| DUKE REALTY CORP Item 1A Risk Factors Our operations involve various risks that could adversely affect our financial condition, results of operations, cash flows, ability to pay distribution on our common stock and the market price of our common stock |
| In addition to the other information contained in this Annual Report, you should carefully consider the following risk factors in evaluating an investment in our securities |
| If we were to cease to qualify as a real estate investment trust, we and our shareholders would lose significant tax benefits |
| We intend to continue to operate so as to qualify as a real estate investment trust (a “REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”) |
| Qualification as a REIT provides significant tax advantages to us and our shareholders |
| However, in order for us to continue to qualify as a REIT, we must satisfy numerous requirements established under highly technical and complex Code provisions for which there are only limited judicial and administrative interpretations |
| Satisfaction of these requirements also depends on various factual circumstances not entirely within our control |
| The fact that we hold our assets through an operating partnership and its subsidiaries further complicates the application of the REIT requirements |
| Even a technical or inadvertent mistake could jeopardize our REIT status |
| Although we believe that we can continue to operate so as to qualify as a REIT, we cannot offer any assurance that we can continue to do so or that legislation, new regulations, administrative interpretations or court decisions will not significantly change the qualification requirements or the federal income tax consequences of qualification |
| If we were to fail to qualify as a REIT in any taxable year, it would have the following effects: 5 ______________________________________________________________________ • We would not be allowed a deduction for distributions to shareholders and would be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates; • Unless we were entitled to relief under certain statutory provisions, we would be disqualified from treatment as a REIT for the four taxable years following the year during which we ceased to qualify as a REIT; • Our net earnings available for investment or distribution to our shareholders would decrease due to the additional tax liability for the year or years involved; and • We would no longer be required to make any distributions to shareholders in order to qualify as a REIT As such, failure to qualify as a REIT would likely have a significant adverse effect on the value of our securities |
| Real estate investment trust distribution requirements limit the amount of cash we will have available for other business purposes, including amounts that we need to fund our future growth |
| To maintain our qualification as a REIT under the Code, we must annually distribute to our shareholders at least 90prca of our ordinary taxable income, excluding net capital gains |
| We intend to continue to make distributions to our shareholders to comply with the 90prca distribution requirement |
| However, this requirement limits our ability to accumulate capital for use for other business purposes |
| If we do not have sufficient cash or other liquid assets to meet the distribution requirements, we may have to borrow funds or sell properties on adverse terms in order to meet the distribution requirements |
| If we fail to make a required distribution, we would cease to qualify as a REIT US federal income tax developments could affect the desirability of investing in us for individual taxpayers |
| In May 2003, federal legislation was enacted that reduced the maximum tax rate for dividends payable to individual taxpayers generally from 38dtta6prca to 15prca (from January 1, 2003 through 2008) |
| However, dividends payable by REITs are not eligible for this treatment, except in limited circumstances |
| Although this legislation did not have a direct adverse effect on the taxation of REITs or dividends paid by REITs, the more favorable treatment for non-REIT dividends could cause individual investors to consider investments in non-REIT corporations as more attractive relative to an investment in us as a REIT US federal income tax treatment of REITs and investments in REITs may change, which may result in the loss of our tax benefits of operating as a REIT The present US federal income tax treatment of a REIT and an investment in a REIT may be modified by legislative, judicial or administrative action at any time |
| Revisions in US federal income tax laws and interpretations of these laws could adversely affect us and the tax consequences of an investment in our common shares |
| Our net earnings available for investment or distribution to shareholders could decrease as a result of factors outside of our control |
| Our business is subject to the risks incident to the ownership and operation of commercial real estate, many of which involve circumstances not within our control |
| Such risks include the following: • Changes in the general economic climate; • Increases in interest rates; • Local conditions such as oversupply of property or a reduction in demand; • Competition for tenants; • Changes in market rental rates; • Oversupply or reduced demand for space in the areas where our properties are located; • Delay or inability to collect rent from tenants who are bankrupt, insolvent or otherwise unwilling or unable to pay; • Difficulty in leasing or re-leasing space quickly or on favorable terms; 6 ______________________________________________________________________ • Costs associated with periodically renovating, repairing and reletting rental space; • Our ability to provide adequate maintenance and insurance on our properties; • Our ability to control variable operating costs; • Changes in government regulations; • Changes in interest rate levels; • The availability of financing on favorable terms; and • Potential liability under, and changes in, environmental, zoning, tax and other laws |
