hiw10k2010.htm




UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-K

[X]          Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the fiscal year ended December 31, 2010

OR

[  ]          Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from________ to___________


HIGHWOODS PROPERTIES, INC.
(Exact name of registrant as specified in its charter)

 
Maryland
001-13100
56-1871668
 
 
(State or other jurisdiction
of incorporation or organization)
(Commission
File Number)
(I.R.S. Employer
Identification Number)
 


HIGHWOODS REALTY LIMITED PARTNERSHIP
(Exact name of registrant as specified in its charter)

 
North Carolina
000-21731
56-1869557
 
 
(State or other jurisdiction
of incorporation or organization)
(Commission
File Number)
(I.R.S. Employer
Identification Number)
 

3100 Smoketree Court, Suite 600
Raleigh, NC 27604
(Address of principal executive offices) (Zip Code)
 
919-872-4924
(Registrants’ telephone number, including area code)
______________

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class
Name of Each Exchange on Which Registered
Common Stock, $.01 par value, of Highwoods Properties, Inc.
New York Stock Exchange
8 5/8% Series A Cumulative Redeemable Preferred Shares of Highwoods Properties, Inc.
New York Stock Exchange
8% Series B Cumulative Redeemable Preferred Shares of Highwoods Properties, Inc.
New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:

NONE

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
 
Highwoods Properties, Inc.  Yes  S    No £            Highwoods Realty Limited Partnership  Yes  S    No £

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act.
 
Highwoods Properties, Inc.  Yes  £    No S            Highwoods Realty Limited Partnership  Yes  £    No S

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.
 
Highwoods Properties, Inc.  Yes  S    No £            Highwoods Realty Limited Partnership  Yes  S    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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
Highwoods Properties, Inc.  Yes  S    No £            Highwoods Realty Limited Partnership  Yes  £    No £

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of such registrants’ knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   S

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of ‘large accelerated filer,’ ‘accelerated filer’ and ‘smaller reporting company’ in Rule 12b-2 of the Securities Exchange Act.
 
Highwoods Properties, Inc.
Large accelerated filer S    Accelerated filer £      Non-accelerated filer £      Smaller reporting company £
 
Highwoods Realty Limited Partnership
Large accelerated filer £    Accelerated filer £      Non-accelerated filer S      Smaller reporting company £

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act).
 
Highwoods Properties, Inc.  Yes  £    No S            Highwoods Realty Limited Partnership  Yes  £    No S

The aggregate market value of shares of Common Stock of Highwoods Properties, Inc. held by non-affiliates (based upon the closing sale price on the New York Stock Exchange) on June 30, 2010 was approximately $2.0 billion. At February 2, 2011, there were 71,704,149 shares of Common Stock outstanding.

There is no public trading market for the Common Units of Highwoods Realty Limited Partnership. As a result, an aggregate market value of the Common Units of Highwoods Realty Limited Partnership cannot be determined.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement of Highwoods Properties, Inc. to be filed in connection with its Annual Meeting of Stockholders to be held May 12, 2011 are incorporated by reference in Part II, Item 5 and Part III, Items 10, 11, 12, 13 and 14.





 
 

 


HIGHWOODS PROPERTIES, INC.
HIGHWOODS REALTY LIMITED PARTNERSHIP

TABLE OF CONTENTS

Item No.
     
Page
 
   
PART I
     
1.
     
1A.
     
1B.
     
2.
     
3.
     
X.
     
           
   
PART II
     
5.
     
6.
     
7.
     
7A.
     
8.
     
9.
     
9A.
     
9B.
     
           
   
PART III
     
10.
     
11.
     
12.
     
13.
     
14.
     
           
   
PART IV
     
15.
     
           


 
3


PART I

We refer to Highwoods Properties, Inc. as the “Company,” Highwoods Realty Limited Partnership as the “Operating Partnership,” the Company’s common stock as “Common Stock” or “Common Shares,” the Company’s preferred stock as “Preferred Stock” or “Preferred Shares,” the Operating Partnership’s common partnership interests as “Common Units,” the Operating Partnership’s preferred partnership interests as “Preferred Units” and in-service properties (excluding rental residential units and for-sale residential condominiums) to which the Company and/or the Operating Partnership have title and 100.0% ownership rights as the “Wholly Owned Properties.” References to “we” and “our” mean the Company and the Operating Partnership, collectively, unless the context indicates otherwise.

The Company is a fully-integrated, self-administered and self-managed equity real estate investment trust (“REIT”). The Common Stock is traded on the New York Stock Exchange (“NYSE”) under the symbol “HIW.” The Company conducts virtually all of its activities through the Operating Partnership and is its sole general partner. The partnership agreement provides that the Operating Partnership will assume and pay when due, or reimburse the Company for payment of, all costs and expenses relating to the ownership and operations of, or for the benefit of, the Operating Partnership. The partnership agreement further provides that all expenses of the Company are deemed to be incurred for the benefit of the Operating Partnership.

ITEM 1. BUSINESS

General

We are one of the largest owners and operators of office properties in the Southeastern and Midwestern United States. While we also own and operate industrial and retail properties in three of our markets, our office properties represented 86.5% of rental and other revenues for the year ended December 31, 2010. At December 31, 2010, we:

 
·
wholly owned 295 in-service office, industrial and retail properties, encompassing approximately 27.2 million rentable square feet, 96 rental residential units and 26 for-sale residential condominiums;

 
·
owned an interest (50.0% or less) in 35 in-service office and industrial properties, encompassing approximately 5.2 million rentable square feet, one office property under development and 11 acres of development land, including a 12.5% interest in a 261,000 square foot office property owned directly by the Company and thus is included in the Company’s Consolidated Financial Statements, but not included in the Operating Partnership’s Consolidated Financial Statements;

 
·
wholly owned 611 acres of undeveloped land, approximately 523 acres of which are considered core holdings, defined as properties expected to be held indefinitely, and which are suitable to develop approximately 5.8 million and 2.7 million rentable square feet of office and industrial space, respectively; and

 
·
wholly owned two completed but not yet stablilized office properties encompassing 265,000 square feet.

At December 31, 2010, the Company owned all of the Preferred Units and 71.3 million, or 95.0%, of the Common Units. Limited partners (including one officer and two directors of the Company) own the remaining 3.8 million Common Units. Generally, the Operating Partnership is obligated to redeem each Common Unit at the request of the holder thereof for cash equal to the value of one share of Common Stock based on the average of the market price for the 10 trading days immediately preceding the notice date of such redemption provided that the Company, at its option, may elect to acquire any such Common Units presented for redemption for cash or one share of Common Stock. The Common Units owned by the Company are not redeemable.

The Company was incorporated in Maryland in 1994. The Operating Partnership was formed in North Carolina in 1994. Our executive offices are located at 3100 Smoketree Court, Suite 600, Raleigh, NC 27604, and our telephone number is (919) 872-4924.

Our business is the operation, acquisition and development of rental real estate properties. We operate office, industrial, retail and residential properties. There are no material inter-segment transactions. See Note 19 to our Consolidated Financial Statements for a summary of the rental and other revenues, net operating income and assets for each reportable segment.

 
4




In addition to this Annual Report, we file or furnish quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”). All documents that the Company files or furnishes with the SEC are made available as soon as reasonably practicable free of charge on our website, which is http://www.highwoods.com. The information on our website is not and should not be considered part of this Annual Report and is not incorporated by reference in this document. You may also read and copy any document that we file or furnish at the public reference facilities of the SEC at 100 F. Street, N.E., Room 1580, Washington, DC 20549. Please call the SEC at (800) 732-0330 for further information about the public reference facilities. These documents also may be accessed through the SEC’s interactive data electronic applications on the SEC’s website, which is http://www.sec.gov. In addition, you can read similar information about us at the offices of the NYSE at 20 Broad Street, New York, NY 10005.

During 2010, the Company filed unqualified Section 303A certifications with the NYSE. The Company and the Operating Partnership have also filed the CEO and CFO certifications required by Sections 302 and 906 of the Sarbanes-Oxley Act of 2002 as exhibits to this Annual Report.

Business and Operating Strategy

Our Strategic Plan focuses on:

    ·  
owning high-quality, differentiated real estate assets in the better submarkets in our core markets;

    ·  
improving the operating results of our existing properties through concentrated leasing, asset management, cost control and customer service efforts;

    ·  
developing and acquiring office properties in in-fill and central business district locations that improve the overall quality of our portfolio and generate attractive returns over the long-term for our stockholders;

    ·  
selectively disposing of properties no longer considered to be core holdings primarily due to location, age, quality and overall strategic fit; and

    ·  
maintaining a conservative, flexible balance sheet with ample liquidity to meet our funding needs and growth prospects.

Local Market Leadership. We focus our real estate activities in markets where we have extensive local knowledge and own a significant amount of assets. We maintain offices in each of our core markets, except Greenville, SC, which are led by division officers that have significant real estate experience in their respective markets. Our real estate professionals are seasoned and cycle-tested. Our senior leadership team has significant experience and maintains important relationships with market participants in each of our core markets.

Customer Service-Oriented Organization. We provide a complete line of real estate services to our customers. We believe that our in-house leasing and asset management, development, acquisition and construction management services allow us to respond to the many demands of our existing and potential customer base. We provide our customers with cost-effective services such as build-to-suit construction and space modification, including tenant improvements and expansions. In addition, the breadth of our capabilities and resources provides us with market information not generally available. We believe that operating efficiencies achieved through our fully integrated organization and the strength of our balance sheet also provide a competitive advantage in retaining existing customers and attracting new customers as well as setting our lease rates and pricing other services. In addition, our relationships with our customers may lead to development projects when these customers seek new space.

Geographic Diversification. Today, including our various joint ventures, our core portfolio consists of office properties in Raleigh, Tampa, Nashville, Memphis, Richmond and Orlando, office and industrial properties in Atlanta and Greensboro and retail and office properties in Kansas City. We do not believe that our operations are significantly dependent upon any particular geographic market. However, economic growth and employment levels in Florida, Georgia, North Carolina and Tennessee will continue to be important determinative factors in predicting our future operating results.

 
5



Conservative and Flexible Balance Sheet. We are committed to maintaining a conservative and flexible balance sheet that allows us to capitalize on favorable development and acquisition opportunities as they arise. Our balance sheet also allows us to proactively assure our existing and prospective customers that we are able to fund tenant improvements and maintain our properties in good condition.

We expect to meet our liquidity needs through a combination of:

    ·  
cash flow from operating activities;

    ·  
borrowings under our credit facilities;

    ·  
the issuance of unsecured debt;

    ·  
the issuance of secured debt;

    ·  
the issuance of equity securities by the Company or the Operating Partnership; and

    ·  
the disposition of non-core assets.

Competition

Our properties compete for customers with similar properties located in our markets primarily on the basis of location, rent, services provided and the design, quality and condition of the facilities. We also compete with other REITs, financial institutions, pension funds, partnerships, individual investors and others when attempting to acquire, develop and operate properties.

Employees

At December 31, 2010, the Company had 397 full-time employees, of which 396 were also employees of the Operating Partnership.

ITEM 1A. RISK FACTORS

An investment in our securities involves various risks. Investors should carefully consider the following risk factors in conjunction with the other information contained in this Annual Report before trading in our securities. If any of these risks actually occur, our business, operating results, prospects and financial condition could be harmed.

Adverse economic conditions in our markets that negatively impact the demand for office space, such as high unemployment, may result in lower occupancy and rental rates for our portfolio, which would result in lower operating results. While we own and operate a limited number of industrial, retail and residential properties, our operating results depend heavily on successfully leasing and operating our office properties. Economic growth and employment levels in Florida, Georgia, North Carolina and Tennessee are and will continue to be important determinative factors in predicting our future operating results.

Key components affecting our rental and other revenues include average occupancy and rental rates. Average occupancy generally increases during times of improving economic growth, as our ability to lease space outpaces vacancies that occur upon the expirations of existing leases. Average occupancy generally declines during times of slower or negative economic growth and decreasing office employment because new vacancies tend to outpace our ability to lease space. In addition, the timing of changes in occupancy levels tends to lag the timing of changes in overall economic activity and employment levels. For additional information regarding our average occupancy and rental rate trends over the past five years, see “Item 2. Properties – Wholly Owned Properties” set forth in this Annual Report. A further indicator of the predictability of future revenues is the expected lease expirations of our portfolio. As a result, in addition to seeking to increase our average occupancy by leasing current vacant space, we also concentrate our leasing efforts on renewing leases on expiring space. For more information regarding our lease expirations, see “Item 2. Properties – Lease Expirations” set forth in this Annual Report. Whether or not our rental revenue tracks average occupancy proportionally depends upon whether rents under new leases signed are higher or lower than the rents under the previous leases. Lower rental revenues resulting from lower average occupancy or lower rental rates with respect to our same property portfolio will generally reduce our operating results unless offset by the impact of any newly acquired or developed properties or lower variable operating expenses, general and administrative expenses and/or interest expense.

 
6




An oversupply of space in our markets would typically cause rental rates and occupancies to decline, making it more difficult for us to lease space at attractive rental rates, if at all. Undeveloped land in many of the markets in which we operate is generally more readily available and less expensive than in higher barrier-to-entry markets such as New York, Chicago, Boston, San Francisco and Los Angeles. As a result, even during times of positive economic growth, our competitors could construct new buildings that would compete with our properties. Any such oversupply could result in lower occupancy and rental rates in our portfolio, which would have a negative impact on our operating results.

In order to maintain the quality of our properties and successfully compete against other properties, we periodically must spend money to maintain, repair and renovate our properties, which reduces our cash flows. If our properties are not as attractive to customers due to physical condition as properties owned by our competitors, we could lose customers or suffer lower rental rates. As a result, we may from time to time be required to make significant capital expenditures to maintain the competitiveness of our properties. There can be no assurances that any such expenditures would result in higher occupancy or higher rental rates or deter existing customers from relocating to properties owned by our competitors.

Our operating results and financial condition could be adversely affected by financial difficulties experienced by a major customer, or by a number of smaller customers, including bankruptcies, insolvencies or general downturns in business. The success of our investments and stability of our operations depend on the financial stability of our customers. A default or termination by a significant customer on its lease payments to us would cause us to lose the revenue associated with such lease. In the event of a customer default or bankruptcy, we may experience delays in enforcing our rights as landlord and may incur substantial costs in protecting our investment and re-leasing the property. If a customer defaults on or terminates a significant lease, we may not be able to recover the full amount of unpaid rent or be able to lease the property for the rent previously received, if at all. These events could reduce our operating results.

