Item 1. Business.
Charles E. Smith Residential Realty L.P., a Delaware limited partnership (the "Operating Partnership"), was formed in 1993 and commenced operations on June 30, 1994. It is managed by its general partner, Charles E. Smith Residential Realty, Inc., a Maryland corporation (the "Company"), which is a self-administered and self-managed equity real estate investment trust("REIT"). The Company was organized in 1993 and also commenced operations on June 30, 1994 upon completion of its initial public offering (the "Initial Public Offering").
The Operating Partnership and the Company are engaged primarily in the acquisition, development, management and operation of multifamily properties. The Operating Partnership, together with the Company and their respective subsidiaries as described below, is a fully integrated real estate organization with in-house acquisition, development, financing, marketing, leasing and property management expertise. The Operating Partnership's primary strategy for growth is to acquire, develop, own and manage high quality multifamily properties for income generation and long-term value appreciation.
The Company is the sole general partner and holds approximately 62% of the common and preferred units of limited partnership interest ("Units") in the Operating Partnership as of March 1, 1999. The other limited partners of the Operating Partnership (the "Minority Interest") primarily consist of the former limited and general partners of properties and the former owners of the property service businesses acquired by the Operating Partnership (see "History of the Company" below). The Operating Partnership and its subsidiaries own all of the properties, property interests, and business assets and conduct all operations on behalf of the Company and
the Operating Partnership. The Operating Partnership owns 100% of the nonvoting common stock, which represents 99% of the total economic interest, of three operating companies (collectively, the "Property Service Businesses") which provide property services to the properties owned by the Operating Partnership and to other multifamily, retail, and office properties. The three Property Service Businesses are: Smith Realty Company, which directly provides management, leasing, financing, development and insurance services and indirectly provides furnished corporate apartments through a wholly-owned subsidiary; Consolidated Engineering Services, Inc., which provides engineering and technical services; and Smith Management Construction, Inc., which provides construction and interior renovation services. As the sole general partner of the Operating Partnership, the Company has the exclusive power to manage and conduct the business of the Operating Partnership, subject to the consent of the holders of Units in connection with the sale of all or substantially all of the assets of the Operating Partnership. Some references made herein to the Company include the Operating Partnership and the Property Service Businesses, as the context requires.
As of March 1, 1999, the Operating Partnership, directly or through its subsidiaries, owned 50 operating multifamily apartment properties containing a total of 19,852 units (the "Multifamily Properties"), two retail centers containing approximately 436,000 square feet of retail space (the "Retail Properties"), and had four properties under construction containing approximately 2,100 units ("Development Properties"). All properties, excluding five in Chicago, Illinois and two in Boston, Massachusetts, are located in the Washington, D.C. metropolitan area (collectively, the "Properties").
The executive offices of the Operating Partnership are located at 2345 Crystal Drive, Crystal City, Arlington, Virginia 22202, and its telephone number is (703) 920-8500.
History of the Company
The Operating Partnership was formed to succeed to the property assets of 38 partnerships (the "Property Partnerships") and certain asset management and property service businesses of the Charles E. Smith Companies (the "Smith Companies"). On June 30, 1994, the Company consummated an initial public offering (the "Initial Public Offering") of 8,632,800 shares of its common stock, $.01 par value per share (the "Common Stock"), and a private placement of 416,667 shares of its Common Stock. The Company contributed the net proceeds of such offerings to the Operating Partnership in return for 9,049,467 Units of general and limited partnership interest therein. On that same date, (i) the Operating Partnership acquired, in exchange for 12,131,292 Units, 30 Properties (reflects the combination of three buildings into one for operational and statistical purposes), partial interests in two additional properties, all of the non-voting common stock of the Property Service Businesses (representing 99% of the economic interest), and notes of the Property Service Businesses in the aggregate amount of $44.5 million; (ii) the Operating Partnership, through its partnership subsidiaries, issued $352.4 million of fixed-rate indebtedness secured by certain of the Properties in private placements to institutional investors and assumed certain other indebtedness (the "Mortgage Loans"); (iii) the Operating Partnership applied the proceeds of the Mortgage Loans and the Company's contribution of offering proceeds to repay approximately $454 million of mortgage indebtedness,
$26.2 million in related party indebtedness and $11.1 million in notes payable to a bank, to pay $13.8 million in prepayment penalties related to the early extinguishment of debt, to pay $14.7 million in transfer taxes and other costs associated with the formation of the Company and the Operating Partnership, and to pay $18.5 million of mortgage recording taxes, origination fees and other expenses associated with the Mortgage Loans, and to supply $15.4 million of working capital; and (iv) the Operating Partnership established a $100 million line of credit to fund development activities and property acquisitions and for general corporate purposes (collectively, the "Formation Transactions").
Since the Formation Transactions and through March 1, 1999, the Operating Partnership developed one and acquired 24 operating Multifamily Properties totaling 9,351 apartment units and sold three properties totaling 1,334 units. In addition, the Operating Partnership had approximately 2,100 units under construction in four Development Properties as of March 1, 1999 (see "Recent Developments" below).
Business Strategy
The Operating Partnership seeks growth in funds from operations (a common measure of equity real estate investment trust performance, defined as net income [loss] computed in accordance with generally accepted accounting principles, excluding gains or losses from debt restructuring and other non- recurring items, plus depreciation and amortization of assets unique to the real estate industry) while preserving and enhancing property values by pursuing the following strategies: (i) maximizing cash flow from operations of the Properties by seeking to maintain high occupancy levels, obtain rent increases, manage tenant turnover efficiently, make strategic capital investments, expand the availability of furnished rental apartments, initiate new tenant fees and control operating expenses; (ii) acquiring additional multifamily properties for Common Stock, Units, or cash in situations where, in the judgment of management, the Operating Partnership's business strengths have the potential to increase property performance and value; (iii) developing new multifamily properties consistent with the predecessor Smith Companies' historical policies of constructing and maintaining high quality properties for long-term income and value enhancement; and (iv) actively promoting the comprehensive property services of the Property Service Businesses to unaffiliated property owners. In addition to its activities in the Washington, D.C. metropolitan area, the Operating Partnership also seeks to acquire additional properties or portfolios in Chicago, Boston, southeast Florida and other markets with characteristics similar to the Operating Partnership's current portfolio that offer opportunities for profitable investment and long-term growth.
Financing Strategy
To the extent that the Company's board of directors determines to seek additional capital for acquisitions or otherwise, the Company or the Operating Partnership may raise such capital through additional equity offerings, debt financing or retention of cash flow (subject to provisions of the Internal Revenue Code of 1986, as amended, requiring the distribution by a REIT of a certain percentage of taxable income and taking into account taxes that would be imposed on undistributed taxable income), or a combination of these methods.
Equity
During 1998 and through March 1, 1999, the Company and the Operating Partnership completed several equity transactions.
In January 1998, the Company sold 500 shares of Series C Cumulative Redeemable Preferred Stock ("Series C Preferred Shares"), $0.01 par value, to Cobalt Capital, L.L.C. The Company contributed the net proceeds to the Operating Partnership in exchange for 500 units of Series C Cumulative Redeemable Preferred Units ("Series C Preferred Units").
The Operating Partnership amended the Articles of Incorporation to designate and establish the rights and privileges of the Series C Preferred Unitholders which include certain voting, distribution and liquidation preferences over the common unitholders. The Series C Preferred Units have a liquidation preference of $100,000 per unit and an initial annual distribution of $7,910 per unit (7.91% of purchase price). If the securities receive an investment grade rating, the distribution will decrease to $7,660 per unit. Distributions are cumulative and are payable quarterly. The Operating Patrnership may redeem Series C Preferred Units after February 1, 2028, at the liquidation price plus accrued distributions.
In April 1998, the Company sold the remaining 978,581 shares of Series A Cumulative Convertible Redeemable Preferred Stock ("Series A Preferred Shares") to Security Capital Preferred Growth Inc. under the May 1997 agreement. The Company contributed the net proceeds to the Operating Partnership in exchange for 978,581 units of Series A Cumulative Convertible Redeemable Preferred Units ("Series A Preferred Units").
In July 1998, the Company completed the sale of 1,400,000 shares of common stock (par value of $0.01 per share) under its existing shelf registration statement. The net proceeds were contributed to the Operating Partnership in exchange for 1,400,000 units of common units.
During 1998, 502,038 shares of Series B Cumulative Convertible Redeemable Preferred Stock ("Series B Preferred Shares") were converted to common shares on a one-for-one basis. The Operating Partnership converted 502,038 units of Series B Cumulative Convertible Redeemable Preferred Units ("Series B Preferred Units") to common units on a one-for-one basis.
The Company currently has on file with the Securities and Exchange Commission an effective registration statement which allows the sale of up to $450,000,000 in debt or equity securities, of which approximately $312,000,000 remains available. As long as the Operating Partnership is in existence, the net proceeds of all equity capital raised by the Company will be contributed to the Operating Partnership in exchange for limited partnership interests in the Operating Partnership. The Company and the Operating Partnership also may issue securities senior to the Common Stock or Units, including additional preferred stock or debt securities (either of which may be convertible into Common Stock or Units or may be accompanied by warrants to purchase Common Stock or Units).
Debt
The Operating Partnership's policy, which is set by the Board of Directors of the Company, is to incur debt (including debt incurred under its lines of credit) only if upon such incurrence its ratio of debt to total market capitalization would be 60% or less. The Operating Partnership may reevaluate or modify this financing policy from time to time in light of economic conditions, relative costs of debt and equity capital, market values of properties, growth and acquisition opportunities and other factors. At December 31, 1998, the Operating Partnership's debt to total market capitalization ratio was 40.3%.
Property Management
The Operating Partnership and its Property Service Businesses are experienced in the management and leasing of multifamily and retail properties. The Operating Partnership believes that the management and leasing of its own portfolio has resulted in consistent income growth and reduced operating expenses. The Property Service Businesses have provided the Operating Partnership both with a source of cash flow and with economies of scale in conjunction with the management and leasing of its own Properties. These Property Service Businesses also allow the Operating Partnership and its subsidiaries to establish additional relationships with tenants that benefit the Properties.
Property Service Businesses
Multifamily Property Management Services. The residential property management business of Smith Realty Company ("SRC"), an operating subsidiary of the Operating Partnership, is a long-established, integrated business with extensive experience in leasing and managing multifamily properties. This subsidiary has been managing and leasing multifamily housing in the Washington, D.C. metropolitan area since 1946 and, as of March 1, 1999, manages 63 apartment properties of which 50 are owned by the Operating Partnership. It also assists in the development and acquisition of additional multifamily properties and carries out a periodic inspection program that addresses all aspects of the property and property management.
During 1998, Multifamily and Retail Property Management Services expanded the corporate apartment program as a result of the acquisition by Smith Realty Company of Noel Enterprises, Inc. ( d.b.a. "Presidential Villas"), a provider of furnished corporate apartments in Chicago, Illinois. A portion of the total purchase price of $8.5 million is contingent upon achievement by Presidential Villas of certain earnings targets over the next two years. The Operating Partnership lent to Smith Realty Company the initial payment of $6.75 million in exchange for a five year note.
Retail Property Management Services. The retail management and leasing business, also conducted through Smith Realty Company, approaches the management and leasing of its retail portfolio with an integrated program of regular direct communication with retail tenants,
proactive assistance with marketing, merchandising and monitoring store operations, and maintenance. A retail marketing staff works to promote the shopping centers as a whole and to work with individual tenants to ensure the effectiveness of store design, marketing, merchandising and sales efforts. The retail management and leasing group, in addition to providing complete property management and leasing services for the Operating Partnership's two Retail Properties totaling approximately 436,000 square feet, also provides such services for a fee to three retail properties owned by affiliated parties totaling approximately 293,000 square feet. Smith Realty Company also provides retail leasing and brokerage services for additional, unaffiliated third parties on a fee-for-service basis.
Financing Services. Historically, the Operating Partnership solicited, procured and arranged financing for a fee on behalf of commercial office properties, the majority of which are affiliated with Robert H. Smith and Robert P. Kogod, the Co-Chief Executives and Co-Chairmen of the Board of the Company and the owners of approximately 13% of the Shares and Units of the Company. During the fourth quarter of 1997, Financing Services personnel transferred to Charles E. Smith Commercial Realty L.P. ("CESCR"), a commercial office partnership affiliated with Messrs. Smith and Kogod. In 1998 most of the remaining commercial office properties were rolled up into CESCR. In connection with the formation of CESCR, the Operating Partnership entered into a 14-month agreement to continue to provide financing services for certain of the properties of CESCR through December 31, 1998. Management does not expect any significant future income from Financing Services.
Engineering and Technical Services. The engineering and technical services business is conducted through Consolidated Engineering Services, Inc., an operating subsidiary of the Operating Partnership, which manages, operates, maintains and repairs the "physical plant" of office, multifamily, and retail properties. Through its staff of on-site and off-site engineers, supervisors, technical specialists and maintenance personnel, this subsidiary provides various services, including on-site building systems operations and maintenance, engineering and technical consulting, automated environmental monitoring and controls, preventive maintenance, management of building environmental systems and repair and replacement of mechanical/electrical systems. This business serves the Properties and also provides facilities management services for both affiliated and unaffiliated third parties, including condominium, bank, university and government buildings. During 1998, services were provided with respect to approximately 46 million square feet of facilities.
Interior Construction and Renovation Services. The construction services business, conducted through Smith Management Construction, Inc., an operating subsidiary of the Operating Partnership, is a construction management and general contracting company that provides interior construction and renovation services to the Properties and various other affiliated and unaffiliated third party clients. This business focuses primarily on capital improvement projects and office and retail tenant space construction and alteration, and provides the expertise necessary to take a project from the initial planning and preconstruction stage through the completion of construction. In 1998, oversight was provided to approximately $80 million of construction activity.
Corporate Services. The corporate services businesses, conducted through Smith Realty Company, enable a central office to provide supporting services in the areas of insurance, legal advice, accounting, information systems, human resources, office administration and marketing to the Operating Partnership and its subsidiaries, as well as to other affiliated third parties, including CESCR. Services are provided at cost (including overhead) in accordance with cost and executive sharing agreements. In management's opinion, the allocation methods provide reasonable estimates of the costs that would have been incurred by the Operating Partnership had the services been provided by the Operating Partnership.
The accounting department is responsible for all accounting, auditing and controls, procedures and management information systems as they relate to the Operating Partnership and the Properties, and for certain other partnerships and corporate entities (including affiliates of Messrs. Smith and Kogod). The legal department provides real estate and corporate advice to management, performs legal services and in some cases coordinates representation by outside counsel. The marketing department develops and implements a variety of marketing programs for the Operating Partnership and its subsidiaries. The human resources department administers all personnel functions. The insurance subsidiary provides property and casualty insurance placement services for both corporate and individual property requirements.
Employees
As of March 1, 1999, the Operating Partnership and its subsidiaries had approximately 1,820 full-time and part-time employees, the latter primarily employed in on-site clerical positions. This total includes 680 employees who provide on-site property services and, in the Property Service Businesses, 690 persons in its engineering and technical services subsidiary, 120 persons in its interior construction and renovation subsidiary, and 330 persons in its residential and retail leasing and management, finance, and corporate services subsidiary.
Recent Developments
Acquisition Properties. During 1998, the Company, through the Operating Partnership, acquired five operating multifamily properties containing 1,942 apartment units, as further described below.
Tunlaw Park. In January 1998, this 120-unit mid-rise property in northwest Washington, D.C. was acquired for $0.8 million in cash and 123,818 Operating Partnership units valued at $4.4 million. The property was developed and managed by the Smith Companies and the Operating Partnership previously owned a 20% minority interest.
Tunlaw Gardens. In January 1998, this 167-unit, garden property in northwest Washington, D.C. was acquired for $6.9 million consisting of $2.5 million cash and 130,371 Operating Partnership units valued at $4.4 million. The property was previously managed by the Operating Partnership.
Parc Vista. In April 1998, this 299-unit, 16-story high-rise built in 1990 was acquired for approximately $39 million of cash funded by $4.3 million in proceeds from the sale of Oxford Manor with the balance drawn on the line of credit. During the fourth quarter of 1998, the property had an average economic occupancy of 98.4% and average monthly rental revenue per apartment unit of approximately $1,430.
McClurg Court. In May 1998, the Operating Partnership acquired a 1,075- unit multifamily property in Chicago, Illinois. The cost of approximately $70 million cash was funded from the line of credit and proceeds from the sale of Series A Preferred Shares totaling $26.5 million. Approximately 13% of the underlying land is included in the purchase, with the balance subject to ground leases expiring in 2067. The total capitalized cost of approximately $74 million reflects $4 million of planned initial capital improvements. During the fourth quarter of 1998, the property had an average economic occupancy of 93.4% and average monthly rental revenue per apartment unit of approximately $1,287.
