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, 2007.

 

¨ 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 per share

  New York Stock Exchange

Series A cumulative redeemable preferred stock, $0.01 par value per share

  New York Stock Exchange

Series B cumulative redeemable preferred stock, $0.01 par value per share

  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  x                Accelerated filer  ¨                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

The aggregate market value of the common equity held by non-affiliates of the registrant as of June 30, 2007 totaled approximately $2,009.8 million based on the closing price for the registrant’s common stock on that day as reported by the New York Stock Exchange. Such value excludes common stock held by executive officers, directors and 10% or greater stockholders as of June 30, 2007. The identification of 10% or greater stockholders as of June 30, 2007 is based on Schedule 13G and amended Schedule 13G reports publicly filed before June 30, 2007. This calculation does not reflect a determination that such parties are affiliates for any other purposes.

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

 

Class

   Outstanding at February 25, 2008

Common Stock, $.01 par value per share

   65,406,240

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s Proxy Statement with respect to its 2008 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, 2007

TABLE OF CONTENTS

 

        PAGE NO.

PART I.

   

ITEM 1.

 

Business

  1

ITEM 1A.

 

Risk Factors

  7

ITEM 1B.

 

Unresolved Staff Comments

  28

ITEM 2.

 

Properties

  28

ITEM 3.

 

Legal Proceedings

  33

ITEM 4.

 

Submission of Matters to a Vote of Security Holders

  33

PART II.

   

ITEM 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

  34

ITEM 6.

 

Selected Financial Data

  37

ITEM 7.

 

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

  40

ITEM 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

  61

ITEM 8.

 

Financial Statements and Supplementary Data

  63

ITEM 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

  108

ITEM 9A.

 

Controls and Procedures

  108

ITEM 9B.

 

Other Information

  108

PART III.

   

ITEM 10.

 

Directors, Executive Officers and Corporate Governance

  110

ITEM 11.

 

Executive Compensation

  110

ITEM 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

  110

ITEM 13.

 

Certain Relationships and Related Transactions and Director Independence

  110

ITEM 14.

 

Principal Accounting Fees and Services

  110

PART IV.

   

ITEM 15.

 

Exhibits and Financial Statement Schedules

  111


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 enterprise datacenter 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, 2007 we owned 70 properties, excluding one property held as an investment in an unconsolidated joint venture. Our properties are primarily located throughout North America with 12 properties in Europe. Our properties contain a total of approximately 12.3 million net rentable square feet, including approximately 1.8 million square feet held for redevelopment. A significant component of our current and future internal growth is anticipated through the development of our existing space held for redevelopment and new properties. Our operations and acquisition activities are focused on a limited number of markets where technology industry tenants and corporate datacenter users are concentrated, including the Chicago, Dallas, Los Angeles, New York, Northern Virginia, Phoenix, San Francisco and Silicon Valley metropolitan areas and the Amsterdam, Dublin, London and Paris markets in Europe. As of December 31, 2007, our portfolio, excluding space held for redevelopment, was approximately 94.7% leased at an average annualized rent per leased square foot of $29.18. The types of properties within our focus include:

 

   

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

 

   

Corporate 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 corporate IT operations;

 

   

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.

Many of our properties have 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 improvements in our facilities are generally readily adaptable for use by similar tenants. We also have approximately 1.8 million square feet available for redevelopment at December 31, 2007.

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, or the Securities and Exchange Commission.

 

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Recent Developments

On December 21, 2007 we acquired Units 1, 2 and 3 of the Foxboro Business Park, a three building complex located in suburban London, England for approximately £21.9 million ($43.6 million based on the exchange rate on December 21, 2007). The acquisition was financed with borrowings under our revolving credit facility.

On December 12, 2007 we acquired Naritaweg 52, a property located in Amsterdam, The Netherlands for approximately €18.5 million ($27.2 million based on the exchange rate on December 12, 2007). The acquisition was financed with borrowings under our revolving credit facility.

On December 10, 2007 we acquired Cressex 1, a property located in suburban London, England for approximately £6.3 million ($12.7 million based on the exchange rate on December 10, 2007). The acquisition was financed with borrowings under our revolving credit facility.

On October 22, 2007, we completed an offering of 4,025,000 shares of common stock for total net proceeds, after underwriting discounts and estimated offering expenses, of $150.4 million, including the proceeds from the exercise of the underwriters’ over-allotment option. We used the net proceeds from the offering to temporarily repay borrowings under our revolving credit facility, to acquire properties, to fund redevelopment activities and for general corporate purposes.

Subsequent Events

On February 25, 2008, 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
  Series C
Preferred Stock
  Series D
Preferred Stock
    Common stock
and common unit

Dividend and distribution amount

  $0.531250   $0.492188   $0.273438   $0.210069 (1)   $0.310000

Dividend and distribution payable date

  March 31, 2008   March 31, 2008   March 31, 2008   March 31, 2008     March 31, 2008

Dividend payable to shareholders of record on

  March 17, 2008   March 17, 2008   March 17, 2008   March 17, 2008     March 17, 2008

Annual equivalent rate of dividend and distribution

  $2.125   $1.969   $1.094   $1.375     $1.240

 

(1) Represents a pro rata dividend from and including the original issue date to and including March 31, 2008.

On February 14, 2008 we acquired 365 South Randolphville Road, a property located in Piscataway, New Jersey for approximately $20.2 million. The acquisition was financed with borrowings under our revolving credit facility.

On February 6, 2008, we issued 13.8 million shares of 5.500% series D cumulative convertible preferred stock for total net proceeds, after underwriting discounts and estimated offering expenses, of approximately $333.6 million, including the proceeds from the exercise of the underwriters’ over-allotment option. We used the net proceeds from the offering to temporarily repay borrowings under our revolving credit facility, to acquire properties, to fund redevelopment activities and for general corporate purposes.

On January 30, 2008, we amended our charter to increase the number of authorized shares of our common stock, $0.01 par value per share, available for issuance from 100,000,000 to 125,000,000 and the number of authorized shares of our preferred stock, $0.01 par value per share, available for issuance from 20,000,000 to 30,000,000.

 

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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 datacenter 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. With a total power capacity of over 1,100 megawatts, or MW, our portfolio of corporate and Internet gateway datacenter facilities is equipped to meet the power and cooling requirements for the most demanding corporate IT applications. In addition, 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.

 

   

Presence in Key Markets. Our portfolio is located in 26 metropolitan areas, including the Chicago, Dallas, Los Angeles, New York, Phoenix, San Francisco and Silicon Valley metropolitan areas in the U.S. and the London, Dublin, Paris and Amsterdam markets in Europe, and is diversified so that no one market represented more than 14.8% of the aggregate annualized rent of our portfolio as of December 31, 2007.

 

 

 

Ability To Sign New Leases. We have considerable experience in identifying and leasing to new tenants. The combination of our specialized datacenter leasing team and customer referrals continues to provide a robust pipeline of new tenants. During the year ended December 31, 2007, we commenced new leases totaling approximately 761,000 square feet, which resulted in annualized GAAP rent of $40.5 million. These leases were comprised of Powered Base Building, Turn-Key Datacenters , and ancillary office and other uses.

 

   

Acquisition Capability. As of December 31, 2007, our portfolio consisted of 70 technology-related real estate properties, excluding one property held through an investment in an unconsolidated joint venture, that we or our predecessor acquired beginning in 2002, for an aggregate of 12.3 million net rentable square feet, including approximately 1.8 million square feet held for redevelopment. We have developed detailed, standardized procedures for evaluating acquisitions, including income producing assets and vacant properties suitable for redevelopment, to ensure that they meet our financial, technical and other criteria. These procedures and our in-depth knowledge of the technology and datacenter industries allow us to identify strategically located properties and evaluate investment opportunities efficiently and, as appropriate, commit and close quickly. 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. As a result, we acquired more than half of our properties before they were broadly marketed by real estate brokers.

 

 

 

Flexible Datacenter Solutions. We provide flexible, customer oriented solutions designed to meet the needs of technology and corporate datacenter users, including Turn-Key Datacenter , Powered Base Building and built-to-suit options. Our Turn-Key Datacenters are move-in ready, physically secure facilities with the power and cooling capabilities to support mission critical IT enterprise applications. We believe our Turn-Key Datacenters are effective solutions for tenants that lack the expertise, capital budget or desire to provide their own extensive datacenter infrastructure, management and security. For tenants that possess the ability to build and operate their own facility, our Powered Base Building solution provides the physical location, required power and network access necessary to support a state-of-the-art datacenter. Our in-house engineering and design and construction professionals can also provide tenants with customized build-to-suit solutions to meet their unique specifications. Our Critical Facilities Management services and team of technical engineers and datacenter operations experts provide 24/7 support for these mission-critical facilities.

 

   

Development Advantages. Our extensive development activity, operating scale and process-based approach to datacenter design, construction and operations result in significant cost savings and added

 

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value for our tenants. We have leveraged our purchasing power by securing global purchasing agreements and developing relationships with major equipment manufacturers, reducing costs and shortening delivery timeframes on key components, including major mechanical and electrical equipment. Utilizing our innovative modular datacenter design referred to as POD Architecture, we deliver what we believe to be a technically superior datacenter environment at significant cost savings. In addition, by utilizing our POD Architecture to develop new Turn-Key Datacenters in our existing Powered Base Buildings, on average we have been able to deliver a fully commissioned facility in just under 30 weeks. Finally, our access to capital allows us to provide financing options for tenants that do not want to invest their own capital.

 

   

Diverse Tenant Base Across a Variety of Industry Sectors. We use our in-depth knowledge of the requirements and trends for Internet and data communications and corporate datacenter users to market our properties to domestic and international tenants with specific technology needs. At December 31, 2007, we had 414 tenants across a variety of industry sectors, ranging from information technology and Internet enterprises to financial services, energy and manufacturing companies. No single tenant accounted for more than 11.8% of the aggregate annualized rent of our portfolio as of December 31, 2007.

 

   

Experienced and Committed Management Team and Organization. Our senior management team, including our Chairman, has an average of over 23 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, 2007, our senior management team collectively owned a common equity interest in our company of approximately 2.2%, which aligns management’s interests with those of our stockholders.

 

   

Long-Term Leases That Complement Our Growth. We have long-term leases with stable cash flows. As of December 31, 2007, our average lease term was in excess of 13 years, with an average of 8 years remaining, excluding renewal options. Our lease expirations through December 31, 2009 are 8.1% of net rentable square feet excluding space held for redevelopment as of December 31, 2007.

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 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 results in 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.

 

 

 

Achieve Superior Returns on Redevelopment Inventory. A significant component of our current and future internal growth is anticipated through the development of our existing space held for redevelopment and new properties. At December 31, 2007, we had approximately 1.8 million square feet held for redevelopment. At December 31, 2007, 637,000 square feet of our space held for redevelopment was under construction for Turn-Key Datacenter, build-to-suit datacenter and Powered Base Building space in 10 U.S. and European markets. These projects have sufficient power capacity to meet the power and cooling requirements of today’s advanced datacenters. We will continue to build-out our redevelopment portfolio when justified by anticipated returns.

 

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Access and Use Capital Efficiently. We believe we can increase stockholder returns by effectively accessing and deploying capital. Since our initial public offering in 2004, we have raised over $2.6 billion of capital through common, preferred and convertible preferred equity offerings, an exchangeable debt offering, our revolving credit facility, secured mortgage financings and refinancings, and sales of non-core assets. We intend to use our liquidity and access to capital to support our acquisition, leasing, development and redevelopment programs, which are important sources of growth for the company.

 

   

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. Moreover, many of our properties contain extensive in-place infrastructure or buildout that 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, including power costs, and certain capital expenditures. Leases covering more than 80% of the leased net rentable square feet in our portfolio as of December 31, 2007 required tenants to pay all or a portion of increases in operating expenses, including real estate taxes, insurance, common area charges and other expenses.

 

   

Leverage Strong Industry Relationships. We use our strong industry relationships with international 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 datacenter and other technology tenants.

 

Competition

We compete with numerous developers, owners and operators of real estate and datacenters, many of which own properties similar to ours in the same markets in which our properties are located, including DuPont Fabros Technology, Inc., 365 Main Inc., Equinix, Inc. and various local developers in the U.S., and Global Switch, Equinix, Inc. and various regional operators in Europe. If our competitors offer space that our tenants or potential tenants perceive to be superior to ours based on numerous factors, including available power, security considerations, location, or connectivity, or if they offer rental rates below current market rates, or below the rental rates we are offering, we may lose tenants or potential tenants or be required to incur costs to improve our properties or reduce our rental rates. In addition, recently many of our competitors have developed or redeveloped additional datacenter space. If the supply of datacenter space continues to increase as a result of these activities or otherwise, rental rates may be reduced or we may face delays in or be unable to lease our vacant space, including space that we develop or redevelop. Finally, if tenants or potential tenants desire services that we do not offer, we may not be able to lease our space to those tenants. Our financial condition, results of operations, cash flow, cash available for distribution, including cash available to pay dividends to our preferred or common stockholders, and ability to satisfy our debt service obligations could be materially adversely affected as a result of any or all of these factors.

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, 2007 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 the ADA, to the extent that such properties are “public accommodations” as defined by the ADA. The ADA may require

 

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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 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 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.”

 

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Employees

As of December 31, 2007 we had 153 employees. None of these employees is represented by a labor union.

Offices

Our headquarters is located in San Francisco. We have regional offices in Boston, Chicago, Dallas, Los Angeles, New York, Northern Virginia and Phoenix and international offices in Dublin, London and Paris.

 

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” starting on page 26.

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, and datacenter real estate in particular. A decrease in the demand for datacenter space, Internet gateway facilities or other technology-related real estate would have a greater adverse effect on our business and financial condition than if we owned a portfolio with a more diversified tenant base or less specialized use. Our substantial redevelopment activities make us particularly susceptible to general economic slowdowns, including recessions, as well as adverse developments in the corporate datacenter, Internet and data communications and broader technology industries. Any such slowdown or adverse development could lead to reduced corporate IT spending or reduced demand for datacenter space. Reduced demand could also result from business relocations, including to markets that we do not currently serve such as Asia. Changes in industry practice or in technology, such as virtualization technology, more efficient computing or networking devices, or devices that require higher power densities than today’s devices, could also reduce demand for the physical datacenter space we provide or make the tenant improvements in our facilities obsolete or in need of significant upgrades to remain viable. In addition, the 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, 2007, the 15 largest tenants in our property portfolio represented approximately 51% 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 1.6 million square feet of net rentable space as of December 31, 2007, representing approximately 11.8% of the total annualized rent generated by our properties. Qwest Communications International leased approximately 771,000 square feet of net rentable space as of December 31, 2007, representing approximately 8.2% of the total annualized rent generated by our properties. In addition, 31 of our 70 properties are occupied by single tenants, including properties occupied solely by Savvis Communications and Qwest Communications International. Our tenants may experience a downturn in their businesses, 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.

 

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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, 2007, we had no significant tenants in bankruptcy, however, there can be no assurance that no significant tenant will enter into bankruptcy in the future.

Our revenue and cash available for distribution, including cash available for us to pay dividends to our stockholders or for our operating partnership to pay distributions to its unitholders, including us, 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 26 metropolitan areas. We depend upon the local economic conditions in these markets, including local real estate conditions. Many of these markets experienced downturns in recent years and either are currently or may experience downturns in the near future. Our operations may also be affected if too many competing properties are built in any of these markets or supply otherwise increases or exceeds demand. 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 for us to pay dividends to our stockholders or for our operating partnership to pay distributions to its unitholders, including us, could be materially adversely affected. We cannot assure you that these markets will grow or will remain favorable to technology-related real estate.

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

 

Metropolitan Market

   Percentage of
total annualized rent(1)
 

Silicon Valley

   14.9 %

Chicago

   12.8 %

New York

   10.4 %

Dallas

   9.9 %

Phoenix

   7.5 %

San Francisco

   6.6 %

Los Angeles

   6.2 %

Other

   31.7 %
      
   100.0 %
      

 

(1) Annualized rent is monthly contractual rent under existing leases as of December 31, 2007, multiplied by 12.

