Item 1. Business
The Company. HRPT Properties Trust ("HRP" or the "Company") was organized on October 9, 1986 as a Maryland real estate investment trust ("REIT"). We invest in office buildings.
As of December 31, 1999, we owned 195 office properties for a total investment of $2.7 billion at cost and a depreciated book value of $2.5 billion. In addition, we had equity investments representing 49.3% and 7.1% of the outstanding common shares of Senior Housing Properties Trust ("SNH") and Hospitality Properties Trust ("HPT"), respectively, with approximate carrying values of $201.8 million and $109.3 million, respectively, for total real estate investments of approximately $3.0 billion. The properties are described in greater detail below in "Properties".
Our principal executive offices are located at 400 Centre Street, Newton, Massachusetts 02458, and our telephone number is (617) 332-3990.
Investment Policy and Method of Operation. Our investment goals are current income for distribution to shareholders, capital growth resulting from appreciation in the residual value of owned properties, and preservation and protection of shareholders' capital. Our income is derived primarily from rent.
Our day to day operations are conducted by REIT Management & Research, Inc. ("RMR"), our investment manager. RMR provides investment, management, property management and administrative services to us. RMR originates and presents investment opportunities to our Board of Trustees. In evaluating potential investments, we consider factors such as: the historical and projected rents received and likely to be received from the property, the historic and expected operating expenses, including real estate taxes, incurred and expected to be incurred at the properties; the growth, tax and regulatory environments of the market in which the property is located; the quality, experience, and credit worthiness of the property's tenants; an appraisal of the property, if available; occupancy and demand for similar properties in the same or nearby markets; the construction quality, physical condition and design of the property; the geographic area and type of property; and the pricing of comparable properties as evidenced by recent arms length market sales.
Our investments are generally structured using leases with minimum and/or additional rent and escalation provisions, joint ventures and partnerships with affiliated or unaffiliated parties, commitments or options to purchase interests in real estate, mergers or any combination of the foregoing that will best suit the particular investment.
In connection with our current bank credit facility, we have agreed to obtain lender approval before exceeding investment concentrations based on certain criteria. No limits, other than those imposed by our bank credit facility, have been set on the number of properties in which we will seek to invest, or on the concentration of investments involving any one facility or geographical area; however, our Board of Trustees consider concentration of investments in determining whether to make new or increase existing investments.
We have in the past considered and may in the future consider, from time to time, the acquisition of or merger with other companies engaged in the same business as us; however, we have no present agreements or understandings concerning any such acquisition or merger.
Borrowing Policy. In addition to the use of equity, we utilize short-term and long-term borrowings to finance investments. We have a bank credit facility of $500 million. In February 1999, the bank credit facility was amended to allow for the spin-off of our senior housing properties. The bank credit facility (which is guaranteed by most of our subsidiaries) is used for acquisition funding on an interim basis until equity or long-term debt is raised and for working capital and general business purposes. Outstanding borrowings under the bank credit facility at December 31, 1999 were $132 million.
Our borrowing guidelines established by our Board of Trustees and covenants in various debt agreements prohibit us from maintaining a debt to equity ratio of greater than 1 to 1. At December 31, 1999, our debt to equity ratio was .89 to 1. Our senior unsecured debt also imposes covenants on us which may limit our ability to borrow. The Declaration of Trust prohibits us from incurring secured and unsecured indebtedness which in the aggregate exceeds 300% of our net assets, unless approved by a majority of the Board of Trustees not affiliated with RMR. There can be no assurance that debt capital will in the future be available at reasonable rates to fund our operations or growth.
Business Developments Since January 1, 1999
Investments
During 1999, we acquired 61 office properties for an aggregate purchase price of $516.5 million.
Financing
During 1999, we issued the following senior unsecured fixed rate term notes: $90 million of 7.875% Senior Notes due 2009 issued in March 1999 and $65 million of 8.375% Senior Notes due 2011 issued in June 1999. The notes are callable at par on April 15, 2002 and June 15, 2003, respectively. The $150.2 million aggregate net proceeds from these notes were used to repay amounts then outstanding under our revolving bank credit facility. In addition, we assumed $32.4 million of secured mortgage notes payable in connection with the acquisition of eight office properties. These mortgage notes payable bear interest at rates ranging from 7.02% to 9.12% and mature between 2004 and 2008.
In February 1999, we amended our unsecured revolving bank credit facility with a group of banks for which Dresdner Bank AG acts as agent to allow for the spin off of our senior housing properties.
Other Developments
In 1999, we disposed of 14 senior housing properties, including 12 senior housing properties leased to an affiliate, for net proceeds of $82.2 million and recognized a gain of $8.3 million. As part of the sale of 12 of the senior housing properties during March of 1999, we provided a $60 million mortgage loan which was paid in full in June 1999.
During 1999, we received regularly scheduled principal payments and repayments on mortgages secured by eight senior housing properties totaling $15.6 million. We also received a $1 million loan repayment from an affiliate. During 1999, we wrote down the carrying value of two real estate mortgages secured by four nursing home properties by $5 million to reflect our estimated future discounted realizable value.
On October 12, 1999, we spun-off 50.7% of our 100% owned subsidiary, SNH, by distributing 13,190,763 common shares of SNH to our shareholders of record on October 8, 1999 (the "Spin-Off"). SNH is a real estate investment trust that invests principally in income producing senior housing real estate and prior to the Spin-Off had 26,000,000 common shares outstanding. In connection with the Spin-Off, we received $200 million from SNH that was used to repay amounts outstanding on our revolving bank credit facility.
In connection with the Spin-Off, we agreed to pay all costs relating to the Spin-Off of SNH. At December 31, 1999, total costs incurred for the Spin-Off were $16.7 million, which included costs of distributing SNH shares to shareholders, legal and accounting fees, Securities and Exchange Commission filing fees, New York Stock Exchange listing fees and the up-front costs of establishing SNH's bank credit facility, the first $200 million proceeds of which was paid to us.
Since the Spin-Off, our investment in SNH is accounted for using the equity method of accounting. Prior to the Spin-Off, the operating results of SNH were included in our results of operations. At December 31, 1999, we owned 12,809,237 common shares of beneficial interest of SNH with a carrying value of $201.8 million and a market value, based on quoted market prices, of $158.5 million.
During January and February 2000, two of SNH's tenants, accounting for approximately 48% of SNH's revenues, filed for bankruptcy. SNH is currently negotiating with these tenants and evaluating its options, including the possibility of reducing rent, selling properties or operating certain properties for its own behalf. Based on estimates of future cash flows from properties leased to these two tenants, SNH has recognized an impairment in the carrying value of certain properties and loans totaling $30 million. This value impairment has increased SNH's expenses and reduced SNH's net income for the year ended December 31, 1999. The Company has recognized $14.8 million of SNH's asset impairment loss on its consolidated statement of income for the year ended December 31, 1999, through its 49.3% ownership interest in SNH. In the short-term, the level of dividends paid by SNH to the Company in future periods will depend on the outcome of SNH's negotiations with these two tenants. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations."
The Investment Manager
RMR is a Delaware corporation owned by Gerard M. Martin and Barry M. Portnoy. RMR's principal executive offices are located at 400 Centre Street, Newton, Massachusetts 02458, and its telephone number is (617) 332-3990. As of January 1, 1998, we entered into separate investment advisor and property management agreements with RMR. RMR provides investment, management, property management services and administrative services to us. In addition, an affiliate of RMR also provides garage management services to some of our properties. RMR also acts as the investment manager to SNH and HPT and has other business interests. The Directors of RMR are Gerard M. Martin, Barry M. Portnoy and David J. Hegarty. The officers of RMR are David J. Hegarty, President and Secretary, John G. Murray, Executive Vice President, John C. Popeo, Treasurer, and Ajay Saini, John A. Mannix, David M. Lepore, Thomas M. O'Brien and Jennifer B. Clark, Vice Presidents. Gerard M. Martin and Barry M. Portnoy are our managing trustees and John A. Mannix, John C. Popeo, David M. Lepore and Jennifer B. Clark are our officers.
Employees
As of March 27, 2000, we had no employees. RMR, which administers our day-to-day operations, had 200 full-time employees and three active directors as of that date.
Competition.
Investing in and operating office buildings is a very competitive business. We compete against other REIT's, numerous financial institutions and numerous individuals and public and private companies who are actively engaged in this business. We do not believe we have a dominant position in any of the geographic markets in which we operate but some of our competitors are dominant in selected markets. Many of our competitors have greater financial and management resources than we have. We believe the geographic diversity of our investments, the experience and abilities of our management, the high quality of our assets and the financial strength of many of our tenants affords us some competitive advantages which have and will allow us to operate our business successfully despite the competitive nature of this business.
FEDERAL INCOME TAX CONSIDERATIONS
The following summary of federal income tax and ERISA consequences is based on existing law, and is limited to investors who own our shares as investment assets rather than as inventory or as property used in a trade or business. The summary does not discuss the particular tax consequences that might be relevant to you if you are subject to special rules under the federal income tax law, for example if you are:
o a bank, life insurance company, regulated investment company, or other financial institution,
o a broker or dealer in securities or foreign currency,
o a person who has a functional currency other than the U.S. dollar,
o a person who acquires our shares in connection with employment or other performance of services,
o a person subject to alternative minimum tax,
o a person who owns our shares as part of a straddle, hedging transaction, constructive sale transaction, or conversion transaction, or
o except as specifically described in the following summary, a tax-exempt entity or a foreign person.
The sections of the Internal Revenue Code that govern the federal income tax qualification and treatment of a REIT and its shareholders are complex. This presentation is a summary of applicable Internal Revenue Code provisions, related rules and regulations and administrative and judicial interpretations, all of which are subject to change, possibly with retroactive effect. Future legislative, judicial, or administrative actions or decisions could affect the accuracy of statements made in this summary. We have not sought a ruling from the IRS with respect to any matter described in this summary, and we cannot assure you that the IRS or a court will agree with the statements made in this summary. In addition, the following summary is not exhaustive of all possible tax consequences, and does not discuss any estate, gift, state, local, or foreign tax consequences. For all these reasons, we urge you and any prospective acquiror of our shares to consult with a tax advisor about the federal income tax and other tax consequences of the acquisition, ownership and disposition of our shares.
Federal income tax consequences may differ depending on whether or not you are a "U.S. shareholder." For purposes of this summary, a U.S. shareholder for federal income tax purposes is:
o a citizen or resident of the United States, including an alien individual who is a lawful permanent resident of the United States or meets the substantial presence residency test under the federal income tax laws,
o a corporation, partnership or other entity treated as a corporation or partnership for federal income tax purposes, that is created or organized in or under the laws of the United States, any state thereof or the District of Columbia, unless otherwise provided by Treasury regulations,
o an estate the income of which is subject to federal income taxation regardless of its source, or
o a trust if a court within the United States is able to exercise primary supervision over the administration of the trust and one or more United States persons have the authority to control all substantial decisions of the trust, or electing trusts in existence on August 20, 1996 to the extent provided in Treasury regulations,
whose status as a U.S. shareholder is not overridden by an applicable tax treaty. Conversely, a "non-U.S. shareholder" is a beneficial owner of our shares who is not a U.S. shareholder.
Taxation as a REIT
We have elected to be taxed as a REIT under Sections 856 through 860 of the Internal Revenue Code, commencing with our taxable year ending December 31, 1987. Our REIT election, assuming continuing compliance with the federal income tax qualification tests summarized below, continues in effect for subsequent taxable years. Although no assurance can be given, we believe that we are organized, have operated, and will continue to operate in a manner that qualifies us to be taxed under the Internal Revenue Code as a REIT.
As a REIT, we generally will not be subject to federal income tax on our net income distributed as dividends to our shareholders. Distributions to our shareholders generally will be includable in their income as dividends to the extent of our current or accumulated earnings and profits. A portion of these dividends may be treated as capital gain dividends, as explained below. No portion of any dividends will be eligible for the dividends received deduction for corporate shareholders. Distributions in excess of current or accumulated earnings and profits generally will be treated for federal income tax purposes as a return of capital to the extent of a recipient shareholder's basis in our shares, and will reduce this basis. Our current or accumulated earnings and profits will generally be allocated first to distributions on our outstanding preferred shares, if any, and thereafter to distributions on our common shares.
Our counsel, Sullivan & Worcester LLP, has opined that we have been organized and have qualified as a REIT under the Internal Revenue Code for our 1987 through 1999 taxable years, and that our current investments and plan of operation will enable us to meet the requirements for qualification and taxation as a REIT under the Internal Revenue Code. Our actual qualification and taxation as a REIT will depend upon our ability to meet the various REIT qualification tests imposed under the Internal Revenue Code and summarized below. While we believe that we will operate in a manner to satisfy the various REIT qualification tests, our counsel has not reviewed and will not review compliance with these tests on a continuing basis. If we fail to qualify as a REIT in any year, we will be subject to federal income taxation as if we were a domestic corporation, and our shareholders will be taxed like shareholders of ordinary corporations. In this event, we could be subject to significant tax liabilities, and the amount of cash available for distribution to our shareholders may be reduced or eliminated.
If we qualify for taxation as a REIT and meet the annual distribution tests described below, we generally will not be subject to federal corporate income taxes on the amount distributed. However, even if we qualify for federal income taxation as a REIT, we may be subject to federal tax in the following circumstances:
o We will be taxed at regular corporate rates on any undistributed "real estate investment trust taxable income," including our undistributed net capital gains.
o If our alternative minimum taxable income exceeds our taxable income, we may be subject to the corporate alternative minimum tax on our items of tax preference.
o If we have net income from the sale or other disposition of "foreclosure property" that is held primarily for sale to customers in the ordinary course of business or other nonqualifying income from foreclosure property, we will be subject to tax on this net income from foreclosure property at the highest regular corporate rate, which is currently 35%.
o If we have net income from prohibited transactions, including sales or other dispositions of inventory or property held primarily for sale to customers in the ordinary course of business other than foreclosure property, we will be subject to tax on this income at a 100% rate.
o If we fail to satisfy the 75% gross income test or the 95% gross income test discussed below, but nonetheless maintain our qualification as a REIT, we will be subject to tax at a 100% rate on the greater of the amount by which we fail the 75% or the 95% test, multiplied by a fraction intended to reflect our profitability.
o If we fail to distribute for any calendar year at least the sum of 85% of our REIT ordinary income for that year, 95% of our REIT capital gain net income for that year, and any undistributed taxable income from prior periods, we will be subject to a 4% excise tax on the excess of the required distribution over the amounts actually distributed.
o If we acquire an asset from a corporation in a transaction in which our basis in the asset is determined by reference to the basis of the asset in the hands of a present or former C corporation, and if we subsequently recognize gain on the disposition of this asset during the ten-year period beginning on the date on which the asset ceased to be owned by the C corporation, then we will pay tax at the highest regular corporate tax rate, which is currently 35%, on the lesser of the excess of the fair market value of the asset over the C corporation's basis in the asset on the date the asset ceased to be owned by the C corporation, or the gain recognized in the disposition.
