UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q 
(Mark one)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended
June 30, 2017
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from
 
to
 
           
Commission file number 1-14023 (Corporate Office Properties Trust)
Commission file number 333-189188 (Corporate Office Properties, L.P.)
Corporate Office Properties Trust
Corporate Office Properties, L.P.
(Exact name of registrant as specified in its charter)
Corporate Office Properties Trust
 
Maryland
 
23-2947217
 
 
(State or other jurisdiction of
 
(IRS Employer
 
 
incorporation or organization)
 
Identification No.)
 
 
 
 
 
Corporate Office Properties, L.P.
 
Delaware
 
23-2930022
 
 
(State or other jurisdiction of
 
(IRS Employer
 
 
incorporation or organization)
 
Identification No.)
6711 Columbia Gateway Drive, Suite 300, Columbia, MD
21046
(Address of principal executive offices)
 
(Zip Code)
 
Registrant’s telephone number, including area code:  (443) 285-5400
 
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 for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Corporate Office Properties Trust ý Yes   o No
Corporate Office Properties, L.P. ý Yes   o No
 
Indicate by check mark 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).

Corporate Office Properties Trust ý Yes   o No
Corporate Office Properties, L.P. ý Yes   o No




Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Corporate Office Properties Trust
Large accelerated filer ý
 
Accelerated filer o
 
Non-accelerated filer o
 
Smaller reporting company o
Emerging growth company o
 
 
 
 
(Do not check if a smaller reporting company)
 
 
 

Corporate Office Properties, L.P.
Large accelerated filer ý
 
Accelerated filer o
 
Non-accelerated filer o
 
Smaller reporting company o
Emerging growth company o
 
 
 
 
(Do not check if a smaller reporting company)
 
 
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 

Corporate Office Properties Trust o
Corporate Office Properties, L.P. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)

Corporate Office Properties Trust o Yes   ý No
Corporate Office Properties, L.P. o Yes   ý No

As of July 21, 2017, 99,466,838 of Corporate Office Properties Trust’s Common Shares of Beneficial Interest, $0.01 par value, were issued and outstanding.
 
 
 
 
 

EXPLANATORY NOTE

This report combines the quarterly reports on Form 10-Q for the period ended June 30, 2017 of Corporate Office Properties Trust (“COPT”) and subsidiaries (collectively, the “Company”) and Corporate Office Properties, L.P. (“COPLP”) and subsidiaries (collectively, the “Operating Partnership”). Unless stated otherwise or the context otherwise requires, “we,” “our,” and “us” refer collectively to COPT, COPLP and their subsidiaries.

COPT is a real estate investment trust, or REIT, and the sole general partner of COPLP. As of June 30, 2017, COPT owned approximately 96.7% of the outstanding common units and none of the outstanding preferred units in COPLP; the remaining common and preferred units in COPLP were owned by third parties. As the sole general partner of COPLP, COPT controls COPLP and can cause it to enter into major transactions including acquisitions, dispositions and refinancings and cause changes in its line of business, capital structure and distribution policies.

There are a few differences between the Company and the Operating Partnership which are reflected in this Form 10-Q. We believe it is important to understand the differences between the Company and the Operating Partnership in the context of how the Company and the Operating Partnership operate as an interrelated, consolidated company. COPT is a real estate investment trust, whose only material asset is its ownership of partnership interests of COPLP. As a result, COPT does not conduct business itself, other than acting as the sole general partner of COPLP, issuing public equity from time to time and guaranteeing certain debt of COPLP. COPT itself is not directly obligated under any indebtedness but guarantees some of the debt of COPLP. COPLP owns substantially all of the assets of COPT either directly or through its subsidiaries, conducts almost all of the operations of the business and is structured as a limited partnership with no publicly traded equity. Except for net proceeds from public equity issuances by COPT, which are contributed to COPLP in exchange for partnership units, COPLP generates the capital required by COPT’s business through COPLP’s operations, by COPLP’s direct or indirect incurrence of indebtedness or through the issuance of partnership units.

Noncontrolling interests and shareholders’ equity and partners’ capital are the main areas of difference between the consolidated financial statements of COPT and those of COPLP. The common limited partnership interests in COPLP not



owned by COPT are accounted for as partners’ capital in COPLP’s consolidated financial statements and as noncontrolling interests in COPT’s consolidated financial statements. COPLP’s consolidated financial statements also reflect COPT’s noncontrolling interests in certain real estate partnerships, limited liability companies (“LLCs”) and corporations; the differences between shareholders’ equity, partners’ capital and noncontrolling interests result from the differences in the equity issued at the COPT and COPLP levels and in COPT’s noncontrolling interests in these real estate partnerships, LLCs, business trusts and corporations. The only other significant differences between the consolidated financial statements of COPT and those of COPLP are assets held in connection with a non-qualified elective deferred compensation plan (comprised primarily of mutual funds and equity securities) and the corresponding liability to the plan’s participants that are held directly by COPT.

We believe combining the quarterly reports on Form 10-Q of the Company and the Operating Partnership into this single report results in the following benefits:
•
combined reports better reflect how management and the analyst community view the business as a single operating unit;
•
combined reports enhance investors’ understanding of the Company and the Operating Partnership by enabling them to view the business as a whole and in the same manner as management;
•
combined reports are more efficient for the Company and the Operating Partnership and result in savings in time, effort and expense; and
•
combined reports are more efficient for investors by reducing duplicative disclosure and providing a single document for their review.

To help investors understand the significant differences between the Company and the Operating Partnership, this report presents the following separate sections for each of the Company and the Operating Partnership:
•
consolidated financial statements;
•
the following notes to the consolidated financial statements:
•
Note 3, Fair Value Measurements of COPT and subsidiaries and COPLP and subsidiaries; and
•
Note 14, Earnings per Share of COPT and subsidiaries and Earnings per Unit of COPLP and subsidiaries;
•
“Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources of COPT”; and
•
“Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources of COPLP.”

This report also includes separate sections under Part I, Item 4. Controls and Procedures and separate Exhibit 31 and Exhibit 32 certifications for each of COPT and COPLP to establish that the Chief Executive Officer and the Chief Financial Officer of each entity have made the requisite certifications and that COPT and COPLP are compliant with Rule 13a-15 and Rule 15d-14 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and 18 U.S.C. §1350.