In addition, we are currently developing or redeveloping properties in these markets, as well as in Dublin, London, Northern Virginia and Paris. Any negative changes in real estate, technology or economic conditions in these markets in particular could negatively impact our performance.

Our growth depends upon the successful development of our existing space held for redevelopment and new properties acquired for redevelopment and any delays or unexpected costs in such development may delay and harm our growth prospects, future operating results and financial condition.

A significant component of our current and future internal growth is anticipated through the development of our existing space held for redevelopment and new properties acquired for redevelopment. Our successful development and redevelopment of these projects depends on many risks, including those associated with:

 

   

delays in construction;

 

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budget overruns;

 

   

increased prices for raw materials or building supplies;

 

   

lack of availability and/or increased costs for specialized data center components;

 

   

financing availability;

 

   

increases in interest rates or credit spreads;

 

   

labor availability;

 

   

timing of the commencement of rental payments;

 

   

ability to lease the space we develop or redevelop at all, or at rates we consider favorable or expected at the time we commenced redevelopment;

 

   

increased supply or reduced demand for datacenters space;

 

   

access to sufficient power and related costs of providing such power to our tenants;

 

   

delays or denials of entitlements or permits; and

 

   

other property development uncertainties.

In addition, development and redevelopment activities, regardless of whether they are ultimately successful, typically require a substantial portion of management’s time and attention. This may distract management from focusing on other operational activities. If we are unable to complete development or redevelopment projects successfully, our business may be adversely affected.

We may be unable to successfully complete and operate developed properties.

We intend to develop and substantially renovate properties for data center use. Our future development and construction activities involve the following significant risks:

 

   

we may be unable to obtain construction financing at all or on favorable terms;

 

   

we may be unable to obtain permanent financing at all or on advantageous terms if we finance development projects through construction loans;

 

   

we may not complete development projects on schedule or within budgeted amounts;

 

   

we may encounter delays or refusals in obtaining all necessary zoning, land use, building, occupancy, and other required governmental permits and authorizations; and occupancy rates and rents at newly developed or renovated properties may fluctuate depending on a number of factors, including market and economic conditions, and may result in our investment not being profitable; and

 

   

we have encountered and may continue to encounter long lead times or other delays in procuring the generators and other infrastructure equipment necessary to complete the development of our Turn-Key Datacenters.™ In addition, the unavailability or increased costs of raw materials may delay our ability to complete the redevelopment of data center space in a timely manner, within budgeted amounts, or at all.

In addition, in certain circumstance we lease data center facilities prior to their completion. If we fail to complete the facilities in a timely manner, the tenant may be entitled to terminate their lease, seek damages against us or pursue other remedies.

While we intend to develop data center properties primarily in markets we are familiar with, we may in the future develop properties in new geographic regions where we expect the development of property to result in favorable risk-adjusted returns on our investment. We may not possess the same level of familiarity with development of other property types or other markets, which could adversely affect our ability to develop such properties successfully or at all or to achieve expected performance.

 

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We may encounter problems during development and construction activities.

We are currently developing data centers in multiple locations. These construction projects, and others that we may undertake from time to time, are subject to significant development and construction risks, any of which could cause unanticipated cost increases and delays. These include the following:

 

   

adverse weather that damages the project or causes delays;

 

   

delays in obtaining or inability to obtain necessary permits, licenses and approvals;

 

   

changes to the plans or specifications;

 

   

shortages of materials and skilled labor;

 

   

increases in material and labor costs;

 

   

engineering problems;

 

   

labor disputes and work stoppages with contractors, subcontractors or others that are constructing the project;

 

   

environmental issues;

 

   

shortages of qualified employees;

 

   

fire, flooding and other natural disasters;

 

   

expenditure of funds on, and the devotion of management time to, projects that may not be completed; and

 

   

geological, construction, excavation, regulatory and equipment problems.

We may not be able to complete the development of any projects we begin and, if completed, our development and construction activities may not be completed in a timely manner or within budget, which could have a material adverse effect on our results of operations and prospects. If any of these factors result in a delay in the completion of or our inability to complete a project, or increase our costs associated with development, our financial performance could be materially adversely affected.

We have owned our properties for a limited time.

We owned 70 properties at December 31, 2007, excluding one property held as an investment in an unconsolidated joint venture. These properties are primarily located throughout North America and 12 properties are located in Europe. The properties contain a total of approximately 12.3 million net rentable square feet, including 1.8 million square feet held for redevelopment. All the properties have been under our management for less than five years, and we have owned 13 of the properties for less than one year at December 31, 2007. 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. In addition, we have a limited history operating Turn-Key Datacenters that we have developed or redeveloped. Because we generally cannot pass operating expenses (other than energy costs) on to our tenants in Turn-Key Datacenters, if we incur operating expenses greater than we anticipated based on our limited operating history, our results of operations could be negatively impacted.

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

We have approximately 1.8 million square feet held for redevelopment at December 31, 2007 including eight vacant buildings. Successful redevelopment of this space depends on numerous factors including success in engaging contractors, obtaining permits, securing key components and availability of financing. We are and

 

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intend to continue building out a large portion of this space on a speculative basis at significant cost. In addition we cannot assure you that once completed we will be able to successfully lease redeveloped space to new or existing tenants at all, or at rates we consider favorable or expected at the time we commenced redevelopment. If we are not able to lease redevelopment space, or lease it at rates below those we expected to achieve when we started the project, our financial performance would be materially adversely affected.

We may have difficulty managing our growth.

We have significantly expanded the size of our company. For example, during 2007, we acquired 13 properties, including five properties outside the United States, our number of employees increased from 109 to 153 and we substantially increased the number and size of our redevelopment activities. 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 negatively impact our cash available for distribution, including cash available for us to pay dividends to our stockholders or for our operating partnership to pay distributions to its unitholders, including us.

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 or failure to meet the requirements of being a public company would have an adverse effect on our cash available for distribution, including cash available for us to pay dividends to our stockholders or for our operating partnership to pay distributions to its unitholders, including us.

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 9.0% of our portfolio’s annualized rent as of December 31, 2007. 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 $17.8 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

 

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loss from riots, terrorist threats, war or nuclear reaction. Most 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 large portion of the properties we own are located in California, an area especially subject to earthquakes. Together, these properties represented approximately 28% of our portfolio’s annualized rent as of December 31, 2007. 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 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, 2007 was approximately $1.4 billion, and we may incur significant additional debt to finance future acquisition and development activities. We have a 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, 2007, $299.7 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 $17.8 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, for our operating partnership to pay distributions to its unitholders, including us, and, consequently, for us to pay dividends to our stockholders that are 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;

 

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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 for us to pay dividends to our stockholders or for our operating partnership to pay distributions to its unitholders, 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 Internal Revenue Code of 1986, as amended, which we refer to as 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 or result in other less favorable terms;

 

   

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 operating businesses or 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,

 

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including cash available for us to pay dividends to our stockholders or for our operating partnership to pay distributions to its unitholders, 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 developers, owners and operators of real estate and datacenters, many of which own properties similar to ours in the same markets in which our properties are located, including DuPont Fabros Technology, Inc., 365 Main Inc., Equinix, Inc. and various local developers in the U.S., and Global Switch, Equinix, Inc. and various regional operators in Europe. In addition, we may in the future face competition from new entrants into the datacenter market, including new entrants who may acquire our current competitors. Some of our competitors and potential competitors have significant advantages over us, including greater name recognition, longer operating histories, pre-existing relationships with current or potential customers, significantly greater financial, marketing and other resources and more ready access to capital which allow them to respond more quickly to new or changing opportunities. If our competitors offer space that our tenants or potential tenants perceive to be superior to ours based on numerous factors, including available power, security considerations, location, or connectivity, or if they offer rental rates below current market rates, or below the rental rates we are offering, we may lose tenants or potential tenants or be required to incur costs to improve our properties or reduce our rental rates. In addition, recently many of our competitors have developed or redeveloped additional datacenter space. If the supply of datacenter space continues to increase as a result of these activities or otherwise, rental rates may be reduced or we may face delays in or be unable to lease our vacant space, including space that we develop or redevelop. Finally, if tenants or potential tenants desire services that we do not offer, we may not be able to lease our space to those tenants. Our financial condition, results of operations, cash flow, cash available for distribution, including cash available for us to pay dividends to our stockholders or for our operating partnership to pay distributions to its unitholders, and ability to satisfy our debt service obligations could be materially adversely affected as a result of any or all of these factors.

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

As of December 31, 2007, leases representing 8.1% of the square footage of the properties in our portfolio, excluding space held for redevelopment were scheduled to expire through 2009, and an additional 5.3% of the net rentable square footage excluding space held for redevelopment was available to be leased. Some of this space may require substantial capital investment for it to meet the power and cooling requirements of today’s advanced data centers, or may no longer be suitable for this use. In addition, we cannot assure you that leases will be renewed or that our properties will be re-leased at all, or 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, we do not re-lease our available space, including newly redeveloped space and space for which leases are scheduled to expire or it takes longer for us to lease or re-lease this space or for rents to commence on this space, our financial condition, results of operations, cash flow, cash available for distribution, including cash available for us to pay dividends to our stockholders or for our operating partnership to pay distributions to its unitholders, 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.

 

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In addition, at December 31, 2007, we owned approximately 1.8 million square feet held for redevelopment. Of this space, we are currently redeveloping 637,000 square feet. We intend to continue to add new space to our redevelopment inventory and to continue to redevelop additional space from this inventory. A substantial portion of the space that we redevelop is, and will continue to be, redeveloped on a speculative basis, meaning that we do not have a signed lease for the space when we begin the redevelopment process. We also develop or redevelop space specifically for tenants pursuant to leases signed prior to beginning the development or redevelopment process. In those cases, if we failed to meet our development or redevelopment obligations under those leases, these tenants may be able to terminate the leases and we would be required to find a new tenant for this space. We cannot assure you that once we have redeveloped a space we will be able to successfully lease it. If we are not able to successfully lease the space that we redevelop, if redevelopment costs are higher than we currently estimate, or if we lease rates are lower than we expected when we began the project or are otherwise undesirable, 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 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 or redevelopment financing, from operating cash flow. Consequently, we rely on third-party sources to fund our capital needs. We may not be able to obtain equity or debt 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 business prospects and growth potential;

 

   

our current debt levels;

 

   

our current and expected future earnings, funds from operations and growth thereof;

 

   

our cash flow and cash distributions; and

 

   

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

Since 2002, with the exception of recent rate cuts, the United States Federal Reserve has been increasing short term interest rates, which has had a significant upward impact on shorter-term interest rates, including the interest rates that our variable rate debt is based upon. Furthermore, difficulties with “sub-prime” residential housing credit have impacted corporate debt. Liquidity traditionally provided by collateralized debt obligations has significantly decreased. The affects on commercial real estate mortgages and other debt include:

 

   

higher loan spreads;

 

   

tighter loan covenants;

 

   

reduced loan to value ratios and resulting borrower proceeds; and

 

   

higher amortization and reserve requirements.

There is no assurance that we will be able to obtain debt financing at all or on terms favorable or acceptable to us.

Potential future increases in interest rates and credit spreads may increase our interest expense and therefore negatively affect our financial condition, results of operations, and reduce our access to capital markets. Increased interest rates may also increase the risk that the counterparties to our swap agreements will default on their obligations, which would further increase our interest expense. Equity markets have experienced high volatility recently and there is no assurance that we will be able to raise capital through the sale of equity

 

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securities at all or on favorable terms. Sales of equity on unfavorable terms could result in substantial dilution to our common stockholders.

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 pay dividends to our stockholders necessary to maintain our qualification as a REIT.

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

Our revolving 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.

These restrictions could cause us to default on our revolving credit facility or negatively affect our operations, our ability to pay dividends to our stockholders or our operating partnership’s ability to pay distributions to its unitholders, including us.

The exchange and repurchase rights of our exchangeable debentures may be detrimental to holders of common stock.

Our operating partnership has $172.5 million principal amount of 4.125% Exchangeable Senior Debentures due 2026, which we refer to as the exchangeable debentures. The exchangeable debentures may under certain circumstances, be exchanged for cash (up to the principal amount of the exchangeable debentures) and, with respect to any excess exchange value, into cash, shares of our common stock or a combination of cash and shares of our common stock at an initial exchange rate of 30.6828 shares per $1,000 principal amount of exchangeable debentures. At the initial exchange rate, the exchangeable debentures are exchangeable for our common stock at an exchange price of approximately $32.5916 per share. The exchange rate of the exchangeable debentures is subject to adjustment for certain events, including, but not limited to, certain dividends on our common stock in excess of $0.265 per share per quarter, the issuance of certain rights, options or warrants to holders of our common stock, subdivisions or combinations of our common stock, certain distributions of assets, debt securities, capital stock or cash to holders of our common stock and certain tender or exchange offers. The exchangeable debentures are redeemable at the Company’s option for cash at any time on or after August 18, 2011 and are subject to repurchase for cash at the option of the holder on August 15 in the years 2011, 2016 and 2021, or upon the occurrence of certain events. The exchangeable debentures are our senior unsecured and unsubordinated obligations.

The exchange of exchangeable debentures for our common stock at a time when our common stock is trading above the exchange price would dilute stockholder ownership in our company, and could adversely affect the market price of our common stock and could impair our ability to raise capital through the sale of additional equity securities. Any adjustments to the exchange rate of the exchangeable debentures would exacerbate their dilutive effect. If the exchangeable debentures are not exchanged, the repurchase rights of holder of the exchangeable debentures may discourage or impede transactions that might otherwise be in the interest of holders of common stock. Further, these exchange or repurchase rights might be triggered in situations where we need to conserve our cash reserves, in which event such repurchase might adversely affect us and our stockholders.

 

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The conversion rights of our convertible preferred stock may be detrimental to holders of common stock.

We have 7,000,000 shares of 4.375% series C cumulative convertible preferred stock, or the series C preferred stock, and 13,800,000 shares of 5.500% series D cumulative convertible preferred stock, or the series D preferred stock, outstanding. The series C preferred stock and the series D preferred stock may be converted into shares of our common stock subject to certain conditions. The initial conversion rate for the series C preferred stock is 0.5164 shares of our common stock per $25.00 liquidation preference, which is equivalent to an initial conversion price of $48.41 per share of our common stock. The initial conversion rate for the series D preferred stock is 0.5955 shares of our common stock per $25.00 liquidation preference, which is equivalent to an initial conversion price of $41.98 per share of our common stock. The conversion rates for the series C preferred stock and the series D preferred stock are subject adjustment upon the occurrence of specified events, including, but not limited to, increases in dividends on our common stock, the issuance of certain rights, options or warrants to holders of our common stock, subdivisions or combinations of our common stock, certain distributions of assets, debt securities, capital stock or cash to holders of our common stock and certain tender or exchange offers.

In addition, on or prior to April 10, 2014 (in the case of the series C preferred stock) or February 6, 2015 (in the case of the series D preferred stock) in the event of a fundamental change when the applicable price of our common stock is less than $40.34 per share (in the case of the series C preferred stock) or $35.73 per share (in the case of the series D preferred stock), then holders of shares of the series C preferred stock and the series D preferred stock will have a special right to convert some or all of their series of preferred stock into a number of shares of our common stock per $25.00 liquidation preference equal to such liquidation preference, plus an amount equal to accrued and unpaid dividends to, but not including, the fundamental change conversion date, divided by 98% of the market price of our common stock. In the event that holders of shares of our preferred stock exercise this special conversion right, we have the right to repurchase for cash all or any part of preferred stock as to which the conversion right was exercised at a repurchase price equal to 100% of the liquidation preference of the preferred stock to be repurchased plus an amount equal to accrued and unpaid dividends to, but not including, the fundamental change conversion date.

The conversion of the series C preferred stock or the series D preferred stock for our common stock would dilute stockholder ownership in our company, and could adversely affect the market price of our common stock and could impair our ability to raise capital through the sale of additional equity securities. Any adjustments to the conversion rates of the series C preferred stock and the series D preferred stock would exacerbate their dilutive effect. Further, the fundamental change conversion rights might be triggered in situations where we need to conserve our cash reserves, which may limit our ability to repurchase the shares of preferred stock in lieu of conversion.

The accounting method for convertible debt securities, like our outstanding 4.125% exchangeable senior debentures, is subject to uncertainty.

The accounting for convertible securities is subject to frequent scrutiny by the accounting regulatory bodies and is subject to change. We cannot predict if or when any such change could be made and any such change could have an adverse impact on our reported or future financial results. Any such impacts could adversely affect the trading prices of our common and preferred stock.

For example, the accounting method for net share settled convertible securities, which would include our outstanding 4.125% exchangeable senior debentures, has been under review by the accounting regulatory bodies for some time. Under the current accounting rules, for the purpose of calculating diluted earnings per share, a net share settled convertible security meeting certain requirements is accounted for in a manner similar to nonconvertible debt, with the stated coupon constituting interest expense and any shares issuable upon conversion of the security being accounted for in a manner similar to the treasury stock method. The effect of this method is that the shares potentially issuable upon conversion of the securities are not included in the calculation

 

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of earnings per share until the conversion price is “in the money”, and the issuer is then assumed to issue the number of shares necessary to settle the conversion.

However, a proposal to change that accounting method has recently been made by the FASB. Under the proposal, cash settled convertible securities would be separated into their debt and equity components. The value assigned to the debt component would be the estimated fair value, as of the issuance date, of a similar debt instrument without the conversion feature, and the difference between the proceeds for the convertible debt and the amount reflected as a debt liability would be recorded as additional paid-in capital. As a result, the debt would be recorded at a discount reflecting its below market coupon interest rate. The debt would subsequently be accreted to its par value over its expected life, with the rate of interest that reflects the market rate at issuance being reflected on the income statement. This change in methodology would affect the calculations of net income and earnings per share for many issuers of cash settled convertible securities, including us.

Implementation of this proposal is ongoing and we cannot predict the exact methodology that will be imposed, which may differ materially from the foregoing description, or when any change will be finally implemented.

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 currently, and may in the future, co-invest 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, tax 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. Our joint venture partners may take actions that are not within our control, which would require us to dispose of the joint venture asset or transfer it to a taxable REIT subsidiary in order to maintain our status as a REIT. 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. Finally, we may share information with our third-party partners or co-venturers that enables them to compete with us in the future. 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 affected.

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, Christopher Crosby, our Senior Vice President, Sales and Technical Services, and James R. Trout, our Senior Vice President of Portfolio and Technical Operations. 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 and other capital markets participants, existing and prospective tenants and industry personnel could suffer. Many of our other senior employees also have strong technology, finance and real estate

 

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industry reputations. As a result, we have greater access to potential acquisitions, financing, leasing and other opportunities, and are better able to negotiate with tenants. As our number of competitors increases, it becomes more likely that a competitor would attempt to hire certain of these individuals away from us. The loss of any of these key personnel would result in the loss of these and other benefits and could materially and 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 78% of our total indebtedness as of December 31, 2007 was subject to fixed interest rates. We do not currently hedge our revolving credit facility and as our borrowings under our revolving credit facility increase, so will our percentage of indebtedness not subject to fixed rates and our exposure to interest rates increase. 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.

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

Because many of our properties contain tenant improvements installed at our tenants’ expense, they may be better suited for a specific corporate enterprise datacenter user or technology industry tenant and could require modification in order for us to re-lease vacant space to another corporate enterprise datacenter user or technology industry tenant. The tenant improvements may also become outdated or obsolete as the result of technological change, the passage of time or other factors. In addition, our redevelopment space will generally require substantial improvement to be suitable for datacenter 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 affect our financial and operating results.

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

We owned 13 properties located outside of the U.S. at December 31, 2007 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 for us to pay dividends to our stockholders or for our operating partnership to pay distributions to its unitholders, the per share trading price of our common stock or preferred stock, our ability to satisfy our debt obligations and our ability to qualify as a REIT.

We may attempt to mitigate some or all of 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.

 

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Any income recognized with respect to foreign currency exchange rate hedging activities 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, development, redevelopment, operation and ownership of foreign properties involve risks greater than those faced by us in the U.S.

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

 

   

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

 

   

our limited knowledge of and relationships with sellers, tenants, contractors, suppliers or other parties 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 development, redevelopment and operations;

 

   

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

 

   

multiple, conflicting and changing legal, regulatory, entitlement and permitting, 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.;

 

   

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, suppliers or contractors; 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 stockholders and our operating partnership’s ability to pay distributions to its unitholders, 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 for us to pay dividends to our stockholders or for our operating partnership to pay distributions to its unitholders, 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;

 

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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 credit spreads, limited or no access to debt or equity capital 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 for us to pay dividends to our stockholders or for our operating partnership to pay distributions to its unitholders, 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 and because there may be even fewer buyers for our specialized real estate, our ability to promptly 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.

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.

 

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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 stockholders or our operating partnership’s ability to pay distributions to its unitholders 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.

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 for us to pay dividends to our stockholders or for our operating partnership to pay distributions to its unitholders, 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

 

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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 for us to pay dividends to our stockholders or for our operating partnership to pay distributions to its unitholders, 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. GI Partners and its related fund, own a property on which we have a right of first offer. GI Partners Fund II, LLP, or GI Partners II, owns The tel(x) Group, an operator of “Meet-Me-Room” network interconnection facilities that leases 87,305 square feet from us under ten lease agreements. Richard Magnuson, the Chairman of our board of directors, is and will continue to be, the chief executive officer of the advisor to GI Partners and GI Partners II. In the future, we may enter into additional agreements with The tel(x) Group or other companies owned by GI Partners or GI Partners II or other GI Partners funds. We may choose not to enforce, or to enforce less vigorously, our rights under theses agreements because of our desire to maintain our ongoing relationship with GI Partners and Mr. Magnuson.

Tax consequences upon sale or refinancing. Sales of properties and repayment of certain 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.

 

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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 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 amend the charter 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% or more of the voting power of our outstanding shares of voting stock 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 shares of voting stock) 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 (except solely by virtue of a revocable proxy), 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

 

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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 for us to pay dividends to our stockholders or for our operating partnership to pay distributions to its unitholders, including us. 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 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.

 

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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 make 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.

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.

 

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The power 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;

 

   

bankruptcy or insolvency of a major tenant;

 

   

downturn of local economic conditions in our geographic markets;

 

   

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;

 

   

our failure to obtain necessary outside financing;

 

   

restrictions on our ability to engage in certain business activities;

 

   

risks related to joint venture investments;

 

   

decreased rental rates or increased vacancy rates;

 

   

inability to successfully develop and lease new properties and space held for redevelopment;

 

   

difficulties in identifying properties to acquire and completing acquisitions;

 

   

increased competition or available supply of data center space;

 

   

our failure to successfully operate acquired properties;

 

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our inability to acquire off-market property;

 

   

delays or unexpected costs in development or redevelopment of properties;

 

   

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; and

 

   

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

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, 2007, we owned 70 properties through our operating partnership, excluding one property held as an investment in an unconsolidated joint venture. These properties are primarily located throughout North America, with 12 properties located in Europe, and contain a total of approximately 12.3 million net rentable square feet including 1.8 million square feet held for redevelopment. The following table presents an overview of our portfolio of properties excluding the one property held as an investment in a joint venture, based on information as of December 31, 2007.

 

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Property(1)

  

Acquisition
date

  

Metropolitan Area

   Net
Rentable
Square Feet
Excluding
Redevelopment
Space(2)
   Redevelopment
Space(3)
   Annualized
Rent
($000)(4)
   Percent
Leased(5)
    Annualized
Rent per
Occupied
Square
Foot

($)(6)

Internet Gateways

                   

350 East Cermak Road

   May-05    Chicago    974,837    158,902    32,149    98.3 %   33.54

120 E. Van Buren Street

   Jul-06    Phoenix    249,425    38,089    19,045    84.6 %   90.23

200 Paul Avenue 1-4

   Nov-04    San Francisco    527,680    —      19,054    97.4 %   37.07

2323 Bryan Street

   Jan-02    Dallas    457,217    19,890    13,257    78.7 %   36.85

600 West Seventh Street

   May-04    Los Angeles    482,089    7,633    13,042    89.4 %   30.25

111 Eighth Avenue(7)

   Mar-07    New York    116,843    —      11,179    100.0 %   95.68

1100 Space Park Drive

   Nov-04    Silicon Valley    165,297    —      7,200    97.6 %   44.63

114 Rue Ambroise Croizat(8)

   Dec-06    Paris, France    130,996    221,150    5,062    100.0 %   38.64

600-780 S. Federal

   Sep-05    Chicago    161,547    —      5,005    80.3 %   38.60

6 Braham Street(9)

   Jul-02    London, England    63,233    —      4,402    100.0 %   69.62

36 NE 2nd Street

   Jan-02    Miami    162,140    —      4,280    95.9 %   27.54

900 Walnut Street

   Aug-07    St Louis    112,266    —      3,333    98.6 %   30.11

731 East Trade Street

   Aug-05    Charlotte    40,879    —      1,131    100.0 %   27.67

113 North Myers

   Aug-05    Charlotte    20,086    9,132    707    100.0 %   35.20

125 North Myers

   Aug-05    Charlotte    25,402    —      390    51.3 %   29.90
                               
         3,689,937    454,796    139,236    92.6 %   40.75

Data Centers

                   

300 Boulevard East

   Nov-02    New York    311,950    —      12,778    100.0 %   40.96

833 Chestnut Street

   Mar-05    Philadelphia    580,147    74,611    9,653    80.5 %   20.66

Unit 9, Blanchardstown Corporate Park(8)

   Dec-06    Dublin, Ireland    120,000    —      9,016    96.4 %   77.97

2045 & 2055 LaFayette Street

   May-04    Silicon Valley    300,000    —      6,300    100.0 %   21.00

3 Corporate Place

   Dec-05    New York    205,106    71,825    6,167    88.4 %   34.02

11830 Webb Chapel Road

   Aug-04    Dallas    365,647    —      5,788    96.6 %   16.39

150 South First Street

   Sep-04    Silicon Valley    179,761    —      5,094    97.7 %   29.01

14901 FAA Boulevard

   Jun-06    Dallas    263,700    —      4,474    100.0 %   16.97

12001 North Freeway

   Apr-06    Houston    280,483    20,222    4,307    98.5 %   15.60

2334 Lundy Place

   Dec-02    Silicon Valley    130,752    —      4,253    100.0 %   32.53

44470 Chilum Place

   Feb-07    Northern Virginia    95,440    —      3,906    100.0 %   40.93

2401 Walsh Street

   Jun-05    Silicon Valley    167,932    —      3,211    100.0 %   19.12

8534 Concord Center Drive

   Jun-05    Denver    85,660    —      3,169    100.0 %   37.00

Naritaweg 52(8)(10)

   Dec-07   

Amsterdam, Netherlands

   63,260    —      2,866    100.0 %   45.31

4025 Midway Road

   Jan-06    Dallas    72,991    27,599    2,459    54.9 %   61.35

210 N Tucker Boulevard

   Aug-07    St Louis    139,588    62,000    2,266    95.0 %   17.09

375 Riverside Parkway

   Jun-03    Atlanta    200,442    49,749    2,238    92.9 %   12.01

200 North Nash Street

   Jun-05    Los Angeles    113,606    —      2,172    100.0 %   19.12

Paul van Vlissingenstraat 16(8)

   Aug-05    Amsterdam, Netherlands    77,472    35,000    2,166    58.8 %   47.56

115 Second Avenue

   Oct-05    Boston    66,730    —      2,064    42.1 %   73.50

2403 Walsh Street

   Jun-05    Silicon Valley    103,940    —      1,988    100.0 %   19.13

1807 Michael Faraday Court

   Oct-06    Northern Virginia    19,237    —      1,953    100.0 %   101.52

8100 Boone Boulevard(7)

   Oct-06    Northern Virginia    17,015    —      1,886    100.0 %   110.84

 

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Table of Contents

Property(1)

  

Acquisition
date

  

Metropolitan Area

   Net
Rentable
Square Feet
Excluding
Redevelopment
Space(2)
   Redevelopment
Space(3)
   Annualized
Rent
($000)(4)
   Percent
Leased(5)
    Annualized
Rent per
Occupied
Square
Foot

($)(6)

4700 Old Ironsides Drive

   Jun-05    Silicon Valley    90,139    —        1,724    100.0 %   19.13

4650 Old Ironsides Drive

   Jun-05    Silicon Valley    84,383    —        1,614    100.0 %   19.13

Chemin de l’Epinglier 2(8)

   Nov-05    Geneva, Switzerland    59,190    —        1,594    100.0 %   26.93

3065 Gold Camp Drive

   Oct-04    Sacramento    62,957    —        1,502    100.0 %   23.86

3015 Winona Avenue

   Dec-04    Los Angeles    82,911    —        1,500    100.0 %   18.09

21110 Ridgetop Circle

   Jan-07    Northern Virginia    135,513    —        1,480    100.0 %   10.92

251 Exchange Place

   Nov-05    Northern Virginia    70,982    —        1,458    100.0 %   20.54

6800 Millcreek Drive

   Apr-06    Toronto, Canada    83,758    —        1,442    100.0 %  

Clonshaugh Industrial Estate(8)

   Feb-06    Dublin, Ireland    20,000    —        1,442    100.0 %   72.10

1125 Energy Park Drive

   Mar-05    Minneapolis/St. Paul    112,827    —        1,437    100.0 %   12.74

101 Aquila Way

   Apr-06    Atlanta    313,581    —        1,411    100.0 %   4.50

43831 Devon Shafron Drive

   Mar-07    Northern Virginia    117,071    —        1,377    100.0 %   11.76

3300 East Birch Street

   Aug-03    Los Angeles    68,807    —        1,319    100.0 %   19.17

Gyroscoopweg 2E-2F(8)

   Jul-06    Amsterdam, Netherlands    55,585    —        1,232    100.0 %   22.16

600 Winter Street

   Sep-06    Boston    30,400    —        763    100.0 %   25.10

7620 Metro Center Drive

   Dec-05    Austin    45,000    —        605    100.0 %   13.44

2300 NW 89th Place

   Sep-06    Miami    64,174    —        581    100.0 %   9.05

43881 Devon Shafron Drive

   Mar-07    Northern Virginia    50,000    130,000      473    100.0 %   9.46

1 St. Anne’s Boulevard(9)

   Dec-07    London, England    20,219    —        327    100.0 %   16.17

2440 Marsh Lane

   Jan-03    Dallas    5,500    129,750      62    100.0 %   11.27

Clonshaugh Industrial Estate (Land)

   Feb-06    Dublin, Ireland    —      124,500      —      0.0 %   —  

Cressex 1

   Dec-07    London, England    —      50,848      —      0.0 %   —  

3 St. Anne’s Boulevard

   Dec-07    London, England    —      96,384      —      0.0 %   —  

2055 East Technology Circle(11)

   Oct-06    Phoenix    —      76,350      —      0.0 %   —  

3011 Lafayette Street

   Jan-07    Silicon Valley    —      90,780      —      0.0 %   —  

43791 Devon Shafron Drive

   Mar-07    Northern Virginia    —      135,000      —      0.0 %   —  

1500 Space Park Drive

   Sep-07    Silicon Valley    —      49,852      —      0.0 %   —  

7500 Metro Center Drive

   Dec-05    Austin    —      74,962      —      0.0 %   —  
                                 
         5,533,856    1,299,432      123,517    94.8 %   23.54

Technology Manufacturing

                   

34551 Ardenwood Boulevard 1-4

   Jan-03    Silicon Valley    307,657    —        8,205    100.0 %   26.67

47700 Kato Road & 1055 Page Avenue

   Sep-03    Silicon Valley    183,050    —        3,684    100.0 %   20.13

2010 East Centennial Circle(12)

   May-03    Phoenix    113,405    —        2,852    100.0 %   25.15

2 St. Anne’s Boulevard(9)

   Dec-07    London, England    30,612    —        496    100.0 %   16.20
                                 
         634,724    —        15,238    100.0 %   24.01

Technology Office

                   

100 & 200 Quannapowitt Parkway

   Jun-04    Boston    386,956    —        7,305    100.0 %   18.88

4849 Alpha Road

   Apr-04    Dallas    125,538    —        2,856    100.0 %   22.75

1 Savvis Parkway

   Aug-07    St Louis    156,000    —        2,644    100.0 %   16.95
                                 
         668,494    —        12,805    100.0 %   19.16
                                 

Portfolio Total/Weighted Average

         10,527,011    1,754,228    $ 290,795    94.7 %   29.18
                                 

 

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Table of Contents

 

(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 datacenter facilities that are ready for use. Most often this is shell space. However, in certain circumstances this may include partially built datacenter space that was not completed by previous ownership or tenants and requires a large capital investment in order to build out the space.
(4) Annualized rent represents the monthly contractual rent under existing leases as of December 31, 2007 multiplied by 12.
(5) Excludes space held for redevelopment. Includes unoccupied space for which we are receiving rent and excludes space for which leases had been executed as of December 31, 2007 but for which we are not receiving rent.
(6) Annualized rent per square foot represents annualized rent as computed above, divided by the total square footage under lease as of the same date.

(7)

111 Eighth Avenue (2nd and 6th floors), 8100 Boone Boulevard and 111 Eighth Avenue (3rd and 7th floors) are subject to operating leases, which expire in June 2014, September 2017 and February 2022, respectively.

(8) Rental amounts for Unit 9, Blanchardstown Corporate Park, 114 Rue Ambroise Croizat, Naritaweg 52, Paul van Vlissingenstraat 16, Chemin de l’Epinglier 2, Clonshaugh Industrial Estate and Gyroscoopweg 2E-2F were calculated based on the exchange rate in effect on December 31, 2007 of $1.46 per € 1.00. Paul Van Vlissingenstraat 16, Chemin de l’Epinglier 2 and Clonshaugh Industrial Estate are subject to ground leases, which expire in the years 2054, 2074 and 2981, respectively.
(9) Rental amounts for 6 Braham Street, 1 St. Anne’s Boulevard and 2 St. Anne’s Boulevard were calculated based on the exchange rate in effect on December 31, 2007 of $1.99 per £1.00.
(10) We are party to a ground sublease for this property. This is a perpetual ground sublease. Lease payments were prepaid by prior owner of this property through December 2036.
(11) We are party to a ground sublease for this property. The term of the ground sublease expires in September 2083. All of the lease payments were prepaid by prior owner of this property.
(12) We are party to a ground sublease for this property. The term of the ground sublease expires in the year 2082.

 

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Table of Contents

Tenant Diversification

As of December 31, 2007 our portfolio was leased to 414 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, 2007.

 

    

Tenant

  Number
of
Locations
  Total
Occupied
Square
Feet (1)
  Percentage
of Net
Rentable
Square
Feet
    Annualized
Rent
($000) (2)
  Percentage
of
Annualized
Rent
    Weighted
Average
Remaining
Lease
Term in
Months
1    Savvis Communications   16   1,578,005   15.0 %   $ 34,223   11.8 %   132
2    Qwest Communications International, Inc.   13   770,928   7.3 %     23,926   8.2 %   91
3    Equinix Operating Company, Inc.   4   454,672   4.3 %     12,042   4.1 %   107
4    TelX Group, Inc.   10   82,581   0.8 %     10,185   3.5 %   227
5    AT & T   11   386,430   3.7 %     8,729   3.0 %   77
6    NTT Communications Company   2   241,370   2.3 %     7,294   2.5 %   57
7    Comverse Technology, Inc.   1   367,033   3.5 %     7,006   2.4 %   37
8    JPMorgan Chase & Co.   2   27,377   0.3 %     6,960   2.4 %   105
9    Microsoft Corporation   1   300,000   2.8 %     6,300   2.2 %   93
10    Level 3 Communications, LLC   11   289,788   2.8 %     5,871   2.0 %   52
11    AboveNet, Inc.   8   150,661   1.4 %     5,859   2.0 %   127
12    Amgen, Inc.   1   131,386   1.2 %     5,551   1.9 %   89
13    Amazon   3   164,847   1.6 %     5,402   1.9 %   141
14    Leslie & Godwin Investments   1   63,233   0.6 %     4,402   1.5 %   24
15    Thomas Jefferson University   1   181,414   1.7 %     3,807   1.3 %   125
                              
   Total/Weighted Average     5,189,725   49.3 %   $ 147,557   50.7 %   101
                              

 

(1) Occupied square footage is defined as leases that have commenced on or before December 31, 2007.
(2) Annualized rent represents the monthly contractual rent under existing leases as of December 31, 2007 multiplied by 12.
(3) Level 3 Communications includes Wiltel Communications & Broadwing Communications.
(4) Leslie & Godwin is a UK subsidiary of AON Corporation.

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, 2007.

 

Square Feet Under Lease

   Number
of
Leases
   Percentage
of All
Leases
    Total Net
Rentable
Square

Feet
   Percentage of
Net Rentable
Square Feet
    Annualized
Rent
($000)
   Percentage
of
Annualized
Rent
 

Available(1)

        559,964    5.3 %   $ —      0.0 %

2,500 or less

   622    67.5 %   269,662    2.6 %     55,989    19.3 %

2,501-10,000

   134    14.6 %   771,273    7.3 %     27,824    9.6 %

10,001- 20,000

   52    5.7 %   1,007,783    9.6 %     26,663    9.2 %

20,001-40,000

   46    5.0 %   1,473,385    14.0 %     36,750    12.6 %

40,001-100,000

   42    4.6 %   2,841,402    27.0 %     73,313    25.1 %

Greater than 100,000

   24    2.6 %   3,603,542    34.2 %     70,256    24.2 %
                                   

Portfolio Total

   920    100.0 %   10,527,011    100.0 %   $ 290,795    100.0 %
                                   

 

(1) Excludes approximately 1.8 million square feet held for redevelopment at December 31, 2007.

 

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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, 2007 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

  Number
of
Leases
Expiring
  Square
Footage of
Expiring
Leases
  Percentage
of Net
Rentable
Square
Feet
    Annualized
Rent
($000)
  Percentage
of
Annualized
Rent
    Annualized
Rent Per
Occupied
Square
Foot
  Annualized
Rent Per
Occupied
Square
Foot at
Expiration
  Annualized
Rent at
Expiration
($000)

Available(1)

    559,964   5.3 %   $ —     0.0 %      

2008

  269   370,801   3.5 %     23,695   8.1 %   $ 63.90   $ 67.70     25,103

2009

  107   479,753   4.6 %     16,998   5.8 %     35.43     38.43     18,435

2010

  92   894,705   8.5 %     23,403   8.0 %     26.16     27.34     24,461

2011

  77   1,586,813   15.1 %     33,024   11.4 %     20.81     23.37     37,089

2012

  63   158,956   1.5 %     13,102   4.5 %     82.43     93.09     14,797

2013

  24   480,588   4.6 %     9,676   3.3 %     20.13     23.12     11,113

2014

  31   497,859   4.7 %     12,842   4.4 %     25.79     32.03     15,945

2015

  77   1,738,028   16.5 %     55,983   19.3 %     32.21     38.21     66,413

2016

  55   828,480   7.9 %     27,300   9.4 %     32.95     39.00     32,308

2017

  30   543,260   5.2 %     13,406   4.6 %     24.68     36.24     19,687

Thereafter

  95   2,387,804   22.6 %     61,366   21.2 %     25.70     39.94     95,373
                                           

Portfolio Total / Weighted Average

  920   10,527,011   100.0 %   $ 290,795   100.0 %   $ 29.18   $ 36.19   $ 360,725
                                           

 

(1) Excludes approximately 1.8 million square feet held for redevelopment at December 31, 2007.
(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, 2007 there is one property located in Germany owned by Global Innovation Partners LLC, or GI Partners, that is subject to a right of first offer agreement, whereby we have the right to make the first offer to purchase this property if GI Partners decides to sell it. This agreement expires on December 31, 2009. We acquired one property from GI Partners that was subject to a right of first offer in June 2005.

 

ITEM 3. LEGAL PROCEEDINGS

In the ordinary course of our business, we may become subject to tort claims, breach of contract and other claims and administrative proceedings. As of December 31, 2007, 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, 2007.

 

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Table of Contents

PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

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    Last    Dividends
Declared

First Quarter 2006

   $ 28.59    $ 22.29    $ 28.17    $ 0.26500

Second Quarter 2006

   $ 29.54    $ 22.66    $ 24.69    $ 0.26500

Third Quarter 2006

   $ 31.88    $ 24.58    $ 31.32    $ 0.26500

Fourth Quarter 2006

   $ 37.31    $ 30.73    $ 34.23    $ 0.28625

First Quarter 2007

   $ 40.42    $ 33.76    $ 39.90    $ 0.28625

Second Quarter 2007

   $ 42.86    $ 36.70    $ 37.68    $ 0.28625

Third Quarter 2007

   $ 40.62    $ 32.04    $ 39.39    $ 0.28625

Fourth Quarter 2007

   $ 44.21    $ 35.05    $ 38.37    $ 0.31000

We intend to continue to declare quarterly dividends on our common stock. The actual amount and timing of dividends, 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 dividends. The exchange rate on our $172.5 million principal amount of exchangeable debentures and the conversion rate on our series C cumulative convertible preferred stock and our series D cumulative convertible preferred stock are each subject to adjustment for certain events, including, but not limited to, certain dividends on our common stock in excess of $0.265 per share per quarter, $0.28625 per share per quarter and $0.31 per share per quarter, respectively. Therefore, increases to our quarterly dividend may increase the dilutive impact of the exchangeable debentures, series C cumulative convertible preferred stock and series D cumulative convertible preferred stock on our common stockholders. See Part I, Item 1A, Risk Factors “Risks Related to Our Business and Operations—The exchange and repurchase rights of our exchangeable debentures may be detrimental to holders of common stock.”

Subject to the dividend 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 dividend of capital or of assets. Such dividends, if any, will be made at the discretion of our board of directors. Dividends will be made in cash to the extent that cash is available for dividend.

As of February 22, 2008, there were 8 stockholders of record of our common stock. This figure does not reflect the beneficial ownership of shares held in nominee name.

 

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Table of Contents

EQUITY COMPENSATION PLAN TABLE

The following table provides information with respect to shares of our common stock that may be issued under our existing equity compensation plan as of December 31, 2007.

Equity Compensation Plan Information

 

    (a)   (b)   (c)   (d)

Plan Category

  Number of shares of
Common Stock to be
issued upon exercise of
outstanding options
  Weighted-average
exercise price of
outstanding options(1)
  Number of shares of
restricted Common Stock
and

Common Stock issuable
upon redemption of
outstanding long-term
incentive units and class
C units(2)
  Number of securities
remaining available for
future issuance under
equity compensation plans
(excluding securities
reflected in column (a)
and (c))(3)

Equity Compensation plans approved by stockholders

  1,158,600   $ 27.86   3,110,200   4,154,137

Equity Compensation plans not approved by stockholders

  N/A     N/A   N/A   N/A

 

(1) The weighted-average remaining term is 8.22 years.
(2) The number of unvested full-value awards is 2,167,667. Full-value awards are comprised of restricted stock, long-term incentive units and class C units.
(3) Includes shares available for future restricted stock grants and shares issuable upon redemption of long-term incentive units available to be granted under the 2004 Incentive Award Plan.

STOCK PERFORMANCE GRAPH

The following graph compares the yearly change in the cumulative total stockholder return on our common stock during the period from November 3, 2004 (the date of our initial public offering) through December 31, 2007, with the cumulative total return on the Morgan Stanley REIT Index (RMS) and the S&P 500 Market Index. The comparison assumes that $100 was invested on November 3, 2004 in our common stock and in each of these indices and assumes reinvestment of dividends, if any.

 

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Table of Contents

COMPARE CUMULATIVE TOTAL RETURN

AMONG DIGITAL REALTY TRUST, INC, S&P 500 INDEX AND RMS INDEX

Assumes $100 invested on November 3, 2004

Assumes dividends reinvested

Fiscal year ending December 31, 2007

LOGO

 

Pricing Date

   DLR($)    S&P 500    RMS

November 3, 2004

   100.0    100.0    100.0

December 31, 2004

   113.6    106.3    107.8

December 31, 2005

   202.0    111.6    121.5

December 31, 2006

   317.5    113.3    164.6

December 31, 2007

   366.8    136.3    136.9

 

 

This graph and the accompanying text is not “soliciting material,” is not deemed filed with the SEC and is not to be incorporated by reference in any filing by us under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date hereof and irrespective of any general incorporation language in any such filing.

 

The stock price performance shown on the graph is not necessarily indicative of future price performance.

 

The hypothetical investment in our common stock presented in the stock performance graph above is based on an initial price of $12.00 per share, the price on November 3, 2004, the date of our initial public offering.

 

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Table of Contents
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 GI Partners contributed to our portfolio in connection with our initial public offering. We have not presented historical information for our 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,     Period from
November 3,
2004 to
December 31,

2004
    Period from
January 1,

2004 to
November 2,

2004
    Year ended
December 31,

2003
 
    2007     2006     2005        

Statement of Operations Data:

           

Operating Revenues:

           

Rental

  $ 319,603     $ 221,371     $ 150,072     $ 18,753     $ 57,112     $ 47,343  

Tenant reimbursements

    75,003       50,340       35,720       3,772       11,248       8,488  

Other

    641       365       5,829       —         —         4,283  
                                               

Total operating revenues

    395,247       272,076       191,621       22,525       68,360       60,114  

Operating Expenses:

           

Rental property operating and maintenance

    108,744       59,255       39,257       4,488       10,933       7,855  

Property taxes

    27,181       26,890       20,189       1,564       5,874       4,330  

Insurance

    5,527       3,682       2,653       435       1,203       579  

Depreciation and amortization

    134,394       86,129       55,702       6,293       18,785       15,100  

General and administrative

    31,600       20,441       12,615       20,766       199       301  

Asset management fees to related party

    —         —         —         —         2,655       3,185  

Other

    912       1,111       1,617       57       1,021       2,459  
                                               

Total operating expenses

    308,358       197,508       132,033       33,603       40,670       33,809  

Operating income (loss)

    86,889       74,568       59,588       (11,078 )     27,690       26,305  

Other Income (Expenses):

           

Equity in earnings of unconsolidated joint venture

    449       177       —         —         —         —    

Interest and other income

    2,287       1,270       1,274       30       69       45  

Interest expense

    (64,404 )     (49,595 )     (35,381 )     (5,000 )     (16,768 )     (9,860 )

Loss from early extinguishment of debt

    —         (527 )     (1,021 )     (283 )     —         —    
                                               

Income (loss) from continuing operations before minority interests

    25,221       25,893       24,460       (16,331 )     10,991       16,490  

Minority interests in consolidated joint ventures of continuing operations

    —         —         —         (20 )     14       (149 )

Minority interests in continuing operations of operating partnership

    (809 )     (5,113 )     (8,330 )     10,192       —         —    
                                               

Income (loss) from continuing operations

    24,412       20,780       16,130       (6,159 )     11,005       16,341  

Income (loss) from discontinued operations before minority interests

    19,444       18,410       (103 )     (39 )     (302 )     301  

Minority interests attributable to discontinued operations

    (3,264 )     (7,798 )     74       29       23       —    
                                               

Income (loss) from discontinued operations

    16,180       10,612       (29 )     (10 )     (279 )     301  
                                               

Net income (loss)