| Further, a significant portion of our costs, such as real estate taxes, insurance and maintenance costs and our debt service payments, are generally not reduced when circumstances cause a decrease in cash flow from our properties |
| Many real estate costs are fixed, even if income from properties decreases |
| Our financial results depend on leasing space in our real estate to tenants on terms favorable to us |
| Our income and funds available for distribution to our stockholders will decrease if a significant number of our tenants cannot pay their rent or we are unable to lease properties on favorable terms |
| In addition, if a tenant does not pay its rent, we may not be able to enforce our rights as landlord without delays and we may incur substantial legal costs |
| Costs associated with real estate investment, such as real estate taxes and maintenance costs, generally are not reduced when circumstances cause a reduction in income from the investment |
| Our real estate development activities are subject to risks particular to development |
| We intend to continue to pursue development activities as opportunities arise |
| These development activities generally require various government and other approvals |
| We may not receive the necessary approvals |
| We are subject to the risks associated with development activities |
| These risks include: • Unsuccessful development opportunities could result in direct expenses to us; • Construction costs of a project may exceed original estimates, possibly making the project less profitable than originally estimated, or possibly unprofitable; • Time required to complete the construction of a project or to lease up the completed project may be greater than originally anticipated, thereby adversely affecting our cash flow and liquidity; • Occupancy rates and rents of a completed project may not be sufficient to make the project profitable; and • Favorable sources to fund our development activities may not be available |
| We are exposed to risks associated with entering new markets |
| We consider entering new markets from time to time |
| The construction and/or acquisition of properties in new markets involves risks, including the risk that the property will not perform as anticipated and the risk that any actual costs for rehabilitation, repositioning, renovation and improvements identified in the pre-construction or pre-acquisition due diligence process will exceed estimates |
| There is, and it is expected that there will continue to be, significant competition for investment opportunities that meet our investment criteria as well as risks associated with obtaining financing for acquisition activities, if necessary |
| We may be unsuccessful in operating completed real estate projects |
| We face the risk that the real estate projects we develop or acquire will not perform in accordance with our expectations |
| This risk exists because of factors such as the following: • Prices paid for acquired facilities are based upon a series of market judgments; and • Costs of any improvements required to bring an acquired facility up to standards to establish the market position intended for that facility might exceed budgeted costs |
| Further, we can give no assurance that acquisition targets meeting our guidelines for quality and yield will be available when we seek them |
| 7 ______________________________________________________________________ We are exposed to the risks of defaults by tenants |
| Any of our tenants may experience a downturn in their businesses that may weaken their financial condition |
| In the event of default or the insolvency of a significant number of our tenants, we may experience a substantial loss of rental revenue and/or delays in collecting rent and incur substantial costs in enforcing our rights as landlord |
| If a tenant files for bankruptcy protection, a court could allow the tenant to reject and terminate its lease with us |
| Our income and distributable cash flow would be adversely affected if a significant number of our tenants became unable to meet their obligations to us, became insolvent or declared bankruptcy |
| We may be unable to renew leases or relet space |
| When our tenants decide not to renew their leases upon their expiration, we may not be able to relet the space |
| Even if our tenants do renew or we are able to relet the space, the terms of renewal or reletting (including the cost of renovations, if necessary) may be less favorable than current lease terms |
| If we are unable to promptly renew the leases or relet the space, or if the rental rates upon such renewal or reletting are significantly lower than current rates, then our income and distributable cash flow would be adversely affected, especially if we were unable to lease a significant amount of the space vacated by tenants in our properties |
| Our insurance coverage on our properties may be inadequate |
| We maintain comprehensive insurance on each of our facilities, including property, liability, fire, flood and extended coverage |
| We believe this coverage is of the type and amount customarily obtained for real property |
| However, there are certain types of losses, generally of a catastrophic nature, such as earthquakes, hurricanes and floods or acts of war or terrorism that may be uninsurable or not economically insurable |
| We use our discretion when determining amounts, coverage limits and deductibles for insurance |
| These terms are determined based on retaining an acceptable level of risk at a reasonable cost |
| This may result in insurance coverage that in the event of a substantial loss would not be sufficient to pay the full current market value or current replacement cost of our lost investment |
| Inflation, changes in building codes and ordinances, environmental considerations and other factors also may make it unfeasible to use insurance proceeds to replace a facility after it has been damaged or destroyed |
