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
September 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 October 20, 2017, 99,609,634 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 September 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 September 30, 2017, COPT owned approximately 96.8% 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 and limited liability companies (“LLCs”); 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 and LLCs. 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)
 
September 30,
2017
 
December 31,
2016
Assets
 

 
 

Properties, net:
 

 
 

Operating properties, net
$
2,690,712

 
$
2,671,831

Projects in development or held for future development
406,319

 
401,531

Total properties, net
3,097,031

 
3,073,362

Assets held for sale, net
74,415

 
94,654

Cash and cash equivalents
10,858

 
209,863

Restricted cash and marketable securities
6,173

 
8,193

Investment in unconsolidated real estate joint venture
25,194

 
25,548

Accounts receivable (net of allowance for doubtful accounts of $639 and $603, respectively)
27,624

 
34,438

Deferred rent receivable (net of allowance of $255 and $373, respectively)
84,743

 
90,219

Intangible assets on real estate acquisitions, net
64,055

 
78,351

Deferred leasing costs (net of accumulated amortization of $28,590 and $65,988, respectively)
47,033

 
41,214

Investing receivables
56,108

 
52,279

Prepaid expenses and other assets, net
66,538

 
72,764

Total assets
$
3,559,772

 
$
3,780,885

Liabilities and equity
 

 
 

Liabilities:
 

 
 

Debt, net
$
1,873,291

 
$
1,904,001

Accounts payable and accrued expenses
121,483

 
108,682

Rents received in advance and security deposits
26,223

 
29,798

Dividends and distributions payable
28,462

 
31,335

Deferred revenue associated with operating leases
12,047

 
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 September 30, 2017)
—

 
26,583

Capital lease obligation
16,347

 
—

Other liabilities
43,866

 
50,177

Total liabilities
2,121,719

 
2,163,242

Commitments and contingencies (Note 15)


 


Redeemable noncontrolling interests
23,269

 
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 September 30, 2017)
—

 
172,500

Common Shares of beneficial interest ($0.01 par value; 125,000,000 shares authorized, shares issued and outstanding of 99,608,170 at September 30, 2017 and 98,498,651 at December 31, 2016)
996

 
985

Additional paid-in capital
2,150,067

 
2,116,581

Cumulative distributions in excess of net income
(800,290
)
 
(765,276
)
Accumulated other comprehensive loss
(859
)
 
(1,731
)
Total Corporate Office Properties Trust’s shareholders’ equity
1,349,914

 
1,523,059

Noncontrolling interests in subsidiaries:
 

 
 

Common units in COPLP
44,089

 
49,228

Preferred units in COPLP
8,800

 
8,800

Other consolidated entities
11,981

 
13,577

Noncontrolling interests in subsidiaries
64,870

 
71,605

Total equity
1,414,784

 
1,594,664

Total liabilities, redeemable noncontrolling interest and equity
$
3,559,772

 
$
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 September 30,
 
For the Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Revenues
 

 
 

 
 
 
 
Rental revenue
$
102,275

 
$
103,956

 
$
304,237

 
$
316,862

Tenant recoveries and other real estate operations revenue
24,956

 
26,998

 
78,058

 
81,103

Construction contract and other service revenues
29,786

 
11,149

 
65,958

 
34,372

Total revenues
157,017

 
142,103

 
448,253

 
432,337

Expenses
 

 
 

 
 

 
 

Property operating expenses
46,368

 
49,952

 
143,515

 
149,968

Depreciation and amortization associated with real estate operations
34,438

 
32,015

 
100,290

 
99,790

Construction contract and other service expenses
28,788

 
10,341

 
63,589

 
32,513

Impairment (recoveries) losses
(161
)
 
27,699

 
1,464

 
99,837

General, administrative and leasing expenses
7,368

 
8,855

 
23,838

 
28,764

Business development expenses and land carry costs
1,277

 
1,716

 
4,567

 
6,497

Total operating expenses
118,078

 
130,578

 
337,263

 
417,369

Operating income
38,939

 
11,525

 
110,990

 
14,968

Interest expense
(19,615
)
 
