| CRESCENT REAL ESTATE EQUITIES CO Item 1A Risk Factors We derive the substantial majority of our office rental revenues from geographically concentrated markets |
| As of December 31, 2005, approximately 69prca of our office portfolio, based on total net rentable square feet, was located in the metropolitan areas of Houston and Dallas, Texas |
| Due to our geographic concentration in these metropolitan areas, any deterioration in economic conditions in the Houston or Dallas metropolitan areas, or in other geographic markets in which we in the future may acquire substantial assets, could adversely affect our results of operations and our ability to make distributions to our shareholders and could decrease our cash flow |
| For the majority of the past five years, the Houston and Dallas office markets experienced negative net absorption which resulted in decreased occupancy and rental rates |
| In addition, we compete for tenants based on rental rates, attractiveness and location of a property and quality of maintenance and management services |
| An increase in the supply of properties competitive with ours in these markets could have a material adverse effect on our ability to attract and retain tenants in these markets |
| Our performance and value are subject to general risks associated with the real estate industry |
| Our economic performance and the value of our real estate assets, and consequently the value of our investments, will be adversely affected if our Office, Resort Residential Development, Resort/Hotel and Temperature-Controlled Logistics properties do not generate revenues sufficient to meet our operating expenses, including debt service and capital expenditures |
| Any reduction in the revenues that our properties generate will adversely affect our cash flow and ability to meet our obligations |
| As a real estate company, we are susceptible to the following real estate industry risks: • downturns in the national, regional and local economic conditions where our properties are located; • competition from other Office, Resort Residential Development, Resort/Hotel and Temperature-Controlled Logistics properties; • adverse changes in local real estate market conditions, such as oversupply or reduction in demand for office space, luxury residences, Resort/Hotel space or Temperature-Controlled Logistics storage space; • changes in tenant preferences that reduce the attractiveness of our properties to tenants; • tenant defaults; • zoning or other regulatory restrictions; 12 _________________________________________________________________ [41]Table of Contents • decreases in market rental rates; • costs associated with the need to periodically repair, renovate and re-lease space; • increases in the cost of maintenance, insurance and other operating costs, including real estate taxes, associated with one or more properties, which may occur even when circumstances such as market factors and competition cause a reduction in revenues from one or more properties; and • illiquidity of real estate investments, which may limit our ability to vary our portfolio promptly in response to changes in economic or other conditions |
| We depend on leasing office space to tenants on economically favorable terms and collecting rent from our tenants, who may not be able to pay |
| Our financial results depend significantly on leasing space in our office properties to tenants on economically favorable terms |
| In addition, because a large portion of our income comes from the renting of real property, our income, funds available to pay debt and funds available for distribution to our shareholders will decrease if a significant number of our tenants cannot pay their rent |
| A number of companies, including some of our tenants, have declared bankruptcy in recent years, and other tenants may declare bankruptcy or become insolvent in the future |
| If a major tenant declares bankruptcy or becomes insolvent, the rental property where it leases space may have lower revenues and financial difficulties |
| Our leases generally do not contain restrictions designed to ensure the creditworthiness of our tenants |
| As a result, the bankruptcy or insolvency of a major tenant could result in a lower level of funds from operations available for distribution to our shareholders or the payment of our debt |
| We maintain an allowance for doubtful accounts that is reviewed for adequacy by assessing such factors as the credit quality of our tenants, any delinquency in payment, historical trends and current economic conditions |
| If our assumptions regarding the collectibility of tenant accounts receivable prove incorrect, we could experience write-offs in excess of the allowance for doubtful accounts, which would result in a decrease in our earnings |
| Bad debt as a percentage of office rental revenue has averaged less than 0dtta2prca over the last three years |
| Our results of operations depends on the ability of El Paso Energy to meet its obligations pursuant to its lease termination agreement with us |
| In June 2005, we entered into an agreement with our largest office tenant, El Paso Energy Services Company and certain of its subsidiaries, which will terminate El Paso’s leases relating to a total of 888cmam000 square feet at Greenway Plaza in Houston, Texas, effective December 31, 2007 |
| Original expirations for the space ranged from 2007 through 2014 |
| Under the agreement, El Paso is required to pay in cash to us: • dlra65 million in termination fees in periodic installments through December 31, 2007 (of which dlra10dtta0 million was received as of December 31, 2005 and is included in restricted cash in our Consolidated Balance Sheets as it is required to be escrowed with the lender); and • dlra62 million in rent according to original contractual lease terms from July 1, 2005, through December 31, 2007 (of which dlra13dtta6 million was received as of December 31, 2005) |
| If El Paso does not comply with the terms of the agreement, our revenues will decline, which will adversely affect our results of operations and reduce the cash available for distribution to our shareholders or the payment of our debt |
| We may experience difficulty or delay in renewing leases or re-leasing space |
| We derive most of our revenue in the form of rent received from our tenants |
