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DUKE REALTY CORP - Quarter Report: 2019 September (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 September 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: 1-9044 (Duke Realty Corporation) 0-20625 (Duke Realty Limited Partnership)
dukerealtylogostacka01a01a15.jpg
DUKE REALTY CORPORATION
DUKE REALTY LIMITED PARTNERSHIP
(Exact Name of Registrant as Specified in Its Charter)
Indiana
(Duke Realty Corporation)
 
35-1740409
 (Duke Realty Corporation)
Indiana
(Duke Realty Limited Partnership)
 
35-1898425
 (Duke Realty Limited Partnership)
(State or Other Jurisdiction
of Incorporation or Organization)
 
(I.R.S. Employer
Identification Number)
600 East 96th Street, Suite 100
 
 
Indianapolis,
Indiana
 
46240
        (Address of Principal Executive Offices)
 
(Zip Code)
Registrant's Telephone Number, Including Area Code:
(317)
808-6000
Securities registered pursuant to Section 12(b) of the Act:
 
 
Title of Class
 
Trading Symbols
 
Name of Exchange on Which Registered
Duke Realty Corporation
 
Common Stock, $0.01 par value
 
DRE
 
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.
Duke Realty Corporation
Yes
 No  
 
Duke Realty Limited Partnership
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).
Duke Realty Corporation
Yes
 No  
 
Duke Realty Limited Partnership
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.
Duke Realty Corporation:
Large accelerated filer
Accelerated filer  
Non-accelerated filer  
Smaller reporting company  
Emerging growth company
Duke Realty Limited Partnership:
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):
Duke Realty Corporation
Yes
No  
 
Duke Realty Limited Partnership
Yes  
No  
The number of shares of Duke Realty Corporation's common stock outstanding at October 30, 2019 was 367,570,672.



EXPLANATORY NOTE
This report (the "Report") combines the quarterly reports on Form 10-Q for the period ended September 30, 2019 of both Duke Realty Corporation and Duke Realty Limited Partnership. Unless stated otherwise or the context otherwise requires, references to "Duke Realty Corporation" or the "General Partner" mean Duke Realty Corporation and its consolidated subsidiaries, and references to the "Partnership" mean Duke Realty Limited Partnership and its consolidated subsidiaries. The terms the "Company," "we," "us" and "our" refer to the General Partner and the Partnership, collectively, and those entities owned or controlled by the General Partner and/or the Partnership.
Duke Realty Corporation is a self-administered and self-managed real estate investment trust ("REIT") and is the sole general partner of the Partnership, owning approximately 99.1% of the common partnership interests of the Partnership ("General Partner Units") as of September 30, 2019. The remaining 0.9% of the common partnership interests ("Limited Partner Units" and, together with the General Partner Units, the "Common Units") are owned by limited partners. As the sole general partner of the Partnership, the General Partner has full, exclusive and complete responsibility and discretion in the day-to-day management and control of the Partnership.
The General Partner and the Partnership are operated as one enterprise. The management of the General Partner consists of the same members as the management of the Partnership. As the sole general partner with control of the Partnership, the General Partner consolidates the Partnership for financial reporting purposes, and the General Partner does not have any significant assets other than its investment in the Partnership. Therefore, the assets and liabilities of the General Partner and the Partnership are substantially the same.
We believe combining the quarterly reports on Form 10-Q of the General Partner and the Partnership into this single report results in the following benefits:
enhances investors' understanding of the General Partner and the Partnership by enabling investors to view the business as a whole in the same manner as management views and operates the business;
eliminates duplicative disclosure and provides a more streamlined and readable presentation of information since a substantial portion of the Company's disclosure applies to both the General Partner and the Partnership; and
creates time and cost efficiencies through the preparation of one combined report instead of two separate reports.
 
We believe it is important to understand the few differences between the General Partner and the Partnership in the context of how we operate as an interrelated consolidated company. The General Partner's only material asset is its ownership of partnership interests in the Partnership. As a result, the General Partner does not conduct business itself, other than acting as the sole general partner of the Partnership and issuing public equity from time to time. The General Partner does not issue any indebtedness, but does guarantee some of the unsecured debt of the Partnership. The Partnership holds substantially all the assets of the business, directly or indirectly, and holds the ownership interests related to certain of the Company's investments. The Partnership conducts the operations of the business and has no publicly traded equity. Except for net proceeds from equity issuances by the General Partner, which are contributed to the Partnership in exchange for General Partner Units or Preferred Units, the Partnership generates the capital required by the business through its operations, its incurrence of indebtedness and the issuance of Limited Partner Units to third parties.
Noncontrolling interests, shareholders' equity and partners' capital are the main areas of difference between the consolidated financial statements of the General Partner and those of the Partnership. The noncontrolling interests in the Partnership's financial statements include the interests in consolidated investees not wholly owned by the Partnership. The noncontrolling interests in the General Partner's financial statements include the same noncontrolling interests at the Partnership level, as well as the common limited partnership interests in the Partnership, which are accounted for as partners' capital by the Partnership.
In order to highlight the differences between the General Partner and the Partnership, there are separate sections in this report, as applicable, that separately discuss the General Partner and the Partnership, including separate financial statements and separate Exhibit 31 and 32 certifications. In the sections that combine disclosure of the General Partner and the Partnership, this report refers to actions or holdings as being actions or holdings of the collective Company.




DUKE REALTY CORPORATION/DUKE REALTY LIMITED PARTNERSHIP
INDEX
 
 
 
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
Duke Realty Corporation:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Duke Realty Limited Partnership:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Duke Realty Corporation and Duke Realty Limited Partnership:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2


PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
DUKE REALTY CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except per share amounts)
 
September 30, 2019
 
December 31,
2018
 
(Unaudited)
 
 
ASSETS
 
 
 
Real estate investments:
 
 
 
Real estate assets
$
7,691,643

 
$
7,248,346

Construction in progress
469,218

 
477,162

Investments in and advances to unconsolidated joint ventures
110,815

 
110,795

Undeveloped land
307,973

 
360,816

 
8,579,649

 
8,197,119

Accumulated depreciation
(1,427,180
)
 
(1,344,176
)
Net real estate investments
7,152,469

 
6,852,943

 
 
 
 
Real estate investments and other assets held-for-sale
23,739

 
1,082

 
 
 
 
Cash and cash equivalents
121,233

 
17,901

Accounts receivable
20,449

 
14,254

Straight-line rent receivable
123,689

 
109,334

Receivables on construction contracts, including retentions
24,186

 
41,215

Deferred leasing and other costs, net of accumulated amortization of $196,817 and $200,744
315,579

 
313,799

Restricted cash held in escrow for like-kind exchange
119,240

 

Notes receivable from property sales
127,550

 
272,550

Other escrow deposits and other assets
234,820

 
180,946

 
$
8,262,954

 
$
7,804,024

LIABILITIES AND EQUITY
 
 
 
Indebtedness:
 
 
 
Secured debt, net of deferred financing costs of $175 and $238
$
34,896

 
$
79,563

Unsecured debt, net of deferred financing costs of $17,314 and $26,062
2,732,686

 
2,548,938

Unsecured line of credit

 
30,000

 
2,767,582

 
2,658,501

 
 
 
 
Liabilities related to real estate investments held-for-sale
2,515

 

 
 
 
 
Construction payables and amounts due subcontractors, including retentions
70,310

 
92,288

Accrued real estate taxes
85,684

 
73,358

Accrued interest
28,680

 
16,153

Other liabilities
242,744

 
205,433

Tenant security deposits and prepaid rents
44,167

 
45,048

Total liabilities
3,241,682

 
3,090,781

Shareholders' equity:
 
 
 
Common shares ($0.01 par value); 600,000 shares authorized; 366,295 and 358,851 shares issued and outstanding, respectively
3,663

 
3,589

Additional paid-in capital
5,472,510

 
5,244,375

Accumulated other comprehensive loss
(42,104
)
 
(4,676
)
Distributions in excess of net income
(476,136
)
 
(585,087
)
Total shareholders' equity
4,957,933

 
4,658,201

Noncontrolling interests
63,339

 
55,042

Total equity
5,021,272

 
4,713,243

 
$
8,262,954

 
$
7,804,024

See accompanying Notes to Consolidated Financial Statements

3


DUKE REALTY CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations and Comprehensive Income
For the three and nine months ended September 30,
(in thousands, except per share amounts)
(Unaudited)
 
Three Months Ended
 
Nine Months Ended
 
2019
 
2018
 
2019
 
2018
Revenues:
 
 
 
 
 
 
 
Rental and related revenue
$
215,374

 
$
196,912

 
$
638,446

 
$
582,461

General contractor and service fee revenue
25,955

 
34,986

 
104,838

 
94,552

 
241,329

 
231,898

 
743,284

 
677,013

Expenses:
 
 
 
 
 
 
 
Rental expenses
19,158

 
17,268

 
57,423

 
53,558

Real estate taxes
31,739

 
31,515

 
96,556

 
93,857

General contractor and other services expenses
23,640

 
33,730

 
99,415

 
89,392

Depreciation and amortization
83,924

 
78,855

 
242,920

 
232,216

 
158,461

 
161,368

 
496,314

 
469,023

Other operating activities:
 
 
 
 
 
 
 
Equity in earnings of unconsolidated joint ventures
3,736

 
5,552

 
12,594

 
15,521

Gain on sale of properties
173,646

 
(107
)
 
204,075

 
194,741

Gain on land sales
3,869

 
3,915

 
6,569

 
7,221

Other operating expenses
(874
)
 
(1,104
)
 
(4,515
)
 
(3,902
)
Non-incremental costs related to successful leases
(1,123
)
 

 
(6,726
)
 

General and administrative expenses
(13,720
)
 
(8,959
)
 
(49,123
)
 
(43,441
)
 
165,534

 
(703
)
 
162,874

 
170,140

Operating income
248,402

 
69,827

 
409,844

 
378,130

Other income (expenses):
 
 
 
 
 
 
 
Interest and other income, net
2,085

 
4,129

 
7,377

 
13,319

Interest expense
(22,604
)
 
(21,462
)
 
(68,246
)
 
(62,137
)
Loss on debt extinguishment

 
(89
)
 
(13
)
 
(240
)
Gain on involuntary conversion

 

 
2,259

 

Income from continuing operations before income taxes
227,883

 
52,405

 
351,221

 
329,072

Income tax benefit (expense)
536

 
897

 
(6,465
)
 
(9,495
)
Income from continuing operations
228,419

 
53,302

 
344,756

 
319,577

Discontinued operations:
 
 
 
 
 
 
 
Income before gain on sales

 
85

 

 
108

Gain on sale of properties
112

 
136

 
366

 
3,157

Income from discontinued operations
112

 
221

 
366

 
3,265

Net income
228,531

 
53,523

 
345,122

 
322,842

Net income attributable to noncontrolling interests
(1,965
)
 
(498
)
 
(2,952
)
 
(3,009
)
Net income attributable to common shareholders
$
226,566

 
$
53,025

 
$
342,170

 
$
319,833

Basic net income per common share:
 
 
 
 
 
 
 
Continuing operations attributable to common shareholders
$
0.62

 
$
0.15

 
$
0.95

 
$
0.88

Discontinued operations attributable to common shareholders

 

 

 
0.01

Total
$
0.62

 
$
0.15

 
$
0.95

 
$
0.89

Diluted net income per common share:
 
 
 
 
 
 
 
Continuing operations attributable to common shareholders
$
0.62

 
$
0.15

 
$
0.94

 
$
0.88

Discontinued operations attributable to common shareholders

 

 

 
0.01

Total
$
0.62

 
$
0.15

 
$
0.94

 
$
0.89

Weighted average number of common shares outstanding
362,416

 
357,898

 
360,424

 
357,235

Weighted average number of common shares and potential dilutive securities
367,271

 
361,410

 
365,343

 
362,745

 
 
 
 
 
 
 
 
Comprehensive income:
 
 
 
 
 
 
 
Net income
$
228,531

 
$
53,523

 
$
345,122

 
$
322,842

Other comprehensive loss:
 
 
 
 
 
 
 
Unrealized losses on interest rate swap contracts
(13,387
)
 

 
(37,428
)
 

Comprehensive income
$
215,144

 
$
53,523

 
$
307,694

 
$
322,842

   
See accompanying Notes to Consolidated Financial Statements

4


DUKE REALTY CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the nine months ended September 30,
(in thousands)
(Unaudited)
 
2019
 
2018
Cash flows from operating activities:
 
 
 
Net income
$
345,122

 
$
322,842

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation of buildings and tenant improvements
202,261

 
190,460

Amortization of deferred leasing and other costs
40,659

 
41,756

Amortization of deferred financing costs
4,606

 
4,303

Straight-line rental income and expense, net
(15,627
)
 
(16,763
)
Loss on debt extinguishment
13

 
240

Gain on involuntary conversion
(2,259
)
 

Gains on land and property sales
(211,010
)
 
(205,119
)
Third-party construction contracts, net
14,218

 
(5,088
)
Other accrued revenues and expenses, net
26,870

 
43,627

Equity in earnings in excess of operating distributions received from unconsolidated joint ventures
(766
)
 
(4,609
)
Net cash provided by operating activities
404,087

 
371,649

Cash flows from investing activities:
 
 
 
Development of real estate investments
(325,825
)
 
(459,513
)
Acquisition of real estate investments and related intangible assets
(146,632
)
 
(208,914
)
Acquisition of undeveloped land
(223,547
)
 
(194,171
)
Second generation tenant improvements, leasing costs and building improvements
(31,644
)
 
(34,311
)
Other deferred leasing costs
(28,551
)
 
(27,691
)
Other assets
(9,104
)
 
(5,929
)
Proceeds from the repayments of notes receivable from property sales
145,000

 
149,913

Proceeds from land and property sales, net
379,774

 
434,584

Capital distributions from unconsolidated joint ventures
2,664

 
19,176

Capital contributions and advances to unconsolidated joint ventures
(5,963
)
 
(2,728
)
Net cash used for investing activities
(243,828
)
 
(329,584
)
Cash flows from financing activities:
 
 
 
Proceeds from issuance of common shares, net
222,672

 
30,591

Proceeds from unsecured debt
182,284

 
450,000

Payments on unsecured debt

 
(1,998
)
Payments on secured indebtedness including principal amortization
(44,652
)
 
(231,070
)
Repayments on line of credit, net
(30,000
)
 

Distributions to common shareholders
(232,323
)
 
(214,463
)
Distributions to noncontrolling interests, net
(1,864
)
 
(1,746
)
Tax payments on stock-based compensation awards
(5,695
)
 
(8,389
)
Change in book cash overdrafts
(14,306
)
 
22,669

Other financing activities
(9,920
)
 

Deferred financing costs
(1,440
)
 
(8,485
)
Net cash provided by financing activities
64,756

 
37,109

Net increase in cash, cash equivalents and restricted cash
225,015

 
79,174

Cash, cash equivalents and restricted cash at beginning of period
25,517

 
193,627

Cash, cash equivalents and restricted cash at end of period
$
250,532

 
$
272,801

 
 
 
 
Non-cash activities:
 
 
 
Liabilities and right-of-use assets - operating leases
$
38,826

 
$

Carrying amount of pre-existing ownership interest in acquired property
$

 
$
5,034

Non-cash property contribution from noncontrolling interests
$

 
$
3,200

Conversion of Limited Partner Units to common shares
$

 
$
1,967

See accompanying Notes to Consolidated Financial Statements


5


DUKE REALTY CORPORATION AND SUBSIDIARIES
Consolidated Statements of Changes in Equity
For the three and nine months ended September 30, 2019 and 2018
(in thousands, except per share data)
(Unaudited)
 
 
Common Shareholders
 
 
 
 
 
Common
Stock
 
Additional
Paid-in
Capital
 
Accumulated
Other
Comprehensive
Loss
 
Distributions
in Excess of
Net Income
 
Noncontrolling
Interests
 
Total
Balance at June 30, 2019
$
3,606

 
$
5,290,382

 
$
(28,717
)
 
$
(624,674
)
 
$
61,524

 
$
4,702,121

Net income

 

 

 
226,566

 
1,965

 
228,531

Other comprehensive loss

 

 
(13,387
)
 

 

 
(13,387
)
Issuance of common shares
55

 
180,489

 

 

 

 
180,544

Stock-based compensation plan activity
2

 
1,639

 

 
(255
)
 
534

 
1,920

Distributions to common shareholders ($0.215 per share)

 

 

 
(77,773
)
 

 
(77,773
)
Distributions to noncontrolling interests

 

 

 

 
(684
)
 
(684
)
Balance at September 30, 2019
$
3,663

 
$
5,472,510

 
$
(42,104
)
 
$
(476,136
)
 
$
63,339

 
$
5,021,272

Balance at December 31, 2018
$
3,589

 
$
5,244,375

 
$
(4,676
)
 
$
(585,087
)
 
$
55,042

 
$
4,713,243

Net income

 

 

 
342,170

 
2,952

 
345,122

Other comprehensive loss

 

 
(37,428
)
 

 

 
(37,428
)
Issuance of common shares
68

 
222,604

 

 

 

 
222,672

Contributions from noncontrolling interests

 

 

 

 
312

 
312

Stock-based compensation plan activity
6

 
5,531

 

 
(896
)
 
7,209

 
11,850

Distributions to common shareholders ($0.645 per share)

 

 

 
(232,323
)
 

 
(232,323
)
Distributions to noncontrolling interests

 

 

 

 
(2,176
)
 
(2,176
)
Balance at September 30, 2019
$
3,663

 
$
5,472,510

 
$
(42,104
)
 
