| PAN PACIFIC RETAIL PROPERTIES INC ITEM 1A RISK FACTORS You should carefully consider the risks described below as well as the risks described elsewhere in this report, which risks are incorporated by reference into this section, before making an investment decision regarding our company |
| The risks and uncertainties described herein are not the only ones facing us and there may be additional risks that we do not presently know of or that we currently consider not likely to have a significant impact |
| All of these risks could adversely affect our business, financial condition, results of operations and cash flows |
| There are Certain Risks Inherent to Investment in Real Estate |
| Real property investments are subject to varying degrees of risk |
| The yields available from equity investments in real estate depend in large part on the amount of income generated and expenses incurred |
| If our properties do not generate revenue sufficient to meet operating expenses, including debt service, tenant improvements, leasing commissions and other capital expenditures, we may have to borrow additional amounts to cover fixed costs |
| This would adversely affect our cash flow and ability to service our debt and make distributions to our stockholders |
| 4 ______________________________________________________________________ [32]Table of Contents Our revenue and the value of our properties may be adversely affected by a number of factors, including: • the national economic climate; • the local economic climate; • local real estate conditions; • changes in retail expenditures by consumers; • the perceptions of prospective tenants of the attractiveness of the properties; • the success of our anchor tenants; • our ability to manage and maintain the properties and secure adequate insurance; • our ability to collect rent from our tenants; • increases in operating costs (including real estate taxes, insurance and utilities); • inability to finance property development and acquisitions on favorable terms; and • natural disasters, future acts of terrorism or war or risk of war |
| In addition, real estate values and income from properties are also affected by factors such as applicable laws, including tax laws, interest rate levels and the availability of financing |
| We will be subject to the risks that, upon expiration or termination, leases may not be renewed, the space may not be relet or the terms of renewal or reletting (including the cost of required renovations) may be less favorable than current lease terms |
| Leases covering a total of approximately 8dtta5prca and 57dtta5prca of the leased gross leasable area, or GLA, of our properties will expire through the end of 2006 and 2010, respectively |
| We budget for renovation and reletting expenses, which takes into consideration our view of both the current and expected market conditions in the geographic regions in which our properties are located, but budgeted amounts may be insufficient to cover these costs |
| Our cash flow and ability to make expected distributions to stockholders could be adversely affected, if: • we are unable to promptly relet or renew leases for all or a substantial portion of this space; • the rental rates upon renewal or reletting are significantly lower than expected; or • our budgeted amounts for these purposes prove inadequate |
| As of December 31, 2005, we have 43 properties with total GLA of 5cmam762cmam000 square feet located in Northern California, 38 properties with total GLA of 7cmam486cmam000 square feet located in Southern California, 21 properties with total GLA of 3cmam414cmam000 square feet located in Oregon, 16 properties with total GLA of 2cmam673cmam000 square feet located in Washington and 15 properties with total GLA of 2cmam472cmam000 square feet located in Nevada |
| To the extent that general economic or other relevant conditions in these regions decline and result in a decrease in consumer demand in these regions, the results of our operations may be adversely affected |
| We May Not be Able to Respond Quickly to Changing Market Conditions Due to the Illiquidity of Real Estate |
| Equity real estate investments are relatively illiquid |
| This illiquidity limits our ability to adjust our portfolio promptly in response to changes in economic or other conditions |
| In addition, the Internal Revenue Code limits a REIT’s ability to sell properties held for fewer than four years, which may limit our ability to sell our properties at optimal times and for the highest price |
| There are numerous commercial developers and real estate companies that compete with us in seeking tenants for properties, properties for acquisition and land for development |
| There are numerous shopping facilities that compete with our properties in attracting retailers to lease space |
| In addition, retailers at our properties face increasing competition from outlet stores, discount shopping clubs, and other forms of marketing of goods, such as direct mail, internet marketing and telemarketing |
| This competition may reduce properties available for acquisition or development, reduce percentage rents payable to us and may, through the introduction of competition, contribute to lease defaults or insolvency of tenants |
| Thus, competition could materially affect our ability to generate net income, service our debt and make distributions to our stockholders |
| Compliance with Changes in Laws May Result in Significant Unexpected Expenditures |
| Because increases in income, service or transfer taxes are generally not passed through to tenants under leases, these increases may adversely affect our cash flow and our ability to service our debt and make distributions to stockholders |
| Our properties are also subject to various federal, state and local regulatory requirements, such as requirements of the Americans with Disabilities Act of 1990 and state and local fire and life safety requirements |
| Failure to comply with these requirements could result in the imposition of fines by governmental authorities or awards of damages to private litigants |
| In addition, these requirements may not be changed and new requirements may be imposed that would require significant unanticipated expenditures by us |
