UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

S	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the quarterly period ended September 30, 2019
	or
£	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the transition period from to

Commission File Number 1-10709

PS BUSINESS PARKS, INC.

(Exact name of registrant as specified in its charter)

California	95-4300881
(State or Other Jurisdiction	(I.R.S. Employer
of Incorporation)	Identification Number)

701 Western Avenue, Glendale, California 91201-2349

(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code: (818) 244-8080

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

Title of Each Class	Ticker Symbol	Name of Each Exchange on Which Registered
Common Stock, $0.01 par value per share	PSB	New York Stock Exchange
Depositary Shares Each Representing 1/1,000 of a 5.750% Cum Pref Stock, Series U, $0.01 par value	PSBPrU	New York Stock Exchange
Depositary Shares Each Representing 1/1,000 of a 5.700% Cum Pref Stock, Series V, $0.01 par value	PSBPrV	New York Stock Exchange
Depositary Shares Each Representing 1/1,000 of a 5.200% Cum Pref Stock, Series W, $0.01 par value	PSBPrW	New York Stock Exchange
Depositary Shares Each Representing 1/1,000 of a 5.250% Cum Pref Stock, Series X, $0.01 par value	PSBPrX	New York Stock Exchange
Depositary Shares Each Representing 1/1,000 of a 5.200% Cum Pref Stock, Series Y, $0.01 par value	PSBPrY	New York Stock Exchange

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Yes S No £

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes S No £

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer S Accelerated filer £ Non-accelerated filer £ Smaller reporting company £ Emerging growth company £

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes £ No S

As of October 21, 2019, the number of shares of the registrant’s common stock, $0.01 par value per share, outstanding was 27,436,547.

PS BUSINESS PARKS, INC.

INDEX

	Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated balance sheets as of September 30, 2019 (unaudited) and December 31, 2018	3
Consolidated statements of income (unaudited) for the three and nine months ended September 30, 2019 and 2018	4
Consolidated statements of equity (unaudited) for the three and nine months ended September 30, 2019 and 2018	5
Consolidated statements of cash flows (unaudited) for the nine months ended September 30, 2019 and 2018	7
Notes to consolidated financial statements (unaudited)	8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	22
Item 3. Quantitative and Qualitative Disclosures About Market Risk	40
Item 4. Controls and Procedures	40
PART II. OTHER INFORMATION
Item 1. Legal Proceedings	40
Item 1A. Risk Factors	41
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	41
Item 6. Exhibits	42

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

PS BUSINESS PARKS, INC.

CONSOLIDATED BALANCE SHEETS

(Amounts in thousands, except share data)

	September 30,		December 31,
	2019		2018
	(Unaudited)
ASSETS
Cash and cash equivalents	$	6,749	$	37,379
Real estate facilities, at cost
Land		837,891		762,731
Buildings and improvements		2,212,166		2,157,407
		3,050,057		2,920,138
Accumulated depreciation		(1,152,946)		(1,097,748)
		1,897,111		1,822,390
Properties held for sale, net		124,937		128,093
Land and building held for development		30,515		30,848
		2,052,563		1,981,331
Rent receivable		1,752		1,403
Deferred rent receivable		35,548		33,308
Other assets		21,122		15,173
Total assets	$	2,117,734	$	2,068,594
LIABILITIES AND EQUITY
Accrued and other liabilities	$	92,252	$	85,141
Credit facility		50,000		—
Total liabilities		142,252		85,141
Commitments and contingencies
Equity
PS Business Parks, Inc.’s shareholders’ equity
Preferred stock, $0.01 par value, 50,000,000 shares authorized,
38,390 shares issued and outstanding at
September 30, 2019 and December 31, 2018,
at liquidation preference		959,750		959,750
Common stock, $0.01 par value, 100,000,000 shares authorized,
27,435,139 and 27,362,101 shares issued and outstanding at
September 30, 2019 and December 31, 2018, respectively		274		274
Paid-in capital		734,760		736,131
Accumulated earnings		64,775		69,207
Total PS Business Parks, Inc.’s shareholders’ equity		1,759,559		1,765,362
Noncontrolling interests		215,923		218,091
Total equity		1,975,482		1,983,453
Total liabilities and equity	$	2,117,734	$	2,068,594

See accompanying notes.

3

PS BUSINESS PARKS, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Amounts in thousands, except per share data)

(Unaudited)

	For The Three Months				For The Nine Months
	Ended September 30,				Ended September 30,
	2019		2018		2019		2018
Rental income	$	108,064	$	103,808	$	323,671	$	309,391
Expenses
Cost of operations		32,468		31,197		97,521		94,449
Depreciation and amortization		26,220		25,207		75,863		73,505
General and administrative		4,051		2,882		10,111		8,560
Total operating expenses		62,739		59,286		183,495		176,514
Interest and other income		1,384		488		2,766		1,066
Interest and other expense		(199)		(167)		(484)		(499)
Gain on sale of real estate facilities		—		—		—		85,283
Net income		46,510		44,843		142,458		218,727
Allocation to noncontrolling interests		(7,020)		(6,514)		(21,670)		(36,814)
Net income allocable to PS Business Parks, Inc.		39,490		38,329		120,788		181,913
Allocation to preferred shareholders		(12,959)		(12,959)		(38,877)		(38,921)
Allocation to restricted stock unit holders		(219)		(239)		(699)		(1,592)
Net income allocable to common shareholders	$	26,312	$	25,131	$	81,212	$	141,400
Net income per common share
Basic	$	0.96	$	0.92	$	2.96	$	5.18
Diluted	$	0.96	$	0.92	$	2.95	$	5.16
Weighted average common shares outstanding
Basic		27,432		27,339		27,411		27,310
Diluted		27,543		27,442		27,512		27,412

See accompanying notes.

4

PS BUSINESS PARKS, INC.

CONSOLIDATED STATEMENTS OF EQUITY

(Amounts in thousands, except share data)

(Unaudited)

											Total PS
											Business Parks,
For the three months ended	Preferred Stock			Common Stock			Paid-in		Accumulated		Inc.’s Shareholders’		Noncontrolling		Total
September 30, 2019	Shares	Amount		Shares	Amount		Capital		Earnings (Deficit)		Equity		Interests		Equity
Balances at June 30, 2019	38,390	$	959,750	27,429,756	$	274	$	733,777	$	67,049	$	1,760,850	$	216,327	$	1,977,177
Issuance of common stock in
connection with stock-based
compensation	—		—	5,383		—		—		—		—		—		—
Stock compensation, net	—		—	—		—		1,883		—		1,883		—		1,883
Cash paid for taxes in lieu of
shares upon vesting of
restricted stock units	—		—	—		—		(620)		—		(620)		—		(620)
Net income	—		—	—		—		—		39,490		39,490		7,020		46,510
Distributions
Preferred stock (Note 8)	—		—	—		—		—		(12,959)		(12,959)		—		(12,959)
Common stock ($1.05 per share)	—		—	—		—		—		(28,805)		(28,805)		—		(28,805)
Noncontrolling interests—
Common Units	—		—	—		—		—		—		—		(7,671)		(7,671)
Joint Venture	—		—	—		—		—		—		—		(33)		(33)
Adjustment to noncontrolling interests—
common units in the OP	—		—	—		—		(280)		—		(280)		280		—
Balances at September 30, 2019	38,390	$	959,750	27,435,139	$	274	$	734,760	$	64,775	$	1,759,559	$	215,923	$	1,975,482
For the three months ended
September 30, 2018
Balances at June 30, 2018	38,390	$	959,750	27,331,834	$	272	$	733,617	$	69,448	$	1,763,087	$	217,932	$	1,981,019
Issuance of common stock in
connection with stock-based
compensation	—		—	14,728		1		450		—		451		—		451
Stock compensation, net	—		—	—		—		853		—		853		—		853
Cash paid for taxes in lieu of
shares upon vesting of
restricted stock units	—		—	—		—		(426)		—		(426)		—		(426)
Net income	—		—	—		—		—		38,329		38,329		6,514		44,843
Distributions
Preferred stock (Note 8)	—		—	—		—		—		(12,959)		(12,959)		—		(12,959)
Common stock ($1.05 per share)	—		—	—		—		—		(28,711)		(28,711)		—		(28,711)
Noncontrolling interests—
common units	—		—	—		—		—		—		—		(7,671)		(7,671)
Adjustment to noncontrolling interests—
common units in the OP	—		—	—		—		(153)		—		(153)		153		—
Balances at September 30, 2018	38,390	$	959,750	27,346,562	$	273	$	734,341	$	66,107	$	1,760,471	$	216,928	$	1,977,399

‎

See accompanying notes.

5

PS BUSINESS PARKS, INC.

CONSOLIDATED STATEMENTS OF EQUITY

(Amounts in thousands, except share data)

(Unaudited)

											Total PS
											Business Parks,
For the nine months ended	Preferred Stock			Common Stock			Paid-in		Accumulated		Inc.’s Shareholders’		Noncontrolling		Total
September 30, 2019	Shares	Amount		Shares	Amount		Capital		Earnings (Deficit)		Equity		Interests		Equity
Balances at December 31, 2018	38,390	$	959,750	27,362,101	$	274	$	736,131	$	69,207	$	1,765,362	$	218,091	$	1,983,453
Issuance of common stock in
connection with stock-based
compensation	—		—	73,038		—		709		—		709		—		709
Stock compensation, net	—		—	—		—		3,292		—		3,292		—		3,292
Cash paid for taxes in lieu of
shares upon vesting of
restricted stock units	—		—	—		—		(6,120)		—		(6,120)		—		(6,120)
Net income	—		—	—		—		—		120,788		120,788		21,670		142,458
Distributions
Preferred stock (Note 8)	—		—	—		—		—		(38,877)		(38,877)		—		(38,877)
Common stock ($3.15 per share)	—		—	—		—		—		(86,343)		(86,343)		—		(86,343)
Noncontrolling interests—
Common Units	—		—	—		—		—		—		—		(23,012)		(23,012)
Joint Venture	—		—	—		—		—		—		—		(78)		(78)
Adjustment to noncontrolling interests—
common units in the OP	—		—	—		—		748		—		748		(748)		—
Balances at September 30, 2019	38,390	$	959,750	27,435,139	$	274	$	734,760	$	64,775	$	1,759,559	$	215,923	$	1,975,482
For the nine months ended
September 30, 2018
Balances at December 31, 2017	38,390	$	959,750	27,254,607	$	272	$	735,067	$	(1,778)	$	1,693,311	$	196,625	$	1,889,936
Issuance of common stock in
connection with stock-based
compensation	—		—	91,955		1		1,678		—		1,679		—		1,679
Stock compensation, net	—		—	—		—		2,098		—		2,098		—		2,098
Cash paid for taxes in lieu of
shares upon vesting of
restricted stock units	—		—	—		—		(4,955)		—		(4,955)		—		(4,955)
Consolidation of joint venture (see Note 3)	—		—	—		—		—		—		—		4,032		4,032
Net income	—		—	—		—		—		181,913		181,913		36,814		218,727
Distributions
Preferred stock (Note 8)	—		—	—		—		—		(38,921)		(38,921)		—		(38,921)
Common stock ($2.75 per share)	—		—	—		—		—		(75,107)		(75,107)		—		(75,107)
Noncontrolling interests—
common units	—		—	—		—		—		—		—		(20,090)		(20,090)
Adjustment to noncontrolling interests—
common units in the OP	—		—	—		—		453		—		453		(453)		—
Balances at September 30, 2018	38,390	$	959,750	27,346,562	$	273	$	734,341	$	66,107	$	1,760,471	$	216,928	$	1,977,399

See accompanying notes.

6

PS BUSINESS PARKS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, amounts in thousands)

	For The Nine Months
	Ended September 30,
	2019		2018
Cash flows from operating activities
Net income	$	142,458	$	218,727
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization expense		75,863		73,505
Tenant improvement reimbursement amortization, net of lease incentive amortization		(788)		(1,690)
Gain on sale of real estate facilities		—		(85,283)
Stock compensation expense		3,991		2,933
Amortization of financing costs		410		400
Other, net		(1,071)		(4,823)
Total adjustments		78,405		(14,958)
Net cash provided by operating activities		220,863		203,769
Cash flows from investing activities
Capital expenditures to real estate facilities		(26,272)		(25,817)
Capital expenditures to land and building held for development		(2,873)		(517)
Acquisition of real estate facilities		(117,691)		(142,399)
Consolidation of joint venture		—		1,082
Proceeds from sale of real estate facilities		—		126,836
Net cash used in investing activities		(146,836)		(40,815)
Cash flows from financing activities
Borrowings on credit facility		70,000		50,000
Repayment of borrowings on credit facility		(20,000)		(50,000)
Payment of financing costs		(237)		(227)
Proceeds from the exercise of stock options		709		1,679
Redemption of preferred stock		—		(130,000)
Cash paid for taxes in lieu of shares upon vesting of restricted stock units		(6,120)		(4,955)
Cash paid to restricted stock unit holders		(699)		(835)
Distributions paid to preferred shareholders		(38,877)		(39,614)
Distributions paid to common shareholders		(86,343)		(75,107)
Distributions paid to noncontrolling interests—common units		(23,012)		(20,090)
Distributions paid to noncontrolling interests—joint venture		(78)		—
Net cash used in financing activities		(104,657)		(269,149)
Net decrease in cash and cash equivalents		(30,630)		(106,195)
Cash, cash equivalents and restricted cash at the beginning of the period		38,467		115,970
Cash, cash equivalents and restricted cash at the end of the period	$	7,837	$	9,775
Supplemental schedule of non-cash investing and financing activities
Adjustment to noncontrolling interests—common units in the OP
Noncontrolling interests—common units	$	(748)	$	(453)
Paid-in capital	$	748	$	453
Consolidation of joint venture
Land	$	—	$	21,814
Buildings and improvements	$	—	$	85,436
Other, net	$	—	$	(2,320)
Investment in and advances to unconsolidated joint venture	$	—	$	(100,898)
Noncontrolling interest — joint venture	$	—	$	(4,032)

See accompanying notes.