$
(476,136
)
 
$
63,339

 
$
5,021,272


 
Common Shareholders
 
 
 
 
 
Common
Stock
 
Additional
Paid-in
Capital
 
Distributions
in Excess of
Net Income
 
Noncontrolling
Interests
 
Total
Balance at June 30, 2018
$
3,572

 
$
5,209,605

 
$
(552,685
)
 
$
48,478

 
$
4,708,970

Net income

 

 
53,025

 
498

 
53,523

Issuance of common shares
10

 
29,205

 

 

 
29,215

Contributions from noncontrolling interests

 

 

 
3,475

 
3,475

Stock-based compensation plan activity
1

 
1,656

 
(301
)
 
701

 
2,057

Conversion of Limited Partner Units

 
29

 

 
(29
)
 

Distributions to common shareholders ($0.20 per share)

 

 
(71,656
)
 

 
(71,656
)
Distributions to noncontrolling interests

 

 

 
(660
)
 
(660
)
Balance at September 30, 2018
$
3,583

 
$
5,240,495

 
$
(571,617
)
 
$
52,463

 
$
4,724,924

Balance at December 31, 2017
$
3,564

 
$
5,205,316

 
$
(676,036
)
 
$
41,534

 
$
4,574,378

Net income

 

 
319,833

 
3,009

 
322,842

Issuance of common shares
11

 
30,580

 

 

 
30,591

Contributions from noncontrolling interests

 

 

 
3,475

 
3,475

Stock-based compensation plan activity
7

 
2,633

 
(951
)
 
8,433

 
10,122

Conversion of Limited Partner Units
1

 
1,966

 

 
(1,967
)
 

Distributions to common shareholders ($0.60 per share)

 

 
(214,463
)
 

 
(214,463
)
Distributions to noncontrolling interests

 

 

 
(2,021
)
 
(2,021
)
Balance at September 30, 2018
$
3,583

 
$
5,240,495

 
$
(571,617
)
 
$
52,463

 
$
4,724,924

See accompanying Notes to Consolidated Financial Statements

6


DUKE REALTY LIMITED PARTNERSHIP AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands)

 
September 30,
2019
 
December 31, 2018
 
(Unaudited)
 
 
ASSETS
 
 
 
Real estate investments:
 
 
 
Real estate assets
$
7,691,643

 
$
7,248,346

     Construction in progress
469,218

 
477,162

     Investments in and advances to unconsolidated joint ventures
110,815

 
110,795

     Undeveloped land
307,973

 
360,816

 
8,579,649

 
8,197,119

     Accumulated depreciation
(1,427,180
)
 
(1,344,176
)
              Net real estate investments
7,152,469

 
6,852,943

 
 
 
 
Real estate investments and other assets held-for-sale
23,739

 
1,082

 
 
 
 
Cash and cash equivalents
121,233

 
17,901

Accounts receivable
20,449

 
14,254

Straight-line rent receivable
123,689

 
109,334

Receivables on construction contracts, including retentions
24,186

 
41,215

Deferred leasing and other costs, net of accumulated amortization of $196,817 and $200,744
315,579

 
313,799

Restricted cash held in escrow for like-kind exchange
119,240

 

Notes receivable from property sales
127,550

 
272,550

Other escrow deposits and other assets
234,820

 
180,946

 
$
8,262,954

 
$
7,804,024

LIABILITIES AND EQUITY
 
 
 
Indebtedness:
 
 
 
     Secured debt, net of deferred financing costs of $175 and $238
$
34,896

 
$
79,563

     Unsecured debt, net of deferred financing costs of $17,314 and $26,062
2,732,686

 
2,548,938

     Unsecured line of credit

 
30,000

 
2,767,582

 
2,658,501

 
 
 
 
Liabilities related to real estate investments held-for-sale
2,515

 

 
 
 
 
Construction payables and amounts due subcontractors, including retentions
70,310

 
92,288

Accrued real estate taxes
85,684

 
73,358

Accrued interest
28,680

 
16,153

Other liabilities
242,744

 
205,433

Tenant security deposits and prepaid rents
44,167

 
45,048

     Total liabilities
3,241,682

 
3,090,781

Partners' equity:
 
 
 
Common equity (366,295 and 358,851 General Partner Units issued and outstanding, respectively)
5,000,037

 
4,662,877

Limited Partners' common equity (3,141 and 2,920 Limited Partner Units issued and outstanding, respectively)
58,736

 
50,585

Accumulated other comprehensive loss
(42,104
)
 
(4,676
)
            Total partners' equity
5,016,669

 
4,708,786

Noncontrolling interests
4,603

 
4,457

     Total equity
5,021,272

 
4,713,243

 
$
8,262,954

 
$
7,804,024

See accompanying Notes to Consolidated Financial Statements

7


DUKE REALTY LIMITED PARTNERSHIP AND SUBSIDIARIES
Consolidated Statements of Operations and Comprehensive Income
For the three and nine months ended September 30,
(in thousands, except per unit amounts)
(Unaudited)
 
Three Months Ended
 
Nine Months Ended
 
2019
 
2018
 
2019
 
2018
Revenues:
 
 
 
 
 
 
 
Rental and related revenue
$
215,374

 
$
196,912

 
$
638,446

 
$
582,461

General contractor and service fee revenue
25,955

 
34,986

 
104,838

 
94,552

 
241,329

 
231,898

 
743,284

 
677,013

Expenses:
 
 
 
 
 
 
 
Rental expenses
19,158

 
17,268

 
57,423

 
53,558

Real estate taxes
31,739

 
31,515

 
96,556

 
93,857

General contractor and other services expenses
23,640

 
33,730

 
99,415

 
89,392

Depreciation and amortization
83,924

 
78,855

 
242,920

 
232,216

 
158,461

 
161,368

 
496,314

 
469,023

Other operating activities:
 
 
 
 
 
 
 
Equity in earnings of unconsolidated joint ventures
3,736

 
5,552

 
12,594

 
15,521

Gain on sale of properties
173,646

 
(107
)
 
204,075

 
194,741

Gain on land sales
3,869

 
3,915

 
6,569

 
7,221

Other operating expenses
(874
)
 
(1,104
)
 
(4,515
)
 
(3,902
)
Non-incremental costs related to successful leases
(1,123
)
 

 
(6,726
)
 

General and administrative expenses
(13,720
)
 
(8,959
)
 
(49,123
)
 
(43,441
)
 
165,534

 
(703
)
 
162,874

 
170,140

Operating income
248,402

 
69,827

 
409,844

 
378,130

Other income (expenses):
 
 
 
 
 
 
 
Interest and other income, net
2,085

 
4,129

 
7,377

 
13,319

Interest expense
(22,604
)
 
(21,462
)
 
(68,246
)
 
(62,137
)
Loss on debt extinguishment

 
(89
)
 
(13
)
 
(240
)
Gain on involuntary conversion

 

 
2,259

 

Income from continuing operations before income taxes
227,883

 
52,405

 
351,221

 
329,072

Income tax benefit (expense)
536

 
897

 
(6,465
)
 
(9,495
)
Income from continuing operations
228,419

 
53,302

 
344,756

 
319,577

Discontinued operations:
 
 
 
 
 
 
 
Income before gain on sales

 
85

 

 
108

Gain on sale of properties
112

 
136

 
366

 
3,157

           Income from discontinued operations
112

 
221

 
366

 
3,265

Net income
228,531

 
53,523

 
345,122

 
322,842

Net loss (income) attributable to noncontrolling interests
3

 
(3
)
 
19

 
(7
)
Net income attributable to common unitholders
$
228,534

 
$
53,520

 
$
345,141

 
$
322,835

Basic net income per Common Unit:
 
 
 
 
 
 
 
Continuing operations attributable to common unitholders
$
0.62

 
$
0.15

 
$
0.95

 
$
0.88

Discontinued operations attributable to common unitholders

 

 

 
0.01

Total
$
0.62

 
$
0.15

 
$
0.95

 
$
0.89

Diluted net income per Common Unit:
 
 
 
 
 
 
 
Continuing operations attributable to common unitholders
$
0.62

 
$
0.15

 
$
0.94

 
$
0.88

Discontinued operations attributable to common unitholders

 

 

 
0.01

Total
$
0.62

 
$
0.15

 
$
0.94

 
$
0.89

Weighted average number of Common Units outstanding
365,558

 
361,200

 
363,542

 
360,585

Weighted average number of Common Units and potential dilutive securities
367,271

 
361,410

 
365,343

 
362,745

Comprehensive income:
 
 
 
 
 
 
 
Net income
$
228,531

 
$
53,523

 
$
345,122

 
$
322,842

Other comprehensive loss:
 
 
 
 
 
 
 
Unrealized losses on interest rate swap contracts
(13,387
)
 

 
(37,428
)
 

Comprehensive income
$
215,144

 
$
53,523

 
$
307,694

 
$
322,842


See accompanying Notes to Consolidated Financial Statements

8


DUKE REALTY LIMITED PARTNERSHIP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the nine months ended September 30,
(in thousands)
(Unaudited)
 
2019
 
2018
Cash flows from operating activities:
 
 
 
Net income
$
345,122

 
$
322,842

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation of buildings and tenant improvements
202,261

 
190,460

Amortization of deferred leasing and other costs
40,659

 
41,756

Amortization of deferred financing costs
4,606

 
4,303

Straight-line rental income and expense, net
(15,627
)
 
(16,763
)
Loss on debt extinguishment
13

 
240

Gain on involuntary conversion
(2,259
)
 

Gains on land and property sales
(211,010
)
 
(205,119
)
Third-party construction contracts, net
14,218

 
(5,088
)
Other accrued revenues and expenses, net
26,870

 
43,627

Equity in earnings in excess of operating distributions received from unconsolidated joint ventures
(766
)
 
(4,609
)
Net cash provided by operating activities
404,087

 
371,649

Cash flows from investing activities:
 
 
 
Development of real estate investments
(325,825
)
 
(459,513
)
Acquisition of real estate investments and related intangible assets
(146,632
)
 
(208,914
)
Acquisition of undeveloped land
(223,547
)
 
(194,171
)
Second generation tenant improvements, leasing costs and building improvements
(31,644
)
 
(34,311
)
Other deferred leasing costs
(28,551
)
 
(27,691
)
Other assets
(9,104
)
 
(5,929
)
        Proceeds from the repayments of notes receivable from property sales
145,000

 
149,913

Proceeds from land and property sales, net
379,774

 
434,584

Capital distributions from unconsolidated joint ventures
2,664

 
19,176

Capital contributions and advances to unconsolidated joint ventures
(5,963
)
 
(2,728
)
Net cash used for investing activities
(243,828
)
 
(329,584
)
Cash flows from financing activities:
 
 
 
Contributions from the General Partner
222,672

 
30,591

Proceeds from unsecured debt
182,284

 
450,000

Payments on unsecured debt

 
(1,998
)
Payments on secured indebtedness including principal amortization
(44,652
)
 
(231,070
)
Repayments on line of credit, net
(30,000
)
 

Distributions to common unitholders
(234,352
)
 
(216,484
)
Contributions from noncontrolling interests, net
165

 
275

Tax payments on stock-based compensation awards
(5,695
)
 
(8,389
)
Change in book cash overdrafts
(14,306
)
 
22,669

Other financing activities
(9,920
)
 

Deferred financing costs
(1,440
)
 
(8,485
)
Net cash provided by financing activities
64,756

 
37,109

Net increase in cash, cash equivalents and restricted cash
225,015

 
79,174

Cash, cash equivalents and restricted cash at beginning of period
25,517

 
193,627

Cash, cash equivalents and restricted cash at end of period
$
250,532

 
$
272,801

 
 
 
 
Non-cash activities:
 
 
 
Liabilities and right-of-use assets - operating leases
$
38,826

 
$

Carrying amount of pre-existing ownership interest in acquired property
$

 
$
5,034

Non-cash property contribution from noncontrolling interests
$

 
$
3,200

Conversion of Limited Partner Units to common shares of the General Partner
$

 
$
1,967

See accompanying Notes to Consolidated Financial Statements

9


DUKE REALTY LIMITED PARTNERSHIP AND SUBSIDIARIES
Consolidated Statements of Changes in Equity
For the three and nine months ended September 30, 2019 and 2018
(in thousands, except per unit data)
(Unaudited)

 
Common Unitholders
 
 
 
 
 
General
 
Limited
 
Accumulated
 
 
 
 
 
 
 
 Partner's
 
Partners'
 
Other
 
Total
 
 
 
 
 
Common Equity
 
Common Equity
 
Comprehensive
Loss
 
Partners' Equity
 
Noncontrolling
Interests
 
Total Equity
Balance at June 30, 2019
$
4,669,314

 
$
56,910

 
$
(28,717
)
 
$
4,697,507

 
$
4,614

 
$
4,702,121

Net income
226,566

 
1,968

 

 
228,534

 
(3
)
 
228,531

Other comprehensive loss

 

 
(13,387
)
 
(13,387
)
 

 
(13,387
)
Capital contribution from the General Partner
180,544

 

 

 
180,544

 

 
180,544

Stock-based compensation plan activity
1,386

 
534

 

 
1,920

 

 
1,920

Distributions to common unitholders ($0.215 per Common Unit)
(77,773
)
 
(676
)
 

 
(78,449
)
 

 
(78,449
)
Distributions to noncontrolling interests

 

 

 

 
(8
)
 
(8
)
Balance at September 30, 2019
$
5,000,037

 
$
58,736

 
$
(42,104
)
 
$
5,016,669

 
$
4,603

 
$
5,021,272

Balance at December 31, 2018
$
4,662,877

 
$
50,585

 
$
(4,676
)
 
$
4,708,786

 
$
4,457

 
$
4,713,243

Net income
342,170

 
2,971

 

 
345,141

 
(19
)
 
345,122

Other comprehensive loss

 

 
(37,428
)
 
(37,428
)
 

 
(37,428
)
Capital contribution from the General Partner
222,672

 

 

 
222,672

 

 
222,672

Stock-based compensation plan activity
4,641

 
7,209

 

 
11,850

 

 
11,850

Contributions from noncontrolling interests

 

 

 

 
312

 
312

Distributions to common unitholders ($0.645 per Common Unit)
(232,323
)
 
(2,029
)
 

 
(234,352
)
 

 
(234,352
)
Distributions to noncontrolling interests

 

 

 

 
(147
)
 
(147
)
Balance at September 30, 2019
$
5,000,037

 
$
58,736

 
$
(42,104
)
 
$
5,016,669

 
$
4,603

 
$
5,021,272


 
Common Unitholders
 
 
 
 
 
General
 
Limited
 
 
 
 
 
 
 
 Partner's
 
Partners'
 
Total
 
 
 
 
 
Common Equity
 
Common Equity
 
Partners' Equity
 
Noncontrolling
Interests
 
Total Equity
Balance at June 30, 2018
$
4,660,492

 
$
47,503

 
$
4,707,995

 
$
975

 
$
4,708,970

Net income
53,025

 
495

 
53,520

 
3

 
53,523

Capital contribution from the General Partner
29,215

 

 
29,215

 

 
29,215

Stock-based compensation plan activity
1,356

 
701

 
2,057

 

 
2,057

Contributions from noncontrolling interests

 

 

 
3,475

 
3,475

Conversion of Limited Partner Units
29

 
(29
)
 

 

 

Distributions to common unitholders ($0.20 per Common Unit)
(71,656
)
 
(660
)
 
(72,316
)
 

 
(72,316
)
Balance at September 30, 2018
$
4,672,461

 
$
48,010

 
$
4,720,471

 
$
4,453

 
$
4,724,924

Balance at December 31, 2017
$
4,532,844

 
$
40,563

 
$
4,573,407

 
$
971

 
$
4,574,378

Net income
319,833

 
3,002

 
322,835

 
7

 
322,842

Capital contribution from the General Partner
30,591

 

 
30,591

 

 
30,591

Stock-based compensation plan activity
1,689

 
8,433

 
10,122

 

 
10,122

Contributions from noncontrolling interests

 

 

 
3,475

 
3,475

Conversion of Limited Partner Units
1,967

 
(1,967
)
 

 

 

Distributions to common unitholders ($0.60 per Common Unit)
(214,463
)
 
(2,021
)
 
(216,484
)
 

 
(216,484
)
Balance at September 30, 2018
$
4,672,461

 
$
48,010

 
$
4,720,471

 
$
4,453

 
$
4,724,924




See accompanying Notes to Consolidated Financial Statements

10


DUKE REALTY CORPORATION AND DUKE REALTY LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
1.    General Basis of Presentation
The interim consolidated financial statements included herein have been prepared by the General Partner and the Partnership. The 2018 year-end consolidated balance sheet data included in this Report was derived from the audited financial statements in the combined Annual Report on Form 10-K of the General Partner and the Partnership for the year ended December 31, 2018 (the "2018 Annual Report"), but does not include all disclosures required by accounting principles generally accepted in the United States of America ("GAAP"). The financial statements have been prepared in accordance with GAAP for interim financial information and in accordance with Rule 10-01 of Regulation S-X of the Securities Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and revenue and expenses during the reporting period. Our actual results could differ from those estimates and assumptions. These financial statements should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations included herein and the consolidated financial statements and notes thereto included in the 2018 Annual Report.
The General Partner was formed in 1985, and we believe that it qualifies as a REIT under the provisions of the Internal Revenue Code of 1986, as amended (the "Code"). The Partnership was formed on October 4, 1993, when the General Partner contributed all of its properties and related assets and liabilities, together with the net proceeds from an offering of additional shares of its common stock, to the Partnership. Simultaneously, the Partnership completed the acquisition of Duke Associates, a full-service commercial real estate firm operating in the Midwest whose operations began in 1972.
The General Partner is the sole general partner of the Partnership, owning approximately 99.1% of the Common Units at September 30, 2019. The remaining 0.9% of the Common Units are owned by limited partners. As the sole general partner of the Partnership, the General Partner has full, exclusive and complete responsibility and discretion in the day-to-day management and control of the Partnership. The General Partner and the Partnership are operated as one enterprise. The management of the General Partner consists of the same members as the management of the Partnership. As the sole general partner with control of the Partnership, the General Partner consolidates the Partnership for financial reporting purposes, and the General Partner does not have any significant assets other than its investment in the Partnership. Therefore, the assets and liabilities of the General Partner and the Partnership are substantially the same.
Limited partners have the right to redeem their Limited Partner Units, subject to certain restrictions. Pursuant to the Fifth Amended and Restated Agreement of Limited Partnership, as amended (the "Partnership Agreement"), the General Partner is obligated to redeem the Limited Partner Units in shares of its common stock, unless it determines in its reasonable discretion that the issuance of shares of its common stock could cause it to fail to qualify as a REIT. Each Limited Partner Unit shall be redeemed for one share of the General Partner's common stock, or, in the event that the issuance of shares could cause the General Partner to fail to qualify as a REIT, cash equal to the fair market value of one share of the General Partner's common stock at the time of redemption, in each case, subject to certain adjustments described in the Partnership Agreement. The Limited Partner Units are not required, per the terms of the Partnership Agreement, to be redeemed in registered shares of the General Partner.
As of September 30, 2019, we owned and operated a portfolio primarily consisting of industrial properties and provided real estate services to third-party owners. Substantially all of our Rental Operations (see Note 11) are conducted through the Partnership. We conduct our Service Operations (see Note 11) through Duke Realty Services, LLC, Duke Realty Services Limited Partnership and Duke Construction Limited Partnership ("DCLP"), which are consolidated entities that are 100% owned by a combination of the General Partner and the Partnership. DCLP is owned through a taxable REIT subsidiary. The consolidated financial statements include our accounts and the accounts of our majority-owned or controlled subsidiaries.  

11


2.    New Accounting Pronouncements
Recently Adopted Accounting Pronouncements
Leases
On January 1, 2019, we adopted Accounting Standards Codification ("ASC") 842, Leases ("ASC 842"), utilizing the available election to adopt on a prospective basis. ASC 842 has superseded all previous GAAP guidance for accounting for leases.
As part of adoption, we elected the package of practical expedients available for implementation, which included: (i) relief from re-assessing whether an expired or existing contract meets the definition of a lease, (ii) relief from re-assessing the classification of expired or existing leases at the adoption date and (iii) allowing previously capitalized initial direct leasing costs to continue to be amortized. Due in large part to electing these practical expedients, the adoption of ASC 842 did not result in recording a cumulative adjustment to the opening balance of distributions in excess of net income.
Lessor Accounting
Our primary business is the development, acquisition, and operation of industrial real estate properties that are held for investment and leased to tenants. Due to electing the package of practical expedients that allow for relief from re-assessing the classification of existing leases at the adoption date, as well as based on the characteristics of our underlying assets and leases, all of our leases are classified as operating leases. We manage residual risk through investing in properties that we believe will appreciate in value over time. We also perform a credit analysis for tenants prior to leases being executed, and on an ongoing basis, to ensure collectability is probable prior to recognizing lease revenues on an accrual basis. For lessors, the accounting under ASC 842 remains largely unchanged with the notable exception that ASC 842 requires that lessors expense certain initial direct costs, which were capitalizable under prior leasing standards, as incurred. Under the new standard, only the incremental costs of signing a lease are capitalizable. As the result of this change, we recognized $1.1 million and $6.7 million of expense for internal costs related to successful leases for the three and nine months ended September 30, 2019, respectively, presented separately in the line item "Non-Incremental Costs Related to Successful Leases" on the Consolidated Statements of Operations and Comprehensive Income, which previously would have been capitalized. For the three and nine months ended September 30, 2018, we capitalized $852,000 and $9.2 million, respectively, of internal lease related costs which would have been expensed had ASC 842 been effective.
ASC 842 also requires lessors to exclude certain lessor costs, such as real estate taxes and insurance, that are paid directly by lessees to third parties from rental revenue and the associated rental expense. Lessor costs that are paid by the lessor and reimbursed by the lessee continue to be recorded through rental revenue and the associated rental expense.
ASC 842 provides lessors an additional practical expedient to not separate rental recovery revenue related to lease-related services from the associated rental revenue related to the lease when certain criteria are met. The lease-related services provided to our tenants include property management, common area maintenance ("CAM") and utilities. We assessed the applicable criteria, concluding that the timing and straight-line pattern of transfer to the lessees for rental recovery revenue from our lease-related services and revenue from the underlying leases are the same and that lease classification does not change, and elected to apply this additional practical expedient.
Our leases generally include scheduled rent increases, but do not include variable payments based on indexes. Our rental revenue is primarily based on fixed, non-cancelable leases. Our variable rental revenue primarily consists of amounts recovered from lessees for property tax, insurance and CAM.

12


All revenues related to lease and lease-related services are included in, and comprise substantially all of, the caption "Rental and Related Revenue" on the Consolidated Statements of Operations and Comprehensive Income. The components of Rental and Related Revenue are as follows (in thousands):
 
Three Months Ended September 30, 2019
 
Nine Months Ended September 30, 2019
Rental revenue - fixed payments
$
163,516

 
$
481,674

Rental revenue - variable payments (1)
51,858

 
156,772

Rental and related revenue
$
215,374

 
$
638,446

(1) Primarily includes tenant recoveries for real estate taxes, insurance and CAM.
The future minimum rents due to us under non-cancelable operating leases are as follows (in thousands):
Year
September 30, 2019
 
December 31, 2018
2019
$
153,301

 
$
600,385

2020
623,291

 
586,609

2021
600,850

 
529,961

2022
537,556

 
463,462

2023
466,514

 
397,150

Thereafter
2,058,372

 
1,582,598

 
$
4,439,884

 
$
4,160,165


Lessee Accounting
ASC 842 requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase of the leased asset by the lessee. This classification determines whether the lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease. A lessee is also required to record a right-of-use ("ROU") asset and a lease liability for all leases with a term of greater than 12 months regardless of classification.
As of September 30, 2019, our lease arrangements primarily consisted of office and ground leases. Adoption of the practical expedients resulted in the continued classification of our leases as operating leases. Expense recognized on these leases for the nine months ended September 30, 2019 was not material.
For these arrangements, we recognized a ROU asset and a corresponding lease liability at the January 1, 2019 adoption date of ASC 842, representing the discounted value of future lease payments required under our lease arrangements. A $38.8 million ROU asset, net of pre-existing lease related accruals, was included in Other Escrow Deposits and Other Assets, and a corresponding lease liability of $45.0 million was included in Other Liabilities on our Consolidated Balance Sheets as of September 30, 2019. In determining these amounts we elected an available practical expedient that allows us, as a lessee, to not separate lease and non-lease components.

13


The following table summarizes the future operating lease payments (in thousands) to be made under our non-cancellable lease arrangements:
Year
September 30, 2019
 
December 31, 2018
2019
$
1,521

 
$
6,487

2020
8,037

 
7,594

2021
3,595

 
2,987

2022
2,877

 
2,255

2023
2,585

 
1,949

Thereafter
86,040

 
85,523

Total undiscounted operating lease payments
$
104,655

 
$
106,795

Less: imputed interest
(59,634
)
 
 
Present value of operating lease payments
$
45,021

 
 

The weighted average remaining lease term for our lease arrangements, on a combined basis as of September 30, 2019, was 32.5 years. The weighted average discount rate for our lease arrangements as of September 30, 2019 was 4.55%. As the discount rates implied in our lease arrangements are not readily determinable, we utilized our current credit ratings and credit yields observed from market traded securities with similar credit ratings to form a reasonable basis to establish secured borrowing rates when determining the present value of future lease payments.
3.    Reclassifications
Certain amounts in the accompanying consolidated financial statements for 2018 have been reclassified to conform to the 2019 consolidated financial statement presentation.
4.    Restricted Cash
In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows: Restricted Cash ("ASU 2016-18"). ASU 2016-18 requires entities to show the changes in the total of cash, cash equivalents and restricted cash in the statement of cash flows. As a result, entities will no longer present transfers between cash, cash equivalents and restricted cash in the statement of cash flows. We adopted this standard on January 1, 2018, on a retrospective basis, and the adoption did not have a material impact on our consolidated financial statements.
The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the Consolidated Balance Sheets that sum to the total of the same such amounts shown in the Consolidated Statements of Cash Flows (in thousands):
 
September 30, 2019
 
December 31, 2018
Cash and cash equivalents
$
121,233

 
$
17,901

Restricted cash held in escrow for like-kind exchange
119,240

 

Restricted cash included in other escrow deposits and other assets
10,059

 
7,616

Total cash, cash equivalents, and restricted cash shown in the Consolidated Statements of Cash Flows
$
250,532

 
$
25,517


Restricted cash held in escrow for like-kind exchange on the Consolidated Balance Sheets includes cash received from the property dispositions but restricted only for qualifying like-kind exchange transactions.

14


5.    Variable Interest Entities
Partnership
Due to the fact that the Limited Partners do not have kick out rights, or substantive participating rights, the Partnership is a variable interest entity ("VIE"). Because the General Partner holds majority ownership and exercises control over every aspect of the Partnership's operations, the General Partner has been determined as the primary beneficiary and, therefore, consolidates the Partnership.

The assets and liabilities of the General Partner and the Partnership are substantially the same, as the General Partner does not have any significant assets other than its investment in the Partnership. All of the Company's debt is an obligation of the Partnership.

Joint Ventures

We have equity interests in unconsolidated joint ventures that primarily own and operate rental properties or hold land for development. We consolidate those joint ventures that are considered to be VIEs where we are the primary beneficiary. We analyze our investments in joint ventures to determine if the joint venture is considered a VIE and would require consolidation. We (i) evaluate the sufficiency of the total equity investment at risk, (ii) review the voting rights and decision-making authority of the equity investment holders as a group and whether there are limited partners (or similar owning entities) that lack substantive participating or kick out rights and (iii) establish whether or not activities within the venture are on behalf of an investor with disproportionately few voting rights in making this VIE determination.

To the extent that we own interests in a VIE and we (i) are the sole entity that has the power to direct the activities of the VIE and (ii) have the obligation or rights to absorb the VIE's losses or receive its benefits, then we would be determined to be the primary beneficiary and would consolidate the VIE. To the extent we own interests in a VIE, then at each reporting period, we re-assess our conclusions as to which, if any, party within the VIE is considered the primary beneficiary. Consolidated joint ventures that are VIEs are not significant in any period presented in these consolidated financial statements.

To the extent that our joint ventures do not qualify as VIEs, they are consolidated if we control them through majority ownership interests or if we are the managing entity (general partner or managing member) and the other partner does not have substantive participating rights. Control is further demonstrated by our ability to unilaterally make significant operating decisions, refinance debt and sell the assets of the joint venture without the consent of the non-managing entity and the inability of the non-managing entity to remove us from our role as the managing entity. Consolidated joint ventures that are not VIEs are not significant in any period presented in these consolidated financial statements.

There were no unconsolidated joint ventures, in which we have any recognized assets or liabilities or have retained any economic exposure to loss at September 30, 2019, that met the criteria to be considered VIEs. Our maximum loss exposure for guarantees of unconsolidated joint venture indebtedness, none of which relate to VIEs, totaled $160.1 million at September 30, 2019.

6.    Acquisitions and Dispositions

Acquisitions and dispositions for the periods presented were completed in accordance with our strategy to reposition our investment concentration among the markets in which we operate and to increase our overall investments in quality industrial projects. Transaction costs related to asset acquisitions are capitalized and transaction costs related to business combinations and dispositions are expensed.




15


Acquisitions

We paid cash of $146.6 million and $208.9 million for asset acquisitions during the nine months ended September 30, 2019 and 2018, respectively.

We acquired four properties during the nine months ended September 30, 2019. We determined that these four properties did not meet the definition of a business and, accordingly, we accounted for them as asset acquisitions as opposed to business combinations.

The following table summarizes amounts recognized for each major class of assets (in thousands) for these acquisitions during the nine months ended September 30, 2019:
Real estate assets
$
140,030

Lease related intangible assets
9,331

Fair value of acquired net assets
$
149,361


The leases in the acquired properties had a weighted average remaining life at acquisition of approximately 6.3 years.

Fair Value Measurements
     
We determine the fair value of the individual components of real estate asset acquisitions primarily through calculating the "as-if vacant" value of a building, using an income approach, which relies significantly upon internally determined assumptions. We have determined that these estimates primarily rely upon level 3 inputs, which are unobservable inputs based on our own assumptions. The most significant assumptions used in calculating the "as-if vacant" value for acquisition activity during the nine months ended September 30, 2019 are as follows: 
 
Low
High
Exit capitalization rate
4.23%
5.26%
Net rental rate per square foot
$5.90
$15.60

Capitalized acquisition costs were insignificant and the fair value of the four properties acquired during the nine months ended September 30, 2019 was substantially the same as the cost of acquisition.
Dispositions
Dispositions of buildings and undeveloped land generated net cash proceeds of $379.8 million and $434.6 million during the nine months ended September 30, 2019 and 2018, respectively.

In September 2019, we completed the sale of 18 non-strategic industrial properties for $217.5 million in proceeds and recorded a gain on sale of $146.3 million. These properties totaled 4.1 million square feet and were located in primarily Midwest markets. Additionally, during the nine months ended September 30, 2019, we collected $145.0 million of principal on notes receivable primarily related to the sale of our medical office portfolio (the "Medical Office Portfolio Disposition") during 2017. The number of buildings sold, as well as their classification between continuing and discontinued operations, is disclosed in Note 12.


16


7. Indebtedness
All debt is issued directly or indirectly by the Partnership. The General Partner does not have any indebtedness, but does guarantee some of the unsecured debt of the Partnership. The following table summarizes the book value and changes in the fair value of our debt (in thousands):
 
Book Value at 12/31/2018
 
Book Value at 9/30/2019
 
Fair Value at 12/31/2018
 
Issuances and
Assumptions
 
Payments/Payoffs
 
Adjustments
to Fair Value
 
Fair Value at 9/30/2019
Fixed rate secured debt
$
77,601

 
$
33,171

 
$
80,238

 
$

 
$
(44,352
)
 
$
(163
)
 
$
35,723

Variable rate secured debt
2,200

 
1,900

 
2,200

 

 
(300
)
 

 
1,900

Unsecured debt
2,575,000

 
2,750,000

 
2,549,963

 
175,000

 

 
172,750

 
2,897,713

Unsecured line of credit
30,000

 

 
30,000

 

 
(30,000
)
 

 

Total
$
2,684,801

 
$
2,785,071

 
$
2,662,401

 
$
175,000

 
$
(74,652
)
 
$
172,587

 
$
2,935,336

Less: Deferred financing costs
26,300

 
17,489

 
 
 
 
 
 
 
 
 
 
Total indebtedness as reported on the consolidated balance sheets
$
2,658,501

 
$
2,767,582

 
 
 
 
 
 
 
 
 
 


Secured Debt

Because our fixed rate secured debt is not actively traded in any marketplace, we utilized a discounted cash flow methodology to determine its fair value. Accordingly, we calculated fair value by applying an estimate of the current market rate to discount the debt's remaining contractual cash flows. Our estimate of a current market rate, which is the most significant input in the discounted cash flow calculation, is intended to replicate debt of similar maturity and loan-to-value relationship. The estimated rates ranged from 3.10% to 3.40%, depending on the attributes of the specific loans. The current market rates we utilized were internally estimated; therefore, we have concluded that our determination of fair value for our fixed rate secured debt was primarily based upon level 3 inputs.

During the nine months ended September 30, 2019, we repaid three fixed rate secured loans, totaling $41.7 million, which had a weighted average stated interest rate of 7.76%.

Unsecured Debt

At September 30, 2019, all of our unsecured debt bore interest at fixed rates and primarily consisted of unsecured notes that are publicly traded. We utilized broker estimates in estimating the fair value of our fixed rate unsecured debt. Our unsecured notes are thinly traded and, in certain cases, the broker estimates were not based upon comparable transactions. The broker estimates took into account any recent trades within the same series of our fixed rate unsecured debt, comparisons to recent trades of other series of our fixed rate unsecured debt, trades of fixed rate unsecured debt from companies with profiles similar to ours, as well as overall economic conditions. We reviewed these broker estimates for reasonableness and accuracy, considering whether the estimates were based upon market participant assumptions within the principal and most advantageous market and whether any other observable inputs would be more accurate indicators of fair value than the broker estimates. We concluded that the broker estimates were representative of fair value. We have determined that our estimation of the fair value of our fixed rate unsecured debt was primarily based upon level 3 inputs. The estimated trading values of our fixed rate unsecured debt, depending on the maturity and coupon rates, ranged from 102.00% to 131.00% of face value.
In August 2019, we issued $175.0 million of senior unsecured notes bearing interest at a stated interest rate of 3.38% and maturing on December 15, 2027, at 104.16% of par value, resulting in an effective interest rate of 2.80%. Proceeds from the unsecured notes offering were primarily used to repay the borrowings under the unsecured line of credit. The notes were issued as additional notes under an indenture pursuant to which we previously issued $300.0 million senior unsecured notes due 2027 in December 2017. These notes have substantially identical terms.

17


The indentures (and related supplemental indentures) governing our outstanding series of unsecured notes also require us to comply with financial ratios and other covenants regarding our operations. We were in compliance with all such financial covenants at September 30, 2019.

Unsecured Line of Credit
Our unsecured line of credit at September 30, 2019 is described as follows (in thousands):
Description
Borrowing
Capacity
 
Maturity Date
 
Outstanding Balance at September 30, 2019
Unsecured Line of Credit - Partnership
$
1,200,000

 
January 30, 2022
 
$



The Partnership's unsecured line of credit has an interest rate on borrowings of LIBOR plus 0.875% and has a maturity date of January 30, 2022, with options to extend until January 30, 2023. Subject to certain conditions, the terms also include an option to increase the facility by up to an additional $800.0 million, for a total of up to $2.00 billion. This line of credit provides us with an option to obtain borrowings from financial institutions that participate in the line at rates that may be lower than the stated interest rate, subject to certain restrictions.
This line of credit contains financial covenants that require us to meet certain financial ratios and defined levels of performance, including those related to fixed charge coverage, unsecured interest expense coverage and debt-to-asset value (with asset value being defined in the Partnership's unsecured line of credit agreement). At September 30, 2019, we were in compliance with all financial covenants under this line of credit.
To the extent there are outstanding borrowings, we utilize a discounted cash flow methodology in order to estimate the fair value of outstanding borrowings on our unsecured line of credit. To the extent that credit spreads have changed since the origination of the line of credit, the net present value of the difference between future contractual interest payments and future interest payments based on our estimate of a current market rate would represent the difference between the book value and the fair value. This estimate of a current market rate is based upon the rate, considering current market conditions and our specific credit profile, at which we estimate we could obtain similar borrowings. As our credit spreads have not changed appreciably, we believe that the contractual interest rate and the current market rate on any outstanding borrowings on the line of credit are the same. The current market rate is internally estimated and therefore is primarily based upon a level 3 input.
      
8.    Shareholders' Equity of the General Partner and Partners' Capital of the Partnership
General Partner
The General Partner has an at the market ("ATM") equity program that allows it to issue and sell its common shares through sales agents from time to time. Actual sales under the ATM equity program depend on a variety of factors to be determined by the General Partner, including, among others, market conditions, the trading price of the General Partner’s common stock, determinations by the General Partner of the appropriate sources of funding and potential uses of funding available.
In August 2019, the General Partner terminated its previous equity distribution agreement for the ATM equity program and entered into a new equity distribution agreement to sell shares of its common stock, $0.01 par value per share, from time to time, up to an aggregate offering price of $400.0 million.
During the nine months ended September 30, 2019, the General Partner issued 6.6 million common shares pursuant to its ATM equity programs, generating gross proceeds of $218.1 million and, after deducting commissions and other costs, net proceeds of $215.6 million. The proceeds from these offerings were contributed to the Partnership and used to fund development activities.

18


Partnership
For each common share or preferred share that the General Partner issues, the Partnership issues a corresponding General Partner Unit or Preferred Unit, as applicable, to the General Partner in exchange for the contribution of the proceeds from the stock issuance. Similarly, when the General Partner redeems or repurchases common shares or preferred shares, the Partnership redeems the corresponding General Partner Units or Preferred Units held by the General Partner at the same price.
9.    Related Party Transactions
We provide property management, asset management, leasing, construction and other tenant-related services to unconsolidated joint ventures in which we have equity interests. We recorded the corresponding fees based on contractual terms that approximate market rates for these types of services and have eliminated our ownership percentage of these fees in the consolidated financial statements. The following table summarizes the fees earned from these joint ventures, prior to the elimination of our ownership percentage (in thousands): 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2019
 
2018
 
2019
 
2018
Management fees
$
452

 
$
462

 
$
1,318

 
$
1,359

Leasing fees
759

 
430

 
1,315

 
1,622

Construction and development fees
582

 
1,128

 
4,520

 
2,804


10.    Net Income per Common Share or Common Unit
Basic net income per common share or Common Unit is computed by dividing net income attributable to common shareholders or common unitholders, less dividends or distributions on share-based awards expected to vest (referred to as "participating securities" and primarily composed of unvested restricted stock units), by the weighted average number of common shares or Common Units outstanding for the period.

19


Diluted net income per common share is computed by dividing the sum of net income attributable to common shareholders and the noncontrolling interest in earnings allocable to Limited Partner Units (to the extent the Limited Partner Units are dilutive), less dividends or distributions on participating securities that are anti-dilutive, by the sum of the weighted average number of common shares outstanding and, to the extent they are dilutive, weighted average number of Limited Partner Units outstanding and any potential dilutive securities for the period. Diluted net income per Common Unit is computed by dividing the net income attributable to common unitholders, less dividends or distributions on participating securities that are anti-dilutive, by the sum of the weighted average number of Common Units outstanding and any potential dilutive securities for the period. The following table reconciles the components of basic and diluted net income per common share or Common Unit (in thousands): 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2019
 
2018
 
2019
 
2018
General Partner
 
 
 
 
 
 
 
Net income attributable to common shareholders
$
226,566

 
$
53,025

 
$
342,170

 
$
319,833

Less: dividends on participating securities
(350
)
 
(394
)
 
(1,125
)
 
(1,249
)
Basic net income attributable to common shareholders
$
226,216

 
$
52,631

 
$
341,045

 
$
318,584

Add back dividends on dilutive participating securities
350

 

 
1,125

 
1,249

Noncontrolling interest in earnings of common unitholders
1,968

 
495

 
2,971

 
3,002

Diluted net income attributable to common shareholders
$
228,534

 
$
53,126

 
$
345,141

 
$
322,835

Weighted average number of common shares outstanding
362,416

 
357,898

 
360,424

 
357,235

Weighted average Limited Partner Units outstanding
3,142

 
3,302

 
3,118

 
3,350

Other potential dilutive shares
1,713

 
210

 
1,801

 
2,160

Weighted average number of common shares and potential dilutive securities
367,271

 
361,410

 
365,343

 
362,745

 
 
 
 
 
 
 
 
Partnership
 
 
 
 
 
 
 
Net income attributable to common unitholders
$
228,534

 
$
53,520

 
$
345,141

 
$
322,835

Less: distributions on participating securities
(350
)
 
(394
)
 
(1,125
)
 
(1,249
)
Basic net income attributable to common unitholders
$
228,184

 
$
53,126

 
$
344,016

 
$
321,586

Add back distributions on dilutive participating securities
350

 

 
1,125

 
1,249

Diluted net income attributable to common unitholders
$
228,534

 
$
53,126

 
$
345,141

 
$
322,835

Weighted average number of Common Units outstanding
365,558

 
361,200

 
363,542

 
360,585

Other potential dilutive units
1,713

 
210

 
1,801

 
2,160

Weighted average number of Common Units and potential dilutive securities
367,271

 
361,410

 
365,343

 
362,745


The following table summarizes the data that is excluded from the computation of net income per common share or Common Unit as a result of being anti-dilutive (in thousands): 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2019
 
2018
 
2019
 
2018
General Partner and Partnership
 
 
 
 
 
 
 
Other potential dilutive shares or units:
 
 
 
 
 
 
 
Anti-dilutive outstanding potential shares or units under fixed stock option and other stock-based compensation plans

 

 

 

Anti-dilutive outstanding participating securities

 
2,147

 

 



20


11.    Segment Reporting
Reportable Segments
As of September 30, 2019, we had two reportable operating segments, the first consisting of the ownership and rental of industrial real estate investments. Our ongoing investments in new real estate investments are determined largely upon anticipated geographic trends in supply and demand for industrial buildings, as well as the real estate needs of our major tenants that operate on a national level. Our strategic initiatives and our allocation of resources have been historically based upon allocation among product types, which was consistent with our designation of reportable segments, and after having sold nearly all of our office and medical office properties we intend to increase our investment in industrial properties and treat them as a single operating and reportable segment. Properties not included in our reportable segments, because they are not industrial properties and do not by themselves meet the quantitative thresholds for separate presentation as a reportable segment, are generally referred to as non-reportable Rental Operations. Our non-reportable Rental Operations primarily include our remaining office properties and medical office property at September 30, 2019. The operations of our industrial properties, as well as our non-reportable Rental Operations, are collectively referred to as "Rental Operations."

Our second reportable segment consists of various real estate services such as property management, asset management, maintenance, leasing, development, general contracting and construction management to third-party property owners and joint ventures, and is collectively referred to as "Service Operations." The Service Operations segment is identified as one single operating segment because the lowest level of financial results reviewed by our chief operating decision maker are the results for the Service Operations segment in total. Further, our reportable segments are managed separately because each segment requires different operating strategies and management expertise.

Revenues by Reportable Segment

The following table shows the revenues for each of the reportable segments, as well as a reconciliation to consolidated revenues (in thousands): 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2019
 
2018
 
2019
 
2018
Revenues
 
 
 
 
 
 
 
Rental Operations:
 
 
 
 
 
 
 
Industrial
$
213,819

 
$
194,922

 
$
633,226

 
$
574,866

Non-reportable Rental Operations
1,471

 
1,481

 
4,401

 
6,300

Service Operations
25,955

 
34,986

 
104,838

 
94,552

Total segment revenues
241,245

 
231,389

 
742,465

 
675,718

Other revenue
84

 
509

 
819

 
1,295

Consolidated revenue from continuing operations
241,329

 
231,898

 
743,284

 
677,013

Discontinued operations

 
85

 

 
117

Consolidated revenue
$
241,329

 
$
231,983

 
$
743,284

 
$
677,130




21


Supplemental Performance Measure

Property-level net operating income on a cash basis ("PNOI") is the non-GAAP supplemental performance measure that we use to evaluate the performance of, and to allocate resources among, the real estate investments in the reportable and operating segments that comprise our Rental Operations. PNOI for our Rental Operations segments is comprised of rental revenues from continuing operations less rental expenses and real estate taxes from continuing operations, along with certain other adjusting items (collectively referred to as "Rental Operations revenues and expenses excluded from PNOI," as shown in the following table). Additionally, we do not allocate interest expense, depreciation expense and certain other non-property specific revenues and expenses (collectively referred to as "Non-Segment Items," as shown in the following table) to our individual operating segments.

We evaluate the performance of our Service Operations reportable segment using net income or loss, as allocated to that segment ("Earnings from Service Operations").

The most comparable GAAP measure to PNOI is income from continuing operations before income taxes. PNOI excludes expenses that materially impact our overall results of operations and, therefore, should not be considered as a substitute for income from continuing operations before income taxes or any other measures derived in accordance with GAAP. Furthermore, PNOI may not be comparable to other similarly titled measures of other companies.
The following table shows a reconciliation of our segment-level measures of profitability to consolidated income from continuing operations before income taxes (in thousands and excluding discontinued operations): 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2019
 
2018
 
2019
 
2018
PNOI
 
 
 
 
 
 
 
 
Industrial
 
$
151,906

 
$
136,456

 
$
446,446

 
$
391,645

Non-reportable Rental Operations
 
883

 
1,312

 
2,623

 
4,029

PNOI, excluding all sold properties
 
152,789

 
137,768

 
449,069

 
395,674

PNOI from sold properties included in continuing operations
 
3,119

 
5,546

 
12,774

 
24,668

PNOI, continuing operations
 
$
155,908

 
$
143,314

 
$
461,843

 
$
420,342

 
 
 
 
 
 
 
 
 
Earnings from Service Operations
 
2,315

 
1,256

 
5,423

 
5,160

 
 

 

 

 

Rental Operations revenues and expenses excluded from PNOI:
 
 
 
 
 
 
 
 
Straight-line rental income and expense, net
 
5,537

 
5,832

 
16,003

 
16,763

Revenues related to lease buyouts
 
1,089

 

 
1,108

 
23

Amortization of lease concessions and above and below market rents
 
1,741

 
593

 
4,545

 
1,599

Intercompany rents and other adjusting items
 
77

 
48

 
180

 
206

Non-Segment Items:
 
 
 
 
 
 
 
 
Equity in earnings of unconsolidated joint ventures
 
3,736

 
5,552

 
12,594

 
15,521

Interest expense
 
(22,604
)
 
(21,462
)
 
(68,246
)
 
(62,137
)
Depreciation and amortization expense
 
(83,924
)
 
(78,855
)
 
(242,920
)
 
(232,216
)
Gain on sale of properties
 
173,646

 
(107
)
 
204,075

 
194,741

Interest and other income, net
 
2,085

 
4,129

 
7,377

 
13,319

General and administrative expenses
 
(13,720
)
 
(8,959
)
 
(49,123
)
 
(43,441
)
Gain on land sales
 
3,869

 
3,915

 
6,569

 
7,221

Other operating expenses
 
(874
)
 
(1,104
)
 
(4,515
)
 
(3,902
)
Loss on extinguishment of debt
 

 
(89
)
 
(13
)
 
(240
)
Gain on involuntary conversion
 

 

 
2,259

 

Non-incremental costs related to successful leases
 
(1,123
)
 

 
(6,726
)
 

Other non-segment revenues and expenses, net
 
125

 
(1,658
)
 
788

 
(3,887
)
Income from continuing operations before income taxes
 
$
227,883

 
$
52,405

 
$
351,221

 
$
329,072



22


12.    Real Estate Assets, Discontinued Operations and Assets Held-for-Sale
Real Estate Assets
Real estate assets, excluding assets held-for-sale, consisted of the following (in thousands):
 
September 30, 2019
 
December 31, 2018
Buildings and tenant improvements
$
5,224,690

 
$
4,980,003

Land and improvements
2,466,953

 
2,268,343

Real estate assets
$
7,691,643

 
$
7,248,346


Discontinued Operations
The following table illustrates the number of sold or held-for-sale properties in this report, all of which were excluded from discontinued operations:
 
Held-for-Sale at September 30, 2019
 
Sold Year-to-Date in 2019
 
Sold in 2018
 
Total
 
 
 
 
 
 
 
 
 Properties sold or classified as held-for-sale
1
 
27
 
15
 
43

 
The following table illustrates the operational results of the buildings reflected in discontinued operations (in thousands):  
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2019
 
2018
 
2019
 
2018
Revenues
$

 
$
85

 
$

 
$
117

Operating expenses

 

 

 
(9
)
Operating income

 
85

 

 
108

Gain on sale of properties
112

 
136

 
366

 
3,157

Income from discontinued operations
$
112

 
$
221

 
$
366

 
$
3,265


The amounts classified in discontinued operations for the three and nine months ended September 30, 2019 and 2018 were comprised of true-up activity related to properties sold in previous years that were classified as discontinued operations.
Allocation of Noncontrolling Interests - General Partner
The following table illustrates the General Partner's share of the income attributable to common shareholders from continuing operations and discontinued operations, reduced by the allocation of income between continuing and discontinued operations to the noncontrolling interests (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2019
 
2018
 
2019
 
2018
Income from continuing operations attributable to common shareholders
$
226,455

 
$
52,806

 
$
341,807

 
$
316,598

Income from discontinued operations attributable to common shareholders
111

 
219

 
363

 
3,235

Net income attributable to common shareholders
$
226,566

 
$
53,025

 
$
342,170

 
$
319,833


Allocation of Noncontrolling Interests - Partnership
Substantially all of the income from discontinued operations for all periods presented in the Partnership's Consolidated Statements of Operations and Comprehensive Income is attributable to the common unitholders.

23


Assets Held-for-Sale
The following table illustrates aggregate balance sheet information for assets held-for-sale (in thousands):
 
Held-for-Sale Properties Included in Continuing Operations
 
September 30, 2019
 
December 31, 2018
Land and improvements
$
1,268

 
$

Buildings and tenant improvements
26,879

 

Undeveloped land

 
1,966

Accumulated depreciation
(7,931
)
 
(884
)
Deferred leasing and other costs, net
3,057

 

Other assets
466

 

Total assets held-for-sale
$
23,739

 
$
1,082

 
 
 
 
Accrued expenses
$
761

 
$

Other liabilities
1,754

 

Total liabilities related to assets held-for-sale
$
2,515

 
$


13.    Financial Instruments
We are exposed to capital market risk, such as changes in interest rates. In an effort to manage interest rate risk, we may enter into interest rate hedging arrangements from time to time. We do not utilize derivative financial instruments for trading or speculative purposes.

As of September 30, 2019 and December 31, 2018, the following forward-starting interest rate swaps designated as cash flow hedges (in thousands) were outstanding:
 
 
Asset (Liability) Fair Value
Notional Amount
 
September 30, 2019
 
December 31, 2018
$
125,000

 
$
(16,630
)
 
$
(2,914
)
75,000

 
(9,993
)
 
(1,762
)
75,000

 
(7,914
)
 

50,000

 
(5,283
)
 

25,000

 
(2,284
)
 

$
350,000

 
$
(42,104
)
 
$
(4,676
)


We entered into these interest rate swap contracts to hedge our exposure to the changes in the interest rates on the debt issuances, meeting certain criteria, which occur between August 1, 2019 and December 31, 2020.

We determined the fair values of these interest rate swaps by using standard market conventions and techniques such as discounted cash flow analysis, option pricing models and termination cost at each balance sheet date. The inputs used to value these interest rate swaps fall within level 2 of the fair value hierarchy. We have recorded the fair values of our interest rate swap contracts, which totaled $42.1 million and $4.7 million as of September 30, 2019 and December 31, 2018, respectively, as liabilities, included in Other Liabilities and Accumulated Other Comprehensive Loss on our Consolidated Balance Sheets.


24


14.    Subsequent Events
Declaration of Dividends/Distributions
The General Partner's board of directors declared the following dividends/distributions at its regularly scheduled board meeting held on October 30, 2019:
Class of stock/units
Quarterly Amount per Share or Unit
 
Record Date
 
Payment Date
Common - Quarterly
$0.235
 
November 14, 2019
 
November 29, 2019

Redemption of Unsecured Notes
On October 24, 2019, we redeemed $250.0 million of unsecured notes that were scheduled to mature in February 2021. We paid a prepayment premium of approximately $6.0 million in connection with the redemption of these notes.

25


Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations
The following Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to help the reader understand our operations and our present business environment. Management's Discussion and Analysis is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the notes thereto contained in Part I, Item 1 of this Report, and the consolidated financial statements and notes thereto contained in Part IV, Item 15 of our 2018 Annual Report.
Cautionary Notice Regarding Forward-Looking Statements
Certain statements contained in or incorporated by reference into this Report, including, without limitation, those related to our future operations, constitute "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. The words "believe," "estimate," "expect," "anticipate," "intend," "plan," "strategy," "continue," "seek," "may," "could" and similar expressions or statements regarding future periods are intended to identify forward-looking statements, although not all forward-looking statements may contain such words.
These forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause our actual results, performance or achievements, or industry results, to differ materially from any predictions of future results, performance or achievements that we express or imply in this Report or in the information incorporated by reference into this Report. Some of the risks, uncertainties and other important factors that may affect future results include, among others:
Changes in general economic and business conditions, including the financial condition of our tenants and the value of our real estate assets;
The General Partner's continued qualification as a REIT for U.S. federal income tax purposes;
Heightened competition for tenants and potential decreases in property occupancy;
Potential changes in the financial markets and interest rates;
Volatility in the General Partner's stock price and trading volume;
Our continuing ability to raise funds on favorable terms, or at all;
Our ability to successfully identify, acquire, develop and/or manage properties on terms that are favorable to us;
Potential increases in real estate construction costs;
Our ability to successfully dispose of properties on terms that are favorable to us;
Our ability to successfully integrate our acquired properties;
Our ability to retain our current credit ratings;
Inherent risks related to disruption of information technology networks and related systems, cyber security attacks and new system implementation;
Inherent risks in the real estate business, including, but not limited to, tenant defaults, potential liability relating to environmental matters and liquidity of real estate investments; and
Other risks and uncertainties described herein, as well as those risks and uncertainties discussed from time to time in our other reports and other public filings with the Securities and Exchange Commission (the "SEC").
Although we presently believe that the plans, expectations and anticipated results expressed in or suggested by the forward-looking statements contained in or incorporated by reference into this Report are reasonable, all forward-looking statements are inherently subjective, uncertain and subject to change, as they involve substantial risks and uncertainties, including those beyond our control. New factors emerge from time to time, and it is not possible for us to predict the nature, or assess the potential impact, of each new factor on our business. Given these uncertainties, we caution you not to place undue reliance on these forward-looking statements. We undertake no obligation to update or revise any of our forward-looking statements for events or circumstances that arise after the statement is made, except as otherwise may be required by law.


26


The above list of risks and uncertainties is only a summary of some of the most important factors and is not intended to be exhaustive. Additional information regarding risk factors that may affect us is included in our 2018 Annual Report. The risk factors contained in our Annual Report are updated by us from time to time in Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other filings that we make with the SEC. 
 
 
Business Overview
The General Partner and Partnership collectively specialize in the ownership, management and development of industrial real estate.
The General Partner is a self-administered and self-managed REIT that began operations in 1986 and is the sole general partner of the Partnership. The Partnership is a limited partnership formed in 1993, at which time all of the properties and related assets and liabilities of the General Partner, as well as proceeds from a secondary offering of the General Partner's common shares, were contributed to the Partnership. Simultaneously, the Partnership completed the acquisition of Duke Associates, a full-service commercial real estate firm operating in the Midwest whose operations began in 1972. We operate the General Partner and the Partnership as one enterprise, and therefore, our discussion and analysis refers to the General Partner and its consolidated subsidiaries, including the Partnership, collectively. A more complete description of our business, and of management's philosophy and priorities, is included in our 2018 Annual Report.
At September 30, 2019, we:
Owned or jointly controlled 516 primarily industrial properties, of which 497 properties with 148.0 million square feet were in service and 19 properties with 7.2 million square feet were under development. The 497 in-service properties were comprised of 457 consolidated properties with 135.3 million square feet and 40 unconsolidated joint venture properties with 12.7 million square feet. The 19 properties under development consisted of 18 consolidated properties with 7.1 million square feet and one unconsolidated joint venture property with 133,000 square feet.
Owned directly, or through ownership interests in unconsolidated joint ventures (with acreage not adjusted for our percentage ownership interest), approximately 1,500 acres of land and controlled approximately 1,000 acres through purchase options.
Our overall strategy is to continue to increase our investment in quality industrial properties primarily through development, on both a speculative and build-to-suit basis, supplemented with acquisitions in higher barrier markets with the highest growth potential.


27


Key Performance Indicators
Our operating results depend primarily upon rental income from our Rental Operations. The following discussion highlights the areas of Rental Operations that we consider to be critical drivers of future revenues.
Occupancy Analysis
Our ability to maintain high occupancy rates is a principal driver of maintaining and increasing rental revenue. The following table sets forth percent leased and average net effective rent information regarding our in-service portfolio of rental properties at September 30, 2019 and 2018, respectively:
 
Total Square Feet
(in thousands)
 
Percent of
Total Square Feet
 
Percent Leased*
 
Average Annual Net Effective Rent**
Type
2019
 
2018
 
2019
 
2018
 
2019
 
2018
 
2019
 
2018
Industrial
135,096

 
130,425

 
99.8
%
 
99.8
%
 
96.1
%
 
97.0
%
 
$4.90
 
$4.64
Non-reportable Rental Operations
211

 
309

 
0.2
%
 
0.2
%
 
77.3
%
 
55.0
%
 
$24.76
 
$24.16
Total Consolidated
135,307

 
130,734

 
100.0
%
 
100.0
%
 
96.0
%
 
96.9
%
 
$4.93
 
$4.67
Unconsolidated Joint Ventures
12,656

 
11,583

 
 
 
 
 
97.6
%
 
93.7
%
 
$4.10
 
$4.25
Total Including Unconsolidated Joint Ventures
147,963

 
142,317

 
 
 
 
 
96.2
%
 
96.6
%
 
 
 
 
 * Represents the percentage of total square feet leased based on executed leases and without regard to whether the leases have commenced.
**Average annual net effective rent represents average annual base rental payments per leased square foot, on a straight-line basis for the term of each lease, from space leased to tenants at the end of the most recent reporting period. This amount excludes additional amounts paid by tenants as reimbursement for operating expenses.
The lower leased percentage in our industrial portfolio at September 30, 2019, compared to September 30, 2018, resulted from new speculative developments being placed in service, partially offset by net absorption of previously vacant space.
Vacancy Activity
The following table sets forth vacancy activity, shown in square feet, from our in-service rental properties for the nine months ended September 30, 2019 (in thousands):
 
Consolidated Properties
 
Unconsolidated Joint Venture Properties
 
Total Including Unconsolidated Joint Venture Properties
Vacant square feet at December 31, 2018
4,847

 
591

 
5,438

  Acquisitions
162

 

 
162

  Vacant space in completed developments
2,508

 
645

 
3,153

  Dispositions
(573
)
 
(95
)
 
(668
)
  Expirations
3,512

 
93

 
3,605

  Early lease terminations
680

 
24

 
704

  Property structural changes/other
5

 

 
5

  Leasing of previously vacant space
(5,772
)
 
(955
)
 
(6,727
)
Vacant square feet at September 30, 2019
5,369

 
303

 
5,672


28


Total Leasing Activity
The initial leasing of development projects or vacant space in acquired properties is referred to as first generation lease activity. Our ability to maintain and improve occupancy rates and net effective rents primarily depends upon our continuing ability to re-lease expiring space. The leasing of such space that we have previously held under lease to a tenant is referred to as second generation lease activity. Second generation lease activity may be in the form of renewals of existing leases or new second generation leases of previously leased space. The total leasing activity for our consolidated and unconsolidated rental properties, expressed in square feet of leases signed, is as follows (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2019
 
2018
 
2019
 
2018
New Leasing Activity - First Generation Industrial
2,111

 
1,601

 
6,775
 
7,281

New Leasing Activity - Second Generation Industrial
984

 
556

 
1,841
 
3,879

Renewal Leasing Activity - Industrial
3,131

 
2,637

 
7,717
 
6,149

Non-reportable Rental Operations Leasing Activity
3

 

 
4
 
4

Total Consolidated Leasing Activity
6,229

 
4,794

 
16,337
 
17,313

Unconsolidated Joint Venture Leasing Activity
1,322

 
375

 
1,532
 
2,599

Total Including Unconsolidated Joint Venture Leasing Activity
7,551

 
5,169

 
17,869
 
19,912





















29


Second Generation Leases
The following table sets forth the estimated costs of tenant improvements and leasing commissions, on a per square foot basis, that we are obligated to fulfill under the second generation industrial leases signed for our rental properties during the three and nine months ended September 30, 2019 and 2018:
 
Square Feet of Leases
(in thousands)
 
Percent of Expiring Leases Renewed
 
Average Term in Years
 
Estimated Tenant Improvement Cost per Square Foot
 
Leasing Costs per Square Foot
 
2019
 
2018
 
2019
 
2018
 
2019
 
2018
 
2019
 
2018
 
2019
 
2018
Three Months
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated - New Second Generation
984

 
556

 
 
 
 
 
5.5

 
5.2
 
$2.21
 
$2.04
 
$2.10
 
$1.64
Unconsolidated Joint Ventures - New Second Generation
49

 
38

 
 
 
 
 
10.2

 
5.5
 
$3.49
 
$3.58
 
$4.57
 
$2.27
Total - New Second Generation
1,033

 
594

 
 
 
 
 
5.7

 
5.2
 
$2.27
 
$2.13
 
$2.22
 
$1.68
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated - Renewal
3,131

 
2,637

 
82.2
%
 
82.5
%
 
4.3

 
4.3
 
$0.46
 
$0.47
 
$1.14
 
$1.08
Unconsolidated Joint Ventures - Renewal
459

 
284

 
90.3
%
 
85.1
%
 
5.9

 
5.0
 
$0.95
 
$0.10
 
$2.29
 
$1.53
Total - Renewal
3,590

 
2,921

 
83.1
%
 
82.7
%
 
4.5

 
4.4
 
$0.52
 
$0.43
 
$1.29
 
$1.12
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated - New Second Generation
1,841

 
3,879

 
 
 
 
 
5.7

 
6.3
 
$2.75
 
$1.62
 
$2.22
 
$1.82
Unconsolidated Joint Ventures - New Second Generation
165

 
215

 
 
 
 
 
7.2

 
8.5
 
$1.82
 
$2.24
 
$2.75
 
$2.91
Total - New Second Generation
2,006

 
4,094

 
 
 
 
 
5.8

 
6.4
 
$2.67
 
$1.65
 
$2.26
 
$1.88
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated - Renewal
7,717

 
6,149

 
82.3
%
 
77.2
%
 
4.4

 
4.4
 
$0.71
 
$0.77
 
$1.30
 
$1.18
Unconsolidated Joint Ventures - Renewal
554

 
395

 
85.6
%
 
63.9
%
 
6.0

 
5.3
 
$0.92
 
$0.40
 
$2.32
 
$1.67
Total - Renewal
8,271

 
6,544

 
82.5
%
 
76.2
%
 
4.5

 
4.4
 
$0.72
 
$0.75
 
$1.37
 
$1.21
Growth in average annual net effective rents for new second generation and renewal leases, on a combined basis, for our consolidated and unconsolidated rental properties, is as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Ownership Type
2019
 
2018
 
2019
 
2018
Consolidated properties
22.5
%
 
27.4
%
 
25.0
%
 
25.0
%
Unconsolidated joint venture properties
44.9
%
 
33.8
%
 
38.2
%
 
33.8
%

30


Lease Expirations
The table below reflects our consolidated in-service portfolio lease expiration schedule at September 30, 2019 (in thousands, except percentage data and number of leases):
 
Total Consolidated Portfolio
 
Industrial
 
Non-reportable
Year of
Expiration
Square
Feet
 
Annual Rental
Revenue*
 
Number of Leases
 
Square
Feet
 
Annual Rental
Revenue*
 
Square
Feet
 
Annual Rental
Revenue*
Remainder of 2019
816

 
$
4,676

 
14
 
816

 
$
4,676

 

 
$

2020
9,929

 
46,552

 
122
 
9,923

 
46,478

 
6

 
74

2021
12,085

 
57,071

 
137
 
12,085

 
57,071

 

 

2022
19,158

 
80,475

 
145
 
19,141

 
80,283

 
17

 
192

2023
13,035

 
65,408

 
137
 
13,019

 
65,187

 
16

 
221

2024
14,795

 
74,772

 
137
 
14,790

 
74,710

 
5

 
62

2025
12,148

 
60,201

 
76
 
12,148

 
60,201

 

 

2026
9,791

 
45,773

 
48
 
9,791

 
45,773

 

 

2027
6,729

 
29,901

 
22
 
6,729

 
29,901

 

 

2028
7,750

 
50,779

 
27
 
7,631

 
47,292

 
119

 
3,487

2029 and Thereafter
23,701

 
125,112

 
66
 
23,701

 
125,112

 

 

Total Leased
129,937

 
$
640,720

 
931
 
129,774

 
$
636,684

 
163

 
$
4,036

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total Portfolio Square Feet
135,307

 
 
 
 
 
135,096

 
 
 
211

 
 
Percent Leased
96.0
%
 
 
 
 
 
96.1
%
 
 
 
77.3
%
 
 
* Annualized rental revenue represents average annual base rental payments, on a straight-line basis for the term of each lease, from space leased to tenants at the end of the most recent reporting period. Annualized rental revenue excludes additional amounts paid by tenants as reimbursement for operating expenses.
Building Acquisitions
Our decision process in determining whether or not to acquire a property or portfolio of properties involves several factors, including expected rent growth, multiple yield metrics, property locations and expected demographic growth in each location, current occupancy of the properties, tenant profile and remaining terms of the in-place leases in the properties. We pursue both brokered and non-brokered acquisitions, and it is difficult to predict which markets may present acquisition opportunities that align with our strategy. Because of the numerous factors considered in our acquisition decisions, we do not establish specific target yields for future acquisitions.
We acquired four buildings during the nine months ended September 30, 2019, and nine buildings during the year ended December 31, 2018. The following table summarizes the acquisition price, percent leased at time of acquisition and in-place yields, by product type, for these acquisitions (in thousands, except percentage data):
 
Year-to-Date 2019 Acquisitions
 
Full Year 2018 Acquisitions
Type
Acquisition Price*
 
In-Place Yield**
 
Percent Leased at Acquisition Date***
 
Acquisition Price*
 
In-Place Yield**
 
Percent Leased at Acquisition Date***
Industrial
$
149,361

 
3.9
%
 
82.7
%
 
$
352,617

 
4.2
%
 
100.0
%
 
 
 
 
 
 
 
 
 
 
 
 
* Includes fair value of real estate assets and net acquired lease-related intangible assets, including above or below market leases, but excludes other acquired working capital assets and liabilities.
** In-place yields of completed acquisitions are calculated as the current annualized net rental payments from space leased to tenants at the date of acquisition, divided by the acquisition price of the acquired real estate. Annualized net rental payments are comprised of base rental payments, excluding additional amounts payable by tenants as reimbursement for operating expenses, less current annualized operating expenses not recovered through tenant reimbursements.
*** Represents percentage of total square feet leased based on executed leases and without regard to whether the leases have commenced, at the date of acquisition.