| Any of these events could adversely affect our cash flow and expected distributions |
| We Rely on Certain Tenants and Anchors and the Closing of One or More Anchor-Occupied Store Could Adversely Affect that Property, Resulting in Lease Terminations and Reductions in Rent |
| Our income and funds from operations could be adversely affected in the event of the bankruptcy or insolvency, or a downturn in the business, of any anchor store, or if any anchor tenant does not renew its lease when it expires |
| If tenant sales at our properties were to decline, tenants might be unable to pay their rent or other occupancy costs |
| In addition, the closing of one or more anchor-occupied stores or lease termination by one or more anchor tenants of a shopping center, whose leases may permit termination or as a result of bankruptcy or insolvency, could adversely impact that property and result in lease terminations or reductions in rent by other tenants, whose leases may permit termination or rent reduction in those circumstances |
| This could adversely affect our ability to re-lease the space that is vacated |
| Each of these developments could adversely affect our funds from operations and our ability to service our debt and make expected distributions to stockholders |
| For the year ended December 31, 2005 our annualized base rent attributable to anchor tenants was 38dtta5prca of our total annualized base rent |
| There is a Lack of Operating History With Respect to Our Recent Acquisition and Development of Properties and We May Not Succeed in the Integration or Management of Additional Properties |
| At December 31, 2005, we owned and operated 138 properties, consisting of approximately 22dtta5 million square feet of space |
| Fifty-three of our properties were acquired during 2000, primarily through the acquisition of Western |
| These properties, together with other individual acquisitions and the 31 properties which we acquired in 2003 in connection with our acquisition of Center Trust, some of which have been sold, may have characteristics or deficiencies currently unknown to us that affect their value or revenue potential |
| It is also possible that the operating performance of these properties may decline under our management |
| As we acquire additional properties, we will be subject to risks associated with managing new properties, including lease-up and tenant retention |
| In addition, our ability to manage our growth effectively will require us to successfully integrate our new acquisitions into our existing management structure |
| We may not succeed with this integration or effectively manage additional properties |
| We are subject to risks normally associated with debt financing, including: • the risk that our cash flow will be insufficient to meet required payments of principal and interest; • the risk that existing indebtedness on our properties (which in all cases will not have been fully amortized at maturity) will not be able to be refinanced; or • the terms of any refinancing will not be as favorable as the terms of existing indebtedness |
| 6 ______________________________________________________________________ [34]Table of Contents At December 31, 2005, we had outstanding indebtedness of approximately dlra1cmam088cmam540cmam000 |
| Since we anticipate that only a small portion of the principal of the indebtedness will be repaid prior to maturity, and that we will not have funds on hand sufficient to repay the balance of the indebtedness in full at maturity, it will be necessary for us to refinance the debt either through additional borrowings or equity or debt offerings |
| If principal payments due at maturity cannot be refinanced, extended or paid with proceeds of other capital transactions, we expect that our cash flow will not be sufficient in all years to pay distributions at expected levels and to repay all of this maturing debt |
| Also, if prevailing interest rates or other factors at the time of refinancing (such as the reluctance of lenders to make commercial real estate loans) result in higher interest rates upon refinancing, the interest expense relating to refinanced indebtedness would increase |
| This could adversely affect our cash flow and our ability to make expected distributions to our stockholders |
| In addition, if we are unable to refinance the indebtedness on acceptable terms, we might dispose of properties upon disadvantageous terms, which might result in losses to us and might adversely affect funds available for distribution to stockholders |
| At December 31, 2005, we had approximately dlra390cmam132cmam000 of mortgage financing and property level bonds |
| The payment and other obligations under certain of the mortgage financing is secured by cross-collateralized and cross-defaulted first mortgage liens in the aggregate amount of approximately dlra50cmam773cmam000 on four properties, dlra49cmam457cmam000 on four other properties, dlra48cmam791cmam000 on four other properties, dlra40cmam461cmam000 on three properties, dlra15cmam172cmam000 on three other properties and dlra30cmam924cmam000 on two properties (the obligations on these two properties were subsequently paid off in January 2006) |
| If we are unable to meet our obligations under the mortgage financing, the properties securing that debt could be foreclosed upon |
| This could have a material adverse effect on us and our ability to make expected distributions and could threaten our continued viability |
| Rising Interest Rates on Our Variable-Rate Debt Could Negatively Impact our Financial Results |
| Advances under our revolving credit agreement bear variable-rate interest, at our option, at either LIBOR plus 0dtta65prca or a reference rate |
| At December 31, 2005, the amount drawn under our revolving credit agreement was dlra44cmam500cmam000 and the interest rate was 5dtta10prca |
| Increases in interest rates on that indebtedness would increase our interest expense, which could adversely affect our cash flow and our ability to service our debt and pay expected distributions to stockholders |
| Commencing with our taxable year ended December 31, 1997, we believe that we have qualified as a REIT under the Internal Revenue Code |
