Table of Contents

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

 

FORM 10-Q

 

(Mark one)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended  September 30, 2008

 

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

(Exact name of registrant as specified in its charter)

 

 

 

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.

x Yes   o No

 

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

 

Large accelerated filer x		Accelerated filer o		Non-accelerated filer o		Smaller reporting company o
				(Do not check if a smaller
				reporting company)

 

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

o Yes   x No

 

As of October 31, 2008, 51,594,302 of the Company’s Common Shares of Beneficial Interest, $0.01 par value, were issued and outstanding.

 

 

Table of Contents

 

TABLE OF CONTENTS

 

FORM 10-Q

 

		PAGE
PART I: FINANCIAL INFORMATION
Item 1:	Financial Statements:
	Consolidated Balance Sheets as of September 30, 2008 and December 31, 2007 (unaudited)	3
	Consolidated Statements of Operations for the three and nine months ended September 30, 2008 and 2007 (unaudited)	4
	Consolidated Statements of Cash Flows for the nine months ended September 30, 2008 and 2007 (unaudited)	5
	Notes to Consolidated Financial Statements (unaudited)	6
Item 2:	Management’s Discussion and Analysis of Financial Condition and Results of Operations	27
Item 3:	Quantitative and Qualitative Disclosures About Market Risk	44
Item 4:	Controls and Procedures	44
PART II: OTHER INFORMATION
Item 1:	Legal Proceedings	45
Item 1A:	Risk Factors	45
Item 2:	Unregistered Sales of Equity Securities and Use of Proceeds	45
Item 3:	Defaults Upon Senior Securities	45
Item 4:	Submission of Matters to a Vote of Security Holders	46
Item 5:	Other Information	46
Item 6:	Exhibits	46
SIGNATURES		47

 

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PART I: FINANCIAL INFORMATION

ITEM 1. Financial Statements

 

Corporate Office Properties Trust and Subsidiaries

Consolidated Balance Sheets

(Dollars in thousands)

(unaudited)

 

		September 30,			December 31,
		2008			2007
Assets
Investment in real estate:
Operating properties, net		$	2,241,412		$	2,192,939
Property held for sale, net		—			14,988
Projects under construction or development		495,875			396,012
Total commercial real estate properties, net		2,737,287			2,603,939
Cash and cash equivalents		21,316			24,638
Restricted cash		15,534			15,121
Accounts receivable, net		13,044			24,831
Deferred rent receivable		62,137			53,631
Intangible assets on real estate acquisitions, net		98,282			108,661
Deferred charges, net		51,680			49,051
Prepaid expenses and other assets		100,448			51,981
Total assets		$	3,099,728		$	2,931,853
Liabilities and shareholders’ equity
Liabilities:
Mortgage and other loans payable		$	1,656,280		$	1,625,842
3.5% Exchangeable Senior Notes		200,000			200,000
Accounts payable and accrued expenses		93,676			75,535
Rents received in advance and security deposits		26,372			31,234
Dividends and distributions payable		25,774			22,441
Deferred revenue associated with acquired operating leases		11,832			11,530
Distributions in excess of investment in unconsolidated real estate joint venture		4,668			4,246
Other liabilities		7,059			8,288
Total liabilities		2,025,661			1,979,116
Minority interests:
Common units in the Operating Partnership		122,557			114,127
Preferred units in the Operating Partnership		8,800			8,800
Other consolidated real estate joint ventures		10,169			7,168
Total minority interests		141,526			130,095
Commitments and contingencies (Note 20)
Shareholders’ equity:
Preferred Shares of beneficial interest ($0.01 par value; shares authorized of 15,000,000, issued and outstanding of 8,121,667 at September 30, 2008 and December 31, 2007 (Note 13))		81			81
Common Shares of beneficial interest ($0.01 par value; 75,000,000 shares authorized, shares issued and outstanding of 51,530,162 at September 30, 2008 and 47,366,475 at December 31, 2007)		515			474
Additional paid-in capital		1,086,210			950,615
Cumulative distributions in excess of net income		(152,589		)	(126,156		)
Accumulated other comprehensive loss		(1,676		)	(2,372		)
Total shareholders’ equity		932,541			822,642
Total liabilities and shareholders’ equity		$	3,099,728		$	2,931,853

 

See accompanying notes to consolidated financial statements.