TABLE OF CONTENTS
 
FORM 10-Q
 
 
PAGE
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2


PART I: FINANCIAL INFORMATION
ITEM 1. Financial Statements


Corporate Office Properties Trust and Subsidiaries
Consolidated Balance Sheets
(in thousands, except share data)
(unaudited)
 
June 30,
2017
 
December 31,
2016
Assets
 

 
 

Properties, net:
 

 
 

Operating properties, net
$
2,688,174

 
$
2,671,831

Projects in development or held for future development
446,385

 
401,531

Total properties, net
3,134,559

 
3,073,362

Assets held for sale, net
51,291

 
94,654

Cash and cash equivalents
10,606

 
209,863

Restricted cash and marketable securities
6,866

 
8,193

Investment in unconsolidated real estate joint venture
25,335

 
25,548

Accounts receivable (net of allowance for doubtful accounts of $435 and $603, respectively)
42,742

 
34,438

Deferred rent receivable (net of allowance of $125 and $373, respectively)
89,832

 
90,219

Intangible assets on real estate acquisitions, net
69,205

 
78,351

Deferred leasing costs (net of accumulated amortization of $29,720 and $65,988, respectively)
40,506

 
41,214

Investing receivables
54,598

 
52,279

Prepaid expenses and other assets, net
49,347

 
72,764

Total assets
$
3,574,887

 
$
3,780,885

Liabilities and equity
 

 
 

Liabilities:
 

 
 

Debt, net
$
1,897,734

 
$
1,904,001

Accounts payable and accrued expenses
95,267

 
108,682

Rents received in advance and security deposits
25,444

 
29,798

Dividends and distributions payable
28,462

 
31,335

Deferred revenue associated with operating leases
13,172

 
12,666

Redeemable preferred shares of beneficial interest ($0.01 par value; 531,667 shares issued and outstanding at December 31, 2016 and none at June 30, 2017)
—

 
26,583

Capital lease obligation
16,177

 
—

Other liabilities
56,076

 
50,177

Total liabilities
2,132,332

 
2,163,242

Commitments and contingencies (Note 15)


 


Redeemable noncontrolling interests
23,731

 
22,979

Equity:
 

 
 

Corporate Office Properties Trust’s shareholders’ equity:
 

 
 

Preferred Shares of beneficial interest at liquidation preference ($0.01 par value; 25,000,000 shares authorized, 6,900,000 shares issued and outstanding at December 31, 2016 and none at June 30, 2017)
—

 
172,500

Common Shares of beneficial interest ($0.01 par value; 125,000,000 shares authorized, shares issued and outstanding of 99,471,641 at June 30, 2017 and 98,498,651 at December 31, 2016)
995

 
985

Additional paid-in capital
2,146,119

 
2,116,581

Cumulative distributions in excess of net income
(793,828
)
 
(765,276
)
Accumulated other comprehensive loss
(1,163
)
 
(1,731
)
Total Corporate Office Properties Trust’s shareholders’ equity
1,352,123

 
1,523,059

Noncontrolling interests in subsidiaries:
 

 
 

Common units in COPLP
46,233

 
49,228

Preferred units in COPLP
8,800

 
8,800

Other consolidated entities
11,668

 
13,577

Noncontrolling interests in subsidiaries
66,701

 
71,605

Total equity
1,418,824

 
1,594,664

Total liabilities, redeemable noncontrolling interest and equity
$
3,574,887

 
$
3,780,885


See accompanying notes to consolidated financial statements.

3


Corporate Office Properties Trust and Subsidiaries
Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Revenues
 

 
 

 
 
 
 
Rental revenue
$
101,347

 
$
107,524

 
$
201,962

 
$
212,906

Tenant recoveries and other real estate operations revenue
26,950

 
26,400

 
53,102

 
54,105

Construction contract and other service revenues
23,138

 
12,003

 
36,172

 
23,223

Total revenues
151,435

 
145,927

 
291,236

 
290,234

Expenses
 

 
 

 
 

 
 

Property operating expenses
48,628

 
48,141

 
97,147

 
100,016

Depreciation and amortization associated with real estate operations
32,793

 
33,248

 
65,852

 
67,775

Construction contract and other service expenses
22,315

 
11,478

 
34,801

 
22,172

Impairment losses
1,625

 
69,692

 
1,625

 
72,138

General, administrative and leasing expenses
7,859

 
8,026

 
16,470

 
19,909

Business development expenses and land carry costs
1,597

 
2,363

 
3,290

 
4,781

Total operating expenses
114,817

 
172,948

 
219,185

 
286,791

Operating income (loss)
36,618

 
(27,021
)
 
72,051

 
3,443

Interest expense
(19,163
)
 
(22,639
)
 
(38,157
)
 
(46,198
)
Interest and other income
1,583

 
1,330

 
3,309

 
2,486

(Loss) gain on early extinguishment of debt
(513
)
 
5

 
(513
)
 
22

Income (loss) before equity in income of unconsolidated entities and income taxes
18,525

 
(48,325
)
 
36,690

 
(40,247
)
Equity in income of unconsolidated entities
718

 
10

 
1,443

 
20

Income tax (expense) benefit
(48
)
 
(1
)
 
(88
)
 
7

Income (loss) before gain on sales of real estate
19,195

 
(48,316
)
 
38,045

 
(40,220
)
Gain on sales of real estate
12

 
—

 
4,250

 
—

Net income (loss)
19,207

 
(48,316
)
 
42,295

 
(40,220
)
Net (income) loss attributable to noncontrolling interests:
 

 
 

 
 

 
 

Common units in COPLP
(273
)
 
1,976

 
(907
)
 
1,849

Preferred units in COPLP
(165
)
 
(165
)
 
(330
)
 
(330
)
Other consolidated entities
(907
)
 
(914
)
 
(1,841
)
 
(1,892
)
Net income (loss) attributable to COPT
17,862

 
(47,419
)
 
39,217

 
(40,593
)
Preferred share dividends
(3,039
)
 
(3,553
)
 
(6,219
)
 
(7,105
)
Issuance costs associated with redeemed preferred shares
(6,847
)
 
—

 
(6,847
)
 
—

Net income (loss) attributable to COPT common shareholders
$
7,976

 
$
(50,972
)
 
$
26,151

 
$
(47,698
)
Earnings per common share:
 

 
 

 
 

 
 

Net income (loss) attributable to COPT common shareholders - basic
$
0.08

 
$
(0.54
)
 
$
0.26

 
$
(0.51
)
Net income (loss) attributable to COPT common shareholders - diluted
$
0.08

 
$
(0.54
)
 
$
0.26

 
$
(0.51
)
Dividends declared per common share
$
0.275

 
$
0.275

 
$
0.550

 
$
0.550


See accompanying notes to consolidated financial statements.

4


Corporate Office Properties Trust and Subsidiaries
Consolidated Statements of Comprehensive Income
(in thousands)
(unaudited)
 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Net income (loss)
$
19,207

 
$
(48,316
)
 
$
42,295

 
$
(40,220
)
Other comprehensive income (loss)
 

 
 

 
 

 
 

Unrealized loss on interest rate derivatives
(1,800
)
 
(5,704
)
 
(1,576
)
 
(16,988
)
Loss on interest rate derivatives recognized in interest expense (effective portion)
853

 
850

 
2,037

 
1,720

Loss on interest rate derivatives recognized in interest expense (ineffective portion)
88

 
—

 
88

 
—

Equity in other comprehensive income (loss) of equity method investee
39

 
(184
)
 
39

 
(184
)
Other comprehensive (loss) income
(820
)
 
(5,038
)
 
588

 
(15,452
)
Comprehensive income (loss)
18,387

 
(53,354
)
 
42,883

 
(55,672
)
Comprehensive (income) loss attributable to noncontrolling interests
(1,318
)
 
1,085

 
(3,098
)
 
205

Comprehensive income (loss) attributable to COPT
$
17,069

 
$
(52,269
)
 
$
39,785

 
$
(55,467
)
 
See accompanying notes to consolidated financial statements.