7

PS BUSINESS PARKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2019

1. Organization and description of business

Organization

PS Business Parks, Inc. (“PSB”) was incorporated in the state of California in 1990. As of September 30, 2019, PSB owned 79.0% of the common partnership units of PS Business Parks, L.P. (the “OP”). The remaining common partnership units are owned by Public Storage (“PS”). PS’s interest in the OP is referred to as the “PS OP Interests.” PSB, as the sole general partner of the OP, has full, exclusive and complete responsibility and discretion in managing and controlling the OP. PSB and its subsidiaries, including the OP and our consolidated joint venture that owns a 395-unit multifamily apartment complex in Tysons, Virginia, are collectively referred to as the “Company,” “we,” “us,” or “our.” PS would own 41.6% (or 14.5 million shares) of the outstanding shares of the Company’s common stock if it redeemed its common partnership units for common shares.

Description of Business

The Company is a fully-integrated, self-advised and self-managed real estate investment trust (“REIT”) that owns, operates, acquires and develops commercial properties, primarily multi-tenant industrial, flex and office space. As of September 30, 2019, the Company owned and operated 28.8 million rentable square feet of commercial space in six states and held a 95.0% interest in a 395-unit multifamily apartment complex in Tysons, Virginia. The Company also manages for a fee approximately 438,000 rentable square feet on behalf of PS.

2. Summary of significant accounting policies

Basis of presentation

The accompanying unaudited consolidated financial statements include the accounts of PSB and its subsidiaries, including the OP and our consolidated joint venture. All significant inter-company balances and transactions have been eliminated in the consolidated financial statements. The financial statements are presented on an accrual basis in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information, instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for audited financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2019 are not necessarily indicative of the results that may be expected for the year ended December 31, 2019. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.

Consolidation and equity method of accounting

We consider entities to be Variable Interest Entities (“VIEs”) when they have insufficient equity to finance their activities without additional subordinated financial support provided by other parties, or the equity holders as a group do not have a controlling financial interest. A limited partnership is also generally considered a VIE if the limited partners do not participate in operating decisions. We consolidate VIEs when we are the primary beneficiary, generally defined as having (i) the power to direct the activities most significantly impacting economic performance and (ii) either the obligation to absorb losses or the right to receive benefits from the VIE.

We account for investments in entities that are not VIEs that we have significant influence over, but do not control, using the equity method of accounting and for investment in entities that we control, we consolidate. On January 1, 2018, we began to consolidate our joint venture due to changes to the joint venture agreement that gave the Company control of the joint venture. See Note 3 for more information on this entity.

8

PS, the sole limited partner in the OP, has no power to direct the activities of the OP. We are the primary beneficiary of the OP. Accordingly, we consider the OP a VIE and consolidate it. Substantially all of our assets and liabilities are held by the OP.

Noncontrolling interests

Noncontrolling interests represent (i) PS’s noncontrolling interest in the OP through its ownership of 7,305,355 common partnership units and (ii) a third-party 5.0% interest in our consolidated joint venture owning a 395-unit multifamily apartment complex. See Note 6 for further information on noncontrolling interests.

Use of estimates

The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from these estimates.

Financial instruments

The methods and assumptions used to estimate the fair value of financial instruments are described below. The Company has estimated the fair value of financial instruments using available market information and appropriate valuation methodologies. Considerable judgment is required in interpreting market data to develop estimates of market value. Accordingly, estimated fair values are not necessarily indicative of the amounts that could be realized in current market exchanges. The Company determines the estimated fair value of financial assets and liabilities utilizing a hierarchy of valuation techniques based on whether the inputs to a fair value measurement are considered to be observable or unobservable in a marketplace. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect market assumptions. This hierarchy requires the use of observable market data when available. The following is the fair value hierarchy:

Level 1—quoted prices for identical instruments in active markets;

Level 2—quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which significant inputs and significant value drivers are observable in active markets; and

Level 3—fair value measurements derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

Financial assets that are exposed to credit risk consist primarily of cash equivalents and receivables. The Company considers all highly liquid investments with a remaining maturity of three months or less at the date of purchase to be cash equivalents. Cash and cash equivalents, which consist primarily of money market investments, are only invested in entities with an investment grade rating. Receivables are comprised of balances due from various customers. Balances that the Company expects to become uncollectible are written off. Due to the short period to maturity of the Company’s cash and cash equivalents, accounts receivable, other assets and accrued and other liabilities, the carrying values as presented on the consolidated balance sheets are reasonable estimates of fair value.

‎

9

The following table provides a reconciliation of cash, cash equivalents and restricted cash per the consolidated statements of cash flow to the corresponding financial statement line items in the consolidated balance sheets (in thousands):

	December 31,
	2018		2017
Consolidated balance sheets
Cash and cash equivalents	$	37,379	$	114,882
Restricted cash included in
Land and building held for development		1,088		1,088
Consolidated statements of cash flows	$	38,467	$	115,970

	September 30,
	2019		2018
Consolidated balance sheets
Cash and cash equivalents	$	6,749	$	8,687
Restricted cash included in
Land and building held for development		1,088		1,088
Consolidated statements of cash flows	$	7,837	$	9,775

Carrying values of the Company’s Credit Facility (as defined in Note 5) approximate fair value. The characteristics of these financial instruments, market data and other comparative metrics utilized in determining these fair values are “Level 2” inputs.

Real estate facilities

Real estate facilities are recorded at cost. Property taxes, insurance, interest and costs essential to the development of property for its intended use are capitalized during the period of development. Direct costs related to the renovation or improvement of the properties are capitalized. Expenditures for repairs and maintenance are expensed as incurred. Expenditures that are expected to benefit a period greater than two years are capitalized and depreciated over their estimated useful life. Buildings and improvements are depreciated using the straight-line method over their estimated useful lives, which generally range from five to 30 years. Transaction costs, which include tenant improvements and lease commissions, for leases with terms greater than one year are capitalized and depreciated over their estimated useful lives.

Property held for sale or development

Real estate is classified as held for sale when the asset is being marketed for sale and we expect that a sale is likely to occur in the next 12 months. Real estate is classified as held for development when it is no longer used in its original form and likely that it will be developed to an alternate use. Property held for development or sale is not depreciated.

Intangible assets/liabilities

When we acquire real estate facilities, an intangible asset is recorded as other assets for leases where the in-place rent is higher than market rents, and an intangible liability is recorded as other liabilities where the market rents are higher than the in-place rents. The amounts recorded are based upon the present value (using a discount rate which reflects the risks associated with the leases acquired) of such differences over the lease term and such amounts are amortized to rental income over the respective remaining lease term. As of September 30, 2019, the value of above-market in-place rents resulted in net intangible assets of $1.4 million, net of $10.4 million of accumulated amortization and the value of below-market in-place rents resulted in net intangible liabilities of $2.5 million, net of $11.2 million of accumulated amortization. As of December 31, 2018, the value of above-market in-place rents resulted in net

10

intangible assets of $1.8 million, net of $10.0 million of accumulated amortization and the value of below-market in-place rents resulted in net intangible liabilities of $1.8 million, net of $10.8 million of accumulated amortization.

Additionally, when we acquire real estate facilities, the value of in-place leases (i.e., customer lease-up costs) is recorded as other assets and is amortized to depreciation and amortization expense over the respective remaining lease term. As of September 30, 2019, the value of acquired in-place leases resulted in net intangible assets of $6.3 million, net of $3.1 million of accumulated amortization. As of December 31, 2018, the value of acquired in-place leases resulted in net intangible assets of $4.7 million, net of $1.3 million of accumulated amortization.

Evaluation of asset impairment

We evaluate our real estate and finite-lived intangible assets for impairment each quarter. If there are indicators of impairment and we determine that the carrying value of the asset is not recoverable from estimated future undiscounted cash flows to be received through the asset’s remaining life (or, if earlier, the expected disposal date), we record an impairment charge to the extent the carrying amount exceeds the asset’s estimated fair value or net proceeds from expected disposal.

No impairment charges were recorded in any period presented herein.

Stock compensation

Share-based payments to employees, including grants of employee stock options, are recognized as stock compensation expense in the Company’s consolidated statements of income based on their grant date fair values, except for performance-based grants, which are accounted for based on their fair values at the beginning of the service period. See Note 10.

Accrued and other liabilities

Accrued and other liabilities consist primarily of rents prepaid by our customers, trade payables, property tax accruals, accrued payroll and contingent loss accruals when probable and estimable, as well as the intangible liabilities discussed above. We disclose the nature of significant unaccrued losses that are reasonably possible of occurring and, if estimable, a range of exposure.

Other assets

Other assets are comprised primarily of prepaid expenses, as well as the intangible assets discussed above.

Revenue recognition

We recognize the aggregate rent to be collected (including the impact of escalators and concessions) under leases ratably throughout the non-cancellable lease term on a “straight-line” basis, commencing when the customer takes control of the leased space. Cumulative straight-line rent recognized in excess of amounts billed per the lease term is presented as “deferred rent receivable” on our consolidated balance sheets. We present reimbursements from customers for real estate taxes and other recoverable operating expenses under a single lease component presentation as the timing and pattern of transfer of such reimbursements are the same as the lease term, and the combined single component of such leases are classified as operating leases. Accordingly, we recognize such variable lease payments resulting from the reimbursements from customers for real estate taxes and other recoverable operating expenses as rental income in the period the applicable costs are incurred.

The Company monitors the collectability of its receivable balances, including deferred rent receivable balances, on an ongoing basis. The Company writes off uncollectible customer receivable balances, including deferred rent receivable balances, in the period such receivable balances are deemed uncollectible. Therefore, recognition of rental income is limited to the lesser of the amount of cash collected or rental income reflected on a “straight-line” basis, plus any accruable variable lease payments for those customer receivable balances deemed uncollectible.

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Property management fees are recognized in the period earned as other income.

Costs incurred in acquiring customers (primarily tenant improvements and lease commissions) are capitalized and amortized over the lease period for leases with terms greater than one year.

Sales of real estate facilities

Sales of real estate facilities are not part of our ordinary activities, and as a result, we consider such sales as contracts with non-customers. We recognize sales of real estate when we have collected payment and the attributes of ownership, such as possession and control of the asset, have been transferred to the buyer. If a contract for sale includes obligations to provide goods or services to the buyer, an allocated portion of the contract price is recognized as revenue as the related goods or services are transferred to the buyer.

General and administrative expense

General and administrative expense includes executive and other compensation, corporate office expenses, professional fees, state income taxes and other such costs that are not directly related to the operation of our real estate facilities.

Income taxes

We have elected to be treated as a REIT, as defined in the Internal Revenue Code of 1986, as amended (the “Code”). As a REIT, we do not incur federal income tax if we distribute substantially all of our “REIT taxable income” each year, and if we meet certain organizational and operational rules. We believe we have met these REIT requirements for all periods presented herein. Accordingly, we have recorded no federal income tax expense related to our “REIT taxable income.”

We recognize tax benefits of uncertain income tax positions that are subject to audit only if we believe it is more likely than not that the position would ultimately be sustained assuming the relevant taxing authorities had full knowledge of the relevant facts and circumstances of our positions. As of September 30, 2019 and December 31, 2018, we did not recognize any tax benefit for uncertain tax positions.

Accounting for preferred equity issuance costs

We record issuance costs as a reduction to paid-in capital on our consolidated balance sheets at the time the preferred securities are issued and reflect the carrying value of the preferred equity at its redemption value. An additional allocation of income is made from the common shareholders to the preferred shareholders in the amount of the original issuance costs, and we reclassify the redemption value from equity to liabilities when we call preferred shares for redemption.

Net income per common share

Notwithstanding the presentation of income allocations on our consolidated statements of income, net income is allocated to (a) preferred shareholders, for distributions paid or payable, (b) preferred shareholders, to the extent redemption value exceeds the related carrying value, (c) our joint venture partner, to the extent the consolidated joint venture produce net income or loss during the period and (d) restricted stock unit (“RSU”) holders, for non-forfeitable dividends paid adjusted for participation rights in undistributed earnings. The remaining net income is allocated to the common partnership units and our common shareholders, respectively, based upon the pro-rata aggregate number of units and shares outstanding.

Basic and diluted net income per common share are each calculated based upon net income allocable to common shareholders, divided by (i) in the case of basic net income per common share, weighted average common shares and (ii) in the case of diluted income per share, weighted average common shares adjusted for the impact of stock compensation awards outstanding (Note 10) using the treasury stock method.
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The following tables set forth the calculation of the components of our basic and diluted income per share that are not reflected on the face of our consolidated statements of income, including the allocation of income to common shareholders and common partnership units, the percentage of weighted average shares and common partnership units, as well as basic and diluted weighted average shares (in thousands):

	For The Three Months				For The Nine Months
	Ended September 30,				Ended September 30,
	2019		2018		2019		2018
Calculation of net income allocable to common shareholders
Net income	$	46,510	$	44,843	$	142,458	$	218,727
Net (income) loss allocated to
Preferred shareholders based upon distributions		(12,959)		(12,959)		(38,877)		(38,921)
Noncontrolling interests—joint venture		(14)		189		(27)		1,008
Restricted stock unit holders		(219)		(239)		(699)		(1,592)
Net income allocable to common shareholders
and noncontrolling interests—common units		33,318		31,834		102,855		179,222
Net income allocation to noncontrolling interests—
common units		(7,006)		(6,703)		(21,643)		(37,822)
Net income allocable to common shareholders	$	26,312	$	25,131	$	81,212	$	141,400
Calculation of common partnership units as a percentage of common share equivalents
Weighted average common shares outstanding		27,432		27,339		27,411		27,310
Weighted average common partnership units outstanding		7,305		7,305		7,305		7,305
Total common share equivalents		34,737		34,644		34,716		34,615
Common partnership units as a percentage of common
share equivalents		21.0%		21.1%		21.0%		21.1%
Weighted average common shares outstanding
Basic weighted average common shares outstanding		27,432		27,339		27,411		27,310
Net effect of dilutive stock compensation—based on
treasury stock method using average market price		111		103		101		102
Diluted weighted average common shares outstanding		27,543		27,442		27,512		27,412

Segment reporting

We have two operating segments: (i) the acquisition, development, ownership and management of commercial real estate and (ii) the acquisition, development, ownership and management of multifamily real estate, but have one reportable segment as the multifamily segment does not meet the quantitative thresholds necessary to require reporting as a separate segment.