To relet space to an existing customer or attract a new customer to occupy space, we may incur significant costs in the process, including potentially substantial tenant improvements, broker commissions and lease incentives. Approximately 10-15% of our revenues at the beginning of any particular year are subject to leases that expire by the end of that year. As a result, in addition to seeking to increase our average occupancy by leasing current vacant space, we also concentrate our leasing efforts on renewing leases on expiring space. To entice customers to renew existing leases or sign new leases, we may be required to make substantial leasing capital expenditures. In addition, if market rents have declined since the time the expiring lease was executed, the terms of any new lease likely will not be as favorable to us as the terms of the expiring lease, thereby reducing the rental revenue earned from that space. If our competitors offer space at rental rates below current market rates or below the rental rates we currently charge our customers, we may lose existing or prospective customers, and we may be pressured to reduce our rental rates below those we currently charge or to offer more substantial rent abatements, tenant improvements, early termination rights and other concessions.

Costs of complying with governmental laws and regulations may reduce our operating results. All real property and the operations conducted on real property are subject to federal, state and local laws and regulations relating to environmental protection and human health and safety. Some of these laws and regulations may impose joint and several liability on customers, owners or operators for the costs to investigate or remediate contaminated properties, regardless of fault or whether the acts causing the contamination were legal. In addition, the presence of hazardous substances, or the failure to properly remediate these substances, may hinder our ability to sell, rent or pledge such property as collateral for future borrowings.

Compliance with new laws or regulations or stricter interpretation of existing laws may require us to incur significant expenditures. Future laws or regulations may impose significant environmental liability. Additionally, our customers’ operations, operations in the vicinity of our properties, such as the presence of underground storage tanks, or activities of unrelated third parties may affect our properties. In addition, there are various local, state and federal fire, health, life-safety and similar regulations with which we may be required to comply and that may subject us to liability in the form of fines or damages for noncompliance. Any expenditures, fines or damages we must pay would reduce our operating results. Proposed legislation to address climate change could increase utility and other costs of operating our properties which, if not offset by rising rental income, would reduce our net income.

 
7




Discovery of previously undetected environmentally hazardous conditions may decrease our operating results and limit our ability to make distributions. Under various federal, state and local environmental laws and regulations, a current or previous property owner or operator may be liable for the cost to remove or remediate hazardous or toxic substances on such property. These costs could be significant. Such laws often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances. Environmental laws also may impose restrictions on the manner in which property may be used or businesses may be operated, and these restrictions may require significant expenditures or prevent us from entering into leases with prospective customers that may be impacted by such laws. Environmental laws provide for sanctions for noncompliance and may be enforced by governmental agencies or private parties. Certain environmental laws and common law principles could be used to impose liability for release of and exposure to hazardous substances, including asbestos-containing materials. Third parties may seek recovery from real property owners or operators for personal injury or property damage associated with exposure to released hazardous substances. The cost of defending against claims of liability, of complying with environmental regulatory requirements, of remediating any contaminated property, or of paying personal injury claims could reduce our operating results.

Our operating results may suffer if costs of operating our properties, such as real estate taxes, utilities, insurance, maintenance and other costs, rise faster than our ability to increase rental revenues. While we receive additional rent from our customers that is based on recovering a portion of operating expenses, increased operating expenses will negatively impact our operating results. Our revenues and expense recoveries are subject to longer-term leases and may not be quickly increased sufficient to recover an increase in operating costs and expenses. Furthermore, the costs associated with owning and operating a property are not necessarily reduced when circumstances such as market factors and competition cause a reduction in rental revenues from the property. Increases in same property operating expenses would reduce our operating results unless offset by the impact of any newly acquired or developed properties or lower general and administrative expenses and/or interest expense.

Recent and future acquisitions and development properties may fail to perform in accordance with our expectations and may require renovation and development costs exceeding our estimates. In the normal course of business, we typically evaluate potential acquisitions, enter into non-binding letters of intent, and may, at any time, enter into contracts to acquire additional properties. Acquired properties may fail to perform in accordance with our expectations due to lease-up risk, renovation cost risks and other factors. In addition, the renovation and improvement costs we incur in bringing an acquired property up to market standards may exceed our estimates. We may not have the financial resources to make suitable acquisitions or renovations on favorable terms or at all.

Further, we face significant competition for attractive investment opportunities from an indeterminate number of other real estate investors, including investors with significantly greater capital resources and access to capital than we have, such as domestic and foreign corporations and financial institutions, publicly-traded and privately-held REITs, private institutional investment funds, investment banking firms, life insurance companies and pension funds. Moreover, owners of office properties may be reluctant to sell, resulting in fewer acquisition opportunities. As a result of such increased competition and limited opportunities, we may be unable to acquire additional properties or the purchase price of such properties may be significantly elevated, which may impede our growth and materially and adversely affect us.

In addition to acquisitions, we periodically consider developing and constructing properties. Risks associated with development and construction activities include:

 
·
the unavailability of favorable construction and/or permanent financing;

 
·
construction costs exceeding original estimates;

 
·
construction and lease-up delays resulting in increased debt service expense and construction costs; and

 
·
lower than anticipated occupancy rates and rents at a newly completed property causing a property to be unprofitable or less profitable than originally estimated.

 
8




Development activities are also subject to risks relating to our ability to obtain, or delays in obtaining, all necessary zoning, land-use, building, occupancy and other required governmental and utility company authorizations.

Illiquidity of real estate investments and the tax effect of dispositions could significantly impede our ability to sell assets or respond to favorable or adverse changes in the performance of our properties. Because real estate investments are relatively illiquid, our ability to promptly sell one or more properties in our portfolio in response to changing economic, financial and investment conditions is limited. In addition, we have a significant amount of mortgage debt under which we would incur significant prepayment penalties if such loans were paid off in connection with the sale of the underlying real estate assets.

We intend to continue to sell some of our properties in the future as part of our investment strategy and activities. However, we cannot predict whether we will be able to sell any property for the price or on the terms set by us, or whether the price or other terms offered by a prospective purchaser would be acceptable to us. We also cannot predict the length of time needed to find a willing purchaser and close the sale of a property.

Certain of our properties have low tax bases relative to their estimated current fair values, and accordingly, the sale of such assets would generate significant taxable gains unless we sold such properties in a tax-deferred exchange under Section 1031 of the Internal Revenue Code or another tax-free or tax-deferred transaction. For an exchange to qualify for tax-deferred treatment under Section 1031, the net proceeds from the sale of a property must be held by an escrow agent until applied toward the purchase of real estate qualifying for gain deferral. Given the competition for properties meeting our investment criteria, there could be a delay in reinvesting such proceeds. Any delay in using the reinvestment proceeds to acquire additional income producing assets would reduce our operating results.

Because holders of our Common Units, including one of our officers and two of our directors, may suffer adverse tax consequences upon the sale of some of our properties, they may seek to influence us not to sell certain properties even if such a sale would otherwise be in our best interest. Holders of Common Units may suffer adverse tax consequences upon the sale of certain properties. Therefore, holders of Common Units, including one of our officers and two of our directors, may have different objectives than the Company’s stockholders regarding the appropriate pricing and timing of a property’s sale. Although the Company is the sole general partner of the Operating Partnership and has the exclusive authority to sell any of our Wholly Owned Properties, officers and directors who hold Common Units may seek to influence the Company not to sell certain properties even if such sale might be financially advantageous to stockholders, creditors, bondholders or our business as a whole or influence the Company to enter into tax deferred exchanges with the proceeds of such sales when such a reinvestment might not otherwise be in our best interest.

The value of our joint venture investments could be adversely affected if we are unable to work effectively with our partners or our partners become unable to satisfy their financial obligations. Instead of owning properties directly, we have in some cases invested, and may continue to invest, as a partner or a co-venturer with one or more third parties. Under certain circumstances, this type of investment may involve risks not otherwise present, including the possibility that a partner or co-venturer might be unable to fund its obligations or might have business interests or goals inconsistent with ours. Also, such a partner or co-venturer may take action contrary to our requests or contrary to provisions in our joint venture agreements that could harm us. If we want to sell our interests in any of our joint ventures or believe that the properties in the joint venture should be sold, we may not be able to do so in a timely manner or at all, and our partner(s) may not cooperate with our desires, which could harm us.

Our insurance coverage on our properties may be inadequate. We carry insurance on all of our properties, including insurance for liability, fire, windstorms, floods, earthquakes and business interruption. Insurance companies, however, limit coverage against certain types of losses, such as losses due to terrorist acts, named windstorms, earthquakes and toxic mold. Thus, we may not have insurance coverage, or sufficient insurance coverage, against certain types of losses and/or there may be decreases in the insurance coverage available. Should an uninsured loss or a loss in excess of our insured limits occur, we could lose all or a portion of the capital we have invested in a property or properties, as well as the anticipated future revenue from the property or properties. If any of our properties were to experience a catastrophic loss, it could disrupt our operations, delay revenue and result in large expenses to repair or rebuild the property. Such events could adversely affect our operating results and financial condition.

 
9




Our use of debt to finance our operations could have a material adverse effect on our cash flow and ability to make distributions. We are subject to risks associated with debt financing, such as the sufficiency of cash flow to meet required payment obligations, ability to comply with financial ratios and other covenants and the availability of capital to refinance existing indebtedness or fund important business initiatives. Increases in interest rates on our variable rate debt would increase our interest expense. If we fail to comply with the financial ratios and other covenants under our credit facilities, we would likely not be able to borrow any further amounts under such facilities, which could adversely affect our ability to fund our operations, and our lenders could accelerate outstanding debt.

We generally do not intend to reserve funds to retire existing secured or unsecured debt upon maturity. We may not be able to repay, refinance or extend any or all of our debt at maturity or upon any acceleration. If any refinancing is done at higher interest rates, the increased interest expense could adversely affect our cash flow and ability to pay distributions. Any such refinancing could also impose tighter financial ratios and other covenants that restrict our ability to take actions that could otherwise be in our best interest, such as funding new development activity, making opportunistic acquisitions, repurchasing our securities or paying distributions. If we do not meet our mortgage financing obligations, any properties securing such indebtedness could be foreclosed on, which could have a material adverse effect on our cash flow and ability to pay distributions.

From time to time, we depend on our revolving credit facility for working capital purposes and for the short-term funding of our development and acquisition activity and, in certain instances, the repayment of other debt upon maturity. Our ability to borrow under the revolving credit facility also allows us to quickly capitalize on accretive opportunities at short-term interest rates. If our lenders default under their obligations under the revolving credit facility or we become unable to borrow additional funds under the facility for any reason, we would be required to seek alternative equity or debt capital, which could be more costly and adversely impact our financial condition. If such alternative capital were unavailable, we may not be able to make new investments and could have difficulty repaying other debt.

The Company may be subject to taxation as a regular corporation if it fails to maintain its REIT status, whichcould also have a material adverse effect on the Company’s stockholders and on the Operating Partnership. The Company is subject to adverse consequences if it fails to continue to qualify as a REIT for federal income tax purposes. While the Company intends to operate in a manner that will allow it to continue to qualify as a REIT, we cannot provide any assurances that it will remain qualified as such in the future, which would have particularly adverse consequences to the Company’s stockholders. Many of the requirements for taxation as a REIT are highly technical and complex and depend upon various factual matters and circumstances that may not be entirely within our control. For example, to qualify as a REIT, at least 95.0% of the Company’s gross income must come from certain sources that are itemized in the REIT tax laws. The fact that the Company holds virtually all of the assets through the Operating Partnership and its subsidiaries further complicates the application of the REIT requirements. Even a technical or inadvertent mistake could jeopardize the Company’s REIT status. Furthermore, Congress and the Internal Revenue Service (“IRS”) might change the tax laws and regulations and the courts might issue new rulings that make it more difficult, or impossible, for the Company to remain qualified as a REIT. If the Company fails to qualify as a REIT, it would be subject to federal income tax at regular corporate rates and would, therefore, have less cash available for investments or payment of principal and interest to our creditors or bondholders. Such events would likely have a significant adverse effect on our operating results and financial condition.

Cash distributions reduce the amount of cash that would otherwise be available for other business purposes, including funding debt maturities or future growth initiatives. For the Company to maintain its qualification as a REIT, it must annually distribute to its stockholders at least 90% of REIT taxable income, excluding net capital gains. In addition, although capital gains are not required to be distributed to maintain REIT status, capital gains, if any, that are generated as part of our capital recycling program are subject to federal and state income tax unless such gains are distributed to the Company’s stockholders. Cash distributions made to stockholders to maintain REIT status or to distribute otherwise taxable capital gains limit our ability to accumulate capital for other business purposes, including funding debt maturities or growth initiatives.

 
10




Because provisions contained in Maryland law, the Company’s charter and its bylaws may have an anti-takeover effect, the Company’s stockholders may be prevented from receiving a “control premium” for the Common Stock. Provisions contained in the Company’s charter and bylaws as well as Maryland general corporation law may have anti-takeover effects that delay, defer or prevent a takeover attempt, and thereby prevent stockholders of the Company from receiving a “control premium” for their shares. For example, these provisions may defer or prevent tender offers for the Common Stock or purchases of large blocks of the Common Stock, thus limiting the opportunities for the Company’s stockholders to receive a premium for their Common Stock over then-prevailing market prices. These provisions include the following:

 
·
Ownership limit. The Company’s charter prohibits direct, indirect or constructive ownership by any person or entity of more than 9.8% of the Company’s outstanding capital stock. Any attempt to own or transfer shares of the Company’s capital stock in excess of the ownership limit without the consent of the Company’s Board of Directors will be void.

 
·
Preferred Stock. The Company’s charter authorizes its Board of Directors to issue Preferred Stock in one or more classes and to establish the preferences and rights of any class of Preferred Stock issued. These actions can be taken without stockholder approval. The issuance of Preferred Stock could have the effect of delaying or preventing someone from taking control of the Company, even if a change in control were in our best interest.

