Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________________________________________
FORM 10-Q
 ___________________________________________________
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For quarterly period ended June 30, 2016
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
COMMISSION FILE NO. 1-6622
 WASHINGTON REAL ESTATE
INVESTMENT TRUST
(Exact name of registrant as specified in its charter)
MARYLAND
 
53-0261100
(State of incorporation)
 
(IRS Employer Identification Number)
1775 EYE STREET, NW, SUITE 1000, WASHINGTON, DC 20006
(Address of principal executive office) (Zip code)
Registrant’s telephone number, including area code: (202) 774-3200
___________________________________________________
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
 
Name of exchange on which registered
Shares of Beneficial Interest
 
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
 ___________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past ninety (90) days.    YES x   NO  o
Indicate by checkmark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  x      NO  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
Accelerated filer
o
Non-accelerated filer
o
Smaller reporting company
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    YES  o    NO  x  
As of July 28, 2016, 73,633,233 common shares were outstanding.
 


WASHINGTON REAL ESTATE INVESTMENT TRUST
INDEX
 
 
 
Page
 
 
 
 
Item 1.
 
 
 
 
 
Consolidated Statement of Equity
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
 

2

PART I
FINANCIAL INFORMATION

ITEM 1: FINANCIAL STATEMENTS

The information furnished in the accompanying unaudited Consolidated Balance Sheets, Condensed Consolidated Statements of Income (Loss), Condensed Consolidated Statements of Comprehensive Income (Loss), Consolidated Statement of Equity and Consolidated Statements of Cash Flows reflects all adjustments, consisting of normal recurring items, which are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods. The accompanying financial statements and notes thereto should be read in conjunction with the financial statements and notes for the three years ended December 31, 2015 included in Washington Real Estate Investment Trust’s 2015 Annual Report on Form 10-K.

3

WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
 
 
June 30, 2016
 
December 31, 2015
 
(Unaudited)
 
Assets
 
 
 
Land
$
573,315

 
$
561,256

Income producing property
2,072,166

 
2,076,541

 
2,645,481

 
2,637,797

Accumulated depreciation and amortization
(613,194
)
 
(692,608
)
Net income producing property
2,032,287

 
1,945,189

Properties under development or held for future development
35,760

 
36,094

Total real estate held for investment, net
2,068,047

 
1,981,283

Investment in real estate sold or held for sale, net
41,704

 
—

Cash and cash equivalents
22,379

 
23,825

Restricted cash
11,054

 
13,383

Rents and other receivables, net of allowance for doubtful accounts of $2,010 and $2,297 respectively
58,970

 
62,890

Prepaid expenses and other assets
99,150

 
109,787

Other assets related to properties sold or held for sale
5,147

 
—

Total assets
$
2,306,451

 
$
2,191,168

Liabilities
 
 
 
Notes payable, net
$
743,769

 
$
743,181

Mortgage notes payable, net
252,044

 
418,052

Lines of credit
269,000

 
105,000

Accounts payable and other liabilities
52,722

 
45,367

Dividend payable
—

 
20,434

Advance rents
10,178

 
12,744

Tenant security deposits
8,290

 
9,378

Liabilities related to properties sold or held for sale
2,338

 
—

Total liabilities
1,338,341

 
1,354,156

Equity
 
 
 
Shareholders’ equity
 
 
 
Preferred shares; $0.01 par value; 10,000 shares authorized; no shares issued or outstanding
—

 
—

Shares of beneficial interest, $0.01 par value; 100,000 shares authorized; 73,651 and 68,191 shares issued and outstanding, respectively
737

 
682

Additional paid in capital
1,338,101

 
1,193,298

Distributions in excess of net income
(366,352
)
 
(357,781
)
Accumulated other comprehensive loss
(5,609
)
 
(550
)
Total shareholders’ equity
966,877

 
835,649

Noncontrolling interests in subsidiaries
1,233

 
1,363

Total equity
968,110

 
837,012

Total liabilities and equity
$
2,306,451

 
$
2,191,168

 

See accompanying notes to the consolidated financial statements.

4

WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Revenue
 
 
 
 
 
 
 
Real estate rental revenue
$
79,405

 
$
74,226

 
$
156,542

 
$
149,082

Expenses
 
 
 
 
 
 
 
Real estate expenses
28,175

 
27,229

 
56,909

 
56,437

Depreciation and amortization
25,161

 
25,503

 
51,199

 
50,778

Acquisition costs
1,024

 
992

 
1,178

 
1,008

General and administrative
4,968

 
4,278

 
10,479

 
10,358

Casualty (gain) and real estate impairment loss, net
(676
)
 
5,909

 
(676
)
 
5,909

 
58,652

 
63,911

 
119,089

 
124,490

Other operating income
 
 
 
 
 
 
 
Gain on sale of real estate
24,112

 
1,454

 
24,112

 
31,731

Real estate operating income
44,865

 
11,769

 
61,565

 
56,323

Other income (expense)
 
 
 
 
 
 
 
Interest expense
(13,820
)
 
(14,700
)
 
(28,180
)
 
(30,048
)
Loss on extinguishment of debt
—

 
(119
)
 
—

 
(119
)
Other income
83

 
192

 
122

 
384

Income tax benefit (expense)
693

 
(28
)
 
693

 
(28
)
 
(13,044
)
 
(14,655
)
 
(27,365
)
 
(29,811
)
Net income (loss)
31,821

 
(2,886
)
 
34,200

 
26,512

Less: Net loss attributable to noncontrolling interests in subsidiaries
15

 
340

 
20

 
448

Net income (loss) attributable to the controlling interests
$
31,836

 
$
(2,546
)
 
$
34,220

 
$
26,960

 
 
 
 
 
 
 
 
Basic net income (loss) attributable to the controlling interests per common share
$
0.44

 
$
(0.04
)
 
$
0.49

 
$
0.39

 
 
 
 
 
 
 
 
Diluted net income (loss) attributable to the controlling interests per common share
$
0.44

 
$
(0.04
)
 
$
0.49

 
$
0.39

Weighted average shares outstanding – basic
71,719

 
68,176

 
70,010

 
68,159

Weighted average shares outstanding – diluted
71,912

 
68,176

 
70,200

 
68,283

Dividends declared per share
$
0.30

 
$
0.30

 
$
0.60

 
$
0.60


See accompanying notes to the consolidated financial statements.

5

WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(IN THOUSANDS)
(UNAUDITED)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Net income (loss)
$
31,821

 
$
(2,886
)
 
$
34,200

 
$
26,512

Other comprehensive loss:
 
 
 
 
 
 
 
Unrealized loss on interest rate hedge
(1,384
)
 
—

 
(5,059
)
 
—

Comprehensive income (loss)
30,437

 
(2,886
)
 
29,141

 
26,512

Less: Comprehensive loss attributable to noncontrolling interests
15

 
340

 
20

 
448

Comprehensive income (loss) attributable to the controlling interests
$
30,452

 
$
(2,546
)
 
$
29,161

 
$
26,960


See accompanying notes to the financial statements.


6

WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF EQUITY
(IN THOUSANDS)
(UNAUDITED)
 
 
Shares Issued and Out-standing
 
Shares of Beneficial Interest at Par Value
 
Additional Paid in Capital
 
Distributions in Excess of
Net Income
 
Accumulated Other Comprehensive Loss
 
Total Shareholders’ Equity
 
Noncontrolling Interests in Subsidiaries
 
Total Equity
Balance, December 31, 2015
68,191

 
$
682

 
$
1,193,298

 
$
(357,781
)
 
$
(550
)
 
$
835,649

 
$
1,363

 
$
837,012

Net income attributable to the controlling interests
—

 
—

 
—

 
34,220

 
—

 
34,220

 
—

 
34,220

Net loss attributable to the noncontrolling interests
—

 
—

 
—

 
—

 
—

 
—

 
(20
)
 
(20
)
Unrealized loss on interest rate hedge
—

 
—

 
—

 
—

 
(5,059
)
 
(5,059
)
 
—

 
(5,059
)
Distributions to noncontrolling interests
—

 
—

 
—

 
—

 
—

 
—

 
(110
)
 
(110
)
Dividends
—

 
—

 
—

 
(42,791
)
 
—

 
(42,791
)
 
—

 
(42,791
)
Equity offerings, net of issuance costs
5,319

 
53

 
143,304

 
—

 
—

 
143,357

 
—

 
143,357

Share grants, net of forfeitures
141

 
2

 
1,499

 
—

 
—

 
1,501

 
—

 
1,501

Balance, June 30, 2016
73,651

 
$
737

 
$
1,338,101

 
$
(366,352
)
 
$
(5,609
)
 
$
966,877

 
$
1,233

 
$
968,110


See accompanying notes to the consolidated financial statements.

7

WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

 
Six Months Ended June 30,
 
2016
 
2015
Cash flows from operating activities
 
 
 
Net income
$
34,200

 
$
26,512

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
51,199

 
50,778

Provision for losses on accounts receivable
708

 
1,126

Casualty (gain) and real estate impairment loss, net
(676
)
 
5,909

Gain on sale of real estate
(24,112
)
 
(31,731
)
Share-based compensation expense
2,421

 
3,073

Deferred tax benefit
(732
)
 
—

Amortization of debt premiums, discounts and related financing costs
1,604

 
1,854

Loss on extinguishment of debt
—

 
119

Changes in operating other assets
(983
)
 
(758
)
Changes in operating other liabilities
(3,175
)
 
(2,550
)
Net cash provided by operating activities
60,454

 
54,332

Cash flows from investing activities
 
 
 
Real estate acquisitions, net
(227,413
)
 
—

Net cash received for sale of real estate
119,513

 
39,059

Capital improvements to real estate
(16,356
)
 
(12,391
)
Development in progress
(17,997
)
 
(13,332
)
Real estate deposits, net
—

 
(3,000
)
Cash released from (held in) replacement reserve escrows
2,001

 
(2,392
)
Insurance proceeds
883

 
—

Non-real estate capital improvements
(42
)
 
(1,836
)
Net cash (used in) provided by investing activities
(139,411
)
 
6,108

Cash flows from financing activities
 
 
 
Line of credit borrowings, net
164,000

 
135,000

Dividends paid
(63,284
)
 
(41,019
)
Principal payments – mortgage notes payable
(166,216
)
 
(2,266
)
Borrowings under construction loan
—

 
3,425

Notes payable repayments
—

 
(150,000
)
Payment of financing costs
(236
)
 
(3,755
)
Contributions from noncontrolling interests
—

 
5

Distributions to noncontrolling interests
(110
)
 
—

Net proceeds from equity offering
143,357

 
5,121

Net cash provided by (used in) financing activities
77,511

 
(53,489
)
Net (decrease) increase in cash and cash equivalents
(1,446
)
 
6,951

Cash and cash equivalents at beginning of period
23,825

 
15,827

Cash and cash equivalents at end of period
$
22,379

 
$
22,778

Supplemental disclosure of cash flow information:
 
 
 
Cash paid for interest, net of amounts capitalized
$
27,154

 
$
30,117

Change in accrued capital improvements and development costs
3,472

 
383


See accompanying notes to the consolidated financial statements.

8

WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2016
(UNAUDITED)

NOTE 1: NATURE OF BUSINESS

Washington Real Estate Investment Trust (“Washington REIT”), a Maryland real estate investment trust, is a self-administered, self-managed equity real estate investment trust, successor to a trust organized in 1960. Our business consists of the ownership and operation of income-producing real estate properties in the greater Washington metro region. We own a diversified portfolio of office buildings, multifamily buildings and retail centers.

Federal Income Taxes

We believe that we qualify as a real estate investment trust (“REIT”) under Sections 856-860 of the Internal Revenue Code and intend to continue to qualify as such. To maintain our status as a REIT, we are, among other things, required to distribute 90% of our REIT taxable income (which is, generally, our ordinary taxable income, with certain modifications), excluding any net capital gains and any deductions for dividends paid to our shareholders on an annual basis. When selling a property, we generally have the option of (a) reinvesting the sales proceeds of property sold, in a way that allows us to defer recognition of some or all taxable gain realized on the sale, (b) distributing the gain to the shareholders with no tax to us or (c) retaining our net long-term capital gain but treating it as having been distributed to our shareholders, paying the tax on the gain deemed distributed and allocating the tax paid as a credit to our shareholders. During the six months ended June 30, 2016, we sold the following properties:
Disposition Date
 
Property Name
 
Segment
 
Gain on Sale
(in thousands)
May 26, 2016
 
Dulles Station, Phase II (1)
 
Office
 
$
527

June 27, 2016
 
Maryland Office Portfolio Transaction I (2)
 
Office
 
23,585

 
 
 
 
Total
 
$
24,112

(1) 
Land held for future development and an interest in a parking garage.
(2) 
Maryland Office Portfolio Transaction I consists of 6110 Executive Boulevard, Wayne Plaza, 600 Jefferson Plaza and West Gude Drive. Maryland Office Portfolio Transaction II, which consists of 51 Monroe Street and One Central Plaza, is scheduled to close in September 2016.      

