Forward-looking statements are based on estimates as of the date of this report. The Company disclaims any obligation to publicly release the results of any revisions to these forward-looking statements reflecting new estimates, events or circumstances after the date of this report.
The risks included here are not exhaustive. Other sections of this report may include additional factors that could adversely affect the Company’s business and financial performance. Moreover, the Company operates in a very competitive and rapidly changing environment. New risk factors emerge from time to time and it is not possible for management to predict all such risk factors, nor can it assess the impact of all such risk factors on the Company’s business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.
Cogdell Spencer Inc., incorporated in Maryland in 2005, together with its subsidiaries (the “Company”) is a fully-integrated, self-administered, and self-managed real estate investment trust (“REIT”) that invests in specialty office buildings for the medical profession, including medical offices and ambulatory surgery and diagnostic centers. The Company focuses on the ownership, delivery, acquisition, and management of strategically located medical office buildings (“MOBs”) and other healthcare related facilities in the United States of America. The Company has been built around understanding and addressing the full range of specialized real estate needs of the healthcare industry. The Company operates its business through Cogdell Spencer LP, its operating partnership subsidiary (the “Operating Partnership”), and its subsidiaries.
The Company’s growth strategy includes leveraging strategic relationships and its integrated ownership and design-build platform for new wholly-owned or partially-owned developments, new design-build construction projects for third parties, and off-market acquisitions. The Company will also continue to enter into development joint ventures with hospitals and physicians.
The Company derives a majority of its revenues from two main sources: 1) from rents received from tenants under existing leases in medical office buildings and other healthcare related facilities, and 2) from revenue earned from design-build construction contracts and development contracts.
The Company expects that rental revenue will remain stable due to multi-year, non-cancellable leases with annual rental increases based on the Consumer Price Index (“CPI”). Generally, the Company’s property operating revenues and expenses have remained consistent over time except for growth due to property developments and property acquisitions. The Company’s property portfolio is stable with an average occupancy rate of 91.5% as of December 31, 2009. The Company’s property management team has a proactive, customer-focused service approach that leads to faster response times and greater resources to serve tenants. The Company’s management believes a strong internal property management capability is a vital component of the Company’s business, both for the properties the Company owns and for those that the Company manages. Strong internal property management allows the Company to control property operating costs, increase tenant satisfaction, and reduce tenant turnover.
The Company has a national full-service planning, design and construction firm specializing in healthcare facilities. The Company, through a taxable REIT subsidiary (“TRS”), provides fully integrated solutions to healthcare facilities throughout the United States, including planning, architecture, engineering, construction, materials management, manufacturing, capital and development services. The Company is a leading design-builder of healthcare facilities with specialized expertise and concentration in high growth healthcare market segments and facility types. Founded in 1951, the Company and its predecessors have a 59 year track record of and reputation for delivering healthcare facilities with appropriate design, longevity, sustainability and excellent operational efficiency. Exclusively focused on the healthcare facilities market, the Company maintains long-term “trusted advisor” status with physicians and physician groups nationwide. The Company has successfully cultivated a client mix that is diversified in both geography and market focus and includes physician group practices and healthcare systems. The Company was ranked as the number one healthcare design-build firm for 2007 and 2008 by Modern Healthcare’s 2008 and 2009 Construction and Design Surveys.
Design-Build and development revenues and financial results can be affected by the amount and timing of capital spending by healthcare systems and providers, the demand for design-build and development services in the healthcare facilities market, the availability of construction level financing, and weather at the construction sites. Deterioration of market or economic conditions and volatility in the financial market has and could continue to influence future revenues, interest, and other costs.
As of December 31, 2009, the Company’s portfolio consisted of 111 medical office buildings and healthcare related facilities, serving 23 hospital systems in 12 states. The Company’s aggregate portfolio at December 31, 2009, was comprised of 62 consolidated wholly-owned and joint venture properties, one wholly-owned property held for sale and presented as discontinued operations, three unconsolidated joint venture properties, and 45 managed medical office buildings. At December 31, 2009, approximately 78.7% of the net rentable square feet of the Company’s wholly-owned properties were situated on hospital campuses. As such, the Company believes that its assets occupy a premier franchise location in relation to local hospitals, providing its properties with a distinct competitive advantage over alternative medical office space in an area. The Company believes that its property locations and relationships with hospitals will allow the Company to capitalize on the increasing healthcare trend of outpatient procedures.
At December 31, 2009, the Company’s aggregate portfolio contained approximately 5.7 million net rentable square feet, consisting of approximately 3.4 million net rentable square feet from consolidated wholly-owned and joint venture properties, 38,703 net rentable square feet from one wholly-owned property reclassified as discontinued operations, approximately 0.2 million net rentable square feet from unconsolidated joint venture properties, and approximately 2.1 million net rentable square feet from properties owned by third parties and managed by the Company. As of December 31, 2009, the Company’s 62 in-service, consolidated wholly-owned and joint venture properties were approximately 91.5% occupied, with a weighted average remaining lease term of approximately 4.5 years.
The Company’s Management and Design-Build Construction Companies
The Company elected to be taxed as a REIT for U.S. federal income tax purposes. In order to qualify as a REIT, a specified percentage of the Company’s gross income must be derived from real property sources, which would generally exclude the Company’s income from providing architectural, construction, development and management services to third parties. In order to avoid realizing such income in a manner that would adversely affect the Company’s ability to qualify as a REIT, some services are provided through the Company’s TRSs. Cogdell Spencer TRS Holdings, LLC and its subsidiaries (collectively “TRS Holdings”) have elected, together with the Company, to be treated as TRSs. TRS Holdings is wholly-owned and controlled by the Operating Partnership.
Management
The Company’s senior management team has an average of more than 22 years of healthcare real estate experience and has been involved in the development, redevelopment, engineering, design and construction, management, and acquisition of a broad array of medical office buildings and healthcare facilities. The Company’s Chairman and founder, James W. Cogdell, has been in the healthcare real estate business for more than 38 years, and Frank C. Spencer, the Company’s Chief Executive Officer, President and a member of its Board of Directors (the “Board of Directors”), has more than 14 years of experience in the industry. Scott Ransom, President, has more than 16 years of experience in the industry. Six members of the senior management team have entered into employment agreements with the Company. At December 31, 2009, the Company’s senior management team owned approximately 7.3% of the units of limited partnership interest in the Operating Partnership (“OP units”) and Company common stock on a fully diluted basis.
Business and Growth Strategies
The Company’s primary business objective is to develop and maintain client relationships in order to maximize total return to the Company’s stockholders through growth in cash available for distribution and appreciation in the value of the Company’s assets.
Operating Strategy
The Company’s operating strategy consists of the following principal elements:
| | • | Strong Relationships with Physicians and Hospitals. |
Healthcare is fundamentally a local business. The Company believes it has developed a reputation based on trust and reliability among physicians and hospitals and believes that these relationships position the Company to secure new development projects and new property acquisition opportunities with both new and existing parties. Many of the Company’s healthcare system clients have collaborated with the Company on multiple projects, including the Company’s five largest healthcare system property management clients, with whom the Company has an average relationship lasting more than 26 years. The Company’s strategy is to continue to grow its portfolio by leveraging these relationships and its integrated ownership and design-build platform to selectively develop new medical office buildings and healthcare related facilities in communities in need of additional facilities to support the delivery of medical services. The Company believes that physicians particularly value renting space from a trusted and reliable property owner that consistently delivers an office environment that meets their specialized needs.
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| | • | Active Management of the Company’s Properties. |
The Company has developed a comprehensive approach to property and operational management to maximize the operating performance of its medical office buildings and healthcare related facilities, leading to high levels of tenant satisfaction. This fully-integrated property and operating management allows the Company to provide high quality seamless services to its tenants on a cost-effective basis. The Company believes that its operating efficiencies, which consistently exceed industry standards, will allow the Company to control costs for its tenants. The Company intends to maximize the Company’s stockholders’ return on their investment and to achieve long-term functionality and appreciation in its medical office buildings and healthcare related facilities through continuing its practice of active management of its properties. The Company manages its properties with a view toward creating an environment that supports successful medical practices. The properties are clean and kept in a condition that is conducive to the delivery of top-quality medical care to patients. The Company understands that in order to maximize the value of its investments, its tenants must prosper as well. Therefore, the Company is committed to maintaining its properties at the highest possible level.| | | |
| | • | Key On-Campus Locations. |
At December 31, 2009, approximately 78.7% of the net rentable square feet of the Company’s wholly-owned properties were situated on hospital campuses. On-campus properties provide the Company’s physician-lessees and their patients with a convenient location so that they can move between medical offices and hospitals with ease, which drives revenues for the Company’s physician-lessees. Many of these properties occupy a premier franchise location in relation to the local hospital, providing the Company’s properties with a distinct competitive advantage over alternative medical office space in the area that are located farther away from the local hospital. The Company has found that the factors most important to physician-lessees when choosing a medical office building or healthcare related facility in which to locate their offices are convenience to a hospital campus, clean and attractive common areas, state-of-the-art amenities and tenant improvements tailored to each practice.
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| | • | Loyal and Diverse Tenant Base. |
The Company’s focus on maintaining the Company’s physician-lessees’ loyalty is a key component of the Company’s marketing and operating strategy. A focus on physician-lessee loyalty and the involvement of the physician-tenants and hospitals as investors in the Company’s properties results in one of the more stable and diversified tenant bases of any medical office company in the United States. As of December 31, 2009, the Company’s 62 in-service, consolidated wholly-owned and joint venture properties had an average occupancy rate of approximately 91.5%. The Company’s tenants are diversified by type of medical practice, medical specialty and sub-specialty. As of December 31, 2009, no single tenant accounted for more than 7.5% of the annualized rental revenue at the wholly-owned properties and no tenants were in default.
The Company focuses exclusively on the ownership, development, redevelopment, acquisition, project delivery and management of medical office buildings and healthcare related facilities in the United States of America. The focus on medical office buildings and healthcare related facilities allows the Company to own, develop, redevelop, acquire and manage medical office buildings and healthcare related facilities more effectively and profitably than its competition. Unlike many other public companies that simply engage in sale/leaseback arrangements in the healthcare real estate sector, the Company also operates its properties. The Company believes that this focus may position the Company to achieve additional cash flow growth and appreciation in the value of its assets.
Development and Acquisition Strategy
The Company’s development and acquisition strategy consists of the following principal elements:
The Company’s project delivery teams focus on the development and design-build components of the integrated business model specializing in healthcare real estate. The Company and its predecessor companies have completed a variety of healthcare facility engagements including hospitals, medical office buildings, ambulatory surgery centers, wellness centers and multi-specialty clinics. The Company provides fully integrated healthcare real estate services from strategic planning and development to architecture to construction. The Company has built strong relationships with leading non-profit and for-profit healthcare systems which look to provide real estate solutions that will support the growth of medical communities built around their hospitals and regional medical centers. The Company focuses exclusively on medical office buildings and healthcare related facilities and believes that its experience and understanding of real estate and healthcare gives it a competitive advantage over less specialized developers. Further, the Company’s specialized regional focus provides extensive local industry knowledge and insight across the United States of America. The Company believes the network of relationships that it has fostered in both the real estate and healthcare industries that span over five decades provides access to a large volume of potential development and acquisitions opportunities.
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| | • | Selective Development and Acquisitions. |
The Company intends to leverage its strong healthcare real estate track record and extensive client network to continue to grow its portfolio of medical office buildings and healthcare relates facilities by selectively acquiring existing medical office buildings and by developing new projects in communities in need of expanded facilities to support the delivery of medical services. While the Company intends to continue the evaluation of acquisition opportunities primarily within its joint venture partnership with Northwestern Mutual, the focus of capital deployment has shifted to development and design-build project delivery. As of December 31, 2009, the joint venture partnership with Northwestern Mutual did not have any acquisitions under contract. For more information on the joint venture partnership with Northwestern, see Management’s Discussion and Analysis of Financial Conditions and Results of Operations - “Liquidity and Capital Resources.”
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| | • | Develop and Maintain Strategic Relationships. |
The Company intends to build upon its key strategic relationships with physicians, hospitals, not-for-profit agencies and religious entities that sponsor healthcare services to further enhance the Company’s franchise. The Company expects to continue entering into joint ventures with individual physicians, physician groups and hospitals. These joint ventures have been, and the Company believes will continue to be, a source of development and acquisition opportunities. Of the 53 healthcare properties the management team developed or acquired and currently manages over the past 25 years, 29 of them represent repeat transactions with an existing client institution. The Company anticipates that it will also continue to offer potential physician-lessees the opportunity to invest in the Company in order that they may continue to feel a strong sense of attachment to the property in which they practice. The Company intends to continue to work closely with its tenants in order to cultivate long-term working relationships and to maximize new business opportunities. The Company works closely with its clients and carefully considers their objectives and needs when evaluating an investment opportunity. The Company believes that this philosophy allows the Company to build long-term relationships and obtain franchise locations otherwise unavailable to the Company’s competition.
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| | • | Investment Criteria and Financing. |
The Company intends to expand in its existing markets and enter into markets that research indicates will meet its investment strategy in the future. The Company generally will seek to select clients and assets in locations that the Company believes will complement its existing portfolio. The Company may also selectively pursue portfolio opportunities outside of its existing markets that will not only add incremental value, but will also add diversification and economies of scale to the existing portfolio.
In assessing a potential development or acquisition opportunity, the Company focuses on the economics of the local medical community and the strength of local hospitals. This analysis focuses on trying to place the project on a hospital campus or in a strategic growth corridor based on demographics.
Historically, the Company has financed real property developments and acquisitions through joint ventures in which the physicians who lease space at the properties, and in some cases, local hospitals or regional medical centers, provided the equity capital. The Company has continued this practice of entering into joint ventures with individual physicians, physician groups and hospitals.
The Company has a $150 million secured revolving credit facility (the “Credit Facility”). As of December 31, 2009, the Company had cash and cash equivalents of approximately $25.9 million and the Company’s Credit Facility had approximately $61.7 of available borrowings, which the Company can use to finance development and acquisition opportunities. The Company plans to finance future developments and acquisitions through a combination of cash, borrowings under the Credit Facility, traditional secured mortgage financing, and equity and debt offerings.
Business Segments
The Company has two identified reportable segments: (1) Property Operations and (2) Design-Build and Development. The Company defines business segments by their distinct customer base and service provided. Each segment operates under a separate management group and produces discrete financial information, which is reviewed by the chief operating decision maker to make resource allocation decisions and assess performance. Inter-segment sales and transfers are accounted for as if the sales and transfers were made to third parties, which involves applying a negotiated fee onto the costs of the services performed. All inter-company balances and transactions are eliminated during the consolidation process.
The Company’s management evaluates the operating performance of its operating segments based on funds from operations (“FFO”) and funds from operations modified (“FFOM”). FFO, as defined by the National Association of Real Estate Investment Trusts (“NAREIT”), represents net income (computed in accordance with GAAP), excluding gains from sales of property, plus real estate depreciation and amortization (excluding amortization of deferred financing costs) and after adjustments for unconsolidated partnerships and joint ventures. The Company adjusts the NAREIT definition to add back noncontrolling interests in real estate partnerships before real estate related depreciation and amortization. FFOM adds back to FFO non-cash amortization of non-real estate related intangible assets associated with purchase accounting. The Company considers FFO and FFOM important supplemental measures of the Company’s operational performance. The Company believes FFO is frequently used by securities analysts, investors and other interested parties in the evaluation of REITs, many of which present FFO when reporting their results. The Company believes that FFOM allows securities analysts, investors and other interested parties to evaluate current period results to results prior to the MEA Holdings, Inc. (“MEA”) transaction. FFO and FFOM are intended to exclude GAAP historical cost depreciation and amortization of real estate and related assets, which assumes that the value of real estate assets diminishes ratably over time. Historically, however, real estate values have risen or fallen with market conditions. Because FFO and FFOM exclude depreciation and amortization unique to real estate, gains and losses from property dispositions and extraordinary items, they provide performance measures that, when compared year over year, reflect the impact to operations from trends in occupancy rates, rental rates, operating costs, development activities and interest costs, providing perspective not immediately apparent from net income. The Company’s methodology may differ from the methodology for calculating FFO and FFOM utilized by other equity REITs and, accordingly, may not be comparable to such other REITs. Further, FFO and FFOM do not represent amounts available for management’s discretionary use because of needed capital replacement or expansion, debt service obligations, or other commitments and uncertainties.
Financial information concerning our business segments is presented in Note 6 to the accompanying Notes to Consolidated Financials Statements.
The following discussion describes certain material U.S. federal healthcare laws and regulations that may affect the Company’s operations and those of the Company’s tenants. However, the discussion does not address state healthcare laws and regulations, except as otherwise indicated. These state laws and regulations, like the U.S. federal healthcare laws and regulations, could affect the Company’s operations and those of the Company’s tenants.
The regulatory environment remains stringent for healthcare providers. The Stark Law and fraud and abuse statutes that regulate hospital and physician relationships continue to broaden the industry’s awareness of the need for experienced real estate management. Rrequirements for Medicare coding, physician recruitment and referrals, outlier charges to commercial and government payors, and corporate governance have created a difficult operating environment for some hospitals. Also, the HITECH Act, signed into law on February 17, 2009, expanded the extensive requirements related to the privacy and security of individually identifiable health information imposed by regulations issued pursuant to the Health Insurance Portability and Accountability Act of 1996 (HIPAA) and contains enhanced enforcement provisions related to those requirements. In addition, the U.S. Congress is currently debating and may enact comprehensive healthcare reform legislation that may have significant impact on the delivery and reimbursement of healthcare items and services. The Company cannot predict the impact that the proposed legislation, if enacted, may have on the Company’s tenants.
Generally, healthcare real estate properties are subject to various laws, ordinances and regulations. Changes in any of these laws or regulations, such as the Comprehensive Environmental Response and Compensation Liability Act, increase the potential liability for environmental conditions or circumstances existing or created by tenants or others on the properties. In addition, laws affecting development, construction, operation, upkeep, safety and taxation requirements may result in significant unanticipated expenditures, loss of healthcare real estate property sites or other impairments to operations, which would adversely affect the Company’s cash flows from operating activities.
As the Company’s properties and entities are not healthcare providers, the healthcare regulatory restrictions that apply to physician investment in healthcare providers are not applicable to the ownership interests held by physicians in the Company’s properties except as discussed below. For example, the Stark law, which, unless an exception applies, prohibits physicians from referring patients to an entity if the physicians have a financial relationship with or ownership interest in the entity and the entity provides designated health services, does not apply to physician ownership in the Company’s entities because these entities do not own or operate any healthcare providers, nor do they provide any designated health services. In addition, the Federal Anti-Kickback Statute, which generally prohibits payment or solicitation of remuneration in exchange for referrals for items and services covered by federal health care programs to persons in a position to refer such business, also does not apply to ownership in the existing properties as these entities do not provide or bill for medical services of any kind. Similar state laws that prohibit physician self referrals or kickbacks also do not apply for the same reasons. Notwithstanding the foregoing, the Company cannot make any assurances that regulatory authorities will agree with the Company’s interpretation of these laws.
Although the Company’s properties and entities are not healthcare providers, certain federal healthcare regulatory restrictions could be implicated by ownership interests held by physicians in the Company’s properties because the properties and entities may have both physician and hospital owners and such hospitals and physicians may have financial relationships apart from the Company’s properties and entities which may create direct and indirect financial relationships subject to these laws and regulations. For example, under the Stark law discussed above, an ownership in one of the Company’s entities may serve as a link in a chain of financial relationships connecting a physician and a hospital which must be analyzed for compliance with the requirements of the Stark law.
Under the Americans with Disabilities Act of 1990, or the ADA, all places of public accommodation are required to meet certain U.S. federal requirements related to access and use by disabled persons. A number of additional U.S. federal, state and local laws also exist that may require modifications to properties, or restrict certain further renovations thereof, with respect to access thereto by disabled persons. Noncompliance with the ADA could result in the imposition of fines or an award of damages to private litigants and also could result in an order to correct any non-complying feature and in substantial capital expenditures. To the extent the Company’s properties are not in compliance, the Company may incur additional costs to comply with the ADA.
Property management activities are often subject to state real estate brokerage laws and regulations as determined by the particular real estate commission for each state.
In addition, state and local laws may regulate expansion, including the addition of new beds or services or acquisition of medical equipment, and the construction of healthcare related facilities, by requiring a certificate of need, which is issued by the applicable state health planning agency only after that agency makes a determination that a need exists in a particular area for a particular service or facility, or other similar approval.
New laws and regulations, changes in existing laws and regulations or changes in the interpretation of such laws or regulations could negatively affect the financial condition of the Company’s lessees. These changes, in some cases, could apply retroactively. The enactment, timing or effect of legislative or regulatory changes cannot be predicted. In addition, certain of the Company’s medical office buildings and healthcare related facilities and their lessees may require licenses or certificates of need to operate. Failure to obtain a license or certificate of need, or loss of a required license would prevent a facility from operating in the manner intended by the lessee.
Pursuant to U.S. federal, state and local environmental laws and regulations, a current or previous owner or operator of real property may be required to investigate, remove and/or remediate a release of hazardous substances or other regulated materials at or emanating from such property. Further, under certain circumstances, such owners or operators of real property may be held liable for property damage, personal injury and/or natural resource damage resulting from or arising in connection with such releases. Certain of these laws have been interpreted to be joint and several unless the harm is divisible and there is a reasonable basis for allocation of responsibility. The failure to properly remediate the property may also adversely affect the owner’s ability to lease, sell or rent the property or to borrow funds using the property as collateral.
In connection with the ownership, operation and management of the Company’s current or past properties and any properties that the Company may acquire and/or manage in the future, the Company could be legally responsible for environmental liabilities or costs relating to a release of hazardous substances or other regulated materials at or emanating from such property. In order to assess the potential for such liability, the Company conducts an environmental assessment of each property prior to acquisition and manages the Company’s properties in accordance with environmental laws while the Company owns or operates them. All of the Company’s leases contain a comprehensive environmental provision that requires tenants to conduct all activities in compliance with environmental laws and to indemnify the owner for any harm caused by the failure to do so. In addition, the Company has engaged qualified, reputable and adequately insured environmental consulting firms to perform environmental site assessments of all of the Company’s properties and is not aware of any environmental issues that are expected to have materially impacted the operations of any property.
Insurance
The Company believes that its properties are covered by adequate (as deemed necessary or as required by the Company’s lenders) fire, flood, earthquake, wind and property insurance, as well as commercial liability insurance, provided by reputable companies and with commercially reasonable deductibles and limits. Furthermore, the Company believes that its businesses and assets are likewise adequately insured against casualty loss and third party liabilities. The Company actively manages the insurance component of the budget for each project. The Company engages a risk management consultant to assist with this process. Most of the Company’s leases provide that insurance premiums are considered part of the operating expenses of the respective property, and the tenants are therefore responsible for any increases in the Company’s premiums.
The Company’s business activities could expose it to potential liability under various environmental laws and under workplace health and safety regulations. The Company cannot predict the magnitude of such potential liabilities. The Company maintains a comprehensive general liability policy with an umbrella policy that covers losses beyond the general liability limits. The Company also maintains professional errors and omissions liability and contractor's pollution liability insurance policies in amounts that the Company believes is adequate coverage for its business.
The Company obtains insurance coverage through a broker that is experienced in the professional liability field. The broker and the Company’s risk manager regularly review the adequacy of the Company’s insurance coverage. Because there are various exclusions and retentions under the policies, or an insurance carrier may become insolvent, there can be no assurance that all potential liabilities will be covered by the Company’s insurance policies or paid by the Company’s carriers.
The Company evaluates the risk associated with claims. If there is a determination that a loss is probable and reasonably estimable, an appropriate reserve is established. A reserve is not established if the Company determines that a claim has no merit or is not probable or reasonably estimable. Partially or completely uninsured claims, if successful and of significant magnitude, could have a material adverse effect on the Company’s business.
The Company competes in developing and acquiring medical office buildings and healthcare related facilities with financial institutions, institutional pension funds, real estate developers, other REITs, other public and private real estate companies and private real estate investors.
Depending on the characteristics of a specific market, the Company may also face competition in leasing available medical office buildings and healthcare related facilities to prospective tenants. However, the Company believes that it brings a depth of knowledge and experience in working with physicians, hospitals, not-for-profit agencies and religious entities that sponsor healthcare services that makes the Company an attractive real estate partner for both development projects and acquisitions.
The market for design-build construction services is generally highly competitive and fragmented. The Company’s competitors are numerous, consisting mainly of small and regional private firms. The Company believes that it is well positioned to compete in its markets because of its healthcare industry specialization, strong reputation, long-term client relationships, and integrated delivery of services.
As of December 31, 2009, the Company had 454 employees. The Company’s professional staff performs functions in property management, acquisitions, real estate development, architecture, engineering, and construction management. Less than 5% of the Company’s employees are covered by collective bargaining agreements, which are subject to amendment in November 2010, or by specific labor agreements, which expire upon completion of the relevant project. There are no material disagreements with employees and the Company considers the relationships with its employees to be favorable.
Equity Offering
In June 2009, the Company issued 23.0 million shares of common stock, resulting in net proceeds to the Company of $76.5 million. The net proceeds were used to fund the $50.0 million repayment under the Term Loan, to reduce borrowings under the Credit Facility, and for working capital purposes.
The Company files its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports with the Securities and Exchange Commission (the “SEC”). You may obtain copies of these documents by visiting the SEC’s Public Reference Room at 100 F Street N.E., Washington, D.C. 20549, or by calling the SEC at 1-800-SEC-0330. The SEC also maintains a Website (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The Company’s Website is www.cogdell.com. Its reports on Forms 10-K, 10-Q and 8-K, and all amendments to those reports are posted on the Company’s Website as soon as reasonably practicable after the reports and amendments are electronically filed with or furnished to the SEC. The contents of the Company’s Website are not incorporated by reference herein.
Risks Related to the Company’s Properties and Operations
The Company’s real estate investments are concentrated in medical office buildings and healthcare related facilities, making the Company more vulnerable economically than if the Company’s investments were diversified.
As a REIT, the Company invests primarily in real estate. Within the real estate industry, the Company selectively owns, develops, redevelops, acquires and manages medical office buildings and healthcare related facilities. The Company is subject to risks inherent in concentrating investments in real estate. The risks resulting from a lack of diversification become even greater as a result of the Company’s business strategy to invest primarily in medical office buildings and healthcare related facilities. A downturn in the medical office building industry or in the commercial real estate industry generally, could significantly adversely affect the value of the Company’s properties. A downturn in the healthcare industry could negatively affect the Company’s tenants’ ability to make rent payments to the Company, which may have a material adverse effect on the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock. These adverse effects could be more pronounced than if the Company held a diverse portfolio of investments outside of real estate or outside of medical office buildings and healthcare related properties.
The Company depends on significant tenants.
As of December 31, 2009, the Company’s five largest tenants represented $17.3 million, or 22.2%, of the annualized rent generated by the Company’s properties. The Company’s five largest tenants based on annualized rents are Carolinas HealthCare System, Palmetto Health Alliance, Bon Secours St. Francis Hospital, Lancaster General Hospital, and Exodus Medical Group, P.A. The Company’s significant tenants, as well as other tenants, may experience a downturn in their businesses, which may weaken their financial condition and result in their failure to make timely rental payments or default under their leases. In the event of any tenant default, the Company may experience delays in enforcing the Company’s rights as landlord and may incur substantial costs in protecting the Company’s investment.
The bankruptcy or insolvency of the Company’s tenants under the Company’s leases could seriously harm the Company’s operating results and financial condition.
The Company will receive a substantial amount of the Company’s income as rent payments under leases of space in the Company’s properties. The Company has no control over the success or failure of the Company’s tenants’ businesses and, at any time, any of the Company’s tenants may experience a downturn in its business that may weaken its financial condition. As a result, the Company’s tenants may delay lease commencement or renewal, fail to make rent payments when due, or declare bankruptcy. Any leasing delays, lessee failures to make rent payments when due, or tenant bankruptcies could result in the termination of the tenant’s lease and, particularly in the case of a large tenant, may have a material adverse effect on the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders, and the trading price of the Company’s common stock.
If tenants are unable to comply with the terms of the Company’s leases, the Company may be forced to modify lease terms in ways that are unfavorable to the Company. Alternatively, the failure of a tenant to perform under a lease or to extend a lease upon expiration of its term could require the Company to declare a default, repossess the property, find a suitable replacement tenant, operate the property, or sell the property. There is no assurance that the Company will be able to lease the property on substantially equivalent or better terms than the prior lease, or at all. The Company may not be able to find another tenant, successfully reposition the property for other uses, successfully operate the property, or sell the property on terms that are favorable to the Company.
If any lease expires or is terminated, the Company will be responsible for all of the operating expenses for that vacant space until it is re-let. If the Company experiences high levels of vacant space, the Company’s operating expenses may increase significantly. Any significant increase in the Company’s operating costs may have a material adverse effect on the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock.
Any bankruptcy filings by or relating to one of the Company’s tenants could bar all efforts by the Company to collect pre-bankruptcy debts from that lessee or seize its property, unless the Company receives an order permitting the Company to do so from the bankruptcy court, which the Company may be unable to obtain. A tenant bankruptcy could also delay the Company’s efforts to collect past due balances under the relevant leases and could ultimately preclude full collection of these sums. If a tenant assumes the lease while in bankruptcy, all pre-bankruptcy balances due under the lease must be paid to the Company in full. However, if a tenant rejects the lease while in bankruptcy, the Company would have only a general unsecured claim for pre-petition damages. Any unsecured claim the Company holds may be paid only to the extent that funds are available and only in the same percentage as is paid to all other holders of unsecured claims. It is possible that the Company may recover substantially less than the full value of any unsecured claims the Company holds, if any, which may have a material adverse effect on the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders, and the trading price of the Company’s common stock. Furthermore, dealing with a tenant bankruptcy or other default may divert management’s attention and cause the Company to incur substantial legal and other costs.
The severely weakened economy, and other events or circumstances beyond the control of the Company, may adversely affect the Company’s industry, business, results of operations, contractual commitments, and access to capital.
Continued concerns about the uncertainty over whether the U.S. economy will be adversely affected by inflation, deflation or stagflation, and the systemic impact of increased unemployment, volatile energy costs, geopolitical issues, the availability and cost of credit, the U.S. mortgage market and a severely distressed real estate market have contributed to increased market volatility and weakened business and consumer confidence. This difficult operating environment could adversely affect the Company's ability to generate revenues and/or increase its costs, thereby reducing the Company's operating income and earnings. It could also have an adverse impact on the ability of the Company's tenants to maintain occupancy and rates in the Company's properties. These economic conditions may have a material adverse effect on the Company's business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock.
Adverse economic or other conditions in the markets in which the Company does business could negatively affect the Company’s occupancy levels and rental rates and therefore the Company’s operating results.
The Company’s operating results are dependent upon its ability to maximize occupancy levels and rental rates in the Company’s portfolio. Adverse economic or other conditions in the markets in which the Company operates may lower the Company’s occupancy levels and limit the Company’s ability to increase rents or require the Company to offer rental discounts. The following factors are primary among those which may adversely affect the operating performance of the Company’s properties:
| · | periods of economic slowdown or recession, rising interest rates or declining demand for medical office buildings and healthcare related facilities, or the public perception that any of these events may occur, could result in a general decline in rental rates or an increase in tenant defaults; |
| · | the national economic climate in which the Company operates, which may be adversely impacted by, among other factors, a reduction in the availability of debt or equity financing, industry slowdowns, relocation of businesses and changing demographics; |
| · | local or regional real estate market conditions such as the oversupply of medical office buildings and healthcare related facilities or a reduction in demand for medical office buildings and healthcare related facilities in a particular area; |
| · | negative perceptions by prospective tenants of the safety, convenience and attractiveness of the Company’s properties and the neighborhoods in which they are located; |
| · | earthquakes and other natural disasters, terrorist acts, civil disturbances or acts of war which may result in uninsured or underinsured losses; and changes in the tax, real estate and zoning laws. |
The failure of the Company’s properties to generate revenues sufficient to meet the Company’s cash requirements, including operating and other expenses, debt service and capital expenditures, may have a material adverse effect on the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock.
Current levels of market volatility are unprecedented.
The capital and credit markets have been experiencing volatility and disruption for more a significant period of time. In some cases, the markets have produced downward pressure on stock prices and credit capacity for certain issuers without regard to those issuers’ underlying financial and/or operating strength. If current levels of market disruption and volatility continue or worsen, there can be no assurance that the Company will not experience an adverse effect, which may be material, on the Company’s business, financial condition, and results of operations. Disruptions, uncertainty or volatility in the capital markets may also limit the Company’s access to capital from financial institutions on attractive terms, or at all, and its ability to raise capital through the issuance of equity securities could be adversely affected by causes beyond the control of the Company through ongoing extraordinary disruptions in the global economy and financial systems or other events.
The majority of the Company’s consolidated wholly-owned and joint venture properties are located in Georgia, North Carolina, and South Carolina, and changes in these markets may materially adversely affect the Company.
The Company’s consolidated wholly-owned and joint venture properties located in Georgia, North Carolina, and South Carolina, provide approximately 10.0%, 25.4% and 26.1%, respectively, of the Company’s total annualized rent as of December 31, 2009. As a result of the geographic concentration of properties in these markets, the Company is particularly exposed to downturns in these local economies or other changes in local real estate market conditions. In the event of negative economic changes in these markets, the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock may be materially and adversely affected.
The Company’s investments in development and redevelopment projects may not yield anticipated returns, which would harm the Company’s operating results and reduce the amount of funds available for distributions.
A key component of the Company’s growth strategy is exploring new-asset development and redevelopment opportunities. To the extent that the Company engages in these development and redevelopment activities, they will be subject to the following risks normally associated with these projects:
| · | the Company may be unable to obtain financing for these projects on attractive terms or at all; |
| · | the Company may not complete development projects on schedule or within budgeted amounts; |
| · | the Company may encounter delays or refusals in obtaining all necessary zoning, land use, building, occupancy and other required governmental permits and authorizations; |
| · | occupancy rates and rents at newly developed or redeveloped properties may fluctuate depending on a number of factors, including market and economic conditions, and may result in the Company’s investment not being profitable; and start-up costs may be higher than anticipated. |
In deciding whether to develop or redevelop a particular property, the Company makes certain assumptions regarding the expected future performance of that property. The Company may underestimate the costs necessary to bring the property up to the standards established for its intended market position or the Company may be unable to increase occupancy at a newly acquired property as quickly as expected or at all. Any substantial unanticipated delays or expenses could adversely affect the investment returns from these development or redevelopment projects and have a material adverse effect on the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock.
The Company may in the future develop medical office buildings and healthcare related facilities in geographic regions where the Company does not currently have a significant presence and where the Company does not possess the same level of familiarity, which could adversely affect the Company’s ability to develop such properties successfully or at all or to achieve expected performance.
The Company has relied, and in the future may rely, on the investments of the Company’s joint venture partners for the funding of the Company’s development and redevelopment projects. If the Company’s reputation in the healthcare real estate industry changes or the number of investors considering the Company as an attractive strategic partner is otherwise reduced, the Company’s ability to develop or redevelop properties could be affected, which would limit the Company’s growth.
If the Company’s investments in development and redevelopment projects do not yield anticipated returns for any reason, including those set forth above, the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock may be materially and adversely affected.
The Company may not be successful in identifying and consummating suitable acquisitions or investment opportunities, which may impede the Company’s growth and negatively affect the Company’s results of operations.
The Company’s ability to expand through acquisitions is a key component of its long-term growth strategy and requires the Company to identify suitable acquisition candidates or investment opportunities that meet its criteria and are compatible with its growth strategy. The Company may not be successful in identifying suitable properties or other assets that meet the Company’s acquisition criteria or in consummating acquisitions or investments on satisfactory terms or at all. Failure to identify or consummate acquisitions or investment opportunities will slow the Company’s growth, which could in turn adversely affect the Company’s stock price.
The Company’s ability to acquire properties on attractive terms and successfully integrate and operate them may be constrained by the following significant risks:
| · | failure to finance an acquisition on attractive terms or at all; |
| · | competition from other real estate investors with significant capital, including other publicly-traded REITs and institutional investment funds; |
| · | competition from other potential acquirers may significantly increase the purchase price for an acquisition property, which could reduce the Company’s profitability; |
| · | unsatisfactory results of the Company’s due diligence investigations or failure to meet other customary closing conditions; |
| · | the Company may spend more than the time and amounts budgeted to make necessary improvements or renovations to acquired properties; and |
| · | the Company may acquire properties subject to liabilities and without any recourse, or with only limited recourse, with respect to unknown liabilities such as liabilities for clean-up of undisclosed environmental contamination, claims by persons in respect of events transpiring or conditions existing before the Company acquired the properties and claims for indemnification by general partners, directors, officers and others indemnified by the former owners of the properties. |
If any of these risks are realized, the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock may be materially and adversely affected.
The Company may not be able to obtain additional capital to further its business objectives.
The Company’s ability to develop, redevelop or acquire properties depends upon its ability to obtain capital. The real estate industry is currently experiencing a debt and equity capital market that is virtually frozen. This lack of capital is expected to cause a decrease in the level of new investment activity by publicly traded real estate companies. A prolonged period in which the Company cannot effectively access the public equity or debt markets may result in heavier reliance on alternative financing sources to undertake new investments. An inability to obtain equity or debt capital on acceptable terms could delay or prevent the Company from acquiring, financing and completing desirable investments, and which could otherwise adversely affect the Company’s business. Also, the issuance of additional shares of capital stock or interests in subsidiaries to fund future operations could dilute the ownership of the Company’s then-existing stockholders. Even as liquidity returns to the market, debt and equity capital may be more expensive than in prior years.
If the Company is unable to promptly re-let its properties, if the rates upon such re-letting are significantly lower than expected or if the Company is required to undertake significant capital expenditures to attract new tenants, then the Company’s business and results of operations would be adversely affected.
Virtually all of the Company’s leases are on a multiple year basis. As of December 31, 2009, leases representing 16.8% of the Company’s net rentable square feet will expire in 2010, 8.9% in 2011 and 19.2% in 2012. These expirations would account for 16.8%, 9.0% and 22.2% of the Company’s annualized rent, respectively. Approximately 67.9% of the square feet of the Company’s properties and 59.7% of the number of the Company’s properties are subject to certain restrictions. These restrictions include limits on the Company’s ability to re-let these properties to tenants not affiliated with the healthcare system that own the underlying property, rights of first offer on sales of the property and limits on the types of medical procedures that may be performed. In addition, lower than expected rental rates upon re-letting could impede the Company’s growth. The Company cannot assure you that it will be able to re-let space on terms that are favorable to the Company or at all. Further, the Company may be required to make significant capital expenditures to renovate or reconfigure space to attract new tenants. If it is unable to promptly re-let its properties, if the rates upon such re-letting are significantly lower than expected or if the Company is required to undertake significant capital expenditures in connection with re-letting units, the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock may be materially and adversely affected.
Certain of the Company’s properties may not have efficient alternative uses.
Some of the Company’s properties, such as the Company’s ambulatory surgery centers, are specialized medical facilities. If the Company or the Company’s tenants terminate the leases for these properties or the Company’s tenants lose their regulatory authority to operate such properties, the Company may not be able to locate suitable replacement tenants to lease the properties for their specialized uses. Alternatively, the Company may be required to spend substantial amounts to adapt the properties to other uses. Any loss of revenues and/or additional capital expenditures occurring as a result may have a material adverse effect on the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock.
The Company faces competition for the acquisition of medical office buildings and healthcare related facilities, which may impede the Company’s ability to make future acquisitions or may increase the cost of these acquisitions.
The Company competes with many other entities engaged in real estate investment activities for acquisitions of medical office buildings and healthcare related facilities, including national, regional and local operators, acquirers and developers of healthcare real estate properties. The competition for healthcare real estate properties may significantly increase the price the Company must pay for medical office buildings and healthcare related facilities or other assets the Company seeks to acquire and the Company’s competitors may succeed in acquiring those properties or assets themselves. In addition, the Company’s potential acquisition targets may find the Company’s competitors to be more attractive because they may have greater resources, may be willing to pay more for the properties or may have a more compatible operating philosophy. In particular, larger healthcare REITs may enjoy significant competitive advantages that result from, among other things, a lower cost of capital and enhanced operating efficiencies. In addition, the number of entities and the amount of funds competing for suitable investment properties may increase. This competition will result in increased demand for these assets and therefore increased prices paid for them. Because of an increased interest in single-property acquisitions among tax-motivated individual purchasers, the Company may pay higher prices if the Company purchases single properties in comparison with portfolio acquisitions. If the Company pays higher prices for medical office buildings and healthcare related facilities or other assets, the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock may be materially and adversely affected.
The Company may not be successful in integrating and operating acquired properties.
The Company expects to make future acquisitions of medical office buildings and healthcare related facilities. If the Company acquires medical office buildings and healthcare related facilities, the Company will be required to integrate them into the Company’s existing portfolio. The acquired properties may turn out to be less compatible with the Company’s growth strategy than originally anticipated, may cause disruptions in the Company’s operations or may divert management’s attention away from day-to-day operations, any or all of which may have a material adverse effect on the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock.
The Company’s medical office buildings and healthcare related facilities, their associated hospitals and the Company’s tenants may be unable to compete successfully.
The Company’s medical office buildings and healthcare related facilities, and their associated hospitals often face competition from nearby hospitals and other medical office buildings that provide comparable services. Some of those competing facilities are owned by governmental agencies and supported by tax revenues, and others are owned by nonprofit corporations and may be supported to a large extent by endowments and charitable contributions. These types of support are not available to the Company’s buildings.
Similarly, the Company’s tenants face competition from other medical practices in nearby hospitals and other medical facilities. The Company’s tenants’ failure to compete successfully with these other practices could adversely affect their ability to make rental payments, which could adversely affect the Company’s rental revenues. Further, from time to time and for reasons beyond the Company’s control, referral sources, including physicians and managed care organizations, may change their lists of hospitals or physicians to which they refer patients. This could adversely affect the Company’s tenants’ ability to make rental payments, which could adversely affect the Company’s rental revenues.
The Company depends upon its tenants to operate their businesses in a manner which generates revenue sufficient to allow them to meet their obligations to the Company, including their obligation to pay rent. Any reduction in rental revenues resulting from the inability of the Company’s medical office buildings and healthcare related facilities, their associated hospitals and the Company’s tenants to compete successfully may have a material adverse effect on the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock.
The Company may incur impairment charges on goodwill or other intangible assets.
Because the Company has grown in part through acquisitions, goodwill and other acquired intangible assets represent a significant portion of the Company’s assets. The Company performs an annual impairment review on its goodwill and other intangible assets in the fourth quarter of every fiscal year. In addition, the Company performs an impairment review whenever events or changes in circumstances indicate that the carrying value of goodwill or other intangible assets may exceed the fair value of such assets. As a result of a decline in our stock price, a decline in the cash flow multiples for comparable public engineering and construction companies, and changes in the cash flow projections for the Design-Build and Development business segment due to a decline in backlog and delays and cancellations of client building projects, we performed an interim impairment review of our goodwill related to this business segment as of March 31, 2009. Based on this review, during the first quarter of 2009, we recorded a pre-tax, non-cash impairment charge of ($120.9 million), resulting in an after-tax impairment charge of ($101.7 million). There is no assurance that continuing adverse economic conditions will not result in additional future impairments of goodwill or other intangible assets which could have a material adverse effect on our financial condition and results of operations.
Uninsured losses or losses in excess of the Company insurance coverage could adversely affect the Company’s financial condition and the Company’s cash flow.
The Company maintains comprehensive liability, fire, flood, earthquake, wind (as deemed necessary or as required by the Company’s lenders), extended coverage and rental loss insurance with respect to the Company’s properties with policy specifications, limits and deductibles customarily carried for similar properties. Certain types of losses, however, may be either uninsurable or not economically insurable, such as losses due to earthquakes, riots, acts of war or terrorism. Should an uninsured loss occur, the Company could lose both the Company’s investment in and anticipated profits and cash flow from a property. If any such loss is insured, the Company may be required to pay a significant deductible on any claim for recovery of such a loss prior to the Company’s insurer being obligated to reimburse the Company for the loss, or the amount of the loss may exceed the Company’s coverage for the loss. In addition, future lenders may require such insurance, and the Company’s failure to obtain such insurance could constitute a default under loan agreements. As a result, the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock may be materially and adversely affected.
Joint investments could be adversely affected by the Company’s lack of sole decision-making authority and reliance upon a co-venturer's financial condition.
The Company may co-invest with third parties through partnerships, joint ventures, co-tenancies or other entities, acquiring non-controlling interests in, or sharing responsibility for managing the affairs of, a property, partnership, joint venture, co-tenancy or other entity. Therefore, the Company may not be in a position to exercise sole decision-making authority regarding that property, partnership, joint venture or other entity. Investments in partnerships, joint ventures, or other entities may involve risks not present were a third party not involved, including the possibility that the Company’s partners, co-tenants or co-venturers might become bankrupt or otherwise fail to fund their share of required capital contributions. Additionally, the Company’s partners or co-venturers might at any time have economic or other business interests or goals, which are inconsistent with the Company’s business interests or goals. These investments may also have the potential risk of impasses on decisions such as a sale, because neither the Company nor the partner, co-tenant or co-venturer would have full control over the partnership or joint venture. Consequently, actions by such partner, co-tenant or co-venturer might result in subjecting properties owned by the partnership or joint venture to additional risk. In addition, the Company may in specific circumstances be liable for the actions of third-party partners, co-tenants or co-venturers.
The Company’s mortgage agreements and ground leases contain certain provisions that may limit the Company’s ability to sell certain of the Company’s medical office buildings and healthcare related facilities.
| · | In order to assign or transfer the Company’s rights and obligations under certain of the Company’s mortgage agreements, the Company generally must: |
| · | obtain the consent of the lender; |
| · | pay a fee equal to a fixed percentage of the outstanding loan balance; and |
| · | pay any costs incurred by the lender in connection with any such assignment or transfer. |
In addition, ground leases on certain of the Company’s properties contain restrictions on transfer such as limiting the assignment or subleasing of the facility only to practicing physicians or physicians in good standing with an affiliated hospital. These provisions of the Company’s mortgage agreements and ground leases may limit the Company’s ability to sell certain of the Company’s medical office buildings and healthcare related facilities which, in turn, could adversely impact the price realized from any such sale
29 of the Company’s consolidated wholly-owned and joint venture properties are subject to ground or air rights leases that expose the Company to the loss of such properties upon breach or termination of the ground or air rights leases
The Company has 29 consolidated wholly-owned and joint venture properties that are subject to leasehold interests in the land or air underlying the buildings and the Company may acquire additional buildings in the future that are subject to similar ground or air leases. These 29 consolidated wholly-owned and joint venture properties represent 52.9% of the Company’s total net rentable square feet. As lessee under a ground lease, the Company is exposed to the possibility of losing the property upon termination, or an earlier breach by the Company, of the ground lease, which may have a material adverse effect on the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock.
Environmental compliance costs and liabilities associated with operating the Company’s properties may affect the Company’s results of operations.
Under various U.S. federal, state and local laws, ordinances and regulations, owners and operators of real estate may be liable for the costs of investigating and remediating certain hazardous substances or other regulated materials on or in such property. Such laws often impose such liability without regard to whether the owner or operator knew of, or was responsible for, the presence of such substances or materials. The presence of such substances or materials, or the failure to properly remediate such substances, may adversely affect the owner’s or operator’s ability to lease, sell or rent such property or to borrow using such property as collateral. Persons who arrange for the disposal or treatment of hazardous substances or other regulated materials may be liable for the costs of removal or remediation of such substances at a disposal or treatment facility, whether or not such facility is owned or operated by such person. Certain environmental laws impose liability for release of asbestos-containing materials into the air and third parties may seek recovery from owners or operators of real properties for personal injury associated with asbestos-containing materials.
Certain environmental laws also impose liability, without regard to knowledge or fault, for removal or remediation of hazardous substances or other regulated materials upon owners and operators of contaminated property even after they no longer own or operate the property. Moreover, the past or present owner or operator from which a release emanates could be liable for any personal injuries or property damages that may result from such releases, as well as any damages to natural resources that may arise from such releases. Certain environmental laws impose compliance obligations on owners and operators of real property with respect to the management of hazardous materials and other regulated substances. For example, environmental laws govern the management of asbestos-containing materials and lead-based paint. Failure to comply with these laws can result in penalties or other sanctions.
No assurances can be given that existing environmental studies with respect to any of the Company’s properties reveal all environmental liabilities, that any prior owner or operator of the Company’s properties did not create any material environmental condition not known to the Company, or that a material environmental condition does not otherwise exist as to any one or more of the Company’s properties. There also exists the risk that material environmental conditions, liabilities or compliance concerns may have arisen after the review was completed or may arise in the future. Finally, future laws, ordinances or regulations and future interpretations of existing laws, ordinances or regulations may impose additional material environmental liability.
The realization of any or all of these risks may have a material adverse effect on the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock.
Costs associated with complying with the Americans with Disabilities Act of 1990 may result in unanticipated expenses.
Under the Americans with Disabilities Act of 1990, or the ADA, all places of public accommodation are required to meet certain U.S. federal requirements related to access and use by disabled persons. A number of additional U.S. federal, state and local laws may also require modifications to the Company’s properties, or restrict certain further renovations of the properties, with respect to access thereto by disabled persons. Noncompliance with the ADA could result in the imposition of fines or an award of damages to private litigants and/or an order to correct any non-complying feature, which could result in substantial capital expenditures. The Company has not conducted an audit or investigation of all of the Company’s properties to determine the Company’s compliance and the Company cannot predict the ultimate cost of compliance with the ADA or other legislation. If one or more of the Company’s properties is not in compliance with the ADA or other related legislation, then the Company would be required to incur additional costs to bring the facility into compliance. If the Company incurs substantial costs to comply with the ADA or other related legislation, the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock may be materially and adversely affected.
Risks Related to the Company's Design-Build and Development Segment
Continuing adverse economic conditions could cause the Company’s clients to delay, curtail or cancel proposed or existing projects, which could result in a decrease in demand for the Company’s services.
The demand for the Company’s services has been, and will likely continue to be, cyclical in nature and vulnerable to general downturns in the U.S. economy. Adverse economic conditions may decrease the Company’s customers’ willingness or ability to make capital expenditures or otherwise reduce their spending to purchase the Company’s services, which could result in reduced revenues or margins for the Company’s business. Many of the Company’s customers finance their projects through cash flow from operations, the incurrence of debt or the issuance of equity. Although the U.S. economy has begun to show signs of recovery, there is still concern over the threat of declines in the credit markets and a lack of availability of credit. Furthermore, the Company’s customers may be affected by economic downturns that decrease the need for their services or the profitability of their services, which could result in a decrease of their cash flow from operations. A reduction in the Company’s customers’ cash flow from operations and the lack of availability of debt or equity financing could cause the Company’s customers to delay, curtail or cancel proposed or existing projects, which could result in a decrease in demand for the Company’s services.
The Company’s results of operations depend upon the award of new design-build contracts and the nature and timing of those awards.
The Company’s revenues are derived primarily from contracts awarded on a project-by-project basis. Generally, it is very difficult to predict whether and when the Company will be awarded a new contract since many potential contracts involve a lengthy and complex bidding and selection process that may be affected by a number of factors, including changes in existing or assumed market conditions, financing arrangements, governmental approvals and environmental matters. Because the Company’s revenues are derived primarily from these contracts, its results of operations and cash flows can fluctuate materially from period to period depending on the timing of contract awards.
In addition, adverse economic conditions could alter the overall mix of services that the Company’s customers seek to purchase, and increased competition during a period of economic decline could result in the Company accepting contract terms that are less favorable to the Company than it might otherwise be able to negotiate. Changes in the Company’s mix of services or a less favorable contracting environment may cause the Company’s revenues and margins to decline.
If the Company experiences delays and/or defaults in customer payments, the Company could be unable to recover all expenditures.
Because of the nature of the Company’s design-build contracts, the Company may at times commit its financial resources to projects prior to receiving payments from the customer in amounts sufficient to cover expenditures on the projects as they are incurred. Delays in customer payments may require the Company to make a working capital investment. If a customer defaults in making payments on a project in which the Company has devoted significant financial resources, it could have a material adverse effect on the Company’s business. This risk can be exacerbated as a result of a downturn in economic conditions, including recent developments in the economy and capital markets.
The Company may experience reduced profits or, in some cases, losses under its guaranteed maximum price contracts if costs increase above its estimates.
Most of the Company’s contracts are currently negotiated guaranteed maximum price or fixed price contracts, giving the Company’s clients a clear understanding of the project’s costs but also locking in the Company so that the Company bears a significant portion or all of the risk for cost overruns. Under these guaranteed maximum price or fixed price contracts, contract prices payable by customers are established in part on cost and scheduling estimates which are based on a number of assumptions, including assumptions about future economic conditions, prices and availability of labor, equipment and materials, and other exigencies. If these estimates prove inaccurate, or the Company encounters other unanticipated difficulties with respect to projects under guaranteed maximum price or fixed price contracts (such as errors, omissions or other deficiencies in the components of projects designed by or on behalf of the Company, problems with new technologies, difficulties in obtaining permits or approvals, adverse weather, unknown or unforeseen conditions, labor actions or disputes, changes in legal requirements, unanticipated decisions, interpretations or actions by governmental authorities having jurisdiction over the Company’s projects, fire or other casualties, terrorist or similar acts, unanticipated difficulty or delay in obtaining materials or equipment, unanticipated increase in the cost of materials or equipment, failures or defaults of suppliers or subcontractors to perform, or other causes within or beyond the control of the Company which delay the performance or completion of a project or increase the Company’s cost of performing the services and work to complete the project), cost overruns may occur, and the Company could experience reduced profits or, in some cases, a loss for that project. The existence or impact of these and other items may not be or become known until the end of a project.
The nature of the Company’s engineering, architecture, construction and other businesses exposes it to potential liabilities and disputes which may reduce its profits.
The Company engages in engineering, architecture, construction and other services where design, construction or systems failures can result in substantial injury or damage to customers and/or third parties. In addition, the nature of the Company’s business results in customers, subcontractors, vendors, suppliers and governmental authorities occasionally asserting claims against the Company for damages or losses for which they believe the Company is liable, including damages and/or losses (including consequential damages or losses) arising from allegations of: (1) defective, nonconforming, legally noncompliant or otherwise deficient design, materials, equipment or workmanship; (2) late performance, completion or delivery of all or any portion of a project; (3) bodily injury, sickness, disease or death; (4) injury to or destruction of property; (5) failure to design or perform work in accordance with applicable laws, statutes, ordinances, and regulations of any governmental authority; (6) violations of the Federal “Occupational Safety and Health Act”, or any other laws, ordinances, rules regulations or orders of any Federal, State or local public authority having jurisdiction for the safety of persons or property, including but not limited to any Fire Department and Board of Health; (7) violations or infringements of any trademark, copyright or patent, or any unfair competition, or infringement of any other tangible or intangible personal or property rights; and (8) failure to pay parties providing services, labor, materials, equipment, supplies and similar items to projects.
Many of the Company’s contracts with customers do not limit the Company’s liability for damages or losses. These claims often arise in the normal course of the Company’s business, and may be asserted with respect to projects completed and/or past occurrences. When it is determined that the Company has liability, such liability may not be covered by insurance or, if covered, the dollar amount of the liability may exceed the Company’s policy limits. Any liability not covered by insurance, in excess of insurance limits or, if covered by insurance but subject to a high deductible, could result in significant loss, which could reduce profits and cash available for operations. Furthermore, claims asserting liability for these and other matters, whether for projects previously completed or projects to be completed in the future, may not be asserted or otherwise become known until a later date. Performance problems and/or liability claims for existing or future projects could adversely impact the Company’s reputation within its industry and among its client base, making it more difficult to obtain future projects.
The Company's Design-Build and Development segment's backlog of uncompleted projects under contract is subject to unexpected adjustments and cancellations and thus, may not accurately reflect future revenue and profits.
Backlog is our estimate of the revenues we expect to earn in future periods on our contracts relating to the Design-Build and Development business segment. There is no assurance that backlog will actually be realized as revenues or, if realized, will result in profits. In accordance with industry practice, substantially all of Erdman's contracts are subject to cancellation, termination, or suspension at the discretion of the client. In addition, the contracts in our backlog are subject to changes in the scope of services to be provided as well as adjustments to the costs relating to the contracts. Projects can remain in backlog for extended periods of time because of the nature of the project and the timing of the particular services required by the project. Accordingly, actual results may differ from the expectations and estimates we rely upon in determining our backlog, which may negatively affect our cash flow projections.
Environmental compliance costs and liabilities associated with the Company’s business may affect the Company’s results of operations .
The Company’s operations are subject to environmental laws and regulations, including those concerning:
| · | generation, storage, handling, treatment and disposal of hazardous material and wastes; |
| · | emissions into the air; |
| · | discharges into waterways; and |
The Company’s projects often involve highly regulated materials, including hazardous wastes. Environmental laws and regulations generally impose limitations and standards for regulated materials and require the Company to obtain permits and comply with various other requirements. The improper characterization, handling, or disposal of regulated materials or any other failure by us to comply with federal, state and local environmental laws and regulations or associated environmental permits could subject the Company to the assessment of administrative, civil and criminal penalties, the imposition of investigatory or remedial obligations, or the issuance of injunctions that could restrict or prevent the Company’s ability to operate its business and complete contracted projects.
In addition, under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (“CERCLA”), and comparable state laws, the Company may be required to investigate and remediate regulated materials. CERCLA and the comparable state laws typically impose liability without regard to whether a company knew of or caused the release, and liability for the entire cost of clean-up can be imposed upon any responsible party.
The environmental, workplace, employment and health and safety laws and regulations, among others, to which the Company is subject are complex, change frequently and could become more stringent in the future. It is impossible to predict the effect that any future changes to these laws and regulations could have on the Company. Any failure to comply with these laws and regulations could materially adversely affect the Company’s business, financial condition and results of operations.
Risks Related to the Healthcare Industry
Pending healthcare legislations and adverse trends in healthcare provider operations may negatively affect the Company’s lease revenues and the Company’s ability to make distributions to the Company’s stockholders.
The healthcare industry is currently experiencing:
| · | changes in the demand for and methods of delivering healthcare services; |
| · | changes in third party reimbursement policies; |
| · | substantial competition for patients among healthcare providers; |
| · | continued pressure by private and governmental payors to reduce payments to providers of services; and |
| · | increased scrutiny of billing, referral and other practices by U.S. federal and state authorities. |
The U.S. Congress is currently debating and may enact comprehensive healthcare reform legislation that may have significant impact on the delivery and reimbursement of healthcare items and services. See "Business - Regulation." These factors may adversely affect the economic performance of some or all of the Company’s tenants and, in turn, the Company’s lease revenues, which may have a material adverse effect on the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock.
Reductions in reimbursement from third party payors, including Medicare and Medicaid, could adversely affect the profitability of the Company’s tenants and hinder their ability to make rent payments to the Company.
Sources of revenue for the Company’s tenants may include the U.S. federal Medicare program, state Medicaid programs, private insurance carriers and health maintenance organizations, among others. Healthcare providers continue to face increased government and private payor pressure to control or reduce costs. Additional cost reduction measures may be included in the healthcare reform legislation being debated in the U.S. Congress. Efforts by government and private payors to reduce healthcare costs will likely continue, which may result in reductions or slower growth in reimbursement for certain services provided by some of the Company’s tenants. In addition, the failure of any of the Company’s tenants to comply with various laws and regulations could jeopardize their ability to continue participating in Medicare, Medicaid and other government sponsored payment programs. A reduction in reimbursements to the Company’s tenants from third party payors for any reason could adversely affect the Company’s tenants’ ability to make rent payments to the Company, which may have a material adverse effect on the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock.
The healthcare industry is heavily regulated, and new laws or regulations, changes to existing laws or regulations, loss of licensure or failure to obtain licensure could result in the inability of the Company’s tenants to make rent payments to the Company.
The healthcare industry is heavily regulated by U.S. federal, state and local governmental bodies. The Company’s tenants generally will be subject to laws and regulations covering, among other things, licensure, certification for participation in government programs and relationships with physicians and other referral sources, and the privacy and security of individually identifiable health information.
In addition, state and local laws regulate expansion, including the addition of new beds or services or acquisition of medical equipment, and the construction of healthcare related facilities, by requiring a certificate of need, which is issued by the applicable state health planning agency only after that agency makes a determination that a need exists in a particular area for a particular service or facility, or other similar approval. New laws and regulations, changes in existing laws and regulations or changes in the interpretation of such laws or regulations could negatively affect the financial condition of the Company’s tenants. These changes, in some cases, could apply retroactively. The enactment, timing or effect of legislative or regulatory changes cannot be predicted. In addition, certain of the Company’s medical office buildings and healthcare related facilities and their tenants may require licenses or certificates of need to operate. Failure to obtain a license or certificate of need, or loss of a required license would prevent a facility from operating in the manner intended by the tenant.
These events could adversely affect the Company’s tenants’ ability to make rent payments to the Company, which may have a material adverse effect on the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock.
Privacy and security regulations issued pursuant to HIPAA extensively regulate the use and disclosure of individually identifiable health information. See "Business - Regulation." The HITECH Act, signed into law on February 17, 2009, broadened the scope of those requirements and contains enhanced enforcement provisions, including: (i) increased civil monetary penalties; (ii) allowing state attorneys general to bring civil actions for HIPAA violations; and (iii) requiring the U.S. Department of Health and Human Services to conduct audits of covered entities, such as healthcare providers, to determine their compliance with HIPAA. The cost of complying with these requirements or the imposition of penalties for HIPAA violations could adversely affect the ability of a tenant to make rent payments to the Company, which may have a material adverse effect on the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and trading price of the Company’s common stock.
The Company’s tenants are subject to the Stark Law and fraud and abuse laws, the violation of which by a tenant may jeopardize the tenant’s ability to make rent payments to the Company.
There are various federal and state laws prohibiting fraudulent and abusive business practices by healthcare providers who participate in, receive payments from or are in a position to make referrals in connection with government-sponsored healthcare programs, including the Medicare and Medicaid programs. The Company’s lease arrangements with certain tenants may also be subject to the Start Law and fraud and abuse laws, to the extent these lease arrangements create indirect financial relationships between the tenants and the Company that are subject to these laws and regulations.
These laws that may apply to tenants include:
| · | the Federal Anti-Kickback Statute, which prohibits, among other things, the offer, payment, solicitation or receipt of any form of remuneration in return for, or to induce, the referral of Medicare and Medicaid patients; |
| · | the Stark Law, which, subject to specific exceptions, restricts physicians who have financial relationships with healthcare providers from making referrals for specifically designated health services for which payment may be made under Medicare or Medicaid programs to an entity with which the physician, or an immediate family member, has a financial relationship; |
| · | the False Claims Act, which prohibits any person from knowingly presenting false or fraudulent claims for payment to the federal government, including under the Medicare and Medicaid programs; and |
| · | the Civil Monetary Penalties Law, which authorizes the Department of Health and Human Services to impose monetary penalties for certain fraudulent acts. |
Each of these laws includes criminal and/or civil penalties for violations that range from punitive sanctions, damage assessments, penalties, imprisonment, denial of Medicare and Medicaid payments and/or exclusion from the Medicare and Medicaid programs. Additionally, certain laws, such as the False Claims Act, allow for individuals to bring whistleblower actions on behalf of the government for violations thereof. Imposition of any of these penalties upon one of the Company’s tenants or associated hospitals could jeopardize that tenant’s ability to operate or to make rent payments or affect the level of occupancy in the Company’s medical office buildings or healthcare related facilities associated with that hospital, which may have a material adverse effect on the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock.
Risks Related to the Real Estate Industry
Illiquidity of real estate investments could significantly impede the Company’s ability to respond to adverse changes in the performance of the Company’s properties.
Because real estate investments are relatively illiquid, the Company’s ability to promptly sell one or more properties in the Company’s portfolio in response to changing economic, financial and investment conditions is limited. The real estate market is affected by many factors, such as general economic conditions, availability of financing, interest rates and other factors, including supply and demand, that are beyond the Company’s control. The Company cannot predict whether the Company will be able to sell any property for the price or on the terms set by the Company or whether any price or other terms offered by a prospective purchaser would be acceptable to the Company. The Company also cannot predict the length of time needed to find a willing purchaser and to close the sale of a property.
The Company may be required to expend funds to correct defects or to make improvements before a property can be sold. The Company cannot assure you that it will have funds available to correct those defects or to make those improvements. In acquiring a property, the Company may agree to transfer restrictions that materially restrict it from selling that property for a period of time or impose other restrictions, such as a limitation on the amount of debt that can be placed or repaid on that property. These transfer restrictions would impede the Company’s ability to sell a property even if the Company deems it necessary or appropriate. These facts and any others that would impede the Company’s ability to respond to adverse changes in the performance of its properties may have a material adverse effect on its business, financial condition, results of operations, or ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock.
Any investments in unimproved real property may take significantly longer to yield income-producing returns, if at all, and may result in additional costs to the Company to comply with re-zoning restrictions or environmental regulations
The Company may invest in unimproved real property. Unimproved properties generally take longer to yield income-producing returns based on the typical time required for development. Any development of unimproved real property may also expose the Company to the risks and uncertainties associated with re-zoning the land for a higher use or development and environmental concerns of governmental entities and/or community groups. Any unsuccessful investments or delays in realizing an income-producing return or increased costs to develop unimproved real property could restrict the Company’s ability to earn its targeted rate of return on an investment or adversely affect the Company’s ability to pay operating expenses, which may have a material adverse effect on the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock.
Risks Related to Debt Financings
Required payments of principal and interest on borrowings may leave the Company with insufficient cash to operate the Company’s properties or to pay the distributions currently contemplated or necessary to qualify as a REIT and may expose the Company to the risk of default under the Company’s debt obligations.
At December 31, 2009, the Company has approximately $410.9 million of outstanding indebtedness, $365.6 million of which is secured. Approximately $25.3 million and $181.7 million of the Company’s outstanding indebtedness will mature in 2010 and 2011, respectively. The Company expects to incur additional debt in connection with future development and redevelopment projects and acquisitions. The Company may borrow under its Credit Facility, or borrow new funds to complete these projects and acquisitions. Additionally, the Company does not anticipate that the Company’s internally generated cash flow will be adequate to repay the Company’s existing indebtedness upon maturity and, therefore, the Company expects to repay the Company’s indebtedness through refinancings and future offerings of equity and/or debt.
If the Company is required to utilize the Company’s Credit Facility for purposes other than development, redevelopment and acquisition activities, this will reduce the amount available for development and redevelopment projects and acquisitions and could slow the Company’s growth. Therefore, the Company’s level of debt and the limitations imposed on the Company by the Company’s debt agreements could have adverse consequences, including the following:
| · | the Company’s cash flow may be insufficient to meet the Company’s required principal and interest payments; |
| · | the Company may be unable to borrow additional funds as needed or on favorable terms, including to make acquisitions; |
| · | the Company may be unable to refinance the Company’s indebtedness at maturity or the refinancing terms may be less favorable than the terms of the Company’s original indebtedness; |
| · | because a portion of the Company’s debt bears interest at variable rates, an increase in interest rates could materially increase the Company’s interest expense; |
| · | the Company may be forced to dispose of one or more of the Company’s properties, possibly on disadvantageous terms; |
| · | after debt service, the amount available for distributions to the Company’s stockholders is reduced; |
| · | the Company’s debt level could place the Company at a competitive disadvantage compared to the Company’s competitors with less debt; |
| · | the Company may experience increased vulnerability to economic and industry downturns, reducing the Company’s ability to respond to changing business and economic conditions; |
| · | the Company may default on the Company’s obligations and the lenders or mortgagees may foreclose on the Company’s properties that secure their loans and receive an assignment of rents and leases; |
| · | the Company may violate financial covenants which would cause a default on the Company’s obligations; |
| · | the Company may inadvertently violate non-financial restrictive covenants in the Company’s loan documents, such as covenants that require the Company to maintain the existence of entities, maintain insurance policies and provide financial statements, which would entitle the lenders to accelerate the Company’s debt obligations; and |
| · | the Company may default under any one of the Company’s mortgage loans with cross-default or cross-collateralization provisions that could result in default on other indebtedness or result in the foreclosures of other properties. |
The realization of any or all of these risks may have a material adverse effect on the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock.
As a result of recent market events, including the contraction among and failure of certain lenders, it may be more difficult for the Company to secure financing.
The Company’s results of operations may be materially affected by conditions in the financial markets and the economy generally. Over the past several years, concerns over inflation, energy costs, geopolitical issues, unemployment, the availability and cost of credit, the mortgage market and a declining real estate market have contributed to increased volatility and diminished expectations for the economy and markets.
Dramatic declines in the housing market, with decreasing home prices and increasing foreclosures and unemployment, have resulted in significant asset write-downs by financial institutions, which have caused many financial institutions to seek additional capital, to merge with other institutions and, in some cases, to fail. The Company relies on the availability of financing to execute its business strategy. Institutions from which the Company may seek to obtain financing may have owned or financed residential mortgage loans, real estate-related securities and real estate loans which have declined in value and caused losses as a result of the recent downturn in the markets. Many lenders and institutional investors have reduced and, in some cases, ceased to provide funding to borrowers, including other financial institutions. If these conditions persist, these institutions may become insolvent. As a result of recent market events, it may be more difficult for the Company to secure financing as there are fewer institutional lenders and those remaining lenders have tightened their lending standards.
As a result of these events, it may be more difficult for the Company to obtain financing on attractive terms, or at all, and the Company’s financial position and results of operations could be adversely affected.
The Company’s ability to pay distributions is dependent on a number of factors and is not assured, and the Company’s distributions to stockholders may decline at any time.
The Company’s ability to make distributions depends upon a variety of factors, including efficient management of the Company’s properties and the successful implementation by the Company of a variety of the Company’s growth initiatives, and may be adversely affected by the risks described elsewhere in this Annual Report on Form 10-K. All distributions will be made at the discretion of the Board of Directors and depend on the Company earnings, the Company’s financial condition, the REIT distribution requirements and other factors that the Board of Directors may consider from time to time. The Company cannot assure you that the level of the Company’s distributions will increase over time or that the Company will be able to maintain the Company’s future distributions at levels that equal or exceed the Company’s historical distributions. The Company may be required to fund future distributions either from borrowings under the Company’s Credit Facility, with the proceeds from equity offerings, which could be dilutive, or from property sales, which could be at a loss, or reduce such distributions. A reduction in distributions to stockholders may negatively impact the Company’s stock price.
The Company’s organizational documents contain no limitations on the amount of debt the Company may incur.
The Company’s organizational documents contain no limitations on the amount of indebtedness that the Company or the Operating Partnership may incur. The Company could alter the balance between the Company’s total outstanding indebtedness and the value of the Company’s wholly-owned properties at any time. If the Company becomes more highly leveraged, the resulting increase in debt service could adversely affect the Company’s ability to make payments on the Company’s outstanding indebtedness and to pay the Company’s anticipated distributions and/or the distributions required to qualify as a REIT, and may materially and adversely affect the Company’s business, financial condition, results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock.
Increases in interest rates may increase the Company’s interest expense and adversely affect the Company’s cash flow and the Company’s ability to service the Company’s indebtedness and make distributions to the Company’s stockholders.
As of December 31, 2009, the Company has approximately $410.9 million of outstanding indebtedness, of which approximately $70.0 million, or 17.1%, is subject to variable interest rates (excluding debt subject to variable to fixed interest rate swap agreements). This variable rate debt had a weighted average interest rate of approximately 2.1% per year as of December 31, 2009. Increases in interest rates on this variable rate debt would increase the Company’s interest expense, which could adversely affect the Company’s cash flow and the Company’s ability to pay distributions. For example, if market rates of interest on this variable rate debt increased by 100 basis points, the increase in interest expense would decrease future earnings and cash flows by approximately $0.7 million annually.
Failure to hedge effectively against interest rate changes may adversely affect the Company’s results of operations.
In certain cases, the Company may seek to manage the Company’s exposure to interest rate volatility by using interest rate hedging arrangements. Hedging involves risks, such as the risk that the counterparty may fail to honor its obligations under an arrangement, that the arrangements may not be effective in reducing the Company’s exposure to interest rate changes and that a court could rule that such an agreement is not legally enforceable. In addition, the Company may be limited in the type and amount of hedging transactions the Company may use in the future by the Company’s need to satisfy the REIT income tests under the Code. Failure to hedge effectively against interest rate changes may have a material adverse effect on the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock.
The Company’s Credit Facility and Term Loan contains financial covenants that could limit the Company’s operations and the Company’s ability to make distributions to the Company’s stockholders.
The Company’s Credit Facility and Term Loan (defined in Note 9 to the accompanying Consolidated Financial Statements) contains financial and operating covenants, including tangible net worth requirements, fixed charge coverage and debt ratios and other limitations on the Company’s ability to make distributions or other payments to the Company’s stockholders (other than those required by the Code), sell all or substantially all of the Company’s assets and engage in mergers, consolidations and certain acquisitions.
The Credit Facility contains customary terms and conditions for credit facilities of this type, including, but not limited to: (1) affirmative covenants relating to the Company’s corporate structure and ownership, maintenance of insurance, compliance with environmental laws and preparation of environmental reports, maintenance of the Company’s REIT qualification and listing on the New York Stock Exchange (the “NYSE”), (2) negative covenants relating to restrictions on liens, indebtedness, certain investments (including loans and certain advances), mergers and other fundamental changes, sales and other dispositions of property or assets and transactions with affiliates. The Term Loan contains customary covenants including, but not limited to, (1) affirmative covenants relating to the Company’s corporate structure and ownership, maintenance of insurance, compliance with environmental laws and preparation of environmental reports, maintenance of the Company’s REIT qualification and listing on the New York Stock Exchange, (2) negative covenants relating to restrictions on liens, indebtedness, certain investments (including loans and certain advances), mergers and other fundamental changes, sales and other dispositions of property or assets and transactions with affiliates. Both the Credit Facility and the Term Loan have financial covenants to be met by the Company at all times including a maximum total leverage ratio (70%), maximum real estate leverage ratio (70%), minimum fixed charge coverage ratio (1.50 to 1.00), maximum total debt to real estate value ratio (90%) and minimum consolidated tangible net worth ($45 million plus 85% of the net proceeds of equity issuances issued after the closing date). In addition, there are financial covenants relating only to Design-Build and Development, including a covenant relating to maximum consolidated senior indebtedness to adjusted consolidated EBITDA (3.50 to 1.00). As of December 31, 2009, consolidated senior indebtedness to adjusted consolidated EBITDA was 2.37, and the Company may be required to repay a portion of the principal balance if adjusted consolidated EBITDA is insufficient to meet the ratio of maximum consolidated senior indebtedness to adjusted consolidated EBITDA.
These covenants may restrict the Company’s ability to engage in transactions that the Company believes would otherwise be in the best interests of the Company’s stockholders. Failure to comply with any of the covenants in the Company’s Credit Facility or Term Loan could result in a default. This could cause one or more of the Company’s lenders to accelerate the timing of payments and may have a material adverse effect on the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock.
If lenders under the Company’s Credit Facility fail to meet their funding commitments, the Company’s financial position would be negatively impacted.
Access to external capital on favorable terms is critical to the Company’s success in growing and maintaining its portfolio. If financial institutions within the Company’s Credit Facility were unwilling or unable to meet their respective funding commitments to the Company, any such failure would have a negative impact on the Company’s operations, financial condition and ability to meet its obligations, including the payment of dividends to stockholders.
Risks Related to the Company’s Organization and Structure
The Company’s business could be harmed if key personnel terminate their employment with the Company.
The Company’s success depends, to a significant extent, on the continued services of Mr. Cogdell, the Company’s Chairman, Mr. Spencer, the Company’s Chief Executive Officer, President and a member of the Board of Directors, and the other members of the Company’s senior management team. The Company’s senior management team has an average of 24 years of experience in the healthcare real estate industry. In addition, the Company’s ability to continue to acquire and develop properties depends on the significant relationships the Company’s senior management team has developed. There is no guarantee that any of them will remain employed by the Company. The Company does not maintain key person life insurance on any of the Company’s officers. The loss of services of one or more members of the Company’s senior management team could harm the Company’s business and the Company’s prospects.
Tax indemnification obligations could limit the Company’s operating flexibility by limiting the Company’s ability to sell specified properties.
In connection with the formation transactions and certain other property acquisitions, the Company entered into a tax protection agreement with the former owners of each contributed medical office building or healthcare related facility who received OP units.
Pursuant to these agreements, the Company will not sell, transfer or otherwise dispose of any of the medical office buildings or healthcare related facilities (each a “protected asset”) or any interest in a protected asset prior to the eighth anniversary of the closing of the offering unless:
1. a majority-in-interest of the former holders of interests in the predecessor partnerships or contributing entities (or their successors, which may include the Company to the extent any OP units have been redeemed or exchanged) with respect to such protected asset consent to the sale, transfer of other disposition; provided, however, with respect to three of the predecessor entities, Cabarrus POB, LLC, Medical Investors I, LLC and Medical Investors III, LLC, the required consent shall be a majority-in-interest of the beneficial owners of interests in the predecessor entities other than Messrs. Cogdell and Spencer and their affiliates; or
2. the Operating Partnership delivers to each such holder of interests, a cash payment intended to approximate the holder’s tax liability related to the recognition of such holder’s built-in gain resulting from the sale of such protected asset; or
3. the sale, transfer or other disposition would not result in the recognition of any built-in gain by any such holder of interests.
Protected assets represent approximately 69.9% of the Company’s total net rentable square feet. If the Company were to sell all of these protected assets and the Company undertook such sale without obtaining the requisite consent of the contributing holders, then the Company would be required to make material payments to these holders. The prospect of making payments under the tax protection agreements could impede the Company’s ability to respond to changing economic, financial and investment conditions. For example, it may not be economical for the Company to raise cash quickly through a sale of one or more of the Company’s protected assets or dispose of a poorly performing protected asset until the expiration of the eight-year protection period.
Tax indemnification obligations may require the Operating Partnership to maintain certain debt levels.
The Company’s tax protection agreements also provide that during the period from the closing of the initial public offering in 2005 through the twelfth anniversary thereof, the Operating Partnership will offer each holder who continues to hold at least 50% of the OP units received in respect of the consolidation transaction the opportunity to: (1) guarantee debt or (2) enter into a deficit restoration obligation. If the Company fails to offer such opportunities, the Company will be required to deliver to each holder a cash payment intended to approximate the holder’s tax liability resulting from the Company’s failure to make such opportunities available to that holder. The Company agreed to these provisions in order to assist such holders in deferring the recognition of taxable gain as a result of and after the consolidation transaction. These obligations may require the Company to maintain more or different indebtedness than the Company would otherwise require for the Company’s business.
The Company may pursue less vigorous enforcement of terms of contribution and other agreements because of conflicts of interest with certain of the Company’s officers.
Mr. Cogdell, the Company’s Chairman, Mr. Spencer, the Company’s Chief Executive Officer, President and a member of the Board of Directors, Charles M. Handy, the Company’s Chief Financial Officer, Senior Vice President and Secretary, and other members of the Company’s management team, have direct or indirect ownership interests in certain properties contributed to the Operating Partnership in the Formation Transactions. The Company, under the agreements relating to the contribution of such interests, is entitled to indemnification and damages in the event of breaches of representations or warranties made by the contributors. The Company may choose not to enforce, or to enforce less vigorously, the Company’s rights under these agreements because of the Company’s desire to maintain the Company’s ongoing relationships with the individual party to these agreements. In connection with the acquisition of MEA, the Company entered into various agreements with MEA, including the merger agreement, pursuant to which the Company is entitled to indemnification and damages in the event of breaches of representations and warranties made by MEA. Because two members of the Company’s Board of Directors, Mr. Lubar and Mr. Ransom, and certain other key employees and personnel were also former owners, officers and directors of MEA, the Company may choose not to enforce, or to enforce less vigorously, the Company’s rights under these agreements. In addition, the Company is party to employment agreements with Messrs. Cogdell, Spencer, Handy and Ransom, which provide for additional severance following termination of employment if the Company elects to subject the executive officer to certain non-competition, confidentiality and non-solicitation provisions. Although their employment agreements require that they devote substantially all of their full business time and attention to the Company, if the executive officer forgoes the additional severance, he will not be subject to such non-competition provisions, which would allow him to compete with the Company. None of these agreements were negotiated on an arm’s-length basis.
Conflicts of interest could arise as a result of the Company UPREIT structure.
Conflicts of interest could arise in the future as a result of the relationships between the Company and the Company’s affiliates, on the one hand, and the Operating Partnership or any partner thereof, on the other. The Company’s directors and officers have duties to the Company under applicable Maryland law in connection with their management of the Company. At the same time, the Company, through the Company’s wholly-owned subsidiary, has fiduciary duties, as a general partner, to the Operating Partnership and to the limited partners under Delaware law in connection with the management of the Operating Partnership. The Company’s duties, through the Company’s wholly-owned subsidiary, as a general partner to the Operating Partnership and its partners may come into conflict with the duties of the Company’s directors and officers. The partnership agreement of the Operating Partnership does not require the Company to resolve such conflicts in favor of either the Company’s stockholders or the limited partners in the Operating Partnership.
Unless otherwise provided for in the relevant partnership agreement, Delaware law generally requires a general partner of a Delaware limited partnership to adhere to fiduciary duty standards under which it owes its limited partners the highest duties of good faith, fairness and loyalty and which generally prohibit such general partner from taking any action or engaging in any transaction as to which it has a conflict of interest.
Additionally, the partnership agreement expressly limits the Company’s liability by providing that neither the Company, nor the Company’s wholly-owned Maryland business trust subsidiary, as the general partner of the Operating Partnership, nor any of the Company or its trustees, directors or officers, will be liable or accountable in damages to the Operating Partnership, the limited partners or assignees for errors in judgment, mistakes of fact or law or for any act or omission if the general partner or such trustee, director or officer, acted in good faith. In addition, the Operating Partnership is required to indemnify the Company, the Company’s affiliates and each of the Company’s respective trustees, officers, directors, employees and agents to the fullest extent permitted by applicable law against any and all losses, claims, damages, liabilities (whether joint or several), expenses (including, without limitation, attorneys’ fees and other legal fees and expenses), judgments, fines, settlements and other amounts arising from any and all claims, demands, actions, suits or proceedings, civil, criminal, administrative or investigative, that relate to the operations of the Operating Partnership, provided that the Operating Partnership will not indemnify any such person for (1) willful misconduct or a knowing violation of the law, (2) any transaction for which such person received an improper personal benefit in violation or breach of any provision of the partnership agreement, or (3) in the case of a criminal proceeding, the person had reasonable cause to believe the act or omission was unlawful.
The provisions of Delaware law that allow the common law fiduciary duties of a general partner to be modified by a partnership agreement have not been resolved in a court of law, and the Company has not obtained an opinion of counsel covering the provisions set forth in the partnership agreement that purport to waive or restrict the Company’s fiduciary duties that would be in effect under common law were it not for the partnership agreement.
Certain provisions of the Company’s organizational documents, including the stock ownership limit imposed by the Company’s charter, could prevent or delay a change in control transaction.
The Company’s charter, subject to certain exceptions, authorizes the Company’s directors to take such actions as are necessary and desirable to preserve the Company’s qualification as a REIT and to limit any person to actual or constructive ownership of 7.75% (by value or by number of shares, whichever is more restrictive) of the Company’s outstanding common stock or 7.75% (by value or by number of shares, whichever is more restrictive) of the Company’s outstanding capital stock. The Board of Directors, in its sole discretion, may exempt additional persons from the ownership limit. However, the Board of Directors may not grant an exemption from the ownership limit to any proposed transferee whose ownership could jeopardize the Company’s qualification as a REIT. These restrictions on ownership will not apply if the Board of Directors determines that it is no longer in the Company’s best interests to attempt to qualify, or to continue to qualify, as a REIT. The ownership limit may delay or impede a transaction or a change of control that might involve a premium price for the Company’s common stock or otherwise be in the best interests of the Company’s stockholders.
Certain provisions of Maryland law may limit the ability of a third party to acquire control of the Company.
Certain provisions of the Maryland General Corporation Law, or the MGCL, may have the effect of delaying, deferring or preventing a transaction or a change in control of the Company that might involve a premium price for holders of the Company’s common stock or otherwise be in their best interests, including:
| · | “business combination” provisions that, subject to certain limitations, prohibit certain business combinations between the Company and an “interested stockholder” (defined generally as any person who beneficially owns 10% or more of the voting power of the Company’s shares or an affiliate thereof) for five years after the most recent date on which the stockholder becomes an interested stockholder, and thereafter impose special minimum price provisions and special stockholder voting requirements on these combinations; and |
| · | “control share” provisions that provide that “control shares” of the Company (defined as shares which, when aggregated with other shares controlled by the stockholder, entitle the stockholder to exercise one of three increasing ranges of voting power in electing directors) acquired in a “control share acquisition” (defined as the direct or indirect acquisition of ownership or control of “control shares”) have no voting rights except to the extent approved by the Company’s stockholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter, excluding all interested shares. |
These provisions of the MGCL relating to business combinations do not apply, however, to business combinations that are approved or exempted by a board of directors prior to the time that the interested stockholder becomes an interested stockholder. Pursuant to the statute, the Board of Directors has by resolution exempted Mr. Cogdell, his affiliates and associates and all persons acting in concert with the foregoing, and Mr. Spencer, his affiliates and associates and all persons acting in concert with the foregoing, from these provisions of the MGCL and, consequently, the five-year prohibition and the supermajority vote requirements will not apply to business combinations between the Company and these persons. As a result, these persons may be able to enter into business combinations with the Company that may not be in the best interests of the Company’s stockholders without compliance by the Company with the supermajority vote requirements and the other provisions of the statute. In addition, the Company’s by-laws contain a provision exempting from the provisions of the MGCL relating to control share acquisitions any and all acquisitions by any person of the Company’s common stock. There can be no assurance that such provision will not be amended or eliminated at any time in the future.
Additionally, Title 3, Subtitle 8 of the MGCL permits the Board of Directors, without stockholder approval and regardless of what is currently provided in the Company’s charter or bylaws, to take certain actions that may have the effect of delaying, deferring or preventing a transaction or a change in control of the Company that might involve a premium to the market price of the Company’s common stock or otherwise be in the Company’s stockholders’ best interests.
The Board of Directors has the power to cause the Company to issue additional shares of the Company’s stock and the general partner has the power to issue additional OP units without stockholder approval.
The Company’s charter authorizes the Board of Directors to cause the Company to issue additional authorized but unissued shares of common stock, or preferred stock and to amend the Company’s charter to increase the aggregate number of authorized shares or the authorized number of shares of any class or series without stockholder approval. The general partner will be given the authority to issue additional OP units. In addition, the Board of Directors may classify or reclassify any unissued shares of common stock or preferred stock and set the preferences, rights and other terms of the classified or reclassified shares. The Board of Directors could cause the Company to issue additional shares of the Company’s common stock or establish a series of preferred stock that could have the effect of delaying, deferring or preventing a change in control or other transaction that might involve a premium price for the Company’s common stock or otherwise be in the best interests of the Company’s stockholders.
The Company’s rights and the rights of the Company’s stockholders to take action to recover money damages from the Company’s directors and officers are limited.
The Company’s charter eliminates the Company’s directors’ and officers’ liability to the Company and the Company’s stockholders for money damages, except for liability resulting from actual receipt of an improper benefit in money, property or services or active and deliberate dishonesty established by a final judgment and which is material to the cause of action. The Company’s charter authorizes the Company, and the Company’s bylaws require the Company, to indemnify the Company’s directors and officers for liability resulting from actions taken by them in those capacities to the maximum extent permitted by Maryland law. In addition, the Company may be obligated to fund the defense costs incurred by the Company’s directors and officers.
You will have limited ability as a stockholder to prevent the Company from making any changes to the Company policies that you believe could harm the Company’s business, prospects, operating results or share price.
The Board of Directors will adopt policies with respect to certain activities, such as investments, dispositions, financing, lending, the Company’s equity capital, conflicts of interest and reporting. These policies may be amended or revised from time to time at the discretion of the Board of Directors without a vote of the Company’s stockholders. This means that the Company’s stockholders will have limited control over changes in the Company’s policies. Such changes in the Company’s policies intended to improve, expand or diversify the Company’s business may not have the anticipated effects and consequently may have a material adverse effect on the Company’s business, financial condition and results of operations, the Company’s ability to make distributions to the Company’s stockholders and the trading price of the Company’s common stock.
To the extent the Company’s distributions represent a return of capital for tax purposes you could recognize an increased capital gain upon a subsequent sale by you of the Company’s common stock.
Distributions in excess of the Company’s current and accumulated earnings and profits and not treated by the Company as a dividend will not be taxable to a U.S. stockholder to the extent those distributions do not exceed the stockholder’s adjusted tax basis in its common stock, but instead will constitute a return of capital and will reduce the stockholder’s adjusted tax basis in its common stock. If distributions result in a reduction of a stockholder’s adjusted basis in such holder’s common stock, subsequent sales of such holder’s common stock potentially will result in recognition of an increased capital gain or reduced capital loss due to the reduction in such adjusted basis.
The Company may choose to make distributions in its own stock, in which case you may be required to pay income taxes in excess of the cash dividends you receive.
As a REIT, the Company is required to distribute at least 90% of its taxable income to its stockholders. In order to satisfy this requirement, the Company may distribute taxable dividends that are payable in cash and shares of its common stock at the election of each stockholder. Under IRS Revenue Procedure 2010-12, up to 90% of any such taxable dividend with respect to the taxable years 2010 and 2011 could be payable in the Company's stock. Taxable stockholders receiving such dividends will be required to include the full amount of the dividend as ordinary income to the extent of the Company's current or accumulated earnings and profits for U.S. federal income tax purposes. As a result, U.S. stockholders may be required to pay income taxes with respect to such dividends in excess of the cash dividends received. Accordingly, U.S. stockholders receiving a distribution of the Company's shares may be required to sell shares received in such distribution or may be required to sell other stock or assets owned by them, at a time that may be disadvantageous, in order to satisfy any tax imposed on such distribution. If a U.S. stockholder sells the stock that it receives as a dividend in order to pay this tax, the sales proceeds may be less than the amount included in income with respect to the dividend, depending on the market price of the Company's stock at the time of the sale. Furthermore, with respect to certain non-U.S. stockholders, the Company may be required to withhold U.S. tax with respect to such dividends, including in respect of all or a portion of such dividend that is payable in stock, by withholding or disposing of part of the shares in such distribution and using the proceeds of such disposition to satisfy the withholding tax imposed. In addition, if a significant number of the Company's stockholders determine to sell shares of the Company's common stock in order to pay taxes owed on dividends, such sale may put downward pressure on the trading price of the Company's common stock.
Further, while Revenue Procedure 2010-12 applies only to taxable dividends payable by the Company in a combination of cash and stock with respect to the taxable years 2010 and 2011, it is unclear whether and to what extent the Company will be able to pay taxable dividends in cash and stock in later years. Moreover, various tax aspects of such a taxable cash/stock dividend are uncertain and have not yet been addressed by the IRS. No assurance can be given that the IRS will not impose additional requirements in the future with respect to taxable cash/stock dividends, including on a retroactive basis, or assert that the requirements for such taxable cash/stock dividends have not been met.
Risks Related to Qualification and Operation as a REIT
The Company’s failure to qualify or remain qualified as a REIT would have significant adverse consequences to the Company and the value of the Company’s common stock.
The Company intends to operate in a manner that will allow the Company to qualify as a REIT for U.S. federal income tax purposes under the Code. The Company has not requested and does not plan to request a ruling from the IRS that the Company qualifies as a REIT, and the statements in the Company’s prospectus and other filings are not binding on the IRS or any court. If the Company fails to qualify or loses the Company’s qualification as a REIT, the Company will face serious tax consequences that would substantially reduce the funds available for distribution to the Company’s stockholders for each of the years involved because:
| · | the Company would not be allowed a deduction for distributions to stockholders in computing the Company’s taxable income and the Company would be subject to U.S. federal income tax at regular corporate rates; |
| · | the Company also could be subject to the U.S. federal alternative minimum tax and possibly increased state and local taxes; and |
| · | unless the Company is entitled to relief under applicable statutory provisions, the Company could not elect to be taxed as a REIT for four taxable years following a year during which the Company was disqualified. |
In addition, if the Company loses its qualification as a REIT, the Company will not be required to make distributions to stockholders, and all distributions to the Company’s stockholders will be subject to tax as regular corporate dividends to the extent of the Company’s current and accumulated earnings and profits. This means that the Company’s U.S. individual stockholders would be taxed on the Company’s dividends at a maximum U.S. federal income tax rate of 15% (through 2010), and the Company’s corporate stockholders generally would be entitled to the dividends received deduction with respect to such dividends, subject, in each case, to applicable limitations under the Code.
Qualification as a REIT involves the application of highly technical and complex Code provisions and regulations promulgated thereunder for which there are only limited judicial and administrative interpretations. The complexity of these provisions and of the applicable U.S. Treasury Department regulations, or Treasury Regulations, that have been promulgated under the Code is greater in the case of a REIT that, like the Company, holds its assets through a partnership. The determination of various factual matters and circumstances not entirely within the Company’s control may affect the Company’s ability to qualify as a REIT. In order to qualify as a REIT, the Company must satisfy a number of requirements, including requirements regarding the composition of the Company’s assets and sources of the Company’s gross income. Also, the Company must make distributions to stockholders aggregating annually at least 90% of the Company’s net taxable income, excluding capital gains.
As a result of these factors, the Company’s loss of its qualification as a REIT also could impair the Company’s ability to expand the Company’s business and raise capital, and would adversely affect the value of the Company’s common stock.
To maintain its REIT qualification, the Company may be forced to borrow funds during unfavorable market conditions.
To qualify as a REIT, the Company generally must distribute to the Company’s stockholders at least 90% of the Company’s net taxable income each year, excluding net capital gains, and the Company will be subject to regular corporate income taxes to the extent that the Company distributes less than 100% of the Company’s net taxable income each year. In addition, the Company will be subject to a 4% nondeductible excise tax on the amount, if any, by which distributions paid by the Company in any calendar year are less than the sum of 85% of the Company’s ordinary income, 95% of the Company’s capital gain net income and 100% of the Company’s undistributed income from prior years. In order to qualify as a REIT and avoid the payment of income and excise taxes, the Company may need to borrow funds on a short-term basis, or possibly on a long-term basis, to meet the REIT distribution requirements even if the then prevailing market conditions are not favorable for these borrowings. These borrowing needs could result from, among other things, a difference in timing between the actual receipt of cash and inclusion of income for U.S. federal income tax purposes, the effect of non-deductible capital expenditures, the creation of reserves or required debt amortization payments.
Dividends payable by REITs generally do not qualify for reduced tax rates.
The maximum tax rate for dividends payable by domestic corporations to individual U.S. stockholders is 15% (through 2010). Dividends payable by REITs, however, are generally not eligible for the reduced rates. The more favorable rates applicable to regular corporate dividends could cause stockholders who are individuals to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the stock of REITs, including the Company’s common stock.
In addition, the relative attractiveness of real estate in general may be adversely affected by the favorable tax treatment given to corporate dividends, which could negatively affect the value of the Company’s properties.
Possible legislative or other actions affecting REITs could adversely affect the Company and the Company’s stockholders.
The rules dealing with U.S. federal income taxation are constantly under review by persons involved in the legislative process and by the IRS and the U.S. Treasury Department. Changes to tax laws (which changes may have retroactive application) could adversely affect the Company or the Company’s stockholders. The Company cannot predict whether, when, in what forms, or with what effective dates, the tax laws applicable to the Company or the Company’s stockholders will be changed.
Complying with REIT requirements may cause the Company to forego otherwise attractive opportunities.
To qualify as a REIT for U.S. federal income tax purposes, the Company must continually satisfy tests concerning, among other things, the sources of the Company’s income, the nature and diversification of the Company’s assets, the amounts the Company distributes to the Company’s stockholders and the ownership of the Company’s stock. In order to meet these tests, the Company may be required to forego attractive business or investment opportunities. Thus, compliance with the REIT requirements may adversely affect the Company’s ability to operate solely to maximize profits.
The Company will pay some taxes.
Even if the Company qualifies as a REIT for U.S. federal income tax purposes, the Company will be required to pay some U.S. federal, state and local taxes on the Company’s income and property. In addition, the Company’s TRSs are fully taxable corporations that will be subject to taxes on their income and such TRSs may be limited in their ability to deduct interest payments made to the Company or the Operating Partnership. The Company also will be subject to a 100% penalty tax on certain amounts if the economic arrangements among the Company’s tenants, the Company’s TRSs and the Company are not comparable to similar arrangements among unrelated parties or if the Company receives payments for inventory or property held for sale to customers in the ordinary course of business. To the extent that the Company or the Company’s TRSs are required to pay U.S. federal, state or local taxes, the Company will have less cash available for distribution to the Company’s stockholders.
The ability of the Board of Directors to revoke the Company REIT election without stockholder approval may cause adverse consequences to the Company’s stockholders.
The Company’s charter provides that the Board of Directors may revoke or otherwise terminate the Company REIT election, without the approval of the Company’s stockholders, if it determines that it is no longer in the Company’s best interests to continue to qualify as a REIT. If the Company ceases to qualify as a REIT, the Company would become subject to U.S. federal income tax on the Company’s taxable income and the Company would no longer be required to distribute most of the Company’s taxable income to the Company’s stockholders, which may have adverse consequences on the total return to the Company’s stockholders.
The Company’s ability to invest in TRSs is limited by its qualification as a REIT, and accordingly may limit its ability to grow the business of the Design-Build and Development segment.
In order for the Company to qualify as a REIT, no more than 25% of the value of its assets may consist of securities of one or more TRSs (20% for taxable years ended on or before December 31, 2008). The Company has jointly elected with TRS Holdings and its subsidiaries to treat such entities as TRSs. Accordingly, the Company’s ability to grow and expand the business of TRS Holdings and its subsidiaries, absent a corresponding increase in the value of its real estate assets, will be limited by the Company’s need to continue to meet the applicable TRS limitation which could adversely affect returns to its stockholders.
If the aggregate value of the securities the Company owns in its TRSs were determined to be in excess of 25% (20% with respect to our taxable years ended on or before December 31, 2008) of the value of its total assets, the Company could fail to qualify as a REIT or be subject to a penalty tax and forced to dispose of TRS securities.
For the Company to continue to qualify as a REIT, the aggregate value of all securities that the Company holds in its TRSs may not exceed 25% (20% with respect to its taxable years ended on or before December 31, 2008) of the value of its total assets. The value of in the Company’s TRS's securities and its real estate assets is based on determinations of fair market value which are not subject to precise determination. The Company will not lose its qualification as a REIT if the Company were to fail the TRS limitation at the end of a quarter because of a discrepancy between the value of its TRSs and its other investments unless such discrepancy exists after the acquisition of TRS securities and is wholly or partially the result of such acquisition (including as a result of an increased investment in existing TRSs, either directly, or by way of a limited partner of the operating partnership exercising an exchange right, or the Company raising additional capital and contributing such capital to its operating partnership). If the Company were to fail to satisfy the TRS limitation at the end of a particular quarter and it was considered to have acquired TRS securities during such quarter, it would fail to qualify as a REIT unless it cured such failure by disposing of TRS securities or otherwise coming into compliance with the TRS limitation within 30 days after the close of such quarter. Based on such rules and the Company’s determination of the fair market value of its assets and the securities of its TRSs, the Company believes that the Company has satisfied and will continue to satisfy the TRS limitation. Notwithstanding the foregoing, as the fair market value of the Company’s TRS securities and real estate assets cannot be determined with absolute certainty, and the Company does not control when a limited partner of its operating partnership will exercise its redemption right, no assurance can be given that the Internal Revenue Service (“IRS”) will not successfully challenge the valuations of the Company’s assets or that the Company has met and will continue to meet the TRS limitation. In addition, if the value of the Company’s real estate assets were to decrease, the Company’s ability to own TRS securities or other assets not qualifying as real estate assets will be limited and the Company could be forced to dispose of its TRS securities or such other assets in order to comply with REIT requirements.
If the Internal Revenue Service were to successfully challenge its valuation of certain of its subsidiaries, the Company may fail to qualify as a REIT.
While the Company believes the Company has properly valued the securities the Company holds in its TRSs, there is no guarantee that the IRS would agree with such valuation or that a court would not agree with such determination by the IRS. In the event the Company has improperly valued the securities the Company holds in its TRSs, the Company may fail to satisfy the 25% (20% with respect to its taxable year ended on or before December 31, 2008 and prior taxable years) asset test which may result in its failure to qualify as a REIT.
Item 1B. Unresolved Staff Comments | |
As of December 31, 2009, the Company owned and/or managed 111 MOBs and healthcare related facilities, 62 of which are consolidated wholly-owned and joint ventures, three of which are jointly owned with unaffiliated third parties and managed through a TRS, 45 of which are managed for third parties through a TRS and one of which is wholly-owned and classified as discontinued operations and is currently being marketed for sale. MOBs typically contain suites for physicians and physician practice groups and also may include facilities that provide hospitals with ancillary and outpatient services, such as ambulatory surgery centers, imaging and diagnostic centers (offering diagnostic services not typically provided in physician offices or clinics), rehabilitation centers, kidney dialysis centers and cancer treatment centers. The Company’s portfolio of owned and managed properties contains an aggregate of approximately 5.7 million net rentable square feet of as of December 31, 2009. As of December 31, 2009, the Company’s 62 in-service, consolidated wholly-owned and joint venture properties were approximately 91.5% occupied with a weighted average remaining lease term of approximately 4.5 years, accounting for 96.0%, 95.7%, and 94.7% of total rental revenue and property management and other income for the years ended December 31, 2009, 2008, and 2007, respectively.
At December 31, 2009, 78.7% of the Company’s consolidated wholly-owned and joint venture properties are located on hospital campuses, 10.7% are located off-campus but in which a hospital is the sole or anchor tenant, and 10.6% are off campus.
At December 31, 2009, no tenant occupied 10% or more of the net rentable square feet at the Company’s properties.
The following table contains additional information about the Company’s consolidated wholly-owned and joint venture properties as of December 31, 2009:
