Item 1. Business
General Development and Description of Business
Glenborough Properties, L.P., a California Limited Partnership (the "Operating Partnership"), is engaged primarily in the ownership, operation, management, leasing, acquisition, expansion and development of various types of income-producing properties. As of December 31, 1999, the Operating Partnership, directly and through various subsidiaries, owned and operated 161 income-producing properties (the "Properties," and each a "Property"). The Properties are comprised of 51 office Properties, 37 office/flex Properties, 24 industrial Properties, 10 retail Properties, 38 multifamily Properties and 1 hotel Property, located in 22 states.
The Operating Partnership was organized in the State of California on August 23, 1995. The Operating Partnership is the primary operating subsidiary of Glenborough Realty Trust Incorporated (the "Company"), a self-administered and self-managed real estate investment trust ("REIT"). On December 31, 1995, the Company completed a consolidation (the "Consolidation") in which eight public limited partnerships (the "Partnerships," collectively with Glenborough Corporation (defined below), the "GRT Predecessor Entities"), merged with and into the Company. The Company (i) issued 5,753,709 shares (the "Shares") of $.001 par value Common Stock to the Partnerships in exchange for 3,979,376 Operating Partnership units; and (ii) merged with Glenborough Corporation, a California Corporation, with the Company being the surviving entity. The Company then transferred certain real estate and related assets to the Operating Partnership in exchange for a sole general partner interest of 1% and a limited partnership interest of 85.37% (88.50% limited partnership interest as of December 31, 1999). The Operating Partnership also acquired interests in certain warehouse distribution facilities from GPA, Ltd., a California limited partnership ("GPA"). The Operating Partnership commenced operations on January 1, 1996. The Operating Partnership operates the assets acquired in the Consolidation and in subsequent acquisitions and intends to continue to invest in income-producing property directly and through joint ventures.
Effective April 1, 1998, the Company contributed to the Operating Partnership the majority of its assets, including 100% of its shares of the non-voting preferred stock of Glenborough Corporation ("GC"), formerly known as Glenborough Realty Corporation, as well as all of the Company's tangible personal property including furniture and fixtures, all cash and investments, and a property management contract. As part of that transaction, the Company also agreed to a substantial reduction in the asset management fees paid by the Operating Partnership to the Company. In return, the Operating Partnership canceled certain obligations of the Company to the Operating Partnership, and issued 2,248,869 units of partnership interest to the Company.
Effective February 15, 1999, the Company contributed to the Operating Partnership 100% of its shares of the non-voting preferred stock of Glenborough Hotel Group ("GHG"). In return, the Operating Partnership issued 67,797 units of partnership interest to the Company.
The contributions of 100% of the shares of non-voting preferred stock in GC and GHG discussed above have been accounted for as a reorganization of entities under common control, similar to a pooling of interests. All periods presented have been restated to give effect to these transactions as if they occurred on December 31, 1995. As a result of the above transactions, the only assets of the Company that have not been contributed to the Operating Partnership are (i) its shares of common stock in twelve qualified REIT subsidiaries, which produce dividends that are not material to the Company, and (ii) a less than 5% limited partnership interest in Glenborough Partners.
Since the Consolidation, and consistent with its strategy for growth, the Operating Partnership has completed the following transactions:
Acquired 20 properties in 1996, 90 properties in 1997, 69 properties in 1998 and 10 properties in 1999. The total acquired Properties consist of an aggregate of approximately 16.5 million rentable square feet of office, office/flex, industrial and retail space, 9,830 multifamily units and 227
hotel suites and aggregate acquisition costs, including third party expenditures incurred for the purpose of these transactions, of approximately $1.9 billion.
From January 1, 1996 to the date of this filing, sold 63 properties which were comprised of nine office properties, 15 office/flex properties, 13 industrial properties, 19 retail properties, two multifamily properties and five hotel properties, to redeploy capital into properties the Operating Partnership believes have characteristics more suited to its overall growth strategy and operating goals.
Issued $150 million of unsecured 7.625% Senior Notes which mature on March 15, 2005. In the second, third and fourth quarters of 1999, $58.9 million of the Senior Notes were retired at a discount which resulted in a net gain on early extinguishment of debt of approximately $3.1 million.
Entered into 4 development alliances in 1998 through which two properties were acquired in 1999. The Operating Partnership currently has 3 development alliances to which it has made advances of approximately $33 million and a loan of $36.4 million as of December 31, 1999.
The Associated Companies
Prior to September 30, 1999, the Operating Partnership held 100% of the non-voting preferred stock of the following associated companies (the "Associated Companies"):
Glenborough Corporation ("GC") is the general partner of several real estate limited partnerships and provides asset and property management services for these partnerships (the "Managed Partnerships"). It also provides partnership administration, asset management, property management and development services to a group of unaffiliated partnerships which include three public partnerships sponsored by Rancon Financial Corporation, an unaffiliated corporation which has significant real estate assets in the Inland Empire region of Southern California (the "Rancon Partnerships").
Glenborough Hotel Group ("GHG") owns an approximate 36% limited partner interest in a real estate joint venture.
Effective September 30, 1999, GHG merged with GC. In the merger, the Operating Partnership received preferred stock of GC in exchange for its preferred stock of GHG. The merger was accounted for as a reorganization of entities under common control.
Following the merger, the Operating Partnership owns 100% of the 47,500 shares (representing 95% of total outstanding shares) of non-voting preferred stock of GC. Six individuals, including Sandra Boyle, Frank Austin and Terri Garnick, executive officers of the Company, own the 2,500 shares (representing 5% of total outstanding shares) of voting common stock of GC. The Operating Partnership and GC intend that the Operating Partnership's interest in GC complies with REIT qualification standards.
The Operating Partnership, through its ownership of preferred stock of GC, is entitled to receive cumulative, preferred annual dividends of $1.896 per share, which GC must pay before it pays any dividends with respect to the common stock of GC. Once GC pays the required cumulative preferred dividend, it will pay any additional dividends in equal amounts per share on both the preferred stock and the common stock at 95% and 5%, respectively. Through the preferred stock, the Operating Partnership is also entitled to receive a preferred liquidation value of $169.49 per share plus all cumulative and unpaid dividends. The preferred stock is subject to redemption at the option of GC after December 31, 2005, for a redemption price of $169.49 per share. As the holder of preferred stock of GC, the Operating Partnership has no voting power with respect to the election of the directors of GC; all power to elect directors of GC is held by the owners of the common stock of GC.
This structure is intended to provide the Operating Partnership with a significant portion of the economic benefits of the operations of GC. The Operating Partnership accounts for the financial results of GC using the equity method.
Employees
The Operating Partnership has no employees. As of December 31, 1999, the Company and the Associated Companies had approximately 460 full-time employees.
Competition
For Tenants The Operating Partnership's Properties compete for tenants with similar properties located in their markets. Management believes that characteristics influencing the competitiveness of a real estate project include the geographic location of the property, the professionalism of the property manager and the maintenance and appearance of the property, in addition to external factors such as general economic circumstances, trends, and the existence of new competing properties in the general area in which the Operating Partnership's properties are located.
Additional competitive factors with respect to commercial properties include the ease of access to the property, the adequacy of related facilities, such as parking, and the ability to provide rent concessions and additional tenant improvements commensurate with local market conditions. Such competition may lead to rent concessions that could adversely affect the Operating Partnership's cash flow. Although the Operating Partnership believes its Properties are competitive with comparable properties as to those factors within the Operating Partnership's control, over-building and other external factors could adversely affect the ability of the Operating Partnership to attract and retain tenants.
For Acquisitions of Real Estate The Operating Partnership experiences competition when attempting to acquire equity interests in desirable real estate, including competition from domestic and foreign financial institutions, other REITs, life insurance companies, pension funds, trust funds, partnerships and individual investors. In competing for such acquisitions, the Operating Partnership and the Company have not given value guarantees in connection with Operating Partnership units or the Company's stock issued in such acquisitions.
For Capital The Operating Partnership and the Company compete with other REITs and investors and owners for debt and equity financing. The Operating Partnership's and the Company's ability to attract debt and equity capital at favorable rates is impacted in part by their positioning in the marketplace relative to similar investments. Factors impacting this include, among other things, the perceived quality of the Operating Partnership's portfolio and the risk adjustment sources of capital give to the returns they expect from their investments. In competing for capital, the Company has not entered into any forward equity commitments or other arrangements which would subject the Company to risks tied to changes in the market value of its equity securities.
Working Capital
The Operating Partnership's practice is to maintain cash reserves for normal repairs, replacements, improvements, working capital and other contingencies while minimizing interest expense. Available cash is kept to a minimum by using available funds to reduce the outstanding balance on the Operating Partnership's unsecured line of credit and drawing on it when necessary.
Other Factors
The Operating Partnership's ability to achieve operational and capital targets is impacted by economic conditions in the markets in which its Properties are located and by broader factors such as prevailing interest rates and the general availability of capital at favorable rates, both debt and equity, for real estate investments. Local economic downturns may adversely affect the occupancy and rental rates of the Operating Partnership's Properties. A lack of available capital may hinder the Operating Partnership's acquisition and development program or cause it to look to other types of transactions, such as asset redeployments, to generate needed liquidity.
Compliance with laws and regulations regarding the discharge of materials into the environment, or otherwise relating to the protection of the environment, is not expected to have any material effect upon the capital expenditures, earnings and competitive position of the Operating Partnership.
The Properties have each been subject to Phase I Environmental Assessments and, where such an assessment indicated it was appropriate, Phase II Environmental Assessments (collectively, the "Environmental Reports") have been conducted. These reports have not indicated any significant environmental issues.
In the event that pre-existing environmental conditions not disclosed in the Environmental Reports which require remediation are subsequently discovered, the cost of remediation will be borne by the Operating Partnership. Additionally, no assurances can be given that (i) future laws, ordinances, or regulations will not impose any material environmental liability, (ii) the current environmental condition of the Properties has not been or will not be affected by tenants and occupants of the Properties, by the condition of properties in the vicinity of the Properties or by third parties unrelated to the Operating Partnership or (iii) that the Operating Partnership will not otherwise incur significant liabilities associated with costs of remediation relating to the Properties.
Item 2.
Item 2. Properties
The Location and Type of the Operating Partnership's Properties
The Operating Partnership's 161 Properties are diversified by type (office, office/flex, industrial, retail, multifamily and hotel) and are located in four geographic regions and 22 states within the United States comprising 32 local markets. The following table sets forth the location, type and size of the Properties (by rentable square feet and/or units) along with average occupancy for the year ended December 31, 1999.
For the years ended December 31, 1999, 1998 and 1997, no tenant contributed 10% or more of the total rental revenue of the Operating Partnership. The largest tenant's annual rent was approximately 1.7% of total rental revenues for the year ended December 31, 1999. A complete listing of Properties owned by the Operating Partnership at December 31, 1999 is included as part of Schedule III in Item 14.
Office Properties
The Operating Partnership owns 51 office Properties with total rentable square footage of 6,859,991. The office Properties range in size from 14,255 square feet to 570,421 square feet, and have lease terms ranging from one to 31 years. The office leases generally require the tenant to reimburse the Operating Partnership for increases in building operating costs over a base amount. Certain of the leases provide for rent increases that are either fixed or based on a consumer price index ("CPI"). For the year ended December 31, 1999, the average occupancy of the office Properties was 91%.
The following table sets forth, for the periods specified, the total rentable area, average occupancy, average effective base rent per leased square foot and total effective annual base rent.
Office/Flex Properties
The Operating Partnership owns 37 office/flex Properties aggregating 3,719,019 square feet. The office/flex Properties are designed for a combination of office and warehouse uses with greater than 10% of the rentable square footage
containing office finish. The office/flex Properties range in size from 35,385 square feet to 278,580 square feet, and have lease terms ranging from one to 13 years. Most of the office/flex leases are "triple net" leases whereby the tenants are required to pay their pro rata share of the Properties' operating costs, common area maintenance, property taxes, insurance, and non-structural repairs. Some of the leases are "industrial gross" leases whereby the tenant pays as additional rent its pro rata share of common area maintenance and repair costs and its share of the increase in taxes and insurance over a specified base year cost. Certain of these leases call for fixed or CPI-based rent increases. For the year ended December 31, 1999, the average occupancy of the office/flex Properties was 88%.
The following table sets forth, for the periods specified, the total rentable area, average occupancy, average effective base rent per leased square foot and total effective annual base rent.
Industrial Properties
The Operating Partnership owns 24 industrial Properties aggregating 3,384,830 square feet. The industrial Properties are designed for warehouse, distribution and light manufacturing, ranging in size from 32,500 square feet to 474,426 square feet. As of December 31, 1999, 8 of the industrial Properties were leased to multiple tenants, 16 were leased to single tenants, and all 16 of the single-tenant Properties are adaptable in design to multi-tenant use. For the year ended December 31, 1999, the average occupancy of the industrial Properties was 99%.
The industrial Properties have leases whose terms range from 1 to 15 years. Most of the leases are "triple net" leases whereby the tenants are required to pay their pro rata share of the Properties' operating costs, common area maintenance, property taxes, insurance, and non-structural repairs. Some of the leases are "industrial gross" leases whereby the tenant pays as additional rent its pro rata share of common area maintenance and repair costs and its share of the increase in taxes and insurance over a specified base year cost. Certain of these leases call for fixed or CPI-based rent increases.
The following table sets forth, for the periods specified, the total rentable area, average occupancy, average effective base rent per leased square foot and total effective annual base rent for the industrial Properties.
Retail Properties
The Operating Partnership owns 10 retail Properties with total rentable square footage of 927,997. The leases for the retail Properties have terms ranging from one to 28 years. Eight of the retail Properties, representing 832,286 square feet or 90% of the total rentable area, are anchored community shopping centers. The anchor tenants of these centers are national or regional hardware stores, supermarkets and drug stores. For the year ended December 31, 1999, the average occupancy of the retail Properties was 90%.
The leases for the retail Properties generally include fixed or CPI-based rent increases and some include provisions for the payment of additional rent based on a percentage of the tenants' gross sales that exceed specified amounts. Retail tenants also typically pay as additional rent their pro rata share of the Properties' operating costs including common area maintenance, property taxes, insurance and non-structural repairs. Some leases contain options to renew at market rates or specified rates.
The following table sets forth, for the periods specified, the total rentable area, average occupancy, average effective base rent per leased square foot and total effective annual base rent for the retail properties.
Tenant Improvements and Leasing Commissions
The following table summarizes by year the capitalized tenant improvement and leasing commission expenditures incurred in the renewal or re-leasing of previously occupied space since January 1, 1995.
