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 AND EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2005

 

or

 

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934

 

For the transition period from                                               to                                                           

 

Commission file number 1-14023

 

Corporate Office Properties Trust

(Exact name of registrant as specified in its charter)

 

Maryland		23-2947217
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)
8815 Centre Park Drive, Suite 400, Columbia MD		21045
(Address of principal executive offices)		(Zip Code)

 

Registrant’s telephone number, including area code:  (410) 730-9092

 

 

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.

ý Yes   o No

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  ýYes   o No

 

On August 1, 2005, 37,212,126 shares of the Company’s Common Shares of Beneficial Interest, $0.01 par value, were issued.

 

 

TABLE OF CONTENTS

 

FORM 10-Q

 

			PAGE
PART I: FINANCIAL INFORMATION
Item 1:	Financial Statements:
	Consolidated Balance Sheets as of June 30, 2005 (unaudited) and December 31, 2004 (unaudited)		3
	Consolidated Statements of Operations for the three and six months ended June 30, 2005 and 2004 (unaudited)		4
	Consolidated Statements of Cash Flows for the six months ended June 30, 2005 and 2004 (unaudited)		5
	Notes to Consolidated Financial Statements		6
Item 2:	Management’s Discussion and Analysis of Financial Condition and Results of Operations		22
Item 3:	Quantitative and Qualitative Disclosures About Market Risk		39
Item 4:	Controls and Procedures		39
PART II: OTHER INFORMATION
Item 1:	Legal Proceedings		40
Item 2:	Unregistered Sales of Equity Securities and Use of Proceeds		40
Item 3:	Defaults Upon Senior Securities		40
Item 4:	Submission of Matters to a Vote of Security Holders		40
Item 5:	Other Information		41
Item 6:	Exhibits		41
SIGNATURES			42

 

2

 

PART I: FINANCIAL INFORMATION

ITEM 1. Financial Statements

 

Corporate Office Properties Trust and Subsidiaries

Consolidated Balance Sheets

(Dollars in thousands)

(unaudited)

 

		June 30, 2005			December 31, 2004
Assets
Investment in real estate:
Operating properties, net		$	1,425,506		$	1,389,369
Properties held for sale, net		17,450			17,779
Projects under construction or development		246,657			136,152
Total commercial real estate properties, net		1,689,613			1,543,300
Investments in and advances to unconsolidated real estate joint ventures		1,233			1,201
Investment in real estate, net		1,690,846			1,544,501
Cash and cash equivalents		21,486			13,821
Restricted cash		15,982			12,617
Accounts receivable, net		13,613			16,771
Investment in other unconsolidated entity		1,621			1,621
Deferred rent receivable		29,291			26,282
Intangible assets on real estate acquisitions, net		66,354			67,560
Deferred charges, net		28,662			27,642
Prepaid and other assets		19,501			18,646
Furniture, fixtures and equipment, net		3,092			2,565
Total assets		$	1,890,448		$	1,732,026
Liabilities and shareholders’ equity
Liabilities:
Mortgage and other loans payable		$	1,177,779		$	1,022,688
Accounts payable and accrued expenses		53,984			46,307
Rents received in advance and security deposits		13,421			12,781
Dividends and distributions payable		14,834			14,713
Deferred revenue associated with acquired operating leases		8,092			7,247
Fair value of derivatives		4,188			—
Other liabilities		4,024			7,488
Total liabilities		1,276,322			1,111,224
Minority interests:
Common units in the Operating Partnership		87,439			88,355
Preferred units in the Operating Partnership		8,800			8,800
Other consolidated real estate joint ventures		861			1,723
Total minority interests		97,100			98,878
Commitments and contingencies (Note 19)
Shareholders’ equity:
Preferred Shares of beneficial interest ($0.01 par value; 15,000,000 shares authorized) (Note 13)		67			67
Common Shares of beneficial interest ($0.01 par value; 75,000,000 shares authorized, shares issued of 37,191,370 at June 30, 2005 and 36,842,108 at December 31, 2004)		372			368
Additional paid-in capital		586,567			578,228
Cumulative distributions in excess of net income		(59,226		)	(51,358		)
Value of unearned restricted common share grants		(7,396		)	(5,381		)
Accumulated other comprehensive loss		(3,358		)	—
Total shareholders’ equity		517,026			521,924
Total liabilities and shareholders’ equity		$	1,890,448		$	1,732,026

 

See accompanying notes to consolidated financial statements.