 

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Corporate Office Properties Trust and Subsidiaries

Consolidated Statements of Operations

(Dollars in thousands, except per share data)

(unaudited)

 

		For the Three Months						For the Nine Months
		Ended September 30,						Ended September 30,
		2008			2007			2008			2007
Revenues
Rental revenue		$	85,060		$	80,038		$	249,924		$	233,650
Tenant recoveries and other real estate operations revenue		16,584			14,064			46,982			39,694
Construction contract revenues		89,653			10,047			121,688			29,358
Other service operations revenues		349			910			1,352			3,369
Total revenues		191,646			105,059			419,946			306,071
Expenses
Property operating expenses		35,854			31,577			104,353			92,168
Depreciation and other amortization associated with real estate operations		25,583			26,025			75,430			78,811
Construction contract expenses		87,111			9,507			118,488			28,126
Other service operations expenses		546			806			1,602			3,337
General and administrative expenses		6,103			5,743			18,072			15,946
Total operating expenses		155,197			73,658			317,945			218,388
Operating income		36,449			31,401			102,001			87,683
Interest expense		(20,506		)	(20,968		)	(60,252		)	(61,181		)
Amortization of deferred financing costs		(1,169		)	(901		)	(2,882		)	(2,706		)
Gain on sale of non-real estate investment		1			—			52			1,033
Income from continuing operations before equity in loss of unconsolidated entities, income taxes and minority interests		14,775			9,532			38,919			24,829
Equity in loss of unconsolidated entities		(57		)	(46		)	(167		)	(197		)
Income tax expense		(97		)	(197		)	(102		)	(480		)
Income from continuing operations before minority interests		14,621			9,289			38,650			24,152
Minority interests in income from continuing operations
Common units in the Operating Partnership		(1,593		)	(789		)	(3,958		)	(1,877		)
Preferred units in the Operating Partnership		(165		)	(165		)	(495		)	(495		)
Other consolidated entities		90			12			(16		)	90
Income from continuing operations		12,953			8,347			34,181			21,870
(Loss) income from discontinued operations, net of minority interests		(8		)	2,046			2,179			1,786
Income before gain on sales of real estate		12,945			10,393			36,360			23,656
Gain on sales of real estate, net		4			1,038			837			1,199
Net income		12,949			11,431			37,197			24,855
Preferred share dividends		(4,025		)	(4,025		)	(12,076		)	(12,043		)
Net income available to common shareholders		$	8,924		$	7,406		$	25,121		$	12,812
Basic earnings per common share
Income from continuing operations		$	0.19		$	0.11		$	0.49		$	0.24
Discontinued operations		—			0.05			0.04			0.04
Net income available to common shareholders		$	0.19		$	0.16		$	0.53		$	0.28
Diluted earnings per common share
Income from continuing operations		$	0.19		$	0.11		$	0.48		$	0.23
Discontinued operations		—			0.04			0.04			0.04
Net income available to common shareholders		$	0.19		$	0.15		$	0.52		$	0.27
Dividends declared per common share		$	0.3725		$	0.3400		$	1.0525		$	0.9600

 

See accompanying notes to consolidated financial statements.

 

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Corporate Office Properties Trust and Subsidiaries

Consolidated Statements of Cash Flows

(Dollars in thousands)

(unaudited)

 