Multifamily Properties
The Operating Partnership owns 38 multifamily Properties, aggregating 9,538 units. All of the units are rented to residential tenants on either a month-to-month basis or for terms of one year or less. For the year ended December 31, 1999, the multifamily Properties were approximately 93% leased.
The following table sets forth, for the periods specified, total units, average occupancy, monthly average effective base rent per unit and total effective annual base rent for the multifamily Properties.
(2) Total Effective Annual Base Rent adjusted for any free rent given for the period. (3) In any given year, base rents are presented on an annualized basis based on results since the acquisition for properties that were acquired during the year. (4) Average effective monthly base rent per unit declined in 1996 due to the acquisition of properties with lower base rents.
Hotel Properties
Through June 1998, the Operating Partnership leased to GHG six Country Suites by Carlson hotels that it owned. In 1998, three of the hotels were sold and the other three hotels were leased to two other hotel operators. In 1999, two of the hotels were sold to one of the hotel operators. The leases terminated upon the sales of the properties. Currently, the Operating Partnership owns one 227 room hotel located in Scottsdale, Arizona.
Item 3.
Item 3. Legal Proceedings
Blumberg. On July 24, 1999, the Supreme Court of the United States denied a petition for a writ of certiorari to review the Company's settlement of a class action complaint originally filed on February 21, 1995 in connection with the Consolidation. No further appeals are possible in this case, and the settlement amount was paid in full in 1995. Under the settlement, the Company agreed to pay $855,000 to settle certain claims by Anthony E. Blumberg, and others (the "Blumberg Action"), that the Company and others had, among other things, breached their fiduciary duty and duty of good faith and fair dealing to investors in the Partnerships involved in the Consolidation. Certain parties objected to the settlement, but the settlement was approved (or review denied) by the Superior Court of the State of California in and for San Mateo County, the California state court of appeals, the California Supreme Court and the Supreme Court of the United States.
BEJ Equity Partners. On December 1, 1995, a second class action complaint relating to the Consolidation was filed in Federal District Court for the Northern District of California (the "BEJ Action"). The plaintiffs in the BEJ Action voluntarily stayed the action pending resolution of the Blumberg Action. Following the resolution of the Blumberg Action, the Company filed a motion to dismiss the BEJ Action in January 2000. As of the date of this report, the plaintiffs had failed to file a timely responsive pleading, so the defendants intend to move for final dismissal.
The plaintiffs in the BEJ Action are BEJ Equity Partners and others, who as a group held limited partner interests in certain of the Partnerships included in the Consolidation, on behalf of themselves and all others similarly situated. The defendants are the Company and other Glenborough entities involved in the Consolidation, as well as Robert Batinovich and Andrew Batinovich. The Partnerships are named as nominal defendants.
This action alleges certain disclosure violations and substantially the same breaches of fiduciary duty as were alleged in the Blumberg Action. The complaint sought injunctive relief, which was denied at a hearing on December 22, 1995. At that hearing, the court also deferred all further proceedings in this case until after the scheduled January 17, 1996 hearing in the Blumberg Action. Following several stipulated extensions of time for the Company to respond to the complaint, the Company filed a motion to dismiss the case. Plaintiffs in the BEJ Action voluntarily stayed the action pending resolution of the Blumberg Action; such plaintiffs can revive their lawsuit.
It is management's position that the BEJ Action is without merit, and management intends to pursue a vigorous defense. However, given the inherent uncertainties of litigation, there can be no assurance that the ultimate outcome in the BEJ Action will be in the Company's favor.
Certain other claims and lawsuits have arisen against the Operating Partnership and the Company in their normal course of business. The Operating Partnership and the Company believe that such other claims and lawsuits will not have a material adverse effect on the Operating Partnership's or the Company's financial position, cash flow or results of operations.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
The Company did not submit any matters to a vote of security holders in the fourth quarter of the year ended December 31, 1999.
PART II
Item 5.
Item 5. Market for Partnership's Equity and Related Partner Matters
(a) Market Information
There is no established trading market for the Units issued by the Operating Partnership.
Holders
As of December 31, 1999, there were 89 holders of Operating Partnership Units.
Distributions
Since its organization, the Operating Partnership has paid regular quarterly distributions to holders of its Units. During the years ended December 31, 1998 and 1999, the Operating Partnership paid the following quarterly distributions:
Distributions Total Quarterly Period Per Unit Distributions - ------------------------ ---------------- --------------------- First Quarter $ 0.42 $ 17,122,000 (1) Second Quarter $ 0.42 $ 20,130,000 (2) Third Quarter $ 0.42 $ 20,650,000 (2) Fourth Quarter $ 0.42 $ 20,607,000 (2) First Quarter $ 0.42 $ 20,697,000 (2) Second Quarter $ 0.42 $ 20,597,000 (2) Third Quarter $ 0.42 $ 20,182,000 (2) Fourth Quarter $ 0.42 $ 19,951,000 (3)
(1) Total distributions include a preferred partner interest distribution paid to the Company of $3,910,000. (2) Total distributions include a preferred partner interest distribution paid to the Company of $5,570,000. (3) Total distributions include a preferred partner interest distribution paid to the Company of $5,488,000.
The Operating Partnership intends to pay regular quarterly distributions to its Unit holders. Future distributions by the Operating Partnership will be at the discretion of management and will depend upon the actual operations of the Operating Partnership, its financial condition, capital requirements, applicable legal restrictions and such other factors as management deems relevant. The Operating Partnership intends to continue its policy of paying quarterly distributions, but there can be no assurance that distributions will continue or be paid at any specific level.
Item 6.
Item 6. Selected Financial Data
Set forth below are selected financial data for:
Glenborough Properties, L.P.: Consolidated balance sheet data is presented as of December 31, 1999, 1998, 1997, 1996 and 1995. Consolidated operating data is presented for the years ended December 31, 1999, 1998, 1997 and 1996, and As Adjusted consolidated
operating data is presented for the year ended December 31, 1995. The As Adjusted data assumes the Consolidation and related transactions occurred on January 1, 1995, in order to present the operations of the Operating Partnership for that period as if the Consolidation had been in effect for that period. As Adjusted data is presented to provide amounts which are comparable to the consolidated results of operations of the Operating Partnership for the years ended December 31, 1999, 1998, 1997 and 1996.
The GRT Predecessor Entities: Combined operating data is presented for the year ended December 31, 1995.
This selected financial data should be read in conjunction with the financial statements of Glenborough Properties, L.P., including the notes thereto, included in Item 14.
(6) The ratio of earnings to fixed charges is computed as net income (loss) from operations, before extraordinary items, plus fixed charges (excluding capitalized interest) divided by fixed charges. Fixed charges consist of interest costs including amortization of deferred financing costs.
(7) The ratio of earnings to fixed charges and Preferred Partner Interest Distributions is computed as net income (loss) from operations, before extraordinary items, plus fixed charges (excluding capitalized interest) divided by fixed charges plus Preferred Partner Interest Distributions. Fixed charges consist of interest costs including amortization of deferred financing costs.
(8) The annual service charge coverage is computed as EBIDA divided by annual service charge. Annual Service Charge for any period means the aggregate interest expense for such period and the amortization during such period of any original issue discount of, debt of the Operating Partnership and its subsidiaries.
(9) Debt to total assets is computed as debt divided by total assets.
(10) Secured debt to total assets is computed as secured debt divided by total assets.
(11) Total unencumbered assets to unsecured debt is computed as total unencumbered assets divided by unsecured debt.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of the financial condition and results of operations of the Operating Partnership should be read in conjunction with the selected financial data in Item 6 and the Consolidated Financial Statements of Glenborough Properties, L.P., including the notes thereto, included in Item 14.
Results of Operations
Comparison of the year ended December 31, 1999 to the year ended December 31, 1998.
Following is a table of net operating income by property type, for comparative purposes, presenting the results for the years ended December 31, 1999 and 1998.
industrial, and multifamily Properties of $2,389,000, $2,590,000 and $27,279,000, respectively. These increases were partially offset by decreases in revenue from the office/flex, retail and hotel Properties of $1,215,000, $890,000 and $2,770,000, respectively, due to the 1998 and 1999 sales of 13 office/flex, three retail and five hotel properties. Excluding properties that have been sold, rental revenue for the year ended December 31, 1999, included $16,504,000 generated from the 1996 Acquisitions, $86,695,000 generated from the 1997 Acquisitions, $132,370,000 generated from the 1998 Acquisitions and $6,958,000 generated from the 1999 Acquisitions. In addition, $12,812,000 of rental revenue was generated from 36 properties that were sold in 1999.
Fees and Reimbursements from Affiliates. Fees and reimbursements from affiliates consist primarily of property management fees, asset management fees and lease commissions paid to the Operating Partnership under property and asset management agreements with the Managed Partnerships. This revenue increased $510,000, or 18%, to $3,312,000 for the year ended December 31, 1999, from $2,802,000 for the year ended December 31, 1998. The change consists primarily of increased transaction fees from GC, which were generated from the disposition of a property and development fees paid by an affiliated entity, and fees earned for the management of two properties in which the Operating Partnership owns a 10% interest. These management fees did not occur in 1998.
Interest and Other Income. Interest and other income increased $1,847,000 or 41%, to $6,404,000 for the year ended December 31, 1999, from $4,557,000 for the year ended December 31, 1998. The increase primarily consisted of interest income on a mortgage loan receivable secured by land located in Aurora, Colorado which originated on June 30, 1998, and interest earned on lender impound accounts and invested cash balances.
Equity in Earnings of Associated Companies. Equity in earnings of Associated Companies decreased $92,000, or 7%, to $1,222,000 for the year ended December 31, 1999, from $1,314,000 for the year ended December 31, 1998. The decrease is primarily due to a decrease in earnings from GC resulting from a provision to reduce the carrying value of management contracts with certain of the Managed Partnerships. This decrease is also due to a decrease in earnings from GHG resulting from the cancellation of GHG's hotel leases with the Operating Partnership.
Net Gain on Sales of Real Estate Assets and Repayment of Notes Receivable. The net gain on sales of real estate assets and repayment of notes receivable of $9,013,000 during the year ended December 31, 1999, resulted from the sales of eight office properties, 13 office/flex properties, three retail properties, seven industrial properties, one multifamily property, two hotel properties, a small interest in real estate securities from the Operating Partnership's portfolio, and a reduction in the purchase price of a hotel sold in 1998 for which the Operating Partnership received full payment on all seller financing in 1999. The net gain on sales of real estate assets and repayment of notes receivable of $4,796,000 during the year ended December 31, 1998, resulted from the sales of one office property, two office/flex properties, four industrial properties, one multifamily property and three hotel properties from the Operating Partnership's portfolio.
Property Operating Expenses. Property operating expenses increased $12,611,000, or 17%, to $88,037,000 for the year ended December 31, 1999, from $75,426,000 for the year ended December 31, 1998. This increase represents increases in property operating expenses attributable to the 1998 Acquisitions and the 1999 Acquisitions offset by decreases in property operating expenses due to the 1998 and 1999 sales of properties.
General and Administrative Expenses. General and administrative expenses decreased $1,010,000, or 9%, to $9,672,000 for the year ended December 31, 1999, from $10,682,000 for the year ended December 31, 1998. The decrease is primarily due to a reduction in staff and overhead expenses in response to a decrease in acquisition and marketing activities since mid-1998 and a reduction in the number of properties owned. As a percentage of rental revenue, general and administrative expenses decreased from 4.7% for the year ended December 31, 1998 to 3.8% for the year ended December 31, 1999.
Depreciation and Amortization. Depreciation and amortization increased $8,126,000, or 16%, to $58,295,000 for the year ended December 31, 1999, from $50,169,000 for the year ended December 31, 1998. The increase is primarily due to depreciation and amortization associated with the 1998 Acquisitions and 1999 Acquisitions.
Interest Expense. Interest expense increased $11,493,000, or 22%, to $64,782,000 for the year ended December 31, 1999, from $53,289,000 for the year ended December 31, 1998. Substantially all of the increase was the result of higher
average borrowings during the year ended December 31, 1999, as compared to the year ended December 31, 1998, due to new debt and the assumption of debt related to the 1998 Acquisitions and 1999 Acquisitions.
Loss on Sale of Mortgage Loan Receivable. During 1999, a note secured by an office property in Phoenix, Arizona was sold to a third-party at a discount of $1,229,000. The proceeds of the sale were invested in the repurchase of preferred stock.
Net Gain (Loss) on Early Extinguishment of Debt. Net gain on early extinguishment of debt of $984,000 during the year ended December 31, 1999, consists of $3,115,000 of net gains on retirement of Senior Notes at a discount, offset by $2,026,000 of losses due to prepayment penalties and $105,000 of losses due to the write-off of unamortized loan fees upon the early payoff of four loans. These loans were paid-off early when more favorable terms were obtained through new financing (discussed below) and upon the sale of the properties securing the loans. Net loss on early extinguishment of debt of $1,400,000 during the year ended December 31, 1998, consisted of prepayment penalties and the write-off of unamortized loan fees upon the early payoff of debt. Various loans were paid-off early when more favorable terms were obtained through new financing and upon the sale of one of the hotels.
Comparison of the year ended December 31, 1998 to the year ended December 31, 1997.
Following is a table of net operating income by property type, for comparative purposes, presenting the results for the years ended December 31, 1998 and 1997.
Rental Revenue. Rental revenue increased $166,563,000, or 271%, to $227,956,000 for the year ended December 31, 1998, from $61,393,000 for the year ended December 31, 1997. The increase included growth in revenue from the office, office/flex, industrial, retail and multifamily Properties of $92,675,000, $26,633,000, $8,784,000, $4,848,000 and $35,329,000, respectively. These increases were partially offset by a $1,798,000 decrease in revenue from the hotel Properties due to the 1998 sales of two hotels. Rental revenue for the year ended December 31, 1998, included $17,404,000 of rental revenue generated from the acquisition of 20 properties in 1996, $96,130,000 of rental revenue generated from the acquisition of 90 properties in 1997 and $104,254,000 of rental revenue generated from the acquisition of 69 properties in 1998.
Fees and Reimbursements from Affiliates. Fees and reimbursements from affiliates consist primarily of property management fees, asset management fees and lease commissions paid to the Operating Partnership under property and asset management agreements with the Managed Partnerships. This revenue increased $2,083,000, or 290%, to $2,802,000 for the year ended December 31, 1998, from $719,000 for the year ended December 31, 1997. The change consisted primarily of increased lease commissions from an affiliated entity and fees resulting from the sale of managed properties.
