Washington Real Estate Investment Trust
Annual Report 2001

Plain-text annual report

WASHINGTON REAL ESTATE INVESTMENT TRUST 6110 Executive Boulevard Rockville, Maryland 20852-3927 301-984-9400 800-565-9748 Fax: 301-984-9610 w w w. w r i t . c o m The graph on the front cover reflects the total return (dividends plus price appreciation with all dividends reinvested) of WRIT, the S&P 500, the Morgan Stanley REIT Index, the NASDAQ and the DOW for the period beginning December 31, 1971, and ending December 31, 2001. COMPARE WRIT’S PERFORMANCE WITH OTHER INDUSTRY LEADERS $10,000 invested in WRIT since 1971, with dividends reinvested, would be worth $1,789,000 as of December 31, 2001. W R I T $ 1 , 7 8 8 , 7 0 1 S & P 5 0 0 $ 3 4 6 , 2 4 4 R E I T I N D U S T R Y $ 4 0 0 , 3 8 8 N A S D A Q $ 1 9 5 , 0 4 0 D 0 W $ 1 1 9 , 4 5 9 COMPOUND ANNUAL RATES OF RETURN: W R I T 1 8 . 2 % S & P 5 0 0 1 2 . 1 % R E I T I N D U S T R Y 1 2 . 6 % N A S D A Q 1 0 . 1 % D 0 W 8 . 3 % COMPARATIVE RETURNS OVER 30-YEAR PERIOD W R I T S & P 5 0 0 R E I T I N D U S T R Y D O W N A S D A Q W A S H I N G T O N R E A L E S T A T E I N V E S T M E N T T R U S T ANNUAL REPORT 2001 VALUE 36 consecutive years of increased earnings per share GROWTH 31 consecutive years of increased dividends per share PERFORMANCE 29 consecutive years of increased funds from operations per share W R I T S & P 5 0 0 R E I T I N D U S T R Y N A S D A Q D O W FUNDS FROM OPERATIONS PER SHARE Washington Real Estate Investment Trust, founded MISSION STATEMENT 2 0 0 1 $ 1 . 9 6 2 0 0 0 $ 1 . 7 9 1 9 9 9 $ 1 . 5 7 1 9 9 8 $ 1 . 3 9 1 9 9 7 $ 1 . 2 3 CASH DIVIDENDS PAID PER SHARE 2 0 0 1 $ 1 . 3 1 2 0 0 0 $ 1 . 2 3 1 9 9 9 $ 1 . 1 6 1 9 9 8 $ 1 . 1 1 1 9 9 7 $ 1 . 0 7 in 1960 and headquar tered in Rockville, Mar yland, invests in a diversified range of income-producing property types. Our purpose is to acquire and manage real estate investments in markets we know well and protect our assets from single proper ty-type value fluctuations through diversified holdings. Our goal is to continue to safely increase earnings and shareholder value. SELECTED FINANCIAL AND OPERATING DATA IN MILLIONS, EXCEPT FULLY DILUTED PER SHARE AMOUNTS F O R T H E Y E A R Real Estate Revenue Income before Gain on Sale of Real Estate Net Income Funds from Operations Cash Dividends Paid Average Shares Outstanding Net Income Funds from Operations Cash Dividends Paid A T Y E A R E N D Total Assets Total Debt Shareholders’ Equity 2001 2000 1999 1998 1997 $ 148 $ 135 $ 119 $ 104 $ 79 48 52 74 50 39 42 45 64 44 36 $1.27 1.38 1.96 1.31 $1.16 1.26 1.79 1.23 $ 708 360 324 $ 632 351 259 36 44 56 41 36 $1.02 1.24 1.57 1.16 $ 608 330 257 34 41 50 40 36 $ .96 1.15 1.39 1.11 $ 559 283 254 30 30 41 36 33 $ .90 .90 1.23 1.07 $ 469 203 252 P E R F U L L Y D I L U T E D C O M M O N S H A R E Income before Gain on Real Estate WRIT trustees and officers TRUSTEES Edmund B. Cronin, Jr. Chairman, President and Chief Executive Officer Director, John J. Kirlin Companies; Potomac Electric Power Company John M. Derrick, Jr. Chairman and Chief Executive Officer, Potomac Electric Power Company Clifford M. Kendall Director, Affiliated Computer Service, Inc.; VSE Corporation; Onsite Sourcing, Inc. John P. McDaniel Chief Executive Officer, MedStar Health Director, AAL/Lutheran Brotherhood Charles T. Nason Chairman and Chief Executive Officer, Acacia Life Insurance David M. Osnos Senior Partner, Arent Fox Kintner Plotkin & Kahn; Director, EastGroup Properties; VSE Corporation Susan J. Williams Chief Executive Officer and President, Williams Aron & Associates OFFICERS Edmund B. Cronin, Jr. Chairman, President and Chief Executive Officer George F. McKenzie Senior Vice President, Real Estate Brian J. Fitzgerald Managing Director, Leasing Laura M. Franklin Managing Director, Accounting and Administration, Corporate Secretary Sara L. Grootwassink Managing Director, Finance and Capital Markets Kenneth C. Reed Managing Director, Property Management Thomas L. Regnell Managing Director, Acquisitions m o c . e v i t a e r c i c f . w w w D M , a d s e h t e B . c n I s n o i t a c i n u m m o C l a i c n a n i F : n g i s e D t s u r T t n e m t s e v n I e t a t s E l a e R n o t g n i h s a W 2 0 0 2 © Clockwise from rear left: Charles T. Nason, Susan J. Williams, Clifford M. Kendall, John P. McDaniel, John M. Derrick Jr., Edmund B. Cronin Jr., David M. Osnos Clockwise from rear left: Kenneth C. Reed, Sara L. Grootwassink, Brian J. Fitzgerald, Laura M. Franklin, Thomas L. Regnell, Edmund B. Cronin Jr., George F. McKenzie TO OUR SHAREHOLDERS What a year! The high-technology implo- management has not applied any ways to demonstrate performance, sion, major national retail chains filing undue pressure on Arthur Andersen to usually through financial engineering. for bankruptcy, September 11, 2001, take unusually aggressive positions. Often it is through off-balance sheet continued decline in the economy, Arthur Andersen has been our transactions and trading cover-ups. international unrest, poor earnings auditor since 1996. Prior to that time, WRIT has no off-balance sheet transac- reports with guarded future guidance, Price Waterhouse, now known as PWC, tions or technology ventures, nor are all topped off with the Enron affair. was our auditor. We changed auditors we in a trading business. So what you WRIT has weathered this storm because PWC moved both their real see in our reporting is real. Unless quite well. Our total return for the year estate audit and tax groups to Atlanta, there is some new definitive reason to was 11.25%. But WRIT also has been Georgia. During PWC’s relocation, sever the relationship, WRIT plans to negatively affected by the declining WRIT was assigned local PWC audit keep Arthur Andersen as its auditor. In economy. It slowed our growth from personnel unfamiliar with real estate the meantime, WRIT is pursuing a con- high double-digit earnings and funds with assistance from the new head real tingency plan. from operations per share to a very estate office in Atlanta. We found that Similar to many professional respectable 9.5% increase over the arrangement unacceptable. economists, I expect that sometime year 2000. Our financial statement Consequently, we invited four of in the late third quarter and into the continues to be one of the strongest the Big Five accounting firms, including fourth quarter of 2002 we should begin in the industry. WRIT continues to PWC, to bid for our business. Both seeing a real recovery. Our diversified retain an A- and Baa1 rating from the Audit Committee and management portfolio will continue to serve us well. Standard & Poor’s and Moody’s, were involved in the process. We It will enable us to continue to extend respectively. I feel very comfortable compared the firms by using a matrix our record of 36 consecutive years of that our geographic focus in the developed by WRIT, which included increased earnings per share, 31 con- Washington-Baltimore region, property- critical real estate and, in particular, secutive years of increased dividends type diversification, and solid balance REIT criteria. The result of several per share, and 29 years of increased sheet will enable us to continue in presentations and meetings with each funds from operations per share. 2002 to grow our earnings and divi- of the firms led us to choose Arthur Please read the following pages dends in spite of the soft economy. Andersen. WRIT has been very satis- to become better acquainted with your The recent Enron event has led to fied with the partners and associates company regarding its properties and increased concern about accounting assigned to us. financial performance. practices and reliable earnings reports. Until recently, Arthur Andersen has Since Arthur Andersen, Enron’s auditor, enjoyed an impeccable reputation, Sincerely, is our auditor, your Trustees and Audit although from time to time they, like Committee have had in-depth discus- the other large national or international sions with Andersen’s senior managers auditing firms, have been cited and, about the Enron affair and its implica- indeed, fined for failure to properly Edmund B. Cronin, Jr. tions for WRIT. I can assure you, as perform. The root of the problem Chairman of the Board, Arthur Andersen told the Trustees, that begins with management seeking out President and Chief Executive Officer Bradlee Shopping Center Courthouse Square 1700 Research Boulevard the results: year after year of performance 1 9 9 9 W R I T 1 2 . 9 % R E I T 1 0 . 2 % 2 0 0 0 W R I T 1 4 . 6 % R E I T 7 . 1 % WRIT VS. REIT INDUSTRY FFO PER SHARE GROWTH 1999–2001 FFO per share growth is the most widely recog- nized earnings performance measure in the REIT industry. As reflected in the accompanying graph, WRIT has outperformed industry average FFO per share growth by 616 basis points over the last three years. The extent of WRIT’s out- performance has increased in each of the last three years. WRIT’s average 12.3% FFO per share growth over the last three years is one 2 0 0 1 W R I T 9 . 5 % R E I T 1 . 2 % SOURCE: NAREIT of the highest in the industry. RATIO OF OPERATING EXPENSES AND G&A TO REVENUE WRIT’s ability to achieve its performance goals includes proactively managing its operating expenses and G&A without diminishing quality service to its tenants. The result, as the accompanying chart demonstrates, is that the ratio of operating expenses and G&A to revenue continues to improve. 1 9 9 7 3 7 . 4 % 1 9 9 8 3 6 . 4 % 1 9 9 9 3 4 . 9 % 2 0 0 0 3 4 . 0 % 2 0 0 1 3 2 . 5 % Dulles South IV 3801 Connecticut Avenue 600 Jefferson Plaza RETURN ON INVESTED CAPITAL W R I T 1 2 . 3 % In all businesses, return on invested R E I T I N D U S T R Y 1 0 . 0 % capital (ROIC) is an extremely important measure of company performance. R E TA I L 9 . 7 % I N D U S T R I A L 9 . 7 % WRIT’s extraordinary performance is M U LT I - FA M I LY 9 . 4 % a result of the effective deployment of O F F I C E 9 . 0 % capital combined with hands-on manage- ment, leasing, and a value-added focus. WRIT’s average 12.3% ROIC ranks fourth out of the 73 companies studied over the 19-quarter period. Over the past eight quarters, WRIT ranks second out of 106 companies. PROPERTY-TYPE DIVERSIFICATION The Greater Washington regional economy is unique, anchored by the very significant federal government presence. With the federal government stability driving continued private sector growth, the region can expect to experience one of the most favorable economic environments in the United States. Owning a diversified property-type portfolio enables WRIT to focus on the Greater Washington region without the concerns of single property-type owners regarding asset concentration and value fluctuations. QUARTER AVERAGES FROM FIRST QUARTER 1997 TO THIRD QUARTER 2001 SOURCE: CREDIT SUISSE FIRST BOSTON 1 7 % M U LT I - FA M I LY 1 4 % R E TA I L 1 5 % I N D U S T R I A L / F L E X 4 % M E D I C A L O F F I C E 2001 NET OPERATING INCOME CONTRIBUTION BY PROPERTY TYPE 5 0 % O F F I C E Tycon Plaza III The Earhart Building The Ashby Apartments the strategy: disciplined asset management ACQUISITIONS One Central Plaza is a 12-story, 274,000-square-foot building containing eight levels of office space and four levels of parking, located at 11300 Rockville Pike in Montgomery County, MD. It is located in the heart of the county across from White Flint Mall, two blocks from the White Flint Metro Station and the Nuclear Regulatory Commission, and within one mile of the National Naval Medical Hospital and the National Institutes of Health. At the time of acquisition, the property was 99.9% occupied by 62 tenants, a definite WRIT profile property with its small tenant base and an “A” location. One Central Plaza WRIT paid $44.4 million or $162.04 per square foot for the building, which was below replacement cost. The initial fiscal year 2002 yield is projected to be 10.4%. In addition to synergies with other properties WRIT owns nearby, substantial upside in rents is expected as both parking and office rental rates are below the current market. Sullyfield Commerce Center is comprised of two one-story with mezzanine flex warehouse buildings containing 248,000 square feet. The property is located at 14320–14370 Sullyfield Circle, Chantilly, VA. The acquisition price was $21.6 million or $87.10 per square foot. This property complements other properties WRIT owns within the Sullyfield Business Park. With this acquisition, WRIT now owns 426,457 square feet in this 1.7-million-square-foot business park. At acquisition, the property was 100% occupied by nine tenants. The average in-place rents of those tenants expiring through 2005 are estimated to be 27% below market. Initial fiscal year 2002 yield Sullyfield Commerce Center is expected to be 10.3%. 