Risks Related to Our Business and Our Properties
We generate a significant portion of our revenues from our joint venture and our separate account management agreements with CalSTRS, and if we were to lose these relationships, our financial results would be significantly negatively affected.
Our joint venture and separate account management agreement relationships with CalSTRS provide us with substantial fee revenues. For the
nine months ended September 30, 2012
, approximately
19.7%
of our revenue has been derived from fees earned from these relationships.
We cannot assure you that our joint venture and separate account management relationships with CalSTRS will continue, and, if they do not, we may not be able to replace these relationships with other strategic alliances that would provide comparable revenues. Our interest in TPG/CalSTRS is subject to a buy-sell provision, which permits CalSTRS to purchase our interest in TPG/CalSTRS at any time. Under the buy-sell provision either our Operating Partnership or CalSTRS can initiate a buy-out of the other's interest at any time by delivering a notice to the other specifying a purchase price for all the joint venture's assets; the other partner then has the option to sell its joint venture interest or purchase the interest of the initiating venture partner. The purchase price is based on what each partner would receive on liquidation if the joint venture's assets were sold for the specified price and the joint venture's liabilities were paid and the remaining assets distributed to the partners. In addition, TPG Austin Partner, LLC, the entity through which we own our interest in TPG/CalSTRS Austin, LLC, is subject to a forced sale and right of first offer provision, starting on the earlier of the
third
anniversary of the date of the agreement,
September 18, 2015
, or the date on which a management committee deadlock occurs after the
first
anniversary of the date of this agreement,
September 18, 2013
, which permits either partner in TPG/CalSTRS Austin, LLC to initiate a sale of one or more of the properties and gives the other partner the right of first offer to purchase.
In addition, upon the occurrence of certain events of default by the Operating Partnership under the TPG/CalSTRS agreement or related management, development and leasing agreements, upon bankruptcy of our Operating Partnership, or upon the death or disability of either James A. Thomas, our Chairman, President and CEO, or John R. Sischo, our Co-Chief Operating Officer, or the failure of either of them to devote the necessary time to perform their duties (unless replaced by an individual approved by CalSTRS) (each, a “Buyout Default”), CalSTRS may elect to purchase our membership interest based on a three percent discount to the appraised fair market value at the time of the Buyout Default.
Upon the occurrence of certain events of default by TPG Austin Partner, LLC, under the TPG/CalSTRS Austin, LLC agreement or by the Operating Partnership under related management, development and leasing agreements, upon bankruptcy of our Operating Partnership, or the Company's senior executive team's failure to devote the time required to perform the duties of the manager under the TPG/CalSTRS Austin, LLC agreement (each, a “TPG/CalSTRS Austin, LLC Buyout Default”), CalSTRS may elect to purchase our membership interest based on a three percent discount to the appraised fair market value at the time of the TPG/CalSTRS Austin, LLC Buyout Default.
The TPG/CalSTRS agreement also prohibits any transfer of securities of the Company or limited partnership units in our Operating Partnership that would result in Mr. Thomas, his immediate family and any entities controlled thereby beneficially owning less than
30%
of our securities entitled to vote for the election of directors; provided, that in connection with the issuance of additional Company shares in one or more public offerings, Mr. Thomas, his immediate family and controlled entities may reduce their collective beneficial ownership interest to no less than
10%
of the total common shares and Operating Partnership units and no less than
15.0 million
shares and Operating Partnership units on a collective basis. There is no comparable requirement in the TPG/CalSTRS Austin, LLC agreement. On
May 29, 2012
, the Company entered into a Common Stock Purchase Agreement, a Stockholders Agreement and a Registration Rights Agreement with affiliates of Madison International Realty (“Madison Agreements”). We issued
8,695,653
shares of our common stock to the Madison affiliates in a non-public transaction. Pursuant to the Madison Agreements, during a lock-up period that generally expires with respect to all of such shares in
June 2015
, Mr. Thomas controls the voting of the shares issued to Madison's affiliates and, therefore, presently has beneficial ownership of more than
40%
of our securities entitled to vote for the election of directors. If Mr. Thomas does not acquire beneficial ownership of additional shares of our common stock prior to expiration or earlier termination of such lock-up period or the TPG/CalSTRS agreement is not otherwise amended prior thereto, the termination of the voting control by Mr. Thomas of the shares of common stock issued pursuant to the Madison Agreements may result in a Buyout Default under the TPG/CalSTRS agreement at the final expiration of such lock-up period.
Most of our fee arrangements under our separate account relationship with CalSTRS are terminable on
30
days' notice. Termination of either our joint venture or separate account relationship with CalSTRS would adversely affect our revenue and profitability and our ability to achieve our business plan by reducing our fee income and access to co-investment capital to acquire additional properties.
Our joint venture investments may be adversely affected by our lack of control or input on decisions or shared decision-making authority or disputes with our co-venturers.