5


Corporate Office Properties Trust and Subsidiaries
Consolidated Statements of Equity
(Dollars in thousands)
(unaudited)
 
Preferred
Shares
 
Common
Shares
 
Additional
Paid-in
Capital
 
Cumulative
Distributions in
Excess of Net
Income
 
Accumulated
Other
Comprehensive Loss
 
Noncontrolling
Interests
 
Total
Balance at December 31, 2015 (94,531,512 common shares outstanding)
$
199,083

 
$
945

 
$
2,004,507

 
$
(657,172
)
 
$
(2,838
)
 
$
72,039

 
$
1,616,564

Conversion of common units to common shares (26,758 shares)
—

 
—

 
371

 
—

 
—

 
(371
)
 
—

Costs associated with common shares issued to the public
—

 
—

 
(5
)
 
—

 
—

 
—

 
(5
)
Share-based compensation (141,089 shares issued, net of redemptions)
—

 
2

 
4,301

 
—

 
—

 
—

 
4,303

Redemption of vested equity awards
—

 
—

 
(1,492
)
 
—

 
—

 
—

 
(1,492
)
Adjustments to noncontrolling interests resulting from changes in ownership of COPLP
—

 
—

 
(5
)
 
—

 
—

 
5

 
—

Comprehensive loss
—

 
—

 
—

 
(40,593
)
 
(14,874
)
 
(1,322
)
 
(56,789
)
Dividends
—

 
—

 
—

 
(59,175
)
 
—

 
—

 
(59,175
)
Distributions to owners of common and preferred units in COPLP
—

 
—

 
—

 
—

 
—

 
(2,346
)
 
(2,346
)
Distributions to noncontrolling interests in other consolidated entities
—

 
—

 
—

 
—

 
—

 
(8
)
 
(8
)
Adjustment to arrive at fair value of redeemable noncontrolling interests
—

 
—

 
(349
)
 
—

 
—

 
—

 
(349
)
Balance at June 30, 2016 (94,699,359 common shares outstanding)
$
199,083

 
$
947

 
$
2,007,328

 
$
(756,940
)
 
$
(17,712
)
 
$
67,997

 
$
1,500,703

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016 (98,498,651 common shares outstanding)
$
172,500

 
$
985

 
$
2,116,581

 
$
(765,276
)
 
$
(1,731
)
 
$
71,605

 
$
1,594,664

Redemption of preferred shares (6,900,000 shares)
(172,500
)
 
—

 
6,847

 
(6,847
)
 
—

 
—

 
(172,500
)
Conversion of common units to common shares (187,000 shares)
—

 
2

 
2,562

 
—

 
—

 
(2,564
)
 
—

Common shares issued under at-the-market program (591,042 shares)
—

 
6

 
19,662

 
—

 
—

 
—

 
19,668

Exercise of share options (5,000 shares)
—

 
—

 
150

 
—

 
—

 
—

 
150

Share-based compensation (189,948 shares issued, net of redemptions)
—

 
2

 
3,045

 
—

 
—

 
—

 
3,047

Redemption of vested equity awards
—

 
—

 
(1,813
)
 
—

 
—

 
—

 
(1,813
)
Adjustments to noncontrolling interests resulting from changes in ownership of COPLP
—

 
—

 
(514
)
 
—

 
—

 
514

 
—

Comprehensive income
—

 
—

 
—

 
39,217

 
568

 
1,958

 
41,743

Dividends
—

 
—

 
—

 
(60,922
)
 
—

 
—

 
(60,922
)
Distributions to owners of common and preferred units in COPLP
—

 
—

 
—

 
—

 
—

 
(2,202
)
 
(2,202
)
Distributions to noncontrolling interests in other consolidated entities
—

 
—

 
—

 
—

 
—

 
(2,610
)
 
(2,610
)
Adjustment to arrive at fair value of redeemable noncontrolling interests
—

 
—

 
(401
)
 
—

 
—

 
—

 
(401
)
Balance at June 30, 2017 (99,471,641 common shares outstanding)
$
—

 
$
995

 
$
2,146,119

 
$
(793,828
)
 
$
(1,163
)
 
$
66,701

 
$
1,418,824


See accompanying notes to consolidated financial statements.

6


Corporate Office Properties Trust and Subsidiaries
Consolidated Statements of Cash Flows
(in thousands)
(unaudited) 
 
For the Six Months Ended June 30,
 
2017
 
2016
Cash flows from operating activities
 

 
 

Revenues from real estate operations received
$
255,302

 
$
261,980

Construction contract and other service revenues received
39,917

 
34,992

Property operating expenses paid
(80,385
)
 
(87,005
)
Construction contract and other service expenses paid
(31,996
)
 
(24,303
)
General, administrative, leasing, business development and land carry costs paid
(20,315
)
 
(19,212
)
Interest expense paid
(36,351
)
 
(41,179
)
Lease incentives
(9,375
)
 
(996
)
Other
940

 
123

Net cash provided by operating activities
117,737

 
124,400

Cash flows from investing activities
 

 
 

Construction, development and redevelopment
(85,926
)
 
(75,339
)
Tenant improvements on operating properties
(13,711
)
 
(14,862
)
Other capital improvements on operating properties
(11,780
)
 
(16,007
)
Proceeds from dispositions of properties
54,798

 
5,448

Leasing costs paid
(3,904
)
 
(3,434
)
Other
1,573

 
(13
)
Net cash used in investing activities
(58,950
)
 
(104,207
)
Cash flows from financing activities
 

 
 

Proceeds from debt
 
 
 
Revolving Credit Facility
213,000

 
133,500

Other debt proceeds
—

 
45,000

Repayments of debt
 
 
 
Revolving Credit Facility
(19,000
)
 
(119,000
)
Scheduled principal amortization
(1,913
)
 
(3,532
)
Other debt repayments
(200,100
)
 
(40,498
)
Net proceeds from issuance of common shares
19,835

 
(5
)
Redemption of preferred shares
(199,083
)
 
—

Common share dividends paid
(54,439
)
 
(52,021
)
Preferred share dividends paid
(9,305
)
 
(7,105
)
Distributions paid to noncontrolling interests in COPLP
(2,274
)
 
(2,362
)
Distributions paid to redeemable noncontrolling interests
(781
)
 
(14,306
)
Redemption of vested equity awards
(1,813
)
 
(1,492
)
Other
(2,171
)
 
(5,365
)
Net cash used in financing activities
(258,044
)
 
(67,186
)
Net decrease in cash and cash equivalents
(199,257
)
 
(46,993
)
Cash and cash equivalents
 

 
 

Beginning of period
209,863

 
60,310

End of period
$
10,606

 
$
13,317


See accompanying notes to consolidated financial statements.
 


