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Significant Accounting Policies
 12 Months Ended
Dec. 31, 2011
Significant Accounting Policies  
Significant Accounting Policies

2.              Significant Accounting Policies

 

Basis of Presentation

 

The accompanying consolidated financial statements include all of the accounts of the Company and its majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

 

Estimates and Assumptions

 

The Company prepares its financial statements and related notes in conformity with accounting principles generally accepted in the United States of America (“GAAP”).  These principles require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period.  Actual results could differ from those estimates.  Significant estimates in the consolidated financial statements include the allowance for doubtful accounts, purchase price allocations, useful lives of fixed assets and the valuation of the derivative.

 

Investments in non-consolidated REITs

 

The Company has a non-controlling common stock interest in 16 Sponsored REITs and a non-controlling preferred stock interest in three Sponsored REITs.  In December 2011, the Company announced that it will no longer sponsor the syndication of newly-formed Sponsored REITs, though it has the capability to sponsor the syndication of any additional shares of preferred stock in existing Sponsored REITs.

 

Common stock investments in Sponsored REITs were consolidated while the entity was controlled by the Company.  Following the commencement of syndication the Company exercises influence over, but does not control these entities and investments are accounted for using the equity method.  Under the equity method of accounting, the Company’s cost basis is adjusted by its share of the Sponsored REITs’ earnings, if any, prior to completion of the syndication. Equity in losses of Sponsored REITs is not recognized to the extent that the investment balance would become negative.  Distributions received are recognized as income once the investment balance is reduced to zero, unless there is a loan receivable from the Sponsored REIT entity.  Equity in losses or distributions received in excess of common stock investment were recorded as an adjustment to the carrying value of the assets held for syndication.

 

Subsequent to the completion of the syndication of preferred shares, the Company does not share in any of the Sponsored REITs’ earnings, or any related distributions, as a result of its common stock ownership.

 

On September 22, 2006, the Company purchased 48 preferred shares (approximately 4.6%) of a Sponsored REIT, FSP Phoenix Tower Corp. (“Phoenix Tower”), for $4,116,000.   The Company agreed to vote its shares in any matter presented to a vote by the stockholders of Phoenix Tower in the same proportion as shares voted by other stockholders of Phoenix Tower.  The investment in Phoenix Tower is accounted for under the equity method.

 

On December 27, 2007, the Company purchased 965.75 preferred shares (approximately 43.7%) of a Sponsored REIT, FSP 303 East Wacker Drive Corp. (“East Wacker”), for $82,813,000.  The Company agreed to vote its shares in any matter presented to a vote by the stockholders of East Wacker in the same proportion as shares voted by other stockholders of East Wacker.  The investment in East Wacker is accounted for under the equity method.

 

On May 29, 2009, the Company purchased 175.5 preferred shares (approximately 27.0%) of a Sponsored REIT, FSP Grand Boulevard Corp. (“Grand Boulevard”), for $15,049,000.  The Company agreed to vote its shares in any matter presented to a vote by the stockholders of Grand Boulevard in the same proportion as shares voted by other stockholders of Grand Boulevard.  The investment in Grand Boulevard is accounted for under the equity method.

 

Real Estate and Depreciation

 

Real estate assets are stated at the lower of cost, less accumulated depreciation.

 

Costs related to property acquisition and improvements are capitalized.  Typical capital items include new roofs, site improvements, various exterior building improvements and major interior renovations.  Costs incurred in connection with leasing (primarily tenant improvements and leasing commissions) are capitalized and amortized over the lease period.  Routine replacements and ordinary maintenance and repairs that do not extend the life of the asset are expensed as incurred.  Funding for repairs and maintenance items typically is provided by cash flows from operating activities.  Depreciation is computed using the straight-line method over the assets’ estimated useful lives as follows:

 

Category

 

Years

Commercial buildings

 

39

Building improvements

 

15-39

Fixtures and equipment

 

3-7

 

The Company reviews its properties to determine if their carrying amounts will be recovered from future operating cash flows if certain indicators of impairment are identified at those properties.  The evaluation of anticipated cash flows is highly subjective and is based in part on assumptions regarding future occupancy, rental rates and capital requirements that could differ materially from actual results in future periods.  Since cash flows are considered on an undiscounted basis in the analysis that the Company conducts to determine whether an asset has been impaired, the Company’s strategy of holding properties over the long term directly decreases the likelihood of recording an impairment loss.  If the Company’s strategy changes or market conditions otherwise dictate an earlier sale date, an impairment loss may be recognized.  If the Company determines that impairment has occurred, the affected assets must be reduced to their fair value.

 

Acquired Real Estate Leases and Amortization

 

The Company recorded the value of acquired real estate leases as a result of five direct acquisitions in 2011, one direct acquisition in 2010 and three direct acquisitions in 2009.  Acquired real estate leases represent costs associated with acquiring an in-place lease (i.e., the market cost to execute a similar lease, including leasing commission, legal, vacancy and other related costs) and the value relating to leases with rents above the market rate.  Amortization is computed using the straight-line method over the term of the leases, which range from 19 months to 281 months.  Amortization expense was approximately $13,697,000, $11,636,000 and $12,885,000 for the years ended December 31, 2011, 2010 and 2009, respectively.

 

Amortization related to costs associated with acquiring an in-place lease is included in depreciation and amortization on the consolidated statements of income.  Amortization related to leases with rents above the market rate is offset against the rental revenue in the consolidated statements of income. The estimated annual amortization expense for the five years and thereafter succeeding December 31, 2011 is as follows:

 

Acquired Real Estate Leases and Amortization (continued)

 

 

 

Year Ended

 

(in thousands)

 

December 31,

 

2012

 

$

15,150

 

2013

 

16,018

 

2014

 

15,085

 

2015

 

14,374

 

2016

 

11,194

 

2017 and thereafter

 

19,792

 

 

Acquired Unfavorable Real Estate Leases and Amortization

 

The Company recorded the value of acquired unfavorable leases as a result of five direct acquisitions in 2011, one direct acquisition in 2010 and three direct acquisitions in 2009.  Acquired unfavorable real estate leases represent the value relating to leases with rents below the market rate.  Amortization is computed using the straight-line method over the term of the leases, which range from 23 months to 281 months.  Amortization expense was approximately $1,301,000, $1,147,000 and $992,000 for the years ended December 31, 2011, 2010 and 2009, respectively.

 

Amortization related to leases with rents below the market rate is included with rental revenue in the consolidated statements of income.  The estimated annual amortization for the five years and thereafter succeeding December 31, 2011 is as follows:

 

(in thousands)

 

 

 

2012

 

$

1,454

 

2013

 

1,357

 

2014

 

1,235

 

2015

 

1,182

 

2016

 

809

 

2017 and thereafter

 

1,581

 

 

Discontinued Operations

 

The Company reports as discontinued operations, the income and expenses associated with a disposal group (i) that qualifies as a component of an entity, (ii) for which cash flows will be eliminated from the ongoing operations of the entity, and (iii) in which the Company will not have significant continuing involvement.

 

The Company accounts for properties sold or held for sale as discontinued operations.  Classification as held for sale typically occurs upon the execution of a purchase and sale agreement and belief by management that the sale or disposition is probable of occurrence within one year.  Upon determining that a property is held for sale, the Company discontinues depreciating the property and reflects the property in its consolidated balance sheets at the lower of its carrying amount or fair value less the cost to sell.  The Company presents property held for sale on its consolidated balance sheets as “Assets held for sale”, on a comparative basis.  The Company reports the results of operations of its properties sold or held for sale in its consolidated statements of income as discontinued operations if no significant continuing involvement exists after the sale or disposition.

 

Cash and Cash Equivalents

 

The Company considers all highly liquid instruments purchased with an original maturity of three months or less to be cash equivalents.

 

Restricted Cash

 

Restricted cash consists of tenant security deposits, which are required by law in some states or by contractual agreement, and escrows arising from property sales.  Tenant security deposits are refunded when tenants vacate, provided that the tenant has not damaged the property.  Cash held in escrow is paid when the related issue is resolved.  Restricted cash also may include funds segregated for specific tenant improvements per lease agreements.

 

Tenant Rent Receivables

 

Tenant rent receivables are expected to be collected within one year. The Company provides an allowance for doubtful accounts based on its estimate of a tenant’s ability to make future rent payments.  The computation of this allowance is based in part on the tenants’ payment history and current credit status.  The Company charged off $399,000 in receivables and increased its allowance by $34,000 during 2011; and charged off $195,000 in receivables and increased its allowance by $1,175,000 during 2010; and charged off $20,000 in receivables and increased its allowance by $131,000 during 2009 based on such analysis.

 

Related Party Mortgage Loan Receivable

 

Management monitors and evaluates the secured loans compared to the value of the underlying real estate and has not experienced a loss on these loans to date.

 

Concentration of Credit Risks

 

Financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash investments, derivatives and accounts receivable.  The Company maintains its cash balances principally in two banks which the Company believes to be creditworthy.  The Company periodically assesses the financial condition of the banks and believes that the risk of loss is minimal.  Cash balances held with various financial institutions frequently exceed the insurance limit of $250,000 provided by the Federal Deposit Insurance Corporation.  The derivative we had was from an interest rate swap agreement that is discussed in Note 6.  The Company performs ongoing credit evaluations of our tenants and require certain tenants to provide security deposits or letters of credit.  Though these security deposits and letters of credit are insufficient to meet the total value of a tenant’s lease obligation, they are a measure of good faith and a source of funds to offset the economic costs associated with lost rent and the costs associated with re-tenanting the space.  The Company has no single tenant which accounts for more than 10% of its annualized rent.

 

Financial Instruments

 

The Company estimates that the carrying values of cash and cash equivalents, restricted cash, mortgage loan receivable and the bank note payable approximate their fair values based on their short-term maturity and prevailing interest rates.

 

Straight-line Rent Receivable

 

Certain leases provide for fixed rent increases over the term of the lease. Rental revenue is recognized on a straight-line basis over the related lease term; however, billings by the Company are based on the lease agreements.  Straight-line rent receivable, which is the cumulative revenue recognized in excess of amounts billed by the Company, is $28,545,000 and $18,752,000 at December 31, 2011 and 2010, respectively.  The Company provides an allowance for doubtful accounts based on its estimate of a tenant’s ability to make future rent payments.  The computation of this allowance is based in part on the tenants’ payment history and current credit status.  The Company charged off $567,000 in receivables and increased its allowance by $2,000 during 2011; increased its allowance by $600,000 during 2010; and charged off $99,000 in receivables and decreased its allowance by $62,000 during 2009 based on such analysis.

 

Deferred Leasing Commissions

 

Deferred leasing commissions represent direct and incremental external leasing costs incurred in the leasing of commercial space.  These costs are capitalized and are amortized on a straight-line basis over the terms of the related lease agreements.  Amortization expense was approximately $3,806,000, $2,867,000 and $2,665,000 for the years ended December 31, 2011, 2010 and 2009, respectively.

 

Deferred Leasing Commissions (continued)

 

The estimated annual amortization for the five years and thereafter following December 31, 2011 is as follows:

 

(in thousands)

 

 

 

2012

 

$

3,928

 

2013

 

3,590

 

2014

 

3,263

 

2015

 

2,800

 

2016

 

2,451

 

2017 and thereafter

 

6,609

 

 

Common Share Repurchases

 

The Company recognizes the gross cost of the common shares it repurchases as a reduction in stockholders’ equity using the treasury stock method.  Maryland law does not recognize a separate treasury stock account but provides that shares repurchased are classified as authorized but unissued shares.  Accordingly, the Company reduces common stock for the par value and the excess of the purchase price over the par value is a reduction to additional paid-in capital.

 

Revenue Recognition

 

Rental revenue includes income from leases, certain reimbursable expenses, straight-line rent adjustments and other income associated with renting the property.  A summary of rental revenue is shown in the following table:

 

 

 

Year Ended
December 31,

 

(in thousands)

 

2011

 

2010

 

2009

 

Income from leases

 

$

99,336

 

$

87,667

 

$

93,870

 

Reimbursable expenses

 

26,108

 

24,549

 

27,084

 

Straight-line rent adjustment

 

9,900

 

3,913

 

1,778

 

Amortization of favorable and unfavorable leases

 

47

 

(1,491

)

(3,391

)

 

 

$

135,391

 

$

114,638

 

$

119,341

 

 

Rental Revenue - The Company has retained substantially all of the risks and benefits of ownership of the Company’s commercial properties and accounts for its leases as operating leases. Rental income from leases, which includes rent concessions (including free rent and tenant improvement allowances) and scheduled increases in rental rates during the lease term, is recognized on a straight-line basis. The Company does not have any significant percentage rent arrangements with its commercial property tenants. Reimbursable costs are included in rental income in the period earned.

 

Other - Other income, including property and asset management fees, is recognized when the related services are performed and the earnings process is complete.

 

Segment Reporting

 

ASC 280 Segment Reporting (“ASC 280”) establishes standards for the way public entities report information about operating segments in the financial statements.  The Company is a REIT focused on real estate investments primarily in the suburban office market and currently operates in only one segment: real estate operations.  In December 2011, the Company discontinued the activities of its investment banking segment, which are included in discontinued operations for all periods presented.

 

Income Taxes

 

Taxes on income for the years ended December 31, 2011, 2010 and 2009 represent taxes incurred by FSP Protective TRS Corp, which is a taxable REIT subsidiary and the State of Texas franchise tax applicable to FSP Corp., which is classified as an income tax for reporting purposes.  Taxes on income incurred by FSP Investments, which is a taxable REIT subsidiary, are classified in discontinued operations.

 

Net Income Per Share

 

Basic net income per share is computed by dividing net income by the weighted average number of shares outstanding during the period. Diluted net income per share reflects the potential dilution that could occur if securities or other contracts to issue shares were exercised or converted into shares.  There were no potential dilutive shares outstanding at December 31, 2011, 2010, and 2009. The denominator used for calculating basic and diluted net income per share was 81,857,000, 79,826,000 and 73,001,000 for the years ended December 31, 2011, 2010, and 2009, respectively.

 

Derivative Instruments

 

The Company recognizes derivatives on the consolidated balance sheet at fair value. Derivatives that do not qualify, or are not designated as hedge relationships, must be adjusted to fair value through income. Derivative instruments designated in a hedge relationship to mitigate exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Cash flow hedges are accounted for by recording the fair value of the derivative instrument on the consolidated balance sheet as either an asset or liability. To the extent hedges are effective, a corresponding amount, adjusted for swap payments, is recorded in accumulated other comprehensive income within stockholders’ equity. Amounts are then reclassified from accumulated other comprehensive income to the income statement in the period or periods the hedged forecasted transaction affects earnings. Ineffectiveness, if any, is recorded in the income statement. The Company periodically reviews the effectiveness of each hedging transaction, which involves estimating future cash flows, at least quarterly.  Derivative instruments designated in a hedge relationship to mitigate exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges.  The Company currently has no fair value hedges outstanding. Fair values of derivatives are subject to significant variability based on changes in interest rates. The results of such variability could be a significant increase or decrease in our derivative assets, derivative liabilities, book equity, and/or earnings.

 

Fair Value Measurements

 

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There is also an established fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value.  Financial assets and liabilities recorded on the consolidated balance sheets at fair value are categorized based on the inputs to the valuation techniques as follows:

 

Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, which is typically based on an entity’s own assumptions, as there is little, if any, related market activity or information. In instances where 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 input that is significant to the fair value measurement in its entirety. The Company’s 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. These inputs were considered and applied to the Company’s derivative, and Level 2 inputs were used to value the interest rate swap.

 

Subsequent Events

 

In preparing these consolidated financial statements the Company evaluated events that occurred through the date of issuance of these financial statements for potential recognition or disclosure.

 

Reclassifications

 

Certain amounts in the 2010 and 2009 financial statements have been reclassified to conform to 2011 presentation. The reclassifications were related primarily to properties sold and the Company’s investment banking segment, which are presented as discontinued operations for all periods presented. Reclassifications of discontinued operations changed rental revenues, operating and maintenance expenses, depreciation and amortization, commission expenses, selling, general and administrative expenses, income taxes and the related assets, and reclassifications of distributions from non-consolidated REITs changed a portion of the distributions from operating to investing cash flows. There was no change to net income for any period presented as a result of these reclassifications.

 

Recent Accounting Standards

 

In June 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2011-05, Presentation of Comprehensive Income.  This standard eliminates the current option to report other comprehensive income and its components in the statement of stockholders’ equity and instead requires the components of other comprehensive income to be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  This standard is intended to enhance comparability between entities that report under GAAP and to provide a more consistent method of presenting non-owner transactions that affect an entity’s equity.  This standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.  The Company early adopted this update.