    40,592       31,392       16,101       (6,169 )   $ 10,726     $ 16,642  
                       

Preferred stock dividends

    (19,330 )     (13,780 )     (10,014 )     —        
                                   

Net income (loss) available to common stockholders

  $ 21,262     $ 17,612     $ 6,087     $ (6,169 )    
                                   

Per Share Data:

           

Basic income (loss) per share available to common stockholders

  $ 0.35     $ 0.49     $ 0.25     $ (0.30 )    

Diluted income (loss) per share available to common stockholders

  $ 0.34     $ 0.47     $ 0.25     $ (0.30 )    

Cash dividend per common share

  $ 1.17     $ 1.08     $ 1.00     $ 0.16      

Weighted average common shares outstanding:

           

Basic

    60,527,625       36,134,983       23,986,288       20,770,875      

Diluted

    62,585,252       37,442,192       24,221,732       20,770,875      

 

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    The Company   The
Predecessor
    December 31,   December 31,
2003
    2007   2006   2005   2004  

Balance Sheet Data:

         

Net investments in real estate

  $ 2,301,694   $ 1,736,802   $ 1,194,106   $ 787,412   $ 391,737

Total assets

    2,809,464     2,186,219     1,529,170     1,013,287     479,698

Revolving credit facility

    299,731     145,452     181,000     44,000     44,436

Mortgages and other secured loans

    895,507     804,686     568,067     475,498     253,429

Exchangeable senior debentures

    172,500     172,500     —       —       —  

Total liabilities

    1,687,637     1,338,031     880,228     584,229     328,303

Minority interests in consolidated joint ventures

    4,928     —       206     997     3,444

Minority interests in operating partnership

    72,983     138,416     262,239     254,862     —  

Total stockholders’/owner’s equity

    1,043,916     709,772     386,497     173,199     147,951

Total liabilities and stockholders’/owner’s equity

  $ 2,809,464   $ 2,186,219   $ 1,529,170   $ 1,013,287   $ 479,698

 

    The Company     The Company
and the
Predecessor
    The
Predecessor
 
    Year Ended
December 31,
2007
    Year Ended
December 31,
2006
    Year Ended
December 31,
2005
    Year ended December 31,  
          2004     2003  

Cash flows from (used in):

         

Operating activities

  $ 105,655     $ 99,364     $ 77,050     $ 44,638     $ 27,628  

Investing activities

    (537,427 )     (597,786 )     (474,713 )     (371,277 )     (213,905 )

Financing activities

    440,863       509,753       404,036       326,022       187,873  

 

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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 financial statements and notes thereto appearing elsewhere in this report. 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 report 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 of common stock (IPO) on November 3, 2004. We believe that we have operated in a manner that 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 the company. Any reference to “our”, “we” and “us” in this filing includes our company and our predecessor. Our predecessor is comprised of the real estate activities and holdings of Global Innovation Partners LLC, or GI Partners, which GI Partners contributed to us in connection with our IPO.

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 and redeveloping technology-related real estate. A significant component of our current and future internal growth is anticipated through the development of our existing space held for redevelopment and new properties. We target high quality, strategically located properties containing applications and operations critical to the day-to-day operations of corporate enterprise datacenter and technology industry tenants and properties that may be redeveloped for such use. 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 datacenter adoption and the technology-related real estate industry generally will be superior to that of the overall economy.

As of December 31, 2007, we own an aggregate of 70 technology-related real estate properties, excluding one property held as an investment in an unconsolidated joint venture, with 12.3 million rentable square feet including approximately 1.8 million square feet of space held for redevelopment. At December 31, 2007, approximately 637,000 square feet of our space held for redevelopment was under construction for Turn-Key Datacenter™, build-to-suit datacenter and Powered Base Building™ space in 10 U.S. and European markets. We have developed detailed, standardized procedures for evaluating acquisitions to ensure that they meet our financial, technical 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 will continue to build out our redevelopment portfolio when justified by anticipated returns.

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, 2007 of $38.37, our ratio of debt to total market capitalization was approximately 31% as of December 31, 2007. Our total market capitalization is defined as the sum of the market

 

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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 (with the per unit value equal to the market value of one share of our common stock and excluding long-term incentive units and Class C units), plus the book value of our total consolidated indebtedness.

In addition, we may sell properties from time to time that no longer meet our business objectives. In June 2006, 7979 East Tufts Avenue met the criteria to be presented as held for sale, which resulted in the reclassification of the operating results of this property to discontinued operations for all periods presented. This property was sold on July 12, 2006. In addition, we sold 100 Technology Center Drive and 4055 Valley View Lane on March 20, 2007 and March 30, 2007, respectively and the results of operations for these properties have also been reclassified as discontinued operations for all periods presented.

Revenue Base. As of December 31, 2007, we owned 70 properties through our Operating Partnership, excluding one property held as an investment in an unconsolidated joint venture. These properties are mainly located throughout the U.S., with 12 properties located in Europe and one property in Canada. We acquired our first portfolio property in January 2002 and have added properties as follows:

 

Year Ended December 31:

   Properties
Acquired(1)
   Net Rentable
Square Feet
Acquired(2)
   Square Feet of Space Held
for Redevelopment as of
December 31, 2007(3)

2002

   5    1,125,292    19,890

2003

   6    878,861    179,499

2004

   10    2,678,836    7,633

2005

   20    3,085,865    424,432

2006

   16    1,838,188    507,910

2007

   13    919,969    614,864
              

Properties owned as of December 31, 2007

     70    10,527,011    1,754,228
              

 

(1) Excludes properties sold in 2007 and 2006: 100 Technology Center Drive (March 2007), 4055 Valley View Lane (March 2007) and 7979 East Tufts Avenue (July 2006). Also excludes a leasehold interest acquired in March 2007 related to an acquisition made in 2006.
(2) Excludes space held for redevelopment.
(3) Redevelopment space is unoccupied space that requires significant capital investment in order to develop datacenter facilities that are ready for use. Most often this is shell space. However, in certain circumstances this may include partially built datacenter space that was not completed by previous ownership and requires a large capital investment in order to build out the space. The amounts included in this table represent redevelopment space as of December 31, 2007 in the properties acquired during the relevant period.

As of December 31, 2007, the properties in our portfolio were approximately 94.7% leased excluding 1.8 million square feet held for redevelopment. Due to the capital intensive and long term nature of the operations being supported, our lease terms are generally longer than standard commercial leases. As of December 31, 2007, our original average lease term was approximately 12 years, with an average of eight years remaining. Leasing since the completion of our initial public offering in November 2004 has been at lease terms shorter than 12 years. Our lease expirations through December 31, 2009 are 8.1% of net rentable square feet excluding space held for redevelopment as of December 31, 2007. Operating revenues from properties outside the United States were $34.2 million, $13.2 million and $6.0 million for the years ended December 31, 2007, 2006 and 2005, respectively.

Operating expenses. Our operating expenses generally consist of utilities, property and ad valorem taxes, property management fees, insurance and site operating and maintenance costs, as well as rental expenses. Since the consummation of our IPO, our asset management function has been internalized and we currently incur our

 

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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 incur significant legal, accounting and other expenses related to corporate governance, U.S. Securities and Exchange Commission reporting and compliance with the various provisions of Sarbanes-Oxley Act of 2002. In addition, we engage third-party property managers to manage most of our properties.

Factors Which May Influence Future Results of Operations

Rental income. The amount of 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 1.8 million square feet held for redevelopment, as of December 31, 2007, the occupancy rate in the properties in our portfolio was approximately 94.7% of our net rentable square feet.

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 10.5 million square feet of net rentable square feet, excluding redevelopment space, at December 31, 2007 is approximately 124,000 net rentable square feet of space with extensive datacenter improvements that is currently, or will shortly be, available for lease. Since our IPO, we have leased approximately 1,236,000 square feet of similar space. These Turn-Key Datacenters™ are effective solutions for tenants who lack the expertise or capital budget to provide their own extensive datacenter infrastructure and security. As experts in datacenter 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.

In addition, as of December 31, 2007, we had approximately 1.8 million square feet of redevelopment space, or approximately 14% of the total space in our portfolio, including eight vacant properties comprising approximately 699,000 square feet. Redevelopment space requires significant capital investment in order to develop datacenter facilities that are ready for use, and in addition, we may require additional time or encounter delays in securing tenants for redevelopment space. We will require additional capital to finance our redevelopment activities, which may not be available or available on terms acceptable to us. Our ability to grow earnings depends in part on our ability to redevelop space and lease redevelopment space at favorable rates, which we may not be able to obtain. We intend to purchase additional vacant properties and properties with vacant redevelopment space in the future.

Economic downturns or regional downturns affecting our submarkets or downturns in the technology-related real estate industry that impair our ability to lease or renew or re-lease space, otherwise reduce returns on our investments or 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. As of December 31, 2007, we had no material tenants in bankruptcy.

Scheduled lease expirations. Our ability to re-lease expiring space at rental rates equal to or in excess of current rental rates will impact our results of operations. In addition to approximately 0.6 million square feet of available space in our portfolio, which excludes approximately 1.8 million square feet available for redevelopment as of December 31, 2007, leases representing approximately 3.5% and 4.6% of the square footage of our portfolio, excluding redevelopment space, are scheduled to expire during the periods ending December 31, 2008 and 2009, respectively.

 

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Market concentration. We depend on the market for technology based real estate in specific geographic regions and significant changes in these regional markets can impact our future results. As of December 31, 2007 our portfolio was geographically concentrated in the following metropolitan markets:

 

Metropolitan Market

   Percentage of
total 
annualized rent(1)
 

Silicon Valley

   14.9 %

Chicago

   12.8 %

New York

   10.4 %

Dallas

   9.9 %

Phoenix

   7.5 %

San Francisco

   6.6 %

Los Angeles

   6.2 %

Other

   31.7 %
      
   100.0 %
      

 

(1) Annualized rent is monthly contractual rent under existing leases as of December 31, 2007 multiplied by 12.

Operating expenses. Our operating expenses generally consist of utilities, property taxes, property management fees, insurance and site maintenance costs, as well as rental expenses on our ground and building leases. We also incur general and administrative expenses, including expenses relating to our asset management function, as well as significant legal, accounting and other expenses related to corporate governance, U.S. Securities and Exchange Commission reporting and compliance with the various provisions of the Sarbanes-Oxley Act. Increases or decreases in such operating expenses will impact our overall performance. We expect to incur additional operating expenses as we expand.

Interest Rates and Liquidity. As of December 31, 2007, we had approximately $563.7 million of variable rate debt, of which approximately $258.4 million was mortgage debt subject to interest rate swap agreements, and $299.7 million was outstanding on our line of credit facility. Since 2002, with the exception of recent rate cuts, the United States Federal Reserve has been increasing short term interest rates, which has had a significant upward impact on shorter-term interest rates, including the interest rates that our variable rate debt is based upon. Furthermore, difficulties with “sub-prime” residential housing credit have impacted corporate debt. Liquidity traditionally provided by collateralized debt obligations has significantly decreased. The affects on commercial real estate mortgages include: 1) higher loan spreads, 2) tightened loan covenants and 3) reduced loan to value ratios and resulting borrower proceeds. Potential future increases in interest rates and credit spreads may increase our interest expense and therefore negatively affect our financial condition, results of operations, and reduce our access to capital markets. Increased interest rates may also increase the risk that the counterparties to our swap agreements will default on their obligations, which would further increase our interest expense. 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 dividends to our stockholders necessary to maintain our qualification as a REIT.

Critical Accounting Policies

Our discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles, or 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 consolidated 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

 

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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 property 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 property 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, any debt assumed from the seller or loans made by the seller to us and any building leases assumed from the seller. 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 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 property 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 property are depreciated over the estimated lives of the property whereas amounts allocated to tenant leases are amortized over the terms of the leases. Additionally, the amortization of the 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 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 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.

 

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Capitalization of costs.

We capitalize pre-acquisition costs related to probable property acquisitions. We also capitalize direct and indirect costs related to construction, development and redevelopment, including property taxes, insurance, financing and employee costs relating to space under development. Costs previously capitalized related to any property acquisitions no longer considered probable are written off, which may have a material effect on our net income. 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 contractual rental payments that would be received under the remaining terms of the leases. Many of our leases contain provisions under which the tenants reimburse us for a portion of property operating expenses and real estate taxes incurred by us. However, we generally are not entitled to reimbursement of property operating expenses and real estate taxes under our leases for Turn-Key Datacenters. 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 collectability 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.

Results of Operations

The discussion below relates to our financial condition and results of operations for the years ended December 31, 2007, 2006 and 2005. A summary of our results for the years ended December 31, 2007, 2006 and 2005 was as follows (in thousands).

 

Year Ended December 31,

   2007     2006     2005  

Statement of Operations Data:

      

Total operating revenues

   $ 395,247     $ 272,076     $ 191,621  

Total operating expenses

     (308,358 )     (197,508 )     (132,033 )
                        

Operating income

     86,889       74,568       59,588  

Other expenses, net

     (61,668 )     (48,675 )     (35,128 )
                        

Income from continuing operations before minority interests

   $ 25,221     $ 25,893     $ 24,460  
                        

 

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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 on the impact on our revenues and expenses resulting both from the new property additions to our portfolio, as well as on a “same store” property basis (same store properties are properties that were owned and operated for the entire current year and the entire immediate preceding year). The following table identifies each of the properties in our portfolio acquired from January 1, 2005 through December 31, 2007.

 

Acquired Properties

  Acquisition
Date
  Redevelopment
Space as of
December 31,
2007(1)
  Net Rentable
Square Feet
Excluding
Redevelopment
Space
  Square Feet
including
Redevelopment
Space
  Occupancy
Rate as of
December 31,
2007(2)
 

As of December 31, 2004 (21 properties)

    207,022   4,682,989   4,890,011   95.7 %

Year Ended December 31, 2005

         

833 Chestnut Street

  Mar-05   74,611   580,147   654,758   80.5  

1125 Energy Park Drive

  Mar-05   —     112,827   112,827   100.0  

350 East Cermak Road

  May-05   158,902   974,837   1,133,739   98.3  

8534 Concord Center Drive

  Jun-05   —     85,660   85,660   100.0  

2401 Walsh Street

  Jun-05   —     167,932   167,932   100.0  

200 North Nash Street

  Jun-05   —     113,606   113,606   100.0  

2403 Walsh Street

  Jun-05   —     103,940   103,940   100.0  

4700 Old Ironsides Drive

  Jun-05   —     90,139   90,139   100.0  

4650 Old Ironsides Drive

  Jun-05   —     84,383   84,383   100.0  

731 East Trade Street

  Aug-05   —     40,879   40,879   100.0  

113 North Myers

  Aug-05   9,132   20,086   29,218   100.0  

125 North Myers

  Aug-05   —     25,402   25,402   51.3  

Paul van Vlissingenstraat 16

  Aug-05   35,000   77,472   112,472   58.8  

600-780 S. Federal

  Sep-05   —     161,547   161,547   80.3  

115 Second Avenue

  Oct-05   —     66,730   66,730   42.1  

Chemin de l’Epinglier 2

  Nov-05   —     59,190   59,190   100.0  

251 Exchange Place

  Nov-05   —     70,982   70,982   100.0  

7500 Metro Center Drive

  Dec-05   74,962   —     74,962   —    

7620 Metro Center Drive

  Dec-05   —     45,000   45,000   100.0  

3 Corporate Place

  Dec-05   71,825   205,106   276,931   88.4  
                   

Subtotal

    424,432   3,085,865   3,510,297   91.3  

Year Ended December 31, 2006

         

4025 Midway Road

  Jan-06   27,599   72,991   100,590   54.9  

Clonshaugh Industrial Estate

  Feb-06   —     20,000   20,000   100.0  

Clonshaugh Industrial Estate (Land)