Reclassifications

We have reclassified our divisional vice presidents’ compensation costs totaling $457,000 and $1.5 million for the three and nine months ended September 30, 2018, respectively, from cost of operations into general and administrative expense on our consolidated statements of income in the three and nine months ended September 30, 2018 in order to conform to the current periods’ presentation. Certain reclassifications have been made to the consolidated financial statements for 2018 in order to conform to the 2019 presentation, including reclassifying assets held for sale as of September 30, 2019 from “real estate facilities, at costs” totaling $128.1 million as of December 31, 2018 into “properties held for sale, net” on our consolidated balance sheets.

Recently issued accounting standards

In May 2014 and February 2016, the Financial Accounting Standards Board (“FASB”) issued two Accounting Standards Updates (“ASU”s), ASU 2014-09, Revenue from Contracts with Customers (the “Revenue Standard”), and ASU 2016-02, Leases (the “Lease Standard”). These standards apply to substantially all of our revenue generating activities, as well as provide a model to account for the disposition of real estate facilities to non-customers.

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Lessor accounting

The Lease Standard directs how we account for payments from the elements of our leases that are generally fixed and determinable at the inception of the lease (“Fixed Lease Payments”) while the Revenue Standard directs how we account for the non-lease components of our lease contracts, primarily expense reimbursements (“Non-Lease Payments”).

The Lease Standard requires us to identify Fixed Lease Payments and Non-Lease Payments of a lease agreement and governs the recognition of revenue for the Fixed Lease Payments. Revenue related to Non-Lease Payments under our lease arrangements is subject to the Revenue Standard effective upon adoption of the Lease Standard. See further discussion below on Fixed Lease Payments and Non-Lease Payments.

Under the Lease Standard, a set of practical expedients for implementation, which must be elected as a package and for all leases, was elected as part of our adoption of the Lease Standard. These practical expedients include (i) relief from re-assessing whether an expired or existing contract meets the definition of a lease, (ii) relief from re-assessing the classification of expired or existing leases at the adoption date and (iii) allowing previously capitalized initial direct leasing costs to continue to be amortized.

We adopted the Lease Standard on its effective date of January 1, 2019. In addition to the package of practical expedients noted above, we also elected the practical expedient not to allocate the total consideration to Fixed Lease Payments and Non-Lease Payments based on their relative standalone selling prices. This practical expedient allows lessors to elect a combined single component presentation if (i) the timing and pattern of the revenue recognition for the Fixed Lease Payments and Non-Lease Payments are the same, and (ii) the combined single component of the lease would continue to be classified as an operating lease. We have assessed and believe the two conditions have been met for Non-Lease Payments as (i) the timing and pattern of transfer of the Fixed Lease Payments and Non-Lease Payments are the same, and (ii) the combined single component of the lease would be classified as an operating lease. The adoption of the Leasing Standard did not result in a material impact to our consolidated financial statements.

We recognized revenue from our lease arrangements aggregating $108.1 million and $103.8 million for the three months ended September 30, 2019 and 2018, respectively, and $323.7 million and $309.4 million for the nine months ended September 30, 2019 and 2018, respectively. This revenue consisted primarily of rental income from operating leases and the related variable lease payments resulting from reimbursements of property operating expenses. Rental income was $84.1 million and $80.9 million for the three months ended September 30, 2019 and 2018, respectively, and $250.7 million and $240.3 million for the nine months ended September 30, 2019 and 2018, respectively. Variable lease payments were $24.0 million and $22.9 million for the three months ended September 30, 2019 and 2018, respectively, and $73.0 million and $69.1 million for the nine months ended September 30, 2019 and 2018, respectively.

The Lease Standard provides two approaches to account for uncollectible customer receivable balances, and the respective deferred rent receivables balances: (i) an impairment model approach or (ii) a reserve approach in accordance to ASU 450-20, Contingencies - Loss Contingencies (“Contingencies - Loss Contingencies Standard”). Under the impairment model, recognition of rental income is limited to the lesser of the amount of cash collected or rental income reflected on a “straight-line” basis, plus any accruable variable lease payments for those customer receivable balances deemed uncollectible. After completing the impairment model approach, a lessor may also choose to apply the reserve approach. Under the reserve approach, a lessor records a reserve for a portion of the receivable balances, based on historical data, for uncollectible amounts. A lessor that chooses the reserve approach will have to apply the guidance from both the Lease Standard and Contingencies - Loss Contingencies Standard. The Company has elected the impairment model approach to account for its uncollectible customer receivable balances, and the respective deferred rent receivable balances. The Company’s uncollectible receivable balances policy is consistent with the impairment model approach as the Company writes off uncollectible receivable balances in the period the amounts are deemed uncollectible. Therefore, our rental income is limited to the lesser of the amount of cash collected or rental income reflected on a “straight-line” basis, plus any accruable variable lease payments for those customer receivable balances deemed uncollectible.

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Costs to execute leases

The Lease Standard also provides updated guidance on the requirements for the capitalization of the incremental costs incurred in executing leases, such as legal fees and commissions. Under the Lease Standard, any costs that would have been incurred regardless of successful lease execution, such as allocated costs of internal personnel, are to be expensed and may not be capitalized. As we have historically not capitalized any such costs, the adoption of the Lease Standard did not result in a material impact to our consolidated financial statements.

Lessee accounting

Under the Lease Standard, lessees are required to apply a dual approach by classifying leases as either finance or operating leases based on the principle whether the lease is effectively a finance purchase of the leased asset by the lessee. This classification determines whether the lease expense is recognized based on an effective interest method or a straight-line basis over the term of the lease. For most leases with a term of greater than 12 months, in which we are the lessee, the present value of future lease payments is recognized on our balance sheet as a right-of-use (“ROU”) asset and related liability. On January 1, 2019, the Company recorded a ROU asset of $1.7 million, included in “other assets” on our consolidated balance sheets and a corresponding liability of $1.7 million under “accrued and other liabilities”, relating to our existing ground lease arrangements. These operating leases were recognized based on the present value of the future minimum lease payments over the lease term. As these leases do not provide an implicit rate, the Company used its incremental borrowing rate based on the information available in determining the present value of future payments. The discount rate used to determine the present value of these operating leases’ future payments was 4.20%. These ground leases expire in 2029 and 2030 and do not have an option to extend. As of September 30, 2019, the remaining lease terms ranged from 10.0 years to 10.3 years. Lease expense for minimum lease payments is recognized in the period the applicable costs are incurred as monthly rent for these operating leases are constant without increases through the remaining terms of these leases. The adoption of the Lease Standard did not result in a material impact to our consolidated financial statements from the initial recognition of each lease liability or from the pattern of recognition subsequent to adoption.

3. Real estate facilities

The activity in real estate facilities for the nine months ended September 30, 2019 was as follows (in thousands):

			Buildings and		Accumulated
	Land		Improvements		Depreciation		Total
Balances at December 31, 2018 (1)	$	762,731	$	2,157,407	$	(1,097,748)	$	1,822,390
Acquisition of real estate facility		75,160		40,765		—		115,925
Capital expenditures		—		26,536		—		26,536
Disposals (2)		—		(11,643)		11,643		—
Depreciation and amortization expense		—		—		(70,896)		(70,896)
Transfer to properties held for sale		—		(899)		4,055		3,156
Balances at September 30, 2019	$	837,891	$	2,212,166	$	(1,152,946)	$	1,897,111

____________________________

⁽¹⁾Land, building and improvements, and accumulated depreciation, respectively, totaling $53.9 million, $217.5 million and $143.3 million were reclassified as of December 31, 2018 to “properties held for sale, net” representing 1.3 million rentable square feet of flex and office business parks located in Rockville and Silver Spring, Maryland.

⁽²⁾Disposals primarily represent the book value of tenant improvements that have been removed upon the customer vacating their space.

As of September 30, 2019, we have commitments, pursuant to executed leases throughout our portfolio, to spend $10.3 million on transaction costs, which include tenant improvements and lease commissions.

The purchase price of acquired properties is allocated to land, buildings and improvements (including tenant improvements, unamortized lease commissions, acquired in-place lease values and customer relationships, if any),

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intangible assets and intangible liabilities (see Note 2), based upon the relative fair value of each component, which are evaluated independently.

We must make significant assumptions in determining the fair value of assets acquired and liabilities assumed, which can affect the recognition and timing of revenue and depreciation and amortization expense. The fair value of land is estimated based upon, among other considerations, comparable sales of land within the same region. The fair value of buildings and improvements is determined using a combination of the income and replacement cost approaches which both utilize available market information relevant to the acquired property. The fair value of other acquired assets including tenant improvements and unamortized lease commissions are determined using the replacement cost approach. The amount recorded to acquired in-place leases is also determined utilizing the income approach using market assumptions which are based on management’s assessment of current market conditions and the estimated lease-up periods for the respective spaces. Transaction costs related to asset acquisitions are capitalized.

On September 5, 2019, we acquired a multi-tenant industrial park comprised of approximately 543,000 rentable square feet in Santa Fe Springs, California, for a total purchase price of $104.3 million, inclusive of capitalized transaction costs.

On April 18, 2019, we acquired a multi-tenant industrial park comprised of approximately 74,000 rentable square feet in Signal Hill, California, for a total purchase price of $13.8 million, inclusive of capitalized transaction costs.

On June 8, 2018, we acquired two multi-tenant industrial parks aggregating 1.1 million rentable square feet in Springfield, Virginia, for a purchase price of $143.8 million, inclusive of capitalized transaction costs.

The following table summarizes the assets acquired and liabilities assumed for the nine months ended September 30, (in thousands):

	2019		2018
Land	$	75,160	$	25,806
Buildings and improvements		40,765		112,230
Other assets (above-market in-place rents)		—		1,487
Accrued and other liabilities (below-market in-place rents)		(1,142)		(1,790)
Other assets (in-place lease value)		3,371		6,033
Total purchase price		118,154		143,766
Net operating assets acquired and liabilities assumed		(463)		(1,367)
Total cash paid	$	117,691	$	142,399

We have a 95.0% interest in a 395-unit multifamily apartment complex on a five-acre site within the Company’s 628,000 square foot office park located in Tysons, Virginia. An unrelated real estate development company (the “JV Partner”) holds the remaining 5.0%. On January 1, 2018, we began to consolidate our joint venture due to changes to the joint venture agreement that gave the Company control of the joint venture.

The following table summarizes the assets acquired and liabilities assumed related to the consolidation of the joint venture, which was accounted for as an asset acquisition, as of January 1, 2018 (in thousands):

	2018
Land	$	21,814
Buildings and improvements		84,903
Other assets (in-place lease value)		1,199
Total consolidated joint venture		107,916
Noncontrolling interest in consolidated joint venture		(4,032)
Net book value of joint venture at consolidation	$	103,884

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Properties Sold and Held for Sale

Subsequent to September 30, 2019, we sold 1.3 million rentable square feet of flex and office business parks located in Rockville and Silver Spring, Maryland, for a gross sales price of $148.8 million. We determined that the sale did not meet the criteria for discontinued operations presentation, as the sale of such assets did not represent a strategic shift that will have a major effect on our operations and financial results. As a result of this classification, the assets of the properties are separately presented as held for sale in the consolidated balance sheet as of December 31, 2018.

On March 5, 2018, we sold Corporate Pointe Business Park, a park consisting of five multi-tenant office buildings totaling 161,000 square feet located in Orange County, California, for net sale proceeds of $41.7 million, which resulted in a gain of $26.8 million. On April 18, 2018, we sold Orange County Business Center, a park consisting of five multi-tenant office buildings totaling 437,000 square feet located in Orange County, California, for net sale proceeds of $73.3 million, which resulted in a gain of $50.6 million. On April 30, 2018, we sold Northgate Business Park, a park consisting of seven multi-tenant flex buildings totaling 194,000 square feet located in Dallas, Texas, for net sale proceeds of $11.8 million, which resulted in a gain of $7.9 million. We determined that these sales also did not meet the criteria for discontinued operations presentation.

4. Leasing activity

The Company leases space in its commercial real estate facilities to customers primarily under non-cancelable leases generally ranging from one to 10 years. Future minimum rental income, excluding recovery of operating expenses under these leases, is as follows as of September 30, 2019 (in thousands):

Remainder of 2019	$	74,648
2020		266,240
2021		205,616
2022		143,955
2023		98,747
Thereafter		146,129
Total (1)	$	935,335

____________________________

⁽¹⁾Excludes future minimum rental income from assets held for sale.

In addition to minimum rental payments, certain customers reimburse the Company for their pro rata share of specified property operating expenses. Such reimbursements amounted to $24.0 million and $22.9 million for the three months ended September 30, 2019 and 2018, respectively, and $73.0 million and $69.1 million for the nine months ended September 30, 2019 and 2018, respectively. These variable lease payment amounts are included as rental income in the accompanying consolidated statements of income.

Leases accounting for 3.3% of total leased square footage are subject to termination options, of which 1.4% of total leased square footage have termination options exercisable through December 31, 2019. In general, these leases provide for termination payments to us should the termination options be exercised. Certain leases also have an option to extend the terms of the lease. The future minimum rental income in the above table assumes termination options and lease extension options are not exercised.

5. Bank loans

We have an unsecured revolving line of credit (the “Credit Facility”) with Wells Fargo Bank, National Association (“Wells Fargo”). The Credit Facility has a borrowing limit of $250.0 million and expires January 10, 2022. The rate of interest charged on borrowings is based on LIBOR plus 0.80% to LIBOR plus 1.55% depending on the Company’s credit ratings. Currently, the Company’s rate under the Credit Facility is LIBOR plus 0.825%. In addition, the Company is required to pay an annual facility fee ranging from 0.10% to 0.30% of the borrowing limit depending on the Company’s credit ratings (currently 0.125%). As of September 30, 2019, the Company had $50.0 million outstanding on the Credit Facility at an interest rate of 2.88%. Subsequent to September 30, 2019, the Company repaid

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the Credit Facility in full. We had no balance outstanding on our Credit Facility at December 31, 2018. The Company had $518,000 and $691,000 of total unamortized loan origination costs as of September 30, 2019 and December 31, 2018, respectively, which is included in other assets in the accompanying consolidated balance sheets. The Credit Facility requires us to meet certain covenants, all of which we were in compliance with as of September 30, 2019. Interest on outstanding borrowings is payable monthly.