(18,301
)
 
(57,772
)
 
(64,499
)
Interest and other income
1,508

 
1,391

 
4,817

 
3,877

Loss on early extinguishment of debt
—

 
(59
)
 
(513
)
 
(37
)
Income (loss) before equity in income of unconsolidated entities and income taxes
20,832

 
(5,444
)
 
57,522

 
(45,691
)
Equity in income of unconsolidated entities
719

 
594

 
2,162

 
614

Income tax (expense) benefit
(57
)
 
21

 
(145
)
 
28

Income (loss) before gain on sales of real estate
21,494

 
(4,829
)
 
59,539

 
(45,049
)
Gain on sales of real estate
1,188

 
34,101

 
5,438

 
34,101

Net income (loss)
22,682

 
29,272

 
64,977

 
(10,948
)
Net (income) loss attributable to noncontrolling interests:
 

 
 

 
 

 
 

Common units in COPLP
(704
)
 
(901
)
 
(1,611
)
 
948

Preferred units in COPLP
(165
)
 
(165
)
 
(495
)
 
(495
)
Other consolidated entities
(897
)
 
(907
)
 
(2,738
)
 
(2,799
)
Net income (loss) attributable to COPT
20,916

 
27,299

 
60,133

 
(13,294
)
Preferred share dividends
—

 
(3,552
)
 
(6,219
)
 
(10,657
)
Issuance costs associated with redeemed preferred shares
—

 
—

 
(6,847
)
 
—

Net income (loss) attributable to COPT common shareholders
$
20,916

 
$
23,747

 
$
47,067

 
$
(23,951
)
Earnings per common share:
 

 
 

 
 

 
 

Net income (loss) attributable to COPT common shareholders - basic
$
0.21

 
$
0.25

 
$
0.47

 
$
(0.26
)
Net income (loss) attributable to COPT common shareholders - diluted
$
0.21

 
$
0.25

 
$
0.47

 
$
(0.26
)
Dividends declared per common share
$
0.275

 
$
0.275

 
$
0.825

 
$
0.825


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 September 30,
 
For the Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Net income (loss)
$
22,682

 
$
29,272

 
$
64,977

 
$
(10,948
)
Other comprehensive income (loss)
 

 
 

 
 

 
 

Unrealized (loss) gain on interest rate derivatives
(301
)
 
407

 
(1,877
)
 
(16,581
)
Loss on interest rate derivatives recognized in interest expense (effective portion)
615

 
1,043

 
2,652

 
2,763

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

 
—

 
88

 
—

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

 
—

 
39

 
(184
)
Other comprehensive income (loss)
314

 
1,450

 
902

 
(14,002
)
Comprehensive income (loss)
22,996

 
30,722

 
65,879

 
(24,950
)
Comprehensive income attributable to noncontrolling interests
(1,776
)
 
(2,025
)
 
(4,874
)
 
(1,820
)
Comprehensive income (loss) attributable to COPT
$
21,220

 
$
28,697

 
$
61,005

 
$
(26,770
)
 
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 (87,000 shares)
—

 
1

 
1,166

 
—

 
—

 
(1,167
)
 
—

Costs associated with common shares issued to the public
—

 
—

 
(5
)
 
—

 
—

 
—

 
(5
)
Share-based compensation (146,274 shares issued, net of redemptions)
—

 
2

 
6,175

 
—

 
—

 
—

 
6,177

Redemption of vested equity awards
—

 
—

 
(2,179
)
 
—

 
—

 
—

 
(2,179
)
Adjustments to noncontrolling interests resulting from changes in ownership of COPLP
—

 
—

 
(42
)
 
—

 
—

 
42

 
—

Comprehensive loss
—

 
—

 
—

 
(13,294
)
 
(13,476
)
 
141

 
(26,629
)
Dividends
—

 
—

 
—

 
(88,796
)
 