Many of our operating properties are owned through a joint venture or partnership with other parties. As a result, we do not exercise sole decision-making authority regarding such joint venture properties, including with respect to cash distributions or the sale of such properties. Furthermore, we may co-invest in the future through other partnerships, joint ventures or other entities, acquiring non-controlling interests or sharing responsibility for managing the affairs of a property, partnership or joint venture. Investments in partnerships, joint ventures, funds or other entities may, under certain circumstances, involve risks, including partners who may have economic or other business interests or goals which are inconsistent with our business interests or goals and may be in a position to take actions contrary to our policies or objectives. These investments may also have the risk of impasses on significant decisions, because neither we nor our partner or co-venturer would have full control over the partnership or joint venture. Future disputes between us and our partners or co-venturers may result in litigation or arbitration that would increase our expenses and prevent our officers and/or directors from focusing their full time and effort on our business. In addition, under the principles of agency and partnership law, we may in certain circumstances be liable for the actions of our third-party partners or co-venturers, such as if a partner or co-venturer became bankrupt and defaulted on its reimbursement and contribution obligations to us, subjecting the property owned by the partnership or joint venture to liabilities in excess of those contemplated by the partnership or joint venture agreement, or incurred debts or liabilities on behalf of the partnership or joint venture in excess of the authority granted by the partnership or joint venture agreement. In some joint ventures or other investments we make, if the entity in which we invest is a limited partnership, we have acquired and may acquire in the future all or a portion of our interest in such partnership as a general partner. In such event, we may be liable for all the liabilities of the partnership, although we attempt to limit such liability to our investment in such partnership by investing through a subsidiary.
Our joint venture partners have rights under our joint venture agreements that could adversely affect us.
As of
September 30, 2012
, we held interests in
six
of our properties through TPG/CalSTRS, and
eight
of our properties through TPG Austin Partner, LLC, in turn as a member of TPG/CalSTRS Austin LLC. TPG/CalSTRS requires a unanimous vote of its management committee on certain major decisions, including approval of annual business plans and budgets, financings and refinancings, and additional capital calls not in compliance with an approved annual plan. The management committee currently consists of
two
members appointed by CalSTRS and
one
member appointed by the Operating Partnership. All other decisions, including sales of properties, are made based upon a majority decision of the management committee. Thus CalSTRS has the ability to control certain decisions for TPG/CalSTRS that may result in an outcome contrary to our interests. The Operating Partnership has the responsibility and authority to carry out day to day management of TPG/CalSTRS and to implement the annual plans approved by the management committee. In addition to CalSTRS' ability to control certain decisions relating to TPG/CalSTRS, our agreement with CalSTRS includes provisions negotiated for the benefit of CalSTRS that could adversely affect us. Unless otherwise determined by the management committee of TPG/CalSTRS, we are required to use diligent efforts to sell each joint venture property generally within
five
years of that property reaching stabilization, except that the holding period for Reflections I and Reflections II will be separately determined by the management committee. With respect to these
two
properties, we are required to perform a hold/sell analysis at least annually, and make a recommendation to the management committee regarding the appropriate holding period. We have a right of first offer to purchase a TPG/CalSTRS property upon a required sale at a price we propose, and if CalSTRS accepts our offer we must close within
90
days. If we do not exercise the right of first offer and we subsequently fail to effect a sale by the end of the specified holding period, CalSTRS has the right to assume control of the sale process. This may require us to sell one or more of our assets at an inopportune time, or for prices that are lower than could be achieved if we had more flexibility in the timing for effecting sales.
TPG/CalSTRS Austin, LLC requires a unanimous vote of its management committee on certain major decisions, including approval of the holding period, annual business plans and budgets, financings and refinancings, and additional capital calls not in compliance with an approved annual plan. The management committee currently consists of
two
members appointed by CalSTRS and
two
members appointed by the Operating Partnership. All other decisions are made based upon a majority decision of the management committee. Through its position as managing member of TPG Austin Partner, LLC, the Operating Partnership has the responsibility and authority to carry out day to day management of TPG/CalSTRS Austin, LLC and to implement the annual plans approved by the management committee. In addition, our interest is subject to a forced sale and right of first offer provision, starting on the earlier of the
third
anniversary of the date of the agreement,
September 18, 2015
, or the date on which a management committee deadlock occurs after the
first
anniversary of the date of the agreement,
September 18, 2013
, or on an event of default or if
three
or more of the Company's senior executives, at the same time, are unable to perform duties for
two
or more months due to death, disability or departure (unless a replacement is reasonably approved by CalSTRS) which permits either partner to initiate a sale of one or more of the properties, and gives the other partner the right of first offer to purchase. This may require us to sell one or more of the Austin assets at an inopportune time, or for prices that are lower than could be achieved if we had more flexibility in the timing for effecting sales.
TPG Austin Partner, LLC has two members, Madison and the Operating Partnership. The agreement permits Madison to require the sale of its direct interest in the limited liability company, subject to a right of first offer in favor of the Operating Partnership. In addition, Madison has a put right, on the earliest of (i)
January 1, 2007
, (ii) a TPG Change of Control (as defined in the LLC agreement), (iii) the removal of TPG Austin Partner, LLC as manager of TPG/CalSTRS Austin, LLC, or (iv) the exercise by CalSTRS of any of its rights pursuant to the TPG/CalSTRS Austin, LLC agreement, to require the Operating Partnership to purchase all of Madison's ownership interest for a purchase price equal to the put price, which is based on fair market value.
