HIW 09.30.2012 10Q
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________
 
FORM 10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2012
 
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)
______________
 
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  S    No £
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of 'large accelerated filer,' 'accelerated filer' and 'smaller reporting company' in Rule 12b-2 of the 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 Company had 78,529,922 shares of Common Stock outstanding as of October 22, 2012.
 



HIGHWOODS PROPERTIES, INC.
HIGHWOODS REALTY LIMITED PARTNERSHIP

QUARTERLY REPORT FOR THE PERIOD ENDED SEPTEMBER 30, 2012

TABLE OF CONTENTS

 
Page
 
 
PART I - FINANCIAL INFORMATION
 
HIGHWOODS PROPERTIES, INC.:
 
HIGHWOODS REALTY LIMITED PARTNERSHIP:
 
 
 
PART II - OTHER INFORMATION
 
ITEM 6. EXHIBITS



2

Table of Contents

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

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 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 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.

Certain information contained herein is presented as of October 22, 2012, the latest practicable date for financial information prior to the filing of this Quarterly Report.


3

Table of Contents

HIGHWOODS PROPERTIES, INC.
Consolidated Balance Sheets
(Unaudited and in thousands, except share and per share data)
 
September 30,
2012
 
December 31,
2011
Assets:
 
 
 
Real estate assets, at cost:
 
 
 
Land
$
371,478

 
$
355,694

Buildings and tenant improvements
3,200,350

 
3,009,155

Development in process
11,566

 

Land held for development
102,482

 
105,206

 
3,685,876

 
3,470,055

Less-accumulated depreciation
(926,668
)
 
(869,046
)
Net real estate assets
2,759,208

 
2,601,009

For-sale residential condominiums
1,238

 
4,751

Real estate and other assets, net, held for sale

 
124,273

Cash and cash equivalents
9,086

 
11,188

Restricted cash
21,578

 
26,666

Accounts receivable, net of allowance of $3,437 and $3,548, respectively
21,144

 
30,093

Mortgages and notes receivable, net of allowance of $211 and $61, respectively
16,943

 
18,600

Accrued straight-line rents receivable, net of allowance of $1,076 and $1,294, respectively
112,660

 
99,490

Investments in and advances to unconsolidated affiliates
78,406

 
100,367

Deferred financing and leasing costs, net of accumulated amortization of $73,579 and $62,319, respectively
149,170

 
127,774

Prepaid expenses and other assets, net of accumulated amortization of $12,585 and $15,089, respectively
40,452

 
36,781

Total Assets
$
3,209,885

 
$
3,180,992

Liabilities, Noncontrolling Interests in the Operating Partnership and Equity:
 
 
 
Mortgages and notes payable
$
1,778,555

 
$
1,868,906

Accounts payable, accrued expenses and other liabilities
152,053

 
148,607

Financing obligations
27,791

 
30,150

Liabilities, net, held for sale

 
35,815

Total Liabilities
1,958,399

 
2,083,478

Commitments and contingencies

 

Noncontrolling interests in the Operating Partnership
123,141

 
110,655

Equity:
 
 
 
Preferred Stock, $.01 par value, 50,000,000 authorized shares;
 
 
 
8.625% Series A Cumulative Redeemable Preferred Shares (liquidation preference $1,000 per share), 29,077 shares issued and outstanding
29,077

 
29,077

Common Stock, $.01 par value, 200,000,000 authorized shares;
 
 
 
78,529,922 and 72,647,697 shares issued and outstanding, respectively
785

 
726

Additional paid-in capital
1,985,322

 
1,803,997

Distributions in excess of net income available for common stockholders
(877,962
)
 
(845,853
)
Accumulated other comprehensive loss
(13,426
)
 
(5,734
)
Total Stockholders’ Equity
1,123,796

 
982,213

Noncontrolling interests in consolidated affiliates
4,549

 
4,646

Total Equity
1,128,345

 
986,859

Total Liabilities, Noncontrolling Interests in the Operating Partnership and Equity
$
3,209,885

 
$
3,180,992


See accompanying notes to consolidated financial statements.



4

Table of Contents

HIGHWOODS PROPERTIES, INC.
Consolidated Statements of Income
(Unaudited and in thousands, except per share amounts)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Rental and other revenues                                                                                           
$
128,214

 
$
117,265

 
$
382,120

 
$
339,497

Operating expenses:
 
 
 
 
 
 
 
Rental property and other expenses
47,233

 
44,031

 
138,132

 
122,358

Depreciation and amortization
38,651

 
35,051

 
115,755

 
99,659

Impairments of real estate assets

 
2,429

 

 
2,429

General and administrative
9,725

 
12,212

 
28,298

 
27,983

Total operating expenses
95,609

 
93,723

 
282,185

 
252,429

Interest expense:
 
 
 
 
 
 
 
Contractual
22,910

 
23,264

 
70,309

 
68,444

Amortization of deferred financing costs
907

 
806

 
2,709

 
2,448

Financing obligations
(205
)
 
201

 
(357
)
 
584

 
23,612

 
24,271

 
72,661

 
71,476

Other income:
 
 
 
 
 
 
 
Interest and other income
1,916

 
1,505

 
5,883

 
5,277

Losses on debt extinguishment

 

 
(973
)
 
(24
)
 
1,916

 
1,505


4,910


5,253

Income from continuing operations before disposition of property, condominiums and investments in unconsolidated affiliates and equity in earnings of unconsolidated affiliates
10,909

 
776

 
32,184

 
20,845

Gains on disposition of property

 
262

 

 
462

Gains/(losses) on for-sale residential condominiums
80

 
(476
)
 
255

 
(322
)
Gains on disposition of investments in unconsolidated affiliates

 
2,282

 

 
2,282

Equity in earnings of unconsolidated affiliates
1,324

 
1,113

 
2,670

 
3,933

Income from continuing operations
12,313

 
3,957

 
35,109

 
27,200

Discontinued operations:
 
 
 
 
 
 
 
Income from discontinued operations
547

 
1,714

 
4,062

 
5,348

Net gains on disposition of discontinued operations
22,936

 
2,573

 
29,455

 
2,573

 
23,483

 
4,287

 
33,517

 
7,921

Net income
35,796

 
8,244

 
68,626

 
35,121

Net (income) attributable to noncontrolling interests in the Operating Partnership
(1,653
)
 
