ALEXANDRIA REAL ESTATE EQUITIES, INC.
(Exact name of Registrant as Specified in its Charter)
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ___________ TO _____________
Commission file number 1-12993
ALEXANDRIA REAL ESTATE EQUITIES, INC.
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135 North Los Robles Ave
Suite 250
Pasadena, California 91101
(Address of principal executive offices including zip code)
(626) 578-0777
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
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(Including related preferred stock purchase rights) 9.50% Series A Cumulative Redeemable Preferred Stock 9.10% Series B Cumulative Redeemable Preferred Stock |
New York Stock Exchange New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K, or any amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [X] No [ ]
The aggregate market value of the shares of Common Stock held by non-affiliates was approximately $835.8 million based on the closing price for such shares on the New York Stock Exchange on June 30, 2003.
As of March 10, 2004, the registrant had outstanding 19,378,282 shares of Common Stock.
Documents Incorporated By Reference
Part III of this report incorporates information by reference from the registrant's definitive proxy statement to be filed within 120 days of the end of the fiscal year covered by this report in connection with the registrant's annual meeting of stockholders to be held on or about May 12, 2004.
INDEX TO FORM 10-K
ALEXANDRIA REAL ESTATE EQUITIES, INC.
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Part I. |
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Item 1. |
Business | |
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Item 2. |
Properties | |
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Item 3. |
Legal Proceedings | |
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Item 4. |
Submission of Matters to a Vote of Security Holders | |
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Part II. |
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Item 5. |
Market for the Registrant's Common Equity and Related Stockholder Matters | |
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Item 6. |
Selected Financial Data | |
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Item 7. |
Management's Discussion and Analysis of Financial Condition and Results of Operations | |
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Item 7a. |
Quantitative and Qualitative Disclosures About Market Risks | |
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Item 8. |
Consolidated Financial Statements and Supplementary Data | |
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Item 9. |
Changes in and Disagreements with Accountants on Accounting and Financial Disclosures | |
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Item 9a. |
Controls and Procedures | |
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Part III. |
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Item 10. |
Directors and Executive Officers of the Registrant | |
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Item 11. |
Executive Compensation | |
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Item 12. |
Security Ownership of Certain Beneficial Owners and Management | |
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Item 13. |
Certain Relationships and Related Transactions | |
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Item 14. |
Principal Accounting Fees and Services | |
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Part IV. |
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Item 15. |
Exhibits, Consolidated Financial Statement Schedules and Reports on Form 8-K | |
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Signatures |
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PART I
This document contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. You can identify some of the forward-looking statements by the use of forward-looking words such as "believes", "expects", "may", "will", "should", "seeks", "intends", "plans", "estimates" or "anticipates", or the negative of these words or similar words. Forward-looking statements involve inherent risks and uncertainties regarding events, conditions and financial trends that may affect our future plans of operation, business strategy, results of operations and financial position. A number of important factors could cause actual results to differ materially from those included within or contemplated by the forward-looking statements, including, but not limited to, those described below under the headings "Item 1. Business--Business Risks" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations". We do not undertake any responsibility to update any of these factors or to announce publicly any revisions to any of the forward-looking statements, whether as a result of new information, future events or otherwise.
The terms "we", "our", "ours" and "us", as used in this report, refer to Alexandria Real Estate Equities, Inc. and its subsidiaries.
Item 1. Business
General
We are a Maryland corporation formed in October 1994 that has elected to be taxed as a real estate investment trust, or REIT, for federal income tax purposes. We are engaged primarily in the ownership, operation, management, acquisition, expansion and selective redevelopment and development of high quality, strategically located properties containing office and laboratory space designed and improved for lease principally to pharmaceutical, biotechnology, life science product and services companies, not-for-profit scientific research institutions, universities and related government agencies (collectively, the "life science industry"). Properties leased to tenants in the life science industry typically consist of suburban office buildings containing scientific research and development laboratories and other improvements that are generic to tenants operating in the life science industry. We refer to such properties as "life science facilities." As of December 31, 2003, we owned 89 properties (collectively, the "properties"), containing approximately 5.7 million rentable square feet of office and laboratory space.
Business and Growth Strategy
We focus our property operations and investment activities principally in the following life science markets:
California (in the San Diego, Pasadena and San Francisco Bay areas).
Seattle.
suburban Washington D.C. (including Maryland and Virginia).
eastern Massachusetts.
New Jersey and suburban Philadelphia.
the Southeast (including North Carolina and Georgia).
Our tenant base is broad and diverse within the life science industry and reflects our focus on regional, national and international tenants with substantial financial and operational resources. For a detailed description of our properties and tenants, see "Item 2. Properties." We have an experienced Board of Directors and are led by a senior management team with extensive experience in both the real estate and life science industries.
We seek to maximize growth in funds from operations ("FFO") and cash available for distribution to stockholders through the ownership, operation, management, acquisition, expansion and selective redevelopment and development of life science facilities. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Funds from Operations" for a discussion of how we compute and view FFO, as well as a discussion of other measures of cash flow. In particular, we seek to increase FFO and cash available for distribution by:
acquiring high quality life science facilities in our life science markets at prices that will enable us to realize attractive returns.
redeveloping or expanding existing or newly acquired office, warehouse or vacant space into generic laboratory space that can be leased at higher rental rates.
selectively developing properties, primarily on a build-to-suit basis.
retenanting and releasing space within our portfolio at higher rental rates and with minimal non-revenue enhancing tenant improvement costs.
realizing contractual rental rate escalations, which are currently provided for in approximately 93% of our leases.
implementing effective cost control measures, including negotiating pass-through provisions in tenant leases for operating expenses and certain capital expenditures.
managing the level of debt on our balance sheet and our exposure to floating rate debt.
Internal Growth. We seek to achieve internal growth from several sources. For example, we seek to:
include rental rate escalation provisions in our leases.
improve investment returns through releasing of vacant space and replacement of existing tenants with new tenants at higher rental rates.
achieve higher rental rates from existing tenants as leases expire.
expand existing facilities that are fully leased and/or redevelop existing and/or newly acquired space to higher rent, generic laboratory space.
implement effective cost control measures, including negotiating pass-through provisions in tenant leases for operating expenses and certain capital expenditures.
Our ability to negotiate contractual rent escalations in future leases and to achieve increases in rental rates will depend upon market conditions and the demand for life science facilities at the time the leases are negotiated and the increases are proposed.
Acquisitions. We seek to identify and acquire high quality life science facilities in our target markets on a selective basis. Critical evaluation of prospective property acquisitions is an essential component of our acquisition strategy. When evaluating acquisition opportunities, we assess a full range of matters relating to the properties, including the:
location of the property and our strategy in the relevant market.
quality of existing and prospective tenants.
condition and capacity of the building infrastructure.
quality and generic characteristics of laboratory facilities.
physical condition of the structure and common area improvements.
opportunities available for leasing vacant space and for retenanting occupied space.
opportunities to redevelop existing space into higher rent generic laboratory space.
opportunities to expand the existing facility.
Redevelopment. We seek to enhance our growth by redeveloping existing office, warehouse or vacant space as generic laboratory space that can be leased at higher rates. As of December 31, 2003, we had 10 properties in our redevelopment program that contained a total of 770,000 square feet. Of this total, 359,000 square feet are under redevelopment and currently vacant, and the remaining 411,000 square feet are currently leased. We have also identified approximately 411,000 square feet of additional space in our existing portfolio for potential redevelopment.
Due to the fact that space undergoing redevelopment is vacant, our redevelopment program has the effect of currently reducing rental revenue and FFO. Despite our ongoing redevelopment activities, we have achieved consistent growth in FFO.
Development. Our development strategy is primarily to pursue selective build-to-suit projects where we expect to achieve investment returns that will equal or exceed our returns on acquisitions. We generally have undertaken build-to-suit projects only if our investment in infrastructure will be substantially made for generic, rather than tenant-specific, improvements. On occasion, we also develop properties in certain life science markets before we have leases in place. Since our initial public offering in 1997, we have completed the development of ten properties containing approximately 643,000 rentable square feet of office and warehouse space. In addition, we currently own parcels of land and may expand existing properties, representing an aggregate future development potential of approximately 1,387,000 rentable square feet, of office/laboratory facilities.
Financing/Working Capital. We believe that cash provided by operations, our unsecured line of credit and our unsecured term loan will be sufficient to fund our working capital requirements. We generally expect to finance future acquisitions and redevelopment and development projects through our unsecured line of credit and unsecured term loan and, then, to refinance some or all of that indebtedness periodically with additional equity or debt capital. We may also issue shares of our common stock, preferred stock or interests in our subsidiaries to fund future operations.
We seek to maintain a balance between the amounts of our fixed and variable debt with a view to moderating our exposure to interest rate risk. We also use financial instruments, such as interest rate swap agreements, to hedge a portion of our exposure to the variable interest rates associated with our unsecured line of credit and unsecured term loan. Interest rate swap agreements involve an exchange of fixed and floating interest rate payments without the exchange of the underlying principal or "notional amount." Interest received under our current interest rate swap agreements is based on the one-month LIBOR rate. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources" for a more complete discussion of our unsecured line of credit, unsecured term loan, interest rate swap agreements and other outstanding indebtedness.
Business Risks
We Are Largely Dependent on the Life Sciences Industry for Revenues from Lease Payments
In general, our strategy is to invest primarily in properties used by tenants in the life science industry. Our business could be adversely affected if the life science industry experiences an economic downturn. Because of our industry focus, events within the life science industry may have a more pronounced effect on our ability to make distributions to our stockholders than if we had diversified investments. Also, our properties may be better suited for a particular life science industry tenant and could require modification before we are able to release vacant space to another life science industry tenant. Generally, our properties also may not be suitable for lease to traditional office tenants without significant expenditures on renovations.