6. Noncontrolling interests

Noncontrolling interests represent (i) PS’s noncontrolling interest in the OP through its ownership of 7,305,355 common partnership units, totaling $213.0 million and $215.1 million at September 30, 2019 and December 31, 2018, respectively, and (ii) the JV Partner’s 5.0% interest in a joint venture owning a 395-unit multifamily apartment complex, totaling $3.0 million at September 30, 2019 and December 31, 2018, respectively.

PS OP Interests

Each common partnership unit receives a cash distribution equal to the dividend paid on our common shares and is redeemable at PS’s option.

If PS exercises its right of redemption, at PSB’s option (a) PS will receive one common share from us for each common partnership unit redeemed, or (b) PS will receive cash from us for each common partnership unit redeemed generally equal to the market value of a common share (as defined in the Operating Partnership Agreement). We can prevent redemptions that we believe would violate either our articles of incorporation or securities laws, cause PSB to no longer qualify as a REIT, or could result in the OP no longer being treated as a partnership for federal tax purposes.

In allocating net income and presenting equity, we treat the common partnership units as if converted to common shares. Accordingly, they receive the same net income allocation per unit as a common share and are adjusted each period to have the same equity per unit as a common share, totaling $7.0 million and $6.7 million for the three months ended September 30, 2019 and 2018, respectively, and $21.6 million and $37.8 million for the nine months ended September 30, 2019 and 2018, respectively.

JV Partner

In conjunction with consolidating the joint venture on January 1, 2018, we recorded noncontrolling interest of $4.0 million related to the JV Partner’s 5.0% interest in a joint venture owning a 395-unit multifamily apartment complex. A total of $14,000 in income and $189,000 in loss was allocated to the JV Partner during the three months ended September 30, 2019 and 2018, respectively, and $27,000 in income and $1.0 million in loss for the nine months ended September 30, 2019 and 2018, respectively. Distributions of $33,000 and $78,000 were paid to the JV Partner during the three and nine months ended September 30, 2019 and none were paid during 2018.

7. Related party transactions

We manage certain industrial, office and retail facilities in the United States for PS under either the “Public Storage” or “PS Business Parks” names (the “PS Management Agreement”). Under PS’s supervision, we coordinate and assist in rental and marketing activities, property maintenance and other operational activities, including the selection of vendors, suppliers, employees and independent contractors. We receive a management fee based upon a percentage of revenues, which is included in “interest and other income” on our consolidated statements of income. Management fee revenues were $71,000 and $93,000 for the three months ended September 30, 2019 and 2018, respectively, and $221,000 and $331,000 for the nine months ended September 30, 2019 and 2018, respectively. We allocate certain operating expenses to PS related to the management of these properties, including payroll and other business expenses, totaling $89,000 and $101,000 for the three months ended September 30, 2019 and 2018, respectively, and $282,000 and $376,000 for the nine months ended September 30, 2019 and 2018, respectively.

The PS Business Parks name and logo are owned by PS and licensed to us under a non-exclusive, royalty-free license agreement. The license can be terminated by either party for any reason with six months written notice.

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PS provides us property management services for the self-storage component of two assets we own and operates them under the “Public Storage” name. Either the Company or PS can cancel the property management contract upon 60 days’ notice. Under our supervision, PS coordinates and assists in rental and marketing activities, and property maintenance and other operational activities, including the selection of vendors, suppliers, employees and independent contractors. Management fee expenses were $25,000 and $24,000 for the three months ended September 30, 2019 and 2018, respectively, and $74,000 and $72,000 for the nine months ended September 30, 2019 and 2018, respectively. Additionally, PS allocated certain operating expenses to us related to the management of these properties totaling $19,000 and $16,000 for the three months ended September 30, 2019 and 2018, respectively, and $56,000 and $51,000 for the nine months ended September 30, 2019 and 2018, respectively. These amounts are included under “cost of operations” on our consolidated statements of income.

Pursuant to a cost sharing agreement, we share certain administrative services, corporate office space, and certain other third party costs with PS which are allocated based upon fair and reasonable estimates of the cost of the services expected to be provided. We reimbursed PS $448,000 and $170,000 for costs PS incurred on our behalf for the three months ended September 30, 2019 and 2018, respectively, and $868,000 and $586,000 for the nine months ended September 30, 2019 and 2018, respectively. PS reimbursed us $9,000 and $10,000 for costs we incurred on their behalf for the three months ended September 30, 2019 and 2018, respectively, and $26,000 and $29,000 for the nine months ended September 30, 2019 and 2018, respectively.

The Company had net amounts due to PS of $152,000 at September 30, 2019 and due from PS of $43,000 at December 31, 2018 for these contracts, as well as certain operating expenses paid by the Company on behalf of PS.

8. Shareholders’ equity

Preferred stock

As of September 30, 2019 and December 31, 2018, the Company had the following series of preferred stock outstanding:

		Earliest Potential	Dividend	Shares	Amount
Series	Issuance Date	Redemption Date	Rate	Outstanding	(in thousands)
Series U	September, 2012	September, 2017	5.75%	9,200	$	230,000
Series V	March, 2013	March, 2018	5.70%	4,400		110,000
Series W	October, 2016	October, 2021	5.20%	7,590		189,750
Series X	September, 2017	September, 2022	5.25%	9,200		230,000
Series Y	December, 2017	December, 2022	5.20%	8,000		200,000
Total				38,390	$	959,750

On January 3, 2018, we completed the redemption of our remaining 6.00% Cumulative Preferred Stock, Series T, at par of $130.0 million.

We paid $13.0 million in distributions to our preferred shareholders for each of the three months ended September 30, 2019 and 2018, and $38.9 million and $39.6 million in distributions to our preferred shareholders for the nine months ended September 30, 2019 and 2018, respectively.

The holders of our preferred stock have general preference rights with respect to liquidation, quarterly distributions and any accumulated unpaid distributions. Holders of our preferred stock will not be entitled to vote on most matters, except under certain conditions. In the event of a cumulative arrearage equal to six quarterly dividends, the holders of the preferred stock will have the right to elect two additional members to serve on the Company’s Board of Directors (the “Board”) until all events of default have been cured. At September 30, 2019, there were no dividends in arrears.

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Except under certain conditions relating to the Company’s qualification as a REIT, the preferred stock is not redeemable prior to the redemption dates noted above. On or after the respective redemption dates, the respective series of preferred stock will be redeemable, at the option of the Company, in whole or in part, at $25.00 per depositary share, plus any accrued and unpaid dividends.

Common stock and units

We paid $28.8 million ($1.05 per common share) and $28.7 million ($1.05 per common share) in distributions to our common shareholders for the three months ended September 30, 2019 and 2018, respectively, and $86.3 million ($3.15 per common share) and $75.1 million ($2.75 per common share) in distributions to our common shareholders for the nine months ended September 30, 2019 and 2018, respectively.

We paid $7.7 million ($1.05 per common unit) in distributions to our common unit holders for each of the three months ended September 30, 2019 and 2018, respectively, and $23.0 million ($3.15 per common unit) and $20.1 million ($2.75 per common unit) in distributions to our common unit holders for the nine months ended September 30, 2019 and 2018, respectively.

Equity stock

The Company is authorized to issue 100.0 million shares of Equity Stock. The Articles of Incorporation provide that Equity Stock may be issued from time to time in one or more series and give the Board broad authority to fix the dividend and distribution rights, conversion and voting rights, redemption provisions and liquidation rights of each series of Equity Stock. As of September 30, 2019 and December 31, 2018, no equity stock had been issued.

9. Commitments and contingencies

We are a party to various legal proceedings and subject to various claims and complaints; however, we believe that the likelihood of these contingencies resulting in a material loss to the Company, either individually or in the aggregate, is remote.

10. Stock compensation

Under various share-based compensation plans, PSB grants non-qualified options to purchase the Company’s common shares at a price not less than fair value on the date of grant, as well as RSUs, to certain directors, officers and key employees.

The service period for stock options and RSUs begins when (i) the Company and the recipient reach a mutual understanding of the key terms of the award, (ii) the award has been authorized, (iii) the recipient is affected by changes in the market price of our stock and (iv) it is probable that any performance conditions will be met, and ends when the stock option or RSUs vests.

We account for forfeitures of share-based payments as they occur by reversing previously amortized share-based compensation expense with respect to grants that are forfeited in the period the employee terminates employment.

We amortize the fair value of awards starting at the beginning of the service period as compensation expense. For awards that are earned solely upon the passage of time and continued service, the entire cost of the award is amortized on a straight-line basis over the service period. For awards with performance conditions, the individual cost of each vesting is amortized separately over each individual service period (the “accelerated attribution” method).

Stock Options

Stock options expire 10 years after the grant date and the exercise price is equal to the closing trading price of our common shares on the grant date. Employees cannot require the Company to settle their award in cash. We use the Black-Scholes option valuation model to estimate the fair value of our stock options on the date of grant.

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For the three and nine months ended September 30, 2019, respectively, we recorded $90,000 and $209,000 in compensation expense related to stock options as compared to $62,000 and $179,000 for the same periods in 2018.

During the nine months ended September 30, 2019, 34,000 stock options were granted, 11,179 options were exercised and 4,000 options were forfeited. A total of 162,236 and 143,415 options were outstanding at September 30, 2019 and December 31, 2018, respectively.

Restricted Stock Units

RSUs granted prior to 2016 are subject to a six-year vesting, with 20% vesting after year two, and 20% vesting after each of the next four years. RSUs granted during and subsequent to 2016 are subject to a five-year vesting at the rate of 20% per year. The grantee receives dividends for each outstanding RSU equal to the per share dividend received by common shareholders. We expense any dividends previously paid upon forfeiture of the related RSU. Upon vesting, the grantee receives common shares equal to the number of vested RSUs, less common shares withheld in exchange for tax withholdings made by the Company to satisfy the grantee’s statutory tax liabilities arising from the vesting. The fair value of our RSUs is determined based upon the applicable closing trading price of our common shares on the date of grant.

Effective March, 2014, the Company entered into a performance-based RSU program, the Senior Management Long-Term Equity Incentive Program for 2014-2017 (“LTEIP”), with certain employees of the Company. Under the LTEIP, the Company established three levels of targeted RSU awards, which would be earned only if the Company achieved one of three defined targets during 2014 to 2017. Under the LTEIP there was an annual award following the end of each of the four years in the program, with the award subject to and based on the achievement of total return targets during the previous year, as well as an award based on achieving total return targets during the cumulative four-year period 2014-2017. In the event the minimum defined target was not achieved for an annual award, the RSUs allocated to be awarded for such year were added to the RSUs that may be received if the four-year target was achieved. All RSU awards under the LTEIP vest in four equal annual installments beginning from the date of award. Compensation expense is recognized based on the RSUs expected to be awarded based on the target level that is expected to be achieved. The compensation expense and RSU counts with respect to the LTEIP are included in the aggregate RSU amounts disclosed above. Senior management earned 145,350 shares of RSUs granted in March, 2018 as the maximum targets were achieved for both the year ended December 31, 2017 and for the cumulative four-year period.

For the three and nine months ended September 30, 2019, respectively, we recorded $813,000 and $2.5 million in compensation expense related to RSUs as compared to $1.0 million and $2.6 million for the same periods in 2018.

During the nine months ended September 30, 2019, 6,400 RSUs were granted, 92,820 RSUs vested and 1,460 RSUs were forfeited. Tax withholdings totaling $6.1 million were made on behalf of employees in exchange for 38,961 common shares withheld upon vesting for the nine months ended September 30, 2019 resulting in the issuance of 53,859 common shares. Tax withholdings totaling $5.0 million were made on behalf of employees in exchange for 43,393 common shares withheld upon vesting for the nine months ended September 30, 2018 resulting in the issuance of 62,030 common shares. A total of 155,410 and 243,290 RSUs were outstanding at September 30, 2019 and December 31, 2018, respectively.

In July, 2019, the Company amended the Retirement Plan for Non-Employee Directors (the “Director Plan”), to increase the maximum shares issued upon retirement for each year served as a director from 8,000 shares to 10,000 shares of common stock. The Company recognizes compensation expense with regard to grants to be issued in the future under the Director Plan over the requisite service period. For the three and nine months ended September 30, 2019, respectively, we recorded $1.2 million and $1.3 million in compensation expense related to these shares as compared to $51,000 and $160,000 for the same periods in 2018.

In April, 2019, we issued 8,000 shares to a director upon retirement with an aggregate fair value of $1.2 million. No shares were issued during the nine months ended September 30, 2018.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements: Forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, are made throughout this Quarterly Report on Form 10-Q. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words “may,” “believes,” “anticipates,” “plans,” “expects,” “seeks,” “estimates,” “intends” and similar expressions are intended to identify forward-looking statements. There are a number of important factors that could cause the results of the Company to differ materially from those indicated by such forward-looking statements, including but not limited to: (a) changes in general economic and business conditions; (b) decreases in rental rates or increases in vacancy rates/failure to renew or replace expiring leases; (c) tenant defaults; (d) the effect of the recent credit and financial market conditions; (e) our failure to maintain our status as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”); (f) the economic health of our customers; (g) increases in operating costs; (h) casualties to our properties not covered by insurance; (i) the availability and cost of capital; (j) increases in interest rates and its effect on our stock price; and (k) other factors discussed under the heading “Part I, Item 1A. Risk Factors” in our annual report on Form 10-K for the year ended December 31, 2018. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved. Moreover, we assume no obligation to update these forward-looking statements to reflect actual results, changes in assumptions or changes in other factors affecting such forward-looking statements, except as required by law.

Critical Accounting Policies and Estimates:

Our accounting policies are described in Note 2 to the consolidated financial statements included in this Form 10-Q. We believe our critical accounting policies relate to income tax expense, accounting for acquired real estate facilities, allowance for doubtful accounts, impairment of long-lived assets, and accrual for uncertain and contingent liabilities, each of which are more fully discussed below.

Income Tax Expense: We have elected to be treated as a REIT, as defined in the Code. As a REIT, we do not incur federal income tax on our “REIT taxable income” that is fully distributed each year (for this purpose, certain distributions paid in a subsequent year may be considered), and if we meet certain organizational and operational rules. We believe we have met these REIT requirements for all periods presented herein. Accordingly, we have recorded no federal income tax expense related to our “REIT taxable income.”

Our evaluation that we have met the REIT requirements could be incorrect, because compliance with the tax rules requires factual determinations, and circumstances we have not identified could result in noncompliance with the tax requirements in current or prior years. For any taxable year that we fail to qualify as a REIT and for which applicable statutory relief provisions did not apply, we would be taxed at the regular corporate rates on all of our taxable income for at least that year and the ensuing four years, we could be subject to penalties and interest, and our net income would be materially different from the amounts shown in our consolidated financial statements.

Accounting for Acquired Real Estate Facilities: We estimate the fair value of land, buildings, intangible assets and intangible liabilities for purposes of allocating purchase price. Such estimates, which are determined with the assistance of third-party valuation specialists where appropriate, are based upon many assumptions and judgments, including, but not limited to, (i) market rates of return and capitalization rates on real estate and intangible assets, (ii) building and material cost levels, (iii) estimated market rent levels, (iv) future revenue growth rates, (v) future cash flows from the real estate and the existing customer base and (vi) comparisons of the acquired underlying land parcels to recent land transactions. Others could come to materially different conclusions as to the estimated fair values, which could result in different depreciation and amortization expense, rental income, gains and losses on sale of real estate assets, and real estate and intangible assets.

Accounting for Customer Receivable Balances, including Deferred Rent Receivable Balances: Customer receivables consist primarily of amounts due for contractual lease payments, reimbursements of common area maintenance expenses, property taxes and other expenses recoverable from customers. Deferred rent receivables

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represent the amount that the cumulative straight-line rental income recorded to date exceeds cash rents billed to date under the lease agreement. The Company writes off uncollectible customer receivable balances, including deferred rent receivable balances, in the period such receivable balances are deemed uncollectible. Significant bad debt losses could materially impact our net income.

Impairment of Long-Lived Assets: The analysis of impairment of our long-lived assets involves identification of indicators of impairment, projections of future operating cash flows and estimates of fair values or selling prices, all of which require significant judgment and subjectivity. Others could come to materially different conclusions. In addition, we may not have identified all current facts and circumstances that may affect impairment. Any unidentified impairment loss, or change in conclusions, could have a material adverse impact on our net income.

Accrual for Uncertain and Contingent Liabilities: We accrue for certain contingent and other liabilities that have significant uncertain elements, such as property taxes, performance bonuses and other operating expenses, as well as other legal claims and disputes involving customers, employees, governmental agencies and other third parties. We estimate such liabilities based upon many factors such as past trends and our evaluation of likely outcomes. However, the estimates of known liabilities could be incorrect or we may not be aware of all such liabilities, in which case our accrued liabilities and net income could be materially different.

Business Overview

Our overall operating results are impacted primarily by the performance of our existing real estate facilities, which at September 30, 2019 were comprised of 28.8 million rentable square feet of primarily multi-tenant industrial, flex and office properties concentrated in six states and a 95.0% interest in a 395-unit multifamily apartment complex. Our multi-tenant commercial properties are located in markets that have experienced long-term economic growth with a particular concentration on small- and medium-size customers. Accordingly, a significant degree of management attention is paid to maximizing the cash flow from our existing real estate portfolio. Also, our strong and conservative capital structure allows us the flexibility to use debt and equity capital prudently to fund our growth, which allows us to acquire properties we believe will create long-term value. From time to time we sell properties which no longer fit the Company’s strategic objectives.

Existing Real Estate Facilities: The operating results of our existing real estate facilities are substantially influenced by demand for rental space within our properties and our markets, which impacts occupancy, rental rates and capital expenditure requirements. We strive to maintain high occupancy levels while increasing rental rates and minimizing capital expenditures when market conditions allow, although the Company may decrease rental rates in markets where conditions require. Management’s initiatives and strategies with respect to our existing real estate facilities, which includes incentivizing our personnel to maximize the return on investment for each lease transaction and providing a superior level of service to our customers, are described in more detail in our Annual Report on Form 10-K for the year ended December 31, 2018.

Acquisitions of Real Estate Facilities: We seek to grow our portfolio through acquisitions of facilities generally consistent with the Company’s focus on owning concentrated business parks with easily configurable space and in markets and product types with favorable long-term return potential.

On September 5, 2019, we acquired a multi-tenant industrial park comprised of approximately 543,000 rentable square feet in Santa Fe Springs, California, for a total purchase price of $104.3 million, inclusive of capitalized transaction costs. The park consists of ten buildings and was 100.0% occupied as of the date of the acquisition. Our Los Angeles industrial portfolio grew to 2.2 million square feet as a result of this acquisition.

On April 18, 2019, we acquired a multi-tenant industrial park comprised of approximately 74,000 rentable square feet in Signal Hill, California, for a total purchase price of $13.8 million, inclusive of capitalized transaction costs. The park consists of eight buildings and was 98.4% occupied as of the date of the acquisition. The eight buildings are located in the Signal Hill industrial submarket where we already own five industrial parks totaling 268,000 square feet.

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On June 8, 2018, we acquired two multi-tenant industrial parks aggregating 1.1 million rentable square feet in Springfield, Virginia, for a purchase price of $143.8 million, inclusive of capitalized transaction costs. The portfolio consists of 19 buildings and was 76.1% occupied as of the date of acquisition. The 19 buildings are located in the Springfield/Newington industrial submarket where we already own three industrial parks totaling 606,000 square feet.

We continue to seek to acquire additional facilities in our existing markets and generally in close proximity to our existing facilities; however, there can be no assurance that we will acquire additional facilities that meet our risk-adjusted return and underwriting requirements.

Development or Redevelopment of Real Estate Facilities: We may seek to redevelop our existing real estate. We own a large contiguous block of real estate (628,000 rentable square feet on 44.5 acres of land) located within an area known as The Mile in Tysons, Virginia. We demolished one of our existing office buildings at The Mile and built a 395-unit multifamily building (“Highgate”) at a cost, including the estimated fair value of existing land, of $115.4 million.

While multifamily real estate is not a core asset class for us, we determined that multifamily real estate represented a unique opportunity and the highest and best use of that parcel. We have partnered through a joint venture with a local developer and operator of multifamily properties in order to leverage their development and operational experience. See “Analysis of Net Income – Multifamily” below and Note 3 to our consolidated financial statements for more information on Highgate.

We have an additional 123,000 square foot vacant office building located within The Mile that we are seeking to demolish in order to construct another multifamily property on the parcel. This parcel is reflected on our consolidated balance sheets as land and building held for development. The scope and timing of development of this site is subject to a variety of contingencies, including approval of entitlements. We do not expect that development will commence any earlier than mid-2020.

Sales of Real Estate Facilities: We may from time to time sell individual real estate facilities based on market conditions, fit with our existing portfolio, evaluation of long-term potential returns of markets or product types, or other reasons.

On March 5, 2018, we sold Corporate Pointe Business Park, a park consisting of five multi-tenant office buildings totaling 161,000 square feet located in Orange County, California, for net sale proceeds of $41.7 million, which resulted in a gain of $26.8 million. On April 18, 2018, we sold Orange County Business Center, a park consisting of five multi-tenant office buildings totaling 437,000 square feet located in Orange County, California, for net sale proceeds of $73.3 million, which resulted in a gain of $50.6 million. On April 30, 2018, we sold Northgate Business Park, a park consisting of seven multi-tenant flex buildings totaling 194,000 square feet located in Dallas, Texas, for net sale proceeds of $11.8 million, which resulted in a gain of $7.9 million.

Subsequent to September 30, 2019, we sold 1.3 million rentable square feet of flex and office business parks located in Rockville and Silver Spring, Maryland, for a gross sales price of $148.8 million. The operations of the facilities we sold are presented below under “assets sold or held for sale.”

Certain Factors that May Impact Future Results

Impact of Inflation: Although inflation has not been significant in recent years, an increase in inflation could impact our future results, and the Company continues to seek ways to mitigate its potential impact. A substantial portion of the Company’s leases require customers to pay operating expenses, including real estate taxes, utilities and insurance, as well as increases in common area expenses, partially reducing the Company’s exposure to inflation during each lease’s respective lease period.

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Regional Concentration: Our portfolio is concentrated in eight regions, in six states. We have chosen to concentrate in these regions because we believe they have characteristics which enable them to be competitive economically, such as above average population growth, job growth, higher education levels and personal income. Changes in economic conditions in these regions in the future could impact our future results.

Industry and Customer Concentrations: We seek to minimize the risk of industry or customer concentrations. As of September 30, 2019, excluding assets held for sale, leases from our top 10 customers comprised 8.8% of our annualized rental income, with only one customer, the U.S. Government (3.9%), representing more than 1%. In terms of industry concentration, 19.3% of our annualized rental income comes from business services, 12.8% from warehouse, distribution, transportation and logistics, and 10.9% from computer hardware, software and related services. No other industry group represents more than 10% of our annualized rental income.

Customer credit risk: We have historically experienced a low level of write-offs of uncollectible rents, with less than 0.5% of rental income written off in any year over the last seven years. However, there can be no assurance that write-offs may not increase because there is inherent uncertainty in a customer’s ability to continue paying rent and meet its full lease obligation. As of October 21, 2019, we had 15,000 square feet of leased space occupied by one customer that is protected by Chapter 11 of the U.S. Bankruptcy Code. From time to time, customers contact us, requesting early termination of their lease, reductions in space leased, or rent deferment or abatement, which we are not obligated to grant but will consider under certain circumstances.

Net Operating Income

We utilize net operating income (“NOI”), a measure that is not defined in accordance with U.S. generally accepted accounting principles (“GAAP”), to evaluate the operating performance of our business parks. We define NOI as rental income less adjusted cost of operations. Adjusted cost of operations represents cost of operations, excluding stock compensation expense, which can vary significantly period to period based upon the performance of the company.

We believe NOI assists investors in analyzing the performance and value of our business parks by excluding (i) corporate overhead (i.e., general and administrative expense) because it does not relate to the direct operating performance of our business parks (ii) depreciation and amortization expense because it does not accurately reflect changes in the fair value of our business parks and (iii) stock compensation expense because this expense item can vary significantly from period to period and thus impact comparability across periods. The Company’s calculation of NOI and adjusted cost of operations may not be comparable to those of other companies and should not be used as an alternative to performance measures calculated in accordance with GAAP.

Beginning January 1, 2019, the Company has recorded our divisional vice presidents’ compensation costs within general and administrative expense, as we determined that the nature of these individuals’ responsibilities is more consistent with corporate oversight as opposed to direct property operations. As a result of this change, we have reclassified our divisional vice presidents’ compensation costs totaling $457,000 for the three months ended September 30, 2018, consisting of $305,000 of compensation costs and $152,000 of stock compensation expense, and compensation costs totaling $1.5 million for the nine months ended September 30, 2018, consisting of $995,000 of compensation costs and $466,000 of stock compensation expense, from cost of operations into general and administrative expense on our consolidated statements of income in the three and nine months ended September 30, 2018 in order to conform to the current periods’ presentation.

See “Analysis of net income” below for reconciliations of each of these measures to their closest analogous GAAP measure from our consolidated statements of income.

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Results of Operations

Operating Results Overview: Three and Nine Months Ended September 30, 2019 and 2018

For the three months ended September 30, 2019, net income allocable to common shareholders was $26.3 million or $0.96 per diluted share, compared to $25.1 million or $0.92 per diluted share for the same period in 2018. The increase was mainly due to a $2.9 million increase in NOI with respect to the Company’s real estate facilities. The increase in NOI includes a $2.4 million, or 3.6%, increase attributable to our Same Park facilities (described below) due to higher rental income per occupied square foot, combined with increased NOI from our Non-Same Park and multifamily assets, partially offset by reduced NOI generated from assets held for sale as of September 30, 2019.

For the nine months ended September 30, 2019, net income allocable to common shareholders was $81.2 million or $2.95 per diluted share, compared to $141.4 million or $5.16 per diluted share for the same period in 2018. The decrease was mainly due to the gain on sale of real estate facilities sold during 2018 that did not recur in 2019 partially offset by an $11.1 million increase in NOI with respect to the Company’s real estate facilities. The increase in NOI includes an $8.6 million, or 4.4%, increase attributable to our Same Park facilities due to higher rental income per occupied square foot, combined with increased NOI from our Non-Same Park and multifamily assets, partially offset by reduced NOI generated from facilities sold in 2018.

Analysis of Net Income

Our net income is comprised primarily of our real estate operations, depreciation and amortization expense, general and administrative expense, interest and other income, interest and other expenses and gain on sale of real estate facilities.

We segregate our real estate activities into (a) same park operations, representing all operating properties acquired prior to January 1, 2017, comprising 25.8 million rentable square feet of our 28.8 million in rentable square feet at September 30, 2019 (the “Same Park” facilities), (b) non-same park operations, representing those facilities we own that were acquired after January 1, 2017 (the “Non-Same Park” facilities), (c) multifamily operations and (d) assets sold or held for sale, representing approximately 1.3 million square feet of assets held for sale as of September 30, 2019 as well as operating results related to 899,000 square feet of assets sold in 2018.

