Equity Commonwealth (EQC) 10-Q2023 Q2 Quarterly report

References in this Quarterly Report on Form 10-Q to the “Company,” “EQC,” “we,” “us” or “our,” refer to Equity Commonwealth and its consolidated subsidiaries as of June 30, 2023, unless the context indicates otherwise.

See accompanying notes.

The Company operates in an umbrella partnership real estate investment trust, or UPREIT, and conducts substantially all of its activities through EQC Operating Trust, a Maryland real estate investment trust, or the Operating Trust. The Company beneficially owned 99.67% of the outstanding shares of beneficial interest, designated as units, in the Operating Trust, or OP Units, as of June 30, 2023, and the Company is the sole trustee of the Operating Trust.  As the sole trustee, the Company generally has the power under the declaration of trust of the Operating Trust to manage and conduct the business of the Operating Trust, subject to certain limited approval and voting rights of other holders of OP Units.

The accompanying condensed consolidated financial statements of EQC have been prepared without audit.  Certain information and footnote disclosures required by U.S. generally accepted accounting principles, or GAAP, for complete financial statements have been condensed or omitted.  We believe the disclosures made are appropriate.  The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes contained in our Annual Report on Form 10-K, or our Annual Report, for the year ended December 31, 2022.  Capitalized terms used, but not defined in this Quarterly Report, have the same meanings as in our Annual Report.

In the opinion of our management, all adjustments, which include only normal recurring adjustments considered necessary for a fair presentation, have been included.  All intercompany transactions and balances with or among our subsidiaries have been eliminated.  Operating results for interim periods are not necessarily indicative of the results that may be expected for the full year.  Certain reclassifications have been made to the prior year’s financial statements to conform to the current year’s presentation.

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect reported amounts.  Actual results could differ from those estimates.  Significant estimates in the condensed consolidated financial statements include the assessment of the collectability of rental revenue, purchase price allocations, useful lives of fixed assets and impairment of real estate and intangible assets.

Dollar amounts presented may be approximate. Share amounts are presented in whole numbers, except where noted.

During the six months ended June 30, 2023 and 2022, we made improvements, excluding tenant-funded improvements, to our properties totaling $3.8 million and $2.3 million, respectively.

We did not sell any properties during the six months ended June 30, 2023 or 2022.

See Note 7 for information regarding equity issuances related to share-based compensation.

On March 15, 2022, our Board of Trustees authorized the repurchase of up to $150.0 million of our outstanding common shares through June 30, 2023. We did not repurchase any common shares under our share repurchase program during the six months ended June 30, 2023. As of June 30, 2023, we had $120.4 million of remaining availability under our share repurchase program, which expired on June 30, 2023. On June 13, 2023, our Board of Trustees authorized the repurchase of up to $150.0 million of our outstanding common shares from July 1, 2023 through June 30, 2024.

During the six months ended June 30, 2023 and 2022, certain of our employees and former employees surrendered 134,193 and 160,506 common shares owned by them, respectively, to satisfy their statutory tax withholding obligations in connection with the vesting of such common shares pursuant to our equity compensation plans.

On February 13, 2023, our Board of Trustees declared a special, one-time cash distribution of $4.25 per common share/unit to shareholders/unitholders of record on February 23, 2023. On March 9, 2023, we paid this distribution to such shareholders/unitholders in the aggregate amount of $468.3 million.

In February 2023, the number of earned awards for recipients of the Company’s restricted stock units and market-based LTIP units granted in January 2020 was determined. Pursuant to the terms of such awards, we paid one-time catch-up cash distributions to these recipients in the aggregate amount of $1.8 million, for distributions to common shareholders and unitholders declared by our Board of Trustees during such awards’ performance measurement period.

Our series D preferred shares are convertible, at the holder’s option, into our common shares at a conversion rate of 0.8204 common shares per series D preferred share, which is equivalent to a conversion price of $30.47 per common share, or 4,032,427 additional common shares at June 30, 2023. The conversion rate changed from 0.6846 to 0.8204 common shares per series D preferred share effective February 24, 2023 as a result of the common share distribution declared by our Board of Trustees in 2023.

Noncontrolling interest represents the portion of the OP Units not beneficially owned by the Company. The ownership of an OP Unit and a common share of beneficial interest have essentially the same economic characteristics. Distributions with respect to OP Units will generally mirror distributions with respect to the Company’s common shares. Unitholders (other than the Company) generally have the right, commencing six months from the date of issuance of such OP Units, to cause the Operating Trust to redeem their OP Units in exchange for cash or, at the option of the Company, common shares of the Company on a one-for-one basis. As sole trustee, the Company has the sole discretion to elect whether the redemption right will be satisfied by the Company in cash or the Company’s common shares. As a result, the Noncontrolling interest is classified as permanent equity. As of June 30, 2023, the portion of the Operating Trust not beneficially owned by the Company is in the form of OP Units and LTIP Units (see Note 7 for a description of LTIP Units). LTIP Units may be subject to additional vesting requirements.

The carrying value of the Noncontrolling interest is allocated based on the number of OP Units and LTIP Units in proportion to the number of OP Units and LTIP Units plus the number of common shares. We adjust the Noncontrolling interest balance at the end of each period to reflect the noncontrolling partners’ interest in the net assets of the Operating Trust. Net income is allocated to the Noncontrolling interest in the Operating Trust based on the weighted average ownership percentage during the period. Equity Commonwealth’s weighted average ownership interest in the Operating Trust was 99.68% and 99.69% for the three and six months ended June 30, 2023, respectively.

We have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended, and are generally not subject to federal and state income taxes provided we distribute a sufficient amount of our taxable income to our shareholders and meet other requirements for qualifying as a REIT.  However, we are subject to certain state and local taxes without regard to our REIT status.

At our annual meeting of shareholders on June 13, 2023, our shareholders approved an amendment to the Equity Commonwealth 2015 Omnibus Incentive Plan to increase the number of common shares of beneficial interest authorized thereunder by 1,650,000.

Recipients of the Company’s restricted shares have the same voting rights as any other common shareholder. During the period of restriction, holders of unvested restricted shares are eligible to receive dividend payments on their shares at the same rate and on the same date as any other common shareholder.  The restricted shares are service based awards and vest over a service period determined by the Compensation Committee of our Board of Trustees, or the Compensation Committee.

Recipients of the Company’s restricted stock units, or RSUs, are entitled to receive dividends with respect to the common shares underlying the RSUs if and when the RSUs are earned, at which time the recipient will be entitled to receive an amount in cash equal to the aggregate amount of cash dividends that would have been paid in respect to the common shares underlying the recipient’s earned RSUs had such common shares been issued to the recipient on the first day of the performance period. To the extent that an award does not vest, the dividends related to unvested RSUs will be forfeited. The RSUs are market-based awards with a service condition and recipients may earn RSUs based on the Company’s total shareholder return, or TSR, relative to the TSRs of the companies that comprise the Nareit Office Index over a three-year performance period. Following the end of the three-year performance period, the number of earned awards will be determined. The earned awards vest in two tranches with 50% of the earned award vesting following the end of the performance period on the date the Compensation Committee determines the level of achievement of the performance metric and the remaining 50% of the earned award vesting approximately one year thereafter, subject to the grant recipient’s continued employment. Compensation expense for the RSUs is determined using a Monte Carlo simulation model and is recognized ratably from the grant date to the vesting date of each tranche.

During the three months ended June 30, 2023 and 2022, we recorded $8.0 million and $3.0 million, respectively, and during the six months ended June 30, 2023 and 2022, we recorded $11.0 million and $6.2 million, respectively, of compensation expense, net of forfeitures, in general and administrative expense for grants to our trustees, employees and an eligible consultant related to our equity compensation plans. Compensation expense recorded during the three months ended June 30, 2023 and 2022 includes $5.2 million and $0.1 million, respectively, of accelerated vesting due to the passing of our former Chairman in 2023 and staffing reductions in 2022. Compensation expense recorded during the six months ended June 30, 2023 and 2022 includes $5.2 million and $0.4 million, respectively, of accelerated vesting due to the passing of our

As of June 30, 2023, we do not have any assets or liabilities measured at fair value.

Our financial instruments include our cash and cash equivalents.  At June 30, 2023 and December 31, 2022, the fair value of these financial instruments was not different from their carrying values.

 

Other financial instruments that potentially subject us to concentrations of credit risk consist principally of rents receivable. As of June 30, 2023, no single tenant of ours is responsible for more than 10% of our consolidated revenues.

(1) The three months ended June 30, 2023 and 2022, include 131 and 86 weighted-average, unvested, earned RSUs, respectively, and the six months ended June 30, 2023 and 2022, include 122 and 124 weighted-average, unvested, earned RSUs, respectively.

(2) Represents the weighted-average number of common shares that would have been issued if the quarter-end was the measurement date for unvested, unearned RSUs.

(3) Represents the weighted-average dilutive shares issuable from market-based LTIP Units if the quarter-end was the measurement date for the periods shown.

(4) These securities are excluded from the diluted earnings per share calculation for one or more of the periods presented because including them results in anti-dilution.

(5) Beneficial interests in the Operating Trust.

Our primary business is the ownership and operation of office properties, and we currently have one reportable segment.  One hundred percent of our revenues for the six months ended June 30, 2023 were from office properties. 

The following discussion includes a description of our related person transactions for the six months ended June 30, 2023 and 2022.

We lease office space for our corporate headquarters from Two North Riverside Plaza Joint Venture Limited Partnership, an entity associated with Equity Group Investments (“EGI”), a private entrepreneurial investment firm founded by Sam Zell, our former Chairman who passed away on May 18, 2023. Messrs. Helfand and Weinberg continue to be advisors to EGI and certain other members of our team are expected to continue to have limited involvement in its activities.

In December 2021, we entered into a second amendment to a July 20, 2015 lease with Two North Riverside Plaza Joint Venture Limited Partnership to occupy office space on the twentieth and twenty-first floors of Two North Riverside Plaza in Chicago, Illinois (20th/21st Floor Office Lease). The second amendment extended the lease term for one year, through December 31, 2022, with no renewal options. The lease payment for the second extended term was $0.4 million. In December 2022, we entered into a third amendment to the 20th/21st Floor Office Lease extending the lease term for one year, through December 31, 2023, with no renewal options. The lease payment for the third extended term is $0.4 million.

During the three months ended June 30, 2023 and 2022, we recognized expense of $0.1 million and $0.1 million, respectively, and during the six months ended June 30, 2023 and 2022, we recognized expense of $0.2 million and $0.2 million, respectively, pursuant to the 20th/21st Floor Office Lease. As of December 31, 2022 and June 30, 2023, we did not have any amounts due to Two North Riverside Plaza Joint Venture Limited Partnership pursuant to the 20th/21st Floor Office Lease.

Preferred Share Distribution

On July 13, 2023, our Board of Trustees declared a dividend of $0.40625 per series D preferred share, which will be paid on August 15, 2023 to shareholders of record on July 31, 2023.

The following discussion should be read in conjunction with our consolidated financial statements and accompanying notes included in this Quarterly Report on Form 10-Q, and in our Annual Report.

Some of the statements contained in this Quarterly Report on Form 10-Q constitute forward-looking statements within the meaning of the federal securities laws including, but not limited to, statements pertaining to our anticipated business strategies, goals, policies and objectives, capital resources and financing, portfolio performance, lease expiration schedules, results of operations or anticipated market conditions, including our statements regarding remote working trends and the overall impact of COVID-19, and changing laws, statutes, regulations, and the interpretations thereof, on the foregoing. Any forward-looking statements contained in this Quarterly Report on Form 10-Q are intended to be made pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. 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. You can identify forward-looking statements by the use of forward-looking terminology, including but not limited to, “may,” “will,” “should,” “could,” “would,” “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. You can also identify forward-looking statements by discussions of strategy, plans or intentions.

 

Any forward-looking statements contained in this Quarterly Report on Form 10-Q reflect our current views about future events and are subject to numerous known and unknown risks, uncertainties, assumptions and changes in circumstances that may cause our actual results to differ significantly from those expressed in any forward-looking statement. We do not guarantee that the transactions and events described will happen as described (or that they will happen at all). We disclaim any obligation to publicly update or revise any forward-looking statement to reflect changes in underlying assumptions or factors, of new information, data or methods, future events or other changes. For a further discussion of these and other factors that could cause our future results to differ materially from any forward-looking statements, see the section entitled “Risk Factors” in our most recent Annual Report and in Part II, Item 1A “Risk Factors” of this Quarterly Report on Form 10-Q.

We are an internally managed and self-advised REIT primarily engaged in the ownership and operation of office properties in the United States. We were formed in 1986 under Maryland law. The Company operates as an UPREIT, conducting substantially all of its activities through the Operating Trust. As of June 30, 2023, the Company beneficially owned 99.67% of the outstanding OP Units.

At June 30, 2023, our portfolio consisted of four properties (eight buildings), with a combined 1.5 million square feet, and we had $2.2 billion of cash and cash equivalents.

We use leasing and occupancy metrics to evaluate the performance of our properties. We believe these metrics provide useful information to investors because they reflect the leasing activity and vacant space at the properties and may facilitate comparisons of our leasing and occupancy metrics with other REITs and real estate companies.

As of June 30, 2023, our overall portfolio was 82.0% leased. During the three months ended June 30, 2023, we entered into leases for 68,000 square feet, including lease renewals for 54,000 square feet and a new lease for 14,000 square feet. The renewal leases entered into during the three months ended June 30, 2023 had cash and GAAP rental rates that were approximately 0.7% lower and 15.3% higher, respectively, compared to prior rental rates for the same space. The new lease entered into during the three months ended June 30, 2023 was excluded from the weighted average cash and GAAP rental rate calculations because the suite was vacant longer than two years. The change in GAAP rents is different than the change in cash rents due to differences in the amount of rent abatements, the magnitude and timing of contractual rent increases over the lease term, and the length of term for the newly executed leases compared to the prior leases. Percent change in GAAP and cash rents is a comparison of current rent, including estimated tenant expense reimbursements, if any, to the rent, including actual/projected tenant expense reimbursements, if any, last received for the same space on a GAAP and cash basis, respectively. Cash rent during the reporting period is calculated before deducting any initial period free rent.

On February 13, 2023, our Board of Trustees declared a special, one-time cash distribution of $4.25 per common share/unit to shareholders/unitholders of record on February 23, 2023. On March 9, 2023, we paid this distribution to such shareholders/unitholders in the aggregate amount of $468.3 million.

We have engaged CBRE, Inc., or CBRE, to provide property management services. We pay CBRE a property-by-property management fee and may engage CBRE from time-to-time to perform project management services, such as coordinating and overseeing the completion of tenant improvements and other capital projects at the properties. We reimburse CBRE for certain expenses incurred in the performance of its duties, including certain personnel and equipment costs. For the three months ended June 30, 2023 and 2022, we incurred expenses of $0.7 million and $0.7 million, respectively, and for the six months ended June 30, 2023 and 2022, we incurred expenses of $1.5 million and $1.5 million, respectively, related to our property management agreement with CBRE, for property management fees, typically calculated as a percentage of the properties’ revenues, and salary and benefits reimbursements for property personnel, such as property managers, engineers and maintenance staff.  As of June 30, 2023 and December 31, 2022, we had amounts payable pursuant to these services of $0.3 million and $0.4 million, respectively.

We are focusing our efforts on capital allocation as we continue to evaluate investment opportunities. We are seeking to use the strength and liquidity of our balance sheet for investments in high-quality assets or businesses in a range of property types that offer a compelling risk-reward profile. We may also determine to sell, liquidate or otherwise exit our business if we believe doing so will maximize shareholder value.

Our business has been and is continuing to be impacted by economic uncertainty and an overall slowdown in the office leasing market following the COVID-19 virus due to a variety of factors, including tenant uncertainty regarding office space needs given the evolving remote and hybrid working trends and other factors impacting the demand for office space. Many of our employees and the majority of our tenants’ employees are currently working at least in part remotely. Overall, our business has experienced a significant reduction in leasing interest and activity as well as parking revenue when compared to pre-pandemic levels. As of June 30, 2023 and December 31, 2019, our comparable property portfolio was 82.0% and 91.5% leased, respectively. The duration of these business disruptions continues to be unknown at this time, and we currently are not able to estimate the full impact of the overall slowdown in the office leasing market on our business.

Property Operations

The weighted average lease term based on square feet for leases entered into during the three months ended June 30, 2023 was 4.9 years.  Commitments made for leasing expenditures and concessions, such as tenant improvements and leasing commissions, for the leases entered into during the three months ended June 30, 2023 totaled $3.0 million, or $43.44 per square foot on average (approximately $8.92 per square foot per year of the lease term).

 

As of June 30, 2023, approximately 3.8% of our leased square feet and 3.9% of our annualized rental revenue, determined as set forth below, are included in leases scheduled to expire through December 31, 2023.  Renewal and new leases and rental rates at which available space may be relet in the future will depend on prevailing market conditions at the times these leases are negotiated.  We believe that the in-place cash rents for leases expiring for the remainder of 2023, that have not been backfilled, are slightly above market. Lease expirations by year, as of June 30, 2023, are as follows (square feet and dollars in thousands):