Douglas Emmett
Annual Report 2014

Plain-text annual report

Annual Report 2014 Dear Fellow Shareholders, Our markets experienced another year of strong fundamentals growth during 2014. Unemployment in West Los Angeles has dropped from approximately 8% two years ago to approximately 6% at year-end 2014 and in Honolulu unemployment is now just over 3%. During 2014, we executed 733 leases covering a record 3.1 million square feet. Rental rates continue to increase across our submarkets; at year-end our office assets were 92.5% leased, our highest since the recession. Our FFO per share grew to $1.54, up 3.4% from 2013 and 32% from 2007, our first full year as a public company. Our AFFO per share increased to $1.21, up 2.5% from 2013 and 70% since 2007. I am very pleased that we kept same store expense growth under 2% last year. This is a tribute to our operating group, and especially to our sustainability team, since 2014 was the warmest year on record in Los Angeles County. “Degree days”, a key measure of cooling requirements, were up an incredible 141% at the measuring station in Santa Monica. Despite this, we were able to keep electrical utilization in our portfolio essentially flat by continuing to implement the latest “best practices” in sustainability. Over 90% of our eligible office space is ENERGY STAR certified by the EPA as having energy efficiency in the top 25 percent of office buildings nationwide. I would like to highlight a few other accomplishments of our company in 2014. Our integrated operating platform has always given us a competitive advantage in servicing the typically small tenants in our markets, and it has enabled us to keep our occupancy well above submarket averages. In 2014, we further supplemented that already very strong platform by adding senior team members in leasing, accounting, portfolio management, and capital markets and enhanced the automated processes we use to run our operations – still, we kept our G&A at less than 5% of revenues. More importantly, in our annual on-line survey of our 2,600 office tenants, the 1,450 tenants who responded gave us an average satisfaction score of 4.45 out of 5, an increase of 7 basis points over 2013. Our expanded capital markets team had a very productive 2014 as well. We refinanced the loan on our Moanalua Hillside Apartments in Honolulu, acquired an office building just outside Beverly Hills and acquired a multi- family property near downtown Honolulu; and in December we agreed to purchase an office building in Encino that we then closed early in 2015. Our balance sheet remains strong, with leverage well within our target range and no material debt maturities during 2015. We increased our dividend to an annualized $0.84 per share and our dividend coverage is still one of the best in our peer group. During 2015, we also plan to secure permanent property level debt for our new properties and to refinance some of our debt maturing in future years to capitalize on favorable interest rates. Overall, I’m excited as we move into 2015. Given our expanding economy, we expect to see meaningful submarket occupancy growth fuel significant rent increases, and, with our expanded capital markets team, hope to see continued investment activity. Like every year, I promise that the Douglas Emmett Team continues to be committed to the high standards that have been our hallmark for more than 40 years. Sincerely, Jordan L. Kaplan President & CEO  DOUGLAS EMMETT, INC. TABLE OF CONTENTS Business Overview Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Selected Financial Data Management’s Discussion and Analysis of Financial Condition and Results of Operations Quantitative and Qualitative Disclosures About Market Risk Consolidated Financial Statements of Douglas Emmett, Inc. Forward Looking Statements. PAGE NO. 2 3 5 6 18 19 This Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (Securities Act), and Section 21E of the Securities Exchange Act of 1934 as amended (Exchange Act). You can find many (but not all) of these statements by looking for words such as “approximates,” “believes,” “expects,” “anticipates,” “estimates,” “intends,” “plans,” “would,” “may” or other similar expressions in this Report. We claim the protection of the safe harbor contained in the Private Securities Litigation Reform Act of 1995. We caution investors that any forward-looking statements presented in this Report, or those that we may make orally or in writing from time to time, are based on our beliefs and assumptions, as well as information currently available to us. The actual outcome will be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control or ability to predict. Although we believe that our assumptions are reasonable, they are not guarantees of future performance and some will inevitably prove to be incorrect. As a result, our actual future results can be expected to differ from our expectations, and those differences may be material. Accordingly, investors should use caution in relying on past forward-looking statements, which are based on known results and trends at the time they are made, to anticipate future results or trends. Some of the risks and uncertainties that may cause our actual results, performance or achievements to differ materially from those expressed or implied by forward-looking statements include the following: • • • • • • • • • • • • • • • • • • • • adverse economic or real estate developments in Southern California and Honolulu, Hawaii; a general downturn in the economy, such the global financial crisis that commenced in 2008; decreased rental rates or increased tenant incentive and vacancy rates; defaults on, early termination of, or non-renewal of leases by tenants; increased interest rates and operating costs; failure to generate sufficient cash flows to service our outstanding indebtedness; difficulties in raising capital for our institutional funds; difficulties in identifying properties to acquire and completing acquisitions; failure to successfully operate acquired properties and operations; failure to maintain our status as a Real Estate Investment Trust (REIT) under federal tax laws; possible adverse changes in rent control laws and regulations; environmental uncertainties; risks related to natural disasters; lack or insufficient amount of insurance, or changes to the cost of maintaining existing insurance coverage; inability to successfully expand into new markets and submarkets; risks associated with property development; conflicts of interest with our officers; changes in real estate zoning laws and increases in real property tax rates; the negative results of litigation or governmental proceedings; and the consequences of any future terrorist attacks. For further discussion of these and other factors, see “Item 1A. Risk Factors” included in our 2014 Annual Report on Form 10-K. This Report and all subsequent written and oral forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. We do not undertake any obligation to release publicly any revisions to our forward-looking statements to reflect events or circumstances after the date of this Report. 1 Business Overview Douglas Emmett, Inc. is a fully integrated, self-administered and self-managed Real Estate Investment Trust (REIT). We are one of the largest owners and operators of high-quality office and multifamily properties located in premier submarkets in California and Hawaii. We focus on owning, acquiring and operating a substantial share of top-tier office properties and premier multifamily communities in neighborhoods that possess significant supply constraints, high-end executive housing and key lifestyle amenities. We intend to increase our market share in our existing submarkets of Los Angeles County and Honolulu, and may selectively enter into other submarkets with similar characteristics where we believe we can gain significant market share. Through our interest in Douglas Emmett Properties, LP (our operating partnership) and its subsidiaries, including our investments in our unconsolidated institutional real estate funds (Funds), we own or partially own, manage, lease, acquire and develop real estate, consisting primarily of office and multifamily properties. At December 31, 2014, we owned a consolidated portfolio of fifty-three office properties (including ancillary retail space) totaling approximately 13.5 million rentable square feet of space and 10 multifamily properties containing 3,336 apartment units, as well as the fee interests in two parcels of land subject to ground leases. Alongside our consolidated portfolio, we also manage and own equity interests in our Funds which, at December 31, 2014, owned eight additional office properties totaling approximately 1.8 million square feet of space. We manage these eight properties alongside our consolidated portfolio; therefore we present our office portfolio statistics on a total portfolio basis, with a combined sixty-one Class A office properties totaling approximately 15.3 million square feet. All of our properties are concentrated in 9 premier Los Angeles County submarkets – Brentwood, Olympic Corridor, Century City, Santa Monica, Beverly Hills, Westwood, Sherman Oaks/Encino, Warner Center/Woodland Hills and Burbank, as well as in Honolulu, Hawaii. We employ a focused business strategy that we have developed and implemented over the last four decades: • Concentration of High Quality Office and Multifamily Assets in Premier Submarkets. First, we select submarkets that are supply constrained, with high barriers to entry, key lifestyle amenities, proximity to high-end executive housing and a strong, diverse economic base. Virtually no entitled Class A office space is currently under construction in any of our targeted submarkets. Our submarkets are dominated by small, affluent tenants, whose rent is very small relative to their revenues and often not the paramount factor in their leasing decisions. In addition, our diverse base of office tenants operates in a variety of legal, medical, entertainment, technology, financial and other professional businesses, reducing our dependence on any one industry. In 2012, 2013 and 2014, no tenant provided more than 10% of our total rental revenue and tenant reimbursements. • Disciplined Strategy of Acquiring Substantial Market Share. Once we select a submarket, we follow a disciplined strategy of gaining substantial market share to provide us with extensive local transactional market information, pricing power in lease and vendor negotiations and an enhanced ability to identify and negotiate investment opportunities. As a result, we average approximately a 24% share of the Class A office space in our targeted submarkets. • Proactive Asset and Property Management. Our fully integrated focused operating platform provides the unsurpassed tenant service demanded in our submarkets, with in-house leasing, proactive asset and property management and internal design and construction services. We believe this provides a key competitive advantage in managing our office portfolio, which at December 31, 2014 included 2,606 office leases with a median size of approximately 2,400 square feet, and our multifamily portfolio, which at December 31, 2014 included 3,336 apartment units. Our property management group oversees day-to-day property management of both our office and multifamily portfolios, allowing us to benefit from the operational efficiencies permitted by our submarket concentration. Our in-house leasing agents and legal specialists allow us to manage and lease a large property portfolio with a diverse group of smaller tenants, closing an average of approximately three office leases each business day. Finally, our in-house construction company allows us to compress the time required for building out many smaller spaces, so that we can reduce the resulting structural vacancy. Available Information We make available free of charge on our website at www.douglasemmett.com our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments thereto, as soon as reasonably practicable after we file such reports with, or furnish them to, the Securities and Exchange Commission (SEC). None of the information on or hyperlinked from our website is incorporated into this Report. 2 Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market for Common Stock; Dividends Our common stock is traded on the New York Stock Exchange under the symbol “DEI”. On December 31, 2014, the reported closing sale price per share of our common stock on the New York Stock Exchange was $28.40. The following table shows our dividends declared, and the high and low sales prices for our common stock as reported by the New York Stock Exchange for the periods indicated: 2014 Dividend declared Common Stock Price High Low 2013 Dividend declared Common Stock Price High Low Holders of Record First Quarter Second Quarter Third Quarter Fourth Quarter $ $ $ $ $ $ 0.20 27.43 23.40 0.18 25.32 23.29 $ $ $ $ $ $ 0.20 29.29 26.31 0.18 28.18 23.74 $ $ $ $ $ $ 0.20 29.38 25.67 0.18 26.53 22.41 $ $ $ $ $ $ 0.21 28.88 25.61 0.20 25.54 22.27 We had 20 holders of record of our common stock on February 20, 2015. Certain of our shares are held in “street” name and accordingly, the number of beneficial owners of such shares is not known or included in the foregoing number. Dividend Policy We typically pay quarterly dividends to common stockholders at the discretion of the Board of Directors. Dividend amounts depend on our available cash flows, financial condition and capital requirements, annual distribution requirements under the REIT provisions of the Internal Revenue Code, and such other factors as the Board of Directors deems relevant. Sales of Unregistered Securities None. Repurchases of Equity Securities None. 3 Performance Graph The information below shall not be deemed to be “soliciting material” or to be “filed” with the U.S. Securities and Exchange Commission or subject to Regulation 14A or 14C, other than as provided in Item 201 of Regulation S-K , or to the liabilities of Section 18 of the Exchange Act, except to the extent we specifically request that such information be treated as soliciting material or specifically incorporate it by reference into a filing under the Securities Act or the Exchange Act. The following graph compares the cumulative total stockholder return on the common stock of Douglas Emmett, Inc. from December 31, 2009 to December 31, 2014 with the cumulative total return of the Standard & Poor’s 500 Index and an appropriate “peer group” index (assuming a $100 investment in our common stock and in each of the indexes on December 31, 2009, and that all dividends were reinvested into additional shares of common stock at the frequency with which dividends are paid on the common stock during the applicable fiscal year). The total return performance presented in this graph is not necessarily indicative of, and is not intended to suggest, the total future return performance. Douglas Emmett, Inc. Douglas Emmett, Inc. Total Return Performance Douglas Emmett, Inc. S&P 500 NAREIT Equity DEI Peer group 12-31-10 12-31-11 12-31-12 12-31-13 12-31-14 12-31-09 100.00 100.00 100.00 100.00 12-31-10 119.40 115.06 127.96 127.83 Period Ending 12-31-11 134.72 117.49 138.57 133.92 12-31-12 176.94 136.30 163.60 149.15 12-31-13 182.33 180.44 167.63 163.47 12-31-14 228.98 205.14 218.16 221.51 250 225 200 175 150 125 100 e u l a V x e d n I 75 12-31-09 Index Douglas Emmett, Inc. S&P 500 NAREIT Equity DEI Peer group *DEI Peer Group index consist of Boston Properties, Inc. (BXP), Kilroy Realty Corporation (KRC), SL Green Realty Corp. (SLG), and Vornado Realty Trust (VNO) 4 Selected Financial Data The table below presents selected consolidated financial and operating data on an historical basis, and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements included elsewhere in this report: Statement of Operations Data (in thousands): Total office revenues Total multifamily revenues Total revenues Operating income Income (Loss) attributable to common stockholders Per Share Data: Income (Loss) per share - basic Income (Loss) per share - diluted Weighted average common shares outstanding (in thousands): Basic Diluted Dividends declared per common share 2014 Year Ended December 31, 2012 2011 2013 2010 $ 519,422 $ 514,600 $ 505,276 $ 505,077 $ 502,700 80,117 599,539 167,854 76,936 591,536 178,691 73,723 578,999 175,810 70,260 575,337 152,474 68,144 570,844 140,027 44,621 45,311 22,942 1,451 (26,423) $ $ $ 0.31 0.30 $ $ 0.32 0.31 $ $ 0.16 0.16 $ $ 0.01 0.01 $ $ (0.22) (0.22) 144,013 176,221 142,556 174,802 139,791 173,120 126,187 159,966 0.81 $ 0.74 $ 0.63 $ 0.49 $ 122,715 122,715 0.40 2014 2013 2012 2011 2010 As of December 31, Balance Sheet Data (in thousands): Total assets $ 5,954,596 $ 5,847,789 $ 6,103,807 $ 6,231,602 $ 6,279,289 Secured notes payable and revolving credit facility Other Data: Number of consolidated properties(1) 3,435,290 3,241,140 3,441,140 3,624,156 3,668,133 63 61 59 59 59 (1) All properties are wholly-owned by our operating partnership, except one property owned by a consolidated joint venture in which we held a two-thirds interest. 5 Management’s Discussion and Analysis of Financial Condition and Results of Operations Forward Looking Statements This Management’s Discussion and Analysis of Financial Condition and Results of Operations includes many forward- looking statements. For cautions about relying on such forward-looking statements, please refer to the section entitled “Forward Looking Statements” at the beginning of this Report immediately after the table of contents. Executive Summary Douglas Emmett, Inc. is a fully integrated, self-administered and self-managed REIT. We are one of the largest owners and operators of high-quality office and multifamily properties in Los Angeles County, California and in Honolulu, Hawaii. We focus on owning and acquiring a substantial share of top-tier office properties and premier multifamily communities in neighborhoods that possess significant supply constraints, high-end executive housing and key lifestyle amenities. Through our interest in Douglas Emmett Properties, LP (our operating partnership) and its subsidiaries, including our investments in unconsolidated Funds, we own or partially own, manage, lease, acquire and develop real estate, consisting primarily of office and multifamily properties. As of December 31, 2014: • Our consolidated portfolio of properties included fifty-three Class A office properties (including ancillary retail space) totaling 13.5 million rentable square feet and ten multifamily properties containing 3,336 apartment units, as well as the fee interests in two parcels of land subject to ground leases. • Our total office portfolio consisted of sixty-one Class A office properties aggregating 15.3 million rentable square feet, consisting of both our consolidated office properties and eight properties owned by our Funds (in which we own a weighted average of 59.3% based on square footage). • Our consolidated office portfolio was 92.0% leased and 90.2% occupied and our total office portfolio was 92.5% leased and 90.5% occupied. • Our multifamily properties were 99.3% leased and 98.2% occupied. • Approximately 83.7% of the annualized rent of our consolidated portfolio was contributed by our office properties and the remaining 16.3% was contributed by our multifamily properties. • Approximately 84.0% of the annualized rent of our consolidated portfolio was contributed by our Los Angeles County office and multifamily properties and the remaining 16.0% was contributed by our Honolulu, Hawaii office and multifamily properties. Financings, Acquisitions, Dispositions, Development and Repositionings Development: We are developing two multifamily projects, one in Brentwood, Los Angeles, and one in Honolulu, Hawaii. Each development is on land which we already own: • We are working on an additional 500 apartments at our Moanalua Hillside Apartments in Honolulu. We have targeting completing construction in 2016 or 2017 at a cost of approximately $120 million, which includes the cost of upgrading the existing 696 apartments, improving the parking and landscaping, building a new leasing and management office, and building a new recreation building with a fitness facility, a new pool and deck area. • In Los Angeles, we are seeking to build a high rise apartment project currently projected to include 376 apartments. Because development in our markets, particularly West Los Angeles, remains a long and uncertain process, even if successful, we would not expect to break ground in Los Angeles before late 2015. We expect the cost of this development to be approximately $100 million to $120 million. 