—

 
—

 
(88,796
)
Distributions to owners of common and preferred units in COPLP
—

 
—

 
—

 
—

 
—

 
(3,498
)
 
(3,498
)
Distributions to noncontrolling interests in other consolidated entities
—

 
—

 
—

 
—

 
—

 
(12
)
 
(12
)
Adjustment to arrive at fair value of redeemable noncontrolling interests
—

 
—

 
(516
)
 
—

 
—

 
—

 
(516
)
Tax loss from share-based compensation
—

 
—

 
(319
)
 
—

 
—

 
—

 
(319
)
Balance at September 30, 2016 (94,764,786 common shares outstanding)
$
199,083

 
$
948

 
$
2,008,787

 
$
(759,262
)
 
$
(16,314
)
 
$
67,545

 
$
1,500,787

 
 
 
 
 
 
 
 
 
 
 
 
 
 
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 (337,000 shares)
—

 
3

 
4,599

 
—

 
—

 
(4,602
)
 
—

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 (176,477 shares issued, net of redemptions)
—

 
2

 
4,442

 
—

 
—

 
—

 
4,444

Redemption of vested equity awards
—

 
—

 
(1,869
)
 
—

 
—

 
—

 
(1,869
)
Adjustments to noncontrolling interests resulting from changes in ownership of COPLP
—

 
—

 
(589
)
 
—

 
—

 
589

 
—

Comprehensive income
—

 
—

 
—

 
60,133

 
872

 
3,154

 
64,159

Dividends
—

 
—

 
—

 
(88,300
)
 
—

 
—

 
(88,300
)
Distributions to owners of common and preferred units in COPLP
—

 
—

 
—

 
—

 
—

 
(3,262
)
 
(3,262
)
Distributions to noncontrolling interests in other consolidated entities
—

 
—

 
—

 
—

 
—

 
(2,614
)
 
(2,614
)
Adjustment to arrive at fair value of redeemable noncontrolling interests
—

 
—

 
244

 
—

 
—

 
—

 
244

Balance at September 30, 2017 (99,608,170 common shares outstanding)
$
—

 
$
996

 
$
2,150,067

 
$
(800,290
)
 
$
(859
)
 
$
64,870

 
$
1,414,784


See accompanying notes to consolidated financial statements.

6


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

 
 

Revenues from real estate operations received
$
390,116

 
$
393,300

Construction contract and other service revenues received
72,682

 
54,399

Property operating expenses paid
(144,187
)
 
(154,203
)
Construction contract and other service expenses paid
(57,189
)
 
(33,169
)
General, administrative, leasing, business development and land carry costs paid
(27,066
)
 
(27,879
)
Interest expense paid
(55,637
)
 
(61,662
)
Lease incentives
(9,414
)
 
(1,789
)
Other
1,373

 
976

Net cash provided by operating activities
170,678

 
169,973

Cash flows from investing activities
 

 
 

Construction, development and redevelopment
(113,678
)
 
(121,297
)
Tenant improvements on operating properties
(19,876
)
 
(26,055
)
Other capital improvements on operating properties
(15,174
)
 
(22,063
)
Proceeds from dispositions of properties
101,107

 
210,661

Proceeds from partial sale of properties, net of related debt
—

 
43,686

Leasing costs paid
(6,468
)
 
(6,024
)
Other
1,359

 
(991
)
Net cash (used in) provided by investing activities
(52,730
)
 
77,917

Cash flows from financing activities
 

 
 

Proceeds from debt
 
 
 
Revolving Credit Facility
268,000

 
362,500

Other debt proceeds
—

 
105,000

Repayments of debt
 
 
 
Revolving Credit Facility
(98,000
)
 
(406,000
)
Scheduled principal amortization
(2,878
)
 
(4,454
)
Other debt repayments
(200,150
)
 
(203,056
)
Deferred financing costs paid
—

 
(825
)
Net proceeds from issuance of common shares
19,834

 
(46
)
Redemption of preferred shares
(199,083
)
 
—

Common share dividends paid
(81,779
)
 
(78,072
)
Preferred share dividends paid
(9,305
)
 
(10,657
)
Distributions paid to noncontrolling interests in COPLP
(3,371
)
 
(3,476
)
Distributions paid to redeemable noncontrolling interests
(7,860
)
 
(14,329
)
Redemption of vested equity awards
(1,869
)
 
(2,179
)
Other
(492
)
 
(5,032
)
Net cash used in financing activities
(316,953
)
 
(260,626
)
Net decrease in cash and cash equivalents
(199,005
)
 
(12,736
)
Cash and cash equivalents
 

 
 

Beginning of period
209,863

 
60,310

End of period
$
10,858

 
$
47,574


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 Nine Months Ended September 30,
 
2017
 
2016
Reconciliation of net income (loss) to net cash provided by operating activities:
 

 
 

Net income (loss)
$
64,977

 
$
(10,948
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 

 
 

Depreciation and amortization
101,963

 
101,429

Impairment losses
1,457

 
99,797

(Gain) loss on interest rate derivatives
(43
)
 
347

Amortization of deferred financing costs and net debt discounts
3,514

 
4,456

Increase in deferred rent receivable
(545
)
 
(930
)
Gain on sales of real estate
(5,438
)
 
(34,101
)
Share-based compensation
4,092

 
5,637

Other
(3,970
)
 
(2,727
)
Operating changes in assets and liabilities:
 

 
 
Decrease in accounts receivable
7,498

 
3,658

Decrease in restricted cash and marketable securities
2,778

 
18

Decrease (increase) in prepaid expenses and other assets, net
3,190

 
(19,778
)
(Decrease) increase in accounts payable, accrued expenses and other liabilities
(5,220
)
 
31,523

Decrease in rents received in advance and security deposits
(3,575
)
 
(8,408
)
Net cash provided by operating activities
$
170,678

 
$
169,973

Supplemental schedule of non-cash investing and financing activities:
 

 
 

Increase in accrued capital improvements, leasing and other investing activity costs
$
17,129

 
$
9,963

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
$
—

 
$
6,683

Non-cash changes from partial sale of properties, net of debt:
 
 
 
Decrease in properties, net
$
—

 
$
(114,597
)
Increase in investment in unconsolidated real estate joint venture
$
—

 
$
25,680

Decrease in debt
$
—

 
$
59,534

Other net decreases in assets and liabilities
$
—

 
$
3,619

Increase (decrease) in fair value of derivatives applied to accumulated other comprehensive loss and noncontrolling interests
$
774

 
$
(13,817
)
Equity in other comprehensive income (loss) of an equity method investee
$
39

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

 
$
30,225

Decrease in noncontrolling interests and increase in shareholders’ equity in connection with the conversion of common units into common shares
$
4,602

 
$
1,167

Adjustments to noncontrolling interests resulting from changes in COPLP ownership
$
589

 
$
42

(Decrease) increase in redeemable noncontrolling interest and (increase) decrease in equity to carry redeemable noncontrolling interest at fair value
$
(244
)
 
$
516

 
See accompanying notes to consolidated financial statements.


8




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

 
 

Properties, net:
 

 
 

Operating properties, net
$
2,690,712

 
$
2,671,831

Projects in development or held for future development
406,319

 
401,531

Total properties, net
3,097,031

 
3,073,362

Assets held for sale, net
74,415

 
94,654

Cash and cash equivalents
10,858

 
209,863

Restricted cash and marketable securities
1,766

 
2,756

Investment in unconsolidated real estate joint venture
25,194

 
25,548

Accounts receivable (net of allowance for doubtful accounts of $639 and $603, respectively)
27,624

 
34,438

Deferred rent receivable (net of allowance of $255 and $373, respectively)
84,743

 
90,219

Intangible assets on real estate acquisitions, net
64,055

 
78,351

Deferred leasing costs (net of accumulated amortization of $28,590 and $65,988, respectively)
47,033

 
41,214

Investing receivables
56,108

 
52,279

Prepaid expenses and other assets, net
66,538

 
72,764

Total assets
$
3,555,365

 
$
3,775,448

Liabilities and equity
 

 
 

