Equity Commonwealth - 10-Q quarterly report FY

HRPT PROPERTIES TRUST

FORM 10-Q

SEPTEMBER 30, 2004

INDEX

References in this Form 10-Q to the “Company”, “we”, “us”, “our”, and “HRPT Properties” refers to HRPT Properties Trust and its consolidated subsidiaries, unless otherwise noted.

HRPT PROPERTIES TRUST

CONSOLIDATED STATEMENT OF INCOME

(in thousands, except per share data)

(unaudited)

See accompanying notes

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HRPT PROPERTIES TRUST

CONSOLIDATED STATEMENT OF CASH FLOWS

(in thousands)

(unaudited)

See accompanying notes

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See accompanying notes

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HRPT PROPERTIES TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except share data)

Note 1.  Basis of Presentation

The accompanying consolidated financial statements of HRPT Properties Trust and its subsidiaries have been prepared without audit.  Certain information and footnote disclosures required by accounting principles generally accepted in the United States for complete financial statements have been condensed or omitted.  We believe the disclosures made are adequate to make the information presented not misleading.  However, the accompanying financial statements should be read in conjunction with the financial statements and notes contained in our Annual Report on Form 10-K for the year ended December 31, 2003.  In the opinion of management, all adjustments, which include only normal recurring adjustments considered necessary for a fair presentation, have been included.  All intercompany transactions and balances between HRPT Properties Trust and its subsidiaries have been eliminated.  Operating results for interim periods are not necessarily indicative of the results that may be expected for the full year.  Reclassifications have been made to prior period financial statements to conform to the current period presentation.

Note 2.  Equity Investments

At September 30, 2004, and December 31, 2003, we had the following equity investments in Senior Housing Properties Trust and Hospitality Properties Trust:

At September 30, 2004, we owned 9,660,738 common shares, or 15.2%, of Senior Housing with a carrying value of $118,172 and a market value, based on quoted market prices, of $172,154, and 4,000,000 common shares, or 6.0%, of Hospitality Properties with a carrying value of $100,002 and a market value, based on quoted market prices, of $169,960.  Our two managing trustees are also managing trustees of Senior Housing and Hospitality Properties and owners of Reit Management & Research LLC, or RMR, which is the investment manager to us, Senior Housing and Hospitality Properties.  We account for our investments in Senior Housing and Hospitality Properties using the equity method of accounting.

In January 2004, Senior Housing issued 5,000,000 common shares in a public offering for $18.20 per common share, raising net proceeds of $86,144.  Our ownership percentage in Senior Housing was reduced from 21.9% prior to this transaction to 20.2% after this transaction, and we recognized a gain of $966 during the nine months ended September 30, 2004.  Simultaneously with this offering, in January and February 2004, we sold 3,148,500 common shares we owned of Senior Housing for $18.20 per common share, for gross proceeds of $57,303 (net $54,413).  As a result of this transaction, we recognized a gain of $14,805 during the nine months ended September 30, 2004, and our ownership percentage in Senior Housing was reduced from 20.2% prior to this transaction to 15.2% after this transaction.

In February and March 2004, Hospitality Properties issued 4,600,000 common shares in a public offering for $43.93 per common share, raising net proceeds of $192,684.  Our ownership percentage in Hospitality Properties was reduced from 6.4% prior to this transaction to 6.0% after this transaction, and we recognized a gain of $4,074 during the nine months ended September 30, 2004.

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Note 3.  Real Estate Properties

On July 16, 2004, we purchased Hallwood Realty Partners, L.P., or Hallwood, for an aggregate net purchase price of $434,659, including closing costs.  Hallwood, formerly a publicly traded limited partnership, owned a portfolio of office and industrial properties that contain 5,156 square feet of space and are located in seven metropolitan areas.  The Hallwood properties are currently leased to approximately 500 tenants with lease expirations between 2004 and 2020.  Upon the acquisition of Hallwood, we assumed approximately $207,000 of Hallwood’s outstanding mortgage debt.  We repaid approximately $100,000 of this mortgage debt simultaneously with the purchase closing; the balance of this mortgage debt is prepayable in 2005 and 2008.  During the nine months ended September 30, 2004, we acquired an additional 14 properties for $306,860, including closing costs, and funded $35,946 of improvements to our owned properties.  We funded all of these transactions with cash on hand and by borrowing under our revolving credit facility.  We allocated $82,628 of our total 2004 acquisition costs to acquired real estate leases and $10,574 to acquired real estate lease obligations.

Note 4.  Indebtedness

In February 2004 we redeemed at par plus accrued interest our $143,000 8.50% senior notes due in November 2013 using proceeds from our revolving credit facility.  In connection with this redemption we recognized a loss of $2,866 from the write off of deferred financing fees.

In February 2004 we entered into a five year $250,000 unsecured term loan with a group of banks.  Terms of this loan include interest at LIBOR plus a spread, which averaged a total of 2.1% per annum from February to September 2004.  In August 2004, we exercised our option to increase this term loan by $100,000 and amended the term loan to extend its maturity by six months to August 24, 2009.  The term loan, as amended, permits prepayment of the loans without penalty beginning in February 2006.  Net proceeds of the term loan were used to repay amounts outstanding under our revolving credit facility and for general business purposes.

In August 2004 we issued $400,000 unsecured senior notes in a public offering, raising net proceeds of $392,236.  The notes bear interest at 6.25%, require semi-annual interest payments and mature in August 2016.  Net proceeds from this offering were used to repay amounts outstanding under our revolving credit facility.

We have a $560,000, interest only, unsecured revolving credit facility which matures in April 2006.  The interest rate, LIBOR plus a spread, averaged 2.2% per annum for the nine months ended September 30, 2004.  As of September 30, 2004, we had $95,000 outstanding on our revolving credit facility and $465,000 available for acquisitions and for general business purposes.

Note 5.  Shareholders’ Equity

In January 2004 we issued 34,500,000 common shares in a public offering, raising net proceeds of $323,639.  Net proceeds from this offering were used to reduce amounts outstanding under our revolving credit facility.

Our revolving credit facility and term loan agreements include financial ratio covenants that generally restrict our ability to make annual common share distributions that exceed 90% of adjusted income available for distributions, as defined.

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Note 6.  Pro Forma Information (unaudited)

The following table presents our pro forma results of operations as if our 2003 and 2004 acquisitions and financings were completed on January 1, 2003.  This pro forma data is not necessarily indicative of what actual results of operations would have been for the periods presented, nor do they purport to represent the results of operations for any future period.  Differences could result from, but are not limited to, additional property sales or investments, changes in interest rates and changes in our debt or equity capital.

Note 7.  Subsequent Events

In October 2004, we declared a distribution of $0.21 per common share, or approximately $37,200, to be paid on or about November 22, 2004, to shareholders of record on October 22, 2004.  We also announced a distribution on our Series A preferred shares of $0.6172 per share, or $4,938, and a distribution on our Series B preferred shares of $0.5469 per share, or $6,563, which will be paid on or about November 15, 2004, to our Series A and B preferred shareholders of record as of November 1, 2004.

Since September 30, 2004, we purchased one building for $38,500 plus closing costs.  We funded this transaction with cash on hand and by borrowing under our revolving credit facility.

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The geographic sources of property level revenue and net operating income (rental income less operating expenses) are as follows (in thousands):

(1) Includes some triple net lease revenues.

Comparable property level revenue and net operating income (rental income less operating expenses) for properties owned by us continuously since July 1, 2003, are as follows (in thousands):

(1)  Includes some triple net lease revenues.

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Three Months Ended September 30, 2004, Compared to Three Months Ended September 30, 2003

Rental income for the three months ended September 30, 2004, was $160.4 million, a 25.9% increase over total revenues of $127.4 million for the three months ended September 30, 2003.  Rents increased primarily because of our acquisition of 127 properties in 2004 and 27 properties in 2003, including 9.8 million square feet of leased industrial land, in December 2003, partially offset by a decline in rent rates at some of our properties.  Occupancy at properties we owned continuously since July 1, 2003, was 90.9% at September 30, 2004, and 90.8% at September 30, 2003.

During the past quarter, the rate of decline in occupancies in some of our continuously owned buildings seems to have slowed.  Also, quoted office rent rates in most of the areas where our properties are located seem to have stabilized.  However, we continue to experience strong competition to retain and attract office tenants in the form of landlord funded tenant build outs and increased leasing commissions payable to tenant brokers.  These build out costs and leasing commissions are generally amortized as a reduction of our income during the terms of the affected leases.  We expect that present leasing market conditions may continue until an increase in office employment causes office occupancies to increase in the respective market areas.  We do not know how long it may take the present market conditions affecting our properties to change.  At this time, however, we believe that modest declines in occupancies and in effective rents will continue to depress the financial results at some of our currently owned office buildings for at least one year.  There are too many variables for us to reasonably project what the financial impact of these market conditions will be on our results for future periods.

Rental income includes non cash straight line rent adjustments totaling $5.7 million in the 2004 period and $4.2 million in the 2003 period and amortization of acquired real estate leases and obligations of ($1.1) million in 2004 and $1.0 million in 2003.  Rental income also includes lease termination fees totaling $1.0 million in 2004 and $2.1 million in 2003.

Total expenses for the three months ended September 30, 2004, were $96.4 million, a 16.5% increase over total expenses of $82.8 million for the three months ended September 30, 2003.  Operating expenses, depreciation and amortization and general and administrative expenses increased by $10.2 million (20.4%), $1.4 million (5.1%), and $2.0 (40.3%), respectively, due primarily to the acquisition of properties in 2004 and 2003.  Interest expense increased by $7.4 million, or 30.7%, due to an increase in total debt outstanding which was used primarily to finance acquisitions in 2004 and 2003.

Equity in earnings of equity investments decreased by $282,000, or 7.3%, for the three months ended September 30, 2004, compared to the same period in 2003 because of lower earnings from Senior Housing resulting from the sale of some of our Senior Housing shares.

Net income was $36.4 million for the 2004 period, a 47.9% increase over net income of $24.6 million for the 2003 period.  The increase is due primarily to property acquisitions in 2004 and 2003.  Net income available for common shareholders is net income reduced by preferred distributions and was $24.9 million, or $0.14 per common share, in the 2004 period, a 89.8% increase from net income available for common shareholders of $13.1 million, or $0.09 per common share in the 2003 period.

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When amounts are outstanding on our revolving credit facility and as the maturity dates of our revolving credit facility and term debts approach, we explore alternatives for the repayment of amounts due.  Such alternatives usually include incurring additional term debt and issuing new equity securities.  On June 28, 2004, our shelf registration statement to increase securities available for issuance to $2.7 billion became effective, and as of September 30, 2004, $2.3 billion was available.  An effective shelf registration statement allows us to issue public securities on an expedited basis, but it does not assure that there will be buyers for such securities.  Although there can be no assurance that we will consummate any debt or equity offerings or other financings, we believe we will have access to various types of financing, including debt or equity offerings, with which to finance future acquisitions and to pay our debt and other obligations.

The completion and the costs of our future debt transactions will depend primarily upon market conditions and our own credit ratings.  We have no control over market conditions, but we expect both short and long term debt costs to increase gradually for at least the next few months.  Our credit ratings depend upon evaluation by credit rating agencies of our business practices and plans and, in particular, whether we appear to have the ability to maintain our earnings, to space our debt maturities and to balance our use of debt and equity capital so that our financial performance and leverage ratios afford us flexibility to withstand any reasonably anticipatable adverse changes.  We intend to conduct our business activities in a manner which will continue to afford us reasonable access to capital for investment and financing activities.

During the first nine months of 2004 we purchased 127 properties for $741.5 million, including closing costs, and funded improvements to our owned properties totaling $35.9 million.  We allocated $82.6 million of our total 2004 acquisition costs to acquired real estate leases and $10.6 million to acquired real estate lease obligations.  Included in these acquisitions is the purchase of Hallwood on July 16, 2004, for an aggregate net purchase price of $434.7 million, including closing costs.  Hallwood, formerly a publicly traded limited partnership, owned office and industrial properties with 5.2 million square feet of space located in seven metropolitan areas.  The Hallwood properties are currently leased to approximately 500 tenants under leases expiring between 2004 and 2020.  Upon the acquisition of Hallwood, we assumed approximately $207.0 million of Hallwood’s outstanding mortgage debt.  Approximately $100 million of this mortgage debt was repaid simultaneously with the purchase closing; the balance of this mortgage debt may be prepaid in 2005 and 2008.  We funded all our 2004 acquisitions with cash on hand and by borrowing under our revolving credit facility

During the quarters and nine month periods ended September 30, 2004 and 2003, cash expenditures made and capitalized for tenant improvements, leasing costs, building improvements and development and redevelopment activities were as follows (in thousands):

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Commitments made for expenditures in connection with leasing space during the quarter ended September 30, 2004, are as follows (in thousands, except as noted):

At September 30, 2004, we owned 9.7 million, or 15.2%, of the common shares of beneficial interest of Senior Housing with a carrying value of $118.2 million and a market value, based on quoted market prices, of $172.2 million, and 4.0 million, or 6.0%, of the common shares of beneficial interest of Hospitality Properties with a carrying value of $100.0 million and a market value, based on quoted market prices, of $170.0 million.  During the nine months ended September 30, 2004, we received cash distributions totaling $10.0 million from Senior Housing and $8.6 million from Hospitality Properties.  We use the income statement method to account for the issuance of common shares by Senior Housing and Hospitality Properties.  Under this method, gains and losses reflecting changes in the value of our investments at the date of issuance of additional common shares by Senior Housing and Hospitality Properties are recognized in our income statement.  In January 2004 Senior Housing completed a public offering of 5 million common shares.  As a result of this transaction, our ownership percentage in Senior Housing was reduced from 21.9% to 20.2%, and we recognized a gain of $966,000.  In addition, in January and February 2004 we sold 3.1 million of our Senior Housing shares in an underwritten public offering for $57.3 million, $54.4 million net of commissions and other costs.  In connection with this transaction, we recognized a gain of $14.8 million and our ownership percentage in Senior Housing was further reduced to 15.2%.  We expect cash distributions received by us from Senior Housing calculated at their current rate to decrease from $15.9 million to approximately $12.2 million per year.  In February and March 2004, Hospitality Properties completed a public offering of common shares that reduced our ownership percentage from 6.4% to 6.0%.  As a result of this transaction, we recognized a gain of $4.1 million.  On November 1, 2004, the market values of our Senior Housing and Hospitality Properties shares were $184.1 million and $175.0 million, respectively.  In the future we may decide to sell some or all of our remaining shares in Hospitality Properties or Senior Housing, based upon several factors including available alternative uses for the sale proceeds and the prices at which sales may be accomplished.

In January 2004 we issued 34,500,000 common shares in a public offering at $9.89 per share, raising gross proceeds of $341.2 million.  Net proceeds of this offering, $323.6 million, were used to reduce amounts outstanding under our revolving credit facility.  In February 2004 we redeemed at par $143 million of our 8.50% senior notes due in November 2013.  We funded this redemption by borrowing under our revolving credit facility.

In February 2004 we entered into a five year $250 million unsecured term loan with a group of banks.  Terms of the new loan include interest at LIBOR plus a spread, which averaged a total of 2.1% per annum from February to September 2004.  In August 2004 we exercised our option to increase this term loan by $100 million and amended the term loan to extend the maturity date by six months to August 24, 2009.  The term loan, as amended, permits prepayment of the loan without penalty beginning in February 2006.  Net proceeds of the loan were used to repay amounts outstanding under our revolving credit facility and for general business purposes.

In August 2004 we issued $400 million unsecured senior notes in a public offering, raising net proceeds of $392.2 million.  The notes bear interest at 6.25%, require semi-annual interest payments and mature in August 2016.  Net proceeds from this offering were used to repay amounts outstanding under our revolving credit facility.

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Item 3.  Quantitative and Qualitative Disclosures About Market Risk

We are exposed to risks associated with market changes in interest rates.  Our strategy to manage exposure to changes in interest rates is unchanged since December 31, 2003.  Other than as described below, we do not foresee any significant changes in our exposure to fluctuations in interest rates or in how we manage this exposure in the near future.

Our unsecured revolving credit facility and our unsecured term loan bear interest at floating rates and mature in April 2006 and August 2009, respectively.  As of September 30, 2004, we had $95 million outstanding and $465 million available for drawing under our revolving credit facility and $350 million outstanding under our term loan.  Repayments under our revolving credit facility may be made at any time without penalty.  Repayments under our term loan may be made without penalty beginning in February 2006.  We borrow in U.S. dollars and borrowings under our revolving credit facility and our term loan require interest at LIBOR plus a premium.  Accordingly, we are vulnerable to changes in U.S. dollar based short term rates, specifically LIBOR.  A change in interest rates would not affect the value of these floating rate debts but would affect our operating results.  For example, the average interest rate payable on our $350 million term loan and $95 million outstanding on our revolving credit facility at September 30, 2004, was 2.2% per annum.  The following table presents the impact a 10% change in interest rates would have on our floating rate interest expense as of September 30, 2004 (dollars in thousands):

The foregoing table shows the impact of an immediate change in floating interest rates.  If interest rates were to change gradually over time, the impact would be spread over time.  Our exposure to fluctuations in floating interest rates will increase or decrease in the future with increases or decreases in the outstanding amount of our floating rate debt.

Our $1.4 billion of publicly issued term debt and our $440.2 million of mortgage notes outstanding on September 30, 2004, bear interest at fixed rates.  Changes in market interest rates during the term of this debt will not affect our operating results.  If all of our fixed rate unsecured and secured notes outstanding at September 30, 2004, were to be refinanced at interest rates which are 10% higher or lower than current interest rates, our per annum interest cost would increase or decrease, respectively, by approximately $12.2 million.

Item 4.  Controls and Procedures

As of the end of the period covered by this report, our management carried out an evaluation, under the supervision and with the participation of our managing trustees, President and Chief Operating Officer and Treasurer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures pursuant to Exchange Act Rules 13a-15 and 15d-15. Based upon that evaluation, our managing trustees, President and Chief Operating Officer and Treasurer and Chief Financial Officer concluded that our disclosure controls and procedures are effective.

There have been no changes in our internal control over financial reporting during the quarter ended September 30, 2004, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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NEEDS FOR LEASED SPACE, OR CHANGES IN THE CAPITAL MARKETS OR THE ECONOMY GENERALLY, ARE BEYOND OUR CONTROL.  SIMILARLY, OUR IMPLEMENTATION OF FAS 141 HAS REQUIRED US TO MAKE JUDGMENTS ABOUT THE ALLOCATION OF THE PURCHASE PRICES OF OUR PROPERTIES WHICH AFFECT OUR FINANCIAL STATEMENTS, INCLUDING FUTURE INCOME; THESE JUDGMENTS ARE BASED UPON OUR ESTIMATES, BELIEFS AND EXPECTATIONS ABOUT VACANT BUILDING VALUES AND RENTAL RATES, BUT SUCH ESTIMATES, BELIEFS AND EXPECTATIONS MAY PROVE TO BE INACCURATE.  THE INFORMATION CONTAINED ELSEWHERE IN THIS QUARTERLY REPORT ON FORM 10-Q AND IN OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2003, REFERRED TO HEREIN, IDENTIFY OTHER IMPORTANT FACTORS THAT COULD CAUSE SUCH DIFFERENCES.

FORWARD LOOKING STATEMENTS ARE ONLY EXPRESSIONS OF OUR PRESENT EXPECTATIONS AND INTENTIONS.  FORWARD LOOKING STATEMENTS ARE NOT GUARANTEED TO OCCUR AND MAY NOT OCCUR.  YOU SHOULD NOT PLACE UNDUE RELIANCE UPON FORWARD LOOKING STATEMENTS.   EXCEPT AS MAY BE REQUIRED BY LAW, WE DO NOT INTEND TO IMPLY THAT WE WILL UPDATE OR REVISE ANY FORWARD LOOKING STATEMENTS AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE.

STATEMENT CONCERNING LIMITED LIABILITY

THE AMENDED AND RESTATED DECLARATION OF TRUST ESTABLISHING HRPT PROPERTIES TRUST, DATED JULY 1, 1994, A COPY OF WHICH, TOGETHER WITH ALL AMENDMENTS AND SUPPLEMENTS THERETO, IS DULY FILED IN THE OFFICE OF THE STATE DEPARTMENT OF ASSESSMENTS AND TAXATION OF MARYLAND, PROVIDES THAT THE NAME “HRPT PROPERTIES TRUST” REFERS TO THE TRUSTEES UNDER THE DECLARATION OF TRUST, AS SO AMENDED AND SUPPLEMENTED, COLLECTIVELY AS TRUSTEES, BUT NOT INDIVIDUALLY OR PERSONALLY, AND THAT NO TRUSTEE, OFFICER, SHAREHOLDER, EMPLOYEE OR AGENT OF HRPT PROPERTIES TRUST SHALL BE HELD TO ANY PERSONAL LIABILITY, JOINTLY OR SEVERALLY, FOR ANY OBLIGATION OF, OR CLAIM AGAINST, HRPT PROPERTIES TRUST.  ALL PERSONS DEALING WITH HRPT PROPERTIES TRUST, IN ANY WAY, SHALL LOOK ONLY TO THE ASSETS OF HRPT PROPERTIES TRUST FOR THE PAYMENT OF ANY SUM OR THE PERFORMANCE OF ANY OBLIGATION.

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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.

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