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The table below sets forth the various components of our net income (in thousands):

	For the Three Months					For The Nine Months
	Ended September 30,					Ended September 30,
	2019		2018		Change	2019		2018		Change
Rental income
Same Park (1)	$	96,234	$	92,356	4.2%	$	287,872	$	275,976	4.3%
Non-Same Park		3,598		2,355	52.8%		9,508		2,982	218.8%
Multifamily		2,519		1,895	32.9%		7,492		5,057	48.2%
Assets sold or held for sale (2)		5,713		7,202	(20.7%)		18,799		25,376	(25.9%)
Total rental income		108,064		103,808	4.1%		323,671		309,391	4.6%
Cost of operations (3)
Adjusted cost of operations (4)
Same Park		27,724		26,252	5.6%		83,113		79,840	4.1%
Non-Same Park		1,137		753	51.0%		3,304		977	238.2%
Multifamily		1,045		1,043	0.2%		3,118		3,013	3.5%
Assets sold or held for sale (2)		2,253		2,793	(19.3%)		7,076		9,556	(26.0%)
Stock compensation expense (5)		309		356	(13.2%)		910		1,063	(14.4%)
Total cost of operations		32,468		31,197	4.1%		97,521		94,449	3.3%
Net operating income (6)
Same Park		68,510		66,104	3.6%		204,759		196,136	4.4%
Non-Same Park		2,461		1,602	53.6%		6,204		2,005	209.4%
Multifamily		1,474		852	73.0%		4,374		2,044	114.0%
Assets sold or held for sale (2) (7)		3,460		4,409	(21.5%)		11,723		15,820	(25.9%)
Stock compensation expense (5)		(309)		(356)	(13.2%)		(910)		(1,063)	(14.4%)
Depreciation and amortization expense		(26,220)		(25,207)	4.0%		(75,863)		(73,505)	3.2%
General and administrative expense (3)		(4,051)		(2,882)	40.6%		(10,111)		(8,560)	18.1%
Interest and other income		1,384		488	183.6%		2,766		1,066	159.5%
Interest and other expense		(199)		(167)	19.2%		(484)		(499)	(3.0%)
Gain on sale of real estate facilities		—		—	—		—		85,283	(100.0%)
Net income	$	46,510	$	44,843	3.7%	$	142,458	$	218,727	(34.9%)

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⁽¹⁾Same Park rental income includes lease buyout income of $183,000 and $213,000 for the three months ended September 30, 2019 and 2018, respectively, and $1.1 million and $463,000 for the nine months ended September 30, 2019 and 2018, respectively.

⁽²⁾Amounts for the three and nine months ended September 30, 2019 reflect the operating results related to 1.3 million square feet of flex and office assets held for sale as of September 30, 2019; amounts shown for the three and nine months ended September 30, 2018 reflect the operating results related to 1.3 million square feet of flex and office assets held for sale as of September 30, 2019 as well as operating results related to 899,000 square feet of assets sold in 2018.

⁽³⁾We have reclassified our divisional vice presidents’ compensation costs totaling $457,000 and $1.5 million for the three and nine months ended September 30, 2018, respectively, from cost of operations into general and administrative expense on our consolidated statements of income in the three and nine months ended September 30, 2018 in order to conform to the current periods’ presentation. Of this amount, $152,000 and $466,000 of stock compensation expense for the three and nine months, respectively, had previously been excluded from NOI.

⁽⁴⁾Adjusted cost of operations excludes the impact of stock compensation expense.

⁽⁵⁾Stock compensation expense, as shown here, represents stock compensation expense for employees whose compensation expense is recorded in cost of operations. Note that stock compensation expense attributable to our executive management team (including divisional vice presidents) and other corporate employees is recorded within general and administrative expense.

⁽⁶⁾Net operating income represents rental income less adjusted cost of operations.

⁽⁷⁾NOI from assets held for sale was $3.5 million and $4.2 million for the three months ended September 30, 2019 and 2018, respectively, and $11.7 million and $12.8 million for the nine months ended September 30, 2019 and 2018, respectively. The three and nine months 2018 remaining NOI balances relate to assets sold during 2018.

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Rental income increased $4.3 million and $14.3 million for the three and nine months ended September 30, 2019 as compared to the same periods in 2018 due primarily from our Same Park facilities and multifamily asset combined with rental income from our Non-Same Park facilities acquired during the second half of 2018 and in 2019 partially offset by a loss of rental income from assets sold and held for sale.

Cost of operations increased $1.3 million and $3.1 million for the three and nine months ended September 30, 2019 as compared to the same periods in 2018. The increase was primarily from our Same Park facilities combined with adjusted cost of operations from our Non-Same Park facilities acquired during the second half of 2018 and in 2019 partially offset by a loss of adjusted cost of operations from assets sold and held for sale.

Net income increased $1.7 million and decreased $76.3 million for the three and nine months ended September 30, 2019 as compared to the same periods in 2018. The three month increase was due primarily to higher NOI partially offset by higher general and administrative expense, while the nine month decrease was due primarily to the gain on sale of office product in Orange County, California and flex product in Dallas, Texas during 2018 combined with higher general and administrative expense partially offset by higher NOI.

Same Park Facilities

The Same Park facilities are those that we have owned and operated since January 1, 2017. We evaluate the operations of these facilities to provide an informative view of how the Company’s portfolio has performed over comparable periods. We believe that investors and analysts use Same Park information in a similar manner.

The following table summarizes the historical operating results of these facilities and certain statistical information related to leasing activity in the three and nine months ended September 30, 2019 and 2018 (in thousands, except per square foot data):

	For The Three Months					For The Nine Months
	Ended September 30,					Ended September 30,
	2019		2018		Change	2019		2018		Change
Rental income (1)	$	96,234	$	92,356	4.2%	$	287,872	$	275,976	4.3%
Adjusted cost of operations (2)
Property taxes		10,302		9,726	5.9%		30,638		29,238	4.8%
Utilities		5,309		5,438	(2.4%)		14,825		15,010	(1.2%)
Repairs and maintenance		5,940		5,358	10.9%		17,666		16,485	7.2%
Snow removal		—		—	—		1,049		655	60.2%
Other expenses		6,173		5,730	7.7%		18,935		18,452	2.6%
Total		27,724		26,252	5.6%		83,113		79,840	4.1%
NOI	$	68,510	$	66,104	3.6%	$	204,759	$	196,136	4.4%
Selected Statistical Data
NOI margin (3)		71.2%		71.6%	(0.6%)		71.1%		71.1%	-
Weighted average square foot occupancy		94.7%		95.1%	(0.4%)		94.6%		94.7%	(0.1%)
Revenue per occupied square foot (4)	$	15.74	$	15.05	4.6%	$	15.72	$	15.05	4.5%
Revenue per available foot (RevPAF) (5)	$	14.91	$	14.31	4.2%	$	14.87	$	14.26	4.3%

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⁽¹⁾Same Park rental income includes lease buyout income of $183,000 and $213,000 for the three months ended September 30, 2019 and 2018, respectively, and $1.1 million and $463,000 for the nine months ended September 30, 2019 and 2018, respectively.

⁽²⁾We have reclassified divisional vice presidents’ compensation costs totaling $281,000 and $936,000 for the three and nine months ended September 30, 2018, respectively, from adjusted cost of operations into general and administrative expense in order to conform to the current periods’ presentation. Non-cash compensation expense for our divisional vice presidents, which totaled $143,000 and $445,000 for the three and nine months ended September 30, 2018, respectively, had previously been excluded from adjusted cost of operations.

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⁽³⁾NOI margin is computed by dividing NOI by rental income.

⁽⁴⁾Revenue per occupied square foot is computed by dividing rental income during the period by weighted average occupied square feet during the same period. For the three and nine month periods ending September 30, 2019 and 2018, rental income amounts have been annualized.

⁽⁵⁾Revenue per available square foot is computed by dividing rental income during the period by weighted average available square feet. For the three and nine month periods ending September 30, 2019 and 2018, rental income amounts have been annualized.

Analysis of Same Park Rental Income

Rental income generated by our Same Park facilities increased 4.2% and 4.3% for the three and nine months ended September 30, 2019, respectively, as compared to the same periods in 2018. The increases were due primarily to higher rental rates charged to our customers, as revenue per occupied square foot increased 4.6% and 4.5% in the three and nine months ended September 30, 2019, respectively, compared to the same periods in 2018.

We believe that high occupancy levels help maximize our rental income. Accordingly, we seek to maintain a weighted average occupancy over 90%.

During the first nine months of 2019 and 2018, most markets continued to reflect conditions favorable to landlords allowing for stable occupancy as well as increasing cash rental rates. With the exception of Northern Virginia and Suburban Maryland markets, new cash rental rates for the Company improved over expiring cash rental rates on executed leases as economic conditions and tenant demand remained robust.

Our future revenue growth will come primarily from contractual rental increases as well as from potential increases in market rents allowing us to increase rent levels when leases are either renewed with existing customers or re-leased to new customers. The following table sets forth the expirations of existing leases in our Same Park portfolio over the next five years based on lease data at September 30, 2019 (dollars and square feet in thousands):

								Percent of
			Rentable Square		Percent of	Annualized Rental		Annualized Rental
	Number of		Footage Subject to		Total Leased	Income Under		Income Represented
Year of Lease Expiration	Customers		Expiring Leases		Square Footage	Expiring Leases		by Expiring Leases
Remainder of 2019		708		2,083	8.5%	$	35,199		8.4%
2020		1,548		5,577	22.7%		89,525		21.4%
2021		1,201		4,720	19.3%		79,287		19.0%
2022		600		4,258	17.4%		74,947		17.9%
2023		331		2,756	11.2%		45,709		10.9%
Thereafter		329		5,134	20.9%		93,506		22.4%
Total		4,717		24,528	100.0%	$	418,173		100.0%

During the three and nine months ended September 30, 2019, we leased approximately 1.9 million and 5.0 million in rentable square feet, respectively, to new and existing customers at an average of 6.5% and 8.6% increases in cash rental rates over the previous rates, respectively. Renewals of leases with existing customers represented 64.9% of our leasing activity for the nine months ended September 30, 2019. See “Analysis of Same Park Market Trends” below for further analysis of such data on a by market basis.

Our ability to re-lease space on expired leases in a way that minimizes vacancy periods and achieves market rental rates will depend upon market conditions in the specific submarkets in which each of our properties are located.

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29

Analysis of Same Park Adjusted Cost of Operations

Adjusted cost of operations generated by the Same Park facilities increased 5.6% and 4.1% for the three and nine months ended September 30, 2019, respectively, as compared to the same periods in the prior year. The three month increase was due primarily to higher repairs and maintenance costs, higher property tax expense and higher other expenses, while the nine month increase was due primarily to an increase in snow removal costs, higher property tax expense, higher repairs and maintenance costs and higher other expenses.

Property taxes increased 5.9% and 4.8% for the three and nine months ended September 30, 2019, respectively, as compared to the same periods in the prior year. The increases were due primarily to higher assessed values. We expect property tax growth in the future due primarily to higher assessed values.

Utilities are dependent primarily upon energy prices and usage levels. Changes in usage levels are driven primarily by weather and temperature. Utilities decreased 2.4% and 1.2% during the three and nine months ended September 30, 2019, respectively, as compared to the same periods in the prior year. It is difficult to estimate future utility costs, because weather, temperature and energy prices are volatile and not predictable. However, based upon current trends and expectations regarding commercial electricity rates, we expect inflationary increases in rates in the future.

Repairs and maintenance increased 10.9% and 7.2% for the three and nine months ended September 30, 2019, respectively, as compared to the same periods in the prior year. Repairs and maintenance costs are dependent upon many factors including weather conditions, which can impact repair and maintenance needs, inflation in material and labor costs and random events, and as a result are not readily predictable.

Snow removal increased 60.2% during the nine months ended September 30, 2019 as compared to the same period in the prior year. The nine month increase was due to colder weather during the first quarter of 2019 in our Northern Virginia and Suburban Maryland markets compared to the same period in 2018. Snow removal costs are weather dependent and therefore not predictable.

Other expenses increased 7.7% and 2.6% for the three and nine months ended September 30, 2019, respectively, as compared to the same periods in the prior year. These expenses are comprised of on site and supervisory personnel, property insurance and other expenses incurred in the operation of our properties. The three and nine month increases were primarily due to a property insurance rate increase for the policy period from 2019 to 2020 and higher than average professional fees tied to typical tenant related matters. We expect increases in other expenses for the remainder of 2019 that are similar to the increases in the nine month period ended September 30, 2019.

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Same Park Quarterly Trends

The following table sets forth historical quarterly data related to the operations of the Same Park facilities for rental income, adjusted cost of operations, occupancies and annualized revenue per occupied square foot (in thousands, except per square foot data):

	For the Three Months Ended
	March 31		June 30		September 30		December 31
Rental income
2019	$	95,693	$	95,945	$	96,234	$	—
2018	$	91,678	$	91,942	$	92,356	$	92,459
Adjusted cost of operations (1)
2019	$	28,442	$	26,947	$	27,724	$	—
2018	$	27,222	$	26,366	$	26,252	$	25,495
NOI (1)
2019	$	67,251	$	68,998	$	68,510	$	—
2018	$	64,456	$	65,576	$	66,104	$	66,964
Weighted average square foot occupancy
2019		94.7%		94.3%		94.7%		—
2018		94.5%		94.5%		95.1%		95.4%
Annualized revenue per occupied square foot
2019	$	15.66	$	15.77	$	15.74	$	—
2018	$	15.04	$	15.08	$	15.05	$	15.01
RevPAF
2019	$	14.83	$	14.87	$	14.91	$	—
2018	$	14.21	$	14.25	$	14.31	$	14.33

____________________________

⁽¹⁾To conform to current period presentation, we have reclassified divisional vice presidents’ compensation costs totaling $366,000, $289,000, $281,000 and $281,000 for each of the three months ended March 31, 2018, June 30, 2018, September 30, 2018 and December 31, 2018, respectively, from adjusted cost of operations into general and administrative expense. Non-cash compensation expense for our divisional vice presidents had previously been excluded from adjusted cost of operations.

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Analysis of Same Park Market Trends

The following tables set forth rental income, adjusted cost of operations, weighted average occupancy and annualized revenue per occupied square foot data in our Same Park facilities (in thousands, except per square foot data):

		For The Three Months				For The Nine Months
		Ended September 30,				Ended September 30,
Region		2019		2018	Change	2019			2018	Change
Geographic Data on Same Park
Rental income
Northern California (7.2 million feet)	$	26,570	$	25,055	6.0%	$	79,409	$	74,076	7.2%
Southern California (3.3 million feet)		13,864		13,433	3.2%		41,013		39,591	3.6%
Dallas (2.9 million feet)		8,466		7,674	10.3%		25,467		22,901	11.2%
Austin (2.0 million feet)		7,688		7,260	5.9%		23,102		22,505	2.7%
Northern Virginia (3.9 million feet)		18,321		18,460	(0.8%)		55,453		55,649	(0.4%)
South Florida (3.9 million feet)		10,999		10,436	5.4%		32,615		31,467	3.6%
Suburban Maryland (1.2 million feet) (1)		5,823		5,689	2.4%		17,517		16,959	3.3%
Seattle (1.4 million feet)		4,503		4,349	3.5%		13,296		12,828	3.6%
Total Same Park (25.8 million feet)		96,234		92,356	4.2%		287,872		275,976	4.3%
Adjusted cost of operations
Northern California		6,337		5,639	12.4%		18,167		16,875	7.7%
Southern California		3,632		3,438	5.6%		10,669		9,993	6.8%
Dallas		2,980		2,734	9.0%		8,818		8,340	5.7%
Austin		2,844		2,691	5.7%		8,454		8,032	5.3%
Northern Virginia		5,944		5,948	(0.1%)		18,930		18,917	0.1%
South Florida		2,914		2,720	7.1%		8,799		8,349	5.4%
Suburban Maryland (1)		1,994		1,988	0.3%		6,095		6,070	0.4%
Seattle		1,079		1,094	(1.4%)		3,181		3,264	(2.5%)
Total Same Park		27,724		26,252	5.6%		83,113		79,840	4.1%
Net operating income
Northern California		20,233		19,416	4.2%		61,242		57,201	7.1%
Southern California		10,232		9,995	2.4%		30,344		29,598	2.5%
Dallas		5,486		4,940	11.1%		16,649		14,561	14.3%
Austin		4,844		4,569	6.0%		14,648		14,473	1.2%
Northern Virginia		12,377		12,512	(1.1%)		36,523		36,732	(0.6%)
South Florida		8,085		7,716	4.8%		23,816		23,118	3.0%
Suburban Maryland (1)		3,829		3,701	3.5%		11,422		10,889	4.9%
Seattle		3,424		3,255	5.2%		10,115		9,564	5.8%
Total Same Park	$	68,510	$	66,104	3.6%	$	204,759	$	196,136	4.4%
Weighted average square foot occupancy
Northern California		97.1%		97.9%	(0.8%)		96.5%		97.8%	(1.3%)
Southern California		95.1%		98.1%	(3.1%)		95.1%		97.9%	(2.9%)
Dallas		91.5%		89.5%	2.2%		92.2%		88.7%	3.9%
Austin		91.3%		91.4%	(0.1%)		91.1%		92.9%	(1.9%)
Northern Virginia		94.3%		94.1%	0.2%		94.2%		92.4%	1.9%
South Florida		95.6%		96.8%	(1.2%)		95.5%		96.4%	(0.9%)
Suburban Maryland (1)		90.1%		85.1%	5.9%		89.9%		83.4%	7.8%
Seattle		95.5%		97.5%	(2.1%)		95.6%		97.9%	(2.3%)
Total Same Park		94.7%		95.1%	(0.4%)		94.6%		94.7%	(0.1%)
Annualized revenue per occupied square foot
Northern California	$	15.11	$	14.13	6.9%	$	15.15	$	13.94	8.7%
Southern California	$	17.77	$	16.69	6.5%	$	17.52	$	16.42	6.7%
Dallas	$	12.81	$	11.87	7.9%	$	12.75	$	11.92	7.0%
Austin	$	17.14	$	16.18	5.9%	$	17.22	$	16.45	4.7%
Northern Virginia	$	19.83	$	20.02	(0.9%)	$	20.02	$	20.50	(2.3%)
South Florida	$	11.90	$	11.15	6.7%	$	11.78	$	11.25	4.7%
Suburban Maryland (1)	$	20.49	$	21.21	(3.4%)	$	20.60	$	21.47	(4.1%)
Seattle	$	13.56	$	12.84	5.6%	$	13.35	$	12.57	6.2%
Total Same Park	$	15.74	$	15.05	4.6%	$	15.72	$	15.05	4.5%

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⁽¹⁾Approximately 1.3 million square feet of flex and office business parks located in Rockville and Silver Spring, Maryland, have been classified as held for sale as of September 30, 2019. As such, these parks have been removed from Same Park results for the three and nine months ended September 30, 2019 and 2018.
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As noted above, our past revenue growth has come from contractual annual rent increases, as well as re-leasing of space at rates above outgoing rental rates. We believe the percentage difference between outgoing billed rent inclusive of estimated expense recoveries and incoming billed rent inclusive of estimated expense recoveries for leases executed (the “Cash Rental Rate Change”) is useful in understanding trends in current market rates relative to our existing lease rates. The following tables summarize the Cash Rental Rate Change and other key statistical information with respect to the Company’s leasing production for its Same Park facilities, on a regional basis, for the three and nine months ended September 30, 2019 (square feet in thousands):

	For the Three Months Ended September 30, 2019
	Square			Transaction
	Footage	Customer		Costs per	Cash Rental
Regions	Leased	Retention		Executed Foot	Rate Change (1)
Northern California	490	79.4%	$	2.09	18.3%
Southern California	285	67.3%	$	1.80	5.8%
Dallas	216	58.3%	$	5.74	5.9%
Austin	110	70.2%	$	4.30	8.1%
Northern Virginia	335	72.1%	$	9.63	(8.8%)
South Florida	217	66.7%	$	1.18	13.2%
Suburban Maryland	70	89.4%	$	4.23	(0.5%)
Seattle	188	91.3%	$	1.04	16.3%
Total	1,911	73.5%	$	3.78	6.5%

	For the Nine Months Ended September 30, 2019
	Square			Transaction
	Footage	Customer		Costs per	Cash Rental
Regions	Leased	Retention		Executed Foot	Rate Change (1)
Northern California	1,217	63.3%	$	2.05	18.9%
Southern California	905	68.1%	$	1.84	8.5%
Dallas	650	63.0%	$	5.51	7.3%
Austin	268	69.9%	$	4.36	7.0%
Northern Virginia	844	75.0%	$	7.66	(3.7%)
South Florida	664	49.9%	$	1.86	13.4%
Suburban Maryland	144	66.0%	$	8.09	(3.8%)
Seattle	340	78.4%	$	0.99	16.8%
Total	5,032	65.9%	$	3.60	8.6%

____________________________

⁽¹⁾Cash Rental Rate Change is computed by taking the percentage difference between the incoming initial billed monthly cash rental rates inclusive of estimated expense recoveries (excluding the impact of certain items such as concessions or future escalators) on new leases or extensions executed in the period, and the outgoing monthly cash rental rates inclusive of estimated expense recoveries last billed on the previous lease for that space. Leases executed on spaces vacant for more than the preceding twelve months have been excluded from this measure.

During the first nine months of 2019 and 2018, most markets, with the exception of Northern Virginia and Suburban Maryland, continued to reflect favorable conditions allowing for stable occupancy as well as increasing cash rental rates. In Northern Virginia and Suburban Maryland, cash rental rates on executed leases declined 3.7% and 3.8%, respectively, for the nine months ended September 30, 2019, reflecting continued soft market conditions that have persisted for several years due to, among other factors, federal government downsizing. To the extent that such trends continue in these markets, which comprised 25.3% of our Same Park rental income for the nine months ended September 30, 2019 and 18.8% of square feet expiring through December 31, 2020, we may continue to face reduced rental income in these markets.

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Non-Same Park facilities: The table below reflects the assets comprising our Non-Same Park facilities (in thousands):

			Purchase		Square	Occupancy at	Occupancy at
Property	Date Acquired	Location	Price		Feet	Acquisition	September 30, 2019
Hathaway Industrial Park	September, 2019	Santa Fe Springs, CA	$	104,330	543	100.0%	100.0%
Walnut Avenue Business Park	April, 2019	Signal Hill, CA		13,824	74	98.4%	98.3%
Northern Virginia and Fullerton	June, 2018	Lorton and Springfield,
Road Industrial Parks		VA		143,766	1,057	76.1%	89.4%
Total			$	261,920	1,674	84.8%	93.3%

We believe that our management and operating infrastructure typically allows us to generate higher NOI from newly acquired real estate facilities than was achieved by the previous owners. However, it can take 24 or more months for us to fully achieve the higher NOI, and the ultimate levels of NOI to be achieved can be affected by changes in general economic conditions. As a result, there can be no assurance that we will achieve our expectations with respect to newly acquired real estate facilities.

We expect the Non-Same Park facilities to continue to provide increased NOI in 2019 as these facilities increase in occupancy.

Multifamily: As of September 30, 2019, we have a 95.0% interest in Highgate, a 395-unit apartment complex. On January 1, 2018, we began to consolidate our joint venture due to changes to the joint venture agreement that gave the Company control of the joint venture.

During the three months ended September 30, 2019, Highgate generated $1.5 million of NOI, consisting of $2.5 million in rental income and $1.0 million in adjusted cost of operations compared to $852,000 of NOI, consisting of $1.9 million in rental income and $1.0 million in adjusted cost of operations for the same period in 2018. During the nine months ended September 30, 2019, Highgate generated $4.4 million of NOI, consisting of $7.5 million in rental income and $3.1 million in adjusted cost of operations compared to $2.0 million of NOI, consisting of $5.1 million in rental income and $3.0 million in adjusted cost of operations for the same period in 2018. Weighted average occupancy was 95.6% and 95.3% for the three and nine months ended September 30, 2019, respectively, compared to 87.8% and 73.1% for the three and nine months ended September 30, 2018, respectively.

The following table summarizes Highgate’s project timeline and certain statistics as of September 30, 2019:

			Schedule		As of September 30, 2019
Apartment ‎Units	Total Costs (1) ‎(in thousands)		Construction Start	Initial Occupancy	Physical ‎Occupancy	Average Rent per Unit (2)
395	$	115,426	Q3 2015	Q2 2017	94.7%	$	2,119

____________________________

⁽¹⁾The project cost for Highgate includes the underlying land at the assigned contribution value upon formation of the joint venture.

⁽²⁾Average rent per unit is defined as the total potential monthly rental revenue (actual rent for occupied apartment units plus market rent for vacant apartment units) divided by the total number of rentable apartment units.

Assets sold or held for sale: These amounts include historical operating results with respect to properties that we sold or are held for sale. Amounts for the three and nine months ended September 30, 2019 reflect the operating results related to 1.3 million square feet of flex and office assets held for sale as of September 30, 2019; amounts for the three and nine months ended September 30, 2018 reflect the operating results related to 1.3 million square feet of flex and office assets held for sale as of September 30, 2019 as well as operating results related to 899,000 square feet of assets sold in 2018.

Depreciation and Amortization Expense: Depreciation and amortization expense was $26.2 million and $75.9 million for the three and nine months ended September 30, 2019, respectively, compared to $25.2 million and $73.5 million for the same periods in 2018, respectively. The three and nine month increases in depreciation and amortization

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expense were primarily due to depreciation expense related to the building held for development combined with depreciation and amortization expense from the Non-Same Park facilities.

General and Administrative Expense: General and administrative expense primarily represents executive and other compensation, audit and tax fees, legal expenses and costs associated with being a public company. For the three and nine months ended September 30, 2019, general and administrative expense increased $1.2 million, or 40.6%, and $1.6 million, or 18.1%, respectively, compared to the same periods in 2018. The three and nine month increases were primarily due to an increase in stock compensation expense tied to a modification of the Director Plan during the third quarter of 2019 as well as an increase in compensation costs relating to the chief financial officer who started during the latter half of 2018.

Gain on sale of real estate facility: On March 5, 2018, we sold Corporate Pointe Business Park, a park consisting of five multi-tenant office buildings totaling 161,000 square feet located in Orange County, California, for net sale proceeds of $41.7 million, which resulted in a gain of $26.8 million. On April 18, 2018, we sold Orange County Business Center, a park consisting of five multi-tenant office buildings totaling 437,000 square feet located in Orange County, California, for net sale proceeds of $73.3 million, which resulted in a gain of $50.6 million. On April 30, 2018, we sold Northgate Business Park, a park consisting of seven multi-tenant flex buildings totaling 194,000 square feet located in Dallas, Texas, for net sale proceeds of $11.8 million, which resulted in a gain of $7.9 million.

Subsequent to September 30, 2019, we sold 1.3 million rentable square feet of flex and office business parks located in Rockville and Silver Spring, Maryland, for a gross sales price of $148.8 million. We expect to record a gain on the sale of real estate facilities in connection with the sale.

Liquidity and Capital Resources

This section should be read in conjunction with our consolidated statements of cash flows for the nine months ended September 30, 2019 and 2018 and the notes to our consolidated financial statements, which set forth the major components of our historical liquidity and capital resources. The discussion below sets forth the factors which we expect will affect our future liquidity and capital resources or which may vary substantially from historical levels.

Capital Raising Strategy: As a REIT, we generally distribute substantially all of our “REIT taxable income” to our shareholders, which relative to a taxable C corporation, limits the amount of cash flow from operations that we can retain for investment purposes. As a result, in order to grow our asset base, access to capital is important.

Our financial profile is characterized by strong credit metrics, including low leverage relative to our total capitalization and operating cash flows. We are a highly rated REIT, as rated by Moody’s and Standard & Poor’s. Our corporate credit rating by Standard and Poor’s is A-, while our preferred shares are rated BBB by Standard and Poor’s and Baa2 by Moody’s. We believe our credit profile and ratings will enable us to efficiently access both the public and private capital markets to raise capital, as necessary.

In order to maintain access to capital markets, we target a minimum ratio of FFO (as defined below) to combined fixed charges and preferred distributions of 3.0 to 1.0. Fixed charges include interest expense, capitalized interest and preferred distributions paid to preferred shareholders. For the nine months ended September 30, 2019, the ratio to FFO to combined fixed charges and preferred distributions paid was 5.6 to 1.0.

We have a $250.0 million revolving Credit Facility that can be expanded to $400.0 million which expires in January, 2022. We can use the Credit Facility as necessary as temporary financing until we are able to raise longer term capital. Historically, we have funded our long-term capital requirements with retained operating cash flow and proceeds from the issuance of common and preferred securities. We will select among these sources of capital based upon availability, relative cost, the impact of constraints on our operations (such as covenants), as well as the desire for leverage.

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Short-term Liquidity and Capital Resource Analysis: We believe that our net cash provided by our operating activities will continue to be sufficient to enable us to meet our ongoing requirements for debt service, capital expenditures and distributions to our shareholders for the foreseeable future.

As of September 30, 2019, we had $6.7 million in unrestricted cash. In the last five years, we have retained approximately $40 to $60 million in operating cash flow per year. Retained operating cash flow represents cash flow provided by operating activities, less shareholder and unit holder distributions and capital expenditures.

Required Debt Repayment: As of September 30, 2019, we have $50.0 million outstanding on our Credit Facility. Subsequent to September 30, 2019, the Company repaid the Credit Facility in full. We are in compliance with all of the covenants and other requirements of our Credit Facility.

Capital Expenditures: We define recurring capital expenditures as those necessary to maintain and operate our real estate at its current economic value. Nonrecurring capital improvements generally are related to property renovations and expenditures related to repositioning asset acquisitions. The following table sets forth our commercial capital expenditures paid for in the nine months ended September 30, 2019 and 2018, respectively, on an aggregate and per square foot basis:

	For the Nine Months Ended September 30,
	2019		2018		2019		2018
Commercial Real Estate	(in thousands)				(per square foot)
Recurring capital expenditures
Capital improvements (1)	$	6,316	$	7,003	$	0.22	$	0.25
Tenant improvements		11,898		12,411		0.42		0.45
Lease commissions		6,027		6,277		0.21		0.23
Total commercial recurring capital expenditures		24,241		25,691		0.85		0.93
Nonrecurring capital improvements		2,011		113		0.07		—
Total commercial capital expenditures (1)	$	26,252	$	25,804	$	0.92	$	0.93

____________________________

⁽¹⁾Excludes $20,000 and $13,000 of recurring capital improvements on our multifamily asset in 2019 and 2018, respectively.

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The following table summarizes Same Park, Non-Same Park, multifamily and assets sold or held for sale recurring capital expenditures paid and the related percentage of NOI by region for the nine months ended September 30, 2019 and 2018 (in thousands):

	For the Nine Months Ended September 30,
						Recurring
	Recurring					Capital Expenditures
	Capital Expenditures					as a Percentage of NOI
		2019		2018	Change	2019		2018
Region
Same Park
Northern California	$	3,164	$	2,281	38.7%		5.2%		4.0%
Southern California		2,788		2,238	24.6%		9.2%		7.6%
Dallas		3,211		3,860	(16.8%)		19.3%		26.5%
Austin		2,470		1,433	72.4%		16.9%		9.9%
Northern Virginia		6,456		7,082	(8.8%)		17.7%		19.3%
South Florida		1,833		2,622	(30.1%)		7.7%		11.3%
Suburban Maryland		1,314		1,901	(30.9%)		11.5%		17.5%
Seattle		458		648	(29.3%)		4.5%		6.8%
Total Same Park		21,694		22,065	(1.7%)		10.6%		11.2%
Non-Same Park
Southern California		26		—	100.0%		—		—
Northern Virginia		1,743		223	681.6%		—		—
Total Non-Same Park		1,769		223	693.3%		—		—
Assets sold or held for sale		778		3,403	(77.1%)		—		—
Total commercial recurring
capital expenditures		24,241		25,691	(5.6%)		—		—
Multifamily		20		13	53.8%		—		—
Total	$	24,261	$	25,704	(5.6%)		—		—

The increase in Non-Same Park recurring capital expenditures are related to transaction costs spent on our Northern Virginia Industrial Portfolio, which was acquired in June, 2018, attributed to the lease-up of that park.

In the last five years, our recurring capital expenditures have averaged generally between $1.10 and $1.64 per square foot, and 11.6% and 18.8% as a percentage of NOI.

Redemption of Preferred Stock: Historically, we have reduced our cost of capital by refinancing higher coupon preferred securities with lower coupon preferred securities.

At September 30, 2019, our 5.75% Series U preferred shares, with a par value of $230.0 million, and our 5.70% Series V preferred shares, with a par value of $110.0 million, were redeemable at par. Redemption of such preferred shares will depend upon many factors, including our cost of capital. None of our preferred securities are redeemable at the option of the holders.

Acquisitions of real estate facilities: On September 5, 2019, we acquired a multi-tenant industrial park comprised of approximately 543,000 rentable square feet in Santa Fe Springs, California, for a total purchase price of $104.3 million, inclusive of capitalized transaction costs. On April 18, 2019, we acquired a multi-tenant industrial park comprised of approximately 74,000 rentable square feet in Signal Hill, California, for a total purchase price of $13.8 million, inclusive of capitalized transaction costs. On June 8, 2018, we acquired two multi-tenant industrial parks aggregating 1.1 million rentable square feet in Springfield, Virginia, for a purchase price of $143.8 million, inclusive of capitalized transaction costs. We continue to seek to acquire additional real estate facilities; however, there is significant competition to acquire existing facilities and there can be no assurance as to the volume of future acquisition activity.

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Sale of real estate: Subsequent to September 30, 2019, we sold 1.3 million rentable square feet of flex and office business parks located in Rockville and Silver Spring, Maryland, that was held for sale as of September 30, 2019, for a gross sales price of $148.8 million. During the nine months ended September 30, 2018, we sold real estate facilities for net sale proceeds of $126.8 million, which resulted in a gain of $85.3 million.

Development of real estate facilities: As noted above, we have a 123,000 square foot vacant building located within The Mile that we are seeking to develop into a multifamily property. There can be no assurance as to the timing or amount of any investment that may occur; however, we do not expect to incur any significant development costs on this potential project any earlier than mid-2020.

Repurchase of Common Stock: No shares of common stock were repurchased under the board-approved common stock repurchase program during the nine months ended September 30, 2019 or the year ended December 31, 2018. As of September 30, 2019, management has the authorization to repurchase an additional 1,614,721 shares.

Requirement to Pay Distributions: Our election to be taxed as a REIT, as defined by the Code, applies to all periods presented herein. As a REIT, we do not incur federal income tax on our “REIT taxable income” that is distributed each year (for this purpose, certain distributions paid in a subsequent year may be considered), and we continue to meet certain organizational and operational rules. We believe we have met these requirements in all periods presented herein, and we expect we will continue to qualify as a REIT in future periods.

We paid REIT qualifying distributions of $125.2 million ($38.9 million to preferred shareholders and $86.3 million to common shareholders) during the nine months ended September 30, 2019.

We estimate the annual distribution requirements with respect to our preferred shares outstanding at September 30, 2019 to be $51.8 million per year.

Our consistent, long-term dividend policy has been to set dividend distribution amounts based on our taxable income. Future quarterly distributions with respect to the common shares will continue to be determined based upon our REIT distribution requirements and, after taking into consideration distributions to the preferred shareholders, will be funded with cash provided by operating activities.

Funds from Operations and Core Funds from Operations

Funds from Operations (“FFO”) is a non-GAAP measure defined by the National Association of Real Estate Investment Trusts and is considered a helpful measure of REIT performance by REITs and many REIT analysts. FFO represents GAAP net income before real estate depreciation and amortization expense, gains or losses on sales of operating properties and land and impairment charges on real estate assets.

We also present “Core FFO per share,” a non-GAAP measure that represents FFO per share excluding the net impact of (i) income allocated to preferred shareholders to the extent redemption value exceeds the related carrying value and (ii) nonrecurring income or expense items.

For the three and nine months ended September 30, 2019 and 2018, Core FFO was equal to FFO as the Company did not incur any preferred share redemption charges or any nonrecurring income or expenses in either period.

We believe FFO and Core FFO assist investors in analyzing and comparing the operating and financial performance of a company’s real estate between periods. FFO and Core FFO are not substitutes for GAAP net income. In addition, other REITs may compute Core FFO differently, which could inhibit comparability.

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The following table reconciles from net income allocable to common shareholders to FFO and Core FFO and net income per share to FFO per share (amounts in thousands, except per share data):

	For The Three Months				For The Nine Months
	Ended September 30,				Ended September 30,
	2019		2018		2019		2018
Net income allocable to common shareholders	$	26,312	$	25,131	$	81,212	$	141,400
Adjustments
Gain on sale of real estate facilities		—		—		—		(85,283)
Depreciation and amortization expense		26,220		25,207		75,863		73,505
Net income allocated to noncontrolling interests		7,020		6,514		21,670		36,814
Net income allocated to restricted stock unit holders		219		239		699		1,592
FFO (income) loss allocated to JV partner		(39)		(3)		(105)		8
FFO allocable to common and dilutive shares	$	59,732	$	57,088	$	179,339	$	168,036
Core FFO allocable to common and dilutive shares	$	59,732	$	57,088	$	179,339	$	168,036
Weighted average outstanding
Common shares		27,432		27,339		27,411		27,310
Common operating partnership units		7,305		7,305		7,305		7,305
Restricted stock units		113		163		126		183
Common share equivalents		111		103		101		102
Total common and dilutive shares		34,961		34,910		34,943		34,900
Reconciliation of Earnings per Share to FFO per Share
Net income per common share—diluted	$	0.96	$	0.92	$	2.95	$	5.16
Gain on sale of real estate facilities		—		—		—		(2.45)
Depreciation and amortization expense		0.75		0.72		2.18		2.10
FFO per share	$	1.71	$	1.64	$	5.13	$	4.81

Off-Balance Sheet Arrangements: The Company does not have any off-balance sheet arrangements that have or are reasonably likely to have a material effect on the Company’s financial condition, results of operations, liquidity, capital expenditures or capital resources.

Contractual Obligations: We paid $38.9 million in distributions to our preferred shareholders for the nine months ended September 30, 2019 and expect to continue to pay quarterly distributions in the same amount for the foreseeable future or until such time as there is a change in the amount or composition of our series of preferred equity outstanding. Dividends on preferred equity are paid when and if declared by the Company’s Board and accumulate if not paid. Shares of preferred equity are redeemable by the Company in order to preserve its status as a REIT and are also redeemable five years after issuance, but are not redeemable at the option of the holder.

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Our significant contractual obligations as of September 30, 2019 and their impact on our cash flows and liquidity are summarized below (in thousands):

	Payments Due by Period
Contractual Obligations	Total		Less than 1 year		1-3 years		4-5 years		More than 5 years
Credit Facility (principal and interest)	$	50,046	$	50,046	$	—	$	—	$	—
Transaction costs (1)		10,277		10,277		—		—		—
Ground lease obligations (2)		2,040		75		594		397		974
Total	$	62,363	$	60,398	$	594	$	397	$	974

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⁽¹⁾Represents transaction costs, including tenant improvements and lease commissions, which we are committed to under the terms of executed leases.

⁽²⁾Represents future contractual payments on land under various operating leases.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

To limit the Company’s exposure to market risk, the Company principally finances its operations and growth with permanent equity capital consisting of either common or preferred stock. As a result, the Company’s debt as a percentage of total equity (based on book values) was 2.5% as of September 30, 2019.

Our exposure to market risk for changes in interest rates relates primarily to the Credit Facility, which is subject to variable interest rates. See Notes 2 and 5 to the consolidated financial statements included in this Quarterly Report on Form 10-Q for additional information regarding the terms, valuations and approximate principal maturities of the Company’s indebtedness, including the Credit Facility. Based on borrowing rates currently available to the Company, the difference between the carrying amount of debt and its fair value is insignificant.

ITEM 4. CONTROLS AND PROCEDURES

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of September 30, 2019. These controls and procedures have been designed to ensure that information required for disclosure is recorded, processed, summarized and reported within the requisite time periods and that such information is accumulated and communicated to management. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of the Company’s disclosure controls and procedures as of September 30, 2019, the Company’s Chief Executive Officer and Chief Financial Officer concluded that, as of such date, the Company’s disclosure controls and procedures were effective at the reasonable assurance level.

There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter ended September 30, 2019 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Company currently is not subject to any material legal proceedings other than ordinary routine litigation and administrative proceedings incidental to its business.

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ITEM 1A. RISK FACTORS

There have been no material changes to the risk factors included in our Annual Report on Form 10-K for the year ended December 31, 2018.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The Company’s Board of Directors has authorized the repurchase, from time to time, of up to 6.5 million shares of the Company’s common stock on the open market or in privately negotiated transactions. The authorization has no expiration date. Purchases will be made subject to market conditions and other investment opportunities available to the Company.

During the three months ended September 30, 2019, there were no shares of the Company’s common stock repurchased. As of September 30, 2019, 1,614,721 shares remain available for purchase under the program.

See Note 10 to the consolidated financial statements for additional information on repurchases of equity securities.
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ITEM 6. EXHIBITS

Exhibits Number	Description
Exhibit 31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Filed herewith.
Exhibit 31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Filed herewith.
Exhibit 32.1	Certifications of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Filed herewith.
Exhibit 101.INS	XBRL Instance Document. Filed herewith.
Exhibit 101.SCH	XBRL Taxonomy Extension Schema. Filed herewith.
Exhibit 101.CAL	XBRL Taxonomy Extension Calculation Linkbase. Filed herewith.
Exhibit 101.DEF	XBRL Taxonomy Extension Definition Linkbase. Filed herewith.
Exhibit 101.LAB	XBRL Taxonomy Extension Label Linkbase. Filed herewith.
Exhibit 101.PRE	XBRL Taxonomy Extension Presentation Linkbase. Filed herewith.
Exhibit 104	Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101).

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Dated: October 22, 2019
PS BUSINESS PARKS, INC.
BY:	/s/ Jeffrey D. Hedges
	Jeffrey D. Hedges
	Executive Vice President and Chief Financial Officer
	(Principal Financial Officer)

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