| We are subject to the risks that, upon expiration, leases for space in our office properties may not be renewed, the space may not be re-leased, or the terms of renewal or re-lease, including the cost of required renovations or concessions to tenants, may be less favorable than current lease terms |
| In the event of any of these circumstances, our results of operations and our ability to meet our obligations could be adversely affected |
| As of December 31, 2005, leases of office space for approximately 2dtta2 million, 2dtta3 million and 2dtta9 million square feet, representing approximately 8dtta4prca, 8dtta9prca and 11dtta2prca of net rentable area, expire in 2006, 2007 and 2008, respectively |
| During these same three years, leases of approximately 24dtta5prca of the net rentable area of our office properties in Dallas and approximately 32dtta2prca of the net rentable area of our office properties in Houston expire |
| 13 _________________________________________________________________ [42]Table of Contents Many real estate costs are fixed, even if income from our properties decreases |
| Our financial results depend primarily on leasing space in our office properties to tenants, renting rooms at our resorts and hotels and successfully developing and selling lots, single-family homes, condominiums, town homes and time-share units at our residential development properties, in each case on terms favorable to us |
| Fixed costs associated with real estate investment, such as real estate taxes and insurance costs, generally do not decrease even when a property is not fully occupied, or the rate of sales at a project decreases, or other circumstances cause a reduction in income from the investment |
| We may be unable to sell properties when appropriate because real estate investments are illiquid |
| Real estate investments generally cannot be sold quickly |
| In addition, there are some limitations under federal income tax laws applicable to REITs that may limit our ability to sell assets |
| We may not be able to alter our portfolio promptly in response to changes in economic or other conditions |
| Our inability to respond quickly to adverse changes in the performance of our investments could have an adverse effect on our ability to meet our obligations |
| The revenues from our eight Resort/Hotel properties are subject to risks associated with the hospitality industry |
| The following factors, among others, are common to the Resort/Hotel industry, and may reduce the receipts generated by our Resort/Hotel properties |
| • Based on features such as access, location, quality of accommodations, room-rate structure and, to a lesser extent, the quality and scope of other amenities such as food and beverage facilities, our Resort/Hotel properties compete for guests with other resorts and hotels, a number of which have greater marketing and financial resources than our lessees or the Resort/Hotel property managers; • If there is an increase in operating costs resulting from inflation or other factors, we or the property managers may not be able to offset the increase by increasing room rates; • Our Resort/Hotel properties are subject to fluctuating and seasonal demands for business travel and tourism; and • Our Resort/Hotel properties are subject to general and local economic conditions that may affect the demand for travel in general and other factors that are beyond our control, such as acts of terrorism |
| Military actions against terrorists, new terrorist attacks (actual or threatened) and other political events could cause a lengthy period of uncertainty that might increase customer reluctance to travel and therefore adversely affect our results of operations and our ability to meet our obligations |
| The revenues from our eight Resort/Hotel properties depend on third-party operators that we do not control |
| We own or have an interest in eight Resort/Hotel properties, seven of which are leased to our own subsidiaries |
| We currently lease the remaining Resort/Hotel property, the Omni Austin Hotel, to a third-party entity, HCD Austin Corporation |
| To maintain our status as a REIT, third-party property managers manage each of the eight Resort/Hotel properties |
| As a result, we are unable to directly implement strategic business decisions with respect to the operation and marketing of our Resort/Hotel properties, such as decisions about quality of accommodations, room-rate structure and the quality and scope of other amenities such as food and beverage facilities and similar matters |
| The amount of revenue that we receive from the Resort/Hotel properties is dependent on the ability of the property managers to maintain and increase the gross receipts from these properties |
| If the gross receipts of our Resort/Hotel properties decline, our revenues will decrease as well, which could adversely affect our results of operations and reduce the amount of cash available to meet our obligations |
| 14 _________________________________________________________________ [43]Table of Contents The performance of our Resort Residential Development properties is affected by national, regional and local economic conditions |
| Our Resort Residential Development properties, which include Desert Mountain and CRDI properties, are generally targeted toward purchasers of high-end primary residences or seasonal secondary residences |
| As a result, the economic performance and value of these properties is particularly sensitive to changes in national, regional and local economic and market conditions |
| Economic downturns may discourage potential customers from purchasing new, larger primary residences or vacation or seasonal homes |
| In addition, other factors may affect the performance and value of a property adversely, including changes in laws and governmental regulations (including those governing usage, zoning and taxes), changes in interest rates (including the risk that increased interest rates may result in decreased sales of lots in any resort residential development property) and the availability to potential customers of financing |
| Adverse changes in any of these factors, each of which is beyond our control, could reduce the income that we receive from the properties, and adversely affect our ability to meet our obligations |
| The amount of debt that we have and the restrictions imposed by that debt could adversely affect our business and our financial condition |
| As of December 31, 2005, we had approximately dlra2dtta3 billion of consolidated debt outstanding, of which approximately dlra1dtta3 billion was secured by approximately 48prca of our gross total assets |
| We do not have a policy limiting the ratio of our debt to our total capitalization or assets |
| The amount of debt we have and may have outstanding could have important consequences to you |
| For example, it could: • make it difficult to satisfy our debt service requirements; • prevent us from making distributions on our outstanding common shares and preferred shares; • require us to dedicate a substantial portion of our cash flow from operations to payments on our debt, thereby reducing funds available for operations, property acquisitions and other appropriate business opportunities that may arise in the future; • require us to dedicate increased amounts of our cash flow from operations to payments on our variable rate, unhedged debt if interest rates rise; • limit our flexibility in planning for, or reacting to, changes in our business and the factors that affect the profitability of our business; • limit our ability to obtain additional financing, if we need it in the future for working capital, debt refinancing, capital expenditures, acquisitions, development or other general corporate purposes; • increase the adverse effect on our available cash flow from operations that may result from changes in conditions in the economy in general and in the areas in which our properties are located; and • limit our flexibility in conducting our business, which may place us at a disadvantage compared to competitors with less debt |
| Our ability to make scheduled payments of the principal of, to pay interest on, or to refinance, our indebtedness will depend on our future performance, which to a certain extent is subject to economic, financial, competitive and other factors beyond our control |
| There can be no assurance that our business will continue to generate sufficient cash flow from operations in the future to service our debt or meet our other cash needs |
| If we are unable to do so, we may be required to refinance all or a portion of our existing debt, or to sell assets or obtain additional financing |
| We cannot assure you that any such refinancing, sale of assets or additional financing would be possible on terms that we would find acceptable |
| If we were to breach certain of our debt covenants, our lenders could require us to repay the debt immediately, and, if the debt is secured, could immediately take possession of the property securing the loan |
| In addition, if any other lender declared its loan in an amount in excess of dlra5dtta0 million due and payable as a result of a default, the holders of our public and private notes, along with the lenders under our credit facility and certain other lenders would be able to require that those debts be paid immediately |
| As a result, any default under our debt covenants could have an adverse effect on our financial condition, results of operations and our ability to meet our obligations |
| 15 _________________________________________________________________ [44]Table of Contents We are obligated to comply with financial and other covenants in our debt that could restrict our operating activities, and the failure to comply could result in defaults that accelerate the payment under our debt |
| Our secured debt generally contains customary covenants, including, among others, provisions: • relating to the maintenance of the property securing the debt; • restricting our ability to pledge assets or create other liens; • restricting our ability to incur additional debt; • restricting our ability to amend or modify existing leases; and • restricting our ability to enter into transactions with affiliates |
| Our unsecured debt generally contains various restrictive covenants |
| The covenants in our unsecured debt include, among others, provisions restricting our ability to: • incur additional debt; • incur additional secured debt and subsidiary debt; • make certain distributions, investments and other restricted payments, including distribution payments on our or our subsidiaries’ outstanding common and preferred equity; • limit the ability of restricted subsidiaries to make payments to us; • enter into transactions with affiliates; • create certain liens; • enter into certain sale-leaseback transactions; and • consolidate, merge or sell all or substantially all of our assets |
| In addition, certain covenants in our bank facilities require us and our subsidiaries to maintain certain financial ratios, which include minimum debt service ratios, maximum leverage ratios and, in the case of the Operating Partnership, a minimum tangible net worth limitation and a fixed charge coverage ratio |
| The indentures under which our senior unsecured debt have been issued require us to meet thresholds for a number of customary financial and other covenants, including maximum leverage ratios, minimum debt service coverage ratios, maximum secured debt as a percentage of total undepreciated assets, and ongoing maintenance of unencumbered assets, in order to incur additional debt |
| Any of the covenants described in this risk factor may restrict our operations and our ability to pursue potentially advantageous business opportunities |
| Our failure to comply with these covenants could also result in an event of default that, if not cured or waived, could result in the acceleration of all or a substantial portion of our debt |
| Many factors affect the trading price of our shares |
| As with other publicly traded securities, the trading price of our shares will depend on a number of factors that change from time to time, including: • the amount of distributions paid on our common and preferred shares; • the market for similar securities; • additional issuance of other classes or series of our shares, particularly preferred shares, or the issuance of debt securities; • our financial condition, performance and prospects; • general economic and financial market conditions; and • prevailing interest rates, increases in which may have a negative effect on the trading value of our preferred shares |