Cronin's Landing. In July 1998, the Operating Partnership acquired a newly-constructed 281-unit mid-rise multifamily property in Boston, Massachusetts. The total capitalized cost of approximately $63.5 million was comprised of $27.0 million cash, $31.5 million in assumed debt, a fair value adjustment to debt of $2.0 million, and 92,793 Operating Partnership units valued at $3.0 million. During the fourth quarter of 1998, the property had an average economic occupancy of 89.5% and average monthly rental revenue per apartment unit of approximately $1,733.
In January 1999, the Company, through the Operating Partnership acquired three additional properties as further described below.
Buchanan House. This 442-unit property in Crystal City, Virginia was acquired for a total capitalized cost of $65.5 million which includes assumed debt of $7.4 million, initial capital improvement costs of $5.0 million and $0.4 million in acquisition related costs. Cash of $52.7 million was provided by $17.7 million in proceeds from the sale of Marbury with the balance drawn on the line of credit. In February 1999, the Operating Partnership repaid the assumed debt of $7.4 million through a draw on the line of credit. The Operating Partnership paid a prepayment penalty of $0.9 million which was recognized as an extraordinary loss.
Parkwest. This 139-unit property in Chicago, Illinois was acquired for a total capitalized cost of approximately $14.1 million, consisting of 201,950 Operating Partnership Units valued at $6.3 million, assumed debt of $6.0 million, a fair value adjustment to debt of $0.4 million, initial capital improvement costs of $0.8 million, and $0.6 million in other related costs.
Terrace. This 427-unit property in Chicago, Illinois was acquired for a total capitalized cost of approximately $26.1 million, consisting of 320,304 Operating Partnership Units valued at $10.0 million, assumed debt of $13.7 million, a fair value adjustment to debt of $0.7 million, initial capital improvement costs of $0.4 million, and $1.3 million in other related costs.
In March 1999, the Operating Partnership acquired the land beneath the Crystal Square property and the 5.1% net profits interest in the Crystal Plaza property. The purchase price of $10 million consisted of 32,258 Operating Partnership Units valued at $1 million and $9 million cash drawn upon the line of credit.
Disposition Properties. During 1998, the Operating Partnership sold two properties (Oxford Manor and Marbury Plaza) in southeast Washington, D.C. for a total of $22.0 million. The Operating Partnership recognized gains on the sales totaling $18.2 million.
In February 1999, the Operating Partnership sold The Manor, a 435-unit property located in suburban Maryland for $23.0 million. The Operating Partnership recognized a gain on the sale of $1.9 million.
Development Properties. During 1998, the Operating Partnership had four properties totaling 2,146 apartment units under construction.
Springfield Station. The Operating Partnership is nearing completion on the construction of its 631-unit mid-rise and garden apartment property in Springfield, Virginia. The project is located adjacent to a new Metrorail and commuter rail station and a regional shopping mall and offers convenient access to major transportation routes. Initial delivery was in May 1998, with final delivery projected in the second quarter of 1999.
Courthouse Place. The Operating Partnership is nearing completion on the construction of its 564-unit high-rise apartment property in Arlington, Virginia. The initial delivery of 103 units was in December 1998. Final delivery is expected in December 1999.
One Superior Place. During 1997, the Operating Partnership began construction on a 52-story, 809-unit high-rise apartment and commercial center in downtown Chicago. Initial occupancy is expected in the third quarter of 1999 with final delivery in mid-2000.
Park Connecticut. During 1998, the Operating Partnership began construction on a 142-unit high- rise apartment property in downtown Washington, D.C. The project is expected to deliver initial units in the fourth quarter of 1999 with stabilization in the second quarter of 2000.
As of March 1, 1999, the Operating Partnership owned $14.5 million of land for future development.
Prepurchase Agreements. During 1998, the Operating Partnership entered into four contracts to purchase to-be-constructed multifamily properties totaling approximately 1,200 apartment units ("Prepurchase Agreements"). The maximum aggregate purchase price totals $151 million with projected closing dates between July 2000 and May 2001. Further details of each project are reflected below.
Reston Landing. This 400-unit property is expected to be completed in the fourth quarter of 1999. The Operating Partnership expects to acquire the property in the third quarter of 2000 at a cost of $44 million, including earn- out payments.
New River Village. This 240-unit property is expected to be completed in the second quarter of 2000. The Operating Partnership expects to acquire the property in the fourth quarter of 2000 at a cost of $32 million, including earn- out payments.
Wilson Boulevard. This 220-unit property is expected to be completed in the second quarter of 2000. The Operating Partnership expects to acquire the property in the fourth quarter of 2000 at a cost of $28 million, including earn- out payments.
Pollard Gardens. This 383-unit property is expected to be completed in the fourth quarter of 2000. The Operating Partnership expects to acquire the property in the second quarter of 2001 at a cost of $47 million, including earn- out payments.
These acquisitions are contingent upon satisfactory completion of construction and attainment of final certificates of occupancy by the owners. At December 31, 1998, the Operating Partnership had posted three letters-of- credit totaling $7.7 million in accordance with three of the contracts to be drawn upon only if the Operating Partnership defaults on its contractual obligations to purchase the completed assets.
Financial Information
For information relating to the Operating Partnership's operating segments, please refer to Footnote 14 in the Financial Statements.
Executive Officers of the Company
The following is a biographical summary of the experience of the executive officers of the Company:
Robert H. Smith. Mr. Smith is Co-Chief Executive Officer and Co-Chairman of the Board of the Company and Co-Chairman of the Board of each of the Property Service
Businesses. Since 1962, Mr. Smith has been the President, Chief Executive Officer and a director of Charles E. Smith Construction, Inc. and its predecessor companies, where he oversees and directs all phases of development and construction of the Smith Companies' office, retail and residential real estate projects. He is also Co-Chairman of the Board and a director of Charles E. Smith Commercial Realty, Inc. which together with its subsidiaries and affiliates is engaged in the ownership, operation, and management of commercial office buildings. Mr. Smith joined the Smith Companies in 1950. Mr. Smith is 70 years old and the brother-in-law of Robert P. Kogod.
Robert P. Kogod. Mr. Kogod is Co-Chief Executive Officer and Co-Chairman of the Board of the Company and Co-Chairman of the Board of each of the Property Service Businesses. From 1964 to 1997, Mr. Kogod was the President, Chief Executive Officer and a director of Charles E. Smith Management, Inc., where he oversaw and directed all phases of the leasing and management of the Smith Companies' commercial real estate portfolio. He is now the Co-Chairman of the Board and a director of Charles E. Smith Commercial Realty, Inc., a successor to Charles E. Smith Management, Inc., and the owner, operator, and manager of commercial office buildings. He is also Secretary/Treasurer and a director of Charles E. Smith Construction, Inc., an affiliated company that specializes in the development and construction of office, retail and residential projects. Mr. Kogod joined the Smith Companies in 1959. Mr. Kogod is 67 years old and the brother-in-law of Robert H. Smith.
Ernest A. Gerardi, Jr. Mr. Gerardi is President, Chief Operating Officer and a Director of the Company, and is President, Chief Executive Officer, and a director of each of the Property Service Businesses. From 1985 until 1994, Mr. Gerardi was a member of the Executive Committee of Charles E. Smith Management, Inc., where he had overall responsibility for all day-to-day business operations and long-range planning. From 1985 through 1993, he served as Executive Vice President and Senior Executive Vice President of Charles E. Smith Management, Inc. Prior to joining the Smith Companies in 1985, Mr. Gerardi was with Arthur Andersen and Co., where he served as senior partner in charge of the firm's accounting and financial practice for over 250 professionals in Washington, D.C. During his 27 years with Arthur Andersen, he specialized in management consultation and strategic planning. He is also a member of the American Institute of Certified Public Accountants and the D.C. Institute of Certified Public Accountants. Mr. Gerardi is 63 years old.
Wesley D. Minami. Mr. Minami is Senior Vice President and Chief Financial Officer of the Company and Smith Realty Company, one of the Property Service Businesses, and is responsible for the Company's debt portfolio, corporate financial planning, local acquisitions, and its treasury, accounting, controls and information systems departments. Prior to joining the Company in 1997, Mr. Minami was the Chief Financial Officer for Ascent Entertainment Company where he was responsible for an $86 million initial public offering spin-off of Ascent, which had been a wholly-owned subsidiary of Comsat Corporation. Formerly, he had served as the Treasurer of Comsat Corporation. From 1985 to 1993, Mr. Minami held several positions, including Senior Vice President, Chief Financial Officer at Oxford Realty Services Corporation which developed and managed a portfolio of over 45,000 apartment units. Mr. Minami is 42 years old.
Robert D. Zimet. Mr. Zimet is Senior Vice President, General Counsel and Secretary of the Company and Smith Realty Company, one of the Property Service Businesses. He was the General Counsel and a Senior Vice President of Charles E. Smith Management, Inc., since joining the Smith Companies in 1983, and became a Group Senior Vice President in 1991. He continues in these capacities for Charles E. Smith Commercial Realty, Inc., a successor to Charles E. Smith Management, Inc., and the owner, operator, and manager of commercial office buildings. Mr. Zimet is responsible for the legal affairs of the Company and the Smith Companies, as well as supervision of the Human Resources and Office Services departments of Smith Realty Company. Mr. Zimet is 60 years old.
John T. Gray. Mr. Gray is the Senior Vice President-Residential Management of the Company and Smith Realty Company, one of the Property Service Businesses. Prior to joining the Smith Companies in November 1998, he was President for two years of Walter V. Clark Associates, a human resources consulting firm. Prior to that, Mr. Gray was with Summit Properties, Inc. for ten years. As President of the Management Company, he was an active participant in Summit's initial public offering and had total responsibility for the residential portfolio of over 20,000 apartment units. Mr. Gray is responsible for the overall management, leasing and operation of Smith's multifamily portfolio. Mr. Gray is 43 years old.
Matthew B. McCormick. Mr. McCormick is the Senior Vice President- Residential Marketing of the Company and Smith Realty Company, one of the Property Service Businesses. Prior to January 1998, Mr. McCormick was the Senior Vice President and Department Head of the Retail Group, where he was responsible for retail property management and leasing, as well as outside retail brokerage services. Prior to joining the Smith Companies in 1988, Mr. McCormick was a retail specialist with the Washington, D.C. office of Coldwell Banker. Mr. McCormick is 38 years old.
Alfred G. Neely. Mr. Neely is Senior Vice President-Development of the Company, responsible for the zoning, planning and development of all multifamily buildings. Since joining Charles E. Smith Construction, Inc., in 1989 as a Senior Vice President and now as a Group Senior Vice President, Mr. Neely has been responsible for zoning, planning and development. Prior to joining the Smith Companies, Mr. Neely was Executive Vice President and Managing General Partner of the New Height Group, a real estate and development company in Denver, Colorado. During his nine years with this company, Mr. Neely has been responsible for development and management of mixed-use properties. Mr. Neely is 53 years old.
Item 2.
Item 2. Properties
General
The 56 Properties as of March 1, 1999 consist of 50 Multifamily Properties, four Development Properties and two Retail Properties, as described in more detail below. Twenty-eight of the Multifamily Properties (reflecting the combination of three buildings into one for operational and statistical purposes) and both Retail Properties were acquired in connection with the Formation Transactions. In addition, the Operating Partnership held a minority limited partnership interest in one other multifamily property in the Washington metropolitan area, acquired in the Formation Transactions and increased in a subsequent transaction.
All of the Operating Partnership's properties are located in developed areas that include other residential and retail properties. The number of competitive residential properties in a particular area could have a material effect on the Operating Partnership's ability to lease apartment units and on the rents charged. In addition, other forms of single and multifamily residential properties provide housing alternatives to tenants and potential tenants of the
Operating Partnership's residential properties. The Operating Partnerships's retail properties face similar competition with other retail properties with respect to tenant leases. The Operating Partnership believes that the properties are well located in their markets and are well constructed and designed. In the opinion of management, the Operating Partnership's properties are adequately covered by insurance.
Multifamily Properties
The 48 operating Multifamily Properties owned as of December 31, 1998 contain a total of 19,279 garden, mid-rise, and high-rise apartment units, ranging in size from 115 to 1,075 apartment units. Two of the properties are located in Chicago, Illinois, two are located in Boston, Massachusetts with the balance in the Washington D.C. metropolitan area. All of the Multifamily Properties are 100% owned by the Operating Partnership and its subsidiaries. In 1998, the average monthly rental revenue per core unit was $970 and the average economic occupancy was 96.6% for the Core Residential Portfolio (Multifamily Properties owned as of December 31, 1996.) As of December 31, 1998, the average age of the operating Multifamily Properties, weighted by 1998 revenues, was 25 years.
Each of the Multifamily Properties is established in its local market and provides residents with numerous amenities and services, which may include 24- hour desk service, swimming pools, tennis courts, exercise rooms and/or saunas, day care centers, party or meeting rooms, tenant newsletters, and laundry facilities. Nearly all units are wired for cable television, and many units also offer additional features, such as washer/dryer, microwave, fireplace, and patio/balcony. The Operating Partnership maintains an ongoing program of regular maintenance and capital improvements and renovations, including roof replacement and exterior maintenance, kitchen and bath renovations, balcony repairs, and replacements of various building systems.
The following table sets forth certain additional information relating to the Multifamily Properties as of December 31, 1998 (in the following table, occupancy is based upon economic occupancy, which measures occupancy beginning on the rent commencement date; monthly revenue per unit is total property revenue divided by the number of apartment units; and certain data may be omitted for properties not operated by the Operating Partnership for the entire year):
CHARLES E. SMITH RESIDENTIAL REALTY L.P. Residential Portfolio Statistics for the Year Ended December 31, 1998
The following table sets forth the total number of apartment units in the Core Residential Portfolio, the economic occupancy, and the average monthly rental revenue per unit as of the end of 1998 and in each of the previous five years:
* Based on economic occupancy
Retail Properties
The Operating Partnership's two Retail Properties, Skyline Mall and Worldgate Centre, are enclosed malls containing a total of approximately 436,000 square feet of retail space. Until December 1997, both Retail Properties leased health club facilities to entities controlled by Messrs. Smith and Kogod pursuant to leases expiring on December 31, 2015. In December 1997, the health clubs were sold by Messrs. Smith and Kogod. In conjunction with that sale, the Operating Partnership agreed to restructure the two leases, including reduced base rent on the Worldgate lease, and extended terms on both leases for ten years, through 2025, in exchange for a $2.3 million cash payment.
Worldgate Centre. Worldgate Centre is a community retail center located in Herndon, Virginia, at the intersection of two major Northern Virginia traffic arteries, the Dulles Airport Access Highway and Centreville Road. Developed by the Smith Companies in 1991, it is a part of a mixed-use development which includes the 320-unit Multifamily Property which the Operating Partnership constructed in 1995. The town of Herndon is located in Fairfax County, one of the highest median income counties in the country. The Property contains the 108,670 square foot Worldgate Athletic Club, a Loew's Cinema, and a mix of approximately 40 other food service, fashion and specialty retailers and various business and general service tenants. Worldgate Centre has 230,926 square feet of leasable area and had an average occupancy rate of 99.5% during 1998. Approximately 16% of the leases, based on net rentable area, are scheduled to expire prior to the year 2003.
Skyline Mall. Skyline Mall is a two-level, enclosed community retail center located on Route 7 in Northern Virginia, at the intersection of Fairfax County, Arlington County, and the City of Alexandria, Virginia. Originally developed by the Smith Companies in 1977, it is part of a mixed-use community which also includes over two million square feet of office space and over 3,300 high-rise condominium and apartment units (including Skyline Towers, a 940-unit Multifamily Property owned by the Operating Partnership), all within walking distance. The Property has 204,914 square feet of leasable area and had an average occupancy rate of 97.2% in 1998. It contains the 79,920
square foot Skyline Racquet and Health Club, an AMC Cinema, and approximately 40 other stores, including restaurants, fashion and specialty retailers, and various business and general services. Approximately 12% of the leases, based on net rentable area, are scheduled to expire prior to the year 2003.
The following table sets forth certain additional information relating to the Retail Properties as of December 31, 1998:
Retail Properties
Property Markets
The Operating Partnership believes that economic trends and market conditions in the locations where the Operating Partnership currently operates - - - Chicago, Boston, Northern Virginia, and Washington, D.C. -- and locations where the Operating Partnership will operate -- southeast Florida -- indicate an excellent potential for continued high occupancy and rental rate growth in 1999 and beyond. These markets have all experienced strong employment growth in 1998, as shown in the table below, and are projected to be among the top U.S. markets in total employment growth over the period 1993 to 2005, with a projected average annual increase in each market of 45,000 jobs or more, according to projections prepared by the U.S. Dept. of Commerce, Bureau of Economic Analysis and released in mid-1996.
In the Washington D.C. metropolitan area, employment and population growth in recent years, and expected in future years, has been strongest in the Northern Virginia segment of the metropolitan area, which is the sector where the majority (68%) of the Operating Partnership's Properties are located. The growth in Northern Virginia is substantially attributable to continuing strong growth in the technology sector, particularly the Internet technology and telecommunications segments. The Operating Partnership believes that this trend will continue due to the concentration of technology firms in Northern Virginia and the growth outlook for the Internet technology and telecommunications industries. The outlook for the District of Columbia economy has improved significantly due to the return to positive employment growth late in 1998 after several years of federal government cutbacks and the election of a new mayor.
