Kilroy Realty - 10-Q quarterly report FY

As of August 9, 2002, 27,925,214 shares of common stock, par value $.01 per share, were outstanding.

Kilroy Realty Corporation (the “Company”) owns, develops, and operates office and industrial real estate, primarily in Southern California. The Company operates as a self-administered real estate investment trust (“REIT”). As of June 30, 2002, the Company’s stabilized portfolio of operating properties consisted of 91 office buildings (the “Office Properties”) and 61 industrial buildings (the “Industrial Properties”), which encompassed an aggregate of approximately 7.6 million and 5.1 million rentable square feet, respectively, and was 94.8% occupied. The Company’s stabilized portfolio of operating properties consists of all of the Company’s Office Properties and Industrial Properties, excluding properties currently under construction, renovation or in pre-development and “lease-up” properties. The Company defines “lease-up” properties as properties recently developed by the Company that have not yet reached 95% occupancy and are within one year of substantial completion. Lease-up properties are included in land and improvements and building and improvements on the consolidated balance sheets upon building shell completion. As of June 30, 2002, the Company had one office property encompassing an aggregate of approximately 151,000 rentable square feet which was in the lease-up phase. In addition, as of June 30, 2002, the Company had four office properties under construction or committed for construction and one property under renovation, which when completed are expected to encompass an aggregate of approximately 546,600 and 78,000 rentable square feet, respectively.

The Company owns its interests in all of its properties through Kilroy Realty, L.P. (the “Operating Partnership”) and Kilroy Realty Finance Partnership, L.P. (the “Finance Partnership”) and conducts substantially all of its operations through the Operating Partnership. The Company owned an 86.2% general partnership interest in the Operating Partnership as of June 30, 2002. Unless otherwise indicated, all references to the Company include the Operating Partnership, the Finance Partnership and all wholly-owned subsidiaries and controlled entities of the Company.

In 1999, the Company, through the Operating Partnership, became a 50% managing member in two limited liability companies (the “Development LLCs”) which were formed to develop two multi-phased office projects in San Diego, California. The Allen Group, a group of affiliated real estate development and investment companies based in San Diego, California, was the other 50% member of the Development LLCs. On March 25, 2002, the Company acquired The Allen Group’s interest in the assets and assumed The Allen Group’s proportionate share of the liabilities of the Development LLCs (see Notes 2 and 5). Subsequent to this transaction, the Development LLCs were liquidated and dissolved. The Development LLCs were consolidated for financial reporting purposes prior to their dissolution on March 25, 2002 since the Company controlled all significant development and operating decisions.

The accompanying interim financial statements have been prepared by the Company’s management in accordance with generally accepted accounting principles (“GAAP”) and in conjunction with the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures required for annual financial statements have been condensed or excluded pursuant to SEC rules and regulations. Accordingly, the interim financial statements do not include all of the information and footnotes required by GAAP in the United States of America for complete financial statements. In the opinion of management, the interim financial statements presented herein reflect all adjustments of a normal and recurring nature which are considered necessary for a fair presentation of the results for the interim periods presented. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the year ended December 31, 2002. These financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2001. Certain prior year amounts have been reclassified to conform to the current period’s presentation.

On January 1, 2002, the Company adopted the provisions of SFAS 142 “Goodwill and Other Intangible Assets” (“SFAS 142”) and SFAS 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”). SFAS 142 discontinues the practice of amortizing goodwill and other intangible assets and requires a periodic review process for impairment. SFAS 144 addresses financial accounting and reporting for the disposal of long-lived assets and supercedes FAS 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” The adoption of these statements did not have a material effect on the Company’s results of operations or financial condition.

The Company voluntarily adopted the fair value recognition method of Statement of Financial Accounting Standard No. 123 “Accounting for Stock Based Compensation” (“SFAS No. 123”) effective January 1, 2002. Under the fair value recognition method of SFAS No. 123, total compensation expense related to stock options is determined using the fair value of the stock options on the date of grant. Total compensation expense is then recognized on a straight-line basis over the option vesting period. The adoption provisions of SFAS No. 123 require that the fair value recognition method be applied to stock options granted after the beginning of the fiscal year in which the recognition provisions are adopted, except to the extent that stock options granted in fiscal years before the year of initial adoption are modified or settled in cash. As a result, the Company will continue to account for stock options granted prior to January 1, 2002 using the intrinsic value based method of accounting prescribed by Accounting Practice Bulletin No. 25 “Accounting for Stock Issued to Employees” and FASB Interpretation No. 44 “Accounting for Certain Transactions Involving Compensation.” The adoption of SFAS No. 123 did not have a material impact on the Company’s results of operations or financial condition (see Note 6).

On March 25, 2002, the Company acquired The Allen Group’s interest in the assets of the Development LLCs which included nine San Diego office properties encompassing approximately 848,300 rentable square feet, and three San Diego development sites, encompassing approximately 11.9 acres (see Notes 1 and 5).

The Company did not sell any properties during the six months ended June 30, 2002. However, the Company did recognize an additional gain of approximately $896,000 related to the disposition of an office property the Company sold in the fourth quarter of 2001. This additional gain had previously been reserved for financial reporting purposes until certain contingencies associated with the disposition were resolved.

During the six months ended June 30, 2002, the Company added the following development projects to the Company’s stabilized portfolio:

At June 30, 2002, the Company had the following office property in the lease-up phase:

In March 2002, the Company obtained a new $425 million unsecured revolving credit facility (the “New Credit Facility”) with a bank group led by J.P. Morgan Securities, Inc. to replace its previous $400 million unsecured revolving credit facility (the “Old Credit Facility”) which was scheduled to mature in November 2002. In connection with obtaining the New Credit Facility, the Company repaid its $100 million unsecured debt facility which was scheduled to mature in September 2002. The New Credit Facility bears interest at an annual rate between LIBOR plus 1.13% and LIBOR plus 1.75% (3.34% at June 30, 2002), depending upon the Company’s leverage ratio at the time of borrowing, and matures in March 2005. At June 30, 2002, the Company had borrowings of $306 million outstanding under the New Credit Facility and availability of approximately $118 million. The fee for unused funds ranges from an annual rate of 0.20% to 0.35% depending on the Company’s leverage ratio. The New Credit Facility contains financial covenants consistent with those under the Old Credit Facility. The Company was in compliance with all its covenants at June 30, 2002. The Company expects to use the New Credit Facility to finance development expenditures, to fund potential acquisitions and for general corporate uses.

In January 2002, the Company borrowed $80.0 million under a mortgage loan that is secured by 11 industrial properties, requires monthly principal and interest payments based on a fixed annual interest rate of 6.70% and matures in January 2012. The Company used the proceeds from the loan to repay borrowings under the Old Credit Facility.

In February 2002, the Company repaid the $9.1 million principal balance of an existing construction loan, which had a stated maturity of April 2002. In March 2002, in connection with the acquisition of The Allen Group’s interest in the Development LLC properties (see Notes 2 and 5), the Company repaid three construction loans which had outstanding principal balances totaling $78.8 million. These loans had been secured by certain of the Development LLCs’ properties and had stated maturities ranging from April 2002 through May 2003. All of the repayments were funded with borrowings under the Company’s Credit Facility and did not require prepayment penalties.

Total interest and loan fees capitalized for both the three months ended June 30, 2002 and 2001 was $3.4 million. Total interest and loan fees capitalized for the six months ended June 30, 2002 and 2001 was $7.2 million and $6.7 million, respectively.

In March 2002, the Company entered into a new interest rate swap agreement with a total notional amount of $50 million, which expires in January 2005. The agreement requires the Company to pay fixed interest payments based on an annual interest rate of 4.46% and receive variable interest payments based on LIBOR. As of June 30, 2002, the Company also had an existing swap agreement with a notional amount of $150 million, which expires in November 2002 and requires the Company to pay fixed interest payments based on an annual interest rate of 5.48% and receive variable interest payments based on LIBOR. As of June 30, 2002, the Company reported a liability of $3.5 million for the fair value of these two instruments which is included in other liabilities in the consolidated balance sheet.

In March 2002, the Company entered into two new interest rate cap agreements with a total notional amount of $100 million and a LIBOR based annual cap rate of 4.25% that expire in January 2005. The $2.4 million cost is amortized over the life of the agreements. As of June 30, 2002, the Company reported an asset of $1.2 million for the fair value of these instruments, which is included in deferred financing costs in the consolidated balance sheets.

All of the instruments described above have been designated as cash flow hedges. For the six months ended June 30, 2002, the Company did not record any gains or losses attributable to cash flow hedge ineffectiveness since the terms of the Company’s derivative contracts and debt obligations were and are expected to continue to be effectively matched. As of June 30, 2002, the balance in accumulated net other comprehensive loss relating to derivatives was $4.7 million. During the twelve-month period ending June 30, 2003, the Company estimates that it will reclassify approximately $3.2 million of this balance to interest expense.

Minority interests represent the preferred limited partnership interests in the Operating Partnership, the common limited partnership interests in the Operating Partnership not owned by the Company, and interests held by The Allen Group in the Development LLCs prior to their dissolution on March 25, 2002 (see Notes 2 and 5). The Company owned an 86.2% general partnership interest in the Operating Partnership as of June 30, 2002.

During the six months ended June 30, 2002, 37,827 common limited partnership units of the Operating Partnership were exchanged into shares of the Company’s common stock on a one-for-one basis. Neither the Company nor the Operating Partnership received any proceeds from the issuance of the common stock to the common limited partnership holders.

On March 25, 2002, the Company acquired The Allen Group’s minority interest in the assets and assumed The Allen Group’s proportionate share of the liabilities of the Development LLCs. The net consideration was approximately $40.9 million. The acquisition was funded with $2.2 million in cash and 1,398,068 common limited partnership units of the Operating Partnership valued at $38.7 million based upon the closing share price of the Company’s common stock as reported on the New York Stock Exchange. In connection with the acquisition, the Company recognized $3.9 million of preferred return income that had been previously earned but had been fully reserved for financial reporting purposes until the acquisition was complete and the related litigation between the parties was settled. The preferred return investment earned a 12.5% rate of return. In connection with the acquisition, the Company repaid three construction loans which were secured by certain of the Development LLC properties (see Note 3).

The Company voluntarily adopted the fair value recognition method of Statement of Financial Accounting Standard No. 123 “Accounting for Stock Based Compensation” (“SFAS No. 123”) effective January 1, 2002. The adoption provisions of SFAS No. 123 require that the fair value recognition method be applied to stock options granted after the beginning of the fiscal year in which the recognition provisions are adopted. Accordingly, the Company recorded approximately $9,000 of compensation expense for the six months ended June 30, 2002 for stock options granted subsequent to January 1, 2002. This compensation expense relates to the Company’s annual grant of 25,000 stock options to the Company’s non-employee Board of Directors which occurred in February 2002.

The fair value of these options was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions: (a) dividend yield of 7.03%, (b) expected volatility of the Company’s stock of 24.6%, (c) risk free interest rate of 4.88%, and (d) expected option life of seven years. The effects of applying SFAS No. 123 may not be representative of the effects on net income for future years because options vest over several years and additional awards can and may be awarded.

On February 26, 2002, the Company’s Compensation Committee granted an aggregate of 81,729 restricted shares of the Company’s Common Stock to certain executive officers under the Company’s 1997 Stock Option and Incentive Plan (the “1997 Plan”). All of the shares issued were granted at a value of $25.74 per share, the Company’s closing share price on the grant date, against the payment of the par value or $0.01 per share. Of the shares granted 20,541, vest over a one-year period and 61,188 vest over a two-year period. Compensation expense for these restricted shares will be amortized on a straight-line basis over the vesting periods. The restricted shares have the same dividend and voting rights as common stock.

On February 26, 2002, the Company’s Compensation Committee approved two new programs under the 1997 Plan for the future potential issuance of restricted stock and one program for the potential payment of cash to certain key employees as part of their annual and long-term incentive compensation. The number of shares that will ultimately be issued and the amount of cash that will ultimately be paid under these programs will be contingent upon both the Company and the individuals meeting certain financial, operating and development performance targets during each fiscal year. The awards are payable at the discretion of the Compensation Committee. The restricted stock awards will vest over one to two years, depending upon the specific program and will be expensed over the performance and vesting periods.

During the quarter ended June 30, 2002 the Company renegotiated the ground leases at Kilroy Airport Center, Phases I, II, and III in Long Beach, California resulting in a reduction of annual ground lease expense of approximately $0.3 million. The ground lease obligation will be subject to fair market value adjustments every five years. The Company also exercised the option to extend the ground leases for an additional fifty years. The ground leases now expire in July 2084.

The Company’s second largest tenant, Peregrine Systems, Inc. (“Peregrine”), currently leases four office buildings totaling approximately 423,900 rentable square feet under four separate leases. Peregrine has advised the Company that it is likely it will need only one of these four operating buildings upon the resolution of their financial issues. As a result, the Company recorded a $5.3 million charge to depreciation and amortization for leasing commissions and certain tenant improvements that were previously capitalized in connection with the leases with Peregrine. In addition, the Company recorded a $0.5 million charge to general and administrative expenses for costs the Company paid for the fifth and final building that was to be leased to Peregrine. This building, which Peregrine surrendered back to the Company in June 2002, was still under construction at June 30, 2002 and was not yet included in the Company’s portfolio of stabilized operating properties.

The Company’s reportable segments consist of the two types of commercial real estate properties for which management internally evaluates operating performance and financial results: Office Properties and Industrial Properties. The Company also has certain corporate level activities including legal administration, accounting, finance, and management information systems which are not considered separate operating segments.

The Company evaluates the performance of its segments based upon net operating income. Net operating income is defined as operating revenues (rental income, tenant reimbursements and other income) less property and related expenses (property expenses, real estate taxes and ground leases) and does not include interest income and expense, depreciation and amortization and corporate general and administrative expenses. All operating revenues are comprised of amounts received from third-party tenants.

Basic earnings per share is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted earnings per share is computed by dividing net income by the sum of the weighted-average number of common shares outstanding for the period plus the number of common shares issuable assuming the exercise of all dilutive securities. The Company does not consider common units of the Operating Partnership to be dilutive since the exchange of common units into common stock is on a one-for-one basis and would not have any effect on diluted earnings per share. The following table reconciles the numerator and denominator of the basic and diluted per-share computations for net income.

At June 30, 2002, Company employees and directors held options to purchase 3,000 shares of the Company’s common stock that were antidilutive to the diluted earnings per share computation. These options could become dilutive in future periods if the average market price of the Company’s common stock exceeds the exercise price of the outstanding options.

In July 2002, KAICO, a partnership owned by John B. Kilroy, Sr., the Chairman of the Company’s Board of Directors, John B. Kilroy, Jr. the Company’s President and Chief Executive Officer, and certain other Kilroy family members, received a $1.4 million net insurance payment for earthquake related damage to two of the three buildings in an office complex the Company acquired from KAICO in a series of transactions from May 2000 through January 2001. In connection with the acquisition, KAICO and the Company agreed that KAICO would be entitled to retain all claims under policies of insurance in effect with respect to these properties, with the exception that KAICO transferred to the Company the rights to any claims under any insurance policy that

On July 17, 2002, aggregate distributions of approximately $15.9 million were paid to common stockholders and common unitholders of record on June 28, 2002.

On August 1, 2002, the Company acquired an office property in Santa Ana, California from an unaffiliated third-party for approximately $8.1 million. The property encompasses approximately 107,000 rentable square feet and the Company will lease 100% of the space back to the seller.

The following discussion relates to the consolidated financial statements of the Company and should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report. Statements contained in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” that are not historical facts may be forward-looking statements. Such statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from those projected. Some of the information presented is forward-looking in nature, including information concerning projected future occupancy rates, rental rate increases, project development timing and investment amounts. Although the information is based on the Company’s current expectations, actual results could vary from expectations stated here. Numerous factors will affect the Company’s actual results, some of which are beyond its control. These include the timing and strength of regional economic growth, the strength of commercial and industrial real estate markets, competitive market conditions, future interest rate levels and capital market conditions. You are cautioned not to place undue reliance on this information, which speaks only as of the date of this report. The Company assumes no obligation to update publicly any forward-looking information, whether as a result of new information, future events or otherwise, except to the extent the Company is required to do so in connection with its ongoing requirements under Federal securities laws to disclose material information. For a discussion of important risks related to the Company’s business, and an investment in its securities, including risks that could cause actual results and events to differ materially from results and events referred to in the forward-looking information, see the discussion under the caption “Business Risks” in the Company’s annual report on Form 10-K for the year ended December 31, 2001 and under the caption “Factors Which May Influence Future Results of Operations” below. In light of these risks, uncertainties and assumptions, the forward-looking events contained herein might not occur.

Kilroy Realty Corporation (the “Company”) owns, develops, and operates office and industrial real estate, primarily in Southern California. The Company operates as a self-administered real estate investment trust (“REIT”). The Company owns its interests in all of its properties through Kilroy Realty, L.P. (the “Operating Partnership”) and Kilroy Realty Finance Partnership, L.P. (the “Finance Partnership”) and conducts substantially all of its operations through the Operating Partnership. The Company owned an 86.2% general partnership interest in the Operating Partnership as of June 30, 2002.

Projected Future Occupancy Rates, Rental Rate Increases and Operating Results Trends.    For the six months ended June 30, 2002 and 2001, average occupancy in the Company’s stabilized portfolio was 94.4% and 96.0%, respectively. Prior to the first quarter of 2002, the Company had achieved historical average occupancy levels of above 95.0% since the time of its IPO in 1997. The Company believes that maintaining average occupancy levels above 95.0% will not be sustainable given the current economic environment as evidenced by the Company’s average occupancy of 94.4% for the six months ended June 30, 2002. In addition, as of June 30, 2002, leases representing approximately 1.5% and 13.1% of the square footage of the Company’s stabilized portfolio are scheduled to expire during the remainder of 2002 and in 2003, respectively. Although the Company has stringent lease underwriting standards and continually evaluates the financial capacity of both its prospective and existing tenants to proactively manage portfolio credit risk, a downturn in tenants’ businesses may weaken tenants’ financial conditions and could result in defaults under lease obligations.

As of June 30, 2002, the Office and Industrial Properties represented 80.0% and 20.0%, respectively, of the Company’s annualized base rent. Leases representing approximately 1.1 million square feet of office space, or 10.8% of the Company’s annualized base rent, and approximately 588,000 square feet of industrial space, or 2.3% of the Company’s annualized base rent, are scheduled to expire during the remainder of 2002 and in 2003. Management believes that the average rental rates for its Office Properties are below currently quoted market rates in each of its submarkets, and are approximately at currently quoted market rates in each of its submarkets for its Industrial Properties. During 2001 and 2000, the Company’s average rental rate increases on a cash and GAAP basis averaged approximately 15% and 26%, respectively. The Company believes that such rental rate increases are not sustainable given the recent economic downturn. If the Company is unable to lease a significant portion of any vacant space or space scheduled to expire, if the Company experiences significant tenant defaults

The Company’s operating results are and will continue to be affected by uncertainties and problems associated with the deregulation of the utility industry in California since 94.8% of the total rentable square footage of the Company’s stabilized portfolio is located in California. Energy deregulation has resulted in higher utility costs in some areas of the state and intermittent service interruptions. In addition, as a result of the events of September 11, 2001, the Company’s insurance costs increased across its portfolio approximately 18%. As of the date of this report, the Company has not experienced any material negative effects arising from either of these issues because approximately 75% (based on net rentable square footage) of the Company’s current leases require tenants to pay utility costs and property insurance premiums directly, thereby limiting the Company’s exposure. The remaining 25% of the Company’s leases provide that the tenants reimburse the Company for these costs in excess of a base year amount.

Current Submarket Information.    While the Company has been encouraged by the recent trends in the demand for rental space in the San Diego and Orange County regions, the demand for space in the Los Angeles County region continues to be challenged and not be as strong as the Company experienced from 1998 through 2000. Consequently, management cannot predict when the Company will see significant positive leasing momentum given the concentration of sublease space currently available in this market. At June 30, 2002, the Company’s Los Angeles office portfolio was 85.3% occupied with approximately 480,000 rentable square feet available for lease. In addition, as of June 30, 2002, leases representing an aggregate of approximately 40,300 and 649,500 rentable square feet were scheduled to expire during the remainder of 2002 and in 2003, respectively, in the Company’s Los Angeles stabilized portfolio. At June 30, 2002, the Company had two in-process development projects in the Los Angeles region encompassing an aggregate of 284,700 rentable square feet, 151,000 of which is presently in lease-up and 133,700 of which became available for lease in the third quarter of 2002. If the Company is unable to lease a significant portion of this available space or space scheduled to expire in 2002, if existing tenants do not renew their leases in this region, or if rental rates for the Company’s Los Angeles properties decrease, the Company’s results of operations, financial condition and cash flows would be adversely affected.

Projected Development Trends.    During the six months ended June 30, 2002, the Company stabilized five office buildings encompassing an aggregate of approximately 345,100 rentable square feet for a total estimated investment of approximately $81 million. Management believes that the most significant part of the Company’s expected revenue growth will come from the lease-up and stabilization of approximately 697,600 rentable square feet of office space in lease-up, under construction or committed for construction at June 30, 2002, and its development pipeline of approximately 1.1 million rentable square feet of office space presently expected to be developed over the next four years. Given the recent economic downturn, the Company may not be able to maintain historical levels of development activity in the future, or may not be able to complete and lease development projects to stabilized portfolio occupancy rates within the timeframes experienced by the Company during the last two to three years. The Company has a proactive development planning process which continually evaluates the size, timing, and scope of the Company’s development program in 2002 and beyond, and as necessary, scales development to reflect the economic conditions and the real estate fundamentals that exist in the Company’s development submarkets.

Current Sublease Space.    As of June 30, 2002, approximately 896,000 rentable square feet, or 7.1% of the square footage in the Company’s stabilized portfolio was available for sublease, of which approximately 5.5% was vacant space and the remaining 1.6% was occupied. Of the total 7.1% of rentable square feet available for sublease, approximately 4.7% is located in Orange County, of which 3.6% represents space available in four Orange County industrial buildings, and approximately 2.0% is in San Diego County. The remaining sublease space is in Los Angeles County and other regions. If the square footage available for sublease increased in specific regions, the rental rates for space available for direct lease by the Company would be impacted which could impact the Company’s results of operations, financial condition and cash flows.

Recent Information Regarding Tenants Representing 5% or Greater of Annual Base Rental Revenue.    As of June 30, 2002, the Company’s largest tenant, The Boeing Company, leased an aggregate of approximately 1.1 million rentable square feet of office space under ten separate leases, representing approximately 10.3% of the Company’s total annual base rental revenues. In December 2001, The Boeing Company exercised an option

The Company’s second largest tenant, Peregrine Systems, Inc. (“Peregrine”) currently leases four office buildings totaling approximately 423,900 rentable square feet under four separate leases. The buildings are all located in a five-building campus designed for multi-tenant use in the Del Mar submarket of San Diego, California. The Company is currently developing the fifth building which, when complete will encompass approximately 114,800 rentable square feet. This building was previously committed to Peregrine. However, Peregrine surrendered this building back to the Company in June 2002.

Peregrine is current on all its rent obligations due through August 31, 2002 under its four operating property leases. Under the terms of its leases, Peregrine is required to provide a letter of credit if it fails to meet certain quarterly financial covenants. Based on Peregrine’s most recently published quarterly financial results dated January 24, 2002, Peregrine has met its financial requirements under the leases through December 31, 2001 and was not required to post letters of credit. Peregrine has advised the Company that it is likely it will only need Building 2 in the event Peregrine resolves its financial issues.

Additional details of the leases are as follows:

The Company’s financial position, revenues and results of operations would be materially adversely affected if the aforementioned tenants, or any other of the Company’s significant tenants failed to renew their leases or renew leases on terms less favorable to the Company, or if they became bankrupt or insolvent or otherwise unable to satisfy their lease obligations.

During the six months ended June 30, 2002, the Company completed the development of five office buildings encompassing an aggregate of approximately 345,100 rentable square feet that were added to the Company’s stabilized portfolio of operating properties. During the year ended December 31, 2001, the Company completed the development of four office buildings encompassing an aggregate of approximately 312,400 rentable square feet, all of which were included in the Company’s stabilized portfolio of operating properties at June 30, 2002. The Company’s stabilized portfolio of operating properties consists of all of the Company’s office and industrial properties, excluding properties recently developed by the Company that have

The Company did not acquire any operating properties during the six months ended June 30, 2002. During the year ended December 31, 2001, the Company acquired a 75% tenancy-in-common interest in a three-building office complex encompassing an aggregate of approximately 366,000 rentable square feet. The initial 25% tenancy-in-common interest was acquired by a wholly-owned subsidiary of the Company in October 2000. During the six months ended June 30, 2002, the Company did not dispose of any properties. During the year ended December 31, 2001, the Company disposed of two office and seventeen industrial buildings encompassing an aggregate of approximately 80,100 and 721,900 rentable square feet, respectively, for an aggregate sales price of $70.4 million and a net gain of approximately $4.7 million.

As a result of the properties disposed of subsequent to June 30, 2001 and the one renovation project taken out of service during 2001, net of the development projects completed and added to the Company’s stabilized portfolio of operating properties subsequent to June 30, 2001, rentable square footage in the Company’s portfolio of stabilized properties decreased by an aggregate of approximately 185,000 rentable square feet, or 1.5%, to 12.7 million rentable square feet at June 30, 2002, compared to 12.8 million rentable square feet at June 30, 2001. As of June 30, 2002, the Company’s stabilized portfolio was comprised of 91 office properties (the “Office Properties”) encompassing an aggregate of approximately 7.6 million rentable square feet and 61 industrial properties (the “Industrial Properties”) encompassing an aggregate of approximately 5.1 million rentable square feet. The stabilized portfolio occupancy rate at June 30, 2002 was 94.8%, with the Office Properties and Industrial Properties 92.4% and 98.3% occupied, respectively.

Management evaluates the operations of its portfolio based on operating property type. The following tables compare the net operating income, defined as operating revenues (rental income, tenant reimbursements and other income) less property and related expenses (property expenses, real estate taxes and ground leases) before depreciation, for the Office Properties and for the Industrial Properties for the three months ended June 30, 2002 and 2001.