Liabilities:
 

 
 

Debt, net
$
1,873,291

 
$
1,904,001

Accounts payable and accrued expenses
121,483

 
108,682

Rents received in advance and security deposits
26,223

 
29,798

Distributions payable
28,462

 
31,335

Deferred revenue associated with operating leases
12,047

 
12,666

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

 
26,583

Capital lease obligation
16,347

—

—

Other liabilities
39,459

 
44,740

Total liabilities
2,117,312

 
2,157,805

Commitments and contingencies (Note 15)


 


Redeemable noncontrolling interests
23,269

 
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 September 30, 2017
—

 
172,500

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

 
8,800

Common units, 99,608,170 and 98,498,651 held by the general partner and 3,253,391 and 3,590,391 held by limited partners at September 30, 2017 and December 31, 2016, respectively
1,394,911

 
1,401,597

Accumulated other comprehensive loss
(952
)
 
(1,854
)
Total Corporate Office Properties, L.P.’s equity
1,402,759

 
1,581,043

Noncontrolling interests in subsidiaries
12,025

 
13,621

Total equity
1,414,784

 
1,594,664

Total liabilities, redeemable noncontrolling interest and equity
$
3,555,365

 
$
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 September 30,
 
For the Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Revenues
 

 
 

 
 
 
 
Rental revenue
$
102,275

 
$
103,956

 
$
304,237

 
$
316,862

Tenant recoveries and other real estate operations revenue
24,956

 
26,998

 
78,058

 
81,103

Construction contract and other service revenues
29,786

 
11,149

 
65,958

 
34,372

Total revenues
157,017

 
142,103

 
448,253

 
432,337

Expenses
 

 
 

 
 

 
 

Property operating expenses
46,368

 
49,952

 
143,515

 
149,968

Depreciation and amortization associated with real estate operations
34,438

 
32,015

 
100,290

 
99,790

Construction contract and other service expenses
28,788

 
10,341

 
63,589

 
32,513

Impairment (recoveries) losses
(161
)
 
27,699

 
1,464

 
99,837

General, administrative and leasing expenses
7,368

 
8,855

 
23,838

 
28,764

Business development expenses and land carry costs
1,277

 
1,716

 
4,567

 
6,497

Total operating expenses
118,078

 
130,578

 
337,263

 
417,369

Operating income
38,939

 
11,525

 
110,990

 
14,968

Interest expense
(19,615
)
 
(18,301
)
 
(57,772
)
 
(64,499
)
Interest and other income
1,508

 
1,391

 
4,817

 
3,877

Loss on early extinguishment of debt
—

 
(59
)
 
(513
)
 
(37
)
Income (loss) before equity in income of unconsolidated entities and income taxes
20,832

 
(5,444
)
 
57,522

 
(45,691
)
Equity in income of unconsolidated entities
719

 
594

 
2,162

 
614

Income tax (expense) benefit
(57
)
 
21

 
(145
)
 
28

Income (loss) before gain on sales of real estate
21,494

 
(4,829
)
 
59,539

 
(45,049
)
Gain on sales of real estate
1,188

 
34,101

 
5,438

 
34,101

Net income (loss)
22,682

 
29,272

 
64,977

 
(10,948
)
Net income attributable to noncontrolling interests in consolidated entities
(897
)
 
(913
)
 
(2,738
)
 
(2,803
)
Net income (loss) attributable to COPLP
21,785

 
28,359

 
62,239

 
(13,751
)
Preferred unit distributions
(165
)
 
(3,717
)
 
(6,714
)
 
(11,152
)
Issuance costs associated with redeemed preferred units
—

 
—

 
(6,847
)
 
—

Net income (loss) attributable to COPLP common unitholders
$
21,620

 
$
24,642

 
$
48,678

 
$
(24,903
)
Earnings per common unit:
 

 
 

 
 

 
 

