Form 10-K
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


FORM 10-K

 


 

x Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2005.

 

¨ 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 001-32336

 


DIGITAL REALTY TRUST, INC.

(Exact name of registrant as specified in its charter)

 


 

Maryland   26-0081711
(State or other jurisdiction of
Incorporation or organization)
  (IRS employer
identification number)
560 Mission Street, Suite 2900
San Francisco, CA
  94105
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code (415) 738-6500

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

 

Title of each class

  

Name of each exchange on which registered

Common stock, $0.01 par value

   New York Stock Exchange

Series A cumulative redeemable preferred stock, $0.01 par value

   New York Stock Exchange

Series B cumulative redeemable preferred stock, $0.01 par value

   New York Stock Exchange

 


Securities registered pursuant to Section 12(g) of the Act: None

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  x    No  ¨

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

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

Large-accelerated filer  ¨                 Accelerated filer  x                Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.).    Yes  ¨    No  x

As of June 30, 2005, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $372.3 million based on the closing sale price as reported on the New York Stock Exchange.

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class

  

Outstanding at March 3, 2006

Common Stock, $.01 par value per share

   27,363,408

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s Proxy Statement with respect to its 2006 Annual Meeting of Stockholders to be filed not later than 120 days after the end of the registrant’s fiscal year are incorporated by reference into Part III hereof.

 



Table of Contents

DIGITAL REALTY TRUST, INC.

FORM 10-K

FOR THE YEAR ENDED DECEMBER 31, 2005

TABLE OF CONTENTS

 

        PAGE NO.

PART I.

   

ITEM 1.

 

Business

  1

ITEM 1A.

 

Risk factors

  7

ITEM 1B.

 

Unresolved staff comments

  23

ITEM 2.

 

Properties

  23

ITEM 3.

 

Legal Proceedings

  30

ITEM 4.

 

Submission of Matters to a Vote of Security Holders

  30

PART II.

   

ITEM 5.

 

Market for Registrant’s Common Equity and Related Stockholder Matters

  31

ITEM 6.

 

Selected Financial Data

  31

ITEM 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  33

ITEM 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

  51

ITEM 8.

 

Financial Statements and Supplementary Data

  52

ITEM 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

  89

ITEM 9A.

 

Controls and Procedures

  89

ITEM 9B.

 

Other Information

  89

PART III.

   

ITEM 10.

 

Directors and Executive Officers of the Registrant

  90

ITEM 11.

 

Executive Compensation

  90

ITEM 12.

 

Security Ownership of Certain Beneficial Owners and Management

  90

ITEM 13.

 

Certain Relationships and Related Transactions

  90

ITEM 14.

 

Principal Accountant Fees and Services

  90

PART IV.

   

ITEM 15.

 

Exhibits and Financial Statement Schedules

  91


Table of Contents

PART 1

 

ITEM 1. BUSINESS

General

As used herein, the terms “we,” “our,” “us,” “the company” and “our company” refer to Digital Realty Trust, Inc., a Maryland corporation, together with our consolidated subsidiaries, including Digital Realty Trust, L.P., a Maryland limited partnership of which we are the sole general partner and which we refer to as our operating partnership. We target high-quality, strategically located properties containing applications and operations critical to the day-to-day operations of technology industry tenants and corporate data center users, including the information technology, or IT, departments of Fortune 1000 and financial services companies. Our tenant base is diversified and reflects a broad spectrum of regional, national and international tenants that are leaders in their respective areas. We operate as a real estate investment trust, or REIT, for federal income tax purposes.

Through our operating partnership, at December 31, 2005 we owned 43 properties. Our properties are primarily located throughout the U.S. with three properties in Europe. Our properties contain a total of approximately 8.1 million net rentable square feet, excluding approximately 1.1 million square feet held for redevelopment. Our operations and acquisition activities are focused on a limited number of markets where technology industry tenants and corporate data center users are concentrated, including the Boston, Chicago, Dallas, Los Angeles, New York, Philadelphia, San Francisco and Silicon Valley metropolitan areas. As of December 31, 2005, our portfolio, excluding space held for redevelopment, was approximately 93.9% leased at an average annualized rent per leased square foot of $20.51. The types of properties within our focus include:

 

    Internet gateways, which serve as hubs for Internet and data communications within and between major metropolitan areas;

 

    Data centers, which provide secure, continuously available environments for the storage and processing of critical electronic information. Data centers are used for disaster recovery purposes, transaction processing and to house the IT operations of companies;

 

    Technology manufacturing properties, which contain highly specialized manufacturing environments for such purposes as disk drive manufacturing, semiconductor manufacturing and specialty pharmaceutical manufacturing; and

 

    Regional or national offices of technology companies that are located in our target markets.

Most of our properties have extensive tenant improvements that have been installed at our tenants’ expense. Unlike traditional office and flex/research and development space, the location of and improvements to our facilities are generally essential to our tenants’ businesses, which we believe results in high occupancy levels, long lease terms and low tenant turnover. The tenant-installed improvements in our facilities are readily adaptable for use by similar tenants. We also have approximately 1.1 million square feet available for redevelopment at December 31, 2005.

Our portfolio includes 21 properties contributed to us by Global Innovation Partners, LLC, or GI Partners, in connection with our initial public offering in November 2004. GI Partners is a private equity fund that was formed to pursue investment opportunities that intersect the real estate and technology industries. GI Partners was formed in February 2001 after a competitive six-month selection process conducted by the California Public Employees’ Retirement System, or CalPERS, the largest U.S. pension fund.

Our principal executive offices are located at 560 Mission Street, Suite 2900, San Francisco, California 94105. Our telephone number at that location is (415) 738-6500. Our website is located at www.digitalrealtytrust.com. The information found on, or otherwise accessible through, our website is not incorporated into, and does not form a part of, this annual report on Form 10-K or any other report or document we file with or furnish to the United States Securities and Exchange Commission.

 

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In the final quarter of 2005 we renamed our properties based on the address of each building. This table shows the names of buildings at December 31, 2005 and the names of those buildings in previous filings.

 

Former name used in prior filings

  

New name

100 Technology Center Drive

  

100 Technology Center Drive

1100 Space Park Drive

  

1100 Space Park Drive

200 Paul Avenue

  

200 Paul Avenue 1-4

36 Northeast Second Street

  

36 NE 2nd Street

833 Chestnut Street

  

833 Chestnut Street

AboveNet Data Center

  

150 South First Street

Ameriquest

  

8534 Concord Center Drive

Amsterdam Data Center

  

Paul van Vlissingenstraat 16

Ardenwood Corporate Park

  

34551 Ardenwood Boulevard 1-4

ASM Lithography Training Facility

  

2010 East Centennial Circle

AT&T Web Hosting Facility

  

375 Riverside Parkway

Brea Data Center

  

3300 East Birch Street

Burbank Data Center

  

3015 Winona Avenue

Camperdown House

  

6 Braham Street

Carrier Center

  

600 West Seventh Street

Charlotte 1

  

731 East Trade Street

Charlotte 2

  

113 North Myers

Charlotte 3

  

125 North Myers

Comverse Technology Building

  

100 & 200 Quannapowitt Parkway

eBay Data Center

  

3065 Gold Camp Drive

Granite Tower

  

4055 Valley View Lane

Hudson Corporate Center

  

300 Boulevard East

Lakeside Technology Center

  

350 East Cermak Road

MAPP Building

  

1125 Energy Park Drive

Maxtor Manufacturing Facility

  

47700 Kato Road & 1055 Page Avenue

NTT/Verio Premier Data Center

  

2334 Lundy Place

Printers’ Square

  

600-780 S. Federal

Savvis Data Center 1

  

2045 & 2055 LaFayette Street

Savvis Data Center 2

  

2401 Walsh Street

Savvis Data Center 3

  

200 North Nash Street

Savvis Data Center 4

  

2403 Walsh Street

Savvis Data Center 5

  

4700 Old Ironsides Drive

Savvis Office Building

  

4650 Old Ironsides Drive

Siemens Building

  

4849 Alpha Road

Stanford Place II

  

7979 East Tufts Avenue

Univision Tower

  

2323 Bryan Street

VarTec Building

  

2440 Marsh Lane

Webb at LBJ

  

11830 Webb Chapel Road

Recent Developments

On December 22, 2005 we acquired 3 Corporate Place, a property located in the New York metropolitan area for approximately $14.7 million.

On December 8, 2005 we acquired 7500 & 7520 Metro Center Drive, a property located in Austin, Texas for approximately $13.5 million.

 

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On November 29, 2005 we acquired 251 Exchange Place, a property located in Northern Virginia for approximately $12.9 million.

On November 10, 2005 we prepaid the outstanding balance of $25.6 million on our 600 West Seventh Street property mortgage. No prepayment fees were incurred as a result of this prepayment.

On November 9, 2005, we prepaid the outstanding balance of $22.0 million for the mezzanine loan on our 34551 Ardenwood Boulevard 1-4, 2334 Lundy Place and 2440 Marsh Lane properties. No prepayment fees were incurred as a result of this prepayment.

On November 1, 2005 we purchased Chemin de l’Epinglier 2, a data center in Geneva, Switzerland for approximately €10.1 million (approximately $12.2 million based on the exchange rate on November 1, 2005).

On October 4, 2005 we purchased 115 Second Avenue, a property in the Boston metropolitan area for approximately $14.3 million.

On October 4, 2005 we refinanced the mortgage related to our 200 Paul Avenue 1-4 property which resulted in a new loan for $81.0 million at an interest rate of 5.74% which matures on October 8, 2015. Also in October 2005, we terminated the interest rate swap related to this loan and received cash of approximately $0.4 million.

Subsequent Events

On February 27, 2006, we declared the following distributions per share and the Operating Partnership made an equivalent distribution per unit.

 

Share class

  Series A
Preferred Stock
  Series B
Preferred Stock
  Common stock

Dividend and distribution amount

  $0.53125   $0.49219   $0.265

Dividend and distribution payable date

  March 31, 2006   March 31, 2006   March 31, 2006

Dividend payable to shareholders of record on

  March 15, 2006   March 15, 2006   March 15, 2006

Annual equivalent rate of dividend and distribution

  $2.125   $1.96875   $1.06

On February 14, 2006 we signed an agreement to acquire a property located in Toronto, Canada for approximately $16.0 million.

On February 14, 2006 we signed an agreement to acquire a property located in Atlanta, Georgia for approximately $25.3 million.

On February 6, 2006 we purchased a property in Dublin, Ireland for €5.2 million ($6.3 million based on the rate of exchange on February 6, 2006) including $0.4 million in Stamp Duty Tax. We also paid an additional $0.8 million in Value Added Tax which we expect to recover in the first quarter of 2006.

On January 6, 2006 we acquired 4025 Midway Road in Carrollton, Texas, a suburb of Dallas for approximately $16.2 million.

Our Competitive Strengths

We believe we distinguish ourselves from other owners, acquirors and managers of technology-related real estate through our competitive strengths, which include:

 

    High-Quality Portfolio that is Difficult to Replicate. Our portfolio contains state-of-the-art facilities with extensive tenant improvements. Based on current market rents and the estimated replacement costs of our properties and their improvements, we believe that they could not be replicated today on a cost-competitive basis. Many of the properties in our portfolio are located on major aggregation points formed by the physical presence of multiple major telecommunications service providers, which reduces our tenants’ costs and operational risks and increases the attractiveness of our buildings.

 

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    Presence in Key Markets. Our portfolio is located in 20 metropolitan areas, including the Boston, Chicago, Dallas, Los Angeles, New York, Philadelphia, San Francisco and Silicon Valley metropolitan areas, and is diversified so that no one market represented more than 25% of the aggregate annualized rent of our portfolio as of December 31, 2005.

 

    Long-Term Leases. We have long-term leases with stable cash flows. As of December 31, 2005, our average lease term was in excess of 12.5 years, with an average of 7.3 years remaining, excluding renewal options. Through 2008, leases representing only 8.4% of our net rentable square feet excluding space held for development, or 8.2% of our aggregate annualized rent, are scheduled to expire. Moreover, through 2006, leases representing only 2.9% of our net rentable square feet excluding space held for development are scheduled to expire.

 

    Specialized Focus in Dynamic and Growing Industry. We focus solely on technology-related real estate because we believe that the growth of the technology industry, particularly Internet and data communications and corporate data center use, will be superior to that of the overall economy. We believe that our specialized understanding of both real estate and technology gives us a significant competitive advantage over less specialized investors. We use our in-depth knowledge of the technology industry, particularly Internet and data communications and corporate data center use, to identify strategically located properties, market our properties to tenants with specific technology needs, evaluate tenants’ creditworthiness and business models and assess the long-term value of in-place technical improvements.

 

    Proven Acquisition Capability. Since 2002, we together with GI Partners, our predecessor have acquired 43 technology-related real estate properties (including 20 properties, which contain over 2.8 million net rentable square feet, excluding 0.8 million square feet held for redevelopment, since our initial public offering in November 2004), for an aggregate of 8.1 million net rentable square feet, excluding approximately 1.1 million square feet held for redevelopment. Our broad network of contacts within a highly fragmented universe of sellers and brokers of technology-related real estate enables us to capitalize on acquisition opportunities. We have developed detailed, standardized procedures for evaluating acquisitions to ensure that they meet our financial, technical and other criteria, which allows us to evaluate investment opportunities efficiently and, as appropriate, commit and close quickly. We acquired more than half of our properties before they were broadly marketed by real estate brokers.

 

    Experienced and Committed Management Team. Our senior management team, including our Executive Chairman, has an average of over 22 years of experience in the technology or real estate industries, including experience as investors in, advisors to and founders of technology companies. We believe that our senior management team’s extensive knowledge of both the real estate and the technology industries provides us with a key competitive advantage. At December 31, 2005, our senior management team collectively owned a common equity interest in our company of approximately 2.7%, which aligns management’s interests with those of our stockholders.

 

    Proven ability to sign new leases. We have considerable experience in identifying and leasing to new tenants. The combination of our specialized data center leasing team, external resources and customer referrals provided a robust funnel of new tenants in 2005. During the year ended December 31, 2005 we leased approximately 108,000 square feet to new tenants which resulted in annualized rent on a straight line basis of $5.7 million.

Business and Growth Strategies

Our primary business objectives are to maximize sustainable long-term growth in earnings, funds from operations and cash flow per share and to maximize returns to our stockholders. Our business strategies to achieve these objectives are:

 

   

Capitalize on Acquisition Opportunities. We believe that acquisitions enable us to increase cash flow and create long-term stockholder value. Our relationships with corporate information technology

 

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groups, technology tenants and real estate brokers who are dedicated to serving these tenants provide us with ongoing access to potential acquisitions and often enable us to avoid competitive bidding. Furthermore, the specialized nature of technology-related real estate makes it more difficult for traditional real estate investors to understand, which fosters reduced competition for acquisitions relative to other property types. We believe this dynamic creates an opportunity for us to obtain better risk-adjusted returns on our capital.

 

    Maximize the Cash Flow of our Properties. We aggressively manage and lease our assets to increase their cash flow. We often acquire properties with substantial in-place cash flow and some vacancy, which enables us to create upside through lease-up. Our portfolio, excluding space held for redevelopment, was approximately 93.9% leased as of December 31, 2005, leaving approximately 0.5 million square feet of net rentable space available for lease-up and approximately 1.1 million square feet held for redevelopment. Moreover, many of our properties contain extensive in-place infrastructure or buildout which may result in higher rents when leased to tenants seeking these improvements. We control our costs by negotiating expense pass-through provisions in tenant leases for operating expenses and certain capital expenditures. Leases covering more than 95% of the leased net rentable square feet in our portfolio as of December 31, 2005 required tenants to pay all or a portion of increases in operating expenses, including real estate taxes, insurance, common area charges and other expenses. Since our initial public offering in November 2004, we have executed leases for 181,000 square feet of technical space at an average annualized rent of $55.54 per square foot and 311,000 square feet of nontechnical space at an average annualized rent of $20.04 per square foot, in each case including lease renewals and expansions commencing in 2004 through 2009.

 

    Develop and obtain optimal returns on our space held for redevelopment. At December 31, 2005 we had approximately 1.1 million square feet held for redevelopment. We intend to redevelop this space for lease when justified by anticipated returns. The rate of return on our initial capital investment will be subject to many factors and we currently expect to obtain a 10% annual return on our investment.

 

    Subdivide Improved Space for Turn-Key Data Center Use. Turn-Key Data Center space is move-in-ready space for the placement of computer and network equipment required to provide a data center environment. We own approximately 264,000 net rentable square feet of space with extensive data center improvements that is currently, or will shortly be, available for lease, or has already been leased. We had leased approximately 123,000 square feet of this space at December 31, 2005. Rather than leasing all of this space to large single tenants, we are subdividing some of it for multi-tenant turn-key data center use, with tenants averaging between 100 and 15,000 square feet of net rentable space. Multi-tenant turn-key data centers are effective solutions for tenants who lack the expertise or capital budget to provide their own extensive data center infrastructure and security. As experts in data center construction and operations, we are able to lease space to these tenants at a significant premium over other uses.

 

    Leverage Strong Industry Relationships. We use our strong industry relationships with national and regional corporate enterprise information technology groups and technology-intensive companies to identify and comprehensively respond to their real estate needs. Our leasing and sales professionals are real estate and technology industry specialists who can develop complex facility solutions for the most demanding corporate data center and other technology tenants.

 

    Use Capital Efficiently. We intend to occasionally sell our assets held for investment opportunistically. We believe that we can increase stockholder returns by effectively redeploying asset sales proceeds into new investment opportunities. Recently, data centers have been particularly attractive candidates for sale to owner/users, as the cost of acquisition is usually substantially lower than the cost to construct a new facility. We will occasionally seek such opportunities to realize gains from these investment assets and reinvest our capital.

 

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Competition

We compete with numerous regional developers, owners and operators of office and commercial real estate, many of which own properties similar to ours in the same submarkets in which our properties are located. If our competitors offer space at rental rates below current market rates, or below the rental rates we currently charge our tenants, we may lose potential tenants and we may be pressured to reduce our rental rates below those we currently charge in order to retain tenants when our tenants’ leases expire. In addition, developers and operators may compete with us for acquisitions.

Regulation

General

Office properties in our submarkets are subject to various laws, ordinances and regulations, including regulations relating to common areas. We believe that each of our properties as of December 31, 2005 has the necessary permits and approvals to operate its business.

Americans With Disabilities Act

Our properties must comply with Title III of the Americans with Disabilities Act of 1990, or ADA, to the extent that such properties are “public accommodations” as defined by the ADA. The ADA may require removal of structural barriers to access by persons with disabilities in certain public areas of our properties where such removal is readily achievable. We believe that our properties are in substantial compliance with the ADA and that we will not be required to make substantial capital expenditures to address the requirements of the ADA. However, noncompliance with the ADA could result in imposition of fines or an award of damages to private litigants. The obligation to make readily achievable accommodations is an ongoing one, and we will continue to assess our properties and to make alterations as appropriate in this respect.

Environmental Matters

Under various laws relating to the protection of the environment, a current or previous owner or operator of real estate may be liable for contamination resulting from the presence or discharge of hazardous or toxic substances at that property, and may be required to investigate and clean up such contamination at that property or emanating from that property. Such laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the presence of the contaminants, and the liability may be joint and several. Previous owners used some of our properties for industrial and retail purposes, so those properties may contain some level of environmental contamination. The presence of contamination or the failure to remediate contamination at our properties may expose us to third-party liability or materially adversely affect our ability to sell, lease or develop the real estate or to borrow using the real estate as collateral.

Some of the properties may contain asbestos-containing building materials. Environmental laws require that asbestos-containing building materials be properly managed and maintained, and may impose fines and penalties on building owners or operators for failure to comply with these requirements. These laws may also allow third parties to seek recovery from owners or operators for personal injury associated with exposure to asbestos-containing building materials.

In addition, some of our tenants, particularly those in the biotechnology and life sciences industry and those in the technology manufacturing industry, routinely handle hazardous substances and wastes as part of their operations at our properties. Environmental laws and regulations subject our tenants, and potentially us, to liability resulting from these activities or from previous industrial or retail uses of those properties. Environmental liabilities could also affect a tenant’s ability to make rental payments to us. We require our tenants to comply with these environmental laws and regulations and to indemnify us for any related liabilities.

Independent environmental consultants have conducted Phase I or similar environmental site assessments on all of the properties in our portfolio. Site assessments are intended to discover and evaluate information regarding

 

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the environmental condition of the surveyed property and surrounding properties. These assessments do not generally include soil samplings, subsurface investigations or an asbestos survey. None of the recent site assessments revealed any past or present environmental liability that we believe would have a material adverse effect on our business, assets or results of operations. However, the assessments may have failed to reveal all environmental conditions, liabilities or compliance concerns. Material environmental conditions, liabilities or compliance concerns may have arisen after the review was completed or may arise in the future; and future laws, ordinances or regulations may impose material additional environmental liability.

Insurance

We carry comprehensive liability, fire, extended coverage, earthquake, business interruption and rental loss insurance covering all of the properties in our portfolio under a blanket policy. We select policy specifications and insured limits which we believe to be appropriate given the relative risk of loss, the cost of the coverage and industry practice and, in the opinion of our company’s management, the properties in our portfolio are currently adequately insured. We do not carry insurance for generally uninsured losses such as loss from riots, war or nuclear reaction. In addition, we carry earthquake insurance on our properties in an amount and with deductibles which we believe are commercially reasonable. Certain of the properties in our portfolio are located in areas known to be seismically active. See “Risk Factors—Risks Related to Our Business and Operations—Potential losses may not be covered by insurance.”

Employees

As of December 31, 2005 we had 53 employees. None of these employees is represented by a labor union.

We entered into an arrangement with a professional employer organization (PEO) pursuant to which the PEO provides personnel management services to us. The services are provided through a co-employment relationship between us and the PEO, under which all of our employees are treated as employed by both the PEO and us. The services and benefits provided by the PEO included payroll services, workers’ compensation insurance and certain employee benefits plan coverage. Our agreement with the PEO was terminable by either party upon 30 days’ prior written notice. We terminated this agreement on January 1, 2006.

Offices

Our headquarters is located in San Francisco. We have regional offices in Boston, Chicago, Dallas, Los Angeles and New York.

 

ITEM 1A. RISK FACTORS

For purposes of this section, the term “stockholders” means the holders of shares of our common stock and of our preferred stock. Set forth below are the risks that we believe are material to our stockholders. You should carefully consider the following factors in evaluating our company, our properties and our business. The occurrence of any of the following risks might cause our stockholders to lose all or a part of their investment. Some statements in this report including statements in the following risk factors constitute forward-looking statements. Please refer to the section entitled “Forward-Looking Statements” at the end of Item 1A.

Risks Related to Our Business and Operations

Our properties depend upon the demand for technology-related real estate.

Our portfolio of properties consists primarily of technology-related real estate. A decrease in the demand for or adoption of data center space, Internet gateway facilities or other technology-related real estate could have a greater adverse effect on our business and financial condition than if we owned a portfolio with a more diversified tenant base. We are susceptible to adverse developments in the corporate data center, Internet and data communications and broader technology industries (such as business layoffs or downsizing, industry

 

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slowdowns, relocations of businesses, costs of complying with government regulations or increased regulation and other factors) and the technology-related real estate market (such as oversupply of or reduced demand for space). In addition, the rapid development of new technologies, the adoption of new industry standards or other factors could render many of our tenants’ current products and services obsolete or unmarketable and contribute to a downturn in their businesses, thereby increasing the likelihood that they default under their leases, become insolvent or file for bankruptcy.

We depend on significant tenants, and many of our properties are single-tenant properties or are currently occupied by single tenants.

As of December 31, 2005, the 15 largest tenants in our property portfolio represented approximately 61% of the total annualized rent generated by our properties. Our largest tenants by annualized rent are Savvis Communications and Qwest Communications International. Savvis Communications leased approximately 1.1 million square feet of net rentable space as of December 31, 2005, representing approximately 14.7% of the total annualized rent generated by our properties. Qwest Communications International leased approximately 655,000 square feet of net rentable space as of December 31, 2005, representing approximately 11.2% of the total annualized rent generated by our properties. In addition, 21 of our properties are occupied by single tenants. Our tenants may experience a downturn in their businesses or other factors which may weaken their financial condition and result in their failure to make timely rental payments or their default under their leases. If any tenant defaults or fails to make timely rent payments, we may experience delays in enforcing our rights as landlord and may incur substantial costs in protecting our investment.

The bankruptcy or insolvency of a major tenant may adversely affect the income produced by our properties.

If any tenant becomes a debtor in a case under the federal Bankruptcy Code, we cannot evict the tenant solely because of the bankruptcy. In addition, the bankruptcy court might authorize the tenant to reject and terminate its lease with us. Our claim against the tenant for unpaid, future rent would be subject to a statutory cap that might be substantially less than the remaining rent actually owed under the lease. In either case, our claim for unpaid rent would likely not be paid in full. At December 31, 2005 one tenant, VarTec Telecom, Inc. (VarTec) was in bankruptcy. As of December 31, 2005, VarTec leased approximately 156,000 square feet of net rentable space across three separate properties and was current on all of its rental obligations. In January 2006 VarTec notified us of its intention to file a motion to reject its lease of approximately 8,600 square feet in our 2323 Bryan Street property. The motion was granted by the bankruptcy court on February 21, 2006 and as such, this lease was rejected effective February 28, 2006. We are currently considering options to pursue appropriate economic relief through the bankruptcy court.

Our revenue and cash available for distribution, including cash available to pay dividends to our preferred stockholders or pay distributions to our common stockholders, could be materially adversely affected if any of our significant tenants were to become bankrupt or insolvent, or suffer a downturn in its business, or fail to renew its lease or renew on terms less favorable to us than its current terms.

Our portfolio of properties depends upon local economic conditions and is geographically concentrated in certain locations.

Our properties are located in the Amsterdam, Atlanta, Austin, Boston, Charlotte, Chicago, Dallas, Denver, Geneva, London, Los Angeles, Miami, Minneapolis/St. Paul, Northern Virginia, New York, Philadelphia, Phoenix, Sacramento, San Francisco and Silicon Valley metropolitan areas. We depend upon the local economic conditions in these markets, including local real estate conditions. Many of these markets experienced downturns within recent years. Our operations may also be affected if too many competing properties are built in any of these markets. If there is a downturn in the economy in any of these markets, our operations and our revenue and cash available for distribution, including cash available to pay dividends to our preferred stockholders or pay distributions to our common stockholders, could be materially adversely affected. We cannot assure you that these markets will grow or will remain favorable to technology-related real estate.

 

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In addition, our portfolio is geographically concentrated in the following metropolitan markets.

 

Metropolitan Market

   Percentage of total
annualized rent at
December 31, 2005
 

Silicon Valley

   24.3 %

Chicago

   14.9 %

Dallas

   13.0 %

San Francisco

   8.3 %

Los Angeles

   8.1 %
      

Total

   68.6 %
      

Any negative changes in real estate, technology or economic conditions in these markets in particular could negatively impact our performance.

We have owned our properties for a limited time.

We owned 43 properties at December 31, 2005. These properties are primarily located throughout the U.S. and three properties are located in Europe. The properties contain a total of approximately 8.1 million net rentable square feet, excluding 1.1 million square feet held for redevelopment. All the properties have been under our management for less than four years, and we have owned 19 of the properties for less than one year at December 31, 2005. The properties may have characteristics or deficiencies unknown to us that could affect their valuation or revenue potential. We cannot assure you that the operating performance of the properties will not decline under our management.

We have space available for redevelopment that may be difficult to redevelop or successfully lease to tenants.

We have approximately 1.1 million square feet held for redevelopment at December 31, 2005 including two vacant buildings. Successful redevelopment of this space depends on numerous factors including success in engaging contractors, obtaining legal permits and availability of financing. In addition there can be no assurance that once completed we will be able to successfully lease to new or existing tenants. If we are not able to successfully redevelop this space, if redevelopment costs are higher than we currently estimate, or if we are not able to lease space that has been redeveloped, our revenue and operating results could be adversely effected.

We may have difficulty managing our growth.

We have significantly expanded the size of our company. For example, during 2005, we acquired 19 properties, including two properties outside the United States, and our number of employees increased from 23 to 53. The growth in our company may significantly strain our management, operational and financial resources and systems. In addition, as a public company, we are subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act, the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, and the rules and regulations of the NYSE. The requirements of these rules and regulations have increased our accounting, legal and financial compliance costs and may strain our management and financial, legal and operational resources and systems. An inability to manage our growth effectively or the increased strain on management of our resources and systems could result in deficiencies in our disclosure controls and procedures or our internal control over financial reporting and could adversely affect our results of operations.

 

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We have limited operating history as a REIT and as a public company.

We were formed in March 2004 and have limited operating history as a REIT and as a public company. We cannot assure you that our past experience will be sufficient to successfully operate our company as a REIT or as a public company. Failure to maintain REIT status would have an adverse effect on our cash available for distribution, including cash available to pay dividends to our preferred stockholders or pay distributions to our common stockholders.

Tax protection provisions on certain properties could limit our operating flexibility.

We have agreed with the third-party contributors who contributed the direct and indirect interests in the 200 Paul Avenue 1-4 and 1100 Space Park Drive properties to indemnify them against adverse tax consequences if we were to sell, convey, transfer or otherwise dispose of all or any portion of these interests, in a taxable transaction, in these properties. However, we can sell these properties in a taxable transaction if we pay the contributors cash in the amount of their tax liabilities arising from the transaction and tax payments. The 200 Paul Avenue 1-4 and 1100 Space Park Drive properties represented 10.6% of our portfolio’s annualized rent as of December 31, 2005. These tax protection provisions apply for a period expiring on the earlier of November 3, 2013 and the date on which these contributors (or certain transferees) hold less than 25% of the units issued to them in connection with the contribution of these properties to our operating partnership. Although it may be in our stockholders’ best interest that we sell a property, it may be economically disadvantageous for us to do so because of these obligations. We have also agreed to make up to $20.0 million of debt available for these contributors to guarantee. We agreed to these provisions in order to assist these contributors in preserving their tax position after their contributions.

Potential losses may not be covered by insurance.

We carry comprehensive liability, fire, extended coverage, earthquake, business interruption and rental loss insurance covering all of the properties in our portfolio under various insurance policies. We select policy specifications and insured limits which we believe to be appropriate and adequate given the relative risk of loss, the cost of the coverage and industry practice. We do not carry insurance for generally uninsured losses such as loss from riots, war or nuclear reaction. Some of our policies, like those covering losses due to floods, are insured subject to limitations involving large deductibles or co-payments and policy limits which may not be sufficient to cover losses. A substantial portion of the properties we own are located in California, an area especially subject to earthquakes. Together, these properties represented approximately 42% of our portfolio’s annualized rent as of December 31, 2005. While we carry earthquake insurance on our properties, the amount of our earthquake insurance coverage may not be sufficient to fully cover losses from earthquakes. In addition, we may discontinue earthquake or other insurance on some or all of our properties in the future if the cost of premiums for any of these policies exceeds, in our judgment, the value of the coverage relative to the risk of loss.

In addition, many of our buildings contain extensive and highly valuable technology-related improvements. Under the terms of our leases, tenants generally retain title to such improvements and are obligated to maintain adequate insurance coverage applicable to such improvements and under most circumstances use their insurance proceeds to restore such improvements after a casualty. In the event of a casualty or other loss involving one of our buildings with extensive installed tenant improvements, our tenants may have the right to terminate their leases if we do not rebuild the base building within prescribed times. In such cases, the proceeds from tenants’ insurance will not be available to us to restore the improvements, and our insurance coverage may be insufficient to replicate the technology-related improvements made by such tenants. Furthermore, the terms of our mortgage indebtedness at certain of our properties may require us to pay insurance proceeds over to our lenders under certain circumstances, rather than use the proceeds to repair the property.

If we or one or more of our tenants experiences a loss which is uninsured or which exceeds policy limits, we could lose the capital invested in the damaged properties as well as the anticipated future cash flows from those

 

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properties. In addition, if the damaged properties are subject to recourse indebtedness, we would continue to be liable for the indebtedness, even if these properties were irreparably damaged.

Payments on our debt reduce cash available for distribution and may expose us to the risk of default under our debt obligations.

Our total consolidated indebtedness at December 31, 2005 was approximately $749.1 million, and we may incur significant additional debt to finance future acquisition and development activities. We also have an unsecured revolving credit facility which has a borrowing limit based upon a percentage of the value of our unsecured properties included in the facility’s borrowing base. At December 31, 2005, $56.5 million was available under this facility. In addition, under our contribution agreement with respect to the 200 Paul Avenue 1-4 and 1100 Space Park Drive properties, we have agreed to make available for guarantee up to $20.0 million of indebtedness and may enter into similar agreements in the future.

Payments of principal and interest on borrowings may leave us with insufficient cash resources to operate our properties, pay the dividends to our preferred stockholders or pay distributions to our common stockholders necessary to maintain our REIT qualification. Our level of debt and the limitations imposed on us by our debt agreements could have significant adverse consequences, including the following:

 

    our cash flow may be insufficient to meet our required principal and interest payments;

 

    we may be unable to borrow additional funds as needed or on favorable terms;

 

    we may be unable to refinance our indebtedness at maturity or the refinancing terms may be less favorable than the terms of our original indebtedness;

 

    because a significant portion of our debt bears interest at variable rates, increases in interest rates could materially increase our interest expense;

 

    we may be forced to dispose of one or more of our properties, possibly on disadvantageous terms;

 

    we may default on our obligations and the lenders or mortgagees may foreclose on our properties or our interests in the entities that own the properties that secure their loans and receive an assignment of rents and leases;

 

    we may violate restrictive covenants in our loan documents, which would entitle the lenders to accelerate our debt obligations; and

 

    our default under any one of our mortgage loans with cross default provisions could result in a default on other indebtedness.

If any one of these events were to occur, our financial condition, results of operations, cash flow, cash available for distribution, including cash available to pay dividends to our preferred stockholders or pay distributions to our common stockholders, per share trading price of our common stock or preferred stock, and our ability to satisfy our debt service obligations could be materially adversely affected. Furthermore, foreclosures could create taxable income without accompanying cash proceeds, a circumstance which could hinder our ability to meet the REIT distribution requirements imposed by the Code.

We may be unable to identify and complete acquisitions and successfully operate acquired properties.

We continually evaluate the market of available properties and may acquire additional technology-related real estate when opportunities exist. Our ability to acquire properties on favorable terms and successfully operate them may be exposed to the following significant risks:

 

    we may be unable to acquire a desired property because of competition from other real estate investors with significant capital, including both publicly traded REITs and institutional investment funds;

 

    even if we are able to acquire a desired property, competition from other potential acquirors may significantly increase the purchase price;

 

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    even if we enter into agreements for the acquisition of technology-related real estate, these agreements are subject to customary conditions to closing, including completion of due diligence investigations to our satisfaction;

 

    we may be unable to finance acquisitions on favorable terms or at all;

 

    we may spend more than budgeted amounts to make necessary improvements or renovations to acquired properties;

 

    we may be unable to integrate new acquisitions quickly and efficiently, particularly acquisitions of portfolios of properties, into our existing operations, and our results of operations and financial condition could be adversely affected;

 

    acquired properties may be subject to reassessment, which may result in higher than expected property tax payments;

 

    market conditions may result in higher than expected vacancy rates and lower than expected rental rates; and

 

    we may acquire properties subject to liabilities and without any recourse, or with only limited recourse, with respect to unknown liabilities such as liabilities for clean-up of undisclosed environmental contamination, claims by tenants, vendors or other persons dealing with the former owners of the properties and claims for indemnification by general partners, directors, officers and others indemnified by the former owners of the properties.

If we cannot finance property acquisitions on favorable terms, or operate acquired properties to meet our financial expectations, our financial condition, results of operations, cash flow, cash available for distribution, including cash available to pay dividends to our preferred stockholders or pay distributions to our common stockholders, per share trading price of our common stock or preferred stock, and ability to satisfy our debt service obligations could be materially adversely affected.

We may be unable to source off-market deal flow in the future.

A key component of our growth strategy is to continue to acquire additional technology-related real estate. To date, more than half of our acquisitions were acquired before they were widely marketed by real estate brokers, or “off-market.” Properties that are acquired off-market are typically more attractive to us as a purchaser because of the absence of competitive bidding, which could potentially lead to higher prices. We obtain access to off-market deal flow from numerous sources. If we cannot obtain off-market deal flow in the future, our ability to locate and acquire additional properties at attractive prices could be adversely affected.

We face significant competition, which may decrease or prevent increases of the occupancy and rental rates of our properties.

We compete with numerous regional developers, owners and operators of real estate, many of which own properties similar to ours in the same submarkets in which our properties are located. If our competitors offer space at rental rates below current market rates, or below the rental rates we currently charge our tenants, we may lose potential tenants and we may be pressured to reduce our rental rates below those we currently charge in order to retain tenants when our tenants’ leases expire. As a result, our financial condition, results of operations, cash flow, cash available for distribution, including cash available to pay dividends to our preferred stockholders or pay distributions to our common stockholders, per share trading price of our common stock or preferred stock, and ability to satisfy our debt service obligations could be materially adversely affected.

We may be unable to renew leases, lease vacant space or re-lease space as leases expire.

As of December 31, 2005, leases representing 2.9% of the square footage of the properties in our portfolio, excluding space held for redevelopment were scheduled to expire in 2006, and an additional 6.1% of the net rentable square footage excluding space held for redevelopment was available to be leased. We cannot assure you

 

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that leases will be renewed or that our properties will be re-leased at net effective rental rates equal to or above the current average net effective rental rates. If the rental rates for our properties decrease, our existing tenants do not renew their leases or we do not re-lease a significant portion of our available space and space for which leases are scheduled to expire, our financial condition, results of operations, cash flow, cash available for distribution, including cash available to pay dividends to our preferred stockholders or pay distributions to our common stockholders, per share trading price of our common stock or preferred stock, and our ability to satisfy our debt service obligations could be materially adversely affected.

In addition at December 31, 2005 we held approximately 1.1 million square feet held for redevelopment. Successful redevelopment of this space depends on numerous factors including success in engaging contractors, obtaining environmental and legal permits and availability of financing. In addition, there can be no assurance that once we have redeveloped a space we will be able to successfully lease to new or existing tenants. If we are not able to successfully redevelop this space, if redevelopment costs are higher than we currently estimate, or if we are not able to lease space that has been redeveloped, our revenue and operating results could be adversely effected.

Our growth depends on external sources of capital which are outside of our control.

In order to maintain our qualification as a REIT, we are required under the Internal Revenue Code of 1986 as amended (the Code) to annually distribute at least 90% of our net taxable income, determined without regard to the dividends paid deduction and excluding any net capital gain. In addition, we will be subject to income tax at regular corporate rates to the extent that we distribute less than 100% of our net taxable income, including any net capital gains. Because of these distribution requirements, we may not be able to fund future capital needs, including any necessary acquisition financing, from operating cash flow. Consequently, we rely on third-party sources to fund our capital needs. We may not be able to obtain the financing on favorable terms or at all. Any additional debt we incur will increase our leverage. Our access to third-party sources of capital depends, in part, on:

 

    general market conditions;

 

    the market’s perception of our growth potential;

 

    our current debt levels;

 

    our current and expected future earnings;

 

    our cash flow and cash distributions; and

 

    the market price per share of our common stock and preferred stock.

If we cannot obtain capital from third-party sources, we may not be able to acquire or develop properties when strategic opportunities exist, satisfy our debt service obligations or make the cash distributions to our stockholders necessary to maintain our qualification as a REIT.

Our unsecured credit facility restricts our ability to engage in some business activities.

Our unsecured credit facility contains negative covenants and other financial and operating covenants that, among other things:

 

    restrict our ability to incur additional indebtedness;

 

    restrict our ability to make certain investments;

 

    restrict our ability to merge with another company;

 

    restrict our ability to create, incur or assume liens;

 

    restrict our ability to make distributions to our stockholders;

 

    require us to maintain financial coverage ratios; and

 

    require us to maintain a pool of unencumbered assets approved by the lenders.

 

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These restrictions could cause us to default on our unsecured credit facility or negatively affect our operations and our ability to pay dividends to our preferred stockholders or distributions to our common stockholders.

Joint venture investments could be adversely affected by our lack of sole decision-making authority, our reliance on co-venturers’ financial condition and disputes between us and our co-venturers.

We may co-invest in the future with third parties through partnerships, joint ventures or other entities, acquiring non-controlling interests in or sharing responsibility for managing the affairs of a property, partnership, joint venture or other entity. In that event, we would not be in a position to exercise sole decision-making authority regarding the property, partnership, joint venture or other entity. Investments in partnerships, joint ventures, or other entities may, under certain circumstances, involve risks not present when a third party is not involved, including the possibility that partners or co-venturers might become bankrupt or fail to fund their share of required capital contributions. Partners or co-venturers may have economic or other business interests or goals which are inconsistent with our business interests or goals, and may be in a position to take actions contrary to our policies or objectives. Such investments may also lead to impasses, for example, as to whether to sell a property, because neither we nor the partner or co-venturer would have full control over the partnership or joint venture. Disputes between us and partners or co-venturers may result in litigation or arbitration that would increase our expenses and prevent our officers and/or directors from focusing their time and effort on our day-to-day business. Consequently, actions by or disputes with partners or co-venturers may subject properties owned by the partnership or joint venture to additional risk. In addition, we may in certain circumstances be liable for the actions of our third-party partners or co-venturers. Each of these factors may result in returns on these investments being less than we expect or in losses and our financial and operating results may be adversely effected.

