▪ | net income attributable to common shareholders of $22.8 million, or $0.19 per diluted common share, for the three months ended September 30, 2018 as compared to a net loss of $69.8 million, or $0.61 per diluted common share, for the three months ended September 30, 2017. Net income attributable to common shareholders of $39.2 million, or $0.33 per diluted common share, for the nine months ended September 30, 2018 as compared to a net loss of $57.9 million, or $0.55 per diluted common share, for the nine months ended September 30, 2017. Net income attributable to common shareholders for the three and nine months ended September 30, 2018 included gains on the sale of real estate of $11.9 million and $45.8 million. Net loss attributable to common shareholders for the three and nine months ended September 30, 2017 included transaction and other costs of $104.1 million and $115.2 million and a gain on bargain purchase of $27.8 million for both periods; operating office portfolio leased and occupied percentages at our share of 87.1% and 85.4% as of September 30, 2018 compared to 87.4% and 86.0% as of June 30, 2018 and 88.0% and 87.2% as of December 31, 2017; operating multifamily portfolio leased and occupied percentages at our share of 96.1% and 94.3% as of September 30, 2018 compared to 95.9% and 92.6% as of June 30, 2018 and 95.6% and 93.8% as of December 31, 2017; | | • | the leasing of approximately 449,000 square feet, or 378,000 square feet at our share, at an initial rent (1) of $42.89 per square foot and a GAAP-basis weighted average rent per square foot (2) of $40.76 for the three months ended September 30, 2018, and the leasing of approximately 1.2 million square feet, or 1.0 million square feet at our share, at an initial rent (1) of $47.78 per square foot and a GAAP-basis weighted average rent per square foot (2) of $47.99 for the nine months ended September 30, 2018; and |
| | • | the decrease in same store (3) net operating income of 0.7% to $70.0 million for the three months ended September 30, 2018 as compared to $70.5 million for the three months ended September 30, 2017, as compared to net income of $21.0 million, or $0.21 per diluted common share, for the three months ended September 30, 2016. The net |
loss for the three months ended September 30, 2017 was due in part to transaction and other costs of $104.1 million partially offset by a gain on bargain purchase of $27.8 million;
| | ▪ | an increase in operating office portfolio leased and occupied percentages to 88.2% leased and 87.5% occupied as of September 30, 2017 from 87.5% and 86.2% as of June 30, 2017; |
| | ▪ | an increase in operating multifamily portfolio occupancy to 94.6% as of September 30, 2017 from 93.9% as of June 30, 2017. Multifamily portfolio leased percentage decreased to 96.2% as of September 30, 2017 from 96.8% as of June 30, 2017; |
| | ▪ | the leasing of approximately 289,000 square feet, or 206,000 square feet at our share (1), at an initial rent (2) of $43.08 per square foot; and
|
| | ▪ | an increase in same store (3) net operating income ("NOI") of 6.3%4.6% to $70.3$203.1 million for the threenine months ended September 30, 20172018 as compared to $66.1$194.2 million for the threenine months ended September 30, 2016.2017. |
_________________
| | (1) | Refers to our ownership percentage of consolidated and unconsolidated assets in real estate ventures. |
| | (2)
| Represents the cash basis weighted average starting rent per square foot, which excludes free rent and periodicfixed escalations. |
| | (2) | Represents the weighted average rent steps.per square foot that is recognized over the term of the respective leases, including the effect of free rent and fixed escalations. |
| | (3) | Includes the results of the properties that are owned, operated and stabilizedin service for the entirety of both periods being compared except for properties for which significant redevelopment, renovation or repositioning occurred during either of the periods being compared. Excludes the JBG Assets acquired in the Combination. |
Additionally, investing and financing activity during the threenine months ended September 30, 2018 included: the sale of three office assets located in Washington D.C. and Reston, Virginia, and the sale of a future development asset located in Reston, Virginia, for an aggregate gross sales price of $358.6 million, resulting in gains on sale of real estate of $45.8 million. See Note 3 to the financial statements for additional information; the closing of a real estate venture with Canadian Pension Plan Investment Board ("CPPIB") to develop and own 1900 N Street, an under construction office asset in Washington, D.C. We contributed 1900 N Street, valued at $95.9 million, to the real estate venture, and CPPIB has committed to contribute approximately $101.0 million to the venture for a 45.0% interest, which will reduce our ownership interest from 100.0% at the real estate venture's formation to 55.0% as contributions are funded; the investment of $10.1 million for a 16.67% interest in a real estate venture with CIM Group and Pacific Life Insurance Company, which purchased the 1,152-key Wardman Park hotel, located adjacent to the Woodley Park Metro Station in northwest Washington, D.C.; the acquisition by our partner in the real estate venture that owned the Investment Building, a 401,000 square foot office building located in Washington, D.C., of our 5.0% interest in the venture for $24.6 million, resulting in a gain of $15.5 million; a $50.0 million draw under our unsecured term loan maturing in January 2023 ("Tranche A-1 Term Loan"), in accordance with the delayed draw provisions of the credit facility, bringing the outstanding borrowings under the term loan facility to $100.0 million. Concurrent with the draw, we entered into an interest rate swap agreement to convert the variable interest rate to a fixed interest rate; a $200.0 million draw under our unsecured term loan maturing in July 2024 ("Tranche A-2 Term Loan"), in accordance with the delayed draw provisions of the credit facility. We also repaid all outstanding revolving credit facility balances; the aggregate borrowings related to construction draws under mortgages payable of $43.8 million; the prepayment of mortgages payable with an aggregate principal balance of $251.1 million and recognized losses on the extinguishment of debt in conjunction with these repayments of $4.5 million; the payment of dividends totaling $0.675 per common share that were declared in December 2017, May 2018 and August 2018; and the investment of $260.4 million in development costs, construction in progress and real estate additions. Activity subsequent to September 30, 2018 included: | | ▪ | the issuance of 94.7 million common shares and 5.8 million OP Units in connection with the Separation (see Note 1 to the financial statements for more information) |
| | ▪ | the completion of the Combination in exchange for 23.3 million common shares and 13.9 million OP Units (see Note 3 to the financial statements for more information); |
| | ▪ | the closing of a $1.4 billion credit facility, consisting of a $1.0 billion revolving credit facility with a four-year term, with two six-month extension options, a five and a half-year delayed draw $200.0 million unsecured term loan and a seven-year delayed draw $200.0 million unsecured term loan; |
| | ▪ | the prepayment of mortgages payable with an aggregate principal balance of $181.7 million; and |
| | ▪ | the investment of $115.9 million in development costs, construction in progress and real estate additions. |
the sale of 1233 20th Street, an office building located in Washington, D.C. for a gross sales price of $65.0 million. In connection with the sale, we repaid the related $41.9 million mortgage loan; the sale ofthe out-of-service portion of Falkland Chase-North, a multifamily building located in Downtown Silver Spring, Maryland for a gross sales price of $3.8 million; and the declaration of a quarterly dividend of $0.225 per common share, payable on November 26, 2018, to shareholders of record on November 13, 2018.
Critical Accounting Policies and Estimates Our Information StatementAnnual Report on Form 10, as amended, filed with10-K for the SEC on June 20,year ended December 31, 2017 contains a description of our critical accounting policies, including business combinations, real estate, deferred costs,investments in and advances to real estate ventures, revenue recognition and income taxes. For the three and nine months ended September 30, 2017, there wereshare-based compensation. There have been no materialsignificant changes to theseour policies except for the addition of the following policy: Business Combinations
We account for business combinations, including the acquisition of real estate, using the acquisition method by recognizing and measuring the identifiable assets acquired, liabilities assumed, and any noncontrolling interests in the acquiree at their acquisition date fair values. As a result, upon the acquisition, we estimate the fair value of the acquired tangible assets (consisting of real estate, cash and cash equivalents, tenant and other receivables, investments in unconsolidated real estate ventures and other assets, as applicable), identified intangible assets and liabilities (consisting of the value of in-place leases, above- and below-market leases, options to enter into ground leases and management contracts, as applicable), assumed debt and other liabilities, and noncontrolling interests, as applicable, based on our evaluation of information and estimates available at that date. Based on these estimates, we allocate the purchase price to the identified assets acquired and liabilities assumed. Any excess of the purchase price over the estimated fair value of the net assets acquired is recorded as goodwill. Any excess of the fair value of assets acquired over the purchase price is recorded as a gain on bargain purchase. If, up to one year from the acquisition date, information regarding the fair value of the net assets acquired and liabilities assumed is received and estimates are refined, appropriate adjustments are made on a prospective basis to the purchase price allocation, which may include adjustments to identified assets, assumed liabilities, and goodwill or the gain on bargain purchase, as applicable. Transaction costs related to business combinations are expensed as incurred and included in "Transaction and other costs" in our statements of operations.
The fair values of tangible real estate assets are determined using the “as-if vacant” approach whereby we use discounted income, or cash flow models with inputs and assumptions that we believe are consistent with current market conditions for similar assets. The most significant assumptions in determining the allocation of the purchase price to tangible assets are the exit capitalization rate, discount rate, estimated market rents and hypothetical expected lease-up periods.
The fair values of identified intangible assets are determined based on the following:
The value allocable to the above- or below-market component of an acquired in-place lease is determined based upon the present value (using a discount rate which reflects the risks associated with the acquired leases) of the difference between (i) the contractual amounts to be received pursuant to the lease over its remaining term and (ii) management’s estimate of the amounts that would be received using market rates over the remaining term of the lease. Amounts allocated to above- market leases are recorded as "Identified intangible assets" in "Other assets, net" in the balance sheets, and amounts allocated to below-market leases are recorded as "Lease intangible liabilities" in "Other liabilities, net" in the balance sheets. These intangibles are amortized to "Property rentals" in our statements of operations over the remaining terms of the respective leases.
Factors considered in determining the value allocable to in-place leases include estimates, during hypothetical lease-up periods, related to space that is actually leased at the time of acquisition. These estimates include (i) lost rent at market rates, (ii) fixed operating costs that will be recovered from tenants and (iii) theoretical leasing commissions required to execute similar leases. These intangible assets are recorded as "Identified intangible assets" in "Other assets, net" in the balance sheets and are amortized over the remaining term of the existing lease.
The fair value of the in-place property management, leasing, asset management, and development and construction management contracts is based on revenue and expense projections over the estimated life of each contract discounted using a market discount rate. These management contract intangibles are amortized over the weighted average life of the management contracts.
The fair value of investments in unconsolidated real estate ventures and related noncontrolling interests is based on the estimated fair values of the identified assets acquired and liabilities assumed of each entity.
The fair value of the mortgages payable assumed was determined using current market interest rates for comparable debt financings. The fair values of the interest rate swaps and caps are based on the estimated amounts we would receive or pay to terminate the contract at the reporting date and are determined using interest rate pricing models and observable inputs. The carrying value of cash, restricted cash, working capital balances, leasehold improvements and equipment, and other assets acquired and liabilities assumed approximates fair value.
The results of operations of acquisitions are included in our financial statements as of the dates they are acquired. The intangible assets and liabilities associated with acquisitions are included in "Other assets, net" and "Other liabilities, net", respectively, in our balance sheets.2018.
Recent Accounting Pronouncements
See Note 2 to the financial statements for a description of the potential impact of the adoption of any new accounting pronouncements.
Results of Operations Comparison of the Three Months Ended September 30, 20172018 to 2016September 30, 2017 The following summarizes certain line items from our statements of operations that we believe are important in understanding our operations and/or those items which significantly changed in the three months ended September 30, 20172018 as compared to the same period in 2016: 2017:
| | | Three Months Ended September 30, | Three Months Ended September 30, | | 2017 | | 2016 | | % Change | 2018 | | 2017 | | % Change | | (In thousands) | | | (In thousands) | | | Property rentals revenue | $ | 116,458 |
| | $ | 103,265 |
| | 12.8 | % | $ | 123,203 |
| | $ | 116,458 |
| | 5.8 | % | Tenant reimbursements revenue | 9,593 |
| | 10,231 |
| | (6.2 | )% | 9,744 |
| | 9,593 |
| | 1.6 | % | Third-party real estate services revenue, including reimbursements
| 25,141 |
| | 8,297 |
| | 203.0 | % | 23,788 |
| | 25,141 |
| | (5.4 | )% | Depreciation and amortization expense | 43,951 |
| | 31,377 |
| | 40.1 | % | 46,603 |
| | 43,951 |
| | 6.0 | % | Property operating expense | 29,634 |
| | 27,287 |
| | 8.6 | % | 34,167 |
| | 29,634 |
| | 15.3 | % | Real estate taxes expense | 17,194 |
| | 14,462 |
| | 18.9 | % | 16,905 |
| | 17,194 |
| | (1.7 | )% | General and administrative expense: | | | | | | | | | | | Corporate and other | 10,593 |
| | 10,913 |
| | (2.9 | )% | 12,415 |
| | 10,593 |
| | 17.2 | % | Third-party real estate services | 21,178 |
| | 4,779 |
| | 343.1 | % | 20,754 |
| | 21,178 |
| | (2.0 | )% | Share-based compensation related to Formation Transaction
| 14,445 |
| | — |
| | * | 8,387 |
| | 14,445 |
| | (41.9 | )% | Transaction and other costs | 104,095 |
| | 1,528 |
| | * | 4,126 |
| | 104,095 |
| | (96.0 | )% | (Loss) income from unconsolidated real estate ventures | (1,679 | ) | | 584 |
| | * | | Income (loss) from unconsolidated real estate ventures, net | | 13,484 |
| | (1,679 | ) | | * | Interest expense | 15,309 |
| | 13,028 |
| | 17.5 | % | 18,979 |
| | 15,309 |
| | 24.0 | % | Loss on extinguishment of debt | 689 |
| | — |
| | * | | Gain on sale of real estate | | 11,938 |
| | — |
| | * | Gain on bargain purchase | 27,771 |
| | — |
| | * | — |
| | 27,771 |
| | * | Net loss attributable to redeemable noncontrolling interests | 8,160 |
| | — |
| | * | |
______________* Not meaningful. Property rentals revenue increased by approximately $13.2$6.7 million, or 12.8%5.8%, to $123.2 million in 2018 from $116.5 million in 2017 from $103.3 million in 2016.2017. The increase was primarily due to revenues$8.8 million of $13.8revenue associated with placing CEB Tower at Central Place and 1221 Van Street into service, higher rent from rent commencements and the additional 17 days of revenue associated with the assets acquired in the Combination. These increases were partially offset by lower revenue of $4.2 million primarily due to the sale of the Bowen Building and Summit I and II in the second quarter of 2018. Tenant reimbursements revenue increased by approximately $151,000, or 1.6%, to $9.7 million in 2018 from $9.6 million in 2017. The increase was primarily due to an increase associated with the assets acquired in the Combination, partially offset by a decrease in tax recoveries related to lower tax assessments and the sale of the Bowen Building. Third-party real estate services revenue, including reimbursements, decreased by approximately $1.4 million, or 5.4%, to $23.8 million in 2018 from $25.1 million in 2017. The decrease was primarily due to lower asset management fee revenue as a result of asset sales within JBG Legacy Funds. Depreciation and amortization expense increased by approximately $2.7 million, or 6.0%, to $46.6 million for 2018 from $44.0 million in 2017. The increase was primarily due to depreciation and amortization expense associated with placing CEB Tower at Central Place and 1221 Van Street into service and the additional 17 days of depreciation and amortization expense associated with the assets acquired in the Combination. These increases were partially offset by lower depreciation and amortization expense due to the sale of the Bowen Building and Summit I and II. Property operating expense increased by approximately $4.5 million, or 15.3%, to $34.2 million in 2018 from $29.6 million in 2017. The increase was primarily due to property operating expense associated with placing CEB Tower at Central Place and 1221 Van Street into service and the additional 17 days of operating expense associated with the assets acquired in the Combination. These increases were partially offset by lower operating expense due to the sale of the Bowen Building and Summit I and II. Real estate tax expense decreased by approximately $289,000, or 1.7%, to $16.9 million in 2018 from $17.2 million in 2017. The decrease was primarily due to lower tax assessments and the sale of the Bowen Building and Summit I and II, partially offset by
real estate tax expense associated with placing CEB Tower at Central Place and 1221 Van Street into service and the additional 17 days of real estate tax expense associated with the assets acquired in the Combination. General and administrative expense: corporate and other increased by approximately $1.8 million, or 17.2%, to $12.4 million for 2018 from $10.6 million in 2017. The increase was due to an increase in general and administrative expense associated with the operations acquired in the Combination. General and administrative expense: third-party real estate services decreased by approximately $424,000, or 2.0%, to $20.8 million in 2018 from $21.2 million in 2017 primarily due to lower allocated expenses. General and administrative expense: share-based compensation related to Formation Transaction of $8.4 million in 2018 and $14.4 million in 2017 consists of expenses related to share-based compensation issued in connection with the Formation Transaction. Transaction and other costs of $4.1 million in 2018 consist primarily of fees and expenses incurred in connection with the Formation Transaction, including amounts incurred for transition services provided by our former parent, integration costs and severance costs. Transaction and other costs of $104.1 million in 2017 consist primarily of fees and expenses incurred in connection with the Formation Transaction, including severance and transaction bonus expense, investment banking fees, legal fees and accounting fees. Income from unconsolidated real estate ventures, net increased by approximately $15.2 million to $13.5 million for 2018 from a $1.7 million loss in 2017. The increase was primarily due the sale of our 5.0% interest in a real estate venture that owned the Investment Building, a 401,000 square foot office building located in Washington, D.C., for $24.6 million, resulting in a gain of $15.5 million. Interest expense increased by approximately $3.7 million, or 24.0%, to $19.0 million for 2018 from $15.3 million in 2017. The increase was primarily due to higher interest rates and interest expense associated with placing CEB Tower at Central Place into service as the interest expense incurred while the property was under development was capitalized. Gain on the sale of real estate of $11.9 million is related to the sale of Executive Tower in September 2018. See Note 3 to the financial statements for additional information. The gain on bargain purchase of $27.8 million in 2017 represents the fair value of the identifiable net assets acquired in excess of the purchase consideration in the Combination. See Note 1 to the financial statements for additional information.
Comparison of the Nine Months Ended September 30, 2018 to September 30, 2017 The following summarizes certain line items from our statements of operations that we believe are important in understanding our operations and/or those items which significantly changed in the nine months ended September 30, 2018 as compared to the same period in 2017: | | | | | | | | | | | | | Nine Months Ended September 30, | | 2018 | | 2017 | | % Change | | (In thousands) | | | Property rentals revenue | $ | 375,094 |
| | $ | 316,899 |
| | 18.4 | % | Tenant reimbursements revenue | 28,651 |
| | 27,161 |
| | 5.5 | % | Third-party real estate services revenue, including reimbursements
| 72,278 |
| | 38,881 |
| | 85.9 | % | Depreciation and amortization expense | 143,880 |
| | 109,726 |
| | 31.1 | % | Property operating expense | 95,462 |
| | 77,341 |
| | 23.4 | % | Real estate taxes expense | 54,024 |
| | 47,978 |
| | 12.6 | % | General and administrative expense: | | | | | | Corporate and other | 37,759 |
| | 35,536 |
| | 6.3 | % | Third-party real estate services | 64,552 |
| | 30,362 |
| | 112.6 | % | Share-based compensation related to Formation Transaction
| 26,912 |
| | 14,445 |
| | 86.3 | % | Transaction and other costs | 12,134 |
| | 115,173 |
| | (89.5 | )% | Income (loss) from unconsolidated real estate ventures, net | 15,418 |
| | (1,365 | ) | | * | Interest expense | 56,263 |
| | 43,813 |
| | 28.4 | % | Gain on sale of real estate | 45,789 |
| | — |
| | * | Loss on extinguishment of debt | 4,536 |
| | 689 |
| | 558.3 | % | Gain (reduction of gain) on bargain purchase | (7,606 | ) | | 27,771 |
| | * |
______________* Not meaningful. Property rentals revenue increased by approximately $58.2 million, or 18.4%, to $375.1 million in 2018 from $316.9 million in 2017. The increase was primarily due to $59.8 million of revenue associated with the assets acquired in the Combination, including $23.3 million of revenue associated with placing CEB Tower at Central Place and 1221 Van Street into service, partially offset by a decrease of $1.6 million in revenue associated with the Vornado Included Assets, primarily due to the sale of the Bowen building. Tenant reimbursements revenue increased by approximately $1.5 million, or 5.5%, to $28.7 million in 2018 from $27.2 million in 2017. The increase was primarily due to an increase of $4.8 million associated with the assets acquired in the Combination, partially offset by a decrease of $0.6$3.3 million in revenues associated with existing assets. The $0.6 million decrease in revenues associated with existing assets is primarily due to 1150 17th St and 1770 Crystal Drive being taken out of service, partially offset by an increase in occupancy and associated rentals at The Bartlett which was placed into service in the second quarter of 2016. Tenant reimbursements revenue decreased by approximately $600,000, or 6.2%, to $9.6 million in 2017 from $10.2 million in 2016. Revenue associated with existing assets decreased $2.0 million,Vornado Included Assets primarily due to lower construction services provided to tenantstax assessments and lower operating expenses, partially offset by an increasethe sale of $1.4 million associated with the assets acquired in the Combination.Bowen building.
Third-party real estate services revenue, including reimbursements, increased by approximately $16.8$33.4 million, or 203.0%85.9%, to $25.1$72.3 million in 20172018 from $8.3$38.9 million in 2016.2017. The increase was primarily due to the real estate services business acquired in the Combination, partially offset by lower management feespayroll reimbursements related to third-party arrangements that were terminated during 2017 and leasing commissions from existing arrangements with third-parties.early 2018. Depreciation and amortization expense increased by approximately $12.6$34.2 million, or 40.1%31.1%, to $44.0$143.9 million for 2018 from $109.7 million in 2017 from $31.4 million in 2016.2017. The increase was primarily due to depreciation and amortization expense associated with the assets acquired in the Combination.Combination, including $8.2 million of depreciation and amortization expense associated with placing CEB Tower at Central Place and 1221 Van Street into service. Property operating expense increased by approximately $2.3$18.1 million, or 8.6%23.4%, to $29.6$95.5 million in 20172018 from $27.3$77.3 million in 2016.2017. The increase was primarily due to property operating expensesexpense of $4.2$14.1 million associated with the assets acquired in the Combination, including $5.1 million of operating expense associated with placing CEB Tower at Central Place and 1221 Van Street into service and an increase of $4.0 million associated with the Vornado Included Assets primarily due to higher ground rent and other operating expense, partially offset by a decreasethe sale of $1.9 million associated with existing assets due primarily to lower tenant services expense and lower utilities.the Bowen Building.
Real estate tax expense increased by approximately $2.7$6.0 million, or 18.9%12.6%, to $17.2$54.0 million in 20172018 from $14.5$48.0 million in 2016.2017. The increase was primarily due to real estate tax expense of $2.1$8.2 million associated with the assets acquired in the Combination, an increase inincluding $2.0 million associated with placing CEB Tower at Central Place and 1221 Van Street into service, partially offset by a $2.1 million decrease associated with the Vornado Included Assets due to lower tax assessments and lower capitalized real estate taxes.the sale of the Bowen Building. General and administrative expense: corporate and other decreasedincreased by approximately $300,000,$2.2 million, or 2.9%6.3%, to $10.6$37.8 million for 2018 from $35.5 million in 2017 from $10.9 million in 2016.2017. The decreaseincrease was due to lower marketing and general office expenses, partially offset by an increase in general operatingand administrative expenses associated with the operations acquired in the Combination.Combination, partially offset by lower corporate overhead costs in the 2018 period compared to the amount allocated and recorded in the 2017 period. General and administrative expense: third-party real estate services increased by approximately $16.4$34.2 million, or 343.1%112.6%, to $21.2$64.6 million in 2018 from $30.4 million in 2017 from $4.8 million in 2016primarily due to the real estate services business acquired in the Combination.
General and administrative expense: share-based compensation related to Formation Transaction of $26.9 million in 2018 and $14.4 million in 2017 consists of expenseexpenses related to share-based compensation issued in connection with the Formation Transaction. Transaction and other costs of $104.1$12.1 million in 2018 consist primarily of fees and expenses incurred in connection with the Formation Transaction, including amounts incurred for transition services provided by our former parent, integration costs and severance costs. Transaction and other costs of $115.2 million in 2017 consistsconsist primarily of fees and expenses incurred in connection with the Formation Transaction, including severance and transaction bonus expense of $34.3 million, investment banking fees of $33.6 million, legal fees of $13.1 million and accounting fees of $8.1 million. Income (loss) from unconsolidated real estate ventures, decreasednet increased by approximately $2.3$16.8 million to a loss of $1.7$15.4 million in 20172018 from income of $584,000a $1.4 million loss in 2016.2017. The decreaseincrease was primarily due to losses from intereststhe sale of our 5.0% interest in a real estate ventures acquiredventure that owned the Investment Building, a 401,000 square foot office building located in the Combination.Washington, D.C., for $24.6 million, resulting in a gain of $15.5 million. Interest expense increased by approximately $2.3$12.5 million, or 17.5%28.4%, to $15.3$56.3 million for 20172018 from $13.0$43.8 million in 2016.2017. The increase was primarily due to $1.8 million of interest expense associated with the assets acquired in the Combination, additional term loan borrowings and lower capitalizedhigher interest related to The Bartlett which was placed into service during the second quarter of 2016,rates, partially offset by lower interest expense associated with mortgages that were repaid.the repayment of mortgages. Gain on the sale of real estate of $45.8 million is primarily related to the sale of Summit I and II, the Bowen Building and Executive Tower during 2018. See Note 3 to the financial statements for additional information. Loss on extinguishment of debt of $4.5 million in 2018 and $689,000 in 2017 relatesis related to our repayment of various mortgages payable during the prepayment of mortgages payable.period. The gain on bargain purchase of approximately $27.8 million in 2017 represents the estimated fair value of the identifiable net assets acquired in excess of the purchase consideration in the Combination. During the fourth quarter of 2017, this gain was reduced by $3.4 million. The purchase consideration was based on the fair valuereduction of the common shares and OP Units issued in the Combination. See Note 3 to the financial statements for additional information. Net loss attributable to redeemable noncontrolling interests of approximately $8.2 million in 2017 relates to the allocation of net loss to the noncontrolling interest in JBG SMITH LP.
Comparison of the Nine Months Ended September 30, 2017 to 2016
The following summarizes certain line items from our statements of operations that we believe are important in understanding our operations and/or those items which significantly changed in the nine months ended September 30, 2017 as compared to the same period in 2016:
| | | | | | | | | | | | | Nine Months Ended September 30, | | 2017 | | 2016 | | % Change | | (In thousands) | | | Property rentals revenue | $ | 316,899 |
| | $ | 299,497 |
| | 5.8 | % | Tenant reimbursements revenue | 27,161 |
| | 28,428 |
| | (4.5 | )% | Third-party real estate services revenue, including reimbursements
| 38,881 |
| | 24,617 |
| | 57.9 | % | Depreciation and amortization expense | 109,726 |
| | 98,291 |
| | 11.6 | % | Property operating expense | 77,341 |
| | 75,087 |
| | 3.0 | % | Real estate taxes expense | 47,978 |
| | 43,712 |
| | 9.8 | % | General and administrative expense: | | | | | | Corporate and other | 35,536 |
| | 36,040 |
| | (1.4 | )% | Third-party real estate services | 30,362 |
| | 14,272 |
| | 112.7 | % | Share-based compensation related to Formation Transaction
| 14,445 |
| | — |
| | * | Transaction and other costs | 115,173 |
| | 1,528 |
| | * | Loss from unconsolidated real estate ventures | (1,365 | ) | | (952 | ) | | 43.4 | % | Interest expense | 43,813 |
| | 38,662 |
| | 13.3 | % | Loss on extinguishment of debt | 689 |
| | — |
| | * | Gain on bargain purchase | 27,771 |
| | — |
| | * | Net loss attributable to redeemable noncontrolling interests | 2,481 |
| | — |
| | * |
______________* Not meaningful.
Property rentals revenue increased by approximately $17.4 million, or 5.8%, to $316.9 million in 2017 from $299.5 million in 2016. The increase was primarily due to revenues of $13.8 million associated with the assets acquired in the Combination and an increase of $3.6 million in revenues associated with existing assets. The $3.6 million increase in revenues associated with existing assets is primarily due to an increase in occupancy and associated rentals at The Bartlett multifamily project as the property was placed into service in the second quarter of 2016 and higher rents at 1215 S. Clark St, partially offset by a decrease in revenues at 1150 17th St and 1770 Crystal Drive, which were taken out of service.
Tenant reimbursements revenue decreased by approximately $1.2 million, or 4.5%, to $27.2 million in 2017 from $28.4 million in 2016. Revenue associated with existing assets decreased by $2.6 million, primarily due to lower construction services provided to tenants and lower operating expenses, partially offset by an increase of $1.4 million associated with the assets acquired in the Combination.
Third-party real estate services revenue, including reimbursements, increased by approximately $14.3 million, or 57.9%, to $38.9 million in 2017 from $24.6 million in 2016. The increase was primarily due to the real estate services business acquired in the Combination, partially offset by lower management fees and leasing commissions from existing arrangements with third-parties.
Depreciation and amortization expense increased by approximately $11.4 million, or 11.6%, to $109.7 million for 2017 from $98.3 million in 2016. The increase was primarily due to depreciation and amortization expense associated with the assets acquired in the Combination.
Property operating expense increased by approximately $2.2 million, or 3.0%, to $77.3 million in 2017 and from $75.1 million in 2016. The increase was primarily due to property operating expenses of $4.2 million associated with the assets acquired in the Combination, partially offset by a decrease of $2.0 million associated with existing assets due primarily to lower tenant services expense and lower utilities.
Real estate tax expense increased by approximately $4.3 million, or 9.8%, to $48.0 million in 2017 from $43.7 million in 2016. The increase was primarily due to real estate tax expense of $2.1 million associated with the assets acquired in the Combination, an increase in the tax assessments and lower capitalized real estate taxes.
General and administrative expense: corporate and other decreased by approximately $500,000, or 1.4%, to $35.5 million for 2017 from $36.0 million in 2016. The decrease was due to lower marketing and general office expenses, partially offset by an increase in general operating expenses associated with the operations acquired in the Combination.
General and administrative expense: third-party real estate services increased by approximately $16.1 million, or 112.7%, to $30.4 million in 2017 from $14.3 million in 2016 primarily due to the real estate services business acquired in the Combination.
General and administrative expense: share-based compensation related to Formation Transaction of $14.4 million in 2017 consists of expense related to share-based compensation issued in connection with the Formation Transaction.
Transaction and other costs of $115.2 million in 2017 consists primarily of fees and expenses incurred in connection with the Formation Transaction, including severance and transaction bonus expense of $34.3 million, investment banking fees of $33.6 million, legal fees of $13.1 million and accounting fees of $8.1 million.
Loss from unconsolidated real estate ventures increased by approximately $400,000 to $1.4 million in 2017 from $1.0 million in 2016. The increase in the loss was primarily due to losses from interests in real estate ventures acquired in the Combination, partially offset by a reduction of interest expense of approximately $1.7 million from the refinancing of the Warner Building mortgage loan in May 2016 at a lower interest rate and for a lower outstanding principal amount.
Interest expense increased by approximately $5.1 million, or 13.3%, to $43.8 million for 2017 from $38.7 million in 2016. The increase was primarily due to $1.8 million of interest expense associated with the assets acquired in the Combination and lower capitalized interest related to The Bartlett which was placed into service during the second quarter of 2016, partially offset by lower interest expense associated with mortgages that were repaid.
Loss on extinguishment of debt of $689,000 in 2017 related to the prepayment of mortgages payable.
The gain on bargain purchase of approximately $27.8$7.6 million in 2017 represents2018 is the estimatedresult of finalizing our fair value of the identifiable net assets acquiredestimates used in excess of the purchase consideration inprice allocation related to the Combination. The purchase consideration was based on the fair value of the common shares and OP Units issued in the Combination. See Note 3 to the financial statements for additional information.
Net loss attributable to redeemable noncontrolling interests of approximately $2.5 million in 2017 relates to the allocation of net loss to the noncontrolling interest in JBG SMITH LP.
Funds From Operations
We believe Funds from OperationsNet Operating Income ("FFO"NOI") (when combined with the primary presentations in accordance with GAAP) is a useful supplemental measure of our operating performance that is a recognized metric used extensively by the real estate industry and, in particular, REITs. The National Association of Real Estate Investment Trusts ("NAREIT") stated in its April 2002 White Paper on Funds from Operations, "Historical cost accounting for real estate assets implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen or fallen with market conditions, many industry investors have considered presentations of operating results for real estate companies that use historical cost accounting to be insufficient by themselves."
FFO, as defined by NAREIT, is "net income (computed in accordance with GAAP), excluding gains (or losses) from sales of, or impairment charges related to, depreciable operating properties, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and real estate ventures. It states further that “adjustments for unconsolidated partnerships and joint ventures will be calculated to reflect funds from operations on the same basis.” We believe that financial analysts, investors and shareholders are better served by the clearer presentation of comparable period operating results generated from our FFO measure. Our method of calculating FFO may be different from methods used by other REITs and, accordingly, may not be comparable to such other REITs.
FFO is presented to assist investors in analyzing our operating performance. FFO (i) does not represent cash flow from operations as defined by GAAP, (ii) is not indicative of cash available to fund all cash flow needs, including the ability to make distributions, (iii) is not an alternative to cash flow as a measure of liquidity, and (iv) should not be considered as an alternative to net (loss) income (which is determined in accordance with GAAP) for purposes of evaluating our operating performance.
The following reflects the reconciliation of net (loss) income attributable to JBG SMITH Properties, the most directly comparable GAAP measure, to FFO for the three months ended September 30, 2017:
| | | | | | Three Months Ended September 30, 2017 | | | (In thousands) | Net loss attributable to JBG SMITH Properties | $ | (69,831 | ) | Net loss attributable to redeemable noncontrolling interests | (8,160 | ) | Net loss | (77,991 | ) | Real estate depreciation and amortization | 41,393 |
| Pro rata share of real estate depreciation and amortization from unconsolidated real estate ventures | 6,059 |
| FFO attributable to the operating partnership common units | (30,539 | ) | FFO attributable to redeemable noncontrolling interests | 3,195 |
| FFO attributable to diluted common shareholders | $ | (27,344 | ) | Weighted average diluted shares | 114,744 |
|
NOI and Same Store NOI
In this section, we presentWe utilize NOI, which is a non-GAAP financial measure, that we use to assess a segment’s performance. The most directly comparable GAAP measure is net income (loss) attributable to JBG SMITH Properties plus depreciation and amortization expense, general and administrative expense, transaction and other costs, interest expense, gain (loss) on extinguishment of debt and income tax expense, less third-party real estate services, less reimbursements, other income, income (loss) from unconsolidated real estate ventures, interest and other (loss) income, gain on bargain purchase and noncontrolling interests.common shareholders. We use NOI internally as a performance measure and believe NOI provides useful information to investors regarding our financial condition and results of operations because it reflects only property related revenue (which includes base rent, tenant reimbursements and other operating revenue) less operating expense, before deferred rent and related party management fees. Management uses NOI as a supplemental performance measure for our assets and believes it provides useful information to investors because it reflects only those revenue and expense items that are incurred at the asset level, excluding non-cash items. In addition, NOI is considered by many in the real estate industry to be a useful starting point for determining the value of a real estate asset or group of assets. However, because NOI excludes depreciation and amortization and captures neither the changes in the value of our assets that result from use or market conditions, nor the level of capital expenditures and capitalized leasing commissions necessary to maintain the operating performance of our assets, all of which have real economic effect and could materially impact the financial performance of our assets, the utility of NOI as a measure of the operating performance of our assets is limited. NOI presented by us may not be comparable to NOI reported by other REITs that define these measures differently. We believe that to facilitate a clear understanding of our operating results, NOI should be examined in conjunction with net income (loss) attributable to JBG SMITH Propertiescommon shareholders as presented in our financial statements. NOI should not be considered as an alternative to net income (loss) attributable to JBG SMITH Propertiescommon shareholders as an indication of our performance or to cash flows as a measure of liquidity or our ability to make distributions.
We also provide certain information on a "same store" basis. Information provided on a same store basis includes the results of properties that are owned, operated and stabilizedin service for the entirety of both periods being compared except for properties for which significant redevelopment, renovation or repositioning occurred during either of the periods being compared. While there is judgment surrounding changes in designations, a property is removed from the same store pool when athe property is considered to be a property under construction because it is undergoing significant redevelopment or renovation pursuant to a formal plan or is being repositioned in the market and such renovation or repositioning is expected to have a significant impact on property operating income. A development property or property under construction is moved to the same store pool once a substantial portion of the growth expected from the development or redevelopment is reflected in both the current and comparable prior year period. Acquisitions are moved into the same store pool once we have owned the property for the entirety of the comparable periods and the property is not under significant development or redevelopment.
For the three and nine months ended September 30, 2017,2018, all of the JBG Assets and two Vornado Included Assets (The Bartlett and 1800 South Bell Street) were not included in the same store comparison as they were not in service or being taken out of service during portions of the periods being compared. Additionally, the Bowen Building, Executive Tower and the Investment Building were excluded because these assets were sold during the period.
Same store NOI decreased by $507,000, or 0.7%, and increased by $4.2$8.9 million, or 6.3%, and $6.3 million, or 3.1%4.6%, for the three and nine months ended September 30, 2017, respectively,2018 as compared to the three and nine months ended September 30, 2016, respectively.2017. The decrease in same store NOI for the three months ended September 30, 2018 was largely attributable to the conversion of unused tenant incentive allowances to free rent, rental abatement and anticipated tenant move-outs. The increase in same store
NOI for the three and nine months ended September 30, 20172018, was primarily due tomainly driven by the expirationburn off of rent abatements, and higher property rental revenue from lease commencements.partially offset by rent abatements given to tenants in 2018.
The following table reflects the reconciliation of net income (loss) income attributable to JBG SMITH Properties, the most directly comparable GAAP measure,common shareholders to NOI and same store NOI for the periods presented: | | | Three Months Ended September 30, | | Nine Months Ended September 30, | Three Months Ended September 30, | | Nine Months Ended September 30, | | 2017 | | 2016 | | 2017 | | 2016 | 2018 | | 2017 | | 2018 | | 2017 | | (In thousands) | (In thousands) | Net (loss) income attributable to JBG SMITH Properties | $ | (69,831 | ) | | $ | 21,014 |
| | $ | (57,851 | ) | | $ | 49,344 |
| | Net income (loss) attributable to common shareholders | | $ | 22,830 |
| | $ | (69,831 | ) | | $ | 39,214 |
| | $ | (57,851 | ) | Add: | | | | | | | | | | | | | | | Depreciation and amortization expense | 43,951 |
| | 31,377 |
| | 109,726 |
| | 98,291 |
| 46,603 |
| | 43,951 |
| | 143,880 |
| | 109,726 |
| General and administrative expense: | | | | | | | | | | | | | | | Corporate and other | 10,593 |
| | 10,913 |
| | 35,536 |
| | 36,040 |
| 12,415 |
| | 10,593 |
| | 37,759 |
| | 35,536 |
| Third-party real estate services | 21,178 |
| | 4,779 |
| | 30,362 |
| | 14,272 |
| 20,754 |
| | 21,178 |
| | 64,552 |
| | 30,362 |
| Share-based compensation related to Formation Transaction
| 14,445 |
| | — |
| | 14,445 |
| | — |
| 8,387 |
| | 14,445 |
| | 26,912 |
| | 14,445 |
| Transaction and other costs | 104,095 |
| | 1,528 |
| | 115,173 |
| | 1,528 |
| 4,126 |
| | 104,095 |
| | 12,134 |
| | 115,173 |
| Interest expense | 15,309 |
| | 13,028 |
| | 43,813 |
| | 38,662 |
| 18,979 |
| | 15,309 |
| | 56,263 |
| | 43,813 |
| Loss on extinguishment of debt | 689 |
| | — |
| | 689 |
| | — |
| 79 |
| | 689 |
| | 4,536 |
| | 689 |
| Income tax (benefit) expense | (1,034 | ) | | 302 |
| | (317 | ) | | 884 |
| | Reduction of gain (gain) on bargain purchase | | — |
| | (27,771 | ) | | 7,606 |
| | (27,771 | ) | Income tax benefit | | (841 | ) | | (1,034 | ) | | (1,436 | ) | | (317 | ) | Net (income) loss attributable to redeemable noncontrolling interests | | 3,552 |
| | (8,160 | ) | | 6,532 |
| | (2,481 | ) | Less: | | | | | | | | | | | | | | | Third-party real estate services, including reimbursements
| 25,141 |
| | 8,297 |
| | 38,881 |
| | 24,617 |
| 23,788 |
| | 25,141 |
| | 72,278 |
| | 38,881 |
| Other income | 1,158 |
| | 1,564 |
| | 3,701 |
| | 3,938 |
| 1,708 |
| | 1,158 |
| | 4,904 |
| | 3,701 |
| (Loss) income from unconsolidated real estate ventures | (1,679 | ) | | 584 |
| | (1,365 | ) | | (952 | ) | | Interest and other (loss) income, net | (379 | ) | | 749 |
| | 1,366 |
| | 2,292 |
| | Gain on bargain purchase | 27,771 |
| | — |
| | 27,771 |
| | — |
| | Net loss attributable to redeemable noncontrolling interests | 8,160 |
| | — |
| | 2,481 |
| | — |
| | Total | 79,223 |
| | 71,747 |
| | 218,741 |
| | 209,126 |
| | Adjustment (1) | 11,315 |
| | 10,492 |
| | 45,645 |
| | 30,762 |
| | Income (loss) from unconsolidated real estate ventures, net | | 13,484 |
| | (1,679 | ) | | 15,418 |
| | (1,365 | ) | Interest and other income (loss), net | | 4,091 |
| | (379 | ) | | 5,177 |
| | 1,366 |
| Gain on sale of real estate | | 11,938 |
| | — |
| | 45,789 |
| | — |
| Net loss attributable to noncontrolling interests | | — |
| | — |
| | 127 |
| | — |
| Consolidated NOI | | 81,875 |
| | 79,223 |
| | 254,259 |
| | 218,741 |
| NOI attributable to consolidated JBG Assets (1) | | — |
| | 2,136 |
| | — |
| | 24,670 |
| Proportionate NOI attributable to unconsolidated JBG Assets (1) | | — |
| | 792 |
| | — |
| | 8,648 |
| Proportionate NOI attributable to unconsolidated real estate ventures | | 9,722 |
| | 7,505 |
| | 27,949 |
| | 12,965 |
| Non-cash rent adjustments (2) | | (1,369 | ) | | (1,575 | ) | | (3,659 | ) | | (7,508 | ) | Other adjustments (3) | | 701 |
| | 1,493 |
| | 3,434 |
| | 1,318 |
| Total adjustments | | 9,054 |
| | 10,351 |
| | 27,724 |
| | 40,093 |
| NOI | 90,538 |
| | 82,239 |
| | 264,386 |
| | 239,888 |
| 90,929 |
| | 89,574 |
| | 281,983 |
| | 258,834 |
| Non-same store NOI (2) | 20,266 |
| | 16,137 |
| | 59,029 |
| | 40,792 |
| | Same store NOI (3) | $ | 70,272 |
| | $ | 66,102 |
| | $ | 205,357 |
| | $ | 199,096 |
| | Non-same store NOI (4) | | 20,910 |
| | 19,048 |
| | 78,862 |
| | 64,643 |
| Same store NOI (5) | | $ | 70,019 |
| | $ | 70,526 |
| | $ | 203,121 |
| | $ | 194,191 |
| | | | | | | | | | | | | | | | Growth in same store NOI | 6.3 | % | | | | 3.1 | % | | | (0.7 | )% | | | | 4.6 | % | | | Number of properties | 36 |
| | | | 36 |
| | | | Number of properties in same store pool | | 34 |
| | | | 33 |
| | |
___________________________________________________ | | (1) | Adjustment to: (i) include theIncludes financial information offor the JBG Assets as if the Combination had been completed as of the beginning of the periods presented; (ii) include proportionate share of NOI attributableperiod presented. |
| | (2) | Adjustment to unconsolidated real estate ventures; (iii) include other income related to operating properties; (iv) exclude straight-line rent, above/below market lease amortization and lease incentive amortization; and (v) exclude NOI related to non-operating assets.amortization. |
| | (2)(3)
| Adjustment to include other income and payments associated with assumed lease liabilities related to operating properties, and exclude incidental income generated by development assets and commercial lease termination revenue. |
| | (4) | Includes the results for properties that were not owned, operated and stabilizedin service for the entirety of both periods being compared and properties for which significant redevelopment, renovation or repositioning occurred during either of the periods being compared. |
| | (3)(5)
| Includes the results of the properties that are owned, operated and stabilizedin service for the entirety of both periods being compared except for properties for which significant redevelopment, renovation or repositioning occurred during either of the periods being compared. |
Reportable Segments | | | | | | | | | | | | | | | | | | Three Months Ended September 30, | | Nine Months Ended September 30, | | 2017 | | 2016 | | 2017 | | 2016 | | (In thousands) | Rental revenue: | | | | | | | | Office | $ | 99,451 |
| | $ | 90,552 |
| | $ | 272,270 |
| | $ | 262,633 |
| Multifamily | 24,945 |
| | 16,726 |
| | 65,822 |
| | 47,625 |
| Other | 4,299 |
| | 5,276 |
| | 10,274 |
| | 19,820 |
| Eliminations | (2,644 | ) | | 942 |
| | (4,306 | ) | | (2,153 | ) | Total rental revenue | 126,051 |
| | 113,496 |
| | 344,060 |
| | 327,925 |
| | | | | | | | | Rental expense: | | | | | | | | Office | 40,038 |
| | 36,876 |
| | 108,562 |
| | 104,595 |
| Multifamily | 9,748 |
| | 6,445 |
| | 24,689 |
| | 17,657 |
| Other | 4,706 |
| | 4,071 |
| | 14,150 |
| | 18,728 |
| Eliminations | (7,664 | ) | | (5,643 | ) | | (22,082 | ) | | (22,181 | ) | Total rental expense | 46,828 |
| | 41,749 |
| | 125,319 |
| | 118,799 |
| | | | | | | | | NOI: | | | | | | | | Office | 59,413 |
| | 53,676 |
| | 163,708 |
| | 158,038 |
| Multifamily | 15,197 |
| | 10,281 |
| | 41,133 |
| | 29,968 |
| Other | (407 | ) | | 1,205 |
| | (3,876 | ) | | 1,092 |
| Eliminations | 5,020 |
| | 6,585 |
| | 17,776 |
| | 20,028 |
| Total NOI | $ | 79,223 |
| | $ | 71,747 |
| | $ | 218,741 |
| | $ | 209,126 |
|
We review operating and financial data for each property on an individual basis; therefore, each of our individual properties is a separate operating segment. Our reportable segments are aligned with our method of internal reporting and the way our Chief
Executive Officer, who is also our Chief Operating Decision Maker ("CODM"), makes key operating decisions, evaluates financial results, allocates resources and manages our business. Accordingly, we aggregate our operating segments into three reportable segments (office, multifamily and third-party real estate services) based on the economic characteristics and nature of our assets and services.
The CODM measures and evaluates the performance of our operating segments, with the exception of the third-party real estate services business, based on the NOI of properties within each segment. NOI includes property rental revenues and tenant reimbursements and deducts property operating expenses and real estate taxes.
With respect to the third-party real estate services business, the CODM reviews revenues streams generated by this segment ("Third-party real estate services, including reimbursements"), as well as the expenses attributable to the segment ("General and administrative: third-party real estate services"), which are disclosed separately in the statements of operations and discussed in the preceding pages under "Results of Operations.” The following presents a reconciliation of revenue from our third-party asset management and real estate services business, excluding reimbursements and service revenue, to "Third-party real estate services revenue, including reimbursements": | | | | | | | | | | | | | | | | | | Three Months Ended September 30, | | Nine Months Ended September 30, | | 2018 | | 2017 | | 2018 | | 2017 | | (In thousands) | Property management fees | $ | 6,355 |
| | $ | 5,671 |
| | $ | 18,773 |
| | $ | 9,892 |
| Asset management fees | 3,720 |
| | 6,007 |
| | 11,288 |
| | 6,007 |
| Leasing fees | 1,455 |
| | 1,580 |
| | 4,753 |
| | 2,183 |
| Development fees | 2,259 |
| | 1,813 |
| | 6,490 |
| | 2,000 |
| Construction management fees | 590 |
| | 903 |
| | 2,076 |
| | 1,367 |
| Other service revenue | 185 |
| | 230 |
| | 1,883 |
| | 365 |
| Third-party real estate services revenue, excluding reimbursements and service revenue | 14,564 |
| | 16,204 |
| | 45,263 |
| | 21,814 |
| Reimbursements and service revenue | 9,224 |
| | 8,937 |
| | 27,015 |
| | 17,067 |
| Third-party real estate services revenue, including reimbursements | $ | 23,788 |
| | $ | 25,141 |
| | $ | 72,278 |
| | $ | 38,881 |
|
Consistent with internal reporting presented to our CODM and our definition of NOI, the third-party real estate services operating results are excluded from the NOI data below.
Rental revenue is calculated as property rentals plus tenant reimbursements. Rental expense is calculated as property operating expenses plus real estate taxes. NOI is calculated as rental revenue less rental expense. See Note 14 to the financial statements for the reconciliation of net income (loss) attributable to common shareholders to consolidated NOI for the three and nine months ended September 30, 2018 and 2017.
| | | | | | | | | | | | | | | | | | Three Months Ended September 30, | | Nine Months Ended September 30, | | 2018 | | 2017 | | 2018 | | 2017 | | (In thousands) | Rental revenue: | | | | | | | | Office | $ | 103,474 |
| | $ | 99,451 |
| | $ | 317,718 |
| | $ | 272,270 |
| Multifamily | 27,730 |
| | 24,945 |
| | 80,422 |
| | 65,822 |
| Other | 2,101 |
| | 4,299 |
| | 6,461 |
| | 10,274 |
| Eliminations of intersegment activity | (358 | ) | | (2,644 | ) | | (856 | ) | | (4,306 | ) | Total rental revenue | 132,947 |
| | 126,051 |
| | 403,745 |
| | 344,060 |
| | | | | | | | | Rental expense: | | | | | | | | Office | 41,549 |
| | 40,038 |
| | 123,095 |
| | 108,562 |
| Multifamily | 11,650 |
| | 9,748 |
| | 33,405 |
| | 24,689 |
| Other | 3,609 |
| | 4,706 |
| | 9,450 |
| | 14,150 |
| Eliminations of intersegment activity | (5,736 | ) | | (7,664 | ) | | (16,464 | ) | | (22,082 | ) | Total rental expense | 51,072 |
| | 46,828 |
| | 149,486 |
| | 125,319 |
| | | | | | | | | Consolidated NOI: | | | | | | | | Office | 61,925 |
| | 59,413 |
| | 194,623 |
| | 163,708 |
| Multifamily | 16,080 |
| | 15,197 |
| | 47,017 |
| | 41,133 |
| Other | (1,508 | ) | | (407 | ) | | (2,989 | ) | | (3,876 | ) | Eliminations of intersegment activity | 5,378 |
| | 5,020 |
| | 15,608 |
| | 17,776 |
| Consolidated NOI | $ | 81,875 |
| | $ | 79,223 |
| | $ | 254,259 |
| | $ | 218,741 |
|
Comparison of the Three Months Ended September 30, 2017 compared2018 to September 30, 20162017 Office: Rental revenue increased by $8.9$4.0 million, or 9.8%4.0%, to $103.5 million in 2018 from $99.5 million in 2017 from $90.6 million in 2016.2017. Consolidated NOI increased by $5.7$2.5 million, or 10.7%4.2%, to $61.9 million in 2018 from $59.4 million in 2017 from $53.7 million in 2016.2017. The increase in rental revenue and consolidated NOI is primarily due to revenue associated with placing CEB Tower at Central Place into service and the Combination.additional 17 days of revenue associated with the assets acquired in the Combination, partially offset by the sale of the Bowen Building and Summit I and II and a decrease in occupancy at 2345 Crystal Drive. Multifamily: Rental revenue increased by $8.2$2.8 million, or 49.1%11.2%, to $27.7 million in 2018 from $24.9 million in 2017 from $16.7 million in 2016.2017. Consolidated NOI increased by $4.9$883,000, or 5.8%, to $16.1 million or 47.8%, toin 2018 from $15.2 million in 2017 from $10.3 million in 2016.2017. The increase in rental revenue and consolidated NOI is primarily due to the Combinationplacing 1221 Van Street into service and an increase in occupancy and associated rentals at The Bartlett which was placed into service in the second quarter of 2016.Bartlett. Other: Rental revenue decreased by $1.0$2.2 million, or 18.5%51.1%, to $2.1 million in 2018 from $4.3 million in 2017 from $5.3 million in 2016. Net operating income (loss)2017. Consolidated NOI decreased by $1.6$1.1 million or 133.8%, to a loss of $1.5 million in 2018 from a loss of $407,000 from income of $1.2 million. The decrease in revenue and net operating income (loss) is primarily2017 due to properties which wereexpenses associated with land assets acquired in the Combination and 501 15th Street being taken out of service, including 1700 M Street and 1770 Crystal Drive.service. Comparison of the Nine Months Ended September 30, 2017 compared2018 to September 30, 20162017 Office: Rental revenue increased by $9.7$45.4 million, or 3.7%16.7%, to $317.7 million in 2018 from $272.3 million in 2017 from $262.6 million in 2016.2017. Consolidated NOI increased by $5.7$30.9 million, or 3.6%18.9%, to $194.6 million in 2018 from $163.7 million in 2017 from $158.0 million in 2016.2017. The increase in rental revenue and consolidated NOI is primarily due to revenue associated with assets acquired in the Combination, including placing CEB Tower at Central Place into service, and higher rents due to rent commencements, partially offset by the sale of the Bowen Building and Summit I and II, and a decrease in occupancy at 1215 S. Clark St.2345 Crystal Drive and 7200 Wisconsin Avenue. Multifamily: Rental revenue increased by $18.2$14.6 million, or 38.2%22.2%, to $80.4 million in 2018 from $65.8 million in 2017 from $47.6 million in 2016.2017. Consolidated NOI increased by $11.1$5.9 million, or 37.3%14.3%, to $47.0 million in 2018 from $41.1 million in 2017 from $30.0 million in 2016.2017. The increase in rental revenue and consolidated NOI is primarily due to the assets acquired in the Combination, including placing 1221 Van Street into service, and an increase in occupancy and associated rentals at The Bartlett which was placed into service in the second quarter of 2016.Bartlett. Other: Rental revenue decreased by $9.5$3.8 million, or 48.2%37.1%, to $6.5 million in 2018 from $10.3 million in 2017 from $19.82017. Consolidated NOI decreased by $0.9 million to a loss of $3.0 million in 2016. Net operating income (loss) decreased by $5.0 million, or 454.9%, to2018 from a loss of $3.9 million from income of $1.1 million. The decrease in revenue and net operating income (loss) is primarily2017 due to properties which wereexpenses associated with land assets acquired in the Combination and 501 15th Street being taken out of service, including 1700 M Street and 1770 Crystal Drive.service.
Liquidity and Capital Resources Property rental income is our primary source of operating cash flow and is dependent on a number of factors including occupancy levels and rental rates, as well as our tenants’ ability to pay rent. In addition, to our portfolio, we have a third-party real estate services business that provides fee-based real estate services to our real estate ventures,the legacy funds formerly organized by JBG ("JBG Legacy Funds") and other third parties. Our assets provide us with a relatively consistent level of cash flow that enables us to pay operating expenses, debt service, recurring capital expenditures, dividends to shareholders and distributions to holders of OP Units. Other sources of liquidity to fund cash requirements include proceeds from financings, the issuance of equity securities and asset sales. We anticipate that cash flows from continuing operations over the next 12 months and proceeds from financings, recapitalizations and asset sales, together with existing cash balances, will be adequate to fund our business operations, debt amortization, capital expenditures, dividends to shareholders and distributions to holders of OP Units.Units over the next 12 months. Financing Activities The following is a summary of mortgages payable as of September 30, 2017 and December 31, 2016:payable: | | | | | | | | | | | | | | Weighted Average Interest Rate | | Balance as of | | | September 30, 2017 | | September 30, 2017 | | December 31, 2016 | | | | | (In thousands) | Variable rate (1) | | 2.95% | | $ | 1,152,106 |
| | $ | 547,291 |
| Fixed rate (2) | | 4.79% | | 836,141 |
| | 620,327 |
| Mortgages payable (3) | | | | 1,988,247 |
| | 1,167,618 |
| Unamortized deferred financing costs and premium/discount, net | | | | (10,573 | ) | | (2,604 | ) | Mortgages payable, net | | | | $ | 1,977,674 |
| | $ | 1,165,014 |
| Payable to former parent (4) | | — | | $ | — |
| | $ | 283,232 |
|
| | | | | | | | | | | | | | Weighted Average Effective Interest Rate (1) | | September 30, 2018 | | December 31, 2017 | | | | | (In thousands) | Variable rate (2) | | 4.16% | | $ | 182,996 |
| | $ | 498,253 |
| Fixed rate (3) (4) | | 4.19% | | 1,590,983 |
| | 1,537,706 |
| Mortgages payable | | | | 1,773,979 |
| | 2,035,959 |
| Unamortized deferred financing costs and premium/ discount, net | | | | (4,041 | ) | | (10,267 | ) | Mortgages payable, net | | | | $ | 1,769,938 |
| | $ | 2,025,692 |
|
__________________________ | | (1) | Includes variable rate mortgages payable withWeighted average effective interest rate caps.as of September 30, 2018. |
| | (2) | Includes variable rate mortgages payable with interest rates effectively fixed pursuant to rate swaps.cap agreements. |
| | (3) | Includes variable rate mortgages payable assumedwith interest rates fixed by interest rate swap agreements. |
| | (4) | Excludes the mortgage payable of $42.0 million related to 1233 20th Street, which is included in "Liabilities related to assets held for sale" in our balance sheet as partof September 30, 2018. This mortgage was repaid in October 2018 concurrent with the closing of the Combination.sale. See Note 3 to the financial statements for additional information. |
| | (4)
| In June 2016, the mortgage loan for the Bowen Building was repaid with proceeds of a $115.6 million draw on our former parent's revolving credit facility collateralized by an interest in the property, and, accordingly, was reflected as a component of "Payable to former parent" on the combined balance sheets as of December 31, 2016. We repaid the loan with amounts drawn under our revolving credit facility collateralized by a mortgage on the property. |
As of September 30, 2017,2018, the net carrying value of real estate collateralizing our mortgages payable, excluding assets held for sale, totaled $3.9$2.3 billion. Our mortgage loans contain covenants that limit our ability to incur additional indebtedness on these properties and in certain circumstances, require lender approval of tenant leases and/or yield maintenance upon repayment prior to maturity. AsCertain of September 30, 2017, we were in compliance with all debt covenants.our mortgage loans are recourse to us. As part of the Combination, we assumed mortgages payable with an aggregate principal balance of $768.5 million. During the threenine months ended September 30, 2017, we2018, aggregate borrowings related to construction draws under mortgages payable totaled $43.8 million. We repaid mortgages payable with an aggregate principal balance of $181.7$251.1 million which includes mortgages payable totaling $63.7 million assumed in the Combination. Weand recognized losses on the extinguishment of debt in conjunction with these repayments of $689,000$79,000 and $4.5 million for the three and nine months ended September 30, 2017.2018.
On July 18,As of September 30, 2018 and December 31, 2017, we had various interest rate swap and cap agreements with an aggregate notional value of $1.3 billion and $1.4 billion on certain of our mortgages payable, which mature on various dates concurrent with the maturity of the related mortgages payable. During the nine months ended September 30, 2018, we entered into avarious interest rate swap and cap agreements on certain of our mortgages payable with an aggregate notional value of $381.3 million.
Our $1.4 billion credit facility, consistingconsists of a $1.0 billion revolving credit facility maturing in July 2021, with two six-month extension options, a delayed draw $200.0 million unsecured term loan ("Tranche A-1 Term Loan") maturing in January 2023 andLoan, a delayed draw $200.0 million unsecured term loan ("maturing in January 2023, and a Tranche A-2 Term Loan")Loan, a delayed draw $200.0 million unsecured term loan maturing in July 2024. The interest rate for the credit facility varies based on a ratio of our total outstanding indebtedness to a valuation of certain real property and assets and ranges (a) in the case of the revolving credit facility, from LIBOR plus 1.10% to LIBOR plus 1.50%, (b) in the case of the Tranche A-1 Term Loan, from LIBOR plus 1.20% to LIBOR plus 1.70% and (c) in the case of the Tranche A-2 Term Loan, from LIBOR plus 1.55% to LIBOR plus 2.35%. On July 18, 2017, in connection with the Combination,
In January 2018, we drew $115.8 million on the revolving credit facility and $50.0 million under the Tranche A-1 Term Loan. In connectionLoan in accordance with the executiondelayed draw provisions of the credit facility, bringing the outstanding borrowings under the term loan facility to $100.0 million. Concurrent with the draw, we incurred $11.2entered into an interest rate swap agreement to convert the variable interest rate to a fixed interest rate. As of September 30, 2018 and December 31, 2017, we had interest rate swaps with an aggregate notional value of $100.0 million and $50.0 million to convert the variable interest rate applicable to our Tranche A-1 Term Loan to a fixed interest rate, providing weighted average base interest rates under the facility agreement of 2.12% and 1.97% per annum. The interest rate swaps mature in fees and expenses.January 2023, concurrent with the maturity of our Tranche A-1 Term Loan. In July 2018, we drew $200.0 million under the Tranche A-2 Term Loan, in accordance with the delayed draw provisions of the credit facility.
The following is a summary of amounts outstanding under the credit facility as of September 30, 2017:facility: | | | | Interest Rate | | Balance as of | | Interest Rate (1) | | September 30, 2018 | | December 31, 2017 | | | September 30, 2017 | | September 30, 2017 | | (In thousands) | | | (In thousands) | | Revolving credit facility (1) | | 2.34% | | $ | 115,751 |
| | Revolving credit facility (2) (3) (4) (5) | | | 3.36% | | $ | — |
| | $ | 115,751 |
| | | | | | | | Tranche A-1 Term Loan | | 2.44% | | $ | 50,000 |
| | 3.32% | | $ | 100,000 |
| | $ | 50,000 |
| Tranche A-2 Term Loan | | | 3.81% | | 200,000 |
| | — |
| Unsecured term loans | | | 300,000 |
| | 50,000 |
| Unamortized deferred financing costs, net | | (3,611 | ) | | (3,019 | ) | | (3,463 | ) | Unsecured term loan, net | | $ | 46,389 |
| | Unsecured term loans, net | | | $ | 296,981 |
| | $ | 46,537 |
|
__________________________ | | (1) | Interest rate as of September 30, 2018. |
| | (2) | As of September 30, 2018 and December 31, 2017, letters of credit with an aggregate face amount of $5.2$5.7 million for both periods were provided under our revolving credit facility. |
| | (3) | As of September 30, 2018 and December 31, 2017, net deferred financing costs related to our revolving credit facility totaling $5.3 million and $6.7 million were included in "Other assets, net." |
| | (4) | In May 2018, in connection with the sale of the Bowen Building, we repaid $115.0 million of the then outstanding balance on our revolving credit facility. See Note 3 to the financial statements for additional information. |
| | (5) | The interest rate for the revolving credit facility excludes a 0.15% facility fee. |
In July 2018, we entered into an equity distribution agreement with various financial institutions relating to the issuance of up to $200.0 million of our common shares from time to time. We may use net proceeds from the issuance of common shares under this program for general corporate purposes, which may include paying down our indebtedness and funding our under construction assets and future development opportunities.
In July 2018, we commenced a dividend reinvestment program, whereby shareholders may use their dividends and optional cash payments to purchase common shares. The common shares sold under this program may either be common shares issued by us or common shares purchased in the open market. Long-term Liquidity Requirements Our long-term capital requirements consist primarily of maturities under our credit facility and mortgage loans, construction commitments for development and redevelopment projects and costs related to growing our business, including acquisitions. We intend to fund these requirements through a combination of sources including available cash, debt proceeds, proceeds from asset recapitalizations and sales capital from institutional partners that desire to form real estate venture relationships with us and available cash.other financing sources, including issuances of equity. Contractual Obligations and Commitments
Below is a summaryDuring the nine months ended September 30, 2018, there were no material changes to the contractual obligation information presented in Item 7 of Part II of our contractual obligationsAnnual Report on Form 10-K for the year ended December 31, 2017. The only significant change was a $85.8 million decrease in outstanding debt primarily from repayments of mortgages payable and commitments asour revolving credit facility, partially offset by draws of September 30, 2017:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | Total | | 2017 | | 2018 | | 2019 | | 2020 | | 2021 | | 2022 | | Thereafter | Contractual cash obligations (principal and interest): | (In thousands) | Debt obligations (1) | $ | 2,480,892 |
| | $ | 23,597 |
| | $ | 464,528 |
| | $ | 294,361 |
| | $ | 276,060 |
| | $ | 261,943 |
| | $ | 371,899 |
| | $ | 788,504 |
| Operating leases (2) | 914,903 |
| | 1,974 |
| | 8,391 |
| | 8,170 |
| | 7,825 |
| | 7,496 |
| | 6,580 |
| | 874,467 |
| Capital lease obligation | 15,767 |
| | 235 |
| | 953 |
| | 972 |
| | 992 |
| | 1,011 |
| | 1,032 |
| | 10,572 |
| Total contractual cash obligations (3) | $ | 3,411,562 |
| | $ | 25,806 |
| | $ | 473,872 |
| | $ | 303,503 |
| | $ | 284,877 |
| | $ | 270,450 |
| | $ | 379,511 |
| | $ | 1,673,543 |
|
_________________$50.0 million under the Tranche A-1 Term Loan and $200.0 million under the Tranche A-2 Term Loan, in accordance with the delayed draw provisions of the credit facility.
| | (1)
| Excludes our proportionate share of unconsolidated real estate venture indebtedness. See further information in Off-Balance Sheet Arrangements section below. |
| | (2)
| Includes ground leases. |
| | (3)
| Excludes obligations related to construction or development contracts, since payments are only due upon satisfactory performance under the contracts. See Commitments and Contingencies section below for further information. |
As of September 30, 2017,2018, we expect to fund additional capital to certain of our unconsolidated investments totaling approximately $50.6$48.6 million, which we anticipate will be primarily expended over the next two to three years. OnIn November 9, 2017, after completion of the period covered by this Quarterly Report on Form 10-Q,2018, our Board of Trustees declared a quarterly dividend of $0.225 per common share, payable on November 30, 2017 to shareholders of record on November 20, 2017.
See Note 18 to the financial statements for additional information about events occurring after September 30, 2017.
share.
Summary of Cash Flows The following summary discussion of our cash flows is based on the statements of cash flows and is not meant to be an all-inclusive discussion of the changes in our cash flows for the periods presented below.flows: | | | | | | | | | | | | | | Nine Months Ended September 30, | | 2017 | | 2016 | | Change | | (In thousands) | Net cash provided by operating activities | $ | 23,393 |
| | $ | 101,383 |
| | $ | (77,990 | ) | Net cash provided by (used in) investing activities | 88,184 |
| | (204,105 | ) | | 292,289 |
| Net cash provided by financing activities | 227,319 |
| | 63,040 |
| | 164,279 |
|
| | | | | | | | | | | | | | Nine Months Ended September 30, | | 2018 | | 2017 | | Change | | (In thousands) | Net cash provided by operating activities | $ | 136,661 |
| | $ | 23,393 |
| | $ | 113,268 |
| Net cash provided by investing activities | 88,881 |
| | 102,442 |
| | (13,561 | ) | Net cash (used in) provided by financing activities | (183,890 | ) | | 227,319 |
| | (411,209 | ) |
Cash Flows for the Nine Months Ended September 30, 2018 Cash and cash equivalents and restricted cash increased $41.7 million to $380.2 million as of September 30, 2018 compared to $338.6 million as of December 31, 2017. This increase resulted from $136.7 million of net cash provided by operating activities and $88.9 million of net cash provided by investing activities, partially offset by $183.9 million of net cash used in financing activities. Our outstanding debt, including mortgages payable classified as "Liabilities related to assets held for sale", was $2.1 billion as of September 30, 2018 compared to $2.2 billion as of December 31, 2017. The $85.8 million decrease in outstanding debt is primarily from repayments of mortgages payable and our revolving credit facility, partially offset by draws under the Tranche A-1 and Tranche A-2 Term Loans. Net cash provided by operating activities of $136.7 million primarily comprised: (i) $181.7 million of net income (before $181.9 million of non-cash items and a $45.8 million gain on sale of real estate) and (ii) $6.8 million of return on capital from unconsolidated real estate ventures, partially offset by $51.9 million of net change in operating assets and liabilities. Non-cash income adjustments of $181.9 million primarily include depreciation and amortization, share-based compensation expense, reduction of gain on bargain purchase and deferred rent. Net cash provided by investing activities of $88.9 million primarily comprised: (i) $346.1 million of proceeds from sale of real estate and (ii) $24.6 million distribution of capital from sale of interest in an unconsolidated real estate venture, partially offset by (iii) $260.4 million of development costs, construction in progress and real estate additions and (iv) $22.7 million of investments in and advances to unconsolidated real estate ventures. Net cash used in financing activities of $183.9 million primarily comprised: (i) $267.3 million of repayment of mortgages payable, (ii) $150.8 million repayment of our revolving credit facility, (iii) $80.2 million of dividends paid to common shareholders and (iv) $13.3 million of distributions to redeemable noncontrolling interests, partially offset by (v) $250.0 million of proceeds from borrowings under our unsecured term loans, (vi) $43.8 million of aggregate proceeds from borrowings under mortgages payable and (vii) $35.0 million of borrowings under our revolving credit facility. Cash Flows for the Nine Months Ended September 30, 2017 Cash and cash equivalents and restricted cash were $367.9$385.4 million at as of September 30, 2017 compared to $29.0$32.3 million at as of December 31, 2016, an increase of $338.9 million.$353.2 million. This increase resulted from $23.4$227.3 million of net cash provided by financing activities, $102.4 million of net cash provided by investing activities and $23.4 million of net cash provided by operating activities, $88.2 million of net cash used in investing activities and $227.3 million of net cash provided by financing activities. Our outstanding debt was $2.1 billion at September 30, 2017, a $974.8 million increase from the balance at December 31, 2016. Net cash provided by operating activities of $23.4 million primarily comprised: (i) $40.5 million of net loss of $60.3 million, (ii) $110.7income (before $100.8 million of non-cash items, which include depreciationitems) and amortization, deferred rent, equity in loss from unconsolidated real estate ventures, amortization(ii) $1.1 million of above- and below-market lease intangibles, unrealized gains on interest rate swaps and bad debt expense, (iii) share-based compensation of $17.2 million, (iv) return on capital from unconsolidated real estate ventures, of $1.1 million, and (v) $689,000 loss on the extinguishment of debt, partially offset by (vi) $27.8(iii) $18.2 million gain on bargain purchase and (vii) theof net change in operating assets and liabilitiesliabilities. Non-cash income adjustments of $18.2 million.$100.8 million primarily include depreciation and amortization, gain on bargain purchase, share-based compensation expense, deferred rent, amortization of lease incentives and other non-cash items. Net cash provided by investing activities of $88.2$102.4 million primarily comprised: (i) $83.9$97.4 million net cash and restricted cash consideration received in connection with the Combination, (ii) $75.0 million of proceeds from repayment of a receivable by our former parent and (iii) $50.9 million repayment of notes receivable, partially offset by (iv) $115.9 million of development costs, construction in progress and real estate additions.additions and (v) $3.5 million of other investments.
Net cash provided by financing activities of $227.3 million primarily comprised: (i) $407.8$242.0 million of proceeds from borrowings related to the credit facility and The Bartlett andunder mortgages payable, (ii) $160.2 million of net contributions from our former parent, net, partially offset by (iii) $192.7$115.8 million for the repayments of borrowings under our revolving credit facility, (iv) $115.6 million repayment of borrowings by our former parent, (v) $17.8 million capital lease payments and (vi) $18.7$50.0 million of debt issuance costs. Cash Flows for the Nine Months Ended September 30, 2016
Cashproceeds from borrowings under our unsecured term loan and cash equivalents were $35.3 million at September 30, 2016, compared to $75.0 million at December 31, 2015, a decrease of $39.7 million. This decrease resulted from $204.1 million of net cash used in investing activities, partially offset by $101.4 million of net cash provided by operating activities and $63.0 million of net cash provided by financing activities.
Net cash provided by operating activities of $101.4 million comprised: (i) net income of $49.3 million, (ii) $92.4 million of non-cash adjustments, which include depreciation and amortization, loss from unconsolidated real estate ventures, deferred rent and accretion of below-market lease intangibles and (iii) distributions of income from unconsolidated real estate ventures of $1.0 million, partially offset by (iv) the net change in operating assets and liabilities of $45.5 million.
Net cash used in investing activities of $204.1 million comprised: (i) $185.4 million of development costs, construction in progress and real estate additions, (ii) $20.0 million of investments in and advances to unconsolidated real estate ventures and (iii) $1.9 million of other investments, partially offset by (iv) a decrease of $3.2 million in restricted cash.
Net cash provided by financing activities of $63.0 million primarily comprised : (i) $39.0(v) $4.0 million of proceeds from borrowings from our former parent, and (ii) $33.0 million of net contributions from our former parent, partially offset by (iii) $8.9(vi) $192.7 million for the repaymentsrepayment of borrowings.mortgages payable, (vii) $115.6 million repayment of borrowings from former parent, (viii) $18.7 million of debt issuance costs and (ix) $17.8 million of capital lease payments.
Off-Balance Sheet Arrangements Unconsolidated Real Estate Ventures We consolidate entities in which we own less than a 100% equity interest if we have a controlling interest or are the primary beneficiary in a variable interest entity. From time to time, we may have off-balance-sheet unconsolidated real estate ventures and other unconsolidated arrangements with varying structures. As of September 30, 2017,2018, we have investments in and advances to unconsolidated real estate ventures totaling $285.0$361.0 million. For the majority of these investments, we exercise significant influence over, but do not control these entities and therefore account for these investments using the equity method of accounting. For a more complete description of our jointreal estate ventures, see Note 54 to the financial statements. From time to time, we (or ventures in which we have an ownership interest) have agreed, and may in the future agree with respect to unconsolidated real estate ventures, to (1) guarantee portions of the principal, interest and other amounts in connection with their borrowings, (2) provide customary environmental indemnifications and nonrecourse carve-outs (e.g., guarantees against fraud, misrepresentation and bankruptcy) in connection with their borrowings and (3) provide guarantees to lenders and other third parties for the completion of development projects. We customarily have agreements with our outside partners whereby the partners agree to reimburse the jointreal estate venture or us for their share of any payments made under certain of these guarantees. Amounts that may be required to be paid in future periods in relation to budget overruns or operating losses that are also included in some of our guarantees are not estimable. Guarantees (excluding environmental) terminate either upon the satisfaction of specified circumstances or repayment of the underlying debt. At times, we have agreements with our outside partners whereby we agree to reimburse our partner for their share of any payments made by them under certain guarantees. As of September 30, 2017, the aggregate amount of our2018, there were no principal payment guarantees was approximately $63.8 million for our unconsolidated real estate ventures. As of September 30, 2017,2018, we expect to fund additional capital to certain of our unconsolidated investments totaling approximately $50.6$48.6 million, which we anticipate will be primarily expended over the next two to three years. Reconsideration events could cause us to consolidate these unconsolidated real estate ventures and partnerships in the future.future or deconsolidate a consolidated entity. We evaluate reconsideration events as we become aware of them. Some triggers to be considered are additional contributions required by each partner and each partners’ ability to make those contributions. Under certain of these circumstances, we may purchase our partner’s interest. Our unconsolidated real estate ventures are held in entities which appear sufficiently stable to meet their capital requirements; however, if market conditions worsen and our partners are unable to meet their commitments, there is a possibility we may have to consolidate these entities.
Commitments and Contingencies Insurance We maintain general liability insurance with limits of $200.0 million per occurrence and in the aggregate, and property and rental value insurance coverage with limits of $2.0 billion per occurrence, with sub-limits for certain perils such as floods and earthquakes on each of our properties. We also maintain coverage, through our wholly owned captive insurance subsidiary, for both terrorist acts and for nuclear, biological, chemical or radiological terrorism events with limits of $2.0 billion per occurrence and in the aggregate, and $2.0 billion per occurrence and in the aggregate for nuclear, biological, chemical and radiological terrorism events, as definedoccurrence. These policies are partially reinsured by the Terrorism Risk Insurance Program Reauthorization Act, which expires in December 2020. Insurance premiums are charged directly to each of the properties.third-party insurance providers. We will continue to monitor the state of the insurance market and the scope and costs of coverage for acts of terrorism. We cannot anticipate what coverage will be available on commercially reasonable terms in the future. We are responsible for deductibles and losses in excess of the insurance coverage, which could be material. Our debt, consisting of mortgage loans secured by our properties, revolving credit facility and unsecured term loans contain customary covenants requiring adequate insurance coverage. Although we believe that we currently have adequate insurance coverage, we may not be able to obtain an equivalent amount of coverage at reasonable costs in the future. If lenders insist on greater coverage than we are able to obtain, it could adversely affect the ability to finance or refinance our properties.
Construction Commitments As of September 30, 2017,2018, we have construction in progress that will require an additional $707.8$396.2 million to complete ($611.1310.8 million related to our consolidated entities and $96.7$85.4 million related to our unconsolidated real estate ventures at our share), based on our current plans and estimates, which we anticipate will be primarily expended over the next two to three years. These capital expenditures are generally due as the work is performed, and we expect to finance them with debt proceeds, proceeds from asset recapitalizations and sales, and available cash. Other There are various legal actions against us in the ordinary course of business. In our opinion, the outcome of such matters will not have a material adverse effect on our financial condition, results of operations or cash flows. AsIn connection with the Formation Transaction, we entered into an agreement with Vornado regarding tax matters (the "Tax Matters Agreement") that provides special rules that allocate tax liabilities if the distribution of September 30, 2017,JBG SMITH shares by Vornado, together with certain related transactions, is not tax-free. Under the Tax Matters Agreement, we expectmay be required to fund additional capital to certain of our unconsolidated investments totaling approximately $50.6 million, which we anticipate will be primarily expended over the next two to three years.
Inflation
Substantially all of our officeindemnify Vornado against any taxes and retail leases contain provisions designed to mitigate the adverse impact of inflation. These provisions generally increase rental rates or reimbursable expenses during the termsrelated amounts and costs resulting from a violation by us of the lease either at (i) fixed rates, (ii) indexed escalations (based onTax Matters Agreement, or from the Consumer Price Indextaking of other measures) or (iii) the lesser of a fixed rate or an indexed escalation. We may be adversely impactedcertain restricted actions by inflation on the leases that do not contain indexed escalation provisions or when the increases provided by the escalation provisions are less than inflation. In addition, most of our office and retail leases require the tenant to pay an allocable share of operating expenses, including common area maintenance costs, real estate taxes and insurance. We believe that inflationary increases may be at least partially offset by the contractual rent increases and expense escalations described above. Our majority multifamily properties are subject to one-year leases, which provide us with the opportunity to adjust rental rates annually and mitigate the impact of inflation. We do not believe inflation has had a material impact on our historical financial position or results of operations.
us.
Environmental Matters Under various federal, state and local laws, ordinances and regulations, an owner of real estate is liable for the costs of removal or remediation of certain hazardous or toxic substances on such real estate. These laws often impose such liability without regard to whether the owner knew of, or was responsible for, the presence of such hazardous or toxic substances. The costs of remediation or removal of such substances may be substantial and the presence of such substances, or the failure to promptly remediate such substances, may adversely affect the owner’s ability to sell such real estate or to borrow using such real estate as collateral. In connection with the ownership and operation of our assets, we may be potentially liable for such costs. The operations of current and former tenants at our assets have involved, or may have involved, the use of hazardous materials or generated hazardous wastes. The release of such hazardous materials and wastes could result in us incurring liabilities to remediate any resulting contamination if the responsible party is unable or unwilling to do so. In addition, our assets are exposed to the risk of contamination originating from other sources. While a property owner generally ismay not be responsible for remediating contamination that has migrated onsite from an identifiable and viable offsite source, the contaminant’s presence can have adverse effects on operations and the redevelopment of our assets.
Most of our assets have been subject, at some point, to environmental assessments that are intended to evaluate the environmental condition of the subject and surrounding assets. These environmental assessments generally have included a historical review, a public records review, a visual inspection of the site and surrounding assets, screening for the presencevisual or historical evidence of asbestos‑containing materials, polychlorinated biphenyls and underground storage tanks, and the preparation and issuance of a written report. Soil and/or groundwater subsurface testing is conducted at our assets, when necessary, to further investigate any issues raised by the initial assessment that could reasonably be expected to pose a material concern to the property or result in us incurring material environmental liabilities.liabilities as a result of redevelopment. They may not, however, have included extensive sampling or subsurface investigations. In each case where the environmental assessments have identified conditions requiring remedial actions required by law, we have initiated the appropriate actions.
Each of our properties has been subjected to varying degrees of environmental assessment at various times. The environmental assessments did not reveal any material environmental contamination that we believe would have a material adverse effect on our overall business, financial condition or results of operations.operations, or that have not been anticipated and remediated during site redevelopment as required by law. Nevertheless, there can be no assurance that the identification of new areas of contamination, changes in the extent or known scope of contamination, the discovery of additional sites or changes in cleanup requirements would not result in significant cost to us.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Interest Rate Risk We have exposure to fluctuations in interest rates, which are sensitive to many factors that are beyond our control. Our exposure to a change in interest rates is summarized in the table below. | | | 2017 | | 2016 | September 30, 2018 | | December 31, 2017 | (Amounts in thousands) | September 30, | | Weighted Average Interest Rate | | Effect of 1% Change in Base Rates | | December 31, | | Weighted Average Interest Rate | | | Balance | | Balance | | | | Weighted Average Effective Interest Rate | | Effect of 1% Change in Base Rates | | | | Weighted Average Effective Interest Rate | Consolidated debt (contractual balances): | | | | | | | | | | | | Balance | | Weighted Average Effective Interest Rate | | Effect of 1% Change in Base Rates | | Balance | | Weighted Average Effective Interest Rate | Debt (contractual balances): | | (Dollars in thousands) | Mortgages payable | | | | | | | | | | | | | | | | | | Variable rate (1) | $ | 1,152,106 |
| | 2.95 | % | | $ | 11,681 |
| | $ | 547,291 |
| | 2.11% | $ | 182,996 |
| | 4.16 | % | | $ | 1,855 |
| | $ | 498,253 |
| | 3.62 | % | Fixed rate (2) | 836,141 |
| | 4.79 | % | | — |
| | 620,327 |
| | 5.52% | | Fixed rate (2) (3) | | 1,590,983 |
| | 4.19 | % | | — |
| | 1,537,706 |
| | 4.25 | % | | $ | 1,988,247 |
| | | | $ | 11,681 |
| | $ | 1,167,618 |
| | $ | 1,773,979 |
| | | | $ | 1,855 |
| | $ | 2,035,959 |
| | | Credit facility (variable rate): | | | | | | | | | | | | | | | | | | Revolving credit facility | $ | 115,751 |
| | 2.34 | % | | $ | 1,174 |
| | — |
| | — | $ | — |
| | 3.36 | % | | $ | — |
| | $ | 115,751 |
| | 2.66 | % | Tranche A-1 Term Loan(4) | 50,000 |
| | 2.44 | % | | $ | 507 |
| | — |
| | — | 100,000 |
| | 3.32 | % | | — |
| | 50,000 |
| | 3.17 | % | | | | | | | | | | | Tranche A-2 Term Loan | | 200,000 |
| | 3.81 | % | | 2,028 |
| | — |
| | — |
| Pro rata share of debt of unconsolidated entities (contractual balances): | | | | | | | | | | | | | | | | | | Variable rate (1) | $ | 159,169 |
| | 4.08 | % | | $ | 1,614 |
| | $ | 17,050 |
| | 1.87% | $ | 151,668 |
| | 5.66 | % | | $ | 1,538 |
| | $ | 158,154 |
| | 4.40 | % | Fixed rate (2) | 230,541 |
| | 3.90 | % | | — |
| | 150,150 |
| | 3.65% | 292,222 |
| | 4.08 | % | | — |
| | 238,138 |
| | 3.79 | % | | $ | 389,710 |
| | | | $ | 1,614 |
| | $ | 167,200 |
| | $ | 443,890 |
| | | | $ | 1,538 |
| | $ | 396,292 |
| | |
_________________________________
| | (1) | Includes variable rate mortgages payable with interest rate caps.cap agreements. |
| | (2) | Includes variable rate mortgages payable with interest rates effectively fixed pursuantby interest rate swaps.swap agreements. |
| | (3) | Excludes the mortgage payable of $42.0 million related to 1233 20th Street, which is included in "Liabilities related to assets held for sale" in our balance sheet as of September 30, 2018. This mortgage was repaid in October 2018 concurrent with the closing of the sale. See Note 3 to the financial statements for additional information. |
| | (4) | As of September 30, 2018 and December 31, 2017, the outstanding balance was fixed by interest rate swap agreements. |
The fair value of our consolidated debtmortgages payable is calculatedestimated by discounting the future contractual cash flows of these instruments using current risk‑adjustedrisk-adjusted rates available to borrowers with similar credit profiles based on market sources. The fair value of our revolving credit facility and unsecured term loans is calculated based on the net present value of payments over the term of the facilities using estimated market rates for similar notes and remaining terms. As of September 30, 20172018 and December 31, 20162017, the estimated fair value of our consolidated debt, excluding debt included in "Liabilities related to assets held for sale", was $2.1 billion and $1.2 billion, respectively.$2.2 billion. These estimates of fair value, which are made at the end of the reporting period, may be different from the amounts that may ultimately be realized upon the disposition of our financial instruments. Hedging Activities To manage, or hedge, our exposure to interest rate risk, we follow established risk management policies and procedures, including the use of a variety of derivative financial instruments. We do not enter into derivative financial instruments for speculative purposes. Derivative Financial Instruments Designated as Cash Flow Hedges Certain derivative financial instruments, consisting of interest rate swap and cap agreements, are designated as cash flow hedges, and are carried at their estimated fair value on a recurring basis. We assess the effectiveness of our cash flow hedges both at inception and on an ongoing basis. If the hedges are deemed to be effective, the fair value is recorded in accumulated other comprehensive income and is subsequently reclassified into "Interest expense" in the period that the hedged forecasted transactions affect earnings. Our cash flow hedges become less than perfectly effective if the critical terms of the hedging instrument and the forecasted transactions do not perfectly match such as notional amounts, settlement dates, reset dates, calculation period and interest rates. In addition, we evaluate the default risk of the counterparty by monitoring the credit worthiness of the counterparty. While management believes its judgments are reasonable, a change in a derivative’s effectiveness as a hedge could materially affect expenses, net income and equity. As of September 30, 2018, we had interest rate swap and cap agreements with an aggregate notional value of $738.9 million, which were designated as cash flow hedges. As of September 30, 2018, the fair value of our interest rate swaps and caps designated as cash flow hedges consisted of assets totaling $21.1 million included in "Other assets, net" in our balance sheet, and liabilities totaling $1.0 million included in "Other liabilities, net" in our balance sheet.
Derivative Financial Instruments Not Designated as Hedges Certain derivative financial instruments, consisting of interest rate swap and cap agreements, are considered economic hedges, but not designated as accounting hedges, and are carried at their estimated fair value on a recurring basis with realizedbasis. Realized and unrealized gains are recorded into earningsin "Interest expense" in the statements of operations in the period in which the change occurs. As of September 30, 2017,2018, we had various interest rate swap and cap agreements assumed in the Combination.with an aggregate notional value of $646.0 million, which were not designated as cash flow hedges. As of September 30, 2017,2018, the fair value of our interest rate swaps and caps not designated as hedges consisted of liabilitiesassets totaling $703,000$7.2 million included in "Accounts payable and accrued expenses""Other assets, net" in our balance sheet.
ITEM 4. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures We maintain disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e)As required by Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended, (the "Exchange Act"), that are designed to provide reasonable assurance that information required to be disclosed in our 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 and Chief Financial Officer, 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.
As required by Rule 13a-15(b) under the Exchange Act, we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of September 30, 2017,2018, our disclosure controls and procedures were effective at the reasonable assurance level such that the information required to be disclosed by us in reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.effective.
Changes in Internal Control over Financial Reporting There have been no changes in our internal control over financial reporting during the quarter ended September 30, 20172018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II – OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS We are, from time to time, involved in legal actions arising in the ordinary course of business. In our opinion, the outcome of such matters is not expected to have a material adverse effect on our financial position, results of operations or cash flows. ITEM 1A. RISK FACTORS
There werehave been no material changes to the Risk Factorsrisk factors previously disclosed in our Information Statement on Form 10, as amended,Annual Report for the year ended December 31, 2017, filed with the SEC on June 20, 2017.March 12, 2018.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a) Not applicable.
(b) Not applicable.
(c) Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION None.
ITEM 6. EXHIBITS
(a) Exhibit Index | | | Exhibits | Description | | | 2.1 | Amendment to Master Transaction Agreement, dated as of July 17, 2017, by and among Vornado Realty Trust, Vornado Realty L.P., JBG Properties, Inc., JBG/Operating Partners, L.P., certain affiliates of JBG Properties Inc. and JBG/Operating Partners set forth on Schedule A thereto, JBG SMITH Properties and JBG SMITH Properties LP (incorporated by reference to Exhibit 2.1 to our Current Report on Form 8-K, filed on July 21, 2017). | | | 2.2 | | | | 2.3 | | | | 2.4 | | | | 2.5 | | | | 2.6 | | | | 2.7 | | | | 2.8 | | | | 2.9 | | | | 3.1 | | | | 3.2 |
| | | 3.3 |
| | | 3.4 | | | | 10.110.1** | | | | 10.2 | | | | 10.3 | | | | 10.4 | Credit Agreement, dated as of July 18, 2017, by and among JBG SMITH Properties LP, as Borrower, the financial institutions party thereto as lenders, and Wells Fargo Bank, National Association, as Administrative Agent (incorporated by reference to Exhibit 10.4 to our Current Report on Form 8-K, filed on July 21, 2017). | | | 10.5 | | | | 10.6 | | | |
| | | Exhibits | Description | 10.7 | | | | 10.8 | | | | 10.9 | | | | 10.10 | | | | 10.11 | | | | 10.12 | | | | 10.13 | | | | 31.131.1** | | | | 31.231.2** | | | | 32.132.1** | | | | 101.INS | XBRL Instance Document | | | 101.SCH | XBRL Taxonomy Extension Schema | | | 101.CAL | XBRL Extension Calculation Linkbase | | | 101.LAB | XBRL Extension Labels Linkbase | | | 101.PRE | XBRL Taxonomy Extension Presentation Linkbase | | | 101.DEF | XBRL Taxonomy Extension Definition Linkbase |
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SIGNATURE
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. | | | | | JBG SMITH Properties | | Date: | November 13, 20177, 2018 | /s/ Stephen W. Theriot | | Stephen W. Theriot
| Chief Financial Officer | | (Principal Financial and Accounting Officer) |
|