| HIGHWOODS PROPERTIES INC ITEM 1A RISK FACTORS An investment in our equity and debt securities involves various risks |
| All investors should carefully consider the following risk factors in conjunction with the other information contained in this Annual Report before trading in our securities |
| If any of these risks actually occur, our business, operating results, prospects and financial condition could be harmed |
| Our performance is subject to risks associated with real estate investment |
| We are a real estate company that derives most of our income from the ownership and operation of our properties |
| There are a number of factors that may adversely affect the income that our properties generate, including the following: • Economic Downturns |
| Downturns in the national economy, particularly in the Southeast, generally will negatively impact the demand and rental rates for our properties |
| • Oversupply of Space |
| An oversupply of space in our markets would typically cause rental rates and occupancies to decline, making it more difficult for us to lease space at attractive rental rates |
| • Competitive Properties |
| If our properties are not as attractive to tenants (in terms of rents, services, condition or location) as other properties that are competitive with ours, we could lose tenants to those properties or receive lower rental rates |
| • Renovation Costs |
| In order to maintain the quality of our properties and successfully compete against other properties, we periodically have to spend money to maintain, repair and renovate our properties |
| • Customer Risk |
| Our performance depends on our ability to collect rent from our customers |
| Our financial condition could be adversely affected by financial difficulties experienced by a major customer, or by a number of smaller customers, including bankruptcies, insolvencies or general downturns in business |
| As leases expire, we try to either relet the space to the existing customer or attract a new customer to occupy the space |
| In either case, we likely will incur significant costs in the process, including potentially substantial tenant improvement expense or lease incentives |
| In addition, if market rents have declined since the time the expiring lease was executed, the terms of any new lease signed likely will not be as favorable to us as the terms of the expiring lease, thereby reducing the rental revenue earned from that space |
| • Regulatory Costs |
| There are a number of government regulations, including zoning, tax and accessibility laws that apply to the ownership and operation of real estate properties |
| Compliance with existing and newly adopted regulations may require us to incur significant costs on our properties |
| • Rising Operating Costs |
| Costs of operating our properties, such as real estate taxes, utilities, insurance, maintenance and other costs, can rise faster than our ability to increase rental income |
| While we do receive some additional rent from our tenants that is based on recovering a portion of the operating expenses, generally increased operating expenses will negatively impact our net operating income from the properties |
| Our revenues and expense recoveries are subject to longer term leases and may not be quickly increased sufficient to recover an increase in operating costs and expenses |
| • Fixed Nature of Costs |
| Most of the costs associated with owning and operating our properties are not necessarily reduced when circumstances such as market factors and competition cause a reduction in rental revenues from the property |
| Increases in such fixed operating expenses, such as increased real estate taxes or insurance costs, would reduce our net income |
| • Environmental Problems |
| Federal, state and local laws and regulations relating to the protection of the environment may require a current or previous owner or operator of real property to investigate and clean up hazardous or toxic substances or petroleum product releases at the property |
| The clean up can be costly |
| The presence of or failure to clean up contamination may adversely affect our ability to sell or lease a property or to borrow funds using a property as collateral |
| A number of other major real estate investors with significant capital compete with us |
| These competitors include publicly-traded REITs, private REITs, private real estate investors and private institutional investment funds |
| Future acquisitions and development properties may fail to perform in accordance with our expectations and may require development and renovation costs exceeding our estimates |
| In the normal course of business, we typically evaluate potential acquisitions, enter into non-binding letters of intent, and may, at any time, enter into contracts to acquire additional properties |
| However, changing market conditions, including competition from others, may diminish our opportunities for making attractive acquisitions |
| Once made, our investments may fail to perform in accordance with our expectations |
| In addition, the renovation and improvement costs we incur in bringing an acquired property up to market standards may exceed our estimates |
| We may not have the financial resources to make suitable acquisitions or renovations on favorable terms or at all |
| In addition to acquisitions, we periodically consider developing and constructing properties |
| Risks associated with development and construction activities include: • the unavailability of favorable financing; • construction costs exceeding original estimates; • construction and lease-up delays resulting in increased debt service expense and construction costs; and • insufficient occupancy rates and rents at a newly completed property causing a property to be unprofitable |
| 7 ______________________________________________________________________ [33]Table of Contents If new developments are financed through construction loans, there is a risk that, upon completion of construction, permanent financing for newly developed properties will not be available or will be available only on disadvantageous terms |
| Development activities are also subject to risks relating to our inability to obtain, or delays in obtaining, all necessary zoning, land-use, building, occupancy and other required governmental and utility company authorizations |
| Illiquidity of real estate investments and the tax effect of dispositions could significantly impede our ability to sell assets or to respond to favorable or adverse changes in the performance of our properties |
| Because real estate investments are relatively illiquid, our ability to promptly sell one or more properties in our portfolio in response to changing economic, financial and investment conditions is limited |
| In addition, approximately dlra1dtta2 billion of our real assets (undepreciated book value) are encumbered by dlra721 million in mortgage loans as of December 31, 2005 under which we could incur significant prepayment penalties if such loans were paid off in connection with the sale of the underlying real estate assets |
| Such loans, even if assumed by a buyer rather than being paid off, could reduce the sale proceeds if we decided to sell such assets |
| However, we cannot predict whether we will be able to sell any property for the price or on the terms set by us, or whether any price or other terms offered by a prospective purchaser would be acceptable to us |
| We also cannot predict the length of time needed to find a willing purchaser and to close the sale of a property |
| Certain of our properties have low tax bases relative to their fair value, and accordingly, the sale of such assets would generate significant taxable gains unless we sold such properties in a tax-free exchange under Section 1031 of the Internal Revenue Code or another tax-free or tax-deferred transaction |
| For an exchange to qualify for tax-deferred treatment under Section 1031, the net proceeds from the sale of a property must be held by an escrow agent until applied toward the purchase of real estate qualifying for gain deferral |
| Given the competition for properties meeting our investment criteria, there could be a delay in reinvesting such proceeds |
| Any delay in using the reinvestment proceeds to acquire additional income producing assets would reduce our income from operations |
| In addition, the sale of certain properties acquired in the JC Nichols Company merger in July 1998 would require us to pay corporate-level tax under Section 1374 of the Internal Revenue Code on the built-in gain relating to such properties unless we sold such properties in a tax-free exchange under Section 1031 of the Internal Revenue Code or another tax-free or tax-deferred transaction |
| This tax will no longer apply after we have owned the assets for 10 years or more |
| As a result, we may be limited or restricted in our ability to sell any of these properties even if management determines that such a sale would otherwise be in the best interests of our stockholders |
| Although we have no current plans to dispose of any properties in a manner that would require us to pay corporate-level tax under Section 1374, we would consider doing so if our management determines that a sale of a property would be in our best interests based on consideration of a number of factors, including the price being offered for the property, the operating performance of the property, the tax consequences of the sale and other factors and circumstances surrounding the proposed sale |
| Because holders of our Common Units, including some of our officers and directors, may suffer adverse tax consequences upon the sale of some of our properties, it is possible that we may sometimes make decisions that are not in your best interest |
| Holders of Common Units may suffer adverse tax consequences upon our sale of certain properties |
| Therefore, holders of Common Units, including certain of our officers and directors, may have different objectives than our stockholders regarding the appropriate pricing and timing of a property’s sale |
| Although we are the sole general partner of the Operating Partnership and have the exclusive authority to sell all of our individual Wholly Owned Properties, officers and directors who hold Common Units may seek to influence us not to sell certain properties even if such sale might be financially advantageous to stockholders or influence us to enter into tax deferred exchanges with the proceeds of such sales when such a reinvestment might not otherwise be in our best interests |
| The success of our joint venture activity depends upon our ability to work effectively with financially sound partners |
| Instead of owning properties directly, we have in some cases invested, and may continue to invest, as a partner or a co-venturer with one or more third parties |
| Under certain circumstances, this type of investment may involve risks not otherwise present, including the possibility that a partner or co-venturer might become bankrupt or that a partner or co-venturer might have business interests or goals inconsistent with ours |
| Also, such a partner or co-venturer may take action contrary to our instructions or requests or contrary to provisions in our joint venture agreements that could harm us, including jeopardizing our qualification as a REIT 8 ______________________________________________________________________ [34]Table of Contents Our insurance coverage on our properties may be inadequate |
| We carry comprehensive insurance on all of our properties, including insurance for liability, fire and flood |
| Insurance companies, however, limit coverage against certain types of losses, such as losses due to terrorist acts, named windstorms and toxic mold |
| Thus, we may not have insurance coverage, or sufficient insurance coverage, against certain types of losses and/or there may be decreases in the limits of insurance available |
| Should an uninsured loss or a loss in excess of our insured limits occur, we could lose all or a portion of the capital we have invested in a property or properties, as well as the anticipated future revenue from the property or properties |
| If any of our properties were to experience a catastrophic loss, it could disrupt our operations, delay revenue and result in large expenses to repair or rebuild the property |
| Such events could adversely affect our ability to pay dividends to our stockholders |
| Our existing property and casualty insurance policies are scheduled to expire on June 30, 2006 |
| We are currently in the process of renewing our existing property and casualty insurance policies through June 30, 2007 |
| Our use of debt to finance our operations could have a material adverse effect on our cash flow and ability to make distributions |
| We are subject to risks normally associated with debt financing, such as the insufficiency of cash flow to meet required payment obligations, difficulty in complying with financial ratios and other covenants and the inability to refinance existing indebtedness |
| Increases in interest rates on our variable rate debt would increase our interest expense |
| If we fail to comply with the financial ratios and other covenants under our revolving credit facility, we would likely not be able to borrow any further amounts under the revolving credit facility, which could adversely affect our ability to fund our operations, and our lenders could accelerate outstanding debt |
| Further, as of the date of this filing, the Operating Partnership has not yet satisfied its requirement under the indenture governing the outstanding notes to file timely SEC reports |
| Under the indenture, the notes may be accelerated if the trustee or 25prca of the holders provide written notice of a default and such default remains uncured after 60 days |
| If the Operating Partnership failed to file its delinquent SEC reports prior to expiration of the 60-day cure period after receipt of any such default notice, the lender under our revolving credit facility would also have the ability to accelerate amounts outstanding under the revolving credit facility |
| To date, neither the trustee nor any note-holder has sent us any such default notice |
| The Operating Partnership is in compliance with all other covenants under the indenture and is current on all payments required thereunder |
| If our debt cannot be paid, refinanced or extended at maturity or on any such acceleration, in addition to our failure to repay our debt, we may not be able to pay dividends to stockholders at expected levels or at all |
| Furthermore, if any refinancing is done at higher interest rates, the increased interest expense could adversely affect our cash flow and ability to pay dividends to stockholders |
| Any such refinancing could also impose tighter financial ratios and other covenants that restrict our ability to take actions that could otherwise be in our stockholders’ best interest, such as funding new development activity, making opportunistic acquisitions, repurchasing our securities or paying distributions |
| If we do not meet our mortgage financing obligations, any properties securing such indebtedness could be foreclosed on, which would have a material adverse effect on our cash flow and ability to make distributions |
| We may be subject to taxation as a regular corporation if we fail to maintain our REIT status |
| Our failure to qualify as a REIT would have serious adverse consequences to our stockholders |
| Many of the requirements for taxation as a REIT are highly technical and complex and depend upon various factual matters and circumstances that may not be totally within our control |
| For example, to qualify as a REIT, at least 95dtta0prca of our gross income must come from certain sources that are itemized in the REIT tax laws |
| We are also required to distribute to stockholders at least 90dtta0prca of our REIT taxable income, excluding capital gains |
| The fact that we hold our assets through the Operating Partnership and its subsidiaries further complicates the application of the REIT requirements |
| Even a technical or inadvertent mistake could jeopardize our REIT status |
| Furthermore, Congress and the IRS might change the tax laws and regulations and the courts might issue new rulings that make it more difficult, or impossible, for us to remain qualified as a REIT If we fail to qualify as a REIT, we would be subject to federal income tax at regular corporate rates |
| Also, unless the IRS granted us relief under certain statutory provisions, we would remain disqualified as a REIT for four years following the year we first failed to qualify |
| If we failed to qualify as a REIT, we would have to pay significant income taxes and would, therefore, have less cash available for investments or to pay dividends to stockholders |
| This would likely have a significant adverse effect on the value of our securities |
| In addition, we would no longer be required to pay dividends to stockholders if we lost our REIT status |
| 9 ______________________________________________________________________ [35]Table of Contents Because provisions contained in Maryland law, our charter and our bylaws may have an anti-takeover effect, investors may be prevented from receiving a “control premium” for their shares |
| Provisions contained in our charter and bylaws as well as Maryland general corporation law may have anti-takeover effects that delay, defer or prevent a takeover attempt, and thereby prevent stockholders from receiving a “control premium” for their shares |
| For example, these provisions may defer or prevent tender offers for our Common Stock or purchases of large blocks of our Common Stock, thus limiting the opportunities for our stockholders to receive a premium for their Common Stock over then-prevailing market prices |
| These provisions include the following: • Ownership limit |
| Our charter prohibits direct, indirect or constructive ownership by any person or entity of more than 9dtta8prca of our outstanding capital stock |
| Any attempt to own or transfer shares of our capital stock in excess of the ownership limit without the consent of our Board of Directors will be void |
| • Preferred Stock |
| Our charter authorizes our Board of Directors to issue Preferred Stock in one or more classes and to establish the preferences and rights of any class of Preferred Stock issued |
| These actions can be taken without stockholder approval |
| The issuance of Preferred Stock could have the effect of delaying or preventing someone from taking control of us, even if a change in control were in our stockholders’ best interest |
| • Staggered board |
| Our Board of Directors is divided into three classes |
| As a result, each director generally serves for a three-year term |
| This staggering of our Board may discourage offers for us or make an acquisition of us more difficult, even when an acquisition is in the best interest of our stockholders |
| • Maryland control share acquisition statute |
| Maryland’s control share acquisition statute applies to us, which means that persons, entities or related groups that acquire more than 20prca of our common stock may not be able to vote such excess shares under certain circumstances if such shares were acquired in one or more transactions not approved by at least two-thirds of our outstanding Common Stock held by disinterested stockholders |
| • Maryland unsolicited takeover statute |
| Under Maryland law, our Board of Directors could adopt various anti-takeover provisions without the consent of stockholders |
| The adoption of such measures could discourage offers for us or make an acquisition of us more difficult, even when an acquisition is in the best interest of our stockholders |
| • Anti-takeover protections of Operating Partnership agreement |
| Upon a change in control of the Company, the limited partnership agreement of the Operating Partnership requires certain acquirers to maintain an UPREIT structure with terms at least as favorable to the limited partners as are currently in place |
| For instance, the acquirer would be required to preserve the limited partner’s right to continue to hold tax-deferred partnership interests that are redeemable for capital stock of the acquirer |
| Some change of control transactions involving the Company could require the approval of two-thirds of the limited partners of the Operating Partnership (other than the Company) |
| These provisions may make a change of control transaction involving the Company more complicated and therefore might limit the possibility of such a transaction occurring, even if such a transaction would be in the best interest of the Company’s stockholders |
| • Dilutive effect of stockholder rights plan |
| We have in effect a stockholder rights plan, which is currently scheduled to expire on October 6, 2007, pursuant to which our existing stockholders would have the ability to acquire additional Common Stock at a significant discount in the event a person or group attempts to acquire us on terms of which our Board of Directors does not approve |
| These rights are designed to deter a hostile takeover by increasing the takeover cost |
| As a result, such rights could discourage offers for us or make an acquisition of us more difficult, even when an acquisition is in the best interest of our stockholders |
| The rights plan should not interfere with any merger or other business combination the Board of Directors approves since we may generally terminate the plan at any time at nominal cost |
| 10 ______________________________________________________________________ [36]Table of Contents SEC investigation |
| As previously disclosed, the SEC’s Division of Enforcement has issued a confidential formal order of investigation in connection with the Company’s previous restatement of its financial results |
| Even though we are cooperating fully, we cannot assure you that the SEC’s Division of Enforcement will not take any action that would adversely affect us |