Table of Contents

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

(Mark One)

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

 

OR

 

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

 

FOR QUARTER ENDED September 30, 2005

 

COMMISSION FILE NO. 1-6622

 


 

WASHINGTON REAL ESTATE INVESTMENT TRUST

(Exact name of registrant as specified in its charter)

 


 

MARYLAND   53-0261100

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification Number)

 

6110 EXECUTIVE BOULEVARD, SUITE 800, ROCKVILLE, MARYLAND 20852

(Address of principal executive office) (Zip code)

 

Registrant’s telephone number, including area code (301) 984-9400

 

 

(Former name, former address and former fiscal year, if changed since last report)

 


 

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 twelve (12) months (or such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past ninety (90) days.    YES  x    NO  ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).    YES  x    NO  ¨

 

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

 

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date, November 4, 2005.

 

SHARES OF BENEFICIAL INTEREST 42,136,214

 



Table of Contents

WASHINGTON REAL ESTATE INVESTMENT TRUST

 

INDEX

 

               Page

Part I: Financial Information     
     Item 1.    Financial Statements (Unaudited)     
          Consolidated Balance Sheets    3
          Condensed Consolidated Statements of Income    4
          Consolidated Statement of Changes in Shareholders’ Equity    5
          Consolidated Statements of Cash Flows    6
          Notes to Financial Statements    7
     Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations    22
     Item 3.    Qualitative and Quantitative Disclosures about Financial Market Risk    43
     Item 4.    Controls and Procedures    43
Part II: Other Information     
     Item 1.    Legal Proceedings    44
     Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds    44
     Item 3.    Defaults upon Senior Securities    44
     Item 4.    Submission of Matters to a Vote of Security Holders    44
     Item 5.    Other Information    44
     Item 6.    Exhibits    44
     Signatures    45

 

Part I

 

FINANCIAL INFORMATION

 

The information furnished in the accompanying unaudited Consolidated Balance Sheets, Statements of Income, Statements of Cash Flows and Statement of Changes in Shareholders’ Equity reflects all adjustments, consisting of normal recurring items, which are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods. The accompanying financial statements and notes thereto should be read in conjunction with the financial statements and notes for the three years ended December 31, 2004 included in the Trust’s 2004 Annual Report on Form 10-K filed with the Securities and Exchange Commission.

 

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Table of Contents

ITEM I. FINANCIAL STATEMENTS

 

WASHINGTON REAL ESTATE INVESTMENT TRUST

 

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts)

 

     (Unaudited)        
     September 30,
2005


    December 31,
2004


 

Assets

                

Land

   $ 226,217     $ 204,831  

Income producing property

     1,014,464       895,553  

Accumulated depreciation

     (229,490 )     (200,375 )
    


 


Net income producing property

     1,011,191       900,009  

Development in progress

     23,222       12,280  
    


 


Total investment in real estate, net

     1,034,413       912,289  

Investment in real estate held for sale, net

     —         36,986  

Cash and cash equivalents

     6,067       5,562  

Restricted cash

     6,645       388  

Rents and other receivables, net of allowance for doubtful accounts of $2,732 and $2,636, respectively

     24,077       21,402  

Prepaid expenses and other assets

     41,139       35,046  

Other assets related to properties held for sale

     —         720  
    


 


Total assets

   $ 1,112,341     $ 1,012,393  
    


 


Liabilities and Shareholders’ Equity

                

Accounts payable and other liabilities

   $ 28,439     $ 22,586  

Advance rents

     5,522       5,108  

Tenant security deposits

     7,220       5,784  

Other liabilities related to properties held for sale

     —         848  

Mortgage notes payable

     170,393       173,429  

Lines of credit payable

     93,500       117,000  

Notes payable

     420,000       320,000  
    


 


Total liabilities

     725,074       644,755  
    


 


Minority Interest

     1,656       1,629  
    


 


Shareholders’ Equity

                

Shares of beneficial interest; $0.01 par value; 100,000 shares authorized: 42,125 and 42,000 shares issued and outstanding

     421       420  

Additional paid-in capital

     407,614       405,029  

Distributions in excess of net income

     (19,361 )     (35,544 )

Less: Deferred compensation on restricted shares

     (3,063 )     (3,896 )
    


 


Total Shareholders’ Equity

     385,611       366,009  
    


 


Total Liabilities and Shareholders’ Equity

   $ 1,112,341     $ 1,012,393  
    


 


 

See accompanying notes to the financial statements.

 

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WASHINGTON REAL ESTATE INVESTMENT TRUST

 

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share amounts)

(UNAUDITED)

 

     Three Months Ended
September 30,


   Nine Months Ended
September 30,


     2005

    2004

   2005

   2004

Revenue

                            

Real estate rental revenue

   $ 48,939     $ 43,246    $ 140,788    $ 127,922

Other income

     335       59      655      239
    


 

  

  

       49,274       43,305      141,443      128,161

Expenses

                            

Real estate expenses

     14,929       13,148      43,075      38,360

Interest expense

     9,798       8,760      27,668      25,949

Depreciation and amortization

     11,988       10,017      35,467      29,027

General and administrative

     2,036       1,616      6,361      4,572
    


 

  

  

       38,751       33,541      112,571      97,908
    


 

  

  

Other income from property settlement

     —         —        504      —  

Income from continuing operations

     10,523       9,764      29,376      30,253

Discontinued operations:

                            

Income (loss) from operations of properties held for sale

     (100 )     1,033      184      2,928

Gain on sale of real estate investment

     3,038       —        37,011      —  
    


 

  

  

       2,938       1,033      37,195      2,928
    


 

  

  

Net income

   $ 13,461     $ 10,797    $ 66,571    $ 33,181
    


 

  

  

Net income per share – basic

                            

Continuing operations

   $ 0.25     $ 0.23    $ 0.70    $ 0.73

Discontinued operations

     0.07       0.03      0.88      0.07
    


 

  

  

Net income per share - basic

   $ 0.32     $ 0.26    $ 1.58    $ 0.80
    


 

  

  

Net income per share – diluted

                            

Continuing operations

   $ 0.25     $ 0.23    $ 0.70    $ 0.72

Discontinued operations

     0.07       0.03      0.88      0.07
    


 

  

  

Net income per share - diluted

   $ 0.32     $ 0.26    $ 1.58    $ 0.79
    


 

  

  

Weighted average shares outstanding – basic

     42,005       41,648      42,088      41,619

Weighted average shares outstanding – diluted

     42,147       41,883      42,228      41,849

Dividends paid per share

   $ 0.4025     $ 0.3925    $ 1.1975    $ 1.1575
    


 

  

  

 

See accompanying notes to the financial statements.

 

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WASHINGTON REAL ESTATE INVESTMENT TRUST

 

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(In thousands)

(UNAUDITED)

 

     Shares

    Par Value

  

Deferred

Compensation


   

Additional

Paid in Capital


   

Distributions

In Excess of
Net Income


   

Shareholders’

Equity


 

Balance, December 31, 2004

   42,000     $ 420    $ (3,896 )   $ 405,029     $ (35,544 )   $ 366,009  

Net income

   —         —        —         —         66,572       66,572  

Dividends

   —         —        —         —         (50,389 )     (50,389 )

Share options exercised

   129       1      —         2,718       —         2,719  

Share grants and

amortization, net of forfeitures

   (4 )     —        833       (133 )     —         700  
    

 

  


 


 


 


Balance, September 30, 2005

   42,125     $ 421    $ (3,063 )   $ 407,614     $ (19,361 )   $ 385,611  
    

 

  


 


 


 


 

See accompanying notes to the financial statements.

 

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WASHINGTON REAL ESTATE INVESTMENT TRUST

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

     (Unaudited)  
     Nine Months Ended September 30,

 
     2005

    2004

 

Cash flows from operating activities

                

Net income

   $ 66,571     $ 33,181  

Adjustments to reconcile net income to net cash provided by operating activities

                

Gain on sale of real estate

     (37,011 )     —    

Depreciation and amortization

     35,538       30,508  

Provision for losses on accounts receivable

     611       825  

Amortization and accrual of share grants

     835       640  

Changes in other assets

     (6,544 )     (8,332 )

Changes in other liabilities

     2,293       (191 )
    


 


Net cash provided by operating activities

     62,293       56,631  

Cash flows from investing activities

                

Real estate acquisitions, net*

     (96,769 )     (20,125 )

Net cash received from sale of real estate

     73,879       —    

Restricted cash held in escrow for tax-free exchanges

     (5,802 )     —    

Capital improvements to real estate and development costs

     (32,505 )     (22,626 )

Non-real estate capital improvements

     (403 )     (58 )
    


 


Cash (used in) investing activities

     (61,600 )     (42,809 )

Cash flows from financing activities

                

Line of credit (repayments)/borrowings, net

     (23,500 )     30,850  

Dividends paid

     (50,387 )     (48,353 )

Principal payments – mortgage notes payable

     (28,047 )     (1,408 )

Net proceeds from debt offering

     99,029       —    

Net proceeds from the exercise of share options

     2,717       2,683  
    


 


Net cash (used in) financing activities

     (188 )     (16,228 )

Net increase in cash and cash equivalents

     505       (2,406 )

Cash and cash equivalents, beginning of period

     5,562       5,467  
    


 


Cash and cash equivalents, end of period

   $ 6,067     $ 3,061  
    


 


Supplemental disclosure of cash flow information:

                

Cash paid for interest

   $ 30,314     $ 26,934  
    


 



* Supplemental discussion of non-cash investing and financing activities: On March 23, 2005 we purchased Frederick Crossing Shopping Center for $44.8 million. We assumed a mortgage in the amount of $24.3 million, fair valued at $25.0 million, and funded the balance ($20.5 million) utilizing $1.0 million in credit facility borrowings and $19.5 million of the $31.3 million in cash escrowed from the sale of Tycon Plaza II, Tycon Plaza III and 7700 Leesburg Pike in February 2005. The $24.3 million of assumed mortgage is not included in the $20.9 million shown as real estate acquisitions for the nine months ended September 30, 2005, as the assumption of the mortgage was a non-cash acquisition cost. On April 9, 2005 we purchased the DBP Coleman Building for $8.8 million which was funded in part ($8.3 million) from cash escrowed from the aforementioned sale of Tycon Plaza II, Tycon Plaza III and 7700 Leesburg Pike.

 

See accompanying notes to the financial statements.

 

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WASHINGTON REAL ESTATE INVESTMENT TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2005

(UNAUDITED)

 

NOTE 1: NATURE OF BUSINESS

 

Washington Real Estate Investment Trust (“WRIT,” the “Company” or the “Trust”), a Maryland Real Estate Investment Trust, is a self-administered, self-managed equity real estate investment trust, successor to a trust organized in 1960. Our business consists of the ownership and development of income-producing real estate properties in the greater Washington – Baltimore region. We own a diversified portfolio of office buildings, industrial/flex properties, multifamily buildings and retail centers.

 

Federal Income Taxes

 

We believe we qualify as a Real Estate Investment Trust (REIT) under Sections 856-860 of the Internal Revenue Code and intend to continue to qualify as such. To maintain our status as a REIT, we are required to distribute at least 90% of our ordinary taxable income to our shareholders. When selling properties, we have the option of (i) reinvesting the sale price of properties sold, allowing for a deferral of income taxes on the sale, (ii) paying out capital gains to the shareholders with no tax to the company or (iii) treating the capital gains as having been distributed to the shareholders, paying the tax on the gain deemed distributed and allocating the tax paid as a credit to the shareholders. All except approximately $3.5 million of gains on the sale of properties disposed during the first nine months of 2005 were, or are expected to be, reinvested in replacement properties. Gains from the property disposed in 2004 were distributed to the shareholders.

 

NOTE 2: ACCOUNTING POLICIES

 

Basis of Presentation

 

The accompanying unaudited financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations, although we believe that the disclosures made are adequate to make the information presented not misleading. In addition, in the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. These unaudited financial statements should be read in conjunction with the financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2004.

 

Within these notes to the financial statements, we refer to the three and nine months ended September 30, 2005 as the “2005 Quarter” and “2005 Period”, respectively, and the three and nine months ended September 30, 2004 as the “2004 Quarter” and “2004 Period”, respectively.

 

New Accounting Pronouncements

 

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”). This Interpretation addresses the consolidation of variable interest entities (“VIE”) in which the equity investors lack one or more of the essential characteristics of a controlling financial interest or where the equity investment at risk is not sufficient for the entity to finance its activities without subordinated financial support from other parties. For entities identified as VIE, FIN No. 46 sets forth a model to evaluate potential consolidation based on an assessment of which party to the VIE, if any, bears a majority of the exposure to its expected losses, or stands to gain from a majority of its expected returns. FIN No. 46 also sets forth certain disclosures regarding interests in VIE that are deemed significant, even if consolidation is not required. In December 2003, the FASB issued a revised Interpretation No. 46 which modifies and clarifies various aspects of the original Interpretation. The adoption of this statement and of the revised interpretation did not have any impact on our financial condition or results of operations, as we do not have any variable interest entities as defined in FIN No. 46R.

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 establishes standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). In particular, it requires that mandatorily redeemable financial instruments be classified as liabilities and reported at fair value and that changes in their fair values be reported as interest cost. SFAS No. 150 was effective for the company as of July 1, 2003. On October 29, 2003, the FASB indefinitely delayed the provision of the statement related to non-controlling interests in limited-life subsidiaries that are consolidated. Based on FASB’s deferral of this provision, adoption of SFAS No. 150 did not affect the company’s financial statements.

 

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WASHINGTON REAL ESTATE INVESTMENT TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2005

(UNAUDITED)

 

In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment.” This statement is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes APB opinion No. 25 (APB25), “Accounting for Stock Issued to Employees.” SFAS No. 123R addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values and eliminates the intrinsic value method of accounting in APB No. 25, which was permitted under SFAS No. 123, as originally issued. The revised statement requires entities to disclose information about the nature of the share-based payment transactions and the effects of those transactions on the financial statements. The provisions of this statement are effective for interim or annual periods beginning after June 15, 2005. All public companies must use either the modified prospective or the modified retrospective transition method of adoption. On April 14, 2005 the Securities and Exchange Commission adopted a new rule that allows companies to implement SFAS No. 123R at the beginning of their next fiscal year, instead of the next reporting period, that begins after June 15, 2005. We will adopt SFAS No. 123R at the beginning of our 2006 fiscal year. We are currently evaluating the provisions of this revision to determine the impact on our consolidated financial statements. It is, however, expected to have some negative effect on consolidated net income.

 

Revenue Recognition

 

Residential properties (our Multi-family segment) are leased under operating leases with terms of generally one year or less, and commercial properties (our Office, Retail and Industrial segments) are leased under operating leases with average terms of three to seven years. We recognize rental income and rental abatements from our residential and commercial leases when earned on a straight-line basis in accordance with SFAS No. 13 “Accounting for Leases.” We record a provision for losses on accounts receivable equal to the estimated uncollectible amounts. This estimate is based on our historical experience and a review of the current status of the company’s receivables. Percentage rents, which represent additional rents based on gross tenant sales, are recognized when tenants’ sales exceed specified thresholds.

 

In accordance with SFAS No. 66, “Accounting for Sales of Real Estate,” sales are recognized at closing only when sufficient down payments have been obtained, possession and other attributes of ownership have been transferred to the buyer and we have no significant continuing involvement.

 

We recognize cost reimbursement income from pass-through expenses on an accrual basis over the periods in which the expenses were incurred. Pass-through expenses are comprised of real estate taxes, operating expenses and common area maintenance costs which are reimbursed by tenants in accordance with specific allowable costs per tenant lease agreements.

 

Minority Interest

 

We entered into an operating agreement with a member of the entity that previously owned Northern Virginia Industrial Park in conjunction with the acquisition of this property in May 1998. This resulted in a minority ownership interest in this property based upon defined company ownership units at the date of purchase. The operating agreement was amended and restated in 2002 resulting in a reduced minority ownership percentage interest. We account for this activity by allocating the minority owner’s percentage ownership interest of the net income of the property to minority interest included in our general and administrative expenses, thereby reducing net income. Minority interest expense was $43,100 and $125,600 for the 2005 Quarter and 2005 Period, respectively, and $41,000 and $118,000 for the 2004 Quarter and the 2004 Period, respectively. Quarterly distributions are made to the minority owner equal to the quarterly dividend per share for each ownership unit.

 

Deferred Financing Costs

 

Costs associated with the issuance of mortgage and other notes and fees associated with the lines of credit are capitalized and amortized using the straight-line method which approximates the effective interest rate method over the term of the related debt. The amortization is included in interest expense on the accompanying consolidated statements of income. The amortization of debt costs included in interest expense totaled $0.4 million for the 2005 Quarter and $0.3 for the 2004 Quarter and $1.0 million for both the 2005 and 2004 Periods.

 

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WASHINGTON REAL ESTATE INVESTMENT TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2005

(UNAUDITED)

 

Deferred Leasing Costs

 

Costs associated with the successful negotiation of leases, both external commissions and internal direct costs, are capitalized and amortized on a straight-line basis over the terms of the respective leases. If an applicable lease terminates prior to the expiration of its initial lease term, the carrying amount of the costs are written-off to expense.

 

Real Estate and Depreciation

 

Buildings are depreciated on a straight-line basis over estimated useful lives ranging from 28 to 50 years. All capital improvement expenditures associated with replacements, improvements, or major repairs to real property that extend its useful life are capitalized and depreciated using the straight-line method over their estimated useful lives ranging from 3 to 30 years. All tenant improvements are amortized over the shorter of the useful life of the improvements or the term of the related tenant lease. Real estate depreciation expense for the 2005 Quarter and 2005 Period was $10.6 million and $31.5 million, respectively, and $8.6 million and $25.4 million for the 2004 Quarter and 2004 Period, respectively. Maintenance and repair costs are charged to expense as incurred.

 

We capitalize interest costs recognized on borrowing obligations while qualifying assets are being readied for their intended use in accordance with SFAS No. 34, “Capitalization of Interest Cost.” Total interest expense capitalized to real estate assets related to development and major renovation activities was $288,000 and $729,000 for the 2005 Quarter and 2005 Period, respectively, and $156,000 and $488,000 for the 2004 Quarter and 2004 Period, respectively. Interest capitalized is amortized over the useful life of the related underlying assets upon those assets being placed into service.

 

We recognize impairment losses on long-lived assets used in operations when indicators of impairment are present and the net undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amount. If such carrying amount is in excess of the estimated cash flows from the operation and disposal of the property, we would recognize an impairment loss equivalent to an amount required to adjust the carrying amount to the estimated fair market value. There were no property impairments recognized during the 2005 and 2004 periods.

 

We allocate the purchase price of acquired properties to the related physical assets and in-place leases based on their fair values, based on SFAS No. 141, “Business Combinations.” The fair values of acquired buildings are determined on an “as-if-vacant” basis considering a variety of factors, including the physical condition and quality of the buildings, estimated rental and absorption rates, estimated future cash flows and valuation assumptions consistent with current market conditions. The “as-if-vacant” fair value is allocated to land, building and tenant improvements based on property tax assessments and other relevant information obtained in connection with the acquisition of the property.

 

The fair value of in-place leases consists of the following components – (1) the estimated cost to us to replace the leases, including foregone rents during the period of finding a new tenant, foregone recovery of tenant pass-through expenses, tenant improvements, and other direct costs associated with obtaining a new tenant (referred to as “Tenant Origination Cost”); (2) estimated leasing commissions associated with obtaining a new tenant (referred to as “Leasing Commissions”); (3) the above/at/below market cash flow of the leases, determined by comparing the projected cash flows of the leases in place to projected cash flows of comparable market-rate leases (referred to as “Net Lease Intangible”); and (4) the value, if any, of customer relationships, determined based on our evaluation of the specific characteristics of each tenant’s lease and our overall relationship with the tenant (referred to as “Customer Relationship Value”).

 

The amounts used to calculate Tenant Origination Cost, Leasing Commissions, and Net Lease Intangible are discounted using an interest rate which reflects the risks associated with the leases acquired. Tenant Origination Costs are included in Real Estate Assets on our balance sheet and are amortized as depreciation expense on a straight-line basis over the remaining life of the underlying leases. Leasing Commissions are classified as Other Assets and are amortized as amortization expense on a straight-line basis over the remaining life of the underlying leases. The aggregate value of the cash flow for the above market leases results in Net Lease Intangible Assets which are classified as Other Assets and are amortized on a straight-line basis as a decrease to Real Estate Rental Revenue over the remaining term of the underlying leases. The aggregate value of the cash flow for the below market leases results in Net Lease Intangible Liabilities which are classified as Other Liabilities and are amortized on a straight-line basis as an increase to Real Estate Rental Revenue over the remaining term of the underlying leases. The aggregate value of the cash flow of leases at market results in no additional assets or liabilities.

 

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WASHINGTON REAL ESTATE INVESTMENT TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2005

(UNAUDITED)

 

Should a tenant terminate its lease, the unamortized portions of the Tenant Origination Cost, Leasing Commissions, and Net Lease Intangible associated with that lease are written off to depreciation expense, amortization expense, and rental revenue, respectively.

 

Balances net of accumulated depreciation or amortization, as appropriate, of the components of the fair value of in-place leases at September 30, 2005 and December 31, 2004 are as follows (in millions):

 

    

September 30,

2005


  

December 31,

2004


Tenant Origination Costs

   $ 9.0    $ 6.3

Leasing Commissions

   $ 5.5    $ 4.1

Net Lease Intangible Assets

   $ 5.4    $ 4.8

Net Lease Intangible Liabilities

   $ 7.4    $ 3.4

 

Amortization of these components combined was $0.8 million for the 2005 Quarter and $2.3 million for the 2005 Period and $0.5 million and $1.4 million for the 2004 Quarter and 2004 Period, respectively.

 

No value had been assigned to Customer Relationship Value at September 30, 2005 or December 31, 2004.

 

Discontinued Operations

 

We classify properties as held for sale when they meet the necessary criteria specified by SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. These criteria include: senior management commits to and actively embarks upon a plan to sell the assets, the sale is expected to be completed within one year under terms usual and customary for such sales and actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. Depreciation on these properties is discontinued, but operating revenues, operating expenses and interest expense continue to be recognized until the date of sale.

 

Under SFAS No. 144, revenues and expenses of properties that are either sold or classified as held for sale are presented as discontinued operations for all periods presented in the Consolidated Statements of Income.

 

Cash and Cash Equivalents

 

Cash and cash equivalents include investments readily convertible to known amounts of cash with original maturities of 90 days or less.

 

Restricted Cash

 

Restricted cash at September 30, 2005 consists of $5.8 million in funds escrowed from the sale of the Pepsi Distribution Center in September, 2005 to be used solely for real estate acquisitions, and $0.8 million of escrow deposits required by lenders on certain of our properties to be used for future building renovations or tenant improvements. At December 31, 2004, restricted cash of $0.4 million consisted only of the lender required replacement reserves.

 

Stock Based Compensation

 

We maintain Share Grant Plans and Incentive Stock Option Plans (the “Plans”), which include qualified and non-qualified options and deferred shares for eligible employees.

 

Shares are granted to officers and trustees under the Share Grant Plans. Officer share grants vest over 5 years in annual installments commencing one year after the date of grant. Trustee share grants are fully vested immediately upon date of share grant. We recognize compensation expense for share grants over the vesting period equal to the fair market value of the shares on the date of issuance. The unvested portion of officer share grants is recognized as deferred compensation.

 

Stock options were historically issued annually to officers, trustees and non-officer key employees under the Incentive Stock Option Plans. They were last issued to officers in 2002, to non-officer key employees in 2003 and to trustees in 2004. The options vest over a 2-year period in annual installments commencing one year after the date of grant, except for trustee options

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2005

(UNAUDITED)

 

which vested immediately upon the date of grant. Stock options are accounted for in accordance with APB 25, whereby if options are priced at fair market value or above at the date of grant and if other requirements are met then the plans are considered fixed and no compensation expense is recognized. Accordingly, we have recognized no compensation cost for stock options.

 

Had we determined compensation cost for the Plans consistent with SFAS No. 123, “Accounting for Stock-Based Compensation,” our net income and earnings per share would have been reduced to the following pro-forma amounts (in thousands, except per share data):

     Quarter ended
September 30,


   

Period ended

September 30,


 
     2005

    2004

    2005

    2004

 

Pro-forma Information

                                

Net income, as reported

   $ 13,461     $ 10,797     $ 66,571     $ 33,181  

Add: Stock-based employee compensation expense included in reported net income

     278       349       835       640  

Deduct: Total stock-based employee compensation expense determined under fair value method

     (297 )     (441 )     (892 )     (917 )
    


 


 


 


Pro-forma net income

   $ 13,442     $ 10,705     $ 66,514     $ 32,904  
    


 


 


 


Earnings per share:

                                

Basic – as reported

   $ 0.32     $ 0.26     $ 1.58     $ 0.80  

Basic – pro-forma

   $ 0.32     $ 0.26     $ 1.58     $ 0.79  

Diluted – as reported

   $ 0.32     $ 0.26     $ 1.58     $ 0.79  

Diluted – pro-forma

   $ 0.32     $ 0.26     $ 1.58     $ 0.79  

 

Earnings Per Common Share

 

We calculate basic and diluted earnings per share in accordance with SFAS No. 128, “Earnings Per Share.” “Basic earnings per share” is computed as net income divided by the weighted-average common shares outstanding. “Diluted earnings per share” is computed as net income divided by the total weighted-average common shares outstanding plus the effect of dilutive common equivalent shares outstanding for the period. Dilutive common equivalent shares reflect the assumed issuance of additional common shares pursuant to certain of our share based compensation plans that could potentially reduce or “dilute” earnings per share, based on the treasury stock method.

 

Use of Estimates in the Financial Statements

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Reclassifications

 

Certain prior year amounts have been reclassified to conform to the current year presentation.

 

NOTE 3: REAL ESTATE INVESTMENTS

 

Our real estate investment portfolio, at cost, consists of properties located in Maryland, Washington, D.C. and Virginia as follows (in thousands):

     September 30,
2005


   December 31,
2004


Office

   $ 657,587    $ 628,200

Retail

     195,922      145,757

Multifamily

     145,952      131,618

Industrial/Flex

     264,442      207,089
    

  

     $ 1,263,903    $ 1,112,664
    

  

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2005

(UNAUDITED)

 

The amounts above reflect properties classified as continuing operations, which means they are to be held and used in rental operations or are currently in development. We dispose of assets (sometimes using tax-deferred exchanges) that are inconsistent with our long-term strategic or return objectives and when market conditions for sale are favorable. The proceeds from the sales may be redeployed into other properties, used to fund development operations or to support other corporate needs, or distributed to our shareholders. Properties are considered held for sale when they meet the criteria specified by SFAS No. 144 (see Note 2 – Discontinued Operations). Depreciation on these properties is discontinued at that time, but operating revenues, other operating expenses and interest continue to be recognized until the date of sale.

 

We had no properties classified as held for sale at September 30, 2005, and four held for sale at December 31, 2004 as follows (in thousands):

 

    

December 31,

2004


 

Office buildings

   $ 45,573  

Industrial buildings

     4,211  
    


Total

     49,784  

Less accumulated depreciation

     (12,798 )
    


     $ 36,986  
    


 

Our results of operations are dependent on the overall economic health of our markets, tenants and the specific segments in which we own properties. These segments include commercial office, retail, multifamily and industrial. All sectors are affected by external economic factors, such as inflation, consumer confidence, unemployment rates, etc., as well as by changing tenant and consumer requirements.

 

WRIT acquired the following properties during the 2005 Period:

 

Acquisition

Date


  

Property

Name


  

Property

Type


  

Rentable

Square Feet


  

Purchase Price

(in thousands)


March 23, 2005    Frederick Crossing    Retail    294,724    $ 44,800
April 8, 2005    Coleman Building    Industrial    59,767      8,800
July 29, 2005    Albemarle Point    Office/Industrial    296,105      66,800
              
  

          Total 2005 Period    650,596    $ 120,400
              
  

 

We accounted for these acquisitions using the purchase method of accounting. As discussed in Note 2, we allocate the purchase price to the related physical assets (land, building and tenant improvements) and in-place leases (tenant origination costs, leasing commissions, and net lease intangible assets/liabilities) based on their fair values, in accordance with SFAS No. 141, “Business Combinations.” Our acquisitions of Frederick Crossing, the Coleman Building and Albemarle Point resulted in the recognition of $4.2 million in tenant origination costs, $2.2 million in leasing commissions, $1.3 million in net intangible lease assets, and $4.8 million in net intangible lease liabilities. The results of operations from these acquired properties are included in the income statement as of their respective acquisition date and forward.

 

WRIT sold the following properties during the 2005 Period:

 

Disposition

Date


  

Property

Name


  

Property

Type


  

Rentable

Square Feet


  

Contract Sale Price

(in thousands)


February 1, 2005    7700 Leesburg Pike    Office    147,000    $ 20,150
February 1, 2005    Tycon Plaza II    Office    127,000      19,400
February 1, 2005    Tycon Plaza III    Office    137,000      27,950
September 8, 2005    Pepsi Distribution Center    Industrial    69,000      6,000
              
  

          Total 2005 Period    480,000    $ 73,500
              
  

 

The Office properties, classified as discontinued operations effective November 2004, were sold to a single buyer for a $67.5 million contract sales price on February 1, 2005. WRIT recognized a gain on disposal of $32.1 million, in accordance with SFAS No. 66, “Accounting for Sales of Real Estate.” $31.3 million of the proceeds from the disposition were escrowed in a tax-free property exchange account and subsequently used to fund a portion of the purchase price of Frederick Crossing Shopping Center on March 23, 2005 and the Coleman Building on April 8, 2005. $31.0 million of the proceeds were used to

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2005

(UNAUDITED)

 

pay down $31.0 million outstanding under Credit Facility No. 2. In September 2005 the industrial property was sold for $6.0 million for a gain of $3.0 million. Proceeds of $5.8 million were escrowed in a tax-free exchange account. Discontinued operations for the 2005 Quarter and 2005 Period consist of the properties sold in February and September 2005. For the 2004 Quarter and 2004 Period, discontinued operations include those same properties and 8230 Boone Boulevard, which was sold on November 15, 2004. There was a gain of $1.9 million recognized in the 2005 Period previously deferred from the sale of Boone Boulevard.

 

Operating results of the properties classified as discontinued operations are summarized as follows (in thousands):

 

     Quarter ended
September 30,


    Period ended
September 30,


 
     2005

    2004

    2005

    2004

 

Revenues

   $ (34 )   $ 2,282     $ 656     $ 6,811  

Property expenses

     (48 )     (752 )     (401 )     (2,402 )

Depreciation and amortization

     (18 )     (497 )     (71 )     (1,481 )
    


 


 


 


     $ (100 )   $ 1,033     $ 184     $ 2,928  
    


 


 


 


 

Operating income by property is summarized below (in thousands):

 

     Quarter ended
September 30,


   Period ended
September 30,


Property


   2005

    2004

   2005

    2004

8230 Boone Boulevard

   $ —       $ 47    $ 2     $ 202

7700 Leesburg Pike

     —         218      90       617

Tycon Plaza II

     —         353      30       1,064

Tycon Plaza III

     —         361      111       877

Pepsi Distribution Center

     (100 )     54      (49 )     168
    


 

  


 

Total

   $ (100 )   $ 1,033    $ 184     $ 2,928
    


 

  


 

 

Other Income from Property Settlement

 

In the second quarter of 2005, we received the final proceeds as compensation for an action by the Maryland State Highway Administration. Curb access to one of our retail properties was closed to the detriment of tenant delivery vehicles. After independent appraisals and engineering studies the State compensated WRIT for this loss of use. The total amount of this compensation was $543,000 and the other income (net of legal, engineering and other professional fees) recorded was $504,000.

 

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WASHINGTON REAL ESTATE INVESTMENT TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2005

(UNAUDITED)

 

NOTE 4: MORTGAGE NOTES PAYABLE

 

     September 30,
2005


   December 31,
2004


On November 30, 1998, we assumed a $9.2 million mortgage note payable and a $12.4 million mortgage note payable as partial consideration for our acquisition of Woodburn Medical Park I and II. Both mortgages bore interest at 7.69% per annum. Principal and interest were paid monthly until September 15, 2005, at which time all unpaid principal and interest were paid in full.    $ —      $ 18,658
On September 20, 1999, we assumed an $8.7 million mortgage note payable as partial consideration for our acquisition of the Avondale Apartments. The mortgage bore interest at 7.88% per annum. Principal and interest were paid monthly until August 15, 2005, at which time all unpaid principal and interest were paid in full.      —        7,677
On September 27, 1999, we executed a $50.0 million mortgage note payable secured by Munson Hill Towers, Country Club Towers, Roosevelt Towers, Park Adams Apartments and the Ashby of McLean. The mortgage bears interest at 7.14% per annum and interest only is payable monthly until October 1, 2009, at which time all unpaid principal and interest are payable in full.      50,000      50,000
On November 1, 2001, we assumed an $8.5 million mortgage note payable, with an estimated fair value of $9.3 million, as partial consideration for our acquisition of Sullyfield Commerce Center. The mortgage bears interest at 9.00% per annum, and includes a significant prepayment penalty. Principal and interest are payable monthly until February 1, 2007, at which time all unpaid principal and interest are payable in full.      8,257      8,487
On January 24, 2003, we assumed a $6.6 million mortgage note payable, with an estimated fair value of $6.8 million, as partial consideration for our acquisition of Fullerton Industrial Center. The mortgage bears interest at 6.77% per annum. Principal and interest are payable monthly until September 1, 2006, at which time all unpaid principal and interest are payable in full.      6,350      6,491
On October 9, 2003, we assumed a $36.1 million mortgage note payable and a $13.7 million mortgage note payable as partial consideration for our acquisition of the Prosperity Medical Centers. The mortgages bear interest at 5.36% per annum and 5.34% per annum, respectively. Principal and interest are payable monthly until May 1, 2013, at which time all unpaid principal and interest are payable in full.      48,373      48,911
On August 12, 2004, we assumed a $10.1 million mortgage note payable, with an estimated fair value of $11.2 million, as partial consideration for our acquisition of Shady Grove Medical Village II. The mortgage bears interest at 6.98% per annum. Principal and interest are payable monthly until December 1, 2011, at which time all unpaid principal and interest are payable in full.      10,958      11,149
On December 22, 2004, we assumed a $15.6 million mortgage note payable, with an estimated fair value of $17.8 million, and a $3.9 million mortgage note payable with an estimated fair value of $4.2 million as partial consideration for our acquisition of Dulles Business Park. The mortgages bear interest at 7.09% per annum and 5.94% per annum, respectively. Principal and interest are payable monthly until August 10, 2012, at which time all unpaid principal and interest are payable in full.      21,649      22,056
On March 23, 2005 we assumed a $24.3 million mortgage note payable, with an estimated fair value of $25.0 million, as partial consideration for the acquisition of Frederick Crossing. The mortgage bears interest at 5.95% per annum. Principal and interest are payable monthly until January 1, 2013 at which time all unpaid principal and interest are payable in full.      24,806      —  
    

  

     $ 170,393    $ 173,429
    

  

 

Total carrying amount of the above mortgaged properties was $286.7 million and $282.0 million at September 30, 2005 and December 31, 2004, respectively.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2005

(UNAUDITED)

 

Scheduled principal payments for the remaining three months in 2005 and the remaining years subsequent to December 31, 2005 are as follows (in thousands):

 

     Total Principal Payments

2005

   $ 614

2006

     8,660

2007

     9,981

2008

     2,242

2009

     52,369

Thereafter

     96,527
    

Total

   $ 170,393
    

 

NOTE 5: UNSECURED LINES OF CREDIT PAYABLE

 

As of September 30, 2005, we maintained an $85.0 million unsecured line of credit maturing in July 2007 (“Credit Facility No.1”) and a $70.0 million line of credit maturing in July 2008 (“Credit Facility No. 2”).

 

Credit Facility No. 1

 

We had $30.5 million outstanding as of September 30, 2005 related to Credit Facility No. 1, with $0.9 million in Letters of Credit issued, with $53.6 million unused and available for subsequent acquisitions or capital improvements. At December 31, 2004, $67.0 million was outstanding under this facility, which was paid in full using a portion of the proceeds from the April 2005 issuance of $50.0 million of seven-year, 5.05% unsecured notes and $50.0 million of ten-year, 5.35% unsecured notes. (See Note 6 – Notes Payable). Of the $30.5 million outstanding at September 30, 2005, $25.5 million was borrowed in August and September 2005 to pay off the Woodburn Medical Park I and II, and Avondale mortgages. The remaining $5.0 million outstanding was borrowed in September 2005 to fund certain capital improvements to real estate. Advances under this agreement bear interest at LIBOR plus a spread based on the credit rating on our publicly issued debt. All outstanding advances are due and payable upon maturity in July 2007. Interest only payments are due and payable generally on a monthly basis. We incurred $77,200 and $764,600 in interest expense (excluding facility fees) for the 2005 Quarter and 2005 Period, respectively, representing an average interest rate of 4.27% and 3.28% respectively, per annum. We incurred $100,200 and $172,400 in interest expense (excluding facility fees) for the 2004 Quarter and 2004 Period, respectively, representing an average interest rate of 2.20% and 2.00%, respectively, per annum. In October 2005, we paid in full the outstanding balance under Credit Facility No. 1, using a portion of the proceeds from the October issuance of an additional $100.0 million of notes of the May 2015 series of 5.35% senior unsecured notes (See Note 6 – Notes Payable).

 

From July 2002 through July 20, 2004, Credit Facility No. 1 had a maximum available commitment of $25.0 million and required us to pay the lender unused line of credit fees ranging from 0.225% to 0.400% per annum according to a sliding scale based on usage and the credit rating on our publicly issued debt. These fees were payable quarterly. We incurred unused commitment fees of $1,800 and $29,500, for the 2004 Quarter, and 2004 Period, respectively.

 

On July 21, 2004, we closed on a new $50.0 million line of credit with JP Morgan Chase Bank, NA and Wells Fargo Bank, National Association, replacing the former $25.0 million facility. On November 10, 2004, we amended the Credit Agreement to increase the maximum available commitment from $50.0 million to $85.0 million. The new Credit Facility No. 1 requires us to pay the lender a facility fee on the total commitment ranging from 0.15% to 0.25% per annum according to a sliding scale based on the credit rating on our publicly issued debt. These fees are payable quarterly. We incurred facility fees of $32,600 and $98,600, for the 2005 Quarter, and 2005 Period, respectively. During both the 2004 Quarter and 2004 Period, we incurred facility fees of $14,600.

 

Credit Facility No. 2

 

We had $63.0 million outstanding as of September 30, 2005 related to Credit Facility No. 2, and $1.1 million in Letter of Credit issued, with $5.9 million unused and available for subsequent acquisitions or capital improvements. At December 31, 2004, $50.0 million was outstanding under this facility. In February 2005, we repaid $31.0 million of the outstanding balance

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2005

(UNAUDITED)

 

at December 31, 2004 under Credit Facility No. 2 using a portion of the $67.5 million proceeds from the disposition of 7700 Leesburg, Tycon Plaza II and Tycon Plaza III. In April 2005, we repaid the remaining outstanding balance at December 31, 2004 under Credit Facility No. 2 using a portion of the proceeds from the April 2005 issuance of $50.0 million of seven-year, 5.05% unsecured notes and $50.0 million of ten-year, 5.35% unsecured notes (See Note 6 – Notes Payable). The entire $63.0 million outstanding at September 30, 2005 was borrowed in July 2005 to fund the acquisition of Albemarle Point. Advances under this agreement bear interest at LIBOR plus a spread based on the credit rating on our publicly issued debt. All outstanding advances are due and payable upon maturity in July 2008. Interest only payments are due and payable on a monthly basis. We incurred $464,200 and $769,600 in interest expense (excluding facility fees) for the 2005 Quarter and 2005 Period, respectively, representing an average interest rate of 4.15% and 3.75%, respectively, per annum and no interest expense (excluding facility fees) for the 2004 Quarter and 2004 Period. In October 2005, we paid in full the outstanding balance under Credit Facility No. 2, using a portion of the proceeds from the October issuance of an additional $100.0 million of notes of the May 2015 series of 5.35% senior unsecured notes (See Note 6 – Notes Payable).

 

Before its renewal in July 2005, Credit Facility No. 2 required us to pay the lender unused line of credit fees ranging from 0.15% to 0.25% per annum according to a sliding scale based on the credit rating on our publicly issued debt. The fee is paid quarterly in arrears. We incurred unused commitment fees of $6,700 and $38,400, for the 2005 Quarter, and 2005 Period, respectively, and $25,600 and $76,400, for the 2004 Quarter, and 2004 Period, respectively.

 

On July 25, 2005 we renewed Credit Facility No. 2, extending its maturity date to July 25, 2008, and increasing the maximum available commitment to $70.0 million. This renewal and extension included a carve-out for letters of credit in the amount of $14.0 million. Credit Facility No. 2 requires us to pay the lender an annual facility fee on the total commitment ranging from 0.15% to 0.25% per annum according to a sliding scale based on the credit rating on our publicly issued debt. These fees are payable quarterly. During both the 2005 Quarter and 2005 Period, we incurred facility fees of $19,800 and no facility fees for the 2004 Quarter and 2004 Period.

 

Credit Facility No. 1 and No. 2 contain certain financial and non-financial covenants, all of which we have met as of September 30, 2005. In addition, Credit Facility No. 1 requires approval to be obtained from the lender for purchases by the Trust over an agreed upon amount.

 

NOTE 6: NOTES PAYABLE

 

On August 13, 1996 we sold $50.0 million of 7.125% 7-year unsecured notes due August 13, 2003, and $50.0 million of 7.25% unsecured 10-year notes due August 13, 2006. The 7-year notes were sold at 99.107% of par and the 10-year notes were sold at 98.166% of par. Net proceeds to the Trust after deducting underwriting expenses were $97.6 million. The 7-year notes, which we paid off at maturity in August 2003 with an advance under Credit Facility No. 2, bore an effective interest rate of 7.46%. The 10-year notes due in August 2006 bear an effective interest rate of 7.49%.

 

On February 20, 1998 we sold $50.0 million of 7.25% unsecured notes due February 25, 2028 at 98.653% to yield approximately 7.36%. We also sold $60.0 million in unsecured Mandatory Par Put Remarketed Securities (“MOPPRS”) at an effective borrowing rate through the remarketing date (February 2008) of approximately 6.74%. Our costs of the borrowings and related closed hedge settlements of approximately $7.2 million are amortized over the lives of the notes using the effective interest method. These notes do not require any principal payment and are due in full at maturity.

 

On November 6, 2000 we sold $55.0 million of 7.78% unsecured notes due November 2004. The notes bore an effective interest rate of 7.89%. Our total proceeds, net of underwriting fees, were $54.8 million. We used the proceeds of these notes to repay advances on our lines of credit. We paid off the notes on November 15, 2004, with a $50.0 million advance under Credit Facility No. 2 and a $7.0 million advance under Credit Facility No. 1.

 

On March 17, 2003, we sold $60.0 million of 5.125% unsecured notes due March 2013. The notes bear an effective interest rate of 5.23%. Our total proceeds, net of underwriting fees, were $59.1 million. We used portions of the proceeds of these notes to repay advances on our lines of credit and to fund general corporate purposes.

 

On December 11, 2003, we sold $100.0 million of 5.25% unsecured notes due January 2014. The notes bear an effective interest rate of 5.34%. Our total proceeds, net of underwriting fees, were $99.3 million. We used the proceeds of these notes to repay advances on our lines of credit.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2005

(UNAUDITED)

 

On April 26, 2005, we sold $50.0 million of 5.05% senior unsecured notes due May 1, 2012 and $50.0 million of 5.35% senior unsecured notes due May 1, 2015, at effective yields of 5.064% and 5.359% respectively. The net proceeds from the sale of the notes of $99.3 million were used to repay borrowings under our lines of credit totaling $90.5 million and the remainder was used for general corporate purposes.

 

In October 2005 we sold an additional $100.0 million of notes of the series of 5.35% senior unsecured notes due May 1, 2015, at an effective yield of 5.49%. $93.5 million of the $100.7 million proceeds (including $2.4 million of accrued interest) from the sale of these notes was used to repay borrowings under our lines of credit and the reminder may be used for the acquisition of real estate and general corporate purposes.

 

Interest on these notes is payable semi-annually. They contain certain financial and non-financial covenants, all of which we have met as of September 30, 2005.

 

The covenants under one of the line of credit agreements require us to insure our properties against loss or damage in the amount of the replacement cost of the improvements at the properties. The covenants for the notes require us to keep all of our insurable properties insured against loss or damage at least equal to their then full insurable value. We have a separate insurance policy which provides terrorism coverage; however, our financial condition and results of operations are subject to the risks associated with acts of terrorism and the potential for uninsured losses as the result of any such acts. Effective November 26, 2002, under this existing coverage, any losses caused by certified acts of terrorism would be partially reimbursed by the United States under a formula established by Federal law. Under this formula the United States pays 90% of covered terrorism losses exceeding the statutorily established deductible paid by the insurance provider. If the aggregate amount of insured losses under the Act exceeds $100 billion during the applicable period for all insured and insurers combined, then each insurance provider will not be liable for payment of any amount which exceeds the aggregate amount of $100 billion. This current legislation expires in November 2005.

 

Scheduled maturity dates of the securities for the remaining three months in 2005 and the remaining years subsequent to December 31, 2005 are as follows (in thousands):

 

2005

   $ —  

2006

     50,000

2007

     —  

2008

     60,000

2009

     —  

Thereafter

     310,000
    

     $ 420,000
    

 

NOTE 7: BENEFIT PLANS

 

Share Options and Grants

 

We maintain Incentive Stock Option Plans (the “Plans”), which include qualified and non-qualified options. In 2003 the Board approved a change in the composition of officer share options and share grant awards. Officers no longer receive annual share option awards. Effective 2003, annual incentive compensation is awarded at the same percentage of cash compensation as in prior years except it is in the form of share grants only.

 

We maintain a Share Grant Plan for officers and trustees. At the approval of the Board, the Share Grant Plan was changed in 2003 so that Managing Directors received an award of shares with a market value of 25% of the individual’s cash compensation (45% for the Chief Executive Officer, 37% for Executive Vice Presidents, and 35% for Senior Vice Presidents) at the date of the award. Beginning in 2003, officers received annual awards of share grants only (as opposed to share options and share grants) in an amount such that the total annual incentive compensation as a percentage of officer cash compensation remained unchanged. Each Trustee received an annual grant of 400 unrestricted shares under the plan.

 

In November 2004, the Board of Trustees approved an amended short-term and long-term incentive plan for officers and executives. The first benefits under the amended short-term and long term plan will be paid in late 2005, in each case based upon 2005 results. The short-term incentive compensation plan provides for the annual payment of cash bonuses based upon WRIT’s achievement of its annual targets, as defined by the revised plan, for Funds From Operations (FFO) per share (a non-GAAP

 

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WASHINGTON REAL ESTATE INVESTMENT TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2005

(UNAUDITED)

 

financial measure) and EBITDA (a non GAAP measure calculated as earnings before interest, taxes, depreciation and amortization). Each target will be determined in November of the preceding year by management and approved by the Board of Trustees. The long-term incentive plan provides for the annual grant of restricted WRIT shares based on total shareholder return. The awards will be granted in the form of restricted shares pursuant to WRIT’s existing share grant plan, will vest ratably over a five-year period from the date of grant and will not be permitted to be sold until the entire award has vested.

 

Also in November 2004, the Board of Trustees approved revisions to the trustee compensation plan, under which the first cash and share grant benefits will be paid in 2005. Under this plan, annual long-term incentive compensation for trustees is changed from options of 2,000 shares plus 400 restricted shares to $30,000 in restricted shares. These restricted shares will vest immediately and will be restricted from sale for the period of the Trustees’ service. Additionally, the amounts of certain fees and retainers were amended.

 

Other Benefit Plans

 

We have a Retirement Savings Plan (the “401(k) Plan”), which permits all eligible employees to defer a portion of their compensation in accordance with the Internal Revenue Code. Under the 401(k) Plan, the company may make discretionary contributions on behalf of eligible employees. For the 2005 Quarter and 2005 Period, the company made contributions to the 401(k) plan of $86,000 and $227,000, respectively. For the 2004 Quarter and 2004 Period, the company made contributions to the 401(k) plan of $62,000 and $190,000, respectively.

 

We adopted a split dollar life insurance plan for executive officers (the Chief Financial Officer, Executive Vice President of Real Estate and Senior Vice President Accounting and Administration) and other company officers, excluding the Chief Executive Officer (“CEO”), in 2000. The purpose of the plan is to provide these officers with financial security in exchange for a career commitment. It is intended that we will recover our costs from the life insurance policies at death prior to retirement, termination prior to retirement or retirement at age 65. It is intended that the officers can use the cash values of the policy in excess of the Trust’s interest. The Trust has a security interest in the cash value and death benefit of each policy to the extent of the sum of premium payments we have made. Subsequent to July 2002 we discontinued premium advances under this plan for the benefit of executive officers. The company paid no premiums for non executive company officers for the 2005 and 2004 Quarters and $0.2 million and $0.4 million for the 2005 Period and 2004 Period, respectively.

 

We have adopted a non-qualified deferred compensation plan for the officers and members of the Board of Trustees. The plan allows for a deferral of a percentage of annual cash compensation and trustee fees. The plan is unfunded and payments are to be made out of the general assets of the Trust. The deferred compensation liability was $1.5 million and $1.3 million at September 30, 2005 and December 31, 2004, respectively.

 

We established a Supplemental Executive Retirement Plan (“SERP”) effective July 1, 2002 for the benefit of the CEO. Upon the CEO’s termination of employment from the Trust for any reason other than death, discharge for cause or total and permanent disability, the CEO will be entitled to receive an annual benefit equal to his accrued benefit times his vested interest. We account for the SERP in accordance with SFAS No. 87, “Employers’ Accounting for Pensions,” whereby we accrue benefit cost in an amount that will result in an accrued balance at the end of the CEO’s employment which is not less than the present value of the estimated benefit payments to be made. We recognized current service cost for the 2005 Quarter and 2005 Periods, of $101,000 and $304,000, respectively, and $91,000 and $263,000 for the 2004 Quarter and 2004 Period, respectively.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2005

(UNAUDITED)

 

NOTE 8: EARNINGS PER SHARE

 

The following table sets forth the computation of net income per average share and diluted average shares (in thousands, except per share data):

 

     Quarter ended
September 30,


   Period ended
September 30,


     2005

   2004

   2005

   2004

Numerator for basic and diluted per share calculations:

                           

Income from continuing operations

   $ 10,523    $ 9,764    $ 29,376    $ 30,253

Discontinued operations including gain on sale of real estate

     2,938      1,033      37,195      2,928
    

  

  

  

Net income

   $ 13,461    $ 10,797    $ 66,571    $ 33,181

Denominator for basic and diluted per share calculations:

                           

Denominator for basic per share amounts – weighted average shares

     42,005      41,648      42,088      41,619

Effect of dilutive securities:

                           

Employee stock option and share grant awards

     142      235      140      230
    

  

  

  

Denominator for diluted per share amounts

     42,147      41,883      42,228      41,849
    

  

  

  

Income from continuing operations per share

                           

Basic

   $ 0.25    $ 0.23    $ 0.70    $ 0.73

Diluted

   $ 0.25    $ 0.23    $ 0.70    $ 0.72

Discontinued operations, including gain on sale of real estate, per share

                           

Basic

   $ 0.07    $ 0.03    $ 0.88    $ 0.07

Diluted

   $ 0.07    $ 0.03    $ 0.88    $ 0.07

Net income per share

                           

Basic

   $ 0.32    $ 0.26    $ 1.58    $ 0.80

Diluted

   $ 0.32    $ 0.26    $ 1.58    $ 0.79

 

NOTE 9: SEGMENT INFORMATION

 

We have four reportable segments: Office Buildings, Retail Centers, Multifamily Properties and Industrial/Flex Centers. Office Buildings, which include medical office buildings, provide office space for various types of businesses and professions. Retail Centers are typically neighborhood grocery store or drug store anchored retail centers. Multifamily Properties provide housing for families throughout the Washington Metropolitan area. Industrial/Flex Centers are used for flex-office, warehousing and distribution type facilities.

 

Real estate revenue as a percentage of total revenue for each of the four reportable operating segments is as follows:

 

     Quarter Ended
September 30,


    Period Ended
September 30,


 
     2005

    2004

    2005

    2004

 

Office Buildings

   50 %   54 %   50 %   54 %

Retail Centers

   17 %   15 %   17 %   16 %

Multifamily Properties

   16 %   17 %   16 %   17 %

Industrial/Flex Centers

   17 %   14 %   17 %   13 %

 

Real estate assets as a percentage of total assets for each of the four reportable operating segments are as follows:

 

    

September 30,

2005


   

December 31,

2004


 

Office Buildings

   52 %   56 %

Retail Centers

   15 %   13 %

Multifamily Properties

   12 %   12 %

Industrial/Flex Centers

   21 %   19 %

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2005

(UNAUDITED)

 

The accounting policies of each of the segments are the same as those described in Note 2. We evaluate performance based upon operating income from the combined properties in each segment. Our reportable segments are consolidations of similar properties. They are managed separately because each segment requires different operating, pricing and leasing strategies. All of these properties have been acquired separately and are incorporated into the applicable segment.

 

Segment Information (in thousands):

Quarter Ended September 30, 2005


     Office
Buildings


   Retail
Centers


   Multifamily

   Industrial/Flex
Center


   Corporate
And Other


    Consolidated

Revenue

                                          

Real estate rental revenue

   $ 24,365    $ 8,279    $ 7,829    $ 8,466    $ —       $ 48,939

Other income

     —        —        —        —        335       335
    

  

  

  

  


 

       24,365      8,279      7,829      8,466      335       49,274

Expenses

                                          

Real estate expenses

     7,948      1,698      3,385      1,898      —         14,929

Interest expense

     1,112      353      986      506      6,841       9,798

Depreciation and amortization

     6,355      1,871      1,272      2,380      110       11,988

General and administration

     —        —        —        —        2,036       2,036
    

  

  

  

  


 

       15,415      3,922      5,643      4,784      8,987       38,751

Other income from property settlement

     —        —        —        —        —         —  

Discontinued operations

     —        —        —        2,938      —         2,938
    

  

  

  

  


 

Net Income

   $ 8,950    $ 4,357    $ 2,186    $ 6,620    $ (8,652 )   $ 13,461
    

  

  

  

  


 

Capital expenditures

   $ 2,978    $ 3,724    $ 4,826    $ 745    $ 10     $ 12,283
    

  

  

  

  


 

Total assets

   $ 565,454    $ 102,705    $ 178,626    $ 238,952    $ 26,604     $ 1,112,341
    

  

  

  

  


 

 

Quarter Ended September 30, 2004


     Office
Buildings


   Retail
Centers


   Multifamily

   Industrial/Flex
Centers


   Corporate
And Other


    Consolidated

Revenue

                                          

Real estate rental revenue

   $ 23,336    $ 6,714    $ 7,288    $ 5,908    $ —       $ 43,246

Other income

     —        —        —        —        59       59
    

  

  

  

  


 

       23,336      6,714      7,288      5,908      59       43,305

Expenses

                                          

Real estate expenses

     7,359      1,443      3,011      1,335      —         13,148

Interest expense

     1,146      —        1,066      250      6,298       8,760

Depreciation and amortization

     6,050      926      1,238      1,387      416       10,017

General and administration

     —        —        —        —        1,616       1,616
    

  

  

  

  


 

       14,555      2,369      5,315      2,972      8,330       33,541

Other income from property settlement

     —        —        —        —        —         —  

Discontinued operations

     979      —        —        54      —         1,033
    

  

  

  

  


 

Net Income

   $ 9,760    $ 4,345    $ 1,973    $ 2,990    $ (8,271 )   $ 10,797
    

  

  

  

  


 

Capital expenditures

   $ 2,336    $ 1,722    $ 3,350    $ 937    $ 12     $ 8,357
    

  

  

  

  


 

Total assets

   $ 587,303    $ 129,235    $ 87,890    $ 138,720    $ 15,054     $ 958,202
    

  

  

  

  


 

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2005

(UNAUDITED)

 

Period Ended September 30, 2005


     Office
Buildings


   Retail
Centers


   Multifamily

   Industrial/Flex
Centers


   Corporate
And Other


    Consolidated

Revenue

                                          

Real estate rental revenue

   $ 70,826    $ 23,489    $ 22,867    $ 23,606    $ —       $ 140,788

Other income

     —        —        —        —        655       655
    

  

  

  

  


 

       70,826      23,489      22,867      23,606      655       141,443

Expenses

                                          

Real estate expenses

     23,091      5,103      9,515      5,366      —         43,075

Interest expense

     3,449      740      3,112      1,526      18,841       27,668

Depreciation and amortization

     18,851      6,313      3,757      6,220      326       35,467

General and administration

     —        —        —        —        6,361       6,361
    

  

  

  

  


 

       45,391      12,156      16,384      13,112      25,528       112,571

Other income from property settlement

     —        504      —        —        —         504

Discontinued operations

     34,204      —        —        2,991      —         37,195
    

  

  

  

  


 

Net Income

   $ 59,639    $ 11,837    $ 6,483    $ 13,485    $ (24,873 )   $ 66,571
    

  

  

  

  


 

Capital expenditures

   $ 9,257    $ 6,271    $ 14,910    $ 2,068    $ 402     $ 32,908
    

  

  

  

  


 

 

Period Ended September 30, 2004


     Office
Buildings


   Retail
Centers


   Multifamily

   Industrial/Flex
Centers


   Corporate
And Other


    Consolidated

Revenue

                                          

Real estate rental revenue

   $ 68,876    $ 20,283    $ 21,522    $ 17,241    $ —       $ 127,922

Other income

     —        —        —        —        239       239
    

  

  

  

  


 

     $ 68,876    $ 20,283    $ 21,522      17,241      239       128,161

Expenses

                                          

Real estate expenses

     21,184      4,495      8,717      3,964      —         38,360

Interest expense

     3,241      —        3,201      755      18,752       25,949

Depreciation and amortization

     17,714      2,762      3,631      3,988      932       29,027

General and administration

     —        —        —        —        4,572       4,572
    

  

  

  

  


 

       42,139      7,257      15,549      8,707      24,256       97,908

Other income from property settlement

     —        —        —        —        —         —  

Discontinued operations

     2,760      —        —        168      —         2,928
    

  

  

  

  


 

Net Income

   $ 29,497    $ 13,026    $ 5,973    $ 8,702    $ (24,017 )   $ 33,181
    

  

  

  

  


 

Capital expenditures

   $ 10,067    $ 3,999    $ 6,962    $ 1,598    $ 58     $ 22,684
    

  

  

  

  


 

 

NOTE 10: SUBSEQUENT EVENTS

 

On October 3, 2005, subsequent to the end of the third quarter, we reopened our series of 5.35% senior unsecured notes due May 1, 2015 and issued an additional $100 million of notes at an effective yield of 5.49%. $93.5 million of the $100.7 million proceeds (including $2.4 million of accrued interest) from the sale of these notes was used to repay borrowings under our lines of credit and the remainder may be used for the acquisition of real estate and general corporate purposes.

 

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(UNAUDITED)

 

ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion should be read in conjunction with the Consolidated Financial Statements of the Company and the notes thereto included elsewhere herein.

 

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, we evaluate these estimates, including those related to useful lives of real estate assets, cost reimbursement income, bad debts, impairment, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. There can be no assurance that actual results will not differ from those estimates.

 

The discussion that follows is based on our consolidated results of operations for the three months (hereinafter referred to as the “Quarter”) and nine months (hereinafter referred to as the “Period”) ended September 30, 2005 and 2004, respectively.

 

Forward Looking Statements

 

We claim the protection of the safe harbor for forward looking statements contained in the Private Securities Litigation Reform Act of 1995 for the forward looking statements contained herein. Forward looking statements include statements in this report preceded by, followed by or that include the words “believe,” “expect,” “intend,” “anticipate,” “potential,” “project,” “will” and other similar expressions. The following important factors, in addition to those discussed in our 2004 Annual Report on Form 10-K under the caption “Risk Factors”, could affect our future results and could cause those results to differ materially from those expressed in the forward looking statements: (a) the economic health of our tenants; (b) the economic health of the Greater Washington-Baltimore region, or other markets we may enter, including the effects of changes in Federal government spending; (c) the supply of competing properties; (d) inflation; (e) consumer confidence; (f) unemployment rates; (g) consumer tastes and preferences; (h) stock price and interest rate fluctuations; (i) our future capital requirements; (j) compliance with applicable laws, including those concerning the environment and access by persons with disabilities; (k) governmental or regulatory actions and initiatives; (l) changes in general economic and business conditions; (m) terrorist attacks or actions; (n) acts of war; (o) weather conditions; and (p) the effects of changes in capital availability to the technology and biotechnology sectors of the economy. We undertake no obligation to update our forward looking statements or risk factors to reflect new information, future events, or otherwise.

 

Overview

 

Our revenues are derived primarily from the ownership and operation of income-producing real properties in the greater Washington/Baltimore region. As of September 30, 2005, we owned a diversified portfolio of 68 properties, consisting of 12 retail centers, 28 office properties, 19 industrial/flex properties and 9 multifamily properties, totaling 10 million net rentable square feet. We have a fundamental strategy of regional focus, diversification by property type and conservative capital management.

 

When evaluating our financial condition and operating performance, management focuses on the following financial and non-financial indicators, discussed in further detail herein:

 

    Net Operating Income (“NOI”) by segment. NOI is calculated as real estate rental revenue less real estate operating expenses.

 

    Economic occupancy and rental rates.

 

    Leasing activity – new leases, renewals and expirations.

 

    Funds From Operations (“FFO”), a supplemental measure to Net Income.

 

Our results in the third quarter of 2005 as compared to the third quarter of 2004, showed continued improvement in both occupancy and rental rate growth. In the Office sector, WRIT’s largest vacancies remain at 7900 Westpark at Tyson’s Corner and with good current leasing prospects, progress to reduce this vacancy is expected. Office vacancies decreased slightly in the suburban Maryland submarket, reflected in the improved leasing activity at our Maryland Trade Centers which are each 85%

 

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SEPTEMBER 30, 2005

(UNAUDITED)

 

leased. WRIT’s retail centers have remained strong at over 99% leased at quarter end reflecting the retail market throughout the Metropolitan region. The Multifamily market showed good improvement in occupancies and rental rates. The best and most active Multifamily areas continue to be the close-in Northern Virginia submarkets and the District of Columbia. Suburban Maryland has improved over the prior quarters of this year, however, it continues to lag the other sub markets due to the continued supply and demand imbalance.

 

Progress continues on our ground-up development and major redevelopment projects at Rosslyn Towers, South Washington Street and Foxchase Shopping Center. Demolition has begun at South Washington Street as well as in the development area of the Foxchase Shopping Center where we expect to deliver a pad site to a large grocery store chain in the fourth quarter 2005. This tenant will begin constructing their store for an anticipated opening in late 2006 at which time rent is expected to commence.

 

GENERAL

 

During the 2005 Period we completed the following significant transactions:

 

    The acquisition of one Retail property, for a purchase price of $44.8 million, adding approximately 295,000 square feet of rentable retail space which was 100% leased as of the end of the 2005 Period, one Industrial property for a purchase price of $8.8 million, adding approximately 60,000 square feet of rentable industrial space which was 100.0% leased as of the end of the 2005 Period and one Office and Industrial property for a purchase price of $67.0 million, adding approximately 90,000 square feet of rentable Office space and approximately 206,000 square feet of rentable Industrial space which was 97% leased as of the end of the 2005 Period.

 

    The disposition of one Industrial and three Office properties, totaling approximately 480,000 square feet, for a gain of approximately $35.2 million and the recognition of a previously deferred gain of $1.9 million from the sale of an Office property in November, 2004.

 

    The extension and increase of our line of credit facility No. 2 until 2008 for $70 million.

 

    The issuance of $50.0 million of 5.05% senior unsecured notes due May 1, 2012 and $50.0 million of 5.35% senior unsecured notes due May 1, 2015, at effective yields of 5.064% and 5.359% respectively. And subsequent to September 30, 2005, reopened the series of 5.35% senior unsecured notes and issued an additional $100 million of notes.

 

    The investment of $11.6 million in the major development and redevelopment of several properties.

 

    The execution of new leases for 1,329,000 square feet of office, retail and industrial space, combined.

 

During the 2004 Period we completed the following significant transactions:

 

    The acquisition of one Industrial property, for a purchase price of $11.5 million, adding approximately 141,000 square feet of rentable space, and one Office property, for $18.5 million, adding approximately 66,000 square feet of rentable space.

 

    The execution of new leases for 1,328,000 square feet of office, retail and industrial space, combined.

 

    The execution of a new $50 million line of credit with Bank One, NA and Wells Fargo Bank, National Association that replaced the previous $25 million facility with Bank One, NA.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our consolidated financial statements. Our significant accounting policies are described in Note 2 in the Notes to the Consolidated Financial Statements.

 

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SEPTEMBER 30, 2005

(UNAUDITED)

 

Revenue Recognition

 

Residential properties are leased under operating leases with terms of generally one year or less, and commercial properties are leased under operating leases with average terms of three to seven years. We recognize rental income and rental abatements from our residential and commercial leases when earned on a straight-line basis in accordance with SFAS No. 13, “Accounting for Leases.” We record a provision for losses on accounts receivable equal to the estimated uncollectible amounts. This estimate is based on our historical experience and a review of the current status of the company’s receivables. Percentage rents, which represent additional rents based on gross tenant sales, are recognized when tenants’ sales exceed specified thresholds.

 

In accordance with SFAS No. 66, “Accounting for Sales of Real Estate,” sales are recognized at closing only when sufficient down payments have been obtained, possession and other attributes of ownership have been transferred to the buyer and we have no significant continuing involvement.

 

We recognize cost reimbursement income from pass-through expenses on an accrual basis over the periods in which the expenses were incurred. Pass-through expenses are comprised of real estate taxes, operating expenses and common area maintenance costs which are reimbursed by tenants in accordance with specific allowable costs per tenant lease agreements.

 

Capital Expenditures

 

We capitalize those expenditures related to acquiring new assets, significantly increasing the value of an existing asset, or substantially extending the useful life of an existing asset. Expenditures necessary to maintain an existing property in ordinary operating condition are expensed as incurred.

 

Real Estate Assets

 

Real estate assets are depreciated on a straight-line basis over estimated useful lives ranging from 28 to 50 years. All capital improvement expenditures associated with replacements, improvements, or major repairs to real property are depreciated using the straight-line method over their estimated useful lives ranging from 3 to 30 years. All tenant improvements are amortized over the shorter of the useful life or the term of the lease.

 

We allocate the purchase price of acquired properties to the related physical assets and in-place leases based on their fair values, based on SFAS No. 141, “Business Combinations.” The fair values of acquired buildings are determined on an “as-if-vacant” basis considering a variety of factors, including the physical condition and quality of the buildings, estimated rental and absorption rates, estimated future cash flows and valuation assumptions consistent with current market conditions. The “as-if-vacant” fair value is allocated to land, building and tenant improvements based on property tax assessments and other relevant information obtained in connection with the acquisition of the property.

 

The fair value of in-place leases consists of the following components – (1) the estimated cost to us to replace the leases, including foregone rents during the period of finding a new tenant, foregone recovery of tenant pass-through expenses, tenant improvements, and other direct costs associated with obtaining a new tenant (referred to as “Tenant Origination Cost”); (2) the estimated leasing commissions associated with obtaining a new tenant (referred to as “Leasing Commissions”); (3) the above/at/below market cash flow of the leases, determined by comparing the projected cash flows of the leases in place to projected cash flows of comparable market-rate leases (referred to as “Net Lease Intangible”); and (4) the value, if any, of customer relationships, determined based on our evaluation of the specific characteristics of each tenant’s lease and our overall relationship with the tenant (referred to as “Customer Relationship Value”). The amounts used to calculate Tenant Origination Cost, Leasing Commissions and Net Lease Intangible are discounted using an interest rate which reflects the risks associated with the leases acquired. Tenant Origination Costs are included in Real Estate Assets on our balance sheet and are amortized as depreciation expense on a straight-line basis over the remaining life of the underlying leases. The remaining components, Leasing Commissions and net Lease Intangible, are included in other assets and other liabilities on our balance sheet. We have attributed no value to Customer Relationship Value as of September 30, 2005 or December 31, 2004.

 

Discontinued Operations

 

We dispose of assets (sometimes using tax-deferred exchanges) that are inconsistent with our long-term strategic or return objectives and when market conditions for sale are favorable. The proceeds from the sales are reinvested into other properties, used to fund development operations or to support other corporate needs, or are distributed to our shareholders.

 

We classify properties as held for sale when they meet the necessary criteria specified by SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” These include: senior management commits to and actively embarks upon a plan to sell the assets, the sale is expected to be completed within one year under terms usual and customary for such sales and

 

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(UNAUDITED)

 

actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. Depreciation on these properties is discontinued, but operating revenues, operating expenses and interest expense continue to be recognized until the date of sale.

 

Under SFAS 144, revenues and expenses of properties that are either sold or classified as held for sale are treated as discontinued operations for all periods presented in the Statements of Income.

 

Impairment Losses on Long-Lived Assets

 

We recognize impairment losses on long-lived assets used in operations when indicators of impairment are present and the net undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amount. If such carrying amount is in excess of the estimated cash flows from the operation and disposal of the property, we would recognize an impairment loss equivalent to an amount required to adjust the carrying amount to the estimated fair market value. There were no property impairments recognized during the 2005 and 2004 periods.

 

Federal Income Taxes

 

We believe we have qualified as a REIT under Sections 856-860 of the Internal Revenue Code and intend to continue to qualify as such. To maintain our status as a REIT, we are required to distribute at least 90% of our ordinary taxable income to our shareholders. When selling properties, we have the option of (i) reinvesting the sale price of properties sold, allowing for a deferral of income taxes on the sale, (ii) paying out capital gains to the shareholders with no tax to the company or (iii) treating the capital gains as having been distributed to the shareholders, paying the tax on the gain deemed distributed and allocating the tax paid as a credit to the shareholders. All except approximately $3.5 million of gains on the sale of properties disposed during the 2005 Period were, or are expected to be, reinvested in replacement properties. We distributed 100% of our 2004 ordinary taxable income, and the gains from the property disposed in 2004, to shareholders.

 

RESULTS OF OPERATIONS

 

The discussion that follows is based on our consolidated results of operations for the Quarter and Period ended September 30, 2005 and 2004, respectively. The ability to compare one period to another may be significantly affected by acquisitions completed and dispositions made during those periods.

 

For purposes of evaluating comparative operating performance, we categorize our properties as “core”, “non-core” or Discontinued Operations. A “core” property is one that was owned for the entirety of the periods being evaluated. A “non-core” property is one that was acquired during either of the periods being evaluated and is included in continuing operations. Results for properties sold or held for sale during any of the periods evaluated are classified as Discontinued Operations. Three properties were acquired during the 2005 Period and two properties were acquired during the 2004 Period. Four properties were sold in 2005 and are classified as Discontinued Operations for the 2005 Period. These four properties and one additional property, sold in November, 2004, are classified as Discontinued Operations for the 2004 Period.

 

To provide more insight into our operating results, our discussion is divided into two main sections: (1) Consolidated Results of Operations where we provide an overview analysis of results on a consolidated basis and (2) Net Operating Income (“NOI”) where we provide a detailed analysis of core versus non-core property-level NOI results by segment. NOI is calculated as real estate rental revenue less real estate operating expenses.

 

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WASHINGTON REAL ESTATE INVESTMENT TRUST

SEPTEMBER 30, 2005

(UNAUDITED)

 

CONSOLIDATED RESULTS OF OPERATIONS

 

REAL ESTATE RENTAL REVENUE

 

Real Estate Rental Revenue is summarized as follows (all data in thousands, except percentage amounts):

 

     Quarter Ended September 30,

    Period Ended September 30,

 
     2005

   2004

   $ Change

   % Change

    2005

   2004

   $ Change

   % Change

 

Minimum base rent

   $ 43,525    $ 39,066    $ 4,459    11.4 %   $ 125,762    $ 115,461    $ 10,301    8.9 %

Recoveries from tenants

     4,099      3,071      1,028    33.5 %     11,544      9,048      2,496    27.6 %

Parking and other tenant charges

     1,315      1,109      206    18.6 %     3,482      3,413      69    2.0 %
    

  

  

  

 

  

  

  

     $ 48,939    $ 43,246    $ 5,693    13.2 %   $ 140,788    $ 127,922    $ 12,866    10.1 %
    

  

  

  

 

  

  

  

 

Real estate rental revenue is comprised of (1) minimum base rent, which includes rental revenues recognized on a straight-line basis, (2) revenue from the recovery of operating expenses from our tenants and (3) other revenue such as parking and termination fees.

 

Minimum base rent increased $4.5 million (11.4%) in the 2005 Quarter and $10.3 million (8.9%) in the 2005 Period compared to the 2004 Quarter and Period, respectively, primarily due to the two Office, one Retail and three Industrial properties acquired in 2004 and year-to-date in 2005. These acquisitions accounted for $1.6 million and $8.3 million of the increase in minimum base rent in the 2005 Quarter and Period over the 2004 Quarter and Period, respectively and $0.5 million and $1.1 million of the increase in recoveries from tenants, respectively. Total real estate revenue from core properties in the 2005 Quarter increased $1.6 million over the prior year driven by increased occupancy in the Multifamily and Retail sectors, increases in rental rate growth in the Multifamily, Retail and Industrial sectors offset by decreased occupancy in the Office sector. In the 2005 Period, real estate revenue from core properties was higher ($3.3 million) than in the 2004 Period due to the increase in occupancy in the multifamily and retail sectors and an increase in rental rates in the Multifamily, Retail and Industrial sectors.

 

A summary of consolidated economic occupancy by sector for properties classified as continuing operations follows:

 

     Quarter Ended September 30,

    Period Ended September 30,

 

Sector


   2005

    2004

    Change

    2005

    2004

    Change

 

Office

   90.4 %   90.8 %   (0.4 )%   89.7 %   90.9 %   (1.2 )%

Retail

   98.2 %   94.6 %   3.6 %   97.3 %   94.5 %   2.8 %

Multifamily

   94.9 %   91.4 %   3.5 %   93.6 %   90.1 %   3.5 %

Industrial

   94.5 %   92.6 %   1.9 %   94.3 %   92.2 %   2.1 %
    

 

 

 

 

 

Total

   93.0 %   91.7 %   1.3 %   92.2 %   91.4 %   0.8 %
    

 

 

 

 

 

 

Economic occupancy represents actual rental revenues recognized for the period indicated as a percentage of gross potential rental revenues for that period. Percentage rents and expense reimbursements are not considered in computing either actual rental revenues or gross potential rental revenues. Our overall economic occupancy increased 130 basis points for the 2005 Quarter and 80 basis points for the 2005 Period as a result of occupancy gains in the Retail, Multifamily and Industrial sectors, partially offset by a decline in occupancy in the Office sector. Occupancy in the Multifamily sector increased due to the lease-up of units at the Ashby that were vacant for renovation in 2004. Industrial occupancy increased 190 basis points in the 2005 Quarter over the 2004 Quarter and 210 basis points in the 2005 Period over the 2004 Period due to leasing activity in the core portfolio and a combined occupancy of 99.4% in the 2005 Quarter and 97.7% in the 2005 Period for the properties acquired in 2005 (Coleman Building and Albemarle Point) and 2004 (8880 Gorman Road, for the year, and Dulles Business Park, for the quarter and year). Retail occupancy was positively impacted by completion of redevelopment activities in the fourth quarter of 2004 at Westminster Shopping Center, allowing for the move in of a large grocery anchor. Office occupancy decreased primarily due to the expiration of several leases that did not renew at 7900 Westpark and 1700 Research Boulevard in the fourth quarter of 2004.

 

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WASHINGTON REAL ESTATE INVESTMENT TRUST

SEPTEMBER 30, 2005

(UNAUDITED)

 

REAL ESTATE OPERATING EXPENSES

 

Real estate operating expenses are summarized as follows (all data in thousands, except percentage amounts):

 

     Quarter Ended September 30,

    Period Ended September 30,

 
     2005

   2004

   $ Change

   % Change

    2005

   2004

   $ Change

   % Change

 

Property operating expenses

   $ 10,928    $ 9,713    $ 1,215    12.5 %   $ 31,229    $ 28,016    $ 3,213    11.5 %

Real estate taxes

     3,999      3,435      564    16.4 %     11,846      10,344      1,502    14.5 %
    

  

  

  

 

  

  

  

     $ 14,927    $ 13,148    $ 1,779    13.5 %   $ 43,075    $ 38,360    $ 4,715    12.3 %
    

  

  

  

 

  

  

  

 

Property operating expenses include utilities, repairs and maintenance, property administration and management, operating services, common area maintenance and other operating expenses.

 

Real estate operating expenses were 30.5% and 30.6% of revenue in the 2005 Quarter and Period, respectively, and 30.4% and 30.0% of revenue in the 2004 Quarter and Period, respectively. The properties acquired in 2004 and 2005 accounted for $0.6 million of the $1.2 million increase in property operating expenses and $0.3 million of the $0.6 million increase in real estate taxes over the 2004 Quarter. Core real estate operating expenses increased $0.8 million as a result of higher utility costs, real estate taxes and repair and maintenance expenses.

 

Properties acquired in 2004 and 2005 accounted for $1.4 million of the $3.2 million increase in property operating expenses and almost $0.8 of the $1.5 million increase in real estate taxes over the 2004 Period. Core property operating expenses increased $2.5 million as a result of higher utility costs, real estate taxes, repairs and maintenance expenses.

 

OTHER OPERATING EXPENSES

 

Other operating expenses are summarized as follows (all data in thousands, except percentage amounts):

 

     Quarter Ended September 30,

    Period Ended September 30,

 
     2005

   2004

   $ Change

   % Change

    2005

   2004

   $ Change

   % Change

 

Depreciation & amortization

   $ 11,988    $ 10,017    $ 1,971    19.7 %   $ 35,467    $ 29,027    $ 6,440    22.2 %

Interest expense

     9,798      8,760      1,038    11.8 %     27,668      25,949      1,719    6.6 %

General & administrative

     2,036      1,616      420    26.0 %     6,361      4,572      1,789    39.1 %
    

  

  

  

 

  

  

  

     $ 23,822    $ 20,393    $ 3,429    16.8 %   $ 69,496    $ 59,548    $ 9,948    16.7 %
    

  

  

  

 

  

  

  

 

Depreciation and amortization expense increased $2.0 million (19.7%) to $12.0 million in the 2005 Quarter from $10.0 million in the 2004 Quarter and increased $6.4 million (22.2%) to $35.5 million in the 2005 Period from $29.0 million in the 2004 Period, due primarily to total acquisitions of $205.8 million and capital and tenant improvement expenditures of $57.2 million in 2004 and in the 2005 Period, combined. In the 2005 Quarter and Period, $1.6 million and $3.5 million, respectively, of the increase in depreciation and amortization expense was from properties acquired in 2005 and 2004. Accelerated depreciation related to development activities at Foxchase and South Washington Street accounted for $0.9 million for the 2005 Quarter and $2.8 million for the Period.

 

Interest expense increased $1.0 million to $9.8 million in the 2005 Quarter and $1.7 million to $27.7 million in the 2005 Period. The increase in interest expense for the 2005 Quarter over the 2004 Quarter was primarily due to an increase of $0.7 million in mortgage interest resulting from mortgage assumptions with certain acquisitions. The increase in interest expense for the 2005 Period over the 2004 Period is due to the increased mortgage debt described above as well as an increase in short- term borrowing on the lines of credit to fund acquisitions.

 

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WASHINGTON REAL ESTATE INVESTMENT TRUST

SEPTEMBER 30, 2005

(UNAUDITED)

 

A summary of interest expense for the Quarter and Period ended September 30, 2005 and 2004, respectively, appears below (in millions):

 

    

Quarter Ended September 30,


   

Period Ended September 30,


 

Debt Type


   2005

    2004

    $ Change

    2005

    2004

    $ Change

 

Notes payable

   $ 6.4     $ 6.3     $ 0.1     $ 17.7     $ 18.8     $ (1.1 )

Mortgages

     3.0       2.5       0.5       8.8       7.2       1.6  

Lines of credit

     0.7       0.2       0.5       1.9       0.4       1.5  

Capitalized interest

     (0.3 )     (0.2 )     (0.1 )     (0.7 )     (0.5 )     (0.2 )
    


 


 


 


 


 


Total

   $ 9.8     $ 8.8     $ 1.0     $ 27.7     $ 25.9     $ 1.8  
    


 


 


 


 


 


 

General and administrative expenses increased to $2.0 million for the 2005 Quarter compared to $1.6 million for the 2004 Quarter, and $6.3 million for the 2005 Period compared to $4.6 million for the 2004 Period primarily due to higher compensation expense and accounting and consulting fees.

 

DISCONTINUED OPERATIONS

 

We dispose of assets that are inconsistent with our long term strategic or return objectives or where market conditions for sale are favorable. The proceeds from the sales are reinvested into other properties, used to fund development operations or support corporate needs, or distributed to our shareholders. WRIT sold the following properties during the 2005 Period:

 

Disposition Date


  

Property

Name


  

Property

Type


  

Rentable

Square Feet


  

Sale Price

(in thousands)


   Gain on Sale

February 1, 2005    7700 Leesburg Pike    Office    147,000    $ 20,150    $ 8,527
February 1, 2005    Tycon Plaza II    Office    127,000      19,400      8,867
February 1, 2005    Tycon Plaza III    Office    137,000      27,950      14,696
September 8, 2005    Pepsi Distribution Center    Industrial    69,000      6,000      3,038
              
  

  

     Total 2005 Period    480,000    $ 73,500    $ 35,128
              
  

  

 

The Office properties, classified as discontinued operations effective November 2004, were sold to a single buyer for a $67.5 million contract sales price on February 1, 2005. WRIT recognized a gain on disposal of $32.1 million, in accordance with SFAS No. 66, “Accounting for Sales of Real Estate.” $31.3 million of the proceeds from the disposition were escrowed in a tax-free property exchange account and subsequently used to fund a portion of the purchase price of Frederick Crossing Shopping Center on March 23, 2005 and the Coleman Building on April 8, 2005. $31.0 million of the proceeds were used to pay down $31.0 million outstanding under Credit Facility No. 2. In September 2005 the Industrial property was sold for $6.0 million for a gain of $3.0 million. Proceeds of $5.8 million were escrowed in a tax-free exchange account. Discontinued operations for the 2005 Quarter and 2005 Period consist of the properties sold in February and September 2005. For the 2004 Quarter and 2004 Period, discontinued operations include those same properties and 8230 Boone Boulevard, which was sold on November 15, 2004. In addition there was a gain of $1.9 million recognized in the 2005 Period previously deferred from the sale of Boone Boulevard.

 

Discontinued operations for the 2005 Quarter and Period consist of the properties sold in February 2005 and September 2005. For the 2004 Quarter and Period, discontinued operations include those same properties and 8230 Boone Boulevard, which was sold on November 15, 2004. Operating results of the properties classified as discontinued operations are summarized as follows (in thousands):

 

     Quarter ended September 30,

    Period ended September 30,

 
     2005

    2004

    2005

    2004

 

Revenues

   $ (34 )   $ 2,282     $ 656     $ 6,811  

Property expenses

     (48 )     (752 )     (401 )     (2,402 )

Depreciation and amortization

     (18 )     (497 )     (71 )     (1,481 )
    


 


 


 


     $ (100 )   $ 1,033     $ 184     $ 2,928  
    


 


 


 


 

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WASHINGTON REAL ESTATE INVESTMENT TRUST

SEPTEMBER 30, 2005

(UNAUDITED)

 

NET OPERATING INCOME

 

Real estate NOI is one of the key performance measures we use to assess the results of our operations at the property level. We provide NOI as a supplement to net income calculated in accordance with accounting principles generally accepted in the United States of America (“GAAP”). NOI does not represent net income calculated in accordance with GAAP. As such, it should not be considered an alternative to net income as an indication of our operating performance. NOI is calculated as net income, less non-real estate (“other”) revenue, plus interest expense, depreciation and amortization and general and administrative expenses. A reconciliation of NOI to net income is provided below.

 

2005 Quarter Compared to the 2004 Quarter

 

The following tables of selected consolidated operating data provide the basis for our discussion of NOI in the 2005 Quarter compared to the 2004 Quarter. All amounts are in thousands except percentage amounts.

 

     Quarter Ended September 30,

 
     2005

    2004

    $ Change

   % Change

 
Real Estate Rental Revenue                              

Core

   $ 44,615     $ 42,983     $ 1,632    3.8 %

Non-core (1)

     4,324       263       4,061    n/a  
    


 


 

  

Total Real Estate Rental Revenue

   $ 48,939     $ 43,246     $ 5,693    13.2 %
Real Estate Expenses                              

Core

   $ 13,916     $ 13,091     $ 825    6.3 %

Non-core (1)

     1,013       57       956    n/a  
    


 


 

  

Total Real Estate Expenses

   $ 14,929     $ 13,148     $ 1,781    13.5 %
Net Operating Income                              

Core

   $ 30,699     $ 29,892     $ 807    2.7 %

Non-core (1)

     3,311       206       3,105    n/a  
    


 


 

  

Total Net Operating Income

   $ 34,010     $ 30,098     $ 3,912    13.0 %
    


 


 

  

Reconciliation to Net Income                              

NOI

   $ 34,010     $ 30,098               

Other revenue

     335       59               

Interest expense

     (9,798 )     (8,760 )             

Depreciation and amortization

     (11,988 )     (10,017 )             

General and administrative expenses

     (2,036 )     (1,616 )             

Discontinued operations(2)

     2,938       1,033               
    


 


            

Net Income

   $ 13,461     $ 10,797               
    


 


            

 

     Quarter Ended September 30,

 
     2005

    2004

 
Economic Occupancy             

Core

   92.5 %   91.6 %

Non-core (1)

   98.4 %   98.0 %
    

 

Total

   93.0 %   91.7 %
    

 


(1) Non-core properties include:

 

2005 acquisitions – Frederick Crossing, Coleman Building, Albemarle Point

2004 acquisitions – Shady Grove Medical Village II, 8301 Arlington Boulevard and Dulles Business Park

(2) Discontinued operations include gain on disposals and income from operations for:

 

2005 disposals – Tycon Plaza II, Tycon Plaza III, 7700 Leesburg Pike and the Pepsi Distribution Center

2004 disposals – 8230 Boone Boulevard

 

We recognized NOI of $34.0 million in the 2005 Quarter, which was $3.9 million or 13.0% greater than in the 2004 Quarter due largely to our acquisitions in the last twelve months. These acquired properties contributed $3.3 million in NOI in the 2005 Quarter (9.7% of total NOI).

 

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SEPTEMBER 30, 2005

(UNAUDITED)

 

Core properties experienced an increase (2.7%) in NOI due to a $1.6 million increase in revenue offset somewhat by a $0.8 increase in property expenses. Real estate revenue benefited from increased occupancy and rental rates in the Multifamily, Retail and Industrial sectors offset somewhat by increased vacancy and reduced rental rates in the Office sector. The increase in core expenses was driven by the Office and Multifamily sectors, which contributed $0.3 million and $0.4 million, respectively, to the increase as a result of higher utilities, repairs and maintenance expense and real estate taxes.

 

Overall economic occupancy increased from 91.7% in the 2004 Quarter to 93.0% in the 2005 Quarter as core economic occupancy increased from 91.6% to 92.5%, due largely to increases in the Retail, Multifamily and Industrial sectors, offset somewhat by a 40 basis point decrease in core Office sector occupancy. As of September 30, 2005, 14.4% of the total commercial square footage leased is scheduled to expire in 2006. During the quarter, 85% of the square footage that expired was renewed. An analysis of NOI by sector follows.

 

Office Sector

 

     Quarter Ended September 30,

 
     2005

    2004

    $ Change

    % Change

 
Real Estate Rental Revenue                               

Core

   $ 23,196     $ 23,073     $ 123     0.5 %

Non-core (1)

     1,169       263       906     n/a  
    


 


 


 

Total Real Estate Rental Revenue

   $ 24,365     $ 23,336     $ 1,029     4.4 %
Real Estate Expenses                               

Core

   $ 7,613     $ 7,302     $ 311     4.3 %

Non-core (1)

     335       57       278     n/a  
    


 


 


 

Total Real Estate Expenses

   $ 7,948     $ 7,359     $ 589     8.0 %
Net Operating Income                               

Core

   $ 15,583     $ 15,771     $ (188 )   (1.2 )%

Non-core (1)

     834       206       628     n/a  
    


 


 


 

Total Net Operating Income

   $ 16,417     $ 15,977     $ 440     2.8 %
    


 


 


 

Reconciliation to Net Income                               

NOI

   $ 16,417     $ 15,977                

Interest expense

     (1,112 )     (1,146 )              

Depreciation and amortization

     (6,355 )     (6,050 )              

Discontinued operations(2)

     —         979                
    


 


             

Net Income

   $ 8,950     $ 9,760                
    


 


             

 

     Quarter Ended September 30,

 
     2005

    2004

 
Economic Occupancy             

Core

   90.2 %   90.7 %

Non-core (1)

   95.2 %   98.0 %
    

 

Total

   90.4 %   90.8 %
    

 


(1) Non-core properties include:

 

2005 acquisitions – Albemarle Point Office Building

2004 acquisitions – Shady Grove Medical Village II and 8301 Arlington Boulevard

(2) Discontinued operations include gain on disposals and income from operations for:

 

2005 disposals – Tycon Plaza II, Tycon Plaza III and 7700 Leesburg Pike

2004 disposals – 8230 Boone Boulevard

 

The Office sector recognized NOI of $16.4 million in the 2005 Quarter, which was $0.4 million, or 2.8%, higher than in the 2004 Quarter primarily due to the NOI contribution of the properties acquired in 2004. These properties contributed $0.6 million to the increase in NOI. Core Office sector NOI was $0.2 million (1.2%) lower than in the comparable quarter in 2004 due primarily to a $0.3 million increase in core real estate expenses offset somewhat by an increase of $0.1 million in rental revenues.

 

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WASHINGTON REAL ESTATE INVESTMENT TRUST

SEPTEMBER 30, 2005

(UNAUDITED)

 

The Core Office rental revenue was flat because rental rates were down 1.3% compared to the second quarter 2004 and occupancy was down 50 basis points. This was driven by the expiration of several leases in the fourth quarter of 2004 that were not renewed at 7900 Westpark and 1700 Research Boulevard. Core real estate expenses were higher due primarily to increased utility and real estate tax expenses as a result of supplier rate increases and higher value assessments, respectively.

 

Core economic occupancy decreased from 90.7% to 90.2% as a result of the aforementioned vacancies. As of September 30, 2005, 15.0% of the total Office square footage leased is scheduled to expire in 2006. During the quarter, 93% of the square footage that expired was renewed.

 

During the 2005 Quarter, we executed new leases for 156,300 square feet of Office space with primarily no change in rental rates.

 

Retail Sector

     Quarter Ended September 30,  
     2005

    2004

    $ Change

   % Change

 
Real Estate Rental Revenue                              

Core

   $ 7,160     $ 6,714     $ 446    6.6 %

Non-core (1)

     1,119       —         1,119    n/a  
    


 


 

  

Total Real Estate Rental Revenue

   $ 8,279     $ 6,714     $ 1,565    23.3 %
Real Estate Expenses                              

Core

   $ 1,513     $ 1,443     $ 70    4.9 %

Non-core (1)

     185       —         185    n/a  
    


 


 

  

Total Real Estate Expenses

   $ 1,698     $ 1,443     $ 255    17.7 %
Net Operating Income                              

Core

   $ 5,647     $ 5,271     $ 376    7.1 %

Non-core (1)

     934       —         934    n/a  
    


 


 

  

Total Net Operating Income

   $ 6,581     $ 5,271     $ 1,310    24.9 %
    


 


 

  

Reconciliation to Net Income                              

NOI

   $ 6,581     $ 5,271               

Interest Expense

     (353 )     —                 

Depreciation and amortization

     (1,871 )     (926 )             
    


 


            

Net Income

   $ 4,357     $ 4,345               
    


 


            

 

     Quarter Ended September 30,

 
     2005

    2004

 
Economic Occupancy             

Core

   97.9 %   94.6 %

Non-core (1)

   100.0 %   —    
    

 

Total

   98.2 %   94.6 %
    

 


(1) Non-core properties include:

 

2005 acquisition – Frederick Crossing

 

Retail sector NOI increased in the 2005 Quarter to $6.6 million from $5.3 million in the 2004 Quarter. The acquisition in March, 2005 contributed $0.9 million (14.2%) to NOI.

 

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SEPTEMBER 30, 2005

(UNAUDITED)

 

The increase in core NOI of $0.4 million was due to a $0.4 million increase in revenues driven a 330 basis point increase in occupancy due to the move-in of the grocery anchor tenant at Westminster Shopping Center upon completion of the center’s redevelopment and a slight increase in rental rates. Core real estate expenses increased slightly due to higher real estate taxes.

 

As of September 30, 2005, 7.9% of the total Retail square footage leased is scheduled to expire in 2006. During the quarter, 98% of the square footage that expired was renewed.

 

During the 2005 Quarter, we executed new leases for 52,100 square feet of Retail space at an average rent increase of 20%.

 

Multifamily Sector

 

     Quarter Ended September 30,

 
     2005

    2004

    $ Change

   % Change

 
Real Estate Rental Revenue                              

Core/Total

   $ 7,829     $ 7,288     $ 541    7.4 %
Real Estate Expenses                              

Core/Total

   $ 3,385     $ 3,011     $ 374    12.4 %
    


 


 

  

Net Operating Income                              

Core/Total

   $ 4,444     $ 4,277     $ 167    3.9 %
    


 


 

  

Reconciliation to Net Income                              

NOI

   $ 4,444     $ 4,277               

Interest expense

     (986 )     (1,066 )             

Depreciation and amortization

     (1,272 )     (1,238 )             
    


 


            

Net Income

   $ 2,186     $ 1,973               
    


 


            

 

     Quarter Ended September 30,

 
     2005

    2004

 
Economic Occupancy             

Core/Total

   94.9 %   91.4 %
    

 

 

Multifamily NOI was higher in the 2005 Quarter as compared to the same time period in 2004 because of a $0.5 million increase in real estate revenue offset partially by a $0.4 million increase in real estate expenses. Revenues were higher due to a 4.0% increase in rental rates that was generally portfolio-wide, and a 350 basis point increase in occupancy resulting from the completed renovation and occupancy of several units at the Ashby at McLean which were off the market in the 2004 Quarter, and higher occupancy at other properties. The increase in real estate expenses was for higher repairs and maintenance expenses and utility costs, as well as increased marketing and other administrative expenses.

 

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SEPTEMBER 30, 2005

(UNAUDITED)

 

Industrial Sector

     Quarter Ended September 30,

 
     2005

    2004

    $ Change

   % Change

 
Real Estate Rental Revenue                              

Core

   $ 6,430     $ 5,908     $ 522    8.8 %

Non-core (1)

     2,036       —         2,036    n/a  
    


 


 

  

Total Real Estate Rental Revenue

   $ 8,466     $ 5,908     $ 2,558    43.3 %
Real Estate Expenses                              

Core

   $ 1,405     $ 1,335     $ 70    5.2 %

Non-core (1)

     493       —         493    n/a  
    


 


 

  

Total Real Estate Expenses

   $ 1,898     $ 1,335     $ 563    42.2 %
Net Operating Income                              

Core

   $ 5,025     $ 4,573     $ 452    9.9 %

Non-core (1)

     1,543       —         1,543    n/a  
    


 


 

  

Total Net Operating Income

   $ 6,568     $ 4,573     $ 1,995    43.6 %
    


 


 

  

Reconciliation to Net Income                              

NOI

   $ 6,568     $ 4,573               

Interest expense

     (506 )     (250 )             

Depreciation and amortization

     (2,380 )     (1,387 )             

Discontinued operations(2)

     2,938       54               
    


 


            

Net Income

   $ 6,620     $ 2,990               
    


 


            

 

     Quarter Ended September 30,

 
     2005

    2004

 
Economic Occupancy             

Core

   92.7 %   92.6 %

Non-core (1)

   99.4 %   —    
    

 

Total

   94.5 %   92.6 %
    

 


(1) Non-core properties include:

 

2005 acquisition – Coleman Building , Albemarle Point Industrial Buildings

2004 acquisitions – Dulles Business Park

(2) Discontinued Operations include:

 

2005 disposal – Pepsi Distribution Center

 

The Industrial sector recognized NOI of $6.6 million in the 2005 Quarter, which was $2.0 million (43.6 %) greater than in the 2004 Quarter due to a $0.5 million increase in core NOI and the acquisitions of Albemarle Point in July 2005, the Coleman Building in April 2005 and the Dulles Business Park portfolio in December 2004 which combined contributed $1.5 million (23.5%) to NOI.

 

Core properties experienced a $0.5 million (9.9%) increase in NOI due to a $0.5 million improvement in revenues, while real estate expenses increased slightly to $1.4 million from $1.3 million. Core revenues increased due primarily to a 4.9% growth in rental rates and a slight increase in occupancy. As of September 30, 2005, 17.7% of the total Industrial square footage leased is scheduled to expire in 2006. During the 2005 Quarter, 76.1% of the square footage that expired was renewed.

 

During the 2005 Quarter, we executed new leases for 234,100 square feet of industrial space at an average rent increase of 25%.

 

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SEPTEMBER 30, 2005

(UNAUDITED)

 

2005 Period Compared to the 2004 Period

 

The following tables of selected consolidated operating data provide the basis for our discussion of NOI in the 2005 Period compared to the 2004 Period. All amounts are in thousands except percentage amounts.

 

     Period Ended September 30,

 
     2005

    2004

    $ Change

   % Change

 
Real Estate Rental Revenue                              

Core

   $ 130,122     $ 127,025     $ 3,097    2.4 %

Non-core (1)

     10,666       897       9,769    n/a  
    


 


 

  

Total Real Estate Rental Revenue

   $ 140,788     $ 127,922     $ 12,866    10.1 %
Real Estate Expenses                              

Core

   $ 40,660     $ 38,206     $ 2,454    6.4 %

Non-core (1)

     2,415       154       2,261    n/a  
    


 


 

  

Total Real Estate Expenses

   $ 43,075     $ 38,360     $ 4,715    12.3 %
Net Operating Income                              

Core

   $ 89,462     $ 88,819     $ 643    0.7 %

Non-core (1)

     8,251       743       7,508    n/a  
    


 


 

  

Total Net Operating Income

   $ 97,713     $ 89,562     $ 8,151    9.1 %
    


 


 

  

Reconciliation to Net Income                              

NOI

   $ 97,713     $ 89,562               

Other revenue

     655       239               

Other income from property settlement

     504       —                 

Interest expense

     (27,668 )     (25,949 )             

Depreciation and amortization

     (35,467 )     (29,027 )             

General and administrative expenses

     (6,361 )     (4,572 )             

Discontinued operations(2)

     37,195       2,928               
    


 


            

Net Income

   $ 66,571     $ 33,181               
    


 


            

 

     Period Ended September 30,

 
     2005

    2004

 
Economic Occupancy             

Core

   91.8 %   91.4 %

Non-core (1)

   97.6 %   99.9 %
    

 

Total

   92.2 %   91.4 %
    

 


(1) Non-core properties include:

 

2005 acquisitions – Frederick Crossing, Coleman Building and Albemarle Point

2004 acquisitions – 8880 Gorman Road, Shady Grove Medical Village II, 8301 Arlington Boulevard and Dulles Business Park

(2) Discontinued operations include gain on disposals and income from operations for:

 

2005 disposals – Tycon Plaza II, Tycon Plaza III, 7700 Leesburg Pike and the Pepsi Distribution Center

2004 disposal – 8230 Boone Boulevard

 

We recognized NOI of $97.7 million in the 2005 Period, which was $8.2 million or 9.1% greater than in the 2004 Period due largely to our 2004 and 2005 acquisitions. These acquired properties contributed $8.3 million in NOI in the 2005 Period (8.4% of total NOI).

 

Core properties experienced a $0.6 million (0.7%) increase in NOI due primarily to the $3.1 million increase in revenue, which was offset somewhat by a $2.5 million increase in real estate expenses. Real estate revenue was positively impacted by the growth in rental rates and increased occupancy in the Multifamily, Industrial and Retail sectors and an increase in expense reimbursements in the Office sector. This was offset somewhat by the decrease in rental rates and occupancy in the Office sector.

 

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SEPTEMBER 30, 2005

(UNAUDITED)

 

The increase in core expenses was a result of increased utility costs, real estate taxes and marketing and other administrative expenses.

 

Overall economic occupancy increased from 91.4% in the 2004 Period to 92.2% in the 2005 Period due largely to the properties acquired in 2005 and 2004. Core economic occupancy was higher at 91.8% compared to 91.4% due largely to the combined increases in the Retail, Multifamily and Industrial occupancy, offset by a 130 basis point decrease in Office sector occupancy. During the 2005 Period, 73.6% of the square footage that expired was renewed. An analysis of NOI by sector follows.

 

Office Sector

 

     Period Ended September 30,

 
     2005

    2004

    $ Change

    % Change

 
Real Estate Rental Revenue                               

Core

   $ 68,024     $ 68,613     $ (589 )   (0.9 )%

Non-core (1)

     2,802       263       2,539     n/a  
    


 


 


 

Total Real Estate Rental Revenue

   $ 70,826     $ 68,876     $ 1,950     2.8 %
Real Estate Expenses                               

Core

   $ 22,279     $ 21,127     $ 1,152     5.5 %

Non-core (1)

     812       57       755     n/a  
    


 


 


 

Total Real Estate Expenses

   $ 23,091     $ 21,184     $ 1,907     9.0 %
Net Operating Income                               

Core

   $ 45,745     $ 47,486     $ (1,741 )   (3.7 )%

Non-core (1)

     1,990       206       1,784     n/a  
    


 


 


 

Total Net Operating Income

   $ 47,735     $ 47,692     $ 43     0.1 %
    


 


 


 

Reconciliation to Net Income                               

NOI

   $ 47,735     $ 47,692                

Interest expense

     (3,449 )     (3,241 )              

Depreciation and amortization

     (18,851 )     (17,714 )              

Discontinued operations(2)

     34,204       2,760                
    


 


             

Net Income

   $ 59,639     $ 29,497                
    


 


             

 

     Period Ended September 30,

 
     2005

    2004

 
Economic Occupancy             

Core

   89.5 %   90.8 %

Non-core (1)

   95.5 %   98.0 %
    

 

Total

   89.7 %   90.9 %
    

 


(1) Non-core properties include:

 

2005 acquisitions – Albemarle Point Office Building

2004 acquisition – Shady Grove Medical Village II and 8301 Arlington Boulevard

(2) Discontinued operations include gain on disposals and income from operations for:

 

2005 disposals – Tycon Plaza II, Tycon Plaza III and 7700 Leesburg Pike

2004 disposal – 8230 Boone Boulevard

 

The Office sector recognized NOI of $47.7 million in the 2005 Period and 2004 period due primarily to increased vacancy in our core portfolio and increased operating expenses, offset by our acquisitions of Shady Grove Medical Village II in August 2004, 8301 Arlington Boulevard in October 2004 and Albemarle Point in July 2005. These properties contributed $2.0 million to NOI (4.2% of the total).

 

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SEPTEMBER 30, 2005

(UNAUDITED)

 

Core Office properties experienced a $1.7 million (3.7%) decrease in NOI due to a $1.1 million increase in real estate expenses and a $0.6 million decline in revenues. Core Office occupancy was 130 basis points lower in the 2005 Period than the 2004 Period. This was offset somewhat by an increase of $0.7 million in recoveries from tenants due to higher operating expenses. Core real estate expenses were higher due primarily to higher utility costs, repairs and maintenance expenses and real estate taxes.

 

Core economic occupancy for the Office sector was down to 89.5% from 90.8% and overall economic occupancy decreased from 90.9% to 89.7%. During the 2005 Period, 76.7% of the square footage that expired was renewed. This renewal rate was lower than usual due to pricing pressure in a period of low demand.

 

During the 2005 Period, we executed new leases for 581,400 square feet of Office space at an average rent increase of 3.7%.

 

Retail Sector

 

     Period Ended September 30,

 
     2005

    2004

    $ Change

   % Change

 
Real Estate Rental Revenue                              

Core

   $ 21,129     $ 20,283     $ 846    4.2 %

Non-core (1)

     2,360       —         2,360    n/a  
    


 


 

  

Total Real Estate Rental Revenue

   $ 23,489     $ 20,283     $ 3,206    15.8 %
Real Estate Expenses                              

Core

   $ 4,730     $ 4,495     $ 235    5.2 %

Non-core (1)

     373       —         373    n/a  
    


 


 

  

Total Real Estate Expenses

   $ 5,103     $ 4,495     $ 608    13.5 %
Net Operating Income                              

Core

   $ 16,399     $ 15,788     $ 611    3.9 %

Non-core (1)

     1,987       —         1,987    n/a  
    


 


 

  

Total Net Operating Income

   $ 18,386     $ 15,788     $ 2,598    16.5 %
    


 


 

  

Reconciliation to Net Income                              

NOI

   $ 18,386     $ 15,788               

Other income from property settlement

     504       —                 

Interest Expense

     (740 )     —                 

Depreciation and amortization

     (6,313 )     (2,762 )             
    


 


            

Net Income

   $ 11,837     $ 13,026               
    


 


            

 

     Period Ended September 30,

 
     2005

    2004

 
Economic Occupancy             

Core

   97.0 %   94.5 %

Non-core (1)

   100.0 %   —    
    

 

Total

   97.3 %   94.5 %
    

 


(1) Non-core properties include:

 

2005 acquisitions – Frederick Crossing

 

The Retail sector recognized NOI of $18.4 million in the 2005 Period, which was $2.6 million (16.5%) greater than in the 2004 Period due primarily to the acquisition of Frederick Crossing in March, 2005 which contributed $2.0 million in NOI (10.8% of the total NOI), and an increase in core NOI of $0.6 million.

 

The increase in core NOI was due to a $0.8 million increase in rental revenues offset somewhat by an increase in real estate expenses of $0.2 million. The revenue increase was driven by increased occupancy and rental rates as well as a $0.6 million increase in expense reimbursements. This was offset somewhat by a $0.1 million decrease in percentage rent. Real estate expenses increased $0.2 million due to increased real estates taxes.

 

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SEPTEMBER 30, 2005

(UNAUDITED)

 

Core economic occupancy for the Retail sector increased to 97.0% from 94.5% primarily as a result of commencement of operations of the grocery anchor tenant after the development activity at Westminster. During the 2005 Period, 96.3% of the square footage that expired was renewed.

 

During the 2005 Period, we executed new leases for 136,100 square feet of retail space at an average rent increase of 23.6%.

 

Multifamily Sector

 

     Period Ended September 30,

 
     2005

    2004

    $ Change

   % Change

 
Real Estate Rental Revenue                              

Core/Total

   $ 22,867     $ 21,522     $ 1,345    6.2 %
Real Estate Expenses                              

Core/Total

   $ 9,515     $ 8,717     $ 798    9.2 %
    


 


 

  

Net Operating Income                              

Core/Total

   $ 13,352     $ 12,805     $ 547    4.3 %
    


 


 

  

Reconciliation to Net Income                              

NOI

   $ 13,352     $ 12,805               

Interest expense

     (3,112 )     (3,201 )             

Depreciation and amortization

     (3,757 )     (3,631 )             
    


 


            

Net Income

   $ 6,483     $ 5,973               
    


 


            

 

     Period Ended September 30,

 
     2005

    2004

 
Economic Occupancy             

Core/Total

   93.6 %   90.1 %
    

 

 

Multifamily NOI increased $0.5 million (4.3%) due primarily to a $1.3 million increase in real estate revenue as a result of increased occupancy and increased rental rates, offset by increased real estate expenses due to increases in property marketing costs and administrative expenses as well as utility costs, repairs and maintenance expenses and real estate taxes. Revenues increased due to a 350 basis point increase in occupancy due primarily to the completed renovation and subsequent leasing of units taken off-market at The Ashby at McLean during the 2004 Period.

 

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SEPTEMBER 30, 2005

(UNAUDITED)

Industrial Sector

     Period Ended September 30,

 
     2005

    2004

    $ Change

   % Change

 
Real Estate Rental Revenue                              

Core

   $ 18,102     $ 16,607     $ 1,495    9.0 %

Non-core (1)

     5,504       634       4,870    n/a  
    


 


 

  

Total Real Estate Rental Revenue

   $ 23,606     $ 17,241     $ 6,365    36.9 %
Real Estate Expenses                              

Core

   $ 4,136     $ 3,867     $ 269    7.0 %

Non-core (1)

     1,230       97       1,133    n/a  
    


 


 

  

Total Real Estate Expenses

   $ 5,366     $ 3,964     $ 1,402    35.4 %
Net Operating Income                              

Core

   $ 13,966     $ 12,740     $ 1,226    9.6 %

Non-core (1)

     4,274       537       3,737    n/a  
    


 


 

  

Total Net Operating Income

   $ 18,240     $ 13,277     $ 4,963    37.4 %
    


 


 

  

Reconciliation to Net Income                              

NOI

   $ 18,240     $ 13,277               

Interest expense

     (1,526 )     (755 )             

Depreciation and amortization

     (6,220 )     (3,988 )             

Discontinued operations(2)

     2,991       168               
    


 


            

Net Income

   $ 13,485     $ 8,702               
    


 


            

 

     Period Ended September 30,

 
     2005

    2004

 
Economic Occupancy             

Core

   92.9 %   92.1 %

Non-core (1)

   97.7 %   100.0 %
    

 

Total

   94.3 %   92.2 %
    

 


(1) Non-core properties include:

 

2005 acquisition – Coleman Building, Albemarle Point Industrial Buildings

2004 acquisitions – 8880 Gorman Road and Dulles Business Park

(2) Discontinued operations include gain on disposals and income from operations for:

 

2005 disposal – Pepsi Distribution Center

 

The Industrial sector recognized NOI of $18.2 million in the 2005 Period, which was $5.0 million (37.4%) greater than in the 2004 Period due to a $1.2 million increase in core NOI and the acquisitions of Albemarle Point in July 2005, the Coleman Building in April 2005, 8880 Gorman Road in March 2004 and Dulles Business Park in December 2004 which together contributed $4.3 million (23.4%) of the total NOI.

 

Core properties experienced a $1.2 million (9.6%) increase in NOI due to a $1.5 million improvement in revenues, while real estate expenses increased $0.3 million. Core revenues increased due primarily to an 80 basis point growth in occupancy and increased rental rates. During the 2005 Period, 63.3% of the square footage that expired was renewed.

 

During the 2005 Period, we executed new leases for 611,800 square feet of Industrial space at an average rent increase of 12.0%.

 

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WASHINGTON REAL ESTATE INVESTMENT TRUST

SEPTEMBER 30, 2005

(UNAUDITED)

 

LIQUIDITY AND CAPITAL RESOURCES

 

Our primary sources of liquidity are cash from our real estate operations and our unsecured credit facilities. As of September 30, 2005, we had approximately $12.7 million in cash and cash equivalents and $61.5 million available for borrowing under our unsecured credit facilities. In February 2005, we sold Tycon Plaza II, Tycon Plaza III and 7700 Leesburg Pike for a combined sale price of $67.5 million. We used $31.0 million of the proceeds in February 2005 to pay down credit facility borrowings, $19.5 million toward the purchase of Frederick Crossing in March 2005 and $8.3 million toward the purchase of the Coleman Building in April 2005. In late April, 2005, we paid in full the remaining amounts outstanding under our unsecured credit facilities using proceeds from two issuances of $50 million unsecured notes (for a net total of $99.3 million) at 5.05% and 5.35%, respectively.

 

In the 2005 Quarter our unsecured credit facilities funded the purchase of Albemarle Point for $63.0 million, the payoff of mortgages for Avondale and Woodburn, $7.5 million and $18.0 million respectively, and development costs. This left $61.5 million available for borrowing under our credit facilities.

 

In October 2005 we issued an additional $100.0 million of notes of the series of 5.35% senior unsecured notes due May 1, 2015, at an effective yield of 5.49%. $93.5 million of the $100.7 million proceeds (including $2.4 million of accrued interest) from the sale of these notes was used to repay borrowings under our lines of credit and the remainder may be used for the acquisition of real estate and general corporate purposes.

 

We derive substantially all of our revenue from tenants under leases at our properties. Our operating cash flow therefore depends materially on our ability to lease our properties to tenants, the rents that we are able to charge to our tenants, and the ability of these tenants to make their rental payments.

 

Our primary uses of cash are to fund distributions to shareholders, to fund capital investments in our existing portfolio of operating assets, to fund new acquisitions, redevelopment and ground-up development activities and to fund operating and administrative expenses. As a REIT, we are required to distribute at least 90% of our taxable income to our shareholders on an annual basis. We also regularly require capital to invest in our existing portfolio of operating assets in connection with large-scale renovations, routine capital improvements, deferred maintenance on properties we have recently acquired, and our leasing activities, including funding tenant improvement allowances and leasing commissions. The amounts of the leasing-related expenditures can vary significantly depending on negotiations with tenants and the current competitive leasing environment.

 

As we review the results of the first nine months and anticipate the business activity for the remainder of 2005, we expect to complete the year with the same significant capital requirements as previously estimated, except for tenant improvements and development costs. Therefore, for the twelve months ended, total anticipated costs are as follows:

 

    Funding dividends on our common shares and minority interest distributions to third party unit holders;

 

    Approximately $33.0 million to invest in our existing portfolio of operating assets, including approximately $8.0 million to fund tenant-related capital requirements;

 

    Approximately $18.0 million to invest in our development projects;

 

    Approximately $121.0 million to fund our expected property acquisitions;

 

We expect to meet our capital requirements using cash generated by our real estate operations and through borrowings on our unsecured credit facilities, additional debt or equity capital raised in the public market, possible asset dispositions or funding acquisitions of properties through property-specific mortgage debt.

 

We believe that we will generate sufficient cash flow from operations and have access to the capital resources necessary to fund our requirements. However, as a result of general, Greater Washington-Baltimore regional, or tenant economic downturns, unfavorable changes in the supply of competing properties, or our properties not performing as expected, we may not generate sufficient cash flow from operations or otherwise have access to capital on favorable terms, or at all. If we are unable to obtain capital from other sources, we may not be able to pay the dividend required to maintain our status as a REIT, make required principal and interest payments, make strategic acquisitions, or make necessary routine capital improvements or undertake redevelopment opportunities with respect to our existing portfolio of operating assets. In addition, if a property is mortgaged to secure payment of indebtedness and we are unable to meet mortgage payments, the holder of the mortgage could foreclose on the property, resulting in loss of income and asset value.

 

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WASHINGTON REAL ESTATE INVESTMENT TRUST

SEPTEMBER 30, 2005

(UNAUDITED)

 

If principal amounts due at maturity cannot be refinanced, extended or paid with proceeds of other capital transactions, such as new debt or equity capital, our cash flow may be insufficient to repay all maturing debt. Prevailing interest rates or other factors at the time of a refinancing (such as possible reluctance of lenders to make commercial real estate loans) may result in higher interest rates and increased interest expense.

 

Capital Structure

 

We manage our capital structure to reflect a long-term investment approach, generally seeking to match the cash flow of our assets with a mix of equity and various debt instruments. We expect that our capital structure will allow us to obtain additional capital from diverse sources that could include additional equity offerings of common shares, public and private debt financings and possible asset dispositions. Our ability to raise funds through the sale of debt and equity securities is dependent on, among other things, general economic conditions, general market conditions for REITs, our operating performance, our debt rating and the current trading price of our shares. We will always analyze which source of capital is most advantageous to us at any particular point in time; however, the capital markets may not consistently be available on terms that are attractive.

 

Debt Financing

 

We generally use unsecured, corporate-level debt, including unsecured notes and our unsecured credit facilities, to meet our borrowing needs. Our total debt at September 30, 2005 is summarized as follows (in thousands):

 

Fixed rate mortgages

   $ 170,393

Unsecured credit facilities

     93,500

Unsecured notes payable

     420,000
    

Total debt

   $ 683,893
    

 

The $170.4 million in fixed rate mortgages, which includes $4.2 million in unamortized premiums due to fair value adjustments associated with the assumption of certain mortgages in connection with acquisitions, bore an effective weighted average interest rate of 5.9% at September 30, 2005 and had a weighted average maturity of 5.8 years.

 

Our primary external source of liquidity is our two revolving credit facilities. At September 30 we could borrow up to $155.0 million under these lines which bear interest at an adjustable spread over LIBOR based on our public debt rating. Credit Facility No. 1 is a three-year, $85.0 million unsecured credit facility expiring in July 2007. Credit Facility No. 2 is a three-year $70.0 million unsecured credit facility that expires in July 2008.

 

On April 26, 2005, we sold $50.05% senior unsecured notes due May 1, 2012 and $50.0 million of 5.35% senior unsecured noted due May 1, 2015 at effective yields of 5.064% and 5.359% respectively. The net proceeds from the sale of the notes of $99.3 million were used to repay borrowings under our lines of credit totaling $90.5 million and the remainder may be used for the acquisition of real estate and general corporate purposes.

 

On October 3, 2005, subsequent to the end of the third quarter, we reopened our series of 5.35% senior unsecured notes due May 1, 2015 and issued an additional $100 million of notes at an effective yield of 5.49%. $93.5 million of the $100.7 million proceeds (including $2.4 million of accured interest) from the sale of these notes was used to repay borrowings under our lines of credit and the remainder may be used for the acquisition of real estate and general corporate purposes.

 

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WASHINGTON REAL ESTATE INVESTMENT TRUST

SEPTEMBER 30, 2005

(UNAUDITED)

 

We anticipate that over the near term, interest rate fluctuations will not have a material adverse effect on earnings. Our unsecured fixed-rate notes payable have maturities ranging from August 2006 through February 2028 (see Note 6), as follows (in thousands):

 

     Note Principal

7.25% notes due 2006

     50,000

6.74% notes due 2008

     60,000

5.05% notes due 2012

     50,000

5.125% notes due 2013

     60,000

5.25% notes due 2014

     100,000

5.35% notes due 2015

     50,000

7.25% notes due 2028

     50,000
    

     $ 420,000
    

 

Our unsecured revolving credit facilities and the unsecured notes payable contain certain financial and non-financial covenants, discussed in greater detail in our 2004 10-K, all of which were met as of September 30, 2005.

 

Dividends

 

We pay dividends quarterly. The maintenance of these dividends is subject to various factors, including the discretion of the Board of Trustees, the ability to pay dividends under Maryland law, the availability of cash to make the necessary dividend payments and the effect of REIT distribution requirements, which require at least 90% of our taxable income to be distributed to shareholders. Dividend and distribution payments were as follows for the 2005 Quarter and 2005 Period (in thousands).

 

     Quarter Ended September 30,

   Period Ended September 30,

     2005

   2004

   2005

   2004

Common dividends

   $ 16,955    $ 16,401    $ 50,397    $ 48,353

Minority interest distributions

     33      32      98      95
    

  

  

  

     $ 16,998    $ 16,433    $ 50,495    $ 48,448
    

  

  

  

 

Dividends paid for the 2005 Quarter and 2005 Period increased as a direct result of a dividend rate increase from $0.3925 per share in June 2004 to $.4025 per share in June 2005.

 

Acquisitions and Development

 

As of September 30 we had acquired one Retail, one Industrial and one Office/Industrial property in 2005 and one Industrial and one Office property in 2004 for a purchase price of $44.8 million, $8.8 million, $67.0 million, $11.5 million and $18.5 million, respectively. The Retail acquisition in 2005 was financed through the assumption of a loan in the amount of $24.3 million bearing an interest rate of 5.95% per annum, escrowed proceeds from the disposition of Tycon Plaza II, Tycon Plaza III and 7700 Leesburg Pike in February, 2005 and borrowings under credit facility No. 1. The Industrial 2005 acquisition was funded with escrowed proceeds from the aforementioned dispositions and through borrowings under Credit Facility No. 1 and the Office/Industrial acquisition in 2005 was funded with borrowings under Credit Facility No. 2 and from general corporate funds. All outstanding amounts under our credit facilities were then paid off with the proceeds of the debt issuance in April, 2005 discussed above and the subsequent debt issuance on October 3, 2005. The 2004 Industrial acquisition was financed through a line of credit advance and the Office acquisition through the assumption of a $10.1 million mortgage bearing interest at 6.98% (fair valued at $11.2 million and 5.26%) and a line of credit advance.

 

As of September 30, 2005, we had funded $24.3 million, in development and land costs, on two major development projects — Rosslyn Towers and South Washington Street — and one major redevelopment project at Foxchase Shopping Center. Investment during the third quarter of 2005 on these projects totaled $5.9 million compared to $1.8 million in the third quarter of 2004.

 

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WASHINGTON REAL ESTATE INVESTMENT TRUST

SEPTEMBER 30, 2005

(UNAUDITED)

 

Historical Cash Flows

 

Consolidated cash flow information is summarized as follows (in millions):

 

     Period Ended September 30,

 
     2005

    2004

    Change

 

Cash provided by operating activities

   $ 62.3     $ 56.6     $ 5.7  

Cash used in investing activities

   $ (61.6 )   $ (42.8 )   $ (18.8 )

Cash used in financing activities

   $ (0.2 )   $ (16.2 )   $ 16.0  

 

Operations generated $62.3 million of net cash in the 2005 Period compared to $56.6 million of net cash generated during the comparable period in 2004. The increase in cash flow was due primarily to additional income from assets acquired in 2005 and 2004. The level of net cash provided by operating activities is also affected by the timing of payment of expenses.

 

Our investing activities used net cash of $61.6 million in the 2005 Period compared to the $42.8 million net cash used in the 2004 Period. This was primarily due to the purchase of Albemarle Point for $67.0 million, $8.3 million to fund the purchase of the Coleman Building and the purchase of Frederick Crossing for $44.8 million net of the assumption of a $24.3 million mortgage. This was partially offset by $66.2 million in cash proceeds ($31.3 million of the proceeds were escrowed in a restricted cash account) from the disposition of Tycon Plaza II, Tycon Plaza III and 7700 Leesburg Pike and $1.9 million from the receipt of a portion of the gain previously deferred from the November, 2004 sale of 8230 Boone Boulevard. Also, capital improvements to real estate increased $7.5 million due to increased funding for the development of Rosslyn Towers and South Washington Street and the redevelopment of Foxchase Shopping Center.

 

Our financing activities used net cash of $0.2 million in the 2005 Period compared to $16.2 million in the 2004 Period. $23.5 million was repaid on our lines of credit compared with $30.9 million in net borrowings in the first half of 2004 and in September 2005, two mortgages were repaid for $25.8 million. Additionally, there was a $2.0 million increase in dividends paid in the 2005 Period due to an increase in the dividend rate to $0.4025 in the 2005 Quarter from $0.3925 in the 2004 Quarter. This was offset somewhat by the proceeds of $99.0 million from the April, 2005 debt issuance of $50.0 million of seven-year, 5.05% unsecured notes and $50.0 million of ten-year, 5.35% unsecured notes (See Note 6 – Notes Payable).

 

RATIOS OF EARNINGS TO FIXED CHARGES AND DEBT SERVICE COVERAGE

 

The following table sets forth the Trust’s ratios of earnings to fixed charges and debt service coverage for the periods shown:

 

     Quarter Ended September 30,

   Period Ended September 30,

     2005

   2004

   2005

   2004

Earnings to fixed charges

   2.0x    2.1x    2.0x    2.1x

Debt service coverage

   3.0x    3.3x    3.1x    3.3x

 

We computed the ratio of earnings to fixed charges by dividing earnings by fixed charges. For this purpose, earnings consist of income from continuing operations plus fixed charges, less capitalized interest. Fixed charges consist of interest expense, including amortized costs of debt issuance, plus interest costs capitalized.

 

We computed the debt service coverage ratio by dividing earnings before interest income and expense, depreciation, amortization and gain on sale of real estate by interest expense and principal amortization.

 

FUNDS FROM OPERATIONS

 

Funds From Operations (“FFO”) is a widely used measure of operating performance for real estate companies. We provide FFO as a supplemental measure to net income calculated in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Although FFO is a widely used measure of operating performance for equity real estate investment trusts (“REITs”), FFO does not represent net income calculated in accordance with GAAP. As such, it should not be considered an alternative to net income as an indication of our operating performance. In addition, FFO does not represent cash generated from operating activities in accordance with GAAP, nor does it represent cash available to pay distributions and should not be considered as an alternative to cash flow from operating activities, determined in accordance with GAAP as a measure of our liquidity. The National Association of Real Estate Investment Trusts, Inc. (“NAREIT”) defines FFO (April,

 

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WASHINGTON REAL ESTATE INVESTMENT TRUST

SEPTEMBER 30, 2005

(UNAUDITED)

 

2002 White Paper) as net income (computed in accordance with GAAP) excluding gains (or losses) from sales of property plus real estate depreciation and amortization. We consider FFO to be a standard supplemental measure for REITs because it facilitates an understanding of the operating performance of our properties without giving effect to real estate depreciation and amortization, which historically assumes that the value of real estate assets diminishes predictably over time. Since real estate values have instead historically risen or fallen with market conditions, we believe that FFO more accurately provides investors an indication of our ability to incur and service debt, make capital expenditures and fund other needs. Our FFO may not be comparable to FFO reported by other REITs. These other REITs may not define the term in accordance with the current NAREIT definition or may interpret the current NAREIT definition differently.

 

The following table provides the calculation of our FFO and a reconciliation of FFO to net income (in thousands):

 

     Quarter Ended September 30,

   Period Ended September 30,

     2005

    2004

   2005

    2004

Net income

   $ 13,461     $ 10,797    $ 66,571     $ 33,181

Adjustments:

                             

Other income from property settlement

     —         —        (504 )     —  

Gain on disposal of real estate investment

     (3,038 )     —        (37,011 )     —  

Depreciation and amortization

     11,988       10,017      35,467       29,027

Discontinued operations depreciation & amortization

     18       499      71       1,481
    


 

  


 

FFO as defined by NAREIT

   $ 22,429     $ 21,313    $ 64,594     $ 63,689
    


 

  


 

 

ITEM 3: QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT FINANCIAL MARKET RISK

 

The principal material financial market risk to which we are exposed is interest-rate risk. Our exposure to market risk for changes in interest rates relates primarily to refinancing long-term fixed rate obligations, the opportunity cost of fixed rate obligations in a falling interest rate environment and our variable rate lines of credit. We primarily enter into debt obligations to support general corporate purposes including acquisition of real estate properties, capital improvements and working capital needs. In the past we have used interest rate hedge agreements to hedge against rising interest rates in anticipation of imminent refinancing or new debt issuance.

 

Our interest rate risk has not changed significantly from what was disclosed in our 2004 Form 10-K.

 

ITEM 4: CONTROLS AND PROCEDURES

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Securities Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer, Chief Financial Officer and Senior Vice President of Accounting, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

 

We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer, Chief Financial Officer and Senior Vice President of Accounting, of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2005. Based on the foregoing, our Chief Executive Officer, Chief Financial Officer and Senior Vice President of Accounting concluded that the Trust’s disclosure controls and procedures were effective.

 

There have been no changes in the Company’s internal control over financial reporting (as defined by Rule 13a-15(f)) that occurred during the period covered by the report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II

OTHER INFORMATION

 

Item 1.    Legal Proceedings
     None
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds
     None
Item 3.    Defaults Upon Senior Securities
     None
Item 4.    Submission of Matters to a Vote of Security Holders
     None
Item 5.    Other Information
     None
Item 6.    Exhibits
     (a)   Exhibits
         10.    Management Contracts, Plans and Arrangements
              (n)   Employment Agreement dated October 3, 2005 with Christopher P. Mundy.
              (o)   Change in Control Agreement dated October 3, 2005 with Christopher P. Mundy.
         12.    Computation of Ratios
         31.    Sarbanes-Oxley Act of 2002 Section 302 Certifications
              (a)   Certification – Chief Executive Officer
              (b)   Certification – Senior Vice President
              (c)   Certification – Chief Financial Officer
         32.    Sarbanes-Oxley Act of 2002 section 906 Certification
              (a)   Written Statement of Chief Executive Officer, Senior Vice President and Chief Financial Officer

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has fully caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

WASHINGTON REAL ESTATE INVESTMENT TRUST

/s/ Edmund B. Cronin, Jr.


Edmund B. Cronin, Jr.

Chairman of the Board, President and

Chief Executive Officer

/s/ Laura M. Franklin


Laura M. Franklin

Senior Vice President

Accounting, Administration and

Corporate Secretary

/s/ Sara L. Grootwassink


Sara L. Grootwassink

Chief Financial Officer

 

Date: November 9, 2005

 

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