| Rising interest rates could adversely affect our cash flow and the market price of our outstanding debt securities and preferred shares |
| Of our approximately dlra2dtta3 billion of debt outstanding as of December 31, 2005, approximately dlra235dtta3 million bears interest at variable rates and is unhedged |
| We also may borrow additional funds at variable interest rates in the future |
| To mitigate part of this risk, we have entered, and in the future may enter into other transactions to limit our exposure to rising interest rates |
| Increases in interest rates, or the loss of the benefits of any interest rate hedging arrangements, would increase our interest expense on our variable rate debt, which would adversely affect cash flow and our ability to service our debt and meet our obligations |
| In addition, an increase in market interest rates may lead purchasers of our securities to demand a higher annual yield, which could adversely affect the market price of our outstanding debt securities and preferred shares |
| 16 _________________________________________________________________ [45]Table of Contents In order to pay distributions to our common shareholders at current levels, we may be required to use proceeds from a combination of asset sales and joint ventures, additional leverage on assets and borrowings under our credit facility |
| Lower occupancy levels, reduced rental rates, increased leasing costs and reduced revenues as a result of asset sales have had the effect of reducing our cash flow from operations |
| For year ended December 31, 2005, our cash flow from operations was insufficient to fully cover the distributions on our common shares |
| We funded this shortfall primarily with a combination of proceeds from asset sales and joint ventures, proceeds from investment land sales and borrowings under our credit facility |
| While we believe that cash flow from operations will be sufficient to cover our normal operating expenses, interest payments on our debt, distributions on our preferred shares, non-revenue enhancing capital expenditures and revenue enhancing capital expenditures (including property improvements, tenant improvements and leasing commissions) in 2006 and 2007, if our Board of Trustees continues to declare distributions on our common shares at current levels, we expect that our cash flow from operations will continue to be insufficient to fully cover distributions to our common shareholders in 2006 and 2007 |
| We intend to use proceeds from asset sales and joint ventures, additional leverage on assets, and borrowings under our credit facility to cover this shortfall |
| There can be no assurance that we will maintain the current quarterly distribution level on our common shares |
| The terms of some of our debt may prevent us from paying distributions on our shares |
| Some of our debt limits the Operating Partnership’s ability to make some types of payments on equity and other distributions to us, which would limit our ability to make some types of payments, including payment of distributions on our shares, unless we meet certain financial tests or are required to make the distributions to maintain our qualification as a REIT As a result, if we are unable to meet the applicable financial tests, we may not be able to pay distributions on our shares in one or more periods |
| Payment of distributions on any class of our shares may be adversely affected by the level of our debt and the terms and number of our other shares that rank on an equal basis with or senior to that class of shares |
| Payment of distributions due on our common shares is subordinated to distributions on our preferred shares, and distributions on both our common and our preferred shares will be subordinated to all of our existing and future debt and will be structurally subordinated to the payment of dividends and distributions on equity, if any, issued by our subsidiaries, including the Operating Partnership |
| In addition, we may issue additional shares of the same or another class or series of shares that rank on a parity with any class or series of our shares as to the payment of distributions and the amounts payable upon liquidation, dissolution or winding up of our business |
| We may have limited flexibility in dealing with our jointly owned investments |
| Our organizational documents do not limit the amount of funds that we may invest in properties and assets jointly with other persons or entities |
| As of December 31, 2005, approximately 48prca of the net rentable area of our office properties was held jointly with other persons or entities |
| In addition, three of our five Resort/Hotel properties, all of our Resort Residential Development properties and our Temperature-Controlled Logistics properties were owned jointly |
| Joint ownership of properties may involve special risks, including the possibility that our partners or co-investors might: • become bankrupt; • have economic or other business interests or goals which are unlike or incompatible with our business interests or goals; • be in a position to take action contrary to our suggestions or instructions, or in opposition to our policies or objectives (including actions that may be inconsistent with our REIT status); and • have different objectives from us regarding the appropriate timing and pricing of any sale or refinancing of the properties |
| Joint ownership also gives a third party the opportunity to influence the return we can achieve on some of our investments and may adversely affect our results of operations and our ability to meet our obligations |
| In addition, in many cases we do not control the timing or amount of distributions that we receive from the joint investment, and amounts otherwise available for distribution to us instead may be reinvested in the property or used for other costs and expenses of the joint operation |
| 17 _________________________________________________________________ [46]Table of Contents We also have joint-venture agreements that contain buy-sell clauses that could require us to buy or sell our interest at a time we do not deem favorable for financial or other reasons, including the availability of cash at such time and the impact of tax consequences resulting from any sale |
| The management and leasing agreements under which we operate our office properties owned through joint ventures may be terminated after an initial period |
| We generally manage the day-to-day operations of our 21 properties held through joint ventures pursuant to separate management and leasing agreements |
| Under these agreements we receive fees for management of the properties and leasing commissions |
| The management and leasing agreements may be terminated, after an initial period of one to five years, by our partners in the joint ventures |
| The termination of one or more of the management and leasing agreements would result in the loss of the management fees and leasing commissions payable under such agreement or agreements |
| Mezzanine loans involve greater risks of loss than senior loans secured by income producing properties |
| We invest in mezzanine loans that typically take the form of limited recourse loans made to a special purpose entity which is the direct or indirect parent of another special purpose entity owning a commercial real estate property |
| These mezzanine loans are secured by a pledge of the ownership interest in the property owner (or in an entity that directly or indirectly owns the property owner) and are thus structurally subordinate to a conventional first mortgage loan made to the property owner |
| We also offer mezzanine financing by taking a junior participating interest in a first mortgage loan |
| These types of investments involve more risk than conventional senior mortgage lending directly secured by real property because these investments are structurally or contractually subordinated to the senior loans (or senior participations) and may become unsecured as a result of foreclosure by a senior lender on its collateral |
| While we will typically have cure rights with respect to loans senior to ours and the right to purchase these senior loans if in default, an exercise of this right may require our investing substantial additional capital on short notice to avoid loss of our initial investment |
| In addition, mezzanine loans usually have higher loan-to-value ratios than conventional mortgage loans, resulting in less equity in the property and increasing the risk of loss of principal |
| Reflecting the risk of these loans, mezzanine borrowers are generally required to pay significantly higher rates of interest than conventional mortgage loan borrowers, increasing borrowers’ cash-flow vulnerability |
| In the event of a bankruptcy of the borrower, we may not have full recourse to the borrower’s assets, or the assets of the borrower may not be sufficient to satisfy our mezzanine loan |
| Additionally, we have no right to participate in the bankruptcy proceedings of any senior borrower (including the property owner) |
| While we normally obtain recourse guaranties to protect against a voluntary bankruptcy or uncontested involuntary bankruptcy of the mezzanine borrower and the senior borrowers, these guaranties may not fully cover our debt |
| As a result of any or all of the foregoing, we may not recover some or all of our mezzanine loan investment |
| In many cases, we do not develop our Resort Residential Development Properties and are dependent on the developer of these properties |
| Some of our Resort Residential Development Corporations co-own Resort Residential Development Properties in partnership with third parties, which are the developers of the properties |
| Our partner for the majority of our Resort Residential Development Properties is Harry Frampton and his East West Partners development team |
| Our income from the development and sale of these properties may be adversely affected if East West Partners fails to provide quality services and workmanship or if it fails to maintain a quality brand name |
| In addition, although we have entered into agreements with East West Partners that contain limited non-competition provisions, at certain times and upon certain conditions, East West Partners may develop, and in some cases own or invest in, Resort Residential Development Properties that compete with our properties, which may result in conflicts of interest |
| As a result, East West Partners may in the future make decisions regarding competing properties that would not be in our best interests |
| While we believe that we could find a replacement for East West Partners, the loss of its services could have an adverse effect on the financial performance of our Resort Residential Development Segment |
| 18 _________________________________________________________________ [47]Table of Contents Development and construction risks could adversely affect our profitability |
| We currently are developing, expanding or renovating some of our office or Resort/Hotel properties and may in the future engage in these activities for other properties we own |
| In addition, our Resort Residential Development properties engage in the development of raw land and construction of single-family homes, condominiums, town homes and time-share units |
| These activities may be exposed to the following risks, each of which could adversely affect our results of operations and our ability to meet our obligations: • We may be unable to obtain, or suffer delays in obtaining, necessary zoning, land-use, building, occupancy and other required governmental permits and authorizations, which could result in increased costs or our abandonment of these activities; • We may incur costs for development, expansion or renovation of a property which exceed our original estimates due to increased costs for materials or labor or other costs that were unexpected; • We may not be able to obtain financing with favorable terms, which may make us unable to proceed with our development and other related activities on the schedule we originally planned or at all; • We may be unable to complete construction and sale or lease-up of a lot, office property or resort residential development unit on schedule, which could result in increased debt service expense or construction costs; • We may lease, rent or sell developed properties at below expected rental rates, room rates or unit prices; and • Occupancy rates, rents or unit sales at newly completed properties may fluctuate depending on a number of factors, including market and economic conditions, and may result in our investment not being profitable |
| Additionally, the time frame required for development, construction and lease-up of these properties means that we may have to wait a few years for a significant cash return |
| As a REIT, we are required to make cash distributions to our shareholders |
| If our cash flows from operations are not sufficient, we may be forced to borrow to fund these distributions, which could affect our ability to meet our other obligations |
| Environmental problems are possible and may be costly |
| Under various federal, state and local laws, ordinances and regulations, we may be required to investigate and clean up certain hazardous or toxic substances released on or in properties we own or operate, and also may be required to pay other costs relating to hazardous or toxic substances |
| This liability may be imposed without regard to whether we knew about the release of these types of substances or were responsible for their release |
| The presence of contamination or the failure to remediate properly contamination at any of our properties may adversely affect our ability to sell or lease those properties or to borrow using those properties as collateral |
| The costs or liabilities could exceed the value of the affected real estate |
| We have not been notified by any governmental authority, however, of any material environmental non-compliance, liability or other environmental claim in connection with any of our properties, and we are not aware of any other environmental condition with respect to any of our properties that management believes would have a material adverse effect on our business, assets or results of operations taken as a whole |
| The uses of any of our properties prior to our acquisition of the property and the building materials used at the property are among the property-specific factors that will affect how the environmental laws are applied to our properties |
| In general, before we purchased each of our properties, independent environmental consultants conducted Phase I environmental assessments, which generally do not involve invasive techniques such as soil or ground water sampling, and where indicated, based on the Phase I results, conducted Phase II environmental assessments which do involve this type of sampling |
| None of these assessments revealed any materially adverse environmental condition relating to any particular property not previously known to us |
| We believe that all of those previously known conditions either have been remediated or are in the process of being remediated at this time |
| There can be no assurance, however, that environmental liabilities have not developed since these environmental assessments were prepared or that future uses or conditions (including changes in applicable environmental laws and regulations) or new information about previously unidentified historical conditions will not result in the imposition of environmental liabilities |
| If we are subject to any material environmental liabilities, the liabilities could adversely affect our results of operations and our ability to meet our obligations |
| 19 _________________________________________________________________ [48]Table of Contents Compliance with the Americans with Disabilities Act could be costly |
| Under the Americans with Disabilities Act of 1990, all public accommodations and commercial facilities must meet certain federal requirements related to access and use by disabled persons |
| Compliance with the ADA requirements could involve removal of structural barriers from certain disabled persons’ entrances |
| Other federal, state and local laws may require modifications to or restrict further renovations of our properties with respect to such accesses |
| Although we believe that our properties are substantially in compliance with present requirements, noncompliance with the ADA or related laws or regulations could result in the United States government’s imposition of fines or in the award to private litigants of damages against us |
| Costs such as these, as well as the general costs of compliance with these laws or regulations, may adversely affect our ability to meet our obligations |
| Our insurance coverage on our properties may be inadequate |
| We currently carry comprehensive insurance on all of our properties, including insurance for property damage and third-party liability |
| We believe this coverage is of the type and amount customarily obtained for or by an owner of real property assets |
| We intend to obtain similar insurance coverage on subsequently acquired properties |
| Our existing primary insurance policies expire on November 1 annually |
| In addition, insurance companies may no longer offer coverage against certain types of losses, such as losses due to terrorist acts, environmental liabilities, or other catastrophic events including hurricanes and floods, or, if offered, the expense of obtaining these types of insurance may not be justified |
| We therefore may cease to have insurance coverage against certain types of losses and/or there may be decreases in the limits of insurance available |
| If an uninsured loss or a loss in excess of our insured limits occurs, we could lose all or a portion of the capital we have invested in a property, as well as the anticipated future revenue from the property, but still remain obligated for any mortgage debt or other financial obligations related to the property |
| We cannot guarantee that material losses in excess of insurance proceeds will not occur in the future |
| If any of our properties were to experience a catastrophic loss, it could seriously disrupt our operations, delay revenue and result in large expenses to repair or rebuild the property |
| Also, due to inflation, changes in codes and ordinances, environmental considerations and other factors, it may not be feasible to use insurance proceeds to replace a building after it has been damaged or destroyed |
| Events such as these could adversely affect our results of operations and our ability to meet our obligations |
| Competition for acquisitions and dispositions could adversely affect us |
| We plan to make select additional investments from time to time in the future and may compete for available investment opportunities with entities that have greater liquidity or financial resources |
| Several real estate companies may compete with us in seeking properties for acquisition or land for development and prospective tenants, guests or purchasers |
| This competition may increase the costs of any acquisitions that we make and adversely affect our results of operations and our ability to meet our obligations by: • reducing the number of suitable investment opportunities offered to us; and • increasing the bargaining power of property owners |
| We face similar competition with other real estate companies in our efforts to dispose of properties, which may result in lower sales prices |
| In addition, if a competitor succeeds in making an acquisition in a market in which our properties compete, ownership of that investment by a competitor may adversely affect our results of operations and our ability to meet our obligations by: • interfering with our ability to attract and retain tenants, guests or purchasers; and • adversely affecting our ability to minimize expenses of operation |
| We intend to focus our investment strategy on investment opportunities and markets considered “demand-driven,” primarily within our Office Property Segment, with a long-term strategy of acquiring properties at a cost significantly below that which would be required to develop a comparable property |
| Acquisition of properties entails risks that include the following, any of which could adversely affect our results of operations and our ability to meet our obligations: • We may not be able to identify suitable properties to acquire or may be unable to complete the acquisition of the properties we select for acquisition; • We may not be able to integrate new acquisitions into our existing operations successfully; • Our estimate of the costs of improving, repositioning or redeveloping an acquired property may prove to be too low, and, as a result, the property may fail to meet our estimates of the profitability of the property, either temporarily or for a longer time; • Office properties, resorts or hotels we acquire may fail to achieve the occupancy and rental or room rates we anticipate at the time we make the decision to invest in the properties, resulting in lower profitability than we expected in analyzing the properties; • Our pre-acquisition evaluation of the physical condition of each new investment may not detect certain defects or necessary repairs until after the property is acquired, which could significantly increase our total acquisition costs; and • Our investigation of a property or building prior to its acquisition, and any representations we may receive from the seller, may fail to reveal various liabilities, which could effectively reduce the cash flow from the property or building, or increase our acquisition cost |
| We are dependent on our key personnel whose continued service is not guaranteed |
| To a large extent we are dependent on our executive officers, particularly John C Goff and Dennis H Alberts, and we also depend on each of the other Trust Managers for strategic business direction and real estate experience |
| Provisions of our declaration of trust and bylaws could inhibit changes in control or discourage takeover attempts beneficial to our shareholders |
| There are certain provisions of our declaration of trust and bylaws that may have the effect of discouraging, delaying or making more difficult a change in control and preventing the removal of incumbent directors |
| The existence of these provisions may discourage third-party bids and reduce any premiums paid to you for common shares that you own |
| These include a staggered Board of Trust Managers, which makes it more difficult for a third party to gain control of our Board, and the ownership limit described below |
| In addition, any future series of preferred shares may have certain voting provisions that could delay or prevent a change of control or other transaction that might involve a premium price or otherwise be beneficial to our security holders |
| The declaration of trust also establishes special requirements with respect to “business combinations,” including certain issuances of equity securities, between us and an “interested shareholder,” and mandates procedures for obtaining voting rights with respect to “control shares” acquired in a control share acquisition |
| 21 _________________________________________________________________ [50]Table of Contents Your ownership of our shares is subject to limitation for REIT tax purposes |
| To remain qualified as a REIT for federal income tax purposes, not more than 50prca in value of our outstanding shares may be owned, directly or indirectly, by five or fewer individuals (as defined in the federal income tax laws applicable to REITs) at any time during the last half of any taxable year, and our outstanding shares must be beneficially owned by 100 or more persons at least 335 days of a taxable year |
| To facilitate maintenance of our REIT qualification, our declaration of trust, subject to certain exceptions, prohibits ownership by any single shareholder of more than 8dtta0prca of our issued and outstanding common shares or such greater percentage as established by our Board of Trust Managers, but in no event greater than 9dtta9prca, or more than 9dtta9prca of any class of our issued and outstanding preferred shares |
| We refer to these limits together as the “ownership limit |
| ” In addition, the declaration of trust prohibits ownership by Richard E Rainwater, the Chairman of our Board of Trust Managers, together with certain of his affiliates or relatives, initially, of more than 8dtta0prca and subsequently, of more than 9dtta5prca of our issued and outstanding common shares |
| We refer to this limit as the “Rainwater ownership limit |
| ” Any transfer of shares may be null and void if it causes a person to violate the ownership limit, or Mr |
| Rainwater, together with his affiliates and relatives, to violate the Rainwater ownership limit, and the intended transferee or holder will acquire no rights in the shares |
| Those shares will automatically convert into excess shares, and the shareholder’s rights to distributions and to vote will terminate |
| The shareholder would have the right to receive payment of the purchase price for such excess shares and certain distributions upon our liquidation |
| Excess shares will be subject to repurchase by us at our election |
| While the ownership limit and the Rainwater ownership limit help preserve our status as a REIT, they could also delay or prevent any person or small group of persons from acquiring, or attempting to acquire, control of us and, therefore, could adversely affect our shareholders’ ability to realize a premium over the then-prevailing market price for their shares |
| The number of shares available for future sale could adversely affect the market price of our publicly traded securities |
| We have entered into various private placement transactions whereby units of limited partnership interests in our Operating Partnership were issued in exchange for properties or interests in properties |
| These units and interests are currently exchangeable for our common shares on the basis of two shares for each one unit or, at our option, an equivalent amount of cash |
| Upon exchange for our common shares, those common shares may be sold in the public market pursuant to registration rights |
| As of December 31, 2005, approximately 11cmam416cmam173 units were outstanding, 8cmam550cmam673 of which were exchangeable for 17cmam101cmam346 of our common shares or, at our option, an equivalent amount of cash |
| In addition, as of December 31, 2005, the Operating Partnership had outstanding options to acquire approximately 3cmam609cmam533 units, of which 868cmam401 were exercisable and exchangeable for 1cmam736cmam802 of our common shares or, at our option, an equivalent amount of cash |
| These options were exercisable at a weighted average exercise price of dlra34 per unit, or dlra17 per common share, with a weighted average remaining contractual life of three years |
| We have also reserved a number of common shares for issuance pursuant to our employee benefit plans, and such common shares will be available for sale from time to time |
| As of December 31, 2005, we had outstanding options to acquire approximately 5cmam144cmam158 common shares, of which approximately 4cmam585cmam817 options were exercisable at a weighted average exercise price of dlra20, with a weighted average remaining contractual life of 4dtta3 years |
| We cannot predict the effect that future sales of common shares, or the perception that such sales could occur, will have on the market prices of our equity securities |
| 22 _________________________________________________________________ [51]Table of Contents Failure to qualify as a REIT would cause us to be taxed as a corporation, which would substantially reduce funds available for payment of distributions |
| We intend to continue to operate in a manner that allows us to meet the requirements for qualification as a REIT under the Internal Revenue Code of 1986, as amended, which we refer to as the Code |
| A REIT generally is not taxed at the corporate level on income it distributes to its shareholders, as long as it distributes at least 90 percent of its income to its shareholders annually and satisfies certain other highly technical and complex requirements |
| Unlike many REITs, which tend to make only one or two types of real estate investments, we invest in a broad range of real estate products |
| Several of our investments also are more complicated than those of other REITs |
| As a result, we are likely to encounter a greater number of interpretative issues under the REIT qualification rules, and more issues which lack clear guidance, than are other REITs |
| We, as a matter of policy, consult with outside tax counsel in structuring our new investments in an effort to satisfy the REIT qualification rules |
| We must meet the requirements of the Code in order to qualify as a REIT now and in the future, so it is possible that we will not continue to qualify as a REIT in the future |
| The laws and regulations governing federal income taxation are the subject of frequent review and amendment, and proposed or contemplated changes in the laws or regulations may affect our ability to qualify as a REIT and the manner in which we conduct our business |
| If we fail to qualify as a REIT for federal income tax purposes, we would not be allowed a deduction for distributions to our shareholders in computing taxable income and would be subject to federal income tax at regular corporate rates |
| In addition to these taxes, we may be subject to the federal alternative minimum tax |
| Unless we are entitled to relief under certain statutory provisions, we could not elect to be taxed as a REIT for four taxable years following any year during which we were first disqualified |
| Therefore, if we lose our REIT status, we could be required to pay significant income taxes, which would reduce our funds available for investments or for distributions to our shareholders |
| This would likely adversely affect the value of your investment in us |
| In addition, we would no longer be required by law or our operating agreements to make any distributions to our shareholders |
| The lower tax rate on dividends from regular corporations may cause investors to prefer to hold stock in regular corporations instead of REITs |
| On May 28, 2003, the President signed into law the Jobs and Growth Tax Relief Reconciliation Act of 2003, which we refer to as the Act |
| Under the Act, the current maximum tax rate on the long-term capital gains of non-corporate taxpayers is reduced to 15prca for the tax years beginning on or before December 31, 2008 |
| The Act also reduced the tax rate on “qualified dividend income” to the maximum capital gains rate |
| Because, as a REIT, we are not generally subject to tax on the portion of our REIT taxable income or capital gains distributed to our shareholders, our distributions are not generally eligible for this new tax rate on dividends |
| As a result, the non-capital-gain portion of our REIT distributions generally continues to be taxed at the higher tax rates applicable to ordinary income |
| Without further legislation, the maximum tax rate on long-term capital gains will revert to 20prca in 2009, and dividends will again be subject to tax at ordinary rates |