| We have not requested and do not plan to request a ruling from the IRS that we qualify as a REIT, and the statements in the Form 10-K are not binding on the IRS or any court |
| We can give no assurance that we have qualified or will continue to quality as a REIT for tax purposes |
| Qualification as a REIT involves the satisfaction of numerous requirements (some on an annual and some on a quarterly basis) established under highly technical and complex Internal Revenue Code provisions for which there are only limited judicial and administrative interpretations |
| These requirements involve the determination of various facts and circumstances not entirely within our control |
| Legislation, new regulations, administrative interpretations or court decisions may adversely affect, possibly retroactively, our ability to qualify as a REIT or the federal income tax consequences of such qualification |
| If we fail to qualify as a REIT in any taxable year, among other things: • we will not be allowed a deduction for distributions to stockholders in computing our taxable income; • we will be subject to federal income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates; • we will be subject to increased state and local taxes; • we will be disqualified from treatment as a real estate investment trust for the four taxable years following the year during which we lost our qualification (unless entitled to relief under certain statutory provisions); • distributions to stockholders would be subject to tax as ordinary corporate distributions; and • we would not be required to make distributions to stockholders |
| 7 ______________________________________________________________________ [35]Table of Contents As a result of these factors, our failure to qualify as a real estate investment trust also could impair our ability to expand our business and raise capital, could substantially reduce the funds available for distribution to our stockholders and could reduce the trading price of our common stock |
| We are Subject to Certain Distribution Requirements Which Could Require Us to Borrow on a Short-Term Basis |
| To maintain our status as a REIT for federal income tax purposes, we generally are required to distribute to our stockholders at least 90prca of our REIT taxable income determined without regard to the dividends paid deduction and by excluding net capital gains each year |
| We also are subject to tax at regular corporate rates to the extent that we distribute less than 100prca of our REIT taxable income (including net capital gains) each year |
| At least 95prca of our gross income in any year must be derived from qualifying sources, and we must satisfy a number of requirements regarding the composition of our assets |
| In addition, we are subject to a 4prca nondeductible excise tax on the amount, if any, by which certain distributions we pay, with respect to any calendar year, are less than the sum of 85prca of our ordinary income for that calendar year, 95prca of our capital gain net income for the calendar year, and any amount of that income that was not distributed in prior years |
| We intend to continue to make distributions to our stockholders to comply with the distribution requirements of the Internal Revenue Code and to reduce exposure to federal income taxes and the nondeductible excise tax |
| Differences in timing between the receipt of income and the payment of expenses in arriving at taxable income and the effect of required debt amortization payments could require us to borrow funds to meet the distribution requirements that are necessary to achieve the tax benefits associated with qualifying as a REIT Acquisition and Development Investments May Not Perform as Expected |
| We intend to continue acquiring, developing and redeveloping shopping center properties |
| Acquisitions of retail properties entail risks that investments will fail to perform as expected |
| Estimates of development costs and costs of improvements, to bring an acquired property up to standards established for the market position intended for that property, may prove inaccurate |
| We intend to expand or renovate our properties from time to time |
| Expansion and renovation projects generally require expenditure of capital as well as various government and other approvals, which we may not receive |
| While our policies with respect to expansion and renovation activities are intended to limit some of the risks otherwise associated with such activities, we will still incur certain risks, including expenditures of funds on, and devotion of management’s time to, projects that may not be completed |
| We intend to renovate properties only to the extent necessary to keep the properties in good working order |
| These renovations generally involve minor as-needed projects such as painting and landscaping |
| We anticipate that future acquisitions, development and renovations will be financed through a combination of advances under our revolving credit agreement and other forms of secured or unsecured financing |
| If new developments are financed through construction loans, there is a risk that, upon completion of construction, permanent financing for newly developed properties may not be available or may be available only on disadvantageous terms |
| It is possible that we will expand our business to new geographic markets in the future |
| We will not initially possess the same level of familiarity with new markets outside of the geographic areas in which our properties are currently located |
| This could adversely affect our ability to acquire, develop, manage or lease properties in any new localities |
| We also intend to develop and construct shopping centers in accordance with our business and growth strategies |
| Risks associated with our development and construction activities may include: • abandonment of development opportunities; • construction costs of a property exceeding original estimates, possibly making the property uneconomical; • occupancy rates and rents at a newly completed property may not be sufficient to make the property profitable; • delay or refusal in obtaining all necessary zoning, land use, building occupancy and other government permits and authorizations; 8 ______________________________________________________________________ [36]Table of Contents • financing may not be available at all or on favorable terms for development of a property; and • construction and lease-up may not be completed on schedule, resulting in increased debt service expense and construction costs |
| In addition, new development activities, regardless of whether they would ultimately be successful, typically require a substantial portion of management’s time and attention |
| Development activities would also be subject to risks relating to our inability to obtain, or delays in obtaining, all necessary zoning, land use, building, occupancy, and other required governmental permits and authorizations |
| We are required to comply with federal, state and local laws, ordinances and regulations regarding health and safety and the protection of the environment |
| Under various federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real estate may be required to investigate and clean up hazardous or toxic substances or petroleum product releases at the property |
| A current or previous owner or operator may also be held liable to a governmental entity or to third parties for property damage and for investigation and clean-up costs incurred by these parties in connection with any such contamination |
| These laws typically impose clean-up responsibility and liability without regard to fault or whether the owner knew of or caused the presence of the contaminants |
| Liability under these laws may still be imposed even when the contaminants were associated with previous owners or operators and the liability under these laws has been interpreted to be joint and several, unless the harm is divisible and there is a reasonable basis for allocation of responsibility |
| The costs of investigation, remediation or removal of these substances may be substantial, and the presence of these substances, or the failure to properly remediate the contamination on the property, may adversely affect the owner’s ability to sell or rent the property or to borrow using the property as collateral |
| The presence of contamination at a property can impair the value of the property even if the contamination is migrating onto the property from an adjoining property |
| A current or previous owner or operator who arranges for the disposal or treatment of hazardous or toxic substances at a disposal or treatment facility may be held liable for the costs of removal or remediation of a release of hazardous or toxic substances at the disposal or treatment facility if a leak or contamination is discovered at the disposal or treatment facility, whether or not the facility is owned or operated by them |
| In addition, some environmental laws create a lien on the contaminated site in favor of the government for damages and costs incurred in connection with the contamination |
| The remedy to remediate contamination may include deed restriction or institutional control which can restrict how the property may be used |
| Finally, the owner of a site may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination stemming from the site, including toxic tort claims |
| Some federal, state and local laws, regulations and ordinances govern the removal, encapsulation or disturbance of asbestos containing materials, or ACMs, when these materials are in poor condition or in the event of construction, remodeling, renovation or demolition of a building |
| In connection with our ownership and operation of our properties, we may be potentially liable for ACM related costs |
| The presence of hazardous substances on or under a property may adversely affect our ability to sell that property and we may incur substantial remediation costs |
| Although our leases generally require our tenants to operate in compliance with all applicable federal, state and local laws, ordinance and regulations and to indemnify us against any environmental liabilities arising from the tenant’s activities on the property, we could nevertheless be subject to strict liability by virtue of our ownership interest, and there can be no assurance that our tenants would satisfy their indemnification obligations under the leases |
| The discovery of environmental liabilities attached to our properties could have a material adverse effect on our results of operations or financial condition or our ability to make distributions to stockholders |
| Shopping centers may have businesses such as dry cleaners and auto repair or servicing businesses that handle, store and generate small quantities of hazardous wastes |
| The operation may result in spills or releases that may result in soil or groundwater contamination |
| Independent environmental consultants have conducted or updated Phase I Environmental Site Assessments at our properties in conformance with the scope and limitations of the American Society of Testing and Materials Practice E1527, Standard Practice for Environmental Site Assessments: Phase I Environmental Site Assessment Process |
| These Phase I Assessments have included, among other things, a 9 ______________________________________________________________________ [37]Table of Contents visual inspection of our properties and the surrounding area and a review of relevant state, federal and historical documents |
| When recommended in the Phase I Assessments, we have conducted Phase II subsurface investigations in conformance with American Society of Testing and Materials Guide E1903, Standard Guide for Environmental Site Assessments: Phase II Environmental Site Assessment Process |
| The Phase I and Phase II investigations of our properties have not revealed any environmental liability that we believe would have a material adverse effect on our business, assets or results of operations taken as a whole, nor are we aware of any material environmental liability |
| It is still possible that our Phase I and Phase II investigations have not revealed all environmental liabilities or that there are material environmental liabilities of which we are unaware |