 

3

 

Corporate Office Properties Trust and Subsidiaries

Consolidated Statements of Operations

(Dollars in thousands, except per share data)

(unaudited)

 

		For the Three Months Ended June 30,						For the Six Months Ended June 30,
		2005			2004			2005			2004
Revenues
Rental revenue		$	53,601		$	48,339		$	106,031		$	90,825
Tenant recoveries and other real estate operations revenue		6,585			4,752			13,860			10,422
Construction contract revenues		17,445			5,233			33,173			11,370
Other service operations revenues		1,019			837			2,388			2,352
Total revenues		78,650			59,161			155,452			114,969
Expenses
Property operating		17,574			14,365			36,139			29,073
Depreciation and other amortization associated with real estate operations		15,068			15,705			29,455			25,893
Construction contract expenses		17,223			4,979			32,120			10,797
Other service operations expenses		955			853			2,246			1,945
General and administrative expenses		3,166			2,487			6,442			4,773
Total operating expenses		53,986			38,389			106,402			72,481
Operating income		24,664			20,772			49,050			42,488
Interest expense		(13,728		)	(10,346		)	(26,911		)	(20,449		)
Amortization of deferred financing costs		(471		)	(500		)	(867		)	(1,359		)
Income from continuing operations before gain (loss) on sales of real estate, equity in loss of unconsolidated entities, income taxes and minority interests		10,465			9,926			21,272			20,680
Gain (loss) on sales of real estate		210			24			234			(198		)
Equity in loss of unconsolidated entities		—			—			—			(88		)
Income tax expense		(213		)	(30		)	(670		)	(230		)
Income from continuing operations before minority interests		10,462			9,920			20,836			20,164
Minority interests in income from continuing operations Common units in the Operating Partnership		(1,307		)	(1,203		)	(2,592		)	(2,571		)
Preferred units in the Operating Partnership		(165		)	—			(330		)	—
Other consolidated entities		15			(8		)	39			(8		)
Income from continuing operations		9,005			8,709			17,953			17,585
Income from discontinued operations, net of minority interests		115			134			207			251
Net income		9,120			8,843			18,160			17,836
Preferred share dividends		(3,654		)	(4,435		)	(7,308		)	(8,891		)
Net income available to common shareholders		$	5,466		$	4,408		$	10,852		$	8,945
Basic earnings per common share
Income from continuing operations		$	0.15		$	0.13		$	0.29		$	0.28
Discontinued operations		—			—			0.01			0.01
Net income		$	0.15		$	0.13		$	0.30		$	0.29
Diluted earnings per common share
Income from continuing operations		$	0.14		$	0.12		$	0.28		$	0.26
Discontinued operations		—			0.01			—			0.01
Net income		$	0.14		$	0.13		$	0.28		$	0.27

 

See accompanying notes to consolidated financial statements.

 

4

 

Corporate Office Properties Trust and Subsidiaries

Consolidated Statements of Cash Flows

(Dollars in thousands)

(unaudited)

 

