Defining The COPT Way
Corporate Office Properties Trust 2006 Annual Report
Our
values
corporate information
Executive Officers
Randall M. Griffin
President and Chief Executive Officer
Karen M. Singer
Senior Vice President, General Counsel and
Secretary
Stephen E. Riffee
Executive Vice President and Chief Financial
Officer
Roger A. Waesche, Jr.
Executive Vice President and Chief Operating
Officer
Service Company Executive Officer
Dwight S. Taylor
President, COPT Development & Construction
Services, LLC
Executive Offices
Corporate Office Properties Trust
6711 Columbia Gateway Drive, Suite 300
Columbia, Maryland 21046
Telephone: (443) 285-5400
Facsimile: (443) 285-7650
&vision
Registrar and Transfer Agent
Shareholders with questions concerning stock
certificates, account information, dividend
payments or stock transfers should contact our
transfer agent:
Wells Fargo Bank, N.A.
Shareholder Services
161 North Concord Exchange
South St. Paul, Minnesota 55075
Toll-free: (800) 468-9716
www.wellsfargo.com/shareownerservices
Pennsylvania Office
Corporate Office Properties Trust
40 Morris Avenue, Suite 220
Bryn Mawr, Pennsylvania 19010
board of trustees
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core purpose
Legal Counsel
Morgan, Lewis & Bockius
1701 Market Street
Philadelphia, Pennsylvania 19103
Independent Auditors
PricewaterhouseCoopers LLP
250 West Pratt Street, Suite 2100
Baltimore, Maryland 21201
Dividend Reinvestment Plan
Registered shareholders may reinvest dividends
through the Company’s dividend reinvestment
plan. For more information, please contact
Wells Fargo Shareholder Services at
(800) 468-9716.
Annual Meeting
The annual meeting of the shareholders will be
held at 9:30 a.m. on Thursday, May 17, 2007, at
the corporate headquarters of Corporate Office
Properties Trust at 6711 Columbia Gateway
Drive, Suite 300, Columbia, Maryland 21046.
Investor Relations
For help with questions about the Company,
or for additional corporate information, please
contact:
Mary Ellen Fowler
Vice President and Treasurer
Corporate Office Properties Trust
6711 Columbia Gateway Drive, Suite 300
Columbia, Maryland 21046
Telephone: (443) 285-5450
Facsimile: (443) 285-7640
Email: ir@copt.com
Shareholder Information
As of March 15, 2007, the Company had
46,743,001 outstanding common shares owned by
approximately 421 shareholders of record. This
does not include the number of persons whose
shares are held in nominee or “street name”
accounts through brokers or clearing agencies.
Common and Preferred Shares
The common and preferred shares of Corporate
Office Properties Trust are traded on the New
York Stock Exchange. Common shares are
traded under the symbol OFC, and preferred
shares are traded under the symbols OFCPrG,
OFCPrH and OFCPrJ.
Website
For additional information on the Company,
visit our website at www.copt.com.
Forward-looking Information
This report contains forward-looking informa-
tion based upon the Company’s current best
judgment and expectations. Actual results
could vary from those presented herein. The
risks and uncertainties associated with the
forward-looking information include the
strength of the commercial office real estate
market in which the Company operates, com-
petitive market conditions, general economic
growth, interest rates and capital market condi-
tions. For further information, please refer to
the Company’s filings with the Securities and
Exchange Commission.
Corporate Governance Certification
The Company submitted to the New York Stock
Exchange in 2006 the Annual CEO Certification
required by Section 303A.12 of the New York
Stock Exchange corporate governance rules.
Sarbanes-Oxley Act Section 302 Certification
The Company filed with the Securities and
Exchange Commission, as an exhibit to its
Form 10-K for the year ended December 31,
2006, the Sarbanes-Oxley Act Section 302
certification regarding the quality of the
Company’s public disclosure.
(left to right)
Jay H. Shidler, Chairman of the Board; Managing Partner, The Shidler Group
Steven D. Kesler, Chief Financial Officer, Chesapeake Commercial Properties, Inc.
Kenneth D. Wethe, Principal, Wethe & Associates
Randall M. Griffin, President and Chief Executive Officer, Corporate Office
Properties Trust
(left to right)
Clay W. Hamlin, III, Vice Chairman of the Board
Kenneth S. Sweet, Jr., Managing Partner, Gordon Stuart Associates
Thomas F. Brady, Executive Vice President, Corporate Strategy and Retail
Competitive Supply, Constellation Energy Group
Robert L. Denton, Managing Partner, The Shidler Group
A REIT WITH A MISSION: THE COPT WAY
Since 1998, Corporate Office Properties Trust
(COPT) has been a leader in shareholder return,
dividend growth and tenant satisfaction.
During 2006, in the midst of another year of
strong performance, we began the process of
ensuring this growth and success would con-
tinue. We asked ourselves the following:
What kind of corporate culture made this growth
possible? What are the values that led us here?
What is our core purpose? And where will it take
us from here?
The answers identified “The COPT Way” as a
means for sustaining our track record and con-
tinuing to improve our performance.&
1
OUR CULTURE, CORE VALUES & VISION
The COPT Way begins with a corporate culture that is committed to caring,
trust and respect for all. A culture that encourages both individual and
professional growth. A culture that is guided by five core values:
Integrity: delivering and expecting the highest ethical conduct.
Service: exceeding expectations by paying attention to details.
Innovation: identifying and seizing opportunities through creative solutions.
Teamwork: supporting each other to enhance our collective strengths.
Excellence: passionately dedicated to being the best.
integrity, service, innovation,
By following these principles, we believe we will achieve our Vision 2025: To
have The COPT Way be recognized as the standard of real estate excellence.
Specifically, our goals are:
• To be ranked #1 or #2 in every meaningful industry evaluation.
• To be one of the top 50 places to work.
• To be a leading contributor in improving the fabric of the communities
where we live and work.
If we strive to be the best at everything we do, financial success will take care
of itself.
2
&teamwork excellence
The Copt Way
3
our core purpose...
Providing the road map to reach our goals is a core purpose that is powerful,
compelling and virtually limitless in scope.
“Creating Environments That Inspire Success” means building spaces that are
strategically located, architecturally pleasing and unmistakably functional. It
means adding art to the hardscape to inspire thought and motivate perfor-
mance. It means building green to benefit the environment. And, it means
making our communities better places to live. Not just by adding attractive
buildings, but by improving social services, educational opportunities and
recreational amenities.
Ultimately, it means doing everything we can to help our tenants, our
employees and our communities succeed. For when they succeed, so do we.
By pursuing our core purpose, our leadership
inspires others—our tenants, communities
and employees—to improve, do their best
and be successful.
Opposite page (left to right): 304 NBP, a LEED* Silver-certified building
leased to Booz Allen Hamilton. George Swintz (COPT) and Joe Wysocki
(Scitor) cut the ribbon on COPT’s first build-to-suit in Colorado Springs. An
interior space in COPT’s new Columbia headquarters.
* Leadership in Energy & Environmental Design, a program of the U.S. Green
Building Council.
4
creating
environments that
inspire
success
5
2006 marked the seventh straight year that REITs outperformed other indi-
ces—ending the year up 33.5% versus the Dow Jones at 15.6%. And as usual,
Corporate Office Properties Trust was among the leaders.
With a total shareholder return of 46%, we finished among the top six in this
banner year for office REITs, outperforming the average office REIT by 38%.
We delivered a five-year total shareholder return of 426%, second highest
among office REITs and fourth highest among all equity REITs. We signifi-
cantly increased our enterprise value by 32% —from $3.3 to $4.3 billion.
And we ended the year with the fourth highest multiple in the office sector
and tenth highest among all 134 equity REITs.
We are also proud of our 2006 performance in a number of other areas:
We purchased a former army base, closing on 500 acres of the 591-acre
Fort Ritchie United States Army base in Cascade, Maryland. The site
contains a mix of office, residential, recreational and woodland areas. Our
redevelopment plan, anticipated to cover a 10 to 15 year timeframe, includes
1.7 million square feet of office space, and will be a significant driver of
future earnings.
We strengthened our presence in Baltimore County and Columbia.
We diligently pursued our largest company merger, closing in early 2007 on the
Nottingham Properties office portfolio of 56 buildings containing 2.4 million
a letter to our shareholders
square feet, 187 acres of land, and bringing 19 employees into the Company.
This makes us the largest office owner in another major core submarket,
with future development capacity of a minimum of 2 million square feet.
We expanded our presence in Colorado Springs. We acquired six office
buildings plus additional land, making us the largest owner of office proper-
ties in that market after entering it only one year ago. We now own 12 office
buildings totaling 842,000 square feet, 94% of which are leased, and we have
an additional four buildings under development totaling 292,000 square feet.
We also own, directly or through joint ventures, sufficient entitled ground to
build approximately 2.6 million square feet.
6
a letter to our shareholders
We positioned the company to double in size. With the acquisition of
Fort Ritchie and Nottingham, we now have approximately 14 million square
feet of entitled land development capacity. This gives us the potential to
nearly double our company size over the next 5–7 years, based on develop-
ment alone. We are strategically focused on adding to our presence in each of
our core markets, and have done so at below market pricing.
We moved into new corporate headquarters and strengthened our
senior management team, strategically positioning us for the future. We
now have space to accommodate our expanding operations with a headquar-
ters that reflects the level of quality space we build for our tenants.
We launched The COPT Way, the culmination of a process to define our
core purpose, core values and vision for our future. We strongly believe that
a unified vision—for our employees, our tenants and our shareholders—will
guide us to new levels of growth and success. That’s why we’ve made it the
theme of this year’s annual report.
The above accomplishments combine to position the company for annual
double digit growth of FFO per share over the next several years, which is at the
high end of the office sector. This growth is bolstered by our government and
defense niche, which accounts for 54% of our revenues and continues to grow.
In 2006, COPT was again recognized nationally
among all office owners as the winner of the CEL &
Associates, Inc. award for quality service and tenant
satisfaction for the large owner category as determined
in a survey of tenants nationwide. This is our third
year in a row as winner of this award.
I would like to personally thank the Board of Trustees for their guidance
during 2006, our shareholders for their continued support, and our employ-
ees for their hard work and dedication throughout the year. We look forward
to continued growth and excellence in 2007.
Sincerely yours,
Randall M. Griffin
President and Chief Executive Officer
7
Market Capitalization
TOTAL MARKET CAPITALIZATION
(in billions)
5
4
3
2
1
$5
4
3
2
1
0
0
0.8
0.4
1.6
1.2
1.20
0.80
$1.60
Dividend Growth
’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06
DIVIDEND GROWTH
(in dollars)
2006 results0
8 6
’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06
COPT
1,100%
0.40
660
880
440
1100
880
440
660
0.0
0
TOTAL SHAREHOLDER RETURN
(in percent)
220
0
220
0
1 Year
3 Years
5 Years
7 Years
9 Years
COPT
RMS
S&P
DOW JONES
Stock Chart
RMS
1100
880
660
440
220
0
S&P
1100
880
660
440
220
0
DOW JONES
1100
880
660
440
220
0
Market Capitalization
TOTAL MARKET CAPITALIZATION
(in billions)
Market Capitalization
Dividend Growth
TOTAL MARKET CAPITALIZATION
(in billions)
’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06
DIVIDEND GROWTH
(in dollars)
5
4
3
2
1
0
1.6
1.2
0.8
0.4
0.0
$5
4
3
2
1
0
$5
4
3
2
1
0
$1.60
1.20
0.80
0.40
0
’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06
’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06
Stock Chart
RMS
1100
880
660
440
220
0
S&P
1100
880
660
440
220
0
DOW JONES
Dividend Growth
COPT
DIVIDEND GROWTH
(in dollars)
TOTAL SHAREHOLDER RETURN
(in percent)
1100
1.6
1100
$1.60
1,100%
880
660
440
220
0
1.20
0.80
0.40
0
1,100%
880
660
440
220
0
COPT
RMS
S&P
DOW JONES
’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06
1 Year
3 Years
5 Years
7 Years
9 Years
TOTAL SHAREHOLDER RETURN
(in percent)
COPT
880
We are proud of our ability to generate strong financial growth and stability
for our shareholders over our almost nine-year history as a NYSE public
company and are focused on continuing this growth in the future.
660
440
220
0
1 Year
3 Years
RMS
S&P
DOW JONES
9 Years
7 Years
2006 WAS ANOTHER GREAT YEAR FOR COPT SHAREHOLDERS.
5 Years
Our stock price hit an historic high of $50.47 at the end of 2006, increasing
almost $15 over the year. Our strong performance enabled us to deliver a
total return to shareholders of 46% for 2006, 165% for the past three years
and 426% over the past five years. For the tenth consecutive year, we increased
our dividend—providing a 10.7% annualized increase from 2005 for our
shareholders. Our total market capitalization grew from $523.1 million for
year end 1998 to $4.3 billion for year end 2006, a remarkable increase.
9
5
4
3
2
1
0
880
660
440
220
1.2
0.8
0.4
0
0.0
1100
DOW JONES
880
660
440
220
0
660
880
220
440
1100
COPT
6
0
Stock Chart
RMS
1100
880
660
440
220
0
S&P
1100
880
660
440
220
0
10
living the COPT way
You will see The COPT Way when you visit our new corporate headquarters
in Columbia, Maryland. In July, we moved into our new building in Columbia
Gateway office park, where we own 26 buildings totaling over 2 million
square feet. We currently occupy two floors of the building, with the build-
ing over 75% leased. The space reflects our quality standards, attention to
detail and appreciation for our team members. And, the interior space meets
LEED Silver certification standards for green buildings. It’s an environment
that truly inspires success.
Opposite page: 6711 Columbia Gateway Drive. Above (l to r): A “collaboration
area” outside the COPT Café. Peg Ohrt, SVP, Human Resources; Dwight S.
Taylor, President, COPT Development & Construction Services; and Connie
Epperlein, Corporate Designer and Programmer, select finishes for the space.
The COPT awards wall, off our main reception lobby.
11
ensuring the future
DURING 2006, WE STRENGTHENED OUR TEAM to ensure a successful future. Changes included:
the promotions of Roger A. Waesche, Jr., to EVP & COO, Karen M. Singer to SVP, General Counsel & Secretary,
and Mary Ellen Fowler to VP & Treasurer, as well as the additions of Stephen E. Riffee as EVP & CFO (for-
merly CFO of CarrAmerica), Stephen B. Kutzer as CIO and Colleen M. Crews as VP & Controller.
Above (l to r): Rand Griffin, President and CEO; Roger Waesche; and Steve Riffee.
12
Steve Kutzer
Chief Information Officer
Mr. Kutzer is the
first CIO at COPT.
Formerly, he was SVP of
Information Technology
with CarrAmerica Realty
Corporation and has held
positions with KPMG
Consulting and The World
Health Organization.
Mary Ellen Fowler
Vice President and Treasurer
In her newly created
position, Ms. Fowler is now
responsible for cash man-
agement and capital mar-
kets in addition to her
responsibilities for investor
relations and marketing.
She has been with COPT
for five years, after 20 years
of banking industry
experience.
Colleen Crews
Vice President and
Controller
A CPA, Ms. Crews brings
15 years of real estate expe-
rience to COPT where she
oversees all accounting
department functions.
Previous employers include
The Town & Country Trust
and Ernst & Young.
Karen Singer
Senior Vice President,
General Counsel and
Secretary
Ms. Singer, who was pro-
moted to SVP, manages our
legal and internal audit
departments. She is respon-
sible for all leases, contracts,
financing documents and
other legal instruments. She
has been with COPT for
ten years.
13
property asset management
&
Baltimore, MD
MARYLAND
Potomac River
VIRGINIA
Washington, D.C.
Each of our five core values is demonstrated by our property and asset
management team in a number of key areas.
14
CUSTOMER SERVICE. For the third year in a row, COPT was recognized as
the winner of the annual CEL & Associates, Inc. award for customer service
among all office owners in the “large owner” category, based on the national
survey of tenant satisfaction. Success in meeting our tenants’ needs every day
is only possible with a team that is dedicated to excellence, attention to detail
and service.
TENANT RELATIONSHIPS. The integrity and strength of our team are evi-
denced by our expanding tenant relationships. Despite significant earlier
vacancies, we brought our Northern Virginia portfolio to 99% leased at year
end. In Colorado Springs, where we entered the market only one year ago, we
are 94% leased within our 842,000 square foot portfolio at year end. And,
our customer service performance continues to provide new opportunities
such as the Northrop Grumman VITA contract in Virginia, that resulted in
two buildings with anticipated construction costs totaling $86 million. Such
teamwork is key to our success. That’s The COPT Way.
Opposite page (l to r): COPT’s market concentration is the Greater Washington,
DC, area. Regional Directors include Michael A. Riley, Jeffrey L. Marquina
and Gregory B. White. Members of the asset management/leasing team include
VPs Derrick C. Boegner and William S. Barroll, and SVP S. Judson Williams.
COPT’s 2006
National
Commercial Real
Estate Customer
Service Award for
Excellence
15
acquisitions
Our innovative approach to development is illustrated through the purchase
of 500 acres of the 591-acre Fort Ritchie, a former U.S. Army base located
near the Maryland-Pennsylvania border. The purchase reflects a strategy to
capture tenant demand for major facilities outside of Washington, DC. It’s
also an excellent opportunity to create an environment that inspires success.
We plan to develop 1.7 million square feet of office space and 673 residential
units—from apartments and condos to single-family homes. We will develop lots
and select high quality builders to carry out our vision. Residents and workers
will enjoy a quality of life that includes 24 acres of lakes, a 67-acre historic area,
20 acres for community use and 257 acres of woodlands. Included in our
plan is a new community center, expanded athletic facilities and retail and
service amenities. We expect to turn a closed army base into an economic
engine that will generate at least 4,500 jobs while revitalizing a community.
fort ritchie
Above (l &r): The historic “Castle Building” will become COPT’s Fort Ritchie
sales and marketing center. Opposite page: Aerial overview of the 591-acre
Fort Ritchie. Far right: Frank W. Ziegler, VP, Government & Construction
Services; Catherine M. Ward, SVP, Asset Management/Leasing; and Charles
J. Fiala, Jr., SVP, Government Services, lead the Fort Ritchie development and
leasing team.
16
Fort Ritchie represents a great opportunity for our
clients and shareholders, a growth driver for the
company and a revitalizing force for the surrounding
communities. That’s The COPT Way.
17
18
IN A TRANSACTION THAT BEGAN IN 2006 and closed in January 2007,
COPT acquired 56 office buildings and 187 acres of land from the Nottingham
Properties portfolio, located primarily in the I-95 corridor north of Baltimore.
We brought onboard 19 of the Nottingham employees to continue to serve
our new tenants’ requirements.
We believe that the purchase is very accretive to our future earnings and
strategically important for several reasons. First, we are now the largest owner
of office properties in White Marsh, a submarket located 18 miles from the
U.S. Army’s Aberdeen Proving Ground, which is preparing to accept thousands
of jobs on and off post as a result of BRAC. Second, we are now the largest office
owner in Baltimore County. And third, the acquisition enhances our dominance
in key Maryland submarkets including Columbia and around BWI Airport.
Our strategy is to aggressively lease and manage the portfolio—as the buildings
were 86% leased at the time of purchase—and to expand our relationship
with strong existing tenants such as Comcast Corporation, Orbital Sciences
Corporation, MedStar Health, Inc. and The Johns Hopkins University. We
believe this transaction creates a value-add opportunity as we were able to
purchase the buildings at below replacement cost. It also gives us a minimum
of 2 million square feet of future development at prices significantly
below market.
nottingham properties
Opposite page (l to r): Corporate Place I, in White Marsh; 216 Schilling
Circle in Hunt Valley. Above (l to r): Campbell Corporate Center in White
Marsh. Members of the Baltimore County properties’ leasing and property
management team: John T. Hermann, VP, Asset Management/Leasing;
Sandi Haertig, Regional Director; Susan Roger, Senior Property Manager;
and Janeann Streat, Leasing Representative.
19
OUR EXPANSION IN COLORADO SPRINGS is representative of The
COPT Way. In 2005, COPT followed a tenant-centric expansion strategy and
entered the Colorado Springs market to bring our clients closer to Peterson
Air Force Base. In 2006, through acquisitions, development and value-add
opportunities, we became the market’s #1 owner of office space.
We purchased a 60,000 square foot facility for $2.6 million—well below market
value—renovated it so that it now has 74,749 square feet, and leased it to a
growing client, The Spectranectics Corporation. Subsequent to year end, we
began construction on a 60,000 square foot building, pre-leased in its entirety
to SI International, Inc.
We’ve invested $175 million in Colorado Springs and have grown our
staff there to ten. We now own 12 buildings totaling 842,000 square feet,
which were 94% leased at year end, and have four buildings under construction
or development, adding another 292,000 square feet. We own or control,
through a joint venture, sufficient entitled land to build an additional
2.6 million square feet.
Colorado Springs offers tremendous potential for both our clients and our
shareholders. Again—The COPT Way.
colorado
springs
Above (l to r): Members of the Colorado Springs team: Harold Martinez,
Senior Property Manager; George Swintz, VP, Asset Management/Leasing;
and Frank Melara, Senior Construction Manager. Scitor’s new building at
Patriot Park. Opposite page (l to r): North Creek office complex; the lobby of
Patriot Park V.
20
21
development
Development produces greater returns than
any other part of our business. Yet even by our
standards, the gains in 2006 were significant.
A LANDMARK YEAR IN DEVELOPMENT. By year end, we placed seven buildings totaling 792,762 square
feet into service. Another 831,066 square feet of strategically located office space is currently under construction
and approximately 2 million square feet are in development/re-development. With a land inventory at year
end of 1,388 acres, plus the additional acreage acquired in January, we have the potential for 14 million square
feet of development, positioning us for a decade of continuous growth.
22
Top: 306 NBP. Above (l to r): Carl M. Nelson, VP, Construction Services; Peter Z. Garver, Director, Development
Services; and George J. Marcin, VP, Interior Construction and Renovation. Center and far right: Washington
Technology Park II in Chantilly, Virginia.
23
Highlights include:
• The purchase of 178 acres adjacent to The National Business Park which will
allow for increased capacity and expansion of NBP over time to meet our
largest tenants’ needs.
• The development of two data centers totaling 296,000 square feet for
Northrop Grumman in Virginia.
• Partnerships with the University of Maryland, Baltimore County and the
University of Maryland, College Park to develop their technology parks.
• Our commitment to build to LEED Silver certification level. Already two
new buildings have been certified at the Silver level, two at the Gold level,
and 19 more are registered in the LEED program. Additionally, we now
have six COPT employees who are LEED certified professionals. Green con-
struction is the future. Our clients demand it and our environment depends
on it. It is part of The COPT Way.
Above (l to r): Lobby of 6711 Columbia Gateway Drive. The U.S. Green
Building Council’s Silver Certification medallion.
24
2006 financials
Selected Financial Data
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s Report on Internal Control Over Financial Reporting
Consolidated Balance Sheet as of December 31, 2006 and 2005
Consolidated Statements of Operations for the Years Ended December 31, 2006, 2005 and 2004
Consolidated Statements of Shareholders’ Equity for the Years Ended December 31, 2006, 2005 and 2004
Consolidated Statements of Cash Flow for the Years Ended December 31, 2006, 2005 and 2004
Notes to Consolidated Financial Statements
Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Repurchases of Equity Securities
Common Shares Performance Graph
26
28
55
Report of Independent Registered Public Accounting Firm 56
57
58
59
60
61
92
92
selected financial data corporate office properties trust and subsidiaries
The following table sets forth summary financial data as of and for each of the years ended December 31, 2002 through 2006. The
table illustrates the significant growth our Company experienced over the periods reported. Most of this growth, particularly
pertaining to revenues, operating income and total assets, was attributable to our addition of properties through acquisition and
development activities. We financed most of the acquisition and development activities by incurring debt and issuing preferred
and common equity, as indicated by the growth in our interest expense, preferred share dividends and weighted average common
shares outstanding. The growth in our general and administrative expenses reflects, in large part, the growth in management
resources required to support the increased size of our portfolio. Since this information is only a summary, you should refer to our
Consolidated Financial Statements and notes thereto and the section of this report entitled “Management’s Discussion and Analysis
of Financial Condition and Results of Operations” for additional information.
(in thousands, except per share data and number of properties)
2006
2005
2004
2003
2002
Total operating expenses
247,497
224,123
146,205
120,989
Revenues
Revenues from real estate operations(1)
Construction contract and other service
operations revenues
Total revenues
Expenses
Property operating expenses(1)
Depreciation and other amortization associated
with real estate operations(1)
Construction contract and other service
operations expenses
General and administrative expenses
Operating income
Interest expense and amortization of deferred
financing costs(1)
Income from continuing operations before equity in
loss of unconsolidated entities, income taxes and minor-
ity interests
Equity in loss of unconsolidated entities
Income tax (expense) benefit
Income from continuing operations before
minority interests
Minority interests in income from continuing operations(1)
Income from continuing operations
Income from discontinued operations, net of
minority interests(1)(2)
Gain (loss) on sales of real estate, net(1)(3)
Net income
Preferred share dividends
Issuance costs associated with redeemed preferred shares(4)
Repurchase of preferred units in excess of recorded
$ 301,319
$ 242,073
$ 203,944
$ 164,053
$ 139,428
60,084
79,234
28,903
31,740
4,704
361,403
321,307
232,847
195,793
144,132
94,504
72,253
58,982
47,564
40,186
78,712
61,049
49,289
34,599
28,452
57,345
16,936
77,287
13,534
26,996
10,938
30,933
7,893
5,008
6,697
80,343
63,789
113,906
97,184
86,642
74,804
(74,225)
(57,101)
(44,568)
(41,487)
(38,991)
39,681
(92)
(887)
38,702
(4,584)
34,118
14,377
732
49,227
(15,404)
(3,896)
40,083
(88)
(668)
39,327
(5,245)
34,082
4,681
268
39,031
(14,615)
—
42,074
(88)
(795)
41,191
(5,473)
35,718
1,427
(113)
37,032
(16,329)
(1,813)
33,317
(98)
169
33,388
(6,260)
27,128
3,413
336
30,877
(12,003)
—
24,798
(402)
347
24,743
(5,996)
18,747
2,778
1,776
23,301
(10,134)
—
book value(5)
—
—
—
(11,224)
—
Net income available to common shareholders
$
29,927
$
24,416
$
18,890
$
7,650
$
13,167
(continued)
2626
(in thousands, except per share data and number of properties)
2006
2005
2004
2003
2002
Basic earnings per common share
Income from continuing operations
Net income available to common shareholders
Diluted earnings per common share
Income from continuing operations
Net income available to common shareholders
Weighted average common shares outstanding—basic
Weighted average common shares outstanding—diluted
Balance Sheet Data (as of year end):
Investment in real estate
Total assets
Debt
Total liabilities
Minority interests
Shareholders’ equity
Other Financial Data (for the year ended):
Cash flows provided by (used in):
Operating activities
Investing activities
Financing activities
Numerator for diluted EPS
Diluted funds from operations(6)
Diluted funds from operations per share(6)
Cash dividends declared per common share
Property Data (as of year end):
Number of properties owned(1)(7)
Total rentable square feet owned(1)(7)
$
$
$
$
0.37
0.72
0.36
0.69
41,463
43,262
$
$
$
$
0.53
0.65
0.51
0.63
37,371
38,997
$
$
$
$
0.53
0.57
0.50
0.54
33,173
34,982
$
$
$
$
0.16
0.29
0.15
0.27
26,659
28,021
$
$
$
$
0.46
0.59
0.44
0.56
22,472
23,350
$ 2,111,310
$ 2,419,601
$ 1,498,537
$ 1,629,111
$ 116,187
$ 674,303
$ 1,888,106
$ 2,129,759
$ 1,348,351
$ 1,442,036
$ 105,210
$ 582,513
$ 1,544,501
$ 1,732,026
$ 1,022,688
$ 1,111,224
$
98,878
$ 521,924
$ 1,189,258
$ 1,332,076
$ 738,698
$ 801,899
$
79,796
$ 450,381
$ 1,042,955
$ 1,138,721
$ 705,056
$ 749,338
$ 100,886
$ 288,497
$ 113,151
$ (253,834)
$ 137,822
29,927
$
98,937
$
1.91
$
1.18
$
$
95,944
$ (419,093)
$ 320,112
24,416
$
88,801
$
1.86
$
1.07
$
$
84,494
$ (263,792)
$ 183,638
18,911
$
76,248
$
1.74
$
0.98
$
$
67,783
$ (172,949)
$ 108,656
7,650
$
61,268
$
1.56
$
0.91
$
$
62,242
$ (128,571)
65,680
$
13,711
$
52,854
$
1.44
$
0.86
$
170
15,050
165
13,708
143
11,765
118
9,876
110
8,942
(1) Certain prior period amounts have been reclassified to conform with the current presentation. These reclassifications did not affect consolidated net
income or shareholders’ equity.
(2) Reflects income derived from one operating real estate property that we sold in 2003, three operating real estate properties that we sold in 2005 and
seven operating real estate properties we sold in 2006 (see Note 18 to our Consolidated Financial Statements).
(3) Reflects gain (loss) from sales of properties and unconsolidated real estate joint ventures not associated with discontinued operations.
(4) Reflects a decrease to net income available to common shareholders pertaining to the original issuance costs recognized upon the redemption of the
Series E and Series F Preferred Shares of beneficial interest in 2006 and the Series B Preferred Shares of beneficial interest in 2004.
(5) Reflects a decrease to net income available to common shareholders representing the excess of the repurchase price of the Series C Preferred Units in
our Operating Partnership over the sum of the recorded book value of the units and the accrued and unpaid return to the unitholder.
(6) For definitions of diluted funds from operations per share and diluted funds from operations and reconciliations of these measures to their
comparable measures under generally accepted accounting principles, you should refer to the section entitled “Funds from Operations” within the
section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
(7) Amounts reported reflect only wholly owned properties.
2727
management’s discussion and analysis of financial condition and results of operations
You should refer to our Consolidated Financial Statements and
the notes thereto and our Selected Financial Data table as you
read this section.
This section contains “forward-looking” statements, as defined
in the Private Securities Litigation Reform Act of 1995, that are
based on our current expectations, estimates and projections
about future events and financial trends affecting the financial
condition and operations of our business. Forward-looking
statements can be identified by the use of words such as “may,”
“will,” “should,” “expect,” “estimate” or other comparable ter-
minology. Forward-looking statements are inherently subject to
risks and uncertainties, many of which we cannot predict with
accuracy and some of which we might not even anticipate.
Although we believe that the expectations, estimates and pro-
jections reflected in such forward-looking statements are based
on reasonable assumptions at the time made, we can give no
assurance that these expectations, estimates and projections
will be achieved. Future events and actual results may differ
materially from those discussed in the forward-looking state-
ments. Important factors that may affect these expectations,
estimates and projections include, but are not limited to:
• our ability to borrow on favorable terms;
• general economic and business conditions, which will,
among other things, affect office property demand and
rents, tenant creditworthiness, interest rates and financ-
ing availability;
• adverse changes in the real estate markets, including,
among other things, increased competition with other
companies;
• risks of real estate acquisition and development activities,
including, among other things, risks that development
projects may not be completed on schedule, that tenants
may not take occupancy or pay rent or that development
and operating costs may be greater than anticipated;
• risks of investing through joint venture structures, includ-
ing risks that our joint venture partners may not fulfill
their financial obligations as investors or may take actions
that are inconsistent with our objectives;
• our ability to satisfy and operate effectively under federal
income tax rules relating to real estate investment trusts
and partnerships;
• governmental actions and initiatives; and
• environmental requirements.
We undertake no obligation to update or supplement forward-
looking statements.
OVERVIEW
We are a real estate investment trust (“REIT”) that focuses on
the acquisition, development, ownership, management and
leasing of primarily Class A suburban office properties in select,
demographically strong submarkets where we can achieve criti-
cal mass, operating synergies and key competitive advantages,
including attracting high quality tenants and securing acqui-
sition and development opportunities. We also have a core
customer expansion strategy that is built on meeting, through
acquisitions and development, the multilocation requirements
of our strategic tenants. As of December 31, 2006, our invest-
ments in real estate included the following:
• 170 wholly owned operating properties in our portfolio
totaling 15.1 million square feet;
• 16 wholly owned office properties under construction or
development that we estimate will total approximately 1.8
million square feet upon completion, and two wholly
owned office properties totaling approximately 129,000
square feet that were under redevelopment;
• wholly owned land parcels totaling 1,048 acres that we
believe are potentially developable into approximately 8.4
million square feet; and
• partial ownership interests in a number of other real
estate projects in operations or under development or
redevelopment.
REITs were created by the United States Congress in order to
provide large numbers of investors with the ability to make
investments into entities that own large scale commercial real
estate. One unique aspect of a REIT is that the entity typically
does not pay corporate income tax, provided that the entity
distributes 100% of its taxable income to its shareholders and
meets a number of other strict requirements of the Internal
Revenue Code of 1986, as amended (it is noteworthy that REITs
are required to distribute a minimum of only 90% of taxable
income to maintain their tax status as a REIT, although any
differential between the 90% and 100% would be taxable).