The taxable gains for the properties sold during the three months ended June 30, 2016 will be distributed to shareholders through the quarterly dividends. The properties included in Maryland Office Portfolio Transaction II have been identified for a reverse tax deferred exchange under Section 1031 of the Internal Revenue Code. We acquired the replacement property, Riverside Apartments, during the three months ended June 30, 2016 (see note 3, under "Acquisition").

Generally, and subject to our ongoing qualification as a REIT, no provisions for income taxes are necessary except for taxes on undistributed taxable income and taxes on the income generated by our taxable REIT subsidiaries (“TRSs”). Our TRSs are subject to corporate federal and state income tax on their taxable income at regular statutory rates, or as calculated under the alternative minimum tax, as appropriate. During the second quarter of 2016, we recognized an income tax benefit of $0.7 million from a reduction of the reserve for a deferred tax asset at one of our taxable REIT subsidiaries. As of June 30, 2016, our TRSs had net deferred tax assets of $0.6 million. Our TRSs had no net deferred tax assets as of December 31, 2015. As of June 30, 2016 and December 31, 2015, our TRSs had net deferred tax liabilities of $0.5 million and $0.7 million, respectively. These deferred tax liabilities are primarily related to temporary differences in the timing of the recognition of revenue, amortization and depreciation.

NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND BASIS OF PRESENTATIONS

Significant Accounting Policies

We have prepared our consolidated financial statements using the accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2015.

New Accounting Pronouncements


9

In June 2016, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update No. 2016-13, Measurement of Credit Losses on Financial Instruments, which requires financial assets measured at an amortized cost basis, including trade receivables, to be presented at the net amount expected to be collected. The new standard is effective for public entities for fiscal years beginning after December 15, 2019 and for interim periods therein with adoption one year earlier permitted. We are currently evaluating the impact the new standard may have on Washington REIT’s consolidated financial statements.

In March 2016, the FASB issued Accounting Standards Update No. 2016-09, Improvements to Employee Share-Based Payment Accounting, which amends existing accounting standards for employee share-based payments, including by allowing an employer to make a policy election to account for forfeitures as they occur or to continue to provide for an estimate as currently required. The new standard also allows an employer to withhold shares in a net settlement in an amount that does not exceed the maximum statutory tax rate in the employees' tax jurisdiction without causing liability classification. The new standard is effective for public entities for fiscal years beginning after December 15, 2016 and for interim periods therein with early adoption permitted. We are currently evaluating the impact the new standard may have on Washington REIT’s consolidated financial statements.

In February 2016, the FASB issued Accounting Standards Update No. 2016-05, Derivatives and Hedging (Topic 815), which clarifies that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument under Topic 815, in and of itself, does not require dedesignation of that hedging relationship provided that all other hedging criteria continue to be met. The new standard is effective for public entities for fiscal years beginning after December 15, 2016 and for interim periods therein with early adoption permitted. We are currently evaluating the impact the new standard may have on Washington REIT’s consolidated financial statements.

In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842), which amends existing accounting standards for lease accounting, including by requiring lessees to recognize most leases on the balance sheet and making certain changes to lessor accounting. The new standard is effective for public entities for fiscal years beginning after December 15, 2018 and for interim periods therein with early adoption permitted. We are currently evaluating the impact the new standard may have on Washington REIT’s consolidated financial statements.
  
In February 2015, the FASB issued Accounting Standards Update No. 2015-02, Consolidation (Topic 810), which changes the analysis an entity must perform to determine whether it should consolidate certain types of legal entities. Specifically, the new standard i) modifies the evaluation of whether limited partnerships and similar legal entities are variable interest entities ("VIEs") or voting interest entities, ii) eliminates the presumption that a general partner should consolidate a limited partnership and iii) affects the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships. The new standard is effective for public entities for fiscal years beginning after December 15, 2015 and for interim periods therein. We adopted the new standard on January 1, 2016, and the provisions of the new standard did not have any impact on the consolidation of our legal entities.

In June 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which creates a single source of revenue guidance. The new standard provides accounting guidance for all revenue arising from contracts with customers and affects all entities that enter into contracts to provide goods or services to their customers (unless the contracts are in the scope of other U.S. generally accepted accounting principles ("GAAP") requirements, such as the leasing literature). The guidance also provides a model for the measurement and recognition of gains and losses on the sale of certain nonfinancial assets, such as property and equipment, including real estate. The new standard is effective for public entities for fiscal years beginning after December 15, 2017 and for interim periods therein. Early adoption is permitted for public entities beginning after December 15, 2016. We are currently evaluating the impact the new standard may have on Washington REIT.

Principles of Consolidation and Basis of Presentation

The accompanying unaudited consolidated financial statements include the consolidated accounts of Washington REIT, our majority-owned subsidiaries and entities in which Washington REIT has a controlling interest, including where Washington REIT has been determined to be a primary beneficiary of a variable interest entity (“VIE”). See note 3 for additional information on the property for which there is a noncontrolling interest. All intercompany balances and transactions have been eliminated in consolidation.

We have prepared the accompanying unaudited financial statements pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to those rules and regulations, although we believe that the disclosures made are adequate to make the information presented not misleading. In addition, in the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the results for the periods

10

presented have been included. These unaudited financial statements should be read in conjunction with the financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2015.

Within these notes to the financial statements, we refer to the three months ended June 30, 2016 and June 30, 2015 as the “2016 Quarter” and the “2015 Quarter,” respectively, and the six months ended June 30, 2016 and June 30, 2015 as the "2016 Period" and "2015 Period," respectively.

Use of Estimates in the Financial Statements

The preparation of financial statements in conformity with GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

NOTE 3: REAL ESTATE

Acquisition

Our current strategy is focused on properties inside the Washington metro region’s Beltway, near major transportation nodes and in areas with strong employment drivers and superior growth demographics. We seek to upgrade our portfolio with acquisitions as opportunities arise. Properties and land for development acquired during the 2016 Period were as follows:
Acquisition Date
 
Property
 
Type
 
# of units (unaudited)
 
Contract
Purchase  Price
(In thousands)
May 20, 2016
 
Riverside Apartments
 
Multifamily
 
1,222
 
$
244,750


Riverside Apartments consists of apartment buildings and an adjacent parcel of land for potential future multifamily development. The purchase of Riverside Apartments was structured as a reverse exchange under Section 1031 of the Internal Revenue Code in a manner such that legal title is held by a Qualified Intermediary until certain identified properties are sold and the reverse exchange transaction is completed. We retain essentially all of the legal and economic benefits and obligations related to Riverside Apartments. As such, Riverside Apartments is considered to be a VIE until legal title is transferred to us upon completion of the 1031 exchange, which is expected during the third quarter of 2016. We have consolidated the assets and liabilities of Riverside Apartments because we have determined that Washington REIT is the primary beneficiary of the VIE. The results of operations from the acquired operating property are included in the consolidated statements of income (loss) as of the acquisition date and are as follows (in thousands):
 
Three and Six Months Ended June 30, 2016
Real estate rental revenue
$
2,484

Net income
583


We record the acquired physical assets (land, building and tenant improvements), in-place leases (absorption, tenant origination costs, leasing commissions, and net lease intangible assets/liabilities), and any other liabilities at their fair values.

We have recorded the total purchase price of the above acquisition as follows (in thousands):
Land
$
38,922

Land for development
15,969

Buildings
184,855

Leasing commissions/absorption costs
4,992

Net lease intangible assets
22

Net lease intangible liabilities
(10
)
Total
$
244,750

 
The weighted remaining average life for the 2016 acquisition components above, other than land and building, are 47 months for leasing commissions/absorption costs, 93 months for net lease intangible assets and 49 months for net lease intangible liabilities.


11

The difference in the total contract price of $244.8 million for the acquisition and the acquisition cost per the consolidated statements of cash flows of $243.4 million is primarily due to credits received at settlement totaling $1.4 million. The portion of the acquisition cost allocated to land for development is reported on the consolidated statements of cash flows as Development in progress.

The following unaudited pro-forma combined condensed statements of operations set forth the consolidated results of operations for the three and six months ended June 30, 2016 and 2015 as if the above-described acquisition in 2016 had occurred on January 1, 2015. The pro forma adjustments include reclassifying costs related to the above-described acquisition to 2015. The unaudited pro-forma information does not purport to be indicative of the results that actually would have occurred if the acquisitions had been in effect for the three and six months ended June 30, 2016 and 2015. The unaudited data presented is in thousands, except per share data.
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Real estate rental revenue
$
82,304

 
$
79,609

 
$
164,823

 
$
159,789

Net income (loss)
32,595

 
(1,136
)
 
36,389

 
29,765

Diluted net income (loss) per share
0.45

 
(0.02
)
 
0.52

 
0.43


Development/Redevelopment

In the office segment, we had a redevelopment project to renovate Silverline Center, an office property in Tysons, Virginia. As of June 30, 2016, we had invested $36.1 million in the renovation. We completed major construction activities on this project during the second quarter of 2015, and placed into service substantially completed portions of the project at that time totaling $25.9 million. The remaining components of the redevelopment project were placed into service as of March 31, 2016, one year from completion of major construction activities. We also currently have a redevelopment project to renovate the common areas and add amenities to the Army Navy Club Building, an office property in Washington, DC. As of June 30, 2016, we had invested $0.6 million in the redevelopment.
 
We have also begun predevelopment activities for the construction of a multifamily building on land adjacent to The Wellington in Arlington, Virginia. As of June 30, 2016, we had invested $16.7 million in the development.

Variable Interest Entities
 
In June 2011, we executed a joint venture operating agreement with a real estate development company to develop The Maxwell, a mid-rise multifamily property at 650 North Glebe Road in Arlington, Virginia. Major construction activities at The Maxwell ended during December 2014, and the building became available for occupancy during the first quarter of 2015. Washington REIT is the 90% owner of the joint venture. The real estate development company owns 10% of the joint venture and was responsible for the development and construction of the property.

We have determined that The Maxwell joint venture is a VIE primarily based on the fact that the equity investment at risk is not sufficient to permit the entity to finance its activities without additional financial support. As of December 31, 2015, $32.2 million was outstanding on The Maxwell's construction loan. In January 2016, Washington REIT exercised its right to purchase at par The Maxwell's construction loan from the original third-party lender. Upon the purchase, the loan became an intercompany payable from the consolidated VIE to Washington REIT that is eliminated in consolidation. We also determined that Washington REIT was the primary beneficiary of the VIE due to the fact that Washington REIT was determined to have a controlling financial interest in the entity.

We include joint venture land acquisitions and related capitalized development costs on our consolidated balance sheets in properties under development or held for future development until placed in service or sold. As of June 30, 2016 and December 31, 2015, The Maxwell's assets were as follows (in thousands):
 
June 30, 2016
 
December 31, 2015
Land
$
12,851

 
$
12,851

Income producing property
37,915

 
37,791

Accumulated depreciation and amortization
(3,457
)
 
(2,347
)
Other assets
823

 
1,188

 
$
48,132

 
$
49,483



12

As of June 30, 2016 and December 31, 2015, The Maxwell's liabilities were as follows (in thousands):
 
June 30, 2016
 
December 31, 2015
Mortgage notes payable
$
32,113

(1) 
$
32,214

Accounts payable and other liabilities
175

 
256

Tenant security deposits
86

 
82

 
$
32,374

 
$
32,552

(1) The mortgage notes payable balance as of June 30, 2016 is eliminated in consolidation due to the purchase of the loan by Washington REIT in January 2016.

Properties Sold and Held for Sale

We intend to hold our properties for investment with a view to long-term appreciation, to engage in the business of acquiring, developing and owning our properties, and to make occasional sales of the properties that no longer meet our long-term strategy or return objectives and where market conditions for sale are favorable. The proceeds from the sales may be reinvested into other properties, used to fund development operations or to support other corporate needs, or distributed to our shareholders. Depreciation on these properties is discontinued when classified as held for sale, but operating revenues, other operating expenses and interest continue to be recognized until the date of sale.

During the 2016 Quarter, we sold Dulles Station, Phase II, which consists of land held for future development and an interest in a parking garage in Herndon, Virginia, for $12.1 million. Also during the 2016 Quarter, we executed two purchase and sale agreements with a single buyer for the sale of a portfolio of six office properties located in Maryland: 6110 Executive Boulevard, Wayne Plaza, 600 Jefferson Plaza, West Gude Drive, 51 Monroe Street and One Central Plaza (collectively, the "Maryland Office Portfolio") for an aggregate contract sales price of $240.0 million. The buyer paid non-refundable deposits of $9.0 million and $1.0 million under the purchase and sale agreements for the first and second sale transactions, respectively. We closed on the first sale transaction in June 2016 and expect to close on the second sale transaction in September 2016. The properties in Maryland Office Portfolio Transaction II met the criteria for classification as held for sale as of June 30, 2016.