| Under such circumstances, the insurance proceeds we receive may not be adequate to restore our economic position in a property |
| If an insured loss occurred, we could lose both our investment in and anticipated profits and cash flow from a property, and we would continue to be obligated on any mortgage indebtedness or other obligations related to the property |
| Although we believe our insurance is with highly rated providers, we are also subject to the risk that such providers may be unwilling or unable to pay our claims when made |
| Acquired properties may expose us to unknown liability |
| From time to time, we may acquire properties subject to liabilities and without any recourse, or with only limited recourse, with respect to unknown liabilities |
| As a result, if a liability were asserted against us based upon ownership of those properties, we might have to pay substantial sums to settle or contest it, which could adversely affect our results of operations and cash flow |
| Unknown liabilities with respect to acquired properties might include: • liabilities for clean-up of undisclosed environmental contamination; • claims by tenants, vendors or other persons against the former owners of the properties; • liabilities incurred in the ordinary course of business; and • claims for indemnification by general partners, directors, officers and others indemnified by the former owners of the properties |
| 8 ______________________________________________________________________ We could be exposed to significant environmental liabilities as a result of conditions of which we currently are not aware |
| As an owner and operator of real property, we may be liable under various federal, state and local laws for the costs of removal or remediation of certain hazardous substances released on or in our property |
| Such laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the release of the hazardous substances |
| In addition, we could have greater difficulty in selling real estate on which hazardous substances were present or in obtaining borrowings using such real estate as collateral |
| It is our general policy to have Phase I environmental audits performed for all of our properties and land by qualified environmental consultants |
| These Phase I environmental audits have not revealed any environmental liability that would have a material adverse effect on our business |
| However, a Phase I environmental audit does not involve invasive procedures such as soil sampling or ground water analysis, and we cannot be sure that the Phase I environmental audits did not fail to reveal a significant environmental liability or that a prior owner did not create a material environmental condition on our properties or land which has not yet been discovered |
| We could also incur environmental liability as a result of future uses or conditions of such real estate or changes in applicable environmental laws |
| Certain of our officers and directors hold units in our operating partnership and may not have the same interests as our shareholders with regard to certain tax matters |
| Certain of our officers and directors own limited partnership units in our operating partnership, Duke Realty Limited Partnership |
| Owners of limited partnership units may suffer adverse tax consequences upon the sale of certain of our properties, the refinancing of debt related to those properties or in the event we are the subject of a tender offer or merger |
| As such, owners of limited partnership units, including certain of our officers and directors, may have different objectives regarding the appropriateness of the pricing and timing of these transactions |
| Though we are the sole general partner of the operating partnership and have the exclusive authority to sell all of our wholly-owned properties or to refinance such properties, officers and directors who hold limited partnership units may influence us not to sell or refinance certain properties even if such sale may be financially advantageous to our shareholders |
| Adverse tax consequences may also influence the decisions of these officers and directors in the event we are the subject of a tender offer or merger |
| We do not have exclusive control over our joint venture investments |
| We have interests in joint ventures and partnerships and may in the future conduct business through joint ventures and partnerships |
| For example, co-investors or partners may become bankrupt or have business interests or goals inconsistent with ours |
| Further, our co-investors or partners may be in a position to take action contrary to our instructions and our interests, including action that may jeopardize our qualification as a REIT Our use of debt financing could have a material adverse effect on our financial condition |
| We are subject to the risks normally associated with debt financing, including the risk that our cash flow will be insufficient to meet required principal and interest payments and the risk that we will be unable to refinance our existing indebtedness, or that the terms of such refinancing will not be as favorable as the terms of our existing indebtedness |
| If our debt cannot be paid, refinanced or extended, we may not be able to make distributions to shareholders at expected levels or at all |
| Further, if prevailing interest rates or other factors at the time of a refinancing result in higher interest rates or other restrictive financial covenants upon the refinancing, then such refinancing would adversely affect our cash flow and funds available for operation, development and distribution |
| We are also subject to financial covenants under our existing debt instruments |
| Should we fail to comply with the covenants in our existing debt instruments, then we would not only be in breach under the applicable debt instruments but we would also likely be unable to borrow any further amounts under these instruments, which could adversely affect our ability to fund operations |
