --------------- (1) The 601 Tchoupitoulas garage was previously considered a stand-alone garage and included in the number of Parking Facilities owned by the Company. Effective in the second quarter of 1999, this garage is no longer considered a stand-alone Parking Facility.
As a result of the acquisition and disposition of Properties, the financial data presented shows changes in revenues and expenses from period-to-period. Therefore the Company does not believe its period-to-period financial data are comparable. The following analysis shows changes resulting from Properties that were held during the entire period for the periods being compared (the "Core Portfolio") and the changes in the Total Portfolio.
As reflected in the tables below, property revenues include rental revenues, reimbursements from tenants for certain expenses, parking revenue and other property operating revenues. Property operating expenses include real estate taxes, insurance, repairs and maintenance and other property operating expenses.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 1999 TO DECEMBER 31, 1998
The table below represents selected operating information for the Total Portfolio and for the Core Portfolio consisting of 236 Office Properties and 16 Parking Facilities acquired or placed in service prior to January 1, 1998.
Property Revenues
The increase in property revenues in the Core Portfolio resulted from a combination of occupancy and rental rate increases. The weighted average occupancy of the Core Portfolio increased from 93.8% at January 1, 1998 to 94.6% at December 31, 1999. This increase represents approximately .5 million square feet of additional occupancy in the Core Portfolio.
Property revenues for the Total Portfolio include lease termination fees of approximately $15.9 million and $15.5 million for the years ended December 31, 1999 and 1998, respectively, and property revenues for the Core Portfolio include lease termination fees of approximately $12.8 million and $14.0 million for the years ended December 31, 1999 and 1998, respectively (lease termination fees are included in the "other revenue" category on the consolidated statements of operations). These fees relate to specific tenants who have paid a fee to terminate their lease obligations before the end of the contractual term of their lease. Although the
Company has historically experienced similar levels of such termination fees, there is no way of predicting the timing or amounts of future lease termination fees.
Property revenues for the Total Portfolio also include straight-line rent adjustments of approximately $65.4 million and $68.1 million for the years ended December 31, 1999 and 1998, respectively. Property revenues for the Core Portfolio include straight-line rent adjustments of approximately $44.7 million and $58.0 million for the years ended December 31, 1999 and 1998, respectively.
Interest Expense
Total Portfolio interest expense increased from the prior period as a result of having more debt outstanding primarily attributable to property acquisitions. The following statistics for each period for the Total Portfolio are as follows:
- Total debt to total assets decreased to 41.7% from 42.3%.
- Interest coverage ratio decreased to 2.9 times from 3.0 times.
- Weighted average interest rate increased to 7.2% from 7.1%.
Core Portfolio interest expense decreased from the prior period due to the paydown of mortgage debt with proceeds from various unsecured notes offerings and borrowing on the lines of credit. Interest expense on the unsecured notes and the lines of credit is not reflected in the Core Portfolio.
Depreciation and Amortization
Total Portfolio depreciation and amortization expense increased as a result of Properties acquired and capital and tenant improvements made during 1999 and 1998. Core Portfolio depreciation and amortization expense increased as a result of capital and tenant improvements made to the Properties.
Property Operating Expenses
Core Portfolio property operating expenses increased due to an increase in real estate tax expense of approximately $10.1 million due to higher property tax assessments in certain markets and an increase in insurance expense. These increases were partially offset by decreases in repairs and maintenance and other property operating expenses.
General and Administrative Expenses
General and administrative expenses increased due to increases in the size of the Company's portfolio and additional expenses associated with being a public company. During 1999, the Company made significant investments in its information systems, including the hiring of additional personnel and established a real estate services group. In addition, the Company incurred severance costs during 1999 that were not incurred in 1998. While general and administrative expenses are expected to continue to increase along with any increase in the size of the Company's portfolio, it is also anticipated that the Company will realize economies of scale with future growth, should it occur.
Income from Investment in Unconsolidated Joint Ventures
Income from investment in unconsolidated joint ventures increased for the Total Portfolio due to the partial sale of twelve Office Properties in December 1999. The Company retained an equity interest in the twelve Office Properties and accounts for its remaining interest under the equity method of accounting. Prior to the sale, the Company consolidated the results of operations of such Office Properties.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 1998 TO DECEMBER 31, 1997
The table below represents selected operating information for the Total Portfolio and for the Core Portfolio consisting of 77 Office Properties and ten Parking Facilities acquired or placed in service prior to January 1, 1997.
Property Revenues
The increase in property revenues in the Core Portfolio resulted from a combination of occupancy and rental rate increases. The weighted average occupancy of the Core Portfolio increased from 91.9% at January 1, 1997 to 96.1% as of December 31, 1998. This increase represents approximately 1.2 million square feet of additional occupancy in the Core Portfolio.
Property revenues for the Total Portfolio include lease termination fees of approximately $15.5 million and $3.9 million for the years ended December 31, 1998 and 1997, respectively, and property revenues for the Core Portfolio include lease termination fees of approximately $3.7 million and $3.8 million for the years ended December 31, 1998 and 1997, respectively, (lease termination fees are included in the "other revenue" category on the consolidated and combined statements of operations). These fees relate to specific tenants who have paid a fee to terminate their lease obligations before the end of the contractual term of their lease. Although the Company has historically experienced similar levels of such termination fees, there is no way of predicting the timing or amounts of future lease termination fees.
Property revenues for the Total Portfolio include straight-line rent adjustments of approximately $68.1 million and $27.7 million, for the years ended December 31, 1998 and 1997, respectively. Property revenues for the Core Portfolio include straight-line rent adjustments of approximately $26.2 million and $23.4 million, for the years ended December 31, 1998 and 1997, respectively.
Fee Income
The increase in fee income for the Total Portfolio is mainly due to lease commissions received of approximately $2.8 million at a single property and the addition of several properties the Company manages.
Interest/Dividend Income
Interest/dividend income for the Total Portfolio decreased mainly as a result of less cash and cash equivalents on deposit during 1998 partially offset by dividend income earned during the year on an investment in preferred securities.
Interest Expense
Total Portfolio interest expense increased from the prior period as a result of having more debt outstanding attributable primarily to Property acquisitions. The following statistics for each period for the Total Portfolio are as follows:
- Total debt to total assets increased to 42.3% from 36.5%.
- Interest coverage ratio increased to 3.0 times from 2.8 times.
- Weighted average interest rate decreased to 7.1% from 7.2%.
The decrease in interest expense in the Core Portfolio is primarily due to the pay down of outstanding indebtedness with the IPO proceeds and the replacement of secured debt with unsecured debt. Interest on unsecured debt is not reflected in the Core Portfolio.
Depreciation and Amortization
Total Portfolio depreciation and amortization expense increased as a result of Properties acquired and capital and tenant improvements made during 1998 and 1997. Core Portfolio depreciation and amortization expense increased as a result of capital and tenant improvements. In addition, a portion of the increase in the depreciation and amortization expense for the Total and Core Portfolio was due to recording substantially all the Company's assets and liabilities at their fair market value in connection with the Consolidation and the IPO.
Property Operating Expenses
Core Portfolio property operating expenses increased mainly as a result of real estate taxes. Real estate taxes increased approximately $4.6 million from the prior period of which approximately $2.3 million related to higher property tax assessments in certain markets and $2.3 million related to lower real estate tax refunds. Insurance expense decreased approximately $1.6 million from the prior period as the Company's ability to achieve economies of scale on its insurance coverage resulted in lower premiums in 1998.
General and Administrative Expenses
General and administrative expenses increased due to the size of the Company's portfolio increasing and additional expenses associated with being a public company. While general and administrative expenses are expected to continue to increase along with any increase in the size of the portfolio, it is currently anticipated that the Company's general and administrative expenses as a percentage of total revenues will remain stable with future growth. General and administrative expense was approximately 3.8% and 4.6% of total revenues for the years ended December 31, 1998 and 1997, respectively.
PARKING OPERATIONS
The Total Portfolio and Core Portfolio selected operating information for 1999, 1998, and 1997 presented above includes results of operations from the Parking Facilities. Summarized information for the Parking Facilities is presented below.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 1999 TO DECEMBER 31, 1998
The table below represents selected operating information for the Total Portfolio and the Core Portfolio consisting of 16 Parking Facilities acquired prior to January 1, 1998.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 1998 TO DECEMBER 31, 1997
The table below represents selected operating information for the Total Portfolio and the Core Portfolio consisting of ten Parking Facilities acquired prior to January 1, 1997.
PROPERTY DISPOSITIONS
The Company has disposed of the following properties since January 1, 1997:
After the Company sold the above properties, the Company continued as the property manager for One Columbus, First Union Center, One Clearlake Centre, Tampa Commons and Westshore Center as well as the Properties described in Note (1) below. Below is a summary of the results of operations of these office properties through their respective disposition dates:
- --------------- (1) These Office Properties were partially sold in December 1999. The above condensed statements of operations include the results of operations for these Properties through their disposition date. Since the Company retained an equity interest in these Office Properties and shares equally in the control of the operations and major decisions of these Properties, the Company now accounts for these Properties under the equity method of accounting. The following table shows the Company's share of the results of operations excluding the gain on sales of real estate from these Properties under the equity method as if
they were partially sold on January 1, 1997 or the Properties original acquisition date if the Property was acquired subsequent to January 1, 1997:
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
Net cash from operations represents the primary source of liquidity to fund distributions, debt service, recurring capital costs and non-revenue enhancing tenant improvements. The Company currently intends to continue to make, but has not contractually bound itself to make, regular quarterly distributions to holders of Units and preferred units. Subject to the foregoing, the Company has established annual distribution rates as follows:
- $1.68 per annum per Unit
- 8.98% per annum ($2.245 per unit) per Series A Preferred Unit
- 5.25% per annum ($2.625 per unit) per Series B Preferred Unit
- 8.625% per annum ($2.15625 per unit) per Series C Preferred Unit
The Company intends to continue to fund distributions, debt service, recurring capital costs and non-revenue enhancing tenant improvements from cash from operations and borrowings under its unsecured credit facilities. The Company also expects that its unsecured credit facilities will provide for temporary working capital, the funding of capital improvements and revenue enhancing tenant improvements, unanticipated cash needs and funding of acquisitions and development costs.
Since the anticipated size of the Company's distributions will not allow the Company, using only cash from operations, to retire all of its debt as it comes due, the Company will be required to repay maturing debt with funds from debt and/or capital financing.
DEBT FINANCING
The table below summarizes the mortgage debt, unsecured notes and lines of credit indebtedness outstanding at December 31, 1999 and 1998, including a net premium on mortgage debt and unsecured notes (net of accumulated amortization of approximately $3.9 million and $2.7 million) of approximately $10.6 million and $17.8 million, respectively, recorded in connection with the Consolidation, debt assumed in connection with certain property acquisitions and the issuances of unsecured notes.
A majority of the variable rate debt shown above bears interest based on various spreads over LIBOR.
MORTGAGE FINANCING
As of December 31, 1999, the Company's total mortgage debt (excluding the Company's share of unconsolidated debt of approximately $264.8 million) consisted of approximately $1.6 billion of fixed rate debt with a weighted average interest rate of approximately 7.5% and $126.3 million of variable rate debt based on various spreads over LIBOR or the prime rate. The Company's mortgage debt at December 31, 1999 will mature as follows:
In February 2000, upon its maturity, the mortgage note secured by the Civic Opera House was repaid in the amount of approximately $30.6 million.
The instruments encumbering the Properties restrict transfer of the respective Properties subject to the terms of the mortgage, prohibit additional liens and require payment of real estate taxes on the Properties, maintenance of the Properties in good condition, maintenance of insurance on the Properties and obtaining lender consent to material tenant leases.
CREDIT FACILITIES
Lines of Credit
In 1998, the Company obtained a revolving credit facility for $1.0 billion (the "$1.0 Billion Credit Facility") maturing on May 29, 2001. The Company incurred fees of approximately $2.5 million at the closing of the facility which are being amortized over the term along with approximately $1.0 million of unamortized
deferred financing costs from the previous $600 million line of credit. The interest rate is based on the Company's investment grade rating on its unsecured debt and is currently LIBOR plus 60 basis points with a facility fee (based on the aggregate amount of the facility) equal to 20 basis points per annum. In addition, a competitive bid option, whereby the lenders participating in the line of credit bid on the interest rate to be charged, is available for up to $350 million of the $1.0 Billion Credit Facility. As of March 1, 2000 and December 31,1999, there was approximately $397.6 million and $453.0 million outstanding on the facility, respectively.
In January 2000, the Company obtained an additional unsecured borrowing facility from the Chase Manhattan Bank for short-term borrowings not to exceed $300 million in the aggregate. Upon request of the Company, and at the lender's option, the lender may offer to lend funds at mutually agreed upon interest rates and terms, as determined by current market conditions. As of March 1, 2000, the Company owed $200 million under this facility at a weighted-average rate of 6.4%. On each of March 15, 2000 and March 24, 2000, the note is repayable in two $100 million installments.
UNSECURED NOTES
The table below summarizes the Company's unsecured notes outstanding as of December 31,1999:
- --------------- (1) Includes the cost of terminated interest rate protection agreements, offering and transaction costs, and premiums and discounts on certain unsecured notes.
(2) The MOPPRS are subject to mandatory redemption in 2002 but do not mature until 2012.
The Company previously filed a shelf registration statement, which was declared effective on July 22, 1998, relating to the issuance from time to time of up to $2.0 billion of unsecured debt securities and warrants exercisable for debt securities in amounts, at initial prices and on terms to be determined at the time of offering. The Company issued $1.2 billion of unsecured notes in 1999 under this registration statement.
Restrictions and Covenants
Agreements or instruments relating to the unsecured notes and lines of credit contain certain restrictions and requirements regarding total debt-to-assets ratios, secured debt-to-total assets ratios, debt service coverage ratios, minimum ratio of unencumbered assets to unsecured debt and other limitations.
EQUITY SECURITIES
A summary of the activity of the Trust's Common Shares and the Company's Units during 1999 is as follows:
- --------------- (1) Certain Common Shares were placed in escrow subject to release pursuant to the provisions of the Merger Agreement, Plan of Liquidation and Escrow Agreements entered into at the time of Consolidation. In 1999, 11,332,203 Common Shares were released from escrow and 8,220,969 of such Common Shares were cancelled and exchanged for Units, which represented a reallocation of Units owned by the Trust to other minority interest partners. This reallocation did not change the total number of Units outstanding or the amount of fully diluted Common Shares and Units outstanding.
(2) In 1999, the Trust announced a share repurchase plan. During 1999, 715,600 Common Shares were repurchased at an average share price of $23.14 for approximately $16.6 million in the aggregate and were retired along with a corresponding number of Units. An additional 4,742,500 Common Shares were repurchased and retired, along with a corresponding number of Units, between January and February 2000 at an average share price of $25.27 for approximately $119.8 million in the aggregate. In February 2000, the Trust suspended its share repurchase plan in anticipation of the Cornerstone Merger. Prior to the implementation of the Trust's share repurchase plan, the Trust repurchased 324,434 Common Shares and the Company repurchased approximately 1.2 million Units in a private transaction, which resulted in the Company repurchasing an equivalent number of Units from the Trust.
The Trust previously filed a shelf registration statement, which was declared effective on July 22, 1998, relating to the registration of $1.5 billion of Common Shares, preferred shares of beneficial interest and warrants to be issued at prices and on terms to be determined at the time of offering. The Trust may or may not issue the securities separately or together, in amounts, at prices and on terms described in one or more supplements to the prospectus. The Series C Preferred Shares were issued under this registration statement in December 1998.
CORNERSTONE MERGER
On February 11, 2000, the Trust, the Company, Cornerstone Properties Inc. ("Cornerstone") and Cornerstone Properties Limited Partnership ("Cornerstone Partnership") entered into a merger agreement where Cornerstone will merge with and into the Trust and Cornerstone Partnership will merge with and into the Company (the "Cornerstone Merger"). The total purchase price will be approximately $4.6 billion including the assumption of approximately $1.8 billion in debt, the payment of $1.1 billion in cash and the issuance of approximately 63.6 million new Common Shares and Units. Cornerstone common shareholders
may elect to receive $18.00 per share in cash, plus any accrued but unpaid dividends, or 0.7009 of the Trust's Common Shares based on a prevailing transaction price of $25.68125 per common share, subject to proration. Cornerstone's convertible preferred shareholders will receive $18.00 per share in cash. Cornerstone Partnership unitholders will receive 0.7009 Units of the Company. The Company intends to finance the $1.1 billion cash portion of the purchase price by obtaining additional term loans, issuing unsecured notes or amending the existing line of credit.
The Cornerstone Merger is expected to be completed in the third quarter of 2000 and is subject to the approval of the shareholders of the Trust and the shareholders of Cornerstone and other customary conditions. Cornerstone is a fully integrated REIT and currently owns 86 office properties in the U.S. totaling over 18.5 million square feet, and has an additional $884 million of projects under development. If the Cornerstone Merger is completed the Company will own approximately 380 office properties consisting of approximately 95.5 million square feet.