Most of our revenues relating to our real estate operations are
derived from rents and property operating expense reimburse-
ments earned from tenants leasing space in our properties.
Most of our expenses relating to our real estate operations take
the form of (1) property operating costs, such as real estate
taxes, utilities and repairs and maintenance; (2) financing
costs, such as interest and loan costs; and (3) depreciation and
amortization associated with our operating properties.
2828
Of the 170 wholly owned operating properties in our port-
folio, 157 were located in the Mid-Atlantic region of the United
States. Our primary regions as of December 31, 2006 are set
forth below:
• Baltimore/Washington Corridor (defined as the Maryland
counties of Howard and Anne Arundel);
• Northern Virginia (defined as Fairfax County, Virginia);
• Suburban Maryland (defined as the Maryland counties of
Montgomery, Prince George’s and Frederick);
• St. Mary’s & King George Counties (located in Maryland
and Virginia, respectively);
• Suburban Baltimore, Maryland;
• Colorado Springs, Colorado;
• San Antonio, Texas;
• Northern/Central New Jersey (as of December 31, 2006,
all of our properties in this segment were located in
Central New Jersey); and
• Greater Philadelphia, Pennsylvania.
As of December 31, 2006, 124 of our properties were located in
what is widely known as the Greater Washington, D.C. region,
which includes the first four regions set forth above, and 23
were located in neighboring Suburban Baltimore. The core cus-
tomer expansion strategy that we began implementing in 2004
led us into the next two regions set forth above: Colorado
Springs and San Antonio, Texas. The last two regions set forth
above are considered non-core to the Company. We discuss fur-
ther the geographic concentrations of our property ownership
in the section below entitled “Concentration of Operations.”
Our strategy for operations and growth revolves around our
goal to be the landlord of choice for select high quality tenants.
As a result of this strategy, a large concentration of our revenue
is derived from several large tenants. Our largest tenants are
also heavily concentrated in the United States defense industry.
Several noteworthy statistics that demonstrate our tenant and
industry concentrations are set forth below:
Percentage of
Annualized Rental
Revenue(1) of
Wholly Owned
Properties at
December 31, 2006
Largest tenant, United States Government
Five largest tenants
Twenty largest tenants
Tenants in the United States defense industry
16.3%
34.2%
56.7%
54.4%
(1) Defined below in the section entitled “Concentration of Operations” in the sub-
section entitled “Geographic Concentration of Property Operations.”
We discuss further our lease concentrations in the section below
entitled “Concentration of Operations.”
In order to maximize the revenue potential of our properties,
we try to maintain high levels of occupancy; as a result, we
consider occupancy rates to be an important measure of the
productivity of our properties. One way that we attempt to
maximize occupancy rates is by renewing a high percentage of
our existing tenants; accordingly, tenant renewal rates are
important to us in monitoring our leasing activities and tenant
relationships. In managing the effect of our leasing activities on
our financial position and future operating performance stabil-
ity, we also monitor the timing of our lease maturities with the
objective that the timing of such maturities not be highly con-
centrated in a given one-year or five-year period. The table
below sets forth certain occupancy and leasing information as
of or for the year ended December 31, 2006 for our portfolio
of wholly owned properties:
Occupancy
Renewal rate of square footage for scheduled lease expira-
tions during year
Average contractual annual rental rate per square foot(1)
Weighted average lease term (in years)(2)
(1) Includes estimated expense reimbursements.
92.8%
55.4%
$20.90
5.0
(2) See assumption relating to our United States Government leases in section
entitled “Results of Operations” in the subsection entitled “Occupancy and
Leasing.”
We discuss further in the section below entitled “Results of
Operations” in the subsection entitled “Occupancy and Leasing.”
Achieving optimal performance from our properties is highly
important to our Company. We evaluate the performance of
our properties by focusing on changes in revenues from real
estate operations (comprised of (1) rental revenue and (2) ten-
ant recoveries and other real estate operations revenue) and
property operating expenses. However, since we experienced
significant growth in number of operating properties between
2004 and 2006, our growth in revenues from real estate opera-
tions and property operating expenses over that time frame can
be misleading. Therefore, we evaluate (1) changes in revenues
from real estate operations and property operating expenses
attributable to property additions separately from (2) the
changes attributable to properties that were owned and opera-
tional throughout any two periods being compared, properties
that we collectively refer to as the Same-Office Properties.
During 2006, we:
• experienced significant growth from 2005 in revenues from
real estate operations and property operating expenses
due primarily to the addition of properties through acqui-
sition and construction activities since January 1, 2005;
2929
management’s discussion and analysis of financial condition and results of operations
• had a $6.5 million, or 2.9%, increase in revenues from the
Same-Office Properties compared to 2005 due primarily
to increased rental revenue and operating expense reim-
bursements at such properties; and
• had a $4.7 million, or 6.8%, increase in property operat-
ing expenses from the Same-Office Properties compared
to 2005 due in large part to increased utilities, real estate
taxes and repairs and maintenance expenses, partially off-
set by decreased snow removal expenses.
We discuss these changes further in the section below entitled
“Results of Operations” in the subsection entitled “Revenues
from Real Estate Operations and Property Operating Expenses.”
In addition to owning real estate properties, we provide real
estate-related services that include (1) property management;
(2) construction and development management; and (3) heat-
ing and air conditioning services and controls. The gross reve-
nue and costs associated with these services generally bear little
relationship to the level of our activity from these operations
since a substantial portion of the costs are subcontracted costs
that are reimbursed to us by the customer at no mark up. As a
result, the operating margins from these operations are small
relative to the revenue. We use the net of such revenues and
expenses to evaluate the performance of our service operations.
For 2006, the operating margins of our service operations
increased $792,000 compared to 2005. These operations are
discussed further in the section below entitled “Results of
Operations” in the subsection entitled “Construction Contract
and Other Service Revenue and Expenses.”
Our 2006 net income available to common shareholders
increased 22.6% and our diluted earnings per share increased
9.5% compared to 2005. We discuss significant factors contrib-
uting to these changes within subsections of the section below
entitled “Results of Operations.”
The investment portion of our growth strategy focuses primar-
ily on two activities: acquisitions and development. These
activities typically target suburban office properties in our
existing geographic regions, neighboring regions or new regions
meeting our investment criteria, but they may also target other
properties as a result of our core customer expansion strategy.
Since we take an opportunistic yet disciplined approach to our
investment activities, the volume of these activities and alloca-
tion between acquisitions versus development naturally change
from year to year. Highlights of our 2006 acquisition and devel-
opment activities are set forth below:
• we acquired in our primary geographic regions set forth
above six operating properties totaling 1.0 million square
feet, a building to be redeveloped totaling 74,749 square
feet and seven parcels of land that we believe can support
up to 2.3 million developable square feet, for a total of
$169.7 million;
• we acquired 500 acres of the 591-acre former Fort Ritchie
United States Army base located in Cascade, Washington
County, Maryland for a value of $5.6 million with an ini-
tial cash outlay of $2.5 million and expect to acquire the
remaining 91 acres in 2007. The 591-acre parcel is antici-
pated to accommodate a total of 1.7 million square feet of
office space and 673 residential units, including approxi-
mately 306,000 square feet of existing office space and 110
existing rentable residential units;
• we had seven newly-constructed properties totaling
866,000 square feet become fully operational. We also had
68,196 square feet placed into service in one partially
operational property; and
• we had eight properties under construction (seven wholly
owned), four properties under redevelopment (two
wholly owned) and 11 properties under development (nine
wholly owned) at December 31, 2006.
While we generally do not acquire properties with the intent
of selling them, we do sell properties from time to time when
we believe that most of the earnings growth potential in that
property has been realized, or determine that the property no
longer fits within our strategic plans due to its type and/or
location. During 2006, we sold seven operating properties,
including three from one of our non-core regions, a newly
constructed property and a parcel of land for a total of $83.0
million, resulting in recognized gains before minority interest
totaling $17.3 million.
Our financing policy is aimed at maintaining a flexible capital
structure in order to facilitate consistent growth and perfor-
mance in the face of differing market conditions in the most
cost-effective way possible. As part of this policy, we monitor
(1) levels of debt relative to our overall capital structure; (2) the
relationship of certain measures of earnings to certain financ-
ing cost requirements (coverage ratios); (3) the relationship of
our total variable-rate debt to our total debt; and (4) the timing
of our debt maturities to ensure that the maximum maturities
of debt in any year do not exceed a defined percentage of total
assets. We also pursue opportunities, when we believe market
conditions to be favorable, to: (1) reduce financing costs by
refinancing existing debt or redeeming existing preferred
equity; (2) issue common and preferred shares of beneficial
interest (“common shares” and “preferred shares”); and (3)
issue equity units in our Operating Partnership. Highlights
of our 2006 financing activities are set forth below:
3030
• we sold 2.0 million common shares to an underwriter
at a net price of $41.31 per share, for net proceeds of
$82.4 million;
• we sold 3,390,000 Series J Cumulative Redeemable Pre-
ferred Shares (the “Series J Preferred Shares”) at a price of
$25 per share for net proceeds of $81.9 million;
• we redeemed the Series E Cumulative Redeemable Pre-
ferred Shares of beneficial interest (the “Series E Preferred
Shares”) and the Series F Cumulative Redeemable Pre-
ferred Shares of beneficial interest (the “Series F Preferred
Shares”) for a redemption price of $25 per share, resulting
in a total payment of $64.4 million. We recognized a $3.9
million decrease to net income available to common
shareholders pertaining to the original issuance costs
of these shares;
• we issued a $200.0 million aggregate principal amount of
3.50% Exchangeable Senior Notes due 2026. The notes are
redeemable by us on or after September 20, 2011. The
notes also contain an exchange settlement feature, which
provides that the notes may, under certain circumstances,
be exchangeable for cash (up to the principal amount of
the notes) and, with respect to any excess exchange value,
may be exchangeable into (at our option) cash, our com-
mon shares or a combination of cash and common shares
at an initial exchange rate of 18.4162 shares per $1,000
principal amount of the notes; and
• we borrowed $146.5 million under a 10-year mortgage
payable requiring payments of interest only at a fixed rate
of 5.43%.
We discuss our 2006 investing and financing activities further
in the section below entitled “Liquidity and Capital Resources,”
along with discussions of, among other things, the following:
• our cash flows;
• how we expect to generate cash for short- and long-term
capital needs;
• our off-balance sheet arrangements in place that are rea-
sonably likely to affect our financial condition; and
• our commitments and contingencies.
On January 9 and 10, 2007, we completed a series of transac-
tions that resulted in the acquisition of 56 operating properties
totaling 2.4 million square feet and land parcels totaling 187
acres. We refer to this transaction as the Nottingham Acqui-
sition. All of the acquired properties are located in Maryland,
with 36 of the operating properties, totaling 1.6 million square
feet, and land parcels totaling 175 acres, located in White Marsh,
Maryland and the remaining properties and land parcels
located in other regions in Northern Baltimore County and the
Baltimore/Washington Corridor. We believe that the land par-
cels totaling 187 acres can support at least 2.0 million develop-
able square feet. We completed the Nottingham Acquisition for
an aggregate cost of approximately $363.9 million. We financed
the acquisition by issuing $26.6 million in Series K Cumulative
Redeemable Convertible Preferred Shares of beneficial interest
(the “Series K Preferred Shares”) to the seller, issuing $154.9
million in common shares to the seller at a deemed value
of $49 per share, using $20.1 million from an escrow funded
by proceeds from one of our property sales and using debt bor-
rowings for the remainder. We discuss this transaction further
in the section below entitled “Liquidity and Capital Resources,”
and the section entitled “Results of Operations” in the subsec-
tion entitled “Occupancy and Leasing.”
CRITICAL ACCOUNTING POLICIES
AND ESTIMATES
Our Consolidated Financial Statements are prepared in accor-
dance with generally accepted accounting principles in the
United States of America (“GAAP”), which require us to make
certain estimates and assumptions. A summary of our sig-
nificant accounting policies is provided in Note 2 to our
Consolidated Financial Statements. The following section is a
summary of certain aspects of those accounting policies involv-
ing estimates and assumptions that (1) require our most diffi-
cult, subjective or complex judgments in accounting for highly
uncertain matters or matters that are susceptible to change and
(2) materially affect our reported operating performance or
financial condition. It is possible that the use of different rea-
sonable estimates or assumptions in making these judgments
could result in materially different amounts being reported in
our Consolidated Financial Statements. While reviewing this
section, you should refer to Note 2 to our Consolidated Financial
Statements, including terms defined therein.
• When we acquire real estate properties, we allocate the
acquisition to numerous tangible and intangible compo-
nents. Most of the terms in this bullet section are defined
in the section of Note 2 to the Consolidated Financial
Statements entitled “Acquisitions of Real Estate.” Our pro-
cess for determining the allocation to these components
is very complex and requires many estimates and assump-
tions. Included among these estimates and assumptions
are the following: (1) determination of market rental rates;
(2) estimate of leasing and tenant improvement costs
associated with the remaining term of acquired leases for
deemed cost avoidance; (3) leasing assumptions used in
determining the lease-up value, as-if vacant value and
tenant relationship value, including the rental rates, period
of time that it will take to lease vacant space and estimated
tenant improvement and leasing costs; (4) estimate of the
3131
management’s discussion and analysis of financial condition and results of operations
property’s future value in determining the as-if vacant
value; (5) estimate of value attributable to market con-
centration premiums and tenant relationship values; and
(6) allocation of the as-if vacant value between land and
building. A change in any of the above key assumptions,
most of which are extremely subjective, can materially
change not only the presentation of acquired properties in
our Consolidated Financial Statements but also reported
results of operations. The allocation to different compo-
nents affects the following:
the amount of the acquisition costs allocated among
different categories of assets and liabilities on our bal-
ance sheet, the amount of costs assigned to individual
properties in multiple property acquisitions and the
amount of costs assigned to individual tenants at the
time of acquisition;
where the amortization of the components appear over
time in our statements of operations. Allocations to
the lease to market value component are amortized
into rental revenue, whereas allocations to most of
the other components (the one exception being the
land component of the as-if vacant value) are amor-
tized into depreciation and amortization expense.
As a REIT, this is important to us since much of the
investment community evaluates our operating per-
formance using non-GAAP measures such as funds
from operations, the computation of which includes
rental revenue but does not include depreciation and
amortization expense; and
the timing over which the items are recognized as
revenue or expense in our statements of operations.
For example, for allocations to the as-if vacant value,
the land portion is not depreciated and the building
portion is depreciated over a longer period of time
than the other components (generally 40 years).
Allocations to lease to market value, deemed cost
avoidance, lease-up value and tenant relationship value
are amortized over significantly shorter time frames,
and if individual tenants’ leases are terminated early,
any unamortized amounts remaining associated with
those tenants are generally expensed upon termina-
tion. These differences in timing can materially affect
our reported results of operations. In addition, we
establish lives for lease-up value and tenant relation-
ship value based on our estimates of how long we
expect the respective tenants to remain in the proper-
ties; establishing these lives requires estimates and
assumptions that are very subjective.
• When events or circumstances indicate that a property
may be impaired, we perform an undiscounted cash flow
3232
analysis. We consider an asset to be impaired when its
undiscounted expected future cash flows are less than its
depreciated cost. If such impairment is present, an impair-
ment loss is recognized based on the excess of the carrying
amount of the asset over its fair value. We compute a real
estate asset’s undiscounted expected future cash flows and
fair value using certain estimates and assumptions. As a
result, these estimates and assumptions impact whether
an impairment is deemed to have occurred and the amount
of impairment loss that we recognize.
• We generally use three different accounting methods to
report our investments in entities: the consolidation
method, the equity method and the cost method (see Note
2 to our Consolidated Financial Statements). We generally
use the consolidation method when we own most of
the outstanding voting interests in an entity and can
control its operations. In accordance with Financial
Accounting Standards Board (“FASB”) Interpretation
No. 46(R), “Consolidation of Variable Interest Entities”
(“FIN 46(R)”), we also consolidate certain entities when
control of such entities can be achieved through means
other than voting rights (“variable interest entities” or
“VIEs”) if we are deemed to be the primary beneficiary.
Generally, FIN 46(R) applies when either (1) the equity
investors (if any) lack one or more of the essential charac-
teristics of a controlling financial interest; (2) the equity
investment at risk is insufficient to finance that entity’s
activities without additional subordinated financial sup-
port; or (3) the equity investors have voting rights that
are not proportionate to their economic interests and
the activities of the entity involve or are conducted on
behalf of an investor with a disproportionately small
voting interest. We generally use the equity method of
accounting when we own an interest in an entity and can
exert significant influence over, but cannot control, the
entity’s operations. In making these determinations, we
typically need to make subjective estimates and judgments
regarding the entity’s future operating performance,
financial condition, future valuation and other variables
that may affect the partners’ share of cash flow from the
entity over time. We also need to estimate the probability
of different scenarios taking place over time and project
the effect that each of those scenarios would have on vari-
ables affecting the partners’ cash flows. The conclusion
reached as a result of this process affects whether or not we
use the consolidation method in accounting for our invest-
ment or either the equity or financing method of account-
ing. Whether or not we consolidate an investment can
materially affect our Consolidated Financial Statements.
• We issue share options and restricted shares to many of
our employees. Prior to January 1, 2006, very little expense
was required to be recognized in our financial statements
for share options under GAAP. On January 1, 2006, we
adopted Statement of Financial Accounting Standards
No. 123(R), “Share-Based Payment” (“SFAS 123(R)”).
SFAS 123(R) requires us to measure the cost of employee
services received in exchange for an award of equity
instruments based generally on the fair value of the award
on the grant date; such cost should then be recognized
over the period during which the employee is required
to provide service in exchange for the award (generally the
vesting period). We compute the grant-date fair value
of share options using the Black-Scholes option-pricing
model, which requires the following input assumptions:
risk-free interest rate, expected life, expected volatility and
expected dividend yield. SFAS 123(R) also requires that
share-based compensation be computed based on awards
that are ultimately expected to vest; as a result, future for-
feitures of our share options and restricted shares are to be
estimated at the time of grant and revised, if necessary, in
subsequent periods if actual forfeitures differ from those
estimates. The input assumptions used under the Black-
Scholes option-pricing model and the estimates used in
deriving the forfeiture rates for share options and restricted
shares are subjective and require a fair amount of judg-
ment. As a result, these estimates and assumptions can
affect the amount of expense that we recognize in our
Consolidated Financial Statements for options and
restricted shares.
CONCENTRATION OF OPERATIONS
Geographic Concentration of Property Operations
During 2005 and 2006, we:
• increased our portfolio of wholly owned properties in
the Baltimore/Washington Corridor, Northern Virginia,
Suburban Baltimore and Suburban Maryland regions
through acquisitions and newly constructed properties
placed into service;
• made our initial entry into the San Antonio, Texas and
Colorado Springs, Colorado regions through acquisitions
in 2005 and further expanded our presence in Colorado
Springs through additional acquisitions in 2006;
• sold 80% of the ownership interest in our Greater Harris-
burg portfolio by contributing it into a real estate joint
venture in 2005;
• sold three wholly owned properties in Northern/Central
New Jersey, two in Suburban Baltimore and two in
Suburban Maryland in 2006; and
• sold three wholly owned properties in Northern/Central
New Jersey and one in the Baltimore/Washington Corridor
in 2005.
The table below sets forth the changes in the regional allocation
of our annualized rental revenue occurring primarily as a result
of these acquisition and development activities and changes in
leasing activity:
% of Annualized
Rental Revenue of
Wholly Owned Properties
as of December 31,
2006
2005
2004
51.2%
20.5%
7.5%
4.2%
4.2%
4.1%
3.7%
2.4%
2.2%
N/A
47.8%
21.5%
10.1%
4.3%
1.7%
5.2%
4.0%
1.5%
3.9%
N/A
49.4%
23.2%
4.1%
4.7%
N/A
3.6%
4.6%
N/A
6.5%
3.9%
100.0% 100.0% 100.0%
REGION
Baltimore/Washington Corridor
Northern Virginia
Suburban Baltimore
St. Mary’s and King George Counties
Colorado Springs, Colorado
Suburban Maryland
Greater Philadelphia
San Antonio, Texas
Northern/Central New Jersey
Greater Harrisburg
Annualized rental revenue is a measure that we use to evaluate
the source of our rental revenue as of a point in time. It is com-
puted by multiplying by 12 the sum of monthly contractual
base rents and estimated monthly expense reimbursements
under active leases as of a point in time. We consider annual-
ized rental revenue to be a useful measure for analyzing revenue
sources because, since it is point-in-time based, it does not
contain increases and decreases in revenue associated with peri-
ods in which lease terms were not in effect; historical revenue
under GAAP does contain such f luctuations. We find the
measure particularly useful for leasing, tenant, segment and
industry analysis.
With the completion of the Nottingham Acquisition in January
2007, the percentage of annualized revenue derived from wholly
owned properties in the Suburban Baltimore region increased
to approximately twice what it was prior to the acquisition.
Concentration of Leases with Certain Tenants
We experienced changes in our tenant base during 2006 and
2005 due primarily to acquisitions, development and leasing
activity. The following schedule lists our 20 largest tenants in
our portfolio of wholly owned properties based on percentage
of annualized rental revenue:
3333
management’s discussion and analysis of financial condition and results of operations
Percentage of Annualized
Rental Revenue of
Wholly Owned Properties
for 20 Largest Tenants
as of December 31,
2006
2005
2004
16.3%
6.9%
4.2%
3.8%
3.0%
3.0%
3.0%
2.4%
2.1%
2.1%
1.4%
1.2%
1.1%
1.0%
1.0%
1.0%
0.8%
0.8%
0.8%
0.8%
N/A
N/A
N/A
N/A
N/A
15.2%
5.0%
4.5%
4.1%
2.7%
3.1%
3.4%
2.6%
2.2%
2.1%
1.6%
1.3%
N/A
1.0%
1.1%
N/A
0.9%
0.9%
N/A
N/A
1.3%
1.0%
1.0%
0.9%
N/A
13.3%
5.5%
3.6%
5.2%
4.2%
3.5%
3.9%
3.8%
2.3%
2.3%
1.8%
1.4%
N/A
N/A
1.2%
1.0%
1.1%
N/A
N/A
N/A
1.4%
1.3%
1.1%
1.0%
1.3%
56.7%
43.3%
55.9%
44.1%
60.2%
39.8%
100.0% 100.0% 100.0%
TENANT
United States Government
Booz Allen Hamilton, Inc.
Northrop Grumman Corporation
Computer Sciences Corporation(1)
AT&T Corporation(1)
Unisys(2)
L-3 Communications Holdings, Inc.(1)
General Dynamics Corporation
The Aerospace Corporation
Wachovia Bank
The Boeing Company(1)
Ciena Corporation
Science Applications International
Corporation
Lockheed Martin Corporation
Magellan Health Services, Inc.
BAE Systems PLC
Merck & Co., Inc.(2)
Wyle Laboratories, Inc.
Harris Corporation
EDO Corporation
VeriSign, Inc.
PricewaterhouseCoopers LLP
Johns Hopkins University(1)
Carefirst, Inc. and Subsidiaries(1)
Commonwealth of Pennsylvania(1)
Subtotal of 20 largest tenants
All remaining tenants
Total
(1) Includes affiliated organizations and agencies and predecessor companies.
(2) Unisys subleases space to Merck and Co., Inc.; revenue from this subleased space
is classified as Merck & Co., Inc. revenue.
One aspect of our strategy involves focusing on the formation
of strategic alliances with certain of our tenants from the stand-
point of fulfilling their real estate needs in multiple locations.
This strategy influences not only our leasing activities but also
our acquisition and construction activities. As a result, our rev-
enue concentration with individual tenants could continue to
grow over time as a result of this strategy.
Most of the leases with the United States Government provide
for a series of one-year terms or provide for early termination
rights. The government may terminate its leases if, among other
reasons, the United States Congress fails to provide funding.
Industry Concentration of Tenants
The percentage of total annualized rental revenue in our wholly
owned properties derived from the United States defense indus-
try increased in 2005 and 2006. One reason for this increase is
the continuing expansion of the industry in the Greater
Washington, D.C. region and, in particular, in our submarkets
since the events of September 11, 2001. Another reason for the
increase is that certain of the properties we acquired or con-
structed in 2005 and 2006 have leases with the United States
Government and defense contractors. The table below sets forth
the percentage of annualized rental revenue in our portfolio of
wholly owned properties derived from that industry and, by
doing so, demonstrates our increasing concentration:
% of Annualized
Rental Revenue of
Wholly Owned Properties
from Defense Industry Tenants
as of December 31,
2006
2005
2004
Total Portfolio
Baltimore/Washington Corridor
Northern Virginia
Suburban Baltimore
Suburban Maryland
St. Mary’s and King George Counties
Colorado Springs
San Antonio
54.4%
49.7%
66.7%
65.7%
54.5%
50.4%
9.8%
6.8%
13.3%
2.2%
89.8%
90.7%
74.1%
39.4%
100.0% 100.0%
47.4%
63.4%
50.3%
N/A
3.6%
90.6%
N/A
N/A
As noted above, one aspect of our strategy involves focusing on
the formation of strategic alliances with certain of our tenants
from the standpoint of fulfilling their real estate needs in mul-
tiple locations. Many of the tenants on which this strategy con-
centrates are in the United States defense industry. As a result of
this strategy, our revenue concentration from that industry
could continue to grow over time.
We classify the revenue from our leases into industry groupings
based solely on our knowledge of the tenants’ operations in
leased space. Occasionally, classifications require subjective
and complex judgments. For example, we have a tenant that is
considered by many to be in the computer industry; however,
since the nature of that tenant’s operations in the space leased
3434
from us is focused on providing service to the United States
Government’s defense department, we classify the revenue we
earn from the lease as United States defense industry revenue.
We do not use independent sources such as Standard Industrial
Classification codes for classifying our revenue into industry
groupings and if we did, the resulting groupings would be mate-
rially different.
RESULTS OF OPERATIONS
While reviewing this section, you should refer to the tables in
the section entitled “Selected Financial Data.” You should also
refer to the section below entitled “Liquidity and Capital
Resources” for certain factors that could negatively affect vari-
ous aspects of our operations.
Occupancy and Leasing
The table below sets forth leasing information pertaining to our
portfolio of wholly owned operating properties:
Occupancy rates at year end
Total
Baltimore/Washington
Corridor
Northern Virginia
Suburban Baltimore
Suburban Maryland
St. Mary’s and King George
Counties
Greater Philadelphia
Northern/Central New Jersey
Colorado Springs, Colorado
San Antonio, Texas
Greater Harrisburg
Renewal rate of square footage
for scheduled lease expirations
during year
Average contractual annual
rental rate per square foot at
year end(1)
December 31,
2006
2005
2004
92.8%
94.0%
94.3%
95.1%
90.9%
81.1%
83.2%
92.1%
100.0%
97.2%
92.8%
100.0%
N/A
96.2%
96.4%
84.7%
79.8%
95.4%
100.0%
96.4%
85.8%
100.0%
N/A
95.6%
94.5%
91.0%
82.8%
96.9%
100.0%
92.7%
N/A
N/A
85.4%
55.4%
66.6%
71.4%
$20.90
$20.28
$20.32
(1) Includes estimated expense reimbursements.
As shown in the above table, our portfolio of wholly owned
properties posted an occupancy rate of approximately 92.8% at
December 31, 2006, down from a year end occupancy rate of
approximately 94% in 2005 and 2004; this decrease reflects the
adverse impact of two large building spaces in Northern
Virginia that we have under leases scheduled to commence in
early 2007. We believe that our occupancy rates have benefited
in each of the last three years from the expansion of the United
States defense industry in our largest submarkets. We also
believe that these rates benefited from a national economic
recovery in the real estate industry in 2005 and the stabilization
that followed in 2006. In addition, our wholly owned property
rates were impacted by our acquisition activity; acquisitions of
wholly owned operating properties in 2006 positively impacted
2006 year end occupancy rates, with such properties carrying a
weighted average occupancy rate of 95.1% at December 31,
2006, while 2005 acquisitions adversely affected 2005 year end
occupancy rates, with such properties carrying a weighted aver-
age occupancy rate of 85.7% at December 31, 2005.
Our renewal rates of square footage for scheduled lease expira-
tions decreased in each of the last two years; the 2006 rate in
particular was low in comparison to the 2000 through 2005
calendar years, when the annual renewal rate ranged from 66%
to 76% and averaged 70%. The 2006 renewal rate was adversely
affected by large amounts of space that we knew were not going
to be renewed when we acquired the properties, including
197,000 square feet in two properties; our renewal rates would
have been in the low to mid 60% range without the effect of this
space. While we believe that the ability for us to retain tenants
at the rates that we did in the 2000 through 2005 period is a
challenging task, particularly as we continue to grow, we believe
that our strategy of positioning to be the landlord of choice for
select high quality tenants will enable us to outperform our
competitors in tenant retention in the long run.
Our average contractual annual rent per square foot increased
approximately 3.0% from December 31, 2005 to December 31,
2006 despite the fact that acquisitions completed during 2006
had rents per square foot at December 31, 2006 of $14.12, 32%
below our wholly owned portfolio rate. The increase in this rate
can be attributed primarily to the effect of new leases entered
into at a higher rate during the year and scheduled increases
that took place at leases remaining in place. The decrease in our
average contractual annual rent per square foot from December
31, 2004 to December 31, 2005 was due primarily to our acqui-
sition in 2005 of properties with rents per square foot that aver-
aged $15.71 at December 31, 2005. The lower rent per square
foot on acquisitions in 2006 and 2005 can be attributed primar-
ily to the following: (1) lower rents in geographic areas where
certain acquisitions took place; (2) lower costs for operating
expenses and tenant improvements associated with underlying
leases in certain acquisitions; and (3) lower rents associated
with lower grade space in certain acquisitions.
3535
management’s discussion and analysis of financial condition and results of operations
We believe that there is a fair amount of uncertainty surround-
ing the outlook for leasing activity in 2007. Certain key eco-
nomic indicators, including employment growth, seem to favor
continued strength in our regions’ real estate markets. However,
the recent and scheduled addition of new square footage in our
regions along with continued strong competition from existing
properties in these regions present challenges to the Company’s
ability to meet our 2007 leasing objectives. As we discussed
above, we believe that our occupancy rates have benefited from
the expansion of the United States defense industry in our larg-
est submarkets. Reporting by the Base Realignment and Closure
Commission of the United States Congress favors continued
expansion in the regions in which our properties are located.
However, while we viewed this reporting as favorable for the
Company’s future leasing outlook, there is uncertainty, partic-
ularly in today’s political environment, over the level of and
timing of such expansion.
Despite any uncertainty regarding our 2007 leasing outlook, we
believe that we are somewhat protected in the short run from a
slow down in leasing activity since the weighted average lease
term for our wholly owned properties at December 31, 2006
was five years. In addition, only 12.4% of our annualized rental
revenues at December 31, 2006 were from leases scheduled to
expire by the end of 2007. Looking longer term, 60.6% of our
annualized rental revenues on leases in place as of December 31,
2006 were from leases scheduled to expire by the end of 2011,
with no more than 16% scheduled to expire in any one calendar
year between 2007 and 2011.
The Nottingham Acquisition will initially have an adverse effect
on our leasing and occupancy measures. At December 31, 2006,
the operating properties included in the transaction were
approximately 86% occupied with average rents per square
foot of approximately $17.00. In addition, approximately one-
third of annualized rental revenue at these properties as of
December 31, 2006 were from leases scheduled to expire by the
end of 2007; we expect to renew a majority of the square footage
scheduled to expire in 2007.
As noted above, most of the leases with our largest tenant, the
United States Government, provide for consecutive one-year
terms or provide for early termination rights; all of the leasing
statistics set forth above assume that the United States
Government will remain in the space that they lease through
the end of the respective arrangements, without ending con-
secutive one-year leases prematurely or exercising early termi-
nation rights. We report the statistics in this manner since we
manage our leasing activities using these same assumptions and
believe these assumptions to be probable. Please refer to the
section entitled “Liquidity and Capital Resources” where we
further discuss our leases with the United States Government
and the underlying risks.
The table below sets forth occupancy information pertaining to
properties in which we have a partial ownership interest:
Ownership
Interest
Occupancy Rates at
December 31,
2006
2005
2004
50.0%
92.5%
20.0%
47.9%
100.0%(1)
91.2%
47.9% 47.9%
100.0%(1)
N/A
N/A
89.4%
Geographic Region
Suburban Maryland
Northern Virginia
Greater Harrisburg
Northern/Central
New Jersey
20.0%
N/A(2)
80.9% 84.2%
(1) Excludes the effect of 62,000 unoccupied square feet undergoing redevelopment
at year end.
(2) The property in this geographic region was sold in July 2006.
Revenues from Real Estate Operations and Property
Operating Expenses
We typically view our changes in revenues from real estate
operations and property operating expenses as being comprised
of three main components:
• Changes attributable to the operations of properties owned
and 100% operational throughout the two years being
compared. We define these as changes from “Same-Office
Properties.” For example, when comparing 2005 and 2006,
Same-Office Properties would be properties owned and
100% operational from January 1, 2005 through December
31, 2006. For further discussion of the concept of “opera-
tional,” you should refer to the section of Note 2 of the
Consolidated Financial Statements entitled “Commercial
Real Estate Properties.”