We sold or classified as held for sale the following properties in 2016 and 2015:
Disposition Date
 
Property Name
 
Segment
 
# of units
 
Rentable Square Feet
 
Contract
Sales  Price
(in thousands)
 
Gain on Sale
(in thousands)
May 26, 2016
 
Dulles Station, Phase II (1)
 
Office
 
N/A
 
N/A
 
$
12,100

 
$
527

June 27, 2016
 
Maryland Office Portfolio Transaction I (2)
 
Office
 
N/A
 
692,000
 
111,500

 
23,585

N/A
 
Maryland Office Portfolio Transaction II (3)
 
Office
 
N/A
 
491,000
 
128,500

 
N/A

 
 
 
 
Total 2016
 
 
 
1,183,000
 
$
252,100

 
$
24,112

 
 
 
 
 
 
 
 
 
 
 
 
 
March 20, 2015
 
Country Club Towers
 
Multifamily
 
227
 
N/A
 
$
37,800

 
$
30,277

September 9, 2015
 
1225 First Street (4)
 
Multifamily
 
N/A
 
N/A
 
14,500

 
—

October 21, 2015
 
Munson Hill Towers
 
Multifamily
 
279
 
N/A
 
57,050

 
51,395

December 14, 2015
 
Montgomery Village Center
 
Retail
 
N/A
 
197,000
 
27,750

 
7,981

 
 
 
 
Total 2015
 
506
 
197,000
 
$
137,100

 
$
89,653

(1) 
Land held for future development and an interest in a parking garage.
(2) 
Maryland Office Portfolio Transaction I consists of 6110 Executive Boulevard, 600 Jefferson Plaza, Wayne Plaza and West Gude Drive.
(3) 
Maryland Office Portfolio Transaction II consists of 51 Monroe Street and One Central Plaza, and is scheduled to close in September 2016.      
(4) 
Interest in land held for future development.



13

The Maryland Office Portfolio, in the aggregate, constitutes an individually significant disposition that does not qualify for presentation and disclosure as a discontinued operation as it does not represent a strategic shift in our operations. Real estate rental revenue and net income for the Maryland Office Portfolio for the three and six months ended June 30, 2016 and 2015 is as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Real estate rental revenue
$
8,147

 
$
8,288

 
$
16,577

 
$
15,882

Net income
4,176

 
2,719

 
6,902

 
4,437


We do not have significant continuing involvement in the operations of the disposed properties.

Casualty Gains

We recorded a net casualty gain of $0.7 million during the 2016 Quarter associated with a fire at Bethesda Hill Towers that damaged four units, which is included in casualty (gain) and real estate impairment loss, net on our Condensed Consolidated Statements of Income (Loss). The net casualty gain is comprised of $0.9 million in third-party insurance proceeds received by us, which were partially offset by casualty charges of $0.2 million to write off the net book value of the damaged units at Bethesda Hill Towers.

NOTE 4: MORTGAGE NOTES PAYABLE

In January 2016, we exercised our right to purchase the construction loan in the amount of $32.2 million secured by The Maxwell without penalty from the lender (see note 3, under "Variable Interest Entities").

In February 2016, we prepaid without penalty the remaining $50.9 million of the mortgage note secured by John Marshall II.

In June 2016, we repaid without penalty the remaining $81.0 million of mortgage notes secured by 3801 Connecticut Avenue, Bethesda Hill Apartments and Walker House Apartments.

NOTE 5: UNSECURED LINES OF CREDIT PAYABLE

We have a $600.0 million unsecured revolving credit agreement ("Revolving Credit Facility") that matures in June 2019, unless extended pursuant to one or both of the two six months extension options. The Revolving Credit Facility has an accordion feature, which we utilized a portion of in September 2015, as described below, that allows us to increase the facility to $1.0 billion, subject to the extent the lenders agree to provide additional revolving loan commitments or term loans. In September 2015, we entered into a $150.0 million unsecured term loan by executing a portion of the accordion feature under the Revolving Credit Facility. The term loan has a 5.5 year term and currently has an interest rate of one month LIBOR plus 110 basis points, based on Washington REIT's current unsecured debt ratings. We entered into two interest rate swaps to effectively fix the interest rate at 2.7% (see note 6).

The Revolving Credit Facility bears interest at a rate of either one month LIBOR plus a margin ranging from 0.875% to 1.55% or the base rate plus a margin ranging from 0.0% to 0.55% (in each case depending upon Washington REIT’s credit rating). The base rate is the highest of the administrative agent's prime rate, the federal funds rate plus 0.50% and the LIBOR market index rate plus 1.0%. In addition, the Revolving Credit Facility requires the payment of a facility fee ranging from 0.125% to 0.30% (depending on Washington REIT’s credit rating) on the $600.0 million committed capacity, without regard to usage. As of June 30, 2016, the interest rate on the facility is one month LIBOR plus 1.00% and the facility fee is 0.20%.

The amount of the Revolving Credit Facility's unsecured line of credit unused and available at June 30, 2016 is as follows (in thousands):
Committed capacity
$
600,000

Borrowings outstanding
(269,000
)
Letters of credit issued
—

Unused and available
$
331,000



14

We executed borrowings and repayments on the Revolving Credit Facility during the 2016 Period as follows (in thousands):
 
Revolving Credit Facility
Balance at December 31, 2015
$
105,000

Borrowings
398,000

Repayments
(234,000
)
Balance at June 30, 2016
$
269,000


NOTE 6: DERIVATIVE INSTRUMENTS

On September 15, 2015, we entered into two interest rate swap arrangements with a total notional amount of $150.0 million to swap the floating interest rate under our term loan (see note 5) to an all-in fixed interest rate of 2.7% starting on October 15, 2015 and extending until the maturity of the term loan on March 15, 2021. The interest rate swaps qualify as cash flow hedges and are recorded at fair value in accordance with GAAP, based on discounted cash flow methodologies and observable inputs. We record the effective portion of changes in fair value of the cash flow hedge in other comprehensive loss. The resulting unrealized loss on the effective portions of the cash flow hedges was the only activity in other comprehensive loss during the periods presented in our consolidated financial statements. We assess the effectiveness of our cash flow hedges both at inception and on an ongoing basis. The cash flow hedges were effective for the 2016 Quarter and hedge ineffectiveness did not impact earnings during the 2016 Quarter or 2016 Period. We had no derivative instruments outstanding during the 2015 Quarter or 2015 Period.
 
The fair value and balance sheet locations of the interest rate swap as of June 30, 2016 and December 31, 2015, are as follows (in thousands):
 
June 30, 2016
 
December 31, 2015
Accounts payable and other liabilities
$
5,609

 
$
550


The interest rate swaps have been effective since inception. The gain or loss on the effective swap is recognized in other comprehensive loss, as follows (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Unrealized loss on interest rate hedge
$
(1,384
)
 
$
—

 
$
(5,059
)
 
$
—


Amounts reported in accumulated other comprehensive loss related to derivatives will be reclassified to interest expense as interest payments are made on our variable-rate debt. During the next twelve months, we estimate that an additional $1.7 million will be reclassified as an increase to interest expense.

We have agreements with each of our derivative counterparties that contain a provision whereby we could be declared in default on our derivative obligations if repayment of the underlying indebtedness is accelerated by the lender due to our default on the indebtedness. As of June 30, 2016, the fair value of derivatives is in a net liability position of $5.6 million, which includes accrued interest but excludes any adjustment for nonperformance risk. As of June 30, 2016, we have not posted any collateral related to these agreements. If we had breached any of these provisions at June 30, 2016, we could have been required to settle our obligations under the agreements at their termination value of $5.6 million.

Derivative instruments expose us to credit risk in the event of non-performance by the counterparty under the terms of the interest rate hedge agreement. We believe that we minimize our credit risk on these transactions by dealing with major, creditworthy financial institutions. We monitor the credit ratings of counterparties and our exposure to any single entity, thus minimizing our credit risk concentration.

NOTE 7: FAIR VALUE DISCLOSURES

Assets and Liabilities Measured at Fair Value

For assets and liabilities measured at fair value on a recurring basis, quantitative disclosures about the fair value measurements are required to be disclosed separately for each major category of assets and liabilities, as follows:

Level 1: Quoted prices in active markets for identical assets

15

Level 2: Significant other observable inputs
Level 3: Significant unobservable inputs

The only assets or liabilities we had at June 30, 2016 and December 31, 2015 that are recorded at fair value on a recurring basis are the assets held in the Supplemental Executive Retirement Plan ("SERP"), which primarily consists of investments in mutual funds, and the interest rate swaps (see note 6).

We base the valuations related to the SERP on assumptions derived from significant other observable inputs and accordingly these valuations fall into Level 2 in the fair value hierarchy.

The valuation of the interest rate swaps is determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each interest rate swap. This analysis reflects the contractual terms of the interest rate swaps, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash payments (or receipts) and the discounted expected variable cash receipts (or payments). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. To comply with the provisions of ASC 820, we incorporate credit valuation adjustments in the fair value measurements to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk. These credit valuation adjustments were concluded to not be significant inputs for the fair value calculations for the periods presented. In adjusting the fair value of our derivative contracts for the effect of nonperformance risk, we have considered the impact of netting and any applicable credit enhancements, such as the posting of collateral, thresholds, mutual puts and guarantees. The valuation of interest rate swaps fall into Level 2 in the fair value hierarchy.

The fair values of these assets and liabilities at June 30, 2016 and December 31, 2015 were as follows (in thousands):
 
June 30, 2016
 
December 31, 2015
 
Fair
Value
 
Level 1
 
Level 2
 
Level 3
 
Fair
Value
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
SERP
$
1,556

 
$
—

 
$
1,556

 
$
—

 
$
1,408

 
$
—

 
$
1,408

 
$
—

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
$
5,609

 
$
—

 
$
5,609

 
$
—

 
$
550

 
$
—

 
$
550

 
$
—


Financial Assets and Liabilities Not Measured at Fair Value

The following disclosures of estimated fair value were determined by management using available market information and established valuation methodologies, including discounted cash flow. Many of these estimates involve significant judgment. The estimated fair value disclosed may not necessarily be indicative of the amounts we could realize on disposition of the financial instruments. The use of different market assumptions or estimation methodologies could have an effect on the estimated fair value amounts. In addition, fair value estimates are made at a point in time and thus, estimates of fair value subsequent to June 30, 2016 may differ significantly from the amounts presented.

Following is a summary of significant methodologies used in estimating fair values and a schedule of fair values at June 30, 2016 and December 31, 2015.

Cash and Cash Equivalents and Restricted Cash

Cash and cash equivalents and restricted cash include cash and commercial paper with original maturities of less than 90 days, which are valued at the carrying value, which approximates fair value due to the short maturity of these instruments (Level 1 inputs).

Notes Receivable

We acquired a note receivable ("2445 M Street note") in 2008 with the purchase of 2445 M Street. We estimate the fair value of the 2445 M Street note based on a discounted cash flow methodology using market discount rates (Level 3 inputs).


16

Debt

Mortgage notes payable consist of instruments in which certain of our real estate assets are used for collateral. We estimate the fair value of the mortgage notes payable by discounting the contractual cash flows at a rate equal to the relevant treasury rates (with respect to the timing of each cash flow) plus credit spreads estimated through independent comparisons to real estate assets or loans with similar characteristics. Lines of credit payable consist of our bank facility which we use for various purposes including working capital, acquisition funding and capital improvements. The lines of credit advances are priced at a specified rate plus a spread. We estimate the market value based on a comparison of the spreads of the advances to market given the adjustable base rate. We estimate the fair value of the notes payable by discounting the contractual cash flows at a rate equal to the relevant treasury rates (with respect to the timing of each cash flow) plus credit spreads derived using the relevant securities’ market prices. We classify these fair value measurements as Level 3 as we use significant unobservable inputs and management judgment due to the absence of quoted market prices.

As of June 30, 2016 and December 31, 2015, the carrying values and estimated fair values of our financial instruments were as follows (in thousands):
 
June 30, 2016
 
December 31, 2015
 
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
Cash and cash equivalents
$
22,379

 
$
22,379

 
$
23,825

 
$
23,825

Restricted cash
11,054

 
11,054

 
13,383

 
13,383

2445 M Street note receivable
3,539

 
3,655

 
3,849

 
4,275

Mortgage notes payable, net
252,044

 
259,779

 
418,052

 
426,693

Lines of credit
269,000

 
269,000

 
105,000

 
105,000

Notes payable, net
743,769

 
784,582

 
743,181

 
753,816


NOTE 8: STOCK BASED COMPENSATION

Washington REIT maintains short-term ("STIP") and long-term ("LTIP") incentive plans that allow for stock-based awards to officers and non-officer employees. Stock based awards are provided to officers and non-officer employees, as well as trustees, under the Washington Real Estate Investment Trust 2007 Omnibus Long-Term Incentive Plan which allows for awards in the form of restricted shares, restricted share units, options and other awards up to an aggregate of 2,000,000 shares over the ten-year period in which the plan will be in effect. Restricted share units are converted into shares of our stock upon full vesting through the issuance of new shares.

In February 2016, we adopted a revised long-term incentive plan ("New LTIP") for non-executive officers and other employees that replaced the previous long-term incentive plan for non-executive officers and other employees. The New LTIP is effective January 1, 2016 for performance years beginning on or after that date. Non-executive officers and other employees earn restricted share unit awards under the New LTIP based upon various percentages of their salaries and annual performance calculations. The restricted share unit awards vest ratably over three years beginning on the grant date based upon continued employment. We initially measure compensation expense for awards under the New LTIP based on the fair value at the grant date, and recognize compensation expense for these awards according to a graded vesting schedule over the three-year requisite service period.