Demand for multifamily rental apartments continues to be strong in all of the Operating Partnership's markets as evidenced by high occupancy and rent growth rates. Surveys of comparable investment grade apartment properties are conducted in each these markets annually by The REIS Reports, Inc. The results of these surveys are shown in the following tables:
Apartment Occupancy and Rental Rate Growth for Smith Residential Markets
- ---------------------- Source: The REIS Reports, Inc., February, 1999, and Appraisal Research Corp., March 1999
The supply of new rental apartment properties in the more urbanized portions of the Operating Partnership's markets has been extremely limited in recent years, particularly in the more desirable submarkets where the Operating Partnership concentrates its focus. In the Washington metro area the supply of new multifamily properties has been increasing moderately over the past several years and is likely to continue to do so based on multifamily permits data compiled by the U.S. Census Bureau. These data show that the number of multifamily permits issued in the area were, 7,786 in 1996, 6,907 in 1997, and 8,935 in 1998, which includes both for-sale condominium and rental apartment properties. These levels remain well below the peak of over 13,000 in 1987. Most of the new supply of rental apartments is occurring in the outer suburban areas and does not compete directly with the Operating Partnership's properties, which are predominantly in the vicinity of and within Interstate 495, the Capital Beltway. Downtown Chicago has actually experienced a
net decrease in higher end rental apartments in recent years due to condo conversions, and the Company's 809-unit Superior Place property is currently the only new apartment property under construction in the downtown area.
Overall, the Operating Partnership believes that the anticipated increases in employment and population projected for the Boston, Chicago, Northern Virginia, Washington D.C. and southeast Florida markets, together with limited increases in supply of new rental units in locations competitive with the Operating Partnership's properties, will result in the Operating Partnership's multifamily rental submarkets remaining in a strong occupancy position for at least the next 18-24 months. As a result, the Operating Partnership believes that these conditions will provide an opportunity to improve apartment rent levels, and will also allow additional development and acquisition opportunities.
Mortgage Financing
As of December 31, 1998, 30 of the 54 Properties were subject to Mortgage Loans aggregating approximately $592,386,000. The Mortgage Loans are collateralized by first lien mortgages or deeds of trust on Properties organized into three pools ("Mortgage Pool Three," "FNMA" and "Prudential" as shown in the chart below) and ten individual loans (the "Individual Mortgages"). The Mortgage Loans bear interest at a weighted average interest rate of 7.1% at December 31, 1998. The Properties collateralizing each Mortgage Loan, the outstanding principal balances as of December 31, 1998, the applicable interest rates, and the maturity dates for each Mortgage Loan are set forth in the chart below.
(1) Operated as a single property, but divided for collateralization purposes. (2) Interest only. (3) Twenty-five year amortization begins June 30, 1999. (4) Thirty year amortization begins in August 2004. (5) Thirty year amortization begins in December 2008. (6) Thirty year amortization. (7) Twenty-five year amortization.
The loan secured by Mortgage Pool Three is interest only through June 30, 1999, at which time amortization begins using a 25-year amortization schedule with a balloon payment at maturity. In addition, this loan may not be prepaid until May 1, 1999, at which time it would be subject to a yield maintenance premium. The loan is cross-collateralized with the $83 million line of credit from
the same lender, as described below. Certain predecessor partners executed guarantees for $42 million of the mortgage loans secured by Mortgage Pool Three.
The Operating Partnership announced a standby credit facility in 1998 of up to $300 million with Fannie Mae which provides for non-recourse, long-term debt for up to fifteen years. The initial draw on this facility was $140 million at 6.75% for fifteen years. The bulk of the proceeds were used to retire Mortgage Pool Two of $125.2 million and the associated prepayment penalty of $9.5 million. Terms and rates of subsequent draws on this facility will be determined at the time of use. Closing of the facility is expected during the second quarter of 1999.
During 1998, the Operating Partnership obtained a $53 million, ten year secured loan from Prudential at a fixed coupon rate of 6.88%. The loan is secured by two Multifamily Properties. In conjunction with this loan, the Operating Partnership terminated a $20 million (notional value) treasury lock contract at a gain of $0.4 million which will be amortized over the term of the new loan.
The Individual Mortgages relate to debt secured by individual Multifamily Properties. The loans require monthly payments of interest and, in certain cases, principal. The loan secured by Patriot Village was refinanced in September 1996 and was obtained jointly with a ground lessor, with a portion of the principal allocated to each of them. The ground lessor has been allocated $9.9 million of the refinanced loan (of the total of $41.0 million outstanding as of December 31, 1998), for which the Operating Partnership is contingently liable. The loan requires the payment of interest only through August 2004, at which time amortization begins using a 30-year amortization schedule with a balloon payment due in August 2009. The Operating Partnership remits full debt service to the lender and reduces its ground rent payment by the corresponding amount of debt service relating to the principal assigned to the ground lessor.
Lines of Credit
The Operating Partnership terminated its $100 million line of credit in 1998 and entered into two new unsecured lines of credit -- a $100 million line and a $185 million line -- with PNC Bank, NationsBank, and U.S. Bank, as agents, which mature in March 2001. Draws upon the new lines are subject to certain unencumbered asset requirements and bear interest at a selected London Interbank Offer Rate (LIBOR) plus 75 to 120 basis points based on the leverage ratio of the Operating Partnership. As of December 31, 1998, the weighted average interest rate on outstanding draws was 6.22%. If the Operating Partnership receives an investment grade rating on its unsecured debt, the interest rate will decrease to 60 to 90 basis points over LIBOR based on the rating. The Operating Partnership pays a fee of 0.20% on the full amount available under the lines of credit. The line of credit agreements contain certain restrictive covenants, including maintenance of minimum equity value, debt to equity ratios and debt service coverage requirements. The maximum amounts outstanding during 1998 and 1997 were $251.5 million and $97.0 million, respectively.
The Operating Partnership also has an $83 million acquisition credit facility which allows for debt maturities up through July 2004. The line of credit provides for an interest rate that is fixed at the time of each borrowing at 150 basis points over 10-year Treasury Bills and is cross-collateralized
with Mortgage Pool Three. Debt outstanding of $30 million at December 31, 1998 bears interest at a weighted-average fixed rate of 7.27% and is collateralized by two Properties. The agreement contains certain restrictive covenants including a limit on debt to asset value and maintenance of debt service coverage ratios. In February 1999, the unused portion, or $53 million, of the line expired.
Construction Loans
In October 1997, the Operating Partnership obtained a variable rate, unsecured construction loan of $46.3 million to finance the construction of an acquired development property. The loan is recourse to the Operating Partnership, bears interest at LIBOR plus 130 basis point (6.85% at December 31, 1998), and matures in October 2000 with three six-month extension options based on certain conditions. The loan balance at December 31, 1998 was $31.6 million.
During 1998, the Operating Partnership obtained a $90 million variable rate, secured construction loan in connection with the development of One Superior Place in Chicago, Illinois, with interest currently at LIBOR plus 135 basis points (6.93% at December 31, 1998), payable monthly, due July 1, 2001. At the Operating Partnership's option, maturity may be extended for two one-year periods based on certain conditions. The loan is collateralized by the property and is recourse to the Operating Partnership. The loan balance at December 31, 1998 was $31.6 million.
Item 3.
Item 3. Legal Proceedings.
The Operating Partnership and/or the Property Service Businesses are presently subject to legal actions or claims for damages that arise in the ordinary course of business. In the opinion of management and counsel to the Operating Partnership, the ultimate outcome of such litigation will not have a material adverse effect on the Operating Partnership's financial position, results of operations or cash flows.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Part II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters.
There is no established public trading market for the Units of the Operating Partnership. The Company's shares of Common Stock have been listed on the New York Stock Exchange ("NYSE") since June 24, 1994, trading under the symbol "SRW." Prior to that date, the Company's shares of Common Stock were not publicly traded.
In December 1998, the Company adopted a Shareholder Rights Plan (the "Rights Plan") in which certain stock purchase rights were granted as a distribution to holders of common stock. The Rights Plan is designed to deter coercive or unfair takeover tactics. In implementing the Rights Plan, the Board of Directors declared a distribution of one Right for each share of the Company's outstanding common stock. Each Right initially entitles the holder thereof to purchase one one-thousandth of a share of preferred stock for $108. One one- thousandth of a share of preferred stock is intended to be approximately the economic equivalent of one share of common stock. The Rights expire on December 13, 2008. At the time of adoption of the Rights Plan, the Rights are neither exercisable nor traded separately from the common stock. The Rights are exercisable only if a person or group in the future becomes the beneficial owner of 15% or more of the common stock or announces a tender or exchange offer which would result in its ownership of 15% or more of the common stock. In connection with these Rights, the partnership agreement of the Operating Partnership was amended to provide for certain purchase rights by Unitholders in the event the Rights become exercisable and are, in fact, exercised. These purchase rights would allow Unitholders to purchase additonal Units at a price which would prevent their dilution by the issuance of additional Units to the Company upon the issuance of additional Common Stock under the Right Plan.
Unregistered Unit Issuances
In December 1998, 259,305 units of Series B Cumulative Convertible Redeemable Preferred Units were converted to common units on a one-for-one basis.
The following table sets forth the distributions made by the Operating Partnership with respect to each such period:
On March 1, 1999, the Operating Partnership had approximately 750 unitholders of record.
Item 6.
Item 6. Selected Financial Data.
The following table sets forth selected financial and operating information on a historical basis for the Operating Partnership and the Predecessor (as hereinafter defined in the Notes to Consolidated Financial Statements). The following information should be read in conjunction with all of the financial statements and notes thereto included elsewhere in this Form 10-K. The historical operating data for the years ended December 31, 1998, 1997, 1996, 1995 and 1994 have been derived from the financial statements of the Operating Partnership and the Predecessor audited by Arthur Andersen LLP, independent accountants.
Charles E. Smith Residential Realty L.P. and CES Group Selected Financial Data
FOOTNOTES TO SELECTED FINANCIAL DATA
1. Funds from Operations (FFO) is defined by the National Association of Real Estate Investment Trusts (NAREIT) as net income (loss) (computed in accordance with generally accepted accounting principles) excluding gains (or losses) from debt restructuring and other non-recurring items, plus depreciation/amortization of assets unique to the real estate industry. Depreciation/amortization of assets not unique to the industry, such as amortization of deferred financing costs and non-real estate assets, is not added back. FFO does not represent cash flow from operating activities in accordance with generally accepted accounting principles (which, unlike Funds from Operations, generally reflects all cash effects of transactions and other events in the determination of net income) and should not be considered an alternative to net income as an indication of the Operating Partnership's performance or to cash flow as a measure of liquidity or ability to make distributions. The Operating Partnership considers FFO a meaningful, additional measure of operating performance because it primarily excludes the assumption that the value of real estate assets diminishes predictably over time, and because industry analysts have accepted it as a performance measure. Comparison of the Operating Partnership presentation of FFO, using the NAREIT definition, to similarly titled measures for other REITs may not necessarily be meaningful due to possible differences in the application of the NAREIT definition used by such REITs.
2. Average occupancy is defined as gross potential rent for the core portfolio less vacancy allowance divided by gross potential rent for the period, expressed as a percentage.
3. Core portfolio represents properties owned or stabilized by the Operating Partnership as of December 31 two years prior to the current reporting date.
4. At the formation of the Operating Partnership, all rental properties were recorded at predecessor partners' historical cost basis which is significantly less than current value and, therefore, results in dilution of shareholders' book value. Shareholders' equity for each year presented is net of $(244,208) contribution by Predecessors of assets at historical cost, net of liabilities.
5. Represents mortgage loans, lines of credit and construction loans.
6. Limited partnership units of the Other Limited Partners may be redeemed at the unitholder's discretion. Consequently, the Other Limited Partners' Interest, measured at redemption value, is not included in partner's equity. Partner's equity has been adjusted to reflect the redemption value of Other Limited Partners' Interest. (See footnote 15 to the financial statements.)
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
BACKGROUND
The following discussion compares historical results of operations for the years ended December 31, 1998 and 1997 as well as the years ended December 31, 1997 and 1996. The discussion should be read in conjunction with the "Selected Financial Data," and the financial statements and notes thereto included elsewhere in this annual report.
THE OPERATING PARTNERSHIP
The Operating Partnership is engaged primarily in the acquisition, development, management and operation of multifamily properties. Together with its subsidiaries, the Operating Partnership is a fully integrated real estate organization with in-house acquisition, development, financing, marketing, leasing and property management expertise.
On June 30, 1994, Charles E. Smith Residential Realty, Inc. (the "Company") made a $201.4 million capital contribution to the Operating Partnership for a 1% general partnership interest and a 41.7% limited partnership interest in the Operating Partnership. The Company is the sole general partner of the Operating Partnership.
As of December 31, 1998, the Operating Partnership and its subsidiaries, owned 48 operating multifamily properties, four multifamily properties under construction and two retail shopping centers (collectively, the "Properties"). Three of the properties are located in Chicago, Illinois and two are located in Boston, Massachusetts; all other properties are located in the Washington, D.C. metropolitan area. The Operating Partnership also had conditional agreements to purchase four additional to-be-constructed multifamily properties.
The operating multifamily properties consist of the following:
The Operating Partnership's two free standing retail properties are enclosed malls containing a total of approximately 436,000 square feet of retail space.
Additionally, the Operating Partnership owned substantially all the equity in the following entities (collectively, the "Property Service Businesses") which provide a range of services to the owned Properties, essentially at cost (including overhead), and for a fee to other properties including commercial office partnerships which have Messrs. Smith and Kogod as the general partners ("Affiliates"):
. Multifamily and Retail Property Management Services provides property management and leasing services to multifamily and retail properties. In addition, this entity leases furnished corporate apartments through a subsidiary.
. Interior Construction and Renovation Services provides construction and project management services for capital improvement and tenant renovation projects of office, retail and residential properties.
. Engineering and Technical Services provides on-site building systems operations and maintenance; engineering and technical consulting; automated environmental monitoring and controls; repair and replacement of mechanical/electrical systems; and facilities management services.
. Financing Services provides negotiation, administration and execution of debt refinancing.
RENTAL PROPERTIES
Revenue, expenses and income from the multifamily and retail properties were as follows (in thousands):
/(1)/ "Core" represents properties owned as of December 31, 1996. /(2)/ Certain prior year balances have been reclassified to conform with current year presentation.
Occupancy Rates
Average occupancy of the Operating Partnership's core multifamily properties in the Washington, D.C. metropolitan area, where over 90% of the Operating Partnership's portfolio is located, is consistent with the area's market-wide average occupancy, based on annual surveys of approximately 80% of comparable investment grade apartment properties conducted by The REIS Reports, Inc. as follows:
It is important to note that market data from The REIS Reports, Inc. is determined on a physical occupancy basis, whereas the Operating Partnership's occupancy data is calculated on an economic basis. Physical occupancy data commonly yields a slightly higher percentage than economic occupancy because apartment units are considered physically rented when a rental applicant's deposit is received, a point in time generally prior to the actual rent commencement date used in computing economic occupancy.
Rental Revenue
Average revenue per apartment unit for the Operating Partnership's core multifamily properties increased approximately 4.8% in 1998 as compared with 1997, and 3.5% in 1997 (based on properties owned as of December 31, 1995) as compared with 1996.
A schedule of portfolio statistics follows:
CHARLES E. SMITH RESIDENTIAL REALTY L.P. - -------------------------------------------------------------------------------- Residential Portfolio Statistics for the Year Ended December 31, 1998
PROPERTY SERVICE BUSINESSES
Revenues, expenses and income from the Property Service Businesses were as follows (in thousands):
/(1)/Includes May 1998 purchase of Presidential Villas.
Multifamily and Retail Property Management Services provide management services to the Operating Partnership at cost plus 5% in accordance with the management agreement. In addition to 50 owned Properties (operating Multifamily and Retail), management services were also provided to 13 third-party owned multifamily properties of approximately 3,800 apartment units and to three third-party owned retail properties of approximately 293,000 square feet. Of the 16 third-party management agreements, eleven are with Affiliates and five are with unaffiliated property owners. The management agreements with Affiliates are for initial terms of three years or more while the management agreements with unaffiliated owners generally have one-year terms.
During 1998, Multifamily and Retail Property Management Services expanded the corporate apartment program as a result of the acquisition by Smith Realty Company of Noel Enterprises, Inc. ( d.b.a. "Presidential Villas"), a provider of furnished corporate apartments in Chicago, Illinois. A portion of the total purchase price of $8.5 million is contingent upon achievement by Presidential Villas of certain earnings targets over the next two years. The Operating Partnership lent to Smith Realty Company the initial payment of $6.75 million in exchange for a five year note.