If we invest in properties in foreign countries, our profits from those investments will generally be subject to tax in the countries where those properties are located. The nature and amount of this taxation will depend on the laws of the countries where the properties are located. If we operate as we currently intend, then we will distribute our taxable income to our shareholders and we will not pay federal income tax, and thus we generally cannot recover the cost of foreign taxes imposed on our foreign investments by claiming foreign tax credits against our federal income tax liability. Also, we cannot pass through to our shareholders any foreign tax credits.
If we fail to qualify for federal income taxation as a REIT in any taxable year, then we will be subject to federal tax in the same manner as an ordinary corporation. Distributions to our shareholders in any year in which we fail to qualify as a REIT will not be deductible, nor will these distributions be required to be made. In that event, to the extent of our current and accumulated earnings and profits, all distributions to our shareholders will be taxable as ordinary dividend income and, subject to limitations in the Internal Revenue Code, will be eligible for the dividends received deduction for corporate recipients. Also in that event, we will generally be disqualified from federal income taxation as a REIT for the four taxable years following disqualification. Failure to qualify for federal income taxation as a REIT for even one year could result in our incurring substantial indebtedness or liquidating substantial investments in order to pay the resulting corporate-level taxes.
REIT Qualification Requirements
General Requirements. Section 856(a) of the Internal Revenue Code defines a REIT as a corporation, trust or association:
(1) that is managed by one or more trustees or directors;
(2) the beneficial ownership of which is evidenced by transferable shares or by transferable certificates of beneficial interest;
(3) that would be taxable, but for Sections 856 through 859 of the Internal Revenue Code, as an ordinary domestic corporation;
(4) that is not a financial institution or an insurance company subject to special provisions of the Internal Revenue Code;
(5) the beneficial ownership of which is held by 100 or more persons;
(6) that is not "closely held" as defined under the personal holding company stock ownership test, as described below; and
(7) that meets other tests regarding income, assets and distributions, all as described below.
Section 856(b) of the Internal Revenue Code provides that conditions (1) to (4), inclusive, must be met during the entire taxable year and that condition (5) must be met during at least 335 days of a taxable year of 12 months, or during a pro rata part of a taxable year of less than 12 months. Section 856(h)(2) of the Internal Revenue Code provides that conditions (5) and (6) need not be met for our first taxable year as a REIT. We believe that we have satisfied conditions (1) to (6), inclusive, during each of the requisite periods ending on or before December 31, 1999, and that we will continue to satisfy those conditions in future taxable years. There can, however, be no assurance in this regard.
By reason of condition (6) above, we will fail to qualify as a REIT for a taxable year if at any time during the last half of the year more than 50% in value of our outstanding shares is owned directly or indirectly by five or fewer individuals. To help comply with condition (6), our declaration of trust contains provisions restricting transfers of our shares. In addition, if we comply with applicable Treasury regulations for ascertaining the ownership of our outstanding shares and do not know, or by exercising reasonable diligence would not have known, that we failed condition (6), then we will be treated as satisfying condition (6). Also, our failure to comply with these applicable Treasury regulations for ascertaining ownership of our outstanding shares may result in a penalty of $25,000, or $50,000 for intentional violations. Accordingly, we intend to comply with these Treasury regulations, and to request annually from record holders of significant percentages of our shares information regarding the ownership of our shares. Under our declaration of trust, our shareholders are required to respond to these requests for information.
For purposes of condition (6) above, shares in a REIT held by a pension trust are treated as held directly by the pension trust's beneficiaries in proportion to their actuarial interests in the pension trust. Consequently, five or fewer pension trusts could own more than 50% of the interests in an entity without jeopardizing that entity's federal income tax qualification as a REIT. However, as discussed below, if a REIT is a "pension-held REIT," each pension trust owning more than 10% of the REIT's shares by value generally will be taxed on a portion of the dividends received from the REIT, based on the ratio of:
(1) the REIT's gross income for the year that would be unrelated trade or business income if the REIT were a qualified pension trust, to
(2) the REIT's total gross income for the year.
Our Wholly-Owned Subsidiaries and Our Investments through Partnerships. Section 856(i) of the Internal Revenue Code provides that any corporation 100% of whose stock is held by a REIT is a qualified REIT subsidiary and shall not be treated as a separate corporation. The assets, liabilities and items of income, deduction and credit of a qualified REIT subsidiary are treated as the REIT's. We believe that each of our direct and indirect wholly-owned subsidiaries will either be a qualified REIT subsidiary within the meaning of Section 856(i) of the Internal Revenue Code, or a noncorporate entity that for federal income tax purposes is not treated as separate from its owner under regulations issued under Section 7701 of the Internal Revenue Code. Thus, in applying all the federal income tax REIT qualification requirements described in this summary, all assets, liabilities and items of income, deduction and credit of our direct and indirect wholly-owned subsidiaries are treated as ours.
We have invested and may invest in real estate through one or more limited or general partnerships or limited liability companies that are treated as partnerships for federal income tax purposes. In the case of a REIT that is a partner in a partnership, regulations under the Internal Revenue Code provide that, for purposes of the REIT qualification requirements regarding income and assets discussed below, the REIT is deemed to own its proportionate share of the assets of the partnership corresponding to the REIT's proportionate capital interest in the partnership and is deemed to be entitled to the income of the partnership attributable to this proportionate share. In addition, for these purposes, the character of the assets and gross income of the partnership generally retain the same character in the hands of the REIT. Accordingly, our proportionate share of the assets, liabilities, and items of income of each partnership in which we are a partner is treated as ours for purposes of the income tests and asset tests discussed below. In contrast, for purposes of the distribution requirement discussed below, we must take into account as a partner our distributive share of the partnership's income as determined under the general federal income tax rules governing partners and partnerships under Sections 701 through 777 of the Internal Revenue Code.
Income Tests. There are two gross income requirements for qualification as a REIT under the Internal Revenue Code:
o At least 75% of our gross income, excluding gross income from sales or other dispositions of property held primarily for sale, must be derived from investments relating to real property, including "rents from real property" as defined under Section 856 of the Internal Revenue Code, mortgages on real property, or shares in other REITs. When we receive new capital in exchange for our shares or in a public offering of five-year or longer debt instruments, income attributable to the temporary investment of this new capital in stock or a debt
instrument, if received or accrued within one year of our receipt of the new capital, is generally also qualifying income under the 75% test.
o At least 95% of our gross income, excluding gross income from sales or other dispositions of property held primarily for sale, must be derived from a combination of items of real property income that satisfy the 75% test described above, dividends, interest, payments under interest rate swap or cap agreements, options, futures contracts, forward rate agreements, or similar financial instruments, and gains from the sale or disposition of stock, securities, or real property.
For purposes of these two requirements, income derived from a "shared appreciation provision" in a mortgage loan is generally treated as gain recognized on the sale of the property to which it relates. Although we will use our best efforts to ensure that the income generated by our investments will be of a type which satisfies both the 75% and 95% gross income tests, there can be no assurance in this regard.
In order to qualify as "rents from real property" under Section 856 of the Internal Revenue Code, several requirements must be met:
o The amount of rent received generally must not be based on the income or profits of any person, but may be based on receipts or sales.
o Rents do not qualify if the REIT owns 10% or more by vote or value of the tenant, whether directly or after application of attribution rules. While we intend not to lease property to any party if rents from that property would not qualify as rents from real property, application of the 10% ownership rule is dependent upon complex attribution rules and circumstances that may be beyond our control. For example, an unaffiliated third party's ownership directly or by attribution of 10% or more by value of our shares, as well as 10% or more by vote or value of the stock of one of our lessees, would result in that lessee's rents not qualifying as rents from real property. Our declaration of trust disallows transfers or purported acquisitions, directly or by attribution, of our shares that could result in disqualification as a REIT under the Internal Revenue Code and permits our trustees to repurchase the shares to the extent necessary to maintain our status as a REIT under the Internal Revenue Code. Nevertheless, there can be no assurance that these provisions in our declaration of trust will be effective to prevent REIT status under the Internal Revenue Code from being jeopardized under the 10% lessee affiliate rule. Furthermore, there can be no assurance that we will be able to monitor and enforce these restrictions, nor will our shareholders necessarily be aware of ownership of shares attributed to them under the Internal Revenue Code's attribution rules.
o In order for rents to qualify, we generally must not manage the property or furnish or render services to the tenants of the property, except through an independent contractor from whom we derive no income. There is an exception to this rule permitting a REIT to perform customary tenant services of the sort which a tax-exempt organization could perform without being considered in receipt of "unrelated business taxable income" as defined in Section 512(b)(3) of the Internal Revenue Code. In addition, a de minimis amount of noncustomary services will not disqualify income as "rents from real property" so long as the value of the impermissible services does not exceed 1% of the gross income from the property.
o If rent attributable to personal property leased in connection with a lease of real property is 15% or less of the total rent received under the lease, then the rent attributable to personal property will qualify as rents from real property; if this 15% threshold is exceeded, the rent attributable to personal property will not so qualify. The portion of rental income treated as attributable to personal property is determined according to the ratio of the tax basis of the personal property to the total tax basis of the real and personal property which is rented. For taxable years after 2000, the ratio will be determined by reference to fair market values rather than tax bases.
We believe that all or substantially all our rents have qualified and will qualify as rents from real property for purposes of Section 856 of the Internal Revenue Code.
In order to qualify as mortgage interest on real property for purposes of the 75% test, interest must derive from a mortgage loan secured by real property with a fair market value, at the time the loan is made, at least equal to the amount of the loan. If the amount of the loan exceeds the fair market value of the real property, the interest will be treated as interest on a mortgage loan in a ratio equal to the ratio of the fair market value of the real property to the total amount of the mortgage loan.
Any gain we realize on the sale of property held as inventory or other property held primarily for sale to customers in the ordinary course of business will be treated as income from a prohibited transaction that is subject to a penalty tax at a 100% rate. This prohibited transaction income also may have an adverse effect upon our ability to
satisfy the 75% and 95% gross income tests for federal income tax qualification as a REIT. We cannot provide assurances as to whether or not the IRS might successfully assert that one or more of our dispositions is subject to the 100% penalty tax. However, we believe that dispositions of assets that we might make will not be subject to the 100% penalty tax, because we intend to:
o own our assets for investment with a view to long-term income production and capital appreciation;
o engage in the business of developing, owning and operating our existing properties and acquiring, developing, owning and operating new properties; and
o make occasional dispositions of our assets consistent with our long-term investment objectives.
If we fail to satisfy one or both of the 75% or 95% gross income tests for any taxable year, we may nevertheless qualify as a REIT for that year if:
o our failure to meet the test was due to reasonable cause and not due to willful neglect;
o we report the nature and amount of each item of our income included in the 75% or 95% gross income tests for that taxable year on a schedule attached to our tax return; and
o any incorrect information on the schedule was not due to fraud with intent to evade tax.
It is impossible to state whether in all circumstances we would be entitled to the benefit of this relief provision for the 75% and 95% gross income tests. Even if this relief provision did apply, a special tax equal to 100% is imposed upon the greater of the amount by which we failed the 75% test or the 95% test, multiplied by a fraction intended to reflect our profitability.
Asset Tests. At the close of each quarter of each taxable year, we must also satisfy three percentage tests relating to the nature of our assets:
o At least 75% of our total assets must consist of real estate assets, cash and cash items, shares in other REITs, government securities, and stock or debt instruments purchased with proceeds of a stock offering or an offering of our debt with a term of at least five years, but only for the one-year period commencing with our receipt of the offering proceeds.
o Not more than 25% of our total assets may be represented by securities other than those securities that count favorably toward the preceding 75% asset test.
o Of the investments included in the preceding 25% asset class, the value of any one issuer's securities that we own may not exceed 5% of the value of our total assets, and we may not own more than 10% of any one non-REIT issuer's outstanding voting securities. For taxable years after 2000, we may not own more than 10% of the vote or value of any one non-REIT issuer's outstanding securities, unless that issuer is our taxable REIT subsidiary or the securities are straight debt securities.
When a failure to satisfy the above asset tests results from an acquisition of securities or other property during a quarter, the failure can be cured by disposition of sufficient nonqualifying assets within 30 days after the close of that quarter. We intend to maintain records of the value of our assets to document our compliance with the above three asset tests, and to take actions as may be required to cure any failure to satisfy the tests within 30 days after the close of any quarter.
Our Investment in Senior Housing Properties Trust. We continue to own a substantial minority of Senior Housing Properties Trust shares, and we expect Senior Housing Properties Trust to qualify as a REIT under the Internal Revenue Code. For so long as it so qualifies, our investment in Senior Housing Properties Trust will count favorably toward the REIT asset tests and the dividends we receive from Senior Housing Properties Trust will count as qualifying income under the REIT gross income tests.
Annual Distribution Requirements. In order to qualify for taxation as a REIT under the Internal Revenue Code, we are required to make annual distributions other than capital gain dividends to our shareholders in an amount at least equal to the excess of:
(A) the sum of 95% of our "real estate investment trust taxable income," as defined in Section 857 of the Internal Revenue Code, computed by excluding any net capital gain and before taking into account any dividends paid
deduction for which we are eligible, and 95% of our net income after tax, if any, from property received in foreclosure, over
(B) the sum of our qualifying noncash income, e.g., imputed rental income or income from transactions inadvertently failing to qualify as like-kind exchanges.
For our taxable years after 2000, the preceding 95% percentages are reduced to 90%. The distributions must be paid in the taxable year to which they relate, or in the following taxable year if declared before we timely file our tax return for the earlier taxable year and if paid on or before the first regular distribution payment after that declaration. Dividends declared in October, November, or December and paid during the following January will be treated as having been both paid and received on December 31 of the prior taxable year. A distribution which is not pro rata within a class of our beneficial interests entitled to a distribution, or which is not consistent with the rights to distributions among our classes of beneficial interests, is a preferential distribution that is not taken into consideration for purposes of the distribution requirements, and accordingly the payment of a preferential distribution could affect our ability to meet the distribution requirements. Taking into account our distribution policies, including the dividend reinvestment plan we have adopted, we expect that we will not make any preferential distributions. The distribution requirements may be waived by the IRS if a REIT establishes that it failed to meet them by reason of distributions previously made to meet the requirements of the 4% excise tax discussed below. To the extent that we do not distribute all of our net capital gain and all of our real estate investment trust taxable income, as adjusted, we will be subject to tax on undistributed amounts.