7900 Westpark Drive Maryland Trade Center 800 Block of South Washington DISPOSITIONS In 2001, WRIT sold its former headquarters at 10400 Connecticut Avenue in Kensington, MD, for $8,400,000. This sale resulted in a net gain of $4,296,000. Since the commencement of WRIT’s asset disposition program in 1998, WRIT has sold 10 properties. In each case, the sale proceeds were reinvested, on a tax-deferred basis, into properties that management believes will have substan- tially stronger earnings potential in line with WRIT’s long-term objectives. 10400 Connecticut Avenue 4 0 % R E C U R R I N G C A P I TA L I M P R O V E M E N T S 1 2 9 % T E N A N T I M P R O V E M E N T S 2 6 % E X PA N S I O N S & M A J O R R E N O VAT I O N S 2 2 5 % A C Q U I S I T I O N - R E L AT E D 2 1 NON-ACCRETIVE 2 ACCRETIVE CAPITAL EXPENDITURES There are four components to WRIT’s capital improve- ment expenditures. Acquisition-related—when acquiring assets, as part of WRIT’s total acquisition price an additional investment is expected for replacement of building components, for example, a new roof or other major replacement needs and deferred maintenance. Tenant improvements—generally when a tenant renews or a new tenant commits for space, improvements to the space is expected to be paid by WRIT. Expansions and major renovations—capital expenditures for new construction, new facades, the retrofit of elevators and lobbies, and other major projects. Recurring capital improvements—the combination of many smaller capital expenditure items that must be spent to keep the properties in first-class operating condition to meet tenant expectations. Capital improvement expenditures are considered either accretive or non-accretive. Although they both add value to a property over its lifetime, current income may not increase in the short term. For investment analysis purposes, it is necessar y to identify the accretive versus the non-accretive capital expenditures. Northern Virginia Washington, D.C. the portfolio: strong real estate markets 9 MARYLAND 6 7 2 5 18 19 20 7 6 4 10 23 2 4 21 1 5 6 9 9 10 12 13 8 5 11 6 WASHINGTON, D.C. 1 3 1 4 22 10 14 4 5 8 7 15 3 1 17 8 9 2 3 8 14 15 16 16 11 VIRGINIA 3 2 7 13 12 Maryland Suburban Technology Corridors multi-family 1 Roosevelt Towers Falls Church, Virginia 2 Park Adams Arlington, Virginia 3 Munson Hill Towers Falls Church, Virginia retail centers 1 Takoma Park Shopping Center Takoma Park, Maryland 2 Westminster Shopping Center Westminster, Maryland 3 Concord Centre Springfield, Virginia 4 Wheaton Park Shopping Center Wheaton, Maryland 4 Country Club Towers Arlington, Virginia 5 3801 Connecticut Avenue, NW Washington, D.C. 6 Walker House Apartments Gaithersburg, Maryland 7 The Ashby at McLean McLean, Virginia 8 Bethesda Hill Apartments Bethesda, Maryland 9 Avondale Apartments Laurel, Maryland 5 Bradlee Shopping Center Alexandria, Virginia 6 Chevy Chase Metro Plaza Washington, D.C. 7 Montgomery Village Center Gaithersburg, Maryland 8 The Shoppes of Foxchase Alexandria, Virginia 9 Frederick County Square Frederick, Maryland 10 The 800 Block of South Washington Street Alexandria, Virginia office buildings 1 1901 Pennsylvania Avenue, N.W. 9 Tycon III Washington, D.C. 2 51 Monroe Street Rockville, Maryland 3 7700 Leesburg Pike Tysons Corner, Virginia 4 515 King Street Alexandria, Virginia 5 The Saratoga Building Rockville, Maryland 6 The Lexington Building Rockville, Maryland 7 Brandywine Center Rockville, Maryland 8 Tycon II Tysons Corner, Virginia 10 6110 Executive Boulevard Rockville, Maryland 11 1220 19th Street, NW Washington, D.C. 12 Maryland Trade Center I Greenbelt, Maryland 13 Maryland Trade Center II Greenbelt, Maryland 14 1600 Wilson Boulevard Arlington, Virginia 15 7900 Westpark Drive Tysons Corner, Virginia 16 Woodburn Medical Park I & II Tysons Corner, Virginia Fairfax, Virginia industrial/flex properties 17 8230 Boone Boulevard Tysons Corner, Virginia 18 600 Jefferson Plaza Rockville, Maryland 19 1700 Research Boulevard Rockville, Maryland 20 11821 Parklawn Drive Rockville, Maryland 21 Wayne Plaza Silver Spring, Maryland 22 Courthouse Square Alexandria, Virginia 23 One Central Plaza Rockville, Maryland 1 Capital Freeway Center Washington, D.C. (sold 2/02) 2 Fullerton Industrial Park Springfield, Virginia 7 Alban Business Center Springfield, Virginia 8 The Earhart Building Chantilly, Virginia 13 8900 Telegraph Road Lorton, Virginia 14 Dulles South IV Chantilly, Virginia 3 Pepsi-Cola Distribution Center 9 Ammendale Technology Park I 15 Sully Square Forestville, Maryland Beltsville, Maryland Chantilly, Virginia 4 Charleston Business Center 10 Ammendale Technology Park II 16 Sullyfield Commerce Center Rockville, Maryland 5 Tech 100 Industrial Park Elkridge, Maryland Beltsville, Maryland 11 Pickett Industrial Park Alexandria, Virginia 6 Crossroads Distribution Center 12 Northern Virginia Industrial Park Elkridge, Maryland Lorton, Virginia Chantilly, Virginia the future: opportunities for adding value Value is not created through acquisitions alone. There must be opportunities to add value through creative thinking. With each new acquisition and the constant review of existing properties, WRIT looks for added- value opportunities through the use of excess density or favorable code modifications. 1901 PENNSYLVANIA AVENUE, NW Facade renovation (new curtain wall) 98,000 square feet Completion expected May 2002 WRIT ROSSLYN CENTER Use of excess density 211 apartments/10 townhouses Completion expected late 2004 WESTMINSTER SHOPPING CENTER Renovation and re-tenanting 146,000 square feet Completion expected May 2002 WALKER HOUSE Mechanical building conversion 14 apartments Completion expected 2004 WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARIES MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS WRIT’s discussion and analysis of its financial condition and results of operations are based upon WRIT’s consolidated financial statements, which have been prepared in accordance with accounting principles RESULTS OF OPERATIONS Real Estate Rental Revenue: 2001 Versus 2000 Total revenues for 2001 increased $13.7 million, or 10%, to $148.4 mil- generally accepted in the United States. The preparation of these lion from $134.7 million in 2000. The percentage increase in real estate financial statements requires WRIT to make estimates and judgments rental revenue from 2000 to 2001 by property type was as follows: that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, WRIT evaluates the company’s esti- mates, including those related to estimated useful lives of real estate assets, cost reimbursement income, bad debts, contingencies and litigation. WRIT bases the company’s estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. There can be no assurance that actual results will not differ from those estimates. CRITICAL ACCOUNTING POLICIES WRIT believes the following critical accounting policies affect the company’s more significant judgments and estimates used in the preparation of the company’s consolidated financial statements. WRIT’s significant accounting policies are described in Note 1 in the Notes to the Consolidated Financial Statements. Revenue Recognition WRIT’s revenue recognition policy is significant because revenue is a key Office Buildings Retail Centers Multifamily Industrial/Flex Properties 14% 5% 5% 8% During 2001, WRIT’s office building revenues and operating income increased by 14% and 15%, respectively, over 2000. These increases were primarily due to the 2001 acquisition of One Central Plaza and 2000 acquisitions of Wayne Plaza and Courthouse Square combined with increased rental rates for the sector, offset in part by the 2001 sale of 10400 Connecticut Avenue. 3.5% of the real estate portfolio revenues are attributable to WRIT’s medical office buildings, which WRIT considers to have less exposure to economic trends than typical office buildings. Occupancy levels remained relatively unchanged. Revenues and operating income in WRIT’s core group of office buildings (excluding 2001 and 2000 acquisitions and dispositions) increased 4% and 5%, respectively, from 2000 to 2001. The increases in revenue and operating income were a result of strong rental rate growth throughout the sector. WRIT’s office markets are strong and, while there is a significant amount of office development underway component of the company’s results from operations. In addition, revenue in several submarkets, management anticipates that this sector will recognition determines the timing of certain expenses, such as leasing continue to perform well in 2002. Economic occupancy rates for the commissions and bad debt. WRIT recognizes real estate rental revenue core group of office buildings averaged 98% for 2001 and 97% for including cost reimbursement income when earned in accordance with 2000. Economic occupancy is defined as gross rental revenue less SFAS 13, “Accounting for Leases”. This requires WRIT to recognize vacancy losses. rental revenue on a straight-line basis over the term of the company’s Rental rate increases of 4% for the core group of office buildings leases. WRIT maintains an allowance for doubtful accounts for esti- were the result of increases at nearly all of the properties. During 2001, mated losses resulting from the inability of the company’s tenants to WRIT executed new leases for 515,000 square feet of office space at make required payments. Estimated Useful Lives of Real Estate Assets Real estate assets are depreciated on a straight-line basis over estimated useful lives not exceeding 50 years. All capital improvement expenditures associated with replacements, improvements, or major repairs to real property are depreciated using the straight-line method over their esti- mated useful lives ranging from 3 to 30 years. All tenant improvements are amortized over the shorter of the useful life or the term of the lease. Maintenance and repair costs are charged to expense as incurred. Impairment Losses on Long-Lived Assets WRIT recognizes impairment losses on long-lived assets used in an average face rent increase of 18% on a non-straight line basis. During 2001, WRIT’s retail center revenues and operating income increased by 5% and 6%, respectively, over 2000. The change was primarily attributable to increased rental rates across the sector offset in part by the 2000 sales of Prince William Plaza and Clairmont retail center. Occupancy levels remained relatively unchanged. Retail center revenue and operating income in WRIT’s core retail centers (excluding 2001 and 2000 acquisitions and disposi- tions) increased 7% and 8%, respectively, from 2000 to 2001 due primarily to the 8% growth in retail center rental rates for this same group. Rental rate increases of 8% for the core group of retail centers operations when indicators of impairment are present and the net were the result of increases at the majority of the properties. During undiscounted cash flows estimated to be generated by those assets 2001, WRIT executed new leases for 188,000 square feet of retail are less than the assets’ carrying amount. If such carrying amount space at an average face rent increase of 64% on a non-straight is in excess of the estimated projected operating cash flows of the line basis. property, WRIT would recognize an impairment loss equivalent to an WRIT’s multifamily revenues and operating income increased by amount required to adjust the carrying amount to the estimated fair market value. There were no property impairments recognized during 5% and 4%, respectively, in 2001 over 2000. These increases were primarily due to increased rental rates offset by declining occupancy the three-year period ending December 31, 2001. levels across the sector. 9 WRIT’s multifamily sector core group revenues and operating with increased rental rates and occupancy levels, offset by the 2000 income increased 4% and 6%, respectively. These increases were the sales of Prince William Plaza and Clairmont Center. result of the 7% rental rate increase throughout the group. Economic Revenues and operating income in WRIT’s core retail centers occupancy rates for the core group of multifamily averaged 95% in (excluding 2000 and 1999 acquisitions and dispositions) increased 2001 and 97% in 2000. 4% and 8%, respectively, from 1999 to 2000 due to increased rental WRIT’s industrial/flex property revenues and operating income rate growth. Retail center rental rates for this same group increased increased by 8% and 6%, respectively, in 2001 over 2000. These 5% in 2000 over 1999. increases were primarily due to the 2001 acquisitions of Sullyfield Rental rate increases of 5% for the core group of retail centers Commerce Center as well as increased rental rates and occupancy were the result of increases at the majority of the properties. During levels across the sector. 2000, WRIT executed new leases for 181,000 square feet of retail Revenues and operating income in WRIT’s core group of industrial/ space at an average face rent increase of 15% on a non-straight flex properties (excluding 2001 and 2000 acquisitions and dispositions) line basis. increased 6% and 8%, respectively, from 2000 to 2001 as a result of rental rate growth and higher occupancy levels in 2001 compared to WRIT’s multifamily revenues and operating income increased by 14% and 19%, respectively, in 2000 over 1999. These increases were 2000. Economic occupancy rates for the core group of industrial proper- primarily due to the 1999 acquisition of Avondale Apartments, combined ties averaged 98% in 2001 compared to 97% in 2000. with increased rental rates and occupancy levels across the sector. Rental rate increases of 6% for the core group of industrial/flex WRIT’s multifamily sector core group revenues and operating centers were the result of increases at the majority of the centers. income (excluding the Avondale Apartments acquired in 1999) During 2001, WRIT executed new leases for 451,000 square feet of increased 7% and 11%, respectively. These increases were the result industrial space leases at an average face rent increase of 9.3% on of the 6% rental rate increase throughout the group. Economic occu- a non-straight line basis. pancy rates for the core group of multifamily averaged 97% in both Real Estate Rental Revenue: 2000 Versus 1999 Total revenues for 2000 increased $15.8 million, or 13%, to $134.7 mil- lion from $119.0 million in 1999. The percentage increase in real estate rental revenue from 1999 to 2000 by property type was as follows: Office Buildings Retail Centers Multifamily Industrial/Flex Properties 15% 1% 14% 19% 2000 and 1999. WRIT’s industrial/flex property revenues and operating income increased by 19% and 21%, respectively, in 2000 over 1999. These increases were primarily due to the 1999 acquisitions of Dulles South IV, Amvax and Sully Square, as well as increased rental rates and occupancy levels primarily at Nor thern Virginia Industrial Park, offset in part by the loss of revenues from the 1999 sales of the Department of Commerce Industrial Center and V Street Distribution Center. Revenues and operating income in WRIT’s core group of industrial/ During 2000, WRIT’s office building revenues and operating flex properties (excluding 2000 and 1999 acquisitions and dispositions) income increased by 15% and 17%, respectively, over 1999. These increased 17% and 10%, respectively, from 1999 to 2000 due to increases were primarily due to increased rental rates for the sector, increased rental rate growth and higher occupancy levels. Economic the 2000 acquisitions of Wayne Plaza and Courthouse Square and occupancy rates for the core group of industrial properties averaged the 1999 acquisitions of 600 Jefferson Plaza, 1700 Research 96% in 2000 compared to 94% in 1999. Boulevard and Parklawn Plaza. These increases were offset in part Rental rate increases of 4% for the core group of industrial/flex by the 1999 sales of Arlington Financial Center and 444 N. Frederick properties were the result of increases at the majority of the centers. Road and a slight decline in occupancy levels. During 2000, WRIT executed new leases for 1,083,000 square feet Revenues and operating income in WRIT’s core group of office of industrial space leases at an average face rent increase of 19% buildings (excluding 2000 and 1999 acquisitions and dispositions) on a non-straight line basis. increased 9% and 10%, respectively, from 1999 to 2000. These increases were a result of strong rental rate growth with some mod- erate occupancy gains throughout the sector. Economic occupancy OPERATING EXPENSES AND OTHER RESULTS OF OPERATIONS Real estate operating expenses as a percentage of revenue were 28% rates for the core group of office buildings averaged 97% for 2000 for both 2001 and 2000 and 30% for 1999. Real estate operating and 1999. expenses increased to $42.1 million in 2001 from $38.3 million in Rental rate increases of 7% for the core group of office buildings 2000 and $35.3 million in 1999 in general due to the acquisition of were the result of increases at nearly all of the properties. During 2000, three real estate properties in 2001, three real estate properties in WRIT executed new leases for 758,000 square feet of office space at 2000 and seven real estate properties in 1999 as well as higher real an average face rent increase of 18% on a non-straight line basis. estate taxes due to increases in assessed value throughout much During 2000, WRIT’s retail center revenues and operating income of the portfolio. Core portfolio operating expenses increased 4% in increased by 1% and 2%, respectively, over 1999. The increases were due to the 2000 acquisition of 833 S. Washington Street combined 2001 from 2000 and 5% in 2000 from 1999 due primarily to higher real estate taxes and property management fees attributable to the 10 increase in real estate revenue. It should be noted property manage- Management believes that WRIT has the liquidity and the capital ment fees are passed through to tenants as part of the full service resources necessary to meet all of its known obligations and to make rent or as a contractual pass through. additional property acquisitions and capital improvements when Depreciation and amortization expense increased $4.0 million appropriate to enhance long-term growth. in 2001 from 2000 due to total acquisitions of $67.8 million in 2001, WRIT has two line of credit commitments in place from commer- $26.6 million of acquisitions throughout 2000 and capital and tenant cial banks: a $25.0 million line of credit and a $50.0 million line of improvement expenditures, of $14.0 million and $16.3 million for credit. Both bear interest at an adjustable spread over LIBOR based 2001 and 2000, respectively. Depreciation and amortization expense on the Trust’s interest coverage ratio and public debt rating. As of increased $3.1 million in 2000 from 1999 due to $26.6 million of December 31, 2001, WRIT had $0 outstanding under the company’s acquisitions in 2000, $61.8 million in acquisitions throughout 1999 lines of credit. The $25.0 million line of credit matures March 2002, and and $16.3 million and $18.4 million, respectively, in 2001 and 2000 negotiations for renewal of this line of credit are under discussion. capital and tenant improvement expenditures. The lines of credit and senior and medium-term notes payable Interest expense increased $1.5 million in 2001 from 2000. The increase is primarily attributable to the issuance of $55.0 million in contain certain financial and non-financial covenants, all of which WRIT has met as of December 31, 2001. The covenants at present medium-term notes in November 2000 used to pay off WRIT’s unse- require insurance coverage for all perils or special form types of cured lines of credit and the assumption of an $8.5 million mortgage insurance. The loan documents currently make no specific reference in November 2001 with the acquisition of Sullyfield Commerce Center. to terrorism insurance. WRIT believes it is currently covered against Interest expense increased $3.3 million in 2000 from 1999. The such acts under the insurance coverage in full force and effect until increase is primarily attributable to a higher average unsecured line of renewal in September 2002. WRIT anticipates obtaining additional credit balance outstanding combined with higher variable interest rates, insurance coverage at higher costs upon renewal; however, the the issuance of $55.0 million in medium-term notes in November 2000 Trust’s financial condition and results of operations are subject to used to pay off WRIT’s unsecured lines of credit and the assumption the risks associated with acts of terrorism and the potential for of an $8.7 million mortgage in September 1999 with the acquisition uninsured losses as the result of any such act. of Avondale Apartments. WRIT acquired three properties in 2001 for total acquisition costs General and administrative expenses were $6.1 million for 2001 of $67.8 million. Acquisitions in 2000 included three improved proper- as compared to $7.5 million for 2000 and $6.2 million for 1999. The ties and the land under Munson Hill Towers at a cost of $26.6 million. decrease in general and administrative expenses in 2001 from 2000 Seven properties were acquired in 1999 for a total acquisition cost of was primarily attributable to increased property management fees $61.8 million. passed through to tenants in 2001 that in turn reduced the adminis- 2001 acquisitions were funded through income from operations, trative expenses of the Trust. General and administrative expenses line of credit advances and proceeds from the public offering in April also declined in 2001 due to lower incentive compensation as a 2001 and a property sale in September 2001. On April 24, 2001 WRIT result of a reduced rate of growth of the Trust. The increase in gen- completed a public offering of 2.3 million shares. The $53.1 million eral and administrative expenses in 2000 from 1999 was primarily net proceeds were used to repay $43.0 million in borrowings under the attributable to increased incentive compensation due to the high rate Trust’s line of credit. WRIT disposed of one property in 2001 resulting of growth of the Trust. in net proceeds of $ 8.1 million. Gain on sale of real estate was $4.3 million for the year ended Line of credit advances and the use of proceeds from property December 31, 2001, resulting from the sale of 10400 Connecticut sales financed the 2000 acquisitions in February and August 2000. Avenue. Gain on sale of real estate in 2000 was $3.6 million result- WRIT disposed of two properties in 2000 resulting in net proceeds of ing from the sales of Prince William Plaza and Clairmont Center. $5.7 million. The proceeds from these sales were used to partially The $7.9 million gain on sale of real estate in 1999 resulted from fund 2000 acquisitions. On November 6, 2000, WRIT sold $55.0 mil- the sales of Arlington Financial Center, 444 North Frederick Avenue, lion of 7.78% unsecured notes due November 2004. The notes bear Department of Commerce and V Street Distribution Center. an effective interest rate of 7.89%. Total proceeds to the Trust, net CAPITAL RESOURCES AND LIQUIDITY WRIT has utilized the proceeds of share offerings, unsecured and of underwriting fees, were $54.8 million. WRIT used the proceeds of these notes to repay advances on its lines of credit. The 1999 acquisitions were financed by line of credit advances, secured debt issuance (medium and long-term fixed interest rate the use of proceeds from property sales in February 1999 and the debt), bank lines of credit and cash flow from operations for its capi- assumption of a non-recourse mortgage payable of $8.7 million. tal needs. Management believes that external sources of capital will WRIT disposed of six properties in 1999 resulting in net proceeds of continue to be available to WRIT from its existing unsecured bank line $22.0 million. On September 27, 1999, WRIT closed on a $50.0 million of credit commitments and from selling additional shares and/or the mortgage note payable, the proceeds of which were used to pay down sale of medium or long-term secured or unsecured notes. The funds raised would be used for new acquisitions and capital improvements. WRIT’s unsecured lines of credit. The mortgage is secured by WRIT’s five Virginia multifamily properties. 11 Cash flow from operating activities totaled $74.7 million, $62.0 million and $53.2 million for the years ended December 31, 2001, 2000 and 1999, respectively, including net income of Accretive Capital Improvements Acquisition Related—These are capital improvements to properties acquired during the current and preceding two years which were $52.4 million (net of $4.3 million gain on property sales), $45.1 million planned during WRIT’s investment analysis. In 2001 the most significant (net of $3.6 million gain on property sales) and $44.3 million (net of of these improvements were made to Wayne Plaza, One Central Plaza, $7.9 million gain on property sales), respectively, and depreciation Courthouse Square and Avondale Apartments. In 2000, the most sig- and amortization of $26.7 million, $22.7 million and $19.6 million, nificant of these improvements were made to Pickett Industrial Center, respectively. The increase in cash flows from operating activities Northern Virginia Industrial Park, Earhart Building, South Washington in 2001 and 2000 was primarily due to real estate acquisitions, Street, Bethesda Hill Apartments and Munson Hill Towers. In 1999, the increased operating income from previously owned properties and most significant of these improvements were made to 7900 Westpark the resultant increase in net income. Drive, Woodburn Medical Park, Bethesda Hill Apartments, Ammendale Cash flows used in investing activities totaled $65.7 million, Technology Park II and Northern Virginia Industrial Park. $37.4 million and $49.9 million for the years ended December 31, 2001, 2000 and 1999, respectively. The increase in cash flows used in investing activities in 2001 from 2000 is attributable to an increase in real estate acquisitions offset by lower capital improve- ments and higher net proceeds for the property sale in 2001. The decline in cash flows used in investing activities in 2000 from 1999 is attributable to a reduction in real estate acquisitions and lower net proceeds from the sale of real estate. Cash flows provided by financing activities were $11.0 million for the year ended December 31, 2001 compared to cash flows used in financing activities of $22.9 million and $3.2 million for the years ended December 31, 2000 and December 31, 1999, respectively. Cash flows provided by financing activities in 2001 compared to 2000 increased as a result of the $53.1 million proceeds from the 2001 public offering Expansions and Major Renovations—Expansions increase the rentable area of a property. Major renovations are improvements sufficient to increase the income otherwise achievable at a property. In February 2001, WRIT acquired an apartment building at 1611 North Clarendon Boulevard adjacent to WRIT’s 1600 Wilson Boulevard office property with the intent of developing a high-rise apartment building on that site utilizing the available density rights from both properties. Expansion costs in 2001 include costs associated with this development as well as a façade renovation of Westminster Shopping Center. 2000 expan- sion costs were related to the final costs associated with the expansion at 7900 Westpark Drive. During 1999, WRIT completed the 49,000 square foot expansion at 7900 Westpark Drive. WRIT also completed the renovation of the Bradlee Shopping Center during 1999. and an increase in share options exercised offset by increased dividend payments in 2001. Cash flows used in financing activities in 2000 com- Tenant Improvements—Tenant Improvements are costs associated with commercial lease transactions such as painting, carpeting and pared to 1999 increased as a result of increased dividend payments in other space build-out. 2000, increased line of credit repayments in excess of advances, offset WRIT’s average Tenant Improvement Costs for 1999–2001 per by net proceeds from the debt offering in 2000. square foot of space leased were as follows: Rental revenue has been the principal source of funds to pay WRIT’s operating expenses, interest expense and dividends to share- holders. In 2001, 2000 and 1999, WRIT paid dividends totaling $49.7 million, $44.0 million and $41.3 million, respectively. Office Buildings Retail Centers Industrial/Flex Properties Year Ended December 31, 2000 $4.71 $1.81 $1.47 1999 $4.59 $0.69 $0.55 2001 $4.56 $2.65 $0.17 CAPITAL IMPROVEMENTS Capital improvements of $14.0 million were completed in 2001, including tenant improvements. Capital improvements to WRIT prop- erties in 2000 and 1999 were approximately $16.3 million and $18.4 million, respectively. WRIT’s capital improvement costs for 1999–2001 were as follows: Year Ended December 31, 2000 1999 2001 (In thousands) Accretive capital improvements: Acquisition related Expansions and major renovations Tenant improvements Total Accretive capital improvements Other Total 12 $ 3,528 $ 1,640 $ 5,716 794 4,096 892 6,342 5,929 2,342 8,418 5,597 $14,015 8,874 7,394 $16,268 13,987 4,384 $18,371 The Retail and Industrial Tenant Improvement costs are sub- stantially lower than Office Improvement costs due to the tenant improvements required in these property types being substantially less extensive than in offices. WRIT believes its office tenant improvement costs are among the lowest in the industry for a number of reasons. Approximately 69% of our office tenants renew their leases with WRIT. Renewing tenants generally require minimal tenant improvements. In addition, lower tenant improvement costs are one of the many benefits of WRIT’s focus on leasing to smaller office tenants. Smaller office suites have limited configuration alternatives. Therefore, WRIT is often able to lease an existing suite with tenant improvements being limited to new paint and carpet. Other Capital Improvements Other Capital Improvements are those not included in the above cate- (c) the supply of competing properties; (d) inflation; (e) consumer confi- dence; (f) unemployment rates; (g) consumer tastes and preferences; gories. These are also referred to as recurring capital improvements. (h) stock price and interest rate fluctuations; (i) WRIT’s future capital Over time these costs will be reincurred to maintain a property’s requirements; (j) competition; (k) compliance with applicable laws, includ- income and value. In the Trust’s residential properties, these include ing those concerning the environment and access by persons with dis- new appliances, flooring, cabinets, bathroom fixtures, and the like. abilities; (l) weather conditions and (m) the effects of changes in capital These improvements are made as needed upon vacancy of an apart- availability to the technology and biotechnology sectors of the economy. ment and averaged $958 for the 39% of apartments turned over in 2001. In 2001, WRIT also expensed an average of $355 per apartment turnover for items which do not have a long-term life and are, therefore, RATIOS OF EARNINGS TO FIXED CHARGES AND DEBT SERVICE COVERAGE The following table sets forth the Trust’s ratios of earnings to fixed not capitalized. charges and debt service coverage for the periods shown: FORWARD-LOOKING STATEMENTS This Annual Report contains forward-looking statements which involve risks and uncertainties. Such forward-looking statements include Earnings to fixed charges Debt service coverage Year Ended December 31, 2000 2.63x 3.40x 1999 2.61x 3.42x 2001 2.78x 3.60x (a) WRIT’s intention to invest in properties that it believes will continue We computed the ratios of earnings to fixed charges by dividing to increase in income and value; (b) WRIT’s belief that its real estate earnings by fixed charges. For this purpose, earnings consist of markets will continue to perform well in 2002; (c) WRIT’s belief that income from continuing operations plus fixed charges. Fixed charges external sources of capital will continue to be available and that addi- consist of interest expense, including interest costs capitalized, and tional sources of capital will be available from the sale of shares or the amortized costs of debt issuance. notes; (d) WRIT’s belief that it has the liquidity and capital resources We computed debt service coverage ratio by dividing earnings necessar y to meet its known obligations and to make additional before interest income and expense, depreciation, amortization and gain property acquisitions and capital improvements when appropriate on sale of real estate by interest expense and principal amortization. to enhance long-term growth and (e) other statements preceded by, followed by or that include the words “believes,” “expects,” “intends,” “anticipates,” “potential” and other similar expressions. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK The principal material financial market risk to which WRIT is exposed is WRIT claims the protection of the safe harbor for forward-looking interest-rate risk. WRIT’s exposure to market risk for changes in inter- statements contained in the Private Securities Litigation Reform Act est rates relates primarily to refinancing long-term fixed rate obliga- of 1995 for the foregoing statements. The following important factors, tions, the opportunity cost of fixed rate obligations in a falling interest in addition to those discussed elsewhere in this Annual Report, could rate environment and its variable rate lines of credit. WRIT primarily affect WRIT’s future results and could cause those results to differ mate- enters into debt obligations to support general corporate purposes rially from those expressed in the forward-looking statements: (a) the including acquisition of real estate properties, capital improvements economic health of WRIT’s tenants; (b) the economic health of the and working capital needs. In the past WRIT has used interest rate Greater Washington-Baltimore region, or other markets WRIT may enter, hedge agreements to hedge against rising interest rates in anticipation including the effects of changes in Federal government spending; of imminent refinancing or new debt issuance. The table below presents principal, interest and related weighted average interest rates by year of maturity, with respect to debt outstanding on December 31, 2001. 2002 2003 2004 2005 2006 Thereafter Total Fair Value (In thousands) DEBT (all fixed rate except lines of credit) Unsecured debt Principal Interest Average interest rate $ — $19,230 $50,000 $18,043 $55,000 $15,311 $ — $11,389 $50,000 $10,180 $110,000 $ 81,558 $265,000 $155,711 $272,689 7.37% 7.36% 7.33% 7.17% 7.11% 7.33% 7.32% Mortgages Principal amortization (30-year schedule) Interest Average interest rate $ 1,177 $ 7,129 $ 7,651 $ 6,456 $ 1,113 $ 6,383 $26,638 $ 5,790 $ 302 $ 4,282 $ 57,845 $ 13,505 $ 94,726 $ 43,545 $ 98,786 7.42% 7.30% 7.30% 7.30% 7.09% 7.01% 7.17% 13 WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands) ASSETS Land Building Total real estate, at cost Accumulated depreciation Total investment in real estate, net Cash and cash equivalents Rents and other receivables, net of allowance for doubtful accounts of $1,993 and $1,743, respectively Prepaid expenses and other assets Total assets LIABILITIES AND SHAREHOLDERS’ EQUITY Accounts payable and other liabilities Advance rents Tenant security deposits Mortgage notes payable Notes payable Total liabilities Minority interest Shareholders’ equity Shares of beneficial interest, $.01 par value; 100,000 shares authorized: 38,829 and 35,740 shares issued and outstanding, respectively Additional paid in capital Retained earnings (deficit) Total shareholders’ equity Total liabilities and shareholders’ equity The accompanying notes are an integral part of these statements. As of December 31, 2001 2000 $ 151,782 $ 142,811 622,804 774,586 (122,625) 651,961 26,441 10,523 19,010 555,702 698,513 (100,906) 597,607 6,426 9,795 19,587 $ 707,935 $ 633,415 $ 13,239 $ 13,048 3,604 6,148 94,726 265,000 382,717 1,611 3,269 5,624 86,260 265,000 373,201 1,558 388 323,257 (38) 323,607 $ 707,935 357 261,004 (2,705) 258,656 $ 633,415 14 WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data) Real estate rental revenue Real estate expenses Utilities Real estate taxes Repairs and maintenance Administrative Management fees Operating services and supplies Common area maintenance Other expenses Total real estate expenses Operating income Depreciation and amortization Income from real estate Other income Interest expense General and administrative expenses Income before gain on sale of real estate Gain on sale of real estate Net income Basic earnings per share Diluted earnings per share Weighted Average Shares Outstanding—Basic Weighted Average Shares Outstanding—Diluted The accompanying notes are an integral part of these statements. For the Years Ended December 31, 2000 2001 1999 $148,424 $134,732 $118,975 8,351 10,307 6,148 3,068 4,669 5,864 2,074 1,666 42,147 106,277 26,735 79,542 1,686 (27,071) (6,100) 48,057 4,296 7,682 9,347 5,580 2,753 4,195 5,459 1,961 1,339 38,316 96,416 22,723 73,693 943 (25,531) (7,533) 41,572 3,567 7,298 8,496 4,765 2,520 3,693 4,856 1,850 1,803 35,281 83,694 19,590 64,104 732 (22,271) (6,173) 36,392 7,909 $ 52,353 $ 45,139 $ 44,301 $ $ 1.39 1.38 37,674 37,951 $ $ 1.26 1.26 35,735 35,872 $ $ 1.24 1.24 35,714 35,723 15 WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (In thousands) Balance, December 31, 1998 Net income Dividends Share options exercised Share grants Balance, December 31, 1999 Net income Dividends Share options exercised Share grants Balance, December 31, 2000 Net income Dividends Share options exercised Share offering Share grants For the Years Ended December 31, 2001, 2000 and 1999 Shares of Beneficial Interest at Par Value Shares Additional Paid in Capital Retained Earnings (Deficit) Shareholders’ Equity 35,692 $357 $260,225 $ (6,849) $253,733 — — 20 9 — — — — — — 286 210 44,301 44,301 (41,341) (41,341) — — 286 210 35,721 357 260,721 (3,889) 257,189 — — 7 12 — — — — — — 100 183 45,139 45,139 (43,955) (43,955) — — 100 183 35,740 357 261,004 (2,705) 258,656 — — 518 2,535 36 — — 5 25 1 — — 8,464 53,083 706 52,353 52,353 (49,686) (49,686) — — — 8,469 53,108 707 Balance, December 31, 2001 38,829 $388 $323,257 $ (38) $323,607 The accompanying notes are an integral part of these statements. 16 WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) CASH FLOW FROM OPERATING ACTIVITIES Net income Adjustments to reconcile net income to cash provided by operating activities: Gain on sale of real estate Depreciation and amortization Increases in other assets Increases (decreases) in other liabilities Share grants Cash provided by operating activities CASH FLOWS FROM INVESTING ACTIVITIES Real estate acquisitions, net* Improvements to real estate Non-real estate capital improvements Net proceeds from sale of real estate Cash used in investing activities CASH FLOWS FROM FINANCING ACTIVITIES Net proceeds from share offering Dividends paid Line of credit advances Repayments of lines of credit Proceeds from mortgage note payable Mortgage principal payments Net proceeds from debt offering Net proceeds from the exercise of share options Cash provided by (used in) financing activities Net increase in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year Supplemental disclosure of cash flow information: Cash paid for interest For the Years Ended December 31, 2000 1999 2001 $ 52,353 $ 45,139 $ 44,301 (3,567) 22,723 (3,382) 834 227 (7,909) 19,590 (1,954) (985) 177 61,974 53,220 (4,296) 26,735 (1,949) 1,610 219 74,672 (59,250) (14,015) (538) 8,115 (26,581) (16,268) (267) 5,732 (65,688) (37,384) 53,083 (49,686) 43,000 (43,000) — (843) — 8,477 11,031 20,015 6,426 — (43,955) 21,000 (54,000) — (778) 54,753 100 (22,880) 1,710 4,716 (53,197) (18,371) (350) 22,033 (49,885) — (41,341) 33,000 (44,000) 49,225 (594) — 496 (3,214) 121 4,595 $ 26,441 $ 6,426 $ 4,716 $ 25,866 $ 24,001 $ 18,968 *SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES On November 1, 2001, WRIT purchased Sullyfield Center for an acquisition cost of $21.7 million. WRIT assumed a mortgage in the amount of $8.5 million and paid the balance in cash. The $8.5 million of assumed mortgage is not included in the $59.3 million amount shown as 2001 real estate acquisitions. On September 20, 1999, WRIT purchased Avondale Apartments for an acquisition cost of $13.0 million. WRIT assumed a mortgage in the amount of $8.7 million and paid the balance in cash. The $8.7 million of assumed mortgage is not included in the $53.2 million amount shown as 1999 real estate acquisitions. The accompanying notes are an integral part of these statements. 17 WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the Years Ended December 31, 2001, 2000 and 1999 1. NATURE OF BUSINESS Washington Real Estate Investment Trust, a Maryland real estate derivative instruments acquired by WRIT in future periods. WRIT has entered into interest rate protection agreements in the past to reduce investment trust (“WRIT,” the “company” or the “Trust”), is a self- its exposure to interest rate risk on anticipated borrowings. The costs administered, self-managed, equity real estate investment trust, (if any) of such agreements which qualify for hedge accounting are successor to a trust organized in 1960. The Trust’s business con- included in other assets and are amortized over the interest rate pro- sists of the ownership and operation of income-producing real estate tection agreement term. In the event that interest rate protection properties in the greater Washington-Baltimore region. WRIT owns agreements that qualify for hedge accounting are terminated or are a diversified portfolio of office buildings, industrial/flex properties, closed out, the associated gain or loss is deferred and amortized multifamily buildings and retail centers. Federal Income Taxes WRIT operates in a manner intended to enable it to qualify as a real estate investment trust (REIT) under the Internal Revenue Code over the term of the underlying hedged asset or liability. Amounts to be paid or received under interest rate protection agreements are accrued currently and are netted with interest expense for financial statement presentation purposes. (the “Code”). In accordance with the Code, a trust which distributes its capital gains and at least 90 percent of its taxable income to Revenue Recognition Residential properties are leased under operating leases with terms its shareholders each year (95% for years prior to 2001), and which of generally one year or less, and commercial properties are leased meets certain other conditions, will not be taxed on that portion of under operating leases with average terms of three to five years. its taxable income which is distributed to its shareholders. WRIT WRIT recognizes rental income and rental abatements from the com- believes it qualifies as a REIT and has distributed all of its taxable pany’s residential and commercial leases when earned in accordance income for the fiscal years through 2001 in accordance with the with SFAS No. 13. WRIT records an allowance for doubtful accounts provisions of the Code. Accordingly, no provision for federal income equal to the estimated uncollectible amounts. This estimate is based taxes is required. 2. ACCOUNTING POLICIES Basis of Presentation The accompanying consolidated financial statements include the on WRIT’s historical experience and a review of the current status of the company’s receivables. Contingent rents are recorded when cumulative sales exceed the amount necessary for the contingent rents to equal minimum annual rent, and WRIT has been informed of cumulative sales data; thereafter, percentage rent is accrued accounts of the Trust and its majority owned subsidiaries, after based on subsequent sales. eliminating all intercompany transactions. New Accounting Pronouncements Impairment or Disposal of Long-Lived Assets In August 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, which supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of”. WRIT recognizes cost reimbursement income from pass-through expenses on an accrual basis over the periods in which the expenses were incurred. Pass-through expenses are comprised of real estate taxes, operating expenses and common area maintenance costs which are reimbursed by tenants in accordance with specific allowable costs per tenant lease agreements. Minority Interest WRIT entered into an operating agreement with a member of the previ- SFAS No. 144 is effective for all quarters of fiscal years beginning ous ownership entity of Northern Virginia Industrial Park in conjunction after December 15, 2001. At December 31, 2001, WRIT held one with the acquisition of this property in May 1998. This resulted in a property under contract for sale which sold subsequent to this date minority ownership interest in this property based upon defined com- (see Note 15). WRIT recognized no impairment on this property prior pany ownership units at the date of purchase. WRIT accounts for this to or upon sale. Derivative Instruments and Hedging Activities In June 1998, SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, was issued. This statement (as amended by activity by allocating the percentage ownership interest of the net oper- ating income of the property to minority interest. Quarterly distributions are made to the minority owner equal to the quarterly dividend per share for each ownership unit. SFAS No. 137, “Accounting for Derivative Instruments and Hedging Activities—Deferral of the Effective Date of SFAS Statement No. 133) Deferred Financing Costs Costs associated with the issuance of mortgage and other notes and establishes accounting and reporting standards for derivative instru- draws on lines of credit are capitalized and amortized using the effective ments, including certain derivative instruments embedded in other interest rate method over the term of the related notes and are included contracts (collectively referred to as derivatives) and for hedging acti- in interest expense on the accompanying statements of income. vities. This statement is effective for all fiscal quarters of fiscal years The amortized debt costs included in interest expense totaled beginning after January 1, 2001. Although WRIT currently has no derivative instruments, this statement will affect the reporting of $1.1 million, $1.0 million and $1.0 million for the years ended December 31, 2001, 2000 and 1999, respectively. 18 Real Estate and Depreciation Buildings are depreciated on a straight-line basis over estimated useful The weighted-average number of shares outstanding for the years ended December 31, 2001, 2000 and 1999 were 37.7 million, 35.7 mil- lives not exceeding 50 years. All capital improvement expenditures asso- lion and 35.7 million, respectively, and 38.0 million, 35.9 million and ciated with replacements, improvements, or major repairs to real prop- 35.7 million on a diluted basis for the years ended December 31, 2001, erty are depreciated using the straight-line method over their estimated 2000 and 1999, respectively. useful lives ranging from 3 to 30 years. All tenant improvements are amortized over the shorter of the useful life or the term of the lease. Maintenance and repair costs are charged to expense as incurred. WRIT recognizes impairment losses on long-lived assets used in operations when indicators of impairment are present and the net undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amount. If such carrying amount is in excess of the estimated projected operating cash flows of the property, WRIT would recognize an impairment loss equivalent to an amount required to adjust the carrying amount to the estimated fair market value. There were no property impairments recognized during Use of Estimates in the Financial Statements The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires manage- ment to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contin- gent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Reclassifications Certain prior year amounts have been reclassified to conform to the the three-year period ending December 31, 2001. In accordance with current year presentation. SFAS No. 66, “Accounting for Sales of Real Estate,” sales are recog- nized at closing only when sufficient down payments have been obtained, possession and other attributes of ownership have been transferred to 3. REAL ESTATE INVESTMENTS WRIT’s real estate investment portfolio, at cost, consists of proper- the buyer and the Trust has no significant continuing involvement. The ties located in Maryland, Washington, D.C. and Virginia as follows: gain or loss resulting from the sale of properties is included in net income at the time of sale. Cash and Cash Equivalents Cash and cash equivalents include investments readily convertible to known amounts of cash with original maturities of 90 days or less. Stock Based Compensation WRIT maintains Incentive Stock Option Plans as described in Note 8 (In thousands) Office Buildings Retail Centers Multifamily Industrial/Flex Properties December 31, 2001 2000 $431,213 95,626 106,381 141,366 $774,586 $383,530 94,900 102,142 117,941 $698,513 WRIT’s results of operations are dependent on the overall eco- which include qualified and non-qualified options for eligible employ- nomic health of its tenants and the specific segments in which WRIT ees. Stock options are accounted for in accordance with APB 25, holds properties, as well as the overall economic health of the mar- whereby if options are priced at fair market value or above at the kets in which it owns property. These segments include commercial date of grant, no compensation expense is recognized. office, multifamily, retail and industrial. Although all sectors are Comprehensive Income WRIT has no items of comprehensive income that would require sepa- rate reporting in the accompanying consolidated statements of income. Earnings Per Common Share The Trust calculates basic and diluted earnings per share in accor- affected by external factors, such as inflation, consumer confidence, unemployment rates and consumer tastes and preferences, the retail segment is particularly sensitive to such factors. A decline in the retail sector of the economy could reduce merchant sales, which could adversely affect the operating results of WRIT. WRIT’s retail properties provided 13% of total revenue and 23% of net income for dance with SFAS No. 128, “Earnings Per Share.” “Basic earnings per the year ended December 31, 2001, 14% and 33% of total revenue share” is computed as net income divided by the weighted-average and net income, respectively, for the year ended December 31, 2000 common shares outstanding. “Diluted earnings per share” is computed and 15% of total revenue and 25% of net income for the year ended as net income divided by the total weighted-average common shares December 31, 1999. outstanding plus the effect of dilutive common equivalent shares out- As of December 31, 2001, 7900 Westpark office building accounted standing for the period. Dilutive common equivalent shares reflect the for 11 percent of total real estate assets and 9 percent of total revenues. assumed issuance of additional common shares pursuant to certain No other single property or tenant accounted for more than 10 percent of of the Trust’s share based compensation plans (see Note 8) that total assets or total revenues. could potentially reduce or “dilute” earnings per share, based on the treasury stock method. 19 Properties acquired by WRIT during the years ending December 31, 2001, 2000 and 1999 are as follows: Acquisition Date February 15, 2001 April 19, 2001 November 1, 2001 February 29, 2000 May 5, 2000 August 9, 2000 October 10, 2000 January 27, 1999 April 16, 1999 May 21, 1999 May 21, 1999 September 10, 1999 September 20, 1999 November 30, 1999 Property 1611 North Clarendon One Central Plaza Sullyfield Commerce Center 833 S. Washington Street 962 Wayne Plaza Munson Hill Towers Land Lease Courthouse Square Dulles South IV Sully Square 600 Jefferson Plaza 1700 Research Boulevard Amvax Avondale (236 units) Parklawn Plaza Type Multifamily Office Industrial Total 2001 Retail Office Multifamily Office Total 2000 Industrial Industrial Office Office Industrial Multifamily Office Total 1999 WRIT accounted for each acquisition using the purchase method of accounting. Properties sold by WRIT during the years ending December 31, 2001, 2000 and 1999 are as follows: Disposition Date September 28, 2001 February 29, 2000 July 7, 2000 August 22, 2000 February 5, 1999 February 5, 1999 February 5, 1999 February 26, 1999 Property 10400 Connecticut Avenue Prince William Plaza Westminster parcel Clairmont Center 444 North Frederick Avenue Arlington Financial Center Department of Commerce V Street Distribution Center Type Office Retail Retail parcel Retail Total 2000 Office Office Industrial Industrial Total 1999 Rentable Square Feet 11,000 274,000 248,000 533,000 6,000 91,000 N/A 113,000 210,000 83,000 95,000 115,000 103,000 32,000 162,000 40,000 630,000 Acquisition Cost (In thousands) $ 1,521 44,549 21,742 $67,812 $ 1,400 7,800 300 17,100 $26,600 $ 6,909 7,557 14,472 12,941 2,231 12,908 4,764 $61,782 Rentable Square Feet 65,000 Sales Price (In thousands) $ 8,400 55,000 10,000 40,000 105,000 66,000 51,000 105,000 31,000 253,000 $ 2,800 425 3,000 $ 6,225 $ 5,671 9,798 7,031 600 $23,100 The total revenues and net income for 10400 Connecticut consideration for WRIT’s acquisition of Woodburn Medical Park I and II. Avenue in 2001 were $1.0 million and $0.4 million, respectively. Both mortgages bear interest at 7.69 percent per annum. Principal The retail properties disposed in the year ended December 31, and interest are payable monthly until September 15, 2005, at which 2000 resulted in total revenues and net income of $0.4 million and time all unpaid principal and interest are payable in full. $0.2 million, respectively. The office and industrial properties dis- On September 20, 1999, WRIT assumed an $8.7 million mortgage posed in the year ended December 31, 1999 resulted in total rev- note payable as partial consideration for WRIT’s acquisition of the enues and net income of $0.4 million and $0.3 million, respectively. Avondale Apartments. The mortgage bears interest at 7.88 percent per 4. MORTGAGE NOTES PAYABLE On August 22, 1995, WRIT assumed a $7.8 million mortgage note annum. Principal and interest are payable monthly until November 1, 2005, at which time all unpaid principal and interest are payable in full. On September 27, 1999, WRIT executed a $50.0 million mortgage payable as partial consideration for WRIT’s acquisition of Frederick note payable secured by Munson Hill Towers, Country Club Towers, County Square retail center. The mortgage bears interest at 9.00 percent Roosevelt Towers, Park Adams Apartments, and the Ashby Apartments. per annum. Principal and interest are payable monthly until January 1, The mortgage bears interest at 7.14 percent per annum and is payable 2003, at which time all unpaid principal and interest are payable in full. monthly until October 1, 2009, at which time all unpaid principal and On November 30, 1998, WRIT assumed a $9.2 million mortgage interest are payable in full. These funds were used to repay advances note payable and a $12.4 million mortgage note payable as partial on WRIT’s lines of credit. 20 On November 1, 2001, WRIT assumed an $8.5 million mortgage Prior to March 17, 1999, all new advances and interest rate note payable, fair valued at $9.3 million, as partial consideration for adjustments, upon the expiration of WRIT’s interest lock-in dates, WRIT’s acquisition of Sullyfield Commerce Center. The mortgage bears bore interest at LIBOR plus a spread based on WRIT’s public debt interest at 9.00 percent per annum. Principal and interest are payable rating. All unpaid interest and principal could be prepaid prior to the monthly until February 1, 2007, at which time all unpaid principal and expiration of WRIT’s interest rate lock-in periods subject to a yield interest are payable in full. In accordance with the purchase method of maintenance obligation. accounting, the mortgage was fair valued at $9.3 million resulting in an On March 17, 1999, WRIT executed an amended and restated adjustment to the basis of this property. agreement extending the maturity date to March 17, 2002. Under Scheduled principal payments during the five years subsequent the amended agreement, WRIT may choose either a Corporate Base to December 31, 2001 and thereafter are as follows: (In thousands) 2002 2003 2004 2005 2006 Thereafter $ 1,177 7,651 1,113 26,638 302 57,845 $94,726 5. UNSECURED LINES OF CREDIT PAYABLE During 2001, WRIT maintained two unsecured lines of credit: a $25.0 million line of credit (“Credit Facility No. 1”) and a $50.0 million line of credit (“Credit Facility No. 2”). Credit Facility No. 1 WRIT had $0 outstanding as of December 31, 2001 and 2000 related to Credit Facility No. 1. The following advances have been made under this commitment: Advance Date May 1999 Mar.–Sept. 1999 Jan.–March 2000 Date Paid in Full July 1999 Jan.–March 2000 November 2000 Amount (In thousands) $12,000 22,000 $22,000 2001 Rate — — — 2000 Rate — 6.33% 7.33% 1999 Rate 5.67% 6.33% — Rate (“CBR”) or a LIBOR advance. Both advances have interest rates based on the applicable rate plus a spread based on the most recent ratings from Moody’s and/or S&P for WRIT’s long-term unsecured debt. Negotiations for renewal of this line of credit are under discussion. This $25.0 million credit commitment requires WRIT to pay quarterly to the lender an unused commitment fee at the rate of 0.375 percent per annum on the amount by which the $25.0 million commitment exceeds the balance of outstanding advances and term loans. At both December 31, 2001 and 2000, $25.0 million of this commitment was unused and available for subsequent acquisitions or capital improvements. This commitment also contains certain finan- cial and non-financial covenants including debt service coverage, net worth, and permitted indebtedness ratios, which WRIT has met as of December 31, 2001. In addition, this commitment requires approval to be obtained from the lender for purchases by the Trust over an agreed upon amount. Credit Facility No. 2 WRIT had $0 outstanding as of December 31, 2001 and 2000 related to Credit Facility No. 2. The following advances have been made under this commitment: Advance Date May 1998 June 1998 Sept.–Nov. 1998 Jan.–Sept. 1999 Sept.–Nov. 1999 March 2000 May 2000 June 2000 August 2000 October 2000 April 19, 2001 Date Paid in Full July 1999 June 1999 March–May 1999 July–Sept. 1999 June–Aug. 2000 November 2000 November 2000 November 2000 November 2000 November 2000 April 27, 2001 Amount (In thousands) $13,000 4,000 27,000 51,000 11,000 2,000 5,000 7,000 4,000 14,000 $43,000 2001 Rate — — — — — — — — — — 5.38% 2000 Rate — — — — — 7.45%–7.81% 7.80%–7.81% 6.64%–7.81% 6.86%–7.51% 7.46% — 1999 Rate 5.54% 6.02% 5.85% 5.90% 6.72% — — — — — — 1998 Rate 5.54%–6.39% 6.02%–6.39% 5.85% — — — — — — — — 21 On July 25, 1999, WRIT executed an agreement to amend and effective interest rate of 7.46 percent, and the 10-year notes bear an restate the original Credit Facility No. 2 agreement. All unpaid interest effective interest rate of 7.49 percent, for a combined effective inter- and principal are due July 2002 and can be prepaid prior to this date est rate of 7.47 percent. WRIT used the proceeds of these notes to without any prepayment fee or yield maintenance obligation. Any new repay advances on its lines of credit and to finance acquisitions and advances shall bear interest at LIBOR plus a spread based on WRIT’s capital improvements. These notes do not require any principal pay- public debt rating. Negotiations for renewal of this line of credit are ment and are due in full at maturity. under discussion. Credit Facility No. 2 provides WRIT the option to convert any advances or portions thereof into a term loan at any time through July 2002. The principal amount of each term loan, if any, shall be repaid in July 2002. This $50.0 million credit commitment requires WRIT to pay the lender an unused commitment fee ranging from 0.15 to 0.25 percent per annum based on WRIT’s public debt rating. The fee is paid on the amount by which the $50.0 million commitment exceeds the balance of outstanding advances and term loans. At December 31, 2001 and 2000, $50.0 million and $50.0 million, respectively, of this commit- ment was unused. This fee is paid quarterly in arrears. This commit- ment also contains certain financial covenants including cash flow to debt service, net worth, capitalization and permitted indebtedness ratios, which WRIT has met as of December 31, 2001. Credit Facility No. 1 and No. 2 contain certain financial and non- financial covenants, all of which WRIT has met as of December 31, 2001. The covenants at present require insurance coverage for all per- ils or special form types of insurance. The loan documents currently make no specific reference to terrorism insurance. WRIT believes it is currently covered against such acts under the insurance coverage in full force and effect until renewal in September 2002. WRIT antici- pates obtaining additional insurance coverage at higher costs upon renewal; however, the Trust’s financial condition and results of opera- tions are subject to the risks associated with acts of terrorism and the potential for uninsured losses as the result of any such act. Information related to short-term borrowings are as follows: (In thousands) Maximum Amount Outstanding Average Amount Outstanding Weighted Average Interest Rate 2001 2000 $43,000 $43,000 $54,000 $33,734 5.38% 7.22% Medium-Term Notes On February 20, 1998, WRIT sold $50.0 million of 7.25 percent unsecured notes due February 25, 2028 at 98.653 percent to yield approximately 7.36 percent. WRIT also sold $60.0 million in unse- cured Mandatory Par Put Remarketed Securities (“MOPPRS”) at an effective borrowing rate through the remarketing date (February 2008) of approximately 6.74 percent. The net proceeds to WRIT after deducting loan origination fees was $102.8 million. WRIT used the proceeds of these notes for general business purposes, including repayment of outstanding advances under its lines of credit and to finance acquisitions and capital improvements to its properties. WRIT’s costs of the borrowings and related closed hedge settlements of approximately $7.2 million are amortized over the lives of the notes using the effective interest method. These notes do not require any principal payment and are due in full at maturity. On November 6, 2000, WRIT sold $55.0 million of 7.78 percent unsecured notes due November 2004. The notes bear an effective interest rate of 7.89 percent. Total proceeds to the Trust, net of underwriting fees, were $54.8 million. WRIT used the proceeds of these notes to repay advances on WRIT’s lines of credit. These notes contain certain financial and non-financial covenants, all of which WRIT has met as of December 31, 2001. The covenants at present require insurance coverage for all perils or spe- cial form types of insurance. The loan documents currently make no specific reference to terrorism insurance. WRIT believes it is currently covered against such acts under the insurance coverage is in full force and effect until renewal in September 2002. WRIT anticipates obtaining additional insurance coverage at higher costs upon renewal; however, the Trust’s financial condition and results of operations are subject to the risks associated with acts of terrorism and the poten- tial for uninsured losses as the result of any such act. The 2001 average balance was based on the individual borrowing outstanding for eight days during this period, and the 2000 average balance represented multiple borrowings outstanding from January 7. DIVIDENDS The following is a breakdown of the taxable percentage of WRIT’s dividends for 2001, 2000 and 1999, respectively: through November 2000. 6. SENIOR AND MEDIUM-TERM NOTES PAYABLE Senior Notes On August 13, 1996 WRIT sold $50.0 million of 7.125 percent 7-year unsecured notes due August 13, 2003, and $50.0 million of 7.25 per- 2001 2000 1999 Ordinary Income 100% 100% 100% Return of Capital 0% 0% 0% 8. SHARE OPTIONS AND GRANTS WRIT maintains Incentive Stock Option Plans (the “Plans”), which cent unsecured 10-year notes due August 13, 2006. The 7-year notes include qualified and non-qualified options. As of December 31, were sold at 99.107 percent of par and the 10-year notes were sold 2001, 1.8 million shares may be awarded to eligible employees. at 98.166 percent of par. Net proceeds to the Trust after deducting Under the Plans, options, which are issued at market price on the underwriting expenses were $97.6 million. The 7-year notes bear an date of grant, vest after not more than two years and expire ten years 22 following the date of grant. WRIT adopted the Washington Real Estate Investment Trust 2001 Stock Option Plan (“New Stock Option Plan”) to replace the 1991 Stock Option Plan (“Stock Option Plan”) that expired on June 25, 2001. The New Stock Option Plan provides for the grant of incentive and non-qualified stock options to the company’s employees. WRIT’s Board of Trustees approved the New Stock Option Plan at a meeting held on May 22, 2001 by a unanimous consent, and WRIT’s shareholders approved the New Stock Option Plan at WRIT’s annual meeting of shareholders, held May 22, 2001. Activity under the Plans is summarized below: Outstanding at January 1 Granted Exercised Expired Outstanding at December 31 Exercisable at December 31 2001 2000 1999 Shares 1,621,000 238,000 (517,000) (106,000) 1,236,000 856,000 Wtd Avg Ex Price $17.16 24.85 16.39 18.11 18.88 16.87 Shares 1,273,000 376,000 (6,000) (22,000) 1,621,000 1,008,000 Wtd Avg Ex Price $15.87 21.34 15.21 14.74 17.16 16.31 Shares 806,000 513,000 (12,000) (34,000) 1,273,000 560,000 Wtd Avg Ex Price $16.83 14.47 15.89 17.28 15.87 16.54 The 856,000 exercisable options outstanding at December 31, WRIT has computed basic earnings per share and fully diluted earn- 2001 have exercise prices between $14.47 and $24.85, with a ings per share. The dilutive impact on basic weighted-average shares weighted-average exercise price of $16.87 and a weighted average outstanding for the year ended December 31, 2001 resulted in a $0.01 remaining contractual life of 7.4 years. The remaining 380,000 options reduction in net income per share. There was no impact of dilution of have exercise prices between $21.34 and $24.85, with a weighted common equivalent shares on the basic weighted-average shares out- average exercise price of $23.28 and a weighted average remaining standing for the years ended December 31, 2001, 2000 and 1999. contractual life of 9.6 years. During 2001 and 2000, WRIT issued 7,209 and 36,417 share WRIT accounts for the Plan under APB Opinion No. 25, under grants, respectively, to executives and trustees of the Trust. The which no compensation cost has been recognized. Had compensation respective compensation expense was recorded based upon the cost for the Plan been determined consistent with SFAS No. 123, share price at the grant date. The Board of Trustees awards share “Accounting for Stock-Based Compensation,” WRIT’s net income and grants subject to Compensation Committee recommendations. The earnings per share would have been reduced to the following pro- total share grants vested were 41,020 at December 31, 2001 and forma amounts: Net Income: As Reported Pro-Forma Basic Earnings Per Share: As Reported Pro-Forma Weighted-average fair value of options granted Weighted-average assumptions: Expected lives (years) Risk free interest rate Expected volatility Expected dividend yield 2001 2000 1999 $52,353 51,523 $45,139 44,214 $44,301 43,419 1.39 1.37 3.49 7 5.08% 19.81% 5.29% 1.26 1.24 2.46 7 5.49% 17.57% 5.85% 1.24 1.22 1.76 7 6.42% 21.05% 7.12% 15,430 at December 31, 2000. 9. BENEFIT PLANS During 1996, management adopted an Incentive Compensation Plan (“the Compensation Plan”) for its senior personnel which is intended to align their compensation growth with shareholders’ interests. Essentially, the Compensation Plan limits future salary increases and provides cash bonus incentives, share options under the Incentive Stock Option Plan and share grants under the Share Grant Plan based on financial performance of the Trust. The financial incentives to man- agement are earned after WRIT has achieved a prescribed level of growth. The Stock Option Plan was adopted in 1991 and expired in June 2001. The New Stock Option Plan was approved and adopted The assumptions used in the calculations of weighted average effective June 2001. The Share Grant Plan is effective from 1996 fair value of options granted are as prescribed under accounting prin- forward and is reviewed by the Board of Trustees’ Compensation ciples generally accepted in the United States. Such assumptions Committee each year. The amounts charged to expense for the share may not be the same as those used by the financial community and grants were $0.2 million, $0.6 million and $0.2 million for the years others in determining the fair value of such options. ended December 31, 2001, 2000 and 1999, respectively. 23 In 1997, WRIT implemented a Retirement Savings Plan (the The estimated fair value information presented is not necessarily “Savings Plan”). It was established so that participants in the Savings indicative of amounts the Trust could realize currently in a market Plan may elect to contribute a portion of their earnings to the Savings sale since the Trust may be unable to sell such instruments due to Plan, and WRIT may, at its discretion, make a voluntary contribution contractual restrictions or the lack of an established market. The to the Savings Plan. estimated market values have not been updated since December 31, WRIT maintained a noncontributory defined benefit pension plan 2001; therefore, current estimates of fair value may differ significantly for all eligible employees through December 31, 1995. At December 31, from the amounts presented. 1995, all benefit accruals under the plan were frozen and thus the pro- Below is a summary of significant methodologies used in estimat- jected benefit obligation (“PBO”) and the accumulated benefit obligation ing fair values and a schedule of fair values at December 31, 2001. (“ABO”) became equal. WRIT terminated the plan as of December 31, 1999, and final participant distributions were made in July 2000. The Trust adopted a split dollar life insurance plan for senior officers, excluding the Chief Executive Officer, in 2000. It is intended that the Trust will recover its costs from the life insurance policies at death prior to retirement, termination prior to retirement or at Cash and Cash Equivalents Includes cash and commercial paper with remaining maturities of less than 90 days, which are valued at the carrying value. Mortgage Notes Payable Mortgage notes payable consist of instruments in which certain of the retirement age 65. It is intended that the cash values of the policy Trust’s real estate assets are used for collateral. The fair value of the in excess of the Trust’s interest can be used by the executive. The mortgage notes payable is estimated based upon dealer quotes for Trust has a security interest in the cash value and death benefit of instruments with similar terms and maturities. each policy to the extent of the sum of premium payments made by the Trust. The Trust has adopted a non-qualified deferred compensation plan for the Chief Executive Officer and members of the Board of Trustees. The plan allows for a deferral of a percentage of annual cash compensation and trustee fees. Compensation deferred will be cred- ited with interest equal to the Trust’s current cost of borrowings. As an incentive, if the Chief Executive Officer should remain employed by WRIT until age 70, the compensation deferred will be credited with an additional 2.5 percent per annum. In the event of death or retirement prior to age 70, the compensation plus interest can be paid in either a Lines of Credit Payable Lines of credit payable consist of bank facilities which the Trust uses for various purposes including working capital, acquisition funding or capital improvements. The lines of credit advances are priced at a specified rate plus a spread. The carrying value of the lines of credit payable is estimated to be market value since the interest rate adjusts with the market. There were no outstanding balances due on the lines of credit at December 31, 2001. Notes Payable Notes payable consists of $50 million, 7.125%, 7-year unsecured lump sum or in equal installments plus interest at the discretion of the notes due August 13, 2003, $50 million, 7.25%, 10-year unsecured plan participant. The plan is unfunded and payments are to be made notes due August 13, 2006, $50 million, 7.25%, 20-year unsecured from general assets of the Trust. 10. FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS No. 107 requires disclosure of the fair value of financial instru- notes due February 25, 2028, $60 million unsecured Mandatory Par Put Remarketed Securities with an effective yield of 6.74% through the remarketing date of February 2008 and $55 million, 7.78%, 4-year unsecured notes due November 15, 2004. The fair ments. Whenever possible, the estimated fair value has been deter- value of these securities is estimated based on dealer quotes for mined using quoted market information as of December 31, 2001. securities with similar terms and characteristics. 2001 2000 1999 Carrying Value $ 26,441 $ 94,726 — $265,000 Fair Value $ 26,441 $ 98,786 — $272,689 Carrying Value $ 6,426 $ 86,260 — $265,000 Fair Value $ 6,426 $ 87,493 — $258,513 Carrying Value $ 4,716 $ 87,037 $ 33,000 $210,000 Fair Value $ 4,716 $ 84,520 $ 33,000 $192,420 (In thousands) Cash and cash equivalents Mortgage notes payable Lines of credit payable Notes payable 24 11. RENTALS UNDER OPERATING LEASES Noncancellable commercial operating leases provide for minimum 13. SEGMENT INFORMATION WRIT has four reportable segments: Office Buildings, Industrial/Flex rental income before any reserve for uncollectible amounts during Properties, Multifamily and Retail Centers. Office Buildings, including each of the next five years of approximately $94.2 million, $76.5 mil- medical office buildings, represent 55 percent of 2001 real estate lion, $59.6 million, $41.7 million, $28.8 million and $66.9 million rental revenue and provide office space for various types of busi- thereafter. Apartment leases are not included as they are generally nesses. Industrial represents 14 percent of 2001 real estate rental for one year. Most of these commercial leases increase in future revenue and are used for flex-office, warehousing and distribution type years based on changes in the Consumer Price Index or agreed-upon facilities. Multifamily properties represent 18 percent of 2001 real percentages. Contingent rentals from the shopping centers, based estate rental revenue. These properties provide housing for families on a percentage of tenants’ gross sales, were $412,000, $217,000 throughout the Washington Metropolitan area. Retail Centers repre- and $425,000 in 2001, 2000 and 1999, respectively. Real estate sent the remaining 13 percent of 2001 real estate rental revenue tax, operating expense and common area maintenance reimburse- and are typically neighborhood grocery store or drug store anchored ment income was $8.4 million, $7.9 million and $6.4 million for the retail centers. years ended December 31, 2001, 2000 and 1999, respectively. The accounting policies of the segments are the same as those 12. CONTINGENCIES In the normal course of business, the Trust is involved in various other described in Note 2. WRIT evaluates performance based upon operat- ing income from the combined properties in each segment. WRIT’s reportable segments are consolidations of similar properties. They are lawsuits and environmental matters arising in the normal course of busi- managed separately because each segment requires different operat- ness. Management believes that such matters will not have a material ing, pricing and leasing strategies. All of these properties have been effect on the financial condition or results of operations of the Trust. acquired separately and are incorporated into the applicable segment. 2001 (In thousands) Real estate rental revenue Real estate expenses Operating income Depreciation and amortization Income from real estate Other income Interest expense General and administrative Income before gain on sale of real estate Gain on sale of real estate Net income Capital investments Total assets 2000 (In thousands) Real estate rental revenue Real estate expenses Operating income Depreciation and amortization Income from real estate Other income Interest expense General and administrative Income before gain on sale of real estate Gain on sale of real estate Net income Capital investments Total assets Office Buildings Industrial/ Flex Properties Multifamily $ 81,023 23,851 57,172 15,195 41,977 499 (1,595) — 40,881 4,296 $ 45,177 $ 53,449 $380,990 $ 20,702 4,546 16,156 4,173 11,983 6 (104) — 11,885 — $ 11,885 $ 14,941 $126,842 $27,455 9,754 17,701 3,836 13,865 22 (4,315) — 9,572 — $ 9,572 $ 3,981 $80,033 Office Buildings Industrial/ Flex Properties Multifamily $ 70,885 21,118 49,767 13,050 36,717 — (1,630) — 35,087 — $ 35,087 $ 31,925 $343,806 $ 19,249 3,997 15,252 3,765 11,487 — — — 11,487 — $ 11,487 $ 4,525 $107,916 $26,234 9,258 16,976 3,486 13,490 — (4,329) — 9,161 — $ 9,161 $ 3,613 $79,767 Retail Centers $19,244 3,996 15,248 2,339 12,909 10 (635) — 12,284 — $12,284 895 $ $81,090 Retail Centers $18,364 3,943 14,421 2,422 11,999 — (637) — 11,362 3,567 $14,929 $ 2,787 $82,492 Corporate and Other $ — — — 1,192 (1,192) 1,149 (20,422) (6,100) (26,565) — $(26,565) 538 $ $ 38,980 Corporate and Other $ — — — — — 943 (18,935) (7,533) (25,525) — $(25,525) $ 814 $ 19,434 Consolidated $148,424 42,147 106,277 26,735 79,542 1,686 (27,071) (6,100) 48,057 4,296 $ 52,353 $ 73,803 $707,935 Consolidated $134,732 38,316 96,416 22,723 73,693 943 (25,531) (7,533) 41,572 3,567 $ 45,139 $ 43,664 $633,415 25 1999 (In thousands) Real estate rental revenue Real estate expenses Operating income Depreciation and amortization Income from real estate Other income Interest expense General and administrative Income before gain on sale of real estate Gain on sale of real estate Net income Capital investments Total assets Office Buildings Industrial/ Flex Properties Multifamily $ 61,657 18,950 42,707 10,979 31,728 — (1,731) — 29,997 2,044 $ 32,041 $ 37,691 $321,741 $ 16,196 3,568 12,628 3,301 9,327 — — — 9,327 5,865 $ 15,192 $ 19,591 $105,177 $22,926 8,714 14,212 2,915 11,297 — (1,145) — 10,152 — $10,152 $20,324 $79,548 Retail Centers $18,196 4,049 14,147 2,395 11,752 — (653) — 11,099 — $11,099 $ 2,049 $84,041 Corporate and Other $ — — — — — 732 (18,742) (6,173) (24,183) — $(24,183) $ 1,216 $ 17,973 Consolidated $118,975 35,281 83,694 19,590 64,104 732 (22,271) (6,173) 36,392 7,909 $ 44,301 $ 80,871 $608,480 14. SELECTED QUARTERLY FINANCIAL DATA (IN THOUSANDS, UNAUDITED) The following table summarizes financial data by quarter for WRIT for 2001, 2000 and 1999. 2001 Real estate rental revenue Net income Net income per share* 2000 Real estate rental revenue Net income Net income per share* 1999 Real estate rental revenue Net income Net income per share* First $35,324 10,728 $ 0.30 $31,935 10,910 $ 0.31 $27,654 16,358 $ 0.46 Second $37,418 12,394 $ 0.33 $33,350 9,963 $ 0.28 $28,864 8,765 $ 0.25 Quarter Third $37,873 16,824 $ 0.43 $34,230 12,793 $ 0.36 $29,566 8,826 $ 0.25 Fourth $37,809 12,407 $ 0.32 $35,217 11,473 $ 0.32 $32,891 10,352 $ 0.29 *Includes gain on the sale of real estate of $0.11 per share in the third quarter of 2001, $0.04 and $0.06 per share in the first and third quarters of 2000 and $0.22 per share in the first quarter of 1999, respectively. 15. SUBSEQUENT EVENT (UNAUDITED) Subsequent to December 31, 2001, WRIT closed on the sale of 1501 South Capitol Street. On February 28, 2002, WRIT sold this industrial property for $ 6.2 million, resulting in a gain of approximately $3.8 million. 26 WASHINGTON REAL ESTATE INVESTMENT TRUST AND SUBSIDIARIES REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS TO THE SHAREHOLDERS OF WASHINGTON REAL ESTATE INVESTMENT TRUST We have audited the accompanying consolidated balance sheets of Washington Real Estate Investment Trust (the “Trust,” a Maryland real estate investment trust) and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of income, changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2001. These financial state- ments are the responsibility of the Trust’s management. Our responsi- bility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the 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 pres- ent fairly, in all material respects, the financial position of the Trust and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. ARTHUR ANDERSEN LLP Vienna, Virginia February 20, 2002 27 CORPORATE INFORMATION CORPORATE HEADQUARTERS Washington Real Estate Investment Trust 6110 Executive Boulevard Rockville, MD 20852-3927 ANNUAL MEETING WRIT will hold its annual meeting of stockholders on May 21, 2002, at 11:00 AM at the Hyatt Regency Hotel–Bethesda, One Bethesda Metro Center, Bethesda, MD. 301.984.9400 800.565.9748 fax 301.984.9610 www.writ.com COUNSEL Arent Fox Kintner Plotkin & Kahn, PLLC 1050 Connecticut Avenue, N.W. Washington, DC 20036-5339 INDEPENDENT PUBLIC ACCOUNTANTS Arthur Andersen LLP 8000 Towers Crescent Drive Vienna, VA 22182-2725 TRANSFER AGENT EquiServe Trust Company, N.A. P.O. Box 2598 Jersey City, NJ 07303-2598 10-K NOTICE A copy of the company’s Annual Report to the Securities and Exchange Commission on Form 10-K may be obtained without charge. Please direct your request to WRIT’s Investor Relations Department. WRIT DIRECT WRIT’s dividend reinvestment and direct stock purchase plan permits cash investment of up to $25,000 per month, plus dividends, with nominal fees, and is IRA eligible. STOCK INFORMATION WRIT is traded on the New York Stock Exchange. The symbol listed in the newspaper is WRIT. The trading symbol is WRE. MEMBER National Association of Real Estate Investment Trusts® 1875 Eye Street, N.W. Suite 600 Washington, DC 20006-5413 28 FUNDS FROM OPERATIONS PER SHARE Washington Real Estate Investment Trust, founded MISSION STATEMENT 2 0 0 1 $ 1 . 9 6 2 0 0 0 $ 1 . 7 9 1 9 9 9 $ 1 . 5 7 1 9 9 8 $ 1 . 3 9 1 9 9 7 $ 1 . 2 3 CASH DIVIDENDS PAID PER SHARE 2 0 0 1 $ 1 . 3 1 2 0 0 0 $ 1 . 2 3 1 9 9 9 $ 1 . 1 6 1 9 9 8 $ 1 . 1 1 1 9 9 7 $ 1 . 0 7 in 1960 and headquar tered in Rockville, Mar yland, invests in a diversified range of income-producing property types. Our purpose is to acquire and manage real estate investments in markets we know well and protect our assets from single proper ty-type value fluctuations through diversified holdings. Our goal is to continue to safely increase earnings and shareholder value. SELECTED FINANCIAL AND OPERATING DATA IN MILLIONS, EXCEPT FULLY DILUTED PER SHARE AMOUNTS F O R T H E Y E A R Real Estate Revenue Income before Gain on Sale of Real Estate Net Income Funds from Operations Cash Dividends Paid Average Shares Outstanding Net Income Funds from Operations Cash Dividends Paid A T Y E A R E N D Total Assets Total Debt Shareholders’ Equity 2001 2000 1999 1998 1997 $ 148 $ 135 $ 119 $ 104 $ 79 48 52 74 50 39 42 45 64 44 36 $1.27 1.38 1.96 1.31 $1.16 1.26 1.79 1.23 $ 708 360 324 $ 632 351 259 36 44 56 41 36 $1.02 1.24 1.57 1.16 $ 608 330 257 34 41 50 40 36 $ .96 1.15 1.39 1.11 $ 559 283 254 30 30 41 36 33 $ .90 .90 1.23 1.07 $ 469 203 252 P E R F U L L Y D I L U T E D C O M M O N S H A R E Income before Gain on Real Estate WRIT trustees and officers TRUSTEES Edmund B. Cronin, Jr. Chairman, President and Chief Executive Officer Director, John J. Kirlin Companies; Potomac Electric Power Company John M. Derrick, Jr. Chairman and Chief Executive Officer, Potomac Electric Power Company Clifford M. Kendall Director, Affiliated Computer Service, Inc.; VSE Corporation; Onsite Sourcing, Inc. John P. McDaniel Chief Executive Officer, MedStar Health Director, AAL/Lutheran Brotherhood Charles T. Nason Chairman and Chief Executive Officer, Acacia Life Insurance David M. Osnos Senior Partner, Arent Fox Kintner Plotkin & Kahn; Director, EastGroup Properties; VSE Corporation Susan J. Williams Chief Executive Officer and President, Williams Aron & Associates OFFICERS Edmund B. Cronin, Jr. Chairman, President and Chief Executive Officer George F. McKenzie Senior Vice President, Real Estate Brian J. Fitzgerald Managing Director, Leasing Laura M. Franklin Managing Director, Accounting and Administration, Corporate Secretary Sara L. Grootwassink Managing Director, Finance and Capital Markets Kenneth C. Reed Managing Director, Property Management Thomas L. Regnell Managing Director, Acquisitions m o c . e v i t a e r c i c f . w w w D M , a d s e h t e B . c n I s n o i t a c i n u m m o C l a i c n a n i F : n g i s e D t s u r T t n e m t s e v n I e t a t s E l a e R n o t g n i h s a W 2 0 0 2 © Clockwise from rear left: Charles T. Nason, Susan J. Williams, Clifford M. Kendall, John P. McDaniel, John M. Derrick Jr., Edmund B. Cronin Jr., David M. Osnos Clockwise from rear left: Kenneth C. Reed, Sara L. Grootwassink, Brian J. Fitzgerald, Laura M. Franklin, Thomas L. Regnell, Edmund B. Cronin Jr., George F. McKenzie WASHINGTON REAL ESTATE INVESTMENT TRUST 6110 Executive Boulevard Rockville, Maryland 20852-3927 301-984-9400 800-565-9748 Fax: 301-984-9610 w w w. w r i t . c o m The graph on the front cover reflects the total return (dividends plus price appreciation with all dividends reinvested) of WRIT, the S&P 500, the Morgan Stanley REIT Index, the NASDAQ and the DOW for the period beginning December 31, 1971, and ending December 31, 2001. COMPARE WRIT’S PERFORMANCE WITH OTHER INDUSTRY LEADERS $10,000 invested in WRIT since 1971, with dividends reinvested, would be worth $1,789,000 as of December 31, 2001. W R I T $ 1 , 7 8 8 , 7 0 1 S & P 5 0 0 $ 3 4 6 , 2 4 4 R E I T I N D U S T R Y $ 4 0 0 , 3 8 8 N A S D A Q $ 1 9 5 , 0 4 0 D 0 W $ 1 1 9 , 4 5 9 COMPOUND ANNUAL RATES OF RETURN: W R I T 1 8 . 2 % S & P 5 0 0 1 2 . 1 % R E I T I N D U S T R Y 1 2 . 6 % N A S D A Q 1 0 . 1 % D 0 W 8 . 3 % COMPARATIVE RETURNS OVER 30-YEAR PERIOD W R I T S & P 5 0 0 R E I T I N D U S T R Y D O W N A S D A Q W A S H I N G T O N R E A L E S T A T E I N V E S T M E N T T R U S T ANNUAL REPORT 2001 VALUE 36 consecutive years of increased earnings per share GROWTH 31 consecutive years of increased dividends per share PERFORMANCE 29 consecutive years of increased funds from operations per share W R I T S & P 5 0 0 R E I T I N D U S T R Y N A S D A Q D O W 

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