Interior Construction and Renovation Services provided oversight to approximately $80 million of gross construction activity in 1998 compared to approximately $66 million in 1997 and $58 million in 1996. Services are provided to the Operating Partnership at cost and to Affiliates and third parties at cost plus a fee.
Engineering and Technical Services provides on-site building systems operations, maintenance and inspection to the Operating Partnership and Affiliates at cost and to third parties at cost plus a fee. Services were provided to approximately 46 million square feet of facilities in 1998, 30 million square feet in 1997, and 28 million square feet in 1996.
Financing Services performed $335 million of refinancings in 1998 compared to $489 million in 1997 and $242 million in 1996.
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998
Comparison to Year Ended December 31, 1997
Summary. Net income of the Operating Partnership increased 33.8%, or $17.7 million, from $52.2 million for the year ended December 31, 1997 to $69.9 million for the year ended December 31, 1998. Funds from Operations ("FFO") of the Operating Partnership increased $25.6 million, or 35.1% during the same period. The increase in both net income and FFO is due to increases in income from the rental properties, primarily the multifamily acquisition and development properties. These increases were partially offset by higher interest and other expenses related to acquisitions and development. The decrease in net income per share is attributable to the loss on an unused treasury lock and extraordinary losses associated with extinguishment of debt.
Rental Properties. Revenue from rental properties increased $50.1 million, or 25.0%, from $200.1 million for 1997 to $250.2 million for 1998. Expenses (including depreciation) from all rental operations increased $26.1 million, or 25.0%, from $104.5 million in 1997 to $130.6 million in 1998.
Core Portfolio. Revenue from the core portfolio increased $7.7 million, or 4.8% over the prior year due to rent increases in all submarkets, slightly improved occupancy and additional cable and telephone revenues. Average monthly revenue per core apartment unit increased from $925 in 1997 to $970 per month during 1998. Revenue growth by submarket over 1997 ranged from 3.7% in the Maryland properties to 6.5% in northwest Washington, D.C. Average economic occupancy for the portfolio increased to 96.6% in 1998 from 96.5% in 1997. The Operating Partnership also continues to expand and aggressively market its furnished apartment program. As a result, revenues from this program increased $0.4 million, or 19.4%, over the prior year period. Operating expenses on the core portfolio increased 1.2% over the prior year. This was primarily due to higher personnel costs (including outsourcing) and real estate tax expenses partially offset by utility savings and lower repair and maintenance costs both related to a mild winter.
Operating margins of the Operating Partnership's core portfolio of approximately 60% and 58% for the years ended December 31, 1998 and 1997, respectively, are generally lower in comparison to industry averages due primarily to the Operating Partnership's method of recovering utility costs. Apartment rents, for the most part, include utility services such as electricity and gas since the Operating Partnership bears utility costs. The majority of the Operating Partnership's competitors, however, require their tenants to pay utilities directly. Management estimates that the Operating Partnership's operating margins would be approximately 63% on a comparable basis.
Acquisition/Disposition Portfolio. The eleven acquisition properties and two disposition properties, contributed $41.2 million, or 82.3%, of the total rental revenue increase and $16.2 million, or 90.8%, of the increase in operating expenses resulting in a contribution to net operating income of $25.0 million. The balance of the portfolio reflects operations of the two properties sold during 1998 - Oxford Manor and Marbury Plaza.
Development Portfolio. Springfield Station delivered initial units in May 1998 and has a total of 280 units delivered as of December 31, 1998. Estimated completion and stabilization is expected in late 1999. Courthouse Place delivered 103 initial units in December 1998. Estimated completion and stabilization is expected by early 2000.
Retail Portfolio. Retail revenues decreased by $0.1 million, or 0.5%, during 1998 compared to the prior year due primarily to the restructuring of the Worldgate health club lease in 1997 partially offset by other rent increases. Average occupancy at the two retail properties increased from 97.4% in 1997 to 98.4% in 1998.
Property Service Businesses. Income from the Property Service Businesses increased $0.8 million, or 11.0%, during 1998 compared to 1997.
Income before depreciation for Multifamily and Retail Property Management Services increased $1.2 million, or 149.5%, primarily due to the acquisition in the second quarter of Presidential Villas.
Income before depreciation for Interior Construction and Renovation Services increased $0.8 million, or 71.1%, due to an increase of $1.7 million in net fee revenue offset by an increase of $0.9 million in related expenses. This was due primarily to an increase in the volume of projects completed on behalf of Affiliated commercial office property partnerships, partially offset by a loss incurred during the first quarter of 1998 associated with cost overruns and unrecovered owner
change orders on a large outside contract. The Operating Partnership is currently pursuing an arbitration claim which may result in a partial recovery of the loss.
Revenue from Engineering and Technical Services increased 34.4%, or $17.4 million, in 1998 with a corresponding increase of $17.1 million in expenses compared to 1997 due primarily to significant additional facilities management contracts obtained in 1997 and 1998. Income before depreciation for Engineering and Technical Services increased 8.8% to $4.2 million for 1998 compared to $3.8 million in 1997. The lower margin in 1998 reflects a decrease in higher margin HVAC repair and replacement projects.
Income before depreciation for Financing Services decreased $1.3 million, or 41.0%, due primarily to an unusually high level of fees in 1997 in connection with the roll-up of Affiliated commercial properties into a single partnership - Charles E. Smith Commercial Realty L.P. ("CESCR"). At the formation of CESCR, the Company entered into a 14-month agreement to continue providing financing services through December 31, 1998 for certain properties owned by CESCR. The 1998 fees were earned in connection with debt refinancings arranged for properties owned or managed by CESCR. Fees on properties owned by CESCR were earned in accordance with the Operating Partnership's agreement while fees on properties managed by CESCR were separately negotiated. Management does not expect any significant future income from Financing Services.
Other. Corporate general and administrative expenses increased by $2.4 million, or 36.3%, due primarily to additional personnel added in mid-1997 to expand the Operating Partnership's acquisition and development program and write-offs of capitalized costs on terminated acquisition and development projects. Interest expense increased by $1.9 million, or 4.2%, primarily due to financing of acquisition and development activities.
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997
Comparison to Year Ended December 31, 1996
Summary. Net income of the Operating Partnership increased 50.0%, or $17.4 million, from $34.8 million for the year ended December 31, 1996 to $52.2 million for the year ended December 31, 1997. Funds from Operations of the Operating Partnership increased $20.2 million, or 38.3%, during the same period. The increase in both net income and FFO is due to increases in income from the rental properties, primarily the multifamily acquisition and development properties. These increases were partially offset by higher interest and expenses related to acquisitions and development.
Rental Properties. Revenue from rental properties increased $36.1 million, or 22.0%, from $164.0 million for 1996 to $200.1 million for 1997. Expenses from rental properties (including depreciation) increased $15.3 million, or 17.2%, from $89.2 million in 1996 to $104.5 million in 1997.
1997 Core Portfolio. Revenue from the 1997 core portfolio (based on properties owned as of December 31, 1995) increased $5.2 million, or 3.5%, from $148.2 million in 1996 to $153.4 in 1997. Based on the 1998 core, revenue was $158.8 million for the year ended December 31, 1997. The difference of $5.4 million represents the transfer of three properties into core on January 1, 1998
and two properties out of core that were sold in 1998. Expenses increased $0.3 million, or 0.4%, over the prior year primarily due to expected increases in payroll and related costs, partially offset by savings from management restructuring and the outsourcing of janitorial services.
Average monthly revenue per apartment unit of the 1997 core portfolio increased 3.5% from $870 in 1996 to $901 per month during 1997. Average economic occupancy decreased slightly to 96.4% in 1997 from 96.9% in 1996. The decrease in occupancy was not unexpected given the aggressive efforts initiated by management to increase rents as well as the implementation during the third quarter of 1996 of several revenue-enhancing initiatives, including a premium for month-to-month leases and the charging of a non-refundable move-in fee in lieu of security deposits.
1997 Acquisition Portfolio. The 1997 acquisition portfolio, consisting of 4,038 apartment units contributed $30.4 million, or 84.2% of the rental revenue increase. This growth was primarily due to the fact that six of the nine properties, or 3,036 units, were acquired during 1997. The acquisition properties added $12.3 million in property operating expenses compared to the prior year.
Retail Portfolio. Retail revenues increased by $0.2 million, or 2.5%, during the year ended December 31, 1997 compared to the prior year due primarily to rent increases and improved vacancy at Skyline Mall. Average occupancy at Skyline Mall increased from 95.1% in 1996 to 97.2% in 1997.
In December 1997, Messrs. Smith and Kogod sold their health club facilities which lease retail space from the Operating Partnership. In conjunction with that sale, the Operating Partnership agreed to restructure the leases by reducing base rent on the Worldgate lease and extending the terms on both leases by ten years, through 2025, in exchange for a $2.3 million cash payment which is being amortized over the lives of the revised leases. The Operating Partnership used the funds to retire 65,000 Operating Partnership units.
Property Service Businesses. Income from the Property Service Businesses decreased $0.2 million, or 3.2%, during 1997 compared to 1996.
Income before depreciation for Multifamily and Retail Property Management Services decreased $1.5 million, or 65.6%, primarily due to a non-recurring fee of $0.6 million earned in 1996 in connection with the termination of a management agreement with a hotel owned by a related party. In addition, revenue decreased by an additional $0.9 million due to the February 1997 acquisition of two properties previously managed by the Operating Partnership.
Income before depreciation for Interior Construction and Renovation Services increased $0.1 million, or 8.9%, due to an increase of $1.0 million in net fee revenue offset by an increase of $0.9 million in related expenses.
Revenue from Engineering and Technical Services increased 20.0%, or $8.4 million, in 1997 with a corresponding increase of $8.2 million in expenses compared to 1996 due primarily to additional HVAC systems operations and preventative maintenance contracts obtained throughout 1997. Due to start-up costs on the new contracts, operating margins during 1997 were lower than 1996. Consequently, income before depreciation for Engineering and Technical Services increased a moderate 4.8% to $3.8 million for 1997 compared to $3.7 million in 1996.
Income before depreciation for Financing Services increased $1.2 million, or 60.2%, due primarily to fees earned on an unusually high level of refinancings performed during the fourth quarter of 1997. Such refinancings were related to the roll-up of Affiliated commercial properties into a single partnership. In conjunction with the roll-up, Financing Services personnel transferred to the new entity, Charles E. Smith Commercial Realty L.P.
Other. Corporate general and administrative expenses increased by $1.3 million, or 24.9%, due primarily to additional personnel added during the year to expand the Operating Partnership's acquisition and development program. Interest expense increased by $1.8 million, or 4.1%, primarily due to assumed debt on acquisitions of multifamily properties. Distributions in excess of earnings allocated to Minority Interest decreased $4.8 million. Such charges are no longer necessary as a result of the February 1997 stock offering and the related elimination of the Minority Interest deficit.
LIQUIDITY AND CAPITAL RESOURCES
Summary
Net cash flow provided by operating activities was $118.6 million for 1998 compared to $75.2 million for 1997. The increase of $43.4 million was primarily due to higher cash flow contributed by the acquisition portfolio as well as core revenue growth.
Net cash flow used by the Operating Partnership for investing activities increased $93.1 million in 1998, from $196.9 million in 1997 to $290.0 million in 1998 due primarily to the substantial increase in development volume during the year as well as increased capital expenditures.
Net cash flow provided by financing activities was $171.4 million in 1998 compared to $117.8 million in 1997. During 1998, the Operating Partnership raised approximately $120 million through sales of common and preferred equity. In addition, the Operating Partnership completed a number of debt financing transactions which resulted in net cash inflows of $122.4 million which is net of prepayment penalties and other related costs. In 1998, the Operating Partnership also paid distributions of $73.5 million, or $2.095 per unit representing three quarters of distributions at $0.52 per unit and one quarter at $0.535, a 3.0% increase.
Equity Activity
During 1997, the Company entered into an agreement with a private investor to sell 2.6 million shares of Series A Cumulative Convertible Redeemable Preferred Stock ("Series A Preferred Shares") for $71.5 million. In 1997, the Company issued 1.6 million shares of Series A Preferred Shares at $27.08 per share resulting in proceeds of $44.5 million, net of underwriting discounts and other expenses totaling $0.5 million. The net proceeds were contributed to the Operating Partnership in exchange for 1.6 million Series A Preferred Units. The Operating Partnership used the proceeds to repay on the line of credit. In April 1998, the Company issued the remaining 1.0 million shares of Series A Preferred Shares at $27.08 per share resulting in proceeds of $26.1 million, net of expenses of $0.4 million. The net proceeds were contributed to the Operating Partnership in
exchange for 1.0 million Series A Preferred Units. These units were also used to repay the line of credit.
In January 1998, the Company sold 500 shares of Series C Cumulative Redeemable Preferred Stock ("Series C Preferred Shares") for $48.6 million, net of offering costs of $1.4 million. The net proceeds were contributed to the Operating Partnership in exchange for 500 units of Series C Preferred Units. The Series C Preferred Shares have a liquidation preference of $100,000 per unit and an initial annual distribution rate of $7,910 per unit. If the securities receive an investment grade rating, the distribution rate will decrease by $250 per unit. The Operating Partnership used the proceeds to repay outstanding amounts under its lines of credit.
In July 1998, the Company completed the sale of 1.4 million shares of common stock (par value of $0.01 per share) under its existing shelf registration statement at a net purchase price of $32.625 per share. The net proceeds of approximately $45.4 million have been used to retire outstanding debt and for working capital needs.
During 1998, 0.5 million Series B Cumulative Convertible Redeemable Preferred Stock ("Series B Preferred Shares") were converted to common shares on a one- for- one basis. The Operating Partnership converted 0.5 million Series B Preferred Units to common units on a one-for-one basis.
During 1998, the Operating Partnership issued approximately 0.3 million Operating Partnership units valued at $11.8 million in connection with property acquisitions.
Funds from Operations
FFO is defined by the National Association of Real Estate Investment Trusts ("NAREIT") as net income (loss) (computed in accordance with generally accepted accounting principles) excluding gains (or losses) from debt restructuring, and other non-recurring items, plus depreciation/amortization of assets unique to the real estate industry. Depreciation/amortization of assets not unique to the industry, such as amortization of deferred financing costs and non-real estate assets, is not added back. FFO does not represent cash flow from operating activities in accordance with generally accepted accounting principles (which, unlike FFO, generally reflects all cash effects of transactions and other events in the determination of net income) and should not be considered an alternative to net income as an indication of the Operating Partnership's performance or to cash flow as a measure of liquidity or ability to make distributions. The Operating Partnership considers FFO a meaningful, additional measure of operating performance because it primarily excludes the assumption that the value of real estate assets diminishes predictably over time, and because industry analysts have accepted it as a performance measure. Comparison of the Operating Partnership's presentation of FFO, using the NAREIT definition, to similarly titled measures for other REITs may not necessarily be meaningful due to possible differences in the application of the NAREIT definition used by such REITs.
The Operating Partnership's FFO for the years ended December 31, 1998, 1997 and 1996 was as follows (in thousands):
Acquisitions/Dispositions
The Operating Partnership acquired the following operating properties during 1998 and 1997:
/(1)/ Purchase included approximately 13% of underlying land. Balance of land is subject to ground leases expiring in 2067.
During 1998, the Operating Partnership sold two properties (Oxford Manor and Marbury Plaza) in southeast Washington, D.C. for a total of $22.0 million. The sales were completed as tax-deferred I.R.C. Section 1031 exchanges. In the financial statements, the Operating Partnership recognized gains on the sales totaling $18.2 million.
In January 1999, the Operating Partnership completed the acquisition of three multifamily properties totaling 1,008 apartment units. The total capitalized cost of $105.7 million was comprised of approximately $55.0 million cash, initial capital improvement costs of $6.2 million, 0.5 million Operating Partnership units valued at approximately $16.3 million, assumed debt of $27.1 million and fair market value adjustments of $1.1 million.
In February, 1999, the Operating Partnership sold The Manor, a 435-unit multifamily property located in suburban Maryland for $23.0 million. The Operating Partnership recognized a gain on the sale of $1.9 million.
In March 1999, the Operating Partnership acquired the land beneath the Crystal Square property and the 5.1% net profits interest in the Crystal Plaza property. The purchase price of $10.0 million consisted of 32,258 Operating Partnership Units valued at $1.0 million and $9.0 million cash drawn upon the line of credit.
Development
The Operating Partnership's development pipeline as of December 31, 1998 consists of the following projects:
Commitments
As of December 31, 1998, the Operating Partnership had executed four contracts to purchase to-be-constructed multifamily properties as follows:
These contracts are contingent upon satisfactory completion of construction and attainment of final certificates of occupancy by the owners. At December 31, 1998, the Operating Partnership had posted three letters-of-credit totaling $7.7 million in accordance with three of the contracts to be drawn upon only in the event the Operating Partnership defaults on its contractual obligations to purchase the completed assets.
Numerous other acquisition and development projects are being pursued by the Operating Partnership. The Operating Partnership anticipates meeting the related funding requirements through draws on its lines of credit, long-term borrowings and public or private issuances of equity, including Operating Partnership unit exchanges.
