Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 

(Mark One)

 

x                QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2010

 

or

 

o                   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: 001-32269

 

EXTRA SPACE STORAGE INC.

(Exact name of registrant as specified in its charter)

 

Maryland

 

20-1076777

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

2795 East Cottonwood Parkway, Suite 400

Salt Lake City, Utah 84121

(Address of principal executive offices)

 

Registrant’s telephone number, including area code:  (801) 562-5556

 

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 o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o  No  x

 

The number of shares outstanding of the registrant’s common stock, par value $0.01 per share, as of October 29, 2010 was 87,546,587.

 

 

 



Table of Contents

 

EXTRA SPACE STORAGE INC.

 

TABLE OF CONTENTS

 

STATEMENT ON FORWARD-LOOKING INFORMATION

3

PART I. FINANCIAL INFORMATION

4

ITEM 1. FINANCIAL STATEMENTS

4

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

9

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

31

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

42

ITEM 4. CONTROLS AND PROCEDURES

43

PART II. OTHER INFORMATION

43

ITEM 1. LEGAL PROCEEDINGS

43

ITEM 1A. RISK FACTORS

43

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

44

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

44

ITEM 4. REMOVED AND RESERVED

44

ITEM 5. OTHER INFORMATION

44

ITEM 6. EXHIBITS

44

SIGNATURES

45

 

2



Table of Contents

 

STATEMENT ON FORWARD-LOOKING INFORMATION

 

Certain information set forth in this report contains “forward-looking statements” within the meaning of the federal securities laws. Forward-looking statements include statements concerning our plans, objectives, goals, strategies, future events, future revenues or performance, capital expenditures, financing needs, plans or intentions relating to acquisitions and other information that is not historical information. In some cases, forward-looking statements can be identified by terminology such as “believes,” “expects,” “estimates,” “may,” “will,” “should,” “anticipates,” or “intends” or the negative of such terms or other comparable terminology, or by discussions of strategy. We may also make additional forward-looking statements from time to time. All such subsequent forward-looking statements, whether written or oral, by us or on our behalf, are also expressly qualified by these cautionary statements.

 

All forward-looking statements, including without limitation, management’s examination of historical operating trends and estimate of future earnings, are based upon our current expectations and various assumptions. Our expectations, beliefs and projections are expressed in good faith and we believe there is a reasonable basis for them, but there can be no assurance that management’s expectations, beliefs and projections will result or be achieved. All forward-looking statements apply only as of the date made. We undertake no obligation to publicly update or revise forward-looking statements which may be made to reflect events or circumstances after the date made or to reflect the occurrence of unanticipated events.

 

There are a number of risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements contained in or contemplated by this report. Any forward-looking statements should be considered in light of the risks referenced in “Part II. Item 1A. Risk Factors” below and in “Part I. Item 1A. Risk Factors” included in our most recent Annual Report on Form 10-K. Such factors include, but are not limited to:

 

·                  adverse changes in general economic conditions, the real estate industry and the markets in which we operate;

 

·                  the effect of competition from new self-storage facilities or other storage alternatives, which could cause rents and occupancy rates to decline;

 

·                  difficulties in our ability to evaluate, finance, complete and integrate acquisitions and developments successfully and to lease up those properties, which could adversely affect our profitability;

 

·                  potential liability for uninsured losses and environmental contamination;

 

·                  the impact of the regulatory environment as well as national, state, and local laws and regulations including, without limitation, those governing real estate investment trusts (“REITS”), which could increase our expenses and reduce our cash available for distribution;

 

·                  disruptions in credit and financial markets and resulting difficulties in raising capital at reasonable rates or at all, which could impede our ability to grow;

 

·                  increased interest rates and operating costs;

 

·                  reductions in asset valuations and related impairment charges;

 

·                  delays in the development and construction process, which could adversely affect our profitability;

 

·                  the failure of our joint venture partners to fulfill their obligations to us or their pursuit of actions that are inconsistent with our objectives;

 

·                  the failure to maintain our REIT status for federal income tax purposes;

 

·                  economic uncertainty due to the impact of war or terrorism, which could adversely affect our business plan; and

 

·                  difficulties in our ability to attract and retain qualified personnel and management members.

 

3



Table of Contents

 

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

Extra Space Storage Inc.

Condensed Consolidated Balance Sheets

(amounts in thousands, except share data)

 

 

 

September 30, 2010

 

December 31, 2009

 

 

 

(unaudited)

 

 

 

Assets:

 

 

 

 

 

Real estate assets:

 

 

 

 

 

Net operating real estate assets

 

$

1,873,161

 

$

2,015,432

 

Real estate under development

 

29,537

 

34,427

 

Net real estate assets

 

1,902,698

 

2,049,859

 

 

 

 

 

 

 

Investments in real estate ventures

 

144,121

 

130,449

 

Cash and cash equivalents

 

21,798

 

131,950

 

Restricted cash

 

32,893

 

39,208

 

Receivables from related parties and affiliated real estate joint ventures

 

24,593

 

5,114

 

Other assets, net

 

49,047

 

50,976

 

Total assets

 

$

2,175,150

 

$

2,407,556

 

 

 

 

 

 

 

Liabilities, Noncontrolling Interests and Equity:

 

 

 

 

 

Notes payable

 

$

851,812

 

$

1,099,593

 

Notes payable to trusts

 

119,590

 

119,590

 

Exchangeable senior notes

 

87,663

 

87,663

 

Discount on exchangeable senior notes

 

(2,633

)

(3,869

)

Lines of credit

 

115,000

 

100,000

 

Accounts payable and accrued expenses

 

37,445

 

33,386

 

Other liabilities

 

32,241

 

24,974

 

Total liabilities

 

1,241,118

 

1,461,337

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Equity:

 

 

 

 

 

Extra Space Storage Inc. stockholders’ equity:

 

 

 

 

 

Preferred stock, $0.01 par value, 50,000,000 shares authorized, no shares issued or outstanding

 

 

 

Common stock, $0.01 par value, 300,000,000 shares authorized, 87,545,312 and 86,721,841 shares issued and outstanding at September 30, 2010 and December 31, 2009, respectively

 

875

 

867

 

Paid-in capital

 

1,146,903

 

1,138,243

 

Accumulated other comprehensive deficit

 

(8,530

)

(1,056

)

Accumulated deficit

 

(262,666

)

(253,875

)

Total Extra Space Storage Inc. stockholders’ equity

 

876,582

 

884,179

 

Noncontrolling interest represented by Preferred Operating Partnership units, net of $100,000 note receivable

 

29,701

 

29,886

 

Noncontrolling interests in Operating Partnership

 

26,608

 

31,381

 

Other noncontrolling interests

 

1,141

 

773

 

Total noncontrolling interests and equity

 

934,032

 

946,219

 

Total liabilities, noncontrolling interests and equity

 

$

2,175,150

 

$

2,407,556

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

4



Table of Contents

 

Extra Space Storage Inc.

Condensed Consolidated Statements of Operations

(amounts in thousands, except share data)

(unaudited)

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

Property rental

 

$

59,332

 

$

60,380

 

$

172,261

 

$

178,494

 

Management and franchise fees

 

5,851

 

5,191

 

17,056

 

15,685

 

Tenant reinsurance

 

6,796

 

5,542

 

19,026

 

15,246

 

Total revenues

 

71,979

 

71,113

 

208,343

 

209,425

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Property operations

 

21,334

 

23,022

 

64,231

 

67,456

 

Tenant reinsurance

 

1,736

 

1,264

 

4,416

 

3,996

 

Unrecovered development and acquisition costs

 

211

 

22

 

423

 

18,905

 

Loss on sublease

 

2,000

 

 

2,000

 

 

Severance costs

 

 

 

 

1,400

 

General and administrative

 

10,618

 

9,791

 

32,903

 

30,994

 

Depreciation and amortization

 

12,519

 

13,797

 

37,140

 

39,160

 

Total expenses

 

48,418

 

47,896

 

141,113

 

161,911

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

23,561

 

23,217

 

67,230

 

47,514

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

(15,702

)

(17,697

)

(49,209

)

(49,308

)

Non-cash interest expense related to amortization of discount on exchangeable senior notes

 

(416

)

(430

)

(1,236

)

(1,834

)

Interest income

 

178

 

245

 

714

 

1,098

 

Interest income on note receivable from Preferred Operating Partnership unit holder

 

1,213

 

1,213

 

3,638

 

3,638

 

Gain on repurchase of exchangeable senior notes

 

 

 

 

27,576

 

Income before equity in earnings of real estate ventures and income tax expense

 

8,834

 

6,548

 

21,137

 

28,684

 

 

 

 

 

 

 

 

 

 

 

Equity in earnings of real estate ventures

 

1,736

 

1,752

 

4,796

 

5,288

 

Income tax expense

 

(1,088

)

(726

)

(3,347

)

(2,317

)

Net income

 

9,482

 

7,574

 

22,586

 

31,655

 

Net income allocated to Preferred Operating Partnership noncontrolling interests

 

(1,524

)

(1,506

)

(4,510

)

(4,681

)

Net income allocated to Operating Partnership and other noncontrolling interests

 

(291

)

(101

)

(661

)

(929

)

Net income attributable to common stockholders

 

$

7,667

 

$

5,967

 

$

17,415

 

$

26,045

 

 

 

 

 

 

 

 

 

 

 

Net income per common share

 

 

 

 

 

 

 

 

 

Basic

 

$

0.09

 

$

0.07

 

$

0.20

 

$

0.30

 

Diluted

 

$

0.09

 

$

0.07

 

$

0.20

 

$

0.30

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares

 

 

 

 

 

 

 

 

 

Basic

 

87,484,731

 

86,437,877

 

87,244,161

 

86,260,442

 

Diluted

 

92,189,852

 

91,548,984

 

91,969,869

 

91,321,503

 

 

 

 

 

 

 

 

 

 

 

Cash dividends paid per common share

 

$

0.10

 

$

 

$

0.30

 

$

0.25

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

5



Table of Contents

 

Extra Space Storage Inc.

Condensed Consolidated Statement of Equity

(amounts in thousands, except share data)

(unaudited)

 

 

 

Noncontrolling Interests

 

Extra Space Storage Inc. Stockholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

Preferred
Operating

 

Operating

 

 

 

 

 

 

 

Paid-in

 

Other
Comprehensive

 

Accumulated

 

Total

 

 

 

Partnership

 

Partnership

 

Other

 

Shares

 

Par Value

 

Capital

 

Deficit

 

Deficit

 

Equity

 

Balances at December 31, 2009

 

$

29,886

 

$

31,381

 

$

773

 

86,721,841

 

$

867

 

$

1,138,243

 

$

(1,056

)

$

(253,875

)

$

946,219

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of common stock upon the exercise of options

 

 

 

 

442,990

 

4

 

5,097

 

 

 

5,101

 

Restricted stock grants issued

 

 

 

 

442,330

 

4

 

 

 

 

4

 

Restricted stock grants cancelled

 

 

 

 

(61,849

)

 

 

 

 

 

Compensation expense related to stock-based awards

 

 

 

 

 

 

3,457

 

 

 

3,457

 

Deconsolidation of noncontrolling interests

 

 

 

104

 

 

 

 

 

 

104

 

Redemption of Operating Partnership units for cash

 

 

(4,116

)

 

 

 

 

 

 

(4,116

)

Investments from other noncontrolling interests

 

 

 

87

 

 

 

 

 

 

87

 

Purchase of noncontrolling interest

 

 

 

223

 

 

 

 

 

 

223

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

4,510

 

707

 

(46

)

 

 

 

 

17,415

 

22,586

 

Change in fair value of interest rate swap

 

(85

)

(303

)

 

 

 

 

(7,474

)

 

(7,862

)

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

14,724

 

Tax effect from vesting of restricted stock grants and stock option exercises

 

 

 

 

 

 

995

 

 

 

995

 

Tax effect from contribution of property to Taxable REIT Subsidiary

 

 

 

 

 

 

(889

)

 

 

(889

)

Distributions to Operating Partnership units held by noncontrolling interests

 

(4,610

)

(1,061

)

 

 

 

 

 

 

(5,671

)

Dividends paid on common stock at $0.30 per share

 

 

 

 

 

 

 

 

(26,206

)

(26,206

)

Balances at September 30, 2010

 

$

29,701

 

$

26,608

 

$

1,141

 

87,545,312

 

$

875

 

$

1,146,903

 

$

(8,530

)

$

(262,666

)

$

934,032

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

6


 

 


Table of Contents

 

Extra Space Storage Inc.

Condensed Consolidated Statements of Cash Flows

(amounts in thousands)

(unaudited)

 

 

 

Nine months ended September 30,

 

 

 

2010

 

2009

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

22,586

 

$

31,655

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

37,140

 

39,160

 

Amortization of deferred financing costs

 

3,323

 

2,978

 

Non-cash interest expense related to amortization of discount on exchangeable senior notes

 

1,236

 

1,834

 

Gain on repurchase of exchangeable senior notes

 

 

(27,576

)

Compensation expense related to stock-based awards

 

3,457

 

2,952

 

Non-cash unrecovered development and acquisition costs

 

 

18,905

 

Loss on sublease

 

2,000

 

 

Severance costs

 

 

1,400

 

Distributions from real estate ventures in excess of earnings

 

4,830

 

4,665

 

Changes in operating assets and liabilities:

 

 

 

 

 

Receivables from related parties and affiliated real estate joint ventures

 

(1,237

)

(10,610

)

Other assets

 

(2,162

)

(3,934

)

Accounts payable and accrued expenses

 

2,059

 

4,176

 

Other liabilities

 

1,498

 

487

 

Net cash provided by operating activities

 

74,730

 

66,092

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Acquisition of real estate assets

 

(24,648

)

(27,378

)

Development and construction of real estate assets

 

(28,523

)

(57,905

)

Proceeds from sale of properties to joint venture (Note 4)

 

15,750

 

4,652

 

Investments in real estate ventures

 

(9,371

)

(2,535

)

Return of investment in real estate ventures

 

7,432

 

 

Change in restricted cash

 

6,315

 

(3,395

)

Purchase of equipment and fixtures

 

(1,450

)

(799

)

Net cash used in investing activities

 

(34,495

)

(87,360

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Repurchase of exchangeable senior notes

 

 

(80,853

)

Proceeds from notes payable and lines of credit

 

131,124

 

382,879

 

Principal payments on notes payable and lines of credit

 

(248,032

)

(207,981

)

Deferred financing costs

 

(2,674

)

(6,697

)

Investments from other noncontrolling interests

 

87

 

 

Redemption of Operating Partnership units held by noncontrolling interest

 

(4,116

)

(1,908

)

Net proceeds from exercise of stock options

 

5,101

 

 

Dividends paid on common stock

 

(26,206

)

(21,526

)

Distributions to noncontrolling interests in Operating Partnership

 

(5,671

)

(5,626

)

Net cash provided by (used in) financing activities

 

(150,387

)

58,288

 

Net increase (decrease) in cash and cash equivalents

 

(110,152

)

37,020

 

Cash and cash equivalents, beginning of the period

 

131,950

 

63,972

 

Cash and cash equivalents, end of the period

 

$

21,798

 

$

100,992

 

 

7



Table of Contents

 

Extra Space Storage Inc.
Condensed Consolidated Statements of Cash Flows
(amounts in thousands)
(unaudited)

 

 

 

Nine months ended September 30,

 

 

 

2010

 

2009

 

Supplemental schedule of cash flow information

 

 

 

 

 

Interest paid, net of amounts capitalized

 

$

45,593

 

$

46,006

 

 

 

 

 

 

 

Supplemental schedule of noncash investing and financing activities:

 

 

 

 

 

Deconsolidation of joint ventures due to application of Accounting Standards Codification 810:

 

 

 

 

 

Real estate assets, net

 

$

(42,739

)

$

 

Investments in real estate ventures

 

404

 

 

Receivables from related parties and affiliated real estate joint ventures

 

21,142

 

 

Other assets and other liabilities

 

(51

)

 

Notes payable

 

21,348

 

 

Other noncontrolling interests

 

(104

)

 

Conversion of Operating Partnership units held by noncontrolling interests for common stock

 

$

 

$

1,003

 

Acquisitions of real estate assets

 

 

 

 

 

Real estate assets, net

 

$

6,475

 

$

 

Notes payable

 

(6,475

)

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

8



Table of Contents

 

EXTRA SPACE STORAGE INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

Amounts in thousands, except property and share data

 

1.     ORGANIZATION

 

Extra Space Storage Inc. (the “Company”) is a self-administered and self-managed real estate investment trust (“REIT”), formed as a Maryland corporation on April 30, 2004 to own, operate, manage, acquire, develop and redevelop professionally managed self-storage facilities located throughout the United States. The Company continues the business of Extra Space Storage LLC and its subsidiaries, which had engaged in the self-storage business since 1977. The Company’s interest in its properties is held through its operating partnership, Extra Space Storage LP (the “Operating Partnership”), which was formed on May 5, 2004. The Company’s primary assets are general partner and limited partner interests in the Operating Partnership. This structure is commonly referred to as an umbrella partnership REIT, or UPREIT. The Company has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended.  To the extent the Company continues to qualify as a REIT, it will not be subject to tax, with certain limited exceptions, on the taxable income that is distributed to its stockholders.

 

The Company invests in self-storage facilities by acquiring or developing wholly-owned facilities or by acquiring an equity interest in real estate entities.  At September 30, 2010, the Company had direct and indirect equity interests in 652 operating storage facilities.  In addition, the Company managed 157 properties for franchisees and third parties, bringing the total number of operating properties which it owns and/or manages to 809 located in 34 states and Washington, D.C.

 

The Company operates in three distinct segments: (1) property management, acquisition and development; (2) rental operations; and (3) tenant reinsurance. The Company’s property management, acquisition and development activities include managing, acquiring, developing and selling self-storage facilities. On June 2, 2009, the Company announced the wind-down of its development activities.  As of September 30, 2010, there were six development projects in process that the Company expects to complete by the end of the second quarter of 2011. The rental operations activities include rental operations of self-storage facilities. No single tenant accounts for more than 5% of rental income.  Tenant reinsurance activities include the reinsurance of risks relating to the loss of goods stored by tenants in the Company’s self storage facilities.

 

2.     BASIS OF PRESENTATION

 

The accompanying unaudited condensed consolidated financial statements of the Company are presented on the accrual basis of accounting in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they may not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (including normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2010 are not necessarily indicative of results that may be expected for the year ended December 31, 2010. The Condensed Consolidated Balance Sheet as of December 31, 2009 has been derived from the Company’s audited financial statements as of that date, but does not include all of the information and footnotes required by GAAP for complete financial statements. For further information refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 as filed with the Securities and Exchange Commission (“SEC”).

 

Recently Issued Accounting Standards

 

In June 2009, the Financial Accounting Standards Board (“FASB”) issued changes to Accounting Standards Codification (“ASC”) 810, “Consolidation,”  which amended guidance for determining whether an entity is a variable interest entity (“VIE”), and requires the performance of a qualitative rather than a quantitative analysis to determine the primary beneficiary of a VIE. Under this guidance, an entity would be required to consolidate a VIE if it has (i) the power to direct the activities that most significantly impact the entity’s economic performance and (ii) the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could be significant to the VIE.  This guidance became effective for the first annual reporting period that began after November 15, 2009, with early adoption prohibited.  The Company adopted this guidance effective January 1, 2010 and reviewed the terms for all joint ventures in relation to the new guidance.  As a result of this analysis, the Company determined that five joint ventures that were consolidated under the previous accounting guidance should be deconsolidated as of January 1, 2010.  The assets and liabilities associated with these joint ventures were removed from the Company’s financial statements and the Company’s investments in these joint ventures were recorded under the equity method of accounting during the three and nine months ended September 30, 2010.

 

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Table of Contents

 

Reclassifications

 

Certain amounts in the 2009 financial statements and supporting note disclosures have been reclassified to conform to the current year presentation. Such reclassifications did not impact previously reported net income or accumulated deficit.

 

Fair Value Disclosures

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

The following table provides information for each major category of assets and liabilities that are measured at fair value on a recurring basis:

 

 

 

 

 

Fair Value Measurements at Reporting Date Using

 

Description

 

September 30, 2010

 

Quoted Prices in Active
Markets for Identical
Assets (Level 1)

 

Significant Other
Observable Inputs
(Level 2)

 

Significant
Unobservable Inputs
(Level 3)

 

 

 

 

 

 

 

 

 

 

 

Other liabilities - Swap Agreement 1

 

$

(2,351

)

$

 

$

(2,351

)

$

 

Other liabilities - Swap Agreement 2

 

(1,909

)

 

(1,909

)

 

Other liabilities - Swap Agreement 3

 

(957

)

 

(957

)

 

Other liabilities - Swap Agreement 4

 

(679

)

 

(679

)

 

Other liabilities - Swap Agreement 5

 

(1,063

)

 

(1,063

)

 

Other liabilities - Swap Agreement 6

 

(2,014

)

 

(2,014

)

 

Total

 

$

(8,973

)

$

 

$

(8,973

)

$

 

 

The fair value of our derivatives is based on quoted market prices of similar instruments from various banking institutions or an independent third party provider for similar instruments. In determining the fair value, we consider our non-performance risk and that of our counterparties.

 

The Company did not have any significant assets or liabilities that are re-measured on a recurring basis using significant unobservable inputs (Level 3) for the three and nine months ended September 30, 2010.

 

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

 

Long-lived assets held for use are evaluated for impairment when events or circumstances indicate there may be impairment.  The Company reviews each self-storage facility at least annually to determine if any such events or circumstances have occurred or exist.  The Company focuses on facilities where occupancy and/or rental income have decreased by a significant amount.  For these facilities, the Company determines whether the decrease is temporary or permanent and whether the facility will likely recover the lost occupancy and/or revenue in the short term.  In addition, the Company carefully reviews facilities in the lease-up stage and compares actual operating results to original projections.

 

When the Company determines that an event that may indicate impairment has occurred, the Company compares the carrying value of the related long-lived assets to the undiscounted future net operating cash flows attributable to the assets.  An impairment loss is recorded if the net carrying value of the assets exceeds the undiscounted future net operating cash flows attributable to the assets.  The impairment loss recognized equals the excess of net carrying value over the related fair value of the assets.

 

When real estate assets are identified by management as held for sale, the Company discontinues depreciating the assets and estimates the fair value of the assets, net of selling costs.  If the estimated fair value, net of selling costs, of the assets that have been identified as held for sale is less than the net carrying value of the assets, then a valuation allowance is established.  The operations of assets held for sale or sold during the period are generally presented as discontinued operations for all periods presented.

 

The Company assesses whether there are any indicators that the value of its investments in unconsolidated real estate ventures may be impaired annually and when events or circumstances indicate there may be impairment.  An investment is impaired if the Company’s estimate of the fair value of the investment is less than its carrying value.  To the extent impairment has occurred, and is considered to be other-than-temporary, the loss is measured as the excess of the carrying amount over the fair value of the investment.

 

The Company treats property acquisitions as businesses and records the related assets and liabilities at their fair values as of the acquisition date.  Acquisition-related transaction costs are expensed as incurred. Intangible assets, which represent the value of existing tenant relationships, are recorded at their fair values based on the avoided cost to replace the current leases. The Company measures the value of tenant relationships based on the Company’s historical experience with turnover in its facilities. Debt assumed as part of an acquisition is recorded at fair value based on current interest rates compared to contractual rates.

 

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Table of Contents

 

On June 2, 2009, the Company announced the wind-down of its development activities.  As a result of this decision, the Company reviewed its properties under construction, unimproved land and its investments in development joint ventures for potential impairments.  This review included the preparation of updated models based on current market conditions, obtaining appraisals and reviewing recent sales and list prices of undeveloped land and mature self storage facilities.  Based on this review, the Company identified certain assets as being impaired.  The impairments relating to long lived assets where the Company intends to complete the development and hold the assets are the result of the estimated future undiscounted cash flows being less than the current carrying value of the assets.  The Company compared the carrying value of certain undeveloped land and seven vacant condominiums that the Company intends to sell to the fair value of similar undeveloped land and condominiums.  For the assets that the Company intends to sell, where the current estimated fair market value less costs to sell was below the carrying value, the Company reduced the carrying value of the assets to the current fair market value less selling costs and recorded an impairment charge.  These assets are classified as held for sale.  The impairments relating to investments in development joint ventures are the result of the Company comparing the estimated current fair value to the carrying value of the investment.  For those investments in development joint ventures where the current estimated fair market value was below the carrying value, the Company reduced the investment to the current fair market value through an impairment charge.  Losses relating to changes in fair value have been included in unrecovered development and acquisition costs on the Company’s condensed consolidated statements of operations.

 

Fair Value of Financial Instruments

 

The carrying values of cash and cash equivalents, restricted cash, receivables, other financial instruments included in other assets, accounts payable and accrued expenses, variable rate notes payable and notes payable to trusts, lines of credit and other liabilities reflected in the condensed consolidated balance sheets at September 30, 2010 and December 31, 2009 approximate fair value. The fair values of the Company’s notes receivable and fixed rate notes payable and notes payable to trusts are as follows:

 

 

 

September 30, 2010

 

December 31, 2009

 

 

 

Fair

 

Carrying

 

Fair

 

Carrying

 

 

 

Value

 

Value

 

Value

 

Value

 

Note receivable from Preferred Operating Partnership unit holder

 

$

117,782

 

$

100,000

 

$

112,740

 

$

100,000

 

Fixed rate notes payable and notes payable to trusts

 

$

733,423

 

$

677,678

 

$

1,067,653

 

$

1,015,063

 

Exchangeable senior notes

 

$

122,918

 

$

87,663

 

$

110,122

 

$

87,663

 

 

3.     NET INCOME PER COMMON SHARE

 

Basic net income per common share is computed by dividing net income by the weighted average common shares outstanding including unvested share based payment awards that contain a non-forfeitable right to dividends or dividend equivalents. Diluted net income per common share measures the performance of the Company over the reporting period while giving effect to all potential common shares that were dilutive and outstanding during the period. The denominator includes the weighted average number of basic shares and the number of additional common shares that would have been outstanding if the potential common shares that were dilutive had been issued and is calculated using either the treasury stock or if-converted method. Potential common shares are securities (such as options, warrants, convertible debt, exchangeable Series A Participating Redeemable Preferred Operating Partnership units (“Preferred OP units”) and exchangeable Operating Partnership units (“OP units”)) that do not have a current right to participate in earnings but could do so in the future by virtue of their option or conversion right. In computing the dilutive effect of convertible securities, net income is adjusted to add back any changes in earnings in the period associated with the convertible security. The numerator also is adjusted for the effects of any other non-discretionary changes in income or loss that would result from the assumed conversion of those potential common shares. In computing diluted earnings per share, only potential common shares that are dilutive, those which reduce earnings per share, are included.

 

The Company’s Operating Partnership has $87,663 of exchangeable senior notes issued and outstanding as of September 30, 2010 that also can potentially have a dilutive effect on its earnings per share calculations. The exchangeable senior notes are exchangeable by holders into shares of the Company’s common stock under certain circumstances per the terms of the indenture governing the exchangeable senior notes. The exchangeable senior notes are not exchangeable unless the price of the Company’s common stock is greater than or equal to 130% of the applicable exchange price for a specified period during a quarter, or unless certain other events occur. The exchange price was $23.45 per share at September 30, 2010, and could change over time as described in the indenture. The price of the Company’s common stock did not exceed 130% of the exchange price for the specified period of time during the third quarter of 2010; therefore holders of the exchangeable senior notes may not elect to convert them during the fourth quarter of 2010.

 

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Table of Contents

 

The Company has irrevocably agreed to pay only cash for the accreted principal amount of the exchangeable senior notes relative to its exchange obligations, but has retained the right to satisfy the exchange obligations in excess of the accreted principal amount in cash and/or common stock. Though the Company has retained that right, ASC 260, “Earnings per Share,” requires an assumption that shares will be used to pay the exchange obligations in excess of the accreted principal amount, and requires that those shares be included in the Company’s calculation of weighted average common shares outstanding for the diluted earnings per share computation. No shares were included in the computations for the three and nine months ended September 30, 2010 or 2009 because there was no excess over the accreted principal for these periods.

 

For the purposes of computing the diluted impact on earnings per share of the potential conversion of Preferred OP units into common shares, where the Company has the option to redeem in cash or shares and where the Company has stated the positive intent and ability to settle at least $115,000 of the instrument in cash (or net settle a portion of the Preferred OP units against the related outstanding note receivable), only the amount of the instrument in excess of $115,000 is considered in the calculation of shares contingently issuable for the purposes of computing diluted earnings per share as allowed by ASC 260-10-45-46.

 

For the three months ended September 30, 2010 and 2009, options to purchase 1,161,799 and 4,458,370 shares of common stock and for the nine months ended September 30, 2010 and 2009, options to purchase 2,187,449 and 5,237,237 shares of common stock, respectively, were excluded from the computation of earnings per share as their effect would have been anti-dilutive.  All restricted stock grants have been included in basic and diluted shares outstanding because such shares earn a non-forfeitable dividend and carry voting rights.

 

The computation of net income per common share is as follows:

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Net income attributable to common stockholders

 

$

7,667

 

$

5,967

 

$

17,415

 

$

26,045

 

Add: Income allocated to noncontrolling interest - Preferred Operating Partnership and Operating Partnership

 

1,827

 

1,777

 

5,217

 

6,250

 

Subtract: Fixed component of income allocated to noncontrolling interest - Preferred Operating Partnership

 

(1,438

)

(1,438

)

(4,313

)

(4,313

)

Net income for diluted computations

 

$

8,056

 

$

6,306

 

$

18,319

 

$

27,982

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding:

 

 

 

 

 

 

 

 

 

Average number of common shares outstanding - basic

 

87,484,731

 

86,437,877

 

87,244,161

 

86,260,442

 

Operating Partnership units

 

3,356,963

 

3,917,941

 

3,356,963

 

3,917,941

 

Preferred Operating Partnership units

 

989,980

 

989,980

 

989,980

 

989,980

 

Dilutive and cancelled stock options

 

358,178

 

203,186

 

378,765

 

153,140

 

Average number of common shares outstanding - diluted

 

92,189,852

 

91,548,984

 

91,969,869

 

91,321,503

 

 

 

 

 

 

 

 

 

 

 

Net income per common share

 

 

 

 

 

 

 

 

 

Basic

 

$

0.09

 

$

0.07

 

$

0.20

 

$

0.30

 

Diluted

 

$

0.09

 

$

0.07

 

$

0.20

 

$

0.30

 

 

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Table of Contents

 

4.     REAL ESTATE ASSETS

 

The components of real estate assets are summarized as follows:

 

 

 

September 30, 2010

 

December 31, 2009

 

 

 

 

 

 

 

Land - operating

 

$

476,355

 

$

501,674

 

Land - development

 

24,284

 

32,635

 

Buildings and improvements

 

1,585,480

 

1,675,340

 

Intangible assets - tenant relationships

 

31,214

 

33,463

 

Intangible lease rights

 

6,150

 

6,150

 

 

 

2,123,483

 

2,249,262

 

Less: accumulated depreciation and amortization

 

(250,322

)

(233,830

)

Net operating real estate assets

 

1,873,161

 

2,015,432

 

Real estate under development

 

29,537

 

34,427

 

Net real estate assets

 

$

1,902,698

 

$

2,049,859

 

 

 

 

 

 

 

Real estate assets held for sale included in net real estate assets

 

$

11,275

 

$

11,275

 

 

Real estate assets held for sale include five parcels of vacant land and seven vacant condominiums.

 

On January 21, 2010, the Company entered into a joint venture with Harrison Street Real Estate Capital, LLC (“Harrison Street”).  Harrison Street contributed $15,750 in cash to the joint venture in return for a 50% ownership interest.  The Company contributed 19 wholly-owned properties with a fair market value of approximately $132,000 and received $15,750 in cash and a 50% ownership interest in the joint venture.  There was no step up in basis for the 50% ownership retained by the Company.  The joint venture assumed $101,000 of existing debt which is secured by the properties. The properties are located in California, Florida, Nevada, Ohio, Pennsylvania, Tennessee, Texas and Virginia.  The Company deconsolidated the 19 properties as of the acquisition date and will continue to manage the properties in exchange for a management fee.

 

The transaction met all of the criteria for sale accounting and profit recognition under the partial sale criteria of ASC 360-40, “Real Estate Sales,” except for a provision in the agreement that was deemed to be a seller “guarantee.”  Accordingly, the Company was required to assess the substance of the transaction to determine, first whether it was a sale, and second, whether there could be any partial profit recognition.  Based on its review of the terms of the arrangement and a review of the property operating projections, the Company concluded that the transaction qualified as a sale and could potentially qualify for some profit recognition under the cost recovery or installment methods; however, because there are preferences on cash distributions, the Company can only recognize profit to the extent that the $15,750 invested by Harrison Street exceeded 100% of the Company’s basis.  Since the Company’s basis was in excess of the $15,750, there was no profit recognition even though the transaction qualified for sale accounting.   The Company recorded the deferred gain of $3,951 as a reduction of its investment in the joint venture with Harrison Street.  The Company applied the guidance under ASC 810 and concluded that the joint venture with Harrison Street should be accounted for under the equity method of accounting.

 

5.     PROPERTY ACQUISITIONS

 

The following table summarizes the Company’s acquisitions of operating properties for the nine months ended September 30, 2010, and does not include purchases of raw land or improvements made to existing assets:

 

 

 

 

 

 

 

Consideration Paid

 

Acquisition Date Fair Value

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net

 

 

 

 

 

Property Location

 

Number of
Properties

 

Date of
Acquisition

 

Total Paid

 

Cash Paid

 

Loan
Assumed

 

Liabilities
(Assets)
Assumed

 

Land

 

Building

 

Intangible

 

Closing
costs - 
expensed

 

Source of Acquisition

 

New York

 

1

 

5/21/2010

 

$

9,629

 

$

3,231

 

$

6,475

 

$

(77

)

$

2,802

 

$

6,536

 

$

220

 

$

71

 

Unrelated third party

 

Georgia

 

3

 

6/17/2010

 

7,661

 

7,551

 

 

110

 

2,769

 

4,487

 

318

 

87

 

Unrelated third party

 

Florida

 

1

 

7/15/2010

 

2,787

 

2,759

 

 

28

 

625

 

2,133

 

19

 

10

 

Unrelated third party

 

Alabama

 

2

 

8/23/2010

 

2,593

 

2,534

 

 

59

 

416

 

2,033

 

140

 

4

 

Unrelated third party

 

 

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Table of Contents

 

The Company treats property acquisitions as businesses and records the related assets and liabilities at their fair values as of the acquisition date.  Acquisition-related transaction costs are expensed as incurred.

 

6.     INVESTMENTS IN REAL ESTATE VENTURES

 

Investments in real estate ventures consisted of the following:

 

 

 

Equity

 

Excess Profit

 

Investment balance at

 

 

 

Ownership %

 

Participation %

 

September 30, 2010

 

December 31, 2009

 

 

 

 

 

 

 

 

 

 

 

Extra Space West One LLC (“ESW”)

 

5%

 

40%

 

$1,198

 

$1,175

 

Extra Space West Two LLC (“ESW II”)

 

5%

 

40%

 

4,645

 

4,749

 

Extra Space Northern Properties Six LLC (“ESNPS”)

 

10%

 

35%

 

1,184

 

1,388

 

Extra Space of Santa Monica LLC (“ESSM”)

 

48%

 

48%

 

2,919

 

2,419

 

Clarendon Storage Associates Limited Partnership (“Clarendon”)

 

50%

 

50%

 

3,210

 

3,245

 

HSRE-ESP IA, LLC (“HSRE”)

 

50%

 

50%

 

12,691

 

 

PRISA Self Storage LLC (“PRISA”)

 

2%

 

17%

 

11,510

 

11,907

 

PRISA II Self Storage LLC (“PRISA II”)

 

2%

 

17%

 

9,912

 

10,239

 

PRISA III Self Storage LLC (“PRISA III”)

 

5%

 

20%

 

3,643

 

3,793

 

VRS Self Storage LLC (“VRS”)

 

45%

 

54%

 

44,824

 

45,579

 

WCOT Self Storage LLC (“WCOT”)

 

5%

 

20%

 

4,849

 

4,983

 

Storage Portfolio I LLC (“SP I”)

 

25%

 

25-40%

 

15,095

 

16,049

 

Storage Portfolio Bravo II (“SPB II”)

 

20%

 

20-45%

 

14,828

 

15,104

 

Extra Space Joint Ventures with Everest Real Estate Fund (“Everest”)

 

10-58%

 

35-50%

 

5,517

 

1,558

 

U-Storage de Mexico S.A. and related entities (“U-Storage”)

 

40%

 

40%

 

6,140

 

6,166

 

Other minority owned properties

 

10-70%

 

10-50%

 

1,956

 

2,095

 

 

 

 

 

 

 

$144,121

 

$130,449

 

 

In these joint ventures, the Company and the joint venture partner generally receive a preferred return on their invested capital. To the extent that cash/profits in excess of these preferred returns are generated through operations or capital transactions, the Company would receive a higher percentage of the excess cash/profits than its equity interest.

 

In accordance with ASC 810, the Company reviews all of its joint venture relationships quarterly to ensure that there are no entities that require consolidation.  As of September 30, 2010, there were no previously unconsolidated entities that were required to be consolidated as a result of this review.

 

On June 15, 2010, the Company paid $193 to obtain an additional 7.2% percentage interest in ESSM, increasing the Company’s interest in the venture from 41.0% to 48.2%.

 

On June 28, 2010, the Company contributed $6,660 to ESW as a result of a capital call related to the joint venture’s repayment of its $16,650 loan.  On August 25, 2010, ESW closed on a new loan and on August 30, 2010, ESW returned $6,660 of investment capital to the Company.

 

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Table of Contents

 

The components of equity in earnings (losses) of real estate ventures consist of the following:

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

 

 

 

 

 

 

 

 

Equity in earnings of ESW

 

$

335

 

$

294

 

$

938

 

$

878

 

Equity in losses of ESW II

 

(5

)

(9

)

(20

)

(19

)

Equity in earnings of ESNPS

 

69

 

119

 

177

 

215

 

Equity in losses of ESSM

 

(26

)

(68

)

(124

)

(68

)

Equity in earnings of Clarendon

 

118

 

101

 

309

 

285

 

Equity in losses of HSRE

 

(44

)

 

(82

)

 

Equity in earnings of PRISA

 

168

 

177

 

479

 

324

 

Equity in earnings of PRISA II

 

77

 

138

 

344

 

415

 

Equity in earnings of PRISA III

 

71

 

63

 

193

 

179

 

Equity in earnings of VRS

 

583

 

517

 

1,632

 

1,569

 

Equity in earnings of WCOT

 

65

 

56

 

184

 

184

 

Equity in earnings of SP I

 

268

 

183

 

675

 

648

 

Equity in earnings of SPB II

 

53

 

27

 

135

 

260

 

Equity in earnings (losses) of Everest

 

52

 

2

 

138

 

(23

)

Equity in earnings (losses) of U-Storage

 

(31

)

(8

)

(26

)

1

 

Equity in earnings (losses) of other minority owned properties

 

(17

)

160

 

(156

)

440

 

 

 

$

1,736

 

$

1,752

 

$

4,796

 

$

5,288

 

 

Equity in earnings (losses) of ESW II, HSRE, SP I and SPB II and a minority owned property in Annapolis, Maryland includes the amortization of the Company’s excess purchase price of $26,075 of these equity investments over its original basis. The excess basis is amortized over 40 years.

 

Variable Interests in Unconsolidated Real Estate Joint Ventures:

 

The Company has interests in four unconsolidated joint ventures with unrelated third parties which are VIEs (the “VIE JVs”).  The Company holds 18-70% equity interests in the VIE JVs, and has 50% of the voting rights in each of the VIE JVs.  Qualification as a VIE was based on the determination that the equity investments at risk for each of these joint ventures was not sufficient based on a qualitative and quantitative analysis performed by the Company.  The Company performed a qualitative analysis for these joint ventures to determine which party was the primary beneficiary of each VIE.  The Company determined that since the powers to direct the activities most significant to the economic performance of these entities are shared equally by the Company and its joint venture partners, there is no primary beneficiary.  Accordingly, these interests are recorded using the equity method.

 

The VIE JVs each own a single pre-stabilized self-storage property.  These joint ventures are financed through a combination of (1) equity contributions from the Company and its joint venture partners, (2) mortgage notes payable and (3) payables to the Company.  The payables to the Company consist of amounts owed for expenses paid on behalf of the joint ventures by the Company as manager and mortgage notes payable to the Company.  The Company performs management services for the VIE JVs in exchange for a management fee of approximately 6% of cash collected by the properties.  The Company has not provided financial or other support during the periods presented to the VIE JVs that it was not previously contractually obligated to provide.

 

The Company guarantees the mortgage notes payable for the VIE JVs. The Company’s maximum exposure to loss for these joint ventures as of September 30, 2010 is the total of the guaranteed loan balances, the payables due to the Company and the Company’s investment balances in the joint ventures.  The Company believes that the risk of incurring a loss as a result of having to perform on the loan guarantees is unlikely and therefore no liability has been recorded related to these guarantees. Also, repossessing and/or selling the self-storage facility and land that collateralize the loans could provide funds sufficient to reimburse the Company. Additionally, the Company believes the payables to the Company are collectible.

 

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Table of Contents

 

The following table compares the liability balance and the maximum exposure to loss related to the VIE JVs as of September 30, 2010:

 

 

 

 

 

 

 

Balance of

 

 

 

Maximum

 

 

 

 

 

Liability

 

Investment

 

Guaranteed

 

Payables to

 

Exposure

 

 

 

 

 

Balance

 

Balance

 

Loan

 

Company

 

to Loss

 

Difference

 

Extra Space of Elk Grove

 

$

 

527

 

4,811

 

2,820

 

$

8,158

 

$

(8,158

)

ESS of Sacramento One LLC

 

 

(765

)

5,000

 

5,348

 

9,583

 

(9,583

)

ES of Washington Avenue LLC

 

 

405

 

6,129

 

2,896

 

9,430

 

(9,430

)

ES of Franklin Blvd LLC

 

 

(304

)

2,947

 

4,569

 

7,212

 

(7,212

)

 

 

$

 

$

(137

)

$

18,887

 

$

15,633

 

$

34,383

 

$

(34,383

)

 

The Company had no consolidated VIEs during the three and nine months ended September 30, 2010.

 

7.     OTHER ASSETS

 

The components of other assets are summarized as follows:

 

 

 

September 30, 2010

 

December 31, 2009

 

 

 

 

 

 

 

Equipment and fixtures

 

$

13,057

 

$

11,836

 

Less: accumulated depreciation

 

(10,065

)

(9,046

)

Other intangible assets

 

3,343

 

3,303

 

Deferred financing costs, net

 

14,065

 

15,458

 

Prepaid expenses and deposits

 

7,856

 

5,173

 

Accounts receivable, net

 

12,007

 

15,086

 

Investments in Trusts

 

3,590

 

3,590

 

Deferred tax asset

 

5,194

 

5,576

 

 

 

$

49,047

 

$

50,976

 

 

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8.     NOTES PAYABLE

 

The components of notes payable are summarized as follows:

 

 

 

September 30, 2010

 

December 31, 2009

 

Fixed Rate

 

 

 

 

 

Mortgage and construction loans with banks (inclulding loans subject to interest rate swaps) bearing interest at fixed rates between 4.2% and 7.3%. The loans are collateralized by mortgages on real estate assets and the assignment of rents. Principal and interest payments are made monthly with all outstanding principal and interest due between June 2011 and August 2019.

 

$

641,595

 

$

895,473

 

 

 

 

 

 

 

Variable Rate

 

 

 

 

 

Mortgage and construction loans with banks bearing floating interest rates based on LIBOR and Prime. Interest rates based on LIBOR are between LIBOR plus 1.5% (1.8% and 1.7% at September 30, 2010 and December 31, 2009, respectively) and LIBOR plus 4.0% (4.3% and 4.2% at September 30, 2010 and December 31, 2009, respectively). Interest rates based on Prime are between Prime plus 0.5% (3.8% at September 30, 2010 and December 31, 2009), and Prime plus 1.5% (4.8% at September 30, 2010 and December 31, 2009). The loans are collateralized by mortgages on real estate assets and the assignment of rents. Principal and interest payments are made monthly with all outstanding principal and interest due between December 2010 and May 2015.

 

210,217

 

204,120

 

 

 

 

 

 

 

 

 

$

851,812

 

$

1,099,593

 

 

Certain mortgage and construction loans with variable rate debt are subject to interest rate floors starting at 4.5%.  Real estate assets are pledged as collateral for the notes payable. Also, certain of these notes payable are cross-collateralized with other properties.  Of the Company’s $851,812 in notes payable outstanding as of September 30, 2010, $421,272 were recourse due to guarantees or other security provisions.  The Company is subject to certain restrictive covenants relating to the outstanding notes payable. The Company was in compliance with all financial covenants at September 30, 2010.

 

9.     DERIVATIVES

 

GAAP requires the recognition of all derivative instruments as either assets or liabilities on the balance sheet at fair value.  The accounting for changes in fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship.  A company must designate each qualifying hedging instrument, based upon the exposure being hedged, as a fair value hedge, cash flow hedge, or a hedge of a net investment in foreign operations.

 

The Company is exposed to certain risks relating to its ongoing business operations.  The primary risk managed by using derivative instruments is interest rate risk.  Interest rate swaps are entered into to manage interest rate risk associated with Company’s fixed and variable-rate borrowings.  The Company designates certain interest rate swaps as cash flow hedges of variable-rate borrowings and the remainder as fair value hedges of fixed-rate borrowings.

 

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The following table summarizes the terms of the Company’s derivative financial instruments at September 30, 2010:

 

Hedge Product

 

Hedge Type

 

Notional Amount

 

Strike

 

Effective Date

 

Maturity

Reverse Swap Agreement

 

Fair Value

 

$

61,770

 

Libor plus 0.65%

 

10/31/2004

 

6/1/2009

Swap Agreement 1

 

Cash Flow

 

$

63,000

 

4.24%

 

2/1/2009

 

6/30/2013

Swap Agreement 2

 

Cash Flow

 

$

26,000

 

6.32%

 

7/1/2009

 

7/1/2014

Swap Agreement 3

 

Cash Flow

 

$

8,462

 

6.98%

 

7/27/2009

 

6/27/2016

Swap Agreement 4

 

Cash Flow

 

$

10,000

 

6.12%

 

11/2/2009

 

11/1/2014

Swap Agreement 5

 

Cash Flow

 

$

20,700

 

5.80%

 

6/11/2010

 

6/1/2015

Swap Agreement 6

 

Cash Flow

 

$

48,876

 

6.10%

 

7/1/2010

 

9/1/2014

 

Monthly interest payments were recognized as an increase or decrease in interest expense as follows:

 

 

 

Classification of

 

Three months ended September 30,

 

Nine months ended September 30,

 

Type

 

Income (Expense)

 

2010

 

2009

 

2010

 

2009

 

Reverse Swap Agreement

 

Interest expense

 

$

 

$

 

$

 

$

916

 

Swap Agreement 1

 

Interest expense

 

(554

)

(307

)

(1,183

)

(609

)

Swap Agreement 2

 

Interest expense

 

(179

)

(124

)

(547

)

(124

)

Swap Agreement 3

 

Interest expense

 

(74

)

(49

)

(218

)

(49

)

Swap Agreement 4

 

Interest expense

 

(64

)

 

(196

)

 

Swap Agreement 5

 

Interest expense

 

(101

)

 

(101

)

 

Swap Agreement 6

 

Interest expense

 

(224

)

 

(224

)

 

 

 

 

 

$

(1,196

)

$

(480

)

$

(2,469

)

$

134

 

 

Information relating to the gains recognized on the swap agreements is as follows:

 

 

 

Gain (loss)

 

Location of
amounts

 

Gain (loss)
reclassified from
OCI

 

 

 

recognized in OCI

 

reclassified from

 

Nine months ended

 

Type

 

September 30, 2010

 

OCI into income

 

September 30, 2010

 

Swap Agreement 1

 

$

(2,351

)

Interest expense

 

$

(1,183

)

Swap Agreement 2

 

(1,909

)

Interest expense

 

(547

)

Swap Agreement 3

 

(957

)

Interest expense

 

(218

)

Swap Agreement 4

 

(679

)

Interest expense

 

(196

)

Swap Agreement 5

 

(1,063

)

Interest expense

 

(101

)

Swap Agreement 6

 

(2,014

)

Interest expense

 

(224

)

 

 

$

(8,973

)

 

 

$

(2,469

)

 

The Swap Agreements were highly effective for the nine months ended September 30, 2010.  The losses reclassified from other comprehensive income (“OCI”) in the preceding table represent the effective portion of the Company’s cash flow hedges reclassified from OCI to interest expense during the nine months ended September 30, 2010.

 

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The balance sheet classification and carrying amounts of the interest rate swaps are as follows:

 

 

 

Asset (Liability) Derivatives

 

 

 

September 30, 2010

 

December 31, 2009

 

Derivatives designated as hedging

 

Balance Sheet

 

Fair

 

Balance Sheet

 

Fair

 

instruments:

 

Location

 

Value

 

Location

 

Value

 

Swap Agreement 1

 

Other liabilities

 

$

(2,351

)

Other liabilities

 

$

(340

)

Swap Agreement 2

 

Other liabilities

 

(1,909

)

Other liabilities

 

(478

)

Swap Agreement 3

 

Other liabilities

 

(957

)

Other liabilities

 

(244

)

Swap Agreement 4

 

Other liabilities

 

(679

)

Other liabilities

 

(49

)

Swap Agreement 5

 

Other liabilities

 

(1,063

)

N/A

 

 

Swap Agreement 6

 

Other liabilities

 

(2,014

)

N/A

 

 

 

 

 

 

$

(8,973

)

 

 

$

(1,111

)

 

10.  NOTES PAYABLE TO TRUSTS

 

During July 2005, ESS Statutory Trust III (the “Trust III”), a newly formed Delaware statutory trust and a wholly-owned, unconsolidated subsidiary of the Operating Partnership, issued an aggregate of $40,000 of preferred securities which mature on July 31, 2035. In addition, the Trust III issued 1,238 of Trust common securities to the Operating Partnership for a purchase price of $1,238. On July 27, 2005, the proceeds from the sale of the preferred and common securities of $41,238 were loaned in the form of a note to the Operating Partnership (“Note 3”). Note 3 had a fixed rate of 6.91% through July 31, 2010, and is now payable at a variable rate equal to the three-month LIBOR plus 2.40% per annum. The interest on Note 3, payable quarterly, will be used by the Trust III to pay dividends on the trust preferred securities. The trust preferred securities became redeemable by the Trust with no prepayment premium on July 27, 2010.

 

During May 2005, ESS Statutory Trust II (the “Trust II”), a newly formed Delaware statutory trust and a wholly-owned, unconsolidated subsidiary of the Operating Partnership, issued an aggregate of $41,000 of preferred securities which mature on June 30, 2035. In addition, the Trust II issued 1,269 of Trust common securities to the Operating Partnership for a purchase price of $1,269. On May 24, 2005, the proceeds from the sale of the preferred and common securities of $42,269 were loaned in the form of a note to the Operating Partnership (“Note 2”). Note 2 had a fixed rate of 6.67% through June 30, 2010, and is now payable at a variable rate equal to the three-month LIBOR plus 2.40% per annum. The interest on Note 2, payable quarterly, will be used by the Trust II to pay dividends on the trust preferred securities. The trust preferred securities became redeemable by the Trust with no prepayment premium on June 30, 2010.

 

During April 2005, ESS Statutory Trust I (the “Trust”), a newly formed Delaware statutory trust and a wholly-owned, unconsolidated subsidiary of the Operating Partnership issued an aggregate of $35,000 of trust preferred securities which mature on June 30, 2035. In addition, the Trust issued 1,083 of trust common securities to the Operating Partnership for a purchase price of $1,083. On April 8, 2005, the proceeds from the sale of the trust preferred and common securities of $36,083 were loaned in the form of a note to the Operating Partnership (the “Note”). The Note has a variable rate equal to the three-month LIBOR plus 2.25% per annum. Effective June 30, 2010, the Trust entered into an interest rate swap that fixes the interest rate to be paid at 5.62% and matures on June 30, 2015.  The interest on the Note, payable quarterly, will be used by the Trust to pay dividends on the trust preferred securities. The trust preferred securities became redeemable by the Trust with no prepayment premium on June 30, 2010.

 

The Trust, Trust II and Trust III are VIEs because the holders of the equity investment at risk (the trust preferred securities) do not have the power to direct the activities of the entities that most significantly affect the entities’ economic performance because of their lack of voting or similar rights.  Because the Operating Partnership’s investment in the trusts’ common securities was financed directly by the trusts as a result of its loan of the proceeds to the Operating Partnership, that investment is not considered to be an equity investment at risk.  The Operating Partnership’s investment in the trusts is not a variable interest because equity interests are variable interests only to the extent that the investment is considered to be at risk, and therefore the Operating Partnership cannot be the primary beneficiary of the trusts.  Since the Company is not the primary beneficiary of the trusts, they have not been consolidated.  A debt obligation has been recorded in the form of notes as discussed above for the proceeds, which are owed to the Trust, Trust II and Trust III by the Company.  The Company has also recorded its investment in the trusts’ common securities as other assets.

 

The Company has not provided financing or other support during the periods presented to the trusts that it was not previously contractually obligated to provide.  The Company’s maximum exposure to loss as a result of its involvement with the trusts is equal to the total amount of the notes discussed above less the amounts of the Company’s investments in the trusts’ common securities.  The net amount is the notes payable that the trusts owe to third parties for their investments in the trusts’ preferred securities.

 

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Following is a tabular comparison of the liabilities the Company has recorded as a result of its involvement with the trusts and the maximum exposure to loss the Company is subject to related to the trusts as of September 30, 2010:

 

 

 

Notes payable

 

 

 

 

 

 

 

to Trusts as of

 

Maximum

 

 

 

 

 

September 30, 2010

 

exposure to loss

 

Difference

 

Trust

 

$

36,083

 

$

35,000

 

$

1,083

 

Trust II

 

42,269

 

41,000

 

1,269

 

Trust III

 

41,238

 

40,000

 

1,238

 

 

 

$

119,590

 

$

116,000

 

$

3,590

 

 

As noted above, these differences represent the amounts that the trusts would repay the Company for its investment in the trusts’ common securities.

 

11.  EXCHANGEABLE SENIOR NOTES

 

On March 27, 2007, the Company’s Operating Partnership issued $250,000 of its 3.625% Exchangeable Senior Notes due April 1, 2027 (the “Notes”). Costs incurred to issue the Notes were approximately $5,700. The remaining portion of these costs are being amortized over five years, which represents the estimated term of the Notes, and are included in other assets in the condensed consolidated balance sheet as of September 30, 2010. The Notes are general unsecured senior obligations of the Operating Partnership and are fully guaranteed by the Company. Interest is payable on April 1 and October 1 of each year until the maturity date of April 1, 2027. The Notes bear interest at 3.625% per annum and contain an exchange settlement feature, which provides that the Notes may, under certain circumstances, be exchangeable for cash (up to the principal amount of the Notes) and, with respect to any excess exchange value, for cash, shares of common stock or a combination of cash and shares of common stock at an exchange rate of approximately 42.6491 shares per one thousand dollars principal amount of Notes at the option of the Operating Partnership.

 

The Operating Partnership may redeem the Notes at any time to preserve the Company’s status as a REIT. In addition, on or after April 5, 2012, the Operating Partnership may redeem the Notes for cash, in whole or in part, at 100% of the principal amount plus accrued and unpaid interest, upon at least 30 days, but not more than 60 days, prior written notice to holders of the Notes.

 

The holders of the Notes have the right to require the Operating Partnership to repurchase the Notes for cash, in whole or in part, on each of April 1, 2012, April 1, 2017 and April 1, 2022, and upon the occurrence of a designated event, in each case for a repurchase price equal to 100% of the principal amount of the Notes plus accrued and unpaid interest. Certain events are considered “Events of Default,” as defined in the indenture governing the Notes, which may result in the accelerated maturity of the Notes.

 

GAAP requires entities with convertible debt instruments that may be settled entirely or partially in cash upon conversion to separately account for the liability and equity components of the instrument in a manner that reflects the issuer’s economic interest cost.  The Company therefore accounts for the liability and equity components of the Notes separately.  The equity component is included in the paid-in-capital section of stockholders’ equity on the condensed consolidated balance sheet, and the value of the equity component is treated as original issue discount for purposes of accounting for the debt component.  The discount is being amortized over the period of the debt as additional interest expense.

 

Information about the carrying amounts of the equity component, the principal amount of the liability component, its unamortized discount, and its net carrying amount are as follows:

 

 

 

September 30, 2010

 

December 31, 2009

 

Carrying amount of equity component

 

$

19,545

 

$

19,545

 

 

 

 

 

 

 

Principal amount of liability component

 

$

87,663

 

$

87,663

 

Unamortized discount

 

(2,633

)

(3,869

)

Net carrying amount of liability component

 

$

85,030

 

$

83,794

 

 

The discount will be amortized over the remaining period of the debt through its first redemption date of April 1, 2012.  The effective interest rate on the liability component is 5.75%.

 

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Table of Contents

 

The amount of interest cost recognized relating to the contractual interest rate and the amortization of the discount on the liability component is as follows:

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Contractual interest

 

$

801

 

$

870

 

$

2,377

 

$

3,723

 

Amortization of discount

 

416

 

430

 

1,236

 

1,834

 

Total interest expense recognized

 

$

1,217

 

$

1,300

 

$

3,613

 

$

5,557

 

 

Repurchases of Notes

 

The Company has repurchased a portion of its Notes.  The Company allocated the value of the consideration paid to repurchase the Notes (1) to the extinguishment of the liability component and (2) the reacquisition of the equity component.  The amount allocated to the extinguishment of the liability component is equal to the fair value of that component immediately prior to extinguishment.  The difference between the consideration attributed to the extinguishment of the liability component and the sum of (a) the net carrying amount of the repurchased liability component, and (b) the related unamortized debt issuance costs is recognized as a gain on debt extinguishment.  The remaining settlement consideration is allocated to the reacquisition of the equity component of the repurchased Notes, and recognized as a reduction of stockholders’ equity.

 

Information on the repurchases made during the nine months ended September 30, 2009 and the related gains is as follows:

 

 

 

May 2009

 

March 2009

 

 

 

 

 

 

 

Principal amount repurchased

 

$

43,000

 

$

71,500

 

Amount allocated to:

 

 

 

 

 

Extinguishment of liability component

 

$

35,000

 

$

43,800

 

Reacquisition of equity component

 

1,340

 

713

 

Total cash paid for repurchase

 

$

36,340

 

$

44,513

 

 

 

 

 

 

 

Exchangeable senior notes repurchased

 

$

43,000

 

$

71,500

 

Extinguishment of liability component

 

(35,000

)

(43,800

)

Discount on exchangeable senior notes

 

(2,349

)

(4,208

)

Related debt issuance costs

 

(558

)

(1,009

)

Gain on repurchase

 

$

5,093

 

$

22,483

 

 

There were no repurchases made during the nine months ended September 30, 2010.

 

12.  LINES OF CREDIT

 

On June 4, 2010, a subsidiary of the Company entered into a $45,000 revolving secured line of credit (the “Third Credit Line”) that is collateralized by mortgages on certain lease-up real estate assets and matures on May 31, 2013 with a two-year extension option available.  The Company intends to use the proceeds of the Third Credit Line to repay debt and for general corporate purposes.  The Third Credit Line has an interest rate of LIBOR plus 350 basis points (3.8% at September 30, 2010).  The Third Credit Line is guaranteed by the Company.  As of September 30, 2010, the Third Credit Line had $25,467 of capacity based on the lease-up of the assets collateralizing the Third Credit Line.  At September 30, 2010, $10,000 was drawn on the Third Credit Line.

 

On February 13, 2009, a subsidiary of the Company entered into a $50,000 revolving secured line of credit (the “Secondary Credit Line”) that is collateralized by mortgages on certain real estate assets and matures on February 13, 2013 with an option to extend one additional year.  The Company intends to use the proceeds of the Secondary Credit Line to repay debt and for general corporate purposes.  The Secondary Credit Line has an interest rate of LIBOR plus 350 basis points (3.8% at September 30, 2010 and 3.7% at December 31, 2009).  As of September 30, 2010 and December 31, 2009, there was $5,000 and $0, respectively, drawn on the Secondary Credit Line.  The Secondary Credit Line is guaranteed by the Company.

 

On October 16, 2007, a subsidiary entered into a $100,000 revolving secured line of credit (the “Credit Line” and together with the Secondary Credit Line and the Third Credit Line, the “Credit Lines”) that matures on October 31, 2010 with two one-year extensions available. As of September 30, 2010 and December 31, 2009, $100,000 was drawn on the Credit Line.  The Company intends to use

 

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the proceeds of the Credit Line to repay debt and for general corporate purposes.  The Credit Line has an interest rate of between 100 and 205 basis points over LIBOR, depending on certain financial ratios of the Company (1.3% at September 30, 2010 and 1.2% at December 31, 2009).  The Credit Line is collateralized by mortgages on certain real estate assets.  As of September 30, 2010, the Credit Line had $100,000 of capacity based on the assets collateralizing the Credit Line.

 

13.       OTHER LIABILITIES

 

The components of other liabilities are summarized as follows:

 

 

 

September 30, 2010

 

December 31, 2009

 

 

 

 

 

 

 

Deferred rental income

 

$

11,655

 

$

12,045

 

Lease obligation liability

 

7,287

 

6,260

 

Fair value of interest rate swaps

 

8,973

 

1,111