  Feb-06   124,500   —     124,500   —    

6800 Millcreek Drive

  Apr-06   —     83,758   83,758   100.0  

101 Aquila Way

  Apr-06   —     313,581   313,581   100.0  

12001 North Freeway

  Apr-06   20,222   280,483   300,705   98.5  

14901 FAA Boulevard

  Jun-06   —     263,700   263,700   100.0  

120 E. Van Buren Street

  Jul-06   38,089   249,425   287,514   84.6  

Gyroscoopweg 2E-2F

  Jul-06   —     55,585   55,585   100.0  

600 Winter Street

  Sep-06   —     30,400   30,400   100.0  

2300 NW 89th Place

  Sep-06   —     64,174   64,174   100.0  

1807 Michael Faraday Court

  Oct-06   —     19,237   19,237   100.0  

8100 Boone Boulevard

  Oct-06   —     17,015   17,015   100.0  

111 8th Avenue(3)

  Oct-06   —     116,843   116,843   100.0  

2055 East Technology Circle

  Oct-06   76,350   —     76,350   —    

114 Rue Ambroise Croizat

  Dec-06   221,150   130,996   352,146   100.0  

Unit 9, Blanchardstown Corporate Park

  Dec-06   —     120,000   120,000   96.4  
                   

Subtotal

    507,910   1,838,188   2,346,098   95.7  

Year Ended December 31, 2007

         

21110 Ridgetop Circle

  Jan-07   —     135,513   135,513   100.0  

3011 LaFayette Street

  Jan-07   90,780   —     90,780   —    

44470 Chilum Place

  Feb-07   —     95,440   95,440   100.0  

43791 Devon Shafron Drive(4)

  Mar-07   135,000   —     135,000   —    

43831 Devon Shafron Drive(4)

  Mar-07   —     117,071   117,071   100.0  

43881 Devon Shafron Drive(4)

  Mar-07   130,000   50,000   180,000   100.0  

Mundells Roundabout (5)

  Apr-07   —     —     —     —    

210 N Tucker Boulevard

  Aug-07   62,000   139,588   201,588   95.0  

900 Walnut Street

  Aug-07   —     112,266   112,266   98.6  

1 Savvis Parkway

  Aug-07   —     156,000   156,000   100.0  

1500 Space Park Drive(6)

  Sep-07   49,852   —     49,852   —    

Cressex 1

  Dec-07   50,848   —     50,848   —    

Naritaweg 52

  Dec-07   —     63,260   63,260   100.0  

1 St. Anne’s Boulevard(7)

  Dec-07   —     20,219   20,219   100.0  

2 St. Anne’s Boulevard(7)

  Dec-07   —     30,612   30,612   100.0  

3 St. Anne’s Boulevard(7)

  Dec-07   96,384   —     96,384   —    
                   

Subtotal

    614,864   919,969   1,534,833   99.1  
                   

Total

    1,754,228   10,527,011   12,281,239   94.7 %
                   

 

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(1) Redevelopment space requires significant capital investment in order to develop datacenter facilities that are ready for use. Most often this is shell space. However, in certain circumstances this may include partially built datacenter 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 space held for redevelopment
(3) Includes additional leasehold interest acquired in March 2007, which is comprised of 33,700 square feet.
(4) The three buildings at Devon Shafron Drive are considered one property for our property count.
(5) Land parcel held for development.
(6) We acquired a 50% interest in a joint venture that owns the building.
(7) The three buildings at St. Anne’s Boulevard are considered one property for our property count.

Comparison of the Year Ended December 31, 2007 to the Year Ended December 31, 2006 and comparison of the Year Ended December 31, 2006 to the Year Ended December 31, 2005

Portfolio

As of December 31, 2007, our portfolio consisted of 70 properties, excluding one property held as an investment in an unconsolidated joint venture, with an aggregate of 12.3 million net rentable square feet including 1.8 million square feet held for redevelopment compared to a portfolio consisting of 59 properties, excluding one property held as an investment in an unconsolidated joint venture, with an aggregate of 9.4 million net rentable square feet excluding space held for redevelopment as of December 31, 2006 and a portfolio consisting of 44 properties with an aggregate of 8.1 million net rentable square feet excluding space held for redevelopment as of December 31, 2005. The increase in our portfolio reflects the acquisition of 20 properties in 2005, 15 properties in 2006 and 11 properties in 2007, net of one property sold during 2006 and two properties sold during 2007.

Revenues

Total operating revenues from continuing operations were as follows (in thousands):

 

    Year Ended December 31,   Change     Percentage Change  
    2007   2006   2005   2007 v 2006   2006 v 2005     2007 v 2006     2006 v 2005  

Rental

  $ 319,603   $ 221,371   $ 150,072   $ 98,232   $ 71,299     44.4 %   47.5 %

Tenant reimbursements

    75,003     50,340     35,720     24,663     14,620     49.0 %   40.9 %

Other

    641     365     5,829     276     (5,464 )   75.6 %   (93.7 %)
                                           

Total operating revenues

  $ 395,247   $ 272,076   $ 191,621   $ 123,171   $ 80,455     45.3 %   42.0 %
                                           

As shown by the same store and new properties table shown below, the increases in rental revenues and tenant reimbursement revenues in the year ended December 31, 2007 compared to 2006 were primarily due to our acquisitions of properties leading to a larger portfolio size. These factors also caused the increases in rental revenues and tenant reimbursements in the year ended December 31, 2006 compared to 2005. Other revenues changes in the years presented were primarily due to the timing of varying tenant termination revenues. We acquired 13, 16 and 20 properties during the years ended December 31, 2007, 2006 and 2005, respectively. Included in the 2006 rental revenues is $0.8 million of straight-line rent adjustment attributable to prior years. This $0.8 million out-of-period adjustment is considered by management to be immaterial to each of the years in which it accumulated.

 

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The following table shows total operating revenues from continuing operations for same store properties and new properties (in thousands).

 

     Same Store
Year Ended December 31,
   New Properties
Year Ended December 31,
 
     2007    2006    Change    2007     2006    Change  

Rental

   $ 222,113    $ 193,051    $ 29,062    $ 97,490     $ 28,320    $ 69,170  

Tenant reimbursements

     63,680      48,735      14,945      11,323       1,605      9,718  

Other

     642      365      277      (1 )     —        (1 )
                                            

Total operating revenues

   $ 286,435    $ 242,151    $ 44,284    $ 108,812     $ 29,925    $ 78,887  
                                            

Same store rental revenues increased for the year ended December 31, 2007 compared to the same period in 2006 primarily as a result of new leases at our properties during 2007, the largest of which was for space in 3 Corporate Place, 350 East Cermak Road, 200 Paul Avenue 1-4 and 300 Boulevard East. Same store tenant reimbursement revenues increased for the year ended December 31, 2007 compared to the same period in 2006 primarily as a result of higher utility and operating expenses being billed to our tenants, the largest occurrences of which were at 300 Boulevard East, 1100 Space Park Drive, 200 Paul Avenue 1-4 and 350 East Cermak Road.

New property increases were caused by properties acquired during the period from January 1, 2006 to December 31, 2007. For the year ended December 31, 2007, 111 8th Avenue, 120 E. Van Buren Street, Unit 9, Blanchardstown Corporate Park and 114 Rue Ambroise Croizat contributed $48.5 million, or approximately 61% of the total new properties increase in total operating revenues compared to the same period in 2006.

 

     Same Store
Change
    New Properties
Change
 
     2006    2005    Change     2006    2005    Change  

Rental

   $ 126,660    $ 115,505    $ 11,155     $ 94,711    $ 34,567    $ 60,144  

Tenant reimbursements

     31,861      26,529      5,332       18,479      9,191      9,288  

Other

     197      4,434      (4,237 )     168      1,395      (1,227 )
                                            

Total operating revenues

   $ 158,718    $ 146,468    $ 12,250     $ 113,358    $ 45,153    $ 68,205  
                                            

Same store rental revenues increased for the year ended December 31, 2006 compared to the same period in 2005 primarily as a result of new leases at our properties during 2006, the largest of which was for space in 200 Paul Avenue 1-4, 300 Boulevard East and 1100 Space Park Drive. Same store tenant reimbursement revenues increased for the year ended December 31, 2006 compared to the same period in 2005 primarily as a result of higher utility and operating expenses being billed to our tenants, the largest occurrences of which were at 200 Paul Avenue 1-4, 2323 Bryan Street and 1100 Space Park Drive. The decrease in same store other revenues was due to termination fee revenues recognized for the year ended December 31, 2005, primarily for a tenant located at 600 West Seventh Street, while the decrease in new properties other revenues was due to termination fee revenues recognized for the year ended December 31, 2005, primarily for a tenant located at 833 Chestnut Street.

New property increases were caused by properties acquired during the period from January 1, 2005 to December 31, 2006. For the year ended December 31, 2006, 350 East Cermak Road, Savvis portfolio (comprising five properties acquired in June 2005), 12001 North Freeway and 120 E. Van Buren Street contributed $36.7 million, or approximately 54% of the total new properties increase in total operating revenues compared to the same period in 2005.

 

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Expenses

Total expenses from continuing operations were as follows (in thousands):

 

    Year Ended December 31,   Change     Percentage Change  
    2007   2006   2005   2007 v 2006     2006 v 2005     2007 v 2006     2006 v 2005  

Rental property operating and maintenance

  $ 108,744   $ 59,255   $ 39,257   $ 49,489     $ 19,998     83.5 %   50.9 %

Property taxes

    27,181     26,890     20,189     291       6,701     1.1 %   33.2 %

Insurance

    5,527     3,682     2,653     1,845       1,029     50.1 %   38.8 %

Depreciation and amortization

    134,394     86,129     55,702     48,265       30,427     56.0 %   54.6 %

General and administrative

    31,600     20,441     12,615     11,159       7,826     54.6 %   62.0 %

Other

    912     1,111     1,617     (199 )     (506 )   (17.9 %)   (31.3 %)
                                             

Total operating expenses

  $ 308,358   $ 197,508   $ 132,033   $ 110,850     $ 65,475     56.1 %   49.6 %
                                             

Interest expense

  $ 64,404   $ 49,595   $ 35,381   $ 14,809     $ 14,214     29.9 %   40.2 %
                                             

As shown in the same store expense and new properties table below, total expenses in the year ended December 31, 2007 increased compared to 2006 primarily as a result of higher operating expenses following acquisition of properties. The following table shows expenses from continuing operations for same store properties and new properties (in thousands).

 

     Same Store
Year Ended December 31,
    New Properties
Year Ended December 31,
 
     2007    2006    Change     2007    2006    Change  

Rental property operating and maintenance

   $ 70,657    $ 50,678    $ 19,979     $ 38,087    $ 8,577    $ 29,510  

Property taxes

     23,878      25,698      (1,820 )     3,303      1,192      2,111  

Insurance

     5,043      3,570      1,473       484      112      372  

Depreciation and amortization

     83,816      69,243      14,573       50,578      16,886      33,692  

General and administrative(1)

     31,600      20,441      11,159       —        —        —    

Other

     776      932      (156 )     136      179      (43 )
                                            

Total operating expenses

   $ 215,770    $ 170,562    $ 45,208     $ 92,588    $ 26,946    $ 65,642  
                                            

Interest expense

   $ 48,470    $ 35,327    $ 13,143     $ 15,934    $ 14,268    $ 1,666  
                                            

 

(1) General and administrative expenses are included in same store as they are not allocable to specific properties.

New property increases were caused by properties acquired during the period from January 1, 2006 to December 31, 2007. For the year ended December 31, 2007, 111 8th Avenue, 120 E. Van Buren Street, Unit 9, Blanchardstown Corporate Park and 4025 Midway Road contributed $43.7 million, or approximately 66% in total operating expenses compared to the same period in 2005.

Same store rental property operating and maintenance expenses increased for the year ended December 31, 2007 compared to the same period in 2006 primarily as a result of higher utility expenses which is attributed to new leasing and increased power rates. The launch of a domestic property maintenance program in 2007 also contributed to the increase leading to higher maintenance expense in 2007. Rental property operating and maintenance expenses included amounts paid to related parties, CB Richard Ellis and The Linc Group, for property management and other fees of $2.1 million and $2.6 million in the year ended December 31, 2007 and 2006, respectively. CB Richard Ellis was for a portion of the year and The Linc Group is, a related party of Richard Magnuson, the Chairman of our Board of Directors. We capitalized amounts relating to compensation

 

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expense of employees directly engaged in construction and successful leasing activities of $5.0 million and $2.4 million in the years ended December 31, 2007 and 2006, respectively.

Same store property taxes decreased in the year ended December 31, 2007 compared to 2006, primarily as a result of a favorable property tax assessment at 350 East Cermak Road.

Same store insurance increased in the year ended December 31, 2007 compared to 2006, primarily as a result of higher insurance rates on our renewal of our insurance program in late 2006.

Same store depreciation and amortization expense increased in the year ended December 31, 2007 compared to 2006, principally because of depreciation of redevelopment projects that were placed into service in late 2006 and during 2007.

General and administrative expenses for the year ended December 31, 2007 increased compared to the same period in 2006 primarily due to the growth of our company, which resulted in more employees, additional incentive compensation, and higher insurance, professional fees and marketing expenses.

Other expenses are primarily comprised of write-offs of the carrying amounts for tenant improvements, acquired in place lease value and acquired above market lease values as a result of the early termination of tenant leases.

Same store interest expense increased for the year ended December 31, 2007 as compared to the same period in 2006 primarily as a result of higher average outstanding debt balances during 2007 compared to 2006 related to financings on 2045 & 2055 LaFayette Street and 150 South First Street along with a full year effect on 2006 refinancings related to 1100 Space Park Drive, 34551 Ardenwood Boulevard 1-4 and 2334 Lundy Place. Interest incurred on our revolving credit facility and senior exchangeable debentures is allocated entirely to new properties in the table above. Interest capitalized during the years ended December 31, 2007 and 2006 was $11.6 million and $3.9 million, respectively.

 

     Same Store
Year Ended December 31,
    New Properties
Year Ended December 31,
     2006    2005    Change     2006    2005    Change

Rental property operating and maintenance

   $ 33,927    $ 27,898    $ 6,029     $ 25,328    $ 11,359    $ 13,969

Property taxes

     11,884      12,677      (793 )     15,006      7,512      7,494

Insurance

     2,197      2,048      149       1,485      605      880

Depreciation and amortization

     44,820      40,477      4,343       41,309      15,225      26,084

General and administrative(1)

     20,441      12,615      7,826       —        —        —  

Other

     774      1,597      (823 )     337      20      317
                                          

Total operating expenses

   $ 114,043    $ 97,312    $ 16,731     $ 83,465    $ 34,721    $ 48,744
                                          

Interest expense

   $ 26,691    $ 25,864    $ 827     $ 22,904    $ 9,517    $ 13,387
                                          

 

(1) General and administrative expenses are included in same store as they are not allocable to specific properties.

New property increases were caused by properties acquired during the period from January 1, 2005 to December 31, 2006. For the year ended December 31, 2006, 350 East Cermak Road, 600-780 S. Federal Street, 12001 North Freeway and 120 E. Van Buren Street contributed $28.3 million, or approximately 47% in total expenses compared to the same period in 2005.

Same store rental property operating and maintenance expenses increased for the year ended December 31, 2006 compared to the same period in 2005 primarily as a result of higher utility rates in several of our properties leading to

 

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higher utility expense in 2006. Rental property operating and maintenance expenses included amounts paid to related parties, CB Richard Ellis and The Linc Group, for property management and other fees of $2.6 million and $1.9 million in the year ended December 31, 2006 and 2005, respectively. CB Richard Ellis and The Linc Group were related parties of GI Partners and Richard Magnuson during the year ended December 31, 2006. We capitalized amounts relating to compensation expense of employees directly engaged in construction and successful leasing activities of $2.4 million and $0.4 million in the years ended December 31, 2006 and 2005, respectively.

Same store depreciation and amortization expense increased in the year ended December 31, 2006 compared to 2005, principally because of the acceleration of depreciation on assets associated with leases by VarTec, a former tenant, which was in bankruptcy.

General and administrative expenses for the year ended December 31, 2006 increased compared to the same period in 2005 primarily due to the growth of our company, which resulted in more employees, additional incentive compensation, and higher insurance, legal and consulting costs. Included in the 2006 general and administrative expenses is a writeoff of approximately $0.5 million of pre-acquisition costs related to a previously targeted acquisition.

Other expenses are primarily comprised of write-offs of the carrying amounts for 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 decreased for the year ended December 31, 2006 compared to the same period in 2005 primarily due to the write off of assets following the termination of a tenant in 2005.

Same store interest expense increased for the year ended December 31, 2006 as compared to the same period in 2005 primarily as a result of higher average outstanding debt balances during 2006 compared to 2005 related to refinancings on 200 Paul Avenue 1-4, 600 West Seventh Street, 34551 Ardenwood Boulevard 1-4 and 2334 Lundy Place partially offset by lower average outstanding balances during 2006 compared to 2005 for 47700 Kato Road and 1055 Page Avenue. Interest incurred on our revolving credit facility and senior exchangeable debentures is allocated entirely to new properties in the table above. Interest capitalized during the years ended December 31, 2006 and 2005 was $3.9 million and $0.3 million.

Equity in earnings of unconsolidated joint venture

The equity in earnings of unconsolidated joint venture relates to a 49% investment in a joint venture that owns a datacenter property in Seattle, Washington. The investment was made in November 2006. The amount recorded in 2007 includes our portion of the write-off of net costs related to the refinance of the previously outstanding mortgage loan on the property, which amounted to approximately $0.6 million.

Minority Interests

Minority interests decreased for the year ended December 31, 2007 as compared to the same period in 2006 primarily as a result of the weighted average minority ownership percentage decreasing from approximately 42% for the year ended December 31, 2006 to approximately 12% for the year ended December 31, 2007. Also, minority interests decreased for the year ended December 31, 2006 as compared to the same period in 2005 primarily as a result of the weighted average minority ownership percentage decreasing from approximately 57% for the year ended December 31, 2005 to approximately 42% for the year ended December 31, 2006. The decreases were primarily a result of GI Partners redeeming all of their Operating Partnership common units during the period from April 1, 2006 through March 31, 2007.

 

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Discontinued operations

Discontinued operations relate to the following properties:

 

Property

  

Date Acquired

  

Date Sold

7979 East Tufts Avenue

  

October 2003

  

July 2006

4055 Valley View Lane

  

September 2003

  

March 2007

100 Technology Center Drive

  

February 2004

  

March 2007

Results of discontinued operations were as follows (in thousands):

 

      Year Ended December 31,  
     2007     2006     2005  

Operating revenues

   $ 2,340     $ 13,285     $ 15,914  

Operating expenses

     (1,283 )     (9,915 )     (12,276 )

Interest and other income

     5       20       —    

Interest expense

     (607 )     (3,076 )     (3,741 )

Gain on derivative instruments

     940       —         —    
                        
     1,395       314       (103 )

Gain on sale of assets

     18,049       18,096       —    

Minority interests attributable to discontinued operations

     (3,264 )     (7,798 )     74  
                        

Income (loss) from discontinued operations

   $ 16,180     $ 10,612     $ (29 )
                        

Liquidity and Capital Resources

Analysis of Liquidity and Capital Resources

As of December 31, 2007, we had $31.4 million of cash and cash equivalents, excluding $41.3 million of restricted cash. Restricted cash primarily consists of interest bearing cash deposits required by the terms of 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, redevelopment costs and other expenditures associated with our properties, dividend payments on our preferred stock, 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 revolving credit facility.

On August 31, 2007, we modified our revolving credit facility, pursuant to which the total capacity of the revolving credit facility was expanded from $500.0 million to $650.0 million and now matures in August 2010, subject to two one-year extension options exercisable by us. As of December 31, 2007, borrowings under the revolving credit facility bore interest at a blended rate of 6.12% (US dollar), 5.86% (Euro) and 7.55% (British Pound Sterling), which is based on 1-month LIBOR, 1-month EURIBOR and 1-month GBP LIBOR, respectively, plus a margin of 1.20%. The margin can range from 1.10% to 2.00%, depending on our Operating Partnership’s total overall leverage. The revolving credit facility has a $325.0 million sub-facility for multicurrency advances in British Pound Sterling, Canadian Dollars, Euros, and Swiss Francs. On February 6, 2008, we executed an amendment to the revolving credit facility, which increased the limit on the multi-currency sub-facility from $325.0 million to $450.0 million. We intend to use available borrowings under the revolving credit facility to, among other things, finance the acquisition of additional properties, to fund tenant improvements and capital expenditures, fund

 

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development and redevelopment activities and to provide for working capital and other corporate purposes. As of December 31, 2007, approximately $299.7 million was drawn under this facility, and $11.3 million of letters of credit were issued, leaving $339.0 million available for use.

On February 6, 2008, we issued 13.8 million shares of 5.500% series D cumulative convertible preferred stock for total net proceeds, after underwriting discounts and estimated offering expenses, of $333.6 million, including the proceeds from the exercise of the underwriters’ over-allotment option. We used the net proceeds from the offering to temporarily repay borrowings under our revolving credit facility, to acquire properties, to fund development and redevelopment activities and for general corporate purposes.

Future uses of cash

Our properties require periodic investments of capital for tenant-related capital expenditures and for general capital improvements. As of December 31, 2007, we have identified from our existing properties approximately 1.8 million square feet of redevelopment space and we also owned approximately 124,000 net rentable square feet of datacenter space with extensive installed tenant improvements that we may subdivide for Turn-Key Datacenter use during the next two years rather than lease such space to large single tenants. Turn-Key Datacenter™ space is move-in-ready space for the placement of computer and network equipment required to provide a datacenter environment. Depending on demand for additional Turn-Key Datacenter space, we expect to incur significant tenant improvement costs to build out and redevelop these spaces. At December 31, 2007, approximately 637,000 square feet of our space held for redevelopment was under construction for Turn-Key Datacenter, build-to-suit datacenter and Powered Base Building space in 10 U.S. and European markets and we had commitments under construction contracts for approximately $74.8 million.

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

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 revolving credit facility pending permanent financing.

Financing transactions in 2007

On October 22, 2007, we completed an offering of 4.0 million shares of common stock for total net proceeds, after underwriting discounts and offering expenses, of $150.5 million, including the proceeds from the exercise of the underwriters’ over-allotment option. We used the net proceeds from the offering to temporarily repay borrowings under our revolving credit facility.

On April 4, 2007, we issued 7.0 million shares of 4.375% Series C Cumulative Convertible Preferred Stock for net proceeds, after underwriting discounts and offering expenses, of $169.1 million. We used the net proceeds from the offering to temporarily repay borrowings under our revolving credit facility.

On February 2, 2007 we completed the financing of 150 South First Street in San Jose, California. The new loan for $53.3 million has a 10-year maturity with no principal amortization for two years, and a fixed rate of 6.2995%. We used the net proceeds from the offering to temporarily repay borrowings under our revolving credit facility.

On January 31, 2007 we completed the financing of 2045 & 2055 LaFayette in Santa Clara, California. The new loan for $68.0 million has a 10-year maturity with no principal amortization for two years, and a fixed rate of 5.9265%. We used the net proceeds from the offering to temporarily repay borrowings under our revolving credit facility.

 

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During the year ended December 31, 2007 we acquired the following properties:

 

Property

  

    Metropolitan Area    

  

        Date Acquired        

   Purchase Price
(in millions)

21110 Ridgetop Circle

   Northern Virginia    January 5, 2007    $ 17.2

3011 LaFayette Street

   Silicon Valley    January 22, 2007      13.7

44470 Chilum Place

   Northern Virginia    February 27, 2007      43.1

111 8th Avenue(1)

   New York City    March 15, 2007      24.4

Devon Shafron Drive(2)

   Northern Virginia    March 23, 2007      63.0

Mundells Roundabout(3)

   London    April 11, 2007      31.4

900 Walnut Street(4)

   St. Louis    August 10, 2007      34.5

210 Tucker Boulevard(4)

   St. Louis    August 10, 2007      20.8

1 Savvis Parkway

   St. Louis    August 22, 2007      27.7

1500 Space Park Drive(5)

   Silicon Valley    September 5, 2007      3.7

Cressex 1

   London    December 10, 2007      12.7

Naritaweg 52

   Amsterdam    December 12, 2007      27.2

Foxboro Business Park(6)

   London    December 21, 2007      43.6
            
         $ 363.0
            

 

(1) Acquisition of an approximately 33,700 square foot leasehold interest.
(2) The purchase consists of three buildings: 43791 Devon Shafron Drive, 43831 Devon Shafron Drive and 43881 Devon Shafron Drive.
(3) A land parcel to be developed. Purchase price excludes refundable value added tax of approximately $5.2 million.
(4) Purchase price includes an earn-out payment made at closing: $0.5 million for 900 Walnut Street and $1.8 million for 210 N. Tucker Boulevard.
(5) Represents the amount we paid to acquire a 50% interest in a joint venture that owns this above building. Since we control the joint venture, we have consolidated the joint venture in the accompanying consolidated financial statements. Upon consolidation, we included total assets of $13.1 million, a third party loan of $5.5 million, other liabilities of $1.0 million and minority interest of $2.9 million.
(6) The purchase consists of three buildings: 1 St. Anne’s Boulevard, 2 St. Anne’s Boulevard and 3 St. Anne’s Boulevard.

We financed the purchase of these properties primarily with borrowings under our revolving credit facility.

Subsequent to December 31, 2007 we acquired the following properties:

 

Location

   Purchase
price

($ millions)
   Purchase
completed on:

365 South Randolphville Road, Piscataway, New Jersey

   $ 20.2    February 14, 2008
         

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

 

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are consistent with our intention to maintain our status as a REIT. The exchange rate on our $172.5 million principal amount of exchangeable debentures and the conversion rate on our series C cumulative convertible preferred stock and our series D cumulative convertible preferred stock are each subject to adjustment for certain events, including, but not limited to, certain dividends on our common stock in excess of $0.265 per share per quarter, $0.28625 per share per quarter and $0.31 per share per quarter, respectively. Therefore, increases to our quarterly dividend may increase the dilutive impact of the exchangeable debentures, series C cumulative convertible preferred stock and series D cumulative convertible preferred stock on our common stockholders. See Part I, Item 1A, Risk Factors “Risks Related to Our Business and Operations—The exchange and repurchase rights of our exchangeable debentures may be detrimental to holders of common stock.”

In 2007, 2006 and 2005, we have declared the following dividends (in thousands):

 

Date dividend and

distribution declared

  

Dividend and distribution payable date

  Series A
Preferred
Stock(1)
  Series B
Preferred
Stock(2)
  Series C
Preferred
Stock(3)
  Common Stock
and Operating
Partnership
Common Units
 

February 14, 2005

   March 31, 2005     1,271     —       —       12,905 (4)

May 16, 2005

   June 30, 2005     2,199     —       —       12,905 (4)

August 9, 2005

   September 30, 2005     2,199     900     —       14,338 (4)

November 8, 2005

  

December 30, 2005 for Series A and B Preferred Stock; January 13, 2006 for Common Stock and Operating Partnership

Common Units

    2,199     1,246     —       15,639 (5)
                            

Total—2005

     $ 7,868   $ 2,146   $ —     $ 55,787  
                            

February 27, 2006

   March 31, 2006     2,199     1,246     —       15,642 (5)

May 1, 2006

   June 30, 2006     2,199     1,246     —       16,709 (5)

July 31, 2006

   October 2, 2006     2,199     1,246     —       16,607 (5)

October 31, 2006

   December 29, 2006 for Series A and B Preferred Stock; January 16, 2007 for Common Stock and Operating Partnership Common Units     2,199     1,246     —       19,387 (6)
                            

Total—2006

     $ 8,796   $ 4,984   $ —     $ 68,345  
                            

February 15, 2007

   April 2, 2007     2,199     1,246     —       19,442 (6)

May 2, 2007

   July 2, 2007     2,199     1,246     1,722     19,458 (6)

August 1, 2007

   October 1, 2007     2,199     1,246     1,914     19,465 (6)

November 1, 2007

   December 31, 2007 for Series A, B and C Preferred Stock; January 14, 2008 for Common Stock and Operating Partnership Common Units     2,199     1,246     1,914     22,345 (7)
                            

Total—2007

     $ 8,796   $ 4,984   $ 5,550   $ 80,710  
                            

 

(1) $2.125 annual rate of dividend per share.
(2) $1.969 annual rate of dividend per share.
(3) $1.094 annual rate of dividend per share.
(4) $0.975 annual rate of dividend and distribution per share and unit.
(5) $1.060 annual rate of dividend and distribution per share and unit.
(6) $1.145 annual rate of dividend and distribution per share and unit.
(7) $1.240 annual rate of dividend and distribution per share and unit.

 

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The tax treatment of dividends on common stock paid in 2007 is as follows: approximately 78% ordinary income and 22% return of capital. The tax treatment of dividends on common stock paid in 2006 is as follows: approximately 74% ordinary income and 26% return of capital. The tax treatment of dividends on common stock paid in 2005 is as follows: approximately 87% ordinary income and 13% return of capital. All dividends paid on our preferred stock in 2007, 2006 and 2005 were classified as ordinary income for income tax purposes.

Contractual Commitments

The following table summarizes our contractual obligations as of December 31, 2007, including the maturities and scheduled principal on our secured debt and revolving credit facility debt, and provides information about the commitments due in connection with our redevelopment program, ground leases, tenant improvement and leasing commissions (in thousands):

 

Obligation

   Total    2008    2009-2010    2011-2012    Thereafter

Long-term debt principal payments(1)

   $ 1,366,000    $ 120,017    $ 376,046    $ 311,017    $ 558,920

Interest payable(2)

     389,167      76,300      133,318      79,178      100,371

Ground leases(3)

     27,618      542      1,083      1,083      24,910

Operating lease

     49,393      5,631      11,903      11,825      20,034

Construction contracts(4)

     74,800      74,800      —        —        —  
                                  
   $ 1,906,978    $ 277,290    $ 522,350    $ 403,103    $ 704,235
                                  

 

(1) Includes $299.7 million of borrowings under our revolving credit facility, which is due to mature in August 2010 and excludes $1.7 million of loan premiums.
(2) Interest payable is based on the interest rate in effect on December 31, 2007 including the effect of interest rate swaps. Interest payable excluding the effect of interest rate swaps is as follows (in thousands):

 

2008

   $ 77,883

2009-2010

     135,773

2011-2012

     80,592

Thereafter

     100,535
      
   $ 394,783
      

 

(3) This is comprised of ground lease payments on 2010 East Centennial Circle, Chemin de l’Epinglier 2, Clonshaugh Industrial Estate, Paul van Vlissingenstraat 16, Gyroscoopweg 2E-2F and Naritaweg 52. 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. After December 2036, rent for the remaining term of the Naritaweg 52 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 Paul van Vlissingenstraat, 16 Chemin de l’Epinglier 2, Gyroscoopweg 2E-2F and Clonshaugh Industrial Estate amounts are translated at the December 31, 2007 exchange rate of $1.46 per € 1.00.
(4) From time to time in the normal course of our business, we enter into various construction contracts with third parties that may obligate us to make payments. At December 31, 2007, we had construction contract related open commitments of $74.8 million, excluding approximately $17.0 million of the obligations which will be reimbursed by third parties.

We have agreed with the seller of the 350 East Cermak Road to share a portion, not to exceed $135,000 per month, of rental revenue, adjusted for our costs to lease the premises, from the lease of the 263,000 square feet of

 

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space held for redevelopment. This revenue sharing agreement will terminate in May 2013. We have recorded a liability of approximately $14,000 for this contingent liability on our balance sheet at December 31, 2007.

As of December 31, 2007, we were a party to interest rate swap agreements which hedge variability in cash flows related to LIBOR, GBP LIBOR and EURIBOR based mortgage loans. Under these swaps, we pay or receive cash net settlements from our swap counterparties based on the notional amounts of our swap agreements and the difference between the fixed swap rate and the underlying benchmark interest rate on our variable rate debt which effectively converts the hedged variable rate debt to a fixed rate over the term of the interest rate swap agreements. See Item 7A “Quantitative and Qualitative Disclosures about Market Risk.”

Outstanding Consolidated Indebtedness

The table below summarizes our debt, at December 31, 2007 (in millions):

 

Debt Summary:

  

Fixed rate

   $ 804.0  

Variable rate—hedged by interest rate swaps

     258.4  
        

Total fixed rate

     1,062.4  

Variable rate—unhedged

     305.3  
        

Total

   $ 1,367.7  
        

Percent of Total Debt:

  

Fixed rate (including swapped debt)

     77.7 %

Variable rate

     22.3 %
        

Total

     100.0 %
        

Effective Interest Rate as of December 31, 2007(1):

  

Fixed rate (including swapped debt)

     5.59 %

Variable rate—unhedged

     6.56 %

Effective interest rate

     5.81 %

 

(1) Excludes impact of deferred financing cost amortization.

As of December 31, 2007, we had approximately $1.4 billion of outstanding consolidated long-term debt as set forth in the table above. Our ratio of debt to total market capitalization was approximately 31% (based on the closing price of our common stock on December 31, 2007 of $38.37). The variable rate debt shown above bears interest at interest rates based on various LIBOR, GBP LIBOR and EURIBOR rates ranging from one to twelve months, depending on the respective agreement governing the debt. Assuming maturity of our exchangeable senior debentures at their first redemption date in August 2011, as of December 31, 2007, our debt had a weighted average term to initial maturity of approximately 5.2 years (approximately 5.8 years assuming exercise of extension options).

Revolving Credit Facility. On August 31, 2007, we modified our revolving credit facility, pursuant to which the total capacity of the revolving credit facility was expanded from $500.0 million to $650.0 million and now matures in August 2010, subject to two one-year extension options exercisable by us. As of December 31, 2007, borrowings under the revolving credit facility bore interest at a blended rate of 6.12% (US dollar), 5.86% (Euro) and 7.55% (British Pound Sterling), which is based on 1-month LIBOR, 1-month EURIBOR and 1-month GBP LIBOR, respectively, plus a margin of 1.20%. The margin can range from 1.10% to 2.00%, depending on our Operating Partnership’s total overall leverage. The revolving credit facility has a $325.0 million sub-facility for multicurrency advances in British Pound Sterling, Canadian Dollars, Euros, and Swiss Francs. On February 6, 2008, we executed an amendment to the revolving credit facility, which increased the limit on the multi-currency sub-facility from $325.0 million to $450.0 million. We intend to use available borrowings under the revolving credit facility to, among other things, finance the acquisition of additional properties, to fund tenant improvements and capital

 

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expenditures, fund development and redevelopment activities and to provide for working capital and other corporate purposes. As of December 31, 2007, approximately $299.7 million was drawn under this facility, and $11.3 million of letters of credit were issued, leaving $339.0 million available for use.

Off-Balance Sheet Arrangements

As of December 31, 2007, we were a party to interest rate cap agreements in connection with debt and interest rate swap agreements related to $258.4 million of outstanding principal on our variable rate debt. See Item 7A “Quantitative and Qualitative Disclosures about Market Risk.”

The exchangeable senior debentures provide for excess exchange value to be paid in shares of our common stock if our stock price exceeds a certain amount. See note 6 to our consolidated financial statements for a further description of our senior exchangeable debentures.

Cash Flows

The following summary discussion of our cash flows is based on the consolidated 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, 2007 to Year Ended December 31, 2006 and Comparison of Year Ended December 31, 2006 to Year Ended December 31, 2005

The following table shows cash flows and ending cash and cash equivalent balances for the years ended December 31, 2007, 2006 and 2005, respectively. Cash flows include the cash flows of 100 Technology Center Drive (sold in March 2007), 4055 Valley View Lane (sold in March 2007) and 7979 East Tufts Avenue (sold in July 2006) (in thousands).

 

     Year Ended December 31,     Increase / (Decrease)  
     2007     2006     2005     2007 v 2006     2006 v 2005  

Net cash provided by operating activities (including discontinued operations)

   $ 105,655     $ 99,364     $ 77,050     $ 6,291     $ 22,314  

Net cash used in investing activities

     (537,427 )     (597,786 )     (474,713 )     62,415       (123,073 )

Net cash provided by financing activities

     440,863       509,753       404,036       (70,946 )     105,717  
                                        

Net increase in cash and cash equivalents

   $ 9,091     $ 11,331     $ 6,373     $ (2,240 )   $ 4,958  
                                        

The increases in net cash provided by operating activities from 2006 to 2007 and from 2005 to 2006 were primarily due to revenues from the properties added to our portfolio which was partially offset by increased operating and interest expenses. We acquired 13, 16 and 20 properties during the years ended December 31, 2007, 2006 and 2005 respectively.

Net cash used in investing activities decreased from 2006 to 2007 primarily as a result of a lower value of properties acquired during the year offset partially by higher capital improvements being added to our redevelopment projects. Net cash used in investing activities increased from 2005 to 2006 primarily as a result of new properties acquired during the year and higher capital improvements being added to our redevelopment projects.

 

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

 

     Year Ended December 31,     Increase / (Decrease)  
     2007     2006     2005     2007 v 2006     2006 v 2005  

Net proceeds from borrowings

   $ 216,006     $ 181,004     $ 205,056     $ 35,002     $ (24,052 )

Net proceeds from issuance of common/preferred stock, including exercise of stock options

     320,751       365,337       258,265       (44,586 )     107,072  

Dividend and distribution payments

     (97,081 )     (78,377 )     (58,438 )     (18,704 )     (19,939 )

Proceeds from exchangeable senior debentures

     —         172,500       —         (172,500 )     172,500  

Redemption of Operating Partnership units

     —         (133,822 )     —         133,822       (133,822 )

Other

     1,187       3,111       (847 )     (3,980 )     3,958  
                                        

Net cash provided by financing activities

   $ 440,863     $ 509,753     $ 404,036     $ (70,946 )   $ 105,717  
                                        

Proceeds from issuance of stock were primarily related to our common stock offerings in October 2007 (net proceeds of $150.4 million), October 2006 ($266.7 million), May 2006 ($95.0 million) and July 2005 ($97.6 million) and preferred stock offerings in April 2007 ($169.1 million), February 2005 ($99.3 million) and July 2005 ($60.5 million). We obtained mortgage loans for approximately $121.3 million, $347.3 million and $181.0 million for the years ended December 31, 2007, 2006 and 2005, respectively. We issued $172.5 million of Senior Exchangeable Debentures on August 15, 2006.

Minority interest

Minority interests relate to the interests in the Operating Partnership that are not owned by us, which, as of December 31, 2007, amounted to 9.3% of the Operating Partnership common units. In conjunction with our formation, GI Partners received common units in exchange for contributing ownership interests in properties to the Operating Partnership. Also in connection with acquiring certain 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 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 filed 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. GI Partners distributed 4,030,184 Operating Partnership common units to its owners and these units were redeemed for an equal number of shares of our common stock on March 29, 2006.

During the year ended December 31, 2007, GI Partners distributed their remaining 6.5 million Operating Partnership common units to its investors, of which approximately 6.2 million Operating Partnership common units were redeemed in exchange for an equal number of shares of our common stock. These redemptions were recorded as a reduction to minority interest and an increase to common stock and additional paid in capital based on the book value per unit in the accompanying consolidated balance sheet. We did not receive any cash proceeds upon redemption of these Operating Partnership units. As of December 31, 2007, GI Partners no longer has an ownership interest in the Operating Partnership.

During the year ended December 31, 2007, third parties redeemed 265,776 Operating Partnership units for an equal number of shares of our common stock. In addition, employees, former employees and directors converted 609,635 long-term incentive units into an equal number of shares of our common stock. The redemptions and conversions were recorded as a reduction to minority interest and an increase to common stock

 

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and additional paid in capital based on the book value per unit in the accompanying consolidated balance sheet. We did not receive any cash proceeds upon redemption of these Operating Partnership units.

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 Issued But Not Yet Adopted

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurement.(FAS 157). This Statement defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. It clarifies that fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts. This Statement does not require any new fair value measurements, but rather, it provides enhanced guidance to other pronouncements that require or permit assets or liabilities to be measured at fair value. This Statement is effective for fiscal years beginning after November 15, 2007, with earlier adoption permitted. Management is currently evaluating the impact that the adoption of FAS 157 will have on the Company’s consolidated financial position, results of operations and cash flows but currently does not believe it will have a material impact on the Company’s consolidated financial statements, but will result in expanded disclosures on how we measure fair value.

In February 2007, the FASB issued FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115 (FAS 159), which provides all entities with an option to report selected financial assets and liabilities at fair value. The objective of the Statement is to improve financial reporting by providing entities with the opportunity to mitigate volatility in earnings caused by measuring related assets and liabilities differently without having to apply the complex provisions of hedge accounting. Certain specified items are eligible for the irrevocable fair value measurement option as established by FAS 159. FAS 159 is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007 provided the entity also elects to apply the provisions of FAS 157, Fair Value Measurements. We have not elected the option to report on selected financial assets and liabilities at fair value under provisions of FAS 159.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“FAS 141R”), which replaces FASB Statement No. 141. FAS 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any non controlling interest in the acquiree and the goodwill acquired. The Statement also establishes disclosure requirements which will enable users to evaluate the nature and financial effects of the business combination. FAS 141R is effective as of the beginning of an entity’s fiscal year that begins after December 15, 2008, which will be our year beginning January 1, 2009. We are currently evaluating the potential impact, if any, of the adoption of FAS 141R on our consolidated financial statements. Management is currently evaluating the impact that the adoption of FAS 141R will have on the Company’s consolidated financial position, results of operations and cash flows.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statement—amendments of ARB No. 51 (FAS 160).” FAS 160 states that accounting and reporting for minority interests will be recharacterized as noncontrolling interests and classified as a component of equity. The Statement also establishes reporting requirements that provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. FAS 160 applies to all entities that prepare consolidated financial statements, except not-for-profit organizations, but will affect only

 

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those entities that have an outstanding noncontrolling interest in one or more subsidiaries or that deconsolidate a subsidiary. This statement is effective as of the beginning of an entity’s first fiscal year beginning after December 15, 2008, which corresponds to our year beginning January 1, 2009. Management is currently evaluating the impact that the adoption of FAS 160 will have on the Company’s consolidated financial position, results of operations and cash flows.

 

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.

Analysis of debt between fixed and variable rate.

We use interest rate swap agreements and fixed rate debt to reduce our exposure to interest rate movements. As of December 31, 2007, our consolidated debt was as follows (in millions):

 

Debt Summary:

  

Fixed rate

   $ 804.0  

Variable rate—hedged by interest rate swaps

     258.4  
        

Total fixed rate

     1,062.4  

Variable rate—unhedged

     305.3  
        

Total

   $ 1,367.7  
        

Percent of Total Debt:

  

Fixed rate (including swapped debt)

     77.7 %

Variable rate

     22.3 %
        

Total

     100.0 %
        

Effective Interest Rate as of December 31, 2007(1):

  

Fixed rate (including swapped debt)

     5.59 %

Variable rate—unhedged

     6.56 %

Effective interest rate

     5.81 %

 

(1) Excludes impact of deferred financing cost amortization.

Interest rate swaps included in this table and their fair values as of December 31, 2007 were as follows (in thousands):

 

Current Notional
Amount
   

Strike Rate

  

Effective Date

  

Expiration Date

   Fair Value  
$ 97,885     4.025    May 26, 2005    Jun. 15, 2008    $ 167  
  8,564     5.020    Dec. 1, 2006    Dec. 1, 2008      (66 )
  26,229 (1)   4.944    Jul. 10, 2006    Apr. 10, 2011      106  
  15,978 (2)   3.981    May 17, 2006    Jul. 18, 2013      333  
  11,558 (2)   4.070    Jun. 23, 2006    Jul. 18, 2013      192  
  10,170 (2)   3.989    Jul. 27, 2006    Oct. 18, 2013      219  
  47,330 (2)   3.776    Dec. 5, 2006    Jan. 18, 2012      1,072  
  40,692 (2)   4.000    Dec. 20, 2006    Jan. 18, 2012      591  
                      
$ 258,406              $ 2,614  
                      

 

(1) Translation to U.S. dollars is based on exchange rate of $1.99 to £1.00 as of December 31, 2007.
(2) Translation to U.S. dollars is based on exchange rate of $1.46 to €1.00 as of December 31, 2007.

 

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Sensitivity to changes in interest rates.

The following table shows the effect if assumed changes in interest rates occurred:

 

Assumed event

   Interest rate
change
(basis points)
    Change
($ millions)
 

Increase in fair value of interest rate swaps following an assumed 10% increase in interest rates

   45     $ 2.6  

Decrease in fair value of interest rate swaps following an assumed 10% decrease in interest rates

   (45 )     (2.7 )

Increase in annual interest expense on our debt that is variable rate and not subject to swapped interest following a 10% increase in interest rates

   45       1.4  

Decrease in annual interest expense on our debt that is variable rate and not subject to swapped interest following a 10% increase in interest rates

   (45 )     (1.4 )

Increase in fair value of fixed rate debt following a 10% decrease in interest rates

   (45 )     16.9  

Decrease in fair value of fixed rate debt following a 10% increase in interest rates

   45       (15.7 )

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.

Foreign currency forward exchange risk

As of December 31, 2007, we have foreign operations in the United Kingdom, Switzerland, France, Ireland, Canada and The Netherlands and, as such, are subject to risk from the effects of exchange rate movements of foreign currencies, which may affect future costs and cash flows. Our foreign operations are conducted in the Euro, Swiss Francs and the British Pound, except for our Canadian property for which the functional currency is the U.S. dollar. For these currencies we are a net receiver of the foreign currency (we receive more cash then we pay out) and therefore our foreign investments benefit from a weaker U.S. dollar and are adversely affected by a stronger U.S. dollar relative to the foreign currency. For the year ended December 31, 2007, operating revenues from properties outside the United States contributed $34.2 million which represented 8.7% of our operating revenues.

As of December 31, 2007, we have not entered into any foreign currency forward exchange contracts to hedge the effects of adverse fluctuations in foreign currency exchange rates, however, $188.7 million of borrowings under our revolving credit facility are foreign currency denominated borrowings. Prior to January 2006, we were 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.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

     Page No.

Consolidated Financial Statements of Digital Realty Trust, Inc.

  

Management’s Report on Internal Control over Financial Reporting

   64

Report of Independent Registered Public Accounting Firm

   65

Consolidated Balance Sheets as of December 31, 2007 and 2006

   66

Consolidated Statements of Operations for each of the years in the three-year period ended December 31, 2007

   67

Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss) for each of the years in the three-year period ended December 31, 2007

   68

Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 2007

   70

Notes to Consolidated Financial Statements

   72

Supplemental Schedule—Schedule III—Properties and Accumulated Depreciation

   104

Notes to Schedule III—Properties and Accumulated Depreciation

   107

 

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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) and 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, 2007. 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 management concluded that, as of December 31, 2007, 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 the Company’s internal control over financial reporting. This report appears on page 65.

 

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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, 2007 and 2006, and the related consolidated statements of operations, stockholders’ equity and comprehensive income and cash flows for each of the years in the three-year period ended December 31, 2007. In connection with our audits of the consolidated financial statements, we also have audited financial statement schedule III, properties and accumulated depreciation. We have also audited the Company’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these consolidated financial statements and financial statement schedule III, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule III and an opinion on the Company’s internal control over financial reporting 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

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, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Digital Realty Trust, Inc. and subsidiaries as of December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2007 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. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

/s/ KPMG LLP

San Francisco, California

February 28, 2008

 

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DIGITAL REALTY TRUST, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

 

    December 31,
2007
    December 31,
2006
 

ASSETS

   

Investments in real estate:

   

Properties:

   

Land

  $ 316,196     $ 228,728  

Acquired ground leases

    2,790       3,028  

Buildings and improvements

    1,968,850