 
·
Maryland control share acquisition statute. Maryland’s control share acquisition statute applies to the Company, which means that persons, entities or related groups that acquire more than 20% of the Common Stock may not be able to vote such excess shares under certain circumstances if such shares were acquired in one or more transactions not approved by at least two-thirds of the outstanding Common Stock held by disinterested stockholders.

 
·
Maryland unsolicited takeover statute. Under Maryland law, the Company’s Board of Directors could adopt various anti-takeover provisions without the consent of stockholders. The adoption of such measures could discourage offers for the Company or make an acquisition of the Company more difficult, even when an acquisition would be in the best interest of its stockholders.

 
·
Anti-takeover protections of Operating Partnership agreement. Upon a change in control of the Company, the partnership agreement of the Operating Partnership requires certain acquirers to maintain an umbrella partnership real estate investment trust structure with terms at least as favorable to the limited partners as are currently in place. For instance, the acquirer would be required to preserve the limited partner’s right to continue to hold tax-deferred partnership interests that are redeemable for capital stock of the acquirer. Exceptions would require the approval of two-thirds of the limited partners of the Operating Partnership (other than the Company). These provisions may make a change of control transaction involving the Company more complicated and therefore might decrease the likelihood of such a transaction occurring, even if such a transaction would be in the best interest of the Company’s stockholders.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

 
11


ITEM 2. PROPERTIES

Wholly Owned Properties

The following table sets forth information about our Wholly Owned Properties:
 
   
December 31, 2010
 
December 31, 2009
 
   
Rentable Square Feet
 
Percent Leased/ Pre-Leased
 
Rentable Square Feet
 
Percent Leased/ Pre-Leased
 
In-Service:
                 
Office (1)                                                                    
 
20,502,000
 
89.9
%
20,445,000
 
88.8
%
Industrial                                                                    
 
5,827,000
 
90.4
 
6,463,000
 
87.4
 
Retail                                                                    
 
853,000
 
97.8
 
869,000
 
98.0
 
Total or Weighted Average
 
27,182,000
 
90.3
%
27,777,000
 
88.8
%
                   
Development:
                 
Completed—Not Stabilized (2)
                 
Office                                                                    
 
265,000
 
13.4
%
301,000
 
46.0
%
Industrial                                                                    
 
 
 
200,000
 
50.0
 
Total or Weighted Average
 
265,000
 
13.4
%
501,000
 
47.6
%
                   
Total:
                 
Office                                                                    
 
20,767,000
     
20,746,000
     
Industrial                                                                    
 
5,827,000
     
6,663,000
     
Retail                                                                    
 
853,000
     
869,000
     
Total
 
27,447,000
     
28,278,000
     
__________
 
(1)
Includes a 60,000 square foot office property, which is reflected as development in process in our Consolidated Financial Statements.
 
(2)
We consider a development project to be stabilized upon the earlier of the original projected stabilization date or the date such project is at least 95% occupied. All of these properties were placed in service at December 31, 2010 and 2009, respectively, as reflected in our Consolidated Financial Statements.
 

The following table sets forth the net changes in square footage in our in-service Wholly Owned Properties:
 
   
Years Ended December 31,
 
   
2010
 
2009
 
2008
 
   
(rentable square feet in thousands)
 
Office, Industrial and Retail Properties:
             
Dispositions                                                                                            
 
(1,309
)
(550
)
(744
)
Developments Placed In-Service                                                                                            
 
413
 
751
 
1,380
 
Redevelopment/Other                                                                                            
 
(35
)
(17
)
(11
)
Acquisitions                                                                                            
 
336
 
220
 
135
 
Net Change in Square Footage of In-Service Wholly Owned Properties
 
(595
)
404
 
760
 


 
12




The following table sets forth information about our in-service Wholly Owned Properties by segment and by geographic location at December 31, 2010:

   
Rentable Square Feet
 
Occupancy
 
Percentage of Annualized Cash Rental Revenue (1)
 
Market
     
Office
 
Industrial
 
Retail
 
Total
 
Raleigh, NC                                                
 
4,196,000
 
90.6
%
16.1
%
 
 
16.1
%
Atlanta, GA                                                
 
5,869,000
 
90.1
 
11.0
 
3.7
%
 
14.7
 
Tampa, FL                                                
 
2,879,000
 
90.0
 
14.5
 
 
 
14.5
 
Nashville, TN                                                
 
3,096,000
 
89.8
 
13.3
 
 
 
13.3
 
Kansas City, MO                                                
 
1,504,000
 
91.3
 
3.4
 
 
6.6
%
10.0
 
Memphis, TN                                                
 
1,920,000
 
91.0
 
9.3
 
 
 
9.3
 
Richmond, VA                                                
 
2,231,000
 
93.4
 
8.7
 
 
 
8.7
 
Piedmont Triad, NC                                                
 
4,173,000
 
89.4
 
5.3
 
2.8
 
 
8.1
 
Greenville, SC                                                
 
898,000
 
88.0
 
3.3
 
 
 
3.3
 
Orlando, FL                                                
 
416,000
 
85.6
 
2.0
 
 
 
2.0
 
Total                                                
 
27,182,000
 
90.3
%
86.9
%
6.5
%
6.6
%
100.0
%
__________
 
(1)
Annualized Cash Rental Revenue is cash rental revenue (base rent plus additional rent based on the level of operating expenses, excluding straight-line rent) for the month of December 2010 multiplied by 12.

The following table sets forth operating information about our in-service Wholly Owned Properties:

     
Average Occupancy
   
Annualized Cash Rent Per Square Foot (1)
 
 
2006                                                                                             
   
88.5
%
 
$
15.89
 
 
2007                                                                                             
   
90.2
%
 
$
16.27
 
 
2008                                                                                             
   
91.2
%
 
$
17.18
 
 
2009                                                                                             
   
88.2
%
 
$
17.53
 
 
2010                                                                                             
   
88.6
%
 
$
17.40
 

__________
 
(1)
Annualized Cash Rent Per Square Foot is cash rental revenue (base rent plus additional rent based on the level of operating expenses, excluding straight-line rent) for the month of December of the respective year multiplied by 12, divided by total occupied square footage.

 
13




Customers

The following table sets forth information concerning the 20 largest customers of our Wholly Owned Properties at December 31, 2010:
 
Customer
 
Rental
Square Feet
 
Annualized
Cash Rental
Revenue (1)
 
Percent
of Total
Annualized
Cash Rental
Revenue (1)
 
Weighted
Average
Remaining
Lease Term
in Years
 
       
(in thousands)
         
Federal Government                                                                       
 
1,963,435
 
$
41,315
 
9.66
%
7.4
 
AT&T                                                                       
 
789,979
   
14,967
 
3.50
 
3.5
 
PricewaterhouseCoopers                                                                       
 
326,909
   
8,663
 
2.03
 
2.5
 
State of Georgia                                                                       
 
401,473
   
7,300
 
1.71
 
6.4
 
Healthways                                                                       
 
290,689
   
6,703
 
1.57
 
11.6
 
Metropolitan Life Insurance                                                                       
 
296,595
   
6,164
 
1.44
 
7.5
 
T-Mobile USA                                                                       
 
207,517
   
5,801
 
1.36
 
3.2
 
Lockton Companies                                                                       
 
170,743
   
4,905
 
1.15
 
2.9
 
BB&T                                                                       
 
318,744
   
4,849
 
1.13
 
4.1
 
HCA Corporation                                                                       
 
211,411
   
4,796
 
1.12
 
4.4
 
Syniverse Technologies, Inc.                                                                       
 
198,750
   
4,199
 
0.98
 
6.1
 
RBC Bank                                                                       
 
164,271
   
3,914
 
0.92
 
16.2
 
SCI Services                                                                       
 
162,784
   
3,735
 
0.87
 
6.8
 
Volvo                                                                       
 
298,321
   
3,597
 
0.84
 
4.0
 
Fluor Enterprises, Inc.                                                                       
 
190,038
   
3,513
 
0.82
 
1.4
 
Vanderbilt University                                                                       
 
162,283
   
3,406
 
0.80
 
5.0
 
Jacob’s Engineering Group, Inc.                                                                       
 
181,794
   
3,118
 
0.73
 
4.4
 
Lifepoint Corporate Services                                                                       
 
147,489
   
3,037
 
0.71
 
5.0
 
Wells Fargo/Wachovia                                                                       
 
112,348
   
2,769
 
0.65
 
1.7
 
Icon Clinical Research                                                                       
 
102,647
   
2,499
 
0.58
 
5.5
 
Total                                                                       
 
6,698,220
 
$
139,250
 
32.57
%
5.8
 

__________
 
(1)
Annualized Cash Rental Revenue is cash rental revenue (base rent plus additional rent based on the level of operating expenses, excluding straight-line rent) for the month of December 2010 multiplied by 12.


 
14




Land Held for Development

We wholly owned 611 acres of development land at December 31, 2010. We estimate that we can develop approximately 5.8 million and 2.7 million rentable square feet of office and industrial space, respectively, on the 523 acres that we consider core, long-term holdings for our future development needs. Additionally, we are currently developing 172,000 square feet of build-to-suit office space on 11.6 acres of land in one of our joint ventures. Our development land is zoned and available for office and industrial development, and nearly all of the land has utility infrastructure in place. We believe that our commercially zoned and unencumbered land in existing business parks gives us a development advantage over other commercial real estate development companies in many of our markets.

We consider 88 acres of our wholly owned development land at December 31, 2010 to be non-core assets that are not necessary for our foreseeable future development needs. We intend to dispose of such non-core development land through sales to third parties or contributions to joint ventures. Approximately 4.4 acres with a net book value of $1.2 million are under contract to be sold and are included in real estate and other assets, net, held for sale in our Consolidated Financial Statements at December 31, 2010 and 2009.

Other Properties

The following table sets forth information about our stabilized in-service properties in which we own an interest (50.0% or less) by segment and by geographic location at December 31, 2010:

   
Rentable Square Feet
 
Occupancy
 
Percentage of Annualized Cash Rental Revenue (1)
 
Market
     
Office
 
Orlando, FL                                                                                 
 
1,853,000
 
84.6
%
42.0
%
Kansas City, MO (2)                                                                                 
 
719,000
 
83.7
 
17.5
 
Atlanta, GA                                                                                 
 
835,000
 
75.0
 
14.9
 
Raleigh, NC                                                                                 
 
814,000
 
93.8
 
11.7
 
Richmond, VA (3)                                                                                 
 
413,000
 
100.0
 
8.3
 
Piedmont Triad, NC                                                                                 
 
258,000
 
42.8
 
1.7
 
Tampa, FL (4)                                                                                 
 
205,000
 
81.5
 
2.7
 
Charlotte, NC                                                                                 
 
148,000
 
100.0
 
1.2
 
Total                                                                                 
 
5,245,000
 
83.8
%
100.0
%

__________
 
(1)
Annualized Cash Rental Revenue is cash rental revenue (base rent plus additional rent based on the level of operating expenses, excluding straight-line rent) for the month of December 2010 multiplied by 12.
 
(2)
Includes a 12.5% interest in a 261,000 square foot office property owned directly by the Company and thus is included in the Company’s Consolidated Financial Statements, but not included in the Operating Partnership’s Consolidated Financial Statements.
 
(3)
We own a 50.0% interest in this joint venture which is consolidated.
 
(4)
We own a 20.0% interest in this joint venture which is consolidated.


 
15




 
Lease Expirations

The following tables set forth scheduled lease expirations for existing leases at our in-service and completed – not stabilized Wholly Owned Properties at December 31, 2010:

Office Properties:
 
 
Lease Expiring
 
Rentable Square Feet Subject to Expiring Leases
 
Percentage of Leased Square Footage Represented by Expiring Leases
 
Annualized Cash Rental Revenue Under Expiring Leases (1)
 
Average Annual Cash Rental Rate Per Square Foot for Expirations
 
Percent of Annualized Cash Rental Revenue Represented by Expiring Leases (1)
 
         
($ in thousands)
       
2011 (2)                                               
 
2,340,038
 
12.7
%
$
46,508
 
$
19.87
 
12.5
%
2012                                               
 
2,412,620
 
13.1
   
51,043
   
21.16
 
13.7
 
2013                                               
 
2,564,716
 
13.8
   
55,721
   
21.73
 
15.0
 
2014                                               
 
2,429,916
 
13.1
   
50,972
   
20.98
 
13.7
 
2015                                               
 
2,173,576
 
11.8
   
45,717
   
21.03
 
12.3
 
2016                                               
 
1,661,230
 
9.0
   
27,803
   
16.74
 
7.5
 
2017                                               
 
1,198,875
 
6.5
   
22,980
   
19.17
 
6.2
 
2018                                               
 
908,131
 
4.9
   
18,852
   
20.76
 
5.1
 
2019                                               
 
682,244
 
3.7
   
12,765
   
18.71
 
3.4
 
2020                                               
 
392,167
 
2.1
   
9,414
   
24.01
 
2.5
 
Thereafter                                               
 
1,710,068
 
9.3
   
30,018
   
17.55
 
8.1
 
   
18,473,581
 
100.0
%
$
371,793
 
$
20.13
 
100.0
%

Industrial Properties:

Lease Expiring
 
Rentable Square Feet Subject to
Expiring Leases
 
Percentage of Leased Square
Footage
Represented
by Expiring
Leases
 
Annualized Cash Rental Revenue
Under Expiring
Leases (1)
 
Average Annual Cash Rental Rate Per Square Foot for Expirations
 
Percent of
Annualized
Cash Rental
Revenue
Represented
by Expiring
Leases (1)
 
         
($ in thousands)
       
2011 (3)                                               
 
819,340
 
15.6
%
$
4,574
 
$
5.58
 
16.5
%
2012                                               
 
548,707
 
10.4
   
3,192
   
5.82
 
11.5
 
2013                                               
 
608,368
 
11.5
   
3,601
   
5.92
 
13.0
 
2014                                               
 
886,788
 
16.9
   
4,690
   
5.29
 
16.8
 
2015                                               
 
451,298
 
8.6
   
2,040
   
4.52
 
7.4
 
2016                                               
 
565,443
 
10.7
   
2,262
   
4.00
 
8.2
 
2017                                               
 
208,099
 
4.0
   
1,076
   
5.17
 
3.9
 
2018                                               
 
88,467
 
1.7
   
214
   
2.42
 
0.8
 
2019                                               
 
176,024
 
3.3
   
677
   
3.85
 
2.4
 
2020                                               
 
86,908
 
1.6
   
378
   
4.35
 
1.4
 
Thereafter                                               
 
828,646
 
15.7
   
5,030
   
6.07
 
18.1
 
   
5,268,088
 
100.0
%
$
27,734
 
$
5.26
 
100.0
%

__________
 
(1)
Annualized Cash Rental Revenue is cash rental revenue (base rent plus additional rent based on the level of operating expenses, excluding straight-line rent) for the month of December 2010 multiplied by 12.
 
