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Section 1: 10-Q (10-Q)

Document
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 March 31, 2019

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 1-12993

ALEXANDRIA REAL ESTATE EQUITIES, INC.
(Exact name of registrant as specified in its charter)
Maryland
 
95-4502084
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer Identification Number)
 385 East Colorado Boulevard, Suite 299, Pasadena, California 91101
(Address of principal executive offices) (Zip code)

(626) 578-0777
(Registrant’s telephone number, including area code)

N/A
(Former name, former address and former fiscal year, if changed since last report)

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 every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T 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,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
 
Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

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

As of April 15, 2019, 112,935,703 shares of common stock, par value $0.01 per share, were outstanding.



TABLE OF CONTENTS

 
 
Page
 
 
 
 
 
 
 
 
 
Consolidated Balance Sheets as of March 31, 2019, and December 31, 2018
 
 
 
 
Consolidated Statements of Income for the Three Months Ended March 31, 2019 and 2018
 
 
 
 
Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2019 and 2018
 
 
 
 
Consolidated Statements of Changes in Stockholders’ Equity and Noncontrolling Interests for the Three Months Ended March 31, 2019 and 2018
 
 
 
 
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2019 and 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


i





GLOSSARY

The following abbreviations or acronyms that may be used in this document shall have the adjacent meanings set forth below:

ASU
Accounting Standards Update
ATM
At the Market
BPS
Basis Points
CIP
Construction in Progress
EPS
Earnings per Share
FASB
Financial Accounting Standards Board
FFO
Funds From Operations
GAAP
U.S. Generally Accepted Accounting Principles
HVAC
Heating, Ventilation, and Air Conditioning
JV
Joint Venture
LEED®
Leadership in Energy and Environmental Design
LIBOR
London Interbank Offered Rate
Nareit
National Association of Real Estate Investment Trusts
NAV
Net Asset Value
REIT
Real Estate Investment Trust
RSF
Rentable Square Feet/Foot
SEC
Securities and Exchange Commission
SF
Square Feet/Foot
SoMa
South of Market (submarket of the San Francisco market)
U.S.
United States
VIE
Variable Interest Entity



ii





PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)

Alexandria Real Estate Equities, Inc.
Consolidated Balance Sheets
(In thousands)
(Unaudited)
 
March 31, 2019
 
December 31, 2018
Assets
 
 
 
Investments in real estate
$
12,410,350

 
$
11,913,693

Investments in unconsolidated real estate joint ventures
290,405

 
237,507

Cash and cash equivalents
261,372

 
234,181

Restricted cash
54,433

 
37,949

Tenant receivables
9,645

 
9,798

Deferred rent
558,103

 
530,237

Deferred leasing costs
241,268

 
239,070

Investments
1,000,904

 
892,264

Other assets
653,726

 
370,257

Total assets
$
15,480,206

 
$
14,464,956

 
 
 
 
Liabilities, Noncontrolling Interests, and Equity
 
 
 
Secured notes payable
$
356,461

 
$
630,547

Unsecured senior notes payable
5,139,500

 
4,292,293

Unsecured senior line of credit

 
208,000

Unsecured senior bank term loan
347,542

 
347,415

Accounts payable, accrued expenses, and tenant security deposits
1,171,377

 
981,707

Dividends payable
110,412

 
110,280

Total liabilities
7,125,292

 
6,570,242

 
 
 
 
Commitments and contingencies


 


 
 
 
 
Redeemable noncontrolling interests
10,889

 
10,786

 
 
 
 
Alexandria Real Estate Equities, Inc.’s stockholders’ equity:
 
 
 
7.00% Series D cumulative convertible preferred stock
57,461

 
64,336

Common stock
1,112

 
1,110

Additional paid-in capital
7,518,716

 
7,286,954

Accumulated other comprehensive loss
(10,712
)
 
(10,435
)
Alexandria Real Estate Equities, Inc.’s stockholders’ equity
7,566,577

 
7,341,965

Noncontrolling interests
777,448

 
541,963

Total equity
8,344,025

 
7,883,928

Total liabilities, noncontrolling interests, and equity
$
15,480,206

 
$
14,464,956



The accompanying notes are an integral part of these consolidated financial statements.

1





Alexandria Real Estate Equities, Inc.
Consolidated Statements of Income
(In thousands, except per share amounts)
(Unaudited)

 
Three Months Ended March 31,
 
2019
 
2018
Revenues:
 
 
 
Income from rentals
$
354,749

 
$
317,655

Other income
4,093


2,484

Total revenues
358,842

 
320,139

 
 
 
 
Expenses:
 
 
 
Rental operations
101,501

 
91,771

General and administrative
24,677

 
22,421

Interest
39,100

 
36,915

Depreciation and amortization
134,087

 
114,219

Loss on early extinguishment of debt
7,361

 

Total expenses
306,726

 
265,326

 
 
 
 
Equity in earnings of unconsolidated real estate joint ventures
1,146

 
1,144

Investment income
83,556

 
85,561

Net income
136,818

 
141,518

Net income attributable to noncontrolling interests
(7,659
)

(5,888
)
Net income attributable to Alexandria Real Estate Equities, Inc.’s stockholders
129,159

 
135,630

Dividends on preferred stock
(1,026
)
 
(1,302
)
Preferred stock redemption charge
(2,580
)
 

Net income attributable to unvested restricted stock awards
(1,955
)
 
(1,941
)
Net income attributable to Alexandria Real Estate Equities, Inc.’s common stockholders
$
123,598

 
$
132,387

 
 
 
 
Net income per share attributable to Alexandria Real Estate Equities, Inc.’s common stockholders:
 
 
 
Basic
$
1.11

 
$
1.33

Diluted
$
1.11

 
$
1.32

 
 
 
 


The accompanying notes are an integral part of these consolidated financial statements.

2





Alexandria Real Estate Equities, Inc.
Consolidated Statements of Comprehensive Income
(In thousands)
(Unaudited)

 
Three Months Ended March 31,
 
2019
 
2018
Net income
$
136,818

 
$
141,518

Other comprehensive (loss) income
 
 
 
Unrealized (losses) gains on interest rate hedge agreements:
 
 
 
Unrealized interest rate hedge (losses) gains arising during the period
(558
)
 
1,982

Reclassification adjustment for amortization of interest income included in net income
(1,929
)
 
(678
)
Unrealized (losses) gains on interest rate hedge agreements, net
(2,487
)
 
1,304

 
 
 
 
Unrealized gains (losses) on foreign currency translation:
 
 
 
Unrealized foreign currency translation gains (losses) arising during the period
2,210

 
(329
)
Unrealized gains (losses) on foreign currency translation, net
2,210

 
(329
)
 
 
 
 
Total other comprehensive (loss) income
(277
)
 
975

Comprehensive income
136,541

 
142,493

Less: comprehensive income attributable to noncontrolling interests
(7,659
)
 
(5,888
)
Comprehensive income attributable to Alexandria Real Estate Equities, Inc.’s stockholders
$
128,882

 
$
136,605


The accompanying notes are an integral part of these consolidated financial statements.


3





Alexandria Real Estate Equities, Inc.
Consolidated Statement of Changes in Stockholders’ Equity and Noncontrolling Interests
(Dollars in thousands)
(Unaudited)

 
 
Alexandria Real Estate Equities, Inc.’s Stockholders’ Equity
 
 
 
 
 
 
 
 
7.00% Series D
Cumulative
Convertible
Preferred
Stock
 
Number of
Common
Shares
 
Common
Stock
 
Additional
Paid-In Capital
 
Retained
Earnings
 
Accumulated Other Comprehensive Income
 
Noncontrolling
Interests
 
Total
Equity
 
Redeemable
Noncontrolling
Interests
Balance as of December 31, 2017
 
$
74,386

 
99,783,686

 
$
998

 
$
5,824,258

 
$

 
$
50,024

 
$
521,994

 
$
6,471,660

 
$
11,509

Net income
 

 

 

 

 
135,630

 

 
5,674

 
141,304

 
214

Total other comprehensive income
 

 

 

 

 

 
975

 

 
975

 

Reclassification of cumulative net unrealized gains on non-real estate investments upon adoption of new ASU on financial instruments
 

 

 

 

 
140,521

 
(49,771
)
 

 
90,750

 

Redemption of noncontrolling interests
 

 

 

 

 

 

 

 

 
(1,297
)
Distributions to noncontrolling interests
 

 

 

 

 

 

 
(5,709
)
 
(5,709
)
 
(214
)
Contributions from noncontrolling interests
 

 

 

 

 

 

 
6,579

 
6,579

 

Issuance of common stock
 

 
843,600

 
8

 
99,361

 

 

 

 
99,369

 

Issuance pursuant to stock plan
 

 
69,075

 
1

 
11,488

 

 

 

 
11,489

 

Dividends declared on common stock ($0.90 per share)
 

 

 

 

 
(91,980
)
 

 

 
(91,980
)
 

Dividends declared on preferred stock ($0.4375 per share)
 

 

 

 

 
(1,302
)
 

 

 
(1,302
)
 

Reclassification for cumulative distributions in excess of earnings
 

 

 

 
182,869

 
(182,869
)
 

 

 

 

Balance as of March 31, 2018
 
$
74,386

 
100,696,361

 
$
1,007

 
$
6,117,976

 
$

 
$
1,228

 
$
528,538

 
$
6,723,135

 
$
10,212



4





Alexandria Real Estate Equities, Inc.
Consolidated Statement of Changes in Stockholders’ Equity and Noncontrolling Interests
(Dollars in thousands)
(Unaudited)

 
 
Alexandria Real Estate Equities, Inc.’s Stockholders’ Equity
 
 
 
 
 
 
 
 
7.00% Series D
Cumulative
Convertible
Preferred
Stock
 
Number of
Common
Shares
 
Common
Stock
 
Additional
Paid-In Capital
 
Retained
Earnings
 
Accumulated Other Comprehensive Loss
 
Noncontrolling
Interests
 
Total
Equity
 
Redeemable
Noncontrolling
Interests
Balance as of December 31, 2018
 
$
64,336

 
111,011,816

 
$
1,110

 
$
7,286,954

 
$

 
$
(10,435
)
 
$
541,963

 
$
7,883,928

 
$
10,786

Net income
 

 

 

 

 
129,159

 

 
7,442

 
136,601

 
217

Total other comprehensive loss
 

 

 

 

 

 
(277
)
 

 
(277
)
 

Distributions to noncontrolling interests
 

 

 

 

 

 

 
(9,501
)
 
(9,501
)
 
(208
)
Contributions from and sales of noncontrolling interests
 

 

 

 
202,246

 

 

 
237,544

 
439,790

 
94

Issuance pursuant to stock plan
 

 
195,992

 
2

 
16,936

 

 

 

 
16,938

 

Taxes paid related to net settlement of equity awards
 

 
(27,149
)
 

 
(89
)
 

 

 

 
(89
)
 

Repurchases of 7.00% Series D preferred stock
 
(6,875
)
 

 

 
215

 
(2,580
)
 

 

 
(9,240
)
 

Dividends declared on common stock ($0.97 per share)
 

 

 

 

 
(109,574
)
 

 

 
(109,574
)
 

Dividends declared on preferred stock ($0.4375 per share)
 

 

 

 

 
(1,026
)
 

 

 
(1,026
)
 

Cumulative effect of adjustment upon adoption of new ASU on lease accounting on January 1, 2019
 

 

 

 

 
(3,525
)
 

 

 
(3,525
)
 

Reclassification of distributions in excess of earnings
 

 

 

 
12,454

 
(12,454
)
 

 

 

 

Balance as of March 31, 2019
 
$
57,461

 
111,180,659

 
$
1,112

 
$
7,518,716

 
$

 
$
(10,712
)
 
$
777,448

 
$
8,344,025

 
$
10,889




The accompanying notes are an integral part of these consolidated financial statements.