Total Compensation Expense

Total compensation expense recognized in the consolidated financial statements for all outstanding share based awards was $0.9 million and $1.2 million for the 2016 Quarter and 2015 Quarter, respectively, and $2.4 million and $3.1 million for the 2016 Period and 2015 Period, respectively.

Restricted Share Awards

The total fair values of restricted share awards vested was $2.5 million and $2.3 million for the 2016 Period and 2015 Period, respectively.

The total unvested restricted share awards at June 30, 2016 was 237,919 shares, which had a weighted average grant date fair value of $26.38 per share. As of June 30, 2016, the total compensation cost related to unvested restricted share awards was $3.3 million, which we expect to recognize over a weighted average period of 23 months.

17


NOTE 9: EARNINGS PER COMMON SHARE

We determine “Basic earnings per share” using the two-class method as our unvested restricted share awards and units have non-forfeitable rights to dividends, and are therefore considered participating securities. We compute basic earnings per share by dividing net income attributable to the controlling interest less the allocation of undistributed earnings to unvested restricted share awards and units by the weighted-average number of common shares outstanding for the period.

We also determine “Diluted earnings per share” as the more dilutive of the two-class method or the treasury stock method with respect to the unvested restricted share awards. We further evaluate any other potentially dilutive securities at the end of the period and adjust the basic earnings per share calculation for the impact of those securities that are dilutive. Our diluted earnings per share calculation includes the dilutive impact of our share based awards with performance conditions prior to the grant date and all market condition awards under the contingently issuable method.

The computations of basic and diluted earnings per share for the three and six months ended June 30, 2016 and 2015 were as follows (in thousands, except per share data):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Numerator:
 
 
 
 
 
 
 
Net income (loss)
$
31,821

 
$
(2,886
)
 
$
34,200

 
$
26,512

Net loss attributable to noncontrolling interests in subsidiaries
15

 
340

 
20

 
448

Allocation of earnings to unvested restricted share awards
(99
)
 
(80
)
 
(155
)
 
(165
)
Adjusted net income (loss) attributable to the controlling interests
$
31,737

 
$
(2,626
)
 
$
34,065

 
$
26,795

Denominator:
 
 
 
 

 

Weighted average shares outstanding – basic
71,719

 
68,176

 
70,010

 
68,159

Effect of dilutive securities:
 
 
 
 
 
 
 
Employee restricted share awards
193

 
—

 
190

 
124

Weighted average shares outstanding – diluted
71,912

 
68,176

 
70,200

 
68,283

 
 
 
 
 
 
 
 
Basic net income (loss) attributable to the controlling interests per common share
$
0.44

 
$
(0.04
)
 
$
0.49

 
$
0.39

Diluted net income (loss) attributable to the controlling interests per common share
$
0.44

 
$
(0.04
)
 
$
0.49

 
$
0.39


NOTE 10: SEGMENT INFORMATION

We have three reportable segments: office, multifamily and retail. Office properties provide office space for various types of businesses and professions. Multifamily properties provide rental housing for individuals and families throughout the Washington metro region. Retail properties are typically grocery store-anchored neighborhood centers that include other small shop tenants or regional power centers with several junior box tenants.

We evaluate performance based upon net operating income from the combined properties in each segment. Our reportable operating segments are consolidations of similar properties. GAAP requires that segment disclosures present the measure(s) used by the chief operating decision maker for purposes of assessing segments’ performance. Net operating income is a key measurement of our segment profit and loss. Net operating income is defined as segment real estate rental revenue less segment real estate expenses.

The following tables present revenues, net operating income, capital expenditures and total assets for the three and six months ended June 30, 2016 and 2015 from these segments, and reconcile net operating income of reportable segments to net income attributable to the controlling interests as reported (in thousands):

18

 
Three Months Ended June 30, 2016
 
Office
 
Retail
 
Multifamily
 
Corporate and Other
 
Consolidated
Real estate rental revenue
$
43,737

 
$
15,080

 
$
20,588

 
$
—

 
$
79,405

Real estate expenses
16,594

 
3,684

 
7,897

 
—

 
28,175

Net operating income
$
27,143

 
$
11,396

 
$
12,691

 
$
—

 
$
51,230

Depreciation and amortization
 
 
 
 
 
 
 
 
(25,161
)
General and administrative
 
 
 
 
 
 
 
 
(4,968
)
Acquisition costs
 
 
 
 
 
 
 
 
(1,024
)
Interest expense
 
 
 
 
 
 
 
 
(13,820
)
Other income
 
 
 
 
 
 
 
 
83

Gain on sale of real estate
 
 
 
 
 
 
 
 
24,112

Casualty gain and real estate impairment (loss), net
 
 
 
 
 
 
 
 
676

Income tax benefit
 
 
 
 
 
 
 
 
693

Net income
 
 
 
 
 
 
 
 
31,821

Less: Net loss attributable to noncontrolling interests in subsidiaries
 
 
 
 
 
 
 
 
15

Net income attributable to the controlling interests
 
 
 
 
 
 
 
 
$
31,836

Capital expenditures
$
5,854

 
$
3,588

 
$
2,198

 
$
29

 
$
11,669

Total assets
$
1,151,041

 
$
352,094

 
$
769,592

 
$
33,724

 
$
2,306,451

 
Three Months Ended June 30, 2015
 
Office
 
Retail
 
Multifamily
 
Corporate
and Other
 
Consolidated
Real estate rental revenue
$
43,143

 
$
15,740

 
$
15,343

 
$
—

 
$
74,226

Real estate expenses
16,842

 
3,702

 
6,685

 
—

 
27,229

Net operating income
$
26,301

 
$
12,038

 
$
8,658

 
$
—

 
$
46,997

Depreciation and amortization
 
 
 
 
 
 
 
 
(25,503
)
Acquisition costs
 
 
 
 
 
 
 
 
(992
)
General and administrative
 
 
 
 
 
 
 
 
(4,278
)
Interest expense
 
 
 
 
 
 
 
 
(14,700
)
Other income
 
 
 
 
 
 
 
 
192

Gain on sale of real estate
 
 
 
 
 
 
 
 
1,454

Income tax expense
 
 
 
 
 
 
 
 
(28
)
Loss on extinguishment of debt
 
 
 
 
 
 
 
 
(119
)
Casualty gain and real estate impairment (loss), net
 
 
 
 
 
 
 
 
(5,909
)
Net loss
 
 
 
 
 
 
 
 
(2,886
)
Less: Net loss attributable to noncontrolling interests in subsidiaries
 
 
 
 
 
 
 
 
340

Net loss attributable to the controlling interests
 
 
 
 
 
 
 
 
$
(2,546
)
Capital expenditures
$
6,092

 
$
649

 
$
869

 
$
460

 
$
8,070

Total assets
$
1,273,256

 
$
376,087

 
$
392,758

 
$
43,288

 
$
2,085,389



19

 
Six Months Ended June 30, 2016
 
Office
 
Retail
 
Multifamily
 
Corporate
and Other
 
Consolidated
Real estate rental revenue
$
87,555

 
$
30,460

 
$
38,527

 
$
—

 
$
156,542

Real estate expenses
33,669

 
8,090

 
15,150

 
—

 
56,909

Net operating income
$
53,886

 
$
22,370

 
$
23,377

 
$
—

 
$
99,633

Depreciation and amortization
 
 
 
 
 
 
 
 
(51,199
)
Interest expense
 
 
 
 
 
 
 
 
(28,180
)
General and administrative
 
 
 
 
 
 
 
 
(10,479
)
Other income
 
 
 
 
 
 
 
 
122

Acquisition costs
 
 
 
 
 
 
 
 
(1,178
)
Gain on sale of real estate, continuing operations
 
 
 
 
 
 
 
 
24,112

Casualty gain and real estate impairment (loss), net
 
 
 
 
 
 
 
 
676

Income tax benefit
 
 
 
 
 
 
 
 
693

Net income
 
 
 
 
 
 
 
 
34,200

Less: Net loss attributable to noncontrolling interests in subsidiaries
 
 
 
 
 
 
 
 
20

Net income attributable to the controlling interests
 
 
 
 
 
 
 
 
$
34,220

Capital expenditures
8,025

 
4,131

 
4,200

 
42

 
16,398

 
Six Months Ended June 30, 2015
 
Office
 
Retail
 
Multifamily
 
Corporate
and Other
 
Consolidated
Real estate rental revenue
$
85,639

 
$
32,070

 
$
31,373

 
$
—

 
$
149,082

Real estate expenses
33,985

 
8,489

 
13,963

 
—

 
56,437

Net operating income
$
51,654

 
$
23,581

 
$
17,410

 
$
—

 
$
92,645

Depreciation and amortization
 
 
 
 
 
 
 
 
(50,778
)
Interest expense
 
 
 
 
 
 
 
 
(30,048
)
General and administrative
 
 
 
 
 
 
 
 
(10,358
)
Acquisition costs
 
 
 
 
 
 
 
 
(1,008
)
Gain on sale of real estate
 
 
 
 
 
 
 
 
31,731

Other income
 
 
 
 
 
 
 
 
384

Gain (loss) on extinguishment of debt, net
 
 
 
 
 
 
 
 
(119
)
Casualty gain and real estate impairment (loss), net
 
 
 
 
 
 
 
 
(5,909
)
Income tax benefit (expense)
 
 
 
 
 
 
 
 
(28
)
Net income
 
 
 
 
 
 
 
 
26,512

Less: Net loss attributable to noncontrolling interests in subsidiaries
 
 
 
 
 
 
 
 
448

Net income attributable to the controlling interests
 
 
 
 
 
 
 
 
$
26,960

Capital expenditures
$
8,610

 
$
1,499

 
$
2,282

 
$
1,836

 
$
14,227


NOTE 11: SUBSEQUENT EVENTS

Subsequent to the end of the 2016 Quarter, we entered into a seven year, $150.0 million unsecured term loan maturing on July 21, 2023 with a deferred draw period of up to six months. We have not yet executed any draws on this unsecured term loan. We also entered into interest rate derivatives to swap from a LIBOR plus 165 basis points floating rate to a 2.86% all-in fixed interest rate commencing on March 31, 2017.

20

ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto appearing in Item 1 of this report and the more detailed information contained in our Annual Report on Form 10-K for the year ended December 31, 2015 filed with the Securities and Exchange Commission on February 26, 2016.

We refer to the three months ended June 30, 2016 and June 30, 2015 as the “2016 Quarter” and the “2015 Quarter,” respectively, and the six months ended June 30, 2016 and June 30, 2015 as the "2016 Period" and "2015 Period," respectively.

Forward-Looking Statements

This Form 10-Q contains forward-looking statements which involve risks and uncertainties. Forward-looking statements include statements in this report preceded by, followed by or that include the words “believe,” “expect,” “intend,” “anticipate,” “potential,” “project,” “will” and other similar expressions. We claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 for these statements. The following important factors, in addition to those discussed elsewhere in this Form 10-Q, could affect our future results and could cause those results to differ materially from those expressed in the forward-looking statements: (a) the effect of credit and financial market conditions; (b) the availability and cost of capital; (c) fluctuations in interest rates; (d) the economic health of our tenants; (e) the timing and pricing of lease transactions; (f) the economic health of the greater Washington metro region, or other markets we may enter; (g) changes in real estate and zoning laws and increases in property tax rates; (h) the effects of changes in federal government spending; (i) the supply of competing properties; (j) consumer confidence; (k) unemployment rates; (l) consumer tastes and preferences; (m) our future capital requirements; (n) inflation; (o) compliance with applicable laws, including those concerning the environment and access by persons with disabilities; (p) governmental or regulatory actions and initiatives; (q) changes in general economic and business conditions; (r) terrorist attacks or actions; (s) acts of war; (t) weather conditions and natural disasters; (u) failure to qualify as a REIT; (v) the availability of and our ability to attract and retain qualified personnel; (w) the effects of changes in capital available to the technology and biotechnology sectors of the economy and (x) other factors discussed under the caption “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2015 filed with the Securities and Exchange Commission on February 26, 2016. We undertake no obligation to update our forward-looking statements or risk factors to reflect new information, future events, or otherwise.

General

Introductory Matters

We provide our Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) in addition to the accompanying consolidated financial statements and notes to assist readers in understanding our results of operations and financial condition. We organize the MD&A as follows:

•
Overview. Discussion of our business outlook, operating results, investment activity, financing activity and capital requirements to provide context for the remainder of MD&A.
•
Results of Operations. Discussion of our financial results comparing the 2016 Quarter to the 2015 Quarter and the 2016 Period to the 2015 Period.
•
Liquidity and Capital Resources. Discussion of our financial condition and analysis of changes in our capital structure and cash flows.
•
Funds From Operations. Calculation of NAREIT Funds From Operations ("NAREIT FFO"), a non-GAAP supplemental measure to net income.
•
Critical Accounting Policies and Estimates. Descriptions of accounting policies that reflect significant judgments and estimates used in the preparation of our consolidated financial statements.

When evaluating our financial condition and operating performance, we focus on the following financial and non-financial indicators:

•
Net operating income (“NOI”), calculated as real estate rental revenue less real estate expenses excluding depreciation and amortization and general and administrative expenses. NOI is a non-GAAP supplemental measure to net income.
•
NAREIT FFO, calculated as set forth below under the caption “Funds from Operations.”
•
Occupancy, calculated as occupied square footage as a percentage of total square footage as of the last day of that period.