Interest and Other Income. Interest and other income increased $2,930,000, or 180%, to $4,557,000 for the year ended December 31, 1998, from $1,627,000 for the year ended December 31, 1997. This increase was primarily due to $1,749,000 of interest income on a mortgage loan receivable secured by Gateway Center which originated on June 30, 1998. In addition, in 1998, the Operating Partnership invested approximately $20 million in the securities of a private REIT which was accounted for using the equity method. In 1998, the Operating Partnership recognized approximately $990,000 as equity in the earnings of this private REIT.
Equity in Earnings of Associated Companies. Equity in earnings of Associated Companies decreased $1,429,000, or 52%, to $1,314,000 for the year ended December 31, 1998, from $2,743,000 for the year ended December 31, 1997. The decrease was primarily due to a decrease in earnings from GHG resulting from the June 30, 1998 cancellation of GHG's hotel leases with the Operating Partnership. The Operating Partnership cancelled the leases with GHG when it sold two of its hotels and leased the other four hotels to other operators. In December 1998, one of the remaining four hotels was sold to one of the operators and two other hotels were in contract to be sold to another operator in 1999. This decrease was partially offset by transaction fees earned by GC related to the disposition of several properties under its management.
Net Gain on Sales of Real Estate Assets and Repayment of Notes Receivable. The net gain on sales of real estate assets and repayment of notes receivable of $4,796,000 during the year ended December 31, 1998, resulted from the sales of one office property, two office/flex properties, four industrial properties, one multifamily property and three hotel properties from the Operating Partnership's portfolio. This net gain was partially offset by a $3.1 million loss on the sale of the Operating Partnership's investment in the securities of a private REIT. The net gain on sales of real estate assets and repayment of notes receivable of $1,491,000 during the year ended December 31, 1997, resulted from the sales of 16 retail properties from the Operating Partnership's portfolio, which resulted in a net gain of $839,000, and the collection of a mortgage loan receivable which had a net carrying value of $6,700,000. The payoff amount totaled $6,863,000, plus a $500,000 note receivable, which, net of legal costs, resulted in a gain of $652,000.
Property Operating Expenses. Property operating expenses increased $54,522,000, or 261%, to $75,426,000 for the year ended December 31, 1998, from $20,904,000 for the year ended December 31, 1997. This increase primarily consisted of $22,750,000 attributable to the 1997 Acquisitions and $31,997,000 attributable to the 1998 Acquisitions.
General and Administrative Expenses. General and administrative expenses increased $6,680,000, or 167%, to $10,682,000 for the year ended December 31, 1998, from $4,002,000 for the year ended December 31, 1997. The increase was primarily due to increased salary and overhead costs resulting from the 1997 Acquisitions and 1998 Acquisitions. As a percentage of rental revenue, general and administrative expenses actually decreased from 6.5% for the year ended December 31, 1997 to 4.7% for the year ended December 31, 1998.
Depreciation and Amortization. Depreciation and amortization increased $35,340,000, or 238%, to $50,169,000 for the year ended December 31, 1998, from $14,829,000 for the year ended December 31, 1997. The increase was primarily due to depreciation and amortization associated with the 1997 Acquisitions and 1998 Acquisitions.
Interest Expense. Interest expense increased $43,621,000, or 451%, to $53,289,000 for the year ended December 31, 1998, from $9,668,000 for the year ended December 31, 1997. Substantially all of the increase was the result of higher average borrowings during the year ended December 31, 1998, as compared to the year ended December 31, 1997, due to new debt and the assumption of debt related to the 1997 Acquisitions and 1998 Acquisitions.
Loss on Interest Rate Protection Agreement. During 1998, the Operating Partnership entered into a forward interest rate agreement to lock in the risk-free interest component of a portion of a secured mortgage to be issued in October 1998. The 10-year Treasury rates decreased during the term of the hedge. During the fourth quarter of 1998, the Operating Partnership recorded an expense for its payment of $4,323,000 to terminate a portion of the forward interest rate agreement in connection with a reduction in the amount of the mortgage to be issued. The Operating Partnership's payment of $6,244,000 in settlement of the remaining portion of the forward interest rate agreement has offset the reduced financing costs of the $248.8 million mortgage issued in October 1998.
Net Loss on Early Extinguishment of Debt. Net loss on early extinguishment of debt of $1,400,000 during the year ended December 31, 1998, consisted of prepayment penalties and the write-off of unamortized loan fees upon the early payoff of debt. Various loans were paid-off early when more favorable terms were obtained through new financing (discussed below) and upon the sale of one of the hotels. Net loss on early extinguishment of debt of $843,000 during the year ended December 31, 1997, resulted from the write-off of unamortized loan fees related to a $50 million secured line of credit which was replaced with a $250 million unsecured line of credit (the "Credit Facility") from a commercial bank.
Liquidity and Capital Resources
Cash Flows For the year ended December 31, 1999, cash provided by operating activities increased by $3,875,000 to $92,004,000 as compared to $88,129,000 in 1998. The increase is primarily due to an increase in net income (before depreciation and amortization, net gain on sales of real estate assets, loss on sale of mortgage loan receivable and net gain on early extinguishment of debt) of $10,567,000 due to the 1998 Acquisitions and 1999 Acquisitions, offset by an increase in cash used for other assets and liabilities. Cash from investing activities increased by $696,711,000 to $82,871,000 for the year ended December 31, 1999, as compared to $613,840,000 of cash used for investing activities for the same period in 1998. The change is primarily due to decreased property acquisitions and increased property dispositions from 1998 to 1999. During the year ended December 31, 1998, the Operating Partnership acquired 69 properties as compared to ten properties during the year ended December 31, 1999 and disposed of 34 properties in 1999 as compared to 11 in 1998. In addition, cash used for investments in development and mortgage loans receivable decreased significantly during the year ended December 31, 1999 as compared to the same period in 1998. Cash from financing activities decreased by $698,591,000 to $172,531,000 of cash used for financing activities for the year ended December 31, 1999, as compared to $526,060,000 of cash provided by financing activities for the same period in 1998. This change was primarily due to a decrease in contributions from the Company of the net proceeds from the issuance of stock, a decrease in the proceeds from new debt and an increase in cash used for the retirement of Senior Notes, partner distributions and redemption of units, offset by a decrease in the repayment of other debt. Subsequent to its original formation, the Company issued additional equity in the form of common and preferred shares. The proceeds from these offerings were contributed to the Operating Partnership. As a result of a preferred stock offering in 1998, the Company holds a preferred partner interest which has been accounted for as additional paid in capital in the accompanying financial statements. No additional units were issued in exchange for this contribution, however it entitles the Company to a preferred partner interest distribution sufficient to pay the Company's preferred stock distributions, which are paid at a rate of $1.94 per share. There have been no such offerings in 1999. In addition, in 1998, the Operating Partnership issued $150,000,000 of unsecured Senior Notes.
The Operating Partnership expects to meets its short-term liquidity requirements generally through its working capital, its Credit Facility (as defined below) and cash generated by operations. The Operating Partnership believes that its cash generated by operations will be adequate to meet operating requirements and to make distributions in both the short and the long-term. In addition to cash generated by operations, the Credit Facility provides for working capital advances. However, there can be no assurance that the Operating Partnership's results of operations will not fluctuate in the future and at times affect (i) its ability to meet its operating requirements and (ii) the amount of its distributions.
The Operating Partnership's principal sources of funding for acquisitions, development, expansion and renovation of properties include the unsecured Credit Facility, permanent secured debt financing, public unsecured debt financing,
contributions from the Company, privately placed financing, the issuance of Operating Partnership units, proceeds from property sales and cash flow provided by operations.
Mortgage Loans Receivable Mortgage loans receivable decreased from $42,420,000 at December 31, 1998, to $37,582,000 at December 31, 1999. This decrease was primarily due to the payoff of two loans totaling $4.3 million and a $1.6 million decrease in a loan secured by a hotel property resulting from a subsequent adjustment to the sales price, offset by a $1,141,000 loan made by the Operating Partnership to the buyer of one of the hotel properties and accrued interest on a loan made by the Operating Partnership under a development alliance.
Secured and Unsecured Financing Mortgage loans payable decreased from $708,578,000 at December 31, 1998, to $701,715,000 at December 31, 1999. This decrease resulted from the payoff of approximately $167,438,000 of mortgage loans in connection with 1999 sales of properties and refinancing of debt, and scheduled principal payments of approximately $9,500,000. This decrease is partially offset by $39,275,000 of new mortgage loans in connection with 1999 Acquisitions and new financing of $130,800,000 (as discussed below).
In March 1999, the Operating Partnership obtained a $26 million loan from a commercial bank. The loan was non-recourse and was secured by seven properties and had a maturity date of December 22, 1999, with an option to extend for six months. The proceeds were used to pay off a loan which was previously secured by these same properties and to reduce other debt. This loan was paid off in June 1999 with proceeds generated from the sales of four properties.
In August 1999, the Operating Partnership closed a $97.6 million secured financing with a commercial bank ("Secured Financing"). The proceeds from this financing, combined with proceeds from a new $7.2 million mortgage and a draw on the Credit Facility, were used to retire a $113.2 million mortgage which would have matured in December of 1999. The new financing is a revolving line of credit maturing in five years with a five-year extension option, and bears interest at a floating rate equal to 75 basis points over the rate for 90-day mortgage backed securities credit-enhanced by FNMA. The December 31, 1999 interest rate on this loan was 6.53%.
In connection with the Secured Financing, the Operating Partnership entered into an interest rate cap agreement to hedge increases in interest rates above a specified level of 11.21%. The agreement is for a term concurrent with the Secured Financing instrument, is indexed to a 90-day LIBOR rate, and is for a notional amount equal to the maximum amount available on the Secured Financing loan. As of December 31, 1999, the 90-day LIBOR rate was 6.00125%. The Operating Partnership paid a fee at the inception of the cap agreement, which is being amortized as additional interest expense over the life of the agreement.
In November 1999, through the acquisition of a property through one of the Operating Partnership's development alliances, the Operating Partnership assumed a $10 million loan from a commercial bank. This loan is secured by one office property, has a maturity date of June 30, 2000 and bears interest at a floating rate of LIBOR plus 2.50% (the December 31, 1999 interest rate on this loan was 8.32%).
In December 1999, the Operating Partnership obtained an unsecured term loan from a commercial bank whereby, until December 9, 2000, the Operating Partnership can borrow the lesser of $125 million or the then Loan Availability (as defined). Any unborrowed amounts from the loan at December 9, 2000 will be cancelled. At December 31, 1999, $33,865,000 was outstanding on the loan. This loan has a maturity date of June 10, 2002 and bears interest at a floating rate of LIBOR plus 1.75%. The December 31, 1999 interest rate on this loan was 8.25%.
In the second, third and fourth quarters of 1999, the Operating Partnership retired approximately $58.9 million of unsecured Senior Notes at a discount. As a result of these transactions, a net gain on early extinguishment of debt of approximately $3.1 million was recorded which is included in the net gain on early extinguishment of debt on the accompanying consolidated statement of income for the year ended December 31, 1999.
In connection with the loan payoffs discussed above and the payoff of other mortgage debt, the Operating Partnership recorded a net gain on early extinguishment of debt of $984,000 for the year ended December 31, 1999. This gain consists of $3,115,000 of net gains on retirement of Senior Notes (as discussed above) offset by $2,026,000 of losses due to prepayment penalties and $105,000 of losses due to the write-off of unamortized loan fees upon the early payoff of four loans. These loans were paid-off early when more favorable terms were obtained through new financing (discussed above) and upon the sale of the properties securing the loans.
The Operating Partnership has an unsecured line of credit provided by a group of commercial banks (the "Credit Facility"). Outstanding borrowings under the Credit Facility increased from $63,519,000 at December 31, 1998, to $70,628,000 at December 31, 1999. The increase was due to draws of $177,683,000 for acquisitions, stock repurchases, purchases of the Operating Partnership's Senior Notes, and debt refinancing, offset by pay downs of $170,574,000 generated from proceeds from the sales of properties and cash from operations. In June 1999, in order to increase the Operating Partnership's financial flexibility, the Credit Facility was modified to increase the commitment from $100 million to $142.5 million. The interest rate, monthly payments and maturity date of December 2000, remained unchanged. Subsequent to December 31, 1999, the maturity date was extended to June 2002.
At December 31, 1999, the Operating Partnership's total indebtedness included fixed-rate debt of $646,763,000 and floating-rate indebtedness of $250,595,000. Approximately 65% of the Operating Partnership's total assets, comprising 102 properties, is encumbered by debt at December 31, 1999.
It is the Operating Partnership's policy to manage its exposure to fluctuations in market interest rates through the use of fixed rate debt instruments to the extent possible. At December 31, 1999, approximately 28% of the Operating Partnership's outstanding debt, including amounts borrowed under the Credit Facility, were subject to variable rates. The Operating Partnership may, from time to time, enter into interest rate protection agreements intended to hedge the cost of new borrowings that are reasonably assured of completion. It is not the Operating Partnership's policy to engage in hedging activities for previously outstanding debt instruments or for speculative purposes. At December 31, 1999, the Operating Partnership was not a party to any open interest rate protection agreements other than the interest rate cap contract associated with the Secured Financing discussed above.
Equity and Debt Offerings In January 1999, the Operating Partnership and the Company filed a shelf registration statement with the SEC (the "January 1999 Shelf Registration Statement") to register $300 million of debt securities of the Operating Partnership and to carry forward the remaining $801.2 million in equity securities of the Company from a November 1997 shelf registration statement (declared effective by the SEC on December 18, 1997). The January 1999 Shelf Registration Statement was declared effective by the SEC on January 25, 1999. Therefore, the Operating Partnership and the Company have the capacity pursuant to the January 1999 Shelf Registration Statement to issue up to $300 million in debt securities and $801.2 million in equity securities, respectively. The Operating Partnership and the Company currently have no plans to issue equity or debt under these shelf registrations.
Development Alliances The Operating Partnership currently has 3 development alliances for the development of approximately 885,000 square feet of office, office/flex and distribution properties and 1,614 multifamily units in Colorado, Texas, New Jersey, Kansas and Michigan. As of December 31, 1999, the Operating Partnership has an investment in these development projects of approximately $33 million. Under these development alliances, the Operating Partnership has certain rights to purchase the properties upon completion of development over the next five years. In addition, the Operating Partnership has loaned approximately $36.4 million (including accrued interest) under another development alliance to continue the build-out of a 1,200 acre master-planned development in Denver, Colorado.