(366
)
 
(3,166
)
 
(1,496
)
Net (income) attributable to noncontrolling interests in consolidated affiliates
(159
)
 
(249
)
 
(566
)
 
(554
)
Dividends on Preferred Stock
(627
)
 
(627
)
 
(1,881
)
 
(3,926
)
Excess of Preferred Stock redemption/repurchase cost over carrying value

 

 

 
(1,895
)
Net income available for common stockholders
$
33,357

 
$
7,002


$
63,013


$
27,250

Earnings per Common Share – basic:
 
 
 
 
 
 
 
Income from continuing operations available for common stockholders
$
0.15

 
$
0.04

 
$
0.42

 
$
0.28

Income from discontinued operations available for common stockholders
0.29

 
0.06

 
0.42

 
0.10

Net income available for common stockholders
$
0.44

 
$
0.10

 
$
0.84

 
$
0.38

Weighted average Common Shares outstanding – basic
76,590

 
72,492

 
74,703

 
72,176

Earnings per Common Share – diluted:
 
 
 
 
 
 
 
Income from continuing operations available for common stockholders
$
0.14

 
$
0.04

 
$
0.42

 
$
0.28

Income from discontinued operations available for common stockholders
0.29

 
0.06

 
0.42

 
0.10

Net income available for common stockholders
$
0.43

 
$
0.10

 
$
0.84

 
$
0.38

Weighted average Common Shares outstanding – diluted
80,495

 
76,402

 
78,568

 
76,127

Dividends declared per Common Share
$
0.425

 
$
0.425

 
$
1.275

 
$
1.275

Net income available for common stockholders:
 
 
 
 
 
 
 
Income from continuing operations available for common stockholders
$
10,980

 
$
2,928

 
$
31,090

 
$
19,724

Income from discontinued operations available for common stockholders
22,377

 
4,074

 
31,923

 
7,526

Net income available for common stockholders
$
33,357

 
$
7,002

 
$
63,013

 
$
27,250

See accompanying notes to consolidated financial statements.

5

Table of Contents

HIGHWOODS PROPERTIES, INC.
Consolidated Statements of Comprehensive Income
(Unaudited and in thousands)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Comprehensive income/(loss):
 
 
 
 
 
 
 
Net income
$
35,796

 
$
8,244

 
$
68,626

 
$
35,121

Other comprehensive income/(loss):
 
 
 
 
 
 
 
Unrealized gains/(losses) on tax increment financing bond
(101
)
 
600

 
482

 
129

Unrealized losses on cash flow hedges
(3,337
)
 

 
(10,424
)
 

Amortization of cash flow hedges
791

 
(30
)
 
2,250

 
(87
)
Total other comprehensive income/(loss)
(2,647
)
 
570

 
(7,692
)
 
42

Total comprehensive income
33,149

 
8,814

 
60,934

 
35,163

Less-comprehensive (income) attributable to noncontrolling interests
(1,812
)
 
(615
)
 
(3,732
)
 
(2,050
)
Comprehensive income attributable to the Company
$
31,337

 
$
8,199

 
$
57,202

 
$
33,113


See accompanying notes to consolidated financial statements.



6

Table of Contents

HIGHWOODS PROPERTIES, INC.
Consolidated Statements of Equity
(Unaudited and in thousands, except share amounts)

 
Number of Common Shares
 
Common Stock
 
Series A Cumulative Redeemable Preferred Shares
 
Additional Paid-In Capital
 
Accumulated Other Compre-hensive Loss
 
Non-controlling Interests in Consolidated Affiliates
 
Distributions in Excess of Net Income Available for Common Stockholders
 
Total
Balance at December 31, 2011
72,647,697

 
$
726

 
$
29,077

 
$
1,803,997

 
$
(5,734
)
 
$
4,646

 
$
(845,853
)
 
$
986,859

Issuances of Common Stock, net
5,701,974

 
57

 

 
186,617

 

 

 

 
186,674

Conversions of Common Units to Common Stock
21,366

 

 

 
731

 

 

 

 
731

Dividends on Common Stock


 

 

 

 

 

 
(95,122
)
 
(95,122
)
Dividends on Preferred Stock


 

 

 

 

 

 
(1,881
)
 
(1,881
)
Adjustment of noncontrolling interests in the Operating Partnership to fair value


 

 

 
(12,485
)
 

 

 

 
(12,485
)
Distributions to noncontrolling interests in consolidated affiliates


 

 

 

 

 
(663
)
 

 
(663
)
Issuances of restricted stock
158,885

 

 

 

 

 

 

 

Share-based compensation expense


 
2

 

 
6,462

 

 

 

 
6,464

Net (income) attributable to noncontrolling interests in the Operating Partnership


 

 

 

 

 

 
(3,166
)
 
(3,166
)
Net (income) attributable to noncontrolling interests in consolidated affiliates


 

 

 

 

 
566

 
(566
)
 

Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income


 

 

 

 

 

 
68,626

 
68,626

Other comprehensive loss


 

 

 

 
(7,692
)
 

 

 
(7,692
)
Total comprehensive income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
60,934

Balance at September 30, 2012
78,529,922

 
$
785

 
$
29,077

 
$
1,985,322

 
$
(13,426
)
 
$
4,549

 
$
(877,962
)
 
$
1,128,345



 
Number of Common Shares
 
Common Stock
 
Series A Cumulative Redeemable Preferred Shares
 
Series B Cumulative Redeemable Preferred Shares
 
Additional Paid-In Capital
 
Accumulated Other Compre-hensive Loss
 
Non-controlling Interests in Consolidated Affiliates
 
Distributions in Excess of Net Income Available for Common Stockholders
 
Total
Balance at December 31, 2010
71,690,487

 
$
717

 
$
29,092

 
$
52,500

 
$
1,766,886

 
$
(3,648
)
 
$
4,460

 
$
(761,785
)
 
$
1,088,222

Issuances of Common Stock, net
711,234

 
7

 

 

 
22,036

 

 

 

 
22,043

Conversions of Common Units to Common Stock
43,308

 

 

 

 
1,344

 

 

 

 
1,344

Dividends on Common Stock

 

 

 

 

 

 

 
(91,900
)
 
(91,900
)
Dividends on Preferred Stock

 

 

 

 

 

 

 
(3,926
)
 
(3,926
)
Adjustment of noncontrolling interests in the Operating Partnership to fair value

 

 

 

 
10,177

 

 

 

 
10,177

Distributions to noncontrolling interests in consolidated affiliates

 

 

 

 

 

 
(391
)
 

 
(391
)
Issuances of restricted stock
134,352

 

 

 

 

 

 

 

 

Redemptions/repurchases of Preferred Stock

 

 
(15
)
 
(52,500
)
 
1,895

 

 

 
(1,895
)
 
(52,515
)
Share-based compensation expense

 
2

 

 

 
4,769

 

 

 

 
4,771

Net (income) attributable to noncontrolling interests in the Operating Partnership

 

 

 

 

 

 

 
(1,496
)
 
(1,496
)
Net (income) attributable to noncontrolling interests in consolidated affiliates

 

 

 

 

 

 
554

 
(554
)
 

Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income

 

 

 

 

 

 

 
35,121

 
35,121

Other comprehensive income

 

 

 

 

 
42

 

 

 
42

Total comprehensive income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
35,163

Balance at September 30, 2011
72,579,381

 
$
726

 
$
29,077

 
$

 
$
1,807,107

 
$
(3,606
)
 
$
4,623

 
$
(826,435
)
 
$
1,011,492


See accompanying notes to consolidated financial statements.

7

Table of Contents

HIGHWOODS PROPERTIES, INC.
Consolidated Statements of Cash Flows
(Unaudited and in thousands)
 
Nine Months Ended September 30,
 
2012
 
2011
Operating activities:
 
 
 
Net income
$
68,626

 
$
35,121

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
117,764

 
103,594

Amortization of lease incentives and acquisition-related intangible assets and liabilities
358

 
1,347

Share-based compensation expense
6,464

 
4,771

Allowance for losses on accounts and accrued straight-line rents receivable
1,235

 
1,586

Amortization of deferred financing costs
2,709

 
2,448

Amortization of cash flow hedges
2,250

 
(87
)
Impairments of real estate assets

 
2,429

Losses on debt extinguishment
973

 
24

Net gains on disposition of property
(29,455
)
 
(3,035
)
(Gains)/losses on for-sale residential condominiums
(255
)
 
322

Gains on disposition of investments in unconsolidated affiliates

 
(2,282
)
Equity in earnings of unconsolidated affiliates
(2,670
)
 
(3,933
)
Changes in financing obligations
(1,010
)
 
(339
)
Distributions of earnings from unconsolidated affiliates
3,249

 
3,400

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
5,310

 
(3,493
)
Prepaid expenses and other assets
(3,258
)
 
(586
)
Accrued straight-line rents receivable
(13,609
)
 
(9,280
)
Accounts payable, accrued expenses and other liabilities
(20,663
)
 
4,118

Net cash provided by operating activities
138,018

 
136,125

Investing activities:
 
 
 
Investments in acquired real estate and related intangible assets, net of cash acquired
(158,200
)
 
(75,510
)
Investments in development in process
(5,392
)
 
(5,835
)
Investments in tenant improvements and deferred leasing costs
(61,821
)
 
(59,692
)
Investments in building improvements
(27,229
)
 
(9,521
)
Net proceeds from disposition of real estate assets
152,456

 
16,530

Net proceeds from disposition of for-sale residential condominiums
3,768

 
2,770

Proceeds from disposition of investments in unconsolidated affiliates

 
4,756

Distributions of capital from unconsolidated affiliates
1,035

 
1,304

Repayments of mortgages and notes receivable
1,657

 
338

Investments in and advances to unconsolidated affiliates
(3,928
)
 
(39,665
)
Changes in restricted cash and other investing activities
2,904

 
(15,598
)
Net cash used in investing activities
(94,750
)
 
(180,123
)
Financing activities:
 
 
 
Dividends on Common Stock
(95,122
)
 
(91,900
)
Redemptions/repurchases of Preferred Stock

 
(52,515
)
Dividends on Preferred Stock
(1,881
)
 
(3,926
)
Distributions to noncontrolling interests in the Operating Partnership
(4,733
)
 
(4,818
)
Distributions to noncontrolling interests in consolidated affiliates
(663
)
 
(391
)
Proceeds from the issuance of Common Stock
191,667

 
22,043

Costs paid for the issuance of Common Stock
(2,745
)
 

Repurchase of shares related to tax withholdings
(2,248
)
 

Borrowings on revolving credit facility
219,800

 
285,400

Repayments of revolving credit facility
(492,800
)
 
(150,400
)
Borrowings on mortgages and notes payable
225,000

 
200,000

Repayments of mortgages and notes payable
(77,264
)
 
(156,602
)
Payments on financing obligations
(1,316
)
 

Additions to deferred financing costs and other financing activities
(3,065
)
 
(6,011
)
Net cash provided by/(used in) financing activities
(45,370
)
 
40,880

Net decrease in cash and cash equivalents
$
(2,102
)
 
$
(3,118
)
See accompanying notes to consolidated financial statements.

8

Table of Contents


HIGHWOODS PROPERTIES, INC.
Consolidated Statements of Cash Flows – Continued
(Unaudited and in thousands)

 
Nine Months Ended September 30,
 
2012
 
2011
Net decrease in cash and cash equivalents
$
(2,102
)
 
$
(3,118
)
Cash and cash equivalents at beginning of the period
11,188

 
14,206

Cash and cash equivalents at end of the period
$
9,086

 
$
11,088


Supplemental disclosure of cash flow information:

 
Nine Months Ended September 30,
 
2012
 
2011
Cash paid for interest, net of amounts capitalized
$
72,793

 
$
69,321


Supplemental disclosure of non-cash investing and financing activities:

 
Nine Months Ended September 30,
 
2012
 
2011
Unrealized losses on cash flow hedges
$
(10,424
)
 
$

Conversion of Common Units to Common Stock
731

 
1,344

Changes in accrued capital expenditures
1,829

 
3,707

Write-off of fully depreciated real estate assets
36,918

 
39,039

Write-off of fully amortized deferred financing and leasing costs
14,189

 
13,683

Unrealized gains/(losses) on marketable securities of non-qualified deferred compensation plan
310

 
(354
)
Adjustment of noncontrolling interests in the Operating Partnership to fair value
12,485

 
(10,177
)
Unrealized gains on tax increment financing bond
482

 
129

Assumption of mortgages and notes payable related to acquisition activities

 
192,367

Reduction of advances to unconsolidated affiliates related to acquisition activities
26,000

 

Issuances of Common Units to acquire real estate assets
2,299

 


See accompanying notes to consolidated financial statements.