		For the Nine Months
		Ended September 30,
		2008			2007
Cash flows from operating activities
Net income		$	37,197		$	24,855
Adjustments to reconcile net income to net cash provided by operating activities:
Minority interests		5,128			2,829
Depreciation and other amortization		76,659			80,660
Amortization of deferred financing costs		2,882			2,706
Amortization of deferred market rental revenue		(1,457		)	(1,569		)
Equity in loss of unconsolidated entities		167			197
Gain on sales of real estate		(4,208		)	(4,199		)
Gain on sale of non-real estate investment		(52		)	(1,033		)
Share-based compensation		6,812			4,969
Excess income tax benefits from share-based compensation		(1,053		)	—
Changes in operating assets and liabilities:
Increase in deferred rent receivable		(8,600		)	(9,248		)
Decrease in accounts receivable		11,787			5,687
Increase in restricted cash and prepaid and other assets		(26,864		)	(10,217		)
Increase (decrease) in accounts payable, accrued expenses and other liabilities		31,521			(3,847		)
(Decrease) increase in rents received in advance and security deposits		(4,862		)	4,679
Other		404			(887		)
Net cash provided by operating activities		125,461			95,582
Cash flows from investing activities
Purchases of and additions to commercial real estate properties		(220,392		)	(301,065		)
Proceeds from sales of properties		33,412			8,763
Proceeds from sale of non-real estate investment		67			2,526
Mortgage loan receivable funded		(24,836		)	—
Acquisition of partner interests in consolidated joint ventures		—			(1,262		)
Leasing costs paid		(4,497		)	(8,984		)
(Increase) decrease in restricted cash associated with investing activities		(629		)	14,631
Other		(7,402		)	(1,847		)
Net cash used in investing activities		(224,277		)	(287,238		)
Cash flows from financing activities
Proceeds from mortgage and other loans payable		684,763			506,571
Repayments of mortgage and other loans payable		(654,255		)	(243,942		)
Deferred financing costs paid		(6,347		)	(1,847		)
Net proceeds from issuance of common shares		141,432			7,013
Dividends paid		(60,541		)	(54,163		)
Distributions paid		(8,815		)	(8,245		)
Excess income tax benefits from share-based compensation		1,053			—
Restricted share redemptions		(1,316		)	—
Other		(480		)	241
Net cash provided by financing activities		95,494			205,628
Net (decrease) increase in cash and cash equivalents		(3,322		)	13,972
Cash and cash equivalents
Beginning of period		24,638			7,923
End of period		$	21,316		$	21,895

 

See accompanying notes to consolidated financial statements.

 

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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”, “we” or “us”) is a specialty office real estate investment trust (“REIT”) that focuses on strategic customer relationships and specialized tenant requirements in the United States Government, defense information technology and data sectors.  We acquire, develop, manage and lease properties that are typically concentrated in large office parks primarily located adjacent to government demand drivers and/or in demographically strong markets possessing growth opportunities.  As of September 30, 2008, our investments in real estate included the following:

 

·                  235 wholly owned operating properties totaling 18.3 million square feet;

·                  18 wholly owned properties under construction or development that we estimate will total approximately 1.9 million square feet upon completion;

·                  wholly owned land parcels totaling 1,598 acres that we believe are potentially developable into approximately 13.5 million square feet; and

·                  partial ownership interests in a number of other real estate projects in operation, under development or redevelopment or held for future development.

 

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 securities owned by COPT as of September 30, 2008 follows:

 

Common Units		86	%
Series G Preferred Units		100	%
Series H Preferred Units		100	%
Series I Preferred Units		0	%
Series J Preferred Units		100	%
Series K Preferred Units		100	%

 

Three of our trustees also controlled at that date, either directly or through ownership by other entities or family members, 12% of the Operating Partnership’s common units.

 

In addition to owning interests in real estate, the Operating Partnership also owns 100% of Corporate Office Management, Inc. (“COMI”) and owns, either directly or through COMI, 100% of the consolidated subsidiaries that are set forth below (collectively defined as the “Service Companies”):

 

Entity Name		Type of Service Business
COPT Property Management Services, LLC (“CPM”)		Real Estate Management
COPT Development & Construction Services, LLC (“CDC”)		Construction and Development
Corporate Development Services, LLC (“CDS”)		Construction and Development
COPT Environmental Systems, LLC (“CES”)		Heating and Air Conditioning

 

Most of the services that CPM and CES provide are for us.  CDC and CDS provide services to us and to third parties.

 

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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 2007 Annual Report on Form 10-K.  The interim financial statements 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.

 

We reclassified certain amounts from the prior period to conform to the current period presentation of our Consolidated Financial Statements.  These reclassifications did not affect previously reported consolidated net income or shareholders’ equity.  Construction contract revenues and expenses for the nine months ended September 30, 2008 also includes adjustments that increased these amounts by $1,622 pertaining to the three months ended March 31, 2008 and $7,280 pertaining to the three months ended June 30, 2008.  Since the increases to construction contract revenues and construction contract expenses were by equal dollar amounts, these adjustments did not affect the operating income or net income previously reported on the Forms 10-Q filed with respect to such periods and are not material to the financial statements.