(2)
Includes 139,000 square feet of leases that are on a month-to-month basis, which represent 0.4% of total annualized cash rental revenue.
 
(3)
Includes 79,000 square feet of leases that are on a month-to-month basis, which represent less than 0.1% of total annualized cash rental revenue.


 
16


Retail Properties:

Lease Expiring
 
Rentable Square Feet Subject to
Expiring Leases
 
Percentage of Leased Square
Footage
Represented
by Expiring
Leases
 
Annualized Cash Rental Revenue
Under Expiring
Leases (1)
 
Average Annual Cash Rental Rate Per Square Foot for Expirations
 
Percent of
Annualized
Cash Rental
Revenue
Represented
by Expiring
Leases (1)
 
         
($ in thousands)
       
 011 (2)                                               
 
96,555
 
11.6
%
$
2,153
 
$
22.30
 
7.6
%
2012                                               
 
58,292
 
7.0
   
2,291
   
39.30
 
8.1
 
2013                                               
 
67,584
 
8.1
   
1,867
   
27.62
 
6.6
 
2014                                               
 
34,030
 
4.1
   
1,616
   
47.49
 
5.7
 
2015                                               
 
63,726
 
7.6
   
3,140
   
49.27
 
11.1
 
2016                                               
 
62,438
 
7.5
   
2,722
   
43.60
 
9.7
 
2017                                               
 
93,570
 
11.2
   
2,052
   
21.93
 
7.3
 
2018                                               
 
73,157
 
8.8
   
3,109
   
42.50
 
11.0
 
2019                                               
 
96,624
 
11.6
   
2,918
   
30.20
 
10.4
 
2020                                               
 
67,675
 
8.1
   
2,095
   
30.96
 
7.4
 
Thereafter                                               
 
120,748
 
14.4
   
4,220
   
34.95
 
15.1
 
   
834,399
 
100.0
%
$
28,183
 
$
33.78
 
100.0
%

Total:

Lease Expiring
 
Rentable Square Feet Subject to
Expiring Leases
 
Percentage of Leased Square
Footage
Represented
by Expiring
Leases
 
Annualized Cash Rental Revenue
Under Expiring
Leases (1)
 
Average Annual Cash Rental Rate Per Square Foot for Expirations
 
Percent of
Annualized
Cash Rental
Revenue
Represented
by Expiring
Leases (1)
 
         
($ in thousands)
       
2011 (3)                                               
 
3,255,933
 
13.2
%
$
53,235
 
$
16.35
 
12.4
%
2012                                               
 
3,019,619
 
12.3
   
56,526
   
18.72
 
13.2
 
2013                                               
 
3,240,668
 
13.2
   
61,189
   
18.88
 
14.3
 
2014                                               
 
3,350,734
 
13.7
   
57,278
   
17.09
 
13.4
 
2015                                               
 
2,688,600
 
10.9
   
50,897
   
18.93
 
11.9
 
2016                                               
 
2,289,111
 
9.3
   
32,787
   
14.32
 
7.7
 
2017                                               
 
1,500,544
 
6.1
   
26,108
   
17.40
 
6.1
 
2018                                               
 
1,069,755
 
4.4
   
22,175
   
20.73
 
5.2
 
2019                                               
 
954,892
 
3.9
   
16,360
   
17.13
 
3.8
 
2020                                               
 
546,750
 
2.2
   
11,887
   
21.74
 
2.8
 
Thereafter                                               
 
2,659,462
 
10.8
   
39,268
   
14.77
 
9.2
 
   
24,576,068
 
100.0
%
$
427,710
 
$
17.40
 
100.0
%

__________
 
(1)
Annualized Cash Rental Revenue is cash rental revenue (base rent plus additional rent based on the level of operating expenses, excluding straight-line rent) for the month of December 2010 multiplied by 12.
 
(2)
Includes 4,000 square feet of leases that are on a month-to-month basis, which represent less than 0.1% of total annualized cash rental revenue.
 
(3)
Includes 222,000 square feet of leases that are on a month-to-month basis, which represent 0.5% of total annualized cash rental revenue.

 
17




ITEM 3. LEGAL PROCEEDINGS

We are from time to time a party to a variety of legal proceedings, claims and assessments arising in the ordinary course of our business. We regularly assess the liabilities and contingencies in connection with these matters based on the latest information available. For those matters where it is probable that we have incurred or will incur a loss and the loss or range of loss can be reasonably estimated, the estimated loss is accrued and charged to income in our Consolidated Financial Statements. In other instances, because of the uncertainties related to both the probable outcome and amount or range of loss, a reasonable estimate of liability, if any, cannot be made. Based on the current expected outcome of such matters, none of these proceedings, claims or assessments is expected to have a material adverse effect on our business, financial condition, results of operations or cash flows.


 
18



ITEM X. EXECUTIVE OFFICERS OF THE REGISTRANT

The Company is the sole general partner of the Operating Partnership. The following table sets forth information with respect to the Company’s executive officers:

Name
Age
Position and Background
Edward J. Fritsch
52
Director, President and Chief Executive Officer.
Mr. Fritsch has been a director since January 2001.  Mr. Fritsch became our chief executive officer and chair of the investment committee of our board of directors on July 1, 2004 and our president in December 2003. Prior to that, Mr. Fritsch was our chief operating officer from January 1998 to July 2004 and was a vice president and secretary from June 1994 to January 1998. Mr. Fritsch joined our predecessor in 1982 and was a partner of that entity at the time of our initial public offering in June 1994. Mr. Fritsch is a member of the National Association of Real Estate Investment Trusts (“NAREIT”) Board of Governors and chair of its audit committee, past chair of the University of North Carolina Board of Visitors, trustee of the North Carolina Symphony, director and president of the YMCA of the Triangle, director of Capital Associated Industries, Inc. and member of its audit committee and member of Wachovia’s Central Regional Advisory Board.
 
Michael E. Harris
61
Executive Vice President and Chief Operating Officer.
Mr. Harris became chief operating officer in July 2004. Prior to that, Mr. Harris was a senior vice president and was responsible for our operations in Memphis, Nashville, Kansas City and Charlotte. Mr. Harris was executive vice president of Crocker Realty Trust prior to its merger with us in 1996. Before joining Crocker Realty Trust, Mr. Harris served as senior vice president, general counsel and chief financial officer of Towermarc Corporation, a privately owned real estate development firm. Mr. Harris is a member of the executive committee of the Urban Land Institute – Triangle Chapter and is past president of the Lambda Alpha International Land Economics Society.
 
Terry L. Stevens
62
Senior Vice President and Chief Financial Officer.
Prior to joining us in December 2003, Mr. Stevens was executive vice president, chief financial officer and trustee for Crown American Realty Trust, a public REIT. Before joining Crown American Realty Trust, Mr. Stevens was director of financial systems development at AlliedSignal, Inc., a large multi-national manufacturer. Mr. Stevens was also an audit partner with Price Waterhouse for seven years. Mr. Stevens currently serves as trustee, chairman of the Audit Committee and member of the Investment and Finance Committee of First Potomac Realty Trust, a public REIT. Mr. Stevens is a member of the American and the Pennsylvania Institutes of Certified Public Accountants.
 
Jeffrey D. Miller
40
Vice President, General Counsel and Secretary.
Prior to joining us in March 2007, Mr. Miller was a partner with DLA Piper US, LLP, where he practiced since 2005. Previously, he was a partner with Alston & Bird LLP, where he practiced from 1997. He is admitted to practice in North Carolina. Mr. Miller currently serves as lead independent director of Hatteras Financial Corp., a publicly-traded mortgage REIT.


 
19



PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The following table sets forth high and low stock prices per share reported on the NYSE and dividends paid per share:
 
   
2010
 
2009
 
Quarter Ended
 
High
 
Low
 
Dividend
 
High
 
Low
 
Dividend
 
March 31
 
$
33.98
 
$
27.09
 
$
0.425
 
$
27.47
 
$
15.53
 
$
0.425
 
June 30
   
33.87
   
27.57
   
0.425
   
26.84
   
19.79
   
0.425
 
September 30
   
33.25
   
26.25
   
0.425
   
34.09
   
19.35
   
0.425
 
December 31
   
35.38
   
29.39
   
0.425
   
35.24
   
26.60
   
0.425
 

On December 31, 2010, the last reported stock price of the Common Stock on the NYSE was $ 31.85 per share and the Company had 1,005 common stockholders of record. There is no public trading market for the Common Units. On December 31, 2010, the Operating Partnership had 116 holders of record of Common Units (other than the Company). At December 31, 2010, there were 71.7 million shares of Common Stock outstanding and 3.8 million Common Units outstanding not owned by the Company.

Because the Company is a REIT, the partnership agreement requires the Operating Partnership to distribute at least enough cash for the Company to be able to distribute to its stockholders at least 90.0% of its REIT taxable income, excluding net capital gains. See “Item 1A. Risk Factors – Cash distributions reduce the amount of cash that would otherwise be available for other business purposes, including funding debt maturities or future growth initiatives.”

We generally expect to use cash flows from operating activities to fund distributions. The following factors will affect such cash flows and, accordingly, influence the decisions of the Company’s Board of Directors regarding distributions:

    ·  
debt service requirements after taking into account debt covenants and the repayment and restructuring of certain indebtedness and the availability of alternative sources of debt and equity capital and their impact on our ability to refinance existing debt and grow our business;

    ·  
scheduled increases in base rents of existing leases;

    ·  
changes in rents attributable to the renewal of existing leases or replacement leases;

    ·  
changes in occupancy rates at existing properties and execution of leases for newly acquired or developed properties;

    ·  
operating expenses;

    ·  
anticipated leasing capital expenditures attributable to the renewal of existing leases or replacement leases;

    ·  
anticipated building improvements; and

    ·  
expected cash flows from financing and investing activities.

The following stock price performance graph compares the performance of our Common Stock to the S&P 500, the Russell 2000 and the FTSE NAREIT All Equity REITs Index. The stock price performance graph assumes an investment of $100 in our Common Stock and the three indices on December 31, 2005 and further assumes the reinvestment of all dividends. Equity REITs are defined as those that derive more than 75.0% of their income from equity investments in real estate assets. The FTSE NAREIT All Equity REITs Index includes all REITs not designated as Timber REITs listed on the NYSE, the American Stock Exchange or the NASDAQ National Market System. Stock price performance is not necessarily indicative of future results.

 
20






   
For the Period from December 31, 2005 to December 31,
 
Index
 
2006
 
2007
 
2008
 
2009
 
2010
 
Highwoods Properties, Inc.                                                          
 
150.55
 
113.41
 
111.78
 
145.77
 
147.26
 
S&P 500                                                          
 
115.79
 
122.16
 
76.96
 
97.33
 
111.99
 
Russell 2000                                                          
 
118.37
 
116.51
 
77.15
 
98.11
 
124.46
 
FTSE NAREIT All Equity REITs Index
 
135.06
 
113.87
 
70.91
 
90.76
 
116.13
 

The performance graph above is being furnished as part of this Annual Report solely in accordance with the requirement under Rule 14a-3(b)(9) to furnish the Company’s stockholders with such information and, therefore, is not deemed to be filed, or incorporated by reference in any filing, by the Company or the Operating Partnership under the Securities Act of 1933 or the Securities Exchange Act of 1934.

During 2010, cash dividends on Common Stock totaled $1.70 per share, $0.85 of which represented return of capital and $0.44 represented capital gains for income tax purposes. The minimum dividend per share of Common Stock required for the Company to maintain its REIT status was $0.32 per share in 2010.

During the fourth quarter of 2010, the Company issued an aggregate of 3,163 shares of Common Stock to holders of Common Units in the Operating Partnership upon the redemption of a like number of Common Units in private offerings exempt from the registration requirements pursuant to Section 4(2) of the Securities Act. Each of the holders of Common Units was an accredited investor under Rule 501 of the Securities Act. The resale of such shares was registered by the Company under the Securities Act.

The Company has a Dividend Reinvestment and Stock Purchase Plan (“DRIP”) under which holders of Common Stock may elect to automatically reinvest their dividends in additional shares of Common Stock and make optional cash payments for additional shares of Common Stock. The Company may elect to satisfy its DRIP obligations by issuing additional shares of Common Stock or causing the DRIP administrator to purchase Common Stock in the open market.

 
21




The Company has an Employee Stock Purchase Plan pursuant to which employees generally may contribute up to 25.0% of their cash compensation for the purchase of Common Stock. At the end of each three-month offering period, each participant’s account balance, which includes accrued dividends, is applied to acquire shares of Common Stock at a cost that is calculated at 85.0% of the average closing price on the NYSE on the five consecutive days preceding the last day of the quarter.

Information about the Company’s equity compensation plans and other related stockholder matters is incorporated herein by reference to the Company’s Proxy Statement to be filed in connection with its annual meeting of stockholders to be held on May 12, 2011.