5





Alexandria Real Estate Equities, Inc.
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)

 
Three Months Ended March 31,
 
2019
 
2018
Operating Activities
 
 
 
Net income
$
136,818

 
$
141,518

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
134,087

 
114,219

Loss on early extinguishment of debt
7,361

 

Equity in earnings of unconsolidated real estate joint ventures
(1,146
)
 
(1,144
)
Distributions of earnings from unconsolidated real estate joint ventures
858

 
144

Amortization of loan fees
2,233

 
2,543

Amortization of debt premiums
(801
)
 
(575
)
Amortization of acquired below-market leases
(7,148
)
 
(6,170
)
Deferred rent
(26,965
)
 
(32,631
)
Stock compensation expense
11,029

 
7,248

Investment income
(83,556
)
 
(85,561
)
Changes in operating assets and liabilities:
 
 
 
Tenant receivables
167

 
(988
)
Deferred leasing costs
(11,279
)
 
(13,819
)
Other assets
(8,684
)
 
(14,279
)
Accounts payable, accrued expenses, and tenant security deposits
(16,244
)
 
18,416

Net cash provided by operating activities
136,730

 
128,921

 
 
 
 
Investing Activities
 
 
 
Additions to real estate
(241,049
)
 
(206,404
)
Purchases of real estate
(418,358
)
 
(303,156
)
Returns of deposits/(deposits) for investing activities
500

 
(7,786
)
Acquisitions of interests in unconsolidated real estate joint ventures

 
(35,922
)
Investments in unconsolidated real estate joint ventures
(52,634
)
 
(22,325
)
Additions to investments
(48,992
)
 
(50,287
)
Sales of investments
26,200

 
27,842

Net cash used in investing activities
$
(734,333
)
 
$
(598,038
)

6





Alexandria Real Estate Equities, Inc.
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)

 
Three Months Ended March 31,
 
2019
 
2018
Financing Activities
 
 
 
Borrowings from secured notes payable
$

 
$
6,142

Repayments of borrowings from secured notes payable
(301,343
)
 
(1,189
)
Proceeds from issuance of unsecured senior notes payable
854,209

 

Borrowings from unsecured senior line of credit
1,405,000

 
1,035,000

Repayments of borrowings from unsecured senior line of credit
(1,613,000
)
 
(595,000
)
Payment of loan fees
(15,225
)
 

Taxes paid related to net settlement of equity awards
(89
)
 

Repurchase of 7.00% Series D cumulative convertible preferred stock
(9,240
)
 

Proceeds from issuance of common stock

 
99,369

Dividends on common stock
(109,342
)
 
(91,060
)
Dividends on preferred stock
(1,126
)
 
(1,302
)
Contributions from and sales of noncontrolling interests
440,671

 
6,579

Distributions to noncontrolling interests
(9,709
)
 
(7,220
)
Net cash provided by financing activities
640,806

 
451,319

 
 
 
 
Effect of foreign exchange rate changes on cash and cash equivalents
472

 
(406
)
 
 
 
 
Net increase (decrease) in cash, cash equivalents, and restricted cash
43,675

 
(18,204
)
Cash, cash equivalents, and restricted cash as of the beginning of period
272,130

 
277,186

Cash, cash equivalents, and restricted cash as of the end of period
$
315,805

 
$
258,982

 
 
 
 
Supplemental Disclosures and Non-Cash Investing and Financing Activities:
 
 
 
Cash paid during the period for interest, net of interest capitalized
$
49,600

 
$
35,493

Change in accrued construction
$
9,939

 
$
19,565

Accrued construction for current period additions to real estate
$
133,502

 
$
130,761

Assumption of secured notes payable in connection with purchase of properties
$
(28,200
)
 
$

Right-of-use asset
$
239,653

 
$

Lease liability
$
(245,638
)
 
$


The accompanying notes are an integral part of these consolidated financial statements.


7


Alexandria Real Estate Equities, Inc.
Notes to Consolidated Financial Statements
(Unaudited)

1.
Organization and basis of presentation

Alexandria Real Estate Equities, Inc. (NYSE:ARE), an S&P 500® company, is an urban office REIT uniquely focused on collaborative life science and technology campuses in AAA innovation cluster locations. As used in this quarterly report on Form 10‑Q, references to the “Company,” “Alexandria,” “ARE,” “we,” “us,” and “our” refer to Alexandria Real Estate Equities, Inc. and its consolidated subsidiaries. The accompanying unaudited consolidated financial statements include the accounts of Alexandria Real Estate Equities, Inc. and its consolidated subsidiaries. All significant intercompany balances and transactions have been eliminated.

We have prepared the accompanying interim consolidated financial statements in accordance with GAAP and in conformity with the rules and regulations of the SEC. In our opinion, the interim consolidated financial statements presented herein reflect all adjustments, of a normal recurring nature, that are necessary to fairly present the interim consolidated financial statements. The results of operations for the interim period are not necessarily indicative of the results that may be expected for the year ending December 31, 2019. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in our annual report on Form 10‑K for the year ended December 31, 2018. Any references to our market capitalization, number or quality of buildings or tenants, quality of location, square footage, number of leases, or occupancy percentage, and any amounts derived from these values in these notes to consolidated financial statements, are outside the scope of our independent registered public accounting firm’s review.

2.
Summary of significant accounting policies

Reclassifications
 
Certain prior period amounts have been reclassified to conform to current period presentation. Refer to the “Lease Accounting” section within this Note 2 – “Summary of Significant Accounting Policies.”

Consolidation

On an ongoing basis, as circumstances indicate the need for reconsideration, we evaluate each legal entity that is not wholly owned by us in accordance with the consolidation guidance. Our evaluation considers all of our variable interests, including equity ownership, as well as fees paid to us for our involvement in the management of each partially owned entity. To fall within the scope of the consolidation guidance, an entity must meet both of the following criteria:

The entity has a legal structure that has been established to conduct business activities and to hold assets; such entity can be in the form of a partnership, limited liability company, or corporation, among others; and
We have a variable interest in the legal entity – i.e., variable interests that are contractual, such as equity ownership, or other financial interests that change with changes in the fair value of the entity’s net assets.

If an entity does not meet both criteria above, we apply other accounting literature, such as the cost or equity method of accounting. If an entity does meet both criteria above, we evaluate such entity for consolidation under either the variable interest model if the legal entity meets any of the following characteristics to qualify as a VIE, or under the voting model for all other legal entities that are not VIEs.

A legal entity is determined to be a VIE if it has any of the following three characteristics:

1)
The entity does not have sufficient equity to finance its activities without additional subordinated financial support;
2)
The entity is established with non-substantive voting rights (i.e., where the entity deprives the majority economic interest holder(s) of voting rights); or
3)
The equity holders, as a group, lack the characteristics of a controlling financial interest. Equity holders meet this criterion if they lack any of the following:
The power, through voting rights or similar rights, to direct the activities of the entity that most significantly influence the entity’s economic performance, as evidenced by:
Substantive participating rights in day-to-day management of the entity’s activities; or
Substantive kick-out rights over the party responsible for significant decisions;
The obligation to absorb the entity’s expected losses; or
The right to receive the entity’s expected residual returns.


8



2.
Summary of significant accounting policies (continued)

Once we consider the sufficiency of equity and voting rights of each legal entity, we then evaluate the characteristics of the equity holders’ interests, as a group, to see if they qualify as controlling financial interests. Our real estate joint ventures consist of limited partnerships or limited liability companies. For an entity structured as a limited partnership or a limited liability company, our evaluation of whether the equity holders (equity partners other than us in each of our joint ventures) lack the characteristics of a controlling financial interest includes the evaluation of whether the limited partners or non-managing members (the noncontrolling equity holders) lack both substantive participating rights and substantive kick-out rights, defined as follows:

Participating rights provide the noncontrolling equity holders the ability to direct significant financial and operating decisions made in the ordinary course of business that most significantly influence the entity’s economic performance.
Kick-out rights allow the noncontrolling equity holders to remove the general partner or managing member without cause.

If we conclude that any of the three characteristics of a VIE are met, including that the equity holders lack the characteristics of a controlling financial interest because they lack both substantive participating rights and substantive kick-out rights, we conclude that the entity is a VIE and evaluate it for consolidation under the variable interest model.

Variable interest model

If an entity is determined to be a VIE, we evaluate whether we are the primary beneficiary. The primary beneficiary analysis is a qualitative analysis based on power and benefits. We consolidate a VIE if we have both power and benefits – that is, (i) we have the power to direct the activities of a VIE that most significantly influence the VIE’s economic performance (power), and (ii) we have the obligation to absorb losses of or the right to receive benefits from the VIE that could potentially be significant to the VIE (benefits). We consolidate VIEs whenever we determine that we are the primary beneficiary. Refer to Note 4 – “Consolidated and Unconsolidated Real Estate Joint Ventures” to these unaudited consolidated financial statements for information on specific joint ventures that qualify as VIEs. If we have a variable interest in a VIE but are not the primary beneficiary, we account for our investment using the equity method of accounting.

Voting model

If a legal entity fails to meet any of the three characteristics of a VIE (due to insufficiency of equity, existence of non-substantive voting rights, or lack of a controlling financial interest), we then evaluate such entity under the voting model. Under the voting model, we consolidate the entity if we determine that we, directly or indirectly, have greater than 50% of the voting shares and that other equity holders do not have substantive participating rights. Refer to Note 4 – “Consolidated and Unconsolidated Real Estate Joint Ventures” to these unaudited consolidated financial statements for further information on one of our unconsolidated real estate joint ventures that qualify for evaluation under the voting model.

Use of estimates

The preparation of consolidated financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, and equity; the disclosure of contingent assets and liabilities as of the date of the consolidated financial statements; and the amounts of revenues and expenses during the reporting period. Actual results could materially differ from those estimates.

Investments in real estate

Evaluation of business combination or asset acquisition

We evaluate each acquisition of real estate or in-substance real estate (including equity interests in entities that predominantly hold real estate assets) to determine whether the integrated set of assets and activities acquired meets the definition of a business and needs to be accounted for as a business combination. An acquisition of an integrated set of assets and activities that does not meet the definition of a business is accounted for as an asset acquisition. If either of the following criteria is met, the integrated set of assets and activities acquired would not qualify as a business:

Substantially all of the fair value of the gross assets acquired is concentrated in either a single identifiable asset or a group of similar identifiable assets; or
The integrated set of assets and activities is lacking, at a minimum, an input and a substantive process that together significantly contribute to the ability to create outputs (i.e., revenue generated before and after the transaction).

An acquired process is considered substantive if:

The process includes an organized workforce (or includes an acquired contract that provides access to an organized workforce) that is skilled, knowledgeable, and experienced in performing the process;
The process cannot be replaced without significant cost, effort, or delay; or
The process is considered unique or scarce.

9



2.
Summary of significant accounting policies (continued)


Generally, we expect that acquisitions of real estate or in-substance real estate will not meet the definition of a business because substantially all of the fair value is concentrated in a single identifiable asset or group of similar identifiable assets (i.e., land, buildings, and related intangible assets) or because the acquisition does not include a substantive process in the form of an acquired workforce or an acquired contract that cannot be replaced without significant cost, effort, or delay. When evaluating acquired service or management contracts, we consider the nature of the services performed, the terms of the contract relative to similar arm’s-length contracts, and the availability of comparable vendors in evaluating whether the acquired contract constitutes a substantive process.

Recognition of real estate acquired

We evaluate each acquisition of real estate or in-substance real estate (including equity interests in entities that predominantly hold real estate assets) to determine whether the integrated set of assets and activities acquired meets the definition of a business and needs to be accounted for as a business combination. An acquisition of an integrated set of assets and activities that does not meet the definition of a business is accounted for as an asset acquisition.

For acquisitions of real estate or in-substance real estate that are accounted for as business combinations, we allocate the acquisition consideration (excluding acquisition costs) to the assets acquired, liabilities assumed, noncontrolling interests, and previously existing ownership interests at fair value as of the acquisition date. Assets include intangible assets such as tenant relationships, acquired in-place leases, and favorable intangibles associated with in-place leases for which we are the lessor. Liabilities include unfavorable intangibles associated with in-place leases for which we are the lessor. In addition, for acquired in-place operating leases for which we are the lessee, acquisition consideration is allocated to lease liabilities and related right-of-use assets, adjusted to reflect favorable or unfavorable terms of the lease when compared with market terms. Any excess (deficit) of the consideration transferred relative to the fair value of the net assets acquired is accounted for as goodwill (bargain purchase gain). Acquisition costs related to business combinations are expensed as incurred.

Generally, we expect that acquisitions of real estate or in-substance real estate will not meet the definition of a business because substantially all of the fair value is concentrated in a single identifiable asset or group of similar identifiable assets (i.e., land, buildings, and related intangible assets). The accounting model for asset acquisitions is similar to the accounting model for business combinations, except that the acquisition consideration (including acquisition costs) is allocated to the individual assets acquired and liabilities assumed on a relative fair value basis. Any excess (deficit) of the consideration transferred relative to the sum of the fair value of the assets acquired and liabilities assumed is allocated to the individual assets and liabilities based on their relative fair values. As a result, asset acquisitions do not result in the recognition of goodwill or a bargain purchase gain. Incremental and external direct acquisition costs (such as legal and third-party expenses) are capitalized.

We exercise judgment to determine the key assumptions used to allocate the purchase price of real estate acquired among its components. The allocation of the consideration to the various components of properties acquired during the year can have an effect on our net income due to the differing depreciable and amortizable lives of each component and the recognition of the related depreciation and amortization expense in our consolidated statements of income. We apply judgment in utilizing available comparable market information to assess relative fair value. We assess the relative fair values of tangible and intangible assets based on numerous factors, including estimated cash flow projections that utilize appropriate discount and capitalization rates and available comparable market information. Estimates of future cash flows are based on a number of factors, including the historical operating results, known and anticipated trends, and market/economic conditions that may affect the property.

The value of tangible assets acquired is based upon our estimation of fair value on an “as if vacant” basis. The value of acquired in-place leases includes the estimated costs during the hypothetical lease-up period and other costs that would have been incurred in the execution of similar leases under the market conditions at the acquisition date of the acquired in-place lease. If there is a bargain fixed-rate renewal option for the period beyond the non-cancelable lease term of an in-place lease, we evaluate intangible factors such as the business conditions in the industry in which the lessee operates, the economic conditions in the area in which the property is located, and the ability of the lessee to sublease the property during the renewal term, in order to determine the likelihood that the lessee will renew. When we determine there is reasonable assurance that such bargain purchase option will be exercised, we consider the option in determining the intangible value of such lease and its related amortization period. We also recognize the relative fair values of assets acquired, the liabilities assumed, and any noncontrolling interest in acquisitions of less than a 100% interest when the acquisition constitutes a change in control of the acquired entity.

The values allocated to buildings and building improvements, land improvements, tenant improvements, and equipment are depreciated on a straight-line basis using the shorter of the respective ground lease term, estimated useful life, or up to 40 years, for buildings and building improvements, estimated life, or up to 20 years, for land improvements, the respective lease term or estimated useful life for tenant improvements, and the shorter of the lease term or estimated useful life for equipment. The values of acquired in-place leases are classified in other assets in the accompanying consolidated balance sheets and amortized over the remaining terms of the related leases.


10



2.
Summary of significant accounting policies (continued)

Capitalized project costs

We capitalize project costs, including pre-construction costs, interest, property taxes, insurance, and other costs directly related and essential to the development, redevelopment, pre-construction, or construction of a project. Capitalization of development, redevelopment, pre-construction, and construction costs is required while activities are ongoing to prepare an asset for its intended use. Fluctuations in our development, redevelopment, pre-construction, and construction activities could result in significant changes to total expenses and net income. Costs incurred after a project is substantially complete and ready for its intended use are expensed as incurred. Should development, redevelopment, pre-construction, or construction activity cease, interest, property taxes, insurance, and certain other costs would no longer be eligible for capitalization and would be expensed as incurred. Expenditures for repairs and maintenance are expensed as incurred.

Real estate sales

A property is classified as held for sale when all of the following criteria for a plan of sale have been met: (i) management, having the authority to approve the action, commits to a plan to sell the property; (ii) the property is available for immediate sale in its present condition, subject only to terms that are usual and customary; (iii) an active program to locate a buyer and other actions required to complete the plan to sell have been initiated; (iv) the sale of the property is probable and is expected to be completed within one year; (v) the property is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and (vi) actions necessary to complete the plan of sale indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. Depreciation of assets ceases upon designation of a property as held for sale.

If the disposal of a property represents a strategic shift that has (or will have) a major effect on our operations or financial results, such as (i) a major line of business, (ii) a major geographic area, (iii) a major equity method investment, or (iv) other major parts of an entity, then the operations of the property, including any interest expense directly attributable to it, are classified as discontinued operations in our consolidated statements of income, and amounts for all prior periods presented are reclassified from continuing operations to discontinued operations. The disposal of an individual property generally will not represent a strategic shift and therefore will typically not meet the criteria for classification as a discontinued operation.

We recognize gains/losses on real estate sales in accordance with the accounting standard on the derecognition of nonfinancial assets arising from contracts with noncustomers. Our ordinary output activities consist of the leasing of space to our tenants in our operating properties, not the sales of real estate. Therefore, sales of real estate (in which we are the seller) qualify as contracts with noncustomers. In our transactions with noncustomers, we apply certain recognition and measurement principles consistent with our method of recognizing revenue arising from contracts with customers. Derecognition of the asset is based on the transfer of control. If a real estate sales contract includes our ongoing involvement with the property, then we evaluate each promised good or service under the contract to determine whether it represents a separate performance obligation, constitutes a guarantee, or prevents the transfer of control. If a good or service is considered a separate performance obligation, an allocated portion of the transaction price is recognized as revenue as we transfer the related good or service to the buyer.

The recognition of gain or loss on the sale of a partial interest also depends on whether we retain a controlling or noncontrolling interest. If we retain a controlling interest upon completion of the sale, we continue to reflect the asset at its book value, record a noncontrolling interest for the book value of the partial interest sold, and recognize additional paid-in capital for the difference between the consideration received and the partial interest at book value. Conversely, if we retain a noncontrolling interest upon completion of the partial sale of real estate, we would recognize a gain or loss as if 100% of the real estate were sold.

Impairment of long-lived assets

Prior to and subsequent to the end of each quarter, we review current activities and changes in the business conditions of all of our long-lived assets to determine the existence of any triggering events or impairment indicators requiring an impairment analysis. If triggering events or impairment indicators are identified, we review an estimate of the future undiscounted cash flows, including, if necessary, a probability-weighted approach if multiple outcomes are under consideration.

Long-lived assets to be held and used, including our rental properties, CIP, land held for development, right-of-use assets related to our operating leases in which we are a lessee, and intangibles, are individually evaluated for impairment when conditions exist that may indicate that the carrying amount of a long-lived asset may not be recoverable. The carrying amount of a long-lived asset to be held and used is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. Triggering events or impairment indicators for long-lived assets to be held and used are assessed by project and include significant fluctuations in estimated net operating income, occupancy changes, significant near-term lease expirations, current and historical operating and/or cash flow losses, construction costs, estimated completion dates, rental rates, and other market factors. We assess the expected undiscounted cash flows based upon numerous factors, including, but not limited to, construction costs, available market information, current and historical operating results, known trends, current market/economic conditions that may affect the asset, and our assumptions about the use of the asset, including, if necessary, a probability-weighted approach if multiple outcomes are under consideration.


11



2.
Summary of significant accounting policies (continued)

Upon determination that an impairment has occurred, a write-down is recognized to reduce the carrying amount to its estimated fair value. If an impairment loss is not required to be recognized, the recognition of depreciation or amortization is adjusted prospectively, as necessary, to reduce the carrying amount of the real estate to its estimated disposition value over the remaining period that the asset is expected to be held and used. We may adjust depreciation of properties that are expected to be disposed of or redeveloped prior to the end of their useful lives.

We use the held for sale impairment model for our properties classified as held for sale. The held for sale impairment model is different from the held and used impairment model. Under the held for sale impairment model, an impairment loss is recognized if the carrying amount of the long-lived asset classified as held for sale exceeds its fair value less cost to sell. Because of these two different models, it is possible for a long-lived asset previously classified as held and used to require the recognition of an impairment charge upon classification as held for sale.

International operations

In addition to operating properties in the U.S., we have three operating properties in Canada and one operating property in China. The functional currency for our subsidiaries operating in the U.S. is the U.S. dollar. The functional currencies for our foreign subsidiaries are the local currencies in each respective country. The assets and liabilities of our foreign subsidiaries are translated into U.S. dollars at the exchange rate in effect as of the financial statement date. Income statement accounts of our foreign subsidiaries are translated using the weighted-average exchange rate for the periods presented. Gains or losses resulting from the translation are classified in accumulated other comprehensive income as a separate component of total equity and are excluded from net income.

Whenever a foreign investment meets the criteria for classification as held for sale, we evaluate the recoverability of the investment under the held for sale impairment model. We may recognize an impairment charge if the carrying amount of the investment exceeds its fair value less cost to sell. In determining an investment’s carrying amount, we consider its net book value and any cumulative unrealized foreign currency translation adjustment related to the investment.

The appropriate amounts of foreign exchange rate gains or losses classified in accumulated other comprehensive income are reclassified to net income when realized upon the sale of our investment or upon the complete or substantially complete liquidation of our investment.

Investments

We hold investments in publicly traded companies and privately held entities primarily involved in the life science and technology industries. As a REIT, we generally limit our ownership percentage in the voting stock of each individual entity to less than 10%.

Our equity investments (except those accounted for under the equity method and those that result in consolidation of the investee) are measured as follows:

Investments in publicly traded companies are classified as investments with readily determinable fair values. These investments are carried at fair value, with changes in fair value recognized in net income. The fair values for our investments in publicly traded companies are determined based on sales prices/quotes available on securities exchanges.
Investments in privately held entities without readily determinable fair values fall into two categories:
Investments in privately held entities that report NAV per share, such as our privately held investments in limited partnerships, are carried at fair value using NAV as a practical expedient with changes in fair value recognized in net income. We use NAV per share reported by limited partnerships without adjustment, unless we are aware of information indicating that the NAV per share reported by a limited partnership does not accurately reflect the fair value of the investment at our reporting date. We disclose the timing of liquidation of an investee’s assets and the date when redemption restrictions will lapse (or indicate if this timing is unknown) if the investee has communicated this information to us or has announced it publicly.
Investments in privately held entities that do not report NAV per share are accounted for using a measurement alternative that measures these investments at cost, adjusted for observable price changes and impairments, with changes recognized in net income.

For investments in privately held entities that do not report NAV per share, an observable price is a price observed in an orderly transaction for an identical or similar investment of the same issuer. Observable price changes result from, among other things, equity transactions for the same issuer executed during the reporting period, including subsequent equity offerings or other reported equity transactions related to the same issuer. For these transactions to be considered observable price changes of the same issuer, we evaluate whether these transactions have similar rights and obligations, including voting rights, distribution preferences, conversion rights, and other factors, to the investments we hold.


12



2.
Summary of significant accounting policies (continued)

We monitor investments in privately held entities that do not report NAV per share throughout the year for new developments, including operating results, prospects and results of clinical trials, new product initiatives, new collaborative agreements, capital-raising events, and merger and acquisition activities. These investments are evaluated on the basis of a qualitative assessment for indicators of impairment by monitoring the presence of the following triggering events or impairment indicators: (i) a significant deterioration in the earnings performance, asset quality, or business prospects of the investee; (ii) a significant adverse change in the regulatory, economic, or technological environment of the investee, (iii) a significant adverse change in the general market condition, including the research and development of technology and products that the investee is bringing or attempting to bring to the market, or (iv) significant concerns about the investee’s ability to continue as a going concern. If such indicators are present, we are required to estimate the investment’s fair value and immediately recognize an impairment loss in an amount equal to the investment’s carrying value in excess of its estimated fair value.

Investments in privately held entities are accounted for under the equity method unless our interest in the entity is deemed to be so minor that we have virtually no influence over the entity’s operating and financial policies. Under the equity method of accounting, we initially recognize our investment at cost and adjust the carrying amount of the investment to recognize our share of the earnings or losses of the investee subsequent to the date of our investment. We had no investments accounted for under the equity method as of March 31, 2019.

We recognize both realized and unrealized gains and losses in our consolidated statements of income, classified within investment income. Unrealized gains and losses represent changes in fair value for investments in publicly traded companies, changes in NAV, as a practical expedient to estimate fair value, for investments in privately held entities that report NAV per share, and observable price changes on our investments in privately held entities that do not report NAV per share. Impairments are realized losses, which result in an adjusted cost, and represent charges to reduce the carrying values of investments in privately held entities that do not report NAV per share to their estimated fair value. Realized gains and losses represent the difference between proceeds received upon disposition of investments and their historical or adjusted cost.

Revenues

The table below provides detail of our consolidated total revenues for the three months ended March 31, 2019 (in thousands):
 
 
Three Months Ended March 31, 2019
Income from rentals:
 
 
Revenues subject to the new lease accounting standard:
 
 
Operating leases
 
$
343,339

Direct financing leases
 
601

Revenues subject to the new lease accounting standard
 
343,940

Revenues subject to the revenue recognition accounting standard
 
10,809

Income from rentals
 
354,749

Other income
 
4,093

Total revenues
 
$
358,842


During the three months ended March 31, 2019, revenues that were subject to the new lease accounting standard aggregated $343.9 million and represented 95.8% of our total revenues. Our total revenues also included $14.9 million, or 4.2%, subject to other accounting guidance. For a detailed discussion related to our revenue streams, refer to the “Lease Accounting” and “Recognition of Revenue Arising From Contracts With Customers” sections within this Note 2 – “Summary of Significant Accounting Policies.”


13



2.
Summary of significant accounting policies (continued)

Lease accounting
On January 1, 2019, we adopted a new lease accounting standard that sets out the principles for the recognition, measurement, presentation, and disclosure of leases for both parties to a lease agreement (i.e., lessees and lessors). Upon adoption of the new lease accounting standard, we elected the following practical expedients provided by this lease standard and discussed in greater detail within this “Lease Accounting” section of Note 2. The summary of the practical expedients we elected is provided below:
Package of practical expedients – requires us to not reevaluate our existing or expired leases as of January 1, 2019, under the new lease accounting standard.
Optional transition method practical expedient – requires us to apply the new lease accounting standard prospectively from the adoption date of January 1, 2019.
Land easements practical expedient – requires us to continue to account for land easements existing as of January 1, 2019, under the accounting standards applied to them prior to January 1, 2019.
Single component practical expedient – requires us to account for lease and nonlease components associated with that lease under the new lease accounting standard if certain criteria are met.
Short-term lease practical expedient – requires us to not record the related lease liabilities and right-of-use assets for our operating leases with a term of 12 months or less in which we are the lessee.

Overview related to both lessee and lessor accounting

Upon adoption of the new lease accounting standard, we elected the package of practical expedients, which requires us to not assess whether our expired or existing contracts as of January 1, 2019, are or contain leases. When we enter into a contract or amend an existing contract subsequent to adoption, we evaluate whether the contract meets the definition of a lease. To meet the definition of a lease, the contract must meet three criteria: (i) there must be an identified asset held by one party to the contract (the lessor), (ii) the counterparty (the lessee) has the right to obtain substantially all of the economic benefits from the use of the asset throughout the period of the contract, and (iii) the counterparty has the right to direct the use of the identified asset throughout the period of the contract. We have determined which of our contracts meet these three criteria and are considered leases, including rental property leases where we are the lessor and operating leases where we are the lessee. Our leases generally contain contractual fixed and variable rental payments. Fixed payments represent our scheduled rental amounts due under our leases. Variable payments relate primarily to the reimbursements of rental operating expenses under our triple net lease structure.

The new lease accounting standard also sets new criteria for determining the classification of finance leases for lessees and sales-type leases for lessors. The criteria to determine whether a lease should be accounted for as a finance (sales-type) lease include any of the following: (i) ownership is transferred from lessor to lessee by the end of the lease term, (ii) an option to purchase is reasonably certain to be exercised, (iii) the lease term is for the major part of the underlying asset’s remaining economic life, (iv) the present value of lease payments equals or exceeds substantially all of the fair value of the underlying asset, or (v) the underlying asset is specialized and is expected to have no alternative use at the end of the lease term. If any of these criteria is met, a lease is classified as a finance lease by the lessee and as a sales-type lease by the lessor. If none of the criteria are met, a lease is classified as an operating lease by the lessee, but may still qualify as a direct financing lease or an operating lease for the lessor. The existence of a residual value guarantee from an unrelated third party other than the lessee may qualify the lease as a direct financing lease by the lessor. Otherwise, the lease is classified as an operating lease by the lessor.

Initial adoption method, package of practical expedients, and optional transition method

The new lease accounting standard requires the use of the modified retrospective transition method. On January 1, 2019, we adopted the new lease accounting standard and elected the package of practical expedients and the optional transition method, which permitted January 1, 2019 to be our initial application date. Our election of the package of practical expedients and the optional transition method allowed us to not reassess:
Whether any expired or existing contracts as of January 1, 2019, are leases or contain leases. This practical expedient is primarily applicable to entities that have contracts containing embedded leases. As of December 31, 2018, we had no such contracts; therefore, this practical expedient had no effect on us.
The lease classification for any leases expired or existing as of January 1, 2019. Our election of the package of practical expedients requires us to not revisit the classification of our leases existing as of January 1, 2019. For example, all of our leases that were classified as operating leases in accordance with the lease accounting standards in effect prior to January 1, 2019, continue to be classified as operating leases after adoption of the new lease accounting standard.
Previously capitalized initial direct costs for any leases existing as of January 1, 2019. Our election of the package of practical expedients and the optional transition method requires us to not reassess whether initial direct leasing costs capitalized prior to the adoption of the new lease accounting standard in connection with the leases that commenced prior to January 1, 2019, qualify for capitalization under the new lease accounting standard. We continue to amortize these costs over the lease term, consistent with the lease accounting guidance in effect prior to January 1, 2019.


14



2.
Summary of significant accounting policies (continued)

We applied the package of practical expedients consistently to all leases (i.e., in which we are a lessee or a lessor) that commenced before January 1, 2019. The election of this package permits us to “run off” our leases that commenced before January 1, 2019, for the remainder of their lease terms, unless our existing leases are modified, and to apply the new lease accounting standard to leases commencing or modified after January 1, 2019.

On January 1, 2019, we recognized a lease liability aggregating $218.7 million for all operating leases in which we are a lessee based on the present value of the lease payments remaining as of the initial application date of January 1, 2019. On January 1, 2019, we also recognized a right-of-use asset corresponding to the lease liability, adjusted for initial direct leasing cost and other consideration exchanges with the landlord prior to the commencement of the lease. Refer to our discussion in the “Lessee Accounting” subsection below for additional information.

In addition, we had certain land easement contracts in effect as of January 1, 2019. Pursuant to our election of the package of practical expedients described above, no reassessment of these contracts was required. Consequently, the adoption of the new lease accounting standard had no effect on our accounting for land easements existing on January 1, 2019.

Costs to execute leases

The new lease accounting standard requires that lessors and lessees capitalize, as initial direct costs, only incremental costs of a lease that would not have been incurred if the lease had not been obtained. Effective January 1, 2019, costs that we incur to negotiate or arrange a lease regardless of its outcome, such as fixed employee compensation, tax, or legal advice to negotiate lease terms, and other costs are expensed as incurred.

Under the package of practical expedients and optional transition method that we elected on January 1, 2019, we were not required to reassess whether initial direct leasing costs capitalized prior to the adoption of the new lease accounting standard in connection with the leases that commenced prior to January 1, 2019, qualify for capitalization under the new lease accounting standard. Therefore, we continue to amortize these initial direct leasing costs over their respective lease terms.

On January 1, 2019, we recognized a cumulative adjustment, as required by the new lease accounting standard, to retained earnings aggregating $3.5 million to write off lease origination costs that were capitalized in connection with leases that were executed but had not commenced before January 1, 2019. These costs were capitalized in accordance with the lease accounting standards existing prior to January 1, 2019, and would not qualify for capitalization under the new lease accounting standard.

Lessor accounting

Under the new lease accounting standard, each lease agreement is evaluated to identify the lease and nonlease components at lease inception. Lease components consist primarily of fixed rental payments, and nonlease components consist primarily of specific tenant recoveries, including recoveries for utilities, repairs and maintenance, and common area expenses. The total consideration in each lease agreement is allocated to the lease and nonlease components based on their relative stand-alone selling prices. If an entity does not elect the single component practical expedient discussed below, revenue related to nonlease components is subject to the revenue recognition accounting standard.

On January 1, 2019, we elected the single component practical expedient, which requires us, by class of underlying asset, to not allocate the total consideration to the lease and nonlease components based on their relative stand-alone selling prices. This single component practical expedient requires us to account for the lease component and nonlease component(s) associated with each lease as a single component if: (i) the timing and pattern of transfer of the lease component and the nonlease component(s) associated with it are the same and (ii) the lease component would be classified as an operating lease if it were accounted for separately. This expedient is applicable to any lease not subject to the aforementioned package of practical expedients and optional transition method.

Under the single component practical expedient, if we determine that the lease component is the predominant component, we are required to account for all of the revenues under such lease as a single component in accordance with the new lease accounting standard. Conversely, if we determine that the nonlease component is the predominant component, we are required to account for all of the revenues under such lease as a single component in accordance with the revenue recognition accounting standard. Our operating leases for which we are the lessor qualified for the single component practical expedient accounting under the new lease accounting standard because the lease components in each of our leases were predominant. Upon adoption of the new lease standard, we classified all revenues recognized under the new lease accounting standard as income from rentals in our consolidated statements of income.

Income from rentals related to fixed rental payments under operating leases is recognized on a straight-line basis over the respective operating lease terms. Income from rentals related to variable payments includes contingent rental payments and tenant recoveries. Tenant recoveries, including reimbursements of utilities, repairs and maintenance, common area expenses, real estate taxes and insurance, and other operating expenses, are recognized as revenue in the period during which the applicable expenses are incurred and the tenant’s obligation to reimburse us arises. Income from rentals related to other variable payments is recognized when associated contingencies are removed.

15



2.
Summary of significant accounting policies (continued)


Income from rentals related to direct financing leases is recognized over the respective lease terms using the effective interest rate method. At lease commencement, we record an asset within other assets in our consolidated balance sheets, which represents our net investment in the direct financing lease. This initial net investment is determined by aggregating the total future lease payments attributable to the direct financing lease and the estimated residual value of the property less unearned income. Over the lease term, the investment in the direct financing lease is reduced and rental income is recognized as income from rentals in our consolidated statements of income and produces a constant periodic rate of return on the net investment in the direct financing lease.

We classify amounts expected to be received in later years as deferred rent in our consolidated balance sheets. Amounts received currently but recognized as revenue in future years are classified in accounts payable, accrued expenses, and tenant security deposits in our consolidated balance sheets. We commence recognition of income from rentals related to the operating leases at the date the property is ready for its intended use by the tenant and the tenant takes possession, or controls the physical use, of the leased asset.

Subsequent to lease commencement, for each of our leases, we assess collectibility from our tenants of future lease payments. If we determine that collectibility is probable, we recognize income from rentals based on the methodology described above. For our operating leases, if we determine that collectibility is not probable, we recognize an adjustment to lower our income from rentals rather than a bad debt expense. For our direct financing lease, if we determine that collectibility is not probable, we evaluate our net investment in the lease for impairment. Upon determination that an impairment has occurred, an impairment charge is recognized to reduce the carrying balance in the net investment in the lease to its estimated fair value. As of March 31, 2019, we assessed the collectibility of future lease payments under all our leases in which we are a lessor, and determined that collectibility was probable.

Reclassification of the prior year presentation of rental revenues and tenant recoveries

As described above, rental revenues and tenant recoveries related to our operating leases for which we are the lessor qualified for the single component practical expedient and were classified as income from rentals in our consolidated statements of income. Prior to the adoption of the new lease accounting standard, we classified rental revenues and tenant recoveries separately in our consolidated statements of income, in accordance with the guidance in effect prior to January 1, 2019. Upon adoption of the new lease accounting standard, our comparative income statements of prior years have been reclassified to conform to the new single component presentation of rental revenues and tenant recoveries, classified within income from rentals in our consolidated statements of income.

The table below provides a reconciliation of the prior period presentation of the income statement line items that were reclassified in our consolidated statements of income to conform to the current period presentation, pursuant to the adoption of the new lease accounting standard and election of the single component practical expedient (in thousands):
 
 
Three Months Ended March 31, 2018
Rental revenues (presentation prior to January 1, 2019)
 
$
244,485

Tenant recoveries (presentation prior to January 1, 2019)
 
73,170

Income from rentals (presentation effective January 1, 2019)
 
$
317,655


Lessee accounting

Under the new lease accounting standard, lessees are required to apply a dual approach by classifying leases as either finance or operating leases based on the principle of whether the lease is effectively a financed purchase of the leased asset by the lessee. This classification will determine whether the lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease, which corresponds to a similar evaluation performed by lessors. In addition to this classification, a lessee is also required to recognize a right-of-use asset and a lease liability for all leases regardless of their classification, whereas a lessor is not required to recognize a right-of-use asset and a lease liability for any operating leases.

Under the package of practical expedients that we elected upon adoption of the new lease accounting standard, all of our operating leases existing as of January 1, 2019, for which we are the lessee, continue to be classified as operating leases subsequent to the adoption of the new lease accounting standard. On January 1, 2019, we recognized a lease liability aggregating $218.7 million and a corresponding right-of-use asset, which represents our obligation for remaining future rental payments related to our operating leases existing as of January 1, 2019, for which we are the lessee. The right-of-use asset was classified in other assets, and the lease liability was classified in accounts payable, accrued expenses, and tenant security deposits in our consolidated balance sheets. The lease liability was calculated as the present value of the lease payments, aggregating $590.3 million, remaining as of the initial application date of January 1, 2019, under our ground and office lease agreements for which we are the lessee. The present value of the remaining lease payments was calculated for each operating lease using each respective remaining lease term and a corresponding estimated incremental borrowing rate, which is the interest rate that we estimate we would have to pay to borrow on a collateralized basis over a similar term for an amount equal to the lease payments.

16



2.
Summary of significant accounting policies (continued)


Recognition of revenue arising from contracts with customers

We recognize revenues associated with transactions arising from contracts with customers, excluding revenues subject to the new lease accounting standard discussed in the “Lease Accounting” section above, in accordance with the revenue recognition accounting standard. A customer is distinguished from a noncustomer by the nature of the goods or services that are transferred. Customers are provided with goods or services that are generated by a company’s ordinary output activities, whereas noncustomers are provided with nonfinancial assets that are outside of a company’s ordinary output activities.
    
We generally recognize revenue representing the transfer of goods and services to customers in an amount that reflects the consideration to which we expect to be entitled in the exchange. In order to determine the recognition of revenue from customer contracts, we use a five-step model to (i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, including variable consideration to the extent that it is probable that a significant future reversal will not occur, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) we satisfy the performance obligation.

We identify contractual performance obligations and determine whether revenue should be recognized at a point in time or over time, based on when control of goods and services transfers to a customer. We consider whether we control the goods or services prior to the transfer to the customer in order to determine whether we should account for the arrangement as a principal or agent. If we determine that we control the goods or services provided to the customer, then we are the principal to the transaction, and we recognize the gross amount of consideration expected in the exchange. If we simply arrange but do not control the goods or services being transferred to the customer, then we are considered to be an agent to the transaction, and we recognize the net amount of consideration we are entitled to retain in the exchange.

Total revenues subject to the revenue recognition accounting standard for the three months ended March 31, 2019, include $10.8 million primarily related to short term parking revenues associated with long term lease agreements. These revenues are classified within income from rentals in our consolidated income statements. Short-term parking revenues do not qualify for the single lease component practical expedient, discussed in the “Lessor Accounting” subsection of the “Lease Accounting” section within this Note 2, due to the difference in the timing and pattern of transfer of our parking service obligations and associated lease components within the same lease agreement. We recognize short-term parking revenues in accordance with the revenue recognition accounting standard when the services are provided and the performance obligations are satisfied, which normally occurs at a point in time.

Monitoring of tenant credit quality

During the term of each lease, we monitor the credit quality and any related material changes of our tenants by (i) monitoring the credit rating of tenants that are rated by a nationally recognized credit rating agency, (ii) reviewing financial statements of the tenants that are publicly available or that are required to be delivered to us pursuant to the applicable lease, (iii) monitoring news reports regarding our tenants and their respective businesses, and (iv) monitoring the timeliness of lease payments.

Income taxes

We are organized and operate as a REIT pursuant to the Internal Revenue Code (the “Code”). Under the Code, a REIT that distributes at least 90% of its REIT taxable income to its stockholders annually (excluding net capital gains) and meets certain other conditions is not subject to federal income tax on its distributed taxable income, but could be subject to certain federal, foreign, state, and local taxes. We distribute 100% of our taxable income annually; therefore, a provision for federal income taxes is not required. In addition to our REIT returns, we file federal, foreign, state, and local tax returns for our subsidiaries. We file with jurisdictions located in the U.S., Canada, India, China, and other international locations. Our tax returns are subject to routine examination in various jurisdictions for the 2013 through 2017 calendar years.

Employee and non-employee share-based payments

We have implemented an entity-wide accounting policy to account for forfeitures of share-based awards granted to employees and non-employees when they occur. As a result of this policy, we recognize expense on share-based awards with time-based vesting conditions without reductions for an estimate of forfeitures. This accounting policy only applies to service condition awards. For performance condition awards, we continue to assess the probability that such conditions will be achieved. Expenses related to forfeited awards are reversed as forfeitures occur. In addition, all nonforfeitable dividends paid on share-based payment awards are initially classified in retained earnings and reclassified to compensation cost only if forfeitures of the underlying awards occur. Our employee and non-employee share-based awards are measured on the grant date and recognized over the required service period of the recipient.


17



2.
Summary of significant accounting policies (continued)

Hedge accounting

We utilize interest rate hedge agreements to manage a portion of our exposure to variable interest rates primarily associated with borrowings based on LIBOR. As a result, all of our interest rate hedge agreements are designated as cash flow hedges. At inception of a hedge agreement, we are required to perform an initial quantitative assessment to determine whether a hedge is highly effective in offsetting changes in cash flows associated with the hedged item. Subsequently, we may perform only a qualitative assessment, unless facts and circumstances change.

We determined that each our cash flow hedges were highly effective at inception and continue to be highly effective. Therefore, we record all changes (effective and ineffective components) in fair value of our hedges in accumulated other comprehensive income within total equity and reclassify them into earnings when the hedged item affects earnings.

In October 2018, the FASB issued an accounting standard that expands the list of U.S. benchmark interest rates permitted in the application of hedge accounting to include the overnight index swap rate based on the Secured Overnight Financing Rate (“SOFR”). The accounting standard became effective for us and was adopted on January 1, 2019. We have no hedges based on SOFR; therefore, the adoption of this accounting standard had no effect on our consolidated financial statements.

Joint venture distributions

We use the “nature of the distribution” approach to determine the classification within our statement of cash flows of cash distributions received from equity method investments, including unconsolidated joint ventures. Under this approach, distributions are classified based on the nature of the underlying activity that generated the cash distributions. If we lack the information necessary to apply this approach in the future, we will be required to apply the “cumulative earnings” approach as an accounting change on a retrospective basis. Under the cumulative earnings approach, distributions up to the amount of cumulative equity in earnings recognized are classified as cash inflows from operating activities, and those in excess of that amount are classified as cash inflows from investing activities.

Restricted cash

We present cash and cash equivalents separately from restricted cash within our consolidated balance sheets. We include restricted cash with cash and cash equivalents when reconciling the beginning of period and end of period total amounts shown in the consolidated statements of cash flows. We provide a reconciliation between the balance sheet and statement of cash flows, as required when the balance includes more than one line item for cash, cash equivalents, restricted cash, and restricted cash equivalents. We also provide a disclosure of the nature of the restrictions related to material restricted cash and restricted cash equivalents balances.


Recent accounting pronouncements

Allowance for credit losses

In June 2016, the FASB issued an accounting standard (further clarified with subsequently issued updates) that changes the impairment model for most financial instruments by requiring companies to recognize an allowance for expected losses, rather than incurred losses as required currently by the other-than-temporary impairment model. The accounting standard will apply to most financial assets measured at amortized cost and certain other instruments, including trade and other receivables, loans, held-to-maturity debt securities, net investments in leases arising from sales-type and direct financing leases, and off-balance-sheet credit exposures (i.e., loan commitments). This standard applies to net investments in leases resulting from sales-type or direct financing leases recognized by a lessor and does not apply to the receivables arising from operating leases, which are accounted for under the new lease accounting standard discussed in “Lease Accounting” section within Note 2 - Summary of Significant Accounting Policies.” The accounting standard is effective for reporting periods beginning after December 15, 2019, with early adoption permitted, and will be applied as a cumulative adjustment to retained earnings as of the effective date. As of March 31, 2019, we had one lease classified as a direct financing lease with a net investment balance aggregating $39.3 million which will be subject to this new guidance. We are currently assessing the potential effect the adoption of this accounting standard will have on our consolidated financial statements.

18


3.
Investments in real estate

Our consolidated investments in real estate, including real estate assets held for sale as described in Note 16, consisted of the following as of March 31, 2019, and December 31, 2018 (in thousands):
 
 
March 31, 2019
 
December 31, 2018
Rental properties:
 
 
 
 
Land (related to rental properties)
 
$
1,737,610

 
$
1,625,349

Buildings and building improvements
 
10,473,469

 
9,986,635

Other improvements
 
1,061,034

 
976,627

Rental properties
 
13,272,113

 
12,588,611

Development and redevelopment of new Class A properties:
 
 
 
 
Development and redevelopment projects (under construction, marketing, or pre‑construction)
 
1,296,913

 
1,460,814

Future development projects
 
181,859

 
98,802

Gross investments in real estate
 
14,750,885

 
14,148,227

Less: accumulated depreciation
 
(2,371,088
)
 
(2,263,797
)
Net investments in real estate – North America
 
12,379,797

 
11,884,430

Net investments in real estate – Asia
 
30,553

 
29,263

Investments in real estate
 
$
12,410,350

 
$
11,913,693


Acquisitions

Our real estate asset acquisitions during the three months ended March 31, 2019, consisted of the following (dollars in thousands):
 
 
 
 
Square Footage
 
 
 
Market
 
Number of Properties
 
Future Development
 
Operating With Future Development/Redevelopment
 
Operating
 
Purchase Price
 
Greater Boston
 
 
175,000

 

 

 
$
81,100

 
San Francisco
 
4
 

 

 
247,770

 
239,450

 
San Diego
 
2
 

 
53,220

 

 
23,250

 
Other
 
4
 

 
75,864

 

 
39,150

 
Three months ended March 31, 2019
 
10
 
175,000

 
129,084

 
247,770

 
$
382,950

(1) 

(1)
Excludes $65.0 million paid in January 2019 for two properties at 10260 Campus Point Drive and 4161 Campus Point Court that we acquired in December 2018. Total purchase price was $80.0 million, of which $15.0 million was paid in December 2018.

We evaluated each acquisition to determine whether the integrated set of assets and activities acquired met the definition of a business. Acquisitions that do not meet the definition of a business are accounted for as asset acquisitions. An integrated set of assets and activities does not qualify as a business if substantially all of the fair value of the gross assets is concentrated in either a single identifiable asset or a group of similar identifiable assets, or if the acquired assets do not include a substantive process.

Based upon our evaluation of each acquisition, we determined that substantially all of the fair value related to each acquisition is concentrated in a single identifiable asset or a group of similar identifiable assets, or is associated with a land parcel with no operations. Accordingly, each transaction did not meet the definition of a business and consequently was accounted for as an asset acquisition. In each of these transactions, we allocated the total consideration for each acquisition to the individual assets and liabilities acquired on a relative fair value basis.

Sale of real estate asset

In February 2019, we completed a partial sale of a 60% interest in 75/125 Binney Street, a Class A property in our Cambridge submarket aggregating 388,270 RSF, for a sales price of $438 million, or $1,880 per RSF. We retained control over, and continue to consolidate, the new joint venture. We accounted for the $202.2 million difference between the consideration received and the book value of the 60% interest sold as an equity transaction with no gain recognized in earnings. Refer to Note 4 – “Consolidated and Unconsolidated Real Estate Joint Ventures” to these unaudited consolidated financial statements for additional information.

19


4.
Consolidated and unconsolidated real estate joint ventures

From time to time, we enter into joint venture agreements through which we own a partial interest in real estate entities that own, develop, and operate real estate properties. As of March 31, 2019, we had the following properties that were held by our real estate joint ventures:
 
Property
 
Market
 
Submarket
 
Our Ownership Interest
 
RSF
Consolidated joint ventures(1):
 
 
 
 
 
 
 
 
 
 
 
 
75/125 Binney Street
 
Greater Boston
 
Cambridge
 
 
40.0
%
 
 
388,270

 
 
225 Binney Street
 
Greater Boston
 
Cambridge
 
 
30.0
%
 
 
305,212

 
 
409 and 499 Illinois Street
 
San Francisco
 
Mission Bay/SoMa
 
 
60.0
%
 
 
455,069

 
 
1500 Owens Street
 
San Francisco
 
Mission Bay/SoMa
 
 
50.1
%
 
 
158,267

 
 
Campus Pointe by Alexandria(2)
 
San Diego
 
University Town Center
 
 
55.0
%
 
 
798,799

 
 
9625 Towne Centre Drive
 
San Diego
 
University Town Center
 
 
50.1
%
 
 
163,648

 
Unconsolidated joint ventures(1):
 
 
 
 
 
 
 
 
 
 
 
 
Menlo Gateway
 
San Francisco
 
Greater Stanford
 
 
44.5
%
(3) 
 
772,983

 
 
1401/1413 Research Boulevard
 
Maryland
 
Rockville
 
 
65.0
%
(4) 
 
(5
)
 
 
704 Quince Orchard Road
 
Maryland
 
Gaithersburg
 
 
56.8
%
(4) 
 
79,931

 
 
1655 and 1725 Third Street
 
San Francisco
 
Mission Bay/SoMa
 
 
10.0
%
 
 
593,765

 

(1)
In addition to the consolidated real estate joint ventures listed, various partners hold insignificant noncontrolling interests in four other joint ventures in North America, and we hold an insignificant noncontrolling interest in one unconsolidated real estate joint venture in North America.
(2)
Includes only 10290 and 10300 Campus Point Drive and 4110 Campus Point Court in our University Town Center submarket.
(3)
As of March 31, 2019, we have a 44.5% ownership interest in Menlo Gateway and expect our ownership to increase to 49% through future funding of construction costs in 2019.
(4)
Represents our ownership interest; our voting interest is limited to 50%.
(5)
Joint venture with a distinguished retail real estate developer for the development of an approximate 90,000 RSF retail shopping center.

Our consolidation policy is fully described under the “Consolidation” section of Note 2 – “Summary of Significant Accounting Policies” to these unaudited consolidated financial statements. Consolidation accounting is highly technical, but its framework is primarily based on the controlling financial interests and benefits of the joint ventures. We generally consolidate a joint venture that is a legal entity that we control (i.e., we have the power to direct the activities of the joint venture that most significantly affect its economic performance) through contractual rights, regardless of our ownership interest, and where we determine that we have benefits through the allocation of earnings or losses and fees paid to us that could be significant to the joint venture (the “VIE model”). We also generally consolidate joint ventures when we have a controlling financial interest through voting rights and where our voting interest is greater than 50% (the “voting model”). Voting interest differs from ownership interest for some joint ventures. We account for joint ventures that do not meet the consolidation criteria under the equity method of accounting by recognizing our share of income and losses. The table below shows the categorization of our existing significant joint ventures under the consolidation framework:
Property
 
Consolidation Model
 
Voting Interest
 
Consolidation Analysis
 
Conclusion
 
 
 
 
 
 
 
 
 
75/125 Binney Street
 
VIE model

 
Not applicable under VIE model
 
We have control and benefits that can be significant to the joint venture; therefore, we are the primary beneficiary of each VIE
 
Consolidated
225 Binney Street
 
409 and 499 Illinois Street
 
1500 Owens Street
 
Campus Pointe by Alexandria
 
9625 Towne Centre Drive
 
Menlo Gateway
 
 
We do not control the joint venture and are therefore not the primary beneficiary
Equity method of accounting
1401/1413 Research Boulevard
 
704 Quince Orchard Road
 
Voting model
 
Does not exceed 50%
Our voting interest is 50% or less
 
1655 and 1725 Third Street
 


20



4.    Consolidated and unconsolidated real estate joint ventures (continued)

Consolidated VIEs’ balance sheet information

The table below aggregates the balance sheet information of our consolidated VIEs as of March 31, 2019, and December 31, 2018 (in thousands):
 
 
March 31, 2019
 
December 31, 2018
Investments in real estate
 
$
1,431,694

 
$
1,108,385

Cash and cash equivalents
 
50,291

 
42,178

Other assets
 
133,148

 
74,901

Total assets
 
$
1,615,133

 
$
1,225,464

 
 
 
 
 
Secured notes payable
 
$

 
$

Other liabilities
 
55,582

 
59,336

Total liabilities
 
55,582

 
59,336

Redeemable noncontrolling interests
 
977

 
874

Alexandria Real Estate Equities, Inc.’s share of equity
 
782,417

 
624,349

Noncontrolling interests’ share of equity
 
776,157

 
540,905

Total liabilities and equity
 
$
1,615,133

 
$
1,225,464


In determining whether to aggregate the balance sheet information of our consolidated VIEs, we considered the similarity of each VIE, including the primary purpose of these entities to own, manage, operate, and lease real estate properties owned by the VIEs, and the similar nature of our involvement in each VIE as a managing member. Due to the similarity of the characteristics, we present the balance sheet information of these entities on an aggregated basis. For each of our consolidated VIEs, none of its assets have restrictions that limit their use to settle specific obligations of the VIE. There are no creditors or other partners of our consolidated VIEs that have recourse to our general credit. Our maximum exposure to our consolidated VIEs is limited to our variable interests in each VIE.

Unconsolidated real estate joint ventures

As of March 31, 2019, and December 31, 2018, our investments in unconsolidated real estate joint ventures accounted for under the equity method of accounting presented in our consolidated balance sheets consist of the following (in thousands):
Property
 
March 31, 2019
 
December 31, 2018
Menlo Gateway
 
$
239,000

 
$
186,504

1401/1413 Research Boulevard
 
7,936

 
8,197

704 Quince Orchard Road
 
4,511

 
4,547

1655 and 1725 Third Street
 
35,414

 
34,917

Other
 
3,544

 
3,342

 
 
$
290,405

 
$
237,507

    
Our maximum exposure to our unconsolidated VIEs is limited to our investment in each VIE.


21



4.    Consolidated and unconsolidated real estate joint ventures (continued)

As of March 31, 2019, our unconsolidated real estate joint ventures have the following non-recourse secured loans that include the following key terms (dollars in thousands):
 
 
 
 
Maturity Date
 
Stated Interest Rate
 
Interest Rate(1)
 
100% at Joint Venture Level
 
Unconsolidated Joint Venture
 
Our Share
 
 
 
 
Debt Balance(2)
 
Remaining Commitments
 
1401/1413 Research Boulevard
 
65.0%
 
 
5/17/20
 
 
L+2.50%
 
5.97%
 
$
22,364

 
$
6,315

 
1655 and 1725 Third Street
 
10.0%
 
 
6/29/21
 
 
L+3.70%
 
6.19%
 
204,830

 
170,170

 
704 Quince Orchard Road
 
56.8%
 
 
3/16/23
 
 
L+1.95%
 
4.68%
 
6,020

 
8,833

 
Menlo Gateway, Phase II
 
44.5%
 
 
5/1/35
 
 
4.53%
 
N/A
 

 
157,270

 
Menlo Gateway, Phase I
 
44.5%
 
 
8/10/35
 
 
4.15%
 
4.18%
 
143,940

 
408

 
 
 
 
 
 
 
 
 
 
 
 
 
$
377,154

 
$
342,996

 

(1)
Includes interest expense and amortization of loan fees for the three months ended March 31, 2019.
(2)
Represents outstanding principal, net of unamortized deferred financing costs, as of March 31, 2019.


5.
Leases
    
On January 1, 2019, we adopted a new lease accounting standard that sets out the principles for the recognition, measurement, presentation, and disclosure of leases for both parties to a lease agreement (i.e., lessees and lessors).

As a lessor, we are required to disclose, among other things, the following:

A description of the nature of leases, including terms for any variable payments, options to extend or terminate, and options to purchase the underlying asset;
Tabular presentation of undiscounted cash flows to be received over the next five years and thereafter separately for operating leases and direct financing leases;
The amount of lease income and its location on the statements of income;
Income classified separately for operating leases and direct financing leases; and
Our risk management strategy to mitigate declines in residual value of the leased assets.

As a lessee, we are required to disclose, among other things, the following:
A description of the nature of leases, including terms for any variable payments, options to extend or terminate, and options to purchase the underlying asset;
The amounts of lease liabilities and corresponding right-of-use assets and their respective locations in the balance sheet;
The weighted-average remaining lease term and weighted-average discount rate of leases;
Tabular presentation of undiscounted cash flows of our remaining lease payment obligations over the next five years and thereafter; and
Total lease costs, including cash paid, amounts expensed, and amounts capitalized.

Refer to the “Lease Accounting” section of Note 2 – “Summary of Significant Accounting Policies” for additional information.

Leases in which we are a lessor

As of March 31, 2019, we had 250 properties aggregating 23.2 million operating RSF located in key locations, including Greater Boston, San Francisco, New York City, San Diego, Seattle, Maryland, and Research Triangle. We focus on developing Class A properties in AAA innovation cluster locations, which we consider to be highly desirable for tenancy by life science and technology entities. Such locations are generally characterized by high barriers to entry for new landlords, high barriers to exit for tenants, and a limited supply of available space. As of March 31, 2019, all our leases in which we are a lessor were classified as operating leases with one exception of a direct financing lease. Our operating leases and direct financing lease are described below.


22



5.    Leases (continued)

Operating leases

As of March 31, 2019, our 250 properties were subject to operating lease agreements. Two of these properties, representing two land parcels, are subject to lease agreements that each contain an option for the lessee to purchase the underlying asset from us at fair market value during each of the 30-day periods commencing on the dates that are 15 years, 30 years, and 74.5 years after the rent commencement date of October 1, 2017. The remaining lease term related to each of the two land parcels is 73.7 years. Our leases generally contain options to extend lease terms at prevailing market rates at the time of expiration and do not have options to early terminate. Lease payments to be received under the terms of our operating lease agreements, excluding expense reimbursements, in effect as of March 31, 2019, are outlined in the table below (in thousands):
Year
 
Amount
2019
 
$
689,769

2020
 
947,419

2021
 
930,216

2022
 
891,279

2023
 
831,843

Thereafter
 
5,968,778

Total
 
$
10,259,304


Refer to Note 3 – “Investments in Real Estate” to these unaudited consolidated financial statements for additional information on our owned real estate assets, which are the underlying assets under our operating leases.

Direct financing lease

As of March 31, 2019, we have one direct financing lease agreement for a parking structure with a remaining lease term of 73.7 years. The lessee has an option to purchase the underlying asset at fair market value during each of the 30-day periods commencing on the dates that are 15 years, 30 years, and 74.5 years after the rent commencement date of October 1, 2017. The components of our net investment in our direct financing lease as of March 31, 2019 and December 31, 2018, are summarized in the table below (in thousands):
 
March 31, 2019
 
December 31, 2018
Gross investment in direct financing lease
$
261,702

 
$
262,111

Less: unearned income
(222,361
)
 
(222,962
)
Net investment in direct financing lease
$
39,341

 
$
39,149


Future lease payments to be received under our direct financing lease as of March 31, 2019, were as follows (in thousands):
Year
 
Total
2019
 
$
1,246

2020
 
1,705

2021
 
1,756

2022
 
1,809

2023
 
1,863

Thereafter
 
253,323

Total
 
$
261,702



23



5.    Leases (continued)

Income from rentals

Our total income from rentals includes revenue related to agreements for rental of our investments in real estate, which primarily includes revenues subject to the guidance of the new lease accounting standard, as well as revenues subject to the revenue recognition accounting standard as summarized below (in thousands):
 
 
Three Months Ended March 31, 2019
Income from rentals:
 
 
Revenues subject to the new lease accounting standard:
 
 
Operating leases
 
$
343,339

Direct financing leases
 
601

Revenues subject to the new lease accounting standard
 
343,940

Revenues subject to the revenue recognition accounting standard
 
10,809

Income from rentals
 
$
354,749


Our revenues that are subject to the revenue recognition accounting standard relate primarily to parking revenues, which consist of short-term rental revenues that are not considered lease revenue under the new lease accounting standard. Refer to the “Revenue” and “Recognition of revenue arising from contracts with customers” sections of Note 2 for additional information.

Residual value risk management strategy

Our leases do not have guarantees of residual value on the underlying assets. We manage risk associated with the residual value of our leased assets by (i) evaluating each potential acquisition of real estate to determine whether it meets our business objective to primarily invest in high-demand markets with limited supply of available space, (ii) directly managing our leased properties, and (iii) carefully selecting our tenants and monitoring their credit quality throughout their respective lease terms. Upon the expiration or termination of a lease, we often have the ability to renew the space with an existing tenant or re-lease to a new tenant within a reasonable amount of time.

Leases in which we are a lessee

We have operating lease agreements for which we are the lessee consisting of ground and office leases. Certain of these leases have options to extend or terminate the contract terms upon meeting certain criteria. There are no notable restrictions or covenants imposed by the leases, nor guarantees of residual value.

Under the new lease accounting standard, we are required to recognize a right-of-use asset and a related liability to account for our future obligations under our ground and office lease arrangements for which we are the lessee. At the lease commencement date or at the acquisition date, if lease is acquired as part of our real estate acquisition, the lease liability is measured based on the present value of the future lease payments and the right-of-use asset is measured based on the corresponding lease liability, adjusted for the initial direct leasing cost and any other consideration exchanged with the landlord prior to the commencement of the lease, as well as, adjustments to reflect favorable or unfavorable terms of the lease when compared with market terms. Subsequently, the lease liability is accreted by applying a discount rate established at the lease commencement date to the lease liability balance as of the beginning of the period, and is reduced by the payments made during the period. The right-of-use asset is amortized on a straight-line basis during the lease term.

As of January 1, 2019, the present value of the remaining contractual payments, aggregating $590.3 million, under our operating lease agreements, including our extension options that we are reasonably certain to exercise, was $218.7 million. The present value of the remaining lease payments was calculated for each operating lease using each respective remaining lease term and a corresponding estimated incremental borrowing rate as of January 1, 2019, which is the interest rate that we estimate we would have to pay to borrow on a collateralized basis over a similar term for an amount equal to the lease payments. On January 1, 2019, we recognized a lease liability along with a corresponding right-of-use asset.

As of March 31, 2019, the present value of the remaining contractual payments, aggregating $657.0 million, under our operating lease agreements, including our extension options that we are reasonably certain to exercise, was $244.6 million. Our corresponding operating lease right-of-use assets, adjusted for initial direct leasing costs and other consideration exchanged with the landlord prior to the commencement of the lease, aggregated $238.4 million. As of March 31, 2019, the weighted-average remaining lease term of our operating leases for which we are a lessee was approximately 45 years, and the weighted-average discount rate was 5.37%.


24



5.    Leases (continued)

Ground lease obligations as of March 31, 2019, included leases for 30 of our properties, which accounted for approximately 12% of our total number of properties. Excluding one ground lease that expires in 2036 related to one operating property with a net book value of $8.2 million as of March 31, 2019, our ground lease obligations have remaining lease terms ranging from approximately 35 years to 96 years, including extension options which we are reasonably certain to exercise.

The reconciliation of future lease payments, under non-cancelable operating ground and office leases for which we are a lessee, to the operating lease liability reflected in our consolidated balance sheet as of March 31, 2019, is presented in the table below (in thousands):
Year
 
Total
2019
 
$
11,859

2020
 
14,208

2021
 
14,257

2022
 
14,390

2023
 
14,508

Thereafter
 
587,787

Total future payments under our operating leases for which we are a lessee
 
657,009

Effect of discounting
 
(412,408
)
Operating lease liability
 
$
244,601


Lessee operating costs

Operating lease costs represent amounts recognized, either expensed or capitalized, related to ground leases and leases for corporate office space in which we are the lessee. For the three months ended March 31, 2019 and 2018, our costs for operating leases in which we are the lessee were as follows (in thousands):
 
 
Three Months Ended March 31,
 
 
2019
 
2018
Gross operating lease costs
 
$
4,554

 
$
3,868

Capitalized lease costs
 
(62
)
 
(36
)
Expenses for operating leases in which we are the lessee
 
$
4,492

 
$
3,832

 
 
 
 
 

For the three months ended March 31, 2019 and 2018, amounts paid and classified as operating activities in our consolidated statements of cash flows for leases in which we are the lessee, were $4.4 million and $3.6 million, respectively.

6.
Cash, cash equivalents, and restricted cash

Cash, cash equivalents, and restricted cash consisted of the following as of March 31, 2019, and December 31, 2018 (in thousands):
 
March 31, 2019
 
December 31, 2018
Cash and cash equivalents
$
261,372

 
$
234,181

Restricted cash:
 
 
 
Funds held in trust under the terms of certain secured notes payable
25,378

 
22,681

Funds held in escrow related to construction projects and investing activities
25,142

 
10,558

Other
3,913

 
4,710

 
54,433

 
37,949

Total
$
315,805

 
$
272,130



25


7.
Investments

We hold investments in publicly traded companies and privately held entities primarily involved in the life science and technology industries. Investments in publicly traded companies are classified as investments with readily determinable fair values, and are carried at fair value, with changes in fair value classified in net income. Our investments in privately held entities consist of (i) investments that report NAV, such as our privately held investments in limited partnerships, which are carried at fair value using NAV as a practical expedient with changes in fair value classified in net income, and (ii) investments in privately held entities that do not report NAV, which are measured at cost, adjusted for observable price changes and impairments, with changes recognized in net income.

Effective January 1, 2018:
Investments in publicly traded companies are presented at fair value in our consolidated balance sheet, with changes in fair value recognized in net income.
Investments in privately held entities without readily determinable fair values previously accounted for under the cost method are accounted for as follows:
Investments in privately held entities that report NAV are presented at fair value using NAV as a practical expedient, with changes in fair value recognized in net income. We use NAV reported by limited partnerships without adjustment, unless we are aware of information indicating that the NAV reported by a limited partnership does not accurately reflect the fair value of the investment at our reporting date.
Investments in privately held entities that do not report NAV are carried at cost, adjusted for observable price changes and impairments, with changes recognized in net income. These investments continue to be evaluated on the basis of a qualitative assessment for indicators of impairment by utilizing the same monitoring criteria described above and monitoring the presence of the following impairment indicators: (i) a significant deterioration in the earnings performance, credit rating, asset quality, or business prospects of the investee; (ii) a significant adverse change in the regulatory, economic, or technological environment of the investee, (iii) a significant adverse change in the general market condition of either the geographical area or the industry in which the investee operates, (iv) significant concerns about the investee’s ability to continue as a going concern. If such indicators are present, we are required to estimate the investment’s fair value and immediately recognize an impairment loss, without consideration as to whether the impairment is other-than-temporary, in an amount equal to the investment’s carrying value in excess of its estimated fair value.
Investments in privately held entities continue to require accounting under the equity method unless our interest in the entity is deemed to be so minor that we have virtually no influence over the entity’s operating and financial policies. Under the equity method of accounting, we initially recognize our investment at cost and adjust the carrying amount of the investment to recognize our share of the earnings or losses of the investee subsequent to the date of our investment. We had no investments accounted for under the equity method as of March 31, 2019.

We classify unrealized and realized gains and losses on our equity investments within investment income in our consolidated statements of income.

Unrealized gains and losses represent (i) changes in fair value for investments in publicly traded companies, (ii) changes in NAV, as a practical expedient to estimate fair value, for investments in privately held entities that report NAV, and (iii) observable price changes on our investments in privately held entities that do not report NAV. An observable price is a price observed in an orderly transaction for an identical or similar investment of the same issuer. Observable price changes result from, among other things, equity transactions for the same issuer executed during the reporting period, including subsequent equity offerings or other reported equity transactions related to the same issuer. For these transactions to be considered observable price changes, we evaluate whether these transactions have similar rights and obligations, including voting rights, distribution preferences, conversion rights, and other factors, to the investments we hold.

Realized gains and losses represent the difference between proceeds received upon disposition of investments and their historical or adjusted cost. Impairments are realized losses, which result in an adjusted cost, and represent charges to reduce the carrying values of investments in privately held entities that do not report NAV to their estimated fair value.


26



7.
Investments (continued)

The following tables summarize our investments as of March 31, 2019, and December 31, 2018 (in thousands):
 
March 31, 2019
 
Cost
 
Adjustments
 
Carrying Amount
Investments:
 
 
 
 
 
Publicly traded companies
$
127,760

 
$
97,194

 
$
224,954

Entities that report NAV
223,986

 
145,616

 
369,602

Entities that do not report NAV:
 
 
 
 
 
Entities with observable price changes
42,865

 
69,551

 
112,416

Entities without observable price changes
293,932

 

 
293,932

Total investments
$
688,543

 
$
312,361

 
$
1,000,904

 
December 31, 2018
 
Cost
 
Adjustments
 
Carrying Amount
Investments:
 
 
 
 
 
Publicly traded companies
$
121,121

 
$
62,884

 
$
184,005

Entities that report NAV
204,646

 
113,159

 
317,805

Entities that do not report NAV:
 
 
 
 
 
Entities with observable price changes
39,421

 
64,112

 
103,533

Entities without observable price changes
286,921

 

 
286,921

Total investments
$
652,109

 
$
240,155

 
$
892,264


Cumulative adjustments recognized on investments in privately held entities that do not report NAV held as of March 31, 2019, aggregated $69.6 million, which consisted of upward adjustments representing unrealized gains of $69.8 million and downward adjustments representing unrealized losses of $247 thousand.

Adjustments recognized on investments in privately held entities that do not report NAV aggregated $5.4 million during the three months ended March 31, 2019, which consisted of upward adjustments representing unrealized gains of $5.5 million and downward adjustments representing unrealized losses of $47 thousand.

Our income from investments during the three months ended March 31, 2019, consisted of the following (in thousands):
 
 
Three Months Ended March 31, 2019
 
 
Unrealized Gains
 
Realized Gains
 
Total
Investments held at March 31, 2019:
 
 
 
 
 
 
Publicly traded companies
 
$
43,654

 
$

 
$
43,654

Entities that report NAV
 
32,429

 

 
32,429

Entities that do not report NAV, held at period end
 
5,440

 

 
5,440

Total investments held at March 31, 2019
 
81,523

 

 
81,523

Investment dispositions during the three months ended March 31, 2019:
 
 
 
 
 
 
Recognized in the current period
 

 
2,033

 
2,033

Previously recognized gains
 
(9,317
)
 
9,317

 

Total investment dispositions during the three months ended March 31, 2019
 
(9,317
)
 
11,350

 
2,033

Investment income
 
$
72,206

 
$
11,350

 
$
83,556


27



7.
Investments (continued)

Our investment income for the three months ended March 31, 2018, consisted of the following (in thousands):
 
 
Three Months Ended March 31, 2018
 
 
Unrealized Gains
 
Realized Gains
 
Total
Investments held at March 31, 2018:
 
 
 
 
 
 
Publicly traded companies
 
$
50,888

 
$

 
$
50,888

Entities that report NAV
 
15,087

 

 
15,087

Entities that do not report NAV, held at period end
 
11,043

 

 
11,043

Total investments held at March 31, 2018
 
77,018

 

 
77,018

Investment dispositions during the three months ended March 31, 2018:
 
 
 
 
 
 
Recognized in the current period
 

 
8,543

 
8,543

Previously recognized gains
 
(4,789
)
 
4,789

 

Total investment dispositions during the three months ended March 31, 2018
 
(4,789
)
 
13,332

 
8,543

Investment income
 
$
72,229

 
$
13,332

 
$
85,561


Investments in privately held entities that report NAV

Investments in privately held entities that report NAV consist primarily of investments in limited partnerships. We are committed to funding approximately $233.8 million for all investments, primarily consisting of $233.3 million related to investments in limited partnerships. Our funding commitments expire at various dates over the next 11 years, with a weighted-average expiration of 8.7 years.

These investments are not redeemable by us, but we normally receive distributions from these investments throughout their term. Our investments in privately held entities that report NAV generally have expected initial terms in excess of 10 years. The weighted-average remaining term during which these investments are expected to be liquidated was 8.6 years as of March 31, 2019.


28


8.
Other assets

The following table summarizes the components of other assets as of March 31, 2019, and December 31, 2018 (in thousands):
 
March 31, 2019
 
December 31, 2018
Acquired below-market ground leases
$

(1) 
$
17,434

Acquired in-place leases
157,194

 
132,906

Deferred compensation plan
19,124

 
19,238

Deferred financing costs – $2.2 billion unsecured senior line of credit
15,271

 
16,060

Deposits
12,524

 
12,974

Furniture, fixtures, and equipment
15,893

 
14,787

Interest rate hedge assets
494

 
2,606

Net investment in direct financing lease
39,341

 
39,149

Notes receivable
506

 
528

Operating lease right-of-use asset(2)
238,433

 

Other assets
19,735

 
19,861

Prepaid expenses
23,012

 
13,690

Property, plant, and equipment
112,199

 
81,024

Total
$
653,726

 
$
370,257


(1)
Upon the adoption of new lease accounting standards on January 1, 2019, this amount has been included in the calculation of our operating lease right-of-use asset.
(2)
Refer to Note 2 – “Summary of Significant Accounting Policies” and Note 5 – “Leases” to these unaudited consolidated financial statements for additional information.

29


9.
Fair value measurements

We provide fair value information about all financial instruments for which it is practicable to estimate fair value. We measure and disclose the estimated fair value of financial assets and liabilities by utilizing a fair value hierarchy that distinguishes between data obtained from sources independent of the reporting entity and the reporting entity’s own assumptions about market participant assumptions. This hierarchy consists of three broad levels, as follows: (i) quoted prices in active markets for identical assets or liabilities (Level 1), (ii) significant other observable inputs (Level 2), and (iii) significant unobservable inputs (Level 3). Significant other observable inputs can include quoted prices for similar assets or liabilities in active markets, as well as inputs that are observable for the asset or liability, such as interest rates, foreign exchange rates, and yield curves. Significant unobservable inputs are typically based on an entity’s own assumptions, since there is little, if any, related market activity. In instances in which the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level of input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability. There were no transfers between the levels in the fair value hierarchy during the three months ended March 31, 2019.

The following tables set forth the assets and liabilities that we measure at fair value on a recurring basis by level within the fair value hierarchy as of March 31, 2019, and December 31, 2018 (in thousands):
 
 
 
 
March 31, 2019
Description
 
Total
 
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets:
 
 
 
 
 
 
 
 
Investments in publicly traded companies
 
$
224,954

 
$
224,954

 
$

 
$

Interest rate hedge agreements
 
$
494

 
$

 
$
494

 
$

Liabilities:
 
 
 
 
 
 
 
 
Interest rate hedge agreements
 
$
1,143

 
$

 
$
1,143

 
$


 
 
 
 
December 31, 2018
Description
 
Total
 
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets:
 
 
 
 
 
 
 
 
Investments in publicly traded companies
 
$
184,005

 
$
184,005

 
$

 
$

Interest rate hedge agreements
 
$
2,606

 
$

 
$
2,606

 
$

Liabilities:
 
 
 
 
 
 
 
 
Interest rate hedge agreements
 
$
768

 
$