7


Corporate Office Properties Trust and Subsidiaries
Consolidated Statements of Cash Flows (continued)
(in thousands)
(unaudited)
 
For the Six Months Ended June 30,
 
2017
 
2016
Reconciliation of net income (loss) to net cash provided by operating activities:
 

 
 

Net income (loss)
$
42,295

 
$
(40,220
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 

 
 

Depreciation and amortization
66,948

 
68,901

Impairment losses
1,618

 
72,138

(Gain) loss on interest rate derivatives
(9
)
 
1,870

Amortization of deferred financing costs and net debt discounts
2,613

 
2,998

Decrease (increase) in deferred rent receivable
669

 
(1,276
)
Gain on sales of real estate
(4,250
)
 
—

Share-based compensation
2,820

 
3,839

Other
(2,548
)
 
(1,725
)
Operating changes in assets and liabilities:
 

 
 
Increase in accounts receivable
(8,304
)
 
(3,320
)
Decrease (increase) in restricted cash and marketable securities
1,826

 
(389
)
Decrease in prepaid expenses and other assets, net
20,800

 
11,303

(Decrease) increase in accounts payable, accrued expenses and other liabilities
(2,387
)
 
15,394

Decrease in rents received in advance and security deposits
(4,354
)
 
(5,113
)
Net cash provided by operating activities
$
117,737

 
$
124,400

Supplemental schedule of non-cash investing and financing activities:
 

 
 

(Decrease) increase in accrued capital improvements, leasing and other investing activity costs
$
(4,927
)
 
$
1,604

Increase in property in connection with capital lease obligation
$
16,127

 
$
—

Increase in property and redeemable noncontrolling interests in connection with property contributed in a joint venture
$
—

 
$
22,600

Decrease in redeemable noncontrolling interests and increase in other liabilities in connection with distribution payable to redeemable noncontrolling interest
$
—

 
$
6,675

Increase (decrease) in fair value of derivatives applied to accumulated other comprehensive loss and noncontrolling interests
$
513

 
$
(15,268
)
Equity in other comprehensive income (loss) of an equity method investee
$
39

 
$
(184
)
Dividends/distribution payable
$
28,462

 
$
30,219

Decrease in noncontrolling interests and increase in shareholders’ equity in connection with the conversion of common units into common shares
$
2,564

 
$
371

Adjustments to noncontrolling interests resulting from changes in COPLP ownership
$
514

 
$
5

Increase in redeemable noncontrolling interest and decrease in equity to carry redeemable noncontrolling interest at fair value
$
401

 
$
349

 
See accompanying notes to consolidated financial statements.


8




Corporate Office Properties, L.P. and Subsidiaries
Consolidated Balance Sheets
(in thousands, except unit data)
(unaudited)
 
June 30,
2017
 
December 31,
2016
Assets
 

 
 

Properties, net:
 

 
 

Operating properties, net
$
2,688,174

 
$
2,671,831

Projects in development or held for future development
446,385

 
401,531

Total properties, net
3,134,559

 
3,073,362

Assets held for sale, net
51,291

 
94,654

Cash and cash equivalents
10,606

 
209,863

Restricted cash and marketable securities
2,721

 
2,756

Investment in unconsolidated real estate joint venture
25,335

 
25,548

Accounts receivable (net of allowance for doubtful accounts of $435 and $603, respectively)
42,742

 
34,438

Deferred rent receivable (net of allowance of $125 and $373, respectively)
89,832

 
90,219

Intangible assets on real estate acquisitions, net
69,205

 
78,351

Deferred leasing costs (net of accumulated amortization of $29,720 and $65,988, respectively)
40,506

 
41,214

Investing receivables
54,598

 
52,279

Prepaid expenses and other assets, net
49,347

 
72,764

Total assets
$
3,570,742

 
$
3,775,448

Liabilities and equity
 

 
 

Liabilities:
 

 
 

Debt, net
$
1,897,734

 
$
1,904,001

Accounts payable and accrued expenses
95,267

 
108,682

Rents received in advance and security deposits
25,444

 
29,798

Distributions payable
28,462

 
31,335

Deferred revenue associated with operating leases
13,172

 
12,666

Redeemable preferred units of general partner, 531,667 units outstanding at December 31, 2016 and none at June 30, 2017
—

 
26,583

Capital lease obligation
16,177

—

—

Other liabilities
51,931

 
44,740

Total liabilities
2,128,187

 
2,157,805

Commitments and contingencies (Note 15)


 


Redeemable noncontrolling interests
23,731

 
22,979

Equity:
 

 
 

Corporate Office Properties, L.P.’s equity:
 

 
 

Preferred units
 
 
 
General partner, 6,900,000 preferred units outstanding at December 31, 2016 and none at June 30, 2017
—

 
172,500

Limited partner, 352,000 preferred units outstanding at June 30, 2017 and December 31, 2016
8,800

 
8,800

Common units, 99,471,641 and 98,498,651 held by the general partner and 3,403,391 and 3,590,391 held by limited partners at June 30, 2017 and December 31, 2016, respectively
1,399,578

 
1,401,597

Accumulated other comprehensive loss
(1,266
)
 
(1,854
)
Total Corporate Office Properties, L.P.’s equity
1,407,112

 
1,581,043

Noncontrolling interests in subsidiaries
11,712

 
13,621

Total equity
1,418,824

 
1,594,664

Total liabilities, redeemable noncontrolling interest and equity
$
3,570,742

 
$
3,775,448


See accompanying notes to consolidated financial statements.


9


Corporate Office Properties, L.P. and Subsidiaries
Consolidated Statements of Operations
(in thousands, except per unit data)
(unaudited)
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Revenues
 

 
 

 
 
 
 
Rental revenue
$
101,347

 
$
107,524

 
$
201,962

 
$
212,906

Tenant recoveries and other real estate operations revenue
26,950

 
26,400

 
53,102

 
54,105

Construction contract and other service revenues
23,138

 
12,003

 
36,172

 
23,223

Total revenues
151,435

 
145,927

 
291,236

 
290,234

Expenses
 

 
 

 
 

 
 

Property operating expenses
48,628

 
48,141

 
97,147

 
100,016

Depreciation and amortization associated with real estate operations
32,793

 
33,248

 
65,852

 
67,775

Construction contract and other service expenses
22,315

 
11,478

 
34,801

 
22,172

Impairment losses
1,625

 
69,692

 
1,625

 
72,138

General, administrative and leasing expenses
7,859

 
8,026

 
16,470

 
19,909

Business development expenses and land carry costs
1,597

 
2,363

 
3,290

 
4,781

Total operating expenses
114,817

 
172,948

 
219,185

 
286,791

Operating income (loss)
36,618

 
(27,021
)
 
72,051

 
3,443

Interest expense
(19,163
)
 
(22,639
)
 
(38,157
)
 
(46,198
)
Interest and other income
1,583

 
1,330

 
3,309

 
2,486

(Loss) gain on early extinguishment of debt
(513
)
 
5

 
(513
)
 
22

Income (loss) before equity in income of unconsolidated entities and income taxes
18,525

 
(48,325
)
 
36,690

 
(40,247
)
Equity in income of unconsolidated entities
718

 
10

 
1,443

 
20

Income tax (expense) benefit
(48
)
 
(1
)
 
(88
)
 
7

Income (loss) before gain on sales of real estate
19,195

 
(48,316
)
 
38,045

 
(40,220
)
Gain on sales of real estate
12

 
—

 
4,250

 
—

Net income (loss)
19,207

 
(48,316
)
 
42,295

 
(40,220
)
Net income attributable to noncontrolling interests in consolidated entities
(907
)
 
(911
)
 
(1,841
)
 
(1,890
)
Net income (loss) attributable to COPLP
18,300

 
(49,227
)
 
40,454

 
(42,110
)
Preferred unit distributions
(3,204
)
 
(3,718
)
 
(6,549
)
 
(7,435
)
Issuance costs associated with redeemed preferred units
(6,847
)
 
—

 
(6,847
)
 
—

Net income (loss) attributable to COPLP common unitholders
$
8,249

 
$
(52,945
)
 
$
27,058

 
$
(49,545
)
Earnings per common unit:
 

 
 

 
 

 
 

Net income (loss) attributable to COPLP common unitholders - basic
$
0.08

 
$
(0.54
)
 
$
0.26

 
$
(0.51
)
Net income (loss) attributable to COPLP common unitholders - diluted
$
0.08

 
$
(0.54
)
 
$
0.26

 
$
(0.51
)
Distributions declared per common unit
$
0.275

 
$
0.275

 
$
0.550

 
$
0.550


See accompanying notes to consolidated financial statements.

10


Corporate Office Properties, L.P. and Subsidiaries
Consolidated Statements of Comprehensive Income
(in thousands)
(unaudited) 
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Net income (loss)
$
19,207

 
$
(48,316
)
 
$
42,295

 
$
(40,220
)
Other comprehensive income (loss)
 

 
 

 
 
 
 
Unrealized loss on interest rate derivatives
(1,800
)
 
(5,704
)
 
(1,576
)
 
(16,988
)
Loss on interest rate derivatives recognized in interest expense (effective portion)
853

 
850

 
2,037

 
1,720

Loss on interest rate derivatives recognized in interest expense (ineffective portion)
88

 
—

 
88

 
—

Equity in other comprehensive income (loss) of equity method investee
39

 
(184
)
 
39

 
(184
)
Other comprehensive (loss) income
(820
)
 
(5,038
)
 
588

 
(15,452
)
Comprehensive income (loss)
18,387

 
(53,354
)
 
42,883

 
(55,672
)
Comprehensive income attributable to noncontrolling interests
(907
)
 
(911
)
 
(1,841
)
 
(1,890
)
Comprehensive income (loss) attributable to COPLP
$
17,480

 
$
(54,265
)
 
$
41,042

 
$
(57,562
)
 
See accompanying notes to consolidated financial statements.



11


Corporate Office Properties, L.P. and Subsidiaries
Consolidated Statements of Equity
(Dollars in thousands)
(unaudited)
 
Limited Partner Preferred Units
 
General Partner
 Preferred Units
 
Common Units
 
Accumulated Other Comprehensive Income (Loss)
 
Noncontrolling Interests in Subsidiaries
 
 
 
Units
 
Amount
 
Units
 
Amount
 
Units
 
Amount
 
 
 
Total Equity
Balance at December 31, 2015
352,000

 
$
8,800

 
7,431,667

 
$
199,083

 
98,208,903

 
$
1,400,745

 
$
(2,985
)
 
$
10,921

 
$
1,616,564

Costs associated with common shares issued to the public
—

 
—

 
—

 
—

 
—

 
(5
)
 
—

 
—

 
(5
)
Share-based compensation (units net of redemption)
—

 
—

 
—

 
—

 
141,089

 
4,303

 
—

 
—

 
4,303

Redemptions of vested equity awards
—

 
—

 
—

 
—

 
—

 
(1,492
)
 
—

 
—

 
(1,492
)
Comprehensive loss
—

 
330

 
—

 
7,105

 
—

 
(49,545
)
 
(15,452
)
 
773

 
(56,789
)
Distributions to owners of common and preferred units
—

 
(330
)
 
—

 
(7,105
)
 
—

 
(54,086
)
 
—

 
—

 
(61,521
)
Distributions to noncontrolling interests in subsidiaries
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(8
)
 
(8
)
Adjustment to arrive at fair value of redeemable noncontrolling interest
—

 
—

 
—

 
—

 
—

 
(349
)
 
—

 
—

 
(349
)
Balance at June 30, 2016
352,000

 
$
8,800

 
7,431,667

 
$
199,083

 
98,349,992

 
$
1,299,571

 
$
(18,437
)
 
$
11,686

 
$
1,500,703

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016
352,000

 
$
8,800

 
6,900,000

 
$
172,500

 
102,089,042

 
$
1,401,597

 
$
(1,854
)
 
$
13,621

 
$
1,594,664

Redemption of preferred units resulting from redemption of preferred shares
—

 
—

 
(6,900,000
)
 
(172,500
)
 
—

 
—

 
—

 
—

 
(172,500
)
Issuance of common units resulting from common shares issued under COPT at-the-market program
—

 
—

 
—

 
—

 
591,042

 
19,668

 
—

 
—

 
19,668

Issuance of common units resulting from exercise of share options
—

 
—

 
—

 
—

 
5,000

 
150

 
—

 
—

 
150

Share-based compensation (units net of redemption)
—

 
—

 
—

 
—

 
189,948

 
3,047

 
—

 
—

 
3,047

Redemptions of vested equity awards
—

 
—

 
—

 
—

 
—

 
(1,813
)
 
—

 
—

 
(1,813
)
Comprehensive income
—

 
330

 
—

 
6,219

 
—

 
33,905

 
588

 
701

 
41,743

Distributions to owners of common and preferred units
—

 
(330
)
 
—

 
(6,219
)
 
—

 
(56,575
)
 
—

 
—

 
(63,124
)
Distributions to noncontrolling interests in subsidiaries
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(2,610
)
 
(2,610
)
Adjustment to arrive at fair value of redeemable noncontrolling interest
—

 
—

 
—

 
—

 
—

 
(401
)
 
—

 
—

 
(401
)
Balance at June 30, 2017
352,000

 
$
8,800

 
—

 
$
—

 
102,875,032

 
$
1,399,578

 
$
(1,266
)
 
$
11,712

 
$
1,418,824


See accompanying notes to consolidated financial statements.