 
22



ITEM 6. SELECTED FINANCIAL DATA

The operating results of the Company for the years ended December 31, 2009, 2008, 2007 and 2006 have been revised from previously reported amounts to reflect in discontinued operations the operations for those properties sold or held for sale which required discontinued operations presentation. The information in the following table should be read in conjunction with the Company’s audited Consolidated Financial Statements and related notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations included herein ($ in thousands, except per share data):
 
   
Years Ended December 31,
 
   
2010
 
2009
 
2008
 
2007
 
2006
 
Rental and other revenues
 
$
463,321
 
$
450,154
 
$
445,268
 
$
412,688
 
$
384,121
 
                                 
Income from continuing operations
 
$
71,978
 
$
47,431
 
$
38,608
 
$
50,128
 
$
28,371
 
                                 
Income from continuing operations available for common stockholders
 
$
61,482
 
$
38,318
 
$
24,889
 
$
31,257
 
$
8,264
 
                                 
Net income
 
$
72,303
 
$
61,694
 
$
35,610
 
$
97,095
 
$
57,527
 
                                 
Net income available for common stockholders
 
$
61,790
 
$
51,778
 
$
22,080
 
$
74,983
 
$
34,878
 
                                 
Earnings per common share – basic:
                               
Income from continuing operations available for common stockholders
 
$
0.86
 
$
0.56
 
$
0.42
 
$
0.55
 
$
0.15
 
Net income
 
$
0.86
 
$
0.76
 
$
0.37
 
$
1.32
 
$
0.64
 
                                 
Earnings per common share – diluted:
                               
Income from continuing operations available for common stockholders
 
$
0.86
 
$
0.56
 
$
0.42
 
$
0.55
 
$
0.15
 
Net income
 
$
0.86
 
$
0.76
 
$
0.37
 
$
1.31
 
$
0.64
 
                                 
Dividends declared and paid per common share
 
$
1.70
 
$
1.70
 
$
1.70
 
$
1.70
 
$
1.70
 


   
December 31,
 
   
2010
 
2009
 
2008
 
2007
 
2006
 
Total assets                                                  
 
$
2,871,835
 
$
2,887,101
 
$
2,946,170
 
$
2,926,955
 
$
2,844,853
 
Mortgages and notes payable
 
$
1,522,945
 
$
1,469,155
 
$
1,604,685
 
$
1,641,987
 
$
1,465,129
 
Financing obligations                                                  
 
$
33,114
 
$
37,706
 
$
34,174
 
$
35,071
 
$
35,530
 


 
23




The operating results of the Operating Partnership for the years ended December 31, 2009, 2008, 2007 and 2006 have been revised from previously reported amounts to reflect in discontinued operations the operations for those properties sold or held for sale which required discontinued operations presentation. The information in the following table should be read in conjunction with the Operating Partnership’s audited Consolidated Financial Statements and related notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations included herein ($ in thousands, except per unit data):
 
   
Years Ended December 31,
 
   
2010
 
2009
 
2008
 
2007
 
2006
 
Rental and other revenues
 
$
463,321
 
$
450,154
 
$
445,268
 
$
412,688
 
$
384,121
 
                                 
Income from continuing operations
 
$
71,951
 
$
47,377
 
$
38,481
 
$
49,387
 
$
28,174
 
                                 
Income from continuing operations available for common unitholders
 
$
64,758
 
$
40,658
 
$
26,528
 
$
32,946
 
$
8,703
 
                                 
Net income
 
$
72,276
 
$
61,640
 
$
35,483
 
$
94,895
 
$
56,912
 
                                 
Net income available for common unitholders
 
$
65,083
 
$
54,921
 
$
23,530
 
$
78,454
 
$
37,441
 
                                 
Earnings per common unit – basic:
                               
Income from continuing operations available for common unitholders
 
$
0.87
 
$
0.57
 
$
0.42
 
$
0.54
 
$
0.15
 
Net income
 
$
0.87
 
$
0.77
 
$
0.37
 
$
1.29
 
$
0.63
 
                                 
Earnings per common unit – diluted:
                               
Income from continuing operations available for common unitholders
 
$
0.87
 
$
0.57
 
$
0.42
 
$
0.54
 
$
0.14
 
Net income
 
$
0.87
 
$
0.77
 
$
0.37
 
$
1.28
 
$
0.61
 
                                 
Distributions declared and paid per common
unit
 
$
1.70
 
$
1.70
 
$
1.70
 
$
1.70
 
$
1.70
 


   
December 31,
 
   
2010
 
2009
 
2008
 
2007
 
2006
 
Total assets                                                  
 
$
2,870,671
 
$
2,885,738
 
$
2,944,856
 
$
2,925,804
 
$
2,837,649
 
Mortgages and notes payable
 
$
1,552,945
 
$
1,469,155
 
$
1,604,685
 
$
1,641,987
 
$
1,464,266
 
Financing obligations                                                  
 
$
33,114
 
$
37,706
 
$
34,174
 
$
35,071
 
$
35,530
 


 
24



ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The Company is a fully integrated, self-administered and self-managed equity REIT that provides leasing, management, development, construction and other customer-related services for our properties and for third parties. The Company conducts virtually all of its activities through the Operating Partnership. The Operating Partnership is managed by the Company, its sole general partner. At December 31, 2010, we owned or had an interest in 330 in-service office, industrial and retail properties, encompassing approximately 32.4 million square feet, 96 rental residential units and 26 for-sale residential condominiums, which includes a 12.5% interest in a 261,000 square foot office property directly owned by the Company and thus is included in the Company’s Consolidated Financial Statements, but not included in the Operating Partnership’s Consolidated Financial Statements. As of that date, we also owned or had an interest in development land and other properties under development as described under “Item 1. Business” and “Item 2. Properties.” We are based in Raleigh, NC, and our properties and development land are located in Florida, Georgia, Maryland, Mississippi, Missouri, North Carolina, South Carolina, Tennessee and Virginia.

You should read the following discussion and analysis in conjunction with the accompanying Consolidated Financial Statements and related notes contained elsewhere herein.

Disclosure Regarding Forward-Looking Statements

Some of the information in this Annual Report may contain forward-looking statements. Such statements include, in particular, statements about our plans, strategies and prospects under this section and under the heading “Item 1. Business.” You can identify forward-looking statements by our use of forward-looking terminology such as “may,” “will,” “expect,” “anticipate,” “estimate,” “continue” or other similar words. Although we believe that our plans, intentions and expectations reflected in or suggested by such forward-looking statements are reasonable, we cannot assure you that our plans, intentions or expectations will be achieved. When considering such forward-looking statements, you should keep in mind the following important factors that could cause our actual results to differ materially from those contained in any forward-looking statement:

 
·
the financial condition of our customers could deteriorate;

 
·
we may not be able to lease or release second generation space, defined as previously occupied space that becomes available for lease, quickly or on as favorable terms as old leases;

 
·
we may not be able to lease our newly constructed buildings as quickly or on as favorable terms as originally anticipated;

 
·
we may not be able to complete development, acquisition, reinvestment, disposition or joint venture projects as quickly or on as favorable terms as anticipated;

 
·
development activity by our competitors in our existing markets could result in an excessive supply of office, industrial and retail properties relative to customer demand;

 
·
our markets may suffer declines in economic growth;

 
·
unanticipated increases in interest rates could increase our debt service costs;

 
·
unanticipated increases in operating expenses could negatively impact our operating results;

 
·
we may not be able to meet our liquidity requirements or obtain capital on favorable terms to fund our working capital needs and growth initiatives or to repay or refinance outstanding debt upon maturity; and

 
·
the Company could lose key executive officers.

 
25




This list of risks and uncertainties, however, is not intended to be exhaustive. You should also review the other cautionary statements we make in “Item 1A. Business – Risk Factors” set forth in this Annual Report. Given these uncertainties, you should not place undue reliance on forward-looking statements. We undertake no obligation to publicly release the results of any revisions to these forward-looking statements to reflect any future events or circumstances or to reflect the occurrence of unanticipated events.

Executive Summary

The Company is a fully-integrated, self-administered and self-managed equity REIT and one of the largest owners and operators of office, industrial and retail properties in nine markets in the Southeastern and Midwestern United States. Our Strategic Plan focuses on:

    ·  
owning high-quality, differentiated real estate assets in the better submarkets in our core markets;

    ·  
improving the operating results of our existing properties through concentrated leasing, asset management, cost control and customer service efforts;

    ·  
developing and acquiring office properties in in-fill and central business district locations that improve the overall quality of our portfolio and generate attractive returns over the long-term for our stockholders;

    ·  
selectively disposing of properties no longer considered to be core holdings primarily due to location, age, quality and overall strategic fit; and

    ·  
maintaining a conservative, flexible balance sheet with ample liquidity to meet our funding needs and growth prospects.

While we own and operate a limited number of industrial, retail and residential properties, our operating results depend heavily on successfully leasing and operating our office properties. Economic growth and employment levels in Florida, Georgia, North Carolina and Tennessee are and will continue to be important determinative factors in predicting our future operating results.

The key components affecting our rental and other revenues are average occupancy, rental rates, new developments placed in service, acquisitions and dispositions. Average occupancy generally increases during times of improving economic growth, as our ability to lease space outpaces vacancies that occur upon the expirations of existing leases. Average occupancy generally declines during times of slower economic growth, when new vacancies tend to outpace our ability to lease space. Asset acquisitions, dispositions and new developments placed in service directly impact our rental revenues and could impact our average occupancy, depending upon the occupancy rate of the properties that are acquired, sold or placed in service. A further indicator of the predictability of future revenues is the expected lease expirations of our portfolio. As a result, in addition to seeking to increase our average occupancy by leasing current vacant space, we also must concentrate our leasing efforts on renewing leases on expiring space. For more information regarding our lease expirations, see “Item 2. Properties – Lease Expirations.” We expect average occupancy to be slightly higher in 2011 as compared to 2010.

Whether or not our rental revenue tracks average occupancy proportionally depends upon whether rents under new leases signed are higher or lower than the rents under the previous leases. The average rental rate per square foot on second generation renewal and re-let leases signed in our Wholly Owned Properties compared to the rent under the previous leases (based on straight line rental rates) was slightly higher in 2010 as compared to 2009. We expect this slight improvement to continue in 2011. The annualized rental revenues from second generation leases signed during any particular year is generally less than 15% of our total annual rental revenues.

We strive to maintain a diverse, stable and creditworthy customer base. We have an internal guideline whereby the Company’s Board of Directors must approve in advance any customer who would account for more than 3% of our annualized revenues on a pro forma basis. Currently, no customer accounts for more than 3% of our annualized revenues other than the federal government, which accounts for 9.7% of our annualized revenues, and AT&T, which accounts for 3.5% of our annualized revenues. See “Item 2. Properties – Customers.”

 
26




Our expenses primarily consist of rental property expenses, depreciation and amortization, general and administrative expenses and interest expense. From time to time, expenses also include impairments of assets held for use. Rental property expenses are expenses associated with our ownership and operation of rental properties and include expenses that vary somewhat proportionately to occupancy levels, such as common area maintenance and utilities, and expenses that do not vary based on occupancy, such as property taxes and insurance. Depreciation and amortization is a non-cash expense associated with the ownership of real property and generally remains relatively consistent each year, unless we buy, place in service or sell assets, since we depreciate our properties and related building and tenant improvement assets on a straight-line basis over a fixed life. General and administrative expenses, net of amounts capitalized, consist primarily of management and employee salaries and other personnel costs, corporate overhead and long-term incentive compensation.

We anticipate commencing up to $200 million of new development in 2011. Any such projects would not be placed in service until 2012 or beyond. We also anticipate acquiring up to $200 million of new properties and selling up to $75 million of non-core properties in 2011.

We intend to maintain a conservative and flexible balance sheet that allows us to capitalize on favorable development and acquisition opportunities as they arise. As of December 31, 2010, our mortgages and notes payable represented 41.1% of the undepreciated book value of our assets. We expect this ratio to remain under 50% during 2011.

Results of Operations

Comparison of 2010 to 2009

Rental and Other Revenues

Rental and other revenues from continuing operations were 2.9% higher in 2010 as compared to 2009 primarily due to the acquisitions of an office property in Memphis, TN in 2010 and an office property in Tampa, FL in 2009, the contribution of development properties recently placed in service and slightly higher average occupancy. We expect 2011 rental and other revenues, adjusted for any discontinued operations, to increase over 2010 due to slightly higher average occupancy as a result of slowly improving economic conditions and the full year contribution of acquisitions closed and development projects delivered during 2010.

Operating Expenses

Rental property and other expenses were 1.0% higher in 2010 as compared to 2009 primarily due to our recent acquisition activity and the contribution of development properties recently placed in service, offset by lower expenses resulting from management’s continuing efforts to reduce operating expenses in our same property portfolio. We expect 2011 rental property and other expenses, adjusted for any discontinued operations, to increase over 2010 due to the full year contribution of acquisitions closed and development projects delivered during 2010. Same property operating expenses are expected to be slightly higher in 2011 as compared to 2010.

Operating margin, defined as rental and other revenues less rental property and other expenses expressed as a percentage of rental and other revenues, was higher at 64.5% in 2010 as compared to 63.8% in 2009. Operating margin is expected to be similar in 2011 as compared to 2010.

Depreciation and amortization was 4.4% higher in 2010 as compared to 2009 primarily due to our recent acquisition activity and the contribution of development properties recently placed in service.

We recorded impairment of assets held for use of $2.6 million in 2009 related to four office properties located in Winston-Salem, NC. Impairments can arise from a number of factors; accordingly, there can be no assurances that we will not be required to record additional impairment charges in the future.

General and administrative expenses were 10.2% lower in 2010 as compared to 2009 primarily due to lower incentive compensation, a decrease in the value of marketable securities held under our non-qualified deferred compensation plan, and lower expenses from management’s continuing efforts to reduce general and administrative expenses. We anticipate continued reductions in general and administrative expenses in 2011, adjusted for changes in value of marketable securities held under our deferred compensation plan.

 
27




Other Income

Other income was $3.9 million lower in 2010 as compared to 2009 primarily due to a decrease in the value of marketable securities held under our non-qualified deferred compensation plan and gains on debt extinguishment and favorable cash settlement of a real estate related legal claim in 2009. We anticipate other income will be slightly higher in 2011 as compared to 2010 due to the full year impact of interest income related to seller financing provided to the buyers of certain non-core assets in 2010.

Interest Expense

Interest expense was 7.6% higher in 2010 as compared to 2009 primarily due to lower capitalized interest from decreased development in process, higher average interest rates and higher fees on our new revolving credit facility partially offset by lower average debt balances and lower swap interest expense. We anticipate interest expense will increase modestly in 2011 due to slightly higher average debt balances from the assumption of debt related to the acquisition of an office property in Memphis, TN, higher average floating interest rates and higher interest expense on our new $200.0 million bank term loan compared to our $137.5 million term loan that is scheduled to mature later in the first quarter of 2011.

Gains on For-Sale Residential Condominiums

In 2010 and 2009, gains on for-sale residential condominiums aggregated $0.3 million and $0.9 million, respectively, resulting from sales of majority-owned residential condominiums. Our partner’s interest in these gains was $(0.4) million and $(0.5) million, respectively, and was recorded as noncontrolling interests in consolidated affiliates. Our partner’s estimated economic interest decreased from 14% at December 31, 2009 to 7% during the year ended December 31, 2010 due to changes in the projected timing of sales and related gains resulting in the allocation of a loss to the partner’s non-controlling interest. On December 31, 2010, we acquired our partner’s interest for $0.5 million. We have 25 for-sale residential condominiums as of February 2, 2011. We anticipate these condominiums will be sold over the next 24 months.

Gains on Disposition of Investment in Unconsolidated Affiliates

Gains on disposition of investment in unconsolidated affiliates were $25.3 million higher in 2010 as compared to 2009 due to the disposition of our equity interests in a series of unconsolidated joint ventures relating to properties in Des Moines, IA in 2010.

Discontinued Operations

The Company classified income of $0.3 million and $14.3 million as discontinued operations in 2010 and 2009, respectively. These amounts relate to 1.9 million square feet of office, industrial and retail properties sold during 2010 and 2009. The $14.3 million of income in 2009 includes impairment of $11.0 million on certain of these properties and gains on disposition of $21.5 million on certain other of these properties.

Equity in Earnings of Unconsolidated Affiliates

Equity in earnings of unconsolidated affiliates was $1.6 million lower in 2010 as compared to 2009 due to the disposition of our equity interests in a series of unconsolidated joint ventures relating to properties in Des Moines, IA in 2010 and our proportionate share of a gain on disposition of property in one of our joint ventures in 2009. Equity in earnings of unconsolidated affiliates is expected to be lower in 2011 compared to 2010 due to the full year impact of the Des Moines sale and lower average occupancy in our remaining joint ventures.

Comparison of 2009 to 2008

Rental and Other Revenues

Rental and other revenues from continuing operations were 1.1% higher in 2009 as compared to 2008 primarily due to the contribution of development properties placed in service in 2008 and 2009, the acquisitions of an office property in Memphis, TN in 2008 and an office property in Tampa, FL in 2009 and higher average rental rates, partly offset by lower revenues in our same property portfolio from lower average occupancy in 2009.

 
28




Operating Expenses

Rental property and other expenses were 1.8% higher in 2009 as compared to 2008 primarily due to our acquisition activity and the contribution of development properties placed in service in 2008 and 2009, partly offset by lower expenses from management’s efforts to reduce operating expenses in our same property portfolio. The overall reduction in same property operating expenses was partly offset by higher real estate taxes and utility rate increases.

Operating margin, defined as rental and other revenues less rental property and other expenses expressed as a percentage of rental and other revenues, was slightly lower at 63.8% in 2009 as compared to 64.1% in 2008.

Depreciation and amortization was 5.9% higher in 2009 as compared to 2008 primarily due to our acquisition activity and the contribution of development properties placed in service in 2008 and 2009.

We recorded impairment of assets held for use of $2.6 million and $3.4 million in 2009 and 2008, respectively, related to four office properties located in Winston-Salem, NC.

General and administrative expenses were 3.6% lower in 2009 as compared to 2008 primarily due to lower salaries, benefits and incentive compensation mostly from reduced headcount and lower expenses from unsuccessful development projects. Partly offsetting this decrease was an increase in the value of marketable securities held under our deferred compensation plan and lower capitalization of development and leasing costs.

Other Income

Other income was $5.7 million higher in 2009 as compared to 2008 primarily due to the year-over-year change in the valuation adjustment of marketable securities held under our non-qualified deferred compensation plan, favorable cash settlement of a real estate-related legal claim and gains on the extinguishment of certain outstanding bonds.

Interest Expense

Interest expense was 11.9% lower in 2009 as compared to 2008 primarily due to lower average outstanding borrowings during 2009 mostly due to the application of proceeds of our sales of Common Stock in September 2008 and June 2009 to pay down debt and lower average floating interest rates, partly offset by lower capitalized interest resulting from decreased development in process.

Gains on For-Sale Residential Condominiums

In 2009 and 2008, gains on for-sale residential condominiums aggregated $0.9 million and $5.6 million, respectively, resulting from sales of majority-owned residential condominiums and related forfeitures of earnest money deposits. Our partner’s interest in these gains was $(0.5) million and $1.3 million, respectively. Our partner’s estimated economic interest decreased from 25% at December 31, 2008 to 14% at December 31, 2009 due to changes in the projected timing of sales and related gains resulting in the allocation of a loss to the partner’s non-controlling interest in 2009.

Discontinued Operations

The Company classified income/(loss) of $14.3 million and $(3.0) million as discontinued operations in 2009 and 2008, respectively. These amounts relate to 2.6 million square feet of office, industrial and retail properties and 13 rental residential units sold during 2010, 2009 and 2008. These balances include impairment of $11.0 million and $29.4 million on certain of these properties and $21.5 million and $18.5 million of gains on disposition of certain other of these properties in 2009 and 2008, respectively.

 
29




Net Income Attributable to Noncontrolling Interests in the Operating Partnership; Net Income Attributable to Noncontrolling Interests in Consolidated Affiliates

The Company’s net income attributable to noncontrolling interests in the Operating Partnership was $1.6 million higher in 2009 as compared to 2008 primarily due to higher income from continuing operations, after preferred equity distributions, of the Operating Partnership.

Net income attributable to noncontrolling interests in consolidated affiliates was $2.0 million lower in 2009 as compared to 2008 primarily due to lower gains on for-sale residential condominiums.

Dividends on Preferred Equity

Dividends on preferred equity were 31.6% lower in 2009 as compared to 2008 due to the retirement of $53.8 million of preferred equity in 2008.


 
30



Liquidity and Capital Resources

Overview

Our goal is to maintain a conservative and flexible balance sheet with access to multiple sources of debt and equity capital and sufficient availability under our credit facilities. We generally use rents received from customers to fund our operating expenses, capital expenditures and distributions. To fund property acquisitions, development activity or building renovations and repay debt upon maturity, we may use current cash balances, sell assets, obtain new debt and/or issue equity. Our debt generally consists of mortgage debt, unsecured debt securities and borrowings under our secured and unsecured credit facilities.

Statements of Cash Flows

We report and analyze our cash flows based on operating activities, investing activities and financing activities. The following table sets forth the changes in the Company’s cash flows ($ in thousands):

   
Years Ended December 31,
     
   
2010
 
2009
 
Change
 
Cash Provided By Operating Activities
 
$
190,537
 
$
189,120
 
$
1,417
 
Cash (Used In) Investing Activities
   
(78,155
)
 
(61,824
)
 
(16,331
)
Cash (Used In) Financing Activities
   
(121,875
)
 
(117,354
)
 
(4,521
)
Total Cash Flows
 
$
(9,493
)
$
9,942
 
$
(19,435
)

In calculating cash flow from operating activities, depreciation and amortization, which are non-cash expenses, are added back to net income. As a result, we have historically generated a positive amount of cash from operating activities. From period to period, cash flow from operations depends primarily upon changes in our net income, as discussed more fully above under “Results of Operations,” changes in receivables and payables, and net additions or decreases in our overall portfolio, which affect the amount of depreciation and amortization expense.

Cash used in or provided by investing activities generally relates to capitalized costs incurred for leasing and major building improvements and our acquisition, development, disposition and joint venture capital activity. During periods of significant net acquisition and/or development activity, our cash used in such investing activities will generally exceed cash provided by investing activities, which typically consists of cash received upon the sale of properties and distributions of capital from our joint ventures.

Cash used in or provided by financing activities generally relates to distributions, incurrence and repayment of debt and issuances, repurchases or redemptions of Common Stock, Common Units and Preferred Stock. As discussed previously, we use a significant amount of our cash to fund distributions. Whether or not we have increases in the outstanding balances of debt during a period depends generally upon the net effect of our acquisition, disposition, development and joint venture activity. We generally use our revolving credit facility for working capital purposes, which means that during any given period, in order to minimize interest expense, we may record significant repayments and borrowings under our revolving credit facility.

Cash provided by operating activities was $1.4 million higher in 2010 as compared to 2009 primarily due to cash rents from recently acquired buildings and development properties recently placed in service, partly offset by the impact of dispositions and lower cash rents in our same property portfolio.

Cash used in investing activities was $16.3 million higher in 2010 as compared to 2009 primarily due to higher leasing capital expenditures, higher acquisitions and lower dispositions in 2010, partly offset by lower development activities in 2010.

Cash used in financing activities was $4.5 million higher in 2010 as compared to 2009 primarily due to higher dividends resulting from a higher number of outstanding shares of Common Stock in 2010 from our May 2009 equity offering.

 
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Capitalization

The following table sets forth the Company’s capitalization (in thousands, except per share amounts):

   
December 31,
 
   
2010
 
2009
 
Mortgages and notes payable, at recorded book value
 
$
1,522,945
 
$
1,469,155
 
Financing obligations                                                                                             
 
$
33,114
 
$
37,706
 
Preferred Stock, at liquidation value                                                                                             
 
$
81,592
 
$
81,592
 
               
Common Stock outstanding                                                                                             
   
71,690
   
71,285
 
Common Units outstanding (not owned by the Company)
   
3,794
   
3,891
 
               
Per share  stock price at year end                                                                                             
 
$
31.85
 
$
33.35
 
Market value of Common Stock and Common Units
 
$
2,404,165
 
$
2,507,120
 
Total market capitalization                                                                                             
 
$
4,041,816
 
$
4,095,573
 

Our mortgages and notes payable represented 37.7% of our total market capitalization and were comprised of $754.4 million of secured indebtedness with a weighted average interest rate of 6.14% and $768.5 million of unsecured indebtedness with a weighted average interest rate of 5.35%. At December 31, 2010, our outstanding mortgages and notes payable and financing obligations were secured by real estate assets with an aggregate undepreciated book value of $1.2 billion.

Current and Future Cash Needs

Rental and other revenues are our principal source of funds to meet our short-term liquidity requirements. Other sources of funds for short-term liquidity needs include available working capital and borrowings under our existing revolving credit facility and secured construction credit facility (which had $379.5 million and $17.9 million of availability, respectively, at February 2, 2011). Our short-term liquidity requirements primarily consist of operating expenses, interest and principal amortization on our debt, distributions and capital expenditures, including building improvement costs, tenant improvement costs and lease commissions. Building improvements are capital costs to maintain existing buildings not typically related to a specific customer. Tenant improvements are the costs required to customize space for the specific needs of customers. We anticipate that our available cash and cash equivalents and cash provided by operating activities, together with cash available from borrowings under our credit facilities, will be adequate to meet our short-term liquidity requirements.

Our long-term liquidity uses generally consist of the retirement or refinancing of debt upon maturity (including mortgage debt, our revolving and construction credit facilities, term loans and other unsecured debt), funding of existing and new building development or land infrastructure projects and funding acquisitions of buildings and development land. Additionally, we may, from time to time, retire some or all of our remaining outstanding Preferred Stock and/or unsecured debt securities through redemptions, open market repurchases, privately negotiated acquisitions or otherwise.

We expect to meet our liquidity needs through a combination of:

    ·  
cash flow from operating activities;

    ·  
borrowings under our credit facilities;

    ·  
the issuance of unsecured debt;

    ·  
the issuance of secured debt;

    ·  
the issuance of equity securities by the Company or the Operating Partnership; and

    ·  
the disposition of non-core assets.

 
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Distributions

To maintain its qualification as a REIT, the Company must pay dividends to stockholders that are at least 90.0% of its annual REIT taxable income, excluding net capital gains. The partnership agreement requires the Operating Partnership to distribute at least enough cash for the Company to be able to pay such dividends. The Company’s REIT taxable income, as determined by the federal tax laws, does not equal its net income under US generally accepted accounting principles (“GAAP”). In addition, although capital gains are not required to be distributed to maintain REIT status, capital gains, if any, are subject to federal and state income tax unless such gains are distributed to stockholders.

Cash distributions reduce the amount of cash that would otherwise be available for other business purposes, including funding debt maturities or future growth initiatives. The amount of future distributions that will be made is at the discretion of the Company’s Board of Directors. For a discussion of the factors that will influence decisions of the Board of Directors regarding distributions, see “Item 5. Market for Registrant’s Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities.”

Financing Activity

Our $400.0 million unsecured revolving credit facility is scheduled to mature on February 21, 2013 and includes an accordion feature that allows for an additional $50.0 million of borrowing capacity subject to additional lender commitments. Assuming we continue to have three publicly announced ratings from the credit rating agencies, the interest rate and facility fee under our revolving credit facility are based on the lower of the two highest publicly announced ratings. Based on our current credit ratings, the interest rate is LIBOR plus 290 basis points and the annual facility fee is 60 basis points. We expect to use our revolving credit facility for working capital purposes and for the short-term funding of our development and acquisition activity and, in certain instances, the repayment of other debt. Continuing ability to borrow under the revolving credit facility allows us to quickly capitalize on strategic opportunities at short-term interest rates. There was $30.0 million and $20.0 million outstanding under our revolving credit facility at December 31, 2010 and February 2, 2011, respectively. At both December 31, 2010 and February 2, 2011, we had $0.5 million of outstanding letters of credit, which reduces the availability on our revolving credit facility. As a result, the unused capacity of our revolving credit facility at December 31, 2010 and February 2, 2011 was $369.5 million and $379.5 million, respectively.

Our $70.0 million secured construction facility, of which $52.1 million was outstanding at December 31, 2010, is scheduled to mature on December 20, 2011. Assuming no defaults have occurred, we have the option to extend the maturity date for an additional one-year period. The interest rate is LIBOR plus 85 basis points. This facility had $17.9 million of availability at December 31, 2010 and February 2, 2011.

On February 2, 2011, we obtained a $200.0 million, five-year unsecured bank term loan bearing interest of LIBOR plus 220 basis points. The funding of this loan will occur on February 25, 2011 and the proceeds will be used on such date to pay off at maturity a $137.5 million unsecured bank term loan, amounts then outstanding under our revolving credit facility and for general corporate purposes.

In 2010, we repaid $10.0 million of our $20.0 million, three-year unsecured term loan. Additionally, we repaid the $5.8 million remaining balance then outstanding on the mortgage payable secured by our 96 rental residential units to unencumber these assets for a planned development project. We incurred a penalty of $0.6 million related to this early repayment, which is included in loss on debt extinguishment in 2010.

