Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2018

OR

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

For the transition period from ____________ to ____________

Commission file number 1-12993

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

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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

Indicate by check mark whether the registrant has submitted electronically 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes x  No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o   (Do not check if a smaller reporting company)
Smaller reporting company o
 
Emerging growth company o


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

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

As of July 16, 2018, 105,757,371 shares of common stock, par value $0.01 per share, were outstanding.


TABLE OF CONTENTS

 
 
Page
 
 
 
 
 
 
 
 
 
Consolidated Balance Sheets as of June 30, 2018, and December 31, 2017
 
 
 
 
Consolidated Statements of Income for the Three and Six Months Ended June 30, 2018 and 2017
 
 
 
 
Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2018 and 2017
 
 
 
 
Consolidated Statement of Changes in Stockholders’ Equity and Noncontrolling Interests for the Six Months Ended June 30, 2018
 
 
 
 
Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2018 and 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


i




GLOSSARY

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

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



ii




PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)

Alexandria Real Estate Equities, Inc.
Consolidated Balance Sheets
(In thousands)
(Unaudited)
 
June 30, 2018
 
December 31, 2017
Assets
 
 
 
Investments in real estate
$
11,190,771

 
$
10,298,019

Investments in unconsolidated real estate joint ventures
192,972

 
110,618

Cash and cash equivalents
287,029

 
254,381

Restricted cash
34,812

 
22,805

Tenant receivables
8,704

 
10,262

Deferred rent
490,428

 
434,731

Deferred leasing costs
232,964

 
221,430

Investments
790,753

 
523,254

Other assets
333,757

 
228,453

Total assets
$
13,562,190

 
$
12,103,953

 
 
 
 
Liabilities, Noncontrolling Interests, and Equity
 
 
 
Secured notes payable
$
776,260

 
$
771,061

Unsecured senior notes payable
4,289,521

 
3,395,804

Unsecured senior line of credit
—

 
50,000

Unsecured senior bank term loans
548,324

 
547,942

Accounts payable, accrued expenses, and tenant security deposits
849,274

 
763,832

Dividends payable
98,676

 
92,145

Total liabilities
6,562,055

 
5,620,784

 
 
 
 
Commitments and contingencies


 


 
 
 
 
Redeemable noncontrolling interests
10,861

 
11,509

 
 
 
 
Alexandria Real Estate Equities, Inc.’s stockholders’ equity:
 
 
 
7.00% Series D cumulative convertible preferred stock
74,386

 
74,386

Common stock
1,033

 
998

Additional paid-in capital
6,387,527

 
5,824,258

Accumulated other comprehensive (loss) income
(2,485
)
 
50,024

Alexandria Real Estate Equities, Inc.’s stockholders’ equity
6,460,461

 
5,949,666

Noncontrolling interests
528,813

 
521,994

Total equity
6,989,274

 
6,471,660

Total liabilities, noncontrolling interests, and equity
$
13,562,190

 
$
12,103,953



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

1




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

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Revenues:
 
 
 
 
 
 
 
Rental
$
250,635

 
$
211,942

 
$
495,120

 
$
419,135

Tenant recoveries
72,159

 
60,470

 
145,329

 
121,816

Other income
2,240


647


4,724


2,985

Total revenues
325,034

 
273,059

 
645,173

 
543,936

 
 
 
 
 
 
 
 
Expenses:
 
 
 
 
 
 
 
Rental operations
91,908

 
76,980

 
183,679

 
154,067

General and administrative
22,939

 
19,234

 
45,360

 
38,463

Interest
38,097

 
31,748

 
75,012

 
61,532

Depreciation and amortization
118,852

 
104,098

 
233,071

 
201,281

Impairment of real estate
6,311

 
203

 
6,311

 
203

Loss on early extinguishment of debt
—

 
—

 
—

 
670

Total expenses
278,107

 
232,263

 
543,433

 
456,216

 
 
 
 
 
 
 
 
Equity in earnings of unconsolidated real estate joint ventures
1,090

 
589

 
2,234

 
950

Investment income
12,530

 
—

 
98,091

 
—

Gain on sales of real estate – rental properties
—

 
—

 
—

 
270

Gain on sales of real estate – land parcels
—

 
111

 
—

 
111

Net income
60,547

 
41,496

 
202,065

 
89,051

Net income attributable to noncontrolling interests
(5,817
)

(7,275
)

(11,705
)

(13,119
)
Net income attributable to Alexandria Real Estate Equities, Inc.’s stockholders
54,730

 
34,221

 
190,360

 
75,932

Dividends on preferred stock
(1,302
)
 
(1,278
)
 
(2,604
)
 
(5,062
)
Preferred stock redemption charge
—

 
—

 
—

 
(11,279
)
Net income attributable to unvested restricted stock awards
(1,412
)
 
(1,313
)
 
(2,765
)
 
(2,300
)
Net income attributable to Alexandria Real Estate Equities, Inc.’s common stockholders
$
52,016

 
$
31,630

 
$
184,991

 
$
57,291

 
 
 
 
 
 
 
 
Net income per share attributable to Alexandria Real Estate Equities, Inc.’s common stockholders:
 
 
 
 
 
 
 
Basic
$
0.51

 
$
0.35

 
$
1.83

 
$
0.64

Diluted
$
0.51

 
$
0.35

 
$
1.83

 
$
0.64

 
 
 
 
 
 
 
 
Dividends declared per share of common stock
$
0.93

 
$
0.86

 
$
1.83

 
$
1.69



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

2




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

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Net income
$
60,547

 
$
41,496

 
$
202,065

 
$
89,051

Other comprehensive (loss) income
 
 
 
 
 
 
 
Unrealized (losses) gains on public investments:
 
 
 
 
 
 
 
Unrealized holding (losses) gains arising during the period
—

 
(4,025
)
 
—

 
6,396

Reclassification adjustment for losses included in net income
—

 
2,349

 
—

 
2,482

Unrealized (losses) gains on public investments, net
—

 
(1,676
)
 
—

 
8,878

 
 
 
 
 
 
 
 
Unrealized (losses) gains on interest rate hedge agreements:
 
 
 
 
 
 
 
Unrealized interest rate hedge gains (losses) arising during the period
661

 
(550
)
 
2,643

 
667

Reclassification adjustment for amortization of interest (income) expense included in net income
(1,131
)
 
707

 
(1,809
)
 
1,612

Unrealized (losses) gains on interest rate hedge agreements, net
(470
)
 
157

 
834

 
2,279

 
 
 
 
 
 
 
 
Unrealized (losses) gains on foreign currency translation:
 
 
 
 
 
 
 
Unrealized foreign currency translation (losses) gains arising during the period
(3,243
)
 
2,744

 
(3,572
)
 
3,756

Reclassification adjustment for cumulative foreign currency translation losses included in net income upon sale or liquidation
—

 
—

 
—

 
2,421

Unrealized (losses) gains on foreign currency translation, net
(3,243
)
 
2,744

 
(3,572
)
 
6,177

 
 
 
 
 
 
 
 
Total other comprehensive (loss) income
(3,713
)
 
1,225

 
(2,738
)
 
17,334

Comprehensive income
56,834

 
42,721

 
199,327

 
106,385

Less: comprehensive income attributable to noncontrolling interests
(5,817
)
 
(7,283
)
 
(11,705
)
 
(13,131
)
Comprehensive income attributable to Alexandria Real Estate Equities, Inc.’s stockholders
$
51,017

 
$
35,438

 
$
187,622

 
$
93,254


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


3




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

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

 
99,783,686

 
$
998

 
$
5,824,258

 
$
—

 
$
50,024

 
$
521,994

 
$
6,471,660

 
$
11,509

Net income
 
—

 
—

 
—

 
—

 
190,360

 
—

 
11,280

 
201,640

 
425

Total other comprehensive loss
 
—

 
—

 
—

 
—

 
—

 
(2,738
)
 
—

 
(2,738
)
 
—

Reclassification of net unrealized gains on non-real estate investments upon adoption of new ASU on financial instruments(1)
 
—

 
—

 
—

 
—

 
140,521

 
(49,771
)
 
—

 
90,750

 
—

Redemption of noncontrolling interests
 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(1,397
)
Distributions to noncontrolling interests
 
—

 
—

 
—

 
—

 
—

 
—

 
(18,018
)
 
(18,018
)
 
(426
)
Contributions from noncontrolling interests
 
—

 
—

 
—

 
257

 
—

 
—

 
13,557

 
13,814

 
750

Issuance of common stock
 
—

 
3,299,637

 
33

 
400,174

 
—

 
—

 
—

 
400,207

 
—

Issuance pursuant to stock plan
 
—

 
262,794

 
2

 
24,132

 
—

 
—

 
—

 
24,134

 
—

Dividends declared on common stock
 
—

 
—

 
—

 
—

 
(189,571
)
 
—

 
—

 
(189,571
)
 
—

Dividends declared on preferred stock
 
—

 
—

 
—

 
—

 
(2,604
)
 
—

 
—

 
(2,604
)
 
—

Reclassification of distributions in excess of earnings
 
—

 
—

 
—

 
138,706

 
(138,706
)
 
—

 
—

 
—

 
—

Balance as of June 30, 2018
 
$
74,386

 
103,346,117

 
$
1,033

 
$
6,387,527

 
$
—

 
$
(2,485
)
 
$
528,813

 
$
6,989,274

 
$
10,861



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

(1)
Adopted on January 1, 2018.

4




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

 
Six Months Ended June 30,
 
2018
 
2017
Operating Activities
 
 
 
Net income
$
202,065

 
$
89,051

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
233,071

 
201,281

Loss on early extinguishment of debt
—

 
670

Gain on sales of real estate – rental properties
—

 
(270
)
Impairment of real estate
6,311

 
203

Gain on sales of real estate – land parcels
—

 
(111
)
Equity in earnings of unconsolidated real estate joint ventures
(2,234
)
 
(950
)
Distributions of earnings from unconsolidated real estate joint ventures
287

 
249

Amortization of loan fees
5,136

 
5,738

Amortization of debt premiums
(1,181
)
 
(1,221
)
Amortization of acquired below-market leases
(11,368
)
 
(10,363
)
Deferred rent
(55,890
)
 
(53,497
)
Stock compensation expense
15,223

 
10,756

Investment income
(98,091
)
 
(962
)
Changes in operating assets and liabilities:
 
 
 
Tenant receivables
1,552

 
1,354

Deferred leasing costs
(29,705
)
 
(26,811
)
Other assets
(15,055
)
 
(4,654
)
Accounts payable, accrued expenses, and tenant security deposits
8,120

 
13,283

Net cash provided by operating activities
258,241

 
223,746

 
 
 
 
Investing Activities
 
 
 
Proceeds from sales of real estate
—

 
3,528

Additions to real estate
(431,225
)
 
(436,377
)
Purchases of real estate
(688,698
)
 
(480,543
)
Deposits for investing activities
5,500

 
450

Acquisitions of interests in unconsolidated real estate joint ventures
(35,922
)
 
—

Investments in unconsolidated real estate joint ventures
(44,486
)
 
(163
)
Additions to investments
(118,775
)
 
(81,192
)
Sales of investments
44,707

 
12,577

Net cash used in investing activities
$
(1,268,899
)
 
$
(981,720
)

5




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

 
Six Months Ended June 30,
 
2018
 
2017
Financing Activities
 
 
 
Borrowings from secured notes payable
$
9,044

 
$
117,666

Repayments of borrowings from secured notes payable
(3,162
)
 
(1,677
)
Proceeds from issuance of unsecured senior notes payable
899,321

 
424,384

Borrowings from unsecured senior line of credit
2,469,000

 
2,069,000

Repayments of borrowings from unsecured senior line of credit
(2,519,000
)
 
(1,797,000
)
Repayments of borrowings from unsecured senior bank term loans
—

 
(200,000
)
Payment of loan fees
(8,003
)
 
(4,344
)
Repurchase of 7.00% Series D cumulative convertible preferred stock
—

 
(17,934
)
Redemption of 6.45% Series E cumulative redeemable preferred stock
—

 
(130,350
)
Proceeds from the issuance of common stock
400,207

 
459,607

Dividends on common stock
(183,040
)
 
(149,296
)
Dividends on preferred stock
(2,604
)
 
(7,015
)
Contributions from noncontrolling interests
14,564

 
8,505

Distributions to and purchases of noncontrolling interests
(19,841
)
 
(10,791
)
Net cash provided by financing activities
1,056,486

 
760,755

 
 
 
 
Effect of foreign exchange rate changes on cash and cash equivalents
(1,173
)
 
732

 
 
 
 
Net increase in cash, cash equivalents, and restricted cash
44,655

 
3,513

Cash, cash equivalents, and restricted cash as of the beginning of period
277,186

 
141,366

Cash, cash equivalents, and restricted cash as of the end of period
$
321,841

 
$
144,879

 
 
 
 
Supplemental Disclosure of Cash Flow Information:
 
 
 
Cash paid during the period for interest, net of interest capitalized
$
68,885

 
$
53,810

 
 
 
 
Non-Cash Investing Activities:
 
 
 
Change in accrued construction
$
48,074

 
$
(25,138
)
Contribution of real estate to an unconsolidated real estate joint venture
$
—

 
$
6,998


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


6

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

1.
Organization and basis of presentation

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

We have prepared the accompanying interim consolidated financial statements in accordance with GAAP and in conformity with the rules and regulations of the SEC. In our opinion, the interim consolidated financial statements presented herein reflect all adjustments, of a normal recurring nature, that are necessary to fairly present the interim consolidated financial statements. The results of operations for the interim period are not necessarily indicative of the results that may be expected for the year ending December 31, 2018. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in our annual report on Form 10‑K for the year ended December 31, 2017. Any references to our market capitalization, number or quality of buildings or tenants, quality of location, square footage, number of leases, or occupancy percentage, and any amounts derived from these values in the notes to consolidated financial statements, are outside the scope of our independent registered public accounting firm’s interim review.

2.
Summary of significant accounting policies

Consolidation

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

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

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

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

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


7


2.
Summary of significant accounting policies (continued)

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

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

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

Variable interest model

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

Voting model

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

Use of estimates

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

Investments in real estate

Evaluation of business combination or asset acquisition

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

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


8


2.
Summary of significant accounting policies (continued)

An acquired process is considered substantive if:

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

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

Recognition of real estate acquired

For acquisitions of real estate or in-substance real estate that are accounted for as business combinations, we recognize the assets acquired (including the intangible value of acquired above- or below-market leases, acquired in-place leases, tenant relationships, and other intangible assets or liabilities), liabilities assumed, noncontrolling interests, and previously existing ownership interests at fair value as of the acquisition date. Any excess (deficit) of the consideration transferred relative to the fair value of the net assets acquired is accounted for as goodwill (bargain purchase gain). Acquisition costs related to business combinations are expensed as incurred.

Acquisitions of real estate and in-substance real estate that do not meet the definition of a business are accounted for as asset acquisitions. The accounting model for asset acquisitions is similar to the accounting model for business combinations except that the acquisition consideration (including acquisition costs) is allocated to the individual assets acquired and liabilities assumed on a relative fair value basis. As a result, asset acquisitions do not result in the recognition of goodwill or a bargain purchase gain. Additionally, because the accounting model for asset acquisitions is a cost accumulation model, preexisting interests in the acquired assets, if any, are not remeasured to fair value but continue to be accounted for at their historical cost. Direct acquisition costs are capitalized if an asset acquisition is probable. If we determine that an asset acquisition is no longer probable, no new costs are capitalized and all capitalized costs that are not recoverable are expensed.

The relative fair values used to allocate the cost of an asset acquisition are determined by the same methodologies and assumptions we utilize to determine fair value in a business combination.

If a real estate property is acquired with an in-place lease that contains a bargain fixed-rate renewal option for the period beyond the non-cancelable lease term, we evaluate factors, such as the business conditions in the industry in which the lessee operates, the economic conditions in the area in which the property is located, and the ability of the lessee to sublease its space during the renewal term, in order to determine the likelihood that the lessee will renew. When we determine there is reasonable assurance that such bargain renewal option will be exercised, we consider the option in determining the intangible value of such lease and its related amortization period. The value of tangible assets acquired is based upon our estimation of value on an “as if vacant” basis. The value of acquired in-place leases includes the estimated costs during the hypothetical lease-up period and other costs that would have been incurred in the execution of similar leases under the market conditions at the acquisition date of the acquired in-place lease. We assess the fair value of tangible and intangible assets based on numerous factors, including estimated cash flow projections that utilize appropriate discount and capitalization rates and available market information. Estimates of future cash flows are based on a number of factors, including the historical operating results, known trends, and market/economic conditions, that may affect the property.

The values allocated to buildings and building improvements, land improvements, tenant improvements, and equipment are depreciated on a straight-line basis using the shorter of the term of the respective ground lease and up to 40 years for buildings and building improvements, an estimated life of up to 20 years for land improvements, the respective lease term for tenant improvements, and the estimated useful life for equipment. The values of acquired above- and below-market leases are amortized over the terms of the related leases and recognized as either increases (for below-market leases) or decreases (for above-market leases) to rental revenue. The values of acquired above- and below-market ground leases are amortized over the terms of the related ground leases and recognized as either increases (for below-market ground leases) or decreases (for above-market ground leases) to rental operating expense. The values of acquired in-place leases are classified in other assets in the accompanying consolidated balance sheets and amortized over the remaining terms of the related leases.


9


2.
Summary of significant accounting policies (continued)

Capitalized project costs

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

Real estate sales

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

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

Impairment of long-lived assets

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

Long-lived assets to be held and used, including our rental properties, CIP, land held for development, and intangibles, are individually evaluated for impairment when conditions exist that may indicate that the carrying amount of a long-lived asset may not be recoverable. The carrying amount of a long-lived asset to be held and used is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. Impairment indicators or triggering events for long-lived assets to be held and used, including our rental properties, CIP, land held for development, and intangibles, are assessed by project and include significant fluctuations in estimated net operating income, occupancy changes, significant near-term lease expirations, current and historical operating and/or cash flow losses, construction costs, estimated completion dates, rental rates, and other market factors. We assess the expected undiscounted cash flows based upon numerous factors, including, but not limited to, construction costs, available market information, current and historical operating results, known trends, current market/economic conditions that may affect the property, and our assumptions about the use of the asset, including, if necessary, a probability-weighted approach if multiple outcomes are under consideration. Upon determination that an impairment has occurred, a write-down is recognized to reduce the carrying amount to its estimated fair value. If an impairment loss is not required to be recognized, the recognition of depreciation is adjusted prospectively, as necessary, to reduce the carrying amount of the real estate to its estimated disposition value over the remaining period that the real estate is expected to be held and used. We may adjust depreciation of properties that are expected to be disposed of or redeveloped prior to the end of their useful lives.

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

10


2.
Summary of significant accounting policies (continued)


International operations

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

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

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

Investments

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

Prior to January 1, 2018

Prior to the adoption of a new ASU on financial instruments effective January 1, 2018, all of our equity investments in actively traded public companies were considered available-for-sale and were presented in the accompanying consolidated balance sheets at fair value. Fair value was determined based upon the closing price as of each balance sheet date, with unrealized gains and losses shown as a separate component of accumulated other comprehensive income within total equity (excluded from net income). The classification of each investment was determined at the time each investment was made, and such determination was reevaluated at each balance sheet date. The cost of each investment sold was determined by the specific identification method, with realized gains or losses classified in other income in the accompanying consolidated statements of income. Investments in privately held entities were generally accounted for under the cost method when our interest in the entity was so minor that we had virtually no influence over the entity’s operating and financial policies. Investments in privately held entities were accounted for under the equity method unless our interest in the entity was deemed to be so minor that we had virtually no influence over the entity’s operating and financial policies. Under the equity method of accounting, we recognized our investment initially at cost and adjusted the carrying amount of the investment to recognize our share of the earnings or losses of the investee subsequent to the date of our investment.

We periodically assessed our investments in available-for-sale equity securities and privately held companies accounted for under the cost method for other-than-temporary impairment. We monitored each of our investments throughout the year for new developments, including operating results, results of clinical trials, capital-raising events, and merger and acquisition activities. Individual investments were evaluated for impairment when changes in conditions indicated an impairment may exist. The factors that we considered in making these assessments included, but were not limited to, market prices, market conditions, available financing, prospects for favorable or unfavorable clinical trial results, new product initiatives, and new collaborative agreements. If an unrealized loss related to an available-for-sale equity security was determined to be other-than-temporary, such unrealized loss was reclassified from accumulated other comprehensive income within total equity into earnings. For a cost method investment, if a decline in the fair value of an investment below its carrying value was determined to be other-than-temporary, such investment was written down to its estimated fair value with a charge to earnings. If there were no identified events or changes in circumstances that might have had an adverse effect on our cost method investments, we did not estimate the investment’s fair value.


11


2.
Summary of significant accounting policies (continued)

Effective January 1, 2018

Beginning on January 1, 2018, under the new ASU, equity investments (except those accounted for under the equity method and those that result in consolidation of the investee) are measured at fair value, with changes in fair value recognized in net income, as follows:

•
Investments in publicly traded companies are classified as investments with readily determinable fair values. These investments are carried at fair value, with changes in fair value recognized in net income, rather than in accumulated other comprehensive income within total equity. The fair values for our investments in publicly traded companies continue to be determined based on sales prices/quotes available on securities exchanges, or published prices that serve as the basis for current transactions.
•
Investments in privately held entities without readily determinable fair values fall into two categories:
•
Investments in privately held entities that report net asset value per share (“NAV”), such as our privately held investments in limited partnerships, are carried at fair value using NAV as a practical expedient with changes in fair value recognized in net income.
•
Investments in privately held entities that do not report NAV are accounted for using a measurement alternative which allows these investments to be measured at cost, adjusted for observable price changes and impairments, with changes recognized in net income.

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

Investments in privately held entities that do not report NAV continue to be evaluated on the basis of a qualitative assessment for indicators of impairment by utilizing the same monitoring criteria described above. If such indicators are present, we are required to estimate the investment’s fair value and immediately recognize an impairment loss, without consideration as to whether the impairment is other-than-temporary, in an amount equal to the investment’s carrying value in excess of its estimated fair value.

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

Initial adoption of new ASU

On January 1, 2018, we recognized the following adjustments upon adoption of the new ASU:

•
For investments in publicly traded companies, reclassification of cumulative unrealized gains as of December 31, 2017, aggregating $49.8 million, from accumulated other comprehensive income to retained earnings.
•
For investments in privately held entities without readily determinable fair values that were previously accounted for under the cost method:
•
Adjustment to investments for unrealized gains aggregating $90.8 million related to investments in privately held entities that report NAV, representing the difference between fair value as of December 31, 2017, using NAV as a practical expedient and the carrying value of the investments as of December 31, 2017, with a corresponding adjustment to retained earnings.
•
No adjustment was required for investments in privately held entities that do not report NAV. The ASU requires a prospective transition approach for investments in privately held entities that do not report NAV. The FASB clarified that it would be difficult for entities to determine the last observable transaction price existing prior to the adoption of this ASU. Therefore, unlike our investments in privately held entities that report NAV that were adjusted to reflect fair values upon adoption of the new ASU, our investments in privately held entities that do not report NAV were not retrospectively adjusted to fair values upon adoption. As such, any initial valuation adjustments made for investments in privately held entities that do not report NAV subsequent to January 1, 2018, as a result of future observable price changes include recognition of unrealized gains or losses equal to the difference between the carrying basis of the investment and the observable price at the date of remeasurement.

12


2.
Summary of significant accounting policies (continued)


Revenue recognition

Recognition of revenue arising from contracts with customers
    
On January 1, 2018, we adopted an ASU on revenue recognition that requires a new model for recognition of revenue arising from contracts with customers, as well as recognition of gains and losses from the transfer of nonfinancial assets arising from contracts with noncustomers. A customer is distinguished from a noncustomer by the nature of the goods or services that are transferred. Customers are provided with goods or services that are generated by a company’s ordinary output activities, whereas noncustomers are provided with nonfinancial assets that are outside of a company’s ordinary output activities.

The core principle underlying the ASU on recognition of revenue arising from contracts with customers is that an entity must recognize revenue to represent the transfer of goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled in such exchange. This requires entities to identify contractual performance obligations and determine whether revenue should be recognized at a point in time or over time, based on when control of goods and services transfers to a customer. The ASU requires the use of a new five-step model to recognize revenue from customer contracts. The five-step model requires that we (i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, including variable consideration to the extent that it is probable that a significant future reversal will not occur, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) we satisfy the performance obligation.

An entity is also required to determine if it controls the goods or services prior to the transfer to the customer in order to determine if it should account for the arrangement as a principal or agent. Principal arrangements, where the entity controls the goods or services provided, result in the recognition of the gross amount of consideration expected in the exchange. Agent arrangements, where the entity simply arranges but does not control the goods or services being transferred to the customer, result in the recognition of the net amount the entity is entitled to retain in the exchange. Upon adoption of the new lease ASU in 2019, we will be required to classify our tenant recoveries into lease and nonlease components, whereby the nonlease components would be subject to the ASU on recognition of revenue arising from contracts with customers. However, if we elect a practical expedient, as discussed in “Lessor Accounting” within the “Lease Accounting” section of “Recent Accounting Pronouncements” contained in Note 2, tenant recoveries for goods and services that are categorized as nonlease components but have the same timing and pattern of transfer as the related lease component may (subject to the predominance test) be accounted for under the new lease ASU. Tenant recoveries that do not qualify for the practical expedient will be accounted for under the ASU on recognition of revenue arising from contracts with customers upon adoption of the new lease ASU. Property services categorized as nonlease components that are reimbursed by our tenants may need to be presented on a net basis if it is determined that we hold an agent arrangement.

Entities had the option to transition to the ASU on recognition of revenue arising from contracts with customers using either the full retrospective or the modified retrospective method. We adopted this ASU using the modified retrospective method, which requires a cumulative adjustment for effects of applying the new standard to periods prior to 2018 to be recorded to retained earnings as of January 1, 2018. We also elected to apply this ASU only to contracts not completed as of January 1, 2018. For all contracts within the scope of this ASU that were not completed as of January 1, 2018, we evaluated the revenue recognition under accounting standards in effect prior to January 1, 2018, and under the new ASU, and determined that amounts recognized and the pattern of revenue recognition were consistent. Therefore, the adoption of the ASU on recognition of revenue arising from contracts with customers did not result in an adjustment to our retained earnings on January 1, 2018.

The table below provides the detail of our consolidated revenues for the three and six months ended June 30, 2018, by (i) revenues that are subject to the ASU on recognition of revenue arising from contracts with customers, and (ii) revenues subject to other accounting standards (in thousands):
 
 
Three months ended June 30, 2018
 
Six Months Ended June 30, 2018
 
 
Subject to the ASU on Recognition of Revenue from Contracts with Customers
 
Subject to Other Accounting Guidance
 
Total
 
Subject to the ASU on Recognition of Revenue from Contracts with Customers
 
Subject to Other Accounting Guidance
 
Total
Rental
 
$
12,086

 
$
238,549

 
$
250,635

 
$
22,519

 
$
472,601

 
$
495,120

Tenant recoveries
 
—

 
72,159

 
72,159

 
—

 
145,329

 
145,329

Other income
 
1,496

 
744

 
2,240

 
3,516

 
1,208

 
4,724

Total revenues
 
$
13,582

 
$
311,452

 
$
325,034

 
$
26,035

 
$
619,138

 
$
645,173


13


2.
Summary of significant accounting policies (continued)

Rental revenues, subject to the new revenue recognition ASU, aggregating $12.1 million and $22.5 million for the three and six months ended June 30, 2018, respectively, consist primarily of parking revenues. Parking revenues consist primarily of short term rental revenues that are not considered lease revenue. Under the previous accounting standards, we recognized parking and other revenue when the amounts were fixed or determinable, collectibility was reasonably assured, and services were rendered. Under the new ASU, the recognition of such revenue occurs when the services are provided and the performance obligations are satisfied. Parking services are normally provided at a point in time; therefore, revenue recognition under the new ASU is substantially similar to the recognition pattern under accounting standards that were in effect prior to January 1, 2018.

Other income, subject to the new revenue recognition ASU, aggregating $1.5 million and $3.5 million for the three and six months ended June 30, 2018, respectively, consists primarily of construction management fees. We earn construction management fees for the day-to-day management of third-party construction projects. Construction management services represent a series of services that are substantially the same and that can be combined into a single performance obligation. Under the previous accounting guidance, we recognized construction management fees using the percentage of completion method. Under the new ASU, we recognize construction management fees using the output method, which is substantially similar to the percentage of completion method used under the guidance in effect prior to January 1, 2018.

In addition to the analysis above, we evaluated the following qualitative and quantitative disclosure requirements outlined in this ASU during the six months ended June 30, 2018, as follows:

•
Prior to the adoption of this ASU, we did not have material contract assets and contract liabilities related to contracts with customers subject to the new revenue recognition ASU, and no additional contract assets or contract liabilities were necessary subsequent to adoption on January 1, 2018.
•
Parking and construction management services subject to the new revenue recognition ASU do not normally create obligations for returns, refunds, warranties, and other similar obligations. Therefore, no corresponding disclosures were necessary.

Recognition of revenue arising from contracts with noncustomers

On January 1, 2018, we also adopted a new ASU on the derecognition of nonfinancial assets in transactions, including real estate sales, with noncustomers. Our ordinary output activities consist of the leasing of space to our tenants in our operating properties, not the sales of real estate. Therefore, sales of real estate qualify as contracts with noncustomers and are subject to this new ASU.

The new ASU on the derecognition of nonfinancial assets requires entities to apply certain recognition and measurement principles consistent with the new ASU on recognition of revenue arising from contracts with customers. The derecognition model is based on the transfer of control. If a real estate sales contract includes ongoing involvement by the seller with the property, the seller must evaluate each promised good or service under the contract to determine whether it represents a separate performance obligation, constitutes a guarantee, or prevents the transfer of control. If a good or service is considered a separate performance obligation, an allocated portion of the transaction price should be recognized as revenue as the entity transfers the related good or service to the buyer.

The recognition of gain or loss on the sale of a partial interest also depends on whether the seller retains a controlling or noncontrolling interest. Under the new standards, a partial sale of real estate in which the seller retains a controlling interest results in the seller’s continuing to reflect the asset at its current book value, recording a noncontrolling interest for the book value of the partial interest sold, and recognizing additional paid-in capital for the difference between the consideration received and the partial interest at book value, consistent with the prior accounting standards. Conversely, a partial sale of real estate in which a seller retains a noncontrolling interest results in the recognition by the seller of a gain or loss as if 100% of the real estate were sold.

We adopted the new ASU on the derecognition of nonfinancial assets using the modified retrospective method, the same transition method used to adopt the ASU on recognition of revenue arising from contracts with customers. We also elected to apply this ASU on the derecognition of nonfinancial assets only to contracts not completed as of January 1, 2018. We had no contracts with noncustomers that were not completed as of January 1, 2018; therefore, the adoption of the ASU on the derecognition of nonfinancial assets had no effect on our consolidated financial statements.

During the six months ended June 30, 2018, we did not complete any partial or full sales of real estate assets.

14


2.
Summary of significant accounting policies (continued)


Recognition of rental income and tenant recoveries

Rental revenue from operating leases is recognized on a straight-line basis over the respective lease terms. We classify amounts currently recognized as rental revenue in our consolidated statements of income, and amounts expected to be received in later years as deferred rent in the accompanying consolidated balance sheets. Amounts received currently but recognized as revenue in future years are classified in accounts payable, accrued expenses, and tenant security deposits in the accompanying consolidated balance sheets. We commence recognition of rental revenue at the date the property is ready for its intended use and the tenant takes possession of or controls the physical use of the property.

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

Tenant recoveries related to reimbursement of real estate taxes, insurance, utilities, repairs and maintenance, common area expenses, and other operating expenses are recognized as revenue in the period during which the applicable expenses are incurred and the tenant’s obligation to reimburse us arises.

Tenant receivables consist primarily of amounts due for contractual lease payments and tenant recoveries. These tenant receivables are expected to be collected within one year. We may maintain an allowance for estimated losses that may result from the inability of our tenants to make payments required under the terms of the lease and for tenant recoveries due. If a tenant fails to make contractual payments beyond any allowance, we may recognize additional bad debt expense in future periods equal to the amount of uncollectible tenant receivables and deferred rent arising from the straight-lining of rent. As of June 30, 2018, and December 31, 2017, no allowance for uncollectible tenant receivables and deferred rent was deemed necessary.

Monitoring tenant credit quality

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

Income taxes

We are organized and operate as a REIT pursuant to the Internal Revenue Code (the “Code”). Under the Code, a REIT that distributes at least 90% of its REIT taxable income to its stockholders annually (excluding net capital gains) and meets certain other conditions is not subject to federal income tax on its distributed taxable income, but could be subject to certain federal, foreign, state, and local taxes. We distribute 100% of our taxable income annually; therefore, a provision for federal income taxes is not required. In addition to our REIT returns, we file federal, foreign, state, and local tax returns for our subsidiaries. We file with jurisdictions located in the U.S., Canada, India, China, and other international locations. Our tax returns are subject to routine examination in various jurisdictions for the 2012 through 2017 calendar years.

On December 22, 2017, the U.S. President signed a tax reform bill commonly referred to as the Tax Cuts and Jobs Act into law. The tax reform legislation is a far-reaching and complex revision to the U.S. federal income tax laws with disparate and, in some cases, countervailing effects on different categories of taxpayers and industries. The legislation is unclear in many respects and will require clarification and interpretation by the U.S. Treasury Department and the Internal Revenue Service (“IRS”) in the form of amendments, technical corrections, regulations, or other forms of guidance, any of which could lessen or increase the effect of the legislation on us or our stockholders. The outcome of this legislation on state and local tax authorities, and the response by such authorities, is also unclear. We will continue to monitor changes made to, or as a result of, the federal tax law and its potential effect on us.


15


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Summary of significant accounting policies (continued)

Employee share-based payments

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

Recent accounting pronouncements

Lease accounting

Overview related to both lessee and lessor accounting
    
In February 2016, the FASB issued an ASU that sets out the principles for the recognition, measurement, presentation, and disclosure of leases for both parties to a lease agreement (i.e., lessees and lessors). The ASU is effective for us no later than January 1, 2019, with early adoption permitted. We expect to adopt the new lease accounting standard on January 1, 2019. The ASU requires us to identify lease and nonlease components of a lease agreement. This ASU will govern the recognition of revenue for lease components. Revenue related to nonlease components under our lease agreements will be subject to the new revenue recognition ASU, effective upon adoption of the new lease accounting standard. However, in July 2018, the FASB issued an ASU to modify the application of this ASU by lessors to lease and nonlease components within lease agreements. See further discussion related to this update and other proposed changes in the “Lessor Accounting” section below.
    
The lease ASU sets new criteria for determining the classification of finance leases for lessees and sales-type leases for lessors. The criteria to determine if a lease should be accounted for as a finance (sales-type) lease include the following: (i) ownership is transferred from lessor to lessee by the end of the lease term, (ii) an option to purchase is reasonably certain to be exercised, (iii) the lease term is for the major part of the underlying asset’s remaining economic life, (iv) the present value of lease payments exceeds substantially all of the fair value of the underlying asset, and (v) the underlying asset is specialized and is expected to have no alternative use at the end of the lease term. If any of these criteria is met, a lease will be classified as a finance lease by the lessee and as a sales-type lease by the lessor. If none of the criteria are met, a lease will be classified as an operating lease by the lessee, but may still qualify as a direct financing lease or an operating lease for the lessor. The existence of a residual value guarantee from an unrelated third party other than the lessee may qualify the lease as a direct financing lease by the lessor. Otherwise, the lease will be classified as an operating lease by both the lessee and lessor.

The lease ASU requires the use of the modified retrospective transition method and does not allow for a full retrospective approach. However, it provides two options for the application of the modified retrospective transition method:

•
Under the first option, this ASU requires application of the standard to all leases that exist as of, or commence after, January 1, 2017 (the beginning of the earliest comparative period presented in the 2019 financial statements), with a cumulative adjustment to the opening balance of retained earnings on January 1, 2017, for the effect of applying the standard at the date of initial application, and restatement of the amounts presented prior to January 1, 2019.

•
Under the second option, an entity may elect a practical expedient package, which allows for the following:
•
An entity need not reassess whether any expired or existing contracts are or contain leases;
•
An entity need not reassess the lease classification for any expired or existing leases; and
•
An entity need not reassess initial direct costs for any existing leases.

This practical expedient package is available as a single election that must be consistently applied to all existing leases at the date of adoption. Lessors that adopt this package are not expected to reassess expired or existing leases at the date of initial application, which is January 1, 2017, under the ASU. This option enables entities to “run off” their existing leases for the remainder of the respective lease terms, which eliminates the need to calculate a cumulative adjustment to the opening balance of retained earnings.

Furthermore, in July 2018, the FASB issued an ASU that provides an optional transition method to make the initial application date of the ASU January 1, 2019, rather than January 1, 2017. Consequently, entities that elect both the practical expedient package and the optional transition method will apply the new lease ASU prospectively to leases commencing or modified after January 1, 2019, and will not be required to apply the disclosures under the new lease ASU to comparative periods.

16


2.
Summary of significant accounting policies (continued)

Recent accounting pronouncements (continued)

Lease accounting (continued)


Under either option above, lessees will be required to recognize a right-of-use asset and a lease liability for all operating leases on the date of the initial application based on the present value of the remaining minimum rental payments that were tracked and disclosed under current accounting standards.

The FASB has also clarified that the lease ASU will require an assessment of whether a land easement meets the definition of a lease under the new lease ASU. An entity with existing land easements that are not accounted for as leases under the current lease accounting standards, however, may elect a practical expedient to exclude those land easements from assessment under the new lease accounting standards. The new lease ASU will be applied to all land easement arrangements entered into or modified on and after the ASU effective date; however, it is expected to have little or no effect on land easements that contain minimal or no consideration.

Lessor accounting

We recognized revenue from our lease agreements aggregating $617.9 million for the six months ended June 30, 2018. This revenue consisted primarily of rental revenues and tenant recoveries for the six months ended June 30, 2018, aggregating $472.6 million and $145.3 million, respectively.

Under current lease accounting standards, we recognize rental revenue from our operating leases on a straight-line basis over the respective lease terms. We commence recognition of rental revenue at the date the property is ready for its intended use and the tenant takes possession of, or controls the physical use of, the property. We recognize rental revenue from direct financing leases over the lease term by using the effective interest rate method.

Under current lease accounting standards, tenant recoveries related to payments of real estate taxes, insurance, utilities, repairs and maintenance, common area expenses, and other operating expenses are considered lease components. We recognize these tenant recoveries as revenue when services are rendered in an amount equal to the related operating expenses incurred that are recoverable under the terms of the applicable lease.

Under the new lease ASU, each lease agreement will be evaluated to identify the lease components and nonlease components at lease inception. The total consideration in the lease agreement will be allocated to the lease and nonlease components based on their relative stand-alone selling prices. The new ASU will govern the recognition of revenue for lease components. Revenue related to nonlease components will be subject to the new revenue recognition ASU, effective upon adoption of the new lease accounting standard. Lessors will continue to recognize the lease revenue component using an approach that is substantially equivalent to existing guidance for operating leases (straight-line basis). Sales-type and direct financing leases will be accounted for as financing transactions, with the lease payments allocated to principal and interest by utilizing the effective interest rate method.
Under the new lease ASU, tenant recoveries for utilities, repairs and maintenance, and common area expenses are expected to primarily be categorized as nonlease components. Tenant recoveries for taxes and insurance are expected to be neither lease nor nonlease components under the lease ASU but instead will be considered additional lease revenue to be recognized by the lessor.

In July 2018, the FASB issued an ASU that allows lessors to elect, as a practical expedient, not to allocate the total consideration to the lease and nonlease components based on their relative stand-alone selling prices. If adopted, this single-lease component practical expedient will allow lessors to elect a combined single-lease component presentation if (i) the timing and pattern of transfer of the lease component and the nonlease component(s) associated with it are the same, and (ii) the lease component would be classified as an operating lease if it were accounted for separately. Nonlease components that do not meet the criteria of this practical expedient will be accounted for under the new revenue recognition ASU. The FASB also decided to require lessors to account for a combined component that meets these two criteria under the new revenue recognition ASU if the nonlease component is the predominant component. If the nonlease component is not the predominant component, entities will be able to account for the combined component as an operating lease in accordance with the new lease ASU. Based on our preliminary analysis, we expect that most of our leases for which we are the lessor will qualify for the single-lease component presentation as operating leases.

If we elect the single-lease component practical expedient described above, tenant recoveries that qualify for this expedient will be accounted for as a single-lease component under the new lease ASU, primarily as variable consideration. Tenant recoveries that do not qualify for the single-lease component practical expedient and are considered nonlease components will be accounted for under the new revenue recognition ASU upon adoption of the new lease ASU.

17


2.
Summary of significant accounting policies (continued)

Recent accounting pronouncements (continued)

Lease accounting (continued)


The new lease ASU also requires a lessor to recognize lessor’s costs (i.e., real estate taxes and insurance) paid directly by a lessee to a third party on a gross basis as lease revenue and lease expense. However, in March 2018, the FASB made a tentative decision to amend the ASU to allow a lessor not to estimate lessor costs paid by the lessee directly to a third party when the lessor cannot determine the amount of those costs. In these cases, lessors will not recognize these costs in their income statements. This ASU has not been issued as of the date of this report.

Costs to execute leases

The new lease ASU will require that lessors and lessees capitalize, as initial direct costs, only those costs that are incurred due to the execution of a lease (i.e., commissions paid to leasing brokers). Under this ASU, allocated payroll costs, legal costs, and other out-of-pocket costs incurred as part of the leasing process prior to the execution of a lease will no longer qualify for classification as initial direct costs and will instead be expensed as incurred. We will have the option, under the practical expedient package provided by the new lease ASU, to continue to amortize previously capitalized initial direct costs incurred prior to the adoption of the ASU.

During the six months ended June 30, 2018, we completed 76 leases aggregating approximately 2.5 million rentable square feet with a weighted average lease term of 10.4 years. These leases generally represent mission-critical office/laboratory space with high barriers to exit for our tenants. As a result, approximately 51% of these leases were negotiated directly with our tenants and did not require payment of third-party commissions to leasing brokers. Our total initial direct leasing costs (leasing commissions, payroll, and legal fees) for the six months ended June 30, 2018 aggregated $33.3 million, or approximately $1.30 per rentable square foot leased per year of lease term. Included in the $33.3 million for the six months ended June 30, 2018 was $9.2 million of allocated payroll and legal costs, or approximately $0.36 per rentable square foot leased per year of lease term, related to these leases, which, if incurred under the new lease ASU, would have been expensed.

Lessee accounting

Under the new lease ASU, lessees are required to apply a dual approach by classifying leases as either finance or operating leases based on the principle of whether the lease is effectively a financed purchase of the leased asset by the lessee. This classification will determine whether the lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease, which corresponds to a similar evaluation performed by lessors. In addition to this classification, a lessee is also required to recognize a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification, whereas a lessor is not required to recognize a right-of-use asset and a lease liability for any operating leases. Leases with a lease term of 12 months or less will be accounted for in a manner similar to existing guidance for operating leases (i.e., straight-line basis).

The new lease ASU requires the recognition of a right-of-use asset and a related liability to account for our future obligations under our ground and office lease agreements for which we are the lessee. At the date of initial application, depending on the practical expedients we elect as discussed above, we will be required to recognize a lease liability measured based on the present value of the remaining lease payments. The present value of the remaining lease payments will be calculated using the incremental borrowing rate, which is the interest rate that we estimate we would have to pay to borrow on a collateralized basis over a similar term for an amount equal to the lease payments. The right-of-use asset will be equal to the corresponding lease liability, adjusted for the initial direct leasing cost and any other consideration exchanged with the landlord prior to the commencement of the lease.

As of June 30, 2018, the remaining contractual payments under our ground and office lease agreements for which we are the lessee aggregated $610.8 million, and the estimated present value of these payments is in the range from $200.0 million to $230.0 million. This estimated present value range is based on a weighted average remaining lease term of 47 years and our estimated weighted average incremental borrowing rate in the range from 5% to 6%. Incremental borrowing rate is the interest rate that we estimate we would have to pay to borrow on a collateralized basis over a similar term for an amount equal to the lease payments. The actual lease liability and right-of-use asset to be recognized upon adoption of the new lease ASU will vary depending on changes to our incremental borrowing rate and the practical expedients we elect as discussed above.


18


2.
Summary of significant accounting policies (continued)

Recent accounting pronouncements (continued)

Lease accounting (continued)

All of our existing ground and office leases for which we are the lessee are currently classified as operating leases. Under the practical expedient package provided by the lease ASU, we will have the option to continue to classify these leases as operating leases upon adoption of the lease ASU. We are still evaluating the effect on our consolidated financial statements of the initial recognition of each lease asset and liability upon adoption, and the pattern of recognition of ground lease expense subsequent to adoption.

Allowance for credit losses

In June 2016, the FASB issued an ASU that changes the impairment model for most financial instruments by requiring companies to recognize an allowance for expected losses, rather than incurred losses as required currently by the other-than-temporary impairment model. The ASU will apply to most financial assets measured at amortized cost and certain other instruments, including trade and other receivables, loans, held-to-maturity debt securities, net investments in leases, and off-balance-sheet credit exposures (i.e., loan commitments). The ASU is effective for reporting periods beginning after December 15, 2019, with early adoption permitted, and will be applied as a cumulative adjustment to retained earnings as of the effective date. We are currently assessing the potential effect the adoption of this ASU will have on our consolidated financial statements.

Joint venture distributions

On January 1, 2018, we adopted an ASU that provides guidance on the classification in the statement of cash flows of cash distributions received from equity method investments, including unconsolidated joint ventures. The ASU provides two approaches to determine the classification of cash distributions received from equity method investees: (i) the “cumulative earnings” approach, under which distributions up to the amount of cumulative equity in earnings recognized are classified as cash inflows from operating activities, and those in excess of that amount are classified as cash inflows from investing activities, and (ii) the “nature of the distribution” approach, under which distributions are classified based on the nature of the underlying activity that generated cash distributions. An entity could elect either the “cumulative earnings” or the “nature of the distribution” approach. If the “nature of the distribution” approach is elected and the entity lacks the information necessary to apply it in the future, that entity will have to apply the “cumulative earnings” approach as an accounting change on a retrospective basis. We adopted this ASU using the “nature of the distribution” approach and applied it retrospectively, as required by the ASU. We previously presented distributions from our equity method investees utilizing the “nature of the distribution” approach; therefore, the adoption of this ASU had no effect on our consolidated financial statements.

Restricted cash

On January 1, 2018, we adopted an ASU that requires entities to include restricted cash with cash and cash equivalents when reconciling the beginning of period and end of period total amounts shown in the statement of cash flows. The ASU requires disclosure of a reconciliation between the balance sheet and the statement of cash flows when the balance sheet includes more than one line item for cash, cash equivalents, restricted cash, and restricted cash equivalents. An entity with material restricted cash and restricted cash equivalents balances is required to disclose the nature of the restrictions. The ASU required a retrospective application to all periods presented. Subsequent to the adoption of this ASU, restricted cash balances are included with cash and cash equivalents balances as of the beginning and ending of each period presented in our consolidated statements of cash flows; separate line items reconciling changes in restricted cash balances to the changes in cash and cash equivalents are no longer presented within the operating, investing, and financing sections of our consolidated statements of cash flows.

Hedge accounting

On January 1, 2018, we adopted an ASU that simplifies hedge accounting. The ASU is effective for reporting periods beginning after December 15, 2018, with early adoption permitted. The purpose of this updated ASU is to better align a company’s financial reporting for hedging activities with the economic objectives of those activities. For cash flow hedges that are highly effective, the new standard requires all changes (effective and ineffective components) in the fair value of the hedging instrument to be recorded in accumulated other comprehensive income within total equity and to be reclassified into earnings only when the hedged item affects earnings.

Prior to the adoption of this ASU, a quantitative assessment was made on an ongoing basis to determine whether a hedge is highly effective in offsetting changes in cash flows associated with the hedged item. Previously applied hedge accounting guidance

19


2.
Summary of significant accounting policies (continued)

required hedge ineffectiveness to be recognized in earnings. Under the new ASU, an entity is still required to perform an initial quantitative test. However, the new standard allows an entity to elect to subsequently perform only a qualitative assessment, unless facts and circumstances change. We made this election upon adoption of the new ASU on January 1, 2018.

We utilize interest rate hedge agreements to hedge a portion of our exposure to variable interest rates primarily associated with borrowings based on LIBOR. As a result, all of our interest rate hedge agreements are designated as cash flow hedges. For cash flow hedges in existence at the date of adoption, an entity is required to apply a cumulative-effect adjustment for previously recognized ineffectiveness from retained earnings to accumulated other comprehensive income as of the beginning of the fiscal year when an entity adopts the amendments in this ASU.

We performed an analysis of all our cash flow hedges existing on January 1, 2018, and determined that all hedges had been highly effective since their inception; therefore, no cumulative-effect adjustment of previously recognized ineffectiveness from retained earnings to accumulated other comprehensive income was needed. The adoption of this ASU had no effect on our financial statements.

3.
Investments in real estate

Our consolidated investments in real estate consisted of the following as of June 30, 2018, and December 31, 2017 (in thousands):
 
 
June 30, 2018
 
December 31, 2017
Land (related to rental properties)
 
$
1,442,071

 
$
1,312,072

Buildings and building improvements
 
9,559,442

 
9,000,626

Other improvements
 
880,549

 
780,117

Rental properties
 
11,882,062

 
11,092,815

Development and redevelopment of new Class A properties:
 
 
 
 
Development and redevelopment projects (under construction, marketing, or
pre-construction)
 
1,253,419

 
955,218

Future development projects
 
92,473

 
96,112

Gross investments in real estate
 
13,227,954

 
12,144,145

Less: accumulated depreciation
 
(2,066,333
)
 
(1,875,810
)
Net investments in real estate – North America
 
11,161,621

 
10,268,335

Net investments in real estate – Asia
 
29,150

 
29,684

Investments in real estate
 
$
11,190,771

 
$
10,298,019


Acquisitions

Our real estate asset acquisitions during the six months ended June 30, 2018 and subsequently, consisted of the following (dollars in thousands):
 
 
Square Footage
 
Three Months Ended
 
Operating
 
Operating with Active or Future Redevelopment
 
Active or Future
Development
 
Purchase Price
March 31, 2018
 
487,227

 
106,733

 
643,765

 
$
339,400

June 30, 2018
 
782,388

 
39,505

 
793,000

 
405,855

Subsequent acquisitions
 
45,626

 
349,947

 
217,000

 
257,000

 
 
1,315,241

 
496,185

 
1,653,765

 
$
1,002,255


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

20


3.
Investments in real estate (continued)


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

Active or future development

1655 and 1725 Third Street – Mission Bay/SoMa, San Francisco

In March 2018, we acquired a 10% interest in a real estate joint venture with Uber Technologies, Inc. (“Uber”) and the Golden State Warriors that owns 1655 and 1725 Third Street, located in our Mission Bay/SoMa submarket of San Francisco. The joint venture is developing two buildings aggregating 593,765 RSF that are integrated within the new Golden State Warriors complex under development. The buildings are 100% leased to Uber. At the closing of the joint venture agreement, we contributed equity totaling $32.0 million. Refer to Note 4 – “Consolidated and Unconsolidated Real Estate Joint Ventures” to these unaudited consolidated financial statements for additional information.

Other acquisitions

During the three months ended June 30, 2018, we acquired one building and four land parcels in five transactions for an aggregate purchase price of $58.2 million in key submarkets with development and redevelopment opportunities of 493,000 RSF.

Operating with active or future development

Summers Ridge Science Park – Sorrento Mesa, San Diego

In January 2018, we acquired Summers Ridge Science Park, a campus with on-site amenities and four operating properties aggregating 316,531 RSF of office/laboratory space, located at 9965, 9975, 9985, and 9995 Summers Ridge Road in our Sorrento Mesa submarket of San Diego, for a purchase price of $148.7 million. The property also includes a future development opportunity for an additional 50,000 RSF building. The properties are 100% leased as of June 30, 2018, to two life science product, service, and device companies for 15 years.

Alexandria PARC – Greater Stanford, San Francisco

In January 2018, we acquired Alexandria PARC, a four-building office campus, aggregating 197,498 RSF, on 11 acres, located at 2100, 2200, 2300, and 2400 Geng Road in our Greater Stanford submarket of San Francisco, for a purchase price of $136.0 million. The property has 14 in-place leases with a weighted-average remaining lease term of three years. We are redeveloping 48,547 RSF into office/laboratory space. 

100 Tech Drive – Route 128, Greater Boston

In April 2018, we acquired a Class A office/laboratory building aggregating 200,431 RSF, located at 100 Tech Drive in our Route 128 submarket of Greater Boston, for a purchase price of $87.3 million. The property is 100% leased by Moderna Therapeutics under a 14.5-year lease. The property can also accommodate future development of an additional 300,000 RSF building.

704 Quince Orchard Road – Rockville/Gaithersburg, Maryland

In March 2018, we acquired a 56.8% interest in 704 Quince Orchard Road, an office building aggregating 79,931 RSF, located in our Gaithersburg submarket of Maryland, for a purchase price of $3.9 million. The building is an expansion of the Alexandria Technology Center® – Gaithersburg II campus. We are redeveloping 58,186 RSF from existing office space into office/laboratory space. Refer to Note 4 – “Consolidated and Unconsolidated Real Estate Joint Ventures” to these unaudited consolidated financial statements for additional information.

Operating

Maryland Life Science Portfolio – Rockville/Gaithersburg, Maryland

21


3.
Investments in real estate (continued)


In May 2018, we acquired an eight-building office/laboratory portfolio aggregating 415,611 RSF, located in our Rockville and Gaithersburg submarkets of Maryland, for a purchase price of $146.5 million. These properties are 100% leased with in-place leases that have below-market rental rates and a weighted-average remaining lease term of 5.7 years.

2301 5th Avenue – Lake Union, Seattle

In June 2018, we acquired 2301 5th Avenue, an office building aggregating 197,136 RSF, located in our Lake Union submarket of Seattle, for a purchase price of $95.0 million. The property is subject to a 54-year ground lease. The building is 97.4% occupied with substantially all investment-grade tenants under three in-place leases where rental rates are currently 25% below market, and a weighted-average remaining lease term of 5.5 years.

July 2018 acquisitions

During July 2018, we acquired three properties for an aggregate purchase price of $257.0 million, including $203.0 million for a fee simple interest in an office building aggregating 349,947 RSF located in New York City, which is currently occupied by Pfizer Inc. with a remaining lease term of six years. Under the Midtown East Rezoning, this property is currently entitled with an as-of-right density for an additional 230,000 developable square feet.

Sales of real estate assets

During the three months ended June 30, 2018, we classified a land parcel located in Northern Virginia as held for sale. As a result, we recognized an impairment charge of $6.3 million to lower the carrying amount to the estimated fair value less selling costs during the three months ended June 30, 2018. We completed the sale, at a price of $6.0 million, in July 2018 with no gain or loss.
    
In January 2017, we completed the sale of a vacant property at 6146 Nancy Ridge Drive located in our Sorrento Mesa submarket of San Diego for a sales price of $3.0 million and recognized a gain of $270 thousand.

In June 2017, we recognized an impairment charge of $203 thousand on a 20,580 RSF property located in a non-cluster market. We completed the sale of this property in July 2017 for a gross sales price of $800 thousand with no gain or loss.

4.
Consolidated and unconsolidated real estate joint ventures

From time to time, we enter into joint venture agreements through which we own a partial interest in real estate entities that own, develop, and operate real estate properties. As of June 30, 2018, we had the following properties that were held by our real estate joint ventures:
 
Property(1)
 
Market
 
Submarket
 
Our Ownership Interest
 
RSF
Consolidated joint ventures:
 
 
 
 
 
 
 
 
 
 
 
 
225 Binney Street
 
Greater Boston
 
Cambridge
 
 
30.0
%
 
 
305,212

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

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

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

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

 
Unconsolidated joint ventures:
 
 
 
 
 
 
 
 
 
 
 
 
Menlo Gateway
 
San Francisco
 
Greater Stanford
 
 
29.4
%
 
 
772,983

 
 
1401/1413 Research Boulevard
 
Maryland
 
Rockville
 
 
65.0
%
(2) 
 
(3)
 
360 Longwood Avenue
 
Greater Boston
 
Longwood Medical Area
 
 
27.5
%
 
 
210,709

 
 
704 Quince Orchard Road
 
Maryland
 
Gaithersburg
 
 
56.8
%
(2) 
 
79,931

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

 

(1)
In addition to the real estate joint ventures listed, various partners hold insignificant noncontrolling interests in four other properties in North America.
(2)
Represents our ownership interest; our voting interest is limited to 50%.
(3)
Joint venture with a distinguished retail real estate developer for the development of a 90,000 RSF retail shopping center.


22


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

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

Property
 
Consolidation Model
 
Voting Interest
 
Consolidation Analysis
 
Conclusion
 
 
 
 
 
 
 
 
 
225 Binney Street
 
VIE model

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


Consolidated VIEs’ balance sheet information

The table below aggregates the balance sheet information of our consolidated VIEs as of June 30, 2018, and December 31, 2017 (in thousands):
 
 
June 30, 2018
 
December 31, 2017
Investments in real estate
 
$
1,097,759

 
$
1,047,472

Cash and cash equivalents
 
40,352

 
41,112

Other assets
 
70,595

 
68,754

Total assets
 
$
1,208,706

 
$
1,157,338

 
 
 
 
 
Secured notes payable
 
$
—

 
$
—

Other liabilities
 
69,191

 
52,201

Total liabilities
 
69,191

 
52,201

Redeemable noncontrolling interests
 
749

 
—

Alexandria Real Estate Equities, Inc.’s share of equity
 
610,996

 
584,160

Noncontrolling interests’ share of equity
 
527,770

 
520,977

Total liabilities and equity
 
$
1,208,706

 
$
1,157,338


23


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


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

Unconsolidated real estate joint ventures

As of June 30, 2018, our investments in unconsolidated real estate joint ventures accounted for under the equity method of accounting presented in our consolidated balance sheet consist of the following (in thousands):
Property
 
June 30, 2018
Menlo Gateway
 
$
121,785

1401/1413 Research Boulevard
 
7,533

360 Longwood Avenue
 
25,538

704 Quince Orchard Road
 
4,384

1655 and 1725 Third Street
 
33,732

 
 
$
192,972

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

As of June 30, 2018, our unconsolidated real estate joint ventures have the following non-recourse secured loans that include the following key terms (dollars in thousands):
 
 
 
 
Maturity Date
 
Stated Interest Rate(1)
 
Interest Rate(1)(2)
 
100% at Joint Venture Level
 
Unconsolidated Joint Venture
 
Our Share
 
 
 
 
Debt Balance(3)
 
Remaining Commitments
 
Menlo Gateway, Phase I
 
29.4%
 
 
3/1/19
 
 
L+2.50%
 
4.49%
 
$
134,564

 
$
13,290

 
1401/1413 Research Boulevard
 
65.0%
 
 
5/17/20
 
 
L+2.50%
 
5.39%
 
14,682

 
9,892

 
1655 and 1725 Third Street
 
10.0%
 
 
6/29/21
 
 
L+3.70%
 
5.68%
 
75,520

 
299,480

 
360 Longwood Avenue
 
27.5%
 
 
9/1/22
 
 
3.32%
 
3.54%
 
94,143

 
17,000

(4) 
704 Quince Orchard Road
 
56.8%
 
 
3/16/23
 
 
L+1.95%
 
4.29%
 
1,016

 
13,809

 
Menlo Gateway, Phase II
 
29.4%
 
 
5/1/35
 
 
4.53%
 
4.56%
 
—

 
157,270

 
 
 
 
 
 
 
 
 
 
 
 
 
$
319,925

 
$
510,741

 

(1)
For acquired loans, interest rate includes adjustments to reflect the joint venture’s effective borrowing costs at the time of acquisition.
(2)
Includes interest expense, amortization of loan fees, and amortization of premiums (discounts) as of June 30, 2018.
(3)
Represents outstanding principal, net of unamortized deferred financing costs and discount/premium.
(4)
The remaining loan commitment balance excludes an earn-out advance provision that allows for incremental borrowings up to $48.0 million, subject to certain conditions.


24





5.
Cash, cash equivalents, and restricted cash

Cash, cash equivalents, and restricted cash consisted of the following as of June 30, 2018, and December 31, 2017 (in thousands):
 
June 30, 2018
 
December 31, 2017
Cash and cash equivalents
$
287,029

 
$
254,381

Restricted cash:
 
 
 
Funds held in trust under the terms of certain secured notes payable
14,384

 
12,301

Funds held in escrow related to construction projects and investing activities
16,551

 
4,546

Other
3,877

 
5,958

 
34,812

 
22,805

Total
$
321,841

 
$
277,186


6.
Investments

We hold investments in publicly traded companies and privately held entities primarily involved in the life science and technology industries. On January 1, 2018, we adopted a new ASU on financial instruments that prospectively changed how we recognize, measure, present, and disclose these investments.

Key differences between prior accounting standards and the new ASU

Prior to January 1, 2018:
•
Investments in publicly traded companies were presented at fair value in the accompanying balance sheet, with changes in fair value recognized in other comprehensive income classified in accumulated other comprehensive income within total equity.
•
Investments in privately held entities were accounted for under the cost method of accounting.
•
Gains or losses were recognized in net income upon the sale of an investment.
•
Investments in privately held entities required accounting under the equity method unless our interest in the entity was deemed to be so minor that we had virtually no influence over the entity’s operating and financial policies. Under the equity method of accounting, we recognized our investment initially at cost and adjusted the carrying amount of the investment to recognize our share of the earnings or losses of the investee subsequent to the date of our investment. We had no investments accounted for under the equity method as of December 31, 2017.
•
Investments were evaluated for impairment, with other-than-temporary impairments recognized in net income.

Effective January 1, 2018:
•
Investments in publicly traded companies are presented at fair value in the accompanying balance sheet, with changes in fair value recognized in net income.
•
Investments in privately held entities without readily determinable fair values previously accounted for under the cost method are accounted for as follows:
•
Investments in privately held entities that report NAV are presented at fair value using NAV as a practical expedient, with changes in fair value recognized in net income.
•
Investments in privately held entities that do not report NAV are carried at cost, adjusted for observable price changes and impairments, with changes recognized in net income.
•
One-time adjustments recognized on January 1, 2018:
•
For investments in publicly traded companies, reclassification of net unrealized gain as of December 31, 2017, aggregating $49.8 million, from accumulated other comprehensive income to retained earnings.
•
For investments in privately held entities without readily determinable fair values that were previously accounted for under the cost method:
•
Adjustment to investments for unrealized gains aggregating $90.8 million related to investments in privately held entities that report NAV, representing the difference between fair value as of December 31, 2017, using NAV as a practical expedient and the carrying value of the investments as of December 31, 2017, with a corresponding adjustment to retained earnings.

25


6.
Investments (continued)

•
No adjustment was required for investments in privately held entities that do not report NAV. The ASU requires a prospective transition approach for investments in privately held entities that do not report NAV. The FASB clarified that it would be difficult for entities to determine the last observable transaction price existing prior to the adoption of this ASU. Therefore, unlike our investments in privately held entities that report NAV that were adjusted to reflect fair values upon adoption of the new ASU, our investments in privately held entities that do not report NAV were not retrospectively adjusted to fair values upon adoption. As such, any initial valuation adjustments made for investments in privately held entities that do not report NAV subsequent to January 1, 2018, as a result of future observable price changes will include recognition of unrealized gains or losses equal to the difference between the carrying basis of the investment and the observable price at the date of remeasurement.
•
Investments in privately held entities continue to require accounting under the equity method unless our interest in the entity is deemed to be so minor that we have virtually no influence over the entity’s operating and financial policies. Under the equity method of accounting, we recognize our investment initially at cost and adjust the carrying amount of the investment to recognize our share of the earnings or losses of the investee subsequent to the date of our investment. We had no investments accounted for under the equity method as of June 30, 2018.

We recognize changes in fair value for investments in publicly traded companies and changes in NAV, as an expedient to estimate fair value, reported by limited partnerships, as unrealized gains and losses within investment income in our consolidated income statements.

For investments in privately held entities without readily determinable fair values, we adjust the cost basis, and record an unrealized gain or loss within investment income in our consolidated income statements, whenever such investments have an observable price change. Further adjustments to these revised carrying amounts are not made until another price change, if any, is observed. For further information regarding the new ASU, refer to the “Investments” section within Note 2 – “Summary of Significant Accounting Policies” to these unaudited consolidated financial statements.

The following tables summarize our investments as of June 30, 2018, and December 31, 2017 (in thousands):
 
June 30, 2018
 
Cost
 
Adjustments
 
Carrying Amount
Investments at fair value:
 
 
 
 
 
Publicly traded companies
$
101,603

 
$
97,013

 
$
198,616

Entities that report NAV
173,813

 
110,843

 
284,656

 


 


 

Entities that do not report NAV:
 
 
 
 
 
Entities with observable price changes since January 1, 2018
12,811

 
10,289

 
23,100

Entities without observable price changes
284,381

 
—

 
284,381

 
 
 
 
 
 
Total investments
$
572,608

 
$
218,145

 
$
790,753


 
December 31, 2017
 
Cost
 
Adjustments
 
Total
Investments in publicly traded companies
$
59,740

 
$
49,771

 
$
109,511

Investments in privately held entities without readily determinable fair values (cost method investments):
 
 
 
 
 
Investments in privately held entities that report NAV
148,627

 
N/A

 
148,627

Investments in privately held entities that do not report NAV
265,116

 
N/A

 
265,116

Total investments
$
473,483

 
$
49,771

 
$
523,254



26


6.
Investments (continued)

Adjustments recorded on investments in privately held entities that do not report NAV aggregating $10.3 million as of June 30, 2018, consisted of upward adjustments representing unrealized gains of $10.8 million and downward adjustments representing unrealized losses of $553 thousand. We adjusted our investments in privately held entities that do not report NAV based on observable price changes from subsequent equity offerings. The subsequent equity offerings observed were for similar securities to those we hold as the securities had similar voting rights, distribution preferences, and conversion rights.

Investments in privately held entities that report NAV

Investments in privately held entities that report NAV consist primarily of investments in limited partnerships. We are committed to funding approximately $190.6 million for all investments over the next several years, primarily consisting of $187.9 million related to investments in limited partnerships.

These investments are not redeemable by us, but we normally receive distributions from these investments throughout their term. Our investments in privately held entities that report NAV generally have an expected initial term in excess of 10 years. The weighted-average remaining term during which these investments are expected to be liquidated was 5.4 years as of June 30, 2018.

Our investment income for the three and six months ended June 30, 2018 consisted of the following (in thousands):
 
 
Three Months Ended June 30, 2018
 
 
Unrealized Gains (Losses)
 
Realized Gains
 
Total
Investments at fair value, held at period end:
 
 
 
 
 
 
Publicly traded companies
 
$
1,138

 
$
—

 
$
1,138

Entities that report NAV
 
4,683

 
—

 
4,683

Entities that do not report NAV with observable price changes since
April 1, 2018, held at period end:
 
(754
)
 
—

 
(754
)
Total investments at fair value, held at period end
 
5,067

 
—

 
5,067

Investment dispositions during the period:
 
 
 
 
 
 
Recognized in the current period
 
—

 
7,463

 
7,463

Previously recognized as unrealized gains
 
—

 
—

 
—

Total investment dispositions during the period
 
—

 
7,463

 
7,463

Investment income
 
$
5,067

 
$
7,463

 
$
12,530

 
 
Six Months Ended June 30, 2018
 
 
Unrealized Gains (Losses)
 
Realized Gains
 
Total
Investments at fair value, held at period end:
 
 
 
 
 
 
Publicly traded companies
 
$
52,026

 
$
—

 
$
52,026

Entities that report NAV
 
19,770

 
—

 
19,770

Entities that do not report NAV with observable price changes since
January 1, 2018, held at period end
 
10,289

 
—

 
10,289

Total investments at fair value, held at period end
 
82,085

 
—

 
82,085

Investment dispositions during the period:
 
 
 
 
 
 
Recognized in the current period
 
—

 
16,006

 
16,006

Previously recognized as unrealized gains
 
(4,789
)
 
4,789

 
—

Total investment dispositions during the period
 
(4,789
)
 
20,795

 
16,006

Investment income
 
$
77,296

 
$
20,795

 
$
98,091


During the three and six months ended June 30, 2017, we recognized unrealized losses of $4.0 million and unrealized gains of $6.4 million, respectively, on our equity securities classified as available-for-sale as of June 30, 2017. These unrealized gains/losses were recognized in our consolidated comprehensive income classified within total equity, in accordance with the accounting standards in effect prior to January 1, 2018.

27

7.
Other assets

The following table summarizes the components of other assets as of June 30, 2018, and December 31, 2017 (in thousands):
 
June 30, 2018
 
December 31, 2017
Acquired below-market ground leases
$
17,624

 
$
12,684

Acquired in-place leases
134,809

 
64,979

Deferred compensation plan
19,400

 
15,534

Deferred financing costs – $1.65 billion unsecured senior line of credit
8,667

 
10,525

Deposits
5,275

 
10,576

Furniture, fixtures, and equipment
11,538

 
11,070

Interest rate hedge assets
5,991

 
5,260

Net investment in direct financing lease
38,763

 
38,382

Notes receivable
572

 
614

Prepaid expenses
13,097

 
10,972

Property, plant, and equipment
56,841

 
32,073

Other assets
21,180

 
15,784

Total
$
333,757

 
$
228,453


The components of our net investment in direct financing lease as of June 30, 2018, and December 31, 2017, are summarized in the table below (in thousands):
 
 
June 30, 2018
 
December 31, 2017
Gross investment in direct financing lease
 
$
262,918

 
$
263,719

Less: unearned income
 
(224,155
)
 
(225,337
)
Net investment in direct financing lease
 
$
38,763

 
$
38,382


Future minimum lease payments to be received under our direct financing lease as of June 30, 2018, were as follows (in thousands):
Year
 
Total
2018
 
$
806

2019
 
1,655

2020
 
1,705

2021
 
1,756

2022
 
1,809

Thereafter
 
255,187

Total
 
$
262,918



28

8.
Fair value measurements

We provide fair value information about all financial instruments for which it is practicable to estimate fair value. We measure and disclose the estimated fair value of financial assets and liabilities utilizing a fair value hierarchy that distinguishes between data obtained from sources independent of the reporting entity and the reporting entity’s own assumptions about market participant assumptions. This hierarchy consists of three broad levels, as follows: (i) quoted prices in active markets for identical assets or liabilities, (ii) significant other observable inputs, and (iii) significant unobservable inputs. Significant other observable inputs can include quoted prices for similar assets or liabilities in active markets, as well as inputs that are observable for the asset or liability, such as interest rates, foreign exchange rates, and yield curves. Significant unobservable inputs are typically based on an entity’s own assumptions, since there is little, if any, related market activity. In instances in which the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level of input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability. There were no transfers between the levels in the fair value hierarchy during the six months ended June 30, 2018.

The following tables set forth the assets and liabilities that we measure at fair value on a recurring basis by level within the fair value hierarchy as of June 30, 2018, and December 31, 2017 (in thousands):
 
 
 
 
June 30, 2018
Description
 
Total
 
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets:
 
 
 
 
 
 
 
 
Investments in publicly traded companies
 
$
198,616

 
$
198,616

 
$
—

 
$
—

Interest rate hedge agreements
 
$
5,991

 
$
—

 
$
5,991

 
$
—


 
 
 
 
December 31, 2017
Description
 
Total
 
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets:
 
 
 
 
 
 
 
 
Investments in publicly traded companies
 
$
109,511

 
$
109,511

 
$
—

 
$
—

Interest rate hedge agreements
 
$
5,260

 
$
—

 
$
5,260

 
$
—

Liabilities:
 
 
 
 
 
 
 
 
Interest rate hedge agreements
 
$
103

 
$
—

 
$
103

 
$
—


Our investments in publicly traded companies have been recognized at fair value. Investments in privately held entities are excluded from the fair value hierarchy above as required by the fair value standards. Refer to Note 6 – “Investments” to these unaudited consolidated financial statements for further details.

Our interest rate hedge agreements have been recognized at fair value. Refer to Note 10 – “Interest Rate Hedge Agreements” to these unaudited consolidated financial statements for further details. The carrying values of cash and cash equivalents, restricted cash, tenant receivables, other assets, accounts payable, accrued expenses, and tenant security deposits approximate fair value.


29


8.
Fair value measurements (continued)

The fair values of our secured notes payable, unsecured senior notes payable, $1.65 billion unsecured senior line of credit, and unsecured senior bank term loans were estimated using widely accepted valuation techniques, including discounted cash flow analyses using significant other observable inputs such as available market information on discount and borrowing rates with similar terms, maturities, and credit ratings. Because the valuations of our financial instruments are based on these types of estimates, the actual fair value of our financial instruments may differ materially if our estimates do not prove to be accurate. Additionally, the use of different market assumptions or estimation methods may have a material effect on the estimated fair value amounts.

As of June 30, 2018, and December 31, 2017, the book and estimated fair values of our investments in privately held entities that report NAV, secured notes payable, unsecured senior notes payable, unsecured senior line of credit, and unsecured senior bank term loans were as follows (in thousands):

June 30, 2018

December 31, 2017

Book Value

Fair Value

Book Value

Fair Value
Assets:











Investments in privately held entities that report NAV
$
284,656

 
$
284,656

 
N/A

 
N/A













Liabilities:











Secured notes payable
$
776,260

 
$
774,955

 
$
771,061

 
$
776,222

Unsecured senior notes payable
$
4,289,521

 
$
4,300,275

 
$
3,395,804

 
$
3,529,713

Unsecured senior line of credit
$
—

 
$
—

 
$
50,000

 
$
49,986

Unsecured senior bank term loans
$
548,324

 
$
550,280

 
$
547,942

 
$
549,361