12


Corporate Office Properties, L.P. and Subsidiaries
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
 
For the Six Months Ended June 30,
 
2017
 
2016
Cash flows from operating activities
 

 
 

Revenues from real estate operations received
$
255,302

 
$
261,980

Construction contract and other service revenues received
39,917

 
34,992

Property operating expenses paid
(80,385
)
 
(87,005
)
Construction contract and other service expenses paid
(31,996
)
 
(24,303
)
General, administrative, leasing, business development and land carry costs paid
(20,315
)
 
(19,212
)
Interest expense paid
(36,351
)
 
(41,179
)
Lease incentives
(9,375
)
 
(996
)
Other
940

 
123

Net cash provided by operating activities
117,737

 
124,400

Cash flows from investing activities
 

 
 

Construction, development and redevelopment
(85,926
)
 
(75,339
)
Tenant improvements on operating properties
(13,711
)
 
(14,862
)
Other capital improvements on operating properties
(11,780
)
 
(16,007
)
Proceeds from dispositions of properties
54,798

 
5,448

Leasing costs paid
(3,904
)
 
(3,434
)
Other
1,573

 
(13
)
Net cash used in investing activities
(58,950
)
 
(104,207
)
Cash flows from financing activities
 

 
 

Proceeds from debt
 
 
 
Revolving Credit Facility
213,000

 
133,500

Other debt proceeds
—

 
45,000

Repayments of debt
 
 
 
Revolving Credit Facility
(19,000
)
 
(119,000
)
Scheduled principal amortization
(1,913
)
 
(3,532
)
Other debt repayments
(200,100
)
 
(40,498
)
Net proceeds from issuance of common units
19,835

 
(5
)
Redemption of preferred units
(199,083
)
 
—

Common unit distributions paid
(56,383
)
 
(54,053
)
Preferred unit distributions paid
(9,635
)
 
(7,435
)
Redemption of vested equity awards
(1,813
)
 
(1,492
)
Distributions paid to redeemable noncontrolling interests
(781
)
 
(14,306
)
Other
(2,171
)
 
(5,365
)
Net cash used in financing activities
(258,044
)
 
(67,186
)
Net decrease in cash and cash equivalents
(199,257
)
 
(46,993
)
Cash and cash equivalents
 

 
 

Beginning of period
209,863

 
60,310

End of period
$
10,606

 
$
13,317


See accompanying notes to consolidated financial statements.

13


Corporate Office Properties, L.P. and Subsidiaries
Consolidated Statements of Cash Flows (Continued)
(in thousands)
(unaudited)

 
For the Six Months Ended June 30,
 
2017
 
2016
Reconciliation of net income (loss) to net cash provided by operating activities:
 

 
 

Net income (loss)
$
42,295

 
$
(40,220
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 

 
 

Depreciation and amortization
66,948

 
68,901

Impairment losses
1,618

 
72,138

(Gain) loss on interest rate derivatives
(9
)
 
1,870

Amortization of deferred financing costs and net debt discounts
2,613

 
2,998

Decrease (increase) in deferred rent receivable
669

 
(1,276
)
Gain on sales of real estate
(4,250
)
 
—

Share-based compensation
2,820

 
3,839

Other
(2,548
)
 
(1,725
)
Operating changes in assets and liabilities:
 

 
 
Increase in accounts receivable
(8,304
)
 
(3,320
)
Decrease (increase) in restricted cash and marketable securities
534

 
(1,106
)
Decrease in prepaid expenses and other assets, net
20,800

 
11,303

(Decrease) increase in accounts payable, accrued expenses and other liabilities
(1,095
)
 
16,111

Decrease in rents received in advance and security deposits
(4,354
)
 
(5,113
)
Net cash provided by operating activities
$
117,737

 
$
124,400

Supplemental schedule of non-cash investing and financing activities:
 

 
 

(Decrease) increase in accrued capital improvements, leasing and other investing activity costs
$
(4,927
)
 
$
1,604

Increase in property in connection with capital lease obligation
$
16,127

 
$
—

Increase in property and redeemable noncontrolling interests in connection with property contributed in a joint venture
$
—

 
$
22,600

Decrease in redeemable noncontrolling interests and increase in other liabilities in connection with distribution payable to redeemable noncontrolling interest
$
—

 
$
6,675

Increase (decrease) in fair value of derivatives applied to accumulated other comprehensive loss and noncontrolling interests
$
513

 
$
(15,268
)
Equity in other comprehensive income (loss) of an equity method investee
$
39

 
$
(184
)
Distributions payable
$
28,462

 
$
30,219

Increase in redeemable noncontrolling interest and decrease in equity to carry redeemable noncontrolling interest at fair value
$
401

 
$
349

 
See accompanying notes to consolidated financial statements.



14


Corporate Office Properties Trust and Subsidiaries and Corporate Office Properties, L.P. and Subsidiaries
Notes to Consolidated Financial Statements
(unaudited)
 
1.    Organization
 
Corporate Office Properties Trust (“COPT”) and subsidiaries (collectively, the “Company”) is a fully-integrated and self-managed real estate investment trust (“REIT”). Corporate Office Properties, L.P. (“COPLP”) and subsidiaries (collectively, the “Operating Partnership”) is the entity through which COPT, the sole general partner of COPLP, conducts almost all of its operations and owns almost all of its assets. Unless otherwise expressly stated or the context otherwise requires, “we”, “us” and “our” as used herein refer to each of the Company and the Operating Partnership. We own, manage, lease, develop and selectively acquire office and data center properties. The majority of our portfolio is in locations that support the United States Government and its contractors, most of whom are engaged in national security, defense and information technology (“IT”) related activities servicing what we believe are growing, durable priority missions (“Defense/IT Locations”). We also own a portfolio of office properties located in select urban/urban-like submarkets within our regional footprint with durable Class-A office fundamentals and characteristics, as well as other properties supporting general commercial office tenants (“Regional Office”). As of June 30, 2017, our properties included the following:

•
165 operating office properties totaling 17.3 million square feet, including 14 triple-net leased, single-tenant data center properties. We owned six of these properties through an unconsolidated real estate joint venture;
•
ten office properties under construction or redevelopment that we estimate will total approximately 1.4 million square feet upon completion, including three partially operational properties and two properties completed but held for future lease to the United States Government;
•
987 acres of land we controlled for future development that we believe could be developed into approximately 12.5 million square feet and an additional 194 acres of other land; and
•
a wholesale data center with a critical load of 19.25 megawatts.
 
COPLP owns real estate directly and through subsidiary partnerships and limited liability companies (“LLCs”).  In addition to owning real estate, COPLP also owns subsidiaries that provide real estate services such as property management and construction and development services primarily for our properties but also for third parties. Some of these services are performed by a taxable REIT subsidiary (“TRS”).

Equity interests in COPLP are in the form of common and preferred units. As of June 30, 2017, COPT owned 96.7% of the outstanding COPLP common units (“common units”) and none of the outstanding COPLP preferred units (“preferred units”); the remaining common and preferred units in COPLP were owned by third parties. Common units in COPLP not owned by COPT carry certain redemption rights. The number of common units in COPLP owned by COPT is equivalent to the number of outstanding common shares of beneficial interest (“common shares”) of COPT, and the entitlement of all COPLP common units to quarterly distributions and payments in liquidation is substantially the same as those of COPT common shareholders. Similarly, in the case of any series of preferred units in COPLP held by COPT, there is a series of preferred shares of beneficial interest (“preferred shares”) in COPT that is equivalent in number and carries substantially the same terms as such series of COPLP preferred units. COPT’s common shares are publicly traded on the New York Stock Exchange (“NYSE”) under the ticker symbol “OFC”.

Because COPLP is managed by COPT, and COPT conducts substantially all of its operations through COPLP, we refer to COPT’s executive officers as COPLP’s executive officers, and although, as a partnership, COPLP does not have a board of trustees, we refer to COPT’s Board of Trustees as COPLP’s Board of Trustees.
  
2.     Summary of Significant Accounting Policies
 
Basis of Presentation
 
The COPT consolidated financial statements include the accounts of COPT, the Operating Partnership, their subsidiaries and other entities in which COPT has a majority voting interest and control.  The COPLP consolidated financial statements include the accounts of COPLP, its subsidiaries and other entities in which COPLP has a majority voting interest and control.  We also consolidate certain entities when control of such entities can be achieved through means other than voting rights (“variable interest entities” or “VIEs”) if we are deemed to be the primary beneficiary of such entities.  We eliminate all intercompany balances and transactions in consolidation.


15


 We use the equity method of accounting when we own an interest in an entity and can exert significant influence over but cannot control the entity’s operations. We discontinue equity method accounting if our investment in an entity (and net advances) is reduced to zero unless we have guaranteed obligations of the entity or are otherwise committed to provide further financial support for the entity.
 
We use the cost method of accounting when we own an interest in an entity and cannot exert significant influence over its operations.

These interim financial statements should be read together with the consolidated financial statements and notes thereto as of and for the year ended December 31, 2016 included in our 2016 Annual Report on Form 10-K.  The unaudited consolidated financial statements include all adjustments that are necessary, in the opinion of management, to fairly state our financial position and results of operations.  All adjustments are of a normal recurring nature.  The consolidated financial statements have been prepared using the accounting policies described in our 2016 Annual Report on Form 10-K.

Reclassification

We reclassified certain amounts from prior periods to conform to the current period presentation of our consolidated financial statements with no effect on previously reported net income or equity.

Recent Accounting Pronouncements

We adopted guidance issued by the Financial Accounting Standards Board (“FASB”) effective January 1, 2017 intended to simplify various aspects related to the accounting and presentation for employee share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the consolidated statement of cash flows. In connection with our adoption of this policy, we made an entity-wide accounting policy election to continue to account for potential future award forfeitures by estimating the number of awards that are expected to vest. Our adoption of this guidance did not have a material impact on our consolidated financial statements.

We adopted guidance issued by the FASB prospectively effective January 1, 2017 that clarifies the definition of a business used by entities in determining whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill and consolidation. Under the new guidance it is expected that the majority of our future operating property acquisitions will be accounted for as asset acquisitions, whereas under the previous guidance our recent acquisitions were accounted for as business combinations; we believe that the primary effect of this change will be that transaction costs associated with future acquisitions will be capitalized rather than expensed as incurred. This guidance had no effect on our consolidated financial statements upon adoption.

In May 2014, the FASB issued guidance regarding the recognition of revenue from contracts with customers. Under this guidance, an entity will recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This guidance also requires improved disclosures regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Also in connection with this guidance, in 2017, the FASB issued additional guidance, including guidance clarifying the scope of asset derecognition provisions and accounting for partial sales of nonfinancial assets. While we are still completing our assessment of the impact of the guidance, below is a summary of the anticipated primary effects on our accounting and reporting.

•
Construction contract revenue: We reviewed our historical construction management arrangements and related contracts. Based on this review, we believe that we will account for these arrangements using the percentage of completion method, which is the method we have used in most cases historically. We do not currently believe that the resulting effect of the change will be material.
•
Sales of real estate: The new guidance requires recognition of a sale of real estate and resulting gain or loss when control transfers and the buyer has the ability to direct use of, or obtain substantially all of the remaining benefit from, the asset (which generally will occur on the closing date); the factor of continuing involvement is no longer a specific consideration for the timing of recognition. The new guidance eliminates the need to consider adequacy of buyer investment, which was replaced by additional judgments regarding collectability and intent and/or ability to pay. The new guidance also requires an entity to derecognize nonfinancial assets and in substance non financial assets once it transfers control of such assets. When an entity transfers its controlling interest in a nonfinancial asset, but retains a noncontrolling ownership interest, the entity is required to measure any non-controlling interest it receives or retains at fair value and recognize a full gain or loss on the transaction; as a result, sales and partial sales of real estate assets will now be subject to the same derecognition

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model as all other nonfinancial assets. Since all but one of our sale transactions previously met the criteria for immediate gain recognition under existing guidance, we do not believe that the recognition pattern for these transactions will be changed by the new guidance. Our one sale transaction that did not meet the criteria for immediate full recognition under the previous standard was our contribution of data center properties into a newly-formed joint venture in July 2016, as discussed further in our 2016 Annual Report on Form 10-K. We believe that this transaction, which was accounted for as a partial sale under existing guidance, would meet the criteria for immediate full gain recognition under the new guidance; this would result in an additional $18 million in income being recognizable in 2016 under the new guidance that is currently being amortized into income in subsequent periods under existing guidance.
•
Real estate revenue associated with executory costs and other non-lease components: Once the new guidance setting forth principles for the recognition, measurement, presentation and disclosure of leases (discussed below) goes into effect, we believe that the new revenue standard may apply to executory costs and other components of revenue due under leases that are deemed to be non-lease components (such as common area maintenance and provision of utilities), even when the revenue for such activities is not separately stipulated in the lease. In that case, then revenue from these items previously recognized on a straight-line basis under current lease guidance would be recognized under the new revenue guidance as the related services are delivered. As a result, while the total revenue recognized over time would not differ under the new guidance, the recognition pattern could be different. We are in the process of evaluating the significance of the difference in the recognition pattern that would result from this change.

We are required to adopt this guidance for our annual and interim periods beginning January 1, 2018 using one of two methods: retrospective restatement for each reporting period presented at the time of adoption, or retrospectively with the cumulative effect of initially applying this guidance recognized at the date of initial application. We have not decided which method of adoption we will use.

In February 2016, the FASB issued guidance that sets forth principles for the recognition, measurement, presentation and disclosure of leases.  This guidance requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase of the leased asset by the lessee. The resulting classification determines whether the lease expense is recognized based on an effective interest method or straight-line basis over the term of the lease. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases. The guidance requires lessors of real estate to account for leases using an approach that is substantially equivalent to existing guidance for sales-type leases, direct financing leases and operating leases.  While we are still completing our assessment of the impact of this guidance, below is a summary of the anticipated primary effects of this guidance on our accounting and reporting.

•
Real estate leases in which we are the lessor:
◦
Balance sheet reporting: We believe that we will apply an approach under the new guidance that is similar to the current accounting for operating leases, in which we will continue to recognize the underlying leased asset as property on our balance sheet.
◦
Deferral of compensation-related lease costs: Under the new lease guidance, lessors may only capitalize their incremental direct costs of leasing. As a result, we believe that we will no longer be able to defer the recognition of compensation-related costs in connection with new or extended tenant leases (refer to amounts reported in our 2016 Annual Report on Form 10-K for amounts deferred in 2014, 2015 and 2016).
◦
Lease revenue reporting: As discussed in further detail above in connection with the new revenue guidance, we believe that the new revenue standard may apply to executory costs and other components of revenue deemed to be non-lease components (such as common area maintenance and provision of utilities), even when the revenue for such activities is not separately stipulated in the lease. In that case, we would need to separate the lease components of revenue due under leases from the non-lease components. Under the new guidance, we would continue to recognize the lease components of lease revenue on a straight-line basis over our respective lease terms as we do under prior guidance. However, we would recognize the non-lease components under the new revenue guidance as the related services are delivered. As discussed above, we are in the process of evaluating the significance of the difference in the recognition pattern that would result from this change.
•
Leases in which we are the lessee:
◦
Our most significant leases as lessee are ground leases we have for certain properties; as of June 30, 2017, our future minimum rental payments under these leases totaled $90.4 million, with various expiration dates extending to the year 2100. While we are still in the process of evaluating these leases under the new guidance, we believe that we will be required to recognize a right-of-use asset and a lease liability for the present value of these minimum lease payments. We believe that these leases most likely will be classified as finance leases under the new guidance; as a result, the interest component of each lease payment would be recorded as interest expense and the right-of-use asset would be amortized into expense using the straight-line method over the life of the lease.

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This guidance is effective for reporting periods beginning January 1, 2019, with modified retrospective restatement for each reporting period presented at the time of adoption. Early adoption is also permitted for this guidance.

In June 2016, the FASB issued guidance that changes how entities measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The guidance replaces the current incurred loss model with an expected loss approach, resulting in a more timely recognition of such losses. The guidance will apply to most financial assets measured at amortized cost and certain other instruments, including trade and other receivables, loans, held-to-maturity debt securities, net investments in leases, and off-balance-sheet credit exposures (e.g. loan commitments). Under the new guidance, an entity will recognize its estimate of expected credit losses as an allowance, as the guidance requires that financial assets be measured on an amortized cost basis and to be presented at the net amount expected to be collected. The guidance is effective for us beginning January 1, 2020, with early adoption permitted after December 2018. We are currently assessing the financial impact of this guidance on our consolidated financial statements.

In August 2016, the FASB issued guidance that clarifies how entities should classify certain cash receipts and cash payments on the statement of cash flows with the objective of reducing the existing diversity in practice related to eight specific cash flow issues. The areas addressed in the new guidance relate to debt prepayment costs, settlement of zero-coupon debt instruments, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned and bank-owned life insurance policies, distributions received from equity method investments, beneficial interest in securitization transactions and separately identifiable cash flows and application of the predominance principle. The guidance is effective for us beginning January 1, 2018, with early adoption permitted. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.

In November 2016, the FASB issued guidance that requires the statement of cash flows to explain the change during the period in the total of cash, cash equivalents and amounts described as restricted cash or restricted cash equivalents.  Under the new guidance, amounts described as restricted cash and restricted cash equivalents will be included with cash and cash equivalents when reconciling the beginning of period and end of period total amounts shown on the statement of cash flows.  The guidance is effective for us beginning January 1, 2018, with early adoption permitted. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.

3.     Fair Value Measurements

Recurring Fair Value Measurements

COPT has a non-qualified elective deferred compensation plan for Trustees and certain members of our management team that permits participants to defer up to 100% of their compensation on a pre-tax basis and receive a tax-deferred return on such deferrals. The assets held in the plan (comprised primarily of mutual funds and equity securities) and the corresponding liability to the participants are measured at fair value on a recurring basis on COPT’s consolidated balance sheet using quoted market prices, as are other marketable securities that we hold. The balance of the plan, which was fully funded, totaled $4.1 million as of June 30, 2017, and is included in the accompanying COPT consolidated balance sheets in the line entitled restricted cash and marketable securities. The offsetting liability associated with the plan is adjusted to fair value at the end of each accounting period based on the fair value of the plan assets and reported in other liabilities on COPT’s consolidated balance sheets. The assets of the plan and other marketable securities that we hold are classified in Level 1 of the fair value hierarchy. The liability associated with the plan is classified in Level 2 of the fair value hierarchy.

The fair values of our interest rate derivatives are determined using widely accepted valuation techniques, including a discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate market data and implied volatilities in such interest rates. While we determined that the majority of the inputs used to value our derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with our interest rate derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default. However, as of June 30, 2017, we assessed the significance of the impact of the credit valuation adjustments on the overall valuation of our derivatives and determined that these adjustments are not significant. As a result, we determined that our interest rate derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.

The carrying values of cash and cash equivalents, restricted cash, accounts receivable, other assets (excluding investing receivables) and accounts payable and accrued expenses are reasonable estimates of their fair values because of the short maturities of these instruments.  As discussed in Note 6, we estimated the fair values of our investing receivables based on the discounted estimated future cash flows of the loans (categorized within Level 3 of the fair value hierarchy); the discount rates

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used approximate current market rates for loans with similar maturities and credit quality, and the estimated cash payments include scheduled principal and interest payments.  For our disclosure of debt fair values in Note 8, we estimated the fair value of our unsecured senior notes based on quoted market rates for publicly-traded debt (categorized within Level 2 of the fair value hierarchy) and estimated the fair value of our other debt based on the discounted estimated future cash payments to be made on such debt (categorized within Level 3 of the fair value hierarchy); the discount rates used approximate current market rates for loans, or groups of loans, with similar maturities and credit quality, and the estimated future payments include scheduled principal and interest payments.  Fair value estimates are made as of a specific point in time, are subjective in nature and involve uncertainties and matters of significant judgment.  Settlement at such fair value amounts may not be possible and may not be a prudent management decision.
 
For additional fair value information, please refer to Note 6 for investing receivables, Note 8 for debt and Note 9 for interest rate derivatives. 

COPT and Subsidiaries

The table below sets forth financial assets and liabilities of COPT and its subsidiaries that are accounted for at fair value on a recurring basis as of June 30, 2017 and the hierarchy level of inputs used in measuring their respective fair values under applicable accounting standards (in thousands):
Description
 
Quoted Prices in
Active Markets for
Identical Assets(Level 1)
 
Significant Other
Observable Inputs(Level 2)
 
Significant
Unobservable Inputs(Level 3)
 
Total
Assets:
 
 

 
 

 
 

 
 

Marketable securities in deferred compensation plan (1)
 
 

 
 

 
 

 
 

Mutual funds
 
$
4,074

 
$
—

 
$
—

 
$
4,074

Other
 
71

 
—

 
—

 
71

Interest rate derivatives (2)
 
—

 
117

 
—

 
117

Total assets
 
$
4,145

 
$
117

 
$
—

 
$
4,262

Liabilities:
 
 

 
 

 
 

 
 

Deferred compensation plan liability (3)
 
$
—

 
$
4,145

 
$
—

 
$
4,145

Interest rate derivatives (3)
 
—

 
601

 
—

 
601

Total liabilities
 
$
—

 
$