MARKET RISK
QUALITATIVE INFORMATION ABOUT MARKET RISK
The Company's future earnings, cash flows and fair values relevant to financial instruments are dependent upon prevalent market rates. Market risk is the risk of loss from adverse changes in market prices and interest rates. The Company manages its market risk by matching projected cash inflows from operating, investing and financing activities with projected cash outflows to fund debt service, acquisitions, capital expenditures, distributions to shareholders and unitholders and other cash requirements. The majority of the Company's outstanding debt (maturing at various times through 2029) has a fixed interest rate, which minimizes the risk of fluctuating interest rates. The Company also utilizes certain derivative financial instruments at times to limit interest rate risk. Interest rate protection agreements are used to convert variable rate debt to a fixed rate basis or to hedge anticipated financing transactions. Derivatives are used for hedging purposes rather than speculation. The Company does not enter into financial instruments for trading purposes.
QUANTITATIVE INFORMATION ABOUT MARKET RISK
Interest Rate Risk
As of December 31, 1999, the Company has total outstanding debt of approximately $5.9 billion of which approximately $.6 billion, or 10%, is variable rate debt. If market rates of interest on the Company's variable rate debt increase by 10% (or approximately 74 basis points), the increase in interest expense on the Company's variable rate debt would decrease future earnings and cash flows by approximately $4.3 million. If market rates of interest increased by 10%, the fair value of the Company's total outstanding debt would decrease by approximately $157.1 million. If market rates of interest on the Company's variable rate debt decrease by 10% (or approximately 74 basis points), the decrease in interest expense on the Company's variable rate debt would increase future earnings and cash flows by approximately $4.3 million. If market rates of interest decreased by 10%, the fair value of the Company's total outstanding debt would increase by approximately $166.2 million.
As of December 31, 1998, the Company had total outstanding debt of approximately $6.0 billion of which approximately $1.3 billion, or 21%, was variable rate debt. If market rates of interest on the Company's variable rate debt increased by 10% (or approximately 64 basis points), the increase in interest expense on the Company's variable rate debt would have decreased future earnings and cash flows by approximately $8.2 million. If market rates of interest increased by 10%, the fair value of the Company's total outstanding debt would have decreased by approximately $141.0 million. If market rates of interest on the Company's variable rate debt decreased by 10% (or approximately 64 basis points), the decrease in interest expense on the Company's variable rate debt would have increased future earnings and cash flows by approximately $8.2 million. If market rates of interest decreased by 10%, the fair value of the Company's total outstanding debt would have increased by approximately $146.0 million.
Market Rate Risk
On August 12, 1999, the Trust and the WR Holders amended their put option agreement to defer to August 13, 2000 (or to August 13, 2001 at the option of the WR Holders) the exercise date for 1,717,844 of the 3,435,688 Common Shares affected by the put option agreement (a maximum exposure to the Company of approximately $54.1 million when and if this put option is exercised). The Trust and the WR Holders also agreed to cancel the put option on the remaining 1,717,844 Common Shares in exchange for the Company's payment to the WR Holders of approximately $11.3 million on September 13, 1999. The payment represented the excess of $31.50 over $24.90 (the average price of a Common Share calculated over the five trading days immediately prior to August 13, 1999), for each of the 1,717,844 Common Shares affected by the put option agreement. The portion of the amounts paid in excess of $29.10625 per Common Share totaling approximately $4.1 million was reflected as a preferred distribution. The remaining $7.2 million of the payment was recorded as a reduction to partners' capital.
On August 13, 2000, (or August 13, 2001 at the option of the WR Holders), the WR Holders can require the Trust to purchase all or a portion of the remaining 1,717,844 Common Shares issued to them at a price equal to $31.50 per Common Share. Prior to such date, if the WR Holders sell all or a portion of their Common Shares to a third party for a price less than $29.10625, then the Trust is obligated to pay to the WR Holders for each Common Share sold at such lower price an amount equal to the difference between $29.10625 and such lower price, not to exceed $3.00 per Common Share. Any amounts paid by the Trust as a result of such sales will result in the Company making an equal payment to the Trust and will be recorded as a reduction in partners' capital. For put options exercised as aforesaid; any amounts paid up to $29.10625 per Common Share would be reflected as a reduction in partners' capital; the portion of any amounts paid in excess of $29.10625 per Common Share (not to exceed $2.39375 per Common Share up to an aggregate of approximately $4.1 million) will be reflected as a preferred distribution. The $4.1 million portion of the total potential payment is being amortized by the Company on a straight-line basis over the period between August 13, 1999 and August 13, 2000.
The Company's cash flows could decrease by up to $5.2 million if, prior to August 13, 2000, the WR Holders sell all their Common Shares to third parties. Cash flows of the Company may decrease by up to approximately $54.1 million if the WR Holders exercise their rights under the put option agreement on August 13, 2000 (or August 13, 2001, if extended at the option of the WR Holders). There will be no impact on cash flows or net income from this transaction if the put option is not exercised.
Effective as of September 3, 1998, the Company amended its pre-existing put option agreement with the seller of the Columbus America Properties (the "CA Holder") related to 1,692,546 Units issued at acquisition. The CA Holder has the option at any time after January 1, 1999 until the earlier of September 3, 2000 or the date the CA Holder has converted all of its Units to Common Shares, to require the Company to purchase the Units at a price equal to $29.00 per Unit. Under the terms of the agreement, prior to September 3, 1999, the option shall be limited to an aggregate of 846,273 Units. In October 1999, the CA Holder exercised its option to require the Company to purchase 1,675,000 Units at a price equal to $29.00 per Unit for a total of approximately $48.6 million. The Company recognized the $48.6 million payment as a reduction of partners' capital and retired the Units.
The Company has several investments in marketable securities. If the market price of these securities increases or decreases by 10%, the Company's investment in the securities would increase or decrease by approximately $7.4 million. The change in market price would also be reflected as a corresponding adjustment to accumulated other comprehensive income. There will be no impact on earnings or cash flows of the Company from market price fluctuations unless the Company disposes of its investments.
These amounts were determined by considering the impact of hypothetical interest rates and equity prices on the Company's financial instruments. These analyses do not consider the effect of the reduced level of overall economic activity that could exist in such an environment. Further, in the event of a change of such magnitude, management would likely take actions to further mitigate its exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, these analyses assume no changes in the Company's financial structure.
CAPITAL IMPROVEMENTS
The Company considers capital improvements and revenue enhancing tenant improvements when a property is acquired in determining the amount of equity and debt financing required to purchase the property and fund the improvements. Therefore, capital improvements made in the year of acquisition and the following two years are treated separately from typical recurring capital expenditures, non-revenue enhancing tenant improvements and leasing commissions required once these properties have reached stabilized occupancy, and deferred maintenance and renovations planned at the time of acquisition have been completed. Capital improvements (including tenant improvements and leasing commissions for shell space) for the years ended December 31, 1999, 1998 and 1997 were approximately $64.9 million, $44.1 million and $46.8 million, respectively or $.84, $.59 and $.72 per square foot, respectively. These amounts exclude capital and tenant improvements of approximately $133.2 million, $70.0 million and $31.2 million incurred for the years ended December 31, 1999, 1998 and 1997, respectively, for developments.
The Company considers capital expenditures to be recurring expenditures relating to the ongoing maintenance of the Office Properties. The table below summarizes capital expenditures for the years ended December 31, 1999, 1998 and 1997. The capital expenditures set forth below are not necessarily indicative of future capital expenditures.
TENANT IMPROVEMENTS AND LEASING COMMISSION COSTS
The Company distinguishes its tenant improvements and leasing commissions between those that are revenue enhancing (i.e., required for space which is vacant at the time of acquisition or that has been vacant for nine months or more) and non-revenue enhancing (i.e., required to maintain the revenue being generated from currently leased space). The table below summarizes the revenue enhancing and non-revenue enhancing tenant improvements and leasing commissions for the years ended December 31, 1999, 1998 and 1997. The tenant improvement and leasing commission costs set forth below are presented on an aggregate basis and do not reflect significant regional variations and, in any event, are not necessarily indicative of future tenant improvements and leasing commission costs:
- ---------------
(1) The per square foot calculations as of December 31, 1999, 1998 and 1997 are calculated taking the total dollars anticipated to be incurred on tenant improvements for tenants taking occupancy during the year divided by the total square footage being improved or total building square footage. The actual amounts incurred as of December 31, 1999, 1998 and 1997 for revenue enhancing, non-revenue enhancing renewal and retenanted space are summarized below:
DEVELOPMENTS
The Company currently owns several Properties in various stages of development or pre-development. The Company funds these developments with proceeds from working capital and the line of credit. Specifically identifiable direct and indirect acquisition, development and construction costs are capitalized including, where applicable, salaries and related costs, real estate taxes, interest and certain pre-construction costs essential to the development of a property. As of December 31, 1999, the Company had incurred approximately $229.2 million of costs in connection with the Properties being developed. The Properties under development as of December 31, 1999 are as follows:
- ---------------
(a) The Estimated Place in Service Date represents the date the certificate of occupancy has been or is anticipated to be obtained. Subsequent to obtaining the certificate of occupancy, the Property will undergo a lease up period. The Total Estimated Costs include amounts attributable to tenanting the Property.
(b) The Total Estimated Cost of this property excludes a vacant land parcel valued at approximately $7.8 million. This property was acquired on July 13, 1999 and is currently undergoing lease-up.
(c) The Company expects to acquire this property upon full occupancy in May 2000. This transaction is contingent upon certain terms and conditions as set forth in its purchase agreement. There can be no assurance that this transaction will be consummated.
(d) The Costs Incurred and Total Estimated Costs reflect the Company's 80% interest in this project including the Company's pro-rata share of the development loan. The total cost of the project including the joint venture partner's share is approximately $90 million of which up to $60 million will be funded by a development loan.
(e) Deferred leasing costs are classified separately on the balance sheet.
In addition to the properties described above, the Company owns various land parcels available for development. However, no significant development activity is taking place on these sites at this time.
YEAR 2000
OVERVIEW OF Y2K PROBLEM
The Year 2000 or "Y2K" problem refers to the inability of many existing computer programs to properly recognize a year that begins with "20" instead of the familiar "19." If the Y2K problem had been left uncorrected, many time sensitive computer systems in use at the Company may have recognized a date using "00" as the year 1900 rather than the year 2000.
THE YEAR 2000 PROGRAM
Over the course of 1998 and 1999, the Company developed and implemented a Y2K readiness program (the "Program") to identify and correct potential Y2K problems. The initial phase of the Program was devoted to assessing the Company's Y2K readiness. During this phase, the Company inventoried all of its information and operating systems and, through a combination of physical inspections, vendor inquiries and research, determined which of the systems could have potential Y2K problems. When the Company's research or inquiries indicated that a particular system had a Y2K problem, the system was upgraded, replaced or retired. If the assessment revealed only the possibility of a Y2K problem, the Company performed an analysis of the impact that a system failure would have on the Company's operations and the likelihood that such a failure would occur. Based on such analysis, the Company determined whether validation testing of each particular system was warranted. With only minor exceptions, all building operating systems were tested, as well as all information systems that were deemed critical to the Company's operation. During the final phase of the Program, contingency plans were developed for each of the Company's Properties and for most of the information systems that were deemed to be critical. Throughout the implementation of the Program, the Company used its best efforts to keep its tenants, investors and other interested parties apprised of the progress of the Company's Year 2000 Program.
YEAR 2000 PROGRAM RESULTS
The Year 2000 Program was successful in uncovering and proactively correcting a number of Y2K problems with respect to the Company's information systems and building operating systems. Without limitation, material Y2K problems were corrected in advance of January 1, 2000 with respect to the Company's Network Operating Systems and Accounting and Property Management Systems. Other Y2K problems were identified and corrected in connection with building operating systems, such as the garage revenue control, building automation and card key access systems.
As a precaution and service to those tenants that were conducting their own Year 2000 tests, each of the Company's Properties was staffed on New Years Eve. Without exception, the Properties continued to operate without interruption after the beginning of the new Millennium. Tests of the Company's building operating systems and information systems on New Years Day did not reveal any problems. The Company is not aware of any Y2K problems that have had a material adverse affect on any of its tenants, contractors or service providers.
YEAR 2000 RELATED COSTS
The total cost of the Company's Year 2000 Program was approximately $9.2 million. Approximately $1.2 million was spent in connection with the assessment, testing, upgrade, remediation and/or replacement of information systems for the Company. Approximately $7.9 million was incurred to assess, test, upgrade, remediate and/or replace building operation systems. In many cases, the systems that were replaced were at or near the end of their useful life. Many of these systems were previously scheduled for replacement and the correction of potential Y2K problems was not the exclusive reason for the upgrade or replacement. The Company anticipates incurring no additional significant costs related to the Program.
INFLATION
Substantially all of the office leases require the tenant to pay, as additional rent, a portion of any increases in real estate taxes (except, in the case of certain California leases, which limit the ability of the landlord to pass through to the tenants the effect of increased real estate taxes attributable to a sale of real property interests) and operating expenses over a base amount. In addition, many of the office leases provide for fixed increases in base rent or indexed escalations (based on the Consumer Price Index or other measures). The Company believes that inflationary increases in expenses will be offset, in part, by the expense reimbursements and contractual rent increases described above.
FUNDS FROM OPERATIONS
Management of the Company believes Funds from Operations, as defined by the National Association of Real Estate Investment Trusts, Inc. ("NAREIT"), to be an appropriate measure of performance for an equity REIT. While Funds from Operations is a relevant and widely used measure of operating performance of equity REITs, it does not represent cash flow from operations or net income as defined by generally accepted accounting principles ("GAAP"), and it should not be considered as an alternative to these indicators in evaluating liquidity or operating performance of the Company.
The following table reflects the calculation of the Company's Funds from Operations for the years ended December 31, 1999, 1998 and 1997 on a historical basis:
- ---------------
(1) Represents the combined results of Equity Office Predecessors for the period from January 1 through July 10, 1997 and the Company from July 11 through December 31, 1997.
(2) The White Paper on Funds from Operations approved by the Board of Governors of the National Association of Real Estate Investment Trusts ("NAREIT") in March 1995 defines Funds from Operations as net income (loss) (computed in accordance with GAAP), excluding gains (or losses) from debt restructuring and sales of properties, plus real estate related depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures. The Company believes that Funds from Operations is helpful to investors as a measure of the performance of an equity REIT because, along with cash flow from operating, investing and financing activities, it provides investors with an indication of the ability of the Company to incur and service debt, to make capital expenditures and to fund other cash needs. The Company computes Funds from Operations in accordance with standards established by NAREIT which may not be comparable to Funds from Operations reported by other REITs that do not define the term in accordance with the current NAREIT definition or that interpret the current NAREIT definition differently than the Company. Funds from Operations does not represent cash generated from operating activities in accordance with GAAP, nor does it represent cash available to pay distributions and should not be considered as an alternative to net income (determined in accordance with GAAP) as an indication of the Company's financial performance or to cash flow from operating activities (determined in accordance with GAAP) as a measure of the Company's liquidity, nor is it indicative of funds available to fund the Company's cash needs, including its ability to make cash distributions.
(3) For the year ended December 31, 1997, cash flow provided by financing activities includes approximately $181.1 million in cash contributed from Equity Office Predecessors in connection with the Consolidation.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information about quantitative and qualitative disclosures about market risk is incorporated herein by reference from Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations in the Market Risk section.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS.
REPORT OF INDEPENDENT AUDITORS
The Partners of EOP Operating Limited Partnership
We have audited the accompanying consolidated balance sheets of EOP Operating Limited Partnership (the "Company") as of December 31, 1999 and 1998, and the related consolidated statements of operations, partners' capital and cash flows of the Company for the years ended December 31, 1999 and 1998 and the period from July 11, 1997 to December 31, 1997, and the related combined statements of operations, owners' equity and cash flows of the Equity Office Predecessors, as defined in Note 1, for the period from January 1, 1997 to July 10, 1997. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. 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 consolidated financial position of EOP Operating Limited Partnership at December 31, 1999 and 1998, the consolidated results of EOP Operating Limited Partnership's operations and cash flows for the years ended December 31, 1999 and 1998 and the period from July 11, 1997 to December 31, 1997, and the combined results of the Equity Office Predecessors', as defined in Note 1, operations and cash flows for the period from January 1, 1997 to July 10, 1997 in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
Ernst & Young LLP
Chicago, Illinois February 8, 2000, except for Note 24, as to which the date is February 15, 2000
EOP OPERATING LIMITED PARTNERSHIP CONSOLIDATED BALANCE SHEETS
See accompanying notes.
EOP OPERATING LIMITED PARTNERSHIP CONSOLIDATED STATEMENTS OF OPERATIONS AND EQUITY OFFICE PREDECESSORS COMBINED STATEMENT OF OPERATIONS
See accompanying notes.
EOP OPERATING LIMITED PARTNERSHIP CONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL AND EQUITY OFFICE PREDECESSORS COMBINED STATEMENT OF CHANGES IN OWNERS' EQUITY
See accompanying notes.
EOP OPERATING LIMITED PARTNERSHIP CONSOLIDATED STATEMENTS OF CASH FLOWS AND EQUITY OFFICE PREDECESSORS COMBINED STATEMENT OF CASH FLOWS
EOP OPERATING LIMITED PARTNERSHIP CONSOLIDATED STATEMENTS OF CASH FLOWS AND EQUITY OFFICE PREDECESSORS COMBINED STATEMENT OF CASH FLOWS -- (CONTINUED)
See accompanying notes.
