ELME COMMUNITIES The following discussion should be read in conjunction with our consolidated financial statements and the notes thereto appearing in Item 1 of this report and the more detailed information contained in our Annual Report on Form 10-K for the year endedDecember 31, 2019 filed with theSecurities and Exchange Commission ("SEC") onFebruary 19, 2020 , as amended by Amendment No. 1 to the Annual Report on Form 10-K filed onMarch 6, 2020 . We refer to the three months endedJune 30, 2020 andJune 30, 2019 as the "2020 Quarter" and the "2019 Quarter," respectively, and the six months endedJune 30, 2020 andJune 30, 2019 as the "2020 Period" and the "2019 Period", respectively.
Forward-Looking Statements
This Form 10-Q contains forward-looking statements which involve risks and uncertainties. Forward-looking statements relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. In some cases, you can identify forward looking statements by the use of forward-looking terminology such as "may," "will," "should," "expects," "intends," "plans," "anticipates," "believes," "estimates," "predicts," or "potential" or the negative of these words and phrases or similar words or phrases which are predictions of or indicate future events or trends and which do not relate solely to historical matters. Such statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance, or achievements of WashREIT to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Currently, one of the most significant factors is the adverse effect of the COVID-19 virus and ensuing economic turmoil on the financial condition, results of operations, cash flows and performance of WashREIT, particularly the impact of our ability to collect rent on schedule or at all and the percentage of rent collected, our ability to lease or re-lease our commercial spaces, and increased credit losses, on the performance of our tenants generally, and on the global economy and financial markets. The extent to which COVID-19 impacts WashREIT and its tenants will depend on future developments, which are highly uncertain and cannot be predicted with confidence, including the scope, severity and duration of the pandemic, the actions taken to contain the pandemic or mitigate its impact, and the direct and indirect economic effects of the pandemic and containment measures, among others. Moreover, investors are cautioned to interpret many of the risks identified in the risk factors discussed in this 10-Q and our Annual Report on Form 10-K for the year endedDecember 31, 2019 , as amended by Amendment No. 1 to the Annual Report on Form 10-K, filed onMarch 6, 2020 , as well as the risks set forth below, as being heightened as a result of the ongoing and numerous adverse impacts of COVID-19. Additional factors which may cause the actual results, performance, or achievements of WashREIT to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements include, but are not limited to the risks associated with the ownership of real estate in general and our real estate assets in particular; the economic health of the greaterWashington metro region; the risk of failure to enter into/and or complete contemplated acquisitions and dispositions at all, within the price ranges anticipated and on the terms and timing anticipated; changes in the composition of our portfolio; fluctuations in interest rates; reductions in or actual or threatened changes to the timing of federal government spending; the risks related to use of third-party providers and joint venture partners; the ability to control our operating expenses; the economic health of our tenants; the supply of competing properties; shifts away from brick and mortar stores to e-commerce; the availability and terms of financing and capital and the general volatility of securities markets; compliance with applicable laws, including those concerning the environment and access by persons with disabilities; terrorist attacks or actions and/or cyber-attacks; weather conditions, natural disasters and pandemics; ability to maintain key personnel; failure to qualify and maintain our qualification as a REIT and the risks of changes in laws affecting REITs; and other risks and uncertainties detailed from time to time in our filings with theSEC , including our 2019 Form 10-K, as amended by Amendment No. 1 to the Annual Report on Form 10-K, filed onMarch 6, 2020 , and subsequent Quarterly Reports on Form 10-Q. While forward-looking statements reflect our good faith beliefs, they are not guarantees of future performance. We undertake no obligation to update our forward-looking statements or risk factors to reflect new information, future events, or otherwise. General Introductory Matters We provide our Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") in addition to the accompanying consolidated financial statements and notes to assist readers in understanding our results of operations and financial condition. We organize the MD&A as follows: 26 -------------------------------------------------------------------------------- •Overview. Discussion of our business outlook, operating results, investment activity, financing activity and capital requirements to provide context for the remainder of MD&A. •Results of Operations. Discussion of our financial results comparing the 2020 Quarter to the 2019 Quarter and the 2020 Period to 2019 Period. •Liquidity and Capital Resources. Discussion of our financial condition and analysis of changes in our capital structure and cash flows. •Funds From Operations. Calculation of NAREIT Funds From Operations ("NAREIT FFO"), a non-GAAP supplemental measure to net income. •Critical Accounting Policies and Estimates. Descriptions of accounting policies that reflect significant judgments and estimates used in the preparation of our consolidated financial statements.
When evaluating our financial condition and operating performance, we focus on the following financial and non-financial indicators:
•Net operating income ("NOI"), calculated as set forth below under the caption
"Results of Operations - Net Operating Income." NOI is a non-GAAP supplemental
measure to net income.
•Funds From Operations ("NAREIT FFO"), calculated as set forth below under the
caption "Funds from Operations." NAREIT FFO is a non-GAAP supplemental measure
to net income.
•Ending occupancy, calculated as occupied square footage or multifamily units as
a percentage of total square footage or multifamily units, respectively, as of
the last day of that period.
•Leased percentage, calculated as the percentage of available physical net
rentable area leased for our commercial properties and percentage of apartments
leased for our multifamily properties.
•Leasing activity, including new leases, renewals and expirations.
For purposes of evaluating comparative operating performance, we categorize our
properties as "same-store", "non-same-store" or discontinued operations.
Same-store properties include properties that were owned for the entirety of the
years being compared, and exclude properties under redevelopment or development
and properties acquired, sold or classified as held for sale during the years
being compared. We define development properties as those for which we have
planned or ongoing major construction activities on existing or acquired land
pursuant to an authorized development plan. We consider a property's development
activities to be complete when the property is ready for its intended use. The
property is categorized as same-store when it has been ready for its intended
use for the entirety of the years being compared. We define redevelopment
properties as those for which we have planned or ongoing significant development
and construction activities on existing or acquired buildings pursuant to an
authorized plan, which has an impact on current operating results, occupancy and
the ability to lease space with the intended result of a higher economic return
on the property. We categorize a redevelopment property as same-store when
redevelopment activities have been complete for the majority of each year being
compared.
Overview
Our revenues are derived primarily from the ownership and operation of income
producing properties in the greater Washington metro region. As of June 30,
2020 , we owned a diversified portfolio of 45 properties, totaling approximately
3.7 million square feet of commercial space and 6,861 multifamily units, and
land held for development. These 45 properties consisted of 15 office
properties, 8 retail centers and 22 multifamily properties.
Outlook
OnMarch 11, 2020 , theWorld Health Organization declared COVID-19, a respiratory illness caused by the novel coronavirus, a pandemic, and onMarch 13, 2020 ,the United States declared a national emergency with respect to COVID-19. The COVID-19 pandemic caused state and local governments within theWashington metro region to institute quarantines, "shelter-in-place" rules and restrictions on travel, the types of business that may continue to operate, and/or the types of construction projects that may continue. These actions resulted in modifications to our normal operations, including requiring our employees to work remotely with the exception of essential building personnel. InJune 2020 , shelter-in-place orders began to phase out in theWashington metro region. As many of our commercial tenants have begun returning to their leased space, we have implemented robust plans to reduce the risk of exposure and further spread of the virus in our properties and continue to follow the mandates of public health officials and government agencies. We are adhering to occupancy restrictions at our properties where required. The effects of the COVID-19 pandemic had a significant impact on our operating results for the 2020 Quarter. Beginning late in the first quarter of 2020 and continuing into the second quarter of 2020, many of our commercial tenants were closed or were 27 -------------------------------------------------------------------------------- operating at significantly reduced capacity. Starting inApril 2020 , we began working with our commercial tenants on a case-by-case basis to the extent they demonstrated hardship as a result of the pandemic and financial ability to work through a satisfactory arrangement on a variety of relief options, generally involving negotiated deferral payment plans, early blend-and-extend renewals or abatement of rent. As ofJuly 22, 2020 , we collected 97% and 72% of office and retail cash rent during the 2020 Quarter, respectively, excluding the impact of contractual rent deferral agreements. By mid-June, most of our retail tenants had reopened. The effects of COVID-19 on our commercial tenants have been reflected in an increase in credit losses of$0.6 million for the 2020 Quarter compared to the first quarter of 2020. At our multifamily properties, we temporarily froze rents on full-year lease renewals, waived late fees and offered a payment deferral plan to residentswho have been adversely financially impacted by COVID-19. As ofJune 30, 2020 , we had collected 99% of multifamily cash rent during the 2020 Quarter excluding rent that has been deferred. As ofJuly 22, 2020 , we agreed to defer$1.2 million ,$1.0 million , and$0.1 million of rent due from office, retail, and multifamily tenants, respectively. The expected timing of the executed deferred rent paybacks is as follows: [[Image Removed: wre-20200630_g1.jpg]]
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(1) Includes paybacks on deferred rent beginning
We had a decline in average occupancy of approximately 0.9% for the 2020 Quarter compared to both the first quarter of 2020 and second quarter of 2019, excluding the Trove which began lease-up in the first quarter of 2020. We continue to monitor and communicate with our commercial tenants to assess their needs and ability to pay rent. The effects of the COVID-19 pandemic have also impacted our ability to lease up available commercial space as physical touring stopped during shelter in place orders and lease decisions have been slower for prospective tenants as they re-evaluate re-entry and space plans. New gross leasing square footage for the 2020 Quarter declined by 38% and 99% for office and retail space, respectively, compared to the 2019 Quarter. As ofJune 30, 2020 , we had approximately 420,000 square feet of vacant commercial space and approximately 140,000 square feet of commercial lease expirations scheduled for the remainder of 2020. For our multifamily properties, we expect the economic disruptions caused by the COVID-19 pandemic to limit our ability to increase rental rates for the foreseeable future. To help mitigate the impact on our operating results of the COVID-19 pandemic, we have initiated various operational cost saving initiatives across our portfolio. 28 -------------------------------------------------------------------------------- We expect the COVID-19 outbreak will continue to affect our financial condition and results of operations going forward, including but not limited to, real estate rental revenues, credit losses and leasing activity. Given our concentration in a single region, theWashington metro region, our entire portfolio could be impacted for the foreseeable future by quarantines, "shelter-in-place" rules and various other restrictions imposed or re-imposed in response to a surge in COVID-19 cases. Due to the uncertainty of the future impacts of the COVID-19 pandemic, the extent of the financial impact cannot be reasonably estimated at this time. For more information, see Part II - Item 1A. Risk Factors" included elsewhere in this Quarterly Report on Form 10-Q. New legislation was enacted during the 2020 Period to provide relief to businesses in response to the COVID-19 pandemic. We continue to evaluate the relief options available, such as the Coronavirus Aid, Relief, and Economic Securities Act ("CARES Act"), as well as other emergency relief initiatives and stimulus packages instituted by the federal government. A number of the relief options contain restrictions on future business activities, including ability to repurchase shares and pay dividends that require careful evaluation and consideration. We will continue to assess these options and any subsequent legislation or other relief packages, including the accompanying restrictions on our business, as the pandemic continues to evolve. The legislation did not have a material impact on our results of operations for the 2020 Quarter or 2020 Period.
Operating Results
Net (loss) income attributable to the controlling interests, NOI and NAREIT FFO for the three months endedJune 30, 2020 and 2019 were as follows (in thousands): Three Months Ended June 30, 2020 2019 $ Change % Change Net (loss) income attributable to the controlling interests$ (5,406) $ 987 $ (6,393) (647.7) % NOI (1) 45,985 48,686 (2,701) (5.5) % NAREIT FFO (2)$ 31,732 $ 37,454 $ (5,722) (15.3) %
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(1) See page 31 of the MD&A for a reconciliation of NOI to net income. (2) See page 41 of the MD&A for a reconciliation of NAREIT FFO to net income. The decrease in net income attributable to the controlling interests is primarily due to lower income from discontinued operations ($7.2 million ), higher loss on sale of real estate ($6.5 million ), lower NOI ($2.7 million ) and loss on extinguishment of debt ($0.2 million ), partially offset by lower interest expense ($6.5 million ), lower depreciation and amortization ($3.4 million ) and lower general and administrative expenses ($0.2 million ) in the 2020 Quarter. The lower NOI is primarily due to the sales of1776 G Street ($2.2 million ) andQuantico Corporate Center ($0.9 million ) during 2019 and John Marshall II ($0.9 million ) during the 2020 Quarter and lower NOI from same-store properties ($1.8 million ) partially offset by the acquisitions of seven suburban Class B apartment communities in northernVirginia andMontgomery County, Maryland ("Assembly Portfolio"), and Cascade at Landmark ($3.2 million ) during 2019. The lower same-store NOI is explained in further detail beginning on page 28 (Results of Operations - 2020 Quarter Compared to 2019 Quarter). Same-store ending occupancy decreased to 90.0% as ofJune 30, 2020 from 92.2% as ofJune 30, 2019 , due to lower occupancy across the portfolio. The lower NAREIT FFO is primarily attributable to lower income from discontinued operations net of depreciation and amortization ($9.5 million ) and lower NOI ($2.7 million ), partially offset by lower interest expense ($6.5 million ).
Investment and Financing Activity
Significant investment and financing transactions during the 2020 Period included the following:
•The prepayment of the$45.6 million mortgage note secured by Yale West, which was scheduled to mature in 2052. As a result of the transaction, we recognized a gain on extinguishment of debt of$0.5 million related to the write-off of an unamortized mortgage premium of$1.4 million , partially offset by a prepayment penalty of$0.9 million . •The disposition of John Marshall II, a 223,000 square foot office property in Tysons,Virginia , for a contract sales price of$57.0 million . As a result of this transaction, we recognized a loss on sale of real estate of$6.9 million . •The prepayment of the$250.0 million of 4.95% Senior Notes without penalty using borrowings from our Revolving Credit Facility. 29 -------------------------------------------------------------------------------- •The execution of the one-year,$150.0 million 2020 Term Loan, maturing onMay 5, 2021 with a one-year extension option. The 2020 Term Loan bears interest at LIBOR + 1.50%, which margin is subject to change based on our credit ratings, with a 0.50% floor for the LIBOR rate. We used the proceeds to repay borrowings under our Revolving Credit Facility. As ofJune 30, 2020 , the interest rate on the$700.0 million unsecured revolving credit facility ("Revolving Credit Facility") was one month LIBOR plus 1.00% and the facility fee was 0.20%. As ofJuly 27, 2020 , our Revolving Credit Facility has a borrowing capacity of$496.0 million .
Capital Requirements
As described in the preceding section, during the 2020 Period we prepaid the mortgage note payable secured by Yale West. Following this prepayment, we have no mortgage notes.
We have no remaining debt maturities in 2020. We expect to have additional capital requirements as set forth on page 31 (Liquidity and Capital Resources - Capital Requirements).
Results of Operations
The discussion that follows is based on our consolidated results of operations
for the 2020 Quarter and 2020 Period and 2019 Quarter and 2019 Period. The
ability to compare one period to another is significantly affected by
acquisitions completed and dispositions made during 2020 and 2019 (see note 3 to
the consolidated financial statements). Additionally, the COVID-19 pandemic
adversely impacted our operating results for the 2020 Quarter, and we expect
that the COVID-19 outbreak will continue to adversely affect our business,
financial condition, results of operations and cash flows going forward,
including but not limited to, real estate rental revenues, credit losses, and
leasing activity, in ways that may vary widely depending on the duration and
magnitude of the COVID-19 pandemic and ensuing economic turmoil, as well as
numerous factors, many of which are outside of our control, as discussed under
"Risk Factors."
Net Operating Income
NOI, defined as real estate rental revenue less real estate expenses, is a
non-GAAP measure. NOI is calculated as net income, less non-real estate revenue
and the results of discontinued operations (including the gain or loss on sale,
if any), plus interest expense, depreciation and amortization, lease origination
expenses, general and administrative expenses, real estate impairment and gain
or loss on extinguishment of debt. We believe that NOI is useful as a
performance measure because, when compared across periods, NOI reflects the
impact on operations of trends in occupancy rates, rental rates and operating
costs on an unleveraged basis, providing perspective not immediately apparent
from net income. NOI excludes certain components from net income in order to
provide results more closely related to a property's results of operations. For
example, interest expense is not necessarily linked to the operating performance
of a real estate asset. In addition, depreciation and amortization, because of
historical cost accounting and useful life estimates, may distort operating
performance at the property level. As a result of the foregoing, we provide NOI
as a supplement to net income, calculated in accordance with GAAP. NOI does not
represent net income or income from continuing operations, in either case
calculated in accordance with GAAP. As such, it should not be considered an
alternative to these measures as an indication of our operating performance. A
reconciliation of NOI to net income follows.
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