Debt
As of December 31, 1998, the Operating Partnership had the following mortgage indebtedness and other borrowings carrying a weighted average interest rate of 6.97% and collateralized by 33 of the 54 Properties:
As of December 31, 1998, the Operating Partnership's Debt to Total Market Capitalization Ratio was 40.3% (based on 31.5 million common units, 3.4 million preferred units and 13.3 million partnership units outstanding at the Company's stock price of $32.125 and $50 million of perpetual preferred units) versus 35.0% at December 31, 1997. The Operating Partnership's Interest Coverage Ratios for the years ended December 31, 1998 and 1997 were 3.24:1 and 2.78:1, respectively.
Outstanding debt matures as follows (in thousands):
At December 31, 1998, the Operating Partnership had $306.1 million of unused borrowing capacity available. Amounts outstanding under lines of credit averaged $202.9 million and $80.1 million for the years ended December 31, 1998 and 1997, respectively.
The Operating Partnership anticipates meeting principal repayment requirements through long-term borrowings, public or private issuances of debt securities or public or private equity offerings.
During 1998, the Operating Partnership completed several debt financing transactions as follows:
. The Operating Partnership terminated its existing $100 million line of credit and entered into two new unsecured lines of credit - a $100 million line and a $185 million line - with PNC Bank, NationsBank, and U.S. Bank which mature in March 2001. The Operating Partnership repaid the balance outstanding under the $100
million line and recognized an extraordinary loss of $0.3 million related to the extinguishment of such debt.
. The Operating Partnership repaid $110.1 million outstanding on Mortgage Pool One by drawing on the new line of credit. The Operating Partnership recognized an extraordinary loss of $4.1 million related to the repayment. The Operating Partnership refinanced part of the draw through a $53 million, ten year secured loan with Prudential at a fixed coupon rate of 6.88%. The loan is secured by two of the multifamily properties. In conjunction with this loan, the Operating Partnership terminated a $20 million (notional value) treasury lock contract at a gain of $0.4 million which will be amortized over the term of the new loan.
. The Operating Partnership repaid mortgage loans totaling $9.2 million and recognized an extraordinary loss of $0.3 million due to extinguishment of debt.
. In connection with the development of One Superior Place in Chicago, Illinois, the Operating Partnership obtained a $90 million interest- only construction loan in July 1998 with interest currently at LIBOR plus 135 basis points, payable monthly, due July 1, 2001. The loan is collateralized by the property.
. The Operating Partnership assumed a $31.5 million mortgage loan in connection with the Cronin's Landing acquisition in July 1998. The loan has an effective fixed interest rate of 6.9% with principal amortized using a 25-year amortization schedule and a final payment due March 2009. A fair value adjustment of $2.0 million was recorded upon assumption of this loan.
. In September 1998, the Operating Partnership terminated a $50 million (notional value) treasury lock contract at a loss of $4.9 million. The treasury lock was put in place in the first quarter of 1998 to hedge interest rate risk associated with an anticipated 10-year, unsecured financing which ultimately did not occur. Therefore, this amount has been charged to current year earnings.
. The Operating Partnership announced a standby credit facility of up to $300 million with Fannie Mae which provides for non-recourse, long- term debt for up to fifteen years. The initial draw on this facility was $140 million at 6.75% for fifteen years. The bulk of the proceeds were used to retire Mortgage Pool Two of $125.2 million and the associated prepayment penalty of $9.7 million. Terms and rates of subsequent draws on this facility will be determined at the time of use. Closing of the facility is expected during the second quarter of 1999.
. The Operating Partnership obtained an interest-only $17.1 million mortgage on 2000 Commonwealth at a fixed interest rate of 6.3% due December 3, 2006.
. The Operating Partnership obtained a $38.3 million mortgage on Crystal House I & II at a fixed interest rate of 6.29%. The loan is interest only through December
2008, at which time principal amortization begins using a 30-year amortization schedule with a balloon payment due December 30, 2010.
. The Operating Partnership obtained a $49.3 million mortgage on Skyline Towers at a fixed interest rate of 6.45%. The loan is interest only through December 2008, at which time principal amortization begins using a 30-year amortization schedule with a balloon payment due December 10, 2010.
. In February 1999, the unused portion, or $53 million, of the Operating Partnership's $83 million line of credit with Northwestern Mutual expired.
. In February 1999, the Operating Partnership repaid $7.4 million of mortgage debt. The Operating Partnership paid a prepayment penalty of $0.9 million which was recognized as an extraordinary loss.
Other
Capital Improvements. In 1998, total capital improvements were $16.9 million, of which $12.4 million, or $871 per apartment unit, was for the core portfolio. Approximately 55% of the capital expenditures on the core portfolio are considered by management to generate net operating income ("NOI") by increasing revenue or decreasing expenses ("NOI generating"). The remaining capital expenditures on the core portfolio indirectly influence the Operating Partnership's ability to generate NOI ("non-NOI generating"). A summary of core capital expenditures during 1998 follows:
Income Taxes. The Company is taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended. As such, the Company generally is not subject to Federal corporate income taxes on net income it distributes currently to shareholders provided that the Company distributes at least 95% of its taxable income each year. REITs are subject to certain organizational requirements and asset and income tests in order to
maintain their REIT status. The Property Service Businesses are taxable corporations, and thus, pay Federal and state income taxes on their net income. Such taxes amounted to $ 0.6 million, $0.4 million and $0.4 million for 1998, 1997 and 1996.
Effect of Inflation. Substantially all of the leases at the Multifamily Properties are for a term of one year or less, which enables the Operating Partnership to seek increased rents upon renewal or reletting of apartments. Retail tenant leases provide for pass-through of common area maintenance, real estate taxes and other operating costs to tenants, which reduces the impact of inflation.
Year 2000. In 1997, the Operating Partnership began a comprehensive review of its year 2000 compliance issues utilizing an overlapping, three-phased approach. Phase I involves assessments of building infrastructure and internal computer systems including both hardware and software to identify possible compliance failures. Phase II involves vendor compliance and actual testing of hardware and software applications including significant electronic interfaces. Phase III involves identifying remaining company-wide risks and development of contingency plans. The Operating Partnership expects to complete Phases I and II of its year 2000 review in mid-1999. Phase III is expected to run from March 1999 through December 1999. Based on the review plan as well as the expected success of remediation efforts currently underway, management believes the Operating Partnership has no material risks related to the ability of its hardware and software to recognize the year 2000 and beyond as valid dates.
The Operating Partnership's primary financial and operational software programs are purchased from outside vendors who have already resolved year 2000 issues. The Operating Partnership has received letters from these vendors indicating that their software is year 2000 compliant. The Operating Partnership is in the process of replacing one computer system, however, which is not currently year 2000 compliant at an estimated cost of approximately $1.6 million. The new system was implemented in January 1999 and is expected to be fully operational in early 1999. The related cost will be depreciated over its estimated useful life.
As part of Phase II, the Operating Partnership has initiated steps to identify and contact key vendors whose inability to provide service in the year 2000 could have a material adverse effect on the Operating Partnership's business operations. With the exception of utility services, the Operating Partnership believes that there are no other critical suppliers whose inability to provide service would materially affect business operations. This is due primarily to the physical nature of the Operating Partnership's product as well as the availability of multiple suppliers of property services. The Operating Partnership does not have a contingency plan to address the possibility that utility services may not be available. However, management believes that this is a very unlikely scenario. Readers are cautioned that these conclusions involve numerous subjective assumptions and there can be no assurances that management has adequately identified or addressed all possible contingencies.
Excluding the replacement system, the Operating Partnership's year 2000 compliance efforts have been primarily conducted with internal staff. Accordingly, the costs have been immaterial and are expensed as incurred.
Item 7a.
Item 7a. Quantitative and Qualitative Disclosures of Market Risk.
None.
Item 8.
Item 8. Financial Statements and Supplementary Data.
See Index to Consolidated and Combined Financial Statements on Page of this Form 10-K.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Part III
Item 10.
Item 10. Directors and Executive Officers of the Registrant.
The information required by this item with respect to directors is hereby incorporated by reference to the material appearing under the caption "Election of Directors" in the Company's definitive proxy statement for the annual meeting of shareholders to be held in 1999 (the "Proxy Statement"). Information required by this item with respect to executive officers is provided in Item 1 of this report. See "Executive Officers of the Company."
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's officers and directors, and persons who own more than ten percent of a registered class of the Company's equity securities, to file reports of ownership and changes in ownership of such securities with the Securities and Exchange Commission and the NYSE. To the best of the Company's knowledge, all required reports were timely filed during and with respect to the fiscal year ended December 31, 1998, except for the following reports which were filed late: Ernest A. Gerardi, Jr. (one report, one transaction); John T. Gray (Form 3); John W. Guinee (amendment to Form 3); Steven E. Gulley (Form 3 and an amendment to Form 3); Charles R. Hagen (one report, four transactions); Matthew B. McCormick (one report, one transaction); Alfred G. Neely (two reports, three transactions); Roger L. Weeks (one report, one transaction); Robert D. Zimet (one transaction, one report).
Item 11.
Item 11. Executive Compensation.
The information required by this item is hereby incorporated by reference to the material appearing under the caption "Executive Compensation" in the Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by this item is hereby incorporated by reference to the material appearing under the caption "Voting Securities and Principal Holders Thereof" in the Proxy Statement.
Item 13.
Item 13. Certain Relationships and Related Transactions.
The information required by this item is hereby incorporated by reference to the material appearing under the caption "Certain Relationships and Related Transactions" in the Proxy Statement.
Part IV
Item 14.
Item 14. Exhibits, Financial Schedules, and Reports on Form 8-K.
14(a)(1) Financial Statements
Reference is made to the Index to Financial Statements and Schedule on Page of this Form 10-K.
14(a)(2) Financial Statement Schedules
Reference is made to the Index to Financial Statements and Schedule on Page of this Form 10-K.
All other schedules have been omitted because the required information of such other schedules is not present in amounts sufficient to require submission of the schedule or because the required information is included in the consolidated financial statements.
14(a)(3) Exhibits
2.1 Third Party Management and Leasing, Hotel Asset Management and Corporate Services Business Transfer Agreement by and between Charles E. Smith Residential Realty, Inc. and Smith Property Management, Inc. (Incorporated by reference to Exhibit No. 2.1 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
2.2 REIT Properties Management and Leasing Business Transfer Agreement by and between Charles E. Smith Management, Inc. and Charles E. Smith Residential Realty L.P. (Incorporated by reference to Exhibit No. 2.2 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
2.3 Assignment by Robert H. Smith, Clarice R. Smith, Robert P. Kogod and Arlene R. Kogod to Charles E. Smith Management, Inc. of 99% of all Partnership Interests of Residential Associates Limited Partnership (Incorporated by reference to Exhibit No. 2.3 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
2.4 Assignment and Assumption Agreement by Residential Associates Limited Partnership and Charles E. Smith Residential Realty L.P. (Incorporated by reference to Exhibit No. 2.4 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
2.5 Debt Assumption Agreement and Accord and Satisfaction of Debt by Charles E. Smith Management, Inc. and Charles E. Smith Residential Realty L.P. (Incorporated by reference to Exhibit No. 2.5 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
2.6 Debt Contribution Agreement between Charles E. Smith Management, Inc. and Charles E. Smith Residential Realty L.P. (the "Operating Partnership") (Incorporated by reference to Exhibit No. 2.6 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
3.1 Amended and Restated Articles of Incorporation of Charles E. Smith Residential Realty, Inc. (the "Company") (Incorporated by reference to Exhibit No. 3.1 of the Company's Registration Statement on Form S-11, No. 33-75288)
3.2 Articles of Amendment to Articles of Amendment and Restatement of Articles of Incorporation of Charles E. Smith Residential Realty, Inc.
3.3 Amended and Restated Bylaws of the Company (Incorporated by reference to Exhibit 3.2 in the Company's Registration Statement on Form S-3 (File No. 33-93986)
3.4 Articles Supplementary to Amended and Restated Articles of Incorporation of the Company (Incorporated by reference to Exhibit No. 3.1 of Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1997)
3.5 Articles Supplementary of the Company for Classifying and Designating Series B Cumulative Convertible Redeemable Preferred Stock (Incorporated by reference to Exhibit No. 4.1 of the Operating Partnership's Report on Form 8-K dated October 3, 1997 and filed November 10, 1997)
3.6 Certificate of Correction relating to Articles Supplementary for Series B Cumulative Convertible Redeemable Preferred Stock (Incorporated by reference to Exhibit No. 4.2 of the Operating Partnership's Report on Form 8-K dated October 3, 1997 and filed November 10, 1997)
3.7 Articles Supplementary for Series C Cumulative Redeemable Preferred Stock (Incorporated by reference to Exhibit No. 3.5 in the Company's Registration Statement on Form S-3, File No. 333-17053)
3.8 Articles Supplementary of the Company for Classifying and Designating a Series of Preferred Stock as Series D Junior Participating Preferred Stock and Fixing Distribution and Other Preferences and Rights of Such Series
4.1 First Amended and Restated Agreement of Limited Partnership of the Operating Partnership, as amended (Incorporated by reference to Exhibit No. 4.1 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
4.2 Certificate of Limited Partnership of the Operating Partnership (Incorporated by reference to Exhibit No. 4.2 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
4.3 Ninth Amendment to Amended and Restated Agreement of Limited Partnership of the Operating Partnership (Incorporated by reference to Exhibit No. 4.1 of the Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1997)
4.4 Tenth Amendment to Amended and Restated Agreement of Limited Partnership of the Operating Partnership (Incorporated by reference to Exhibit No. 4.4 of the Operating Partnership's Form 10-K for the year ended December 31, 1997)
4.5 Fifteenth Amendment to First Amended and Restated Agreement of Limited Partnership of the Operating Partnership (Incorporated by reference to Exhibit 99.1 of the Operating Partnership's Quarterly Report on Form 10- Q for the Quarter Ended March 31, 1998)
4.6 Seventeenth Amendment to First Amended and Restated Agreement of Limited Partnership of the Operating Partnership
10.1 Noncompetition Agreement by and among the Company, the Operating Partnership and Robert P. Kogod and Robert H. Smith (Incorporated by reference to Exhibit No. 10.1 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
10.2 Registration Rights and Lock-up Agreement (Incorporated by reference to Exhibit No. 10.2 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
10.3 Pledge Agreement (Incorporated by reference to Exhibit No. 10.3 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
10.4 First Amended and Restated 1994 Employee Stock and Unit Option Plan (Incorporated by reference to Exhibit No. 10.4 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
10.5 First Amended and Restated 1994 Employee Restricted Stock and Restricted Unit Plan (Incorporated by reference to Exhibit No. 10.5 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
10.6 Non-Employee Directors Stock Option Plan (Incorporated by reference to Exhibit No. 10.6 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
10.7 Subscription Agreement (Incorporated by reference to Exhibit No. 10.7 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
10.8 Voting Stock Partnership Agreement for Smith Property Management Partnership (Incorporated by reference to Exhibit No. 10.8 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
10.9 Voting Stock Partnership Agreement for Smith Management Construction Partnership (Incorporated by reference to Exhibit No. 10.9 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
10.10 Voting Stock Partnership Agreement for Consolidated Engineering Services Partnership (Incorporated by reference to Exhibit No. 10.10 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
10.11 Amended and Restated Articles of Incorporation of Smith Realty Company (Incorporated by reference to Exhibit No. 10.11 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
10.12 By-Laws of Smith Property Management, Inc. (Incorporated by reference to Exhibit No. 10.12 of the Company's Registration Statement on Form S-11, No. 33-75288)
10.13 Articles of Incorporation of Smith Management Construction, Inc. (Incorporated by reference to Exhibit No. 10.13 of the Company's Registration Statement on Form S-11, No. 33-75288)
10.14 By-Laws of Smith Management Construction, Inc. (Incorporated by reference to Exhibit No. 10.14 of the Company's Registration Statement on Form S-11, No. 33-75288)
10.15 Articles of Incorporation of Consolidated Engineering Services, Inc. (Incorporated by reference to Exhibit No. 10.15 of the Company's Registration Statement on Form S-11, No. 33-75288)
10.16 By-Laws of Consolidated Engineering Services, Inc. (Incorporated by reference to Exhibit No. 10.16 of the Company's Registration Statement on Form S-11, No. 33-75288)
10.17 Certificate of Incorporation of Smith One, Inc. (Incorporated by reference to Exhibit No. 10.17 of the Company's Registration Statement on Form S-11, No. 33-75288)
10.18 By-Laws of Smith One, Inc. (Incorporated by reference to Exhibit No. 10.18 of the Company's Registration Statement on Form S-11, No. 33-75288)
10.19 Agreement of Limited Partnership of Smith Property Holdings One L.P. (Incorporated by reference to Exhibit No. 10.19 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