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
NOTE 1 -- BUSINESS AND FORMATION OF THE COMPANY
As used herein, "Company" means EOP Operating Limited Partnership, a Delaware limited partnership, and the predecessors thereof ("Equity Office Predecessors"). The Company is a subsidiary of Equity Office Properties Trust (the "Trust") which was formed on October 9, 1996 to continue and expand the national office property business organized by Mr. Samuel Zell, Chairman of the Board of Trustees of the Trust, and to complete the consolidation of the Equity Office Predecessors (the "Consolidation"). The Trust completed its initial public offering (the "IPO") on July 11, 1997. The Company is a fully integrated, self-administered and self-managed real estate company engaged in acquiring, owning, managing, leasing and renovating office properties and parking facilities. The Trust's assets, which include investments in joint ventures, are owned by, and substantially all of its operations are conducted through the Company. The Trust is the managing general partner of the Company. The Trust elected to be taxed as a real estate investment trust ("REIT") for federal income tax purposes and generally will not be subject to federal income tax if it distributes 100% of its taxable income and complies with a number of organizational and operational requirements. As of December 31, 1999, the Company owned or had an interest in 294 office properties (the "Office Properties") containing approximately 77.0 million rentable square feet of office space and owned 20 stand-alone parking facilities (the "Parking Facilities" and, together with the Office Properties, the "Properties") containing approximately 20,506 parking spaces. The weighted average occupancy for the Office Properties at December 31, 1999 was approximately 93.7%. The Office Properties are located in 81 submarkets in 35 markets in 23 states and the District of Columbia. The Office Properties, by rentable square feet, are located approximately 52% in central business districts ("CBDs") and 48% in suburban markets.
On July 11, 1997, the Company consummated the Consolidation in connection with the IPO of the Trust, in which the Trust sold 28,750,000 of its common shares of beneficial interest, $0.01 par value per share ("Common Shares") at $21.00 per Common Share generating gross proceeds of approximately $603.8 million. The Trust contributed the net proceeds from the IPO of approximately $564.5 million to the Company in exchange for 28,750,000 units of partnership interest in the Operating Partnership ("Units"). The Company used the net proceeds of the IPO and available cash reserves to repay debt.
Concurrent with the IPO, the Equity Office Predecessors contributed their interest in the Properties to the Company in exchange for 126,419,397 Units and 122,927,030 Common Shares of the Trust which resulted in the Company issuing 122,927,030 Units to the Trust. In addition, Equity Group Investments, Inc. an Illinois corporation ("EGI"), and Equity Office Holdings, L.L.C., a Delaware limited liability company ("EOH" and together with EGI, the "Equity Group") contributed substantially all of their interests in their office property and asset management business and parking facilities management business (collectively the "Management Business") to the Operating Partnership in exchange for 8,358,822 Units.
On December 19, 1997, the Trust, the Company, Beacon Properties Corporation, a Maryland corporation ("Beacon") and Beacon Partnership L.P. ("Beacon Partnership") consummated the merger of Beacon with and into the Trust and Beacon Partnership with and into the Company (the "Beacon Merger") at a cost of approximately $4.3 billion in the form of 89,167,003 Units, of which 80,596,117 Units were issued to the Trust, 8,000,000 preferred units, stock options assumed which would result in the Company issuing additional Units to the Trust, $1.2 billion of debt assumed and merger costs of $85 million. As a result of the Beacon Merger, the Company acquired an interest in 130 Beacon properties containing approximately 20.9 million rentable square feet of office space.
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements represent the financial condition and results of the Company and its subsidiaries.
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) The Consolidation and the Beacon Merger were accounted for as purchases in accordance with Accounting Principles Board Opinion No. 16. Accordingly, the fair value of the consideration given by the Company was used as the valuation basis for these transactions. The assets acquired and liabilities assumed by the Company were recorded at their fair values as of the closing dates of the Consolidation and the Beacon Merger and the excess of the purchase price over the related historical basis of the net assets acquired was allocated primarily to investment in real estate.
The combined financial statements of Equity Office Predecessors includes interests in the properties owned and the Management Business. The financial statements of Equity Office Predecessors is presented on a combined basis because the properties owned and the Management Business were under common control. All intercompany transactions and balances have been eliminated in combination.
Investment in Real Estate
Rental property and improvements, including interest and other costs capitalized during construction, are included in investment in real estate and are stated at cost. Expenditures for ordinary maintenance and repairs are expensed to operations as they are incurred. Significant renovations and improvements which improve or extend the useful life of the assets are capitalized. Except for amounts attributed to land, rental property and improvements are depreciated over their estimated useful lives using the straight-line method. The estimated useful lives by asset category are:
Deferred Leasing and Financing Costs
Deferred leasing and financing costs are recorded at cost. The deferred leasing costs are amortized over the terms of the respective leases and the deferred financing costs are amortized over the terms of the respective financings on a straight-line basis, which approximates the effective yield method.
Rental Income
Certain leases provide for tenant occupancy during periods for which no rent is due or where minimum rent payments increase during the term of the lease. The Company records rental income for the full term of each lease on a straight-line basis. Accordingly, the Company records a receivable from tenants for the amount that the Company expects to collect over the remaining lease term rather than currently ("Deferred Rent Receivable"). When the Company acquires a property the term of existing leases is considered to commence as of the acquisition date for purposes of this calculation. The amounts included in rental income for the year ended December 31, 1999 and 1998, the period from July 11, 1997 through December 31, 1997 and the period from January 1, 1997 through July 10, 1997, which were not currently collectible as of such dates, were approximately $65.4 million, $68.1 million, $20.0 million and $7.7 million, respectively. Deferred Rent Receivable is not recognized for income tax purposes.
Cash Equivalents
The Company considers cash equivalents to be all highly liquid investments purchased with a maturity of three months or less at the date of purchase.
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) Escrow Deposits and Restricted Cash
Escrow deposits primarily consist of amounts held by lenders to provide for future real estate tax expenditures and tenant improvements, earnest money deposits on acquisitions and net proceeds from dispositions. Restricted cash represents amounts committed for various utility deposits and security deposits. Certain of these amounts may be reduced upon the fulfillment of certain obligations.
Fair Value of Financial Instruments
Investments in marketable equity securities and investments in note receivables are reported at fair value and included in other assets. All marketable equity securities held by the Company at December 31, 1999 were designated as available for sale, with unrealized holding gains and losses included in partners' capital as accumulated other comprehensive income.
Management believes that the carrying basis of the Company's long-term debt consisting of secured and unsecured borrowings and an interest rate protection agreement approximate their respective fair market values as of December 31, 1999 and 1998, respectively. The current value of debt was computed by discounting the projected debt service payments for each loan based on the spread between the market rate and the effective rate, including the amortization of loan origination costs, for each year. In addition, the carrying values of cash and cash equivalents, restricted cash, escrow deposits, tenant and other rents receivable, accounts payable and accrued expenses are reasonable estimates of their fair value.
Interest Rate Protection Agreements
The Company periodically enters into certain interest rate protection agreements to effectively convert or cap floating rate debt to a fixed rate basis, as well as to hedge anticipated future finance transactions. Net amounts paid or received under these agreements are recognized as an adjustment to interest expense when such amounts are incurred or earned. Settlement amounts paid or received in connection with terminated interest rate protection agreements are deferred and amortized as an adjustment to interest expense over the term of the related financing transaction on a straight-line basis, which approximates the effective yield method.
Derivatives and Hedging Activities
In June 1998, the FASB issued Statement No. 133 "Accounting for Derivative Instruments and Hedging Activities." The statement requires recording all derivative instruments as assets or liabilities, measured at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. The standard's effective date was deferred by FASB Statement No. 137 to all fiscal quarters of all fiscal years beginning after June 15, 2000. The Company is planning to adopt the standard once it is effective and does not anticipate that the adoption will have a material impact on the Company's financial condition and results of operations.
Deferred Revenue
During 1999, the Company received common stock and/or warrants to purchase common stock for allowing companies that provide telecommunication and other services access to the Properties. The securities received from these companies were recorded as deferred revenue at fair value at the time such securities were earned and are included in other liabilities on the balance sheet. The deferred revenue will be amortized into other income over the terms of the respective license agreements. As of December 31, 1999, approximately EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) $31.6 million is recorded as deferred revenue relating to these agreements and is being amortized over a five-year period. Approximately $.7 million was recorded as other income during 1999.
Income Taxes
The Company is not liable for federal taxes as the partners recognize their proportionate share of the Company's income or loss in their tax returns. The Office Properties and Parking Facilities are primarily owned by limited partnerships or limited liability companies, which are substantially pass-through entities. Some of the pass-through entities have corporate general partners or members, which are subject to federal and state income and franchise taxes. In addition, the Management Business is owned by a corporation and is subject to federal and state income taxes. The Company incurred federal and state income and franchise taxes of approximately $.7 million, $1.7 million, $0.2 million and $0.9 million for the years ended December 31, 1999 and 1998, the period from July 11, 1997 through December 31, 1997, and the period from January 1, 1997 through July 10, 1997, respectively, which are included in general and administrative expenses.
The Trust elected to be taxed as a REIT, under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the "Code"). As a REIT, the Trust generally will not be subject to federal income tax if it distributes 100% of its taxable income for each tax year to its shareholders. REITs are subject to a number of organization and operational requirements. If the Trust fails to qualify as a REIT in any taxable year, the Trust will be subject to federal income tax (including any applicable alternative minimum tax) on its taxable income at regular corporate tax rates. Even if the Trust qualifies for taxation as a REIT, the Trust may be subject to state and local income taxes and to federal income tax and excise tax on its undistributed income. The aggregate cost of land and depreciable property for federal income tax purposes as of December 31, 1999 and 1998 was approximately $10.3 billion and $9.7 billion, respectively.
Minority Interests -- partially owned properties
The Company reflects minority interests in partially owned properties on the balance sheet for the portion of properties consolidated by the Company that are not wholly owned by the Company. The earnings or losses from these properties attributable to the minority interests are reflected as minority interests in partially owned properties in the statement of operations.
Use of Estimates
The preparation of the consolidated financial statements of the Company and the combined financial statements of Equity Office Predecessors in conformity with accounting principles generally accepted in the United States requires management to make 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 periods. Actual results could differ from those estimates.
Reclassifications
Certain reclassifications have been made to the previously reported 1998 and 1997 statements in order to provide comparability with the 1999 statements reported herein. These reclassifications have not changed the 1998 or 1997 results, partners' capital or owners' equity.
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3 -- INVESTMENT IN REAL ESTATE
Investment in real estate, including Office Properties, Parking Facilities, properties under development and vacant land was as follows:
During the year ended December 31, 1999, the Company acquired the Properties listed below. Each Property was purchased from an unaffiliated party, except for Palo Alto Square (see footnote (4) below), and was funded from working capital, credit facilities, assumption of mortgage debt, and/or issuance of Units. During 1998 the Company acquired 28 Office Properties, an office property under development, several vacant land parcels and two Parking Facilities, for a total cost of approximately $2.5 billion including the issuance of 7,043,510 Units at a weighted average price of $25.07 per Unit for a total of approximately $176.6 million. During 1997, the Company acquired 176 Office Properties and seven parking facilities, including those acquired in connection with the Beacon Merger, for a total cost of approximately $6.6 billion.
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(1) Total acquisition cost includes the purchase price specified in the purchase contract, closing costs, acquisition costs and accounting adjustments recorded in accordance with GAAP.
(2) The total acquisition cost includes a vacant land parcel valued at $12.4 million.
(3) The total acquisition cost includes a vacant land parcel valued at $7.8 million.
(4) Palo Alto Square was acquired from a private investment partnership controlled by Mr. Samuel Zell. The terms of the acquisition were reviewed and recommended for Board approval by a special subcommittee of the Board of Trustees of the Trust formed to review related party conflicts between trustees and their affiliates. Upon the recommendation of the special subcommittee, the non-affiliated members of the Board of Trustees of the Trust approved the transaction. The acquisition was funded primarily through the issuance of 1,035,389 Units valued at $23.64 per Unit for a total of approximately $24.5 million and the assumption of $53.2 million in debt. EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4 -- DISPOSITIONS
During 1999 the Company disposed of the following office properties:
- --------------- (a) 215 Fremont Street was a redevelopment property.
(b) The Company sold an interest in these Office Properties to Lend Lease Australia/US Properties. Prior to the sale, the Company consolidated the financial condition and results of operations of the Office Properties. Upon the sale, the Company retained an equity interest in the Office Properties and shares equally in the control of the operations and major decisions of the Office Properties. Therefore, the Company accounts for its remaining interest in the Office Properties under the equity method of accounting and classifies its net equity investment of approximately $486.9 million as investment in unconsolidated joint ventures on the consolidated balance sheet and its interest in the net income from investment in unconsolidated joint ventures is reflected in the consolidated statements of operations. Net proceeds were approximately $480 million from this transaction after giving effect to the buyer's assumption of debt and additional financings.
During 1998, the Company disposed of four office properties located in Florida and one office property located in Washington, D.C. The combined square footage of these office properties was approximately 986,391 square feet. These office properties were sold for approximately $132.6 million generating a gain on sale of approximately $12.4 million.
During 1997, the Company disposed of one office property located in California and one office property located in Texas. These office properties were sold for approximately $72.5 million generating a gain on sale of approximately $12.6 million. The combined square footage of these office properties was approximately 535,992 square feet.
NOTE 5 -- INVESTMENT IN NOTE RECEIVABLE
On September 2, 1999, the Company acquired a mezzanine-level debt position as part of a debt restructuring related to the SunAmerica Center office property. The property is owned by an unaffiliated party and is located in Century City, California. The Company invested approximately $73.9 million for a 67% share of a $202.2 million Tranche B note. The Company's share of the Tranche B note is approximately $136.0 million. The discount to the face amount of the note of approximately $62.4 million will be amortized to interest income based on the estimated yield of the investment. The Company will also provide property management and leasing services for the property.
The Tranche B Note accrues interest at 7.25% per annum compounded quarterly and matures on August 31, 2014. Interest is payable on the Tranche B Note from available cash flow from the property as defined in the Noteholder Agreement. In addition, the Company previously had entered into two forward rate interest protection agreements effectively hedging the investment. These agreements were terminated prior to
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 5 -- INVESTMENT IN NOTE RECEIVABLE -- (CONTINUED) the Company's investment in the Tranche B Note for proceeds to the Company of approximately $1.1 million. The proceeds will be amortized to interest income over the term of the Tranche B Note.
In addition, the Company has the option to acquire 67% of the aggregate face amount of the Tranche D Note and the Tranche E Note debt position from the current holder, an affiliate of the property owner. The current aggregate face amount of the Tranche D Note and Tranche E Note is $15.0 million.
NOTE 6 -- INVESTMENT IN SECURITIES
The following investments are included in other assets on the Consolidated Balance Sheet.
During 1999, the Company invested approximately $2.0 million for approximately .1 million common shares of Allied Riser Communications Corporation ("ARC"). ARC is a facilities based provider of broadband data, video and voice communications services, delivered over fiber optic networks designed, constructed and owned by ARC in large- and medium-sized office buildings. The Company and ARC entered into various license agreements allowing ARC to install and provide its services to tenants in certain Office Properties containing approximately 75.6 million square feet. In return for allowing ARC access to the Office Properties, ARC granted the Company, in addition to the purchased securities described above, approximately 1.4 million warrants to acquire an equal number of common shares of ARC for no additional consideration, as well as an additional .2 million common shares for nominal consideration, and other ARC investors transferred approximately .3 million ARC common shares to the Company. The warrants and the common shares were recorded at fair value as deferred revenue and will be amortized over the term of the licensing agreements of five years. The total deferred revenue at December 31, 1999, was approximately $29.1 million. As of December 31, 1999, the fair value of the ARC common shares and warrants, which are exercisable into ARC common shares at the Company's option commencing in April 2000, was approximately $41.5 million. A gross unrealized holding gain of approximately $9.7 million is included in other comprehensive income and represents the increase in the fair value of the ARC securities. A private investment entity controlled by Mr. Zell has a substantial investment in ARC.
Also during 1999, the Company was granted approximately 2.4 million common shares of Broadband Office, Inc. ("Broadband"). Broadband is also a facilities based provider of broadband data, video and voice communications services, delivered over fiber optic networks similar to ARC. The Company and Broadband entered into various license agreements allowing Broadband to install and provide its services to tenants in certain Office Properties containing approximately 55.0 million square feet. Broadband granted the common shares to the Company in return for allowing Broadband access to the Office Properties. The common shares were recorded at fair value of approximately $1.3 million and will be amortized over the term of the license agreements of five years. The shares issued to the Company are not currently registered, and Broadband is not currently qualified as a public reporting company under the Securities and Exchange Act of 1934.
Also during 1999, the Company was issued a warrant to acquire approximately .9 million common shares of Captivate Network, Inc. ("Captivate"). Captivate installs high-resolution, flat-panel screens in elevators, and programs the network with news, features, and advertising. The Company and Captivate entered into a master license agreement allowing Captivate to install its screens in elevators at certain Office Properties. Captivate granted the warrant to the Company in return for executing the master license agreement and for allowing access to the Office Properties. As license agreements for specific Office Properties are executed, a portion of the warrant becomes vested. The vested portion of the warrant was recorded at a fair value of approximately $1.2 million and will be amortized over the term of the license agreements of five years. The warrant issued to the Company is not currently registered, and Captivate is not currently qualified as a public reporting company under the Securities and Exchange Act of 1934.
In July 1998, the Company purchased 50,000 shares of Capital Trust 8.25% Preferred Securities, $1,000 liquidation preference per share, for $48.5 million. The discount of $1.5 million is being amortized as EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6 -- INVESTMENT IN SECURITIES -- (CONTINUED) additional dividend revenue over the term of 20 years. The preferred shares are convertible at any time into common shares of Capital Trust at a conversion price of $11.70 and are non-callable for five years. The dividend is payable each quarter and commencing in year seven, the dividend will increase by 75 basis points per annum. Mr. Zell is Chairman of the Board of Capital Trust.
NOTE 7 -- INVESTMENT IN UNCONSOLIDATED JOINT VENTURES
The following is a summary of the Company's ownership in the unconsolidated joint ventures:
- --------------- (1) The Company owns a mortgage note receivable secured by the property and land underlying and adjacent to the property.
(2) The Company owns a 28.5% non-controlling interest in this property management and development company.
(3) The Company and the Trust are shareholders in the corporation (a private REIT) which owns the property.
(4) The Company owns a 50% equity interest in the property and 50% of the first mortgage notes.
(5) The Company owns a 3% general partner interest in this general partnership which owns an 85% general partnership interest in the property.
(6) In July 1998, the Company entered into a joint venture agreement with an unaffiliated party to develop Metropoint II, a 150,181 square foot office building in Denver, Colorado, which was completed in 1999. A buy/sell option may be exercised to acquire the other venturer's interest by either the Company or its joint venture partner if certain conditions are met as defined in the joint venture agreement.
(7) In July 1998, the Company entered into a joint venture agreement with WRALP, an affiliated party, to develop Sunset North Corporate Campus, a three building, 460,629 square-foot office complex in
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 7 -- INVESTMENT IN UNCONSOLIDATED JOINT VENTURES -- (CONTINUED) Bellevue, Washington, which was completed in 1999. A buy/sell option may be exercised to acquire the other venturer's interest by either the Company or its joint venture partner if certain conditions are met as defined in the joint venture agreement.
(8) In December 1998, the Company entered into a joint venture agreement with WRALP to develop Three Bellevue Center, a 471,635 square foot office building in Bellevue, Washington. Completion of the 22-story office building is scheduled for the second quarter of 2000. A buy/sell option may be exercised to acquire the other venturer's interest by either the Company or its joint venture partner if certain conditions are met as defined in the joint venture agreement.
(9) The joint venture partner has the option to increase its ownership in the property by an additional 25% by December 31, 2001, at the greater of 25% of the fair market value at the time of the exercise or $122.5 million.
(10) These properties were partially sold during 1999. See Note 4, footnote (b) for additional information.
(11) The Company owns a 47.5% membership interest in this joint venture. The joint venture provides fully furnished offices with short term, flexible rental agreements to prospective tenants seeking this type of office space.
These investments are accounted for utilizing the equity method of accounting except for the Company's investment in Lehndorff Four Oaks Place Associates, which is accounted for utilizing the cost method of accounting. Under the equity method of accounting, the net equity investment of the Company is reflected on the consolidated balance sheets, and the consolidated and combined statements of operations include the Company's share of net income or loss from the unconsolidated joint ventures. Any difference between the carrying amount of these investments on the balance sheet of the Company and the underlying equity in net assets is amortized as an adjustment to income from unconsolidated joint ventures over 40 years.
Combined summarized financial information of the unconsolidated joint ventures is as follows:
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 7 -- INVESTMENT IN UNCONSOLIDATED JOINT VENTURES -- (CONTINUED)
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 8 -- MORTGAGE DEBT
The Company had outstanding mortgage indebtedness of approximately $1.7 billion and $2.4 billion as of December 31, 1999 and 1998, respectively. The historical cost, net of accumulated depreciation of encumbered properties at December 31, 1999 and 1998 was approximately $3.8 billion and $5.3 billion, respectively. During the years ended December 31, 1999 and 1998, the following transactions occurred:
- --------------- (1) Excludes net premium on mortgage debt of approximately $10,574, $13,517 and $1,157 as of December 31, 1999, 1998 and 1997, respectively.
(2) See Note 4 footnote (b).
A summary of the Company's fixed and variable rate mortgage debt is as follows:
Fixed Rate Mortgage Debt
As of December 31, 1999 and 1998, the Company had outstanding fixed rate mortgage indebtedness of approximately $1.6 billion and $2.3 billion, respectively. Payments on fixed rate mortgage debt are generally due in monthly installments of principal and interest or interest only. As of December 31, 1999 and 1998, fixed interest rates ranged from 6.9% to 8.6% and 6.9% to 9.1%, respectively. The weighted average fixed interest rate was approximately 7.5% and 7.6% as of December 31, 1999 and 1998, respectively.
The Company entered into an interest rate swap agreement in 1995 which effectively fixed the interest rate on a $93.6 million variable rate mortgage loan at 6.9% through the maturity of the loan on June 30, 2000.
Variable Rate Mortgage Debt
As of December 31, 1999 and 1998, the Company had outstanding variable rate mortgage indebtedness of approximately $126.3 million and $70.4 million, respectively. Payments on variable rate mortgage debt are generally due in monthly installments of principal and interest or interest only. The variable interest rates are based on a variety of options including LIBOR-based interest rates. As of December 31, 1999 and 1998, the weighted average variable interest rate was 7.2% and 6.4%, respectively.
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 8 -- MORTGAGE DEBT -- (CONTINUED) Repayment Schedule
Scheduled payments of principal on mortgage debt for each of the next five years and thereafter as of December 31, 1999 are as follows:
NOTE 9 -- LINES OF CREDIT
Lines of Credit
In 1998, the Company obtained a revolving credit facility for $1.0 billion (the "$1.0 Billion Credit Facility") maturing on May 29, 2001. The Company incurred fees of approximately $2.5 million at the closing of the facility which are being amortized over the term along with approximately $1.0 million of unamortized deferred financing costs on the previous $600 million line of credit. The interest rate is based on the Company's investment grade rating on its unsecured debt and is currently LIBOR plus 60 basis points with a facility fee (based on the aggregate amount of the facility) equal to 20 basis points per annum. In addition, a competitive bid option, whereby the lenders participating in the line of credit bid on the interest rate to be charged, is available for up to $350 million of the $1.0 Billion Credit Facility. As of December 31, 1999 there was approximately $453.0 million outstanding on the facility.
Term Loan Facilities
In October 1997, the Company obtained a $1.5 billion unsecured credit facility (the "$1.5 Billion Credit Facility"). The $1.5 Billion Credit Facility carried an interest rate equal to LIBOR plus 100 basis points subject to an increase or decrease upon receipt of an investment grade unsecured debt rating. The Company paid an underwriting fee on the $1.5 Billion Credit Facility at closing of approximately $4.9 million. In addition, an unused commitment fee of 15 to 25 basis points was payable quarterly in arrears based upon the unused amount of the $1.5 Billion Credit Facility. The $1.5 Billion Credit Facility was repaid and terminated in May 1998 with amounts borrowed from the $1.0 Billion Credit Facility.
On August 14, 1998, the Company completed a term loan agreement with various financial institutions to provide the Company a $328 million unsecured term loan facility (the "$328 Million Credit Facility"). The term loan was priced at 90-day LIBOR plus 80 basis points and was prepayable on any interest payment date. The term loan had a maturity date of August 15, 2000. On August 9, 1999 the Company prepaid the facility with proceeds from the $1.0 Billion Credit Facility and approximately $.2 million of unamortized loan costs were written-off and accounted for as an extraordinary loss.
On September 22, 1998, the Company completed a term loan to provide the Company a $200 million unsecured term loan facility (the "$200 Million Credit Facility"). Interest accrued under the term loan at an initial rate of LIBOR plus 50 basis points with a facility fee equal to 20 basis points per annum. Pricing for the first twelve months was based on a matrix tied to the Company's credit rating. The proceeds were used to pay
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9 -- LINES OF CREDIT -- (CONTINUED) down the $1.0 Billion Credit Facility. On September 15, 1999, the Company repaid the facility upon its maturity with proceeds from the $1.0 Billion Credit Facility.
NOTE 10 -- UNSECURED NOTES
$180 Million Notes Offering
On September 3, 1997, the Company privately placed (the "$180 Million Notes Offering") $180 million of unsecured notes (the "$180 Million Notes"). The notes consist of four tranches with maturities from seven to ten years, which were priced at an interest rate spread over the corresponding U.S. Treasury rate. The Company used the proceeds to repay a portion of its credit facilities. In connection with the offering, the Company terminated $150 million of hedge agreements at a cost of approximately $3.9 million which is being amortized over the terms of the respective tranches as an adjustment to interest expense.
$1.25 Billion Notes Offering
In February 1998, the Company privately placed (the "$1.25 Billion Notes Offering") $1.25 billion of unsecured notes (the "$1.25 Billion Notes"). The notes consist of four tranches with maturities of five to 20 years priced at an interest rate spread over the corresponding U.S. Treasury rate. The notes were issued as a discount of approximately $2.0 million, which is being amortized over the terms of the respective tranches as an adjustment to interest expense.
$250 Million Mandatory Par Put Remarketed Securities Offering
Also in February 1998, the Company privately placed $250 million of 6.4% Mandatory Par Put Remarketed Securities due February 15, 2012 ("MOPPRS"), which are subject to mandatory tender on February 15, 2002 (the "$250 Million MOPPRS Offering"). The MOPPRS are unsecured obligations of the Company. The MOPPRS were issued at a premium of approximately $6.5 million which is being amortized over the terms of the MOPPRS as an adjustment to interest expense.
The proceeds to the Company from the $1.25 Billion Notes Offering and the $250 Million MOPPRS Offering, net of offering costs, were approximately $1.5 billion. The Company terminated $700 million of hedge agreements in connection with the issuance of the $1.25 Billion Notes and the MOPPRS at a cost of approximately $31.3 million which is being amortized as an adjustment to interest expense. The net proceeds were used to pay down the line of credit and other unsecured borrowings.
$775 Million Notes and 300,000 Warrants Offering
In June 1998, the Company issued $775 million of unsecured notes (the '$775 Million Notes") and 300,000 warrants to purchase an additional $300 million in unsecured notes at a later date (the "$775 Million Notes Offering"). The notes consist of three tranches with maturities of six to 30 years. The $775 Million Notes and warrants were issued at a net premium of $119,250, which is being amortized over the terms of the respective tranches as an adjustment to interest expense. In exchange for issuing the warrants, the Company received a $2.4 million premium (80 basis points) at closing. Total proceeds to the Company, net of selling commissions, were approximately $768.6 million and were used to pay down borrowings under the $1.0 Billion Credit Facility. The warrants expired and no additional notes were issued by the Company.
$1.0 Billion Notes Offering
On January 26, 1999, the Company issued $1.0 Billion of unsecured notes (the "$1.0 Billion Notes") in three tranches (the "$1.0 Billion Notes Offering"). The $1.0 Billion Notes were issued at a discount of approximately $3.3 million, which is being amortized over terms of the respective tranches as an adjustment to
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 10 -- UNSECURED NOTES -- (CONTINUED) interest expense. Net proceeds to the Company after offering costs were approximately $989.2 million. The net proceeds were used to repay mortgage debt and amounts outstanding on the $1.0 Billion Credit Facility.
$200 Million Notes Offering
On April 19, 1999, the Company issued $200 million of unsecured notes due April 19, 2029 (the "$200 Million Notes") in an offering to institutional investors (the "$200 Million Notes Offering"). The net proceeds after discount and offering expenses were approximately $196.6 million and were used to repay amounts outstanding on the $1.0 Billion Credit Facility.
A summary of the terms of the unsecured notes outstanding as of December 31, 1999 is presented below:
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(1) Includes the cost of the terminated interest rate protection agreements, offering and transaction costs and premiums and discounts on certain unsecured notes.
(2) MOPPRS are subject to mandatory redemption in 2002 but do not mature until 2012.
The Company filed a registration statement, which was declared effective on June 18, 1998, relating to an offer to exchange the $180 Million Notes, the $1.25 Billion Notes and the MOPPRS for registered securities of the Company with terms identical in all material respects to the terms of the existing notes and MOPPRS. This exchange offer expired on July 30, 1998 and a majority of the holders exchanged their notes for registered notes of the Company.
The Company filed a shelf registration statement, which was declared effective on July 22, 1998, relating to the issuance from time to time of up to $2.0 billion of unsecured debt securities and warrants exercisable for debt securities in amounts, at initial prices and on terms to be determined at the time of offering. The Company issued $1.2 billion of unsecured notes in 1999 under this registration statement.
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 10 -- UNSECURED NOTES -- (CONTINUED) The Company filed a registration statement, which was declared effective on September 4, 1998, relating to an offer to exchange (a) the $775 Million Notes; (b) the 300,000 warrants to purchase an additional $300 million in unsecured notes at a later date; and (c) portions of the $1.25 Billion Notes and MOPPRS for registered securities of the Company with terms identical in all material respects to the terms of the existing securities. This exchange offer expired on October 27, 1998 and a majority of the holders exchanged their notes for registered securities of the Company.
NOTE 11 -- MINORITY INTERESTS IN PARTIALLY OWNED PROPERTIES
The following Properties are controlled and partially owned by the Company but have partners with minority interests. The Company has included 100% of the financial condition and results of operations of these properties in the consolidated financial statements of the Company and the combined financial statements of Equity Office Predecessors. The equity interests of the unaffiliated partners are reflected as minority interests:
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(1) The Company owns a controlling interest and is the managing general partner. The 5100 Brookline (CIGNA Center) property was disposed of during 1999.
(2) The Company is the managing general partner and receives preferential allocations resulting in the Company receiving 100% of the economic benefits.
(3) The Company owns a controlling interest and receives preferential allocations. The unaffiliated partner is entitled to receive 50% of the remaining cash flow and residual profits after the Company receives its preferential allocations.
(4) The Company has an 89% managing general partner interest in 11 Office Properties and receives preferential allocations entitling the Company to 99% of the economic benefits. The Company has the option of purchasing the remaining interest in the 11 Office Properties, exercisable for a designated period commencing three years after the respective closing dates on the initial purchases, for additional consideration in the amount of approximately $2.1 million, all payable in Units valued at $28.775 per Unit.
(5) The Company acquired a first mortgage note secured by the property. In accordance with certain agreements concerning the first mortgage note and the Property, the Company controls the financial and operational decisions for the Property and is entitled to substantially all cash flow and residual profit. Accordingly, the Company consolidated the financial position and results of operations of the Property. During 1999, the minority interest partner contributed $11.0 million.
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 12 -- PARTNERS' CAPITAL
Units
On October 1, 1999, the Company issued 1,035,389 Units valued at $23.64 per Unit for a total of approximately $24.5 million for the acquisition of Palo Alto Square.
In April 1998, the Trust privately placed 1,628,009 Common Shares at $28.5625 per share for net proceeds of approximately $44.1 million (the "UIT Offering") which was contributed to the Company in exchange for a corresponding number of Units. The Company used the net proceeds to fund property acquisitions. These shares were subsequently registered with the SEC.
The Trust filed a shelf registration statement which was declared effective on July 22, 1998, relating to the registration of $1.5 billion of Common Shares, preferred shares of beneficial interest and warrants to be issued at prices and on terms to be determined at the time of offering. The Trust may or may not issue the securities separately or together, in amounts, at prices and on terms described in one or more supplements to the prospectus. The Series C Preferred Shares were issued under this registration statement in December 1998.
The following table presents the changes in the Company's issued and outstanding Units:
- --------------- (1) In 1999, the Trust announced a share repurchase plan. During 1999, 715,600 Common Shares were repurchased at an average share price of $23.14 for approximately $16.6 million in the aggregate and were retired along with a corresponding number of Units. An additional 4,742,500 Common Shares were repurchased and retired, along with a corresponding number of Units, between January and February 2000 at an average share price of $25.27 for approximately $119.8 million in the aggregate. In February 2000, the Trust suspended its share repurchase plan in anticipation of the Cornerstone Merger (see Note 24). Prior to the implementation of the Trust's share repurchase plan, the Trust repurchased 324,434 Common Shares and the Company repurchased approximately 1.2 million Units in a private transaction, which resulted in the Company repurchasing an equivalent number of Units from the Trust.
Ownership of the Company
As of December 31, 1999, the Trust and its subsidiaries had a 1% general partnership interest and an approximate 87.0% limited partnership interest in the Company. The remaining limited partners had an approximate 12.0% interest in the Company and consist of various individuals and entities that contributed
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 12 -- PARTNERS' CAPITAL -- (CONTINUED) their properties to the Company in exchange for partnership interests and are represented by 34,203,912 Units which are exchangeable on a one-for-one basis into the Trust's Common Shares.
As of December 31, 1998, the Trust and its subsidiaries had a 2% general partnership interest and an approximate 88.1% limited partnership interest in the Company. The remaining limited partners had an approximate 9.9% interest in the Company and consisted of various individuals and entities that contributed their properties to the Company in exchange for partnership interests and were represented by 28,645,699 Units which were exchangeable on a one-for-one basis into the Trust's Common Shares.
In regards to the Trust, net proceeds from the various offerings of the Trust have been contributed by the Trust to the Company in return for Units, which results in an increased ownership percentage that the Trust has in the Company.
