Easterly Government Properties, Inc. — 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. This is an annual report, not a standalone fourth-quarter filing. Amounts below are U.S. dollars.
Business context
Easterly is an internally managed REIT focused on owning, developing and managing Class A commercial properties leased primarily to U.S. Government agencies. At year-end, it owned 46 operating properties, all reported 100% leased, totaling approximately 3.7 million square feet, plus three properties under development. Government tenants represented 98.7% of annualized lease income; weighted-average remaining lease term was 7.0 years.
Key financial metrics
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Total revenue | $130.7 million | $104.6 million | Up $26.1 million, or 24.9% |
| Operating income | $22.8 million | $13.7 million | Up $9.1 million |
| Net income | $5.4 million | $5.5 million | Down $0.1 million |
| Net income attributable to Easterly | $4.4 million | $4.0 million | Up $0.5 million |
| Diluted EPS | $0.10 | $0.12 | Down $0.02 |
| FFO / FFO, as Adjusted | $60.6 million / $54.8 million | $51.4 million / $49.6 million | Up 17.9% / 10.5% |
Revenue growth principally reflected four operating properties acquired after year-end 2016 and a full year of contribution from seven properties acquired in 2016. Expenses rose 18.7%, including higher property costs, taxes and depreciation; interest expense more than doubled to $17.1 million, reflecting new debt. Approximate operating margin increased to 17.4% from 13.1%; approximate net margin declined to 4.1% from 5.3%.
Operating cash flow was $49.2 million, compared with $47.4 million. Investing activities used $397.7 million, mainly for acquisitions and development; financing activities provided $356.4 million. Year-end cash and cash equivalents were $12.7 million, with $300.2 million available on the revolving credit facility. Total assets were $1.425 billion and total equity was $791.1 million.
Year-end debt principal was approximately $579.7 million (reported debt, net of financing costs and other adjustments, was $575.9 million). Debt comprised $204.9 million of mortgages, $99.8 million drawn on the revolver, a $100 million term loan and $175 million of unsecured notes. Weighted-average interest rate was 3.6%; 80.1% was fixed-rate and 19.9% variable-rate. Weighted-average debt maturity was 7.8 years. The company reported compliance with applicable debt covenants.
Dividends declared for 2017 were $1.02 per share across the four quarterly declarations. The company issued common shares through an underwritten offering and its ATM program during the year.
Material changes and unusual items
- Debt increased from $293.0 million at year-end 2016 to $579.7 million in principal, largely due to the $175 million unsecured note issuance, $100 million term-loan draw and $127.5 million mortgage secured by VA–Loma Linda.
- Four operating properties were acquired for an aggregate purchase price of $385.3 million; two properties under development were also acquired. One property was sold for net proceeds of $10.5 million, with a $0.3 million loss.
- The company revised prior-period financial statements for an error in useful-life estimates for assets associated with three IPO-contributed properties. It said the error was not material to previously issued statements; the revision reduced depreciation expense and increased reported 2016 net income by $0.8 million and 2015 net income by $0.7 million.
- Reported EPS declined despite higher attributable net income, alongside substantial growth in weighted-average common shares outstanding. FFO and adjusted FFO are supplemental non-GAAP measures and are not measures of cash flow or liquidity.
Outlook, risks and contingencies
Management stated that cash, operating cash flow and available borrowing capacity were expected to cover anticipated uses for the next 12 months, including debt service, tenant improvements and REIT distributions. No formal earnings or acquisition guidance was provided in the filing. Three development projects—FDA–Alameda, FDA–Lenexa and FEMA–Tracy—were expected to add approximately 333,000 square feet; the filing identifies construction, cost, timing and financing risks.
- Tenant and lease concentration: Government agencies account for nearly all rental income; the FBI, VA and DEA together represented approximately 50.2% of annualized lease income. Six tenants had exercisable early-termination rights affecting 12.8% of rentable area and 11.4% of annualized lease income. Leases representing 27.9% of annualized lease income were scheduled to expire by the end of 2020.
- Geographic concentration: California accounted for 33.3% of annualized lease income. The company cited exposure to local market conditions and earthquakes, wildfires and other natural disasters.
- Financing: The revolving credit facility matures in February 2019, subject to extension options. Variable-rate debt, refinancing costs, covenant compliance and access to capital markets could affect cash flow and distributions. A 25-basis-point change in variable rates was estimated to affect annual interest expense by about $0.3 million.
- REIT and tax matters: The company must meet REIT qualification and distribution tests. It noted uncertainty about the effects of the Tax Cuts and Jobs Act enacted in December 2017, including interest-deduction limits and REIT dividend tax treatment.
- The filing discusses real-estate development, competition, insurance, environmental, cybersecurity and other risks. Easterly reported no material litigation and no material off-balance-sheet arrangements; it was not aware of environmental liabilities expected to have a material adverse effect.
Important facts for investors to verify
- Confirm the revised prior-year figures and the effect of the depreciation useful-life correction on reported earnings and asset values.
- Review the 2019 revolver maturity, available capacity, debt covenants, interest-rate exposure and refinancing plans.
- Assess renewal and early-termination exposure, particularly near-term lease expirations and concentration among the FBI, VA and DEA.
- Monitor construction progress, costs and lease commencement for the three development properties.
- Evaluate dividend coverage against operating cash flow, required REIT distributions, debt service and continuing reliance on external financing.