| Moreover, future laws, ordinances or regulations may impose material environmental liability and the current environmental condition of our properties may be affected by tenants, by the condition of land or operations in the vicinity of our properties, such as the presence of underground storage tanks, or by third parties unrelated to us |
| While we believe we are in substantial compliance with applicable federal, state and local laws, ordinances and regulations regarding health and safety and the protection of the environment, we cannot assure you that environmental matters will not rise in the future at properties where no problem is currently known to us |
| There is No Limitation on Amount of Indebtedness We May Incur Which Could Increase the Risk of Default on Our Indebtedness |
| Our total market capitalization at December 31, 2005 was approximately dlra3cmam852cmam490cmam000, based on the market closing price of our common stock at December 31, 2005 of dlra66dtta89 per share (assuming the conversion of 619cmam755 operating subsidiary units to common stock) and our debt outstanding of approximately dlra1cmam088cmam540cmam000 (exclusive of accounts payable and accrued expenses) |
| At December 31, 2005, our debt to total market capitalization ratio was approximately 28dtta3prca (assuming the conversion of all operating subsidiary units) |
| We currently have a board of directors approved policy of incurring debt only if upon incurrence the debt to total market capitalization ratio would be 50prca or less |
| It should be noted, however, that our organizational documents do not contain any limitation on the amount of indebtedness we may incur |
| Accordingly, our board of directors could alter or eliminate this policy |
| If this policy were changed, we could become more highly leveraged, resulting in an increase in debt service that could adversely affect our cash flow and, consequently, reduce the amount available for distribution to stockholders |
| This could also increase the risk of default on our indebtedness |
| We carry comprehensive liability, public area liability, fire, earthquake, flood, boiler and machinery, extended coverage and rental loss insurance covering our properties, with policy specifications and insured limits that we believe are adequate and appropriate under the circumstances |
| There are, however, certain types of losses that are not generally insured because it is not economically feasible to insure against these losses |
| If an uninsured loss or a loss exceeding insured limits occurs, we could lose our capital invested in the property, as well as the anticipated future revenue from the property |
| In the case of debt which is with recourse to us, we would remain obligated for any mortgage debt or other financial obligations related to the property |
| In these circumstances, any loss would adversely affect us |
| We May be Subject to Tax Upon Disposition of Properties with Built-In Gain |
| In connection with our formation in 1997, certain entities taxable as “C” corporations were merged either into us or into our subsidiaries which qualified as “qualified REIT subsidiaries” |
| Certain of these entities held 13 properties with “built-in gain” at the time the entities were merged into us or into our subsidiaries |
| During 2002, Oregon Real Estate Services, Inc, a “C” corporation, was merged into us |
| was merged into us, it held 10 properties and land with “built-in gain” |
| A property has “built-in gain” if (i) on the day it was acquired, the former owner’s tax basis in the property was less than the property’s fair market value, and (ii) it was acquired in a transaction in which our tax basis in the property was determined by reference to the former owner’s tax basis in the property |
| Under the applicable Treasury Regulations, if these properties are sold within 10 years of the date we acquired them, we may be required to pay taxes on the built-in gain that would have been realized if the merging “C” corporation had liquidated on the day before the date of the merger |
| Therefore, we may have less flexibility in determining whether or not to dispose of these properties |
| If we desire to dispose of these properties at some future date within the 10 year periods, we may be subject to tax on the built-in gain |
| Future Acts of Terrorism, War, Risk of War or Natural Disasters May Have a Negative Impact on Our Business |
| The continued threat of terrorism and continued military action and heightened security measures in response to this threat may cause significant disruption to commerce |
| There can be no assurance that the armed hostilities will not escalate or that these terrorist attacks, or the United States’ responses to them, will not lead to further acts of terrorism and civil disturbances, which may further contribute to economic instability |
| Any civil unrest, additional terrorist activities, or continued armed conflict and the attendant political instability and societal disruption, may adversely affect our results of operations, financial condition, the ability to raise capital or our future growth |
| In addition, natural disasters such as major floods, hurricanes and earthquakes could also adversely impact our business and operating results |
| 10 ______________________________________________________________________ [38]Table of Contents Ownership of Partnership Interest Could Jeopardize Our Status as a REIT We have direct or indirect control of certain partnerships in which we are a partner and intend to continue to operate them in a manner consistent with the requirements for qualification as a real estate investment trust |
| If a partnership in which we own an interest takes or expects to take actions which could jeopardize our status as a REIT or require us to pay tax, we may be forced to dispose of our interest in that entity |
| In addition, it is possible that a partnership could take an action which could cause us to fail a REIT income or asset test, and that we would not become aware of such action in a time frame which would allow us to dispose of our interest in the partnership or take other corrective action on a timely basis |
| In such a case, we could fail to qualify as a REIT |