		For the Six Months Ended June 30,
		2005			2004
Cash flows from operating activities
Net income		$	18,160		$	17,836
Adjustments to reconcile net income to net cash provided by operating activities:
Minority interests		2,934			2,654
Depreciation and other amortization		29,924			26,243
Amortization of deferred financing costs		867			1,359
Amortization of deferred market rental revenue		(261		)	(582		)
Equity in loss of unconsolidated entities		—			88
(Gain) loss on sales of real estate		(234		)	198
Changes in operating assets and liabilities:
Increase in deferred rent receivable		(3,009		)	(2,947		)
Decrease (increase) in accounts receivable, restricted cash and prepaid and other assets		235			(11,169		)
Increase in accounts payable, accrued expenses, rents received in advance and security deposits		9,854			3,892
Other		1,647			1,465
Net cash provided by operating activities		60,117			39,037
Cash flows from investing activities
Purchases of and additions to commercial real estate properties		(174,455		)	(114,393		)
Proceeds from sales of properties		2,545			—
Acquisition of minority interest in consolidated joint venture		(1,208		)	—
Investments in and advances to unconsolidated entities		(32		)	—
Leasing costs paid		(2,468		)	(3,909		)
Advances to certain real estate joint ventures		—			(515		)
Other		(1,593		)	793
Net cash used in investing activities		(177,211		)	(118,024		)
Cash flows from financing activities
Proceeds from mortgage and other loans payable		278,455			253,302
Repayments of mortgage and other loans payable		(123,154		)	(207,719		)
Deferred financing costs paid		(2,173		)	(1,992		)
Increase in other liabilities associated with financing activities		—			4,000
Net proceeds from issuance of common shares		2,252			61,746
Dividends paid		(25,933		)	(22,348		)
Distributions paid		(4,688		)	(4,166		)
Other		—			(1,115		)
Net cash provided by financing activities		124,759			81,708
Net increase in cash and cash equivalents		7,665			2,721
Cash and cash equivalents
Beginning of period		13,821			9,481
End of period		$	21,486		$	12,202

 

See accompanying notes to consolidated financial statements.

 

5

 

Corporate Office Properties Trust and Subsidiaries

 

Notes to Consolidated Financial Statements
(Dollars in thousands, except per share data)

(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”).  We focus on the ownership, management, leasing, acquisition and development of suburban office properties.  We typically focus our operations geographically in select submarkets that are attractive to our tenant base and in which we believe we can establish a critical mass of square footage.  At June 30, 2005, all of our operating properties were located in the Mid-Atlantic region of the United States, although in accordance with our strategy of focusing on submarkets that are attractive to our tenants, we do from time to time seek to expand our operations outside of that region, as evidenced by our acquisitions in 2005 of properties in San Antonio, Texas and Colorado Springs, Colorado.  COPT is qualified as a REIT as defined in the Internal Revenue Code of 1986 and is the successor to a corporation organized in 1988.  As of June 30, 2005, our portfolio included 147 office properties in operations, including two properties owned through joint ventures.

 

We conduct almost all of our operations through our operating partnership, Corporate Office Properties, L.P. (the “Operating Partnership”), for which we are the managing general partner.  The Operating Partnership owns real estate both directly and through subsidiary partnerships and limited liability companies (“LLCs”).  A summary of our Operating Partnership’s forms of ownership and the percentage of those ownership forms owned by COPT as of June 30, 2005 follows:

 

		% Owned by COPT
Common Units		80	%
Series E Preferred Units		100	%
Series F Preferred Units		100	%
Series G Preferred Units		100	%
Series H Preferred Units		100	%
Series I Preferred Units		0	%

 

The Operating Partnership also owns 100% of Corporate Office Management, Inc. (“COMI”) (collectively with its subsidiaries defined as the “Service Companies”).  COMI’s consolidated subsidiaries are set forth below:

 

Entity Name		Type of Service Business
Corporate Realty Management, LLC (“CRM”)		Real Estate Management
Corporate Development Services, LLC (“CDS”)		Construction and Development
Corporate Cooling and Controls, LLC (“CC&C”)		Heating and Air Conditioning

 

COMI owns 100% of these entities.  Most of the services that CRM and CDS provide are for us.

 

2.                                      Basis of Presentation

 

The accompanying unaudited interim Consolidated Financial Statements have been prepared in accordance with the rules and regulations for reporting on Form 10-Q.  Accordingly, certain information and disclosures required by accounting principles generally accepted in the United States for complete Consolidated Financial Statements are not included herein.  These interim financial statements should be read together with the financial statements and notes thereto included in our 2004 Annual Report on Form 10-K.  The interim financial statements on the previous pages reflect all adjustments that we believe are necessary for the fair statement of our financial position and results of operations for the interim periods presented.  These adjustments are of a normal recurring nature.  The results of operations for such interim periods are not necessarily indicative of the results for a full year.

 

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3.             Earnings Per Share (“EPS”)

 

A summary of the numerator and denominator for purposes of our basic and diluted EPS calculations is set forth below (dollars and shares in thousands, except per share data):

 

		For the Three Months Ended June 30,						For the Six Months Ended June 30,
		2005			2004			2005			2004
Numerator:
Income from continuing operations		$	9,005		$	8,709		$	17,953		$	17,585
Less: Preferred share dividends		(3,654		)	(4,435		)	(7,308		)	(8,891		)
Numerator for basic EPS from continuing operations		5,351			4,274			10,645			8,694
Add: Convertible preferred share dividends		—			—			—			21
Numerator for diluted EPS from continuing operations		5,351			4,274			10,645			8,715
Add: Income from discontinued operations, net		115			134			207			251
Less: Convertible preferred share dividends		—			—			—			(21		)
Numerator for basic EPS on net income available to common shareholders		5,466			4,408			10,852			8,945
Add: Convertible preferred share dividends		—			—			—			21
Numerator for diluted EPS on net income available to common shareholders		$	5,466		$	4,408		$	10,852		$	8,966
Denominator (all weighted averages):
Denominator for basic EPS (common shares)		36,692			32,743			36,624			31,278
Assumed conversion of share options		1,528			1,639			1,534			1,691
Assumed conversion of convertible preferred shares		—			—			—			270
Denominator for diluted EPS		38,220			34,382			38,158			33,239
Basic EPS:
Income from continuing operations		$	0.15		$	0.13		$	0.29		$	0.28
Income from discontinued operations		—			—			0.01			0.01
Net income available to common shareholders		$	0.15		$	0.13		$	0.30		$	0.29
Diluted EPS
Income from continuing operations		$	0.14		$	0.12		$	0.28		$	0.26
Income from discontinued operations		—			0.01			—			0.01
Net income available to common shareholders		$	0.14		$	0.13		$	0.28		$	0.27

 

Our diluted EPS computations do not include the effects of the following securities since the conversions of such securities would increase diluted EPS for the respective periods:  

 

		Weighted Average Shares in Denominator
		For the Three Months Ended June 30,				For the Six Months Ended June 30,
		2005		2004		2005		2004
Conversion of weighted average common units		8,676		8,765		8,681		8,814
Conversion of weighted average convertible preferred units		176		—		176		—
Restricted common shares		147		162		149		168
Conversion of share options		—		—		—		5

 

7

 

4.             Share-Based Compensation

 

Expenses from share-based compensation are reflected in our Consolidated Statements of Operations as follows:

 

		For the Three Months Ended June 30,						For the Six Months Ended June 30,
		2005			2004			2005			2004
Increase in general and administrative expenses		$	510		$	401		$	923		$	760
Increase in construction contract and other service operations expenses		77			145			123			284

 

The following table summarizes our operating results as if we elected to account for our share-based compensation under the fair value provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation:”

 

		For the Three Months Ended June 30,						For the Six Months Ended June 30,
		2005			2004			2005			2004
Net income, as reported		$	9,120		$	8,843		$	18,160		$	17,836
Add: Share-based compensation expense, net of related tax effects and minority interests, included in the determination of net income		448			381			802			718
Less: Share-based compensation expense determined under the fair value based method, net of related tax effects and minority interests		(429		)	(316		)	(768		)	(595		)
Net income, pro forma		$	9,139		$	8,908		$	18,194		$	17,959
Basic EPS on net income available to common shareholders, as reported		$	0.15		$	0.13		$	0.30		$	0.29
Basic EPS on net income available to common shareholders, pro forma		$	0.15		$	0.14		$	0.30		$	0.29
Diluted EPS on net income available to common shareholders, as reported		$	0.14		$	0.13		$	0.28		$	0.27
Diluted EPS on net income available to common shareholders, pro forma		$	0.14		$	0.13		$	0.29		$	0.27

 

The share-based compensation expense under the fair value method, as reported in the above table, was computed using the Black-Scholes option-pricing model.

 

5.             Recent Accounting Pronouncements

 

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 153, “Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29” (“SFAS 153”).  The Accounting Principles Board’s Opinion No. 29, “Accounting for Nonmonetary Transactions” (“APB 29”) is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged.  However, the guidance in APB 29 included certain exceptions to that principle.  SFAS 153 amends APB 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance.  Under SFAS 153, a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange.  SFAS 153 will be effective for us for nonmonetary asset exchanges occurring after December 31, 2005.  We are reviewing the provisions of SFAS 153 and assessing the impact it will have on us upon adoption.

 

In March 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations-an interpretation of FASB Statement No. 143” (“FIN 47”).  FIN 47 clarifies that the term “conditional asset retirement obligation” as used in FASB Statement No. 143, “Accounting for Asset Retirement Obligations,”

 

8

 

refers to an unconditional obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional upon future events that may or may not be within the entity’s control.  The fair value of liabilities related to such obligations should be recognized when incurred and reasonably estimable.  Uncertainty about the timing and (or) method of settlement of a conditional asset retirement obligation should be factored into the measurement of the liability when sufficient information exists. Statement 143 acknowledges that in some cases, sufficient information may not be available to reasonably estimate the fair value of an asset retirement obligation.  This Interpretation also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation.  FIN 47 is effective no later than December 31, 2005.  We are reviewing the provisions of FIN 47 and assessing the impact it will have on us upon adoption.

 

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” (“SFAS 123(R)”).  The statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services, focusing primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions.  The statement will require us to measure the cost of employee services received in exchange for an award of equity instruments based generally on the fair value of the award on the grant date; such cost will be recognized over the period during which the employee is required to provide service in exchange for the award (generally the vesting period).  No compensation cost is recognized for equity instruments for which employees do not render the requisite service.  SFAS 123(R) was to be effective for us in June 2005 for applicability to all awards granted, modified, repurchased or cancelled after July 1, 2005; the statement also was to require that we recognize compensation cost on or after July 1, 2005 for the portion of outstanding awards for which the requisite service has not yet been rendered, based on the fair value of those awards on the date of grant.  In April 2005, the Securities and Exchange Commission (the “SEC”) extended the effective date of SFAS 123(R) to the beginning of our next fiscal year (January 1, 2006).  The SEC’s new rule does not change the accounting required by SFAS 123(R); it changes only the dates for compliance with the standard.  We are reviewing the provisions of SFAS 123(R) and assessing the impact it will have on us upon adoption.

 

In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”).  SAB 107 expresses the SEC staff’s views regarding the interaction between SFAS 123(R) and certain SEC rules and regulations and provides the SEC staff’s views regarding the valuation of share-based payment arrangements for public companies.  In particular, it provides guidance in a number of areas, including share-based payment transactions with nonemployees, valuation methods, the classification of compensation expense, non-GAAP measures, capitalization of compensation costs related to share-based payment arrangements, the accounting for income tax effects of share-based payment arrangements upon adoption of SFAS 123(R), the modification of employee share options prior to adoption of SFAS 123(R) and certain disclosure requirements.  We are reviewing the provisions of SAB 107 and assessing the impact it will have on us upon our adoption of SFAS 123(R).

 

6.             Commercial Real Estate Properties

 

Operating properties consisted of the following:

 

		June 30, 2005			December 31, 2004
Land		$	270,861		$	264,631
Buildings and improvements		1,316,239			1,263,340
		1,587,100			1,527,971
Less: accumulated depreciation		(161,594		)	(138,602		)
		$	1,425,506		$	1,389,369

 

As of June 30, 2005, we were under contract to sell three of our properties located in the Northern/Central New Jersey region.  As a result, these properties were classified as held for sale.  The components associated with these properties at June 30, 2005 included the following:

 

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		June 30, 2005			December 31, 2004
Land		$	3,670		$	3,696
Buildings and improvements		17,287			17,197
		20,957			20,893
Less: accumulated depreciation		(3,507		)	(3,114		)
		$	17,450		$	17,779

 

Projects we had under construction or pre-construction consisted of the following:

 

		June 30, 2005			December 31, 2004
Land		$	108,320		$	74,190
Construction in progress		138,337			61,962
		$	246,657		$	136,152

 

2005 Acquisitions

 

We acquired the following office properties during the six months ended June 30, 2005:

 

Project Name		Location		Date of Acquisition		Number of Buildings		Total Rentable Square Feet		Initial Cost
1 Sony Place (1)		San Antonio, TX		3/30/2005		2		468,994		$	30,720
Rockville Corporate Center		Rockville, MD (2)		4/7/2005		2		221,702		37,617
								690,696		$	68,337

 

(1)          The buildings in this project are initially undergoing redevelopment that is expected to be completed by the fourth quarter of 2005.

(2)          Located in the Suburban Maryland region.

 

The table below sets forth the allocation of the acquisition costs of these properties:

 

		1 Sony Place			Rockville Corporate Center			Total
Land, operating properties		$	—		$	6,222		$	6,222
Land, construction or development		10,962			—			10,962
Building and improvements		—			28,925			28,925
Construction in progress		19,758			—			19,758
Intangible assets on real estate acquisitions		—			4,004			4,004
Total assets		30,720			39,151			69,871
Deferred revenue associated with acquired operating leases		—			(1,534		)	(1,534		)
Total acquisition cost		$	30,720		$	37,617		$	68,337

 

We also acquired the following during the six months ended June 30, 2005:

 

•                  a 19 acre parcel of land located in Chantilly, Virginia that is adjacent to existing properties we own for $7,141 on January 27, 2005 (Chantilly, Virginia is located in the Northern Virginia region).  We expect to develop this land parcel in the future;

•                  a 39 acre parcel of land located in Dahlgren, Virginia that is adjacent to one of our office properties for $1,227 on March 16, 2005 (Dahlgren, Virginia is located in the St. Mary’s and King George Counties region).  We expect to develop this land parcel in the future;

 

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•                  a 16 acre parcel of land adjacent to the two office properties we acquired in San Antonio, Texas for $3,013 on March 30, 2005.  We expect to operate this land parcel as part of the campus that includes the two acquired office properties;

•                  a 10 acre parcel of land adjacent to the Rockville Corporate Center for $6,234 on April 7, 2005.  We expect to develop this land parcel in the future; and

•                  a 27 acre parcel of land adjacent to the two office properties we acquired in San Antonio, Texas for $5,893 on June 14, 2005.  We expect to develop this land parcel in the future.

 

In 2004, we sold a land parcel in Columbia, Maryland and a land parcel in Linthicum, Maryland for an aggregate of $9,600.  We issued to the buyer a $5,600 mortgage loan; the balance of the acquisition was in the form of cash from the buyer.  The buyer in this transaction had an option to contribute the two land parcels into our Operating Partnership between January 1, 2005 and February 28, 2005 in exchange for extinguishment of the $5,600 mortgage loan with us and common units in our Operating Partnership; the buyer exercised its option in February 2005 and, as a result, on April 18, 2005, the debt from us was essentially extinguished and the buyer received 142,776 common units in the Operating Partnership valued at $3,697.  We accounted for the 2004 transaction using the financing method of accounting; as a result, the 2004 sale transaction was not recorded as a sale and the $4,000 in net proceeds received from the buyer was recorded as a liability prior to the contribution of the land parcels back into the Operating Partnership in April 2005.

 

We financed our acquisitions primarily using borrowings from our revolving credit facility and a new mortgage loan.

 

2005 Construction and Pre-Construction Activities

 

As of June 30, 2005, we had construction underway on seven new buildings in the Baltimore/Washington Corridor, one in Northern Virginia and one in St. Mary’s County, Maryland.  We also had pre-construction activities underway on two new buildings located in the Baltimore/Washington Corridor and one building in King George County and redevelopment underway on two existing buildings in San Antonio, Texas.  We financed a significant portion of our construction activities using borrowings from new and existing construction loans and our revolving credit facility.

 

2005 Dispositions

 

On June 10, 2005, we sold a four acre parcel of land located in Columbia, Maryland for $2,571.  We recognized a gain of $186 on this sale.

 

7.                                      Real Estate Joint Ventures

 

Our investments in and advances to unconsolidated real estate joint ventures accounted for using the equity method of accounting included the following:

 

		Balance at												Total			Maximum
		June 30, 2005			December 31, 2004			Date Acquired		Ownership		Nature of Activity		Assets at 6/30/2005			Exposure to Loss (1)
Route 46 Partners, LLC		$	1,233		$	1,201		3/14/2003		20	%	Operating building (2)		$	23,061		$	1,647

 

(1)	Derived from the sum of our investment balance and maximum additional unilateral capital contributions or loans required from us. Not reported above are additional amounts that we and our partner are required to fund when needed by this joint venture; these funding requirements are proportional to our respective ownership percentages.
(2)	This joint venture’s property is located in Fairfield, NJ.

 

The following table sets forth a condensed balance sheet for Route 46 Partners, LLC as of June 30, 2005:

 

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Commercial real estate property		$	21,326
Other assets		1,735
Total assets		$	23,061
Liabilities		$	14,641
Owners’ equity		8,420
Total liabilities and owners’ equity		$	23,061

 

Our joint venture partner in Route 46 Partners, LLC has preference in receiving distributions of cash flows for a defined return.  Once our partner receives its defined return, we are entitled to receive distributions for a defined return.  We did not recognize income from our investment in Route 46 Partners, LLC in the six months ended June 30, 2005 and 2004 since the income earned by the entity in those periods did not exceed our partner’s defined return.

 

Our investments in consolidated real estate joint ventures included the following:

 

		Date Acquired		Ownership % at 6/30/05		Nature of Activity		Total Assets at 6/30/05			Collateralized Assets at 6/30/05
MOR Forbes 2 LLC		12/24/02		50	%	Operating building (1)		$	4,623		$	4,051
MOR Montpelier 3 LLC		2/21/02		50	%	Developing land parcel (2)		1,377			—
								$	6,000		$	4,051

 

(1)  This joint venture’s property is located in Lanham, Maryland (located in the Suburban Maryland region).

(2)  This joint venture’s property is located in Laurel, Maryland (located in the Suburban Maryland region).

 

From April 4, 2001 until June 9, 2005, we owned an 80% interest in Gateway 70 LLC, a consolidated joint venture developing two land parcels in Columbia, Maryland.  On June 9, 2005, we acquired the remaining 20% interest in Gateway 70 LLC not previously owned by us for $1,208.

 

On April 11, 2005, we executed a contribution agreement that formed a joint venture relationship with a limited partnership to develop up to 1.8 million square feet of office space on 63 acres of land located in Hanover, Maryland (located in the Baltimore/Washington Corridor).  Under the contribution agreement, we agreed to fund up to $2,200 in pre-construction costs associated with the property.  As we and the joint venture partner agree to proceed with the construction of buildings in the future, we would make additional cash capital contributions into newly-formed entities and our joint venture partner would contribute land into such entities.  We will have a 50% interest in this joint venture relationship.

 

Our commitments and contingencies pertaining to our real estate joint ventures are disclosed in Note 19.

 

8.             Investment in Other Unconsolidated Entity

 

Our investment in an unconsolidated non-real estate entity is set forth below:

 

		June 30, 2005			December 31, 2004			Date Acquired		Ownership % at 6/30/2005		Investment Accounting Method
TractManager, Inc. (1)		$	1,621		$	1,621		Various 2000		5	%	Cost

 

(1)

TractManager, Inc. has developed an Internet-based contract imaging and management system for sale to real estate owners and healthcare providers.

 

 

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9.             Intangible Assets on Real Estate Acquisitions

 

Intangible assets on real estate acquisitions consisted of the following:

 

		June 30, 2005			December 31, 2004
Lease-up value		$	68,165		$	65,638
Lease to market value		9,595			9,595
Lease cost portion of deemed cost avoidance		9,053			8,700
Market concentration premium		1,333			1,333
Tenant relationship value		1,148			—
Subtotal		89,294			85,266
Accumulated amortization		(22,940		)	(17,706		)
Intangible assets on real estate acquisitions, net		$	66,354		$	67,560

 

10.          Deferred Charges

 

Deferred charges consisted of the following:

 

		June 30, 2005			December 31, 2004
Deferred leasing costs		$	34,991		$	33,302
Deferred financing costs		19,282			16,996
Goodwill		1,853			1,853
Deferred other		155			155
		56,281			52,306
Accumulated amortization		(27,619		)	(24,664		)
Deferred charges, net		$	28,662		$	27,642

 

11.          Accounts Receivable

 

Our accounts receivable are reported net of an allowance for bad debts of $287 at June 30, 2005 and $490 at December 31, 2004.

 

12.          Derivatives

 

The following table sets forth our derivative contracts and their respective fair values:

 

Nature of Derivative		Notional Amount in (millions)			One-Month LIBOR base		Effective Date		Expiration Date		Fair Value at June 30, 2005			Fair Value at December 31, 2004
Interest rate swap		$	50.0		2.3075	%	1/2/2003		1/3/2005		$	—		$	—
Forward starting swap		73.4			5.0244	%	7/15/2005		7/15/2015		(4,188		)	—
											$	(4,188	)	$	—

 

We designated each of these derivatives as cash flow hedges.  The first swap noted above hedged the risk of changes in interest rates on certain of our one-month LIBOR-based variable rate borrowings.  On April 7, 2005, we entered into the forward starting swap to lock in the 10-year LIBOR swap rate in contemplation of our obtaining a long-term, fixed rate financing later in 2005.  We expect to cash settle the swap at the time we lock the rate on a long-term, fixed rate financing.  If the 10-year LIBOR swap rate is below 5.0244% at the time we cash settle the swap, we would be required to make a payment to the swap counter-party; if the 10-year LIBOR swap rate is above 5.0244% at the time we cash settle the swap, we would receive a payment from the swap counter-party.  The amount that we either pay or receive would be equal to the present value of the basis point differential between

 

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5.0244% and the 10-year LIBOR swap rate at the time we cash settle the swap.  As of June 30, 2005, the forward starting swap is considered a highly effective cash flow hedge under Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended.

 

The table below sets forth our accounting application of changes in derivative fair values:

 

		For the Six Months Ended June 30,
		2005			2004
(Decrease) increase in fair value applied to AOCL (1) and minority interests		$	(4,188	)	$	284
Increase in fair value recognized as gain (2)		$	—		$	77

 

(1)               AOCL is defined as accumulated other comprehensive loss.

 

(2)               Represents hedge ineffectiveness and is included in interest expense on our Consolidated Statements of Operations.

 

13.          Shareholders’ Equity

 

Preferred Shares

 

Preferred shares of beneficial interest (“preferred shares”) consisted of the following:

 

		June 30, 2005			December 31, 2004
1,265,000 designated as Series E Cumulative Redeemable Preferred Shares of beneficial interest (1,150,000 shares issued with an aggregate liquidation preference of $28,750)		11			11
1,425,000 designated as Series F Cumulative Redeemable Preferred Shares of beneficial interest (1,425,000 shares issued with an aggregate liquidation preference of $35,625)		14			14
2,200,000 designated as Series G Cumulative Redeemable Preferred Shares of beneficial interest (2,200,000 shares issued with an aggregate liquidation preference of $55,000)		22			22
2,000,000 designated as Series H Cumulative Redeemable Preferred Shares of beneficial interest (2,000,000 shares issued with an aggregate liquidation preference of $50,000)		20			20
Total preferred shares		$	67		$	67

 

Common Shares

 

During the six months ended June 30, 2005, we issued 130,975 common shares of beneficial interest (“common shares”) to certain employees.  All of these shares are subject to forfeiture restrictions that lapse annually throughout their respective terms provided that the employees remain employed by us.  During the same period, forfeiture restrictions lapsed on 136,056 common shares previously issued to employees.

 

We issued 216,389 common shares upon the exercise of share options during the six months ended June 30, 2005.  During the same period, we converted 12,320 common units in our Operating Partnership into common shares on the basis of one common share for each common unit.

 

Comprehensive Income

 

A summary of the activity in the AOCL component of shareholders’ equity for the six months ended June 30, 2005 follows:

 

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