In
November 2010
, our subsidiaries entered into amended and restated partnership agreements and contribution agreements with Brandywine, with respect to our One Commerce Square and Two Commerce Square buildings in Philadelphia, Pennsylvania. Brandywine contributed capital, and committed to additional capital contributions to the existing owners of the buildings, in return for a
25%
limited partnership interest in each building. Our wholly-owned subsidiaries are the general partners of the Commerce Square partnerships, with authority to manage and carry out the day to day business of the partnerships, subject only to approval by Brandywine of certain specified major decisions, including approval of certain capital budgets, leasing budgets and leasing guidelines, financing or refinancing of each building, and certain major leases. We retained sole approval over the operating budgets and other decisions that are not major decisions. Brandywine has the right to purchase all of the Company's interest in each of the buildings subject to the retention of a nominal interest by the Company with an allocation of mortgage debt for a minimum of five years, which right is exercisable between
October 31, 2016
and
April 30, 2017
. The exercise of such call right triggers certain rights and obligations of the Company, including the right to elect to market our interests in the buildings to third parties to achieve a price for our interests that we deem to be acceptable. If the Company deems a third party bid for our interests to be acceptable, then under certain conditions Brandywine will have a right of first refusal to purchase our interests for the same price and terms offered by the third party. If Brandywine does not exercise, or does not have, such right of first refusal, and if we elect to sell our interests in Commerce Square to a third party, Brandywine has a right to “piggyback” on such sale and sell its interests in Commerce Square to the third party on the same terms. We retain, as general partner, the right to sell the Commerce Square buildings at any time, but Brandywine has certain rights to acquire our interests in Commerce Square in lieu of such a sale of the buildings to a third party, as long as we receive the same amount we would have received on a sale to a third party. Finally, on or after the 10
th
anniversary of the admission of Brandywine as a partner, either the Company or Brandywine may elect to cause the sale of the Commerce Square buildings and dissolve the partnerships, which will give the other party the right to trigger a buy-sell procedure for the purchase of the electing partner's interest in the partnerships.
We may not receive funding from our joint venture partners in connection with proposed acquisitions, which could adversely affect our growth.
We have entered into, and may enter into in the future, certain joint venture acquisition arrangements with third parties in which we identify potential acquisition properties on behalf of the joint venture, and a portion (in some cases, a substantial portion) of the capital required for each project would be funded by our joint venture partners. Although our joint venture partners have committed to fund property acquisitions, such joint venture partners may decide not to fund a particular or any potential acquisition properties for any number of reasons, including such entities may not have the capital necessary to fund projects at the time of the proposed acquisition. Accordingly, if we identify potential acquisition opportunities in the future for these programs, we may not receive approval and/or funding from joint venture partners, notwithstanding any prior commitments for funding.
We depend on significant tenants, and their failure to pay rent could seriously harm our operating results and financial condition.
As of
September 30, 2012
, the
20
largest tenants for properties in which we held an ownership interest collectively leased
37.1%
of the rentable square feet of space at properties in which we hold an ownership interest, representing
41.5%
of the total annualized rent generated by these properties.
Any of our tenants may experience a downturn in its business, which may weaken such tenant's financial condition. As a result, tenants may delay lease commencement, fail to make rental payments when due, decline to extend a lease upon its expiration, become insolvent, declare bankruptcy or default under their leases. Certain of our tenants also have termination rights under their leases with us, which they might choose to exercise if they experience a downturn in their business. In addition, current economic and market conditions increase the possibility that one or more of our tenants will become insolvent. Any tenant bankruptcy or insolvency, leasing delay, failure to make rental payments when due, or default under a lease could result in the termination of the tenant's lease and material losses to our Company.
In particular, if a significant tenant becomes insolvent, suffers a downturn in its business and decides not to renew its lease or vacates a property, it may seriously harm our business. Failure on the part of a tenant to comply with the terms of a lease may give us the right to terminate the lease, repossess the applicable property and enforce the payment obligations under
the lease. In those circumstances, we would be required to find another tenant. We cannot assure you that we would be able to find another tenant without incurring substantial costs, or at all, or that if another tenant were found, we would be able to enter into a new lease on favorable terms to us or at the same rental rates.
Bankruptcy filings by or relating to one of our tenants could bar us from collecting pre-bankruptcy debts from that tenant or their property. A tenant bankruptcy would delay our efforts to collect past due balances under the relevant leases, and could ultimately preclude full collection of these amounts. If a lease is assumed by the tenant in bankruptcy, all pre-bankruptcy amounts due under the lease must be paid to us in full. However, if a lease is rejected by a tenant in bankruptcy, we would have only a general unsecured claim for damages. Any unsecured claim we hold against a bankrupt entity may be paid only to the extent that funds are available and only in the same percentage as is paid to all other holders of unsecured claims. We may recover substantially less than the full value of any unsecured claim in the event of the bankruptcy of a large tenant, which could adversely impact our financial condition.
Our operating results depend upon the regional economies in which our properties are located and the demand for office and other mixed-use space, and unique or disproportionate economic downturns or adverse regulatory or taxation policies in any of these regions could harm our operating results.
Our operating and development properties are located in three geographic regions of the United States: the West Coast, Southwest and Mid-Atlantic regions. Historically, the largest part of our revenues has been derived from our ownership and management of properties consisting primarily of office buildings.
A decrease in the demand for office space in these geographic regions, and for Class A office space in particular, may have a greater adverse effect on our business and financial condition than if we owned a more diversified real estate portfolio. We are also susceptible to disproportionate or unique adverse developments in these regions and in the national office market generally, such as business layoffs or downsizing, industry slowdowns, relocations of businesses, changing demographics, terrorist targeting of high-rise structures, infrastructure quality, increases in real estate and other taxes, costs of complying with government regulations or increased regulation, oversupply of or reduced demand for office space, and other factors. Some of the regional issues we face include the more highly regulated and taxed economy of Southern California and high local and municipal taxes for our Philadelphia properties. Any adverse economic or real estate developments in one or more of our regions, or any decrease in demand for office space resulting from the local regulatory environment, business climate or energy or fiscal problems, could adversely impact our revenue and profitability, thereby causing a significant decline in our financial condition, results of operations, cash flow, the trading price of our common stock and impairing our ability to satisfy our debt service obligations.
