UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

1775 EYE STREET, NW, SUITE 1000, WASHINGTON, DC 20006

(Address of principal executive office) (Zip code)

Securities registered pursuant to Section 12(b) of the Act:

 

The information furnished in the accompanying unaudited Consolidated Balance Sheets, Condensed Consolidated Statements of Income, Condensed Consolidated Statements of Comprehensive Income, Consolidated Statement of Equity and Consolidated Statements of Cash Flows reflects all adjustments, consisting of normal recurring items, which are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods. The accompanying financial statements and notes thereto should be read in conjunction with the financial statements and notes for the three years ended December 31, 20162017 included in Washington Real Estate Investment Trust’s 20162017 Annual Report on Form 10-K.

NOTE 1: NATURE OF BUSINESS

Washington Real Estate Investment Trust (“Washington REIT”), a Maryland real estate investment trust, is a self-administered equity real estate investment trust, successor to a trust organized in 1960. Our business consists of the ownership and operation of income producing real estate properties in the greater Washington metro region. We own a diversified portfolio of office buildings, multifamily buildings and retail centers.

We believe that we qualify as a Real Estate Investment Trustreal estate investment trust (“REIT”) under Sections 856-860 of the Internal Revenue Code of 1986, as amended (the "Code"), and intend to continue to qualify as such. We have considered the provisions of the Tax Cuts and Jobs Act (the "TCJA"), which was signed into law on December 22, 2017 and which generally takes effect for taxable years beginning on or after January 1, 2018, and do not expect the TCJA to have a material impact on our ability to continue to qualify as a REIT. To maintain our status as a REIT, we are, among other things, required to distribute 90% of our REIT taxable income (which is, generally, our ordinary taxable income, with certain modifications), excluding any net capital gains and any deductions for dividends paid to our shareholders on an annual basis. When selling a property, we generally have the option of (a) reinvesting the sales proceeds of property sold, in a way that allows us to defer recognition of some or all taxable gain realized on the sale, (b) distributing gains to the shareholders with no tax to us or (c) treating net long-term capital gains as having been distributed to our shareholders, paying the tax on the gain deemed distributed and allocating the tax paid as a credit to our shareholders. During 2018, we sold our interests in Braddock Metro Center, a 356,000 square foot office property in Alexandria, Virginia, and 2445 M Street, a 292,000 square foot office property in Washington, DC (see note 3).

Generally, and subject to our ongoing qualification as a REIT, no provisions for income taxes are necessary except for taxes on undistributed taxable income and taxes on the income generated by our taxable REIT subsidiaries (“TRSs”). Our TRSs are subject to corporate federal and state income tax on their taxable income at regular statutory rates, or as calculated under the alternative minimum tax, as appropriate. As of Septemberboth June 30, 20172018 and December 31, 2016,2017, our TRSs had a deferred tax assetsasset of $0.6$1.4 million that was fully reserved. As of both June 30, 2018 and $0.5 million, respectively, net of valuation allowances of $2.7 million and $2.9 million, respectively. During theDecember 31, 2017, Period (as defined below), we recognizedhad a deferred state and local tax liability of $0.6 million in connection with the acquisition of Watergate 600 (see note 3). As of September 30, 2017 and December 31, 2016, we had netmillion. This deferred tax liabilities of $1.0 million and $0.4 million, respectively. The deferred tax liabilities areliability is primarily related to temporary differences in the timing of the recognition of revenue, amortizationdepreciation and depreciation.amortization.

We have prepared our consolidated financial statements using the accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2016.2017.

In August 2017, the Financial Accounting Standards Board (the “FASB”(”FASB”) issued Accounting Standards Update (“ASU”) 2017-12, Derivatives and Hedging: Targeted Improvements to Accounting for Hedging Activities. The purpose of this updated guidance is to better align a company’s financial reporting for hedging activities with the economic objectives of those activities. The transition guidance provides companies with the option of early adopting the new standard using a modified retrospective transition method in any interim period after issuance of the update, or alternatively requires adoption for fiscal years beginning after December 15, 2018. This adoption method will require us to recognizeWe adopted the cumulative effect of initially applying the ASU, if any, as an adjustment to accumulated other comprehensive income with a corresponding adjustment to the opening balance of retained earningsnew standard as of January 1, 2018 and the beginning of the fiscal year that an entity adopts the update. While we continue to assess all potential impacts of the standard, we doadoption did not expect adoption to have a material impact on our consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments, which provides specific guidance on how cash receipts and payments should be presented and classified in the statement of cash flows for eight specific issues. The new standard is effective for public entities for fiscal years beginning after December 15, 2017 and for interim periods therein, with early adoption permitted. We are currently evaluating the impactadopted the new standard mayas of January 1, 2018 and the adoption did not have a material impact on Washington REIT’sour consolidated financial statements.

In JuneJanuary 2016, the FASB issued ASU 2016-13,2016-01, Recognition and Measurement of Credit Losses on Financial InstrumentsAssets and Liabilities, which requireseliminates the requirement for public entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial assetsinstruments measured at an amortized cost basis, including trade receivables, to be presented aton the net amount expected to be collected.balance sheet. The new standard is effective for public entities for fiscal years beginning after December 15, 20192017 and for interim periods therein with adoption one year earlier permitted.therein. We are currently evaluating the impactadopted the new standard mayas of January 1, 2018 and the adoption did not have a material impact on Washington REIT’sour consolidated financial statements.

The accompanying unaudited consolidated financial statements include the consolidated accounts of Washington REIT, our majority-owned subsidiaries and entities in which Washington REIT has a controlling interest, including where Washington REIT has been determined to be a primary beneficiary of a variable interest entity (“VIE”). See note 3 for additional information on the property for which there is a noncontrolling interest. All intercompany balances and transactions have been eliminated in consolidation.

We have prepared the accompanying unaudited financial statements pursuant to the rules and regulations of the Securities and Exchange Commission “SEC”(“SEC”). Certain information and note disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to those rules and regulations, although we believe that the disclosures made are adequate to make the information presented not misleading. In addition, in the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the results for the periods presented have been included. These unaudited financial statements should be read in conjunction with the financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2016.2017.

Within these notes to the financial statements, we refer to the three months ended SeptemberJune 30, 2018 and June 30, 2017 and September 30, 2016 as the “2017“2018 Quarter” and the “2016“2017 Quarter,” respectively, and the ninesix months ended SeptemberJune 30, 2018 and June 30, 2017 and September 30, 2016 as the "2017 Period"“2018 Period” and "2016the “2017 Period,"” respectively.

The preparation of financial statements in conformity with GAAP requires management to make certain 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 revenues and expenses during the reporting period. Actual results could differ from those estimates.

Our current strategy is focusedincludes recycling legacy assets that lack the income growth potential we seek and to invest in high-quality assets with compelling value-add returns through redevelopment opportunities in our existing portfolio and acquisitions that meet our stringent investment criteria. We focus on properties inside the Washington metro region’s Beltway, near major transportation nodes and in areas with strong employment drivers and superior growth demographics. We seek to upgrade our portfolio with acquisitions as appropriate opportunities arise. We acquired the following property during the 20172018 Period (the “2017“2018 acquisition”):

The results of operations from the 20172018 acquisition are included in the condensed consolidated statements of income from the acquisition date and are as follows (in thousands):

We accounted for the 2018 acquisition of Watergate 600 as an asset acquisition. Accordingly, we capitalized $2.8$0.6 million of costs directly associated with the acquisition. We measured the value of the acquired physical assets (land and building), in-place leases (tenant origination costs, leasing commissions, absorption costs and lease intangible assets/liabilities), and any other liabilities by allocating the total cost of the acquisition on a relative fair value basis.

We have recorded the total cost of the 20172018 acquisition as follows (in thousands):

The weighted remaining average life for the 20172018 acquisition components above, other than land and building, and deferred tax liability, are 9277 months for tenant origination costs, 8567 months for leasing commissions/absorption costs, 1669 months for net lease intangible assets and 10584 months for net lease intangible liabilities.

The difference in the total contract purchase price of $135.0$250.0 million for the 20172018 acquisition and cash paid for the acquisition per the consolidated statements of cash flows of $138.4$106.4 million is primarily due to capitalized acquisition-related costsa mortgage note assumed and repaid at settlement ($2.8135.5 million), an acquisition deposit made during 2017 ($6.3 million) and a net credit to the buyer for certain expenditures ($1.01.8 million), partially offset by the issuance of 12,124 operating partnership units (“Operating Partnership Units”) as part of the consideration ($0.4 million). The Operating Partnership Units are units in WashREIT Watergate 600 OP LP, a consolidated subsidiary of Washington REIT. These Operating Partnership Units may be

We have properties under development/redevelopment and held for current or future development as of SeptemberJune 30, 2017. In the office segment, we have a redevelopment project at the Army Navy Building, an office property in Washington, DC, to upgrade its common areas and add significant amenities in order to make the property more competitive within its sub-market. As of September 30, 2017, we had invested $4.4 million in the redevelopment and have placed $4.3 million of the project into service. We have substantially completed the additional amenities and common areas and expect to place 11th floor common areas into service by the end of 2017.2018.

In the multifamily segment, we have The Trove, a multifamily development adjacent to The Wellington, and own land held for future multifamily development adjacent to Riverside Apartments. As of SeptemberJune 30, 2017,2018, we had invested $27.3$44.0 million and $19.0$21.2 million, including the costs of acquired land, in The Trove and the development adjacent to Riverside Apartments, respectively.

In the retail segment, we currently have a redevelopment project to add rentable space at Spring Valley Village. As of SeptemberJune 30, 2017,2018, we had invested $2.5$6.1 million in the redevelopment.

We intend to hold our properties for investment with a view to long-term appreciation, to engage in the business of acquiring, developing and owning our properties, and to make occasional sales of the properties that no longer meet our long-term strategy or return objectives and where market conditions for sale are favorable. The proceeds from the sales may be reinvested into other properties, used to fund development operations or to support other corporate needs, or distributed to our shareholders. Depreciation on these properties is discontinued when classified as held for sale, but operating revenues, other operating expenses and interest continue to be recognized until the date of sale.

During the 2017 Quarter,first quarter of 2018, we entered into negotiations to sellsold Braddock Metro Center, a 356,000 square foot office property in Alexandria, Virginia. Subsequent to the 2017 Quarter, we executedVirginia, for a lettercontract sales price of intent with a potential buyer for the property and are in the process of negotiating a purchase and sale agreement.$93.0 million. Due to thethen-ongoing negotiations to sell the property, we evaluated Braddock Metro Center for impairment. Weimpairment and recognized a $5.0$9.1 million impairment charge for theduring 2017 Quarter in order to reduce the carrying value of the property to its estimated fair value.value, less selling costs. We based this fair valuation on the expected net proceedssale price from a potential sale. There are few observable market transactions for similar properties. This fair valuation falls into Level 2 of the fair value hierarchy due to its reliance on a quoted price in a market that is not active. Braddock Metro Center does not meet the criteria for classification as held for sale as of September 30, 2017.

During the secondfirst quarter of 2017,2018, we executed a purchase and sale agreement for the sale of Walker House Apartments,to sell 2445 M Street, a multifamily292,000 square foot office property in Gaithersburg, Maryland,Washington, DC, for a contract salesales price of $32.2 million. We determined that$100.0 million, with settlement originally scheduled for the third quarter of 2018. During 2017, we evaluated 2445 M Street for impairment and recognized a $24.1 million impairment charge in order to reduce the carrying value of the property to its estimated fair value. Upon execution of the purchase and sale agreement, the property met the criteria for classification as held for sale as of June 30, 2017, andsale. Due to the property continues to meet the criteria forproperty’s classification as held for sale, aswe recorded an additional impairment charge of September 30, 2017.$1.9 million in the first quarter of 2018 in order to reduce the carrying value of the property to its estimated fair value, less estimated selling costs. We closedbased this fair valuation on the expected sales price from a potential sale. There are few observable market transactions for similar properties. This fair valuation falls into Level 2 of the fair value hierarchy due to its reliance on a quoted price in a market that is not active. During the 2018 Quarter, we executed an amendment to the purchase and sale on October 23, 2017.

We haveDuring the first quarter of 2018, we entered into an amended and restated credit agreement (“Credit Agreement”) which provides for a $700.0 million unsecured revolving credit facility (“Revolving Credit Facility”), the continuation of an existing $150.0 million unsecured term loan (“2015 Term Loan”) and an additional $250.0 million unsecured term loan (“2018 Term Loan”). The Revolving Credit Facility has a four-year term ending in March 2022, with two six-month extension options, and expands our prior $600.0 million unsecured revolving credit agreement (“Revolving Credit Facility”)facility that matureswas set to expire in June 2019, unless extended pursuant to one or both of the two six months extension options.2019. The Revolving Credit FacilityAgreement has an accordion feature which we utilized a portion of in September 2015, as described below, that allows us to increase the aggregate facility to $1.0$1.5 billion, subject to the extent the lenders agree to provide additional revolving loan commitments or term loans. In September 2015, we entered into a $150.0 million unsecured term loan (“2015 Term Loan”) by executing a portion of the accordion feature under the Revolving Credit Facility. The 2015 Term Loan has a 5.5 year term and currently has an interest rate of one month LIBOR plus 110 basis points, based on Washington REIT’s current unsecured debt ratings. We entered into two interest rate swaps to effectively fix the interest rate at 2.7% (see note 7).

The Revolving Credit Facility bears interest at a rate of either one month LIBOR plus a margin ranging from 0.875%0.775% to 1.55% or the base rate plus a margin ranging from 0.0% to 0.55% (in each case depending upon Washington REIT’s credit rating). The base rate is the highest of the administrative agent’s prime rate, the federal funds rate plus 0.50% and the LIBOR market index rate plus 1.0%. In addition, the Revolving Credit Facility requires the payment of a facility fee ranging from 0.125%0.10% to 0.30% (depending on Washington REIT’s credit rating) on the $600.0$700.0 million committed revolving loan capacity, without regard to usage. As of SeptemberJune 30, 2017,2018, the interest rate on the facilityRevolving Credit Facility is one month LIBOR plus 1.00%, the one month LIBOR is 2.09% and the facility fee is 0.20%.

We had previously used interest rate derivatives to effectively fix the interest rate of the 2016 Term Loan. These interest rate derivatives now effectively fix the interest rate on a $150.0 million portion of the 2018 Term Loan at 2.31%. In March 2018, we entered into interest rate derivatives that commenced on June 29, 2018 to effectively fix the interest rate on the remaining $100.0 million of the 2018 Term Loan at 3.71%.

The amount of the Revolving Credit Facility’s unsecured line of credit unused and available at SeptemberJune 30, 20172018 is as follows (in thousands):

We executed borrowings and repayments on the Revolving Credit Facility during the 20172018 Period as follows (in thousands):

On September 15, 2015, we entered into two interest rate swap arrangements with a total notional amount of $150.0 million to swap the floating interest rate under the 2015 Term Loan (see note 5)4) to an all-in fixed interest rate of 2.7%2.72% starting on October 15, 2015 and extending until the maturity of the 2015 Term Loan on March 15, 2021.

On July 22, 2016, we entered into two forward interest rate swap arrangements with a total notional amount of $150.0 million to swap the floating interest rate under the 2016

The interest rate swaps qualify as cash flow hedges and are recorded at fair value in accordance with GAAP, based on discounted cash flow methodologies and observable inputs. We record the effective portion of changestotal change in fair value of the interest rate swap arrangements associated with our cash flow hedges in other comprehensive income. The resulting unrealized gain (loss) on the effective portions of the cash flow hedges was the only activity in other comprehensive income during the periods presented in our consolidated financial statements. We assess the effectiveness of our cash flow hedges both at inception and on an ongoing basis. The cash flow hedges were effective for the 2017 Quarter and 2017 Period and 2016 Quarter and 2016 Period, and therefore hedge ineffectiveness did not impact earnings during the 2017 Quarter and 2017 Period and 2016 Quarter and 2016 Period.all periods presented.

 

The fair values of the interest rate swaps as of SeptemberJune 30, 20172018 and December 31, 2016,2017, are as follows (in thousands):

We record interest rate swaps on our consolidated balance sheets withwithin prepaid expenses and other assets when in a net asset position and withwithin accounts payable and other liabilities when in a net liability position. The interest rate swaps have been effective since inception. The net gains or losses on the effective swaps are recognized in other comprehensive income, as follows (in thousands):

Amounts reported in accumulated other comprehensive income (loss) related to derivatives will be reclassified to interest expense as interest payments are made on our variable-rate debt. During the next twelve months, we estimate that an additional $0.1$2.7 million will be reclassified as a decrease to interest expense.

We have agreements with each of our derivative counterparties that contain a provision whereby we could be declared in default on our derivative obligations if repayment of the underlying indebtedness is accelerated by the lender due to our default on the indebtedness. As of SeptemberJune 30, 2017,2018, the fair value of derivatives is in a net asset position of $6.8$15.7 million, which includes accrued interest but excludes any adjustment for nonperformance risk. As of SeptemberJune 30, 2017,2018, we have not posted any collateral related to these agreements.

Derivative instruments expose us to credit risk in the event of non-performance by the counterparty under the terms of the interest rate hedge agreement. We believe that we minimize our credit risk on these transactions by dealing with major, creditworthy financial institutions. We monitor the credit ratings of counterparties and our exposure to any single entity, thus minimizing our credit risk concentration.

For assets and liabilities measured at fair value on a recurring basis, quantitative disclosures about the fair value measurements are required to be disclosed separately for each major category of assets and liabilities, as follows:

Level 1: Quoted prices in active markets for identical assets

Level 2: Significant other observable inputs

Level 3: Significant unobservable inputs

The only assets or liabilities we had at SeptemberJune 30, 20172018 and December 31, 20162017 that are recorded at fair value on a recurring basis are the assets held in the Supplemental Executive Retirement Plan (“SERP”), which primarily consist of investments in mutual funds, and the interest rate swaps (see note 7)5).

We base the valuations related to the SERP on assumptions derived from significant other observable inputs and accordingly these valuations fall into Level 2 in the fair value hierarchy.

The fair values of these assets and liabilities at SeptemberJune 30, 20172018 and December 31, 20162017 were as follows (in thousands):

The following disclosures of estimated fair value were determined by management using available market information and established valuation methodologies, including discounted cash flow. Many of these estimates involve significant judgment. The estimated fair value disclosed may not necessarily be indicative of the amounts we could realize on disposition of the financial instruments. The use of different market assumptions or estimation methodologies could have an effect on the estimated fair value amounts. In addition, fair value estimates are made at a point in time and thus, estimates of fair value subsequent to SeptemberJune 30, 20172018 may differ significantly from the amounts presented.

As of SeptemberJune 30, 20172018 and December 31, 2016,2017, the carrying values and estimated fair values of our financial instruments were as follows (in thousands):

Washington REIT maintains short-term (“STIP”) and long-term (“LTIP”) incentive plans that allow for stock based awards to officers and non-officer employees. Stock based awards are provided to officers and non-officer employees, as well as trustees, under the Washington Real Estate Investment Trust 2016 Omnibus Incentive Plan which allows for awards in the form of restricted shares, restricted share units, options and other awards up to an aggregate of 2,400,000 shares over the ten-year period in which the plan will be in effect. Restricted share units are converted into shares of our stock upon full vesting through the issuance of new shares.

Total compensation expense recognized in the consolidated financial statements for all outstanding share based awards was $1.2$1.8 million and $0.3$1.2 million for the 20172018 Quarter and 20162017 Quarter, respectively, and $3.6$3.4 million and $2.7$2.4 million for the 20172018 Period and 20162017 Period, respectively.

The total fair values of restricted share awards vested was $2.0$1.1 million and $2.5$2.0 million for the 20172018 Period and 20162017 Period, respectively.

The total unvested restricted share awards at SeptemberJune 30, 20172018 was 355,120480,657 shares, which had a weighted average grant date fair value of $30.86$28.57 per share. As of SeptemberJune 30, 2017,2018, the total compensation cost related to unvested restricted share awards was $7.4$10.5 million, which we expect to recognize over a weighted average period of 3730 months.

We determine “Basic earnings per share” using the two-class method as our unvested restricted share awards and units have non-forfeitable rights to dividends, and are therefore considered participating securities. We compute basic earnings per share by dividing net income attributable to the controlling interest less the allocation of undistributed earnings to unvested restricted share awards and units by the weighted-average number of common shares outstanding for the period.

We also determine “Diluted earnings per share” as the more dilutive of the two-class method or the treasury stock method with respect to the unvested restricted share awards. We further evaluate any other potentially dilutive securities at the end of the period and adjust the basic earnings per share calculation for the impact of those securities that are dilutive. Our diluteddilutive earnings per share calculation includes the dilutive impact of operating partnership units under the if-converted method and our share based awards with performance conditions prior to the grant date and awards withall market conditionscondition awards under the contingently issuable method. The dilutive earnings per share calculation also considers the Operating Partnership Units issued in connection with the 2017 acquisition, which were not dilutive for any of the periods presented.

The computations of basic and diluted earnings per share for the three and ninesix months ended SeptemberJune 30, 20172018 and 20162017 were as follows (in thousands, except per share data):

We have three reportable segments: office, multifamily and retail. Office properties provide office space for various types of businesses and professions. Multifamily properties provide rental housing for individuals and families throughout the greater Washington metro region. Retail properties are typically grocery store-anchored neighborhood centers that include other small shop tenants or regional power centers with several junior box tenants.

We evaluate performance based upon net operating income from the combined properties in each segment. Our reportable operating segments are consolidations of similar properties. GAAP requires that segment disclosures present the measure(s) used by the chief operating decision maker for purposes of assessing segments’each segment’s performance. Net operating income is a key measurement of our segment profit and loss. Net operating income is defined as segment real estate rental revenue less segment real estate expenses.

The following tables present revenues, net operating income, capital expenditures and total assets for the three and ninesix months ended SeptemberJune 30, 20172018 and 20162017 from these segments, and reconcile net operating income of reportable segments to net income attributable to the controlling interests as reported (in thousands):