31


Building Dispositions
We regularly work to identify, consider and pursue opportunities to dispose of properties on an opportunistic basis and on a basis that is generally consistent with our strategic plans.
We sold 27 consolidated buildings during the nine months ended September 30, 2019 and 15 consolidated buildings during the year ended December 31, 2018. The following table summarizes the sales prices, in-place yields and percent leased, by product type, of these buildings (in thousands, except percentage data):
 
Year-to-Date 2019 Dispositions
 
Full Year 2018 Dispositions
Type
Sales Price
 
In-Place Yield*
 
Percent Leased**
 
Sales Price
 
In-Place Yield*
 
Percent Leased**
Industrial
$
371,067

 
5.6
%
 
89.9
%
 
$
384,137

 
5.8
%
 
97.3
%
Non-reportable Rental Operations

 
%
 
%
 
121,077

 
4.2
%
 
80.1
%
Total
$
371,067

 
5.6
%
 
89.9
%
 
$
505,214

 
5.4
%
 
95.8
%
 
 
 
 
 
 
 
 
 
 
 
 
*   In-place yields of completed dispositions are calculated as annualized net operating income from space leased to tenants at the date of sale on a lease-up basis, including full rent from all executed leases, even if currently in a free rent period, divided by the sales price. Annualized net operating income is comprised of base rental payments, excluding reimbursement of operating expenses, less current annualized operating expenses not recovered through tenant reimbursements.
** Represents percentage of total square feet leased based on executed leases and without regard to whether the leases have commenced, at the date of sale.
Development
At September 30, 2019, we had 7.2 million square feet of property under development with total estimated costs upon completion of $933.8 million compared to 10.6 million square feet with total estimated costs upon completion of $893.1 million at September 30, 2018. The square footage and estimated costs include both consolidated properties and unconsolidated joint venture development activity at 100%.
The following table summarizes our properties under development at September 30, 2019 (in thousands, except percentage data): 
Ownership Type
Square
Feet
 
Percent
Leased
 
Total
Estimated
Project Costs
 
Total
Incurred
to Date
 
Amount
Remaining
to be Spent
Consolidated properties
7,023

 
45
%
 
$
925,607

 
$
448,789

 
$
476,818

Unconsolidated joint venture properties
133

 
100
%
 
8,181

 
348

 
7,833

Total
7,156

 
46
%
 
$
933,788

 
$
449,137

 
$
484,651


32


Results of Operations
A summary of our operating results and property statistics is as follows (in thousands, except number of properties and per share or Common Unit data):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2019
 
2018
 
2019
 
2018
Rental and related revenue from continuing operations
$
215,374

 
$
196,912

 
$
638,446

 
$
582,461

General contractor and service fee revenue
25,955

 
34,986

 
104,838

 
94,552

Operating income
248,402

 
69,827

 
409,844

 
378,130

General Partner
 
 
 
 
 
 
 
Net income attributable to common shareholders
$
226,566

 
$
53,025

 
$
342,170

 
$
319,833

Weighted average common shares outstanding
362,416

 
357,898

 
360,424

 
357,235

Weighted average common shares and potential dilutive securities
367,271

 
361,410

 
365,343

 
362,745

Partnership
 
 
 
 
 
 
 
Net income attributable to common unitholders
$
228,534

 
$
53,520

 
$
345,141

 
$
322,835

Weighted average Common Units outstanding
365,558

 
361,200

 
363,542

 
360,585

Weighted average Common Units and potential dilutive securities
367,271

 
361,410

 
365,343

 
362,745

General Partner and Partnership
 
 
 
 
 
 
 
Basic income per common share or Common Unit:
 
 
 
 
 
 
 
Continuing operations
$
0.62

 
$
0.15

 
$
0.95

 
$
0.88

Discontinued operations
$

 
$

 
$

 
$
0.01

Diluted income per common share or Common Unit:
 
 
 
 
 
 
 
Continuing operations
$
0.62

 
$
0.15

 
$
0.94

 
$
0.88

Discontinued operations
$

 
$

 
$

 
$
0.01

Number of in-service consolidated properties at end of period:
457

 
455

 
457

 
455

In-service consolidated square footage at end of period
135,307

 
130,734

 
135,307

 
130,734

Number of in-service unconsolidated joint venture properties at end of period
40

 
41

 
40

 
41

In-service unconsolidated joint venture square footage at end of period
12,656

 
11,583

 
12,656

 
11,583

Supplemental Performance Measures
In addition to net income computed in accordance with GAAP, we assess and measure the overall operating results of the General Partner and the Partnership using certain non-GAAP supplemental performance measures, which include (i) Funds From Operations ("FFO"), (ii) PNOI and (iii) Same-Property Net Operating Income - Cash Basis ("SPNOI").
These non-GAAP metrics are commonly used by industry analysts and investors as supplemental operating performance measures of REITs and are viewed by management to be useful indicators of operating performance. Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen or fallen with market conditions, many industry analysts and investors have considered presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves. Management believes that the use of FFO, PNOI and SPNOI, combined with net income (which remains the primary measure of performance), improves the understanding of operating results of REITs among the investing public and makes comparisons of REIT operating results more meaningful.
The most comparable GAAP measure to FFO is net income (loss) attributable to common shareholders or common unitholders, while the most comparable GAAP measure to PNOI and SPNOI is income (loss) from continuing operations before income taxes.

33


FFO, PNOI and SPNOI each exclude expenses that materially impact our overall results of operations and, therefore, should not be considered as a substitute for net income (loss) attributable to common shareholders or common unitholders, income (loss) from continuing operations before income taxes, or any other measures derived in accordance with GAAP. Furthermore, these metrics may not be comparable to other similarly titled measures of other companies.
Funds From Operations
The National Association of Real Estate Investment Trusts ("NAREIT") created FFO as a non-GAAP supplemental measure of REIT operating performance. FFO, as defined by NAREIT, represents GAAP net income (loss), excluding gains or losses from sales of real estate assets (including real estate assets incidental to our business) and related taxes, gains and losses from change in control, impairment charges related to real estate assets (including real estate assets incidental to our business) plus certain non-cash items such as real estate asset depreciation and amortization, and after similar adjustments for unconsolidated partnerships and joint ventures. We calculate FFO in accordance with the definition that was adopted by the Board of Governors of NAREIT.
Management believes that the use of FFO as a performance measure enables investors and analysts to readily identify the operating results of the long-term assets that form the core of a REIT's activity and assists them in comparing these operating results between periods or between different companies that use the NAREIT definition of FFO.
The following table shows a reconciliation of net income attributable to common shareholders or common unitholders to the calculation of FFO attributable to common shareholders or common unitholders (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2019
 
2018
 
2019
 
2018
Net income attributable to common shareholders of the General Partner
$
226,566

 
$
53,025

 
$
342,170

 
$
319,833

Add back: Net income attributable to noncontrolling interests - common limited partnership interests in the Partnership
1,968

 
495

 
2,971

 
3,002

Net income attributable to common unitholders of the Partnership
228,534

 
53,520

 
345,141

 
322,835

Adjustments:
 
 
 
 
 
 
 
Depreciation and amortization
83,924

 
78,855

 
242,920

 
232,216

Company share of unconsolidated joint venture depreciation, amortization and other adjustments
2,858

 
2,367

 
7,628

 
6,647

Gain on sale of properties
(173,758
)
 
(29
)
 
(204,441
)
 
(197,898
)
Gain on land sales
(3,869
)
 
(3,915
)
 
(6,569
)
 
(7,221
)
Income tax (benefit) expense triggered by sales of real estate assets
(536
)
 
(897
)
 
6,465

 
9,495

Gains on sales of real estate assets - share of unconsolidated joint ventures
(332
)
 
(2,008
)
 
(4,859
)
 
(8,186
)
FFO attributable to common unitholders of the Partnership
$
136,821

 
$
127,893

 
$
386,285

 
$
357,888

Additional General Partner Adjustments:
 
 
 
 
 
 
 
Net income attributable to noncontrolling interests - common limited partnership interests in the Partnership
(1,968
)
 
(495
)
 
(2,971
)
 
(3,002
)
        Noncontrolling interest share of adjustments
788

 
(680
)
 
(353
)
 
(326
)
FFO attributable to common shareholders of the General Partner
$
135,641

 
$
126,718

 
$
382,961

 
$
354,560

Property-Level Net Operating Income - Cash Basis
PNOI is comprised of rental revenues from continuing operations less rental expenses and real estate taxes from continuing operations, along with certain other adjusting items. As a performance metric that consists of only the cash-based revenues and expenses directly related to ongoing real estate rental operations, PNOI is narrower in scope than NAREIT FFO.

34


PNOI, as we calculate it, may not be directly comparable to similarly titled, but differently calculated, measures for other REITs. We believe that PNOI is another useful supplemental performance measure, as it is an input in many REIT valuation models and it provides a means by which to evaluate the performance of the properties within our Rental Operations segments. The operations of our industrial properties, as well as our non-reportable Rental Operations (our residual non-industrial properties that have not yet been sold, referred to throughout as "non-reportable"), are collectively referred to as "Rental Operations."
The major factors influencing PNOI are occupancy levels, acquisitions and sales, development properties that achieve stabilized operations, rental rate increases or decreases, and the recoverability of operating expenses.
Note 11 to the consolidated financial statements included in Part I, Item 1 of this Report shows a calculation of our PNOI for the three and nine months ended September 30, 2019 and 2018 and provides a reconciliation of PNOI for our Rental Operations segments to income from continuing operations before income taxes.
Same Property Net Operating Income - Cash Basis
We also evaluate the performance of our properties, including our share of properties we jointly control, on a "same property" basis, using a metric referred to as SPNOI. We view SPNOI as a useful supplemental performance measure because it improves comparability between periods by eliminating the effects of changes in the composition of our portfolio.
On an individual property basis, SPNOI is generally computed in a consistent manner as PNOI.
Effective January 1, 2018, we define our "same property" population once a year at the beginning of the current calendar year and include buildings that were stabilized (the term "stabilized" means properties that have reached 90% leased or that have been in-service for at least one year since development completion or acquisition) as of January 1 of the prior calendar year. The "same property" pool is also adjusted to remove properties that were sold subsequent to the beginning of the current calendar year. As such, the "same property" population for the period ended September 30, 2019 includes all properties that we owned or jointly controlled at January 1, 2019, which had both been owned or jointly controlled and had reached stabilization by January 1, 2018, and have not been sold.
A reconciliation of income from continuing operations before income taxes to SPNOI is presented as follows (in thousands, except percentage data):
 
Three Months Ended September 30,
Percent
 
Nine Months Ended September 30,
Percent
 
2019
 
2018
Change
 
2019
 
2018
Change
Income from continuing operations before income taxes
$
227,883

 
$
52,405


 
$
351,221

 
$
329,072

 
  Share of SPNOI from unconsolidated joint ventures
4,277

 
4,063

 
 
12,696

 
12,014

 
  PNOI excluded from the "same property" population
(25,717
)
 
(14,074
)
 
 
(69,386
)
 
(33,762
)
 
  Earnings from Service Operations
(2,315
)
 
(1,256
)
 
 
(5,423
)
 
(5,160
)
 
  Rental Operations revenues and expenses excluded from PNOI
(11,563
)
 
(12,019
)
 
 
(34,610
)
 
(43,259
)
 
  Non-Segment Items
(61,216
)
 
98,638

 
 
137,881

 
115,021

 
SPNOI
$
131,349

 
$
127,757

2.8
%
 
$
392,379

 
$
373,926

4.9
%
The composition of the line items titled "Rental Operations revenues and expenses excluded from PNOI" and "Non-Segment Items" from the table above are shown in greater detail in Note 11 to the consolidated financial statements included in Part I, Item 1 of this Report.


35


We believe that the factors that impact SPNOI are generally the same as those that impact PNOI. The following table details the number of properties, square feet, average commencement occupancy and average cash rental rates for the properties included in SPNOI for the respective periods:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2019
 
2018
 
2019
 
2018
Number of properties
424
 
424
 
424
 
424
Square feet (in thousands) (1)
115,893
 
115,893
 
115,893
 
115,893
Average commencement occupancy percentage (2)
98.3%
 
98.9%
 
98.6%
 
98.3%
Average rental rate - cash basis (3)
$4.56
 
$4.42
 
$4.53
 
$4.40
(1) Includes the total square feet of the consolidated properties that are in the "same property" population as well as 4.5 million square feet of space for unconsolidated joint ventures, which represents our ratable share of the 9.1 million total square feet of space for buildings owned by unconsolidated joint ventures that are in the "same property" population.
(2) Commencement occupancy represents the percentage of total square feet where the leases have commenced.
(3) Represents the average annualized contractual rent per square foot for tenants in occupancy in properties in the "same property" population. Cash rent does not include the tenant's obligation to pay property operating expenses and real estate taxes. If a tenant was within a free rent period, its rent would equal zero for purposes of this metric.
Comparison of Three Months Ended September 30, 2019 to Three Months Ended September 30, 2018
Rental and Related Revenue
The following table sets forth rental and related revenue from continuing and discontinued operations (in thousands): 
 
Three Months Ended September 30,
 
2019
 
2018
Rental and related revenue:
 
 
 
Industrial
$
213,819

 
$
194,922

Non-reportable Rental Operations and non-segment revenues
1,555

 
1,990

Total rental and related revenue from continuing operations
$
215,374

 
$
196,912

Rental and related revenue from discontinued operations

 
85

Total rental and related revenue from continuing and discontinued operations
$
215,374

 
$
196,997

The primary reasons for the increase in rental and related revenue from continuing operations were:
We acquired 13 properties and placed 35 developments in service from January 1, 2018 to September 30, 2019, which provided incremental revenues from continuing operations of $16.7 million during the three months ended September 30, 2019, as compared to the same period in 2018.
Increases in rental rates within our "same property" portfolio, as well as the lease up of properties that were placed in service prior to January 1, 2018 but were not in the "same property" portfolio, also contributed to the increase to rental and related revenue from continuing operations.
The sale of 42 in-service properties since January 1, 2018, which did not meet the criteria to be classified within discontinued operations, resulted in a decrease of $2.7 million to rental and related revenue from continuing operations in the three months ended September 30, 2019, as compared to the same period in 2018, which partially offset the aforementioned increases to rental and related revenue from continuing operations.

36


Rental Expenses and Real Estate Taxes
The following table sets forth rental expenses and real estate taxes from continuing operations (in thousands):
 
Three Months Ended September 30,
 
2019
 
2018
Rental expenses:
 
 
 
Industrial
$
18,928

 
$
15,692

Non-reportable Rental Operations and non-segment expenses
230

 
1,576

Total rental expenses from continuing operations
$
19,158

 
$
17,268

Real estate taxes:
 
 
 
Industrial
$
31,503

 
$
30,681

Non-reportable Rental Operations and non-segment expenses
236

 
834

Total real estate tax expense from continuing operations
$
31,739

 
$
31,515


Rental expenses from continuing operations increased by $1.9 million during the three months ended September 30, 2019, compared to the same period in 2018. The increase to rental expenses was primarily the result of acquisitions and developments placed in service from January 1, 2018 to September 30, 2019, partially offset by the impact of property sales that did not meet the criteria to be classified within discontinued operations.

Real estate tax expense from continuing operations increased by $224,000 during the three months ended September 30, 2019, compared to the same period in 2018. The increase to real estate tax expense was mainly the result of acquisitions and developments placed in service from January 1, 2018 to September 30, 2019, partially offset by the impact of the adoption of ASC 842, for certain tenants that pay real estate taxes directly to taxing authorities, and the impact of property sales that did not meet the criteria to be classified within discontinued operations.

Depreciation and Amortization
Depreciation and amortization expense from continuing operations was $83.9 million and $78.9 million for the three months ended September 30, 2019 and 2018, respectively. The increase in depreciation and amortization expense for the three months ended September 30, 2019 was mainly the result of continued growth in our portfolio through development and acquisition.
Gain on Sale of Properties - Continuing Operations
The $173.6 million recognized as gain on sale of properties in continuing operations for the three months ended September 30, 2019 was primarily the result of the sale of 26 properties that did not meet the criteria for inclusion in discontinued operations.
There were no sales of consolidated properties during the three months ended September 30, 2018.
Non-Incremental Costs Related to Successful Leases
As the result of adoption of the new lease standard on January 1, 2019 (see Note 2 to the consolidated financial statements included in Part I, Item 1 of this Report), $1.1 million of non-incremental costs related to successful leases were expensed for the three months ended September 30, 2019. As we have adopted the standard on a prospective basis, there was no adjustment to non-incremental costs previously capitalized for the three months ended September 30, 2018.

37


General and Administrative Expenses
General and administrative expenses consist of two components. The first component includes general corporate expenses, and the second component represents the indirect operating costs not allocated to, or absorbed by, either the development, leasing and operation of our consolidated properties or our Service Operations. Such indirect operating costs are primarily comprised of employee compensation, including related costs such as benefits and wage-related taxes, but also include other ancillary costs such as travel and information technology support. Total indirect operating costs, prior to any allocation or absorption, and general corporate expenses are collectively referred to as our overall pool of overhead costs.
Those indirect costs not allocated to or absorbed by these operations are charged to general and administrative expenses. We regularly review our total overhead cost structure relative to our leasing, development and construction volume and adjust the level of total overhead, generally through changes in our level of staffing in various functional departments, as necessary, in order to control overall general and administrative expense.
General and administrative expenses were $13.7 million and $9.0 million for the three months ended September 30, 2019 and 2018, respectively. The following table sets forth the factors that led to the increased general and administrative expenses (in millions):
General and administrative expenses - three months ended September 30, 2018
$
9.0

  Decrease to overall pool of overhead costs
(0.8
)
  Decreased absorption of costs by consolidated leasing and development activities (1)
5.8

  Increased allocation of costs to Service Operations and Rental Operations
(0.3
)
General and administrative expenses - three months ended September 30, 2019
$
13.7

(1) We capitalized $900,000 and $5.8 million of our total overhead costs to leasing and development, respectively, for consolidated properties during the three months ended September 30, 2019, compared to capitalizing $1.8 million and $11.9 million of such costs, respectively, for the three months ended September 30, 2018. Combined overhead costs capitalized to leasing and development totaled 22.5% and 44.8% of our overall pool of overhead costs for the three months ended September 30, 2019 and 2018, respectively. The decrease in overhead costs capitalized to leasing was primarily due to $1.1 million of previously capitalizable internal costs that were immediately expensed due to the adoption of ASC 842 (see Note 2 to the consolidated financial statements included in Part I, Item 1 of this Report) and presented separately in the line item "Non-Incremental Costs Related to Successful Leases" on the Consolidated Statements of Operations.

Interest Expense
Interest expense allocable to continuing operations was $22.6 million and $21.5 million for the three months ended September 30, 2019 and 2018, respectively. The increase in interest expense from continuing operations for the three months ended September 30, 2019 was primarily due to increased overall borrowings, partially offset by lower average interest rates.
We capitalized $6.2 million and $6.5 million of interest costs for the three months ended September 30, 2019 and 2018, respectively.
Discontinued Operations
The property-specific components of earnings that are classified as discontinued operations include rental revenues, rental expenses, real estate taxes, allocated interest expense and depreciation expense, as well as the net gain or loss on the disposition of the properties.
We had no buildings classified as discontinued operations for the three months ended September 30, 2019 and 2018. The amounts classified in discontinued operations for the three months ended September 30, 2019 and 2018 were comprised of true-up activity related to properties sold in previous years that were classified as discontinued operations. 

38


Comparison of Nine Months Ended September 30, 2019 to Nine Months Ended September 30, 2018
Rental and Related Revenue
The following table sets forth rental and related revenue from continuing and discontinued operations (in thousands): 
 
Nine Months Ended September 30,
 
2019
 
2018
Rental and related revenue:
 
 
 
Industrial
$
633,226

 
$
574,866

Non-reportable Rental Operations and non-segment revenues
5,220

 
7,595

Total rental and related revenue from continuing operations
$
638,446

 
$
582,461

Rental and related revenue from discontinued operations

 
117

Total rental and related revenue from continuing and discontinued operations
$
638,446

 
$
582,578

The following factors contributed to the increase in rental and related revenue from continuing operations:

We acquired 13 properties and placed 35 developments in service from January 1, 2018 to September 30, 2019, which provided incremental revenues from continuing operations of $49.7 million in the nine months ended September 30, 2019, as compared to the same period in 2018.

Increased occupancy and rental rates within our "same property" portfolio, as well as the lease up of properties that were placed in service prior to January 1, 2018 but were not in the "same property" portfolio, also contributed to the increase to rental and related revenue from continuing operations. Average commencement occupancy and rental rates in our "same property" portfolio both increased from the nine months ended September 30, 2018.

The sale of 42 in-service properties, since January 1, 2018, which did not meet the criteria for inclusion within discontinued operations, resulted in a decrease of $13.5 million to rental and related revenue from continuing operations in the nine months ended September 30, 2019, as compared to the same period in 2018, which partially offset the aforementioned increases to rental and related revenue from continuing operations.


39


Rental Expenses and Real Estate Taxes
The following table sets forth rental expenses and real estate taxes from continuing and discontinued operations (in thousands):
 
Nine Months Ended September 30,
 
2019
 
2018
Rental expenses:
 
 
 
Industrial
$
56,339

 
$
49,675

Non-reportable Rental Operations and non-segment expenses
1,084

 
3,883

Total rental expenses from continuing operations
$
57,423

 
$
53,558

Rental expenses from discontinued operations

 
(8
)
Total rental expenses from continuing and discontinued operations
$
57,423

 
$
53,550

Real estate taxes:
 
 
 
Industrial
$
96,031

 
$
91,720

Non-reportable Rental Operations and non-segment expenses
525

 
2,137

Total real estate tax expense from continuing operations
$
96,556

 
$
93,857

Real estate tax expense from discontinued operations

 
17

Total real estate tax expense from continuing and discontinued operations
$
96,556

 
$
93,874

Overall, rental expenses from continuing operations increased by $3.9 million in the nine months ended September 30, 2019, compared to the same period in 2018. The increase to rental expenses from continuing operations was primarily the result of acquisitions and developments placed in service from January 1, 2018 to September 30, 2019, partially offset by the impact of property sales that did not meet the criteria to be classified within discontinued operations.
Overall, real estate tax expense from continuing operations increased by $2.7 million in the nine months ended September 30, 2019, compared to the same period in 2018. The increase to real estate tax expense was mainly the result of acquisitions and developments placed in service from January 1, 2018 to September 30, 2019 and increased real estate taxes levied by the related taxing authority. The increases were partially offset by the impact of the adoption of ASC 842, for certain tenants that pay real estate taxes directly to taxing authorities, and the impact of property sales that did not meet the criteria to be classified within discontinued operations.
Depreciation and Amortization
Depreciation and amortization expense was $242.9 million and $232.2 million for the nine months ended September 30, 2019 and 2018, respectively. The increase in depreciation and amortization expense for the nine months ended September 30, 2019 was mainly the result of continued growth in our portfolio through development and acquisition.
Equity in Earnings of Unconsolidated Joint Ventures
Equity in earnings of unconsolidated joint ventures represents our ownership share of net income from investments in unconsolidated joint ventures that generally own and operate rental properties. Equity in earnings from unconsolidated joint ventures was $12.6 million and $15.5 million for the nine months ended September 30, 2019 and 2018, respectively. The decrease in equity in earnings from unconsolidated joint ventures for the nine months ended September 30, 2019 was primarily due to the timing of property dispositions within certain of our unconsolidated joint ventures.

Gain on Sale of Properties - Continuing Operations
The $204.1 million recognized as gain on sale of properties in continuing operations for the nine months ended September 30, 2019 was primarily the result of the sale of 27 properties that did not meet the criteria for inclusion in discontinued operations.

40


The $194.7 million recognized as gain on sale of properties in continuing operations for the nine months ended September 30, 2018 was primarily comprised of the gains from the sale of 13 properties that did not meet the criteria for inclusion in discontinued operations.
Non-Incremental Costs Related to Successful Leases
As the result of adoption of the new lease standard on January 1, 2019 (see Note 2 to the consolidated financial statements included in Part I, Item 1 of this Report), $6.7 million of non-incremental costs related to successful leases were expensed for the nine months ended September 30, 2019. As we have adopted the standard on a prospective basis, there was no adjustment to non-incremental costs previously capitalized for the nine months ended September 30, 2018.
General and Administrative Expense
General and administrative expenses were $49.1 million and $43.4 million for the nine months ended September 30, 2019 and 2018, respectively. The following table sets forth the factors that led to the increased general and administrative expenses (in millions):
General and administrative expenses - nine months ended September 30, 2018
$
43.4

Decrease to overall pool of overhead costs
(5.3
)
Decreased absorption of costs by consolidated leasing and development activities (1)
11.1

Increased allocation of costs to Service Operations and Rental Operations
(0.1
)
General and administrative expenses - nine months ended September 30, 2019
$
49.1

(1) We capitalized $4.1 million and $16.8 million of our total overhead costs to leasing and development, respectively, for consolidated properties during the nine months ended September 30, 2019, compared to capitalizing $14.9 million and $23.9 million of such costs, respectively, for the nine months ended September 30, 2018. Combined overhead costs capitalized to leasing and development totaled 29.0% and 36.2% of our overall pool of overhead costs for the nine months ended September 30, 2019 and 2018, respectively. The decrease in overhead costs capitalized to leasing was primarily due to lower leasing activity as well as $6.7 million of previously capitalizable internal costs that were immediately expensed due to the adoption of ASC 842 (see Note 2 to the consolidated financial statements included in Part I, Item 1 of this Report) and presented separately in the line item "Non-Incremental Costs Related to Successful Leases" on the Consolidated Statements of Operations.
Interest Expense
Interest expense allocable to continuing operations was $68.2 million and $62.1 million for the nine months ended September 30, 2019 and 2018, respectively. The increase in interest expense from continuing operations for the nine months ended September 30, 2019 was primarily due to increased overall borrowings, partially offset by lower average interest rates.
We capitalized $19.1 million and $21.8 million of interest costs during the nine months ended September 30, 2019 and 2018, respectively.
Discontinued Operations
We had no buildings classified as discontinued operations for the nine months ended September 30, 2019 and 2018. The amounts classified in discontinued operations for the nine months ended September 30, 2019 and 2018 were comprised of true-up activity related to properties sold in previous years that were classified as discontinued operations. 

41


Liquidity and Capital Resources

Sources of Liquidity
We expect to meet our short-term liquidity requirements over the next 12 months including payments of dividends and distributions and the capital expenditures needed to maintain our current real estate assets, primarily through working capital and net cash provided by operating activities. We had no outstanding borrowings on the Partnership's $1.20 billion unsecured line of credit, had $121.2 million of cash on hand and held $119.2 million of restricted cash for future like kind exchange transactions at September 30, 2019.

In addition to our existing sources of liquidity, we expect to meet long-term liquidity requirements, such as scheduled mortgage and unsecured debt maturities, property acquisitions, financing of development activities and other capital improvements, through multiple sources of capital including operating cash flow, proceeds from property dispositions and accessing the public debt and equity markets. At September 30, 2019, we also held $110.0 million of notes receivable from the various entities that purchased our medical office properties in 2017, as part of the Medical Office Portfolio Disposition, which are scheduled to mature in January 2020.

Rental Operations

Cash flows from Rental Operations is our primary source of liquidity and provides a stable source of cash flow to fund operational expenses. We believe that this cash-based revenue stream is substantially aligned with revenue recognition (except for items such as periodic straight-line rental income accruals and amortization of above or below market rents) as cash receipts from the leasing of rental properties are generally received in advance of, or a short time following, the actual revenue recognition.

We are subject to a number of risks related to general economic conditions, including reduced occupancy, tenant defaults and bankruptcies and potential reduction in rental rates upon renewal or re-letting of properties, any of which would result in reduced cash flow from operations.

Unsecured Debt and Equity Securities

We use the Partnership's unsecured line of credit (which is guaranteed by the General Partner) as a temporary source of capital to fund development activities, acquire additional rental properties and provide working capital.

In August 2019, we issued $175.0 million of senior unsecured notes, which bear interest at a stated interest rate of 3.38%, have an effective interest rate of 2.80%, and mature on December 15, 2027, for gross proceeds of $182.3 million.

The Partnership has issued debt securities pursuant to certain indentures and related supplemental indentures, which also require us to comply with financial ratios and other covenants regarding our operations. We were in compliance with all such covenants, as well as applicable covenants under our unsecured line of credit, at September 30, 2019.

In 2017, the Alternative Reference Rates Committee ("ARRC") proposed that the Secured Overnight Funding Rate ("SOFR") replace LIBOR. Also ARRC proposed that the transition to SOFR from LIBOR take place by the end of 2021. As the Partnership's unsecured line of credit agreement has provisions that allow for automatic transition to a new rate, the Partnership has no other material debt arrangements that are indexed to LIBOR, and all of our outstanding interest rate swaps will have matured by end of 2019, we believe that the transition will not have a material impact on our consolidated financial statements.


42


At September 30, 2019, we had on file with the SEC an automatic shelf registration statement on Form S-3 relating to the offer and sale, from time to time, of an indeterminate amount of debt and equity securities (including guarantees of the Partnership's debt securities by the General Partner). Equity securities are offered and sold by the General Partner, and the net proceeds of such offerings are contributed to the Partnership in exchange for additional General Partner Units or Preferred Units. From time to time, we expect to issue additional securities under this automatic shelf registration statement to fund the repayment of long-term debt upon maturity and for other general corporate purposes.

On August 1, 2019, the General Partner and the Partnership terminated the equity distribution agreement for the ATM equity program with an aggregate offering price of up to $200.0 million. On August 2, 2019, the General Partner and the Partnership entered into a new equity distribution agreement to sell shares of the General Partner’s common stock, $0.01 par value per share, from time to time, up to an aggregate offering price of $400.0 million. During the nine months ended September 30, 2019, the General Partner issued 1.8 million common shares pursuant to its previous ATM equity program, resulting in net proceeds of $56.3 million after paying total compensation of $568,000 to the applicable sales agents. During the nine months ended September 30, 2019, the General Partner also issued 4.8 million shares pursuant to its current ATM equity program, resulting in net proceeds of $159.6 million after paying total compensation of $1.6 million to the applicable sales agents. Other fees related to these issuances, totaling $283,000, were also paid during the nine months ended September 30, 2019. These issuances resulted in net proceeds of $215.6 million under both ATM programs during the nine months ended September 30, 2019.

Sale of Real Estate Assets
We regularly work to identify, consider and pursue opportunities to dispose of non-strategic properties on an opportunistic basis and on a basis that is generally consistent with our strategic plans. Our ability to dispose of such properties on favorable terms, or at all, is dependent upon a number of factors including the availability of credit to potential buyers to purchase properties at prices that we consider acceptable. Although we believe that we have demonstrated our ability to generate significant liquidity through the disposition of non-strategic properties, potential future adverse changes to general market and economic conditions could negatively impact our further ability to dispose of such properties.
Sales of land and depreciable properties provided $379.8 million and $434.6 million in net proceeds during the nine months ended September 30, 2019 and 2018, respectively.
Transactions with Unconsolidated Joint Ventures
Transactions with unconsolidated joint ventures also provide a source of liquidity. From time to time we will sell properties to unconsolidated joint ventures, while retaining a continuing interest in that entity, and receive proceeds commensurate to those interests that we do not own. Additionally, unconsolidated joint ventures will from time to time obtain debt financing or sell properties and will then distribute to us, and our joint venture partners, all or a portion of the proceeds from such transactions. During the nine months ended September 30, 2019 and 2018, our share of sale and capital distributions from unconsolidated joint ventures totaled $2.7 million and $19.2 million, respectively.
Uses of Liquidity
Our principal uses of liquidity include the following:
property investment;
leasing/capital costs;
dividends and distributions to shareholders and unitholders;
long-term debt maturities;
opportunistic repurchases of outstanding debt; and
other contractual obligations.

43


Property Investment
Our overall strategy is to continue to increase our investment in quality industrial properties, primarily through development, on both a speculative and build-to-suit basis, supplemented with acquisitions in higher barrier markets with the highest growth potential. Pursuant to this strategy, we evaluate development and acquisition opportunities based upon our market outlook, including general economic conditions, supply and long-term growth potential. Our ability to make future property investments is dependent upon identifying suitable acquisition and development opportunities, and our continued access to our longer-term sources of liquidity, including issuances of debt or equity securities as well as generating cash flow by disposing of selected properties.
  
Leasing/Capital Costs
Tenant improvements and lease-related costs pertaining to our initial leasing of newly completed space, or vacant space in acquired properties, are referred to as first generation expenditures. Such first generation expenditures for tenant improvements are included within "development of real estate investments" in our Consolidated Statements of Cash Flows, while such expenditures for capitalizable lease-related costs are included within "other deferred leasing costs."
Cash expenditures related to the construction of a building's shell, as well as the associated site improvements, are also included within "development of real estate investments" in our Consolidated Statements of Cash Flows.
Tenant improvements and leasing costs to renew or re-let rental space that we previously leased to tenants for new second generation leases are referred to as second generation expenditures. Building improvements that are not specific to any tenant but serve to improve integral components of our real estate properties are also second generation expenditures. One of the principal uses of our liquidity is to fund the second generation leasing/capital expenditures of our real estate investments.
The following table summarizes our second generation capital expenditures by type of expenditure, as well as capital expenditures for the development of real estate investments and for other deferred leasing costs (in thousands):
 
Nine Months Ended September 30,
 
2019
 
2018
Second generation tenant improvements
$
9,837

 
$
13,213

Second generation leasing costs
15,478

 
18,411

Building improvements
6,329

 
2,687

Total second generation capital expenditures
$
31,644

 
$
34,311

Development of real estate investments
$
325,825

 
$
459,513

Other deferred leasing costs
$
28,551

 
$
27,691

The capital expenditures in the table above include the capitalization of internal overhead costs. We capitalized $4.1 million and $14.9 million of overhead costs related to leasing activities, including both first and second generation leases, during the nine months ended September 30, 2019 and 2018, respectively. We capitalized $16.8 million and $23.9 million of overhead costs related to development activities, including both development and tenant improvement projects on first and second generation space, during the nine months ended September 30, 2019 and 2018, respectively. Combined overhead costs capitalized to leasing and development totaled 29.0% and 36.2% of our overall pool of overhead costs for the nine months ended September 30, 2019 and 2018, respectively. The decrease in the overhead costs capitalized to leasing for the nine months ended September 30, 2019 was primarily due to lower leasing activity and the expense impact of internal costs related to successful leasing which was not capitalizable as a result of the adoption of the new lease standard on January 1, 2019 (see Note 2 to the consolidated financial statements included in Part I, Item 1 of this Report) and was included in the line item "Non-Incremental Costs Related to Successful Leases" on the Consolidated Statement of Operations and Comprehensive Income for the nine months ended September 30, 2019.

44



Further discussion of the capitalization of overhead costs can be found herein, in the quarter-to-quarter and year-to-year comparisons of general and administrative expenses of this Item 2 as well as in the Critical Accounting Policies section of Management's Discussion and Analysis of Financial Condition and Results of Operations in our 2018 Annual Report.

In addition to the capitalization of overhead costs, the totals for development of real estate assets in the table above include the capitalization of $19.1 million and $21.8 million of interest costs during the nine months ended September 30, 2019 and 2018, respectively.
Both our first and second generation expenditures vary significantly between leases on a per square foot basis, dependent upon several factors including the product type, the nature of a tenant's operations, the specific physical characteristics of each individual property and the market in which the property is located.