• Changes attributable to operating properties acquired
during the two years being compared and newly-
constructed properties that were placed into service and
not 100% operational throughout the two years being
compared. We define these as changes from “Property
Additions.”
• Changes attributable to properties sold during the two
years being compared that are not reported as discon-
tinued operations. We define these as changes from “Sold
Properties.”
3636
The tables below set forth the components of our changes in revenues from real estate operations and property operating expenses
from continuing operations (dollars in thousands):
Changes from 2005 to 2006
Property
Additions
Dollar
Change(1)
Same-Office
Properties
Dollar
Change
Percentage
Change
Sold
Properties
Dollar
Change(2)
Other
Dollar
Change(3)
Total
Revenues from real estate operations
Rental revenue
Tenant recoveries and other real estate operations revenue
Total
Property operating expenses
Straight-line rental revenue adjustments included in
rental revenue
Amortization of deferred market rental revenue
$51,649
8,232
$ 3,839
2,698
$59,881
$ 6,537
$20,022
$ 4,681
$ 5,194
$ (2,068)
$ 1,272
$
27
Number of operating properties included in component category
53
118
1.9%
9.9%
2.9%
6.8%
N/A
N/A
N/A
$(5,586)
(1,025)
$(1,419)
858
$ 48,483
$ 10,763
$(6,611)
$ (561)
$ 59,246
$(2,259)
$ (193)
$ 22,251
$ (56)
$ (826)
$ 2,244
$ —
$ (27)
$ 1,272
16
1
188
(1) Includes 43 acquired properties and ten newly-constructed properties.
(2) Includes sold properties that are not reported as discontinued operations.
(3) Includes, among other things, the effects of amounts eliminated in consolidation. Certain amounts eliminated in consolidation are attributable to the Property Additions
and Same-Office Properties.
Changes from 2004 to 2005
Property
Additions
Dollar
Change(1)
Same-Office
Properties
Dollar
Change
Percentage
Change
Sold
Properties
Dollar
Change(2)
Other
Dollar
Change(3)
Total
Revenues from real estate operations
Rental revenue
Tenant recoveries and other real estate operations revenue
$34,228
4,088
$ (1,678)
4,332
(1.1)%
22.5%
$(1,991)
(257)
$(1,409)
816
$ 29,150
$ 8,979
Total
$38,316
$ 2,654
1.5%
$(2,248)
$ (593)
$ 38,129
Property operating expenses
$ 9,954
$ 5,344
10.5%
$ (691)
$(1,336)
$ 13,271
Straight-line rental revenue adjustments included in
rental revenue
Amortization of deferred market rental revenue
$ 2,968
$ (4,913)
$ 240
$ (451)
Number of operating properties included in component category
65
93
N/A
N/A
N/A
$ 238
$ (4)
$ (1,711)
$ —
$ (294)
$ (505)
16
1
175
(1) Includes 58 acquired properties and seven newly-constructed properties.
(2) Includes sold properties that are not reported as discontinued operations.
(3) Includes, among other things, the effects of amounts eliminated in consolidation. Certain amounts eliminated in consolidation are attributable to the Property Additions
and Same-Office Properties.
3737
management’s discussion and analysis of financial condition and results of operations
The analysis set forth below in this section pertains to proper-
ties included in continuing operations.
• the change in rental revenue from the Same-Office Prop-
erties from 2004 to 2005 included the following:
As the tables above indicate, our total increase in revenues from
real estate operations and property operating expenses from
2005 to 2006 and from 2004 to 2005 was attributable primarily
to the Property Additions.
The real estate operations in 2005 and 2006 associated with our
property additions were adversely affected somewhat by our
2005 acquisitions carrying occupancy rates that were lower
than the average occupancy rate of our previously existing
properties. Acquisitions in 2005 with particularly low occu-
pancy rates upon acquisition included the following: (1) a 1.1
million square foot portfolio acquired in December 2005 that
has had an occupancy rate averaging approximately 80% since
its acquisition; (2) a 118,000 square foot property acquired in
October 2005 that has been 58% occupied since its acquisition
through the end of 2006; and (3) a 113,000 square foot property
acquired in April 2005 that was 23% occupied from its acquisi-
tion until December 2005, when it became 100% operational.
We occasionally acquire lower occupancy properties such as
these for what we view to be the potential for particularly high
rates of return on our investment in these properties if we are
successful in stabilizing their operations.
With regard to changes in the Same-Office Properties’ revenues
from real estate operations:
• the increase in rental revenue from the Same-Office
Properties from 2005 to 2006 included the following:
• an increase of $2.6 million, or 1.4%, in rental revenue
from the Same-Office Properties attributable primar-
ily to changes in occupancy and rental rates between
the two periods; and
• an increase of $1.2 million, or 26.8%, in net revenue
from the early termination of leases. To explain further
the term net revenue from the early termination of
leases, when tenants terminate their lease obligations
prior to the end of the agreed lease terms, they typi-
cally pay fees to break these obligations. We recognize
such fees as revenue and write off against such revenue
any (1) deferred rents receivable and (2) deferred reve-
nue and deferred assets that are amortizable into rental
revenue associated with the leases; the resulting net
amount is the net revenue from the early termination
of the leases.
• a decrease of $6.4 million, or 66.2%, in net revenue
from the early termination of leases, which was attrib-
utable primarily to two properties; and
• an increase of $4.7 million, or 3.2%, attributable to
changes in occupancy and rental rates between the two
periods; and
• tenant recoveries and other revenue from the Same-Office
Properties increased from 2005 to 2006 and from 2004 to
2005 due primarily to the increase in property operating
expenses described below. While we do have some lease
structures under which tenants pay for 100% of proper-
ties’ operating expenses, our most prevalent lease struc-
ture is for tenants to pay for a portion of property operating
expenses to the extent that such expenses exceed amounts
established in their respective leases that are based on his-
torical expense levels. As a result, while there is an inher-
ent direct relationship between our tenant recoveries and
property operating expenses, this relationship does not
result in a dollar for dollar increase in tenant recoveries as
property operating expenses increase.
With regard to changes in the Same-Office Properties’ property
operating expenses:
• the increase in the Same-Office Properties’ property oper-
ating expenses from 2005 to 2006 included the following:
• an increase of $2.0 million, or 13.3%, in utilities due
primarily to (1) rate increases that we believe are the
result of (a) increased oil prices and (b) energy deregu-
lation in Maryland and (2) our assumption of respon-
sibility for payment of utilities at certain properties
due to changes in occupancy and lease structure;
• an increase of $1.3 million, or 10.3%, in real estate
taxes reflecting primarily an increase in the assessed
value of many of our properties;
• an increase of $651,000, or 8.5%, in repairs and main-
tenance labor due in large part to higher labor hour
rates resulting from an increase in the underlying costs
for labor. The higher labor rates were attributable in
part to an inflationary trend but also to the increased
need for us to employ individuals with specialized
skills who command higher rates;
3838
• an increase of $548,000, or 6.1%, in cleaning expenses
due primarily to (1) increased rates for services at cer-
tain of our properties requiring specialized services
and (2) our assumption of responsibility for payment
of such costs at certain properties due to changes in
occupancy and lease structures;
• an increase of $528,000, or 24.1%, in grounds mainte-
nance due in large part to increased parking lot main-
tenance projects undertaken in the current period;
• an increase of $353,000, or 42.5%, in electric expense,
$154,000 of which pertained to one property which
had a large repair project take place; and
• a decrease of $1.6 million, or 69.1%, due to decreased
snow removal expenses due to less snow and ice pre-
cipitation in 2006.
• the increase in the Same-Office Properties’ property oper-
ating expenses from 2004 to 2005 included the following:
• an increase of $3.7 million, or 43.6%, in utilities due
again primarily to (1) changes in occupancy and lease
structures and (2) rate increases;
• an increase of $915,000, or 84.4%, in snow removal
expense due to greater snow and ice precipitation in
2005; and
• an increase of $572,000, or 8.2%, in building cleaning
expenses due primarily to our assumption of responsi-
bility for payment of such costs at certain properties
due to changes in occupancy and lease structure.
Construction Contract and Other Service Revenues and Expenses
The table below sets forth changes in our construction contract and other service revenues and expenses:
Changes from 2005 to 2006
Changes from 2004 to 2005
Construction
Contract
Dollar Change
Other Service
Operations
Dollar Change
Total
Dollar
Change
Construction
Contract
Dollar Change
Other Service
Operations
Dollar Change
Total
Dollar
Change
Service operations
Revenues
Expenses
Income from service operations
$(22,175)
(22,573)
$ 398
$3,025
2,631
$ 394
$(19,150)
(19,942)
$
792
$49,339
48,801
$ 538
$ 992
1,490
$ (498)
$ 50,331
50,291
$
40
We use the net amount of service operations revenues over
related expenses to evaluate performance. We believe that the
changes in net amounts reflected above were not significant.
Construction contract revenues were significantly higher in
2005 compared to 2006 and 2004 due primarily to a large vol-
ume of activity for certain existing contracts in 2005. It is note-
worthy that our revenue from construction contract activity is
highly concentrated, with five contracts representing approxi-
mately 81% of our 2006 construction contract revenue and four
contracts representing approximately 81% of our construction
contract revenue in 2005.
Other service operations revenue increased 62.0% from 2005 to
2006 due primarily to a higher volume of work for heating and
air conditioning controls and plumbing. Much of the revenue
contributing to this increase was attributable to one client rela-
tionship. We do not expect revenue from other service opera-
tions to increase in the future and it may in fact decrease.
Depreciation and Amortization
Our increase in depreciation and other amortization expense
from 2005 to 2006 was due primarily to a $19.7 million increase
attributable to the Property Additions, offset in part by a $1.6
million decrease attributable to the absence of depreciation and
amortization in 2006 on the Harrisburg portfolio due to its
contribution into an unconsolidated real estate joint venture
in September 2005.
Our increase in depreciation and other amortization expense
from 2004 to 2005 was due primarily to a $9.7 million increase
attributable to the Property Additions and a $2.1 million, or
4.9%, increase attributable to the Same-Office Properties.
General and Administrative Expenses
General and administrative expenses increased as a percentage
of operating income from 12.6% in 2004 to 13.9% in 2005 and
to 14.9% in 2006. Much of this trend can be attributed to an
increase in the size of our employee base in response to the
continued growth of the Company. We expect this trend to
continue in the next one to two years and perhaps longer until
we determine that the Company’s employee base and processes
are positioned appropriately in anticipation of our future
growth expectations.
3939
management’s discussion and analysis of financial condition and results of operations
The increase in general and administrative expense from 2005
to 2006 was attributable primarily to an increase of $2.5 mil-
lion, or 21.5%, in compensation expense due to the increased
number of employees, increased salaries and bonuses for exist-
ing employees and increased expense associated with employee
stock options attributable to our adoption of SFAS 123(R) on
January 1, 2006.
The increase in general and administrative expense from 2004
to 2005 was attributable primarily to an increase of $2.2 mil-
lion, or 23.3%, in compensation expense due to the increased
number of employees, increased expenses associated with
employee restricted share grants and increased salaries and
bonuses for existing employees.
Interest Expense and Amortization of Deferred Financing Costs
Our interest expense and amortization of deferred financing
costs included in continuing operations increased $17.1 million,
or 30.0%, from 2005 to 2006. This increase included the effects
of the following:
• a 20.7% increase in our average outstanding debt balance,
resulting primarily from our 2005 and 2006 acquisition
and construction activities;
• an increase in our weighted average interest rates from
5.8% to 6.2%; and
• a partial offset attributable to a $4.7 million increase
in interest capitalized to construction and development
projects due to increased construction and development
activity.
Our interest expense and amortization of deferred financing
costs included in continuing operations increased $12.5 mil-
lion, or 28.1%, from 2004 to 2005. This increase is due primar-
ily to a 33.4% increase in our average outstanding debt balance
resulting primarily from our 2004 and 2005 acquisition and
construction activities, offset in part by a $4.8 million increase
in interest capitalized to construction and development proj-
ects due to increased construction and development activity.
Interest expense and deferred financing costs as a percentage of
net operating income increased from 51.4% in 2004 to 58.8% in
2005 and to 65.2% in 2006 due in large part to a higher propor-
tion of our investing and financing activities having been
funded by debt versus equity and the reasons discussed above
for the changes in interest expense.
We historically have financed our long-term capital needs,
including property acquisition and development activities,
through a combination of the following:
• borrowings under our Revolving Credit Facility;
• borrowings from new debt;
• issuances of common shares, preferred shares and
common units and/or preferred units in our Operating
Partnership;
• contributions from outside investors into real estate joint
ventures;
• proceeds from sales of real estate; and
• any available residual cash flow from operations.
Many factors go into our decisions regarding when to finance
investing and financing activities using debt versus equity. We
generally use long-term borrowing as attractive financing con-
ditions arise and equity issuances as attractive equity market
conditions arise. As a result, the change in the proportion of
our investing and financing activities funded by debt versus
equity described above is not a trend that necessarily should
be expected to continue.
As of December 31, 2006, 93.1% of our fixed-rate debt was
scheduled to mature after 2007. As of December 31, 2006, 11.7%
of our total debt had variable interest rates, including the effect
of interest rate swaps. For a more comprehensive presentation
of our fixed-rate loan maturities, please refer to the section
below entitled “Quantitative and Qualitative Disclosures About
Market Risk.”
Minority Interests
Interests in our Operating Partnership are in the form of pre-
ferred and common units. The line entitled “minority interests
in income from continuing operations” includes primarily
income before continuing operations allocated to preferred and
common units not owned by us; for the amount of this line
attributable to preferred units versus common units, you should
refer to our Consolidated Statements of Operations. Income
is allocated to minority interest preferred unitholders in an
amount equal to the priority return from the Operating
Partnership to which they are entitled. Income is allocated to
minority interest common unitholders based on the income
earned by the Operating Partnership after allocation to pre-
ferred unitholders multiplied by the percentage of the common
units in the Operating Partnership owned by those common
unitholders.
4040
As of December 31, 2006, we owned 95.6% of the outstanding
preferred units and 82.8% of the outstanding common units.
The percentage of the Operating Partnership owned by minor-
ity interests during the last three years decreased in the aggre-
gate due primarily to the effect of the following transactions:
• the issuance of additional units to us as we issued new pre-
ferred shares and common shares during 2004 through
2006 due to the fact that we receive preferred units and
common units in the Operating Partnership each time we
issue preferred shares and common shares;
• the exchange of common units for our common shares by
certain minority interest holders of common units;
• our redemption of the Series B Cumulative Redeemable
Preferred Shares of beneficial interest (the “Series B Pre-
ferred Shares”) in July 2004;
• our issuance of common units to third parties totaling
181,097 in 2006 and 232,655 in 2005 in connection with
acquisitions;
• our issuance of the Series I Preferred Units to a third party
in 2004 (as discussed in Note 2 to the Consolidated Finan-
cial Statements); and
• the redemption by us of the Series E and Series F Preferred
Shares in 2006.
Our income allocated to minority interest holders of preferred
units increased from 2004 to 2005 due to our issuance of the
Series I Preferred Units in September 2004. Our income from
continuing operations allocated to minority interest holders of
common units decreased from 2004 to 2005 and from 2005 to
2006 due primarily to our increasing ownership of common
units (from 75% at December 31, 2003 to 83% at December 31,
2006) and preferred units.
Income from Discontinued Operations
Our income from discontinued operations increased from
2005 to 2006 and from 2004 to 2005 due primarily to increased
gain from sales of properties. See Note 18 to the Consolidated
Financial Statements for a summary of income from discontin-
ued operations.
Adjustments to Net Income to Arrive at Net Income Available
to Common Shareholders
Preferred share dividends increased from 2005 to 2006 due
to the additional dividends attributable to the newly issued
Series J Preferred Shares exceeding the decrease in dividends
attributable to the redemption of the Series E and Series F
Preferred Shares. Preferred share dividends decreased from
2004 to 2005 due primarily to the redemption of the Series B
Preferred Shares.
In 2006, we recognized a $3.9 million decrease to net income
available to common shareholders pertaining to the original
issuance costs incurred on the Series E and Series F Preferred
Shares redeemed during the year. In 2004, we recognized a
$1.8 million decrease to net income available to common share-
holders pertaining to the original issuance costs incurred on
the Series B Preferred Shares redeemed during the year.
Diluted Earnings per Common Share
Diluted earnings per common share on net income available to
common shareholders increased both from 2005 to 2006 and
from 2004 to 2005 due to the effects of increases in net income
available to common shareholders, attributable primarily to the
reasons set forth above, offset somewhat by the higher numbers
of common shares outstanding due to share issuances from
2004 to 2006.
LIQUIDITY AND CAPITAL RESOURCES
In our discussion of liquidity and capital resources set forth
below, we describe certain of the risks and uncertainties relat-
ing to our business. However, they may not be the only ones
that we face.
Cash and Cash Equivalents
Our cash and cash equivalents balance as of December 31, 2006
totaled $7.9 million, a decrease of 26.5% from the balance as
of December 31, 2005. The balance of cash and cash equivalents
that we carried as of the end of each of the eight calendar quar-
ters during the two years ended December 31, 2006 ranged from
$5.7 million to $21.5 million and averaged $12.6 million. The
cash and cash equivalents balances that we carry as of a point
in time can vary significantly due in part to the inherent vari-
ability of the cash needs of our acquisition and development
activities. We maintain sufficient cash and cash equivalents to
meet our operating cash requirements and short-term investing
and financing cash requirements. When we determine that
the amount of cash and cash equivalents on hand is more than
we need to meet such requirements, we may pay down our
Revolving Credit Facility or forgo borrowing under construc-
tion loan credit facilities to fund development activities.
Operating Activities
We generate most of our cash from the operations of our prop-
erties. A review of our Consolidated Statements of Operations
indicates that over the last three years, approximately 29% to
31% of our revenues from real estate operations (defined as the
sum of (1) rental revenue and (2) tenant recoveries and other
real estate operations revenue) were used for property operating
expenses. Most of the amount by which our revenues from real
estate operations exceeded property operating expenses was
cash flow; we applied most of this cash flow towards interest
4141
management’s discussion and analysis of financial condition and results of operations
expense, scheduled principal amortization on debt, dividends
to our shareholders, distributions to minority interest holders
of preferred and common units in the Operating Partnership,
capital improvements and leasing costs for our operating prop-
erties and general and administrative expenses.
affect the ability of our tenants in the defense industry to
fulfill lease obligations or decrease the likelihood that
these tenants will renew their leases. In the case of the
United States Government, a reduction in government
spending could result in the early termination of leases.
Our cash flow from operations determined in accordance with
GAAP increased $17.2 million, or 17.9%, from 2005 to 2006;
this increase is attributable primarily to the additional cash
flow from operations generated by our newly-acquired and
newly-constructed properties. We expect to continue to use
cash flow provided by operations to meet our short-term capi-
tal needs, including all property operating expenses, general
and administrative expenses, interest expense, scheduled prin-
cipal amortization of debt, dividends and distributions and
capital improvements and leasing costs. We do not anticipate
borrowing to meet these requirements. Factors that could
negatively affect our ability to generate cash flow from opera-
tions in the future include the following:
• We earn revenue from renting our properties. Our operat-
ing costs do not necessarily fluctuate in relation to changes
in our rental revenue. This means that our costs will not
necessarily decline and may increase even if our revenue
declines.
• For new tenants or upon lease expiration for existing ten-
ants, we generally must make improvements and pay other
tenant related costs for which we may not receive increased
rents. We also may make building related capital improve-
ments for which tenants may not reimburse us.
• When leases for our properties expire, our tenants may
not renew or may renew on terms less favorable to us than
the terms of their original leases. If a tenant leaves, we can
expect to experience a vacancy for some period of time as
well as higher tenant improvement and leasing costs than
if a tenant renews. As a result, our financial performance
could be adversely affected if we experience a high volume
of tenant departures at the end of their lease terms.
• As discussed earlier, we are dependent on a highly concen-
trated number of tenants for a large percentage of our rev-
enue. Most of the leases of one of these tenants, the United
States Government, provide for a series of one-year terms
or provide for early termination rights. Our cash flow
from operations would be adversely affected if our larger
tenants failed to make rental payments to us, or if the
United States Government elects to terminate several of
its leases and the affected space cannot be re-leased on
satisfactory terms.
• As discussed earlier, a high concentration of our revenues
comes from tenants in the United States defense industry.
A reduction in government spending for defense could
4242
• Our performance depends on the ability of our tenants
to fulfill their lease obligations by paying their rental
payments in a timely manner. In addition, as noted above,
we rely on a relatively small number of tenants for a large
percentage of our revenue from real estate operations. If
one of our major tenants or a number of our smaller ten-
ants were to experience financial difficulties, including
bankruptcy, insolvency or general downturn of business,
there could be an adverse effect on our results of opera-
tions and financial condition.
• We provide construction management services for third-
party clients. When providing these services, we usually
pay for the costs of construction and subsequently bill our
clients for the costs of construction plus a construction
management fee. When we provide construction man-
agement services, the costs of construction can amount
to millions of dollars. If any of our clients for these
services fail to reimburse us for costs incurred under a
significant construction management contract, it could
have an adverse effect on our results of operations and
financial condition.
• Since our properties are primarily located in the Mid-
Atlantic region of the United States, especially in the
Greater Washington, D.C. region, and are also typically
concentrated in office parks in which we own most of the
properties, we do not have a broad geographic distribution
of our properties. As a result, a decline in the real estate
market or general economic conditions in the Mid-Atlantic
region, the Greater Washington, D.C. region or the office
parks in which our properties are located could have an
adverse effect on our financial position, results of opera-
tions and cash flows.
• The commercial real estate market is highly competitive.
We compete for the purchase of commercial property with
many entities, including other publicly traded commercial
REITs. Many of our competitors have substantially greater
financial resources than we do. If our competitors prevent
us from buying properties that we target for acquisition,
we may not be able to meet our property acquisition and
development goals. Moreover, numerous commercial
properties compete for tenants with our properties. Some
of the properties competing with ours may have newer or
more desirable locations or the competing properties’
owners may be willing to accept lower rates than are
acceptable to us. Competition for property acquisitions, or
for tenants in properties that we own, could have an
adverse effect on our financial performance.
• $2.4 million using an escrow funded by proceeds from one
of our property sales discussed below; and
• If short-term interest rates were to increase, the interest
payments on our variable-rate debt would increase,
although this increase may be reduced to the extent that
we have interest rate swap and cap agreements outstand-
ing. If longer-term interest rates were to increase, we may
not be able to refinance our existing indebtedness on
terms as favorable as the terms of our existing indebted-
ness and we would pay more for interest expense on new
indebtedness that we incur for future property additions.
• Our portfolio of properties is insured for losses under
our property, casualty and umbrella insurance policies
through September 2007. These policies include coverage
for acts of terrorism. Although we believe that we ade-
quately insure our properties, we are subject to the risk
that our insurance may not cover all of the costs to restore
properties damaged by a fire or other catastrophic event.
In addition, changes in the insurance industry could occur
in the future that may increase the cost of insuring our
properties and decrease the scope of insurance coverage,
either of which could adversely affect our financial posi-
tion and operating results.
• As a REIT, we must distribute at least 90% of our annual
taxable income (excluding capital gains), which limits the
amount of cash we have available for other business pur-
poses, including amounts to fund our growth. Also, it is
possible that because of the differences between the time
that we actually receive revenue or pay expenses and the
period we report those items for distribution purposes, we
may have to borrow funds on a short-term basis to meet
the 90% distribution requirement. We may become sub-
ject to tax liabilities that adversely affect our operating
cash flow.
Investing and Financing Activities During the Year Ended
December 31, 2006
In our primary geographic regions, we acquired six office prop-
erties totaling 1.0 million square feet, a building to be redevel-
oped totaling 74,749 square feet and seven parcels of land that
we believe can support up to 2.3 million developable square feet
for $169.7 million. These acquisitions were financed using the
following:
• $93.4 million in borrowings under our Revolving Credit
Facility;
• $37.5 million from an assumed mortgage loan;
• $7.5 million from the issuance of common units in the
Operating Partnership;
• cash reserves for the balance.
Highlights of these acquisitions include the following:
• we acquired a 611,379 square foot building and land
parcels that we believe can support up to 1.4 million
developable square feet in the Baltimore/Washington
Corridor; and
• after making our initial entry in San Antonio, Texas and
Colorado Springs in 2005, we added to our positions in
each of these regions by acquiring land parcels in each
of these regions and five operational properties totaling
400,000 square feet and a 74,749 square foot redevelop-
ment property in Colorado Springs.
We also acquired approximately 500 acres of the 591-acre for-
mer Fort Ritchie United States Army base located in Cascade,
Washington County, Maryland for a value of $5.6 million using
an initial cash outlay of $2.5 million, and expect to acquire the
remaining 91 acres in 2007. The 591-acre parcel is anticipated to
accommodate a total of 1.7 million square feet of office space
and 673 residential units, including approximately 306,000
square feet of existing office space and 110 existing rentable
residential units, with development expected to occur over a
period of 10 to 15 years. In connection with the aggregate acqui-
sition, we expect to initially make the following future cash
payments to the seller: (1) $465,000 in 2007 in connection with
the acquisition of the remaining 91 acres; and (2) an additional
$2.0 million over the period from 2007 through 2009. We could
incur an additional cash obligation to the seller after that of up
to $4.0 million; this obligation is subject to reduction by an
amount ranging between $750,000 and $4.0 million, with the
amount of such reduction to be determined based on defined
levels of (1) job creation resulting from the future development
of the property and (2) future real estate taxes generated by
the property. We are also obligated under the terms of the
acquisition agreement to incur $7.5 million in development and
construction costs for the property by 2011.
In addition, we acquired, using cash reserves, the following
properties through joint venture structures:
• a land parcel located in the Baltimore /Washington
Corridor, with a value upon our acquisition of approxi-
mately $4.6 million, through Commons Office 6-B, LLC,
a 50% owned consolidated joint venture constructing an
office property totaling approximately 44,000 square feet.
Our initial cash investment in this joint venture was $1.6
million; and
4343
management’s discussion and analysis of financial condition and results of operations
• a 153-acre parcel of land located near the Indian Head
Naval Surface War Center in Charles County, Maryland,
with a value upon our acquisition of $2.9 million, through
COPT-FD Indian Head, LLC, a 75% owned consolidated
joint venture. Our initial cash investment in this joint ven-
ture was $2.2 million.
As part of our core customer expansion strategy, we also entered
into lease agreements with Northrop Grumman Corporation
to develop two data and call centers totaling 296,000 square
feet. The terms of these lease agreements call for the land par-
cels on which the centers are being developed to be conveyed to
us for no cash payment other than closing costs. One of these
centers is located in Greater Richmond, Virginia and the other
in Southwest Virginia. The land parcel in Greater Richmond,
Virginia was conveyed to us in 2006 and we expect the land
parcel in Southwest Virginia to be conveyed in 2007.
We had seven newly-constructed properties totaling 866,000
square feet become fully operational in 2006. These properties,
which were 94.6% leased in the aggregate at December 31, 2006,
were located in the following geographic regions: four proper-
ties totaling 532,000 square feet in the Baltimore/Washington
Corridor; one property totaling 223,610 square feet in Northern
Virginia; one property totaling 50,000 square feet in Colorado
Springs; and one property totaling 60,029 square feet in St.
Mary’s County, Maryland. Costs incurred on these properties
through December 31, 2006 totaled $144.2 million, $30.6 mil-
lion of which was incurred in 2006. We financed the 2006 costs
using primarily borrowings under existing construction loan
facilities and proceeds from our Revolving Credit Facility.
At December 31, 2006, we had construction activities underway
on eight office properties totaling 831,000 rentable square feet
that were 79.5% pre-leased, including 68,196 square feet already
placed into service in a partially operational property. One of
these properties is owned through a consolidated joint venture
in which we have a 50% interest. Six of these properties totaling
535,000 square feet are located in our primary geographic
regions, including four properties totaling 452,000 square feet
in the Baltimore/Washington Corridor, and the other two
properties totaling 296,000 square feet are the Northrop
Grumman Corporation data and call centers in Virginia dis-
cussed above. Costs incurred on these properties through
December 31, 2006 totaled approximately $194.0 million, of
which approximately $79.1 million was incurred in 2006. We
have construction loan facilities in place totaling $73.7 million
to finance the construction of four of these properties; bor-
rowings under these facilities totaled $52.4 million at Decem-
ber 31, 2006, $43.8 million of which was borrowed in 2006.
The remaining costs incurred in 2006 were funded using
primarily borrowings from our Revolving Credit Facility and
cash reserves.
The table below sets forth the major components of our
additions to the line entitled “Total Commercial Real Estate
Properties” on our Consolidated Balance Sheet for 2006 (in
thousands):
Acquisitions
Construction and development
Capital improvements on operating properties
Tenant improvements on operating properties
$166,416
132,565
20,767
20,414(1)
$340,162
(1) Tenant improvement costs incurred on newly-constructed properties are classi-
fied in this table as construction and development.
We sold the following during 2006:
• seven operational properties totaling 531,000 square feet,
a newly-constructed property and a land parcel for a total
of $83.0 million, resulting in recognized gain of $17.3 mil-
lion. The net proceeds from these sales after transaction
costs totaled $80.4 million. We used $36.1 million of these
proceeds to fund escrows to be applied towards future
acquisitions and $4.8 million to repay a mortgage loan on
a property and applied most of the balance to pay down
our Revolving Credit Facility; and
• a 157,394 square foot property, which was owned by an
unconsolidated real estate joint venture in which we had a
20% interest, for $27.0 million, resulting in a recognized
gain to us of $563,000. The net proceeds to us from this
transaction were approximately $1.5 million.
On September 18, 2006, the Operating Partnership issued a
$200.0 million aggregate principal amount of 3.50% Exchange-
able Senior Notes due 2026. Interest on the notes is payable on
March 15 and September 15 of each year. The notes have an
exchange settlement feature that provides that the notes may,
under certain circumstances, be exchangeable for cash (up to
the principal amount of the notes) and, with respect to any
excess exchange value, may be exchangeable into (at our option)
cash, our common shares or a combination of cash and our
common shares at an exchange rate (subject to adjustment)
of 18.4284 shares per $1,000 principal amount of the notes
(exchange rate is as of December 31, 2006 and is equivalent to
an exchange price of $54.30 per common share). On or after
September 20, 2011, the Operating Partnership may redeem the
notes in cash in whole or in part. The holders of the notes have
the right to require us to repurchase the notes in cash in whole
or in part on each of September 15, 2011, September 15, 2016
and September 15, 2021, or in the event of a “fundamental
change,” as defined under the terms of the notes, for a repur-
chase price equal to 100% of the principal amount of the notes
plus accrued and unpaid interest. Prior to September 11, 2011,
subject to certain exceptions, if (1) a “fundamental change”
occurs as a result of certain forms of transactions or series of
4444
transactions and (2) a holder elects to exchange its notes in con-
nection with such “fundamental change,” we will increase the
applicable exchange rate for the notes surrendered for exchange
by a number of additional shares of our common shares as a
“make whole premium.” The notes are general unsecured senior
obligations of the Operating Partnership and rank equally in
right of payment with all other senior unsecured indebtedness
of the Operating Partnership. The Operating Partnership’s obli-
gations under the notes are fully and unconditionally guaran-
teed by us. We used the $195.7 million in net proceeds available
after transaction costs from this issuance as follows:
• $134.0 million to pay down borrowings under our Revolv-
ing Credit Facility;
• $52.5 million to repay other debt; and
• applied the balance to cash reserves.
On December 28, 2006, we borrowed $146.5 million under a
mortgage loan with a 10-year term at a fixed rate of 5.43%. We
used the proceeds from this loan to pay down borrowings under
our Revolving Credit Facility.
During 2006, we entered into three interest rate swaps to hedge
the risk of changes in interest rates on certain of our one-month
LIBOR-based variable rate borrowings until their respective
maturities, information for which is set forth below (dollars
in thousands):
Nature of
Derivative
Notional
Amount
One-Month
LIBOR Base
Effective
Date
Expiration
Date
Interest rate swap
Interest rate swap
Interest rate swap
$50,000
25,000
25,000
5.0360% 3/28/2006
5.2320% 5/1/2006
5.2320% 5/1/2006
3/30/2009
5/1/2009
5/1/2009
During 2006, we completed the following sales of equity:
• 2.0 million common shares in April 2006 to an under-
writer at a net price of $41.31 per share for net proceeds
of $82.4 million. We contributed the net proceeds to our
Operating Partnership in exchange for 2.0 million com-
mon units. The proceeds were used primarily to pay down
our Revolving Credit Facility.
• 3,390,000 Series J Preferred Shares on July 20, 2006 at a
price of $25.00 per share for net proceeds of $81.9 million.
These shares are nonvoting and redeemable for cash at
$25.00 per share at our option on or after July 20, 2011.
Holders of these shares are entitled to cumulative divi-
dends, payable quarterly (as and if declared by the Board
of Trustees). Dividends accrue from the date of issue at
the annual rate of $1.90625 per share, which is equal to
7.625% of the $25.00 per share redemption price. We con-
tributed the net proceeds from the sale to our Operating
Partnership in exchange for 3,390,000 Series J Preferred
Units. The Series J Preferred Units carry terms that are
substantially the same as the Series J Preferred Shares. The
Operating Partnership used most of the net proceeds to
pay down our Revolving Credit Facility.
During 2006, we completed the following preferred share
redemptions using borrowings under our Revolving Credit
Facility:
• all of our outstanding Series E Preferred Shares, which had
carried an annual dividend yield of 10.25%, for $28.8 mil-
lion on July 15, 2006; and
• all of our outstanding Series F Preferred Shares, which had
carried an annual dividend yield of 9.875%, for $35.6 mil-
lion on October 15, 2006.
Analysis of Cash Flow Associated with Investing and
Financing Activities
Our net cash flow used in investing activities decreased $166.5
million, or 39.6%, from 2005 to 2006. This decrease was due
primarily to the following:
• a $217.8 million, or 43.6%, decrease in purchases of and
additions to commercial real estate. This decrease is due
primarily to a decrease in property acquisitions. We found
the market for acquisitions to be extremely competitive in
2006, with potential target properties selling to our com-
petitors at what we believed to be very aggressive prices;
this contributed somewhat to the decrease in property
acquisitions, although timing played a part as well since
the Nottingham Acquisition, to which we had dedicated
considerable time in 2006, closed in January 2007. Our
ability to locate and complete acquisitions is dependent on
numerous variables and, as a result, is inherently subject
to significant fluctuation from period to period; and
• a $49.9 million, or 50.8%, decrease in proceeds from sales
of properties and unconsolidated real estate joint ventures
and contributions of assets to an unconsolidated real
estate joint venture. Since our real estate sales activity is
driven by transactions unrelated to our core operations,
our proceeds from sales of properties are subject to sig-
nificant fluctuation from period to period and, therefore,
we do not believe that the change described above is nec-
essarily indicative of a trend. While we expect to reduce
or eliminate our real estate investments in certain of our
non-core markets in the future, we cannot predict when
and if these dispositions will occur.
4545
management’s discussion and analysis of financial condition and results of operations
Our cash flow provided by financing activities decreased $183.5
million, or 57.1%, from 2005 to 2006. This decrease included
the following:
• a $181.9 million, or 31.3%, increase in repayments of
mortgage and other loans payable. This increase is attrib-
utable primarily to our use of proceeds from additional
equity offerings and the 3.5% Exchangeable Senior Notes
to pay down these loans;
• $64.4 million in cash used to redeem our Series E and
Series F Preferred Shares in 2006; and
• a $216.2 million, or 24.3%, decrease in proceeds from
mortgage and other loans payable due to a larger volume
of refinancing activity; offset in part by
• $200.0 million in proceeds from the 3.5% Exchangeable
Senior Notes in 2006; and
• a $91.5 million, or 115.1%, increase in proceeds from the
issuance of common and preferred shares.
Off-Balance Sheet Arrangements
During 2006, we owned investments in two unconsolidated
joint ventures: Harrisburg Corporate Gateway Partners, L.P.
and Route 46 Partners. We accounted for these joint venture
investments using the equity method of accounting. These joint
ventures were entered into in prior years to enable us to con-
tribute office properties that were previously wholly owned
by us into the joint ventures in order to partially dispose of
our interests. We managed the joint ventures’ property opera-
tions and any required construction projects and earned fees
for these services. Both of these joint ventures have a two-
member management committee that is responsible for making
major decisions (as defined in the joint venture agreements),
and we control one of the management committee positions in
each case.
Route 46 Partners sold its property in July 2006, resulting in
the dissolution of the joint venture and our recognition of
a $563,000 gain. Upon its dissolution, our partner received
a preferential distribution of cash flows for a defined return
and once our partner received its defined return, we received
the remainder.
For Harrisburg Corporate Gateway Partners, L.P., we and our
partner receive returns in proportion to our investments. As
part of our obligations under the joint venture, we may be
required to make unilateral payments to fund rent shortfalls on
behalf of a tenant that was in bankruptcy at the time the joint
venture was formed; our total unilateral commitment under
this guaranty is approximately $306,000, although the tenant’s
account was current as of December 31, 2006. We also agreed to
indemnify the partnership’s lender for 80% of losses under
standard nonrecourse loan guarantees (environmental indem-
nifications and guarantees against fraud and misrepresenta-
tion) during the period of time in which we manage the
partnership’s properties; we do not expect to incur any losses
under these loan guarantees.
The table below sets forth certain additional information
regarding these unconsolidated joint ventures (in thousands):
Investment
Balance at
12/31/06(1)
Net
Cash
Inflow
in 2006
Income
Recognized
from
Investment
in 2006(2)
Fees
Earned
from Joint
Ventures
in 2006(3)
Obligation to
Unilaterally
Fund
Additional
Project Costs
(if necessary)(4)
$(3,614)
$2,438
$471
$619
$306
(1) This amount represents distributions in excess of our investment in Harrisburg
Corporate Gateway Partners, L.P. at December 31, 2006 due to our not recog-
nizing gain on the contribution of properties into the joint venture. We did not
recognize a gain on the contribution since we have contingent obligations, as
described above, that may exceed our proportionate interest remaining in effect
as long as we continue to manage the joint venture’s properties.
(2) This amount includes a gain of $563 on the dissolution of Route 46 Partners.
(3) Fees earned by us for construction, asset management and property manage-
ment services provided to unconsolidated joint ventures.
(4) Amounts reported in this column represent additional investments we could be
required to fund on a unilateral basis, including the rent shortfall payments and
lender indemnifications discussed above. We and our partner are also required
to fund proportionally (based on our ownership percentage) additional amounts
when needed. Since the additional fundings described in this footnote are uncer-
tain in dollar amount and we do not expect that they will be necessary, they are
not included in the table.
During 2006, we also owned investments in four joint ventures
that we accounted for using the consolidation method of
accounting. We use joint ventures such as these from time to
time for reasons that include the following: (1) they can provide
a facility to access new markets and investment opportunities
while enabling us to benefit from the expertise of our part-
ners; (2) they are an alternative source for raising capital to put
towards acquisition or development activities; and (3) they
can reduce our exposure to risks associated with a property and
its activities. Our consolidated and unconsolidated joint ven-
tures are discussed in Note 5 to our Consolidated Financial
Statements, and certain commitments and contingencies related
to these joint ventures are discussed in Note 19.
We had no other material off-balance sheet arrangements dur-
ing 2006.
4646
Contractual Obligations
The following table summarizes our contractual obligations as of December 31, 2006 (in thousands):
CONTRACTUAL OBLIGATIONS(1)(2)
Debt(3)
Interest on debt(4)
Acquisitions of properties(5)
New construction and development contracts and obligations(6)(7)
Third-party construction and development contracts(7)(8)
Capital expenditures for operating properties(7)(9)
Operating leases(10)
Other purchase obligations(11)
For the Years Ended December 31,
2007
2008 to
2009
2010 to
2011
Thereafter
Total
$140,950
76,500
370,865
77,595
59,597
4,283
2,615
2,334
$436,999
112,284
310
—
—
—
1,028
4,545
$181,982
87,654
—
—
—
—
268
4,482
$738,396
204,327
4,000
—
—
—
—
9,714
$1,498,327
480,765
375,175
77,595
59,597
4,283
3,911
21,075
Total contractual cash obligations
$734,739
$555,166
$274,386
$956,437
$2,520,728
(1) The contractual obligations set forth in this table generally exclude individual contracts that had a value of less than $20 thousand. Also excluded are contracts associ-
ated with the operations of our properties that may be terminated with notice of one month or less, which is the arrangement that applies to most of our property
operations contracts.
(2) Not included in this section are amounts contingently payable by us to acquire the membership interests of certain real estate joint venture partners. See Note 19 to our
Consolidated Financial Statements for further discussion of such amounts.
(3) Represents principal maturities only and therefore excludes a net premium of $210,000. Our loan maturities in 2007 include $48.8 million that may be extended until
2008, subject to certain conditions, and approximately $75.8 million that we expect to refinance; the balance of the 2007 maturities represent primarily scheduled
principal amortization payments that we expect to pay using cash flow from operations.
(4) Represents interest costs for debt at December 31, 2006 for the terms of such debt. For variable rate debt, the amounts reflected above used December 31, 2006 interest
rates on variable rate debt in computing interest costs for the terms of such debt. For construction loan facilities where the interest payments are not payable as incurred
but, rather, are added to the balance of the loan during the construction period, the amounts reflected above assumed that such interest costs are paid monthly as
incurred.
(5) Represents contractual obligations at December 31, 2006 to (1) complete the Nottingham Acquisition, which was completed in January 2007 as described below in
“Investing and Financing Activities Subsequent to December 31, 2006”; (2) acquire a parcel of land located in Aberdeen, Maryland, which we expect to
complete in 2007 using borrowings under the Revolving Credit Facility; and (3) complete the acquisition of the remaining 91 acres of the Fort Ritchie Project. A $4.0
million final payment on the Fort Ritchie acquisition included in the “Thereafter” column could be reduced by a range of $750,000 to the full $4.0 million; the amount
of such decrease will be determined based on (1) defined levels of job creation resulting from the future development of the property taking place and (2) future real
estate taxes generated by the property.
(6) Represents contractual obligations pertaining to new construction and development activities. We expect to finance these costs primarily using proceeds from our
Revolving Credit Facility and construction loans.
(7) Because of the long-term nature of certain construction and development contracts, some of these costs will be incurred beyond 2007.
(8) Represents contractual obligations pertaining to projects for which we are acting as construction manager on behalf of unrelated parties who are our clients.
We expect to be reimbursed in full for these costs by our clients.
(9) Represents contractual obligations pertaining to capital expenditures for our operating properties. We expect to finance all of these costs using cash flow from opera-
tions.
(10) We expect to pay these items using cash flow from operations.
(11) Primarily represents contractual obligations pertaining to managed-energy service contracts in place for certain of our operating properties. We expect to pay these
items using cash flow from operations.
Certain of our debt instruments require that we comply with a number of restrictive financial covenants, including leverage ratio,
minimum net worth, minimum fixed charge coverage, minimum debt service and maximum secured indebtedness. As of
December 31, 2006, we were in compliance with these financial covenants.
4747
management’s discussion and analysis of financial condition and results of operations
Investing and Financing Activities Subsequent to
December 31, 2006
On January 9 and 10, 2007, we completed the Nottingham
Acquisition, which resulted in the acquisition of 56 operating
properties totaling 2.4 million square feet and land parcels
totaling 187 acres. All of the acquired properties are located in
Maryland, with 36 of the operating properties, totaling 1.6 mil-
lion square feet, and land parcels totaling 175 acres, located
in White Marsh, Maryland and the remaining properties and
land parcels located in other regions in Northern Baltimore
County and the Baltimore/Washington Corridor. We believe
that the land parcels totaling 187 acres can support at least 2.0
million developable square feet. We completed the Nottingham
Acquisition for an aggregate cost of approximately $363.9 mil-
lion, including approximately $1.4 million in transaction costs.
We financed the acquisition by (1) issuing $26.6 million
in Series K Preferred Shares to the seller; (2) issuing $154.9
million in common shares to the seller, at a deemed value of
$49 per share; (3) assuming existing mortgage loans totaling
$38.0 million, with an average interest rate of approximately
6.0%; (4) assuming an existing mortgage loan totaling $10.3
million, which we repaid on January 11, 2007 using borrowings
under our Revolving Credit Facility; (5) assuming an existing
unsecured loan totaling $89.1 million, with a variable interest
rate of LIBOR plus 1.15% to 1.55% depending on our leverage
levels at different points in time; (6) using $20.1 million from
an escrow funded by proceeds from one of our property sales;
and (7) using borrowings under the Revolving Credit Facility
for the balance.
We believe that the Nottingham Acquisition has the following
strategic benefits:
• we become the largest owner of office properties in White
Marsh, Maryland, a submarket located in the Baltimore/
Washington Corridor, which we believe will be efficiently
integrated into our operations in that region. White Marsh
is also located off of Interstate 95, approximately 18 miles
from Aberdeen Proving Ground, a United States Army
base; we believe that this proximity could potentially ben-
efit certain of our existing and future tenants in the United
States defense industry;
• it increases our critical mass of property holdings in
the Baltimore /Washington Corridor and Suburban
Baltimore;
• it adds future development capacity of approximately 2.0
million square feet in submarkets in which we have sig-
nificant operating property holdings; and
• we were able to hire a number of individuals who were
members of the selling parties’ property management team.
The Series K Preferred Shares issued in the Nottingham Acqui-
sition are valued at, and carry a liquidation preference equal to,
$50 per share. The Series K Preferred Shares are nonvoting,
redeemable for cash at $50 per share at our option on or after
January 9, 2017, and are convertible, subject to certain condi-
tions, into common shares on the basis of 0.8163 common
shares for each preferred share, in accordance with the terms of
the Articles Supplementary describing the Series K Preferred
Shares. Holders of the Series K Preferred Shares are entitled to
cumulative dividends, payable quarterly (as and if declared by
our Board of Trustees). Dividends will accrue from the date of
issue at the annual rate of $2.80 per share, which is equal to
5.6% of the $50 per share liquidation preference.
Other Future Cash Requirements for Investing and
Financing Activities
As previously discussed, as of December 31, 2006, we had con-
struction activities underway on eight office properties totaling
831,000 square feet that were 79.5% pre-leased (one of these
properties is owned through a consolidated joint venture in
which we have a 50% interest). We estimate remaining costs to
be incurred will total approximately $85.6 million upon com-
pletion of these properties; we expect to incur these costs pri-
marily in 2007 and 2008. We have $21.3 million remaining to
be borrowed under construction loan facilities totaling $73.7
million for four of these properties. We expect to fund the
remaining portion of these costs using borrowings from new
construction loan facilities and our Revolving Credit Facility.
As of December 31, 2006, we had development activities under-
way on 11 new office properties estimated to total 1.3 million
square feet (we own a 50% interest in two of these properties).
We estimate that costs for these properties will total approxi-
mately $258.2 million. As of December 31, 2006, costs incurred
on these properties totaled $25.7 million and the balance is
expected to be incurred from 2007 through 2009. We expect to
fund most of these costs using borrowings from new construc-
tion loan facilities.
4848
As of December 31, 2006, we had redevelopment activities
underway on four properties totaling 740,000 square feet (two
of these properties are owned through a consolidated joint
venture in which we own a 92.5% interest). We estimate that
remaining costs of the redevelopment activities will total
approximately $48.3 million. We expect to fund most of these
costs using borrowings under new construction loan facilities.
During 2007 and beyond, we expect to complete other acquisi-
tions of properties and commence construction and develop-
ment activities in addition to the ones previously described. We
expect to finance these activities as we have in the past, using
mostly a combination of borrowings from new debt, borrow-
ings under our Revolving Credit Facility, proceeds from sales of
existing properties and additional equity issuances of common
and/or preferred shares or units.
We often use our Revolving Credit Facility initially to finance
much of our investing and financing activities. We then pay
down our Revolving Credit Facility using proceeds from long-
term borrowings as attractive financing conditions arise and
equity issuances as attractive equity market conditions arise.
The maximum principal amount on our Revolving Credit is
$500.0 million (increased from $400.0 million in July 2006),
with a right to further increase the maximum principal amount
in the future to $600.0 million, subject to certain conditions.
The facility has a scheduled maturity date in March 2008, with
a one-year extension available, subject to certain conditions,
and carries a fee of 0.125% to 0.25% on the amount of the credit
facility that is unused. The borrowing capacity under this
Revolving Credit Facility is generally computed based on 65%
of the value of assets identified by us to support repayment of
the loan. As of February 26, 2007, the borrowing capacity under
the Revolving Credit Facility was $500.0 million, of which
$234.0 million was available.
Factors that could negatively affect our ability to finance our
long-term financing and investing needs in the future include
the following:
• Our strategy is to operate with slightly higher debt levels
than many other REITs. However, these higher debt levels
could make it difficult to obtain additional financing
when required and could also make us more vulnerable to
an economic downturn. Most of our properties have been
mortgaged or encumbered for indebtedness. In addition,
we rely on borrowings to fund some or all of the costs of
new property acquisitions, construction and development
activities and other items.
• We may not be able to refinance our existing indebtedness.
• Much of our ability to raise capital through the issuance of
preferred shares, common shares or securities that are
convertible into our common shares is dependent on the
value of our common and preferred shares. As is the case
with any publicly traded securities, certain factors outside
of our control could influence the value of our common
and preferred shares. These conditions include, but are not
limited to: (1) market perception of REITs in general and
office REITs in particular; (2) market perception of REITs
relative to other investment opportunities; (3) the level of
institutional investor interest in our company; (4) general
economic and business conditions; (5) prevailing interest
rates; and (6) market perception of our financial condi-
tion, performance, dividends and growth potential.
• In 2005 and 2006, we completed acquisitions of proper-
ties in regions where we did not previously own proper-
ties. Moreover, we expect to continue to pursue selective
acquisitions of properties in new regions. These acquisi-
tions may entail risks in addition to those we have faced
in past acquisitions, such as the risk that we do not
correctly anticipate conditions or trends in a new region
and are therefore not able to operate the acquired prop-
erty profitably.
• When we develop and construct properties, we assume the
risk that actual costs will exceed our budgets, that we will
experience construction or development delays and that
projected leasing will not occur, any of which could
adversely affect our financial performance and our ability
to make distributions to our shareholders. In addition, we
generally do not obtain construction financing commit-
ments until the development stage of a project is complete
and construction is about to commence. We may find that
we are unable to obtain financing needed to continue with
the construction activities for such projects.
• We invest in certain entities in which we are not the exclu-
sive investor or principal decision maker. Aside from our
inability to unilaterally control the operations of these
joint ventures, our investments entail the additional
risks that (1) the other parties to these investments may
not fulfill their financial obligations as investors, in which
case we may need to fund such parties’ share of additional
capital requirements and (2) the other parties to these
investments may take actions that are inconsistent with
our objectives.
4949
management’s discussion and analysis of financial condition and results of operations
• Real estate investments can be difficult to sell and con-
vert to cash quickly, especially if market conditions are
depressed. Such illiquidity will tend to limit our ability to
vary our portfolio of properties promptly in response to
changes in economic or other conditions. Moreover, under
certain circumstances, the Internal Revenue Code imposes
certain penalties on a REIT that sells property held for less
than four years. In addition, for certain of our properties
that we acquired by issuing units in our Operating
Partnership, we are restricted by agreements with the sell-
ers of the properties for a certain period of time from
entering into transactions (such as the sale or refinancing
of the acquired property) that will result in a taxable gain
to the sellers without the sellers’ consent. Due to all of
these factors, we may be unable to sell a property at an
advantageous time to fund our long-term capital needs.
• We are subject to various federal, state and local environ-
mental laws. These laws can impose liability on property
owners or operators for the costs of removal or remedia-
tion of hazardous substances released on a property, even
if the property owner was not responsible for the release
of the hazardous substances. Costs resulting from envi-
ronmental liability could be substantial. The presence of
hazardous substances on our properties may also adversely
affect occupancy and our ability to sell or borrow against
those properties. In addition to the costs of government
claims under environmental laws, private plaintiffs may
bring claims for personal injury or other reasons. Addi-
tionally, various laws impose liability for the costs of
removal or remediation of hazardous substances at the
disposal or treatment facility. Anyone who arranges for
the disposal or treatment of hazardous substances at such
a facility is potentially liable under such laws. These laws
often impose liability on an entity even if the facility was
not owned or operated by the entity.
Management Changes
We implemented the following management changes effective
on August 14, 2006:
• Roger A. Waesche, Jr., an Executive Vice President who
had been our Chief Financial Officer since March 1999,
was appointed Executive Vice President and Chief Oper-
ating Officer and, at the same time, ceased to serve as our
Chief Financial Officer; and
• Stephen E. Riffee commenced service as our Executive
Vice President and Chief Financial Officer.
FUNDS FROM OPERATIONS
Funds from operations (“FFO”) is defined as net income
computed using GAAP, excluding gains (or losses) from sales
of real estate, plus real estate-related depreciation and amorti-
zation, and after adjustments for unconsolidated partnerships
and joint ventures. Gains from sales of newly-developed prop-
erties less accumulated depreciation, if any, required under
GAAP are included in FFO on the basis that development ser-
vices are the primary revenue generating activity; we believe
that inclusion of these development gains is in accordance
with the National Association of Real Estate Investment Trusts
(“NAREIT”) definition of FFO, although others may interpret
the definition differently.
Accounting for real estate assets using historical cost account-
ing under GAAP assumes that the value of real estate assets
diminishes predictably over time. NAREIT stated in its April
2002 White Paper on Funds from Operations that “since real
estate asset values have historically risen or fallen with market
conditions, many industry investors have considered presenta-
tions of operating results for real estate companies that use his-
torical cost accounting to be insufficient by themselves.” As a
result, the concept of FFO was created by NAREIT for the REIT
industry to “address this problem.” We agree with the concept
of FFO and believe that FFO is useful to management and inves-
tors as a supplemental measure of operating performance
because, by excluding gains and losses related to sales of previ-
ously depreciated operating real estate properties and excluding
real estate-related depreciation and amortization, FFO can help
one compare our operating performance between periods. In
addition, since most equity REITs provide FFO information to
the investment community, we believe that FFO is useful to
investors as a supplemental measure for comparing our results
to those of other equity REITs. We believe that net income is
the most directly comparable GAAP measure to FFO.
Since FFO excludes certain items includable in net income, reli-
ance on the measure has limitations; management compensates
for these limitations by using the measure simply as a supple-
mental measure that is weighed in the balance with other GAAP
and non-GAAP measures. FFO is not necessarily an indication
of our cash flow available to fund cash needs. Additionally,
5050
it should not be used as an alternative to net income when
evaluating our financial performance or to cash f low from
operating, investing and financing activities when evaluating
our liquidity or ability to make cash distributions or pay debt
service. The FFO we present may not be comparable to the FFO
presented by other REITs since they may interpret the current
NAREIT definition of FFO differently or they may not use the
current NAREIT definition of FFO.
Basic funds from operations (“Basic FFO”) is FFO adjusted
to (1) subtract preferred share dividends and (2) add back
GAAP net income allocated to common units in the Operating
Partnership not owned by us. With these adjustments, Basic
FFO represents FFO available to common shareholders and
common unitholders. Common units in the Operating Partner-
ship are substantially similar to our common shares and are
exchangeable into common shares, subject to certain con-
ditions. We believe that Basic FFO is useful to investors due to
the close correlation of common units to common shares. We
believe that net income is the most directly comparable GAAP
measure to Basic FFO. Basic FFO has essentially the same limi-
tations as FFO; management compensates for these limitations
in essentially the same manner as described above for FFO.
Diluted funds from operations (“Diluted FFO”) is Basic FFO
adjusted to add back any convertible preferred share dividends
and any other changes in Basic FFO that would result from the
assumed conversion of securities that are convertible or
exchangeable into common shares. However, the computation
of Diluted FFO does not assume conversion of securities other
than common units in the Operating Partnership that are con-
vertible into common shares if the conversion of those securi-
ties would increase Diluted FFO per share in a given period. We
believe that Diluted FFO is useful to investors because it is the
numerator used to compute Diluted FFO per share, discussed
below. In addition, since most equity REITs provide Diluted
FFO information to the investment community, we believe
Diluted FFO is a useful supplemental measure for comparing us
to other equity REITs. We believe that the numerator for diluted
earnings per share (“EPS”) is the most directly comparable
GAAP measure to Diluted FFO. Since Diluted FFO excludes
certain items includable in the numerator to diluted EPS, reli-
ance on the measure has limitations; management compensates
for these limitations by using the measure simply as a sup-
plemental measure that is weighed in the balance with other
GAAP and non-GAAP measures. Diluted FFO is not necessar-
ily an indication of our cash flow available to fund cash needs.
Additionally, it should not be used as an alternative to net
income when evaluating our financial performance or to cash
flow from operating, investing and financing activities when
evaluating our liquidity or ability to make cash distributions or
pay debt service. The Diluted FFO that we present may not be
comparable to the Diluted FFO presented by other REITs.
Diluted funds from operations per share (“Diluted FFO per
share”) is (1) Diluted FFO divided by (2) the sum of the (a)
weighted average common shares outstanding during a period,
(b) weighted average common units outstanding during a
period and (c) weighted average number of potential additional
common shares that would have been outstanding during a
period if other securities that are convertible or exchangeable
into common shares were converted or exchanged. However,
the computation of Diluted FFO per share does not assume
conversion of securities other than common units in the
Operating Partnership that are convertible into common shares
if the conversion of those securities would increase Diluted FFO
per share in a given period. We believe that Diluted FFO per
share is useful to investors because it provides investors with a
further context for evaluating our FFO results in the same man-
ner that investors use EPS in evaluating net income available to
common shareholders. In addition, since most equity REITs
provide Diluted FFO per share information to the investment
community, we believe Diluted FFO per share is a useful sup-
plemental measure for comparing us to other equity REITs. We
believe that diluted EPS is the most directly comparable GAAP
measure to Diluted FFO per share. Diluted FFO per share has
most of the same limitations as Diluted FFO (described above);
management compensates for these limitations in essentially
the same manner as described above for Diluted FFO.
5151
management’s discussion and analysis of financial condition and results of operations
Our Basic FFO, Diluted FFO and Diluted FFO per share for 2002 through 2006 and reconciliations of (1) net income to FFO,
(2) the numerator for diluted EPS to diluted FFO and (3) the denominator for diluted EPS to the denominator for diluted FFO
per share are set forth in the following table:
(in thousands, except per share data)
Net income
Add: Real estate-related depreciation and amortization
Add: Depreciation and amortization on unconsolidated real estate entities
Less: Depreciation and amortization allocable to minority interests in other
consolidated entities
Less: Gain on sales of real estate, excluding development portion(1)
Funds from operations (“FFO”)
Add: Minority interests—common units in the Operating Partnership
Less: Preferred share dividends
Less: Issuance costs associated with redeemed preferred shares
Funds from Operations—basic (“Basic FFO”)
Add: Preferred unit distributions
Add: Expense on dilutive share-based compensation
Add: Convertible preferred share dividends
For the Years Ended December 31,
2006
2005
2004
2003
2002
$ 49,227
78,631
910
$ 39,031
62,850
182
$ 37,032
51,371
106
$ 30,877
36,681
295
$ 23,301
30,832
165
(163)
(17,644)
110,961
7,276
(15,404)
(3,896)
98,937
—
—
—
(114)
(4,422)
97,527
5,889
(14,615)
—
88,801
—
—
—
(86)
(95)
88,328
5,659
(16,329)
(1,813)
75,845
—
382
21
—
(2,897)
64,956
6,712
(12,003)
—
59,665
1,049
10
544
—
(268)
54,030
5,800
(10,134)
—
49,696
2,287
327
544
Funds from Operations—diluted (“Diluted FFO”)
$ 98,937
$ 88,801
$ 76,248
$ 61,268
$ 52,854
Weighted average common shares
Conversion of weighted average common units
Weighted average common shares/units—Basic FFO
Dilutive effect of share-based compensation awards
Assumed conversion of weighted average convertible preferred units
Assumed conversion of weighted average convertible preferred shares
Weighted average common shares/units—Diluted FFO
Diluted FFO per common share
Numerator for diluted EPS
Add: Minority interests—common units in the Operating Partnership
Add: Real estate-related depreciation and amortization
Add: Depreciation and amortization on unconsolidated real estate entities
Less: Depreciation and amortization allocable to minority interests in other
consolidated entities
Less: Gain on sales of real estate, excluding development portion(1)
Add: Convertible preferred share dividends
Add: Preferred unit distributions
Add: Expense on dilutive share-based compensation
Add: Repurchase of Series C Preferred Units in excess of recorded book value
Diluted FFO
Denominator for diluted EPS
Weighted average common units
Assumed conversion of weighted average convertible preferred shares
Assumed conversion of weighted average convertible preferred units
Dilutive effect of share-based compensation awards
Denominator for Diluted FFO per share
41,463
8,511
49,974
1,799
—
—
51,773
37,371
8,702
46,073
1,626
—
—
47,699
33,173
8,726
41,899
1,896
—
134
43,929
26,659
8,932
35,591
1,405
1,101
1,197
39,294
22,472
9,282
31,754
1,262
2,421
1,197
36,634
$
1.91
$
1.86
$
1.74
$
1.56
$
1.44
$ 29,927
7,276
78,631
910
$ 24,416
5,889
62,850
182
$ 18,911
5,659
51,371
106
$ 7,650
6,712
36,681
295
$ 13,167
5,800
30,832
165
(163)
(17,644)
—
—
—
—
(114)
(4,422)
—
—
—
—
(86)
(95)
—
—
382
—
—
(2,897)
544
1,049
10
11,224
—
(268)
544
2,287
327
—
$ 98,937
$ 88,801
$ 76,248
$ 61,268
$ 52,854
43,262
8,511
—
—
—
51,773
38,997
8,702
—
—
—
47,699
34,982
8,726
—
—
221
43,929
28,021
8,932
1,197
1,101
43
39,294
23,350
9,282
1,197
2,421
384
36,634
(1) Gains from the sale of real estate that are attributable to sales of non-operating properties are included in FFO. Gains from newly-developed or redeveloped properties
less accumulated depreciation, if any, required under GAAP are also included in FFO on the basis that development services are the primary revenue generating activ-
ity; we believe that inclusion of these development gains is in compliance with the NAREIT definition of FFO, although others may interpret the definition differently.
5252
INFLATION
Most of our tenants are obligated to pay their share of a building’s operating expenses to the extent such expenses exceed amounts
established in their leases, based on historical expense levels. Some of our tenants are obligated to pay their full share of a
building’s operating expenses. These arrangements somewhat reduce our exposure to increases in such costs resulting from
inflation. In addition, since our average lease life is approximately five years, we generally expect to be able to compensate for
increased operating expenses through increased rental rates upon lease renewal or expiration.
Our costs associated with constructing buildings and completing renovation and tenant improvement work increased due
to higher cost of materials. We expect to recover a portion of these costs through higher tenant rents and reimbursements for
tenant improvements. The additional costs that we do not recover increase depreciation expense as projects are completed and
placed into service.
RECENT ACCOUNTING PRONOUNCEMENTS
For disclosure regarding recent accounting pronouncements and the anticipated impact they will have on our operations, you
should refer to Note 2 to our Consolidated Financial Statements.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to certain market risks, the most predominant of which is change in interest rates. Increases in interest rates can
result in increased interest expense under our Revolving Credit Facility and our other debt carrying variable interest rate terms.
Increases in interest rates can also result in increased interest expense when our debt carrying fixed interest rate terms mature and
need to be refinanced. Our debt strategy favors long-term, fixed-rate, secured debt over variable-rate debt to minimize the risk of
short-term increases in interest rates. As of December 31, 2006, 93.1% of our fixed-rate debt was scheduled to mature after 2007. As
of December 31, 2006, 7.2% of our total debt had variable interest rates, including the effect of interest rate swaps. As of December
31, 2006, the percentage of variable-rate debt, including the effect of interest rate swaps, relative to total assets was 11.4%.
The following table sets forth our long-term debt obligations by scheduled maturity and weighted average interest rates at December
31, 2006 (dollars in thousands):
Long-term debt:
Fixed rate(1)
Average interest rate
Variable rate
Average interest rate
For the Years Ended December 31,
2007
2008
2009
2010
2011
Thereafter
Total
$ 83,818
$ 156,761
$ 61,791
$ 73,128
$ 108,854
$738,396
$ 1,222,748
6.49%
6.42%
6.20%
5.98%
5.76%
7.27%
6.82%
$ 57,132
$ 218,447
7.20%
6.83%
$ — $ — $ — $ —
—
—
—
—
$ 275,579
7.05%
(1) Represents principal maturities only and therefore excludes net premiums of $210,000.
The fair market value of our debt was $1.50 billion at December 31, 2006 and $1.35 billion at December 31, 2005. If interest rates
on our fixed-rate debt had been 1% lower, the fair value of this debt would have increased by $48.4 million at December 31, 2006
and $41.9 million at December 31, 2005.
5353
We occasionally use derivative instruments such as interest rate swaps to further reduce our exposure to changes in interest rates.
The following table sets forth information pertaining to our derivative contracts in place as of December 31, 2006 and 2005, and
their respective fair values (dollars in thousands):
Nature of Derivative
Interest rate swap
Interest rate swap
Interest rate swap
Notional
Amount
One-Month
LIBOR Base
Effective
Date
Expiration
Date
$50,000
25,000
25,000
5.0360%
5.2320%
5.2320%
3/28/2006
5/1/2006
5/1/2006
3/30/2009
5/1/2009
5/1/2009
Fair Value at
December 31,
2006
2005
$ (42) N/A
(133) N/A
(133) N/A
$ (308)
$ —
Based on our variable-rate debt balances, our interest expense would have increased by $3.2 million in 2006 and $3.6 million in
2005 if short-term interest rates were 1% higher. Interest expense in 2006 was less sensitive to a change in interest rates than 2005
due primarily to our having a lower average variable-rate debt balance in 2006.