21

•
Leased percentage, calculated as the percentage of available physical net rentable area leased for our office and retail segments and percentage of apartments leased for our multifamily segment.
•
Rental rates.
•
Leasing activity, including new leases, renewals and expirations.

For purposes of evaluating comparative operating performance, we categorize our properties as “same-store”, “non-same-store” or discontinued operations. A "same-store" property is one that was owned for the entirety of 2016 and the prior year, and excludes properties under redevelopment or development and properties purchased or sold at any time during 2016 or the prior year. A "non-same-store" property is one that was acquired, under redevelopment or development, or placed into service during 2016 or the prior year. We define redevelopment properties as those for which we expect to spend significant development and construction costs on existing or acquired buildings pursuant to a formal plan which has a current impact on operating results, occupancy and the ability to lease space with the intended result of a higher economic return on the property. Properties under redevelopment or development are included within the non-same-store properties beginning in the period during which redevelopment or development activities commence. We consider properties to no longer be under redevelopment or development upon substantial completion of redevelopment or development activities, and the earlier of achieving 90% occupancy or two years after substantial completion.

Overview

Business Outlook

Our revenues are derived primarily from the ownership and operation of income-producing properties in the greater Washington metro region. As of June 30, 2016, we owned a diversified portfolio of 51 properties, totaling approximately 6.5 million square feet of commercial space and 4,480 multifamily units, and land held for development. These 51 properties consisted of 21 office properties, 16 retail centers and 14 multifamily properties.

In accordance with our strategy of recycling legacy assets to invest in high-quality assets with compelling value-add returns, in April 2016 we executed two purchase and sale agreements with a single buyer for the sale of a portfolio of six office properties located in Maryland: 51 Monroe Street, 6110 Executive Boulevard, Wayne Plaza, 600 Jefferson Plaza, One Central Plaza and West Gude Drive (collectively, the "Maryland Office Portfolio") for an aggregate contract sale price of $240.0 million. We closed on the first sale transaction for four of the properties in June, and expect to close on the second sale transaction in September 2016. In May 2016, we acquired a multifamily property with further development potential in Alexandria, Virginia, for $244.8 million (see "Investment Activity" below).

Operating Results

Net income attributable to the controlling interests, NOI and NAREIT FFO for the three months ended June 30, 2016 and 2015 were as follows (in thousands): 
 
Three Months Ended June 30,
 
 
 
 
 
2016
 
2015
 
$ Change
 
% Change
Net income (loss) attributable to the controlling interests
$
31,836

 
$
(2,546
)
 
$
34,382

 
(1,350.4
)%
NOI (1)
$
51,230

 
$
46,997

 
$
4,233

 
9.0
 %
NAREIT FFO (2)
$
32,870

 
$
22,617

 
$
10,253

 
45.3
 %
 
 
 
 
 
 
 
 
(1) See page 24 of the MD&A for a reconciliation of NOI to net income.
(2) See page 34 of the MD&A for a reconciliation of NAREIT FFO to net income.
 

The higher net income attributable to the controlling interests is primarily due to higher gains on sale of real estate ($22.7 million) and higher NOI ($4.2 million) in the 2016 Quarter and a property impairment ($5.9 million) recognized in the 2015 Quarter.

The increase in NOI is primarily due to acquisitions ($3.7 million) and the lease-up of The Maxwell ($0.5 million), partially offset by the property sales during 2015 and 2016 ($1.6 million). Same-store NOI increased by $1.6 million primarily due to higher rental rates ($1.1 million), lower bad debt ($0.5 million), higher reimbursements ($0.3 million), lower administrative expenses ($0.3 million) and higher parking income ($0.2 million), partially offset by lower occupancy ($0.9 million). Same-store physical occupancy decreased to 92.7% as of June 30, 2016, from 93.3% one year ago, primarily due to lower occupancy in the retail segment.

22

The higher NAREIT FFO is primarily attributable to the higher NOI ($4.2 million) in the 2016 Quarter and a property impairment ($5.9 million) recognized in the 2015 Quarter.

Investment Activity

Significant investment transactions during the 2016 Period included the following:
•
The acquisition of Riverside Apartments, a multifamily property consisting of three buildings totaling 1,222 units in Alexandria, Virginia, and an adjacent undeveloped land parcel with potential to develop approximately 550 additional units, in May 2016 for a contract purchase price of $244.8 million. We incurred $1.2 million of acquisition costs.
•
The sale of Dulles Station, Phase II, which consisted of land held for future development and an interest in a parking garage in Herndon, Virginia, in May 2016 for $12.1 million. We recognized a gain on sale of real estate of $0.5 million.
•
The execution of the first sale transaction with respect to the Maryland Office Portfolio (for the sale of 6110 Executive Boulevard, Wayne Plaza, 600 Jefferson Plaza and West Gude Drive) in June 2016 for $111.5 million. We recognized a gain on sale of real estate of $23.6 million.

Financing Activity

Significant financing transactions during the 2016 Period included the following:
•
The exercise of our right to purchase the $32.2 million construction loan secured by The Maxwell without penalty from the lender in January 2016.
•
The prepayment at par of the remaining $50.9 million of the mortgage note secured by John Marshall II in February 2016.
•
The issuance in May 2016 of approximately 5.3 million common shares at a price to the public of $28.20 per share, for net proceeds of approximately $143.4 million.
•
The repayment of the remaining $81.0 million of mortgage notes secured by 3801 Connecticut Avenue, Bethesda Hill Apartments and Walker House Apartments in June 2016.

Subsequent to the end of the 2016 Quarter, we entered into a seven year, $150 million unsecured term loan maturing on July 21, 2023 with a deferred draw period of up to six months. We expect to draw on the term loan in the fourth quarter of 2016 or early in January 2017 to refinance maturing secured debt. We also entered into interest rate derivatives to swap from a LIBOR plus 165 basis points floating rate to a 2.86% all-in fixed interest rate commencing on March 31, 2017.

As of June 30, 2016, the interest rate on the Revolving Credit Facility was one month LIBOR plus 1.00% and the facility fee was 0.20%. As of July 28, 2016, our Revolving Credit Facility has a borrowing capacity of $335.0 million.

Capital Requirements

As of the end of the 2016 Quarter, we do not have any scheduled debt maturities during the remainder of 2016, though we do have mortgage notes totaling approximately $101.9 million that may be prepaid without penalty beginning on October 6, 2016. We also expect to have the additional capital requirements as set forth on page 32 (Liquidity and Capital Resources - Capital Requirements).

Results of Operations

The discussion that follows is based on our consolidated results of operations for the 2016 Quarter and 2015 Quarter and 2016 Period and 2015 Period. The ability to compare one period to another is significantly affected by acquisitions completed and dispositions made during 2016 and 2015 (see note 3 to the consolidated financial statements).
Net Operating Income

NOI is a non-GAAP measure calculated as real estate rental revenue less real estate expenses excluding depreciation and amortization and general and administrative expenses. NOI is the primary performance measure we use to assess the results of our operations at the property level. We believe that NOI is useful as a performance measure because, when compared across periods, NOI reflects the impact on operations of trends in occupancy rates, rental rates and operating costs on an unleveraged basis, providing perspective not immediately apparent from net income. NOI excludes certain components from net income in order to provide results more closely related to a property’s results of operations. For example, interest expense is not necessarily linked to the operating performance of a real estate asset. In addition, depreciation and amortization, because of historical cost accounting and useful life estimates, may distort operating performance at the property level. As a result of the foregoing, we provide NOI as a supplement to net income, calculated in accordance with GAAP. NOI does not represent net income or income

23

from continuing operations, in either case calculated in accordance with GAAP. As such, it should not be considered an alternative to these measures as an indication of our operating performance. A reconciliation of NOI to net income follows.

2016 Quarter Compared to 2015 Quarter

The following tables reconcile NOI to net income (loss) attributable to the controlling interests and provide the basis for our discussion of our consolidated results of operations and NOI in the 2016 Quarter compared to the 2015 Quarter. All amounts are in thousands except percentage amounts.
 
 
 
 
 
 
 
 
 
Non-Same-Store
 
 
 
 
 
 
 
 
 
Same-Store
 
 
 
 
 
Acquisitions (1)
 
Development/Redevelopment (2)
 
Dispositions (3)
 
All Properties
 
 
 
2016
 
2015
 
$ 
Change
 
% 
Change
 
2016
 
2015
 
2016
 
2015
 
2016
 
2015
 
2016
 
2015
 
$ 
Change
 
% 
Change
Real estate rental revenue
$
64,473

 
$
63,224

 
$
1,249

 
2.0
 %
 
$
5,799

 
$
—

 
$
4,966

 
$
4,552

 
$
4,167

 
$
6,450

 
$
79,405

 
$
74,226

 
$
5,179

 
7.0
 %
Real estate expenses
21,840

 
22,183

 
(343
)
 
(1.5
)%
 
2,123

 
—

 
2,394

 
2,524

 
1,818

 
2,522

 
28,175

 
27,229

 
946

 
3.5
 %
NOI
$
42,633

 
$
41,041

 
$
1,592

 
3.9
 %
 
$
3,676

 
$
—

 
$
2,572

 
$
2,028

 
$
2,349

 
$
3,928

 
$
51,230

 
$
46,997

 
$
4,233

 
9.0
 %
Reconciliation to net income attributable to the controlling interests:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Depreciation and amortization
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(25,161
)
 
(25,503
)
 
342

 
(1.3
)%
Acquisition costs
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1,024
)
 
(992
)
 
(32
)
 
3.2
 %
General and administrative expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(4,968
)
 
(4,278
)
 
(690
)
 
16.1
 %
Casualty gain and impairment (loss), net
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
676

 
(5,909
)
 
6,585

 
(111.4
)%
Gain on sale of real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
24,112

 
1,454

 
22,658

 
1,558.3
 %
Interest expense
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(13,820
)
 
(14,700
)
 
880

 
(6.0
)%
Other income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
83

 
192

 
(109
)
 
(56.8
)%
Loss on extinguishment of debt
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
—

 
(119
)
 
119

 
—

Income tax benefit (expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
693

 
(28
)
 
721

 
(2,575.0
)%
Net income (loss)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
31,821

 
(2,886
)
 
34,707

 
(1,202.6
)%
Less: Net loss attributable to noncontrolling interests
 
 
 
 
 
 
 
 
 
 
 
 
 
15

 
340

 
(325
)
 
(95.6
)%
Net income (loss) attributable to the controlling interests
 
 
 
 
 
 
 
 
 
 
 
 
 
$
31,836

 
$
(2,546
)
 
$
34,382

 
(1,350.4
)%
 
(1) 
Acquisitions:
2016 Multifamily – Riverside Apartments
2015 Multifamily – The Wellington

(2) 
Development/redevelopment properties:
Multifamily development property – The Maxwell
Office redevelopment properties – Silverline Center and Army Navy Club Building

(3) 
Dispositions (classified as continuing operations):
2016 Office – 6110 Executive Boulevard, 600 Jefferson Plaza, Wayne Plaza and West Gude Drive
2015 Multifamily – Country Club Towers and Munson Hill Towers    
2015 Retail – Montgomery Village Center

Real Estate Rental Revenue

Real estate rental revenue is comprised of (a) minimum base rent, which includes rental revenues recognized on a straight-line basis, (b) revenue from the recovery of operating expenses from our tenants, (c) provisions for doubtful accounts in the same quarter that we established the receivable, which include provisions for straight-line receivables, (d) revenue from the collection of lease termination fees and (e) parking and other tenant charges such as percentage rents.


24

Real estate rental revenue for same-store properties for the three and six months ended June 30, 2016 and 2015 was as follows (in thousands):
 
Three Months Ended June 30,
 
 
 
 
 
2016
 
2015
 
$ Change
 
% Change
Minimum base rent
$
53,794

 
$
53,735

 
$
59

 
0.1
 %
Recoveries from tenants
7,212

 
6,882

 
330

 
4.8
 %
Provision for doubtful accounts
(63
)
 
(407
)
 
344

 
(84.5
)%
Lease termination fees
183

 
46

 
137

 
297.8
 %
Parking and other tenant charges
3,347

 
2,968

 
379

 
12.8
 %
Total same-store real estate rental revenue
$
64,473

 
$
63,224

 
$
1,249

 
2.0
 %

•
Minimum base rent: Increase primarily due to higher rental rates ($1.1 million), partially offset by lower occupancy ($0.9 million) and higher rent abatements ($0.2 million).
•
Recoveries from tenants: Increase primarily due to higher reimbursements for operating expenses ($0.2 million) and real estate taxes ($0.1 million).
•
Provision for doubtful accounts: Decrease primarily due to lower provisions in the office ($0.2 million) and retail segments ($0.1 million).
•
Lease termination fees: Increase primarily due to higher fees in the office segment ($0.1 million).
•
Parking and other tenant charges: Increase primarily due to higher parking income ($0.2 million), primarily in the office segment, and short-term rents ($0.1 million) in the retail segment.