In addition, we will be subject to a 4% excise tax to the extent we fail within a calendar year to make required distributions to our shareholders of 85% of our ordinary income and 95% of our capital gain net income plus the excess, if any, of the "grossed up required distribution" for the preceding calendar year over the amount treated as distributed for that preceding calendar year. For this purpose, the term "grossed up required distribution" for any calendar year is the sum of our taxable income for the calendar year without regard to the deduction for dividends paid and all amounts from earlier years that are not treated as having been distributed under the provision.
If we do not have enough cash or other liquid assets to meet the 95% distribution requirements, we may find it necessary to arrange for new debt or equity financing to provide funds for required distributions, or else our REIT status for federal income tax purposes could be jeopardized. We can provide no assurance that financing would be available for these purposes on favorable terms.
If we fail to distribute sufficient dividends for any year, we may be able to rectify this failure by paying "deficiency dividends" to shareholders in a later year. These deficiency dividends may be included in our deduction for dividends paid for the earlier year, but an interest charge would be imposed upon us for the delay in distribution. Although we may be able to avoid being taxed on amounts distributed as deficiency dividends, we will remain liable for the 4% excise tax discussed above.
Recent Federal Taxation Changes. The Tax Relief Extension Act of 1999 was enacted late in 1999 and is effective for taxable years after 2000. This legislation contained several tax provisions regarding REITs, including a reduction of the annual distribution requirement for real estate investment trust taxable income from 95% to 90%, as mentioned above. The Act also changed the 10% voting securities test under current law to a 10% vote or value test. Thus, subject to exceptions, a REIT will no longer be allowed to own more that 10% by vote or value of the outstanding securities of any issuer, other than a qualified REIT subsidiary or another REIT. Another exception to this new test, which is also an exception to the 5% asset test under current law, allows a REIT to own any or all of the securities of an electing "taxable REIT subsidiary," provided that no more than 20% of the REIT's assets is represented by the stock or securities of taxable REIT subsidiaries. A taxable REIT subsidiary can perform noncustomary services for tenants of a REIT without disqualifying rents received from the tenants for purposes of the REIT's gross income tests and can also undertake third-party management and development activities and activities that are not related to real estate. A taxable REIT subsidiary will be taxed as a subchapter C corporation but will be subject to earnings stripping limitations on the deductibility of interest paid to the REIT. In addition, a REIT will be subject to a 100% excise tax on certain excess amounts to ensure that:
o tenants who pay a taxable REIT subsidiary for services are charged an arm's length amount by the taxable REIT subsidiary for these services;
o shared expenses of a REIT and its taxable REIT subsidiary are allocated fairly between the two; and
o interest paid by a taxable REIT subsidiary to the REIT that owns it is commercially reasonable.
Depreciation and Federal Income Tax Treatment of Leases
Our initial tax bases in our assets will generally be our acquisition cost. We will generally depreciate our real property on a straight-line basis over 40 years and our personal property over 12 years. These depreciation schedules may vary for properties that we acquire through tax-free or carryover basis acquisitions.
We will be entitled to depreciation deductions from our facilities only if we are treated for federal income tax purposes as the owner of the facilities. This means that the leases of the facilities must be classified for federal income tax purposes as true leases, rather than as sales or financing arrangements, and we believe this to be the case. In the case of sale-leaseback arrangements, the IRS could assert that we realized prepaid rental income in the year of purchase to the extent that the value of a leased property, at the time of purchase, exceeded the purchase price for that property. While we believe that the value of leased property at the time of purchase did not exceed purchase prices, because of the lack of clear precedent we cannot provide assurances as to whether the IRS might successfully assert the existence of prepaid rental income in any of our sale-leaseback transactions.
Additionally, Section 467 of the Internal Revenue Code, which concerns leases with increasing rents, may apply to those of our leases which provide for rents that increase from one period to the next. Section 467 of the Internal Revenue Code provides that in the case of a so-called "disqualified leaseback agreement" rental income must be accrued at a constant rate. Where constant rent accrual is required, we could recognize rental income from a lease in excess of cash rents and, as a result, encounter difficulty in meeting the annual distribution requirement. Disqualified leaseback agreements include leaseback transactions where a principal purpose for providing increasing rent under the agreement is the avoidance of federal income tax. Recently issued Treasury regulations provide that rents will not be treated as increasing for tax avoidance purposes where the increases are based upon a fixed percentage of lessee receipts. Therefore, the additional rent provisions in our leases that are based on a fixed percentage of lessee receipts generally should not cause the leases to be disqualified leaseback agreements under Section 467.
Taxation of U.S. Shareholders
As long as we qualify as a REIT for federal income tax purposes, a distribution to our U.S. shareholders that we do not designate as a capital gain dividend will be treated as an ordinary income dividend to the extent that it is made out of current or accumulated earnings and profits. Distributions made out of our current or accumulated earnings and profits that we properly designate as capital gain dividends will be taxed as long-term capital gains, as discussed below, to the extent they do not exceed our actual net capital gain for the taxable year. However, corporate shareholders may be required to treat up to 20% of any capital gain dividend as ordinary income under Section 291 of the Internal Revenue Code.
In addition, we may elect to retain net capital gain income and treat it as constructively distributed. In that case:
(1) we will be taxed at regular corporate capital gains tax rates on retained amounts,
(2) each U.S. shareholder will be taxed on its designated proportionate share of our retained net capital gains as though that amount were distributed and designated a capital gain dividend,
(3) each U.S. shareholder will receive a credit for its designated proportionate share of the tax that we pay,
(4) each U.S. shareholder will increase its adjusted basis in our shares by the excess of the amount of its proportionate share of these retained net capital gains over its proportionate share of this tax that we pay, and
(5) both we and our corporate shareholders will make commensurate adjustments in our respective earnings and profits for federal income tax purposes.
If we elect to retain our net capital gains in this fashion, we will notify our U.S. shareholders of the relevant tax information within 60 days after the close of the affected taxable year.
For noncorporate U.S. shareholders, long-term capital gains are generally taxed at maximum rates of 20% or 25%, depending upon the type of property disposed of and the previously claimed depreciation with respect to this property. If for any taxable year we designate as capital gain dividends any portion of the dividends paid or made available for the year to our U.S. shareholders, including our retained capital gains treated as capital gain dividends, then the portion of the capital gain dividends so designated that will be allocated to the holders of a particular class of shares will on a percentage basis equal the ratio of the amount of the total dividends paid or made available for the year
to the holders of that class of shares to the total dividends paid or made available for the year to holders of all classes of our shares. We will similarly designate the portion of any capital gain dividend that is to be taxed to noncorporate U.S. shareholders at the maximum rates of 20% or 25% so that the designations will be proportional among all classes of our shares.
Distributions in excess of current or accumulated earnings and profits will not be taxable to a U.S. shareholder to the extent that they do not exceed the shareholder's adjusted basis in the shareholder's shares, but will reduce the shareholder's basis in those shares. To the extent that these excess distributions exceed the adjusted basis of a U.S. shareholder's shares, they will be included in income as capital gain, with long-term gain generally taxed to noncorporate U.S. shareholders at a maximum rate of 20%. No U.S. shareholder may include on his federal income tax return any of our net operating losses or any of our capital losses.
Dividends that we declare in October, November or December of a taxable year to U.S. shareholders of record on a date in those months will be deemed to have been received by shareholders on December 31 of that taxable year, provided we actually pay these dividends during the following January. Also, items that are treated differently for regular and alternative minimum tax purposes are to be allocated between a REIT and its shareholders under Treasury regulations which are to be prescribed. It is possible that these Treasury regulations will require tax preference items to be allocated to our shareholders with respect to any accelerated depreciation or other tax preference items that we claim.
A U.S. shareholder's sale or exchange of our shares will result in recognition of gain or loss in an amount equal to the difference between the amount realized and the shareholder's adjusted basis in the shares sold or exchanged. This gain or loss will be capital gain or loss, and will be long-term capital gain or loss if the shareholder's holding period in the shares exceeds one year. In addition, any loss upon a sale or exchange of our shares held for six months or less will generally be treated as a long-term capital loss to the extent of our long-term capital gain dividends during the holding period.
Noncorporate U.S. shareholders who borrow funds to finance their acquisition of our shares could be limited in the amount of deductions allowed for the interest paid on the indebtedness incurred. Under Section 163(d) of the Internal Revenue Code, interest paid or accrued on indebtedness incurred or continued to purchase or carry property held for investment is generally deductible only to the extent of the investor's net investment income. A U.S. shareholder's net investment income will include ordinary income dividend distributions received from us and, if an appropriate election is made by the shareholder, capital gain dividend distributions received from us; however, distributions treated as a nontaxable return of the shareholder's basis will not enter into the computation of net investment income.
Taxation of Tax-Exempt Shareholders
In Revenue Ruling 66-106, the IRS ruled that amounts distributed by a REIT to a tax-exempt employees' pension trust did not constitute "unrelated business taxable income," even though the REIT may have financed some its activities with acquisition indebtedness. Although revenue rulings are interpretive in nature and subject to revocation or modification by the IRS, based upon the analysis and conclusion of Revenue Ruling 66-106, our distributions made to shareholders that are tax-exempt pension plans, individual retirement accounts, or other qualifying tax-exempt entities should not constitute unrelated business taxable income, unless the shareholder has financed its acquisition of our shares with "acquisition indebtedness" within the meaning of the Internal Revenue Code.
Special rules apply to tax-exempt pension trusts, including so-called 401(k) plans but excluding individual retirement accounts or government pension plans, that own more than 10% by value of a "pension-held REIT" at any time during a taxable year. The pension trust may be required to treat a percentage of all dividends received from the pension-held REIT during the year as unrelated business taxable income. This percentage is equal to the ratio of:
(1) the pension-held REIT's gross income derived from the conduct of unrelated trades or businesses, determined as if the pension-held REIT were a tax-exempt pension fund, less direct expenses related to that income, to
(2) the pension-held REIT's gross income from all sources, less direct expenses related to that income,
except that this percentage shall be deemed to be zero unless it would otherwise equal or exceed 5%. A REIT is a pension-held REIT if:
o the REIT is "predominantly held" by tax-exempt pension trusts, and
o the REIT would otherwise fail to satisfy the "closely held" ownership requirement discussed above if the stock or beneficial interests in the REIT held by tax-exempt pension trusts were viewed as held by tax-exempt pension trusts rather than by their respective beneficiaries.
A REIT is predominantly held by tax-exempt pension trusts if at least one tax-exempt pension trust owns more than 25% by value of the REIT's stock or beneficial interests, or if one or more tax-exempt pension trusts, each owning more than 10% by value of the REIT's stock or beneficial interests, own in the aggregate more than 50% by value of the REIT's stock or beneficial interests. Because of the restrictions in our declaration of trust regarding the ownership concentration of our shares, we believe that we are not and will not be a pension-held REIT. However, because our shares are publicly traded, we cannot completely control whether or not we are or will become a pension-held REIT.
Taxation of Non-U.S. Shareholders
The rules governing the United States federal income taxation of non-U.S. shareholders are complex, and the following discussion is intended only as a summary of these rules. If you are a non-U.S. shareholder, we urge you to consult with your own tax advisor to determine the impact of United States federal, state, local, and foreign tax laws, including any tax return filing and other reporting requirements, with respect to your investment in our shares.
In general, a non-U.S. shareholder will be subject to regular United States federal income tax in the same manner as a U.S. shareholder with respect to its investment in our shares if that investment is effectively connected with the non-U.S. shareholder's conduct of a trade or business in the United States. In addition, a corporate non-U.S. shareholder that receives income that is or is deemed effectively connected with a trade or business in the United States may also be subject to the 30% branch profits tax under Section 884 of the Internal Revenue Code, which is payable in addition to regular United States federal corporate income tax. The balance of this discussion on the United States federal income taxation of non-U.S. shareholders addresses only those non-U.S. shareholders whose investment in our shares is not effectively connected with the conduct of a trade or business in the United States.
A distribution by us to a non-U.S. shareholder that is not attributable to gain from the sale or exchange of a United States real property interest and that is not designated as a capital gain dividend will be treated as an ordinary income dividend to the extent that it is made out of current or accumulated earnings and profits. A distribution of this type will generally be subject to United States federal income tax and withholding at the rate of 30%, or the lower rate that may be specified by a tax treaty if the non-U.S. shareholder has in the manner prescribed by the IRS demonstrated its entitlement to benefits under a tax treaty. Because we cannot determine our current and accumulated earnings and profits until the end of the taxable year, withholding at the rate of 30% or applicable lower treaty rate will be imposed on the gross amount of any distribution to a non-U.S. shareholder that we make and do not designate a capital gain dividend. Notwithstanding this withholding on distributions in excess of our current and accumulated earnings and profits, these distributions are a nontaxable return of capital to the extent that they do not exceed the non-U.S. shareholder's adjusted basis in our shares, and the nontaxable return of capital will reduce the adjusted basis in these shares. To the extent that distributions in excess of current and accumulated earnings and profits exceed the non-U.S. shareholder's adjusted basis in our shares, the distributions will give rise to tax liability if the non-U.S. shareholder would otherwise be subject to tax on any gain from the sale or exchange of these shares, as discussed below. A non-U.S. shareholder may seek a refund from the IRS of amounts withheld on distributions to him in excess of our current and accumulated earnings and profits.
For any year in which we qualify as a REIT, distributions that are attributable to gain from the sale or exchange of a United States real property interest are taxed to a non-U.S. shareholder as if these distributions were gains effectively connected with a trade or business in the United States conducted by the non-U.S. shareholder. Accordingly, a non-U.S. shareholder will be taxed on these amounts at the normal capital gain rates applicable to a U.S. shareholder, subject to any applicable alternative minimum tax and to a special alternative minimum tax in the case of nonresident alien individuals; the non-U.S. shareholder will be required to file a United States federal income tax return reporting these amounts, even if applicable withholding is imposed as described below; and corporate non-U.S. shareholders may owe the 30% branch profits tax under Section 884 of the Internal Revenue Code in respect of these amounts. We will be required to withhold from distributions to non-U.S. shareholders, and remit to the IRS, 35% of the maximum amount of any distribution that could be designated as a capital gain dividend. In addition, for purposes of this withholding rule, if we designate prior distributions as capital gain dividends, then subsequent distributions up to the amount of the designated prior distributions will be treated as capital gain dividends. The amount of any tax withheld is creditable against the non-U.S. shareholder's United States federal income tax liability, and any amount of tax withheld in excess of that tax liability may be refunded provided that an appropriate claim for refund is filed with the IRS. If for any taxable year we designate as capital gain dividends any portion of the dividends paid or made available for the year to our shareholders, including our retained capital gains treated as capital gain dividends, then the portion of the capital gain dividends so designated that will be allocated to the holders of a particular class of shares will on a percentage basis equal the ratio of the amount of the total dividends paid or made available for the year to the
holders of that class of shares to the total dividends paid or made available for the year to holders of all classes of our shares.