| We also have incurred and may incur in the future indebtedness that bears interest at variable rates |
| Thus, as market interest rates increase, so will our debt expense, affecting our cash flow and our ability to make distributions to shareholders |
| 9 ______________________________________________________________________ We are subject to various financial covenants under existing credit agreements |
| The terms of our various credit agreements and other indebtedness require that we comply with a number of customary financial and other covenants, such as maintaining debt service coverage and leverage ratios and maintaining insurance coverage |
| These covenants may limit our flexibility in our operations, and breaches of these covenants could result in defaults under the instruments governing the applicable indebtedness even if we have satisfied our payment obligations |
| If we are unable to refinance our indebtedness at maturity or meet our payment obligations, the amount of our distributable cash flow would be adversely affected |
| We are subject to certain provisions that could discourage change-of-control transactions, which may reduce the likelihood of our shareholders receiving a control premium for their shares |
| Indiana anti-takeover legislation and certain provisions in our governing documents, as we discuss below, may discourage potential acquirers from pursuing a change-of-control transaction with us |
| As a result, our shareholders may be less likely to receive a control premium for their shares |
| Unissued Preferred Stock |
| Our charter permits our board of directors to classify unissued preferred stock by setting the rights and preferences of the shares at the time of issuance |
| This power enables our board to adopt a shareholder rights plan, also known as a poison pill |
| Although we have repealed our previously existing poison pill and our current board of directors has adopted a policy not to issue preferred stock as an anti-takeover measure, our board can change this policy at any time |
| The adoption of a poison pill would discourage a potential bidder from acquiring a significant position in the company without the approval of our board |
| Business-Combination Provisions of Indiana Law |
| We have not opted out of the business-combination provisions of the Indiana Business Corporation Law |
| As a result, potential bidders may have to negotiate with our board of directors before acquiring 10prca of our stock |
| Without securing board approval of the proposed business combination before crossing the 10prca ownership threshold, a bidder would not be permitted to complete a business combination for five years after becoming a 10prca shareholder |
| Even after the five-year period, a business combination with the significant shareholder would require a “fair price” as defined in the Indiana Business Corporation Law or the approval of a majority of the disinterested shareholders |
| We have not opted out of the provisions of the Indiana Business Corporation Law regarding acquisitions of control shares |
| Therefore, those who acquire a significant block (at least 20prca) of our shares may only vote a portion of their shares unless our other shareholders vote to accord full voting rights to the acquiring person |
| Moreover, if the other shareholders vote to give full voting rights with respect to the control shares and the acquiring person has acquired a majority of our outstanding shares, the other shareholders would be entitled to special dissenters’ rights |
| Our charter prohibits business combinations or significant disposition transactions with a holder of 10prca of our shares unless: • The holders of 80prca of our outstanding shares of capital stock approve the transaction; • The transaction has been approved by three-fourths of those directors who served on the board before the shareholder became a 10prca owner; or • The significant shareholder complies with the “fair price” provisions of our charter |
| Among the transactions with large shareholders requiring the supermajority shareholder approval are dispositions of assets with a value of dlra1cmam000cmam000 and business combinations |
| Operating Partnership Provisions |
| The limited partnership agreement of the Operating Partnership contains provisions that could discourage change-of-control transactions, including a requirement that holders of at least 90prca of the outstanding partnership units held by us and other unit holders approve: 10 ______________________________________________________________________ • Any voluntary sale, exchange, merger, consolidation or other disposition of all or substantially all of the assets of the Operating Partnership in one or more transactions other than a disposition occurring upon a financing or refinancing of the Operating Partnership; • Our merger, consolidation or other business combination with another entity unless after the transaction substantially all of the assets of the surviving entity are contributed to the Operating Partnership in exchange for units; • Our transfer of our interests in the Operating Partnership other than to one of our wholly owned subsidiaries; and • Any reclassification or recapitalization or change of outstanding shares of our common stock other than certain changes in par value, stock splits, stock dividends or combinations |
| We are dependent on key personnel |
| Our executive officers and other senior officers have a significant role in the success of our Company |
| Our ability to retain our management group or to attract suitable replacements should any members of the management group leave our Company is dependent on the competitive nature of the employment market |
| The loss of services from key members of the management group or a limitation in their availability could adversely impact our financial condition and cash flow |
| Further, such a loss could be negatively perceived in the capital markets |