Real estate rental revenue from same-store properties by segment was as follows (in thousands):
 
Three Months Ended June 30,
 
 
 
 
 
2016
 
2015
 
$ Change
 
% Change
Office
$
35,590

 
$
34,658

 
$
932

 
2.7
%
Multifamily
13,803

 
13,626

 
177

 
1.3
%
Retail
15,080

 
14,940

 
140

 
0.9
%
Total same-store real estate rental revenue
$
64,473

 
$
63,224

 
$
1,249

 
2.0
%

•
Office: Increase primarily due to higher rental rates ($0.7 million), higher reimbursements for operating expenses ($0.3 million) and lower provisions for uncollectible revenue ($0.2 million), partially offset by lower occupancy ($0.2 million) and higher rent abatements ($0.2 million).
•
Multifamily: Increase primarily due to higher tenant fees ($0.2 million).
•
Retail: Increase primarily due to higher rental rates ($0.4 million), higher reimbursements for real estate taxes ($0.2 million) and lower provisions for uncollectible revenue ($0.1 million), partially offset by lower occupancy ($0.7 million).

Real estate rental revenue from acquisitions increased due to the acquisitions of The Wellington in the third quarter of 2015 and Riverside Apartments in the 2016 Quarter.

Real estate rental revenue from development/redevelopment properties increased primarily due to leasing up The Maxwell ($0.6 million) and higher rental rates ($0.3 million) and occupancy ($0.2 million) at Silverline Center, partially offset by lower occupancy ($0.4 million) and rental rates ($0.1 million) at the Army Navy Club Building, which is under redevelopment.

Occupancy represents occupied square footage indicated as a percentage of total square footage as of the last day of that period. Occupancy by segment for the 2016 Quarter and 2015 Quarter was as follows:
 
June 30, 2016
 
June 30, 2015
 
Increase (decrease)
Segment
Same-Store
 
Non-Same-Store
 
Total
 
Same-Store
 
Non-Same-Store
 
Total
 
Same-Store
 
Non-Same-Store
 
Total
Office
91.8
%
 
63.8
%
 
87.5
%
 
92.2
%
 
75.5
%
 
87.6
%
 
(0.4
)%
 
(11.7
)%
 
(0.1
)%
Multifamily
94.8
%
 
94.0
%
 
94.4
%
 
94.3
%
 
78.2
%
 
91.7
%
 
0.5
 %
 
15.8
 %
 
2.7
 %
Retail
92.1
%
 
N/A

 
92.1
%
 
94.1
%
 
78.7
%
 
92.9
%
 
(2.0
)%
 
N/A

 
(0.8
)%
Total
92.7
%
 
86.5
%
 
91.1
%
 
93.3
%
 
76.4
%
 
90.0
%
 
(0.6
)%
 
10.1
 %
 
1.1
 %


25

•
Office: The decrease in same-store occupancy was primarily due to lower occupancy at 1776 G Street and Quantico Corporate Center, partially offset by higher occupancy at 1775 Eye Street and 1600 Wilson Boulevard. The decrease in non-same-store occupancy was primarily due to lower occupancy at the Army Navy Club Building, which is under redevelopment, partially offset by higher occupancy at Silverline Center.
•
Multifamily: The increase in same-store occupancy was primarily due to higher occupancy at Yale West, partially offset by lower occupancy at The Ashby. The increase in non-same-store occupancy was primarily due to the lease-up of The Maxwell.
•
Retail: The decrease in same-store occupancy was primarily due to lower occupancy at the Centre at Hagerstown, Spring Valley Shopping Center and Bradlee Shopping Center, partially offset by higher occupancy at Concord Centre.

During the 2016 Quarter, we executed new and renewal leases in our office and retail segments as follows:
 
Square Feet
(in thousands)
 
Average Rental Rate
(per square foot)
 
% Rental Rate Increase
 
Incentives (1) 
(per square foot)
 
Retention Rate
Office
59

 
$
37.01

 
14.3
%
 
$
50.40

 
30.9
%
Retail
15

 
36.18

 
16.4
%
 
19.95

 
17.5
%
Total
74

 
36.83

 
14.8
%
 
44.09

 
29.4
%
(1) Incentives include tenant improvements, leasing commissions and leasing incentives, including free rent.

Real Estate Expenses

Real estate expenses as a percentage of revenue for the 2016 Quarter and 2015 Quarter were 35.5% and 36.7%, respectively.

Real estate expenses from same-store properties by segment were as follows (in thousands):
 
Three Months Ended June 30,
 
 
 
 
 
2016
 
2015
 
$ Change
 
% Change
Office
$
12,751

 
$
13,046

 
$
(295
)
 
(2.3
)%
Multifamily
5,405

 
5,694

 
(289
)
 
(5.1
)%
Retail
3,684

 
3,443

 
241

 
7.0
 %
Total same-store real estate expenses
$
21,840

 
$
22,183

 
$
(343
)
 
(1.5
)%

•
Office: Decrease primarily due to lower utilities ($0.1 million), administrative ($0.1 million) and real estate tax ($0.1 million) expenses.
•
Multifamily: Decrease primarily due to lower administrative ($0.2 million) and repairs and maintenance ($0.1 million) expenses.
•
Retail: Increase primarily due to higher real estate taxes ($0.2 million).

Other Income and Expenses

Depreciation and Amortization: Decrease primarily due to classifying the Maryland Office Portfolio as held for sale and stopping depreciation on the assets during the 2016 Quarter ($2.0 million) and lower depreciation and amortization at same-store properties ($0.4 million) primarily due to lower amortization of acquired intangible lease assets, partially offset by the acquisition of The Wellington and Riverside Apartments ($2.1 million).

Acquisition Costs: Increase primarily due to the settlement of the Riverside Apartments acquisition in the 2016 Quarter, partially offset by due diligence costs during the 2015 Quarter associated with The Wellington acquisition.

General and Administrative Expenses: Increase primarily due to a higher estimate of short-term incentive compensation ($0.7 million).

Casualty gain and impairment (loss), net: The casualty gain in the 2016 Quarter represents the gain recognized upon the receipt of insurance proceeds related to damage from a fire at Bethesda Hill Towers during the first quarter of 2015 that damaged four units. The impairment loss in the 2015 Quarter reduced the carrying value of our interest in a joint venture to develop a multifamily property at 1225 First Street to its estimated fair value. We subsequently disposed of our interest in the joint venture during the third quarter of 2015.


26

Gain on sale of real estate: Increase due to settling on the sales of Dulles Station II, 6110 Executive Boulevard, 51 Monroe Street, 600 Jefferson Plaza and West Gude during the 2016 Quarter. The $1.5 million gain in the 2015 Quarter resulted from the compensation received for the condemnation as part of an eminent domain taking action of 15,000 square feet of land at Montrose Shopping Center.

Interest Expense: Interest expense by debt type for the three months ended June 30, 2016 and 2015 were as follows (in thousands):
 
Three Months Ended June 30,
 
 
 
 
Debt Type
2016
 
2015
 
$ Change
 
% Change
Notes payable
$
8,289

 
$
7,914

 
$
375

 
4.7
 %
Mortgage notes payable
4,223

 
5,657

 
(1,434
)
 
(25.3
)%
Lines of credit
1,473

 
1,249

 
224

 
17.9
 %
Capitalized interest
(165
)
 
(120
)
 
(45
)
 
37.5
 %
Total
$
13,820

 
$
14,700

 
$
(880
)
 
(6.0
)%

•
Notes payable: Increase primarily due to executing the $150.0 million term loan in September 2015, which has a floating interest rate effectively fixed at 2.7% by interest rate swaps, partially offset by the repayment of $150.0 million of our 5.35% senior notes in May 2015.
•
Mortgage notes payable: Decrease primarily due to the repayment of the mortgage notes secured by John Marshall II, 3801 Connecticut Avenue, Bethesda Hill Apartments and Walker House Apartments, and the purchase of the construction loan secured by The Maxwell (a consolidated entity) during the 2016 Period.
•
Lines of credit: Increase primarily due to weighted average daily borrowings of $242.0 million during 2016 Quarter, as compared to $131.2 million during the 2015 Quarter.
•
Capitalized interest: Increase primarily due to capitalization of interest on spending related to the development adjacent to The Wellington.

Income tax benefit (expense): The income tax benefit in the 2016 Quarter resulted from a reduction of the valuation allowance on a deferred tax asset at one of our taxable REIT subsidiaries due to a net operating loss as a result of the sale of Dulles Station II.  We have concluded that there is sufficient positive evidence as of June 30, 2016 that it is more likely than not that a portion of the deferred tax asset related to the net operating loss is realizable.


27

2016 Period Compared to 2015 Period

The following tables reconcile NOI to net income attributable to the controlling interests and provide the basis for our discussion of our consolidated results of operations and NOI in the 2016 Period compared to the 2015 Period. All amounts are in thousands except percentage amounts.
 
 
 
 
 
 
 
 
 
Non-Same-Store
 
 
 
 
 
 
 
 
 
Same-Store
 
 
 
 
 
Acquisitions (1)
 
Development/Redevelopment (2)
 
Dispositions (3) (continuing operations)
 
All Properties
 
 
 
2016
 
2015
 
$ 
Change
 
% 
Change
 
2016
 
2015
 
2016
 
2015
 
2016
 
2015
 
2016
 
2015
 
$ 
Change
 
% 
Change
Real estate rental revenue
$
128,499

 
$
127,545

 
$
954

 
0.7
 %
 
$
9,080

 
$
—

 
$
10,423

 
$
8,526

 
$
8,540

 
$
13,011

 
$
156,542

 
$
149,082

 
$
7,460

 
5.0
 %
Real estate expenses
45,104

 
45,794

 
(690
)
 
(1.5
)%
 
3,424

 
—

 
4,767

 
4,845

 
3,614

 
5,798

 
56,909

 
56,437

 
472

 
0.8
 %
NOI
$
83,395

 
$
81,751

 
$
1,644

 
2.0
 %
 
$
5,656

 
$
—

 
$
5,656

 
$
3,681

 
$
4,926

 
$
7,213

 
$
99,633

 
$
92,645

 
$
6,988

 
7.5
 %
Reconciliation to net income attributable to the controlling interests:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Depreciation and amortization
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(51,199
)
 
(50,778
)
 
(421
)
 
0.8
 %
Acquisition costs
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1,178
)
 
(1,008
)
 
(170
)
 
16.9
 %
General and administrative expenses
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(10,479
)
 
(10,358
)
 
(121
)
 
1.2
 %
Casualty gain and impairment (loss), net
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
676

 
(5,909
)
 
6,585

 
111.4
 %
Gain on sale of real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
24,112

 
31,731

 
(7,619
)
 
(24.0
)%
Interest expense
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(28,180
)
 
(30,048
)
 
1,868

 
(6.2
)%
Other income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
122

 
384

 
(262
)
 
(68.2
)%
Loss on extinguishment of debt
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
—

 
(119
)
 
119

 
(100.0
)%
Income tax benefit (expense)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
693

 
(28
)
 
721

 
(2,575.0
)%
Net income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
34,200

 
26,512

 
7,688

 
29.0
 %
Less: Net loss attributable to noncontrolling interests
 
 
 
 
 
 
 
 
 
 
 
 
 
20

 
448

 
(428
)
 
(95.5
)%
Net income attributable to the controlling interests
 
 
 
 
 
 
 
 
 
 
 
 
 
$
34,220

 
$
26,960

 
$
7,260

 
26.9
 %
 
(1) 
Acquisitions:
2016 Multifamily – Riverside Apartments
2015 Multifamily – The Wellington

(2) 
Development/redevelopment properties:
Multifamily development property – The Maxwell
Office redevelopment properties – Silverline Center and Army Navy Club Building

(3) 
Dispositions (classified as continuing operations):
2016 Office – 6110 Executive Boulevard, 600 Jefferson Plaza, Wayne Plaza and West Gude Drive
2015 Multifamily – Country Club Towers and Munson Hill Towers    
2015 Retail – Montgomery Village Center

Real Estate Rental Revenue

Real estate rental revenue is comprised of (a) minimum base rent, which includes rental revenues recognized on a straight-line basis, (b) revenue from the recovery of operating expenses from our tenants, (c) provisions for doubtful accounts in the same quarter that we established the receivable, which include provisions for straight-line receivables, (d) revenue from the collection of lease termination fees and (e) parking and other tenant charges such as percentage rents.

Real estate rental revenue for same-store properties for the six months ended June 30, 2016 and 2015 was as follows (in thousands):
 
Six Months Ended June 30,
 
 
 
 
 
2016
 
2015
 
$ Change
 
% Change
Minimum base rent
$
107,004

 
$
107,453

 
$
(449
)
 
(0.4
)%
Recoveries from tenants
14,969

 
14,713

 
256

 
1.7
 %
Provision for doubtful accounts
(449
)
 
(725
)
 
276

 
(38.1
)%
Lease termination fees
305

 
231

 
74

 
32.0
 %
Parking and other tenant charges
6,670

 
5,873

 
797

 
13.6
 %
Total same-store real estate rental revenue
$
128,499

 
$
127,545

 
$
954

 
0.7
 %


28

•
Minimum base rent: Decrease primarily due to lower occupancy ($2.1 million) and higher abatements ($0.3 million), partially offset by higher rental rates ($1.9 million).
•
Recoveries from tenants: Increase primarily due to higher reimbursements for operating expenses ($0.3 million).
•
Provision for doubtful accounts: Decrease primarily due to lower provisions in the office segment ($0.3 million).
•
Lease termination fees: Increase primarily due to higher fees in the multifamily segment ($0.1 million).
•
Parking and other tenant charges: Increase primarily due to higher parking income ($0.3 million) in the office segment, higher percentage rent ($0.1 million) in the retail segment and higher antenna rent ($0.1 million) in the multifamily segment.