5454
management’s report on internal control over financial reporting
Management is responsible for establishing and maintaining
adequate internal control over financial reporting, and for per-
forming an assessment of the effectiveness of internal control
over financial reporting as of December 31, 2006. Internal con-
trol over financial reporting is a process designed to provide
reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for exter-
nal purposes in accordance with generally accepted accounting
principles. Our internal control over financial reporting
includes those policies and procedures that (i) pertain to the
maintenance of records that, in reasonable detail, accurately
and fairly reflect the transactions and dispositions of our assets;
(ii) provide reasonable assurance that transactions are recorded
as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and
that our receipts and expenditures are being made only in
accordance with authorizations of our management and trust-
ees; and (iii) provide reasonable assurance regarding preven-
tion or timely detection of unauthorized acquisition, use or
disposition of our assets that could have a material effect on
the financial statements. Because of its inherent limitations,
internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that con-
trols may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures
may deteriorate.
Management performed an assessment of the effectiveness of
our internal control over financial reporting as of December
31, 2006 based upon criteria in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organiza-
tions of the Treadway Commission (“COSO”). Based on our
assessment, management determined that our internal control
over financial reporting was effective as of December 31, 2006
based on the criteria in Internal Control—Integrated Framework
issued by the COSO.
Our management’s assessment of the effectiveness of the Com-
pany’s internal control over financial reporting as of December
31, 2006 has been audited by PricewaterhouseCoopers LLP,
an independent registered public accounting firm, as stated in
their report which appears herein.
Dated: March 1, 2007
Randall M. Griffin
President and
Chief Executive Officer
Stephen E. Riffee
Executive Vice President
and Chief Financial Officer
5555
report of independent registered public accounting firm
To Board of Trustees and Shareholders of
Corporate Office Properties Trust:
We have completed integrated audits of Corporate Office
Properties Trust’s consolidated financial statements and of its
internal control over financial reporting as of December 31,
2006, in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Our opinions,
based on our audits, are presented below.
Consolidated Financial Statements and Financial
Statement Schedule
In our opinion, the accompanying consolidated balance sheets
and the related consolidated statements of operations, share-
holders’ equity and cash flows present fairly, in all material
respects, the financial position of Corporate Office Properties
Trust and its subsidiaries at December 31, 2006 and 2005, and
the results of their operations and their cash flows for each of
the three years in the period ended December 31, 2006 in con-
formity with accounting principles generally accepted in the
United States of America. These financial statements are the
responsibility of the Company’s management. Our responsibil-
ity is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements
in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of
material misstatement. An audit of financial statements includes
examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by
management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable
basis for our opinion.
Internal Control over Financial Reporting
Also, in our opinion, management’s assessment, included in the
accompanying “Management’s Report on Internal Control over
Financial Reporting,” that the Company maintained effective
internal control over financial reporting as of December 31,
2006 based on criteria established in Internal Control—
Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO), is fairly
stated, in all material respects, based on those criteria. Fur-
thermore, in our opinion, the Company maintained, in all
material respects, effective internal control over financial
reporting as of December 31, 2006, based on criteria established
in Internal Control—Integrated Framework issued by the COSO.
The Company’s management is responsible for maintaining
5656
effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express opinions on manage-
ment’s assessment and on the effectiveness of the Company’s
internal control over financial reporting based on our audit.
We conducted our audit of internal control over financial
reporting in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control
over financial reporting was maintained in all material respects.
An audit of internal control over financial reporting includes
obtaining an understanding of internal control over financial
reporting, evaluating management’s assessment, testing and
evaluating the design and operating effectiveness of internal
control, and performing such other procedures as we consider
necessary in the circumstances. We believe that our audit pro-
vides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a
process designed to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with
generally accepted accounting principles. A company’s internal
control over financial reporting includes those policies and
procedures that (i) pertain to the maintenance of records that,
in reasonable detail, accurately and fairly ref lect the trans-
actions and dispositions of the assets of the company; (ii) pro-
vide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and
that receipts and expenditures of the company are being made
only in accordance with authorizations of management and
directors of the company; and (iii) provide reasonable assur-
ance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company’s assets that
could have a material effect on the financial statements.
Because of its inherent limitations, internal control over finan-
cial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods
are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compli-
ance with the policies or procedures may deteriorate.
PricewaterhouseCoopers LLP
Baltimore, Maryland
March 1, 2007
consolidated balance sheets corporate office properties trust and subsidiaries
(Dollars in thousands)
ASSETS
Investment in real estate:
Operating properties, net
Projects under construction or development
Total commercial real estate properties, net
Investments in and advances to unconsolidated real estate joint ventures
Investment in real estate, net
Cash and cash equivalents
Restricted cash
Accounts receivable, net
Deferred rent receivable
Intangible assets on real estate acquisitions, net
Deferred charges, net
Prepaid and other assets
Total assets
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Mortgage and other loans payable
3.5% Exchangeable Senior Notes
Accounts payable and accrued expenses
Rents received in advance and security deposits
Dividends and distributions payable
Deferred revenue associated with acquired operating leases
Distributions in excess of investment in unconsolidated real estate joint venture
Fair value of derivatives
Other liabilities
Total liabilities
Minority interests:
Common units in the Operating Partnership
Preferred units in the Operating Partnership
Other consolidated real estate joint ventures
Total minority interests
Commitments and contingencies (Note 19)
Shareholders’ equity:
Preferred Shares of beneficial interest ($0.01 par value; shares authorized of 15,000,000, issued and
outstanding of 7,590,000 at December 31, 2006 and 6,775,000 at December 31, 2005 (Note 11))
Common Shares of beneficial interest ($0.01 par value; 75,000,000 shares authorized, shares issued
and outstanding of 42,897,639 at December 31, 2006 and 39,927,316 at December 31, 2005)
Additional paid-in capital
Cumulative distributions in excess of net income
Value of unearned restricted common share grants
Accumulated other comprehensive loss
Total shareholders’ equity
Total liabilities and shareholders’ equity
See accompanying notes to consolidated financial statements.
December 31,
2006
2005
$ 1,812,883
298,427
$ 1,631,038
255,617
2,111,310
—
2,111,310
7,923
52,856
26,367
41,643
87,325
43,710
48,467
1,886,655
1,451
1,888,106
10,784
21,476
15,606
32,579
90,984
35,046
35,178
$ 2,419,601
$ 2,129,759
$ 1,298,537
200,000
68,190
20,237
19,164
11,120
3,614
308
7,941
$ 1,348,351
—
41,693
14,774
16,703
12,707
3,081
—
4,727
1,629,111
1,442,036
104,934
8,800
2,453
116,187
95,014
8,800
1,396
105,210
76
67
429
758,032
(83,541)
—
(693)
399
657,339
(67,697)
(7,113)
(482)
674,303
582,513
$ 2,419,601
$ 2,129,759
5757
consolidated statements of operations corporate office properties trust and subsidiaries
(Dollars in thousands, except per share data)
Revenues
Rental revenue
Tenant recoveries and other real estate operations revenue
Construction contract revenues
Other service operations revenues
Total revenues
Expenses
Property operating expenses
Depreciation and other amortization associated with real estate operations
Construction contract expenses
Other service operations expenses
General and administrative expenses
Total operating expenses
Operating income
Interest expense
Amortization of deferred financing costs
Income from continuing operations before equity in loss of unconsolidated entities, income
taxes and minority interests
Equity in loss of unconsolidated entities
Income tax expense
Income from continuing operations before minority interests
Minority interests in income from continuing operations
Common units in the Operating Partnership
Preferred units in the Operating Partnership
Other consolidated entities
Income from continuing operations
Income from discontinued operations, net of minority interests
Income before gain (loss) on sales of real estate
Gain (loss) on sales of real estate, net of minority interests
Net income
Preferred share dividends
Issuance costs associated with redeemed preferred shares
Net income available to common shareholders
Basic earnings per common share
Income from continuing operations
Discontinued operations
Net income available to common shareholders
Diluted earnings per common share
Income from continuing operations
Discontinued operations
Net income available to common shareholders
See accompanying notes to consolidated financial statements.
5858
For the Years Ended December 31,
2006
2005
2004
$ 260,493
40,826
52,182
7,902
$ 212,010
30,063
74,357
4,877
$ 182,860
21,084
25,018
3,885
361,403
321,307
232,847
94,504
78,712
49,961
7,384
16,936
72,253
61,049
72,534
4,753
13,534
58,982
49,289
23,733
3,263
10,938
247,497
224,123
146,205
113,906
(71,378)
(2,847)
97,184
(54,872)
(2,229)
86,642
(42,148)
(2,420)
39,681
(92)
(887)
40,083
(88)
(668)
42,074
(88)
(795)
38,702
39,327
41,191
(4,060)
(660)
136
34,118
14,377
48,495
732
(4,670)
(660)
85
34,082
4,681
38,763
268
(5,306)
(179)
12
35,718
1,427
37,145
(113)
49,227
(15,404)
(3,896)
39,031
(14,615)
—
37,032
(16,329)
(1,813)
$ 29,927
$ 24,416
$ 18,890
$
0.37
0.35
$
0.53
0.12
$
0.53
0.04
$
0.72
$
0.65
$
0.57
$
0.36
0.33
$
0.51
0.12
$
0.50
0.04
$
0.69
$
0.63
$
0.54
consolidated statements of shareholders’ equity
corporate office properties trust and subsidiaries
(Dollars in thousands)
Balance at December 31, 2003
(29,397,267 common shares outstanding)
Conversion of common units to common shares (326,108 shares)
Common shares issued to the public (5,033,600 shares)
Common shares issued to employees (4,000 shares)
Series B Preferred Shares redemption
Series D Preferred Shares conversion
Increase in fair value of derivatives
Restricted common share grants issued (99,935 shares)
Value of earned restricted share grants
Exercise of share options (784,398 shares)
Expense associated with share options
Adjustments to minority interests resulting from changes in
ownership of Operating Partnership by COPT
Increase in tax benefit from share-based compensation
Net income
Dividends
Balance at December 31, 2004
(36,842,108 common shares outstanding)
Conversion of common units to common shares (253,575 shares)
Common shares issued to the public (2,300,000 shares)
Decrease in fair value of derivatives
Restricted common share grants issued (130,975 shares)
Restricted common share cancellations (10,422 shares)
Value of earned restricted share grants
Exercise of share options (411,080 shares)
Expense associated with share options
Adjustments to minority interests resulting from changes in
ownership of Operating Partnership by COPT
Decrease in tax benefit from share-based compensation
Net income
Dividends
Balance at December 31, 2005
(39,927,316 common shares outstanding)
Conversion of common units to common shares (245,793 shares)
Common shares issued to the public (2,000,000 shares)
Series J Preferred Shares issued to the public (3,390,000 shares)
Series E Preferred Shares redemption
Series F Preferred Shares redemption
Decrease in fair value of derivatives
Reversal of unearned restricted common share grants upon
adoption of SFAS 123(R)
Exercise of share options (581,932 shares)
Expense associated with share-based compensation
Adjustments to minority interests resulting from changes in
ownership of Operating Partnership by COPT
Increase in tax benefit from share-based compensation
Net income
Dividends
Balance at December 31, 2006
(42,897,639 common shares outstanding)
See accompanying notes to consolidated financial statements.
Preferred
Shares
Common
Shares
Additional
Paid-in
Capital
Cumulative
Distributions
in Excess of
Net Income
Value of
Unearned
Restricted
Common
Share
Grants
Accumulated
Other
Comprehensive
Loss
$ 85
—
—
—
(13)
(5)
—
—
—
—
—
—
—
—
—
67
—
—
—
—
—
—
—
—
—
—
—
—
67
—
—
34
(11)
(14)
—
—
—
—
—
—
—
—
$294
3
50
—
—
12
—
1
—
8
—
—
—
—
—
368
3
23
—
1
—
—
4
—
—
—
—
—
$492,886
8,038
115,184
91
(31,238)
(7)
—
2,270
388
7,502
519
(19,360)
1,955
—
—
578,228
9,117
75,118
—
3,480
(205)
536
4,394
93
(12,888)
(534)
—
—
$(38,483)
—
—
—
—
—
—
—
—
—
—
—
—
37,032
(49,907)
(51,358)
—
—
—
—
—
—
—
—
—
—
39,031
(55,370)
$(4,107)
—
—
—
—
—
—
(2,271)
997
—
—
—
—
—
—
(5,381)
—
—
—
(3,481)
205
1,544
—
—
—
—
—
—
399
657,339
(67,697)
(7,113)
3
20
—
—
—
—
1
6
—
—
—
—
—
11,075
82,413
81,823
(28,739)
(35,611)
—
(5,169)
6,761
3,833
(16,255)
562
—
—
—
—
—
—
—
—
—
—
—
—
—
49,227
(65,071)
—
—
—
—
—
—
7,113
—
—
—
—
—
—
$(294)
—
—
—
—
—
294
—
—
—
—
—
—
—
—
—
—
—
(482)
—
—
—
—
—
—
—
—
—
(482)
—
—
—
—
—
(211)
—
—
—
—
—
—
—
Total
$ 450,381
8,041
115,234
91
(31,251)
—
294
—
1,385
7,510
519
(19,360)
1,955
37,032
(49,907)
521,924
9,120
75,141
(482)
—
—
2,080
4,398
93
(12,888)
(534)
39,031
(55,370)
582,513
11,078
82,433
81,857
(28,750)
(35,625)
(211)
1,945
6,767
3,833
(16,255)
562
49,227
(65,071)
$ 76
$429
$758,032
$(83,541)
$ —
$(693)
$ 674,303
5959
consolidated statements of cash flows corporate office properties trust and subsidiaries
(Dollars in thousands)
Cash flows from operating activities
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Minority interests
Depreciation and other amortization
Amortization of deferred financing costs
Amortization of deferred market rental revenue
Equity in loss of unconsolidated entities
(Gain) loss on sales of real estate
Share-based compensation
Excess income tax benefits from share-based compensation
Changes in operating assets and liabilities:
Increase in deferred rent receivable
(Increase) decrease in accounts receivable
Increase in restricted cash and prepaid and other assets
Increase in accounts payable, accrued expenses and other liabilities
Increase in rents received in advance and security deposits
Other
For the Years Ended December 31,
2006
2005
2004
$ 49,227
$ 39,031
$ 37,032
7,800
80,074
2,981
(1,904)
92
(17,920)
3,833
(562)
(10,004)
(10,844)
(7,098)
13,544
4,181
(249)
6,464
63,555
2,240
(426)
88
(4,690)
2,173
—
(6,922)
1,165
(14,260)
5,953
1,993
(420)
5,826
51,904
2,431
(931)
88
150
1,904
—
(8,372)
(3,579)
(7,859)
3,528
2,322
50
Net cash provided by operating activities
113,151
95,944
84,494
Cash flows from investing activities
Purchases of and additions to commercial real estate properties
Proceeds from sales of properties
Proceeds from sale of unconsolidated real estate joint venture
Proceeds from contribution of assets to unconsolidated real estate joint venture
Acquisition of partner interests in consolidated joint ventures
Investments in and advances from (to) unconsolidated entities
Distributions from unconsolidated entities
Leasing costs paid
Advances to certain real estate joint ventures
Decrease (increase) in restricted cash associated with investing activities
Purchases of furniture, fixtures and equipment
Other
Net cash used in investing activities
Cash flows from financing activities
Proceeds from mortgage and other loans payable
Proceeds from 3.5% Exchangeable Senior Notes
Repayments of mortgage and other loans payable
Deferred financing costs paid
Increase in other liabilities associated with financing activities
Distributions paid to partners in consolidated joint ventures
Net proceeds from issuance of common shares
Net proceeds from issuance of preferred shares
Redemption of preferred shares
Dividends paid
Distributions paid
Excess income tax benefits from share-based compensation
Other
Net cash provided by financing activities
Net (decrease) increase in cash and cash equivalents
Cash and cash equivalents
Beginning of period
End of period
See accompanying notes to consolidated financial statements.
6060
(282,099)
46,704
1,524
—
(5,250)
454
499
(10,480)
—
5,260
(8,109)
(2,337)
(499,926)
29,467
—
68,633
(1,208)
(130)
250
(9,272)
—
(5,620)
(2,434)
(61)
(251,982)
—
—
—
(4,928)
(146)
—
(11,024)
(515)
1,183
(1,308)
—
(253,834)
(420,301)
(268,720)
673,176
200,000
(762,590)
(6,605)
—
(787)
89,202
81,857
(64,375)
(62,845)
(10,422)
562
649
889,399
—
(580,642)
(4,307)
—
—
79,539
—
—
(53,587)
(9,677)
—
595
573,879
—
(421,621)
(3,436)
4,000
—
122,744
—
(31,251)
(47,551)
(8,435)
—
237
137,822
321,320
188,566
(2,861)
(3,037)
4,340
10,784
13,821
9,481
$
7,923
$ 10,784
$ 13,821
notes to consolidated financial statements corporate office properties trust and subsidiaries
(Dollars in thousands, except per share data)
1. ORGANIZATION
Corporate Office Properties Trust (“COPT”) and subsidiaries
(collectively, the “Company”) is a fully-integrated and self-
managed real estate investment trust (“REIT”) that focuses on
the acquisition, development, ownership, management and
leasing of primarily Class A suburban office properties in the
Greater Washington, D.C. region and other select submarkets.
We also have a core customer expansion strategy that is built on
meeting, through acquisitions and development, the multi-
location requirements of our strategic tenants. As of December
31, 2006, our investments in real estate included the following:
• 170 wholly owned operating properties in our portfolio
totaling 15.1 million square feet;
• 16 wholly owned office properties under construction or
development that we estimate will total approximately 1.8
million square feet upon completion and two wholly
owned office properties totaling approximately 129,000
square feet that were under redevelopment;
• wholly owned land parcels totaling 1,048 acres that we
believe are potentially developable into approximately 8.4
million square feet; and
• partial ownership interests in a number of other real
estate projects in operations or under development or
redevelopment.
We conduct almost all of our operations through our operating
partnership, Corporate Office Properties, L.P. (the “Operating
Partnership”), for which we are the managing general partner.
The Operating Partnership owns real estate both directly and
through subsidiary partnerships and limited liability compa-
nies (“LLCs”). A summary of our Operating Partnership’s forms
of ownership and the percentage of those ownership forms
owned by COPT as of December 31, 2006 and 2005 follows:
December 31,
2006
2005
Common Units
Series E Preferred Units(1)
Series F Preferred Units(1)
Series G Preferred Units
Series H Preferred Units
Series I Preferred Units
Series J Preferred Units(2)
(1) These preferred units were redeemed in 2006.
(2) These preferred units were issued in 2006.
83%
N/A
N/A
82%
100%
100%
100% 100%
100% 100%
0%
N/A
0%
100%
Two of our trustees controlled, either directly or through own-
ership by other entities or family members, an additional 14%
of the Operating Partnership’s common units.
In addition to owning interests in real estate, the Operating
Partnership also owns 100% of Corporate Office Management,
Inc. (“COMI”) and owns, either directly or through COMI,
100% of the consolidated subsidiaries that are set forth below
(collectively defined as the “Service Companies”):
Entity Name
Type of Service Business
COPT Property Management Services,
Real Estate Management
LLC (“CPM”)
COPT Development & Construction
Services, LLC (“CDC”)
Corporate Development Services,
LLC (“CDS”)
COPT Environmental Systems,
LLC (“CES”)(1)
Construction and
Development
Construction and
Development
Heating and Air
Conditioning
(1) Prior to 2007, CES’s name was Corporate Cooling and Controls, LLC.
Most of the services that CPM provides are for us. CDC, CDS
and CES provide services to us and to third parties.
2. SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
Basis of Presentation
We generally use three different accounting methods to report
our investments in entities: the consolidation method, the
equity method and the cost method. These methods are
described below.
Consolidation Method
We generally use the consolidation method when we own most
of the outstanding voting interests in an entity and can control
its operations. In accordance with Financial Accounting Stan-
dards Board (“FASB”) Interpretation No. 46(R), “Consolidation
of Variable Interest Entities” (“FIN 46(R)”), we also consolidate
certain entities when control of such entities can be achieved
through means other than voting rights (“variable interest
entities” or “VIEs”) if we are deemed to be the primary benefi-
ciary. Generally, FIN 46(R) applies when either (1) the equity
investors (if any) lack one or more of the essential characteris-
tics of a controlling financial interest; (2) the equity investment
at risk is insufficient to finance that entity’s activities without
additional subordinated financial support; or (3) the equity
investors have voting rights that are not proportionate to their
economic interests and the activities of the entity involve or are
conducted on behalf of an investor with a disproportionately
small voting interest.
6161
notes to consolidated financial statements corporate office properties trust and subsidiaries
(Dollars in thousands, except per share data)
Under the consolidation method of accounting, the accounts
of the entity being consolidated are combined with our
accounts. We eliminate balances and transactions between
companies when we consolidate these accounts. For all of the
periods presented, our Consolidated Financial Statements
include the accounts of:
• COPT;
• the Operating Partnership and its subsidiary partnerships
and LLCs;
• the Service Companies; and
• Corporate Office Properties Holdings, Inc. (of which we
own 100%).
Equity Method
We generally use the equity method of accounting when we
own an interest in an entity and can exert significant influence
over the entity’s operations but cannot control the entity’s
operations. FIN 46(R) affects our determination of when to use
the equity method of accounting since we would generally use
the equity method for VIEs of which we are not the primary
beneficiary. Under the equity method, we report:
• our ownership interest in the entity’s capital as an invest-
ment on our Consolidated Balance Sheets; and
• our percentage share of the earnings or losses from the
entity in our Consolidated Statements of Operations.
Cost Method
We use the cost method of accounting when we own an interest
in an entity and cannot exert significant influence over the
entity’s operations. Under the cost method, we report:
• the cost of our investment in the entity as an investment
on our Consolidated Balance Sheets; and
• distributions to us of the entity’s earnings in our Consoli-
dated Statements of Operations.
Use of Estimates in the Preparation of Financial Statements
We make estimates and assumptions when preparing financial
statements under generally accepted accounting principles
(“GAAP”). These estimates and assumptions affect various
matters, including:
• the reported amounts of assets and liabilities in our
Consolidated Balance Sheets at the dates of the financial
statements;
• the disclosure of contingent assets and liabilities at the
dates of the financial statements; and
• the reported amounts of revenues and expenses in our
Consolidated Statements of Operations during the report-
ing periods.
These estimates include such items as depreciation, allocation
of real estate acquisition costs and allowances for doubtful
accounts. Actual results could differ from those estimates.
These estimates involve judgments with respect to, among other
things, future economic factors that are difficult to predict and
are often beyond management’s control. As a result, actual
amounts could differ from these estimates.
Acquisitions of Real Estate
We allocate the costs of real estate acquisitions to assets acquired
and liabilities assumed based on the relative fair values at the
date of acquisition pursuant to the provisions of Statement
of Financial Accounting Standards No. 141, “Business Com-
binations.” In estimating the fair value of the tangible and
intangible assets acquired, we consider, among other things,
information obtained about each property as a result of our due
diligence, leasing activities and knowledge of the markets in
which the properties are located. We utilize various valuation
methods, such as estimated cash f low projections utilizing
discount and capitalization rate assumptions and available
market information. We allocate the costs of real estate acqui-
sitions to the following components:
• Real estate based on a valuation of the acquired property
performed with the assumption that the property is vacant
upon acquisition (the “as if vacant value”). We then allo-
cate the real estate value derived using this approach
between land and building and improvements using our
estimates and assumptions.
• In-place operating leases to the extent that the present
value of future rents under the contractual lease terms are
above or below the present value of market rents at the
time of acquisition (the “lease to market value”). For
example, if we acquire a property and the leases in place
for that property carry rents below the market rent for
such leases at the time of acquisition, we classify the
amount equal to the difference between (1) the present
value of the future rental revenue under the lease using
market rent assumptions and (2) the present value of
future rental revenue under the terms of the lease as
deferred revenue. Conversely, if the leases in place for that
property carry rents above the market rent, we classify the
difference as an intangible asset. Deferred revenue or
deferred assets recorded in connection with in-place oper-
ating leases of acquired properties are amortized into
rental revenue over the terms of the leases.
• Existing tenants in a property (the “lease-up value”). This
amount represents the value associated with acquiring a
built-in revenue stream on a leased building. It is com-
puted as the difference between the present value of the
property’s (1) revenues less operating expenses as if the
6262
property was vacant upon acquisition and (2) revenues
less operating expenses as if the property was acquired
with leases in place at market rents.
• Deemed cost avoidance of acquiring in-place operating
leases (“deemed cost avoidance”). For example, when a
new lease is entered into, the lessor typically incurs a num-
ber of origination costs in connection with the leases; such
costs include tenant improvements and leasing costs.
When a property is acquired with in-place leases, the orig-
ination costs for such leases were already incurred by the
prior owner. Therefore, to recognize the value of these
costs in recording a property acquisition, we assign value
to the tenant improvements and leasing costs associated
with the remaining term of in-place operating leases.
• Tenant relationship value equal to the additional amount
that we pay for a property in connection with the pres-
ence of a particular tenant in that property (the “tenant
relationship value”). Our valuation of this component
is affected by, among other things, our tenant lease
renewal assumptions and evaluation of existing relation-
ships with tenants.
• Market concentration premium equal to the additional
amount that we pay for a property over the fair value of
assets in connection with our strategy of increasing our
presence in regional submarkets (the “market concentra-
tion premium”).
Commercial Real Estate Properties
We report commercial real estate properties at our depreciated
cost. The amounts reported for our commercial real estate
properties include our costs of:
• acquisitions;
• development and construction;
• building and land improvements; and
• tenant improvements paid by us.
We capitalize interest expense, real estate taxes, direct internal
labor (including allocable overhead costs) and other costs asso-
ciated with real estate undergoing construction and develop-
ment activities to the cost of such activities. We continue to
capitalize these costs while construction and development
activities are underway until a property becomes “operational,”
which occurs upon the earlier of when leases commence on
space or one year after the cessation of major construction
activities. When leases commence on portions of a newly-
constructed property’s space in the period prior to one year
from the cessation of major construction activities, we consider
that property to be “partially operational.” When a property is
partially operational, we allocate the costs associated with the
property between the portion that is operational and the
portion under construction. We start depreciating newly-
constructed properties as they become operational.
We depreciate our assets evenly over their estimated useful
lives as follows:
• Buildings and building
10–40 years
improvements
• Land improvements
10–20 years
• Tenant improvements on
Related lease terms
operating properties
• Equipment and personal property
3–10 years
When events or circumstances indicate that a property may
be impaired, we perform an undiscounted cash flow analysis.
We consider an asset to be impaired when its undiscounted
expected future cash flows are less than its depreciated cost.
When we determine that an asset is impaired, we utilize meth-
ods similar to those used by independent appraisers in estimat-
ing the fair value of the asset; this process requires us to make
certain estimates and assumptions. We then recognize an
impairment loss based on the excess of the carrying amount of
the asset over its fair value. We have not recognized impairment
losses on our real estate assets to date.
When we determine that a real estate asset will be held for sale,
we discontinue the recording of depreciation expense of the
asset and estimate the sales price, net of selling costs; if we then
determine that the estimated sales price, net of selling costs,
is less than the net book value of the asset, we recognize an
impairment loss equal to the difference and reduce the carrying
amounts of assets.
When we sell an operating property, or determine that an
operating property is held for sale, and determine that we have
no significant continuing involvement in such property, we
classify the results of operations for such property as discon-
tinued operations. Interest expense that is specifically identifi-
able to properties included in discontinued operations is used
in the computation of interest expense attributable to discon-
tinued operations. When properties included in the borrowing
base to support lines of credit are classified as discontinued
operations, we allocate a portion of such credit lines’ interest
expense to discontinued operations; we compute this allocation
based on the percentage that the related properties represent of
all properties included in the borrowing base to support such
credit lines.
We expense property maintenance and repair costs when
incurred.
6363
notes to consolidated financial statements corporate office properties trust and subsidiaries
(Dollars in thousands, except per share data)
Sales of Interests in Real Estate
We recognize gains from sales of interests in real estate using
the full accrual method, provided that various criteria relating
to the terms of sale and any subsequent involvement by us with
the real estate sold are met. We recognize gains relating to
transactions that do not meet the requirements of the full
accrual method of accounting when the full accrual method of
accounting criteria are met.
Cash and Cash Equivalents
Cash and cash equivalents include all cash and liquid invest-
ments that mature three months or less from when they are
purchased. Cash equivalents are reported at cost, which approx-
imates fair value. We maintain our cash in bank accounts
in amounts that may exceed federally insured limits at times.
We have not experienced any losses in these accounts in
the past and believe that we are not exposed to significant
credit risk because our accounts are deposited with major
financial institutions.
Accounts Receivable
Our accounts receivable are reported net of an allowance for
bad debts of $252 at December 31, 2006 and $421 at December
31, 2005.
Revenue Recognition
We recognize rental revenue evenly over the terms of tenant
leases. When our leases provide for contractual rent increases,
which is most often the case, we average the non-cancelable
rental revenues over the lease terms to evenly recognize such
revenues; we refer to the adjustments resulting from this pro-
cess as straight-line rental revenue adjustments. We consider
rental revenue under a lease to be non-cancelable when a tenant
(1) may not terminate its lease obligation early or (2) may ter-
minate its lease obligation early in exchange for a fee or penalty
that we consider material enough such that termination would
not be probable. We report these straight-line rental revenue
adjustments recognized in advance of payments received as
deferred rent receivable on our Consolidated Balance Sheets.
We report prepaid tenant rents as rents received in advance on
our Consolidated Balance Sheets.
When tenants terminate their lease obligations prior to the end
of their agreed lease terms, they typically pay fees to cancel
these obligations. We recognize such fees as revenue and write
off against such revenue any (1) deferred rents receivable and
(2) deferred revenue and intangible assets that are amortizable
into rental revenue associated with the leases; the resulting
net amount is the net revenue from the early termination of
the leases. When a tenant’s lease for space in a property is
terminated early but the tenant continues to lease such space
under a new or modified lease in the property, the net revenue
from the early termination of the lease is recognized evenly
over the remaining life of the new or modified lease in place
on that property.
We recognize tenant recovery revenue in the same periods in
which we incur the related expenses. Tenant recovery revenue
includes payments from tenants as reimbursement for property
taxes, utilities and other property operating expenses.
We recognize fees for services provided by us once services are
rendered, fees are determinable and collectibility is assured.
We generally recognize revenue under construction contracts
using the percentage of completion method when the contracts
call for services to be provided over a period of time exceeding
six months and the revenue and costs for such contracts can
be estimated with reasonable accuracy; when these criteria do
not apply to a contract, we recognize revenue on that contract
once the services under the contract are complete. Under the
percentage of completion method, we recognize a percentage of
the total estimated revenue on a contract based on the cost of
services provided on the contract as of a point in time relative
to the total estimated costs on the contract.
Intangible Assets and Deferred Revenue on
Real Estate Acquisitions
We capitalize intangible assets and deferred revenue on real
estate acquisitions as described in the section above entitled
“Acquisitions of Real Estate.” We amortize the intangible assets
and deferred revenue as follows:
• Lease to market value
Related lease terms
• Lease-up value
Related lease terms or
estimated period of time
that tenant will lease space
in property
• Deemed cost avoidance
Related lease terms
• Tenant relationship value
Estimated period of time
that tenant will lease space
in property
• Market concentration
40 years
premium
We recognize the amortization of lease to market value assets
and deferred revenues as adjustments to rental revenue reported
in our Consolidated Statements of Operations; we refer to this
amortization as amortization of origination value of leases
on acquired properties. We recognize the amortization of
other intangible assets on real estate acquisitions as deprecia-
tion and amortization expense on our Consolidated Statements
of Operations.
6464
Deferred Charges
We defer costs that we incur to obtain new tenant leases or
extend existing tenant leases. We amortize these costs evenly
over the lease terms. When tenant leases are terminated early,
we expense any unamortized deferred leasing costs associated
with those leases.
We also defer costs for long-term financing arrangements
and amortize these costs over the related loan terms on a
straight-line basis, which approximates the amortization that
would occur under the effective interest method of amortiza-
tion. We expense any unamortized loan costs when loans are
retired early.
When the costs of acquisitions exceed the fair value of tangible
and identifiable intangible assets and liabilities, we record
goodwill in connection with such acquisitions. We test good-
will annually for impairment and in interim periods if certain
events occur indicating that the carrying value of goodwill
may be impaired. We recognize an impairment loss when the
discounted expected future cash f lows associated with the
related reporting unit are less than its unamortized cost.
Derivatives
We are exposed to the effect of interest rate changes in the nor-
mal course of business. We use interest rate swap, interest rate
cap and forward starting swap agreements in order to attempt
to reduce the impact of such interest rate changes. Interest rate
differentials that arise under interest rate swap and interest rate
cap contracts are recognized in interest expense over the life
of the respective contracts. Interest rate differentials that arise
under forward starting swaps are recognized in interest expense
over the life of the respective loans for which such swaps are
obtained. We do not use such derivatives for trading or specula-
tive purposes. We manage counter-party risk by only entering
into contracts with major financial institutions based upon
their credit ratings and other risk factors.
We recognize all derivatives as assets or liabilities in the balance
sheet at fair value with the offset to:
• the accumulated other comprehensive loss component of
shareholders’ equity (“AOCL”), net of the share attribut-
able to minority interests, for any derivatives designated as
cash flow hedges to the extent such derivatives are deemed
effective in hedging risks (risk in the case of our existing
derivatives being defined as changes in interest rates);
• interest expense on our Statements of Operations for any
derivatives designated as cash flow hedges to the extent such
derivatives are deemed ineffective in hedging risks; or
• other revenue on our Statements of Operations for any
derivatives designated as fair value hedges.
We use standard market conventions and techniques such as
discounted cash flow analysis, option pricing models, replace-
ment cost and termination cost in computing the fair value
of derivatives at each balance sheet date.
Minority Interests
As discussed previously, we consolidate the accounts of our
Operating Partnership and its subsidiaries into our financial
statements. However, we do not own 100% of the Operating
Partnership. We also do not own 100% of certain consolidated
real estate joint ventures. The amounts reported for minority
interests on our Consolidated Balance Sheets represent the
portion of these consolidated entities’ equity that we do not
own. The amounts reported for minority interests on our
Consolidated Statements of Operations represent the portion of
these consolidated entities’ net income not allocated to us.
Common units of the Operating Partnership (“common units”)
are substantially similar economically to our common shares
of beneficial interest (“common shares”). Common units not
owned by us are also exchangeable into our common shares,
subject to certain conditions.
On September 23, 2004, we issued 352,000 Series I Preferred
Units in the Operating Partnership to an unrelated party in
connection with our acquisition of two properties in Northern
Virginia. These units have a liquidation preference of $25.00
per unit, plus any accrued and unpaid distributions of return
thereon (as described below), and may be redeemed for cash
by the Operating Partnership at our option any time after
September 22, 2019. The owner of these units is entitled to a
priority annual cumulative return equal to 7.5% of their liqui-
dation preference through September 22, 2019; the annual
cumulative preferred return increases for each subsequent five-
year period, subject to certain maximum limits. These units are
convertible into common units on the basis of 0.5 common
units for each Series I Preferred Unit; the resulting common
units would then be exchangeable for common shares in accor-
dance with the terms of the Operating Partnership’s agreement
of limited partnership.
Earnings Per Share (“EPS”)
We present both basic and diluted EPS. We compute basic EPS
by dividing net income available to common shareholders by
the weighted average number of common shares outstanding
during the year. Our computation of diluted EPS is similar
except that:
6565
notes to consolidated financial statements corporate office properties trust and subsidiaries
(Dollars in thousands, except per share data)
• the denominator is increased to include: (1) the weighted
average number of potential additional common shares that
would have been outstanding if securities that are convert-
ible into our common shares were converted; and (2) the
effect of dilutive potential common shares outstanding
during the period attributable to share-based compensation
using the treasury stock method; and
• the numerator is adjusted to add back any convertible
preferred dividends and any other changes in income or
loss that would result from the assumed conversion into
common shares.
Our computation of diluted EPS does not assume conversion of securities into our common shares if conversion of those securities
would increase our diluted EPS in a given year. A summary of the numerator and denominator for purposes of basic and diluted
EPS calculations is set forth below (dollars and shares in thousands, except per share data):
Numerator:
Income from continuing operations
Add (less): Gain (loss) on sales of real estate, net
Less: Preferred share dividends
Less: Issuance costs associated with redeemed preferred shares
Numerator for basic EPS from continuing operations
Add: Convertible preferred share dividends
Numerator for diluted EPS from continuing operations
Add: Income from discontinued operations, net
Less: Convertible preferred share dividends
Numerator for basic EPS on net income available to common shareholders
Add: Convertible preferred share dividends
For the Years Ended December 31,
2006
2005
2004
$ 34,118
732
(15,404)
(3,896)
$ 34,082
268
(14,615)
—
$ 35,718
(113)
(16,329)
(1,813)
15,550
—
15,550
14,377
—
29,927
—
19,735
—
19,735
4,681
—
24,416
—
17,463
21
17,484
1,427
(21)
18,890
21
Numerator for diluted EPS on net income available to common shareholders
$ 29,927
$ 24,416
$ 18,911
41,463
1,799
—
37,371
1,626
—
33,173
1,675
134
43,262
38,997
34,982
$
0.37
0.35
$
0.53
0.12
$
0.53
0.04
$
0.72
$
0.65
$
0.57
$
0.36
0.33
$
0.51
0.12
$
0.50
0.04
$
0.69
$
0.63
$
0.54
Denominator (all weighted averages):
Denominator for basic EPS (common shares)
Dilutive effect of share-based compensation awards
Assumed conversion of convertible preferred shares
Denominator for diluted EPS
Basic EPS:
Income from continuing operations
Income from discontinued operations
Net income available to common shareholders
Diluted EPS
Income from continuing operations
Income from discontinued operations
Net income available to common shareholders
6666
Our diluted EPS computations do not include the effects of the
following securities since the conversions of such securities
would increase diluted EPS for the respective periods:
Weighted Average Shares
in Denominator
for the Years Ended
December 31,
2006
2005
2004
8,511
8,702
8,726
176
—
176
206
48
226
Conversion of weighted average
common units
Conversion of weighted average
convertible preferred units
Share-based compensation awards
As discussed in Note 9, the Operating Partnership issued on
September 18, 2006 a $200,000 aggregate principal amount of
3.50% Exchangeable Senior Notes due 2026. The notes have an
exchange settlement feature that provides that the notes may,
under certain circumstances, be exchangeable for cash (up to
the principal amount of the notes) and, with respect to any
excess exchange value, may be exchangeable into (at our option)
cash, our common shares or a combination of cash and our
common shares at an exchange rate of 18.4284 shares per $1,000
principal amount of the notes (exchange rate is as of December
31, 2006 and is equivalent to an exchange price of $54.30 per
common share). The Exchangeable Senior Notes did not affect
our diluted EPS reported above since the weighted average
closing price of our common shares during the period over
which the notes were outstanding was less than $54.30.
Share-Based Compensation
We have historically issued two forms of share-based compen-
sation: share options and restricted shares. Prior to January 1,
2006, our general method for accounting for these forms of
share-based compensation was as follows:
• Share options: These awards were accounted for using the
intrinsic value method. Under this method, we recorded
compensation expense only when the exercise price of a
grant was less than the market price of our common shares
on the option grant date; when this occurred, we rec-
ognized compensation expense equal to the difference
between the exercise price and the grant-date market price
over the service period to which the options related.
• Restricted shares: We computed compensation expense
for restricted share grants based on the value of such
grants, as determined by the value of our common shares
on the applicable measurement date (generally the date
of grant). We recognized compensation expense for such
grants over the service periods to which the grants related
based on the vesting schedules for such grants.
In December 2004, the Financial Accounting Standards Board
(“FASB”) issued Statement of Financial Accounting Standards
No. 123(R), “Share-Based Payment” (“SFAS 123(R)”). The state-
ment establishes standards for the accounting for transactions
in which an entity exchanges its equity instruments for goods
or services, focusing primarily on accounting for transactions
in which an entity obtains employee services in share-based
payment transactions. The statement requires us to measure
the cost of employee services received in exchange for an award
of equity instruments based generally on the fair value of the
award on the grant date; such cost should then be recognized
over the period during which the employee is required to pro-
vide service in exchange for the award (generally the vesting
period). No compensation cost is recognized for equity instru-
ments for which employees do not render the requisite service.
In 2005, the FASB also issued several FASB Staff Positions that
clarify certain aspects of SFAS 123(R). SFAS 123(R) became
effective for us on January 1, 2006, applying to all awards
granted after January 1, 2006 and to awards modified, repur-
chased or cancelled after that date. We used the modified pro-
spective application approach to adoption provided for under
SFAS 123(R); under this approach, we recognized compensa-
tion cost on or after January 1, 2006 for the portion of out-
standing awards for which the requisite service was not yet
rendered, based on the fair value of those awards on the date
of grant.
The primary effect of our adoption of SFAS 123(R) on our
Consolidated Financial Statements is that beginning January 1,
2006 we are: (1) incurring higher expense associated with share
options issued to employees relative to what we would have
recognized under the intrinsic value method; (2) recognizing
expenses associated with restricted common shares over the life
of the grant using a straight-line basis methodology over the
service period; and (3) reporting the benefits of tax deductions
in excess of recognized compensation costs as cash flow from
financing activities (such benefits were previously reported as
operating cash flows).
Prior to our adoption of SFAS 123(R), we provided disclosures
in our financial statements for years prior to 2006 that summa-
rized what our operating results would have been if we had
elected to account for our share-based compensation under
the fair value provisions of Statement of Financial Accounting
Standards No. 123, “Accounting for Stock-Based Compensation”
(“SFAS 123”). In computing the amounts that appeared in
these disclosures, we accounted for forfeitures as they occurred.
SFAS 123(R) requires that share-based compensation be com-
puted based on awards that are ultimately expected to vest. As
a result, future forfeitures of awards are to be estimated at the
6767
notes to consolidated financial statements corporate office properties trust and subsidiaries
(Dollars in thousands, except per share data)
time of grant and revised, if necessary, in subsequent periods
if actual forfeitures differ from those estimates. SFAS 123(R)
also requires that companies make a one-time cumulative effect
adjustment upon adoption of the standard to record the effect
that estimated future forfeitures of outstanding awards would
have on expenses previously recognized in the companies’
financial statements; we did not record such a cumulative effect
adjustment since we determined that the effect of pre-vesting
forfeitures on our recorded expense has historically been negli-
gible. The amounts included in our Consolidated Statements
of Operations for share-based compensation in the twelve
months ended December 31, 2006 reflected an estimate of pre-
vesting forfeitures of approximately 5%.
In the disclosures that we provided in our financial statements
for years prior to 2006 that summarized what our operating
results would have been if we had elected to account for our
share-based compensation under the fair value provisions of
SFAS 123, we did not capitalize costs associated with share-
based compensation. Effective upon our adoption of SFAS
123(R), we began capitalizing costs associated with share-based
compensation attributable to employees engaged in construc-
tion and development activities.
On November 10, 2005, the FASB issued FASB Staff Position
No. FAS 123(R)-3, “Transition Election Related to Accounting
for Tax Effects of Share-Based Payment Awards.” We elected
to adopt the alternative transition method provided in this
FASB Staff Position for calculating the tax effects of share-based
compensation pursuant to SFAS 123(R). The alternative transi-
tion method includes a simplified method to establish the
beginning balance of the additional paid-in capital pool related
to the tax effects of employee share-based compensation, which
is available to absorb tax deficiencies recognized subsequent
to the adoption of SFAS 123(R).
We compute the fair value of share options under SFAS 123(R)
using the Black-Scholes option-pricing model. Under that
model, the risk-free interest rate is based on the U.S. Treasury
yield curve in effect at the time of grant. The expected option
life is based on our historical experience of employee exercise
behavior. Expected volatility is based on historical volatility of
our common shares. Expected dividend yield is based on the
average historical dividend yield on our common shares over
a period of time ending on the grant date of the options.
Fair Value of Financial Instruments
Our financial instruments include primarily notes receivable,
debt and interest rate derivatives. The carrying or contract
values of notes receivable approximated their fair values at
December 31, 2006 and 2005. You should refer to Notes 9 and
10 for fair value of debt and derivative information.
Reclassification
We reclassified certain amounts from the prior periods to
conform to the current period presentation of our Consoli-
dated Financial Statements. These reclassifications did not
affect previously reported consolidated net income or share-
holders’ equity.
Recent Accounting Pronouncement
See the section above entitled “Stock-Based Compensation” for
disclosure pertaining to SFAS 123(R).
In June 2005, the FASB ratified the consensus reached by the
Emerging Issues Task Force (“EITF”) regarding EITF 04-05,
“Determining Whether a General Partner, or the General
Partners as a Group, Controls a Limited Partnership or Similar
Entity When the Limited Partners Have Certain Rights.” The
conclusion provided a framework for addressing the question
of when a general partner, as defined in EITF 04-05, should
consolidate a limited partnership. Under the consensus, a gen-
eral partner is presumed to control a limited partnership (or
similar entity) and should consolidate that entity unless the
limited partners possess kick-out rights or other substantive
participating rights as described in EITF 96-16, “Investor’s
Accounting for an Investee When the Investor has a Majority
of the Voting Interest but the Minority Shareholder or Share-
holders Have Certain Approval or Veto Rights.” This EITF
was initially effective for all new limited partnerships formed
and for existing limited partnerships for which the partner-
ship agreements were modified after June 29, 2005, and, as of
January 1, 2006, for existing limited partnership agreements.
The EITF did not impact us in 2005. The adoption of this EITF
in 2006 for existing limited partnership agreements did not
have a material effect on our financial position, results of oper-
ations or cash flows.
In June 2006, the FASB issued Interpretation No. 48, “Account-
ing for Uncertainty in Income Taxes—an interpretation of
FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an
enterprise’s financial statements in accordance with FASB
Statement No. 109, “Accounting for Income Taxes.” FIN 48
prescribes a recognition threshold and measurement attribute
for the financial statement recognition and measurement of
a tax position taken or expected to be taken in a tax return.
FIN 48 also provides guidance on de-recognition, classification,
interest and penalties, accounting in interim periods, disclosure
and transition. FIN 48 is effective for fiscal years beginning
after December 15, 2006. We are in the process of evaluating
the effect, if any, that implementing FIN 48 will have on our
financial position, results of operations or cash flows.
6868
In September 2006, the FASB issued Statement of Financial
Accounting Standards No. 157, “Fair Value Measurements”
(“SFAS 157”). SFAS 157 defines fair value, establishes a frame-
work for measuring fair value in generally accepted accounting
principles and expands disclosures about fair value measure-
ments. The Statement does not require any new fair value
measurements but does apply under other accounting pro-
nouncements that require or permit fair value measurements.
The changes to current practice resulting from the Statement
relate to the definition of fair value, the methods used to mea-
sure fair value and the expanded disclosures about fair value
measurements. SFAS 157 is effective for financial statements
issued for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years, with earlier appli-
cation encouraged. We do not expect that the adoption of this
Statement will have a material effect on our financial position,
results of operations or cash flows.
In September 2006, the Securities and Exchange Commission
issued Staff Accounting Bulletin No. 108 (“SAB 108”), which
addresses diversity in practice in quantifying financial state-
ment misstatements and the potential under current practice
for the build up of improper amounts on the balance sheet.
There have historically been two widely recognized methods
for quantifying the effects of financial statement errors: the
“roll-over” method and the “iron curtain” method. The roll-
over method focuses primarily on the impact of a misstatement
on the income statement, including the reversing effect of prior
year misstatements, but its use can lead to the accumulation
of misstatements on the balance sheet. Conversely, the iron-
curtain method focuses primarily on the effect of correcting
the period end balance sheet with less emphasis on the revers-
ing effects of prior year errors on the income statement. SAB
108 establishes an approach that requires quantification of
financial statement errors based on the effects of the error on
each of the company’s financial statements and the related
financial statement disclosures. This model is commonly
referred to as a “dual approach” because it requires quantifica-
tion of errors under both the iron-curtain and the roll-over
methods. SAB 108 was effective for financial statements for
fiscal years ending after November 15, 2006. Our adoption of
SAB 108 did not have a material effect on our financial posi-
tion, results of operations or cash flows.
3. CONCENTRATION OF RENTAL REVENUE
Major Tenants
The following table summarizes the percentage of our total
rental revenue earned from (1) individual tenants that accounted
for at least 5% of our total rental revenue and (2) the aggregate
of the five tenants from which we recognized the most rental
revenue in the respective years:
United States Government
Booz Allen Hamilton, Inc.
Computer Sciences Corporation
AT&T Local Services(1)
Five largest tenants
For the Years Ended
December 31,
2006
2005
2004
13%
7%
N/A
N/A
32%
11%
6%
5%
N/A
30%
11%
5%
6%
6%
33%
(1) Includes affiliated organizations and agencies.
Geographical Concentration
We derived large concentrations of our total revenue from real
estate operations (defined as the sum of rental revenue and
tenant recoveries and other real estate operations revenue)
from certain geographic regions. The table below sets forth
certain of these concentrations:
Percentage of
Total Rental Revenue
from Real Estate
Operations for the Years
Ended December 31,
2006
2005
2004
95%
78%
48%
99% 100%
79%
83%
49%
49%
Mid-Atlantic
Greater Washington, D.C.(1)
Baltimore/Washington Corridor
(1) Comprised of our properties in the Baltimore/Washington Corridor (defined as
the Maryland counties of Howard and Anne Arundel), Northern Virginia
(defined as Fairfax County, Virginia), Suburban Maryland (defined as
the Maryland counties of Montgomery, Prince George’s and Frederick)
and St. Mary’s and King George Counties (located in Maryland and
Virginia, respectively).
Substantially all of our construction contract and service oper-
ations revenues were derived from operations in the Greater
Washington, D.C. region.
6969
notes to consolidated financial statements corporate office properties trust and subsidiaries
(Dollars in thousands, except per share data)
4. COMMERCIAL REAL ESTATE PROPERTIES
Operating properties consisted of the following:
December 31,
2006
2005
Land
Buildings and improvements
$ 343,098
1,689,359
$ 314,719
1,491,254
Land
Construction in progress
Less: accumulated depreciation
2,032,457
(219,574)
1,805,973
(174,935)
$ 1,812,883
$ 1,631,038
Projects we had under construction or development consisted
of the following:
December 31,
2006
2005
$ 153,436
144,991
$ 117,434
138,183
$ 298,427
$ 255,617
2006 Acquisitions
We acquired the following office properties in 2006:
Project Name
Location
North Creek
1915 & 1925 Aerotech Drive
7125 Columbia Gateway Drive
Colorado Springs, CO
Colorado Springs, CO
Columbia, MD(1)
(1) Located in the Baltimore/Washington Corridor.
Date of
Acquisition
5/18/2006
6/8/2006
6/29/2006
Number of
Buildings
Total Rentable
Square Feet
3
2
1
6
324,549
75,892
611,379
1,011,820
The table below sets forth the allocation of the acquisition costs of the properties described above:
North Creek
1915 & 1925
Aerotech Drive
7125 Columbia
Gateway Drive
Initial
Cost
$ 41,508
8,378
74,168
$ 124,054
Total
$ 20,974
87,286
18,888
127,148
(3,094)
$ 2,735
34,161
5,694
42,590
(1,082)
$41,508
$1,113
6,161
1,235
8,509
(131)
$8,378
$17,126
46,964
11,959
76,049
(1,881)
$74,168
$ 124,054
• a six-acre parcel of land located in Hanover, Maryland
that we believe can support approximately 60,000
developable square feet for $2,141 on February 28, 2006
(Hanover, Mar yland is located in t he Ba ltimore /
Washington Corridor);
• a 20-acre parcel of land located in Colorado Springs,
Colorado that we believe can support approximately
300,000 developable square feet for $1,060 on April
21, 2006;
Land, operating properties
Building and improvements
Intangible assets on real estate acquisitions
Total assets
Deferred revenue associated with acquired operating leases
Total acquisition cost
We also acquired the following properties in 2006:
• a property located in Colorado Springs, Colorado contain-
ing a 74,749 square foot building that will be redeveloped
and a four-acre parcel of land that we believe can support
approximately 30,000 developable square feet for $2,602
on January 19, 2006;
• a 31-acre parcel of land located in San Antonio, Texas that
we believe can support approximately 375,000 developable
square feet for $7,430 on January 20, 2006;
7070
• a 153-acre parcel of land located near the Indian Head
Naval Surface War Center in Charles County, Maryland,
with a value upon our acquisition of $2,905, on October
23, 2006 through COPT-FD Indian Head, LLC, a 75%
owned consolidated joint venture (Charles County,
Maryland is included in our “other” business segment).
We describe these joint ventures further in Note 5.
2006 Construction and Development Activities
During 2006, we had seven properties totaling 866,000 square
feet (four located in the Baltimore/Washington Corridor and
one each in Northern Virginia, Colorado Springs, Colorado
and St. Mary’s County, Maryland) become fully operational
and had one property in the Baltimore/Washington Corridor
become partially operational due to 68,196 square feet being
placed into service.
As of December 31, 2006, we had construction underway
on four new buildings in the Baltimore/Washington Corridor
(including the partially operational property discussed above
and one property owned through a 50% joint venture) and
one each in Suburban Baltimore, Colorado Springs, Colorado,
Chesterfield, Virginia and Southwest Virginia. We also had
development activities underway on five new buildings located
in the Baltimore/Washington Corridor (including one owned
through a joint venture), two each in Suburban Maryland
and Colorado Springs, Colorado (one of which we own a 50%
undivided interest) and one each in Suburban Baltimore and
King George County, Virginia. In addition, we had redevelop-
ment underway on two wholly owned existing buildings (one is
located in the Baltimore/Washington Corridor and one in
Colorado Springs) and two buildings owned by a joint venture
(one is located in Northern Virginia and one in the Baltimore/
Washington Corridor).
• a 13-acre parcel of land located in Colorado Springs,
Colorado that we believe can support approximately
150,000 developable square feet for $2,263 on May
19, 2006;
• a 178-acre parcel of land located in Annapolis Junction,
Maryland, located adjacent to the National Business Park,
that we believe can support approximately 1.25 million
developable square feet for $26,833 on June 29, 2006
(Annapolis Junction, Maryland is located in the Baltimore/
Washington Corridor);
• a five-acre parcel of land located in Columbia, Maryland
that we believe can support approximately 120,000 devel-
opable square feet for $3,361 on June 29, 2006;
• a 28-acre parcel of land located in Chesterfield, Virginia
on September 15, 2006 that was acquired under the terms
of a lease for a 193,000 square foot building that we are
constructing on the property (Chesterfield, Virginia,
which is located in Greater Richmond, Virginia, is included
in our “other” business segment). The fair value of the
land and closing costs associated with the title transfer
totaled $1,303; and
• approximately 500 acres of the 591-acre former Fort
Ritchie United States Army base located in Cascade,
Washington County, Maryland for a value of $5,576
(Washington County, Maryland is included in our “other”
business segment); we expect to acquire the remaining
91 acres in 2007. The 591-acre parcel is anticipated to
accommodate a total of 1.7 million square feet of office
space and 673 residential units, including approximately
306,000 square feet of existing office space and 110 exist-
ing rentable residential units.
In addition, we acquired the following properties through con-
solidated real estate joint ventures in 2006:
• a land parcel located in the Baltimore/Washington Cor-
ridor, with a value upon our acquisition of $4,564, on
February 10, 2006 through Commons Office 6-B, LLC,
a 50% owned consolidated joint venture constructing
an office property totaling approximately 44,000 square
feet; and
7171
notes to consolidated financial statements corporate office properties trust and subsidiaries
(Dollars in thousands, except per share data)
2006 Dispositions
We sold the following operating properties in 2006:
Project Name
Location
Lakeview at the Greens
68 Culver Road
710 Route 46
230 Schilling Circle
7 Centre Drive
Brown’s Wharf
Laurel, MD(1)
Dayton, NJ
Fairfield, NJ
Hunt Valley, MD(2)
Monroe, NJ
Baltimore, MD
Date
of Sale
2/6/2006
3/8/2006
7/26/2006
8/9/2006
8/30/2006
9/28/2006
(1) Located in the Suburban Maryland region.
(2) Located in the Suburban Baltimore region.
We also sold the following in 2006:
Number of
Buildings
Total Rentable
Square Feet
2
1
1
1
1
1
7
141,783
57,280
101,263
107,348
19,468
104,203
531,345
Sale
Price
$ 17,000
9,700
15,750
13,795
3,000
20,300
$ 79,545
Gain
on Sale
$ 2,087
335
4,498
951
684
8,476
$ 17,031
• A newly constructed property in Columbia, Maryland for $2,530 on January 17, 2006. We recognized a gain of $111 on this
sale; and
• A two-acre parcel of land located in Linthicum Heights, Maryland for $900 on September 7, 2006. We recognized a gain of
$165 on this sale.
2005 Acquisitions
We acquired the following office properties in 2005:
Project Name
Location
8611 Military Drive
Rockville Corporate Center
7175 Riverwood Drive
Gateway Crossing 95
Patriot Park I & II
1670 N. Newport Road
110 Thomas Johnson Drive
7015 Albert Einstein Drive
Interquest 3 & 4
Hunt Valley/Rutherford portfolios
San Antonio, TX
Rockville, MD(1)
Columbia, MD(2)
Columbia, MD(2)
Colorado Springs, CO
Colorado Springs, CO
Frederick, MD(1)
Columbia, MD(2)
Colorado Springs, CO
Hunt Valley/Woodlawn, MD(3)
(1) Located in the Suburban Maryland region.
(2) Located in the Baltimore/Washington Corridor region.
(3) Located in the Suburban Baltimore region.
During 2005, we entered into a joint venture called COPT
Opportunity Invest I, LLC in which we have a 92.5% owner-
ship interest. This joint venture identifies and acquires proper-
ties to renovate into Class A office space and completes such
renovations. We use the consolidation method of accounting
to account for our investment in this entity. On December
20, 2005, we acquired the following properties through this
joint venture:
7272
Date of
Acquisition
Number of
Buildings
Total Rentable
Square Feet
3/30/2005
4/7/2005
7/27/2005
9/19/2005
9/28/2005
9/30/2005
10/21/2005
12/1/2005
12/22/2005
12/22/2005
2
2
1
5
2
1
1
1
2
21
38
468,994
221,702
26,500
188,819
135,907
67,500
117,803
61,203
113,170
1,106,866
2,508,464
Initial
Cost
$ 30,845
37,617
2,456
26,060
17,949
9,056
16,099
9,428
11,443
123,988
$ 284,941
• 2900 Towerview Road, located in Herndon, Virginia (which is
in the Northern Virginia region), for an initial cost of $12,372.
The property includes a 61,000 square foot office building
with an attached 79,000 square foot warehouse building that
the joint venture plans to convert to office space. The prop-
erty also includes an additional four-acre land parcel that can
support the future development; and
• 7468 Candlewood Road, located in Columbia, Maryland
(which is in the Baltimore/Washington Corridor), for an ini-
tial cost of $19,222. The property includes a 472,000 square
foot warehouse building that the joint venture plans to con-
vert into two office buildings totaling 325,000 square feet.
The table below sets forth the allocation of the acquisition costs of the properties described above:
8611
Military
Drive
Rockville
Corporate
Center
7175
Riverwood
Drive
Gateway
Crossing
95
Patriot
Park
I & II
1670
N. Newport
Road
110
Thomas
Johnson
Drive
7015
Albert
Einstein
Drive
9950 &
9960
Federal
Drive
Hunt
Valley/
Rutherford
2900
Towerview
Road
7468
Candlewood
Road
Total
$11,007
$ 6,222
$1,788
$ 5,533
$ 1,303
$ 851
$ 2,810
$2,054
$ 1,572
$ 18,715
$ 3,207
$ — $ 55,062
—
—
—
—
—
—
—
—
—
—
1,261
5,598
6,859
19,838
28,925
763
17,582
14,333
6,989
12,075
6,084
8,913
87,933
4,467
—
207,902
—
—
—
—
—
—
—
—
—
—
3,526
13,624
17,150
—
4,004
113
3,317
2,358
30,845
39,151
2,664
26,432
17,994
1,216
9,056
1,214
1,290
1,678
20,527
1,412
—
37,129
16,099
9,428
12,163
127,175
13,873
19,222
324,102
—
(1,534)
(208)
(372)
(45)
—
—
—
(720)
(3,187)
(1,501)
—
(7,567)
Land, operating
properties
Land, construction
or development
Building and
improvements
Construction in
progress
Intangible assets
on real estate
acquisitions
Total assets
Deferred revenue asso-
ciated with acquired
operating leases
Total acquisition cost
$30,845
$37,617
$2,456
$26,060
$ 17,949
$9,056
$16,099
$9,428
$ 11,443
$123,988
$12,372
$19,222
$ 316,535
We also acquired the following in 2005:
• a 19-acre parcel of land located in Chantilly, Virginia that
is adjacent to existing properties we own for $7,141 on
January 27, 2005 (Chantilly, Virginia is located in the
Northern Virginia region). We expect to develop this land
parcel in the future;
• a 32-acre parcel of land located in Dahlgren, Virginia that
is adjacent to one of our office properties for $1,227 on
March 16, 2005 (Dahlgren, Virginia is located in the
St. Mary’s and King George Counties region). We expect
to develop this land parcel in the future;
• a 16-acre parcel of land adjacent to 8611 Military Drive
in San Antonio, Texas for $3,013 on March 30, 2005. We
expect to operate this land parcel as part of the campus
that includes 8611 Military Drive;
• a 10-acre parcel of land adjacent to the Rockville Cor-
porate Center for $6,234 on April 7, 2005. We commenced
development on a portion of this land parcel in 2006;
• a 27-acre parcel of land adjacent to 8611 Military Drive in
San Antonio, Texas for $5,893 on June 14, 2005. We expect
to develop this land parcel in the future;
• a two-acre parcel of land located in Linthicum, Maryland
that is adjacent to one of our office properties for $735 on
July 6, 2005;
• a 64-acre land parcel located in Colorado Springs,
Colorado, five acres of which is undergoing construction
of a 50,000 square foot, fully-leased building, for a pur-
chase price of $9,408 on July 8, 2005. We expect to develop
this land parcel in the future;
• a four-acre parcel of land located in Columbia, Maryland
that is adjacent to 7175 Riverwood Drive for $1,367 on
July 27, 2005. We commenced development on a portion
of this land parcel in 2006;
• a 50% undivided interest in a 132-acre land parcel, subject
to a cotenancy agreement, in Colorado Springs, Colorado
for $10,757 on September 28, 2005. We commenced devel-
opment on a portion of this land parcel in 2006; and
• a six-acre parcel of land located in Frederick, Maryland
that is adjacent to 110 Thomas Johnson Drive for $1,092
on October 21, 2005. We commenced development on a
portion of this land parcel in 2006.
In 2004, we sold a land parcel in Columbia, Maryland and a
land parcel in Linthicum, Maryland for an aggregate of $9,600.
We issued to the buyer a $5,600 mortgage loan; the balance of
the acquisition was in the form of cash from the buyer. The
buyer in this transaction had an option to contribute the two
land parcels into our Operating Partnership between January 1,
2005 and February 28, 2005 in exchange for extinguishment
of the $5,600 mortgage loan with us and common units in
7373
notes to consolidated financial statements corporate office properties trust and subsidiaries
(Dollars in thousands, except per share data)
our Operating Partnership; the buyer exercised its option in
February 2005 and, as a result, on April 18, 2005, the debt from
us was essentially extinguished and the buyer received 142,776
common units in the Operating Partnership valued at $3,697.
We accounted for the 2004 transaction using the financing
method of accounting; as a result, the 2004 sale transaction was
not recorded as a sale and the $4,000 in net proceeds received
from the buyer was recorded as a liability prior to the contribu-
tion of the land parcels back into the Operating Partnership in
April 2005.
2005 Construction and Pre-Construction Activities
During 2005, we placed into service two buildings located
in Annapolis Junction, Maryland and one in Columbia,
Maryland.
As of December 31, 2005, we had construction underway on
six new buildings in the Baltimore/Washington Corridor,
one in Northern Virginia, one in St. Mary’s County, Maryland
and one in Colorado Springs, Colorado. We also had pre-
construction activities underway on four new buildings located
in the Baltimore/Washington Corridor, one in King George
County, Virginia, and one in Colorado Springs, Colorado.
We had redevelopment underway on (1) one wholly owned
existing building in the Baltimore/Washington Corridor and
(2) two buildings owned by a joint venture (one is located in
Northern Virginia and the other in the Baltimore/Washington
Corridor).
2005 Dispositions
On June 10, 2005, we sold a four-acre parcel of land located in
Columbia, Maryland for $2,571. We recognized a gain of $186
on this sale.
On August 31, 2005, we sold a newly constructed property in
Columbia, Maryland for $4,794. We recognized a gain of $82
on this sale.
On September 8, 2005, we sold three office properties totaling
152,731 square feet located in the Northern/Central New Jersey
region for a total sale price of $22,458. We recognized a total
gain of $4,324 on this sale.
On September 29, 2005, we contributed our portfolio of prop-
erties in Harrisburg, Pennsylvania, consisting of 16 office
properties, one unimproved land parcel and an option to
acquire a land parcel, into a real estate joint venture at a value
of $73,000. In exchange for our contribution, we received
$69,587 in cash (after closing costs and operating prorations)
and a 20% interest in Harrisburg Corporate Gateway Partners,
L.P. As part of this transaction, we entered into an agreement to
manage the operations of the joint venture’s properties for a
five-year term. We did not recognize a gain on this transaction
since we have certain contingent obligations that may exceed
our proportionate interest remaining in effect as long as we
continue to manage the properties; these contingent obligations
are described below in Note 19.
5. REAL ESTATE JOINT VENTURES
Our investments in and advances to unconsolidated real estate joint ventures accounted for using the equity method of accounting
included the following:
Balance at
December 31,
2006
2005
Date Acquired Ownership Nature of Activity
Total Assets
at 12/31/2006
Maximum
Exposure
to Loss(1)
Harrisburg Corporate Gateway
Partners, L.P.
Route 46 Partners
$(3,614)(2)
—
$(3,081)(2)
1,451(4)
9/29/2005
3/14/2003
20%
20%
Operates 16 buildings(3)
Operates one building(5)
$75,895
$ —
$—
N/A
(1) Derived from the sum of our investment balance and maximum additional unilateral capital contributions or loans required from us. Not reported above
are additional amounts that we and our partner are required to fund when needed by this joint venture; these funding requirements are proportional to our respective
ownership percentages. Also not reported above are additional unilateral contributions or loans from us, the amounts of which are uncertain, that would be due if certain
contingent events occurred.
(2) The carrying amount of our investment in this joint venture is lower than our share of the equity in the joint venture by $5,072 at December 31, 2006 and $5,204 at
December 31, 2005 due to our deferral of gain on the contribution by us of real estate into the joint venture upon its formation. This difference will continue to exist to
the extent the nature of our continuing involvement in the joint venture does not change.
(3) This joint venture’s property is located in Greater Harrisburg, Pennsylvania.
(4) As discussed further below, the joint venture sold the property on July 26, 2006, after which the joint venture was dissolved. The carrying amount of our
investment in this joint venture was lower than our share of the equity in the joint venture by $1,370 at December 31, 2005 due to our deferral of gain on the contribution
by us of real estate into the joint venture upon its formation.
(5) This joint venture’s property was located in Fairfield, New Jersey.
7474
On July 26, 2006, Route 46 Partners sold its property for
$27,000. After the sale, the joint venture was dissolved. We
recognized a gain of $563 on the disposition of our joint
venture interest.
A two-member management committee is responsible for
making major decisions (as defined in the joint venture agree-
ment) for Harrisburg Corporate Gateway Partners, L.P., and
we control one of its management committee positions. We
have additional commitments pertaining to our real estate joint
venture that are disclosed in Note 19.
The following table sets forth a combined condensed balance
sheet for our unconsolidated joint ventures:
Commercial real estate property
Other assets
Total assets
Liabilities
Owners’ equity
December 31,
2006
2005
$ 72,688
3,207
$ 94,552
8,006
$ 75,895
$ 102,558
$ 67,350
8,545
$ 82,550
20,008
Total liabilities and owners’ equity
$ 75,895
$ 102,558
The following table sets forth a combined condensed statement
of operations for Harrisburg Corporate Gateway Partners, L.P.
and Route 46 Partners:
Revenues
Property operating expenses
Interest expense
Depreciation and amortization
expense
Gain on sale
Net income
For the Years Ended
December 31,
2006
2005
2004
$ 11,521
(4,067)
(4,224)
$ 5,850
(2,351)
(1,843)
$ 3,054
(1,461)
(847)
(4,464)
4,032
(1,490)
—
(514)
—
$ 2,798
$ 166
$ 232
The table above includes net income from Route 46 Partners
of $3,501 for 2006, the year in which it was dissolved. Our
joint venture partner in Route 46 Partners had preference in
receiving distributions of cash flows for a defined return. We
were not entitled to receive distributions for a defined return
until our partner received its defined return. We did not rec-
ognize income from our investment in Route 46 Partners in
2004, 2005 and 2006 until the dissolution of the entity since
the income earned by the entity in those periods did not exceed
our partner’s defined return until that point in time. Upon
dissolution of the entity, we recognized income from our
investment of $60, excluding the $563 gain on disposition of
the joint venture interest discussed above.
As described in Note 4, we acquired the following interests
in consolidated real estate joint ventures in 2005 and 2006:
• a 92.5% interest in COPT Opportunity Invest I, LLC. This
joint venture identifies and acquires properties to reno-
vate into Class A office space and complete such renova-
tions. On December 20, 2005, we acquired two properties
through this joint venture;
• a 50% interest in Commons Office 6-B, LLC. On February
10, 2006, this entity acquired a land parcel located in
Hanover, Maryland, on which an office property total-
ing approximately 44,000 square feet is under construc-
tion; and
• a 75% interest in COPT–FD Indian Head, LLC. This
entity acquired a 153-acre land parcel located near the
Indian Head Naval Surface War Center in Charles County,
Maryland on October 23, 2006.
The table below sets forth information pertaining to our investments in consolidated joint ventures at December 31, 2006:
COPT Opportunity Invest I, LLC
Commons Office 6-B, LLC
MOR Forbes 2 LLC
COPT-FD Indian Head, LLC
Date
Acquired
12/20/2005
2/10/2006
12/24/2002
10/23/2006
Ownership
% at
12/31/2006
92.5%
50.0%
50.0%
75.0%
Nature of Activity
Redeveloping two properties(1)
Developing land parcel(2)
Developing land parcel(3)
Developing land parcel(4)
Total Assets at
12/31/2006
Collateralized
Assets at
12/31/2006
$41,696
7,287
4,155
2,969
$56,107
$ —
7,287
3,734
—
$11,021
(1) This joint venture owns one property in the Northern Virginia region and one in the Baltimore/Washington Corridor region.
(2) This joint venture’s property is located in Hanover, Maryland (located in the Baltimore/Washington Corridor region).
(3) This joint venture’s property is located in Lanham, Maryland (located in the Suburban Maryland region).
(4) This joint venture’s property is located in Charles County, Maryland (included in our “other” business segment).
Our commitments and contingencies pertaining to our real estate joint ventures are disclosed in Note 19.
7575
notes to consolidated financial statements corporate office properties trust and subsidiaries
(Dollars in thousands, except per share data)
6. INTANGIBLE ASSETS ON REAL ESTATE ACQUISITIONS
Intangible assets on real estate acquisitions consisted of the following:
Lease-up value
Lease cost portion of deemed cost avoidance
Lease to market value
Tenant relationship value
Market concentration premium
December 31, 2006
December 31, 2005
Gross
Carrying
Amount
$105,719
12,880
10,623
9,371
1,333
$139,926
Accumulated
Amortization
$38,279
5,819
7,178
1,178
147
$52,601
Net
Carrying
Amount
$67,440
7,061
3,445
8,193
1,186
Gross
Carrying
Amount
$ 92,812
11,054
9,772
6,349
1,333
$87,325
$121,320
Accumulated
Amortization
$20,824
3,991
5,277
130
114
$30,336
Net
Carrying
Amount
$71,988
7,063
4,495
6,219
1,219
$90,984
8. PREPAID AND OTHER ASSETS
Prepaid and other assets consisted of the following:
Construction contract costs incurred
in excess of billings
Furniture, fixtures and equipment
Prepaid expenses
Other assets
Prepaid and other assets
December 31,
2006
2005
$ 18,324
10,495
9,059
10,589
$ 15,277
4,302
7,007
8,592
$ 48,467
$ 35,178
Amortization of the intangible asset categories set forth above
totaled $20,675 in 2006, $12,525 in 2005 and $9,739 in 2004.
The approximate weighted average amortization periods of
the categories set forth below follow: lease-up value: 11 years;
lease cost portion of deemed cost avoidance: six years; lease to
market value: five years; tenant relationship value: nine years;
and market concentration premium: 36 years. The approximate
weighted average amortization period for all of the categories
combined is 10 years. Estimated amortization expense asso-
ciated with the intangible asset categories set forth above for
2007 is $14.3 million, 2008 is $12.7 million, 2009 is $11.4 mil-
lion, 2010 is $8.4 million and 2011 is $6.6 million.
7. DEFERRED CHARGES
Deferred charges consisted of the following:
Deferred leasing costs
Deferred financing costs
Goodwill
Deferred other
Accumulated amortization
Deferred charges, net
December 31,
2006
2005
$ 52,263
28,275
1,853
155
$ 42,752
21,574
1,853
155
82,546
(38,836)
66,334
(31,288)
$ 43,710
$ 35,046
7676
9. DEBT
Our debt consisted of the following:
Maximum
Principal Amount
Under Debt at
December 31, 2006
Carrying Value
at December 31,
2006
2005
Stated Interest
Rates at
December 31, 2006
Scheduled
Maturity Dates at
December 31, 2006
Mortgage and other loans payable:
Revolving Credit Facility
Wachovia Bank, N.A. Revolving
Credit Facility
$500,000
$ 185,000
$ 273,000
Mortgage Loans
Fixed rate mortgage loans(2)
Variable rate construction
loan facilities
Other variable rate mortgage loans
Total mortgage loans
Note Payable
Unsecured seller notes
Total mortgage and other
loans payable
3.5% Exchangeable Senior Notes
Total debt
LIBOR + 1.15%
to 1.55%
March 2008(1)
3.00%–9.48%(3)
LIBOR + 1.40%
to 2.20%
LIBOR + 1.20%
to 1.50%
2007–2034(4)
2007–2008(5)
September 2007(6)
N/A
1,020,619
921,265
56,079
70,238
34,500
82,800
$1,111,198
1,074,303
72,207
N/A
N/A
N/A
2,339
1,048
0%–5.95%
2007–2008
1,298,537
200,000
1,348,351
—
$ 1,498,537
$ 1,348,351
3.50%
September 2026(7)
(1) The Revolving Credit Facility may be extended for a one-year period, subject to certain conditions.
(2) Several of the fixed rate mortgages carry interest rates that were above or below market rates upon assumption and therefore are recorded at their fair value
based on applicable effective interest rates. The carrying values of these loans ref lect net premiums totaling $210 at December 31, 2006 and $1,391 at
December 31, 2005.
(3) The weighted average interest rate on these loans was 5.6% at December 31, 2006.
(4) A loan with a balance of $4,893 at December 31, 2006 that matures in 2034 may be repaid in March 2014, subject to certain conditions.
(5) At December 31, 2006, $33,447 in loans scheduled to mature in 2008 may be extended for a one-year period, subject to certain conditions.
(6) At December 31, 2006, the $34,500 loan scheduled to mature in 2007 may be extended for a one-year period, subject to certain conditions.
(7) Refer to the paragraph below for descriptions of provisions for early redemption and repurchase of these notes.
On September 18, 2006, the Operating Partnership issued a
$200,000 aggregate principal amount of 3.50% Exchangeable
Senior Notes due 2026. Interest on the notes is payable on
March 15 and September 15 of each year. The notes have an
exchange settlement feature that provides that the notes may,
under certain circumstances, be exchangeable for cash (up to
the principal amount of the notes) and, with respect to any
excess exchange value, may be exchangeable into (at our option)
cash, our common shares or a combination of cash and our
common shares at an exchange rate (subject to adjustment)
7777
notes to consolidated financial statements corporate office properties trust and subsidiaries
(Dollars in thousands, except per share data)
of 18.4284 shares per $1,000 principal amount of the notes
(exchange rate is as of December 31, 2006 and is equivalent to
an exchange price of $54.30 per common share). On or after
September 20, 2011, the Operating Partnership may redeem
the notes in cash in whole or in part. The holders of the notes
have the right to require us to repurchase the notes in cash in
whole or in part on each of September 15, 2011, September 15,
2016 and September 15, 2021, or in the event of a “fundamental
change,” as defined under the terms of the notes, for a repur-
chase price equal to 100% of the principal amount of the notes
plus accrued and unpaid interest. Prior to September 11, 2011,
subject to certain exceptions, if (1) a “fundamental change”
occurs as a result of certain forms of transactions or series
of transactions and (2) a holder elects to exchange its notes in
connection with such “fundamental change,” we will increase
the applicable exchange rate for the notes surrendered for
exchange by a number of additional shares of our common
shares as a “make whole premium.” The notes are general
unsecured senior obligations of the Operating Partnership and
rank equally in right of payment with all other senior
unsecured indebtedness of the Operating Partnership. The
Operating Partnership’s obligations under the notes are fully
and unconditionally guaranteed by us.
In the case of each of our mortgage loans, we have pledged
certain of our real estate assets as collateral. As of December
31, 2006, a majority of our real estate properties were collat-
eralized on loan obligations or, in the case of our Revolving
Credit Facility with Wachovia Bank, National Association (the
“Revolving Credit Facility”), identified by us to support repay-
ment of the loan. Certain of our debt instruments require that
we comply with a number of restrictive financial covenants,
including adjusted consolidated net worth, minimum property
interest coverage, minimum property hedged interest coverage,
minimum consolidated interest coverage, maximum consoli-
dated unhedged floating rate debt and maximum consolidated
total indebtedness. As of December 31, 2006, we were in com-
pliance with these financial covenants.
Our debt matures on the following schedule:
2007
2008
2009
2010
2011
Thereafter
Total
$ 140,950
375,208
61,791
73,128
108,854
738,396
$ 1,498,327(1)
(1) Represents principal maturities only and therefore excludes net premiums
of $210.
We estimate that the fair value of our debt was $1,510,698 at
December 31, 2006 and $1,345,789 at December 31, 2005.
Weighted average borrowings under our Revolving Credit
Facility totaled $290,660 in 2006 and $272,267 in 2005. The
weighted average interest rate on this credit facility was 6.42%
in 2006 and 4.62% in 2005.
On June 24, 2005, we amended our Revolving Credit Facility.
Under the amendment, the maximum principal amount was
increased from $300,000 to $400,000, with a right to further
increase the maximum principal amount in the future to
$600,000, subject to certain conditions. In addition, the sched-
uled maturity date was extended for one year to March 2008,
with a one-year extension available, subject to certain con-
ditions. On July 3, 2006, we exercised our right to increase the
borrowing capacity under our Revolving Credit Facility from
$400,000 to $500,000. The borrowing capacity under the
Revolving Credit Facility is generally computed based on 65%
of the value of assets identified by us to support repayment of
the loan. As of December 31, 2006, the maximum amount of
borrowing capacity under this line of credit totaled $431,500,
of which $245,500 was available.
We capitalized interest costs of $14,559 in 2006, $9,871 in 2005
and $5,112 in 2004.
10. DERIVATIVES
The following table sets forth our derivative contracts and their respective fair values:
Nature of Derivative
Interest rate swap
Interest rate swap
Interest rate swap
Forward starting swap
7878
Notional One-Month
LIBOR Base
Amount
Effective
Date
Expiration
Date
$50,000
25,000
25,000
73,400
5.0360%
5.2320%
5.2320%
5.0244%
3/28/2006
5/1/2006
5/1/2006
7/15/2005
3/30/2009
5/1/2009
5/1/2009
N/A
Fair Value at
December 31,
2006
2005
$ (42)
(133)
(133)
N/A
$ (308)
N/A
N/A
N/A
N/A
$—
We designated these derivatives as cash flow hedges. The first three contracts set forth above hedge the risk of changes in interest
rates on certain of our one-month LIBOR-based variable rate borrowings until their respective maturities. The last contract set
forth above represents a forward starting swap into which we entered to lock in the 10-year LIBOR swap rate in contemplation of
our obtaining a long-term, fixed rate financing later in 2005. We obtained this long-term financing in October 2005 and cash
settled the swap at that time for a payment of $603. This payment represented the present value of the basis point differential
between 5.0244% and the 10-year LIBOR swap rate at the time we cash settled the swap, plus accrued interest.
The table below sets forth our accounting application of changes in derivative fair values:
(Decrease) increase in fair value applied to AOCL(1) and minority interests
Increase in fair value recognized as gain(2)
(1) AOCL is defined in Note 2.
(2) Included in interest expense on our Consolidated Statements of Operations.
For the Years Ended
December 31,
2006
2005
2004
$(308)
—
$— $390
77
—
The $603 discussed above that we paid to cash settle the forward starting swap was recorded to AOCL and will be amortized into
interest expense over the 10-year term of the loan it was hedging.
11. SHAREHOLDERS’ EQUITY
Preferred Shares
Preferred shares of beneficial interest (“preferred shares”) consisted of the following:
1,265,000 designated as Series E Cumulative Redeemable Preferred Shares of beneficial interest
(1,150,000 shares issued with an aggregate liquidation preference of $28,750)
1,425,000 designated as Series F Cumulative Redeemable Preferred Shares of beneficial interest
(1,425,000 shares issued with an aggregate liquidation preference of $35,625)
2,200,000 designated as Series G Cumulative Redeemable Preferred Shares of beneficial interest
(2,200,000 shares issued with an aggregate liquidation preference of $55,000)
2,000,000 designated as Series H Cumulative Redeemable Preferred Shares of beneficial interest
(2,000,000 shares issued with an aggregate liquidation preference of $50,000)
3,390,000 designated as Series J Cumulative Redeemable Preferred Shares of beneficial interest
(3,390,000 shares issued with an aggregate liquidation preference of $84,750)
Total preferred shares
December 31,
2006
2005
$—
$11
—
22
20
34
$76
14
22
20
—
$67
Set forth below is a summary of additional information pertaining to our preferred shares of beneficial interest:
Series of Preferred Shares
of Beneficial Interest
Series E
Series F
Series G
Series H
Series J
(1) Yield computed based on $25 per share redemption price.
(2) All outstanding Series E Preferred Shares were redeemed on July 15, 2006.
(3) All outstanding Series F Preferred Shares were redeemed on October 15, 2006.
# of
Shares
Issued
1,150,000
1,425,000
2,200,000
2,000,000
3,390,000
Month of
Issuance
April 2001
September 2001
August 2003
December 2003
July 2006
Annual
Dividend
Yield(1)
Annual
Dividend
per Share
Earliest
Redemption
Date
10.250%
9.875%
8.000%
7.500%
7.625%
2.56250
2.46875
2.00000
1.87500
1.90625
NA(2)
NA(3)
8/11/2008
12/18/2008
7/20/2011
7979
notes to consolidated financial statements corporate office properties trust and subsidiaries
(Dollars in thousands, except per share data)
All of the classes of preferred shares set forth in the table above
are nonvoting and redeemable for cash at $25.00 per share at
our option on or after the earliest redemption date. Holders of
these shares are entitled to cumulative dividends, payable quar-
terly (as and if declared by the Board of Trustees). In the case
of each series of preferred shares, there is a series of preferred
units in the Operating Partnership owned by us that carries
substantially the same terms.
On July 15, 2006, we redeemed all of the outstanding 10.25%
Series E Cumulative Redeemable Preferred Shares of beneficial
interest (the “Series E Preferred Shares”) at a price of $25 per
share, or $28,750. On October 15, 2006, we redeemed all of the
outstanding Series F Cumulative Redeemable Preferred Shares
of beneficial interest (the “Series F Preferred Shares”) at a price
of $25 per share, or $35,625. We recognized a $3,896 decrease
to net income available to common shareholders pertaining to
the original issuance costs incurred on the Series E and Series F
Preferred Shares at the time of the redemption.
On July 20, 2006, we completed the sale of 3.39 million Series J
Cumulative Redeemable Preferred Shares (the “Series J Pre-
ferred Shares”) at a price of $25.00 per share. We contributed
the net proceeds after offering costs totaling $81,857 to our
Operating Partnership in exchange for 3.39 million Series J
Preferred Units. The Series J Preferred Units carry terms that
are substantially the same as the Series J Preferred Shares.
Common Shares
In September 2005, we sold 2.3 million common shares to an
underwriter at a net price of $32.76 per share. We contrib-
uted the net proceeds after offering costs totaling $75,170 to
our Operating Partnership in exchange for 2.3 million com-
mon units.
In April 2006, we sold 2.0 million common shares to an under-
writer at a net price of $41.31 per share. We contributed the net
proceeds after offering costs totaling $82,433 to our Operating
Partnership in exchange for 2.0 million common units.
Over the three years ended December 31, 2006, common units
in our Operating Partnership were converted into common
shares on the basis of one common share for each common unit
in the amount of 245,793 in 2006, 253,575 in 2005 and 326,108
in 2004.
See Note 12 for disclosure of common share activity pertaining
to our share-based compensation plans.
Accumulated Other Comprehensive Loss
The table below sets forth activity in the accumulated other
comprehensive loss component of shareholders’ equity:
Beginning balance
Unrealized (loss) gain on deriva-
tives, net of minority interests
Realized loss on derivatives,
net of minority interests
For the Years Ended
December 31,
2006
2005
2004
$ (482)
$ — $ (294)
(262)
(482)
294
51
—
—
Ending balance
$ (693)
$ (482)
$ —
The table below sets forth our comprehensive income:
Net income
Unrealized (loss) gain on deriva-
tives, net of minority interests
Realized loss on derivatives,
net of minority interests
For the Years Ended
December 31,
2006
2005
2004
$ 49,227
$ 39,031
$ 37,032
(262)
(482)
294
51
—
—
Total comprehensive income
$ 49,016
$ 38,549
$ 37,326
12. SHARE-BASED COMPENSATION AND
EMPLOYEE BENEFIT PLANS
Share-based Compensation Plans
In 1993, we adopted a share option plan for our Trustees under
which we have 75,000 common shares reserved for issuance.
These options expire ten years after the date of grant and are
all exercisable. Shares for this plan are issued under a registra-
tion statement on Form S-8 that became effective upon filing
with the Securities and Exchange Commission. As of December
31, 2006, there were no awards available for future grant under
this plan.
In March 1998, we adopted a long-term incentive plan for our
Trustees and employees. This plan provides for the award of
options to acquire our common shares (“share options”),
common shares subject to forfeiture restrictions (“restricted
shares”) and dividend equivalents. We are authorized to issue
awards under the plan amounting to no more than 13% of
the total of (1) our common shares outstanding plus (2) the
number of shares that would be outstanding upon redemption
8080
of all units of the Operating Partnership or other securities
that are convertible into our common shares. Trustee options
under this plan become exercisable beginning on the first
anniversary of their grant. The vesting periods for employees’
options under this plan range from immediately to five years,
although they generally are three years. Options expire ten
years after the date of grant. Restricted shares generally vest
annually in the following increments: 16% upon the first
anniversary following the date of grant, 18% upon the second
anniversary, 20% upon the third anniversary, 22% upon the
fourth anniversary and 24% upon the fifth anniversary. Shares
for this plan are issued under a registration statement on
Form S-8 that became effective upon filing with the Securities
and Exchange Commission. As of December 31, 2006, we had
711,844 awards available for future grant under this plan.
The following table summarizes share option transactions under the plans described above:
Range of
Exercise Price
per Share
Weighted Average
Exercise Price
per Share
Weighted Average
Remaining
Contractual Term
(in Years)
Aggregate
Intrinsic
Value
Outstanding at December 31, 2003
Granted—2004
Forfeited/Expired—2004
Exercised—2004
Outstanding at December 31, 2004
Granted—2005
Forfeited/Expired—2005
Exercised—2005
Shares
3,202,026
290,450
(20,994)
(784,398)
2,687,084
521,588
(87,665)
(411,080)
$5.25–$14.30
$15.93–$28.69
$8.63–$25.05
$5.63–$17.25
$5.38–$28.69
$25.52–$36.08
$10.00–$34.89
$5.38–$25.05
Outstanding at December 31, 2005
2,709,927
$5.63–$36.08
Granted—2006
Forfeited/Expired—2006
Exercised—2006
503,800
(68,107)
(589,101)
$36.24–$50.59
$13.60–$47.79
$5.63–$34.76
Outstanding at December 31, 2006
2,556,519
$7.38–$50.59
Exercisable at December 31, 2004
Exercisable at December 31, 2005
Exercisable at December 31, 2006
1,617,080
2,054,919
1,753,428
(1)
(2)
(3)
Options expected to vest
762,936
$20.34–$50.59
$10.03
$22.30
$17.81
$ 9.57
$11.43
$28.38
$23.60
$10.70
$14.41
$42.84
$33.43
$11.49
$20.18
$10.26
$10.58
$12.65
$36.61
6
4
9
$77,447
$66,318
$10,573
(1) 312,650 of these options had an exercise price ranging from $5.38 to $7.99; 704,238 had an exercise price ranging from $8.00 to $10.99; and 600,192 had an exercise
price ranging from $11.00 to $18.08.
(2) 486,250 of these options had an exercise price ranging from $5.63 to $7.99; 854,027 had an exercise price ranging from $8.00 to $10.99; 590,104 had an exercise price
ranging from $11.00 to $16.99; and 124,538 had an exercise price ranging from $17.00 to $28.69.
(3) 234,082 of these options had an exercise price ranging from $7.38 to $7.99, 754,068 had an exercise price ranging from $8.00 to $10.99, 456,732 had an exercise price
ranging from $11.00 to $16.99, 198,241 had an exercise price ranging from $17.00 to $25.99 and 110,305 had an exercise price range of $26.00 to $36.08.
The total intrinsic value of options exercised was $19,748 in 2006, $8,366 in 2005 and $11,578 in 2004.
We received proceeds from the exercise of share options of $6,767 in 2006, $4,398 in 2005 and $7,510 in 2004.
8181
notes to consolidated financial statements corporate office properties trust and subsidiaries
(Dollars in thousands, except per share data)
We computed share-based compensation expense under the
fair value method using the Black-Scholes option-pricing
model; the weighted average assumptions we used in that model
are set forth below:
For the Years Ended
December 31,
2006
2005
2004
$8.99
4.91%(1)
6.82
23.69%(2)
3.82%(3)
$2.18
3.15%
4.21
$2.82
3.97%
6.00
22.70% 22.89%
7.60%
6.90%
Weighted average fair value
of grants on grant date
Risk-free interest rate
Expected life-years
Expected volatility
Expected dividend yield
(1) Ranged from 4.38% to 5.30%.
(2) Ranged from 22.37% to 25.11%.
(3) Ranged from 3.36% to 4.25%.
A summary of the weighted average grant-date fair value per
option granted is as follows:
The following table summarizes restricted share transactions
under the plans described above for 2006:
Unvested at December 31, 2005
Granted
Forfeited
Vested
Unvested at December 31, 2006
Restricted shares expected to vest
Weighted Average
Grant Date
Fair Value
$19.88
$42.65
$23.67
$17.16
$29.51
Shares
395,609
163,420
(20,822)
(124,517)
413,690
395,662
The total fair value of restricted shares that vested during the
year ended December 31, 2006 was $5,319.
We realized a windfall tax benefit of $562 in 2006 on options
exercised and restricted shares vested by employees of our sub-
sidiaries that are subject to income tax.
The table below sets forth information relating to expenses
from share-based compensation included in our Consolidated
Statements of Operations for 2006:
For the Years Ended
December 31,
2006
2005
2004
$8.99
$2.82
$2.18
Increase in general and administrative
expenses
$ 8.99
$ 2.83
$ 2.15
Increase in construction contract and
other service operations expenses
N/A
$ 2.51
$ 1.65
Share-based compensation expense
Income taxes
Minority interests
For the Year Ended
December 31, 2006
$2,659
964
3,623
(107)
(617)
Weighted average grant-date fair value
Weighted average grant-date fair value-
exercise price equals market price on
grant-date
Weighted average grant-date fair value-
exercise price exceeds market price on
grant-date
Weighted average grant-date fair value-
exercise price less than market price on
grant-date
N/A
N/A
$ 2.24
Net share-based compensation expense
$2,899
Net share-based compensation expense
The weighted average grant-date fair value of option issuances
increased significantly in 2006 over previous years due in large
part to a large decrease in the weighted average dividend yield
assumption from 2006 to 2005. We derive our dividend yield
assumption from the average historical dividend yield on our
common shares over a period of time ending on the grant-date
of options. Prior to 2006, we used a longer historical time frame
for purposes of estimating our dividend yield assumption. In
response to the trading price for our common shares having
increased significantly in recent years, which has had a decreas-
ing effect on our dividend yield, we concluded that the use of a
shorter historical time frame for estimating the dividend yield
assumption was appropriate.
per share
Basic
Diluted
$ 0.07
$ 0.07
We also capitalized share-based compensation costs of approxi-
mately $212 in 2006.
As of December 31, 2006, there was $3,769 of unrecognized
compensation cost related to nonvested options that is expected
to be recognized over a weighted average period of approxi-
mately two years. As of December 31, 2006, there was $8,571 of
unrecognized compensation cost related to unvested restricted
shares that is expected to be recognized over a weighted average
period of approximately three years.
8282
Disclosure for Periods Prior to 2006, Including Pro Forma
Financial Information Under SFAS 123
Expenses from share-based compensation ref lected in our
Consolidated Statements of Operations for the year ended
December 31, 2005 and 2004 were as follows:
Increase in general and administrative
expenses
Increase in construction contract and
other service operations expenses
For the
Years Ended
December 31,
2005
2004
$ 1,903
$ 1,579
230
552
The following table summarizes our operating results for the
years ended December 31, 2005 and 2004 as if we elected to
account for our share-based compensation under the fair value
provisions of SFAS 123 in those periods:
For the
Years Ended
December 31,
2005
2004
$ 39,031
$ 37,032
1,670
1,824
Net income, as reported
Add: Share-based compensation expense, net
of related tax effects and minority interests,
included in the determination of net income
Less: Share-based compensation expense
determined under the fair value based
method, net of related tax effects and
minority interests
2006, $396 in 2005 and $323 in 2004. The 401(k) plan is fully
funded at December 31, 2006.
Deferred Compensation Plan
We have a non-qualified elective deferred compensation plan
for certain members of our management team that permits
participants to defer up to 100% of their compensation on a
pre-tax basis and receive a tax-deferred return on such defer-
rals. We match the participant’s contribution in an amount
equal to 50% of the participant’s elective deferral for the plan
year up to a maximum of 6% of a participant’s annual compen-
sation after deducting contributions, if any, made under our
401(k) plan. Deferred compensation related to an employee
contribution is charged to expense and is fully vested. Deferred
compensation related to the Company’s matching contribution
is charged to expense and vests in annual one-third increments.
Once an employee has been with us for three years, all match-
ing contributions are fully vested. The balance of the plan,
which was fully funded, totaled $5,195 at December 31, 2006
and $4,166 at December 31, 2005, and is included in the accom-
panying Consolidated Balance Sheets.
13. RELATED PARTY TRANSACTIONS
We earned fees from unconsolidated joint ventures totaling
$619 in 2006, $326 in 2005 and $219 in 2004. These fees were
for property management, construction and leasing services
performed.
(1,671)
(1,500)
14. OPERATING LEASES
Net income, pro forma
$ 39,030
$ 37,356
Basic EPS on net income available to
common shareholders, as reported
Basic EPS on net income available to
common shareholders, pro forma
Diluted EPS on net income available to
common shareholders, as reported
Diluted EPS on net income available to
common shareholders, pro forma
$ 0.65
$ 0.57
$ 0.65
$ 0.58
$ 0.63
$ 0.54
$ 0.63
$ 0.55
401(k) Plan
We have a 401(k) defined contribution plan covering substan-
tially all of our employees that permits participants to defer
up to a maximum of 15% of their compensation. We match a
participant’s contribution in an amount equal to 50% of the
participant’s elective deferral for the plan year up to a maxi-
mum of 6% of a participant’s annual compensation. Employees’
contributions are fully vested and our matching contributions
vest in annual one-third increments. Once an employee has
been with us for three years, all matching contributions are
fully vested. We fund all contributions with cash. Our match-
ing contributions under the plan totaled approximately $538 in
We lease our properties to tenants under operating leases with
various expiration dates extending to the year 2025. Gross min-
imum future rentals on noncancelable leases in our consoli-
dated properties at December 31, 2006 were as follows:
For the Years Ended December 31,
2007
2008
2009
2010
2011
Thereafter
Total
$ 243,062
211,470
193,638
155,790
123,461
445,738
$ 1,373,159
We consider a lease to be noncancelable when a tenant (1) may
not terminate its lease obligation early or (2) may terminate its
lease obligation early in exchange for a fee or penalty that we
consider material enough such that termination would be
highly unlikely.
8383
notes to consolidated financial statements corporate office properties trust and subsidiaries
(Dollars in thousands, except per share data)
15. SUPPLEMENTAL INFORMATION TO STATEMENTS OF CASH FLOWS
Interest paid, net of capitalized interest
Income taxes paid
Supplemental schedule of non-cash investing and financing activities:
Consolidation of real estate joint ventures in connection with adoption of FASB Interpretation FIN 46(R),
“Consolidation of Variable Interest Entities”:
Operating properties
Projects under construction or development
Investments in and advances to unconsolidated real estate joint ventures
Restricted cash
Accounts receivable, net
Deferred rent receivable
Deferred charges, net
Prepaid and other assets
Mortgage and other loans payable
Accounts payable and accrued expenses
Rents received in advance and security deposits
Other liabilities
Minority interests—other consolidated real estate entities
Net adjustment
Adjustment to purchase of commercial real estate properties by acquiring joint venture interests:
Operating properties
Investments in and advances to unconsolidated real estate joint ventures
Net adjustment
Debt assumed in connection with acquisitions
For the Years Ended
December 31,
2006
2005
2004
$ 68,617
$ 57,100
$ 43,717
$
54
$ — $ —
$ — $ — $ 2,176
17,959
(3,957)
10
145
7
1,026
(3,263)
(10,171)
(2,737)
(347)
4,650
(5,498)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
$ — $ — $ —
$ — $ — $
—
—
(83)
83
$ — $ — $ —
$ 39,011
$ 17,347
$ 120,817
Property acquired through lease arrangement included in rents received in advance and security deposits
$ 1,282
$ — $ —
Proceeds from sales of properties invested in restricted cash account
Increase (decrease) in accrued capital improvements and leasing costs
$ 33,730
$ — $ —
$ 18,181
$ (9,349)
$ 17,234
Amortization of discounts and premiums on mortgage loans to commercial real estate properties
$
196
$
273
$
Accretion of other liability to commercial real estate properties
(Decrease) increase in fair value of derivatives applied to AOCL and minority interests
$ — $ — $
$ (308)
$ — $
925
147
390
Issuance of common units in the Operating Partnership in connection with contribution of properties
accounted for under the financing method of accounting
$ — $ 3,687
$ —
Issuance of common units in the Operating Partnership in connection with acquisition of properties
$ 7,497
$ 2,647
$ —
Issuance of preferred units in the Operating Partnership in connection with acquisition of properties
$ — $ — $ 8,800
Adjustments to minority interests resulting from changes in ownership of Operating Partnership by COPT
$ 16,255
$ 12,888
$ 19,360
Dividends/distribution payable
Decrease in minority interests and increase in shareholders’ equity in connection with the conversion of
common units into common shares
Conversion of preferred shares adjusted to common shares and paid in capital
Issuance of restricted shares
$ 19,164
$ 16,703
$ 14,713
$ 11,078
$ 9,120
$ 8,041
$ — $ — $
12
$ — $ 3,276
$ 2,271
8484
16. INFORMATION BY BUSINESS SEGMENT
As of December 31, 2006, we had nine primary office property segments: Baltimore/Washington Corridor; Northern Virginia;
Suburban Baltimore; Colorado Springs, Colorado; Suburban Maryland; Greater Philadelphia; St. Mary’s and King George
Counties; San Antonio, Texas; and Northern/Central New Jersey. We also had an office property segment in Greater Harrisburg,
Pennsylvania prior to the contribution of our properties in that region into a real estate joint venture in exchange for cash and a
20% interest in such joint venture on September 29, 2005.
The table below reports segment financial information. Our segment entitled “Other” includes assets and operations not specifi-
cally associated with the other defined segments, including corporate assets, investments in unconsolidated entities and elimina-
tion entries required in consolidation. We measure the performance of our segments based on total revenues less property
operating expenses, a measure we define as net operating income (“NOI”). We believe that NOI is an important supplemental
measure of operating performance for a REIT’s operating real estate because it provides a measure of the core operations that is
unaffected by depreciation, amortization, financing and general and administrative expenses; this measure is particularly useful
in our opinion in evaluating the performance of geographic segments, same-office property groupings and individual properties.
Baltimore/
Washington
Corridor
Northern
Virginia
Suburban
Baltimore
Colorado
Springs
Suburban
Maryland
Greater
Philadelphia
St. Mary’s &
King George
Counties
San
Antonio
Northern/
Central
New Jersey
Greater
Harrisburg Other
Total
Year Ended
December 31, 2006
Revenues
Property operating expenses
$ 147,648
45,667
$ 63,515 $ 28,570 $ 9,776 $ 15,316
5,710
11,889
22,727
3,659
$ 10,025
168
$ 12,087
3,116
$ 7,441
1,533
$ 12,295
3,311
$ (6)
(49)
$
(875) $ 305,792
96,033
(1,698)
NOI
$ 101,981
$ 40,788 $ 16,681 $ 6,117 $ 9,606
$ 9,857
$ 8,971
$ 5,908
$ 8,984
$ 43
$
823 $ 209,759
Additions to commercial
real estate properties
Segment assets at
$ 190,038
$ 21,638 $ 6,206 $ 66,628 $ 4,664
$ 1,202
$ 1,823
$ 8,814
$ 1,398
$ 5
$ 37,746 $ 340,162
December 31, 2006
$ 1,081,356
$ 473,540 $ 162,786 $ 135,118 $ 117,573
$ 97,795
$ 97,661
$ 52,661
$ 48,499
$ — $ 152,612 $ 2,419,601
Year Ended
December 31, 2005
Revenues
Property operating expenses
$ 123,819
37,373
$ 60,255 $ 11,099 $ 1,006 $ 12,555
4,791
20,348
4,367
407
$ 10,025
157
$ 12,852
2,784
$ 1,814
334
$ 13,779
5,737
$ 6,605
2,209
$ (1,450) $ 252,359
76,240
(2,267)
NOI
$
86,446
$ 39,907 $ 6,732 $
599 $ 7,764
$ 9,868
$ 10,068
$ 1,480
$ 8,042
$ 4,396
$
817 $ 176,119
Additions to commercial
real estate properties
Segment assets at
$ 144,334
$ 57,972 $ 110,085 $ 57,901 $ 58,707
$
872
$ 5,739
$ 42,658
$ 2,199
$ 449
$
419 $ 481,335
December 31, 2005
$ 901,718
$ 463,179 $ 189,576 $ 63,767 $ 130,221
$ 99,357
$ 99,191
$ 42,884
$ 67,206
$ — $ 72,660 $ 2,129,759
Year Ended
December 31, 2004
Revenues
Property operating expenses
$ 105,945
33,252
$ 48,701 $ 8,406 $
14,323
3,465
— $ 8,924
3,372
—
$ 10,025
165
$ 5,483
1,327
$ — $ 18,793
5,362
—
$ 8,855
2,874
$
(559) $ 214,573
63,053
(1,087)
NOI
$
72,693
$ 34,378 $ 4,941 $
— $ 5,552
$ 9,860
$ 4,156
$ — $ 13,431
$ 5,981
$
528 $ 151,520
Additions to commercial
real estate properties
Segment assets at
$ 111,260
$ 148,400 $ 17,781 $
— $ 26,513
$ 1,176
$ 90,214
$ — $ 2,063
$ 509
$
34 $ 397,950
December 31, 2004
$ 774,541
$ 421,434 $ 60,216 $
— $ 69,213
$ 101,042
$ 96,413
$ — $ 85,110
$68,126
$ 55,931 $ 1,732,026
8585
notes to consolidated financial statements corporate office properties trust and subsidiaries
(Dollars in thousands, except per share data)
The following table reconciles our segment revenues to total
revenues as reported on our Consolidated Statements of
Operations:
Segment revenues
Construction contract revenues
Other service operations
revenues
Less: Revenues from discontin-
ued operations (Note 18)
For the Years Ended December 31,
2006
2005
2004
$ 305,792
52,182
$ 252,359
74,357
$ 214,573
25,018
7,902
4,877
3,885
(4,473)
(10,286)
(10,629)
Total revenues
$ 361,403
$ 321,307
$ 232,847
The following table reconciles our segment property operating
expenses to property operating expenses as reported on our
Consolidated Statements of Operations:
Segment property operating
expenses
Less: Property expenses from
discontinued real estate
operations (Note 18)
Total property operating
expenses
For the Years Ended December 31,
2006
2005
2004
$ 96,033
$ 76,240
$ 63,053
(1,529)
(3,987)
(4,071)
$ 94,504
$ 72,253
$ 58,982
The following table reconciles our NOI for reportable segments
to income from continuing operations as reported on our
Consolidated Statements of Operations:
The accounting policies of the segments are the same as those
previously disclosed for Corporate Office Properties Trust and
subsidiaries, where applicable. We did not allocate interest
expense, amortization of deferred financing costs and depre-
ciation and other amortization to segments since they are not
included in the measure of segment profit reviewed by man-
agement. We also did not allocate construction contract reve-
nues, other service operations revenues, construction contract
expenses, other service operations expenses, equity in loss of
unconsolidated entities, general and administrative expenses,
income taxes and minority interests because these items repre-
sent general corporate items not attributable to segments.
17. INCOME TAXES
Corporate Office Properties Trust elected to be treated as a
REIT under Sections 856 through 860 of the Internal Revenue
Code. To qualify as a REIT, we must meet a number of organi-
zational and operational requirements, including a requirement
that we distribute at least 90% of our adjusted taxable income
to our shareholders. As a REIT, we generally will not be subject
to Federal income tax if we distribute at least 100% of our
taxable income to our shareholders and satisfy certain other
requirements (see discussion below). If we fail to qualify as a
REIT in any tax year, we will be subject to Federal income tax
on our taxable income at regular corporate rates and may not
be able to qualify as a REIT for four subsequent tax years.
For the Years Ended December 31,
2006
2005
2004
$ 209,759
52,182
$ 176,119
74,357
$ 151,520
25,018
The differences between taxable income reported on our
income tax return (estimated 2006 and actual 2005 and 2004)
and net income as reported on our Consolidated Statements of
Operations are set forth below (unaudited):
7,902
4,877
3,885
(92)
(887)
(88)
(668)
(88)
(795)
(78,712)
(61,049)
(49,289)
(49,961)
(72,534)
(23,733)
(7,384)
(4,753)
(3,263)
Net income
Adjustments:
Rental revenue recognition
Compensation expense
recognition
Operating expense recognition
Gain on sales of properties
(16,936)
(13,534)
(10,938)
Interest income
(71,378)
(54,872)
(42,148)
(2,847)
(2,229)
(2,420)
(4,584)
(5,245)
(5,473)
(2,944)
(6,299)
(6,558)
Losses from service operations
Income tax expense
Depreciation and amortization
Earnings from unconsolidated
real estate joint ventures
Minority interests, gross
Other
For the Years Ended December 31,
2006
2005
2004
(Estimated)
$ 49,227
$ 39,031
$ 37,032
(8,144)
(7,225)
(6,400)
(17,163)
(169)
(11,045)
—
(2,321)
887
29,680
373
2,586
(191)
(5,068)
(68)
7,174
—
(1,780)
699
18,668
307
(4,828)
(737)
(9,633)
(57)
150
84
(1,971)
795
11,588
41
1,202
7
$ 34,118
$ 34,082
$ 35,718
Taxable income
$ 43,720
$ 46,173
$ 32,838
NOI for reportable segments
Construction contract revenues
Other service operations
revenues
Equity in loss of unconsolidated
entities
Income tax expense
Less:
Depreciation and other
amortization associated
with real estate operations
Construction contract
expenses
Other service operations
expenses
General and administrative
expenses
Interest expense on continu-
ing operations
Amortization of deferred
financing costs
Minority interests in con-
tinuing operations
NOI from discontinued
operations
Income from continuing
operations
8686
For Federal income tax purposes, dividends to shareholders may be characterized as ordinary income, capital gains or return of
capital. The characterization of dividends declared on our common and preferred shares during each of the last three years was
as follows:
Ordinary income
Long-term capital gain
Return of capital
We distributed all of our REIT taxable income in 2006, 2005
and 2004 and, as a result, did not incur Federal income tax in
those years on such income.
COMI is subject to Federal and state income taxes. COMI had
income before income taxes under GAAP of $2,288 in 2006,
$1,780 in 2005 and $1,971 in 2004. COMI’s provision for income
tax consisted of the following:
Deferred
Federal
State
Current
Federal
State
Total
For the Years Ended
December 31,
2006
2005
2004
$ 641
141
$ 572
127
$ 654
141
782
699
795
86
19
105
—
—
—
—
—
—
$ 887
$ 699
$ 795
A reconciliation of COMI’s Federal statutory rate to the effec-
tive tax rate for income tax reported on our Statements of
Operations is set forth below:
For the Years Ended
December 31,
2006
2005
2004
34.0% 34.0% 35.0%
4.6%
0.2%
4.7%
0.6%
4.6%
0.7%
Income taxes at U.S. statutory rate
State and local, net of U.S. Federal tax
benefit
Other
Effective tax rate
Common Shares
Preferred Shares
For the Years Ended
December 31,
For the Years Ended
December 31,
2006
2005
2004
2006
2005
2004
50.3% 70.7% 67.4%
0.0%
7.2% 17.8%
42.5% 11.5% 32.6%
87.4% 79.9% 100.0%
0.0%
12.6% 20.1%
0.0%
0.0%
0.0%
Items contributing to temporary differences that lead to
deferred taxes include net operating losses that are not deduct-
ible until future periods, depreciation and amortization, share-
based compensation, certain accrued compensation and
compensation paid in the form of contributions to a deferred
nonqualified compensation plan.
We are subject to certain state and local income and franchise
taxes. The expense associated with these state and local taxes is
included in general and administrative expenses on our
Consolidated Statements of Operations. We did not separately
state these amounts on our Consolidated Statements of
Operations because they are insignificant.
18. DISCONTINUED OPERATIONS
Income from discontinued operations includes revenues and
expenses associated with the following:
• three properties located in the Northern/Central New
Jersey region that were sold on September 8, 2005;
• the two Lakeview at the Greens properties that were sold
on February 6, 2006;
• the 68 Culver Road property that was sold on March 8,
2006;
• the 710 Route 46 property that was sold on July 26, 2006;
• the 230 Schilling Circle property that was sold on August
9, 2006;
• the 7 Centre Drive property that was sold on August 30,
2006; and
• the Brown’s Wharf property that was sold on September
38.8% 39.3% 40.3%
28, 2006.
8787
notes to consolidated financial statements corporate office properties trust and subsidiaries
(Dollars in thousands, except per share data)
The table below sets forth the components of income from dis-
continued operations:
• a parcel of land in Aberdeen, Maryland for $10,000, of
which we paid a deposit of $100 in 2006; and
For the Years Ended
December 31,
2006
2005
2004
Revenue from real estate operations
$ 4,473
$ 10,286
$ 10,629
Expenses from real estate
operations:
Property operating expenses
Depreciation and amortization
Interest expense
Other
Expenses from real estate
1,529
1,362
1,042
135
3,987
2,506
2,272
11
4,071
2,615
2,115
11
operations
4,068
8,776
8,812
Income from discontinued opera-
tions before gain on sales of real
estate and minority interests
Gain on sales of real estate
Minority interests in discontinued
405
17,031
1,510
4,324
1,817
—
operations
(3,059)
(1,153)
(390)
Income from discontinued opera-
tions, net of minority interests
$ 14,377
$ 4,681
$ 1,427
19. COMMITMENTS AND CONTINGENCIES
In the normal course of business, we are involved in legal
actions arising from our ownership and administration of
properties. Management does not anticipate that any liabilities
that may result will have a materially adverse effect on our
financial position, operations or liquidity. We are subject to
various Federal, state and local environmental regulations
related to our property ownership and operation. We have per-
formed environmental assessments of our properties, the results
of which have not revealed any environmental liability that we
believe would have a materially adverse effect on our financial
position, operations or liquidity.
Acquisitions
As of December 31, 2006, we were under contract to acquire the
following properties:
• the Nottingham Acquisition, as described in Note 22, for
$362,500, of which we paid a deposit of $2,000 in 2006.
We completed this acquisition in January 2007, as dis-
cussed in Note 22;
• the remaining 91 acres of land not yet acquired as part
of the acquisition of property in Washington County,
Maryland discussed in Note 4; we expect to make the fol-
lowing additional future cash payments to the seller for (1)
the acquisition of the remaining 91 acres and (2) portions
of the contract price on which payment was deferred per
the contract: $1,310 in 2007, $1,000 in 2008 and $155 in
2009. We could incur an additional cash obligation to the
seller after that of up to $4,000; this $4,000 cash obliga-
tion is subject to reduction by an amount ranging between
$750 and $4,000, with the amount of such reduction to be
determined based on defined levels of (1) job creation
resulting from the future development of the property and
(2) future real estate taxes generated by the property. Upon
completion of this acquisition, we will be obligated to
incur $7,500 in development and construction costs for
the property.
Joint Ventures
As part of our obligations under the partnership agreement of
Harrisburg Corporate Gateway Partners, LP, we may be required
to make unilateral payments to fund rent shortfalls on behalf of
a tenant that was in bankruptcy at the time the partnership was
formed. Our total unilateral commitment under this guaranty
is approximately $306; the tenant’s account was current as of
December 31, 2006. We also agreed to indemnify the partner-
ship’s lender for 80% of losses under standard nonrecourse loan
guarantees (environmental indemnifications and guarantees
against fraud and misrepresentation) during the period of time
in which we manage the partnership’s properties; we do not
expect to incur any losses under these loan guarantees.
We are party to a contribution agreement that formed a joint
venture relationship with a limited partnership to develop up to
1.8 million square feet of office space on 63 acres of land located
in Hanover, Maryland. Under the contribution agreement, we
agreed to fund up to $2,200 in pre-construction costs associ-
ated with the property. As we and the joint venture partner
agree to proceed with the construction of buildings in the
future, we would make additional cash capital contributions
into newly-formed entities and our joint venture partner would
contribute land into such entities. We will have a 50% interest
in this joint venture relationship.
8888
We may need to make our pro rata share of additional invest-
ments in our real estate joint ventures (generally based on our
percentage ownership) in the event that additional funds are
needed. In the event that the other members of these joint
ventures do not pay their share of investments when additional
funds are needed, we may then need to make even larger invest-
ments in these joint ventures.
In two of the consolidated joint ventures that we owned as of
December 31, 2006, we would be obligated to acquire the other
members’ 50% interests in the joint ventures if defined events
were to occur. The amounts we would need to pay for those
membership interests are computed based on the amounts that
the owners of the interests would receive under the joint ven-
ture agreements in the event that office properties owned by the
joint ventures were sold for a capitalized fair value (as defined
in the agreements) on a defined date. We estimate the aggregate
amount we would need to pay for the other members’ member-
ship interests in these joint ventures to be $2,383; however,
since the determination of this amount is dependent on the
operations of the office properties, which are not both com-
pleted and sufficiently occupied, this estimate is preliminary
and could be materially different from the actual obligation.
Ground Lease
On April 4, 2006, we entered into a 62-year ground lease agree-
ment on a six-acre land parcel on which we expect to construct
a 110,000 square foot property. We paid $550 to the lessor upon
lease execution and expect to pay an additional $1,870 in rent
under the lease in 2007. No other rental payments are required
over the life of the lease, although we are responsible for
expenses associated with the property. We will recognize the
total lease payments incurred under the lease evenly over the
term of the lease.
Office Space Operating Leases
We are obligated as lessee under four operating leases for office
space. Future minimum rental payments due under the terms
of these leases as of December 31, 2006 follow:
2007
2008
2009
2010
2011
$ 270
261
175
135
57
$ 898
Other Operating Leases
We are obligated under various leases for vehicles and office
equipment. Future minimum rental payments due under the
terms of these leases as of December 31, 2006 follow:
2007
2008
2009
2010
2011
$ 475
383
209
67
9
$ 1,143
Environmental Indemnity Agreement
We agreed to provide certain environmental indemnifications
in connection with a lease of three properties in our Northern/
Central New Jersey region. The prior owner of the properties, a
Fortune 100 company which is responsible for groundwater
contamination at such properties, previously agreed to indem-
nify us for (1) direct losses incurred in connection with the
contamination and (2) its failure to perform remediation activ-
ities required by the State of New Jersey, up to the point that the
state declares the remediation to be complete. Under the lease
agreement, we agreed to the following:
• to indemnify the tenant against losses covered under the
prior owner’s indemnity agreement if the prior owner fails
to indemnify the tenant for such losses. This indemnifica-
tion is capped at $5,000 in perpetuity after the State of
New Jersey declares the remediation to be complete;
• to indemnify the tenant for consequential damages (e.g.,
business interruption) at one of the buildings in perpetu-
ity and another of the buildings for 15 years after the ten-
ant’s acquisition of the property from us, if such acquisition
occurs. This indemnification is capped at $12,500; and
• to pay 50% of additional costs related to construction and
environmental regulatory activities incurred by the tenant
as a result of the indemnified environmental condition of
the properties. This indemnification is capped at $300
annually and $1,500 in the aggregate.
8989
notes to consolidated financial statements corporate office properties trust and subsidiaries
(Dollars in thousands, except per share data)
20. QUARTERLY DATA (UNAUDITED)
The tables below set forth selected quarterly information for the years ended December 31, 2006 and 2005. Certain of the amounts
below have been reclassified to conform to our current presentation of discontinued operations, which is discussed in Note 18.
Revenues
Operating income
Income from continuing operations
For the Year Ended December 31, 2006
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
$ 86,476
$ 85,689
$ 92,927
$ 96,311
$ 26,693
$ 28,419
$ 27,631
$ 31,163
$ 7,652
$ 8,999
$ 7,799
$ 9,668
Income (loss) from discontinued operations, net of minority interests
$ 2,175
$
92
$ 12,191
$ (81)
Net income
Preferred share dividends
Issuance costs associated with redeemed preferred shares
Net income available to common shareholders
Basic earnings per share:
Income from continuing operations
Net income available to common shareholders
Diluted earnings per share:
Income from continuing operations
Net income available to common shareholders
Revenues
Operating income
Income from continuing operations
$ 9,937
(3,654)
—
$ 9,116
(3,653)
—
$ 20,587
(4,307)
(1,829)
$ 9,587
(3,790)
(2,067)
$ 6,283
$ 5,463
$ 14,451
$ 3,730
$ 0.10
$ 0.13
$ 0.05
$ 0.09
$ 0.16
$ 0.13
$ 0.34
$ 0.09
$ 0.10
$ 0.13
$ 0.05
$ 0.09
$ 0.15
$ 0.13
$ 0.33
$ 0.08
For the Year Ended December 31, 2005
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
$ 74,887
$ 76,791
$ 90,792
$ 78,837
$ 23,816
$ 23,965
$ 22,354
$ 27,049
$ 8,798
$ 8,631
$ 6,660
$ 9,993
Income from discontinued operations, net of minority interests
$
223
$
320
$ 3,870
$
268
Net income
Preferred share dividends
Net income available to common shareholders
Basic earnings per share:
Income from continuing operations
Net income available to common shareholders
Diluted earnings per share:
Income from continuing operations
Net income available to common shareholders
$ 9,040
(3,654)
$ 9,120
(3,654)
$ 10,589
(3,653)
$ 10,282
(3,654)
$ 5,386
$ 5,466
$ 6,936
$ 6,628
$ 0.14
$ 0.14
$ 0.08
$ 0.16
$ 0.15
$ 0.15
$ 0.19
$ 0.17
$ 0.14
$ 0.13
$ 0.08
$ 0.16
$ 0.14
$ 0.14
$ 0.18
$ 0.16
9090
21. PRO FORMA FINANCIAL INFORMATION
(UNAUDITED)
We accounted for our acquisitions using the purchase method
of accounting. We included the results of operations for
our acquisitions in our Consolidated Statements of Opera-
tions from their respective purchase dates through December
31, 2006.
We prepared our pro forma condensed consolidated financial
information presented below as if our 2005 acquisition of the
Hunt Valley/Rutherford portfolios and all of our 2004 acquisi-
tions and dispositions of operating properties had occurred at
the beginning of the respective periods. The pro forma finan-
cial information is unaudited and is not necessarily indicative
of the results that actually would have occurred if these acquisi-
tions and dispositions had occurred at the beginning of the
respective periods, nor does it purport to indicate our results of
operations for future periods.
Pro forma total revenues
Pro forma net income
For the Years Ended
December 31,
2005
2004
$ 347,417
$ 274,893
$ 38,233
$ 36,484
Pro forma net income available to common
shareholders
$ 23,618
$ 18,342
Pro forma earnings per common share on net
income available to common shareholders
Basic
Diluted
$
$
0.63
0.61
$
$
0.55
0.52
22. SUBSEQUENT EVENTS
On January 9 and 10, 2007, we completed a series of transactions
that resulted in the acquisition of 56 operating properties total-
ing 2.4 million square feet and land parcels totaling 187 acres.
We refer to this transaction as the Nottingham Acquisition.
All of the acquired properties are located in Maryland, with
36 of the operating properties, totaling 1.6 million square feet,
and land parcels totaling 175 acres, located in White Marsh,
Maryland and the remaining properties and land parcels
located in other regions in Northern Baltimore County and
the Baltimore/Washington Corridor. We believe that the
land parcels totaling 187 acres can support at least 2.0 million
developable square feet. We completed the Nottingham
Acquisition for an aggregate cost of approximately $363.9 mil-
lion, including approximately $1.4 million in transaction costs.
We financed the acquisition by (1) issuing $26.6 million in
Series K Cumulative Redeemable Convertible Preferred Shares
of beneficial interest (the “Series K Preferred Shares”) to the
seller; (2) issuing $154.9 million in common shares to the
seller, at a deemed value of $49 per share; (3) assuming existing
mortgage loans totaling $38.0 million, with an average interest
rate of approximately 6.0%; (4) assuming an existing mortgage
loan totaling $10.3 million, which we repaid on January 11,
2007 using borrowings under our Revolving Credit Facility;
(5) assuming an existing unsecured loan totaling $89.1 million,
with a variable interest rate of LIBOR plus 1.15% to 1.55%
depending on our leverage levels at different points in time;
(6) using $20.1 million from an escrow funded by proceeds
from one of our property sales; and (7) using borrowings under
the Revolving Credit Facility for the balance.
The Series K Preferred Shares issued in the Nottingham Acqui-
sition are valued at, and carry a liquidation preference equal to,
$50 per share. The Series K Preferred Shares are nonvoting,
redeemable for cash at $50 per share at our option on or after
January 9, 2017, and are convertible, subject to certain condi-
tions, into common shares on the basis of 0.8163 common
shares for each preferred share, in accordance with the terms of
the Articles Supplementary describing the Series K Preferred
Shares. Holders of the Series K Preferred Shares are entitled to
cumulative dividends, payable quarterly (as and if declared by
our Board of Trustees). Dividends will accrue from the date of
issue at the annual rate of $2.80 per share, which is equal to
5.6% of the $50 per share liquidation preference.
9191
market for registrant’s common equity,
related shareholder matters and issuer repurchases of equity securities
Our common shares trade on the New York Stock Exchange
(“NYSE”) under the symbol “OFC.” The table below shows the
range of the high and low sale prices for our common shares as
reported on the NYSE, as well as the quarterly common share
dividends per share declared.
The number of holders of record of our common shares was 355
as of December 31, 2006. This number does not include share-
holders whose shares are held of record by a brokerage house or
clearing agency, but does include any such brokerage house or
clearing agency as one record holder.
2005
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
2006
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
Price Range
Low
High
Dividends
per Share
$25.14
$25.39
$29.27
$32.50
$29.30
$29.78
$35.68
$37.15
$0.255
$0.255
$0.280
$0.280
Price Range
Low
High
Dividends
per Share
$34.91
$37.32
$40.65
$44.21
$46.12
$45.74
$47.54
$51.45
$0.280
$0.280
$0.310
$0.310
We will pay future dividends at the discretion of our Board of
Trustees. Our ability to pay cash dividends in the future will be
dependent upon (i) the income and cash flow generated from
our operations; (ii) cash generated or used by our financing and
investing activities; and (iii) the annual distribution require-
ments under the REIT provisions of the Code described above
and such other factors as the Board of Trustees deems relevant.
Our ability to make cash dividends will also be limited by the
terms of our Operating Partnership Agreement and our financ-
ing arrangements as well as limitations imposed by state law
and the agreements governing any future indebtedness.
common shares performance graph
The graph and the table set forth below assume $100 was invested on December 31, 2001 in the common shares of Corporate Office
Properties Trust. The graph and the table compare the cumulative return (assuming reinvestment of dividends) of this investment
with a $100 investment at that time in the S&P 500 Index or the Equity Index of the National Association of Real Estate Investment
Trusts (“NAREIT”).
COPT
COPT
S&P
S&P
NAREIT
NAREIT
TOTAL RETURN PERFORMANCE
TOTAL RETURN PERFORMANCE
550
550
440
440
330
330
220
220
110
110
0
0
550
550
440
440
330
330
220
220
110
110
0
0
550
550
440
440
330
330
220
220
110
110
0
0
550
550
440
440
e
u
s
l
r
a
a
V
l
l
x
o
D
e
d
n
I
330
330
220
220
110
110
0
0
CORPORATE OFFICE
CORPORATE OFFICE
PROPERTIES TRUST
PROPERTIES TRUST
Source: SNL Financial LC, Charlottesville, VA © 2007
Source: SNL Financial LC, Charlottesville, VA ©2007
for Corporate Office Properties Trust
for Corporate Office Properties Trust
& NAREIT All Equity REIT Index data
& NAREIT All Equity REIT Index data
Source: Standard & Poor’s for S&P 500 data
Source: Standard & Poor’s for S&P 500 data
NAREIT ALL EQUITY
NAREIT ALL EQUITY
REIT INDEX
REIT INDEX
S&P 500
S&P 500
12/31/01
12/31/01
12/31/02 12/31/03 12/31/04
12/31/02 12/31/03 12/31/04
12/31/05 12/31/06
12/31/05 12/31/06
Index
12/31/01
12/31/02
12/31/03
12/31/04
12/31/05
12/31/06
Corporate Office Properties Trust
S&P 500
NAREIT All Equity REIT Index
$100.00
100.00
100.00
$125.79
77.90
103.82
$198.28
100.24
142.37
$287.84
111.14
187.33
$360.82
116.59
210.12
$525.99
135.00
283.78
Value at
92
Our
values
corporate information
Executive Officers
Randall M. Griffin
President and Chief Executive Officer
Karen M. Singer
Senior Vice President, General Counsel and
Secretary
Stephen E. Riffee
Executive Vice President and Chief Financial
Officer
Roger A. Waesche, Jr.
Executive Vice President and Chief Operating
Officer
Service Company Executive Officer
Dwight S. Taylor
President, COPT Development & Construction
Services, LLC
Executive Offices
Corporate Office Properties Trust
6711 Columbia Gateway Drive, Suite 300
Columbia, Maryland 21046
Telephone: (443) 285-5400
Facsimile: (443) 285-7650
&vision
Registrar and Transfer Agent
Shareholders with questions concerning stock
certificates, account information, dividend
payments or stock transfers should contact our
transfer agent:
Wells Fargo Bank, N.A.
Shareholder Services
161 North Concord Exchange
South St. Paul, Minnesota 55075
Toll-free: (800) 468-9716
www.wellsfargo.com/shareownerservices
Pennsylvania Office
Corporate Office Properties Trust
40 Morris Avenue, Suite 220
Bryn Mawr, Pennsylvania 19010
board of trustees
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Legal Counsel
Morgan, Lewis & Bockius
1701 Market Street
Philadelphia, Pennsylvania 19103
Independent Auditors
PricewaterhouseCoopers LLP
250 West Pratt Street, Suite 2100
Baltimore, Maryland 21201
Dividend Reinvestment Plan
Registered shareholders may reinvest dividends
through the Company’s dividend reinvestment
plan. For more information, please contact
Wells Fargo Shareholder Services at
(800) 468-9716.
Annual Meeting
The annual meeting of the shareholders will be
held at 9:30 a.m. on Thursday, May 17, 2007, at
the corporate headquarters of Corporate Office
Properties Trust at 6711 Columbia Gateway
Drive, Suite 300, Columbia, Maryland 21046.
Investor Relations
For help with questions about the Company,
or for additional corporate information, please
contact:
Mary Ellen Fowler
Vice President and Treasurer
Corporate Office Properties Trust
6711 Columbia Gateway Drive, Suite 300
Columbia, Maryland 21046
Telephone: (443) 285-5450
Facsimile: (443) 285-7640
Email: ir@copt.com
Shareholder Information
As of March 15, 2007, the Company had
46,743,001 outstanding common shares owned by
approximately 421 shareholders of record. This
does not include the number of persons whose
shares are held in nominee or “street name”
accounts through brokers or clearing agencies.
Common and Preferred Shares
The common and preferred shares of Corporate
Office Properties Trust are traded on the New
York Stock Exchange. Common shares are
traded under the symbol OFC, and preferred
shares are traded under the symbols OFCPrG,
OFCPrH and OFCPrJ.
Website
For additional information on the Company,
visit our website at www.copt.com.
Forward-looking Information
This report contains forward-looking informa-
tion based upon the Company’s current best
judgment and expectations. Actual results
could vary from those presented herein. The
risks and uncertainties associated with the
forward-looking information include the
strength of the commercial office real estate
market in which the Company operates, com-
petitive market conditions, general economic
growth, interest rates and capital market condi-
tions. For further information, please refer to
the Company’s filings with the Securities and
Exchange Commission.
Corporate Governance Certification
The Company submitted to the New York Stock
Exchange in 2006 the Annual CEO Certification
required by Section 303A.12 of the New York
Stock Exchange corporate governance rules.
Sarbanes-Oxley Act Section 302 Certification
The Company filed with the Securities and
Exchange Commission, as an exhibit to its
Form 10-K for the year ended December 31,
2006, the Sarbanes-Oxley Act Section 302
certification regarding the quality of the
Company’s public disclosure.
(left to right)
Jay H. Shidler, Chairman of the Board; Managing Partner, The Shidler Group
Steven D. Kesler, Chief Financial Officer, Chesapeake Commercial Properties, Inc.
Kenneth D. Wethe, Principal, Wethe & Associates
Randall M. Griffin, President and Chief Executive Officer, Corporate Office
Properties Trust
(left to right)
Clay W. Hamlin, III, Vice Chairman of the Board
Kenneth S. Sweet, Jr., Managing Partner, Gordon Stuart Associates
Thomas F. Brady, Executive Vice President, Corporate Strategy and Retail
Competitive Supply, Constellation Energy Group
Robert L. Denton, Managing Partner, The Shidler Group
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Defining The COPT Way
Corporate Office Properties Trust 2006 Annual Report
6711 Columbia Gateway Drive, Columbia, Maryland 21046 443-285-5400 w w w.copt.com NYSE : OFC