6 Financings: • During the first quarter of 2014, we refinanced a $16.1 million loan that was scheduled to mature on March 3, 2014, lowering the interest rate to LIBOR + 1.60% and extending the maturity date to March 1, 2016. • On October 1, 2014, we closed a $145.0 million interest only five year term loan with a floating interest rate of LIBOR + 1.25%. We used $111.9 million of the proceeds to pay off an existing loan that was scheduled to mature on February 1, 2015 and the remaining proceeds for an acquisition. • On December 24, 2014, we closed a $20.0 million interest only one year term loan with a floating interest rate of LIBOR + 1.45%. See Note 6 to our consolidated financial statements included in this Report for more information regarding our debt. Acquisitions and Dispositions: • During the second quarter of 2014, we acquired a very small land parcel in connection with our Moanalua apartment development project. • On October 16, 2014, we purchased a 216,000 square foot Class "A" multi-tenant office property adjacent to Beverly Hills for $74.5 million, or approximately $345 per square foot. • On December 30, 2014, we purchased a 468 unit multifamily property in Honolulu for $146.0 million, or approximately $312,000 per unit. • On December 29, 2014, we agreed to purchase a 224,000 square foot Class “A” multi-tenant office property in Encino for $89.0 million, or approximately $397 per square foot. Subject to typical closing conditions, the purchase is scheduled to close in the first quarter of 2015. See Note 3 to our consolidated financial statements included in this Report for more information regarding our acquisitions. Repositionings: We often strategically purchase properties with large vacancies or expected near-term lease roll-over and use our knowledge of the property and submarket to reposition the property for the optimal use and tenant mix. The work we undertake to reposition a building typically takes months or even years, and could involve a range of improvements from a complete structural renovation to a targeted remodeling of selected spaces. We generally select a property for repositioning at the time we purchase it, although repositioning efforts can also occur at properties that we already own. During the repositioning, the affected property may display depressed rental revenue and occupancy levels which impacts our results and, therefore, comparisons of our performance from period to period. We are currently repositioning a 79,000 square foot office property in Honolulu in which we own a two-thirds interest, and a a 413,000 square foot office property which included a 35,000 square foot store on which we expect to develop a residential tower. Results of Operations and Basis of Presentation The accompanying consolidated financial statements as of December 31, 2014 and 2013 and for the three years ended December 31, 2014, 2013 and 2012 are the consolidated financial statements of Douglas Emmett, Inc. and our subsidiaries including our operating partnership. All significant intercompany balances and transactions have been eliminated in our consolidated financial statements. The comparability of our results of operations during this period was affected by a number of acquisitions: two properties that we acquired in each of 2014 and 2013, and additional interests that we acquired in our Funds in both 2012 and 2013. See Notes 3 and 18 to our consolidated financial statements included in this Report. 7 Funds From Operations Many investors use Funds From Operations (FFO) as one performance yardstick to compare our operating performance with that of other REITs. FFO represents net income (loss), computed in accordance with GAAP, excluding gains (or losses) from sales of depreciable operating property, impairments of depreciable operating property and investments, real estate depreciation and amortization (other than amortization of deferred financing costs), and after adjustments for unconsolidated partnerships and joint ventures. We calculate FFO in accordance with the standards established by the National Association of Real Estate Investment Trusts (NAREIT), adjusted to treat debt interest rate swaps as terminated for all purposes in the quarter of termination. Like any metric, FFO is not perfect as a measure of our performance, because it excludes depreciation and amortization, and captures neither the changes in the value of our properties that result from use or market conditions, nor the level of capital expenditures and leasing commissions necessary to maintain the operating performance of our properties, all of which have real economic effect and could materially impact our results from operations. Other REITs may not calculate FFO in accordance with the NAREIT definition or may not adjust that definition to treat debt interest rate swaps as terminated for all purposes in the quarter of termination and, accordingly, our FFO may not be comparable to those other REITs’ FFO. Accordingly, FFO should be considered only as a supplement to net income as a measure of our performance. FFO should not be used as a measure of our liquidity, nor is it indicative of funds available to fund our cash needs, including our ability to pay dividends. FFO should not be used as a supplement to or substitute measure for cash flow from operating activities computed in accordance with GAAP. FFO increased by $11.0 million, or 4.2%, to $271.0 million for 2014 compared to $260.1 million for 2013. The increase was primarily due to (i) increased operating income from our multifamily portfolio due to higher rents, which primarily reflects higher rental rates, (ii) additional operating income from our office properties that we acquired in 2013 and 2014, (iii) an increase in our share of the FFO of our unconsolidated funds, (iv) insurance recoveries related to property damage, and (v) a decrease in interest expense as a result of lower debt balances. FFO (adjusted for our terminated swaps)(see footnote to table below) increased by $24.7 million, or 10.5%, to $260.1 million for 2013 compared to $235.4 million for 2012. The increase was primarily due to (i) an increase in operating income from our office portfolio due to properties that we acquired in 2013, (ii) an increase in operating income from our multifamily portfolio due to increases in rental rates, (iii) an increase in our share of the FFO of our unconsolidated funds due to lower interest expense of one of our Funds as a result of a debt refinancing, as well as (iv) a decrease in interest expense as a result of the maturing of $340.0 million in notional amount of interest rate swaps in the first quarter of 2013. The table below (in thousands) reconciles our FFO to net income attributable to common stockholders computed in accordance with GAAP: Year Ended December 31, 2014 2013 2012 Funds From Operations (FFO) Net income attributable to common stockholders $ 44,621 $ 45,311 $ Depreciation and amortization of real estate assets Net income attributable to noncontrolling interests Less: adjustments attributable to consolidated joint venture and unconsolidated investment in real estate funds (1) FFO (before adjustments for terminated swaps) Amortization of accumulated other comprehensive income as a result of terminated swaps (2) FFO (after adjustments for terminated swaps) 202,512 8,233 15,670 271,036 191,351 7,526 15,894 260,082 22,942 184,849 5,403 13,311 226,505 — — 8,855 $ 271,036 $ 260,082 $ 235,360 ___________________________________________________ (1) Adjusts for (i) the portion of each listed adjustment item that is attributed to the noncontrolling interest in our consolidated joint venture and (ii) the effect of each listed adjustment item on our share of the results of our unconsolidated Funds. (2) In 2012, GAAP net income was reduced by amortization expense as a result of swaps terminated in December 2011 in connection with the refinancing of related loans. In calculating FFO, we treat interest rate swaps as terminated for all purposes in the quarter of termination. In contrast, under GAAP, terminated swaps can continue to impact net income over their original lives as if they were still outstanding. 8 Rental Rate Trends Office Rental Rates: The table below presents the average effective annual rental rate per leased square foot and the annualized lease transaction costs for leases executed in our total office portfolio: Historical straight-line rents:(1) Average rental rate(2) Annualized lease transaction costs(3) 2014 $35.93 $4.66 ____________________________________________________ Year Ended December 31, 2012 2011 2013 $34.72 $4.16 $32.86 $4.06 $32.76 $3.64 2010 $32.33 $3.68 (1) Because straight-line rent takes into account the full economic value of each lease, including accommodations and rent escalations, we believe that it may provide a better comparison than ending cash rents, which include the impact of the annual escalations over the entire term of the lease. However, care should be taken in any comparison, as the averages are often significantly affected from period to period by factors such as the buildings, submarkets, types of space and term involved in the leases executed during the period. (2) Represents the weighted average straight-line annualized base rent (i.e., excludes tenant reimbursements, parking and other revenue) per leased square foot for leases entered into within our total office portfolio. For our triple net Burbank and Honolulu office properties, annualized rent is calculated by adding expense reimbursements to base rent. (3) Represents the weighted average leasing commissions and tenant improvement allowances under each office lease within our total office portfolio that were executed during the applicable period, divided by the number of years of that lease. This number increased as a result of increased leasing to larger tenants, in submarkets with more vacancy, and in larger to lease spaces throughout our portfolio. During the fourth quarter of 2014, we experienced positive rent roll up, with the average straight-line rent of $39.39 under new and renewal leases that we signed in the quarter averaging 6.2% greater than the average straight-line rent of $37.10 under the expiring leases for the same space. This improvement reflects both (i) continuing increases in average starting rental rates, and (ii) more leases containing annual rent escalations in excess of 3% per annum. Quarterly fluctuations in submarkets, buildings and term of the expiring leases make predicting the changes in rent in any specific quarter difficult. Our average starting cash rental rate on new leases of $37.58 signed during the fourth quarter of 2014 were 6.1% greater than the average starting cash rental rate on the expiring leases for the same space of $35.42, although, as a result of our high annual rent escalations, less than the average ending cash rental rate of $39.95 on those expiring leases. However, the negative effect of cash rent roll downs, which affect approximately 10 to 16 percent of our office portfolio each year, was offset by the positive impact of the annual cash rent escalations in virtually all of our continuing in-place office leases. Over the next four quarters, we expect to see expiring cash rents in our total office portfolio as presented in the table below: Three Months Ended Expiring cash rents: Expiring square feet (1) Expiring rent per square foot (2) $ March 31, 2015 June 30, 2015 September 30, 2015 December 31, 2015 255,892 32.99 $ 415,506 34.32 $ 262,304 34.46 $ 504,475 34.33 ___________________________________________________ (1) Includes scheduled expirations for our total office portfolio, including our consolidated portfolio of fifty-three properties totaling 13.5 million square feet, as well as eight properties totaling 1.8 million square feet owned by our Funds. Expiring square footage reflects all existing leases that are scheduled to expire in the respective quarters shown above, excluding the square footage under leases where (i) the existing tenant renewed the lease prior to December 31, 2014, (ii) a new tenant has executed a lease on or before December 31, 2014 that will commence after December 31, 2014, (iii) early termination options are exercised after December 31, 2014, (iv) defaults occurring after December 31, 2014, and (v) short term leases, such as month to month leases and other short term leases. Short term leases are excluded because (i) they are not included in our changes in rental rate data, (ii) have rental rates that may not be reflective of market conditions, and (iii) can distort the data trends, particularly in the first upcoming quarter. The variations in this number from quarter to quarter primarily reflect the mix of buildings/submarkets involved, although it is also impacted by the varying terms and square footage of the individual leases involved. (2) Represents annualized base rent (i.e., excludes tenant reimbursements, parking and other revenue) per leased square foot at expiration. The amount reflects total cash base rent before abatements. For our Burbank and Honolulu office properties, we calculate annualized base rent for triple net leases by adding expense reimbursements to base rent. Expiring rent per square foot on a quarterly basis is impacted by a number of variables, including variations in the submarkets or buildings involved. 9 Multifamily Rental Rates: With respect to our residential properties, our average rent on leases to new tenants during the fourth quarter of 2014 was 6.6% higher than the rent for the same unit at the time it became vacant. The table below presents the average effective annual rental rate per leased unit for leases executed in our residential portfolio: Average annual rental rate - new tenants: Rental rate Occupancy Rates 2014 Year Ended December 31, 2012 2011 2013 2010 $ 28,870 $ 27,392 $ 26,308 $ 24,502 $ 22,497 Occupancy Rates: The tables below present the occupancy rates for our total office portfolio and multifamily portfolio: Occupancy Rates as of: Office Portfolio Multifamily Portfolio December 31, 2014 2013 2012 2011 2010 90.5% 98.2% 90.4% 98.7% 89.6% 98.7% 87.5% 98.4% 86.9% 98.4% Average Occupancy Rates(1)(2) for: Office Portfolio Multifamily Portfolio 2014 90.0% 98.5% ______________________________________________________ Year Ended December 31, 2012 2013 2011 89.7% 98.6% 88.3% 98.5% 87.0% 98.2% 2010 88.0% 98.3% (1) Average occupancy rates are calculated by averaging the occupancy rates on the first and last day of a quarter, and for periods longer than a quarter, by averaging the occupancy rates at the end of each of the quarters in the period and at the end of the quarter immediately prior to the start of the period. (2) Occupancy rates include the negative impact of property acquisitions, most of whose occupancy rates at the time of acquisition are well below that of our existing portfolio. Comparison of 2014 to 2013 Revenues Office Rental Revenue: Rental revenue includes rental revenues from our office properties, percentage rent on the retail space contained within our office properties and lease termination income. Total office rental revenue increased by $1.8 million, or 0.5%, to $396.5 million for 2014 compared to $394.7 million for 2013. The increase was primarily due to an increase in rental revenue of $8.3 million from properties that we acquired in the second and third quarters of 2013 and the fourth quarter of 2014, partly offset by a decrease in rental revenue of $6.5 million from the properties that we owned throughout both years. The decrease in rental revenue from properties that we owned throughout both years was primarily due to a decrease in our revenues of $5.5 million (on a straight line basis), as well as a decrease from the net accretion of above- and below-market leases of $2.6 million, largely as the result of the ongoing expiration of leases in place at the time of our IPO. See Note 3 to our consolidated financial statements included in this Report for more information regarding our acquisitions. Office Tenant Recoveries: Total office tenant recoveries decreased by $0.7 million, or 1.5%, to $44.5 million for 2014, compared to $45.1 million for 2013. The decrease was primarily due to an decrease in recoveries of $0.9 million from the properties that we owned throughout both years, partly offset by an increase in recoveries of $0.2 million primarily from properties that we acquired in the second and third quarters of 2013 and the fourth quarter of 2014. The decrease from the properties that we owned throughout both years primarily reflects lower recoverable operating expenses as well as lower income from prior period reconciliations. Office Parking and Other Income: Total office parking and other income increased by $3.7 million, or 5.0%, to $78.4 million for 2014 compared to $74.7 million for 2013. The increase was primarily due to an increase of $2.2 million in parking and other income from properties that we owned throughout both years, as well as an increase in parking and other income of $1.5 million primarily from properties that we acquired in the second and third quarters of 2013 and the fourth quarter of 2014. The increase in parking and other income for the properties that we owned throughout both years reflects increases in rates as well as higher utilization. 10 Multifamily Revenue: Total multifamily revenue increased by $3.2 million, or 4.1%, to $80.1 million for 2014 compared to $76.9 million for 2013. The increase was primarily due to increases in rental rates. Operating Expenses Office Rental Expenses: Total office rental expense increased by $6.2 million, or 3.6%, to $181.2 million for 2014 compared to $175.0 million for 2013. The increase was primarily due to an increase in office rental expenses of $3.7 million for properties that we acquired in the second and in the third quarters of 2013 and the fourth quarter of 2014, as well as an increase in office rental expenses of $2.6 million from properties that we owned throughout both years. The increase in office rental expenses for the properties that we owned throughout both years primarily reflects higher utilities expense. Multifamily Rental Expenses: Total multifamily rental expense increased by $0.7 million, or 3.7%, to $20.7 million for 2014 compared to $19.9 million for 2013. The increase was primarily due to higher utilities expense. General and Administrative Expenses: General and administrative expenses increased by $0.7 million, or 2.7%, to $27.3 million for 2014, compared to $26.6 million for 2013. The increase was primarily because of the reversal of liability accruals that reduced expenses in 2013. Depreciation and Amortization: Depreciation and amortization expense increased by $11.2 million, or 5.8%, to $202.5 million for 2014 compared to $191.4 million for 2013. The increase was primarily due to depreciation and amortization of $7.7 million from properties that we owned throughout both periods, as well as depreciation and amortization of $3.5 million primarily from properties that we acquired in the second and third quarters of 2013 and the fourth quarter of 2014. The increase in depreciation and amortization for the properties that we owned throughout both years reflects accelerated depreciation with respect to a former supermarket that we expect to demolish in connection with our residential development project in Los Angeles. Non-Operating Income and Expenses Other Income and Other Expenses: Other income increased by $11.3 million, or 176.1% to $17.7 million for 2014, compared to $6.4 million for 2013, and other expenses increased by $2.9 million, or 69.0% to $7.1 million for 2014, compared to $4.2 million for 2013. The increase in other income was primarily due to $6.2 million of insurance recoveries related to property repairs for damage from a fire at one of our residential properties, $2.2 million of accelerated accretion related to an above market ground lease for which we acquired the underlying fee in 2015, as well as an increase in revenues from a health club at one of our office properties in Honolulu that we commenced operating in the second quarter of 2013. The increase in other expenses similarly reflects the increase in expenses for the health club. Income (Loss), including Depreciation, from Unconsolidated Real Estate Funds: Our share of the income, including depreciation, from our Funds increased by $0.6 million, or 19.9% to $3.7 million for 2014 compared to $3.1 million for 2013. The increase was primarily due to an increase in revenue for our Funds. See Note 18 to our consolidated financial statements included in this Report for more information regarding our Funds. Interest Expense: Interest expense decreased by $2.0 million, or 1.6%, to $128.5 million for 2014, compared to $130.5 million for 2013. The decrease was primarily due to lower debt balances. See Notes 6 and 8 to our consolidated financial statements included in this Report for more information regarding our debt and interest rate contracts. Acquisition Expenses: Acquisition expenses, which include the costs of both the acquisitions that we close and those we do not close, were $786,000 in 2014 and $607,000 in 2013. See Note 3 to our consolidated financial statements included in this Report for more information regarding our acquisitions. Comparison of 2013 to 2012 Revenues Office Rental Revenue: Total office rental revenue increased by $3.3 million, or 0.8%, to $394.7 million for 2013 compared to $391.4 million for 2012. The increase was primarily due to rental revenue of $6.4 million from properties that we acquired in the second and third quarters of 2013, partly offset by lower revenues from net accretion of above- and below-market leases which declined by $3.0 million in 2013 as the result of the ongoing expiration of leases that were in place at the time of our initial public offering (IPO). 11 Office Tenant Recoveries: Total office tenant recoveries increased by $1.1 million, or 2.4%, to $45.1 million for 2013, compared to $44.1 million for 2012. The increase was primarily due to an increase of $847 thousand in recoveries from the properties that we owned during both comparable periods, as well as recoveries of $203 thousand from properties that we acquired in the second and third quarters of 2013. The increase in recoveries for our comparable properties primarily reflects higher recoverable operating expenses, as well as an increase in recoveries related to prior year reconciliations. Office Parking and Other Income: Total office parking and other income increased by $5.0 million, or 7.1%, to $74.7 million for 2013 compared to $69.7 million for 2012. The increase was primarily due to an increase of $4.0 million in parking and other income from properties that we owned during both comparable periods, as well as revenue of $1.0 million from properties that we acquired in the second and third quarters of 2013. The increase in parking and other income for our comparable properties reflects higher parking cash revenue primarily due to increases in rates as well as higher utilization. Multifamily Revenue: Total multifamily revenue increased by $3.2 million, or 4.4%, to $76.9 million for 2013 compared to $73.7 million for 2012. The increase was primarily due to increases in rental rates. Operating Expenses Office Rental Expenses: Total office rental expense increased by $4.2 million, or 2.5%, to $175.0 million for 2013 compared to $170.7 million for 2012. The increase was primarily due to office rental expenses of $3.1 million from properties that we acquired in the second and in the third quarters of 2013, as well as an increase in office rental expenses of $1.1 million from properties that we owned during both comparable periods. The increase in office rental expenses for our comparable properties primarily reflects higher property taxes, utilities expense and scheduled services. Multifamily Rental Expenses: Total multifamily rental expense increased by $0.3 million, or 1.3%, to $19.9 million for 2013 compared to $19.7 million for 2012. The increase was primarily due to higher property taxes and utilities expense. General and Administrative Expenses: General and administrative expenses decreased by $1.3 million, or 4.8%, to $26.6 million for 2013, compared to $27.9 million for 2012. The decrease was primarily due to a decrease in employee equity compensation expense as well as the reversal of accruals which reduced expenses in 2013. Depreciation and Amortization: Depreciation and amortization expense increased by $6.5 million, or 3.5%, to $191.4 million for 2013 compared to $184.8 million for 2012. The increase was primarily due to depreciation and amortization of $4.0 million from properties that we owned during both comparable periods, as well as depreciation and amortization of $2.5 million from properties that we acquired in the second and third quarters of 2013. The increase in depreciation and amortization for our comparable properties reflects accelerated depreciation of tenant improvements as a result of a tenant bankruptcy at one of our office properties in Honolulu, as well as accelerated depreciation with respect to a former supermarket that we expect to demolish in connection with our residential development project in Los Angeles. Non-Operating Income and Expenses Other Income and Other Expenses: Other income increased by $3.6 million, or 126.9%, to $6.4 million for 2013, compared to $2.8 million for 2012, and other expenses increased by $2.3 million, or 123.0% to $4.2 million for 2013, compared to $1.9 million for 2012. These changes primarily reflect the inclusion of the revenues and expenses of a health club at one of our office properties in Honolulu, which we commenced operating in the second quarter of 2013, in other income and other expenses, respectively. The club was previously operated by a third party tenant which paid us rent which was included in office revenues. Since that tenant rejected the lease after going bankrupt, a subsidiary of our consolidated joint venture has been operating the club while the building is being repositioned. In 2013, other income also included $431,000 of insurance proceeds that we received related to a fire at one of our residential properties. Income (Loss), including Depreciation, from Unconsolidated Real Estate Funds: This amount represents our equity interest in the operating results from our Funds, including the operating income net of historical cost-basis depreciation, for the full year. Our share of the income (loss), including depreciation, from our Funds increased by $4.8 million to income of $3.1 million for 2013 compared to a loss of $1.7 million for 2012. The increase was primarily due to lower interest expense of one of our Funds, as a result of the refinancing of debt with lower principal and a lower effective interest rate, at the beginning of the second quarter of 2013. See Note 18 to our consolidated financial statements included in this Report for more information regarding our Funds. 12 Interest Expense: Interest expense decreased by $16.1 million, or 11.0%, to $130.5 million for 2013, compared to $146.7 million for 2012. The decrease was primarily due to lower cash interest expense of $8.3 million as a result of the expiration of certain interest rate swaps in the first quarter of 2013, as well as a decrease in non-cash amortization of $8.8 million related to interest rate swaps that were terminated in 2012, partially offset by reduced non-cash amortization of loan premium of $1.1 million. See Notes 6 and 8 to our consolidated financial statements included in this Report for more information regarding our debt and interest rate contracts. Acquisition Expenses: Our 2013 results included $607,000 of acquisition expenses related to both completed and terminated acquisitions. For 2013, the acquired properties included a 225,000 square foot office property in Beverly Hills acquired in May 2013 and a 191,000 square foot office property in Encino acquired in August 2013. We did not acquire any properties in 2012. See Note 3 to our consolidated financial statements included in this Report for more information regarding our acquisitions. Liquidity and Capital Resources General We have typically financed our capital needs through lines of credit and long-term secured mortgages. We had total indebtedness of $3.44 billion at December 31, 2014. See Note 6 to our consolidated financial statements included in this Report for more information regarding our debt. To mitigate the impact of fluctuations in interest rates on our cash flows from operations, some of our long-term secured mortgages carry fixed interest rates, and we generally enter into interest rate swap or interest rate cap agreements with respect to our mortgages with floating interest rates. These swaps generally expire between one and two years before the maturity date of the related loan, during which time we can refinance the loan without any interest penalty. See Note 8 to our consolidated financial statements included in this Report for more information regarding our derivatives. As of December 31, 2014, approximately $2.97 billion, or 86.5%, of our debt had an annual interest rate that was effectively fixed, with an average rate of 4.1% per annum (on an actual / 360-day basis). The weighted average remaining period during which the interest rate was fixed was 2.4 years. For more information regarding the estimated impact of changes in market interest rates on our annual earnings, please see "Quantitative and Qualitative Disclosures about Market Risk". At December 31, 2014, our net consolidated debt (consisting of our $3.44 billion of borrowings under secured loans less our cash and cash equivalents of $18.8 million) represented 40.4% of our total enterprise value of $8.45 billion. Our total enterprise value includes our net consolidated debt and the value of our common stock, the noncontrolling units in our operating partnership and other convertible equity instruments, each based on our common stock closing price on December 31, 2014 (the last business day of the year) on the New York Stock Exchange of $28.40 per share. Activity for 2014 For a description of our financing transactions during the year ended December 31, 2014, please see "Financings, Acquisitions, Dispositions, Development and Repositionings" above. On February 28, 2014, we loaned $27.5 million to the owner of the fee interest under one of our buildings. The loan carried interest of 4.9% and was secured by that land. In February 2015, the loan was partly repaid and contributed to our operating partnership. See Notes 5, 13 and 19 to our consolidated financial statements included in this Report. Short term liquidity We expect to meet our operating liquidity requirements through cash on hand, cash generated by operations, and if necessary, our revolving credit facility. At December 31, 2014, our revolving credit facility had an unused balance of $118.0 million. See Note 6 to our consolidated financial statements included in this Report for more information regarding our revolving credit facility. On December 29, 2014, we entered into an agreement to purchase a 224 thousand square foot Class “A” multi-tenant office property in Encino for $89.0 million, or approximately $397 per square foot. Subject to typical closing conditions, the purchase is scheduled to close in the first quarter of 2015. See "Financings, Acquisitions, Dispositions, Development and Repositionings" above. 13 We are currently developing two multifamily projects, one in Brentwood, Los Angeles, and one in Honolulu, Hawaii, please see "Financings, Acquisitions, Dispositions, Development and Repositionings" above. We intend to finance the costs of these development projects through cash provided by operations and our revolving credit facility. Excluding any other potential acquisitions and debt refinancings, we anticipate that our cash on hand, cash generated by operations, and our revolving credit facility will be sufficient to meet our liquidity requirements for at least the next 12 months. Long term liquidity Our long-term liquidity needs consist primarily of funds necessary to pay for acquisitions, development and repositioning of properties, non-recurring capital expenditures and refinancing of indebtedness. We do not expect that we will have sufficient funds on hand to cover all of these long-term cash requirements. The nature of our business, and the requirements imposed by REIT rules that we distribute a substantial majority of our income on an annual basis, may cause us to have substantial liquidity needs over the long term. We will seek to satisfy our additional long-term liquidity needs through long-term secured and unsecured indebtedness, the issuance of debt and equity securities, including units in our operating partnership, property dispositions and joint venture transactions. We have an At-the-Market, or ATM, program which would allow us to sell up to an additional $300.0 million of common stock, none of which has been sold as of December 31, 2014. Commitments and other future expected transactions We have no material debt maturities in 2015, however, during 2015, we expect to refinance $100.0 million of residential loans due in 2016 and 2017, a $400.0 million loan due in 2017, and to obtain permanent financing for our recent and announced acquisitions to pay off our floating rate credit line. Contractual obligations The table below presents (in thousands) our principal obligations and commitments, excluding periodic interest payments, as of December 31, 2014: Contractual Obligations Debt obligations(1) Ground lease payments(2) Purchase commitments related to in progress capital expenditures and tenant improvements Total Payment due by period 2-3 years Less than 1 year 4-5 years Total Thereafter $ 3,435,290 $ 22,267 $ 728,749 $ 2,296,194 $ 388,080 52,775 733 1,466 1,466 49,110 5,964 5,964 — — — $ 3,494,029 $ 28,964 $ 730,215 $ 2,297,660 $ 437,190 ____________________________________________________ (1) Represents the future principal payments due on our secured notes payable and revolving credit facility. For detail of the interest rates that determine our periodic interest payments related to our debt obligations, see Note 6 to our consolidated financial statements included in this Report. (2) Represents the future minimum ground lease payments. For more detail, see Note 14 to our consolidated financial statements included in this Report. Cash Flows Our cash and cash equivalents were $18.8 million and $44.2 million at December 31, 2014 and 2013, respectively. Comparison of 2014 to 2013 Our cash flows from operating activities are primarily dependent upon the occupancy level of our portfolio, the rental rates achieved on our leases, the collectability of rent and recoveries from our tenants, and the level of operating expenses and other general and administrative costs. Net cash provided by operating activities increased by $3.2 million to $246.7 million for 2014 compared to $243.5 million for 2013. The increase was primarily due to an increase in cash operating income from our multifamily portfolio, an increase in the cash operating income from our office portfolio, a decrease in cash general and administrative expense and lower cash interest expense. 14 Our net cash used in investing activities is generally used to fund property acquisitions, development and redevelopment projects, and recurring and non-recurring capital expenditures. Net cash used in investing activities increased by $73.4 million to $320.0 million for 2014 compared to $246.6 million for 2013. The increase was primarily due to an increase in cash used to fund property acquisitions in 2014. See Note 3 to our consolidated financial statements included in this Report. Our net cash related to financing activities is generally impacted by our borrowings and capital activities, net of dividends and distributions paid to common stockholders and noncontrolling interests, respectively. Our financing activities provided net cash of $47.9 million for 2014, compared to net cash used of $326.0 million for 2013. The increase in net cash provided was primarily due to increased net borrowings in 2014. Off-Balance Sheet Arrangements We manage our Funds through which we and other institutional investors acquired a total of eight office properties. The capital that we invested in our Funds was invested on a pari passu basis with the other investors. In addition, we also receive certain additional distributions based on invested capital and on any profits that exceed certain specified cash returns to the investors. See Note 18 to our consolidated financial statements included in this Report for more information regarding our Funds. Other than operating cash flows, we do not expect to receive additional significant liquidity from our investments in our Funds until the disposition of their properties, which may not be for many years. Certain of our wholly-owned affiliates provide property management and other services with respect to the real estate owned by our Funds for which we are paid fees and/or reimbursed for our costs. We do not have any debt outstanding in connection with our interest in our Funds, however each of our Funds has their own debt secured by the properties that they own. The table below summarizes the debt of our Funds. The amounts represent 100% (not our pro-rata share) of amounts related to the Funds at December 31, 2014: Type of Debt Fixed rate term loan (1) Variable rate term loan (2) Principal Balance (in millions) $ $ 52.0 325.0 377.0 Maturity Date Interest Rate 4/1/2016 5/1/2018 5.67% 2.35% _____________________________________________________ (1) This loan was assumed by one of our Funds upon acquisition of the property securing the loan, and requires monthly payments of principal and interest. Interest on the loan is fixed. (2) This loan is secured by six properties in a collateralized pool, requires monthly payments of interest only, and the outstanding principal is due upon maturity. The interest on this loan is effectively fixed by an interest rate swap which matures on May 1, 2017. We made certain environmental and other limited indemnities and guarantees covering customary non-recourse carve outs under this loan, and also guaranteed the related swap, although we have an indemnity from that Fund for any amounts that we would be required to pay under these agreements. As of December 31, 2014, the maximum future payments under the swap agreement were $4.6 million. As of December 31, 2014, all obligations under the loan and swap agreements have been performed by the Fund in accordance with the terms of those agreements. Critical Accounting Policies Our discussion and analysis of our historical financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles (GAAP). The preparation of these financial statements in conformity with GAAP requires us to make estimates of certain items and judgments as to certain future events (for example with respect to the allocation of the purchase price of acquired property among land, buildings and improvements, tenant improvements and lease intangibles, and above and below market leases). These determinations, which are inherently subjective and subject to change, affect the reported amounts of our assets, liabilities, revenues and expenses. While we believe that our estimates are based upon reasonable assumptions and judgments at the time that they are made, some of our assumptions, estimates and judgments, will inevitably prove to be incorrect. As a result, actual outcomes will likely differ from our estimates, and those differences—positive or negative—could be material. Some of our estimates are subject to adjustment as we believe appropriate, based on revised estimates, and reconciliation to the actual results when available. For a discussion of recently issued accounting literature, see Note 2 to our consolidated financial statements included in this Report. 15 Investment in Real Estate We determine the fair values of our tangible assets on an ‘‘as-if-vacant’’ basis. We use our estimates of future cash flows and other valuation techniques to allocate the purchase price of each acquired property among land, buildings and improvements, tenant improvements and identifiable intangible assets such as amounts related to in-place at-market leases, and acquired above- and below-market ground and tenant leases. The estimated fair value of acquired in-place at-market leases are the estimated costs to lease the property to the occupancy level of the property at the date of acquisition, including the fair value of leasing commissions and legal costs. Additionally, we evaluate the time period over which such occupancy level would be achieved and include an estimate of the net operating costs (primarily real estate taxes, insurance and utilities) incurred during the lease-up period. Above and below-market ground and tenant lease values are recorded as an asset or liability based on the present value (using an interest rate which reflects the risks associated with the leases acquired) of the difference between the contractual amounts to be paid or received pursuant to the in-place ground or tenant leases, respectively, and our estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining noncancelable term of the lease. Each of these estimates requires a great deal of judgment, and some of the estimates involve complex calculations. These allocation assessments have a direct impact on our results of operations because, for example, there would be less depreciation if we allocate more value to land. Similarly, if we allocate more value to the buildings as opposed to allocating the value to tenant leases, this amount would be recognized as an expense over a much longer period of time, since the amounts allocated to buildings are depreciated over the estimated lives of the buildings whereas amounts allocated to tenant leases are amortized over the remaining terms of the leases. In accordance with GAAP, we may change our initial purchase price allocation up to 12 months from the acquisition date. Interest, insurance, property taxes and other costs incurred during the period of construction of real estate facilities are capitalized. Cost capitalization of development and redevelopment activities begins during the predevelopment period, which we define as activities that are necessary to the development of the property. We cease capitalization upon substantial completion of the project, but no later than one year from cessation of major construction activity. We also cease capitalization when activities necessary to prepare the property for its intended use have been suspended. Impairment of Long-Lived Assets We assess whether there has been impairment in the value of our long-lived assets whenever events or changes in circumstances indicate the carrying amount of that asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount to the undiscounted future cash flows expected to be generated by the asset. We consider factors such as future operating income, trends and prospects, as well as the effects of leasing demand, competition and other factors. If our evaluation indicates that we may be unable to recover the carrying value of an investment in real estate or in one of our Funds, we record an impairment loss to the extent that the carrying value exceeds the estimated fair value of the property or equity investment. These losses have a direct impact on our net income, because recording an impairment loss would reduce our net income. We record assets that we have determined to dispose at the lower of the carrying amount or our estimate of fair value, less costs to sell. The evaluation of anticipated cash flows and other values is highly subjective and is based in part on assumptions regarding future occupancy, rental rates and capital requirements that could differ materially from actual results in future periods. If our strategy changes or market conditions otherwise dictate an earlier sale date, we may recognize an impairment loss, which could be material. Income Taxes As a REIT, we are permitted to deduct distributions paid to our stockholders, eliminating the federal taxation of income represented by such distributions at the corporate level. REITs are subject to a number of organizational and operational requirements. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate tax rates. Revenue Recognition Four basic criteria must be met before revenue can be recognized: persuasive evidence of an arrangement exists; services are rendered; the fee is fixed and determinable; and collectibility is reasonably assured. All real property leases are classified as operating leases. For all lease terms exceeding one year, rental income is recognized on a straight-line basis over the term of the lease. Deferred rent receivables represent rental revenue recognized on a straight-line basis in excess of billed rents. Lease termination fees are included in rental revenues and are recognized when the related lease is canceled and we have no continuing obligation to provide the leased space to the former tenant. 16 Estimated recoveries from tenants for real estate taxes, common area maintenance and other recoverable operating expenses are recognized as revenues in the period that the expenses are incurred. Subsequent to year-end, we perform final reconciliations on a lease-by-lease basis and bill or credit each tenant for any cumulative annual adjustments. In addition, we record a capital asset for leasehold improvements constructed by us that are reimbursed by tenants, with the offsetting side of this accounting entry recorded to deferred revenue. The deferred revenue is amortized as additional rental revenue over the life of the related lease. Rental revenue from month-to-month leases or leases with no scheduled rent increases or other adjustments is recognized on a monthly basis when earned. The recognition of gains on sales of real estate requires that we measure the timing of a sale against various criteria related to the terms of the transaction, as well as any continuing involvement in the form of management or financial assistance associated with the property. If the sales criteria are not met, we defer gain recognition and account for the continued operations of the property by applying the finance, profit-sharing or leasing method. If the sales criteria have been met, we further analyze whether profit recognition is appropriate using the full accrual method. If the criteria to recognize profit using the full accrual method have not been met, we defer the gain and recognize it when the criteria are met or use the installment or cost recovery method as appropriate under the circumstances. Monitoring of Rents and Other Receivables We maintain an allowance for estimated losses that may result from the inability of tenants to make required payments. We also maintain an allowance for deferred rent to account for the possibility that some tenants may not complete their lease terms. If a tenant fails to make contractual payments beyond any allowance, we may recognize bad debt expense in future periods equal to the amount of unpaid rent and deferred rent. We generally do not require collateral or other security from our tenants, other than security deposits or letters of credit. If our estimates of collectability differ from the cash received, the timing and amount of our reported revenue could be impacted. Stock-Based Compensation We have awarded stock-based compensation to certain employees and members of our Board of Directors in the form of stock options and LTIP units. We recognize the estimated fair value of the awards over the requisite vesting period. We utilize a Black-Scholes model to calculate the fair value of options, which uses assumptions related to the stock, including volatility and dividend yield, as well as assumptions related to the stock award itself, such as the expected term and estimated forfeiture rate. Option valuation models require the input of somewhat subjective assumptions for which we have relied on observations of both historical trends and implied estimates as determined by independent third parties. For LTIP units, the fair value is based on the market value of our common stock on the date of grant and a discount for post-vesting restrictions estimated by a third-party consultant. Interest Rate Agreements We manage our interest rate risk associated with our floating-rate borrowings by entering into interest rate swap and interest rate cap contracts. When we enter into a floating-rate term loan, we generally enter into an interest rate swap agreement for the equivalent principal amount, for a period covering the majority of the loan term, which effectively converts our floating- rate debt to a fixed-rate basis during that time. In limited instances, we make use of interest rate caps to limit our exposure to interest rate increases on our underlying floating-rate debt. We use derivative instruments for the sole purpose of hedging our interest rate risk associated with our floating-rate borrowings, we do not use derivative instruments for speculative purposes. We do not use any other derivative instruments. For derivative instruments designated as cash flow hedges for accounting purposes, gain or loss recognition are generally matched to the earnings effect of the related hedged item or transaction, with any resulting hedge ineffectiveness recorded as interest expense. Hedge ineffectiveness is determined by comparing the changes in the fair value or cash flows of the derivative to the changes in the fair value or cash flows of the related hedged item or transaction. All other changes in the fair value of these derivatives are recorded in accumulated other comprehensive income (loss) (AOCI), which is a component of equity outside of earnings. Amounts reported in AOCI related to our derivatives are then reclassified to interest expense as interest payments are made on the hedged item or transaction. Amounts reported in AOCI related to our Funds' derivatives are reclassified to income (loss), including depreciation, from unconsolidated real estate funds, as interest payments are made by our Funds on their hedged items or transactions. Changes in fair value of derivatives not designated as hedges for accounting purposes are recognized as interest expense. 17 Quantitative and Qualitative Disclosures about Market Risk Our future income, cash flows and fair values relevant to financial instruments depend in part on prevailing market interest rates. Market risk refers to the risk of loss from adverse changes in market prices and interest rates. We use derivative financial instruments to manage, or hedge, interest rate risk related to our floating rate borrowings. However, our use of these instruments to hedge exposure to changes in interest rates does expose us to credit risk from the potential inability of our counterparties to perform under the terms of the agreements. We attempt to minimize this credit risk by contracting with high-quality financial counterparties. For a description of our debt and derivative contracts see Notes 6 and 8 to our consolidated financial statements included in this Report. At December 31, 2014, $1.14 billion (33.3%) of our debt was fixed rate debt, $1.83 billion (53.2%) of our debt was floating rate debt hedged with derivative instruments that swapped to fixed interest rates and $463.1 million (13.5%) was unhedged floating rate debt. Based on the level of unhedged floating rate debt outstanding at December 31, 2014, including the balance on our revolving credit line, a 50 basis point change in the one month USD London Interbank Offered Rate (LIBOR) would result in an annual impact to our earnings (through interest expense) of approximately $2.3 million. We calculate interest sensitivity by multiplying the amount of unhedged floating rate debt by the assumed change in rate. The sensitivity analysis does not take into consideration the possible changes in the balances of our unhedged floating rate debt or the inability of our counterparties to perform under the interest rate hedge agreements. 18 Consolidated Financial Statements of Douglas Emmett, Inc. Report of Management on Internal Control over Financial Reporting The management of Douglas Emmett, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Our system of internal control is designed to provide reasonable assurance regarding the reliability of financial reporting and preparation of our financial statements for external reporting purposes in accordance with United States generally accepted accounting principles. Our management, including the undersigned Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of our internal control over financial reporting as of December 31, 2014. In conducting its assessment, management used the criteria issued by the Committee of Sponsoring Organizations of the Treadway Commission on Internal Control— Integrated Framework (2013 Framework). Based on this assessment, management concluded that, as of December 31, 2014, our internal control over financial reporting was effective based on those criteria. Management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures, or our internal controls will prevent all error and fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefit of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. The effectiveness of our internal control over financial reporting as of December 31, 2014, has been audited by Ernst & Young LLP, the independent registered public accounting firm that audited the consolidated financial statements included in this annual report, as stated in their report appearing on page 22, which expresses an unqualified opinion on the effectiveness of our internal control over financial reporting as of December 31, 2014. /s/ JORDAN L. KAPLAN Jordan L. Kaplan Chief Executive Officer /s/ THEODORE E. GUTH Theodore E. Guth Chief Financial Officer February 27, 2015 19 Report of Independent Registered Public Accounting Firm The Board of Directors and Shareholders of Douglas Emmett, Inc. We have audited the accompanying consolidated balance sheets of Douglas Emmett, Inc. (the “Company”) as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2014. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits 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 includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Douglas Emmett, Inc. at December 31, 2014 and 2013, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Douglas Emmett, Inc.'s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework) and our report dated February 27, 2015 expressed an unqualified opinion thereon. /s/ Ernst & Young LLP Los Angeles, California February 27, 2015 20 Report of Independent Registered Public Accounting Firm The Board of Directors and Shareholders of Douglas Emmett, Inc. We have audited Douglas Emmett, Inc.’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework) (the COSO criteria). Douglas Emmett, Inc.'s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Report of Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company's internal control over financial reporting based on our audit. We conducted our audit 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. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. 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 (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide 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 (3) provide reasonable assurance 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 financial 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 compliance with the policies or procedures may deteriorate. In our opinion, Douglas Emmett, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on the COSO criteria. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Douglas Emmett, Inc. as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive income, equity and cash flows for each of the three years in the period ended December 31, 2014, and our report dated February 27, 2015 expressed an unqualified opinion thereon. /s/ Ernst & Young LLP Los Angeles, California February 27, 2015 21 Douglas Emmett, Inc. Consolidated Balance Sheets (in thousands, except share data) December 31, 2014 December 31, 2013 Assets Investment in real estate: Land Buildings and improvements Tenant improvements and lease intangibles Investment in real estate, gross Less: accumulated depreciation and amortization Investment in real estate, net Cash and cash equivalents Tenant receivables, net Deferred rent receivables, net Acquired lease intangible assets, net Investment in unconsolidated real estate funds Other assets Total assets Liabilities Secured notes payable and revolving credit facility Interest payable, accounts payable and deferred revenue Security deposits Acquired lease intangible liabilities, net Interest rate contracts Dividends payable Total liabilities Equity Douglas Emmett, Inc. stockholders' equity: Common Stock, $0.01 par value 750,000,000 authorized, 144,869,101 and 142,605,390 outstanding at December 31, 2014 and December 31, 2013, respectively Additional paid-in capital Accumulated other comprehensive income (loss) Accumulated deficit Total Douglas Emmett, Inc. stockholders' equity Noncontrolling interests Total equity Total liabilities and equity $ $ $ $ 900,813 5,590,118 666,672 7,157,603 (1,531,157) 5,626,446 18,823 2,143 74,997 3,527 171,390 57,270 5,954,596 3,435,290 54,364 37,450 45,959 37,386 30,423 3,640,872 1,449 2,678,798 (30,089) (706,700) 1,943,458 370,266 2,313,724 5,954,596 $ $ $ $ 867,284 5,386,446 759,003 7,012,733 (1,495,819) 5,516,914 44,206 1,760 69,662 3,744 182,896 28,607 5,847,789 3,241,140 52,763 35,470 59,543 63,144 28,521 3,480,581 1,426 2,653,905 (50,554) (634,380) 1,970,397 396,811 2,367,208 5,847,789 See notes to consolidated financial statements. 22 Douglas Emmett, Inc. Consolidated Statements of Operations (in thousands, except per share data) Year Ended December 31, 2014 2013 2012 $ 396,524 $ 394,739 $ 391,447 44,461 78,437 519,422 74,289 5,828 80,117 45,144 74,717 514,600 71,209 5,727 76,936 44,093 69,736 505,276 68,262 5,461 73,723 599,539 591,536 578,999 Revenues Office rental Rental revenues Tenant recoveries Parking and other income Total office revenues Multifamily rental Rental revenues Parking and other income Total multifamily revenues Total revenues Operating Expenses Office expense Multifamily expense General and administrative Depreciation and amortization Total operating expenses Operating income Other income Other expenses 181,177 20,664 27,332 202,512 431,685 174,952 19,928 26,614 191,351 412,845 170,725 19,672 27,943 184,849 403,189 167,854 178,691 175,810 17,675 (7,095) 3,713 (128,507) (786) 52,854 (8,233) 44,621 0.31 0.30 $ $ $ 6,402 (4,199) 3,098 (130,548) (607) 52,837 (7,526) 45,311 0.32 0.31 $ $ $ 2,821 (1,883) (1,710) (146,693) — 28,345 (5,403) 22,942 0.16 0.16 Income (loss), including depreciation, from unconsolidated real estate funds Interest expense Acquisition-related expenses Net income Less: Net income attributable to noncontrolling interests Net income attributable to common stockholders Net income attributable to common stockholders per share – basic Net income attributable to common stockholders per share – diluted $ $ $ See notes to consolidated financial statements. 23 Douglas Emmett, Inc. Consolidated Statements of Comprehensive Income (in thousands) Net income Other comprehensive income: cash flow hedges Comprehensive income Less: comprehensive income attributable to noncontrolling interests Comprehensive income attributable to common stockholders Year Ended December 31, 2014 2013 2012 $ $ 52,854 $ 52,837 $ 25,045 77,899 39,562 92,399 (12,813) 65,086 $ (14,651) 77,748 $ 28,345 10,491 38,836 (9,705) 29,131 See notes to consolidated financial statements. 24 Shares of Common Stock Balance at beginning of period Conversion of operating partnership units Issuance of common stock Exercise of stock options Balance at end of period Common Stock Balance at beginning of period Conversion of operating partnership units Issuance of common stock Exercise of stock options Balance at end of period Additional Paid-in Capital Balance at beginning of period Conversion of operating partnership units Repurchase of operating partnership units Repurchase of stock options Issuance of common stock Equity compensation Exercise of stock options Balance at end of period Accumulated Other Comprehensive Income (Loss) Balance at beginning of period Cash flow hedge adjustment Balance at end of period Accumulated Deficit Balance at beginning of period Net income attributable to common stockholders Dividends Balance at end of period Noncontrolling Interests Balance at beginning of period Net income attributable to noncontrolling interests Cash flow hedge adjustment Contributions Distributions Conversion of operating partnership units Repurchase of operating partnership units Equity compensation Balance at end of period Total Equity Balance at beginning of period Net income Cash flow hedge adjustment Issuance of common stock Repurchase of operating partnership units Repurchase of stock options Exercise of stock options Dividends Contributions Distributions Equity compensation Balance at end of period Dividends declared per common share Douglas Emmett, Inc. Consolidated Statements of Equity (in thousands, except per share data) 2014 Year Ended December 31, 2013 2012 142,605 2,224 — 40 144,869 141,246 1,359 — — 142,605 131,070 3,239 6,937 — 141,246 1,426 $ 1,412 $ 1,311 22 — 1 1,449 2,653,905 30,013 (1,197) (4,524) — — 601 2,678,798 (50,554) 20,465 (30,089) (634,380) 44,621 (116,941) (706,700) 396,811 8,233 4,580 290 (22,813) (30,035) (1,629) 14,829 370,266 2,367,208 52,854 25,045 — (2,826) (4,524) 602 (116,941) 290 (22,813) 14,829 2,313,724 0.81 $ $ $ $ $ $ $ $ $ $ $ $ $ $ 14 — — $ $ $ 1,426 2,635,408 18,670 (173) — — — — $ 2,653,905 (82,991) 32,437 (50,554) (574,173) 45,311 (105,518) (634,380) 410,803 7,526 7,125 653 (21,237) (18,684) (180) 10,805 396,811 2,390,459 52,837 39,562 — (352) — — (105,519) 653 (21,237) 10,805 2,367,208 0.74 $ $ $ $ $ $ $ $ $ $ 32 69 — 1,412 2,461,649 44,876 — — 128,188 695 — 2,635,408 (89,180) 6,189 (82,991) (508,674) 22,942 (88,441) (574,173) 450,849 5,403 4,302 (10) (18,315) (44,908) — 13,482 410,803 2,315,955 28,345 10,491 128,257 — — — (88,441) (10) (18,315) 14,177 2,390,459 0.63 $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ See notes to consolidated financial statements. 25 Douglas Emmett, Inc. Consolidated Statements of Cash Flows (in thousands) Year Ended December 31, 2013 2012 2014 $ 52,854 $ 52,837 $ 28,345 Operating Activities Net income Adjustments to reconcile net income to net cash provided by operating activities: (Income) loss, including depreciation, from unconsolidated real estate funds Gain from insurance recoveries for damage to real estate Depreciation and amortization Net accretion of acquired lease intangibles Decrease in the allowance for doubtful accounts Amortization of deferred loan costs Amortization of loan premium Non-cash market value adjustments on interest rate contracts Non-cash amortization of equity compensation Operating distributions from unconsolidated real estate funds Change in working capital components: Tenant receivables Deferred rent receivables Interest payable, accounts payable and deferred revenue Security deposits Other assets Net cash provided by operating activities Investing Activities Capital expenditures for improvements to real estate Capital expenditures for developments Insurance recoveries for damage to real estate Property acquisitions Deposits for property acquisitions Note receivable Loan to related party Loan payments received from related party Contributions to unconsolidated real estate funds Acquisitions of additional interests in unconsolidated real estate funds Capital distributions from unconsolidated real estate funds Net cash used in investing activities Financing Activities Proceeds from borrowings Deferred loan cost payments Repayment of borrowings Refund of refundable loan deposit Contributions by noncontrolling interests Distributions to noncontrolling interests Distributions of capital to noncontrolling interests Repurchase of stock options Repurchase of operating partnership units Cash dividends to common stockholders Issuance of common stock, net Exercise of stock options Net cash provided by (used in) financing activities Decrease in Cash and Cash Equivalents Cash and Cash Equivalents at Beginning of Year Cash and Cash Equivalents at End of Year (3,713) (6,621) 202,512 (16,084) (2,865) 4,097 — 50 13,722 909 78 (2,931) 2,668 1,980 59 246,715 (84,444) (4,259) 6,506 (220,469) (2,500) (27,500) — 1,187 — — 11,514 (319,965) 307,000 (1,974) (112,850) — 290 (22,813) — (4,524) (2,826) (115,039) — 603 47,867 (3,098) (431) 191,351 (15,693) (3,988) 4,214 — 88 10,005 783 (331) (2,580) 8,816 1,186 383 243,542 (66,907) (549) 431 (150,000) — — (2,882) 213 (26,405) (8,004) 7,518 (246,585) 40,000 (2,596) (240,000) — 653 (21,237) — — (352) (102,422) — — (325,954) 1,710 — 184,849 (18,094) (4,392) 4,211 (1,060) 8,956 10,581 752 4,113 (3,841) (6,873) 330 786 210,373 (60,158) — — — — — — — (2,604) (33,454) 4,699 (91,517) 440,000 (2,125) (621,956) 1,575 — (18,315) (10) — — (80,056) 128,257 — (152,630) (33,774) 406,977 373,203 (25,383) 44,206 18,823 $ (328,997) 373,203 44,206 $ $ 26 Douglas Emmett, Inc. Consolidated Statements of Cash Flows - (Continued) (in thousands) Year Ended December 31, 2014 2013 2012 SUPPLEMENTAL CASH FLOWS INFORMATION: Cash paid for interest (net of capitalized interest of $294 and $75 for 2014 and 2013, respectively) NONCASH INVESTING TRANSACTIONS: Accrual for capital expenditures for improvements to real estate and developments Write-off of fully depreciated and amortized tenant improvements and lease intangibles Write-off of fully amortized above-market acquired lease intangible assets Write-off of fully accreted below-market acquired lease intangible liabilities NONCASH FINANCING TRANSACTIONS: Accrual for dividends payable to common stockholders Operating Partnership units redeemed with shares of the Company's common stock $ $ $ $ $ $ $ 123,673 1,504 161,828 32,230 137,313 30,423 30,035 $ $ $ $ $ $ $ 127,110 2,455 $ $ — $ — $ — $ 134,830 2,233 — — — 28,521 18,685 $ $ 25,424 44,908 See notes to consolidated financial statements for additional non-cash items. 27 Douglas Emmett, Inc. Notes to Consolidated Financial Statements 1. Overview Organization and Description of Business Douglas Emmett, Inc. is a fully integrated, self-administered and self-managed Real Estate Investment Trust (REIT). We are one of the largest owners and operators of high-quality office and multifamily properties in Los Angeles County, California and Honolulu, Hawaii. We focus on owning and acquiring a substantial share of top-tier office properties and premier multifamily communities in neighborhoods that possess significant supply constraints, high-end executive housing and key lifestyle amenities. Through our interest in Douglas Emmett Properties, LP (our operating partnership) and its subsidiaries, as well as our investment in our two institutional unconsolidated real estate funds (Funds), we own or partially own, manage, lease, acquire and develop real estate, consisting primarily of office and multifamily properties in Los Angeles County, California and Honolulu, Hawaii. As of December 31, 2014, we owned a consolidated portfolio of fifty-three office properties (including ancillary retail space) and ten multifamily properties, as well as the fee interests in two parcels of land subject to ground leases. Alongside our consolidated portfolio, we also manage and own equity interests in our Funds which, at December 31, 2014, owned eight additional office properties, for a combined sixty-one office properties in our total portfolio. The terms "us," "we" and "our" as used in these financial statements refer to Douglas Emmett, Inc. and its subsidiaries. Basis of Presentation The financial statements presented are the consolidated financial statements of Douglas Emmett, Inc. and its subsidiaries, including our operating partnership. All significant intercompany balances and transactions have been eliminated in our consolidated financial statements, and certain prior period amounts have been reclassified to conform with the current period presentation. Substantially all of our business is conducted through our consolidated operating partnership, in which other investors own a noncontrolling interest. See Note 9. Our business also includes a consolidated joint venture in which our operating partnership owns a two-thirds interest. The balances and results of the property owned by this consolidated joint venture are included in our financial statements. The accompanying financial statements have been prepared pursuant to the rules and regulations of the United States Securities and Exchange Commission (SEC) in conformity with Generally Accepted Accounting Principles of the United States (GAAP) as established by the Financial Accounting Standards Board (FASB) in the Accounting Standards Codification (ASC), including modifications issued under Accounting Standards Updates (ASUs). The accompanying financial statements include, in our opinion, all adjustments, consisting of normal recurring adjustments, necessary to present fairly the financial information set forth therein. Any reference to the number of properties, square footage and geography, are unaudited and outside the scope of our independent registered public accounting firm’s audit of our financial statements in accordance with the standards of the United States Public Company Accounting Oversight Board. 2. Summary of Significant Accounting Policies Use of Estimates The preparation of financial statements in conformity with GAAP requires management to make certain estimates and assumptions that affect the reported amounts in the consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates. Investments in Real Estate We account for acquisitions of properties utilizing the purchase method, and include the results of operations of the acquired properties in our results of operations from their respective dates of acquisition. We expense transaction costs related to acquisitions when they are incurred. When we acquire a property, we determine the fair values of the tangible assets on an ‘‘as-if-vacant’’ basis. We use estimates of future cash flows, comparable sales, other relevant information obtained in connection with the acquisition of the property, and other valuation techniques to allocate the purchase price of each acquired property between land, buildings and improvements, tenant improvements and leasing costs, and identifiable intangible assets and liabilities such as amounts related to in-place at-market leases, acquired above- and below-market tenant leases, and acquired above- and below-market ground leases. 28 Douglas Emmett, Inc. Notes to Consolidated Financial Statements (continued) The estimated fair value of acquired in-place at-market tenant leases represents the estimated costs that we would have incurred to lease the property to the occupancy level of the property at the date of acquisition, including the fair value of leasing commissions and legal costs. Additionally, we evaluate the time period over which such occupancy level would be achieved and include an estimate of the net operating costs (primarily real estate taxes, insurance and utilities) incurred during the lease-up period. We record above-market and below-market in-place lease intangibles as an asset or liability based on the present value (using a discount rate which reflects the risks associated with the leases acquired) of the difference between the contractual amounts to be received or paid pursuant to the in-place tenant or ground leases, respectively, and our estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining non-cancelable term of the lease. Our initial valuations and allocations are subject to change until the allocation is finalized within 12 months after the acquisition date. See Note 3 for our property acquisition disclosures. Buildings and site improvements are depreciated on a straight-line basis using an estimated life of forty years for buildings and fifteen years for site improvements. We carry buildings and site improvements, offset by the related accumulated depreciation, on our balance sheet until they are either sold or impaired. Tenant improvements are depreciated over the life of the related lease, with any remaining balance depreciated in the period of any early termination of that lease. During 2014, we removed the cost and accumulated depreciation of $79.2 million of fully depreciated tenant improvements determined to be no longer in use from our balance sheet. Acquired in-place leases are amortized on a straight line basis over the weighted average remaining term of the acquired in-place leases. We carry acquired in-place leases, offset by the related accumulated amortization, on our balance sheet until the related building is either sold or impaired. Leasing intangibles are amortized on a straight-line basis over the related lease term, with any remaining balance amortized in the period of any early termination of that lease. During 2014, we removed the cost and accumulated amortization of $82.6 million of fully amortized leasing intangibles from our balance sheet. Acquired above- and below-market tenant leases are amortized over the life of the related lease and recorded as either an increase (for below-market leases) or a decrease (for above-market leases) to rental income. Acquired above- and below-market ground leases are amortized over the life of the lease and recorded either as an increase (for below-market leases) or a decrease (for above-market leases) to revenue. During 2014, we removed the cost and accumulated amortization/accretion of $32.2 million of fully amortized above-market tenant leases and $137.3 million of fully accreted below-market tenant leases from our balance sheet. When assets are sold or retired, their cost and related accumulated depreciation or amortization are removed from our balance sheet with the resulting gains or losses, if any, reflected in discontinued operations for the respective period. Repairs and maintenance are recorded as expense when incurred. Interest, insurance, property taxes and other costs incurred during the period of construction of real estate are capitalized. Cost capitalization of development and redevelopment activities begins during the predevelopment period, which we define as activities that are necessary for the development of the property. We cease capitalization upon substantial completion of the project, but no later than one year from cessation of major construction activity. We also cease capitalization when activities necessary to prepare the property for its intended use have been suspended. During 2014 and 2013, we capitalized $4.3 million and $549 thousand of costs related to our multifamily developments in Honolulu and Brentwood, respectively, which includes $294 thousand and $75 thousand of capitalized interest expense, respectively. We did not capitalize any costs during 2012 related to development or redevelopment activities. Investment in Unconsolidated Real Estate Funds At December 31, 2014, we managed and held equity interests in two Funds: Fund X and Partnership X. We held a 68.61% interest in Fund X, and an aggregate 24.25% interest in the properties held by Partnership X and its subsidiaries. We account for our investments in the Funds using the equity method because we have significant influence but not control over the entities and our Funds do not qualify as variable interest entities. Our investment balance represents our share of the net assets of the combined Funds, additional basis of approximately $2.9 million (primarily due to the inclusion of the cost of raising capital that is accounted for as part of our investment basis), and a note receivable with an outstanding balance of $1.5 million. See Note 18. 29 Douglas Emmett, Inc. Notes to Consolidated Financial Statements (continued) Impairment of Long-Lived Assets We assess whether there has been impairment in the value of our long-lived assets whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount to the undiscounted future cash flows expected to be generated by the asset. If the current carrying value exceeds the estimated undiscounted cash flows, an impairment loss is recorded equal to the difference between the asset’s current carrying value and its fair value based on the discounted estimated future cash flows. Assets to be disposed of are reported at the lower of the carrying amount or fair value, less costs to sell. Based upon such periodic assessments, no impairments occurred during 2014, 2013 or 2012. We assess whether there has been impairment in the value of our investments in our Funds periodically. An impairment charge is recorded when events or change in circumstances indicate that a decline in the fair value below the carrying value has occurred and such decline is other-than-temporary. The ultimate realization of the investments in our Funds is dependent on a number of factors, including the performance of the investment and market conditions. We will record an impairment charge if we determine that a decline in the value of an investment in one of our Funds is other-than-temporary. Based upon such periodic assessments, no impairment occurred during 2014, 2013 or 2012. An asset is classified as an asset held for sale when it meets certain requirements, including the approval of the sale of the asset, the marketing of the asset for sale, and our expectation that the sale will likely occur within the next 12 months. Upon classification of an asset as held for disposition, the net book value of the asset, excluding long-term debt, is included on the balance sheet as properties held for disposition, we cease to depreciate the asset, and the operating results of the asset are included in discontinued operations for all periods presented. As of December 31, 2014, we did not have any assets classified as held for sale. Cash and Cash Equivalents For purposes of the consolidated statements of cash flows, we consider short-term investments with maturities of three months or less when purchased to be cash equivalents. Revenue and Gain Recognition Four basic criteria must be met before revenue can be recognized: persuasive evidence of an arrangement exists; services are rendered; the fee is fixed and determinable; and collectibility is reasonably assured. All leases are classified as operating leases. For all lease terms exceeding one year, rental income is recognized on a straight-line basis over the term of the lease. Deferred rent receivables represent rental revenue recognized on a straight-line basis in excess of billed rents. Lease termination fees, which are included in rental revenues in the accompanying consolidated statements of operations, are recognized when the related lease is canceled and we have no continuing obligation to provide services to such former tenant. We recorded total lease termination revenue of $2.6 million for 2014, $576 thousand for 2013 and $985 thousand for 2012. Estimated recoveries from tenants for real estate taxes, common area maintenance and other recoverable operating expenses are recognized as revenues in the period that the expenses are incurred. Subsequent to year-end, we perform reconciliations on a lease-by-lease basis and bill or credit each tenant for any cumulative annual adjustments. In addition, we record a tenant improvement and deferred revenue for leasehold improvements constructed by us that are reimbursed by tenants. The deferred revenue is amortized as additional rental revenue over the related lease term. Rental revenue from month-to-month leases or leases with no scheduled rent increases or other adjustments is recognized on a monthly basis when earned. The recognition of gains on sales of real estate requires that we measure the timing of a sale against various criteria related to the terms of the transaction, as well as any continuing involvement in the form of management or financial assistance associated with the property. If the sales criteria are not met, we defer gain recognition and account for the continued operations of the property by applying the finance, profit-sharing or leasing method. If the sales criteria have been met, we further analyze whether profit recognition is appropriate using the full accrual method. If the criteria to recognize profit using the full accrual method have not been met, we defer the gain and recognize it when the criteria are met or use the installment or cost recovery method as appropriate under the circumstances. 30 Douglas Emmett, Inc. Notes to Consolidated Financial Statements (continued) Monitoring of Rents and Other Receivables We maintain an allowance for estimated losses that may result from the inability of tenants to make required payments. If a tenant fails to make contractual payments beyond any allowance, we may recognize bad debt expense in future periods equal to the amount of unpaid rent and deferred rent. We take into consideration many factors to evaluate the level of reserves necessary, including historical termination/default activity and current economic conditions. As of December 31, 2014 and 2013, we had an allowance for doubtful accounts of $7.8 million and $10.7 million, respectively. We generally do not require collateral or other security from our tenants other than letters of credit or cash security deposits. As of December 31, 2014 and 2013, we had a total of approximately $14.7 million and $17.0 million, respectively, of letters of credit held for security, as well as $37.5 million and $35.5 million, respectively, of cash security deposits. Insurance Recoveries The amount by which insurance recoveries related to property damage exceed any losses recognized from that damage are recorded as other income when payment is either received or receipt is determined to be probable. Interest Income Interest income on our notes receivable is recognized over the life of the respective notes using the effective interest method and recognized on the accrual basis. Interest income is included in other income in the consolidated statements of operations. See Notes 5 and 18. Deferred Loan Costs Costs incurred directly with the issuance of secured notes payable are capitalized and amortized to interest expense over the respective loan term. Any unamortized amounts are fully amortized upon early repayment of secured notes payable, and the related cost and accumulated amortization are removed from our balance sheet. Deferred loan costs are included in other assets in the consolidated balance sheets. See Note 5. Interest Rate Agreements We generally manage our interest rate risk associated with floating rate borrowings by entering into interest rate swap and interest rate cap contracts. The interest rate swap agreements that we utilize effectively modify our exposure to interest rate risk by converting our floating-rate debt to a fixed-rate basis, thus reducing the impact of interest-rate changes on future interest expense. These agreements involve the receipt of floating-rate amounts in exchange for fixed-rate interest payments over the life of the agreements without an exchange of the underlying principal amount. We do not use any other derivative instruments. We record all derivatives on the balance sheet at fair value on a gross basis. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative and the resulting designation. Derivatives used to hedge exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, are considered to be fair value hedges. Derivatives used to hedge the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered to be cash flow hedges. Our objective in using derivatives is to add stability to interest expense and to manage our exposure to interest rate movements and other identified risks. To accomplish this objective, we primarily use interest rate swaps as part of our cash flow hedging strategy. For derivatives designated as cash flow hedges, the effective portion of changes in the fair value of the derivative are initially reported in other comprehensive income (a component of equity outside of earnings) and subsequently reclassified to earnings when the hedged transaction affects earnings. The ineffective portion of changes in the fair value of the derivative are recognized directly in earnings. We assess the effectiveness of each hedging relationship by comparing the changes in fair value or cash flows of the derivative hedging instrument with the changes in fair value or cash flows of the designated hedged item or transaction. For derivatives not designated as hedges, changes in fair value are recognized directly in earnings. The fair value of these hedges is obtained through independent third-party valuation sources that use conventional valuation algorithms. See Note 8. 31 Douglas Emmett, Inc. Notes to Consolidated Financial Statements (continued) Stock-Based Compensation We account for stock-based compensation, including stock options and long-term incentive plan units, using the fair value method of accounting. The estimated fair value of the stock options and the long-term incentive units is amortized over their respective vesting periods. See Note 11. Earnings Per Share Basic earnings per share is calculated by dividing the net income attributable to common stockholders for the period by the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated by dividing the net income attributable to common stockholders and noncontrolling interests in our consolidated operating partnership for the period by the weighted average number of common shares and dilutive instruments outstanding during the period using the treasury stock method. See Note 10. Segment Information Segment information is prepared on the same basis that our management reviews information for operational decision- making purposes. We operate two business segments: the acquisition, development, ownership and management of office real estate, and the acquisition, development, ownership and management of multifamily real estate. The products for our office segment include primarily rental of office space and other tenant services, including parking and storage space rental. The products for our multifamily segment include primarily rental of apartments and other tenant services, including parking and storage space rental. See Note 16. Income Taxes We have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (IRC), commencing with our initial taxable year ending December 31, 2006. To qualify as a REIT, we are required (among other things) to distribute at least 90% of our REIT taxable income to our stockholders and meet the various other requirements imposed by the IRC relating to matters such as operating results, asset holdings, distribution levels and diversity of stock ownership. Provided that we qualify for taxation as a REIT, we are generally not subject to corporate-level income tax on the earnings distributed currently to our stockholders that we derive from our REIT qualifying activities. If we fail to qualify as a REIT in any taxable year, and were unable to avail ourselves of certain savings provisions set forth in the IRC, all of our taxable income would be subject to federal income tax at regular corporate rates, including any applicable alternative minimum tax. In addition, we are subject to taxation by various state and local jurisdictions, including those in which we transact business or reside. Our non taxable REIT subsidiaries, including our operating partnership, are either partnerships or disregarded entities for federal income tax purposes. Under applicable federal and state income tax rules, the allocated share of net income or loss from disregarded entities (including limited partnerships and S-Corporations) is reportable in the income tax returns of the respective partners and stockholders. Accordingly, no income tax provision is included in the accompanying consolidated financial statements. We have elected to treat two of our subsidiaries as taxable REIT subsidiaries (TRS) which generally may engage in any business, including the provision of customary or non-customary services for our tenants. A TRS is treated as a regular corporation and is subject to federal income tax and applicable state income and franchise taxes at regular corporate rates. Our TRS subsidiaries did not have significant tax provisions or deferred income tax items for 2014, 2013 or 2012. New Accounting Pronouncements Changes to GAAP are established by the Financial Accounting Standards Board (FASB) in the form of Accounting Standard Updates (ASUs). We consider the applicability and impact of all ASUs. In February 2013, the FASB issued ASU No. 2013-04, Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation is Fixed at the Reporting Date (Topic 405), which provides guidance for the recognition, measurement and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this ASU is fixed at the reporting date, except for obligations addressed within existing guidance in GAAP. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013, which for us was the first quarter of 2014. We adopted ASU No. 2013-04 during the first quarter of 2014, and it did not have a material impact on our financial position or results of operations, as we do not currently have any obligations within the scope of this ASU. 32 Douglas Emmett, Inc. Notes to Consolidated Financial Statements (continued) In April 2014, the FASB issued ASU No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity (Topics 205 and 360), which provides guidance for reporting discontinued operations. The amendments in this Update change the requirements for reporting discontinued operations in Subtopic 205-20, Presentation of Financial Statements. The ASU is effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2014, which for us is the first quarter of 2015. Early adoption is permitted, but only for disposals (or classifications as held for sale) that have not been reported in financial statements previously issued or available for issuance. We do not expect this ASU to have a material impact on our financial position or results of operations. In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which provides guidance for the accounting of revenue from contracts with customers. The guidance supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance throughout the Industry Topics of the Codification. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, which for us is the first quarter of 2017. Early adoption is not permitted. We do not expect this ASU to have a material impact on our financial position or results of operations, as lease contracts are not within the scope of this ASU. In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40), which provides guidance about management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern and to provide related footnote disclosures if necessary. The ASU is effective for the annual period ending after December 15, 2016, and for annual and interim periods thereafter, which for us is the fiscal year ended December 31, 2016. Early application is permitted. We do not expect this ASU to have a material impact on our disclosures. In November 2014, the FASB issued ASU No. 2014-17, Pushdown Accounting (Topic 805), which provides guidance regarding pushdown accounting for acquired entities when an acquirer obtains control of the acquired entity. The objective of this ASU is to provide guidance on whether and at what threshold an acquired entity can apply pushdown accounting in its separate financial statements. The ASU was effective on November 18, 2014. We do not expect this ASU to have a material impact on our financial position or results of operations. In January 2015, the FASB issued ASU No. 2015-01, Income Statement—Extraordinary and Unusual Items (Subtopic 225-20), which eliminates from GAAP the concept of extraordinary items. The Board is issuing this Update as part of its initiative to reduce complexity in accounting standards (the Simplification Initiative). The objective of the Simplification Initiative is to identify, evaluate, and improve areas of generally accepted accounting principles (GAAP) for which cost and complexity can be reduced while maintaining or improving the usefulness of the information provided to the users of financial statements. The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015, which for us is the first quarter of 2016. A reporting entity may apply the amendments prospectively or retrospectively to all prior periods presented in the financial statements, and early adoption is permitted. We do not expect this ASU to have a material impact on our disclosures. In February 2015, the FASB issued ASU No. 2015-02, Amendments to the Consolidation Analysis (Consolidation - Topic 810), which provides guidance regarding the consolidation of certain legal entities. All legal entities are subject to reevaluation under the revised consolidation model. The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015, which for us is the first quarter of 2016. Early adoption is permitted, including adoption in an interim period. We are currently evaluating the impact of this ASU. The FASB has not issued any other ASUs during 2014 or 2015 that we expect to be applicable and have a material impact on our future financial position or results of operations. 3. Investment in Real Estate 2014 Acquisitions During 2014, we made two acquisitions: on October 16, 2014, we purchased a 216 thousand square foot Class A multi- tenant office property located adjacent to Beverly Hills (Carthay Campus) for $74.5 million, or approximately $345 per square foot, and on December 30, 2014, we purchased a 468 unit multifamily property in Honolulu, Hawaii (Waena) for $146.0 million, or approximately $312 thousand per unit. The results of operations for these acquired properties are included in our consolidated statements of operations after the respective date of their acquisitions. 33 Douglas Emmett, Inc. Notes to Consolidated Financial Statements (continued) The table below (in thousands) summarizes our preliminary purchase price allocations for the acquired properties (these allocations are subject to adjustment within twelve months of the acquisition date): Investment in real estate: Land Buildings and improvements Tenant improvements and lease intangibles Acquired above and below-market leases, net Net assets and liabilities acquired 2013 Acquisitions Carthay Campus Waena $ $ 6,595 $ 64,511 5,943 (2,580) 74,469 $ 26,864 117,541 1,732 (137) 146,000 During 2013, we made two acquisitions: on May 15, 2013, we purchased a 225 thousand square foot Class A multi-tenant office property located in Beverly Hills (8484 Wilshire) for $89.0 million, or approximately $395 per square foot, and on August 15, 2013, we purchased a 191 thousand square foot Class A multi-tenant office property located in Encino (16501 Ventura) for $61.0 million, or approximately $319 per square foot. The results of operations for these acquired properties are included in our consolidated statements of operations after the respective date of their acquisitions. The table below (in thousands) summarizes our purchase price allocations for the acquired properties: Investment in real estate: Land Buildings and improvements Tenant improvements and lease intangibles Acquired above and below-market leases, net Net assets and liabilities acquired 2012 Acquisitions We did not acquire any properties during 2012. 8484 Wilshire 16501 Ventura $ $ 8,847 $ 77,158 6,485 (3,490) 89,000 $ 6,759 55,179 4,736 (5,674) 61,000 34 Douglas Emmett, Inc. Notes to Consolidated Financial Statements (continued) 4. Acquired Lease Intangibles The following summarizes (in thousands) our acquired lease intangibles related to above and below-market leases as of December 31: Above-market tenant leases(1) Accumulated amortization(1) Below-market ground leases Accumulated amortization Acquired lease intangible assets, net Below-market tenant leases(2) Accumulated accretion(2) Above-market ground leases Accumulated accretion Acquired lease intangible liabilities, net ________________________________________ 2014 2013 3,040 $ (2,082) 3,198 (629) 3,527 138,088 (102,335) 16,200 (5,994) 45,959 $ $ $ 34,997 (33,899) 3,198 (552) 3,744 272,413 (225,425) 16,200 (3,645) 59,543 $ $ $ $ (1) During 2014, we removed the cost and accumulated amortization of $32.2 million of fully amortized above-market tenant leases from our balance sheet. December 31, 2013 balances include $31.1 million of fully amortized above-market tenant leases. (2) During 2014, we removed the cost and accumulated accretion of $137.3 million of fully accreted below-market tenant leases from our balance sheet. December 31, 2013 balances include $131.1 million of fully accreted below-market tenant leases. Net accretion of above- and below-market tenant leases recorded as an increase to rental income totaled $13.9 million in 2014, $15.7 million in 2013 and $18.1 million in 2012. Net accretion of above- and below-market ground leases recorded as an increased to other income totaled $2.2 million in 2014, and decreased office rental operating expense by $122 thousand for 2014, 2013 and 2012. The accretion of an above-market ground lease of $2.2 million that we recognized in other income in 2014 resulted from a change in estimate regarding the acquisition of the related fee interest. We expect that an additional $6.6 million of accretion will be recognized in other income in the first quarter of 2015. The impact on our basic and diluted EPS for 2014 was 2 cents per share and 1 cent per share respectively. See Note 19. The table below presents (in thousands) the estimated net accretion of above- and below-market tenant leases and ground leases (excluding the impact of any acquisitions or dispositions) at December 31, 2014 for the next five years: Year 2015 2016 2017 2018 2019 Thereafter Total $ 18,448 (1) 8,626 3,825 3,402 2,803 5,328 $ 42,432 __________________________________________ (1) Includes $6.6 million of accretion of an above-market ground lease as a result of our acquisition of the related fee interest in February 2015. See Note 19. 35 Douglas Emmett, Inc. Notes to Consolidated Financial Statements (continued) 5. Other Assets Other assets consisted of the following (in thousands) at December 31: Deferred loan costs, net of accumulated amortization of $13,042 and $9,395 at December 31, 2014 and December 31, 2013, respectively(1) Note receivable(2) $ Restricted cash Prepaid expenses Other indefinite-lived intangible Deposits in escrow Other Total other assets 2014 2013 15,623 $ 27,500 194 6,108 1,988 2,500 3,357 17,745 — 194 5,747 1,988 — 2,933 28,607 $ 57,270 $ ___________________________________________________ (1) We recognized deferred loan cost amortization expense of $4.1 million in 2014 and $4.2 million in 2013 and 2012. Deferred loan cost amortization is included as a component of interest expense in the consolidated statements of operations. (2) On February 28, 2014, we loaned $27.5 million to the owner of a fee interest related to one of our office buildings. The loan carried interest of 4.9% and was repaid in February 2015. See Note 19. The interest recognized on this note is included in other income in the consolidated statements of operations. 36 Douglas Emmett, Inc. Notes to Consolidated Financial Statements (continued) 6. Secured Notes Payable and Revolving Credit Facility The following table summarizes (in thousands) our secured notes payable and revolving credit facility: Outstanding Principal Balance as of December 31, 2014 Outstanding Principal Balance as of December 31, 2013 Variable Interest Rate Description (1) Fannie Mae Loan Term Loan Term Loan (3) Fannie Mae Loan Fannie Mae Loan Term Loan Term Loan Term Loan Term Loan (4) Term Loan (5) Term Loan (6) Fannie Mae Loan Term Loan (7) Fannie Mae Loans Maturity Date 2/1/2015 12/24/2015 3/1/2016 3/1/2016 6/1/2017 10/2/2017 4/2/2018 8/1/2018 8/5/2018 2/1/2019 6/5/2019 10/1/2019 3/1/2020 11/2/2020 Aggregate loan principal Revolving credit line (9) 12/11/2017 Total (10) Aggregate effectively fixed rate loans Aggregate fixed rate loans Aggregate variable rate loans Total (10) — 20,000 16,140 82,000 18,000 400,000 510,000 530,000 355,000 155,000 285,000 145,000 349,070 388,080 3,253,290 182,000 3,435,290 1,828,080 1,144,070 463,140 3,435,290 (8) $ $ $ Effective Annual Fixed Interest Rate (2) N/A N/A N/A N/A N/A 4.45% 4.12% 3.74% 4.14% 4.00% 3.85% N/A 4.46% Swap Maturity Date -- -- -- -- -- 7/1/2015 4/1/2016 8/1/2016 -- -- -- -- -- 111,920 DMBS + 0.707% — LIBOR + 1.45% 16,140 LIBOR + 1.60% 82,000 LIBOR + 0.62% 18,000 LIBOR + 0.62% 400,000 LIBOR + 2.00% 510,000 LIBOR + 2.00% 530,000 LIBOR + 1.70% 355,000 N/A 155,000 285,000 N/A N/A — LIBOR + 1.25% 350,000 N/A 388,080 LIBOR + 1.65% 3.65% 11/1/2017 3,201,140 40,000 LIBOR + 1.40% N/A -- $ $ $ 3,241,140 1,828,080 1,145,000 268,060 3,241,140 3.98% 4.15% N/A __________________________________________________ (1) As of December 31, 2014, (i) the weighted average remaining life of our outstanding term debt (excluding our revolving credit line) was 3.9 years ; (ii) of the $2.97 billion of term debt on which the interest rate was fixed under the terms of the loan or a swap, (a) the weighted average remaining life was 4.0 years, the weighted average remaining period during which the interest rate was fixed was 2.4 years and the weighted average annual interest rate was 4.05%; and (b) including the non-cash amortization of prepaid loan fees, the effective weighted average interest rate was 4.15%. Except as otherwise noted below, each loan is secured by a separate collateral pool consisting of one or more properties, requiring monthly payments of interest only, with the outstanding principal due upon maturity. (2) Includes the effect of interest rate contracts as of December 31, 2014, and excludes amortization of prepaid loan fees, all shown on an actual/360-day basis. See Note 8 for the details of our interest rate contracts. (3) The borrower is a consolidated entity in which our operating partnership owns a two-thirds interest. (4) Interest-only until February 2016, with principal amortization thereafter based upon a thirty years amortization table. (5) Interest-only until February 2015, with principal amortization thereafter based upon a thirty years amortization table. (6) Interest only until February 2017, with principal amortization thereafter based upon a thirty years amortization table. (7) Interest at a fixed interest rate until March 2018 and a floating rate thereafter, with interest-only payments until May 2016 and payments thereafter based upon a thirty years amortization table. (8) We have two one-year extension options, which would extend the maturity to March 1, 2020 from March 1, 2018, subject to meeting certain conditions. (9) Revolving credit facility under which we can borrow up to $300.0 million, and which is secured by 3 separate collateral pools consisting of a total of 6 properties. We are charged unused fees on the unused balance ranging from 0.15% to 0.20%. (10) See Note 12 for our fair value disclosures. 37 Douglas Emmett, Inc. Notes to Consolidated Financial Statements (continued) As of December 31, 2014, the minimum future principal payments due on our secured notes payable and revolving credit facility, excluding any maturity extension options, were as follows (in thousands): Twelve months ending December 31: 2015 2016 2017 2018 2019 Thereafter Total future principal payments $ 22,267 109,339 619,410 1,731,874 564,320 388,080 $ 3,435,290 7. Interest Payable, Accounts Payable and Deferred Revenue Interest payable, accounts payable and deferred revenue consist of the following (in thousands) as of December 31: Interest payable Accounts payable and accrued liabilities Deferred revenue Total interest payable, accounts payable and deferred revenue 8. Interest Rate Contracts Cash Flow Hedges of Interest Rate Risk 2014 2013 $ $ 9,656 22,195 22,513 54,364 $ $ 9,263 20,761 22,739 52,763 We make use of interest rate swap and interest rate cap contracts to manage the risk associated with changes in the interest rates on our floating-rate borrowings. When we enter into a floating-rate term loan, we generally enter into an interest rate swap agreement for the equivalent principal amount, for a period covering the majority of the loan term, which effectively converts our floating-rate debt to a fixed-rate basis during that time. In limited instances, we make use of interest rate caps to limit our exposure to interest rate increases on underlying floating-rate debt. We may enter into derivative contracts that are intended to hedge certain economic risks, even though hedge accounting does not apply or we elect to not apply hedge accounting. We do not make use of any other derivative instruments, and we do not speculate in derivatives. See note 6 for the details of our floating-rate debt that we have hedged. Designated Hedges As of December 31, 2014, the totals of our existing swaps that qualified as highly effective cash flow hedges were as follows: Interest Rate Derivative Number of Instruments Notional (in thousands) Interest Rate Swaps 7 $1,828,080 As of December 31, 2014, the totals of our Funds' existing swaps that qualified as highly effective cash flow hedges were as follows: Interest Rate Derivative Number of Instruments Notional (in thousands) Interest Rate Swap 1 38 $325,000 Douglas Emmett, Inc. Notes to Consolidated Financial Statements (continued) Non-designated Hedges Derivatives not designated as hedges are not speculative. As of December 31, 2014, we had the following outstanding interest rate derivatives that were not designated for accounting purposes as hedging instruments, but were used to hedge our economic exposure to interest rate risk: Interest Rate Derivative Number of Instruments Notional (in thousands) Purchased Caps 4 $100,000 Credit-risk-related Contingent Features We have agreements with each of our derivative counterparties that contain a provision under which we could also be declared in default on our derivative obligations if we default on the underlying indebtedness that we are hedging. As of December 31, 2014, there have been no events of default with respect to any of our derivatives. As of December 31, 2014 and 2013, the fair value of our derivatives in a net liability position, when aggregated by counterparty, was $41.0 million and $67.2 million, respectively, which includes accrued interest but excludes any adjustment for nonperformance risk related to these agreements. As of December 31, 2014 and 2013, our Funds did not have any derivatives in a net liability position. Accounting for Interest Rate Contracts For hedging instruments designated as cash flow hedges, gain or loss recognition are generally matched to the earnings effect of the related hedged item or transaction, with any resulting hedge ineffectiveness recorded as interest expense. Hedge ineffectiveness is determined by comparing the changes in the fair value or cash flows of the hedge to the changes in the fair value or cash flows of the related hedged item or transaction. All other changes in the fair value of these hedges are recorded in accumulated other comprehensive income (loss) (AOCI), which is a component of equity outside of earnings. Amounts reported in AOCI related to our hedges are then reclassified to interest expense as interest payments are made on the hedged item or transaction. Amounts reported in AOCI related to our Funds' hedges are reclassified to income (loss), including depreciation, from unconsolidated real estate funds as interest payments are made by our Funds on their hedged items or transactions. Changes in fair value of derivatives not designated as hedges are recorded as interest expense. We estimate that $29.2 million of our AOCI related to our derivatives designated as cash flow hedges will be reclassified as an increase to interest expense during the next twelve months, and $584 thousand of our AOCI related to our Funds derivatives designated as cash flow hedges will be reclassified as a decrease to income (increase to loss), including depreciation, from unconsolidated real estate funds during the next twelve months. We terminated cash flow swaps in December 2011 that had an AOCI balance of $10.1 million at the time they were terminated. Amortization of $1.3 million of this balance was included as part of the reclassification from AOCI to interest expense in 2011, and the remaining $8.8 million was reclassified from AOCI to interest expense in 2012. 39 Douglas Emmett, Inc. Notes to Consolidated Financial Statements (continued) The table below presents (in thousands) the effect of our derivative instruments on our AOCI and consolidated statements of operations for the year ended December 31: Derivatives Designated as Cash Flow Hedges: Gain (loss) recognized in AOCI (effective portion)1 Gain (loss) recognized in AOCI (effective portion)1 related to our investment in unconsolidated real estate funds Loss reclassified from AOCI into interest expense (effective portion) Loss reclassified from AOCI into income (loss), including depreciation, from unconsolidated real estate funds (effective portion) Gain (loss) reclassified from AOCI into interest expense (ineffective portion and amount excluded from effectiveness testing) Loss on derivatives recognized as interest expense (ineffective portion and amount excluded from effectiveness testing) Derivatives Not Designated as Cash Flow Hedges: Realized and unrealized loss recognized as interest expense __________________________________________________ 2014 2013 2012 $ (11,116) $ 903 $ (49,432) (1,767) $ (1,356) $ $ (36,874) $ (36,247) $ (55,748) 1,779 $ $ $ $ $ (1,005) $ (549) $ (5,535) (50) $ (85) $ 4 — $ — (64) — $ (4) $ (42) (1) Gains and losses recognized in AOCI do not impact the income statement. Refer to the reconciliation of our AOCI in Note 9. Fair Value Measurement We record all derivatives on the balance sheet at fair value, on a gross basis, excluding accrued interest. See Note 12 for our fair value disclosures. The table below presents (in thousands) the fair values of derivative instruments: Derivative liabilities disclosed as "Interest Rate Contracts" (1): Derivatives designated as cash flow hedges Derivatives not designated as cash flow hedges Total derivative liabilities _________________________________________________________ (1) We did not have any derivative assets as of December 31, 2014 and December 31, 2013. 2014 2013 $ $ 37,386 — 37,386 $ $ 63,144 — 63,144 9. Equity Equity Transactions During 2014, we exchanged 2.2 million units in our operating partnership for shares of our common stock, and we redeemed 120 thousand units for cash, for a total purchase price of $2.8 million, for an average price of $23.56 per unit. We also cash settled options covering 691 thousand shares of our common stock for a total cost of $4.5 million, for an average price of $6.55 per option. We issued 40 thousand shares of our common stock on the exercise of options for net proceeds of $603 thousand, for an average price of $15.05 per share. During 2013, we exchanged 1.4 million units in our operating partnership for shares of our common stock, and we redeemed 13 thousand units for cash, for a total purchase price of $352 thousand, for an average price of $26.68 per unit. We did not sell any shares of our common stock during 2013. During 2012, we exchanged 3.2 million units in our operating partnership for shares of our common stock, and we sold 6.9 million shares of our common stock in open market transactions under our ATM program for net proceeds of $128.3 million after commissions and other expenses. 40 Douglas Emmett, Inc. Notes to Consolidated Financial Statements (continued) Noncontrolling Interests As of December 31, 2014, we had 144.9 million shares of common stock and 27.6 million operating partnership units and fully-vested LTIP units outstanding. Noncontrolling interests in our operating partnership relate to interests in our operating partnership that are not owned by us. As of December 31, 2014, noncontrolling interests represented approximately 16% of our operating partnership. A unit in our operating partnership and a share of our common stock have essentially the same economic characteristics, as they share equally in the total net income or loss distributions of our operating partnership. Investors who own units in our operating partnership have the right to cause our operating partnership to redeem any or all of their units in our operating partnership for an amount of cash per unit equal to the then current market value of one share of common stock, or, at our election, shares of our common stock on a one-for-one basis. Noncontrolling interests also include a one-third interest of a minority partner in a consolidated joint venture which owns an office building in Honolulu, Hawaii. The table below presents (in thousands) the net income attributable to common stockholders and transfers from the noncontrolling interests for the year ended December 31: Net income attributable to common stockholders $ 44,621 $ 45,311 $ 22,942 2014 2013 2012 Transfers from the noncontrolling interests: Increase in common stockholders paid-in capital for redemption of operating partnership units Change from net income attributable to common stockholders and transfers from noncontrolling interests 30,013 18,670 44,876 $ 74,634 $ 63,981 $ 67,818 AOCI Reconciliation The table below presents (in thousands) a reconciliation of our AOCI, which consists solely of adjustments related to our cash flow hedges and the cash flow hedges of our unconsolidated Funds for the year ended December 31: Balance at beginning of period Other comprehensive income (loss) before reclassifications 1 Reclassifications from AOCI 2 Net current period other comprehensive income Less other comprehensive income attributable to noncontrolling interests Other comprehensive income attributable to common stockholders Balance at end of period __________________________________________________ 2014 2013 2012 $ $ (50,554) $ (12,884) 37,929 25,045 (4,580) 20,465 (30,089) $ (82,991) $ 2,681 36,881 39,562 (7,125) 32,437 (50,554) $ (89,180) (50,788) 61,279 10,491 (4,302) 6,189 (82,991) (1) Includes (i) the fair value adjustments to our derivatives designated as cash flow hedges of $(11.1) million, $0.9 million and $(49.4) million in 2014 , 2013 and 2012, respectively, as well as (ii) our share of the fair value adjustments to the derivatives designated as cash flow hedges of our unconsolidated Funds of $(1.8) million, $1.8 million and $(1.4) million in 2014, 2013 and 2012, respectively. (2) Includes (i) a reclassification from AOCI to interest expense of $36.9 million, $36.3 million and $55.7 million in 2014, 2013 and 2012, respectively, of our derivatives designated as cash flow hedges, as well as (ii) a reclassification from AOCI to income (loss), including depreciation, of our unconsolidated real estate funds of $1 million, $0.5 million and $5.5 million in 2014, 2013 and 2012, respectively, related to derivatives designated as cash flow hedges of our unconsolidated Funds. (3) See Note 8 for the details of our derivatives that qualified and were designated as cash flow hedges. (4) See Note 12 for our fair value disclosures. Dividends During the fourth quarter of 2013, we increased our quarterly dividend from $0.18 per share to $0.20 per share, so that we paid aggregate dividends of $0.80 per share during 2014. Earnings and profits, which determine the taxability of distributions to stockholders, may differ from income reported for financial reporting purposes, due to the differences for federal income tax 41 Douglas Emmett, Inc. Notes to Consolidated Financial Statements (continued) purposes in the treatment of loss on extinguishment of debt, revenue recognition, and compensation expense, and in the basis of depreciable assets and estimated useful lives used to compute depreciation. Our common stock dividends are classified for United States federal income tax purposes as follows (unaudited): Record Date Paid Date Dividend Per Share Ordinary Income Capital Gain Return of Capital 12/30/2013 3/31/2014 6/30/2014 9/30/2014 1/15/2014 4/15/2014 7/15/2014 10/15/2014 Total: $0.20 0.20 0.20 0.20 $0.80 $0.0740 0.0740 0.0740 0.0740 $0.2960 $— — — — $— $0.1260 0.1260 0.1260 0.1260 $0.5040 10. Earnings Per Share We calculate basic EPS by dividing the net income attributable to common stockholders for the year by the weighted average number of common shares outstanding during the year. We calculate diluted EPS by dividing the net income attributable to common stockholders and noncontrolling interests in our consolidated operating partnership for the year by the weighted average number of common shares and dilutive instruments outstanding during the year using the treasury stock method. The table below presents the calculation of basic and diluted EPS: Numerator (in thousands): Net income attributable to common stockholders Add back: Net income attributable to noncontrolling interests in our Operating Partnership Numerator for diluted net income attributable to all equity holders Denominator (in thousands): Weighted average shares of common stock outstanding - basic Effect of dilutive securities(1): Operating partnership units and vested long term incentive plan (LTIP) units Stock options Unvested LTIP units Weighted average shares of common stock and common stock equivalents outstanding - diluted Basic earnings per share: Net income attributable to common stockholders per share Diluted earnings per share: Net income attributable to common stockholders per share ____________________________________________________ Year Ended December 31, 2014 2013 2012 44,621 $ 45,311 $ 22,942 8,543 9,021 53,164 $ 54,332 $ 4,965 27,907 144,013 142,556 139,791 27,574 4,108 526 28,381 3,288 577 30,251 2,487 591 176,221 174,802 173,120 0.31 $ 0.32 $ 0.16 0.30 $ 0.31 $ 0.16 $ $ $ $ (1) Diluted shares are calculated in accordance with GAAP, and represent ownership in our company through shares of common stock, units in our operating partnership and other convertible equity instruments. 42 Douglas Emmett, Inc. Notes to Consolidated Financial Statements (continued) 11. Stock-Based Compensation 2006 Omnibus Stock Incentive Plan The Douglas Emmett, Inc. 2006 Omnibus Stock Incentive Plan, as amended, our stock incentive plan, permits us to make grants of incentive stock options, non-qualified stock options, stock appreciation rights, deferred stock awards, restricted stock awards, dividend equivalent rights and other stock-based awards. We had an aggregate of 16.7 million shares available for grant as of December 31, 2014, although “full value” awards (such as deferred stock awards, restricted stock awards and LTIP unit awards) are counted against our stock incentive plan overall limits as two shares (rather than one), while options and Stock Appreciation Rights are counted as one share (0.9 shares for options or Stock Appreciation Rights with terms of five years or less). The number of shares reserved under our stock incentive plan is also subject to adjustment in the event of a stock split, stock dividend or other change in our capitalization. Shares that are forfeited or canceled from awards under our stock incentive plan also will generally be available for future awards. Our stock incentive plan is administered by the compensation committee of our board of directors. The compensation committee may interpret our stock incentive plan and make all determinations necessary or desirable for the administration of our plan. The committee has full power and authority to select the participants to whom awards will be granted, to make any combination of awards to participants, to accelerate the exercisability or vesting of any award and to determine the specific terms and conditions of each award, subject to the provisions of our stock incentive plan. All full-time and part-time officers, employees, directors and other key persons (including consultants and prospective employees) are eligible to participate in our stock incentive plan. Other stock-based awards under our stock incentive plan include awards that are valued in whole or in part by reference to shares of our common stock, including convertible preferred stock, convertible debentures and other convertible or exchangeable securities, partnership interests in a subsidiary or our operating partnership, awards valued by reference to book value, fair value or performance of a subsidiary and any class of profits interest or limited liability company membership interest. We have made certain awards in the form of a separate series of units of limited partnership interests in our operating partnership called long term incentive plan units ("LTIP Units"), which can be granted either as free-standing awards or in tandem with other awards under our stock incentive plan. Our LTIP Units are valued by reference to the value of our common stock at the time of grant, and are subject to such conditions and restrictions as the compensation committee may determine, including continued employment or service, computation of financial metrics and/or achievement of pre-established performance goals and objectives. We grant equity compensation in the form of LTIP Units as a part of the annual incentive compensation to our key employees each year, a portion which vests at the date of grant, and the remainder which vests in three equal annual installments over the three calendar years following the grant. We accrue compensation expense during each year for the portion of the annual bonuses which we expect to pay out in the form of immediately vested equity grants. Grants with respect to years prior to 2012 were awarded shortly after the respective year end, but commencing in 2012, we awarded the grants before the end of the year for which they were awarded. Compensation expense for LTIP Units which are not vested at the grant date is recognized on a straight- line basis over the requisite service period for each separately vesting portion of the award. In addition to our annual incentive compensation, we also make long-term grants in the form of LTIP Units to our executives and certain key employees. The grants generally vest in equal annual installments over four to five calendar years following the grant, and some of these grants include a portion which vests at the date of grant. Compensation expense for options which are not vested at the grant date is recognized on a straight-line basis over the requisite service period for the entire award. Certain amounts of equity compensation expense are capitalized for employees who provide leasing and construction services. We granted LTIP Units to employees totaling 1.1 million in 2014, 0.6 million in 2013 and 1.2 million in 2012. We did not grant any options in 2014, 2013, and 2012. Each year, we grant LTIP Units to our non-employee directors which vest ratably over the year of grant in lieu of cash retainers. These awards totaled 15 thousand in 2014, 19 thousand in 2013 and 46 thousand in 2012. In addition, every three years we have also made long-term grants of LTIP Units to our non-employee directors which vest over the following three years. These awards totaled 54 thousand at the end of 2012. When a new director joins our board, we have made pro rata grants vesting over the remainder of the respective three year vesting period. Those grants totaled 1 thousand in 2012. Total equity compensation expense during 2014, 2013 and 2012 was $13.7 million, $10.0 million, and $10.6 million, respectively. These amounts do not include capitalized equity compensation totaling $1.1 million, $800 thousand, and $561 thousand during 2014, 2013 and 2012, respectively. Total equity compensation expense is included in general and administrative expenses in the consolidated statements of operations. 43 Douglas Emmett, Inc. Notes to Consolidated Financial Statements (continued) We calculate the fair value of the LTIP Units granted using the market value of our common stock on the date of grant with a discount estimated by a third-party consultant for post-vesting restrictions. The total grant date fair value of LTIP Units which were granted in 2014, 2013 and 2012 was $21.4 million, $10.1 million and $19.2 million, respectively. The total grant date fair value of LTIP Units which vested in 2014, 2013 and 2012 was $14.9 million, $10.9 million and $13.5 million, respectively. Equity grants fully vested at the time of grant to satisfy a portion of the annual bonuses that were accrued during the prior year were $4.1 million for 2012. The total intrinsic value of options exercised and repurchased in 2014 was $5.0 million. Our policy is to issue new shares of common stock for stock options exercised on a one for one basis. Total unrecognized compensation cost related to nonvested option and LTIP Unit awards was $15.4 million at December 31, 2014. This expense will be recognized over a weighted-average term of twenty-six months. The table below presents the activity of our outstanding stock options granted under our stock incentive plan: Stock Options: Number of Stock Options (thousands) Weighted Average Exercise Price Weighted Average Remaining Contract Life (months) Total Intrinsic Value (thousands) Outstanding at December 31, 2011 12,540 $ 18.10 72 $ 26,051 Granted Outstanding at December 31, 2012 Granted Outstanding at December 31, 2013 Granted Exercised Outstanding at December 31, 2014 Exercisable at December 31, 2014 — 12,540 — 12,540 — (731) 11,809 11,809 18.10 18.10 20.03 17.98 17.98 59 47 65,177 65,051 36 36 $ 123,017 123,017 The table below presents the activity of our outstanding unvested LTIP Units granted under our stock incentive plan: Unvested LTIP Units: Outstanding at December 31, 2011 Granted Vested Forfeited Outstanding at December 31, 2012 Granted Vested Forfeited Outstanding at December 31, 2013 Granted Vested Forfeited Outstanding at December 31, 2014 12. Fair Value of Financial Instruments Number of Units (thousands) 603 $ 1,255 (965) (2) 891 663 (785) (15) 754 1,106 (854) (8) 998 Weighted Average Grant Date Fair Value 12.64 15.26 13.76 17.43 15.12 15.26 14.15 21.52 15.63 19.31 17.44 22.48 18.48 Our estimates of the fair value of financial instruments were determined using available market information and appropriate valuation methods. Considerable judgment is necessary to interpret market data and develop an estimated fair value. The use of different market assumptions or estimation methods may have a material effect on the estimated fair value amounts. The FASB 44 Douglas Emmett, Inc. Notes to Consolidated Financial Statements (continued) fair value framework hierarchy distinguishes between assumptions based on market data obtained from sources independent of the reporting entity, and the reporting entity’s own assumptions about market-based inputs. The hierarchy is as follows: Level 1 - inputs utilize unadjusted quoted prices in active markets for identical assets or liabilities. Level 2 - inputs are observable either directly or indirectly for similar assets and liabilities in active markets. Level 3 - inputs are unobservable assumptions generated by the reporting entity. As of December 31, 2014, we did not have any fair value measurements using Level 3 inputs. Short term financial instruments (disclosure of fair value) The carrying amounts for cash and cash equivalents, tenant receivables, revolving credit lines, interest payable, accounts payable, security deposits and dividends payable approximate fair value because of the short-term nature of these instruments. Secured notes receivable (disclosure of fair value) See Notes 5 and 18 for the details of our secured notes receivable. The fair value of our secured notes receivable is determined using Level 2 inputs based on current market interest rates. The carrying value of our secured notes receivable approximated their fair values at December 31, 2014. Secured notes payable (disclosure of fair value) See Note 6 for the details of our secured notes payable. We calculate the fair value of our secured notes payable by calculating the credit-adjusted present value of the principal and interest payments using current market interest rates, assuming that the loans will be outstanding through maturity, and excluding any maturity extension options. We determined that the fair value of our secured notes payable is calculated using Level 2 inputs. The table below presents (in thousands) the estimated fair value of our secured notes payable: Secured Notes Payable: Fair value Carrying value Derivative instruments (measured at fair value) December 31, 2014 December 31, 2013 $ $ 3,293,351 $ 3,253,290 $ 3,233,555 3,201,140 See Note 8 for the details of our derivatives. We present our derivatives on the balance sheet at fair value, on a gross basis, excluding accrued interest, without reflecting any net settlement positions with the same counterparty, using the framework for measuring fair value established by the FASB. The valuation of our interest rate swaps and caps is determined using widely accepted valuation methods, including discounted cash flow analysis of the expected future cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, and uses observable market-based inputs, including forward interest rate curves. We incorporate credit valuation adjustments to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. We determined that the fair value of our derivatives are calculated using Level 2 inputs. The table below presents (in thousands) the estimated fair value of our derivative liabilities: Derivative Instruments in a liability position:(1) Level 1 Level 2 Level 3 Fair Value of Derivative Instruments _________________________________________________________ December 31, 2014 December 31, 2013 $ $ — $ 37,386 — 37,386 $ — 63,144 — 63,144 (1) We did not have any derivative assets as of December 31, 2014 and December 31, 2013. 13. Future Minimum Lease Receipts We lease space to tenants primarily under non-cancelable operating leases that generally contain provisions for a base rent plus reimbursement for certain operating expenses. Operating expense reimbursements are reflected in our consolidated statements of operations as tenant recoveries. 45 Douglas Emmett, Inc. Notes to Consolidated Financial Statements (continued) We also lease space to certain tenants under non-cancelable leases that provide for percentage rents based upon tenant revenues. Percentage rental income totaled $548 thousand for 2014, $576 thousand for 2013 and $658 thousand for 2012. The table below presents (in thousands) the future minimum base rentals on our non-cancelable office and ground operating leases at December 31, 2014: Twelve months ending December 31: 2015 2016 2017 2018 2019 Thereafter Total future minimum base rentals $ 376,141 335,928 284,546 226,177 182,292 444,007 $ 1,849,091 The above future minimum lease receipts exclude residential leases, which typically have a term of one year or less, as well as tenant reimbursements, amortization of deferred rent receivables, and amortization of acquired above/below-market lease intangibles. Some leases are subject to termination options, generally upon payment of a termination fee. The preceding table assumes that these termination options are not exercised. 14. Future Minimum Lease Payments We leased portions of the land underlying two of our office buildings. We expensed ground lease payments of $2.6 million for 2014 and $2.2 million for both 2013 and 2012. We acquired the fee interest related to one of these two leases in February 2015. See Note 19. Because we had the ability to acquire the respective fee interest, we excluded payments under this lease from the future minimum ground rent payments in the table below. The table below presents (in thousands) our future minimum ground lease payments as of December 31, 2014: Twelve months ending December 31: 2015 2016 2017 2018 2019 Thereafter Total future minimum lease payments ___________________________________________________ $ $ 733 733 733 733 733 49,110 52,775 (1) (1) Lease term ends on December 31, 2086, and requires ground rent payments totaling $733 thousand per year that will continue until February 28, 2019, rental payments for successive rental periods thereafter shall be determined by mutual agreement with the lessor. The future minimum ground lease payments in the table above assume that the rental will continue to be $733 thousand per year after February 28, 2019. 15. Commitments, Contingencies and Guarantees Legal Proceedings We are subject to various legal proceedings and claims that arise in the ordinary course of business. Excluding ordinary, routine litigation incidental to our business, we are not currently a party to any legal proceedings that we believe would reasonably be expected to have a materially adverse effect on our business, financial condition or results of operations. Concentration of Credit Risk 46 Douglas Emmett, Inc. Notes to Consolidated Financial Statements (continued) Our properties are located in Los Angeles County, California and Honolulu, Hawaii. The ability of our tenants to honor the terms of their respective leases is dependent upon the economic, regulatory and social factors affecting the markets in which the tenants operate. We perform ongoing credit evaluations of our tenants for potential credit losses. In addition, we have financial instruments that subject us to credit risk, which consist primarily of accounts receivable, deferred rents receivable and interest rate contracts. We maintain our cash and cash equivalents at high quality financial institutions with investment grade ratings. Interest bearing accounts at each U.S. banking institution are insured by the Federal Deposit Insurance Corporation up to $250 thousand. To date, we have not experienced any losses on our deposited cash. Asset Retirement Obligations Conditional asset retirement obligations represent a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement is conditional on a future event that may or may not be within our control. A liability for a conditional asset retirement obligation must be recorded if the fair value of the obligation can be reasonably estimated. Environmental site assessments and investigations have identified twenty-three properties in our consolidated portfolio, and four properties owned by our Funds, containing asbestos, which would have to be removed in compliance with applicable environmental regulations if these properties undergo major renovations or are demolished. As of December 31, 2014, the obligations to remove the asbestos from these properties have indeterminable settlement dates, and we are unable to reasonably estimate the fair value of the associated conditional asset retirement obligation. Guarantees We made certain environmental and other limited indemnities and guarantees covering customary non-recourse carve outs for a $325.0 million loan of one of our Funds. The loan matures on May 1, 2018, and carries interest that is effectively fixed by an interest rate swap which matures on May 1, 2017. We have also guaranteed the related swap. We have an indemnity from the Fund for any amounts that we would be required to pay under these agreements. As of December 31, 2014, the maximum future payments under the swap agreement were approximately $4.6 million. As of December 31, 2014, all of the obligations under the loan and swap agreements have been performed by the Fund in accordance with the terms of those agreements. Tenant Concentrations In 2014, 2013 and 2012, no tenant accounted for more than 10% of our total rental revenue and tenant recoveries. 16. Segment Reporting Segment information is prepared on the same basis that we review information for operational decision-making purposes. We operate in two business segments: (i) the acquisition, development, ownership and management of office real estate and (ii) the acquisition, development, ownership and management of multifamily real estate. The services for our office segment primarily include rental of office space and other tenant services, including parking and storage space rental. The services for our multifamily segment include rental of apartments and other tenant services, including parking and storage space rental. Asset information by segment is not reported because we do not use this measure to assess performance or make decisions to allocate resources. Therefore, depreciation and amortization expense is not allocated among segments. General and administrative expenses and interest expense are not included in segment profit as our internal reporting addresses these items on a corporate level. Segment profit is not a measure of operating income or cash flows from operating activities as measured by GAAP, is not indicative of cash available to fund cash needs and should not be considered an alternative to cash flows as a measure of liquidity. Not all companies may calculate segment profit in the same manner. We consider segment profit to be an appropriate supplemental measure to net income because it can assist both investors and management in understanding the core operations of our properties. 47 Douglas Emmett, Inc. Notes to Consolidated Financial Statements (continued) The table below presents (in thousands) the operating activity of our reportable segments: Office Segment Total office revenues Office expenses Segment profit Multifamily Segment Total multifamily revenues Multifamily expenses Segment profit Year Ended December 31, 2014 2013 2012 $ $ 519,422 (181,177) 338,245 $ 514,600 (174,952) 339,648 505,276 (170,725) 334,551 80,117 (20,664) 59,453 76,936 (19,928) 57,008 73,723 (19,672) 54,051 Total profit from all segments $ 397,698 $ 396,656 $ 388,602 The table below (in thousands) is a reconciliation of the total profit from all segments to net income attributable to common stockholders: Total profit from all segments General and administrative expenses Depreciation and amortization Other income Other expenses Income (loss), including depreciation, from unconsolidated real estate funds Interest expense Acquisition-related expenses Net income Less: Net income attributable to noncontrolling interests Net income attributable to common stockholders Year Ended December 31, 2014 2013 2012 $ $ 397,698 (27,332) (202,512) 17,675 (7,095) 3,713 (128,507) (786) 52,854 (8,233) 44,621 $ $ 396,656 (26,614) (191,351) 6,402 (4,199) 3,098 (130,548) (607) 52,837 (7,526) 45,311 $ $ 388,602 (27,943) (184,849) 2,821 (1,883) (1,710) (146,693) — 28,345 (5,403) 22,942 48 Douglas Emmett, Inc. Notes to Consolidated Financial Statements (continued) 17. Quarterly Financial Information (unaudited) The tables below present (in thousands, except per share amounts) selected quarterly information for 2014 and 2013: Total revenue Net income before noncontrolling interests Net income attributable to common stockholders Net income per common share - basic Net income per common share - diluted Weighted average shares of common stock outstanding - basic Weighted average shares of common stock outstanding - diluted Total revenue Net income before noncontrolling interests Net income attributable to common stockholders Net income per common share - basic Net income per common share - diluted Weighted average shares of common stock outstanding - basic Weighted average shares of common stock outstanding - diluted $ $ $ $ $ $ Three Months Ended March 31, 2014 June 30, 2014 September 30, 2014 December 31, 2014 148,876 $ 151,426 $ 148,146 $ 151,091 15,458 12,976 15,917 13,363 0.09 0.09 $ $ 0.09 0.09 $ $ 8,681 7,389 0.05 0.05 $ $ 12,798 10,893 0.08 0.07 143,140 143,717 144,361 144,823 175,751 176,310 176,413 176,436 Three Months Ended March 31, 2013 June 30, 2013 September 30, 2013 December 31, 2013 145,458 $ 148,716 $ 149,686 $ 147,676 14,612 12,082 14,978 13,635 0.08 0.08 $ $ 0.10 0.09 $ $ 12,743 10,751 0.08 0.07 $ $ 10,504 8,843 0.06 0.06 142,440 142,581 142,598 142,603 174,579 175,252 174,756 174,600 49 Douglas Emmett, Inc. Notes to Consolidated Financial Statements (continued) 18. Investments in Unconsolidated Real Estate Funds We manage and own an equity interest in two Funds, Fund X and Partnership X, through which we and institutional investors own 8 office properties totaling 1.8 million square feet in our core markets. At December 31, 2014, we held equity interests of 68.61% of Fund X and 24.25% of Partnership X. We received cash distributions from our Funds totaling $12.4 million for 2014, $8.3 million for 2013 and $5.5 million for 2012. We did not acquire any additional interests in our Funds in 2014. During the first quarter of 2013, we acquired an additional 3.3% interest in Fund X and an additional 0.9% interest in Partnership X from an existing investor for an aggregate of approximately $8.0 million in cash. During the first quarter of 2012, we acquired an additional 16.3% interest in Fund X from existing investors for approximately $33.4 million in cash. Our investment in the Funds includes a note receivable. On April 3, 2013, we loaned $2.9 million to a related party investor in connection with a capital call made by Fund X. The loan carries interest at one month LIBOR plus 2.5%, and is due and payable no later than April 1, 2017, with mandatory prepayments equal to any distributions with respect to the related party's interest in Fund X. As of December 31, 2014, and 2013 the balance outstanding on the loan was $1.5 million and $2.7 million, respectively. The interest recognized on this note is included in other income in the consolidated statements of operations. The tables below present (in thousands) selected financial information for the Funds on a combined basis. The accounting policies of the Funds are consistent with those of the Company. The amounts presented represent 100% (not our pro-rata share) of amounts related to the Funds and are based upon historical acquired book value: Total revenues Operating income Net income (loss) Total assets Total liabilities Total equity 19. Subsequent events Year Ended December 31, 2014 2013 $ 66,234 $ 11,738 254 63,976 10,151 (829) December 31, 2014 December 31, 2013 $ 703,130 $ 389,413 313,717 722,983 391,892 331,091 On December 29, 2014, we entered into an agreement to purchase a 224 thousand square foot Class “A” multi-tenant office property in Encino for $89.0 million, or approximately $397 per square foot. Subject to typical closing conditions, the purchase is scheduled to close during the first quarter of 2015. On February 12, 2015, the owner of a fee interest related to one of our office buildings, to whom we previously loaned $27.5 million, repaid $1.0 million of the loan and then contributed the fee interest, subject to the remaining balance of that loan of $26.5 million, in exchange for 34,412 units in our operating partnership valued at $1.0 million. We expect that an additional $6.6 million of accretion of an above-market ground lease related to the fee interest will be recognized in other income in the first quarter of 2015 as a result of this transaction. See Note 4. 50 OUR SENIOR MANAGEMENT OUR BOARD OF DIRECTORS STOCK EXCHANGE Dan a. EmmEtt Executive Chairman Dan a. EmmEtt Chairman of the Board The New York Stock Exchange – NYSE Ticker Symbol – DEI JorDan L. KapLan President & Chief Executive Officer JorDan L. KapLan President & Chief Executive Officer KEnnEth m. panzEr Chief Operating Officer thEoDorE E. Guth Chief Financial Officer KEvin a. Crummy Chief Investment Officer CORPORATE HEADQUARTERS 808 Wilshire Boulevard 2nd Floor Santa Monica, CA 90401 310.255.7700 INVESTOR INFORMATION KEnnEth m. panzEr Chief Operating Officer ChristophEr h. anDErson Real Estate Executive and Investor LEsLiE E. BiDEr Chief Executive Officer - PinnacleCare Dr. DaviD t. FEinBErG President & Chief Executive Officer – Geisinger Health System thomas E. o’hErn Senior Executive Vice President, Chief Financial Officer & Treasurer – Macerich Company For additional information, please contact: WiLLiam E. simon, Jr. Co-chairman, William E. Simon & Sons, LLC Stuart McElhinney Vice President – Investor Relations smcelhinney@douglasemmett.com 310.255.7751 Our SEC Filings, including our latest 10-K and proxy statement, are available on our website at www.douglasemmett.com LEGAL COUNSEL Manatt I Phelps I Phillips LLP Los Angeles, CA INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Ernst & Young LLP Los Angeles, CA SHAREHOLDER ACCOUNT ASSISTANCE Shareholder records are maintained by Douglas Emmett’s Transfer Agent: Computershare Investor Services, LLC 312.588.4990 ANNUAL MEETING Le Meridien Delfina 530 Pico Boulevard Santa Monica, CA 90405 May 28, 2015 9:00 a.m. (PDT) At Douglas Emmett concern for the environment is ingrained in our corporate culture. We are committed to implementing and maintaining financially responsible sustainability programs in our properties. Through the years we have proactively introduced conservation and sustainability measures across our portfolio that have significantly reduced our energy consumption, increased our operational efficiencies and reduced our carbon footprint. We engage our service providers, suppliers, and tenants to join our mission and work with them to pursue opportunities where cost savings and social responsibility merge. At Douglas Emmett we know that sustainability is a yard stick for both social responsibility and fiscal management. Simply put, thoughtful implementation of sustainable initiatives is good business. Map of Offi ce and Residential Properties Los Angeles Submarkets Los Angeles Submarkets Warner Center/Woodland Hills WARNER CENTER/WOODLAND HILLS SANTA MONICA BURBANK WESTWOOD BRENTWOOD BEVERLY HILLS CENTURY CITY ENCINO/SHERMAN OAKS OLYMPIC CORRIDOR Warner Center/Woodland Hills Honolulu Submarket www.douglasemmett.com 

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