Real estate rental revenue from same-store properties by segment was as follows (in thousands):
 
Six Months Ended June 30,
 
 
 
 
 
2016
 
2015
 
$ Change
 
% Change
Office
$
70,557

 
$
69,884

 
$
673

 
1.0
%
Multifamily
27,482

 
27,242

 
240

 
0.9
%
Retail
30,460

 
30,419

 
41

 
0.1
%
Total same-store real estate rental revenue
$
128,499

 
$
127,545

 
$
954

 
0.7
%

•
Office: Increase primarily due to higher rental rates ($1.1 million) and lower provisions for uncollectible accounts ($0.3 million), partially offset by lower occupancy ($0.7 million).
•
Multifamily: Increase primarily due to higher tenant fees ($0.3 million).
•
Retail: Increase primarily due to higher rental rates ($0.8 million), reimbursements ($0.2 million), percentage rent ($0.1 million) and parking income ($0.1 million), partially offset by lower occupancy ($1.3 million).

Real estate rental revenue from acquisitions increased due to the acquisitions of The Wellington in the third quarter of 2015 and Riverside Apartments in the 2016 Quarter.

Real estate rental revenue from development/redevelopment properties increased primarily due to leasing up The Maxwell ($1.5 million) and higher rental rates ($0.6 million) and occupancy ($0.5 million) at Silverline Center, partially offset by lower occupancy ($0.5 million) and rental rates ($0.2 million) at the Army Navy Club Building, which remained under redevelopment.

During the 2016 Period, we executed new and renewal leases in our office and retail segments as follows:
 
Square Feet
(in thousands)
 
Average Rental Rate
(per square foot)
 
% Rental Rate Increase
 
Incentives (1) 
(per square foot)
 
Retention Rate
Office
285

 
$
39.82

 
13.7
%
 
$
71.15

 
40.5
%
Retail
54

 
34.52

 
46.0
%
 
39.54

 
87.4
%
Total
339

 
38.97

 
17.4
%
 
66.08

 
61.2
%
(1) Incentives include tenant improvements, leasing commissions and leasing incentives, including free rent.

Real Estate Expenses

Real estate expenses as a percentage of revenue for the 2016 Period and 2015 Period were 36.4% and 37.9%, respectively.

Real estate expenses from same-store properties by segment were as follows (in thousands):
 
Six Months Ended June 30,
 
 
 
 
 
2016
 
2015
 
$ Change
 
% Change
Office
$
25,937

 
$
26,414

 
$
(477
)
 
(1.8
)%
Multifamily
11,077

 
11,469

 
(392
)
 
(3.4
)%
Retail
8,090

 
7,911

 
179

 
2.3
 %
Total same-store real estate expenses
$
45,104

 
$
45,794

 
$
(690
)
 
(1.5
)%

•
Office: Decrease primarily due to lower utilities expenses ($0.3 million) due to milder weather and lower administrative expenses ($0.1 million).
•
Multifamily: Decrease primarily due to lower administrative ($0.3 million) and repairs and maintenance ($0.2 million) expenses.

29

•
Retail: Increase primarily due to higher real estate taxes ($0.3 million).

Other Income and Expenses

Depreciation and Amortization: Increase primarily due to the acquisition of The Wellington and Riverside Apartments ($3.2 million) and placing development/redevelopment properties into service ($0.5 million), partially offset by classifying the Maryland Office Portfolio as held for sale and stopping depreciation on the assets during the 2016 Quarter ($2.5 million) and lower depreciation and amortization at same-store properties ($0.8 million) primarily due to lower amortization of acquired intangible lease assets.

Acquisition Costs: Increase primarily due to the settlement of the Riverside Apartments acquisition in the 2016 Quarter, partially offset by due diligence costs during the 2015 Quarter associated with The Wellington acquisition.

General and Administrative Expenses: Increase primarily due to a higher estimate of short-term incentive compensation ($0.8 million), partially offset by lower officer share-based incentive compensation ($0.7 million) due to departures in 2015.

Casualty gain and impairment (loss), net: The casualty gain in the 2016 Period represents the gain recognized upon the receipt of insurance proceeds related to damage from a fire at Bethesda Hill Towers during the first quarter of 2015 that damaged four units. The impairment loss in the 2015 Period reduced the carrying value of our interest in a joint venture to develop a multifamily property at 1225 First Street to its estimated fair value. We subsequently disposed of our interest in the joint venture during the third quarter of 2015.

Gain on sale of real estate: Decrease due to completion of the sales of Dulles Station II, 6110 Executive Boulevard, 51 Monroe Street, 600 Jefferson Plaza and West Gude during the 2016 Period, as compared to the gain on the sale of Country Club Towers during the 2015 Period.

Interest Expense: Interest expense by debt type for the six months ended June 30, 2016 and 2015 were as follows (in thousands):
 
Six Months Ended June 30,
 
 
 
 
Debt Type
2016
 
2015
 
$ Change
 
% Change
Notes payable
$
16,582

 
$
17,210

 
$
(628
)
 
(3.6
)%
Mortgage notes payable
9,209

 
11,281

 
(2,072
)
 
(18.4
)%
Lines of credit
2,677

 
2,016

 
661

 
32.8
 %
Capitalized interest
(288
)
 
(459
)
 
171

 
(37.3
)%
Total
$
28,180

 
$
30,048

 
$
(1,868
)
 
(6.2
)%

•
Notes payable: Decrease primarily due to the repayment of $150.0 million of our 5.35% senior notes in May 2015, partially offset by executing the $150.0 million term loan in September 2015, which has a floating interest rate effectively fixed at 2.7% by interest rate swaps.
•
Mortgage notes payable: Decrease primarily due to the repayment of the mortgage note secured by John Marshall II, 3801 Connecticut Avenue, Bethesda Hill Apartments and Walker House Apartments, and the purchase of the construction loan secured by The Maxwell (a consolidated entity) during the 2016 Period.
•
Lines of credit: Increase primarily due to weighted average daily borrowings of $203.9 million during 2016 Period, as compared to $87.0 million during the 2015 Period.
•
Capitalized interest: Decrease primarily due to placing into service our development project at The Maxwell and redevelopment project at Silverline Center, partially offset by capitalization of interest on spending related to the development adjacent to The Wellington.

Income tax benefit (expense): The income tax benefit in the 2016 Period resulted from a reduction of the valuation allowance on a deferred tax asset at one of our taxable REIT subsidiaries due to a net operating loss as a result of the sale of Dulles Station II.  We have concluded that there is sufficient positive evidence as of June 30, 2016 that it is more likely than not that a portion of the deferred tax asset related to the net operating loss is realizable.


30

Liquidity and Capital Resources

Capital Requirements

As of the end of the second quarter of 2016, we summarize our 2016 capital requirements as follows:
•
Funding dividends and distributions to our shareholders;
•
$160.0 million to repay or refinance our secured notes scheduled to mature in 2016, plus $101.9 million to prepay in 2016 without penalty a secured loan scheduled to mature in 2017;
•
Approximately $60 - $65 million to invest in our existing portfolio of operating assets, including approximately $35 - $40 million to fund tenant-related capital requirements and leasing commissions;
•
Approximately $10 - $15 million to invest in our development and redevelopment projects; and
•
Funding for potential property acquisitions throughout the remainder of 2016, offset by proceeds from potential property dispositions.

Debt Financing

Our total debt at June 30, 2016 and December 31, 2015 is as follows (in thousands):
 
June 30, 2016
 
December 31, 2015
Mortgage notes payable
$
252,044

 
$
418,052

Lines of credit
269,000

 
105,000

Notes payable
743,769

 
743,181

 
$
1,264,813

 
$
1,266,233


Mortgage Notes Payable

At June 30, 2016, our mortgage notes payable bore an effective weighted average fair value interest rate of 5.3% and had an estimated weighted average maturity of 2.4 years. We may either initiate secured mortgage debt or assume mortgage debt from time-to-time in conjunction with property acquisitions.

Our mortgage notes contain covenants with which we must comply. Failure to comply with any of the covenants under our mortgage notes could result in a default under one or more of our debt instruments. This could cause our debt holders to accelerate the timing of payments and would therefore have a material adverse effect on our business, operations, financial condition and liquidity. As of June 30, 2016, we were in compliance with our mortgage notes covenants.

Lines of Credit and Term Loan

Our primary source of liquidity is our Revolving Credit Facility, a $600.0 million unsecured credit agreement that matures in June 2019, unless extended pursuant to one or both of the two six-month extension options. The Revolving Credit Facility has an accordion feature that allows us to increase the facility to $1.0 billion, subject to the extent the lenders agree to provide additional revolving loan commitments or term loans. In September 2015, we entered into a $150.0 million unsecured term loan by exercising a portion of the accordion feature under the Revolving Credit Facility (as discussed below). The $600.0 million committed capacity of the unsecured line of credit under the Revolving Credit Facility was not changed as a result of the incurrence of the term loan. The Revolving Credit Facility bears interest at a rate of either one month LIBOR plus a margin ranging from 0.875% to 1.55% (depending on our credit rating) or the base rate plus a margin ranging from 0.0% to 0.55% (based upon our credit rating). The base rate is the highest of the administrative agent's prime rate, the federal funds rate plus 0.50% and the one month LIBOR market index rate plus 1.0%. In addition, the Revolving Credit Facility requires the payment of a facility fee ranging from 0.125% to 0.30% (depending on our credit rating) on the $600.0 million committed capacity, without regard to usage. As of June 30, 2016, the interest rate on the facility is one month LIBOR plus 1.00% and the facility fee is 0.20%. We had $269.0 million in borrowings outstanding as of June 30, 2016.

During the third quarter of 2015, we executed a $150.0 million unsecured term loan by exercising a portion of the accordion feature under the Revolving Credit Facility. The term loan has a 5.5 year term scheduled to mature on March 15, 2021 and currently has an interest rate of one month LIBOR plus 110 basis points, based on our current unsecured debt ratings. We entered into two interest rate swap arrangements with a total notional amount of $150.0 million to swap the floating interest rate under the term loan to an all-in fixed interest rate of 2.7% starting on October 15, 2015 and extending until the maturity of the term loan on March 15, 2021.


31

The Revolving Credit Facility contains financial and other covenants with which we must comply. Failure to comply with any of the covenants under the Revolving Credit Facility or other debt instruments could result in a default under one or more of our debt instruments. This could cause our lenders to accelerate the timing of payments and could therefore have a material adverse effect on our business, operations, financial condition and liquidity. In addition, our ability to draw on the Revolving Credit Facility or incur other unsecured debt in the future could be restricted by the loan covenants. As of June 30, 2016, we were in compliance with our loan covenants.

Notes Payable

We generally issue unsecured notes to fund our real estate assets long term. In issuing future unsecured notes, we intend to ladder the maturities of our debt to mitigate exposure to interest rate risk in future years.

Subsequent to the end of the 2016 Quarter, we entered into a seven year, $150 million unsecured term loan maturing on July 21, 2023 with a deferred draw period of up to six months. We expect to draw on the term loan in the fourth quarter of 2016 or early in January 2017 to refinance maturing secured debt. We also entered into interest rate derivatives to swap from a LIBOR plus 165 basis points floating rate to a 2.86% all-in fixed interest rate commencing on March 31, 2017.

Our unsecured notes contain covenants with which we must comply. Failure to comply with any of the covenants under our unsecured notes could result in a default under one or more of our debt instruments. This could cause our debt holders to accelerate the timing of payments and would therefore have a material adverse effect on our business, operations, financial condition and liquidity. As of June 30, 2016, we were in compliance with our unsecured notes covenants. In addition, our ability to draw on our Revolving Credit Facility or incur other unsecured debt in the future could be restricted by our unsecured note covenants.

From time to time, we may seek to repurchase and cancel our outstanding notes through open market purchases, privately negotiated transactions or otherwise. Such repurchases, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors.

Common Equity

We have authorized for issuance 100.0 million common shares, of which 73.7 million shares were outstanding at June 30, 2016.

On May 4, 2016, we sold approximately 5.3 million common shares, including 693,750 shares sold pursuant to the underwriters' over-allotment option, at a price to the public of $28.20 per share. We received net proceeds of approximately $143.4 million, which we used initially to repay borrowings outstanding under our revolving credit facility and subsequently to fund our acquisition and for other general corporate purposes.