Dividend and Distribution Requirements
The General Partner is required to meet the distribution requirements of the Code in order to maintain its REIT status. We paid regular dividends or distributions of $0.215 per common share or Common Unit in the first, second and third quarters of 2019, and the General Partner's board of directors declared dividends or distributions of $0.235 per common share or Common Unit for the fourth quarter of 2019.
We expect to continue to distribute at least an amount equal to our taxable earnings, to meet the requirements to maintain the General Partner's REIT status, and additional amounts as determined by the General Partner's board of directors. Distributions are declared at the discretion of the General Partner's board of directors and are subject to actual cash available for distribution, our financial condition, capital requirements and such other factors as the General Partner's board of directors deems relevant.
Debt Maturities
Debt outstanding at September 30, 2019 had a face value totaling $2.78 billion with a weighted average interest rate of 3.87% and maturities at various dates through 2028. Of this total amount, we had $2.75 billion of unsecured debt, $35.0 million of secured debt and no outstanding borrowings on our unsecured line of credit at September 30, 2019. Scheduled principal amortization, maturities and early repayments of such debt totaled $74.7 million for the nine months ended September 30, 2019.
The following table is a summary of the scheduled future amortization and maturities of our indebtedness at September 30, 2019 (in thousands, except percentage data):
 
 
Future Repayments
 
 
Year
Scheduled
Amortization
 
Maturities
 
Total
 
Weighted Average Interest Rate of
Future Repayments
Remainder of 2019
$
863

 
$

 
$
863

 
5.98
%
2020
3,883

 

 
3,883

 
5.63
%
2021
3,416

 
259,047

 
262,463

 
3.99
%
2022
3,611

 
600,000

 
603,611

 
4.20
%
2023
3,817

 
250,000

 
253,817

 
3.75
%
2024
4,036

 
300,000

 
304,036

 
3.92
%
2025
3,938

 

 
3,938

 
5.58
%
2026
2,029

 
375,000

 
377,029

 
3.37
%
2027
358

 
475,000

 
475,358

 
3.18
%
2028

 
500,000

 
500,000

 
4.45
%
Thereafter

 

 

 
N/A

 
$
25,951

 
$
2,759,047

 
$
2,784,998

 
3.87
%


45


We anticipate generating capital to fund our debt maturities by using undistributed cash generated from our Rental Operations and property dispositions and by raising additional capital from future debt or equity transactions.

On October 24, 2019, we redeemed $250.0 million of unsecured notes that were scheduled to mature in February 2021.

Repayments of Outstanding Debt

To the extent that it supports our overall capital strategy, we may purchase or redeem some of our outstanding unsecured notes prior to their stated maturities.

During the nine months ended September 30, 2019, we repaid three fixed rate secured loans, totaling $41.7 million, which had a weighted average stated interest rate of 7.76%.

Contractual Obligations

Aside from repayments of long-term debt and the issuance of the $175.0 million of senior unsecured notes described above, there have been no other material changes in our outstanding commitments since December 31, 2018, as previously discussed in our 2018 Annual Report.

Historical Cash Flows
Cash, cash equivalents and restricted cash were $250.5 million and $272.8 million at September 30, 2019 and 2018, respectively. The following table highlights significant changes in net cash associated with our operating, investing and financing activities (in millions): 
 
Nine Months Ended September 30,
 
2019
 
2018
General Partner
 
 
 
Net cash provided by operating activities
$
404.1

 
$
371.6

Net cash used for investing activities
$
(243.8
)
 
$
(329.6
)
Net cash provided by financing activities
$
64.8

 
$
37.1

 
 
 
 
Partnership
 
 
 
Net cash provided by operating activities
$
404.1

 
$
371.6

Net cash used for investing activities
$
(243.8
)
 
$
(329.6
)
Net cash provided by financing activities
$
64.8

 
$
37.1


Operating Activities

Cash flows from operating activities provide the cash necessary to meet our operational requirements and the receipt of rental income from Rental Operations continues to be our primary source of operating cash flows. The increase to net cash provided by operating activities, compared to the nine months ended September 30, 2018, was due to the timing of cash receipts on third party construction projects as well as increased cash flows from our Rental Operations.

Investing Activities

Highlights of significant cash sources and uses are as follows:
During the nine months ended September 30, 2019, we paid cash of $146.6 million and $223.5 million, respectively, for real estate and undeveloped land acquisitions, compared to $208.9 million and $194.2 million, respectively, for real estate and undeveloped land acquisitions in the same period in 2018.

46


Real estate development costs were $325.8 million during the nine months ended September 30, 2019, compared to $459.5 million for the same period in 2018.
Sales of land and depreciated properties provided $379.8 million in net proceeds for the nine months ended September 30, 2019, compared to $434.6 million for the same period in 2018.
During the nine months ended September 30, 2019, we received repayments of $145.0 million on notes receivable from property sales, compared to $149.9 million of repayments of notes receivable from property sales for the same period in 2018.
Second generation tenant improvements, leasing costs and building improvements totaled $31.6 million for the nine months ended September 30, 2019 compared to $34.3 million for the same period in 2018.
For the nine months ended September 30, 2019, we received $2.7 million capital distributions from unconsolidated joint ventures, compared to $19.2 million received during the same period in 2018, primarily related to our share of distributions from the sale of properties owned by unconsolidated joint ventures.
For the nine months ended September 30, 2019, we made capital contributions of $6.0 million to unconsolidated joint ventures, compared to $2.7 million during the same period in 2018.
Financing Activities
The following items highlight significant capital transactions:
During the nine months ended September 30, 2019, the General Partner issued 6.6 million common shares pursuant to its ATM equity programs for net proceeds of $215.6 million, compared to 990,400 common shares for net proceeds of $28.4 million during the nine months ended September 30, 2018.
During the nine months ended September 30, 2019, the Partnership repaid three secured loans for $41.7 million. The Partnership repaid three secured loans for $227.1 million during the same period in 2018.
For the nine months ended September 30, 2019, we repaid $30.0 million of net borrowings on the Partnership's unsecured line of credit. There were no net borrowings or repayments on the Partnership's unsecured line of credit for the same period in 2018.
During the nine months ended September 30, 2019, the Partnership issued $175.0 million of senior unsecured notes, which bear interest at a stated interest rate of 3.38%, have an effective interest rate of 2.8% and mature on December 15, 2027, for gross proceeds of $182.3 million. We issued $450.0 million of senior unsecured notes during the nine months ended September 30, 2018.
We paid regular cash dividends totaling $232.3 million and $214.5 million for the nine months ended September 30, 2019 and 2018, respectively.
Changes in book cash overdrafts are classified as financing activities within our Consolidated Statements of Cash Flows. Book cash overdrafts were $59.1 million at September 30, 2018. We did not have any book cash overdrafts at September 30, 2019.
During the nine months ended September 30, 2019 we paid off a special assessment bond for $9.9 million which was reflected within Other Financing Activities on our Consolidated Statements of Cash Flows. We did not make similar significant repayments during the nine months ended September 30, 2018.

Off Balance Sheet Arrangements - Investments in Unconsolidated Joint Ventures
We analyze our investments in unconsolidated joint ventures to determine if they meet the criteria for classification as a VIE and would require consolidation. We (i) evaluate the sufficiency of the total equity at risk, (ii) review the voting rights and decision-making authority of the equity investment holders as a group and whether there are limited partners (or similar owning entities) that lack substantive participating or kick out rights and (iii) establish whether or not activities within the venture are on behalf of an investor with disproportionately few voting rights in making this VIE determination. To the extent that we (i) are the sole entity that has the power to direct the activities of the VIE and (ii) have the obligation or rights to absorb the VIE's losses or receive its benefits, then we would be determined to be the primary beneficiary of the VIE and would consolidate it. At the end of each reporting period,

47


we re-assess our conclusions as to which, if any, party within the VIE is considered the primary beneficiary. To the extent that our joint ventures do not qualify as VIEs, we further assess each joint venture partner's substantive participating rights to determine if the venture should be consolidated. There were no unconsolidated joint ventures that met the criteria to be a VIE at September 30, 2019.
We have equity interests in unconsolidated partnerships and limited liability companies that primarily own and operate rental properties and hold land for development. These unconsolidated joint ventures are primarily engaged in the operation and development of industrial real estate properties. These investments provide us with increased market share and tenant and property diversification. The equity method of accounting is used for these investments in which we have the ability to exercise significant influence, but not control, over operating and financial policies. As a result, the assets and liabilities of these entities are not included on our balance sheet. Our investments in and advances to unconsolidated joint ventures represented approximately 1% of our total assets at September 30, 2019 and December 31, 2018. Total assets of our unconsolidated joint ventures were $486.1 million and $489.5 million at September 30, 2019 and December 31, 2018, respectively. The combined revenues of our unconsolidated joint ventures totaled $45.8 million and $45.2 million for the nine months ended September 30, 2019 and 2018, respectively.
We have guaranteed the repayment of certain secured and unsecured loans of our unconsolidated joint ventures. The outstanding balances on the guaranteed portion of these loans totaled $160.1 million and $110.9 million at September 30, 2019 and 2018, respectively.
Item 3.    Quantitative and Qualitative Disclosures About Market Risk
We are exposed to interest rate changes primarily as a result of our line of credit and our long-term borrowings. Our interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash flows and to lower overall borrowing costs. To achieve our objectives, we borrow primarily at fixed rates and may enter into derivative financial instruments such as interest rate swaps, from time to time, in order to mitigate our interest rate risk. We do not enter into derivative or interest rate transactions for speculative purposes.
Our interest rate risk is monitored using a variety of techniques. The table below provides information about our financial instruments that are sensitive to changes in interest rates, including long-term debt and interest rate swaps. For long-term debt, the table presents the principal amounts (in thousands) of the expected annual maturities, weighted average interest rates for the average debt outstanding in the specified period and fair values (in thousands). For interest rate swaps, the table presents notional amount and fair value (in thousands).
 
Remainder of 2019
 
2020
 
2021
 
2022
 
2023
 
Thereafter
 
Face Value
 
Fair Value
Long-Term Debt:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed rate
secured debt
$
863

 
$
3,583

 
$
12,163

 
$
3,311

 
$
3,517

 
$
9,661

 
$
33,098

 
$
35,723

Weighted average
interest rate
5.98
%
 
5.98
%
 
5.73
%
 
6.06
%
 
6.06
%
 
6.07
%
 
5.93
%
 
 
Variable rate
secured debt
$

 
$
300

 
$
300

 
$
300

 
$
300

 
$
700

 
$
1,900

 
$
1,900

Weighted average
interest rate
N/A

 
1.52
%
 
1.52
%
 
1.52
%
 
1.52
%
 
1.52
%
 
1.52
%
 
 
Fixed rate
unsecured debt
$

 
$

 
$
250,000

 
$
600,000

 
$
250,000

 
$
1,650,000

 
$
2,750,000

 
$
2,897,713

Weighted average
interest rate
N/A

 
N/A

 
3.91
%
 
4.20
%
 
3.72
%
 
3.73
%
 
3.85
%
 
 
Interest Rate Swaps:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed to variable
$
350,000

 
$

 
$

 
$

 
$

 
$

 
$
350,000

 
$
(42,104
)


48


Following the end of the period covered by this Report, on October 24, 2019, we redeemed $250.0 million of unsecured notes that were scheduled to mature in February 2021.
As the above table incorporates only those exposures that existed at September 30, 2019, it does not consider those exposures or positions that could arise after that date. As a result, the ultimate impact of interest rate fluctuations will depend on future exposures that arise, our hedging strategies at that time, to the extent we are party to interest rate derivatives, and interest rates. Interest expense on our unsecured line of credit, to the extent we have outstanding borrowings, will be affected by fluctuations in the LIBOR indices or applicable replacement rates as well as changes in our credit rating. The interest rate at such point in the future as we may renew, extend or replace our unsecured line of credit will be heavily dependent upon the state of the credit environment.
As of September 30, 2019, we held an aggregate $350.0 million notional amount of five forward-starting interest rate swaps with a weighted average pay rate of 2.87% to hedge interest rates on an anticipated debt offering in late 2019. The fair value of these swaps was $42.1 million in a liability position at September 30, 2019.



49


Item 4.    Controls and Procedures
Controls and Procedures (General Partner)
(a) Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. These disclosure controls and procedures are further designed to ensure that such information is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, to allow timely decisions regarding required disclosure.
We carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rules 13a-15 and 15d-15. Based upon the foregoing, the Chief Executive Officer and the Chief Financial Officer concluded that, as of the end of the period covered by this Report, our disclosure controls and procedures were effective.
(b) Changes in Internal Control over Financial Reporting
Other than as noted below, there have been no changes in our internal control over financial reporting during the period covered by this Report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

In August 2019, the General Partner completed implementation of the first phase of a new enterprise resource planning (ERP) system, which is designed to replace certain internal financial and operating systems. In connection with the ERP implementation, in August 2019, we updated the processes and controls that comprise our internal control over financial reporting, as necessary, to accommodate related changes to our accounting procedures and business processes.

Controls and Procedures (Partnership)

(a) Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. These disclosure controls and procedures are further designed to ensure that such information is accumulated and communicated to management, including the General Partner's Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.
We carried out an evaluation, under the supervision and with the participation of management, including the General Partner's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rules 13a-15 and 15d-15. Based upon the foregoing, the General Partner's Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this Report, our disclosure controls and procedures were effective.
(b) Changes in Internal Control over Financial Reporting
Other than as noted below, there have been no changes in our internal control over financial reporting during the period covered by this Report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


50


In August 2019, the Partnership completed implementation of the first phase of a new enterprise resource planning (ERP) system, which is designed to replace certain internal financial and operating systems. In connection with the ERP implementation, in August 2019, we updated the processes and controls that comprise our internal control over financial reporting, as necessary, to accommodate related changes to our accounting procedures and business processes.


51


Part II - Other Information
 
Item 1. Legal Proceedings
From time to time, we are parties to a variety of legal proceedings and claims arising in the ordinary course of our businesses. While these matters generally are covered by insurance, there is no assurance that our insurance will cover any particular proceeding or claim. We are not subject to any material pending legal proceedings other than routine litigation arising in the ordinary course of business. We presently believe that all of the proceedings to which we were subject as of September 30, 2019, taken as a whole, will not have a material adverse effect on our liquidity, business, financial condition or results of operations.
Item 1A. Risk Factors
In addition to the information set forth in this Report, you also should carefully review and consider the information contained in our other reports and periodic filings that we make with the SEC, including, without limitation the information contained under the caption "Item 1A. Risk Factors" in our 2018 Annual Report. The risks and uncertainties described in our 2018 Annual Report are not the only risks that we face. Additional risks and uncertainties not currently known to us, or that we presently deem to be immaterial, also may materially adversely affect our business, financial condition and results of operations. There have not been any material changes to the risk factors that we face since our 2018 Annual Report.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(a) Unregistered Sales of Equity Securities
None
(b) Use of Proceeds
None
(c) Issuer Purchases of Equity Securities
From time to time, we repurchase our securities under a repurchase program that initially was approved by the General Partner's board of directors and publicly announced in October 2001 (the "Repurchase Program").
On January 30, 2019, the General Partner's board of directors adopted a resolution that amended and restated the Repurchase Program and delegated authority to management to repurchase a maximum of $300.0 million of the General Partner's common shares, $500.0 million of the Partnership's debt securities and $500.0 million of the General Partner's preferred shares, subject to the prior notification of the Chairman of the Finance Committee of the board of directors of planned repurchases within these limits. We did not repurchase any equity securities through the Repurchase Program during the three months ended September 30, 2019.
Item 3. Defaults upon Senior Securities

During the period covered by this Report, we did not default under the terms of any of our material indebtedness.

Item 4. Mine Safety Disclosures

Not applicable. 
Item 5. Other Information

During the period covered by this Report, there was no information required to be disclosed by us in a Current Report on Form 8-K that was not so reported, nor were there any material changes to the procedures by which our security holders may recommend nominees to the General Partner's board of directors.



Item 6. Exhibits
(a) Exhibits
 
 
 
3.1

 
 
 
 
3.2

 
 
 
 
3.3

 
 
 
 
3.4 (i)

 
 
 
 
3.4 (ii)

 
 
 
 
3.4 (iii)

 
 
 
 
3.4 (iv)

 
 
 
 
3.4 (v)

 
 
 
 
3.4 (vi)

 
 
 
 
10.1

 
 
 
 
11.1

 
Statement Regarding Computation of Earnings.***
 
 
 
31.1

 
 
 
 
31.2

 
 
 
 
31.3

 
 
 
 
31.4

 
 
 
 
32.1

 
 
 
 
32.2

 
 
 
 
32.3

 
 
 
 
32.4

 
 
 
 
101.Def

 
Definition Linkbase Document
 
 
 
101.Pre

 
Presentation Linkbase Document
 
 
 
101.Lab

 
Labels Linkbase Document
 
 
 
101.Cal

 
Calculation Linkbase Document
 
 
 
101.Sch

 
Schema Document
 
 
 
101.Ins

 
Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document
 
 
 
104

 
Cover Page Interactive Data File (embedded within the Inline XBRL document and contained in Exhibit 101)

52


*
Filed herewith.
**
The certifications attached as Exhibits 32.1, 32.2, 32.3 and 32.4 accompany this Quarterly Report on Form 10-Q and are "furnished" to the Securities and Exchange Commission pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed "filed" by the General Partner or the Partnership, respectively, for purposes of Section 18 of the Securities Exchange Act of 1934, as amended.
***
Data required by Financial Accounting Standards Board Auditing Standards Codification No. 260 is provided in Note 10 to the Consolidated Financial Statements included in this Report.


53


SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
 
 
 
DUKE REALTY CORPORATION
 
 
 
 
/s/ James B. Connor
 
 
James B. Connor
 
 
Chairman and Chief Executive Officer
 
 
 
 
/s/ Mark A. Denien
 
 
Mark A. Denien
 
 
Executive Vice President and Chief Financial Officer
 
 

 
 
 
 
 
DUKE REALTY LIMITED PARTNERSHIP
 
 
By: DUKE REALTY CORPORATION, its general partner
 
 
 
 
/s/ James B. Connor
 
 
James B. Connor
 
 
Chairman and Chief Executive Officer of the General Partner
 
 
 
 
/s/ Mark A. Denien
 
 
Mark A. Denien
 
 
Executive Vice President and Chief Financial Officer of the General Partner
 
 
 
 
 
Date:
November 1, 2019
 
 
 
 


54