10-Q
United States
Securities and Exchange Commission
Washington, D.C. 20549
 
FORM 10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2016
 
Commission file number 001-33106

Douglas Emmett, Inc.

(Exact name of registrant as specified in its charter)
Maryland
20-3073047
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
 
808 Wilshire Boulevard, Suite 200, Santa Monica, California
90401
(Address of principal executive offices)
(Zip Code)
 
(310) 255-7700
(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 ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
Yes  x No  ¨
 
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 definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer  x     
Accelerated filer ¨
Non-accelerated filer ¨ (Do not check if a smaller reporting company)
Smaller reporting company ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 Yes  ¨ No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
Class
 
Outstanding at
April 29, 2016
Common Stock, $0.01 par value per share
 
147,803,520
shares

1


DOUGLAS EMMETT, INC.
FORM 10-Q

Table of Contents
 
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2

Table of Contents
Glossary

Abbreviations used in this document:
ASU
Accounting Standards Updates
CEO
Chief Executive Officer
CFO
Chief Financial Officer
Code
Internal Revenue Code of 1986, as amended
Company
Douglas Emmett, Inc.
EPS
Earnings Per Share
Exchange Act
Securities Exchange Act of 1934, as amended
FASB
Financial Accounting Standards Board
FDIC
Federal Deposit Insurance Corporation
FFO
Funds from Operations
Fund X
Douglas Emmett Fund X, LLC
Funds
Unconsolidated real estate funds
GAAP
Generally Accepted Accounting Principles
LIBOR
London Interbank Offered Rate
LTIP Units
Long-Term Incentive Plan Units
NAREIT
National Association of Real Estate Investment Trusts
OP Units
Operating Partnership Units
Operating Partnership
Douglas Emmett Properties, LP
Partnership X
Douglas Emmett Partnership X, LP
PCAOB
Public Company Accounting Oversight Board (United States)
REIT
Real Estate Investment Trust
Report
Quarterly Report on Form 10-Q
SEC
Securities and Exchange Commission (United States)
Securities Act
Securities Act of 1933, as amended
TRS
Taxable REIT subsidiary(ies)
US
United States
VIE
Variable Interest Entity

Defined terms used in this document:
Annualized rent
Annualized cash base rent (excludes tenant reimbursements, parking income, lost rent recovered from insurance and other revenue) before abatements under leases commenced as of the reporting date. For our triple net Burbank and Honolulu office properties, annualized rent is calculated by adding expense reimbursements to base rent.


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Table of Contents
Forward Looking Statements



This Report contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act.  You can find many (but not all) of these statements by looking for words such as "approximates," "believes," "expects," "anticipates," "estimates," "intends," "plans," "would," "could", "may", "future" or other similar expressions in this Report.  We claim the protection of the safe harbor contained in the Private Securities Litigation Reform Act of 1995.  We caution investors that any forward-looking statements presented in this Report, or those that we may make orally or in writing from time to time, are based on our beliefs and assumptions, as well as information currently available to us.  The actual outcome will be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control or ability to predict.  Although we believe that our assumptions are reasonable, they are not guarantees of future performance and some will inevitably prove to be incorrect.  As a result, our actual future results can be expected to differ from our expectations, and those differences may be material.  Accordingly, investors should use caution when relying on previously reported forward-looking statements, which were based on results and trends at the time they were made, to anticipate future results or trends.

Some of the risks and uncertainties that may cause our actual results, performance or achievements to differ materially from those expressed or implied by forward-looking statements include the following:

adverse economic or real estate developments in Southern California and Honolulu, Hawaii;
a general downturn in the economy, such as the global financial crisis that commenced in 2008;
decreased rental rates or increased tenant incentive and vacancy rates;
defaults on, early termination of, or non-renewal of leases by tenants;
increased interest rates and operating costs;
failure to generate sufficient cash flows to service our outstanding indebtedness;
difficulties in raising capital for our unconsolidated Funds;
difficulties in identifying properties to acquire and completing acquisitions;
failure to successfully operate acquired properties;
failure to maintain our status as a REIT under federal tax laws;
possible adverse changes in rent control laws and regulations;
environmental uncertainties;
risks related to natural disasters;
lack or insufficient amount of insurance, or changes to the cost of maintaining existing insurance coverage;
inability to successfully expand into new markets and submarkets;
risks associated with property development;
conflicts of interest with our officers;
changes in real estate zoning laws and increases in real property tax rates;
the negative results of litigation or governmental proceedings;
the consequences of any possible future terrorist attacks or wars; and
the consequences of any possible future cyber attacks or intrusions.

For further discussion of the above risk factors, see "Item 1A. Risk Factors" in our 2015 Annual Report on Form 10-K.

This Report and all subsequent written and oral forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section.  We do not undertake any obligation to release publicly any revisions to our forward-looking statements to reflect events or circumstances after the date of this Report.


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Table of Contents


PART I. FINANCIAL INFORMATION

Item 1. Financial Statements
Douglas Emmett, Inc.
Consolidated Balance Sheets
(Unaudited; in thousands, except share data)
 
March 31, 2016
 
December 31, 2015
Assets
 

 
 

Investment in real estate:
 

 
 

Land
$
993,043

 
$
897,916

Buildings and improvements
6,884,342

 
5,644,546

Tenant improvements and lease intangibles
756,695

 
696,647

Property under development
28,316

 
26,900

Investment in real estate, gross
8,662,396

 
7,266,009

Less: accumulated depreciation and amortization
(1,738,848
)
 
(1,687,998
)
Investment in real estate, net
6,923,548

 
5,578,011

Real estate held for sale, net
42,551

 
42,943

Cash and cash equivalents
72,191

 
101,798

Tenant receivables, net
3,668

 
1,907

Deferred rent receivables, net
82,756

 
79,837

Acquired lease intangible assets, net
4,661

 
4,484

Interest rate contract assets
1,493

 
4,830

Investment in unconsolidated real estate funds
148,602

 
164,631

Other assets
11,954

 
87,720

Total assets
$
7,291,424

 
$
6,066,161

 
 
 
 
Liabilities
 

 
 

Secured notes payable and revolving credit facility, net
$
4,469,957

 
$
3,611,276

Interest payable, accounts payable and deferred revenue
75,587

 
57,417

Security deposits
43,014

 
38,683

Acquired lease intangible liabilities, net
76,752

 
28,605

Interest rate contract liabilities
33,075

 
16,310

Dividends payable
32,424

 
32,322

Total liabilities
4,730,809

 
3,784,613

 
 
 
 
Equity
 

 
 

Douglas Emmett, Inc. stockholders' equity:
 

 
 

Common Stock, $0.01 par value 750,000,000 authorized, 147,383,520 and 146,919,187 outstanding at March 31, 2016 and December 31, 2015, respectively
1,474

 
1,469

Additional paid-in capital
2,712,150

 
2,706,753

Accumulated other comprehensive loss
(27,313
)
 
(9,285
)
Accumulated deficit
(789,784
)
 
(772,726
)
Total Douglas Emmett, Inc. stockholders' equity
1,896,527

 
1,926,211

Noncontrolling interests
664,088

 
355,337

Total equity
2,560,615

 
2,281,548

Total liabilities and equity
$
7,291,424

 
$
6,066,161

See accompanying notes to the consolidated financial statements.

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Table of Contents
Douglas Emmett, Inc.
Consolidated Statements of Operations
(Unaudited; in thousands, except per share data)



 
Three Months Ended March 31,
 
2016
 
2015
 
 
 
 
Revenues
 

 
 

Office rental
 

 
 

Rental revenues
$
111,006

 
$
100,651

Tenant recoveries
10,211

 
10,150

Parking and other income
23,162

 
20,655

Total office revenues
144,379

 
131,456

 
 
 
 
Multifamily rental
 

 
 

Rental revenues
22,427

 
21,644

Parking and other income
1,766

 
1,709

Total multifamily revenues
24,193

 
23,353

 
 
 
 
Total revenues
168,572

 
154,809

 
 
 
 
Operating Expenses
 

 
 

Office expenses
47,883

 
44,199

Multifamily expenses
6,031

 
5,820

General and administrative
8,071

 
7,361

Depreciation and amortization
55,552

 
49,834

Total operating expenses
117,537

 
107,214

 
 
 
 
Operating income
51,035

 
47,595

 
 
 
 
Other income
2,089

 
8,559

Other expenses
(1,551
)
 
(1,572
)
Income, including depreciation, from unconsolidated real estate funds
1,586

 
1,443

Interest expense
(35,660
)
 
(33,639
)
Acquisition-related expenses
(1,453
)
 
(290
)
Net income
16,046

 
22,096

Less:  Net income attributable to noncontrolling interests
(680
)
 
(3,397
)
Net income attributable to common stockholders
$
15,366

 
$
18,699

 
 
 
 
Net income attributable to common stockholders per share – basic
$
0.104

 
$
0.128

Net income attributable to common stockholders per share – diluted
$
0.101

 
$
0.124

 
 
 
 
Dividends declared per common share
$
0.22

 
$
0.21

 
See accompanying notes to the consolidated financial statements.

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Table of Contents
Douglas Emmett, Inc.
Consolidated Statements of Comprehensive Income (Loss)
(Unaudited and in thousands)



 
Three Months Ended March 31,
 
2016
 
2015
 
 
 
 
Net income
$
16,046

 
$
22,096

Other comprehensive income (loss): cash flow hedges
(20,608
)
 
1,018

Comprehensive income (loss)
(4,562
)
 
23,114

Less: Comprehensive (income) loss attributable to noncontrolling interests
1,900

 
(3,730
)
Comprehensive income (loss) attributable to common stockholders
$
(2,662
)
 
$
19,384

 
See accompanying notes to the consolidated financial statements.



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Table of Contents
Douglas Emmett, Inc.
Consolidated Statements of Cash Flows
(Unaudited and in thousands)


 
Three Months Ended March 31,
 
2016
 
2015
Operating Activities
 

 
 

Net income
$
16,046

 
$
22,096

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

 
 

Income, including depreciation, from unconsolidated real estate funds
(1,586
)
 
(1,443
)
Depreciation and amortization
55,552

 
49,834

Net accretion of acquired lease intangibles
(3,304
)
 
(9,800
)
Straight-line rent
(2,919
)
 
(2,225
)
Increase in the allowance for doubtful accounts
679

 
(135
)
Amortization of deferred loan costs
1,319

 
1,773

Amortization of stock-based compensation
2,379

 
1,947

Operating distributions from unconsolidated real estate funds
375

 
286

Change in working capital components:
 

 
 

Tenant receivables
(2,440
)
 
458

Interest payable, accounts payable and deferred revenue
18,444

 
9,719

Security deposits
4,331

 
(1,009
)
Other assets
965

 
1,425

Net cash provided by operating activities
89,841

 
72,926

 
 
 
 
Investing Activities
 

 
 

Capital expenditures for improvements to real estate
(15,556
)
 
(20,526
)
Capital expenditures for developments
(1,412
)
 
(667
)
Property acquisitions
(1,257,513
)
 
(89,906
)
Proceeds from repayment of note receivable

 
1,000

Loan payments received from related parties
763

 
307

Capital distributions from unconsolidated real estate funds
15,773

 
2,060

Net cash used in investing activities
(1,257,945
)
 
(107,732
)
 
 
 
 
Financing Activities
 

 
 

Proceeds from borrowings
900,000

 
214,400

Repayment of borrowings
(31,194
)
 
(146,224
)
Loan costs
(11,444
)
 
(960
)
Contributions from noncontrolling interests in consolidated joint venture
320,000

 

Distributions to noncontrolling interests in our Operating Partnership
(6,098
)
 
(5,995
)
Cash dividends to common stockholders
(32,322
)
 
(30,422
)
Exercise of stock options

 
1,823

Withholding taxes for exercise of stock options
(445
)
 

Net cash provided by financing activities
1,138,497

 
32,622

 
 
 
 
Decrease in cash and cash equivalents
(29,607
)
 
(2,184
)
Cash and cash equivalents at beginning of period
101,798

 
18,823

Cash and cash equivalents at end of period
$
72,191

 
$
16,639


See supplemental cash flows information on the next page.

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Table of Contents
Douglas Emmett, Inc.
Consolidated Statements of Cash Flows
(Unaudited and in thousands)


 
Three Months Ended March 31,
 
2016
 
2015
SUPPLEMENTAL CASH FLOWS INFORMATION
 
 
 
 
 
 
 
OPERATING ACTIVITIES
 
 
 
Cash paid for interest, net of capitalized interest of $238 and $166 for the three months ended March 31, 2016 and 2015, respectively
$
32,893

 
$
31,644

 
 
 
 
NONCASH INVESTING TRANSACTIONS
 
 
 
Decrease in accrual for capital expenditures for improvements to real estate and developments
$

 
$
943

Capitalized stock-based compensation for improvements to real estate and developments
$
217

 
$
193

Write-off of fully depreciated and amortized tenant improvements and lease intangibles
$
4,230

 
$

Write-off of fully amortized acquired lease intangible assets
$
150

 
$

Write-off of fully accreted acquired lease intangible liabilities
$
6,424

 
$
10,040

Settlement of note receivable in exchange for land and building acquired
$

 
$
26,500

Issuance of OP Units in exchange for land and building acquired
$

 
$
1,000

Application of deposit to purchase price of property
$
75,000

 
$
2,500

Loss from market value adjustments - our derivatives
$
(28,812
)
 
$
(7,022
)
Loss from market value adjustments - our unconsolidated Funds' derivatives
$
(611
)
 
$
(1,333
)
 
 
 
 
NONCASH FINANCING TRANSACTIONS
 
 
 
Dividends declared
$
32,424

 
$
30,631

Common stock issued in exchange for OP Units
$
5,847

 
$
11,408


See accompanying notes to the consolidated financial statements for additional non-cash items.


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Table of Contents
Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited)




1. Overview

Organization and Business Description

Douglas Emmett, Inc. is a fully integrated, self-administered and self-managed REIT. We are one of the largest owners and operators of high-quality office and multifamily properties in Los Angeles County, California and Honolulu, Hawaii. We focus on owning, acquiring, developing and managing a substantial share of top-tier office properties and premier multifamily communities in neighborhoods that possess significant supply constraints, high-end executive housing and key lifestyle amenities.

Through our interest in our Operating Partnership and its subsidiaries, our consolidated joint ventures and our unconsolidated Funds, we own or partially own, acquire, develop and manage real estate, consisting primarily of office and multifamily properties in Los Angeles County, California and Honolulu, Hawaii.

As of March 31, 2016, we owned a consolidated portfolio of (i) fifty-eight office properties (including ancillary retail space), which included five office properties owned by our consolidated joint ventures, (ii) ten multifamily properties and (iii) fee interests in two parcels of land subject to ground leases from which we earn ground rent income. Alongside our consolidated portfolio, we also manage and own equity interests in our unconsolidated Funds, which at March 31, 2016, owned eight additional office properties, for a combined sixty-six office properties in our total portfolio.

The terms "us," "we" and "our" as used in these financial statements refer to Douglas Emmett, Inc. and its subsidiaries.

Basis of Presentation

The accompanying financial statements are the consolidated financial statements of Douglas Emmett, Inc. and its subsidiaries, including our Operating Partnership and our consolidated joint ventures.  All significant intercompany balances and transactions have been eliminated in our consolidated financial statements.

As of March 31, 2016, the consolidated financial statements included one VIE, in which we were deemed to be the primary beneficiary. The VIE was established in the first quarter of 2016 in connection with Westwood portfolio acquisition, see Note 3. As of March 31, 2016, the impact of consolidating the VIE increased the Company’s total assets, liabilities and equity by approximately $1.43 billion million (of which $1.38 billion related to real estate held for investment), $631.7 million and $798.3 million (of which $318.6 million related to the noncontrolling interests equity), respectively.

As of March 31, 2016, the carrying value of a property that we are currently marketing was reclassified from investment in real estate to real estate held for sale in our accompanying Consolidated Balance Sheets, and we reclassified the comparable period to conform to the current period presentation.

During the current reporting period, we reported our proceeds from, and repayments of, borrowings related to our credit facility on a gross basis in the accompanying Consolidated Statements of Cash Flows, and we reclassified the prior periods, which were previously reported on a net basis, to conform to the current period presentation. The change in presentation did not change the net cash provided by (used in) financing activities that we previously reported for the prior periods.

The accompanying unaudited interim financial statements have been prepared pursuant to the rules and regulations of the SEC. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with US GAAP may have been condensed or omitted pursuant to SEC rules and regulations, although we believe that the disclosures are adequate to make their presentation not misleading. The accompanying unaudited interim financial statements include, in our opinion, all adjustments, consisting of normal recurring adjustments, necessary to present fairly the financial information set forth therein. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the year ending December 31, 2016. The interim financial statements should be read in conjunction with the consolidated financial statements in our 2015 Annual Report on Form 10-K and the notes thereto. Any references in this report to the number of properties, square footage, per square footage amounts, apartment units and geography, are outside the scope of our independent registered public accounting firm’s review of our financial statements, in accordance with the standards of the PCAOB.


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Table of Contents
Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

2. Summary of Significant Accounting Policies

During the period covered by this Report, we have not made any material changes to our significant accounting policies included in our 2015 Annual Report on Form 10-K.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make certain estimates and assumptions that affect the reported amounts in the consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates.

Income Taxes

We have elected to be taxed as a REIT under the Code. Provided that we qualify for taxation as a REIT, we are generally not subject to corporate-level income tax on the earnings distributed currently to our stockholders that we derive from our REIT qualifying activities. We are subject to corporate-level tax on the earnings that we derive through our TRS.

New Accounting Pronouncements 

Changes to GAAP are established by the FASB in the form ASUs.  We consider the applicability and impact of all ASUs.

Recently Issued and Adopted Accounting Pronouncements

In January 2015, the FASB issued ASU No. 2015-01, "Income Statement—Extraordinary and Unusual Items (Subtopic 225-20)", which eliminates the concept of extraordinary items from GAAP. The Board is issuing this Update as part of its initiative to reduce complexity in accounting standards (the Simplification Initiative). The objective of the Simplification Initiative is to identify, evaluate, and improve areas of GAAP for which cost and complexity can be reduced while maintaining or improving the usefulness of the information provided to the users of financial statements. The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015, which for us is the first quarter of 2016. We adopted the ASU in the first quarter of 2016 and it did not have a material impact on our financial position, results of operations or disclosures.

In February 2015, the FASB issued ASU No. 2015-02, "Amendments to the Consolidation Analysis (Consolidation - Topic 810)", which provides guidance regarding the consolidation of certain legal entities. All legal entities are subject to reevaluation under the revised consolidation model. The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015, which for us is the first quarter of 2016. We adopted the ASU in the first quarter of 2016 and it did not have a material impact on our financial position, results of operations or disclosures.

In September 2015, the FASB issued ASU No. 2015-16, "Simplifying the Accounting for Measurement-Period Adjustments", which amends "Business Combinations" (Topic 805). The ASU requires that an acquirer (i) recognize adjustments to provisional amounts from business combinations that are identified during the measurement period in the reporting period in which the adjustment amounts are determined, (ii) record, in the same period’s financial statements, the effect on earnings, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date and (iii) disclose of the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015, which for us is the first quarter of 2016. We adopted the ASU in the first quarter of 2016 and it did not have a material impact on our financial position, results of operations or disclosures.

In March 2016, the FASB issued ASU No. 2016-05, "Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships", which amends "Derivatives and Hedging" (Topic 815). The ASU provides guidance on the effect of derivative contract novations on existing hedge accounting relationships. The ASU clarifies that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument under Topic 815, does not in and of itself require dedesignation of that hedging relationship provided that all other hedge accounting criteria continue to be met. The ASU is effective for fiscal years beginning after December 15, 2016, and interim periods within those years, which for us would be the first quarter of 2017, and early adoption is permitted. We adopted the ASU in the first quarter of 2016 and it did not have a material impact on our financial position, results of operations or disclosures.


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Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

Recently Issued Accounting Pronouncements

In January 2016, the FASB issued ASU No. 2016-01, "Recognition and Measurement of Financial Assets and Financial Liabilities" which amends "Financial Instruments - Overall" (Subtopic 825-10). The amendments in this Update address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those years, which for us would be the first quarter of 2018. The amendments in this Update should be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption, and early adoption is permitted under certain circumstances. We do not expect the ASU to have a material impact on our financial position, results of operations or disclosures.

In February 2016, the FASB issued ASU No. 2016-02, "Leases" (Topic 842). The ASU increases transparency and comparability among organizations by recognizing lease assets and liabilities on the balance sheet and disclosing key information about leasing arrangements. To meet that objective, the FASB has created Topic 842. The accounting applied by a lessor is largely unchanged from that applied under previous GAAP. For example, the vast majority of operating leases will remain classified as operating leases, and lessors will continue to recognize lease income for those leases on a generally straight-line basis over the lease term. The ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those years, which for us would be the first quarter of 2019, and early adoption is permitted. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The modified retrospective approach includes a number of optional practical expedients that entities may elect to apply. We do not expect the ASU to have a material impact on our financial position, results of operations or disclosures.

In March 2016, the FASB issued ASU No. 2016-07, "Simplifying the Transition to the Equity Method of Accounting" which amends "Investments-Equity Method and Joint Ventures" (Topic 323). The ASU simplifies the transition to the equity method of accounting by eliminating the requirement that an entity retroactively adopt the equity method of accounting if an investment qualifies for use of the equity method as a result of an increase in the level of ownership or degree of influence. The ASU requires that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment qualifies for equity method accounting. The ASU is effective for fiscal years beginning after December 15, 2016, including interim periods within those years, which for us would be the first quarter of 2017, and early adoption is permitted. The amendments in this Update should be applied prospectively. We do not expect the ASU to have a material impact on our financial position, results of operations or disclosures.

In March 2016, the FASB issued ASU No. 2016-08, "Principal versus Agent Considerations (Reporting Revenue Gross versus Net)" which amends "Revenue from Contracts with Customers" (Topic 606). The ASU clarifies the implementation guidance for principal versus agent considerations. The ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those years, which for us would be the first quarter of 2018, and early adoption is permitted commencing the first quarter of 2017. The amendments in this Update should be applied retrospectively. We are currently evaluating the impact of this ASU.

In March 2016, the FASB issued ASU No. 2016-09, "Improvements to Employee Share-Based Payment Accounting" which amends "Compensation-Stock Compensation" (Topic 718). This ASU simplifies the accounting for several aspects of share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Some of the areas for simplification apply only to nonpublic entities. The ASU is effective for fiscal years beginning after December 15, 2016, including interim periods within those years, which for us would be the first quarter of 2017, and early adoption is permitted. The ASU amendments are applied on a prospective or retrospective basis depending on the specific amendment. We do not expect the ASU to have a material impact on our financial position, results of operations or disclosures.

The FASB has not issued any other ASUs during 2016 that we expect to be applicable and have a material impact on our future financial position, results of operations or disclosures.


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Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

3. Investment in Real Estate

2016 First Quarter Acquisitions

Acquisition of the Westwood Portfolio

On February 29, 2016, a consolidated joint venture which we manage and own an equity interest in, acquired four class A multi-tenant office properties located in Westwood, California (Westwood Portfolio) for a contract price of $1.34 billion or approximately $777 per square foot. As of the acquisition date, we contributed sixty percent of the equity to the joint venture, but are scheduled to reduce that investment to 30% during the second quarter of 2016. See Note 17.

The table below (in thousands) summarizes our preliminary purchase accounting and funding sources for the acquisition (the purchase accounting is subject to adjustment within twelve months of the acquisition date):
Sources and Uses of Funds
At February 29, 2016(1)
Adjustments(2)
Pro Forma
 
 
 
 
Building square footage (in thousands)
1,725
1,725
 
 
 
 
Uses of funds - Investment in real estate:
 
 
 
Land
$
95,127

$

$
95,127

Buildings and improvements
1,238,162


1,238,162

Tenant improvements and lease intangibles
50,497


50,497

Acquired above and below-market leases, net
(51,273
)

(51,273
)
Net assets and liabilities acquired(3)
$
1,332,513

$

$
1,332,513

 
 
 
 
Source of funds:
 
 
 
Cash on hand(4)
$
153,745

$

$
153,745

Credit facility(5)
290,000

(240,000
)
50,000

Non-recourse term loan, net(6)
568,768


568,768

Noncontrolling interests
320,000

240,000

560,000

Total source of funds
$
1,332,513

$

$
1,332,513

________________________________________________    
(1)
Reflects the purchase of the Westwood portfolio on February 29, 2016 when we contributed 60% of the equity (including $240 million of bridge equity) to the consolidated joint venture.
(2)
Adjusted for the repayment of $240 million of bridge equity we provided at closing, which would reduce our ownership interest to 30%. The repayment (with interest at 2% per annum) is scheduled for the second quarter.
(3)
Difference between the contract price and the purchase price relates to a credit received for prorations.
(4)
Cash paid included $75.0 million paid through a deposit made before December 31, 2015, which was included in other assets in the Company's consolidated balance sheet as reported in the Form 10-K, $67.5 million paid at closing, and $11.2 million spent on loan costs in connection with securing the $580 million term loan.
(5)
Reflects borrowings using the Company's credit facility, which bears interest at LIBOR plus 1.40%. See Note 7.
(6)
Reflects 100%, not only the Company's pro rata share, of a $580.0 million interest-only non-recourse loan, net of loan fees of $11.2 million incurred to secure the loan. The loan has a seven-year term and is secured by the Westwood Portfolio. Interest on the loan is floating at LIBOR plus 1.40%, which has been effectively fixed at 2.37% per annum for five years through interest rate swaps. The loan costs will be deferred and amortized over the seven-year loan term. Deferred loan costs are presented in the balance sheet as a direct deduction from the carrying amount of our secured notes payable and revolving credit facility.



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Table of Contents
Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

The table below (in thousands) presents the revenues and net income attributable to common stockholders from the Westwood Portfolio which are included in the Company’s consolidated statement of operations from the date of acquisition:
Total office revenues
$
8,223

Net loss attributable to common stockholders
$
(2,611
)

Pro Forma Operating Results

The pro forma operating results presented in the table below (in thousands) combine the historical results of Douglas Emmett Inc., along with the historical results of the Westwood Portfolio, as if the acquisition was completed on January 1, 2015, based on our expected thirty-percent ownership interest, and includes adjustments that give effect to events that are (i) directly attributable to the acquisition, (ii)  expected to have a continuing impact on the Company, and (iii) are factually supportable. The pro forma reflects the hypothetical impact of the acquisition on the Company and does not (a) purport to represent what the Company’s results of operations would actually have been had the acquisition occurred on January 1, 2015, or (b) project the results of operations for any future period. The information does not reflect cost savings or operating synergies that may result from the acquisition or the costs to achieve any such potential cost savings or operating synergies.
 
Three Months Ended March 31,
 
2016
 
2015
 
 
 
 
Pro forma revenues
$
181,900

 
$
178,132

Pro forma net income attributable to common stockholders(1)
$
16,404

 
$
19,153

Pro forma net income attributable to common stockholders per share – basic
$
0.111

 
$
0.131

Pro forma net income attributable to common stockholders per share – diluted
$
0.108

 
$
0.127

_____________________________________________________
(1)    In the first quarter of 2015, we recognized an additional $6.6 million of accretion for an above-market ground lease in other income related to the purchase of the Harbor Court Land (see "2015 First Quarter Acquisitions" below and Note 4).

2015 First Quarter Acquisitions

During the three months ended March 31, 2015, we closed two acquisitions: (i) on March 5, 2015, we purchased a Class A multi-tenant office property (First Financial Plaza), located in Encino, California, for $92.4 million, or approximately $407 per square foot, and (ii) on February 12, 2015, we acquired the fee interest in the land (Harbor Court Land) under one of our office buildings for $27.5 million. We recognized $6.6 million of accretion of an above-market ground lease related to the purchase of the Harbor Court Land, which is included in other income in the consolidated statement of operations. See Note 4. The results of operations for these acquisitions are included in our consolidated statements of operations after the respective date of their acquisitions. The table below (in thousands) summarizes our purchase price allocations for the acquisitions:
 
Harbor Court Land
 
First Financial Plaza
 
 
 
 
Building square footage (if applicable) (in thousands)
 
 
227
 
 
 
 
Investment in real estate:
 
 
 
Land
$
12,060

 
$
12,092

Buildings and improvements
15,440

 
75,039

Tenant improvements and lease intangibles

 
6,065

Acquired above and below-market leases, net

 
(790
)
Net assets and liabilities acquired
$
27,500

 
$
92,406


Properties Held for Sale

We are currently marketing a 168,000 square foot Class A office property located in Sherman Oaks that we wholly own through a consolidated subsidiary. As of March 31, 2016, the carrying value of the property was reclassified from investment in real estate to real estate held for sale in our consolidated balance sheets.

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Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

4. Acquired Lease Intangibles

Summary of our Acquired Lease Intangibles

The table below (in thousands) summarizes our above/below-market leases:
 
March 31, 2016
 
December 31, 2015
 
 
 
 
Above-market tenant leases
$
5,081

(1) 
$
4,661

Accumulated amortization - above-market tenant leases
(2,893
)
(1) 
(2,670
)
Below-market ground leases
3,198

 
3,198

Accumulated amortization - below-market ground leases
(725
)
 
(705
)
Acquired lease intangible assets, net
$
4,661

 
$
4,484

 
 
 
 
Below-market tenant leases
$
148,563

(1) 
$
103,327

Accumulated accretion - below-market tenant leases
(75,356
)
(1) 
(78,280
)
Above-market ground leases
4,017

 
4,017

Accumulated accretion - above-market ground leases
(472
)
 
(459
)
Acquired lease intangible liabilities, net
$
76,752

 
$
28,605

________________________________________________    
(1)
Includes leases from the Westwood Portfolio that we purchased in the first quarter of 2016. See Note 3. The weighted average remaining life of the acquired above-and below-market leases is approximately 4.4 years.
 
Impact on the Consolidated Statements of Operations

Acquired above- and below-market leases are amortized/accreted over the life of the lease. The table below (in thousands) summarizes the net amortization/accretion related to our above/below-market leases:
 
Three Months Ended March 31,
 
2016
 
2015
 
 
 
 
Net accretion of above/below-market tenant leases(1)
$
3,295

 
$
3,191

Amortization of an below-market ground lease(2)
(4
)
 
(4
)
Accretion of above-market ground leases(3)
13

 
13

Accretion of an above-market ground lease(4)

 
6,600

Total
$
3,304

 
$
9,800

_______________________________________________
(1)
Recorded as a net increase to office and multifamily rental revenues. Includes the impact of leases from the Westwood Portfolio for the period after its purchase on February 29, 2016.
(2)
Ground lease from which we earn ground rent income. Recorded as a decrease to office parking and other income.
(3)
Ground lease from which we incur ground rent expense. Recorded as a decrease to office expense.
(4)
Ground lease from which we incurred ground rent expense. Recorded as an increase to other income. During the first quarter of 2015, we acquired the fee interest in the land (Harbor Court Land). See Note 3.




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Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

5. Investments in Unconsolidated Real Estate Funds

Description of our Funds

We manage and own equity interests in two unconsolidated Funds, Fund X and Partnership X, through which we and investors own eight office properties totaling 1.8 million square feet.  At March 31, 2016, we held equity interests of 68.61% of Fund X and 24.25% of Partnership X.

Our Funds pay us fees and reimburse us for certain expenses related to property management and other services we provide to the Funds. We also receive distributions based on invested capital and on any profits that exceed certain specified cash returns to the investors. The table below presents (in thousands) cash distributions received from our Funds:

 
Three Months Ended March 31,
 
2016
 
2015
 
 
 
 
Cash distributions received from our Funds
$
16,148

 
$
2,346


Notes receivable

In April 2013, we loaned $2.9 million to a related party investor in connection with a capital call made by Fund X. The loan carried interest at one month LIBOR plus 2.5% per annum, and was due and payable no later than April 1, 2017, with mandatory prepayments equal to any distributions with respect the related party's interest in Fund X. In November 2015, we loaned $0.5 million to Partnership X to fund working capital. The loan carried interest at one month LIBOR plus 2.5% per annum, and was due and payable no later than March 31, 2016. Both of the outstanding loans were repaid in full during the first quarter of 2016. The outstanding balance of the Fund X and Partnership X loans at December 31, 2015 were $0.3 million and $0.5 million, respectively, and were included in our investment in our unconsolidated funds on our balance sheet. The interest income recognized on these notes receivable is included in Other income in our Consolidated Statements of Operations.

Summarized Financial Information for our Funds

The accounting policies of the Funds are consistent with ours. The tables below present (in thousands) selected financial information for the Funds on a combined basis.  The amounts presented represent 100% (not our pro-rata share) of amounts related to the Funds, and are based upon historical acquired book value:

 
March 31, 2016
 
December 31, 2015
 
 
 
 
Total assets
$
695,136

 
$
691,543

Total liabilities
448,569

 
389,372

Total equity
246,567

 
302,171


 
Three Months Ended March 31,
 
2016
 
2015
 
 
 
 
Total revenues
$
17,475

 
$
17,480

Operating income
4,242

 
3,814

Net income
1,404

 
960




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Table of Contents
Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

6. Other Assets

Other assets consisted of the following (in thousands):
 
March 31, 2016
 
December 31, 2015
 
 
 
 
Restricted cash
$
194

 
$
194

Prepaid expenses
6,657

 
6,720

Other indefinite-lived intangible
1,988

 
1,988

Deposits in escrow (1)

 
75,000

Furniture, fixtures and equipment, net
1,345

 
1,448

Other
1,770

 
2,370

Total other assets
$
11,954

 
$
87,720

__________________________________________________________________________________
(1)
At December 31, 2015, deposits in escrow included a $75.0 million deposit in connection with the purchase of the Westwood Portfolio. See Note 3.






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Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

7. Secured Notes Payable and Revolving Credit Facility, net


The following table summarizes (in thousands) our secured notes payable and revolving credit facility:
Description
 
Maturity
Date
 
Principal Balance as of March 31, 2016
 
Principal Balance as of December 31, 2015
 
Variable Interest Rate
 
Fixed Interest
Rate(1)
 
Swap Maturity Date
 
 
 
 
 
 
 
 
 
 
 
 
 
Wholly Owned Subsidiaries
Term Loan
 
12/24/2016
 
$
20,000

 
$
20,000

 
LIBOR + 1.45%
 
3.57%
 
4/1/2016
Term Loan
 
4/2/2018
 
256,140

 
256,140

 
LIBOR + 2.00%
 
4.12%
 
4/1/2016
Term Loan
 
8/1/2018
 
530,000

 
530,000

 
LIBOR + 1.70%
 
3.74%
 
8/1/2016
Term Loan(2)
 
8/5/2018
 
354,501

 
355,000

 
 N/A
 
4.14%
 
 --
Term Loan(2)
 
2/1/2019
 
152,038

 
152,733

 
 N/A
 
4.00%
 
 --
Term Loan(3)
 
6/5/2019
 
285,000

 
285,000

 
N/A
 
3.85%
 
 --
Fannie Mae Loan
 
10/1/2019
 
145,000

 
145,000

 
LIBOR + 1.25%
(6) 
3.37%
 
4/1/2016
Term Loan(4)
 
3/1/2020
 
349,070

 
349,070

 
 N/A
 
4.46%
 
 --
Fannie Mae Loans
 
11/2/2020
 
388,080

 
388,080

 
LIBOR + 1.65%
 
3.65%
 
11/1/2017
Term Loan
 
4/15/2022
 
340,000

 
340,000

 
LIBOR + 1.40%
(6) 
2.77%
 
4/1/2020
Term Loan
 
7/27/2022
 
180,000

 
180,000

 
LIBOR + 1.45%
(6) 
3.06%
 
7/1/2020
Term Loan
 
11/2/2022
 
400,000

 
400,000

 
LIBOR + 1.35%
(6) 
2.64%
 
11/1/2020
Fannie Mae Loan
 
4/1/2025
 
102,400

 
102,400

 
LIBOR + 1.25%
(6) 
2.84%
 
3/1/2020
Fannie Mae Loan
 
12/1/2025
 
115,000

 
115,000

 
LIBOR + 1.25%
(6) 
2.76%
 
12/1/2020
Revolving credit line(5)
 
8/21/2020
 
290,000

 

 
LIBOR + 1.40%
 
N/A
 
 --
Total Wholly Owned Debt
$
3,907,229

 
$
3,618,423

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated Joint Ventures
Term Loan
 
3/1/2017
 
$
15,740

 
$
15,740

 
LIBOR + 1.60%
 
3.72%
 
4/1/2016
Term Loan
 
2/28/2023
 
580,000

 

 
LIBOR + 1.40%
(6) 
2.37%
 
3/1/2021
Total Debt(7)
$
4,502,969

 
$
3,634,163

 
 
 
 
 
 
Deferred loan costs, net(8)
 
(33,012
)
 
(22,887
)
 
 
 
 
 
 
Total Debt, net
$
4,469,957

 
$
3,611,276

 
 
 
 
 
 
___________________________________________________
As of March 31, 2016, the weighted average remaining life, including extension options, of our term debt (excluding our revolving credit facility) was 4.6 years. For the $4.21 billion of term debt on which the interest rate was fixed under the terms of the loan or a swap, (i) the weighted average remaining life was 4.6 years, (ii) the weighted average remaining period during which interest was fixed was 2.7 years, (iii) the weighted average annual interest rate was 3.42% and (iv) including the non-cash amortization of deferred loan costs, the weighted average effective interest rate was 3.57%. Except as otherwise noted below, each loan (including our revolving credit facility) is secured by a one or more separate collateral pools consisting of one or more properties, requiring monthly payments of interest only, with the outstanding principal due upon maturity. Maturity dates include the effect of extension options.  The following table summarizes (in thousands) our fixed and floating rate debt:
Description
 
Principal Balance as of March 31, 2016
 
Principal Balance as of December 31, 2015
 
 
 
 
 
Aggregate swap fixed rate loans
 
$
3,072,360

 
$
2,492,360

Aggregate fixed rate loans
 
1,140,609

 
1,141,803

Aggregate floating rate loans
 
290,000

 

Total Debt
 
$
4,502,969

 
$
3,634,163

 
(1)
Includes the effect of interest rate swaps and excludes the effect of prepaid loan fees. See Note 9 for the details of our interest rate contracts.
(2)
Requires monthly payments of principal and interest. Principal amortization is based upon a 30-year amortization schedule.

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Table of Contents
Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

(3)
Interest only until February 2017, with principal amortization thereafter based upon a 30-year amortization schedule.
(4)
Interest is fixed until March 1, 2018, and is floating thereafter, with interest-only payments until May 1, 2016, and principal amortization thereafter based upon a 30-year amortization schedule.
(5)
$400.0 million revolving credit facility. Unused commitment fees range from 0.15% to 0.20%.
(6)
Loan agreement includes a zero-percent LIBOR floor. The corresponding swaps do not include such a floor.
(7)
See Note 12 for our fair value disclosures.
(8)
Net of accumulated amortization of $16.6 million and $15.2 million at March 31, 2016 and December 31, 2015, respectively. Deferred loan cost amortization was $1.3 million and $1.8 million for the three months ended March 31, 2016 and March 31, 2015, respectively.
    
As of March 31, 2016, the minimum future principal payments due on our secured notes payable and revolving credit facility, excluding any maturity extension options, were as follows (in thousands):

Twelve months ending March 31:
 
 
 
2017
$
49,890

2018
358,828

2019
1,279,730

2020
419,041

2021
973,080

Thereafter
1,422,400

Total future principal payments
$
4,502,969



8. Interest Payable, Accounts Payable and Deferred Revenue

Interest payable, accounts payable and deferred revenue consisted of the following (in thousands):

 
March 31, 2016
 
December 31, 2015
 
 
 
 
Interest payable
$
11,476

 
$
10,028

Accounts payable and accrued liabilities
41,285

 
23,716

Deferred revenue
22,826

 
23,673

Total interest payable, accounts payable and deferred revenue
$
75,587

 
$
57,417



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Table of Contents
Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

9. Derivative Contracts

Hedges of Interest Rate Risk

We make use of interest rate swap and interest rate cap contracts to manage the risk associated with changes in interest rates on our floating-rate debt. When we enter into a floating-rate term loan, we generally enter into an interest rate swap agreement for the equivalent principal amount, for a period covering the majority of the loan term, which effectively converts our floating-rate debt to a fixed-rate basis during that time. In limited instances, we make use of interest rate caps to limit our exposure to interest rate increases on our floating-rate debt. We do not speculate in derivatives and we do not make use of any other derivative instruments. See Note 7 for the details of our floating-rate debt that we have hedged.

Accounting for Hedges of Interest Rate Risk

When we enter into derivative agreements, we generally elect to have them designated as cash flow hedges for accounting purposes. For hedging instruments designated as cash flow hedges, changes in fair value of the hedging instrument are recorded in accumulated other comprehensive income (loss) (AOCI), which is a component of equity outside of earnings, and any hedge ineffectiveness is recorded as interest expense. Amounts recorded in AOCI related to our designated hedges are reclassified to interest expense as interest payments are made on the hedged floating rate debt. Amounts reported in AOCI related to our unconsolidated Funds' hedges are reclassified to income, including depreciation, from unconsolidated real estate funds, as interest payments are made by our Funds on their hedged floating rate debt. For hedging instruments which are not designated as cash flow hedges, changes in fair value of the hedging instrument are recorded as interest expense. We present our derivatives, including the derivative of our consolidated joint venture, on our consolidated balance sheet at fair value on a gross basis. Our share of the AOCI related to our unconsolidated Funds' derivatives is included in our investment in unconsolidated real estate funds on our consolidated balance sheet.

Summary of our derivatives

As of March 31, 2016, all of our interest rate swaps, including our unconsolidated Funds' interest rate swaps, were designated as cash flow hedges:
 
 
Number of Interest Rate Swaps
 
Notional (in thousands)(1)
 
 
 
 
 
Derivatives(2)
 
18
 
$3,145,480
Unconsolidated Funds' derivatives(3)
 
2
 
$435,000
___________________________________________________
(1)
See Note 12 for our derivative fair value disclosures.
(2)
Includes a consolidated joint venture's derivatives.
(3)
The notional amount presented represents 100%, not our pro-rata share, of the amounts related to our unconsolidated Funds. See Note 5 for more information regarding our unconsolidated Funds.


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Table of Contents
Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

Credit-risk-related Contingent Features

We have agreements with each of our interest rate swap counterparties that contain a provision under which we could also be declared in default on our derivative obligations if we default on the underlying indebtedness that we are hedging. As of March 31, 2016, there have been no events of default with respect to our interest rate swaps or our unconsolidated Funds' interest rate swaps. The fair value of our interest rate swaps in a liability position were as follows (in thousands):
 
 
 
March 31, 2016
 
December 31, 2015
Fair value of derivatives in a liability position(1)
 
 
 
 
Derivatives
 
$
36,692

 
$
19,047

Unconsolidated Funds' derivatives(2)
 
$
118

 
$


__________________________________________________________________________________
(1)
Includes accrued interest and excludes any adjustment for nonperformance risk.
(2)
The notional amount presented represents 100%, not our pro-rata share, of the amounts related to our unconsolidated Funds. See Note 5 for more information regarding our unconsolidated Funds.
 
Counterparty Credit Risk

We are also subject to credit risk from the counterparties on our interest rate swap and interest rate cap contracts. We seek to minimize our credit risk by entering into agreements with a variety of high quality counterparties with investment grade ratings. The fair value of our interest rate swaps in an asset position were as follows (in thousands):

 
 
March 31, 2016
 
December 31, 2015
Fair value of derivatives in an asset position(1)
 
 
 
 
Derivatives(2)
 
$
1,514

 
$
4,220

Unconsolidated Funds' derivatives(3)
 
$
621

 
$
737

___________________________________________________
(1)
Includes accrued interest and excludes any adjustment for nonperformance risk.
(2)
Includes a consolidated joint venture's derivatives.
(3)
The notional amount presented represents 100%, not our pro-rata share, of the amounts related to our unconsolidated Funds. See Note 5 for more information regarding our unconsolidated Funds.


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Table of Contents
Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

Impact of Hedges on AOCI and Consolidated Statements of Operations

The table below presents (in thousands) the effect of our derivative instruments, including our unconsolidated Funds' derivative instruments on our AOCI and statements of operations for the three months ended March 31:
 
2016
 
2015
Derivatives Designated as Cash Flow Hedges:
 
 
 
Loss recorded in AOCI (effective portion) - derivatives(1)(5)
$
(28,812
)
 
$
(7,022
)
Loss recorded in AOCI (effective portion) - unconsolidated Funds' derivatives(2)(5)
$
(611
)
 
$
(1,333
)
Loss reclassified from AOCI (effective portion) - derivatives(3)(5)
$
(8,710
)
 
$
(9,133
)
Loss reclassified from AOCI (effective portion) - unconsolidated Funds' derivatives(4)(5)
$
(105
)
 
$
(240
)
Gain (loss) recorded as interest expense (ineffective portion)(6)
$

 
$

 
 
 
 
Derivatives Not Designated as Cash Flow Hedges:
 

 
 

Gain (loss) recorded as interest expense(7)
$

 
$

___________________________________________________
(1)
Represents the change in fair value of our interest rate swaps, including a consolidated joint venture's interest rate swaps, designated as cash flow hedges, which does not impact the statement of operations.
(2)
Represents our share of the change in fair value of our unconsolidated Funds' interest rate swaps designated as a cash flow hedges, which does not impact the statement of operations.
(3)
Reclassified from AOCI as an increase to interest expense.
(4)
Reclassified from AOCI as a decrease to income, including depreciation, from unconsolidated real estate funds.
(5)
See the reconciliation of our AOCI in Note 10.
(6)
We did not record any ineffectiveness related to our derivatives designated as cash flow hedges.
(7)
We do not have any derivatives that are not designated as cash flow hedges.


Future Reclassifications from AOCI

The table below presents (in thousands) our estimate of the AOCI related to our derivatives, including our unconsolidated Funds' derivatives, designated as cash flow hedges, that will be reclassified to earnings during the next twelve months:

Derivatives(1)
 
$
20,457

Unconsolidated Funds' derivatives(2)
 
$
158

________________________________________
(1)
Reclassified as an increase to interest expense (includes the impact of the derivatives of our consolidated joint venture).
(2)
Reclassified as a decrease to income, including depreciation, from unconsolidated real estate funds.



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Table of Contents
Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

10.  Equity

Equity Transactions

During the three months ended March 31, 2016, we (i) acquired 0.4 million OP Units in exchange for issuing to the holders of the OP Units an equal number of shares of our common stock, and (ii) issued 24 thousand shares of our common stock for the exercise of 65 thousand stock options. In connection with the acquisition of the Westwood Portfolio, an investor contributed $320.0 million to the joint venture for a forty-percent ownership interest, and we expect an additional investor to acquire a 30% interest in this joint venture during the second quarter of 2016, reducing our ownership interest to thirty percent. See Note 3 and 17.

During the three months ended March 31, 2015, we (i) acquired 0.9 million OP Units in exchange for issuing to the holders of the OP Units an equal number of shares of our common stock and (ii) issued 136 thousand shares of our common stock for the exercise of options for net proceeds of $1.8 million at an average price of $13.44 per option. In addition, we issued 34 thousand OP Units valued at $1.0 million in connection with the acquisition of land under one of our office buildings.

Condensed Consolidated Statements of Equity

The tables below present (in thousands) our condensed consolidated statements of equity:

 
Douglas Emmett, Inc. Stockholders' Equity
 
Noncontrolling Interests
 
Total Equity
 
 
 
 
 
 
Balance as of January 1, 2016
$
1,926,211

 
$
355,337

 
$
2,281,548

Net income
15,366

 
680

 
16,046

Cash flow hedge fair value adjustment
(18,028
)
 
(2,580
)
 
(20,608
)
Contributions

 
320,000

 
320,000

Dividends and distributions
(32,424
)
 
(6,098
)
 
(38,522
)
Exchange of OP units
5,847

 
(5,847
)
 

Exercise of stock options
(445
)
 


 
(445
)
Stock-based compensation

 
2,596

 
2,596

Balance as of March 31, 2016
$
1,896,527

 
$
664,088

 
$
2,560,615


 
 
Douglas Emmett, Inc. Stockholders' Equity
 
Noncontrolling Interests
 
Total Equity
 
 
 
 
 
 
Balance as of January 1, 2015
$
1,943,458

 
$
370,266

 
$
2,313,724

Net income
18,699

 
3,397

 
22,096

Cash flow hedge fair value adjustment
685

 
333

 
1,018

Dividends and distributions
(30,630
)
 
(5,995
)
 
(36,625
)
Exchange of OP units
11,408

 
(11,408
)
 

Issuance of OP unit for cash

 
1,000

 
1,000

Exercise of stock options
1,823

 

 
1,823

Stock-based compensation

 
2,155

 
2,155

Balance as of March 31, 2015
$
1,945,443

 
$
359,748

 
$
2,305,191





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Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

Noncontrolling Interests

Our noncontrolling interests consist of (i) interests in our Operating Partnership which are not owned by us, (ii) a joint venture investor who owns a forty-percent interest in a consolidated joint venture that acquired the Westwood Portfolio (see Note 3) and (iii) a minority partner's one-third interest in a consolidated joint venture which owns an office building in Honolulu, Hawaii. Noncontrolling interests in our Operating Partnership consist of OP Units and fully-vested LTIP Units and represented approximately 15% of our Operating Partnership's total interests as of March 31, 2016 when we and our Operating Partnership had 147.4 million shares of common stock and 26.2 million OP Units and LTIP Units outstanding, respectively. A share of our common stock, an OP Unit and an LTIP Unit (once vested and booked up) have essentially the same economic characteristics, sharing equally in the distributions from our Operating Partnership.  Investors who own OP Units have the right to cause our Operating Partnership to redeem their OP Units for an amount of cash per unit equal to the market value of one share of our common stock at the date of redemption, or, at our election, exchange their OP Units for shares of our common stock on a one-for-one basis. LTIP Units have been granted to our key employees and non-employee directors as part of their compensation. These awards generally vest over the service period and once vested can generally be converted to OP Units.

Changes in our Ownership Interest in our Operating Partnership

The table below presents (in thousands) the effect on our equity from net income and changes in our ownership interest in our Operating Partnership:
 
Three Months Ended March 31,
 
2016
 
2015
 
 
 
 
Net income attributable to common stockholders
$
15,366

 
$
18,699

 
 
 
 
Transfers (to) from noncontrolling interests:
 
 
 
Exchange of OP units with noncontrolling interests
5,847

 
11,408

Repurchase of OP units from noncontrolling interests

 

Net transfers from noncontrolling interests
$
5,847

 
$
11,408

 
 
 
 
Change from net income attributable to common stockholders and transfers from noncontrolling interests
$
21,213

 
$
30,107


AOCI Reconciliation(1) 

The table below presents (in thousands) a reconciliation of our AOCI, which consists solely of adjustments related to derivatives designated as cash flow hedges for the three months ended March 31:
 
2016
 
2015
 
 
 
 
Beginning balance
$
(9,285
)
 
$
(30,089
)
 
 
 
 
Other comprehensive loss before reclassifications - derivatives(2)
(28,812
)
 
(7,022
)
Other comprehensive loss before reclassifications - unconsolidated Funds' derivatives
(611
)
 
(1,333
)
Reclassifications from AOCI - derivatives(2)(3)
8,710

 
9,133

Reclassifications from AOCI - unconsolidated Funds' derivatives(4)
105

 
240

Net current period OCI
(20,608
)
 
1,018

Less OCI attributable to noncontrolling interests
2,580

 
(333
)
OCI attributable to common stockholders
(18,028
)
 
685

 
 
 
 
Ending balance
$
(27,313
)
 
$
(29,404
)
___________________________________________________
(1)
See Note 9 for the details of our derivatives and Note 12 for our derivative fair value disclosures.
(2)
Includes the derivative of a consolidated joint venture.
(3)
Reclassification as an increase to interest expense.
(4)
Reclassification as an decrease to income, including depreciation, from unconsolidated real estate funds.

24

Table of Contents
Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

Equity Compensation

The Douglas Emmett, Inc. 2006 Omnibus Stock Incentive Plan, as amended, our stock incentive plan, is administered by the compensation committee of our board of directors.  All officers, employees, directors and consultants are eligible to participate in our stock incentive plan.  For more information on our stock incentive plan, please refer to Note 12 to the consolidated financial statements in our 2015 Annual Report on Form 10-K.

Total net stock-based compensation expense for equity grants was $2.4 million and $1.9 million for the three months ended March 31, 2016 and 2015, respectively. These amounts are net of capitalized stock-based compensation of $217 thousand and $193 thousand for the three months ended March 31, 2016 and 2015, respectively. The total intrinsic value of options exercised for the three months ended March 31, 2016 and 2015 was $1.1 million and $2.2 million, respectively.

11. EPS

We calculate basic EPS by dividing the net income attributable to common stockholders for the period by the weighted average number of common shares outstanding during the period. We calculate diluted EPS by dividing the net income attributable to common stockholders for the period by the weighted average number of common shares and dilutive instruments outstanding during the period using the treasury stock method. We account for unvested LTIP awards that contain nonforfeitable rights to dividends as participating securities and include these securities in the computation of basic and diluted EPS using the two-class method. The table below presents the calculation of basic and diluted EPS:
 
Three Months Ended March 31,
 
2016

2015
Numerator (in thousands):
 

 
 

Net income attributable to common stockholders
$
15,366

 
$
18,699

Allocation to participating securities: Unvested LTIP units
(84
)
 
(98
)
Numerator for basic and diluted net income attributable to common stockholders
$
15,282

 
$
18,601

 
 
 
 
Denominator (in thousands):
 
 
 
Weighted average shares of common stock outstanding - basic
147,236

 
145,327

Effect of dilutive securities: Stock options(1)
4,215

 
4,475

Weighted average shares of common stock and common stock equivalents outstanding - diluted
151,451

 
149,802

 
 
 
 
Basic EPS:
 
 
 

Net income attributable to common stockholders per share
$
0.104

 
$
0.128

 
 
 
 
Diluted EPS:
 

 
 

Net income attributable to common stockholders per share
$
0.101

 
$
0.124

____________________________________________________
(1)
The following securities were excluded from the computation of the weighted average diluted shares because the effect of including them would be anti-dilutive to the calculation of diluted EPS:

 
Three Months Ended March 31,
 
2016
 
2015
 
 
 
 
OP Units
25,549

 
26,513

Vested LTIP Units
815

 
702

Unvested LTIP units
532

 
503


25

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Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

12. Fair Value of Financial Instruments

Our estimates of the fair value of financial instruments were determined using available market information and widely used valuation methods.  Considerable judgment is necessary to interpret market data and determine an estimated fair value.  The use of different market assumptions or valuation methods may have a material effect on the estimated fair values. The FASB fair value framework hierarchy distinguishes between assumptions based on market data obtained from sources independent of the reporting entity, and the reporting entity’s own assumptions about market-based inputs.  The hierarchy is as follows:
 
Level 1 - inputs utilize unadjusted quoted prices in active markets for identical assets or liabilities.  
Level 2 - inputs are observable either directly or indirectly for similar assets and liabilities in active markets.  
Level 3 - inputs are unobservable assumptions generated by the reporting entity

As of March 31, 2016, we did not have any fair value measurements of financial instruments using Level 3 inputs.

Financial instruments disclosed at fair value

Short term financial instruments: The carrying amounts for cash and cash equivalents, tenant receivables, revolving credit lines, interest payable, accounts payable, security deposits and dividends payable approximate fair value because of the short-term nature of these instruments.

Secured notes payable: See Note 7 for the details of our secured notes payable. We estimate the fair value of our secured notes payable, which includes the secured notes payable of our consolidated joint ventures, by calculating the credit-adjusted present value of the principal and interest payments for each secured note payable. The calculation incorporates observable market interest rates which we consider to be Level 2 inputs, assumes that the loans will be outstanding through maturity, and excludes any maturity extension options. The table below presents (in thousands) the estimated fair value of our secured notes payable:
Secured Notes Payable:
March 31, 2016
 
December 31, 2015
 
 
 
 
Fair value
$
4,271,849

 
$
3,691,075

Carrying value
$
4,212,969

 
$
3,634,163


Financial instruments measured at fair value

Derivative instruments: See Note 9 for the details of our derivatives. We present our derivatives on the balance sheet at fair value, on a gross basis, excluding accrued interest.  We estimate the fair value of our derivative instruments by calculating the credit-adjusted present value of the expected future cash flows of each derivative.  The calculation incorporates the contractual terms of the derivatives, observable market interest rates which we consider to be Level 2 inputs, and credit risk adjustments to reflect the counterparty's as well as our own nonperformance risk. Our derivatives are not subject to master netting arrangements.  The table below presents (in thousands) the estimated fair value of our derivatives:
 
March 31, 2016
 
December 31, 2015
Derivative Assets:
 
 
 
Fair value - derivatives(1)
$
1,493

 
$
4,830

Fair value - unconsolidated Funds' derivatives(2)
$
499

 
$
837

 
 
 
 
Derivative Liabilities:
 
 
 
Fair value - derivatives(1)
$
33,075

 
$
16,310

Fair value - unconsolidated Funds' derivatives(2)
$
70

 
$

____________________________________________________
(1)
Our derivatives, which include the derivatives of a consolidated joint venture, are included in interest rate contracts in our consolidated balance sheet. The fair value excludes accrued interest (which is included in interest payable in the consolidated balance sheet).
(2)
Represents 100%, not our pro-rata share, of the amounts related to the unconsolidated Funds. Our pro-rata share of the amounts related to the unconsolidated Funds' derivatives is included in our investment in unconsolidated real estate funds in our consolidated balance sheet. See Note 5 for more information regarding our unconsolidated Funds.

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Table of Contents
Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

13. Segment Reporting

Segment information is prepared on the same basis that our management reviews information for operational decision-making purposes.  We operate in two business segments: (i) the acquisition, development, ownership and management of office real estate and (ii) the acquisition, development, ownership and management of multifamily real estate.  The services for our office segment primarily include rental of office space and other tenant services, including parking and storage space rental.  The services for our multifamily segment include rental of apartments and other tenant services, including parking and storage space rental.

Asset information by segment is not reported because we do not use this measure to assess performance or make decisions to allocate resources.  Therefore, depreciation and amortization expense is not allocated among segments.  General and administrative expenses and interest expense are not included in segment profit as our internal reporting addresses these items on a corporate level.

Segment profit is not a measure of operating income or cash flows from operating activities as measured by GAAP, it is not indicative of cash available to fund cash needs, and should not be considered as an alternative to cash flows as a measure of liquidity.  Not all companies may calculate segment profit in the same manner.  We consider segment profit to be an appropriate supplemental measure to net income because it can assist both investors and management in understanding the core operations of our properties.
The table below presents (in thousands) the operating activity of our reportable segments:
 
Three Months Ended March 31,
 
2016
 
2015
Office Segment
 
 
 
Total office revenues
$
144,379

 
$
131,456

Office expenses
(47,883
)
 
(44,199
)
Office Segment profit
96,496

 
87,257

 
 
 
 
Multifamily Segment
 
 
 
Total multifamily revenues
24,193

 
23,353

Multifamily expenses
(6,031
)
 
(5,820
)
Multifamily Segment profit
18,162

 
17,533

 
 
 
 
Total profit from all segments
$
114,658

 
$
104,790

The table below (in thousands) is a reconciliation of the total profit from all segments to net income attributable to common stockholders:
 
Three Months Ended March 31,
 
2016
 
2015
 
 
 
 
Total profit from all segments
$
114,658

 
$
104,790

General and administrative expense
(8,071
)
 
(7,361
)
Depreciation and amortization
(55,552
)
 
(49,834
)
Other income
2,089

 
8,559

Other expenses
(1,551
)
 
(1,572
)
Income, including depreciation, from unconsolidated real estate funds
1,586

 
1,443

Interest expense
(35,660
)
 
(33,639
)
Acquisition-related expenses
(1,453
)
 
(290
)
Net income
16,046

 
22,096

Less: Net income attributable to noncontrolling interests
(680
)
 
(3,397
)
Net income attributable to common stockholders
$
15,366

 
$
18,699


27

Table of Contents
Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

14. Future Minimum Lease Rental Receipts

We lease space to tenants primarily under non-cancelable operating leases that generally contain provisions for a base rent plus reimbursement for certain operating expenses, and we own fee interests in two parcels of land subject to ground leases from which we earn ground rent income. The table below presents (in thousands) the future minimum base rentals on our non-cancelable office tenant and ground operating leases at March 31, 2016:

Twelve months ending March 31:
 
 
 
2017
$
462,305

2018
418,016

2019
344,628

2020
291,447

2021
230,194

Thereafter
630,528

Total future minimum base rentals(1)
$
2,377,118

_____________________________________________________
(1)
Does not include (i) residential leases, which typically have a term of one year or less, (ii) tenant reimbursements, (iii) straight line rent, (iv) amortization/accretion of acquired above/below-market lease intangibles and (v) percentage rents.  The amounts assume that those tenants with early termination options do not exercise them.

15. Future Minimum Lease Rental Payments

We incurred lease payments related to ground leases of $183 thousand (one ground lease) and $192 thousand (two ground leases) for the three months ended March 31, 2016 and 2015, respectively. We acquired the fee interest related to one ground lease in February 2015, see Note 3. The table below presents (in thousands) the future minimum ground lease payments of our remaining ground lease as of March 31, 2016:
 
Twelve months ending March 31:
 
 
 
2017
$
733

2018
733

2019
733

2020
733

2021
733

Thereafter
48,194

Total future minimum lease payments(1)
$
51,859

___________________________________________________
(1)
Lease term ends on December 31, 2086. Ground rent is fixed at $733 thousand per year until February 28, 2019, and will then be reset to the greater of the existing ground rent or market. The table above assume that the rental payments will continue to be $733 thousand per year after February 28, 2019.

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Table of Contents
Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

16. Commitments, Contingencies and Guarantees

Legal Proceedings

From time to time, we are party to various lawsuits, claims and other legal proceedings that arise in the ordinary course of our business.  Excluding ordinary, routine litigation incidental to our business, we are not currently a party to any legal proceedings that we believe would reasonably be expected to have a materially adverse effect on our business, financial condition or results of operations.

Concentration of Risk

We are subject to credit risk with respect to our tenant receivables and deferred rent receivables related to our tenant leases. Our tenants' ability to honor the terms of their respective leases remains dependent upon the economic, regulatory and social factors. We seek to minimize our credit risk from our tenant leases by (i) targeting smaller, more affluent tenants, from a diverse mix of industries, (ii) performing credit evaluations of prospective tenants and (iii) obtaining security deposits from our tenants.  For the three months ended March 31, 2016 and 2015, no tenant accounted for more than 10% of our total revenues.  

All of our properties (including the properties owned by our unconsolidated Funds) are located in Los Angeles County, California and Honolulu, Hawaii, and we are dependent on the Southern California and Honolulu economies. Therefore, we are susceptible to adverse local conditions and regulations, as well as natural disasters in those areas.

We are also subject to credit risk from the counterparties on our interest rate swap and interest rate cap contracts that we use to manage the risk associated with our floating rate debt. See Note 9 for the details of our interest rate contracts. We seek to
minimize our credit risk by entering into agreements with a variety of high quality counterparties with investment grade ratings.

We maintain our cash and cash equivalents at high quality financial institutions with investment grade ratings.  Interest bearing accounts at each U.S. banking institution are insured by the FDIC up to $250 thousand.

Asset Retirement Obligations

Conditional asset retirement obligations represent a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement is conditional on a future event that may or may not be within our control.  A liability for a conditional asset retirement obligation must be recorded if the fair value of the obligation can be reasonably estimated.  Environmental site assessments and investigations have identified twenty-five properties in our consolidated portfolio, which included two properties owned by our consolidated joint venture which acquired the Westwood Portfolio, and four properties owned by our unconsolidated Funds, which contain asbestos, and would have to be removed in compliance with applicable environmental regulations if these properties undergo major renovations or are demolished.  As of March 31, 2016, the obligations to remove the asbestos from these properties have indeterminable settlement dates, and we are unable to reasonably estimate the fair value of the associated conditional asset retirement obligation.

Development Contract

We are building an additional 475 apartments (net of existing units removed) at our Moanalua Hillside Apartments in Honolulu, Hawaii. We expect construction will take approximately 18 months and cost approximately $120.0 million. The $120.0 million estimated cost of the new units does not include the cost of the land which we owned before beginning the project. As of March 31, 2016, we had a commitment of $118.6 million for a contract directly related to this development project.


29

Table of Contents
Douglas Emmett, Inc.
Notes to Consolidated Financial Statements (unaudited) (continued)

Guarantees

We made certain environmental and other limited indemnities and guarantees covering customary non-recourse carve- outs for loans related to both of our unconsolidated Funds. We have also guaranteed the related swaps. The entities have agreed to indemnify us for any amounts that we would be required to pay under these agreements. As of March 31, 2016, all obligations under these loans and swap agreements have been performed in accordance with the terms of those agreements. The table below summarizes the debt of our Funds as of March 31, 2016, the amounts represent 100% (not our pro-rata share) of amounts related to our Funds:
 
 
 
 
 
 
 
 
 
 
 
 
Fund(1)
 
Principal Balance(1)
(in millions)
 
Loan Maturity Date
 
Swap Maturity Date
 
Swap Fixed Interest Rate
 
 
 
 
 
 
 
 
 
 
 
 
 
Fund X(2)
 
$
325.0

 
5/1/2018
 
5/1/2017
 
2.35%
 
 
Partnership X(3)
 
110.0

 
3/1/2023
 
3/1/2021
 
2.30%
 
 
 
 
$
435.0

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
___________________________________________________
(1)
See Note 5 for more information regarding our unconsolidated Funds.
(2)
Floating rate term loan, swapped to fixed, which is secured by six properties and requires monthly payments of interest only, with the outstanding principal due upon maturity. As of March 31, 2016, the maximum future payments under the swap agreement were approximately $2.1 million.
(3)
Floating rate term loan, swapped to fixed, which is secured by two properties and requires monthly payments of interest only, with the outstanding principal due upon maturity. As of March 31, 2016, the maximum future payments under the swap agreement were approximately $5.0 million.

17. Subsequent events

We have agreed to sell 30% of the joint venture that acquired the Westwood Portfolio for $240.0 million (the amount of our capital contribution with respect to the interest being sold) plus an additional amount equal to 2% per annum for the period from February 29, 2016 to the date of the closing of the sale (expected to occur during the second quarter of 2016). The sale will reduce our interest in the joint venture to 30%. See Note 3 for more detail regarding the joint venture involved.



30

Table of Contents


Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Executive Summary

Business Description and Portfolio Summary

Douglas Emmett, Inc. is a fully integrated, self-administered and self-managed REIT. We are one of the largest owners and operators of high-quality office and multifamily properties in Los Angeles County, California and in Honolulu, Hawaii. We focus on owning, acquiring, developing and managing a substantial share of top-tier office properties and premier multifamily communities in neighborhoods that possess significant supply constraints, high-end executive housing and key lifestyle amenities.

As of March 31, 2016, our portfolio consisted of the following:
 
 
 
 
 
 
 
 
Consolidated(1)
 
Total Portfolio(2)
 
 
Office
 
 
 
 
 
Class A Properties(3) 
58
 
66
 
 
Rentable square feet (in thousands)
15,419
 
17,243
 
 
Leased rate
92.1%
 
92.1%
 
 
Occupied rate
90.4%
 
90.4%
 
 
 
 
 
 
 
 
Multifamily
 
 
 
 
 
Properties
10
 
10
 
 
Units
3,336
 
3,336
 
 
Leased rate
99.3%
 
99.3%
 
 
Occupied rate
97.9%
 
97.9%
 
 
 
 
 
 
 
__________________________________________________
(1)
Our consolidated portfolio includes all of the properties included in our consolidated results. We own 100% of these properties except for five office properties totaling approximately 1.8 million square feet, which we own through two consolidated joint ventures. Our consolidated portfolio also included two parcels of land which are ground leased to the owners of a Class A office building and a hotel.
(2)
Our total portfolio includes our consolidated portfolio plus eight properties totaling approximately 1.8 million square feet owned by our unconsolidated Funds, in which we own a weighted average of approximately 60% based on square footage. See Note 5 to our consolidated financial statements in Item 1 of this Report for more information regarding our unconsolidated Funds.
(3) Office portfolio includes ancillary retail space.

Annualized rent

Annualized rent from our consolidated portfolio was derived as follows as of March 31, 2016:

______

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Table of Contents


Acquisitions and Dispositions, Financings, Developments and Repositionings
 
 
Acquisitions and Dispositions 
 
On February 29, 2016, a consolidated joint venture which we manage acquired four class A multi-tenant office properties located in Westwood, California (Westwood Portfolio) for a contract price of $1.34 billion or approximately $777 per square foot. As of the acquisition date, we contributed sixty percent of the equity to the joint venture, but we expect to reduce that investment to thirty-percent during the second quarter of 2016.
We are currently marketing a 168,000 square foot Class A office property located in Sherman Oaks that we wholly own through a consolidated subsidiary. As of March 31, 2016, the carrying value of the property was reclassified from investment in real estate to real estate held for sale in our consolidated balance sheets.
See Note 3 to our consolidated financial statements in Item 1 of this Report for more detail regarding our acquisition and property held for sale.

Financings  
 
During the first quarter of 2016, one of our consolidated joint ventures closed a seven year, non-recourse $580.0 million interest-only term loan as part of the acquisition of the Westwood Portfolio. The loan bears interest at LIBOR + 1.40%, and has been effectively fixed at 2.37% per annum until March 2021 through an interest rate swap. The loan is secured by the Westwood Portfolio.
During the first quarter of 2016, one of our unconsolidated Funds closed a seven year, non-recourse $110.0 million interest-only term loan. The loan bears interest at LIBOR + 1.40%, and has been effectively fixed at 2.30% per annum until March 2021 though an interest rate swap. The loan is secured by two office properties.

See Note 7 to our consolidated financial statements in Item 1 of this Report for more detail regarding our debt.

Developments
We are developing two multifamily projects, one in our Brentwood submarket in Los Angeles, California and one in Honolulu, Hawaii. Each development is on land which we already own:

We are building an additional 475 apartments at our Moanalua Hillside Apartments in Honolulu. We expect construction will take approximately 18 months and cost approximately $120 million. The $120.0 million estimated cost of the new units does not include the cost of the land which we owned before beginning the project. As of March 31, 2016, we had a commitment of $118.6 million for a contract directly related to this development project.
In Los Angeles, we are seeking to build a high rise apartment project with 376 residential units. Because development in our markets, particularly West Los Angeles, remains a long and uncertain process, we do not expect to break ground in Los Angeles before late 2017, even if the entitlement process is successful. We expect the cost of this development to be approximately $120 million to $140 million.

Repositionings

    We often strategically purchase properties with large vacancies or expected near-term lease roll-over and use our knowledge of the property and submarket to reposition the property for the optimal use and tenant mix. The work we undertake to reposition a building typically takes months or even years, and could involve a range of improvements from a complete structural renovation to a targeted remodeling of selected spaces. We generally select a property for repositioning at the time we purchase it, although repositioning efforts can also occur at properties that we already own. During the repositioning, the affected property may display depressed rental revenue and occupancy levels which impacts our results and, therefore, comparisons of our performance from period to period.

In addition to our Moanalua Hillside Apartments in Honolulu, described above under "Developments", as of March 31, 2016, we were repositioning two properties, (i) a 661,000 square foot office property in Woodland Hills, California, which included a 35,000 square foot gym, and (ii) a 79,000 square foot office property in Honolulu, Hawaii, owned by a consolidated joint venture in which we own a two-thirds interest.


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Table of Contents


Historical Results of Operations

Portfolio Overview

Our results of operations for the three months ended March 31, 2016 consisted of the rental operations of fifty-four consolidated office properties and ten consolidated multifamily properties, as well as (after the respective date of acquisition) four additional office properties that one of our consolidated joint ventures acquired on February 29, 2016. Our results of operations for the three months ended March 31, 2015 consisted of the rental operations of fifty-three consolidated office properties and ten consolidated multifamily properties, as well as (after the respective date of acquisition) one additional office property that we acquired on March 5, 2015. Our share of the earnings from our unconsolidated Funds, which owned an additional eight office properties during the three months ended March 2016 and 2015, is included in income, including depreciation, from unconsolidated real estate funds in our consolidated statements of operations. See Note 3 to our consolidated financial statements in Item 1 of this Report for more detail regarding our acquisitions, and see Note 5 for more detail regarding our unconsolidated Funds.

Rental Rate Trends - Total Portfolio

Office Rental Rates

The table below presents the average effective annual rental rate per leased square foot and the annualized lease transaction costs per leased square foot for leases executed in our total office portfolio during each period:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended
 
Twelve Months Ended December 31,
 
 
Historical straight-line rents:(1)
 
March 31, 2016
 
2015
 
2014
 
2013
 
2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Average rental rate(2)
 
$39.89
 
$42.65
 
$35.93
 
$34.72
 
$32.86
 
 
Annualized lease transaction costs(3)
 
$5.71
 
$4.77
 
$4.66
 
$4.16
 
$4.06
 
 
 
 
 
 
 
 
 
 
 
 
 
 
___________________________________________________
(1)
Because straight-line rent takes into account the full economic value of each lease, including accommodations and rent escalations, we believe that it may provide a better comparison than ending cash rents, which include the impact of the annual escalations over the entire term of the lease. However, care should be taken in any comparison, as the averages are often significantly affected from period to period by factors such as the buildings, submarkets, and types of space and terms involved in the leases executed during the respective reporting period.
(2)
Represents the weighted average straight-line annualized base rent (i.e., excludes tenant reimbursements, parking and other revenue) per leased square foot for leases executed within our total office portfolio.  For our triple net leases, annualized rent is calculated by adding estimated expense reimbursements to base rent.
(3)
Represents the weighted average leasing commissions and tenant improvement allowances for leases executed within our total office portfolio, divided by the weighted average number of years for those respective leases.

Office Rent Roll Up

During the first quarter of 2016,

Straight-line rent roll up. The average straight-line rent of $39.89 per square foot under new and renewal leases that we signed during the quarter was 22.7% greater than the average straight-line rent of $32.50 per square foot on the expiring leases for the same space.  The rent roll up reflects continuing increases in average starting rental rates and more leases containing annual rent escalations in excess of 3% per annum.

Cash rent roll up. The average starting cash rental rate of $38.51 per square foot under new and renewal leases that we signed during the quarter averaging 22.3% greater than the average starting cash rental rate of $31.48 per square foot on the expiring leases for the same space, and 7.0% greater than the average ending cash rental rate of $35.99 per square foot on those expiring leases.

Fluctuations in submarkets, buildings and term of the expiring leases make predicting the changes in rent in any specific reporting period difficult.





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Table of Contents


Office Lease Expirations

The table below presents our expected expiring cash rents in our total office portfolio over the next four quarters:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ending,
 
 
Expiring cash rents:
 
June 30, 2016
 
September 30, 2016
 
December 31, 2016
 
March 31, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
Expiring square feet (1)
 
235,233

 
293,522

 
573,549

 
722,316

 
 
Percentage of the portfolio
 
1.4
%
 
1.7
%
 
3.3
%
 
4.2
%
 
 
Expiring rent per square foot (2)
 
$
34.10

 
$
33.63

 
$
35.67

 
$
36.78

 
 
 
 
 
 
 
 
 
 
 
 
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(1)
Scheduled square footage expirations for our total office portfolio, which reflects all existing leases that are scheduled to expire in the respective quarter shown above, excluding the square footage under leases where (i) the existing tenant has renewed the lease on or before March 31, 2016, (ii) a new tenant has executed a lease on or before March 31, 2016 that will commence after March 31, 2016, (iii) early termination options that are exercised after March 31, 2016, (iv) defaults occurring after March 31, 2016, and (v) short term leases, such as month to month leases and other short term leases. Short term leases are excluded because (a) they are not included in our changes in rental rate data, (b) have rental rates that may not be reflective of market conditions, and (c) can distort the data trends, particularly in the first quarter of the fiscal year. The variations in this number from quarter to quarter primarily reflects the mix of buildings/submarkets involved, although it is also impacted by the varying terms and square footage of the individual leases involved.
(2)
Represents annualized base rent (i.e., excludes tenant reimbursements, parking and other revenue) per leased square foot at expiration.  The amount reflects total cash base rent before abatements.  For our triple net leases, we calculate annualized base rent for triple net leases by adding expense reimbursements to base rent.  Expiring rent per square foot on a quarterly basis is impacted by a number of variables, including variations in the submarkets or buildings involved.
 
Multifamily Rental Rates

The table below presents the average annual rental rate per leased unit for new tenants.
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