10.20 Agreement of Limited Partnership of Smith Property Holdings One (D.C.) L.P. (Incorporated by reference to Exhibit No. 10.20 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
10.21 Certificate of Incorporation of Smith Two, Inc. (Incorporated by reference to Exhibit No. 10.21 of the Company's Registration Statement on Form S-11, No. 33-75288)
10.22 By-Laws of Smith Two, Inc. (Incorporated by reference to Exhibit No. 10.22 of the Company's Registration Statement on Form S-11, No. 33-75288)
10.23 Agreement of Limited Partnership of Smith Property Holdings Two L.P.(Incorporated by reference to Exhibit No. 10.23 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
10.24 Agreement of Limited Partnership of Smith Property Holdings Two (D.C.) L.P. (Incorporated by reference to Exhibit No. 10.24 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
10.25 Certificate of Incorporation of Smith Three, Inc. (Incorporated by reference to Exhibit No. 10.25 of the Company's Registration Statement on Form S-11, No. 33-75288)
10.26 By-Laws of Smith Three, Inc. (Incorporated by reference to Exhibit No. 10.26 of the Company's Registration Statement on Form S-11, No. 33-75288)
10.27 Agreement of limited Partnership of Smith Property Holdings Three L.P. (Incorporated by reference to Exhibit No. 10.27 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
10.28 Agreement of Limited Partnership of Smith Property Holdings Three (D.C.) L.P.(Incorporated by reference to Exhibit No. 10.28 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
10.29 Certificate of Incorporation of Smith Four, Inc. (Incorporated by reference to Exhibit No. 10.29 of the Company's Registration Statement on Form S-11, No. 33-75288)
10.30 By-Laws of Smith Four, Inc. (Incorporated by reference to Exhibit No. 10.30 of the Company's Registration Statement on Form S-11, No. 33-75288)
10.31 Agreement of Limited Partnership of Smith Property Holding Four L.P. (Incorporated by reference to Exhibit No. 10.31 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
10.32 Amended and Restated Certificate of Incorporation of Smith Five, Inc. (Incorporated by reference to Exhibit No. 10.32 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
10.33 By-Laws of Smith Five, Inc. (Incorporated by reference to Exhibit No. 10.33 of the Company's Registration Statement on Form S-11, No. 33-75288)
10.34 Agreement of Limited Partnership of Smith Property Holdings Five (D.C.) L.P. (Incorporated by reference to Exhibit No. 10.34 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
10.35 License Agreement between Charles E. Smith Management, Inc. and the Company (Incorporated by reference to Exhibit No. 10.35 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
10.36 License Agreement between Charles E. Smith Management, Inc. and the Operating Partnership (Incorporated by reference to Exhibit No. 10.36 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
10.37 Agreement of Limited Partnership of Smith Property Holdings Five L.P. (Incorporated by reference to Exhibit No. 10.0 of the Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended September 30, 1994)
10.38 Certificate of Limited Partnership of Smith Property Holdings Five L.P. (Incorporated by reference to Exhibit No. 10.38 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
10.39 Deed of Trust and Security Agreement between Smith Property Holdings Three L.P. ("Smith Three") and The Northwestern Mutual Life Insurance Company ("Northwestern") (Incorporated by reference to Exhibit No. 10.2 of the Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1994)
10.40 Guarantee of Recourse Obligations by Smith Three and the Operating Partnership (Incorporated by reference to Exhibit No. 10.3 of the Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1994)
10.41 Absolute Assignment of Leases and Rents between Smith Three and Northwestern (Incorporated by reference to Exhibit No. 10.4 of the Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1994)
10.42 Promissory Note of Smith Three to Northwestern (Incorporated by reference to Exhibit No. 10.5 of the Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1994)
10.43 Purchase Money Deed of Trust and Security Agreement between Smith Property Holdings Three (D.C.) L.P. ("Smith Three D.C.") and Northwestern (Incorporated by reference to Exhibit No. 10.6 of the Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1994)
10.44 Guarantee of Recourse Obligations by Smith Three D.C. and the Operating Partnership (Incorporated by reference to Exhibit No. 10.7 of the Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1994)
10.45 Absolute Assignment of Leases and Rents between Smith Three D.C. and Northwestern (Incorporated by reference to Exhibit No. 10.8 of the Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1994)
10.46 Purchase Money Promissory Note of Smith Three D.C. to Northwestern (Incorporated by reference to Exhibit No. 10.9 of the Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1994)
10.47 Supplemental Loan Agreement by and among Smith Property Holdings Two L.P. ("Smith Two"), Smith Property Holdings Two (D.C.) L.P. ("Smith Two D.C.") and Green Park Financial Limited Partnership ("Green Park")
10.48 Supplemental Loan Agreement by and among Smith Property Holdings One L.P. ("Smith One D.C."), Smith Property Holdings One (D.C.) L.P. ("Smith One D.C.") and GMAC (Incorporated by reference to Exhibit No. 10.13 of the Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1994)
10.49 Multifamily Note of Smith One to GMAC (Incorporated by reference to Exhibit No. 10.14 of the Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1994)
10.50 Multifamily Note of Smith One D.C. to GMAC (Incorporated by reference to Exhibit No. 10.15 of the Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1994)
10.51 Absolute Assignment of Leases and Rents by Smith One D.C. to GMAC (Incorporated by reference to Exhibit No. 10.16 of the Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1994)
10.52 Property Management Agreement by and between Smith One and the Operating Partnership (Incorporated by reference to Exhibit No. 10.17 of the Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1994)
10.53 Multifamily Deed of Trust, Assignment of Rents and Security Agreement between Smith One D.C. and GMAC (Incorporated by reference to Exhibit No. 10.18 of the Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1994)
10.54 Commercial Leasing and Property Management Agreement between Smith Three and the Operating Partnership (Incorporated by reference to Exhibit No. 10.19 of the Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1994)
10.55 Agreement of Limited Partnership of Smith Employment Services L.P. (Incorporated by reference to Exhibit No. 10.58 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
10.56 Certificate of Limited Partnership of Smith Employment Services L.P. (Incorporated by reference to Exhibit No. 10.59 of the Operating Partnership's Form 10-K for the year ended December 31, 1994)
10.57 Second Restated and Amended Agreement of Limited Partnership of First Herndon Associated Limited Partnership (Incorporated by reference to Exhibit No. 10.1 of the Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1995)
10.58 Second Amendment to the Certificate of Limited Partnership of First Herndon Associates Limited Partnership (Incorporated by reference to Exhibit No. 10.2 of the Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1995)
10.59 Certificate of Incorporation of Smith Six, Inc. (Incorporated by reference to Exhibit No. 10.1 of the Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended March 31, 1995)
10.60 By-Laws of Smith Six, Inc. (Incorporated by reference to Exhibit No. 10.2 of the Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended March 31, 1995)
10.61 Agreement of Limited Partnership of Smith Property Holdings Six L.P. (Incorporated by reference to Exhibit No. 10.3 of the Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended March 31, 1995)
10.62 Agreement of Limited Partnership of Smith Property Holdings Six (D.C.) L.P. (Incorporated by reference to Exhibit No. 10.4 of the Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended March 31, 1995)
10.63 Certificate of Incorporation of Smith Seven, Inc. (Incorporated by reference to Exhibit No. 10.66 of the Operating Partnership's Form 10-K for the year ended December 31, 1995)
10.64 By-Laws of Smith Seven, Inc. (Incorporated by reference to Exhibit No. 10.67 of the Operating Partnership's Form 10-K for the year ended December 31, 1995)
10.65 Agreement of Limited Partnership of Smith Property Holdings Seven L.P. (Incorporated by reference to Exhibit No. 10.68 of the Operating Partnership's Form 10-K for the year ended December 31, 1995)
10.66 Commitment for Mortgage Loan to the Operating Partnership from Northwestern Mutual Life Insurance Company (Incorporated by reference to Exhibit No. 10.69 of the Operating Partnership's Form 10-K for the year ended December 31, 1995)
10.67 Third Amended and Restated Credit Agreement by and between the Operating Partnership and PNC Bank, National Association, et. al. (Incorporated by reference to Exhibit No. 10.71 of the Operating Partnership's Form 10-K for the year ended December 31, 1997)
10.68 First Amendment to Third Amended and Restated Credit Agreement between the Operating Partnership and PNC Bank, National Association, et. al. (Incorporated by reference to Exhibit 99.1 of the Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1998)
10.69 Second Amendment to Third Amended and Restated Credit Agreement between the Operating Partnership and PNC Bank, National Association, et. al. (Incorporated by reference to Exhibit 99.2 of the Operating Partnership's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1998)
10.70 First Amendment to First Amended and Restated Agreement of 1994 Employee Stock and Unit Option Plan of Charles E. Smith Residential Realty, Inc. (Incorporated by reference to Exhibit 4.9 in the Operating Partnership's Registration Statement on Form S-8, File No. 333-67421)
10.71 Second Amendment to First Amended and Restated Agreement of 1994 Employee Stock and Unit Option Plan of Charles E. Smith Residential Realty, Inc.
10.72 Rights Agreement between Charles E. Smith Residential Realty, Inc. and First Union National Bank, as Rights Agent
21 Subsidiaries of the Registrant
23.1 Consent of Arthur Andersen LLP
27 Financial Data Schedule
___________________________________
14(b) Reports on Form 8-K
A report on Form 8-K was filed on May 13, 1998 providing information on a Property acquired by the Operating Partnership during the second quarter of 1998, including certain unaudited proforma balance sheets and statements of operations of the Operating Partnership reflecting the acquisition and statements of revenue and certain expenses for the McClurg Court Property for the year ended December 31, 1997, and applicable subsequent periods.
A report on Form 8-K was filed on July 15, 1998 providing information on a Property (Cronin's Landing) acquired by the Operating Partnership during the third quarter of 1998.
A report on Form 8-K was filed on December 8, 1998 providing information on the Rights Plan.
14(c) Exhibits
The list of Exhibits filed with this report is set forth in response to Item 14(a)(3). The required exhibit index has been filed with the exhibits.
14(d) Financial Statements
See Index to Financial Statements and Schedules on Page of this Form 10-K.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 26th day of March, 1999.
CHARLES E. SMITH RESIDENTIAL REALTY, L.P.
By Charles E. Smith Residential Realty, Inc., it's General Partner
By /s/Ernest A. Gerardi, Jr. ------------------------------------- Ernest A. Gerardi, Jr. President and Chief Operating Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on this 26th day of March, 1999.
Signature Title --------- -----
/s/Robert H. Smith Co-Chairman of the Board, Co-Chief -------------------------- Robert H. Smith Executive Officer, and Director
/s/Robert P. Kogod Co-Chairman of the Board, Co-Chief -------------------------- Robert P. Kogod Executive Officer, and Director
/s/Ernest A. Gerardi, Jr. President, Chief Operating Officer, and -------------------------- Ernest A. Gerardi, Jr. Director
/s/Wesley D. Minami Senior Vice President and -------------------------- Wesley D. Minami Chief Financial Officer
/s/ Steven E. Gulley Vice President, Controller, and Chief -------------------------- Steven E. Gulley Accounting Officer
/s/Fred J. Brinkman Director -------------------------- Fred J. Brinkman
/s/Charles B. Gill Director -------------------------- Charles B. Gill
/s/Mandell J. Ourisman Director -------------------------- Mandell J. Ourisman
/s/Mallory Walker Director -------------------------- Mallory Walker
CHARLES E. SMITH RESIDENTIAL REALTY L.P.
Index to Financial Statements and Schedules -------------------------------------------
CHARLES E. SMITH RESIDENTIAL REALTY L.P. FINANCIAL STATEMENTS FILED AS PART OF THIS REPORT
Pages -----
Report of Independent Public Accountants
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Partner's Equity and Other Limited Partners' Interest
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements to
SCHEDULES FILED AS PART OF THIS REPORT
Schedule III - Real Estate and Accumulated Depreciation S-1 to S-2
All other Schedules have been omitted because the required information of such other Schedules is not present in amounts sufficient to require submission of the schedule or because the required information is included in the consolidated financial statements.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Charles E. Smith Residential Realty, L.P.:
We have audited the accompanying consolidated balance sheets of Charles E. Smith Residential Realty L.P. (a Delaware limited partnership) and subsidiaries as of December 31, 1998 and 1997 and the related consolidated statements of operations, partners' equity and other limited partners' interest, and cash flows for each of the years in the three years ended December 31, 1998. These consolidated financial statements and the schedule referred to below are the responsibility of the management of Charles E. Smith Residential Realty, L.P. Our responsibility is to express an opinion on these consolidated financial statements and schedule 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Charles E. Smith Residential Realty L.P. and subsidiaries as of December 31, 1998 and 1997, and the consolidated results of its operations and its cash flows for each of the years in the three years ended December 31, 1998, in conformity with generally accepted accounting principles.
Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index to financial statements is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
Arthur Andersen LLP Washington, D.C. February 9, 1999
CHARLES E. SMITH RESIDENTIAL REALTY L.P. CONSOLIDATED STATEMENTS OF PARTNER'S EQUITY AND OTHER LIMITED PARTNERS' INTEREST (Dollars in Thousands, Except Per Unit Data)
The accompanying notes are an integral part of these statements.
CHARLES E. SMITH RESIDENTIAL REALTY L.P. CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in Thousands)
The accompanying notes are an integral part of these statements.
CHARLES E. SMITH RESIDENTIAL REALTY L.P. CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in Thousands, Except Per Unit Data)
The accompanying notes are an integral part of these statements.
CHARLES E. SMITH RESIDENTIAL REALTY L.P. CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, (Dollars in Thousands)
The accompanying notes are an integral part of these statements.
CHARLES E. SMITH RESIDENTIAL REALTY, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND FORMATION OF COMPANY
Charles E. Smith Residential Realty L.P. (The "Operating Partnership") was organized in Delaware in 1993. The Operating Partnership had no operations prior to the completion of the business combination (discussed below) which occurred on June 30, 1994. Charles E. Smith Residential Realty, Inc. (the "Company"), formed in June 1993, is a self-administered and self-managed equity real estate investment trust ("REIT"). On June 30, 1994, the Company raised equity through an initial public offering and a private placement (the "Offerings"), and issued debt in a series of concurrent private financing transactions. The proceeds from the Offerings were used to acquire the 1.0% sole general partnership and a 41.7% limited partnership interest in the Operating Partnership.
Simultaneous with the Offerings, the entities that owned the properties and the related service businesses included in the CES Group contributed the properties (the "Predecessor Properties") and the management, development, leasing, interior construction, engineering, and financing services business segments of the Predecessor to the Operating Partnership (or corporations in which the Operating Partnership owns substantially all of the equity) and received in exchange, directly or indirectly, units of limited partnership in the Operating Partnership. (The contributing entities and their owners, which include Robert H. Smith and Robert P. Kogod and their families, and other former owners of indirect interests in contributed properties, are referred to collectively as the "Other Limited Partners"). The contributed assets and liabilities were recorded at historical net book value which transferred a net carry-over deficit of $244.2 million to the Operating Partnership.
The Operating Partnership and its subsidiaries are engaged in the ownership, operation, management, leasing, acquisition, and development of real estate properties, primarily residential multifamily properties. As of December 31, 1998, the Operating Partnership owned 48 operating multifamily properties containing 19,279 apartment units (the "Properties"), had approximately 2,100 units under construction at four owned sites and had agreements to purchase approximately 1,200 units at four additional sites. In addition, the Operating Partnership owned two free-standing community retail shopping centers aggregating 436,000 square feet. The properties are located in the following metropolitan areas:
Additionally, the Operating Partnership owned substantially all of the equity in entities which provide multifamily and retail property management and leasing, furnished corporate apartments, interior construction and renovation, building engineering and technical services, and financial advisory services (collectively, the "Property Service Businesses").
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements include all of the accounts of the Operating Partnership and its subsidiaries and affiliates. The Operating Partnership uses the equity method of accounting for its 99% non- voting interest in the Property Service Businesses.
All significant intercompany balances and transactions have been eliminated.
Rental Property
The Operating Partnership recorded the contributed Predecessor Properties at the Predecessor's historical cost. Rental property subsequently acquired or developed is recorded at the Operating Partnership's actual cost, including interest and real estate taxes incurred during development. Ordinary repairs and maintenance, such as minor replacements and painting, are expensed as incurred. Major improvements, such as new HVAC equipment and kitchen/bath renovations, are capitalized when they extend the useful life, increase capacity or improve the efficiency of the asset. Depreciation on buildings and improvements is computed using the straight-line method over estimated useful asset lives as follows:
Deferred Charges
Deferred charges consist primarily of permanent loan fees, which are amortized to interest expense over the terms of the notes using the effective interest rate method, and retail lease acquisition costs, which are amortized over the terms of the related leases.
Revenue Recognition
Rental income attributable to residential leases is recognized when due from tenants. The Operating Partnership requires residential tenants to initially execute a one-year lease. At the expiration of the lease term, if not renewed, the lease converts to a month-to-month basis.