Inflation Substantially all of the leases at the office/flex, industrial and retail Properties provide for pass-through to tenants of certain operating costs, including real estate taxes, common area maintenance expenses, and insurance. Leases at the multifamily properties generally provide for an initial term of one month or one year and allow for rent adjustments at the time of renewal. Leases at the office Properties typically provide for rent adjustment and
pass-through of certain operating expenses during the term of the lease. All of these provisions may permit the Operating Partnership to increase rental rates or other charges to tenants in response to rising prices and therefore, serve to reduce the Operating Partnership's exposure to the adverse effects of inflation.
Forward Looking Statements; Factors That May Affect Operating Results This Report on Form 10-K contains forward looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934, including statements regarding the Operating Partnership's expectations, hopes, intentions, beliefs and strategies regarding the future. Forward looking statements include statements regarding potential acquisitions, the anticipated performance of future acquisitions, recently completed acquisitions and existing properties, and statements regarding the Operating Partnership's financing activities. All forward looking statements included in this document are based on information available to the Operating Partnership on the date hereof. It is important to note that the Operating Partnership's actual results could differ materially from those stated or implied in such forward looking statements. Some of the factors that could cause actual results to differ materially are set forth below.
The Limited Availability of and Competition for Real Estate Acquisitions May Restrict the Operating Partnership's Ability to Grow The Operating Partnership's growth depends, in part, upon acquisitions. The Operating Partnership cannot be sure that properties will be available for acquisition or, if available, that it will be able to purchase those properties on favorable terms. The unavailability of such acquisitions could limit the Operating Partnership's growth. Furthermore, the Operating Partnership faces competition from several other businesses, individuals, fiduciary accounts and plans and entities in the acquisition, operation and sale of properties. Some of the Operating Partnership's competitors are larger than it is and have greater financial resources than it does. This competition could cause the cost of properties it wishes to purchase to rise. If the Operating Partnership is unable to continue to grow through acquisitions, then its results of operations and financial condition could be negatively impacted.
Competition for Tenants Could Adversely Affect the Operating Partnership's Operations When space becomes available at the Operating Partnership's properties, the leases may not be renewed, the space may not be leased or re-leased, or the terms of the renewal or re-lease (including the cost of required renovations or concessions to tenants) may be less favorable to it than the prior lease. The Operating Partnership has established annual property budgets that include estimates of costs for renovation and re-leasing expenses. The Operating Partnership believes that these estimates are reasonable in light of each property's situation; however, no assurance can be given that these estimates will sufficiently cover these expenses. If the Operating Partnership cannot lease all or substantially all of the space at its properties promptly, if the rental rates are significantly lower than expected, or if the Operating Partnership's reserves for these purposes prove inadequate, then the Operating Partnership's results of operations and financial condition could be negatively impacted.
Tenants' Defaults Could Adversely Affect the Operating Partnership's Operations The Operating Partnership's ability to manage its assets is subject to federal bankruptcy laws and state laws that limit creditors' rights and remedies available to real property owners to collect delinquent rents. If a tenant becomes insolvent or bankrupt, the Operating Partnership cannot be sure that it could recover the premises from the tenant promptly or from a trustee or debtor-in-possession in any bankruptcy proceeding relating to that tenant. The Operating Partnership also cannot be sure that it would receive rent in the proceeding sufficient to cover its expenses with respect to the premises. If a tenant becomes bankrupt, the federal bankruptcy code will apply, which in some instances may restrict the amount and recoverability of the Operating Partnership's claims against the tenant. A tenant's default on its obligations to the Operating Partnership could adversely affect its results of operations and financial condition.
Cash Flow May Be Insufficient for Debt Service Requirements The Operating Partnership intends to incur indebtedness in the future, including through borrowings under its Credit Facility, to finance property acquisitions, retirement of debt and stock repurchases. As a result, the Operating Partnership expects to be subject to the following risks associated with debt financing including:
that interest rates may increase; that the Operating Partnership's cash flow may be insufficient to meet required payments on its debt; and that the Operating Partnership may be unable to refinance or repay the debt as it comes due.
Debt Restrictions May Affect Operations and Negatively Affect the Operating Partnership's Ability to Repay Indebtedness at Maturity The Operating Partnership's current $142.5 million unsecured Credit Facility contains provisions that restrict the amount of distributions it can make. These provisions provide that distributions may not exceed 90% of funds from operations for any fiscal quarter. If the Operating Partnership cannot obtain acceptable financing to repay indebtedness at maturity, it may have to sell properties to repay indebtedness or properties may be foreclosed upon, which could adversely affect its results of operations, financial condition and ability to service debt. Also, as of December 31, 1999, approximately $470.4 million of the Operating Partnership's total indebtedness included secured mortgages with cross-collateralization provisions. In the event of a default, the holders of this indebtedness may seek to foreclose upon properties which are not the primary collateral for their loan. This may, in turn, accelerate other indebtedness secured by these properties. Foreclosure of properties would cause a loss to the Operating Partnership of income and asset value.
Fluctuations in Interest Rates May Adversely Affect the Operating Partnership's Operations As of December 31, 1999, the Operating Partnership had approximately $250.6 million of variable interest rate indebtedness. Accordingly, an increase in interest rates will adversely affect the Operating Partnership's net income and results of operations.
Management of Newly Acquired Properties Could Be Difficult Since the Consolidation on December 31, 1995, and through December 31, 1999, the Operating Partnership acquired approximately $1.9 billion in properties. To manage these new properties effectively, the Operating Partnership has sought to successfully apply its experience managing its existing portfolio to expanded markets and to an increased number of properties. The assimilation of these properties is a continuing process whose success cannot be assured indefinitely. Should the Operating Partnership encounter future difficulties in managing these newly acquired properties, this could adversely affect its results of operations and financial condition.
Acquisitions Could Adversely Affect Operations Consistent with the Operating Partnership's growth strategy, the Operating Partnership is continually pursuing and evaluating potential acquisition opportunities. From time to time the Operating Partnership is actively considering the possible acquisition of specific properties, which may include properties managed by GC or owned by affiliated parties. It is possible that one or more of such possible future acquisitions, if completed, could adversely affect the Operating Partnership's results of operations and financial condition.
Potential Adverse Consequences of Transactions Involving Conflicts of Interest The Operating Partnership has acquired, and from time to time may acquire, properties from partnerships that Robert Batinovich, the Company's Chairman and Chief Executive Officer, and Andrew Batinovich, the Company's President and Chief Operating Officer, control, and in which they and members of their families have substantial interests. These transactions involve or will involve conflicts of interest. These transactions also may provide substantial economic benefits to those individuals such as:
payments or issuances of partnership units in the Operating Partnership, relief or deferral of tax liabilities, relief of primary or secondary liability for debt, and reduction in exposure to other property-related liabilities.
The Operating Partnership's policy provides that interested directors may not vote with regard to transactions in which they have a substantial interest. These transactions may only be completed if they are approved by a majority of the disinterested directors, with the interested directors abstaining. Despite this policy and the presence of appraisals or fairness opinions or review by parties who have no interest in the transactions, the transactions will not be
the product of arm's-length negotiation. These transactions may not be as favorable to the Operating Partnership as transactions that it negotiates with unrelated parties and they could result in undue benefit to Robert and Andrew Batinovich and members of their families. None of these parties has guaranteed that any properties acquired from entities they control or in which they have a significant interest will be as profitable as other investments made by the Operating Partnership or will not result in losses.
Dependence on Executive Officers The Operating Partnership depends on the efforts of Robert Batinovich, its Chief Executive Officer and Andrew Batinovich, its President and Chief Operating Officer, and of its other executive officers. The loss of the services of any of them could have an adverse effect on the Operating Partnership's results of operations and financial condition. Both Robert and Andrew Batinovich have entered into employment agreements with the Company.
Potential Liability Due to Environmental Matters Under federal, state and local laws relating to protection of the environment ("Environmental Laws"), a current or previous owner or operator of real estate may be liable for contamination resulting from the presence or discharge of petroleum products or other hazardous or toxic substances on the property. These owners may be required to investigate and clean-up the contamination on the property as well as the contamination which has migrated from the property. Environmental Laws typically impose liability and clean-up responsibility without regard to whether the owner or operator knew of, or was responsible for, the presence of the contamination. This liability may be joint and several unless the harm is divisible and there is a reasonable basis for allocation of responsibility. In addition, the owner or operator of a property may be subject to claims by third parties based on personal injury, property damage and/or other costs, including investigation and clean-up costs, resulting from environmental contamination. Environmental Laws may also impose restrictions on the manner in which a property may be used or transferred or in which businesses may be operated. These restrictions may require expenditures. Under the Environmental Laws, any person who arranges for the transportation, disposal or treatment of hazardous or toxic substances may also be liable for the costs of investigation or clean-up of those substances at the disposal or treatment facility, whether or not the facility is or ever was owned or operated by that person.
Tenants of the Operating Partnership's properties generally are required by their leases to operate in compliance with all applicable Environmental Laws, and to indemnify the Operating Partnership against any environmental liability arising from their activities on the properties. However, the Operating Partnership could be subject to environmental liability relating to its management of the properties or strict liability by virtue of its ownership interest in the properties. Also tenants may not satisfy their indemnification obligations under the leases. The Operating Partnership is also subject to the risk that:
any environmental assessments of its properties, properties being considered for acquisition, or the properties owned by the partnerships managed by GC may not have revealed all potential environmental liabilities, any prior owner or prior or current operator of such properties may have created an environmental condition not known to the Operating Partnership, or an environmental condition may otherwise exist as to any one or more of such properties.
Any one of these conditions could have an adverse effect on the Operating Partnership's results of operations and financial condition or ability to service debt, either directly (with respect to its properties), or indirectly (with respect to properties owned by partnerships managed by GC). Any condition adversely affecting the financial condition of GC could adversely affect the Operating Partnership by diminishing the value of its interest in GC. Moreover, future environmental laws, ordinances or regulations may have an adverse effect on the Operating Partnership's results of operations, financial condition and ability to service debt. Also, the current environmental condition of those properties may be affected by tenants and occupants of the properties, by the condition of land or operations in the vicinity of the properties (such as the presence of underground storage tanks), or by third parties unrelated to the Operating Partnership.
Environmental Assessments and Potential Liability Due to Asbestos-Containing Materials Environmental Laws also govern the presence, maintenance and removal of asbestos-containing building materials. These laws require that asbestos-containing building materials be properly managed and maintained and that those who may come into contact with asbestos-containing building materials be adequately informed and trained. They also require that special precautions, including removal or other abatement, be undertaken in the event asbestos-containing building materials is disturbed during renovation or demolition of a building. These laws may impose fines and penalties on building owners or operators for failure to comply with these requirements. They also may allow third parties to seek recovery from owners or operators for personal injury associated with exposure to asbestos fibers.
All of the properties that the Operating Partnership presently owns have been subject to Phase I environmental assessments by independent environmental consultants. Some of the Phase I environmental assessments recommended further investigations in the form of Phase II environmental assessments, including soil and groundwater sampling. The Operating Partnership has completed all of these investigations or is in the process of completing them. Certain of the Operating Partnership's properties have been found to contain asbestos-containing building materials. The Operating Partnership believes that these materials have been adequately contained and it has implemented an asbestos-containing building materials operations and maintenance program for the properties found to contain asbestos-containing building materials.
Some, but not all, of the properties owned by partnerships managed by GC have been subject to Phase I environmental assessments by independent environmental consultants. GC determines on a case-by-case basis whether to obtain Phase I environmental assessments on these properties and whether to undertake further investigation or remediation. Certain of these properties contain asbestos-containing building materials. In each case GC believes that these materials have been adequately contained and has implemented an asbestos-containing building materials operations and maintenance program has been implemented for the properties found to contain asbestos-containing building materials.
Potential Environmental Liability Resulting From Underground Storage Tanks Some of the Operating Partnership's properties, as well as properties that it has previously owned, are leased or have been leased to owners or operators of businesses that use, store or otherwise handle petroleum products or other hazardous or toxic substances. These businesses include dry cleaners that operate on-site dry cleaning plants and auto care centers. Some of these properties contain, or may have contained, underground storage tanks for the storage of petroleum products and other hazardous or toxic substances. These operations create a potential for the release of those substances. Some of the Operating Partnership's properties are adjacent to or near other properties that have contained or currently contain underground storage tanks used to store petroleum products or other hazardous or toxic substances. Several of the Operating Partnership's properties have been contaminated with these substances from on-site operations or operations on adjacent or nearby properties. In addition, certain of the Operating Partnership's properties are on, or are adjacent to or near other properties upon which others, including former owners or tenants of the properties, have engaged or may engage in activities that may release petroleum products or other hazardous or toxic substances.
Environmental Liabilities May Adversely Affect Operating Costs and Ability to Borrow The obligation to pay for the cost of complying with existing Environmental Laws as well as the cost of complying with future legislation may affect the Operating Partnership's operating costs. In addition, the presence of petroleum products or other hazardous or toxic substances at any of the Operating Partnership's properties, or the failure to remediate those properties properly, may adversely affect its ability to borrow by using those properties as collateral. The cost of defending against claims of liability and the cost of complying with Environmental Laws, including investigation or clean-up of contaminated property, could materially adversely affect the Operating Partnership's results of operations and financial condition.
General Risks of Ownership of Real Estate The Operating Partnership is subject to risks generally incidental to the ownership of real estate. These risks include:
- changes in general economic or local conditions; - changes in supply of or demand for similar or competing properties in an area; - the impact of environmental protection laws; - changes in interest rates and availability of financing which may render the sale or financing of a property difficult or unattractive; - changes in tax, real estate and zoning laws; and - the creation of mechanics' liens or similar encumbrances placed on the property by a lessee or other parties without the Operating Partnership's knowledge and consent.
Should any of these events occur, the Operating Partnership's results of operations and financial condition could be adversely affected.
General Risks Associated With Management, Leasing and Brokerage Contracts The Operating Partnership is subject to the risks generally associated with the property management, leasing and brokerage businesses. These risks include the risk that:
- management contracts or service agreements may be terminated; - contracts will not be renewed upon expiration or will not be renewed on terms consistent with current terms; and - leasing and brokerage activity generally may decline.
In addition, the Operating Partnership's acquisition of properties from partnerships managed by GC or another subsidiary could result in a decrease in revenues to such subsidiary and a corresponding decrease in dividends received by the Operating Partnership from such subsidiary. Each of these developments could have an adverse effect on the Operating Partnership's results of operations and financial condition.
Uninsured Losses May Adversely Affect Operations The Operating Partnership, or in certain instances, tenants of the properties, carry comprehensive liability, fire and extended coverage with respect to the properties. This coverage has policy specification and insured limits customarily carried for similar properties. However, certain types of losses (such as from earthquakes and floods) may be either uninsurable or not economically insurable. Further, certain of the properties are located in areas that are subject to earthquake activity and floods. Should a property sustain damage as a result of an earthquake or flood, the Operating Partnership may incur losses due to insurance deductibles, co-payments on insured losses or uninsured losses. Should an uninsured loss occur, the Operating Partnership could lose some or all of its capital investment, cash flow and anticipated profits related to one or more properties. This could have an adverse effect on the Operating Partnership's results of operations and financial condition.
Illiquidity of Real Estate May Limit Our Ability to Vary the Operating Partnership's Portfolio Real estate investments are relatively illiquid and, therefore, will tend to limit the Operating Partnership's ability to vary its portfolio promptly in response to changes in economic or other conditions. In addition, the Internal Revenue Code of 1986, as amended (the "Code"), and individual agreements with sellers of properties place limits on the Operating Partnership's ability to sell properties. Fifty-five of the Operating Partnership's properties were acquired on terms and conditions under which they can be disposed of only in a like-kind exchange or other non-taxable transaction. The agreed upon time periods for these restrictions on dispositions vary from transaction to transaction.
Potential Liability Under the Americans With Disabilities Act As of January 26, 1992, all of the Operating Partnership's properties were required to be in compliance with the Americans With Disabilities Act. The Americans With Disabilities Act generally requires that places of public accommodation be made accessible to people with disabilities to the extent readily achievable. Compliance with the Americans With Disabilities Act requirements could require removal of access barriers. Non-compliance could result in imposition of fines by the federal government, an award of damages to
private litigants and/or a court order to remove access barriers. Because of the limited history of the Americans With Disabilities Act, the impact of its application to the Operating Partnership's properties, including the extent and timing of required renovations, is uncertain. Pursuant to lease agreements with tenants in certain of the "single-tenant" properties, the tenants are obligated to comply with the Americans With Disabilities Act provisions. If the Operating Partnership's costs are greater than anticipated or tenants are unable to meet their obligations, the Operating Partnership's results of operations and financial condition could be adversely affected.
Development Alliances May Adversely Affect Operations The Operating Partnership may, from time to time, enter into alliances with selected developers for the purpose of developing new projects in which these developers have, in the opinion of management, significant expertise or experience. These projects generally require various governmental and other approvals, the receipt of which cannot be assured. These development activities also may entail certain risks, including the risk that:
- management may expend funds on and devote time to projects which may not come to fruition; - construction costs of a project may exceed original estimates, possibly making the project uneconomical; - occupancy rates and rents at a completed project may be less than anticipated; and - expenses at a completed development may be higher than anticipated.
In addition, the partners in development alliances may have significant control over the operation of the alliance project. Therefore, these investments may, under certain circumstances, involve risks such as the possibility that the partner might:
- become bankrupt; - have economic or business interests or goals that are inconsistent with the Operating Partnership's business interest or goals; or - be in a position to take action contrary to the Operating Partnership's instructions or requests or contrary to its policies or objectives.
Consequently, actions by a partner in a development alliance might subject property owned by the alliance to additional risk. Although the Operating Partnership will seek to maintain sufficient control of any alliance to permit its objectives to be achieved, the Operating Partnership may be unable to take action without the approval of its development alliance partners. Conversely, the Operating Partnership's development alliance partners could take actions binding on the alliance without the Operating Partnership's consent. In addition, should a partner in a development alliance become bankrupt the Operating Partnership could become liable for the partner's share of the project's liabilities. These risks may result in a development project adversely affecting the Operating Partnership's results of operations and financial condition.
Material Tax Risks Since 1996, the Company has operated as a REIT under the Code. However, the Company may not be able to maintain its status as a REIT. To qualify as a REIT the Company must satisfy numerous requirements (some on an annual and quarterly basis) established under highly technical and complex Code provisions. Only limited judicial or administrative interpretation exists for these provisions and involves the determination of various factual matters and circumstances not entirely within the Company's control. The Company receives nonqualifying management fee income and owns nonqualifying preferred stock in certain subsidiaries. As a result, the Company may approach the income and asset test limits imposed by the Code. There is a risk that the Company may not satisfy these tests. In order to avoid exceeding the asset test limit, for example, the Company may have to reduce its interest in its subsidiaries. The Company is relying on the opinion of its tax counsel regarding its ability to qualify as a REIT. This legal opinion, however, is not binding on the Internal Revenue Service ("IRS").
Consequences of Failure to Qualify as a REIT If the Company fails to qualify as a REIT in any taxable year, the Company would be subject to federal income tax on its taxable income at corporate rates. In addition, the Company also may be disqualified from treatment as a REIT for the four taxable years following the year in which the Company failed to qualify.
This would reduce the Company's net earnings available for investment or distribution to stockholders because of the additional tax liability. In addition, the Company would no longer be required to make distributions to stockholders.
Even if the Company continues to qualify as a REIT, it will be subject to certain federal, state and local taxes on its income and property.
Possible Changes in Tax Laws; Effect on the Market Value of Real Estate Investments Income tax treatment of REITs may be modified by legislative, judicial or administrative action at any time. These changes may be applied to past as well as future operations. Legislation, regulations, administrative interpretations or court decisions may significantly change the tax laws with respect to (1) the qualification as a REIT or (2) the federal income tax consequences of this qualification. In addition, the changes might also indirectly affect the market value of all real estate investments, and consequently the Company's ability to realize its investment objectives.
Additional Capital Requirements; Possible Adverse Effects on Holders of Equity The Operating Partnership's ability to continue its growth pattern established in 1996-1999, which was funded largely through the raising of equity capital, depends in large part upon its ability to raise additional capital in the future on satisfactory terms. If the Company raises additional capital through the issuance of additional equity securities, or securities convertible into or exercisable for equity securities, the interests of holders of the Company's shares of Common Stock could be diluted. Likewise, the Company's Board of Directors is authorized to issue Preferred Stock and to determine the rights of the Preferred Stock. Accordingly, the Board of Directors may authorize the issuance of Preferred Stock with rights which may dilute or otherwise adversely affect the interests of holders of the Company's shares of Common Stock. If the Operating Partnership raises additional capital through debt financing, it will be subject to the risks described below, among others.
The Operating Partnership's Indebtedness Restrictions May Adversely Affect its Ability to Incur Indebtedness The Company's organizational documents limit its ability to incur additional debt if the total debt, including the additional debt, would exceed 50% of the "Borrowing Base." This debt limitation in the Company's Charter can only be amended by an affirmative vote of the majority of all outstanding stock entitled to vote on such amendment. The term "Borrowing Base" is defined as the greater of Fair Market Value or Total Market Capitalization. Fair Market Value is based upon the value of the Operating Partnership's assets as determined by an independent appraiser. Total Market Capitalization is the sum of the market value of the Company's outstanding capital stock, including shares issuable on exercise of redemption options by holders of units of the limited partnership, plus debt. An exception is made for refinancings and borrowings required to make distributions to maintain the Company's status as a REIT. In light of these debt restrictions, it should be noted that a change in the value of the Company's common stock could affect the Borrowing Base, and therefore the Operating Partnership's ability to incur additional indebtedness, even though such change in the common stock's value is unrelated to the Operating Partnership's liquidity.
Limitation on Ownership of Common Stock And Stockholder's Rights Plan May Preclude Acquisition of Control Provisions of the Company's Charter are designed to assist the Company in maintaining its qualification as a REIT under the Code by preventing concentrated ownership of the Company which might jeopardize REIT qualification. Among other things, these provisions provide that:
- any transfer or acquisition of the Company's common or preferred stock that would result in its disqualification as a REIT under the Code will be void; and - if any person attempts to acquire shares of the Company's common or preferred stock that after the acquisition would cause the person to own an amount of common stock and preferred stock in excess of a predetermined limit, such acquisitions would be void.
Ownership is determined by operation of certain attribution rules set out in the Code. Pursuant to Board action, the limit currently is 9.9% of the value of the outstanding shares of common stock and preferred stock (the "Ownership Limitation"). The common stock or preferred stock the transfer of which would cause any person to violate the Ownership Limitation, is referred to as the "Excess Shares." A transfer that would violate the Ownership Limitation will be void and the common stock or preferred stock subject to the transfer will automatically be transferred to an unaffiliated trustee for the benefit of a charitable organization designated by the Board of Directors until sold by the trustee to a third party or purchased by the Company. This limitation on the ownership of common stock and preferred stock may preclude the acquisition of control of the Company by a third party without the consent of the Board of Directors. If the Board of Directors waives the Ownership Limitation for any person, the Ownership Limitation will be proportionally and automatically reduced with regard to all other persons such that no five persons may own more than 50% of the value of the common stock and preferred stock. Certain other provisions contained in the Company's Charter and Bylaws may also have the effect of discouraging a third party from making an acquisition proposal for the Company and may thereby inhibit a change in control in the Company even if a change in control would be in the best interests of the stockholders.
In addition, in July 1998, the Board of Directors adopted a stockholder rights plan. Under the plan, the Company declared a dividend of rights on its common stock. The rights issued under the plan will be triggered, with certain exceptions, if and when any person or group acquires, or commences a tender offer to acquire, 15% or more of the Company's shares. The rights plan is intended to prevent abusive hostile takeover attempts by requiring a potential acquirer to negotiate the terms of an acquisition with the Board of Directors. However, it could have the effect of deterring or preventing an acquisition of the Company, even if a majority of the Company's stockholders would be in favor of such acquisition, and could also have the effect of making it more difficult for a person or group to gain control of the Company or to change existing management.
Losses Relating to Consolidation The Company was created through the merger of eight partnerships and a corporation (the "Consolidation"). Prior to the completion of the Consolidation, two lawsuits were filed in 1995 contesting the fairness of the Consolidation, one in California State court and one in federal court. The complaints in both actions alleged, among other things, breaches by the defendants of fiduciary duties and inadequate disclosures. The State court action was settled over the objection of certain parties, and the settlement was approved (or review denied) by the Superior Court of the State of California in and for San Mateo County, the California state court of appeals, the California Supreme Court and the Supreme Court of the United States. In the federal action, the court in December of 1995 deferred all further proceedings pending a ruling in the State court action. Following the final resolution of the State court action, the defendants in January 2000 filed a motion to dismiss the federal court action. As of the date of this report, the plaintiffs had failed to file a timely responsive pleading, so the defendants intend to move for final dismissal. The Company believes that it is very unlikely that this litigation would result in a liability that would exceed the accrued liability by a material amount. However, given the inherent uncertainties of litigation, there can be no assurance that the ultimate outcomes of these actions will be favorable to the Company.
From time to time the Operating Partnership and the Company are involved in other litigation arising out of their business activities. Certain other claims and lawsuits have arisen against the Operating Partnership and the Company in their normal course of business. It is possible that this litigation and the other litigation previously described could result in significant losses in excess of amounts reserved, which could have an adverse effect on their results of operations and financial condition.
Uncertainty Due to the Board of Directors' Ability to Change Investment Policies The Board of Directors may change the Company's investment policies without a vote of the stockholders. If the Company's investment policies change, the risks and potential rewards of an investment in the shares may also change. In addition, the methods of implementing the Company's investment policies may vary as new investment techniques are developed.
Effect of Market Interest Rates on Price of Common Stock The annual yield on the price paid for shares of the Company's common stock from distributions by the Company may influence the market price of the shares of its
common stock in public markets. An increase in market interest rates may lead prospective purchasers of the Company's common stock to seek a higher annual yield from their investments. This may adversely affect the market price of the Company's common stock.
Shares Available for Future Sale The Company cannot predict the effect, if any, that future sales of shares of its common stock or future conversions or exercises of securities for future sales will have on the market price of its common stock. Sales of substantial amounts of the Company's common stock, or the perception that such sales could occur, may adversely affect the prevailing market price for the Company's common stock.
Item 7A.
Item 7A. Qualitative and Quantitative Information About Market Risk
Interest Rates The Operating Partnership's primary market risk exposure is to changes in interest rates obtainable on its mortgage loans receivable and its secured and unsecured borrowings. The Operating Partnership does not believe that changes in market interest rates will have a material impact on the performance or fair value of its portfolio of mortgage loans receivable.
It is the Operating Partnership's policy to manage its exposure to fluctuations in market interest rates for its borrowings through the use of fixed rate debt instruments to the extent that reasonably favorable rates are obtainable with such arrangements. In order to maximize financial flexibility when selling properties and minimize potential prepayment penalties on fixed rate loans, the Operating Partnership has also entered into variable rate debt arrangements. Approximately 28% and 20% of the Operating Partnership's outstanding debt, including amounts borrowed under the Credit Facility, were subject to variable rates at December 31, 1999 and 1998, respectively. In addition, the average interest rate on the Operating Partnership's debt increased from 7.08% at December 31, 1998 to 7.16% at December 31, 1999. The Operating Partnership reviews interest rate exposure in the portfolio quarterly in an effort to minimize the risk of interest rate fluctuations. The Operating Partnership does not have any other material market-sensitive financial instruments. It is not the Operating Partnership's policy to engage in hedging activities for previously outstanding debt instruments or for speculative or trading purposes.
The Operating Partnership may enter into forward interest rate, or similar, agreements to hedge specific anticipated debt issuances where management believes the risk of adverse changes in market rates is significant. Under a forward interest rate agreement, if the referenced interest rate increases, the Operating Partnership is entitled to a receipt in settlement of the agreement that economically would offset the higher financing cost of the debt issued. If the referenced interest rate decreases, the Operating Partnership makes payment in settlement of the agreement, creating an expense that economically would offset the reduced financing cost of the debt issued. At December 31, 1999, the Operating Partnership was not a party to any forward interest rate or similar agreements other than the interest rate cap contract associated with the Secured Financing loan discussed above.
The table below provides information about the Operating Partnership's financial instruments that are sensitive to changes in interest rates. For debt obligations, the table presents principal cash flows and related weighted average interest rates by expected maturity dates. Weighted average variable rates are based on rates in effect at the reporting date.
The Operating Partnership believes that the interest rates given in the table for fixed rate borrowings approximate the rates the Operating Partnership could currently obtain for instruments of similar terms and maturities and that the fair values of such instruments approximate carrying value at December 31, 1999.
A change of 1/8% in the index rate to which the Operating Partnership's variable rate debt is tied would change the annual interest incurred by the Operating Partnership by $313,000, based upon the balances outstanding on variable rate instruments at December 31, 1999.
Item 8.
Item 8. Financial Statements and Supplementary Data
The response to this item is submitted as a separate section of this Form 10-K. See Item 14.
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 Company
The information required by Item 10 is incorporated by reference from the Company's definitive proxy statement for its annual stockholders' meeting to be held on May 5, 2000.
Item 11.
Item 11. Executive Compensation
The information required by Item 11 is incorporated by reference from the Company's definitive proxy statement for its annual stockholders' meeting to be held on May 5, 2000.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by Item 12 is incorporated by reference from the Company's definitive proxy statement for its annual stockholders' meeting to be held on May 5, 2000.
Item 13.
Item 13. Certain Relationships and Related Transactions
The information required by Item 13 is incorporated by reference from the Company's definitive proxy statement for its annual stockholders' meeting to be held on May 5, 2000.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Partners of GLENBOROUGH PROPERTIES, L.P.:
We have audited the accompanying consolidated balance sheets of GLENBOROUGH PROPERTIES, L.P., as of December 31, 1999 and 1998, and the related consolidated statements of income, partners' equity and cash flows for the years ended December 31, 1999, 1998 and 1997. These consolidated financial statements and the schedules referred to below are the responsibility of the Operating Partnership's management. Our responsibility is to express an opinion on these consolidated financial statements and schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of GLENBOROUGH PROPERTIES, L.P., as of December 31, 1999 and 1998, and the consolidated results of its operations and its cash flows for the years ended December 31, 1999, 1998 and 1997, in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The accompanying schedules listed in the index to financial statements and schedules are presented for the purpose of complying with the Securities and Exchange Commission's rules and are not a required part of the basic consolidated financial statements. These schedules have been subjected to the auditing procedures applied in our audits of the basic consolidated financial statements and, in our opinion, are fairly stated in all material respects in relation to the basic consolidated financial statements taken as a whole.
ARTHUR ANDERSEN LLP
San Francisco, California March 1, 2000
GLENBOROUGH PROPERTIES, L.P.
Notes to Consolidated Financial Statements December 31, 1999 and 1998
Note 1. ORGANIZATION
Glenborough Properties, L.P., a California Limited Partnership (the "Operating Partnership") was organized in the State of California on August 23, 1995. The Operating Partnership is the primary operating subsidiary of Glenborough Realty Trust Incorporated (the "Company"), a self-administered and self-managed real estate investment trust ("REIT"). On December 31, 1995, the Company completed a consolidation (the "Consolidation") in which eight public limited partnerships (the "Partnerships," collectively with Glenborough Corporation (defined below), the "GRT Predecessor Entities"), merged with and into the Company. The Company (i) issued 5,753,709 shares (the "Shares") of $.001 par value Common Stock to the Partnerships in exchange for 3,979,376 Operating Partnership units; and (ii) merged with Glenborough Corporation, a California Corporation, with the Company being the surviving entity. The Company then transferred certain real estate and related assets to the Operating Partnership in exchange for a sole general partner interest of 1% and a limited partnership interest of 85.37% (88.50% limited partnership interest as of December 31, 1999). The Operating Partnership also acquired interests in certain warehouse distribution facilities from GPA, Ltd., a California limited partnership ("GPA"). The Operating Partnership commenced operations on January 1, 1996.
Subsequent to its original formation, the Company issued additional equity in the form of common and preferred shares. The proceeds from these offerings were contributed to the Operating Partnership. As a result of its preferred stock offering, the Company holds a preferred partner interest which has been accounted for as additional paid in capital in the accompanying financial statements. No additional units were issued in exchange for this contribution, however it entitles the Company to a preferred partner interest distribution sufficient to pay the Company's preferred stock distributions, which are paid at a rate of $1.94 per share.
The Operating Partnership, directly and through subsidiary entities, is engaged primarily in the ownership, operation, management, leasing, acquisition, expansion and development of various types of income-producing properties. As of December 31, 1999, the Operating Partnership, directly and through the subsidiaries in which it and the Company own 100% of the ownership interests, controls a portfolio of 161 real estate projects, including office, office/flex, industrial, multifamily, retail and hotel properties, located in 22 states.
Effective April 1, 1998, the Company contributed to the Operating Partnership the majority of its assets, including 100% of its shares of the non-voting preferred stock of Glenborough Corporation ("GC"), formerly known as Glenborough Realty Corporation, as well as all of the Company's tangible personal property including furniture and fixtures, all cash and investments, and a property management contract. As part of that transaction, the Company also agreed to a substantial reduction in the asset management fees paid by the Operating Partnership to the Company. In return, the Operating Partnership canceled certain obligations of the Company to the Operating Partnership, and issued 2,248,869 units of partnership interest to the Company.
Effective February 15, 1999, the Company contributed to the Operating Partnership 100% of its shares of the non-voting preferred stock of Glenborough Hotel Group ("GHG"). In return, the Operating Partnership issued 67,797 units of partnership interest to the Company.
The contributions of 100% of the shares of non-voting preferred stock in GC and GHG discussed above have been accounted for as a reorganization of entities under common control, similar to a pooling of interests. All periods presented have been restated to give effect to these transactions as if they occurred on December 31, 1995. As a result of the above transactions, the only assets of the Company that have not been contributed to the Operating Partnership are (i) its shares of common stock in twelve qualified REIT subsidiaries, which produce dividends that are not material to the Company, and (ii) a less than 5% limited partnership interest in Glenborough Partners.
Prior to September 30, 1999, the Operating Partnership held 100% of the non-voting preferred stock of the following associated companies (the "Associated Companies"):
Glenborough Corporation ("GC") is the general partner of several real estate limited partnerships and provides asset and property management services for these partnerships (the "Managed Partnerships"). It also provides partnership administration, asset management, property management and development services to a group of unaffiliated
GLENBOROUGH PROPERTIES, L.P.
Notes to Consolidated Financial Statements December 31, 1999 and 1998
partnerships, which include three public partnerships sponsored by Rancon Financial Corporation, an unaffiliated corporation which has significant real estate assets in the Inland Empire region of Southern California (the "Rancon Partnerships").
Glenborough Hotel Group ("GHG") owns an approximate 36% limited partner interest in a real estate joint venture.
Effective September 30, 1999, GHG merged with GC. In the merger, the Operating Partnership received preferred stock of GC in exchange for its preferred stock of GHG. The merger was accounted for as a reorganization of entities under common control.
Following the merger, the Operating Partnership owns 100% of the 47,500 shares (representing 95% of total outstanding shares) of non-voting preferred stock of GC. Six individuals, including Sandra Boyle, Frank Austin and Terri Garnick, executive officers of the Company, own the 2,500 shares (representing 5% of total outstanding shares) of voting common stock of GC. The Operating Partnership and GC intend that the Operating Partnership's interest in GC complies with REIT qualification standards.
The Operating Partnership, through its ownership of preferred stock of GC, is entitled to receive cumulative, preferred annual dividends of $1.896 per share, which GC must pay before it pays any dividends with respect to the common stock of GC. Once GC pays the required cumulative preferred dividend, it will pay any additional dividends in equal amounts per share on both the preferred stock and the common stock at 95% and 5%, respectively. Through the preferred stock, the Operating Partnership is also entitled to receive a preferred liquidation value of $169.49 per share plus all cumulative and unpaid dividends. The preferred stock is subject to redemption at the option of GC after December 31, 2005, for a redemption price of $169.49 per share. As the holder of preferred stock of GC, the Operating Partnership has no voting power with respect to the election of the directors of GC; all power to elect directors of GC is held by the owners of the common stock of GC.
This structure is intended to provide the Operating Partnership with a significant portion of the economic benefits of the operations of GC. The Operating Partnership accounts for the financial results of GC using the equity method.
Note 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation The accompanying financial statements present the consolidated financial position of the Operating Partnership as of December 31, 1999 and 1998, and the consolidated results of operations and cash flows of the Operating Partnership for the years ended December 31, 1999, 1998 and 1997. All intercompany transactions, receivables and payables have been eliminated in consolidation.
Reclassification Certain prior year balances have been reclassified to conform with the current year presentation.
Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles 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 results of operations during the reporting period. Actual results could differ from those estimates.
New Accounting Pronouncements Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities" was issued in June 1998. SFAS No. 133 was originally effective for fiscal years beginning after June 15, 1999, with early adoption permitted. In June 1999, SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133 - an amendment of FASB Statement No. 133" was issued which, among other things, deferred the final implementation to fiscal years
GLENBOROUGH PROPERTIES, L.P.
Notes to Consolidated Financial Statements December 31, 1999 and 1998
beginning after June 15, 2000. SFAS No. 133 provides comprehensive guidelines for the recognition and measurement of derivatives and hedging activities and specifically requires all derivatives to be recorded on the balance sheet at fair value. Management is evaluating the effects, if any, that this pronouncement will have on the Operating Partnership's consolidated financial position, results of operations and financial statement position.
Rental Properties Rental properties are stated at cost unless circumstances indicate that cost cannot be recovered, in which case, the carrying value of the property is reduced to estimated fair value. Estimated fair value: (i) is based upon the Operating Partnership's plans for the continued operation of each property; and (ii) is computed using estimated sales price, as determined by prevailing market values for comparable properties and/or the use of capitalization rates multiplied by annualized rental income based upon the age, construction and use of the building. The fulfillment of the Operating Partnership's plans related to each of its properties is dependent upon, among other things, the presence of economic conditions which will enable the Operating Partnership to continue to hold and operate the properties prior to their eventual sale. Due to uncertainties inherent in the valuation process and in the economy, it is reasonably possible that the actual results of operating and disposing of the Operating Partnership's properties could be materially different than current expectations.
Depreciation is provided using the straight line method over the useful lives of the respective assets.
The useful lives are as follow:
Buildings and Improvements 10 to 40 years Tenant Improvements Term of the related lease Furniture and Equipment 5 to 7 years
Real Estate Held for Sale Real estate held for sale consists of rental properties that are under contract to be disposed of. The fulfillment of the Operating Partnership's plans to dispose of property is dependent upon, among other things, the presence of economic conditions which will enable the Operating Partnership to hold the property for eventual sale. The Operating Partnership discontinues depreciation of rental property once it is classified as held for sale.
Investments in Development The Operating Partnership, through mezzanine loans and equity contributions, invests in various development alliances with projects currently under development. The interest on advances and other direct project costs incurred by the Operating Partnership are capitalized to the investment during the period in which the projects are under development. See Note 6 for further discussion.
Investments in Associated Companies The Operating Partnership's investments in the Associated Companies are accounted for using the equity method, as discussed further in Note 4.
Mortgage Loans Receivable The Operating Partnership monitors the recoverability of its loans and notes receivable through ongoing contact with the borrowers to ensure timely receipt of interest and principal payments, and where appropriate, obtains financial information concerning the operation of the properties. Interest on mortgage loans is recognized as revenue as it accrues during the period the loan is outstanding. Mortgage loans receivable will be evaluated for impairment if it becomes evident that the borrower is unable to meet its debt service obligations in a timely manner and cannot satisfy its payments using sources other than the operations of the property securing the loan. If it is concluded that such circumstances exist, then such loan will be considered to be impaired and its recorded amount will be reduced to the fair value of the collateral securing it. Interest income will also cease to accrue under such circumstances. Due to uncertainties inherent in the valuation process, it is reasonably possible that the amount ultimately realized from the Operating Partnership's collection on these receivables will be different than the recorded amounts.
GLENBOROUGH PROPERTIES, L.P.
Notes to Consolidated Financial Statements December 31, 1999 and 1998
Cash Equivalents The Operating Partnership considers short-term investments (including certificates of deposit) with a maturity of three months or less at the time of investment to be cash equivalents.
Marketable Securities The Operating Partnership records its marketable securities at fair value. Unrealized gains and losses on securities are reported as a separate component of partners' equity and realized gains and losses are included in net income. As of December 31, 1999, the Operating Partnership did not hold any marketable securities. As of December 31, 1998, marketable securities with a fair value of approximately $2,639,000 were included in other assets on the accompanying consolidated balance sheet.
Fair Value of Financial Instruments Statement of Financial Accounting Standards No. 107 requires disclosure about fair value for all financial instruments. Based on the borrowing rates currently available to the Operating Partnership, the carrying amount of debt approximates fair value. Certain assumed debt instruments have been recorded at a premium based upon the stated rate on the instrument and the then available borrowing rates for the Operating Partnership. Cash and cash equivalents consist of demand deposits and certificates of deposit with financial institutions. The carrying amount of cash and cash equivalents as well as the mortgage loans receivable described above, approximates fair value.
Derivative Financial Instruments The Operating Partnership may use derivative financial instruments in the event that it believes such instruments will be an effective hedge against fluctuations in interest rates on a specific anticipated borrowing. Derivative financial instruments such as forward rate agreements or interest rate swaps may be used in this capacity. To the extent such instruments do not qualify as hedges, they will be accounted for on a mark-to-market basis and recorded in earnings each period as appropriate. The cost of terminated instruments not qualifying as hedges will be recorded in earnings in the period they are terminated. Instruments which qualify as hedges upon obtaining the related debt will be recorded as a premium or discount on the related debt principal and amortized into earnings over the life of the debt instrument. If the hedged instrument is retired early, the unamortized discount or premium will be included as a component of the calculation of gain or loss on retirement.
At December 31, 1999 and 1998, the Operating Partnership was not a party to any open interest rate protection agreements other than the interest rate cap contract entered into in August 1999 as discussed in Note 7 below.
Deferred Financing and Other Fees Fees paid in connection with the financing and leasing of the Operating Partnership's properties are amortized over the term of the related notes payable or leases and are included in other assets.
Revenues All leases are classified as operating leases. Rental revenue is recognized as earned over the terms of the related leases.
For the years ended December 31, 1999, 1998 and 1997, no tenants represented 10% or more of rental revenue of the Operating Partnership.
Fees and reimbursements revenue consists of property management fees, overhead administration fees, and transaction fees from the acquisition, disposition, refinancing, leasing and construction supervision of real estate for unconsolidated affiliates.
Revenues are recognized only after the Operating Partnership is contractually entitled to receive payment, after the services for which the fee is received have been provided, and after the ability and timing of payments are reasonably assured and predictable.
GLENBOROUGH PROPERTIES, L.P.
Notes to Consolidated Financial Statements December 31, 1999 and 1998
Scheduled rent increases are based primarily on the Consumer Price Index or a similar factor. Material incentives paid, if any, by the Operating Partnership to a tenant are amortized as a reduction of rental income over the life of the related lease.