Our success depends on key personnel whose continued service is not guaranteed.

We depend on the efforts of key personnel, particularly Michael Foust, our Chief Executive Officer, A. William Stein, our Chief Financial Officer and Chief Investment Officer, Scott Peterson, our Senior Vice President, Acquisitions and Christopher Crosby, our Senior Vice President, Sales and Technical Services. They are important to our success for many reasons, including that each has a national or regional reputation in our industry and the investment community that attracts investors and business and investment opportunities and assists us in negotiations with investors, lenders, existing and potential tenants and industry personnel. If we lost their services, our business and investment opportunities and our relationships with lenders, existing and prospective tenants and industry personnel could suffer. Many of our other senior executives also have strong technology and real estate industry reputations. As a result, we have greater access to potential acquisitions and leasing and other opportunities, and are better able to negotiate with tenants. The loss of any of these key personnel would result in the loss of these and other benefits and could adversely affect our results of operations.

Failure to hedge effectively against interest rate changes may adversely affect results of operations.

We seek to manage our exposure to interest rate volatility by using interest rate hedging arrangements, such as interest cap and interest rate swap agreements. These agreements involve risks, such as the risk that counterparties may fail to honor their obligations under these arrangements, that these arrangements may not be effective in reducing our exposure to interest rate changes and that a court could rule that such an agreement is not legally enforceable. Our policy is to use derivatives only to hedge interest rate risks related to our borrowings, not for speculative or trading purposes, and to enter into contracts only with major financial institutions based on their credit ratings and other factors. However, we may choose to change this policy in the future. Including loans currently subject to interest rate swaps, approximately 73% of our total indebtedness as of December 31, 2005 was subject to fixed interest rates. Hedging may reduce the overall returns on our investments. Failure to hedge effectively against interest rate changes may materially adversely affect our results of operations.

 

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Our properties may not be suitable for lease to traditional data center or technology office tenants without significant expenditures or renovations.

Because many of our properties contain extensive tenant improvements installed at our tenants’ expense, they may be better suited for a specific corporate enterprise data center user or technology industry tenant and could require modification in order for us to re-lease vacant space to another corporate enterprise data center user or technology industry tenant. In addition, our redevelopment space will generally require substantial improvement to be suitable for data center use. For the same reason, our properties also may not be suitable for lease to traditional office tenants without significant expenditures or renovations. As a result, we may be required to invest significant amounts or offer significant discounts to tenants in order to lease or re-lease that space, either of which could adversely effect our financial and operating results.

Ownership of properties located outside of the United States subjects us to foreign currency risks which may adversely impact our ability to make distributions.

We owned three properties located outside of the U.S. at December 31, 2005 and have a right of first offer with respect to another property. In addition, we are currently considering, and will in the future consider, additional international acquisitions.

The ownership of properties located outside of the U.S. subjects us to risk from fluctuations in exchange rates between foreign currencies and the U.S. dollar. We expect that our principal foreign currency exposure will be to the British pound and the Euro. Changes in the relation of these currencies to U.S. dollars will affect our revenues and operating margins, may materially adversely impact our financial condition, results of operations, cash flow, cash available for distribution, including cash available to pay dividends to our preferred stockholders or pay distributions to our common stockholders, per share trading price of our common stock or preferred stock, ability to satisfy our debt obligations and ability to qualify as a REIT.

We intend to attempt to mitigate the risk of currency fluctuation by financing our properties in the local currency denominations, although we cannot assure you that we will be able to do so or that this will be effective. We may also engage in direct hedging activities to mitigate the risks of exchange rate fluctuations. If we do engage in foreign currency exchange rate hedging activities, any income recognized with respect to these hedges (as well as any foreign currency gain recognized with respect to changes in exchange rates) may not qualify under the 75% gross income test or the 95% gross income test that we must satisfy annually in order to qualify and maintain our status as a REIT.

Acquisition and ownership of foreign properties involve risks greater than those faced by us in the U.S.

Foreign real estate investments generally involve certain risks not generally associated with investments in the United States. Our international acquisitions and operations are subject to a number of risks, including:

 

    acquisition risk resulting from our lack of knowledge of local real estate markets, economies and business practices and customs;

 

    our limited knowledge of and relationships with sellers and tenants in these markets;

 

    due diligence, transaction and structuring costs higher than those we may face in the U.S.;

 

    complexity and costs associated with managing international operations;

 

    difficulty in hiring qualified management, sales personnel and service providers in a timely fashion;

 

    multiple, conflicting and changing legal, regulatory, tax and treaty environments;

 

    exposure to increased taxation, confiscation or expropriation;

 

    currency transfer restrictions and limitations on our ability to distribute cash earned in foreign jurisdictions to the U.S.;

 

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    difficulty in enforcing agreements in non-U.S. jurisdictions, including those entered into in connection with our acquisitions or in the event of a default by one or more of our tenants; and

 

    political and economic instability in certain geographic regions.

Our inability to overcome these risks could adversely affect our foreign operations and could harm our business and results of operations.

Risks Related to the Real Estate Industry

Our performance and value are subject to risks associated with real estate assets and with the real estate industry.

Our ability to pay dividends to our preferred stockholders or pay distributions to our common stockholders depends on our ability to generate revenues in excess of expenses, scheduled principal payments on debt and capital expenditure requirements. Events and conditions generally applicable to owners and operators of real property that are beyond our control may decrease cash available for distribution, including cash available to pay dividends to our preferred stockholders or pay distributions to our common stockholders, and the value of our properties. These events and conditions include:

 

    local oversupply, increased competition or reduction in demand for technology-related space;

 

    inability to collect rent from tenants;

 

    vacancies or our inability to rent space on favorable terms;

 

    inability to finance property development and acquisitions on favorable terms;

 

    increased operating costs, including insurance premiums, utilities and real estate taxes;

 

    costs of complying with changes in governmental regulations; and

 

    the relative illiquidity of real estate investments.

In addition, periods of economic slowdown or recession, rising interest rates or declining demand for real estate, or the public perception that any of these events may occur, could result in a general decline in rents or an increased incidence of defaults under existing leases, which would materially adversely affect our financial condition, results of operations, cash flow, cash available for distribution, including cash available to pay dividends to our preferred stockholders or pay distributions to our common stockholders, per share trading price of our common stock or preferred stock and ability to satisfy our debt service obligations.

Illiquidity of real estate investments could significantly impede our ability to respond to adverse changes in the performance of our properties and harm our financial condition.

Because real estate investments are relatively illiquid, our ability promptly to sell properties in our portfolio in response to adverse changes in their performance may be limited, which may harm our financial condition. The real estate market is affected by many factors that are beyond our control, including:

 

    adverse changes in national and local economic and market conditions;

 

    changes in interest rates and in the availability, cost and terms of debt financing;

 

    changes in laws and regulations, fiscal policies and zoning ordinances and costs of compliance with laws and regulations, fiscal policies and ordinances;

 

    the ongoing need for capital improvements, particularly in older structures;

 

    changes in operating expenses; and

 

    civil unrest, acts of war, terrorist attacks and natural disasters, including earthquakes and floods, which may result in uninsured and underinsured losses.

 

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We could incur significant costs related to government regulation and private litigation over environmental matters.

Under various laws relating to the protection of the environment, a current or previous owner or operator of real estate may be liable for contamination resulting from the presence or discharge of hazardous or toxic substances at that property, and may be required to investigate and clean up such contamination at or emanating from that property. Such laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the presence of the contaminants, and the liability may be joint and several. Previous owners used some of our properties for industrial and retail purposes, so those properties may contain some level of environmental contamination. The presence of contamination or the failure to remediate contamination at our properties may expose us to third-party liability or materially adversely affect our ability to sell, lease or develop the real estate or to borrow using the real estate as collateral.

Some of the properties may contain asbestos-containing building materials. Environmental laws require that asbestos-containing building materials be properly managed and maintained, and may impose fines and penalties on building owners or operators for failure to comply with these requirements. These laws may also allow third parties to seek recovery from owners or operators for personal injury associated with exposure to asbestos-containing building materials.

In addition, some of our tenants, particularly those in the biotechnology and life sciences industry and those in the technology manufacturing industry, routinely handle hazardous substances and wastes as part of their operations at our properties. Environmental laws and regulations subject our tenants, and potentially us, to liability resulting from these activities or from previous industrial or retail uses of those properties. Environmental liabilities could also affect a tenant’s ability to make rental payments to us.

Existing conditions at some of our properties may expose us to liability related to environmental matters.

Independent environmental consultants have conducted Phase I or similar environmental site assessments on all of the properties in our portfolio. Site assessments are intended to discover and evaluate information regarding the environmental condition of the surveyed property and surrounding properties. These assessments do not generally include soil samplings, subsurface investigations or an asbestos survey and the assessments may fail to reveal all environmental conditions, liabilities or compliance concerns. In addition material environmental conditions, liabilities or compliance concerns may arise after these reviews are completed or may arise in the future. Future laws, ordinances or regulations may impose additional material environmental liability.

We cannot assure you that costs of future environmental compliance will not affect our ability to pay dividends to our preferred stockholders or pay distributions to our common stockholders or that such costs or other remedial measures will not have a material adverse effect on our business, assets or results of operations.

Our properties may contain or develop harmful mold or suffer from other air quality issues, which could lead to liability for adverse health effects and costs to remedy the problem.

When excessive moisture accumulates in buildings or on building materials, mold may grow, particularly if the moisture problem remains undiscovered or is not addressed over a period of time. Some molds may produce airborne toxins or irritants. Indoor air quality issues can also stem from inadequate ventilation, chemical contamination from indoor or outdoor sources and other biological contaminants such as pollen, viruses and bacteria. Indoor exposure to airborne toxins or irritants above certain levels can be alleged to cause a variety of adverse health effects and symptoms, including allergic or other reactions. As a result, the presence of significant mold or other airborne contaminants at any of our properties could require us to undertake a costly remediation program to contain or remove the mold or other airborne contaminants from the affected property or increase indoor ventilation. In addition, the presence of significant mold or other airborne contaminants could expose us to liability from our tenants, employees of our tenants and others if property damage or health concerns arise.

 

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We may incur significant costs complying with the Americans with Disabilities Act and similar laws.

Under the Americans with Disabilities Act of 1990, or the ADA, all public accommodations must meet federal requirements related to access and use by disabled persons. We have not conducted an audit or investigation of all of our properties to determine our compliance with the ADA. If one or more of the properties in our portfolio does not comply with the ADA, then we would be required to incur additional costs to bring the property into compliance. Additional federal, state and local laws also may require modifications to our properties, or restrict our ability to renovate our properties. We cannot predict the ultimate cost of compliance with the ADA or other legislation. If we incur substantial costs to comply with the ADA and any other similar legislation, our financial condition, results of operations, cash flow, cash available for distribution, including cash available to pay dividends to our preferred stockholders or pay distributions to our common stockholders, per share trading price of our common stock or preferred stock and our ability to satisfy our debt service obligations could be materially adversely affected.

We may incur significant costs complying with other regulations.

The properties in our portfolio are subject to various federal, state and local regulations, such as state and local fire and life safety regulations. If we fail to comply with these various regulations, we may have to pay fines or private damage awards. In addition, we do not know whether existing regulations will change or whether future regulations will require us to make significant unanticipated expenditures that will materially adversely impact our financial condition, results of operations, cash flow, cash available for distribution, including cash available to pay dividends to our preferred stockholders or pay distributions to our common stockholders, per share trading price of our common stock or preferred stock and our ability to satisfy our debt service obligations.

Risks Related to Our Organizational Structure

Conflicts of interest may exist or could arise in the future with holders of units in our operating partnership.

Conflicts of interest may exist or could arise in the future as a result of the relationships between us and our affiliates, on the one hand, and our operating partnership or any partner thereof, on the other. Our directors and officers have duties to our company and our stockholders under Maryland law in connection with their management of our company. At the same time, we, as general partner, have fiduciary duties under Maryland law to our operating partnership and to the limited partners in connection with the management of our operating partnership. Our duties as general partner to our operating partnership and its partners may come into conflict with the duties of our directors and officers to our company and our stockholders. Under Maryland law, a general partner of a Maryland limited partnership owes its limited partners the duties of good faith, fairness and loyalty, unless the partnership agreement provides otherwise. The partnership agreement of our operating partnership provides that for so long as we own a controlling interest in our operating partnership, any conflict that cannot be resolved in a manner not adverse to either our stockholders or the limited partners will be resolved in favor of our stockholders.

The provisions of Maryland law that allow the fiduciary duties of a general partner to be modified by a partnership agreement have not been tested in a court of law, and we have not obtained an opinion of counsel covering the provisions set forth in the partnership agreement that purport to waive or restrict our fiduciary duties.

We are also subject to the following additional conflicts of interest with holders of units in our operating partnership:

We may pursue less vigorous enforcement of terms of certain agreements because of conflicts of interest with GI Partners and certain of our officers. GI Partners, which owned a 40.2% interest in our operating partnership at December 31, 2005, owns the property on which we have a right of first offer. In addition, GI Partners has entered into a non-competition agreement with us pursuant to which it agreed, among other things, not to compete with us in certain business activities. Richard Magnuson, the Executive Chairman of our board of directors, is also, and will continue to be, the chief executive officer of the advisor to GI Partners. He and certain

 

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of our other senior executives have entered into employment agreements with us containing non-competition provisions. None of these right of first offer, employment and non-competition agreements was negotiated at arm’s-length. We may choose not to enforce, or to enforce less vigorously, our rights under these right of first offer, employment and non-competition agreements because of our desire to maintain our ongoing relationship with GI Partners and the other individuals involved.

Tax consequences upon sale or refinancing. Sales of properties and repayment of related indebtedness will affect holders of common units in our operating partnership and our stockholders differently. The parties who contributed the 200 Paul Avenue 1-4 and 1100 Space Park Drive properties to our operating partnership would incur adverse tax consequences upon the sale of these properties and on the repayment of related debt which differ from the tax consequences to us and our stockholders. Consequently, these holders of common units in our operating partnership may have different objectives regarding the appropriate pricing and timing of any such sale or repayment of debt. While we have exclusive authority under the limited partnership agreement of our operating partnership to determine when to refinance or repay debt or whether, when, and on what terms to sell a property, any such decision would require the approval of our board of directors. Certain of our directors and executive officers could exercise their influence in a manner inconsistent with the interests of some, or a majority, of our stockholders, including in a manner which could prevent completion of a sale of a property or the repayment of indebtedness.

Our charter and Maryland law contain provisions that may delay, defer or prevent a change of control transaction.

Our charter and the articles supplementary with respect to the preferred stock contain 9.8% ownership limits. Our charter, subject to certain exceptions, authorizes our directors to take such actions as are necessary and desirable to preserve our qualification as a REIT and to limit any person to actual or constructive ownership of no more than 9.8% (by value or by number of shares, whichever is more restrictive) of the outstanding shares of our common stock, 9.8% (by value or by number of shares, whichever is more restrictive) of the outstanding shares of any series of preferred stock and 9.8% of the value of our outstanding capital stock. Our board of directors, in its sole discretion, may exempt a proposed transferee from the ownership limit. However, our board of directors may not grant an exemption from the ownership limit to any proposed transferee whose direct or indirect ownership of more than 9.8% of the outstanding shares of our common stock, more than of 9.8% of the outstanding shares of any series of preferred stock or more than 9.8% of the value of our outstanding capital stock could jeopardize our status as a REIT. These restrictions on transferability and ownership will not apply if our board of directors determines that it is no longer in our best interests to attempt to qualify, or to continue to qualify, as a REIT. The ownership limit may delay, defer or prevent a transaction or a change of control that might be in the best interest of our common or preferred stockholders.

We could increase the number of authorized shares of stock and issue stock without stockholder approval. Our charter authorizes our board of directors, without stockholder approval, to increase the aggregate number of authorized shares of stock or the number of authorized shares of stock of any class or series, to issue authorized but unissued shares of our common stock or preferred stock and, subject to the voting rights of holders of preferred stock, to classify or reclassify any unissued shares of our common stock or preferred stock and to set the preferences, rights and other terms of such classified or reclassified shares. Although our board of directors has no such intention at the present time, it could establish a series of preferred stock that could, depending on the terms of such series, delay, defer or prevent a transaction or a change of control that might be in the best interest of our common or preferred stockholders.

Certain provisions of Maryland law could inhibit changes in control. Certain provisions of the MGCL may have the effect of impeding a third party from making a proposal to acquire us or of impeding a change of control under circumstances that otherwise could be in the best interests of our common or preferred stockholders, including:

 

   

“business combination” provisions that, subject to limitations, prohibit certain business combinations between us and an “interested stockholder” (defined generally as any person who beneficially owns 10%

 

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or more of the voting power of our shares or an affiliate or associate of ours who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of our then outstanding voting shares) or an affiliate thereof for five years after the most recent date on which the stockholder becomes an interested stockholder, and thereafter imposes special appraisal rights and special stockholder voting requirements on these combinations; and

 

    “control share” provisions that provide that “control shares” of our company (defined as shares which, when aggregated with other shares controlled by the stockholder, entitle the stockholder to exercise one of three increasing ranges of voting power in electing directors) acquired in a “control share acquisition” (defined as the direct or indirect acquisition of ownership or control of “control shares”) have no voting rights except to the extent approved by our stockholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter, excluding all interested shares.

We have opted out of these provisions of the MGCL, in the case of the business combination provisions of the MGCL by resolution of our board of directors, and in the case of the control share provisions of the MGCL pursuant to a provision in our bylaws. However, our board of directors may by resolution elect to opt in to the business combination provisions of the MGCL and we may, by amendment to our bylaws, opt in to the control share provisions of the MGCL in the future.

The provisions of our charter on removal of directors and the advance notice provisions of the bylaws could delay, defer or prevent a transaction or a change of control of our company that might be in the best interest of our common or preferred stockholders. Likewise, if our company’s board of directors were to opt in to the business combination provisions of the MGCL or the provisions of Title 3, Subtitle 8 of the MGCL, or if the provision in our bylaws opting out of the control share acquisition provisions of the MGCL were rescinded, these provisions of the MGCL could have similar anti-takeover effects. Further, our partnership agreement provides that our company may not engage in any merger, consolidation or other combination with or into another person, sale of all or substantially all of our assets or any reclassification or any recapitalization or change in outstanding shares of our common stock, unless in connection with such transaction we obtain the consent of the holders of at least 35% of our operating partnership’s common and long-term incentive units (including units held by us), and certain other conditions are met.

Our board of directors may change our investment and financing policies without stockholder approval and we may become more highly leveraged, which may increase our risk of default under our debt obligations.

Our board of directors adopted a policy of limiting our indebtedness to 60% of our total market capitalization. Our total market capitalization is defined as the sum of the market value of our outstanding common stock (which may decrease, thereby increasing our debt to total capitalization ratio), excluding options issued under our incentive award plan, plus the aggregate value of the units not held by us, plus the liquidation preference of outstanding preferred stock, plus the book value of our total consolidated indebtedness. However, our organizational documents do not limit the amount or percentage of indebtedness, funded or otherwise, that we may incur. Our board of directors may alter or eliminate our current policy on borrowing at any time without stockholder approval. If this policy changed, we could become more highly leveraged which could result in an increase in our debt service and which could materially adversely affect our cash flow and our ability to make distributions, including cash available to pay dividends to our preferred stockholders or pay distribution to our common stockholders. Higher leverage also increases the risk of default on our obligations.

Our rights and the rights of our stockholders to take action against our directors and officers are limited.

Maryland law provides that our directors and officers have no liability in their capacities as directors or officers if they perform their duties in good faith, in a manner they reasonably believe to be in our best interests and with the care that an ordinarily prudent person in a like position would use under similar circumstances. As

 

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permitted by the MGCL, our charter limits the liability of our directors and officers to us and our stockholders for money damages, except for liability resulting from:

 

    actual receipt of an improper benefit or profit in money, property or services; or

 

    a final judgment based upon a finding of active and deliberate dishonesty by the director or officer that was material to the cause of action adjudicated.

In addition, our charter authorizes us to obligate our company, and our bylaws require us, to indemnify our directors and officers for actions taken by them in those capacities to the maximum extent permitted by Maryland law and we have entered in indemnification agreements with our officers and directors. As a result, we and our stockholders may have more limited rights against our directors and officers than might otherwise exist under common law. Accordingly, in the event that actions taken in good faith by any of our directors or officers impede the performance of our company, your ability to recover damages from that director or officer will be limited.

Risks Related to Our Status as a REIT

Failure to qualify as a REIT would have significant adverse consequences to us and the value of our stock.