Net income (loss) attributable to COPLP common unitholders - basic
$
0.21

 
$
0.25

 
$
0.47

 
$
(0.26
)
Net income (loss) attributable to COPLP common unitholders - diluted
$
0.21

 
$
0.25

 
$
0.47

 
$
(0.26
)
Distributions declared per common unit
$
0.275

 
$
0.275

 
$
0.825

 
$
0.825


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 September 30,
 
For the Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Net income (loss)
$
22,682

 
$
29,272

 
$
64,977

 
$
(10,948
)
Other comprehensive income (loss)
 

 
 

 
 
 
 
Unrealized (loss) gain on interest rate derivatives
(301
)
 
407

 
(1,877
)
 
(16,581
)
Loss on interest rate derivatives recognized in interest expense (effective portion)
615

 
1,043

 
2,652

 
2,763

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

 
—

 
88

 
—

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

 
—

 
39

 
(184
)
Other comprehensive income (loss)
314

 
1,450

 
902

 
(14,002
)
Comprehensive income (loss)
22,996

 
30,722

 
65,879

 
(24,950
)
Comprehensive income attributable to noncontrolling interests
(897
)
 
(913
)
 
(2,738
)
 
(2,803
)
Comprehensive income (loss) attributable to COPLP
$
22,099

 
$
29,809

 
$
63,141

 
$
(27,753
)
 
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)
—

 
—

 
—

 
—

 
146,274

 
6,177

 
—

 
—

 
6,177

Redemptions of vested equity awards
—

 
—

 
—

 
—

 
—

 
(2,179
)
 
—

 
—

 
(2,179
)
Comprehensive loss
—

 
495

 
—

 
10,657

 
—

 
(24,903
)
 
(14,002
)
 
1,124

 
(26,629
)
Distributions to owners of common and preferred units
—

 
(495
)
 
—

 
(10,657
)
 
—

 
(81,142
)
 
—

 
—

 
(92,294
)
Distributions to noncontrolling interests in subsidiaries
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(12
)
 
(12
)
Adjustment to arrive at fair value of redeemable noncontrolling interest
—

 
—

 
—

 
—

 
—

 
(516
)
 
—

 
—

 
(516
)
Tax loss from share-based compensation
—

 
—

 
—

 
—

 
—

 
(319
)
 
—

 
—

 
(319
)
Balance at September 30, 2016
352,000

 
$
8,800

 
7,431,667

 
$
199,083

 
98,355,177

 
$
1,297,858

 
$
(16,987
)
 
$
12,033

 
$
1,500,787

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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)
—

 
—

 
—

 
—

 
176,477

 
4,444

 
—

 
—

 
4,444

Redemptions of vested equity awards
—

 
—

 
—

 
—

 
—

 
(1,869
)
 
—

 
—

 
(1,869
)
Comprehensive income
—

 
495

 
—

 
6,219

 
—

 
55,525

 
902

 
1,018

 
64,159

Distributions to owners of common and preferred units
—

 
(495
)
 
—

 
(6,219
)
 
—

 
(84,848
)
 
—

 
—

 
(91,562
)
Distributions to noncontrolling interests in subsidiaries
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(2,614
)
 
(2,614
)
Adjustment to arrive at fair value of redeemable noncontrolling interest
—

 
—

 
—

 
—

 
—

 
244

 
—

 
—

 
244

Balance at September 30, 2017
352,000

 
$
8,800

 
—

 
$
—

 
102,861,561

 
$
1,394,911

 
$
(952
)
 
$
12,025

 
$
1,414,784


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 Nine Months Ended September 30,
 
2017
 
2016
Cash flows from operating activities
 

 
 

Revenues from real estate operations received
$
390,116

 
$
393,300

Construction contract and other service revenues received
72,682

 
54,399

Property operating expenses paid
(144,187
)
 
(154,203
)
Construction contract and other service expenses paid
(57,189
)
 
(33,169
)
General, administrative, leasing, business development and land carry costs paid
(27,066
)
 
(27,879
)
Interest expense paid
(55,637
)
 
(61,662
)
Lease incentives
(9,414
)
 
(1,789
)
Other
1,373

 
976

Net cash provided by operating activities
170,678

 
169,973

Cash flows from investing activities
 

 
 

Construction, development and redevelopment
(113,678
)
 
(121,297
)
Tenant improvements on operating properties
(19,876
)
 
(26,055
)
Other capital improvements on operating properties
(15,174
)
 
(22,063
)
Proceeds from dispositions of properties
101,107

 
210,661

Proceeds from partial sale of properties, net of related debt
—

 
43,686

Leasing costs paid
(6,468
)
 
(6,024
)
Other
1,359

 
(991
)
Net cash (used in) provided by investing activities
(52,730
)
 
77,917

Cash flows from financing activities
 

 
 

Proceeds from debt
 
 
 
Revolving Credit Facility
268,000

 
362,500

Other debt proceeds
—

 
105,000

Repayments of debt
 
 
 
Revolving Credit Facility
(98,000
)
 
(406,000
)
Scheduled principal amortization
(2,878
)
 
(4,454
)
Other debt repayments
(200,150
)
 
(203,056
)
Deferred financing costs paid
—

 
(825
)
Net proceeds from issuance of common units
19,834

 
(46
)
Redemption of preferred units
(199,083
)
 
—

Common unit distributions paid
(84,655
)
 
(81,053
)
Preferred unit distributions paid
(9,800
)
 
(11,152
)
Distributions paid to redeemable noncontrolling interests
(7,860
)
 
(14,329
)
Redemption of vested equity awards
(1,869
)
 
(2,179
)
Other
(492
)
 
(5,032
)
Net cash used in financing activities
(316,953
)
 
(260,626
)
Net decrease in cash and cash equivalents
(199,005
)
 
(12,736
)
Cash and cash equivalents
 

 
 

Beginning of period
209,863

 
60,310

End of period
$
10,858

 
$
47,574


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 Nine Months Ended September 30,
 
2017
 
2016
Reconciliation of net income (loss) to net cash provided by operating activities:
 

 
 

Net income (loss)
$
64,977

 
$
(10,948
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 

 
 

Depreciation and amortization
101,963

 
101,429

Impairment losses
1,457

 
99,797

(Gain) loss on interest rate derivatives
(43
)
 
347

Amortization of deferred financing costs and net debt discounts
3,514

 
4,456

Increase in deferred rent receivable
(545
)
 
(930
)
Gain on sales of real estate
(5,438
)
 
(34,101
)
Share-based compensation
4,092

 
5,637

Other
(3,970
)
 
(2,727
)
Operating changes in assets and liabilities:
 

 
 
Decrease in accounts receivable
7,498

 
3,658

Decrease (increase) in restricted cash and marketable securities
1,748

 
(495
)
Decrease (increase) in prepaid expenses and other assets, net
3,190

 
(19,778
)
(Decrease) increase in accounts payable, accrued expenses and other liabilities
(4,190
)
 
32,036

Decrease in rents received in advance and security deposits
(3,575
)
 
(8,408
)
Net cash provided by operating activities
$
170,678

 
$
169,973

Supplemental schedule of non-cash investing and financing activities:
 

 
 

Increase in accrued capital improvements, leasing and other investing activity costs
$
17,129

 
$
9,963

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
$
—

 
$
6,683

Non-cash changes from partial sale of properties, net of debt:
 
 
 
Decrease in properties, net
$
—

 
$
(114,597
)
Increase in investment in unconsolidated real estate joint venture
$
—

 
$
25,680

Decrease in debt
$
—

 
$
59,534

Other net decreases in assets and liabilities
$
—

 
$
3,619

Increase (decrease) in fair value of derivatives applied to accumulated other comprehensive loss and noncontrolling interests
$
774

 
$
(13,817
)
Equity in other comprehensive income (loss) of an equity method investee
$
39

 
$
(184
)
Distributions payable
$
28,462

 
$
30,225

(Decrease) increase in redeemable noncontrolling interest and (increase) decrease in equity to carry redeemable noncontrolling interest at fair value
$
(244
)
 
$
516

 
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 September 30, 2017, our properties included the following:

•
159 operating office properties totaling 17.4 million square feet, including 15 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 1.1 million square feet upon completion, including three triple-net leased, single-tenant data center properties, three partially operational properties and two properties completed but held for future lease to the United States Government;
•
984 acres of land we controlled for future development that we believe could be developed into approximately 12.3 million square feet and an additional 152 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 September 30, 2017, COPT owned 96.8% 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, we expect 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. We will adopt this guidance for our annual and interim periods beginning January 1, 2018 and expect to use the modified retrospective method, under which the cumulative effect of initially applying the guidance is recognized at the date of initial application. We do not believe that our adoption of this guidance beginning on January 1, 2018 will have a material effect on our consolidated financial statements. However, as discussed further below, once the new guidance setting forth principles for the recognition, measurement, presentation and disclosure of leases goes into effect on January 1, 2019, we believe that the new revenue standard will 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), which could affect our recognition pattern for such revenue.

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.  This guidance is effective for reporting periods beginning January 1, 2019 using a modified retrospective transition approach at

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the time of adoption. Early adoption is also permitted for this guidance. In addition, the guidance permits lessees and lessors to elect to apply a package of practical expedients that allow them not to reassess upon adoption: the lease classification for any expired or existing leases; their deferred recognition of incremental direct costs of leasing for any expired or existing leases; and whether any expired or existing contracts are, or contain, 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.

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Real estate leases in which we are the lessor:
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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.
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Deferral of non-incremental lease costs: Under the new lease guidance, we will no longer be able to defer the recognition of non-incremental 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). Upon adoption of the new guidance, we would expense previously deferred non-incremental lease costs for existing leases unless we elect the package of practical expedients, in which case such costs would remain deferred and amortized over the remaining lease terms.
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Lease revenue reporting: We believe that the new revenue standard will 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 and the 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.
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Leases in which we are the lessee:
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Our most significant leases as lessee are ground leases we have for certain properties; as of September 30, 2017, our future minimum rental payments under these leases totaled $90.2 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 also believe that these types of leases most likely would be classified as finance leases under the new guidance, which would result in the interest component of each lease payment being recorded as interest expense and the right-of-use asset being amortized into expense using the straight-line method over the life of the lease; however, if we elect to apply the package of practical expedients, we will continue to account for our existing ground leases as operating leases upon adoption of the 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. 

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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 February 2017, the FASB issued guidance clarifying the scope of asset derecognition provisions and accounting for partial sales of nonfinancial assets. 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 model as all other nonfinancial assets. As discussed further in our 2016 Annual Report on Form 10-K, we had a transaction in July 2016 accounted for as a partial sale under existing guidance that would meet the criteria for immediate full gain recognition under the new guidance; this would result in an additional $18 million in income being recognized in 2016 that is currently being amortized into income in subsequent periods under existing guidance. We do not believe that the recognition pattern for our other sales of real estate will be changed by the new guidance. We will adopt this guidance for our annual and interim periods beginning January 1, 2018 and expect to use the the full retrospective method, under which we would retrospectively restate each reporting period presented at the time of adoption.

In August 2017, the FASB issued guidance that makes targeted improvements to hedge accounting. This new guidance simplifies the application of hedge accounting and better aligns financial reporting for hedging activities with companies’ economic objectives in undertaking those activities. Under the new guidance, all changes in the fair value of highly effective cash flow hedges will be recorded in other comprehensive income instead of income. The new guidance also eases the administrative burden of hedge documentation requirements and assessing hedge effectiveness. The guidance is effective for us beginning January 1, 2019, with early adoption permitted. We are currently evaluating the impact of this guidance, including transition elections and required disclosures, on our financial statements and the timing of adoption.

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 $4.4 million as of September 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 September 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 used approximate current market rates for loans with similar maturities and credit quality, and the estimated cash payments

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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 September 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: