City Office REIT, Inc. - Quarter Report: 2019 June (Form 10-Q)

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the quarterly period ended June 30, 2019

OR

 

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

For the transition period from                      to                     

Commission File Number: 001-36409

 

 

CITY OFFICE REIT, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Maryland		98-1141883
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

666 Burrard Street

Suite 3210

Vancouver, BC

V6C 2X8

(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code: (604) 806-3366

Former name, former address and former fiscal year, if changed since last report: N/A

 

 

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

 

Title of Each Class		Trading Symbol(s)		Name of each Exchange on Which Registered
Common Stock, $0.01 par value		“CIO”		New York Stock Exchange
6.625% Series A Cumulative Redeemable Preferred Stock, $0.01 par value per share		“CIO.PrA”		New York Stock Exchange

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    ☐  No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    ☒  Yes    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer		☐		Accelerated filer		☒
Non-accelerated filer		☐		Smaller reporting company		☐
				Emerging growth company		☒

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act  ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    ☒  No

The number of shares of Common Stock, $0.01 par value, of the registrant outstanding at July 29, 2019 was 39,647,063.

 

 

 

City Office REIT, Inc.

Quarterly Report on Form 10-Q

For the Quarter Ended June 30, 2019

Table of Contents

 

PART I. FINANCIAL INFORMATION					3
Item 1.		Financial Statements			3
		Condensed Consolidated Balance Sheets as of June  30, 2019 and December 31, 2018			3
		Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2019 and 2018			4
		Condensed Consolidated Statements of Changes in Equity for the Three and Six Months Ended June 30, 2019 and 2018			5
		Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2019 and 2018			6
		Notes to Condensed Consolidated Financial Statements			7
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			16
Item 3.		Quantitative and Qualitative Disclosures about Market Risk			24
Item 4.		Controls and Procedures			25
PART II. OTHER INFORMATION					26
Item 1.		Legal Proceedings			26
Item 1A.		Risk Factors			26
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			26
Item 3.		Defaults Upon Senior Securities			26
Item 4.		Mine Safety Disclosures			26
Item 5.		Other Information			26
Item 6.		Exhibits			27
Signatures					29

 

2

PART I.    FINANCIAL INFORMATION

 

Item 1.

Financial Statements

City Office REIT, Inc.

Condensed Consolidated Balance Sheets

(Unaudited)

(In thousands, except par value and share data)

 

		June 30,				December 31,
		2019				2018
Assets
Real estate properties
Land		$	224,837			$	223,789
Building and improvement			762,537				704,113
Tenant improvement			86,374				77,426
Furniture, fixtures and equipment			285				319
			1,074,033				1,005,647
Accumulated depreciation			(86,475	)			(70,484	)
			987,558				935,163
Cash and cash equivalents			11,581				16,138
Restricted cash			19,295				17,007
Rents receivable, net			31,008				26,095
Deferred leasing costs, net			11,039				10,402
Acquired lease intangible assets, net			71,972				75,501
Other assets			17,141				2,755
Assets held for sale			—				17,370
Total Assets		$	1,149,594			$	1,100,431
Liabilities and Equity
Liabilities:
Debt		$	709,670			$	645,354
Accounts payable and accrued liabilities			22,960				25,892
Deferred rent			5,625				5,331
Tenant rent deposits			5,780				4,564
Acquired lease intangible liabilities, net			9,249				8,887
Other liabilities			19,512				11,148
Liabilities related to assets held for sale			—				878
Total Liabilities			772,796				702,054
Commitments and Contingencies (Note 9)
Equity:
6.625% Series A Preferred stock, $0.01 par value per share, 5,600,000 shares authorized, 4,480,000 issued and outstanding			112,000				112,000
Common stock, $0.01 par value, 100,000,000 shares authorized, 39,647,063 and 39,544,073 shares issued and outstanding			396				395
Additional paid-in capital			377,937				377,126
Accumulated deficit			(114,565	)			(92,108	)
Total Stockholders’ Equity			375,768				397,413
Non-controlling interests in properties			1,030				964
Total Equity			376,798				398,377
Total Liabilities and Equity		$	1,149,594			$	1,100,431
Subsequent Events (Note 11)

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

3

City Office REIT, Inc.

Condensed Consolidated Statements of Operations

(Unaudited)

(In thousands, except per share data)

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2019				2018				2019				2018
Rental and other revenues		$	41,171			$	30,236				78,291				61,770
Operating expenses:
Property operating expenses			14,526				11,748				28,370				23,374
General and administrative			3,362				1,966				5,660				3,943
Depreciation and amortization			14,604				11,771				29,022				23,665
Total operating expenses			32,492				25,485				63,052				50,982
Operating income			8,679				4,751				15,239				10,788
Interest expense:
Contractual interest expense			(7,502	)			(5,081	)			(14,645	)			(10,269	)
Amortization of deferred financing costs and debt fair value			(334	)			(354	)			(671	)			(986	)
			(7,836	)			(5,435	)			(15,316	)			(11,255	)
Net gain on sale of real estate property			478				—				478				46,980
Net income/(loss)			1,321				(684	)			401				46,513
Less:
Net income attributable to non-controlling interests in properties			(165	)			(114	)			(334	)			(249	)
Net income/(loss) attributable to the Company			1,156				(798	)			67				46,264
Preferred stock distributions			(1,855	)			(1,855	)			(3,710	)			(3,710	)
Net (loss)/income attributable to common stockholders		$	(699	)		$	(2,653	)		$	(3,643	)		$	42,554
Net (loss)/income per common share:
Basic		$	(0.02	)		$	(0.07	)		$	(0.09	)		$	1.18
Diluted		$	(0.02	)		$	(0.07	)		$	(0.09	)		$	1.17
Weighted average common shares outstanding:
Basic			39,640				36,132				39,603				36,103
Diluted			39,640				36,132				39,603				36,452
Dividend distributions declared per common share		$	0.235			$	0.235			$	0.470			$	0.470

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

4

City Office REIT, Inc.

Condensed Consolidated Statements of Changes in Equity

(Unaudited)

(In thousands)

 

		Number of shares of preferred stock				Preferred stock				Number of shares of common stock				Common stock				Additional paid-in capital				Accumulated deficit				Total stockholders’ equity				Non- controlling interests in properties				Total equity
Balance - December 31, 2018			4,480			$	112,000				39,544			$	395			$	377,126			$	(92,108	)		$	397,413			$	964			$	398,377
Restricted stock award grants and vesting			—				—				92				1				302				(83	)			220				—				220
Common stock dividend distributions declared			—				—				—				—				—				(9,314	)			(9,314	)			—				(9,314	)
Preferred stock dividend distributions declared			—				—				—				—				—				(1,855	)			(1,855	)			—				(1,855	)
Contributions			—				—				—				—				—				—				—				12				12
Distributions			—				—				—				—				—				—				—				(134	)			(134	)
Net income			—				—				—				—				—				(1,089	)			(1,089	)			169				(920	)
Balance - March 31, 2019			4,480			$	112,000				39,636			$	396			$	377,428			$	(104,449	)		$	385,375			$	1,011			$	386,386
Restricted stock award grants and vesting			—				—				11				—				509				(99	)			410				—				410
Common stock dividend distributions declared			—				—				—				—				—				(9,318	)			(9,318	)			—				(9,318	)
Preferred stock dividend distributions declared			—				—				—				—				—				(1,855	)			(1,855	)			—				(1,855	)
Contributions			—				—				—				—				—				—				—				10				10
Distributions			—				—				—				—				—				—				—				(156	)			(156	)
Net income			—				—				—				—				—				1,156				1,156				165				1,321
Balance - June 30, 2019			4,480			$	112,000				39,647			$	396			$	377,937			$	(114,565	)		$	375,768			$	1,030			$	376,798
		Number of shares of preferred stock				Preferred stock				Number of shares of common stock				Common stock				Additional paid-in capital				Accumulated deficit				Total stockholders’ equity				Non- controlling interests in properties				Total equity
Balance – December 31, 2017			4,480			$	112,000				36,012			$	360			$	334,241			$	(86,977	)		$	359,624			$	208			$	359,832
Restricted stock award grants and vesting			—				—				120				1				356				(72	)			285				—				285
Common stock dividend distributions declared			—				—				—				—				—				(8,491	)			(8,491	)			—				(8,491	)
Preferred stock dividend distributions declared			—				—				—				—				—				(1,855	)			(1,855	)			—				(1,855	)
Distributions			—				—				—				—				—				—				—				(29	)			(29	)
Net income			—				—				—				—				—				47,063				47,063				135				47,198
Balance – March 31, 2018			4,480			$	112,000				36,132			$	361			$	334,597			$	(50,332	)		$	396,626			$	314			$	396,940
Restricted stock award grants and vesting			—				—				1				—				412				(80	)			332				—				332
Common stock dividend distributions declared			—				—				—				—				—				(8,491	)			(8,491	)			—				(8,491	)
Preferred stock dividend distributions declared			—				—				—				—				—				(1,855	)			(1,855	)			—				(1,855	)
Contributions			—				—				—				—				—				—				—				43				43
Distributions			—				—				—				—				—				—				—				(135	)			(135	)
Net income			—				—				—				—				—				(798	)			(798	)			114				(684	)
Balance - June 30, 2018			4,480			$	112,000				36,133			$	361			$	335,009			$	(61,556	)		$	385,814			$	336			$	386,150

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

5

City Office REIT, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)

 

		Six Months Ended June 30,
		2019				2018
Cash Flows from Operating Activities:
Net income		$	401			$	46,513
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			29,022				23,665
Amortization of deferred financing costs and debt fair value			671				986
Amortization of above/below market leases			(92	)			(140	)
Increase in straight-line rent/expense			(3,424	)			(1,842	)
Non-cash stock compensation			879				705
Net gain on sale of real estate property			(478	)			(46,980	)
Changes in non-cash working capital:
Rents receivable, net			(1,677	)			(93	)
Other assets			(1,082	)			(3,034	)
Accounts payable and accrued liabilities			(5,241	)			(6,467	)
Deferred rent			53				(2,042	)
Tenant rent deposits			(394	)			89
Net Cash Provided By Operating Activities			18,638				11,360
Cash Flows (to)/from Investing Activities:
Additions to real estate properties			(9,881	)			(9,156	)
Acquisition of real estate			(61,012	)			(55,453	)
Net proceeds from sale of real estate			33,941				84,839
Deferred leasing costs			(1,598	)			(2,057	)
Net Cash (Used In)/Provided By Investing Activities			(38,550	)			18,173
Cash Flows from/(to) Financing Activities:
Debt issuance and extinguishment costs			(648	)			(1,942	)
Proceeds from mortgage loans payable			40,950				—
Repayment of mortgage loans payable			(2,327	)			(34,121	)
Proceeds from credit facility			55,000				82,000
Repayment of credit facility			(52,500	)			(57,000	)
Shares withheld for payment of taxes on restricted stock unit vesting			(246	)			(86	)
Contributions from non-controlling interests in properties			22				43
Distributions to non-controlling interests in properties			(290	)			(165	)
Dividend distributions paid to stockholders and Operating Partnership unitholders			(22,318	)			(20,664	)
Net Cash Provided By/(Used In) Financing Activities			17,643				(31,935	)
Net Decrease in Cash, Cash Equivalents and Restricted Cash			(2,269	)			(2,402	)
Cash, Cash Equivalents and Restricted Cash, Beginning of Period			33,145				35,014
Cash, Cash Equivalents and Restricted Cash, End of Period		$	30,876			$	32,612
Reconciliation of Cash, Cash Equivalents and Restricted Cash:
Cash and Cash Equivalents, End of Period		$	11,581			$	14,655
Restricted Cash, End of Period			19,295				17,957
Cash, Cash Equivalents and Restricted Cash, End of Period		$	30,876			$	32,612
Supplemental Disclosures of Cash Flow Information:
Cash paid for interest		$	14,696			$	9,962
Purchases of additions in real estate properties included in accounts payable		$	1,411			$	3,380
Purchases of deferred leasing costs included in accounts payable		$	160			$	158
Debt assumed on acquisition of real estate		$	22,473			$	—

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

6

City Office REIT, Inc.

Notes to the Condensed Consolidated Financial Statements

1. Organization and Description of Business

City Office REIT, Inc. (the “Company”) was organized in the state of Maryland on November 26, 2013. On April 21, 2014, the Company completed its initial public offering (“IPO”) of shares of the Company’s common stock. The Company contributed the net proceeds of the IPO to City Office REIT Operating Partnership, L.P., a Maryland limited partnership (the “Operating Partnership”), in exchange for common units of limited partnership interest in the Operating Partnership (“common units”).

The Company’s interest in the Operating Partnership entitles the Company to share in distributions from, and allocations of profits and losses of, the Operating Partnership in proportion to the Company’s percentage ownership of common units. As the sole general partner of the Operating Partnership, the Company has the exclusive power under the Operating Partnership’s partnership agreement to manage and conduct the Operating Partnership’s business, subject to limited approval and voting rights of the limited partners.

The Company has elected to be taxed, and will continue to operate in a manner that will allow it to continue to qualify, as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”). Subject to qualification as a REIT, the Company will be permitted to deduct dividend distributions paid to its stockholders, eliminating the U.S. federal taxation of income represented by such distributions at the Company level. REITs are subject to a number of organizational and operational requirements. If the Company fails to qualify as a REIT in any taxable year, the Company will be subject to U.S. federal and state income tax on its taxable income at regular corporate tax rates and, for tax years beginning before 2018, any applicable alternative minimum tax.

2. Summary of Significant Accounting Policies

Basis of Preparation and Summary of Significant Accounting Policies

The accompanying unaudited condensed consolidated financial statements have been prepared by the Company in accordance with Securities and Exchange Commission rules and regulations and generally accepted accounting principles in the United States of America (“US GAAP”) and in the opinion of management contain all adjustments (including normal recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows for the periods presented. The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.

New Accounting Pronouncements

Adopted in the Current Year

In February 2016, the Financial Accounting Standards Board, or FASB, established Topic 842, Leases, by issuing Accounting Standards Update (“ASU”) No. 2016-02, which requires lessors to classify leases as a sales-type, direct financing, or operating lease and requires lessees to recognize leases on-balance sheet and disclose key information about leasing arrangements. Topic 842 was subsequently amended by ASU No. 2018-01, Land Easement Practical Expedient for Transition to Topic 842; ASU No. 2018-10, Codification Improvements to Topic 842, Leases; and ASU No. 2018-11, Targeted Improvements.

The Company adopted the new standard effective January 1, 2019 and elected the effective date method for the transition. The Company elected the following practical expedients:

 

•

Transition method practical expedient – permits the Company to use the effective date as the date of initial application. Upon adoption, the Company did not have a cumulative-effect adjustment to the opening balance of retained earnings. Financial information and disclosures for periods before January 1, 2019 were not updated.

 

7

•

Package of practical expedients – permits the Company not to reassess under the new standard its prior conclusions about lease identification, lease classification, and initial direct costs. This allowed the Company to continue classifying its leases at transition in substantially the same manner.

 

•

Single component practical expedient – permits the Company to not separate lease and non-lease components of leases. Upon transition, rental income, expense reimbursement, and other were aggregated into a single line within rental and other revenues on the condensed consolidated statement of operations.

 

•

Land easement practical expedient – permits the Company not to reassess under the new standard its prior conclusions about land easements.

 

•

Short-term lease practical expedient – permits the Company not to recognize leases with a term equal to or less than 12 months.

Lessor Accounting

The accounting for lessors under the new standard remained relatively unchanged with a few targeted updates impacting the Company, which included: (i) narrower definition of initial direct costs that requires certain costs to be expensed rather than capitalized, and (ii) provisions for uncollectible rents to be recorded as a reduction in revenue rather than as bad debt expense.

Lessee Accounting

The new standard requires lessees to recognize a right-of-use asset and lease liability on the balance sheet for all leases with a term longer than 12 months. Leases are classified as finance or operating at inception, with classification affecting the pattern and recording of expenses in the statement of operations. Upon transition the Company recognized right-of use assets and lease liabilities principally for its ground and office leases.

3. Real Estate Investments

Acquisitions

During the six months ended June 30, 2019 and 2018 the Company acquired the following properties:

 

Property		Date Acquired				Percentage Owned
Cascade Station			June 2019				100	%
Canyon Park			February 2019				100	%
Pima Center			April 2018				100	%

Each of the foregoing acquisitions were accounted for as asset acquisitions.

The following table summarizes the Company’s allocation of the purchase price of assets acquired and liabilities assumed during the six months ended June 30, 2019 (in thousands):

 

		Canyon Park				Cascade     Station				Total June 30, 2019
Land		$	7,098			$	—			$	7,098
Buildings and improvements			36,619				25,141				61,760
Tenant improvements			1,797				2,080				3,877
Acquired intangible assets			8,109				3,134				11,243
Other assets			10				3,164				3,174
Debt			—				(697	)			(697	)
Accounts payable and other liabilities			(1,266	)			(186	)			(1,452	)
Lease intangible liabilities			(1,297	)			(220	)			(1,517	)
Net assets acquired		$	51,070			$	32,416			$	83,486

 

8

The acquisition of the Cascade Station property was partially funded through an assumption of debt in the amount of $22.5 million.

The following table summarizes the Company’s allocation of the purchase price of assets acquired and liabilities assumed during the six months ended June 30, 2018 (in thousands):

 

		Pima Center
Buildings and improvements		$	42,235
Tenant improvements			2,898
Acquired intangible assets			10,691
Other assets			95
Accounts payable and other liabilities			(337	)
Lease intangible liabilities			(129	)
Net assets acquired		$	55,453

Sale of Real Estate Property

On May 7, 2019, the Company sold the 10455 Pacific Center building of the Sorrento Mesa property in San Diego, California for $16.5 million, resulting in an aggregate gain of $0.5 million net of disposal-related costs, which has been classified as net gain on sale of real estate property in the condensed consolidated statements of operations.

On February 7, 2019, the Company sold the Plaza 25 property in Denver, Colorado for $17.9 million. No gain or loss was recognized on the sale as the property was carried at fair value less cost to sell on the date of disposition.

On March 8, 2018, the Company sold the Washington Group Plaza property in Boise, Idaho for $86.5 million, resulting in an aggregate net gain of $47.0 million, net of $1.7 million in costs, which has been classified as net gain on sale of real estate property in the condensed consolidated statements of operations. In connection with the sale of the property, certain debt repayments were made.

4. Lease Intangibles

Lease intangibles and the value of assumed lease obligations as of June 30, 2019 and December 31, 2018 were comprised as follows (in thousands):

 

		Lease Intangible Assets																				Lease Intangible Liabilities
June 30, 2019		Above Market Leases				Below Market Ground Lease(1)				In Place Leases				Leasing Commissions				Total				Below Market Leases				Below Market Ground Lease(1)				Total
Cost		$	11,924			$	—			$	86,640			$	35,126			$	133,690			$	(14,359	)		$	(138	)		$	(14,497	)
Accumulated amortization			(5,784	)			—				(41,672	)			(14,262	)			(61,718	)			5,210				38				5,248
		$	6,140			$	—			$	44,968			$	20,864			$	71,972			$	(9,149	)		$	(100	)		$	(9,249	)
		Lease Intangible Assets																				Lease Intangible Liabilities
December 31, 2018		Above Market Leases				Below Market Ground Lease(1)				In Place Leases				Leasing Commissions				Total				Below Market Leases				Below Market Ground Lease(1)				Total
Cost		$	10,595			$	1,855			$	82,474			$	31,706			$	126,630			$	(12,925	)		$	(138	)		$	(13,063	)
Accumulated amortization			(4,800	)			(19	)			(34,273	)			(12,037	)			(51,129	)			4,140				36				4,176
		$	5,795			$	1,836			$	48,201			$	19,669			$	75,501			$	(8,785	)		$	(102	)		$	(8,887	)

 

(1)

For the below market ground lease asset, the Company is the lessee, whereas, for the below market ground lease liability, the Company is the lessor. Upon the adoption of Topic 842 on January 1, 2019, the Company derecognized the below market ground lease intangible asset related to one of its lessee ground leases and included the net carrying value of the intangible asset within the right-of-use asset recognized upon transition to the new standard.

 

9

The estimated aggregate amortization expense for lease intangibles for the next five years and in the aggregate are as follows (in thousands):

 

2019		$	10,192
2020			18,332
2021			15,022
2022			7,255
2023			4,393
Thereafter			7,529
		$	62,723

5. Debt

The following table summarizes the indebtedness as of June 30, 2019 and December 31, 2018 (dollars in thousands):

 

Property		June 30, 2019				December 31, 2018				Interest Rate as of June 30, 2019 (1)				Maturity
Unsecured Credit Facility (2)		$	150,000			$	147,500				LIBOR +1.60	%(3)		March 2022
Midland Life Insurance (4)			86,142				86,973				4.34			May 2021
Mission City			47,000				47,000				3.78			November 2027
190 Office Center			41,152				41,250				4.79			October 2025
Canyon Park (5)			40,950				—				4.30			March 2027
Circle Point			39,650				39,650				4.49			September 2028
SanTan			34,347				34,682				4.56			March 2027
Intellicenter			33,227				33,481				4.65			October 2025
The Quad			30,600				30,600				4.20			September 2028
FRP Collection			29,288				29,589				3.85			September 2023
2525 McKinnon			27,000				27,000				4.24			April 2027
Cascade Station			22,474				—				4.55			May 2024
Greenwood Blvd			22,425				22,425				4.60			December 2025
5090 N 40th St			22,000				22,000				3.92			January 2027
AmberGlen			20,000				20,000				3.69			May 2027
Lake Vista Pointe			17,882				18,044				4.28			August 2024
Central Fairwinds			17,712				17,882				4.00			June 2024
FRP Ingenuity Drive			17,000				17,000				4.44			December 2024
Carillon Point			16,154				16,330				3.50			October 2023
Total Principal			715,003				651,406
Deferred financing costs, net			(6,030	)			(6,052	)
Unamortized fair value adjustments			697				—
Total		$	709,670			$	645,354

 

(1)	All interest rates are fixed interest rates with the exception of the unsecured credit facility (“Unsecured Credit Facility”) as explained in footnote 2 below.

(2)

As of June 30, 2019, the Unsecured Credit Facility had $250 million authorized with $150 million drawn and a $5.3 million letter of credit to satisfy escrow requirements for a mortgage lender. On March 15, 2018, the Company entered into a $250 million Unsecured Credit Facility, which includes an accordion feature that will permit the Company to borrow up to $500 million, subject to customary terms and conditions. The Unsecured Credit Facility matures in March 2022, which may be extended to March 2023 at the Company’s option upon meeting certain conditions. Borrowings under the Unsecured Credit Facility will bear interest at a rate equal to the LIBOR rate plus a margin of between 140 to 225 basis points depending upon the Company’s consolidated leverage ratio. The Unsecured Credit Facility requires the Company to maintain a fixed charge coverage ratio of no less than 1.50x.

(3)	As of June 30, 2019, the one month LIBOR rate was 2.40%.

(4)	The mortgage loan is cross-collateralized by DTC Crossroads, Cherry Creek and City Center.

(5)

The mortgage loan anticipated repayment date (“ARD”) is March 1, 2027. The final scheduled maturity date can be extended up to 5 years beyond the ARD. If the loan is not paid off at ARD, loan’s interest rate shall be adjusted to the greater of (i) the initial interest rate plus 200 basis points or (ii) the yield on the five year “on the run” treasury reported by Bloomberg market data service plus 450 basis points.

 

10

The scheduled principal repayments of debt as of June 30, 2019 are as follows (in thousands):

 

2019		$	2,692
2020			6,186
2021			89,125
2022			156,165
2023			47,822
Thereafter			413,013
		$	715,003

6. Fair Value of Financial Instruments

Fair value measurements are based on assumptions that market participants would use in pricing an asset or a liability. The hierarchy for inputs used in measuring fair value is as follows:

Level 1 Inputs – quoted prices in active markets for identical assets or liabilities

Level 2 Inputs – observable inputs other than quoted prices in active markets for identical assets and liabilities

Level 3 Inputs – unobservable inputs

As of each of June 30, 2019 and December 31, 2018, the Company did not have any hedges or derivatives.

Cash, Cash Equivalents, Restricted Cash, Rents Receivable, Accounts Payable and Accrued Liabilities

The Company estimates that the fair value approximates carrying value due to the relatively short-term nature of these instruments.

Fair Value of Financial Instruments Not Carried at Fair Value

With the exception of fixed rate mortgage loans payable, the carrying amounts of the Company’s financial instruments approximate their fair value. The Company determines the fair value of its fixed rate mortgage loan payable based on a discounted cash flow analysis using a discount rate that approximates the current borrowing rates for instruments of similar maturities. Based on this, the Company has determined that the fair value of these instruments was $580.7 million and $503.3 million as of June 30, 2019 and December 31, 2018, respectively. Accordingly, the fair value of mortgage loans payable have been classified as Level 3 fair value measurements.

7. Related Party Transactions

Administrative Services Agreement

For the six months ended June 30, 2019 and 2018, the Company earned $0.3 million and $0.4 million, respectively, in administrative services performed for Second City Real Estate II Corporation and its affiliates (collectively, “Second City”). Also during the six months ended June 30, 2019, the Company was assigned a purchase contract which had been entered into by an entity affiliated with principals of Second City, which principals are also officers of the Company. The Company subsequently assigned the purchase contract to a third party during the six months ended June 30, 2019. The Company paid no consideration to the related party for the contract other than return of deposits which the Company subsequently recovered from a third party in addition to an assignment fee. The Company recognized income of $2.6 million on the assignment of the purchase contract to the third party, which was recorded in rental and other revenues on the condensed consolidated statement of operations.

 

11

8. Leases

Lessor Accounting

The Company is focused on acquiring, owning and operating high-quality office properties for lease to a stable and diverse tenant base. Our properties have both full-service gross and net leases which are generally classified as operating leases. Rental income related to such leases is recognized on a straight-line basis over the remaining lease term. The Company’s total revenue includes fixed base rental payments provided under the lease and variable payments which principally consist of tenant expense reimbursements for certain property operating expenses. The Company elected the practical expedient to account for its lease and non-lease components as a single combined operating lease component under the new leasing standard. As a result, rental income, expense reimbursement, and other were aggregated into a single line within rental and other revenues on the condensed consolidated statement of operations.

For the three and six months ended June 30, 2019, the Company recognized $38.5 million and $75.6 million, respectively, of rental and other revenue related to its operating leases (in thousands):

 

		Three months ended     June 30, 2019					Six months ended     June 30, 2019
Fixed payments			$	32,861				$	65,060
Variable payments				5,646					10,526
			$	38,507				$	75,586

Future minimum lease payments to be received by the Company as of June 30, 2019 under non-cancellable operating leases for the next five years and thereafter are as follows (in thousands):

 

2019		$	60,208
2020			113,808
2021			102,819
2022			85,402
2023			67,284
Thereafter			143,674
		$	573,195

The Company’s leases may include various provisions such as scheduled rent increases, renewal options and termination options. The majority of the Company’s leases include defined rent increase rather than variable payments based on an index or unknown rate. Seven state government tenants currently have the exercisable right to terminate their leases if the applicable state legislature does not appropriate rent in its annual budget. The Company has determined that the occurrence of any government tenant not being appropriated the rent in the applicable annual budget is a remote contingency and accordingly recognizes lease revenue on a straight-line basis over the respective lease term. These tenants represent approximately 8.2% of the Company’s total future minimum lease payments as of June 30, 2019.

Lessee Accounting

As a lessee, the Company has ground and office leases classified as operating leases and one office lease classified as a financing lease. Upon adoption of Topic 842, on January 1, 2019, the Company recognized right-of-use assets of $9.2 million and lease liabilities of $7.2 million. The difference between the recorded right-of-use assets and lease liabilities is mainly due to the reclassification of the below market ground lease intangible asset, which was included within the right-of-use assets recognized upon transition. As of June 30, 2019, these leases had remaining terms of 2 to 70 years and a weighted average remaining lease term of 56 years. Operating and financing

 

12

right-of-use assets and lease liabilities have been included within other assets and other liabilities on the Company’s condensed consolidated balance sheet as follows (in thousands):

 

		As of June 30, 2019
Right-of-use asset – operating leases		$	13,215
Lease liability – operating leases		$	8,250
Right-of-use asset – financing leases		$	91
Lease liability – financing leases		$	90

Lease liabilities are measured at the commencement date based on the present value of future lease payments. One of the Company’s operating ground leases includes rental payment increases over the lease term based on increases in the Consumer Price Index (“CPI”). Changes in the CPI were not estimated as part of the measurement of the operating lease liability. As most of the Company’s leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at the commencement date in determining the present value of future payments. The Company used a weighted average discount rate of 6.31% in determining its lease liabilities. The discount rates were derived from the Company’s assessment of the credit quality of the Company and adjusted to reflect secured borrowing, estimated yield curves and long-term spread adjustments.

Right-of-use assets include any prepaid lease payments and exclude any lease incentives and initial direct costs incurred. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term. The lease terms may include options to extend or terminate the lease if it is reasonably certain that the Company will exercise that option.

Operating lease expense for the three and six months ended June 30, 2019 was $0.2 million and $0.4 million, respectively. Financing lease expense for the three and six months ended June 30, 2019 was nominal.

Future minimum lease payments to be paid by the Company as a lessee as of June 30, 2019 for the next five years and thereafter are as follows (in thousands):

 

		Operating Leases				Financing Leases
2019		$	303			$	13
2020			782				27
2021			781				27
2022			741				27
2023			659				4
Thereafter			27,277				—
Total future minimum lease payments			30,543				98
Discount			(22,293	)			(8	)
Total		$	8,250			$	90

9. Commitments and Contingencies

The Company is obligated under certain tenant leases to fund tenant improvements and the expansion of the underlying leased properties.

Under various federal, state and local laws, ordinances and regulations relating to the protection of the environment, a current or previous owner or operator of real estate may be liable for the cost of removal or remediation of certain hazardous or toxic substances disposed, stored, generated, released, manufactured or discharged from, on, at, under, or in a property. As such, the Company may be potentially liable for costs associated with any potential environmental remediation at any of its formerly or currently owned properties.

 

13

The Company believes that it is in compliance in all material respects with all federal, state and local ordinances and regulations regarding hazardous or toxic substances. Management is not aware of any environmental liability that it believes would have a material adverse impact on the Company’s financial position or results of operations. Management is unaware of any instances in which the Company would incur significant environmental costs if any or all properties were sold, disposed of or abandoned. However, there can be no assurance that any such non-compliance, liability, claim or expenditure will not arise in the future.

The Company is involved from time to time in lawsuits and other disputes which arise in the ordinary course of business. As of June 30, 2019, management believes that these matters will not have a material adverse effect, individually or in the aggregate, on the Company’s financial position or results of operations.

10. Stockholders’ Equity

Common Stock and Common Unit Distributions

On June 14, 2019, the Company’s Board of Directors approved and the Company declared a cash dividend distribution of $0.235 per common share for the quarterly period ended June 30, 2019. The dividend was paid subsequent to quarter end on July 25, 2019 to common stockholders and common unitholders of record as of the close of business on July 11, 2019, resulting in an aggregate payment of $9.3 million.

Preferred Stock Distributions

On June 14, 2019, the Company’s Board of Directors approved and the Company declared a cash dividend of $0.4140625 per preferred share for the quarterly period ended June 30, 2019. The dividend was paid subsequent to quarter end on July 25, 2019 to preferred stockholders of record as of the close of business on July 11, 2019, resulting in an aggregate payment of $1.9 million.

Restricted Stock Units

The Company has an equity incentive plan (“Equity Incentive Plan”) for executive officers, directors and certain non-executive employees, and with approval of the Board of Directors, for subsidiaries and their respective affiliates. The Equity Incentive Plan provides for grants of restricted common stock, restricted stock units, phantom shares, stock options, dividend equivalent rights and other equity-based awards (including LTIP Units), subject to the total number of shares available for issuance under the plan. The Equity Incentive Plan is administered by the compensation committee of the Board of Directors (the “Plan Administrator”).

On May 2, 2019, the Company’s stockholders approved an amendment to the Equity Incentive Plan increasing the maximum number of shares of common stock that may be issued under the Equity Incentive Plan from 1,263,580 shares to 2,263,580 shares. To the extent an award granted under the Equity Incentive Plan expires or terminates, the shares subject to any portion of the award that expires or terminates without having been exercised or paid, as the case may be, will again become available for the issuance of additional awards.

During the six months ended June 30, 2019, 162,500 restricted stock units (“RSUs”) were granted to executive officers, directors and certain non-executive employees with a fair value of $1.8 million. The awards will vest in three equal, annual installments on each of the first three anniversaries of the date of grant. For the three and six months ended June 30, 2019, the Company recognized net compensation expense of $0.5 million and $0.9 million, respectively, related to the RSUs. For the three and six months ended June 30, 2018 the Company recognized net compensation expense of $0.3 million and $0.7 million, respectively, related to the RSUs.

A RSU award represents the right to receive shares of the Company’s common stock in the future, after the applicable vesting criteria, determined by the Plan Administrator, has been satisfied. The holder of an award of RSU has no rights as a stockholder until shares of common stock are issued in settlement of vested RSUs. The Plan Administrator may provide for a grant of dividend equivalent rights in connection with the grant of RSU; provided, however, that if the RSUs do not vest solely upon satisfaction of continued employment or service, any payment in respect to the related dividend equivalent rights will be held by the Company and paid when, and only to the extent that, the related RSU vests.

 

14

11. Subsequent Events

On July 31, 2019, an indirect, wholly-owned subsidiary of the Company entered into an Administrative Services Agreement (the “Administrative Services Agreement”) with Clarity Real Estate III GP, Limited Partnership and Clarity Real Estate Ventures GP, Limited Partnership (together, “Clarity”), entities affiliated with principals of Second City and officers of the Company. Pursuant to the Administrative Services Agreement, the Company will provide various administrative services and support to the related entities managing the Clarity funds.

 

15

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis is based on, and should be read in conjunction with, the condensed, consolidated financial statements and the related notes thereto of the City Office REIT, Inc. contained in this Quarterly Report on Form 10-Q.

As used in this section, unless the context otherwise requires, references to “we,” “our,” “us,” and “our company” refer to City Office REIT, Inc., a Maryland corporation, together with our consolidated subsidiaries, including City Office REIT Operating Partnership L.P., a Maryland limited partnership, of which we are the sole general partner and which we refer to in this section as our Operating Partnership, except where it is clear from the context that the term only means City Office REIT, Inc.

Cautionary Statement Regarding Forward-Looking Statements

This quarterly report on Form 10-Q, including “Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition,” contains both historical and forward-looking statements. All statements, other than statements of historical fact are, or may be deemed to be, forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward looking statements are not based on historical facts, but rather reflect our current expectations and projections about our future results, performance, prospects and opportunities. These forward looking statements may be identified by the use of words including “anticipate,” “believe,” “expect,” “intend,” “may,” “might,” “plan,” “estimate,” “project,” “should,” “will,” “result” and similar terms and phrases. These forward looking statements are subject to a number of known and unknown risks, uncertainties and other factors that are difficult to predict and which could cause our actual future results, performance, prospects or opportunities to differ materially from those expressed in, or implied by, these forward looking statements. These risks, uncertainties and other factors include, among others:

 

•

adverse economic or real estate developments in the office sector or the markets in which we operate;

 

•

changes in local, regional, national and international economic conditions;

 

•

our inability to compete effectively;

 

•

our inability to collect rent from tenants or renew tenants’ leases on attractive terms if at all;

 

•

demand for and market acceptance of our properties for rental purposes;

 

•

defaults on or non-renewal of leases by tenants;

 

•

increased interest rates and any resulting increase in financing or operating costs;

 

•

decreased rental rates or increased vacancy rates;

 

•

our failure to obtain necessary financing or access the capital markets on favorable terms or at all;

 

•

changes in the availability of acquisition opportunities;

 

•

availability of qualified personnel;

 

•

our inability to successfully complete real estate acquisitions or dispositions on the terms and timing we expect, or at all;

 

•

our failure to successfully operate acquired properties and operations;

 

•

changes in our business, financing or investment strategy or the markets in which we operate;

 

16

•

our failure to generate sufficient cash flows to service our outstanding indebtedness;

 

•

environmental uncertainties and risks related to adverse weather conditions and natural disasters;

 

•

our failure to qualify and maintain our status as a real estate investment trust (“REIT”);

 

•

government approvals, actions and initiatives, including the need for compliance with environmental requirements;

 

•

outcome of claims and litigation involving or affecting us;

 

•

financial market fluctuations;

 

•

changes in real estate, taxation and zoning laws and other legislation and government activity and changes to real property tax rates and the taxation of REITs in general;

 

•

uncertaintly regarding the Company’s obligations under its floating rate debt instruments upon discontinuation of LIBOR;

 

•

a material increase in institutional ownership of real estate in secondary markets that could result in, among others, compression of cap rates and fewer acquisition opportunities being available to the Company; and

 

•

other factors described in our news releases and filings with the United States Securities and Exchange Commission (the “SEC”), including but not limited to those described in our Annual Report on Form 10-K for the year ended December 31, 2018 under the heading “Risk Factors” and in our subsequent reports filed with the SEC.

The forward looking statements included in this report are made only as of the date of this report, and except as otherwise required by federal securities law, we do not have any obligation to publicly update or revise any forward looking statements to reflect subsequent events or circumstances.

Overview

Company

We were formed as a Maryland corporation on November 26, 2013. On April 21, 2014, we completed our initial public offering (“IPO”) of shares of common stock. We contributed the net proceeds of the IPO to our Operating Partnership in exchange for common units in our Operating Partnership. Both we and our Operating Partnership commenced operations upon completion of the IPO and certain related formation transactions.

Revenue Base

As of June 30, 2019, we owned 27 properties comprised of 65 office buildings with a total of approximately 5.7 million square feet of net rentable area (“NRA”). As of June 30, 2019, our properties were approximately 93.4% leased.

Office Leases

Historically, most leases for our properties were on a full-service gross or net lease basis, and we expect to continue to use such leases in the future. A full-service gross lease generally has a base year expense “stop”, whereby we pay a stated amount of expenses as part of the rent payment while future increases (above the base year stop) in property operating expenses are billed to the tenant based on such tenant’s proportionate square footage in the property. The property operating expenses are reflected in operating expenses; however, only the increased property operating expenses above the base year stop recovered from tenants are reflected as tenant recoveries in our statements of operations. In a triple net lease, the tenant is typically responsible for all property taxes and operating expenses. As such, the base rent payment does not include any operating expenses, but rather all such expenses are

 

17

billed to or paid by the tenant. The full amount of the expenses for this lease type is reflected in operating expenses, and the reimbursement is reflected in tenant recoveries. All tenants in our Lake Vista Pointe, FRP Ingenuity Drive, Sorrento Mesa, and Canyon Park properties have triple net leases. Certain tenants at AmberGlen, Superior Pointe, FRP Collection, 2525 McKinnon, Circle Point, The Quad and Cascade Station have leases on a triple net basis. We are also a lessor for a fee simple ground lease at the AmberGlen property. All of our remaining leases are full-service gross leases.

Factors That May Influence Our Operating Results and Financial Condition

Business and Strategy

We focus on owning and acquiring office properties in our target markets. Our target markets generally possess what we believe are favorable economic growth trends, growing populations with above-average employment growth forecasts, a large number of government offices, large international, national and regional employers across diversified industries, are generally low-cost centers for business operations, and exhibit favorable occupancy trends. We utilize our management’s market-specific knowledge and relationships as well as the expertise of local real estate operators and our investment partners to identify acquisition opportunities that we believe will offer cash flow stability and long-term value appreciation. Our target markets are attractive, among other reasons, because we believe that ownership is often concentrated among local real estate operators that typically do not benefit from the same access to capital as public REITs and there is a relatively low level of participation of large institutional investors. We believe that these factors result in attractive pricing levels and risk-adjusted returns.

Rental Revenue and Tenant Recoveries

The amount of net rental revenue generated by our properties will depend principally on our ability to maintain the occupancy rates of currently leased space and to lease currently available space and space that becomes available from lease terminations. The amount of rental revenue generated also depends on our ability to maintain or increase rental rates at our properties. We believe that the average rental rates for our portfolio of properties are generally in-line or slightly below the current average quoted market rates. Negative trends in one or more of these factors could adversely affect our rental revenue in future periods. Future economic downturns or regional downturns affecting our markets or submarkets or downturns in our tenants’ industries that impair our ability to renew or re-let space and the ability of our tenants to fulfill their lease commitments, as in the case of tenant bankruptcies, could adversely affect our ability to maintain or increase rental rates at our properties. In addition, growth in rental revenue will also partially depend on our ability to acquire additional properties that meet our investment criteria.

 

18

Our Properties

As of June 30, 2019, we owned 27 office complexes comprised of 65 office buildings with a total of approximately 5.7 million square feet of NRA in the metropolitan areas of Dallas, Denver, Orlando, Phoenix, Portland, San Diego, Seattle and Tampa. The following table presents an overview of our portfolio as of June 30, 2019 (properties listed by descending NRA by market).

 

Metropolitan Area		Property		Economic Interest				NRA (000s Square Feet)				In Place Occupancy				Annualized Base Rent per Square Foot				Annualized Gross Rent per Square Foot(1)				Annualized Base Rent(2) ($000s)
Phoenix, AZ (21.3% of NRA)		Pima Center			100.0	%			272				96.5	%		$	27.15			$	27.15			$	7,122
		SanTan			100.0	%			267				98.6	%		$	27.67			$	27.67			$	7,272
		5090 N 40th St			100.0	%			175				95.8	%		$	28.96			$	28.96			$	4,848
		Camelback Square			100.0	%			173				80.8	%		$	29.24			$	29.24			$	4,092
		The Quad			100.0	%			163				100.0	%		$	28.14			$	28.39			$	4,587
		Papago Tech			100.0	%			163				100.0	%		$	21.85			$	21.85			$	3,556
Denver, CO (18.3%)		Cherry Creek			100.0	%			356				100.0	%		$	18.53			$	18.53			$	6,591
		Circle Point			100.0	%			272				98.8	%		$	17.46			$	30.36			$	4,692
		DTC Crossroads			100.0	%			189				53.7	%		$	26.24			$	26.24			$	2,665
		Superior Pointe			100.0	%			151				96.5	%		$	17.66			$	29.17			$	2,579
		Logan Tower			100.0	%			72				73.3	%		$	21.62			$	21.62			$	1,139
Tampa, FL (18.2%)		Park Tower			94.8	%			471				93.5	%		$	24.45			$	24.45			$	10,761
		City Center			95.0	%			241				94.7	%		$	25.40			$	25.40			$	5,807
		Intellicenter			100.0	%			204				100.0	%		$	23.99			$	23.99			$	4,881
		Carillon Point			100.0	%			124				100.0	%		$	28.06			$	28.06			$	3,485
Orlando, FL (12.6%)		FRP Collection			95.0	%			272				84.5	%		$	24.29			$	26.17			$	5,575
		Central Fairwinds			97.0	%			168				89.5	%		$	24.49			$	24.49			$	3,685
		Greenwood Blvd			100.0	%			155				100.0	%		$	22.75			$	22.75			$	3,527
		FRP Ingenuity Drive			100.0	%			125				100.0	%		$	21.50			$	29.50			$	2,677
San Diego, CA (10.2%)		Sorrento Mesa			100.0	%			296				85.3	%		$	25.19			$	31.19			$	6,360
		Mission City			100.0	%			286				95.6	%		$	35.14			$	35.14			$	9,603
Dallas, TX (10.1%)		190 Office Center			100.0	%			303				89.5	%		$	25.64			$	25.64			$	6,960
		Lake Vista Pointe			100.0	%			163				100.0	%		$	16.00			$	24.00			$	2,613
		2525 McKinnon			100.0	%			111				90.4	%		$	28.04			$	45.04			$	2,822
Portland, OR (5.8%)		AmberGlen			76.0	%			201				96.9	%		$	21.30			$	23.89			$	4,151
		Cascade Station			100.0	%			128				100.0	%		$	26.37			$	32.38			$	3,363
Seattle, WA (3.5%)		Canyon Park			100.0	%			207				100.0	%		$	21.20			$	29.20			$	4,384
Total / Weighted Average – June 30, 2019 (3)									5,708				93.4	%		$	24.36			$	27.00			$	129,797

 

(1)

For FRP Ingenuity Drive, Lake Vista Pointe, 2525 McKinnon, Sorrento Mesa, and Canyon Park the annualized base rent per square foot on a triple net basis was increased by $8, $8, $17, $6, and $8 respectively, to estimate a gross equivalent base rent. AmberGlen has a net lease for one tenant which has been grossed up by $7 on a pro rata basis. Superior Pointe has net leases for eight tenants which have been grossed up by $12 on a pro-rata basis. FRP Collection has net leases for five tenants which have been grossed up by $9 on a pro-rata basis. Circle Point has net leases for fourteen tenants which have been grossed up by $13 on a pro-rata basis. The Quad has one tenant with a net lease, which has been grossed up by $8 on a pro-rata basis. Cascade Station has net leases for six tenants which have been grossed up by $7 on a pro-rata basis.

(2)	Annualized base rent is calculated by multiplying (i) rental payments (defined as cash rents before abatements) for the month ended June 30, 2019 by (ii) 12.

(3)	Averages weighted based on the property’s NRA, adjusted for occupancy

 

19