9

Table of Contents

HIGHWOODS PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2012
(tabular dollar amounts in thousands, except per share data)
(Unaudited)

1.    Description of Business and Significant Accounting Policies

Description of Business

Highwoods Properties, Inc., together with its consolidated subsidiaries (the “Company”), is a fully-integrated, self-administered and self-managed equity real estate investment trust (“REIT”) that provides leasing, management, development, construction and other customer-related services for its properties and for third parties. The Company conducts virtually all of its activities through Highwoods Realty Limited Partnership (the “Operating Partnership”). At September 30, 2012, the Company and/or the Operating Partnership wholly owned: 299 in-service office, industrial and retail properties, comprising 29.0 million square feet; five for-sale residential condominiums; 581 acres of undeveloped land suitable for future development, of which 518 acres are considered core assets; and one office property under development.

The Company is the sole general partner of the Operating Partnership. At September 30, 2012, the Company owned all of the Preferred Units and 78.1 million, or 95.4%, of the Common Units in the Operating Partnership. Limited partners, including one officer and two directors of the Company, own the remaining 3.8 million Common Units. In the event the Company issues shares of Common Stock, the net proceeds are contributed to the Operating Partnership in exchange for additional Common Units. Generally, the Operating Partnership is required to redeem each Common Unit at the request of the holder thereof for cash equal to the value of one share of the Company’s Common Stock, $0.01 par value, 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. During the nine months ended September 30, 2012, the Company redeemed 21,366 Common Units for a like number of shares of Common Stock and issued 66,864 Common Units to acquire real estate assets. As a result of this activity, the percentage of Common Units owned by the Company increased from 95.1% at December 31, 2011 to 95.4% at September 30, 2012.

Common Stock Offerings
 
The Company has entered into equity sales agreements with various financial institutions to offer and sell, from time to time, shares of its Common Stock by means of ordinary brokers' transactions on the New York Stock Exchange or otherwise at market prices prevailing at the time of sale, at prices related to prevailing market prices or at negotiated prices or as otherwise agreed with any of the institutions. During the three and nine months ended September 30, 2012, the Company issued 2,867,768 and 5,490,244 shares, respectively, of Common Stock under these agreements at an average gross sales price of $33.22 and $33.33 per share, respectively, raising net proceeds, after sales commissions and expenses, of $93.8 million and $180.2 million, respectively.

Basis of Presentation

Our Consolidated Financial Statements are prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). Our Consolidated Balance Sheet at December 31, 2011 was recast from previously reported amounts to reflect in real estate and other assets, net, held for sale those properties which qualified as held for sale during the three months ended September 30, 2012. Our Consolidated Statements of Income for the three and nine months ended September 30, 2011 were recast from previously reported amounts to reflect in discontinued operations the operations for those properties that qualified for discontinued operations. Prior period amounts related to capital expenditures in our Consolidated Statements of Cash Flows have been disaggregated to conform to the current period presentation.

Our Consolidated Financial Statements include the Operating Partnership, wholly owned subsidiaries and those entities in which we have the controlling financial interest. All intercompany transactions and accounts have been eliminated. At September 30, 2012 and December 31, 2011, we had involvement with no entities that we concluded to be variable interest entities.

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HIGHWOODS PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(tabular dollar amounts in thousands, except per share data)


1.    Description of Business and Significant Accounting Policies – Continued

The unaudited interim consolidated financial statements and accompanying unaudited consolidated financial information, in the opinion of management, contain all adjustments (including normal recurring accruals) necessary for a fair presentation of our financial position, results of operations and cash flows. We have omitted certain notes and other information from the interim consolidated financial statements presented in this Quarterly Report on Form 10-Q as permitted by SEC rules and regulations. These Consolidated Financial Statements should be read in conjunction with our 2011 Annual Report on Form 10-K.

Use of Estimates

The preparation of consolidated financial statements in accordance with GAAP requires us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Recently Issued Accounting Standards
 
As a result of adopting certain new or amended accounting pronouncements in the first quarter of 2012, we have enhanced our disclosure of assets and liabilities measured at fair value and elected to continue use of credit valuation adjustments on a net basis by counterparty as part of the calculation to determine the fair value of our derivatives. Our disclosures now include: (1) significant transfers between Levels 1 and 2 of the fair value hierarchy, if any; (2) additional quantitative and qualitative information regarding fair value measurements categorized as Level 3 of the fair value hierarchy; and (3) the hierarchy classification for items whose fair value is not recorded on our Consolidated Balance Sheets but was disclosed previously in our Notes to Consolidated Financial Statements. Additionally, we have presented comprehensive income in a separate financial statement entitled Consolidated Statements of Comprehensive Income.

2.    Real Estate Assets
 
Acquisitions
 
During the third quarter of 2012, we acquired three properties for a total purchase price of $161.2 million, consisting of (1) a 492,000 square foot office property in Atlanta, GA for $144.9 million and (2) two medical office properties in Greensboro, NC for $16.3 million, which included the issuance of 66,864 Common Units and contingent consideration with fair value at the acquisition date of $0.7 million. We expensed approximately $0.7 million of acquisition costs related to these transactions. The assets acquired and liabilities assumed were recorded at fair value as determined by management based on information available at the acquisition date and on current assumptions as to future operations.

The following table sets forth a summary of the assets acquired and liabilities assumed in the acquisition of the office property in Atlanta, GA discussed above:

 
Total
Purchase Price Allocation
Real estate assets
$
135,128

Acquisition-related intangible assets (in deferred financing and leasing costs)
21,637

Acquisition-related below market lease liabilities (in accounts payable, accrued expenses and other liabilities)
(11,875
)
Total allocation
$
144,890



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HIGHWOODS PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(tabular dollar amounts in thousands, except per share data)


2.    Real Estate Assets - Continued

During the third quarter of 2011, we acquired a six-building, 1,540,000 square foot office complex in Pittsburgh, PA and a 503,000 square foot office building in Atlanta, GA for a purchase price of $188.5 million and $78.3 million, respectively.

The following table sets forth our rental and other revenues and net income, adjusted for interest expense and depreciation and amortization related to purchase price allocations and acquisition costs assuming: (1) the 492,000 square foot office building in Atlanta, GA was acquired on January 1, 2011, with proforma adjustments being included in the three and nine months ended September 30, 2012 and 2011 and (2) the office complex in Pittsburgh, PA and the 503,000 square foot office building in Atlanta, GA were acquired on January 1, 2010, with proforma adjustments being included in the three and nine months ended September 30, 2011.

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Proforma rental and other revenues
$
132,632

 
$
132,269

 
$
395,161

 
$
385,246

Proforma net income
$
35,765

 
$
7,626

 
$
68,526

 
$
33,268

Proforma earnings per share - basic
$
0.43

 
$
0.09

 
$
0.84

 
$
0.35

Proforma earnings per share - diluted
$
0.43

 
$
0.09

 
$
0.84

 
$
0.35


During the second quarter of 2012, we also acquired a 178,300 square foot office property in Cary, NC from our DLF I joint venture for an agreed upon value of $26.0 million by reducing the balance of the advance due to us from the joint venture.

Dispositions

During the third quarter of 2012, we sold:

an office property in Kansas City, MO for $6.5 million and recorded gain on disposition of discontinued operations of $1.9 million.

five office buildings in Nashville, TN for $41.0 million and recorded gain on disposition of discontinued operations of $7.0 million.

three buildings in Jackson, MS and Atlanta, GA for $86.5 million and recorded gain on disposition of discontinued operations of $14.0 million.

During the second quarter of 2012, we sold an office property in Pinellas County, FL for gross proceeds of $9.5 million and recorded gain on disposition of discontinued operations of $1.4 million related to this disposition.

During the first quarter of 2012, we sold 96 vacant rental residential units in Kansas City, MO for gross proceeds of $11.0 million and recorded gain on disposition of discontinued operations of $5.1 million related to this disposition.


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HIGHWOODS PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(tabular dollar amounts in thousands, except per share data)



3.    Mortgages and Notes Receivable

The following table sets forth our mortgages and notes receivable:

 
September 30,
2012
 
December 31,
2011
Seller financing (first mortgages)
$
15,853

 
$
17,180

Less allowance

 

 
15,853

 
17,180

Promissory notes
1,301

 
1,481

Less allowance
(211
)
 
(61
)
 
1,090

 
1,420

Mortgages and notes receivable, net
$
16,943

 
$
18,600


Our mortgages and notes receivable consist primarily of seller financing issued in conjunction with two disposition transactions in 2010. This seller financing is evidenced by first mortgages secured by the assignment of rents and the underlying real estate assets. We evaluate the collectability of the receivables by monitoring the leasing statistics and market fundamentals of these assets. As of September 30, 2012, the payments on both mortgages receivable were current and there were no other indications of impairment on the receivables. We may be required to take impairment charges in the future if and to the extent the underlying collateral diminishes in value.

The following table sets forth our notes receivable allowance, which relates only to promissory notes:

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Beginning notes receivable allowance
$
118

 
$
617

 
$
61

 
$
868

Bad debt expense

 

 

 
184

Recoveries/write-offs/other
93

 
(72
)
 
150

 
(507
)
Total notes receivable allowance
$
211

 
$
545

 
$
211

 
$
545



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HIGHWOODS PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(tabular dollar amounts in thousands, except per share data)



4.    Investments in and Advances to Affiliates

Unconsolidated Affiliates

We have equity interests of up to 50.0% in various joint ventures with unrelated third parties and a secured debt interest in one of those joint ventures, as described below. The following table sets forth the combined, summarized income statements for our unconsolidated joint ventures on the purchase accounting basis:

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Income Statements:
 
 
 
 
 
 
 
Rental and other revenues
$
25,051

 
$
25,623

 
$
75,920

 
$
75,619

Expenses:
 
 
 
 
 
 
 
Rental property and other expenses
11,624

 
10,805

 
35,706

 
33,576

Depreciation and amortization
6,355

 
6,759

 
18,839

 
19,670

Impairments of real estate assets

 

 
7,180

 

Interest expense
4,980

 
5,976

 
16,077

 
17,841

Total expenses
22,959

 
23,540

 
77,802

 
71,087

Income/(loss) before disposition of properties
2,092

 
2,083

 
(1,882
)
 
4,532

Gains on disposition of properties

 

 
6,275

 

Net income
$
2,092


$
2,083

 
$
4,393

 
$
4,532

Our share of:
 
 
 
 
 
 
 
Depreciation and amortization of real estate assets
$
2,028

 
$
2,066

 
$
5,801

 
$
6,192

Impairments of real estate assets
$

 
$

 
$
1,002

 
$

Interest expense
$
1,775

 
$
1,965

 
$
5,598

 
$
6,159

Net income
$
914

 
$
442

 
$
1,252

 
$
2,112

 
 
 
 
 
 
 
 
Our share of net income
$
914

 
$
442

 
$
1,252

 
$
2,112

Adjustments for management and other fees
410

 
671

 
1,418

 
1,821

Equity in earnings of unconsolidated affiliates
$
1,324

 
$
1,113

 
$
2,670

 
$
3,933


During the second quarter of 2011, we provided a $38.3 million interest-only secured loan to our DLF I joint venture that originally was scheduled to mature in March 2012. The loan bears interest at LIBOR plus 500 basis points. The maturity date of the loan has been extended to December 31, 2012. In the second quarter of 2012, the outstanding balance of the loan was reduced to $13.0 million as a result of our acquisition of an office property from the joint venture. We recorded interest income from this loan in interest and other income of $0.1 million and $0.5 million during the three months ended September 30, 2012 and 2011, respectively, and $0.8 million and $0.8 million during the nine months ended September 30, 2012 and 2011, respectively.

During the second quarter of 2012, our DLF II joint venture obtained a $50.0 million, three-year secured mortgage loan from a third party lender, bearing a fixed interest rate of 3.5% on $39.1 million of the loan and a floating interest rate of LIBOR plus 250 basis points on $10.9 million of the loan, which was used by the joint venture to repay a secured loan at maturity to a third party lender.

During the first quarter of 2012, we recorded $1.0 million as our share of impairments of real estate assets on two office properties in our DLF I joint venture, due to a decline in projected occupancy and a change in the assumed holding period of those assets, which reduced the expected future cash flows from the properties.


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HIGHWOODS PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(tabular dollar amounts in thousands, except per share data)


4.    Investments in and Advances to Affiliates - Continued

Consolidated Affiliates

During the third quarter of 2012, we provided a three-year, $20.8 million interest-only secured loan to our Harborview Plaza joint venture that is scheduled to mature in September 2015, which the joint venture used to repay a secured loan at maturity to a third party lender. This new loan bears interest at LIBOR plus 500 basis points, subject to a LIBOR floor of 0.5%.

5.    Intangible Assets and Below Market Lease Liabilities
 
The following table sets forth total intangible assets and acquisition-related below market lease liabilities, net of accumulated amortization:
 
 
September 30,
2012
 
December 31,
2011
Assets:
 
 
 
Deferred financing costs
$
19,952

 
$
18,044

Less accumulated amortization
(8,115
)
 
(5,797
)
 
11,837

 
12,247

Deferred leasing costs (including lease incentives and acquisition-related intangible assets)
202,797

 
172,049

Less accumulated amortization
(65,464
)
 
(56,522
)
 
137,333

 
115,527

Deferred financing and leasing costs, net
$
149,170

 
$
127,774

 
 
 
 
Liabilities (in accounts payable, accrued expenses and other liabilities):
 
 
 
Acquisition-related below market lease liabilities
$
28,015

 
$
16,441

Less accumulated amortization
(2,556
)
 
(971
)
 
$
25,459

 
$
15,470

 
The following table sets forth amortization of intangible assets and acquisition-related below market lease liabilities:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Amortization of deferred financing costs
$
907

 
$
806

 
$
2,709

 
$
2,448

Amortization of deferred leasing costs and acquisition-related intangible assets (in depreciation and amortization)
$
6,836

 
$
5,189

 
$
20,542

 
$
13,945

Amortization of lease incentives (in rental and other revenues)
$
393

 
$
369

 
$
1,075

 
$
1,010

Amortization of acquisition-related intangible assets (in rental and other revenues)
$
433

 
$
239

 
$
1,027

 
$
617

Amortization of acquisition-related intangible assets (in rental property and other expenses)
$
46

 
$

 
$
46

 
$

Amortization of acquisition-related below market lease liabilities (in rental and other revenues)
$
(647
)
 
$
(230
)
 
$
(1,744
)
 
$
(280
)


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HIGHWOODS PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(tabular dollar amounts in thousands, except per share data)


5.    Intangible Assets and Below Market Lease Liabilities - Continued

The following table sets forth scheduled future amortization of intangible assets and below market lease liabilities:

 
 
Amortization of Deferred Financing Costs
 
Amortization of Deferred Leasing Costs and Acquisition-Related Intangible Assets (in Depreciation and Amortization)
 
Amortization of Lease Incentives (in Rental and Other Revenues)
 
Amortization of Acquisition-Related Intangible Assets (in Rental and Other Revenues)
 
Amortization of Acquisition-Related Intangible Assets (in Rental Property and Other Expenses)
 
Amortization of Acquisition-Related Below Market Lease Liabilities (in Rental and Other Revenues)
October 1 through December 31, 2012
 
$
1,069

 
$
7,020

 
$
349

 
$
293

 
$
140

 
$
(802
)
2013
 
3,381

 
25,080

 
1,286

 
991

 
553

 
(3,168
)
2014
 
3,009

 
21,190

 
1,134

 
734

 
553

 
(3,106
)
2015
 
2,395

 
17,216

 
902

 
549

 
553

 
(2,894
)
2016
 
1,024

 
14,047

 
708

 
489

 
553

 
(2,603
)
Thereafter
 
959

 
37,292

 
2,536

 
969

 
2,196

 
(12,886
)
 
 
$
11,837

 
$
121,845

 
$
6,915

 
$
4,025

 
$
4,548

 
$
(25,459
)
Weighted average remaining amortization periods as of September 30, 2012 (in years)
 
3.6

 
7.1

 
7.6

 
5.6

 
8.2

 
9.9


The following table sets forth the intangible assets acquired and below market lease liabilities assumed as a result of 2012 acquisition activity:

 
 
Above Market Lease Intangible Assets
 
In-Place Lease Intangible Assets
 
Tax Abatement Intangible Assets
 
Below Market Lease Liabilities
Amount recorded from acquisition activity
 
$
1,285

 
$
21,479

 
$
4,593

 
$
(11,875
)
Weighted average remaining amortization periods (in years)
 
5.3

 
9.2

 
8.2

 
11.3


6.    Mortgages and Notes Payable

The following table sets forth our mortgages and notes payable:

 
September 30,
2012
 
December 31,
2011
Secured indebtedness
$
685,390

 
$
715,742

Unsecured indebtedness
1,093,165

 
1,153,164

Total mortgages and notes payable
$
1,778,555

 
$
1,868,906


At September 30, 2012, our secured mortgage loans were secured by real estate assets with an aggregate undepreciated book value of $1,148.2 million.


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HIGHWOODS PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(tabular dollar amounts in thousands, except per share data)


6.    Mortgages and Notes Payable - Continued

Our $475.0 million unsecured revolving credit facility is scheduled to mature on July 27, 2015 and includes an accordion feature that allows for an additional $75.0 million of borrowing capacity subject to additional lender commitments. Assuming no defaults have occurred, we have an option to extend the maturity for an additional year. The interest rate at our current credit ratings is LIBOR plus 150 basis points and the annual facility fee is 35 basis points. The interest rate and facility fee are based on the higher of the publicly announced ratings from Moody's Investors Service or Standard & Poor's Ratings Services. We 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. The continued ability to borrow under the revolving credit facility allows us to quickly capitalize on strategic opportunities at short-term interest rates. There was $89.0 million and $59.5 million outstanding under our revolving credit facility at September 30, 2012 and October 22, 2012, respectively. At both September 30, 2012 and October 22, 2012, we had $0.1 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 September 30, 2012 and October 22, 2012 was $385.9 million and $415.4 million, respectively.

During the third quarter of 2012, we paid down the amount outstanding under our variable rate construction loan by $34.3 million.

During the second quarter of 2012, we repurchased $12.1 million principal amount of unsecured notes due March 2017 bearing interest of 5.85% for a purchase price of 107.5% of par value. We recorded $1.0 million of loss on debt extinguishment related to this repurchase.

During the first quarter of 2012, we obtained a $225.0 million, seven-year unsecured bank term loan bearing interest of LIBOR plus 190 basis points. This floating interest rate effectively was fixed by the interest rate swaps discussed in Note 7. The proceeds were used to pay off amounts then outstanding under our revolving credit facility.

We are currently in compliance with the debt covenants and other requirements with respect to our outstanding debt.

7.
Derivative Financial Instruments

We have six floating-to-fixed interest rate swaps for seven-year periods each with respect to an aggregate of $225.0 million LIBOR-based borrowings. These swaps effectively fix the underlying LIBOR rate at a weighted average of 1.678%. The counterparties under the swaps are major financial institutions. The swap agreements contain a provision whereby if we default on any of our indebtedness, if greater than $10.0 million and that results in repayment of such indebtedness being, or becoming capable of being accelerated by the lender, then we could also be declared in default on our derivative obligations. These swaps have been designated as and are being accounted for as cash flow hedges with changes in fair value recorded in other comprehensive income each reporting period. No gain or loss was recognized related to hedge ineffectiveness or to amounts excluded from effectiveness testing on our cash flow hedges during the nine months ended September 30, 2012. As of September 30, 2012, we have not posted any collateral related to our interest rate swap liability.

Amounts reported in accumulated other comprehensive loss ("AOCL") related to derivatives will be reclassified to interest expense as interest payments are made on our variable-rate debt. During the period from October 1, 2012 through September 30, 2013, we estimate that $3.3 million will be reclassified as an increase to interest expense.

The following table sets forth the fair value of our derivative instruments:

 
September 30,
2012
 
December 31,
2011
Liability Derivatives:
 
 
 
Derivatives designated as cash flow hedges in accounts payable, accrued expenses and other liabilities:
 
 
 
Interest rate swaps
$
10,274

 
$
2,202



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HIGHWOODS PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(tabular dollar amounts in thousands, except per share data)


7.
Derivative Financial Instruments - Continued
 
The following table sets forth the effect of our cash flow hedges on AOCL and interest expense:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Derivatives Designated as Cash Flow Hedges:
 
 
 
 
 
 
 
Amount of unrealized losses recognized in AOCL on derivatives (effective portion):
 
 
 
 
 
 
 
Interest rate swaps
$
(3,337
)
 
$

 
$
(10,424
)
 
$

Amount of (gains)/losses reclassified out of AOCL into contractual interest expense (effective portion):
 
 
 
 
 
 
 
Interest rate swaps
$
791

 
$
(30
)
 
$
2,250

 
$
(87
)

8.
Noncontrolling Interests

Noncontrolling Interests in the Operating Partnership

Noncontrolling interests in the Operating Partnership relate to the ownership of Common Units by various individuals and entities other than the Company. Net income attributable to noncontrolling interests in the Operating Partnership is computed by applying the weighted average percentage of Common Units not owned by the Company during the period, as a percent of the total number of outstanding Common Units, to the Operating Partnership’s net income for the period after deducting distributions on Preferred Units.
 
The following table sets forth noncontrolling interests in the Operating Partnership:
 
 
Nine Months Ended September 30,
 
2012
 
2011
Beginning noncontrolling interests in the Operating Partnership
$
110,655

 
$
120,838

Adjustments of noncontrolling interests in the Operating Partnership to fair value
12,485

 
(10,177
)
Issuances of Common Units
2,299

 

Conversion of Common Units to Common Stock
(731
)
 
(1,344
)
Net income attributable to noncontrolling interests in the Operating Partnership
3,166

 
1,496

Distributions to noncontrolling interests in the Operating Partnership
(4,733
)
 
(4,818
)
Total noncontrolling interests in the Operating Partnership
$
123,141

 
$
105,995

 
The following table sets forth net income available for common stockholders and transfers from noncontrolling interests in the Operating Partnership:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Net income available for common stockholders
$
33,357

 
$
7,002

 
$
63,013

 
$
27,250

Increase in additional paid in capital from conversion of Common Units to Common Stock
100

 
709

 
731

 
1,344

Issuances of Common Units
(2,299
)
 

 
(2,299
)
 

Change from net income available for common stockholders and transfers from noncontrolling interests
$
31,158

 
$
7,711

 
$
61,445

 
$
28,594

 

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Table of Contents
HIGHWOODS PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(tabular dollar amounts in thousands, except per share data)


8.
Noncontrolling Interests - Continued

Noncontrolling Interests in Consolidated Affiliates
 
At September 30, 2012, noncontrolling interests in consolidated affiliates relates to our joint venture partner's 50.0% interest in office properties located in Richmond, VA. Our joint venture partner is an unrelated third party.

9.
Disclosure About Fair Value of Financial Instruments

The following summarizes the three levels of inputs that we use to measure fair value, as well as the assets, noncontrolling interests in the Operating Partnership and liabilities that we recognize at fair value using those levels of inputs.

Level 1.  Quoted prices in active markets for identical assets or liabilities.

Our Level 1 assets are investments in marketable securities that we use to pay benefits under our non-qualified deferred compensation plan. Our Level 1 noncontrolling interests in the Operating Partnership relate to the ownership of Common Units by various individuals and entities other than the Company. Our Level 1 liability is our non-qualified deferred compensation obligation.

Level 2. Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the related assets or liabilities.

Our Level 2 asset is the fair value of our mortgages and notes receivable, which was estimated by the income approach utilizing contractual cash flows and market-based interest rates to approximate the price that would be paid in an orderly transaction between market participants.
 
Our Level 2 liabilities include (1) the fair value of our mortgages and notes payable, which was estimated by the income approach utilizing contractual cash flows and market-based interest rates to approximate the price that would be paid in an orderly transaction between market participants and (2) interest rate swaps whose fair value is determined using the market standard methodology of netting the discounted future fixed cash receipts and the discounted expected variable cash payments. The variable cash payments of our interest rate swaps are based on the expectation of future LIBOR interest rates (forward curves) derived from observed market LIBOR interest rate curves. In addition, credit valuation adjustments are incorporated in the fair values to account for potential nonperformance risk, but were concluded to not be significant inputs to the calculation for the periods presented.
 
Level 3. Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
 
Our Level 3 assets include our tax increment financing bond, which is not routinely traded but whose fair value is determined by the income approach utilizing contractual cash flows and market-based interest rates to estimate the projected redemption value based on quoted bid/ask prices for similar unrated municipal bonds and, if any, real estate assets and for-sale residential condominiums recorded at fair value on a non-recurring basis as a result of our quarterly impairment analysis, which were valued using broker opinion of value and substantiated by internal cash flow projections.
 
Our Level 3 liabilities include the fair value of our contingent consideration to acquire real estate assets and financing obligations, which were estimated by the income approach to approximate the price that would be paid in an orderly transaction between market participants, utilizing: (1) contractual cash flows; (2) market-based interest rates; and (3) a number of other assumptions including demand for space, competition for customers, changes in market rental rates, costs of operation and expected ownership periods.
 

19

Table of Contents
HIGHWOODS PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(tabular dollar amounts in thousands, except per share data)


9.
Disclosure About Fair Value of Financial Instruments - Continued
 
The following tables set forth the assets, noncontrolling interests in the Operating Partnership and liabilities that we measure at fair value by level within the fair value hierarchy. We determine the level based on the lowest level of substantive input used to determine fair value.
 
 
 
 
Level 1
 
Level 2
 
Level 3
 
September 30, 2012
 
Quoted Prices
in Active
Markets for Identical Assets or Liabilities
 
Significant Observable Inputs
 
Significant Unobservable Inputs
Assets:
 
 
 
 
 
 
 
Mortgages and notes receivable, at fair value (1)
$
17,382

 
$

 
$
17,382

 
$

Marketable securities of non-qualified deferred compensation plan (in prepaid expenses and other assets)
3,264

 
3,264

 

 

Tax increment financing bond (in prepaid expenses and other assets)
15,270

 

 

 
15,270

Total Assets
$
35,916

 
$
3,264

 
$
17,382

 
$
15,270

Noncontrolling Interests in the Operating Partnership
$
123,141

 
$
123,141

 
$

 
$

Liabilities:
 
 
 
 
 
 
 
Mortgages and notes payable, at fair value (1)
$
1,889,775

 
$

 
$
1,889,775

 
$

Interest rate swaps (in accounts payable, accrued expenses and other liabilities)
10,274

 

 
10,274

 

Non-qualified deferred compensation obligation (in accounts payable, accrued expenses and other liabilities)
3,264

 
3,264

 

 

Contingent consideration to acquire real estate assets (in accounts payable, accrued expenses and other liabilities)
563

 

 

 
563

Financing obligations, at fair value (1)
18,930

 

 

 
18,930

Total Liabilities
$
1,922,806

 
$
3,264

 
$
1,900,049

 
$
19,493

 
 
 
 
Level 1
 
Level 2
 
Level 3
 
December 31, 2011
 
Quoted Prices
in Active
Markets for Identical Assets or Liabilities
 
Significant Observable Inputs
 
Significant Unobservable Inputs
Assets:
 
 
 
 
 
 
 
Mortgages and notes receivable, at fair value (1)
$
18,990

 
$

 
$
18,990

 
$

Marketable securities of non-qualified deferred compensation plan (in prepaid expenses and other assets)
3,149

 
3,149

 

 

Tax increment financing bond (in prepaid expenses and other assets)
14,788

 

 

 
14,788

Impaired real estate assets and for-sale residential condominiums
12,767

 

 

 
12,767

Total Assets
$
49,694

 
$
3,149

 
$
18,990

 
$
27,555

Noncontrolling Interests in the Operating Partnership
$
110,655

 
$
110,655

 
$

 
$

Liabilities:
 
 
 
 
 
 
 
Mortgages and notes payable, at fair value (1)
$
1,959,438

 
$

 
$
1,959,438

 
$

Interest rate swaps (in accounts payable, accrued expenses and other liabilities)
2,202

 

 
2,202

 

Non-qualified deferred compensation obligation (in accounts payable, accrued expenses and other liabilities)
3,149

 
3,149

 

 

Financing obligations, at fair value (1)
18,866

 

 

 
18,866

Total Liabilities
$
1,983,655

 
$
3,149

 
$
1,961,640

 
$
18,866

__________

20

Table of Contents
HIGHWOODS PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(tabular dollar amounts in thousands, except per share data)

 
9.
Disclosure About Fair Value of Financial Instruments - Continued

(1)    Amounts carried at historical cost on our Consolidated Balance Sheets at September 30, 2012 and December 31, 2011, respectively.

The following table sets forth the changes in our Level 3 asset and liability, which are recorded at fair value on our Consolidated Balance Sheets on a recurring basis:

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Asset:
 
 
 
 
 
 
 
Tax Increment Financing Bond:
 
 
 
 
 
 
 
Beginning balance
$
15,371

 
$
15,228

 
$
14,788

 
$
15,699

Unrealized gains/(losses) (in AOCL)
(101
)
 
600

 
482

 
129

Ending balance
$
15,270

 
$
15,828

 
$
15,270

 
$
15,828