Preferred Units
On December 19, 1997, the Trust exchanged its 8,000,000 Series A Cumulative Redeemable Preferred Shares, liquidation preference of $25.00 per share for the Beacon Series A Preferred Shares in connection with the Beacon Merger. The Series A Preferred Shareholders are entitled to receive, when and as authorized by the Trust, cumulative preferential cash distributions at the rate of 8.98% of the $25.00 liquidation preference per annum (equivalent to a fixed annual amount of $2.245 per share). Such distributions are cumulative and are payable quarterly in arrears of $.56125 per unit. Holders of the units have no other voting rights except as provided by law and have no preemptive rights. On and after June 15, 2002, the Trust, at its option may redeem the shares, in whole or in part, at any time for cash at a redemption price of $25.00 per share, plus all accrued and unpaid distributions thereon to the date fixed for redemption. As a result of this transaction, the Company issued preferred units to the Trust on a one-for-one basis.
In February 1998, the Trust privately placed (the "Series B Preferred Share Offering") 6,000,000 of its 5.25% Series B Convertible, Cumulative Redeemable Preferred Shares, $50 liquidation preference per share (the "Series B Preferred Shares"). This offering generated net proceeds of approximately $290.3 million after offering costs of $9.7 million. Proceeds from the Series B Preferred Share Offering were contributed to the Company in exchange for a corresponding number of Series B Preferred Units. The net proceeds were used to pay down the line of credit. The Series B Preferred Shares are convertible at any time by the holder into Common Shares at a conversion price of $35.70 per Common Share, equivalent to a conversion ratio of 1.40056 Common Shares for each Series B Preferred Share. Such conversion would require the Company to issue Units on a one-for-one basis to the Trust. The Series B Preferred Shares are non-callable for five years with a mandatory call on February 15, 2008. Each Series B Preferred Share/Unit will receive a quarterly distribution of $0.65625 per share/unit when and as authorized by the Trust.
The Trust filed a registration statement, which was declared effective on September 4, 1998, relating to the resale of the Series B Preferred Shares. The shares were required to be registered under the terms of a registration rights agreement entered into at the time of the original private placement.
In December 1998, the Trust completed the offering (the "Series C Preferred Share Offering") of 4,600,000 of its 8.625% Series C Cumulative Redeemable Preferred Shares, $25 liquidation preference per share (the "Series C Preferred Shares"). This offering generated net proceeds of approximately $111.4 million after offering costs of $3.6 million. Proceeds from the Series C Preferred Share Offering were contributed to the Company in exchange for a corresponding number of Series C Preferred Units. The net proceeds were used to pay down the $1.0 Billion Credit Facility. On and after December 8, 2003, the Trust may redeem the shares, in whole or in part, at any time or from time to time, for cash at a redemption price of $25.00 per share, plus all accrued and unpaid distributions thereon to the date fixed for redemption. Any such redemptions would require the Company to redeem Series C Preferred Units from the Trust on an equivalent basis. Each
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 12 -- PARTNERS' CAPITAL -- (CONTINUED) Series C Preferred Share/Unit will receive a quarterly distribution of $0.5390625 per share/unit when and as authorized by the Trust.
Distributions
The following tables summarizes the distributions paid to unit holders and preferred unitholders related to the years ended December 31, 1999 and 1998.
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(1) Partial distribution of $0.619792 covers the period from February 19 through May 15, 1998.
(2) The distribution represents a pro-rated distribution from December 8, 1998 (the closing date of the Series C Preferred Shares Offering) through March 14, 1999.
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 13 -- FUTURE MINIMUM RENTS
Future minimum rental receipts due on noncancelable operating leases at the Office Properties and Parking Facilities as of December 31, 1999 were as follows:
The Company is subject to the usual business risks associated with the collection of the above scheduled rents. The future minimum rents from the Company's investment in unconsolidated joint ventures have not been included in the above schedule.
NOTE 14 -- FUTURE MINIMUM LEASE PAYMENTS
As of December 31, 1999, the Company's ownership of various Office Properties and Parking Facilities are subject to ground leases. Certain of these leases are subject to rental increases based upon the appraised value of the Property at specified dates or certain financial calculations of the respective Property. As disclosed in Note 20, the Company leases its office space from an affiliate. Future minimum lease obligations under these noncancelable leases as of December 31, 1999 were as follows:
Rental expense for the year ended December 31, 1999 and 1998, the period from July 11, 1997 through December 31, 1997 and the period from January 1, 1997 through July 10, 1997, was approximately $10.6 million, $11.1 million, $3.4 million and $3.8 million, respectively.
NOTE 15 -- EXTRAORDINARY ITEMS
The Company incurred an extraordinary loss of approximately $10.5 million during 1999 consisting of the following transactions:
- $3.2 million due to the write-off of unamortized mark-to-market adjustments in connection with the repayment of certain mortgage debt;
- $7.1 million consisting of a $13.6 million prepayment penalty partially offset by the write-off of approximately $6.5 million of unamortized mark-to-market premium in connection with the repayment of a mortgage debt; and
- $.2 million due to the write-off of unamortized loan costs in connection with the prepayment of the $328 Million Credit Facility.
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 15 -- EXTRAORDINARY ITEMS -- (CONTINUED) The Company reported an extraordinary loss of approximately $7.5 million during the year ended December 31, 1998. This loss consisted of approximately $7.0 million of fees charged upon termination of $300 million of interest rate protection agreements in connection with the Series B Preferred Share Offering and approximately $0.5 million of unamortized deferred financing costs related to the termination of the $1.0 Billion Credit Facility.
The Company and Equity Office Predecessors reported an extraordinary loss of approximately $16.4 million and $0.3 million, for the period from July 11 through December 31, 1997 and January 1 through July 10, 1997, respectively, related to pre-payment penalties on debt retired prior to maturity during the respective periods with net proceeds from the IPO and available cash reserves.
NOTE 16 -- EARNINGS PER UNIT
The following table sets forth the computation of basic and diluted earnings per Unit:
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 16 -- EARNINGS PER UNIT -- (CONTINUED) The following securities were not included in the computation of diluted earnings per Unit since they would have an antidilutive effect:
Upon exercise of the above antidilutive securities, the Company would issue a corresponding number of Units to the Trust on a one-for-one basis.
For additional disclosures regarding the Trust's employee stock options and the Trust's restricted shares see Note 22.
NOTE 17 -- SEGMENT INFORMATION
As discussed in Note 1, the Company's primary business is the ownership and operation of Office Properties. The Company's long-term tenants are in a variety of businesses and no single tenant is significant to the Company's business. Information related to this segment for the years ended December 31, 1999, 1998 and 1997 is below:
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 17 -- SEGMENT INFORMATION -- (CONTINUED)
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(1) Interest expense for the Office Properties does not include allocations of interest expense on corporate unsecured debt.
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 18 -- PRO FORMA STATEMENT OF OPERATIONS (UNAUDITED)
The pro forma data presented below is included to illustrate the effect on the Company's operations as a result of the following transactions which occurred in 1998 and 1997 as if they occurred on January 1, 1997.
- the acquisition and disposition of Office Properties and Parking Facilities;
- the purchase of the remaining partnership interests in a joint venture;
- the $1.25 Billion Notes Offering, the $250 Million MOPPRS Offering, the $775 Million Notes Offering, the $180 Million Notes Offering;
- the Series B and Series C Preferred Share Offerings, which resulted in the Company issuing preferred Units to the Trust;
- the increase in the line of credit to $1.0 billion;
- the $48.5 million investment in preferred shares of Capital Trust;
- the Consolidation and the IPO and the paydown of debt with the proceeds;
- the Beacon Merger; and
- the UIT Offering, which resulted in the Company issuing Units to the Trust.
The accompanying unaudited pro forma condensed combined financial statements have been prepared by management of the Company and do not purport to be indicative of the results which would actually have been obtained had the transactions described above been completed on the dates indicated or which may be obtained in the future.
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 19 -- QUARTERLY DATA (UNAUDITED)
The quarterly data for the last three years are presented in the tables below:
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 19 -- QUARTERLY DATA (UNAUDITED) -- (CONTINUED)
- --------------- (1) This column includes the operations of Equity Office Predecessors from July 1 through July 10, 1997 and the operations of the Company from July 11 through September 30, 1997. The earnings per Unit disclosures pertain only to the operations of the Company from July 11 through September 30, 1997.
NOTE 20 -- RELATED PARTY TRANSACTIONS
Affiliates provide various services to the Company. Fees and reimbursements paid by the Company to affiliates for the years ended December 31, 1999, 1998 and 1997 and payable as of December 31, 1999 and 1998 were as follows:
- --------------- (1) Represents amounts primarily paid to Rosenberg & Liebentritt, P.C., a law firm, for legal fees and expenses incurred in connection with acquisition, corporate and leasing activity. A trustee of the Trust was a principal of this law firm until September 1, 1997. In 1999, Rosenberg & Liebentritt, P.C. dissolved and, as a result, no longer provides legal services to the Company.
(2) Represents amounts paid to EGI Risk Services Inc. for reimbursement of property insurance premiums to an affiliated company and fees for risk management services including reviewing, obtaining and/or
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 20 -- RELATED PARTY TRANSACTIONS -- (CONTINUED) researching various insurance policies. EGI Risk Services, Inc. was a wholly owned subsidiary of the Equity Group, of which Samuel Zell is the Chairman of the Board. Effective October 1, 1999, the Company no longer utilizes the services provided by EGI Risk Services Inc., and its employees have become employees of the Company.
(3) In December 1997, the Company acquired ten Office Properties from an entity affiliated with Wright Runstad & Company for approximately $640 million. Mr. Runstad, a principal of the Wright Runstad & Company, is a trustee of the Trust. In addition, the Company and an affiliate of the Equity Group acquired a 30% non-controlling interest in WRALP, a subsidiary of Wright Runstad & Company, which provides property management, leasing and development services. The Company has agreed to make available to WRALP up to $20 million in additional financing for future development. As of December 31, 1999, no amounts have been funded. However, the Company has guaranteed WRALP's line of credit which has an outstanding balance of approximately $16.9 million as of December 31, 1999. The Company recorded income of approximately $0.9 million and $1.3 million from its investment in WRALP for the years ended December 31, 1999 and 1998, respectively.
WRALP serves as co-property manager with the Company for the Properties acquired from its affiliates in December, 1997. In addition, WRALP serves as co-property manager for four properties acquired by the Company from unaffiliated parties during 1998 and 1999. WRALP served as the developer on Sunset North Corporate Campus project placed in service during 1999 and currently serves as developer of the Three Bellevue Center project which is under construction. The Company has an 80% interest in each development project, and WRALP owns the remaining 20% interest. WRALP is the developer of the World Trade Center in Seattle, Washington. The Company has agreed to acquire that building after its completion and occupancy by a third-party tenant, currently scheduled for the second quarter of 2000. Mr. Runstad did not, in his capacity as Trustee of the Trust, approve the foregoing arrangements with the Company.
(4) The Company leases its corporate office space from an affiliate of the Equity Group. The terms of this lease were reviewed and recommended for Board approval by a special subcommittee of the Board of Trustees of the Trust formed to review related party conflicts between trustees and their affiliates. Upon the recommendation of the special subcommittee, the non-affiliated members of the Board of Trustees of the Trust approved the transaction.
(5) During 1999, fees were paid to the Equity Group for miscellaneous consulting services. In 1998 and 1997 administrative services also included fees paid to Equity Group for centralized services such as real estate tax consulting, payroll processing, employee benefits and telecommunications all of which are now performed by the Company.
(6) Represents amounts paid by Equity Office Predecessors to Merrill Lynch, a limited partner of the general partner of the certain entities included in the Equity Office Predecessors.
(7) Affiliates of the Equity Group were reimbursed for reasonable costs incurred in connection with the organization and the offering of units in the Equity Office Predecessors, including legal and accounting fees and expenses, printing costs and filing fees.
An affiliate of the Equity Group has an indirect minority interest in Standard Parking Limited Partnership ("SPLP"). An affiliate of SPLP manages the parking operations at certain Properties owned by the Company.
The Company was a party to various other transactions with related parties as disclosed in Note 3 and Note 6.
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 20 -- RELATED PARTY TRANSACTIONS -- (CONTINUED) Amounts Received from Affiliates
Affiliates of the Company leased space in certain of the Office Properties owned by the Company. Total rents and other amounts paid by affiliates under the terms of their respective leases were approximately $1.2 million, $0.3 million, and $3.0 million for the years ended December 31, 1999, 1998, and 1997, respectively. In addition, in 1999, the Company provided real estate tax consulting and risk management services to affiliates for which it received approximately $1.2 million.
The Company entered into various lease agreements with affiliates of SPLP whereby such affiliates leased certain of the Company's stand-alone Parking Facilities. Certain of these lease agreements provide the lessee with a series of annual options to extend the term of the lease through various dates. The rent paid in the years ended December 31, 1999, 1998, and 1997 under these lease agreements was approximately $9.0 million, $13.1 million, and $11.0 million, respectively. The Company may receive additional rent based upon actual gross revenues generated by these Parking Facilities. In accordance with certain of these leases, the Company may be obligated to make an early termination payment if agreement is not reached as to rent amounts to be paid for future periods.
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 21 -- NON-CASH INVESTING AND FINANCING ACTIVITIES
Additional supplemental disclosures of non-cash investing and financing activities of the Company are as follows:
NOTE 22 -- SHARE OPTION PLAN AND SHARE AWARD PLAN
The following is a description of the Trust's 1997 Share Option and Share Award Plan, as amended, (the "Employee Plan"), which is included in the financial statements because any Common Shares issued pursuant to the Employee Plan will result in the Company issuing Units to the Trust, on a one-for-one basis.
In July 1997, the Trust adopted the Employee Plan. The purpose of the Employee Plan is to attract and retain highly qualified executive officers, trustees, employees and consultants. Through the Employee Plan, certain officers, trustees, certain employees and consultants of the Trust are offered the opportunity to acquire Common Shares pursuant to grants of (i) options to purchase Common Shares ("Options") and (ii) Share Awards. The Employee Plan is administered by the Compensation and Option Committee (the "Compensation Committee") which is appointed by the Board of Trustees of the Trust. The Compensation Committee determines those officers, trustees, key employees and consultants to whom, and the time or times of which, grants of Options and Share Awards will be made. The Compensation Committee interprets the Employee Plan, adopts rules relating thereto and determines the terms and provisions of Options. In 1999, 1998 and
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 22 -- SHARE OPTION PLAN AND SHARE AWARD PLAN -- (CONTINUED) 1997, the Common Shares subject to Options and Share Awards under the Employee Plan were limited to 19,433,472, 11,121,786 and 11,121,786, respectively. The maximum aggregate number of Common Shares that may be granted for all rights under the Plan shall not exceed 6.8% of the outstanding shares, calculated on a fully diluted basis and determined annually on the first day of each calendar year. No more than one-half of the maximum aggregate number of Common Shares shall be granted as Share Awards. To the extent that Options expire unexercised or are terminated, surrendered or canceled, the Common Shares allocated to such Options shall become available for future grants under the Plan, unless the Plan has terminated. The Employee Plan will terminate at such times as it issues all of the unissued Common Shares reserved for the Plan. The Board of Trustees may at any time amend or terminate the Employee Plan, but termination will not affect Options and Share Awards previously granted. Any Options or Share Awards which vest prior to any such termination will continue to be exercisable by the holder thereof.
The Compensation Committee determines the vesting schedule of each Option and the term, which term shall not exceed ten years from the date of the grant. As to the Options that have been granted through December 31, 1999, the vesting schedules range from the entire option grant being exercisable as of the grant date, to one-third of the Options being exercisable as of the first anniversary of the grant date, an additional one-third being exercisable as of the second anniversary of the grant date and the remaining one-third of the Options being exercisable as of the third anniversary of the grant date. The exercise price for all Options under the Employee Plan shall not be less than the fair market value of the underlying Common Shares at the time the Option is granted.
In addition, the Employee Plan permits the Trust to issue Share Awards to executive officers, other key employees and trustees upon such terms and conditions as shall be determined by the Compensation Committee in its sole discretion. A share award is an award of Common Shares which (i) may be fully vested upon issuance ("Share Awards") or (ii) may be subject to risk of forfeiture under Section 83 of the Internal Revenue Code ("Restricted Share Award"). Generally, members of the Board of Trustees have been granted Share Awards pursuant to the Employee Plan as payment of their board fees. In addition, certain senior officers were issued Share Awards as part of their bonus for fiscal year 1998. In each case, the number of Share Awards granted to trustees and senior officers was equal to the dollar value of the fees or bonus earned divided by the fair market value of the shares on the date the fee or bonus would have been paid. In addition to these Share Awards, Restricted Share Awards were granted to certain officers in 1997 and 1998 and based upon performance for 1999. The Restricted Share Awards vest over a five year period as follows: (i) fifty percent of each Restricted Share Award vests on the third anniversary of the initial grant date; (ii) an additional twenty-five percent of each Restricted Share Award vests on the fourth anniversary of the initial grant date; and (iii) the remaining twenty-five percent of each Restricted Share Award vests on the fifth anniversary of the initial grant date.
The Trust has elected to apply the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25") in the computation of compensation expense. Under APB No. 25's intrinsic value method, compensation expense is determined by computing the excess of the market price of the shares over the exercise price on the measurement date. For the Trust's Options, the intrinsic value on the measurement date (or grant date) is zero, and no compensation expense is recognized. Financial Accounting Standards Board No. 123 ("FASB No. 123") requires the Trust to disclose pro forma net income and income per share as if a fair value based accounting method had been used in the computation of compensation expense. The fair value of the Options computed under FASB No. 123 would be recognized over the vesting period of the Options. The fair value for the Trust's Options granted in 1999, 1998 and 1997 was estimated at the time the Options were granted using the Black-Scholes option pricing model with the following weighted average assumptions for 1999, 1998 and 1997, respectively: risk-free interest rates of 6.4%, 5.4% and 5.6%; dividend yields of 6.8%, 5.8% and 4.0%; volatility factors of the expected market price of the
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 22 -- SHARE OPTION PLAN AND SHARE AWARD PLAN -- (CONTINUED) Trust's Common Shares of 0.19, 0.30 and 0.24; and a weighted average expected life of the Options of five years.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because the Trust's Options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its Options.
For purposes of pro forma disclosures, the estimated fair value of the Options is amortized to expense over the Options' vesting period. The following is the unaudited pro forma information for the year ended December 31, 1999 and 1998 and the period from July 11, 1997 through December 31, 1997:
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 22 -- SHARE OPTION PLAN AND SHARE AWARD PLAN -- (CONTINUED) The table below summarizes the Option activity of the Employee Plan for the years ended December 31, 1999, 1998 and the period from July 11, 1997 through December 31, 1997:
As of December 31, 1999, there were 5,174,418 Options under the Employee Plan that were exercisable and 8,287,736 Options that were not exercisable. Exercise prices for the 13,462,154 Options outstanding as of December 31, 1999 ranged from $12.09 to $33.00, with a weighted average exercise price of $24.66. Expiration dates ranged from July 11, 2007 to December 31, 2009. The remaining weighted average contractual life of Options was 8.70 years. The weighted average grant date fair value of Options granted during 1999, 1998 and 1997 was $2.91, $4.88 and $4.44, respectively. In addition, there were 380,000 and 298,000 Restricted Shares issued during 1998 and 1997, respectively, which vest over three to five years. The Restricted Shares were valued at an average of $21.57 per share.
NOTE 23 -- COMMITMENTS AND CONTINGENCIES
Concentration of Credit Risk
The Company maintains its cash and cash equivalents at financial institutions. The combined account balances at each institution typically exceed FDIC insurance coverage and, as a result, there is a concentration of credit risk related to amounts on deposit in excess of FDIC insurance coverage. Management of the Company believes that the risk is not significant.
The Company from time to time enters into interest rate protection agreements to effectively convert floating rate debt to a fixed rate basis, as well as to hedge anticipated financing transactions. The Company believes it has limited exposure to the risk of non-performance by the swap counterparties since each counterparty is a major U.S. or foreign financial institution; management does not anticipate any such non-performance. As of December 31, 1999, the Company has one interest rate protection agreement which effectively fixed the interest rate on a $93.6 million loan at 6.9% through the maturity of the loan on June 30, 2000.
Environmental
The Company, as an owner of real estate, is subject to various environmental laws of federal and local governments. Compliance by the Company with existing laws has not had a material adverse effect on the Company's financial condition and results of operations, and management does not believe it will have such an
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 23 -- COMMITMENTS AND CONTINGENCIES -- (CONTINUED) impact in the future. However, the Company cannot predict the impact of new or changed laws or regulations on its current Properties or on properties that it may acquire in the future.
Litigation
The Company has become a party to various legal actions resulting from the operational activities transferred to the Operating Partnership in connection with the Consolidation and the Beacon Merger. These actions are incidental to the transferred business and management does not believe that these actions will have a material adverse effect on the Company.
Neither the Company nor any of the Properties is presently subject to any material litigation nor, to the Company's knowledge, is any litigation threatened against the Company or any of the Properties, other than actions which the Company does not believe to be material, or routine actions for negligence and other claims and administrative proceedings arising in the ordinary course of business, some of which are expected to be covered by liability insurance and all of which collectively are not expected to have a material adverse effect on the liquidity, business, results of operations or financial condition of the Company.
Insurance
The Company is self-insured for certain amounts related to losses that may be incurred at the Properties. However, management does not believe that this exposure will have a material adverse effect on the Company.
The Company carries earthquake insurance on all of the Properties, including those located in California, subject to coverage limitations which the Company believes are commercially reasonable. In light of the California earthquake risk, California building codes since the early 1970s have established construction standards for all new buildings. The current and strictest construction standards were adopted in 1987. Of the 49 Properties located in California, 12 have been built since January 1, 1988 and the Company believes that all of the Properties were constructed in full compliance with the applicable standards existing at the time of construction. No assurance can be given that material losses in excess of insurance proceeds will not occur in the future.
Commitments
In July 1998, the Company entered into an agreement to purchase the World Trade Center project in Seattle, Washington. The property consists of approximately 186,787 square feet of office space and is 100% preleased to a single tenant. After the tenant takes full occupancy in 2000, the Company is expected to purchase the building for approximately $39.0 million. This transaction is contingent upon certain terms and conditions as set forth in the purchase agreement. There can be no assurance that this transaction will be consummated as described above.
In accordance with the agreement governing the Company's investment in WRALP, the Company agreed to make available to WRALP up to $20.0 million in additional financing or credit support for future development. As of December 31, 1999, no amounts have been funded pursuant to this agreement. However, the Company has guaranteed WRALP's line of credit which has an outstanding balance of approximately $16.9 million as of December 31, 1999.
Contingencies
On August 12, 1999, the Trust and the WR Holders amended their put option agreement to defer to August 13, 2000 (or to August 13, 2001 at the option of the WR Holders) the exercise date for 1,717,844 of the 3,435,688 Common Shares affected by the put option agreement (a maximum exposure to the Company of approximately $54.1 million when and if this put option is exercised). The Trust and the WR Holders also
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 23 -- COMMITMENTS AND CONTINGENCIES -- (CONTINUED) agreed to cancel the put option on the remaining 1,717,844 Common Shares in exchange for the Company's payment to the WR Holders of approximately $11.3 million on September 13, 1999. The payment represented the excess of $31.50 over $24.90 (the average price of a Common Share calculated over the five trading days immediately prior to August 13, 1999), for each of 1,717,844 Common Shares affected by the put option agreement. The portion of the amounts paid in excess of $29.10625 per Common Share totaling approximately $4.1 million was reflected as a preferred distribution. The remaining $7.2 million of the payment was recorded as a reduction to partners' capital.
On August 13, 2000, (or August 13, 2001 at the option of the WR Holders) the WR Holders can require the Trust to purchase all or a portion of the remaining 1,717,844 Common Shares issued to them in the acquisition at a price equal to $31.50 per Common Share. Prior to such date, if the WR Holders sell all or a portion of their Common Shares to a third party for a price less than $29.10625, then the Trust is obligated to pay to the WR Holders for each Common Share sold at such lower price an amount equal to the difference between $29.10625 and such lower price, not to exceed $3.00 per Common Share. Any amounts paid by the Trust as a result of such sales will result in the Company making an equal payment to the Trust and will be recorded as a reduction in partners' capital. For put options exercised as aforesaid, any amounts paid up to $29.10625 per Common Share would be reflected as a reduction in partners' capital; the portion of any amounts paid in excess of $29.10625 per Common Share (not to exceed $2.39375 per Common Share up to an aggregate of approximately $4.1 million) will be reflected as a preferred distribution. The $4.1 million portion of the total potential payment is being amortized by the Company on a straight-line basis over the period between August 13, 1999 and August 13, 2000. The Company will not incur any loss on this transaction if the put option is not exercised.
Effective as of September 3, 1998, the Company amended its pre-existing put option agreement with the seller of the Columbus America Properties (the "CA Holder") related to 1,692,546 Units issued at acquisition. The CA Holder has the option at any time after January 1, 1999 until the earlier of September 3, 2000 or the date the CA Holder has converted all of its Units to Common Shares, to require the Company to purchase the Units at a price equal to $29.00 per Unit. In October 1999, the CA Holder exercised its option to require the Company to purchase 1,675,000 Units at a price equal to $29.00 per Unit for a total of approximately $48.6 million. The Company recognized the $48.6 million payment as a reduction of partners' capital and retired the Units.
In connection with the acquisition of Worldwide Plaza on October 1, 1998, the Company issued a transferable put option on the 6,861,166 Units issued at acquisition which is exercisable only on the third anniversary of closing with an estimated fair value of approximately $27.4 million. This option entitles its holder to additional Common Shares, the number of which shall be determined using a formula based on the extent, if any, that the Common Shares are then trading at less than $29.05 per share.
NOTE 24 -- SUBSEQUENT EVENTS
1) The Company entered into an agreement with OnSite Access, Inc. ("OnSite"), a facilities based provider of broadband data, video and voice communications services, delivered over fiber optic networks designed, constructed and owned by OnSite in large- and medium-sized office buildings. OnSite will provide its services to tenants in certain Office Properties. In return for allowing OnSite access to the Office Properties, OnSite will grant the Company warrants to acquire common shares of OnSite for $2.36 per share. Although OnSite is not currently a public company, it has filed a registration statement with the SEC to register the issuance of its common shares and is expected to become a reporting company under the Securities and Exchange Act of 1934.
EOP OPERATING LIMITED PARTNERSHIP AND EQUITY OFFICE PREDECESSORS NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 24 -- SUBSEQUENT EVENTS -- (CONTINUED) 2) On January 14, 2000, the Board of Trustees of the Trust declared a first quarter distribution for the Series B Preferred Shares of $0.65625 per share. The distribution was paid on February 15, 2000 to holders of record as of February 1, 2000.
3) On January 17, 2000, the Company obtained an additional unsecured borrowing facility from the Chase Manhattan Bank for short-term borrowings not to exceed $300 million in the aggregate. Upon request of the Company, and at the lender's option, the lender may offer to lend funds at mutually agreed upon interest rates and terms, as determined by current market conditions. As of March 1, 2000, the Company owed $200 million under this facility at a weighted average rate of 6.4%. On each of March 15, 2000, and March 24, 2000, the note is repayable in two $100 million installments.
4) On February 10, 2000, the Company sold Sarasota City Center in Sarasota, Florida, for approximately $27.7 million to an unaffiliated party. The office property consisted of approximately 247,891 square feet and was 88.5% occupied at December 31, 1999.
5) On February 11, 2000, the Trust, the Company, Cornerstone Properties, Inc. ("Cornerstone") and Cornerstone Properties Limited Partnership ("Cornerstone Partnership") entered into a merger agreement where Cornerstone will merge with and into the Trust and Cornerstone Partnership will merge with and into the Company (the "Cornerstone Merger"). The total purchase price will be approximately $4.6 billion, including the assumption of approximately $1.8 billion in debt, the payment of $1.1 billion in cash and the issuance of approximately 63.6 million new Common Shares and Units. Cornerstone common shareholders may elect to receive $18.00 per share in cash, plus any accrued but unpaid dividends, or 0.7009 of the Trust's Common Shares based on a prevailing transaction price of $25.68125 per common share, subject to proration. Cornerstone's convertible preferred shareholders will receive $18.00 per share in cash. Cornerstone Partnership unitholders will receive 0.7009 Units of the Company. The Company intends to finance the $1.1 billion cash portion of the purchase price by obtaining additional term loans, issuing unsecured notes or amending the existing line of credit.
The Cornerstone Merger is expected to be completed in the third quarter of 2000 and is subject to the approval of the shareholders of the Company and the shareholders of Cornerstone and other customary conditions. Cornerstone is a fully integrated REIT and currently owns 86 office properties in the U.S. totaling over 18.5 million square feet, and has an additional $884 million of projects under development. If the Cornerstone Merger is completed the Company will own approximately 380 office properties consisting of approximately 95.5 million square feet.
6) On February 15, 2000, the Board of Trustees of the Trust declared a first quarter distribution for the Series A and Series C Preferred Shares. On March 15, 2000, the Trust will pay the 8.98% Series A Cumulative Redeemable Preferred Share dividend of $0.56125 per share to the holders of record on March 1, 2000. On the same date, the Trust will pay the 8.625% Series C Cumulative Redeemable Preferred Share dividend of $0.5390625 per share to the holders of record on March 1, 2000.
7) On February 15, 2000, upon its maturity, the mortgage note secured by the Civic Opera House was repaid in the amount of approximately $30.6 million.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The Company does not have any trustees or executive officers.
The following table sets forth certain information with respect to the trustees of the Trust, which is the managing general partner of the Company, as of March 7, 2000. The balance of the response to this item is contained in the discussion entitled Executive and Senior Officers of Equity Office in Part I of this Form 10-K
The following is a biographical summary of the experience of the trustees of the Trust.
Samuel Zell, has been a trustee and Chairman of the Board of the Trust since October 1996. Since January 1999, Mr. Zell has served as Chairman of Equity Group Investments, LLC. For more than five years, Mr. Zell has served as Chairman of the Boards of Directors of Anixter International Inc. and American Classic Voyages Co., a provider of overnight passenger cruises in the United States. Since March 1995, Mr. Zell has served as Chairman of the Board of Manufactured Home Communities, Inc. Since March 1993, Mr. Zell has served as Chairman of the Board of Trustees of Equity Residential Properties Trust. Since July 1997, Mr. Zell has been Chairman of the Board of Capital Trust, Inc. Since April 1996, Mr. Zell has served as a director of Ramco Energy PLC, an independent oil company based in the United Kingdom. Since March 1997, Mr. Zell has served as a director of Chart House Enterprises, Inc., an owner and operator of restaurants and since May 1998, Mr. Zell has been Chairman of the Board. Since June 1998, Mr. Zell has served as a member of the Board of Directors, and since July 1999 has been Chairman of the Board, of Davel Communications, Inc., an operator of public pay telephones. Mr. Zell currently is the Chairman of the Trust's Executive Committee. (1)
D.J. Andre de Bock has been a trustee of the Trust since May 1998. He currently is a member of the Board of Directors of Rodamco North America N.V., a Dutch real estate investment company, OTIS B.V., Orange Global Property Fund N.V., an international real estate investment fund listed on the Amsterdam stock exchange, and Stichting ROZ Index, a Dutch property index, and serves as an advisor to Jones Lang LaSalle N.V., an international real estate services company. From 1995 through 1996, prior to his retirement, Mr. de Bock was Chairman and Chief Executive Officer of ING Real Estate, the real estate development and investment arm of ING Group. From 1991 until 1994, Mr. de Bock was Managing Director of Innovest Management, an Amsterdam-listed REIT organized under Dutch law. (5)
Thomas E. Dobrowski has been a trustee of the Trust since July 1997. Since December 1994, Mr. Dobrowski has been the managing director of real estate and alternative investments of General Motors Investment Management Corporation located in New York, New York, an investment advisor to several pension funds, including those of General Motors Corporation, its subsidiaries and affiliates. For more than five years, Mr. Dobrowski has been a director of Manufactured Home Communities, Inc. Since August 1998, Mr. Dobrowski has been a trustee of Capital Trust, Inc. (2)
William M. Goodyear has been a trustee of the Trust since July 1997. From July 1997 until January 1999, Mr. Goodyear was Chairman of Bank of America, Illinois, the Midwest business unit of BankAmerica Corporation, a commercial bank. From July 1997 until January 1999, he was also President of Bank of America, Private Bank. Mr. Goodyear was Chairman and Chief Executive Officer of Bank of America Illinois, a subsidiary of BankAmerica Corporation, from September 1994 until June 1997, at which time it merged with Bank of America NT & SA. For more than two years prior to September 1994, Mr. Goodyear was a Vice Chairman and a member of the Board of Directors of Continental Bank Corporation, the parent company of Continental Bank, N.A., a commercial bank which merged into Bank of America Illinois in September 1994. Since June 1992, Mr. Goodyear has been a member of the Board of Trustees of the Museum of Science and Industry in Chicago, Illinois. Mr. Goodyear has been a member of the Board of Trustees of the University of Notre Dame since May 1996 and of Rush-Presbyterian St. Lukes Medical Center in Chicago, Illinois, since June 1996. Since June 1999, Mr. Goodyear has served as a member of the Board of Directors of Homeplace of America, Inc., a holding company for retail stores specializing in home furnishings and houseware items. Since December 1999, Mr. Goodyear has served as a member of the Board of Directors of Navagant Consulting, Inc., an energy consultant for utility companies. Mr. Goodyear currently is Chairman of the Trust's Audit Committee. (2) (4)
James D. Harper, Jr. has been a trustee of the Trust since July 1997. Mr. Harper has been president of JDH Realty Co., a real estate development and investment company since 1982. Since 1988, he has been a co-managing partner in AH Development, S.E. and AH HA Investments, S.E., special limited partnerships formed to develop over 400 acres of land in Puerto Rico. Since May 1993, Mr. Harper has been a trustee of Equity Residential Properties Trust. Since 1993, Mr. Harper has been a trustee of Urban Land Institute. Since 1997, Mr. Harper has been a director of Burnham Pacific Properties Inc., a REIT that owns, develops and manages commercial real estate properties in California. Mr. Harper currently is Chairman of the Trust's Compensation and Option and Conflicts Committees. (2) (3) (4)
David K. McKown has been a trustee of the Trust since July 1997. Mr. McKown has been Group Executive of Diversified Finance of BankBoston, N.A., a commercial bank since 1993. Mr. McKown was Chairman of the Domestic Senior Credit Committee for BankBoston, N.A. from 1985 until 1990 and Managing Director responsible for all problem loan management for BankBoston, N.A. from 1990 to 1993. (1) (3) (4)
Jerry M. Reinsdorf has been a trustee of the Trust since July 1997. Mr. Reinsdorf has been the Chairman of the Chicago White Sox baseball team, the Chairman of the Chicago Bulls basketball team, and a partner of Bojer Financial Ltd., a real estate investment company located in Park City, Utah, for more than five years. Since 1996, Mr. Reinsdorf has served as a director of LaSalle National Bank, N.A., a commercial bank in Chicago, Illinois, the holding company of which is LaSalle National Corporation, of which Mr. Reinsdorf is also a director. Since 1993, Mr. Reinsdorf has been a trustee of Northwestern University in Evanston, Illinois. Mr. Reinsdorf is a stockholder, officer and director of Jerbo Holdings I, Inc., which is the corporate general partner of a limited partnership which is the general partner of Bojer Realty Limited Partnership I.
Sheli Z. Rosenberg has been a trustee of the Trust since March 1997. Since February 2000, Ms. Rosenberg has been the Vice Chairman of Equity Group Investments L.L.C. From January 1999 until February 2000, Ms. Rosenberg was Chief Executive Officer and President of Equity Group Investments L.L.C., an owner and financier of real estate and corporate investments. Ms. Rosenberg was Chief Executive Officer and President of Equity Group Investments, Inc., from November 1994 through December 1998. From 1980 until September 1997, Ms. Rosenberg was a principal of the law firm of Rosenberg & Liebentritt, P.C. For more than five years, Ms. Rosenberg has served on the Board of Directors of Anixter International
Inc., a provider of integrated network and cabling solutions and previously served for more than five years on the Board of Directors of Equity Group Investments, Inc. Since March 1993, Ms. Rosenberg has been a trustee of Equity Residential Properties Trust, a REIT that owns and operates multifamily residential properties. Since August 1996, Ms. Rosenberg has been a director of Manufactured Home Communities, Inc., a REIT engaged in the ownership and management of manufactured home communities. Since April 1997, Ms. Rosenberg has been a director of Illinois Power Co., a supplier of electricity and natural gas in Illinois, the holding company of which is Dynegy Inc., of which Ms. Rosenberg is also a director. Since May 1997, Ms. Rosenberg has been a director of CVS Corporation, a drugstore chain. Since July 1997, Ms. Rosenberg has been a member of the board of Capital Trust, Inc., a specialized finance company. Since February 2000, Ms. Rosenberg has been a member of the Board of Directors of Danka Business Systems PLC, a business services provider. Ms. Rosenberg currently is the Chairman of the Trust's Governance Committee. (3) (5)
H. Jon Runstad has been a trustee of the Trust since January 1998. Since 1971, Mr. Runstad has been Chief Executive Officer of Wright Runstad & Company, a Seattle, Washington based owner, manager and developer of office buildings in the western United States, primarily in the Pacific Northwest; and since January 1995, he has served as its Chairman. From 1971 until May 1995, Mr. Runstad was President of Wright Runstad & Company. From 1987 through September 1998, Mr. Runstad served as a member of the Board of Regents for the University of Washington.
Edwin N. Sidman has been a trustee of the Trust since March 1998. Until the consummation of the merger of Beacon Properties Corporation into Equity Office in December 1997, Mr. Sidman served as Chairman of the Board and a director of Beacon Properties Corporation from 1994. He is currently the managing partner of The Beacon Companies, a private company in Boston, Massachusetts, which is involved in real estate investment, development and management. Prior to joining Beacon Properties Corporation's predecessor in 1971, Mr. Sidman practiced law with the predecessor to the firm of Rubin and Rudman in Boston, Massachusetts. Mr. Sidman's past professional affiliations include service as Chairman of the National Realty Committee, now the Real Estate Roundtable. Mr. Sidman is a member of the Board of Trustees and Executive Committee of Duke University and of the Board of Directors and Executive Committee of the United Way of Massachusetts Bay. (5) - ---------------
(1) Member of the Executive Committee
(2) Member of the Audit Committee
(3) Member of the Compensation and Option Committee
(4) Member of the Conflicts Committee
(5) Member of the Trust Governance Committee.
MEETINGS AND COMMITTEES OF THE TRUST'S BOARD OF TRUSTEES
MEETINGS. The Board of Trustees held six meetings during 1999. All of the trustees, except Mr. Reinsdorf, attended over 75% of the meetings of the Board and those committees on which he or she served during the year. Mr. Reinsdorf attended four of the six meetings of the Board during the year. The Board of Trustees has standing executive, compensation and option, audit, conflicts and trust governance committees, which are described below.
EXECUTIVE COMMITTEE. The Trust's Board of Trustees' Executive Committee consists of the trustees identified above, with Mr. Zell as its Chairman. Subject to limitations which are specified in the Trust's Bylaws, the Executive Committee has the general authority to acquire, dispose of and finance investments and to approve the execution of contracts and agreements, including those related to indebtedness. Although the Trust's Executive Committee did not formally meet during 1999, its members were in frequent communication and approved numerous matters by unanimous written consent.
COMPENSATION AND OPTION COMMITTEE. The Trust's Board of Trustees' Compensation and Option Committee consists of the independent trustees identified above, with Mr. Harper as its Chairman. The
Compensation and Option Committee determines compensation and benefits for all executive officers other than the President and Chief Executive Officer and makes recommendations to the Trust's Board's disinterested Board members in respect to the compensation and benefits for the Trust's President and Chief Executive Officer. The Compensation and Option Committee met five times during 1999.
AUDIT COMMITTEE. The Trust's Board of Trustees' Audit Committee consists of the independent trustees identified above, with Mr. Goodyear as its Chairman. The Audit Committee recommends the engagement of independent public accountants, reviews with the independent public accountants the plans and results of the audit engagement, approves professional services provided by the independent public accountants, reviews the independence of the independent public accountants, considers the range of audit and nonaudit fees and reviews the adequacy of the Trust's and the Company's internal accounting controls. The Audit Committee met twice during 1999.
CONFLICTS COMMITTEE. The Trust's Board of Trustees' Conflicts Committee consists of the independent trustees identified above, with Mr. Harper as its Chairman. The Trust's Bylaws permit any trustee to require that the Conflicts Committee review and approve, prior to a vote of the disinterested trustees of the full Board, any transaction in which a trustee has a direct or indirect interest. The Conflicts Committee met twice during 1999.
TRUST GOVERNANCE COMMITTEE. The Trust's Board of Trustees' Governance Committee consists of the independent trustees identified above, with Ms. Rosenberg as its Chairman. The Trust's Committee on Trust Governance is responsible for on-going review of the effectiveness of the Trust's Board, the maintenance of criteria and procedures for the identification and recruitment of candidates for election or reelection as Trustees and the recommendation to the Trust's Board, with the advice of the Trust's Board's Chairman and the Trust's President and Chief Executive Officer, of nominees for election or reelection as Trustees. In 1999, the Board adopted Guidelines on Trust Governance Issues after their recommendation to the Board by the Trust Governance Committee. The Trust Governance Committee met twice during 1999.
The Trust does not have a nominating committee.
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
Section 16(a) of the Securities Exchange Act of 1934 requires the trustees and executive officers of the Trust to file reports of holdings and transactions in the Trust's shares with the SEC and the New York Stock Exchange.
Management believes that, during 1999, all applicable filing requirements of the officers and trustees of the Trust were satisfied with the exception of the initial filing requirement for Mr. Helfand who was late in filing his Form 3.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION OF TRUST'S BOARD OF TRUSTEES; PAYMENT IN COMMON SHARES
Annual Fees: The trustees who are employees of the Trust receive no fees for his services as trustees. Each of the Trust's non-employee trustees receives an annual fee of $50,000 and an additional $1,000 per annum for each committee on which he or she serves. Committee chairs receive an additional $500 per annum for each committee chaired. Generally, these fees are paid in common shares. In addition, independent trustees receive an annual grant of options to purchase 10,000 common shares at the fair market value on the date of each annual meeting of shareholders. The annual trustee option grants vest as follows: options for 3,333 common shares vest six months after grant date; options for an additional 3,333 common shares vest on the first anniversary of the grant date; and options for the remaining 3,334 common shares vest on the second anniversary of the grant date.
Option: On February 16, 1999, the Board of Trustees' Compensation and Option Committee granted Mr. Zell options to purchase 500,000 common shares at an above-market exercise price of $29.50 per share. On December 31, 1999, the Board of Trustees granted Mr. Zell options to purchase an additional 750,000
common shares at $24.225 per share, which equaled fair market value on the date of grant. One third of such options granted to Mr. Zell will vest on each of the first three anniversary dates of the option grants.
Indemnification: As required under the Trust's Bylaws, the Trust indemnifies the trustees and officers to the fullest extent permitted by law. The Trust has also signed agreements with each of those individuals contractually obligating us to provide this indemnification to them.
EXECUTIVE COMPENSATION
The following tables show information with respect to the annual compensation (including option grants) for services rendered to the Trust for the year ended December 31, 1999.
SUMMARY COMPENSATION TABLE.
The following table shows the annual compensation for Timothy H. Callahan, the Chief Executive Officer of the Trust, and the other four most highly compensated executive officers of the Trust.
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(1) Amounts shown include cash compensation earned and received by executive officers as well as amounts earned but deferred at the election of these officers. Mr. Helfand's employment with Equity Office commenced in July 1998.
(2) Cash and non-cash bonuses payable in common shares, including amounts earned but deferred, are reported in the year in which the compensation service was performed, even if the bonuses were paid in a subsequent year.
(3) Represents the dollar value of restricted share awards calculated by multiplying the closing market price of the Trust's common shares on the date of grant by the number of shares awarded. This valuation does not take into account the diminution in value attributable to the restrictions applicable to the common shares. The restricted share awards vest over a five-year period (50% on the third anniversary of the grant date, 25% on the fourth anniversary of the grant date, and 25% on the fifth anniversary of the grant date).
The number and value of the aggregate restricted share holdings of each executive officer listed above at December 31, 1999 were as follows:
Distributions are paid on all restricted common share awards at the same rate as on unrestricted common shares.
(4) Securities underlying options are reported in the year granted.
(5) Includes employer matching and profit-sharing contributions to Equity Office's 401(k) Retirement Savings Plan.
1999 OPTION GRANTS.
The following table gives more information on share options granted during the last fiscal year to Timothy H. Callahan, the Chief Executive Officer of the Trust, and the other four most highly compensated executive officers of the Trust.
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(1) All options were granted at the fair market value of common shares as of the date of grant. Options granted are for a term of not more than ten years from the date of grant and vest in three annual installments over three years.
(2) The exercise price for the grant of options on December 31, 1999 was the average closing price of the common shares as listed on the New York Stock Exchange for the five trading days immediately preceding the date of grant.
(3) As permitted by the Securities and Exchange Commission rules, the Trust elected to present the grant date present value of the options set forth in this table calculated using the Black-Scholes option-pricing model. The Trust's use of this model should not be construed as an endorsement of its accuracy at valuing options. All share option models require a prediction about the future movement of the share price. The following assumptions were made for purposes of calculating grant date present value: expected time of exercise of 5 years, volatility of 30%, risk-free interest of 5.4% and dividend yield of 5.8%. The real value of the options in this table depends upon the actual performance of the Equity Office's shares during the applicable period and upon when they are exercised. The dollar amounts in this column are not intended to forecast potential future appreciation, if any, of the Equity Office's common shares.
OPTION EXERCISES AND FISCAL YEAR-END OPTION VALUES
The following table shows the number and value of share options (exercisable and unexercisable) for Messrs. Callahan, Kincaid, Steele, Stevens and Helfand during the last fiscal year
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(1) Represents the fair market value of a common share on December 31, 1999 ($24.4375) less the option exercise price. An option is "in-the-money" if the fair market value of the common shares subject to the option exceeds the option exercise price.
REPORT OF THE TRUST'S COMPENSATION AND OPTION COMMITTEE ON EXECUTIVE COMPENSATION
Trust's Compensation and Option Committee: long-term roles and 1999 actions:
The role of the Compensation and Option Committee of the Board is to:
- - Review and approve a compensation philosophy for Equity Office which is consistent with its mission and strategies;
- - Ensure that the rewards program in total and each of its component parts are designed consistent with the approved compensation philosophy;
- - Review and approve all compensation plans impacting the senior officers of Equity Office;
- - Review and approve the benefit plans impacting all Equity Office employees;
- - Determine the specific levels of compensation for the four highest paid officers other than the President and Chief Executive Officer; and
- - Recommend to the Board the specific levels of compensation for the Chairman, the President and Chief Executive Officer, as well as the Trustees.
During 1999, the Compensation and Option Committee, with the advice and assistance of a team of outside compensation consultants, fully reviewed Equity Office's "total rewards" programs for senior officers (as well as other employees). The results of this review were refinements to Equity Office's existing compensation plans, which are designed to:
- - Align the compensation packages of senior officers with Equity Office's mission and strategies as well as the long-term interests of shareholders;
- - Improve the incentive to achieve key financial and strategic performance metrics by linking annual incentive award opportunities to the achievement of performance benchmark goals in these areas; and
- - Foster greater shareholder identification by:
* Adopting and implementing share ownership requirements for senior officers; and
* Providing a large portion of total compensation opportunities in the form of restricted shares and share options; and
* Enhancing opportunities for retention of key people through vesting of equity opportunities and by initiating change-in-control agreements
1999 compensation decisions were made with a view towards furthering the foregoing compensation objectives and in light of Equity Office's performance in 1999.
1999 COMPENSATION PROGRAM
For 1999, Equity Office's outside compensation consultants provided competitive compensation data to help the Committee in establishing the desired positioning of Equity Office relative to the market, as well as the desired mix of base salary, annual incentive opportunity and long-term compensation opportunities.
The competitive market for senior officers included:
- Large REITS with an emphasis on office REITs;
- Other for profit companies of comparable size to Equity Office in the general business arena; and
- The real estate industry in general.
TYPES OF COMPENSATION:
The three major components of executive compensation include base salary, annual incentive bonus and long-term/equity compensation.
BASE SALARY. Positions are classified by salary on the basis of assigned responsibilities and an evaluation of the latest available survey information. A range of earnings opportunities has been established for each position. The mid-point of the salary range is dependent on the position's responsibilities relative to the market references. Where salary information is unavailable for a particular position, the salary range is based on other positions having similar responsibilities at Equity Office.
Each salary range has three defined points of reference:
- Minimum or the lowest salary to be paid to a qualified incumbent;
- Mid-point or the middle position of the salary range established with reference to the market value and objectives of Equity Office; and
- Maximum or the highest amount to be paid to an incumbent in this position.
Individual base salaries are reviewed at least annually. Salary increases are granted based on each executive's performance as well as his or her position in the applicable salary range.
INCENTIVE BONUS. Equity Office's bonus program is designed to motivate all employees by more closely linking bonus awards to value added for Equity Office's shareholders. Equity Office has created and intends to promote a culture of performance and ownership among its managers. Executive officers' short-term incentives are accomplished by tying the executive officers' performance to Equity Office's continued performance.
The incentive bonus program recognizes three aspects of performance which are corporate, team and individual:
- "Corporate" refers to the performance measures of Equity Office, including its financial and strategic measures;
- "Team" refers to key functional or departmental performance measures. This aspect of performance links individuals to the performance of their collective work group or assigned geographic territory, and is intended to foster cooperation within Equity Office; and
- "Individual" performance refers to specific performance measures developed for each individual participant in the program. This aspect of performance motivates individuals to achieve a high level of individual success and personal contribution.
The senior officers have their annual incentives weighted more heavily toward the achievement of corporate and team performance rather than individual performance.
SHARE OPTIONS AND RESTRICTED SHARE AWARDS. The Trust's Compensation and Option Committee recognizes that, while the bonus program provides awards for positive short-term and mid-term performance, the interests of shareholders are best served by giving key employees the opportunity to participate in the appreciation of Equity Office's common shares thorough the granting of share options and restricted share awards. The members of the Committee believe that share performance, over the long-term, will reflect executive performance and that such arrangements further reinforce management goals and incentives to achieve shareholder objectives. All employee share options granted to date vest over a period of three years at a rate of one third of such grant each year and all restricted share awards vest over a period of five years. The Committee used the compensation surveys, and an assessment of the senior officer's achieved performance goals and objectives, to determine the amount of share options and restricted shares awarded each senior officer.
CHIEF EXECUTIVE OFFICER'S COMPENSATION. Based on the executive compensation surveys and Equity Office's financial performance in 1999, the Trust's Compensation and Option Committee concluded that (i) the recommended salary, bonus, restricted share awards and option grants to Mr. Callahan, Equity Office's Chief Executive Officer and President, is fair and competitive in light of Mr. Callahan's contribution and (ii) Equity Office's overall executive compensation ranks within the upper quartile among the general real estate industry and among REITs. The Committee determined that this was appropriate given Equity Office's performance in 1999 and its status as the largest public office company in the United States. The Committee further noted that third-party analysts have consistently pointed to the strength of Equity Office's management team as a reason for their positive view of Equity Office and its future prospects.
SECTION 162(M) POLICY. Section 162(m) of the Internal Revenue Code limits to $1 million Equity Office's tax deduction each year for compensation to each of its Chief Executive Officer and other four most highly paid executive officers. Section 162(m), however, allows a deduction without regard to amount for payments of performance-based compensation, which includes most share option, and other incentive arrangements, the material terms of which have been approved by shareholders. Awards issued under Equity Office's Amended and Restated 1997 Share Option and Share Award Plan may, but need not, satisfy the requirements of Section 162(m). Options under this plan that have an exercise price equal to grant date fair market value and that vest based solely on continued employment qualify as "performance-based compensation." Incentive bonuses are determined based on the evaluation of Equity Office's performance, taking into consideration such factors as pre-set financial and strategic goals. Since, the Board, however, does not apply these factors on a strict formula basis, the incentive bonuses do not satisfy the requirements of 162(m). Restricted share grants, which are used to help retain key executives in a highly competitive job market, also do not qualify as performance based under 162(m). Equity Office believes that because it qualifies as a REIT under the Code and is, therefore, not subject to Federal income taxes, the payment of compensation that does not satisfy the requirements of Section 162(m) does not have a material adverse financial consequence to it provided it continues to distribute 100% of its taxable income.
Respectfully submitted,
James D. Harper, Jr., Chairman David K. McKown Sheli Z. Rosenberg
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
This table indicates how many Units in the Company the executive officers and trustees beneficially owned as of March 7, 2000. In general, "beneficial ownership" includes those Units a trustee or executive
officer has the power to vote, or the power to transfer. Except as otherwise noted, the persons named in the table below have sole voting and investment power with respect to all Units shown as beneficially owned by them.
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* Less than 1%.
(1) Assumes a total of 281,453,518 Units outstanding as of March 7, 2000.
(2) Includes 1,775,065 Units held by Samstock/SZRT, L.L.C. of which may be deemed to be beneficially owned by Mr. Zell. Excludes an additional 11,858,068 Units in which Mr. Zell has an interest but does not have voting or dispositive power.
(3) Does not include 13,620,819 Units attributable to EGI Holdings, Inc., EGIL Investments, Inc., Samstock/ZFT, L.L.C., Samstock/SZRT, L.L.C., Samstock/ZGPI, L.L.C. and Samstock/Alpha, L.L.C., which may be deemed to be beneficially owned by Ms. Rosenberg solely as a result of her position as director, and/or executive officer of the ultimate general partner or shareholder of such entities, or a director, and/or executive officer, of such entities. Ms. Rosenberg disclaims beneficial ownership of such 13,620,819 Units.
(4) Includes 24,115 Units held by Wright Runstad & Company which may be deemed to be beneficially owned by Mr. Runstad; however, Mr. Runstad disclaims beneficial ownership of such 24,115 Units.
(5) Does not include 401,809 Units held by The Leventhal Family Limited Partnership. Paula Sidman, Mr. Sidman's spouse, is a general partner of such partnership; however, Mrs. Sidman disclaims beneficial ownership of the Units beneficially owned by such partnership except for the Units in which she has a pecuniary interest.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
WRIGHT RUNSTAD AFFILIATED TRANSACTIONS.
H. Jon Runstad, a trustee of the Trust, is the Chairman, Chief Executive Officer and a director of Wright Runstad & Company, the general partner of Wright Runstad Associates Limited Partnership, which we refer to as "WRALP." Through direct and indirect holdings, Mr. Runstad owns 40.27% of WRALP. A subsidiary of The Trust and an affiliate of Equity Group Investments, L.L.C. together own a 30% limited partnership interest in WRALP. During 1999, such subsidiary and limited partner received distributions of $.9 million from WRALP. In addition, various subsidiaries of the Trust made payments to WRALP during
1999 totaling $5.1 million as development and management fees, leasing commissions and related expense reimbursements with respect to some of the Properties. An additional $4.7 million was paid during 1999 to Wright Runstad & Company for the reimbursement of salaries of personnel in connection with such management services.
Wright Runstad & Company leases space in some of the Office Properties. The terms of the leases are consistent with terms of unaffiliated tenants' leases. Total rents and other amounts paid by Wright Runstad & Company under its lease were approximately $.3 million for the year ending December 31, 1999.
In addition, Mr. Runstad had an interest in the following transactions during 1999:
- WRALP serves as the co-property manager with the Company and leasing agent for our portfolio of office buildings acquired in December 1997 from an entity affiliated with WRALP. Those buildings are located in Seattle and Bellevue, Washington; Portland, Oregon and Anchorage, Alaska.
- In December 1997, the Company agreed to guarantee a line of credit obtained by WRALP from a third-party lender in an amount of up to $19.5 million in principal plus $.5 million in costs. The balance outstanding on that line of credit at December 31, 1999 was approximately $16.9 million. We have not been required to make any payments under that guarantee.
- WRALP is the property manager for two additional office buildings which we acquired in 1998 and are located in Seattle, Washington.
- WRALP is the property manager for one additional office building which we acquired in 1999 and is located in Bellevue, Washington.
- WRALP owns a 20% interest and the Company owns an 80% interest in WRC Sunset North LLC, a Washington limited liability company that developed a three-building office complex, Sunset North Corporate Campus, in Bellevue, Washington. WRALP served as developer of that project and currently serves as its co-property manager with the Company and leasing agent.
- WRALP owns a 20% interest and the Company owns an 80% interest in Three Bellevue Center LLC, a Washington limited liability company that is developing an office building, Three Bellevue Center, in Bellevue, Washington. WRALP is serving as developer of that project and, upon completion, is expected to serve as co-property manager with the Company and leasing agent.
- WRALP is currently developing an office building, The World Trade Center in Seattle, Washington. Upon completion of the building, the Company will serve as co-property manager and leasing agent with WRALP. We have agreed to acquire that building after it has been completed and occupied by a third party tenant.
EQUITY GROUP INVESTMENTS AFFILIATED TRANSACTIONS
The Company leases office space at Two North Riverside Plaza, Chicago, Illinois owned by Two North Riverside Plaza Joint Venture, a partnership comprised of trusts established for the benefit of the families of Samuel Zell and Robert Lurie, a deceased former business partner of Mr. Zell. Prior to May 1, 1999, Equity Group Investments, L.L.C., and its affiliates provided the Company and its subsidiaries with real estate tax services. We paid approximately $3.5 million during 1999 to Equity Group Investments, L.L.C. and its affiliates for such office space and services. Management believes these amounts equal a market rental rate for the office space and the actual cost of providing these services.
Prior to October 1, 1999, EGI Risk Services Inc., a wholly owned subsidiary of Equity Group Investments, L.L.C. provided risk management services to the Company, including reviewing, obtaining and/or researching various insurance policies. In addition, National Liberty, an affiliate of Equity Group Investments, L.L.C. provided certain insurance coverage for the Company for the period prior to October 1, 1999. Fees paid to EGI Risk Services Inc. and insurance premiums paid to National Liberty during 1999 were approximately $3.5 million.
An affiliate of Equity Group Investments, L.L.C. has an indirect minority interest in Standard Parking Limited Partnership, which we refer to as "SPLP." An affiliate of SPLP manages the parking operations at certain properties that are owned by the Company. We believe amounts paid to SPLP's affiliate are equal to market rates for such services.
The Company has entered into various lease agreements with SPLP's affiliates whereby such affiliates lease certain stand-alone parking facilities. Certain of these lease agreements provide such affiliates with annual successive options to extend the term of the lease through various dates. The rent paid in 1999 under these lease agreements was approximately $9.0 million. In addition, we may receive additional rent based upon actual gross revenues generated by these parking facilities. In accordance with certain of these leases, we may be obligated to make an early termination payment if agreement is not reached as to rent amounts to be paid for future periods.
On July 28, 1998, the Company purchased for $48.5 million 50,000 8.25% Step Up Convertible Trust Preferred Securities, $1,000 liquidation preference per share, issued by CT Convertible Trust I, a subsidiary of Capital Trust, Inc., in a private placement. The preferred securities are convertible at any time into Class A common shares of Capital Trust, Inc. at a conversion price of $11.70, reflecting a 30% conversion premium over Capital Trust, Inc.'s common share price at the close of business on July 24, 1998. The preferred securities are non-callable for five years, and have a 20-year maturity. Mr. Zell, Chairman of our Board of Trustees is also Chairman of the Board of Capital Trust, Inc, and Ms. Rosenberg and Mr. Dobrowski are directors of Capital Trust, Inc. The Company earned approximately $4.1 million in dividends in 1999. The dividend is payable each calendar quarter; commencing in year seven, the dividend will increase by 75 basis points per annum. In connection with the investment, Capital Trust, Inc. has granted the Company and other investors the right to participate in certain strategic lending opportunities.
During 1999, the Company invested approximately $2.0 million for approximately .1 million common shares of Allied Riser Communications Corporation ("ARC"). ARC is a facilities based provider of broadband data, video and voice communications services, delivered over fiber optic networks designed, constructed and owned by ARC in large- and medium-sized office buildings. The Company and ARC entered into various license agreements allowing ARC to install and provide its services to tenants in certain of our office properties containing approximately 75.6 million square feet. In return for allowing ARC access to our office properties, ARC granted us, in addition to the purchased securities described above, approximately 1.4 million warrants to acquire an equal number of common shares of ARC for no additional consideration, as well as an additional .2 million common shares for nominal consideration, and other ARC investors transferred approximately .3 million ARC common shares to us. The warrants and the common shares were recorded at fair value as deferred revenue and will be amortized over the term of the licensing agreements of five years. The total deferred revenue at December 31, 1999, was approximately $29.1 million. As of December 31, 1999, the fair value of the ARC common shares and warrants which are exercisable into ARC common shares at our option commencing in April 2000, was estimated to be approximately $41.5 million.
In 1999, ARC paid the Company rent and expense reimbursements in the amount of approximately $0.9 million and access fees in the amount of approximately $62,000. A private investment entity controlled by Mr. Zell has a substantial investment in ARC.
MANAGEMENT AFFILIATED TRANSACTIONS
In order to satisfy certain REIT tax requirements, our five senior-most officers of the Trust own the equity in Access Holding Company, L.L.C. ("Access"). Access is the owner of one hundred percent (100%) of the voting shares (a five percent economic interest) in Real State Insurance Corporation ("Real State"), a captive insurance company which we created effective October 1, 1999, to provide insurance solely to the Company and its affiliates. The Company indirectly owns one hundred percent (100%) of the non-voting shares (a ninety-five percent economic interest) and has an option through its subsidiary to acquire the interest of Access in Real State, effective on or after January 1, 2001, when REIT tax laws will permit such acquisition and ownership. In 1999, the Company paid Real State insurance premiums in the amount of approximately $1.6 million, substantially all of which was allocated to reserves for potential future losses.
In 1999, the Company entered into a revolving loan agreement with Equity Health Club Holding Corp., an entity in which Messrs. Callahan, Kincaid, Steele and Stevens each owns a 25% equity interest. This entity is the owner of 100% of the membership interest in Equity Health Club, L.L.C. which, for REIT tax reasons, has leased certain health club facilities from us. Under the terms of this loan agreement, interest accrues prior to default on the balance outstanding at the so-called "prime rate" plus 4% per annum and the note is payable on or before July 6, 2004. As of December 31, 1999, the outstanding principal balance in respect of this loan was approximately $.2 million.
MISCELLANEOUS
Equity Office Properties Management Corp., a Delaware corporation, has entered into third-party management contracts, on terms equivalent to third-party transactions, with respect to properties which are owned or controlled by affiliates of Mr. Zell. Income recognized for such services rendered for 1999 was approximately $2.2 million.
Certain services for the Company tenants that for tax reasons may not be performed by a REIT are performed by a service corporation owned entirely by an affiliate of Mr. Zell. The Company has no control over, or ownership interest in, this service corporation, which operates as an independent contractor. The Company may terminate such services at any time upon 30-days' notice. In 1999, the Company paid this entity and its affiliate an amount equal to $1.2 million substantially all of which was applied to expenses incurred.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a)(1) and (2) Financial Statements and Schedules:
FINANCIAL STATEMENTS
Report of Independent Auditors
Consolidated Balance Sheets of EOP Operating Limited Partnership as of December 31, 1999 and 1998
Consolidated Statements of Operations of EOP Operating Limited Partnership for the years ended December 31, 1999 and 1998, the period from July 11, 1997 through December 31, 1997 and the Combined Statement of Operations of Equity Office Predecessors for the period from January 1, 1997 through July 10, 1997.
Consolidated Statements of Changes in Partners' Capital of EOP Operating Limited Partnership for the years ended December 31, 1999 and 1998, the period from July 11, 1997 through December 31, 1997 and the Combined Statement of Owners' Equity for Equity Office Predecessors for the period from January 1, 1997 through July 10, 1997.
Consolidated Statements of Cash Flows of EOP Operating Limited Partnership for the years ended December 31, 1999 and 1998, the period from July 11, 1997 through December 31, 1997, and the Combined Statements of Cash Flows of Equity Office Predecessors for the period from January 1, 1997 through July 10, 1997.
Notes to Consolidated and Combined Financial Statements
SCHEDULES
Schedule III -- Real Estate and Accumulated Depreciation
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.
(a)(3) Exhibits:
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* Incorporated herein by reference to the same-numbered exhibit to the Trust's Annual Report on Form 10-K for the year ended December 31, 1997, as amended
(b) Reports on Form 8-K:
None
(b) Exhibits
See Item 14(a)(3) above
(c) Financial Statement Schedules:
None
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in Chicago, Illinois, as of the 27th day of March, 2000.
EOP OPERATING LIMITED PARTNERSHIP
By: EQUITY OFFICE PROPERTIES TRUST its general partner
By: /s/ TIMOTHY H. CALLAHAN ---------------------------------- Timothy H. Callahan 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 in the capacities indicated as of the 27th day of March, 2000.
Each person whose signature appears below hereby constitutes and appoints Samuel Zell and Timothy H. Callahan, and each of them, his attorney-in-fact and agent, with full power of substitution and resubstitution for him in any and all capacities, to sign any or all amendments to this annual report on Form 10-K for the fiscal year ended December 31, 1999, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto such attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary in connection with such matters and hereby ratifying and confirming all that such attorney-in-fact or his substitutes may do or cause to be done by virtue hereof.
SCHEDULE III -- REAL ESTATE AND ACCUMULATED DEPRECIATION AS OF DECEMBER 31, 1999
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(1) The aggregate cost for Federal Income Tax purposes as of December 31, 1999 was approximately $10.3 billion.
(2) The life to compute depreciation on building is 40 years. The life to compute depreciation on building improvements is 4-40 years.
(3) The date acquired represents the date these Properties were acquired by Equity Office Predecessors. The acquisition of the Properties, or interest therein, by the Company from Equity Office Predecessors in connection with the Consolidation on July 11, 1997, was accounted for using the purchase method of accounting in accordance with Accounting Principles Board Opinion No. 16. Accordingly, the assets were recorded by the Company at their fair values.
(4) This Property contains 106 residential units in addition to 224,405 square feet of office space.
(5) These Properties were previously under development and have been placed into service during 1999.
(6) This Property contains 161 residential units in addition to 187,573 square feet of office space.
(7) These loans are subject to cross default and collateralization provisions.
(8) The Prudential Portfolio consists of six Office Buildings located in Philadelphia, PA, Dallas, TX, and Houston, TX. These Office Buildings were constructed between 1969 and 1984.
(9) These loans are subject to cross default and collateralization provisions.
(10) These properties are in various development stages. During the development period certain operating costs, including real estate taxes together with interest incurred during the development stages will be capitalized.
(11) During 1998, the Company committed to acquire this property upon its completion. The costs reflected above include legal and other professional fees incurred in connection with the Company's potential acquisition of this project. This transaction is contingent upon certain terms and conditions as set forth in its respective purchase agreement. There can be no assurance that this transaction will be consummated.
(12) The encumbrance on the 203 North LaSalle Garage is also secured by a first lien on the Theatre District Garage.
(13) The encumbrances at December 31, 1999 include a net premium (net of accumulated amortization of approximately $4.0 million) of approximately $10.6 million.
A SUMMARY OF ACTIVITY OF INVESTMENT IN REAL ESTATE AND ACCUMULATED DEPRECIATION IS AS FOLLOWS:
The changes in investment in real estate for the years ended December 31, 1999 and 1998, the period from July 11, 1997 through December 31, 1997 and the period from January 1, 1997 through July 10, 1997 are as follows:
The changes in accumulated depreciation for the years ended December 31, 1999 and 1998, the period from July 11, 1997 through December 31, 1997 and the period from January 1, 1997 through July 10, 1997 are as follows:
(1) The disposition amount of approximately $1.2 billion and the related accumulated depreciation of $61.6 million for the year ended December 31, 1999 includes approximately $1.1 billion and $58.5 million, respectively, related to the partial sale of interest in various Properties to Lend Lease Australia/US Properties. Prior to the sale, the Company consolidated the financial condition and results of operations of the Office Properties. Upon the sale, the Company retained an equity interest in the Office Properties and shares equally in the control of the operations and major decisions of the Office Properties. Therefore, the Company accounts for its remaining interest in the Office Properties under the equity method of accounting and classifies its net equity investment of approximately $486.9 million as investment in unconsolidated joint ventures on the consolidated balance sheet and its interest in the net income from investment in unconsolidated joint venture is reflected in the consolidated statements of operations.