The Operating Partnership's portfolio of leases turns over continuously, with the number and value of expiring leases varying from year to year. The Operating Partnership's ability to release the space to existing or new tenants at rates equal to or greater than those realized historically is impacted by, among other things, the economic conditions of the market in which a property is located, the availability of competing space, and the level of improvements which may be required at the property. No assurance can be given that the rental rates that the Operating Partnership will obtain in the future will be equal to or greater than those obtained under existing contractual commitments.
Income Taxes As a partnership, the allocated share of income of the Operating Partnership is included in the income tax returns of the partners. Accordingly, no accounting for income taxes is required in the accompanying consolidated financial statements. State and local taxes are not material. Taxable income of the Operating Partnership for the years ended December 31, 1998 and 1997 was $58,266,000 and $23,795,000, respectively. Estimated taxable income for the year ended December 31, 1999 is $62,143,000. Reconciling differences between book income and tax income primarily result from timing differences in depreciation expense.
The Operating Partnership declared distributions per unit of $1.68, $1.68 and $1.38 for the years ended December 31, 1999, 1998 and 1997, respectively. The following is a summary of distributions per unit which represent a return of capital measured using generally accepted accounting principles:
Distribution Per Unit 1999 1998 1997 ------------------------------- ----------- ------------ ---------
From book net income $ 1.28 $ 1.31 $ 1.38 Representing return of capital 0.40 0.37 0.00 Total Distributions $ 1.68 $ 1.68 $ 1.38
For the years ended December 31, 1999, 1998 and 1997, respectively, 24%, 22% and 0% of the distributions paid represented a return of capital for federal income tax purposes
Net Income Per Partnership Unit Net income per partnership unit is calculated using the weighted average number of partnership units outstanding during the period. No effect on per unit amounts has been attributed to a potential conversion of the Preferred Partner Interest into limited partner units as the impact is anti-dilutive. No other potentially dilutive securities of the Operating Partnership exist.
Note 3. RENTAL PROPERTY
The cost and accumulated depreciation of rental property as of December 31, 1999 and 1998 are as follows (in thousands):
Acquisitions In the fourth quarter of 1999, through one of its development alliances, the Operating Partnership acquired Chase Monroe Phase II, a 96-unit addition to the Operating Partnership's existing 120-unit multifamily complex in the Charlotte, North Carolina area. The total acquisition cost, including third party expenditures incurred for the purpose of this transaction, was approximately $5 million in cash, including a $4.4 million advance under the Credit Facility. The development pipeline also produced Bridgewater II, an 84,000 square foot office building in Northern New Jersey. The acquisition was structured through an exchange of interests in other development projects with the same development alliance and involved the assumption of $10 million in debt. There was no cash involved in the transaction.
In the third quarter of 1999, the Operating Partnership acquired all of the real estate assets of Prudential-Bache/Equitec Real Estate Partnership, a California limited partnership (the "Pru Bache Portfolio") in which the managing general partner was Prudential-Bache Properties, Inc., and in which GC and Robert Batinovich, Chief Executive Officer of the Company served as co-general partners since March 1994. Neither GC nor Robert Batinovich held a material equity or economic interest in the Pru-Bache Portfolio. The acquisition was unanimously approved by the Company's independent directors, with Robert Batinovich and Andrew Batinovich abstaining. The total acquisition cost, including third party expenditures incurred for the purpose of the transaction, was approximately $49.1 million, which consisted of (i) approximately $15.2 million of assumed debt and (ii) the balance in cash, including approximately $21.4 million of proceeds from the sales of real estate assets and an $11.2 million advance under the Credit Facility. The Pru-Bache Portfolio consists of four office buildings and one office/flex property, aggregating 550,592 total square feet and located in Rockville, Maryland, Memphis, Tennessee, Sacramento, California and Seattle, Washington.
In the second quarter of 1999, the Operating Partnership expanded its existing holdings near Los Angeles International Airport by purchasing a 41,709 square foot industrial building plus additional land which is the second phase of the project purchased in the first quarter (see below). This second phase has been
GLENBOROUGH PROPERTIES, L.P.
Notes to Consolidated Financial Statements December 31, 1999 and 1998
leased on a long term triple net basis to the tenant currently occupying phase one of the project. The total acquisition cost, including third party expenditures incurred for the purpose of the transaction, was approximately $5.6 million.
In the first quarter of 1999, the Operating Partnership acquired a 285 unit multifamily property ("Springs of Indian Creek") located in Carrolton, Texas. The property is the first phase of a two-phase project comprising a total of 519 units. The 234 unit second phase of the project is currently under construction through one of the Operating Partnership's development alliances and is expected to be completed in the first quarter of the year 2000. The total acquisition cost, including third party expenditures incurred for the purpose of the transaction, was approximately $20.8 million comprising: (i) approximately $14.1 million in assumption of debt and (ii) the balance in cash. In addition, the Operating Partnership acquired a 1.45-acre parcel containing 34,500 square feet of industrial buildings in Los Angeles, California, near the Los Angeles International Airport. This property is the first phase of a two-phase project. The total acquisition cost, including third party expenditures incurred for the purpose of the transaction, was approximately $3.1 million, which was paid entirely in cash. The property has been leased to a single tenant under a 15-year triple-net lease.
Dispositions In the fourth quarter of 1999, the Operating Partnership sold eight properties, including one office, two office/flex, five industrial and one building from an office/flex property. The assets were sold for an aggregate sales price of approximately $28,697,000 and generated an aggregate net gain of approximately $2,291,000.
In the third quarter of 1999, the Operating Partnership sold five properties, including two office, two office/flex and one hotel. The assets were sold for an aggregate sales price of approximately $19,865,000 and generated an aggregate net loss of approximately $371,000.
In the second quarter of 1999, the Operating Partnership sold fourteen properties, including five office, four office/flex, one retail, two industrial, one multifamily and one hotel. The assets were sold for an aggregate sales price of approximately $109,135,000 and generated an aggregate net gain of approximately $5,742,000.
In the first quarter of 1999, the Operating Partnership sold seven properties, including five office/flex properties and two retail properties, and a partial interest in a REIT. These assets were sold for an aggregate sales price of approximately $27.3 million and generated an aggregate net gain of approximately $1,351,000.
These transactions are reflected as the net gain on sales of real estate assets on the accompanying consolidated statement of income for the year ended December 31, 1999.
The Operating Partnership leases its commercial and industrial property under non-cancelable operating lease agreements. Future minimum rents to be received as of December 31, 1999 are as follows (in thousands):
Year Ending December 31, 2000 $ 173,142 2001 134,000 2002 110,945 2003 89,334 2004 66,933 Thereafter 211,580 $ 785,934
Note 4. INVESTMENTS IN ASSOCIATED COMPANIES
The Operating Partnership accounts for its investment in GC (as defined in Note 1) using the equity method as a substantial portion of the economic benefits flow to the Operating Partnership by virtue of its 100% non-voting preferred stock interest in GC, which interest constitutes substantially all of GC's
GLENBOROUGH PROPERTIES, L.P.
Notes to Consolidated Financial Statements December 31, 1999 and 1998
capitalization. Three of the holders of the voting common stock of GC are officers of the Company; however, the Operating Partnership has no direct voting or management control of GC. The Operating Partnership records earnings on its investment in GC equal to its cash flow preference, to the extent of earnings, plus its pro rata share of remaining earnings, based on cash flow allocation percentages. Distributions received from GC are recorded as a reduction of the Operating Partnership's investments.
As of December 31, 1999 and 1998, the Operating Partnership had the following investments in the Associated Companies (in thousands): GC (1) Investment at December 31, 1997 $ 10,948 Distributions (3,455) Equity in earnings 1,314 Investment at December 31, 1998 8,807 Distributions (625) Equity in earnings (loss) 1,222 Investment at December 31, 1999 $ 9,404
Summary condensed balance sheet information as of December 31, 1999 and 1998, and the condensed statements of income for the years then ended are as follows (in thousands):
GLENBOROUGH PROPERTIES, L.P.
Notes to Consolidated Financial Statements December 31, 1999 and 1998
Note 5. MORTGAGE LOANS RECEIVABLE
The Operating Partnership's mortgage loans receivable consist of the following as of December 31, 1999 and 1998 (dollars in thousands):
In November 1999, a note secured by an office property in Phoenix, Arizona was sold to a third party at a discount of $1,229,000 and the proceeds of the sale were invested in the repurchase of preferred stock. This discount is recorded as a loss on sale of mortgage loan receivable on the accompanying consolidated statement of income for the year ended December 31, 1999.
In September 1999, the Operating Partnership sold a hotel property in Arlington, Texas, to a third party for a sale price of $2.1 million, of which $1.14 million was represented by a note receivable secured by the hotel property. This note was paid off in January 2000.
In 1998, the Operating Partnership sold a hotel property in Dallas, Texas, to a third party for a sale price of $4.2 million, of which $3.6 million was represented by a note receivable secured by the hotel property. In September 1999, the loan agreement was modified to reduce the sale price of the hotel by $1.6 million and, thus, the principal amount of the note receivable was also reduced by $1.6 million. In addition, the maturity date of the note was extended to March 2000. This note was paid off in December 1999.
In 1998, the Operating Partnership entered into a development alliance with The Pauls Corporation (see Note 6). In addition to this development alliance, the Operating Partnership loaned approximately $34 million ($36.4 million, including accrued interest, at December 31, 1999), secured by a First Mortgage, to continue the build-out of Gateway Park. In this arrangement, the Operating Partnership has rights under certain conditions and subject to certain contingencies to purchase the properties upon completion of development and, thus, through this arrangement, the Operating Partnership could acquire up to 2.2 million square feet of office, office/flex and industrial space and 1,600 multifamily units over the next ten years.
Contractually due principal payments of the mortgage loans receivable are as follows (in thousands):
GLENBOROUGH PROPERTIES, L.P.
Notes to Consolidated Financial Statements December 31, 1999 and 1998
Year Ending December 31, 2000 $ 1,141 2001 - 2002 - 2003 - 2004 - Thereafter 36,441 Total $ 37,582
Note 6. INVESTMENTS IN DEVELOPMENT AND OTHER ASSETS
The Operating Partnership currently has 3 alliances for the development of approximately 885,000 square feet of office, office/flex and distribution properties and 1,614 multifamily units in Colorado, Texas, New Jersey, Kansas and Michigan. As of December 31, 1999, the Operating Partnership has an investment of approximately $33 million. Under these development alliances, the Operating Partnership has certain rights to purchase the properties upon completion of development over the next five years.
In June 1999, the Operating Partnership entered into a joint venture in which it sold a 90% interest in Rockwall I & II, a 340,252 square foot office complex located in Rockville, Maryland. The Operating Partnership maintains a 10% interest in the asset along with a contract for property management and asset management services under which the Operating Partnership is entitled to receive property management fees of 3% of cash receipts and an annual asset management fee of $350,000. The proceeds from the sale were used to paydown the Credit Facility (discussed below), to reduce other secured debt and to repurchase the Company's stock. The value of this 10% interest is approximately $1.4 million and is included in Other Assets on the accompanying consolidated balance sheet as of December 31, 1999. This investment is accounted for using the equity method.
In April 1999, the Operating Partnership also purchased a 10% interest in a joint venture holding the fee simple title to the land under Rincon Center I & II in San Francisco, California. The land was purchased from the United States Post Office for a purchase price of $80.5 million. The land has a triple net ground lease with a remaining term of 51 years with minimum 30% rental increases every six years. In October 1999, the joint venture purchased the leasehold improvements comprising Rincon Center I & II. Occupying a full city block near the waterfront in the Financial District, Rincon Center I & II contains approximately 700,000 square feet which includes commercial office and retail space, 320 multifamily units and 381 subterranean parking spaces. The Operating Partnership took over management and leasing of the project on November 1, 1999 and is now entitled to receive property management fees of 1.75% of cash receipts. The book value of this 10% interest is approximately $4.2 million and is included in Other Assets on the accompanying consolidated balance sheet as of December 31, 1999. This investment is accounted for using the equity method.
As of December 31, 1999 and 1998, other assets on the consolidated balance sheets consists of the following (in thousands): 1999 1998 ------------ ------------ Accounts receivable $ 3,863 $ 1,968 Prepaid expenses 8,164 8,157 Impound accounts 12,970 12,280 Lease commissions and loan fees 20,867 13,120 Investment in joint ventures 5,679 - Corporate office fixed assets 4,726 4,259 Marketable securities - 2,639 Related party receivable (Note 9) 1,847 - Other 3,118 3,014 ------------ ------------
Total other assets $ 61,234 $ 45,437 ============ ============
GLENBOROUGH PROPERTIES, L.P.
Notes to Consolidated Financial Statements December 31, 1999 and 1998
Note 7. SECURED AND UNSECURED LIABILITIES
The Operating Partnership had the following mortgage loans, bank lines, and notes payable outstanding as of December 31, 1999 and 1998 (in thousands):
GLENBOROUGH PROPERTIES, L.P.
Notes to Consolidated Financial Statements December 31, 1999 and 1998
In March 1999, the Operating Partnership obtained a $26 million loan from a commercial bank. The loan was non-recourse and was secured by seven properties and had a maturity date of December 22, 1999, with an option to extend for six months. The proceeds were used to pay off a loan which was previously secured by these same properties and to reduce other debt. This loan was paid off in June 1999 with proceeds generated from the sales of four properties.
In June 1999, in order to increase the Operating Partnership's financial flexibility, the Credit Facility was modified to increase the commitment from $100 million to $142.5 million. The interest rate, monthly payments and maturity date remained unchanged. Subsequent to December 31, 1999, the maturity date was extended to June 2002.
In August 1999, the Operating Partnership closed a $97.6 million secured financing with a commercial bank ("Secured Financing"). The proceeds from this financing, combined with proceeds from a new $7.2 million mortgage and a draw on the Credit Facility, were used to retire a $113.2 million mortgage which would have matured in December of 1999. The new financing is a revolving line of credit maturing in five years with a five-year extension option, and bears interest at a floating rate equal to 75 basis points over the rate for 90-day mortgage backed securities credit-enhanced by FNMA. The December 31, 1999 interest rate on this loan was 6.53%.
In connection with the Secured Financing, the Operating Partnership entered into an interest rate cap agreement to hedge increases in interest rates above a specified level of 11.21%. The agreement is for a term concurrent with the Secured Financing instrument, is indexed to a 90-day LIBOR rate, and is for a notional amount equal to the maximum amount available on the Secured Financing loan. As of December 31, 1999, the 90-day LIBOR rate was 6.00125%. The Operating Partnership paid a premium fee at the inception of the cap agreement, which is being amortized as additional interest expense over the life of the agreement.