Our Tenants May Not Be Able to Pay Us if They Are Unsuccessful in Discovering, Developing, Making or Selling Their Products and Technologies
Our life science industry tenants are subject to a number of risks, including the following, any one or more of which may adversely affect their ability to make rental payments to us:
Some of our tenants require significant funding to develop and commercialize their products and technologies, which funding must be obtained from private investors, the public market, companies in the life science industry or federal, state and local governments. Such funding may become unavailable or difficult to obtain, which in turn may adversely affect a tenant's ability to generate revenues or to pay us rent.
Even with sufficient funding, some of our tenants may not be able to discover or identify potential drug targets in humans, or potential drugs for use in humans, or to create tools or technologies which are commercially useful in the discovery or identification of potential drug targets or drugs.
Some of our tenants developing potential drugs may find that their drugs are not effective, or may even be harmful, when tested in humans.
Some of our tenants may not be able to manufacture their drugs economically, even if such drugs are proven through human clinical trials to be safe and effective in humans.
Drugs that are developed and manufactured by some of our tenants require regulatory approval prior to being made, marketed, sold and used. The regulatory approval process to manufacture and market drugs is costly, typically takes several years, requires the expenditure of substantial resources and is often unpredictable. A tenant may fail or experience significant delays in obtaining these approvals.
Some of our tenants and their licensors require patent, copyright or trade secret protection to develop, make, market and sell their products and technologies. A tenant may be unable to commercialize its products or technologies if patents covering such products or technologies do not issue, or are successfully challenged, narrowed, invalidated or circumvented by third parties, or if a tenant fails to obtain licenses to the discoveries of third parties necessary to commercialize its products or technologies.
A drug made by a tenant may not be well accepted by doctors and patients, or may be less effective or accepted than competitor's drugs, or may be subsequently recalled from the market, even if it is successfully developed, proven safe and effective in human clinical trials and manufactured and the requisite regulatory approvals are obtained.
We cannot assure you that our tenants will be able to develop, make, market or sell their products and technologies due to the risks inherent in the life science industry. Any tenant that is unable to avoid, or sufficiently mitigate, the risks described above, may have difficulty making rental payments to us.
We Could be Held Liable for Damages Resulting from Our Tenants' Use of Hazardous Materials
Many of our life science industry tenants engage in research and development activities that involve the controlled use of hazardous materials, chemicals and biological and radioactive compounds. In the event of contamination or injury from the use of these hazardous materials, we could be held liable for damages that result. This liability could exceed our resources and any recovery available through any applicable environmental remediation insurance coverage and could adversely affect our ability to make distributions to our stockholders.
Together with our tenants, we must comply with federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of hazardous materials and waste products. Failure to comply with, or changes in, these laws and regulations could adversely affect our business or our tenants' business and their ability to make rental payments to us.
The Inability of Any Tenant to Pay Us Rent Could Adversely Affect Our Business
Our revenues are derived primarily from rental payments and reimbursement of operating expenses under our leases. If our tenants, especially significant tenants, failed to make rental payments under their leases, our financial condition, cash flow and our ability to make distributions to our stockholders could be adversely affected.
As of December 31, 2003, we had 208 leases with a total of 179 tenants. Of our 89 properties, 50 were occupied by a single tenant. Three of our tenants accounted for approximately 12.8% of our aggregate annualized base rent, or approximately 4.9%, 4.6% and 3.3%, respectively. "Annualized base rent" means the annualized fixed base rental amount in effect as of December 31, 2003, using rental revenue calculated on a straight-line basis in accordance with generally accepted accounting principles ("GAAP"). Annualized base rent does not include reimbursements for real estate taxes and insurance, common area and other operating expenses, substantially all of which are borne by the tenants in the case of triple net leases.
The bankruptcy or insolvency of a major tenant may also adversely affect the income produced by a property. If any of our tenants becomes a debtor in a case under the U.S. Bankruptcy Code, we cannot evict that tenant solely because of its bankruptcy. The bankruptcy court may authorize the tenant to reject and terminate its lease with us. Our claim against such a tenant for unpaid future rent would be subject to a statutory limitation that might be substantially less than the remaining rent actually owed to us under the tenant's lease. Any shortfall in rent payments could adversely affect our cash flow and our ability to make distributions to our stockholders.
Our U.S. Government Tenants May Not Receive Annual Appropriations, Which Could Adversely Affect Their Ability to Pay Us
U.S. government tenants may be subject to annual appropriations. If one of our U.S. government tenants fails to receive its annual appropriation, it might not be able to make its lease payments to us. In addition, defaults under leases with federal government tenants are governed by federal statute and not by state eviction or rent deficiency laws. All of our leases with U.S. government tenants provide that the government tenant may terminate the lease under certain circumstances. As of December 31, 2003, leases with U.S. government tenants at our properties accounted for approximately 3.1% of our aggregate annualized base rent.
Loss of a Tenant Could Have a Negative Impact on Our Business
A tenant may not renew its lease upon the expiration of the initial term. In addition, we may not be able to locate a qualified replacement tenant upon expiration or termination of a lease. Consequently, we could lose the cash flow from the affected property, which could negatively impact our business. We may have to divert cash flow generated by other properties to meet our mortgage payments, if any, or to pay other expenses related to owning the affected property. As of December 31, 2003, leases at our properties representing approximately 10.8% and 5.6% of the total square footage of our properties were scheduled to expire in 2004 and 2005, respectively.
Poor Economic Conditions in Our Markets Could Adversely Affect Our Business
Our properties are located only in the following markets:
California (in the San Diego, Pasadena and San Francisco Bay areas).
Seattle.
suburban Washington D.C. (including Maryland and Virginia).
eastern Massachusetts.
New Jersey and suburban Philadelphia.
the Southeast (including North Carolina and Georgia).
As a result of our geographic concentration, we depend upon the local economic conditions in these markets, including local real estate conditions. We are, therefore, subject to increased exposure (positive or negative) to economic and other competitive factors specific to markets in confined geographic areas. Our operations may also be affected if too many competing properties are built in any of these markets. An economic downturn in any of these markets could adversely affect our operations and our ability to make distributions to stockholders. We cannot assure you that these markets will continue to grow or will remain favorable to the life science industry.
We May Have Difficulty Managing Our Growth
We expect to continue to grow by acquiring, redeveloping and selectively developing additional properties. To manage our growth effectively, we must successfully integrate new properties into our existing operations. We may not succeed with the integration. In addition, we may not effectively manage new properties, and new properties may not perform as expected. Our business could be adversely affected if we are unsuccessful in managing our growth.
Our Debt Service Obligations May Have Adverse Consequences on Our Business Operations
We use debt to finance our operations, including acquisitions of properties. Our use of debt may have adverse consequences, including the following:
our cash flow from operations may be not be sufficient to meet required payments of principal and interest.
we may be forced to dispose of one or more of our properties, possibly on disadvantageous terms, to make payments on our debt.
we may default on our debt obligations, and the lenders or mortgagees may foreclose on our properties that secure those loans.
a foreclosure on one of our properties could create taxable income without any accompanying cash proceeds to pay the tax.
a default under a mortgage loan that has cross default provisions may cause us to automatically default on another loan.
we may not be able to refinance or extend our existing debt.
the terms of any refinancing or extension may not be as favorable as the terms of our existing debt.
we may be subject to a significant increase in the variable interest rate on our unsecured line of credit or unsecured term loan which could adversely impact our operations.
As of December 31, 2003, we had outstanding mortgage indebtedness of approximately $320.0 million, secured by 39 properties, and outstanding debt under our unsecured line of credit and unsecured term loan of $389.0 million.
Our Unsecured Line of Credit and Unsecured Term Loan Restricts Our Ability to Engage in Some Business Activities
Our unsecured line of credit and unsecured term loan facilities contain customary negative covenants and other financial and operating covenants that, among other things:
restrict our ability to incur additional indebtedness.
restrict our ability to make certain investments.
restrict our ability to merge with another company.
restrict our ability to make distributions to stockholders.
require us to maintain financial coverage ratios.
require us to maintain a pool of unencumbered assets approved by the lenders.
These restrictions could cause us to default on our unsecured line of credit and unsecured term loan or negatively affect our operations and our ability to make distributions to our stockholders.
We May Not Be Able to Obtain Additional Capital to Further Our Business Objectives
Our ability to acquire, redevelop or develop properties depends upon our ability to obtain capital. Periodically, the real estate industry experiences reduced supplies of favorably-priced equity or debt capital, which decreases the level of new investment activity by publicly-traded real estate companies. A prolonged period in which we cannot effectively access public equity or debt markets may result in heavier reliance on alternative financing sources to undertake new investments. An inability to obtain equity or debt capital on acceptable terms could delay or prevent us from acquiring, structuring and completing desirable investments, which could adversely affect our business. Also, the issuance of additional shares of capital stock or interests in subsidiaries to fund future operations could dilute the ownership of then existing stockholders.
If Interest Rates Rise, Our Debt Service Costs Will Increase
Borrowings outstanding under our unsecured line of credit, unsecured term loan and certain other borrowings bear interest at a variable rate, and we may incur additional variable rate debt in the future. Increases in market interest rates would increase our interest expenses under these debt instruments and would increase the costs of refinancing existing indebtedness or obtaining new debt. Accordingly, these increases could adversely affect our financial position and our ability to make distributions to stockholders.
We May Not Be Able to Acquire Properties or Operate Them Successfully
Our success depends in large part upon our ability to acquire additional properties on satisfactory terms and to operate them successfully. If we are unable to do so, our business could be adversely affected. In addition, the acquisition of life science facilities generally involves a higher per square foot price than the acquisition of traditional suburban office properties.
The acquisition, ownership and operation of real estate is subject to many risks that may adversely affect our business and our ability to make payments to stockholders, including the risks that:
our properties may not perform as we expect.
we may not be able to acquire a desired property because of competition from other real estate investors with significant capital.
we may lease space at rates below our expectations.
we may not be able to obtain financing on acceptable terms.
we may overpay for new acquisitions.
If we encounter any of these risks, our business and our ability to make payments to stockholders could be adversely affected.we may underestimate the cost of improvements required to bring an acquired property up to standards established for the market position intended for that property.
We May Not Be Able to Complete Redevelopment and Development Projects Effectively
Our redevelopment and development activities subject us to many risks, including those associated with:
delays in construction.
budget overruns.
increasing costs of materials.
financing availability.
volatility in interest rates.
labor availability.
timing of the commencement of rental payments.
delays or denials of entitlements or permits.
other property development uncertainties.
In addition, redevelopment and development activities, regardless of whether they are ultimately successful, typically require a substantial portion of management's time and attention. This may distract management from focusing on other operational activities. If we are unable to complete redevelopment and development projects successfully, our business may be adversely affected.
If Our Revenues Are Less Than Our Expenses, We May Have to Borrow Additional Funds and We May Not Be Able to Make Distributions to Our Stockholders
If our properties do not generate revenues sufficient to meet our operating expenses, including debt service and other capital expenditures, we may have to borrow additional amounts to cover fixed costs and cash flow needs. This could adversely affect our ability to make distributions to our stockholders. Factors that could adversely affect the revenues from and the value of our properties include:
national and local economic conditions.
competition from other life science facilities.
changes in the life science industry.
real estate conditions in our target markets.
our ability to collect rent payments.
availability of financing.
changes in interest rate levels.
vacancies at our properties and our ability to release space.
changes in tax or other regulatory laws.
costs of compliance with government regulation.
lack of liquidity of real estate investments.
increased operating costs.
In addition, if a lease at a property is not a triple net lease, we will have greater expenses associated with that property and greater exposure to increases in such expenses. Significant expenditures, such as mortgage payments, real estate taxes, insurance and maintenance costs, generally are fixed and do not decrease when revenues at the related property decrease.
Improvements to Life Science Facilities Are More Costly Than Traditional Office Space
Our properties contain generic infrastructure improvements that are more costly than other property types. Although we have historically been able to recover the additional investment in generic infrastructure improvements through higher rental rates, there is the risk that we will not be able to continue to do so in the future. Typical improvements include:
reinforced concrete floors.
upgraded roof loading capacity.
increased floor to ceiling heights.
heavy-duty HVAC systems.
enhanced environmental control technology.
significantly upgraded electrical, gas and plumbing infrastructure.
laboratory benches.
We May Not Be Able to Sell Our Properties Quickly to Raise Money
Investments in real estate are relatively illiquid. Accordingly, we may not be able to sell our properties when we desire or at acceptable prices in response to changes in economic or other conditions. In addition, the Internal Revenue Code limits our ability to sell properties held for fewer than four years. These limitations on our ability to sell our properties may adversely affect our cash flows and our ability to make distributions to stockholders.
We Face Substantial Competition in Our Target Markets
The significant competition for business in our target markets could have an adverse effect on our operations. We compete for investment opportunities with:
insurance companies.
pension and investment funds.
partnerships.
developers.
investment companies.
other REITs.
owner/occupants.
Many of these entities have substantially greater financial resources than we do and may be able to accept more risk than we are willing to accept. These entities may be less sensitive to risks with respect to the creditworthiness of a tenant or the geographic concentration of their investments. Competition may also reduce the number of suitable investment opportunities available to us or may increase the bargaining power of property owners seeking to sell.
Our Properties May Have Defects That Are Unknown to Us
Although we review the physical condition of our properties before they are acquired, and on a periodic basis after acquisition, any of our properties may have characteristics or deficiencies unknown to us that could adversely affect the property's value or revenue potential.
If We Fail to Qualify as a REIT, We Would Be Taxed at Corporate Rates and Would Not Be Able to Take Certain Deductions When Computing Our Taxable Income
If in any taxable year we fail to qualify as a REIT:
we would be subject to federal income tax on our taxable income at regular corporate rates.
we would not be allowed a deduction for distributions to stockholders in computing taxable income.
unless we were entitled to relief under the Internal Revenue Code of 1986, as amended , we would also be disqualified from treatment as a REIT for the four taxable years following the year during which we lost qualification.
we would no longer be required by the Internal Revenue Code to make any distributions to our stockholders.
As a result of any additional tax liability, we might need to borrow funds or liquidate certain investments in order to pay the applicable tax. Accordingly, funds available for investment or distribution to our stockholders would be reduced for each of the years involved.
Qualification as a REIT involves the application of highly technical and complex provisions of the Internal Revenue Code to our operations and the determination of various factual matters and circumstances not entirely within our control. There are only limited judicial or administrative interpretations of these provisions. Although we believe that we have operated, commencing with our taxable year ended December 31, 1996, in a manner so as to qualify as a REIT, we cannot assure you that we are or will remain so qualified.
In addition, although we are not aware of any pending tax legislation that would adversely affect our ability to operate as a REIT, new legislation, regulations, administrative interpretations or court decisions could change the tax laws or interpretations of the tax laws regarding qualification as a REIT, or the federal income tax consequences of that qualification, in a manner that is adverse to our stockholders.
There Are Limits on the Ownership of Our Capital Stock Under Which A Stockholder May Lose Beneficial Ownership of Its Shares
The Internal Revenue Code provides that, in order for us to maintain our qualification as a REIT, not more than 50% of the value of our outstanding capital stock may be owned, directly or constructively, by five or fewer individuals or entities.
In addition, our charter prohibits, with certain limited exceptions, direct or constructive ownership of shares of our capital stock representing more than 9.8% of the combined total value of the outstanding shares of our capital stock by any person (the "Ownership Limit"). Our Board of Directors may exempt a stockholder from the Ownership Limit if, prior to the exemption, our Board of Directors receives all information it deems necessary to determine or ensure our status as a REIT.
The constructive ownership rules are complex and may cause shares of our common stock owned directly or constructively by a group of related individuals or entities to be constructively owned by one individual or entity. A transfer of shares to a person who, as a result of the transfer, violates the Ownership Limit, may be void or may be deemed to be made to a trust, for the benefit of one or more qualified charitable organizations designated by us. In that case, the intended transferee will have only a right to share, to the extent of the transferee's original purchase price for such shares, in proceeds from the trust's sale of those shares.
In Addition to the Ownership Limit, Certain Provisions of Our Charter and Bylaws and Our Stockholder Rights Plan May Delay or Prevent Transactions That May Be Deemed to Be Desirable to Our Stockholders
As authorized by Maryland law, our charter allows our Board of Directors to cause us to issue additional authorized but unissued shares of our common stock or preferred stock and to classify or reclassify unissued shares of common or preferred stock without any stockholder approval. Our Board of Directors could establish a series of preferred stock that could delay, defer or prevent a transaction that might involve a premium price for our common stock or for other reasons be desired by our common stockholders or that have a dividend preference which may adversely affect our ability to pay dividends on our common stock.
Our charter permits the removal of a director only upon a two-thirds vote of the votes entitled to be cast generally in the election of directors and our bylaws require advance notice of a stockholder's intention to nominate directors or to present business for consideration by stockholders at an annual meeting of our stockholders. Our charter and bylaws also contain other provisions that may delay, defer or prevent a transaction or change in control that involves a premium price for our common stock or that for other reasons may be desired by our stockholders.
Our Insurance May Not Adequately Cover All Potential Losses
If we experience a loss at any of our properties that is not covered by insurance or that exceeds our insurance policy limits, we could lose the capital invested in the affected property and, possibly, future revenues from that property. In addition, we could continue to be obligated on any mortgage indebtedness or other obligations related to the affected properties. We carry comprehensive liability, fire, extended coverage and rental loss insurance with respect to our properties. We have obtained earthquake insurance for all of our properties because many of them are located in the vicinity of active earthquake faults. We also carry environmental remediation insurance and have title insurance policies on all of our properties. We obtain our title insurance policies when we acquire the property, with each policy covering an amount equal to the initial purchase price of each property. Accordingly, any of our title insurance policies may be in an amount less than the current value of the related property.
We believe that our insurance policy specifications, insured limits and deductibles are consistent with or superior to those customarily carried for similar properties. Our tenants are also required to maintain comprehensive insurance, including liability and casualty insurance, that is customarily obtained for similar properties. There are, however, certain types of losses that we and our tenants do not generally insure against because they are uninsurable or because it is not economical to insure against them. In the current market, there have recently been substantial increases in the premium cost of property and liability insurance. The availability of coverage against certain types of losses, such as from terrorism or toxic mold, has become more limited and, when available, is at a significantly higher premium cost. We cannot predict whether insurance coverage against terrorism or toxic mold will remain available for our properties because insurance companies may no longer offer coverage against such losses or, if offered, such coverage may become prohibitively expensive. Most, but not all, of our properties are low-rise buildings in suburban areas
. Toxic mold has not presented any material problems at any of our properties.We Could Incur Significant Costs Complying With Environmental Laws
Federal, state and local environmental laws and regulations may require us, as a current or prior owner or operator of real estate, to investigate and clean up hazardous or toxic substances or petroleum products released at or from any of our properties. The cost of investigating and cleaning up contamination could be substantial and could exceed the amount of any environmental remediation insurance coverage available to us. In addition, the presence of contamination, or the failure to properly clean it up, may adversely affect our ability to lease or sell an affected property, or to borrow funds using that property as collateral.
Under environmental laws and regulations, we may have to pay governmental entities or third parties for property damage and for investigation and clean-up costs incurred by those parties relating to contaminated properties regardless of whether we knew of or caused the contamination. Even if more than one party may have been responsible for the contamination, we may be held responsible for all of the clean-up costs. In addition, third parties may sue us for damages and costs resulting from environmental contamination or jointly responsible parties may contest their responsibility or be financially unable to pay their share of such costs.
Environmental laws also govern the presence, maintenance and removal of asbestos-containing materials. These laws may impose fines and penalties on us for the release of asbestos-containing materials and may allow third parties to seek recovery from us for personal injury from exposure to asbestos fibers. We have detected asbestos-containing materials at some of our properties, but we do not expect that it will result in material environmental costs or liabilities to us.
Environmental laws and regulations also require the removal or upgrading of certain underground storage tanks and regulate:
the discharge of storm water, wastewater and any water pollutants.
the emission of air pollutants.
the generation, management and disposal of hazardous or toxic chemicals, substances or wastes.
workplace health and safety.
Many of our tenants routinely handle hazardous substances and wastes as part of their operations at our properties. Environmental laws and regulations subject our tenants, and potentially us, to liability resulting from these activities. Environmental liabilities could also affect a tenant's ability to make rental payments to us. We require our tenants to comply with these environmental laws and regulations and to indemnify us for any related liabilities.
Independent environmental consultants have conducted Phase I or similar environmental assessments at all of our properties. We intend to use consultants to conduct similar environmental assessments on our future acquisitions. This type of assessment generally includes a site inspection, interviews and a public records review, but no subsurface sampling. These assessments and certain additional investigations of our properties have not to date revealed any environmental liability that we believe would have a material adverse effect on our business or results of operations.
The additional investigations included, as appropriate:
asbestos surveys.
radon surveys.
lead surveys.
additional public records review.
subsurface sampling.
other testing.
Nevertheless, it is possible that the assessments on our properties have not revealed, or that assessments on future acquisitions will not reveal, all environmental liabilities. Consequently, there may be material environmental liabilities of which we are unaware that may result in substantial costs to us or our tenants and that could have a material adverse effect on our business.
We May Incur Significant Costs Complying With the Americans With Disabilities Act and Similar Laws
Under the Americans With Disabilities Act, places of public accommodation and/or commercial facilities are required to meet federal requirements related to access and use by disabled persons. We may be required to make substantial capital expenditures at our properties to comply with this law. In addition, our noncompliance could result in the imposition of fines or an award of damages to private litigants.
A number of additional federal, state and local laws and regulations exist regarding access by disabled persons. These regulations may require modifications to our properties or may affect future renovations. This may limit the overall returns on our investments.
We believe that our properties are substantially in compliance with the present requirements of the Americans With Disabilities Act and similar laws.
We May Incur Significant Costs If We Fail to Comply With Laws or If Laws Change
Our properties are subject to many federal, state and local regulatory requirements and to state and local fire and life-safety requirements. If we do not comply with all of these requirements, we may have to pay fines to governmental authorities or damage awards to private litigants. We believe that our properties are currently in compliance with all of these regulatory requirements. We do not know whether these requirements will change or whether new requirements will be imposed. Changes in these regulatory requirements could require us to make significant unanticipated expenditures. These expenditures could have an adverse effect on us and our ability to make distributions to stockholders.
The Loss of Services of Any of Our Executive Officers Could Adversely Affect Us
We depend upon the services of relatively few executive officers. The loss of services of any one of them may adversely affect our business, financial condition and prospects. We use the extensive personal and business relationships that members of our management have developed over time with owners of life science facilities and with major life science industry tenants. We have employment agreements with all of our executive officers, but cannot assure you that they will remain employed with us.
We May Change Our Business Policies Without Stockholder Approval
Our Board of Directors determines all of our material business policies, with management's input, including those related to our:
status as a REIT.
incurrence of debt and debt management activities.
acquisition and selective development activities.
stockholder distributions.
other policies, as appropriate.
Our Board of Directors may amend or revise these policies at any time without a vote of our stockholders. A change in these policies could adversely affect our business and our ability to make distributions to our stockholders.
We Could Become Highly Leveraged and Our Debt Service Obligations Could Increase
Our organizational documents do not limit the amount of debt that we may incur. Therefore, we could become highly leveraged. This would result in an increase in our debt service obligations that could adversely affect our cash flow and our ability to make distributions to our stockholders.
We have adopted a policy of incurring debt only if upon such incurrence our debt to total market capitalization ratio would not exceed 57.5%. Our total market capitalization is the market value of our capital stock, including interests exchangeable for shares of capital stock, plus total debt. Our Board of Directors could, however, change or eliminate this policy at any time. Higher leverage could also increase the risk of default on our debt obligations.
Our Distributions to Stockholders May Decline at Any Time
We may not continue our current level of distributions to stockholders. Our Board of Directors will determine future distributions based on a number of factors, including:
our amount of cash available for distribution.
our financial condition.
any decision by our Board of Directors to reinvest funds rather than to distribute such funds.
our capital expenditures.
the annual distribution requirements under the REIT provisions of the Internal Revenue Code.
other factors our Board of Directors deems relevant.
Possible Future Sales of Shares of Our Common Stock Could Adversely Affect Its Market Price
We cannot predict the effect, if any, of future sales of shares of our common stock on the market price of our common stock from time to time. Sales of substantial amounts of capital stock (including common stock issued upon the exercise of stock options), or the perception that such sales may occur, could adversely affect prevailing market prices for our common stock.
We have reserved for issuance to our officers, directors and employees pursuant to our Amended and Restated 1997 Stock Award and Incentive Plan that number of shares of our common stock that equals 12% of the total number of shares outstanding at any time, provided that in no event may the number of shares of our common stock available for issuance under the plan exceed 3,000,000 shares at any time.
As of December 31, 2003, options to purchase 809,583 shares of our common stock were outstanding, of which options to purchase 533,420 shares of our common stock were exercisable. We have filed a registration statement with respect to the issuance of shares of our common stock pursuant to grants under our equity incentive plan. In addition, any shares issued under our equity incentive plan will be available for sale in the public market from time to time without restriction by persons who are not our "affiliates" (as defined in Rule 144 adopted under the Securities Act of 1933). Affiliates will be able to sell shares of our common stock pursuant to exemptions from registration requirements or upon registration.
External Factors May Adversely Impact the Valuation of Investments
We hold equity investments in certain publicly-traded companies and privately held entities primarily involved in the life science industry. The valuation of these investments is affected by many external factors beyond our control, including, but not limited to, market prices, market conditions, prospects for favorable or unfavorable clinical trial results, new product initiatives and new collaborative agreements. Unfavorable developments with respect to any of these factors may have an adverse impact on the valuation of our investments.
We will, upon request, provide free paper copies of our annual report on Form 10-K, our quarterly reports on Form 10-Q and our current reports on Form 8-K, including any amendments to the foregoing reports, as soon as is reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. These materials are also available at no cost at the Securities and Exchange Commission's website at www.sec.gov. These materials are not available from us over the Internet because we do not have a corporate website.
Employees
As of December 31, 2003, we had 58 full-time employees. We believe that we have good relations with our employees.
General.
Our properties range in size from approximately 15,000 to 248,000 square feet, are built to accommodate single or multiple tenants and are generally one or two story concrete tilt-up, block and/or steel frame structures. The exteriors typically resemble traditional suburban office properties, but interior infrastructures are designed to accommodate the needs of life science industry tenants. These improvements typically are generic to life science industry tenants rather than being specific to a particular tenant. As a result, we believe that the improvements have long-term value and utility and are usable by a wide range of life science industry tenants. Generic infrastructure improvements include:
reinforced concrete floors.
upgraded roof loading capacity.
increased floor to ceiling heights.
heavy-duty HVAC systems.
enhanced environmental control technology.
significantly upgraded electrical, gas and plumbing infrastructure.
laboratory benches.
We own fee simple title in each of our properties, except with respect to:
three properties in the San Francisco Bay area (Harbor Bay Parkway #2, Harbor Bay Parkway #3 and Harbor Bay Parkway #4), in which we own a commercial condominium interest, together with an undivided interest in the common areas of the project of which the property is a part; and
the properties at Garcia Avenue & Bayshore Parkway, Hanover Street, Alexander Road, Charlestown Navy Yard, Virginia Manor Road and Porter Drive, in which we own ground leasehold interests.
As of December 31, 2003, we had 208 leases with a total of 179 tenants, and 50 of our properties were single-tenant properties. Leases in our multi-tenant buildings typically have terms of three to seven years, while the single-tenant building leases typically have initial terms of 10 to 20 years. As of December 31, 2003:
approximately 88% of our leases (on a square footage basis) were triple net leases, requiring tenants to pay substantially all real estate taxes and insurance, common area and other operating expenses (including increases thereto) in addition to base rent, and, in addition to our triple net leases, approximately 7% of our leases (on a square footage basis) required the tenants to pay a majority of operating expenses;
approximately 93% of our leases (on a square footage basis) contained effective annual rent escalations that are either fixed (generally ranging from 3% to 3.5%) or indexed based on a consumer price index or other index; and
approximately 91% of our leases (on a square footage basis) provided for the recapture of certain capital expenditures (such as HVAC systems maintenance and/or replacement, roof replacement and parking lot resurfacing), which we believe would otherwise typically be borne by the landlord in traditional office leases.
Our leases also typically give us the right to review and approve tenant alterations to the property. Generally, tenant-installed improvements to the facilities remain our property after termination of the lease at our election. However, we are permitted under the terms of most of our leases to require that the tenant remove the improvements and restore the premises to their original condition.
As of December 31, 2003, we managed all of our properties.
The following table sets forth information with respect to our properties as of December 31, 2003:
Annualized
Percentage Annualized Net
of Base Effective
Aggregate Rent Per Rent Per
Rentable Annualized Portfolio Leased Leased
Year Built/ Square Percentage Base Annualized Square Square
Properties Renovated (1) Feet Leased (2) Rent (2) (3) Base Rent Foot (3) Foot (4) Major Tenants
- ---------------------------------------------- ---------- ---------- ------------ --------- --------- --------- ---------------------------------------
San Diego
North Torrey Pines Road #1 1971/2003 107,710 78% $2,430,345 1.8% $28.76 $28.00 Smith & Nephew plc
San Diego, CA
Science Park Road 2000 74,557 100% 2,309,667 1.7% 30.98 20.95 Biogen Idec Inc.
San Diego, CA
North Torrey Pines Road #2 1986/1996 86,962 100% 2,972,236 2.2% 34.18 32.80 Senomyx, Inc.
San Diego, CA
General Atomics Court #1 1986/2000 76,084 100% 2,683,633 2.0% 35.27 34.28 Merck & Co., Inc.
San Diego, CA
General Atomics Court #2 1991 43,600 100% 1,805,198 1.4% 41.40 41.37 Pfizer Inc.
San Diego, CA
Roselle Street #1 1983/1998 18,173 100% 507,698 0.4% 27.94 27.70 Schering AG
San Diego, CA
Nexus Centre Drive 1989 67,050 100% 2,236,108 1.7% 33.35 33.25 Cardinal Health, Inc.
San Diego, CA
Nancy Ridge Drive #1 1997 29,333 100% 638,606 0.5% 21.77 15.44 Arena Pharmaceuticals, Inc.
San Diego, CA
Roselle Street #2 late 17,603 100% 476,944 0.4% 27.09 23.81 Structural GenomiX, Inc.
San Diego, CA 1970's/1999
Tansy Street 1978/1999 15,410 100% 409,171 0.3% 26.55 20.78 Structural GenomiX, Inc.
San Diego, CA
John Hopkins Court #1 2000 34,723 100% 671,101 0.5% 19.33 16.79 Merck & Co., Inc.
San Diego, CA
John Hopkins Court #2 1999 55,200 100% 1,096,769 0.8% 19.87 18.33 Merck & Co., Inc.
San Diego, CA
Towne Centre Drive #1 1987/2003 45,030 100% 1,517,581 1.1% 33.70 25.71 Amylin Pharmaceuticals, Inc.
San Diego, CA
Towne Centre Drive #2 1987/2000 52,228 100% 1,527,863 1.1% 29.25 27.58 Amylin Pharmaceuticals, Inc.
San Diego, CA Vical Incorporated
Towne Centre Drive #3 1987/2000 41,780 88% 1,087,586 0.8% 29.57 25.72 Conforma Therapeutics, Inc.
San Diego, CA TargeGen, Inc.
Roselle Street #3 1981 17,590 0% - 0.0% - - Vacant
San Diego, CA
Roselle Street #4 1981/1998 30,147 78% 585,362 0.4% 24.80 24.00 Integra Life Sciences Holdings Corporation
San Diego, CA
Roselle Street #5 1981/1995 22,577 100% 639,241 0.5% 28.31 27.61 Cell Geneysys, Inc.
San Diego, CA
Roselle Street #6 1981/1999 17,433 100% 249,323 0.2% 14.30 14.29 Biosite Incorporated
San Diego, CA
Roselle Street #7 1981/1995 24,208 100% 685,421 0.5% 28.31 27.62 Cell Geneysys, Inc.
San Diego, CA
Nancy Ridge Drive #2 early 1980's/ 21,940 100% 481,443 0.4% 21.94 14.98 GeneOhm Sciences, Inc.
San Diego, CA 2001
Nancy Ridge Drive #3 1987/2001 56,698 100% 1,586,011 1.2% 27.97 27.97 Arena Pharmaceuticals, Inc.
San Diego, CA
Campus Point Drive 1986/1998 71,510 100% 2,390,948 1.8% 33.44 33.44 LION bioscience, Inc.
San Diego, CA
Pasadena
North Hill Avenue 1940's/2002 31,343 46% 392,878 0.3% 27.39 25.09 Biocatalytics, Inc.
Pasadena, CA
San Francisco Bay Area
Harbor Bay Parkway #1 1983/1999 61,015 100% 1,282,826 1.0% 21.02 19.51 Avigen, Inc.
Alameda, CA MiraiBio, Inc.
Harbor Bay Parkway #2 1984/2000 27,745 100% 654,910 0.5% 23.60 18.14 Berkeley HeartLab, Inc.
Alameda, CA Applera Corporation
Harbor Bay Parkway #3 1986/1994 47,777 100% 968,645 0.7% 20.27 18.53 Applera Corporation
Alameda, CA
Harbor Bay Parkway #4 1985/1994 68,711 100% 1,415,246 1.1% 20.60 19.66 U.S. Food & Drug Administration
Alameda, CA
Mitten Road & Malcolm Road (5) 1962/2002 153,837 77% 2,600,817 2.0% 21.98 18.28 Valentis, Inc. (6)
Burlingame, CA Berkeley HeartLab, Inc.
U.S. Federal Aviation Administration
Hanover Street (6) 1968/2000 32,074 66% 805,173 0.6% 38.21 34.83 Nanosys, Inc. (6)
Palo Alto, CA
Garcia Avenue & Bayshore 1980/2003 98,964 78% 2,291,493 1.7% 29.51 27.07 Google Inc. (6)
Parkway (6) Vitra Bioscience, Inc.
Mountain View, CA
Oyster Point Boulevard #1 2001 53,980 100% 2,812,914 2.1% 52.11 41.33 Sunesis Pharmaceuticals, Inc.
S. San Francisco, CA
Oyster Point Boulevard #2 2001 53,980 100% 1,650,085 1.2% 30.57 27.44 diaDexus, Inc.
S. San Francisco, CA
Gateway Boulevard #1 2000 110,428 100% 3,765,339 2.8% 34.10 34.10 Theravance, Inc.
San Francisco, CA
Gateway Boulevard #2 2002 59,816 100% 2,371,062 1.8% 39.64 35.44 Theravance, Inc.
San Francisco, CA
Harbor Bay Parkway #5 1984/2001 67,482 100% 1,505,894 1.1% 22.32 22.32 Avigen, Inc.
Alameda, CA
Porter Drive 1962/2002 91,644 100% 3,491,353 2.6% 38.10 38.10 Telik, Inc.
Palo Alto, CA
Seattle
Columbia Street #1 1975/1997 163,235 99% 5,501,569 4.1% 33.88 30.34 Corixa Corporation
Seattle, WA nura, Inc.
Columbia Street #2 (6) 1975/1997 46,303 51% 371,684 0.3% 15.72 14.44 Corixa Corporation (6)
Seattle, WA Anawah, Inc.
Western Avenue 1929/2000 47,746 100% 1,576,856 1.2% 33.03 28.38 University of Washington
Seattle, Washington
First Avenue 1980/2000 70,647 100% 2,532,667 1.9% 35.85 29.41 Dendreon Corporation
Seattle, Washington
Eastlake Avenue #1 1997 106,003 100% 4,387,383 3.3% 41.39 41.35 ZymoGenetics, Inc.
Seattle, Washington
Eastlake Avenue #2 1997 52,333 100% 2,166,023 1.6% 41.39 41.36 ZymoGenetics, Inc.
Seattle, Washington
Suburban Washington, D.C.
Professional Drive #1 1989/1999 47,558 74% 878,128 0.7% 24.87 16.37 BioPort Corporation
Gaithersburg, MD Wisor Telecom, Inc.
Professional Drive #2 1987 62,739 100% 1,109,289 0.8% 17.68 17.66 The Gillette Company
Gaithersburg, MD
West Watkins Mill Road #1 1989/1997 138,938 100% 2,732,255 2.0% 19.67 18.32 MedImmune, Inc.
Gaithersburg, MD Wellstat Biologics, Inc.
Quince Orchard Road #1 1982/1997 49,225 100% 1,461,699 1.1% 29.69 18.32 Gene Logic Inc.
Gaithersburg, MD
Clopper Road #1 1989 44,464 100% 770,387 0.6% 17.33 14.98 Immunomatrix, Inc.
Gaithersburg, MD Fiserv
Research Boulevard 1967/2000 105,000 100% 2,175,071 1.6% 20.71 20.04 U.S. Army Corps of Engineers
Rockville, MD
East Gude Drive #1 1981/2003 45,989 100% 755,442 0.6% 16.43 14.75 bioMerieux SA
Rockville, MD MacroGenics, Inc.
East Gude Drive #2 1981/1995 44,500 100% 775,000 0.6% 17.42 16.51 Shire Pharmaceuticals Group plc
Rockville, MD
Piccard Drive (6) 1978/1994 131,415 48% 1,909,294 1.4% 29.97 27.41 Biosciences Laboratories, Inc. (bioMerieux SA) (
Rockville, MD Midwest Research Institute, Inc.
Newbrook Drive 1992 248,186 100% 4,341,125 3.3% 17.49 17.49 Quest Diagnostics Incorporated
Chantilly, VA
Virginia Manor Road 1990/2003 191,884 95% 2,287,524 1.7% 12.58 11.85 Baxter International Inc.
Beltsville, MD Bank of America
Old Columbia Road 1983/1997 75,500 100% 1,002,941 0.8% 13.28 10.24 Baxter International Inc.
Columbia, MD
Firstfield Road #1 1974/2000 25,175 55% 371,782 0.3% 27.01 26.26 Psychiatric Genomics, Inc.
Gaithersburg, MD Tetracore, Inc.
Shady Grove Road (7) 1987 42,142 8% 88,169 0.1% 25.91 19.93 No major tenants (7)
Rockville, MD
West Watkins Mill Road #2 1988/2000 57,410 100% 877,790 0.7% 15.29 12.66 Gene Logic Inc.
Gaithersburg, MD
Clopper Road #2 2000 92,990 100% 2,634,285 2.0% 28.33 17.31 Digene Corporation
Gaithersburg, MD
Firstfield Road #2 1980/2001 53,599 100% 1,347,099 1.0% 25.13 19.39 IOMAI Corporation
Gaithersburg, MD Artesian Therapeutics, Inc.
Firstfield Road #3 1980/2003 53,595 61% 711,500 0.5% 21.89 17.96 Provident Bank of Maryland
Gaithersburg, MD SAIC - Frederick, Inc.
Quince Orchard Road #2 1981/2003 54,874 100% 812,584 0.6% 14.81 14.37 Montgomery County, Maryland
Gaithersburg, MD
Clopper Road #3 1989/1992 59,838 100% 813,334 0.6% 13.59 10.81 Wellstat Biologics, Inc.
Gaithersburg, MD
Research Place 1972/2003 58,632 100% 1,087,040 0.8% 18.54 15.46 The Center For The Advancement of
Rockville, MD Genomics
Eastern Massachusetts
Charlestown Navy Yard 1880/1991 24,940 100% 907,816 0.7% 36.40 36.17 GenVec, Inc.
Charlestown, MA
Pond Street 1965/1990 24,867 0% - 0.0% - - Vacant
Randolph, MA
Westview Street (6) 1975 40,000 0% - 0.0% - - Vacant (6)
Lexington, MA
Plantation Street #1 1993 92,711 100% 2,174,315 1.6% 23.45 21.82 University of Massachusetts
Worcester, MA Athena Diagnostics, Inc.
Innovation Drive 1991 113,956 77% 2,053,217 1.5% 23.37 21.16 ViaCell, Inc.
Worcester, MA BioValve Technologies, Inc.
Plantation Street #2 2000 92,423 87% 2,029,473 1.5% 25.24 20.52 Abbott Laboratories
Worcester, MA Hypnion, Inc.
Arsenal Street #1 1978/2001 92,500 100% 4,350,486 3.3% 47.03 36.38 Enanta Pharmaceuticals, Inc.
Watertown, MA Acusphere, Inc.
Hartwell Avenue #1 1972/2002 59,000 100% 2,644,269 2.0% 44.82 33.63 TransForm Pharmaceuticals, Inc.
Lexington, MA
Arsenal Street #2 (6) 1980/2003 96,150 31% 1,031,332 0.8% 34.83 28.91 EnVivo Pharmaceuticals (6)
Watertown, MA Protein Forest, Inc.
Hartwell Avenue #2 (6) 1972 51,340 0% - 0.0% - - Vacant (6)
Lexington, MA
Memorial Drive #1 2002 51,000 100% 3,330,755 2.5% 65.31 50.83 Infinity Pharmaceuticals, Inc.
Cambridge, MA
Memorial Drive #2 2002 47,497 85% 2,725,665 2.0% 67.30 59.08 Infinity Pharmaceuticals, Inc.
Cambridge, MA Alnylam Pharmaceuticals, Inc.
New Jersey/Suburban Philadelphia
College Road 1968/1984 106,036 100% 1,793,771 1.3% 16.92 15.45 Synaptic Pharmaceutical Corporation (8)
Paramus, NJ Gryphon Development Corporation
Williams Drive 1982/1994 37,000 100% 536,500 0.4% 14.50 14.17 Alteon, Inc.
Ramsey, NJ
Phillips Parkway late 1960's/ 78,501 100% 1,756,129 1.3% 22.37 14.38 Memory Pharmaceuticals Corp.
Montvale, NJ 1999 Ferolie Corporation
Campus Drive 1989 42,782 100% 646,653 0.5% 15.12 14.43 Genaera Corporation
Plymouth Meeting, PA Pharmerica, Inc. (9)
Electronic Drive 1983/1998 40,000 100% 937,527 0.7% 23.44 15.85 OSI Pharmaceuticals, Inc.
Horsham, PA
Princeton Parkway 1984/1999 42,600 100% 580,320 0.4% 13.62 9.52 Lexicon Genetics, Inc.
Princeton, NJ
Southeast
Capitola Drive #1 1986 65,114 33% 390,257 0.3% 18.81 15.22 Batelle Survey Research, Inc.
Durham, NC Johnson Travel Corporation
Capitola Drive #2 (6) 1985 119,916 64% 1,534,354 1.2% 19.93 16.41 RAO Enterprises (dba Integrated Laboratory
Durham, NC Systems) (6)
Amphora Discovery Corporation
Technology Parkway 1976/1993 37,080 62% 301,099 0.2% 13.07 11.60 CytRx Corporation
Norcross, GA Atherogenics, Inc.
Triangle Drive 1981 32,120 75% 408,659 0.3% 16.86 16.55 Mantech Environmental Technology, Inc.
Research Triangle Park, NC
Alexander Road 2000 86,239 100% 1,849,188 1.4% 21.44 20.01 Paradigm Genetics, Inc.
Research Triangle Park, NC
Kit Creek Road 1995/2003 38,861 97% 829,058 0.6% 22.08 11.96 Norak Biosciences, Inc.
Research Triangle Park, NC A.M. Pappas & Associates, L.L.C.
---------- ---------- ------------ --------- --------- ---------
Total/Weighted Average (10): 5,668,895 88.4%(11)$133,285,653 100.0% $26.61 $23.53
========== ========== ============ ========= ========= =========
- Includes year in which construction was completed and, where applicable, year of most recent major renovation.
- Based on all leases at the respective property in effect as of December 31, 2003.
- Annualized base rent means the annualized fixed base rental amount in effect as of December 31, 2003 (using rental revenue computed on a straight-line basis in accordance with GAAP). This amount, divided by the rentable square feet leased at the property as of December 31, 2003, is the annualized base rent per leased square foot.
- Annualized net effective rent is the annualized base rent in effect as of December 31, 2003 (using rental revenue computed on a straight-line basis in accordance with GAAP), less (for gross leases) real estate taxes and insurance, common area and other operating expenses and (for all leases) amortization of tenant improvements and leasing commissions. This amount, divided by the rentable square feet leased at the property as of December 31, 2003, is the annualized net effective rent per leased square foot.
- Considered as two properties.
- All or a portion of this property is currently under redevelopment.
- As of December 31, 2003, the property was designated as "held for sale".
- Synaptic Pharmaceutical Corporation is a wholly owned subsidiary of H. Lunbeck A/S..
- PharMerica, Inc. is a wholly owned subsidiary of AmerisourceBergen Corporation.
- Weighted average based on a percentage of aggregate leased square feet.
- Weighted average percentage leased includes properties under redevelopment (see footnote 6). Excluding properties under redevelopment, the weighted average percentage leased is 94%.
Location of Properties
The following table sets forth, as of December 31, 2003, the total rentable square footage and annualized base rent of our properties in each of our existing markets.
% of Total % of
Number of Total Rentable Rentable Annualized Annualized
Geographic Area Properties Square Footage Square Footage Base Rent (1) Base Rent
- --------------- ---------- -------------- ------------- -------------- -----------
San Diego 23 1,027,546 18.1% $28,988,254 21.7%
Pasadena 1 31,343 0.5% 392,878 0.3%
San Francisco Bay Area 14 927,453 16.4% 25,615,758 19.2%
Seattle 6 486,267 8.6% 16,536,182 12.4%
Suburban Washington D.C 21 1,683,653 29.7% 28,941,737 21.7%
Eastern Massachusetts 12 786,384 13.9% 21,247,329 15.9%
New Jersey/Suburban Philadelphia 6 346,919 6.1% 6,250,900 4.7%
Southeast 6 379,330 6.7% 5,312,615 4.1%
---------- -------------- ------------- -------------- -----------
Total 89 5,668,895 100.0% $133,285,653 100.0%
========== ============== ============= ============== ===========
- Annualized base rent means the annualized fixed base rental amount in effect as of December 31, 2003 (using rental revenue computed on a straight-line basis in accordance with GAAP).
Tenants
Our properties are leased principally to tenants in a broad spectrum of sectors within the life science industry. The following table sets forth information regarding leases with our 20 largest tenants based upon annualized base rent as of December 31, 2003.20 Largest Tenants
Remaining Percentage
Initial Percentage of Aggregate
Lease Approximate Percentage of Aggregate Annualized Portfolio
Number Term Aggregate of Aggregate Annualized Portfolio Net Effective Annualized
of in Rentable Leased Base Rent (in Annualized Rent (in Net Effective
Tenant Leases Years Square Feet Square Feet thousands) (1) Base Rent thousands) (2) Rent
- ---------------------------------------- -------- ------------ ------------ -------------- ------------ -------------- -------------
ZymoGenetics, Inc. 2 13.8 158,336 3.2% $6,553 4.9% $6,548 5.6%
Theravance, Inc. 2 8.3 170,244 3.4% 6,136 4.6% 5,885 5.0%
Merck & Co., Inc. 3 6.8 166,007 3.3% 4,452 3.3% 4,203 3.6%
Quest Diagnostics Incorporated 1 13.0 248,186 5.0% 4,341 3.3% 4,340 3.7%
Infinity Pharmaceuticals, Inc. 2 9.0 60,482 1.2% 4,302 3.2% 3,484 3.0%
Telik, Inc. 1 10.4 91,644 1.8% 3,491 2.6% 3,491 3.0%
Corixa Corporation 3 2.0 (3) 91,934 1.8% 3,301 2.5% 2,938 2.5%
Senomyx, Inc. 1 3.0 86,962 1.7% 2,972 2.2% 2,852 2.4%
Sunesis Pharmaceuticals, Inc. 1 9.5 53,980 1.1% 2,813 2.1% 2,231 1.9%
TransForm Pharmaceuticals, Inc. 1 8.7 59,000 1.2% 2,644 2.0% 1,984 1.7%
Digene Corporation 1 6.0 92,990 1.9% 2,634 2.0% 1,610 1.4%
Dendreon Corporation 1 5.0 70,647 1.4% 2,533 1.9% 2,078 1.8%
Baxter International Inc. 2 5.1 (4) 185,912 3.7% 2,507 1.9% 2,201 1.9%
Avigen, Inc. 2 5.9 (5) 112,830 2.3% 2,458 1.8% 2,433 2.1%
Gene Logic Inc. 3 5.4 (6) 112,271 2.2% 2,420 1.8% 1,699 1.4%
Amylin Pharmaceuticals, Inc. 2 11.1 77,203 1.5% 2,393 1.8% 1,979 1.7%
LION bioscience, Inc. (7) 1 4.3 71,510 1.4% 2,391 1.8% 2,391 2.0%
Acusphere, Inc. 1 8.0 47,500 0.9% 2,340 1.8% 1,834 1.6%
Biogen Idec Inc. 1 6.6 74,557 1.5% 2,310 1.7% 1,562 1.3%
Cardinal Health, Inc. 1 8.9 67,050 1.3% 2,237 1.7% 2,230 1.9%
------- -------- ------------ ------------ -------------- ------------ -------------- -------------
Total/Weighted Average (8): 32 7.9 2,099,245 41.9% $65,228 48.9% $57,973 49.2%
======= ======== ============ ============ ============== ============ ============== =============
- Annualized base rent means the annualized fixed base rental amount in effect as of December 31, 2003 (using rental revenue computed on a straight-line basis in accordance with GAAP).
- Annualized net effective rent is the annualized base rent in effect as of December 31, 2003 (using rental revenue computed on a straight-line basis in accordance with GAAP), less (for gross leases) real estate taxes and insurance, common area and other operating expenses and (for all leases) amortization of tenant improvements and leasing commissions.
- Amount shown is a weighted average of multiple leases with this tenant for 13,883 rentable square feet, 69,997 rentable square feet and 8,054 rentable square feet with remaining lease terms of 7.8 years, 1.0 years and 0.1 years, respectively.
- Amount shown is a weighted average of multiple leases with this tenant for 110,412 rentable square feet and 75,500 rentable square feet with remaining lease terms of 8.4 years and 0.2 years, respectively.
- Amount shown is a weighted average of multiple leases with this tenant for 67,482 rentable square feet and 45,348 rentable square feet with remaining lease terms of 6.9 years and 4.4 years, respectively.
- Amount shown is a weighted average of multiple leases with this tenant for 57,410 rentable square feet, 49,225 rentable square feet and 5,636 rentable square feet with remaining lease terms of 7.1 years, 3.9 years and 0.5 years, respectively.
- In February 2004, tenant elected to terminate its lease pursuant to an existing right to terminate.
- Weighted average based on percentage of aggregate leased square feet.
To our knowledge, no litigation is pending against us, other than routine actions and administrative proceedings, substantially all of which are expected to be covered by liability insurance or which, in the aggregate, are not expected to have a material adverse effect on our financial condition, results of operations or cash flows.
Item 4. Submission of Matters to a Vote of Security Holders
We did not submit any matters to a vote of our security holders in the fourth quarter of the fiscal year ended December 31, 2003.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Our common stock is traded on the New York Stock Exchange ("NYSE") under the symbol "ARE". On March 10, 2004, the last reported sales price per share of our common stock was $60.75, and there were approximately 239 holders of record of our common stock (excluding beneficial owners whose shares are held in the name of CEDE & Co.). The following table sets forth the quarterly high and low sales prices per share of our common stock as reported on the NYSE and the distributions paid by us with respect to each such period.
Per Share
Period High Low Disribution
- ------ ------ ------ ------------
2003
Fourth Quarter........................ $58.99 $48.03 $0.58
Third Quarter......................... $48.55 $44.34 $0.56
Second Quarter........................ $45.63 $41.61 $0.53
First Quarter......................... $42.80 $39.81 $0.53
2002
Fourth Quarter........................ $42.79 $37.56 $0.50
Third Quarter......................... $47.69 $36.92 $0.50
Second Quarter........................ $47.85 $42.10 $0.50
First Quarter......................... $42.73 $37.66 $0.50
Future distributions on our common stock will be determined by and at the discretion of our Board of Directors and will be dependent upon a number of factors, including actual cash available for distribution, our financial condition and capital requirements, the annual distribution requirements under the REIT provisions of the Internal Revenue Code and such other factors as our Board of Directors deems relevant. To maintain our qualification as a REIT, we must make annual distributions to stockholders of at least 90% of our taxable income for the current taxable year, determined without regard to deductions for dividends paid and excluding any net capital gains. Under certain circumstances, we may be required to make distributions in excess of cash flow available for distributions to meet these distribution requirements. In such a case, we may borrow funds or may raise funds through the issuance of additional debt or equity capital. We cannot assure you that we will make any future distributions.
Item 6. Selected Financial Data
The following table should be read in conjunction with our consolidated financial statements and notes thereto appearing elsewhere in this Form 10-K.
Year Ended December 31,
---------------------------------------------------------------
2003 2002 2001 2000 1999
----------- ----------- ----------- ----------- -----------
(Dollars in thousands, except per share amounts)
Operating Data:
Total revenue ........................................... $ 160,558 $ 142,271 $ 120,861 $ 100,122 $ 79,533
Total expenses .......................................... 112,054 104,000 93,279 76,685 60,030
----------- ----------- ----------- ----------- -----------
Income from continuing operations........................ 48,504 38,271 27,582 23,437 19,503
Income from discontinued operations, net................ 11,139 1,761 2,695 2,572 2,550
----------- ----------- ----------- ----------- -----------
Net income............................................... 59,643 40,032 30,277 26,009 22,053
Dividends on preferred stock............................. 8,898 8,579 3,666 3,666 2,036
----------- ----------- ----------- ----------- -----------
Net income available to common stockholders.............. $ 50,745 $ 31,453 $ 26,611 $ 22,343 $ 20,017
=========== =========== =========== =========== ===========
Basic income per common share:
Income from continuing operations................. $ 2.55 $ 2.18 $ 1.73 $ 1.62 $ 1.44
=========== =========== =========== =========== ===========
Income from discontinued operations, net.......... $ 0.59 $ 0.10 $ 0.17 $ 0.18 $ 0.19
=========== =========== =========== =========== ===========
Net income........................................ $ 3.14 $ 2.28 $ 1.90 $ 1.80 $ 1.63
=========== =========== =========== =========== ===========
Net income available to common stockholders....... $ 2.67 $ 1.79 $ 1.67 $ 1.55 $ 1.48
=========== =========== =========== =========== ===========
Diluted income per common share:
Income from continuing operations................. $ 2.52 $ 2.14 $ 1.70 $ 1.59 $ 1.43
=========== =========== =========== =========== ===========
Income from discontinued operations, net.......... $ 0.58 $ 0.10 $ 0.17 $ 0.17 $ 0.19
=========== =========== =========== =========== ===========
Net income........................................ $ 3.10 $ 2.24 $ 1.87 $ 1.77 $ 1.61
=========== =========== =========== =========== ===========
Net income available to common stockholders....... $ 2.64 $ 1.76 $ 1.64 $ 1.52 $ 1.46
=========== =========== =========== =========== ===========
Weighted average shares of common stock
outstanding
Basic ............................................ 18,993,856 17,594,228 15,953,459 14,460,711 13,525,840
=========== =========== =========== =========== ===========
Diluted .......................................... 19,247,790 17,859,787 16,208,178 14,699,478 13,670,568
=========== =========== =========== =========== ===========
Cash dividends declared per share of common stock........ $ 2.20 $ 2.00 $ 1.84 $ 1.72 $ 1.69
=========== =========== =========== =========== ===========
Balance Sheet Data (at year end):
Rental properties - net of accumulated depreciation...... $ 982,297 $ 976,422 $ 796,626 $ 679,653 $ 554,706
Total assets ............................................ $ 1,272,577 $ 1,159,243 $ 962,146 $ 780,984 $ 643,118
Secured notes payable, unsecured line of credit and
unsecured term loan............................... $ 709,007 $ 614,878 $ 573,161 $ 431,256 $ 350,512
Total liabilities ....................................... $ 765,442 $ 673,390 $ 629,508 $ 461,832 $ 380,535
Stockholders' equity .................................... $ 507,135 $ 485,853 $ 332,638 $ 319,152 $ 262,583
Other Data:
Net income............................................... $ 59,643 $ 40,032 $ 30,277 $ 26,009 $ 22,053
Add:
Depreciation and amortization (1)........................ 38,901 34,071 30,578 24,251 18,532
Impairment on investments................................ - 2,545 - - -
Subtract:
Dividends on preferred stock............................. (8,898) (8,579) (3,666) (3,666) (2,036)
Net gain on sales of property (2)........................ (8,286) - - - -
----------- ----------- ----------- ----------- -----------
Funds from operations (3) ............................... $ 81,360 $ 68,069 $ 57,189 $ 46,594 $ 38,549
----------- ----------- ----------- ----------- -----------
Cash flows from operating activities .................... $ 74,847 67,050 60,340 32,931 46,011
Cash flows from investing activities .................... $ (139,810) (227,840) (192,179) (132,480) (113,549)
Cash flows from financing activities .................... $ 66,158 162,204 131,439 98,879 69,430
Number of properties owned at year end .................. 89 89 83 76 59
Rentable square feet of properties owned
at year end .......................................... 5,668,895 5,739,987 5,312,910 4,859,820 4,030,083
Occupancy of properties owned at year end ............... 88% 89% 89% 91% 92%
Occupancy of properties owned at year end,
excluding properties under redevelopment.............. 94% 96% 99% 98% 96%
- Includes depreciation and amortization on assets "held for sale" reflected as discontinued operations (for the periods prior to when such assets were designated as "held for sale").
- Net gain on sales of property relates to the disposition of a property in the Suburban Washington D.C. market during the quarter ended December 31, 2003, the disposition of a property in the Eastern Massachusetts market during the quarter ended September 30, 2003 and the disposition of a property in the San Francisco Bay market during the quarter ended March 31, 2003. Net gain on sales of property is included on the income statement in income from discontinued operations.
- GAAP basis accounting for real estate assets utilizes historical cost accounting and assumes real estate values diminish over time. In an effort to overcome the miscorrelation between real estate values and historical cost accounting for real estate assets, the Board of Governors of the National Association of Real Estate Investment Trusts ("NAREIT") established the measurement tool of funds from operations ("FFO"). Since its introduction, FFO has become a widely used non-GAAP financial measure by REITs. We believe that FFO is helpful to investors as an additional measure of the performance of an equity REIT. We compute FFO in accordance with standards established by the Board of Governors of NAREIT in its April 2002 White Paper (the "White Paper") and related implementation guidance, which may differ from the methodology for calculating FFO utilized by other equity REITs, and, accordingly, may not be comparable to such other REITs. In 2003, NAREIT issued guidance which modifies the calculation of FFO for both past and future periods. In accordance with NAREIT's revised guidance, we now include losses from early extinguishment of debt and real estate impairment charges in our calculation of FFO. As such, the reported amounts of FFO for the year ended December 31, 2002 have been modified from those previously reported. The White Paper defines FFO as net income (loss) (computed in accordance with GAAP), excluding gains (or losses) from sales, plus real estate depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures. While FFO is a relevant and widely used measure of operating performance for REITs, it should not be considered as an alternative to net income (determined in accordance with GAAP) as an indication of financial performance, or to cash flows from operating activities (determined in accordance with GAAP) as a measure of our liquidity, nor is it indicative of funds available to fund our cash needs, including our ability to make distributions. We believe that net income is the most directly comparable GAAP financial measure to FFO. For a more detailed discussion of FFO, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Funds from Operations."
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The terms "we", "our", "ours" and "us" as used in this Form 10-K refer to Alexandria Real Estate Equities, Inc. and its subsidiaries. The following discussion should be read in conjunction with our consolidated financial statements and notes thereto appearing elsewhere in this Form 10-K.
Overview
We are a publicly-traded real estate operating company focused principally on the ownership, operation, management, acquisition, expansion and selective redevelopment and development of high quality, strategically located properties containing a combination of office and laboratory space leased principally to tenants in the life science industry. We refer to these properties as "life science facilities".
In 2003, we:
Acquired four properties with an aggregate of approximately 267,000 rentable square feet.
Expanded our unsecured line of credit from $425 million to $440 million and extended its term to November 2006, which may be further extended at our sole option for an additional one-year period.
Obtained an unsecured term loan for $150 million that is due November 2008.
Sold three properties with an aggregate of approximately 289,000 rentable square feet.
Our primary source of revenue is rental income and tenant recoveries from leases at the properties we own. Of the 89 properties we owned as of December 31, 2003, four were acquired in 1994, nine in 1996, nine in 1997, 27 in 1998, six in 1999, 11 in 2000, five in 2001, four in 2002 and four in 2003. In addition, we completed the development of one property in 1999, five properties in 2000 (together with the 11 properties acquired in 2000, the "2000 Properties"), two properties in 2001 (together with the five properties acquired in 2001, the "2001 Properties") and two properties in 2002 (together with the four properties acquired in 2002, the "2002 Properties"). As a result of these acquisition and development activities, as well as our ongoing leasing and redevelopment activities, there have been significant increases in total revenues and expenses, including significant increases in total revenues and expenses for 2003 as compared to 2002, and for 2002 as compared to 2001.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). Our significant accounting policies are described in the notes to our consolidated financial statements. The preparation of these financial statements in conformity with GAAP requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. We base these estimates, judgments and assumptions on historical experience and on various other factors that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.
REIT Compliance
We have elected to be taxed as a real estate investment trust ("REIT") under the Internal Revenue Code. Qualification as a REIT involves the application of highly technical and complex provisions of the Internal Revenue Code to our operations and financial results and the determination of various factual matters and circumstances not entirely within our control. We believe that our current organization and method of operation comply with the rules and regulations promulgated under the Internal Revenue Code to enable us to qualify, and continue to qualify, as a REIT. However, it is possible that we have been organized or have operated in a manner that would not allow us to qualify as a REIT, or that our future operations could cause us to fail to qualify.
If we fail to qualify as a REIT in any taxable year, then we will be required to pay federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates. If we lose our REIT status, then our net earnings available for investment or distribution to stockholders would be significantly reduced for each of the years involved and we would no longer be required to make distributions to our stockholders.
Rental Properties and Properties Under Development
In accordance with Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141"), we perform the following procedures when making an allocation of the purchase price of real estate: 1) estimate the value of the real estate as of the acquisition date on an "as if vacant" basis, 2) allocate the "as if vacant" value among land, land improvements, buildings, building improvements, tenant improvements and equipment, 3) calculate the value of the intangibles as the difference between the "as if vacant" value and the purchase price, and 4) allocate the intangible value to above, below and at market leases, origination costs associated with in-place leases, tenant relationships and other intangible assets.
The values allocated to land improvements, buildings, building improvements, tenant improvements and equipment are depreciated on a straight-line basis using an estimated life of 20 years for land improvements, 40 years for buildings and building improvements, the respective lease term for tenant improvements and the estimated useful life of equipment. The values of above and below market leases are amortized over the life of the related lease and recorded as either an increase (for below market leases) or a decrease (for above market leases) to rental income. The values of at-market leases and origination costs are classified as leasing costs, included in other assets on our balance sheets and amortized over the remaining life of the lease. The values of other intangible assets are amortized over the estimated useful life.
Rental properties and properties under development are individually evaluated for impairment when conditions exist which may indicate that it is probable that the sum of expected future undiscounted cash flows is less than its carrying amount. Upon determination that an impairment has occurred, a write- down is recorded to reduce the carrying amount of the property to its estimated fair value.
Capitalization of Costs
We also capitalize costs directly related and essential to our leasing activities, including broker fees and certain costs related to our leasing personnel. These costs are amortized on a straight-line basis over the terms of the related leases. Costs previously capitalized related to unsuccessful leasing opportunities are written-off.
Accounting of Investments
We hold equity investments in certain publicly-traded companies and privately held entities primarily involved in the life science industry. All of our investments in publicly-traded companies are considered "available for sale" under the provisions of Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"), and are recorded at fair value. Fair value has been determined by the closing trading price at the balance sheet date, with unrealized gains and losses shown as a separate component of stockholders' equity. The classification of investments under SFAS 115 is determined at the time each investment is made, and such determination is reevaluated at each balance sheet date. The cost of investments sold is determined by the specific identification method, with realized gains and losses included in other income.
Investments in privately held entities are generally accounted for under the cost method because we do not influence any operating or financial policies of the entities in which we invest. Certain investments are accounted for under the equity method of accounting under the provisions of Accounting Principles Board Opinion No. 18, "The Equity Method of Accounting for Investments in Common Stock" ("APB 18") and Emerging Issues Task Force ("EITF") Topic D-46, "Accounting for Limited Partnership Investments". Pursuant to APB 18, the equity method of accounting should be used when an investor has "the ability to exercise significant influence over operating and financial policies of an investee even though the investor holds 50% or less of the voting stock". EITF- D-46 further clarifies the Securities and Exchange Commission's position on the accounting for limited partnerships and provides that the equity method of accounting be used unless the investor's interest "is so minor that the limited partner may have virtually no influence over partnership operating and financial policies". Under the equity method of accounting, we record our investment initially at cost and adjust the carrying amount of the investment to recognize our share of the earnings or losses of the investee subsequent to the date of our investment.
For all of our investments, if a decline in the fair value of an investment below its carrying value is determined to be other than temporary, such investment is written down to its estimated fair value with a non-cash charge to current earnings.
The factors that we consider in making these assessments include, but are not limited to, market prices, market conditions, prospects for favorable or unfavorable clinical trial results, new product initiatives and new collaborative agreements.
Interest Rate Swap Agreements
We utilize interest rate swap agreements to hedge a portion of our exposure to variable interest rates associated with our unsecured line of credit and unsecured term loan. These agreements involve an exchange of fixed and floating interest payments without the exchange of the underlying principal amount. Interest received under all of our swap agreements is based on the one- month LIBOR rate. The net difference between the interest paid and the interest received is reflected as an adjustment to interest expense.
We reflect our interest rate swap agreements on the balance sheet at their estimated fair values. We use a variety of methods and assumptions based on market conditions and risks existing at each balance sheet date to determine the fair values of our interest rate swap agreements. These methods of assessing fair value result in a general approximation of value, and such value may never be realized.
All of our interest rate swap agreements meet the criteria to be deemed "highly effective" under Statement of Financial Accounting Standards No. 133 in reducing our exposure to variable interest rates. Accordingly, we have categorized these instruments as cash flow hedges. While we intend to continue to meet the conditions for such hedge accounting, if hedges did not qualify as "highly effective", the changes in the fair value of the derivatives used as hedges would be reflected in earnings.
We do not believe we are exposed to more than a nominal amount of credit risk in our interest rate swap agreements as our counterparties are established, well-capitalized financial institutions.
Recognition of Rental Income
Rental income from leases with scheduled rent increases, free rent and other rent adjustments are recognized on a straight-line basis over the respective lease terms. We maintain an allowance for estimated losses that may result from the inability of our tenants to make required pay