Our need for additional debt financing, our existing level of debt and the limitations imposed by our debt agreements could have significant adverse consequences on us.
We may seek to incur additional debt to finance future acquisition and development activities; however debt financing may not be available to us on acceptable terms under current market conditions. In addition, it is possible the required payments of principal and interest on borrowings may leave us with insufficient cash to operate our properties profitably. Our need for debt financing, our existing level of debt and the limitations imposed on us by our debt agreements could have significant adverse consequences, including the following:
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our cash flow may be insufficient to meet our required principal and interest payments or to pay dividends;
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we may be unable to borrow additional funds as needed or on favorable terms;
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we may be unable to refinance our indebtedness at maturity or the refinancing terms may be less favorable than the terms of our original indebtedness;
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we may be unable to distribute funds from a property to our Operating Partnership or apply such funds to cover expenses related to another property;
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we could be required to dispose of one or more of our properties, possibly on disadvantageous terms and/or at disadvantageous times;
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we could default on our obligations and the lenders or mortgagees may foreclose on our properties that secure their loans and receive an assignment of rents and leases;
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we could violate covenants in our loan documents or our joint venture agreements, including provisions that may limit our ability to further mortgage a property, make distributions, acquire additional properties, repay indebtedness prior to a set date without payment of a premium or other pre-payment penalties, all of which would entitle the lenders to accelerate our debt obligations;
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because we have agreed to use commercially reasonable efforts to maintain certain debt levels to provide the ability
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for Mr. Thomas and entities controlled by him to guarantee debt of
$210 million
, including
$3 million
of debt available for guarantee by Mr. Richard Gilchrist, an individual formerly affiliated with Maguire Thomas Partners, we may not be able to refinance our debt when it would otherwise be advantageous to do so or to reduce our indebtedness when our board of directors determines it is prudent.
If any one or more of these events were to occur, our revenue and profitability could be adversely impacted, causing a significant downturn in our financial condition, results of operations, cash flow, and the trading price of our common stock, and could impair our ability to satisfy our debt service obligations.
We may be unable to complete acquisitions necessary to grow our business, and even if consummated, we may fail to successfully operate these acquired properties.
Our planned growth strategy includes the acquisition of additional properties as opportunities arise with a focus in the western region of the United States. We regularly evaluate approximately
10
markets in the United States for strategic opportunities to acquire office, mixed-use and other properties. Our ability to acquire properties on favorable terms and successfully operate them is subject to the following significant risks:
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we may be unable to generate sufficient cash from operations, or obtain the necessary debt or equity to consummate an acquisition or, if obtainable, such financing may not be on favorable terms;
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we may need to spend more than budgeted amounts to make necessary improvements or renovations to acquired properties;
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we may be unable to acquire a desired property because of competition from other real estate investors with more available capital, including other real estate operating companies, real estate investment trusts and investment funds;
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competition from other potential acquirers may significantly increase the purchase price, even if we are able to acquire a desired property;
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agreements for the acquisition of office properties are typically subject to customary conditions to closing, including satisfactory completion of due diligence investigations, and we may spend significant time and money on a potential acquisition we eventually decide not to pursue;
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we may be unable to quickly and efficiently integrate new acquisitions, particularly acquisitions of portfolios of properties, into our existing operations;
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market conditions may result in higher than expected vacancy rates and lower than expected rental rates; and
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we may acquire properties subject to liabilities without any recourse, or with only limited recourse, for unknown liabilities such as clean-up of undisclosed environmental contamination, claims by tenants, vendors or other persons dealing with the former owners of the properties and claims for indemnification by general partners, directors, officers and others indemnified by the former owners of the properties.
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If we cannot complete property acquisitions on favorable terms or at all, or operate acquired properties to meet our expectations, our revenue and profitability could be adversely impacted.
Any real estate acquisitions that we consummate may result in disruptions to our business as a result of the burden of integrating operations placed on our management.
Our business strategy includes acquisitions and investments in real estate on an ongoing basis as market conditions warrant. These acquisitions may cause disruptions in our operations and divert management's attention from our other day-to-day operations, which could impair our relationships with our current tenants and employees. If we acquire real estate by acquiring another entity, we may be unable to effectively integrate the operations and personnel of the acquired business. In addition, we may be unable to train, retain and motivate any key personnel from the acquired business. If our management is unable to effectively implement our acquisition strategy, we may experience disruptions to our business, which could harm our results of operations.
We may be unable to successfully complete and operate properties under development, which would impair our financial condition and operating results.
Part of our business is devoted to the development of office, mixed-use and other properties, and the redevelopment of core plus and value-add properties. Our development and redevelopment activities involve the following significant risks:
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we may be unable to obtain financing on favorable terms or at all;
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if we finance projects through construction loans, we may be unable to obtain permanent financing at all or on advantageous terms;
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we may not complete projects on schedule or within budgeted amounts;
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we may underestimate the expected costs and time necessary to achieve the desired result with a redevelopment project;
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we may discover structural, environmental or other feasibility issues with properties acquired as redevelopment projects following our acquisition, which may render the redevelopment as planned not possible;
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we may encounter delays or refusals in obtaining all necessary zoning, land use, building, occupancy, and other required governmental permits and authorizations;
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occupancy rates and rents may fluctuate depending on a number of factors, including market and economic conditions, and may result in our investment not being profitable;
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adverse weather that damages the project or causes delays;
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unanticipated changes to the plans or specifications;
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unanticipated shortages of materials and skilled labor;
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unanticipated increases in material and labor costs; and
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fire, flooding and other natural disasters.
