Piedmont Realty Trust, Inc. (PDM) FY 2021 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with our audited consolidated financial statements and notes thereto as of December 31, 2021 and 2020, and for the years ended December 31, 2021, 2020, and 2019, included elsewhere in this Annual Report on Form 10-K. See also “Cautionary Note Regarding Forward-Looking Statements” preceding Part I of this report and “Risk Factors" set forth in Item 1A. of this report.
Given our low-leverage operating model of long-term leases targeted toward creditworthy tenants, the COVID-19 pandemic has not materially impacted our financial condition, overall liquidity position and outlook, or caused material impairments in our portfolio of operating properties; however, the pandemic-related slowdown of leasing activity, particularly leasing of vacant space to new tenants, during 2020 and the first half of 2021 has moderated earnings growth and negatively impacted our occupancy levels and rental rate growth. The pandemic has had an ongoing impact on a few of our small, primarily retail, tenants and the long-term repercussions on our tenant's operations, future leasing decisions, and the global economy remains unclear.
Liquidity and Capital Resources
We intend to use cash on hand, cash flows generated from the operation of our properties, net proceeds from the disposition of select properties, and borrowings under our $500 Million Unsecured 2018 Line of Credit as our primary sources of immediate liquidity. We have $309 million of capacity on our $500 million line of credit available as of the date of this filing. When necessary, we may seek other new secured or unsecured borrowings from third party lenders or issue securities as additional sources of capital. The nature and timing of these additional sources of capital will be highly dependent on market conditions.
Our most consistent use of capital has historically been, and we believe will continue to be, to fund capital expenditures for our existing portfolio of properties. During the years ended December 31, 2021 and 2020, we incurred the following types of capital expenditures (in thousands):
| December 31, 2021 | December 31, 2020 | |||||
|---|---|---|---|---|---|---|
| Capital expenditures for redevelopment/ renovations | $ | 51,617 | $ | 18,600 | ||
| Other capital expenditures, including building and tenant improvements | 71,009 | 93,980 | ||||
| Total capital expenditures (1) | $ | 122,626 | $ | 112,580 |
(1)Of the total amounts paid, approximately $6.3 million and $0.6 million related to soft costs such as capitalized interest, payroll, and other general and administrative expenses for the year ended December 31, 2021 and 2020, respectively.
"Capital expenditures for redevelopment/renovations" during the years ended December 31, 2021 and 2020 primarily related to building upgrades, primarily to the lobbies and the addition of tenant amenities at our 60 Broad Street building in New York City; our 200 and 222 South Orange Avenue buildings in Orlando, Florida; our Galleria buildings in Atlanta, Georgia; and our 25 Burlington Mall Road building in Boston, Massachusetts.
"Other capital expenditures, including building and tenant improvements" include all other capital expenditures during the respective period and are typically comprised of tenant and building improvements necessary to lease, maintain, or provide enhancements, including energy efficient equipment to our existing portfolio of office properties. We currently do not anticipate incurring any unusually large or material capital expenditures within any given year in order to meet recognized sustainable development standards, and achieve our environmental impact goals.
Given that our operating model frequently results in leases for large blocks of space to credit-worthy tenants, our leasing success can result in capital outlays which vary from one reporting period to another based upon the specific leases executed. For example, for leases executed during the year ended December 31, 2021, we committed to spend approximately $4.25 per square foot per year of lease term for tenant improvement allowances and lease commissions (net of expired lease commitments) as compared to $5.79 (net of expired lease commitments) for the year ended December 31, 2020. As of December 31, 2021, we had one individually significant unrecorded tenant allowance commitment outstanding of approximately $18.4 million related to the State of New York's lease at our 60 Broad Street building in New York.
In addition to the amounts that we have already committed to as a part of executed leases, we also anticipate continuing to incur similar market-based tenant improvement allowances and leasing commissions in conjunction with procuring future leases for our existing portfolio of properties. Both the timing and magnitude of expenditures related to future leasing activity can vary
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due to a number of factors and are highly dependent on the size of the leased square footage and the competitive market conditions of the particular office market at the time a lease is being negotiated.
There are other uses of capital that may arise as part of our typical operations. Subject to the identification and availability of attractive investment opportunities and our ability to consummate such acquisitions on satisfactory terms, acquiring new assets consistent with our investment strategy could also be a significant use of capital. We may also use capital resources to repurchase additional shares of our common stock under our stock repurchase program when we believe the stock is trading disparately from our peers and at a significant discount to net asset value. Also, during the year ended December 31, 2021, we repurchased approximately 1.1 million shares at an average price of $17.76, or approximately $18.9 million. As of December 31, 2021, we had approximately $150.5 million of remaining capacity under the program which may be used for share repurchases through February 2024. Finally, other than our $500 Million Unsecured 2018 Line of Credit, which has a maturity date of September 2022 but can be extended for up to one additional year, we have no scheduled debt maturities until the second quarter of 2023. We may use capital to repay debt obligations when we deem it prudent to refinance various obligations.