We regularly evaluate the financial condition of the lenders that participate in our credit facilities using publicly available information. Based on this review, we currently expect our lenders, which are major financial institutions, to perform their obligations under our existing facilities.

Covenant Compliance

We are currently in compliance with the covenants and other requirements with respect to our outstanding debt. Although we expect to remain in compliance with these covenants and ratios for at least the next year, depending upon our future operating performance, property and financing transactions and general economic conditions, we cannot assure you that we will continue to be in compliance.

 
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Our revolving credit facility and bank terms require us to comply with customary operating covenants and various financial requirements. Upon an event of default on the revolving credit facility, the lenders having at least 66.7% of the total commitments under the revolving credit facility can accelerate all borrowings then outstanding, and we could be prohibited from borrowing any further amounts under our revolving credit facility, which would adversely affect our ability to fund our operations.

The Operating Partnership has $391.0 million carrying amount of 2017 bonds outstanding and $200.0 million carrying amount of 2018 bonds outstanding. The indenture that governs these outstanding notes requires us to comply with customary operating covenants and various financial ratios. The trustee or the holders of at least 25% in principal amount of either series of bonds can accelerate the principal amount of such series upon written notice of a default that remains uncured after 60 days.

We may not be able to repay, refinance or extend any or all of our debt at maturity or upon any acceleration. If any refinancing is done at higher interest rates, the increased interest expense could adversely affect our cash flow and ability to pay distributions. Any such refinancing could also impose tighter financial ratios and other covenants that restrict our ability to take actions that could otherwise be in our best interest, such as funding new development activity, making opportunistic acquisitions, repurchasing our securities or paying distributions.

Contractual Obligations

The following table sets forth a summary regarding our known contractual obligations, including required interest payments for those items that are interest bearing, at December 31, 2010 ($ in thousands):

       
Amounts due during years ending December 31,
     
   
Total
 
2011
 
2012
 
2013
 
2014
 
2015
 
Thereafter
 
Mortgages and Notes Payable:
                                           
Principal payments (1)
 
$
1,522,945
 
$
201,375
 
$
224,649
 
$
272,922
 
$
34,841
 
$
42,005
 
$
747,153
 
Interest payments
   
382,826
   
85,525
   
69,467
   
61,062
   
51,703
   
51,334
   
63,735
 
Financing Obligations:
                                           
SF-HIW Harborview Plaza, LP financing obligation
   
10,232
   
   
   
   
10,232
   
   
 
Tax increment financing bond
   
14,258
   
1,193
   
1,277
   
1,365
   
1,460
   
1,561
   
7,402
 
Capitalized ground lease obligation (2)
   
1,240
   
   
   
   
   
1,240
   
 
Interest on financing obligations (3)
   
5,684
   
1,042
   
963
   
880
   
791
   
683
   
1,325
 
Capitalized Lease Obligations
   
175
   
125
   
42
   
8
   
   
   
 
Purchase Obligations:
                                           
Completion contracts (4)
   
8,637
   
8,637
   
   
   
   
   
 
Operating Lease Obligations:
                                           
Operating ground leases
   
35,757
   
1,129
   
1,150
   
1,171
   
1,193
   
1,217
   
29,897
 
Other Long Term Obligations:
                                           
DLF I obligation
   
1,388
   
567
   
578
   
243
   
   
   
 
Total
 
$
1,983,142
 
$
299,593
 
$
298,126
 
$
337,651
 
$
100,220
 
$
98,040
 
$
849,512
 

__________
 
(1)
Does not reflect a one-year extension option related to outstanding amounts on our $70.0 million secured construction facility.
 
(2)
Assumes that we will exercise our purchase option in 2015. The ground lease contractually extends through 2022.
 
(3)
Does not include interest on the SF-HIW Harborview Plaza, LP financing obligation, which cannot be reasonably estimated for future periods. The interest expense on this financing obligation was $1.1 million, $0.8 million and $1.6 million in 2010, 2009 and 2008, respectively.
 
(4)
Relates to payments to be made under current contracts for various development/construction projects.

The interest payments due on mortgages and notes payable are based on the stated rates for the fixed rate debt and on the rates in effect at December 31, 2010 for the variable rate debt. The weighted average interest rate on the fixed and variable rate debt was 6.43% and 1.51%, respectively, at December 31, 2010. For additional information about our mortgages and notes payable, see Note 6 to our Consolidated Financial Statements.

 
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For additional information about our financing obligations, see Note 8 to our Consolidated Financial Statements. For additional information about purchase obligations, operating lease obligations and other long term obligations, see Note 9 to our Consolidated Financial Statements.

Off Balance Sheet Arrangements

We generally account for our investments in less than majority owned joint ventures, partnerships and limited liability companies using the equity method. As a result, these joint ventures are not included in our Consolidated Financial Statements, other than as investment in unconsolidated affiliates and equity in earnings of unconsolidated affiliates.

At December 31, 2010, our unconsolidated joint ventures had $672.7 million of total assets and $451.1 million of total liabilities. Our weighted average equity interest based on the total assets of these unconsolidated joint ventures was 34.0%. During 2010, these unconsolidated joint ventures earned $3.6 million of aggregate net income, of which our share was $1.5 million. Additionally, we recorded $2.4 million of purchase accounting and other adjustments related primarily to management and leasing fees in equity in earnings of unconsolidated affiliates. For additional information about our unconsolidated joint venture activity, see Note 4 to our Consolidated Financial Statements.

At December 31, 2010, our unconsolidated joint ventures had $424.8 million of outstanding mortgage debt. The following table sets forth the scheduled maturities of the Company’s proportionate share of the outstanding debt of its unconsolidated joint ventures at December 31, 2010 ($ in thousands):

2011                                                                                
 
$
4,124
 
2012                                                                                
   
22,901
 
2013                                                                                
   
23,830
 
2014 (1)                                                                                
   
64,475
 
2015                                                                                
   
1,139
 
Thereafter (2)                                                                                
   
34,229
 
   
$
150,698
 

__________
 
(1)
Includes our 22.81% portion of a $38.7 million mortgage payable which is callable at the lender’s sole discretion on either of the following call dates: May 1, 2014, 2019 or 2024, by giving written notice at least six months prior to the elected call date.
 
(2)
Includes our 12.5% portion of a $10.6 million mortgage payable related to an equity method investee owned directly by the Company, which is included in the Company’s Consolidated Financial Statements but not included in the Operating Partnership’s Consolidated Financial Statements.

All of this joint venture debt is non-recourse to us except in the case of customary exceptions pertaining to such matters as misuse of funds, environmental conditions and material misrepresentations.

During the second quarter of 2010, we sold our equity interests in a series of unconsolidated joint ventures relating to properties in Des Moines, IA. The assets in the joint ventures included 1.7 million square feet of office, 788,000 square feet of industrial and 45,000 square feet of retail properties, as well as 418 apartment units. In connection with the closing, we received $15.0 million in cash. We had a negative book basis in certain of the joint ventures, primarily as a result of prior cash distributions to the partners. Accordingly, we recorded gain on disposition of investment in unconsolidated affiliates of $25.3 million in the second quarter of 2010. As of the closing date, the joint ventures had approximately $170 million of secured debt, which was non-recourse to us except (1) in the case of customary exceptions pertaining to matters such as misuse of funds, borrower bankruptcy, unpermitted transfers, environmental conditions and material misrepresentations and (2) approximately $9.0 million of direct and indirect guarantees. We have been released by the applicable lenders from all such direct and indirect guarantees and we have no ongoing lender liability relating to such customary exceptions to non-recourse liability with respect to most, but not all, of the debt. The buyer has agreed to indemnify and hold us harmless from any and all future losses that we suffer as a result of our prior investment in the joint ventures (other than losses directly resulting from our acts or omissions). In the event we are exposed to any such future loss, our financial condition and operating results would not be adversely affected unless the buyer defaults on its indemnification obligation.

 
35




In connection with the disposition of six industrial properties in Piedmont Triad, NC in the second quarter of 2010, we entered into a limited rent guarantee agreement with the buyer relating to an existing 237,500 square foot lease with one customer, who has leased space in the properties for 14 years. This agreement guarantees the payment of rent for an approximate two-year period from March 2011 through June 2013 in the event the customer exercises its limited termination right. As of December 31, 2010, our maximum exposure under this rent guarantee agreement was approximately $0.7 million. No accrual has been recorded for this guarantee because we have concluded that a loss is not probable.

Financing Arrangements

- SF-HIW Harborview Plaza, LP (“Harborview”)

Our joint venture partner in Harborview has the right to put its 80.0% equity interest in the joint venture to us in exchange for cash at any time during the one-year period commencing September 11, 2014. The value of the 80.0% equity interest will be determined at the time that our partner elects to exercise its put right, if ever, based upon the then fair market value of Harborview LP’s assets and liabilities, less 3.0%, which amount was intended to cover the normal costs of a sale transaction. Because of the put option, this transaction is accounted for as a financing transaction. Accordingly, the assets, liabilities and operations related to Harborview Plaza, the property owned by Harborview LP remain in our Consolidated Financial Statements.

As a result, we established a financing obligation equal to the $12.7 million net equity contributed by the other partner. At the end of each reporting period, the balance of the gross financing obligation is adjusted to equal the greater of the original financing obligation or the current fair value of the put option discussed above. This financing obligation, net of payments made to our joint venture partner, is adjusted by a related valuation allowance account, which is being amortized prospectively through September 2014 as interest expense on financing obligation. The fair value of the put option was $10.2 million and $12.2 million at December 31, 2010 and 2009, respectively. Additionally, the net income from the operations before depreciation of Harborview Plaza allocable to the 80.0% partner is recorded as interest expense on financing obligation. We continue to depreciate the property and record all of the depreciation on our books. At such time as the put option expires or is otherwise terminated, we will record the transaction as a partial sale and recognize gain accordingly.

- Tax Increment Financing Bond

In connection with tax increment financing for construction of a public garage related to a wholly owned office building, we are obligated to pay fixed special assessments over a 20-year period ending in 2019. The net present value of these assessments, discounted at 6.93% at the inception of the obligation, which represents the interest rate on the underlying bond financing, is recorded as a financing obligation. We receive special tax revenues and property tax rebates recorded in interest and other income, which are intended, but not guaranteed, to provide funds to pay the special assessments. We acquired the underlying bond in a privately negotiated transaction in 2007 (see Note 11 to our Consolidated Financial Statements).

- Capitalized Ground Lease Obligation

The capitalized ground lease obligation represents an obligation to the lessor of land on which we constructed a building. We are obligated to make fixed payments to the lessor through October 2022 and the lease provides for fixed price purchase options in the ninth and tenth years of the lease. We intend to exercise the purchase option in order to prevent an economic penalty related to conveying the building to the lessor at the expiration of the lease. The net present value of the fixed rental payments and purchase option through the ninth year was calculated at the inception of the lease using a discount rate of 7.1%. The assets and liabilities under the capital lease are recorded at the lower of the present value of minimum lease payments or the fair value. The liability accretes into interest expense for the difference between the interest rate on the financing obligation and the fixed payments. The accretion will continue until the liability equals the purchase option of the land in the ninth year of the lease.

 
36




Interest Rate Hedging Activities

We borrow funds at a combination of fixed and variable rates. Borrowings under our revolving credit facility, construction facility and bank term loans bear interest at variable rates. Our long-term debt, which consists of secured and unsecured long-term financings and the issuance of unsecured debt securities, typically bears interest at fixed rates although some loans bear interest at variable rates. Our interest rate risk management objectives are to limit the impact of interest rate changes on earnings and cash flows and to lower our overall borrowing costs. To achieve these objectives, from time to time, we enter into interest rate hedge contracts such as collars, swaps, caps and treasury lock agreements in order to mitigate our interest rate risk with respect to various debt instruments. We do not hold or issue these derivative contracts for trading or speculative purposes. The interest rate on all of our variable rate debt is generally adjusted at one or three month intervals, subject to settlements under these interest rate hedge contracts. We also enter into treasury lock or similar agreements from time to time in order to limit our exposure to an increase in interest rates with respect to future debt offerings. At December 31, 2010, we have no outstanding interest rate hedge contracts.

Critical Accounting Estimates

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the reporting period. Actual results could differ from our estimates.

The policies used in the preparation of our Consolidated Financial Statements are described in Note 1 to our Consolidated Financial Statements for the year ended December 31, 2010. However, certain of our significant accounting policies contain an increased level of assumptions used or estimates made in determining their impact in our Consolidated Financial Statements. Management has reviewed and determined the appropriateness of our critical accounting policies and estimates with the audit committee of the Company’s Board of Directors.

We consider our critical accounting estimates to be those used in the determination of the reported amounts and disclosure related to the following:

 
·
Real estate and related assets;

 
·
Impairment of long-lived assets and investments in unconsolidated affiliates;

 
·
Sales of real estate;

 
·
Rental and other revenues; and

 
·
Allowance for doubtful accounts.

Real Estate and Related Assets

Real estate and related assets are recorded at cost and stated at cost less accumulated depreciation. Renovations, replacements and other expenditures that improve or extend the life of assets are capitalized and depreciated over their estimated useful lives. Expenditures for ordinary maintenance and repairs are charged to expense as incurred. Depreciation is computed using the straight-line method over the estimated useful life of 40 years for buildings and depreciable land infrastructure costs, 15 years for building improvements and five to seven years for furniture, fixtures and equipment. Tenant improvements are amortized using the straight-line method over initial fixed terms of the respective leases, which generally are from three to 10 years.

Expenditures directly related to the development and construction of real estate assets are included in net real estate assets and are stated at depreciated cost. Development expenditures include pre-construction costs essential to the development of properties, development and construction costs, interest costs on qualifying assets, real estate taxes, development personnel salaries and related costs and other costs incurred during the period of development. Interest and other carrying costs are capitalized until the building is ready for its intended use, but not later than one year from cessation of major construction activity. We consider a construction project as substantially completed and ready for its intended use upon the completion of tenant improvements. We cease capitalization on the portion that is substantially completed and occupied or held available for occupancy, and capitalize only those costs associated with the portion under construction.