In November 1999, through the acquisition of a property through one of the Operating Partnership's development alliances (as discussed above), the Operating Partnership assumed a $10 million loan from a commercial bank. This loan is secured by one office property, has a maturity date of June 30, 2000 and bears interest at a floating rate of LIBOR plus 2.50%. The December 31, 1999 interest rate on this loan was 8.32%.
In December 1999, the Operating Partnership obtained an unsecured term loan from a commercial bank whereby, until December 9, 2000, the Operating Partnership can borrow the lesser of $125 million or the then Loan Availability (as defined). Any unborrowed amounts from the loan at December 9, 2000 will be cancelled. At December 31, 1999, $33,865,000 was outstanding on the loan. This loan has a maturity date of June 10, 2002 and bears interest at a floating rate of LIBOR plus 1.75%. The December 31, 1999 interest rate on this loan was 8.25%.
In the second, third and fourth quarters of 1999, the Operating Partnership retired approximately $58.9 million of unsecured Senior Notes at a discount. As a result of these transactions, a net gain on early extinguishment of debt of approximately $3.1 million was recorded which is included in the net gain on early extinguishment of debt on the accompanying consolidated statement of income for the year ended December 31, 1999, as discussed in Note 8 below.
Some of the Operating Partnership's properties are held in limited partnerships and limited liability companies in order to facilitate financing. Such limited partnerships and limited liability companies are included in the consolidated financial statements of the Operating Partnership in accordance with Generally Accepted Accounting Principles ("GAAP").
The required principal payments on the Operating Partnership's debt for the next five years and thereafter, as of December 31, 1999, are as follows (in thousands):
GLENBOROUGH PROPERTIES, L.P.
Notes to Consolidated Financial Statements December 31, 1999 and 1998
Year Ending December 31, 2000 $ 102,843 (1) 2001 22,535 2002 118,794 (1) 2003 37,849 2004 125,391 Thereafter 489,946 Total $ 897,358
(1) Subsequent to December 31, 1999, the maturity date on the Credit Facility was extended from December 2000 to June 2002. The payment schedule has been updated for this subsequent event and reflects a June 2002 payoff.
Note 8. NET GAIN (LOSS) ON EARLY EXTINGUISHMENT OF DEBT
In connection with the loan payoffs discussed above and the payoff of other mortgage debt, the Operating Partnership recorded a net gain on early extinguishment of debt of $984,000 for the year ended December 31, 1999. This gain consists of $3,115,000 of gains on retirement of Senior Notes (as discussed above) offset by $2,026,000 of losses due to prepayment penalties and $105,000 of losses due to the writeoff of unamortized loan fees upon the early payoff of four loans. These loans were paid-off early when more favorable terms were obtained through new financing (discussed above) and upon the sale of the properties securing the loans. Net loss on early extinguishment of debt of $1,400,000 during the year ended December 31, 1998, consisted of prepayment penalties and the write-off of unamortized loan fees upon the early payoff of debt. Various loans were paid-off early when more favorable terms were obtained through new financing and upon the sale of one of the hotels. Net loss on early extinguishment of debt of $843,000 during the year ended December 31, 1997, resulted from the write-off of unamortized loan fees related to a $50 million secured line of credit which was replaced with a $250 million unsecured line of credit (the "Credit Facility") from a commercial bank.
Note 9. RELATED PARTY TRANSACTIONS
Fee and reimbursement income earned by the Operating Partnership from related entities totaled $3,312,000, $2,802,000 and $719,000 for the years ended December 31, 1999, 1998 and 1997, respectively, and consisted of property management fees, asset management fees and other fee income. In addition, the Operating Partnership paid GC property management fees and salary reimbursements totaling $1,572,000 and $1,273,000 for the years ended December 31, 1999 and 1998, respectively, for management of a portfolio of residential properties owned by the Company, which is included in property operating expenses and general and administrative expenses on the accompanying consolidated statements of income.
In 1998, the Operating Partnership acquired from a Managed Partnership an option to purchase all of its rights under a Lease with Option to Purchase Agreement, for certain undeveloped land located in Burlingame, California. Upon expiration of the option period, the independent members of the Company's Board of Directors concluded that proceeding with the development of the property would have required that the Operating Partnership incur substantial debt. Accordingly, on February 1, 1999, the Operating Partnership elected not to proceed with the development and not to exercise the option in return for the Managed Partnership's agreement to reimburse the Operating Partnership for $2,309,000 of predevelopment costs, $462,000 to be paid in cash with the balance of $1,847,000 in a promissory note bearing interest at 10% and due on the earlier of sale, refinance or March 31, 2002. The note also contains a participation in profits realized by the Managed Partnership from the development and sale of the property. The principal balance of the note is included in Other Assets on the accompanying consolidated balance sheet as of December 31, 1999.
The Operating Partnership has no employees and reimburses, at cost, the Company for all employee-related costs included in the accompanying consolidated financial statements.
GLENBOROUGH PROPERTIES, L.P.
Notes to Consolidated Financial Statements December 31, 1999 and 1998
Note 10. COMMITMENTS AND CONTINGENCIES
Environmental Matters. The Operating Partnership follows a policy of monitoring its properties for the presence of hazardous or toxic substances. The Operating Partnership is not aware of any environmental liability with respect to the properties that would have a material adverse effect on the Operating Partnership's business, assets or results of operations. There can be no assurance that such a material environmental liability does not exist. The existence of any such material environmental liability could have an adverse effect on the Operating Partnership's results of operations and cash flow.
General Uninsured Losses. The Operating Partnership carries comprehensive liability, fire, flood, extended coverage and rental loss insurance with policy specifications, limits and deductibles customarily carried for similar properties. There are, however, certain types of extraordinary losses which may be either uninsurable, or not economically insurable. Further, certain of the properties are located in areas that are subject to earthquake activity. Should a property sustain damage as a result of an earthquake, the Operating Partnership may incur losses due to insurance deductibles, co-payments on insured losses or uninsured losses. Should an uninsured loss occur, the Operating Partnership could lose its investment in, and anticipated profits and cash flows from, a property.
Litigation. Prior to the completion of the Consolidation, two lawsuits were filed in 1995 contesting the fairness of the Consolidation, one in California State court and one in federal court. The complaints in both actions alleged, among other things, breaches by the defendants of fiduciary duties and inadequate disclosures. The State court action was settled over the objection of certain parties, and the settlement was approved (or review denied) by the Superior Court of the State of California in and for San Mateo County, the California state court of appeals, the California Supreme Court and the Supreme Court of the United States. In the federal action, the court in December of 1995 deferred all further proceedings pending a ruling in the State court action. Following the final resolution of the State court action, the defendants in January 2000 filed a motion to dismiss the federal court action. As of the date of this report, the plaintiffs had failed to file a timely responsive pleading, so the defendants intend to move for final dismissal. The Operating Partnership and the Company believe that it is very unlikely that this litigation would result in a liability that would exceed the accrued liability by a material amount. However, given the inherent uncertainties of litigation, there can be no assurance that the ultimate outcomes of these actions will be favorable to the Operating Partnership and the Company.
Certain other claims and lawsuits have arisen against the Operating Partnership and the Company in their normal course of business. The Operating Partnership and the Company believe that such other claims and lawsuits will not have a material adverse effect on their financial position, cash flow or results of operations.
Note 11. SEGMENT INFORMATION
The Operating Partnership owns a diverse portfolio of properties comprising six product types: office, office/flex, industrial, retail, multifamily and hotels. Each of these product types represents a reportable segment with distinct uses and tenant types which require the Operating Partnership to employ different management strategies. Each segment contains properties located in various regions and markets within the United States. The office portfolio consists primarily of suburban office buildings. The office/flex portfolio consists of properties designed for a combination of office and warehouse uses. The industrial portfolio consists of properties designed for warehouse, distribution and light manufacturing for single-tenant or multi-tenant use. The retail portfolio consists primarily of community shopping centers anchored with national or regional supermarkets or drug stores. The properties in the multifamily portfolio are apartment buildings with units rented to residential tenants on either a month-by-month basis or for terms of one year or less. The Operating Partnership's hotel operations are from three limited service "all-suite" properties leased to and operated by third parties. As of December 31, 1999, two of these hotel properties have been sold with only one remaining in the Operating Partnership's portfolio.
The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Operating Partnership evaluates performance of its property types based on net operating income derived by subtracting rental expenses and real estate taxes (operating expenses) from
GLENBOROUGH PROPERTIES, L.P.
Notes to Consolidated Financial Statements December 31, 1999 and 1998
rental revenues. Significant information used by the Operating Partnership for its reportable segments as of and for the years ended December 31, 1999 and 1998 is as follows (in thousands):
The following is a reconciliation of segment revenues, income and assets to consolidated revenues, income and assets for the periods presented above (in thousands):
GLENBOROUGH PROPERTIES, L.P.
Notes to Consolidated Financial Statements December 31, 1999 and 1998
Note 12. SUBSEQUENT EVENTS
On February 18, 2000, the Operating Partnership formed a limited liability company (the "LLC") with an independent third party and contributed its interest in the office property known as 2000 Corporate Ridge, located in McLean, Virginia. The Operating Partnership retains a 10% interest in the LLC. Consideration received for this contribution included $20.6 million in debt assumption by the LLC and $14.7 million in cash, which approximates the carrying value of the portion of the property now held by a third party. Cash proceeds to the Operating Partnership were funded by the capital contributions of the third party to the LLC. The LLC agreement provides for, among other things, a 3% annual management fee to the Operating Partnership for property management services, certain asset management fees and certain additional distributions in excess of its 10% interest, if available, upon the ultimate sale of the property by the LLC. The Operating Partnership will account for its interest in the LLC under the equity method.
In February 2000, the Operating Partnership entered into sale negotiations and on February 24, 2000, sold its interest in the office/flex property known as Columbia Warehouse, located in Columbia, Maryland, to an independent third party for all cash consideration of $1,640,000. This resulted in a loss on sale, to be recognized in the first quarter of 2000, of approximately $430,000.
Note 13. UNAUDITED QUARTERLY RESULTS OF OPERATIONS
The following represents an unaudited summary of quarterly results of operations for the years ended December 31, 1999 and 1998 (in thousands, except for weighted average units and per unit amounts):
GLENBOROUGH PROPERTIES, L.P.
Notes to Consolidated Financial Statements December 31, 1999 and 1998
GLENBOROUGH PROPERTIES, L.P.
Notes to Consolidated Financial Statements December 31, 1999 and 1998
SIGNATURES
Pursuant to the requirements of Section l3 or l5(d) of the Securities Exchange Act of l934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
GLENBOROUGH PROPERTIES, L.P., a California Limited Partnership
By: Glenborough Realty Trust Incorporated, its General Partner
Date: March 14, 2000 /s/ Andrew Batinovich Andrew Batinovich Director, President and Chief Operating Officer
Date: March 14, 2000 /s/ Stephen Saul Stephen Saul Chief Financial Officer (Principal Financial Officer)
Date: March 14, 2000 /s/ Terri Garnick Terri Garnick Senior Vice President, Chief Accounting Officer, Treasurer (Principal Accounting Officer)
EXHIBIT INDEX
Exhibit Number Exhibit Title
3.01 Articles of Amendment and Restatement of Articles of Incorporation of the Company are incorporated herein by reference to Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998.
3.02 Amended Bylaws of the Company are incorporated herein by reference to Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998.
3.03 The Company's Form of Articles Supplementary relating to the 7-3/4% Series A Convertible Preferred Stock is incorporated herein by reference to Exhibit 3.03 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997.
3.04 Articles Supplementary of the Series B Preferred Stock (relating to the Rights Plan) are incorporated herein by reference to Exhibit 3.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998.
4.01 Form of Common Stock Certificate of the Company is incorporated herein by reference to Exhibit 4.02 to the Company's Registration Statement on Form S-4 (Registration No. 33-83506), which became effective October 26, 1995.
4.02 Form of 7-3/4% Series A Convertible Preferred Stock Certificate of the Company is incorporated herein by reference to Exhibit 4.1 to the Company's Registration Statement on Form 8-A which was filed on January 22, 1998.
10.01 Form of Indemnification Agreement for existing Officers and Directors of the Company is incorporated herein by reference to Exhibit 10.02 to the Company's Registration Statement on Form S-4 (Registration No. 33-83506), which became effective October 26, 1995.
10.02* Stock Incentive Plan of the Company (amended and restated as of March 20, 1997) is incorporated herein by reference to Exhibit 4.0 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997.
10.03* Employment Agreement between the Company and Robert Batinovich is incorporated herein by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998.
10.04* Employment Agreement between the Company and Andrew Batinovich is incorporated herein by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998.
10.05 Rights Agreement, dated as of July 20, 1998, between the Company and the Registrar and Transfer Company, together with Exhibit A Form of Rights Certificate; Exhibit B Summary of Rights to Purchase Preferred Stock; and Exhibit C Form of Articles Supplementary of the Series B Preferred Stock are incorporated herein by reference to Exhibit 1 to the Company's Form 8-A, filed on July 16, 1998.
10.06 Registration Agreement between the Company and GPA, Ltd. is incorporated herein by reference to Exhibit 10.27 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995.
10.07 Indemnification Agreement for Glenborough Realty Corporation and the Company, with Robert Batinovich as indemnitor is incorporated herein by reference to Exhibit 10.31 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995.
EXHIBIT INDEX - continued
Exhibit Number Exhibit Title
12.01 Computation of Ratio of Earnings to Fixed Charges and Ratio of Earnings to Fixed Charges and Preferred Partner Interest Distributions
23.01 Consent of Arthur Andersen LLP, independent public accountants
27.01 Financial Data Schedule * Indicates management contract or compensatory plan or arrangement.
Exhibit 12.01
GLENBOROUGH PROPERTIES, L.P. Computation of Ratio of Earnings to Fixed Charges and Ratio of Earnings to Fixed Charges and Preferred Partner Interest Distributions For the five years ended December 31, 1999 (dollars in thousands)
Exhibit 23.01
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our report dated March 1, 2000 on the financial statements of Glenborough Properties, L.P. included in this Form 10-K, into the Operating Partnership's previously filed Registration Statement File Nos. 333-70463 and 333-08806. It should be noted that we have not audited any financial statements of the Operating Partnership subsequent to December 31, 1999 or performed any audit procedures subsequent to the date of our report.
/s/ ARTHUR ANDERSEN LLP ARTHUR ANDERSEN LLP
San Francisco, California March 14, 2000