The amount and form of payment (cash or stock issuance) of future dividends to be paid to our stockholders will continue to be largely dependent upon (i) the amount of cash generated from our operating activities; (ii) our expectations of future cash flows; (iii) our determination of near-term cash needs for debt repayments, development projects, and selective acquisitions of new properties; (iv) the timing of significant expenditures for tenant improvements, leasing commissions, building redevelopment projects, and general property capital improvements; (v) long-term dividend payout ratios for comparable companies; (vi) our ability to continue to access additional sources of capital, including potential sales of our properties; and (vii) the amount required to be distributed to maintain our status as a REIT. With the fluctuating nature of cash flows and expenditures, we may periodically borrow funds on a short-term basis to cover timing differences in cash receipts and cash disbursements.
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Results of Operations (2021 vs. 2020)
Overview
As a result of a $41.0 million impairment charge related to our last remaining Chicago asset (see Note 7), that was recorded during the fourth quarter of 2021, Piedmont recognized net loss applicable to common stockholders for the year ended December 31, 2021 of $1.2 million, or $0.01 per diluted share, as compared with net income applicable to common stockholders of $232.7 million, or $1.85 per diluted share, for the year ended December 31, 2020. The year ended December 31, 2020 included approximately $196.4 million, or $1.56 per diluted share, of gains on sales of real estate assets, net of a $9.3 million loss on early extinguishment of debt, whereas the year ended December 31, 2021 included no gains or losses on sales of real estate assets or early extinguishment of debt.
Comparison of the accompanying consolidated statements of operations for the year ended December 31, 2021 vs. the year ended December 31, 2020.
The following table sets forth selected data from our consolidated statements of operations for the years ended December 31, 2021 and 2020, respectively, as well as each balance as a percentage of total revenues for the years presented (dollars in millions):
| December 31, 2021 | % of Revenues | December 31, 2020 | % of Revenues | Variance | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Revenue: | ||||||||||||||||
| Rental and tenant reimbursement revenue | $ | 514.6 | $ | 519.9 | $ | (5.3) | ||||||||||
| Property management fee revenue | 2.5 | 2.9 | (0.4) | |||||||||||||
| Other property related income | 11.6 | 12.2 | (0.6) | |||||||||||||
| Total revenues | 528.7 | 100 | % | 535.0 | 100 | % | (6.3) | |||||||||
| Expense: | ||||||||||||||||
| Property operating costs | 210.9 | 40 | % | 214.9 | 40 | % | (4.0) | |||||||||
| Depreciation | 120.6 | 23 | % | 110.6 | 21 | % | 10.0 | |||||||||
| Amortization | 86.0 | 16 | % | 93.3 | 17 | % | (7.3) | |||||||||
| Impairment loss on real estate assets | 41.0 | 8 | % | — | — | % | 41.0 | |||||||||
| General and administrative | 30.3 | 5 | % | 27.5 | 5 | % | 2.8 | |||||||||
| 488.8 | 446.3 | 42.5 | ||||||||||||||
| Other income (expense): | ||||||||||||||||
| Interest expense | (51.3) | 10 | % | (55.0) | 10 | % | 3.7 | |||||||||
| Other income | 10.2 | 2 | % | 2.6 | — | % | 7.6 | |||||||||
| Loss on extinguishment of debt | — | — | % | (9.3) | 2 | % | 9.3 | |||||||||
| Gain on sale of real estate assets | — | — | % | 205.7 | 38 | % | (205.7) | |||||||||
| Net income/(loss) | $ | (1.2) | — | % | $ | 232.7 | 43 | % | $ | (233.9) |
Revenue
Rental and tenant reimbursement revenue decreased approximately $5.3 million for the year ended December 31, 2021 as compared to the prior year, reflecting a full year of COVID impacts as compared to a partial year of impact in 2020. Additionally, a 1% decrease in portfolio occupancy was partially offset by accretive capital recycling activity during the two years ended December 31, 2021, rental rate increases associated with recent leasing activity across the portfolio, and higher tenant reimbursements as a result of the expiration of operating expense abatements on certain large leases during the year ended December 31, 2021.
Property management fee revenue decreased approximately $0.4 million for the year ended December 31, 2021 as compared to the prior year. Such fees fluctuate from period to period due to the variability of construction activity as well as the termination or commencement of property management agreements we may enter into with the buyers of properties in our portfolio.
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Other property related income decreased approximately $0.6 million for the year ended December 31, 2021 as compared to the prior year primarily due to lower transient parking at our buildings reflecting a full year of the COVID-19 pandemic impact in 2021 versus a partial year for the year ended December 31, 2020.
Expense
Property operating costs decreased approximately $4.0 million for the year ended December 31, 2021 as compared to the prior year. The variance was primarily due to lower operating costs, largely associated with lower real estate taxes in certain jurisdictions.
Depreciation expense increased approximately $10.0 million for the year ended December 31, 2021 compared to the prior year. The increase was primarily due to additional building and tenant improvements placed in service subsequent to January 1, 2020.
Amortization expense decreased approximately $7.3 million for the year ended December 31, 2021 compared to the prior year. Amortization expense decreased primarily due to certain lease intangible assets at our existing properties becoming fully amortized subsequent to January 1, 2020.
During the year ended December 31, 2021, we recognized an impairment loss on real estate assets of approximately $41.0 million related to a change in hold period assumptions for our last remaining Chicago asset, Two Pierce Place in Itasca, Illinois. No impairment loss on real estate assets were recorded during the year ended December 31, 2020.
General and administrative expenses increased approximately $2.8 million for the year ended December 31, 2021 as compared to the year ended December 31, 2020, with the year ended December 31, 2021 primarily reflecting increased accruals for potential performance based equity compensation.