 

3.             Earnings Per Share (“EPS”)

 

We present both basic and diluted EPS.  We compute basic EPS by dividing net income available to common shareholders by the weighted average number of common shares of beneficial interest (“common shares”) outstanding during the period.  Our computation of diluted EPS is similar except that:

 

·                  the denominator is increased to include: (1) the weighted average number of potential additional common shares that would have been outstanding if securities that are convertible into our common shares were converted; and (2) the effect of dilutive potential common shares outstanding during the period attributable to share-based compensation using the treasury stock method; and

·                  the numerator is adjusted to add back any changes in income or loss that would result from the assumed conversion into common shares that we added to the denominator.

 

Our computation of diluted EPS does not assume conversion of securities into our common shares if conversion of those securities would increase our diluted EPS in a given period.  A summary of the numerator and denominator for purposes of basic and diluted EPS calculations is set forth below (dollars and shares in thousands, except per share data):

 

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		For the Three Months						For the Nine Months
		Ended September 30,						Ended September 30,
		2008			2007			2008			2007
Numerator:
Income from continuing operations		$	12,953		$	8,347		$	34,181		$	21,870
Add: Gain on sales of real estate, net		4			1,038			837			1,199
Less: Preferred share dividends		(4,025		)	(4,025		)	(12,076		)	(12,043		)
Numerator for basic and diluted EPS from continuing operations		8,932			5,360			22,942			11,026
(Loss) income from discontinued operations, net		(8		)	2,046			2,179			1,786
Numerator for basic and diluted EPS on net income available to common shareholders		$	8,924		$	7,406		$	25,121		$	12,812
Denominator (all weighted averages):
Denominator for basic EPS (common shares)		47,273			46,781			47,128			46,386
Dilutive effect of share-based compensation awards		916			1,005			820			1,180
Denominator for diluted EPS		48,189			47,786			47,948			47,566
Basic EPS:
Income from continuing operations		$	0.19		$	0.11		$	0.49		$	0.24
Income from discontinued operations		—			0.05			0.04			0.04
Net income available to common shareholders		$	0.19		$	0.16		$	0.53		$	0.28
Diluted EPS:
Income from continuing operations		$	0.19		$	0.11		$	0.48		$	0.23
Income from discontinued operations		—			0.04			0.04			0.04
Net income available to common shareholders		$	0.19		$	0.15		$	0.52		$	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				For the Nine Months
		Ended September 30,				Ended September 30,
		2008		2007		2008		2007
Conversion of weighted average common units		8,130		8,297		8,145		8,339
Conversion of weighted average convertible preferred shares		434		434		434		421
Conversion of weighted average convertible preferred units		176		176		176		176

 

The 3.5% Exchangeable Senior Notes did not affect our diluted EPS reported above since the weighted average closing price of our common shares during each of the periods was less than the exchange price per common share applicable for such periods.

 

4.             Recent Accounting Pronouncements

 

SFAS 157

 

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS 157”).   SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements.  The Statement does not require or permit any new fair value measurements but does apply under other accounting pronouncements that require or permit fair value measurements.  The changes to current practice resulting from the Statement relate to the definition of fair value, the methods used to measure fair value and the expanded disclosures about fair value measurements.  With respect to SFAS 157, the FASB also issued FASB Staff Position SFAS 157-1, “Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13” (“FSP FAS 157-1”) and FASB Staff Position SFAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP FAS 157-2”).  FSP FAS 157-1 amends SFAS 157 to exclude from the scope of SFAS 157 certain leasing transactions accounted for under Statement of Financial

 

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Accounting Standards No. 13, “Accounting for Leases.”  FSP FAS 157-2 amends SFAS 157 to defer the effective date of SFAS 157 for all non-financial assets and non-financial liabilities except those that are recognized or disclosed at fair value in the financial statements on a recurring basis to fiscal years beginning after November 15, 2008.  Effective January 1, 2008, we adopted, on a prospective basis, the portions of SFAS 157 not deferred by FSP FAS 157-2; this adoption did not have a material effect on our financial position, results of operations or cash flows.  We are evaluating the impact that SFAS 157 will have on our non-financial assets and non-financial liabilities since the application of SFAS 157 for such items for us was deferred to January 1, 2009.

 

We also adopted FASB Staff Position SFAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active” (“FSP FAS-157-3”) effective upon its issuance by the FASB on October 10, 2008.  The adoption of FSP FAS-157-3 did not have a material effect on our financial position, results of operations or cash flows.

 

Under SFAS 157, fair value is defined as the exit price, or the amount that would be received upon sale of an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date.  SFAS 157 also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available.  Observable inputs are inputs market participants would use in valuing the asset or liability developed based on market data obtained from sources independent of us.  Unobservable inputs are inputs that reflect our assumptions about the factors market participants would use in valuing the asset or liability developed based upon the best information available in the circumstances.  The hierarchy of these inputs is broken down into three levels: Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities; Level 2 inputs include (1) quoted prices for similar assets or liabilities in active markets, (2) quoted prices for identical or similar assets or liabilities in markets that are not active and (3) inputs (other than quoted prices) that are observable for the asset or liability, either directly or indirectly; and Level 3 inputs are unobservable inputs for the asset or liability.  Categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

 

The assets held in connection with our non-qualified elective deferred compensation plan and the corresponding liability to the participants are measured at fair value on a recurring basis on our consolidated balance sheet using quoted market prices.  The assets are treated as trading securities for accounting purposes and included in restricted cash on our consolidated balance sheet.  The offsetting liability 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 in our consolidated balance sheet.  The assets and corresponding liability of our non-qualified elective deferred compensation plan are classified in Level 1 of the fair value hierarchy.

 

The valuation of our derivatives is determined using widely accepted valuation techniques, including 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 under SFAS 157, the credit valuation adjustments associated with our derivatives also utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default.  However, as of September 30, 2008, 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 to the overall valuation of our derivatives.  As a result, we determined that our derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.

 

The table below sets forth our financial assets and liabilities that are accounted for at fair value on a recurring basis as of September 30, 2008:

 

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		Quoted Prices in
		Active Markets for			Significant Other			Significant
		Identical Assets			Observable Inputs			Unobservable Inputs
Description		(Level 1)			(Level 2)			(Level 3)			Total
Assets:
Deferred compensation plan assets (1)		$	5,630		$	—		$	—		$	5,630
Liabilities:
Deferred compensation plan liability (2)		$	5,630		$	—		$	—		$	5,630
Interest rate swap contracts (2)		—			1,531			—			1,531
Liabilities		$	5,630		$	1,531		$	—		$	7,161

 

(1) Included in the line entitled “restricted cash” on our Consolidated Balance Sheet.

(2) Included in the line entitled “other liabilities” on our Consolidated Balance Sheet.

 

Other Recent Accounting Pronouncements

 

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”).  SFAS 159 permits entities to choose to measure many financial assets and financial liabilities at fair value.  Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings.  We adopted SFAS 159 on a prospective basis effective January 1, 2008.  Our adoption of SFAS 159 did not have a material effect on our financial position, results of operations or cash flows since we did not elect to apply the fair value option for any of our eligible financial instruments or other items on the January 1, 2008 effective date.

 

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141(R), “Business Combinations” (“SFAS 141(R)”).  SFAS 141(R) requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transactions; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination.  SFAS 141(R) is effective for fiscal years beginning after December 15, 2008.  While we are currently assessing the impact of SFAS 141(R) on our consolidated financial position and results of operations, SFAS 141(R) will require us to expense transaction costs associated with property acquisitions occurring subsequent to the pronouncement’s effective date, which is a significant change since our current practice is to capitalize such costs into the cost of the acquisitions.

 

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“SFAS 160”).  SFAS 160 requires all entities to report noncontrolling (minority) interests in subsidiaries as equity in the consolidated financial statements.  SFAS 160 is effective for fiscal years beginning after December 15, 2008.  We are currently assessing the impact of SFAS 160 on our consolidated financial position and results of operations.

 

In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS 161”). This new standard expands the disclosure requirements for derivative instruments and for hedging activities in order to provide users of financial statements with an enhanced understanding of: (1) how and why an entity uses derivative instruments; (2) how derivative instruments and related hedged items are accounted for under Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” and its related interpretations; and (3) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS 161 is to be applied prospectively for the first annual reporting period beginning on or after November 15, 2008.  We are evaluating the impact that SFAS 161 will have on our reporting for derivatives.

 

In May 2008, the FASB issued FASB Staff Position No. APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (“FSP APB-14-1”).  FSP APB-14-1 requires that the initial proceeds from convertible debt instruments that may be settled in cash, including partial cash settlements, be allocated between a liability component and an equity component associated with the embedded conversion option.  This pronouncement’s objective is to require the liability and equity components of convertible debt to be separately accounted for in order to enable interest expense to be recorded at a

 

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rate that would reflect the issuer’s conventional debt borrowing rate (previously, interest expense on such debt was recorded based on the contractual rate of interest under the debt).  Under this pronouncement, the liability component is recorded at its fair value, as calculated based on the present value of its cash flows discounted using the issuer’s conventional debt borrowing rate.  The equity component is recorded based on the difference between the debt proceeds and the fair value of the liability.  The difference between the liability’s principal amount and fair value is reported as a debt discount and amortized as interest expense over the debt’s expected life using the effective interest method.  The provisions of FSP APB-14-1 will be effective beginning January 1, 2009 and are to be applied retrospectively to all periods presented.  While we are in the process of evaluating FSP APB-14-1, we currently believe that this pronouncement will affect the accounting for our 3.5% Exchangeable Senior Notes by resulting in our recognition of additional annual interest expense of approximately $3,000 to $4,000 over the five-year expected life of the debt, beginning on the debt’s September 18, 2006 origination date.

 

In June 2008, the FASB issued FASB Staff Position No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities” (“FSP EITF 03-6-1”).   FSP EITF 03-6-1 requires that all unvested share-based payment awards that contain nonforfeitable rights to dividends be considered participating securities and therefore shall be included in the computation of EPS pursuant to the two-class method.  The two-class method is an earnings allocation formula that determines EPS for each class of common shares and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings.  FSP EITF 03-6-1 is effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years, and the EPS of prior periods will be adjusted retrospectively.  We believe that upon our adoption of FSP EITF 03-6-1, we will be required to include a larger number of shares in our denominator for EPS attributable to our weighted average unvested restricted shares outstanding, which will have a decreasing effect to our EPS; however, we do not believe that the decreasing effect to our EPS from the larger number of shares will be material.

 

5.             Commercial Real Estate Properties

 

Operating properties consisted of the following:

 

		September 30,			December 31,
		2008			2007
Land		$	421,311		$	413,779
Buildings and improvements		2,159,530			2,064,960
		2,580,841			2,478,739
Less: accumulated depreciation		(339,429		)	(285,800		)
		$	2,241,412		$	2,192,939

 

As of December 31, 2007, 429 Ridge Road, an office property located in Dayton, New Jersey that we were under contract to sell for $17,000, was classified as held for sale (Dayton, New Jersey is located in the Northern/Central New Jersey Region).  We completed the sale of this property on January 31, 2008.  The components associated with 429 Ridge Road as of December 31, 2007 included the following:

 

		December 31,
		2007
Land		$	2,932
Buildings and improvements		15,003
		17,935
Less: accumulated depreciation		(2,947		)
		$	14,988

 

Projects we had under construction or development consisted of the following:

 

		September 30,			December 31,
		2008			2007
Land		$	221,066		$	214,696
Construction in progress		274,809			181,316
		$	495,875		$	396,012

 

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2008 Acquisitions

 

We acquired the following office properties during the nine months ended September 30, 2008:

 

Total

Date of

Number of

Rentable

Acquisition

Project Name

Location

Acquisition

Buildings

Square Feet

Cost

3535 Northrop Grumman Point

Colorado Springs, CO

6/10/2008

1

124,305

$

23,240

1560 Cable Ranch Road (Buildings A and B)

San Antonio, TX

6/19/2008

2

122,975

17,317

3

247,280

$

40,557

 

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

 

		3535 Northrop			1560 Cable
		Grumman Point			Ranch Road			Total
Land, operating properties		$	—		$	3,396		$	3,396
Building and improvements		22,163			10,315			32,478
Intangible assets on real estate acquisitions		3,423			4,208			7,631
Total assets		25,586			17,919			43,505
Deferred revenue associated with acquired operating leases		(2,346		)	(602		)	(2,948		)
Total acquisition cost		$	23,240		$	17,317		$	40,557

 

Intangible assets recorded in connection with the above acquisitions included the following:

 

					Weighted
					Average
					Amortization
					Period (in Years)
Lease-up value		$	4,558		10
Tenant relationship value		1,537			12
Lease cost portion of deemed cost avoidance		1,536			11
		$	7,631		11

 

We also completed the following acquisitions during the nine months ended September 30, 2008:

 

·                  a 107-acre land parcel in Frederick, Maryland that we believe can support approximately 1.0 million developable square feet for $8,696 on August 28, 2008 (Frederick, Maryland is located in our Suburban Maryland region); and

·                  a 31-acre land parcel located in San Antonio, Texas (“San Antonio”) that we believe can support approximately 500,000 developable square feet for $8,126 on July 16, 2008.

 

2008 Construction, Development and Redevelopment Activities

 

During the nine months ended September 30, 2008, we had five properties totaling 438,347 square feet become fully operational (89,497 of these square feet were placed into service in 2007); three of these properties are located in Colorado Springs, Colorado (“Colorado Springs”) and two in the Baltimore/Washington Corridor.  We also placed into service an aggregate of 85,221 square feet in two partially operational properties located in Colorado Springs and Suburban Maryland.

 

As of September 30, 2008, we had construction underway on four new properties each in Colorado Springs and the Baltimore/Washington Corridor (including one through a joint venture) and two each in San Antonio and Suburban Maryland (including two through a joint venture).  We also had development activities underway on three new properties each in the Baltimore/Washington Corridor and Suburban Baltimore, two in San Antonio and one in Suburban Maryland.  In addition, we had redevelopment underway on two properties owned by a joint venture (one located in the Baltimore/Washington Corridor and the other in Northern Virginia).

 

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2008 Dispositions

 

We sold the following operating properties during the nine months ended September 30, 2008:

 

						Number		Total
				Date of		of		Rentable					Gain on
Project Name		Location		Sale		Buildings		Square Feet		Sale Price			Sale
429 Ridge Road		Dayton, New Jersey		1/31/2008		1		142,385		$	17,000		$	1,365
7253 Ambassador Road		Woodlawn, Maryland		6/2/2008		1		38,930		5,100			1,278
47 Commerce Road		Cranbury, New Jersey		4/1/2008		1		41,398		3,150			—
						3		222,713		$	25,250		$	2,643

 

The gain from these sales is included on the line of our Consolidated Statements of Operations entitled “(loss) income from discontinued operations, net of minority interests.”

 

During the nine months ended September 30, 2008, we also completed the sale of six recently constructed office condominiums located in Herndon Virginia (located in the Northern Virginia region) for sale prices totaling $8,388 in the aggregate.  We recognized an aggregate gain before minority interests and taxes of $1,368 on these sales, which is included on the line of our Consolidated Statements of Operations entitled “gain on sales of real estate, net”.

 

The table below sets forth the components of the line on our Consolidated Statements of Operations entitled “gain on sales of real estate” for the three and nine months ended September 30, 2008:

 

		For the Three Months						For the Nine Months
		Ended September 30,						Ended September 30,
		2008			2007			2008			2007
Gain on sales of real estate		$	4		$	1,227		$	1,682		$	1,421
Income taxes		—			—			(578		)	(3		)
Minority interests
Common units in the Operating Partnership		—			(189		)	(151		)	(219		)
Other consolidated entities		—			—			(116		)	—
Gain on sale of real estate, net		$	4		$	1,038		$	837		$	1,199

 

6.                                      Real Estate Joint Ventures

 

During the nine months ended September 30, 2008, we had an investment in one unconsolidated real estate joint venture accounted for using the equity method of accounting.  Information pertaining to this joint venture investment is set forth below.

 

		Investment Balance at												Total			Maximum
		September 30,			December 31,			Date				Nature of		Assets at			Exposure
		2008			2007			Acquired		Ownership		Activity		9/30/2008			to Loss (1)
Harrisburg Corporate Gateway Partners, L.P.		$	(4,668	)(2)	$	(4,246	)(2)	9/29/2005		20	%	Operates 16 buildings	(3)	$	70,387		$	—

 

(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. Also not reported above are additional unilateral contributions or loans from us, the amounts of which are uncertain, which we would be required to make if certain contingent events occur.
(2)		The carrying amount of our investment in this joint venture was lower than our share of the equity in the joint venture by $5,196 at September 30, 2008 and December 31, 2007 due to our deferral of gain on the contribution by us of real estate into the joint venture upon its formation. A difference will continue to exist to the extent the nature of our continuing involvement in the joint venture remains the same.
(3)		This joint venture’s properties are located in Greater Harrisburg, Pennsylvania.

 

The following table sets forth condensed balance sheets for Harrisburg Corporate Gateway Partners, L.P.:

 

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		September 30,			December 31,
		2008			2007
Commercial real estate property		$	62,711		$	63,773
Other assets		7,676			9,051
Total assets		$	70,387		$	72,824
Liabilities		$	67,762		$	67,991
Owners’ equity		2,625			4,833
Total liabilities and owners’ equity		$	70,387		$	72,824

 

The following table sets forth condensed statements of operations for Harrisburg Corporate Gateway Partners, L.P.:

 

		For the Three Months						For the Nine Months
		Ended September 30,						Ended September 30,
		2008			2007			2008			2007
Revenues		$	2,432		$	2,455		$	7,228		$	7,325
Property operating expenses		(870		)	(850		)	(2,571		)	(2,686		)
Interest expense		(991		)	(991		)	(2,951		)	(3,109		)
Depreciation and amortization expense		(824		)	(842		)	(2,484		)	(2,564		)
Net loss		$	(253	)	$	(228	)	$	(778	)	$	(1,034	)

 

On January 29, 2008, we completed the formation of M Square Associates, LLC (“M Square”), a consolidated joint venture in which we hold a 50% equity interest through Enterprise Campus Developer, LLC, another consolidated joint venture in which we own a 90% interest.  M Square was formed to develop and own office properties, approved for up to approximately 750,000 square feet, located in M Square Research Park in College Park, Maryland (located in the Suburban Maryland region).

 

The table below sets forth information pertaining to our investments in consolidated joint ventures at September 30, 2008:

 

				Ownership				Total			Collateralized
		Date		% at		Nature of		Assets at			Assets at
		Acquired		9/30/2008		Activity		9/30/2008			9/30/2008
COPT Opportunity Invest I, LLC		12/20/2005		92.5	%	Redeveloping two properties (1)		$	43,833		$	—
Arundel Preserve #5, LLC		7/2/2007		50.0	%	Developing land parcel (2)		27,126			—
Enterprise Campus Developer, LLC		6/26/2007		90.0	%	Developing land parcels (3)		25,402			—
COPT-FD Indian Head, LLC		10/23/2006		75.0	%	Developing land parcel (4)		4,959			—
MOR Forbes 2 LLC		12/24/2002		50.0	%	Operates one building (5)		4,472			—
13849 Park Center Road, LLC		10/2/2007		92.5	%	Redeveloping one property (6)		563			—
								$	106,355		$	—

 

(1)		This joint venture owns one property in the Northern Virginia region and one in the Baltimore/Washington Corridor region.
(2)		This joint venture is developing a land parcel located in Hanover, Maryland (located in the Baltimore/Washington Corridor region).
(3)		This joint venture is developing land parcels located in College Park, Maryland through the M Square joint venture.
(4)		This joint venture’s property is located in Charles County, Maryland (located in our “other” business segment).
(5)		This joint venture’s property is located in Lanham, Maryland (located in the Suburban Maryland region).
(6)		This joint venture is redeveloping a property in the Northern Virginia region.

 

Our commitments and contingencies pertaining to our real estate joint ventures are disclosed in Note 20.

 

7.             Intangible Assets on Real Estate Acquisitions

 

Intangible assets on real estate acquisitions consisted of the following:

 

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