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If we are not successful in our property development and redevelopment initiatives, it could adversely impact our financial condition, results of operations, and the trading price of our common stock.
We face significant competition, which may decrease or prevent increases of the occupancy and rental rates of our properties.
We face significant competition from other managers and owners of office and mixed-use real estate, many of which own or manage properties similar to ours in the same regional markets in which our properties are located. We also compete with other diversified real estate companies and companies focused solely on offering property investment management and brokerage services. A number of our competitors are larger and better able to take advantage of efficiencies created by size, have better financial resources, or increased access to capital at lower costs, and may be better known in regional markets in which we compete. Our smaller size as compared to some of our competition may increase our susceptibility to economic downturns and pressures on rents. Our failure to compete successfully in our industry would materially affect our business prospects and operating results.
We may be unable to renew leases, lease vacant space or re-lease space as leases expire resulting in increased vacancy rates, lower revenue and an adverse effect on our operating results.
As of
September 30, 2012
, leases representing
2.8%
and
5.6%
of the rentable square feet of the office and retail space of our consolidated and unconsolidated properties will expire in 2012 and 2013, respectively. Further, an additional
14.4%
of the square feet of these properties was available for lease as of
September 30, 2012
. Current economic conditions have resulted in depressed leasing activity recently in certain markets as a result of tenant unwillingness to make long term leasing commitments, and it is unclear how long this market condition may continue. If the rental rates for our properties decrease, our existing tenants do not renew their leases or we do not re-lease a significant portion of our available space and space for which leases will expire, our revenue and profitability could be adversely impacted, causing a significant downturn in our financial condition, results of operations, cash flow, and the trading price of our common stock and impairing our ability to satisfy our debt service obligations.
Our growth depends on external sources of capital, some of which are outside of our control. If we are unable to access capital from external sources, we may not be able to implement our business strategy.
Our business strategy requires us to rely significantly on third-party sources to fund our capital needs. We may not be able to obtain debt or equity on favorable terms or at all. Any additional debt we incur will increase our leverage and may impose operating restrictions on us. Any issuance of equity by our Company to fund our portion of equity capital requirements could be dilutive to our existing stockholders, and could have a negative impact on our stock price. Our access to third-party sources of capital depends, in part, on:
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our current debt levels, which were
$285.0 million
of consolidated debt and
$1.4 billion
of unconsolidated debt, of which our share was
$344.8 million
as of
September 30, 2012
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our ability to generate consistent cash flow from operating activities, which resulted in a net use of cash of
$1.7
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for the
nine months ended September 30, 2012
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our current and expected future earnings;
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the market's perception of our growth potential;
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the market price of our common stock;
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the perception of the value of an investment in our common stock; and
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general market conditions.
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If we cannot obtain capital from third-party sources when needed, we may not be able to acquire or develop properties when strategic opportunities exist, or to repay existing debt as it matures.
As a result of the limited time which we have to perform due diligence of many of our acquired properties, we may become subject to significant unexpected liabilities and our properties may not meet projections.
When we enter into an agreement to acquire a property or portfolio of properties, we often have limited time to complete our due diligence prior to acquiring the property. To the extent we underestimate or fail to investigate or identify risks and liabilities associated with the properties we acquire, we may incur unexpected liabilities or the properties may fail to perform as we expected. If we do not accurately assess the liabilities associated with properties prior to their acquisition, we may pay a purchase price that exceeds the current fair value of the net identifiable assets of the acquired property. As a result, intangible assets would be required to be recorded, which could result in significant accounting charges in future periods. These charges, in addition to the financial impact of significant liabilities that we may assume, and any failure of properties to perform as expected, could adversely impact our revenue and profitability, causing a significant downturn in our financial condition, results of operations and the trading price of our common stock and impairing our ability to satisfy our debt service obligations.
As the current or previous owner or operator of real property, we could become subject to liability for environmental contamination, regardless of whether we caused such contamination.
Under various federal, state and local environmental laws, regulations and ordinances, a current or previous owner or operator (e.g., tenant or manager) of real property may be liable for the cost to remove or remediate contamination resulting from the presence or discharge of hazardous or toxic substances, wastes or petroleum products on, under, from or in such property. These costs could be substantial and liability under these laws may attach without regard to fault, or whether the owner or operator knew of, or was responsible for, the presence of the contamination. The liability may be joint and several for the full amount of the investigation, clean-up and monitoring costs incurred or to be incurred or actions to be undertaken, although a party held jointly and severally liable may obtain contributions from other identified, solvent, responsible parties of their fair share toward these costs to the extent such contributions are possible to obtain. In addition, the current or previous owner or operator of property may be subject to damage awards for personal injury or property damage resulting from contamination at or migrating from its property. Previous owners used some of our properties for industrial and retail purposes, so those properties may contain some level of environmental contamination. In addition, the presence of contamination, or the failure to properly remediate contamination on a property may limit the ability of the owner or operator to sell, develop or rent that property or to borrow using the property as collateral, and may cause our investment in that property to decline in value.
As the owner of real property, we could become subject to liability for asbestos-containing building materials in the buildings on our property.
Some of our properties may contain asbestos-containing materials. Environmental laws require that owners or operators of buildings with asbestos-containing building materials properly manage and maintain these materials, adequately inform or train those who may come into contact with asbestos and undertake special precautions, including removal or other abatement, in the event that asbestos is disturbed during building renovation or demolition. These laws may impose fines and penalties on building owners or operators for failure to comply with these requirements. In addition, these laws may also allow third parties to seek recovery from owners or operators for personal injury associated with exposure to asbestos-containing building materials.
Our properties may contain or develop harmful mold or suffer from other adverse conditions, which could lead to liability for adverse health effects and costs of remediation.
When excessive moisture accumulates in buildings or on building materials, mold growth may occur, particularly if the moisture problem remains undiscovered or is not addressed over a period of time. Some molds may produce airborne toxins or irritants. Indoor air quality issues can also stem from inadequate ventilation, chemical contamination from indoor or outdoor
sources and other biological contaminants such as pollen, viruses and bacteria. Indoor exposure to airborne toxins or irritants above certain levels can be alleged to cause a variety of adverse health effects and symptoms, including allergic or other reactions. As a result, the presence of significant mold or other airborne contaminants at any of our properties could require us to undertake a costly remediation program to contain or remove the mold or other airborne contaminants from the affected property or increase indoor ventilation. In addition, the presence of significant mold or other airborne contaminants could expose us to liability from our tenants, employees of our tenants and others if property damage or health concerns arise.
As the owner of real property, we could become subject to liability for failure to comply with environmental requirements regarding the handling and disposal of regulated substances and wastes or for non-compliance with health and safety requirements.
Environmental laws and regulations regarding the handling of regulated substances and wastes apply to our properties. The properties in our portfolio are also subject to various federal, state and local health and safety requirements, such as state and local fire requirements. If we or our tenants fail to comply with these various requirements, we might incur governmental fines or private damage awards. Moreover, we do not know whether existing requirements will change or whether future requirements will require us to make significant unanticipated expenditures that will materially adversely impact our financial condition, results of operations, cash flow, cash available for distribution, the per share trading price of our common stock and our ability to satisfy our debt service obligations. Environmental noncompliance liability could also affect a tenant's ability to make rental payments to us.
Tax indemnification obligations that may arise in the event we or our Operating Partnership sell an interest in either of two of our properties could limit our operating flexibility.
We and our Operating Partnership agreed at the time of our initial public offering in 2004 to indemnify Mr. Thomas against adverse direct and indirect tax consequences in the event that our Operating Partnership or the underlying property owner directly or indirectly sells, exchanges or otherwise disposes (including by way of merger, sale of assets or otherwise) of any portion of its interests, in a taxable transaction, in either One Commerce Square or Two Commerce Square. These
two
properties represented
16.3%
of annualized rent for properties in which we held an ownership interest as of
September 30, 2012
. The indemnification obligation currently expires
October 13, 2013
, which may be further extended to
October 13, 2016
provided Mr. Thomas and his controlled entities collectively retain at least
50%
of the Operating Partnership units received by them in connection with our formation transactions at the time of our initial public offering.
We agreed at the time of the initial public offering to use commercially reasonable efforts to make an aggregate of approximately
$210 million
of debt available to be guaranteed by entities controlled by Mr. Thomas. Of this debt,
$3 million
is available for guarantee by Mr. Gilchrist, an individual formerly affiliated with Maguire Thomas Partners. We agreed to make this debt available for guarantee in order to assist Mr. Thomas and Mr. Gilchrist in preserving their respective tax positions after their contributions at the time of our initial public offering.
The current economic environment for real estate companies may significantly adversely impact our results of operations and business prospects.
The success of our business and profitability of our operations are dependent on continued investment in the real estate markets and access to capital and debt financing. A long term crisis of confidence in real estate investing and lack of available credit for acquisitions would be likely to constrain our business growth. As part of our business goals, we intend to grow our properties portfolio with strategic acquisitions of core properties at advantageous prices, and core plus and value added properties where we believe we can bring necessary expertise to bear to increase property values. In order to pursue acquisitions, we need access to equity capital and also property-level debt financing. Conditions in the financial markets may adversely impact the availability and cost of credit in the near future. Our ability to make scheduled payments or to refinance our obligations with respect to indebtedness depends on our operating and financial performance, which in turn is subject to prevailing economic conditions.
Illiquidity of real estate investments and the susceptibility of the real estate industry to economic conditions could significantly impede our ability to respond to adverse changes in the performance of our properties.
Our ability to achieve desired and projected results for growth of our business depends on our ability to generate revenues in excess of expenses, and make scheduled principal payments on debt and fund capital expenditure requirements. Events and conditions generally applicable to owners and operators of real property that are beyond our control may adversely impact our results of operations and the value of our properties. These events include:
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vacancies or our inability to rent space on favorable terms;
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inability to collect rent from tenants;
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difficulty in accessing credit in the present economic environment, in particular for larger mortgage loans;
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inability to finance property development and acquisitions on favorable terms;
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increased operating costs, including real estate taxes, insurance premiums and utilities;
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local oversupply, increased competition or reduction in demand for office space;
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fluctuating condominium prices and absorption rates;
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costs of complying with changes in governmental regulations;
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the relative illiquidity of real estate investments;
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changing submarket demographics; and
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the significant transaction costs related to property sales.
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In addition, periods of economic slowdown or recession, rising interest rates or declining demand for real estate, or the public perception that any of these events may occur, could result in a general decline in rents or an increased incidence of defaults under existing leases. If any of these events were to happen, our revenue and profitability could be impaired, causing a significant downturn in our financial condition, results of operations, cash flow, and the trading price of our common stock, and our ability to satisfy our debt service obligations could be impaired.
Compliance with the Americans with Disabilities Act and fire, safety and other regulations may require us to make unintended expenditures that adversely impact our financial condition.
All of our commercial properties are required to comply with the Americans with Disabilities Act, or ADA. The ADA has separate compliance requirements for “public accommodations” and “commercial facilities,” but generally requires that buildings be made accessible to people with disabilities. The obligation to make readily achievable accommodations is an ongoing one, and we assess our properties and make alterations as appropriate. Compliance with the ADA requirements could require removal of access barriers.
If one or more of our properties is not in compliance with the ADA, we would be required to incur additional costs to bring the property or properties into compliance. In addition, non-compliance could result in imposition of fines by the U.S. government or an award of damages to private litigants, or both. Typically, we are responsible for changes to a building structure that are required by the ADA, which can be costly. In addition, we are required to operate our properties in compliance with fire and safety regulations, building codes and other land use regulations. We may be required to make substantial capital expenditures to comply with these requirements thereby limiting the funds available to operate, develop and redevelop our properties and acquire additional properties. As a result, these expenditures could negatively impact our revenue and profitability.
Potential losses to our properties may not be covered by insurance and may result in our inability to repair damaged properties; as a result we could lose invested capital.
We carry comprehensive liability, fire, flood, extended coverage, wind, earthquake, terrorism, pollution legal liability, business interruption and rental loss insurance under policies covering all of the properties in which we own an interest in or manage for third parties, including our development properties (although we carry only liability insurance for the California Environmental Protection Agency (“CalEPA”) headquarters building because the tenant has the right to provide all other forms of coverage it deems necessary, and it has elected to do so, and we do not insure 816 Congress and Austin Centre because the third party owner has elected to insure those properties under its policy). We believe the policy specifications and insured limits are appropriate and adequate given the relative risk of loss, the cost of the coverage and industry practice.
We either own or manage two properties in Southern California, an area especially prone to earthquakes. We carry earthquake insurance on our properties located in seismically active areas, which includes our Southern California properties, wind insurance on our properties located in “tier 1” wind zones, which includes our Houston, Texas properties, and terrorism insurance on all of our properties. Our terrorism insurance is subject to exclusions for loss or damage caused by nuclear substances, pollutants, contaminants, and biological and chemical weapons as more specifically excluded under the actual terrorism policies. Some of our policies, like those covering losses due to earthquakes and terrorism, are subject to limitations involving deductibles and policy limits which may not be sufficient to cover potential losses.
Under their leases, our tenants are generally required to indemnify us against liabilities resulting from injury to persons, air, water, land or property, on or off the premises due to activities conducted by them on our properties. There is generally an exception for claims arising from the negligence or intentional misconduct by us or our agents. Additionally, tenants are generally required, with the exception of governmental entities and other entities that are self-insured, to obtain at their own
expense and keep in force during the term of the lease both liability and property damage insurance policies issued by companies holding ratings at a minimum level at their own expense.
Although we have not experienced such a loss to date, if we experience a loss that is uninsured or that exceeds policy limits, we could lose the capital invested in the damaged property as well as the anticipated future cash flows from that property, including lost revenue from unpaid rent from tenants. In addition, if the damaged property is subject to recourse indebtedness, we would continue to be liable for the indebtedness, even if the property was irreparably damaged. In the event of a significant loss at one or more of the properties covered by our policies, the remaining insurance under the policy, if any, could be insufficient to adequately insure our remaining properties. In this event, securing additional insurance, if possible, could be significantly more expensive than our current policy.
Risks Related to Our Organization and Structure
Our senior management has existing conflicts of interest with us and our public stockholders that could result in decisions adverse to our Company.
In addition to the common stock owned by Mr. Thomas as of
September 30, 2012
, he owned or controlled a significant interest in our Operating Partnership consisting of
12,313,331
units, or a
21%
interest in the Operating Partnership as of such date. In addition, our senior executive officers, excluding Mr. Thomas, collectively held an interest in incentive units (vested and unvested) representing an aggregate
2.8%
equity interest in the Operating Partnership.
Members of senior management could make decisions that could have different implications for our Operating Partnership and for us, our stockholders, and our senior executive officers. For example, dispositions of interests in One Commerce Square or Two Commerce Square could trigger our tax indemnification obligations with respect to Mr. Thomas.
We have a holding company structure and rely upon funds received from our Operating Partnership to pay liabilities.
We are a holding company. Our primary asset is our general partnership interest in our Operating Partnership. We have no independent means of generating revenues. To the extent we require funds to pay taxes or other liabilities incurred by us, to pay dividends or for any other purpose, we must rely on funds received from our Operating Partnership. If our Operating Partnership should become unable to distribute funds to us, we would be unable to continue operations after a short period. Most of the properties owned by our subsidiaries and joint ventures are encumbered by loans. These loans generally contain lockbox arrangements and reserve requirements that may affect the amount of cash available for distribution from the subsidiaries that own the properties to the Operating Partnership. Some of the loans include cash sweep and other restrictions and provisions that prior to an event of default may prevent the distribution of funds from the subsidiaries who own these properties to our Operating Partnership. In the event of a default under any of these loans, the defaulting subsidiary or joint venture would be prohibited from distributing cash to our Operating Partnership. As a result, our Operating Partnership may be unable to distribute funds to us and we may be unable to use funds from one property to support the operation of another property. As we acquire new properties and refinance our existing properties, we may finance these properties with new loans that contain similar provisions. Some of the loans to our subsidiaries and joint ventures may contain provisions that restrict us from loaning funds to our other subsidiaries or joint ventures. If we are permitted to loan funds to our subsidiaries or joint ventures, our loans generally will be subordinated to the existing debt on our properties.
Mr. Thomas has a significant vote in certain matters as a result of his control of
100%
of our limited voting stock.
Each entity that received Operating Partnership units in our formation transactions received shares of our limited voting stock that are paired with units in our Operating Partnership on a one-for-one basis. All of these entities are directly or indirectly controlled by Mr. Thomas, and, as a result, Mr. Thomas controls
100%
of our outstanding limited voting stock, and
42.0%
of our outstanding voting stock (including outstanding shares of common stock owned by Mr. Thomas and his affiliates as well as
8,695,653
shares owned by Madison and subject to a lock-up period which generally expires with respect to all of such Madison shares in June 2015) as of
September 30, 2012
. The limited voting shares are entitled to vote in the election of directors, for the approval of certain extraordinary transactions including any merger, sale or liquidation of the Company, amendments to our certificate of incorporation and any other matter required to be submitted to a separate class vote under Delaware law. Mr. Thomas may have interests that differ from that of our public stockholders, including by reason of his interests held in Operating Partnership units, and may accordingly vote as a stockholder in ways that may not be consistent with the interests of our public stockholders. This significant voting influence over certain matters may have the effect of delaying, preventing or deterring a change of control of our Company, or could deprive our stockholders of an opportunity to receive a premium for their common stock as part of a sale of our Company. Pursuant to the Madison Agreements, subject to certain exceptions, during the period from the
sixth
anniversary of the issuance of shares to Madison's affiliates until the
ninth
anniversary of such date, Mr. Thomas has agreed to vote (and to cause his affiliated entities to vote) all of his controlled group's shares of common stock and limited voting stock in a manner that is in direct proportion to the manner in which other holders
of the common stock vote on a proposed company sale transaction. This vote neutralization provision will not apply, however, if Madison's affiliates no longer beneficially own at least
10%
of the our total voting securities or if the volume-weighted average price of our common stock is at least
$12.50
per share during the six month period prior to the
sixth
anniversary of the issuance of the shares to Madison's affiliates (or at least
$10.00
per share if our common stock has met certain trading volume tests).
Some provisions of our certificate of incorporation and bylaws may deter takeover attempts, which may limit the opportunity of our stockholders to sell their shares at a favorable price.
Some of the provisions of our certificate of incorporation and bylaws could make it more difficult for a third party to acquire us, even if doing so might be beneficial to our stockholders by potentially providing them with the opportunity to sell their shares at a premium over the then market price. Our certificate of incorporation and bylaws contain provisions which may deter takeover attempts, including the following:
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vacancies on our board of directors may only be filled by the remaining directors;
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only the board of directors can change the number of directors;
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there is no provision for cumulative voting for directors;
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directors may only be removed for cause; and
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our stockholders are not permitted to act by written consent.
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In addition, our certificate of incorporation authorizes the board of directors to issue up to
25,000,000
shares of preferred stock. The preferred stock may be issued in one or more series, the terms of which will be determined at the time of issuance by our board of directors without further action by our stockholders. These terms may include voting rights, including the right to vote as a series on particular matters, preferences as to dividends and liquidation, conversion rights, redemption rights and sinking fund provisions. The issuance of any preferred stock could diminish the rights of holders of our common stock, and therefore could reduce the value of our common stock. In addition, specific rights granted to future holders of preferred stock could be used to restrict our ability to merge with, or sell assets to, a third party. The ability of our board of directors to issue preferred stock could make it more difficult, delay, discourage, prevent or make it more costly to acquire or effect a change in control, thereby preserving the current stockholders' control of our Company.
Finally, we are also subject to Section 203 of the Delaware General Corporation Law which, subject to certain exceptions, prohibits a Delaware corporation from engaging in any business combination with any "interested stockholder" for a period of three years following the date that such stockholder became an interested stockholder.
The provisions of our certificate of incorporation and bylaws, described above, as well as Section 203 of the Delaware General Corporation Law, could discourage potential acquisition proposals, delay or prevent a change of control and prevent changes in our management, even if these events would be in the best interests of our stockholders.
We could authorize and issue stock without stockholder approval, which could cause our stock price to decline and which could dilute the holdings of our existing stockholders.
Our certificate of incorporation authorizes our board of directors to issue authorized but unissued shares of our common stock or preferred stock to classify or reclassify any unissued shares of our preferred stock and to set the preferences, rights and other terms of the classified or unclassified shares. Our board of directors could establish a series of preferred stock that could, depending on the terms of the series, delay, defer or prevent a transaction or a change of control that might involve a premium price for our common stock or otherwise be in the best interests of our stockholders.
The payment of dividends on our common stock is at the discretion of our board of directors and subject to various restrictions and considerations and, consequently, may be changed or discontinued at any time.
Although we historically paid quarterly cash dividends on our common stock after our initial public offering until December 2009, and since December 2011 have resumed paying a quarterly cash dividend, the payment of cash dividends in the future, if any, will be at the discretion of our board of directors and will depend upon such factors as earnings levels, capital requirements, our overall financial condition, and any other factors deemed relevant by our board of directors. There is no guarantee that dividend payments will continue. Without dividend payments, the only opportunity to achieve a positive return on an investment in our common stock is if the market price of our common stock appreciates.
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ITEM 4.
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MINE SAFETY DISCLOSURES
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Not applicable.