Other Income (Expense)
Interest expense decreased approximately $3.7 million for the year ended December 31, 2021 as compared to the prior year as a result of the repayment of a $160 million mortgage in conjunction with the sale of the 1901 Market Street building in 2020, as well as an increase in capitalized interest associated with various redevelopment projects during the year ended December 31, 2021. These decreases were partially offset by higher average borrowings on our $500 Million Unsecured 2018 Line of Credit during the current year as compared to the year ended December 31, 2020, largely driven by the purchase of the 999 Peachtree Street building in Atlanta, Georgia during the fourth quarter of 2021.
Other income increased approximately $7.6 million for the year ended December 31, 2021 as compared to the prior year. The variance is primarily attributable to interest income recognized on notes receivable extended to the purchaser of our New Jersey Portfolio in October 2020. These notes receivable mature in October 2023 and are secured by the 200 and 400 Bridgewater Crossing properties (see Note 13 to the accompanying consolidated financial statements for more details).
The loss on extinguishment of debt for the year ended December 31, 2020 was associated with the early repayment of the $160 Million Fixed-Rate Loan which was collateralized by the 1901 Market Street building (see "Gain on sale of real estate assets" explanation below). The property was sold in June 2020. The loss was comprised of a prepayment penalty and the write-off of unamortized debt issuance costs and discounts associated with the loan.
Gain on sale of real estate assets during the year ended December 31, 2020 includes a gain of approximately $191.0 million recognized on the sale of the 1901 Market Street building in Philadelphia, Pennsylvania and a gain of approximately $14.6 million recognized on the sale of the New Jersey Portfolio.
Results of Operations (2020 vs. 2019)
Please refer to "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations (2020 vs. 2019)" in our Annual Report on Form 10-K for the year ended December 31, 2020, as filed with the SEC on February 17, 2021, for a discussion of the results of operations for the year ended December 31, 2020 as compared to the year ended December 31, 2019.
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Issuer and Guarantor Financial Information
Piedmont, through its wholly-owned subsidiary Piedmont Operating Partnership, LP ("Piedmont OP" or the "Issuer"), has issued senior unsecured notes payable of $350 million that mature in 2023, $400 million that mature in 2024, and two separate issuances of $300 million, that mature in 2030 and 2032, respectively, (collectively, the "Notes"). The Notes are senior unsecured obligations of Piedmont OP, rank equally in right of payment with all of Piedmont OP's other existing and future senior unsecured indebtedness, and would be effectively subordinated in right of payment to any of Piedmont OP’s future mortgage or other secured indebtedness (to the extent of the value of the collateral securing such indebtedness) and to all existing and future indebtedness and other liabilities of Piedmont OP’s subsidiaries, whether secured or unsecured.
The Notes are fully and unconditionally guaranteed by Piedmont Office Realty Trust, Inc. (the "Guarantor"), the parent entity that consolidates Piedmont OP and all other subsidiaries. By execution of the guarantee, the Guarantor guarantees to each holder of the Notes that the principal and interest on the Notes will be paid in full when due, whether at the maturity dates of the respective loans, or upon acceleration, upon redemption, or otherwise; interest on overdue principal and interest on any overdue interest, if any, on the Notes will also be paid in full when due; and all other obligations of the Issuer to the holders of the Notes will be promptly paid in full. The Guarantor's guarantee of the Notes is its senior unsecured obligation and ranks equally in right of payment with all of the Guarantor's other existing and future senior unsecured indebtedness and guarantees. The Guarantor’s guarantee of the Notes is effectively subordinated in right of payment to any future mortgage or other secured indebtedness or secured guarantees of the Guarantor (to the extent of the value of the collateral securing such indebtedness and guarantees); and all existing and future indebtedness and other liabilities, whether secured or unsecured, of the Guarantor’s subsidiaries.
In the event of the bankruptcy, liquidation, reorganization or other winding up of Piedmont OP or the Guarantor, assets that secure any of their respective secured indebtedness and other secured obligations will be available to pay their respective obligations under the Notes or the guarantee, as applicable, and their other respective unsecured indebtedness and other unsecured obligations only after all of their respective indebtedness and other obligations secured by those assets have been repaid in full.
The non-Guarantors are separate and distinct legal entities and have no obligation, contingent or otherwise, to pay any amounts due pursuant to the Notes, or to make any funds available therefore, whether by dividends, loans, distributions or other payments.