 
37




Expenditures directly related to the leasing of properties are included in deferred financing and leasing costs and are stated at amortized cost. Such expenditures are part of the investment necessary to execute leases and, therefore, are classified as investment activities in the statement of cash flows. All leasing commissions paid to third parties for new leases or lease renewals are capitalized. Internal leasing costs include primarily compensation, benefits and other costs, such as legal fees related to leasing activities, which are incurred in connection with successfully securing leases of properties. Capitalized leasing costs are amortized on a straight-line basis over the initial fixed terms of the respective leases, which generally are from three to 10 years. Estimated costs related to unsuccessful activities are expensed as incurred.

We record liabilities for the performance of asset retirement activities when the obligation to perform such activities is unconditional, whether or not the timing or method of settlement of the obligation may be conditional on a future event.

Upon the acquisition of real estate assets, we assess the fair value of acquired tangible assets such as land, buildings and tenant improvements, intangible assets such as above and below market leases, acquired in-place leases, customer relationships and other identified intangible assets and assumed liabilities. We assess fair value based on estimated cash flow projections that utilize discount and/or capitalization rates as well as available market information. The fair value of the tangible assets of an acquired property considers the value of the property as if it were vacant.

The above and below market rate portions of leases acquired in connection with property acquisitions are recorded in deferred financing and leasing costs or in accounts payable, accrued expenses and other liabilities at their fair value. Fair value is calculated as the present value of the difference between (1) the contractual amounts to be paid pursuant to each in-place lease and (2) our estimate of fair market lease rates for each corresponding in-place lease, using a discount rate that reflects the risks associated with the leases acquired and measured over a period equal to the remaining term of the lease for above-market leases and the initial term plus the term of any below-market fixed rate renewal options for below-market leases. The capitalized above-market lease values are amortized as a reduction of base rental revenue over the remaining term of the respective leases and the accrued below-market lease values are amortized as an increase to base rental revenue over the remaining term of the respective leases and any below market option periods.

In-place leases acquired are recorded at their fair value in deferred financing and leasing costs and are amortized to depreciation and amortization expense over the remaining term of the respective lease. The value of in-place leases is based on our evaluation of the specific characteristics of each customer’s lease. Factors considered include estimates of carrying costs during hypothetical expected lease-up periods, current market conditions, the customer’s credit quality and costs to execute similar leases. In estimating carrying costs, we include real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates during the expected lease-up periods, depending on local market conditions. In estimating costs to execute similar leases, we consider tenant improvements, leasing commissions and legal and other related expenses.

Real estate and other assets are classified as long-lived assets held for use or as long-lived assets held for sale. Real estate is classified as held for sale when the Company’s Board of Directors, or its investment committee has approved the sale of the asset, a legally enforceable contract has been executed and the buyer’s due diligence period has expired.

Impairment of Long-Lived Assets and Investments in Unconsolidated Affiliates

With respect to assets classified as held for use, if events or changes in circumstances (such as a significant decline in occupancy, identification of materially adverse legal or environmental factors, change in our designation of an asset to non-core which impacts the anticipated holding period or market value less than cost) indicate that the carrying value may be impaired, an impairment analysis is performed. Such analysis is generally performed at the property level, except when an asset is part of an interdependent group (e.g. office park) and consists of determining whether the asset’s carrying amount will be recovered from its undiscounted estimated future operating and residual cash flows. These cash flows are estimated based on a number of assumptions that are subject to economic and market uncertainties including, among others, demand for space, competition for customers, changes in market rental rates, costs to operate each property and expected ownership periods. For properties under development, the cash flows are based on expected service potential of the asset (group) when development is substantially complete.

 
38



If the carrying amount of a held for use asset exceeds the sum of its undiscounted future operating and residual cash flows, an impairment loss is recorded for the difference between estimated fair value of the asset and the carrying amount. We generally estimate the fair value of assets held for use by using discounted cash flow analysis. In some instances, appraisal information may be available and is used in addition to the discounted cash flow analysis. As the factors used in generating these cash flows are difficult to predict and are subject to future events that may alter our assumptions, the discounted and/or undiscounted future operating and residual cash flows estimated by us in our impairment analyses or those established by appraisal may not be achieved and we may be required to recognize future impairment losses on our properties held for use.

We record assets held for sale (including for-sale residential condominiums) at the lower of the carrying amount or estimated fair value. Fair value of assets held for sale is equal to the estimated or contracted sales price with a potential buyer, less costs to sell. The impairment loss is the amount by which the carrying amount exceeds the estimated fair value.

We analyze our investments in unconsolidated affiliates for impairment. Such analysis consists of determining whether an expected loss in market value of an investment is other than temporary by evaluating the length of time and the extent to which the market value has been less than cost, the financial condition and near-term prospects of the investee, and our intent and ability to retain our investment for a period of time sufficient to allow for any anticipated recovery in market value. As the factors used in this analysis are difficult to predict and are subject to future events that may alter our assumptions, we may be required to recognize future impairment losses on our investments in unconsolidated affiliates.

Sales of Real Estate

For sales transactions meeting the requirements for full profit recognition, the related assets and liabilities are removed from the balance sheet and the resultant gain or loss is recorded in the period the transaction closes. For sales transactions with continuing involvement after the sale, if the continuing involvement with the property is limited by the terms of the sales contract, profit is recognized at the time of sale and is reduced by the maximum exposure to loss related to the nature of the continuing involvement. Sales to entities in which we have or receive an interest are accounted for using partial sale accounting.

For transactions that do not meet the criteria for a sale, we evaluate the nature of the continuing involvement, including put and call provisions, if present, and account for the transaction as a financing arrangement, profit-sharing arrangement, leasing arrangement or other alternate method of accounting, rather than as a sale, based on the nature and extent of the continuing involvement. Some transactions may have numerous forms of continuing involvement. In those cases, we determine which method is most appropriate based on the substance of the transaction.

If we have an obligation to repurchase the property at a higher price or at a future indeterminable value (such as fair market value), or we guarantee the return of the buyer’s investment or a return on that investment for an extended period, we account for such transaction as a financing arrangement. For transactions treated as financing arrangements, we record the amounts received from the buyer as a financing obligation and continue to keep the property and related accounts recorded in our Consolidated Financial Statements. The results of operations of the property, net of expenses other than depreciation, are reflected as interest expense on the financing obligation. If the transaction includes an obligation or option to repurchase the asset at a higher price, additional interest is recorded to accrete the liability to the repurchase price. For options or obligations to repurchase the asset at fair market value at the end of each reporting period, the balance of the liability is adjusted to equal the then current fair value to the extent fair value exceeds the original financing obligation. The corresponding debit or credit is recorded to a related discount account and the revised discount is amortized over the expected term until termination of the option or obligation. If it is unlikely such option will be exercised, the transaction is accounted for under the deposit method or profit-sharing method. If we have an obligation or option to repurchase at a lower price, the transaction is accounted for as a leasing arrangement. At such time as a repurchase obligation expires, a sale is recorded and gain recognized.

If we retain an interest in the buyer and provide certain rent guarantees or other forms of support where the maximum exposure to loss exceeds the gain, we account for such transaction as a profit-sharing arrangement. For transactions treated as profit-sharing arrangements, we record a profit-sharing obligation for the amount of equity contributed by the other partner and continue to keep the property and related accounts recorded in our Consolidated Financial Statements. The results of operations of the property, net of expenses other than depreciation, are allocated to the other partner for its percentage interest and reflected as “co-venture expense” in our Consolidated Financial Statements. In future periods, a sale is recorded and profit is recognized when the remaining maximum exposure to loss is reduced below the amount of gain deferred.

 
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Rental and Other Revenues

Minimum contractual rents from leases are recognized on a straight-line basis over the terms of the respective leases. This means that, with respect to a particular lease, actual amounts billed in accordance with the lease during any given period may be higher or lower than the amount of rental revenue recognized for the period. Straight-line rental revenue is commenced when the customer assumes control of the leased premises. Accrued straight-line rents receivable represents the amount by which straight-line rental revenue exceeds rents currently billed in accordance with lease agreements. Contingent rental revenue, such as percentage rent, is accrued when the contingency is removed. Termination fee income is recognized as revenue at the later of when the customer has vacated the space or the lease has expired and the following conditions are met: a fully executed lease termination agreement has been delivered; the amount of the fee is determinable; and collectability of the fee is reasonably assured. Rental revenue reductions related to co-tenancy lease provisions, if any, are accrued when events have occurred that trigger such provisions.

Property operating cost recoveries from customers (“cost reimbursements”) are determined on a calendar year and a lease-by-lease basis. The most common types of cost reimbursements in our leases are common area maintenance (“CAM”) and real estate taxes, for which the customer pays its pro-rata share of operating and administrative expenses and real estate taxes in excess of a base year. The computation of property operating cost recovery income from customers is complex and involves numerous judgments, including the interpretation of terms and other customer lease provisions. Leases are not uniform in dealing with such cost reimbursements and there are many variations in the computation. Many customers make monthly fixed payments of CAM, real estate taxes and other cost reimbursement items. We accrue income related to these payments each month. We make quarterly accrual adjustments, positive or negative, to cost recovery income to adjust the recorded amounts to our best estimate of the final annual amounts to be billed and collected with respect to the cost reimbursements. After the end of the calendar year, we compute each customer’s final cost reimbursements and, after considering amounts paid by the customer during the year, issue a bill or credit for the appropriate amount to the customer. The differences between the amounts billed less previously received payments and the accrual adjustment are recorded as increases or decreases to cost recovery income when the final bills are prepared, which occurs during the first half of the subsequent year.

Allowance for Doubtful Accounts

Accounts receivable, accrued straight-line rents receivable and mortgages and notes receivable are reduced by an allowance for amounts that may become uncollectible in the future. We regularly evaluate the adequacy of our allowance for doubtful accounts. The evaluation primarily consists of reviewing past due account balances and considering such factors as the credit quality of our customer, historical trends of the customer and changes in customer payment terms. Additionally, with respect to customers in bankruptcy, we estimate the probable recovery through bankruptcy claims and adjust the allowance for amounts deemed uncollectible. If our assumptions regarding the collectability of receivables prove incorrect, we could experience losses in excess of our allowance for doubtful accounts. The allowance and its related receivable are written-off when we have concluded there is a low probability of collection.

 
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Non-Gaap Measures - FFO and NOI

The Company believes that Funds from Operations (“FFO”) and FFO per share are beneficial to management and investors and are important indicators of the performance of any equity REIT. Because FFO and FFO per share calculations exclude such factors as depreciation and amortization of real estate assets and gains or losses from sales of operating real estate assets, which can vary among owners of identical assets in similar conditions based on historical cost accounting and useful life estimates, they facilitate comparisons of operating performance between periods and between other REITs. Management believes that 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 have historically risen or fallen with market conditions, many industry investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting to be insufficient on a standalone basis. As a result, management believes that the use of FFO and FFO per share, together with the required GAAP presentations, provide a more complete understanding of the Company’s performance relative to its competitors and a more informed and appropriate basis on which to make decisions involving operating, financing and investing activities.

FFO and FFO per share are non-GAAP financial measures and therefore do not represent net income or net income per share as defined by GAAP. Net income and net income per share as defined by GAAP are the most relevant measures in determining the Company’s operating performance because FFO and FFO per share include adjustments that investors may deem subjective, such as adding back expenses such as depreciation and amortization. Furthermore, FFO per share does not depict the amount that accrues directly to the stockholders’ benefit. Accordingly, FFO and FFO per share should never be considered as alternatives to net income or net income per share as indicators of the Company’s operating performance.

The Company’s presentation of FFO is consistent with FFO as defined by the National Association of Real Estate Investment Trusts (“NAREIT”), which is calculated as follows:

 
·
Net income/(loss) computed in accordance with GAAP;

 
·
Less dividends to holders of Preferred Stock and less excess of Preferred Stock redemption cost over carrying value;

 
·
Less net income attributable to noncontrolling interests in consolidated affliates;

 
·
Plus depreciation and amortization of real estate assets;

 
·
Less gains, or plus losses, from sales of depreciable operating properties (but excluding impairment losses) and excluding items that are classified as extraordinary items under GAAP;

 
·
Plus or minus adjustments for unconsolidated partnerships and joint ventures (to reflect funds from operations on the same basis); and

 
·
Plus or minus adjustments for depreciation and amortization and gains/(losses) on sales and noncontrolling interests in consolidated affiliates, related to discontinued operations.

In calculating FFO, the Company adds back net income attributable to noncontrolling interests in the Operating Partnership, which the Company believes is consistent with standard industry practice for REITs that operate through an UPREIT structure. The Company believes that it is important to present FFO on an as-converted basis since all of the Common Units not owned by the Company are redeemable on a one-for-one basis for shares of its Common Stock.

Other REITs may not define FFO in accordance with the current NAREIT definition or may interpret the current NAREIT definition differently than we do.

 
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The Company’s FFO and FFO per share are summarized in the following table ($ in thousands, except per share amounts):

   
Years Ended December 31,
 
   
2010
 
2009
 
2008
 
   
Amount
 
Per Share
 
Amount
 
Per Share
 
Amount
 
Per Share
 
Funds from operations:
                                     
Net income                                                                      
 
$
72,303
       
$
61,694
       
$
35,610
       
Net (income) attributable to noncontrolling interests in the Operating Partnership
   
(3,320
)
       
(3,197
)
       
(1,577
)
     
Net (income) attributable to noncontrolling interests in consolidated affiliates
   
(485
)
       
(11
)
       
(2,041
)
     
Dividends on preferred stock
   
(6,708
)
       
(6,708
)
       
(9,804
)
     
Excess of preferred stock redemption/repurchase cost over carrying value
   
         
         
(108
)
     
Net income available for common stockholders
   
61,790
 
$
0.86
   
51,778
 
$
0.76
   
22,080
 
$
0.37
 
Add/(Deduct):
                                     
Depreciation and amortization of real estate assets
   
134,058
   
1.78
   
128,130
   
1.77
   
120,890
   
1.90
 
(Gains) on disposition of depreciable properties
   
(74
)
 
   
(127
)
 
   
(126
)
 
 
(Gains) on disposition of investment in unconsolidated affiliates
   
(25,330
)
 
(0.34
)
 
   
   
   
 
Net income attributable to noncontrolling interests in the Operating Partnership
   
3,320
   
   
3,197
   
   
1,577
   
 
Unconsolidated affiliates: