City Office REIT, Inc. - Annual Report: 2021 (Form 10-K)

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of (§ 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 filer, a smaller reporting , or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in of the Act).    Yes  ☐    No  ☒

As of June 30, 2021, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the registrant’s common stock held by of the registrant was approximately $528.3 million, based on the closing sales price of $12.43 per share as reported on the New York Stock Exchange.

Documents incorporated by reference: Portions of the registrant’s Definitive Proxy Statement for the 2022 Annual Meeting of Shareholders (to be filed with the United States Securities and Exchange Commission no later than 120 days after the end of the registrant’s fiscal year end) are incorporated by reference in this Annual Report on Form in response to Part II, Item 5 and Part III, Items 10, 11, 12, 13 and 14.

This Annual Report on Form contains “forward-looking statements” within the meaning of the federal securities laws. These forward-looking statements are included throughout this Annual Report on Form including in the sections entitled “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Business” and “Certain Relationships and Related Person Transactions,” and relate to matters such as our industry, business strategy, goals and expectations concerning our market position, future operations, margins, profitability, capital expenditures, financial condition, liquidity, capital resources, cash flows, results of operations and other financial and operating information. We have used the words “approximately,” “anticipate,” “assume,” “believe,” “budget,” “contemplate,” “continue,” “could,” “estimate,” “expect,” “future,” “intend,” “may,” “outlook,” “plan,” “potential,” “predict,” “project,” “seek,” “should,” “target,” “will” and similar terms and phrases to identify forward-looking statements in this Annual Report on Form All of our forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those that we are expecting, including:

The forward-looking statements contained in this Annual Report on Form are based on historical performance and management’s current plans, estimates and expectations in light of information currently available to us and are subject to uncertainty and changes in circumstances. There can be no assurance that future developments affecting us will be those that we have anticipated. Actual results may differ materially from these expectations due to the factors, risks and uncertainties described above, changes in global, regional or local political, economic, business, competitive, market, regulatory and other factors described in “Risk Factors,” many of which are beyond our control. We believe that these factors include those described in “Risk Factors.” Should one or more of these risks or uncertainties materialize, or should any of our assumptions prove to be incorrect, our actual results may vary in material respects from what we may have expressed or implied by these forward-looking statements. We caution that you should not place undue reliance on any of our forward-looking statements. Any forward-looking statement made by us in this Annual Report on Form speaks only as of the date of this Annual Report on Form Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by applicable securities laws.

We are an internally-managed corporation organized in the state of Maryland on November 26, 2013 focused on owning, operating and acquiring high-quality office properties located in cities” in the Southern and Western United States. Our markets possess a number of attractive demographic and employment characteristics that we believe will lead to capital appreciation and growth in rental income at our properties. Our senior management team has extensive industry relationships and a proven track record in executing this strategy, which we believe provides a competitive advantage to our stockholders. We have elected to be taxed, and intend to continue to qualify, as a REIT for U.S. federal income tax purposes.

We evaluate a range of strategies to create per share growth, including at the property level and through prudent capital allocation. In addition to driving rental revenue through strategic leasing, we also evaluate the opportunity to harvest value through dispositions and accretive redeployment of capital. We also evaluate and have executed prior share repurchase programs to buy back our shares at what we believe are significant discounts to their inherent value.

Our leases typically provide for contractual increases in base rental rates. These rental escalations are expected to result in predictable increases in rental revenues for us over time. We will continue to seek to include contractual rent escalators in future leases to further facilitate predictable growth in rental income. In circumstances where rental rates are below market rental rates, we will aim to capture increases in cash flow by increasing rents to market.

As of December 31, 2021, our portfolio was approximately 84.9% occupied, and we believe that there is potential to generate additional rental income by leasing space in these properties that is currently unoccupied. We believe we have been successful in enhancing the appeal of vacant spaces by completing improvements to vacant leasable space, creating or improving building amenities and renovating common areas. We also seek to create stable, long-term cash flow through strategic lease renewals at market rental rates.

We seek to expand our portfolio through acquisitions of office properties located in vibrant cities. We believe that expanding the depth of our portfolio in our markets and adding new strategic markets with similar characteristics creates economies of scale and builds a more desirable portfolio. We use our management team’s market-specific knowledge to identify acquisitions that we believe offer cash flow stability and long-term value creation opportunities.

Our senior management team has extensive relationships within our markets, including with real estate owners, developers, operators and brokers. We have strong relationships with our local third-party property and leasing managers who typically operate a large number of properties in the submarkets and markets where our properties are located, providing economies of scale and local market insight. In addition, our management team has strong lending relationships with various banks and insurance companies.

We actively pursue opportunities to enhance our properties through capital improvements initiatives to position them optimally within their competitive set. We also pursue cost reduction initiatives and use our scale to generate operating synergies.

During 2021, we had one reportable segment, our office properties segment. For information about our office property revenues and long-lived assets and other financial information, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations” in this Annual Report on Form

We believe that our properties are in compliance in all material respects with all federal, state and local environmental laws and regulations regarding hazardous or toxic substances and other environmental matters. We have not been notified by any governmental authority of any material liability or claim relating to hazardous or toxic substances or other environmental matter in connection with any of our properties.

As of December 31, 2021, the Company employed 19 full-time employees. The Company believes that corporate social responsibility goes with business growth and maximizing returns for our investors. Social responsibility furthers our mission to be an upstanding corporate citizen within the real estate community. We take pride in our work culture and strive to create an environment where our employees feel valued and are compensated fairly. Our reputation for acting with integrity, discipline and transparency is essential to the successful execution of our business goals. Key areas of focus for the Company include:

Equal employment opportunity has been, and will continue to be, a fundamental principle of our business success, where employment is based upon personal capabilities and qualifications without discrimination.

We recognize that having an engaging and rewarding work environment allows us to attract and retain the highest caliber personnel. We also encourage professional growth, which is why we invest in employee development and ensure that onboarding and ongoing training are pillars of our workplace. We achieve this through ongoing training and continuing education opportunities for every employee within the company. In addition, employees are encouraged to further their own unique development through reimbursement for approved courses and training.

We offer modern, open and amenitized office space to our employees, which creates a positive and collaborative work environment. To promote health and wellness within our offices, we provide an annual employee fitness allowance, which allows all employees to be reimbursed for gym memberships, sports lessons or similar fitness-oriented expenses as well as a variety of other initiatives. To encourage intra-company team building, we hold team events regularly throughout the year and participate in community and charitable events.

We offer competitive employment compensation packages that strive to equitably reward employees’ contributions. We believe that recognizing special employee contributions creates an environment where team members are driven to achieve exceptional performance.

A copy of this Annual Report on Form as well as our Quarterly Reports on Form current reports on Form and any amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), are available, free of charge, on our Internet website (www.cioreit.com). All of these reports are made available on our website as soon as reasonably practicable after they are electronically filed with or furnished to the United States Securities and Exchange Commission (the “SEC”). Our Governance Guidelines and Code of Business Conduct and Ethics and the charters of the Audit, Compensation, Investment, and Nominating and Corporate Governance Committees of our Board of Directors are also available on our website at www.cioreit.com, and are available in print to any stockholder upon written request to City Office REIT, Inc., c/o Investor Relations, Suite 3210—666 Burrard Street, Vancouver, British Columbia, V6C 2X8. The Company may, from time to time, amend these charters and policies, and such amended charters and policies will be posted on the Company’s website. Our telephone number is +1 (604) The information on or accessible through our website is not, and shall not be deemed to be, a part of this report or incorporated into any other filing we make with the SEC.

At December 31, 2021, approximately 14.6%, 15.9% and 9.1% of our annualized base rent is scheduled to expire in 2022, 2023, and 2024, respectively, excluding leases. Current tenants may not renew their leases upon the expiration of their terms and may attempt to terminate their leases prior to the expiration of their current terms. This risk has been increased by tenants working from home during the pandemic which has resulted in certain tenants the size and/or of their existing leased premises. If or terminations occur, we may not be able to locate qualified replacement tenants and, as a result, we could lose a significant source of revenue while remaining responsible for the payment of our financial obligations. Moreover, the terms of a renewal or new lease, including the amount of rent, may be less favorable to us than the current lease terms, or we may be forced to provide tenant improvements at our expense or provide other concessions or additional services to maintain or attract tenants. Any of these factors could cause a decline in lease revenue or an increase in operating expenses, which would have a material adverse effect on our financial condition, results of operations, cash flows, or the market price of our common stock or preferred stock.

Our portfolio of properties consists of office properties and because we seek to acquire similar properties, a decrease in the demand for office space may have a greater adverse effect on our business and financial condition than if we owned a more diversified real estate portfolio. If parts of our properties are leased within a particular sector, a significant downturn in that sector in which the tenants’ businesses operate would adversely affect our results of operations. In addition, where a government agency is a tenant, which is the case for a number of our properties, austerity measures, the inability of the federal, state, or local government to approve a budget, and governmental deficit reduction programs may lead government agencies to stop paying rent, consolidate and reduce their office space, terminate their lease or decrease their workforce, which may reduce demand for office space in the government sector. In addition, the ongoing pandemic has resulted in lower than normal utilization levels for our properties and it is uncertain how utilization levels will be impacted as the pandemic continues and after the pandemic ends. In the event that our tenants implement full or partial “work from home” or other remote work policies after the pandemic ends, the overall demand for office space in the markets in which we own properties or seek to acquire properties may be materially adversely affected, which may impact our leasing activity and ability to enter into leases favorable to the Company and result in a material adverse effect on our results of operations, cash flow and market price of our common stock or preferred stock.

As of December 31, 2021, approximately 26.9% of the base rental revenue of our properties was derived from our ten largest tenants. At any time, our tenants may experience a downturn in their businesses that may significantly weaken their financial condition, whether as a result of general economic conditions, changes in the severity or duration of the pandemic or otherwise. As a result, our tenants may fail to make rental payments when due, delay lease commencements, decline to extend or renew leases upon expiration or declare bankruptcy or be subject to involuntary insolvency proceedings. Any of these actions could result in the termination of the tenants’ leases or the failure to renew a lease and the loss of rental income attributable to the terminated leases. The occurrence of any of the situations described above could have a material adverse effect on our financial condition, results of operations, cash flows, or the market price of our common stock or preferred stock.

Since being reported in December 2019, has spread globally, including to every state in the United States. On March 11, 2020, the World Health Organization declared a pandemic, and on March 13, 2020, the United States declared a national emergency with respect to Since that time, the global impact of the outbreak has been rapidly evolving and many countries, including the United States, have reacted by instituting quarantines, mandating business and school closures and restricting travel.

The pandemic has had, and a future outbreak of other highly infectious or contagious diseases could have, repercussions across regional and global financial markets and economies. The outbreak of in many countries, including the United States, has contributed to significant volatility in economic activity and financial markets.

Certain states and cities, including where we own properties and where our principal place of business is located, have also reacted by instituting quarantines, restrictions on travel, rules, and restrictions on the types of businesses that may continue to operate. As certain states and cities begin to lift these rules and

restrictions, the Company cannot predict whether the rules and restrictions will be as certain variants of the virus emerge or when restrictions currently in place or modified restrictions in the future will expire. As a result, the pandemic has negatively impacted and continues to negatively impact many industries and governmental operations directly or indirectly, including the industries in which the Company and its tenants operate. A number of our tenants have decreased use of their office spaces and, primarily earlier in the pandemic, requested rent deferral or rent abatements. To date, we have provided temporary relief to certain tenants in the form of rent deferral and rent abatements, the financial impacts of which have been immaterial to the Company. However, it is impossible to predict the extent to which future requests from tenants for rent deferrals, rent abatements or relief from other contractual obligations, or a failure to pay rent, as a result of, among others, changes in business behavior stemming from the ongoing pandemic, the availability of government assistance programs, the efficacy and availability of vaccines or other remedies for the long-term economic impacts from the pandemic or otherwise, may impact our financial condition, results of operations and cash flow.

Though our employees in our principal offices generally work from those offices, it is not possible to predict whether employees may in the future work remotely or may be required to work remotely due to The effects of an extended period of remote work arrangements could strain our business continuity plans, introduce operational risk, including but not limited to cybersecurity risks, and impair our ability to manage our properties and business.

The pandemic, or a future outbreak of other highly infectious or contagious diseases, could also have material adverse effects on our financial condition, results of operations, cash flow, ability to pay dividends and the per share market price of our common stock or preferred stock, due to, among other factors:

The extent to which the pandemic impacts our financial condition, results of operations and cash flow, and those of our tenants, will depend on future developments, which continue to be highly uncertain and are not reasonably estimable, including the scope, severity and duration of the pandemic, the actions taken to contain the pandemic or mitigate its impact, and the direct and indirect economic effects of the pandemic and containment measures, among others. In addition, of rent or early lease terminations by our tenants could reduce our cash flows, which could impact our ability to pay dividends to the holders of our common stock or preferred stock.

In order to retain existing tenants and attract new tenants, we may be required to offer more substantial rent abatements, tenant improvements and early termination rights, provide options to purchase our properties within the lease term or accommodate requests for renovations, remodeling and other improvements or provide additional services to our tenants. As a result, we may have to make significant capital or other expenditures in order to retain tenants whose leases expire and to attract new tenants in sufficient numbers, which could adversely affect our results of operations and cash flow. Additionally, if we need to raise capital to make such expenditures and are unable to do so, or such capital is otherwise unavailable, we may be unable to make the required expenditures. This could result in by tenants upon expiration of their leases, which could adversely affect our financial condition, results of operations, cash flows, or the market price of our common stock or preferred stock.

Hedging involves risk and typically involves costs, including transaction costs, that may reduce our overall returns on our investments. These costs increase as the period covered by the hedging increases and during periods of rising and volatile interest rates. These costs will also limit the amount of cash available for distribution to stockholders. We generally intend to hedge as much of the interest rate risk as we determine is in our best interests given the cost of such hedging transactions. The REIT tax rules may limit our ability to enter into hedging transactions by requiring us to limit our income from hedges. If we are unable to hedge effectively because of the REIT tax rules, we will face greater interest rate exposure than may be commercially prudent.

In September 2019, in connection with the increase in authorized borrowings under our Unsecured Credit Facility from $250 million to $300 million, we entered into a five-year interest rate swap for a notional amount of $50 million (the “Interest Rate Swap”). Pursuant to the Interest Rate Swap, the Company will pay a fixed rate of approximately 1.27% of the notional amount annually, payable monthly, and receive floating rate LIBOR payments. We have been incorporating LIBOR transition language in our existing floating rate instruments, including the Interest Rate Swap, when they are extended or refinanced.

For the year ended December 31, 2021, the amount of realized losses reclassified to interest expense due to payments made to the swap counterparty was $0.6 million. Accordingly, the fair value of the Interest Rate Swap has been classified as a Level 2 fair value measurement. See Note 7 to our consolidated financial statements in this Annual Report on Form

On March 5, 2021, the chief executive of the United Kingdom Financial Conduct Authority (“FCA”), which regulates LIBOR, announced that all LIBOR tenors relevant to us will cease to be published or will no longer be representative after June 30, 2023. The FCA’s announcement coincides with the March 5, 2021 announcement of LIBOR’s administrator, the ICE Benchmark Administration Limited (“IBA”), indicating that, as a result of not having access to input data necessary to calculate LIBOR tenors relevant to us on a representative basis after June 30, 2023, IBA would have to cease publication of such LIBOR tenors immediately after the last publication on June 30, 2023. These announcements mean that any of our LIBOR-based borrowings and assets that mature beyond June 30, 2023 need to be converted to alternative interest rates. In addition, based on guidance from US banking regulators, US financial institutions are not expected to enter into new U.S. Dollar LIBOR contracts after December 31, 2021, which means that any of our new borrowings after December 31, 2021, will be done at alternative rates. Furthermore, in the United States, efforts to identify a set of alternative U.S. dollar reference interest rates include proposals by the Alternative Reference Rates Committee of the Federal Reserve Board and the Federal Reserve Bank of New York. The U.S. Federal Reserve, in conjunction with the Alternative Reference Rates Committee (“ARRC”), a steering committee comprised of large U.S. financial institutions, is considering replacing U.S. dollar LIBOR with the Secured Overnight Financing Rate (“SOFR”), a new index calculated by short-term repurchase agreements, backed by Treasury securities. There are significant differences between LIBOR and SOFR, such as LIBOR being an unsecured lending rate while SOFR is a secured lending rate, and SOFR is an overnight rate while LIBOR reflects term rates at different maturities. If our LIBOR-based borrowings are converted to SOFR, the differences between LIBOR and SOFR, plus the recommended spread adjustment, could result in interest costs that are higher than if LIBOR remained available, which could have a material adverse effect on our results. Although SOFR is the ARRC’s recommended replacement rate, it is also possible that lenders may instead choose alternative replacement rates that may differ from LIBOR in ways similar to SOFR or in other ways that would result in higher borrowing costs for us. It is not yet possible to predict the magnitude of LIBOR’s end on our borrowing costs given the uncertainty about which rates will replace LIBOR and the timing of actual replacement.

US regulators and the ARRC have recommended that all LIBOR-based instruments include robust fallback language dictating what rate will apply when LIBOR ends. The fallbacks recommended by the ARRC are different for various instruments, and not all instruments will incorporate the recommended fallbacks. The International Swaps and Derivatives Association (“ISDA”) has implemented fallback language and a protocol that will ensure derivatives amongst protocol participants fallback to compounded SOFR. We have opted into the ISDA 2020 IBOR Fallbacks protocol. However, the variations in fallback language in different financial instruments and the adoption of different replacement rates or methodologies in such fallback language could result in unexpected differences between our assets and our interest rate hedges. In addition, we may incur costs amending instruments not covered by the ISDA protocol or by clearinghouse rulebooks to implement fallbacks recommended by the ARRC. We may also decide not to amend, in which case we may bear the cost and risk of litigation. Some instruments, particularly consumer-facing adjustable-rate mortgages, are impractical to amend. With respect to those instruments, we may bear the cost and risk of litigation. Our lenders may be less willing to extend credit secured by assets that do not include robust fallbacks.

has recommended the same methodology for all financial instruments. The adjustment calculation is intended to minimize value transfer between counterparties, borrowers, and lenders, but there is no assurance that the calculated spread adjustment will be fair and accurate or that it will not result in higher interest costs.

Uncertainty over whether the U.S. economy will be adversely affected by inflation or stagflation, volatile energy costs, geopolitical issues, the possibility of any pandemic, including the pandemic, the availability and cost of credit, future policy and fiscal decisions of the federal government, the mortgage market in the United States and the late-cycle real estate market may contribute to increased market volatility or threaten business and consumer confidence. This uncertain operating environment could adversely affect our ability to generate revenues, thereby reducing our operating income and earnings.

We have in the past and may in the future with third parties through partnerships, joint ventures or other structures, acquiring interests in, or sharing responsibility for managing the affairs of, a property, partnership, or other entity. Investments in joint ventures may, under certain circumstances, involve risks not present when a third party is not involved, including potential deadlocks in making major decisions, restrictions on our ability to exit the joint venture, triggering of forced sale or mechanisms, reliance on our joint venture partners and the possibility that joint venture partners might become bankrupt or fail to fund their share of required capital contributions, thus exposing us to liabilities in excess of our share of the investment or take action that could jeopardize our REIT status. The funding of our capital contributions may be dependent on proceeds from asset sales, credit facility advances and/or sales of equity

Certain of our properties are located in states where natural disasters such as tornadoes, hurricanes and earthquakes are more common than in other states. Given recent extreme weather events across parts of the United States, including devastating hurricanes in Florida and wildfires in California, it is also possible that our other properties could incur significant damage due to other natural disasters. While we carry insurance to cover a substantial portion of the cost of such events, such as droughts or flooding, our insurance includes deductible amounts and certain items may not be covered by insurance. Future natural disasters may significantly affect our operations and properties and, more specifically, may cause us to experience reduced rental revenue (including from increased vacancy), incur costs or otherwise incur costs in connection with such events. Any of these events may have a material adverse effect on our financial condition, results of operations, cash flows, or the market price of our common stock or preferred stock.

We may acquire properties in exchange for common units and agree to restrictions on sales or refinancing, called provisions, which are intended to preserve favorable tax treatment for the owners of such properties who sell them to us. In addition, we may agree to provisions in connection with obtaining financing for the acquisition of properties. provisions could materially restrict us from selling, otherwise disposing of or refinancing properties. These restrictions could affect our ability to turn our investments into cash and thus affect cash available for distributions to our stockholders. provisions could impair our ability to take actions during the period that would otherwise be in the best interests of our stockholders and, therefore, could adversely impact the market value of our common stock. In particular, provisions could preclude us from participating in major transactions that could result in a disposition of our assets or a change in control even though that disposition or change in control might be in the best interests of our stockholders.

The bankruptcy or insolvency of one or more of our tenants may adversely affect the income produced by our properties. We cannot assure you that any tenant that files for bankruptcy protection will continue to pay us rent. If a tenant files for bankruptcy, any or all of the tenant’s or a guarantor of a tenant’s lease obligations could be subject to a bankruptcy proceeding pursuant to Chapter 11 or Chapter 7 of the U.S. Bankruptcy Code. Such a bankruptcy filing would impose an automatic stay barring all efforts by us to collect rents from these entities or their properties, unless we receive an order from the bankruptcy court lifting the automatic stay to permit us to pursue collections. A tenant or lease guarantor bankruptcy could delay our efforts to collect past due balances under the relevant leases and could ultimately preclude collection of these sums. If a lease is rejected by a tenant in bankruptcy, we would only have a general unsecured claim for damages. This claim could be paid only in the event funds were available and then only in the same percentage as that realized on other unsecured claims. Our claim would be capped at the rent reserved under the lease, without acceleration, for the greater of one year or 15% of the remaining term of the lease, but not greater than three years, plus rent already due but unpaid. Therefore, if a lease is rejected, it is possible that we would not receive payment from the tenant or that we would receive substantially less than the full value of any unsecured claims we hold, which would result in a reduction in our rental income, cash flow and the amount of cash available for distribution to the holders of our common stock or preferred stock.

We have entered into a lease with the sole tenant at our Lake Vista Pointe property that contains a right of first refusal and option to purchase the property according to a pricing formula during a specified period of time. In the event that the right of first refusal or option are exercised by the tenant, the applicable lease would terminate and we would be contractually obligated to sell the property in accordance therewith. Termination of the lease for the Lake Vista Pointe property would result in the loss of future rental income from such property, which could impact our results of operations and cash flows. Likewise, if the property is sold, we may not realize the full benefits from continuing to hold the property or consummating the disposition on terms then available in the market. The occurrence of any of the situations described above could have a material adverse effect our financial condition, results of operations, cash flows, or the market price of our common stock or preferred stock.

We may in the future with third parties through partnerships, joint ventures or other entities. We may acquire interests or share responsibility for managing the affairs of a property, partnership, joint venture or other entity. In such events, we would not be in a position to exercise sole decision-making authority regarding the property or entity. Investments in entities may, under certain circumstances, involve risks not present were a third party not involved. These risks include the possibility that partners or joint-venturers:

These and other federal, state and local laws may require modifications to our properties, or affect renovations of our properties. with these laws 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 feature, which could result in substantial capital expenditures.

as rents from real property, and we must satisfy a number of requirements regarding the composition of our assets. Also, we must make distributions to stockholders aggregating annually at least 90% of our REIT taxable income, determined without regard to the deduction for dividends paid and excluding net capital gains. In addition, new legislation, regulations, administrative interpretations or court decisions, each of which could have retroactive effect, may make it more difficult or impossible for us to maintain our qualificationas a REIT, or could reduce the desirability of an investment in a REIT relative to other investments. We have not requested and do not plan to request a ruling from the Internal Revenue Service (the “IRS”) that we qualify as a REIT, and the statements in this annual report are not binding on the IRS or any court. Accordingly, we cannot be certain that we will be successful in maintaining our qualification as a REIT.

The maximum U.S. federal income tax rate applicable to qualified dividend income payable to certain U.S. stockholders, including individuals, trusts and estates, is 20%. Dividends payable by REITs, however, generally are not eligible for the reduced qualified dividend rates. For taxable years beginning before January 1, 2026, taxpayers may deduct up to 20% of certain pass-through business income, including “qualified REIT dividends” (generally, dividends received by a REIT shareholder that are not designated as capital gain dividends or qualified dividend income), subject to certain limitations, resulting in an effective maximum U.S. federal income tax rate of 29.6% on such income. Although the reduced U.S. federal income tax rate applicable to qualified dividend income does not adversely affect the taxation of REITs or dividends payable by REITs, the more favorable rates applicable to regular corporate qualified dividends and the reduced corporate tax rate could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of corporations that pay dividends, which could adversely affect the value of the shares of REITs, including the market price of our capital stock.

We face risks associated with security breaches, whether through cyber-attacks or cyber intrusions over the Internet, malware, computer viruses, attachments to persons inside our organization or persons with access to systems inside our organization, and other significant disruptions of our IT networks and related systems. The risk of a security breach or disruption, particularly through cyber-attack or cyber intrusion, including by computer hackers, foreign governments and cyber terrorists, has generally increased as the number, intensity and sophistication of attempted attacks and intrusions from around the world have increased. Our IT networks and related systems are essential to the operation of our business and our ability to perform operations (including managing our building systems or those of our third-party providers that we rely on), and, in some cases, may be critical to the operations of certain of our tenants. There can be no assurance that our efforts to maintain the security and integrity of these types of IT networks and related systems will be effective or that attempted security breaches or disruptions would not be successful or damaging. A security breach or other significant disruption involving our IT networks and related systems could, among other things:

Repurchased shares of common stock will be classified as authorized and unissued shares. The Company recognizes the cost of shares of common stock it repurchases, including direct costs incurred, as a reduction in stockholders’ equity. Such reductions of stockholders equity due to the repurchases of shares of common stock repurchased will be applied first, to reduce common stock in the amount of the par value associated with the shares of common stock repurchased and second, to reduce additional capital by the amount that the purchase price for the shares of common stock repurchased exceed the par value.

During the first quarter of 2020, the World Health Organization declared the outbreak a pandemic. There have been mandates from international, federal, state and local authorities requiring forced closures of businesses and other facilities, and most of the markets in which our buildings are located have been or are subject to some form of pandemic-related restrictions. These forced closures and restrictions have had a volatile effect on the global economy and the regional U.S. economies in which we operate, including negatively impacting some of our tenants’ ability to pay their rent.

All of our buildings are open and continue to operate. We have adopted new policies and procedures to incorporate best practices for the safety of our tenants, our vendors and our employees. However, the usage of our assets in 2021 was significantly lower than usage. Usage of our assets in the near future depends on the duration of the pandemic, the continued implementation and effectiveness of vaccines and other therapeutics and corporate and individual decisions regarding return to usage of office space, which is impossible to estimate.

We continue to closely monitor the impact of the pandemic on all aspects of our business and geographies. While we did not experience any significant disruptions during the year ended December 31, 2021, as a result of or governmental or tenant actions in response thereto, the Company granted rent relief to five tenants comprising approximately 0.2% of the Company’s occupied NRA, most often in the form of rent abatement. Although the rent abatements granted to date did not have a material impact on our rental revenue, the long-term impact of the pandemic on our tenants and the world-wide economy is uncertain and impossible to estimate, and will depend on the scope, severity and duration of the pandemic.

We collected over 99% of contractually required base rents from our tenants for both the three months and fiscal year ended December 31, 2021. We granted rent relief for another approximately 0.1% of contractually required base rent from our tenants for both the three months and fiscal year ended December 31, 2021. We have developed dedicated teams and processes to evaluate and rent relief requests. We may incur additional losses in future periods due to tenants that default on their leases, file for bankruptcy and/or otherwise experience significant financial difficulty as a result of the duration of the pandemic, but the extent of those losses is impossible to predict given the fluidity of the pandemic and its uncertain impact on economic activity.

Leasing activity has generally been slow, and we believe it will continue to be impacted by the pandemic until and unless tenants increase the utilization of their spaces. We have experienced and we expect that we will continue to experience slower new leasing, and there remains uncertainty over existing tenants’ long-term space requirements. Overall, this could reduce our anticipated rental revenues. In addition, certain tenants in our markets have and may explore opportunities to sublease all or a portion of their leased square footage to other tenants or third parties. While subleasing generally does not impact the ability to collect payment from the original lessee and will not result in any decrease in the rental revenues expected to be received from the primary tenant, this trend could reduce our ability to lease incremental square footage to new tenants, could increase the square footage of our properties that “goes dark,” could reduce anticipated rental revenue should tenants determine their long-term needs for square footage are lower than originally anticipated and potentially impact the pricing and competitiveness for lease office space in our markets.

We believe economic conditions, leasing activity and acquisition prospects have improved substantially since the initial onset of the pandemic and we will continue to actively evaluate business operations and strategies to optimally position ourselves. For a discussion of the impact of the pandemic on our liquidity and balance sheet, see “Liquidity and Capital Resources” below.

The situation surrounding the pandemic and additional variants that may spread remains fluid. As certain restrictions are lifted in various geographical locations through the U.S., we will continue to monitor

and actively manage our response in collaboration with tenants, government officials and other third parties. Additional information about our response to the pandemic and the impact on our business is included elsewhere in this MD&A.

We focus on owning and acquiring office properties in our footprint of growth markets in the Southern and Western United States. Our markets generally possess growing populations with above-average employment growth forecasts, a large number of government offices, large international, national and regional employers across diversified industries, generally centers for business operations and a high quality of life. We believe these characteristics have made our markets particularly desirable in light of as evidenced by domestic net migration generally towards our geographic footprint. We utilize our management’s market-specific knowledge and relationships as well as the expertise of local real estate property and leasing managers to identify acquisition opportunities that we believe will offer cash flow stability and long-term value appreciation.

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 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, including as a result of the pandemic, that impair our ability to renew or 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.

Our operating expenses generally consist of utilities, property and ad valorem taxes, insurance and site maintenance costs. Increases in these expenses over tenants’ base years (until the base year is reset at expiration) are generally passed along to tenants in our full-service gross leased properties and are generally paid in full by tenants in our net leased properties. The pandemic did not cause a material change in our operating expenses for the fiscal year ended December 31, 2021.

Positive or negative changes in economic or other conditions in the markets we operate in, including state budgetary shortfalls, employment rates, natural hazards and other factors, may impact our overall performance. While we generally expect the trend of positive population and economic growth in our cities to continue, there is no way for us to predict whether these trends will continue, especially in light of the potential changes in tax policy, fiscal policy and monetary policy. In addition, it is uncertain and impossible to estimate the potential impact that the pandemic will have on the short- and long-term demand for office space in our markets.

The fair value of the real estate acquired, which includes the impact of fair value adjustments for assumed mortgage debt related to property acquisitions, is allocated to the acquired tangible assets, consisting of land, building and improvements and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases, other value of leases and value of tenant relationships, based in each case on their fair values. For acquisitions that do not meet the business combination accounting criteria, these are accounted for as asset acquisitions. The Company allocates the cost of the acquisition, which includes any associated acquisition costs to individual assets and liabilities assumed on a relative fair value basis. Also, interests acquired are recorded at estimated fair market value.

The fair value of the tangible assets of an acquired property (which includes land, building and improvements and fixtures and equipment) is determined by valuing the property as if it were vacant. The value is then allocated to land and building and improvements based on our determination of relative fair values of these assets. Factors considered by us in performing these analyses include an estimate of carrying costs during the expected periods considering current market conditions and costs to execute similar leases. In estimating carrying costs, we include real estate taxes, insurance and other operating expenses and estimates of lost rental revenue during the expected periods based on current market demand. We also estimate costs to execute similar leases including leasing commissions.

The fair value of above-market and below-market lease values are recorded based on the difference between the current in place lease rent and our estimate of current market rents. Below-market lease intangibles are recorded as part lease intangibles liability and amortized into rental revenue over the periods and bargain renewal periods of the respective leases. Above-market leases are recorded as part of intangible assets and amortized as a direct charge against rental revenue over the portion of the respective leases.

The fair value of acquired in place leases are recorded based on the costs we estimate we would have incurred to lease the property to the occupancy level of the property at the date of acquisition. Such estimates include the fair value of leasing commissions and legal costs that would be incurred to lease the property to this occupancy level. Additionally, we evaluate the time period over such occupancy level would be achieved and include an estimate of the net operating costs incurred during the period.

We determine if an arrangement is a lease at inception. Operating and financing assets and lease liabilities are included within other assets and other liabilities on the consolidated balance sheets. assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at the commencement date in determining the present value of future payments. 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 we will exercise that option. For lease agreements with lease and components, we account for the components as a single combined lease component.

In March 2020, the Financial Accounting Standards Board (the “FASB”) established Topic 848, Facilitation of the Effects of Reference Rate Reform on Financial Reporting, by issuing Accounting Standards Update (“ASU”) (“ASU ASU provides companies with optional expedients and exceptions to the guidance on contract modifications and hedge accounting to ease the potential accounting burden associated with transitioning away from reference rates that are expected to be discontinued. For contracts

affected by reference rate reform, if certain criteria are met, companies can elect to not remeasure contracts at the modification date or reassess a previous accounting conclusion. Companies can also elect various optional expedients that would allow them to continue applying hedge accounting for hedging relationships affected by reference rate reform if certain criteria are met. Further, in January 2021, the FASB issued ASU Reference Rate Reform (Topic 848)(“ASU ASU clarifies the scope of Topic 848 so that derivatives affected by the discounting transition are explicitly eligible for certain optional expedients and exceptions in Topic 848.ASU and ASU can be applied as of the beginning of the interim period that includes March 12, 2020, however, the guidance will only be available for optional use through December 31, 2022. The new standard applies prospectively to contract modifications and hedging relationships and may be elected over time as reference rate reform activities occur. The Company has not yet adopted the standard and continues to evaluate the impact of ASU and ASU on its consolidated financial statements and may elect optional expedients in future periods as reference rate reform activities occur.

In July 2021, the FASB issued ASU (“ASU Leases (Topic 842): Lessors—Certain Leases with Variable Lease Payments. ASU requires lessors to classify a lease with variable lease payments that do not depend on an index or rate as an operating lease if the lease would have been classified as a sales-type lease or a direct financing lease under the classification criteria, and sales-type or direct financing classification would result in a Day 1 loss. The ASU is effective for fiscal years beginning after December 15, 2021. The ASU may be early adopted and can be applied either retrospectively to leases that commenced or were modified on or after the adoption of ASU or prospectively to leases that commence or are modified on or after the date that an entity first applies the amendments. The Company will adopt ASU prospectively on January 1, 2022. Historically our leases in which we are the lessor have been operating leases, and the adoption of ASU is not expected to have a material impact on our consolidated financial statements.

Revenue includes net rental income, including parking, signage and other income, as well as the recovery of operating costs and property taxes from tenants. Rental and other revenues increased $3.2 million, or 2%, to $164.0 million for the year ended December 31, 2021 compared to $160.8 million for the year ended December 31, 2020. Of this increase, the acquisitions of Block 23 and The Terraces in December 2021 contributed increases of $0.5 million, and $0.6 million, respectively. The Bloc 83 acquisition, which closed on December 31, 2021, did not have a material impact on the 2021 results. A further increase can be attributed to our Park Tower and SanTan properties, which recorded significant termination fee income during the year ended December 31, 2021, which increased revenue by $4.8 million and $2.1 million, respectively. Revenue also increased by $1.0 million due to a significant leasing transaction at our 7595 Tech property within our Denver Tech portfolio which increased occupancy and rental income. While our Sorrento Mesa portfolio was sold in December 2021, it contributed a $2.2 million increase to rental income over the prior year due to a combination of the acquisitions of two additional buildings adjacent to our Sorrento Mesa portfolio in May 2021 and lease renewals with existing tenants at significantly higher rates. Offsetting these increases, the disposition of Cherry Creek in February 2021 decreased revenue by $7.3 million. Revenue also decreased at Pima Center by $1.1 million due to an average decrease in occupancy year over year. The remaining properties’ rental and other revenues were relatively unchanged in comparison to the prior period.

Total operating expenses consist of property operating expenses, general and administrative expenses and depreciation and amortization. Total operating expenses increased by $1.4 million, or 1%, to $130.8 million for the year ended December 31, 2021, from $129.4 million for the year ended December 31, 2020. General and administrative expenses increased by $4.8 million over the prior year primarily

due to a $3.5 million employee bonus accrual incurred as a result of the Sorrento Mesa portfolio sale in December 2021. Further increases were attributable to the acquisitions during the year ended December 31, 2021, including the acquisition of Block 23 and The Terraces in December 2021 which contributed $0.5 million and $0.5 million, respectively. Total operating expenses for the Sorrento Mesa portfolio also increased by $0.4 million due in part to the acquisition of two additional buildings adjacent to our Sorrento Mesa portfolio in May 2021, partially offset by lower operating expenses from the existing buildings as a result of the sale of the Sorrento Mesa portfolio in December 2021. An increase of $0.8 million was attributable to the Denver Tech portfolio due to a combination of higher property operating expenses and depreciation and amortization. Offsetting these increases, the disposition of Cherry Creek resulted in a $4.5 million decrease in total operating expenses. The remaining expenses were relatively flat in comparison to the prior year.

Property operating expenses are comprised mainly of building common area and maintenance expenses, insurance, property taxes, property management fees, as well as certain expenses that are not recoverable from tenants, the majority of which are related to costs necessary to maintain the appearance and marketability of vacant space. In the normal course of business, property expenses fluctuate and are impacted by various factors including, but not limited to, occupancy levels, weather, utility costs, repairs, maintenance and costs. Property operating expenses decreased by $0.3 million, or 1%, to $58.0 million for the year ended December 31, 2021, compared to $58.3 million for the year ended December 31, 2020. The disposition of Cherry Creek resulted in a $2.3 million decrease in expenses. Offsetting these decreases, an increase of $0.7 million, $0.2 million and $0.2 million, was attributable to the acquisitions of two additional buildings adjacent to our Sorrento Mesa portfolio in May 2021, the acquisition of Block 23 in December 2021 and the acquisition of The Terraces in December 2021, respectively. The majority of the remaining properties’ expenses were marginally higher in comparison to the prior period resulting in a total increase of $0.9 million.

General and administrative expenses are comprised of public company reporting costs and the compensation of our management team and board of directors, as well as stock-based compensation expenses. General and administrative expenses increased $4.8 million, or 45%, to $15.5 million for the year ended December 31, 2021, from $10.7 million reported in the prior year. General and administrative expenses increased primarily due to a $3.5 million employee bonus accrual incurred as a result of the Sorrento Mesa portfolio sale in December 2021. The remaining increase is due to higher professional fees.

Depreciation and amortization decreased $3.1 million, or 5%, to $57.3 million for the year ended December 31, 2021, from $60.4 million reported for the same period in 2020. The disposition of Cherry Creek resulted in a $2.3 million decrease to depreciation and amortization. This decrease was offset by the depreciation related to the acquisitions of two additional buildings adjacent to our Sorrento Mesa portfolio in May 2021, and the acquisitions of Block 23 and The Terraces in December 2021. The remaining properties’ depreciation expenses were marginally lower in comparison to the prior year.

Interest expense decreased $3.1 million, or 11%, to $24.6 million for the year ended December 31, 2021, from $27.7 million for the year ended December 31, 2020. The decrease was primarily attributable to the sale of Cherry Creek in February 2021 as the proceeds of the sale were used to repay debt. In December 2021, the proceeds from the sale of the Sorrento Mesa portfolio were used to acquire Block 23, The Terraces and Bloc 83 and thus did not have a significant impact on interest expense.

 We recorded a net gain on the sale of real estate property of $476.7 million for the year ended December 31, 2021 related to the sale of Cherry Creek in February 2021 and the sale of the Sorrento Mesa portfolio in December 2021 for net gains of $47.4 million and $429.3 million, respectively. In the prior year, we recorded a gain on sale of real estate property of $1.3 million related to the sale of the land parcel at the Circle Point property in July 2020.

Net cash provided by operating activities increased by $13.3 million to $73.2 million for the year ended December 31, 2021 compared to $59.9 million for the year ended December 31, 2020. The increase was primarily attributable to increased operating cash flows from acquired properties offset by changes in working capital due to the sale of the Sorrento Mesa portfolio and Cherry Creek.

Net cash used in investing activities decreased by $10.4 million to $17.4 million for the year ended December 31, 2021 compared to $27.8 million for the year ended December 31, 2020. The decrease in cash used in investing activities was primarily due to acquisitions of real estate for the year ended December 31, 2021 compared to none for the year ended December 31, 2020, partially offset by higher proceeds from the sale of real estate in 2021 compared to 2020. The decrease was also due to lower additions to real estate properties in 2021 compared to 2020.

Net cash used in financing activities decreased by $14.2 million to $59.5 million for the year ended December 31, 2021 compared to $73.7 million for the year ended December 31, 2020. The decrease in cash used in financing activities was primarily due to repurchases of our common stock for the year ended December 31, 2020 compared to no repurchases of our common stock for the year ended December 31, 2021, partially offset by higher net proceeds from borrowings in 2020 compared to 2021.

On September 27, 2019, the Company entered into the five-year Term Loan, increasing its authorized borrowings under the Company’s Unsecured Credit Facility from $250 million to $300 million. Borrowings under the Term Loan bear interest at a rate equal to the LIBOR rate plus a margin between 125 to 215 basis points depending upon the Company’s consolidated leverage ratio. In conjunction with the Term Loan, the Company also entered into the five-year Interest Rate Swap (the “Interest Rate Swap”) for a notional amount of $50 million. Pursuant to the Interest Rate Swap, the Company will pay a fixed rate of approximately 1.27% of the notional amount annually, payable monthly, and receive floating rate LIBOR payments.

Our long-term liquidity needs consist primarily of funds necessary for the repayment of debt at maturity, property acquisitions and capital improvements. We expect to meet our long-term liquidity requirements with net cash from operations, long-term secured and unsecured indebtedness and the issuance of equity and debt securities. We also may fund property acquisitions and capital improvements using our Unsecured Credit Facility pending longer term financing.

As of December 31, 2021, we had approximately $658.5 million of outstanding consolidated principal indebtedness, 70.8% of which is fixed rate debt. The following table sets forth information as of December 31, 2021 with respect to our outstanding indebtedness (in thousands).

 

 

 

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The following table provides information with respect to our commitments as of December 31, 2021, including any guaranteed or minimum commitments under contractual obligations. The table does not reflect available debt extension options.

 

 

We believe that we are less susceptible to the negative economic effects that inflation may have on our industry due to the presence of expense pass through provisions in our leases and the predominance of fixed contractual interest rates on our indebtedness.

Substantially all of our office leases include expense reimbursements that provide for property operating expense escalations. In addition, most of the leases provide for fixed rent increases.

As of December 31, 2021, 70.8% of our outstanding consolidated indebtedness had a fixed contractual interest rate. A portion of the balance relates to the Term Loan against which we have applied the Interest Rate Swap. The Interest Rate Swap effectively fixes the LIBOR rate at approximately 1.27% until maturity of the Term Loan. When factoring in the Term Loan as fixed rate debt through the Interest Rate Swap, 78.4% of our debt was fixed rate debt as of December 31, 2021.

Our future income, cash flows and fair values relevant to financial instruments are dependent upon prevailing market interest rates. Market risk refers to the risk of loss from adverse changes in market prices and interest rates. We use derivative financial instruments to manage or hedge interest rate risks related to borrowings. We do not use derivatives for trading or speculative purposes and only enter into contracts with major financial institutions based upon their credit rating and other factors. We have entered, and we will only enter into, contracts with major financial institutions based on their credit rating and other factors. See Note 7 to our consolidated financial statements in Item 15 of this Annual Report on Form for more information regarding our derivatives.

The primary market risk to which we are exposed is interest rate risk. Our primary interest rate exposure is LIBOR. We primarily use fixed interest rate financing to manage our exposure to fluctuations in interest rates.

 

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The Financial Conduct Authority (the authority that regulates LIBOR) has announced that it intends to stop compelling banks to submit rates for the calculation of LIBOR by June 30, 2023. The Alternative Reference Rates Committee (“AARC”) has proposed that the Secured Overnight Financing Rate (“SOFR”) is the rate that represents best practice as the alternative to LIBOR for future use in derivatives and other financial contracts that are currently indexed to LIBOR. ARRC has proposed a paced market transition plan to SOFR from LIBOR and organizations are currently working on industry-wide and company specific transition plans as it relates to derivatives and cash markets exposed to LIBOR. We currently consider our interest rate exposure to be minimal because as of December 31, 2021, approximately $466.5 million, or 70.8%, of our debt had fixed interest rates and $192.0 million, or 29.2%, had variable interest rates. Of the $192.0 million variable rate debt, $50.0 million relates to the Term Loan against which we have applied the Interest Rate Swap. The Interest Rate Swap effectively fixes the LIBOR rate at approximately 1.27% until maturity of the Term Loan. When factoring in the Term Loan as fixed rate debt through the Interest Rate Swap, 78.4% of our debt was fixed rate debt and 21.6% was variable rate debt as of December 31, 2021. An increase of 1% in LIBOR would result in a $1.9 million increase to our annual interest costs on debt outstanding as of December 31, 2021 and would decrease the fair value of our outstanding debt, as well as increase interest costs associated with future debt issuances or borrowings under our Unsecured Credit Facility. A 1% decrease in LIBOR, assuming a rate floor of 0%, would result in a nominal decrease to our annual interest costs on debt outstanding as of December 31, 2021 and would increase the fair value of our outstanding debt, as well as decrease interest costs associated with future debt issuances or borrowings under our Unsecured Credit Facility.

The information required by Item 8 is included as a separate section in this Annual Report on Form Refer to “Item 15. Exhibits, Financial Statement Schedules.”

We maintain disclosure controls and procedures (as such term is defined in Rule and under the Exchange Act of 1934, as amended (the “Exchange Act”)), that are designed to ensure that information required to be disclosed in our reports under the Exchange Act is processed, recorded, summarized and reported within the time periods specified in the rules and regulations of the SEC and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

We have audited the accompanying consolidated balance sheets of City Office REIT, Inc. (the Company) as of December 31, 2021 and 2020, the related consolidated statements of operations, comprehensive income, changes in equity, and cash flows for each of the years in the period ended December 31, 2021, and the related notes and financial statement schedule III (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the years in the period ended December 31, 2021, in conformity with U.S. generally accepted accounting principles.