Pursuant to Rule 13-01 of Regulation S-X, Guarantors and Issuers of Guaranteed Securities Registered or Being Registered, the following tables present summarized financial information for Piedmont OP as Issuer and Piedmont Office Realty Trust, Inc. as Guarantor on a combined basis after elimination of (i) intercompany transactions and balances among the Issuer and the Guarantor and (ii) equity in earnings from and investments in any subsidiary that is a non-Guarantor (in thousands):
| Combined Balances of Piedmont OP and Piedmont Office Realty Trust, Inc. as Issuer and Guarantor, respectively | As ofDecember 31, 2021 | As of December 31, 2020 | ||||
|---|---|---|---|---|---|---|
| Due from non-guarantor subsidiary | $ | 900 | $ | 810 | ||
| Total assets | $ | 352,788 | $ | 347,757 | ||
| Total liabilities | $ | 1,945,846 | $ | 1,654,009 | ||
| For the Year Ended December 31, 2021 | ||||||
| Total revenues | $ | 48,853 | ||||
| Net loss | $ | (44,463) |
Net Operating Income by Geographic Segment
The chief operating decision maker ("CODM"), who is our President and Chief Executive Officer, evaluates our portfolio and assesses the ongoing operations and performance of our properties utilizing the following geographic segments: Atlanta, Dallas, Washington, D.C., Minneapolis, Boston, Orlando, and New York. These operating segments are also Piedmont’s reportable segments. Additionally, as of December 31, 2021, Piedmont owned two properties in Houston and one property in Chicago that
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do not meet the definition of an operating or reportable segment as the CODM does not regularly review these properties for purposes of allocating resources or assessing performance, and Piedmont does not maintain a significant presence or anticipate further investment in these markets. These three properties are included in "Corporate and other" below. See Note 16, Segment Information, to the accompanying consolidated financial statements for additional information and a reconciliation of Net income/(loss) applicable to Piedmont to Net Operating Income ("NOI").
The following table presents NOI by geographic segment (in thousands):
| Years Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2021 | 2020 | |||||
| Dallas | $ | 66,155 | $ | 59,845 | ||
| Atlanta | 62,772 | 60,276 | ||||
| Washington, D.C. | 36,914 | 36,696 | ||||
| Minneapolis | 32,538 | 33,588 | ||||
| Boston | 45,587 | 41,722 | ||||
| Orlando | 33,449 | 34,427 | ||||
| New York | 30,049 | 38,990 | ||||
| Total reportable segments | 307,464 | 305,544 | ||||
| Corporate and other | 10,163 | 13,915 | ||||
| Total NOI | $ | 317,627 | $ | 319,459 |
Comparison of the Year Ended December 31, 2021 Versus the Year Ended December 31, 2020
Dallas
NOI increased primarily due to a full year of operating income at the Dallas Galleria Office Towers, purchased in February 2020.
Atlanta
NOI increased primarily due to operating income at the 999 Peachtree Street building, purchased in October 2021.
Boston
NOI increased primarily as a result of executing a renewal and expansion totaling approximately 155,000 square feet at 5&15 Wayside, as well as a rent increase related to a single tenant at our 5 Wall Street building during 2021.
New York
NOI decreased primarily due to the sale of the New Jersey Portfolio in October 2020.
Corporate and other
NOI decreased primarily as a result of the sale of 1901 Market Street building in Philadelphia, Pennsylvania in June 2020.
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Funds From Operations ("FFO"), Core Funds From Operations ("Core FFO"), and Adjusted Funds From Operations (“AFFO”)
Net income/(loss) calculated in accordance with GAAP is the starting point for calculating FFO, Core FFO, and AFFO. These metrics are non-GAAP financial measures and should not be viewed as an alternative measurement of our operating performance to net income/(loss). Management believes that accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values have historically risen or fallen with market conditions, many industry investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting alone to be insufficient. As a result, we believe that the additive use of FFO, Core FFO, and AFFO, together with the required GAAP presentation, provides a more complete understanding of our performance relative to our competitors and a more informed and appropriate basis on which to make decisions involving operating, financing, and investing activities.
We calculate FFO in accordance with the current National Association of Real Estate Investment Trusts ("NAREIT") definition. NAREIT currently defines FFO as Net income/(loss) (calculated in accordance with GAAP), excluding depreciation and amortization related to real estate, gains and losses from the sale of certain real estate assets, gains and losses from change in control, and impairment write-downs of certain real estate assets and investment in entities when the impairment is directly attributable to decreases in the value of depreciable real estate held by the entity. Other REITs may not define FFO in accordance with the NAREIT definition, or may interpret the current NAREIT definition differently than we do; therefore, our computation of FFO may not be comparable to the computation made by other REITs.
We calculate Core FFO by starting with FFO, as defined by NAREIT, and adjusting for gains or losses on the extinguishment of swaps and/or debt and any significant non-recurring or infrequent items. Core FFO is a non-GAAP financial measure and should not be viewed as an alternative to net income/(loss) calculated in accordance with GAAP as a measurement of our operating performance. We believe that Core FFO is helpful to investors as a supplemental performance measure because it excludes the effects of certain infrequent or non-recurring items which can create significant earnings volatility, but which do not directly relate to our core recurring business operations. As a result, we believe that Core FFO can help facilitate comparisons of operating performance between periods and provides a more meaningful predictor of future earnings potential. Other REITs may not define Core FFO in the same manner as us; therefore, our computation of Core FFO may not be comparable to the computation made by other REITs.
We calculate AFFO by starting with Core FFO and adjusting for non-incremental capital expenditures and non-cash items including: non-real estate depreciation, straight-lined rent and fair value lease adjustments, non-cash components of interest expense and compensation expense. AFFO is a non-GAAP financial measure and should not be viewed as an alternative to net income/(loss) calculated in accordance with GAAP as a measurement of our operating performance. We believe that AFFO is helpful to investors as a meaningful supplemental comparative performance measure of our ability to make incremental capital investments in new properties or enhancements to existing properties that improve revenue growth potential. Other REITs may not define AFFO in the same manner as us; therefore, our computation of AFFO may not be comparable to the computation of other REITs.
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Reconciliations of net income/(loss) to FFO, Core FFO, and AFFO for the years ended December 31, 2021, 2020, and 2019, respectively, are presented below (in thousands except per share amounts):
| 2021 | PerShare (1) | 2020 | PerShare(1) | 2019 | PerShare(1) | |||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| GAAP net income/(loss) applicable to common stock | $ | (1,153) | $ | (0.01) | $ | 232,688 | $ | 1.85 | $ | 229,261 | $ | 1.82 | ||||||||||
| Depreciation of real assets | 119,629 | 0.96 | 109,326 | 0.86 | 105,111 | 0.83 | ||||||||||||||||
| Amortization of lease-related costs | 85,946 | 0.69 | 93,242 | 0.74 | 76,610 | 0.61 | ||||||||||||||||
| Impairment loss on real estate assets | 41,000 | 0.33 | — | — | 8,953 | 0.07 | ||||||||||||||||
| Gain on sale of real estate assets | — | — | (205,666) | (1.63) | (197,010) | (1.56) | ||||||||||||||||
| NAREIT Funds From Operations applicable to common stock | $ | 245,422 | $ | 1.97 | $ | 229,590 | $ | 1.82 | $ | 222,925 | $ | 1.77 | ||||||||||
| Adjustments: | ||||||||||||||||||||||
| Retirement and separation expenses associated with senior management transition in June 2019 | — | — | — | — | 3,175 | 0.02 | ||||||||||||||||
| Loss on extinguishment of debt | — | — | 9,336 | 0.07 | — | — | ||||||||||||||||
| Core Funds From Operations applicable to common stock | $ | 245,422 | $ | 1.97 | $ | 238,926 | $ | 1.89 | $ | 226,100 | $ | 1.79 | ||||||||||
| Adjustments: | ||||||||||||||||||||||
| Amortization of debt issuance costs, fair market adjustments on notes payable, and discounts on debt | 2,857 | 2,833 | 2,101 | |||||||||||||||||||
| Depreciation of non real estate assets | 949 | 1,216 | 872 | |||||||||||||||||||
| Straight-line effects of lease revenue | (10,566) | (22,601) | (10,411) | |||||||||||||||||||
| Stock-based compensation adjustments | 7,924 | 7,014 | 5,030 | |||||||||||||||||||
| Amortization of lease-related intangibles | (11,290) | (12,284) | (8,323) | |||||||||||||||||||
| Non-incremental capital expenditures (2) | (75,162) | (77,682) | (49,653) | |||||||||||||||||||
| Adjusted Funds From Operations applicable to common stock | $ | 160,134 | $ | 137,422 | $ | 165,716 | ||||||||||||||||
| Weighted-average shares outstanding – diluted | 124,455 | (3) | 126,104 | 126,182 |
(1)Based on weighted-average shares outstanding—diluted.
(2)We define non-incremental capital expenditures as capital expenditures of a recurring nature related to tenant improvements, leasing commissions, and building capital that do not incrementally enhance the underlying assets' income generating capacity. Tenant improvements, leasing commissions, building capital and deferred lease incentives incurred to lease space that was vacant at acquisition, leasing costs for spaces vacant for greater than one year, leasing costs for spaces at newly acquired properties for which in-place leases expire shortly after acquisition, improvements associated with the expansion of a building, and renovations that either enhance the rental rates of a building or change the property's underlying classification, such as from a Class B to a Class A property, are excluded from this measure.
(3)Includes potential dilution under the treasury stock method that would occur if our remaining unvested and potential stock awards vested and resulted in additional common shares outstanding. Such shares are not included when calculating net loss per diluted share applicable to Piedmont for the year ended December 31, 2021 as they would reduce the loss per share presented.
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Property and Same Store Net Operating Income
Property Net Operating Income ("Property NOI") is a non-GAAP measure which we use to assess our operating results. We calculate Property NOI beginning with Net income/(loss) (calculated in accordance with GAAP) before interest, income-related federal, state, and local taxes, depreciation and amortization and removing any impairments and gains or losses from sales of property and other significant infrequent items that create volatility within our earnings and make it difficult to determine the earnings generated by our core ongoing business. Furthermore, we remove general and administrative expenses, income associated with property management performed by us for other organizations, and other income or expense items such as interest income from loan investments or costs from the pursuit of non-consummated transactions. For Property NOI (cash basis), the effects of straight-lined rents and fair value lease revenue are also eliminated; while such effects are not adjusted in calculating Property NOI (accrual basis). Property NOI is a non-GAAP financial measure and should not be viewed as an alternative to net income/(loss) calculated in accordance with GAAP as a measurement of our operating performance. We believe that Property NOI, on either a cash or accrual basis, is helpful to investors as a supplemental comparative performance measure of income generated by our properties alone without our administrative overhead. Other REITs may not define Property NOI in the same manner as we do; therefore, our computation of Property NOI may not be comparable to that of other REITs.
We calculate Same Store Net Operating Income ("Same Store NOI") as Property NOI attributable to the properties (excluding undeveloped land parcels) that were (i) owned by us during the entire span of the current and prior year reporting periods; (ii) that were not being developed or redeveloped during those periods; and (iii) for which no operating expenses were capitalized during those periods. For Same Store NOI (cash basis), the effects of straight-lined rents and fair value lease revenue are also eliminated. Same Store NOI, on either a cash or accrual basis, is a non-GAAP financial measure and should not be viewed as an alternative to net income/(loss) calculated in accordance with GAAP as a measurement of our operating performance. We believe that Same Store NOI is helpful to investors as a supplemental comparative performance measure of the income generated from the same group of properties from one period to the next. Other REITs may not define Same Store NOI in the same manner as we do; therefore, our computation of Same Store NOI may not be comparable to that of other REITs.
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The following table sets forth a reconciliation from net income/(loss) calculated in accordance with GAAP to EBITDAre, Core EBITDA, Property NOI, and Same Store NOI on both a cash and accrual basis, for the years ended December 31, 2021 and 2020, respectively (in thousands):
| Cash Basis | Accrual Basis | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| December 31, 2021 | December 31, 2020 | December 31, 2021 | December 31, 2020 | |||||||||||
| Net income/(loss) applicable to Piedmont (GAAP basis) | $ | (1,153) | $ | 232,688 | $ | (1,153) | $ | 232,688 | ||||||
| Net loss applicable to noncontrolling interest | (14) | (3) | (14) | (3) | ||||||||||
| Interest expense | 51,292 | 54,990 | 51,292 | 54,990 | ||||||||||
| Depreciation | 120,578 | 110,542 | 120,578 | 110,542 | ||||||||||
| Amortization | 85,946 | 93,242 | 85,946 | 93,242 | ||||||||||
| Depreciation and amortization attributable to noncontrolling interests | 84 | 85 | 84 | 85 | ||||||||||
| Impairment loss on real estate assets | 41,000 | — | 41,000 | — | ||||||||||
| Gain on sale of real estate assets | — | (205,666) | — | (205,666) | ||||||||||
| EBITDAre(1) | 297,733 | 285,878 | 297,733 | 285,878 | ||||||||||
| Loss on extinguishment of debt | — | 9,336 | — | 9,336 | ||||||||||
| Core EBITDA(2) | 297,733 | 295,214 | 297,733 | 295,214 | ||||||||||
| General & administrative expenses | 30,252 | 27,464 | 30,252 | 27,464 | ||||||||||
| Management fee revenue(3) | (1,269) | (1,495) | (1,269) | (1,495) | ||||||||||
| Other income | (9,089) | (1,724) | (9,089) | (1,724) | ||||||||||
| Non-cash general reserve/(recovery) for uncollectible accounts | (553) | 4,553 | ||||||||||||
| Straight-line rent effects of lease revenue | (10,566) | (22,601) | ||||||||||||
| Straight-line effects of lease revenue attributable to noncontrolling interests | 3 | (16) | ||||||||||||
| Amortization of lease-related intangibles | (11,290) | (12,284) | ||||||||||||
| Property NOI | 295,221 | 289,111 | 317,627 | 319,459 | ||||||||||
| Net operating income from: | ||||||||||||||
| Acquisitions(4) | (34,446) | (23,115) | (41,720) | (30,397) | ||||||||||
| Dispositions(5) | (204) | (21,049) | (205) | (22,113) | ||||||||||
| Other investments(6) | 783 | 550 | 1,009 | 769 | ||||||||||
| Same Store NOI | $ | 261,354 | $ | 245,497 | $ | 276,711 | $ | 267,718 | ||||||
| Change period over period in Same Store NOI | 6.5 | % | N/A | 3.4 | % | N/A |
(1)We calculate Earnings Before Interest, Taxes, Depreciation, and Amortization- Real Estate ("EBITDAre") in accordance with the current National Association of Real Estate Investment Trusts (“NAREIT”) definition. NAREIT currently defines EBITDAre as net income/(loss) (computed in accordance with GAAP) adjusted for gains or losses from sales of property, impairment losses, depreciation on real estate assets, amortization on real estate assets, interest expense and taxes. Some of the adjustments mentioned can vary among owners of identical assets in similar conditions based on historical cost accounting and useful-life estimates. EBITDAre is a non-GAAP financial measure and should not be viewed as an alternative to net income/(loss) calculated in accordance with GAAP as a measurement of our operating performance. We believe that EBITDAre is helpful to investors as a supplemental performance measure because it provides a metric for understanding our results from ongoing operations without taking into account the effects of non-cash expenses (such as depreciation and amortization) and capitalization and capital structure expenses (such as interest expense and taxes). We also believe that EBITDAre can help facilitate comparisons of operating performance between periods and with other REITs. However, other REITs may not define EBITDAre in accordance with the
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NAREIT definition, or may interpret the current NAREIT definition differently than us; therefore, our computation of EBITDAre may not be comparable to that of such other REITs.
(2)We calculate Core Earnings Before Interest, Taxes, Depreciation, and Amortization ("Core EBITDA") as net income/(loss) (computed in accordance with GAAP) before interest, taxes, depreciation and amortization and incrementally removing any impairment losses, gains or losses from sales of property and other significant infrequent items that create volatility within our earnings and make it difficult to determine the earnings generated by our core ongoing business. Core EBITDA is a non-GAAP financial measure and should not be viewed as an alternative to net income/(loss) calculated in accordance with GAAP as a measurement of our operating performance. We believe that Core EBITDA is helpful to investors as a supplemental performance measure because it provides a metric for understanding the performance of our results from ongoing operations without taking into account the effects of non-cash expenses (such as depreciation and amortization), as well as items that are not part of normal day-to-day operations of our business. Other REITs may not define Core EBITDA in the same manner as us; therefore, our computation of Core EBITDA may not be comparable to that of other REITs.
(3)Presented net of related operating expenses incurred to earn such management fee revenue.
(4)Acquisitions include One Galleria Tower, Two Galleria Tower and Three Galleria Tower in Dallas, Texas, purchased on February 12, 2020, and 999 Peachtree Street in Atlanta, Georgia, purchased on October 22, 2021.
(5)Dispositions include 1901 Market Street in Philadelphia, Pennsylvania, sold on June 25, 2020, and the New Jersey Portfolio sold on October 28, 2020 (consisting of the Company's final remaining assets in the state; 200 and 400 Bridgewater Crossing in Bridgewater, New Jersey, and 600 Corporate Drive in Lebanon, New Jersey).
(6)Other investments consist of active redevelopment and development projects, land, and recently completed redevelopment and development projects for which some portion of operating expenses were capitalized during the current and/or prior year reporting periods. The operating results from 222 South Orange Avenue in Florida are included in this line item.
Overview
Our portfolio is a geographically diverse group of properties located primarily in select sub-markets within seven major U.S. office markets, with a majority of our Annualized Lease Revenue ("ALR") being generated from Sunbelt markets. We typically lease space to large, creditworthy corporate or governmental tenants on a long-term basis. As of December 31, 2021, our average lease was approximately 15,000 square feet with six years of lease term remaining. Consequently, leased percentage, as well as rent roll ups and roll downs, which we experience as a result of re-leasing, can fluctuate widely between buildings and between tenants, depending on when a particular lease is scheduled to commence or expire.
Leased Percentage
Our portfolio was approximately 86% leased as of December 31, 2021, as compared to approximately 87% leased as of December 31, 2020. As of December 31, 2021, we had only one lease greater than 1% of our ALR that is scheduled to expire over the following twelve months. This lease at our 750 West John Carpenter Freeway asset (assigned to the Dallas geographic reportable segment) represents 1.2% of our ALR, and is scheduled to expire during the fourth quarter of 2022. We are currently in advanced discussions with the tenant for a renewal of a majority of their space. As the economy has continued to recover from the impacts of the COVID-19 pandemic, leasing activity across our portfolio has improved; however, to the extent new leases for currently vacant space outweigh or fall short of scheduled expirations, such leases would increase or decrease our overall leased percentage, respectively.
Impact of Downtime, Abatement Periods, and Rental Rate Changes
Commencement of new tenant leases typically occurs 6-18 months after the lease execution date, after refurbishment of the space is completed. The downtime between a lease expiration and a new lease's commencement can negatively impact Property NOI and Same Store NOI comparisons (both accrual and cash basis). In addition, office leases, both new and renewal, often contain upfront rental and/or operating expense abatement periods which delay the cash flow benefits of the lease even after the new or renewal lease has commenced and negatively impact Property NOI and Same Store NOI on a cash basis until such abatements expire. As of December 31, 2021, we had approximately 750,000 square feet of executed leases for vacant space yet to commence or under rental abatement.
If we are unable to replace expiring leases with new or renewal leases at rental rates equal to or greater than the expiring rates, rental rate roll downs could occur and negatively impact Property NOI and Same Store NOI comparisons. As mentioned above, our geographically diverse portfolio and the magnitude of some of our tenant's leased space can result in rent roll ups and roll downs that can fluctuate widely on a building-by-building and a quarter-to-quarter basis. During the year ended December 31, 2021, we experienced a 15.6% and 7.5% roll up in accrual and cash rents, respectively, on executed leases related to space vacant one year or less.
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Same Store NOI increased by 6.5% and 3.4% on a cash and accrual basis, respectively, for the year ended December 31, 2021. The primary drivers of the increases in both metrics included increased rental rates and decreased operating expenses, particularly real estate taxes, as well as the expiration of abatements at certain properties. These increases were partially offset by an approximately 1% overall reduction in portfolio occupancy during 2021 due to slower new tenant touring and leasing activity in 2020 as a result of the COVID-19 pandemic. Property NOI and Same Store NOI comparisons for any given period fluctuate as a result of the mix of net leasing activity during the respective period.
Election as a REIT
We have elected to be taxed as a REIT under the Code and have operated as such beginning with our taxable year ended December 31, 1998. To qualify as a REIT, we must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of our adjusted REIT taxable income, computed without regard to the dividends-paid deduction and by excluding net capital gains attributable to our stockholders, as defined by the Code. As a REIT, we generally will not be subject to federal income tax on income that we distribute to our stockholders. If we fail to qualify as a REIT in any taxable year, we may be subject to federal income taxes on our taxable income for that year and for the four years following the year during which qualification is lost and/or penalties, unless the IRS grants us relief under certain statutory provisions. Such an event could materially adversely affect our net income/(loss) and net cash available for distribution to our stockholders. However, we believe that we are organized and operate in such a manner as to qualify for treatment as a REIT and intend to continue to operate in the foreseeable future in such a manner that we will remain qualified as a REIT for federal income tax purposes. We have elected to treat one of our wholly owned subsidiaries as a taxable REIT subsidiary ("TRS"). Our TRS performs non-customary services for tenants of buildings that we own, including real estate and non-real estate related-services. Any earnings related to such services performed by our TRS are subject to federal and state income taxes. In addition, for us to continue to qualify as a REIT, our investments in TRS cannot exceed 20% of the value of our total assets.
Inflation
We are exposed to inflation risk, as income from long-term leases is the primary source of our cash flows from operations. There are provisions in the majority of our tenant leases that are intended to protect us from, and mitigate the risk of, the impact of inflation. These provisions include rent steps, reimbursement billings for operating expense pass-through charges, real estate tax, and insurance on a per square-foot basis, or in some cases, annual reimbursement of operating expenses above certain per square-foot allowances. However, due to the long-term nature of the leases, the leases may not readjust their reimbursement rates frequently enough to fully cover inflation.
Application of Critical Accounting Estimates
Our accounting policies have been established to conform with GAAP. The preparation of financial statements in conformity with GAAP requires management to use judgment in the application of accounting policies, including making estimates and assumptions. These judgments affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. If our judgment or interpretation of the facts and circumstances relating to various transactions had been different, it is possible that different accounting policies would have been applied, thus, resulting in a different presentation of the financial statements. Additionally, other companies may utilize different estimates that may impact comparability of our results of operations to those of companies in similar businesses. The critical accounting policies outlined below have been discussed with members of the Audit Committee of the board of directors.
Valuation of Real Estate Assets
We continually monitor events and changes in circumstances that could indicate that the carrying amounts of the real estate and related intangible assets, both operating properties and properties under construction, in which we have an ownership interest, either directly or through investments in joint ventures, may not be recoverable. When indicators of potential impairment are present, we assess whether the respective carrying values will be recovered from the undiscounted future operating cash flows expected from the use of the asset and its eventual disposition for assets held for use, or from the estimated fair value, less costs to sell, for assets held for sale. In the event that the expected undiscounted future cash flows for assets held for use or the estimated fair value, less costs to sell, for assets held for sale do not exceed the respective asset carrying value, we adjust such assets to the respective estimated fair values and recognize an impairment loss.
Projections of expected future cash flows require that we estimate future market rental income amounts subsequent to the expiration of current lease agreements, property operating expenses, the number of months it takes to re-lease the property, and the number of years the property is held for investment, among other factors. The changing of these assumptions and the subjectivity of assumptions used in the future cash flow analysis, including capitalization and discount rates, could result in a
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changed assessment or an incorrect assessment of the property’s estimated fair value and, therefore, could result in the misstatement of the carrying value of our real estate and related intangible assets and our reported net income/(loss) attributable to Piedmont.
Rental Revenue Recognition
Rental income for office properties is our principal source of revenue. The timing of rental revenue recognition is largely dependent on our conclusion as to whether we, or our tenant, are the owner of tenant improvements at the leased property. The determination of whether we, or our tenant, are the owner of tenant improvements for accounting purposes is subject to significant judgment. In making that determination, we consider numerous factors and perform an evaluation of each individual lease. No one factor is determinative in reaching a conclusion. The factors we evaluate include but are not limited to the following:
•whether the tenant is obligated by the terms of the lease agreement to construct or install the leasehold improvements as a condition of the lease;
•whether the landlord can require the lessee to make specified improvements or otherwise enforce its economic rights to those assets;
•whether the tenant is required to provide the landlord with documentation supporting the cost of tenant improvements prior to reimbursement by the landlord;
•whether the landlord is obligated to fund cost overruns for the construction of leasehold improvements;
•whether the leasehold improvements are unique to the tenant or could reasonably be used by other parties; and
•whether the estimated economic life of the leasehold improvements is long enough to allow for a significant residual value that could benefit the landlord at the end of the lease term.
When we conclude that we are the owner of tenant improvements, we record the cost to construct the tenant improvements as an asset and commence rental revenue recognition when the tenant takes possession of or controls the finished space, which is typically when the improvements being recorded as our asset are substantially complete, and our landlord obligation has been materially satisfied. When we conclude that our tenant is the owner of certain tenant improvements, we record our contribution towards those improvements as a lease incentive, which is amortized as a reduction to rental and tenant reimbursement revenue on a straight-line basis over the term of the related lease, and the recognition of rental revenue begins when the tenant takes possession of or controls the space.
In addition, we also record the cost of certain tenant improvements paid for or reimbursed by tenants when we conclude that we are the owner of such tenant improvements using the factors discussed above. For these tenant-funded tenant improvements, we record the amount funded or reimbursed by tenants as an asset and deferred revenue. The asset is depreciated and the deferred revenue is amortized and recognized as rental revenue over the term of the related lease beginning upon substantial completion of the leased premises. Consequently, our determination as to whether we, or our tenant, are the owner of tenant improvements for accounting purposes has a significant impact on both the amount and timing of rental revenue that we record related to tenant-funded tenant improvements.
Related-Party Transactions and Agreements
There were no related-party transactions during the three years ended December 31, 2021, other than a consulting agreement with our former Chief Investment Officer ("CIO"), Raymond L. Owens. Mr. Owens retired effective June 30, 2017, and remained a consultant for us until June 30, 2020, earning $18,500 per month. During the years ended December 31, 2021, 2020, and 2019, Piedmont recognized approximately $0, $0.1 million, and $0.2 million, respectively, of expense related to this consulting agreement. Additionally, during the year ended December 31, 2019, we entered into employment or retirement agreements with certain of our current and former executive officers as more fully described in our Definitive Proxy Statement and Current Report on Form 8-K filed on March 19, 2019.
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