On June 23, 2015, we entered into four separate equity distribution agreements (collectively, the “Equity Distribution Agreements”) with each of Wells Fargo Securities, LLC, BNY Mellon Capital Markets, LLC, Citigroup Global Markets Inc. and RBC Capital Markets, LLC relating to the issuance and sale of up to $200.0 million of our common shares from time to time. Sales of our common shares are made at market prices prevailing at the time of sale. We may use net proceeds from the sale of common shares under this program for general corporate purposes, including, without limitation, working capital, the acquisition, renovation, expansion, improvement, development or redevelopment of income producing properties or the repayment of debt. We have not issued any shares under the Equity Distribution Agreements.

We have a dividend reinvestment program, whereby shareholders may use their dividends and optional cash payments to purchase common shares. The common shares sold under this program may either be common shares issued by us or common shares purchased in the open market. We did not issue any shares under this program during the 2016 Period.

Preferred Equity

Washington REIT's board of trustees can, at its discretion, authorize the issuance of up to 10.0 million preferred shares. The ability to issue preferred equity provides Washington REIT an additional financing tool that may be used to raise capital for future acquisitions or other business purposes. As of June 30, 2016, no preferred shares had been issued.

Dividends

We currently declare dividends quarterly at a rate of $0.30 per share. The maintenance of our dividend level is subject to various factors reviewed by the board of trustees in its discretion. These factors include our results of operations, the availability of cash and the REIT distribution requirements, which require at least 90% of our REIT taxable income to be distributed to shareholders

32

on an annual basis. When setting the dividend level, our board of trustees looks in particular at trends in our level of funds from operations, together with associated recurring capital improvements, tenant improvements, leasing commissions and incentives, and adjustments to straight-line rents to reflect cash rents received.

Our dividend and distribution payments for the three and six months ended June 30, 2016 and 2015 are as follows (in thousands):
 
Three Months Ended June 30,
 
Change
 
Six Months Ended June 30,
 
Change
 
2016
 
2015
 
$
 
%
 
2016
 
2015
 
$
 
%
Common dividends
$
22,147

 
$
20,500

 
$
1,647

 
8.0
%
 
$
63,284

 
$
41,019

 
$
22,265

 
54.3
%
Distributions to noncontrolling interests
19

 
—

 
19

 
—

 
110

 
—

 
110

 
—

 
$
22,166

 
$
20,500

 
$
1,666

 
8.1
%
 
$
63,394

 
$
41,019

 
$
22,375

 
54.5
%

Dividends paid during the 2016 Quarter increased due to the issuance of 5.3 million common shares in May 2016. Dividends paid during the 2016 Period increased due to the issuance of common shares and the payment on January 5, 2016 of the $20.4 million of dividends declared during the fourth quarter of 2015.

Historical Cash Flows

Cash flows from operations are an important factor in our ability to sustain our dividend at its current rate. If our cash flows from operations were to decline significantly from current levels, we may have to reduce our dividend. Consolidated cash flow information is summarized as follows (in thousands):
 
Six Months Ended June 30,
 
Change
 
2016
 
2015
 
$
 
%
Net cash provided by operating activities
$
60,454

 
$
54,332

 
$
6,122

 
11.3
%
Net cash (used in) provided by investing activities
(139,411
)
 
6,108

 
(145,519
)
 
2,382.4
%
Net cash provided by (used in) financing activities
77,511

 
(53,489
)
 
131,000

 
244.9
%

Cash provided by operating activities increased primarily due to acquisitions and lower interest payments, partially offset by dispositions.

Cash used in investing activities increased primarily due to the acquisition of Riverside Apartments in the 2016 Period, partially offset by the disposition of four office properties in the 2016 Period, as compared to no acquisitions and one disposition during the 2015 Period.

Cash provided by financing activities increased primarily due to proceeds from an equity offering and higher net borrowings on our Revolving Credit Facility during the 2016 Period, partially offset by higher debt repayments and dividends paid during the 2016 Period.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements as of June 30, 2016 that are reasonably likely to have a current or future material effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

33


Funds From Operations

NAREIT FFO is a widely used measure of operating performance for real estate companies. We provide NAREIT FFO as a supplemental measure to net income calculated in accordance with GAAP. Although NAREIT FFO is a widely used measure of operating performance for REITs, NAREIT FFO does not represent net income calculated in accordance with GAAP. As such, it should not be considered an alternative to net income as an indication of our operating performance. In addition, NAREIT FFO does not represent cash generated from operating activities in accordance with GAAP, nor does it represent cash available to pay distributions and should not be considered as an alternative to cash flow from operating activities, determined in accordance with GAAP, as a measure of our liquidity. The National Association of Real Estate Investment Trusts, Inc. (“NAREIT”) defines NAREIT FFO (April, 2002 White Paper) as net income (computed in accordance with GAAP) excluding gains (or losses) associated with sales of property, impairments of depreciable real estate, and real estate depreciation and amortization. We consider NAREIT FFO to be a standard supplemental measure for REITs because it facilitates an understanding of the operating performance of our properties without giving effect to real estate depreciation and amortization, which historically assumes that the value of real estate assets diminishes predictably over time. Since real estate values have instead historically risen or fallen with market conditions, we believe that NAREIT FFO more accurately provides investors an indication of our ability to incur and service debt, make capital expenditures and fund other needs. Our NAREIT FFO may not be comparable to FFO reported by other REITs. These other REITs may not define the term in accordance with the current NAREIT definition or may interpret the current NAREIT definition differently.

The following table provides the calculation of our NAREIT FFO and a reconciliation of NAREIT FFO to net income for the three and six months ended June 30, 2016 and 2015 (in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Net income (loss)
$
31,821

 
$
(2,886
)
 
$
34,200

 
$
26,512

Adjustments:
 
 
 
 
 
 
 
Depreciation and amortization
25,161

 
25,503

 
51,199

 
50,778

Net gain on sale of depreciable real estate
(24,112
)
 
—

 
(24,112
)
 
(30,277
)
NAREIT FFO
$
32,870

 
$
22,617

 
$
61,287

 
$
47,013


Critical Accounting Policies and Estimates

We base the discussion and analysis of our financial condition and results of operations upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. We discuss the most critical estimates in our Annual Report on Form 10-K for the year ended December 31, 2015 filed with the Securities and Exchange Commission on February 26, 2016.

34


ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The principal material financial market risk to which we are exposed is interest-rate risk. Our exposure to market risk for changes in interest rates relates primarily to refinancing long-term fixed rate obligations, the opportunity cost of fixed rate obligations in a falling interest rate environment and our variable rate lines of credit.

The table below presents principal, interest and related weighted average fair value interest rates by year of maturity, with respect to debt outstanding on June 30, 2016.
 
2016
 
2017
 
2018
 
2019
 
2020
 
Thereafter
 
Total
 
Fair Value
(In thousands)
 
 
 
 
 
 
 
Unsecured fixed rate debt (1)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Principal
$
—

 
$
—

 
$
—

 
$
—

 
$
250,000

 
$
500,000

 
$
750,000

 
$
784,582

Interest payments
$
15,967

 
$
31,934

 
$
31,934

 
$
31,934

 
$
31,934

 
$
51,907

 
$
195,610

 
 
Interest rate on debt maturities
—
%
 
—
%
 
—
%
 
—
%
 
5.05
%
 
3.96
%
 
4.33
%
 
 
Unsecured variable rate debt
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Principal
$
—

 
$
—

 
$
269,000

 
$
—

 
$
—

 
$
—

 
$
269,000

 
$
269,000

Variable interest rate on debt maturities
—
%
 
—
%
 
1.43
%
 
—
%
 
—
%
 
—
%
 
1.43
%
 
 
Mortgages
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Principal amortization (2) 
(30 year schedule)
$
1,979

 
$
154,436

 
$
3,135

 
$
33,909

 
$
2,659

 
$
52,212

 
$
248,330

 
$
259,779

Interest payments (3)
$
6,475

 
$
6,616

 
$
5,089

 
$
3,627

 
$
3,046

 
$
3,604

 
$
28,457

 
 
Weighted average interest rate on principal amortization
4.38
%
 
5.90
%
 
4.87
%
 
5.32
%
 
4.70
%
 
3.91
%
 
5.36
%
 
 
(1) Includes $150.0 million term loan with a floating interest rate that is effectively fixed at 2.7% by interest rate swap arrangements.
(2) Excludes net discounts of $4.3 million and net unamortized debt issuance costs of $0.5 million at June 30, 2016.

On September 15, 2015, we entered into interest rate swap arrangements with a total notional amount of $150.0 million to swap the floating interest rate under our new $150.0 million term loan to an all-in fixed interest rate of 2.7% starting on October 15, 2015 and extending until the maturity of the term loan on March 15, 2021 (see note 6 to the consolidated financial statements). We entered into the interest rate swap arrangements designated and qualifying as cash flow hedges to reduce our exposure to the variability in future cash flows attributable to changes in interest rates. Derivative instruments expose us to credit risk in the event of non-performance by the counterparty under the terms of the interest rate hedge agreement. We believe that we minimize our credit risk on these transactions by dealing with major, creditworthy financial institutions. As part of our ongoing control procedures, we monitor the credit ratings of counterparties and our exposure to any single entity, thus minimizing our credit risk concentration. The following table sets forth information pertaining to interest rate swap contracts in place as of June 30, 2016 and December 31, 2015 and their respective fair values (dollars in thousands):
Notional Amount
 
 
 
Floating Index Rate
 
 
 
 
 
Fair Value as of:
 
Fixed Rate
 
 
Effective Date
 
Expiration Date
 
June 30, 2016
 
December 31, 2015
$
75,000

 
1.619%
 
One-Month LIBOR
 
10/15/2015
 
3/15/2021
 
$
(2,790
)
 
$
(259
)
75,000

 
1.626%
 
One-Month LIBOR
 
10/15/2015
 
3/15/2021
 
(2,819
)
 
(291
)
$
150,000

 
 
 
 
 
 
 
 
 
$
(5,609
)
 
$
(550
)

We enter into debt obligations primarily to support general corporate purposes including acquisition of real estate properties, capital improvements and working capital needs.

As the majority of our outstanding debt is long-term, fixed rate debt, our interest rate risk has not changed significantly from what was disclosed in our Annual Report on Form 10-K for the year ended December 31, 2015 filed with the Securities and Exchange Commission on February 26, 2016. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources – Debt Financing.”

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ITEM 4: CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Securities Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer and Controller, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer and Controller, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on the foregoing, our Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer and Controller concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

There have been no changes in Washington REIT’s internal control over financial reporting (as defined by Rule 13a-15(f)) that occurred during the period covered by the report that have materially affected, or are reasonably likely to materially affect, Washington REIT’s internal control over financial reporting.

36

PART II
OTHER INFORMATION

ITEM 1: LEGAL PROCEEDINGS

None.

ITEM 1A: RISK FACTORS

None.

ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3: DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4: MINE SAFETY DISCLOSURES

None.

ITEM 5: OTHER INFORMATION

None.

37


ITEM 6: EXHIBITS
 
 
 
Incorporated by Reference
 
 
Exhibit
Number
Exhibit Description
 
Form
 
File
Number
 
Exhibit
 
Filing Date
 
Filed
Herewith
10.49
Purchase and Sale Agreement, dated April 26, 2016, for Riverside Apartments
 
 
 
 
 
 
 
 
 
X
10.50
Purchase and Sale Agreement, dated April 26, 2016, for Wayne Plaza, West Gude Drive, 600 Jefferson Plaza and 6110 Executive Boulevard
 
 
 
 
 
 
 
 
 
X
10.51
Purchase and Sale Agreement, dated April 26, 2016, for 51 Monroe Street and One Central Plaza
 
 
 
 
 
 
 
 
 
X
10.52
First Amendment to Purchase and Sale Agreement, dated June 3, 2016, for Wayne Plaza, West Gude Drive, 600 Jefferson Plaza and 6110 Executive Boulevard
 
 
 
 
 
 
 
 
 
X
10.53
2016 Omnibus Long Term Incentive Plan
 
DEF 14A
 
 
 
Annex A
 
3/23/2016
 
 
12
Computation of Ratios
 
 
 
 
 
 
 
 
 
X
31.1
Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended (“the Exchange Act”)
 
 
 
 
 
 
 
 
 
X
31.2
Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act
 
 
 
 
 
 
 
 
 
X
31.3
Certification of the Chief Accounting Officer pursuant to Rule 13a-14(a) of the Exchange Act
 
 
 
 
 
 
 
 
 
X
32
Certification of the Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer pursuant to Rule 13a-14(b) of the Exchange Act and 18U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
 
 
 
 
 
 
X
101
The following materials from our Quarterly Report on Form 10–Q for the quarter ended June 30, 2016 formatted in eXtensible Business Reporting Language (“XBRL”): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Shareholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) notes to these consolidated financial statements
 
 
 
 
 
 
 
 
 
X



38


SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
WASHINGTON REAL ESTATE INVESTMENT TRUST
 
 
 
 
 
/s/ Paul T. McDermott
 
 
Paul T. McDermott
 
 
President and Chief Executive Officer
 
 
 
 
 
/s/ Stephen E. Riffee
 
 
Stephen E. Riffee
 
 
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
 
 
 
 
 
/s/ W. Drew Hammond
 
 
W. Drew Hammond
 
 
Vice President, Chief Accounting Officer and Controller
(Principal Accounting Officer)

DATE: August 1, 2016

39