Minimum rental income attributable to retail leases is recognized on a straight-line basis over the term of the lease regardless of when payments are due. Minimum rental income recognized in excess of payments due was $5.4 million and $5.0 million at December 31, 1998 and 1997, respectively, and is included in other assets. The lease agreements contain provisions that provide for additional rentals based on the tenants' sales volume and reimbursement from the tenants for their share of real estate taxes and certain common area maintenance costs. Additional rentals are recognized on the accrual basis.
The future minimum lease payments to be received by the Operating Partnership under noncancelable retail leases as of December 31, 1998, are as follows (in thousands):
Income Taxes
These financial statements contain no provision for Federal income taxes since the entity is a partnership and, therefore, all Federal income tax liabilities and/or tax benefits are passed through to the individual partners in accordance with the partnership agreement and the Internal Revenue Code.
The Operating Partnership's income tax basis in its assets and liabilities was $966 million and $879 million, respectively, at December 31, 1998 and $702 million and $635 million, respectively, at December 31, 1997.
Cash and Cash Equivalents
Cash and cash equivalents include all cash and cash equivalent investments with original maturities of three months or less.
Use of Estimates in the Financial Statements
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions related to the net realizable value of rental property, the collectibility of accounts and notes receivable, and the outcome of asserted and unasserted claims that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Impairment of Long-Lived Assets
Management assesses for impairment any property whenever events or circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recognized when the sum of the estimated undiscounted future cash flows before interest charges is less than its carrying value. The loss is measured as the difference between the carrying value and the fair value of the property.
Stock-based compensation
The Company accounts for stock-based compensation programs under Accounting Principles Board Opinion No. 25 whereby compensation expense is equal to the excess, if any, of the quoted market price of the stock at the grant date over the exercise price.
New Accounting Pronouncements
During 1998, the Company implemented Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income", which had no impact, and SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information", which is reflected in Note 14.
During 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" which is effective for years beginning after June 15, 1999. The standard is not expected to have a significant impact on the Operating Partnership's financial statements since the Operating Partnership has no derivative instruments.
Reclassifications
Certain reclassifications of the prior years' information have been made to conform to the current year's presentation.
3. RENTAL PROPERTY
Rental Property Rental property consists of the following as of December 31 (in thousands):
Depreciation expense of the Operating Partnership was $28.6 million, $20.3 million and $17.7 million for the years ended December 31, 1998, 1997 and 1996, respectively. Repairs and maintenance expense of the Operating Partnership was $13.6 million, $13.2 million and $11.8 million for the years ended December 31, 1998, 1997 and 1996, respectively.
Acquisitions
During 1998, the Operating Partnership acquired five properties for $190.5 million, adding 1,942 apartment units. The Operating Partnership issued a total of approximately 0.3 million Operating Partnership units valued at $11.8 million and assumed a $31.5 million mortgage loan which was adjusted to its fair value of $33.5 million. The balance was funded from available cash and draws on the line of credit. The conversion of these Operating Partnership units into Company common stock is restricted for up to two years. One of the properties acquired included 13% of the underlying land with the balance subject to ground leases expiring in 2067.
During 1997, the Operating Partnership acquired six properties for $288.6 million, adding 3,036 apartment units. The Operating Partnership issued a total of approximately 2.1 million Operating Partnership units valued at $61.1 million and assumed $93.5 million in mortgage loans. The balance was funded from available cash and draws on the line of credit. The conversion of these Operating Partnership units into Company common stock is restricted for up to one year.
During 1996, the Operating Partnership acquired four properties for $64.1 million, adding 1,049 apartment units. The Operating Partnership issued a total of approximately 0.1 million Operating Partnership units valued at approximately $2.4 million and assumed a $3.3 million mortgage loan. The balance was funded from available cash and draws on the line of credit.
Dispositions
During 1998, the Operating Partnership sold two properties in southeast Washington, D.C. for a total of $22.0 million. The sales were completed as tax- deferred I.R.C. Section 1031 exchanges. Under generally accepted accounting principles, the Operating Partnership recognized gains on the sales totaling $18.2 million.
Development
At December 31, 1998, the Operating Partnership had approximately 2,100 apartment units under construction at four sites. Total estimated cost (including land) is approximately $269 million.
4. INVESTMENT IN AND ADVANCES TO PROPERTY SERVICE BUSINESSES
The Operating Partnership uses the equity method of accounting for its 99% non-voting interest in the Property Service Businesses, which include Smith Realty Company ("SRC"), Consolidated Engineering Services, Inc. ("CES") and Smith Management Construction, Inc. ("SMC"). These companies provide services which include property management, leasing, engineering and technical, financing and property construction and renovation. Under the equity method, the Operating Partnership's investment is adjusted for its proportionate share of earnings or losses of the Property Service Businesses and by dividends received. The Operating Partnership recognized its 99% interest in the earnings of each of the Property Service Businesses which aggregated $8.4 million, $7.6 million and $7.8 million for the years ended December 31, 1998, 1997 and 1996, respectively. The Operating Partnership received distributions aggregating $10.5 million, $8.9 million and $8.9 million for the years ended December 31, 1998, 1997 and 1996, respectively.
The Property Service Businesses provide services to the Operating Partnership under one-year agreements which are automatically renewable. Such services are generally provided at cost (including a proportionate share of total overhead) except property management and leasing services which are provided at cost plus five percent. The Property Service Businesses also provide services to certain partnerships which own multifamily and commercial office properties and have Messrs. Smith and Kogod as the general partners ("Affiliates"). Such services are generally provided at cost (including overhead) plus a fee, except for certain engineering and technical services which are provided at cost and overhead.
In November 1997, certain commercial office Affiliates combined into a single partnership, Charles E. Smith Commercial Realty L.P. ("CESCR"). In conjunction with the combination, CES and SMC each entered into eight-year agreements with CESCR to continue providing services under the same terms and conditions in place prior to the business combination. In addition, certain Financing Services personnel of SRC transferred to CESCR. SRC entered into an agreement which expired December 31, 1998 to provide Financing Services for certain properties owned by CESCR. Services were provided by SRC in 1998 utilizing CESCR personnel on a negotiated cost basis. SRC separately negotiated revenue and cost sharing agreements for Financing Services provided to properties managed but not owned by CESCR.
In addition to the above, SRC provided administrative services such as accounting, systems and human resources services to the Operating Partnership and Affiliates at cost and overhead in accordance with cost and executive sharing agreements. In management's opinion, the allocation
methods provide reasonable estimates of the costs that would have been incurred had the services been provided by the Operating Partnership.
Total fees and administrative services charged by the Property Service Businesses to the Operating Partnership and Affiliates follows (in thousands):
The Operating Partnership had net working capital advances to the Property Service Businesses of $25.9 million and $10.6 million at December 31, 1998 and 1997, respectively, which are reflected in the investment balance.
Combined summarized balance sheet information for the Property Service Businesses follows (in thousands):
/(1)/ Balance sheets exclude $44.5 million of notes due to the Operating Partnership which, under the equity method, are eliminated for purposes of carry-over basis accounting.
Combined summarized income statement information for the Property Service Businesses follows (in thousands):
/(1)/ Represents 100% of the Property Service Businesses' net income, of which the Operating Partnership's share was $8.4 million, $7.6 million and $7.8 million, respectively, for the years ended December 31, 1998, 1997 and 1996.
5. DEFERRED CHARGES Deferred charges consist of the following as of December 31 (in thousands):
Amortization of permanent loan fees (which is charged to interest expense) was $1.6 million, $2.3 million and $2.7 million for the years ended December 31, 1998, 1997 and 1996, respectively. Other amortization expense was $0.3 million, $0.4 million and $0.2 million for the years ended December 31, 1998, 1997 and 1996, respectively.
6. MORTGAGE LOANS AND NOTES PAYABLE
The Operating Partnership, through its subsidiary financing partnerships, has mortgage loans and notes payable as follows as of December 31:
These loans require monthly interest and, where applicable, principal payments and are collateralized by first lien mortgages or deeds of trust on 33 of the 54 Properties, bear interest at a weighted-average interest rate of 6.97% as of December 31, 1998 and have a weighted-average maturity of 9.3 years.
Mortgage Pools
The $110.1 million principal balance of Mortgage Pool One was partially repaid on February 28, 1998, in conjunction with the sale of Oxford Manor, and fully repaid on March 31, 1998. An extraordinary loss of $4.1 million was recognized which consisted of a $2.9 million yield maintenance premium and a $1.2 million non-cash write-off of unamortized loan fees.
The $125.2 million principal balance of Mortgage Pool Two was repaid on October 31, 1998. An extraordinary loss of $11.7 million was recognized consisting of a $9.7 million prepayment penalty and a $2.0 million non-cash write-off of unamortized loan fees.
The loan for Mortgage Pool Three is interest only, at a fixed rate of 7.99% paid monthly, through June 30, 1999, at which time principal amortization begins using a 25-year amortization schedule with a balloon payment due June 30, 2009. The loan requires a capital and repair escrow. Certain Predecessor partners guaranteed $42 million of the mortgage loan secured by Mortgage Pool Three.
During 1998, the Operating Partnership obtained a $53 million, ten year secured loan from Prudential at a fixed coupon rate of 6.88%. The loan is secured by two of the multifamily properties with an aggregate book value of $71.7 million. In conjunction with this loan, the Operating Partnership terminated a $20 million (notional value) treasury lock contract at a gain of $0.4 million which will be amortized over the term of the new loan.
The Operating Partnership announced a standby credit facility in 1998 of up to $300 million with Fannie Mae which provides for non-recourse, long-term debt for up to fifteen years. The initial draw on this facility was $140 million at 6.75% for fifteen years. The bulk of the proceeds were used to retire Mortgage Pool Two of $125.2 million and the associated prepayment penalty of $9.7 million. Terms and rates of subsequent draws on this facility will be determined at the time of use. Closing of the facility is expected during the second quarter of 1999.
Individual Mortgages
Individual mortgages have fixed interest rates ranging from 6.3% to 9.0%.
During 1998, in connection with the Cronin's Landing acquisition, the Operating Partnership assumed a $31.5 million mortgage loan which was adjusted to its fair value of $33.5 million. The loan has an effective fixed interest rate of 6.9% with principal amortized using a 25-year amortization schedule and a final payment due March 2009.
During 1998, the Operating Partnership also obtained a $38.3 million mortgage on the Crystal House properties at a fixed interest rate of 6.29% and a $49.3 million mortgage on the Skyline Towers property at a fixed interest rate of 6.45%. The Crystal House loan is interest only through December 2008, at which time principal amortization begins using a 30-year amortization schedule with a balloon payment due December 30, 2010. The Skyline loan is interest only through December 2008, at which time principal amortization begins using a 30-year amortization schedule
with a balloon payment due December 30, 2010. The Skyline loan is interest only through December 2008, at which time principal amortization begins using a 30-year amortization schedule with a balloon payment due December 10, 2010. The Operating Partnership also refinanced mortgages on 2000 Commonwealth and Connecticut Heights in 1998.
In September, 1998, the Operating Partnership terminated a $50 million (notional value) treasury lock contract at a loss of $4.9 million. The treasury lock was put in place in the first quarter of 1998 to hedge interest rate risk associated with an anticipated 10-year, unsecured financing which ultimately did not occur. Therefore, this amount has been charged to current year earnings.
In September 1996, the outstanding loan balance of $40.6 million for Mortgage Pool Four was refinanced for a new loan amount of $41 million. The ground lessor (see Note 8) has been allocated $9.9 million of the refinanced loan for which the Operating Partnership is contingently liable. The remaining $31.1 million of debt is allocated to the Operating Partnership. The loan bears interest at a fixed rate of 8.24%, paid monthly through August, 2004, at which time principal amortization begins, using a 30-year amortization schedule with a final payment due August 1, 2009.
Lines of Credit
The Operating Partnership terminated its $100 million line of credit in 1998 and entered into two new unsecured lines of credit -- a $100 million line and a $185 million line -- with PNC Bank, NationsBank, and U.S. Bank, as agents, which mature in March 2001. Draws upon the new lines are subject to certain unencumbered asset requirements and bear interest at a selected London Interbank Offer Rate (LIBOR) plus 75 to 120 basis points based on the leverage ratio of the Operating Partnership. As of December 31, 1998, the weighted average interest rate on outstanding draws was 6.22%. If the Operating Partnership receives an investment grade rating on its unsecured debt, the interest rate will decrease to 60 to 90 basis points over LIBOR based on the rating. The Operating Partnership pays a fee of 0.20% on the full amount available under the line of credit. The line of credit agreements contain certain restrictive covenants, including maintenance of minimum equity value, debt to equity ratios and debt service coverage requirements. The maximum amounts outstanding during 1998 and 1997 were $251.5 million and $97.0 million, respectively.
The Operating Partnership also has an $83 million acquisition credit facility which allows for debt maturities up through July 2004. The line of credit provides for an interest rate that is fixed at the time of each borrowing at 150 basis points over 10-year Treasury Bills and is cross-collateralized with Mortgage Pool Three. Borrowings outstanding of $30 million at December 31, 1998 bear interest at a weighted-average fixed rate of 7.27% and are collateralized by two Properties with an aggregate book value of $30.5 million. The agreement contains certain restrictive covenants including a limit on debt to asset value and maintenance of debt service coverage ratios.
Construction Loans
In October 1997, the Operating Partnership obtained a variable rate, unsecured construction loan of $46.3 million to finance the construction of an acquired development property. The loan is recourse to the Operating Partnership, bears interest at LIBOR plus 130 basis point (6.85% at December 31, 1998), and matures in October 2000 with three six-month extension options based on certain conditions. The loan balance at December 31, 1998 was $31.6 million.
During 1998, the Operating Partnership obtained a $90 million interest-only construction loan in connection with the development of One Superior Place in Chicago, Illinois, with interest currently at LIBOR plus 135 basis points (6.93% at December 31, 1998), payable monthly, due July 1, 2001. At the Operating Partnership's option, maturity may be extended for two one-year periods based on certain conditions. The loan is collateralized by the property, which has a net book value of $54.8 million, and is recourse to the Operating Partnership The loan balance at December 31, 1998 was $31.6 million.
The scheduled principal payments for all mortgage loans and notes payable are as follows (in thousands):
7. PARTNERS' EQUITY
During the first quarter of 1997, the Company completed an equity offering and issued 3.1 million shares of common stock at $28.375 per share totaling $82.9 million, net of underwriting discount and other expenses totaling $5.2 million. The net proceeds of the offering was contributed to the Operating Partnership in exchange for 3.1 million common units and were used to repay $72.1 million of notes payable and $9 million of mortgage debt and to fund property acquisitions.
In May 1997, the Company entered into an agreement with Security Capital Preferred Growth Inc. ("Security Capital") to sell 2.6 million shares of Series A Cumulative Convertible Redeemable Preferred Stock ("Series A Preferred Shares"), $0.01 par value (liquidation preference of $27.08 per share), at $27.08 per share for a total of $71.5 million. During 1997, the Company sold 1.6 million Series A Preferred Shares for proceeds of $44.5 million, net of $0.5 million in offering costs. In April 1998, the Company sold the remaining 1.0 million shares of Series A Preferred Shares for $26.1 million, which is net of offering costs of $0.4 million. The net proceeds of the Sale was contributed to the Operating Partnership in exchange for 2.6 million Series A Preferred Units.
Series A Preferred Unitholders have certain voting, distribution and liquidation preferences over the common unitholders. Distributions are cumulative from the date of original issue and are payable quarterly at the greater of the rate declared on the common units or the annual rate of $2.02 per unit. The Series A Preferred Units are not redeemable prior to May 15, 2003. On or after May
15, 2003, the Operating Partnership, at its option, may redeem the Series A Preferred Units for cash at a redemption price of $27.08 per unit, plus accrued and unpaid distributions. Under certain circumstances, the Operating Partnership may elect to make such redemption with common units at the then market price of the Company's common stock. On or after January 31, 1999, Security Capital may convert the Series A Preferred Shares into shares of common stock on a one-for- one basis subject to certain limitations. Prior to January 31, 1999, the Series A Preferred Shares will not be convertible unless the Company undergoes a change in control, as defined by the agreement, or fails to qualify as a REIT for tax purposes.
In October 1997, the Company sold 1.45 million shares of common stock and 1.22 million shares of Series B Cumulative Convertible Redeemable Preferred Stock ("Series B Preferred Shares"), $0.01 par value, to the Prudential Insurance Company of America ("Prudential") for approximately $76 million in connection with a property acquisition. The net proceeds were contributed to the Operating Partnership in exchange for 1.45 million common units and 1.22 million Series B Preferred Units. During 1998, 0.5 million shares of Series B Preferred Shares were converted to common shares on a one-for-one basis. The Operating Partnership converted 0.5 million units of Series B Preferred Units to common shares on a one-for-one basis.
Series B Preferred Unitholders have certain voting, distribution and liquidation preferences over the common unitholders. The Series B Preferred Units have a liquidation preference of $28.50 per unit. Distributions are cumulative and are payable quarterly at the greater of the rate declared on the common units or the annual rate of $2.02 per unit. Prudential may convert the Series B Preferred Shares into shares of common stock on a one-for-one basis, subject to certain adjustments and limitations related to its ownership of common stock of the Company. The Operating Partnership may redeem Series B Preferred Units at any time for common units, plus accrued and unpaid distributions.
In January 1998, the Company sold 500 shares of Series C Cumulative Redeemable Preferred Stock ("Series C Preferred Shares"), $0.01 par value, for $48.6 million, net of offering costs of $1.4 million. The net proceeds were contributid to the Operating Partnership in exchange for 500 units of Series C Preferred Units. The Operating Partnership amended the Articles of Incorporation to designate and establish the rights and privileges of the Series C Preferred Unitholders which include certain voting, distribution and liquidation preferences over the common unitholders. The Series C Preferred Units have a liquidation preference of $100,000 per unit and an initial annual distribution rate of $7,910 per unit. If the securities receive an investment grade rating, the distribution rate will decrease by $250 per unit. Distributions are cumulative and are payable quarterly. The Operating Partnership may redeem Series C Preferred Units after February 1, 2028, at the liquidation price plus accrued distributions.
In July 1998, the Company completed the sale of 1.4 million shares of common stock (par value of $0.01 per share) under its existing shelf registration statement at a net purchase price of $32.625 per share. The net proceeds were contributed to the Operating Partnership in exchange for 1.4 million common units and proceeds of approximately $45.4 million have been used to retire outstanding debt and for working capital needs.
In December 1998, the Company adopted a Shareholder Rights Plan (the "Rights Plan") in which certain stock purchase rights were granted as a distribution to holders of common stock. The Rights allow the holder to purchase preferred stock only if a person or group becomes the owner of
15% or more of the common stock or announces an offer to acquire 15% or more of the common stock. The Rights expire on December 13, 2008.
During 1998, the Operating Partnership issued approximately 0.3 million Operating Partnership units valued at $11.8 million in connection with property acquisitions.
As of December 31, 1998, approximately 17.3 million shares of the Company's authorized common stock had been reserved for redemption of Operating Partnership units and 1.0 million shares were reserved under the Company's Dividend and Distribution Investment and Share Purchase Plan, respectively.
8. COMMITMENTS AND CONTINGENCIES
Purchase Commitments
As of December 31, 1998, the Operating Partnership had executed four contracts to purchase to-be-constructed multifamily properties totaling approximately 1,200 apartment units. The maximum aggregate purchase price totals $151 million with projected closing dates between July 2000 and May 2001.
These contracts are contingent upon satisfactory completion of construction and attainment of final certificates of occupancy by the owners. At December 31, 1998, the Operating Partnership had posted three letters-of-credit totaling $ 7.7 million in accordance with three of the contracts to be drawn upon only if the Operating Partnership defaults on its contractual obligations to purchase the completed assets.
Land Leases
Eight of the Properties have ground leases expiring at various dates between December 2032 and April 2067. (See Note 17 for related subsequent event.) Generally, each ground lease provides for a nominal annual rental and an additional rental calculated from the results of Property operations after capital expenditures.
The base rental expense to the Operating Partnership under the ground leases was $1.7 million for 1998 and $0.5 million for each of the years ended December 31, 1997 and 1996. The
additional rental expense to the Operating Partnership under the ground leases was $4.1 million, $3.2 million and $2.6 million for the years ended December 31, 1998, 1997 and 1996, respectively. At the expiration of the ground leases, the land and all of the improvements thereon will revert to the land owner. In most cases, the leases are subordinated to the mortgage debt on the related rental property.
The future nominal base annual rentals as of December 31, 1998 for the ground leases are as follows (in thousands):
Net Profits Interest
An unaffiliated third party has a 5.1% interest in the net profits of one of the Properties acquired in 1997. Net profit is calculated based on the results of Property operations less capital expenditures. (See Note 16 for related subsequent event).
Litigation
The Operating Partnership and/or the Property Service Businesses are presently subject to legal actions or claims for damages that arise in the ordinary course of business. In the opinion of management and counsel to the Operating Partnership, the ultimate outcome of such litigation will not have a material adverse effect on the Operating Partnership's financial position, results of operations or cash flows.
401 (k) Retirement Plan
Substantially all of the personnel employed at the Properties are eligible and participate in the Charles E. Smith 401 (k) Retirement Plan, a defined contribution, tax-qualified savings plan (the "Plan"). These personnel are employed by Smith Employment Services, L.P. ("Employment Services"), a limited partnership owned by the Operating Partnership, which is the primary employer in the Plan. Previously, such employees were participants in the Charles E. Smith Building Employees Retirement Plan which was merged into the Plan effective July 1, 1998. Employment Services generally contributes 4% of employee-qualified earnings. The total contributions were $0.2 million in 1998, $ 0.4 million in 1997, and $ 0.3 million in 1996. Employees of the Property Service Businesses are also covered by the Plan.
9. RELATED-PARTY TRANSACTIONS
The Operating Partnership conducts business with entities in which Messrs. Smith and Kogod exercise control. In each case, the Company's Board of Directors reviews the transaction and obtains, as required, independent assurance as to the arms-length nature of the terms. The following is a description of these transactions.
. For the years ended December 31, 1998, 1997 and 1996, the Operating Partnership paid approximately $2.3 million, $0.7 million and $0.7 million, respectively, in payroll reimbursements to an entity controlled by Messrs. Smith and Kogod for efforts on development properties and potential development sites. The increase in 1998 reflects the higher level of activity associated with expanding the Operating Partnership's development pipeline during the year.
.In January, 1998, the Operating Partnership purchased a multifamily property (Tunlaw Park) for $6.7 million from a partnership in which Messrs. Smith and Kogod had ownership interests.
.In connection with the development of Springfield Station, a contract was executed with an entity controlled by Messrs. Smith and Kogod to manage the construction of the apartments at a fee of 4% of hard construction costs. Construction management fees were $0.7 million and $0.4 million for the years ended December 31, 1998 and 1997, respectively.
.In November 1998, the Operating Partnership purchased land for future development for $5.4 million from a partnership in which Messrs. Smith and Kogod had ownership interests.
.Prior to December 1997, the two retail properties leased health club facilities to entities controlled by Messrs. Smith and Kogod. Rental income earned under these leases approximated $5.0 million for each of the years ended December 31, 1997 and 1996. In December 1997, the health clubs were sold. In conjunction with that sale, the Operating Partnership agreed to restructure the leases by reducing base rent on the Worldgate lease and extending the terms of both leases for ten years, through 2025, in exchange for a $2.3 million cash payment which is amortized over the lives of the revised leases.
10. 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 for mortgages with similar terms and remaining maturities, the fair value of mortgages payable was approximately $619 million and $527 million at December 31, 1998 and 1997, respectively. The fair values of lines of credit and construction loans approximate the carrying values.
11. EARNINGS PER UNIT
For the years ended December 31, 1998, 1997 and 1996, basic earnings per common unit is computed based on 30.2 million, 26.7 million and 21.9 million weighted average units outstanding during the year, respectively, and diluted earnings per common unit is computed based on 30.3 million, 26.8 million, and 21.9 million weighted average units outstanding during the year adjusted for the assumed conversion of dilutive securities, respectively. In 1998, the per-share impact of the extraordinary item was $0.54 per common unit (basic and diluted).
A reconciliation of income (before extraordinary item) and units used to calculate basic and diluted earnings per common unit for 1998 and 1997 follows (dilutive securities had no effect on earnings in 1996):
Options to purchase 771,750 shares of the Company's common stock were not included in the computation of diluted earnings per unit because the options' exercise price was higher than the average price of the Company's common shares. All convertible preferred units were also excluded from the calculation of diluted earnings per unit since the preferred distributions paid per unit exceeded basic earnings per unit.
12. INCENTIVE PLANS
The Company applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations in accounting for its plans. Accordingly, no compensation expense has been recognized for its stock- based compensation plans other than for restricted stock and performance-based awards. Had compensation cost for the Company's other stock option plans been determined based on the fair value at the grant date consistent with the methodology prescribed under SFAS 123, the Operating Partnership's net income would have been reduced by approximately $499,000 for the year ended December 31, 1998 ($0.02 per basic and diluted common unit), $65,000 (less than $0.01 per basic and diluted common unit) for the year ended December 31, 1997 and $8,000 for the year ended December 31, 1996. The fair value of options granted during 1998, 1997 and 1996 is estimated at approximately $305,000, $2,111,000 and $23,000, respectively, based on the date of grant using the Black-Scholes option-pricing model. The following assumptions were used:
Option Plans
The Company with the Operating Partnership maintains an employee stock and unit option plan designed for executive officers and other key employees of the Company, the Operating Partnership and the Property Service Businesses. The Company also maintains a Director's stock option plan which provides for automatic grants of vested options, exercisable for 5,000 shares of common stock, to newly appointed non-employee directors. The plans authorize the issuance of up to 3,150,000 shares of common stock and/or units pursuant to options granted. Options outstanding under both plans are as follows:
/(1)/Weighted average exercise price is $27 /(2)/ Range of exercise prices is $24-$35
The exercise price of options granted under the plans may not be less than the fair market value of the common stock on the date of grant. Payment for shares and/or units granted under the plans may be made either in cash, or, if permitted by the option agreement, by exchanging shares of common stock of the Company having a fair market value equal to the option exercise price. The weighted average remaining contractual life of options outstanding as of December 31, 1998 was 7.7 years.
Options granted under the employee plan have a maximum term of ten years and vest generally in three to five equal annual installments beginning on the first anniversary of the date of grant. Generally, options terminate three months after the optionee's termination of employment with the Company. The Executive Compensation Committee of the Board of Directors may provide, however, that an option may be exercised over a longer period following termination of employment, but in no event beyond the expiration date of the option.
Restricted Stock and Unit Plan
The Company, with the Operating Partnership, maintains a restricted stock and unit plan for executive officers and other key employees of the Company, the Operating Partnership and the Property Service Businesses. Messrs. Smith and Kogod are not eligible to participate under the plan. A maximum of 300,000 shares of common stock and/or units may be issued under the plan. Restricted shares and/or units that have not vested at the time of an employee's termination of employment with the Company will be forfeited, except where such termination occurs by reason of death or disability. Any restricted shares and/or units forfeited pursuant to the vesting provisions of the plan will again be available for award under the plan. During 1998, 21,823 grants were awarded and 28,801 units vested. During 1997, 24,000 grants were awarded and 20,700 units vested. During 1996, 7,500 grants were canceled and 23,750 units vested. During 1995, 23,750 units vested. During 1994, 95,000 grants were awarded. For the years ended December 31, 1998, 1997
and 1996, compensation expense relating to the plan was $0.5 million, $0.6 million and $0.5 million, respectively, based on the market value of the Company's stock at the date of grant.
13. SUPPLEMENTAL CASH FLOW DATA
Information on non-cash investing and financing activities and cash interest paid is as follows (in thousands):
14. OTHER LIMITED PARTNERS' INTEREST
Limited partnership units of the Other Limited Partners may be redeemed at the unitholders' discretion. At the option of the Company, such redemption may be made for cash, at the then fair value of the Company's stock, or for shares of common stock of the Company on a one-for-one basis. As of December 31, 1998, approximately 17.3 million shares of the Company's authorized common stock had been reserved for possible issuance upon redemption of limited partnership units.
In accordance with generally accepted accounting principles, the Other Limited Partners' redemption rights are not included in partner's equity. Consequently, the accompanying consolidated balance sheets and statements of partner's equity reflect the Other Limited Partners' Interest in the Operating Partnership, measured at redemption value. Such interest is deducted from partner's equity.
15. SEGMENT REPORTING
The Operating Partnership adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information", during 1998. SFAS No. 131 established standards for reporting information about operating segments in annual financial statements and requires selected information about operating segments in interim financial reports issued to unitholders. It also established standards for related disclosures about products and services, and geographic areas. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by senior management in deciding how to allocate resources and in assessing performance.
Property Segments
The Operating Partnership's primary business is the ownership and operation of multifamily residential real estate. As such, the residential rental properties constitute the three primary operating segments -- Core, Acquisition and Development portfolios -- depending upon the maturity of each property. Core consists of all multifamily properties which have been owned more than one full calendar year. Therefore, the 1998 Core represents properties owned as of December 31, 1996. Acquisition consists of purchased properties which have not yet reflected one full calendar year of operations. Development consists of properties which the Operating Partnership has constructed or
is in the process of constructing which have not yet had a full calendar year of stabilized operating results. On the first of January each year, Acquisition and Development properties that meet the one year requirements are transferred to the Core portfolio.
The Operating Partnership's fourth property segment is the Retail portfolio which consists of the two free-standing retail properties.
The Operating Partnership evaluates performance for the Property Segments based on Net Operating Income ("NOI") which is the difference between Rental Revenue and Operating Expenses (which primarily excludes interest expense, general and administrative costs and depreciation.)
Property Service Business Segments
The Operating Partnership also evaluates the separate financial information of its equity investment in the Property Service Businesses. Therefore, the Operating Partnership has three additional segments based on service type -- Multifamily and Retail Management, Engineering and Technical Services and Interior Construction and Renovation. The Operating Partnership evaluates performance for the Property Service Business segments based on Funds from Operations ("FFO"). Funds from Operations is defined under the revised definition adopted by the National Association of Real Estate Investment Trusts ("NAREIT") as net income (loss) (computed in accordance with generally accepted accounting principles) excluding gains (or losses) from debt restructuring and sale of property, plus depreciation/amortization of assets unique to the real estate industry. Depreciation/amortization of assets not unique to the industry, such as amortization of deferred financing costs and non-real estate assets, is not added back.
The accounting policies for all seven segments are the same as those described in the summary of significant accounting policies.
Information concerning operations by segment for each of the three years ended December 31, was as follows (in thousands):
Property Service Business Segments
16. EXTRAORDINARY ITEM
The Operating Partnership recognized an extraordinary loss of $16.4 million in connection with debt extinguishments in 1998. Losses of $4.1 million and $11.7 million were recognized in connection with the repayment of Mortgage Pool One and Mortgage Pool Two, respectively. The losses consisted of $2.9 million and $9.7 million in yield maintenance premiums and $1.2 million and $2.0 million in non-cash write-offs of unamortized loan fees. In addition, a loss of $0.6 million was recognized on the write-off of unamortized loan fees associated with the termination of the $100 million line of credit and the refinancing of $9.2 million of mortgage loans.
17. SUBSEQUENT EVENTS (Unaudited)
In January 1999, the Operating Partnership acquired a 442-unit multifamily property in Crystal City, Virginia ("Buchanan House") for a capitalized cost of $65.5 million which includes assumed debt of $7.4 million, initial capital improvement costs of $5.0 million, $0.4 million in acquisition related costs and $17.7 million in proceeds from the sale of Marbury. The balance was funded by the Operating Partnership's bank line of credit. In February 1999, the Operating Partnership repaid the assumed debt through a draw on its line of credit. The Operating Partnership paid a prepayment penalty of $0.9 million which was recognized as an extraordinary loss.
In January 1999, the Operating Partnership acquired a 139-unit multifamily property in Chicago, Illinois ("Parkwest") for a capitalized cost of approximately $14.1 million, consisting of 201,950 Operating Partnership Units valued at $6.3 million, assumed debt of $6.0 million, a fair value adjustment to debt of $0.4 million, initial capital improvement costs of $0.8 million, and $0.6 million in other related costs.
In January 1999, the Operating Partnership acquired a 427-unit multifamily property in Chicago, Illinois ("Terrace") for a capitalized cost of approximately $26.1 million, consisting of 320,304 Operating Partnership Units valued at $10.0 million, assumed debt of $13.7 million, a fair value adjustment to debt of $0.7 million, initial capital improvement costs of $0.4 million, and $1.3 million in other related costs.
In February 1999, the Operating Partnership sold The Manor, a 435-unit multifamily property located in suburban Maryland for $23.0 million. The Operating Partnership recognized a gain on the sale of $1.9 million.
In February 1999, the unused portion, or $53 million, of the Operating Partnership's $83 million line of credit with Northwestern Mutual expired.
In March 1999, the Operating Partnership acquired the land beneath the Crystal Square property and the 5.1% net profits interest in the Crystal Plaza property. The purchase price of $10 million consisted of 32,258 Operating Partnership Units valued at $1 million and $9 million cash drawn upon the line of credit. This transaction was reviewed and approved by the Operating Partnership's Board of Directors as it was completed concurrently with the purchase by CESCR of commercial land and partnership interests.
17. QUARTERLY FINANCIAL INFORMATION (Unaudited)
Quarterly financial information for 1998 and 1997 is as follows (in thousands except per share data):
CHARLES E. SMITH RESIDENTIAL REALTY L.P. SCHEDULE III REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 1998 (DOLLAR AMOUNTS IN THOUSANDS)
S-1
The aggregate cost for Federal income tax purposes of the Operating Partnership's investment in real estate was approximately $1,054 million and $896 million at December 31, 1998 and 1997, respectively. The changes in total real estate and accumulated depreciation for the three years ended December 31 are as follows (in thousands):
S-2
EXHIBIT INDEX