REAL ESTATE

As of December 31, 2018 and 2017, our real estate investment portfolio classified as held and used, at cost, consists of properties as follows (in thousands):



	December 31,
	2018		2017
Office	$	1,507,986	$	1,355,033
Multifamily	919,285		895,811
Retail	459,314		451,158
	$	2,886,585	$	2,702,002

Our results of operations are dependent on the overall economic health of our markets, tenants and the specific segments in which we own properties. These segments are office, retail and multifamily. All segments are affected by external economic factors, such as inflation, consumer confidence and unemployment rates, as well as changing tenant and consumer requirements.

As of December 31, 2018, one property, Arlington Tower, accounted for approximately 10% of total assets. No single property or tenant accounted for more than 10% of the real estate rental revenue.

We have properties under development/redevelopment and held for current or future development. The cost of our real estate portfolio under development or held for future development as of December 31, 2018 and 2017 is as follows (in thousands):



	December 31,
	2018		2017
Office	$	478	$	680
Multifamily	83,945		49,616
Retail	2,808		4,126
	$	87,231	$	54,422

In the multifamily segment, we have The Trove, a multifamily development adjacent to The Wellington, and we own land held for future multifamily development adjacent to Riverside Apartments. As of December 31, 2018, we had invested $61.7 million and $22.9 million, including the costs of acquired land, in The Trove and the development adjacent to Riverside Apartments, respectively.

In the retail segment, we have a redevelopment project to add rentable space at Spring Valley Village. As of December 31, 2018, we had invested $6.5 million in the redevelopment. We substantially completed major construction activities on this project during the fourth quarter of 2018 and placed into service assets totaling $4.2 million.

In addition, there are several other projects with minor development activity in the multifamily, office and retail segments.

Acquisitions

Our current strategy is to recycle legacy assets that lack the income growth potential we seek and to invest in high-quality assets with compelling value-add returns through redevelopment opportunities in our existing portfolio and acquisitions that meet our stringent investment criteria. We focus on properties inside the Washington metro region’s Beltway, near major transportation nodes and in areas with strong employment drivers and superior growth demographics.

Properties and land for development acquired during the three years ended December 31, 2018 were as follows:

Acquisition Date

Property

Type

# of units (unaudited)

Rentable

Square Feet

(unaudited)

Contract

Purchase Price

(in thousands)

January 18, 2018

Arlington Tower

Office

N/A

391,000

250,000

April 4, 2017

Watergate 600

Office

N/A

278,000

135,000

May 20, 2016

Riverside Apartments

Multifamily

1,222

N/A

244,750

The results of operations from acquired operating properties are included in the consolidated statements of income as of their acquisition dates.

The revenue and earnings of our acquisitions during their year of acquisition for the three years ended December 31, 2018 are as follows (in thousands):



	Year Ended December 31,
	2018		2017		2016
Real estate rental revenue	$	22,389	$	14,518	$	13,112
Net income (loss)	3,623		2,226		(1,688		)

As discussed in note 2, we record the acquired physical assets (land, building and tenant improvements), in-place leases (absorption, tenant origination costs, leasing commissions, and net lease intangible assets/liabilities), and any other liabilities on a relative fair value basis.

We recorded the total cost of the above acquisitions as follows (in thousands):



	2018			2017			2016
Land	$	63,970		$	45,981		$	38,924
Land held for development	—			—			15,968
Buildings	142,900			66,241			184,854
Tenant origination costs	13,625			12,084			—
Leasing commissions/absorption costs	27,465			23,161			4,992
Net lease intangible assets	3,142			498			22
Net lease intangible liabilities	(545		)	(9,585		)	(10		)
Deferred tax liability	—			(560		)	—
Total	$	250,557		$	137,820		$	244,750

The weighted remaining average life for 2018 acquisition components above, other than land and building, are 71 months for tenant origination costs, 61 months for leasing commissions/absorption costs, 63 months for net lease intangible assets and 78 months for net lease intangible liabilities.

The difference in the total contract purchase price of $250.0 million for the 2018 acquisition and cash paid for the acquisition per the consolidated statements of cash flows of $106.4 million is primarily due to a mortgage note assumed and repaid at settlement ($135.5 million), an acquisition deposit made during 2017 ($6.3 million), and a net credit to the buyer for certain expenditures ($2.4 million), partially offset by capitalized acquisition related costs ($0.6 million).

The difference in the total contract price of $135.0 million for the 2017 acquisition and cash paid for the acquisition per the consolidated statements of cash flows of $138.4 million is primarily due to capitalized acquisition-related costs ($2.8 million) and a net credit to the buyer for certain expenditures ($1.0 million), partially offset by the issuance of 12,124 operating partnership units (“Operating Partnership Units”) as part of the consideration ($0.4 million). The Operating Partnership Units are units in WashREIT Watergate 600 OP LP, a consolidated subsidiary of Washington REIT. These Operating Partnership Units may be redeemed for either cash equal to the fair market value of a share of Washington REIT common stock at the time of redemption (based on a 20-day average price) or, at the option of Washington REIT, one registered or unregistered share of Washington REIT common stock. In connection with the 2017 acquisition, we granted registration rights to the two contributors of the Watergate 600 property relating to the resale of any shares issued upon exchange of Operating Partnership Units pursuant to a shelf registration statement that we had an obligation to make available to the contributors approximately one year after the issuance of the Operating Partnership Units. This shelf registration statement was filed on March 8, 2018.

The difference in the total contract price of $244.8 million for the 2016 acquisitions and cash paid for the acquisitions per the consolidated statements of cash flows of $227.4 million is primarily due to acquisition of land for development of $16.0 million and credits received at settlement totaling $1.4 million.

Balances, net of accumulated depreciation or amortization, as appropriate, of the components of the fair value of in-place leases at December 31, 2018 and 2017 were as follows (in thousands):



	December 31,
	2018						2017
	Gross Carrying Value		Accumulated Amortization		Net		Gross Carrying Value		Accumulated Amortization		Net
Tenant origination costs	$	62,759	$	41,109	$	21,650	$	66,378	$	50,157	$	16,221
Leasing commissions/absorption costs	126,707		87,660		39,047		123,992		95,115		28,877
Net lease intangible assets	18,062		13,617		4,445		19,362		16,089		3,273
Net lease intangible liabilities	35,530		24,073		11,457		43,230		28,174		15,056
Below-market ground lease intangible asset	12,080		2,093		9,987		12,080		1,903		10,177

Amortization of these combined components during the three years ended December 31, 2018, 2017 and 2016 was as follows (in thousands):



	Year Ended December 31,
	2018			2017			2016
Depreciation and amortization expense	$	22,723		$	14,911		$	17,655
Real estate rental revenue (increase) decrease, net	(1,314		)	(922		)	410
	$	21,409		$	13,989		$	18,065

Amortization of these combined components over the next five years is projected to be as follows (in thousands):



	Depreciation and amortization expense		Real estate rental revenue, net increase			Total
2019	$	13,045	$	(1,066	)	$	11,979
2020	9,513		(399		)	9,114
2021	8,716		(567		)	8,149
2022	8,214		(756		)	7,458
2023	6,278		(1,030		)	5,248
Thereafter	24,918		(3,194		)	21,724

Variable Interest Entities

In June 2011, we executed a joint venture operating agreement with a real estate development company to develop The Maxwell, a mid-rise multifamily property in Arlington, Virginia. Major construction activities at The Maxwell ended during December 2014, and the building became available for occupancy during the first quarter of 2015. Washington REIT was the 90% owner of the joint venture. The real estate development company owned 10% of the joint venture and was responsible for the development and construction of the property. During the fourth quarter of 2017, we purchased the 10% joint venture interest from the real estate development company for a contract purchase price of $4.1 million. With the completion of this transaction, the joint venture ended and Washington REIT became sole owner of The Maxwell. As a result, we no longer have any VIEs.

We determined that, prior to completion of this transaction, The Maxwell joint venture was a VIE primarily based on the fact that the equity investment at risk was not sufficient to permit the entity to finance its activities without additional financial support. We also determined that Washington REIT was the primary beneficiary of the VIE due to the fact that Washington REIT was determined to have a controlling financial interest in the entity. In January 2016, Washington REIT exercised its right to purchase at par The Maxwell’s construction loan from the original third-party lender. Upon the purchase, the construction loan became an intercompany loan payable from the consolidated VIE to Washington REIT that is eliminated in consolidation. The intercompany loan payable was extinguished as part of Washington REIT’s purchase of the joint venture partner’s 10% interest during the fourth quarter of 2017.

Properties Sold and Held for Sale

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

During the first quarter of 2018, we sold Braddock Metro Center, a 356,000 square foot office property in Alexandria, Virginia for a contract sales price of $93.0 million. Due to then-ongoing negotiations to sell the property, we evaluated Braddock Metro Center for impairment and recognized a $9.1 million impairment charge during 2017 in order to reduce the carrying value of the property to its estimated fair value, less selling costs. We based this fair valuation on the expected sale price from a potential sale. There are few observable market transactions for similar properties. This fair valuation falls into Level 2 of the fair value hierarchy due to its reliance on a quoted price in a market that is not active.

During the first quarter of 2018, we executed a purchase and sale agreement to sell 2445 M Street, a 292,000 square foot office property in Washington, DC, for a contract sales price of $100.0 million, with settlement originally scheduled for the third quarter of 2018. During 2017, we evaluated 2445 M Street for impairment and recognized a $24.1 million impairment charge in order to reduce the carrying value of the property to its estimated fair value. Upon execution of the purchase and sale agreement, the property met the criteria for classification as held for sale. Due to the property’s classification as held for sale, we recorded an additional impairment charge of $1.9 million in the first quarter of 2018 in order to reduce the carrying value of the property to its estimated fair value, less estimated selling costs. We based this fair value on the expected sales price from a potential sale. There are few observable market transactions for similar properties. This fair valuation falls into Level 2 of the fair value hierarchy due to its reliance on a quoted price in a market that is not active. During the second quarter of 2018, we executed an amendment to the purchase and sale agreement which increased the contract sales price to $101.6 million and advanced the settlement date. On June 28, 2018, we sold 2445 M Street, recognizing a gain on sale of real estate of $2.5 million.

During the second quarter of 2017, we executed a purchase and sale agreement for the sale of Walker House Apartments, a 212- unit multifamily property in Gaithersburg, Maryland, for a contract sales price of $32.2 million. We closed on the sale during the fourth quarter of 2017, recognizing a gain on sale of $23.8 million.

During the second quarter of 2016, we sold Dulles Station, Phase II, which consists of land held for future development and an interest in a parking garage in Herndon, Virginia, for $12.1 million. Also during the second quarter of 2016, we executed two purchase and sale agreements with a single buyer for the sale of a portfolio of six office properties located in Maryland: 6110 Executive Boulevard, Wayne Plaza, 600 Jefferson Plaza, West Gude Drive, 51 Monroe Street and One Central Plaza (collectively, the "Maryland Office Portfolio") for an aggregate contract sales price of $240.0 million. We closed on the first sale transaction in June 2016 and closed on the second sale transaction in September 2016.

We sold our interests in the following properties during the three years ended December 31, 2018:



Disposition Date	Property	Segment	# of units (unaudited)	Rentable Square Feet (unaudited)	Contract Sale Price (in thousands)		Gain on Sale (in thousands)
January 19, 2018	Braddock Metro Center	Office	N/A	356,000	$	93,000	$	—
June 28, 2018	2445 M Street	Office	N/A	292,000	101,600		2,495
		Total 2018		648,000	$	194,600	$	2,495

October 23, 2017	Walker House Apartments	Multifamily	212	N/A	$	32,200	$	23,838
		Total 2017			$	32,200	$	23,838

May 26, 2016	Dulles Station, Phase II ⁽¹⁾	Office	N/A	N/A	$	12,100	$	527
June 27, 2016	Maryland Office Portfolio Transaction I ⁽²⁾	Office	N/A	692,000	111,500		23,585
September 22, 2016	Maryland Office Portfolio Transaction II ⁽³⁾	Office	N/A	491,000	128,500		77,592
		Total 2016		1,183,000	$	252,100	$	101,704


⁽¹⁾	Land held for future development and an interest in a parking garage.


⁽²⁾	Maryland Office Portfolio Transaction I consists of 6110 Executive Boulevard, 600 Jefferson Plaza, Wayne Plaza and West Gude Drive.


⁽³⁾	Maryland Office Portfolio Transaction II consists of 51 Monroe Street and One Central Plaza.

We have fully transferred control of the assets associated with these disposed properties and do not have significant continuing involvement in the operations of these properties.

While the Maryland Office Portfolio, in the aggregate, constitutes an individually significant disposition, it does not qualify for presentation and disclosure as a discontinued operation as it does not represent a strategic shift in our operations.

Real estate rental revenue and net income for the Maryland Office Portfolio for the three years ended December 31, 2018 are as follows:



	Year Ending December 31,
	2018		2017		2016
Real estate rental revenue	$	—	$	—	$	20,266
Net income	—		—		9,376

Casualty Gain

We recorded a net casualty gain of $0.7 million during the second quarter of 2016 associated with a fire at Bethesda Hill Towers that damaged four units, which is included in real estate impairment and casualty (gain), net on our consolidated statements of income. The net casualty gain is comprised of $0.9 million in third-party insurance proceeds received by us, which were partially offset by casualty charges of $0.2 million to write off the net book value of the damaged units at Bethesda Hill Towers.