We have operated and intend to continue operating in a manner that we believe will allow us to qualify as a REIT for federal income tax purposes under the Code. We have not requested and do not plan to request a ruling from the IRS that we qualify as a REIT. If we lose our REIT status, we will face serious tax consequences that would substantially reduce our cash available for distribution, including cash available to pay dividends to our preferred stockholders or pay distributions to our common stockholders, for each of the years involved because:

 

    we would not be allowed a deduction for distributions to stockholders in computing our taxable income and would be subject to federal income tax at regular corporate rates;

 

    we also could be subject to the federal alternative minimum tax and possibly increased state and local taxes; and

 

    unless we are entitled to relief under applicable statutory provisions, we could not elect to be taxed as a REIT for four taxable years following the year during which we were disqualified.

In addition, if we fail to qualify as a REIT, we will not be required to make distributions to stockholders. As a result of all these factors, our failure to qualify as a REIT also could impair our ability to expand our business and raise capital, and would materially adversely affect the value of our capital stock.

Qualification as a REIT involves the application of highly technical and complex Code provisions for which there are only limited judicial and administrative interpretations. The complexity of these provisions and of the applicable Treasury Regulations that have been promulgated under the Code is greater in the case of a REIT that, like us, holds its assets through a partnership. Our ability to qualify as a REIT may be affected by facts and circumstances that are not entirely within our control. In order to qualify as a REIT, we must satisfy a number of requirements, including requirements regarding the composition of our assets and a requirement that at least 95% of our gross income in any year must be derived from qualifying sources, such as “rents from real property.” Also, we must make distributions to stockholders aggregating annually at least 90% of our net taxable income, excluding net capital gains. In addition, legislation, new regulations, administrative interpretations or court decisions may materially adversely affect our investors, our ability to qualify as a REIT for federal income tax purposes or the desirability of an investment in a REIT relative to other investments.

Even if we qualify as a REIT for federal income tax purposes, we may be subject to some federal, state and local taxes on our income or property and, in certain cases, a 100% penalty tax, in the event we sell property as a dealer. In addition, our domestic taxable REIT subsidiary could be subject to Federal and state taxes and our foreign properties and companies are subject to tax in the jurisdictions in which they operate and are located.

 

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To maintain our REIT status, we may be forced to borrow funds on a short-term basis during unfavorable market conditions.

To qualify as a REIT, we generally must distribute to our stockholders at least 90% of our net taxable income each year, excluding capital gains, and we will be subject to regular corporate income taxes to the extent that we distribute less than 100% of our net taxable income each year. In addition, we will be subject to a 4% nondeductible excise tax on the amount, if any, by which distributions paid by us in any calendar year are less than the sum of 85% of our ordinary income, 95% of our capital gain net income and 100% of our undistributed income from prior years. In order to maintain our REIT status and avoid the payment of income and excise taxes, we may need to borrow funds on a short-term basis to meet the REIT distribution requirements even if the then prevailing market conditions are not favorable for these borrowings. These short-term borrowing needs could result from differences in timing between the actual receipt of cash and inclusion of income for federal income tax purposes, or the effect of non-deductible capital expenditures, the creation of reserves or required debt or amortization payments.

The ability of our board of directors to revoke our REIT election without stockholder approval may cause adverse consequences to our stockholders.

Our charter provides that our board of directors may revoke or otherwise terminate our REIT election, without the approval of our stockholders, if it determines that it is no longer in our best interests to continue to qualify as a REIT. If we cease to qualify as a REIT, we would become subject to U.S. federal income tax on our taxable income and we would no longer be required to distribute most of our taxable income to our stockholders, which may have adverse consequences on the total return to our common or preferred stockholders.

Forward-Looking Statements

We make statements in this report that are forward-looking statements within the meaning of the federal securities laws. In particular, statements pertaining to our capital resources, portfolio performance and results of operations contain forward-looking statements. Likewise, all of our statements regarding anticipated market conditions, demographics and results of operations are forward-looking statements. You can identify forward-looking statements by the use of forward-looking terminology such as “believes,” “expects,” “may,” “will,” “should,” “seeks,” “approximately,” “intends,” “plans,” “pro forma,” “estimates” or “anticipates” or the negative of these words and phrases or similar words or phrases which are predictions of or indicate future events or trends and which do not relate solely to historical matters. You can also identify forward looking statements by discussions of strategy, plans or intentions.

Forward-looking statements involve numerous risks and uncertainties and you should not rely on them as predictions of future events. Forward-looking statements depend on assumptions, data or methods which may be incorrect or imprecise and we may not be able to realize them. We do not guarantee that the transactions and events described will happen as described (or that they will happen at all). The following factors, among others, could cause actual results and future events to differ materially from those set forth or contemplated in the forward-looking statements:

 

    adverse economic or real estate developments in our markets or the technology industry;

 

    our dependence upon significant tenants;

 

    our inability to comply with the rules and regulations applicable to public companies or to manage our growth effectively;

 

    difficulty acquiring or operating properties in foreign jurisdictions;

 

    defaults on or non-renewal of leases by tenants;

 

    increased interest rates and operating costs;

 

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    our failure to obtain necessary outside financing;

 

    decreased rental rates or increased vacancy rates;

 

    difficulties in identifying properties to acquire and completing acquisitions;

 

    our failure to successfully operate acquired properties and operations;

 

    our failure to maintain our status as a REIT;

 

    possible adverse changes to tax laws;

 

    environmental uncertainties and risks related to natural disasters;

 

    financial market fluctuations;

 

    changes in foreign currency exchange rates;

 

    changes in foreign laws and regulations, including those related to taxation and real estate ownership and operation;

 

    changes in real estate and zoning laws and increases in real property tax rates; and

 

    inability to successfully develop and lease space held for redevelopment.

While forward-looking statements reflect our good faith beliefs, they are not guaranties of future performance. We disclaim any obligation to publicly update or revise any forward-looking statement to reflect changes in underlying assumptions or factors, new information, data or methods, future events or other changes. For a further discussion of these and other factors that could impact our future results, performance or transactions, see the sections above.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

 

ITEM 2. PROPERTIES

Our Portfolio

As of December 31, 2005, we owned 43 properties through our operating partnership. These properties are primarily located throughout the U.S., with three properties located in Europe, and contain a total of approximately 8.1 million net rentable square feet excluding 1.1 million square feet held for redevelopment. The following table presents an overview of our portfolio of properties, based on information as of December 31, 2005.

 

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Property(1)

 

Metropolitan Area

  Percent
Ownership
    Year
built/renovated
 

Net

Rentable
Square Feet
Excluding
Redevelopment
Space(2)

  Redevelopment
Space(3)
  Percent
leased(4)
    Annualized
Rent
($000)(5)
 

Annualized
Rent per
Leased
Square
Foot

($000)(6)

Internet Gateways

               

350 East Cermak Road

  Chicago   100.0 %   1912-1929/2000   870,183   263,208   92.2 %   $ 18,640   $ 23.23

200 Paul Avenue 1-4

  San Francisco   100.0     1955/1999 & 2001   494,608   37,630   95.8       12,881     27.18

2323 Bryan Street

  Dallas   100.0     1983   457,217   19,890   82.0       8,455     22.55

600 West Seventh Street

  Los Angeles   100.0     1922/1999   430,759   59,319   90.8       7,858     20.09

600-780 S. Federal

  Chicago   100.0     1912/1982   161,547   —     84.1       4,405     32.42

6 Braham Street(7)

  London, England   100.0     1983/1999   63,233   —     100.0       3,816     60.35

1100 Space Park Drive

  Silicon Valley   100.0     2001   82,409   85,542   94.9       3,598     46.01

36 NE 2nd Street

  Miami   100.0     1927/1999   162,140   —     81.2       3,232     24.55

731 East Trade Street

  Charlotte   100.0     1999/2000/2001   40,879   —     100.0       1,007     24.63

113 North Myers

  Charlotte   100.0     1999/2000/2001   18,717   10,501   100.0       444     23.72

125 North Myers

  Charlotte   100.0     1999/2000/2001   12,151   13,242   85.8       229     21.97
                       
        2,793,843   489,332   90.2       64,565     25.61

Data Centers

               

833 Chestnut Street

  Philadelphia   100.0     1927/1998   535,098   119,660   91.5       7,222     14.75

300 Boulevard East

  New York   100.0     1989/2000   311,950   —     87.4       6,867     25.19

2045 & 2055 LaFayette Street

  Silicon Valley   100.0     2000   300,000   —     100.0       5,940     19.80

150 South First Street

  Silicon Valley   100.0     1987/1999   187,334   —     98.5       4,750     25.74

11830 Webb Chapel Road

  Dallas   100.0     1966/2000   365,648   —     93.3       4,689     13.74

2334 Lundy Place

  Silicon Valley   100.0     1982-83/2001   130,752   —     100.0       3,932     30.07

2401 Walsh Street

  Silicon Valley   100.0     1973/2000   167,932   —     100.0       3,028     18.03

200 North Nash Street

  Los Angeles   100.0     1975/1998-99   113,606   —     100.0       2,048     18.03

2403 Walsh Street

  Silicon Valley   100.0     1972/1999   103,940   —     100.0       1,874     18.03

Paul van Vlissingenstraat 16(7)(12)

  Amsterdam, Netherlands   100.0     1988/2000   112,472   —     62.0       1,658     23.78

4700 Old Ironsides Drive

  Silicon Valley   100.0     1977/2000   90,139   —     100.0       1,625     18.03

8534 Concord Center Drive

  Denver   100.0     2001   82,229   —     100.0       1,521     18.50

3065 Gold Camp Drive

  Sacramento   100.0     1983/2000   62,957   —     100.0       1,487     23.62

3015 Winona Avenue

  Los Angeles   100.0     1991   82,911   —     100.0       1,414     17.05

251 Exchange Place

  Northern Virginia   100.0     1984   70,982   —     100.0       1,374     19.36

2440 Marsh Lane

  Dallas   100.0     1999   135,250   —     100.0       1,353     10.00

1125 Energy Park Drive

  Minneapolis/St. Paul   100.0     1947/1999   88,134   —     100.0       1,340     15.20

3300 East Birch Street

  Los Angeles   100.0     1981/2000   68,807   —     100.0       1,228     17.85

Chemin de l’Epinglier 2(7)

  Geneva, Switzerland   100.0     1984/2003   59,190   —     100.0       1,176     19.87

375 Riverside Parkway

  Atlanta   100.0     1998   126,300   123,891   100.0       1,138     9.01

7500 & 7520 Metro Center Drive

  Austin   100.0     2000   45,000   74,962   100.0       551     12.24

3 Corporate Place

  New York   100.0     1974/1993-1996   —     283,124   —         —       —  

115 Second Avenue

  Boston   100.0     1960/2001   12,500   55,569       —       —  
                       
        3,253,131      657,206   94.9         56,215     18.22

 

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Property(1)

 

Metropolitan Area

  Percent
Ownership
    Year
built/renovated
   

Net

Rentable
Square Feet
Excluding
Redevelopment
Space(2)

  Redevelopment
Space(3)
  Percent
leased(4)
    Annualized
Rent
($000)(5)
 

Annualized
Rent per
Leased
Square
Foot

($000)(6)

Technology Manufacturing

               

34551 Ardenwood Boulevard 1-4

  Silicon Valley   100.0 %   1985-86     307,657   —     100.0 %   $ 7,941   $ 25.81

47700 Kato Road & 1055 Page Avenue

  Silicon Valley   100.0     1991 & 1997 (8)   183,050   —     100.0       3,472     18.97

2010 East Centennial Circle(9)

  Phoenix   100.0     2002     113,405   —     100.0       2,549     22.48
                       
        604,112   —     100.0       13,962     23.11

Technology Office

               

100 & 200 Quannapowitt Parkway

  Boston   100.0     1957 & 1999 (10)   386,956   —     100.0       5,989     15.48

100 Technology Center Drive

  Boston   100.0     1989/2001     197,000   —     100.0       3,743     19.00

4055 Valley View Lane

  Dallas   100.0     1999     240,065   —     94.3       3,435     15.17

7979 East Tufts Avenue

  Denver   98.0 (11)   1982     366,184   —     89.0       3,286     10.08

4849 Alpha Road

  Dallas   100.0     1999     125,538   —     100.0       2,263     18.03

4650 Old Ironsides Drive

  Silicon Valley   100.0     1977/2000     84,383   —     100.0       1,521     18.02
                       
        1,400,126   —     96.1       20,237     15.03
                       

Portfolio Total/Weighted Average

        8,051,212   1,146,538   93.9 %   $ 154,979   $ 20.51
                           

 

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(1) We have categorized the properties in our portfolio by their principal use based on annualized rent. However, many of our properties support multiple uses.
(2) Net rentable square feet at a building represents the current square feet at that building under lease as specified in the lease agreements plus management’s estimate of space available for lease based on engineering drawings. Net rentable square feet includes tenants’ proportional share of common areas but excludes space held for redevelopment.
(3) Redevelopment space is unoccupied space that requires significant capital investment in order to develop data center facilities that are ready for use. Most often this is shell space. However, in certain circumstances this may include partially built data center space that was not completed by previous ownership and requires a large capital investment in order to build out the space.
(4) Excludes space held for redevelopment. Includes unoccupied space for which we are receiving rent and excludes space for which leases had commenced as of December 31, 2005 but for which we are not receiving rent. We completed a review of space held for redevelopment in the quarter ended September 30, 2005 and have not amended filings for earlier periods. This will cause occupancy statistics for these periods to not be comparable to the December 31, 2005 occupancy statistics presented in this filing.
(5) Annualized rent represents monthly contractual rent under existing leases as of December 31, 2005 multiplied by twelve. This amount reflects total base rent before any one-time or non-recurring rent abatements but after annually recurring rent credits and is shown on a net basis; thus, for any tenant under a partial gross lease, the expense stop, or under a full gross lease, the current year operating expenses (which may be estimates as of such date), are subtracted from gross rent.
(6) Annualized rent per leased square foot represents annualized rent as computed above, divided by the total square footage under lease as of the same date.
(7) Rental amounts for 6 Braham Street were calculated based on the exchange rate in effect on December 31, 2005 of $1.72 per £1.00 and rental amounts for Paul van Vlissingenstraat 16 and Chemin de l’Epinglier 2 were calculated based on the exchange rate in effect on December 31, 2005 of $1.18 per € 1.00. Chemin de l’Epinglier 2 is subject to a ground lease which expires in July 2074.
(8) 1055 Page Avenue was built in 1991 and 47700 Kato Road was built in 1997.
(9) We own the subsidiary that is party to a ground sublease for this property. The term of the ground sublease expires on December 31, 2082.
(10) 100 Quannapowitt was built in 1999 and 200 Quannapowitt was built in 1957 and has subsequently been renovated.
(11) We indirectly own a 98% interest in a subsidiary that holds the fee simple interest in this property. An unrelated third party holds the remaining 2% interest in this subsidiary.
(12) We are party to a ground sublease for this property. The term of the ground sublease expires on April 2054.

 

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Tenant Diversification

As of December 31, 2005 our portfolio was leased to more than 205 companies, many of which are nationally recognized firms. The following table sets forth information regarding the 15 largest tenants in our portfolio based on annualized rent as of December 31, 2005.

 

Tenant

  

Property

  

Lease

Expiration(1)

   Total
Leased
Square Feet
    Percentage of
Net Rentable
Square Feet(2)
    Annualized
Rent
(thousands)
   Percentage
of Portfolio
Annualized
Rent
 

Savvis Communications

               
   300 Boulevard East    Sep. 2013    $ 234,570     2.9 %   $ 6,099    3.9 %
   2045 & 2055 LaFayette Street(3)    Sep. 2015      300,000     3.7       5,940    3.8  
   2401 Walsh Street    Feb. 2019      167,932     2.1       3,028    2.0  
   200 North Nash Street    Feb. 2019      113,606     1.4       2,048    1.3  
   2403 Walsh Street    Feb. 2019      103,940     1.3       1,874    1.2  
   4700 Old Ironsides Drive    Feb. 2019      90,139     1.1       1,625    1.1  
   4650 Old Ironsides Drive    Feb. 2019      84,383     1.1       1,521    1.0  
   36 NE 2nd Street    Aug. 2009      23,805     0.3       631    0.4  
   2323 Bryan Street    Sep. 2009      1,026     —         9    —    
                                 
           1,119,401     13.9       22,775    14.7  

Qwest Communications International, Inc.  

   350 East Cermak Road    Jun. 2015      142,346     1.8       3,300    2.1  
   200 Paul Avenue 1-4    Aug. 2015      65,622     0.8       2,901    1.9  
   350 East Cermak Road    Jun. 2015      74,412     0.9       2,680    1.7  
   36 NE 2nd Street    Feb. 2014      78,540     1.0       1,642    1.1  
   600 West Seventh Street    Jan. 2020      68,000     0.9       1,482    1.0  
   3015 Winona Avenue    Jan. 2011      82,911     1.0       1,414    0.9  
   350 East Cermak Road    Jun. 2015      50,000     0.6       1,159    0.7  
   731 East Trade Street    Jun. 2020      40,879     0.5       1,007    0.6  
   200 Paul Avenue 1-4    Aug. 2015      24,205     0.3       893    0.6  
   2323 Bryan Street    Apr. 2008      20,135     0.3       636    0.4  
   113 North Myers    Nov. 2019      3,806     0.1       87    0.1  
   2323 Bryan Street    Apr. 2008      3,650     —         81    0.1  
   600-780 S. Federal    Sept. 2010      978     —         57    —    
   1100 Space Park Drive    Aug. 2011      10 (4)   —         20    —    
                                 
           655,494     8.1       17,359    11.2  

Verio, Inc.(5)

   2334 Lundy Place    May 2010      130,752     1.7       3,932    2.5  
   350 East Cermak Road(5)    Aug. 2015      107,299     1.3       2,552    1.7  
                                 
           238,051     3.0       6,484    4.2  

Comverse Network Systems

   100 & 200 Quannapowitt Parkway    Feb. 2011      166,109     2.1       2,990    2.0  
   100 & 200 Quannapowitt Parkway    Feb. 2011      199,033     2.5       2,680    1.7  
   100 & 200 Quannapowitt Parkway    Feb. 2011      1,891     0       20    —    
                                 
           367,033     4.6       5,690    3.7  

Equinix, Inc.  

   350 East Cermak Road    Mar. 2015      195,080     2.4       2,997    1.9  
   600 West Seventh Street    Oct. 2015      129,274     1.6       2,430    1.6  
                                 
           324,354     4.0       5,427    3.5  

Abgenix(6)

   34551 Ardenwood Boulevard 1-4    Apr. 2011      73,887     0.9       3,475    2.2  
   34551 Ardenwood Boulevard 1-4    Apr. 2011      33,499     0.4       1,000    0.7  
   34551 Ardenwood Boulevard 1-4    Apr. 2011      24,000     0.3       671    0.4  
                                 
           131,386     1.6       5,146    3.3  

 

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Tenant

  

Property

  

Lease

Expiration(1)

   Total
Leased
Square Feet
    Percentage of
Net Rentable
Square Feet(2)
    Annualized
Rent
(thousands)
   Percentage
of Portfolio
Annualized
Rent
 

AT&T

   11830 Webb Chapel Road    Nov. 2010    141,663     1.8       2,773    1.8  
   7500 & 7520 Metro Center Drive    Mar. 2016    126,300     1.6       1,138    0.7  
   1100 Space Park Drive    Jul. 2011    14,035     0.2       620    0.4  
   600-780 S. Federal    Jan. 2006    5,137     0.1       171    0.1  
   2323 Bryan Street    Sept. 2006    2,197     0.0       62    0.0  
   200 Paul Avenue 1-4    Nov. 2009    10 (4)   0.0       18    0.0  
   113 North Myers    Aug. 2011    1 (4)   0.0       3    0.0  
                               
         289,343     3.6       4,785    3.1  

AboveNet, Inc.

   150 South First Street    Nov. 2019    131,721     1.7       3,723    2.4  
   600-780 S. Federal    Aug. 2010    19,112     0.2       655    0.4  
   2323 Bryan Street    Apr. 2014    3,372     —         64    0.1  
   200 Paul Avenue 1-4    Sept. 2010    10 (4)   —         33    —    
                               
         154,215     1.9       4,475    2.9  

Leslie & Godwin(7)

   6 Braham Street    Dec. 2009    63,233     0.8       3,816    2.5 (8)

Stone & Webster, Inc.(9)

   100 Technology Center Drive    Mar. 2013    197,000     2.4       3,743    2.4  

Maxtor Corporation(10)

   47700 Kato Road & 1055 Page Avenue    Sep. 2011    183,050     2.3       3,472    2.2  

XO Communications

   200 Paul Avenue 1-4    Feb. 2015    64,907     0.8       2,098    1.3  
   600 West Seventh Street    Aug. 2015    29,000     0.4       555    0.4  
   600-780 S. Federal    Oct. 2006    322 (4)   —         100    0.1  
   2323 Bryan Street    Oct. 2008    2,559     —         92    0.1  
   350 East Cermak Road    Sept. 2015    1,747     —         61    —    
   4055 Valley View Lane    Sept. 2009    343 (4)   —         7    —    
                               
         98,878     1.2       2,913    1.9  

VSNL Networks, Inc.

   1100 Space Park Drive    Nov. 2016    59,289     0.7       2,803    1.8  

Thomas Jefferson University

   833 Chestnut Street    Jul. 2008    63,500     0.8       938    0.6  
   833 Chestnut Street    Apr. 2015    28,503     0.4       314    0.2  
   833 Chestnut Street    Oct. 2010    18,017     0.2       297    0.2  
   833 Chestnut Street    Dec. 2011    16,313     0.2       259    0.2  
   833 Chestnut Street    Feb. 2011    12,787     0.2       189    0.1  
   833 Chestnut Street    Aug. 2009    11,979     0.1       186    0.1  
   833 Chestnut Street    Jun. 2012    7,068     0.1       112    0.1  
   833 Chestnut Street    Nov. 2012    5,076     0.1       89    0.1  
   833 Chestnut Street    Dec. 2008    6,312     0.1       87    0.1  
   833 Chestnut Street    Nov. 2009    5,261     0.1       82    0.1  
   833 Chestnut Street    Mar. 2008    2,379     —         33    —    
   833 Chestnut Street    Feb. 2009    1,478     —         23    —    
   833 Chestnut Street    Mar. 2012    986     —         17    —    
                               
         179,659     2.2       2,626    1.7  

ASM Lithography

   2010 East Centennial Circle    Feb. 2017    113,405     1.4       2,549    1.6  
                               

Total, Top 15 tenants

         4,173,791     51.7 %   $ 94,063    60.7 %
                               

(1) Assumes the exercise of no renewal options and the exercise of all early termination options.
(2) Net rentable square feet excludes 1.1 million square feet held for development at December 31, 2005.
(3) Microsoft Corporation subleases a portion of Savvis’ space in this property. Microsoft has the right to become the main tenant if Savvis defaults on the lease.
(4) Telecommunications colocation space.
(5) Verio, Inc. is a wholly owned subsidiary of Nippon Telegraph & Telephone. In July 2005, Verio and Equinix executed an agreement to sublease, pursuant to which Verio will sublease all of its space in 350 East Cermak Road to Equinix.
(6) Amgen signed an agreement to acquire Abgenix in December 2005.
(7)

Leslie & Godwin is a United Kingdom subsidiary of AON Corporation. 100% of the 6 Braham Street property is subleased by Level 3 Communications from Leslie & Godwin through December 2009. Leslie &

 

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Godwin remains liable to us for rents under its lease. Subject to a payment by Level 3 Communications, which we can waive, Level 3 Communications is obligated to take a further lease of this property for a term expiring in 2015, subject to one five-year extension option. Including the 6 Braham Street sublease, Level 3 Communications occupies a total of 106,223 square feet of net rentable space in our buildings at an aggregate annualized rent of approximately $4.9 million.

(8) Rental amounts for 6 Braham Street were calculated based on the exchange rate in effect on December 31, 2005 at $1.72 per £1.00.
(9) Stone & Webster, Inc. is the primary operating unit of the Engineering, Construction and Maintenance segment of The Shaw Group Inc.
(10) Seagate Technology signed an agreement to acquire Maxtor in December 2005.

Lease Distribution

The following table sets forth information relating to the distribution of leases in the properties in our portfolio, based on net rentable square feet (excluding space held for redevelopment) under lease as of December 31, 2005.

 

Square Feet Under Lease

  

Number

of
Leases

   Percentage of
All Leases
    Total
Leased
Square Feet
  

Percentage

of Portfolio
Leased
Square Feet

    Annualized
Rent ($000)
  

Percentage

of Portfolio
Annualized
Rent

 

Available (1)

   —      —       494,232    6.1 %     

2,500 or less

   235    51.2 %   128,648    1.6 %     5,070    3.3 %

2,501-10,000

   90    19.6 %   479,993    6.1 %     12,229    7.9 %

10,001-20,000

   44    9.6 %   647,115    8.0 %     13,730    8.9 %

20,001-40,000

   37    8.0 %   1,006,201    12.5 %     15,647    10.1 %

40,001-100,000

   33    7.2 %   2,151,155    26.7 %     47,421    30.6 %

Greater than 100,000

   20    4.4 %   3,143,868    39.0 %     60,882    39.2 %
                                   

Portfolio Total

   459    100.0 %   8,051,212    100.0 %   $ 154,979    100.0 %
                                   

(1) Excludes approximately 1.1 million square feet held for redevelopment at December 31, 2005.

 

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Table of Contents

Lease Expirations

The following table sets forth a summary schedule of the lease expirations for leases in place as of December 31, 2005 plus available space for each of the next ten full calendar years at the properties in our portfolio. Unless otherwise stated in the footnotes, the information set forth in the table assumes that tenants exercise no renewal options and all early termination rights.

 

Year of Lease
Expiration

  Number of
Leases
Expiring
  Square
Footage of
Expiring
Leases
  Percentage
of Portfolio
Square Feet
    Annualized
Rent ($000)
  Percentage of
Annualized
Rent
    Annualized
Rent per
Occupied
Square Foot
  Annualized
Rent per
Leased Square
Foot at
Expiration
  Annualized
Rent at
Expiration
($000)

Available(1)

    494,232   6.1 %   $ —          

2006

  62   230,595   2.9 %     3,605   2.3 %   $ 15.63   $ 17.39     4,010

2007

  37   149,890   1.8 %     3,249   2.1 %     21.68     23.82     3,571

2008

  53   294,721   3.7 %     5,825   3.8 %     19.76     21.26     6,265

2009

  71   506,940   6.3 %     11,770   7.6 %     23.22     25.69     13,024

2010

  71   1,016,795   12.6 %     22,086   14.3 %     21.72     21.27     21,626

2011

  43   1,201,911   14.9 %     25,140   16.2 %     20.92     23.76     28,553

2012

  11   134,748   1.7 %     2,655   1.7 %     19.70     23.01     3,100

2013

  20   705,167   8.8 %     11,494   7.4 %     16.30     19.50     13,751

2014(2)

  22   546,019   6.8 %     9,446   6.1 %     17.30     21.99     12,005

2015

  38   1,414,282   17.6 %     32,434   20.9 %     22.93     31.59     44,680

Thereafter

  31   1,355,912   16.8 %     27,275   17.6 %     20.12     29.71     40,281
                                           

Portfolio Total/Weighted Average

  459   8,051,212   100.0 %   $ 154,979   100.0 %   $ 20.51   $ 25.26   $ 190,866
                                           

(1) Excludes approximately 1.1 million square feet held for redevelopment at December 31, 2005.
(2) Includes 63,233 square feet of net rentable space in 6 Braham Street. This property is subleased by Level 3 Communications from Leslie & Godwin, a United Kingdom subsidiary of AON Corporation, through December 2009. Level 3 Communications has executed a lease that will commence upon expiration of the Leslie & Godwin lease and continue through December 2014. Leslie & Godwin remain liable to us for rents under its lease.

Right of First Offer Property

At December 31, 2005 there is one property located in Germany owned by GI Partners that is subject to right of first offer agreements, whereby we have the right to make the first offer to purchase this property if GI Partners decides to sell it. We acquired one property from GI Partners that was subject to a right of first offer on June 3, 2005.

 

ITEM 3. LEGAL PROCEEDINGS

In the ordinary course of our business, we may become subject to tort claims and other claims and administrative proceedings. As of December 31, 2005, we were not a party to any legal proceedings which we believe would have a material adverse effect on us.

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of our stockholders during the fourth quarter of the year ended December 31, 2005.

 

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Table of Contents

PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our common stock has been listed and is traded on the NYSE under the symbol “DLR” since October 29, 2004. The following table sets forth, for the periods indicated, the high, low and last sale prices in dollars on the NYSE for our common stock and the distributions we declared with respect to the periods indicated.

 

     High    Low    Distributions
declared

Period October 29, 2004 to December 31, 2004

   $ 14.10    $ 12.00    $ 0.15600

First Quarter 2005

   $ 14.81    $ 12.50    $ 0.24375

Second Quarter 2005

   $ 17.49    $ 13.67    $ 0.24375

Third Quarter 2005

   $ 19.97    $ 16.80    $ 0.24375

Fourth Quarter 2005

   $ 24.70    $ 17.73    $ 0.26500

We intend to continue to declare quarterly distributions on our common stock. The actual amount and timing of distributions, however, will be at the discretion of our board of directors and will depend upon our financial condition in addition to the requirements of the Code, and no assurance can be given as to the amounts or timing of future distributions.

Subject to the distribution requirements applicable to REITs under the Code, we intend, to the extent practicable, to invest substantially all of the proceeds from sales and refinancings of our assets in real estate-related assets and other assets. We may, however, under certain circumstances, make a distribution of capital or of assets. Such distributions, if any, will be made at the discretion of our board of directors. Distributions will be made in cash to the extent that cash is available for distribution.

As of February 21, 2006, there were 10 stockholders of record of our common stock. This figure does not reflect the beneficial ownership of shares held in nominee name.

 

ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth selected consolidated financial and operating data on an historical basis for our company and on a combined historical basis for our company’s Predecessor. The Predecessor is comprised of the real estate activities and holdings of GI Partners related to the properties in our portfolio. We have not presented historical information for the Company for periods prior to the consummation of our initial public offering because we did not have any corporate activity until the completion of our initial public offering other than the issuance of shares of common stock in connection with the initial capitalization of our company, and because we believe that a discussion of the results of the Company would not be meaningful. The Predecessor’s combined historical financial information includes:

 

    the wholly owned real estate subsidiaries and majority-owned real estate joint ventures that GI Partners contributed to our operating partnership in connection with our initial public offering;

 

    an allocation of GI Partners’ line of credit to the extent that borrowings and related interest expense relate to (1) borrowings to fund acquisitions of the properties in our portfolio and (2) borrowings to pay asset management fees paid by GI Partners that were allocated to the properties in our portfolio; and

 

    an allocation of the asset management fees paid to a related party and incurred by GI Partners, along with an allocation of the liability for any such fees that were unpaid as of December 31, 2003 and an allocation of GI Partners’ general and administrative expenses.

The following data should be read in conjunction with our financial statements and notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included below in this Form 10-K. Certain prior year amounts have been reclassified to conform to the current year presentation.

 

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Table of Contents

The Company and the Company Predecessor

(Amounts in thousands, except per share data)

 

    The Company     The Predecessor  
    Year Ended
December 31,
2005
   

Period from
November 3,
2004 to
December 31,

2004

   

Period from
January 1,
2004 to
November 2,

2004

  Year ended
December 31,
   

Period from
February 28, 2001
(inception) through
December 31,

2001

 
          2003     2002    

Statement of Operations Data:

           

Revenues:

           

Rental

  $ 164,219     $ 21,232     $ 67,876   $ 50,099     $ 21,203     $ —    

Tenant reimbursements

    37,454       4,083       12,146     8,661       3,894       —    

Other

    7,136       30       1,754     4,328       458       12  
                                             

Total revenues

    208,809       25,345       81,776     63,088       25,555       12  

Expenses:

           

Rental property operating and maintenance

    43,157       5,173       13,801     8,624       4,997       —    

Property taxes

    21,867       2,085       7,249     4,688       2,755       —    

Insurance

    2,804       472       1,403     626       83       —    

Interest

    39,122       5,547       18,914     10,091       5,249       —    

Asset management fees to related party

    —         —         2,655     3,185       3,185       2,663  

Depreciation and amortization

    62,232       7,373       24,025     16,295       7,659       —    

General and administrative

    12,615       20,725       292     329       249       —    

Loss from early extinguishment of debt

    1,021       283       —       —         —         —    

Other

    1,634       57       2,748     2,459       1,249       107  
                                             

Total expenses

    184,452       41,715       71,087     46,297       25,426       2,770  

Income (loss) before minority interests

    24,357       (16,370 )     10,689     16,791       129       (2,758 )

Minority interests in consolidated joint ventures

    12       (13 )     37     (149 )     (190 )     —    

Minority interests in operating partnership

    (8,268 )     10,214       —       —         —         —    
                                             

Net income (loss)

    16,101       (6,169 )   $ 10,726   $ 16,642     $ (61 )   $ (2,758 )
                                 

Preferred stock dividends

    (10,014 )     —            
                       

Net income (loss) available to common stockholders

  $ 6,087     $ (6,169 )        
                       

Per Share Data:

           

Basic income per share available to common stockholders

  $ 0.25     $ (0.30 )   $ —     $ —       $ —       $ —    

Diluted income per share available to common stockholders

  $ 0.25     $ (0.30 )   $ —     $ —       $ —       $ —    

Cash dividend per common share

  $ 1.00     $ 0.16     $ —     $ —       $ —       $ —    

Weighted average common shares outstanding:

           

Basic

    23,986,288       20,770,875       —       —         —         —    

Diluted

    24,221,732       20,770,875       —       —         —         —    

 

     The Company    The Predecessor
     December 31,    December 31,
     2005    2004    2003    2002    2001

Balance Sheet Data:

              

Net investments in real estate

   $ 1,194,106    $ 787,412    $ 391,737    $ 217,009    $ —  

Total assets

     1,529,170      1,013,287      479,698      269,836      1,893

Notes payable under line of credit

     181,000      44,000      44,436      53,000      —  

Mortgages and other secured loans

     568,067      475,498      253,429      103,560      —  

Total liabilities

     880,228      584,229      328,303      183,524      903

Minority interests in consolidated joint ventures

     206      997      3,444      3,135      —  

Minority interests in operating partnership

     262,239      254,862      —        —        —  

Total stockholders’/owner’s equity

     386,497      173,199      147,951      83,177      990

Total liabilities and stockholders’/owner’s equity

   $ 1,529,170    $ 1,013,287    $ 479,698    $ 269,836    $ 1,893

 

     The Company     The Company
and the
Predecessor
    The Predecessor  
     Year Ended
December 31,
2005
    Year ended December 31,     Period from
February 28, 2001
(inception) through
December 31, 2001
 
       2004     2003     2002    

Cash flows from (used in):

          

Operating activities

   $ 82,848     $ 44,638     $ 27,628     $ 9,645     $ (1,867 )

Investing activities

     (480,815 )     (371,277 )     (213,905 )     (164,755 )     (1,881 )

Financing activities

     404,340       326,022       187,873       158,688       3,748  

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the consolidated and combined financial statements and notes thereto appearing elsewhere in this report. Where appropriate, the following discussion includes analysis of the effects of our initial public offering, the formation transactions and related refinancing transactions and certain other transactions. We make statements in this section that are forward-looking statements within the meaning of the federal securities laws. For a complete discussion of forward-looking statements, see the section in this Form 10-K entitled “Forward-Looking Statements.” Certain risk factors may cause our actual results, performance or achievements to differ materially from those expressed or implied by the following discussion. For a discussion of such risk factors, see the sections in this report entitled “Risk Factors” and “Forward-Looking Statements.”

Overview

Our company. We completed our initial public offering, or IPO, of common stock on November 3, 2004. We have operated in a manner that we believe has enabled us to qualify and have elected to be treated, as a Real Estate Investment Trust (REIT) under Sections 856 through 860 of the Internal Revenue Code of 1986 as amended (the Code). Our company was formed on March 9, 2004. During the period from our formation until we commenced operations in connection with the completion of our IPO, we did not have any corporate activity other than the issuance of shares of common stock in connection with the initial capitalization of our company. Because we believe that a discussion of the results of our company prior to the completion of our IPO would not be meaningful, we have set forth below a discussion of historical combined operations for our company and our company’s Predecessor and as such, any reference in the Management’s Discussion and Analysis of Financial Condition and Results of Operations to “our,” “we” and “us” in this Item 7 includes the Predecessor.

Business and strategy. Our primary business objectives are to maximize sustainable long-term growth in earnings, funds from operations and cash flow per share and to maximize returns to our stockholders. We expect to achieve our objectives by focusing on our core business of investing in technology-related real estate. We target high quality, strategically located properties containing applications and operations critical to the day-to-day operations of corporate enterprise data center and technology industry tenants. Most of our properties contain fully redundant electrical supply systems, multiple power feeds, above-standard precision cooling systems, raised floor areas, extensive in-building communications cabling and high-level security systems. We focus solely on technology-related real estate because we believe that the growth in corporate data center adoption and the technology-related real estate industry generally will be superior to that of the overall economy.

Since the acquisition of our first property in 2002 and through December 31, 2005, we acquired an aggregate of 43 technology-related real estate properties with 8.1 million net rentable square feet excluding approximately 1.1 million square feet of space held for redevelopment. We have developed detailed, standardized procedures for evaluating acquisitions to ensure that they meet our financial and other criteria. We expect to continue to acquire additional assets as a key part of our growth strategy. We intend to aggressively manage and lease our assets to increase their cash flow.

We may acquire properties subject to existing mortgage financing and other indebtedness or new indebtedness may be incurred in connection with acquiring or refinancing these properties. Debt service on such indebtedness will have a priority over any dividends with respect to our common stock and our preferred stock. We currently intend to limit our indebtedness to 60% of our total market capitalization and, based on the closing price of our common stock on December 31, 2005 of $22.63, our ratio of debt to total market capitalization was approximately 33% as of December 31, 2005. Our total market capitalization is defined as the sum of the market value of our outstanding common stock (which may decrease, thereby increasing our debt to total market capitalization ratio), excluding options issued under our incentive award plan, plus the liquidation value of our preferred stock, plus the aggregate value of the units not held by us, plus the book value of our total consolidated indebtedness.

 

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Revenue Base. As of December 31, 2005, we owned 43 properties through our operating partnership. These properties are located throughout the U.S., with three properties located in Europe, and contain a total of approximately 8.1 million net rentable square feet excluding approximately 1.1 million square feet held for redevelopment. We acquired our first portfolio property in January 2002, an additional four properties through December 31, 2002, eight properties during the year ended December 31, 2003 11 properties during the year ended December 31, 2004 and 19 properties during the year ended December 31, 2005. As of December 31, 2005, the properties in our portfolio were approximately 93.9% leased excluding 1.1 million square feet held for redevelopment at an average annualized rent per leased square foot of $20.51. Due to the capital intensive and long term nature of the operations being supported, our lease terms are generally longer than standard commercial leases. At December 31, 2005, our average lease term was 12.5 years, with an average of 7.3 years remaining. Our lease expirations through 2008 are 8.4% of net rentable square feet excluding space held for redevelopment or 8.2% of aggregate annualized rent as of December 31, 2005. Revenues from properties outside the United States were $6.0 million and $4.4 for the years ended December 31, 2005 and 2004, respectively.

Operating expenses. Our operating expenses generally consist of utilities, property and ad valorem taxes, insurance and site maintenance costs, as well as rental expenses on our ground leases. For our Predecessor, a significant portion of the general and administrative type expenses have been reflected in the asset management fees that were paid to GI Partners’ related-party asset manager. The asset management fees were based on a fixed percentage of capital commitments made by the investors in GI Partners, a portion of which have been allocated to our Predecessor. Since the consummation of our IPO, our asset management function has been internalized and we are incurring our general and administrative expenses directly. Prior to April 2005, we had a transition services agreement with CB Richard Ellis Investors with respect to transitional accounting and other services. In addition, as a public company, we are incurring significant legal, accounting and other expenses related to corporate governance, Securities and Exchange Commission reporting and compliance with the various provisions of Sarbanes-Oxley Act of 2002. In addition, we engaged third-party property managers to manage most of our properties. As of December 31, 2005, 32 of our properties were managed by affiliates of CB Richard Ellis, an affiliate of GI Partners.

Formation Transactions. In connection with the completion of our IPO, our operating partnership received contributions of direct and indirect interests in 23 of the properties in our portfolio in exchange for consideration that included cash, assumption of debt, and an aggregate of 38,262,206 units in our operating partnership (with the cash, assumed debt and units having an aggregate value of $1,097.7 million based on the IPO price per share of $12.00).

We accounted for the ownership interests contributed to us by GI Partners in exchange for a partnership interest in our operating partnership as a reorganization of entities under common control in a manner similar to a pooling of interests. Accordingly, the assets and liabilities contributed by GI Partners are accounted for by our operating partnership at GI Partners’ historical cost. We utilized purchase accounting to account for the acquisition of ownership interests in 200 Paul Avenue 1-4 and 1100 Space Park Drive, which were contributed to us by third parties in exchange for interests in our operating partnership, cash and the assumption of debt and the 10% minority ownership interest in 2323 Bryan Street, which was contributed to us by our joint venture partner in exchange for an interest in our operating partnership and the repayment of debt. Accordingly, the purchase price for these interests, which are equal to the value of the operating partnership units that we issued in exchange for these interests plus cash paid and debt assumed, were allocated to the assets acquired and liabilities assumed based on the fair value of the assets and liabilities.

Factors Which May Influence Future Results of Operations

Rental income. The amount of net rental income generated by the properties in our portfolio depends principally on our ability to maintain the occupancy rates of currently leased space and to lease currently available space and space available from lease terminations. Excluding 1.1 million square feet held for redevelopment, as of December 31, 2005, the occupancy rate in the properties in our portfolio was approximately 93.9% of our net rentable square feet.

 

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The amount of rental income generated by us also depends on our ability to maintain or increase rental rates at our properties. Included in our approximately 8.1 million square feet of net rentable square feet at December 31, 2005 is approximately 264,000 net rentable square feet of space with extensive data center improvements that is currently, or will shortly be, available for lease, or already has been leased. We had leased approximately 123,000 square feet of this space at December 31, 2005. Rather than leasing all of this space to large single tenants, we are subdividing some of it for multi-tenant turn-key data center use, with tenants averaging between 100 and 15,000 square feet of net rentable space. Multi-tenant turn-key data centers are effective solutions for tenants who lack the expertise or capital budget to provide their own extensive data center infrastructure and security. As experts in data center construction and operations we are able to lease space to these tenants at a significant premium over other uses. Negative trends in one or more of these factors could adversely affect our rental income in future periods.

Future economic downturns or regional downturns affecting our submarkets or downturns in the technology-related real estate industry that impair our ability to renew or re-lease space and the ability of our tenants to fulfill their lease commitments, as in the case of tenant bankruptcies, could adversely affect our ability to maintain or increase rental rates at our properties. At December 31, 2005 one tenant, VarTec Telecom, Inc. (VarTec) was in bankruptcy and leased approximately 156,000 square feet of net rentable space across three separate properties and was current on all of its rental obligations. In January 2006 VarTec notified us of its intention to file a motion to reject its lease of approximately 8,600 square feet in our 2323 Bryan Street property. The motion was granted by the bankruptcy court on February 21, 2006 and as such, this lease was rejected effective February 28, 2006. We are currently considering options to pursue appropriate economic relief through the bankruptcy court.

Scheduled lease expirations. Our ability to re-lease expiring space will impact our results of operations. In addition to approximately 0.5 million square feet of available space in our portfolio excluding approximately 1.1 million square feet available for redevelopment as of December 31, 2005, leases representing approximately 2.9% and 1.8% of the square footage of our portfolio excluding redevelopment space are scheduled to expire during the 12-month periods ending December 31, 2006 and 2007, respectively. The leases scheduled to expire in the 12-month periods ending December 31, 2006 and 2007 represent approximately 2.3% and 2.1%, respectively, of our total annualized base rent.

Conditions in significant markets. As of December 31, 2005, our portfolio was geographically concentrated in the following metropolitan markets;

 

Metropolitan Market

   Percentage of total
annualized rent
 

Silicon Valley

   24.3 %

Chicago

   14.9 %

Dallas

   13.0 %

San Francisco

   8.3 %

Los Angeles

   8.1 %

Boston

   6.3 %

Philadelphia

   4.7 %

New York

   4.4 %

Other

   16.0 %
      
   100.0 %
      

Operating expenses. Our operating expenses generally consist of utilities, property and ad valorem taxes, insurance and site maintenance costs, as well as rental expenses on our ground leases. We are also incurring general and administrative expenses, including expenses relating to the internalization of our asset management function, as well as significant legal, accounting and other expenses related to corporate governance, Securities and Exchange Commission reporting and compliance with the various provisions of the Sarbanes-Oxley Act.

 

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Increases or decreases in such operating expenses will impact our overall performance. As a relatively new public company, we expect to incur additional operating expenses as we expand our various business functions.

Critical Accounting Policies

Our discussion and analysis of financial condition and results of operations are based upon our consolidated and combined financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles (GAAP). The preparation of these financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses in the reporting period. Our actual results may differ from these estimates. We have provided a summary of our significant accounting policies in Note 2 to our financial statements included elsewhere in this report. We describe below those accounting policies that require material subjective or complex judgments and that have the most significant impact on our financial condition and results of operations. Our management evaluates these estimates on an ongoing basis, based upon information currently available and on various assumptions management believes are reasonable as of the date on the front cover of this report.

Investments in Real Estate

Acquisition of real estate. The price that we pay to acquire a property is impacted by many factors including the condition of the buildings and improvements, the occupancy of the building, the existence of above and below market tenant leases, the creditworthiness of the tenants, favorable or unfavorable financing, above or below market ground leases and numerous other factors. Accordingly, we are required to make subjective assessments to allocate the purchase price paid to acquire investments in real estate among the assets acquired and liabilities assumed based on our estimate of the fair values of such assets and liabilities. This includes determining the value of the buildings and improvements, land, any ground leases, tenant improvements, in-place tenant leases, tenant relationships, the value (or negative value) of above (or below) market leases and any debt assumed from the seller or loans made by the seller to us. Each of these estimates requires a great deal of judgment and some of the estimates involve complex calculations. Our allocation methodology is summarized in Note 2 to our consolidated and combined financial statements. These allocation assessments have a direct impact on our results of operations. For example, if we were to allocate more value to land, there would be no depreciation with respect to such amount. If we were to allocate more value to the buildings as opposed to allocating to the value of tenant leases, this amount would be recognized as an expense over a much longer period of time. This potential effect occurs because the amounts allocated to buildings are depreciated over the estimated lives of the buildings whereas amounts allocated to tenant leases are amortized over the terms of the leases. Additionally, the amortization of value (or negative value) assigned to above (or below) market rate leases is recorded as an adjustment to rental revenue as compared to amortization of the value of in-place leases and tenant relationships, which is included in depreciation and amortization in our consolidated and combined statements of operations.

Useful lives of assets. We are required to make subjective assessments as to the useful lives of our properties for purposes of determining the amount of depreciation to record on an annual basis with respect to our investments in real estate. These assessments have a direct impact on our net income because if we were to shorten the expected useful lives of our investments in real estate we would depreciate such investments over fewer years, resulting in more depreciation expense and lower net income on an annual basis.

Asset impairment evaluation. We review the carrying value of our properties when circumstances, such as adverse market conditions, indicate potential impairment may exist. We base our review on an estimate of the future cash flows (excluding interest charges) expected to result from the real estate investment’s use and eventual disposition. We consider factors such as future operating income, trends and prospects, as well as the effects of leasing demand, competition and other factors. If our evaluation indicates that we may be unable to recover the carrying value of a real estate investment, an impairment loss is recorded to the extent that the

 

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carrying value exceeds the estimated fair value of the property. These losses have a direct impact on our net income because recording an impairment loss results in an immediate negative adjustment to net income. The evaluation of anticipated cash flows is highly subjective and is based in part on assumptions regarding future occupancy, rental rates and capital requirements that could differ materially from actual results in future periods. Since cash flows on properties considered to be long-lived assets to be held and used are considered on an undiscounted basis to determine whether an asset has been impaired, our strategy of holding properties over the long-term directly decreases the likelihood of recording an impairment loss. If our strategy changes or market conditions otherwise dictate an earlier sale date, an impairment loss may be recognized and such loss could be material. If we determine that impairment has occurred, the affected assets must be reduced to their fair value. No such impairment losses have been recognized to date.

We estimate the fair value of rental properties utilizing a discounted cash flow analysis that includes projections of future revenues, expenses and capital improvement costs, similar to the income approach that is commonly utilized by appraisers.

Capitalization of costs.

We capitalize pre-acquisition costs related to probable property acquisitions. We also capitalize direct and indirect costs related to construction and development, including property taxes, insurance and financing costs relating to space under development. Costs previously capitalized related to any property acquisitions no longer considered probable are written off. The selection of costs to capitalize and which acquisitions are probable is subjective and depends on many assumptions including the timing of potential acquisitions and the probability that future acquisitions occur. If we made different assumptions in this respect we would have a different amount of capitalized costs in the periods presented leading to different net income.

Revenue Recognition

Rental income is recognized using the straight-line method over the terms of the tenant leases. Deferred rents included in our balance sheets represent the aggregate excess of rental revenue recognized on a straight-line basis over the rental revenue that would be recognized under the terms of the leases. Our leases generally contain provisions under which the tenants reimburse us for a portion of property operating expenses and real estate taxes incurred by us. Such reimbursements are recognized in the period that the expenses are incurred. Lease termination fees are recognized over the remaining term of the lease, effective as of the date the lease modification is finalized, assuming collection is not considered doubtful. As discussed above, we recognize amortization of the value of acquired above or below market tenant leases as a reduction of rental income in the case of above market leases or an increase to rental revenue in the case of below market leases.

We must make subjective estimates as to when our revenue is earned and the collectibility of our accounts receivable related to minimum rent, deferred rent, expense reimbursements, lease termination fees and other income. We specifically analyze accounts receivable and historical bad debts, tenant concentrations, tenant creditworthiness, and current economic trends when evaluating the adequacy of the allowance for bad debts. These estimates have a direct impact on our net income because a higher bad debt allowance would result in lower net income, and recognizing rental revenue as earned in one period versus another would result in higher or lower net income for a particular period.

Share-based awards

We recognize compensation expense related to share-based awards. We generally amortize this compensation expense over the vesting period of the award. The calculation of the fair value of share-based awards is subjective and requires several assumptions over such items as expected stock volatility, dividend payments and future company results. These assumptions have a direct impact on our net income because a higher share-based awards amount would result in lower net income for a particular period.

 

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Results of Operations

The discussion below relates to our financial condition and results of operations for the years ended December 31, 2005, 2004 and 2003. We have combined the results of operations for the period from November 3, 2004 through December 31, 2004 and the period from January 1, 2004 through November 2, 2004 to provide a meaningful comparison to the results of operations for the other years. A summary of our results for the years ended December 31, 2005, 2004 and 2003 was as follows (in thousands).

 

Year ended December 31,

   2005    2004     2003

Statement of Operations Data:

       

Total revenues

     208,809      107,121       63,088

Total expenses

     184,452      112,802       46,297
                     

Income (loss) before minority interests

   $ 24,357    $ (5,681 )   $ 16,791
                     

 

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Our property portfolio has experienced consistent and significant growth since the first property acquisition in January 2002. As a result of such growth, a period-to-period comparison of our financial performance focuses primarily on the impact on our revenues and expenses resulting from the new property additions to our portfolio. On a “same store” property basis, our revenues and expenses have remained substantially stable as a result of the generally consistent occupancy rates at our properties. The following table identifies each of the properties in our portfolio acquired from January 1, 2003 through December 31, 2005.

 

Acquired Properties

 

Metropolitan

Area

  Acquisition
date
  Redevelopment
Space(1)
  Net Rentable
Square Feet
excluding
redevelopment
space
  Square Feet
including
redevelopment
space
  Occupancy
Rate
December 31,
2005(2)
 

Balance at December 31, 2002

      19,890   1,125,292   1,145,182  

Year Ended December 31, 2003

           

34551 Ardenwood Boulevard 1-4

  Silicon Valley   Jan. 2003   —     307,657   307,657   100.0 %

2440 Marsh Lane

  Dallas   Jan. 2003   —     135,250   135,250   100.0  

2010 East Centennial Circle

  Phoenix   May 2003   —     113,405   113,405   100.0  

375 Riverside Parkway

  Atlanta   June 2003   123,891   126,300   250,191   100.0  

3300 East Birch Street

  Los Angeles   Aug. 2003   —     68,807   68,807   100.0  

4055 Valley View Lane

  Dallas   Sept. 2003   —     240,065   240,065   94.3  

47700 Kato Road & 1055 Page Avenue

  Silicon Valley   Sept. 2003   —     183,050   183,050   100.0  

7979 East Tufts Avenue

  Denver   Oct. 2003   —     366,184   366,184   89.0  
                 

Subtotal

      123,891   1,540,718   1,664,609  

Year Ended December 31, 2004

           

100 Technology Center Drive

  Boston   Feb. 2004   —     197,000   197,000   100.0  

4849 Alpha Road

  Dallas   April 2004   —     125,538   125,538   100.0  

600 West Seventh Street

  Los Angeles   May 2004   59,319   430,759   490,078   90.8  

2045 & 2055 LaFayette Street

  Silicon Valley   May 2004   —     300,000   300,000   100.0  

100 & 200 Quannapowitt Parkway

  Boston   June 2004   —     386,956   386,956   100.0  

11830 Webb Chapel Road

  Dallas   Aug. 2004   —     365,648   365,648   93.3  

150 South First Street

  Silicon Valley   Sept. 2004   —     187,334   187,334   98.5  

3065 Gold Camp Drive

  Sacramento   Oct. 2004   —     62,957   62,957   100.0  

200 Paul Avenue 1-4

  San Francisco   Nov. 2004   37,630   494,608   532,238   95.8  

1100 Space Park Drive

  Silicon Valley   Nov. 2004   85,542   82,409   167,951   94.9  

3015 Winona Avenue

  Los Angeles   Dec. 2004   —     82,911   82,911   100.0  
                 

Subtotal

      182,491   2,716,120   2,898,611  

Year Ended December 31, 2005

           

833 Chestnut Street

  Philadelphia   Mar. 2005   119,660   535,098   654,758   91.5  

1125 Energy Park Drive

  Minneapolis/St. Paul   Mar. 2005   —     88,134   88,134   100.0  

350 East Cermak Road

  Chicago   May 2005   263,208   870,183   1,133,391   92.2  

8534 Concord Center Drive

  Denver   June 2005   —     82,229   82,229   100.0  

2401 Walsh Street

  Silicon Valley   June 2005   —     167,932   167,932   100.0  

200 North Nash Street

  Los Angeles   June 2005   —     113,606   113,606   100.0  

2403 Walsh Street

  Silicon Valley   June 2005   —     103,940   103,940   100.0  

4700 Old Ironsides Drive

  Silicon Valley   June 2005   —     90,139   90,139   100.0  

4650 Old Ironsides Drive

  Silicon Valley   June 2005   —     84,383   84,383   100.0  

731 East Trade Street

  Charlotte   Aug. 2005   —     40,879   40,879   100.0  

113 North Myers

  Charlotte   Aug. 2005   10,501   18,717   29,218   100.0  

125 North Myers

  Charlotte   Aug. 2005   13,242   12,151   25,393   85.8  

Paul van Vlissingenstraat 16

  Amsterdam, Netherlands   Aug. 2005   —     112,472   112,472   62.0  

600-780 S. Federal

  Chicago   Sept. 2005   —     161,547   161,547   84.1  

115 Second Avenue

  Boston   Oct. 2005   55,569   12,500   68,069   —    

Chemin de l’Epinglier 2

  Geneva, Switzerland   Nov. 2005   —     59,190   59,190   100.0  

251 Exchange Place

  Northern Virginia   Nov. 2005   —     70,982   70,982   100.0  

7500 & 7520 Metro Center Drive

  Austin   Dec. 2005   74,962   45,000   119,962   100.0 %

3 Corporate Place

  New York   Dec. 2005   283,124   —     283,124   —    
                 

Subtotal

      820,266   2,669,082   3,489,348  
                 

Total

      1,146,538   8,051,212   9,197,750  
                 

(1)

Redevelopment space requires significant capital investment in order to develop data center facilities that are ready for use. Most often this is shell space. However, in certain circumstances this may include

 

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partially built data center space that was not completed by previous ownership and requires a large capital investment in order to build out the space.

(2) Occupancy rates exclude redevelopment space.

Comparison of the Year Ended December 31, 2005 to the Year Ended December 31, 2004 and comparison of the Year Ended December 31, 2004 to the Year Ended December 31, 2003

Portfolio

As of December 31, 2005, our portfolio consisted of 43 properties with an aggregate of 8.1 million net rentable square feet excluding 1.1 million square feet held for redevelopment compared to a portfolio consisting of 24 properties with an aggregate of 5.4 million net rentable square feet excluding space held for redevelopment as of December 31, 2004 and a portfolio consisting of 13 properties with an aggregate of 2.7 million net rentable square feet excluding space held for redevelopment as of December 31, 2003. The increase in our portfolio reflects the acquisition of 11 properties in 2004 and 19 properties in 2005.

Revenues

 

     Year Ended December 31,    Change     Percentage Change  
     2005    2004    2003    2005 v 2004    2004 v 2003     2005 v 2004     2004 v 2003  

Rental

   $ 164,219    $ 89,108    $ 50,099    $ 75,111    $ 39,009     84.3 %   77.9 %

Tenant reimbursements

     37,454      16,229      8,661      21,225      7,568     130.8 %   87.4 %

Other

     7,136      1,784      4,328      5,352      (2,544 )   300.0 %   (58.8 %)
                                                

Total Revenues

   $ 208,809    $ 107,121    $ 63,088    $ 101,688    $ 44,033     94.9 %   69.8 %
                                                

As shown by the same space and new properties table shown below, the increases in rental revenues and tenant reimbursement revenues in the year ended December 31, 2005 compared to 2004 were primarily due to our acquisitions of properties leading to a higher portfolio size in later years. These factors also caused the increases in rental revenues and tenant reimbursements in the year ended December 31, 2004 compared to 2003. Other revenues changes in the years presented were primarily due to varying tenant termination revenues. We acquired 19, 11 and eight properties during the years ended December 31, 2005, 2004 and 2003 respectively.

The following table shows total revenues for new properties (properties that were not owned for each of the full years ended December 31, 2005 and 2004) and same space properties (in thousands).

 

    

Same space

Year Ended December 31,

   

New properties

Year Ended December 31,

     2005    2004    Change     2005    2004    Change

Rental

   $ 62,007    $ 61,929    $ 78     $ 102,212    $ 27,179    $ 75,033

Tenant reimbursements

     12,015      10,513      1,502       25,439      5,716      19,723

Other

     561      1,745      (1,184 )     6,575      39      6,536
                                          

Total Revenues

   $ 74,583    $ 74,187    $ 396     $ 134,226    $ 32,934    $ 101,292
                                          

Same space tenant reimbursement revenues increased in the year ended December 31, 2005 compared to 2004 primarily as a result of increased operating expenses leading to higher tenant reimbursement income and favorable outcomes of tenant reimbursement billings in 2005. Same space other revenues decreased in 2005 compared to 2004 as a result of decreased termination fee revenues.

 

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Expenses

 

     Year Ended December 31,    Change     Percentage Change  
     2005    2004    2003    2005 v 2004     2004 v 2003     2005 v 2004     2004 v 2003  

Rental property operating and maintenance

   $ 43,157    $ 18,974    $ 8,624    $ 24,183     $ 10,350     127.5 %   120.0 %

Property taxes

     21,867      9,334      4,688      12,533       4,646     134.3 %   99.1 %

Insurance

     2,804      1,875      626      929       1,249     49.5 %   199.5 %

Interest

     39,122      24,461      10,091      14,661       14,370     59.9 %   142.4 %

Asset management fees to related party

     —        2,655      3,185      (2,655 )     (530 )   (100.0 %)   (16.6 %)

Depreciation and amortization

     62,232      31,398      16,295      30,834       15,103     98.2 %   92.7 %

General and administrative

     12,615      21,017      329      (8,402 )     20,688     (40.0 %)   6,288.1 %

Net loss from early extinguishment of debt

     1,021      283      —        738       283     260.8 %   (100.0 %)

Other

     1,634      2,805      2,459      (1,171 )     346     (41.7 %)   14.1 %
                                                 

Total expenses

   $ 184,452    $ 112,802    $ 46,297    $ 71,650     $ 66,505     63.5 %   143.6 %
                                                 

As shown in the same space expense and new properties table below, total expenses in the year ended December 31, 2005 increased compared to 2004 primarily as a result of higher operating expenses following acquisition of properties. The increase in total expenses in the year ended December 31, 2004 compared to 2003 was also due to expenses incurred in connection with the completion of our IPO and the related formation transactions. The following table shows expenses for new properties (properties that were not owned for each of the full years ended December 31, 2005 and 2004) and same space properties (in thousands).

 

    

Same space

Year Ended December 31,

   

New properties

Year Ended December 31,

     2005    2004    Change     2005    2004    Change

Rental property operating and maintenance

   $ 14,251    $ 12,278    $ 1,973     $ 28,906    $ 6,696    $ 22,210

Property taxes

     6,622      7,206      (584 )     15,245      2,128      13,117

Insurance

     735      1,047      (312 )     2,069      828      1,241

Interest

     18,740      16,467      2,273       20,382      7,994      12,388

Depreciation and amortization

     22,004      21,876      128       40,228      9,522      30,706

Net loss from early extinguishment of debt

     150      135      15       871      148      723

Other

     314      2,690      (2,376 )     1,320      115      1,205
                                          

Total property related expenses

     62,816      61,699      1,117       109,021      27,431      81,590

Asset management fees to related party(1)

     —        2,655      (2,655 )     —        —        —  

General and administrative(1)

     12,615      21,017      (8,402 )     —        —        —  
                                          
   $ 75,431    $ 85,371    $ (9,940 )   $ 109,021    $ 27,431    $ 81,590
                                          

(1) Asset management fees to related party and general and administrative expenses are included in same store as they are not allocable to specific properties.

Rental property operating and maintenance expenses included amounts paid to affiliates of CB Richard Ellis Investors for property management and other fees of $1.2 million, $1.1 million and $0.4 million in the years ended December 31, 2005, 2004 and 2003, respectively. Same space rental property and maintenance expenses increased in 2005 compared to 2004 primarily as a result of utility rate increases in the Dallas region.

 

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Property taxes increases in the years presented were primarily a result of new properties acquired in later years leading to a larger expense. Same space property taxes decreased in the year ended December 31, 2005 compared to 2004 primarily due to a favorable outcome of appealing a property tax amount at 4055 Valley View Lane.

Insurance expense increases in the years presented was primarily a result of new properties acquired in later years leading to a larger expense. Same space insurance decreased in the year ended December 31, 2005 compared to 2004 primarily as a result of more favorable insurance rates on our properties following a more established insurance history and claim pattern of properties under our ownership.

Interest expense increases were associated with new mortgage and other secured debt incurred primarily in connection with the properties added to our portfolio. The increase in interest related to property acquisitions in all years presented was partially offset by a reduction in interest related to loans repaid or refinanced. Same space interest expense increased in 2005 compared to 2004 primarily because the interest rates obtained on interest rate swaps upon completion of our IPO in November 2004 were higher than interest rates prevailing throughout 2004. This effect was partially offset by the repayment of $22.0 million of a mezzanine loan in November 2005.

For the years ended December 31, 2004 and 2003 the monthly asset management fee to a related party was based on a fixed percentage of capital commitments by the investors in GI Partners, a portion of which was allocated to the Company Predecessor. Effective as of the completion of our IPO, no such fees are allocated to us.

Depreciation and amortization expense increases were primarily due to our acquisitions of properties leading to a higher portfolio size in later years. We acquired 19, 11 and 8 properties during the years ended December 31, 2005, 2004 and 2003 respectively.

The changes in general and administrative expenses for the years presented was caused by higher expenses in 2005 offset by $17.9 million of compensation expense recorded upon completion of our IPO related to fully vested long-term incentive units granted in connection with the IPO in 2004. As a public company, we are incurring significant legal, accounting and other costs related to corporate governance, Securities and Exchange Commission reporting and other public company overhead. We incurred higher general and administrative expenses as we internalized our accounting functions in 2005, partially related to increased staff necessary to manage the growth of operations. In addition we incurred expenses related to compliance with the requirements of the Sarbanes Oxley Act. Prior to the completion of our IPO, general and administrative expenses were incurred by our Predecessor’s related party asset manager and our Predecessor incurred an asset management fee, which is included separately in the combined statement of operations.

Net loss from early extinguishment of debt related to prepayment costs and the write offs of unamortized deferred financing costs when we prepaid loans. The net loss from early extinguishment of debt increased in the year ended December 31, 2005 compared to 2004 as a result of higher loan prepayments. There were no loan prepayments in 2003.

Other expenses are primarily comprised of write-offs of the carrying amounts for deferred tenant improvements, acquired in place lease value and acquired above market lease values as a result of the early termination of tenant leases. Other expenses during the years presented varied as a result of the level of terminations and the carrying values of the assets associated with the leases that terminated early. Same store other expenses decreased in the year ended December 31, 2005 compared to 2004 primarily as a result of reduced write off or assets following tenant terminations.

Liquidity and Capital Resources

Analysis of Liquidity and Capital Resources

As of December 31, 2005, we had $10.9 million of cash and cash equivalents, excluding $22.1 million of restricted cash. Restricted cash primarily consists of interest bearing cash deposits required by the terms of

 

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several of our mortgage loans for a variety of purposes, including real estate taxes, insurance, anticipated or contractually obligated tenant improvements and leasing deposits.

Our short term liquidity requirements primarily consist of operating expenses and other expenditures associated with our properties, dividend payments on our series A and series B preferred stock, which were issued on February 9, 2005 and July 26, 2005, respectively, dividend payments to our stockholders and distributions to our unitholders in the operating partnership required to maintain our REIT status, capital expenditures, debt service on our loans and, potentially, acquisitions. We expect to meet our short-term liquidity requirements through net cash provided by operations, restricted cash accounts established for certain future payments and by drawing upon our unsecured credit facility.

As of December 31, 2005 our operating partnership has a $350 million unsecured revolving credit facility (with the option to further increase the unsecured revolving credit facility to $500 million subject to receipt of lender commitments and satisfaction of other conditions). Borrowings under this facility currently bear interest at a rate based on LIBOR plus margin ranging from 1.250% to 1.625%, depending on our operating partnership’s overall leverage, which margin was 1.50% as of December 31, 2005. The unsecured revolving credit facility matures in October 2008, subject to a one-year extension option that we may exercise if certain conditions are met. The amended unsecured revolving credit facility has a $150.0 million sub-facility for foreign exchange advances in Euros and British Sterling. We intend to use available borrowings under the amended unsecured revolving credit facility to, among other things, finance the acquisition of future properties, to fund tenant improvements and capital expenditures, and to provide for working capital and other corporate purposes.

Financing transactions in 2005

On November 10, 2005 we prepaid the outstanding balance of $25.6 million on our 600 West Seventh Street property mortgage. No prepayment fees were incurred as a result of this prepayment.

On November 9, 2005, we prepaid the outstanding balance of $22.0 million for the mezzanine loan on our 34551 Ardenwood Boulevard 1-4, 2334 Lundy Place and 2440 Marsh Lane properties. No prepayment fees were incurred as a result of this prepayment.

On October 4, 2005 we refinanced the mortgage related to our 200 Paul Avenue 1-4 property which resulted in a new loan for $81.0 million at an interest rate of 5.74% which matures on October 8, 2015. Also in October 2005, we terminated the interest rate swap related to this loan and received cash of approximately $0.4 million.

On July 26, 2005, we completed the offering of approximately 5.9 million shares of common stock for total net proceeds, after underwriting discounts and estimated expenses, of $97.8 million, including the proceeds from the exercise of the underwriters’ over-allotment option. Concurrently, we completed the offering of approximately 2.5 million shares of 7.875% Series B cumulative redeemable preferred stock (liquidation preference of $25.00 per share) for total net proceeds, after underwriting discounts and estimated expenses, of $60.5 million, including the proceeds from the exercise of the underwriters’ over-allotment option. We used the net proceeds from the concurrent offerings to reduce borrowings under our unsecured credit facility, to acquire properties and for general corporate purposes.

In February 2005, we completed the offering of 4.14 million shares of our 8.50% series A preferred stock for total net proceeds, after underwriting discounts and estimated expenses, of $99.3 million, including the proceeds from the exercise of the underwriters’ over-allotment option. We used the net proceeds from this offering to reduce borrowings under our unsecured credit facility, acquire properties and for investment and general corporate purposes.

 

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During the year ended December 31, 2005 we purchased the following properties:

 

Property

  

Metropolitan Area

   Date acquired    Associated
mortgage debt
($ millions)
   Purchase price
($ millions)

833 Chestnut Street

   Philadelphia    Mar. 2005       $ 59.0

1125 Energy Park Drive

   Minneapolis/St. Paul    Mar. 2005      9.7      15.6

350 East Cermak Road

   Chicago    May 2005      100.0      141.6

8534 Concord Center Drive

   Denver    June 2005         16.5

2401 Walsh Street

   Silicon Valley    June 2005         27.4

200 North Nash Street

   Los Angeles    June 2005         18.6

2403 Walsh Street

   Silicon Valley    June 2005         18.3

4700 Old Ironsides Drive

   Silicon Valley    June 2005         16.4

4650 Old Ironsides Drive

   Silicon Valley    June 2005         11.8

731 East Trade Street

   Charlotte    Aug. 2005      6.1      7.2

113 North Myers

   Charlotte    Aug. 2005         4.7

125 North Myers

   Charlotte    Aug. 2005         5.3

Paul van Vlissingenstraat 16

   Amsterdam, Netherlands    Aug. 2005         17.3

600-780 S. Federal

   Chicago    Sept. 2005         39.0

115 Second Avenue

   Boston    Oct. 2005         14.3

Chemin de l’Epinglier 2

   Geneva, Switzerland    Nov. 2005         12.2

251 Exchange Place

   Northern Virginia    Nov. 2005         12.9

7500 & 7520 Metro Center Drive

   Austin    Dec. 2005         13.5

3 Corporate Place

   New York    Dec. 2005         14.7
                   
         $ 115.8    $ 466.3
                   

The purchase price for the 833 Chestnut Street and 1125 Energy Park Drive properties was paid from the proceeds of our offering of series A preferred stock described above along with the assumption of a $9.7 million mortgage loan on the 1125 Energy Park Drive Building. To finance the 350 East Cermak Road purchase we borrowed $100.0 million in the form of a mortgage on the property and also borrowed $35.0 million under our unsecured credit facility.

We acquired 8534 Concord Center Drive from GI Partners. The purchase price of approximately $16.5 million was determined through negotiations between us and GI Partners and was less than the value determined by an independent third party appraiser retained in connection with the acquisition. We funded the purchase price with borrowings under the credit facility. We completed the acquisition of 2401 Walsh Street, 200 North Nash Street, 2403 Walsh Street, 4700 Old Ironsides Drive and 4650 Old Ironsides Drive for a combined purchase price of approximately $92.5 million, which we borrowed under our unsecured credit facility.

Future uses of cash

On January 25, 2006 we purchased a property in Carrollton, Texas for $16.2 million.

On February 6, 2006 we purchased a property in Dublin, Ireland for €5.2 million ($6.3 million at the rate of exchange at the date of purchase) including $0.4 million in Stamp Duty Tax. We also paid an additional $0.8 million in Value Added Tax which we expect to recover in the first quarter of 2006.

Our properties require periodic investments of capital for tenant-related capital expenditures and for general capital improvements. As of December 31, 2005, we had commitments under leases in effect for $30.0 million of tenant improvement costs and leasing commissions all of which we expect to incur in 2006.

As of December 31, 2005 we have identified from our existing properties approximately 1.1 million square feet of shell condition space as redevelopment space and we also owned approximately 264,000 net rentable

 

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square feet of data center space with extensive installed tenant improvements that we may subdivide for multi-tenant turn-key data center use during the next two years rather than lease such space to large single tenants. Turn-Key Data Center space is move-in-ready space for the placement of computer and network equipment required to provide a data center environment. We had leased approximately 123,000 square feet of this space at December 31, 2005. Depending on demand in these buildings, we may incur significant tenant improvement costs to build out and redevelop these spaces.

As of March 7, 2006 we also have signed purchase agreements over the following properties. As we are completing due diligence over these potential acquisitions we can give no assurance that we will complete the purchase of these properties:

 

    a property located in Toronto, Canada for approximately $16.0 million

 

    a property located in Atlanta for approximately $25.3 million.

On December 3, 2005 we terminated share purchase agreements to acquire 100% of the shares of two German entities which together own IBM Technology Park, an approximately 80 acre technical campus located near Mainz, Germany containing 11 buildings with a total of approximately 1.5 million net rentable square feet. The terminated share purchase agreements provided for an aggregate purchase price, excluding expenses, for 100% of the shares in the two entities of approximately €77.4 million (approximately $93.4 million based on the rate of exchange on March 15, 2006). We are still in discussions with the owner of this property but there can be no assurance that we will acquire this property in the future or if we do so that the price will be similar to the terminated agreements.

We are also subject to the commitments discussed below under “Commitments and Contingencies” and Off-Balance Sheet Arrangements.

We expect to meet our long-term liquidity requirements to pay for scheduled debt maturities and to fund property acquisitions and non-recurring capital improvements with net cash from operations, future long-term secured and unsecured indebtedness and the issuance of equity and debt securities. We also may fund future property acquisitions and non-recurring capital improvements using our unsecured credit facility pending permanent financing.

Distributions

We are required to distribute 90% of our REIT taxable income (excluding capital gains) on an annual basis in order to continue to qualify as a REIT for federal income tax purposes. Accordingly, we intend to make, but are not contractually bound to make, regular quarterly distributions to preferred stockholders, common stockholders and unit holders from cash flow from operating activities. All such distributions are at the discretion of our board of directors. We may be required to use borrowings under the credit facility, if necessary, to meet REIT distribution requirements and maintain our REIT status. We consider market factors and our performance in addition to REIT requirements in determining distribution levels. Amounts accumulated for distribution to stockholders are invested primarily in interest-bearing accounts and short-term interest-bearing securities, which are consistent with our intention to maintain our status as a REIT.

 

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In 2005 and 2004, we have declared the following dividends:

 

Date dividend and
distribution declared

 

Share class

  Dividend and
distribution
amount
per share
  Period covered  

Dividend and
distribution
payable date

  Annual equivalent
rate of dividend
and distribution
per share
  Dividend and
distribution
amount (in
thousands)

November 8, 2005

  Series A Preferred Stock   $ 0.53125   October 1, 2005 to
December 31, 2005
  December 30, 2005 to shareholders on record on December 15, 2005.   $ 2.125   $ 2,199

November 8, 2005

  Series B Preferred Stock   $ 0.49219   October 1, 2005 to
December 31, 2005
  December 30, 2005 to shareholders on record on December 15, 2005.   $ 1.969     1,246

November 8, 2005

  Common stock and operating partnership common units and long term incentive units.   $ 0.26500   October 1, 2005 to
December 31, 2005
  January 13, 2006 to shareholders on record on December 30, 2005.   $ 1.060     15,639

August 9, 2005

  Series A Preferred Stock   $ 0.53125   July 1, 2005 to
September 30, 2005
  September 30, 2005 to shareholders on record on September 15, 2005.   $ 2.125     2,199

August 9, 2005

  Series B Preferred Stock   $ 0.35547   July 26, 2005 to
September 30, 2005
  September 30, 2005 to shareholders on record on September 15, 2005.   $ 1.969     900

August 9, 2005

  Common stock and operating partnership common units and long term incentive units.   $ 0.24375   July 1, 2005 to
September 30, 2005
  September 30, 2005 to shareholders on record on September 15, 2005.   $ 0.975     14,338

May 16, 2005

  Series A Preferred Stock   $ 0.53125   April 1, 2005 to June
30, 2005
  June 30, 2005 to shareholders on record on June 15, 2005.   $ 2.125     2,199

May 16, 2005

  Common stock and operating partnership common units and long term incentive units.   $ 0.24375   April 1, 2005 to June
30, 2005
  June 30, 2005 to shareholders on record on June 15, 2005.   $ 0.975     12,905

February 14, 2005

  Series A Preferred Stock   $ 0.30694   February 9, 2005 to
March 31, 2005
  March 31, 2005 to shareholders on record on March 15, 2005.   $ 2.125     1,271

February 14, 2005

  Common stock and operating partnership common units and long term incentive units.   $ 0.24375   January 1, 2005 to
March 31, 2005
  March 31, 2005 to shareholders on record on March 15, 2005.   $ 0.975     12,905

December 14, 2004

  Common stock and operating partnership common units and long term incentive units.   $ 0.15632   November 3, 2004 to
December 31, 2004
  January 14, 2005 to shareholders on record on December 31, 2004.   $ 0.975     8,276

 

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Total 2005 dividends and distributions declared through December 31, 2005:

 

     Declared in 2004    Declared in 2005    Total

Series A Preferred Stock

     —        7,868      7,868

Series B Preferred Stock

     —        2,146      2,146

Common stock and operating partnership common units and long term incentive units

     8,276      55,787      64,063
                    
   $ 8,276    $ 65,801    $ 74,077
                    

All dividends paid on our common and preferred stock in 2005 were classified as ordinary income for income tax purposes.

Contractual Commitments

The following table summarizes our contractual obligations as of December 31, 2005, including the maturities and scheduled principal on our secured debt and unsecured credit facility debt, and provides information about the commitments due in connection with our ground leases, tenant improvement and leasing commissions (in thousands):

 

Obligation

   Total    2006    2007-2008    2009-2010    Thereafter

Long-term debt principal payments(1)

   $ 746,872    $ 75,306    $ 294,108    $ 145,640    $ 231,818

Interest payable(2)

     212,590      42,824      74,251      32,051      63,464

Ground leases(3)

     21,240      407      814      814      19,205

Operating lease

     2,432      358      719      794      561

Tenant improvements and leasing commissions

     29,998      29,998      —        —        —  
                                  
   $ 1,013,132    $ 148,893    $ 369,892    $ 179,299    $ 315,048
                                  

(1) Includes $181.0 million of borrowings under our unsecured credit facility, which is due to mature in October 2008 and excludes $2.2 million of loan premiums.
(2) Interest payable is based on the interest rate in effect on December 31, 2005 including the effect of interest rate swaps. Interest payable excluding the effect of interest rate swaps is as follows (in thousands):

 

2006

   $ 43,896

2007-2008

     75,408

2009-2010

     32,086

Thereafter

     63,464
      
   $ 214,854
      

 

(3) This is comprised of ground lease payments on 2010 East Centennial Circle, Chemin de l’Epinglier 2 and Paul van Vlissingenstraat 16. After February 2036, rent for the remaining term of the 2010 East Centennial Circle ground lease will be determined based on a fair market value appraisal of the asset and, as a result, is excluded from the above information. The Chemin de l’Epinglier 2 ground lease which expires in July 2074 contains potential inflation increases which are not reflected in the table above. The Chemin de l’Epinglier 2 and Paul van Vlissingenstraat 16 amounts are translated at the December 31, 2005 exchange rate of $1.32 per Swiss Franc and $1.18 per € 1.00, respectively.

Paul van Vlissingenstraat 16 is subject to an operating ground lease of approximately $3,000 per month expiring in April 2054. We are obligated to pay the seller of the 350 East Cermak Road a contingent fee of up to $20.0 million in the event a new real estate tax classification for the property is obtained prior to December 31, 2006. We have also agreed with the seller to share a portion, not to exceed $135,000 per month, of rental

 

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revenue, adjusted for our costs to lease the premises, from the lease of the 263,000 square feet of space held for redevelopment. This revenue sharing agreement will terminate in May 2013. As part of the acquisition of Paul van Vlissingenstraat 16, we entered into an agreement with the seller, whereby, for twelve months from the execution of the purchase and sale agreement, our purchase price may increase dependant upon future leasing activity as a result of actions by the seller. The amount of the potential commitment is not currently quantifiable as it is based on a 10% cap rate on the incremental operating income from qualifying new leases that are closed or binding during the participation period. We have no liability for these contingent liabilities on our balance sheet at December 31, 2005.

We are party to interest rate swap agreements with Keybank National Association and Bank of America for approximately $192.9 million of our variable rate debt as of December 31, 2005. Under these swaps, we receive variable-rate amounts in exchange for fixed-rate payments over the life of the agreements without exchange of the underlying principal amounts. See Item 7A “Quantitative and Qualitative Disclosures about Market Risk.”

Outstanding Consolidated Indebtedness

The table below summarizes our debt, at December 31, 2005 (in millions):

 

Debt Summary:

  

Fixed rate

   $ 355.4  

Variable rate—hedged by interest rate swaps

     192.9  
        

Total fixed rate

     548.3  

Variable rate—unhedged

     198.6  
        

Total

     746.9  
        

Percent of Total Debt:

  

Fixed rate (including swapped debt)

     73.4 %

Variable rate

     26.6 %
        

Total

     100.0 %
        

Effective Interest Rate at December 31, 2005

  

Fixed rate (including swapped debt)

     5.79 %

Variable rate—unhedged

     5.91 %

Effective interest rate

     5.82 %

At December 31, 2005, we had approximately $746.9 million of outstanding consolidated long-term debt as set forth in the table above. Our ratio of debt to total market capitalization was approximately 33% (based on the closing price of our common stock on December 31, 2005 of $22.63. The variable rate debt shown above bears interest at an interest rate based on various LIBOR rates ranging from one to twelve months, depending on the agreement governing the debt. The debt secured by our properties at December 31, 2005 had a weighted average term to initial maturity of approximately 5.0 years (approximately 5.7 years assuming exercise of extension options).

Unsecured Credit Facility. At December 31, 2005 our operating partnership has an unsecured revolving credit facility with commitments thereunder for $350.0 million (with the option to further increase the unsecured revolving credit facility to $500 million subject to receipt of lender commitments and satisfaction of other conditions). Borrowings under the revolving credit facility currently bear interest at a rate based on LIBOR plus margin ranging from 1.250% to 1.625%, depending on our operating partnership’s overall leverage, which margin was 1.50% as of December 31, 2005. The unsecured revolving credit facility matures in October 2008, subject to a one-year extension option, which we may exercise if certain conditions are met. The unsecured revolving credit facility has a $150.0 million sub-facility for foreign exchange advances in Euros and British Sterling. At December 31, 2005 our operating partnership had outstanding $181.0 million under the revolving credit facility and $56.5 million was available for use.

 

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Off-Balance Sheet Arrangements

At December 31, 2005 we were a party to interest rate cap agreements in connection with certain of our indebtedness and interest rate swap agreements with KeyBank National Association and Bank of America related to $192.9 million of outstanding principal on our variable rate debt. See Item 7A “Quantitative and Qualitative Disclosures about Market Risk.” We were also a party to a foreign currency forward sale contract in connection with our ownership of the 6 Braham Street property in London, England. We terminated this contract in January 2006 and received cash of approximately $0.7 million.

As of December 31, 2005, GI Partners had $1.2 million of letters of credit outstanding that secure obligations relating to two of our properties, 600 West Seventh Street and 7979 East Tufts Avenue. These letters of credit were initially issued in lieu of making deposits required by a local utility and in lieu of establishing a restricted cash account on behalf of a lender. These letters of credit were transferred to us on January 1, 2006. Prior to this transfer, we were reimbursing GI Partners for the costs of maintaining the letters of credit, which payments are less than $5,000 per quarter. We currently have no other off-balance sheet arrangements.

Cash Flows

The following summary discussion of our cash flows is based on the consolidated and combined statements of cash flows in Item 8— “Financial Statements and Supplementary Data” and is not meant to be an all-inclusive discussion of the changes in our cash flows for the periods presented below.

Comparison of Year Ended December 31, 2005 to Year Ended December 31, 2004 and Comparison of Year Ended December 31, 2004 to Year Ended December 31, 2003

The following table shows cash flows and ending cash and cash equivalent balances for the years ended December 31, 2005, 2004 and 2003, respectively (in thousands).

 

     Year Ended December 31,     Increase        
     2005     2004     2003     2005 v 2004     2004 v 2003  

Net cash provided from operations

   $ 82,848     $ 44,638     $ 27,628     $ 38,210     $ 17,010  

Net cash used in investing activities

     (480,815 )     (371,277 )     (213,905 )     (109,538 )     (157,372 )

Net cash provided by financing activities

     404,340       326,022       187,873       78,318       138,149  
                                        

Net increase (decrease) in cash and cash equivalents

   $ 6,373     $ (617 )   $ 1,596     $ 6,990     $ (2,213 )
                                        

Cash and cash equivalents at end of year

   $ 10,930     $ 4,557     $ 5,174     $ 6,373     $ (617 )
                                        

The increases in net cash provided by operating activities was primarily due to revenues from the properties added to our portfolio which was partially offset by increased operating and interest expenses. We acquired 19, 11 and 8 properties during the years ended December 31, 2005, 2004 and 2003 respectively.

Net cash used in investing activities primarily consists of new properties acquired during the year. The increases in net cash used in investing activities were due to higher expenditures to acquire more properties in later years.

Net cash flows from financing activities consisted of the following amounts (in thousands).

 

     Year Ended December 31,  
     2005     2004     2003  

Net proceeds from borrowings

   $ 209,829     $ 134,087     $ 142,183  

Proceeds from issuance of stock

     258,265       230,798       —    

Dividend payments

     (58,440 )     —         —    

Purchase of operating partnership units

     —         (91,862 )     —    

Predecessor net contributions

     —         61,670       48,290  

Other

     (5,314 )     (8,671 )     (2,600 )
                        

Net cash provided by financing activities

   $ 404,340     $ 326,022     $ 187,873  
                        

 

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We experienced net borrowings in all years as a result of our financing of new property acquisitions. Proceeds from issuance of stock related to our initial public offering in November 2004 and subsequent common and preferred stock offerings in February 2005 and July 2005.

Minority interest

Minority interests relate to the interests in the Operating Partnership that are not owned by us, which, at December 31, 2005, amounted to 53.6% of the Operating Partnership Common Units. In conjunction with the our formation, GI Partners received common units, in exchange for contributing ownership interests in the Predecessor’s properties to the Operating Partnership. Also in connection with acquiring real estate interests owned by third parties, the Operating Partnership issued common units to those sellers. Limited partners who acquired common units in the formation transactions have the right, commencing on or after January 3, 2006, to require the Operating Partnership to redeem part or all of their common units for cash based upon the fair market value of an equivalent number of shares of our common stock at the time of the redemption. Alternatively, we may elect to acquire those common units in exchange for shares of our common stock on a one-for-one basis, subject to adjustment in the event of stock splits, stock dividends, issuance of stock rights, specified extraordinary distributions and similar events. Pursuant to registration rights agreements we entered into with GI Partners and the other third party contributors, we are required to file a shelf registration statement covering the issuance of the shares of our common stock issuable upon redemption of the common units, and the resale of those shares of common stock by the holders. We made the initial filing of this registration statement in November 2005 and currently anticipate that this registration statement will be effective in the first quarter of 2006.

Inflation

Substantially all of our leases provide for separate real estate tax and operating expense escalations. In addition, many of the leases provide for fixed base rent increases. We believe that inflationary increases may be at least partially offset by the contractual rent increases and expense escalations described above.

New Accounting Pronouncements

In March 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations,” which clarifies that an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value can be reasonably estimated even though uncertainty exists about the timing and/or method of settlement. We adopted Interpretation No. 47 for these financial statements ended December 31, 2005 and the there was no material impact on the financial statements from the adoption of this Interpretation.

In December 2004, the Financial Accounting Standards Board issued Statement of Financial Reporting Standard (FAS) No. 123 (revised 2004), Share-Based Payment (“FAS No. 123R”), which is a revision of FAS No. 123, Accounting for Stock-Based Compensation. FAS No. 123R supersedes Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and amends FAS No. 95, Statement of Cash Flows. Registrants were initially required to adopt FAS No. 123R as of the beginning of the first interim or annual period that begins after June 15, 2005. We adopted FAS No. 123R as of October 1, 2005 and there was no material impact on our financial statements.

 

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our future income, cash flows and fair values relevant to financial instruments depend upon prevalent market interest rates. Market risk refers to the risk of loss from adverse changes in market prices and interest rates. We do not use derivatives for trading or speculative purposes and only enter into contracts with major financial institutions based on their credit rating and other factors.

Effective November 2004 and May 2005, we entered into interest rate swap agreements with KeyBank National Association and Bank of America to hedge variability in cash flows related to certain of our variable rate debt. The table below summarizes the terms of these interest rate swaps and their fair values as of December 31, 2005 (in thousands):

 

Current Notional
Amount
  Strike rate     Effective Date   Expiration date   Fair value
$ 43,000   3.250 %   Nov. 26, 2004   Sept. 15, 2006   $ 431
  21,105   3.754 %   Nov. 26, 2004   Jan. 2, 2009     551
  20,000   3.824 %   Nov. 26, 2004   Apr. 1, 2009     555
  8,775   3.331 %   Nov. 26, 2004   Dec. 1, 2006     110
  100,000   4.025 %   May 26, 2005   Jun. 15, 2008     1,620
               
$   192,880         $   3,267
               

If the underlying base interest rates were to increase by 10%, or approximately 47 basis points, the fair value of our interest rate swaps would increase by approximately $1.7 million. If interest rates were to decrease by 10%, or approximately 47 basis points, the fair value of our interest rate swaps would decrease by approximately $1.7 million.

As of December 31, 2005, our total outstanding debt was approximately $749.1 million, which consisted of $565.9 million of principal outstanding for mortgage loans and $2.2 million for the debt premium on two of our mortgage loans and $181.0 million of notes payable under our line of credit. Approximately $391.5 million of our total outstanding debt was variable rate debt and after considering that $192.9 million of such debt is hedged with interest rate swaps, our variable rate debt comprises 26.6% of our total outstanding debt. As of December 31, 2005, the fair value of our outstanding fixed-rate debt approximated $362.6 million compared to the carrying value of $357.6 million, comprised of $355.4 of principal and $2.2 million of debt premium.

If interest rates were to increase by 10%, or approximately 47 basis points, the increase in interest expense on the unhedged variable rate debt would decrease future earnings and cash flows by approximately $0.9 million annually. If fixed interest rates were to increase by 10%, the fair value of our $355.4 million principal amount of outstanding fixed rate debt would decrease by approximately $6.1 million. If interest rates were to decrease by 10%, or approximately 47 basis points, the decrease in interest expense on the unhedged variable rate debt would be approximately $0.9 million annually. If interest rates were to decrease by 10%, the fair value of our $355.4 million principal amount of outstanding fixed rate debt would increase by approximately $6.3 million.

Interest risk amounts were determined by considering the impact of hypothetical interest rates on our financial instruments. These analyses do not consider the effect of any change in overall economic activity that could occur in that environment. Further, in the event of a change of that magnitude, we may take actions to further mitigate our exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, these analyses assume no changes in our financial structure.

We are also party to a foreign currency forward sale contract with a notional value of approximately £7.9 million. We terminated this contract in January 2006 and received cash of approximately $0.7 million. The fair value of this forward contract was $1.0 million as of December 31, 2005 using the currency exchange rate in effect as of that date. We terminated this contract in January 2006 and received cash of approximately $0.7 million.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO THE CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS

 

     Page No.

Consolidated and Combined Financial Statements of Digital Realty Trust, Inc. and Digital Realty Trust, Inc. Predecessor

  

Management’s Report on Internal Control over Financial Reporting

   53

Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting

   54

Report of Independent Registered Public Accounting Firm

   55

Consolidated Balance Sheets of Digital Realty Trust, Inc. as of December 31, 2005 and 2004

   56

Consolidated and Combined Statements of Operations for Digital Realty Trust, Inc for year ended December 31, 2005 and the period from November 3, 2004 through December 31, 2004, and for Digital Realty Trust, Inc. Predecessor for the period from January 1, 2004 through November 2, 2004 and for the year ended December 31, 2003

   57

Consolidated and Combined Statements of Stockholders’ and Owners’ Equity (Deficit) and Comprehensive Income (Loss) for Digital Realty Trust, Inc. for the year ended December 31, 2005 and the period November 3, 2004 through December 31, 2004, and for Digital Realty Trust, Inc. Predecessor for the period from January 1, 2004 through November 2, 2004 and for the year ended December 31, 2003

   58

Consolidated and Combined Statements of Cash Flows for the years ended December 31, 2005, 2004 and 2003

   60

Notes to Consolidated and Combined Financial Statements

   63

Supplemental Schedule—Schedule III—Properties and Accumulated Depreciation

   86

Notes to Schedule III—Properties and Accumulated Depreciation

   88

 

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Management’s Report on Internal Control over Financial Reporting

The management of Digital Realty Trust, Inc. (the Company) is responsible for establishing and maintaining adequate internal control over financial reporting, as such item is defined in Exchange Act Rules 13a-15(f) or 15(d)-15(f). Our internal control system was designed to provide reasonable assurance to the company’s management and board of directors regarding the preparation and fair presentation of published financial statements.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

Under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial and Investment Officer, we assessed the effectiveness of the company’s internal control over financial reporting as of December 31, 2005. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control—Integrated Framework. Based on our assessment we believe that, as of December 31, 2005, the Company’s internal control over financial reporting is effective based on those criteria.

Our independent registered public accounting firm has issued an audit report on our assessment of the Company’s internal control over financial reporting. This report appears on page 54.

 

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Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting

The Board of Directors and Stockholders

Digital Realty Trust, Inc.:

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Digital Realty Trust, Inc. maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Digital Realty Trust, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that Digital Realty Trust, Inc. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by COSO. Also, in our opinion, Digital Realty Trust, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by COSO.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Digital Realty Trust, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders’ equity and comprehensive income (loss) for the year ended December 31, 2005 and for the period from November 3, 2004 (commencement of operations) through December 31, 2004, the related combined statements of operations, owners’ equity of Digital Realty Trust, Inc. Predecessor, as defined in note 1 to the financial statements, for the period from January 1, 2004 through November 2, 2004, and the year ended December 31, 2003, the related consolidated statement of cash flows of Digital Realty Trust, Inc. and subsidiaries for the year ended December 31, 2005 and the related consolidated and combined statement of cash flows of Digital Realty Trust, Inc. and subsidiaries and Digital Realty Trust, Inc. Predecessor for the year ended December 31, 2004, and the related combined statement of cash flows of Digital Realty Trust, Inc. Predecessor for the year ended December 31, 2003, and our report dated March 14, 2006 expressed an unqualified opinion on those consolidated and combined financial statements and related financial statement schedule.

/s/ KPMG LLP

San Francisco, California

March 14, 2006

 

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Digital Realty Trust, Inc.:

We have audited the accompanying consolidated balance sheets of Digital Realty Trust, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders’ equity and comprehensive income (loss) for the year ended December 31, 2005 and for the period from November 3, 2004 (commencement of operations) through December 31, 2004, the related combined statements of operations, owners’ equity of Digital Realty Trust, Inc. Predecessor, as defined in note 1 to the financial statements, for the period from January 1, 2004 through November 2, 2004, and the year ended December 31, 2003, the related consolidated statement of cash flows of Digital Realty Trust, Inc. and subsidiaries for the year ended December 31, 2005 and the related consolidated and combined statement of cash flows of Digital Realty Trust, Inc. and subsidiaries and Digital Realty Trust, Inc. Predecessor for the year ended December 31, 2004, and the related combined statement of cash flows of Digital Realty Trust, Inc. Predecessor for the year ended December 31, 2003. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule III, properties and accumulated depreciation. These consolidated and combined financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated and combined financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Digital Realty Trust, Inc. and subsidiaries as of December 31, 2005 and 2004, the consolidated results of operations for the year ended December 31, 2005 and for the period from November 3, 2004 (commencement of operations) through December 31, 2004, the combined results of operations of Digital Realty Trust, Inc. Predecessor, for the period from January 1, 2004 through November 2, 2004, and the year ended December 31, 2003, the consolidated cash flows of Digital Realty Trust, Inc. and subsidiaries for the year ended December 31, 2005, and the consolidated and combined cash flows of Digital Realty Trust, Inc. and subsidiaries and Digital Realty Trust, Inc. Predecessor for the year ended December 31, 2004, and the combined cash flows of Digital Realty Trust, Inc. Predecessor for the year ended December 31, 2003 in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule III, properties and accumulated depreciation, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Digital Realty Trust, Inc.’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 14, 2006 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

/s/ KPMG LLP

San Francisco, California

March 14, 2006

 

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DIGITAL REALTY TRUST, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

 

    December 31,
2005
    December 31,
2004
 

ASSETS

   

Investments in real estate:

   

Land

  $ 191,961     $ 129,112  

Acquired ground lease

    1,477       1,477  

Buildings and improvements

    941,115       613,058  

Tenant improvements

    123,957       74,745  
               

Investments in real estate

    1,258,510       818,392  

Accumulated depreciation and amortization

    (64,404 )     (30,980 )
               

Net investments in real estate

    1,194,106       787,412  

Cash and cash equivalents

    10,930       4,557  

Accounts and other receivables, net of allowance for doubtful accounts of $763 and $362 as of December 31, 2005 and 2004, respectively

    7,587       3,051  

Deferred rent

    25,094       12,236  

Acquired above market leases, net of accumulated amortization of $12,154 and $5,659 as of December 31, 2005 and 2004, respectively

    48,237       43,947  

Acquired in place lease value and deferred leasing costs, net of accumulated amortization of $50,974 and $22,972 as of December 31, 2005 and 2004, respectively

    201,141       136,721  

Deferred financing costs, net of accumulated amortization of $7,873 and $6,555 as of December 31, 2005 and 2004, respectively

    7,659       8,236  

Restricted cash

    22,123       14,207  

Other assets

    12,293       2,920  
               

Total Assets

  $ 1,529,170     $ 1,013,287  
               

LIABILITIES AND STOCKHOLDERS’ EQUITY

   

Notes payable under line of credit

  $ 181,000     $ 44,000  

Mortgage loans

    568,067       453,498  

Other secured loans

    —         22,000  

Accounts payable and other accrued liabilities

    36,869       12,789  

Accrued dividends and distributions

    15,639       8,276  

Acquired below market leases, net of accumulated amortization of $17,190 and $9,528 as of December 31, 2005 and 2004, respectively

    67,177       37,390  

Security deposits and prepaid rents

    11,476       6,276  
               

Total liabilities

    880,228       584,229  

Commitments and contingencies

   

Minority interests in consolidated joint ventures

    206       997  

Minority interests in operating partnership

    262,239       254,862  

Stockholders’ equity:

   

Preferred Stock: $0.01 par value, 20,000,000 authorized:

   

Series A Cumulative Redeemable Preferred Stock, 8.50%, $103,500,000 liquidation preference ($25.00 per share), 4,140,000 issued and outstanding

    99,297       —    

Series B Cumulative Redeemable Preferred Stock, 7.875%, $63,250,000 liquidation preference ($25.00 per share), 2,530,000 issued and outstanding

    60,502       —    

Common Stock; $0.01 par value: 100,000,000 authorized, 27,363,408 and 21,421,300 shares issued and outstanding as of December 31, 2005 and December 31, 2004

    274       214  

Additional paid-in capital

    252,562       182,411  

Dividends in excess of earnings

    (27,782 )     (9,517 )

Accumulated other comprehensive income, net

    1,644       91  
               

Total stockholders’ equity

    386,497       173,199  
               

Total liabilities and stockholders’ equity

  $ 1,529,170     $ 1,013,287  
               

See accompanying notes to the consolidated and combined financial statements.

 

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DIGITAL REALTY TRUST, INC. AND

DIGITAL REALTY TRUST, INC. PREDECESSOR

CONSOLIDATED AND COMBINED STATEMENTS OF OPERATIONS

(in thousands, except share data)

 

    The Company     The Predecessor  
    Year Ended
December 31,
2005
    Period from
November 3,
2004
through
December 31,
2004
    Period from
January 1,
2004
through
November 2,
2004
  Year Ended
December 31,
2003
 

Revenues:

       

Rental

  $ 164,219     $ 21,232     $ 67,876   $ 50,099  

Tenant reimbursements

    37,454       4,083       12,146     8,661  

Other

    7,136       30       1,754     4,328  
                             

Total revenues

    208,809       25,345       81,776     63,088  
                             

Expenses:

       

Rental property operating and maintenance

    43,157       5,173       13,801     8,624  

Property taxes

    21,867       2,085       7,249     4,688  

Insurance

    2,804       472       1,403     626  

Interest

    39,122       5,547       18,914     10,091  

Asset management fees to related party

    —         —         2,655     3,185  

Depreciation and amortization

    62,232       7,373       24,025     16,295  

General and administrative

    12,615       20,725       292     329  

Loss from early extinguishment of debt

    1,021       283       —       —    

Other

    1,634       57       2,748     2,459  
                             

Total expenses

    184,452       41,715       71,087     46,297  
                             

Income (loss) before minority interests

    24,357       (16,370 )     10,689     16,791  

Minority interests in consolidated joint ventures

    12       (13 )     37     (149 )

Minority interests in operating partnership

    (8,268 )     10,214       —       —    
                             

Net income (loss)

    16,101       (6,169 )   $ 10,726   $ 16,642  
                 

Preferred stock dividends

    (10,014 )     —        
                   

Net income (loss) available to common stockholders

  $ 6,087     $ (6,169 )    
                   

Basic and diluted income (loss) per share available to common stockholders

  $ 0.25     $ (0.30 )    
                   

Weighted average common shares outstanding:

       

Basic

    23,986,288       20,770,875      

Diluted

    24,221,732       20,770,875      

See accompanying notes to the consolidated and combined financial statements.

 

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DIGITAL REALTY TRUST, INC. AND

DIGITAL REALTY TRUST, INC. PREDECESSOR

CONSOLIDATED AND COMBINED STATEMENTS OF STOCKHOLDERS’ AND

OWNERS’ EQUITY (DEFICIT) AND COMPREHENSIVE INCOME (LOSS)

(in thousands, except share data)

 

    Series A
Preferred
Stock
  Series B
Preferred
Stock
  Number of
Common
Shares
  Common
Stock
  Additional
Paid in
Capital
   

Accumulated
Dividends

In Excess of

Earnings

    Accumulated
Other
Comprehensive
Income, net
    Owner’s
Equity
    Total  

Predecessor:

                 

Balance at December 31, 2002

  $ —     $ —     —     $ —     $ —       $ —       $ 463     $ 82,714     $ 83,177  

Contributions

    —       —     —       —       —         —         —         131,181       131,181  

Distributions

    —       —     —       —       —         —         —         (82,891 )     (82,891 )

Net income

    —       —     —       —       —         —         —         16,642       16,642  

Other comprehensive income:

                 

Foreign currency translation adjustments

    —       —     —       —       —         —         (158 )       (158 )
                       

Comprehensive income

                    16,484  
                                                             

Balance at December 31, 2003

    —       —     —       —       —         —         305       147,646       147,951  

Contributions

    —       —     —       —       —         —         —         130,264       130,264  

Distributions

    —       —     —       —       —         —         —         (68,971 )     (68,971 )

Net income

    —       —     —       —       —         —         —         10,726       10,726  

Other comprehensive income: