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Duke Realty 10-Q 2011
10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2011

OR

 

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

For the transition period from              to             

Commission File Number: 1-9044

DUKE REALTY CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

 

Indiana   35-1740409
(State or Other Jurisdiction
of Incorporation or Organization)
  (I.R.S. Employer
Identification Number)

600 East 96th Street, Suite 100

Indianapolis, Indiana

  46240
(Address of Principal Executive Offices)   (Zip Code)

Registrant’s Telephone Number, Including Area Code: (317) 808-6000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x    No   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes  x    No  ¨

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

 

Large accelerated filer  x

  Accelerated filer  ¨

Non-accelerated filer  ¨

  Smaller reporting company  ¨
(Do not check if a smaller reporting company)  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):    YES  ¨    NO  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

 

Class

 

Outstanding at August 2, 2011

Common Stock, $.01 par value per share

  252,787,074 shares


Table of Contents

DUKE REALTY CORPORATION

INDEX

 

          Page  

Part I - Financial Information

  
Item 1.    Financial Statements   
   Consolidated Balance Sheets as of June 30, 2011 (Unaudited) and December 31, 2010      2   
   Consolidated Statements of Operations (Unaudited) for the three and six months ended June 30, 2011 and 2010      3   
   Consolidated Statements of Cash Flows (Unaudited) for the six months ended June 30, 2011 and 2010      4   
   Consolidated Statement of Changes in Equity (Unaudited) for the six months ended June 30, 2011      5   
   Notes to Consolidated Financial Statements (Unaudited)      6-15   
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      16-32   
Item 3.    Quantitative and Qualitative Disclosures About Market Risk      32-33   
Item 4.    Controls and Procedures      33   
Part II - Other Information   
Item 1.    Legal Proceedings      34   
Item 1A.    Risk Factors      34   
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds      34   
Item 3.    Defaults Upon Senior Securities      35   
Item 4.    Reserved      35   
Item 5.    Other Information      35   
Item 6.    Exhibits      35-36   


Table of Contents

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

DUKE REALTY CORPORATION AND SUBSIDIARIES

Consolidated Balance Sheets

(in thousands, except per share amounts)

 

     June 30,
2011
    December 31,
2010
 
     (Unaudited)        
ASSETS     

Real estate investments:

    

Land and improvements

   $ 1,276,820      $ 1,166,409   

Buildings and tenant improvements

     5,525,808        5,396,339   

Construction in progress

     70,424        61,205   

Investments in and advances to unconsolidated companies

     365,323        367,445   

Undeveloped land

     617,470        625,353   
  

 

 

   

 

 

 
     7,855,845        7,616,751   

Accumulated depreciation

     (1,381,919     (1,290,417
  

 

 

   

 

 

 

Net real estate investments

     6,473,926        6,326,334   

Real estate investments and other assets held-for-sale

     —          394,287   

Cash and cash equivalents

     117,645        18,384   

Accounts receivable, net of allowance of $3,802 and $2,945

     24,741        22,588   

Straight-line rent receivable, net of allowance of $7,924 and $7,260

     136,171        125,185   

Receivables on construction contracts, including retentions

     48,263        7,408   

Deferred financing costs, net of accumulated amortization of $52,844 and $46,407

     42,223        46,320   

Deferred leasing and other costs, net of accumulated amortization of $313,986 and $269,000

     497,174        517,934   

Escrow deposits and other assets

     186,942        185,836   
  

 

 

   

 

 

 
   $ 7,527,085      $ 7,644,276   
  

 

 

   

 

 

 
LIABILITIES AND EQUITY     

Indebtedness:

    

Secured debt

   $ 1,187,044      $ 1,065,628   

Unsecured notes

     2,906,154        2,948,405   

Unsecured lines of credit

     18,329        193,046   
  

 

 

   

 

 

 
     4,111,527        4,207,079   

Liabilities related to real estate investments held-for-sale

     —          14,732   

Construction payables and amounts due subcontractors, including retentions

     67,757        44,782   

Accrued real estate taxes

     102,695        83,615   

Accrued interest

     62,046        62,407   

Other accrued expenses

     38,561        61,448   

Other liabilities

     136,336        129,860   

Tenant security deposits and prepaid rents

     53,391        50,450   
  

 

 

   

 

 

 

Total liabilities

     4,572,313        4,654,373   
  

 

 

   

 

 

 

Shareholders’ equity:

    

Preferred shares ($.01 par value); 5,000 shares authorized; 3,610 and 3,618 shares issued and outstanding

     902,540        904,540   

Common shares ($.01 par value); 400,000 shares authorized; 252,663 and 252,195 shares issued and outstanding

     2,527        2,522   

Additional paid-in capital

     3,582,973        3,573,720   

Accumulated other comprehensive income (loss)

     56        (1,432

Distributions in excess of net income

     (1,602,634     (1,533,740
  

 

 

   

 

 

 

Total shareholders’ equity

     2,885,462        2,945,610   

Noncontrolling interests

     69,310        44,293   
  

 

 

   

 

 

 

Total equity

     2,954,772        2,989,903   
  

 

 

   

 

 

 
   $ 7,527,085      $ 7,644,276   
  

 

 

   

 

 

 

See accompanying Notes to Consolidated Financial Statements

 

- 2 -


Table of Contents

DUKE REALTY CORPORATION AND SUBSIDIARIES

Consolidated Statements of Operations

For the three and six months ended June 30,

(in thousands, except per share amounts)

(Unaudited)

 

     Three Months Ended     Six Months Ended  
     2011     2010     2011     2010  

Revenues:

        

Rental and related revenue

   $ 227,708      $ 205,588      $ 467,744      $ 417,084   

General contractor and service fee revenue

     135,362        168,398        281,909        282,039   
  

 

 

   

 

 

   

 

 

   

 

 

 
     363,070        373,986        749,653        699,123   

Expenses:

        

Rental expenses

     47,153        45,446        103,939        96,575   

Real estate taxes

     33,647        27,489        68,591        55,915   

General contractor and other services expenses

     122,969        160,617        258,633        267,779   

Depreciation and amortization

     100,058        78,956        194,743        159,481   
  

 

 

   

 

 

   

 

 

   

 

 

 
     303,827        312,508        625,906        579,750   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other operating activities:

        

Equity in earnings of unconsolidated companies

     1,713        2,016        2,786        6,945   

Gain on sale of properties

     493        4,973        68,348        7,042   

Undeveloped land carrying costs

     (2,453     (2,542     (4,762     (4,793

Impairment charges

     —          (7,974     —          (7,974

Other operating expenses

     (26     (145     (111     (422

General and administrative expense

     (8,541     (9,151     (19,738     (22,695
  

 

 

   

 

 

   

 

 

   

 

 

 
     (8,814     (12,823     46,523        (21,897
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     50,429        48,655        170,270        97,476   

Other income (expenses):

        

Interest and other income, net

     284        204        371        355   

Interest expense

     (66,846     (58,044     (132,950     (114,300

Loss on debt transactions

     —          (15,773     —          (16,127

Acquisition costs

     (594     —          (1,183     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations

     (16,727     (24,958     36,508        (32,596

Discontinued operations:

        

Income before gain on sales

     157        1,240        107        1,748   

Gain on sale of depreciable properties

     2,712        3,078        14,316        12,856   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from discontinued operations

     2,869        4,318        14,423        14,604   

Net income (loss)

     (13,858     (20,640     50,931        (17,992

Dividends on preferred shares

     (15,974     (18,363     (31,948     (36,726

Adjustments for repurchase of preferred shares

     —          (4,492     (163     (4,492

Net (income) loss attributable to noncontrolling interests

     790        1,104        (293     1,555   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to common shareholders

   $ (29,042   $ (42,391   $ 18,527      $ (57,655
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic net income (loss) per common share:

        

Continuing operations attributable to common shareholders

   $ (0.13   $ (0.21   $ 0.01      $ (0.32

Discontinued operations attributable to common shareholders

     0.01        0.02        0.06        0.06   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ (0.12   $ (0.19   $ 0.07      $ (0.26
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted net income (loss) per common share:

        

Continuing operations attributable to common shareholders

   $ (0.13   $ (0.21   $ 0.01      $ (0.32

Discontinued operations attributable to common shareholders

     0.01        0.02        0.06        0.06   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ (0.12   $ (0.19   $ 0.07      $ (0.26
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average number of common shares outstanding

     252,640        227,082        252,524        225,625   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average number of common shares and potential dilutive securities

     252,640        227,082        259,390        225,625   
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying Notes to Consolidated Financial Statements

 

- 3 -


Table of Contents

DUKE REALTY CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows

For the six months ended June 30,

(in thousands)

(Unaudited)

 

     2011     2010  

Cash flows from operating activities:

    

Net income (loss)

   $ 50,931      $ (17,992

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

    

Depreciation of buildings and tenant improvements

     135,809        130,236   

Amortization of deferred leasing and other costs

     59,285        35,937   

Amortization of deferred financing costs

     7,351        7,092   

Straight-line rent adjustment

     (11,887     (9,083

Impairment charges

     —          7,974   

Loss on debt extinguishment

     —          16,127   

Earnings from land and depreciated property sales

     (82,664     (19,898

Third-party construction contracts, net

     (25,658     (17,407

Other accrued revenues and expenses, net

     263        12,815   

Operating distributions received in excess of equity in earnings from unconsolidated companies

     10,862        2,597   
  

 

 

   

 

 

 

Net cash provided by operating activities

     144,292        148,398   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Development of real estate investments

     (78,645     (56,762

Acquisition of real estate investments and related intangible assets, net of cash acquired

     (99,817     (19,205

Acquisition of undeveloped land

     —          (4,706

Second generation tenant improvements, leasing costs and building improvements

     (41,284     (34,805

Other deferred leasing costs

     (13,807     (16,752

Other assets

     3,149        (28,699

Proceeds from land and depreciated property sales, net

     498,249        151,835   

Capital distributions from unconsolidated companies

     54,730        3,897   

Capital contributions and advances to unconsolidated companies, net

     (16,917     (16,577
  

 

 

   

 

 

 

Net cash provided by (used for) investing activities

     305,658        (21,774
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Proceeds from issuance of common shares, net

     —          298,148   

Payments for repurchases of preferred shares

     (2,096     (58,304

Proceeds from unsecured debt issuance

     —          250,000   

Payments on and repurchases of unsecured debt

     (43,377     (387,860

Proceeds from secured debt financings

     —          4,160   

Payments on secured indebtedness including principal amortization

     (7,968     (5,317

Borrowings (payments) on lines of credit, net

     (174,717     313   

Distributions to common shareholders

     (85,843     (76,259

Distributions to preferred shareholders

     (31,948     (36,726

Distributions to noncontrolling interests

     (2,398     (3,866

Deferred financing costs

     (2,342     (1,970
  

 

 

   

 

 

 

Net cash used for financing activities

     (350,689     (17,681
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     99,261        108,943   

Cash and cash equivalents at beginning of period

     18,384        147,322   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 117,645      $ 256,265   
  

 

 

   

 

 

 

Non-cash investing and financing activities:

    

Assumption of indebtedness for real estate acquisitions

   $ 130,474      $ 4,503   
  

 

 

   

 

 

 

Contribution of properties to unconsolidated companies

   $ 52,868      $ 7,002   
  

 

 

   

 

 

 

Conversion of Limited Partner Units to common shares

   $ 1,235      $ (4,335
  

 

 

   

 

 

 

Issuance of Limited Partner Units for acquisition

   $ 28,357      $ —     
  

 

 

   

 

 

 

See accompanying Notes to Consolidated Financial Statements

 

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Table of Contents

DUKE REALTY CORPORATION AND SUBSIDIARIES

Consolidated Statement of Changes in Equity

For the six months ended June 30, 2011

(in thousands, except per share data)

(Unaudited)

 

     Common Shareholders              
     Preferred
Stock
    Common
Stock
     Additional
Paid-in
Capital
     Accumulated
Other
Comprehensive
Income (Loss)
    Distributions
in Excess of
Net Income
    Non-
Controlling
Interests
    Total  

Balance at December 31, 2010

   $ 904,540      $ 2,522       $ 3,573,720       $ (1,432   $ (1,533,740   $ 44,293      $ 2,989,903   

Comprehensive income:

                

Net income

     —          —           —           —          50,638        293        50,931   

Derivative instrument activity

     —          —           —           1,488        —          —          1,488   
                

 

 

 

Comprehensive income

                   52,419   

Issuance of Limited Partner Units for acquisition

     —          —           —           —          —          28,357        28,357   

Stock based compensation plan activity

     —          4         7,952         —          (1,578     —          6,378   

Conversion of Limited Partner Units

     —          1         1,234         —          —          (1,235     —     

Distributions to preferred shareholders

     —          —           —           —          (31,948     —          (31,948

Repurchase of preferred shares

     (2,000     —           67         —          (163     —          (2,096

Distributions to common shareholders ($0.34 per share)

     —          —           —           —          (85,843     —          (85,843

Distributions to noncontrolling interests

     —          —           —           —          —          (2,398     (2,398
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance at June 30, 2011

   $ 902,540      $ 2,527       $ 3,582,973       $ 56      $ (1,602,634   $ 69,310      $ 2,954,772   
  

 

 

   

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying Notes to Consolidated Financial Statements

 

- 5 -


Table of Contents

DUKE REALTY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. General Basis of Presentation

The interim consolidated financial statements included herein have been prepared by Duke Realty Corporation (the “Company”). The 2010 year-end consolidated balance sheet data included in this Quarterly Report on Form 10-Q (this “Report”) was derived from the audited financial statements in our Annual Report on Form 10-K for the year ended December 31, 2010, but does not include all disclosures required by accounting principles generally accepted in the United States of America (“GAAP”). The financial statements have been prepared in accordance with GAAP for interim financial information and in accordance with Rule 10-01 of Regulation S-X of the Securities Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and revenue and expenses during the reporting period. Our actual results could differ from those estimates and assumptions. These financial statements should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations included herein and the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2010.

We believe that we qualify as a real estate investment trust (“REIT”) under the provisions of the Internal Revenue Code of 1986, as amended (the “Code”). Substantially all of our Rental Operations (see Note 9) are conducted through Duke Realty Limited Partnership (“DRLP”). We owned approximately 97.2% of the common partnership interests of DRLP (“Units”) at June 30, 2011. At the option of the holders, and subject to certain restrictions, the remaining Units are redeemable for shares of our common stock on a one-to-one basis and earn dividends at the same rate as shares of our common stock. If it is determined to be necessary in order to continue to qualify as a REIT, we may elect to purchase the Units for an equivalent amount of cash rather than issuing shares of common stock upon redemption. We conduct our Service Operations (see Note 9) through Duke Realty Services, LLC, Duke Realty Services Limited Partnership and Duke Construction Limited Partnership (“DCLP”). DCLP is owned through a taxable REIT subsidiary. The consolidated financial statements include our accounts and the accounts of our majority-owned or controlled subsidiaries. In this Report, unless the context indicates otherwise, the terms “we,” “us” and “our” refer to the Company and those entities owned or controlled by the Company.

 

2. Reclassifications

Certain amounts in the accompanying consolidated financial statements for 2010 have been reclassified to conform to the 2011 consolidated financial statement presentation.

 

3. Variable Interest Entities

At June 30, 2011, there are four unconsolidated joint ventures that we have determined meet the criteria to be considered variable interest entities (“VIEs”). These four unconsolidated joint ventures were formed with the sole purpose of developing, constructing, leasing, marketing and selling or operating properties. The business activities of these unconsolidated joint ventures have been financed through a combination of equity contributions, partner/member loans, and third-party debt that is guaranteed by both us and the other partner/member of each entity. All significant decisions for these unconsolidated joint ventures, including those decisions that most significantly impact each venture’s economic performance, require unanimous approval of each joint venture’s partners or members. In certain cases, these decisions also require lender approval. Unanimous approval requirements for these unconsolidated joint ventures include entering into new leases, setting annual operating budgets, selling underlying properties, and incurring additional indebtedness. Because no single entity exercises control over the decisions that most significantly affect each joint venture’s economic performance, we determined that the equity method of accounting is appropriate.

 

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Table of Contents

The following is a summary of the carrying value in our consolidated balance sheet, as well as our maximum loss exposure under guarantees for the four unconsolidated subsidiaries that we have determined to be VIEs as of June 30, 2011:

 

     Carrying Value      Maximum Loss Exposure  

Investment in Unconsolidated Company

   $ 38.3 million       $ 38.3 million   

Guarantee Obligations (1)

   $ (22.9 million)       $ (62.4 million)   

 

(1) We are party to guarantees of the third-party debt of these joint ventures and our maximum loss exposure is equal to the maximum monetary obligation pursuant to the guarantee agreements. In 2009, we recorded a liability for our probable future obligation under a guarantee to the lender of one of these ventures. Pursuant to an agreement with the lender, we may make partner loans to this joint venture that will reduce our maximum guarantee obligation on a dollar-for-dollar basis. The carrying value of our recorded guarantee obligations is included in other liabilities in our Consolidated Balance Sheets.

 

4. Acquisitions and Dispositions

Acquisition of Premier Portfolio

We purchased twelve industrial and four office buildings, as well as other real estate assets, during the six months ended June 30, 2011. These purchases completed our acquisition of a portfolio of buildings in South Florida (the “Premier Portfolio”), which was placed under contract in 2010, and resulted in cash payments to the sellers of $27.4 million, the assumption of secured loans with a face value of $124.4 million (Note 5) and the issuance to the sellers of 2.1 million Units with a fair value at issuance of $28.4 million (Note 6). These units are not convertible until early 2012.

On December 30, 2010, we purchased 38 industrial buildings, one office building and other real estate assets within the Premier Portfolio. The allocation of the fair value of the amounts recognized from this acquisition to buildings and other related assets was preliminary at December 31, 2010. The following table summarizes our allocation of the fair value of amounts recognized for each major class of assets and liabilities related to the 55 properties and other real estate assets from the Premier Portfolio that have been purchased through June 30, 2011 (in thousands):

 

     Year ended
December 31, 2010
     Six months
ended
June 30, 2011
     Total acquired
through
June 30, 2011
 

Real estate assets

   $ 249,960       $ 153,656       $ 403,616   

Lease-related intangible assets

     31,091         25,445         56,536   

Other assets

     1,801         2,571         4,372   
  

 

 

    

 

 

    

 

 

 

Total acquired assets

     282,852         181,672         464,524   

Secured debt

     158,238         125,003         283,241   

Other liabilities

     4,075         4,284         8,359   
  

 

 

    

 

 

    

 

 

 

Total assumed liabilities

     162,313         129,287         291,600   

Fair value of acquired net assets

   $ 120,539       $ 52,385       $ 172,924   

The leases in the acquired properties had a weighted average remaining life at acquisition of approximately 3.5 years.

 

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Table of Contents

Other 2011 Acquisitions

We also acquired four additional properties during the six months ended June 30, 2011. These acquisitions consisted of one bulk industrial property in Southern California, one bulk industrial property in Phoenix, Arizona, one bulk industrial property in Savannah, Georgia and one office property in Atlanta, Georgia. The following table summarizes our allocation of the fair value of amounts recognized for each major class of assets and liabilities (in thousands) for these acquisitions:

 

Real estate assets

   $ 70,547   

Lease related intangible assets

     9,491   

Other assets

     194   
  

 

 

 

Total acquired assets

     80,232   

Secured debt

     5,470   

Other liabilities

     311   
  

 

 

 

Total assumed liabilities

     5,781   

Fair value of acquired net assets

   $ 74,451   

The leases in the acquired properties had a weighted average remaining life at acquisition of approximately 5.9 years.

Fair Value Measurements

The fair value estimates used in allocating the aggregate purchase price of each acquisition among the individual components of real estate assets and liabilities were determined primarily through calculating the “as-if vacant” value of each building, using the income approach, and relied significantly upon internally determined assumptions. As a result, we have, thus, determined these estimates to have been primarily based upon Level 3 inputs, which are unobservable inputs based on our own assumptions. The most significant assumptions utilized in making the lease-up and future disposition estimates used in calculating the “as-if vacant” value of each building acquired during the six months ended June 30, 2011 were as follows:

 

Discount rate

     6.4% - 10.0%   

Exit capitalization rate

     4.8% - 8.7%   

Lease- up period

     12 - 36 months   

Net rental rate per square foot – Industrial

Net rental rate per square foot – Office

   $

$

3.30 - $6.50

8.61 - $16.00

  

  

Dispositions

We disposed of income-producing real estate assets and undeveloped land and received net proceeds of $498.2 million during the six-month period ended June 30, 2011. Included in the building dispositions in the six months ended June 30, 2011 is the sale, in March 2011, of 13 suburban office buildings, totaling approximately 2.0 million square feet, to an existing 20% owned unconsolidated joint venture. These buildings were sold to the unconsolidated joint venture for $342.8 million and our share of net proceeds totaled $273.7 million.

 

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5. Indebtedness

The following table summarizes the book value and changes in the fair value of our debt for the six months ended June 30, 2011 (in thousands):

 

    Book Value
at 12/31/10
    Book Value
at 6/30/11
    Fair Value
at 12/31/10
    Issuances and
Assumptions
    Payoffs     Adjustments
to Fair Value
    Fair Value
at 6/30/11
 

Fixed rate secured debt

  $ 1,042,722      $ 1,164,138      $ 1,069,562      $ 129,831      $ (7,968   $ 38,042      $ 1,229,467   

Variable rate secured debt

    22,906        22,906        22,906        —          —          —          22,906   

Fixed rate unsecured notes

    2,948,405        2,906,154        3,164,651        —          (43,377     53,435        3,174,709   

Unsecured lines of credit

    193,046        18,329        193,224        283        (175,000     (390     18,117   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 4,207,079      $ 4,111,527      $ 4,450,343      $ 130,114      $ (226,345   $ 91,087      $ 4,445,199   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Fixed Rate Secured Debt

Because our fixed rate secured debt is not actively traded in any marketplace, we utilized a discounted cash flow methodology to determine its fair value. Accordingly, we calculated fair value by applying an estimate of the current market rate to discount the debt’s remaining contractual cash flows. Our estimate of a current market rate, which is the most significant input in the discounted cash flow calculation, is intended to replicate debt of similar maturity and loan-to-value relationship. The estimated rates ranged from 4.10% to 5.80%, depending on the attributes of the specific loans. The current market rates we utilized were internally estimated; therefore, we have concluded that our determination of fair value for our fixed rate secured debt was primarily based upon Level 3 inputs, as defined.

In the first six months of 2011, we assumed nine secured loans associated with the acquisition of the Premier Portfolio, which had a total acquisition date face value of $124.4 million and fair value of $125.0 million. The assumed loans carry a weighted average interest rate of 5.78% and a weighted remaining term upon acquisition of 5.0 years. We used estimated market rates ranging between 4.40% and 5.81% in determining the fair value of the loans.

Fixed Rate Unsecured Debt

In March 2011, we repaid $42.5 million of senior unsecured notes, which had an effective interest rate of 6.96%, at their scheduled maturity date.

We utilized broker estimates in estimating the fair value of our fixed rate unsecured debt. Our unsecured notes are thinly traded and, in certain cases, the broker estimates were not based upon comparable transactions. The broker estimates took into account any recent trades within the same series of our fixed rate unsecured debt, comparisons to recent trades of other series of our fixed rate unsecured debt, trades of fixed rate unsecured debt from companies with profiles similar to ours, as well as overall economic conditions. We reviewed these broker estimates for reasonableness and accuracy, considering whether the estimates were based upon market participant assumptions within the principal and most advantageous market and whether any other observable inputs would be more accurate indicators of fair value than the broker estimates. We concluded that the broker estimates were representative of fair value. We have determined that our estimation of the fair value of our fixed rate unsecured debt was primarily based upon Level 3 inputs, as defined. The estimated trading values of our fixed rate unsecured debt, depending on the maturity and coupon rates, ranged from 100.0% to 121.0% of face value.

The indentures (and related supplemental indentures) governing our outstanding series of notes also require us to comply with financial ratios and other covenants regarding our operations. We were in compliance with all such covenants as of June 30, 2011.

 

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Unsecured Lines of Credit

Our unsecured lines of credit as of June 30, 2011 are described as follows (in thousands):

 

Description

   Maximum
Capacity
     Maturity Date      Outstanding
Balance at
June 30, 2011
 

Unsecured Line of Credit - DRLP

   $ 850,000         February 2013       $ —     

Unsecured Line of Credit - Consolidated Subsidiary

   $ 30,000         July 2012       $ 18,329   

The DRLP unsecured line of credit has an interest rate on borrowings of LIBOR plus 2.75%, and a maturity date of February 2013. There were no borrowings on the DRLP unsecured line of credit at June 30, 2011. Subject to certain conditions, the terms also include an option to increase the facility by up to an additional $200.0 million, for a total of up to $1.05 billion.

This line of credit provides us with an option to obtain borrowings from financial institutions that participate in the line at rates that may be lower than the stated interest rate, subject to certain restrictions.

This line of credit contains financial covenants that require us to meet certain financial ratios and defined levels of performance, including those related to fixed charge coverage and debt-to-asset value (with asset value being defined in the DRLP unsecured line of credit agreement). As of June 30, 2011, we were in compliance with all covenants under this line of credit.

The consolidated subsidiary’s unsecured line of credit allows for borrowings up to $30.0 million at a rate of LIBOR plus .85% (equal to 1.04% for outstanding borrowings as of June 30, 2011). This unsecured line of credit is used to fund development activities within the consolidated subsidiary and matures in July 2012.

To the extent that there are outstanding borrowings, we utilize a discounted cash flow methodology in order to estimate the fair value of our unsecured lines of credit. The net present value of the difference between future contractual interest payments and future interest payments based on our estimate of a current market rate represents the difference between the book value and the fair value. Our estimate of a current market rate is based upon the rate, considering current market conditions and our specific credit profile, at which we estimate we could obtain similar borrowings. The current market rate of 2.19% that we utilized was internally estimated; therefore, we have concluded that our determination of fair value for our unsecured lines of credit was primarily based upon Level 3 inputs, as defined.

 

6. Shareholders’ Equity

In the first six months of 2011, we repurchased 80,000 shares of our 8.375% Series O Cumulative Redeemable Preferred Shares (“Series O Shares”). The Series O Shares that we repurchased had a total redemption value of $2.0 million and were repurchased for $2.1 million. An adjustment of approximately $163,000, which included a ratable portion of original issuance costs, was included in net income attributable to common shareholders.

In conjunction with the acquisition of the Premier Portfolio (Note 4), we issued 2.1 million Units with a fair value at issuance of $28.4 million, which are included in noncontrolling interests.

 

7. Related Party Transactions

We provide property management, asset management, leasing, construction and other tenant related services to unconsolidated companies in which we have equity interests. We recorded the corresponding fees based on contractual terms that approximate market rates for these types of services and we have eliminated our ownership percentage of these fees in the consolidated financial statements. The following table summarizes the fees earned from these companies for the six months ended June 30, 2011 and 2010, respectively (in thousands):

 

     Six Months
Ended June 30,
 
     2011      2010  

Management fees

   $ 4,623       $ 4,142   

Leasing fees

     2,801         1,105   

Construction and development fees

     2,396         4,036   

 

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8. Net Income (Loss) Per Common Share

Basic net income (loss) per common share is computed by dividing net income (loss) attributable to common shareholders, less dividends on share-based awards expected to vest (referred to as “participating securities” and primarily composed of unvested restricted stock units), by the weighted average number of common shares outstanding for the period. Diluted net income (loss) per common share is computed by dividing the sum of basic net income (loss) attributable to common shareholders and the noncontrolling interest in earnings allocable to Units not owned by us (to the extent the Units are dilutive) by the sum of the weighted average number of common shares outstanding and, to the extent they are dilutive, Units outstanding, as well as any potential dilutive securities for the period.

The following table reconciles the components of basic and diluted net income (loss) per common share for the three and six months ended June 30, 2011 and 2010, respectively (in thousands):

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2011     2010     2011     2010  

Net income (loss) attributable to common shareholders

   $ (29,042   $ (42,391   $ 18,527      $ (57,655

Less: Dividends on participating securities

     (806     (505     (1,605     (1,005
                                

Basic net income (loss) attributable to common shareholders

     (29,848     (42,896     16,922        (58,660

Noncontrolling interest in earnings of common unitholders

     —          —          499        —     
                                

Diluted net income (loss) attributable to common shareholders

   $ (29,848   $ (42,896   $ 17,421      $ (58,660
                                

Weighted average number of common shares outstanding

     252,640        227,082        252,524        225,625   

Weighted average partnership Units outstanding

     —          —          6,798        —     

Other potential dilutive shares

     —          —          68        —     
                                

Weighted average number of common shares and potential dilutive securities

     252,640        227,082        259,390        225,625   
                                

The partnership Units are anti-dilutive for the three months ended June 30, 2011 and the three and six months ended June 30, 2010 as a result of the net loss for these periods. In addition, potential shares related to the majority of our stock-based compensation plans as well as our 3.75% Exchangeable Senior Notes (“Exchangeable Notes”) are anti-dilutive for all periods presented. The following table summarizes the data that is excluded from the computation of net income (loss) per common share as a result of being anti-dilutive (in thousands):

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2011      2010      2011      2010  

Noncontrolling interest in earnings of common unitholders

   $ 706       $ 1,212       $ —         $ 1,661   

Weighted average partnership Units outstanding

     7,209         6,404         —           6,505   

Other potential dilutive shares:

           

Anti-dilutive outstanding potential shares under fixed stock option plans

     1,677         1,787         1,677         1,787   

Anti-dilutive potential shares under the Exchangeable Notes

     3,432         4,335         3,432         4,335   

Outstanding participating securities

     4,816         4,188         4,816         4,188   

 

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9. Segment Reporting

We have three reportable operating segments, the first two of which consist of the ownership and rental of (i) office and (ii) industrial real estate investments. The operations of our office and industrial properties, along with our medical office and retail properties, are collectively referred to as “Rental Operations.” Our medical office and retail properties do not by themselves meet the quantitative thresholds for separate presentation as reportable segments. The third reportable segment consists of various real estate services such as property management, asset management, maintenance, leasing, development and construction management to third-party property owners and joint ventures, and is collectively referred to as “Service Operations.” Our reportable segments offer different products or services and are managed separately because each segment requires different operating strategies and management expertise.

Other revenue consists of other operating revenues not identified with one of our operating segments. Interest expense and other non-property specific revenues and expenses are not allocated to individual segments in determining our performance measure.

We assess and measure our overall operating results based upon an industry performance measure referred to as Funds From Operations (“FFO”), which management believes is a useful indicator of our consolidated operating performance. FFO is used by industry analysts and investors as a supplemental operating performance measure of a REIT. The National Association of Real Estate Investment Trusts (“NAREIT”) created FFO as a supplemental measure of REIT operating performance that excludes historical cost depreciation, among other items, from net income determined in accordance with GAAP. FFO is a non-GAAP financial measure. The most comparable GAAP measure is net income (loss) attributable to common shareholders. Consolidated FFO attributable to common shareholders should not be considered as a substitute for net income (loss) attributable to common shareholders or any other measures derived in accordance with GAAP and may not be comparable to other similarly titled measures of other companies. FFO is calculated in accordance with the definition that was adopted by the Board of Governors of NAREIT. We do not allocate certain income and expenses (“Non-Segment Items”, as shown in the table below) to our operating segments. Thus, the operational performance measure presented here on a segment-level basis represents net earnings, excluding depreciation expense and the Non-Segment Items not allocated, and is not meant to present FFO as defined by NAREIT.

Historical cost 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 instead have historically risen or fallen with market conditions, many industry analysts and investors have considered presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves. FFO, as defined by NAREIT, represents GAAP net income (loss), excluding extraordinary items as defined under GAAP and gains or losses from sales of previously depreciated real estate assets, plus certain non-cash items such as real estate asset depreciation and amortization, and after similar adjustments for unconsolidated partnerships and joint ventures.

Management believes that the use of FFO attributable to common shareholders, combined with net income (which remains the primary measure of performance), improves the understanding of operating results of REITs among the investing public and makes comparisons of REIT operating results more meaningful. Management believes that excluding gains or losses related to sales of previously depreciated real estate assets and excluding real estate asset depreciation and amortization enables investors and analysts to readily identify the operating results of the long-term assets that form the core of a REIT’s activity and assist them in comparing these operating results between periods or between different companies.

 

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The following table shows (i) the revenues for each of the reportable segments and (ii) a reconciliation of FFO attributable to common shareholders to net income (loss) attributable to common shareholders for the three and six months ended June 30, 2011 and 2010, respectively (in thousands):

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
    2011     2010     2011     2010  

Revenues

       

Rental Operations:

       

Office

  $ 109,671      $ 122,790      $ 231,787      $ 249,703   

Industrial

    95,062        62,499        191,345        128,583   

Non-reportable Rental Operations segments

    19,710        16,725        39,364        32,958   

General contractor and service fee revenue (“Service Operations”)

    135,362        168,398        281,909        282,039   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total Segment Revenues

    359,805        370,412        744,405        693,283   

Other Revenue

    3,265        3,574        5,248        5,840   
 

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated Revenue from continuing operations

    363,070        373,986        749,653        699,123   

Discontinued Operations

    365        11,234        3,485        23,997   
 

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated Revenue

  $ 363,435      $ 385,220      $ 753,138      $ 723,120   
 

 

 

   

 

 

   

 

 

   

 

 

 

Reconciliation of Funds From Operations

       

Net earnings excluding depreciation and Non-Segment Items

       

Office

  $ 63,250      $ 71,588      $ 130,376      $ 142,867   

Industrial

    69,093        47,515        136,918        95,850   

Non-reportable Rental Operations segments

    13,024        11,577        25,398        22,155   

Service Operations

    12,393        7,781        23,276        14,260   
 

 

 

   

 

 

   

 

 

   

 

 

 
    157,760        138,461        315,968        275,132   

Non-Segment Items:

       

Interest expense

    (66,846     (58,044     (132,950     (114,300

Impairment charges

    —          (7,974     —          (7,974

Interest and other income

    284        204        371        355   

Other operating expenses

    (26     (145     (111     (422

General and administrative expenses

    (8,541     (9,151     (19,738     (22,695

Undeveloped land carrying costs

    (2,453     (2,542     (4,762     (4,793

Loss on debt transactions

    —          (15,773     —          (16,127

Acquisition costs

    (594     —          (1,183     —     

Other non-segment income

    1,541        1,973        2,522        3,722   

Net (income) loss attributable to noncontrolling interests

    790        1,104        (293     1,555   

Noncontrolling interest share of FFO adjustments

    (2,802     (2,315     (3,371     (4,593

Joint venture items

    10,352        12,384        18,962        24,572   

Dividends on preferred shares

    (15,974     (18,363     (31,948     (36,726

Adjustments for repurchase of preferred shares

    —          (4,492     (163     (4,492

Discontinued operations

    212        4,289        458        8,440   
 

 

 

   

 

 

   

 

 

   

 

 

 

FFO attributable to common shareholders

    73,703        39,616        143,762        101,654   

Depreciation and amortization on continuing operations

    (100,058     (78,956     (194,743     (159,481

Depreciation and amortization on discontinued operations

    (55     (3,049     (351     (6,692

Company’s share of joint venture adjustments

    (8,639     (10,372     (16,267     (19,935

Earnings from depreciated property sales on continuing operations

    493        4,973        68,348        7,042   

Earnings from depreciated property sales on discontinued operations

    2,712        3,078        14,316        12,856   

Earnings from depreciated property sales—share of joint venture

    —          4        91        2,308   

Noncontrolling interest share of FFO adjustments

    2,802        2,315        3,371        4,593   
 

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to common shareholders

  $ (29,042   $ (42,391   $ 18,527      $ (57,655
 

 

 

   

 

 

   

 

 

   

 

 

 

 

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The assets for each of the reportable segments as of June 30, 2011 and December 31, 2010 are as follows (in thousands):

 

     June 30,
2011
     December 31,
2010
 

Assets

     

Rental Operations:

     

Office

   $ 2,769,228       $ 3,122,565   

Industrial

     3,314,481         3,210,566   

Non-reportable Rental Operations segments

     634,058         627,491   

Service Operations

     169,559         231,662   
                 

Total Segment Assets

     6,887,326         7,192,284   

Non-Segment Assets

     639,759         451,992   
                 

Consolidated Assets

   $ 7,527,085       $ 7,644,276   
                 

 

10. Discontinued Operations

The following table illustrates the number of properties in discontinued operations:

 

     Sold in 2011      Sold in 2010      Total  

Office

     10         11         21   

Industrial

     2         6         8   

Retail

     —           2         2   
                          
     12         19         31   

We allocate interest expense to discontinued operations and have included such interest expense in computing income from discontinued operations. Interest expense allocable to discontinued operations includes interest on any secured debt for properties included in discontinued operations and an allocable share of our consolidated unsecured interest expense for unencumbered properties. The allocation of unsecured interest expense to discontinued operations was based upon the gross book value of the unencumbered real estate assets included in discontinued operations as it related to the total gross book value of our unencumbered real estate assets.

The following table illustrates the operations of the buildings reflected in discontinued operations for the three and six months ended June 30, 2011 and 2010, respectively (in thousands):

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2011     2010     2011     2010  

Revenues

   $ 365      $ 11,234      $ 3,485      $ 23,997   

Operating expenses

     (74     (4,118     (1,787     (9,301

Depreciation and amortization

     (55     (3,049     (351     (6,692
                                

Operating income

     236        4,067        1,347        8,004   

Interest expense

     (79     (2,827     (1,240     (6,256
                                

Income before gain on sales

     157        1,240        107        1,748   

Gain on sale of depreciable properties

     2,712        3,078        14,316        12,856   
                                

Income from discontinued operations

   $ 2,869      $ 4,318      $ 14,423      $ 14,604   
                                

 

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Dividends on preferred shares and adjustments for repurchase of preferred shares are allocated entirely to continuing operations. The following table illustrates the allocation of the income (loss) attributable to common shareholders between continuing operations and discontinued operations, reflecting an allocation of income or loss attributable to noncontrolling interests between continuing and discontinued operations, for the three and six months ended June 30, 2011 and 2010, respectively (in thousands):

 

     Three Months Ended     Six Months Ended  
     June 30,     June 30,  
     2011     2010     2011      2010  

Income (loss) from continuing operations attributable to common shareholders

   $ (31,832   $ (46,591   $ 4,482       $ (71,850

Income from discontinued operations attributable to common shareholders

     2,790        4,200        14,045         14,195   
  

 

 

   

 

 

   

 

 

    

 

 

 

Net income (loss) attributable to common shareholders

   $ (29,042   $ (42,391   $ 18,527       $ (57,655
  

 

 

   

 

 

   

 

 

    

 

 

 

 

11. Subsequent Events

Declaration of Dividends

Our board of directors declared the following dividends at its regularly scheduled board meeting held on July 27, 2011:

 

Class

   Quarterly
Amount/Share
     Record Date      Payment Date  

Common

   $ 0.17         August 17, 2011         August 31, 2011   

Preferred (per depositary share):

        

Series J

   $ 0.414063         August 17, 2011         August 31, 2011   

Series K

   $ 0.406250         August 17, 2011         August 31, 2011   

Series L

   $ 0.412500         August 17, 2011         August 31, 2011   

Series M

   $ 0.434375         September 16, 2011         September 30, 2011   

Series O

   $ 0.523438         September 16, 2011         September 30, 2011   

On June 17, 2011, we called for redemption all of our 434,520 outstanding 7.25% Series N Cumulative Redeemable Preferred Shares. The redemption took place on July 18, 2011 for $109.0 million, which included dividends accrued through the redemption date.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to help the reader understand our operations and our present business environment. Management’s Discussion and Analysis is provided as a supplement to and should be read in conjunction with our consolidated financial statements and the notes thereto, contained in Part I, Item I of this Quarterly Report on Form 10-Q (this “Report”) and the consolidated financial statements and notes thereto, contained in Part IV, Item 15 of our Annual Report on Form 10-K for the year ended December 31, 2010, as filed with the Securities and Exchange commission (the “SEC”) on February 25, 2011. As used herein, the terms “we”, “us” and “our” refer to Duke Realty Corporation (the “Company”) and those entities owned or controlled by the Company.

Cautionary Notice Regarding Forward-Looking Statements

Certain statements contained in or incorporated by reference into this Report including, without limitation, those related to our future operations, constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The words “believe,” “estimate,” “expect,” “anticipate,” “intend,” “plan,” “seek,” “may,” and similar expressions or statements regarding future periods are intended to identify forward-looking statements.

These forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause our actual results, performance or achievements, or industry results, to differ materially from any predictions of future results, performance or achievements that we express or imply in this Report. Some of the risks, uncertainties and other important factors that may affect future results include, among others:

 

   

Changes in general economic and business conditions, including, without limitation, the continuing impact of the economic down-turn, which is having and may continue to have a negative effect on the fundamentals of our business, the financial condition of our tenants, and the value of our real estate assets;

 

   

Our continued qualification as a real estate investment trust (“REIT”) for U.S. federal income tax purposes;

 

   

Heightened competition for tenants and potential decreases in property occupancy;

 

   

Potential changes in the financial markets and interest rates;

 

   

Volatility in our stock price and trading volume;

 

   

Our continuing ability to raise funds on favorable terms;

 

   

Our ability to successfully identify, acquire, develop and/or manage properties on terms that are favorable to us;

 

   

Potential increases in real estate construction costs;

 

   

Our ability to successfully dispose of properties on terms that are favorable to us, including, without limitation, through one or more transactions that are consistent with our previously disclosed strategic plans;

 

   

Our ability to retain our current credit ratings;

 

   

Inherent risks in the real estate business, including, but not limited to, tenant defaults, potential liability relating to environmental matters, climate change and liquidity of real estate investments; and

 

   

Other risks and uncertainties described herein, as well as those risks and uncertainties discussed from time to time in our other reports and other public filings with the SEC.

 

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Table of Contents

Although we presently believe that the plans, expectations and results expressed in or suggested by the forward-looking statements are reasonable, all forward-looking statements are inherently subjective, uncertain and subject to change, as they involve substantial risks and uncertainties beyond our control. New factors emerge from time to time, and it is not possible for us to predict the nature, or assess the potential impact, of each new factor on our business. Given these uncertainties, we caution you not to place undue reliance on these forward-looking statements. We undertake no obligation to update or revise any of our forward-looking statements for events or circumstances that arise after the statement is made, except as otherwise may be required by law.

This list of risks and uncertainties, however, is only a summary of some of the most important factors and is not intended to be exhaustive. Additional information regarding risk factors that may affect us is included under the caption “Risk Factors” in Part II, Item 1A of this Report, and in our Annual Report on Form 10-K for the fiscal year ended December 31, 2010, which we filed with the SEC on February 25, 2011. The risk factors contained in our Annual Report are updated by us from time to time in Quarterly Reports on Form 10-Q and other public filings.

Business Overview

We are a self-administered and self-managed REIT that began operations through a related entity in 1972. A more complete description of our business, and of management’s philosophy and priorities, is included in our 2010 Annual Report on Form 10-K.

As of June 30, 2011, we:

 

   

Owned or jointly controlled 797 industrial, office, medical office and other properties, of which 790 properties with more than 138.6 million square feet are in service and seven properties with more than 2.0 million square feet are under development. The 790 in-service properties are comprised of 662 consolidated properties with approximately 113.0 million square feet and 128 jointly controlled unconsolidated properties with approximately 25.6 million square feet. The seven properties under development consist of six consolidated properties with more than 1.6 million square feet and one jointly controlled unconsolidated property with approximately 405,000 million square feet.

 

   

Owned, including through ownership interests in unconsolidated joint ventures, approximately 4,700 acres of land and controlled an additional 1,650 acres through purchase options.

We have three reportable operating segments, the first two of which consist of the ownership and rental of (i) office and (ii) industrial real estate investments. The operations of our office and industrial properties, along with our medical office and retail properties, are collectively referred to as “Rental Operations.” Our medical office and retail properties do not by themselves meet the quantitative thresholds for separate presentation as reportable segments. The third reportable segment consists of various real estate services such as property management, asset management, maintenance, leasing, development and construction management to third-party property owners and joint ventures, and is collectively referred to as “Service Operations.” Our reportable segments offer different products or services and are managed separately because each segment requires different operating strategies and management expertise.

A key component of our overall strategy is to increase our investment in quality industrial properties in both existing and select new markets, expand our medical office portfolio nationally to take advantage of demographic trends and to reduce our investment in suburban office properties and other non-strategic assets.

Key Performance Indicators

Our operating results depend primarily upon rental income from our Rental Operations. The following discussion highlights the areas of Rental Operations that we consider critical for future revenues.

 

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Occupancy Analysis

Our ability to maintain high occupancy rates is a principal driver of maintaining and increasing rental revenue from continuing operations. The following table sets forth occupancy information regarding our in-service portfolio of consolidated rental properties as of June 30, 2011 and 2010, respectively (in thousands, except percentage data):

 

     Total Square Feet      Percent of
Total Square Feet
    Percent Occupied  

Type

   2011      2010      2011     2010     2011     2010  

Industrial

     84,112         56,320         74.4     62.9     90.5     91.9

Office

     25,994         30,496         23.0     34.1     84.4     85.0

Other (Medical Office and Retail)

     2,956         2,678         2.6     3.0     86.5     82.9
                                      

Total

     113,062         89,494         100.0     100.0     89.0     89.2
                                      

Lease Expiration and Renewals

Our ability to maintain and improve occupancy rates primarily depends upon our continuing ability to re-lease expiring space. The following table reflects our consolidated in-service portfolio lease expiration schedule by property type as of June 30, 2011. The table indicates square footage and annualized net effective rents (based on June 2011 rental revenue) under expiring leases (in thousands, except percentage data):

 

     Total Portfolio     Industrial      Office      Other  

Year of

Expiration

   Square
Feet
    Ann. Rent
Revenue
     % of
Revenue
    Square
Feet
    Ann. Rent
Revenue
     Square
Feet
    Ann. Rent
Revenue
     Square
Feet
    Ann. Rent
Revenue
 

Remainder of 2011

     4,981      $ 30,738         5     3,604      $ 14,388         1,344      $ 15,912         33      $ 438   

2012

     8,318        60,860         9     5,465        23,925         2,792        35,834         61        1,101   

2013

     15,411        98,015         15     11,845        47,801         3,517        49,291         49        923   

2014

     12,001        71,981         11     9,216        34,943         2,633        34,258         152        2,780   

2015

     12,874        73,449         11     10,111        38,509         2,735        34,339         28        601   

2016

     12,094        63,762         10     9,959        36,281         2,038        25,322         97        2,159   

2017

     8,156        48,405         8     6,504        24,417         1,351        17,655         301        6,333   

2018

     5,680        47,692         7     3,640        14,475         1,500        20,746         540        12,471   

2019

     4,088        39,263         6     2,227        9,924         1,593        22,796         268        6,543   

2020

     6,386        42,111         7     5,009        18,109         1,000        16,117         377        7,885   

2021 and Thereafter

     10,602        68,934         11     8,516        34,075         1,435        19,405         651        15,454   
                                                                           

Total Leased

     100,591      $ 645,210         100     76,096      $ 296,847         21,938      $ 291,675         2,557      $ 56,688   
                                                                           

Total Portfolio

                     

Square Feet

     113,062             84,112           25,994           2,956     
                                             

Percent Occupied

     89.0          90.5        84.4        86.5  
                                             

Within our consolidated properties, we renewed 51.5% and 60.5% of our leases up for renewal in the three and six months ended June 30, 2011, totaling more than 2.1 million and 5.0 million square feet, respectively. This compares to renewals of 81.5% and 83.4% for the three and six months ended June 30, 2010, which totaled approximately 2.8 million and 4.9 million square feet, respectively. Although our lease renewal percentage declined from the same periods in 2010, new leasing activity enabled us to maintain a consistent level of occupancy for our consolidated properties. There was a 2.7% and 3.0% decline in average contractual rents on these renewals in the three and six months ended June 30, 2011, respectively.

The average term of renewals for the three and six months ended June 30, 2011 was 4.4 years for both periods, compared to 5.4 and 6.3 years for the three and six months ended June 30, 2010, respectively.

 

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Acquisition and Disposition Activity

For the six months ended June 30, 2011, we acquired 20 properties and other real estate-related assets, for $257.7 million, with 16 of these 20 properties representing the completion of our acquisition of a portfolio of buildings in South Florida (the “Premier Portfolio”), of which the initial 39 properties were acquired on December 30, 2010. These acquisitions represent further advancement of our strategy to increase our concentration in industrial properties.

For the six months ended June 30, 2010, we acquired $24.0 million of industrial real estate properties comprised of two properties in South Florida and one in Phoenix, Arizona. Additionally, in the first six months of 2010, one of our unconsolidated joint ventures, in which we have a 20% equity interest, acquired two properties for $42.3 million. We contributed $8.6 million to the joint venture for our share of these acquisitions.

Net cash proceeds related to the dispositions of wholly owned undeveloped land and buildings totaled $498.2 million and $151.8 million for the six months ended June 30, 2011 and 2010, respectively. Included in the wholly owned building dispositions in the six months ended June 30, 2011 is the sale of 13 suburban office properties for net proceeds of $273.7 million, totaling approximately 2.0 million square feet, to a joint venture in which we own 20%.

Our share of proceeds from sales of properties within unconsolidated joint ventures in which we have less than a 100% interest totaled $4.7 million for the six months ended June 30, 2010. There were no such dispositions in the same period in 2011.

We regularly work to identify, consider and pursue opportunities to acquire and dispose of properties on an opportunistic basis and on a basis that is generally consistent with our strategic plans.

Development

At June 30, 2011, we had 2.0 million square feet of property under development with total estimated costs upon completion of $125.3 million compared to 823,000 square feet with total costs of $264.1 million at June 30, 2010. We have continued to limit our development projects to build-to-suit or partially pre-leased industrial properties and select medical office developments. The square footage and estimated costs include both consolidated and joint venture development activity at 100%.

The following table summarizes our properties under development as of June 30, 2011 (in thousands, except percentage data):

 

Ownership Type

   Square
Feet
     Percent
Leased
    Total
Estimated
Project
Costs
     Total
Incurred
to Date
     Amount
Remaining
to be Spent
 

Consolidated properties

     1,613         94   $ 105,696       $ 56,396       $ 49,300   

Joint venture properties

     405         100     19,609         9,770         9,839   
  

 

 

      

 

 

    

 

 

    

 

 

 

Total

     2,018         95   $ 125,305       $ 66,166       $ 59,139   
  

 

 

      

 

 

    

 

 

    

 

 

 

 

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Funds From Operations

Funds From Operations (“FFO”) is used by industry analysts and investors as a supplemental operating performance measure of a REIT. The National Association of Real Estate Investment Trusts (“NAREIT”) created FFO as a supplemental measure of REIT operating performance that excludes historical cost depreciation, among other items, from net income determined in accordance with accounting principles generally accepted in the United States of America (“GAAP”). FFO is a non-GAAP financial measure. The most comparable GAAP measure is net income (loss) attributable to common shareholders. FFO attributable to common shareholders should not be considered as a substitute for net income (loss) attributable to common shareholders or any other measures derived in accordance with GAAP and may not be comparable to other similarly titled measures of other companies. FFO is calculated in accordance with the definition that was adopted by the Board of Governors of NAREIT.

Historical cost 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 instead have historically risen or fallen with market conditions, many industry analysts and investors have considered presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves. FFO, as defined by NAREIT, represents GAAP net income (loss), excluding extraordinary items as defined under GAAP and gains or losses from sales of previously depreciated real estate assets, plus certain non-cash items such as real estate asset depreciation and amortization, and after similar adjustments for unconsolidated partnerships and joint ventures.

Management believes that the use of FFO attributable to common shareholders, combined with net income (which remains the primary measure of performance), improves the understanding of operating results of REITs among the investing public and makes comparisons of REIT operating results more meaningful. Management believes that excluding gains or losses related to sales of previously depreciated real estate assets and excluding real estate asset depreciation and amortization enables investors and analysts to readily identify the operating results of the long-term assets that form the core of a REIT’s activity and assist them in comparing these operating results between periods or between different companies.

The following table shows a reconciliation of net income (loss) attributable to common shareholders to the calculation of FFO attributable to common shareholders for the three and six months ended June 30, 2011 and 2010, respectively (in thousands):

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
    2011     2010     2011     2010  

Net income (loss) attributable to common shareholders

  $ (29,042   $ (42,391   $ 18,527      $ (57,655

Adjustments:

       

Depreciation and amortization

    100,113        82,005        195,094        166,173   

Company share of joint venture depreciation and amortization

    8,639        10,372        16,267        19,935   

Earnings from depreciable property sales—wholly owned

    (3,205     (8,051     (82,664     (19,898

Earnings from depreciable property sales—share of joint venture

    —          (4     (91     (2,308

Noncontrolling interest share of adjustments

    (2,802     (2,315     (3,371     (4,593
 

 

 

   

 

 

   

 

 

   

 

 

 

Funds From Operations attributable to common shareholders

  $ 73,703      $ 39,616      $ 143,762      $ 101,654   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

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Results of Operations

A summary of our operating results and property statistics for the three and six months ended June 30, 2011 and 2010, respectively, is as follows (in thousands, except number of properties and per share data):

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2011     2010     2011      2010  

Rental and related revenue

   $ 227,708      $ 205,588      $ 467,744       $ 417,084   

General contractor and service fee revenue

     135,362        168,398        281,909         282,039   

Operating income

     50,429        48,655        170,270         97,476   

Net income (loss) attributable to common shareholders

     (29,042     (42,391     18,527         (57,655

Weighted average common shares outstanding

     252,640        227,082        252,524         225,625   

Weighted average common shares and potential dilutive securities

     252,640        227,082        259,390         225,625   

Basic income (loss) per common share:

         

Continuing operations

   $ (0.13   $ (0.21   $ 0.01       $ (0.32

Discontinued operations

   $ 0.01      $ 0.02      $ 0.06       $ 0.06   

Diluted income (loss) per common share:

         

Continuing operations

   $ (0.13   $ (0.21   $ 0.01       $ (0.32

Discontinued operations

   $ 0.01      $ 0.02      $ 0.06       $ 0.06   

Number of in-service consolidated properties at end of period

     662        529        662         529   

In-service consolidated square footage at end of period

     113,062        89,494        113,062         89,494   

Number of in-service joint venture properties at end of period

     128        215        128         215   

In-service joint venture square footage at end of period

     25,571        43,820        25,571         43,820   

Comparison of Three Months Ended June 30, 2011 to Three Months Ended June 30, 2010

Rental and Related Revenue

The following table sets forth rental and related revenue from continuing operations by reportable segment for the three months ended June 30, 2011 and 2010, respectively (in thousands):

 

     Three Months Ended
June 30,
 
     2011      2010  

Rental and Related Revenue:

     

Office

   $ 109,671       $ 122,790   

Industrial

     95,062         62,499   

Non-reportable segments

     22,975         20,299   
  

 

 

    

 

 

 

Total

   $ 227,708       $ 205,588   
  

 

 

    

 

 

 

The following factors contributed to these results:

 

   

We acquired 71 properties, of which 62 were industrial, and placed five developments in service from January 1, 2010 to June 30, 2011, which provided incremental revenues of $18.9 million in the second quarter of 2011, as compared to the same period in 2010.

 

   

We consolidated 106 industrial buildings as a result of acquiring our joint venture partner’s 50% interest in Dugan Realty, L.L.C. (“Dugan”) on July 1, 2010. The consolidation of these buildings resulted in an increase of $19.2 million in rental and related revenue for the three months ended June 30, 2011, as compared to the same period in 2010.

 

   

We sold 23 office properties to an unconsolidated joint venture in 2010 and the first quarter of 2011, resulting in a $15.7 million decrease in rental and related revenue from continuing operations in the three months ended June 30, 2011.

 

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The overall shift of revenues and income from office properties to industrial properties is consistent with our continuing strategy to increase our asset concentration in industrial properties while reducing our exposure to office properties.

Rental Expenses and Real Estate Taxes

The following table sets forth rental expenses and real estate taxes by reportable segment for the three months ended June 30, 2011 and 2010, respectively (in thousands):

 

     Three Months Ended
June 30,
 
     2011      2010  

Rental Expenses:

     

Office

   $ 30,312       $ 34,692   

Industrial

     10,296         5,827   

Non-reportable segments

     6,545         4,927   
  

 

 

    

 

 

 

Total

   $ 47,153       $ 45,446   
  

 

 

    

 

 

 

Real Estate Taxes:

     

Office

   $ 16,109       $ 16,510   

Industrial

     15,673         9,157   

Non-reportable segments

     1,865         1,822   
  

 

 

    

 

 

 

Total

   $ 33,647       $ 27,489   
  

 

 

    

 

 

 

Overall, rental expenses increased by $1.7 million in the second quarter of 2011, compared to the same period in 2010. We recognized incremental costs of $4.3 million associated with the additional 71 properties acquired (of which 62 were industrial) and five developments placed in service since January 1, 2010. The July 1, 2010 consolidation of 106 industrial buildings in Dugan also resulted in a $1.9 million increase in rental expense for industrial properties in the second quarter of 2011. Partially offsetting the impact of our acquisition and development activity was a decrease to rental expenses of $3.6 million related to 23 office properties that were sold to an unconsolidated joint venture during 2010 and the first quarter of 2011.

Overall, real estate taxes increased by $6.2 million in the second quarter of 2011, compared to the same period in 2010. The consolidation of the 106 industrial buildings in Dugan resulted in incremental real estate taxes of $3.7 million. There were also incremental costs of $3.6 million associated with the additional 71 properties acquired and five developments placed in service since January 1, 2010. The aforementioned increases were partially offset by a decrease of $2.5 million related to the 23 properties that were sold to a joint venture during 2010 and the first quarter of 2011. The remaining increase in real estate tax expense was the result of increased taxes on our existing properties.

Service Operations

The following table sets forth the components of the Service Operations reportable segment for the three months ended June 30, 2011 and 2010, respectively (in thousands):

 

     Three Months Ended
June 30,
 
     2011     2010  

Service Operations:

    

General contractor and service fee revenue

   $ 135,362      $ 168,398   

General contractor and other services expenses

     (122,969     (160,617
  

 

 

   

 

 

 

Total

   $ 12,393      $ 7,781   
  

 

 

   

 

 

 

Service Operations primarily consist of the leasing, property management, asset management, development, construction management and general contractor services for joint venture properties and properties owned by third parties. Service Operations are heavily influenced by the current state of the economy, as leasing and property management fees are dependent upon occupancy, while construction and development services rely on the expansion of business operations of third-party property owners and joint venture partners. Although total construction volume decreased from the second quarter of 2010, increased profitability on the third-party construction activity during the second quarter of 2011 drove the increase to our earnings from Service Operations.

 

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Depreciation and Amortization

Depreciation and amortization expense increased from $79.0 million during the second quarter of 2010 to $100.1 million for the same period in 2011, primarily due to shorter-lived lease-based intangible assets being recognized in conjunction with our acquisition activity in 2010 and 2011.

Equity in Earnings of Unconsolidated Companies

Equity in earnings represents our ownership share of net income or loss from investments in unconsolidated joint ventures that generally own and operate rental properties and develop properties for sale. These earnings decreased from $2.0 million in the three months ended June 30, 2010 to $1.7 million for the same period in 2011. The slight decrease in equity in earnings was largely due to the consolidation of 106 properties upon the acquisition of our partner’s 50% interest in Dugan on July 1, 2010, partially offset by increases in our share of earnings from various other unconsolidated joint ventures.

Gain on Sale of Properties

During the second quarter of 2011, we sold three properties that did not meet the criteria for inclusion in discontinued operations, recognizing total gains on sale of $493,000.

During the second quarter of 2010, we sold four properties that did not meet the criteria for inclusion within discontinued operations, recognizing total gains on sale of $5.0 million.

Impairment Charges

In the second quarter of 2010, we sold 50 acres of land, which resulted in an impairment charge of $8.0 million. We had not previously identified or actively marketed this land for disposition.

General and Administrative Expense

General and administrative expenses decreased from $9.2 million for the second quarter of 2010 to $8.5 million for the same period in 2011. General and administrative expenses consist of two components. The first component includes general corporate expenses and the second component includes the indirect operating costs not allocated to the development or operations of our owned properties and Service Operations. Those indirect costs not allocated to or absorbed by these operations are charged to general and administrative expenses. The reduction in general and administrative expenses was primarily the result of an increase to indirect costs absorbed by operations, which was due to an increase in leasing activity during the second quarter of 2011 from the second quarter of 2010.

 

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Interest Expense

Interest expense increased from $58.0 million in the second quarter of 2010 to $66.8 million in the second quarter of 2011. The increase to interest expense was primarily driven by additional secured debt assumed over the last year in conjunction with our acquisition activities. A $2.0 million decrease in the capitalization of interest costs, the result of reduced development activity, also contributed to the increase in interest expense.

Loss on Debt Transactions

During the second quarter of 2010, through a cash tender offer and other open market transactions, we repurchased certain of our outstanding series of unsecured notes scheduled to mature in 2011 and 2013. In total, we paid $273.1 million for unsecured notes that had a face value of $260.7 million, recognizing a net loss on extinguishment of $15.8 million after considering the write-off of unamortized deferred financing costs and discounts.

Discontinued Operations

Subject to certain criteria, the results of operations for properties sold during the year to unrelated parties or classified as held-for-sale at the end of the period are required to be classified as discontinued operations. The property specific components of earnings that are classified as discontinued operations include rental revenues, rental expenses, real estate taxes, allocated interest expense and depreciation expense, as well as the net gain or loss on the disposition of properties.

The operations of 31 buildings are classified as discontinued operations for both the three months ended June 30, 2011 and June 30, 2010. These 31 buildings consist of 21 office, eight industrial, and two retail properties. As a result, we classified income, before gain on sales, of $157,000 and $1.2 million in discontinued operations for the three months ended June 30, 2011 and 2010, respectively.

Of these properties, three were sold during the second quarter of 2011 and two were sold during the second quarter of 2010. The gains on disposal of $2.7 million and $3.1 million for the three months ended June 30, 2011 and 2010, respectively, are reported in discontinued operations.

Comparison of Six Months Ended June 30, 2011 to Six Months Ended June 30, 2010

Rental and Related Revenue

The following table sets forth rental and related revenue from continuing operations by reportable segment for the six months ended June 30, 2011 and 2010, respectively (in thousands):

 

     Six Months Ended
June 30,
 
     2011      2010  

Rental and Related Revenue:

     

Office

   $ 231,787       $ 249,703   

Industrial

     191,345         128,583   

Non-reportable segments

     44,612         38,798   
                 

Total

   $ 467,744       $ 417,084   
                 

The following factors contributed to these results:

 

   

We acquired 71 properties, of which 62 were industrial, and placed five developments in service from January 1, 2010 to June 30, 2011, which provided incremental revenues of $36.3 million in the six months ended June 30, 2011, as compared to the same period in 2010.

 

   

We consolidated 106 industrial buildings as a result of acquiring our joint venture partner’s 50% interest in Dugan on July 1, 2010. The consolidation of these buildings resulted in an increase of $39.3 million in rental and related revenue for the six months ended June 30, 2011, as compared to the same period in 2010.

 

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We sold 23 office properties to an unconsolidated joint venture in 2010 and the first quarter of 2011, resulting in a $23.4 million decrease in rental and related revenue from continuing operations in the six months ended June 30, 2011.

 

   

The overall shift of revenues and income from office properties to industrial properties is consistent with our continuing strategy to increase our asset concentration in industrial properties while reducing our exposure to office properties.

Rental Expenses and Real Estate Taxes

The following table sets forth rental expenses and real estate taxes by reportable segment for the six months ended June 30, 2011 and 2010, respectively (in thousands):

 

     Six Months Ended
June 30,
 
     2011      2010  

Rental Expenses:

     

Office

   $ 67,829       $ 72,810   

Industrial

     23,467         14,350   

Non-reportable segments

     12,643         9,415   
                 

Total

   $ 103,939       $ 96,575   
                 

Real Estate Taxes:

     

Office

   $ 33,582       $ 34,026   

Industrial

     30,960         18,383   

Non-reportable segments

     4,049         3,506   
                 

Total

   $ 68,591       $ 55,915   
                 

Overall, rental expenses increased by $7.4 million in the six months ended June 30, 2011, compared to the same period in 2010. We recognized incremental costs of $7.7 million associated with the additional 71 properties acquired (of which 62 were industrial) and five developments placed in service. The July 1, 2010 consolidation of 106 industrial buildings in Dugan also resulted in a $5.6 million increase in rental expense for industrial properties in the first six months of 2011, which was partially offset by a decrease of $5.2 million related to 23 properties that were sold to an unconsolidated joint venture during 2010 and the first quarter of 2011.

Overall, real estate taxes increased by $12.7 million in the six months ended June 30, 2011, compared to the same period in 2010. The consolidation of the 106 industrial buildings in Dugan resulted in incremental real estate taxes of $7.2 million. There were also incremental costs of $6.7 million associated with the additional 71 properties acquired and five developments placed in service since January 1, 2010. The aforementioned increases were partially offset by a decrease of $3.4 million related to 23 properties that were sold to an unconsolidated joint venture during 2010 and the first quarter of 2011. The remaining increases were the result of increased taxes on our existing properties.

 

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Table of Contents

Service Operations

The following table sets forth the components of the Service Operations reportable segment for the six months ended June 30, 2011 and 2010, respectively (in thousands):

 

     Six Months Ended
June 30,
 
     2011     2010  

Service Operations:

    

General contractor and service fee revenue

   $ 281,909      $ 282,039   

General contractor and other services expenses

     (258,633     (267,779
                

Total

   $ 23,276      $ 14,260   
                

The improvement to income from Service Operations was due to improved profit margins on third-party construction activities performed during the first six months of 2011.

Depreciation and Amortization

Depreciation and amortization expense increased from $159.5 million during the first six months of 2010 to $194.7 million for the same period in 2011, primarily due to shorter-lived lease-based intangible assets being recognized in conjunction with our acquisition activity in 2010 and 2011.

Equity in Earnings of Unconsolidated Companies

Equity in earnings decreased from $6.9 million in the six months ended June 30, 2010 to $2.8 million for the same period in 2011. This decrease was largely due to the consolidation of 106 properties upon the acquisition of our partner’s 50% interest in Dugan on July 1, 2010.

Gain on Sale of Properties

During the six months ended June 30, 2011, we sold 18 properties that did not meet the criteria for inclusion in discontinued operations, recognizing total gains on sale of $68.3 million.

During the six-month period ended June 30, 2010, we sold eight properties that did not meet the criteria for inclusion in discontinued operations, recognizing total gains on sale of $7.0 million.

Impairment Charges

The decrease in impairment charges from $8.0 million in the six months ended June 30, 2010 to no impairment charges in the six months ended June 30, 2011 is primarily due to the sale of 50 acres of land in the second quarter of 2010.

General and Administrative Expense

General and administrative expenses decreased from $22.7 million for the six months ended June 30, 2010 to $19.7 million for the same period in 2011. The reduction in general and administrative expenses was primarily the result of an increase to indirect costs absorbed by operations, due in large part to increased leasing activity.

Interest Expense

Interest expense increased from $114.3 million in the first six months of 2010 to $133.0 million in the first six months of 2011. The increase to interest expense was primarily driven by additional secured debt assumed over the last year in conjunction with our acquisition activity. A $4.3 million decrease in the capitalization of interest costs, the result of reduced development activity, also contributed to the increase in interest expense.

 

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Discontinued Operations

The operations of 31 buildings are classified as discontinued operations for the six months ended June 30, 2011 and June 30, 2010. These 31 buildings consist of 21 office, eight industrial, and two retail properties. As a result, we classified income, before gain on sales, of $107,000 and $1.7 million in discontinued operations for the six months ended June 30, 2011 and 2010, respectively.

Of these properties, twelve were sold during the first six months of 2011 and eleven were sold during the first six months of 2010. The $14.3 million and $12.9 million gains on disposal of these properties for the six months ended June 30, 2011 and 2010, respectively, are also reported in discontinued operations.

Liquidity and Capital Resources

Sources of Liquidity

We expect to meet our short-term liquidity requirements over the next twelve months, including payments of dividends and distributions as well as capital expenditures needed to maintain our current real estate assets, primarily through working capital, net cash provided by operating activities and proceeds received from real estate dispositions. Additionally, we have no outstanding borrowings on DRLP’s $850.0 million unsecured line of credit at June 30, 2011, which allows us significant additional flexibility for temporary financing of either short-term obligations or strategic acquisitions.

In addition to our existing sources of liquidity, we expect to meet long-term liquidity requirements, such as scheduled mortgage and unsecured debt maturities, property acquisitions, financing of development activities and other capital improvements, through multiple sources of capital including operating cash flow, proceeds from property dispositions and accessing the public debt and equity markets.

Rental Operations

Cash flows from Rental Operations is our primary source of liquidity and provides a stable source of cash flow to fund operational expenses. We believe that this cash-based revenue stream is substantially aligned with revenue recognition (except for periodic straight-line rental income accruals and amortization of above or below market rents) as cash receipts from the leasing of rental properties are generally received in advance of, or a short time following, the actual revenue recognition.

We are subject to a number of risks as a result of general economic conditions, including reduced occupancy, tenant defaults and bankruptcies and potential reduction in rental rates upon renewal or re-letting of properties, any of which would result in reduced cash flow from operations.

Unsecured Debt and Equity Securities

We have historically used the DRLP unsecured line of credit to fund development activities, acquire additional rental properties and provide working capital.

At June 30, 2011, we had on file with the SEC an automatic shelf registration statement on Form S-3 relating to the offer and sale, from time to time, of an indeterminate amount of DRLP’s debt securities (including guarantees thereof) and the Company’s common shares, preferred shares and other securities. From time to time, we expect to issue additional securities under this automatic shelf registration statement to fund the repayment of long-term debt upon maturity and for other general corporate purposes.

 

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Pursuant to our automatic shelf registration statement, at June 30, 2011, we had on file with the SEC a prospectus supplement that allows us to issue new shares of our common stock, from time to time, pursuant to an at the market offering program, with an aggregate offering price of up to $150.0 million. No new shares have been issued pursuant to this prospectus supplement as of June 30, 2011.

The indentures (and related supplemental indentures) governing our outstanding series of notes require us to comply with financial ratios and other covenants regarding our operations. We were in compliance with all such covenants, as well as applicable covenants under our unsecured line of credit, as of June 30, 2011.

Sale of Real Estate Assets

We regularly work to identify, consider and pursue opportunities to dispose of non-strategic properties on an opportunistic basis and on a basis that is generally consistent with our strategic plans. Our ability to dispose of such properties on favorable terms, or at all, is dependent upon a number of factors including the availability of credit to potential buyers to purchase properties at prices that we consider acceptable. Future adverse changes to market and economic conditions, including, without limitation, the availability and cost of credit, the U.S. mortgage market, and condition of the equity and real estate markets could prevent us from disposing of such properties quickly, if at all.

Transactions with Unconsolidated Entities

Transactions with unconsolidated partnerships and joint ventures also provide a source of liquidity. From time to time we will sell properties to unconsolidated entities, while retaining a continuing interest in that entity, and receive proceeds commensurate to those interests that we do not own. Additionally, unconsolidated entities will from time to time obtain debt financing and will distribute to us, and our joint venture partners, all or a portion of the proceeds from such debt financing.

We have a 20% equity interest in an unconsolidated joint venture (“Duke/Hulfish”) which, along with its subsidiary entities, has acquired 35 properties from us since its formation in May 2008. We have received cumulative net sale and financing proceeds of approximately $847.2 million through June 30, 2011. We are party to an agreement that allows Duke/Hulfish a right of first offer to acquire future build-to-suit or speculative developments on certain of our parcels of undeveloped land.

During the six months ended June 30, 2011, we sold 13 suburban office buildings, totaling approximately 2.0 million square feet, to Duke/Hulfish, for $342.8 million, of which our 80% share of net proceeds totaled $273.7 million. Concurrent with the aforementioned sale of 13 properties, we also received a distribution of $54.7 million, which is commensurate to our 20% share of the net proceeds of a non-guaranteed short-term loan that was obtained by Duke/Hulfish.

 

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Uses of Liquidity

Our principal uses of liquidity include the following:

 

   

accretive property investment;

 

   

leasing/capital costs;

 

   

dividends and distributions to shareholders and unitholders;

 

   

long-term debt maturities;

 

   

opportunistic repurchases of outstanding debt and preferred stock; and

 

   

other contractual obligations.

Property Investment

We continue to pursue an asset repositioning strategy that involves increasing our investment concentration in industrial and medical office properties while reducing our investment concentration in suburban office properties. Pursuant to this strategy, we evaluate development and acquisition opportunities based upon market outlook, supply and long-term growth potential. Our ability to make future property investments, along with being dependent upon identifying suitable acquisition and development opportunities, is also dependent upon our continued access to our longer-term sources of liquidity, including issuances of debt or equity securities as well as generating cash flow by disposing of selected properties.

In light of current economic conditions, management continues to evaluate our investment priorities and remains focused on accretive growth.

Second Generation Expenditures

Tenant improvements and leasing costs to re-let rental space that has been previously under lease to tenants are referred to as second generation expenditures. Building improvements that are not specific to any tenant but serve to improve integral components of our real estate properties are also second generation expenditures.

One of the principal uses of our liquidity is to fund the second generation leasing/capital expenditures of our real estate investments. The following is a summary of our second generation capital expenditures for the six months ended June 30, 2011 and 2010, respectively (in thousands):

 

     Six Months Ended
June 30,
 
     2011      2010  

Second generation tenant improvements

   $ 21,491       $ 16,450   

Second generation leasing costs

     18,557         16,389   

Building improvements

     1,236         1,966   
  

 

 

    

 

 

 

Totals

   $ 41,284       $ 34,805   
  

 

 

    

 

 

 

Dividend and Distribution Requirements

We are required to meet the distribution requirements of the Internal Revenue Code of 1986, as amended (the “Code”), in order to maintain our REIT status. Because depreciation is a non-cash expense, cash flow will typically be greater than operating income. We paid distributions of $0.17 per common share in the first and second quarters of 2011 and our board of directors declared dividends of $0.17 per share for the third quarter of 2011. Our future dividends will be declared at the discretion of our board of directors and will be subject to our future capital needs and availability.

 

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At June 30, 2011, we had six series of preferred stock outstanding. The annual dividend rates on our preferred shares range between 6.5% and 8.375% and are paid in arrears quarterly. In July 2011, we redeemed all of our 7.25% Series N Cumulative Redeemable Preferred Shares (“Series N Shares”) for a total payment of $109.0 million, thus reducing our future quarterly dividend commitments by $2.0 million.

Debt Maturities

Debt outstanding at June 30, 2011 had a face value totaling $4.1 billion with a weighted average interest rate of 6.36% and matures at various dates through 2028. Of this total amount, we had $2.9 billion of unsecured notes, $18.3 million outstanding on a consolidated subsidiary’s unsecured line of credit and $1.2 billion of secured debt outstanding at June 30, 2011. Scheduled principal amortization, repurchases and maturities of such debt totaled $226.3 million for the six months ended June 30, 2011.

The following is a summary of the scheduled future amortization and maturities of our indebtedness at June 30, 2011 (in thousands, except percentage data):

 

     Future Repayments      Weighted Average  

Year

   Scheduled
Amortization
     Maturities      Total      Interest Rate of
Future Repayments
 

Remainder of 2011

   $ 9,438       $ 302,313       $ 311,751         4.96

2012

     17,009         351,053         368,062         5.65

2013

     16,575         521,644         538,219         6.28

2014

     15,270         305,012         320,282         6.34

2015

     12,911         349,102         362,013         6.84

2016

     10,976         492,560         503,536         6.16

2017

     9,293         536,921         546,214         5.95

2018

     7,356         300,000         307,356         6.08

2019

     6,322         518,438         524,760         7.97

2020

     4,732         250,000         254,732         6.73

2021

     3,416         —           3,416         5.54

Thereafter

     17,789         50,000         67,789         6.86
  

 

 

    

 

 

    

 

 

    
   $ 131,087       $ 3,977,043       $ 4,108,130         6.36
  

 

 

    

 

 

    

 

 

    

We anticipate generating capital to fund our debt maturities by using undistributed cash generated from our Rental Operations and property dispositions, and by raising additional capital from future debt or equity transactions.

Repurchases of Outstanding Debt and Preferred Stock

In the first six months of 2011, we repaid $42.5 million of senior unsecured notes, which had an effective interest rate of 6.96%, at their scheduled maturity date.

During the first six months of 2011, we repurchased 80,000 shares of our 8.375% Series O Cumulative Redeemable Preferred Shares (the “Series O Shares”). In total, we paid $2.1 million for these preferred shares that had a face value of $2.0 million. We paid $109.0 million in July 2011 to redeem our Series N Shares, which included dividends accrued through the redemption date.

To the extent that it supports our overall capital strategy, we may purchase certain of our outstanding unsecured debt prior to its stated maturity or redeem or repurchase certain of our outstanding series of preferred stock.

 

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Historical Cash Flows

Cash and cash equivalents were $117.6 million and $256.3 million at June 30, 2011 and 2010, respectively. The following highlights significant changes in net cash associated with our operating, investing and financing activities (in millions):

 

     Six Months Ended
June 30,
 
     2011     2010  

Net Cash Provided by Operating Activities

   $ 144.3      $ 148.4   

Net Cash Provided by (Used for) Investing Activities

   $ 305.7      $ (21.8

Net Cash Used for Financing Activities

   $ (350.7   $ (17.7

Operating Activities

The receipt of rental income from Rental Operations continues to be our primary source of operating cash flows. For the six months ended June 30, 2011, cash provided by operating activities decreased to $144.3 million from $148.4 million in the same period in 2010. The decrease in cash provided by operating activities is primarily attributable to the timing of cash payments and receipts on third-party construction contracts.

Investing Activities

Investing activities are one of the primary uses of our liquidity. Development and acquisition activities typically generate additional rental revenues and provide cash flows for operational requirements. Highlights of significant cash sources and uses are as follows:

 

   

Real estate development costs increased to $78.6 million for the six-month period ended June 30, 2011 from $56.8 million for the same period in 2010, primarily as a result of one build-to-suit property that was completed and sold in June 2011.

 

   

Sales of land and depreciated property provided $498.2 million in net proceeds for the six-month period ended June 30, 2011, compared to $151.8 million for the same period in 2010.

 

   

During the six-month period ended June 30, 2011, we received a $54.7 million cash distribution, which represented our share of the net proceeds from a loan obtained by one of our unconsolidated joint ventures.

 

   

During the six-month period ended June 30, 2011, we paid cash of $99.8 million for real estate acquisitions, compared to $19.2 million for real estate acquisitions and $4.7 million for undeveloped land acquisitions in the same period in 2010.

Financing Activities

The following items highlight some of the factors that account for the difference in net cash flow related to financing activities in the first six months of 2011 compared to the same period in 2010:

 

   

In March 2011, we repaid $42.5 million of unsecured notes with an effective rate of 6.96% at their scheduled maturity date, while, in January 2010, we repaid $99.8 million of senior unsecured notes with an effective interest rate of 5.37% on their scheduled maturity date.

 

   

In April 2010, we issued $250.0 million of senior unsecured notes that bear interest at 6.75% and mature in March 2020, compared to no issuances of senior unsecured notes for the six-month period ended June 30, 2011.

 

   

In March 2011, we repaid $175.0 million on DRLP’s $850.0 million unsecured line of credit, while there was no net change in these borrowings for the six months ended June 30, 2010. We had no outstanding borrowings on the DRLP line of credit at June 30, 2011.

 

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During the first six months of 2010, through a cash tender offer and other open market transactions, we repurchased certain of our outstanding series of unsecured notes scheduled to mature in 2011 and 2013. In total, we paid $288.0 million for unsecured notes that had a face value of $275.7 million.

 

   

During June 2010, we completed open market repurchases of approximately 2.2 million shares of the Series O Shares compared to repurchases of 80,000 of such shares during the six-month period ended June 30, 2011. During the six-month period ended June 30, 2010, we paid $58.3 million to repurchase these shares, which had a face value of $55.7 million, as compared to paying $2.1 million during the six-month period ended June 30, 2011 for shares which had a face value of $2.0 million.

 

   

In June 2010, we issued 26.5 million shares of common stock for net proceeds of $298.1 million, compared to no issuances of common stock for the six-month period ended June 30, 2011.

Contractual Obligations

Aside from changes in long-term debt, there have not been material changes in our outstanding commitments since December 31, 2010, as previously discussed in our 2010 Annual Report on Form 10-K.

Off Balance Sheet Arrangements - Investments in Unconsolidated Companies

We analyze our investments in unconsolidated joint ventures to determine if they meet the criteria for classification as a variable interest entity (a “VIE”) and would require consolidation. We (i) evaluate the sufficiency of the total equity at risk, (ii) review the voting rights and decision-making authority of the equity investment holders as a group, and whether there are any guaranteed returns, protection against losses, or capping of residual returns within the group and (iii) establish whether activities within the venture are on behalf of an investor with disproportionately few voting rights in making this VIE determination. We would consolidate a venture that is determined to be a VIE if we were the primary beneficiary. To the extent that our joint ventures do not qualify as VIEs, we further assess each joint venture partner’s substantive participating rights to determine if the venture should be consolidated.

We have equity interests in unconsolidated partnerships and limited liability companies that own and operate rental properties and hold land for development. These unconsolidated joint ventures are primarily engaged in the operations and development of industrial, office and medical office real estate properties. These investments provide us with increased market share and tenant and property diversification. The equity method of accounting is used for these investments in which we have the ability to exercise significant influence, but not control, over operating and financial policies. As a result, the assets and liabilities of these entities are not included on our balance sheet. Our investments in and advances to unconsolidated subsidiaries represented approximately 5% of our total assets as of both June 30, 2011 and December 31, 2010. Total assets of our unconsolidated subsidiaries were $2.6 billion and $2.2 billion as of June 30, 2011 and December 31, 2010, respectively. The combined revenues of our unconsolidated subsidiaries totaled $129.0 million and $136.2 million for the six-month periods ended June 30, 2011 and 2010, respectively.

We have guaranteed the repayment of certain secured and unsecured loans of our unconsolidated subsidiaries and the outstanding balances on the guaranteed portion of these loans totaled $249.9 million at June 30, 2011.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to interest rate changes primarily as a result of our line of credit and our long-term borrowings. Our interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash flows and to lower overall borrowing costs. To achieve our objectives, we borrow primarily at fixed rates. We do not enter into derivative or interest rate transactions for speculative purposes. Our two outstanding swaps, which fixed the rates on two of our variable rate loans, were not significant to our Financial Statements in terms of notional amount or fair value at June 30, 2011.

 

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Our interest rate risk is monitored using a variety of techniques. The table below presents the principal amounts (in thousands) of the expected annual maturities, weighted average interest rates for the average debt outstanding in the specified period, fair values (in thousands) and other terms required to evaluate the expected cash flows and sensitivity to interest rate changes.

 

     Remainder
of 2011
    2012     2013     2014     2015     Thereafter     Face Value      Fair Value  

Fixed rate secured debt

   $ 19,912      $ 109,981      $ 110,374      $ 67,254      $ 109,487      $ 742,768      $ 1,159,776       $ 1,229,467   

Weighted average interest rate

     7.04