Tax treaties may reduce the withholding obligations on our distributions. Under some treaties, however, rates below 30% generally applicable to ordinary income dividends from United States corporations may not apply to ordinary income dividends from a REIT. If the amount of tax withheld by us with respect to a distribution to a non-U.S. shareholder exceeds the shareholder's United States federal income tax liability with respect to the distribution, the non-U.S. shareholder may file for a refund of the excess from the IRS. In this regard, note that the 35% withholding tax rate on capital gain dividends corresponds to the maximum income tax rate applicable to corporate non-U.S. shareholders but is higher than the 20% and 25% maximum rates on capital gains generally applicable to noncorporate non-U.S. shareholders. Generally effective with respect to distributions paid after December 31, 2000, new Treasury regulations alter the information reporting and backup withholding rules applicable to non-U.S. shareholders and provide presumptions under which a non-U.S. shareholder is subject to backup withholding and information reporting until we or the applicable withholding agent receives certification from the shareholder of its non-U.S. shareholder status. In some instances, these certification requirements are more burdensome than those applicable under current Treasury regulations. These new Treasury regulations also provide special rules to determine whether, for purposes of determining the applicability of a tax treaty, our distributions to a non-U.S. shareholder that is an entity should be treated as paid to the entity or to those owning an interest in that entity, and whether the entity or its owners are entitled to benefits under the tax treaty. These new Treasury regulations encourage non-U.S. shareholders and withholding agents to use the new IRS Forms W-8 series, rather than the predecessor IRS Forms W-8, 1001, and 4224, and require use of the IRS Forms W-8 series for payments made after December 31, 2000.
If our shares are not "United States real property interests" within the meaning of Section 897 of the Internal Revenue Code, a non-U.S. shareholder's gain on sale of these shares generally will not be subject to United States federal income taxation, except that a nonresident alien individual who was present in the United States for 183 days or more during the taxable year will be subject to a 30% tax on this gain. Our shares will not constitute a United States real property interest if we are a "domestically controlled REIT." A domestically controlled REIT is a REIT in which at all times during the preceding five-year period less than 50% in value of its shares is held directly or indirectly by foreign persons. We believe that we are and will be a domestically controlled REIT and thus a non-U.S. shareholder's gain on sale of our shares will not be subject to United States federal income taxation. However, because our shares are publicly traded, we can provide no assurance that we will be a domestically controlled REIT. If we are not a domestically controlled REIT, a non-U.S. shareholder's gain on sale of our shares will not be subject to United States federal income taxation as a sale of a United States real property interest, if that class of shares is "regularly traded," as defined by applicable Treasury regulations, on an established securities market like the New York Stock Exchange, and the non-U.S. shareholder has at all times during the preceding five years owned 5% or less by value of that class of shares. If the gain on the sale of our shares were subject to United States federal income taxation, the non-U.S. shareholder will generally be subject to the same treatment as a U.S. shareholder with respect to its gain, will be required to file a United States federal income tax return reporting that gain, and in the case of corporate non-U.S. shareholders might owe branch profits tax under Section 884 of the Internal Revenue Code. A purchaser of our shares from a non-U.S. shareholder will not be required to withhold on the purchase price if the purchased shares are regularly traded on an established securities market or if we are a domestically controlled REIT. Otherwise, a purchaser of our shares from a non-U.S. shareholder may be required to withhold 10% of the purchase price paid to the non-U.S. shareholder and to remit the withheld amount to the IRS.
Backup Withholding and Information Reporting
Information reporting and backup withholding may apply to distributions or proceeds paid to our shareholders under the circumstances discussed below. Amounts withheld under backup withholding are generally not an additional tax and may be refunded or credited against the REIT shareholder's federal income tax liability.
A U.S. shareholder will be subject to backup withholding at a 31% rate when it receives distributions on our shares or proceeds upon the sale, exchange, redemption, retirement or other disposition of our shares, unless the U.S. shareholder properly executes under penalties of perjury an IRS Form W-9 or substantially similar form that:
o provides the U.S. shareholder's correct taxpayer identification number; and
o certifies that the U.S. shareholder is exempt from backup withholding because it is a corporation or comes within another exempt category, it has not been notified by the IRS that it is subject to backup withholding, or it has been notified by the IRS that it is no longer subject to backup withholding.
If the U.S. shareholder does not provide its correct taxpayer identification number on the IRS Form W-9 or substantially similar form, it may be subject to penalties imposed by the IRS and the REIT or other applicable withholding agent may also have to withhold a portion of any capital gain distributions paid to it. Unless the U.S. shareholder has established on a properly executed IRS Form W-9 or substantially similar form that it is a corporation or comes within another exempt category, distributions on our shares paid to it during the calendar year, and the amount of tax withheld if any, will be reported to it and to the IRS.
Distributions on our shares to a non-U.S. shareholder during each calendar year and the amount of tax withheld, if any, will generally be reported to the non-U.S. shareholder and to the IRS. This information reporting requirement applies regardless of whether the non-U.S. shareholder is subject to withholding on distributions on our shares or whether the withholding was reduced or eliminated by an applicable tax treaty. Also, distributions paid to a non-U.S. shareholder on our shares may be subject to backup withholding at a 31% rate, unless the non-U.S. shareholder properly certifies its non-U.S. shareholder status on an IRS Form W-8 or substantially similar form in the manner described above. Similarly, information reporting and 31% backup withholding will not apply to proceeds a non-U.S. shareholder receives upon the sale, exchange, redemption, retirement or other disposition of our shares, if the non-U.S. shareholder properly certifies its non-U.S. shareholder status on an IRS Form W-8 or substantially similar form. Even without having executed an IRS Form W-8 or substantially similar form, however, in some cases information reporting and 31% backup withholding will not apply to proceeds that a non-U.S. shareholder receives upon the sale, exchange, redemption, retirement or other disposition of our shares if the non-U.S. shareholder receives those proceeds through a broker's foreign office. As described above, new Treasury regulations alter the information reporting and backup withholding rules applicable to non-U.S. shareholders for payments made after December 31, 2000, and in general these new Treasury Regulations replace IRS Forms W-8, 1001, and 4224 with the new IRS Forms W-8 series. For a non-U.S. shareholder whose income and gain on our shares is effectively connected to the conduct of a United States trade or business, a slightly different rule may apply to proceeds received upon the sale, exchange, redemption, retirement or other disposition of our shares. Until the non-U.S. shareholder complies with the new Treasury regulations, information reporting and 31% backup withholding may apply in the same manner as to a U.S. shareholder, and thus the non-U.S. shareholder may have to execute an IRS Form W-9 or substantially similar form to prevent the backup withholding.
Other Tax Consequences
You should recognize that our and our shareholders' federal income tax treatment may be modified by legislative, judicial, or administrative actions at any time, which actions may be retroactive in effect. The rules dealing with federal income taxation are constantly under review by the Congress, the IRS and the Treasury Department, and statutory changes as well as promulgation of new regulations, revisions to existing regulations, and revised interpretations of established concepts occur frequently. No prediction can be made as to the likelihood of passage of new tax legislation or other provisions either directly or indirectly affecting us and our shareholders. Revisions in federal income tax laws and interpretations of these laws could adversely affect the tax consequences of an investment in our shares. We and our shareholders may also be subject to state or local taxation in various state or local jurisdictions, including those in which we or our shareholders transact business or reside. State and local tax consequences may not be comparable to the federal income tax consequences discussed above.
ERISA PLANS, KEOGH PLANS AND INDIVIDUAL RETIREMENT ACCOUNTS
General Fiduciary Obligations
Fiduciaries of a pension, profit-sharing or other employee benefit plan subject to Title I of the Employee Retirement Income Security Act of 1974, ERISA, must consider whether:
o their investment in our shares satisfies the diversification requirements of ERISA;
o the investment is prudent in light of possible limitations on the marketability of our shares;
o they have authority to acquire our shares under the applicable governing instrument and Title I of ERISA; and
o the investment is otherwise consistent with their fiduciary responsibilities.
Trustees and other fiduciaries of an ERISA plan may incur personal liability for any loss suffered by the plan on account of a violation of their fiduciary responsibilities. In addition, these fiduciaries may be subject to a civil penalty of up to 20% of any amount recovered by the plan on account of a violation. Fiduciaries of any IRA, Roth IRA, Keogh Plan or other qualified retirement plan not subject to Title I of ERISA, referred to as "non-ERISA plans," should consider that a plan may only make investments that are authorized by the appropriate governing instrument. Fiduciary shareholders should consult their own legal advisors if they have any concern as to whether the investment is consistent with the foregoing criteria.
Prohibited Transactions
Fiduciaries of ERISA plans and persons making the investment decision for an IRA or other non-ERISA plan should consider the application of the prohibited transaction provisions of ERISA and the Internal Revenue Code in making their investment decision. Sales and other transactions between an ERISA plan or a non-ERISA plan, and persons related to it are prohibited transactions. The particular facts concerning the sponsorship, operations and other investments of an ERISA plan or non-ERISA plan may cause a wide range of other persons to be treated as disqualified persons or parties in interest with respect to it. A prohibited transaction, in addition to imposing potential personal liability upon fiduciaries of ERISA plans, may also result in the imposition of an excise tax under the Internal Revenue Code or a penalty under ERISA upon the disqualified person or party in interest with respect to the plan. If the disqualified person who engages in the transaction is the individual on behalf of whom an IRA or Roth IRA is maintained or his beneficiary, the IRA or Roth IRA may lose its tax-exempt status and its assets may be deemed to have been distributed to the individual in a taxable distribution on account of the prohibited transaction, but no excise tax will be imposed. Fiduciary shareholders should consult their own legal advisors as to whether the ownership of our shares involves a prohibited transaction.
Special Fiduciary and Prohibited Transactions Consequences
The Department of Labor, which has administrative responsibility over ERISA plans as well as non-ERISA plans, has issued a regulation defining "plan assets." The regulation generally provides that when an ERISA or non-ERISA plan acquires a security that is an equity interest in an entity and that security is neither a "publicly offered security" nor a security issued by an investment company registered under the Investment Company Act of 1940, the ERISA plan's or non-ERISA plan's assets include both the equity interest and an undivided interest in each of the underlying assets of the entity, unless it is established either that the entity is an operating company or that equity participation in the entity by benefit plan investors is not significant.
Each class of our shares, that is our common shares and any class of preferred shares that we may issue, must be analyzed separately to ascertain whether it is a publicly offered security. The regulation defines a publicly offered security as a security that is "widely held," "freely transferable" and either part of a class of securities registered under the Securities Exchange Act of 1934, or sold under an effective registration statement under the Securities Act of 1933, provided the securities are registered under the Securities Exchange Act of 1934 within 120 days after the end of the fiscal year of the issuer during which the offering occurred. All our outstanding shares have been registered under the Securities Exchange Act of 1934.
The regulation provides that a security is "widely held" only if it is part of a class of securities that is owned by 100 or more investors independent of the issuer and of one another. However, a security will not fail to be "widely held" because the number of independent investors falls below 100 subsequent to the initial public offering as a result of events beyond the issuer's control. Our common shares have been widely held and we expect our common shares to
continue to be widely held. We expect the same to be true of any class of preferred stock that we may issue, but we can give no assurance in that regard.
The regulation provides that whether a security is "freely transferable" is a factual question to be determined on the basis of all relevant facts and circumstances. The regulation further provides that, where a security is part of an offering in which the minimum investment is $10,000 or less, some restrictions on transfer ordinarily will not, alone or in combination, affect a finding that these securities are freely transferable. The restrictions on transfer enumerated in the regulation as not affecting that finding include:
o any restriction on or prohibition against any transfer or assignment which would result in a termination or reclassification for federal or state tax purposes, or would otherwise violate any state or federal law or court order;
o any requirement that advance notice of a transfer or assignment be given to the issuer and any requirement that either the transferor or transferee, or both, execute documentation setting forth representations as to compliance with any restrictions on transfer which are among those enumerated in the regulation as not affecting free transferability, including those described in the preceding clause of this sentence;
o any administrative procedure which establishes an effective date, or an event prior to which a transfer or assignment will not be effective; and
o any limitation or restriction on transfer or assignment which is not imposed by the issuer or a person acting on behalf of the issuer.
We believe that the restrictions imposed under our declaration of trust on the transfer of shares do not result in the failure of our shares to be "freely transferable." Furthermore, we believe that at present there exist no other facts or circumstances limiting the transferability of our shares which are not included among those enumerated as not affecting their free transferability under the regulation, and we do not expect or intend to impose in the future, or to permit any person to impose on our behalf, any limitations or restrictions on transfer which would not be among the enumerated permissible limitations or restrictions.
Assuming that each class of our shares will be "widely held" and that no other facts and circumstances exist which restrict transferability of these shares, we have received an opinion of our counsel Sullivan & Worcester LLP that our shares will not fail to be "freely transferable" for purposes of the regulation due to the restrictions on transfer of the shares under our declaration of trust and that under the regulation the shares are publicly offered securities and our assets will not be deemed to be "plan assets" of any ERISA plan or non-ERISA plan that invests in our shares.
Item 2.
Item 2. Properties
General. At December 31, 1999, approximately 89% of our total investments were in office buildings, 7% were in senior housing properties through our equity investment in SNH and 4% were in hotels through our equity investment in HPT. We believe that the physical plant of each of the properties in which we have invested is suitable and adequate for our present and any currently proposed uses. At December 31, 1999, we had real estate investments totaling $2.7 billion at cost in 201 properties that were leased to or operated by over 800 tenants, plus equity investments of approximately $201.8 million (carrying value) and $109.3 million (carrying value) in approximately 49.3% and 7.1% of the common shares of SNH and HPT, respectively. At December 31, 1999, SNH and HPT had investments in 93 senior housing properties and 210 hotel properties, respectively. At December 31, 1999, 11 properties we owned with an aggregate cost of $99 million were secured by five mortgage notes payable aggregating $55.4 million.
The following table summarizes some information about our properties as of December 31, 1999. All dollar figures are in thousands.
Item 3.
Item 3. Legal Proceedings
As previously disclosed, in early 1995 we commenced an action in Florida state court to collect on a secured indemnity agreement from a former tenant and mortgagor, together with certain related parties (collectively, the "Former Tenant"). In May 1995 the Former Tenant filed a counterclaim and third-party complaint against us and others, including Messrs. Martin and Portnoy, HRPT Advisors, Inc. and Sullivan & Worcester LLP, seeking, among other things, to set aside the indemnity agreement and to recover substantial damages. After a Massachusetts state court ordered the dispute to arbitration and a Florida court stayed further proceedings pending arbitration, the Former Tenant brought a separate action against us in the United States District Court for the District of Massachusetts and realleged many of the same allegations made in the counterclaims and third-party complaints previously brought by them in response to our original action, and added allegations of violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, Rule 10b-5 promulgated thereunder and violations of 18 U.S.C. ss. 1962 (RICO). In September 1996, the United States District Court for the District of Massachusetts ordered the case brought by the Former Tenant dismissed and all disputes between the Former Tenant and us referred to arbitration. The arbitration is proceeding, and although the amount of damages claimed by the Former Tenant is material, all claims of the Former Tenant against us were dismissed in January 1999, except one claim for common law fraud. The arbitrators' ruling, dismissing all but one claim against us, both narrows substantially the scope of claims pending against us and diminishes greatly the risk of the Former Tenant being able to hold us liable for (i) attorneys fees and costs, or (ii) multiple damages, should the Former Tenant prevail on its sole remaining claim. We continue to pursue our indemnity claims in the arbitration. As we have previously disclosed, certain related cases have also been filed by creditors or assignees of the Former Tenant. The amounts of damages claimed by the creditors or assignees of the Former Tenant are material. We are defending the claims of the creditors or assignees of the Former Tenant in these related proceedings, currently pending in Massachusetts Superior Court. The outcome of the arbitration and the related pending claims and proceedings cannot be predicted.
The Declaration of Trust provides that our Trustees shall be indemnified in certain circumstances by us in connection with claims asserted against them by reason of their status, subject to various limitations contained in the Declaration of Trust. Were Messrs. Martin and Portnoy to be held liable in the proceedings described above, they may have a claim for indemnification from us.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of shareholders during the fourth quarter of the year covered by this Annual Report on Form 10-K.
PART II
Item 5.
Item 5. Market for Registrant's Common Stock and Related Shareholder Matters
Our shares are traded on the New York Stock Exchange (symbol: HRP). The following table sets forth for the periods indicated the high and low sale prices for our shares as reported in the New York Stock Exchange Composite Transactions reports. Share prices on or before October 13, 1999 have not been restated to reflect the spin-off of SNH.
High Low ---- --- First Quarter $20 15/16 $19 5/8 Second Quarter 20 1/4 17 7/8 Third Quarter 18 13/16 15 5/8 Fourth Quarter 17 1/8 14
First Quarter 15 13 Second Quarter 15 9/16 13 5/16 Third Quarter 15 1/8 11 1/4 Fourth Quarter 12 1/8 7 7/16
The closing price of our shares on the New York Stock Exchange on March 27, 2000 was $8.
As of March 10, 2000, there were 5,575 holders of record of our shares, and we estimate that as of that date there were in excess of 120,000 beneficial owners of our shares.
Distributions declared with respect to each period for the two most recent fiscal years are set forth in the following table. Distributions are generally paid in the quarter following the quarter to which they relate.
Distribution Per Share First Quarter $0.38 Second Quarter 0.38 Third Quarter 0.38 Fourth Quarter 0.38
First Quarter 0.38 Second Quarter 0.38 Third Quarter 0.32 Fourth Quarter 0.32
All distributions declared have been paid. We intend to continue to declare and pay future distributions on a quarterly basis. In addition to the distributions shown above, a non-cash distribution of $1.65 per share was made on October 12, 1999 for the spin-off of SNH.
In order to qualify for the beneficial tax treatment accorded to REITs by Sections 856 through 860 of the Internal Revenue Code, we are required to make distributions to shareholders which annually are equal to at least 95% of our taxable income. All distributions made by us are at the discretion of the Trustees and depend on our earnings, our cash flow available for distribution, our financial condition and other factors that the Trustees deem relevant.
In December 1999, we issued 500 shares pursuant to our Incentive Share Award Plan to an independent trustee elected to the Board of Trustees to fill a vacancy. The shares were valued at $7.625 per share, the closing price of our shares on the New York Stock Exchange on December 16, 1999. The grant was made pursuant to the exemption from registration contained in Section 4(2) of the Securities Act of 1933, as amended.
Item 6.
Item 6. Selected Financial Data
Set forth below is selected financial data for the periods and dates indicated. This data should be read in conjunction with, and is qualified in its entirety by reference to, the consolidated financial statements and accompanying notes included herein in Item 14 of this Annual Report on Form 10-K. Amounts are in thousands, except per share information.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following information is provided in connection with, and should be read in conjunction with, the consolidated financial statements included herein in Item 14 of this Annual Report on Form 10-K.
Results of Operations
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
Total revenues for the year ended December 31, 1999 increased to $427.5 million from $356.6 million for the year ended December 31, 1998. Revenues from our office segment increased $102.5 million and revenues from our senior housing segment decreased $32.5 million. The increase in revenues from our office segment is due to our increased real estate investments in office buildings. The decrease in revenues from our senior housing segment is due primarily to the spin-off of our subsidiary, Senior Housing Properties Trust ("SNH") discussed below, and the sale of some senior housing properties.
Rental income increased by $75.3 million and interest and other income decreased by $4.4 million. Rental income increased because of real estate investments made in 1999 and 1998, offset by the spin-off of SNH and the sale of some senior housing properties. Interest and other income decreased as a result of the spin-off and the repayment of many of our mortgage loan investments.
Total expenses for the year ended December 31, 1999, increased to $319.7 million from $219.8 million for the year ended December 31, 1998. Included in total expenses for 1999 are unusual and non-recurring items aggregating $23.7 million: approximately $16.7 million represents the SNH spin-off transaction costs, and $7 million represents the write-down to net realizable value of the carrying value of two real estate mortgages receivable. Operating expenses increased by $38.8 million primarily as a result of our increased investment in "gross leased" real estate assets during 1999 and 1998. Interest expense increased to $87.5 million for the year ended December 31, 1999, from $64.3 million for the year ended December 31, 1998, mainly due to higher borrowings outstanding during 1999 compared to 1998. Similarly, depreciation and amortization and general and administrative expenses increased from 1998 to 1999 as a result of new real estate investments during 1999 and 1998.
Net income decreased to $113.9 million, or $0.86 per basic and diluted share for the 1999 period, from $144.5 million, or $1.21 per basic and diluted share, for the 1998 period. The decrease in net income is due primarily to the spin-off of SNH and the unusual and non-recurring items discussed above, offset by new real estate investments in 1999 and 1998. Also, our equity in earnings of equity investments reflects a non-recurring loss recognized by SNH in December 1999, discussed below.
On October 12, 1999, we spun-off 50.7% of our 100% owned subsidiary, SNH, by distributing 13.2 million common shares of SNH to our shareholders of record on October 8, 1999. SNH is a real estate investment trust with 26 million common shares outstanding that invests principally in income producing senior housing real estate. In connection with the spin-off, we received $200 million from SNH that was used to repay amounts outstanding under our revolving bank credit facility.
At December 31, 1999, SNH had investments in 93 assisted living, congregate care and nursing home properties. Since the spin-off, our investment in SNH has been accounted for using the equity method. Prior to the spin-off, the operating results and investments of SNH were included in the Company's results of operations and total assets. At December 31, 1999, we owned 12.8 million, or 49.3%, of the common shares of beneficial interest of SNH with a carrying value of $201.8 million and a market value of $158.5 million.
We agreed to pay all costs relating to the spin-off of SNH. Through December 31, 1999, these costs totaled $16.7 million, which included costs of distributing SNH shares to shareholders, legal and accounting fees, Securities and Exchange Commission filing fees, New York Stock Exchange listing fees and the up-front costs of establishing SNH's bank credit facility.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - continued
Our principal business goal is to maximize funds from operations ("FFO") rather than net income. Our Board of Trustees considers FFO, among other factors, when determining distributions to be paid to shareholders. FFO, as defined in the White Paper on Funds From Operations, which was approved by the Board of Governors of NAREIT in March 1995, means net income (computed in accordance with Generally Accepted Accounting Principles ("GAAP")), excluding gains or losses from debt restructuring and sales of properties, plus depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures. Adjustments for unconsolidated partnerships and joint ventures is calculated to reflect funds from operations on the same basis. As provided in the NAREIT guidance, items classified by GAAP as extraordinary or unusual, along with significant non-recurring events that materially distort the comparative measurement of company performance over time, are disregarded in the calculation. We consider FFO to be an appropriate measure of performance for an equity REIT, along with cash flow from operating activities, financing activities and investing activities, because it provides investors with an indication of an equity REIT's ability to incur and service debt, make capital expenditures, pay distributions and fund other cash needs. We compute FFO in accordance with the standards established by NAREIT which may not be comparable to FFO reported by other REITs that do not define the term in accordance with the current NAREIT definition or that interpret the current NAREIT definition differently. FFO does not represent cash generated by operating activities in accordance with GAAP and should not be considered as an alternative to net income, determined in accordance with GAAP, as an indication of financial performance or the cash flow from operating activities, determined in accordance with GAAP, as a measure of liquidity.
Funds from operations for the year ended December 31, 1999, were $241.0 million, or $1.68 per diluted share, compared to $227.9 million, or $1.74 per diluted share, in 1998. The increase is primarily the result of new investments in 1999 and 1998, offset by a loss of FFO resulting from the spin-off of SNH. Extraordinary, unusual and non-recurring losses excluded from the 1999 calculation aggregated $23.7 million. The decrease in FFO per diluted share is due primarily to the issuance of additional shares in 1998 and the spin-off of SNH in 1999. Effective January 1, 2000, based on revised NAREIT guidance, FFO will include both recurring and non-recurring results of operations. Consequently, under the new definition, 1999's unusual and non-recurring losses would not have been excluded.
Cash distributions declared for the years ended December 31, 1999 and 1998 were $184.7 million, or $1.40 per share, and $190.3 million, or $1.52 per share, respectively. In addition, shares of SNH were distributed on October 12, 1999, to complete the spin-off discussed above. Dividends paid in the first quarter of the year generally pertain to the prior year. Distributions in excess of net income constitute return of capital. For 1999, the return of capital was 39.8% of distributions.
Cash flows provided by (used for) operating, investing and financing activities were $223.6 million, ($213.8) million and ($12.3) million, respectively, for the year ended December 31, 1999 and $194.3 million, ($947.4) million and $746.3 million, respectively, for the year ended December 31, 1998. Changes in all three categories between 1999 and 1998 are primarily related to new office property investments, the sale of senior housing investments and the spin-off of SNH.
Cash flow provided by operating activities and cash available for distribution may not necessarily equal funds from operations as cash flow is affected by other factors not included in the funds from operations calculation, such as changes in assets and liabilities.
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Total revenues for the year ended December 31, 1998 increased to $356.6 million from $208.9 million for the year ended December 31, 1997. Revenues from our office segment increased $152.3 million and revenues from our senior housing segment decreased $3.1 million. The increase in revenues from our office segment is due to our increased real estate investments in office buildings in 1998 and 1997. The decrease in rental income from our senior housing segment is a result of the repayment of some of our senior housing mortgage loan investments.
Total expenses for the year ended December 31, 1998, increased to $219.8 million from $114.5 million for the year ended December 31, 1997. Operating expenses increased by $50.8 million as a result of our increased investment in "gross leased" real estate assets during the 1998 and 1997 periods. Interest expense increased to $64.3 million for the year ended December 31, 1998, from $36.8 million for the year ended December 31, 1997, as a result of higher borrowings outstanding in the 1998 period compared to the 1997 period. Similarly, depreciation and amortization and general and administrative expenses increased between 1998 and 1997 as a result of new real estate investments in 1998 and 1997.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - continued
Net income was $144.5 million, or $1.21 per basic and diluted share for 1998, compared to $114.0 million, or $1.24 per basic and diluted share for 1997. Net income increased primarily as a result of new real estate investments in 1998 and 1997. On a per share basis, net income decreased due to the issuance of additional shares in 1998 and 1997.
Funds from operations for the year ended December 31, 1998, were $227.9 million, or $1.74 per diluted share, versus $162.7 million, or $1.57 per diluted share, in 1997. The increase is primarily the result of new investments in 1998 and 1997. Distributions declared for the years ended December 31, 1998 and 1997 were $190.3 million, or $1.52 per share, and $144.3 million, or $1.46 per share, respectively. Distributions in excess of net income constitute a return of capital. For 1998, return of capital was 6.4% of distributions.
Cash flows provided by (used for) operating, investing and financing activities were $194.3 million, ($947.4) million and $746.3 million, respectively, for the year ended December 31, 1998, and $185.7 million, ($815.2) million and $630 million, respectively, for the year ended December 31, 1997. The increases in all three categories are primarily the result of new real estate investments in 1998 and 1997 and the related financings to fund these investments.
Cash flow provided by operating activities and cash available for distribution may not necessarily equal funds from operations as cash flow is affected by other factors not included in the funds from operations calculation, such as changes in assets and liabilities.
Liquidity and Capital Resources
Total assets were $3.0 billion at December 31, 1999 compared to $3.1 billion as of December 31, 1998.
During 1999, we purchased 61 office buildings for $516.5 million and funded $9.7 million of improvements to our existing properties, using cash on hand, borrowings under our bank credit facility and the assumption of $32.4 million of mortgage debt. In addition, we sold 14 senior housing properties for net proceeds of $82.2 million and recognized a gain of $8.3 million. As part of the sale of 12 of the senior housing properties during March of 1999, we provided a $60 million mortgage loan which was paid in full in June 1999.
During 1999, we received regularly scheduled principal payments and repayments on mortgages secured by eight senior housing properties totaling $15.6 million. We also received a $1 million loan repayment from an affiliate. During 1999, we wrote down the carrying value of two real estate mortgages secured by four nursing home properties by $5 million to reflect our estimated future discounted realizable value.
At December 31, 1999, we owned 12.8 million, or 49.3%, of the common shares of beneficial interest of SNH with a carrying value of $201.8 million and a market value of $158.5 million. On March 16, 2000, the market value of our 12.8 million SNH shares was $109.6 million.
During January and February of 2000, two of SNH's tenants, accounting for approximately 48% of SNH's revenues, filed for bankruptcy. Based on estimates of future cash flows from properties leased to these two bankrupt tenants, SNH has recognized an impairment in the carrying value of properties totaling $30 million. This value impairment has reduced SNH's net income for the year ended December 31, 1999. We recognized $14.8 million of SNH's asset impairment loss on our consolidated statement of income for the year ended December 31, 1999, through our 49.3% ownership interest in SNH. This non-cash amount is not reflected in our calculation of FFO. In the short-term, the level of dividends paid by SNH to its shareholders, including HRPT, will depend on the final outcome of SNH's negotiations with these two tenants.
In March 2000, SNH and one of its bankrupt tenants reached an agreement which would result in the cancellation and modification of the leases and the exchange of certain properties leased to the tenant for cash and other consideration. This agreement is subject to final documentation, approval by the bankruptcy court and approval by SNH's board of trustees. Therefore, no assurance can be given as to if, and when, this transaction will close, or if all of the terms currently agreed to will be accepted. SNH is currently in negotiations to reach a settlement agreement with the other bankrupt tenant. The current negotiations include, but are not limited to, the possibilities that SNH will sell the properties, that lease terms may be changed, that new tenants may begin operations of properties or that properties may be operated by SNH for its own account. SNH may recognize additional gains or losses when these negotiations are completed, which will be reflected in our consolidated statement of income through our 49.3% ownership interest of SNH. Pending completion of the negotiations, SNH is relying on an agreement with a third party principal obligor for payment of rents in evaluating its asset impairment loss.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - continued
At December 31, 1999, we owned 4 million, or 7.1%, of the common shares of beneficial interest of HPT with a carrying value of $109.3 million and a market value of $76.3 million. On March 16, 2000, the market value of our 4 million HPT shares was $80.8 million. During 1999, HPT completed a public offering of 10.8 million common shares of beneficial interest at a per share price of $26.8125 for total consideration of approximately $289.9 million. As a result of this transaction, our ownership percentage in HPT was reduced from 8.8% to 7.1% and we recognized a loss of $711,000. Although we did not sell any shares, pursuant to our accounting policy, gains and losses on the issuance of common shares of beneficial interest by HPT are recognized in our income statement. This amount is not reflected in our calculation of FFO.
During 1999, we issued $90 million unsecured 7.875% senior notes due 2009 and $65 million unsecured 8.375% senior notes due 2011. Net proceeds of $150.2 million were used to repay amounts outstanding under our revolving credit facility. These notes are callable at par on April 15, 2002 and June 15, 2003, respectively. In addition, we assumed $32.4 million of secured mortgage notes payable in connection with the acquisition of eight office properties. These mortgage notes bear interest at rates ranging from 7.02% to 9.12% and mature between 2004 and 2008.
At December 31, 1999, we had $13.2 million of cash and cash equivalents, and $132 million outstanding and $368 million available on our $500 million revolving bank credit facility. At December 31, 1999, $2.5 billion was available on our $3 billion shelf registration statement.
In December 1999 we announced a three-part initiative. First, 10 properties containing approximately 900,000 square feet have been targeted for possible sales. Negotiations for these sales are underway. If all the targeted properties are sold, the proceeds are expected to be approximately $150-$160 million. Second, we commenced discussions regarding two separate joint ventures by which part interests in different pools of properties may be sold to investors. If these joint ventures are successfully concluded, we expect to realize between $200 million and $400 million, and at the same time, the risk profile of our asset concentrations will be diversified. Third, the proceeds from these sales and joint ventures will be used to prepay debt, to selectively purchase new investments and to fund a share buy back program. There can be no assurance that our sales or joint venture efforts will be successfully concluded.
There can be no assurances that debt or equity financing will be available to fund future growth, but we do expect that financing will be available. As of December 31, 1999, our debt as a percentage of total book capitalization was approximately 47%.
Impact of Inflation
Management does not believe that the modest inflation which we expect to occur in the United States economy during the next few years will have a material effect on our business. In the real estate market, inflation tends to increase the value of our underlying real estate that may be realized when properties are sold. Similarly, rent yields we can charge would most likely increase with inflation. Conversely, inflation might cause our cost of new acquisitions and of debt capital to increase. To mitigate the potential impact of inflation on our cost of debt capital, we may purchase interest rate cap contracts when we believe material interest rate increases are likely to occur.
Year 2000
In prior years, we discussed the nature and progress of our plans to become Year 2000 compliant and, in late 1999, we completed our remediation and testing of systems. As a result of our efforts, we experienced no significant disruptions in our information and non-information technology systems, and we believe these systems successfully responded to the Year 2000 date change. We are not aware of any material problems resulting from Year 2000 issues by our systems or the systems of our tenants and vendors, but we will continue to monitor these systems throughout the year to ensure that any late Year 2000 issues that may arise are addressed promptly. Costs incurred to date and anticipated future costs are not material.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - continued
Certain Considerations
The discussion and analysis of our financial condition and results of operations requires us to make estimates and assumptions and contains statements of our beliefs, intent or expectations concerning projections, plans, future events and performance. The estimates, assumptions and statements, such as those relating to our ability to sell assets at estimated prices or at any price, our ability to successfully conclude joint ventures, our ability to repurchase shares at favorable prices or at any price, our ability to expand our portfolio, performance of our assets, the ability to pay distributions from FFO, our tax status as a "real estate investment trust" and the ability to access capital markets depends upon various factors over which we and our tenants have or may have limited or no control. Those factors include, without limitation, the status of the economy, capital markets (including prevailing interest rates), competition, changes in federal, state and local legislation and other factors. We cannot predict the impact of these factors, if any. These factors could cause our actual results for subsequent periods to be different from those stated, estimated or assumed in this discussion and analysis of our financial condition and results of operations. We believe that our estimates and assumptions are reasonable at this time. However, investors are cautioned not to place undue reliance upon our estimates, assumptions or other forward looking statements.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market changes in interest rates. We manage our exposure to this market risk through our monitoring of available financing alternatives. Our strategy to manage exposure to changes in interest rates is unchanged from December 31, 1998. Furthermore, we do not foresee any significant changes in our exposure to fluctuations in interest rates or in how this exposure is managed in the near future. At December 31, 1999, our total outstanding debt for fixed rate notes consisted of the following:
Amount Coupon Maturity Unsecured senior notes: $40.0 million 7.25% 2001 160.0 million 6.875% 2002 150.0 million 6.75% 2002 164.9 million 7.50% 2003 100.0 million 6.7% 2005 90.0 million 7.875% 2009 65.0 million 8.375% 2011 143.0 million 8.5% 2013 Secured notes: $3.5 million 9.12% 2004 11.1 million 8.40% 2007 17.7 million 7.02% 2008 12.2 million 8.00% 2008 10.9 million 7.66% 2009
No principal repayments are due under the unsecured senior notes until maturity. If, at maturity, the unsecured senior notes were to be refinanced at interest rates which are 1/2 percentage point higher than shown above, our per annum interest cost would increase by approximately $4.6 million. The secured notes are secured by 11 of our office properties and require principal and interest payments through maturity.
The market prices, if any, of each of our fixed rate obligations as of December 31, 1999, are sensitive to changes in interest rates. Typically, if market rates of interest increase, the current market price of a fixed rate obligation will decrease. Conversely, if market rates of interest decrease, the current market price of a fixed rate obligation will typically increase. Based on the balances outstanding at December 31, 1999 and discounted cash flow analyses, a hypothetical immediate one percentage point change in interest rates would change the fair value of our fixed rate debt obligations by approximately $41.1 million.
Each of our obligations for borrowed money has provisions that allow us to make repayments earlier than the stated maturity date. In some cases, we are not allowed to make early repayment prior to a cutoff date and in other cases we are allowed to make prepayments only at a premium to face value. In any event, these prepayment rights may afford us the opportunity to mitigate the risk of refinancing at maturity at higher rates by refinancing at lower rates prior to maturity.
At December 31, 1999, we had a $500 million unsecured bank credit facility and unsecured Remarketed Reset Notes (the "Reset Notes") that were subject to floating interest rates. Because these debt instruments are at a floating rate, changes in interest rates will not affect their value. However, changes in interest rates will affect our operating results. For example, the interest rate payable on our outstanding Reset Notes of $250 million at December 31, 1999, was 7.43% per annum. An immediate 10% change in that interest rate, or 74 basis points, would increase or decrease our costs by $1.9 million, or $0.01 per share per year (dollars in thousands):
Impact of Changes in Interest Rates ------------------------------------------------------ Total Interest Interest Rate Outstanding Expense Per Per Year Debt Year --------------- ------------- -------------- At December 31, 1999 7.43% $250,000 $18,575 10% reduction 6.69% 250,000 16,725 10% increase 8.17% 250,000 20,425
Item 7A. Quantitative and Qualitative Disclosures About Market Risk - continued
The foregoing table presents a so called "shock" analysis which assumes that the interest rate change by 10% is in effect for a whole year. If interest rates were to change gradually over one year the impact would be less.
We borrow in U.S. dollars and our current borrowings under our bank credit facility and our Reset Notes are subject to interest at LIBOR plus a premium. Accordingly, we are vulnerable to changes in U.S. dollar based short term rates, specifically LIBOR.
During the past few months, short-term U.S. dollar based interest rates have tended to rise. We are unable to predict the direction or amount of interest rate changes during the next year. We have decided not to purchase an interest rate cap or other hedge to protect against future rate increases, but we may enter such agreements in the future. Also, we may incur additional debt at floating or fixed rates, which would increase our exposure to market changes in interest rates.
At December 31, 1999, we owned real estate mortgages and notes receivable with a carrying value of $10.4 million. When comparable term market interest rates decline, the value of these receivables increases; when comparable term market interest rates rise, the value of these receivables declines. Using discounted cash flow analyses at a weighted average estimated per year market rate of 10.75%, the estimated fair value of our real estate mortgages and notes receivable at December 31, 1999 is $11.6 million. An immediate 10% change in the market rate of interest, or 108 basis points, applicable to our real estate mortgages and notes receivable would affect the fair value of those receivables as follows (dollars in thousands):
Carrying Value Interest Rate of Mortgage Estimated Fair Per Year Receivables Value ------------------------------------------------------- Estimated market 10.75% $10,373 $11,556 10% reduction 9.67% 10,373 11,692 10% increase 11.83% 10,373 11,422
If the market rate changes occur gradually over time, the effect of these changes would be realized gradually. Because our mortgage receivables are fixed rate instruments, changes in market interest rates will have no effect on our operating results unless these receivables are sold. At this time, we expect to hold our existing mortgages to their maturity and not to realize any profit or loss from trading these mortgage receivables. Also, we do not presently expect to expand our mortgage investments.
The interest rate changes which affect the valuations of our mortgages are U.S. dollar long term rates for corporate obligations of companies with ratings similar to our mortgagors.
Item 8.
Item 8. Financial Statements and Supplementary Data
The information required by this item is included herein in Item 14 of this Annual Report on Form 10-K.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
PART III
The information in Part III (Items 10, 11, 12 and 13) is incorporated by reference to our definitive Proxy Statement, which will be filed not later than 120 days after the end of our fiscal year.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) Index to Financial Statements and Financial Statement Schedules
HRPT PROPERTIES TRUST
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions, or are inapplicable, and therefore have been omitted.
(b) Reports on Form 8-K
During the fourth quarter of 1999, we filed the following Current Reports on Form 8-K:
(i) Current Report on Form 8-K dated October 12, 1999, relating to a) the spin-off of Senior Housing Properties Trust, b) unaudited pro forma consolidated financial statements, and c) filing as exhibits: 1) Transaction Agreement, dated as of September 21, 1999, between Senior Housing Properties Trust and HRPT Properties Trust, and 2) Promissory Note, dated September 1, 1999, from SPTMRT Properties Trust and Senior Housing Properties Trust, as makers, to HRPT Properties Trust, as holder (Items 2 and 7).
(ii) Current Report on Form 8-K dated December 16, 1999, relating to a) the election of new trustee and senior vice president, b) the possible sale of properties and share buy back program, c) amendment to HRPT Properties Trust advisory agreement, and d) filing as an exhibit: Amendment No. 1 to Advisory Agreement, dated as of October 12, 1999, between HRPT Properties Trust and REIT Management & Research, Inc. (Items 5 and 7).
(c) Exhibits
3.1 Composite Copy of Third Amendment and Restatement of Declaration of Trust of the Company dated July 1, 1994, as amended to date. (incorporated by reference to the Company's Current Report on Form 8-K, dated July 1, 1998)
3.2 Articles Supplementary dated November 4, 1994 to Third Amendment and Restatement of Declaration of Trust dated July 1, 1994 creating the Junior Participating Preferred Shares. (incorporated by reference to the Company's Current Report on Form 8-K, dated May 27, 1998)
3.3 Articles Supplementary dated May 13, 1997 to Third Amendment and Restatement of Declaration of Trust dated July 1, 1994 increasing the Junior Participating Preferred Shares. (incorporated by reference to the Company's Current Report on Form 8-K, dated May 27, 1998)
3.4 Articles Supplementary dated May 22, 1998 to Third Amendment and Restatement of Declaration of Trust dated July 1, 1997 increasing the Junior Participating Preferred Shares. (incorporated by reference to the Company's Current Report on Form 8-K, dated May 27, 1998)
3.5 By-laws of the Company, as amended (incorporated by reference to the Company's Current Report on Form 8-K, dated March 11, 1999)
4.1 Form of Common Share Certificate. (incorporated by reference to the Company's Current Report on Form 8-K, dated March 11, 1999)
4.2 Rights Agreement dated October 17, 1994 between the Company and State Street Bank and Trust Company, as Rights Agent (including the form of Articles Supplementary relating to the Junior Participating Preferred Shares annexed as an exhibit thereto). (incorporated by reference to the Company's Current Report on Form 8-A, dated October 24, 1994)
4.3 Indenture, dated as of September 20, 1996, between the Company and Fleet National Bank ("Fleet") as trustee. (incorporated by reference to the Company's Registration Statement on Form S-3, File No. 333-02863)
4.4 First Supplemental Indenture, dated as of October 7, 1996, between the Company and Fleet, as Trustee, relating to the Company's 7.5% Convertible Subordinated Debentures due 2003, Series A, including form thereof. (incorporated by reference to the Company's Current Report on Form 8-K, dated October 7, 1996)
4.5 Second Supplemental Indenture, dated October 7, 1996, between the Company and Fleet, as trustee, relating to the Company's 7.5% Convertible Subordinated Debentures due 2003, Series B, including form thereof. (incorporated by reference to the Company's Current Report on Form 8-K, dated October 7, 1996)
4.6 Third Supplemental Indenture, dated as of October 7, 1996, between the Company and Fleet, as trustee, relating to the Company's 7.25% Convertible Subordinated Debentures due 2001, including form thereof. (incorporated by reference to the Company's Current Report on Form 10-K, dated October 7, 1996)
4.7 Indenture, dated as of July 9, 1997, by and between the Company and State Street Bank and Trust Company, as Trustee. (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1997)
4.8 Supplemental Indenture, dated July 9, 1997, by and between the Company and State Street Bank and Trust Company, as Trustee, relating to the Remarketed Reset Notes due July 9, 2007. (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1997)
4.9 Supplemental Indenture No. 2, dated as of February 23, 1998 between the Company and State Street bank and Trust Company, relating to $50,000,000 in principal amount of Remarketed Reset Notes due July 9, 2007. (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1997)
4.10 Form of Global Note relating to the Remarketed Reset Notes due July 9, 2007. (incorporated by reference to the Company's Current Report on Form 8-K, dated July 2, 1997)
4.11 Supplemental Indenture No. 3 dated as of February 23, 1998 by and between the Company and State Street Bank and Trust Company, relating to the Company's 6.7% Senior Notes due 2005, including form thereof. (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1997)
4.12 Supplemental Indenture No. 4 dated as of August 26, 1998 by and between the Company and State Street Bank and Trust Company, relating to $160,000,000 in aggregate principal amount of 6 ?% Senior Notes due 2002, including form thereof. (incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998)
4.13 Supplemental Indenture No. 5 dated as of November 30, 1998 by and between the Company and State Street Bank and Trust Company, relating to $130,000,000 in aggregate principal amount of 81/2% Monthly Income Senior Notes due 2013, including form thereof. (incorporated by reference to the Company's Current Report on Form 8-K, dated March 11, 1999)
4.14 Supplemental Indenture No. 6 dated as of March 24, 1999 by and between the Company and State Street Bank and Trust Company, relating to $90,000,000 in aggregate principal amount of 7 ?% Monthly Income Senior Notes due 2009, including form thereof. (incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1998)
4.15 Supplemental Indenture No. 7, dated as of June 17, 1999, by and between the Company and State Street Bank and Trust Company, relating to $65,000,000 in aggregate principal amount of 8?% Monthly Income Senior Notes due 2011, including form thereof). (incorporated by reference to the Company's Current Report on Form 8-K, dated June 14, 1999)
4.16 Indenture dated as of December 18, 1997 by and between the Company and State Street Bank and Trust Company, as Trustee. (incorporated by reference to the Company's Current Report on Form 8-K, dated December 5, 1997)
4.17 Supplemental Indenture dated as of December 18, 1997 by and between the Company and State Street Bank and Trust Company, as Trustee, relating to the Company's 6 3/4% Senior Notes due 2002, including form thereof. (incorporated by reference to the Company's Current Report on Form 8-K, dated December 5, 1997)
8.1 Opinion of Sullivan & Worcester LLP as to certain tax matters. (filed herewith)
9.1 Amended and Restated AMS Voting Trust Agreement. (incorporated by reference to the Company's Registration Statement on Form S-11, File No. 33-55684, dated December 23, 1992)
10.1 Advisory Agreement by and between REIT Management & Research, Inc. and the Company dated as of January 1, 1998.(+) (incorporated by reference to the Company's Current Report on Form 8-K, dated February 11, 1998)
10.2 Amendment No. 1 to Advisory Agreement between the Company and REIT Management & Research, Inc. dated as of October 12, 1999. (+) (incorporated by reference to the Company's Current Report on Form 8-K, dated December 16, 1999)
10.3 Agreement (for Property Management and Leasing Agent) between M&P Partners Limited Partnership and various subsidiaries of the Company, effective as of March 25, 1997, relating to properties leased to Agencies of the United States Government (incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1999)
10.4 Master Management Agreement by and among M&P Partners Limited Partnership and the parties named therein dated as of December 31, 1997. (incorporated by reference to the Company's Current Report on Form 8-K, dated February 27, 1998)
10.5 Master Management Agreement by and between the Company and REIT Management & Research, Inc. dated as of December 31, 1997. (incorporated by reference to the Company's Current Report on Form 8-K, dated February 27, 1998)
10.6 Representative Property Management Agreement, for properties managed by REIT Management & Research, Inc. (filed herewith)
10.7 Parking Operation Management Agreement by and between HUB Properties Trust, a subsidiary of the Company, and REIT Management & Research, Inc. dated as of January 1, 1998. (incorporated by reference to the Company's Current Report on Form 8-K, dated February 27, 1998)
10.8 Incentive Share Award Plan.(+) (incorporated by reference to the Company's Registration Statement on Form S-11, File No. 33-55684, dated December 23, 1992)
10.9 Fourth Amended and Restated Revolving Credit Agreement, dated as of April 2, 1998, among the Company, as borrower, the lenders named therein, Dresdner Kleinwort Benson North America LLC, as agent, and Fleet National Bank, as administrative agent. (incorporated by reference to the Company's Current Report on Form 8-K, dated April 14, 1998)
10.10 First Amendment and Limited Waiver to Loan Agreement, dated as of February 12, 1999, among the Company, as borrower, the lenders named therein, and Dresdner Kleinwart Benson North America LLC, as agent. (filed herewith)
10.11 Transaction Agreement between Senior Housing Properties Trust and the Company, dated as of September 21, 1999. (incorporated by reference to the Company's Current Report on Form 8-K, dated October 12, 1999)
10.12 Promissory Note from SPTMRT Properties Trust and Senior Housing Properties Trust, as makers, to the Company, dated September 1, 1999. (incorporated by reference to the Company's Current Report on Form 8-K, dated October 12, 1999)
12.1 Statement regarding computation of ratio of earnings to fixed charges. (filed herewith)
21.1 Subsidiaries of the Registrant. (filed herewith)
23.1 Consent of Ernst & Young LLP. (filed herewith)
23.2 Consent of Arthur Andersen LLP. (filed herewith)
23.3 Consent of Sullivan & Worcester LLP (included as part of Exhibit 8.1 hereto)
27.1 Financial Data Schedule. (filed herewith)
(+) Management contract or compensatory plan or arrangement.
REPORT OF INDEPENDENT AUDITORS
To the Trustees and Shareholders of HRPT Properties Trust
We have audited the accompanying consolidated balance sheets of HRPT Properties Trust as of December 31, 1999 and 1998, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1999. Our audits also included the financial statements and schedules listed in the Index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits. The financial statements of Hospitality Properties Trust (a real estate investment trust in which the Company has a 7.1% and 8.8% interest as of December 31, 1999 and 1998, respectively) have been audited by other auditors whose report has been furnished to us; insofar as our opinion on the consolidated financial statements relates to data included for Hospitality Properties Trust, it is based solely on their report.
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 and the report of other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of HRPT Properties Trust at December 31, 1999 and 1998, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
/s/ Ernst & Young LLP
ERNST & YOUNG LLP
Boston, Massachusetts March 17, 2000
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Trustees and Shareholders of Hospitality Properties Trust:
We have audited the consolidated balance sheet of Hospitality Properties Trust and subsidiaries (the "Company") as of December 31, 1999 and 1998, and the related consolidated statements of income, shareholders' equity and cash flows (not presented herein) for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform an 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Hospitality Properties Trust and subsidiaries as of December 31, 1999 and 1998 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Vienna, Virginia January 14, 2000
See accompanying notes
See accompanying notes
See accompanying notes
See accompanying notes
See accompanying notes
HRPT PROPERTIES TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Organization
HRPT Properties Trust, a Maryland real estate investment trust (the "Company"), was organized on October 9, 1986. As of December 31, 1999, the Company had investments in 195 office properties located in 27 states and the District of Columbia. In addition, at December 31, 1999, the Company had equity investments in Senior Housing Properties Trust ("SNH") and Hospitality Properties Trust ("HPT") of 49.3% and 7.1%, respectively. At December 31, 1999, SNH had investments in 93 senior housing properties in 26 states and HPT owned 210 hotels in 35 states.
Note 2. Summary of Significant Accounting Policies
Basis of Presentation. The consolidated financial statements include the Company's investment in 100% owned subsidiaries. The Company's investments in 50% or less owned companies over which it can exercise influence, but does not control, are accounted for using the equity method of accounting. All inter-company transactions have been eliminated. The Company uses the income statement method to account for issuance of common shares of beneficial interest by SNH and HPT. Under this method, gains and losses reflecting changes in the value of the Company's ownership stake on issuance of stock by SNH or HPT are recognized in the Company's income statement.
Real Estate Property and Mortgage Investments. Real estate properties and mortgages are recorded at cost. Depreciation on real estate investments is provided for on a straight-line basis over estimated useful lives ranging up to 40 years. Impairment losses on investments are recognized where indicators of impairment are present and the undiscounted cash flow estimated to be generated by the Company's investments is less than the carrying amount of such investments. The determination of undiscounted cash flow includes consideration of many factors including income to be earned from the investment, holding costs (exclusive of interest), estimated selling prices, and prevailing economic and market conditions.
Cash and Cash Equivalents. Cash, over-night repurchase agreements and short-term investments with original maturities of three months or less at the date of purchase are carried at cost plus accrued interest.
Investments in Marketable Equity Securities. Marketable equity securities are classified as available for sale and carried at fair value, with unrealized gains and losses reported as a separate component of shareholders' equity. At December 31, 1999, the Company's investments in marketable equity securities were included in other assets and had a fair value of $4.3 million and unrealized holding losses of $7.4 million. At March 16, 2000, these investments had a fair value of $3.0 million and unrealized holding losses of $8.7 million.
Deferred Finance Costs. Issuance costs related to borrowings are capitalized and amortized over the terms of the respective loans. Accumulated amortization at December 31, 1999 and 1998 was $5.3 million and $2.8 million, respectively.
Revenue Recognition. Rental income from operating leases is recognized on a straight-line basis over the life of the lease agreements. Interest income is recognized as earned over the terms of the real estate mortgages. Percentage rent and additional mortgage interest revenue is recognized as earned. For the years ended December 31, 1999, 1998 and 1997, percentage rent and additional mortgage interest revenue was $3.4 million, $3.1 million and $3.1 million, respectively.
Earnings Per Common Share. Basic earnings per common share is computed using the weighted average number of shares outstanding during the period. At December 31, 1999 and 1998, $204.9 million of convertible securities were convertible into 11.4 million shares of the Company. Basic earnings per share equals diluted earnings per share, as the effect of these convertible securities is anti-dilutive to diluted earnings per share.
Reclassifications. Reclassifications have been made to the prior years' financial statements to conform to the current year's presentation.
Income Taxes. The Company is a real estate investment trust under the Internal Revenue Code of 1986, as amended. Accordingly, the Company expects not to be subject to federal income taxes provided it distributes its taxable income and meets other requirements for qualifying as a real estate investment trust. However, it is subject to some state and local taxes on its income and property.
Use of Estimates. Preparation of these financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that may affect the amounts reported in these financial statements and related notes. The actual results could differ from these estimates.
New Accounting Pronouncements. The Financial Accounting Standards Board issued Financial Accounting Standards Board Statement No. 133 "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133") in 1998. FAS 133 must be adopted for the Company's 2001 financial statements. The Company anticipates that FAS 133 will not have a significant impact on the Company's reported financial condition or results of operations.
Note 3. Real Estate Properties
During the year ended December 31, 1999, the Company acquired 61 office properties for an aggregate amount of approximately $516.5 million in 25 separate transactions. In addition, the Company funded improvements to its existing properties of approximately $9.7 million.
Also during the year ended December 31, 1999, the Company disposed of 14 senior housing properties, including 12 senior housing properties leased to an affiliate, for net proceeds of $82.2 million and recognized a gain of $8.3 million. As part of the sale of 12 senior housing properties, the Company provided a $60 million real estate mortgage receivable secured by the 12 senior housing properties that was subsequently paid to the Company in June 1999.
The Company's real estate properties are leased on a gross lease, modified gross lease or triple net lease basis pursuant to noncancelable, fixed term operating leases expiring from 2000 to 2020. The triple net leases generally require the lessee to provide all property management services. The Company's gross leases and modified gross leases require the Company to provide property management services. The office properties owned by the Company are managed by REIT Management & Research, Inc. ("RMR"), an affiliate of the Company.
The future minimum lease payments to be received by the Company during the current terms of the leases as of December 31, 1999, are approximately $311.0 million in 2000, $286.1 million in 2001, $254.1 million in 2002, $222.9 million in 2003, $179.4 million in 2004 and $895.2 million thereafter.
Note 4. Equity Investments
On October 12, 1999, the Company spun-off 50.7% of its 100% owned subsidiary, SNH, by distributing 13,190,763 common shares of SNH to the Company's shareholders of record on October 8, 1999 (the "Spin-Off"). SNH is a real estate investment trust that invests principally in income producing senior housing real estate. In connection with the Spin-Off, the Company received $200 million from SNH that was used to repay amounts outstanding on the revolving bank credit facility.
The Company incurred $16.7 million of expenses relating to the Spin-Off, which included costs of distributing SNH shares to shareholders, legal and accounting fees, Securities and Exchange Commission filing fees, New York Stock Exchange listing fees and the up-front costs of establishing SNH's bank credit facility.
Since the Spin-Off, the Company's investment in SNH is accounted for using the equity method of accounting. Prior to the Spin-Off, the operating results of SNH were included in the Company's results of operations. At December 31, 1999, the Company owned 12,809,237 common shares of beneficial interest of SNH with a carrying value of $201.8 million and a market value, based on quoted market prices, of $158.5 million.
The following summarized financial data of SNH includes results of operations prior to the Spin-Off that are included in the Company's results of operations (amounts in thousands, except per share amounts):
In July 1999, one of SNH's tenants, accounting for 2% of SNH's revenues, filed for bankruptcy. During January and February 2000, two of SNH's tenants, accounting for approximately 48% of SNH's revenues, filed for bankruptcy. SNH is currently negotiating with these tenants and evaluating its options, including the possibility of reducing rent, selling properties, and operating certain properties for its own behalf. Based on estimates of future cash flows from properties leased to these two tenants, SNH has recognized an impairment in the carrying value of certain loans and properties totaling $30 million. This value impairment has increased SNH's expenses and reduced SNH's net income for the year ended December 31, 1999. The Company has recognized $14.8 million of SNH's asset impairment loss on its consolidated statement of income for the year ended December 31, 1999, through its 49.3% ownership interest in SNH. In the short-term, the level of dividends paid by SNH to the Company in future periods will depend on the outcome of SNH's negotiations with these two tenants.
At December 31, 1999, the Company owned 4,000,000 common shares of beneficial interest of HPT with a carrying value of $109.3 million and a market value, based on quoted market prices, of $76.3 million. HPT is a real estate investment trust that invests principally in income producing hotel real estate. During 1999, HPT completed a public stock offering of common shares. As a result of this transaction, the Company's ownership percentage in HPT was reduced from 8.8% in 1998 to 7.1% in 1999 and the Company realized a loss of $711,000. Although the Company did not sell any shares, pursuant to the Company's accounting policy, gains and losses on the issuance of common shares of beneficial interest by HPT are recognized in the Company's income statement.
Summarized financial data of HPT is as follows (amounts in thousands, except per share amounts):
Note 5. Real Estate Mortgages and Notes Receivable, Net
December 31, ----------------------- 1999 1998 ----------------------- (dollars in thousands) Mortgage notes receivable, due September 2001 through December 2006 $ 3,874 $30,961 Mortgage notes receivable due December 2010 -- 18,992 Mortgage notes receivable due December 2000 12,600 12,233 Mortgage notes receivable due December 2016 -- 7,040 Other collateralized notes receivable -- 12 Loan to an affiliate -- 1,000 ------- ------- 16,474 70,238 Less allowance 6,101 1,010 ------- ------- $10,373 $69,228 ======= =======
During 1999, the Company received regularly scheduled principal payments of $495,000, repayments of mortgages secured by eight senior housing properties of $15.1 million, principal repayment of $1 million from a loan to an affiliate and $60 million as payment of a mortgage loan provided in connection with the sale of the 12 senior housing properties discussed in Note 3. In addition, the Company established additional reserves and an allowance for the impairment of two mortgage loans with a carrying value of $15 million, totaling $5.1 million.
At December 31, 1999, the interest rates on the real estate mortgages and notes receivable ranged from 9.96% to 12.5% per annum.
Note 6. Shareholders' Equity
During 1999, the Company issued 256,246 common shares as additional consideration in connection with the final installment payment for the 1997 acquisition of office buildings leased to agencies of the United States Government, and issued 89,702 common shares to RMR as the incentive fee earned for the year ended December 31, 1998.
The Company originally reserved 1,000,000 shares of the Company's common shares under the terms of the 1992 Incentive Share Award Plan (the "Award Plan"). During 1999, 1998 and 1997, 13,000, 13,000 and 9,500 common shares, respectively, were awarded to officers of the Company and certain employees of RMR and HRPT Advisors, Inc. ("Advisors"). In addition, the Independent Trustees, as part of their annual fee, are each awarded 500 common shares annually. The shares awarded to the Trustees vest immediately. The shares awarded to the officers and certain employees of RMR and Advisors vest over a three-year period. At December 31, 1999, 684,426 shares of the Company's common shares remain reserved for issuance under the Award Plan.
A dividend of $0.32 per share was paid on February 15, 2000, to shareholders of record on January 10, 2000. Cash dividends per share paid by the Company in 1999, 1998 and 1997 were $1.46, $1.51 and $1.45, respectively.
The Company has adopted a Shareholders Rights Plan ("Right"). Each Right entitles the holder to purchase or to receive securities or other assets of the Company upon the occurrence of certain events. The Rights expire on October 17, 2004 and are redeemable at the Company's option at any time.
Note 7. Commitments and Contingencies
The Company is involved in litigation with a former tenant. Since 1995, the Company has asserted its claims and rights against the former tenant. The outcome of the Company's claims and the former tenant's counter claims against the Company cannot be predicted.
Note 8. Transactions with Affiliates
As of January 1, 1998, the Company entered into an agreement with RMR to provide investment, management, property management and administrative services to the Company. During the year ended December 31, 1997, such services were provided by HRPT Advisors, Inc. and M&P Partners Limited Partnership ("M&P"), affiliates of the Company, on similar terms. RMR, Advisors and M&P are owned by Gerard M. Martin and Barry M. Portnoy, who also serve as Managing Trustees of the Company. RMR is compensated at an annual rate equal to 0.7% of the Company's real estate investments up to $250 million and 0.5% of investments thereafter, plus property management fees equal to three percent of gross rents. RMR is, and Advisors was, also entitled to an incentive fee which is paid in restricted shares of the Company's common stock based on a formula. Incentive fees for the years ended December 31, 1999, 1998 and 1997 were $215,000, $1.4 million and $1.0 million, which represent approximately 26,221, 89,702 and 52,316 common shares, respectively. During 1999, RMR sold 89,702 common shares to Gerard M. Martin and Barry M. Portnoy, the Managing Trustees of the Company and owners of RMR. At December 31, 1999, the Managing Trustees and Advisors owned 89,702 and 1,134,373 common shares, respectively.
Prior to the Spin-Off of SNH, the Company leased 15 senior housing properties to four affiliated entities (collectively, the "Affiliated Entities"). In March 1999, the Company sold 12 of these senior housing properties to an unaffiliated party. The remaining three senior housing properties were transferred to SNH as part of the Spin-Off. Messrs. Martin and Portnoy are principal shareholders of the Affiliated Entities and, subject to the review and approval of this transaction by the Independent Trustees, may be entitled to a portion of the sale proceeds. The Company also extended a $4 million line of credit to one of the Affiliated Entities which was paid off and terminated with the sale of the 12 properties discussed above. One million dollars was outstanding at December 31, 1998 under this line of credit arrangement.
Amounts resulting from transactions with affiliates are as follows (dollars in thousands):
Year Ended December 31, ---------------------------------------- 1999 1998 1997 ---------------------------------------- Investment advisory fees paid $15,404 $13,592 $ 8,620 Dividends 3,807 1,694 1,557 Rent and interest income received 5,870 13,741 13,616 Management fees paid 9,779 6,703 2,382
During 1999, the Company issued unsecured senior notes totaling $155 million, in two separate transactions, raising net proceeds of $150.2 million. Net proceeds from the notes were used to repay amounts then outstanding under the Company's revolving bank credit facility. In addition, the Company assumed $32.4 million of secured mortgage notes payable in connection with the acquisition of eight office properties.
The Company's convertible subordinated debentures were callable in October 1999 and are convertible at any time into common shares of the Company at $18 per share.
At December 31, 1999, 11 properties with an aggregate net book value of $96.3 million were secured by mortgages totaling $55.4 million due in 2004, 2007, 2008 and 2009.
The required principal payments due during the next five years under all debt outstanding at December 31, 1999, are $2.2 million in 2000, $42.4 million in 2001, $444.5 million in 2002, $167.6 million in 2003, $6.3 million in 2004 and $687.3 million thereafter.
Note 10. Fair Value of Financial Instruments
The Company's financial instruments include cash and cash equivalents, real estate mortgages and notes receivable, rents receivable, equity investments, senior notes, mortgage notes payable, convertible debentures, accounts payable and other accrued expenses, a letter of credit and security deposits. Except as follows, the fair values of the financial instruments were not materially different from their carrying values (dollars in thousands):
The fair values of the real estate mortgages and notes receivable, senior notes, mortgage notes payable and convertible debentures are based on estimates using discounted cash flow analysis and currently prevailing rates. The fair value of the equity investments are based on quoted per share prices for HPT of $19.0625 and $24.125 at December 31, 1999 and 1998, respectively, and a quoted per share price for SNH of $12.375 at December 31, 1999. The fair value of the commitments and letter of credit represents the actual amounts committed.
Note 11. Concentration of Credit Risk
The Company's assets are primarily invested in income producing office properties located throughout the United States. At December 31, 1999 and 1998, properties leased to the United States Government represented $421.5 million and $431.1 million of net real estate investments, respectively, and for the years ended December 31, 1999 and 1998, provided rental revenue of $59.6 million and $60.3 million, respectively. At December 31, 1997, properties leased to the United States Government, Marriott International, Inc. and Integrated Health Services, Inc. represented $433.2 million, $299.9 million and $172.8 million of net real estate investments, respectively, and provided revenue of $43.4 million, $30.4 million and $27 million, respectively.
Note 12. Segment Information
The Company has two reportable segments; senior housing and office properties. Substantially all of the Company's senior housing assets were spun-off on October 12, 1999, and consisted of senior housing, congregate care communities, assisted living and nursing homes. The Company's office properties consist of government office, medical office and commercial office properties.
The Company evaluates its segments based on net operating income. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies.
The following is a summary of the Company's reportable segments as of December 31, 1999 and 1998 and for the years ended December 31, 1999, 1998 and 1997 (dollars in thousands):
Year Ended December 31, 1999 --------------------------------------- Senior Housing Office Total --------------------------------------- Revenues $ 77,579 $ 348,497 $ 426,076 Operating expenses -- 116,365 116,365 Depreciation 18,578 51,502 70,080 Impairment of assets 5,000 2,000 7,000 ---------- ---------- ---------- Net operating income $ 54,001 $ 178,630 $ 232,631 ========== ========== ==========
Real estate at year end $ 10,373 $2,656,344 $2,666,717 Real estate acquired during the year -- 526,177 526,177
Year Ended December 31, 1998 --------------------------------------- Senior Housing Office Total --------------------------------------- Revenues $ 110,096 $ 245,955 $ 356,051 Operating expenses -- 77,536 77,536 Depreciation 21,798 37,039 58,837 ---------- ---------- ---------- Net operating income $ 88,298 $ 131,380 $ 219,678 ========== ========== ==========
Real estate at year end $ 895,748 $2,129,962 $3,025,710 Real estate acquired during the year 12,924 985,894 998,818
Year Ended December 31, 1997 --------------------------------------- Senior Housing Office Total --------------------------------------- Revenues $113,243 $ 93,670 $206,913 Operating expenses -- 26,765 26,765 Depreciation 21,728 15,891 37,619 -------- -------- -------- Net operating income $ 91,515 $ 51,014 $142,529 ======== ======== ========
The following tables reconcile the reported segment information to the consolidated financial statements for the years ended December 31, 1999, 1998 and 1997 (dollars in thousands):
HRPT PROPERTIES TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the years ended December 31, 1999, 1998 and 1997, office segment revenues from the United States Government represented $59.6 million, $60.3 million, and $43.4 million, respectively, of the Company's consolidated revenues. For the years ended December 31, 1999, 1998 and 1997, senior housing segment revenues from Marriott International, Inc. represented $24.2 million, $31.9 million and $30.4 million, respectively, of the Company's consolidated revenues. For the same periods, senior housing segment revenues from Integrated Health Services, Inc. represented $21.2 million, $28.4 million and $27 million, respectively, of the Company's consolidated revenues.
Note 13. Selected Quarterly Financial Data (Unaudited)
The following is a summary of the unaudited quarterly results of operations of the Company for 1999 and 1998. The amounts are in thousands except for per share amounts.
Note 14. Pro Forma Information (Unaudited)
In 1999, as described in Note 4, the Company spun-off 50.7% of its 100% owned subsidiary, SNH, by distributing 13,190,763 common shares of SNH to the Company's shareholders of record on October 8, 1999.
In 1997 and 1998, the Company acquired 29 office buildings (the "Government Properties") leased to various agencies of the United States Government through the acquisition of Government Property Investors, Inc. ("GPI"). The acquisition was accounted for as a purchase and the net assets and results of operations are included in the consolidated financial statements since the dates of acquisition. The acquisitions of the Government Properties were funded, in part, with the proceeds from the issuance of the Company's common shares pursuant to a public offering, the issuance of common shares of the Company in a private placement and the assumption of debt.
The following unaudited condensed Pro Forma Statements of Income assume the Spin-Off of SNH and the acquisition of GPI had both occurred on January 1, 1997.
These pro forma statements of income are not necessarily indicative of the expected results of operations for any future period. Differences could result from, but are not limited to, additional property investments, changes in interest rates and changes in the debt and equity structure of the Company.
S-1
Reconciliation of the carrying amount of real estate and equipment and accumulated depreciation at the beginning of the period:
Real Estate and Accumulated Equipment Depreciation --------------- -------------- Balance at January 1, 1997 $ 1,005,739 $ 76,921 Additions 998,579 37,619 Disposals (35,295) (2,871) ----------- ----------- Balance at December 31, 1997 1,969,023 111,669 Additions 1,004,523 58,837 Disposals (17,064) (695) ----------- ----------- Balance at December 31, 1998 2,956,482 169,811 Additions 526,502 70,080 Disposals (94,247) (20,977) Spin-off of SNH (732,393) (112,055) ----------- ----------- Balance at December 31, 1999 $ 2,656,344 $ 106,859 =========== ===========
(1) Aggregate cost for federal income tax purposes is approximately $2,557,428. (2) Depreciation is provided for on buildings and improvements for periods ranging up to 40 years and on equipment up to 12 years.
S-8
Reconciliation of the carrying amount of mortgage loans at the beginning of the period:
Balance at January 1, 1997 $ 137,245 New mortgage loans 1,520 Collections of principal, net of discounts (37,263) --------- Balance at December 31, 1997 101,502 Collections of principal, net of discounts (33,408) --------- Balance at December 31, 1998 68,094 New mortgage loans 60,000 Collections of principal, net of discounts (75,188) Impairment of mortgage loans (5,000) Spin-off of SNH (37,533) --------- Balance at December 31, 1999 $ 10,373 =========
(1) Also represents cost for federal income tax purposes.
S-9
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
HRPT PROPERTIES TRUST
By: /s/ John A. Mannix John A. Mannix President and Chief Operating Officer Dated: March 30, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons, or by their attorney-in-fact, in the capacities and on the dates indicated.
Signature Title Date - --------- ----- ----
/s/ John A. Mannix President and March 30, 2000 John A. Mannix Chief Operating Officer
/s/ John C. Popeo Treasurer, Chief Financial March 30, 2000 John C. Popeo Officer and Secretary
/s/ Frederick N. Zeytoonjian Trustee March 30, 2000 Frederick N. Zeytoonjian
/s/ Patrick F. Donelan Trustee March 30, 2000 Patrick F. Donelan
/s/ Justinian Manning, C.P. Trustee March 30, 2000 Rev. Justinian Manning, C.P.
/s/ Gerard M. Martin Trustee March 30, 2000 Gerard M. Martin
/s/ Barry M. Portnoy Trustee March 30, 2000 Barry M. Portnoy